Company Quick10K Filing
Isabella Bank
Price26.95 EPS1
Shares8 P/E18
MCap218 P/FCF13
Net Debt-34 EBIT27
TEV184 TEV/EBIT7
TTM 2019-09-30, in MM, except price, ratios
10-Q 2020-03-31 Filed 2020-04-29
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ISBA 10Q Quarterly Report

Part I - Financial Information
Item 1. Financial Statements.
Note 1 - Basis of Presentation
Note 2 - Accounting Standards Updates
Note 3 - Afs Securities
Note 4 - Loans and Alll
Note 5 - Borrowed Funds
Note 6 - Computation of Earnings per Common Share
Note 7 - Other Noninterest Expenses
Note 8 - Federal Income Taxes
Note 9 - Accumulated Other Comprehensive Income
Note 10 - Fair Value
Note 11 - Operating Segments
Note 12 - Parent Company Only Financial Information
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Item 4. Controls and Procedures.
Part II - Other Information
Item 1. Legal Proceedings.
Item 1A. Risk Factors.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Item 3. Defaults Upon Senior Securities.
Item 4. Mine Safety Disclosures.
Item 5. Other Information.
Item 6. Exhibits.
EX-31.A isba_20200331xqxex31a.htm
EX-31.B isba_20200331xqxex31b.htm
EX-32 isba_20200331xqxex32.htm

Isabella Bank Earnings 2020-03-31

Balance SheetIncome StatementCash Flow
1.91.51.10.80.40.02012201420172020
Assets, Equity
0.10.10.10.00.00.02012201420172020
Rev, G Profit, Net Income
0.10.10.0-0.0-0.1-0.12012201420172020
Ops, Inv, Fin

10-Q 1 isba_20200331x10q.htm 10-Q Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
ý
Quarterly Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
For the quarterly period ended March 31, 2020
or
¨
Transition Report Pursuant to Section 13 or 15(d) of The Securities Exchange Act of 1934
For the transition period from                      to                     
Commission File Number: 0-18415
 
Isabella Bank Corporation
(Exact name of registrant as specified in its charter)
 
Michigan
 
38-2830092
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
401 N. Main St, Mt. Pleasant, MI
 
48858
(Address of principal executive offices)
 
(Zip code)
(989) 772-9471
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
None
N/A
N/A
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ý  Yes    ¨  No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    ý  Yes    ¨  No
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 the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
 
Accelerated filer
 
¨
 
 
 
 
 
Non-accelerated filer
 
ý
 
Smaller reporting company
 
ý
 
 
 
 
 
 
 
 
 
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. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ¨  Yes   ý  No
The number of common shares outstanding of the registrant’s Common Stock (no par value) was 7,927,845 as of April 28, 2020.



ISABELLA BANK CORPORATION
QUARTERLY REPORT ON FORM 10-Q

2


Forward Looking Statements
This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and 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, a health crisis, 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 financial results, is included in our filings with the SEC.
Glossary of Acronyms and Abbreviations
The acronyms and abbreviations identified below may be used throughout this Quarterly Report on Form 10-Q or in our other SEC filings. You may find it helpful to refer back to this page while reading this report.
ACL: Allowance for credit losses
 
FTE: Fully taxable equivalent
AFS: Available-for-sale
 
GAAP: U.S. generally accepted accounting principles
ALLL: Allowance for loan and lease losses
 
IFRS: International Financial Reporting Standards
AOCI: Accumulated other comprehensive income
 
IRR: Interest rate risk
ASC: FASB Accounting Standards Codification
 
ISDA: International Swaps and Derivatives Association
ASU: FASB Accounting Standards Update
 
LIBOR: London Interbank Offered Rate
ATM: Automated teller machine
 
N/A: Not applicable
BHC Act: Bank Holding Company Act of 1956
 
N/M: Not meaningful
CARES Act: Coronavirus Aid, Relief, and Economic Security Act
 
