What changed in this filing

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Item 7. Management’s Discussion and Analysis

2021-03-10 compared with 2020-03-16 · 337 added, 164 removed, 427 unchanged (54% of the section changed)

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Net income and earnings per common share for the year ended December 31, 2019 were $13,024 and $1.65, respectively.

Interest income for the year ended December 31, 2019 increased $3,442 when compared to 2018 primarily as the result of a combination of improved yields and growth in our loan portfolio, which totaled $57,863 during 2019 .

Interest expense on deposits and borrowings increased $2,230 for the year ended December 31, 2019 when compared to the same period in 2018 primarily due to higher interest rates.

Net interest income increased by $1,212 for the year ended December 31, 2019 in comparison to 2018 .

The provision for loan losses decreased by $948 , primarily as the result of improvement in credit quality.

Noninterest income for the year ended December 31, 2019 decreased $2,942 when compared to 2018 primarily as a result of a $3,566 reduction in our joint venture investment in Corporate Settlement Solutions, LLC (“ CSS ”) due to CSS ' recorded impairment of intangible assets (see discussion below).

Noninterest income in 2019 also included an increase in debit card transaction fee income, gains related to the sale of loans, and gains related to foreclosed assets.

Noninterest expenses for the year ended December 31, 2019 exceeded noninterest expenses in 2018 by $198 .

Expenses related to our employee incentive plans account for a portion of the increase in noninterest expenses, which was partially offset by an FDIC assessment credit, reduced audit and consulting fees, and ongoing cost control initiatives.

These initiatives include managing capital expenditures, vendor costs, and staffing levels.

In 2008, we merged the assets of our wholly owned subsidiary, IBT Title and Insurance Agency, Inc.

(“ IBT Title ”) into a 50/50 joint venture with Corporate Title Agency, LLC, a third-party business based in Traverse City, Michigan, to form CSS .

The purpose of the joint venture was to help IBT Title expand its service area and to take advantage of economies of scale.

As a 50% owner of the membership units of this entity, we account for our investment under the equity method of accounting, and our share of income and loss from the joint venture is included in noninterest income.

As of December 31, 2008, we had a recorded investment of $6,905 in CSS , which was included in equity securities without readily determinable fair values on our balance sheet.

During the second half of 2019, a new line of business was proposed by the General Manager of CSS which did not interest us as it was unrelated to the Bank's core business.

Subsequently, the General Manager of CSS elected to have a company valuation performed during the fourth quarter of 2019 for purposes of investor planning, and the independent valuation identified that CSS ’ intangible assets required an impairment of $7,133 .

As a 50% owner of the membership units of CSS , we recognized the reduced value of our investment which resulted in a reduction to income of $3,566 in the fourth quarter of 2019.

While we continually analyze all investments, there are no current plans to change our ownership or investment in CSS .

A decline in the interest rate environment was a large driver of a $3,134 decrease in interest income for 2020 when compared to 2019.

Interest expense on deposits and borrowings decreased $4,036 for the year ended December 31, 2020 when compared to the same period in 2019 primarily due to reduced interest rates and reduced reliance on higher-cost borrowings.

Net interest income increased by $902 for the year ended December 31, 2020 in comparison to the prior year.

The provision for loan losses increased by $1,635 in 2020 when compared to 2019 as the result of increased economic and environmental risk factors, predominantly driven by COVID-19.

Noninterest income for the year ended December 31, 2020 increased $6,384 when compared to 2019 mainly as a result of net gain on sold mortgage loans and the redemption of corporate owned life insurance policies.

Our joint venture investment in Corporate Settlement Solutions, LLC (“CSS”) also contributed to the variance in noninterest income.

We sold our membership interest in CSS during the fourth quarter of 2020, which resulted in a $394 reduction in income.

During the fourth quarter of 2019, we recorded a reduction of $3,566 in our joint venture investment in CSS due to CSS' recorded impairment of intangible assets.

Noninterest expenses for the year ended December 31, 2020 increased $8,183 when compared to 2019, which can be attributed to a $7,643 cost to extinguish $100,000 of FHLB advances.

As a result of this debt extinguishment, future interest expense and net yields are expected to be impacted favorably.

As of December 31, 2020, total assets and assets under management were $1,957,378 and $2,702,722, respectively.

Assets under management include loans sold and serviced of $259,375 and assets managed by our Investment and Trust Services Department of $436,181 , in addition to assets on our consolidated balance sheet.

As a result of the flat yield curve that has existed for over a year, the opportunity to identify new investment securities for purchase at an acceptable yield has been minimal.

Therefore, our securities portfolio has declined $64,995 since December 31, 2018 .

Based on strategic objectives, we utilized this available cash flow to reduce higher-cost funding sources and other borrowings as they mature, resulting in a decline in total assets as of December 31, 2019 when compared to December 31, 2018 .

Assets under management include loans sold and serviced of $301,377 and investment and trust assets managed by Isabella Wealth of $443,967, in addition to assets on our consolidated balance sheet.

In the first half of 2020, the Bank’s investment and trust services business was re-engineered and rebranded as Isabella Wealth to enhance the client experience, build scalability, and expand market awareness.

Loans outstanding as of December 31, 2020 totaled $1,238,311.

During 2019 , gross loans increased $57,863 which was largely driven by growth in our commercial loan portfolio.

Total deposits increased $21,158 during the year, primarily due to increases in savings and trust related deposits, and totaled $1,313,851 as of December 31, 2019 .

During 2020, gross loans increased $51,741 which was largely the result of SBA PPP loans in the commercial loan portfolio.

Our securities portfolio declined $90,611 since December 31, 2019, predominantly as a result of increased monthly prepayments and payoffs of AFS securities.

Due to the flat yield curve that has existed for the last few years, the opportunity to identify new investment securities for purchase at an acceptable yield has been minimal.

Based on strategic objectives, we utilized this available cash flow to reduce higher-cost funding sources and other borrowings as they matured.

Total deposits increased $252,466 during the year, driven by growth in demand and savings deposits, and totaled $1,566,317 as of December 31, 2020.

All regulatory capital ratios for the Bank exceeded the minimum thresholds to be considered a “well capitalized” institution.

Our net yield on interest earning assets (FTE) was 3.07% for 2019 which is an improvement from 2.98% for 2018 .

Management has implemented various initiatives which, over time, are expected to continue to improve our net yield on interest earning assets.

These initiatives included transitioning a larger percentage of assets from lower yielding investment securities to higher yielding loan opportunities, continued growth of the loan portfolio, reduced reliance on borrowings and brokered deposits, and enhanced pricing strategies related to loan and deposit products.

While the current interest rate environment may slow this pace of improvement, we are actively committed to increasing earnings and shareholder value

through growth in our loan portfolio while maintaining strong underwriting standards, growth in our investment and trust services, increasing our presence within our geographical footprint, and managing operating costs.

Recent Legislation

The Dodd-Frank Act of 2010 had, and is expected to continue to have, a negative impact on our operating results.

The Dodd-Frank Act established the CFPB which made significant changes in the regulation of financial institutions aimed at strengthening the oversight of the federal government over the operation of the financial services sector and increasing the protection of consumers.

Recent regulations issued by the CFPB regarding consumer lending, including residential mortgage lending, have increased our compensation expenses and this trend is expected to continue.

On July 2, 2013, the FRB published revised BASEL III Capital standards for banks.

The rules redefined what is included or deducted from equity capital, changed risk weighting for certain on and off-balance sheet assets, increased the minimum required equity capital to be considered well capitalized, and introduced a capital cushion buffer.

