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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
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
(State or other jurisdiction of
incorporation or organization)
38-2830092
(I.R.S. Employer
identification No.)
401 North Main Street, Mount Pleasant, Michigan 48858
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code (989) 772-9471
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Securities registered pursuant to Section 12(g) of the Act:
Common Stock - No Par Value
(Title of Class)
Indicated by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨
Yes x
No
Indicated by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ¨
Yes x
No
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. x
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). x
Yes ¨
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be
contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth
company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act
(Check One).
Large accelerated filer
Non-accelerated filer
¨
¨
Accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised
financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
x
¨
¨
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨
Yes x
No
The aggregate market value of the voting stock held by non-affiliates of the registrant was $211,421,000 as of the last business day of the registrant’s most recently completed
second fiscal quarter.
The number of common shares outstanding of the registrant’s Common Stock (no par value) was 7,873,337 as of March 11, 2019 .
(Such documents are incorporated herein only to the extent specifically set forth in response to an item herein.)
Portions of the Isabella Bank Corporation Proxy Statement for its Annual Meeting of Shareholders to be held May 7, 2019 are incorporated by reference in this Form 10-K in
response to Part III . The Isabella Bank Corporation Proxy Statement will be mailed on or before March 25, 2019 .
DOCUMENTS INCORPORATED BY REFERENCE
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PART I
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
PART II
Item 5.
Item 6.
Item 7.
ISABELLA BANK CORPORATION
ANNUAL REPORT ON FORM 10-K
Table of Contents
Business
Risk Factors
Unresolved Staff Comments
Properties
Legal Proceedings
Mine Safety Disclosures
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Selected Financial Data
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Item 8.
Item 9.
Item 9A.
Item 9B.
PART III
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
PART IV
Item 15.
Item 16.
SIGNATURES
Financial Statements and Supplementary Data
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Controls and Procedures
Other Information
Directors, Executive Officers and Corporate Governance
Executive Compensation
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Certain Relationships and Related Transactions, and Director Independence
Principal Accountant Fees and Services
Exhibits and Financial Statement Schedules
Form 10-K Summary
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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 Rule 175 promulgated
thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended and Rule 3b-6 promulgated thereunder. 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, federal or state tax laws, monetary
and fiscal policy, the quality or composition of the loan or investment portfolio, demand for loan products, fluctuation in the value of collateral securing our loan
portfolio, deposit flows, competition, cybersecurity risk, 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 consolidated 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 Annual Report on Form 10-K or in our other SEC filings. You may find it helpful to
refer back to this page while reading this report.
ACL: Allowance for Credit Losses
AFS: Available-for-sale
ALLL: Allowance for loan and lease losses
AOCI: Accumulated other comprehensive income
ASC: FASB Accounting Standards Codification
ASU: FASB Accounting Standards Update
ATM: Automated Teller Machine
BHC Act: Bank Holding Company Act of 1956
CECL: Current Expected Credit Losses
CFPB: Consumer Financial Protection Bureau
CIK: Central Index Key
CRA: Community Reinvestment Act
DIF: Deposit Insurance Fund
GAAP: U.S. generally accepted accounting principles
GLB Act: Gramm-Leach-Bliley Act of 1999
IFRS: International Financial Reporting Standards
IRR: Interest rate risk
ISDA: International Swaps and Derivatives Association
JOBS Act: Jumpstart our Business Startups Act
LIBOR: London Interbank Offered Rate
N/A: Not applicable
N/M: Not meaningful
NASDAQ: NASDAQ Stock Market Index
NASDAQ Banks: NASDAQ Bank Stock Index
NAV: Net asset value
NOW: Negotiable order of withdrawal
DIFS: Department of Insurance and Financial Services
NSF: Non-sufficient funds
Directors Plan: Isabella Bank Corporation and Related Companies Deferred
Compensation Plan for Directors
Dividend Reinvestment Plan: Isabella Bank Corporation Stockholder Dividend
Reinvestment Plan and Employee Stock Purchase Plan
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection
Act of 2010
OCI: Other comprehensive income (loss)
OMSR: Originated mortgage servicing rights
OREO: Other real estate owned
ESOP: Employee Stock Ownership Plan
Exchange Act: Securities Exchange Act of 1934
FASB: Financial Accounting Standards Board
FDI Act: Federal Deposit Insurance Act
FDIC: Federal Deposit Insurance Corporation
OTTI: Other-than-temporary impairment
PBO: Projected benefit obligation
PCAOB: Public Company Accounting Oversight Board
Rabbi Trust: A trust established to fund our Directors Plan
SEC: U.S. Securities and Exchange Commission
FFIEC: Federal Financial Institutions Examinations Council
SOX: Sarbanes-Oxley Act of 2002
FRB: Federal Reserve Bank
FHLB: Federal Home Loan Bank
Tax Act: Tax Cuts and Jobs Act, enacted December 22, 2017
TDR: Troubled debt restructuring
Freddie Mac: Federal Home Loan Mortgage Corporation
XBRL: eXtensible Business Reporting Language
FTE: Fully taxable equivalent
Yield Curve: U.S. Treasury Yield Curve
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Item 1. Business . ( Dollars in thousands )
General
PART I
Isabella Bank Corporation is a registered financial services holding company that was incorporated in September 1988 under Michigan law. The Corporation's
wholly owned subsidiary, Isabella Bank, has 30 banking offices located throughout Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties .
The area includes significant agricultural production, manufacturing, retail, gaming and tourism, and several colleges and universities.
As used in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations as well as in Item 8. Financial Statements and
Supplementary Data , references to “the Corporation”, “Isabella”, “we”, “our”, “us”, and similar terms refer to the consolidated entity consisting of Isabella Bank
Corporation and its subsidiary. References to Isabella Bank or the “Bank” refers to Isabella Bank Corporation’s subsidiary, Isabella Bank.
Our reportable segments are based on legal entities that account for at least 10% of net operating results. Retail banking operations for 2018 , 2017 , and 2016
represent approximately 90% or greater of total assets and operating results. As such, we have only one reportable segment.
We are a community bank with a focus on providing high quality, personalized service at a fair price. We offer a broad array of banking services to businesses,
institutions, individuals and their families. We compete with other commercial banks, savings and loan associations, mortgage brokers, finance companies, credit
unions, retail brokerage firms, and other companies providing financial services.
Lending activities include loans for commercial and agricultural operating and real estate purposes, residential real estate loans, and consumer loans. We limit
lending activities primarily to local markets and have not purchased any loans from the secondary market. We do not make loans to fund leveraged buyouts, have
no foreign corporate or government loans, and have limited holdings of corporate debt securities. Our general lending philosophy is to limit concentrations to
individuals and business segments. For additional information related to our lending strategies and policies, see “ Note 4 – Loans and ALLL ” of “Notes to
Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data .
Deposit services offered include checking accounts, savings accounts, certificates of deposit, direct deposits, cash management services, mobile and internet
banking, electronic bill pay services, and automated teller machines. We also offer full service investment management and trust services.
As of December 31, 2018 , we had 371 full-time equivalent employees. We provide group life, health, accident, disability, and other insurance programs as well as
a number of other employee benefit programs. None of our workforce is subject to collective bargaining agreements.
Available Information
Our SEC filings (including our Annual Report on Form 10-K , Quarterly Reports on Form 10-Q, Definitive Proxy Statements, Current Reports on Form 8-K and
amendments to those reports) are available through our website (www.isabellabank.com). We will provide paper copies of our SEC reports free of charge upon
request by a shareholder.
The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements and other information regarding Isabella Bank Corporation (
CIK # 0000842517 ) and other issuers.
Supervision and Regulation
The earnings and growth of the banking industry are affected by the credit policies of monetary authorities, including the FRB . An important function of the FRB
is to regulate the national supply of bank credit in order to combat recessions and respond to inflationary pressures. Among the instruments of monetary policy
used by the FRB to implement these objectives are open market operations in U.S. Treasury and U.S. Government Agency securities, changes in the discount rate
on member bank borrowings, and changes in reserve requirements against member bank deposits. These methods are used in varying combinations to influence
overall growth of bank loans, investments and deposits and also affect interest rates charged on loans or paid for deposits. The monetary policies of the FRB have
had a significant effect on the operating results of commercial banks and related financial service providers in the past and are expected to continue to do so in the
future. The effect of such policies upon our future business and earnings cannot be predicted.
We, as a financial holding company, are regulated under the BHC Act , and are subject to the supervision of the FRB . We are registered as a financial services
holding company with the FRB and are subject to reporting requirements and inspections and
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audits. Under FRB policy, we are expected to act as a source of financial strength to the Bank and to commit resources to support its subsidiaries. This support may
be required at times when, in the absence of such FRB policy, it would not otherwise be required to provide support.
Under Michigan law, if the capital of a Michigan state chartered bank has become impaired by losses or otherwise, the Commissioner of the DIFS may require that
the deficiency in capital be met by assessment upon the bank’s shareholders. Each shareholder would be responsible for a pro rata share of the deficiency, based on
the amount of capital stock held by each shareholder. If an assessment is not paid by any shareholder within 30 days of the date of notice to the shareholder, sale of
their stock will occur in order to pay such assessment.
Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of
such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to
maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. This priority would apply to guarantees of
capital plans under the FDIC Improvement Act of 1991.
SOX contains important requirements for public companies in the area of financial disclosure and corporate governance. In accordance with Section 302(a) of
SOX , written certifications by our principal executive, financial, and accounting officers are required. These certifications attest that our quarterly and annual
reports filed with the SEC do not contain any untrue statement of a material fact (see the certifications filed as Exhibits 31 (a) and (b) to this Form 10-K for such
certification of consolidated financial statements and other information for this 2018 Form 10-K). We have also implemented a program designed to comply with
Section 404 of SOX , which included the identification of significant processes and accounts, documentation of the design effectiveness over process and entity
level controls, and testing of the operating effectiveness of key controls. See Item 9A. Controls and Procedures for our evaluation of disclosure controls and
procedures and internal control over financial reporting.
Certain additional information concerning regulatory guidelines for capital adequacy and other regulatory matters is presented herein under the caption “ Capital ”
in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and in “ Note 9 – Off-Balance-Sheet Activities, Commitments
and Other Matters ” and “ Note 10 – Minimum Regulatory Capital Requirements ” of “Notes to Consolidated Financial Statements” in Item 8. Financial
Statements and Supplementary Data .
Isabella Bank
The Bank is supervised and regulated by DIFS and the FRB . These agencies and federal and state laws extensively regulate various aspects of the banking
business including, among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on
loans and deposits, and the safety and soundness of banking practices.
Our deposits are insured up to applicable limits by the DIF of the FDIC and are subject to deposit insurance assessments to maintain the DIF . The FDIC assesses
insurance premiums based upon a financial ratios method that takes into account asset and capital levels and supervisory ratings.
Banking laws and regulations restrict transactions by insured banks owned by a bank holding company. These restrictions include loans to and certain purchases
from the parent holding company, non-bank and bank subsidiaries of the parent holding company. Additional restrictions apply to principal shareholders, officers,
directors and their affiliates, and investments by the subsidiary bank in the shares or securities of the parent holding company (or any of the other non-bank or bank
affiliates), or acceptance of such shares or securities as collateral security for loans to any borrower.
The Bank is subject to legal limitations on the frequency and amount of dividends that can be paid to Isabella Bank Corporation. For example, a Michigan state
chartered bank may not declare a cash dividend or a dividend in kind except out of net profits then on hand after deducting all losses and bad debts, and then only if
it will have a surplus amounting to not less than 20% of its capital after the payment of the dividend. Moreover, a Michigan state chartered bank may not declare or
pay any cash dividend or dividend in kind until the cumulative dividends on its preferred stock, if any, have been paid in full. Further, if the surplus of a Michigan
state chartered bank is at any time less than the amount of its capital, before the declaration of a cash dividend or dividend in kind, it must transfer to surplus not
less than 10% of its net profits for the preceding six months (in the case of quarterly or semi-annual dividends) or the preceding two consecutive six month periods
(in the case of annual dividends).
The payment of dividends by Isabella Bank Corporation and the Bank is also affected by various regulatory requirements and policies, such as the requirement to
keep adequate capital in compliance with regulatory guidelines. Federal laws impose
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further restrictions on the payment of dividends by insured banks that fail to meet specified capital levels. The FDIC may prevent an insured bank from paying
dividends if the bank is in default of payment of any assessment due to the FDIC . In addition, payment of dividends by a bank may be prevented by the applicable
federal regulatory authority if such payment is determined, by reason of the financial condition of such bank, to be an unsafe and unsound banking practice. The
FRB and the FDIC have issued policy statements providing that bank holding companies and insured banks should generally pay dividends only out of current
operating earnings. Additionally, the FRB Board of Governors requires a bank holding company to notify the FRB prior to increasing its cash dividend by more
than 10% over the prior year.
The aforementioned regulations and restrictions may limit our ability to obtain funds from the Bank for our cash needs, including payment of dividends and
operating expenses.
The activities and operations of the Bank are also subject to various federal and state laws and regulations.
Item 1A. Risk Factors .
In the normal course of business, we are exposed to various risks. These risks, if not managed correctly, could have a significant impact on our earnings, capital,
share price, and ability to pay dividends. In order to effectively monitor and control the following risks, we utilize an enterprise risk model. We balance our
strategic goals, including revenue and profitability objectives, with associated risks through the use of policies, systems, and procedures which have been adopted
to identify, assess, control, monitor, and manage each risk area. We continually review the adequacy and effectiveness of these policies, systems, and procedures.
Our enterprise risk process covers each of the following areas.
Changes in credit quality and required allowance for loan and lease losses
To manage the credit risk arising from lending activities, our most significant source of credit risk, we maintain sound underwriting policies and procedures. We
continuously monitor asset quality in order to manage our credit risk to determine the appropriateness of valuation allowances. These valuation allowances take
into consideration various factors including, but not limited to, local, regional, and national economic conditions.
We maintain an ALLL to reserve for estimated incurred loan losses within our loan portfolio. The level of the ALLL reflects our evaluation of industry
concentrations; specific credit risks; loan loss experience; loan portfolio quality; and economic, political and regulatory conditions. The determination of the
appropriate level of the ALLL inherently involves a high degree of subjectivity and requires us to make significant estimates, all of which may undergo material
changes.
Changes in economic conditions
An economic downturn within our local markets, as well as downturns in the state, national, or global markets, could negatively impact household and corporate
incomes. This could lead to decreased demand for both loan and deposit products and lead to an increase of customers who fail to pay interest or principal on their
loans. We continually monitor key economic indicators in an effort to anticipate the possible effects of downturns in the local, regional, and national economies.
Our success depends primarily on the general economic conditions of the State of Michigan and the specific local markets in which we operate. Unlike banks that
are more geographically diversified, we provide banking and financial services to customers located primarily in the Clare, Gratiot, Isabella, Mecosta, Midland,
Montcalm, and Saginaw counties in Michigan. The local economic conditions in these areas have a significant impact on the demand for our products and services,
as well as the ability of our customers to repay loans, the value of the collateral securing loans, and the stability of our deposit funding sources. A significant
decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences,
unemployment, changes in securities markets or other factors could impact these local economic conditions and, in turn, have a material adverse effect on our
financial condition and results of operations.
Interest rate risk
IRR results from the timing differences in the maturity or repricing frequency of a financial institution’s interest earning assets and its interest bearing liabilities.
We monitor the potential effects of changes in interest rates through simulations and gap analyses. To help mitigate the effects of changes in interest rates, we
make significant efforts to stagger projected cash flows and maturities of interest sensitive assets and liabilities.
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Liquidity risk
Liquidity risk is the risk to earnings or capital arising from our inability to meet our obligations when they come due without incurring unacceptable costs.
Liquidity risk includes the inability to manage unplanned changes in funding sources, or failure to address changes in market conditions that affect the ability to
liquidate assets quickly and with minimal loss in value. We have significant borrowing capacity through correspondent banks and the ability to sell certain
investments to fund potential cash shortages, which we may use to help mitigate this risk.
The value of investment securities may be negatively impacted by fluctuations in the market
A volatile, illiquid market or decline in credit quality could require us to recognize an OTTI loss related to the investment securities held in our portfolio. We
consider many factors in determining whether an OTTI exists including the length of time and extent to which fair value has been less than cost, the investment
credit rating, and the probability that the issuer will be unable to pay the amount when due. The presence of these factors could lead to impairment charges. These
risks are mitigated by the fact that we do not intend to sell the security in an unrealized loss position and it is more likely than not that we will not have to sell the
security before recovery of its cost basis.
Operational risk
Operational risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems, or external events and includes reputation risk and
transaction risk. Reputation risk is managed by developing and retaining marketplace confidence in handling customers’ financial transactions in an appropriate
manner and protecting our safety and soundness. Transaction risk includes losses from fraud, error, the inability to deliver products or services, and loss or theft of
information. Transaction risk also encompasses product development and delivery, transaction processing, information technology systems, and the internal control
environment.
To minimize potential losses due to operational risks, we have established a robust system of internal controls that is regularly tested by our internal audit
department in conjunction with the services of certified public accounting firms who assist in performing such internal audit work. The focus of these internal audit
procedures is to verify the validity and appropriateness of various transactions, processes, and controls. The results of these procedures are reported to our Audit
Committee.
The adoption of, violations of, or nonconformance with laws, rules, regulations, or prescribed practices
The financial services industry and public companies are extensively regulated and must meet regulatory standards set by the FDIC , DIFS , FRB , FASB , SEC ,
PCAOB , CFPB , and other regulatory bodies. Federal and state laws and regulations are designed primarily to protect deposit insurance funds and consumers, and
not necessarily to benefit our shareholders. The nature, extent, and timing of the adoption of significant new laws, changes in existing laws, or repeal of existing
laws may have a material impact on our business, results of operations, and financial condition, the effect of which is impossible to predict at this time.
Our compliance department annually assesses the adequacy and effectiveness of our processes for controlling and managing our principal compliance risks.
Changes to the financial services industry as a result of regulatory changes or actions, or significant litigation
The financial services industry is extensively regulated by state and federal regulation that governs almost all aspects of our operations. Laws and regulations may
change from time-to-time and are primarily intended for the protection of consumers, depositors, and the deposit insurance fund. The impact of any changes to
laws and regulations or other actions by regulatory agencies may negatively impact us or our ability to increase the value of our business. Regulatory authorities
have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution,
the classification of assets by the institution, and the appropriateness of an institution’s ALLL . Future regulatory changes or accounting pronouncements may
increase our regulatory capital requirements or adversely affect our regulatory capital levels. Additionally, actions by regulatory agencies or significant litigation
against us could require the dedication of significant time and resources to defend our business and may lead to penalties.
We may not adjust to changes in the financial services industry
Our financial performance depends in part on our ability to maintain and grow our core deposit customer base and expand our financial services to our existing and
new customers. The increasingly competitive environment is, in part, a result of changes in technology and product delivery systems and the accelerating pace of
consolidation among financial service providers. New competitors may emerge to increase the degree of competition for our products and services. Financial
services and products are also constantly changing. Our financial performance is dependent upon customer demand for our products and services,
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our ability to develop and offer competitive financial products and services, and our ability to adapt to enhancements in financial technology.
We may be required to recognize an impairment of goodwill
Goodwill represents the excess of the amounts paid to acquire subsidiaries over the fair value of their net assets at the date of acquisition. The majority of the
recorded goodwill is related to acquisitions of other banks, which were subsequently merged into Isabella Bank. If it is determined that the goodwill is impaired,
we must write-down the goodwill by the amount of the impairment.
We may face pressure from purchasers of our residential mortgage loans to repurchase loans sold or reimburse purchasers for losses related to such
loans
We generally sell the fixed rate long-term residential mortgage loans we originate to the secondary market. The purchasers of residential mortgage loans, such as
government sponsored entities, increased their efforts to require sellers of residential mortgage loans to either repurchase loans previously sold, or reimburse the
purchasers for losses incurred on foreclosed loans due to actual or alleged failure to strictly conform to the terms of the contract.
Consumers may decide not to use banks to complete their financial transactions
Technology and other changes are allowing customers to complete financial transactions without the involvement of banks. For example, consumers can now pay
bills and transfer funds directly without banks. The process of eliminating banks as intermediaries in financial transactions could result in the loss of fee income, as
well as the loss of customer deposits and income generated from those deposits.
Unauthorized disclosure of sensitive or confidential client or customer information, whether through cyber attacks, breach of computer systems or other
means
Our products, services and systems are accessed through critical company or third-party operations. This involves the storage, processing and transmission of
sensitive data, including proprietary or confidential data, regulated data, and personal information of employees and customers. Successful breaches, employee
wrongdoing, or human or technological error could result in unauthorized access to, disclosure, modification, misuse, loss, or destruction of company, customer, or
other third party data or systems. Examples include theft of sensitive, regulated, or confidential data including personal information; loss of access to critical data
or systems through ransomware, destructive attacks or other means; and business delays, service or system disruptions or denials of service.
Cybersecurity incidents have increased in number and severity and it is expected that these trends will continue. Should we, or third parties we do business with,
fall victim to successful cyber attacks or experience other cybersecurity incidents, including the loss of personally identifiable customer or other sensitive data, the
result could severely damage our reputation, expose us to the risks of litigation and liability, disrupt our operations and increase cybersecurity or other insurance
premiums.
We have cybersecurity insurance, in the event a cybersecurity attack were to occur, covering expenses related to notification, credit monitoring, investigation, crisis
management, public relations, and legal advice. In addition, we maintain insurance to cover restoration of data, certain physical damage or third-party injuries
caused by potential cybersecurity incidents. However, damage and claims arising from such incidents may not be covered or may exceed the amount of any
insurance available. Insurance policies are reviewed annually in detail.
A strong reputation is vital and requires utmost protection. An operating incident, significant cybersecurity disruption, or other adverse event may have a negative
impact on our reputation which could make it more difficult for us to compete successfully for new opportunities, obtain necessary regulatory approvals, or
severely reduce consumer demand for our products.
Our estimates and assumptions may be incorrect
Our consolidated financial statements conform with GAAP, which require us to make estimates and assumptions that affect the amounts reported in the
consolidated financial statements . Estimates are based on information available to us at the time the estimates are made. Actual results could differ from estimates.
For further discussion regarding significant accounting estimates, see “ Note 1 – Nature of Operations and Summary of Significant Accounting Policies ” of “Notes
to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data .
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Disruption of infrastructure
Our operations depend upon our technological and physical infrastructure, including our equipment and facilities. Extended disruption of our vital infrastructure by
fire, power loss, natural disaster, telecommunications failure, computer hacking and viruses, or other events outside of our control, could have a significant impact
on our operations. We have developed and tested disaster recovery plans for all significant aspects of our operations.
Anti-takeover provisions
Our articles of incorporation include anti-takeover provisions that require a two-thirds majority vote to approve a sale of the Corporation. Additionally, changes to
our articles of incorporation must be approved by a two-thirds majority vote of our shareholders. These provisions may make our stock less attractive to potential
shareholders.
Item 1B. Unresolved Staff Comments .
None.
Item 2. Properties .
Our executive offices are located at 401 North Main Street in Mount Pleasant, Michigan. In addition to this location, we own 29 branches, two operations centers,
our previous main office building and vacant land. We also lease property in Saginaw, Michigan which serves as a full-service branch. Our facilities' current,
planned, and best use is for conducting our current activities, with the exception of our previous main office location which is vacant. We continually monitor and
assess the need for expansion and/or improvement of all facilities. In our opinion, each facility has sufficient capacity and is in good condition.
Item 3. 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 our consolidated operations, earnings, financial condition, or cash flows.
Item 4. Mine Safety Disclosures .
Not applicable.
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Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities .
PART II
Common Stock and Dividend Information
Our authorized common stock consists of 15,000,000 shares, of which 7,870,969 shares are issued and outstanding as of December 31, 2018 . As of that date, there
were 3,083 shareholders of record.
Our common stock is traded in the over-the-counter market. Our common stock is quoted on the OTCQX market tier of the OTC Markets Group Inc.’s (" OTC
Markets ") electronic quotation system (www.otcmarkets.com) under the symbol “ISBA”. Other trades in our common stock occur in privately negotiated
transactions from time to time of which we may have little or no information.
We have reviewed the information available as to the range of reported high and low bid quotations, including high and low bid information as reported by OTC
Markets . The following table sets forth our compilation of that information for the periods indicated. Price information obtained from OTC Markets reflects inter-
dealer prices, without retail mark up, mark down, or commissions and may not necessarily represent actual transactions. The following compiled data is provided
for information purposes only and should not be viewed as indicative of the actual or market value of our common stock.
2018
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
2017
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
The following table sets forth the cash dividends paid for the following quarters:
First Quarter
Second Quarter
Third Quarter
Fourth Quarter
Total
Number of
Common Shares
Sale Price
Low
High
65,782 $
26.11 $
78,922
86,032
73,364
304,100
26.25
26.05
22.50
96,592 $
27.60 $
64,160
66,000
60,227
286,979
27.60
27.65
27.99
Per Share
2018
2017
$
$
0.26 $
0.26
0.26
0.26
1.04 $
28.25
27.25
27.65
27.00
29.00
28.45
29.10
29.95
0.25
0.25
0.26
0.26
1.02
We have adopted and publicly announced a common stock repurchase plan. The plan was last amended on August 22, 2018 , 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 shares are repurchased under this plan, they are
retired and revert back to the status of authorized, but unissued, shares.
10
Table of Contents
The following table provides information for the unaudited three month period ended December 31, 2018 , with respect to our common stock repurchase plan:
Balance, September 30
October 1 - 31
November 1 - 30
December 1 - 31
Balance, December 31
Common Shares Repurchased
Number
Average Price
Per Common Share
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
2,797 $
3,325
26,468
32,590 $
26.81
25.26
24.07
24.42
2,797
3,325
26,468
32,590
200,244
197,447
194,122
167,654
167,654
Information concerning securities authorized for issuance under equity compensation plans appears under Item 12. Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder Matters .