NAV: Net asset value
CECL: Current expected credit losses
 
NSF: Non-sufficient funds
CFPB: Consumer Financial Protection Bureau
 
OCI: Other comprehensive income (loss)
CIK: Central Index Key
 
OMSR: Originated mortgage servicing rights
COVID-19: Coronavirus disease 2019
 
OREO: Other real estate owned
CRA: Community Reinvestment Act
 
OTTI: Other-than-temporary impairment
DIF: Deposit Insurance Fund
 
PBO: Projected benefit obligation
DIFS: Department of Insurance and Financial Services
 
PCAOB: Public Company Accounting Oversight Board
Directors Plan: Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors
 
PPP: Paycheck Protection Program
Dividend Reinvestment Plan: Isabella Bank Corporation Stockholder Dividend Reinvestment Plan and Employee Stock Purchase Plan
 
Rabbi Trust: A trust established to fund our Directors Plan
Exchange Act: Securities Exchange Act of 1934
 
SBA: Small Business Administration
FASB: Financial Accounting Standards Board
 
SEC: U.S. Securities and Exchange Commission
FDIC: Federal Deposit Insurance Corporation
 
SOX: Sarbanes-Oxley Act of 2002
FFIEC: Federal Financial Institutions Examinations Council
 
Tax Act: Tax Cuts and Jobs Act, enacted December 22, 2017
FRB: Federal Reserve Bank
 
TDR: Troubled debt restructuring
FHLB: Federal Home Loan Bank
 
XBRL: eXtensible Business Reporting Language
Freddie Mac: Federal Home Loan Mortgage Corporation
 
Yield Curve: U.S. Treasury Yield Curve

3


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

March 31
2020
 
December 31
2019
ASSETS
 
 
 
Cash and cash equivalents
 
 
 
Cash and demand deposits due from banks
$
19,160

 
$
20,311

Interest bearing balances due from banks
77,591

 
40,261

Total cash and cash equivalents
96,751

 
60,572

AFS securities, at fair value
407,189

 
429,839

Mortgage loans AFS
1,228

 
904

Loans
 
 
 
Commercial
695,278

 
700,941

Agricultural
108,856

 
116,920

Residential real estate
302,016

 
298,569

Consumer
69,786

 
70,140

Gross loans
1,175,936

 
1,186,570

Less allowance for loan and lease losses
8,697

 
7,939

Net loans
1,167,239

 
1,178,631

Premises and equipment
25,946

 
26,242

Corporate owned life insurance policies
27,691

 
28,455

Accrued interest receivable
7,022

 
6,501

Equity securities without readily determinable fair values
21,535

 
21,629

Goodwill and other intangible assets
48,366

 
48,379

Other assets
12,937

 
13,046

TOTAL ASSETS
$
1,815,904

 
$
1,814,198

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits
 
 
 
Noninterest bearing
$
249,424

 
$
249,152

Interest bearing demand deposits
237,392

 
229,865

Certificates of deposit under $250 and other savings
739,925

 
739,023

Certificates of deposit over $250
95,342

 
95,811

Total deposits
1,322,083

 
1,313,851

Borrowed funds
263,171

 
275,999

Accrued interest payable and other liabilities
15,152

 
14,166

Total liabilities
1,600,406

 
1,604,016

Shareholders’ equity
 
 
 
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,921,291 shares (including 44,687 shares held in the Rabbi Trust) in 2020 and 7,910,804 shares (including 27,069 shares held in the Rabbi Trust) in 2019
140,945

 
141,069

Shares to be issued for deferred compensation obligations
4,802

 
5,043

Retained earnings
63,041

 
62,099

Accumulated other comprehensive income (loss)
6,710

 
1,971

Total shareholders’ equity
215,498

 
210,182

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,815,904

 
$
1,814,198





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

4


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

Three Months Ended 
 March 31
 
2020
 
2019
Interest income
 
 
 
Loans, including fees
$
13,254

 
$
12,891

AFS securities
 
 
 