The rules, which were gradually phased in between 2015 and 2019, did not have a material impact on the Corporation but does require us to hold more capital than we have historically.

On December 22, 2017, the Tax Act was enacted.

The law established a flat corporate federal statutory income tax rate of 21%, effective January 1, 2018, and eliminated the corporate alternative minimum tax.

The new tax law provided for a wide array of changes with only some having a direct impact on our federal income tax expense.

Some of these changes included, but were not limited to, the following items:

limits to the deduction for net interest expense;

immediate expense (for tax purposes) for certain qualified depreciable assets;

elimination or reduction of certain deductions related to meals and entertainment expenses;

and limits to the deductibility of deposit insurance premiums.

Our net yield on interest earning assets (FTE) was 2.96% for 2020 which declined from 3.07% in 2019.

Management implemented strategic programs focused on improving our net yield on interest earning assets, which includes enhanced pricing related to loans and a reduced reliance on higher-cost borrowed funds and brokered deposits as funding sources.

While these efforts have helped, the current interest rate environment has had a negative impact on the yield of interest earning assets and future improvements may be gradual.

We are committed to increasing earnings and shareholder value through growth in our loan portfolio while maintaining strong underwriting standards, growth in our wealth management services, managing operating costs and increasing our presence within our geographical footprint.

Recent Events and Legislation

Restricted Stock Plan:

On June 24, 2020, the Board of Directors adopted the RSP, an equity-based bonus plan.

The RSP authorizes the issuance of unvested restricted stock to an eligible employee with a maximum award ranging from 25% to 40% of the employee’s annual salary, on a calendar year basis.

Under the RSP, the Board of Directors may grant restricted stock awards to eligible employees on an annual basis based on the satisfactory achievement of performance targets and measures established by the Board of Directors.

If these grant conditions are not satisfied, then the award of restricted shares will lapse or be adjusted appropriately, at the discretion of the Board of Directors.

Restricted stock awards granted are not fully transferable or vested until certain conditions are met, as stated in the plan.

In connection with the adoption of the RSP, the Isabella Bank Corporation Stock Award Incentive Plan was terminated.

Also on June 24, 2020, we made initial awards under the RSP to Isabella Bank's CEO, President, and CFO.

As of December 31, 2020, certain targets specified in the award agreements pursuant to the RSP were achieved and therefore, we recognized compensation expense of $14 pursuant to the RSP.

Additional disclosures about the RSP are included in “Note 13 – Benefit Plans” of “Notes to Consolidated Financial Statements” in Item 8.

Financial Statements and Supplementary Data.

Executive Cash Incentive Plan:

Also on June 24, 2020, we amended and restated the Isabella Bank Corporation Employee Cash Incentive Plans to create two separate plans:

one for non-executive employees and the other, the Isabella Bank Corporation Executive Cash Incentive Plan for executive employees.

The executive plan provides separate potential payouts for Isabella Bank's CEO, President and CFO based on achievement of personal and corporate goals.

The potential payouts under the plan range from 20% to 30% of the employee's annual salary.

Impact of COVID-19:

Unexpected and unprecedented changes have occurred during 2020 and into 2021 as the result of COVID-19.

This aggressive and persistent virus causes a respiratory disease and can result in serious illness or death.

The World Health Organization has declared the situation a global pandemic.

The pandemic has created significant market volatility, economic uncertainty, and disruption to normal business operations around the world, with slowdowns and shutdowns affecting entire industries.

The Michigan governor issued on March 23, 2020 a stay-at-home order, which limited gatherings and travel, and required those in select businesses who were not deemed essential to sustain or protect life to stay home.

The Michigan stay-at-home order was in effect until early June.

Additional executive and Michigan State Health Department orders have been put in place since June 2020.

During the fourth quarter of 2020, certain restrictions were put in place on industries within our communities and continued through December 31, 2020.

The orders, as the result of COVID-19, led to financial stress for many businesses and their employees throughout the communities we serve.

The CARES Act, an unprecedented federal government support program, was enacted on March 27, 2020 in response to the COVID-19 pandemic.

It is a $2 trillion stimulus package intended to provide financial relief across the country.

The CARES Act included the PPP, which enabled businesses to obtain a forgivable SBA loan to meet payroll, rent, utility, and mortgage interest obligations for the 24-week period following the loan origination, and re-open quickly once the public health crisis ends.

The first applications for PPP funds, with a term of two years, were accepted April 3, 2020.

During 2020, we were privileged to have facilitated more than 950 SBA PPP loans for a total of $99,459 and we are pleased to have the opportunity to provide additional funding in 2021 under an additional government stimulus program.

Bank regulators issued an interim rule that neutralizes the regulatory capital effects by allowing a zero percent risk weight, for capital purposes, to loans originated under the PPP.

The capital rule was issued April 9, 2020, with an immediate effective date.

During 2020, many of our customers expressed their general concern about the uncertain economic conditions, but it is still premature to reasonably predict the magnitude of the impact.

One measure we took to assist our customers included reduced service charges and fees on deposit accounts.

Since the COVID-19 pandemic led to an increase in the need for electronic services and products, we elected to temporarily waive certain charges and fees, and permanently remove some charges and fees, to ease the financial stress on our customers.

Other measures we have taken to assist our customers include loan programs that provide short-term payment relief.

Under these programs, borrowers whose loans were in good standing as of March 1, 2020 could elect to defer full or partial payments for a period not to exceed 180 days.

Loan payment deferrals totaled $306,103, or 23.8% of gross loans, as of June 30, 2020.

As of September 30, 2020, active loan payment deferrals declined to $103,858, or 8.0% of gross loans, as the majority of borrowers granted loan payment deferrals had reverted back to contractual payments.

As of December 31, 2020, active loan payment deferrals declined even further and totaled $6,048, or 0.5% of gross loans.

Bank regulators issued a statement on March 22, 2020, and a revised statement on April 7, 2020, which provided confirmation that short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers with a current payment status are not categorized as TDRs.

Pursuant to this guidance, borrowers granted a short-term loan modification meeting this criteria were not categorized as TDR as of December 31, 2020.

These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.

The extent to which COVID-19 impacts our business will depend on future developments, which are highly uncertain and cannot be predicted with any accuracy.

Future developments include new information which may emerge concerning the severity of COVID-19 and the actions to contain the coronavirus or treat its impact, among others.

We expect the significance of the pandemic, including the extent of its effect on our financial and operational results, to be dictated by, among other factors, its duration, the success of efforts to contain it and the impact of actions taken in response, including the development and distribution of effective vaccines.

Uncertainty created by the pandemic is pervasive, and has impacted our operations, customers, and various areas of risk.

With the uncertainty created by COVID-19, it's challenging to determine the full impact

on our ongoing financial and operational results.

We continue to closely monitor external events and are in continual discussion with our customers to assess, prepare and respond to conditions as they evolve.

Reclassifications

Certain amounts reported in management's discussion and analysis of financial condition and results of operations for 2019 and 2018 have been reclassified to conform with the 2020 presentation.

Other assets and other liabilities on the 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:

This resulted in a $5,195 increase in total assets and total liabilities as of December 31, 2018.

Other assets and other liabilities on the consolidated balance sheets were decreased by $1,555 as of December 31, 2019 to reclassify pension liabilities.

This resulted in a $1,555 decrease in total assets and total liabilities as of December 31, 2019.

All other balances and ratios were not materially impacted.

Subsequent Events

We evaluated subsequent events for potential recognition and disclosure through the date the consolidated financial statements were issued.

