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Section 1: 10-Q (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 June 30, 2019
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
 
ý
 
 
 
 
 
Non-accelerated filer
 
¨
 
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 7,917,099 as of August 6, 2019.


Table of Contents

ISABELLA BANK CORPORATION
QUARTERLY REPORT ON FORM 10-Q
Table of Contents
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 1A.
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
Item 3.
 
 
 
 
 
 
 
Item 4.
 
 
 
 
 
 
 
Item 5.
 
 
 
 
 
 
 
Item 6.
 
 
 
 
 
 
 
 
 
 

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Table of Contents

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 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
 
GAAP: U.S. generally accepted accounting principles
AFS: Available-for-sale
 
GLB Act: Gramm-Leach-Bliley Act of 1999
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
 
JOBS Act: Jumpstart our Business Startups Act
ATM: Automated Teller Machine
 
LIBOR: London Interbank Offered Rate
BHC Act: Bank Holding Company Act of 1956
 
N/A: Not applicable
CECL: Current Expected Credit Losses
 
N/M: Not meaningful
CFPB: Consumer Financial Protection Bureau
 
NASDAQ: NASDAQ Stock Market Index
CIK: Central Index Key
 
NASDAQ Banks: NASDAQ Bank Stock Index
CRA: Community Reinvestment Act
 
NAV: Net asset value
DIF: Deposit Insurance Fund
 
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
 
OCI: Other comprehensive income (loss)
Dividend Reinvestment Plan: Isabella Bank Corporation Stockholder Dividend Reinvestment Plan and Employee Stock Purchase Plan
 
OMSR: Originated mortgage servicing rights
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
 
OREO: Other real estate owned
ESOP: Employee Stock Ownership Plan
 
OTTI: Other-than-temporary impairment
Exchange Act: Securities Exchange Act of 1934
 
PBO: Projected benefit obligation
FASB: Financial Accounting Standards Board
 
PCAOB: Public Company Accounting Oversight Board
FDI Act: Federal Deposit Insurance Act
 
Rabbi Trust: A trust established to fund our Directors Plan
FDIC: Federal Deposit Insurance Corporation
 
SEC: U.S. Securities and Exchange Commission
FFIEC: Federal Financial Institutions Examinations Council
 
SOX: Sarbanes-Oxley Act of 2002
FRB: Federal Reserve Bank
 
Tax Act: Tax Cuts and Jobs Act, enacted December 22, 2017
FHLB: Federal Home Loan Bank
 
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

3

Table of Contents

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

June 30
2019
 
December 31
2018
ASSETS
 
 
 
Cash and cash equivalents
 
 
 
Cash and demand deposits due from banks
$
21,935

 
$
23,534

Interest bearing balances due from banks
14,027

 
49,937

Total cash and cash equivalents
35,962

 
73,471

AFS securities, at fair value
470,449

 
494,834

Mortgage loans AFS
1,372

 
358

Loans
 
 
 
Commercial
701,954

 
659,529

Agricultural
120,363

 
127,161

Residential real estate
283,285

 
275,343

Consumer
71,020

 
66,674

Gross loans
1,176,622

 
1,128,707

Less allowance for loan and lease losses
8,037

 
8,375

Net loans
1,168,585

 
1,120,332

Premises and equipment
26,954

 
27,815

Corporate owned life insurance policies
28,090

 
27,733

Accrued interest receivable
6,193

 
6,928

Equity securities without readily determinable fair values
25,024

 
24,948

Goodwill and other intangible assets
48,413

 
48,451

Other assets
13,550

 
17,632

TOTAL ASSETS
$
1,824,592

 
$
1,842,502

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits
 
 
 
Noninterest bearing
$
244,240

 
$
236,534

NOW accounts
228,704

 
235,287

Certificates of deposit under $250 and other savings
722,860

 
744,944

Certificates of deposit over $250
85,614

 
75,928

Total deposits
1,281,418

 
1,292,693

Borrowed funds
320,462

 
340,299

Accrued interest payable and other liabilities
14,598

 
13,991

Total liabilities
1,616,478

 
1,646,983

Shareholders’ equity
 
 
 
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,918,494 shares (including 40,514 shares held in the Rabbi Trust) in 2019 and 7,870,969 shares (including 16,673 shares held in the Rabbi Trust) in 2018
140,965