Stock Performance
The following graph compares the cumulative total shareholder return on our common stock for the last five years with the cumulative total return on (1)
NASDAQ , which is comprised of all United States common shares traded on the NASDAQ and (2) the NASDAQ Banks , which is comprised of bank and bank
holding company common shares traded on the NASDAQ over the same period. The graph assumes the value of an investment in the Corporation's common stock
and each index was $100 at December 31, 2013 and all dividends were reinvested.
Year
12/31/2013
12/31/2014
12/31/2015
12/31/2016
12/31/2017
12/31/2018
ISBA
NASDAQ
$
100.00 $
100.00 $
98.00
135.30
130.50
137.20
114.10
114.83
122.99
134.02
173.86
168.98
NASDAQ
Banks
100.00
104.92
114.20
157.56
166.15
139.28
11
Table of Contents
Item 6. Selected Financial Data .
Results of Operations ( Dollars in thousands except per share amounts)
The following table outlines the results of operations and provides certain key performance measures as of, and for the years ended, December 31 :
INCOME STATEMENT DATA
Interest income
Interest expense
Net interest income
Provision for loan losses
Noninterest income
Noninterest expenses
Federal income tax expense (1)
Net income
PER SHARE
Basic earnings
Diluted earnings
Dividends
Tangible book value (2)
Quoted market value
High
Low
Close (3)
Common shares outstanding (3)
PERFORMANCE RATIOS
Return on average total assets
Return on average shareholders' equity
Return on average tangible shareholders' equity
Net interest margin yield (FTE) (1)
BALANCE SHEET DATA (3)
Gross loans
AFS securities
Total assets
Deposits
Borrowed funds
Shareholders' equity
Gross loans to deposits
ASSETS UNDER MANAGEMENT (3)
Loans sold with servicing retained
Assets managed by our Investment and Trust Services Department
Total assets under management
ASSET QUALITY (3)
Nonperforming loans to gross loans
Nonperforming assets to total assets
ALLL to gross loans
CAPITAL RATIOS (3)
Shareholders' equity to assets
Tier 1 leverage
Common equity tier 1 capital
Tier 1 risk-based capital
Total risk-based capital
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
2018
2017
2016
2015
2014
$
63,864
15,631
48,233
978
10,946
42,817
1,363
$
58,413
12,494
45,919
253
10,812
40,225
3,016
$
53,666
10,865
42,801
(135)
11,108
37,897
2,348
$
51,502
10,163
41,339
(2,771)
10,359
36,051
3,288
14,021
$
13,237
$
13,799
$
15,130
$
1.78
1.74
1.04
18.68
28.25
22.50
22.56
$
$
$
$
$
$
$
1.69
1.65
1.02
18.63
29.95
27.60
28.25
$
$
$
$
$
$
$
1.77
1.73
0.98
17.80
29.90
27.25
27.85
$
$
$
$
$
$
$
1.95
1.90
0.94
17.33
29.90
22.00
29.90
$
$
$
$
$
$
$
51,148
9,970
41,178
(668)
9,325
35,103
2,344
13,724
1.77
1.74
0.89
16.52
24.00
21.73
22.50
7,870,969
7,857,293
7,821,069
7,799,867
7,776,274
0.77%
7.26%
9.14%
2.97%
0.75%
6.75%
9.09%
3.03%
0.82%
7.12%
9.95%
3.00%
0.95%
8.33%
11.46%
3.10%
0.90%
8.06%
10.80%
3.24%
1,128,707
494,834
1,837,307
1,292,693
340,299
195,519
$
$
$
$
$
$
1,091,519
548,730
1,813,130
1,265,258
344,878
194,905
$
$
$
$
$
$
1,010,615
554,671
1,732,151
1,195,040
337,694
187,899
$
$
$
$
$
$
850,492
656,837
1,668,112
1,164,563
309,732
183,971
$
$
$
$
$
$
836,550
561,394
1,549,543
1,074,484
289,709
174,594
87.31%
86.27%
84.57%
73.03%
77.86%
259,481
447,487
2,544,275
$
$
$
266,789
478,146
2,558,065
$
$
$
272,882
427,693
2,432,726
$
$
$
287,029
405,109
2,360,250
$
$
$
288,639
383,878
2,222,060
0.65%
0.42%
0.74%
10.64%
8.72%
12.58%
12.58%
13.26%
0.31%
0.20%
0.71%
10.75%
8.54%
12.23%
12.23%
12.86%
0.17%
0.11%
0.73%
10.85%
8.56%
12.39%
12.39%
13.04%
0.09%
0.07%
0.87%
11.03%
8.52%
13.44%
13.44%
14.17%
0.50%
0.33%
1.21%
11.27%
8.59%
N/A
14.08%
15.19%
(1) Calculations are based on a federal income tax rate of 21% in 2018 and 34% for all prior periods.
(2) Tangible book value calculations include unrealized gain/loss on AFS securities.
(3) At end of year
12
Table of Contents
The following table outlines our interim results of operations and key performance measures as of, and for the unaudited periods ended:
Total interest income
Total interest expense
Net interest income
Provision for loan losses
Noninterest income
Noninterest expenses
Federal income tax expense
Net income
PER SHARE
Basic earnings
Diluted earnings
Dividends
Quoted market value (1)
Tangible book value (2)
December 31
2018
September 30
2018
June 30
2018
March 31
2018
December 31
2017
September 30
2017
June 30
2017
March 31
2017
$
16,611 $
16,419 $
15,713 $
15,121 $
15,078 $
14,976 $
14,498 $
13,861
Quarter to Date
4,258
12,353
342
2,860
10,865
476
4,231
3,741
3,401
3,435
3,200
3,028
12,188
11,972
11,720
11,643
11,776
11,470
(76)
2,863
11,072
359
328
2,736
384
2,487
168
2,710
10,784
10,096
10,628
263
265
836
49
2,698
10,139
750
9
2,788
9,507
898
3,530 $
3,696 $
3,333 $
3,462 $
2,721 $
3,536 $
3,844 $
0.45 $
0.47 $
0.42 $
0.44 $
0.35 $
0.45 $
0.49 $
0.44
0.26
22.56
18.68
0.46
0.26
26.75
19.44
0.41
0.26
26.65
19.36
0.43
0.26
27.40
19.16
0.34
0.26
28.25
18.96
0.44
0.26
29.00
18.82
0.48
0.25
28.00
18.62
2,831
11,030
27
2,616
9,951
532
3,136
0.40
0.39
0.25
27.60
18.34
$
$
(1) At end of period
(2) Tangible book value calculations include unrealized gain/loss on AFS securities.
13
Table of Contents
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations .
ISABELLA BANK CORPORATION FINANCIAL REVIEW
( Dollars in thousands except per share amounts)
The following is management’s discussion and analysis of the financial condition and results of our operations. This discussion and analysis is intended to provide
a better understanding of the consolidated financial statements and statistical data included elsewhere in this Annual Report on Form 10-K .
Executive Summary
We reported net income of $14,021 and earnings per common share of $1.78 for the year ended December 31, 2018 . Net income and earnings per common share
for the year ended December 31, 2017 were $13,237 and $1.69 , respectively. Interest income for the year ended December 31, 2018 increased $5,451 when
compared to 2017 primarily as the result of strong loan growth, which totaled $37,188 during 2018 . Net interest income increased by $2,314 for the year ended
December 31, 2018 in comparison to 2017 . The provision for loan losses increased by $725 and was the result of loan growth, increased charge-offs, and an
increase in criticized assets largely related to our agricultural loan portfolio. Noninterest expenses for the year ended December 31, 2018 exceeded noninterest
expenses in 2017 due to increased compensation and benefits, certain loan expenses and increased costs related to upgrades with technology and network security.
Additionally in 2017 , noninterest expenses were reduced by a settlement with an insurance claims administrator in favor of Isabella Bank. Net income in 2018 has
benefited from the lower federal statutory tax rate established by the Tax Act .
As of December 31, 2018 , total assets and assets under management were $1,837,307 and $2,544,275 , respectively. Assets under management include loans sold
and serviced of $259,481 and assets managed by our Investment and Trust Services Department of $447,487 , in addition to assets on our consolidated balance
sheet. In 2018 , the loan growth of $37,188 was attributable to commercial portfolio growth of $24,770 and increases in residential real estate and consumer loans
of $13,526 , offset by a $1,108 decline in the agricultural portfolio. Loan growth was funded through maturities and the receipt of principal payments in the AFS
securities portfolio and growth in total deposits. All regulatory capital ratios for the Bank exceeded the minimum thresholds to be considered a "well capitalized"
institution.
Our net yield on interest earning assets (FTE) was 2.97% for 2018 and experienced a slight decline in comparison to prior periods. The FRB increased short-term
interest rates during each quarter of 2018. Over the next few years, we anticipate incremental improvement in our net yield on interest earning assets as a result of a
combination of our asset mix shifting to an increasing percentage of loans compared to investment securities, strategic growth in loans, and market driven loan
pricing. We are committed to increasing earnings and shareholder value through growth in our loan portfolio, growth in our investment and trust services,
increasing our presence within our geographic footprint, and managing operating costs.
The current interest rate environment, which consists of low rates and a flat yield curve, is having an impact on investor confidence in the financial sector. Interest
rate environments with flattened yield curves generally result in a decline in the market price of bank stocks. In early 2017, the difference between the yields of the
2-year treasury and 10-year treasury notes was above 120 basis points. Since the first part of December 2018, the same yield variance has remained below 20 basis
points, which is not favorable for financial institutions.
Bank stocks, in general, were negatively impacted in 2018 by the interest rate environment. The Nasdaq Bank Stock Index declined 19% in the fourth quarter of
2018. The price per share of our common stock fell approximately 16% from $26.75 on September 28, 2018 to $22.56 on December 31, 2018. Even within this
declining period, there were a few trades that we were aware of at $25.95 per share between December 14, 2018 and December 24, 2018. Historically, our stock
price lags market changes, both upward and downward, 60 to 90 days.
Our Board of Directors and management team closely monitor our stock price, and are focused on improving the metrics which should serve to have a favorable
impact on the stock price. In the second half of 2018, we engaged the services of an investor relations firm whose mission is to help build brand awareness of
Isabella Bank Corporation in the investment community, and get management in front of selected investment professionals and advisors through small group
presentations. The feedback from this strategy has been positive thus far.
Recent Legislation
The Dodd-Frank Act of 2010, has already had, and is expected to continue to have, a negative impact on our operating results. The Dodd-Frank Act established the
CFPB which has made significant changes in the regulation of financial institutions aimed at strengthening the oversight of the federal government over the
operation of the financial services sector and increasing the
14
Table of Contents
protection of consumers. Recent regulations issued by the CFPB regarding consumer lending, including residential mortgage lending, have increased our
compensation expenses and this trend is expected to continue.
On July 2, 2013, the FRB published revised BASEL III Capital standards for banks. The 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.
On December 22, 2017, the Tax Cuts and Jobs Act was enacted. The law established a flat corporate federal statutory income tax rate of 21%, effective January 1,
2018, and eliminated the corporate alternative minimum tax which can be carried forward and used to reduce future income tax. The tax law provided for a wide
array of changes, only some of which had a direct impact on our federal income tax expense. Some of these changes included, but are not limited to, the following
items: limits to the deduction for net interest expense; immediate expense (for tax purposes) for certain qualified depreciable assets; elimination or reduction of
certain deductions related to meals and entertainment expenses; and limits to the deductibility of deposit insurance premiums.
Reclassifications
Certain amounts reported in management's discussion and analysis of financial condition and results of operations for 2017 and 2016 have been reclassified to
conform with the 2018 presentation.
Other
We have not received any notices of regulatory actions as of March 12, 2019 .
CRITICAL ACCOUNTING POLICIES
Our significant accounting policies are set forth in “ Note 1 – Nature of Operations and Summary of Significant Accounting Policies ” of “Notes to Consolidated
Financial Statements” in Item 8. Financial Statements and Supplementary Data . Of these significant accounting policies, we consider our policies regarding the
ALLL , acquisition intangibles and goodwill, and the determination of the fair value and assessment of OTTI of investment securities to be our most critical
accounting policies.
The ALLL requires our most subjective and complex judgment. Changes in economic conditions and other external factors can have a significant impact on the
ALLL and, therefore, the provision for loan losses and results of operations. We have developed policies and procedures for assessing the appropriateness of the
ALLL , recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future
periods by changes in economic conditions, and the discovery of information with respect to borrowers which is not known to us at the time of the issuance of the
consolidated financial statements . For additional discussion concerning our ALLL and related matters, see “ Allowance for Loan and Lease Losses ” and “ Note 4
– Loans and ALLL ” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data .
U.S. generally accepted accounting principles require that we determine the fair value of the assets and liabilities of an acquired entity, and record the fair value on
the date of acquisition. We employ a variety of measures in the determination of the fair value, including the use of discounted cash flow analysis, market
appraisals, and projected future revenue streams. For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to
use our own calculations of the value. In other cases, where the value is not easily determined, we consult with independent experts to determine the fair value of
the identified asset or liability. Once valuations have been adjusted, the net difference between the price paid for the acquired entity and the net value of assets
acquired on our balance sheet, including identifiable intangibles, is recorded as goodwill. Acquisition intangibles and goodwill are qualitatively evaluated to
determine if it is more likely than not that the carrying balance is impaired on at least an annual basis.
AFS securities are carried at fair value with changes in the fair value included as a component of other comprehensive income. Declines in the fair value of AFS
securities below their cost that are other-than-temporary are reflected as realized losses in the consolidated statements of income. We evaluate AFS securities for
indications of losses that are considered other-than-temporary , if any, on a regular basis. The market values for most AFS investment securities are typically
obtained from outside sources and applied to individual securities within the portfolio. Municipal securities for which no readily determinable market values are
available are priced using fair value curves which most closely match the securities' characteristics.
15
Table of Contents
Average Balances, Interest Rates, and Net Interest Income
The following schedules present the daily average amount outstanding for each major category of interest earning assets, non-earning assets, interest bearing
liabilities, and noninterest bearing liabilities for the last three years. 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 federal income tax rate of 21% in 2018 and 34% in 2017 and 2016. 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.
2018
Tax
Equivalent
Interest
Average
Balance
Average
Yield /
Rate
Average
Balance
2017
Tax
Equivalent
Interest
Average
Yield /
Rate
Average
Balance
2016
Tax
Equivalent
Interest
Average
Yield /
Rate
Year Ended December 31
INTEREST EARNING
ASSETS
Loans
$
1,120,021 $
49,229
4.40% $
1,040,630 $
43,537
4.18% $
922,333 $
38,537
4.18%
Taxable investment
securities (1)
Nontaxable investment
securities
Fed funds sold
Other
341,095
8,294
2.43%
361,783
8,564
2.37%
392,810
8,746
2.23%
191,281
7,115
3.72%
202,375
9,126
4
—
35,719
1,062
Total earning assets
1,688,120
65,700
NONEARNING ASSETS
Allowance for loan losses
(8,094)
Cash and demand
deposits due from banks
Premises and equipment
Accrued income and other
assets
19,770
28,349
87,895
—%
2.97%
3.89%
663
26,815
5
737
1,632,266
61,969
(7,607)
19,309
28,933
99,456
Total assets
$
1,816,040
$
1,772,357
4.51%
0.75%
2.75%
3.80%
205,450
9,351
—
25,557
—
668
1,546,150
57,302
4.55%
—%
2.61%
3.71%
(7,638)
18,178
28,670
101,995
$
1,687,355
INTEREST BEARING
LIABILITIES
Interest bearing demand
deposits
Savings deposits
Time deposits
Borrowed funds
Total interest bearing
liabilities
NONINTEREST
BEARING LIABILITIES
Demand deposits
Other
Shareholders’ equity
Total liabilities and
shareholders’ equity
Net interest income (FTE)
Net yield on
interest
earning
assets (FTE)
$
229,411 $
361,743
454,916
344,352
267
1,698
7,296
6,370
0.12% $
213,648 $
0.47%
1.60%
1.85%
356,963
433,562
352,400
232
1,091
5,486
5,685
0.11% $
203,198 $
0.31%
1.27%
1.61%
336,859
429,731
319,049
163
663
5,010
5,029
0.08%
0.20%
1.17%
1.58%
1,390,422
15,631
1.12%
1,356,573
12,494
0.92%
1,288,837
10,865
0.84%
224,777
7,597
193,244
208,988
10,641
196,155
194,892
9,841
193,785
$
1,816,040
$
1,772,357
$
1,687,355
$
50,069
$
49,475
$
46,437
2.97%
3.03%
3.00%
(1) Includes taxable AFS securities and equity securities
Net interest income is the amount by which interest income on earning assets exceeds the interest expense 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
16
Table of Contents
analytical purposes, net interest income is adjusted to an FTE basis by includng the income tax savings from interest on tax exempt loans, and nontaxable
investment securities, thus making year to year comparisons more meaningful. The FTE adjustment is based on a federal income tax rate of 21% for 2018 and 34%
for 2017 and 2016.
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 FTE rate.
Rate—change in the FTE rate multiplied by the previous period's volume.
All interest income presented in the table below is reported on a FTE basis using a federal income tax rate of 21% for 2018 and 34% for 2017 and 2016. 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.
Changes in interest income
Loans
$
3,423 $
2,269 $
5,692 $
4,949 $
51 $
2018 Compared to 2017
Increase (Decrease) Due to
2017 Compared to 2016
Increase (Decrease) Due to
Volume
Rate
Net
Volume
Rate
Net
Taxable investment securities
Nontaxable investment securities
Fed Funds Sold
Other
Total changes in interest income
Changes in interest expense
Interest bearing demand deposits
Savings deposits
Time deposits
Borrowed funds
Total changes in interest expense
Net change in interest
margin (FTE)
(499)
(479)
—
261
2,706
18
15
281
(132)
182
229
(1,532)
(5)
64
1,025
17
592
1,529
817
2,955
(270)
(2,011)
(5)
325
3,731
35
607
1,810
685
3,137
(715)
(139)
5
34
4,134
9
42
45
536
632
533
(86)
—
35
533
60
386
431
120
997
$
2,524 $
(1,930) $
594 $
3,502 $
(464) $
5,000
(182)
(225)
5
69
4,667
69
428
476
656
1,629
3,038
Our net yield on interest earning assets remained unchanged during most of 2018, improving slightly in the fourth quarter. The continuing flattening of the yield
curve and rising deposit rates combined with a high concentration of AFS securities as a percentage of earning assets has also placed pressure on net interest
margin.
Total earning assets
Total interest bearing liabilities
Net yield on interest earning assets (FTE)
Total interest income (FTE)
Total interest expense
Net interest income (FTE)
Average Yield / Rate for the Three Month Periods Ended:
December 31
2018
September 30
2018
June 30
2018
March 31
2018
December 31
2017
4.01%
1.23%
3.01%
3.94%
1.20%
2.95%
3.84%
1.08%
2.95%
3.77%
0.99%
2.95%
3.86%
1.01%
3.02%
Quarter to Date Net Interest Income (FTE)
December 31
2018
September 30
2018
June 30
2018
March 31
2018
December 31
2017
$
$
17,005 $
16,873 $
16,191 $
15,631 $
4,258
4,231
3,741
3,401
12,747 $
12,642 $
12,450 $
12,230 $
15,939
3,435
12,504
17
Table of Contents
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-off
s, 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
representation of other qualitative risks that reflect 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, provision for loan losses, and ALLL balances as of, and for the unaudited three month periods ended:
December 31
2018
September 30
2018
June 30
2018
March 31
2018
December 31
2017
Total charge-offs
Total recoveries
Net loan charge-offs (recoveries)
Net loan charge-offs (recoveries) to average
loans outstanding
Provision for loan losses
Provision for loan losses to average loans
outstanding
ALLL
$
$
$
$
253
186
67
0.01%
342
$
$
179
155
24
— %
(76)
$
$
566
238
328
0.03%
328
$
$
103
219
(116)
(0.01)%
384
$
0.03%
(0.01)%
0.03%
0.04 %
8,375
$
8,100
$
8,200
$
8,200
$
ALLL as a % of loans at end of period
0.74%
0.71 %
0.71%
0.75 %
401
233
168
0.02%
168
0.02%
7,700
0.71%
The following table summarizes our charge-off and recovery activity for the years ended December 31 :
ALLL at beginning of period
$
7,700
$
7,400
$
7,400
$
10,100
$
11,500
2018
2017
2016
2015
2014
Charge-offs
Commercial and agricultural
Residential real estate
Consumer
Total charge-offs
Recoveries
Commercial and agricultural
Residential real estate
Consumer
Total recoveries
Provision for loan losses
626
151
324
1,101
328
261
209
798
978
265
200
306
771
453
206
159
818
253
ALLL at end of period
Net loan charge-offs (recoveries)
Net loan charge-offs (recoveries) to average loans
outstanding
ALLL as a% of loans at end of period
$
$
8,375
303
$
$
7,700
(47)
$
$
0.03%
0.74%
—%
0.71%
18
57
574
285
916
540
287
224
1,051
(135)
7,400
(135)
$
$
(0.01)%
0.73 %
134
397
373
904
549
220
206
975
(2,771)
7,400
(71)
$
$
(0.01)%
0.87 %
590
722
316
1,628
550
197
149
896
(668)
10,100
732
0.09%
1.21%
Table of Contents
We experienced a higher level of charge-offs in 2018 when compared to 2017 which was significantly related to one borrower and is therefore, not indicative of a
trend in charge-off activity. While we have experienced a slight deterioration in credit quality indicators in recent periods, credit quality remains strong. Overall,
our level of required reserve is modest due to strong credit quality, low historical loss factors, and a low amount of net charge-offs. The following table illustrates
our changes within the two main components of the ALLL as of:
ALLL
Individually evaluated for impairment
Collectively evaluated for impairment
Total
ALLL to gross loans
Individually evaluated for impairment
Collectively evaluated for impairment
Total
December 31
2018
September 30
2018
June 30
2018
March 31
2018
December 31
2017
$
$
1,938
6,437
8,375
$
$
0.17%
0.57%
0.74%
2,074
6,026
8,100
$
$
0.18%
0.53%
0.71%
2,059
6,141
8,200
$
$
0.18%
0.53%
0.71%
2,503
5,697
8,200
$
$
0.23%
0.52%
0.75%
2,130
5,570
7,700
0.20%
0.51%
0.71%
For further discussion of the allocation of the ALLL , see “ Note 4 – Loans and ALLL ” of “Notes to Consolidated Financial Statements” in Item 8. Financial
Statements and Supplementary Data .
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 loans in
nonaccrual status for indications of additional deterioration.
Commercial
Agricultural
Residential real estate
Consumer
Total
Total Past Due and Nonaccrual Loans as of December 31
2018
2017
2016
2015
2014
$
$
$
2,722
5,377
3,208
105
$
2,518
2,367
4,881
70
$
3,347
1,251
2,716
115
$
1,015
1,232
2,520
31
11,412
$
9,836
$
7,429
$
4,798
$
4,496
309
4,181
138
9,124
Total past due and nonaccrual loans to gross loans
1.01%
0.90%
0.74%
0.56%
1.09%
Past due and nonaccrual status loans have increased over the last year but continue to be at low levels as a result of strong repayment performance. 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 4 – Loans and
ALLL ” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data .
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. This approach has allowed certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure.
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 in nonaccrual status may be placed back on accrual status after six months of continued
performance and achievement of current payment status.
We restructure debt with borrowers who due to financial difficulties are unable to service their debt under the original terms. We may extend the amortization
period, reduce interest rates, allow interest only payment structures, forgive principal, forgive interest, or grant a combination of these modifications. Typically, the
modifications are for a period of three years or less. There were no TDRs that were government sponsored as of December 31, 2018 or December 31, 2017 .
19
Table of Contents
Losses associated with TDRs , if any, are included in the estimation of the ALLL during the quarter in which a loan is identified as a TDR , and we review the
analysis of the ALLL estimation each reporting period thereafter to ensure its continued appropriateness.
The following table provides a roll-forward of TDRs for the years ended December 31, 2017 and 2018 :
Accruing Interest
Nonaccrual
Total
January 1, 2017
New modifications
Principal advances (payments)
Loans paid off
Partial charge-offs
Balances charged-off
Transfers to OREO
Transfers to accrual status
Transfers to nonaccrual status
December 31, 2017
New modifications
Principal advances (payments)
Loans paid off
Partial charge-offs
Balances charged-off
Transfers to OREO
Transfers to accrual status
Transfers to nonaccrual status
December 31, 2018
Number
of
Loans
153 $
20
—
(22)
—
(2)
—
2
(4)
147
27
—
(35)
—
—
—
1
(7)
133 $
Balance
Number
of
Loans
Balance
20,593
7,128
(1,501)
(1,500)
—
(62)
—
126
(1,500)
23,284
6,623
(1,456)
(4,361)
—
—
—
520
(1,210)
23,400
$
5
8
—
—
—
—
(2)
(2)
4
13
18
—
(7)
—
(1)
(1)
(1)
7
28
$
789
1,138
(127)
—
(170)
—
(91)
(126)
1,500
2,913
1,733
(714)
(819)
(39)
(7)
(206)
(520)
1,210
3,551
Number
of
Loans
158 $
28
—
(22)
—
(2)
(2)
—
—
160
45
—
(42)
—
(1)
(1)
—
—
Balance
21,382
8,266
(1,628)
(1,500)
(170)
(62)
(91)
—
—
26,197
8,356
(2,170)
(5,180)
(39)
(7)
(206)
—
—
161 $
26,951
The following table summarizes our TDRs as of December 31 :
Accruing
Interest
2018
Nonaccrual
Current
$
21,794 $
2,673 $
Accruing
Interest
2017
Nonaccrual
21,234 $
— $
Total
24,467 $
Accruing
Interest
2016
Nonaccrual
17,557 $
559 $
Total
18,116
Total
21,234 $
Past due 30-59
days
Past due 60-89
days
Past due 90 days
or more
899
707
—
—
899
1,778
805
2,583
2,898
230
3,128
707
219
708
927
138
—
—
138
—
—
878
878
53
1,400
1,453
—
Total
$
23,400 $
3,551 $
26,951 $
23,284 $
2,913 $
26,197 $
20,593 $
789 $
21,382
Current
Past due 30-59 days
Past due 60-89 days
Past due 90 days or more
Total
Accruing
Interest
2015
Nonaccrual
$
20,550 $
146 $
357
24
—
—
—
248
Accruing
Interest
2014
Nonaccrual
20,012 $
272 $
804
115
—
592
3
1,543
Total
20,696 $
357
24
248
Total
20,284
1,396
118
1,543
$
20,931 $
394 $
21,325 $
20,931 $
2,410 $
23,341
Additional disclosures about TDRs are included in “ Note 4 – Loans and ALLL ” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements
and Supplementary Data .