Events or transactions occurring after December 31, 2019 , but prior to the date the consolidated financial statements were issued, include anticipated proceeds from the redemption of a corporate owned life insurance policy.

For additional information, refer to “ Note 22 – Subsequent Events ” of “Notes to Consolidated Financial Statements” in Item 8.

Financial Statements and Supplementary Data .

We have not received any notices of regulatory actions as of March 13, 2020 .

We evaluated subsequent events after December 31, 2020 through the date our consolidated financial statements were issued for potential recognition and disclosure.

No subsequent events require financial statement recognition or disclosure between December 31, 2020 and the date our consolidated financial statements were issued.

We have not received, nor are aware of, any notices of regulatory actions as of March 9, 2021.

CRITICAL ACCOUNTING POLICIES

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Financial Statements and Supplementary Data.

Of these significant accounting policies, we consider our policies regarding the ALLL , acquisition intangibles and goodwill, the determination of the fair value and assessment of OTTI of investment securities, and equity securities without readily determinable fair values related to our joint venture investment in CSS to be our most critical accounting policies.

Of these significant accounting policies, we consider our policies regarding the ALLL, acquisition intangibles and goodwill, and the determination of the fair value and assessment of OTTI of investment securities to be our most critical accounting policies.

The ALLL requires our most subjective and complex judgment.

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In other cases, where the value is not easily determined, we consult with independent experts to determine the fair value of the identified asset or liability.

Once valuations have been adjusted, the net difference between the price paid for the acquired entity and the net value of assets acquired on our balance sheet, including identifiable intangibles, is recorded as goodwill.

Once valuations have been determined, the net difference between the price paid for the acquired entity and the net value of assets acquired on our balance sheet, including identifiable intangibles, is recorded as goodwill.

Acquisition intangibles and goodwill are qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired on at least an annual basis.

During the fourth quarter of 2020, we engaged a third-party valuation firm to perform a quantitative analysis of goodwill as of December 31, 2020.

In determining the fair value of the Bank and Isabella Bank Corporation, the third-party firm assessed general economic conditions, industry and market considerations, the impact of recent events to financial performance, the market price of our common stock, and other relevant events.

Based on the valuation prepared, it was determined that our estimated fair values of the Bank and Isabella Bank Corporation at December 31, 2020 were greater than our recorded book value and no impairment of goodwill was identified.

The carrying amount of goodwill as of December 31, 2020 relied on assumptions and use of estimates pursuant to the valuations obtained.

AFS securities are carried at fair value with changes in the fair value included as a component of other comprehensive income.

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Municipal securities for which no readily determinable market values are available are priced using fair value curves which most closely match the securities' characteristics.

Our joint venture investment in CSS was made in the 1st quarter of 2008 and is included in equity securities without readily determinable fair values on our consolidated balance sheets.

We are not the managing entity of CSS but do appoint 50% of the Board of Directors of CSS .

As a 50% investor of the membership units, we account for our investment in this entity under the equity method of accounting.

The General Manager of CSS , through the normal course of business, chose to evaluate operations of the company and obtained an independent, third-party valuation of the company during the fourth quarter of 2019.

As a result of this valuation, CSS recognized an impairment related to intangible assets as of December 31, 2019 .

Accordingly, we reduced our investment in CSS and as such, our recorded investment in CSS as of December 31, 2019 relied on assumptions and use of estimates pursuant to the valuation obtained.

Average Balances, Interest Rates, and Net Interest Income

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These schedules also present an analysis of interest income and interest expense for the periods indicated.

All interest income is reported on a FTE basis using a federal income tax rate of 21% in 2019 and 2018 and 34% in 2017.

All interest income is reported on a FTE basis using a federal income tax rate of 21%.

Loans in nonaccrual status, for the purpose of the following computations, are included in the average loan balances.

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Year Ended December 31

2020 2019 2018

Interest Average

INTEREST EARNING ASSETS

Loans $ 1,236,169 $ 54,102 4.38 % $ 1,162,210 $ 54,192 4.66 % $ 1,120,021 $ 49,229 4.40 %

Taxable investment securities (1)

229,468 5,214 2.27 % 296,758 7,185 2.42 % 341,095 8,294 2.43 %

Nontaxable investment securities 140,665 5,189 3.69 % 169,049 6,380 3.77 % 191,281 7,115 3.72 %

Fed funds sold 4 — 0.06 % 64 2 2.48 % 4 — — %

Other 142,717 1,026 0.72 % 38,549 1,199 3.11 % 28,255 1,062 3.76 %

Total earning assets 1,749,023 65,531 3.75 % 1,666,630 68,958 4.14 % 1,680,656 65,700 3.91 %

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Accrued income and other assets 118,195 108,073 95,359

Total assets $ 1,909,214 $ 1,813,539 $ 1,816,040

INTEREST BEARING LIABILITIES

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Demand deposits 320,820 237,675 224,777

Other 15,613 13,337 7,597

Shareholders’ equity 220,655 208,503 193,244

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We exert some control over these factors;

however, FRB monetary policy and competition have a significant

however, FRB monetary policy and competition have a significant impact.

For analytical purposes, net interest income is adjusted to an FTE basis by including the income tax savings from interest on tax exempt loans and nontaxable investment securities, thus making year to year comparisons more meaningful.

The FTE adjustment is based on a federal income tax rate of 21% for 2019 and 2018 and 34% for 2017.

The FTE adjustment is based on a federal income tax rate of 21%.

Volume and Rate Variance Analysis

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Rate—change in the FTE rate multiplied by the previous period's volume.

All interest income presented in the table below is reported on a FTE basis using a federal income tax rate of 21% for 2019 and 2018 and 34% for 2017.

All interest income presented in the table below is reported on a FTE basis using a federal income tax rate of 21%.

The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

2020 Compared to 2019

Increase (Decrease) Due to

2018 Compared to 2017

Increase (Decrease) Due to 2019 Compared to 2018

Increase (Decrease) Due to

Volume Rate Net Volume Rate Net

Changes in interest income

Loans $ 3,341 $ (3,431) $ (90) $ 1,898 $ 3,065 $ 4,963

Taxable investment securities (1,550) (421) (1,971) (1,074) (35) (1,109)

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Fed Funds Sold (1) (1) (2) — 2 2

Other 1,301 (1,474) (173) 342 (205) 137

Total changes in interest income 2,041 (5,468) (3,427) 328 2,930 3,258

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Net change in interest margin (FTE) $ 3,614 $ (3,005) $ 609 $ 1,385 $ (357) $ 1,028

The flattening of the yield curve and rising deposit rates continues to place pressure on our net interest margin.

Despite this pressure, we experienced improvement as a result of improved loan yields and a decline in higher-cost deposits and borrowings.

The flattening of the yield curve continues to place pressure on our net interest margin.

Despite this pressure, we experienced improvement as a result of a decline in higher-cost deposits and borrowings.

Average Yield / Rate for the Three-Month Periods Ended:

2020 September 30

2020 March 31

2020 December 31

Total earning assets 3.66 % 3.61 % 3.74 % 3.99 % 4.13 %

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Quarter to Date Net Interest Income (FTE)

2020 September 30

2020 March 31

2020 December 31

Total interest income (FTE) $ 16,722 $ 16,027 $ 16,216 $ 16,566 $ 17,245

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The ALLL is our estimation of incurred losses within the existing loan portfolio.

We allocate the ALLL throughout the loan portfolio based on our assessment of the underlying risks associated with each loan segment.

