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EX-32 - EXHIBIT 32 - ISABELLA BANK Corpisba_20160930xex32.htm
EX-31.B - EXHIBIT 31.B - ISABELLA BANK Corpisba_20160930xex31b.htm
EX-31.A - EXHIBIT 31.A - ISABELLA BANK Corpisba_20160930xex31a.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ý
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2016
or
¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File Number: 0-18415
 
Isabella Bank Corporation
(Exact name of registrant as specified in its charter)
 
Michigan
 
38-2830092
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
 
401 N. Main St, Mt. Pleasant, MI
 
48858
(Address of principal executive offices)
 
(Zip code)
(989) 772-9471
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ý  Yes    ¨  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ý  Yes    ¨  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
 
¨
 
Accelerated filer
 
ý
 
 
 
 
 
Non-accelerated filer
 
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     ¨  Yes    ý  No
The number of common shares outstanding of the registrant’s Common Stock (no par value) was 7,831,272 as of November 4, 2016.



ISABELLA BANK CORPORATION
QUARTERLY REPORT ON FORM 10-Q

2


Forward Looking Statements
This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward looking statements to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, and are included in this statement for purposes of these safe harbor provisions. Forward looking statements, which are based on certain assumptions and describe future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, monetary and fiscal policy, the quality or composition of the loan or investment portfolios, demand for loan products, fluctuation in the value of collateral securing our loan portfolio, deposit flows, competition, demand for financial services in our market area, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward looking statements and undue reliance should not be placed on such statements. Further information concerning our business, including additional factors that could materially affect our financial results, is included in our filings with the SEC.
Glossary of Acronyms and Abbreviations
The acronyms and abbreviations identified below may be used throughout this Quarterly Report on Form 10-Q, or in our other SEC filings. You may find it helpful to refer back to this page while reading this report.
AFS: Available-for-sale
 
GAAP: U.S. generally accepted accounting principles
ALLL: Allowance for loan and lease losses
 
GLB Act: Gramm-Leach-Bliley Act of 1999
AOCI: Accumulated other comprehensive income
 
IFRS: International Financial Reporting Standards
ASC: FASB Accounting Standards Codification
 
IRR: Interest rate risk
ASU: FASB Accounting Standards Update
 
ISDA: International Swaps and Derivatives Association
ATM: Automated Teller Machine
 
JOBS Act: Jumpstart our Business Startups Act
BHC Act: Bank Holding Company Act of 1956
 
LIBOR: London Interbank Offered Rate
CFPB: Consumer Financial Protection Bureau
 
N/A: Not applicable
CIK: Central Index Key
 
N/M: Not meaningful
CRA: Community Reinvestment Act
 
NASDAQ: NASDAQ Stock Market Index
DIF: Deposit Insurance Fund
 
NASDAQ Banks: NASDAQ Bank Stock Index
DIFS: Department of Insurance and Financial Services
 
NAV: Net asset value
Directors Plan: Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors
 
NOW: Negotiable order of withdrawal
Dividend Reinvestment Plan: Isabella Bank Corporation Stockholder Dividend Reinvestment Plan and Employee Stock Purchase Plan
 
NSF: Non-sufficient funds
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
 
OCI: Other comprehensive income (loss)
ESOP: Employee Stock Ownership Plan
 
OMSR: Originated mortgage servicing rights
Exchange Act: Securities Exchange Act of 1934
 
OREO: Other real estate owned
FASB: Financial Accounting Standards Board
 
OTTI: Other-than-temporary impairment
FDI Act: Federal Deposit Insurance Act
 
PBO: Projected benefit obligation
FDIC: Federal Deposit Insurance Corporation
 
PCAOB: Public Company Accounting Oversight Board
FFIEC: Federal Financial Institutions Examinations Council
 
Rabbi Trust: A trust established to fund the Directors Plan
FRB: Federal Reserve Bank
 
SEC: U.S. Securities & Exchange Commission
FHLB: Federal Home Loan Bank
 
SOX: Sarbanes-Oxley Act of 2002
Freddie Mac: Federal Home Loan Mortgage Corporation
 
TDR: Troubled debt restructuring
FTE: Fully taxable equivalent
 
XBRL: eXtensible Business Reporting Language

3


PART I – FINANCIAL INFORMATION
Item 1. Financial Statements.
INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(Dollars in thousands)

September 30
2016
 
December 31
2015
ASSETS
 
 
 
Cash and cash equivalents
 
 
 
Cash and demand deposits due from banks
$
19,274

 
$
18,810

Interest bearing balances due from banks
2,061

 
2,759

Total cash and cash equivalents
21,335

 
21,569

AFS securities (amortized cost of $549,893 in 2016 and $654,348 in 2015)
564,229

 
660,136

Mortgage loans AFS
685

 
1,187

Loans
 
 
 
Commercial
554,847

 
448,381

Agricultural
133,637

 
115,911

Residential real estate
260,122

 
251,501

Consumer
40,760

 
34,699

Gross loans
989,366

 
850,492

Less allowance for loan and lease losses
7,800

 
7,400

Net loans
981,566

 
843,092

Premises and equipment
28,986

 
28,331

Corporate owned life insurance policies
25,985

 
26,423

Accrued interest receivable
6,868

 
6,269

Equity securities without readily determinable fair values
22,573

 
22,286

Goodwill and other intangible assets
48,700

 
48,828

Other assets
5,571

 
9,991

TOTAL ASSETS
$
1,706,498

 
$
1,668,112

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits
 
 
 
Noninterest bearing
$
201,804

 
$
191,376

NOW accounts
205,817

 
212,666

Certificates of deposit under $100 and other savings
504,599

 
521,793

Certificates of deposit over $100
263,613

 
238,728

Total deposits
1,175,833

 
1,164,563

Borrowed funds
325,409

 
309,732

Accrued interest payable and other liabilities
10,072

 
9,846

Total liabilities
1,511,314

 
1,484,141

Shareholders’ equity
 
 
 
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,833,481 shares (including 22,296 shares held in the Rabbi Trust) in 2016 and 7,799,867 shares (including 19,401 shares held in the Rabbi Trust) in 2015
139,980

 
139,198

Shares to be issued for deferred compensation obligations
4,908

 
4,592

Retained earnings
44,280

 
39,960

Accumulated other comprehensive income
6,016

 
221

Total shareholders’ equity
195,184

 
183,971

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,706,498

 
$
1,668,112



See notes to interim condensed consolidated financial statements (unaudited).

4


INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(Dollars in thousands except per share amounts)

Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30
 
2016
 
2015
 
2016
 
2015
Interest income
 
 
 
 
 
 
 
Loans, including fees
$
9,965

 
$
8,984

 
$
28,320

 
$
26,884

AFS securities
 
 
 
 
 
 
 
Taxable
2,037

 
2,310

 
6,740

 
6,655

Nontaxable
1,411

 
1,507

 
4,337

 
4,496

Federal funds sold and other
194

 
166

 
509

 
444

Total interest income
13,607

 
12,967

 
39,906

 
38,479

Interest expense
 
 
 
 
 
 
 
Deposits
1,496

 
1,480

 
4,313

 
4,405

Borrowings
1,251

 
1,100

 
3,726

 
3,181

Total interest expense
2,747

 
2,580

 
8,039

 
7,586

Net interest income
10,860

 
10,387

 
31,867

 
30,893

Provision for loan losses
17

 
(738
)
 
185

 
(1,999
)
Net interest income after provision for loan losses
10,843

 
11,125

 
31,682

 
32,892

Noninterest income
 
 
 
 
 
 
 
Service charges and fees
1,276

 
1,468

 
3,652

 
4,024

Net gain on sale of mortgage loans
263

 
157

 
472

 
472

Earnings on corporate owned life insurance policies
183

 
188

 
566

 
570

Net gains on sale of AFS securities

 

 
245

 

Other
1,224

 
1,288

 
2,986

 
2,792

Total noninterest income
2,946

 
3,101

 
7,921

 
7,858

Noninterest expenses
 
 
 
 
 
 
 
Compensation and benefits
4,940

 
4,750

 
14,412

 
13,856

Furniture and equipment
1,543

 
1,511

 
4,564

 
4,251

Occupancy
790

 
728

 
2,280

 
2,121

Other
2,160

 
2,172

 
6,475

 
5,938

Total noninterest expenses
9,433

 
9,161

 
27,731

 
26,166

Income before federal income tax expense
4,356

 
5,065

 
11,872

 
14,584

Federal income tax expense
763

 
1,002

 
1,855

 
2,750

NET INCOME
$
3,593

 
$
4,063

 
$
10,017

 
$
11,834

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.46

 
$
0.52

 
$
1.28

 
$
1.52

Diluted
$
0.45

 
$
0.51

 
$
1.25

 
$
1.49

Cash dividends per common share
$
0.25

 
$
0.24

 
$
0.73

 
$
0.70






See notes to interim condensed consolidated financial statements (unaudited).

5


INTERIM CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(Dollars in thousands)

Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30
 
2016
 
2015
 
2016
 
2015
Net income
$
3,593

 
$
4,063

 
$
10,017

 
$
11,834

Unrealized gains (losses) on AFS securities arising during the period
(2,548
)
 
5,301

 
8,793

 
3,137

Unrealized gains (losses) on derivative instruments arising during the period
91

 

 
(61
)
 

Reclassification adjustment for net realized (gains) losses included in net income

 

 
(245
)
 

Comprehensive income (loss) before income tax (expense) benefit
(2,457
)
 
5,301

 
8,487

 
3,137

Tax effect (1)
906

 
(1,818
)
 
(2,692
)
 
(1,019
)
Other comprehensive income, net of tax
(1,551
)
 
3,483

 
5,795

 
2,118

Comprehensive income
$
2,042

 
$
7,546

 
$
15,812

 
$
13,952

(1) 
See “Note 12 – Accumulated Other Comprehensive Income” for tax effect reconciliation.





















See notes to interim condensed consolidated financial statements (unaudited).

6


INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)
(Dollars in thousands except per share amounts)
 
Common Stock
 
 
 
 
 
 
 
 

Common Shares
Outstanding
 
Amount
 
Common Shares to be
Issued for
Deferred
Compensation
Obligations
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Totals
Balance, January 1, 2015
7,776,274

 
$
138,755

 
$
4,242

 
$
32,103

 
$
(506
)
 
$
174,594

Comprehensive income (loss)

 

 

 
11,834

 
2,118

 
13,952

Issuance of common stock
142,388

 
3,310

 

 

 

 
3,310

Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations

 
123

 
(123
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
425

 

 

 
425

Common stock purchased for deferred compensation obligations

 
(279
)
 

 

 

 
(279
)
Common stock repurchased pursuant to publicly announced repurchase plan
(153,329
)
 
(3,588
)
 

 

 

 
(3,588
)
Cash dividends paid ($0.70 per common share)

 

 

 
(5,416
)
 

 
(5,416
)
Balance, September 30, 2015
7,765,333

 
$
138,321

 
$
4,544

 
$
38,521

 
$
1,612

 
$
182,998

Balance, January 1, 2016
7,799,867

 
$
139,198

 
$
4,592

 
$
39,960

 
$
221

 
$
183,971

Comprehensive income (loss)

 

 

 
10,017

 
5,795

 
15,812

Issuance of common stock
131,697

 
3,683

 

 

 

 
3,683

Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations

 
127

 
(127
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
443

 

 

 
443

Common stock purchased for deferred compensation obligations

 
(279
)
 

 

 

 
(279
)
Common stock repurchased pursuant to publicly announced repurchase plan
(98,083
)
 
(2,749
)
 

 

 

 
(2,749
)
Cash dividends paid ($0.73 per common share)

 

 

 
(5,697
)
 

 
(5,697
)
Balance, September 30, 2016
7,833,481

 
$
139,980

 
$
4,908

 
$
44,280

 
$
6,016

 
$
195,184















See notes to interim condensed consolidated financial statements (unaudited).

7


INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Dollars in thousands)

Nine Months Ended 
 September 30
 
2016
 
2015
OPERATING ACTIVITIES
 
 
 
Net income
$
10,017

 
$
11,834

Reconciliation of net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
185

 
(1,999
)
Impairment of foreclosed assets

 
22

Depreciation
2,116

 
1,925

Amortization of OMSR
299

 
273

Amortization of acquisition intangibles
128

 
122

Net amortization of AFS securities
2,115

 
1,514

Net (gains) losses on sale of AFS securities
(245
)
 

Net gain on sale of mortgage loans
(472
)
 
(472
)
Increase in cash value of corporate owned life insurance policies
(566
)
 
(570
)
Share-based payment awards under equity compensation plan
443

 
425

Origination of loans held-for-sale
(22,994
)
 
(36,140
)
Proceeds from loan sales
23,968

 
36,682

Net changes in operating assets and liabilities which provided (used) cash:
 
 
 
Accrued interest receivable
(599
)
 
(1,141
)
Other assets
1,005

 
(5,277
)
Accrued interest payable and other liabilities
165

 
(117
)
Net cash provided by (used in) operating activities
15,565

 
7,081

INVESTING ACTIVITIES
 
 
 
Activity in AFS securities
 
 
 
Sales
35,664

 

Maturities, calls, and principal payments
111,543

 
72,345

Purchases
(44,622
)
 
(131,800
)
Net loan principal (originations) collections
(138,870
)
 
(1,065
)
Proceeds from sales of foreclosed assets
348

 
1,305

Purchases of premises and equipment
(2,771
)
 
(4,397
)
Purchases of corporate owned life insurance policies

 
(500
)
Proceeds from redemption of corporate owned life insurance policies
1,004

 

Net cash provided by (used in) investing activities
(37,704
)
 
(64,112
)

8


INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
 
Nine Months Ended 
 September 30
 
2016
 
2015
FINANCING ACTIVITIES
 
 
 
Net increase (decrease) in deposits
$
11,270

 
$
53,519

Net increase (decrease) in borrowed funds
15,677

 
7,901

Cash dividends paid on common stock
(5,697
)
 
(5,416
)
Proceeds from issuance of common stock
3,683

 
3,310

Common stock repurchased
(2,749
)
 
(3,588
)
Common stock purchased for deferred compensation obligations
(279
)
 
(279
)
Net cash provided by (used in) financing activities
21,905

 
55,447

Increase (decrease) in cash and cash equivalents
(234
)
 
(1,584
)
Cash and cash equivalents at beginning of period
21,569

 
19,906

Cash and cash equivalents at end of period
$
21,335

 
$
18,322

SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Interest paid
$
8,042

 
$
7,587

Income taxes paid
1,350

 
3,193

SUPPLEMENTAL NONCASH INFORMATION:
 
 
 
Transfers of loans to foreclosed assets
$
211

 
$
1,043





















See notes to interim condensed consolidated financial statements (unaudited).

9


NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Dollars in thousands except per share amounts)
Note 1 – Basis of Presentation
As used in these notes, as well as in Management's Discussion and Analysis of Financial Condition and Results of Operations, references to “Isabella,” the “Corporation”, “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiaries. Isabella Bank Corporation refers solely to the parent holding company, and Isabella Bank or the “Bank” refer to Isabella Bank Corporation’s subsidiary, Isabella Bank.
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2015.
Our accounting policies are materially the same as those discussed in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2015.
Reclassifications: Certain amounts reported in the 2015 consolidated financial statements have been reclassified to conform with the 2016 presentation.
Restatements: In this Quarterly Report on Form 10-Q, certain prior period financial information has been restated due to an accounting correction. Impacted sections of the Consolidated Financial Statements include:
1.
Consolidated Statements of Income for the three and nine month periods ended September 30, 2015 and Consolidated Statements of Cash Flows for the nine month period ended September 30, 2015; and
2.
Notes to Consolidated Financial Statements for the three and nine month periods ended September 30, 2015.
On the Consolidated Statements of Income, the effects of the restatement reduced loan interest and fee income by $871 and $2,564, respectively, and compensation and benefits were reduced by $871 and $2,564, respectively, for the three and nine month periods ended September 30, 2015. The restatement did not impact net income for the three and nine month periods ended September 30, 2015.
All amounts in this Quarterly Report on Form 10-Q affected by the restatement adjustments are reflected as the restated amounts. For information related to the restatement, refer to our Annual Report on Form 10-K for the year ended December 31, 2015.
Note 2 – Computation of Earnings Per Common Share
Basic earnings per common share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued relate solely to outstanding shares in the Directors Plan.
 
Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30

2016
 
2015
 
2016
 
2015
Average number of common shares outstanding for basic calculation
7,824,751

 
7,768,230

 
7,813,084

 
7,773,655

Average potential effect of common shares in the Directors Plan (1)
186,667

 
178,882

 
184,996

 
177,531

Average number of common shares outstanding used to calculate diluted earnings per common share
8,011,418

 
7,947,112

 
7,998,080

 
7,951,186

Net income
$
3,593

 
$
4,063

 
$
10,017

 
$
11,834

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.46

 
$
0.52

 
$
1.28

 
$
1.52

Diluted
$
0.45

 
$
0.51

 
$
1.25

 
$
1.49

(1) 
Exclusive of shares held in the Rabbi Trust

10


Note 3 – Accounting Standards Updates
Pending Accounting Standards Updates
ASU No. 2016-01: Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Liabilities”
In January 2016, ASU No. 2016-01 set forth the following: 1) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income; 2) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment and when an impairment exists, an entity is required to measure the investment at fair value; 3) for public entities, eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; 4) for public entities, requires the use of exit price notion when measuring the fair value of financial instruments for disclosure purposes; 5) requires an entity to present separately in other comprehensive income, the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; 6) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; and 7) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2017 and is not expected to have a significant impact on our operations or financial statement disclosures due to existing equity investments.
ASU No. 2016-02: “Leases (Topic 842)”
In February 2016, ASU No. 2016-02 was issued to create Topic 842 - Leases which will require recognition of lease assets and lease liabilities on the balance sheet for leases previously classified as operating leases. Accounting guidance is set forth for both lessee and lessor accounting. Under lessee accounting, a lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.
For finance leases, a lessee is required to do the following: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position; 2) recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of comprehensive income; and 3) classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows. For operating leases, a lessee is required to do the following: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position; 2) recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis; and 3) classify all cash payments within operating activities in the statement of cash flows.
The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2018 and is not expected to have a significant impact on our operations or financial statement disclosures.
ASU No. 2016-05: “Derivatives and Hedging (Topic 815): Effect Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships”
In March 2016, ASU No. 2016-05 was issued to clarify designation of a hedging instrument when there is a change in counterparty. A change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of itself, require dedesignation of that hedging relationship provided that all other hedge accounting criteria continue to be met. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2016 and is not expected to have a significant impact on our operations or financial statement disclosures.
ASU No. 2016-07: “Investments - Equity Method and Joint Ventures (Topic 323): Simplifying the Transition of the Equity Method of Accounting”
In March 2016, ASU No. 2016-07 was issued and eliminates the requirement that when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence, an investor must adjust the investment, results of operations, and retained earnings retroactively on a step-by-step basis as if the equity method had been in effect during all previous periods that the investment had been held. Additionally, the update requires that the equity method

11


investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. Therefore, upon qualifying for the equity method of accounting, no retroactive adjustment of the investment is required. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2016 and is not expected to have a significant impact on our operations or financial statement disclosures.
ASU No. 2016-09: “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting”
In March 2016, ASU No. 2016-09 updated several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2016 and is not expected to have a significant impact on our operations or financial statement disclosures.
ASU No. 2016-13: “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”
In June 2016, ASU No. 2016-13 updated the measurement for credit losses for AFS debt securities and assets measured at amortized cost which include loans, trade receivables, and any other financial assets with the contractual right to receive cash. Current GAAP requires an “incurred loss” methodology for recognizing credit losses that delays recognition until it is probable a loss has been incurred. Under the incurred loss approach, entities are limited to a probable initial recognition threshold when credit losses are measured under GAAP; an entity generally only considers past events and current conditions in measuring the incurred loss.
In the new guidance, the incurred loss impairment methodology in current GAAP is replaced with a methodology that reflects expected credit losses. This methodology requires consideration of a broader range of reasonable and supportable information to calculate credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. An entity must use judgment in determining the relevant information and estimation methods that are appropriate in its circumstances which applies to assets measured either collectively or individually.
The update allows an entity to revert to historical loss information that is reflective of the contractual term (considering the effect of prepayments) for periods that are beyond the time frame for which the entity is able to develop reasonable and supportable forecasts. In addition, the disclosures of credit quality indicators in relation to the amortized cost of financing receivables, a current disclosure requirement, are further disaggregated by year of origination (or vintage). The vintage information will be useful for financial statement users to better assess changes in underwriting standards and credit quality trends in asset portfolios over time and the effect of those changes on credit losses.