20
Table of Contents
Impaired Loans
The following is a summary of information pertaining to impaired loans as of December 31 :
TDRs
Commercial real estate
Commercial other
Agricultural real estate
Agricultural other
Residential real estate senior liens
Residential real estate junior liens
Home equity lines of credit
Consumer secured
Total TDRs
Other impaired loans
Commercial real estate
Commercial other
Agricultural real estate
Agricultural other
Residential real estate senior liens
Residential real estate junior liens
Home equity lines of credit
Consumer secured
Recorded
Balance
2018
Unpaid
Principal
Balance
Valuation
Allowance
Recorded
Balance
2017
Unpaid
Principal
Balance
Valuation
Allowance
$
6,507 $
6,840 $
437 $
5,780 $
6,082 $
1,713
7,452
5,288
5,923
12
47
9
1,713
7,452
5,331
6,205
12
347
9
—
112
—
1,181
2
—
—
2,219
7,913
2,685
7,460
44
79
17
2,219
7,913
2,685
7,839
44
379
17
626
24
—
—
1,406
7
—
—
26,951
27,909
1,732
26,197
27,178
2,063
256
1,423
557
1,001
911
—
—
—
318
1,530
558
1,000
1,084
—
—
—
—
6
—
20
180
—
—
—
206
100
—
—
—
356
—
—
—
456
161
—
—
—
620
—
—
—
781
—
—
—
—
67
—
—
—
67
Total other impaired loans
4,148
4,490
Total impaired loans
$
31,099 $
32,399 $
1,938 $
26,653 $
27,959 $
2,130
Additional disclosure related to impaired loans is included in “ Note 4 – Loans and ALLL ” of “Notes to Consolidated Financial Statements” in Item 8. Financial
Statements and Supplementary Data .
21
Table of Contents
Nonperforming Assets
The following table summarizes our nonperforming assets as of December 31 :
Nonaccrual status loans
Accruing loans past due 90 days or more
Total nonperforming loans
Foreclosed assets
Total nonperforming assets
Nonperforming loans as a % of total loans
Nonperforming assets as a % of total assets
$
$
2018
2017
2016
2015
2014
7,260
$
3,027
$
1,060
$
113
7,373
355
395
3,422
291
633
1,693
231
792
$
—
792
421
7,728
$
3,713
$
1,924
$
1,213
$
0.65%
0.42%
0.31%
0.20%
0.17%
0.11%
0.09%
0.07%
4,044
148
4,192
885
5,077
0.50%
0.33%
Typically after a loan is 90 days past due, it is placed in nonaccrual status unless it is well secured and in the process of short-term collection. Upon transferring a
loan 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 and achievement of current payment status.
While the level of nonperforming loans has increased in recent periods, it remains low in comparison to peer banks.
Included in the nonaccrual loan balances above were loans also classified as TDR as of December 31 :
Commercial and agricultural
Residential real estate
Consumer
Total
2018
2017
2016
2015
2014
$
$
3,551 $
2,679 $
—
—
234
—
3,551 $
2,913 $
405 $
384
—
789 $
232 $
162
—
394 $
1,995
262
153
2,410
Additional disclosures about nonaccrual status loans are included in “ Note 4 – Loans and ALLL ”of “Notes to Consolidated Financial Statements” in Item 8.
Financial Statements and Supplementary Data .
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 have identified all impaired loans as of December 31, 2018 .
The level of the ALLL is appropriate as of December 31, 2018 . We 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.
22
Table of Contents
Noninterest Income and Noninterest Expenses
Significant noninterest income balances are highlighted in the following tables for the years ended December 31 :
Service charges and fees
$
6,210 $
6,013 $
197
3.28 % $
5,230 $
783
2018
2017
$
%
2016
$
Change
Change
Earnings on corporate owned life insurance
policies
Net gain on sale of mortgage loans
Net gains on sale of AFS securities
Other
707
525
—
726
647
142
(19)
(122)
(142)
(2.62)%
(18.86)%
(100.00)%
761
651
245
(35)
(4)
(103)
%
14.97 %
(4.60)%
(0.61)%
(42.04)%
Investment and Trust advisory fees
2,836
2,607
229
8.78 %
2,705
(98)
(3.62)%
Corporate Settlement Solutions joint
venture
Gain on redemption of BOLI policies
Other
Total other
274
—
394
164
—
513
3,504
3,284
Total noninterest income
$
10,946 $
10,812 $
110
—
(119)
220
134
67.07 %
— %
(23.20)%
415
469
632
6.70 %
4,221
1.24 % $
11,108 $
(251)
(469)
(119)
(937)
(296)
(60.48)%
N/M
(18.83)%
(22.20)%
(2.66)%
Significant changes in noninterest income are detailed below:
•
•
Service charges and fees include ATM and debit card fees, NSF and overdraft fees, loan servicing fee income, OMSR income and other deposit account
fees. Fluctuations have primarily been attributed to changes in ATM and debit card fees and OMSR income. ATM and debit card fees fluctuate from
period-to-period based primarily on usage of ATM and debit cards. We developed initiatives to increase ATM and debit card income in 2018 and expect
that fees will continue to increase in 2019 as the usage of ATM and debit cards continues to increase. OMSR income results are driven, in part, by
changes in offering rates on residential mortgage loans, anticipated prepayments in the servicing-retained portfolio, and the volume of loans within the
servicing-retained portfolio. As such, OMSR income during 2019 could experience fluctuations and may not exceed 2018 OMSR income.
Net gain on sale of mortgage loans fluctuates primarily as the result of a change in the amount of loans sold, and the amount of loans sold can fluctuate
based on balance sheet management strategy.
• We are continually analyzing our AFS securities for potential sale opportunities. Securities with unrealized gains and less than desirable yields may be
sold for funding and profitability purposes. During 2016 and 2017, we identified several agency securities that were desirable to be sold and recognized
gains with these sales. We took this same approach in 2018 but did not identify sale opportunities. We anticipate taking this same approach in 2019.
•
•
•
•
In recent periods, we have invested considerable efforts to increase our market share in Investment and Trust advisory services through marketing efforts
and talent acquisition. We anticipate that these fees will increase in 2019 similar to the increase we experienced in 2018.
Income from our interest in Corporate Settlement Solutions, a title insurance company, has increased as a result of national sales volume and strong
operating expense controls. Income for 2019 is expected to exceed 2018 levels.
In 2016, we recognized a $469 gain on the redemption of a bank owned life insurance policy and had no similar redemptions in 2017 and 2018.
The fluctuations in all other income are spread throughout various categories, none of which are individually significant.
23
Table of Contents
Significant noninterest expense balances are highlighted in the following table for the years ended December 31 :
Compensation and benefits
Furniture and equipment
Occupancy
Other
Audit, consulting, and legal fees
ATM and debit card fees
Loan underwriting fees
Director fees
FDIC insurance premiums
Donations and community
relations
Marketing costs
OTTI on AFS securities
All other
Total other
Total noninterest
expenses
2018
2017
$
%
2016
$
$
22,609 $
21,525 $
1,084
5.04 % $
19,170 $
2,355
Change
Change
6,182
3,263
2,263
1,036
1,016
858
726
710
596
—
3,558
10,763
5,523
3,133
2,043
1,181
556
856
642
657
568
—
3,541
10,044
659
130
220
(145)
460
2
84
53
28
—
17
719
11.93 %
4.15 %
10.77 %
(12.28)%
82.73 %
0.23 %
13.08 %
8.07 %
4.93 %
N/M
0.48 %
7.16 %
5,275
3,227
1,952
887
535
851
719
582
586
770
3,343
10,225
248
(94)
91
294
21
5
(77)
75
(18)
(770)
198
(181)
%
12.28 %
4.70 %
(2.91)%
4.66 %
33.15 %
3.93 %
0.59 %
(10.71)%
12.89 %
(3.07)%
(100.00)%
5.92 %
(1.77)%
$
42,817 $
40,225 $
2,592
6.44 % $
37,897 $
2,328
6.14 %
Significant changes in noninterest expenses are detailed below:
•
•
•
Compensation and benefits in 2017 and 2018 exceeded 2016 levels as a result of new positions required for growth within our markets, merit increases,
increased service costs related to our defined benefit plan, and additional costs related to compliance requirements. In 2017, benefits expense was partially
offset by a settlement with an insurance claim administrator in favor of Isabella Bank. Compensation and benefits expense in 2019 is expected to exceed
2018 levels as a result of merit increases.
Furniture and equipment expense consists primarily of depreciation, services contracts and computer expenses. Computer expense increased in 2018 due
to data and system upgrades, additional network security costs, and one-time implementation costs. Expenses in 2019 are expected to approximate 2018
levels.
Audit, consulting, and legal fees increased in 2018 primarily as a result of one-time charges related to income tax strategies. As a result, fees are expected
to approximate 2017 levels in 2019.
• We developed initiatives to increase ATM and debit card income in 2018 which resulted in increased ATM and debit card expenses. Expenses in 2017
included a one-time early termination fee with a card provider. ATM and debit card expenses are expected to approximate 2018 levels in 2019.
•
•
•
Loan underwriting fees increased during 2018 as a result of new loan products, including first time home buyer and down payment assistance programs
designed to generate residential mortgage growth. Expenses in 2019 are not expected to exceed 2018 levels.
During the fourth quarter of 2016, we identified an AFS security that was impaired which resulted in an OTTI loss of $770. No such similar OTTI loss
occurred in 2017 or 2018.
The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.
24
Table of Contents
Analysis of Changes in Financial Condition
The following table shows the composition and changes in our balance sheet as of December 31 :
ASSETS
Cash and cash equivalents
AFS securities
Amortized cost of AFS securities
Unrealized gains (losses) on AFS securities
AFS securities
Equity securities, at fair value
Mortgage loans AFS
Loans
Gross loans
Less allowance for loan and lease losses
Net loans
Premises and equipment
Corporate owned life insurance policies
Accrued interest receivable
Equity securities without readily determinable fair values
Goodwill and other intangible assets
Other assets
TOTAL ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits
Borrowed funds
Accrued interest payable and other liabilities
Total liabilities
Shareholders’ equity
TOTAL LIABILITIES AND
SHAREHOLDERS’ EQUITY
2018
2017
$
%
Change
$
73,471 $
30,848 $
42,623
138.17 %
501,245
(6,411)
494,834
—
358
547,912
818
548,730
3,577
1,560
1,128,707
1,091,519
8,375
7,700
1,120,332
1,083,819
27,815
27,733
6,928
24,948
48,451
12,437
28,450
27,026
7,063
23,454
48,547
10,056
(46,667)
(7,229)
(53,896)
(3,577)
(1,202)
37,188
675
36,513
(635)
707
(135)
1,494
(96)
2,381
$
$
1,837,307 $
1,813,130 $
24,177
1,292,693 $
1,265,258 $
340,299
8,796
1,641,788
195,519
344,878
8,089
1,618,225
194,905
27,435
(4,579)
707
23,563
614
$
1,837,307 $
1,813,130 $
24,177
(8.52)%
N/M
(9.82)%
(100.00)%
(77.05)%
3.41 %
8.77 %
3.37 %
(2.23)%
2.62 %
(1.91)%
6.37 %
(0.20)%
23.68 %
1.33 %
2.17 %
(1.33)%
8.74 %
1.46 %
0.32 %
1.33 %
As shown above, total assets increased $24,177 during 2018 which was primarily driven by loan growth of $37,188 . This growth was funded through maturities
and the receipt of principal payments in AFS securities as well as growth in deposits. While generating quality loans will continue to be challenging as a result of
competition, loan growth is expected in 2019 .
A discussion of changes in balance sheet amounts by major categories follows:
Cash and cash equivalents
Included in cash and cash equivalents are funds held with the FRB which fluctuate from period-to-period. Cash levels were elevated at December 31, 2018 as
excess liquidity is expected to be used to pay off maturing long-term borrowings and other short-term liabilities during the first quarter of 2019.
AFS securities
The primary objective of our investing activities is to provide for safety of the principal invested. Secondary considerations include the need for earnings, liquidity,
and our overall exposure to changes in interest rates. The current flat yield curve encourages using excess liquidity to reduce high-cost borrowings and therefore,
AFS securities balances are not expected to rise significantly in the near term.
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Table of Contents
The following is a schedule of the carrying value of AFS investment securities as of December 31 :
Government sponsored enterprises
States and political subdivisions
Auction rate money market preferred
Mortgage-backed securities
Collateralized mortgage obligations
Total
2018
2017
2016
2015
2014
170 $
216 $
10,259 $
24,345 $
190,866
2,554
184,484
116,760
208,474
3,049
208,797
128,194
212,919
2,794
227,256
101,443
232,217
2,866
263,384
134,025
494,834 $
548,730 $
554,671 $
656,837 $
24,136
215,345
2,619
166,926
152,368
561,394
$
$
Excluding those holdings in government sponsored enterprises and municipalities within the State of Michigan, there were no investments in securities of any one
issuer that exceeded 10% of shareholders’ equity. We have a policy prohibiting investments in securities that we deem unsuitable due to their inherent credit or
market risks. Prohibited investments include stripped mortgage-backed securities, zero coupon bonds, nongovernment agency asset-backed securities, and
structured notes. Our holdings in mortgage-backed securities and collateralized mortgage obligations include only government agencies and government sponsored
agencies as we hold no investments in private label mortgage-backed securities or collateralized mortgage obligations.
The following is a schedule of maturities of AFS investment securities and their weighted average yields as of December 31, 2018 . Weighted average yields have
been computed on an FTE basis using a tax rate of 21% . Our auction rate money market preferred investments are long-term floating rate instruments. The issuers
of auction rate securities generally have the right to redeem or refinance the debt. Because of their lack of contractual maturities, auction rate money market
preferred stocks are not reported by a specific maturity group. Mortgage-backed securities and collateralized mortgage obligations are not reported by a specific
maturity group due to their variable monthly payments. Expected maturities may differ from contractual maturities because issuers may have the right to call or
prepay obligations.
Maturing
After One
Year But
Within
Five Years
After Five
Years But
Within
Ten Years
Within
One Year
After
Ten Years
Securities with
Variable Monthly
Payments or
Noncontractual
Maturities
Amount
Yield (%)
Amount
Yield (%)
Amount
Yield (%)
Amount
Yield (%)
Amount
Yield (%)
Government
sponsored
enterprises
States and
political
subdivisions
Mortgage-
backed securities
Collateralized
mortgage
obligations
Auction rate
money market
preferred
Total
Loans
$
—
— $
170
2.06 $
—
— $
—
— $
—
23,189
2.96
82,492
3.46
56,842
3.61
28,343
4.04
—
—
—
—
—
—
—
—
—
—
—
184,484
2.36
—
—
—
—
—
—
—
—
116,760
2.44
—
—
—
—
—
—
—
—
2,554
$
23,189
2.96 $
82,662
3.46 $
56,842
3.61 $
28,343
4.04 $
303,798
6.20
2.42
Loans are the largest component of earning assets. The proper management of credit and market risk inherent in the loan portfolio is critical to our financial well-
being. To control these risks, we have adopted strict underwriting standards which include lending limits to a single borrower, loan to collateral value limits, and a
defined market area. We also monitor and limit loan concentrations to specific industries. We have no foreign loans and there were no concentrations greater than
10% of total loans that are not disclosed as a separate category in the following table.
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Table of Contents
The following table presents the composition of the loan portfolio for the years ended December 31 :
Commercial
Agricultural
Residential real estate
Consumer
Total
2018
2017
2016
2015
2014
$
$
659,529 $
634,759 $
575,664 $
448,381 $
127,161
275,343
66,674
128,269
272,368
56,123
126,492
266,050
42,409
115,911
251,501
34,699
1,128,707 $
1,091,519 $
1,010,615 $
850,492 $
433,270
104,721
266,155
32,404
836,550
The following table presents the change in the loan portfolio categories for the years ended December 31 :
Commercial
Agricultural
Residential real estate
Consumer
Total
2018
2017
2016
$ Change
% Change
$ Change
% Change
$ Change
% Change
$
$
24,770
(1,108)
2,975
10,551
37,188
3.90 % $
(0.86)%
1.09 %
18.80 %
3.41 % $
59,095
1,777
6,318
13,714
80,904
10.27% $
127,283
1.40%
2.37%
32.34%
10,581
14,549
7,710
8.01% $
160,123
28.39%
9.13%
5.78%
22.22%
18.83%
While competition for commercial loans continues to be strong, we experienced significant growth in this segment of the portfolio during 2016 and 2017 and had
modest growth in 2018. Growth in 2019 is expected to be consistent with growth during 2018. Despite a decline in agricultural loans, we expect modest change in
the agricultural portfolio in 2019. Residential real estate and consumer loans also experienced growth over the last year and are both expected to increase in 2019.
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 (see “ Note 1 – Nature of Operations and Summary of Significant Accounting Policies ” and “ Note 17 – Fair
Value ” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data ).
Other assets
Other assets consist primarily of prepaid expenses, OMSR, and net deferred tax assets. For more information related to estimates and deferred taxes, refer to “ Note
1 – Nature of Operations and Summary of Significant Accounting Policies ” and “ Note 15 – Federal Income Taxes ” of “Notes to Consolidated Financial
Statements” in Item 8. Financial Statements and Supplementary Data .
Deposits
Deposits are our primary source of funding. The following table presents the composition of the deposit portfolio as of December 31 :
Noninterest bearing demand deposits
Interest bearing demand deposits
Savings deposits
Certificates of deposit
Brokered certificates of deposit
Internet certificates of deposit
Total
2018
2017
2016
2015
2014
$
236,534 $
237,511 $
205,071 $
191,376 $
235,287
387,252
348,046
72,229
13,345
231,666
342,815
331,718
102,808
18,740
209,325
347,230
321,914
88,632
22,868
212,666
337,641
324,101
73,815
24,964
181,826
190,984
261,412
339,824
72,134
28,304
$
1,292,693 $
1,265,258 $
1,195,040 $
1,164,563 $
1,074,484
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Table of Contents
The following table presents the change in the deposit categories for the years ended December 31 :
2018
2017
2016
$ Change
% Change
$ Change
% Change
$ Change
% Change
Noninterest bearing demand deposits
Interest bearing demand deposits
Savings deposits
Certificates of deposit
Brokered certificates of deposit
Internet certificates of deposit
Total
$
$
(977)
3,621
44,437
16,328
(30,579)
(5,395)
27,435
(0.41)% $
1.56 %
12.96 %
4.92 %
(29.74)%
(28.79)%
2.17 % $
32,440
22,341
(4,415)
9,804
14,176
(4,128)
70,218
15.82 % $
10.67 %
(1.27)%
3.05 %
15.99 %
(18.05)%
5.88 % $
13,695
(3,341)
9,589
(2,187)
14,817
(2,096)
30,477
7.16 %
(1.57)%
2.84 %
(0.67)%
20.07 %
(8.40)%
2.62 %
Deposit demand continues to be driven by non-contractual deposits, such as demand and savings deposits. We've also experienced growth in certificates of deposit
in the past two years. Brokered certificates of deposit offer another source of funding and fluctuate from period-to-period based on our funding needs, including
changes in assets such as loans and investments.
The remaining maturity of certificates of deposit of $250 or more as of December 31, 2018 was as follows:
Maturity
Within 3 months
Within 3 to 6 months
Within 6 to 12 months
Over 12 months
Total
Borrowed Funds
$
$
24,668
6,088
17,679
27,493
75,928
Borrowed funds include FHLB advances, securities sold under agreements to repurchase, and federal funds purchased. The balance of borrowed funds fluctuates
from period-to-period based on our funding needs that arise from changes in loans, investments, and deposits. To provide balance sheet growth, we utilize
borrowings and brokered deposits to fund earning assets.
The following table presents borrowed funds balances for the years ended December 31 :
FHLB advances
$
300,000 $
290,000 $
270,000 $
235,000 $
192,000
2018
2017
2016
2015
2014
Securities sold under agreements to repurchase without
stated maturity dates
Securities sold under agreements to repurchase with
stated maturity dates
Federal funds purchased
Total
40,299
54,878
60,894
70,532
95,070
—
—
—
—
—
6,800
—
4,200
439
2,200
$
340,299 $
344,878 $
337,694 $
309,732 $
289,709
For additional disclosure related to borrowed funds, see “ Note 8 – Borrowed Funds ” of “Notes to Consolidated Financial Statements” in Item 8. Financial
Statements and Supplementary Data .
Accrued interest payable and other liabilities
Included in accrued interest payable and other liabilities are obligations related to our defined benefit pension plan and other employee benefits. For more
information on the defined benefit pension plan and other employee benefits, see “ Note 12 – Benefit Plans ” of “Notes to Consolidated Financial Statements” in
Item 8. Financial Statements and Supplementary Data .
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Table of Contents
Contractual Obligations and Loan Commitments
We have various financial obligations, including contractual obligations and commitments, which may require future cash payments. The following schedule
summarizes our non-cancellable obligations and future minimum payments as of December 31, 2018 :
Minimum Payments Due by Period
Due in
One Year
or Less
After One
Year But
Within
Three Years
After Three
Years But
Within
Five Years
After
Five Years
Deposits
Deposits with no stated maturity
$
859,073 $
— $
— $
— $
Certificates of deposit with stated maturities
Total deposits
Borrowed funds
Short-term borrowings
Long-term borrowings
Total borrowed funds
232,349
1,091,422
40,299
100,000
140,299
121,087
121,087
—
115,000
115,000
73,216
73,216
—
55,000
55,000
6,968
6,968
—
30,000
30,000
Total
859,073
433,620
1,292,693
40,299
300,000
340,299
Total contractual obligations
$
1,231,721 $
236,087 $
128,216 $
36,968 $
1,632,992
We also have loan commitments that may impact liquidity. The following schedule summarizes our loan commitments and expiration dates by period as of
December 31, 2018 . Commitments to grant loans include residential mortgage loans with the majority committed to be sold to the secondary market. Since many
of these commitments historically have expired without being drawn upon, the total amount of these commitments does not necessarily represent our future cash
requirements.
Expiration Dates by Period
Due in
One Year
or Less
After One
Year But
Within
Three Years
After Three
Years But
Within
Five Years
After
Five
Years
Unused commitments under lines of credit
Commercial and standby letters of credit
Commitments to grant loans
Total loan commitments
$
$
95,540 $
70,701 $
24,362 $
9,049 $
1,723
13,225
—
—
—
—
—
—
110,488 $
70,701 $
24,362 $
9,049 $
Total
199,652
1,723
13,225
214,600
For additional disclosure related to Contractual Obligations and Loan Commitments, see “ Note 9 – Off-Balance-Sheet Activities, Commitments and Other Matters
” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data .
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Capital
Capital consists of common stock, retained earnings, and accumulated other comprehensive income (loss). We are authorized to raise capital through dividend
reinvestment, employee stock purchases, and shareholder stock purchases. Pursuant to these authorizations, we issued 261,693 shares or $6,864 of common stock
during 2018 , and 220,510 shares or $6,177 of common stock in 2017 . We also offer the Directors Plan in which participants purchase stock units through deferred
fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $612 and $640 during 2018 and 2017 , respectively.
We have a publicly announced common stock repurchase plan. Pursuant to this plan, we repurchased 248,017 shares or $7,007 of common stock during 2018 and
184,286 shares or $5,181 during 2017 . As of December 31, 2018 , we were authorized to repurchase up to an additional 167,654 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 conservation 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 minimum primary capital to adjusted assets ratio requirement is 6.00% .
Our primary capital to adjusted average assets, or tier 1 leverage ratio, was 8.72% as of December 31, 2018 .
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 is 8.00% .
Also effective January 1, 2015 was the new common equity tier 1 capital ratio which had a minimum requirement of 4.50% . Beginning on January 1, 2016, the
capital conservation buffer went into effect which further increased the required levels. The following table sets forth the percentages required under the Risk
Based Capital guidelines and our ratios as of December 31 :
Common equity tier 1 capital
Tier 1 capital
Total Capital
Actual
2018
Minimum Required
2017
Actual
Minimum Required
12.58%
12.58%
13.26%
6.375%
7.875%
9.875%
12.23%
12.23%
12.86%
5.750%
7.250%
9.250%
At December 31, 2018 , the Bank exceeded minimum capital requirements. For further information regarding the Bank’s capital requirements, see “ Note 10 –
Minimum Regulatory Capital Requirements ” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data .
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 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 , impaired loans, goodwill, 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 1 – Nature of Operations and Summary of Significant Accounting Policies ” and “ Note 17 –
Fair Value ” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data .
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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 unencumbered AFS securities. These categories totaled $256,583 or 13.97% of assets as of
December 31, 2018 as compared to $296,765 or 16.37% as of December 31, 2017 . The decrease in primary liquidity is a direct result of our unencumbered AFS
securities' maturity and principal payment activity during 2018. 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 could vary significantly daily, based on customer activity.