Our assessments include allocations based on specific impairment valuation allowances, historical charge-off s, internally assigned credit risk ratings, and past due and nonaccrual balances.

We allocate the ALLL throughout the loan portfolio based on our assessment of the underlying risks associated within each loan segment.

Our assessments include allocations based on specific impairment valuation allowances, historical charge-offs, internally assigned credit risk ratings, and past due and nonaccrual balances.

A portion of the ALLL is not allocated to any one loan segment, but is instead a representation of other qualitative risks that reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

The following table summarizes our charge-offs, recoveries, provision for loan losses, and ALLL balances as of, and for the unaudited three month periods ended:

2020 September 30

2020 March 31

2020 December 31

Total charge-offs $ 111 $ 46 $ 66 $ 158 $ 334

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Provision for loan losses to average loans outstanding 0.02 % 0.04 % 0.01 % 0.07 % — %

ALLL $ 9,744 $ 9,506 $ 8,877 $ 8,697 $ 7,939

ALLL as a % of loans at end of period 0.79 % 0.73 % 0.69 % 0.74 % 0.67 %

The following table summarizes our charge-off and recovery activity for the years ended December 31:

2020 2019 2018 2017 2016

ALLL at beginning of period $ 7,939 $ 8,375 $ 7,700 $ 7,400 $ 7,400

Commercial 7 143 575 263 57

Agricultural 24 240 51 2 —

Residential real estate 28 99 151 200 574

Consumer 322 466 324 306 285

Total charge-offs 381 948 1,101 771 916

Commercial 149 123 325 449 445

Agricultural 39 3 3 4 95

Residential real estate 136 189 261 206 287

Consumer 197 167 209 159 224

Total recoveries 521 482 798 818 1,051

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ALLL as a % of loans at end of period 0.79 % 0.67 % 0.74 % 0.71 % 0.73 %

While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remains strong.

Overall, our level of required reserve is modest, in comparison to peer banks, due to strong credit quality indicators, low historical loss factors, and a low amount of net charge-offs.

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

While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong at December 31, 2020.

The COVID-19 pandemic led to some temporary and permanent closures of businesses throughout the communities in which we serve, which resulted in increased unemployment.

We increased the ALLL during the year as a result of increased economic and environmental related risk factors, primarily driven by COVID-19.

The economic impact from the COVID-19 pandemic could pose significant credit risk due to the potential inability of consumer and commercial borrowers to make contractual payments.

In late March 2020, we implemented payment programs for borrowers to alleviate the financial setback due to the temporary closure of businesses and lost wages.

These programs, along with the SBA PPP, could mask or delay the detection and reporting of deterioration in credit quality indicators.

We continue to monitor the economic impact from COVID-19 as it relates to credit risk to ensure the ALLL is appropriate.

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

2020 September 30

2020 March 31

2020 December 31

Individually evaluated for impairment $ 911 $ 869 $ 950 $ 1,309 $ 1,114

Collectively evaluated for impairment 8,833 8,637 7,927 7,388 6,825

Total $ 9,744 $ 9,506 $ 8,877 $ 8,697 $ 7,939

ALLL to gross loans

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Collectively evaluated for impairment 0.72 % 0.66 % 0.62 % 0.63 % 0.58 %

The level of the ALLL is appropriate as of December 31, 2019 .

Total 0.79 % 0.73 % 0.69 % 0.74 % 0.67 %

While we utilize our best judgment and information available, the ultimate adequacy of the ALLL is dependent upon a variety of factors beyond our control, including the performance of our borrowers, the economy, and changes in interest rates.

We closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at an appropriate level.

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Total Past Due and Nonaccrual Loans as of December 31

2020 2019 2018 2017 2016

Commercial $ 2,148 $ 2,477 $ 2,722 $ 2,518 $ 3,347

Agricultural 3,786 4,285 5,377 2,367 1,251

Residential real estate 3,580 4,572 3,208 4,881 2,716

Consumer 96 71 105 70 115

Total $ 9,610 $ 11,405 $ 11,412 $ 9,836 $ 7,429

Total past due and nonaccrual loans to gross loans 0.78 % 0.96 % 1.01 % 0.90 % 0.74 %

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Troubled Debt Restructurings

We have taken a proactive approach to avoid foreclosures on borrowers who are willing to work with us in modifying their loans, thus making them more affordable.

We have taken a proactive approach to modifying loans to assist borrowers who are willing to work with us, thus making them less likely to default, and to avoid foreclosure.

This approach has permitted certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure.

The modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures.

Modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures.

The majority of new modifications result in terms that satisfy our criteria for continued interest accrual.

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We restructure debt with borrowers who due to financial difficulties are unable to service their debt under the original terms.

We may extend the amortization period, reduce interest rates, allow interest only payment structures, forgive principal, forgive interest, or grant a combination of these modifications.

We may extend the amortization period, reduce interest rates, allow temporary interest-only payment structures, forgive principal, forgive interest, or grant a combination of these modifications.

Typically, the modifications are for a period of three years or less.

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The following table provides a roll-forward of TDRs for the years ended December 31, 2019 and 2020:

Accruing Interest

Accruing Interest Nonaccrual Total

Loans Balance Number

Loans Balance

January 1, 2019 133 $ 23,400 28 $ 3,551 161 $ 26,951

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Partial charge-offs — — — (65) — (65)

Balances charged-off

Transfers to OREO — — (1) (48) (1) (48)

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The following table summarizes our TDRs as of December 31:

2020 2019 2018

Interest Nonaccrual Total Accruing

Interest Nonaccrual Total

Current $ 22,017 $ 2,421 $ 24,438 $ 20,847 $ 507 $ 21,354 $ 21,794 $ 2,673 $ 24,467

Past due 30-59 days 183 — 183 346 — 346 899 — 899

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Past due 90 days or more — 309 309 — 3,036 3,036 — 878 878

Total $ 22,200 $ 2,730 $ 24,930 $ 21,194 $ 3,543 $ 24,737 $ 23,400 $ 3,551 $ 26,951

Interest Nonaccrual Total Accruing

Interest Nonaccrual Total

Current $ 21,234 $ — $ 21,234 $ 17,557 $ 559 $ 18,116

Past due 30-59 days 1,778 805 2,583 2,898 230 3,128

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Past due 90 days or more 53 1,400 1,453 — — —

Total $ 23,284 $ 2,913 $ 26,197 $ 20,593 $ 789 $ 21,382

Additional disclosures about TDRs are included in “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8.

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The following is a summary of information pertaining to impaired loans as of December 31:

Balance Unpaid

Balance Valuation

Allowance Recorded

Balance Unpaid

Balance Valuation

Commercial real estate $ 4,915 $ 5,169 $ 79 $ 5,325 $ 5,643 $ 15

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Residential real estate senior liens 3,878 4,073 692 4,641 4,923 922

Residential real estate junior liens

Home equity lines of credit — — — 12 312 —

Consumer secured

Total TDRs 24,930 25,379 832 24,737 25,636 963

Other impaired loans

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The following table summarizes our nonperforming assets as of December 31:

2020 2019 2018 2017 2016

Nonaccrual status loans $ 5,313 $ 6,535 $ 7,260 $ 3,027 $ 1,060

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Foreclosed assets 527 456 355 291 231

Debt securities 230 230 230 230 230

Total nonperforming assets $ 6,070 $ 7,221 $ 7,958 $ 3,943 $ 2,154

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Loans may be placed back on accrual status after six months of continued performance and achievement of current payment status.

While the level of nonperforming loans has fluctuated in recent periods, it remains low relative to gross loans.