Overall, the update will allow entities the ability to measure expected credit losses without the restriction of incurred or probable losses that exist under current GAAP. For users of the financial statements, the update provides decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2019 and is expected to have a significant impact on our operations and financial statement disclosures as well as that of the banking industry as a whole.
ASU No. 2016-15: “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments”
In August 2016, ASU No. 2016-15 was issued to provide guidance on eight specific cash flow issues: 1) debt prepayment or debt extinguishment costs; 2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; 3) contingent consideration payments made after a business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life insurance policies; 6) including bank-owned life insurance policies; 7) distributions received from equity method investees, beneficial interests in securitization transactions; and 8) separately identifiable cash flows and application of the predominance principle. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2017 and is not expected to have a significant impact on our operations or financial statement disclosures.

12


Note 4 – AFS Securities
The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:
 
September 30, 2016

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
340

 
$
4

 
$

 
$
344

States and political subdivisions
211,073

 
8,627

 
11

 
219,689

Auction rate money market preferred
3,200

 

 
55

 
3,145

Preferred stocks
3,800

 

 
212

 
3,588

Mortgage-backed securities
222,342

 
4,341

 
34

 
226,649

Collateralized mortgage obligations
109,138

 
1,796

 
120

 
110,814

Total
$
549,893

 
$
14,768

 
$
432

 
$
564,229

 
December 31, 2015

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
24,407

 
$
13

 
$
75

 
$
24,345

States and political subdivisions
224,752

 
7,511

 
46

 
232,217

Auction rate money market preferred
3,200

 

 
334

 
2,866

Preferred stocks
3,800

 

 
501

 
3,299

Mortgage-backed securities
264,109

 
1,156

 
1,881

 
263,384

Collateralized mortgage obligations
134,080

 
1,136

 
1,191

 
134,025

Total
$
654,348

 
$
9,816

 
$
4,028

 
$
660,136

The amortized cost and fair value of AFS securities by contractual maturity at September 30, 2016 are as follows:
 
Maturing
 
Securities with Variable Monthly Payments or Noncontractual Maturities
 
 

Due in
One Year
or Less
 
After One
Year But
Within
Five Years
 
After Five
Years But
Within
Ten Years
 
After
Ten Years
 
 
Total
Government sponsored enterprises
$
32

 
$

 
$
308

 
$

 
$

 
$
340

States and political subdivisions
26,139

 
71,388

 
83,884

 
29,662

 

 
211,073

Auction rate money market preferred

 

 

 

 
3,200

 
3,200

Preferred stocks

 

 

 

 
3,800

 
3,800

Mortgage-backed securities

 

 

 

 
222,342

 
222,342

Collateralized mortgage obligations

 

 

 

 
109,138

 
109,138

Total amortized cost
$
26,171

 
$
71,388

 
$
84,192

 
$
29,662

 
$
338,480

 
$
549,893

Fair value
$
26,277


$
73,959


$
88,507


$
31,290


$
344,196

 
$
564,229

Expected maturities for government sponsored enterprises and states and political subdivisions may differ from contractual maturities because issuers may have the right to call or prepay obligations.
As the auction rate money market preferred and preferred stocks have continual call dates, they are not reported by a specific maturity group. Because of their variable monthly payments, mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group.

13


A summary of the sales activity of AFS securities was as follows for the:
 
Three Months Ended September 30
 
Nine Months Ended September 30
 
2016
 
2016
Proceeds from sales of AFS securities
$

 
$
35,664

Gross realized gains (losses)
$

 
$
245

Applicable income tax expense (benefit)
$

 
$
83

We had no sales of AFS securities in the three and nine month periods ended September 30, 2015.
The cost basis used to determine the realized gains or losses of AFS securities sold was the amortized cost of the individual investment security as of the trade date.
The following information pertains to AFS securities with gross unrealized losses at September 30, 2016 and December 31, 2015, aggregated by investment category and length of time that individual securities have been in a continuous loss position.
 
September 30, 2016
 
Less Than Twelve Months
 
Twelve Months or More
 
 

Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total
Unrealized
Losses
Government sponsored enterprises
$

 
$

 
$

 
$

 
$

States and political subdivisions

 

 
11

 
394

 
11

Auction rate money market preferred

 

 
55

 
3,145

 
55

Preferred stocks

 

 
212

 
3,588

 
212

Mortgage-backed securities
34

 
15,672

 

 

 
34

Collateralized mortgage obligations
14

 
6,474

 
106

 
12,152

 
120

Total
$
48

 
$
22,146

 
$
384

 
$
19,279

 
$
432

Number of securities in an unrealized loss position:
 
 
4

 
 
 
9

 
13

 
December 31, 2015
 
Less Than Twelve Months
 
Twelve Months or More
 
 

Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total
Unrealized
Losses
Government sponsored enterprises
$

 
$

 
$
75

 
$
4,925

 
$
75

States and political subdivisions
14

 
3,355

 
32

 
2,623

 
46

Auction rate money market preferred

 

 
334

 
2,866

 
334

Preferred stocks

 

 
501

 
3,299

 
501

Mortgage-backed securities
882

 
131,885

 
999

 
37,179

 
1,881

Collateralized mortgage obligations
415

 
53,441

 
776

 
26,717

 
1,191

Total
$
1,311

 
$
188,681

 
$
2,717

 
$
77,609

 
$
4,028

Number of securities in an unrealized loss position:
 
 
36

 
 
 
26

 
62

As of September 30, 2016 and December 31, 2015, we conducted an analysis to determine whether any AFS securities currently in an unrealized loss position should be other-than-temporarily impaired. Such analyses considered, among other factors, the following criteria:
Has the value of the investment declined more than what is deemed to be reasonable based on a risk and maturity adjusted discount rate?
Is the investment credit rating below investment grade?
Is it probable the issuer will be unable to pay the amount when due?
Is it more likely than not that we will have to sell the security before recovery of its cost basis?
Has the duration of the investment been extended?

14


Based on our analyses, the fact that we have asserted that we do not have the intent to sell AFS securities in an unrealized loss position, and considering it is unlikely that we will have to sell any AFS securities in an unrealized loss position before recovery of their cost basis, we do not believe that the values of any AFS securities were other-than-temporarily impaired as of September 30, 2016 or December 31, 2015.
Note 5 – Loans and ALLL
We grant commercial, agricultural, residential real estate, and consumer loans to customers situated primarily in Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties in Michigan. The ability of the borrowers to honor their repayment obligations is often dependent upon the real estate, agricultural, manufacturing, retail, gaming, tourism, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees; a portion of loans are unsecured.
Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and any deferred fees or costs. Interest income is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the level yield method.
The accrual of interest on commercial, agricultural, and residential real estate loans is discontinued at the time the loan is 90 days or more past due unless the credit is well-secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful.
For loans that are placed on nonaccrual status or charged-off, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the ALLL. Loans may be returned to accrual status after six months of continuous performance.
Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, advances to mortgage brokers, farmland and agricultural production, and states and political subdivisions. Repayment of these loans is dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of direct credit exposure to any one borrower to $15,000. Borrowers with direct credit needs of more than $15,000 are serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans commonly require loan-to-value limits of 80% or less. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, and property and equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we require annual financial statements, prepare cash flow analyses, and review credit reports.
We entered into a mortgage purchase program with a financial institution where we participate in advances to mortgage brokers ("advances"). The mortgage brokers originate residential mortgage loans with the intent to sell on the secondary market. We participate in the advance to the mortgage broker, which is secured by the underlying mortgage loan, until it is ultimately sold on the secondary market. As such, the average life of each participated advance is approximately 20-30 days. Funds from the sale of the loan are used to payoff our participation in the advance to the mortgage broker. We classify these advances as commercial loans and include the outstanding balance in commercial loans on our balance sheet. Under the participation agreement, we committed to a maximum outstanding aggregate amount of $30,000. The difference between our outstanding balances and the maximum outstanding aggregate amount are classified as “Unfunded commitments under lines of credit” in the “Contractual Obligations and Loan Commitments” section of the Management's Discussion and Analysis of Financial Condition and Results of Operations of this report.
We offer adjustable rate mortgages, construction loans, and fixed rate residential real estate loans which have amortization periods up to a maximum of 30 years. We consider the anticipated direction of interest rates, balance sheet duration, the sensitivity of our balance sheet to changes in interest rates, and overall loan demand to determine whether or not to sell fixed rate loans to Freddie Mac.
Our lending policies generally limit the maximum loan-to-value ratio on residential real estate loans to 97% of the lower of the appraised value of the property or the purchase price, with the condition that private mortgage insurance is required on loans with loan-to-value ratios in excess of 80%.

15


Underwriting criteria for originated residential real estate loans include:
Evaluation of the borrower’s ability to make monthly payments.
Evaluation of the value of the property securing the loan.
Ensuring the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower’s gross income.
Ensuring all debt servicing does not exceed 36% of income.
Verification of acceptable credit reports.
Verification of employment, income, and financial information.
Appraisals are performed by independent appraisers and reviewed for appropriateness. All originated mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market underwriting system; loans in excess of $500 require the approval of our Internal Loan Committee, the Executive Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors.
Consumer loans include secured and unsecured personal loans. Loans are amortized for a period of up to 12 years based on the age and value of the underlying collateral. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market.
The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL.
The appropriateness of the ALLL is evaluated on a quarterly basis and is based upon a periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. Specific allocations for impaired loans are primarily determined based on the difference between the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell. Historical loss allocations are calculated at the loan class and segment levels based on a migration analysis of the loan portfolio, with the exception of advances to mortgage brokers, over the preceding five years. With no historical losses on advances to mortgage brokers, there is no allocation in the commercial segment displayed below based on historical loss factors. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A summary of changes in the ALLL and the recorded investment in loans by segments follows:
 
Allowance for Loan Losses
 
Three Months Ended September 30, 2016

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
July 1, 2016
$
2,119

 
$
534

 
$
3,130

 
$
541

 
$
1,276

 
$
7,600

Charge-offs

 

 
(57
)
 
(74
)
 

 
(131
)
Recoveries
118

 

 
153

 
43

 

 
314

Provision for loan losses
(367
)
 
612

 
(452
)
 
94

 
130

 
17

September 30, 2016
$
1,870

 
$
1,146

 
$
2,774

 
$
604

 
$
1,406

 
$
7,800

 
Allowance for Loan Losses

Nine Months Ended September 30, 2016

Commercial

Agricultural

Residential Real Estate

Consumer

Unallocated

Total
January 1, 2016
$
2,171


$
329


$
3,330


$
522


$
1,048


$
7,400

Charge-offs
(48
)



(426
)

(206
)



(680
)
Recoveries
396


92


248


159




895

Provision for loan losses
(649
)

725


(378
)

129


358


185

September 30, 2016
$
1,870


$
1,146


$
2,774


$
604


$
1,406


$
7,800


16


 
Allowance for Loan Losses and Recorded Investment in Loans
 
September 30, 2016

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
804

 
$
16

 
$
1,703

 
$

 
$

 
$
2,523

Collectively evaluated for impairment
1,066

 
1,130

 
1,071

 
604

 
1,406

 
5,277

Total
$
1,870

 
$
1,146

 
$
2,774

 
$
604

 
$
1,406

 
$
7,800

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
7,719

 
$
4,520

 
$
8,792

 
$
29

 
 
 
$
21,060

Collectively evaluated for impairment
547,128

 
129,117

 
251,330

 
40,731

 
 
 
968,306

Total
$
554,847

 
$
133,637

 
$
260,122

 
$
40,760

 
 
 
$
989,366

 
Allowance for Loan Losses
 
Three Months Ended September 30, 2015

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
July 1, 2015
$
3,482

 
$
363

 
$
3,512

 
$
591

 
$
1,052

 
$
9,000

Charge-offs
(61
)
 

 
(70
)
 
(79
)
 

 
(210
)
Recoveries
68

 

 
33

 
47

 

 
148

Provision for loan losses
(500
)
 
15

 
(163
)
 
(50
)
 
(40
)
 
(738
)
September 30, 2015
$
2,989

 
$
378

 
$
3,312

 
$
509

 
$
1,012

 
$
8,200

 
Allowance for Loan Losses
 
Nine Months Ended September 30, 2015

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
January 1, 2015
$
3,821

 
$
216

 
$
4,235

 
$
645

 
$
1,183

 
$
10,100

Charge-offs
(89
)
 

 
(325
)
 
(252
)
 

 
(666
)
Recoveries
387

 
72

 
152

 
154

 

 
765

Provision for loan losses
(1,130
)
 
90

 
(750
)
 
(38
)
 
(171
)
 
(1,999
)
September 30, 2015
$
2,989

 
$
378

 
$
3,312

 
$
509

 
$
1,012

 
$
8,200

 
Allowance for Loan Losses and Recorded Investment in Loans
 
December 31, 2015

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
829

 
$
2

 
$
1,989

 
$

 
$

 
$
2,820

Collectively evaluated for impairment
1,342

 
327

 
1,341

 
522

 
1,048

 
4,580

Total
$
2,171

 
$
329

 
$
3,330

 
$
522

 
$
1,048

 
$
7,400

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
7,969

 
$
4,068

 
$
10,266

 
$
35

 
 
 
$
22,338

Collectively evaluated for impairment
440,412

 
111,843

 
241,235

 
34,664

 
 
 
828,154

Total
$
448,381


$
115,911

 
$
251,501

 
$
34,699

 
 
 
$
850,492


17


The following table displays the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit risk ratings as of:
 
September 30, 2016
 
Commercial
 
Agricultural
 
 

Real Estate
 
Other
 
Advances to Mortgage Brokers
 
Total
 
Real Estate
 
Other
 
Total
 
Total
Rating
 
 
 
 
 
 
 
 
 
 
 
 

 
 
1 - Excellent
$

 
$
529

 
$

 
$
529

 
$

 
$

 
$

 
$
529

2 - High quality
8,819

 
10,193

 
27,832

 
46,844

 
3,828

 
1,562

 
5,390

 
52,234

3 - High satisfactory
107,613

 
37,839

 

 
145,452

 
23,612

 
11,557

 
35,169

 
180,621

4 - Low satisfactory
275,806

 
73,465

 

 
349,271

 
50,083

 
25,066

 
75,149

 
424,420

5 - Special mention
4,448

 
733

 

 
5,181

 
6,483

 
6,810

 
13,293

 
18,474

6 - Substandard
6,037

 
1,527

 

 
7,564

 
3,126

 
1,510

 
4,636

 
12,200

7 - Vulnerable
6

 

 

 
6

 

 

 

 
6

8 - Doubtful

 

 

 

 

 

 

 

Total
$
402,729

 
$
124,286

 
$
27,832

 
$
554,847

 
$
87,132

 
$
46,505

 
$
133,637

 
$
688,484

 
December 31, 2015
 
Commercial
 
Agricultural
 
 

Real Estate
 
Other
 
Advances to Mortgage Brokers
 
Total
 
Real Estate
 
Other
 
Total
 
Total
Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1 - Excellent
$

 
$
499

 
$

 
$
499

 
$

 
$

 
$

 
$
499

2 - High quality
7,397

 
11,263

 

 
18,660

 
4,647

 
2,150

 
6,797

 
25,457

3 - High satisfactory
99,136

 
29,286

 

 
128,422

 
28,886

 
13,039

 
41,925

 
170,347

4 - Low satisfactory
222,431

 
62,987

 

 
285,418

 
37,279

 
22,166

 
59,445

 
344,863

5 - Special mention
4,501

 
473

 

 
4,974

 
3,961

 
1,875

 
5,836

 
10,810

6 - Substandard
9,941

 
256

 

 
10,197

 
1,623

 
139

 
1,762

 
11,959

7 - Vulnerable
211

 

 

 
211

 
146

 

 
146

 
357

8 - Doubtful

 

 

 

 

 

 

 

Total
$
343,617

 
$
104,764

 
$

 
$
448,381

 
$
76,542

 
$
39,369

 
$
115,911

 
$
564,292

Internally assigned credit risk ratings are reviewed, at a minimum, when loans are renewed or when management has knowledge of improvements or deterioration of the credit quality of individual credits. Descriptions of the internally assigned credit risk ratings for commercial and agricultural loans are as follows:
1. EXCELLENT – Substantially Risk Free
Credit has strong financial condition and solid earnings history, characterized by:
High liquidity, strong cash flow, low leverage.
Unquestioned ability to meet all obligations when due.
Experienced management, with management succession in place.
Secured by cash.
2. HIGH QUALITY – Limited Risk
Credit with sound financial condition and a positive trend in earnings supplemented by:
Favorable liquidity and leverage ratios.
Ability to meet all obligations when due.
Management with successful track record.
Steady and satisfactory earnings history.
If loan is secured, collateral is of high quality and readily marketable.

18


Access to alternative financing.
Well defined primary and secondary source of repayment.
If supported by guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident.
3. HIGH SATISFACTORY – Reasonable Risk
Credit with satisfactory financial condition and further characterized by:
Working capital adequate to support operations.
Cash flow sufficient to pay debts as scheduled.
Management experience and depth appear favorable.
Loan performing according to terms.
If loan is secured, collateral is acceptable and loan is fully protected.
4. LOW SATISFACTORY – Acceptable Risk
Credit with bankable risks, although some signs of weaknesses are shown:
Would include most start-up businesses.
Occasional instances of trade slowness or repayment delinquency – may have been 10-30 days slow within the past year.
Management’s abilities are apparent, yet unproven.
Weakness in primary source of repayment with adequate secondary source of repayment.
Loan structure generally in accordance with policy.
If secured, loan collateral coverage is marginal.
Adequate cash flow to service debt, but coverage is low.
To be classified as less than satisfactory, only one of the following criteria must be met.
5. SPECIAL MENTION – Criticized
Credit constitutes an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific loan:
Downward trend in sales, profit levels, and margins.
Impaired working capital position.
Cash flow is strained in order to meet debt repayment.
Loan delinquency (30-60 days) and overdrafts may occur.
Shrinking equity cushion.
Diminishing primary source of repayment and questionable secondary source.
Management abilities are questionable.
Weak industry conditions.
Litigation pending against the borrower.
Collateral or guaranty offers limited protection.
Negative debt service coverage, however the credit is well collateralized and payments are current.
6. SUBSTANDARD – Classified
Credit where the borrower’s current net worth, paying capacity, and value of the collateral pledged is inadequate. There is a distinct possibility that we will implement collection procedures if the loan deficiencies are not corrected. In addition, the following characteristics may apply:
Sustained losses have severely eroded the equity and cash flow.
Deteriorating liquidity.
Serious management problems or internal fraud.
Original repayment terms liberalized.
Likelihood of bankruptcy.
Inability to access other funding sources.
Reliance on secondary source of repayment.
Litigation filed against borrower.
Collateral provides little or no value.