Taxable
1,489

 
1,958

Nontaxable
1,053

 
1,253

Federal funds sold and other
405

 
379

Total interest income
16,201

 
16,481

Interest expense
 
 
 
Deposits
2,791

 
2,718

Borrowings
1,408

 
1,574

Total interest expense
4,199

 
4,292

Net interest income
12,002

 
12,189

Provision for loan losses
788

 
34

Net interest income after provision for loan losses
11,214

 
12,155

Noninterest income
 
 
 
Service charges and fees
1,353

 
1,461

Investment and trust advisory fees
572

 
677

Gains from redemption of corporate owned life insurance policies
524

 

Earnings on corporate owned life insurance policies
182

 
184

Net gain on sale of mortgage loans
151

 
93

Other
216

 
75

Total noninterest income
2,998

 
2,490

Noninterest expenses
 
 
 
Compensation and benefits
5,869

 
5,722

Furniture and equipment
1,461

 
1,494

Occupancy
867

 
930

Other
2,748

 
2,654

Total noninterest expenses
10,945

 
10,800

Income before federal income tax expense
3,267

 
3,845

Federal income tax expense
203

 
349

NET INCOME
$
3,064

 
$
3,496

Earnings per common share
 
 
 
Basic
$
0.39

 
$
0.44

Diluted
$
0.38

 
$
0.43

Cash dividends per common share
$
0.27

 
$
0.26







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

5


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

Three Months Ended 
 March 31
 
2020
 
2019
Net income
$
3,064

 
$
3,496

Unrealized gains (losses) on AFS securities arising during the period
6,311

 
5,954

Reclassification adjustment for net (gains) losses included in net income
(71
)
 

Tax effect (1)
(1,393
)
 
(1,195
)
Unrealized gains (losses) on AFS securities, net of tax
4,847

 
4,759

Unrealized gains (losses) on derivative instruments arising during the period
(136
)
 
(81
)
Tax effect (1)
28

 
17

Unrealized gains (losses) on derivative instruments, net of tax
(108
)
 
(64
)
Other comprehensive income (loss), net of tax
4,739

 
4,695

Comprehensive income (loss)
$
7,803

 
$
8,191

(1) 
See “Note 9 – Accumulated Other Comprehensive Income” for tax effect reconciliation.
























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

6


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

Common Shares
Outstanding
 
Amount
 
Common Shares to be
Issued for
Deferred
Compensation
Obligations
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Totals
Balance, January 1, 2019
7,870,969

 
$
140,416

 
$
5,431

 
$
57,357

 
$
(7,685
)
 
$
195,519

Comprehensive income (loss)

 

 

 
3,496

 
4,695

 
8,191

Issuance of common stock
61,405

 
1,433

 

 

 

 
1,433

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

 
268

 
(268
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
131

 

 

 
131

Common stock purchased for deferred compensation obligations

 
(186
)
 

 

 

 
(186
)
Common stock repurchased pursuant to publicly announced repurchase plan
(26,296
)
 
(632
)
 

 

 

 
(632
)
Cash dividends paid ($0.26 per common share)

 

 

 
(2,043
)
 

 
(2,043
)
Balance, March 31, 2019
7,906,078

 
$
141,299

 
$
5,294

 
$
58,810

 
$
(2,990
)
 
$
202,413

Balance, January 1, 2020
7,910,804

 
$
141,069

 
$
5,043

 
$
62,099

 
$
1,971

 
$
210,182

Comprehensive income (loss)

 

 

 
3,064

 
4,739

 
7,803

Issuance of common stock
69,907

 
1,330

 

 

 

 
1,330

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

 
364

 
(364
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
123

 

 

 
123

Common stock purchased for deferred compensation obligations

 
(650
)
 

 

 

 
(650
)
Common stock repurchased pursuant to publicly announced repurchase plan
(59,420
)
 
(1,168
)
 

 

 

 
(1,168
)
Cash dividends paid ($0.27 per common share)

 

 

 
(2,122
)
 