Recent fluctuations in nonaccrual loans have been concentrated in our agricultural portfolio as a result of the challenges facing much of the agricultural industry.

While the level of nonperforming loans has fluctuated in recent periods, it remains low in comparison to peer banks.

The following table summarizes nonaccrual loans as of December 31:

2020 2019 2018 2017 2016

Commercial $ 1,329 $ 1,621 $ 1,757 $ 729 $ 4

Agricultural 3,785 4,285 4,949 1,950 533

Residential real estate 199 629 554 348 523

Total $ 5,313 $ 6,535 $ 7,260 $ 3,027 $ 1,060

Included in the nonaccrual loan balances above were loans also classified as TDR as of December 31:

2020 2019 2018 2017 2016

Commercial $ 129 $ 390 $ 160 $ 729 $ —

Agricultural 2,559 3,048 3,391 1,950 405

Residential real estate 42 105 — 234 384

Total $ 2,730 $ 3,543 $ 3,551 $ 2,913 $ 789

Additional disclosures about nonaccrual status loans are included in “Note 4 – Loans and ALLL”of “Notes to Consolidated Financial Statements” in Item 8.

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Significant noninterest income balances are highlighted in the following table for the years ended December 31:

Change Change

2020 2019 $ % 2018 $ %

Service charges and fees

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Freddie Mac servicing fee 625 626 (1) (0.16) % 651 (25) (3.84) %

Net OMSR income (loss)

Net OMSR income (loss) 44 (170) 214 N/M 25 (195) (780.00) %

Other fees for customer services 305 324 (19) (5.86) % 370 (46) (12.43) %

Total service charges and fees 6,544 6,347 197 3.10 % 6,210 137 2.21 %

Investment and Trust advisory fees

Earnings on corporate owned life insurance policies

Net gain on sale of mortgage loans 2,716 650 2,066 317.85 % 525 125 23.81 %

Net gains on foreclosed assets

Net gains on sale of AFS securities

Net income (loss) on joint venture investment

Wealth management fees 2,578 2,792 (214) (7.66) % 2,836 (44) (1.55) %

Gains from redemption of corporate owned life insurance policies 891 — 891 N/M — — — %

Earnings on corporate owned life insurance policies 755 764 (9) (1.18) % 742 22 2.96 %

Net income (loss) on joint venture investment 577 (3,108) 3,685 N/M 274 (3,382) N/M

Other 362 594 (232) (39.06) % 394 200 50.76 %

Total noninterest income $ 14,423 $ 8,039 $ 6,384 79.41 % $ 10,981 $ (2,942) (26.79) %

Significant changes in noninterest income are detailed below:

ATM and debit card fees fluctuate from period to period based primarily on usage of ATM and debit cards.

ATM and debit card fees fluctuate from period to period based primarily on their usage.

While we do not anticipate significant changes to our ATM and debit card fee structure, we do expect that fee income will continue to increase in 2021 as the usage of ATM and debit cards continues to increase.

Service charges and fees on deposit accounts declined in 2020 as a result of waived fees.

In response to COVID-19, which has led to an increase in the need for electronic services and products, we elected to temporarily waive certain charges and fees, and permanently remove some charges and fees, to ease the financial stress of our customers.

As such, we expect service charges and fees in 2021 to approximate 2020 levels.

OMSR income results are driven, in part, by changes in offering rates on residential mortgage loans, anticipated prepayments in the servicing-retained portfolio, and the volume of loans within the servicing-retained portfolio.

As a result of these factors, OMSR income during 2020 could experience fluctuations and could vary from 2019 levels.

Net gain on sale of mortgage loans fluctuates primarily as the result of a change in the amount of loans sold, and the amount of loans sold can fluctuate based on balance sheet management strategy.

As such, net gain on sale of mortgage loans will continue to fluctuate in 2020.

Net gains on foreclosed assets fluctuate from time to time and are based on the level of activity in foreclosures, properties owned, and changes in market values of properties owned.

While we do not anticipate a significant change in activity or market values, net gains may continue to fluctuate in 2020 and may not exceed net gains in 2019.

We are continually analyzing our AFS securities portfolio for potential sale opportunities.

Securities with unrealized gains or less than desirable yields may be sold for funding and profitability purposes.

During 2017 and 2019, we identified $12,827 and $33,840 , respectively, in securities that were desirable to be sold and recognized net gains with these sales of $142 and $6 , respectively.

We anticipate taking this same approach of analyzing our AFS securities portfolio for potential sale opportunities in 2020.

Increased prepayment speeds, as a result of a decline in interest rates during the first quarter of 2020, were the primary driver of the losses recognized during the first half of 2020.

During the second half of 2020, the volume of loans serviced increased which resulted in an increase in the value of the servicing rights.

OMSR income during 2021 may continue to experience fluctuations and could vary from 2020 levels.

Net gain on sale of mortgage loans fluctuates as the result of a change in the amount of loans sold and pricing.

The amount of loans sold is driven by customer demand and balance sheet management strategies.

We experienced a significant increase in loan demand during 2020 which led to an increase in the number and dollar amount of loans sold during the year.

As such, net gain on sale of mortgage loans increased significantly.

As demand is expected to slow during 2021, net gain on sale of mortgage loans is not expected to exceed 2020 levels.

The decrease in wealth management fees, primarily during the first quarter of 2020, was driven by a decline in the stock market causing the value of investment assets under management to decrease.

While strategic additions in staffing have already led to new business within Isabella Wealth, wealth management fees during 2021 may not exceed 2020 levels due to the uncertainty in the stock market as a result of COVID-19.

We recognized income during 2020 due to the redemption of corporate owned life insurance policies in connection with the passing of three retired bank employees.

We sold our membership interest in our joint venture investment in CSS during the fourth quarter of 2020, which resulted in a $394 reduction in income.

As a result of a valuation during the fourth quarter of 2019, CSS recognized a $7,133 impairment related to intangible assets as of December 31, 2019.

Since we account for our investment in CSS under the equity method of accounting, we reduced our investment in CSS by $3,566 during the fourth quarter of 2019.

Since we accounted for our investment in CSS under the equity method of accounting, we reduced our investment in CSS by $3,566 during the fourth quarter of 2019.

The fluctuations in all other income are spread throughout various categories, none of which are individually significant.

Significant noninterest expense balances are highlighted in the following table for the years ended December 31:

Change Change

2020 2019 $ % 2018 $ %

Compensation and benefits $ 23,772 $ 23,205 $ 567 2.44 % $ 22,609 $ 596 2.64 %

Losses on extinguishment of debt 7,643 — 7,643 N/M — — — %

Furniture and equipment 5,787 5,866 (79) (1.35) % 6,055 (189) (3.12) %

Occupancy 3,557 3,418 139 4.07 % 3,263 155 4.75 %

Audit, consulting, and legal fees 1,836 1,884 (48) (2.55) % 2,222 (338) (15.21) %

ATM and debit card fees 1,441 1,210 231 19.09 % 1,036 174 16.80 %

Donations and community relations

Marketing costs 877 762 115 15.09 % 596 166 27.85 %

Loan underwriting fees 825 905 (80) (8.84) % 1,016 (111) (10.93) %

Donations and community relations 723 1,026 (303) (29.53) % 710 316 44.51 %

Director fees 695 788 (93) (11.80) % 858 (70) (8.16) %

Marketing costs

FDIC insurance premiums 612 211 401 190.05 % 726 (515) (70.94) %

All other 3,465 3,775 (310) (8.21) % 3,761 14 0.37 %

Total other 10,474 10,561 (87) (0.82) % 10,925 (364) (3.33) %

Total noninterest expenses $ 51,233 $ 43,050 $ 8,183 19.01 % $ 42,852 $ 198 0.46 %

Significant changes in noninterest expenses are detailed below:

The compensation and benefits expense increase from 2018 to 2019 is primarily related to our employee incentive plans.