19


Requires excessive attention of the loan officer.
Borrower is uncooperative with loan officer.
7. VULNERABLE – Classified
Credit is considered “Substandard” and warrants placing on nonaccrual status. Risk of loss is being evaluated and exit strategy options are under review. Other characteristics that may apply:
Insufficient cash flow to service debt.
Minimal or no payments being received.
Limited options available to avoid the collection process.
Transition status, expect action will take place to collect loan without immediate progress being made.
8. DOUBTFUL – Workout
Credit has all the weaknesses inherent in a “Substandard” loan with the added characteristic that collection and/or liquidation is pending. The possibility of a loss is extremely high, but its classification as a loss is deferred until liquidation procedures are completed, or reasonably estimable. Other characteristics that may apply:
Normal operations are severely diminished or have ceased.
Seriously impaired cash flow.
Original repayment terms materially altered.
Secondary source of repayment is inadequate.
Survivability as a “going concern” is impossible.
Collection process has begun.
Bankruptcy petition has been filed.
Judgments have been filed.
Portion of the loan balance has been charged-off.
Our primary credit quality indicator for residential real estate and consumer loans is the individual loan’s past due aging. The following tables summarize the past due and current loans as of:
 
September 30, 2016
 
Accruing Interest
and Past Due:
 
 
 
Total Past Due and Nonaccrual
 
 
 
 

30-59
Days
 
60-89
Days
 
90 Days
or More
 
Nonaccrual
 
 
Current
 
Total
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
979

 
$
48

 
$
160

 
$
68

 
$
1,255

 
$
401,474

 
$
402,729

Commercial other
284

 
202

 
24

 

 
510

 
123,776

 
124,286

Advances to mortgage brokers

 

 

 

 

 
27,832

 
27,832

Total commercial
1,263

 
250

 
184

 
68

 
1,765

 
553,082

 
554,847

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate
517

 
181

 
465

 

 
1,163

 
85,969

 
87,132

Agricultural other
214

 

 
6

 

 
220

 
46,285

 
46,505

Total agricultural
731

 
181

 
471

 

 
1,383

 
132,254

 
133,637

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
1,077

 
240

 
192

 
595

 
2,104

 
210,826

 
212,930

Junior liens
15

 
15

 

 
27

 
57

 
8,342

 
8,399

Home equity lines of credit
275

 

 

 

 
275

 
38,518

 
38,793

Total residential real estate
1,367

 
255

 
192

 
622

 
2,436

 
257,686

 
260,122

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
19

 
19

 

 

 
38

 
36,893

 
36,931

Unsecured
10

 
3

 

 

 
13

 
3,816

 
3,829

Total consumer
29

 
22

 

 

 
51

 
40,709

 
40,760

Total
$
3,390

 
$
708

 
$
847

 
$
690

 
$
5,635

 
$
983,731

 
$
989,366


20


 
December 31, 2015
 
Accruing Interest
and Past Due:
 
 
 
Total Past Due and Nonaccrual
 
 
 
 

30-59
Days
 
60-89
Days
 
90 Days
or More
 
Nonaccrual
 
 
Current
 
Total
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
505

 
$
281

 
$

 
$
211

 
$
997

 
$
342,620

 
$
343,617

Commercial other
18

 

 

 

 
18

 
104,746

 
104,764

Advances to mortgage brokers

 

 

 

 

 

 

Total commercial
523

 
281

 

 
211

 
1,015

 
447,366

 
448,381

Agricultural
 
 
 
 
 
 
 
 
 
 
 
 
 
Agricultural real estate
196

 
890

 

 
146

 
1,232

 
75,310

 
76,542

Agricultural other

 

 

 

 

 
39,369

 
39,369

Total agricultural
196

 
890

 

 
146

 
1,232

 
114,679

 
115,911

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
1,551

 
261

 

 
429

 
2,241

 
199,622

 
201,863

Junior liens
40

 
8

 

 
6

 
54

 
9,325

 
9,379

Home equity lines of credit
225

 

 

 

 
225

 
40,034

 
40,259

Total residential real estate
1,816

 
269

 

 
435

 
2,520

 
248,981

 
251,501

Consumer
 
 
 
 
 
 
 
 
 
 
 
 
 
Secured
27

 

 

 

 
27

 
30,839

 
30,866

Unsecured
4

 

 

 

 
4

 
3,829

 
3,833

Total consumer
31

 

 

 

 
31

 
34,668

 
34,699

Total
$
2,566

 
$
1,440

 
$

 
$
792

 
$
4,798

 
$
845,694

 
$
850,492

Impaired Loans
Loans may be classified as impaired if they meet one or more of the following criteria:
1.
There has been a charge-off of its principal balance (in whole or in part);
2.
The loan has been classified as a TDR; or
3.
The loan is in nonaccrual status.
Impairment is measured on a loan-by-loan basis for commercial and agricultural loans by comparing the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Impairment is measured on a loan-by-loan basis for residential real estate and consumer loans by comparing the loan’s unpaid principal balance to the present value of expected future cash flows discounted at the loan’s effective interest rate.

21


We do not recognize interest income on impaired loans in nonaccrual status. For impaired loans not classified as nonaccrual, interest income is recognized daily, as earned, according to the terms of the loan agreement and the principal amount outstanding. The following is a summary of information pertaining to impaired loans as of:
 
September 30, 2016
 
December 31, 2015

Outstanding Balance
 
Unpaid Principal Balance
 
Valuation Allowance
 
Outstanding Balance
 
Unpaid Principal Balance
 
Valuation Allowance
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
5,669

 
$
5,788

 
$
719

 
$
5,659

 
$
5,777

 
$
818

Commercial other
1,399

 
1,399

 
85

 
8

 
8

 
11

Agricultural real estate
181

 
181

 
15

 

 

 

Agricultural other
134

 
134

 
1

 
335

 
335

 
2

Residential real estate senior liens
8,608

 
9,193

 
1,688

 
9,996

 
10,765

 
1,959

Residential real estate junior liens
76

 
86

 
15

 
143

 
163

 
30

Home equity lines of credit

 

 

 

 

 

Consumer secured

 

 

 

 

 

Total impaired loans with a valuation allowance
16,067

 
16,781

 
2,523

 
16,141

 
17,048

 
2,820

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
590

 
603

 
 
 
2,122

 
2,256

 
 
Commercial other
61

 
72

 
 
 
180

 
191

 
 
Agricultural real estate
3,357

 
3,357

 
 
 
3,549

 
3,549

 
 
Agricultural other
848

 
848

 
 
 
184

 
184

 
 
Home equity lines of credit
108

 
408

 
 
 
127

 
434

 
 
Consumer secured
29

 
29

 
 
 
35

 
35

 
 
Total impaired loans without a valuation allowance
4,993

 
5,317

 
 
 
6,197

 
6,649

 
 
Impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial
7,719

 
7,862

 
804

 
7,969

 
8,232

 
829

Agricultural
4,520

 
4,520

 
16

 
4,068

 
4,068

 
2

Residential real estate
8,792

 
9,687

 
1,703

 
10,266

 
11,362

 
1,989

Consumer
29

 
29

 

 
35

 
35

 

Total impaired loans
$
21,060

 
$
22,098

 
$
2,523

 
$
22,338

 
$
23,697

 
$
2,820


22


The following is a summary of information pertaining to impaired loans for the:
 
Three Months Ended September 30
 
2016
 
2015

Average Outstanding Balance
 
Interest Income Recognized
 
Average Outstanding Balance
 
Interest Income Recognized
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
$
5,699

 
$
90

 
$
7,532

 
$
112

Commercial other
746

 
2

 
280

 

Agricultural real estate
181

 
4

 

 

Agricultural other
67

 
1

 
168

 
4

Residential real estate senior liens
8,896

 
85

 
10,021

 
106

Residential real estate junior liens
105

 

 
138

 
1

Home equity lines of credit

 

 

 

Consumer secured

 

 
40

 
1

Total impaired loans with a valuation allowance
15,694


182


18,179


224

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
705

 
10

 
1,432

 
28

Commercial other
67

 
2

 
83

 
2

Agricultural real estate
3,360

 
42

 
1,819

 
23

Agricultural other
767

 
11

 
494

 
5

Home equity lines of credit
112

 
4

 
136

 
4

Consumer secured
31

 
1

 

 

Total impaired loans without a valuation allowance
5,042


70


3,964


62

Impaired loans
 
 
 
 
 
 
 
Commercial
7,217

 
104

 
9,327

 
142

Agricultural
4,375

 
58

 
2,481

 
32

Residential real estate
9,113

 
89

 
10,295

 
111

Consumer
31

 
1

 
40

 
1

Total impaired loans
$
20,736


$
252


$
22,143


$
286


23


 
Nine Months Ended September 30
 
2016
 
2015

Average Outstanding Balance
 
Interest Income Recognized
 
Average Outstanding Balance
 
Interest Income Recognized
Impaired loans with a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
$
5,748

 
$
259

 
$
7,287

 
$
295

Commercial other
298

 
5

 
481

 
19

Agricultural real estate
91

 
6

 
29

 
1

Agricultural other
78

 
1

 
56

 
4

Residential real estate senior liens
9,439

 
278

 
10,812

 
323

Residential real estate junior liens
126

 
2

 
197

 
15

Home equity lines of credit

 

 
42

 

Consumer secured

 

 
46

 
3

Total impaired loans with a valuation allowance
15,780

 
551


18,950


660

Impaired loans without a valuation allowance
 
 
 
 
 
 
 
Commercial real estate
995

 
57

 
2,356

 
163

Commercial other
92

 
6

 
94

 
7

Agricultural real estate
3,454

 
130

 
1,615

 
64

Agricultural other
574

 
27

 
300

 
13

Home equity lines of credit
118

 
12

 
149

 
14

Consumer secured
33

 
3

 
2

 

Total impaired loans without a valuation allowance
5,266

 
235

 
4,516

 
261

Impaired loans
 
 
 
 
 
 
 
Commercial
7,133

 
327

 
10,218

 
484

Agricultural
4,197

 
164

 
2,000

 
82

Residential real estate
9,683

 
292

 
11,200

 
352

Consumer
33

 
3

 
48

 
3

Total impaired loans
$
21,046

 
$
786

 
$
23,466

 
$
921

As of September 30, 2016 and December 31, 2015, we had no commitments to advance additional funds in connection with impaired loans, which include TDRs.
Troubled Debt Restructurings
Loan modifications are considered to be TDRs when the modification includes terms outside of normal lending practices to a borrower who is experiencing financial difficulties.
Typical concessions granted include, but are not limited to:
1.
Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics.
2.
Extending the amortization period beyond typical lending guidelines for loans with similar risk characteristics.
3.
Forgiving principal.
4.
Forgiving accrued interest.
To determine if a borrower is experiencing financial difficulties, factors we consider include:
1.
The borrower is currently in default on any of their debt.
2.
The borrower would likely default on any of their debt if the concession was not granted.
3.
The borrower’s cash flow was insufficient to service all of their debt if the concession was not granted.
4.
The borrower has declared, or is in the process of declaring, bankruptcy.
5.
The borrower is unlikely to continue as a going concern (if the entity is a business).

24


The following is a summary of information pertaining to TDRs granted for the:
 
Three Months Ended September 30
 
2016
 
2015

Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
Commercial other
1

 
$
1,315

 
$
1,315

 
3

 
$
1,926

 
$
1,926

Agricultural other
2

 
319

 
319

 
3

 
636

 
636

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Senior liens

 

 

 
1

 
151

 
151

Junior liens

 

 

 

 

 

Home equity lines of credit

 

 

 

 

 

Total residential real estate

 

 

 
1

 
151

 
151

Consumer unsecured

 

 

 

 

 

Total
3

 
$
1,634

 
$
1,634

 
7

 
$
2,713

 
$
2,713

 
Nine Months Ended September 30
 
2016
 
2015

Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Post-Modification Recorded Investment
Commercial other
1

 
$
1,315

 
$
1,315

 
8

 
$
2,511

 
$
2,511

Agricultural other
5

 
520

 
520

 
10

 
1,406

 
1,406

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
Senior liens
2

 
26

 
26

 
5

 
599

 
599

Junior liens

 

 

 
1

 
30

 
30

Home equity lines of credit

 

 

 
1

 
94

 
94

Total residential real estate
2

 
26

 
26

 
7

 
723

 
723

Consumer unsecured
1

 
2

 
2

 

 

 

Total
9

 
$
1,863

 
$
1,863

 
25

 
$
4,640

 
$
4,640

The following tables summarize concessions we granted to borrowers in financial difficulty for the:
 
Three Months Ended September 30
 
2016
 
2015

Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
Commercial other

 
$

 
1

 
$
1,315

 
3

 
$
1,926

 

 
$

Agricultural other
1

 
14

 
1

 
305

 
3

 
636

 

 

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens

 

 

 

 
1

 
151

 

 

Junior liens

 

 

 

 

 

 

 

Home equity lines of credit

 

 

 

 

 

 

 

Total residential real estate

 

 

 

 
1

 
151

 

 

Consumer unsecured

 

 

 

 

 

 

 

Total
1


$
14


2


$
1,620


7


$
2,713




$


25


 
Nine Months Ended September 30
 
2016
 
2015

Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Below Market Interest Rate
 
Below Market Interest Rate and Extension of Amortization Period
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
 
Number of Loans
 
Pre-Modification Recorded Investment
Commercial other

 
$

 
1

 
$
1,315

 
6

 
$
2,180

 
2

 
$
331

Agricultural other
1

 
14

 
4

 
506

 
9

 
1,360

 
1

 
46

Residential real estate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Senior liens
2

 
26

 

 

 
2

 
201

 
3

 
398

Junior liens

 

 

 

 

 

 
1

 
30

Home equity lines of credit

 

 

 

 

 

 
1

 
94

Total residential real estate
2

 
26

 

 

 
2

 
201

 
5

 
522

Consumer unsecured

 

 
1

 
2

 

 

 

 

Total
3

 
$
40

 
6

 
$
1,823

 
17

 
$
3,741

 
8

 
$
899

We did not restructure any loans by forgiving principal or accrued interest in the three and nine month periods ended September 30, 2016 or 2015.
Based on our historical loss experience, losses associated with TDRs are not significantly different than other impaired loans within the same loan segment. As such, TDRs, including TDRs that have been modified in the past 12 months that subsequently defaulted, are analyzed in the same manner as other impaired loans within their respective loan segment.
We had no loans that defaulted in the three and nine month periods ended September 30, 2016 which were modified within 12 months prior to the default date. Following is a summary of loans that defaulted in the three and nine month periods ended September 30, 2015, which were modified within 12 months prior to the default date.
 
Three Months Ended September 30, 2015
 
Nine Months Ended September 30, 2015
 
Number of Loans
 
Pre-
Default
Recorded
Investment
 
Charge-Off
Recorded
Upon
Default
 
Post-
Default
Recorded
Investment
 
Number of Loans
 
Pre-
Default
Recorded
Investment
 
Charge-Off
Recorded
Upon
Default
 
Post-
Default
Recorded
Investment
Commercial other
1

 
$
216

 
$
25

 
$
191

 
1

 
$
216

 
$
25

 
$
191

The following is a summary of TDR loan balances as of:
 
September 30, 2016
 
December 31, 2015
TDRs
$
20,522

 
$
21,325

Note 6 – Equity Securities Without Readily Determinable Fair Values
Included in equity securities without readily determinable fair values are restricted securities, which are carried at cost, and investments in unconsolidated entities accounted for under the equity method of accounting.
Equity securities without readily determinable fair values consist of the following as of:

September 30
2016
 
December 31
2015
FHLB Stock
$
11,700

 
$
11,700

Corporate Settlement Solutions, LLC
7,539

 
7,249

FRB Stock
1,999

 
1,999

Valley Financial Corporation
1,000

 
1,000

Other
335

 
338

Total
$
22,573

 
$
22,286


26


Note 7 – Foreclosed Assets
Foreclosed assets are included in other assets in the consolidated balance sheets and consist of other real estate owned and repossessed assets. The following is a summary of foreclosed assets:

September 30
2016
 
December 31
2015
Consumer mortgage loans collateralized by residential real estate foreclosed as a result of obtaining physical possession
$
28

 
$

All other foreclosed assets
256

 
421

Total
$
284

 
$
421

Below is a summary of changes in foreclosed assets during the:
 
Three Months Ended September 30
 
2016
 
2015
Balance, July 1
$
249

 
$
873

Properties transferred
95

 
234

Impairments

 

Proceeds from sale
(60
)
 
(506
)
Balance, September 30
$
284

 
$
601

 
Nine Months Ended September 30

2016
 
2015
Balance, January 1
$
421

 
$
885

Properties transferred
211

 
1,043

Impairments

 
(22
)
Proceeds from sale
(348
)
 
(1,305
)
Balance, September 30
$
284

 
$
601

There were no consumer mortgage loans collateralized by residential real estate in the process of foreclosure as of September 30, 2016.
Note 8 – Borrowed Funds
Borrowed funds consist of the following obligations as of:
 
September 30, 2016
 
December 31, 2015

Amount
 
Rate
 
Amount
 
Rate
FHLB advances
$
250,000

 
2.19
%
 
$
235,000

 
1.93
%
Securities sold under agreements to repurchase without stated maturity dates
54,809

 
0.13
%
 
70,532

 
0.12
%
Federal funds purchased
20,600

 
0.67
%
 
4,200

 
0.75
%
Total
$
325,409

 
1.74
%
 
$
309,732

 
1.50
%
FHLB advances are collateralized by a blanket lien on all qualified 1-4 family residential real estate loans, specific AFS securities, and FHLB stock.

27


The following table lists the maturities and weighted average interest rates of FHLB advances as of:
 
September 30, 2016
 
December 31, 2015

Amount
 
Rate
 
Amount
 
Rate
Fixed rate due 2016
$
20,000

 
1.40
%
 
$
30,000

 
1.25
%
Variable rate due 2016

 
%
 
15,000

 
0.62
%
Fixed rate due 2017
50,000

 
1.77
%
 
50,000

 
1.56
%
Fixed rate due 2018
50,000

 
1.87
%
 
50,000

 
2.16
%
Fixed rate due 2019
60,000

 
2.55
%
 
40,000

 
2.35
%
Fixed rate due 2020
10,000

 
1.12
%
 
10,000

 
1.98
%
Fixed rate due 2021
40,000

 
3.10
%
 
30,000

 
2.26
%
Variable rate due 2021 1
10,000

 
1.23
%
 

 
%
Fixed rate due 2023
10,000

 
3.53
%
 
10,000

 
3.90
%
Total
$
250,000

 
2.19
%
 
$
235,000

 
1.93
%
(1) 
Hedged advance (see "Derivative Instruments" section below)
Securities sold under agreements to repurchase are classified as secured borrowings and are reflected at the amount of cash received in connection with the transaction. The securities underlying the agreements have a carrying value and a fair value of $55,148 and $70,555 at September 30, 2016 and December 31, 2015, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.
Securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances generally mature within one to four days from the transaction date. The following table provides a summary of securities sold under repurchase agreements without stated maturity dates and federal funds purchased. We had no FRB Discount Window advances during the three and nine month periods ended September 30, 2016 or 2015.
 