Our primary source of funds is deposit accounts. Our secondary sources include the ability to borrow from the FHLB , from 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 December 31, 2018 , we had available lines of credit of $150,162 .
The following table summarizes our sources and uses of cash for the years ended December 31 :
Net cash provided by (used in) operating activities
Net cash provided by (used in) investing activities
Net cash provided by (used in) financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents January 1
Cash and cash equivalents December 31
Market Risk
2018
2017
$ Variance
22,010 $
19,721 $
6,470
14,143
42,623
30,848
(81,755)
69,988
7,954
22,894
73,471 $
30,848 $
2,289
88,225
(55,845)
34,669
7,954
42,623
$
$
Our primary market risks are interest rate risk and liquidity risk. 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 funding sources. These
forecasts are compared against net 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 December 31, 2018 , 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 and 200 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. These projections
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Table of Contents
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 change 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. As of December 31, 2018 , our interest rate sensitivity results were within Board
approved limits.
The following tables summarize our interest rate sensitivity for 12 and 24 months as of:
Immediate basis point change assumption
(short-term)
Percent change in net interest income vs.
constant rates
Immediate basis point change assumption
(short-term)
Percent change in net interest income vs.
constant rates
Immediate basis point change assumption
(short-term)
Percent change in net interest income vs.
constant rates
Immediate basis point change assumption
(short-term)
Percent change in net interest income vs.
constant rates
December 31, 2018
12 Months
-200
-100
+100
+200
+300
+400
(4.90)%
(2.85)%
1.06%
2.67%
5.15%
6.22%
24 Months
-200
-100
+100
+200
+300
+400
(6.76)%
(4.04)%
1.83%
3.82%
6.53%
6.54%
December 31, 2017
12 Months
-200
-100
+100
+200
+300
+400
(5.57)%
(2.43)%
2.36%
4.18%
5.99%
7.94%
24 Months
-200
-100
+100
+200
+300
+400
(5.10)%
(2.29)%
2.61%
4.17%
5.39%
6.09%
Gap analysis, the secondary method to measure IRR , measures the cash flows and/or the earliest repricing of our interest bearing assets and liabilities. This
analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the
embedded repricing options contained in assets and liabilities. Residential real estate and consumer loans allow the borrower to repay the balance prior to maturity
without penalty, while commercial and agricultural loans may have prepayment penalties. The amount of prepayments is dependent upon many factors, including
the interest rate of a given loan in comparison to the current offering rates, the level of sales of used homes, and the overall availability of credit in the market
place. Generally, a decrease in interest rates will result in an increase in cash flows from these assets. A significant portion of our securities are callable or have
prepayment options. The call and prepayment options are more likely to be exercised in a period of decreasing interest rates. Savings and demand accounts may
generally be withdrawn on request without prior notice. The timing of cash flows from these deposits is estimated based on historical experience. Certificates of
deposit have penalties that discourage early withdrawals.
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Table of Contents
The following tables provide information about assets and liabilities that are sensitive to changes in interest rates as of December 31, 2018 and December 31, 2017
. 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.
2019
2020
2021
2022
2023
Thereafter
Total
Fair Value
December 31, 2018
Rate sensitive assets
Other interest bearing assets
Average interest rates
AFS securities
Average interest rates
Equity securities
Average interest rates
Fixed interest rate loans (1)
Average interest rates
Variable interest rate loans (1)
Average interest rates
Rate sensitive liabilities
Fixed rate borrowed funds
Average interest rates
Variable rate borrowed funds
Average interest rates
Savings and NOW accounts
Average interest rates
Fixed interest rate certificates of deposit
Average interest rates
Variable interest rate certificates of deposit
Average interest rates
Rate sensitive assets
Other interest bearing assets
Average interest rates
AFS securities
Average interest rates
Equity securities
Average interest rates
Fixed interest rate loans (1)
Average interest rates
Variable interest rate loans (1)
Average interest rates
Rate sensitive liabilities
Fixed rate borrowed funds
Average interest rates
Variable rate borrowed funds
Average interest rates
Savings and NOW accounts
Average interest rates
Fixed interest rate certificates of deposit
Average interest rates
Variable interest rate certificates of deposit
Average interest rates
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
49,837
$
1.85%
$
100
1.72%
— $
—%
— $
—%
— $
—%
— $
—%
84,691
$
77,165
$
70,081
$
70,033
$
59,541
$
133,323
$
2.49%
2.62%
2.60%
2.43%
2.52%
2.75%
— $
— $
$
152,336
— $
— $
$
118,585
— $
— $
$
142,107
— $
— $
$
113,587
— $
— $
$
119,069
— $
— $
$
188,082
4.44%
4.37%
4.34%
4.46%
4.49%
4.23%
70,336
$
30,855
$
42,968
$
22,766
$
18,685
$
109,331
$
6.14%
5.75%
5.76%
5.22%
5.01%
4.16%
140,299
$
55,000
$
50,000
$
20,000
$
35,000
$
30,000
$
1.41%
2.18%
1.91%
1.97%
3.17%
2.36%
— $
—%
— $
—%
10,000
$
2.62%
— $
—%
— $
—%
— $
—%
55,248
$
49,944
$
44,783
$
40,191
$
36,105
$
396,268
$
0.52%
0.51%
0.50%
0.50%
0.49%
227,451
$
54,051
$
65,036
$
41,502
$
31,714
$
1.63%
$
4,898
2.32%
1.90%
$
2,000
2.61%
2.09%
1.99%
2.23%
— $
—%
— $
—%
— $
—%
0.44%
$
6,968
2.14%
— $
—%
December 31, 2017
49,937
494,834
$
1.85%
$
2.59%
— $
—
$
4.38%
$
5.16%
833,766
294,941
330,299
622,539
10,000
$
1.92%
$
2.62%
$
0.46%
$
1.82%
$
6,898
2.40%
426,722
49,937
494,834
—
792,394
287,196
323,903
9,926
622,539
419,116
6,877
2018
2019
2020
2021
2022
Thereafter
Total
Fair Value
$
5,481
1.65%
— $
—%
$
100
0.35%
— $
—%
— $
—%
— $
—%
95,000
$
72,551
$
71,591
$
68,127
$
60,607
$
180,854
$
2.33%
2.46%
2.59%
2.58%
2.38%
— $
—%
— $
—%
— $
—%
— $
—%
— $
—%
2.56%
$
3,577
4.00%
153,100
$
118,068
$
114,872
$
129,992
$
116,779
$
222,971
$
4.12%
4.34%
4.24%
4.16%
4.34%
4.01%
70,738
$
35,473
$
27,164
$
25,494
$
20,158
$
56,710
$
5.48%
4.79%
4.91%
4.43%
4.39%
3.72%
124,878
$
85,000
$
35,000
$
50,000
$
20,000
$
20,000
$
1.15%
1.87%
1.80%
1.91%
1.97%
2.54%
— $
—%
— $
—%
— $
—%
10,000
$
1.72%
— $
—%
— $
—%
49,140
$
44,096
$
39,607
$
35,611
$
32,051
$
373,976
$
0.22%
0.22%
0.22%
0.22%
0.21%
0.27%
188,598
$
109,047
$
37,604
$
50,814
$
38,843
$
21,840
$
1.05%
$
2,414
1.40%
1.57%
$
4,106
1.66%
1.62%
1.76%
1.85%
2.05%
— $
—%
— $
—%
— $
—%
— $
—%
548,730
$
5,581
1.63%
$
2.49%
$
3,577
4.00%
$
4.17%
$
4.68%
855,782
235,737
334,878
574,481
10,000
$
1.65%
$
1.72%
$
0.25%
$
1.42%
$
6,520
1.56%
446,746
5,581
548,730
3,577
825,855
231,051
332,146
9,943
574,481
437,400
6,492
(1) The fair value reported is exclusive of the allocation of the ALLL .
33
Table of Contents
We do not believe 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. 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. We
do not expect to make material changes to our market risk methods in the near term. We may change those methods in the future to adapt to changes in
circumstances or to implement new techniques.
Interest Rate Sensitivity
Interest rate sensitivity is determined by the amount of earning assets and interest bearing liabilities repricing within a specific time period, and their relative
sensitivity to a change in interest rates. We strive to achieve reasonable stability in the net interest margin through periods of changing interest rates. One tool we
use to measure interest rate sensitivity is gap analysis. As shown in the following table, the gap analysis depicts our position for specific time periods and the
cumulative repricing gap as a percentage of total assets.
The interest rate sensitivity information for AFS securities is based on the expected prepayments and call dates versus stated maturities. Fixed rate loans are
included in the appropriate time frame based on their scheduled amortization. Variable rate loans, which totaled $294,941 as of December 31, 2018 , are included
in the time frame of their earliest repricing. Time deposit liabilities are scheduled based on their contractual maturity except for variable rate time deposits in the
amount of $6,898 that are included in the 0 to 3 month time frame.
The following table shows the time periods and the amount of assets and liabilities available for interest rate repricing as of December 31, 2018 . For purposes of
this analysis, nonaccrual loans and the ALLL are excluded.
Interest sensitive assets
AFS securities
Loans
Total
Interest sensitive liabilities
Borrowed funds
Time deposits
Savings
NOW
Total
Cumulative repricing gap
0 to 3
Months
4 to 12
Months
1 to 5
Years
Over 5
Years
$
$
$
$
$
16,844
$
342,087
67,847
97,930
$
276,820
$
493,348
358,931
$
165,777
$
770,168
$
95,299
85,979
387,252
235,287
803,817
(444,886)
$
45,000
$
170,000
$
148,370
192,303
—
—
—
—
$
$
193,370
(472,479)
$
$
362,303
(64,614)
$
$
133,323
188,082
321,405
30,000
6,968
—
—
36,968
219,823
Cumulative repricing gap as a % of assets
(24.21)%
(25.72)%
(3.52)%
11.96%
The following table shows the maturity of commercial and agricultural loans outstanding at December 31, 2018 . Also provided are the amounts due after one year,
classified according to the sensitivity to changes in interest rates.
Commercial and agricultural
Interest sensitivity
Loans maturing after one year that have:
Fixed interest rates
Variable interest rates
Total
1 Year
or Less
1 to 5
Years
Over 5
Years
Total
$
117,472 $
447,279 $
221,939 $
786,690
$
$
381,791 $
65,488
447,279 $
186,836
35,103
221,939
34
Table of Contents
Item 7A. Quantitative and Qualitative Disclosures About Market Risk .
The information presented in the section captioned “ Market Risk ” in Item 7. Management's Discussion and Analysis of Financial Condition and Results of
Operations is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data .
The following consolidated financial statements accompanied by the report of our independent registered public accounting firm are set forth beginning on the
following page of this report:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Income
Consolidated Statements of Comprehensive Income (Loss)
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Supplementary data regarding quarterly results of operations is included in Item 6. Selected Financial Data .
35
Table of Contents
Shareholders and Board of Directors
Isabella Bank Corporation
Mount Pleasant, Michigan
Report of Independent Registered Public Accounting Firm
Opinion on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Isabella
Bank
Corporation
as of December 31, 2018 and 2017 , and the related consolidated
statements of changes in shareholders’ equity, income, comprehensive income, and cash flows for each of the years in the three-year period ended December 31,
2018 , and the related notes (collectively referred to as the financial statements). We also have audited Isabella
Bank
Corporation’s
internal control over financial
reporting as of December 31, 2018 , based on criteria established in the Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (2013 framework) (the COSO criteria).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Isabella
Bank
Corporation
as of December 31, 2018 and 2017 , and the consolidated results of their operations and their cash flows for each of the years in the three-year period
ended December 31, 2018 , in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion Isabella
Bank
Corporation
maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018 , based on the COSO criteria.
Basis for Opinions
Isabella
Bank
Corporation’s
management is responsible for these consolidated financial statements, for maintaining effective internal control over financial
reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal
Control over Financial Reporting. Our responsibility is to express opinions on Isabella
Bank
Corporation
’ s
consolidated financial statements and on Isabella
Bank
Corporation
’s internal control over financial reporting based on our integrated audits. We are a public accounting firm registered with the Public Company
Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to Isabella
Bank
Corporation
in accordance with the
U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable
assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal
control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial
statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence
regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant
estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial
reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material misstatement exists, and testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk. We believe that our audits provide a reasonable basis for our
opinions.
Definition and Limitations of Internal Control over Financial Reporting
A corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and
the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. A corporation’s internal
control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the corporation; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the corporation
are being made only in accordance with authorizations of management and directors of the corporation; and (3) provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use, or disposition of the corporation’s assets that could have a material effect on the consolidated financial
statements.
36
Table of Contents
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.
/s/ Rehmann Robson LLC
We have served as Isabella Bank Corporation's independent auditor since 1996.
Saginaw, Michigan
March 13, 2019
37
Table of Contents
CONSOLIDATED BALANCE SHEETS
( Dollars in thousands )
ASSETS
Cash and cash equivalents
Cash and demand deposits due from banks
Interest bearing balances due from banks
Total cash and cash equivalents
AFS securities, at fair value
Equity securities, at fair value
Mortgage loans AFS
Loans
Commercial
Agricultural
Residential real estate
Consumer
Gross loans
Less allowance for loan and lease losses
Net loans
Premises and equipment
Corporate owned life insurance policies
Accrued interest receivable
Equity securities without readily determinable fair values
Goodwill and other intangible assets
Other assets
TOTAL ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest bearing
NOW accounts
Certificates of deposit under $250 and other savings
Certificates of deposit over $250
Total deposits
Borrowed funds
Accrued interest payable and other liabilities
Total liabilities
Shareholders’ equity
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,870,969 shares (including
16,673 shares held in the Rabbi Trust) in 2018 and 7,857,293 shares (including 31,769 shares held in the Rabbi
Trust) in 2017
Shares to be issued for deferred compensation obligations
Retained earnings
Accumulated other comprehensive income (loss)
Total shareholders’ equity
$
$
December 31
2018
2017
$
23,534 $
49,937
73,471
494,834
—
358
659,529
127,161
275,343
66,674
1,128,707
8,375
1,120,332
27,815
27,733
6,928
24,948
48,451
12,437
25,267
5,581
30,848
548,730
3,577
1,560
634,759
128,269
272,368
56,123
1,091,519
7,700
1,083,819
28,450
27,026
7,063
23,454
48,547
10,056
1,837,307 $
1,813,130
236,534 $
235,287
744,944
75,928
1,292,693
340,299
8,796
1,641,788
140,416
5,431
57,357
(7,685)
195,519
237,511
231,666
728,090
67,991
1,265,258
344,878
8,089
1,618,225
140,277
5,502
51,728
(2,602)
194,905
1,813,130
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,837,307 $
The accompanying notes are an integral part of these consolidated financial statements.
38
Table of Contents
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
( Dollars in thousands except per share amounts)
Balance, January 1, 2016
Comprehensive income (loss)
Issuance of common stock
Common stock issued for deferred compensation
obligations
Common stock transferred from the Rabbi Trust to
satisfy deferred compensation obligations
Share-based payment awards under equity
compensation plan
Common stock purchased for deferred compensation
obligations
Common stock repurchased pursuant to publicly
announced repurchase plan
Cash dividends paid ($0.98 per common share)
Balance, December 31, 2016
Comprehensive income (loss)
Reclassification resulting from the enactment of the
Tax Act
Issuance of common stock
Common stock issued for deferred compensation
obligations
Common stock transferred from the Rabbi Trust to
satisfy deferred compensation obligations
Share-based payment awards under equity
compensation plan
Common stock purchased for deferred compensation
obligations
Common stock repurchased pursuant to publicly
announced repurchase plan
Cash dividends paid ($1.02 per common share)
Balance, December 31, 2017
Comprehensive income (loss)
Adoption of ASU 2016-01
Issuance of common stock
Common stock issued for deferred compensation
obligations
Common stock transferred from the Rabbi Trust to
satisfy deferred compensation obligations
Share-based payment awards under equity
compensation plan
Common stock purchased for deferred compensation
obligations
Common stock repurchased pursuant to publicly
announced repurchase plan
Cash dividends paid ($1.04 per common share)
Balance, December 31, 2018
Common Stock
Common Shares
Outstanding
Amount
Common Shares to
be
Issued for
Deferred
Compensation
Obligations
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
7,799,867 $
139,198 $
4,592
$
39,960 $
221 $
—
179,903
—
5,023
—
—
—
—
(158,701)
—
—
127
—
(383)
(4,440)
—
—
—
—
(127)
573
—
—
—
7,821,069
139,525
5,038
—
—
220,510
—
—
—
—
(184,286)
—
—
—
6,177
—
176
—
(420)
(5,181)
—
—
—
—
—
(176)
640
—
—
—
7,857,293
140,277
5,502
—
—
—
—
261,693
6,864
—
—
—
—
(248,017)
—
—
683
—
(401)
(7,007)
—
—
—
—
—
(683)
612
—
—
—
13,799
(2,999)
—
—
—
—
—
—
(7,645)
46,114
13,237
367
—
—
—
—
—
—
(7,990)
51,728
14,021
(223)
—
—
—
—
—
—
(8,169)
—
—
—
—
—
—
—
(2,778)
543
(367)
—
—
—
—
—
—
—
(2,602)
(5,306)
223
—
—
—
—
—
—
—
Totals
183,971
10,800
5,023
—
—
573
(383)
(4,440)
(7,645)
187,899
13,780
—
6,177
—
—
640
(420)
(5,181)
(7,990)
194,905
8,715
—
6,864
—
—
612
(401)
(7,007)
(8,169)
7,870,969 $
140,416 $
5,431
$
57,357 $
(7,685)
$
195,519
The accompanying notes are an integral part of these consolidated financial statements.
39
CONSOLIDATED STATEMENTS OF INCOME
( Dollars in thousands except per share amounts)
Year Ended December 31
2018
2017
2016
$
49,229 $
43,537 $
38,537
8,239
5,279
1,117
63,864
9,261
6,370
15,631
48,233
978
47,255
6,210
707
525
—
3,504
10,946
22,609
6,182
3,263
10,763
42,817
15,384
1,363
8,410
5,570
896
58,413
6,809
5,685
12,494
45,919
253
45,666
6,013
726
647
142
3,284
10,812
21,525
5,523
3,133
10,044
40,225
16,253
3,016
$
$
$
$
14,021 $
13,237 $
1.78 $
1.74 $
1.04 $
1.69 $
1.65 $
1.02 $
8,591
5,715
823
53,666
5,836
5,029
10,865
42,801
(135)
42,936
5,230
761
651
245
4,221
11,108
19,170
5,275
3,227
10,225
37,897
16,147
2,348
13,799
1.77
1.73
0.98
Table of Contents
Interest income
Loans, including fees
AFS securities
Taxable
Nontaxable
Federal funds sold and other
Total interest income
Interest expense
Deposits
Borrowings
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Service charges and fees
Earnings on corporate owned life insurance policies
Net gain on sale of mortgage loans
Net gains on sale of AFS securities
Other
Total noninterest income
Noninterest expenses
Compensation and benefits
Furniture and equipment
Occupancy
Other
Total noninterest expenses
Income before federal income tax expense
Federal income tax expense
NET INCOME
Earnings per common share
Basic
Diluted
Cash dividends per common share
The accompanying notes are an integral part of these consolidated financial statements.
40
Table of Contents
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
( Dollars in thousands )
Net income
Unrealized gains (losses) on AFS securities
Unrealized gains (losses) arising during the period
Reclassification adjustment for net realized (gains) losses included in net income
Reclassification adjustment for impairment loss included in net income
Comprehensive income (loss) before income tax (expense) benefit
Tax effect (1)
Unrealized gains (losses) on AFS securities, net of tax
Unrealized gains (losses) on derivative instruments
Unrealized gains (losses) on derivative instruments arising during the period
Tax effect (1)
Unrealized gains (losses) on derivative instruments, net of tax
Change in unrecognized pension cost on defined benefit pension plan
Change in unrecognized pension cost arising during the period
Reclassification adjustment for net periodic benefit cost included in net income
Net change in unrecognized pension cost
Tax effect (1)
Change in unrealized pension cost, net of tax
Year Ended December 31
2018
2017
2016
$
14,021 $
13,237 $
13,799
(7,229)
—
—
(7,229)
1,415
(5,814)
33
(7)
26
265
345
610
(128)
482
289
(142)
—
147
89
236
43
(15)
28
11
412
423
(144)
279
543
13,780 $
(5,865)
(245)
770
(5,340)
1,834
(3,506)
248
(84)
164
282
238
520
(177)
343
(2,999)
10,800
Other comprehensive income (loss), net of tax
Comprehensive income (loss)
$
(5,306)
8,715 $
(1) See “ Note 16 – Accumulated Other Comprehensive Income (Loss) ” in the accompanying notes to consolidated financial statements for tax effect
reconciliation.
The accompanying notes are an integral part of these consolidated financial statements.
41
Table of Contents
CONSOLIDATED STATEMENTS OF CASH FLOWS
( Dollars in thousands )
OPERATING ACTIVITIES
Net income
Reconciliation of net income to net cash provided by operating activities:
Undistributed earnings of equity securities without readily determinable fair values
Provision for loan losses
Impairment of foreclosed assets
Depreciation
Amortization of OMSR
Amortization of acquisition intangibles
Net amortization of AFS securities
AFS security impairment loss
Net unrealized (gains) losses on equity securities, at fair value
Net (gains) losses on sale of AFS securities
Net (gains) losses on sale of equity securities, at fair value
Net gain on sale of mortgage loans
Increase in cash value of corporate owned life insurance policies
Gains from redemption of corporate owned life insurance policies
Share-based payment awards under equity compensation plan
Deferred income tax expense (benefit)
Origination of loans held-for-sale
Proceeds from loan sales
Net changes in operating assets and liabilities which provided (used) cash:
Accrued interest receivable
Other assets
Accrued interest payable and other liabilities
Net cash provided by (used in) operating activities
INVESTING ACTIVITIES
Activity in AFS securities
Sales
Maturities, calls, and principal payments
Purchases
Sale of equity securities, at fair value
Net loan principal (originations) collections
Proceeds from sales of foreclosed assets
Purchases of premises and equipment
Proceeds from redemption of corporate owned life insurance policies
Purchases of FHLB Stock
Funding of low income housing tax credit investments
Net cash provided by (used in) investing activities
42
Year Ended December 31
2018
2017
2016
$
14,021 $
13,237 $
13,799
(144)
978
—
2,940
218
96
1,873
—
41
—
(1)
(525)
(707)
—
612
275
(29,242)
30,969
135
113
358
22,010
—
80,005
(35,211)
3,537
(37,958)
403
(2,305)
—
(1,350)
(651)
6,470
40
253
2
2,902
340
119
2,144
—
—
(142)
—
(647)
(726)
—
640
2,836
(36,276)
37,179
(483)
800
(2,497)
19,721
12,827
97,617
(106,510)
—
(81,188)
269
(2,038)
—
(1,800)
(932)
(81,755)
791
(135)
10
2,821
394
162
2,747
770
—
(245)
—
(651)
(761)
(469)
573
(282)
(33,089)
33,111
(311)
455
550
20,240
35,664
137,278
(79,514)
—
(160,294)
486
(3,804)
1,353
(200)
(878)
(69,909)
Table of Contents
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
( Dollars in thousands )
Year Ended December 31
2018
2017
2016
$
27,435 $
70,218 $
(4,579)
(8,169)
6,864
(7,007)
(401)
14,143
42,623
30,848
7,184
(7,990)
6,177
(5,181)
(420)
69,988
7,954
22,894
73,471 $
30,848 $
15,485 $
50
12,388 $
3,120
30,477
27,962
(7,645)
5,023
(4,440)
(383)
50,994
1,325
21,569
22,894
10,836
1,415
467 $
331 $
306
$
$
$
FINANCING ACTIVITIES
Net increase (decrease) in deposits
Net increase (decrease) in borrowed funds
Cash dividends paid on common stock
Proceeds from issuance of common stock
Common stock repurchased
Common stock purchased for deferred compensation obligations
Net cash provided by (used in) financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid
Income taxes paid
SUPPLEMENTAL NONCASH INFORMATION:
Transfers of loans to foreclosed assets
The accompanying notes are an integral part of these consolidated financial statements.
43
Table of Contents
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
( Dollars in thousands except per share amounts)
Note 1 – Nature of Operations and Summary of Significant Accounting Policies
BASIS OF PRESENTATION AND CONSOLIDATION: The consolidated financial statements include the accounts of Isabella Bank Corporation, a financial
services holding company, and its wholly owned subsidiary, Isabella Bank. All intercompany balances and accounts have been eliminated in consolidation.
References to “the Corporation”, “Isabella”, “we”, “our”, “us”, and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its
subsidiary. References to Isabella Bank or the “Bank” refers to Isabella Bank Corporation’s subsidiary, Isabella Bank.
For additional information, see “ Note 18 – Related Party Transactions .”
NATURE OF OPERATIONS: Isabella Bank Corporation is a financial services holding company offering a wide array of financial products and services in
several mid-Michigan counties. Our banking subsidiary, Isabella Bank, offers banking services through 30 locations, 24 hour banking services locally and
nationally through shared automatic teller machines, 24 hour online banking, mobile banking, and direct deposits to businesses, institutions, individuals and their
families. Lending services offered include commercial loans, agricultural loans, residential real estate loans, and consumer loans. Deposit services include interest
and noninterest bearing checking accounts, savings accounts, money market accounts, certificates of deposit, direct deposits, cash management services, mobile
and internet banking, electronic bill pay services, and automated teller machines. Other related financial products include trust and investment services, safe
deposit box rentals, and credit life insurance. Active competition, principally from other commercial banks, savings and loan associations, mortgage brokers,
finance companies, credit unions, and retail brokerage firms exists in all of our principal markets. Our results of operations can be significantly affected by changes
in interest rates, changes in the local economic environment and changes in regulations.
USE OF ESTIMATES: In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of
America, we make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet and reported
amounts of revenues and expenses during the reporting year. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the ALLL , the fair value of AFS investment
securities, and the valuation of goodwill and other intangible assets.
FAIR VALUE MEASUREMENTS : Fair value refers to the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly
transaction between market participants in the market in which the reporting entity transacts such sales or transfers based on the assumptions market participants
would use when pricing an asset or liability. Assumptions are developed based on prioritizing information within a fair value hierarchy that gives the highest
priority to quoted prices in active markets and the lowest priority to unobservable data, such as the reporting entity’s own data. We may choose to measure eligible
items at fair value at specified election dates.
For assets and liabilities recorded at fair value, it is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when
developing fair value measurements for those financial instruments for which there is an active market. In cases where the market for a financial asset or liability is
not active, we include appropriate risk adjustments that market participants would make for nonperformance and liquidity risks when developing fair value
measurements. Fair value measurements for assets and liabilities for which limited or no observable market data exists are accordingly based primarily upon
estimates, are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the
results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there may be
inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows,
could significantly affect the results of current or future values.
We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Investment securities
AFS and derivative instruments are recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record other assets and
liabilities at fair value on a nonrecurring basis, such as mortgage loans AFS , impaired loans, foreclosed assets, OMSR , goodwill, 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.
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Fair Value Hierarchy
Under fair value measurement and disclosure authoritative guidance, we group assets and liabilities measured at fair value into three levels, based on the markets in
which the assets and liabilities are traded, and the reliability of the assumptions used to determine fair value, based on the prioritization of inputs in the valuation
techniques. These levels are:
Level 1:
Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2:
Level 3:
Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that
are not active and model based valuation techniques for which all significant assumptions are observable in the market.
Valuation is generated from model based techniques that use at least one significant assumption not observable in the market. These unobservable
assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.
The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value
measurement. Valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. Transfers between measurement levels are
recognized at the end of reporting periods.
For further discussion of fair value considerations, refer to “ Note 17 – Fair Value .”
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK : Most of our activities are conducted with customers located within the central Michigan
area. A significant amount of our outstanding loans are secured by commercial and residential real estate. Other than these types of loans, there is no significant
concentration to any other industry or any one customer.
CASH AND CASH EQUIVALENTS: For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from
banks, federal funds sold, and other deposit accounts. Generally, federal funds sold are for a one day period. We maintain deposit accounts in various financial
institutions which generally exceed federally insured limits or are not insured. We do not believe we are exposed to any significant interest, credit or other financial
risk as a result of these deposits.
AFS SECURITIES: Purchases of investment securities are generally classified as AFS . However, we may elect to classify securities as either held to maturity or
trading. Securities classified as AFS debt securities are recorded at fair value, with unrealized gains and losses, net of the effect of deferred income taxes, excluded
from earnings and reported in other comprehensive income. Included in AFS securities are auction rate money market preferred securities. These investments, for
federal income tax purposes, have no federal income tax impact given the nature of the investments. Auction rate money market preferred securities and preferred
stocks are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Purchase premiums and
discounts are recognized in interest income using the interest method over the term of the securities. Realized gains and losses on the sale of AFS securities are
determined using the specific identification method.
AFS securities are reviewed quarterly for possible OTTI . In determining whether an OTTI exists for debt securities, we assert that: (a) we do not have the intent to
sell the security; and (b) it is more likely than not we will not have to sell the security before recovery of its cost basis. If these conditions are not met, we
recognize an OTTI charge through earnings for the difference between the debt security’s amortized cost basis and its fair value, and such amount is included in
noninterest income. For debt securities that do not meet the above criteria, and we do not expect to recover the security’s amortized cost basis, the security is
considered other-than-temporarily impaired. For these debt securities, we separate the total impairment into the credit risk loss component and the amount of the
loss related to market and other risk factors. In order to determine the amount of the credit loss for a debt security, we calculate the recovery value by performing a
discounted cash flow analysis based on the current cash flows and future cash flows we expect to recover. The amount of the total OTTI related to the credit risk is
recognized in earnings and is included in noninterest income. The amount of the total OTTI related to other risk factors is recognized as a component of other
comprehensive income. For debt securities that have recognized OTTI through earnings, if through subsequent evaluation there is a significant increase in the cash
flow expected, the difference between the amortized cost basis and the cash flows expected to be collected is accreted as interest income.
AFS equity securities are reviewed for OTTI at each reporting date. This evaluation considers a number of factors including, but not limited to, the length of time
and extent to which the fair value has been less than cost, the financial condition and near term prospects of the issuer, and our ability and intent to hold the
securities until fair value recovers. If it is determined that we do not have the ability and intent to hold the securities until recovery or that there are conditions that
indicate that a security may not recover in value then the difference between the fair value and the cost of the security is recognized in earnings and is included in
noninterest income.
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LOANS: Loans that we have the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balance
adjusted for any charge-offs , the ALLL , and any deferred fees or costs on originated loans. Interest income on loans 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 appropriate yield methods.
The accrual of interest on agricultural, commercial and mortgage 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. 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 in nonaccrual 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 . Interest income on loans in nonaccrual status is not recognized until qualifying for
return to accrual status. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are
reasonably assured. For impaired loans not classified as nonaccrual , interest income continues to be accrued over the term of the loan based on the principal
amount outstanding.
ALLOWANCE FOR LOAN AND LEASE LOSSES: 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 allowance when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if
any, are credited to the allowance.
We evaluate the ALLL on a regular basis. Our periodic review of the collectability of loans considers 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 ALLL consists of specific, general, and unallocated components. The specific component relates to loans that are deemed to be impaired. For such loans that
are analyzed for specific allowance allocations, an allowance is established when the discounted cash flows, collateral value or observable market price of the
impaired loan is lower than the carrying value of that loan. The general component covers non-impaired loans and is based on historical loss experience adjusted
for current conditions. An unallocated component is maintained to cover uncertainties that we believe affect our estimate of probable losses based on qualitative
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.
Loans may be classified as impaired if they meet one or more of the following criteria:
1.
2.
3.
There has been a charge-off of its principal balance;
The loan has been classified as a TDR ; or
The loan is in nonaccrual status.
Impairment is measured on a loan-by-loan basis by either 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.
LOANS HELD FOR SALE: Mortgage loans held for sale on the secondary market are carried at the lower of cost or fair value as determined by aggregating
outstanding commitments from investors or current investor yield requirements. Net unrealized losses, if any, would be recognized as a component of other
noninterest expenses.
Mortgage loans held for sale are sold with the mortgage servicing rights retained by us. Gains or losses on sales of mortgage loans are recognized based on the
difference between the selling price and the carrying value of the related mortgage loans sold.
TRANSFERS OF FINANCIAL ASSETS: Transfers of financial assets, including mortgage loans and participation loans, are accounted for as sales when control
over the assets has been surrendered. Control over transferred assets is determined to be surrendered when 1) the assets have been legally isolated from us, 2) the
transferee obtains the right (free of conditions that constrain it from taking advantage of the right) to pledge or exchange the transferred assets, and 3) we do not
maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Other than servicing, we have no substantive
continuing involvement related to these loans.
SERVICING: Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. We have no
purchased servicing rights. For sales of mortgage loans, a portion of the cost of originating the
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loan is allocated to the servicing right based on relative fair value. Fair value is based on market prices for comparable mortgage servicing contracts, when
available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model
incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial
earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses.
Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights
into tranches based on predominant risk characteristics, such as interest rate, loan type, and investor type. Impairment is recognized through a valuation allowance
for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranche. If we later determine that all or a portion of the impairment
no longer exists for a particular tranche, a reduction of the valuation allowance may be recorded as an increase to income. Capitalized servicing rights are reported
in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying
financial assets. The unpaid principal balance of mortgages serviced for others was $259,481 and $266,789 with capitalized servicing rights of $2,435 and $2,409
at December 31, 2018 and 2017 , respectively.
Servicing fee income is recorded for fees earned for servicing loans for others. The fees are based on a contractual percentage of the outstanding principal or a
fixed amount per loan and are recorded as income when earned. We recorded servicing fee revenue of $651 , $671 , and $696 related to residential mortgage loans
serviced for others during 2018 , 2017 , and 2016 , respectively, which is included in other noninterest income.
FORECLOSED ASSETS: Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of our carrying amount
or fair value less estimated selling costs at the date of transfer, establishing a new cost basis. Any write downs based on the asset’s fair value at the date of
acquisition are charged to the ALLL . After foreclosure, property held for sale is carried at the lower of the new cost basis or fair value less costs to sell.
Impairment losses on property to be held and used are measured at the amount by which the carrying amount of property exceeds its fair value. Costs relating to
holding these assets are expensed as incurred. We periodically perform valuations and any subsequent write downs are recorded as a charge to operations, if
necessary, to reduce the carrying value of a property to the lower of our carrying amount or fair value less costs to sell. Foreclosed assets of $355 and $291 as of
December 31, 2018 and 2017 , respectively, are included in other assets.
PREMISES AND EQUIPMENT: Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation which is computed
principally by the straight-line method based upon the estimated useful lives of the related assets, which range from 3 to 40 years. Major improvements are
capitalized and appropriately amortized based upon the useful lives of the related assets or the expected terms of the leases, if shorter, using the straight-line
method. Maintenance, repairs and minor alterations are charged to current operations as expenditures occur. We annually review these assets to determine whether
carrying values have been impaired.
EQUITY SECURITIES WITHOUT READILY DETERMINABLE FAIR VALUES: Included in equity securities without readily determinable fair values are
our holdings in FHLB stock and FRB stock as well as our ownership interest in Corporate Settlement Solutions, LLC . Our investment in Corporate Settlement
Solutions, LLC , a title insurance company, was made in the 1st quarter of 2008. We are not the managing entity of Corporate Settlement Solutions, LLC , and
account for our investment in that entity under the equity method of accounting.
Equity securities without readily determinable fair values consist of the following holdings as of December 31 :
FHLB Stock
Corporate Settlement Solutions, LLC
FRB Stock
Other
Total
2018
2017
15,050 $
7,565
1,999
334
24,948 $
13,700
7,421
1,999
334
23,454
$
$
EQUITY COMPENSATION PLAN: At December 31, 2018 , the Directors Plan had 220,171 shares eligible to be issued to participants, for which the Rabbi
Trust held 16,673 shares. We had 226,909 shares to be issued at December 31, 2017 , with 31,769 shares held in the Rabbi Trust . Compensation costs relating to
share-based payment transactions are recognized as the services are rendered, with the cost measured based on the fair value of the equity or liability instruments
issued (see “ Note 12 – Benefit Plans ”).
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CORPORATE OWNED LIFE INSURANCE: We have purchased life insurance policies on key members of management, partially for the purpose of funding
certain post-retirement benefits. In the event of death of one of these individuals, we would receive a specified cash payment equal to the face value of the policy.
Such policies are recorded at their cash surrender value, or the amount that can be realized on the balance sheet date. Increases in cash surrender value in excess of
single premiums paid are reported as other noninterest income.
As of December 31, 2018 and 2017 , the present value of the post retirement benefits payable by us to the covered insured participants was estimated to be $2,751
and $2,751 , respectively, and is included in accrued interest payable and other liabilities. The expenses associated with these policies totaled $0 , $577 , and $(8)
for 2018 , 2017 , and 2016 , respectively.
ACQUISITION INTANGIBLES AND GOODWILL: We previously acquired branch facilities and related deposits in business combinations accounted for as a
purchase. The acquisitions included amounts related to the valuation of customer deposit relationships (core deposit intangibles). Core deposit intangibles arising
from acquisitions are included in goodwill and other intangible assets are being amortized over their estimated lives and evaluated for potential impairment on at
least an annual basis. Goodwill, which represents the excess of the purchase price over identifiable assets, is not amortized but is evaluated for 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 is more likely than not to be impaired, we perform a cash flow valuation to determine the extent of the
potential impairment. This valuation method requires a significant degree of our judgment. In the event the projected undiscounted net operating cash flows for
these intangible assets are less than the carrying value, the asset is recorded at fair value as determined by the valuation model.
OFF BALANCE SHEET CREDIT RELATED FINANCIAL INSTRUMENTS: In the ordinary course of business, we have entered into commitments to
extend credit, including commitments under credit card arrangements, commercial lines of credit, home equity lines of credit, commercial letters of credit, and
standby letters of credit. Such financial instruments are recorded only when funded.
REVENUE RECOGNITION: Our revenue is comprised primarily of interest income, service charges and fees, gains on the sale of loans and AFS securities ,
earnings on corporate owned life insurance policies, and other noninterest income. Other noninterest income is typically service and performance driven in nature
and comprised primarily of investment and trust advisory fees. We recognize revenue, excluding interest income, in accordance with ASC 606, Revenue From
Contracts with Customers. Revenue is recognized when our performance obligation has been satisfied according to our contractual obligation.
FEDERAL INCOME TAXES: Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net
deferred tax assets or liabilities are determined based on the tax effects of the temporary differences between the book and tax basis on the various balance sheet
assets and liabilities and gives current recognition to changes in tax rates and laws. Valuation allowances are established, where necessary, to reduce deferred tax
assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the year plus or minus the change during the year in deferred
tax assets and liabilities.
On December 22, 2017, the Tax Cuts and Jobs Act was enacted. The law established a flat corporate federal statutory income tax rate of 21%. In accordance with
ASC 740, Income Taxes, the effect of income tax law changes on deferred taxes was recognized as a component of income tax expense related to continuing
operations in the period in which the law was enacted. As such, federal income tax expense for the year ended December 31, 2017 reflects the effect of the tax rate
change on net deferred tax assets and liabilities (see “ Note 15 – Federal Income Taxes ” and “ Note 16 – Accumulated Other Comprehensive Income (Loss) ”).
We analyze our filing positions in the jurisdictions where we are required to file income tax returns, as well as all open tax years in these jurisdictions. We also
treat interest and penalties attributable to income taxes, to the extent they arise, as a component of our noninterest expenses.
DEFINED BENEFIT PENSION PLAN: We maintain a noncontributory defined benefit pension plan, which was curtailed effective March 1, 2007. The service
cost component of the defined benefit pension plan is included in “compensation and benefits” on the consolidated statements of income and is funded consistent
with the requirements of federal laws and regulations. All other costs related to the defined benefit pension plan are included in “other” noninterest expenses on the
consolidated statements of income. The current benefit obligation is included in "accrued interest payable and other liabilities" on the consolidated balance sheets.
Inherent in the determination of defined benefit pension costs are assumptions concerning future events that will affect the amount and timing of required benefit
payments under the plan. These assumptions include demographic assumptions such as mortality, a discount rate used to determine the current benefit obligation
and a long-term expected rate of return on plan assets. Net periodic benefit cost includes the interest cost based on the assumed discount rate, an expected return on
plan assets based on an actuarially derived market-related value of assets, and amortization of
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unrecognized net actuarial gains or losses. Actuarial gains and losses result from experience different from that assumed and from changes in assumptions
(excluding asset gains and losses not yet reflected in market-related value). Amortization of actuarial gains and losses is included as a component of net periodic
defined benefit pension cost.
For additional information, see “ Note 12 – Benefit Plans .”
MARKETING COSTS: Marketing costs are expensed as incurred (see “ Note 14 – Other Noninterest Expenses ”).
RECLASSIFICATIONS: Certain amounts reported in the 2017 and 2016 consolidated financial statements have been reclassified to conform with the 2018
presentation.
Note 2 – Accounting Standards Updates
Recently Adopted Accounting Standards Updates
ASU
No.
2014-09:
“Revenue
from
Contracts
with
Customers”
In May 2014, ASU No. 2014-09 was issued and created new Topic 606 to provide a common revenue standard to achieve consistency and clarification to the
revenue recognition principles. The guidance outlines steps to achieve the core principle that an entity should recognize revenue to depict the transfer of promised
goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. These
steps consist of: (1) identify the contract with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate
the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation.
The new authoritative guidance, as amended, was effective on January 1, 2018. We reviewed our contracts related to trust and investment services and those
related to other noninterest income to determine if changes in income recognition were required as a result of this guidance. Implementation of this guidance did
not have a significant impact on our operating results for the year ended December 31, 2018 .
ASU
No.
2016-01:
“Financial
Instruments
-
Overall
(Subtopic
825-10):
Recognition
and
Measurement
of
Financial
Assets
and
Liabilities”
and
ASU
No.
2018-03:
“Technical
Corrections
and
Improvements
to
Financial
Instruments
-
Overall
(Subtopic
825-10:
Recognition
and
Measurement
of
Financial
Assets
and
Financial
Liabilities”
In January 2016, ASU No. 2016-01 was issued and sets 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 requiring measurement of the investment at fair value when an impairment exists; 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 was effective for interim and annual periods beginning after December 15, 2017. As a result of this guidance, the change in the fair
value of equity investments has been recorded in net income beginning on January 1, 2018 (see “ Note 17 – Fair Value ”). Equity securities are now recorded
separately from AFS securities at a fair value which approximates an exit price notion. Adoption of this guidance did not have a significant impact on our
operations and its future impact will depend on the fair value of these investments, or any securities acquired subsequent to this guidance, at future measurement
dates. The disclosures related to equity investment securities reflect a fully retrospective presentation for comparative purposes.
For discussion of the fair value measurement of financial instruments, refer to “ Note 17 – Fair Value ”.
In February 2018, ASU No. 2018-03 was issued and sets forth correction or improvement amendments for specific issues that may arise within the scope of ASU
2016-01. These amendments have been adopted and did not have a significant impact on our operating results or financial statement disclosures.
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ASU
No.
2017-08:
“Receivables
-
Nonrefundable
Fees
and
Other
Costs
(Subtopic
310-20):
Premium
Amortization
on
Purchased
Callable
Debt
Securities”
In March 2017, ASU No. 2017-08 amended the amortization period for certain purchased callable debt securities held at a premium. Under current GAAP, entities
generally amortize the premium as an adjustment of yield over the contractual life of the instrument. The amendments in this update shorten the amortization
period and require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the
discount continues to be amortized to maturity.
The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2018 with early adoption permitted. The guidance has
been adopted and did not have a significant impact on our operating results or financial statement disclosures.
ASU
No.
2017-09:
“ Compensation
-
Stock
Compensation
(Topic
718):
Scope
of
Modification
Accounting”
In May 2017, ASU No. 2017-09 was issued and provided guidance about which changes to the terms or conditions of a share-based payment award require an
entity to apply modification accounting under Topic 718. The current disclosure requirements in Topic 718 apply regardless of whether an entity is required to
apply modification accounting under the amendments in this update. An entity should account for the effects of a modification unless all of the following are met:
1. The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair
value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is
modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate
the value immediately before and after the modification.
2. The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is
modified.
3. The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award
immediately before the original award is modified.
The new authoritative guidance was effective on January 1, 2018 and did not have a significant impact on our operating results or financial statement disclosures.
Pending Accounting Standards Updates
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. We have reviewed our lease agreements to determine the appropriate treatment under this guidance. These
changes will not have a significant impact on our operating results or financial statement disclosures upon adoption.
In July 2018, ASU No. 2018-10 was issued and provided codification improvements for various leasing issues. Also during July 2018, ASU No. 2018-11 was
issued for targeted improvements related to the transition of the new guidance. In December
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2018, ASU No. 2018-20 was issued and provided narrow-scope improvements for lessors. These updates are effective with the implementation of ASU 2016-02.
ASU
No.
2016-13:
“Financial
Instruments
-
Credit
Losses
(Topic
326):
Measurement
of
Credit
Losses
on
Financial
Instruments”
In June 2016, ASU No. 2016-13 was issued and 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.
Under the new guidance, the incurred loss impairment methodology in current GAAP is replaced with a methodology that reflects current expected credit losses
(CECL). 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 requires disclosure of 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 may have a significant impact on our operations and financial statement disclosures as well as that of the banking industry
as a whole.
We have invested a considerable amount of effort toward this guidance and will continue to invest considerable effort until its effective date. A committee was
formed and has developed a road map to implementation, and the committee is accountable for timely and accurate adoption of the guidance. A company that has
been focused on the ALLL for more than 10 years and serves hundreds of financial institutions has been engaged to provide us with education, advisory, and
software solutions exclusively related to the ACL . We expect to run parallel processes during 2019, which will help to ensure we are ready to calculate, review,
and report the ACL by the required implementation date.
In November 2018, ASU No. 2018-19 was issued and provided codification improvements for two issues: transition and effective date for nonpublic business
entities and operating lease receivables. The update is effective with the implementation of ASU 2016-13 and is not expected to impact our operating results or
financial statement disclosures.
ASU
No.
2018-13:
“Fair
Value
Measurement
(Topic
820):
Disclosure
Framework-Changes
to
the
Disclosure
Requirements
for
Fair
Value
Measurement”
In August 2018, ASU No. 2018-13 was issued and provided an updated framework related to fair value disclosures. For entities required to make disclosures about
recurring or nonrecurring fair value measurements, the update provides disclosure modifications which include the removal, modification and addition of specific
disclosure requirements.
The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2019 and will impact our financial statement disclosures.
51
Table of Contents
ASU
No.
2018-14:
“Compensation
-
Retirement
Benefits
-
Defined
Pension
Plans
-
General
(Subtopic
715-20):
Disclosure
Framework
-
Changes
to
the
Disclosure
Requirements
for
Defined
Benefit
Plans”
In August 2018, ASU No. 2018-14 was issued and provided updated framework related to defined benefit plans. For employers that sponsor defined benefit
pension or other postretirement plans, the update provides disclosure modifications which include the removal of six specific requirements, the addition of two
specific requirements and clarification to existing requirements.
Disclosure additions include 1) the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates; 2) an
explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. Clarification items relate to 1) the projected
benefit obligation (PBO) and fair value of plan assets for plans with PBOs in excess of plan assets; and 2) the accumulated benefit obligation (ABO) and fair value
of plan assets for plans with ABOs in excess of plan assets.
The new authoritative guidance is effective for fiscal years ending after December 15, 2020, with early adoption permitted, and will likely impact our financial
statement disclosures.
ASU
No.
2018-15:
“Intangibles
-
Goodwill
and
Other
-
Internal-Use
Software
(Subtopic
350-40):
Customer’s
Accounting
for
Implementation
Costs
Incurred
in
a
Cloud
Computing
Arrangement
That
Is
a
Service
Contract”
In August 2018, ASU No. 2018-15 was issued and provided guidance on the accounting for implementation, setup, and other upfront costs (collectively referred to
as implementation costs) for entities that are a customer in a hosting arrangement that is a service contract. The guidance also provides clarification on
requirements to capitalize implementation costs and the required accounting for expenses related to capitalization of implementation costs.
The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted. The impact on our
operating results and financial statement disclosures as a result of this update will depend upon our arrangements and whether or not they meet the requirement to
be capitalized.
ASU
No.
2018-16:
“Derivatives
and
Hedging
(Topic
815):
Inclusion
of
the
Secured
Overnight
Financing
Rate
(SOFR)
Overnight
Index
Swap
(OIS)
Rate
as
a
Benchmark
Interest
Rate
of
Hedge
Accounting
Purposes”
In October 2018, ASU No. 2018-16 was issued and permits the OIS rate based on SOFR as a U.S. benchmark interest rate. Including the OIS rate based on SOFR
as an eligible benchmark interest rate during the early stages of the marketplace transition will facilitate the LIBOR to SOFR transition and provide sufficient lead
time for entities to prepare for changes to interest rate risk hedging strategies for both risk management and hedge accounting purposes.
For entities that have not already adopted ASU No. 2017-12 (“Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging
Activities”), the amendments in this update are required to be adopted concurrently with the amendments in ASU No. 2017-12. For entities that already have
adopted ASU No. 2017-12, the amendments in this update are effective for interim and annual periods beginning after December 15, 2018, with early adoption
permitted. The amendments in this update are not expected to have a significant impact on our operating results or financial statement disclosures.
52
Table of Contents
Note 3 – AFS Securities
The amortized cost and fair value of AFS securities , with gross unrealized gains and losses, are as follows as of December 31 :
Government sponsored enterprises
States and political subdivisions
Auction rate money market preferred
Mortgage-backed securities
Collateralized mortgage obligations
Total
Government sponsored enterprises
States and political subdivisions
Auction rate money market preferred
Mortgage-backed securities
Collateralized mortgage obligations
Total
Amortized
Cost
172 $
188,992
3,200
189,688
119,193
2018
Gross
Unrealized
Gains
Gross
Unrealized
Losses
— $
2,125
—
76
71
2 $
251
646
5,280
2,504
501,245 $
2,272 $
8,683 $
Amortized
Cost
217 $
204,131
3,200
210,757
129,607
2017
Gross
Unrealized
Gains
Gross
Unrealized
Losses
— $
4,486
—
390
160
1 $
143
151
2,350
1,573
547,912 $
5,036 $
4,218 $
$
$
$
$
The amortized cost and fair value of AFS securities by contractual maturity at December 31, 2018 are as follows:
Government sponsored enterprises
States and political subdivisions
Auction rate money market preferred
Mortgage-backed securities
Collateralized mortgage obligations
Total amortized cost
Fair value
Due in
One Year
or Less
Maturing
After One
Year But
Within
Five Years
After Five
Years But
Within
Ten Years
Securities with
Variable Monthly
Payments or
Noncontractual
Maturities
After
Ten Years
$
$
$
— $
172 $
— $
— $
23,151
81,901
55,923
28,017
—
—
—
—
—
—
—
—
—
—
—
—
— $
—
3,200
189,688
119,193
23,151 $
23,189 $
82,073 $
82,662 $
55,923 $
56,842 $
28,017 $
312,081 $
28,343 $
303,798 $
Fair
Value
170
190,866
2,554
184,484
116,760
494,834
Fair
Value
216
208,474
3,049
208,797
128,194
548,730
Total
172
188,992
3,200
189,688
119,193
501,245
494,834
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 investments 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.
A summary of the sales activity of AFS securities during the years ended December 31 is displayed in the following table. There were no sales of AFS securities
during 2018.
Proceeds from sales of AFS securities
Gross realized gains (losses)
Applicable income tax expense (benefit)
53
2017
2016
12,827 $
35,664
142 $
48 $
245
83
$
$
$
Table of Contents
The following information pertains to AFS securities with gross unrealized losses at December 31 aggregated by investment category and length of time that
individual securities have been in a continuous loss position.
Government sponsored enterprises
States and political subdivisions
Auction rate money market preferred
Mortgage-backed securities
Collateralized mortgage obligations
Total
Number of securities in an unrealized loss position:
Government sponsored enterprises
States and political subdivisions
Auction rate money market preferred
Mortgage-backed securities
Collateralized mortgage obligations
Total
Number of securities in an unrealized loss position:
2018
Less Than Twelve Months
Twelve Months or More
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Total
Unrealized
Losses
— $
— $
2 $
170 $
83
—
896
199
14,732
—
43,485
21,886
168
646
4,384
2,305
15,090
2,554
124,253
87,929
1,178 $
80,103 $
7,505 $
229,996 $
66
102
2
251
646
5,280
2,504
8,683
168
2017
Less Than Twelve Months
Twelve Months or More
Gross
Unrealized
Losses
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Total
Unrealized
Losses
1 $
216 $
— $
— $
142
—
454
701
16,139
—
72,007
76,435
1
151
1,896
872
188
3,049
76,065
25,308
1,298 $
164,797 $
2,920 $
104,610 $
81
24
1
143
151
2,350
1,573
4,218
105
$
$
$
$
Unrealized losses on our AFS securities portfolio are the result of recent increases in intermediate-term and long-term benchmark interest rates and not credit
issues.
As of December 31, 2018 and 2017 , we conducted an analysis to determine whether any securities currently in an unrealized loss position should be identified as
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?
During the fourth quarter of 2016, we identified one municipal bond as other-than-temporarily impaired. While management estimated the OTTI to be realized, we
also engaged the services of an independent investment valuation firm to estimate the amount of impairment as of December 31, 2016. The valuation calculated the
estimated market value utilizing two different approaches:
1) Market - Appraisal and Comparable Investments
2) Income - Discounted Cash Flow Method
The two methods were then weighted, with a higher weighting applied to the Market approach, to determine the estimated impairment. As a result of this analysis,
we reduced the carrying value to $230 which required us to recognize an OTTI of $770 in earnings for the year ended December 31, 2016. Based on internal
analysis of the bond as of December 31, 2018 , a change in the estimated valuation was not deemed necessary and the carrying value of this bond remained at
$230.
54
Table of Contents
The following table provides a roll-forward of credit related impairment recorded in earnings for the years ended December 31 :
Balance at beginning of the period
Additions to credit losses for which no previous OTTI was recognized
Reductions for credit losses realized on securities sold during the period
Balance at end of the period
2018
2017
2016
770 $
—
—
770 $
770 $
—
—
770 $
—
770
—
770
$
$
Based on our analysis which included the criteria outlined above, 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 other AFS securities are other-than-temporarily impaired as of December 31, 2018 and 2017 , with the exception of the one
municipal bond discussed above.
Note 4 – 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. Some 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 appropriate yield methods.
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 short-term 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 in nonaccrual status or charged-off at an
earlier date if collection of principal or interest is considered doubtful.
When loans are placed in 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 and achievement of current payment status.
Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, advances to mortgage brokers, farmland and agricultural
production, and loans to 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 may
be 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, property, or equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole
proprietorships. In addition, we may require annual financial statements, prepare cash flow analyses, and review credit reports.
We entered into a mortgage purchase program in 2016 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 them 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 pay off 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 consolidated balance sheet. Under the participation agreement, we committed
to a maximum outstanding aggregate amount of $30,000. The difference between our outstanding balance and the maximum outstanding aggregate amount is
classified as “ Unfunded commitments
55
Table of Contents
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, our liquidity needs,
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 100% of the lower of the appraised value of the property or
the purchase price. Private mortgage insurance is typically required on loans with loan-to-value ratios in excess of 80% unless the loan qualifies for government
guarantees.
Underwriting criteria for residential real estate loans generally 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 40% of income.
Verification of acceptable credit reports.
Verification of employment, income, and financial information.
Appraisals are performed by independent appraisers and reviewed for appropriateness. Generally, mortgage loan requests are reviewed by our mortgage loan
committee or through a secondary market underwriting system; loans in excess of $1,000 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 15 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 probable. Subsequent recoveries, if any, are credited to the ALLL .
The ALLL is evaluated on a regular basis for appropriateness. Our periodic review of the collectability of the loans considers 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 and 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 in the following tables. 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.
56
Table of Contents
A summary of changes in the ALLL and the recorded investment in loans by segments follows:
January 1, 2018
Charge-offs
Recoveries
Provision for loan losses
December 31, 2018
January 1, 2017
Charge-offs
Recoveries
Provision for loan losses
December 31, 2017
ALLL
Individually evaluated for impairment
Collectively evaluated for impairment
Total
Loans
Individually evaluated for impairment
Collectively evaluated for impairment
Total
ALLL
Individually evaluated for impairment
Collectively evaluated for impairment
Total
Loans
Individually evaluated for impairment
Collectively evaluated for impairment
Total
Allowance for Loan Losses
Year Ended December 31, 2018
Commercial
Agricultural
Residential
Real Estate
Consumer
Unallocated
Total
1,706 $
611 $
2,563 $
900 $
1,920 $
(626)
328
1,155
—
—
164
(151)
261
(681)
(324)
209
72
—
—
268
2,563 $
775 $
1,992 $
857 $
2,188 $
7,700
(1,101)
798
978
8,375
Allowance for Loan Losses
Year Ended December 31, 2017
Commercial
Agricultural
Residential
Real Estate
Consumer
Unallocated
Total
1,814 $
884
$
2,664 $
624 $
1,414 $
(265)
453
(296)
—
—
(273)
(200)
206
(107)
(306)
159
423
—
—
506
1,706 $
611
$
2,563 $
900 $
1,920 $
7,400
(771)
818
253
7,700
Allowance for Loan Losses and Recorded Investment in Loans
As of December 31, 2018
Commercial
Agricultural
Residential
Real Estate
Consumer
Unallocated
Total
443 $
2,120
2,563 $
132 $
643
775 $
1,363 $
629
1,992 $
— $
857
857 $
— $
2,188
2,188 $
1,938
6,437
8,375
9,899 $
14,298 $
6,893 $
649,630
112,863
268,450
659,529 $
127,161 $
275,343 $
9
66,665
66,674
$
31,099
1,097,608
$
1,128,707
Allowance for Loan Losses and Recorded Investment in Loans
As of December 31, 2017
Commercial
Agricultural
Residential
Real Estate
Consumer
Unallocated
Total
650 $
1,056
1,706 $
— $
611
611 $
1,480 $
1,083
2,563 $
— $
900
900 $
— $
1,920
1,920 $
2,130
5,570
7,700
8,099 $
10,598 $
7,939 $
626,660
117,671
264,429
634,759 $
128,269 $
272,368 $
17
56,106
56,123
$
26,653
1,064,866
$
1,091,519
$
$
$
$
$
$
$
$
$
$
$
$
57
Table of Contents
The following tables display the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit risk ratings as of
December 31 :
Total
$
497,687 $
150,049 $
11,793 $
659,529 $
87,320 $
39,841 $
127,161 $
786,690
Real Estate
Other
Commercial
Advances to
Mortgage
Brokers
Rating
1 - Excellent
2 - High quality
3 - High satisfactory
4 - Low satisfactory
5 - Special mention
6 - Substandard
7 - Vulnerable
8 - Doubtful
9 - Loss
$
21 $
31 $
4,564
127,573
344,920
12,847
7,428
334
—
—
13,473
43,199
84,634
5,287
2,002
1,423
—
—
— $
—
18,037
11,793
182,565
—
—
—
—
—
—
429,554
18,134
9,430
1,757
—
—
Real Estate
Other
Commercial
Advances to
Mortgage
Brokers
Rating
1 - Excellent
2 - High quality
3 - High satisfactory
4 - Low satisfactory
5 - Special mention
6 - Substandard
7 - Vulnerable
8 - Doubtful
9 - Loss
$
24 $
316 $
8,402
131,826
326,166
8,986
5,521
729
—
—
12,262
46,668
75,591
3,889
2,298
—
—
—
— $
—
20,664
12,081
190,575
—
—
—
—
—
—
401,757
12,875
7,819
729
—
—
2018
Agricultural
Total
Real Estate
Other
Total
Total
52 $
51 $
28 $
79 $
131
2,729
18,325
46,636
10,520
6,343
2,716
—
—
613
7,039
19,344
5,624
4,960
2,233
—
—
3,342
25,364
65,980
16,144
11,303
4,949
—
—
21,379
207,929
495,534
34,278
20,733
6,706
—
—
2017
Agricultural
Total
Real Estate
Other
Total
Total
340 $
— $
34 $
34 $
374
2,909
21,072
47,835
10,493
4,325
1,531
—
—
1,024
8,867
18,467
8,546
2,747
419
—
—
3,933
29,939
66,302
19,039
7,072
1,950
—
—
24,597
220,514
468,059
31,914
14,891
2,679
—
—
Total
$
481,654 $
141,024 $
12,081 $
634,759 $
88,165 $
40,104 $
128,269 $
763,028
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.
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Table of Contents
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.
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.
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 constitutes 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.
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•
•
•
Loan may need to be restructured to improve collateral position or reduce payments.
Collateral or guaranty offers limited protection.
Negative debt service coverage, however the credit is well collateralized and payments are current.
6. SUBSTANDARD – Classified
Credit is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged. There is a distinct possibility we will
implement collection procedures if the loan deficiencies are not corrected. Any commercial loan placed in nonaccrual status will be rated "7" or worse. 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.
Interest non-accrual may be warranted.
Collateral provides little or no value.
Requires excessive attention of the loan officer.
Borrower is uncooperative with loan officer.
7. VULNERABLE – Classified
Credit is considered “Substandard” and warrants placing in 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 .
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9. LOSS – Charge-off
Credit is considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification is for charged-off loans
but does not mean that the asset has absolutely no recovery or salvage value. These loans are further characterized by:
•
•
•
•
•
Liquidation or reorganization under Bankruptcy, with poor prospects of collection.
Fraudulently overstated assets and/or earnings.
Collateral has marginal or no value.
Debtor cannot be located.
Over 120 days delinquent.
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 December 31 :
Accruing Interest
and Past Due:
2018
30-59
Days
60-89
Days
90 Days
or More
Nonaccrual
Total Past Due
and Nonaccrual
Current
Total
Commercial
Commercial real estate
$
60 $
— $
— $
334 $
394 $
497,293 $
Commercial other
Advances to mortgage brokers
Total commercial
Agricultural
Agricultural real estate
Agricultural other
Total agricultural
Residential real estate
Senior liens
Junior liens
Home equity lines of credit
Total residential real estate
Consumer
Secured
Unsecured
Total consumer
Total
277
—
337
428
—
428
2,254
2
76
2,332
95
10
105
628
—
628
—
—
—
203
6
—
209
—
—
—
—
—
—
—
—
—
113
—
—
113
—
—
—
1,423
—
1,757
2,716
2,233
4,949
554
—
—
554
—
—
—
2,328
—
2,722
3,144
2,233
5,377
147,721
11,793
656,807
84,176
37,608
497,687
150,049
11,793
659,529
87,320
39,841
121,784
127,161
3,124
233,438
236,562
8
76
6,001
32,696
6,009
32,772
3,208
272,135
275,343
95
10
105
62,721
3,848
66,569
62,816
3,858
66,674
$
3,202 $
837 $
113 $
7,260 $
11,412 $
1,117,295 $
1,128,707
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Commercial
Accruing Interest
and Past Due:
2017
30-59
Days
60-89
Days
90 Days
or More
Nonaccrual
Total Past Due and
Nonaccrual
Current
Total
Commercial real estate
$
295 $
325 $
54 $
729 $
1,403 $
480,251 $
Commercial other
Advances to mortgage brokers
Total commercial
Agricultural
Agricultural real estate
Agricultural other
Total agricultural
Residential real estate
Senior liens
Junior liens
Home equity lines of credit
Total residential real estate
Consumer
Secured
Unsecured
Total consumer
Total
Impaired Loans
1,069
—
1,364
84
39
123
3,718
69
293
4,080
37
13
50
28
—
353
190
—
190
234
10
—
244
10
—
10
18
—
72
—
104
104
132
—
77
209
10
—
10
—
—
729
1,531
419
1,950
325
23
—
348
—
—
—
1,115
—
2,518
1,805
562
2,367
139,909
12,081
632,241
86,360
39,542
481,654
141,024
12,081
634,759
88,165
40,104
125,902
128,269
4,409
225,007
229,416
102
370
6,812
35,668
6,914
36,038
4,881
267,487
272,368
57
13
70
52,005
4,048
56,053
52,062
4,061
56,123
$
5,617 $
797 $
395 $
3,027 $
9,836 $
1,081,683 $
1,091,519
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, 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. Large groups of smaller-balance, homogeneous residential real
estate and consumer loans are collectively evaluated for impairment 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.
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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 summarizes information pertaining to impaired loans
as of, and for the years ended, December 31 :
Recorded Balance
Unpaid Principal
Balance
Valuation Allowance
Average Recorded
Balance
Interest Income
Recognized
2018
Impaired loans with a valuation allowance
Commercial real estate
Commercial other
Agricultural real estate
Agricultural other
Residential real estate senior liens
Residential real estate junior liens
Home equity lines of credit
Total impaired loans with a valuation
allowance
Impaired loans without a valuation allowance
Commercial real estate
Commercial other
Agricultural real estate
Agricultural other
Home equity lines of credit
Consumer secured
Total impaired loans without a valuation
allowance
Impaired loans
Commercial
Agricultural
Residential real estate
Consumer
Total impaired loans
$
3,969 $
4,211 $
437 $
12
392
44
6,834
12
—
12
392
44
7,289
12
—
6
112
20
1,361
2
—
4,589 $
1,040
606
168
7,545
25
—
11,263
11,960
1,938
13,973
2,794
3,124
7,618
6,244
47
9
2,947
3,231
7,618
6,287
347
9
19,836
20,439
9,899
14,298
6,893
9
10,401
14,341
7,648
9
2,728
1,533
7,559
4,636
64
12
16,532
9,890
12,969
7,634
12
443
132
1,363
—
129
55
50
46
126
—
—
406
74
43
585
279
5
—
986
301
960
131
—
$
31,099 $
32,399 $
1,938 $
30,505 $
1,392
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Table of Contents
Impaired loans with a valuation allowance
Commercial real estate
Commercial other
Agricultural real estate
Agricultural other
Residential real estate senior liens
Residential real estate junior liens
Home equity lines of credit
Total impaired loans with a valuation
allowance
Impaired loans without a valuation allowance
Commercial real estate
Commercial other
Agricultural real estate
Agricultural other
Home equity lines of credit
Consumer secured
Impaired loans
Commercial
Agricultural
Residential real estate
Consumer
Total impaired loans
Recorded Balance
Unpaid Principal
Balance
Valuation Allowance
Average Recorded
Balance
Interest Income
Recognized
2017
$
4,089 $
4,378 $
626 $
995
—
—
7,816
44
—
995
—
—
8,459
44
—
24
—
—
1,473
7
—
4,608 $
1,427
—
17
8,296
71
23
12,944
13,876
2,130
14,442
277
93
—
—
323
2
—
695
111
23
307
126
19
—
586
504
433
344
—
1,585
246
6,421
2,494
106
21
10,873
7,866
8,932
8,496
21
1,791
1,224
7,913
2,685
79
17
1,865
1,224
7,913
2,685
379
17
Total impaired loans without a valuation
allowance
13,709
14,083
8,099
10,598
7,939
17
8,462
10,598
8,882
17
650
—
1,480
—
$
26,653 $
27,959 $
2,130 $
25,315 $
1,281
We had committed to advance $542 and $472 in connection with impaired loans, which includes TDRs , as of December 31, 2018 and 2017 , respectively.
Troubled Debt Restructurings
A loan modification is considered to be a TDR 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. Agreeing to an interest only payment structure and delaying principal payments.
4. Forgiving principal.
5. 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 is not granted.
3. The borrower’s cash flow is insufficient to service all of their debt if the concession is 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).
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The following is a summary of information pertaining to TDRs granted in the years ended December 31 :
Number of Loans
Pre-Modification
Recorded Investment
Post-Modification
Recorded Investment
Number of Loans
Pre-Modification
Recorded Investment
2018
2017
Commercial other
Agricultural other
Residential real estate
Senior liens
Junior liens
Total residential real estate
Total
4 $
31
10
—
10
1,360 $
6,318
701
—
701
1,360
6,295
701
—
701
6 $
15
6
1
7
1,702 $
6,092
464
8
472
45 $
8,379 $
8,356
28 $
8,266 $
Post-Modification
Recorded Investment
1,702
6,092
464
8
472
8,266
The following tables summarize concessions we granted to borrowers in financial difficulty in the years ended December 31 :
2018
2017
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
1 $
18
174
2,625
3 $
13
1,186
3,693
— $
11
—
1,972
3
—
203
—
7
—
498
—
3
22 $
203
3,002
7
23 $
498
5,377
—
1
1
—
8
8
12 $
1,980
6 $
4
6
—
6
16 $
1,702
4,120
464
—
464
6,286
Commercial other
Agricultural other
Residential real estate
Senior liens
Junior liens
Total residential real
estate
Total
We did not restructure any loans by forgiving principal or accrued interest during 2018 or 2017 .
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 years ended December 31, 2018 and 2017 , which were modified within 12 months prior to the default date.
The following is a summary of TDR loan balances as of December 31 :
TDRs
2018
2017
$
26,951 $
26,197
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Note 5 – Premises and Equipment
A summary of premises and equipment at December 31 follows:
Land
Buildings and improvements
Furniture and equipment
Total
Less: accumulated depreciation
Premises and equipment, net
2018
2017
6,336 $
30,100
34,825
71,261
43,446
27,815 $
6,336
29,661
33,466
69,463
41,013
28,450
$
$
Depreciation expense amounted to $2,940 , $2,902 , and $2,821 in 2018 , 2017 , and 2016 , respectively.
Note 6 – Goodwill and Other Intangible Assets
The carrying amount of goodwill was $48,282 at December 31, 2018 and 2017 .
Identifiable intangible assets were as follows as of December 31 :
Core deposit premium resulting from acquisitions
Core deposit premium resulting from acquisitions
Gross
Intangible
Assets
2018
Accumulated
Amortization
Net
Intangible
Assets
5,579 $
5,410 $
169
Gross
Intangible
Assets
2017
Accumulated
Amortization
Net
Intangible
Assets
5,579 $
5,314 $
265
$
$
Amortization expense associated with identifiable intangible assets was $96 , $119 , and $162 in 2018 , 2017 , and 2016 , respectively.
Estimated amortization expense associated with identifiable intangibles for each of the next five years succeeding December 31, 2018 , and thereafter is as follows:
2019
2020
2021
2022
2023
Thereafter
Total
Estimated Amortization
Expense
71
48
29
15
2
4
169
$
$
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Note 7 – Deposits
Scheduled maturities of time deposits for the next five years, and thereafter, are as follows:
2019
2020
2021
2022
2023
Thereafter
Total
Scheduled Maturities of Time
Deposits
$
$
232,349
56,051
65,036
41,502
31,714
6,968
433,620
Interest expense on time deposits greater than $250 was $1,280 in 2018 , $825 in 2017 and $678 in 2016 .
Note 8 – Borrowed Funds
Borrowed funds consist of the following obligations at December 31 :
FHLB advances
Securities sold under agreements to repurchase without stated maturity
dates
Total
$
$
2018
2017
Amount
Rate
Amount
Rate
300,000
2.20% $
290,000
40,299
340,299
0.11%
1.95% $
54,878
344,878
FHLB advances are collateralized by a blanket lien on all qualified 1-4 family residential real estate loans, specific AFS securities, and FHLB stock.
The following table lists the maturities and weighted average interest rates of FHLB advances as of December 31 :
Fixed rate due 2018
Fixed rate due 2019
Fixed rate due 2020
Fixed rate due 2021
Variable rate due 2021 (1)
Fixed rate due 2022
Fixed rate due 2023
Fixed rate due 2024
Fixed rate due 2026
Total
2018
2017
Amount
Rate
Amount
Rate
$
—
100,000
55,000
50,000
10,000
20,000
35,000
20,000
10,000
—% $
1.94%
2.18%
1.91%
2.93%
1.97%
3.17%
2.96%
1.17%
$
300,000
2.20% $
70,000
85,000
35,000
50,000
10,000
20,000
10,000
—
10,000
290,000
1.94%
0.12%
1.65%
1.96%
1.87%
1.80%
1.91%
1.72%
1.97%
3.90%
—%
1.17%
1.94%
(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 $40,316 and $54,898 at December 31, 2018 and 2017 , respectively.
Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.
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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 tables provide a summary of securities sold under repurchase agreements without stated maturity dates,
federal funds purchased, and FRB Discount advances at December 31 :
Maximum
Month End
Balance
2018
Average
Balance
Weighted Average
Interest Rate
During the Period
Maximum
Month End
Balance
2017
Average
Balance
Weighted Average
Interest Rate
During the Period
Securities sold under agreements to repurchase without stated
maturity dates
Federal funds purchased
FRB Discount Window
$
63,133 $
38,036
0.10% $
58,464 $
55,206
16,200
—
3,741
—
1.78%
—%
5,965
—
2,726
43
0.13%
1.15%
1.54%
We had pledged AFS securities and 1-4 family residential real estate loans in the following amounts at December 31 :
Pledged to secure borrowed funds
Pledged to secure repurchase agreements
Pledged for public deposits and for other purposes necessary or required by law
Total
2018
2017
431,430 $
40,316
58,107
529,853 $
410,988
54,898
27,976
493,862
$
$
AFS securities pledged to repurchase agreements without stated maturity dates consisted of the following at December 31 :
States and political subdivisions
Mortgage-backed securities
Collateralized mortgage obligations
Total
2018
2017
23,268 $
10,736
6,312
40,316 $
7,332
13,199
34,367
54,898
$
$
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 an adequate level of AFS securities available to pledge to satisfy required collateral.
As of December 31, 2018 , we had the ability to borrow up to an additional $150,162 , based on assets pledged as collateral. We had no investment securities that
were restricted to be pledged for specific purposes.
Derivative Instruments
We 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 tables provide information on derivatives related to variable rate borrowings as of December 31 :
Pay Rate
Receive Rate
Remaining Life (Years)
Notional Amount
Balance Sheet Location
Fair Value
2018
Derivatives designated as
hedging instruments
Cash Flow Hedges:
Interest rate swaps
1.56%
3-Month LIBOR
2.3
$
10,000
Other Assets
$
323
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Table of Contents
Derivatives designated as
hedging instruments
Cash Flow Hedges:
Pay Rate
Receive Rate
Remaining Life (Years)
Notional Amount
Balance Sheet Location
Fair Value
2017
Interest rate swaps
1.56%
3-Month LIBOR
3.3
$
10,000
Other Assets
$
291
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 the use of counterparty limits. We do not
anticipate any losses from failure of interest rate derivative counterparties to honor their obligations.
Note 9 – Off-Balance-Sheet Activities, Commitments and Other Matters
Credit-Related Financial Instruments
We are party to credit related financial instruments with off-balance-sheet risk. These financial instruments are entered into during the normal course of business to
meet the financing needs of our customers. These financial instruments, which include commitments to extend credit and standby letters of credit, involve, to
varying degrees, elements of credit and IRR 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 December 31 :
Unfunded commitments under lines of credit
Commercial and standby letters of credit
Commitments to grant loans
Total
2018
2017
199,652 $
1,723
13,225
214,600 $
184,317
1,622
24,782
210,721
$
$
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 unfunded commitment is the difference between our outstanding balances and 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 we deem necessary, is
based on management's credit evaluation of the customer. Commitments to grant loans include residential mortgage loans that may be committed to be sold to the
secondary market.
Commercial and standby letters of credit are conditional commitments we 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 we deem necessary upon the
extension of credit, is based on our 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 in deciding to make these commitments as we
do for extending loans to customers. No significant losses are anticipated as a result of these commitments.
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Derivative Loan Commitments
Mortgage loan commitments are referred to as derivative loan commitments if the loan that will result from exercise of the commitment will be held for sale upon
funding. We enter into commitments to fund residential mortgage loans at specific times in the future, with the intention that these loans will subsequently be sold
in the secondary market. A mortgage loan commitment binds us to lend funds to a potential borrower at a specified interest rate within a specified period of time,
generally up to 60 days after inception of the rate lock.
Outstanding derivative loan commitments expose us to the risk that the price of the loans arising from the exercise of the loan commitment might decline from the
inception of the rate lock to funding of the loan due to increases in mortgage interest rates. If interest rates increase, the value of these loan commitments decreases.
Conversely, if interest rates decrease, the value of these loan commitments increase. The notional amount of undesignated interest rate lock commitments was
$1,088 and $805 at December 31, 2018 and 2017 , respectively.
Forward Loan Sale Commitments
To protect against the price risk inherent in derivative loan commitments, we utilize both “mandatory delivery” and “best efforts” forward loan sale commitments
to mitigate the risk of potential decreases in the values of loan that would result from the exercise of the derivative loan commitments.
With a “mandatory delivery” contract, we commit to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified
date. If we fail to deliver the amount of mortgages necessary to fulfill the commitment by the specified date, we are obligated to pay a “pair-off” fee, based on then
current market prices, to the investor to compensate the investor for the shortfall.
With a “best efforts” contract, we commit to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the
underlying borrower closes. Generally, the price the investor will pay the seller for an individual loan is specified prior to the loan being funded (e.g. on the same
day the lender commits to lend funds to a potential borrower).
We expect that these forward loan sale commitments will experience changes in fair value opposite to the change in fair value of derivative loan commitments. The
notional amount of undesignated forward loan sale commitments was $1,089 and $1,843 at December 31, 2018 and 2017 , respectively.
The fair values of the rate lock loan commitments related to the origination of mortgage loans that will be held for sale and the forward loan sale commitments are
deemed insignificant by management and, accordingly, are not recorded in our consolidated financial statements .
Other Matters
Banking regulations require us to maintain cash reserve balances in currency or deposits with the FRB . At December 31, 2018 and 2017 , the reserve balances
amounted to $1,220 and $1,458 , respectively.
Banking regulations limit the transfer of assets in the form of dividends, loans, or advances from the Bank to the Corporation. At December 31, 2018 , substantially
all of the Bank’s assets were restricted from transfer to the Corporation in the form of loans or advances. Bank dividends are the principal source of funds for the
Corporation. Payment of dividends without regulatory approval is limited to the current year’s retained net income plus retained net income for the preceding two
years, less any required transfers to common stock. At January 1, 2019 , the amount available to the Corporation for dividends from the Bank, without regulatory
approval, was approximately $18,900 .
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Note 10 – Minimum Regulatory Capital Requirements
The Corporation (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the FRB and the FDIC . Failure to
meet minimum capital requirements can initiate mandatory and possibly additional discretionary actions by the FRB and the FDIC that, if undertaken, could have a
material effect on our financial statements. Under regulatory capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet
specific capital guidelines that include quantitative measures of assets, liabilities, capital, and certain off-balance-sheet items, as calculated under regulatory
accounting standards. Our capital amounts and classifications are also subject to qualitative judgments by the FRB and the FDIC about components, risk
weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require us to maintain minimum amounts and ratios (set forth in the following table) of
total capital, tier 1 capital, and common equity tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and tier 1 capital to average assets
(as defined). We believe, as of December 31, 2018 and 2017 , that we met all capital adequacy requirements.
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.
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 remained
at 8.00% . Also effective January 1, 2015 was the new common equity tier 1 capital ratio which had a minimum requirement of 4.50% . Beginning on January 1,
2016 the capital conservation buffer went into effect which will further increase the required levels each year through 2019.
As of December 31, 2018 and 2017 , the most recent notifications from the FRB and the FDIC categorized us as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized, an institution must maintain total risk-based, Tier 1 risk-based, Common Equity Tier 1, and
Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notifications that we believe have changed our categories. Our
actual capital amounts and ratios are also presented in the table.
Actual
Minimum
Capital
Requirement
Minimum To Be Well
Capitalized Under Prompt
Corrective Action Provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
December 31, 2018
Common equity Tier 1 capital to risk
weighted assets
Isabella Bank
Consolidated
$
143,429
154,705
11.75% $
12.58%
Tier 1 capital to risk weighted assets
Isabella Bank
Consolidated
Total capital to risk weighted assets
Isabella Bank
Consolidated
Tier 1 capital to average assets
Isabella Bank
Consolidated
143,429
154,705
151,804
163,080
143,429
154,705
11.75%
12.58%
12.43%
13.26%
8.07%
8.72%
71
48,832
49,212
48,832
49,212
97,664
98,423
71,085
70,996
6.375% $
6.375%
7.875%
7.875%
9.875%
9.875%
4.00%
4.00%
73,248
N/A
73,248
N/A
122,080
N/A
88,856
N/A
6.50%
N/A
8.00%
N/A
10.00%
N/A
5.00%
N/A
Table of Contents
December 31, 2017
Common equity Tier 1 capital to risk
weighted assets
Actual
Minimum
Capital
Requirement
Minimum To Be Well
Capitalized Under Prompt Corrective
Action Provisions
Amount
Ratio
Amount
Ratio
Amount
Ratio
Isabella Bank
Consolidated
$
139,897
149,013
11.56% $
12.23%
Tier 1 capital to risk weighted assets
Isabella Bank
Consolidated
Total capital to risk weighted assets
Isabella Bank
Consolidated
Tier 1 capital to average assets
Isabella Bank
Consolidated
139,897
149,013
147,597
156,713
139,897
149,013
11.56%
12.23%
12.20%
12.86%
8.07%
8.54%
48,404
48,744
48,404
48,744
96,807
97,488
69,373
69,827
5.750% $
5.750%
7.250%
7.250%
9.250%
9.250%
4.000%
4.000%
72,605
N/A
72,605
N/A
121,009
N/A
86,717
N/A
6.50%
N/A
8.00%
N/A
10.00%
N/A
5.00%
N/A
Note 11 – 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 includes 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 , see " Note 12 – Benefit Plans ."
Earnings per common share have been computed based on the following:
Average number of common shares outstanding for basic calculation
Average potential effect of common shares in the Directors Plan (1)
Average number of common shares outstanding used to calculate diluted earnings per common
share
Net income
Earnings per common share
Basic
Diluted
(1) Exclusive of shares held in the Rabbi Trust
2018
7,872,077
200,771
2017
7,841,451
192,286
8,072,848
8,033,737
14,021 $
13,237 $
2016
7,813,739
185,611
7,999,350
13,799
1.78 $
1.74 $
1.69 $
1.65 $
1.77
1.73
$
$
$
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Note 12 – Benefit Plans
401(k) Plan
We have a 401(k) plan in which substantially all employees are eligible to participate. Employees may contribute up to 100% of their compensation subject to
certain limits based on federal tax laws. The plan was amended in 2013 to provide a matching safe harbor contribution for all eligible employees equal to 100% of
the first 5.0% of an employee's compensation contributed to the Plan during the year. Employees are 100% vested in the safe harbor matching contributions.
For 2018 , 2017 and 2016 , expenses attributable to the Plan were $743 , $713 , and $686 , respectively.
Defined Benefit Pension Plan
We maintain a noncontributory defined benefit pension plan, which was curtailed effective March 1, 2007 . As a result of the curtailment, future salary increases
are no longer considered (the projected benefit obligation is equal to the accumulated benefit obligation), and plan benefits are based on years of service and the
individual employee’s five highest consecutive years of compensation out of the last ten years of service through March 1, 2007 .
Changes in the projected benefit obligation and plan assets during each year, the funded status of the plan, and the net amount recognized in our consolidated
balance sheets using an actuarial measurement date of December 31 , are summarized as follows during the years ended December 31 :
Change in benefit obligation
Benefit obligation, January 1
Interest cost
Actuarial (gain) loss
Benefits paid, including plan expenses
Benefit obligation, December 31
Change in plan assets
Fair value of plan assets, January 1
Investment (loss) return
Contributions
Benefits paid, including plan expenses
Fair value of plan assets, December 31
Deficiency in funded status at December 31, included on the consolidated balance sheets in accrued interest
payable and other liabilities
Change in accrued pension benefit costs
Accrued benefit cost at January 1
Contributions
Net periodic benefit cost
Net change in unrecognized actuarial loss and prior service cost
Accrued pension benefit cost at December 31
2018
2017
$
11,381 $
11,448
388
(1,194)
(1,163)
9,412
9,469
(541)
—
(1,163)
7,765
(1,647) $
444
578
(1,089)
11,381
9,325
1,033
200
(1,089)
9,469
(1,912)
2018
2017
(1,912) $
(2,123)
—
(345)
610
(1,647) $
200
(412)
423
(1,912)
$
$
$
We have recorded the funded status of the plan in our consolidated balance sheets. We adjust the underfunded status in a liability account to reflect the current
funded status of the plan. Any gains or losses that arise during the year but are not recognized as components of net periodic benefit cost are recognized as a
component of other comprehensive income (loss).
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The components of net periodic benefit cost are as follows for the years ended December 31 :
Interest cost on benefit obligation
Expected return on plan assets
Amortization of unrecognized actuarial net loss
Settlement loss
Net periodic benefit cost
2018
2017
2016
388 $
444 $
(554)
242
269
(546)
279
235
345 $
412 $
485
(560)
313
—
238
$
$
During 2018 , 2017 and 2016 , additional settlement losses of $269 , $235 and $0 were recognized in connection with lump-sum benefit distributions. Many plan
participants elect to receive their retirement benefit payments in the form of lump-sum settlements. Pro rata settlement losses, which can occasionally occur as a
result of these lump-sum distributions, are recognized only in years when the total of such distributions exceed the sum of the service and interest expense
components of net periodic benefit cost.
Accumulated other comprehensive income at December 31, 2018 includes net unrecognized pension costs before income taxes of $3,470 , of which $140 is
expected to be amortized into benefit cost during 2019 .
The actuarial assumptions used in determining the benefit obligation are as follows for the years ended December 31 :
Discount rate
Expected long-term rate of return on plan assets
2018
2017
2016
4.11%
6.00%
3.48%
6.00%
The actuarial weighted average assumptions used in determining the net periodic pension costs are as follows for the years ended December 31 :
Discount rate
Expected long-term rate of return on plan assets
2018
2017
2016
3.48%
6.00%
3.96%
6.00%
3.96%
6.00%
4.13%
6.00%
As a result of the curtailment of the Plan, there is no rate of compensation increase considered in the above assumptions.
The expected long-term rate of return is an estimate of anticipated future long-term rates of return on plan assets as measured on a market value basis. Factors
considered in arriving at this assumption include:
•
•
•
•
Historical long-term rates of return for broad asset classes.
Actual past rates of return achieved by the plan.
The general mix of assets held by the plan.
The stated investment policy for the plan.
The selected rate of return is net of anticipated investment related expenses.
Pension Plan Assets
Our overall investment strategy is to moderately grow the portfolio by investing 50% of the portfolio in equity securities and 50% in fixed income securities. This
strategy is designed to generate a long-term rate of return of 6.00% . Equity securities primarily consist of the S&P 500 Index with a smaller allocation to the
Small Cap and International Index. Fixed income securities are invested in the Bond Market Index. The Plan has appropriate assets invested in short-term
investments to meet near term benefit payments.
The asset mix and the sector weighting of the investments are determined by our pension committee, which is comprised of members of our management. To
manage the Plan, we retain a third party investment advisor to conduct consultations. We review the performance of the advisor at least annually.
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The fair values of our pension plan assets by asset category were as follows as of December 31 :
Short-term investments
Common collective trusts
Fixed income
Equity investments
Total
2018
2017
Total
(Level 2)
Total
(Level 2)
$
$
98 $
98 $
300 $
2,924
4,743
7,765 $
2,924
4,743
7,765 $
3,815
5,354
9,469 $
300
3,815
5,354
9,469
The following is a description of the valuation methodologies used for assets measured at fair value. There have been no changes in the methodologies used at
December 31, 2018 and 2017 :
•
•
Short-term investments: Shares of a money market portfolio valued at amortized cost, which approximates fair value.
Common collective trusts: These investments are public investment securities valued using the NAV provided by a third party investment
advisor. The NAV is quoted on a private market that is not active; however, the unit price is based on underlying investments which are traded
on an active market.
We anticipate contributions to the Plan in 2019 to approximate net contribution costs.
The components of projected net periodic benefit cost are as follows for the year ending:
Interest cost on projected benefit obligation
Expected return on plan assets
Amortization of unrecognized actuarial net loss
Net periodic benefit cost
Estimated future benefit payments are as follows for the next ten years:
2019
2020
2021
2022
2023
2024 - 2028
Directors Plan
December 31, 2019
378
(452)
214
140
$
$
Estimated Benefit Payments
450
$
486
479
481
481
2,540
Pursuant to the terms of the Directors Plan, our directors are required to invest at least 25% of their board fees in our common stock. These stock investments can
be made either through deferred fees or through the purchase of shares through the Dividend Reinvestment Plan. Deferred fees, under the Directors Plan, are
converted on a quarterly basis into stock units of our common stock based on the fair value of a share of our common stock as of the relevant valuation date. Stock
units credited to a participant’s account are eligible for stock and cash dividends as declared. Dividend Reinvestment Plan shares are purchased pursuant to the
Dividend Reinvestment Plan.
Distribution of deferred fees from the Directors Plan occurs when the participant retires from the Board or upon the occurrence of certain other events. The
participant is eligible to receive a distribution in the form of shares of our common stock of all of the stock units that are then in his or her account, and any
unconverted cash will be converted to and rounded up to whole shares of stock and distributed, as well. The Directors Plan does not allow for cash settlement, and
therefore, such share-based payment awards qualify for classification as equity. We may use authorized but unissued shares or purchase shares of common stock
on the open market to meet our obligations under the Directors Plan.
We maintain the Rabbi Trust to fund the Directors Plan . The Rabbi Trust is an irrevocable grantor trust to which we may contribute assets for the limited purpose
of funding a nonqualified deferred compensation plan. Although we may not reach the
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assets of the Rabbi Trust for any purpose other than meeting our obligations under the Directors Plan , the assets of the Rabbi Trust remain subject to the claims of
our creditors and are included in the consolidated financial statements . We may contribute cash or common stock to the Rabbi Trust from time-to-time for the sole
purpose of funding the Directors Plan . The Rabbi Trust will use any cash that we contributed to purchase shares of our common stock on the open market through
our Investment and Trust Services department. Shares held in the Rabbi Trust are included in the calculation of earnings per share.
The components of shares eligible to be issued under the Directors Plan were as follows as of December 31 :
Unissued
Shares held in Rabbi Trust
Total
Stock Award Incentive Plan
2018
2017
Eligible
Shares
Market
Value
Eligible
Shares
Market
Value
203,498 $
16,673
220,171 $
4,591
376
4,967
195,140 $
31,769
226,909 $
5,513
897
6,410
We maintain an equity incentive plan for the purpose of promoting growth and profitability, as well as attracting and retaining executive officers of outstanding
competence, through ownership of equity. Stock may be granted to specified individuals subject to certain conditions, and transfer of shares granted under the plan
is restricted. Expenses related to this plan for 2018 , 2017 and 2016 were $45 , $38 , and $70 , respectively.
Other Employee Benefit Plans
We maintain nonqualified defined contribution retirement plans to provide supplemental retirement benefits to specified participants. Expenses related to these
programs for 2018 , 2017 and 2016 were $356 , $473 , and $440 , respectively. Expenses are recognized over the participants’ expected years of service.
We maintained a non-leveraged ESOP which was frozen to new participants on December 31, 2006. Contributions to the plan were discretionary and were
approved by the Board of Directors and recorded as compensation expense. We made no contributions to the ESOP in 2018 , 2017 and 2016 . Compensation costs
related to the plan for 2018 , 2017 and 2016 were $21 , $23 , and $33 , respectively. Total allocated shares outstanding related to the ESOP at December 31, 2018 ,
2017 , and 2016 were 0 , 166,833 , and 204,669 , respectively. Such shares are included in the computation of dividends and earnings per share in each of the
respective years. On December 21, 2016, the Board approved the termination of the ESOP effective December 31, 2016. Actual dissolution of the ESOP occurred
in 2018.
We maintain a self-funded medical plan under which we are responsible for the first $ 75 per year of claims made by a covered family. Expenses are accrued based
on estimates of the aggregate liability for claims incurred and our experience. Expenses were $2,695 in 2018 , $2,324 in 2017 and $2,150 in 2016 .
Note 13 – Revenue
Our revenue is comprised primarily of interest income, service charges and fees, gains on the sale of loans and AFS securities , earnings on corporate owned life
insurance policies, and other noninterest income. Other noninterest income is typically service and performance driven in nature and comprised primarily of
investment and trust advisory fees. We recognize revenue, excluding interest income, in accordance with ASC 606, Revenue From Contracts with Customers.
Revenue is recognized when our performance obligation has been satisfied according to our contractual obligation.
We record receivables when revenue is unpaid and collectability is reasonably assured. Accounts receivable balances primarily represent amounts due from
customers for which revenue has been recognized. Accounts receivable balances are recorded in the consolidated balance sheets in accrued interest receivable and
other assets. For the years ended December 31, 2018 , 2017 and 2016 we satisfied our performance obligations pursuant to contracts with customers. As a result,
we have not recorded any contract assets or liabilities. We estimate no returns or allowances for the years ended December 31, 2018 , 2017 and 2016 .
Our contracts with customers define our performance obligations with clearly established pricing which did not require us to allocate or disaggregate revenue by
performance obligation. A summary of revenue recognized for each major category of
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contracts with customers, subject to ASC 606, is as follows for the years ended December 31 :
Debit card income
Trust service fees
Investment advisory fees
Service charges and fees related to deposit accounts
Total
2018
2017
2016
2,487 $
2,134
702
332
2,435 $
1,928
679
343
5,655 $
5,385 $
2,131
2,089
616
349
5,185
$
$
A large portion of our revenue consists of interest income which is not subject to the requirements set forth in ASC 606. This recently adopted guidance required us
to review our other noninterest revenue sources within the scope of the guidance to ensure appropriate recognition of revenue from contracts with customers. This
review process did not identify significant changes related to revenue recognition. As such, we did not record or disclose transactions related to the adoption of this
guidance.
Note 14 – Other Noninterest Expenses
A summary of expenses included in other noninterest expenses is as follows for the years ended December 31 :
Audit, consulting, and legal fees
ATM and debit card fees
Loan underwriting fees
Director fees
FDIC insurance premiums
Donations and community relations
Marketing costs
OTTI on AFS securities
All other
Total other
Note 15 – Federal Income Taxes
2018
2017
2016
2,263 $
1,036
1,016
858
726
710
596
—
2,043 $
1,181
556
856
642
657
568
—
3,558
10,763 $
3,541
10,044 $
1,952
887
535
851
719
582
586
770
3,343
10,225
$
$
Components of the consolidated provision for federal income taxes are as follows for the years ended December 31 :
Currently payable
Deferred expense (benefit)
Income tax expense
2018
2017
2016
$
$
1,088 $
275
1,363 $
180 $
2,836
3,016 $
2,630
(282)
2,348
In 2017 we implemented tax strategies which resulted in changes to our federal income tax components, as illustrated above. These strategies, which were
primarily related to premises and equipment, significantly decreased our taxes currently payable and led to an increase in our level of alternative minimum tax.
Changes in these deferred tax components are displayed in the deferred tax assets and liabilities table on the following page.
On December 22, 2017, the Tax Cuts and Jobs Act was enacted. The law established a flat corporate federal statutory income tax rate of 21% and eliminated the
corporate alternative minimum tax which can be carried forward and used to reduce future income tax. The tax law provided for a wide array of changes, only
some of which had a direct impact on our federal income tax expense. Some of these changes included, but are not limited to, the following items: limits to the
deduction for net interest expense; immediate expense (for tax purposes) for certain qualified depreciable assets; elimination or reduction of certain deductions
related to meals and entertainment expenses; and limits to the deductibility of deposit insurance premiums.
In accordance with ASC 740, Income Taxes, the effect of income tax law changes on deferred taxes are recognized as a component of income tax expense related
to continuing operations in the period in which the law was enacted. As such, federal income tax expense for the year ended December 31, 2017 reflects the effect
of the tax rate change on net deferred tax assets and liabilities. This requirement also applies to items initially recognized in other comprehensive income. In
January 2018,
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FASB issued ASU 2018-02 which allowed for the "stranded" tax effects in AOCI to be reclassified to retained earnings rather than income tax expense. We early
adopted this guidance and applied this accounting alternative in our consolidated statements of changes in shareholders equity as of December 31, 2017.
The reconciliation of the provision for federal income taxes and the amount computed at the federal statutory tax rate of income before federal income tax expense
is as follows for the year ended December 31 :
Income taxes at statutory rate (21% in 2018 and 34% in 2017 and 2016)
$
3,231 $
5,526 $
5,490
2018
2017
2016
Effect of nontaxable income
Interest income on tax exempt municipal securities
Earnings on corporate owned life insurance policies
Deferred tax adjustment resulting from the statutory rate reduction pursuant to the Tax Act
Other
Total effect of nontaxable income
Effect of nondeductible expenses
Effect of tax credits
Federal income tax expense
(1,106)
(148)
—
231
(1,023)
113
(958)
(1,889)
(247)
319
34
(1,783)
149
(876)
$
1,363 $
3,016 $
(1,938)
(419)
—
(154)
(2,511)
143
(774)
2,348
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for federal income tax purposes. Significant components of our deferred tax assets and liabilities, measured at the 21% statutory rate, included in
other assets in the accompanying consolidated balance sheets, are as follows as of December 31 :
Deferred tax assets
Allowance for loan losses
Deferred directors’ fees
Employee benefit plans
Core deposit premium and acquisition expenses
Net unrecognized actuarial losses on pension plan
Net unrealized losses on available-for-sale securities
Life insurance death benefit payable
Alternative minimum tax
Other
Total deferred tax assets
Deferred tax liabilities
Prepaid pension cost
Premises and equipment
Accretion on securities
Core deposit premium and acquisition expenses
Net unrealized gains on available-for-sale securities
Net unrealized gains on derivative instruments
Other
Total deferred tax liabilities
Net deferred tax assets
2018
2017
$
1,304 $
1,667
81
752
729
1,211
497
710
716
7,667
383
1,548
41
946
—
68
1,696
4,682
2,985 $
$
1,076
1,758
70
733
857
—
497
1,463
607
7,061
455
1,728
40
909
204
61
1,684
5,081
1,980
We are subject to U.S. federal income tax; however, we are no longer subject to examination by taxing authorities for years before 2015 . There are no material
uncertain tax positions requiring recognition in our consolidated financial statements . We do not expect the total amount of unrecognized tax benefits to
significantly increase in the next twelve months.
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We recognize interest and/or penalties related to income tax matters in income tax expense. We do not have any amounts accrued for interest and penalties at
December 31, 2018 and 2017 and we are not aware of any claims for such amounts by federal income tax authorities.
Note 16 – Accumulated Other Comprehensive Income (Loss)
AOCI includes net income as well as unrealized gains and losses, net of tax, on AFS securities and derivative instruments, as well as changes in the funded status
of our defined benefit pension plan. Unrealized gains and losses and changes in the funded status of the pension plan, net of tax, are excluded from net income, and
are reflected as a direct charge or credit to shareholders’ equity. Comprehensive income (loss) and the related components are disclosed in the consolidated
statements of comprehensive income.
The following table provides a roll-forward of the changes in AOCI by component for the years ended December 31, 2016 , 2017 and 2018 (net of tax):
Unrealized
Holding Gains
(Losses) on
AFS
Securities
Unrealized
Gains
(Losses) on Derivative
Instruments
Change in Unrecognized
Pension Cost on Defined
Benefit
Pension Plan
Total
Balance, January 1, 2016
$
3,536 $
OCI before reclassifications
Amounts reclassified from AOCI
Subtotal
Tax effect
OCI, net of tax
Balance, December 31, 2016
OCI before reclassifications
Amounts reclassified from AOCI
Subtotal
Tax effect
OCI, net of tax
One-time non-cash tax rate adjustment due to
the Tax Act
Balance, December 31, 2017
OCI before reclassifications
Amounts reclassified from AOCI
Subtotal
Tax effect
OCI, net of tax
Adoption of ASU 2016-01
(5,865)
525
(5,340)
1,834
(3,506)
30
289
(142)
147
89
236
125
391
(7,229)
—
(7,229)
1,415
(5,814)
223
Balance, December 31, 2018
$
(5,200) $
— $
248
—
248
(84)
164
164
43
—
43
(15)
28
38
230
33
—
33
(7)
26
—
256
$
(3,315) $
282
238
520
(177)
343
(2,972)
11
412
423
(144)
279
(530)
(3,223)
265
345
610
(128)
482
—
(2,741) $
221
(5,335)
763
(4,572)
1,573
(2,999)
(2,778)
343
270
613
(70)
543
(367)
(2,602)
(6,931)
345
(6,586)
1,280
(5,306)
223
(7,685)
Included in OCI for the year ended December 31, 2018 are changes in unrealized holding gains and losses related to auction rate money market preferred stocks.
These investments, for federal income tax purposes, have no deferred federal income taxes related to unrealized holding gains or losses given the nature of the
investments.
In accordance with the Tax Act , the effect of income tax law changes on deferred taxes also applies to items recognized in other comprehensive income. In
January 2018, FASB issued ASU 2018-02 which allowed for the "stranded" tax effects in AOCI to be reclassified to retained earnings rather than income tax
expense. We early adopted this guidance and applied this accounting alternative in our consolidated statements of changes in shareholders equity as of
December 31, 2017.
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A summary of the components of unrealized holding gains on AFS securities included in OCI follows for the years ended December 31 :
2018
2017
Auction Rate
Money Market
Preferred Stocks
All Other
AFS
Securities
Auction Rate
Money Market
Preferred Stocks
All Other AFS
Securities
Total
Total
Auction Rate
Money Market
Preferred and
Preferred Stocks
2016
All Other
AFS
securities
Total
$
(495) $
(6,734) $
(7,229) $
407 $
(118) $
289 $
54 $
(5,919) $
(5,865)
—
—
—
—
(142)
(142)
—
(245)
(245)
—
(495)
—
—
(6,734)
1,415
—
(7,229)
1,415
—
407
—
—
(260)
89
—
147
89
—
54
—
770
(5,394)
1,834
770
(5,340)
1,834
$
(495) $
(5,319) $
(5,814) $
407 $
(171) $
236 $
54 $
(3,560) $
(3,506)
Unrealized gains (losses)
arising during the period
Reclassification adjustment
for net (gains) losses
included in net income
Reclassification adjustment
for impairment loss included
in net income
Net unrealized gains (losses)
Tax effect (1)
Unrealized gains
(losses), net of tax
(1) Calculations are based on a federal income tax rate of 21% in 2018 and 34% in 2017 and 2016.
The following table details reclassification adjustments and the related affected line items in our consolidated statements of income for the years ended December
31 :
Details about AOCI components
Unrealized holding gains (losses) on AFS
securities
Change in unrecognized pension cost on
defined benefit pension plan
$
$
$
$
Amount
Reclassified from
AOCI
Affected Line Item in the
Consolidated
Statements of Income
2018
2017
2016
— $
142 $
245 Net gains on sale of AFS securities
—
—
—
—
142
48
(770) Other noninterest expenses
(525) Income before federal income tax expense
(179) Federal income tax expense (benefit) (1)
— $
94 $
(346) Net income
345 $
72
273 $
412 $
140
272 $
238 Other noninterest expenses
81 Federal income tax expense (1)
157 Net income
(1) Calculations are based on a federal income tax rate of 21% in 2018 and 34% in 2017 and 2016.
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Table of Contents
Note 17 – Fair Value
Under fair value measurement and disclosure authoritative guidance, we group assets and liabilities measured at fair value into three levels, based on the markets in
which the assets and liabilities are traded, and the reliability of the assumptions used to determine fair value, based on the prioritization of inputs in the valuation
techniques. These levels are:
Level 1:
Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2:
Level 3:
Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that
are not active and model based valuation techniques for which all significant assumptions are observable in the market.
Valuation is generated from model based techniques that use at least one significant assumption not observable in the market. These unobservable
assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability.
The asset’s or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value
measurement. Valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. Transfers between measurement levels are
recognized at the end of reporting periods.
Fair value measurement requires the use of an exit price notion which may differ from entrance pricing. Generally we believe our assets and liabilities classified as
Level 1 or Level 2 approximate an exit price notion.
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.
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.
Equity securities, at fair value: Equity securities are recorded at fair value on a recurring basis. Level 1 fair value measurement is based upon quoted prices for
identical instruments. The values for Level 1 investment securities are generally obtained from an independent third party. On a quarterly basis, we compare the
values provided to alternative pricing sources.
Loans
:
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 costs 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.
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Table of Contents
The following tables list the quantitative fair value information about impaired loans as of:
Valuation Technique
Fair Value
Discounted value
$20,045
Valuation Technique
Fair Value
Discounted value
$15,956
December 31, 2018
Unobservable Input
Discount applied to collateral:
Real Estate
Equipment
Cash crop inventory
Livestock
Other inventory
Accounts receivable
Liquor license
Furniture, fixtures & equipment
December 31, 2017
Unobservable Input
Discount applied to collateral:
Real Estate
Equipment
Cash crop inventory
Livestock
Other inventory
Accounts receivable
Liquor license
Furniture, fixtures & equipment
Actual Range
20% - 30%
20% - 40%
30% - 40%
30%
45% - 50%
50%
75%
35% - 45%
Actual Range
20% - 30%
20% - 35%
30% - 40%
30%
50% - 75%
50%
75%
35% - 45%
Collateral discount rates may have ranges to accommodate differences in the age of the independent appraisal, broker price opinion, or internal evaluation.
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.
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.
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Table of Contents
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 differs 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
December 31 :
Carrying
Value
Estimated
Fair Value
Level 1
Level 2
Level 3
2018
ASSETS
Cash and cash equivalents
Mortgage loans AFS
Gross loans
Less allowance for loan and lease losses
Net loans
Accrued interest receivable
Equity securities without readily determinable fair
values (1)
OMSR
LIABILITIES
Deposits without stated maturities
Deposits with stated maturities
Borrowed funds
Accrued interest payable
$
73,471 $
73,471 $
73,471 $
358
365
1,128,707
1,099,645
8,375
8,375
1,120,332
1,091,270
—
—
—
—
6,928
6,928
6,928
24,948
2,434
859,073
433,620
340,299
826
N/A
2,602
859,073
425,993
333,829
826
—
—
859,073
—
—
826
2017
— $
365
—
—
—
—
—
2,602
—
425,993
333,829
—
ASSETS
Cash and cash equivalents
Mortgage loans AFS
Gross loans
Less allowance for loan and lease losses
Net loans
Accrued interest receivable
Equity securities without readily determinable fair
values (1)
OMSR
LIABILITIES
Deposits without stated maturities
Deposits with stated maturities
Borrowed funds
$
30,848 $
30,848 $
30,848 $
1,560
1,587
1,091,519
1,056,906
7,700
7,700
1,083,819
1,049,206
—
—
—
—
7,063
7,063
7,063
23,454
2,409
811,992
453,266
344,878
N/A
2,409
811,992
443,892
342,089
—
—
811,992
—
—
— $
1,587
—
—
—
—
—
2,409
—
443,892
342,089
—
—
1,099,645
8,375
1,091,270
—
—
—
—
—
—
—
—
—
1,056,906
7,700
1,049,206
—
—
—
—
—
—
Carrying
Value
Estimated
Fair Value
Level 1
Level 2
Level 3
Accrued interest payable
—
(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.
680
680
680
—
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Financial Instruments Recorded at Fair Value
The table below presents the recorded amount of assets and liabilities measured at fair value on December 31 :
Total
Level 1
Level 2
Level 3
Total
Level 1
Level 2
Level 3
2018
2017
Recurring items
AFS securities
Government-sponsored
enterprises
States and political
subdivisions
Auction rate money market
preferred
Mortgage-backed securities
Collateralized mortgage
obligations
Total AFS securities
Equity securities
Derivative instruments
Nonrecurring items
Impaired loans (net of the
ALLL)
$
170 $
— $
170
$
— $
216 $
— $
216
$
190,866
—
190,866
—
208,474
—
208,474
2,554
184,484
116,760
494,834
—
323
—
—
—
—
—
—
2,554
184,484
116,760
494,834
—
323
—
—
—
—
—
—
3,049
208,797
128,194
548,730
3,577
291
—
—
—
—
3,577
—
3,049
208,797
128,194
548,730
—
291
20,045
—
—
20,045
15,956
—
—
Total
$
515,202 $
— $
495,157
$
20,045
$
568,554 $
3,577
$
549,021
$
—
—
—
—
—
—
—
—
15,956
15,956
Percent of assets and liabilities
measured at fair value
—%
96.11%
3.89%
0.63%
96.56%
2.81%
Equity securities are recorded at fair value with changes in fair value recognized through earnings on a recurring basis. For the year ended December 31, 2018 , we
recorded a loss of $41 through earnings. We had no other assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a
recurring basis or nonrecurring basis, as of December 31, 2018 .
Note 18 – Related Party Transactions
In the ordinary course of business, we grant loans to principal officers and directors and their affiliates (including their families and companies in which they have
10% or more ownership). Annual activity consisted of the following for the years ended December 31 :
Balance, January 1
New loans
Repayments
Balance, December 31
2018
2017
4,335 $
1,184
(2,176)
3,343 $
3,946
3,895
(3,506)
4,335
$
$
Total deposits of these principal officers and directors and their affiliates amounted to $5,029 and $5,671 at December 31, 2018 and 2017 , respectively. In
addition, the ESOP held deposits with the Bank aggregating $266 at December 31, 2017 . No deposits were held as of December 31, 2018 due to the dissolution of
the ESOP during 2018.
From time-to-time , we make charitable donations to The Isabella Bank Foundation (the “Foundation”), which is a non-controlled nonprofit organization formed
for the purpose of distributing charitable donations to recipient organizations generally located in the communities we serve. Our donations are expensed when
committed to the Foundation. The assets and transactions of the Foundation are not included in our consolidated financial statements .
Assets of the Foundation include cash and cash equivalents, certificates of deposit, and shares of Isabella Bank Corporation common stock. The Foundation owned
44,350 shares of our common stock as of December 31, 2018 and 2017 , respectively. Such shares are included in the computation of dividends and earnings per
share.
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We did not make donations to the Foundation for the years ended December 31, 2018 , 2017 and 2016 . The following table displays total asset balances of the
Foundation as of December 31 :
Total assets
Note 19 – Operating Segments
2018
2017
2016
$
1,731 $
2,162 $
2,213
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 December 31, 2018 ,
2017 , and 2016 represent approximately 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented.
Note 20 – Parent Company Only Financial Information
Condensed Balance Sheets
ASSETS
Cash on deposit at the Bank
Investments in subsidiaries
Premises and equipment
Other assets
TOTAL ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
Other liabilities
Shareholders' equity
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
December 31
2018
2017
2,499 $
143,942
1,912
51,674
200,027 $
4,508 $
195,519
200,027 $
185
145,962
1,950
52,253
200,350
5,445
194,905
200,350
$
$
$
$
Condensed Statements of Income
Year Ended December 31
2018
2017
2016
$
13,100 $
9,600 $
1
3,030
16,131
4,132
513
368
1,615
6,628
9,503
749
10,252
3,769
2
6,463
16,065
5,196
1,779
527
2,566
10,068
5,997
91
6,088
7,149
7,400
14
6,574
13,988
4,898
1,696
536
2,120
9,250
4,738
1,058
5,796
8,003
$
14,021 $
13,237 $
13,799
Income
Dividends from subsidiaries
Interest income
Management fee and other
Total income
Expenses
Compensation and benefits
Occupancy and equipment
Audit and related fees
Other
Total expenses
Income before income tax benefit and equity in undistributed earnings of subsidiaries
Federal income tax benefit
Income before equity in undistributed earnings of subsidiaries
Undistributed earnings of subsidiaries
Net income
85
Table of Contents
Operating activities
Net income
Condensed Statements of Cash Flows
Year Ended December 31
2018
2017
2016
$
14,021 $
13,237 $
13,799
Adjustments to reconcile net income to cash provided by operations
Undistributed earnings of subsidiaries
Undistributed earnings of equity securities without readily determinable fair values
Share-based payment awards under equity compensation plan
Depreciation
Deferred income tax expense (benefit)
Changes in operating assets and liabilities which provided (used) cash
Other assets
Accrued interest and other liabilities
Net cash provided by (used in) operating activities
Investing activities
Maturities, calls, principal payments, and sales of AFS securities
Sales (purchases) of premises and equipment
Net cash provided by (used in) investing activities
Financing activities
Net increase (decrease) in borrowed funds
Cash dividends paid on common stock
Proceeds from the issuance of common stock
Common stock repurchased
Common stock purchased for deferred compensation obligations
Net cash provided by (used in) financing activities
Increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
(3,769)
(144)
612
134
(31)
1,237
(937)
11,123
—
(96)
(96)
—
(8,169)
6,864
(7,007)
(401)
(8,713)
2,314
185
(7,149)
(8,003)
40
640
154
792
42
(1,590)
6,166
249
(113)
136
—
(7,990)
6,177
(5,181)
(420)
(7,414)
(1,112)
1,297
791
573
156
147
(44)
(2,669)
4,750
—
(133)
(133)
—
(7,645)
5,023
(4,440)
(383)
(7,445)
(2,828)
4,125
1,297
Cash and cash equivalents at end of period
$
2,499 $
185 $
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Table of Contents
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure .
None.
Item 9A. 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 December 31, 2018 , 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 December 31, 2018 , 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
We also conducted an evaluation of internal control over financial reporting to determine whether any changes occurred during the quarter ended December 31,
2018 , that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on this evaluation, we have
concluded that there have been no such changes during the quarter ended December 31, 2018 .
Management’s Report on Internal Control Over Financial Reporting
We are responsible for the preparation and integrity of our published consolidated financial statements . The consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States of America and, accordingly, include amounts based on judgments and estimates.
We also prepared the other information included in the Annual Report on Form 10-K and are responsible for the accuracy and consistency with the consolidated
financial statements .
We are responsible for establishing and maintaining a system of internal control over financial reporting, which is intended to provide reasonable assurance to our
management and Board of Directors regarding the reliability of our consolidated financial statements . The system includes but is not limited to:
•
•
•
•
•
•
A documented organizational structure and division of responsibility;
Established policies and procedures, including a code of conduct to foster a strong ethical climate which is communicated throughout our
Corporation;
Internal auditors that monitor the operation of the internal control system and report findings and recommendations to management and the
Audit Committee;
Procedures for taking action in response to an internal audit finding or recommendation;
Regular reviews of our consolidated financial statements by qualified individuals; and
The careful selection, training and development of our people.
There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and the circumvention or overriding of
controls. Also, the effectiveness of an internal control system may change over time. We have implemented a system of internal control that was designed to
provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in
accordance with generally accepted accounting principles.
We have assessed our internal control system in relation to criteria for effective internal control over financial reporting described in “Internal
Control-Integrated
Framework
” issued by the Committee of Sponsoring Organizations (2013 framework) of the Treadway Commission.
Based upon these criteria, we believe that, as of December 31, 2018 , our system of internal control over financial reporting was effective.
Our independent registered public accounting firm, Rehmann Robson LLC ("Rehmann"), has audited our 2018 consolidated financial statements and our internal
control over financial reporting as of December 31, 2018 . Rehmann was given unrestricted access to all financial records and related data, including minutes of all
meetings of stockholders, the Board of Directors and committees of the Board. Rehmann has issued an unqualified audit opinion on our 2018 consolidated
financial
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Table of Contents
statements as a result of the integrated audit and an unqualified opinion on the effectiveness of our internal controls as of December 31, 2018 .
Isabella Bank Corporation
By:
/s/ Jae A. Evans
Jae A. Evans
President, Chief Executive Officer
(Principal Executive Officer)
March 13, 2019
/s/ Neil M. McDonnell
Neil M. McDonnell
Chief Financial Officer
(Principal Financial Officer)
March 13, 2019
Item 9B. Other Information .
None.
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Table of Contents
Item 10. Directors, Executive Officers and Corporate Governance .
PART III
For information concerning our directors and certain executive officers, see “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting
Compliance” in our Proxy Statement for the Annual Meeting of Shareholders to be held May 7, 2019 (“Proxy Statement”) which is incorporated herein by
reference.
For Information concerning our Audit Committee financial experts, see “Committees of the Board of Directors and Meeting Attendance” in the Proxy Statement
which is incorporated herein by reference.
We have adopted a Code of Business Conduct and Ethics that applies to our Chief Executive Officer and Chief Financial Officer. We shall provide to any person
without charge upon request, a copy of our Code of Business Conduct and Ethics. Written requests should be sent to: Secretary, Isabella Bank Corporation, 401
North Main Street, Mount Pleasant, Michigan 48858.
Item 11. Executive Compensation .
For information concerning executive compensation, see “Executive Officers,” “Compensation Committee Report,” “Compensation Committee Interlocks and
Insider Participation,” “Compensation Discussion and Analysis,” and “Remuneration of Directors” in the Proxy Statement which is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters .
For information concerning the security ownership of certain owners and management, see “Security Ownership of Certain Beneficial Owners and Management”
in the Proxy Statement which is incorporated herein by reference.
Equity Compensation Plan Information
The following table provides information as of December 31, 2018 , with respect to compensation plans under which our common shares are authorized for
issuance to directors, officers or employees in exchange for consideration in the form of goods or services.
Plan Category
Equity compensation plans approved by shareholders:
None
Equity compensation plans not approved by shareholders:
Deferred director compensation plan (1)
Stock Award Incentive Plan (2)
Total
Number of Securities
to be Issued
Upon Exercise of
Outstanding
Options, Warrants,
and Rights
(A)
Weighted Average
Exercise Price
of Outstanding
Options, Warrants,
and Rights
(B)
—
203,498 (3)
4,122 (4)
207,620
—
— (5)
— (5)
Number of Securities
Remaining
Available for Future
Issuance Under Equity
Compensation Plans
(Excluding Securities
Reflected in Column (A))
(C)
—
— (6)
— (6)
(1) Pursuant to the terms of the Directors Plan, our directors are required to invest at least 25% of their board fees in our common stock. These stock investments can
be made either through deferred fees or through the purchase of shares through the Dividend Reinvestment Plan. Deferred fees, under the Directors Plan, are
converted on a quarterly basis into stock units of our common stock based on the fair value of a share of our common stock as of the relevant valuation date. Stock
units credited to a participant’s account are eligible for stock and cash dividends as declared. Dividend Reinvestment Plan shares are purchased pursuant to the
Dividend Reinvestment Plan.
Distribution of deferred fees from the Directors Plan occurs when the participant retires from the Board or upon the occurrence of certain other events. The
participant is eligible to receive a distribution in the form of shares of our common stock of all of the stock units that are then in his or her account, and any
unconverted cash will be converted to and rounded up to whole shares of stock and distributed, as well. The Directors Plan does not allow for cash settlement, and
therefore, such share-based payment awards qualify for classification as equity. We may use authorized but unissued shares or purchase shares of common stock
on the open market to meet our obligations under the Directors Plan.
(2) The Stock Award Incentive Plan is an equity-based bonus plan. Under the plan, we may award stock bonuses to the President and CEO, CFO and Bank
President. The plan authorizes the issuance of vested stock to eligible employees worth up to 10% of the employee’s annualized base wages, on a calendar year
basis. The plan imposes several conditions on the
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Table of Contents
issuance of stock awards and therefore, the stock awards are restricted. Awards are converted to shares upon payment to the participant based on the market value
of our common stock on the date of award.
(3) As of December 31, 2018 , the Directors Plan had 220,171 shares eligible to be distributed under the Directors Plan . The Rabbi Trust holds 16,673 shares for
the benefit of participants pursuant to the Directors Plan . Accordingly, such shares are not included in the number of securities issuable in column (A).
(4) This amount includes shares subject to outstanding incentive awards at the maximum amount of shares issuable under such awards. However, payout of
incentive awards is contingent on the individual and the Corporation reaching certain levels of performance during 2018. If the performance criteria for these
awards are not fully satisfied, the award recipient will receive less than the maximum number of shares eligible under these grants and may receive nothing from
these grants. Additionally, this amount assumes the closing price of our common stock as of December 31, 2018 for purposes of the conversion from awards to
stock.
(5) The Directors Plan and the Stock Award Incentive Plan do not have an exercise price.
(6) There is no maximum number of shares available for issuance under the Directors Plan and the Stock Award Incentive Plan.
Item 13. Certain Relationships and Related Transactions, and Director Independence .
For information, see “Indebtedness of and Transactions with Management” and “Election of Directors” in the Proxy Statement, which is incorporated herein by
reference.
Item 14. Principal Accountant Fees and Services .
For information concerning our principal accountant fees and services see “Fees for Professional Services Provided by Rehmann Robson LLC” and “Pre-approval
Policies and Procedures” in our Proxy Statement which is incorporated herein by reference.
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Item 15. Exhibits and Financial Statement Schedules .
PART IV
(a)
(1)
Financial Statements: The following documents are filed as part of Item 8 of this report:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Income
Consolidated Statements of Comprehensive Income (Loss)
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
(2)
(3)
Financial Statement Schedules: All schedules are omitted because they are neither applicable nor required, or because the required
information is included in the consolidated financial statements or related notes.
See the exhibits listed below under Item 15(b):
(b) The following exhibits required by Item 601 of Regulation S-K are filed as part of this report:
3(a)
3(b)
3(c)
3(d)
3(e)
3(f)
3(g)
3(h)
3(i)
10(a)
10(b)
10(c)
10(d)
10(e)
10(f)
14
21
23
31(a)
31(b)
32
Amended Articles of Incorporation (1)
Amendment to the Articles of Incorporation (2)
Amendment to the Articles of Incorporation (3)
Amendment to the Articles of Incorporation (4)
Amendment to the Articles of Incorporation (8)
Amended Bylaws (6)
Amendment to Bylaws (7)
Amendment to Bylaws (10)
Amendment to Bylaws (11)
Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors* (9)
Isabella Bank Corporation Split Dollar Plan* (13)
Isabella Bank Corporation Retirement Bonus Plan* (12)
Isabella Bank Corporation Supplemental Executive Retirement Plan* (14)
Amendment to the Isabella Bank Corporation Supplemental Executive Retirement Plan* (15)
Isabella Bank Corporation Stock Award Incentive Plan* (15)
Code of Business Conduct and Ethics (5)
Subsidiaries of the Registrant
Consent of Rehmann Robson LLC, Independent Registered Public Accounting Firm
Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002 by the Chief Executive Officer
Certification pursuant to section 302 of the Sarbanes-Oxley Act of 2002 by the Chief Financial Officer
Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
101.INS
XBRL Interactive Data File**
101.SCH
XBRL Interactive Data File**
101.CAL
XBRL Interactive Data File**
101.LAB
XBRL Interactive Data File**
101.PRE
XBRL Interactive Data File**
101.DEF
XBRL Interactive Data File**
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*
**
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
(12)
(13)
(14)
(15)
Management Contract or Compensatory Plan or Arrangement.
As provided by Rule 406T in Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933
and Section 18 of the Exchange Act
Previously filed as an Exhibit to the Isabella Bank Corporation Form 10-K, filed March 12, 1991, and incorporated herein by reference
Previously filed as an Exhibit to the Isabella Bank Corporation Form 10-K, filed March 26, 1994, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 10-K, filed March 22, 2000, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 10-K, filed March 27, 2001, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 8-K, filed April 25, 2006, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 10-K, filed March 16, 2005, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 8-K, filed November 22, 2006, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 8-K, filed May 16, 2008, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 8-K, filed March 13, 2019, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 8-K, filed August 28, 2009, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 8-K, filed December 23, 2009, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 8-K, filed December 19, 2008, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 8-K, filed March 31, 2015, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 8-K, filed April 27, 2015, and incorporated herein by reference.
Previously filed as an Exhibit to Isabella Bank Corporation Form 8-K, filed February 12, 2019, and incorporated herein by reference.
Item 16. Form 10-K Summary.
Not applicable.
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SIGNATURES
Pursuant to the requirements of Section 16 or 15(d) 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
(Registrant)
By:
/s/ Jae A. Evans
Jae A. Evans
President, Chief Executive Officer
(Principal Executive Officer)
Date:
March 13, 2019
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in
the capacities and on the dates indicated.
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Table of Contents
Signatures
/s/ Dr. Jeffrey J. Barnes
Dr. Jeffrey J. Barnes
/s/ Jill Bourland
Jill Bourland
/s/ Jae A. Evans
Jae A. Evans
/s/ G. Charles Hubscher
G. Charles Hubscher
/s/ Thomas L. Kleinhardt
Thomas L. Kleinhardt
/s/ Joseph LaFramboise
Joseph LaFramboise
/s/ David J. Maness
David J. Maness
/s/ W. Joseph Manifold
W. Joseph Manifold
/s/ Neil M. McDonnell
Neil M. McDonnell
/s/ W. Michael McGuire
W. Michael McGuire
/s/ Sarah R. Opperman
Sarah R. Opperman
/s/ Jerome Schwind
Jerome Schwind
/s/ Rhonda S. Tudor
Rhonda S. Tudor
/s/ Gregory V. Varner
Gregory V. Varner
Capacity
Director
Director
President, Chief Executive Officer
(Principal Executive Officer), and Director
Director
Director
Director
Director
Director
Chief Financial Officer
(Principal Financial Officer)
Director
Director
Date
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
March 13, 2019
Isabella Bank President and Director
March 13, 2019
Controller
Director
94
March 13, 2019
March 13, 2019
Exhibit 21
Subsidiaries of Isabella Bank Corporation:
Isabella Bank
Wholly owned
Exhibit 23
Consent of Independent Registered Public Accounting Firm
We hereby consent to the incorporation by reference in the registration statements ( Form S-3 No. 333-226638 and Form S-8 No. 333-228953 ) pertaining to the
Isabella Bank Corporation Stockholder Dividend Reinvestment and Employee Stock Purchase Plan of our integrated audit report dated March 13, 2019 , relating to
the consolidated financial statements and the effectiveness of internal control over financial reporting of Isabella Bank Corporation, included in this Annual Report
on Form 10-K for the year ended December 31, 2018 .
/s/ Rehmann Robson LLC
Saginaw, Michigan
March 13, 2019
I, Jae A. Evans , certify that:
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Isabella Bank Corporation (the “registrant”).
Based on my knowledge, this Annual Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this Annual Report .
Based on my knowledge, the financial statements, and other financial information included in this Annual Report , fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this Annual Report .
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
Exhibit 31(a)
a)
b)
c)
d)
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this Annual Report is being prepared;
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed
under my supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles;
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on
such evaluation; and
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s
internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to
the registrant’s auditors and the audit committee of registrant’s board of directors:
a)
b)
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial
information; and
any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Date: March 13, 2019
/s/ Jae A. Evans
President, Chief Executive Officer
(Principal Executive Officer)
I, Neil M. McDonnell , certify that:
1.
2.
3.
4.
I have reviewed this Annual Report on Form 10-K of Isabella Bank Corporation (the “registrant”).
Based on my knowledge, this Annual Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period
covered by this Annual Report .
Based on my knowledge, the financial statements, and other financial information included in this Annual Report , fairly present in all material
respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this Annual Report .
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and
15d-15(f)) for the registrant and have:
Exhibit 31(b)
a)
b)
c)
d)
designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under my
supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this Annual Report is being prepared;
designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed
under my supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting principles;
evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions
about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on
such evaluation; and
disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the
registrant’s most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant’s
internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to
the registrant’s auditors and the audit committee of registrant’s board of directors:
a)
b)
all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting
which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial
information; and
any fraud, whether or not material, that involves management or other employees who have a significant role in the
registrant’s internal control over financial reporting.
Date: March 13, 2019
/s/ Neil M. McDonnell
Chief Financial Officer
(Principal Financial Officer)
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
Exhibit 32
In connection with the Annual Report of Isabella Bank Corporation (the “Corporation”) on Form 10-K for the year ended December 31, 2018 as filed with
the Securities and Exchange Commission on the date hereof (the “Report”), Jae A. Evans , President and Chief Executive Officer and Neil M. McDonnell , Chief
Financial Officer of the Corporation, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation.
/s/ Jae A. Evans
President, Chief Executive Officer
(Principal Executive Officer)
March 13, 2019
/s/ Neil M. McDonnell
Chief Financial Officer
(Principal Financial Officer)
March 13, 2019