The increase in 2018 from 2017 resulted significantly from a settlement with an insurance claim administrator in favor of Isabella Bank, which reduced 2017 benefits expense.

Compensation and benefits expense in 2020 may not approximate 2019 levels as expenses related to our employee incentive plans fluctuate based on financial performance.

Furniture and equipment expense consists primarily of depreciation, services contracts and computer expenses.

Computer expense increased in 2018 due to data and system upgrades, additional network security costs, and one-time implementation costs and therefore, exceeded expenses in 2019 and 2017.

Expenses in 2020 are expected to approximate 2019 levels.

During the fourth quarter of 2020, we incurred expense of $7,643 as a result of the extinguishment of $100,000 of FHLB advances.

Audit, consulting, and legal fees in 2018 included one-time charges related to income tax strategies.

As a result, 2019 expenses were less than 2018 expenses.

Audit, consulting, and legal fees are expected to approximate 2019 levels in 2020.

In 2018, we developed initiatives to increase ATM and debit card income which resulted in increased ATM and debit card expenses during 2018 and 2019.

Expenses in 2017 included a one-time early termination fee with a card provider.

ATM and debit card expenses are expected to approximate 2019 levels in 2020.

Donations and community relations increased during 2019 as a result of initiatives designed to deepen and strengthen our relationship with the communities in which we operate and serve which includes an expanded footprint.

In addition to providing monetary contributions, some of these initiatives include volunteering our time, which is not a component of donations and community relations costs.

Expenses in 2020 are expected to approximate 2019 levels.

As a result, 2020 and 2019 expenses were less than 2018 expenses.

We have experienced increased usage of ATM and debit cards which has resulted in increased income and also increased ATM and debit card expenses.

Based on the anticipated continuation of increased ATM and debit card usage, we expect expenses to increase in 2021.

Loan underwriting fees increased during the second half of 2018 and continued in the first quarter of 2019 as a result of new loan products, including first time home buyer and down payment assistance programs designed to generate residential mortgage growth.

Loan underwriting fees in 2019 did not exceed 2018 levels based on the nature of products offered during 2019.

Additionally, loan underwriting fees in 2020 are not expected to exceed 2019 levels.

As a result of an assessment credit of $440, received during the third quarter of 2019, FDIC insurance premiums declined in 2019 as compared to 2018 expenses.

As such, FDIC insurance premiums are expected to increase in 2020 and approximate 2018 levels.

Additionally, loan underwriting fees in 2020 did not exceed 2019 levels.

Fees in 2021 are expected to approximate 2020 levels.

Donations and community relations increased during 2019 as a result of initiatives designed to deepen and strengthen our relationship with the communities in which we operate and serve.

In addition to providing monetary contributions, some of these initiatives include volunteering our time, which is not a component of donations and community relations costs.

Government restrictions and temporary business closures related to COVID-19 impacted our ability to maintain their level of support in 2020.

Donations and community relations is expected to approximate 2020 levels in 2021.

As a result of an assessment credit of $440 received during the third quarter of 2019, FDIC insurance premiums declined in 2019 as compared to 2020 and 2018 expenses.

FDIC insurance premiums in 2021 are expected to approximate 2020 levels.

All other expenses declined during 2020 primarily as a result of reduced employee education and travel expenses.

Due to COVID-19, many events were cancelled or offered at no cost.

While education and travel expenses in 2021 are expected to exceed 2020 levels, expenses are not expected to resume normal levels and as a result, total all other expenses are not expected to resume normal levels.

The fluctuations in all other expenses are spread throughout various categories, none of which are individually significant.

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The following table shows the composition and changes in our balance sheet as of December 31:

Cash and cash equivalents

2020 2019 $ %

Cash and cash equivalents $ 246,640 $ 60,572 $ 186,068 N/M

AFS securities

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AFS securities 339,228 429,839 (90,611) (21.08) %

Mortgage loans AFS

Mortgage loans AFS 2,741 904 1,837 N/M

Gross loans 1,238,311 1,186,570 51,741 4.36 %

Less allowance for loan and lease losses 9,744 7,939 1,805 22.74 %

Net loans 1,228,567 1,178,631 49,936 4.24 %

Premises and equipment 25,140 26,242 (1,102) (4.20) %

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Goodwill and other intangible assets 48,331 48,379 (48) (0.10) %

Other assets 14,174 11,491 2,683 23.35 %

TOTAL ASSETS $ 1,957,378 $ 1,812,643 $ 144,735 7.98 %

LIABILITIES AND SHAREHOLDERS’ EQUITY

Deposits $ 1,566,317 $ 1,313,851 $ 252,466 19.22 %

Borrowed funds 158,747 275,999 (117,252) (42.48) %

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TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $ 1,957,378 $ 1,812,643 $ 144,735 7.98 %

As shown above, total assets declined $28,304 since December 31, 2018, primarily driven by a decline in cash and cash equivalents and AFS securities which was partially offset by continued loan growth.

In the current interest rate environment, we have elected to use excess funds and proceeds from the sale of AFS securities to lend and reduce borrowed funds.

As a result, the investment portfolio declined due to sales and normal calls and maturities.

We experienced a $57,863 increase in loans during 2019 which was largely driven by growth in our commercial loan portfolio.

A discussion of changes in balance sheet amounts by major categories follows:

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Included in cash and cash equivalents are funds held with the FRB which fluctuate from period to period.

Cash levels continued to be elevated at December 31, 2019 .

During 2019, excess funds were used to pay maturing long-term borrowings and other short-term liabilities, which is expected to continue in 2020.

Cash levels increased significantly during 2020 as a result of increased monthly prepayments and payoffs of AFS securities, funding from the SBA for PPP loan forgiveness, and an increase in customer deposits.

During 2020, excess funds were used to pay maturing long-term borrowings, extinguish long-term borrowings, and pay other short-term liabilities.

Payments for maturing borrowings is expected to continue in 2021.

AFS securities

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Secondary considerations include providing earnings and liquidity while managing our overall exposure to changes in interest rates.

The current flat yield curve encourages using excess funds to reduce higher-cost borrowings and therefore, AFS securities balances are not expected to rise significantly in the near term as a result of the current rate environment.

Over the last two years, the flat yield curve encouraged the use of excess funds to reduce higher-cost borrowings as opposed to investing in AFS securities.

However, based on balance sheet strategies, excess funds above what is required to retire higher-cost funding sources may prudently be deployed to purchase of AFS securities in future periods.

The following is a schedule of the carrying value of AFS securities as of December 31:

2020 2019 2018

Government sponsored enterprises $ — $ — $ 170

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Collateralized mortgage obligations 101,983 116,764 116,760

Corporate 1,700 — —

Total $ 339,228 $ 429,839 $ 494,834

Excluding those holdings in government sponsored enterprises and municipalities within the State of Michigan, there were no investments in securities of any one issuer that exceeded 10% of shareholders’ equity during 2020, 2019, and 2018.