 
(2,122
)
Balance, March 31, 2020
7,921,291

 
$
140,945

 
$
4,802

 
$
63,041

 
$
6,710

 
$
215,498
















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

7


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

Three Months Ended 
 March 31
 
2020
 
2019
OPERATING ACTIVITIES
 
 
 
Net income
$
3,064

 
$
3,496

Reconciliation of net income to net cash provided by operating activities:
 
 
 
Undistributed earnings of equity securities without readily determinable fair values
94

 
57

Provision for loan losses
788

 
34

Depreciation
668

 
731

Amortization of OMSR
97

 
44

Amortization of acquisition intangibles
13

 
19

Net amortization of AFS securities
444

 
435

Net gains on sale of AFS securities
(71
)
 

Net gain on sale of mortgage loans
(151
)
 
(93
)
OMSR impairment loss
245

 

Net gains on foreclosed assets
(42
)
 
(33
)
Increase in cash value of corporate owned life insurance policies, net of expenses
(170
)
 
(173
)
Gains from redemption of corporate owned life insurance policies
(524
)
 

Share-based payment awards under equity compensation plan
123

 
131

Origination of loans held-for-sale
(8,890
)
 
(6,520
)
Proceeds from loan sales
8,717

 
6,826

Net changes in operating assets and liabilities which provided (used) cash:
 
 
 
Accrued interest receivable
(521
)
 
(823
)
Other assets
(379
)
 
(1,492
)
Accrued interest payable and other liabilities
(111
)
 
437

Net cash provided by (used in) operating activities
3,394

 
3,076

INVESTING ACTIVITIES
 
 
 
Activity in AFS securities
 
 
 
Sales
26,855

 

Maturities, calls, and principal payments
12,674

 
11,824

Purchases
(11,012
)
 
(6,313
)
Net loan principal (originations) collections
10,487

 
(16,373
)
Proceeds from sales of foreclosed assets
51

 
224

Purchases of premises and equipment
(372
)
 
(340
)
Proceeds from redemption of corporate owned life insurance policies
1,458

 

Funding of low income housing tax credit investments
(150
)
 
(117
)
Net cash provided by (used in) investing activities
39,991

 
(11,095
)

8


INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
 
Three Months Ended 
 March 31
 
2020
 
2019
FINANCING ACTIVITIES
 
 
 
Net increase (decrease) in deposits
$
8,232

 
$
(14,730
)
Net increase (decrease) in borrowed funds
(12,828
)
 
(28,615
)
Cash dividends paid on common stock
(2,122
)
 
(2,043
)
Proceeds from issuance of common stock
1,330

 
1,433

Common stock repurchased
(1,168
)
 
(632
)
Common stock purchased for deferred compensation obligations
(650
)
 
(186
)
Net cash provided by (used in) financing activities
(7,206
)
 
(44,773
)
Increase (decrease) in cash and cash equivalents
36,179

 
(52,792
)
Cash and cash equivalents at beginning of period
60,572

 
73,471

Cash and cash equivalents at end of period
$
96,751


$
20,679

SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Interest paid
$
4,214

 
$
4,227

SUPPLEMENTAL NONCASH INFORMATION:
 
 
 
Transfers of loans to foreclosed assets
$
117

 
$
237





















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

9


NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(Dollars in thousands except per share amounts)
Note 1 – Basis of Presentation
As used in these notes, as well as in Management's Discussion and Analysis of Financial Condition and Results of Operations, references to 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” refer to Isabella Bank Corporation’s subsidiary, Isabella Bank.
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three-month period ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2019.
Our accounting policies are materially the same as those discussed in Note 1 to the Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2019.
Reclassifications: Certain amounts reported in the interim 2019 consolidated financial statements have been reclassified to conform with the 2020 presentation.
Note 2 – Accounting Standards Updates
Recently Adopted
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 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 was effective January 1, 2020 and did not have a significant impact on 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 was effective January 1, 2020. Based on the prospective approach, we will review future arrangements to determine the appropriate treatment under this guidance. These changes are not expected to have a significant impact on our operating results or financial statement disclosures.
Pending
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.

10


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 was originally effective for interim and annual periods beginning after December 15, 2019. Effective October 16, 2019, the FASB approved changes to the implementation date of this guidance for some filers. As a small reporting company, as defined by the SEC, our implementation date was delayed from January 1, 2020 to January 1, 2023. Early adoption continues to be permissible under the revised implementation date; currently we have no plans for early adoption. This guidance may have a significant impact on the results of 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 our implementation date. A committee was formed and is accountable for timely and accurate adoption of the guidance. A service provider that has 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 will run parallel processes which will help to ensure we are ready to calculate, review, and report the ACL by the required implementation date.
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 an 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.

11


Note 3 – AFS Securities
The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:
 
March 31, 2020

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
States and political subdivisions
$
159,267

 
$
3,849

 
$

 
$
163,116

Auction rate money market preferred
3,200

 

 
474

 
2,726

Mortgage-backed securities
122,544

 
4,010

 

 
126,554

Collateralized mortgage obligations
110,079

 
4,714

 

 
114,793

Total
$
395,090

 
$
12,573

 
$
474

 
$
407,189

 
December 31, 2019

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
States and political subdivisions
$
165,005

 
$
4,747

 
$

 
$
169,752

Auction rate money market preferred
3,200

 

 
81

 
3,119

Mortgage-backed securities
139,831

 
933

 
560

 
140,204

Collateralized mortgage obligations
115,944

 
1,007

 
187

 
116,764

Total
$
423,980

 
$
6,687

 
$
828

 
$
429,839

The amortized cost and fair value of AFS securities by contractual maturity at March 31, 2020 are as follows:
 
Maturing
 
Securities with Variable Monthly Payments or Noncontractual Maturities
 
 

Due in
One Year
or Less
 
After One
Year But
Within
Five Years
 
After Five
Years But
Within
Ten Years
 
After
Ten Years
 
 
Total
States and political subdivisions
$
27,544

 
$
69,886

 
$
38,580

 
$
23,257

 
$

 
$
159,267

Auction rate money market preferred

 

 

 

 
3,200

 
3,200

Mortgage-backed securities

 

 

 

 
122,544

 
122,544

Collateralized mortgage obligations

 

 

 

 
110,079

 
110,079

Total amortized cost
$
27,544

 
$
69,886

 
$
38,580

 
$
23,257

 
$
235,823

 
$
395,090

Fair value
$
27,616

 
$
71,184

 
$
39,799

 
$
24,517

 
$
244,073

 
$
407,189

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 was as follows for the three months ended March 31, 2020. There were no sales of AFS securities for the three months ended March 31, 2019.
 
March 31
2020
Proceeds from sales of AFS securities
$
26,855

Realized gains (losses)
$
71

Applicable income tax expense (benefit)
$
15


12


The following information pertains to AFS securities with gross unrealized losses at March 31, 2020 and December 31, 2019, aggregated by investment category and length of time that individual securities have been in a continuous loss position. There were no AFS securities with gross unrealized losses in a continuous loss position less than twelve months at March 31, 2020.
 
March 31, 2020
 
Twelve Months or More

Gross
Unrealized
Losses
 
Fair
Value
Auction rate money market preferred
$
474

 
$
2,726

Number of securities in an unrealized loss position:
 
 
2

 
December 31, 2019
 
Less Than Twelve Months
 
Twelve Months or More
 
 

Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Total
Unrealized
Losses
Auction rate money market preferred
$

 
$

 
$
81

 
$
3,119

 
$
81

Mortgage-backed securities
3

 
3,974

 
557

 
49,701

 
560

Collateralized mortgage obligations
43

 
20,262

 
144

 
13,309

 
187

Total
$
46

 
$
24,236

 
$
782

 
$
66,129

 
$
828

Number of securities in an unrealized loss position:
 
 
9

 
 
 
19

 
28

The reduction in unrealized losses on our AFS securities portfolio resulted from recent decreases in intermediate-term and long-term benchmark interest rates.
As of March 31, 2020 and December 31, 2019, we conducted an analysis to determine whether any AFS 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?
Based on our analysis, which included the criteria outlined above and the fact that we have asserted that we do not have to sell any AFS securities in an unrealized loss position, we do not believe that the values of any AFS securities are other-than-temporarily impaired as of March 31, 2020 or December 31, 2019, with the exception of one municipal bond previously identified which had no activity during the period.

13


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, health care, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees. A portion of loans are unsecured.
Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and deferred fees or costs. Unless a loan has a nonaccrual status, 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 amortization method.
The accrual of interest on commercial and agricultural loans, as well as residential real estate loans, is discontinued at the time a loan is 90 days or more past due unless the credit 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 a charge-off is necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on the contractual term of the loan. In all cases, a loan is placed in nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful.
When a loan is 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. Government agency guarantee may be required. Personal guarantees and/or life insurance beneficiary assignments 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 sheets. Under the participation agreement, we committed to a maximum outstanding aggregate amount of $50,000. The difference between our outstanding balance and the maximum outstanding aggregate amount is classified as “Unfunded commitments under lines of credit” in the “Contractual Obligations and Loan Commitments” section of the Management's Discussion and Analysis of Financial Condition and Results of Operations of this report.
We offer adjustable rate mortgages, construction loans, and fixed rate residential real estate loans which have amortization periods up to a maximum of 30 years. We consider the anticipated direction of interest rates, balance sheet duration, the sensitivity of our balance sheet to changes in interest rates, 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.

14


Underwriting criteria for originated 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 are 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. Full or partial loan balances are charged against the ALLL when we believe uncollectability 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 a loan 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, or the fair value of the collateral, less costs to sell, if the loan is collateral dependent. 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 related to this portfolio. 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.
While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong at March 31, 2020. However, the COVID-19 pandemic has led to the temporary closure of businesses throughout the communities in which we serve, which has also led to increased unemployment. Therefore, we increased the ALLL during the quarter to account for inherent risk within the loan portfolio as of March 31, 2020. We continue to monitor the economic impact from COVID-19 as it relates to credit risk to ensure the ALLL is appropriate.
A summary of the ALLL and the recorded investment in loans by segments follows:
 
Allowance for Loan Losses

Three Months Ended March 31, 2020

Commercial

Agricultural

Residential Real Estate

Consumer

Unallocated

Total
January 1, 2020
$
1,914


$
634


$
2,047


$
922


$
2,422


$
7,939

Charge-offs
(4
)

(16
)

(15
)

(123
)



(158
)
Recoveries
22


33


27


46




128

Provision for loan losses
443


(161
)

(342
)

116


732


788

March 31, 2020
$
2,375


$
490


$
1,717


$
961


$
3,154


$
8,697


15


 
Allowance for Loan Losses and Recorded Investment in Loans
 
March 31, 2020

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
179

 
$
78

 
$
1,052

 
$

 
$

 
$
1,309

Collectively evaluated for impairment
2,196

 
412

 
665

 
961

 
3,154

 
7,388

Total
$
2,375

 
$
490

 
$
1,717

 
$
961

 
$
3,154

 
$
8,697

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
8,598

 
$
13,660

 
$
5,374

 
$
3

 
 
 
$
27,635

Collectively evaluated for impairment
686,680

 
95,196

 
296,642

 
69,783

 
 
 
1,148,301

Total
$
695,278

 
$
108,856

 
$
302,016

 
$
69,786

 
 
 
$
1,175,936

 
Allowance for Loan Losses
 
Three Months Ended March 31, 2019

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
January 1, 2019
$
2,563

 
$
775

 
$
1,992

 
$
857

 
$
2,188

 
$
8,375

Charge-offs
(8
)
 

 
(2
)
 
(128
)
 

 
(138
)
Recoveries
51

 
1

 
27

 
48

 

 
127

Provision for loan losses
(358
)
 
(1
)
 
288

 
114

 
(9
)
 
34

March 31, 2019
$
2,248

 
$
775

 
$
2,305

 
$
891

 
$
2,179

 
$
8,398

 
Allowance for Loan Losses and Recorded Investment in Loans
 
December 31, 2019

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
15

 
$
26

 
$
1,073

 
$

 
$

 
$
1,114

Collectively evaluated for impairment
1,899

 
608

 
974

 
922

 
2,422

 
6,825

Total
$
1,914

 
$
634

 
$
2,047

 
$
922

 
$
2,422

 
$
7,939

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
7,865

 
$
14,840

 
$
5,486

 
$

 
 
 
$
28,191

Collectively evaluated for impairment
693,076

 
102,080

 
293,083

 
70,140

 
 
 
1,158,379

Total
$
700,941


$
116,920

 
$
298,569

 
$
70,140

 
 
 
$
1,186,570


16


The following tables display the internally assigned credit risk ratings for commercial and agricultural credit exposures as of:
 
March 31, 2020
 
Commercial
 
Agricultural
 
 

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

 
 
1 - Excellent
$

 
$
10

 
$

 
$
10

 
$

 
$

 
$

 
$
10

2 - High quality
4,326

 
10,760

 

 
15,086

 
894

 
13

 
907

 
15,993

3 - High satisfactory
93,092

 
43,940

 
34,416

 
171,448

 
16,835

 
4,976

 
21,811

 
193,259

4 - Low satisfactory
381,334

 
92,789

 

 
474,123

 
42,602

 
19,671

 
62,273

 
536,396

5 - Special mention
15,404

 
3,530

 

 
18,934

 
5,601

 
2,164

 
7,765

 
26,699

6 - Substandard
7,177

 
6,857

 

 
14,034

 
8,236

 
3,258

 
11,494

 
25,528

7 - Vulnerable
29

 
1,339

 

 
1,368

 
2,839

 
1,579

 
4,418

 
5,786

8 - Doubtful
275

 

 

 
275

 
188

 

 
188

 
463

9 - Loss

 

 

 

 

 

 

 

Total
$
501,637

 
$
159,225

 
$
34,416

 
$
695,278

 
$
77,195

 
$
31,661

 
$
108,856

 
$
804,134

 
December 31, 2019
 
Commercial
 
Agricultural
 
 

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

 
$
390

 
$

 
$
390

 
$

 
$

 
$

 
$
390

2 - High quality
2,582

 
8,844

 

 
11,426

 
1,452

 
99

 
1,551

 
12,977

3 - High satisfactory
109,737

 
42,858

 
35,523

 
188,118

 
16,765

 
6,769

 
23,534

 
211,652

4 - Low satisfactory
377,198

 
94,847

 

 
472,045

 
42,798

 
20,861

 
63,659

 
535,704

5 - Special mention
15,372

 
3,470

 

 
18,842

 
7,165

 
3,754

 
10,919

 
29,761

6 - Substandard
4,874

 
3,625

 

 
8,499

 
9,136

 
3,836

 
12,972

 
21,471

7 - Vulnerable
390

 
1,231

 

 
1,621

 
2,711

 
1,574

 
4,285

 
5,906

8 - Doubtful

 

 

 

 

 

 



9 - Loss

 

 

 

 

 

 

 

Total
$
510,153

 
$
155,265

 
$
35,523

 
$
700,941

 
$
80,027

 
$
36,893

 
$
116,920


$
817,861

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.

17


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.
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.

18


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.
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.

19


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 for the entire loan portfolio as of:
 
March 31, 2020
 
Accruing Interest
and Past Due:
 
 
 
Total Past Due and Nonaccrual
 
 
 
 

30-59
Days
 
60-89
Days
 
90 Days
or More
 
Nonaccrual
 
 
Current
 
Total
Commercial
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
2,199

 
$
94

 
$