Three Months Ended September 30
 
2016
 
2015
 
Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
 
Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates
$
56,057

 
$
54,446

 
0.13
%
 
$
71,170

 
$
68,693

 
0.13
%
Federal funds purchased
20,600

 
8,848

 
0.69
%
 
13,100

 
7,265

 
0.51
%
 
Nine Months Ended September 30
 
2016
 
2015

Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
 
Maximum Month End Balance
 
Average Balance
 
Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates
$
61,783

 
$
57,159

 
0.13
%
 
$
84,859

 
$
70,399

 
0.13
%
Federal funds purchased
20,600

 
8,614

 
0.69
%
 
13,100

 
6,253

 
0.50
%
We had pledged AFS securities and 1-4 family residential real estate loans in the following amounts at:

September 30
2016
 
December 31
2015
Pledged to secure borrowed funds
$
358,795

 
$
339,078

Pledged to secure repurchase agreements
55,148

 
70,555

Pledged for public deposits and for other purposes necessary or required by law
26,594

 
39,038

Total
$
440,537

 
$
448,671


28


AFS securities pledged to repurchase agreements without stated maturity dates consisted of the following at:

September 30
2016
 
December 31
2015
States and political subdivisions
$
6,906

 
$
3,639

Mortgage-backed securities
10,883

 
23,075

Collateralized mortgage obligations
37,359

 
43,841

Total
$
55,148

 
$
70,555

AFS securities pledged to repurchase agreements are monitored to ensure the appropriate level is collateralized. In the event of maturities, calls, significant principal repayments, or significant decline in market values, we have adequate levels of AFS securities to pledge to satisfy required collateral.
As of September 30, 2016, we had the ability to borrow up to an additional $15,173, based on assets pledged as collateral. We had no investment securities that are restricted to be pledged for specific purposes.
Derivative Instruments
During the second quarter of 2016, we began to enter into interest rate swaps to manage exposure to interest rate risk and variability in cash flows. The interest rate swaps, associated with our variable rate borrowings, are designated upon inception as cash flow hedges of forecasted interest payments. We enter into LIBOR-based interest rate swaps that involve the receipt of variable amounts in exchange for fixed rate payments, in effect converting variable rate debt to fixed rate debt.
Cash flow hedges are assessed for effectiveness using regression analysis. The effective portion of changes in fair value are recorded in OCI and subsequently reclassified into interest expense in the same period in which the related interest on the variable rate borrowings affects earnings. In the event that a portion of the changes in fair value were determined to be ineffective, the ineffective amount would be recorded in earnings.
The following table provides information on derivatives related to variable rate borrowings as of September 30, 2016.
 
Pay Rate
 
Receive Rate
 
Remaining Life (Years)
 
Notional Amount
 
Balance Sheet Location
 
Fair Value
Derivatives designated as hedging instruments
 
 
 
 
 
 
 
 
 
 
 
Cash Flow Hedges:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
1.56
%
 
3-Month LIBOR
 
4.6
 
$
10,000

 
Other liabilities
 
$
(61
)
Derivatives contain an element of credit risk which arises from the possibility that we will incur a loss as a result of a counterparty failing to meet its contractual obligations. Credit risk is minimized through counterparty collateral, transaction limits and monitoring procedures. We also manage dealer credit risk by entering into interest rate derivatives only with primary and highly rated counterparties, the use of ISDA master agreements and counterparties limits. We do not anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.

29


Note 9 – Other Noninterest Expenses
A summary of expenses included in other noninterest expenses is as follows for the:

Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30
 
2016
 
2015
 
2016
 
2015
Audit and related fees
$
319

 
$
223

 
$
664

 
$
582

FDIC insurance premiums
224

 
204

 
646

 
619

Director fees
207

 
204

 
630

 
608

Consulting fees
198

 
124

 
567

 
341

Loan underwriting fees
142

 
98

 
377

 
248

Donations and community relations
134

 
155

 
374

 
412

Marketing costs
101

 
124

 
359

 
350

Education and travel
90

 
91

 
351

 
319

Postage and freight
95

 
94

 
292

 
284

Printing and supplies
103

 
111

 
286

 
309

Legal fees
68

 
121

 
226

 
273

All other
479

 
623

 
1,703

 
1,593

Total other
$
2,160

 
$
2,172

 
$
6,475

 
$
5,938

Note 10 – Federal Income Taxes
The reconciliation of the provision for federal income taxes and the amount computed at the federal statutory tax rate of 34% of income before federal income tax expense is as follows for the:

Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30
 
2016
 
2015
 
2016
 
2015
Income taxes at 34% statutory rate
$
1,481

 
$
1,723

 
$
4,036

 
$
4,959

Effect of nontaxable income
 
 
 
 
 
 
 
Interest income on tax exempt municipal securities
(477
)
 
(509
)
 
(1,465
)
 
(1,519
)
Earnings on corporate owned life insurance policies
(62
)
 
(64
)
 
(192
)
 
(194
)
Effect of tax credits
(188
)
 
(175
)
 
(575
)
 
(542
)
Other
(19
)
 
(18
)
 
(55
)
 
(70
)
Total effect of nontaxable income
(746
)
 
(766
)
 
(2,287
)
 
(2,325
)
Effect of nondeductible expenses
28

 
45

 
106

 
116

Federal income tax expense
$
763

 
$
1,002

 
$
1,855

 
$
2,750

Note 11 – Fair Value
Following is a description of the valuation methodologies, key inputs, and an indication of the level of the fair value hierarchy in which the assets or liabilities are classified.
Cash and cash equivalents: The carrying amounts of cash and demand deposits due from banks and interest bearing balances due from banks approximate fair values. As such, we classify cash and cash equivalents as Level 1.
AFS securities: AFS securities are recorded at fair value on a recurring basis. Level 1 fair value measurement is based upon quoted prices for identical instruments. Level 2 fair value measurement is based upon quoted prices for similar instruments. If quoted prices are not available, fair values are measured using independent pricing models or other model based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions. The values for Level 1 and Level 2 investment securities are generally obtained from an independent third party. On a quarterly basis, we compare the values provided to alternative pricing sources.

30


Mortgage loans AFS: Mortgage loans AFS are carried at the lower of cost or fair value. The fair value of Mortgage loans AFS are based on the price secondary markets are currently offering for portfolios with similar characteristics. As such, we classify Mortgage loans AFS subject to nonrecurring fair value adjustments as Level 2.
Loans: For variable rate loans with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. As such, we classify loans as Level 3 assets.
We do not record loans at fair value on a recurring basis. However, from time-to-time, loans are classified as impaired and a specific allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will be significantly different than the contractual terms of the original loan agreement are considered impaired. Once a loan is identified as impaired, we measure the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell, if the loan is collateral dependent. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.
We review the net realizable values of the underlying collateral for collateral dependent impaired loans on at least a quarterly basis for all loan types. To determine the collateral value, we utilize independent appraisals, broker price opinions, or internal evaluations. We review these valuations to determine whether an additional discount should be applied given the age of market information that may have been considered as well as other factors such as costs to sell an asset if it is determined that the collateral will be liquidated in connection with the ultimate settlement of the loan. We use these valuations to determine if any specific reserves or charge-offs are necessary. We may obtain new valuations in certain circumstances, including when there has been significant deterioration in the condition of the collateral, if the foreclosure process has begun, or if the existing valuation is deemed to be outdated.
The following tables list the quantitative fair value information about impaired loans as of:

September 30, 2016
Valuation Technique
Fair Value
Unobservable Input
 
Range
 
 
Discount applied to collateral appraisal:
 
 
 
 
Real Estate
 
20% - 30%
 
 
Equipment
 
20% - 50%
Discounted appraisal value
$8,844
Furniture, fixtures & equipment
 
45%
 
 
Cash crop inventory
 
40%
 
 
Other inventory
 
50%
 
 
Accounts receivable
 
50%
 
 
Liquor license
 
75%

December 31, 2015
Valuation Technique
Fair Value
Unobservable Input
 
Range
 
 
Discount applied to collateral appraisal:
 
 
 
 
Real Estate
 
20% - 30%
 
 
Equipment
 
20% - 35%
Discounted appraisal value
$9,301
Furniture, fixtures & equipment
 
35% - 45%
 
 
Cash crop inventory
 
40%
 
 
Other inventory
 
50%
 
 
Accounts receivable
 
50%
 
 
Liquor license
 
75%
Discount factors with ranges are based on the age of the independent appraisal, broker price opinion, or internal evaluation.
Accrued interest receivable: The carrying amounts of accrued interest receivable approximate fair value. As such, we classify accrued interest receivable as Level 1.

31


Equity securities without readily determinable fair values: Included in equity securities without readily determinable fair values are FHLB stock and FRB stock as well as our ownership interests in Corporate Settlement Solutions, LLC and Valley Financial Corporation. The investment in Corporate Settlement Solutions, LLC, a title insurance company, was made in the first quarter 2008 and we account for our investment under the equity method of accounting. Valley Financial Corporation is the parent company of 1st State Bank in Saginaw, Michigan, which is a community bank that opened in 2005. We made investments in Valley Financial Corporation in 2004 and in 2007 and we account for our investment under the cost method of accounting.
The lack of an active market, or other independent sources to validate fair value estimates coupled with the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. As the fair values of these investments are not readily determinable, they are not disclosed under a specific fair value hierarchy; however, they are reviewed quarterly for impairment. If we were to record an impairment adjustment related to these securities, it would be classified as a nonrecurring Level 3 fair value adjustment. During 2016 and 2015, there were no impairments recorded on equity securities without readily determinable fair values.
Foreclosed assets: Upon transfer from the loan portfolio, foreclosed assets (which are included in other assets) are adjusted to and subsequently carried at the lower of carrying value or fair value less costs to sell. Net realizable value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. Due to the inherent level of estimation in the valuation process, we classify foreclosed assets as nonrecurring Level 3.
The table below lists the quantitative fair value information related to foreclosed assets as of:
 
September 30, 2016
Valuation Technique
Fair Value
 
Unobservable Input
 
Range
 
 
 
Discount applied to collateral appraisal:
 
 
Discounted appraisal value
$
284

 
Real Estate
 
20% - 30%
 
December 31, 2015
Valuation Technique
Fair Value
 
Unobservable Input
 
Range
 
 
 
Discount applied to collateral appraisal:
 
 
Discounted appraisal value
$
421

 
Real Estate
 
20% - 30%
Discount factors with ranges are based on the age of the independent appraisal, broker price opinion, or internal evaluations.
Goodwill and other intangible assets: Acquisition intangibles and goodwill are evaluated for potential impairment on at least an annual basis. Acquisition intangibles and goodwill are typically qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired. If it is determined that the carrying balance of acquisition intangibles or goodwill is more likely than not to be impaired, we perform a cash flow valuation to determine the extent of the potential impairment. If the testing resulted in impairment, we would classify goodwill and other acquisition intangibles subjected to nonrecurring fair value adjustments as Level 3. During 2016 and 2015, there were no impairments recorded on goodwill and other acquisition intangibles.
OMSR: OMSR (which are included in other assets) are subject to impairment testing. To test for impairment, we utilize a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and discount rates. If the valuation model reflects a value less than the carrying value, OMSR are adjusted to fair value through a valuation allowance as determined by the model. As such, we classify OMSR subject to nonrecurring fair value adjustments as Level 2.
Deposits: The fair value of demand, savings, and money market deposits are equal to their carrying amounts and are classified as Level 1. Fair values for variable rate certificates of deposit approximate their carrying value. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. As such, fixed rate certificates of deposit are classified as Level 2.
Borrowed funds: The carrying amounts of federal funds purchased, borrowings under overnight repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values. The fair values of other borrowed funds are estimated using discounted cash flow analyses based on current incremental borrowing arrangements. As such, borrowed funds are classified as Level 2.

32


Accrued interest payable: The carrying amounts of accrued interest payable approximate fair value. As such, we classify accrued interest payable as Level 1.
Derivative instruments: Derivative instruments, consisting solely of interest rate swaps, are recorded at fair value on a recurring basis. Derivatives qualifying as cash flow hedges, when highly effective, are reported at fair value in other assets or other liabilities on our Consolidated Balance Sheets with changes in value recorded in OCI. Should the hedge no longer be considered effective, the ineffective portion of the change in fair value is recorded directly in earnings in the period in which the change occurs. The fair value of a derivative is determined by quoted market prices and model based valuation techniques. As such, we classify derivative instruments as Level 2.
Commitments to extend credit, standby letters of credit, and undisbursed loans: Our commitments to extend credit, standby letters of credit, and undisbursed funds have no carrying amount and are estimated to have no realizable fair value. Historically, a majority of the unused commitments to extend credit have not been drawn upon and, generally, we do not receive fees in connection with these commitments other than standby letter of credit fees, which are not significant.
The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Although we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement.
Estimated Fair Values of Financial Instruments Not Recorded at Fair Value in their Entirety on a Recurring Basis
Disclosure of the estimated fair values of financial instruments, which differ from carrying values, often requires the use of estimates. In cases where quoted market values in an active market are not available, we use present value techniques and other valuation methods to estimate the fair values of our financial instruments. These valuation methods require considerable judgment and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used.
The carrying amount and estimated fair value of financial instruments not recorded at fair value in their entirety on a recurring basis were as follows as of:
 
September 30, 2016

Carrying
Value
 
Estimated
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
21,335

 
$
21,335

 
$
21,335

 
$

 
$

Mortgage loans AFS
685

 
691

 

 
691

 

Gross loans
989,366

 
979,645

 

 

 
979,645

Less allowance for loan and lease losses
7,800

 
7,800

 

 

 
7,800

Net loans
981,566

 
971,845

 

 

 
971,845

Accrued interest receivable
6,868

 
6,868

 
6,868

 

 

Equity securities without readily determinable fair values (1)
22,573

 
N/A

 

 

 

OMSR
2,068

 
2,068

 

 
2,068

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
739,035

 
739,035

 
739,035

 

 

Deposits with stated maturities
436,798

 
435,892

 

 
435,892

 

Borrowed funds
325,409

 
330,077

 

 
330,077

 

Accrued interest payable
542

 
542

 
542

 

 


33


 
December 31, 2015
 
Carrying
Value
 
Estimated
Fair Value
 
(Level 1)
 
(Level 2)
 
(Level 3)
ASSETS
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
21,569

 
$
21,569

 
$
21,569

 
$

 
$

Mortgage loans AFS
1,187

 
1,210

 

 
1,210

 

Gross loans
850,492

 
839,398

 

 

 
839,398

Less allowance for loan and lease losses
7,400

 
7,400

 

 

 
7,400

Net loans
843,092

 
831,998

 

 

 
831,998

Accrued interest receivable
6,269

 
6,269

 
6,269

 

 

Equity securities without readily determinable fair values (1)
22,286

 
N/A

 

 

 

OMSR
2,505

 
2,518

 

 
2,518

 

LIABILITIES
 
 
 
 
 
 
 
 
 
Deposits without stated maturities
741,683

 
741,683

 
741,683

 

 

Deposits with stated maturities
422,880

 
421,429

 

 
421,429

 

Borrowed funds
309,732

 
312,495

 

 
312,495

 

Accrued interest payable
545

 
545

 
545

 

 

(1) 
Due to the characteristics of equity securities without readily determinable fair values, they are not disclosed under a specific fair value hierarchy. If we were to record an impairment adjustment related to these securities, such amount would be classified as a nonrecurring Level 3 fair value adjustment.
Financial Instruments Recorded at Fair Value
The table below presents the recorded amount of assets and liabilities measured at fair value on:
 
September 30, 2016
 
December 31, 2015

Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
 
Total
 
(Level 1)
 
(Level 2)
 
(Level 3)
Recurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
AFS securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Government-sponsored enterprises
$
344

 
$

 
$
344

 
$

 
$
24,345

 
$

 
$
24,345

 
$

States and political subdivisions
219,689

 

 
219,689

 

 
232,217

 

 
232,217

 

Auction rate money market preferred
3,145

 

 
3,145

 

 
2,866

 

 
2,866

 

Preferred stocks
3,588

 
3,588

 

 

 
3,299

 
3,299

 

 

Mortgage-backed securities
226,649

 

 
226,649

 

 
263,384

 

 
263,384

 

Collateralized mortgage obligations
110,814

 

 
110,814

 

 
134,025

 

 
134,025

 

Total AFS securities
564,229

 
3,588

 
560,641

 

 
660,136

 
3,299

 
656,837

 

Derivative instruments
(61
)
 

 
(61
)
 

 

 

 

 

Nonrecurring items
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Impaired loans (net of the ALLL)
8,844

 

 

 
8,844

 
9,301

 

 

 
9,301

Foreclosed assets
284

 

 

 
284

 
421

 

 

 
421

Total
$
573,296

 
$
3,588

 
$
560,580

 
$
9,128

 
$
669,858

 
$
3,299

 
$
656,837

 
$
9,722

Percent of assets and liabilities measured at fair value
 
 
0.63
%
 
97.78
%
 
1.59
%
 
 
 
0.49
%
 
98.06
%
 
1.45
%
We had no assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a recurring basis, as of September 30, 2016. Additionally, we had no assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a nonrecurring basis, as of September 30, 2016.

34


Note 12 – Accumulated Other Comprehensive Income
The following table summarizes the changes in AOCI by component for the:
 
Three Months Ended September 30
 
2016
 
2015

Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
 
Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
Balance, July 1
$
10,982

 
$
(100
)
 
$
(3,315
)
 
$
7,567

 
$
1,937

 
$

 
$
(3,808
)
 
$
(1,871
)
OCI before reclassifications
(2,548
)
 
91

 

 
(2,457
)
 
5,301

 

 

 
5,301

Amounts reclassified from AOCI

 

 

 

 

 

 

 

Subtotal
(2,548
)
 
91

 

 
(2,457
)
 
5,301

 

 

 
5,301

Tax effect
937

 
(31
)
 

 
906

 
(1,818
)
 

 

 
(1,818
)
OCI, net of tax
(1,611
)
 
60

 

 
(1,551
)
 
3,483

 

 

 
3,483

Balance, September 30
$
9,371

 
$
(40
)
 
$
(3,315
)
 
$
6,016

 
$
5,420

 
$

 
$
(3,808
)
 
$
1,612

 
Nine Months Ended September 30
 
2016
 
2015

Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
 
Unrealized
Holding Gains
(Losses) on
AFS
Securities
 
Unrealized
Gains
(Losses) on Derivative Instruments
 
Defined
Benefit
Pension Plan
 
Total
Balance, January 1
$
3,536

 
$

 
$
(3,315
)
 
$
221

 
$
3,302

 
$

 
$
(3,808
)
 
$
(506
)
OCI before reclassifications
8,793

 
(61
)
 

 
8,732

 
3,137

 

 

 
3,137

Amounts reclassified from AOCI
(245
)
 

 

 
(245
)
 

 

 

 

Subtotal
8,548

 
(61
)
 

 
8,487

 
3,137

 

 

 
3,137

Tax effect
(2,713
)
 
21

 

 
(2,692
)
 
(1,019
)
 

 

 
(1,019
)
OCI, net of tax
5,835

 
(40
)
 

 
5,795

 
2,118

 

 

 
2,118

Balance, September 30
$
9,371

 
$
(40
)
 
$
(3,315
)
 
$
6,016

 
$
5,420

 
$

 
$
(3,808
)
 
$
1,612

Included in OCI for the three and nine month periods ended September 30, 2016 and 2015 are changes in unrealized holding gains and losses related to auction rate money market preferred and preferred stocks. For federal income tax purposes, these securities are considered equity investments. As such, no deferred federal income taxes related to unrealized holding gains or losses are expected or recorded.

35


A summary of the components of unrealized holding gains on AFS securities included in OCI follows for the:
 
Three Months Ended September 30
 
2016
 
2015

Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
 
Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
Unrealized gains (losses) arising during the period
$
208

 
$
(2,756
)
 
$
(2,548
)
 
$
140

 
$
5,161

 
$
5,301

Reclassification adjustment for net realized (gains) losses included in net income

 

 

 

 

 

Net unrealized gains (losses)
208

 
(2,756
)
 
(2,548
)
 
140

 
5,161

 
5,301

Tax effect

 
937

 
937

 

 
(1,818
)
 
(1,818
)
Unrealized gains (losses), net of tax
$
208

 
$
(1,819
)
 
$
(1,611
)
 
$
140

 
$
3,343

 
$
3,483

 
Nine Months Ended September 30
 
2016
 
2015
 
Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
 
Auction Rate Money Market Preferred and Preferred Stocks
 
All Other AFS Securities
 
Total
Unrealized gains (losses) arising during the period
$
568

 
$
8,225

 
$
8,793

 
$
140

 
$
2,997

 
$
3,137

Reclassification adjustment for net realized (gains) losses included in net income

 
(245
)
 
(245
)
 

 

 

Net unrealized gains (losses)
568

 
7,980

 
8,548

 
140

 
2,997

 
3,137

Tax effect

 
(2,713
)
 
(2,713
)
 

 
(1,019
)
 
(1,019
)
Unrealized gains (losses), net of tax
$
568

 
$
5,267

 
$
5,835

 
$
140

 
$
1,978

 
$
2,118


36


Note 13 – Parent Company Only Financial Information
Interim Condensed Balance Sheets

September 30
2016
 
December 31
2015
ASSETS
 
 
 
Cash on deposit at the Bank
$
1,250

 
$
4,125

AFS securities
251

 
257

Investments in subsidiaries
145,320

 
133,883

Premises and equipment
1,983

 
2,014

Other assets
53,509

 
53,396

TOTAL ASSETS
$
202,313

 
$
193,675

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Other liabilities
$
7,129

 
$
9,704

Shareholders' equity
195,184

 
183,971

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
202,313

 
$
193,675

Interim Condensed Statements of Income
 
Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30

2016
 
2015
 
2016
 
2015
Income
 
 
 
 
 
 
 
Dividends from subsidiaries
$
2,000

 
$
1,700

 
$
5,600

 
$
5,000

Interest income
3

 
4

 
11

 
75

Management fee and other
1,680

 
1,859

 
4,962

 
4,913

Total income
3,683

 
3,563

 
10,573

 
9,988

Expenses
 
 
 
 
 
 
 
Compensation and benefits
1,196

 
1,228

 
3,580

 
3,658

Occupancy and equipment
438

 
415

 
1,281

 
1,226

Audit and related fees
193

 
101

 
389

 
316

Other
427

 
501

 
1,561

 
1,533

Total expenses
2,254

 
2,245

 
6,811

 
6,733

Income before income tax benefit and equity in undistributed earnings of subsidiaries
1,429

 
1,318

 
3,762

 
3,255

Federal income tax benefit
199

 
123

 
616

 
588

Income before equity in undistributed earnings of subsidiaries
1,628

 
1,441

 
4,378

 
3,843

Undistributed earnings of subsidiaries
1,965

 
2,622

 
5,639

 
7,991

Net income
$
3,593

 
$
4,063

 
$
10,017

 
$
11,834



37


Interim Condensed Statements of Cash Flows
 
Nine Months Ended 
 September 30

2016
 
2015
Operating activities
 
 
 
Net income
$
10,017

 
$
11,834

Adjustments to reconcile net income to cash provided by operations
 
 
 
Undistributed earnings of subsidiaries
(5,639
)
 
(7,991
)
Undistributed earnings of equity securities without readily determinable fair values
(287
)
 
(364
)
Share-based payment awards under equity compensation plan
443

 
425

Depreciation
117

 
113

Changes in operating assets and liabilities which provided (used) cash
 
 
 
Other assets
177

 
406

Accrued interest and other liabilities
(2,575
)
 
94

Net cash provided by (used in) operating activities
2,253

 
4,517

Investing activities
 
 
 
Maturities, calls, principal payments, and sales of AFS securities

 
3,000

Purchases of premises and equipment
(86
)
 
(146
)
Net (advances to) repayments from subsidiaries

 
300

Net cash provided by (used in) investing activities
(86
)
 
3,154

Financing activities
 
 
 
Net increase (decrease) in borrowed funds

 
(211
)
Cash dividends paid on common stock
(5,697
)
 
(5,416
)
Proceeds from the issuance of common stock
3,683

 
3,310

Common stock repurchased
(2,749
)
 
(3,588
)
Common stock purchased for deferred compensation obligations
(279
)
 
(279
)
Net cash provided by (used in) financing activities
(5,042
)
 
(6,184
)
Increase (decrease) in cash and cash equivalents
(2,875
)
 
1,487

Cash and cash equivalents at beginning of period
4,125

 
1,035

Cash and cash equivalents at end of period
$
1,250

 
$
2,522

Note 14 – Operating Segments
Our reportable segments are based on legal entities that account for at least 10% of net operating results. The operations of the Bank as of September 30, 2016 and 2015 and each of the three and nine month periods then ended, represent approximately 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented.

38


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
ISABELLA BANK CORPORATION FINANCIAL REVIEW
(Dollars in thousands except per share amounts)
This section reviews our financial condition and results of our operations for the unaudited three and nine month periods ended September 30, 2016 and 2015. This analysis should be read in conjunction with our 2015 Annual Report on Form 10-K and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 4 of this report.
Executive Summary
During the three and nine months ended September 30, 2016, we reported net income of $3,593 and $10,017 and earnings per common share of $0.46 and $1.28, respectively. Net income and earnings per common share for the same periods of 2015 were $4,063 and $11,834 and $0.52 and $1.52, respectively. While interest income for the first nine months of 2016 increased $1,427 in comparison to the same period in 2015, the decrease in net income and earnings per common share is due primarily to changes in the provision for loan losses. During the first nine months of 2016, an increase in gross loans of $138,874, offset by improvements in various credit quality indicators and net loan recoveries, resulted in a provision for loan losses in the amount of $185. By contrast, during the first nine months of 2015, a reduction in gross loans during the period of $235, coupled with significant improvements in various credit quality indicators, resulted in a reversal of the provision for loan losses in the amount of $1,999.
During the nine month period ended September 30, 2016, total assets grew by 2.30% to $1,706,498, and assets under management increased to $2,406,108 which includes loans sold and serviced, and assets managed by our Investment and Trust Services Department of $699,610. Total loans increased by $138,874 from December 31, 2015 which was largely driven by growth in the commercial portfolio. During the third quarter of 2016, we began to participate in advances to mortgage brokers which contributed $27,832 of the growth in the commercial loan portfolio. Growth in our residential mortgage and consumer loan portfolios has been challenging; however, we have seen growth during the first nine months of 2016. Our residential mortgage and consumer loan portfolios were $260,122 and $40,760 as of September 30, 2016 compared to $251,501 and $34,699 as of December 31, 2015, respectively. We implemented new products, enhanced our marketing efforts and streamlined delivery channels for direct and indirect loans in an effort to generate growth by attracting new customers while expanding our relationships with current customers.
Our net yield on interest earning assets remains historically low at 3.00% for the nine month period ended September 30, 2016. The growth in net interest income will increase only through continued growth in a strategic mix of loans, investments, and other income earning assets. We do not anticipate that the Federal Reserve Bank will increase short term interest rates significantly in the remainder of 2016; therefore, we do not anticipate significant improvements in our net yield on interest earning assets in the short term. We are committed to increasing earnings and shareholder value through growth in our loan portfolio, growth in our investment and trust services, and increasing our geographical presence while managing operating costs.
Reclassifications: Certain amounts reported in the 2015 consolidated financial statements have been reclassified to conform with the 2016 presentation.
Restatements: In this Quarterly Report on Form 10-Q, certain prior period financial information has been restated due to an accounting correction. All amounts in this Quarterly Report on Form 10-Q affected by the restatement adjustments are reflected as the restated amounts. For information related to the restatement, refer to our Annual Report on Form 10-K for the year ended December 31, 2015.

39


Results of Operations

The following table outlines our results of operations and provides certain performance measures as of, and for the three month periods ended:

September 30
2016
 
June 30
2016
 
March 31
2016
 
December 31
2015
 
September 30
2015
INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
Interest income
$
13,607

 
$
13,218

 
$
13,081

 
$
13,023

 
$
12,967

Interest expense
2,747

 
2,678

 
2,614

 
2,577

 
2,580

Net interest income
10,860

 
10,540

 
10,467

 
10,446

 
10,387

Provision for loan losses
17

 
12

 
156

 
(772
)
 
(738
)
Noninterest income
2,946

 
2,752

 
2,223

 
2,501

 
3,101

Noninterest expenses
9,433

 
9,218

 
9,080

 
9,885

 
9,161

Federal income tax expense
763

 
655

 
437

 
538

 
1,002

Net Income
$
3,593

 
$
3,407

 
$
3,017

 
$
3,296

 
$
4,063

PER SHARE
 
 
 
 
 
 
 
 
 
Basic earnings
$
0.46

 
$
0.44

 
$
0.39

 
$
0.42

 
$
0.52

Diluted earnings
$
0.45

 
$
0.43

 
$
0.38

 
$
0.41

 
$
0.51

Dividends
$
0.25

 
$
0.24

 
$
0.24

 
$
0.24

 
$
0.24

Tangible book value*
$
17.93

 
$
17.72

 
$
17.47

 
$
17.30

 
$
17.06

Quoted market value
 
 
 
 
 
 
 
 
 
High
$
28.08

 
$
28.25

 
$
29.90

 
$
29.90

 
$
23.85

Low
$
27.60

 
$
27.63

 
$
27.25

 
$
23.50

 
$
22.75

Close*
$
27.70

 
$
27.90

 
$
28.25

 
$
29.90

 
$
23.69

Common shares outstanding*
7,833,481

 
7,836,442

 
7,809,079

 
7,799,867

 
7,765,333

PERFORMANCE RATIOS
 
 
 
 
 
 
 
 
 
Return on average total assets
0.85
%
 
0.81
%
 
0.72
%
 
0.81
%
 
1.01
%
Return on average shareholders' equity
7.27
%
 
7.05
%
 
6.37
%
 
7.17
%
 
9.03
%
Return on average tangible shareholders' equity
10.28
%
 
9.89
%
 
8.88
%
 
9.83
%
 
12.18
%
Net interest margin yield (FTE)
3.05
%
 
2.97
%
 
2.98
%
 
3.04
%
 
3.09
%
BALANCE SHEET DATA*
 
 
 
 
 
 
 
 
 
Gross loans
$
989,366

 
$
919,594

 
$
870,291

 
$
850,492

 
$
836,671

AFS securities
$
564,229

 
$
602,463

 
$
649,859

 
$
660,136

 
$
628,612

Total assets
$
1,706,498

 
$
1,680,359

 
$
1,681,818

 
$
1,668,112

 
$
1,619,250

Deposits
$
1,175,833

 
$
1,156,870

 
$
1,173,507

 
$
1,164,563

 
$
1,128,003

Borrowed funds
$
325,409

 
$
318,596

 
$
307,896

 
$
309,732

 
$
297,610

Shareholders' equity
$
195,184

 
$
195,133

 
$
190,247

 
$
183,971

 
$
182,998

Gross loans to deposits
84.14
%
 
79.49
%
 
74.16
%
 
73.03
%
 
74.17
%
ASSETS UNDER MANAGEMENT*
 
 
 
 
 
 
 
 
 
Loans sold with servicing retained
$
275,037

 
$
275,958

 
$
282,618

 
$
287,029

 
$
289,268

Assets managed by our Investment and Trust Services Department
$
424,573

 
$
415,762

 
$
408,224

 
$
405,109

 
$
392,124

Total assets under management
$
2,406,108

 
$
2,372,079

 
$
2,372,660

 
$
2,360,250

 
$
2,300,642

ASSET QUALITY*
 
 
 
 
 
 
 
 
 
Nonperforming loans to gross loans
0.16
%
 
0.13
%
 
0.12
%
 
0.09
%
 
0.10
%
Nonperforming assets to total assets
0.11
%
 
0.09
%
 
0.08
%
 
0.07
%
 
0.09
%
ALLL to gross loans
0.79
%
 
0.83
%
 
0.86
%
 
0.87
%
 
0.98
%
CAPITAL RATIOS*
 
 
 
 
 
 
 
 
 
Shareholders' equity to assets
11.44
%
 
11.61
%
 
11.31
%
 
11.03
%
 
11.30
%
Tier 1 leverage
8.59
%
 
8.50
%
 
8.44
%
 
8.52
%
 
8.54
%
Common equity tier 1 capital
12.41
%
 
13.08
%
 
13.24
%
 
13.44
%
 
13.57
%
Tier 1 risk-based capital
12.41
%
 
13.08
%
 
13.24
%
 
13.44
%
 
13.57
%
Total risk-based capital
13.10
%
 
13.80
%
 
13.97
%
 
14.17
%
 
14.20
%
* At end of period

40


The following table outlines our results of operations and provides certain performance measures as of, and for the nine month periods ended:

September 30
2016
 
September 30
2015
 
September 30
2014
 
September 30
2013
 
September 30
2012
INCOME STATEMENT DATA
 
 
 
 
 
 
 
 
 
Interest income
$
39,906

 
$
38,479

 
$
38,118

 
$
37,695

 
$
40,174

Interest expense
8,039

 
7,586

 
7,466

 
8,338

 
10,372

Net interest income
31,867

 
30,893

 
30,652

 
29,357

 
29,802

Provision for loan losses
185

 
(1,999
)
 
(604
)
 
866

 
1,100

Noninterest income
7,921

 
7,858

 
6,899

 
8,045

 
8,844

Noninterest expenses
27,731

 
26,166

 
26,180

 
25,057

 
25,507

Federal income tax expense
1,855

 
2,750

 
1,696

 
1,893

 
2,344

Net Income
$
10,017

 
$
11,834


$
10,279

 
$
9,586

 
$
9,695

PER SHARE
 
 
 
 
 
 
 
 
 
Basic earnings
$
1.28

 
$
1.52

 
$
1.33

 
$
1.25

 
$
1.28

Diluted earnings
$
1.25

 
$
1.49

 
$
1.30

 
$
1.22

 
$
1.24

Dividends
$
0.73

 
$
0.70

 
$
0.66

 
$
0.63

 
$
0.60

Tangible book value*
$
17.93

 
$
17.06

 
$
16.33

 
$
15.43

 
$
14.65

Quoted market value
 
 
 
 
 
 
 
 
 
High
$
29.90

 
$
23.85

 
$
24.00

 
$
26.00

 
$
24.98

Low
$
27.25

 
$
22.00

 
$
21.73

 
$
21.55

 
$
22.30

Close*
$
27.70

 
$
23.69

 
$
23.60

 
$
24.85

 
$
22.50

Common shares outstanding*
7,833,481

 
7,765,333

 
7,740,730

 
7,709,781

 
7,611,350

PERFORMANCE RATIOS
 
 
 
 
 
 
 
 
 
Return on average total assets
0.80
%
 
1.00
%
 
0.90
%
 
0.89
%
 
0.94
%
Return on average shareholders' equity
6.90
%
 
8.80
%
 
8.13
%
 
7.84
%
 
8.37
%
Return on average tangible shareholders' equity
9.68
%
 
12.06
%
 
10.95
%
 
11.02
%
 
11.96
%
Net interest margin yield (FTE)
3.00
%
 
3.12
%
 
3.20
%
 
3.22
%
 
3.46
%
BALANCE SHEET DATA*
 
 
 
 
 
 
 
 
 
Gross loans
$
989,366

 
$
836,671

 
$
825,238

 
$
810,335

 
$
768,452

AFS securities
$
564,229

 
$
628,612

 
$
575,080

 
$
501,057

 
$
467,414

Total assets
$
1,706,498

 
$
1,619,250

 
$
1,553,974

 
$
1,459,341

 
$
1,389,138

Deposits
$
1,175,833

 
$
1,128,003

 
$
1,081,890

 
$
1,023,931

 
$
989,491

Borrowed funds
$
325,409

 
$
297,610

 
$
290,438

 
$
266,001

 
$
226,580

Shareholders' equity
$
195,184

 
$
182,998

 
$
172,076

 
$
161,305

 
$
164,147

Gross loans to deposits
84.14
%
 
74.17
%
 
76.28
%
 
79.14
%
 
77.66
%
ASSETS UNDER MANAGEMENT*
 
 
 
 
 
 
 
 
 
Loans sold with servicing retained
$
275,037

 
$
289,268

 
$
290,697

 
$
294,999

 
$
304,523

Assets managed by our Investment and Trust Services Department
$
424,573

 
$
392,124

 
$
374,878

 
$
351,505

 
$
321,661

Total assets under management
$
2,406,108

 
$
2,300,642

 
$
2,219,549

 
$
2,105,845

 
$
2,015,322

ASSET QUALITY*
 
 
 
 
 
 
 
 
 
Nonperforming loans to gross loans
0.16
%
 
0.10
%
 
0.56
%
 
0.53
%
 
0.98
%
Nonperforming assets to total assets
0.11
%
 
0.09
%
 
0.37
%
 
0.37
%
 
0.68
%
ALLL to gross loans
0.79
%
 
0.98
%
 
1.26
%
 
1.44
%
 
1.57
%
CAPITAL RATIOS*
 
 
 
 
 
 
 
 
 
Shareholders' equity to assets
11.44
%
 
11.30
%
 
11.07
%
 
11.05
%
 
11.82
%
Tier 1 leverage
8.59
%
 
8.54
%
 
8.47
%
 
8.45
%
 
8.27
%
Common equity tier 1 capital
12.41
%
 
13.57
%
 
N/A

 
N/A

 
N/A

Tier 1 risk-based capital
12.41
%
 
13.57
%
 
13.86
%
 
13.75
%
 
13.35
%
Total risk-based capital
13.10
%
 
14.20
%
 
15.11
%
 
15.00
%
 
14.60
%
* At end of period

41


Average Balances, Interest Rate, and Net Interest Income
The following schedules present the daily average amount outstanding for each major category of interest earning assets, nonearning assets, interest bearing liabilities, and noninterest bearing liabilities. These schedules also present an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a FTE basis using a 34% federal income tax rate. Loans in nonaccrual status, for the purpose of the following computations, are included in the average loan balances. FRB and FHLB restricted equity holdings are included in accrued income and other assets.

Three Months Ended

September 30, 2016

June 30, 2016

September 30, 2015

Average
Balance

Tax
Equivalent
Interest

Average
Yield /
Rate

Average
Balance

Tax
Equivalent
Interest

Average
Yield /
Rate

Average
Balance

Tax
Equivalent
Interest

Average
Yield /
Rate
INTEREST EARNING ASSETS

















Loans
$
948,465


$
9,965


4.20
%

$
893,282


$
9,317


4.17
%

$
831,520


$
8,984


4.32
%
Taxable investment securities
365,612


2,037


2.23
%

419,252


2,303


2.20
%

402,993


2,310


2.29
%
Nontaxable investment securities
203,236


2,312


4.55
%

208,425


2,356


4.52
%

207,443


2,459


4.74
%
Other
25,134


194


3.09
%

23,564


157


2.67
%

27,689


166


2.40
%
Total earning assets
1,542,447


14,508


3.76
%

1,544,523


14,133


3.66
%

1,469,645


13,919


3.79
%
NONEARNING ASSETS

















Allowance for loan losses
(7,731
)





(7,557
)





(9,007
)




Cash and demand deposits due from banks
18,672






17,942






18,442





Premises and equipment
28,865






28,363






26,904





Accrued income and other assets
104,125






101,341






98,767





Total assets
$
1,686,378






$
1,684,612






$
1,604,751





INTEREST BEARING LIABILITIES

















Interest bearing demand deposits
$
203,994


41


0.08
%

$
204,044


40


0.08
%

$
198,351


40


0.08
%
Savings deposits
330,872


178


0.22
%

340,251


144


0.17
%

306,816


123


0.16
%
Time deposits
433,591


1,277


1.18
%

427,753


1,234


1.15
%

434,103


1,317


1.21
%
Borrowed funds
314,218


1,251


1.59
%

320,337


1,260


1.57
%

292,858


1,100


1.50
%
Total interest bearing liabilities
1,282,675


2,747


0.86
%

1,292,385


2,678


0.83
%

1,232,128


2,580


0.84
%
NONINTEREST BEARING LIABILITIES

















Demand deposits
196,682






189,520






181,289





Other
9,332






9,360






11,357





Shareholders’ equity
197,689






193,347






179,977





Total liabilities and shareholders’ equity
$
1,686,378






$
1,684,612






$
1,604,751





Net interest income (FTE)


$
11,761






$
11,455






$
11,339



Net yield on interest earning assets (FTE)




3.05
%





2.97
%





3.09
%

42


 
Nine Months Ended
 
September 30, 2016
 
September 30, 2015

Average
Balance
 
Tax
Equivalent
Interest
 
Average
Yield /
Rate
 
Average
Balance
 
Tax
Equivalent
Interest
 
Average
Yield /
Rate
INTEREST EARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
Loans
$
900,021

 
$
28,320

 
4.20
%
 
$
826,393

 
$
26,884

 
4.34
%
Taxable investment securities
405,722

 
6,740

 
2.21
%
 
388,964

 
6,655

 
2.28
%
Nontaxable investment securities
207,769

 
7,091

 
4.55
%
 
202,294

 
7,423

 
4.89
%
Other
25,208

 
509

 
2.69
%
 
25,769

 
444

 
2.30
%
Total earning assets
1,538,720

 
42,660

 
3.70
%
 
1,443,420

 
41,406

 
3.82
%
NONEARNING ASSETS
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses
(7,576
)
 
 
 
 
 
(9,630
)
 
 
 
 
Cash and demand deposits due from banks
18,130

 
 
 
 
 
17,824

 
 
 
 
Premises and equipment
28,495

 
 
 
 
 
26,481

 
 
 
 
Accrued income and other assets
102,072

 
 
 
 
 
98,124

 
 
 
 
Total assets
$
1,679,841

 
 
 
 
 
$
1,576,219

 
 
 
 
INTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits
$
205,444

 
123

 
0.08
%
 
$
194,648

 
116

 
0.08
%
Savings deposits
337,863

 
466

 
0.18
%
 
284,886

 
311

 
0.15
%
Time deposits
427,441

 
3,724

 
1.16
%
 
435,853

 
3,978

 
1.22
%
Borrowed funds
315,061

 
3,726

 
1.58
%
 
292,127

 
3,181

 
1.45
%
Total interest bearing liabilities
1,285,809

 
8,039

 
0.83
%
 
1,207,514

 
7,586

 
0.84
%
NONINTEREST BEARING LIABILITIES
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
191,082

 
 
 
 
 
178,353

 
 
 
 
Other
9,435

 
 
 
 
 
11,106

 
 
 
 
Shareholders’ equity
193,515

 
 
 
 
 
179,246

 
 
 
 
Total liabilities and shareholders’ equity
$
1,679,841

 
 
 
 
 
$
1,576,219

 
 
 
 
Net interest income (FTE)
 
 
$
34,621

 
 
 
 
 
$
33,820

 
 
Net yield on interest earning assets (FTE)
 
 
 
 
3.00
%
 
 
 
 
 
3.12
%
Net Interest Income
Net interest income is the amount by which interest income on earning assets exceeds the interest expenses on interest bearing liabilities. Net interest income is influenced by changes in the balance and mix of assets and liabilities and market interest rates. We exert some control over these factors; however, FRB monetary policy and competition have a significant impact. For analytical purposes, net interest income is adjusted to an FTE basis by adding the income tax savings from interest on tax exempt loans, and nontaxable investment securities, thus making year to year comparisons more meaningful.

43


Volume and Rate Variance Analysis
The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. For the purpose of this table, changes in interest due to volume and rate were determined as follows:
Volume—change in volume multiplied by the previous period's rate.
Rate—change in the FTE rate multiplied by the previous period's volume.
The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
 
Three Months Ended 
 September 30, 2016 Compared to 
 June 30, 2016 
 Increase (Decrease) Due to
 
Three Months Ended 
 September 30, 2016 Compared to  
 September 30, 2015 
  Increase (Decrease) Due to
 
Nine Months Ended 
 September 30, 2016 Compared to 
 September 30, 2015 
 Increase (Decrease) Due to

Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
 
Volume
 
Rate
 
Net
Changes in interest income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Loans
$
579

 
$
69

 
$
648

 
$
1,234

 
$
(253
)
 
$
981

 
$
2,338

 
$
(902
)
 
$
1,436

Taxable investment securities
(298
)
 
32

 
(266
)
 
(210
)
 
(63
)
 
(273
)
 
282

 
(197
)
 
85

Nontaxable investment securities
(59
)
 
15

 
(44
)
 
(49
)
 
(98
)
 
(147
)
 
197

 
(529
)
 
(332
)
Other
11

 
26

 
37

 
(16
)
 
44

 
28

 
(10
)
 
75

 
65

Total changes in interest income
233

 
142

 
375

 
959

 
(370
)
 
589

 
2,807

 
(1,553
)
 
1,254

Changes in interest expense
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest bearing demand deposits

 
1

 
1

 
1

 

 
1

 
6

 
1

 
7

Savings deposits
(4
)
 
38

 
34

 
10

 
45

 
55

 
64

 
91

 
155

Time deposits
17

 
26

 
43

 
(2
)
 
(38
)
 
(40
)
 
(76
)
 
(178
)
 
(254
)
Borrowed funds
(24
)
 
15

 
(9
)
 
83

 
68

 
151

 
260

 
285

 
545

Total changes in interest expense
(11
)
 
80

 
69

 
92

 
75

 
167

 
254

 
199

 
453

Net change in interest margin (FTE)
$
244

 
$
62

 
$
306

 
$
867

 
$
(445
)
 
$
422

 
$
2,553

 
$
(1,752
)
 
$
801

Our net yield on interest earning assets remains at historically low levels as a result of the persistent low interest rate environment. While we do not anticipate significant improvement in our net yield on interest earning assets, we do expect marginal improvement as a result of loan growth throughout 2016.
 
Average Yield / Rate for the Three Month Periods Ended:

September 30
2016

June 30
2016

March 31
2016

December 31
2015

September 30
2015
Total earning assets
3.76
%
 
3.66
%
 
3.67
%
 
3.73
%
 
3.79
%
Total interest bearing liabilities
0.86
%
 
0.83
%
 
0.82
%
 
0.83
%
 
0.84
%
Net yield on interest earning assets (FTE)
3.05
%

2.97
%
 
2.98
%
 
3.04
%
 
3.09
%
 
Quarter to Date Net Interest Income (FTE)

September 30
2016
 
June 30
2016
 
March 31
2016
 
December 31
2015
 
September 30
2015
Total interest income (FTE)
$
14,508

 
$
14,133

 
$
14,020

 
$
13,970

 
$
13,919

Total interest expense
2,747

 
2,678

 
2,614

 
2,577

 
2,580

Net interest income (FTE)
$
11,761

 
$
11,455

 
$
11,406

 
$
11,393

 
$
11,339


44


Allowance for Loan and Lease Losses
The viability of any financial institution is ultimately determined by its management of credit risk. Loans represent our single largest concentration of risk. The ALLL is our estimation of incurred losses within the existing loan portfolio. We allocate the ALLL throughout the loan portfolio based on our assessment of the underlying risks associated with each loan segment. Our assessments include allocations based on specific impairment valuation allowances, historical charge-offs, internally assigned credit risk ratings, and past due and nonaccrual balances. A portion of the ALLL is not allocated to any one loan segment, but is instead a reflection of other qualitative risks that reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
The following table summarizes our charge-offs, recoveries, provisions for loan losses, and ALLL balances as of, and for the:
 
Three Months Ended 
 September 30
 
Nine Months Ended 
 September 30

2016
 
2015
 
2016
 
2015
ALLL at beginning of period
$
7,600

 
$
9,000

 
$
7,400

 
$
10,100

Charge-offs
 
 
 
 
 
 
 
Commercial and agricultural

 
61

 
48

 
89

Residential real estate
57

 
70

 
426

 
325

Consumer
74

 
79

 
206

 
252

Total charge-offs
131

 
210

 
680

 
666

Recoveries
 
 
 
 
 
 
 
Commercial and agricultural
118

 
68

 
488

 
459

Residential real estate
153

 
33

 
248

 
152

Consumer
43

 
47

 
159

 
154

Total recoveries
314

 
148

 
895

 
765

Net loan charge-offs
(183
)
 
62

 
(215
)
 
(99
)
Provision for loan losses
17

 
(738
)
 
185

 
(1,999
)
ALLL at end of period
$
7,800

 
$
8,200

 
$
7,800

 
$
8,200

Net loan charge-offs to average loans outstanding
(0.02
)%
 
0.01
%
 
(0.02
)%
 
(0.01
)%
The following table summarizes our charge-offs, recoveries, provisions for loan losses, and ALLL balances as of, and for the three month periods ended:

September 30
2016
 
June 30
2016
 
March 31
2016
 
December 31
2015
 
September 30
2015
Total charge-offs
$
131

 
$
208

 
$
341

 
$
238

 
$
210

Total recoveries
314

 
296

 
285

 
210

 
148

Net loan charge-offs
(183
)
 
(88
)
 
56

 
28

 
62

Net loan charge-offs to average loans outstanding
(0.02
)%
 
(0.01
)%
 
0.01
%
 
 %
 
0.01
 %
Provision for loan losses
$
17

 
$
12

 
$
156

 
$
(772
)
 
$
(738
)
Provision for loan losses to average loans outstanding
 %
 
 %
 
0.02
%
 
(0.09
)%
 
(0.09
)%
ALLL
$
7,800

 
$
7,600

 
$
7,500

 
$
7,400

 
$
8,200

ALLL as a % of loans at end of period
0.79
 %
 
0.83
 %
 
0.86
%
 
0.87
 %
 
0.98
 %
During 2015, net loan recoveries and continued improvement in credit quality indicators resulted in a reduction of the ALLL in both amount and as a percentage of loans. While we have experienced significant loan growth during 2016, the level of ALLL as of September 30, 2016 has not increased at the same rate. We continue to experience improvements in various credit quality indicators, specifically historical loss factors which have led to lower levels of required reserves. The addition of advances to mortgage brokers contributed to the overall decline in the level of ALLL to gross loans as there are no historical losses requiring reserves. While these advances contribute to other qualitative factors, the impact is not significant on the required level of the ALLL. Additionally, our recoveries continue to exceed our charge-offs which has increased the ALLL and led to lower provision for loan losses expense.

45


The following table illustrates our changes within the two main components of the ALLL as of:

September 30
2016
 
June 30
2016
 
March 31
2016
 
December 31
2015
 
September 30
2015
ALLL
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
2,523

 
$
2,602

 
$
2,731

 
$
2,820

 
$
3,217

Collectively evaluated for impairment
5,277

 
4,998

 
4,769

 
4,580

 
4,983

Total
$
7,800

 
$
7,600

 
$
7,500

 
$
7,400

 
$
8,200

ALLL to gross loans
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
0.26
%
 
0.28
%
 
0.31
%
 
0.33
%
 
0.38
%
Collectively evaluated for impairment
0.53
%
 
0.55
%
 
0.55
%
 
0.54
%
 
0.60
%
Total
0.79
%
 
0.83
%
 
0.86
%
 
0.87
%
 
0.98
%
While more volatile, loans individually evaluated for impairment have been relatively flat in recent quarters. The lower levels of loans collectively evaluated for impairment over the past year illustrates the downward trend we are experiencing in our overall level of ALLL to gross loans. As we anticipate continued loan growth during 2016, the level of those collectively evaluated for impairment is expected to increase provided there are no significant increases to the level of loans individually evaluated for impairment.
For further discussion of the allocation of the ALLL, see “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
Loans Past Due and Loans in Nonaccrual Status
Fluctuations in past due and nonaccrual status loans can have a significant impact on the ALLL. To determine the potential impact, and corresponding estimated losses, we analyze our historical loss trends on loans past due greater than 30 days and nonaccrual status loans. We monitor all loans that are past due and in nonaccrual status for indications of additional deterioration.
 
Total Past Due and Nonaccrual Loans

September 30
2016
 
June 30
2016
 
March 31
2016
 
December 31
2015
 
September 30
2015
Commercial and agricultural
$
3,148

 
$
2,247

 
$
2,167

 
$
2,247

 
$
1,709

Residential real estate
2,436

 
2,755

 
2,847

 
2,520

 
2,030

Consumer
51

 
23

 
28

 
31

 
60

Total
$
5,635

 
$
5,025

 
$
5,042

 
$
4,798

 
$
3,799

Total past due and nonaccrual loans to gross loans
0.57
%
 
0.55
%
 
0.58
%
 
0.56
%
 
0.45
%
While we experienced an increase in loans past due and nonaccrual during the third quarter, our level of past due and nonaccrual status loans remain low. These levels are the result of strengthened loan performance throughout all loan segements. A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual status loans by type, is included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

46


Troubled Debt Restructurings
We have taken a proactive approach to avoid foreclosures on borrowers who are willing to work with us in modifying their loans, thus making them more affordable. While this approach has permitted certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure, it has contributed to a significant increase in the level of loans classified as TDRs. The modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. At the time of the TDR, the loan is reviewed to determine whether or not to classify the loan as accrual or nonaccrual status. The majority of new modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed on nonaccrual status may be placed back on accrual status after six months of continued performance.
We restructure debt with borrowers who, due to temporary financial difficulties, are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, forgive principal, forgive interest, or a combination of these modifications. Typically, the modifications are for a period of five years or less. There were no TDRs that were government sponsored as of September 30, 2016 or December 31, 2015.
Losses associated with TDRs, if any, are included in the estimation of the ALLL in the quarter in which a loan is identified as a TDR, and we review the analysis of the ALLL estimation each reporting period to ensure its continued appropriateness.
The following tables provide a roll-forward of TDRs for the:

Three Months Ended September 30, 2016
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
July 1, 2016
151

 
$
18,843

 
6

 
$
587

 
157

 
$
19,430

New modifications
3

 
1,634

 

 

 
3

 
1,634

Principal advances (payments)

 
(204
)
 

 
(9
)
 

 
(213
)
Loans paid-off
(5
)
 
(272
)
 

 

 
(5
)
 
(272
)
Partial charge-offs

 

 

 

 

 

Balances charged-off
(1
)
 
(57
)
 

 

 
(1
)
 
(57
)
Transfers to OREO

 

 

 

 

 

Transfers to accrual status
3

 
218

 
(3
)
 
(218
)
 

 

Transfers to nonaccrual status
(2
)
 
(103
)
 
2

 
103

 

 

September 30, 2016
149

 
$
20,059

 
5

 
$
463

 
154

 
$
20,522


Nine Months Ended September 30, 2016
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
January 1, 2016
155

 
$
20,931

 
5

 
$
394

 
160

 
$
21,325

New modifications
9

 
1,863

 

 

 
9

 
1,863

Principal advances (payments)

 
(831
)
 

 
(26
)
 

 
(857
)
Loans paid-off
(11
)
 
(1,348
)
 
(1
)
 
(221
)
 
(12
)
 
(1,569
)
Partial charge-offs

 

 

 
(133
)
 

 
(133
)
Balances charged-off
(2
)
 
(72
)
 

 

 
(2
)
 
(72
)
Transfers to OREO

 

 
(1
)
 
(35
)
 
(1
)
 
(35
)
Transfers to accrual status
3

 
218

 
(3
)
 
(218
)
 

 

Transfers to nonaccrual status
(5
)
 
(702
)
 
5

 
702

 

 

September 30, 2016
149

 
$
20,059

 
5

 
$
463

 
154

 
$
20,522


47



Three Months Ended September 30, 2015
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
July 1, 2015
156

 
$
19,518

 
5

 
$
940

 
161

 
$
20,458

New modifications
5

 
2,543

 
2

 
170

 
7

 
2,713

Principal advances (payments)
 
 
(308
)
 
 
 
(552
)
 

 
(860
)
Loans paid-off
(4
)
 
(638
)
 
(1
)
 
(1
)
 
(5
)
 
(639
)
Partial charge-offs
 
 

 
 
 
(25
)
 

 
(25
)
Balances charged-off

 

 

 

 

 

Transfers to OREO

 

 
(1
)
 
(190
)
 
(1
)
 
(190
)
Transfers to accrual status
1

 
30

 
(1
)
 
(30
)
 

 

Transfers to nonaccrual status
(1
)
 
(21
)
 
1

 
21

 

 

September 30, 2015
157

 
$
21,124

 
5

 
$
333

 
162

 
$
21,457


Nine Months Ended September 30, 2015
 
Accruing Interest
 
Nonaccrual
 
Total
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
 
Number
of
Loans
 
Balance
January 1, 2015
156

 
$
20,931

 
13

 
$
2,410

 
169

 
$
23,341

New modifications
21

 
4,149

 
4

 
491

 
25

 
4,640

Principal advances (payments)

 
(1,033
)
 

 
(977
)
 

 
(2,010
)
Loans paid-off
(19
)
 
(3,016
)
 
(7
)
 
(597
)
 
(26
)
 
(3,613
)
Partial charge-offs

 

 

 
(87
)
 

 
(87
)
Balances charged-off
(1
)
 
(39
)
 

 

 
(1
)
 
(39
)
Transfers to OREO

 

 
(5
)
 
(775
)
 
(5
)
 
(775
)
Transfers to accrual status
3

 
292

 
(3
)
 
(292
)
 

 

Transfers to nonaccrual status
(3
)
 
(160
)
 
3

 
160

 

 

September 30, 2015
157

 
$
21,124

 
5

 
$
333

 
162

 
$
21,457

The following table summarizes our TDRs as of:
 
September 30, 2016
 
December 31, 2015
 
 

Accruing
Interest
 
Nonaccrual
 
Total
 
Accruing
Interest
 
Nonaccrual
 
Total
 
Total
Change
Current
$
18,787

 
$
201

 
$
18,988

 
$
20,550

 
$
146

 
$
20,696

 
$
(1,708
)
Past due 30-59 days
367

 
235

 
602

 
357

 

 
357

 
245

Past due 60-89 days
308

 

 
308

 
24

 

 
24

 
284

Past due 90 days or more
597

 
27

 
624

 

 
248

 
248

 
376

Total
$
20,059

 
$
463

 
$
20,522

 
$
20,931

 
$
394

 
$
21,325

 
$
(803
)
Additional disclosures about TDRs are included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

48


Impaired Loans
The following is a summary of information pertaining to impaired loans as of:
 
September 30, 2016
 
December 31, 2015

Outstanding
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
 
Outstanding
Balance
 
Unpaid
Principal
Balance
 
Valuation
Allowance
TDRs
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
6,156

 
$
6,274

 
$
719

 
$
7,619

 
$
7,858

 
$
818

Commercial other
1,460

 
1,471

 
85

 
188

 
199

 
11

Agricultural real estate
3,538

 
3,538

 
15

 
3,549

 
3,549

 

Agricultural other
982

 
982

 
1

 
519

 
519

 
2

Residential real estate senior liens
8,175

 
8,553

 
1,603

 
9,155

 
9,457

 
1,851

Residential real estate junior liens
74

 
74

 
14

 
133

 
133

 
28

Home equity lines of credit
108

 
408

 

 
127

 
427

 

Consumer secured
29

 
29

 

 
35

 
35

 

Total TDRs
20,522

 
21,329

 
2,437

 
21,325

 
22,177

 
2,710

Other impaired loans
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
103

 
117

 

 
162

 
175

 

Commercial other

 

 

 

 

 

Agricultural real estate

 

 

 

 

 

Agricultural other

 

 

 

 

 

Residential real estate senior liens
433

 
640

 
85

 
841

 
1,308

 
108

Residential real estate junior liens
2

 
12

 
1

 
10

 
30

 
2

Home equity lines of credit

 

 

 

 
7

 

Consumer secured

 

 

 

 

 

Total other impaired loans
538

 
769

 
86

 
1,013

 
1,520

 
110

Total impaired loans
$
21,060

 
$
22,098

 
$
2,523

 
$
22,338

 
$
23,697

 
$
2,820

Additional disclosure related to impaired loans is included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
Nonperforming Assets
The following table summarizes our nonperforming assets as of:

September 30
2016
 
June 30
2016
 
March 31
2016
 
December 31
2015
 
September 30
2015
Nonaccrual status loans
$
690

 
$
974

 
$
1,016

 
$
792

 
$
796

Accruing loans past due 90 days or more
847

 
208

 
55

 

 

Total nonperforming loans
1,537

 
1,182

 
1,071

 
792

 
796

Foreclosed assets
284

 
249

 
276

 
421

 
601

Total nonperforming assets
$
1,821

 
$
1,431

 
$
1,347

 
$
1,213

 
$
1,397

Nonperforming loans as a % of total loans
0.16
%
 
0.13
%
 
0.12
%
 
0.09
%
 
0.10
%
Nonperforming assets as a % of total assets
0.11
%
 
0.09
%
 
0.08
%
 
0.07
%
 
0.09
%
After a loan is 90 days past due, it is placed on nonaccrual status unless it is well secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Loans may be placed back on accrual status after six months of continued performance. Total nonperforming loans continues to be at historic low levels.

49


Included in the nonaccrual loan balances above were loans currently classified as TDRs as of:

September 30
2016
 
December 31
2015
Commercial and agricultural
$

 
$
232

Residential real estate
463

 
162

Total
$
463

 
$
394

Additional disclosures about nonaccrual status loans are included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.
We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recording of a charge-off. We believe that we have identified all impaired loans as of September 30, 2016.
We believe that the level of the ALLL is appropriate as of September 30, 2016. We will continue to closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at the appropriate level.
Noninterest Income and Noninterest Expenses
Significant noninterest account balances are highlighted in the following table with additional descriptions of significant fluctuations:

Three Months Ended September 30
 
 
 
 
 
Change
 
2016
 
2015
 
$
 
%
Service charges and fees
 
 
 
 
 
 
 
ATM and debit card fees
$
606

 
$
708

 
$
(102
)
 
(14.41
)%
NSF and overdraft fees
480

 
492

 
(12
)
 
(2.44
)%
Freddie Mac servicing fee
172

 
179

 
(7
)
 
(3.91
)%
Service charges on deposit accounts
92

 
88

 
4

 
4.55
 %
Net OMSR income (loss)
(108
)
 
(34
)
 
(74
)
 
(217.65
)%
All other
34

 
35

 
(1
)
 
(2.86
)%
Total service charges and fees
1,276

 
1,468

 
(192
)
 
(13.08
)%
Net gain on sale of mortgage loans
263

 
157

 
106

 
67.52
 %
Earnings on corporate owned life insurance policies
183

 
188

 
(5
)
 
(2.66
)%
Net gains (losses) on sale of AFS securities

 

 

 
 %
Other
 
 
 
 
 
 
 
Trust and brokerage advisory fees
1,000

 
538

 
462

 
85.87
 %
Corporate Settlement Solutions joint venture
145

 
399

 
(254
)
 
(63.66
)%
Other
79

 
351

 
(272
)
 
(77.49
)%
Total other
1,224


1,288


(64
)

(4.97
)%
Total noninterest income
$
2,946


$
3,101


$
(155
)

(5.00
)%

50



Nine Months Ended September 30
 
 
 
 
 
Change
 
2016
 
2015
 
$
 
%
Service charges and fees
 
 
 
 
 
 
 
ATM and debit card fees
$
1,840

 
$
1,798

 
$
42

 
2.34
 %
NSF and overdraft fees
1,360

 
1,392

 
(32
)
 
(2.30
)%
Freddie Mac servicing fee
529

 
538

 
(9
)
 
(1.67
)%
Service charges on deposit accounts
263

 
258

 
5

 
1.94
 %
Net OMSR income (loss)
(437
)
 
(61
)
 
(376
)
 
(616.39
)%
All other
97

 
99

 
(2
)
 
(2.02
)%
Total service charges and fees
3,652

 
4,024

 
(372
)
 
(9.24
)%
Net gain on sale of mortgage loans
472

 
472

 

 
 %
Earnings on corporate owned life insurance policies
566

 
570

 
(4
)
 
(0.70
)%
Net gains (losses) on sale of AFS securities
245

 

 
245

 
N/M

Other
 
 
 
 
 
 
 
Trust and brokerage advisory fees
2,135

 
1,640

 
495

 
30.18
 %
Corporate Settlement Solutions joint venture
362

 
518

 
(156
)
 
(30.12
)%
Other
489

 
634

 
(145
)
 
(22.87
)%
Total other
2,986

 
2,792

 
194

 
6.95
 %
Total noninterest income
$
7,921

 
$
7,858

 
$
63

 
0.80
 %
Significant changes in noninterest income are detailed below:
ATM and debit card fees fluctuate from period-to-period based on usage of ATM and debit cards. Income for the remainder of 2016 is expected to approximate 2015 levels.
NSF and overdraft fees fluctuate from period-to-period based on customer activity as well as the number of business days in the period. We anticipate NSF and overdraft fees in 2016 to approximate 2015 levels.
Offering rates on residential mortgage loans and increased prepayment speeds have been the most significant drivers behind fluctuations in net OMSR income (loss). While mortgage rates are expected to approximate current levels in the foreseeable future, we anticipate increases in our originations in purchase money mortgage activity as a result of our various initiatives to drive growth. As such, we anticipate net OMSR income (loss) to improve during the remainder of 2016 based on volume.
We are continually analyzing our AFS security portfolio for potential sale opportunities. During the second quarter of 2016, we identified several mortgage-backed securities with unrealized gains that had less than desirable yields. There were none identified during the third quarter; however, we may continue to sell AFS securities with low yields during the remainder of 2016.
We continue to invest considerable efforts to increase our market share in trust and brokerage advisory services. These efforts have translated into increases in trust fees and brokerage and advisory fees. We anticipate that these fees will continue to increase during the remainder of 2016 but not at the same rate as the third quarter.
The fluctuations in all other income is spread throughout various categories, none of which are individually significant.

51


Significant noninterest expense account balances are highlighted in the following table with additional descriptions of significant fluctuations:
 
Three Months Ended September 30

 
 
 
 
Change
 
2016
 
2015
 
$
 
%
Compensation and benefits
 
 
 
 
 
 
 
Employee salaries
$
3,431

 
$
3,427

 
$
4

 
0.12
 %
Employee benefits
1,509

 
1,323

 
$
186

 
14.06
 %
Total compensation and benefits
4,940

 
4,750

 
190

 
4.00
 %
Furniture and equipment
 
 
 
 
 
 
 
Service contracts
822

 
780

 
42

 
5.38
 %
Depreciation
483

 
473

 
10

 
2.11
 %
ATM and debit card fees
210

 
232

 
(22
)
 
(9.48
)%
All other
28

 
26

 
2

 
7.69
 %
Total furniture and equipment
1,543

 
1,511

 
32

 
2.12
 %
Occupancy
 
 
 
 
 
 
 
Depreciation
195

 
180

 
15

 
8.33
 %
Outside services
171

 
167

 
4

 
2.40
 %
Utilities
168

 
130

 
38

 
29.23
 %
Property taxes
141

 
135

 
6

 
4.44
 %
All other
115

 
116

 
(1
)
 
(0.86
)%
Total occupancy
790

 
728

 
62

 
8.52
 %
Other
 
 
 
 
 
 
 
Audit and related fees
319

 
223

 
96

 
43.05
 %
FDIC insurance premiums
224

 
204

 
20

 
9.80
 %
Director fees
207

 
204

 
3

 
1.47
 %
Consulting fees
198

 
124

 
74

 
59.68
 %
Loan underwriting fees
142

 
98

 
44

 
44.90
 %
Donations and community relations
134

 
155

 
(21
)
 
(13.55
)%
Marketing costs
101

 
124

 
(23
)
 
(18.55
)%
Education and travel
90

 
91

 
(1
)
 
(1.10
)%
Postage and freight
95

 
94

 
1

 
1.06
 %
Printing and supplies
103

 
111

 
(8
)
 
(7.21
)%
Legal fees
68

 
121

 
(53
)
 
(43.80
)%
All other
479

 
623

 
(144
)
 
(23.11
)%
Total other
2,160

 
2,172

 
(12
)
 
(0.55
)%
Total noninterest expenses
$
9,433


$
9,161


$
272


2.97
 %

52


 
Nine Months Ended September 30

 
 
 
 
Change
 
2016
 
2015
 
$
 
%
Compensation and benefits
 
 
 
 
 
 
 
Employee salaries
$
10,056

 
$
10,059

 
$
(3
)
 
(0.03
)%
Employee benefits
4,356

 
3,797

 
559

 
14.72
 %
Total compensation and benefits
14,412

 
13,856

 
556

 
4.01
 %
Furniture and equipment
 
 
 
 
 
 
 
Service contracts
2,314

 
2,220

 
94

 
4.23
 %
Depreciation
1,533

 
1,390

 
143

 
10.29
 %
ATM and debit card fees
627

 
564

 
63

 
11.17
 %
All other
90

 
77

 
13

 
16.88
 %
Total furniture and equipment
4,564

 
4,251

 
313

 
7.36
 %
Occupancy
 
 
 
 
 
 
 
Depreciation
583

 
535

 
48

 
8.97
 %
Outside services
555

 
542

 
13

 
2.40
 %
Utilities
429

 
404

 
25

 
6.19
 %
Property taxes
429

 
400

 
29

 
7.25
 %
All other
284

 
240

 
44

 
18.33
 %
Total occupancy
2,280

 
2,121

 
159

 
7.50
 %
Other
 
 
 
 
 
 
 
Audit and related fees
664

 
582

 
82

 
14.09
 %
FDIC insurance premiums
646

 
619

 
27

 
4.36
 %
Director fees
630

 
608

 
22

 
3.62
 %
Consulting fees
567

 
341

 
226

 
66.28
 %
Loan underwriting fees
377

 
248

 
129

 
52.02
 %
Donations and community relations
374

 
412

 
(38
)
 
(9.22
)%
Marketing costs
359

 
350

 
9

 
2.57
 %
Education and travel
351

 
319

 
32

 
10.03
 %
Postage and freight
292

 
284

 
8

 
2.82
 %
Printing and supplies
286

 
309

 
(23
)
 
(7.44
)%
Legal fees
226

 
273

 
(47
)
 
(17.22
)%
All other
1,703

 
1,593

 
110

 
6.91
 %
Total other
6,475

 
5,938

 
537

 
9.04
 %
Total noninterest expenses
$
27,731

 
$
26,166

 
$
1,565

 
5.98
 %
Significant changes in noninterest expenses are detailed below:
We acquired two branches in mid-2015 which resulted in increased expenses in 2016 for most of the categories presented above. None of the increases are individually significant.
Employee benefits were low in 2015 due to lower than anticipated medical coverage costs. We anticipate expense to continue to increase slightly during the remainder of 2016.
Consulting fees in 2016 increased as a result of outsourced operational functions related to our investment and trust services, consulting services to streamline processes, and talent recruitment services. As such, fees in 2016 are expected to exceed 2015 levels.
The increase in loan underwriting fees is related to the increase in loan volume throughout 2016 and, such fees are expected to continue to increase during the remainder of 2016.

53


We have consistently been a strong supporter of the various communities, schools, and charities in the markets we serve. Donations and community relations fluctuate from period-to-period with 2016 expenses expected to approximate 2015 levels.
The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.
Analysis of Changes in Financial Condition

September 30
2016
 
December 31
2015
 
$ Change
 
% Change
(unannualized)
ASSETS
 
 
 
 
 
 
 
Cash and cash equivalents
$
21,335

 
$
21,569

 
$
(234
)
 
(1.08
)%
AFS securities
 
 
 
 
 
 
 
Amortized cost of AFS securities
549,893

 
654,348

 
(104,455
)
 
(15.96
)%
Unrealized gains (losses) on AFS securities
14,336

 
5,788

 
8,548

 
147.68
 %
AFS securities
564,229

 
660,136

 
(95,907
)
 
(14.53
)%
Mortgage loans AFS
685

 
1,187

 
(502
)
 
(42.29
)%
Loans
 
 
 
 


 
 
Gross loans
989,366

 
850,492

 
138,874

 
16.33
 %
Less allowance for loan and lease losses
7,800

 
7,400

 
400

 
5.41
 %
Net loans
981,566

 
843,092

 
138,474

 
16.42
 %
Premises and equipment
28,986

 
28,331

 
655

 
2.31
 %
Corporate owned life insurance policies
25,985

 
26,423

 
(438
)
 
(1.66
)%
Accrued interest receivable
6,868

 
6,269

 
599

 
9.55
 %
Equity securities without readily determinable fair values
22,573

 
22,286

 
287

 
1.29
 %
Goodwill and other intangible assets
48,700

 
48,828

 
(128
)
 
(0.26
)%
Other assets
5,571

 
9,991

 
(4,420
)
 
(44.24
)%
TOTAL ASSETS
$
1,706,498

 
$
1,668,112

 
$
38,386

 
2.30
 %
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Deposits
$
1,175,833

 
$
1,164,563

 
$
11,270

 
0.97
 %
Borrowed funds
325,409

 
309,732

 
15,677

 
5.06
 %
Accrued interest payable and other liabilities
10,072

 
9,846

 
226

 
2.30
 %
Total liabilities
1,511,314

 
1,484,141

 
27,173

 
1.83
 %
Shareholders’ equity
195,184

 
183,971

 
11,213

 
6.09
 %
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,706,498

 
$
1,668,112

 
$
38,386

 
2.30
 %

54


The following table outlines the changes in loans:

September 30
2016
 
December 31
2015
 
$ Change
 
% Change
(unannualized)
Commercial
$
554,847

 
$
448,381

 
$
106,466

 
23.74
%
Agricultural
133,637

 
115,911

 
17,726

 
15.29
%
Residential real estate
260,122

 
251,501

 
8,621

 
3.43
%
Consumer
40,760

 
34,699

 
6,061

 
17.47
%
Total
$
989,366

 
$
850,492

 
$
138,874

 
16.33
%
The following table displays loan balances as of:

September 30
2016
 
June 30
2016
 
March 31
2016
 
December 31
2015
 
September 30
2015
Commercial
$
554,847

 
$
500,374

 
$
470,305

 
$
448,381

 
$
434,823

Agricultural
133,637

 
126,517

 
115,686

 
115,911

 
116,293

Residential real estate
260,122

 
255,116

 
249,318

 
251,501

 
251,324

Consumer
40,760

 
37,587

 
34,982

 
34,699

 
34,231

Total
$
989,366

 
$
919,594

 
$
870,291

 
$
850,492

 
$
836,671

While competition for commercial and agricultural loans continues to be strong, we experienced growth in these segments of the portfolio during 2016 and anticipate continued growth in the remainder of 2016. During the third quarter of 2016, we entered into a participation agreement to provide advances to mortgage brokers which contributed $27,832 of commercial loan growth as of September 30, 2016. Residential real estate and consumer loans continued to increase during the third quarter of 2016. We anticipate continued growth in both portfolios during the remainder of 2016 as a result of initiatives designed to increase loan volume and the number of originations.
The following table outlines the changes in deposits:

September 30
2016
 
December 31
2015
 
$ Change
 
% Change
(unannualized)
Noninterest bearing demand deposits
$
201,804

 
$
191,376

 
$
10,428

 
5.45
 %
Interest bearing demand deposits
205,817

 
212,666

 
(6,849
)
 
(3.22
)%
Savings deposits
331,414

 
337,641

 
(6,227
)
 
(1.84
)%
Certificates of deposit
324,910

 
324,101

 
809

 
0.25
 %
Brokered certificates of deposit
87,583

 
73,815

 
13,768

 
18.65
 %
Internet certificates of deposit
24,305

 
24,964

 
(659
)
 
(2.64
)%
Total
$
1,175,833

 
$
1,164,563

 
$
11,270

 
0.97
 %
The following table displays deposit balances as of:

September 30
2016
 
June 30
2016
 
March 31
2016
 
December 31
2015
 
September 30
2015
Noninterest bearing demand deposits
$
201,804

 
$
192,194

 
$
183,820

 
$
191,376

 
$
181,782

Interest bearing demand deposits
205,817

 
197,590

 
215,327

 
212,666

 
197,476

Savings deposits
331,414

 
331,144

 
352,115

 
337,641

 
316,590

Certificates of deposit
324,910

 
328,771

 
323,350

 
324,101

 
328,806

Brokered certificates of deposit
87,583

 
83,677

 
76,014

 
73,815

 
76,948

Internet certificates of deposit
24,305

 
23,494

 
22,881

 
24,964

 
26,401

Total
$
1,175,833

 
$
1,156,870

 
$
1,173,507

 
$
1,164,563

 
$
1,128,003

Deposit growth during 2016 continues to be driven by noninterest bearing demand deposits and brokered certificates of deposit. We continue to see a gradual decline in certificates of deposits and interest bearing deposit accounts. Growth is anticipated to continue to come in the form of non-contractual deposits, while certificates of deposit are expected to continue to decline.

55


Our strong loan growth in 2016, coupled with softer deposit growth, led to sales of AFS securities during the year. Additionally, we have slowed our purchases of mortgage-backed securities and collateralized mortgage obligations in response to loan growth. We remain active in investments with our local schools and municipalities; therefore, future growth is anticipated in state and political subdivisions AFS securities. The following table displays fair values of AFS securities as of:

September 30
2016
 
June 30
2016
 
March 31
2016
 
December 31
2015
 
September 30
2015
Government sponsored enterprises
$
344

 
$
10,371

 
$
24,428

 
$
24,345

 
$
24,368

States and political subdivisions
219,689

 
226,047

 
231,472

 
232,217

 
232,374

Auction rate money market preferred
3,145

 
3,119

 
2,807

 
2,866

 
2,707

Preferred stocks
3,588

 
3,406

 
3,346

 
3,299

 
3,192

Mortgage-backed securities
226,649

 
240,195

 
258,284

 
263,384

 
234,258

Collateralized mortgage obligations
110,814

 
119,325

 
129,522

 
134,025

 
131,713

Total
$
564,229

 
$
602,463

 
$
649,859

 
$
660,136

 
$
628,612

The following table displays borrowed funds balances as of:

September 30
2016
 
June 30
2016
 
March 31
2016
 
December 31
2015
 
September 30
2015
FHLB advances
$
250,000

 
$
265,000

 
$
245,000

 
$
235,000

 
$
215,000

Securities sold under agreements to repurchase without stated maturity dates
54,809

 
53,596

 
58,096

 
70,532

 
69,510

Federal funds purchased
20,600

 

 
4,800

 
4,200

 
13,100

Total
$
325,409

 
$
318,596

 
$
307,896

 
$
309,732

 
$
297,610

Capital
Capital consists solely of common stock, retained earnings, and accumulated other comprehensive income (loss). We are authorized to raise capital through dividend reinvestment, employee and director stock purchases, and shareholder stock purchases. Pursuant to these authorizations, we issued 131,697 shares or $3,683 of common stock during the first nine months of 2016, as compared to 142,388 shares or $3,310 of common stock during the same period in 2015. We also offer the Directors Plan in which participants either directly purchase stock or purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $443 and $425 during the nine month periods ended September 30, 2016 and 2015, respectively.
We have approved a publicly announced common stock repurchase plan. Pursuant to this plan, we repurchased 98,083 shares or $2,749 of common stock compared to 153,329 shares for $3,588 during the first nine months of 2016 and 2015, respectively. As of September 30, 2016, we were authorized to repurchase up to an additional 60,575 shares of common stock.
The FRB has established minimum risk based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital. On July 2, 2013, the FRB published revised BASEL III Capital standards for banks. The final rules redefine what is included or deducted from equity capital, changes risk weighting for certain on and off-balance sheet assets, increases the minimum required equity capital to be considered well capitalized, and introduces a capital cushion buffer. The rules, which are being gradually phased in between 2015 and 2019, are not expected to have a material impact on the Corporation but will require us to hold more capital than we have historically.
There are no significant regulatory constraints placed on our capital. The FRB’s current recommended minimum primary capital to assets requirement is 6.00%. Our primary capital to adjusted average assets, or tier 1 leverage ratio, was 8.59% as of September 30, 2016.

56


Effective January 1, 2015, the minimum standard for primary, or tier 1, capital increased from 4.00% to 6.00%. The minimum standard for total capital remains at 8.00%. Also effective January 1, 2015 is the new common equity tier 1 capital ratio which has a minimum requirement of 4.50%. The following table sets forth the percentages required under the Risk Based Capital guidelines and our values as of:

September 30
2016
 
December 31
2015
 
Required
Common equity tier 1 capital
12.41
%
 
13.44
%
 
4.50
%
 
 
 
 
 
 
Tier 1 capital
12.41
%
 
13.44
%
 
6.00
%
Tier 2 capital
0.69
%
 
0.73
%
 
2.00
%
Total Capital
13.10
%
 
14.17
%
 
8.00
%
Tier 2 capital, or secondary capital, includes only the ALLL. The percentage for the secondary capital under the required column is the maximum amount allowed from all sources.
The FRB and FDIC also prescribe minimum capital requirements for Isabella Bank. At September 30, 2016, the Bank exceeded these minimum capital requirements.
Contractual Obligations and Loan Commitments
We are party to credit related financial instruments with off-balance-sheet risk. These financial instruments are entered into in the normal course of business to meet the financing needs of our customers. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of these instruments reflect the extent of involvement we have in a particular class of financial instrument.
The following table summarizes our credit related financial instruments with off-balance-sheet risk as of:

September 30
2016
 
December 31
2015
Unfunded commitments under lines of credit
$
166,007

 
$
134,412

Commitments to grant loans
44,981

 
53,946

Commercial and standby letters of credit
1,106

 
915

Total
$
212,094

 
$
189,273

Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. These commitments may expire without being drawn upon and do not necessarily represent future cash requirements. Advances to mortgage brokers are also included in unfunded commitments under lines of credit. The balance is the difference between our outstanding balances and the maximum outstanding aggregate amount.
Commitments to grant loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The amount of collateral obtained, if it is deemed necessary, is based on management’s credit evaluation of the customer. Commitments to grant loans include residential mortgage loans with the majority being loans committed to be sold to the secondary market.
Commercial and standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements, including commercial paper, bond financing, and similar transactions. These commitments to extend credit and letters of credit generally mature within one year. The credit risk involved in these transactions is essentially the same as that involved in extending loans to customers. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon the extension of credit, is based on a credit evaluation of the borrower. While we consider standby letters of credit to be guarantees, the amount of the liability related to such guarantees on the commitment date is not significant and a liability related to such guarantees is not recorded on the consolidated balance sheets.
Our exposure to credit-related loss in the event of nonperformance by the counter parties to the financial instruments for commitments to extend credit and standby letters of credit could be up to the contractual notional amount of those instruments. We use the same credit policies as we do for extending loans to customers. No significant losses are anticipated as a result of these commitments.

57


Fair Value
We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. AFS securities, cash flow hedge derivative instruments and certain liabilities are recorded at fair value on a recurring basis. Additionally, from time-to-time, we may be required to record at fair value other assets on a nonrecurring basis, such as mortgage loans AFS, foreclosed assets, OMSR, and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets.
For further information regarding fair value measurements see “Note 11 – Fair Value” of our notes to the interim condensed consolidated financial statements.
Liquidity
Liquidity is monitored regularly by our Market Risk Committee, which consists of members of senior management. The committee reviews projected cash flows, key ratios, and liquidity available from both primary and secondary sources.
Our primary sources of liquidity are cash and cash equivalents and AFS securities. These categories totaled $585,564 or 34.31% of assets as of September 30, 2016 as compared to $681,705 or 40.87% as of December 31, 2015. The decline in primary liquidity is a direct result of our sale of AFS securities during 2016. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Liquidity varies significantly daily, based on customer activity.
Our primary source of funds is through deposit accounts. We also have the ability to borrow from the FHLB, the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As of September 30, 2016, we had available lines of credit of $15,173.
The following table summarizes our sources and uses of cash for the nine month period ended September 30:

2016
 
2015
 
$ Variance
Net cash provided by (used in) operating activities
$
15,565

 
$
7,081

 
$
8,484

Net cash provided by (used in) investing activities
(37,704
)
 
(64,112
)
 
26,408

Net cash provided by (used in) financing activities
21,905

 
55,447

 
(33,542
)
Increase (decrease) in cash and cash equivalents
(234
)
 
(1,584
)
 
1,350

Cash and cash equivalents January 1
21,569

 
19,906

 
1,663

Cash and cash equivalents September 30
$
21,335

 
$
18,322

 
$
3,013

Market Risk
Our primary market risks are interest rate risk and liquidity risk. We have no significant foreign exchange risk in the management of IRR. Any changes in foreign exchange rates or commodity prices would have an insignificant impact on our interest income and cash flows.
IRR is the exposure of our net interest income to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. IRR is the fundamental method by which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to our earnings and capital.
The FRB has adopted a policy requiring us to effectively manage the various risks that can have a material impact on our safety and soundness. The risks include credit, interest rate, liquidity, operational, and reputational. We have policies, procedures, and internal controls for measuring and managing these risks. Specifically, our Funds Management policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long term assets, limiting the mismatch in repricing opportunity of assets and liabilities, and the frequency of measuring and reporting to our Board.
The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield curves, interest rate relationships, loan prepayments, and changes in funding sources. These forecasts are compared against net

58


interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies.
Our interest rate sensitivity is estimated by first forecasting the next 12 and 24 months of net interest income under an assumed environment of a constant balance sheet and constant market interest rates (base case). We then compare the results of various simulation analyses to the base case. At September 30, 2016, we projected the change in net interest income during the next 12 and 24 months assuming market interest rates were to immediately decrease by 100 basis points and increase by 100, 200, 300, and 400 basis points in a parallel fashion over the entire yield curve during the same time period. We did not project scenarios showing decreases in interest rates beyond 100 basis points as this is considered extremely unlikely given current interest rate levels. These projections were based on our assets and liabilities remaining static over the next 12 and 24 months, while factoring in probable calls and prepayments of certain investment securities and residential real estate and consumer loans. While it is extremely unlikely that interest rates would immediately increase to these levels, we feel that these extreme scenarios help us identify potential gaps and mismatches in the repricing characteristics of assets and liabilities. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits.
The following tables summarize our interest rate sensitivity for the next 12 and 24 months as of:

September 30, 2016

12 Months

24 Months
Immediate basis point change assumption (short-term)
-100
 
+100
 
+200
 
+300
 
+400
 
-100
 
+100
 
+200
 
+300
 
+400
Percent change in net interest income vs. constant rates
2.16
%
 
1.58
%
 
4.22
%
 
5.75
%
 
6.83
%
 
(1.59
)%
 
2.05
%
 
6.00
%
 
8.43
%
 
10.23
%
 
December 31, 2015
 
12 Months
 
24 Months
Immediate basis point change assumption (short-term)
-100
 
+100
 
+200
 
+300
 
+400
 
-100
 
+100
 
+200
 
+300
 
+400
Percent change in net interest income vs. constant rates
(2.08
)%
 
1.27
%
 
2.00
%
 
2.11
%
 
2.23
%
 
(1.77
)%
 
2.00
%
 
3.47
%
 
4.02
%
 
4.39
%
The following tables provide information about assets and liabilities that are sensitive to changes in interest rates as of September 30, 2016 and December 31, 2015. The principal amounts of investments, loans, other interest earning assets, borrowings, and time deposits maturing were calculated based on the contractual maturity dates. Estimated cash flows for savings and NOW accounts are based on our estimated deposit decay rates.

59



September 30, 2016
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
 
Total
 
Fair Value
Rate sensitive assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest bearing assets
$
2,061

 
$

 
$

 
$

 
$

 
$

 
$
2,061

 
$
2,060

Average interest rates
0.23
%
 
%
 
%
 
%
 
%
 
%
 
0.23
%
 
 
AFS securities
$
177,551

 
$
111,006

 
$
84,152

 
$
57,432

 
$
37,220

 
$
96,868

 
$
564,229

 
$
564,229

Average interest rates
1.57
%
 
1.42
%
 
1.68
%
 
2.30
%
 
2.72
%
 
2.22
%
 
1.82
%
 
 
Fixed interest rate loans (1)
$
166,013

 
$
120,093

 
$
103,839

 
$
99,242

 
$
114,484

 
$
192,540

 
$
796,211

 
$
786,490

Average interest rates
4.10
%
 
4.26
%
 
4.31
%
 
4.15
%
 
4.21
%
 
4.13
%
 
4.18
%
 
 
Variable interest rate loans (1)
$
64,158

 
$
29,852

 
$
33,955

 
$
14,661

 
$
20,277

 
$
30,252

 
$
193,155

 
$
193,155

Average interest rates
4.54
%
 
4.27
%
 
4.00
%
 
3.58
%
 
3.64
%
 
3.91
%
 
4.14
%
 
 
Rate sensitive liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate borrowed funds
$
125,409

 
$
60,000

 
$
70,000

 
$
10,000

 
$
20,000

 
$
30,000

 
$
315,409

 
$
320,077

Average interest rates
0.77
%
 
1.89
%
 
1.90
%
 
1.98
%
 
1.80
%
 
2.77
%
 
1.53
%
 
 
Variable rate borrowed funds
$

 
$

 
$

 
$

 
$
10,000

 
$

 
$
10,000

 
$
10,000

Average interest rates
%
 
%
 
%
 
%
 
0.93
%
 
%
 
0.93
%
 
 
Savings and NOW accounts
$
144,685

 
$
38,027

 
$
34,016

 
$
30,450

 
$
27,279

 
$
262,774

 
$
537,231

 
$
537,231

Average interest rates
0.40
%
 
0.10
%
 
0.10
%
 
0.10
%
 
0.10
%
 
0.09
%
 
0.18
%
 
 
Fixed interest rate certificates of deposit
$
196,912

 
$
85,975

 
$
45,914

 
$
30,815

 
$
49,741

 
$
24,582

 
$
433,939

 
$
433,033

Average interest rates
0.89
%
 
1.20
%
 
1.30
%
 
1.59
%
 
1.65
%
 
1.81
%
 
1.19
%
 
 
Variable interest rate certificates of deposit
$
1,121

 
$
1,738

 
$

 
$

 
$

 
$

 
$
2,859

 
$
2,859

Average interest rates
0.47
%
 
0.71
%
 
%
 
%
 
%
 
%
 
0.61
%
 
 

December 31, 2015
 
2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
 
Total
 
Fair Value
Rate sensitive assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other interest bearing assets
$
2,659

 
$
100

 
$

 
$

 
$

 
$

 
$
2,759

 
$
2,758

Average interest rates
0.23
%
 
0.35
%
 
%
 
%
 
%
 
%
 
0.24
%
 
 
AFS securities
$
148,692

 
$
120,692

 
$
81,726

 
$
73,541

 
$
71,083

 
$
164,402

 
$
660,136

 
$
660,136

Average interest rates
2.16
%
 
2.11
%
 
2.18
%
 
2.25
%
 
2.37
%
 
2.43
%
 
2.25
%
 
 
Fixed interest rate loans (1)
$
116,143

 
$
130,873

 
$
103,265

 
$
83,457

 
$
91,436

 
$
156,784

 
$
681,958

 
$
670,864

Average interest rates
4.56
%
 
4.42
%
 
4.27
%
 
4.36
%
 
4.18
%
 
4.28
%
 
4.35
%
 
 
Variable interest rate loans (1)
$
61,672

 
$
24,289

 
$
24,359

 
$
14,398

 
$
16,842

 
$
26,974

 
$
168,534

 
$
168,534

Average interest rates
4.08
%
 
4.12
%
 
4.19
%
 
3.45
%
 
3.40
%
 
3.69
%
 
3.92
%
 
 
Rate sensitive liabilities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fixed rate borrowed funds
$
104,732

 
$
50,000

 
$
50,000

 
$
40,000

 
$
10,000

 
$
40,000

 
$
294,732

 
$
297,495

Average interest rates
0.47
%
 
1.56
%
 
2.16
%
 
2.35
%
 
1.98
%
 
2.67
%
 
1.55
%
 
 
Variable rate borrowed funds
$
15,000

 
$

 
$

 
$

 
$

 
$

 
$
15,000

 
$
15,000

Average interest rates
0.62
%
 
%
 
%
 
%
 
%
 
%
 
0.62
%
 
 
Savings and NOW accounts
$
80,242

 
$
42,064

 
$
37,773

 
$
33,950

 
$
30,548

 
$
325,730

 
$
550,307

 
$
550,307

Average interest rates
0.59
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.11
%
 
0.18
%
 
 
Fixed interest rate certificates of deposit
$
190,500

 
$
89,689

 
$
63,167

 
$
23,883

 
$
33,012

 
$
21,028

 
$
421,279

 
$
419,828

Average interest rates
0.92
%
 
1.26
%
 
1.27
%
 
1.50
%
 
1.59
%
 
1.84
%
 
1.18
%
 
 
Variable interest rate certificates of deposit
$
1,358

 
$
243

 
$

 
$

 
$

 
$

 
$
1,601

 
$
1,601

Average interest rates
0.49
%
 
0.40
%
 
%
 
%
 
%
 
%
 
0.48
%
 
 
 (1) The fair value reported is exclusive of the allocation of the ALLL.

60


We do not believe that there has been a material change in the nature or categories of our primary market risk exposure, or the particular markets that present the primary risk of loss. As of the date of this report, we do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term and we do not expect to make material changes in those methods in the near term. We may change those methods in the future to adapt to changes in circumstances or to implement new techniques.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
The information presented in the section captioned “Market Risk” in Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.
Item 4. Controls and Procedures.
DISCLOSURE CONTROLS AND PROCEDURES
We carried out an evaluation, under the supervision and with the participation of the Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15(d)-15(e) under the Exchange Act) as of September 30, 2016, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as of September 30, 2016, were effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
During the most recent fiscal quarter, no change occurred in our internal control over financial reporting that materially affected, or is likely to materially effect, our internal control over financial reporting.


61


PART II – OTHER INFORMATION
Item 1. Legal Proceedings.
We are not involved in any material legal proceedings. We are involved in ordinary, routine litigation incidental to our business; however, no such routine proceedings are expected to result in any material adverse effect on operations, earnings, financial condition, or cash flows.
Item 1A. Risk Factors.
There have been no material changes to the risk factors disclosed in Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2015.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
(A)
None
(B)
None
(C)
Repurchases of Common Stock
We have adopted and publicly announced a common stock repurchase plan. The plan was last amended on September 23, 2015, to allow for the repurchase of an additional 200,000 shares of common stock after that date. These authorizations do not have expiration dates. As common shares are repurchased under this plan, they are retired and revert back to the status of authorized, but unissued common shares.
The following table provides information for the three month period ended September 30, 2016, with respect to this plan:
 
Common Shares Repurchased
 
Total Number of Common Shares Purchased as Part of Publicly Announced Plan or Program
 
Maximum Number of Common Shares That May Yet Be Purchased Under the Plans or Programs

Number
 
Average Price
Per Common Share
 
 
Balance, June 30
 
 
 
 
 
 
106,748

July 1 - 31
11,664

 
$
27.86

 
11,664

 
95,084

August 1 - 31
20,927

 
27.91

 
20,927

 
74,157

September 1 - 30
13,582

 
27.90

 
13,582

 
60,575

Balance, September 30
46,173

 
$
27.90

 
46,173

 
60,575

Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Other Information.
Not applicable.

62


Item 6. Exhibits.
(a) Exhibits
Exhibit Number
 
Exhibits
 
 
 
31(a)
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Executive Officer
 
 
 
31(b)
 
Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Financial Officer
 
 
 
32
 
Section 1350 Certification of Principal Executive Officer and Principal Financial Officer
 
 
 
101.1*
 
101.INS (XBRL Instance Document)
 
 
 
 
 
101.SCH (XBRL Taxonomy Extension Schema Document)
 
 
 
 
 
101.CAL (XBRL Calculation Linkbase Document)
 
 
 
 
 
101.LAB (XBRL Taxonomy Label Linkbase Document)
 
 
 
 
 
101.DEF (XBRL Taxonomy Linkbase Document)
 
 
 
 
 
101.PRE (XBRL Taxonomy Presentation Linkbase Document)
*
In accordance with Rule 406T of Regulations S-T, the XBRL related information shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.


63


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Isabella Bank Corporation
 
 
 
 
Date:
November 9, 2016
 
 
/s/ Jae A. Evans
 
 
 
 
Jae A. Evans
 
 
 
 
Chief Executive Officer
 
 
 
 
(Principal Executive Officer)
 
 
 
 
Date:
November 9, 2016
 
 
/s/ Dennis P. Angner
 
 
 
 
Dennis P. Angner
 
 
 
 
President, Chief Financial Officer
 
 
 
 
(Principal Financial Officer, Principal Accounting Officer)

64