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Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

Securities with

One Year After One

Five Years After Five

Ten Years After

Ten Years Securities with

Variable Monthly

Noncontractual

Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%) Amount Yield (%)

States and political subdivisions $ 23,922 2.36 $ 65,462 3.25 $ 25,290 3.97 $ 28,982 3.69 $ — —

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Auction rate money market preferred — — — — — — — — 3,237 6.27

Corporate — — — — 1,700 5.00 — — — —

Total $ 23,922 2.36 $ 65,462 3.25 $ 26,990 4.04 $ 28,982 3.69 $ 193,872 2.25

Loans are the largest component of earning assets.

The proper management of credit and market risk inherent in the loan portfolio is critical to our financial well-being.

To control these risks, we have adopted strict underwriting standards which include lending limits to a single borrower, loan to collateral value limits, and a defined market area.

The proper management of credit and market risk inherent in the loan portfolio is critical to our financial stability.

To control these risks, we have adopted strict underwriting standards, lending limits to a single borrower, loan to collateral value limits, and a defined market area.

We also monitor and limit loan concentrations to specific industries.

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The following table presents the composition of the loan portfolio for the years ended December 31:

2020 2019 2018 2017 2016

Commercial $ 756,686 $ 700,941 $ 659,529 $ 634,759 $ 575,664

Agricultural 100,461 116,920 127,161 128,269 126,492

Residential real estate 307,543 298,569 275,343 272,368 266,050

Consumer 73,621 70,140 66,674 56,123 42,409

Total $ 1,238,311 $ 1,186,570 $ 1,128,707 $ 1,091,519 $ 1,010,615

The following table presents the change in the loan portfolio categories for the years ended December 31:

2020 2019 2018

$ Change % Change $ Change % Change $ Change % Change

Commercial $ 55,745 7.95 % $ 41,412 6.28 % $ 24,770 3.90 %

Agricultural (16,459) (14.08) % (10,241) (8.05) % (1,108) (0.86) %

Residential real estate 8,974 3.01 % 23,226 8.44 % 2,975 1.09 %

While the competition for commercial loan opportunities continues to be strong, we experienced growth in this segment of the portfolio during 2019.

Contributing to our $41,412 growth in commercial loans was $23,730 in advances to mortgage brokers.

We expect continued growth in the commercial loan portfolio in 2020 as we will continue to provide attractive and competitive loan products.

Over the last 12 months, agricultural loans have declined;

however, we do not expect this trend to continue into 2020.

Consumer 3,481 4.96 % 3,466 5.20 % 10,551 18.80 %

Total $ 51,741 4.36 % $ 57,863 5.13 % $ 37,188 3.41 %

Loan demand has been negatively impacted by the pandemic and competition for new commercial loan opportunities continues to be strong.

Growth in the commercial loan portfolio during 2020 was driven by SBA PPP loans.

While we expect loan forgiveness on the remaining SBA PPP loans during 2021, we are still expecting overall growth during 2021 within the commercial portfolio as we continue to provide attractive and competitive loan products.

Agricultural loans continued to decline in 2020 due to the competitive environment.

Residential real estate and consumer loans have experienced growth over the last year and continued growth is expected in 2021.

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Included in equity securities without readily determinable fair values are restricted securities, which are carried at cost, and our joint venture investment in CSS accounted for under the equity method of accounting.

As of December 31, 2019 , we reduced our investment in CSS by $3,566 as a result of an impairment recognized by CSS during the fourth quarter of 2019.

We sold our membership interest in CSS during the fourth quarter of 2020, which reduced equity securities without readily determinable fair values $4,246 when compared to December 31, 2019.

For more information related to this investment, refer to “Note 1 – Nature of Operations and Summary of Significant Accounting Policies”, “Note 6 – Investment in Joint Venture”, and “Note 18 – Fair Value” of “Notes to Consolidated Financial Statements” in Item 8.

Financial Statements and Supplementary Data.

Other assets consist primarily of prepaid expenses, OMSR , and net deferred tax assets.

Changes in deferred taxes and income taxes receivable have largely contributed to the $4,586 decline in other assets during 2019 .

Goodwill and other intangible assets

Goodwill represents the excess of the amounts paid to acquire subsidiaries over the fair value of their net assets at the date of acquisition.

The majority of the recorded goodwill is related to acquisitions of other banks, which were subsequently merged into Isabella Bank.

If it is determined that the goodwill is impaired, a write-down of goodwill by the amount of the impairment would be required.

The decline in economic conditions, as a result of the COVID-19 pandemic and other factors, led to a significant decline in the stock market causing the value of investments, including our stock, to decline.

Our stock price was negatively impacted in March 2020, which continued during most of 2020.

Since the price of our stock increased but had not fully recovered through the fourth quarter, we decided to engage a reputable, third-party valuation firm to perform a quantitative analysis of goodwill as of December 31 , 2020.

Based on the valuation prepared, it was determined that our

estimated fair values of the Bank and Isabella Bank Corporation at Dece mber 31, 2020 were greater than our recorded book value and no impairment of goodwill was identified.

Furthermore, management noted that despite the decline of the market capitalization as a result of the COVID-19 pandemic, our financial performance remained positive.

This is evidenced by our financial results, strong credit quality indicators, increased liquidity position, as well as the strong capital position.

Finally, by the end of the fourth quarter, our stock price had increased to levels consistent with prices prior to the second quarter of 2020.

Based on these factors and the results of the independent quantitative analysis of goodwill, management concluded that it was more likely than not that there was no goodwill impairment as of December 31, 2020.

Other assets consist primarily of prepaid expenses, OMSR, receivables, and net deferred tax assets.

As a result of the sale in our joint venture investment in CSS, we recorded a $3,227 receivable related to this transaction.

For more information related to estimates and deferred taxes, refer to “Note 1 – Nature of Operations and Summary of Significant Accounting Policies” and “Note 16 – Federal Income Taxes” of “Notes to Consolidated Financial Statements” in Item 8.

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The following table presents the composition of the deposit portfolio as of December 31:

2020 2019 2018

Noninterest bearing demand deposits $ 375,395 $ 249,152 $ 236,534

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Internet certificates of deposit 10,787 15,112 13,345

Total $ 1,566,317 $ 1,313,851 $ 1,292,693

The following table presents the change in the deposit categories for the years ended December 31:

$ Change % Change $ Change % Change

Noninterest bearing demand deposits $ 126,243 50.67 % $ 12,618 5.33 %

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Internet certificates of deposit (4,325) (28.62) % 1,767 13.24 %

While total deposits have fluctuated over the past year, we experienced growth in non-contractual deposits, such as noninterest bearing demand and savings deposits.

This trend is expected to continue in 2020 as we anticipate continued growth in noninterest bearing demand and savings deposits.

We also experienced marginal growth in certificates of deposit over the past year.

Total $ 252,466 19.22 % $ 21,158 1.64 %

Total deposits have increased over the past 12 months with significant growth in non-contractual deposits, such as demand and savings deposits.

This trend is anticipated to continue during 2021 as the financial markets continue to exhibit significant signs of instability.

Additionally, government stimulus programs have driven growth in deposits.

We experienced a decline in certificates of deposit over the past year as a result of the low interest rate environment.

Brokered certificates of deposit offer another source of funding and may fluctuate from period to period based on our funding needs, including changes in assets such as loans and investments.

In recent periods, we used excess funds to reduce higher-cost deposits, such as brokered certificates of deposit and expect this trend to continue in 2020.

During 2019 and 2020, we used excess funds to reduce higher-cost deposits, such as brokered certificates of deposit.

This trend is expected to continue into 2021.

The remaining maturity of certificates of deposit of $250 or more as of December 31, 2020 was as follows:

3 unchanged sentences

Over 12 months 29,184

Total $ 107,192

Borrowed Funds

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To provide balance sheet growth, we may utilize borrowings and brokered deposits to fund earning assets.