 
140,416

Shares to be issued for deferred compensation obligations
5,434

 
5,431

Retained earnings
60,948

 
57,357

Accumulated other comprehensive income (loss)
767

 
(7,685
)
Total shareholders’ equity
208,114

 
195,519

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,824,592

 
$
1,842,502





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

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

Three Months Ended 
 June 30
 
Six Months Ended 
 June 30
 
2019
 
2018
 
2019
 
2018
Interest income
 
 
 
 
 
 
 
Loans, including fees
$
13,587

 
$
12,076

 
$
26,478

 
$
23,372

AFS securities
 
 
 
 
 
 
 
Taxable
1,873

 
2,110

 
3,831

 
4,232

Nontaxable
1,207

 
1,331

 
2,460

 
2,713

Federal funds sold and other
148

 
196

 
527

 
517

Total interest income
16,815

 
15,713

 
33,296

 
30,834

Interest expense
 
 
 
 
 
 
 
Deposits
2,865

 
2,230

 
5,583

 
4,276

Borrowings
1,662

 
1,511

 
3,236

 
2,866

Total interest expense
4,527

 
3,741

 
8,819

 
7,142

Net interest income
12,288

 
11,972

 
24,477

 
23,692

Provision for loan losses
(179
)
 
328

 
(145
)
 
712

Net interest income after provision for loan losses
12,467

 
11,644

 
24,622

 
22,980

Noninterest income
 
 
 
 
 
 
 
Service charges and fees
1,540

 
1,488

 
3,001

 
2,976

Investment and Trust advisory fees
780

 
738

 
1,457

 
1,396

Earnings on corporate owned life insurance policies
201

 
185

 
374

 
366

Net gain on sale of mortgage loans
116

 
87

 
209

 
168

Other
374

 
242

 
449

 
332

Total noninterest income
3,011

 
2,740

 
5,490

 
5,238

Noninterest expenses
 
 
 
 
 
 
 
Compensation and benefits
5,957

 
5,679

 
11,679

 
11,173

Furniture and equipment
1,409

 
1,537

 
2,903

 
2,986

Occupancy
834

 
807

 
1,764

 
1,631

Other
2,549

 
2,765

 
5,192

 
5,105

Total noninterest expenses
10,749

 
10,788

 
21,538

 
20,895

Income before federal income tax expense
4,729

 
3,596

 
8,574

 
7,323

Federal income tax expense
541

 
263

 
890

 
528

NET INCOME
$
4,188

 
$
3,333

 
$
7,684

 
$
6,795

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.53

 
$
0.42

 
$
0.97

 
$
0.86

Diluted
$
0.52

 
$
0.41

 
$
0.95

 
$
0.84

Cash dividends per common share
$
0.26

 
$
0.26

 
$
0.52

 
$
0.52








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

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Table of Contents

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

Three Months Ended 
 June 30
 
Six Months Ended 
 June 30
 
2019
 
2018
 
2019
 
2018
Net income
$
4,188

 
$
3,333

 
$
7,684

 
$
6,795

Unrealized gains (losses) on AFS securities arising during the period
4,876

 
(1,978
)
 
10,830

 
(10,035
)
Tax effect (1)
(1,018
)
 
442

 
(2,213
)
 
2,126

Unrealized gains (losses) on AFS securities, net of tax
3,858

 
(1,536
)
 
8,617

 
(7,909
)
Unrealized gains (losses) on derivative instruments arising during the period
(127
)
 
31

 
(208
)
 
153

Tax effect (1)
26

 
(6
)
 
43

 
(32
)
Unrealized gains (losses) on derivative instruments, net of tax
(101
)
 
25

 
(165
)
 
121

Other comprehensive income (loss), net of tax
3,757

 
(1,511
)
 
8,452

 
(7,788
)
Comprehensive income (loss)
$
7,945

 
$
1,822

 
$
16,136

 
$
(993
)
(1) 
See “Note 11 – Accumulated Other Comprehensive Income” for tax effect reconciliation.






















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

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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, 2018
7,857,293

 
$
140,277

 
$
5,502

 
$
51,728

 
$
(2,602
)
 
$
194,905

Comprehensive income (loss)

 

 

 
6,795

 
(7,788
)
 
(993
)
Adoption of ASU 2016-01

 

 

 
(223
)
 
223

 

Issuance of common stock
121,437

 
3,272

 

 

 

 
3,272

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

 
383

 
(383
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
304

 

 

 
304

Common stock purchased for deferred compensation obligations

 
(205
)
 

 

 

 
(205
)
Common stock repurchased pursuant to publicly announced repurchase plan
(45,480
)
 
(1,238
)
 

 

 

 
(1,238
)
Cash dividends paid ($0.52 per common share)

 

 

 
(4,096
)
 

 
(4,096
)
Balance, June 30, 2018
7,933,250

 
$
142,489

 
$
5,423

 
$
54,204

 
$
(10,167
)
 
$
191,949

Balance, January 1, 2019
7,870,969

 
$
140,416

 
$
5,431

 
$
57,357

 
$
(7,685
)
 
$
195,519

Comprehensive income (loss)

 

 

 
7,684

 
8,452

 
16,136

Issuance of common stock
104,598

 
2,436

 

 

 

 
2,436

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

 
268

 
(268
)
 

 

 

Share-based payment awards under equity compensation plan

 

 
271

 

 

 
271

Common stock purchased for deferred compensation obligations

 
(816
)
 

 

 

 
(816
)
Common stock repurchased pursuant to publicly announced repurchase plan
(57,073
)
 
(1,339
)
 

 

 

 
(1,339
)
Cash dividends paid ($0.52 per common share)

 

 

 
(4,093
)
 

 
(4,093
)
Balance, June 30, 2019
7,918,494

 
$
140,965

 
$
5,434

 
$
60,948

 
$
767

 
$
208,114














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

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

Six Months Ended 
 June 30
 
2019
 
2018
OPERATING ACTIVITIES
 
 
 
Net income
$
7,684

 
$
6,795

Reconciliation of net income to net cash provided by operating activities:
 
 
 
Undistributed earnings of equity securities without readily determinable fair values
(76
)
 
(64
)
Provision for loan losses
(145
)
 
712

Depreciation
1,476

 
1,448

Amortization of OMSR
118

 
153

Amortization of acquisition intangibles
38

 
50

Net amortization of AFS securities
882

 
969

Net unrealized (gains) losses on equity securities, at fair value

 
41

Net (gains) losses on sale of equity securities, at fair value

 
(1
)
Net gain on sale of mortgage loans
(209
)
 
(168
)
Increase in cash value of corporate owned life insurance policies, net of expenses
(357
)
 
(351
)
Share-based payment awards under equity compensation plan
271

 
304

Origination of loans held-for-sale
(14,110
)
 
(10,178
)
Proceeds from loan sales
13,305

 
10,486

Net changes in operating assets and liabilities which provided (used) cash:
 
 
 
Accrued interest receivable
735

 
1,379

Other assets
1,744

 
(64
)
Accrued interest payable and other liabilities
756

 
94

Net cash provided by (used in) operating activities
12,112

 
11,605

INVESTING ACTIVITIES
 
 
 
Activity in AFS securities
 
 
 
Maturities, calls, and principal payments
43,296

 
39,609

Purchases
(8,963
)
 
(25,991
)
Sale of equity securities, at fair value

 
3,537

Net loan principal (originations) collections
(48,585
)
 
(60,517
)
Proceeds from sales of foreclosed assets
319

 
192

Purchases of premises and equipment
(615
)
 
(1,265
)
Purchases of FHLB Stock

 
(225
)
Funding of low income housing tax credit investments
(149
)
 
(435
)
Net cash provided by (used in) investing activities
(14,697
)
 
(45,095
)

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INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Dollars in thousands)
 
Six Months Ended 
 June 30
 
2019
 
2018
FINANCING ACTIVITIES
 
 
 
Net increase (decrease) in deposits
$
(11,275
)
 
$
9,504

Net increase (decrease) in borrowed funds
(19,837
)
 
17,618

Cash dividends paid on common stock
(4,093
)
 
(4,096
)
Proceeds from issuance of common stock
2,436

 
3,272

Common stock repurchased
(1,339
)
 
(1,238
)
Common stock purchased for deferred compensation obligations
(816
)
 
(205
)
Net cash provided by (used in) financing activities
(34,924
)
 
24,855

Increase (decrease) in cash and cash equivalents
(37,509
)
 
(8,635
)
Cash and cash equivalents at beginning of period
73,471

 
30,848

Cash and cash equivalents at end of period
$
35,962


$
22,213

SUPPLEMENTAL CASH FLOWS INFORMATION:
 
 
 
Interest paid
$
8,760

 
$
7,120

SUPPLEMENTAL NONCASH INFORMATION:
 
 
 
Transfers of loans to foreclosed assets
$
477

 
$
68





















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

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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” refers to Isabella Bank Corporation’s subsidiary, Isabella Bank.
The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2018.
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, 2018.
Reclassifications: Certain amounts reported in the interim 2018 consolidated financial statements have been reclassified to conform with the 2019 presentation. Other assets and other liabilities on the interim condensed consolidated balance sheets were increased by $5,195 as of December 31, 2018 to reclassify pension and income tax related liabilities (pension: $3,470, income taxes $1,725). This resulted in a $5,195 increase in total assets as of December 31, 2018. All other balances and ratios were not materially impacted.
Note 2 – Accounting Standards Updates
Recently Adopted 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 was effective on January 1, 2019. We reviewed our lease agreements to determine the appropriate treatment under this guidance. These changes resulted in the recognition of a $72 operating lease asset and liability on the balance sheet as of January 1, 2019 which was restated prospectively. Given the current insignificant impact to our operating results, further financial statement disclosures were not considered necessary as of June 30, 2019.
Pending Accounting Standards Updates
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 includes 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

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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 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. 2018-13: “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 is effective for interim and annual periods beginning after December 15, 2019 and will impact our financial statement disclosures.
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.

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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 current and future arrangements and whether or not they meet the requirement to be capitalized.
Note 3 – AFS Securities
The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:
 
June 30, 2019

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
160

 
$

 
$

 
$
160

States and political subdivisions
172,197

 
4,546

 
1

 
176,742

Auction rate money market preferred
3,200

 

 
351

 
2,849

Mortgage-backed securities
173,992

 
621

 
1,273

 
173,340

Collateralized mortgage obligations
116,481

 
1,130

 
253

 
117,358

Total
$
466,030

 
$
6,297

 
$
1,878

 
$
470,449

 
December 31, 2018

Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
Government sponsored enterprises
$
172

 
$

 
$
2

 
$
170

States and political subdivisions
188,992

 
2,125

 
251

 
190,866

Auction rate money market preferred
3,200

 

 
646

 
2,554

Mortgage-backed securities
189,688

 
76

 
5,280

 
184,484

Collateralized mortgage obligations
119,193

 
71

 
2,504

 
116,760

Total
$
501,245

 
$
2,272

 
$
8,683

 
$
494,834

The amortized cost and fair value of AFS securities by contractual maturity at June 30, 2019 are as follows:
 
Maturing
 
Securities with Variable Monthly Payments or Noncontractual Maturities
 
 

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

 
$
160

 
$

 
$

 
$

 
$
160

States and political subdivisions
28,931

 
71,394

 
44,668

 
27,204

 

 
172,197

Auction rate money market preferred

 

 

 

 
3,200

 
3,200

Mortgage-backed securities

 

 

 

 
173,992

 
173,992

Collateralized mortgage obligations

 

 

 

 
116,481

 
116,481

Total amortized cost
$
28,931

 
$
71,554

 
$
44,668

 
$
27,204

 
$
293,673

 
$
466,030

Fair value
$
29,073

 
$
73,042

 
$
46,185

 
$
28,602

 
$
293,547

 
$
470,449

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.

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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.
The following information pertains to AFS securities with gross unrealized losses at June 30, 2019 and December 31, 2018, aggregated by investment category and length of time that individual securities have been in a continuous loss position.
 
June 30, 2019
 
Less Than Twelve Months
 
Twelve Months or More
 
 

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

 
$

 
$

 
$

 
$

States and political subdivisions

 

 
1

 
824

 
1

Auction rate money market preferred

 

 
351

 
2,849

 
351

Mortgage-backed securities
6

 
3,193

 
1,267

 
106,137

 
1,273

Collateralized mortgage obligations

 

 
253

 
23,423

 
253

Total
$
6

 
$
3,193

 
$
1,872

 
$
133,233

 
$
1,878

Number of securities in an unrealized loss position:
 
 
1

 
 
 
39

 
40

 
December 31, 2018
 
Less Than Twelve Months
 
Twelve Months or More
 
 

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

 
$

 
$
2

 
$
170

 
$
2

States and political subdivisions
83

 
14,732

 
168

 
15,090

 
251

Auction rate money market preferred

 

 
646

 
2,554

 
646

Mortgage-backed securities
896

 
43,485

 
4,384

 
124,253

 
5,280

Collateralized mortgage obligations
199

 
21,886

 
2,305

 
87,929

 
2,504

Total
$
1,178

 
$
80,103

 
$
7,505

 
$
229,996

 
$
8,683

Number of securities in an unrealized loss position:
 
 
66

 
 
 
102

 
168

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 June 30, 2019 and December 31, 2018, 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 AFS securities in an unrealized loss position, we do not believe that the values of any other AFS securities are other-than-temporarily impaired as of June 30, 2019 or December 31, 2018, with the exception of one municipal bond previously identified which had no activity during the period.

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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 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 amortization methods.
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. 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 $40,000. 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.

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Table of Contents

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 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 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 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.
A summary of changes in the ALLL and the recorded investment in loans by segments follows:
 
Allowance for Loan Losses
 
Three Months Ended June 30, 2019

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
April 1, 2019
$
2,248

 
$
775

 
$
2,305

 
$
891

 
$
2,179

 
$
8,398

Charge-offs
(164
)
 

 
(94
)
 
(75
)
 

 
(333
)
Recoveries
22

 

 
91

 
38

 

 
151

Provision for loan losses
(26
)
 
(163
)
 
(420
)
 
73

 
357

 
(179
)
June 30, 2019
$
2,080

 
$
612

 
$
1,882

 
$
927

 
$
2,536

 
$
8,037

 
Allowance for Loan Losses

Six Months Ended June 30, 2019

Commercial

Agricultural

Residential Real Estate

Consumer

Unallocated

Total
January 1, 2019
$
2,563


$
775


$
1,992


$
857


$
2,188


$
8,375

Charge-offs
(172
)



(96
)

(203
)



(471
)
Recoveries
74




118


86




278

Provision for loan losses
(385
)

(163
)

(132
)

187


348


(145
)
June 30, 2019
$
2,080


$
612


$
1,882


$
927


$
2,536


$
8,037


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Table of Contents

 
Allowance for Loan Losses and Recorded Investment in Loans
 
June 30, 2019

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
58

 
$
123

 
$
1,298

 
$

 
$

 
$
1,479

Collectively evaluated for impairment
2,022

 
489

 
584

 
927

 
2,536

 
6,558

Total
$
2,080

 
$
612

 
$
1,882

 
$
927

 
$
2,536

 
$
8,037

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
9,029

 
$
13,472

 
$
6,389

 
$
7

 
 
 
$
28,897

Collectively evaluated for impairment
692,925

 
106,891

 
276,896

 
71,013

 
 
 
1,147,725

Total
$
701,954

 
$
120,363

 
$
283,285

 
$
71,020

 
 
 
$
1,176,622

 
Allowance for Loan Losses
 
Three Months Ended June 30, 2018

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
April 1, 2018
$
1,840

 
$
1,224

 
$
2,482

 
$
795

 
$
1,859

 
$
8,200

Charge-offs
(489
)
 

 
(29
)
 
(48
)
 

 
(566
)
Recoveries
101

 

 
69

 
68

 

 
238

Provision for loan losses
745

 
(242
)
 
(355
)
 
67

 
113

 
328

June 30, 2018
$
2,197

 
$
982

 
$
2,167

 
$
882

 
$
1,972

 
$
8,200

 
Allowance for Loan Losses
 
Six Months Ended June 30, 2018

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
January 1, 2018
$
1,706

 
$
611

 
$
2,563

 
$
900

 
$
1,920

 
$
7,700

Charge-offs
(494
)
 

 
(39
)
 
(136
)
 

 
(669
)
Recoveries
204

 

 
125

 
128

 

 
457

Provision for loan losses
781

 
371

 
(482
)
 
(10
)
 
52

 
712

June 30, 2018
$
2,197

 
$
982

 
$
2,167

 
$
882

 
$
1,972

 
$
8,200

 
Allowance for Loan Losses and Recorded Investment in Loans
 
December 31, 2018

Commercial
 
Agricultural
 
Residential Real Estate
 
Consumer
 
Unallocated
 
Total
ALLL
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
443

 
$
132

 
$
1,363

 
$

 
$

 
$
1,938

Collectively evaluated for impairment
2,120

 
643

 
629

 
857

 
2,188

 
6,437

Total
$
2,563

 
$
775

 
$
1,992

 
$
857

 
$
2,188

 
$
8,375

Loans
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
9,899

 
$
14,298

 
$
6,893

 
$
9

 
 
 
$
31,099

Collectively evaluated for impairment
649,630

 
112,863

 
268,450

 
66,665

 
 
 
1,097,608

Total
$
659,529


$
127,161

 
$
275,343

 
$
66,674

 
 
 
$
1,128,707


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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:
 
June 30, 2019
 
Commercial
 
Agricultural
 
 

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

 
 
1 - Excellent
$

 
$
19

 
$

 
$
19

 
$

 
$

 
$

 
$
19

2 - High quality
3,324

 
14,853

 

 
18,177

 
2,333

 
405

 
2,738

 
20,915

3 - High satisfactory
121,222

 
46,845

 
37,966

 
206,033

 
17,632

 
5,814

 
23,446

 
229,479

4 - Low satisfactory
359,329

 
88,910

 

 
448,239

 
44,106

 
19,816

 
63,922

 
512,161

5 - Special mention
16,631

 
5,768

 

 
22,399

 
10,060

 
5,065

 
15,125

 
37,524

6 - Substandard
4,803

 
592

 

 
5,395

 
6,013

 
3,587

 
9,600

 
14,995

7 - Vulnerable
450

 
1,242

 

 
1,692

 
3,593

 
1,939

 
5,532

 
7,224

8 - Doubtful

 

 

 

 

 

 

 

9 - Loss

 

 

 

 

 

 

 

Total
$
505,759

 
$
158,229

 
$
37,966

 
$
701,954

 
$
83,737

 
$
36,626

 
$
120,363

 
$
822,317

 
December 31, 2018
 
Commercial
 
Agricultural
 
 

Real Estate
 
Other
 
Advances to Mortgage Brokers
 
Total
 
Real Estate
 
Other
 
Total
 
Total
Rating
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
1 - Excellent
$
21

 
$
31

 
$

 
$
52

 
$
51

 
$
28

 
$
79

 
$
131

2 - High quality
4,564

 
13,473

 

 
18,037

 
2,729

 
613

 
3,342

 
21,379

3 - High satisfactory
127,573

 
43,199

 
11,793

 
182,565

 
18,325

 
7,039

 
25,364

 
207,929

4 - Low satisfactory
344,920

 
84,634

 

 
429,554

 
46,636

 
19,344

 
65,980

 
495,534

5 - Special mention
12,847

 
5,287

 

 
18,134

 
10,520

 
5,624

 
16,144

 
34,278

6 - Substandard
7,428

 
2,002

 

 
9,430

 
6,343

 
4,960

 
11,303

 
20,733

7 - Vulnerable
334

 
1,423

 

 
1,757

 
2,716

 
2,233

 
4,949

 
6,706

8 - Doubtful

 

 

 

 

 

 



9 - Loss

 

 

 

 

 

 

 

Total
$
497,687

 
$
150,049

 
$
11,793

 
$
659,529

 
$
87,320

 
$
39,841

 
$
127,161


$
786,690

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.
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.

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Table of Contents

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

Table of Contents

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:
 
June 30, 2019
 
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
$
47

 
$

 
$

 
$
450

 
$
497

 
$
505,262

 
$
505,759

Commercial other
484

 
20

 

 
1,242

 
1,746

 
156,483

 
158,229

Advances to mortgage brokers

 

 

 

 

 
37,966

 
37,966

Total commercial
531

 
20

 

 
1,692

 
2,243

 
699,711

 
701,954

Agricultural