We had no fed funds purchased for the years ended December 31, 2019 , 2018 , or 2017 .

The following table presents borrowed funds balances for the years ended December 31:

2020 2019 2018

FHLB advances $ 90,000 $ 245,000 $ 300,000

Securities sold under agreements to repurchase without stated maturity dates 68,747 30,999 40,299

Total $ 158,747 $ 275,999 $ 340,299

During the fourth quarter of 2020, we elected to extinguish $100,000 of FHLB advances based on our level of cash reserves and strategic initiatives.

Due to a significant increase in deposit accounts during the fourth quarter of 2020, our level of securities sold under agreements to repurchase increased as of December 31, 2020.

We believe this to be a short-term increase and expect the balance of securities sold under agreements to repurchase to decline in the first half of 2021.

We had no fed funds purchased for the years ended December 31, 2020, 2019, or 2018.

For additional disclosure related to borrowed funds, see “Note 9 – Borrowed Funds” of “Notes to Consolidated Financial Statements” in Item 8.

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Pursuant to these authorizations, we issued 231,393 shares or $4,185 of common stock during 2020, and 209,583 shares or $4,876 of common stock in 2019.

We also offer the Directors Plan in which participants purchase stock units through deferred fees, in lieu of cash payments.

We offer the Directors Plan in which participants purchase stock units through deferred fees, in lieu of cash payments.

Pursuant to this plan, we increased shareholders’ equity by $413 and $523 during 2020 and 2019, respectively.

We also grant restricted stock awards pursuant to the RSP, effective June 24, 2020.

Pursuant to this plan, we increased shareholders’ equity by $14 during 2020.

We have a publicly announced common stock repurchase plan.

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Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital.

On July 2, 2013, the FRB published revised BASEL III Capital standards for banks.

The final rules redefined what is included or deducted from equity capital, changed risk weighting for certain on and off-balance sheet assets, increased the minimum required equity capital to be considered well capitalized, and introduced a capital conservation buffer.

The rules, which were gradually phased in between 2015 and 2019, did not have a material impact on the Corporation but do require us to hold more capital than we have historically.

Effective January 1, 2015, the minimum standard for primary, or Tier 1, capital increased from 4.00% to 6.00% .

The minimum standard for total capital is 8.00% .

Also effective January 1, 2015 was the new common equity tier 1 capital ratio which had a minimum requirement of 4.50% .

Beginning on January 1, 2016, the capital conservation buffer went into effect which increased the required levels.

The following table sets forth the minimum percentages required under the Risk Based Capital guidelines and our ratios as of December 31 :

Minimum Required - BASEL III

Required to be Considered Well Capitalized

Minimum Required - BASEL III

Required to be Considered Well Capitalized

The common equity tier 1 capital ratio has a minimum requirement of 4.50%.

The minimum standard for primary, or Tier 1 capital is 6.00% and the minimum standard for total capital is 8.00%.

The minimum requirements presented below include the minimum required capital levels based on the Basel III Capital Rules.

Capital requirements to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.

The following table sets forth these requirements and our ratios as of December 31:

Actual Minimum Required - BASEL III Required to be Considered Well Capitalized Actual Minimum Required - BASEL III Required to be Considered Well Capitalized

Common equity tier 1 capital 12.97 % 7.000 % 6.500 % 12.56 % 7.000 % 6.500 %

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Financial Statements and Supplementary Data.

Liquidity is monitored regularly by our Market Risk Committee, which consists of members of senior management.

Liquidity is monitored regularly by our ALCO, which consists of members of senior management.

The committee reviews projected cash flows, key ratios, and liquidity available from both primary and secondary sources.

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These categories totaled $444,051 or 22.69% of assets as of December 31, 2020 as compared to $291,190 or 16.06% as of December 31, 2019.

The increase in the percentage of primary liquidity is a direct result of an increase in market deposits and a reduction in non-market funding which required collateralization.

The increase in both the amount and percentage of primary liquidity is a direct result of an increase in market deposits and a

deliberate reduction in non-market funding which required collateralization.

Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends.

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As of December 31, 2020, we had available lines of credit of $214,625.

Our stress testing of liquidity increased during 2020 and continues to evolve due to economic uncertainly as a result of COVID-19.

Our liquidity position remained strong at the end of 2020 which is illustrated in the following table:

Total cash and cash equivalents $ 246,640

Available lines of credit

Fed funds lines with correspondent banks 93,000

FHLB borrowings 106,638

FRB Discount Window 9,987

Other lines of credit 5,000

Total available lines of credit 214,625

Unencumbered lendable value of FRB collateral, estimated 1

Total cash and liquidity $ 621,265

(1) Includes estimated unencumbered lendable value of FHLB collateral of $115,000

The following table summarizes our sources and uses of cash for the years ended December 31:

2020 2019 $ Variance

Net cash provided by (used in) operating activities $ 21,997 $ 23,303 $ (1,306)

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IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities.

IRR is the fundamental method by which financial institutions earn income and create shareholder value.

Managing IRR is the fundamental method by which financial institutions earn income and create shareholder value.

Excessive exposure to IRR could pose a significant risk to our earnings and capital.

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We have policies, procedures, and internal controls for measuring and managing these risks.

Specifically, our Funds Management policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments

in long-term assets, limiting the mismatch in repricing opportunities of assets and liabilities, and the frequency of measuring and reporting to our Board.

Specifically, our Funds Management policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long-term assets, limiting the mismatch in repricing opportunities of assets and liabilities, and the frequency of measuring and reporting to our Board of Directors.

The primary technique to measure IRR is simulation analysis.

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These forecasts are compared against net interest income projected in a stable interest rate environment.

While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior.

While many assets and liabilities reprice either at maturity or in

accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior.

Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences.

7 unchanged sentences

Residential real estate and consumer loans allow the borrower to repay the balance prior to maturity without penalty, while commercial and agricultural loans may have prepayment penalties.

The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current offering rates, the level of sales of used homes, and the overall availability of credit in the market place.

The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current offering rates, the level of home sales, and the overall availability of credit in the market place.

Generally, a decrease in interest rates will result in an increase in cash flows from these assets.

13 unchanged sentences

Also provided are the amounts due after one year, classified according to the sensitivity to changes in interest rates.

or Less 1 to 5

Commercial and agricultural $ 179,820 $ 374,313 $ 303,014 $ 857,147

3 unchanged sentences

Variable interest rates 61,863 186,464

Total $ 374,313 $ 303,014

Our primary market risk exposures related to the COVID-19 pandemic remain uncertain.

A review of our market risk methods are ongoing and modeling is incorporating additional assumptions to account for this uncertainty related to this crisis.

Repricing, cash flows, and prepayment projections for loans and mortgage-backed securities are not expected to behave as they would be expected to in a more stable interest rate environment.

The SBA PPP loan is a new instrument and has payment characteristics that are still uncertain.

In late March 2020, we implemented loan repayment programs for customers to alleviate the financial setback caused by the temporary closure of businesses and lost wages.

Under these programs, borrowers whose loans were in good standing as of March 1, 2020 could elect to defer full or partial payments for a short period of time.

Customer deposit levels may experience unusual fluctuations due to government support programs, customer and business needs, and general money supply.

We continue to closely monitor customer and economic indicators to develop more precise market risk assumptions as the economic impact of this crisis begins to reveal itself.

Quantitative and Qualitative Disclosures About Market Risk.

2 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis