Isabella Bank (ISBA) 10-Q 2017 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

ý Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2017

or

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

Commission File Number: 0-18415

Isabella Bank Corporation

(Exact name of registrant as specified in its charter)

Michigan	38-2830092
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
401 N. Main St, Mt. Pleasant, MI	48858
(Address of principal executive offices)	(Zip code)

(989) 772-9471

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ý  Yes    ¨  No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ý  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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	¨  (Do not check if a smaller reporting company)	Smaller reporting company	¨
		Emerging growth company	¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.			¨

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 7,853,629 as of October 31, 2017.

ISABELLA BANK CORPORATION

QUARTERLY REPORT ON FORM 10-Q

Table of Contents

PART I – FINANCIAL INFORMATION		4
Item 1.	Financial Statements	4
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	41
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	64
Item 4.	Controls and Procedures	64
PART II – OTHER INFORMATION		65
Item 1.	Legal Proceedings	65
Item 1A.	Risk Factors	65
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	65
Item 3.	Defaults Upon Senior Securities	65
Item 4.	Mine Safety Disclosures	65
Item 5.	Other Information	65
Item 6.	Exhibits	66
SIGNATURES		67

2

Forward Looking Statements

This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward looking statements to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, and are included in this statement for purposes of these safe harbor provisions. Forward looking statements, which are based on certain assumptions and describe future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, monetary and fiscal policy, the quality or composition of the loan or investment portfolios, demand for loan products, fluctuation in the value of collateral securing our loan portfolio, deposit flows, competition, demand for financial services in our market area, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward looking statements and undue reliance should not be placed on such statements. Further information concerning our business, including additional factors that could materially affect our financial results, is included in our filings with the SEC.

Glossary of Acronyms and Abbreviations

The acronyms and abbreviations identified below may be used throughout this Quarterly Report on Form 10-Q, or in our other SEC filings. You may find it helpful to refer back to this page while reading this report.

AFS: Available-for-sale	GAAP: U.S. generally accepted accounting principles
ALLL: Allowance for loan and lease losses	GLB Act: Gramm-Leach-Bliley Act of 1999
AOCI: Accumulated other comprehensive income	IFRS: International Financial Reporting Standards
ASC: FASB Accounting Standards Codification	IRR: Interest rate risk
ASU: FASB Accounting Standards Update	ISDA: International Swaps and Derivatives Association
ATM: Automated Teller Machine	JOBS Act: Jumpstart our Business Startups Act
BHC Act: Bank Holding Company Act of 1956	LIBOR: London Interbank Offered Rate
CFPB: Consumer Financial Protection Bureau	N/A: Not applicable
CIK: Central Index Key	N/M: Not meaningful
CRA: Community Reinvestment Act	NASDAQ: NASDAQ Stock Market Index
DIF: Deposit Insurance Fund	NASDAQ Banks: NASDAQ Bank Stock Index
DIFS: Department of Insurance and Financial Services	NAV: Net asset value
Directors Plan: Isabella Bank Corporation and Related Companies Deferred Compensation Plan for Directors	NOW: Negotiable order of withdrawal
Dividend Reinvestment Plan: Isabella Bank Corporation Stockholder Dividend Reinvestment Plan and Employee Stock Purchase Plan	NSF: Non-sufficient funds
Dodd-Frank Act: Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010	OCI: Other comprehensive income (loss)
ESOP: Employee Stock Ownership Plan	OMSR: Originated mortgage servicing rights
Exchange Act: Securities Exchange Act of 1934	OREO: Other real estate owned
FASB: Financial Accounting Standards Board	OTTI: Other-than-temporary impairment
FDI Act: Federal Deposit Insurance Act	PBO: Projected benefit obligation
FDIC: Federal Deposit Insurance Corporation	PCAOB: Public Company Accounting Oversight Board
FFIEC: Federal Financial Institutions Examinations Council	Rabbi Trust: A trust established to fund the Directors Plan
FRB: Federal Reserve Bank	SEC: U.S. Securities and Exchange Commission
FHLB: Federal Home Loan Bank	SOX: Sarbanes-Oxley Act of 2002
Freddie Mac: Federal Home Loan Mortgage Corporation	TDR: Troubled debt restructuring
FTE: Fully taxable equivalent	XBRL: eXtensible Business Reporting Language

3

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(Dollars in thousands)

	September 30 2017		December 31 2016
ASSETS
Cash and cash equivalents
Cash and demand deposits due from banks	$	20,650	$	20,167
Interest bearing balances due from banks	417		2,727
Total cash and cash equivalents	21,067		22,894
AFS securities (amortized cost of $548,468 in 2017 and $557,648 in 2016)	552,925		558,096
Mortgage loans AFS	1,237		1,816
Loans
Commercial	620,135		575,664
Agricultural	132,998		126,492
Residential real estate	271,480		266,050
Consumer	52,931		42,409
Gross loans	1,077,544		1,010,615
Less allowance for loan and lease losses	7,700		7,400
Net loans	1,069,844		1,003,215
Premises and equipment	28,761		29,314
Corporate owned life insurance policies	26,837		26,300
Accrued interest receivable	7,388		6,580
Equity securities without readily determinable fair values	23,461		21,694
Goodwill and other intangible assets	48,575		48,666
Other assets	11,872		13,576
TOTAL ASSETS	$	1,791,967	$	1,732,151
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest bearing	$	212,608	$	205,071
NOW accounts	220,601		209,325
Certificates of deposit under $250 and other savings	723,834		717,078
Certificates of deposit over $250	59,019		63,566
Total deposits	1,216,062		1,195,040
Borrowed funds	367,027		337,694
Accrued interest payable and other liabilities	12,415		11,518
Total liabilities	1,595,504		1,544,252
Shareholders’ equity
Common stock — no par value 15,000,000 shares authorized; issued and outstanding 7,856,664 shares (including 28,547 shares held in the Rabbi Trust) in 2017 and 7,821,069 shares (including 26,042 shares held in the Rabbi Trust) in 2016	140,368		139,525
Shares to be issued for deferred compensation obligations	5,364		5,038
Retained earnings	50,680		46,114
Accumulated other comprehensive income (loss)	51		(2,778		)
Total shareholders’ equity	196,463		187,899
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,791,967	$	1,732,151

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

4

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(Dollars in thousands except per share amounts)

	Three Months Ended   September 30				Nine Months Ended   September 30
	2017		2016		2017		2016
Interest income
Loans, including fees	$	11,297	$	9,965	$	32,102	$	28,320
AFS securities
Taxable	2,075		2,037		6,452		6,740
Nontaxable	1,406		1,411		4,234		4,337
Federal funds sold and other	198		194		547		509
Total interest income	14,976		13,607		43,335		39,906
Interest expense
Deposits	1,715		1,496		4,870		4,313
Borrowings	1,485		1,251		4,189		3,726
Total interest expense	3,200		2,747		9,059		8,039
Net interest income	11,776		10,860		34,276		31,867
Provision for loan losses	49		17		85		185
Net interest income after provision for loan losses	11,727		10,843		34,191		31,682
Noninterest income
Service charges and fees	1,435		1,276		4,370		3,652
Net gain on sale of mortgage loans	153		263		507		472
Earnings on corporate owned life insurance policies	174		183		537		566
Net gains on sale of AFS securities	—		—		142		245
Other	936		1,224		2,546		2,986
Total noninterest income	2,698		2,946		8,102		7,921
Noninterest expenses
Compensation and benefits	5,360		4,940		15,869		14,412
Furniture and equipment	1,377		1,353		4,073		3,988
Occupancy	809		845		2,461		2,443
Other	2,593		2,295		7,194		6,888
Total noninterest expenses	10,139		9,433		29,597		27,731
Income before federal income tax expense	4,286		4,356		12,696		11,872
Federal income tax expense	750		763		2,180		1,855
NET INCOME	$	3,536	$	3,593	$	10,516	$	10,017
Earnings per common share
Basic	$	0.45	$	0.46	$	1.34	$	1.28
Diluted	$	0.44	$	0.45	$	1.31	$	1.25
Cash dividends per common share	$	0.26	$	0.25	$	0.76	$	0.73

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

5

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(Dollars in thousands)

	Three Months Ended   September 30						Nine Months Ended   September 30
	2017			2016			2017			2016
Net income	$	3,536		$	3,593		$	10,516		$	10,017
Unrealized gains (losses) on AFS securities
Unrealized gains (losses) on AFS securities arising during the period	(96		)	(2,548		)	4,151			8,793
Reclassification adjustment for net realized (gains) losses included in net income	—			—			(142		)	(245		)
Tax effect (1)	54			937			(1,158		)	(2,713		)
Unrealized gains (losses) on AFS securities, net of tax	(42		)	(1,611		)	2,851			5,835
Unrealized gains (losses) on derivative instruments arising during the period	11			91			(33		)	(61		)
Tax effect (1)	(4		)	(31		)	11			21
Unrealized gains (losses) on derivative instruments, net of tax	7			60			(22		)	(40		)
Other comprehensive income, net of tax	(35		)	(1,551		)	2,829			5,795
Comprehensive income	$	3,501		$	2,042		$	13,345		$	15,812

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

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

6

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

(Dollars in thousands except per share amounts)

	Common Stock
	Common Shares Outstanding		Amount			Common Shares to be Issued for Deferred Compensation Obligations			Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Totals
Balance, January 1, 2016	7,799,867		$	139,198		$	4,592		$	39,960		$	221		$	183,971
Comprehensive income (loss)	—		—			—			10,017			5,795			15,812
Issuance of common stock	131,697		3,683			—			—			—			3,683
Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations	—		127			(127		)	—			—			—
Share-based payment awards under equity compensation plan	—		—			443			—			—			443
Common stock purchased for deferred compensation obligations	—		(279		)	—			—			—			(279		)
Common stock repurchased pursuant to publicly announced repurchase plan	(98,083	)	(2,749		)	—			—			—			(2,749		)
Cash dividends paid ($0.73 per common share)	—		—			—			(5,697		)	—			(5,697		)
Balance, September 30, 2016	7,833,481		$	139,980		$	4,908		$	44,280		$	6,016		$	195,184
Balance, January 1, 2017	7,821,069		$	139,525		$	5,038		$	46,114		$	(2,778	)	$	187,899
Comprehensive income (loss)	—		—			—			10,516			2,829			13,345
Issuance of common stock	178,712		4,999			—			—			—			4,999
Common stock transferred from the Rabbi Trust to satisfy deferred compensation obligations	—		176			(176		)	—			—			—
Share-based payment awards under equity compensation plan	—		—			502			—			—			502
Common stock purchased for deferred compensation obligations	—		(327		)	—			—			—			(327		)
Common stock repurchased pursuant to publicly announced repurchase plan	(143,117	)	(4,005		)	—			—			—			(4,005		)
Cash dividends paid ($0.76 per common share)	—		—			—			(5,950		)	—			(5,950		)
Balance, September 30, 2017	7,856,664		$	140,368		$	5,364		$	50,680		$	51		$	196,463

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

7

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Dollars in thousands)

	Nine Months Ended   September 30
	2017			2016
OPERATING ACTIVITIES
Net income	$	10,516		$	10,017
Reconciliation of net income to net cash provided by operating activities:
Provision for loan losses	85			185
Impairment of foreclosed assets	2			—
Depreciation	2,163			2,116
Amortization of OMSR	257			299
Amortization of acquisition intangibles	91			128
Net amortization of AFS securities	1,614			2,115
Net (gains) losses on sale of AFS securities	(142		)	(245		)
Net gain on sale of mortgage loans	(507		)	(472		)
Increase in cash value of corporate owned life insurance policies	(537		)	(566		)
Share-based payment awards under equity compensation plan	502			443
Origination of loans held-for-sale	(28,436		)	(22,994		)
Proceeds from loan sales	29,522			23,968
Net changes in operating assets and liabilities which provided (used) cash:
Accrued interest receivable	(808		)	(599		)
Other assets	(1,491		)	1,005
Accrued interest payable and other liabilities	897			165
Net cash provided by (used in) operating activities	13,728			15,565
INVESTING ACTIVITIES
Activity in AFS securities
Sales	12,827			35,664
Maturities, calls, and principal payments	78,352			111,543
Purchases	(83,471		)	(44,622		)
Net loan principal (originations) collections	(66,928		)	(138,870		)
Proceeds from sales of foreclosed assets	203			348
Purchases of premises and equipment	(1,610		)	(2,771		)
Proceeds from redemption of corporate owned life insurance policies	—			1,004
Net cash provided by (used in) investing activities	(60,627		)	(37,704		)

8

INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

(Dollars in thousands)

	Nine Months Ended   September 30
	2017			2016
FINANCING ACTIVITIES
Net increase (decrease) in deposits	$	21,022		$	11,270
Net increase (decrease) in borrowed funds	29,333			15,677
Cash dividends paid on common stock	(5,950		)	(5,697		)
Proceeds from issuance of common stock	4,999			3,683
Common stock repurchased	(4,005		)	(2,749		)
Common stock purchased for deferred compensation obligations	(327		)	(279		)
Net cash provided by (used in) financing activities	45,072			21,905
Increase (decrease) in cash and cash equivalents	(1,827		)	(234		)
Cash and cash equivalents at beginning of period	22,894			21,569
Cash and cash equivalents at end of period	$	21,067		$	21,335
SUPPLEMENTAL CASH FLOWS INFORMATION:
Interest paid	$	9,000		$	8,042
Income taxes paid	$	2,470		$	1,350
SUPPLEMENTAL NONCASH INFORMATION:
Transfers of loans to foreclosed assets	$	214		$	211

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

9

NOTES TO INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands except per share amounts)

Note 1 – Basis of Presentation

As used in these notes, as well as in Management's Discussion and Analysis of Financial Condition and Results of Operations, references to “Isabella,” the “Corporation”, “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiaries. Isabella Bank Corporation refers solely to the parent holding company, and Isabella Bank or the “Bank” refer to Isabella Bank Corporation’s subsidiary, Isabella Bank.

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In our opinion, all adjustments considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. For further information, refer to our Annual Report on Form 10-K for the year ended December 31, 2016.

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, 2016.

Reclassifications: Certain amounts reported in the interim 2016 consolidated financial statements have been reclassified to conform with the 2017 presentation.

Note 2 – Computation of Earnings Per Common Share

Basic earnings per common share represents income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued relate solely to outstanding shares in the Directors Plan.

	Three Months Ended   September 30				Nine Months Ended   September 30
	2017		2016		2017		2016
Average number of common shares outstanding for basic calculation	7,848,317		7,824,751		7,839,172		7,813,084
Average potential effect of common shares in the Directors Plan (1)	192,572		186,667		191,548		184,996
Average number of common shares outstanding used to calculate diluted earnings per common share	8,040,889		8,011,418		8,030,720		7,998,080
Net income	$	3,536	$	3,593	$	10,516	$	10,017
Earnings per common share
Basic	$	0.45	$	0.46	$	1.34	$	1.28
Diluted	$	0.44	$	0.45	$	1.31	$	1.25

⁽¹⁾  Exclusive of shares held in the Rabbi Trust

Note 3 – Accounting Standards Updates

Pending Accounting Standards Updates

ASU No. 2014-09: “Revenue from Contracts with Customers”

In May 2014, ASU No. 2014-09 created new Topic 606 to provide a common revenue standard to achieve consistency and clarification to the revenue recognition principles. The guidance outlines steps to achieve the core principle which states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. These steps consist of: (1) identify the contract(s) with a customer, (2) identify the performance obligations in the contract, (3) determine the transaction price, (4) allocate the transaction price to the performance obligations in the contract, and (5) recognize revenue when (or as) the entity satisfies a performance obligation.

10

The new authoritative guidance was originally effective on January 1, 2017; however, ASU 2015-14 was issued which deferred the effective date of ASU 2014-09 by one year to January 1, 2018. The majority of our income, as well as that of the vast majority of financial institutions, is excluded from this guidance. We are reviewing our contracts related to trust and investment services and those related to other noninterest income to determine if changes in income recognition is required as a result of this guidance. While we anticipate some change as a result of implementing this guidance, we do not expect it to have a significant impact on our operating results or financial statement disclosures.

ASU No. 2016-02: “Leases (Topic 842)”

In February 2016, ASU No. 2016-02 was issued to create Topic 842 - Leases which will require recognition of lease assets and lease liabilities on the balance sheet for leases previously classified as operating leases. Accounting guidance is set forth for both lessee and lessor accounting. Under lessee accounting, a lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term.

For finance leases, a lessee is required to do the following: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position; 2) recognize interest on the lease liability separately from amortization of the right-of-use asset in the statement of comprehensive income; and 3) classify repayments of the principal portion of the lease liability within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows. For operating leases, a lessee is required to do the following: 1) recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in the statement of financial position; 2) recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis; and 3) classify all cash payments within operating activities in the statement of cash flows.

The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2018. We have and will continue to review our lease agreements to determine the appropriate treatment under this guidance. We do not expect these changes to have a significant impact on our operating results or financial statement disclosures.

ASU No. 2017-09: “Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting”

In May 2017, ASU No. 2017-09 provided guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting under Topic 718. The current disclosure requirements in Topic 718 apply regardless of whether an entity is required to apply modification accounting under the amendments in this update. An entity should account for the effects of a modification unless all of the following are met:

1. The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification.

2. The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified.

3. The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified.

The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2017 and is not expected to have a significant impact on our operating results or financial statement disclosures.

ASU No. 2017-12: “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities”

In August 2017, ASU No. 2017-12 was issued to improve financial reporting of hedging activities to better portray the economic results of an entity’s risk management activities. The update provides changes to both the designation and measurement guidance for qualifying hedging relationships and the presentation of hedge results.

The update addresses current GAAP designation limitations by permitting hedge accounting for risk components in hedging relationships involving nonfinancial risk and interest rate risk as follows:

1. For a cash flow hedge of a forecasted purchase or sale of a nonfinancial asset, an entity could designate as the hedged risk the variability in cash flows attributable to changes in a contractually specified component stated in the contract. The amendments remove the requirement in current GAAP that only the overall variability in cash flows or variability related to foreign currency risk could be designated as the hedged risk in a cash flow hedge of a nonfinancial asset.

11

2. For a cash flow hedge of interest rate risk of a variable-rate financial instrument, an entity could designate as the hedged risk the variability in cash flows attributable to the contractually specified interest rate. By eliminating the concept of benchmark interest rates for hedges of variable-rate instruments in current GAAP, the amendments remove the requirement to designate only the overall variability in cash flows as the hedged risk in a cash flow hedge of a variable-rate instrument indexed to a non-benchmark interest rate.

3. For a fair value hedge of interest rate risk, the amendments add the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate as an eligible benchmark interest rate in the United States in addition to those already permitted under current GAAP (the U.S. Treasury Rate, the London Interbank Offered Rate [LIBOR] Swap Rate, and the Fed Funds Effective Swap Rate [or Overnight Index Swap Rate]). This allows an entity that issues or invests in fixed-rate tax-exempt financial instruments to designate as the hedged risk changes in fair value attributable to interest rate risk related to the SIFMA Municipal Swap Rate rather than overall changes in fair value.

The amendments in this update provide further revisions to the current limitations on designation in a fair value hedge of interest rate risk. Specifically, the update changes the guidance for designating fair value hedges of interest rate risk and for measuring the change in fair value of the hedged item in fair value hedges of interest rate risk by providing four permissible accounting treatments.

In addition to the amendments to the designation and measurement guidance for qualifying hedging relationships, the amendments in this update also align the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. The following recognition and presentation guidance for qualifying hedges is required:

1. For fair value hedges, the entire change in the fair value of the hedging instrument included in the assessment of hedge effectiveness is presented in the same income statement line that is used to present the earnings effect of the hedged item. The timing of recognition of the change in fair value of a hedging instrument included in the assessment of hedge effectiveness is the same as under current GAAP, but the presentation of hedge results could change because current GAAP does not specify a required presentation of the change in fair value of the hedging instrument.

2. For cash flow and net investment hedges, the entire change in the fair value of the hedging instrument included in the assessment of hedge effectiveness is recorded in other comprehensive income (for cash flow hedges) or in the currency translation adjustment section of other comprehensive income (for net investment hedges). Those amounts are reclassified to earnings in the same income statement line item that is used to present the earnings effect of the hedged item when the hedged

item affects earnings. The timing of recognition of the change in fair value of a hedging instrument could change relative to current GAAP because hedge ineffectiveness no longer is recognized in current period earnings. The presentation of hedge results also could change because current GAAP does not specify a required presentation of the change in fair value of the hedging instrument in the income statement.

Lastly, the guidance within this update provides exclusions from the hedge effectiveness assessment and five other targeted improvements to current guidance also related to the assessment of hedge effectiveness. Excluding option premiums and forward points will still be permissible under the new guidance. The new authoritative guidance is effective for interim and annual periods beginning after December 15, 2018 and is not expected to have a significant impact on our operating results or financial statement disclosures.

12

Note 4 – AFS Securities

The amortized cost and fair value of AFS securities, with gross unrealized gains and losses, are as follows at:

	September 30, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Government sponsored enterprises	$	231	$	1	$	—	$	232
States and political subdivisions	207,874		5,596		13		213,457
Auction rate money market preferred	3,200		—		28		3,172
Preferred stocks	3,800		—		149		3,651
Mortgage-backed securities	216,684		860		1,630		215,914
Collateralized mortgage obligations	116,679		600		780		116,499
Total	$	548,468	$	7,057	$	2,600	$	552,925

	December 31, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Government sponsored enterprises	$	10,258	$	3	$	2	$	10,259
States and political subdivisions	208,977		4,262		320		212,919
Auction rate money market preferred	3,200		—		406		2,794
Preferred stocks	3,800		—		375		3,425
Mortgage-backed securities	229,593		581		2,918		227,256
Collateralized mortgage obligations	101,820		600		977		101,443
Total	$	557,648	$	5,446	$	4,998	$	558,096

The amortized cost and fair value of AFS securities by contractual maturity at September 30, 2017 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	$	—	$	231	$	—	$	—	$	—	$	231
States and political subdivisions	25,689		73,810		75,598		32,777		—		207,874
Auction rate money market preferred	—		—		—		—		3,200		3,200
Preferred stocks	—		—		—		—		3,800		3,800
Mortgage-backed securities	—		—		—		—		216,684		216,684
Collateralized mortgage obligations	—		—		—		—		116,679		116,679
Total amortized cost	$	25,689	$	74,041	$	75,598	$	32,777	$	340,363	$	548,468
Fair value	$	25,746	$	76,105	$	78,383	$	33,455	$	339,236	$	552,925

Expected maturities for government sponsored enterprises and states and political subdivisions may differ from contractual maturities because issuers may have the right to call or prepay obligations.

As the auction rate money market preferred and preferred stocks have continual call dates, they are not reported by a specific maturity group. Because of their variable monthly payments, mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group.

13

A summary of the sales activity of AFS securities was as follows for the:

	Three Months Ended September 30				Nine Months Ended September 30
	2017		2016		2017		2016
Proceeds from sales of AFS securities	$	—	$	—	$	12,827	$	35,664
Gross realized gains (losses)	$	—	$	—	$	142	$	245
Applicable income tax expense (benefit)	$	—	$	—	$	48	$	83

The following information pertains to AFS securities with gross unrealized losses at September 30, 2017 and December 31, 2016, aggregated by investment category and length of time that individual securities have been in a continuous loss position.

	September 30, 2017
	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	12		3,321		1		221		13
Auction rate money market preferred	—		—		28		3,172		28
Preferred stocks	—		—		149		3,651		149
Mortgage-backed securities	1,277		106,229		353		12,777		1,630
Collateralized mortgage obligations	331		33,969		449		15,303		780
Total	$	1,620	$	143,519	$	980	$	35,124	$	2,600
Number of securities in an unrealized loss position:			35				13		48

	December 31, 2016
	Less Than Twelve Months				Twelve Months or More
	Gross Unrealized Losses		Fair Value		Gross Unrealized Losses		Fair Value		Total Unrealized Losses
Government sponsored enterprises	$	2	$	9,936	$	—	$	—	$	2
States and political subdivisions	311		21,800		9		355		320
Auction rate money market preferred	—		—		406		2,794		406
Preferred stocks	—		—		375		3,425		375
Mortgage-backed securities	2,918		175,212		—		—		2,918
Collateralized mortgage obligations	628		51,466		349		11,381		977
Total	$	3,859	$	258,414	$	1,139	$	17,955	$	4,998
Number of securities in an unrealized loss position:			104				9		113

As of September 30, 2017 and December 31, 2016, we conducted an analysis to determine whether any AFS securities currently in an unrealized loss position should be other-than-temporarily impaired. Such analyses considered, among other factors, the following criteria:

• Has the value of the investment declined more than what is deemed to be reasonable based on a risk and maturity adjusted discount rate?

• Is the investment credit rating below investment grade?

• Is it probable the issuer will be unable to pay the amount when due?

• Is it more likely than not that we will have to sell the security before recovery of its cost basis?

• Has the duration of the investment been extended?

During the fourth quarter of 2016, we identified one municipal bond as other-than-temporarily impaired. While management estimated the OTTI to be realized, we also engaged the services of an independent investment valuation firm to estimate the amount of impairment as of December 31, 2016. The valuation calculated the estimated market value utilizing two different approaches:

1) Market - Appraisal and Comparable Investments

2) Income - Discounted Cash Flow Method

14

The two methods were then weighted, with a higher weighting applied to the Market approach, to determine the estimated impairment. As a result of this analysis, we recognized an OTTI of $770 in earnings for the year ended December 31, 2016. Based on analysis of this bond, there was no additional OTTI recognized as of September 30, 2017.

Based on our analysis which included the criteria outlined above, the fact that we have asserted that we do not have the intent to sell AFS securities in an unrealized loss position, and considering it is unlikely that we will have to sell any AFS securities in an unrealized loss position before recovery of their cost basis, we do not believe that the values of any other AFS securities are other-than-temporarily impaired as of September 30, 2017 or December 31, 2016, with the exception of the one municipal bond discussed above.

Note 5 – Loans and ALLL

We grant commercial, agricultural, residential real estate, and consumer loans to customers situated primarily in Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties in Michigan. The ability of the borrowers to honor their repayment obligations is often dependent upon the real estate, agricultural, manufacturing, retail, gaming, tourism, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees. A portion of loans are unsecured.

Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs, the ALLL, and any deferred fees or costs. Interest income is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the level yield method.

The accrual of interest on commercial, agricultural, and residential real estate loans is discontinued at the time the loan is 90 days or more past due unless the credit is well-secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful.

For loans that are placed on nonaccrual status or charged-off, all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the ALLL. Loans may be returned to accrual status after six months of continuous performance 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 states and political subdivisions. Repayment of these loans is dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of direct credit exposure to any one borrower to $15,000. Borrowers with direct credit needs of more than $15,000 are serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans commonly require loan-to-value limits of 80% or less. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, and property and equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we require annual financial statements, prepare cash flow analyses, and review credit reports.

We entered into a mortgage purchase program 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 payoff our participation in the advance to the mortgage broker. We classify these advances as commercial loans and include the outstanding balance in commercial loans on our balance sheet. Under the participation agreement, we committed to a maximum outstanding aggregate amount of $30,000. The difference between our outstanding balances and the maximum outstanding aggregate amount 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, and overall loan demand to determine whether or not to sell fixed rate loans to Freddie Mac.

15

Our lending policies generally limit the maximum loan-to-value ratio on residential real estate loans to 100% of the lower of the appraised value of the property or the purchase price. Private mortgage insurance is typically required on loans with loan-to-value ratios in excess of 80% unless the loan qualifies for government guarantees.

Underwriting criteria for 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. All originated mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market underwriting system; loans in excess of $500 require the approval of our Internal Loan Committee, the Executive Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors.

Consumer loans include secured and unsecured personal loans. Loans are amortized for a period of up to 12 years based on the age and value of the underlying collateral. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market.

The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL.

The appropriateness of the ALLL is evaluated on a quarterly basis and is based upon a periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. Specific allocations for impaired loans are primarily determined based on the difference between the loan’s outstanding balance and the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell. Historical loss allocations are calculated at the loan class and segment levels based on a migration analysis of the loan portfolio, with the exception of advances to mortgage brokers, over the preceding five years. With no historical losses on advances to mortgage brokers, there is no allocation in the commercial segment displayed in the following tables based on historical loss factors. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A summary of changes in the ALLL and the recorded investment in loans by segments follows:

	Allowance for Loan Losses
	Three Months Ended September 30, 2017
	Commercial			Agricultural			Residential Real Estate			Consumer			Unallocated		Total
July 1, 2017	$	1,978		$	475		$	2,598		$	583		$	1,966	$	7,600
Charge-offs	(8		)	—			(77		)	(72		)	—		(157		)
Recoveries	134			—			41			33			—		208
Provision for loan losses	65			(40		)	(71		)	89			6		49
September 30, 2017	$	2,169		$	435		$	2,491		$	633		$	1,972	$	7,700

16

	Allowance for Loan Losses
	Nine Months Ended September 30, 2017
	Commercial			Agricultural			Residential Real Estate			Consumer			Unallocated		Total
January 1, 2017	$	1,814		$	884		$	2,664		$	624		$	1,414	$	7,400
Charge-offs	(60		)	—			(120		)	(190		)	—		(370		)
Recoveries	322			—			140			123			—		585
Provision for loan losses	93			(449		)	(193		)	76			558		85
September 30, 2017	$	2,169		$	435		$	2,491		$	633		$	1,972	$	7,700

	Allowance for Loan Losses and Recorded Investment in Loans
	September 30, 2017
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
ALLL
Individually evaluated for impairment	$	933	$	—	$	1,618	$	—	$	—	$	2,551
Collectively evaluated for impairment	1,236		435		873		633		1,972		5,149
Total	$	2,169	$	435	$	2,491	$	633	$	1,972	$	7,700
Loans
Individually evaluated for impairment	$	8,525	$	10,976	$	8,426	$	18			$	27,945
Collectively evaluated for impairment	611,610		122,022		263,054		52,913				1,049,599
Total	$	620,135	$	132,998	$	271,480	$	52,931			$	1,077,544

	Allowance for Loan Losses
	Three Months Ended September 30, 2016
	Commercial			Agricultural		Residential Real Estate			Consumer			Unallocated		Total
July 1, 2016	$	2,119		$	534	$	3,130		$	541		$	1,276	$	7,600
Charge-offs	—			—		(57		)	(74		)	—		(131		)
Recoveries	118			—		153			43			—		314
Provision for loan losses	(367		)	612		(452		)	94			130		17
September 30, 2016	$	1,870		$	1,146	$	2,774		$	604		$	1,406	$	7,800

	Allowance for Loan Losses
	Nine Months Ended September 30, 2016
	Commercial			Agricultural		Residential Real Estate			Consumer			Unallocated		Total
January 1, 2016	$	2,171		$	329	$	3,330		$	522		$	1,048	$	7,400
Charge-offs	(48		)	—		(426		)	(206		)	—		(680		)
Recoveries	396			92		248			159			—		895
Provision for loan losses	(649		)	725		(378		)	129			358		185
September 30, 2016	$	1,870		$	1,146	$	2,774		$	604		$	1,406	$	7,800

17

	Allowance for Loan Losses and Recorded Investment in Loans
	December 31, 2016
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
ALLL
Individually evaluated for impairment	$	741	$	1	$	1,629	$	—	$	—	$	2,371
Collectively evaluated for impairment	1,073		883		1,035		624		1,414		5,029
Total	$	1,814	$	884	$	2,664	$	624	$	1,414	$	7,400
Loans
Individually evaluated for impairment	$	7,859	$	5,545	$	8,638	$	26			$	22,068
Collectively evaluated for impairment	567,805		120,947		257,412		42,383				988,547
Total	$	575,664	$	126,492	$	266,050	$	42,409			$	1,010,615

The following table displays the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit risk ratings as of:

	September 30, 2017
	Commercial								Agricultural
	Real Estate		Other		Advances to Mortgage Brokers		Total		Real Estate		Other		Total		Total
Rating
1 - Excellent	$	25	$	227	$	—	$	252	$	—	$	—	$	—	$	252
2 - High quality	6,736		10,474		—		17,210		3,088		1,001		4,089		21,299
3 - High satisfactory	117,596		41,844		22,834		182,274		21,743		9,822		31,565		213,839
4 - Low satisfactory	327,648		77,519		—		405,167		48,902		21,363		70,265		475,432
5 - Special mention	4,402		1,912		—		6,314		11,206		9,115		20,321		26,635
6 - Substandard	6,303		2,402		—		8,705		3,861		1,912		5,773		14,478
7 - Vulnerable	210		3		—		213		488		497		985		1,198
8 - Doubtful	—		—		—		—		—		—		—		—
Total	$	462,920	$	134,381	$	22,834	$	620,135	$	89,288	$	43,710	$	132,998	$	753,133

	December 31, 2016
	Commercial								Agricultural
	Real Estate		Other		Advances to Mortgage Brokers		Total		Real Estate		Other		Total		Total
Rating
1 - Excellent	$	28	$	438	$	—	$	466	$	—	$	—	$	—	$	466
2 - High quality	11,821		12,091		19,688		43,600		3,566		1,426		4,992		48,592
3 - High satisfactory	103,529		41,982		—		145,511		21,657		11,388		33,045		178,556
4 - Low satisfactory	299,317		74,432		—		373,749		48,955		22,715		71,670		445,419
5 - Special mention	3,781		1,178		—		4,959		6,009		3,085		9,094		14,053
6 - Substandard	5,901		1,474		—		7,375		3,650		3,508		7,158		14,533
7 - Vulnerable	4		—		—		4		—		533		533		537
8 - Doubtful	—		—		—		—		—		—		—		—
Total	$	424,381	$	131,595	$	19,688	$	575,664	$	83,837	$	42,655	$	126,492	$	702,156

18

Internally assigned credit risk ratings are reviewed, at a minimum, when loans are renewed or when management has knowledge of improvements or deterioration of the credit quality of individual credits. Descriptions of the internally assigned credit risk ratings for commercial and agricultural loans are as follows:

1. EXCELLENT – Substantially Risk Free

Credit has strong financial condition and solid earnings history, characterized by:

• High liquidity, strong cash flow, low leverage.

• Unquestioned ability to meet all obligations when due.

• Experienced management, with management succession in place.

• Secured by cash.

2. HIGH QUALITY – Limited Risk

Credit with sound financial condition and a positive trend in earnings supplemented by:

• Favorable liquidity and leverage ratios.

• Ability to meet all obligations when due.

• Management with successful track record.

• Steady and satisfactory earnings history.

• If loan is secured, collateral is of high quality and readily marketable.

• Access to alternative financing.

• Well defined primary and secondary source of repayment.

• If supported by guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident.

3.HIGH SATISFACTORY – Reasonable Risk

Credit with satisfactory financial condition and further characterized by:

• Working capital adequate to support operations.

• Cash flow sufficient to pay debts as scheduled.

• Management experience and depth appear favorable.

• Loan performing according to terms.

• If loan is secured, collateral is acceptable and loan is fully protected.

4. LOW SATISFACTORY – Acceptable Risk

Credit with bankable risks, although some signs of weaknesses are shown:

• Would include most start-up businesses.

• Occasional instances of trade slowness or repayment delinquency – may have been 10-30 days slow within the past year.

• Management’s abilities are apparent, yet unproven.

• Weakness in primary source of repayment with adequate secondary source of repayment.

• Loan structure generally in accordance with policy.

• If secured, loan collateral coverage is marginal.

• Adequate cash flow to service debt, but coverage is low.

To be classified as less than satisfactory, only one of the following criteria must be met.

5. SPECIAL MENTION – Criticized

Credit constitutes an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific loan:

• Downward trend in sales, profit levels, and margins.

• Impaired working capital position.

• Cash flow is strained in order to meet debt repayment.

• Loan delinquency (30-60 days) and overdrafts may occur.

• Shrinking equity cushion.

• Diminishing primary source of repayment and questionable secondary source.

19

• Management abilities are questionable.

• Weak industry conditions.

• Litigation pending against the borrower.

• Collateral or guaranty offers limited protection.

• Negative debt service coverage, however the credit is well collateralized and payments are current.

6. SUBSTANDARD – Classified

Credit where the borrower’s current net worth, paying capacity, and value of the collateral pledged is inadequate. There is a distinct possibility that we will implement collection procedures if the loan deficiencies are not corrected. In addition, the following characteristics may apply:

• Sustained losses have severely eroded the equity and cash flow.

• Deteriorating liquidity.

• Serious management problems or internal fraud.

• Original repayment terms liberalized.

• Likelihood of bankruptcy.

• Inability to access other funding sources.

• Reliance on secondary source of repayment.

• Litigation filed against borrower.

• Collateral provides little or no value.

• Requires excessive attention of the loan officer.

• Borrower is uncooperative with loan officer.

7.VULNERABLE – Classified

Credit is considered “Substandard” and warrants placing on nonaccrual status. Risk of loss is being evaluated and exit strategy options are under review. Other characteristics that may apply:

• Insufficient cash flow to service debt.

• Minimal or no payments being received.

• Limited options available to avoid the collection process.

• Transition status, expect action will take place to collect loan without immediate progress being made.

8. DOUBTFUL – Workout

Credit has all the weaknesses inherent in a “Substandard” loan with the added characteristic that collection and/or liquidation is pending. The possibility of a loss is extremely high, but its classification as a loss is deferred until liquidation procedures are completed, or reasonably estimable. Other characteristics that may apply:

• Normal operations are severely diminished or have ceased.

• Seriously impaired cash flow.

• Original repayment terms materially altered.

• Secondary source of repayment is inadequate.

• Survivability as a “going concern” is impossible.

• Collection process has begun.

• Bankruptcy petition has been filed.

• Judgments have been filed.

• Portion of the loan balance has been charged-off.

20

Our primary credit quality indicator for residential real estate and consumer loans is the individual loan’s past due aging. The following tables summarize the past due and current loans as of:

	September 30, 2017
	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	$	466	$	—	$	—	$	211	$	677	$	462,243	$	462,920
Commercial other	823		29		—		3		855		133,526		134,381
Advances to mortgage brokers	—		—		—		—		—		22,834		22,834
Total commercial	1,289		29		—		214		1,532		618,603		620,135
Agricultural
Agricultural real estate	—		—		590		488		1,078		88,210		89,288
Agricultural other	490		3		—		497		990		42,720		43,710
Total agricultural	490		3		590		985		2,068		130,930		132,998
Residential real estate
Senior liens	1,514		—		56		383		1,953		225,215		227,168
Junior liens	8		—		—		23		31		7,348		7,379
Home equity lines of credit	217		—		—		—		217		36,716		36,933
Total residential real estate	1,739		—		56		406		2,201		269,279		271,480
Consumer
Secured	39		11		—		—		50		49,027		49,077
Unsecured	2		—		—		—		2		3,852		3,854
Total consumer	41		11		—		—		52		52,879		52,931
Total	$	3,559	$	43	$	646	$	1,605	$	5,853	$	1,071,691	$	1,077,544

21

	December 31, 2016
	Accruing Interest and Past Due:								Total Past Due and Nonaccrual
	30-59 Days		60-89 Days		90 Days or More		Nonaccrual				Current		Total
Commercial
Commercial real estate	$	1,580	$	—	$	35	$	4	$	1,619	$	422,762	$	424,381
Commercial other	1,693		35		—		—		1,728		129,867		131,595
Advances to mortgage brokers	—		—		—		—		—		19,688		19,688
Total commercial	3,273		35		35		4		3,347		572,317		575,664
Agricultural
Agricultural real estate	191		—		508		—		699		83,138		83,837
Agricultural other	19		—		—		533		552		42,103		42,655
Total agricultural	210		—		508		533		1,251		125,241		126,492
Residential real estate
Senior liens	1,638		174		22		498		2,332		216,681		219,013
Junior liens	15		—		—		25		40		8,317		8,357
Home equity lines of credit	270		6		68		—		344		38,336		38,680
Total residential real estate	1,923		180		90		523		2,716		263,334		266,050
Consumer
Secured	110		—		—		—		110		38,582		38,692
Unsecured	5		—		—		—		5		3,712		3,717
Total consumer	115		—		—		—		115		42,294		42,409
Total	$	5,521	$	215	$	633	$	1,060	$	7,429	$	1,003,186	$	1,010,615

Impaired Loans

Loans may be classified as impaired if they meet one or more of the following criteria:

1. There has been a charge-off of its principal balance (in whole or in part);

2. The loan has been classified as a TDR; or

3. The loan is in nonaccrual status.

Impairment is measured on a loan-by-loan basis for commercial and agricultural loans by comparing the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Impairment is measured on a loan-by-loan basis for residential real estate and consumer loans by comparing the loan’s unpaid principal balance to the present value of expected future cash flows discounted at the loan’s effective interest rate.

22

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

	September 30, 2017						December 31, 2016
	Recorded Balance		Unpaid Principal Balance		Valuation Allowance		Recorded Balance		Unpaid Principal Balance		Valuation Allowance
Impaired loans with a valuation allowance
Commercial real estate	$	4,209	$	4,328	$	766	$	5,811	$	5,992	$	716
Commercial other	2,239		2,239		167		1,358		1,358		25
Agricultural real estate	—		—		—		—		—		—
Agricultural other	—		—		—		134		134		1
Residential real estate senior liens	8,273		8,903		1,605		8,464		9,049		1,615
Residential real estate junior liens	70		70		13		72		82		14
Home equity lines of credit	—		—		—		—		—		—
Consumer secured	—		—		—		—		—		—
Total impaired loans with a valuation allowance	14,791		15,540		2,551		15,839		16,615		2,371
Impaired loans without a valuation allowance
Commercial real estate	1,988		2,062				604		617
Commercial other	89		89				86		97
Agricultural real estate	7,834		7,834				4,037		4,037
Agricultural other	3,142		3,142				1,374		1,374
Home equity lines of credit	83		383				102		402
Consumer secured	18		18				26		26
Total impaired loans without a valuation allowance	13,154		13,528				6,229		6,553
Impaired loans
Commercial	8,525		8,718		933		7,859		8,064		741
Agricultural	10,976		10,976		—		5,545		5,545		1
Residential real estate	8,426		9,356		1,618		8,638		9,533		1,629
Consumer	18		18		—		26		26		—
Total impaired loans	$	27,945	$	29,068	$	2,551	$	22,068	$	23,168	$	2,371

23

The following is a summary of information pertaining to impaired loans for the:

	Three Months Ended September 30
	2017				2016
	Average Recorded Balance		Interest Income Recognized		Average Recorded Balance		Interest Income Recognized
Impaired loans with a valuation allowance
Commercial real estate	$	4,636	$	68	$	5,699	$	90
Commercial other	1,669		28		746		2
Agricultural real estate	—		—		181		4
Agricultural other	—		—		67		1
Residential real estate senior liens	8,333		79		8,896		85
Residential real estate junior liens	73		1		105		—
Home equity lines of credit	35		—		—		—
Consumer secured	—		—		—		—
Total impaired loans with a valuation allowance	14,746		176		15,694		182
Impaired loans without a valuation allowance
Commercial real estate	1,546		31		705		10
Commercial other	93		2		67		2
Agricultural real estate	7,830		98		3,360		42
Agricultural other	3,221		39		767		11
Home equity lines of credit	86		5		112		4
Consumer secured	19		—		31		1
Total impaired loans without a valuation allowance	12,795		175		5,042		70
Impaired loans
Commercial	7,944		129		7,217		104
Agricultural	11,051		137		4,375		58
Residential real estate	8,527		85		9,113		89
Consumer	19		—		31		1
Total impaired loans	$	27,541	$	351	$	20,736	$	252

24

	Nine Months Ended September 30
	2017				2016
	Average Recorded Balance		Interest Income Recognized		Average Recorded Balance		Interest Income Recognized
Impaired loans with a valuation allowance
Commercial real estate	$	4,765	$	225	$	5,748	$	259
Commercial other	1,363		75		298		5
Agricultural real estate	—		—		91		6
Agricultural other	22		—		78		1
Residential real estate senior liens	8,379		245		9,439		278
Residential real estate junior liens	75		2		126		2
Home equity lines of credit	23		—		—		—
Consumer secured	—		—		—		—
Total impaired loans with a valuation allowance	14,627		547		15,780		551
Impaired loans without a valuation allowance
Commercial real estate	1,483		83		995		57
Commercial other	109		6		92		6
Agricultural real estate	5,936		218		3,454		130
Agricultural other	2,353		85		574		27
Home equity lines of credit	115		15		118		12
Consumer secured	22		—		33		3
Total impaired loans without a valuation allowance	10,018		407		5,266		235
Impaired loans
Commercial	7,720		389		7,133		327
Agricultural	8,311		303		4,197		164
Residential real estate	8,592		262		9,683		292
Consumer	22		—		33		3
Total impaired loans	$	24,645	$	954	$	21,046	$	786

We had committed to advance $125 and $117 in connection with impaired loans, which includes TDRs, as of September 30, 2017 and December 31, 2016, respectively.

Troubled Debt Restructurings

Loan modifications are considered to be TDRs when the modification includes terms outside of normal lending practices to a borrower who is experiencing financial difficulties.

Typical concessions granted include, but are not limited to:

•Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics.

•Extending the amortization period beyond typical lending guidelines for loans with similar risk characteristics.

•Agreeing to an interest only payment structure and delaying principal payments.

•Forgiving principal.

•Forgiving accrued interest.

To determine if a borrower is experiencing financial difficulties, factors we consider include:

• The borrower is currently in default on any of their debt.

• The borrower would likely default on any of their debt if the concession was not granted.

• The borrower’s cash flow was insufficient to service all of their debt if the concession was not granted.

• The borrower has declared, or is in the process of declaring, bankruptcy.

• The borrower is unlikely to continue as a going concern (if the entity is a business).

25

The following is a summary of information pertaining to TDRs granted for the:

	Three Months Ended September 30
	2017					2016
	Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial other	3	$	1,385	$	1,385	1	$	1,315	$	1,315
Agricultural other	—	—		—		2	319		319
Residential real estate
Senior liens	2	179		179		—	—		—
Junior liens	—	—		—		—	—		—
Total residential real estate	2	179		179		—	—		—
Consumer unsecured	—	—		—		—	—		—
Total	5	$	1,564	$	1,564	3	$	1,634	$	1,634

	Nine Months Ended September 30
	2017					2016
	Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Post-Modification Recorded Investment
Commercial other	6	$	1,698	$	1,698	1	$	1,315	$	1,315
Agricultural other	7	5,445		5,445		5	520		520
Residential real estate
Senior liens	5	434		434		2	26		26
Junior liens	1	8		8		—	—		—
Total residential real estate	6	442		442		2	26		26
Consumer unsecured	—	—		—		1	2		2
Total	19	$	7,585	$	7,585	9	$	1,863	$	1,863

The following tables summarize concessions we granted to borrowers in financial difficulty for the:

	Three Months Ended September 30
	2017						2016
	Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period			Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period
	Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment
Commercial other	—	$	—	3	$	1,385	—	$	—	1	$	1,315
Agricultural other	—	—		—	—		1	14		1	305
Residential real estate
Senior liens	—	—		2	179		—	—		—	—
Junior liens	—	—		—	—		—	—		—	—
Total residential real estate	—	—		2	179		—	—		—	—
Consumer unsecured	—	—		—	—		—	—		—	—
Total	—	$	—	5	$	1,564	1	$	14	2	$	1,620

26

	Nine Months Ended September 30
	2017						2016
	Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period			Below Market Interest Rate			Below Market Interest Rate and Extension of Amortization Period
	Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment		Number of Loans	Pre-Modification Recorded Investment
Commercial other	—	$	—	6	$	1,698	—	$	—	1	$	1,315
Agricultural other	4	1,349		3	4,096		1	14		4	506
Residential real estate
Senior liens	—	—		5	434		2	26		—	—
Junior liens	1	8		—	—		—	—		—	—
Total residential real estate	1	8		5	434		2	26		—	—
Consumer unsecured	—	—		—	—		—	—		1	2
Total	5	$	1,357	14	$	6,228	3	$	40	6	$	1,823

We did not restructure any loans by forgiving principal or accrued interest in the three and nine month periods ended September 30, 2017 or 2016.

Based on our historical loss experience, losses associated with TDRs are not significantly different than other impaired loans within the same loan segment. As such, TDRs, including TDRs that have been modified in the past 12 months that subsequently defaulted, are analyzed in the same manner as other impaired loans within their respective loan segment.

We had no loans that defaulted in the three and nine month periods ended September 30, 2017 and September 30, 2016 which were modified within 12 months prior to the default date.

The following is a summary of TDR loan balances as of:

	September 30, 2017		December 31, 2016
TDRs	$	27,259	$	21,382

Note 6 – Equity Securities Without Readily Determinable Fair Values

Included in equity securities without readily determinable fair values are restricted securities, which are carried at cost, and investments in unconsolidated entities accounted for under the equity method of accounting.

Equity securities without readily determinable fair values consist of the following as of:

	September 30 2017		December 31 2016
FHLB Stock	$	13,700	$	11,900
Corporate Settlement Solutions, LLC	7,428		7,461
FRB Stock	1,999		1,999
Other	334		334
Total	$	23,461	$	21,694

27

Note 7 – Foreclosed Assets

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

	September 30 2017		December 31 2016
Consumer mortgage loans collateralized by residential real estate foreclosed as a result of obtaining physical possession	$	20	$	18
All other foreclosed assets	220		213
Total	$	240	$	231

There were $260 and $18 of consumer mortgage loans collateralized by residential real estate in the process of foreclosure as of September 30, 2017 and December 31, 2016.

Below is a summary of changes in foreclosed assets during the:

	Three Months Ended September 30
	2017			2016
Balance, July 1	$	229		$	249
Properties transferred	118			95
Impairments	(2		)	—
Proceeds from sale	(105		)	(60		)
Balance, September 30	$	240		$	284

	Nine Months Ended September 30
	2017			2016
Balance, January 1	$	231		$	421
Properties transferred	214			211
Impairments	(2		)	—
Proceeds from sale	(203		)	(348		)
Balance, September 30	$	240		$	284

Note 8 – Borrowed Funds

Borrowed funds consist of the following obligations as of:

	September 30, 2017				December 31, 2016
	Amount		Rate		Amount		Rate
FHLB advances	$	310,000	1.83	%	$	270,000	1.82	%
Securities sold under agreements to repurchase without stated maturity dates	54,977		0.12	%	60,894		0.13	%
Federal funds purchased	2,050		1.39	%	6,800		1.00	%
Total	$	367,027	1.57	%	$	337,694	1.50	%

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

28

The following table lists the maturities and weighted average interest rates of FHLB advances as of:

	September 30, 2017				December 31, 2016
	Amount		Rate		Amount		Rate
Fixed rate due 2017	$	40,000	1.13	%	$	70,000	1.39	%
Fixed rate due 2018	50,000		2.16	%	50,000		2.16	%
Fixed rate due 2019	85,000		1.87	%	60,000		1.99	%
Fixed rate due 2020	35,000		1.52	%	10,000		1.98	%
Fixed rate due 2021	50,000		1.91	%	50,000		1.91	%
Variable rate due 2021 1	10,000		1.61	%	10,000		1.21	%
Fixed rate due 2022	20,000		1.97	%	—		—	%
Fixed rate due 2023	10,000		3.90	%	10,000		3.90	%
Fixed rate due 2026	10,000		1.17	%	10,000		1.17	%
Total	$	310,000	1.83	%	$	270,000	1.82	%

⁽¹⁾  Hedged advance (see "Derivative Instruments" section below)

Securities sold under agreements to repurchase are classified as secured borrowings and are reflected at the amount of cash received in connection with the transaction. The securities underlying the agreements have a carrying value and a fair value of $54,996 and $60,918 at September 30, 2017 and December 31, 2016, respectively. Such securities remain under our control. We may be required to provide additional collateral based on the fair value of underlying securities.

Securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances generally mature within one to four days from the transaction date. The following table provides a summary of securities sold under repurchase agreements without stated maturity dates, federal funds purchased, and FRB Discount Window advances.

	Three Months Ended September 30
	2017						2016
	Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period		Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates	$	58,464	$	53,846	0.13	%	$	56,057	$	54,446	0.13	%
Federal funds purchased	3,815		1,474		1.20	%	20,600		8,848		0.69	%
FRB Discount Window	—		82		1.60	%	—		—		—	%

	Nine Months Ended September 30
	2017						2016
	Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period		Maximum Month End Balance		Average Balance		Weighted Average Interest Rate During the Period
Securities sold under agreements to repurchase without stated maturity dates	$	58,464	$	55,051	0.13	%	$	61,783	$	57,159	0.13	%
Federal funds purchased	5,965		3,280		1.13	%	20,600		8,614		0.69	%
FRB Discount Window	—		57		1.54	%	—		—		—	%

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

	September 30 2017		December 31 2016
Pledged to secure borrowed funds	$	416,279	$	363,427
Pledged to secure repurchase agreements	54,996		60,918
Pledged for public deposits and for other purposes necessary or required by law	29,774		33,916
Total	$	501,049	$	458,261

29

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

	September 30 2017		December 31 2016
States and political subdivisions	$	4,256	$	5,676
Mortgage-backed securities	15,419		11,383
Collateralized mortgage obligations	35,321		43,859
Total	$	54,996	$	60,918

AFS securities pledged to repurchase agreements are monitored to ensure the appropriate level is collateralized. In the event of maturities, calls, significant principal repayments, or significant decline in market values, we have adequate levels of AFS securities to pledge to satisfy required collateral.

As of September 30, 2017, we had the ability to borrow up to an additional $114,839, based on assets pledged as collateral. We had no investment securities that are restricted to be pledged for specific purposes.

Derivative Instruments

We enter into interest rate swaps to manage exposure to interest rate risk and variability in cash flows. The interest rate swaps, associated with our variable rate borrowings, are designated upon inception as cash flow hedges of forecasted interest payments. We enter into LIBOR-based interest rate swaps that involve the receipt of variable amounts in exchange for fixed rate payments, in effect converting variable rate debt to fixed rate debt.

Cash flow hedges are assessed for effectiveness using regression analysis. The effective portion of changes in fair value are recorded in OCI and subsequently reclassified into interest expense in the same period in which the related interest on the variable rate borrowings affects earnings. In the event that a portion of the changes in fair value were determined to be ineffective, the ineffective amount would be recorded in earnings.

The following tables provide information on derivatives related to variable rate borrowings as of:

	September 30, 2017
	Pay Rate		Receive Rate	Remaining Life (Years)	Notional Amount		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments
Cash Flow Hedges:
Interest rate swaps	1.56	%	3-Month LIBOR	3.6	$	10,000	Other Assets	$	215

	December 31, 2016
	Pay Rate		Receive Rate	Remaining Life (Years)	Notional Amount		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments
Cash Flow Hedges:
Interest rate swaps	1.56	%	3-Month LIBOR	4.3	$	10,000	Other Assets	$	248

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

30

Note 9 – Other Noninterest Expenses

A summary of expenses included in other noninterest expenses is as follows for the:

	Three Months Ended   September 30				Nine Months Ended   September 30
	2017		2016		2017		2016
ATM and debit card fees	$	253	$	210	$	873	$	627
Audit and related fees	322		319		757		664
Consulting fees	259		198		672		567
Director fees	212		207		634		630
Loan underwriting fees	237		142		546		377
Donations and community relations	190		134		488		399
FDIC insurance premiums	172		224		480		646
Marketing costs	172		101		361		359
Education and travel	143		73		332		309
Printing and supplies	110		105		320		325
Postage and freight	85		96		304		293
All other	438		486		1,427		1,692
Total other	$	2,593	$	2,295	$	7,194	$	6,888

Note 10 – Federal Income Taxes

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

	Three Months Ended   September 30						Nine Months Ended   September 30
	2017			2016			2017			2016
Income taxes at 34% statutory rate	$	1,458		$	1,481		$	4,317		$	4,036
Effect of nontaxable income
Interest income on tax exempt municipal securities	(452		)	(457		)	(1,361		)	(1,400		)
Earnings on corporate owned life insurance policies	(60		)	(62		)	(183		)	(192		)
Effect of tax credits	(186		)	(188		)	(566		)	(575		)
Other	(18		)	(19		)	(54		)	(55		)
Total effect of nontaxable income	(716		)	(726		)	(2,164		)	(2,222		)
Effect of nondeductible expenses	8			8			27			41
Federal income tax expense	$	750		$	763		$	2,180		$	1,855

31

Note 11 – Fair Value

Following is a description of the valuation methodologies, key inputs, and an indication of the level of the fair value hierarchy in which the assets or liabilities are classified.

Cash and cash equivalents: The carrying amounts of cash and demand deposits due from banks and interest bearing balances due from banks approximate fair values. As such, we classify cash and cash equivalents as Level 1.

AFS securities: AFS securities are recorded at fair value on a recurring basis. Level 1 fair value measurement is based upon quoted prices for identical instruments. Level 2 fair value measurement is based upon quoted prices for similar instruments. If quoted prices are not available, fair values are measured using independent pricing models or other model based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss and liquidity assumptions. The values for Level 1 and Level 2 investment securities are generally obtained from an independent third party. On a quarterly basis, we compare the values provided to alternative pricing sources.

Mortgage loans AFS:Mortgage loans AFS are carried at the lower of cost or fair value. The fair value of mortgage loans AFS are based on the price secondary markets are currently offering for portfolios with similar characteristics. As such, we classify mortgage loans AFS subject to nonrecurring fair value adjustments as Level 2.

Loans: For variable rate loans with no significant change in credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. As such, we classify loans as Level 3 assets.

We do not record loans at fair value on a recurring basis. However, from time-to-time, loans are classified as impaired and a specific allowance for loan losses may be established. Loans for which it is probable that payment of interest and principal will be significantly different than the contractual terms of the original loan agreement are considered impaired. Once a loan is identified as impaired, we measure the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less costs to sell, if the loan is collateral dependent. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.

We review the net realizable values of the underlying collateral for collateral dependent impaired loans on at least a quarterly basis for all loan types. To determine the collateral value, we utilize independent appraisals, broker price opinions, or internal evaluations. We review these valuations to determine whether an additional discount should be applied given the age of market information that may have been considered as well as other factors such as costs to sell an asset if it is determined that the collateral will be liquidated in connection with the ultimate settlement of the loan. We use these valuations to determine if any specific reserves or charge-offs are necessary. We may obtain new valuations in certain circumstances, including when there has been significant deterioration in the condition of the collateral, if the foreclosure process has begun, or if the existing valuation is deemed to be outdated.

The following tables list the quantitative fair value information about impaired loans as of:

	September 30, 2017
Valuation Technique	Fair Value	Unobservable Input	Range
		Discount applied to collateral:
		Real Estate	20% - 30%
		Equipment	20% - 45%
		Accounts receivable	50%
Discounted value	$16,158	Cash crop inventory	30% - 40%
		Other inventory	50% - 75%
		Liquor license	75%
		Furniture, fixtures & equipment	35% - 45%

32

	December 31, 2016
Valuation Technique	Fair Value	Unobservable Input	Range
		Discount applied to collateral:
		Real Estate	20% - 30%
		Equipment	20% - 45%
Discounted value	$9,166	Cash crop inventory	30% - 40%
		Liquor license	75%
		Furniture, fixtures & equipment	45%

Collateral discount rates may have ranges to accommodate differences in the age of the independent appraisal, broker price opinion, or internal evaluation.

Accrued interest receivable: The carrying amounts of accrued interest receivable approximate fair value. As such, we classify accrued interest receivable as Level 1.

Equity securities without readily determinable fair values: Included in equity securities without readily determinable fair values are FHLB stock and FRB stock as well as our minority ownership interest in Corporate Settlement Solutions, LLC. The investment in Corporate Settlement Solutions, LLC, a title insurance agency, was made in the first quarter 2008 and we account for our investment under the equity method of accounting.

The lack of an active market, or other independent sources to validate fair value estimates coupled with the impact of future capital calls and transfer restrictions, is an inherent limitation in the valuation process. As the fair values of these investments are not readily determinable, they are not disclosed under a specific fair value hierarchy; however, they are reviewed quarterly for impairment. If we were to record an impairment adjustment related to these securities, it would be classified as a nonrecurring Level 3 fair value adjustment. During 2017 and 2016, there were no impairments recorded on equity securities without readily determinable fair values.

Foreclosed assets: Upon transfer from the loan portfolio, foreclosed assets (which are included in other assets) are adjusted to and subsequently carried at the lower of carrying value or fair value less costs to sell. Net realizable value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. Due to the inherent level of estimation in the valuation process, we classify foreclosed assets as nonrecurring Level 3.

The table below lists the quantitative fair value information related to foreclosed assets as of:

	September 30, 2017
Valuation Technique	Fair Value		Unobservable Input	Range
			Discount applied to collateral:
Discounted value	$	240	Real Estate	20% - 30%

	December 31, 2016
Valuation Technique	Fair Value		Unobservable Input	Range
			Discount applied to collateral:
Discounted value	$	231	Real Estate	20% - 30%

Collateral discount rates may have ranges to accommodate differences in the age of the independent appraisal, broker price opinion, or internal evaluations.

Goodwill and other intangible assets: Acquisition intangibles and goodwill are evaluated for potential impairment on at least an annual basis. Acquisition intangibles and goodwill are typically qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired. If it is determined that the carrying balance of acquisition intangibles or goodwill is more likely than not to be impaired, we perform a cash flow valuation to determine the extent of the potential impairment. If the testing resulted in impairment, we would classify goodwill and other acquisition intangibles subjected to nonrecurring fair value adjustments as Level 3. During 2017 and 2016, there were no impairments recorded on goodwill and other acquisition intangibles.

33

OMSR:OMSR (which are included in other assets) are subject to impairment testing. To test for impairment, we utilize a discounted cash flow analysis using interest rates and prepayment speed assumptions currently quoted for comparable instruments and discount rates. If the valuation model reflects a value less than the carrying value, OMSR are adjusted to fair value through a valuation allowance as determined by the model. As such, we classify OMSR subject to nonrecurring fair value adjustments as Level 2.

Deposits: The fair value of demand, savings, and money market deposits are equal to their carrying amounts and are classified as Level 1. Fair values for variable rate certificates of deposit approximate their carrying value. Fair values for fixed rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits. As such, fixed rate certificates of deposit are classified as Level 2.

Borrowed funds: The carrying amounts of federal funds purchased, borrowings under overnight repurchase agreements, and other short-term borrowings maturing within ninety days approximate their fair values. The fair values of other borrowed funds are estimated using discounted cash flow analyses based on current incremental borrowing arrangements. As such, borrowed funds are classified as Level 2.

Accrued interest payable: The carrying amounts of accrued interest payable approximate fair value. As such, we classify accrued interest payable as Level 1.

Derivative instruments: Derivative instruments, consisting solely of interest rate swaps, are recorded at fair value on a recurring basis. Derivatives qualifying as cash flow hedges, when highly effective, are reported at fair value in other assets or other liabilities on our Consolidated Balance Sheets with changes in value recorded in OCI. Should the hedge no longer be considered effective, the ineffective portion of the change in fair value is recorded directly in earnings in the period in which the change occurs. The fair value of a derivative is determined by quoted market prices and model based valuation techniques. As such, we classify derivative instruments as Level 2.

Commitments to extend credit, standby letters of credit, and undisbursed loans: Our commitments to extend credit, standby letters of credit, and undisbursed funds have no carrying amount and are estimated to have no realizable fair value. Historically, a majority of the unused commitments to extend credit have not been drawn upon and, generally, we do not receive fees in connection with these commitments other than standby letter of credit fees, which are not significant.

The preceding methods described may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. Although we believe our valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different fair value measurement.

34

Estimated Fair Values of Financial Instruments Not Recorded at Fair Value in their Entirety on a Recurring Basis

Disclosure of the estimated fair values of financial instruments, which differ from carrying values, often requires the use of estimates. In cases where quoted market values in an active market are not available, we use present value techniques and other valuation methods to estimate the fair values of our financial instruments. These valuation methods require considerable judgment and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used.

The carrying amount and estimated fair value of financial instruments not recorded at fair value in their entirety on a recurring basis were as follows as of:

	September 30, 2017
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
ASSETS
Cash and cash equivalents	$	21,067	$	21,067	$	21,067	$	—	$	—
Mortgage loans AFS	1,237		1,245		—		1,245		—
Gross loans	1,077,544		1,056,912		—		—		1,056,912
Less allowance for loan and lease losses	7,700		7,700		—		—		7,700
Net loans	1,069,844		1,049,212		—		—		1,049,212
Accrued interest receivable	7,388		7,388		7,388		—		—
Equity securities without readily determinable fair values (1)	23,461		N/A		—		—		—
OMSR	2,413		2,413		—		2,413		—
LIABILITIES
Deposits without stated maturities	791,567		791,567		791,567		—		—
Deposits with stated maturities	424,495		423,536		—		423,536		—
Borrowed funds	367,027		367,873		—		367,873		—
Accrued interest payable	633		633		633		—		—

	December 31, 2016
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
ASSETS
Cash and cash equivalents	$	22,894	$	22,894	$	22,894	$	—	$	—
Mortgage loans AFS	1,816		1,836		—		1,836		—
Gross loans	1,010,615		991,009		—		—		991,009
Less allowance for loan and lease losses	7,400		7,400		—		—		7,400
Net loans	1,003,215		983,609		—		—		983,609
Accrued interest receivable	6,580		6,580		6,580		—		—
Equity securities without readily determinable fair values (1)	21,694		N/A		—		—		—
OMSR	2,306		2,306		—		2,306		—
LIABILITIES
Deposits without stated maturities	761,626		761,626		761,626		—		—
Deposits with stated maturities	433,414		430,088		—		430,088		—
Borrowed funds	337,694		336,975		—		336,975		—
Accrued interest payable	574		574		574		—		—

⁽¹⁾  Due to the characteristics of equity securities without readily determinable fair values, they are not disclosed under a specific fair value hierarchy. If we were to record an impairment adjustment related to these securities, such amount would be classified as a nonrecurring Level 3 fair value adjustment.

35

Financial Instruments Recorded at Fair Value

The table below presents the recorded amount of assets and liabilities measured at fair value on:

	September 30, 2017											December 31, 2016
	Total		Level 1			Level 2			Level 3			Total		Level 1			Level 2			Level 3
Recurring items
AFS securities
Government-sponsored enterprises	$	232	$	—		$	232		$	—		$	10,259	$	—		$	10,259		$	—
States and political subdivisions	213,457		—			213,457			—			212,919		—			212,919			—
Auction rate money market preferred	3,172		—			3,172			—			2,794		—			2,794			—
Preferred stocks	3,651		3,651			—			—			3,425		3,425			—			—
Mortgage-backed securities	215,914		—			215,914			—			227,256		—			227,256			—
Collateralized mortgage obligations	116,499		—			116,499			—			101,443		—			101,443			—
Total AFS securities	552,925		3,651			549,274			—			558,096		3,425			554,671			—
Derivative instruments	215		—			215			—			248		—			248			—
Nonrecurring items
Impaired loans (net of the ALLL)	16,158		—			—			16,158			9,166		—			—			9,166
Foreclosed assets	240		—			—			240			231		—			—			231
Total	$	569,538	$	3,651		$	549,489		$	16,398		$	567,741	$	3,425		$	554,919		$	9,397
Percent of assets and liabilities measured at fair value			0.64		%	96.48		%	2.88		%			0.60		%	97.74		%	1.66		%

We had no assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a recurring basis, as of September 30, 2017. Foreclosed assets, which are recorded at fair value with changes in fair value recognized through earnings on a nonrecurring basis, were written down to $240 as of September 30, 2017 which resulted in an impairment recorded through earnings in the amount of $2 for the nine month period ended September 30, 2017. We had no other assets or liabilities recorded at fair value with changes in fair value recognized through earnings, on a nonrecurring basis, as of September 30, 2017.

36

Note 12 – Accumulated Other Comprehensive Income

The following table summarizes the changes in AOCI by component for the:

	Three Months Ended September 30
	2017												2016
	Unrealized Holding Gains (Losses) on AFS Securities			Unrealized Gains (Losses) on Derivative Instruments			Defined Benefit Pension Plan			Total			Unrealized Holding Gains (Losses) on AFS Securities			Unrealized Gains (Losses) on Derivative Instruments			Defined Benefit Pension Plan			Total
Balance, July 1	$	2,923		$	135		$	(2,972	)	$	86		$	10,982		$	(100	)	$	(3,315	)	$	7,567
OCI before reclassifications	(96		)	11			—			(85		)	(2,548		)	91			—			(2,457		)
Amounts reclassified from AOCI	—			—			—			—			—			—			—			—
Subtotal	(96		)	11			—			(85		)	(2,548		)	91			—			(2,457		)
Tax effect	54			(4		)	—			50			937			(31		)	—			906
OCI, net of tax	(42		)	7			—			(35		)	(1,611		)	60			—			(1,551		)
Balance, September 30	$	2,881		$	142		$	(2,972	)	$	51		$	9,371		$	(40	)	$	(3,315	)	$	6,016

	Nine Months Ended September 30
	2017												2016
	Unrealized Holding Gains (Losses) on AFS Securities			Unrealized Gains (Losses) on Derivative Instruments			Defined Benefit Pension Plan			Total			Unrealized Holding Gains (Losses) on AFS Securities			Unrealized Gains (Losses) on Derivative Instruments			Defined Benefit Pension Plan			Total
Balance, January 1	$	30		$	164		$	(2,972	)	$	(2,778	)	$	3,536		$	—		$	(3,315	)	$	221
OCI before reclassifications	4,151			(33		)	—			4,118			8,793			(61		)	—			8,732
Amounts reclassified from AOCI	(142		)	—			—			(142		)	(245		)	—			—			(245		)
Subtotal	4,009			(33		)	—			3,976			8,548			(61		)	—			8,487
Tax effect	(1,158		)	11			—			(1,147		)	(2,713		)	21			—			(2,692		)
OCI, net of tax	2,851			(22		)	—			2,829			5,835			(40		)	—			5,795
Balance, September 30	$	2,881		$	142		$	(2,972	)	$	51		$	9,371		$	(40	)	$	(3,315	)	$	6,016

Included in OCI for the three and nine month periods ended September 30, 2017 and 2016 are changes in unrealized holding gains and losses related to auction rate money market preferred and preferred stocks. For federal income tax purposes, these securities are considered equity investments. As such, no deferred federal income taxes related to unrealized holding gains or losses are expected or recorded.

37

A summary of the components of unrealized holding gains on AFS securities included in OCI follows for the:

	Three Months Ended September 30
	2017								2016
	Auction Rate Money Market Preferred and Preferred Stocks		All Other AFS Securities			Total			Auction Rate Money Market Preferred and Preferred Stocks		All Other AFS Securities			Total
Unrealized gains (losses) arising during the period	$	63	$	(159	)	$	(96	)	$	208	$	(2,756	)	$	(2,548	)
Reclassification adjustment for net realized (gains) losses included in net income	—		—			—			—		—			—
Net unrealized gains (losses)	63		(159		)	(96		)	208		(2,756		)	(2,548		)
Tax effect	—		54			54			—		937			937
Unrealized gains (losses), net of tax	$	63	$	(105	)	$	(42	)	$	208	$	(1,819	)	$	(1,611	)

	Nine Months Ended September 30
	2017								2016
	Auction Rate Money Market Preferred and Preferred Stocks		All Other AFS Securities			Total			Auction Rate Money Market Preferred and Preferred Stocks		All Other AFS Securities			Total
Unrealized gains (losses) arising during the period	$	604	$	3,547		$	4,151		$	568	$	8,225		$	8,793
Reclassification adjustment for net realized (gains) losses included in net income	—		(142		)	(142		)	—		(245		)	(245		)
Net unrealized gains (losses)	604		3,405			4,009			568		7,980			8,548
Tax effect	—		(1,158		)	(1,158		)	—		(2,713		)	(2,713		)
Unrealized gains (losses), net of tax	$	604	$	2,247		$	2,851		$	568	$	5,267		$	5,835

38

Note 13 – Parent Company Only Financial Information

Interim Condensed Balance Sheets

	September 30 2017		December 31 2016
ASSETS
Cash on deposit at the Bank	$	945	$	1,297
AFS securities	—		251
Investments in subsidiaries	146,138		138,549
Premises and equipment	1,961		1,991
Other assets	52,795		52,846
TOTAL ASSETS	$	201,839	$	194,934
LIABILITIES AND SHAREHOLDERS’ EQUITY
Other liabilities	$	5,376	$	7,035
Shareholders' equity	196,463		187,899
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	201,839	$	194,934

Interim Condensed Statements of Income

	Three Months Ended   September 30				Nine Months Ended   September 30
	2017		2016		2017		2016
Income
Dividends from subsidiaries	$	2,900	$	2,000	$	7,200	$	5,600
Interest income	—		3		2		11
Management fee and other	1,660		1,680		4,901		4,962
Total income	4,560		3,683		12,103		10,573
Expenses
Compensation and benefits	1,118		1,196		3,608		3,580
Occupancy and equipment	456		438		1,332		1,281
Audit and related fees	148		193		412		389
Other	556		427		1,731		1,561
Total expenses	2,278		2,254		7,083		6,811
Income before income tax benefit and equity in undistributed earnings of subsidiaries	2,282		1,429		5,020		3,762
Federal income tax benefit	209		199		737		616
Income before equity in undistributed earnings of subsidiaries	2,491		1,628		5,757		4,378
Undistributed earnings of subsidiaries	1,045		1,965		4,759		5,639
Net income	$	3,536	$	3,593	$	10,516	$	10,017

39

Interim Condensed Statements of Cash Flows

	Nine Months Ended   September 30
	2017			2016
Operating activities
Net income	$	10,516		$	10,017
Adjustments to reconcile net income to cash provided by operations
Undistributed earnings of subsidiaries	(4,759		)	(5,639		)
Undistributed earnings of equity securities without readily determinable fair values	33			(287		)
Share-based payment awards under equity compensation plan	502			443
Depreciation	116			117
Changes in operating assets and liabilities which provided (used) cash
Other assets	19			177
Accrued interest and other liabilities	(1,659		)	(2,575		)
Net cash provided by (used in) operating activities	4,768			2,253
Investing activities
Maturities, calls, principal payments, and sales of AFS securities	249			—
Purchases of premises and equipment	(86		)	(86		)
Net cash provided by (used in) investing activities	163			(86		)
Financing activities
Cash dividends paid on common stock	(5,950		)	(5,697		)
Proceeds from the issuance of common stock	4,999			3,683
Common stock repurchased	(4,005		)	(2,749		)
Common stock purchased for deferred compensation obligations	(327		)	(279		)
Net cash provided by (used in) financing activities	(5,283		)	(5,042		)
Increase (decrease) in cash and cash equivalents	(352		)	(2,875		)
Cash and cash equivalents at beginning of period	1,297			4,125
Cash and cash equivalents at end of period	$	945		$	1,250

Note 14 – Operating Segments

Our reportable segments are based on legal entities that account for at least 10% of net operating results. The operations of the Bank as of September 30, 2017 and 2016 and each of the three and nine month periods then ended, represent approximately 90% or more of our consolidated total assets and operating results. As such, no additional segment reporting is presented.

40

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

ISABELLA BANK CORPORATION FINANCIAL REVIEW

(Dollars in thousands except per share amounts)

This section reviews our financial condition and results of our operations for the unaudited three and nine month periods ended September 30, 2017 and 2016. This analysis should be read in conjunction with our 2016 Annual Report on Form 10-K and with the unaudited interim condensed consolidated financial statements and notes, beginning on page 4 of this report.

Executive Summary

During the three and nine months ended September 30, 2017, we reported net income of $3,536 and $10,516 and earnings per common share of $0.45 and $1.34, respectively. Net income and earnings per common share for the same periods of 2016 were $3,593 and $10,017 and $0.46 and $1.28, respectively. The increase in year-to-date earnings was primarily driven by interest income which increased $3,429 for the first nine months of 2017 in comparison to the same period in 2016. Increased interest income resulted primarily from strong loan growth during the past year.

During the nine month period ended September 30, 2017, total assets grew by 3.45% to $1,791,967, and assets under management increased to $2,528,385 which includes loans sold and serviced, and assets managed by our Investment and Trust Services Department of $736,418. Total loans increased by $66,929 from December 31, 2016 which was largely driven by growth of $44,471 in the commercial loan portfolio. The growth in the loan portfolio was funded by an increase of $21,022 in deposits since December 31, 2016, with the remainder being funded through additional borrowed funds.

Our net yield on interest earning assets (FTE) remained low at 3.03% for the nine month period ended September 30, 2017. The growth in net interest income will increase primarily through continued growth in a strategic mix of loans, investments, and other income earning assets. We do not anticipate that the Federal Reserve Bank will increase short term interest rates significantly in the near future; therefore, we anticipate marginal improvements in our net yield on interest earning assets in the short term. We are committed to increasing earnings and shareholder value through growth in our loan portfolio, investment and trust services, and in deposits while managing operating costs.

Reclassifications: Certain amounts reported in the 2016 consolidated financial statements have been reclassified to conform with the 2017 presentation.

41

Results of Operations

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

	September 30 2017			June 30 2017			March 31 2017			December 31 2016			September 30 2016
INCOME STATEMENT DATA
Interest income	$	14,976		$	14,498		$	13,861		$	13,760		$	13,607
Interest expense	3,200			3,028			2,831			2,826			2,747
Net interest income	11,776			11,470			11,030			10,934			10,860
Provision for loan losses	49			9			27			(320		)	17
Noninterest income	2,698			2,788			2,616			3,187			2,946
Noninterest expenses	10,139			9,507			9,951			10,166			9,433
Federal income tax expense	750			898			532			493			763
Net Income	$	3,536		$	3,844		$	3,136		$	3,782		$	3,593
PER SHARE
Basic earnings	$	0.45		$	0.49		$	0.40		$	0.48		$	0.46
Diluted earnings	$	0.44		$	0.48		$	0.39		$	0.47		$	0.45
Dividends	$	0.26		$	0.25		$	0.25		$	0.25		$	0.25
Tangible book value*	$	18.82		$	18.62		$	18.34		$	18.16		$	17.93
Quoted market value
High	$	29.10		$	28.45		$	29.00		$	28.35		$	28.08
Low	$	27.65		$	27.60		$	27.60		$	27.60		$	27.60
Close*	$	29.00		$	28.00		$	27.60		$	27.85		$	27.70
Common shares outstanding*	7,856,664			7,862,553			7,843,120			7,821,069			7,833,481
PERFORMANCE RATIOS
Return on average total assets	0.79		%	0.87		%	0.72		%	0.88		%	0.85		%
Return on average shareholders' equity	7.11		%	7.85		%	6.56		%	7.77		%	7.27		%
Return on average tangible shareholders' equity	9.61		%	10.59		%	8.77		%	10.70		%	10.28		%
Net interest margin yield (FTE)	3.08		%	3.03		%	2.99		%	3.01		%	3.05		%
BALANCE SHEET DATA*
Gross loans	$	1,077,544		$	1,048,497		$	1,012,920		$	1,010,615		$	989,366
AFS securities	$	552,925		$	567,862		$	590,114		$	558,096		$	564,229
Total assets	$	1,791,967		$	1,777,298		$	1,760,860		$	1,732,151		$	1,706,498
Deposits	$	1,216,062		$	1,210,152		$	1,231,061		$	1,195,040		$	1,175,833
Borrowed funds	$	367,027		$	360,940		$	327,375		$	337,694		$	325,409
Shareholders' equity	$	196,463		$	195,070		$	190,976		$	187,899		$	195,184
Gross loans to deposits	88.61		%	86.64		%	82.28		%	84.57		%	84.14		%
ASSETS UNDER MANAGEMENT*
Loans sold with servicing retained	$	268,817		$	269,595		$	270,217		$	272,882		$	275,037
Assets managed by our Investment and Trust Services Department	$	467,601		$	454,294		$	444,749		$	427,693		$	424,573
Total assets under management	$	2,528,385		$	2,501,187		$	2,475,826		$	2,432,726		$	2,406,108
ASSET QUALITY*
Nonperforming loans to gross loans	0.21		%	0.26		%	0.24		%	0.17		%	0.16		%
Nonperforming assets to total assets	0.14		%	0.17		%	0.15		%	0.11		%	0.11		%
ALLL to gross loans	0.71		%	0.72		%	0.74		%	0.73		%	0.79		%
CAPITAL RATIOS*
Shareholders' equity to assets	10.96		%	10.98		%	10.85		%	10.85		%	11.44		%
Tier 1 leverage	8.50		%	8.50		%	8.54		%	8.56		%	8.59		%
Common equity tier 1 capital	12.20		%	12.43		%	12.49		%	12.39		%	12.41		%
Tier 1 risk-based capital	12.20		%	12.43		%	12.49		%	12.39		%	12.41		%
Total risk-based capital	12.84		%	13.07		%	13.14		%	13.04		%	13.10		%

* At end of period

42

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

	September 30 2017			September 30 2016			September 30 2015			September 30 2014			September 30 2013
INCOME STATEMENT DATA
Interest income	$	43,335		$	39,906		$	38,479		$	38,118		$	37,695
Interest expense	9,059			8,039			7,586			7,466			8,338
Net interest income	34,276			31,867			30,893			30,652			29,357
Provision for loan losses	85			185			(1,999		)	(604		)	866
Noninterest income	8,102			7,921			7,858			6,899			8,045
Noninterest expenses	29,597			27,731			26,166			26,180			25,057
Federal income tax expense	2,180			1,855			2,750			1,696			1,893
Net Income	$	10,516		$	10,017		$	11,834		$	10,279		$	9,586
PER SHARE
Basic earnings	$	1.34		$	1.28		$	1.52		$	1.33		$	1.25
Diluted earnings	$	1.31		$	1.25		$	1.49		$	1.30		$	1.22
Dividends	$	0.76		$	0.73		$	0.70		$	0.66		$	0.63
Tangible book value*	$	18.82		$	17.93		$	17.06		$	16.33		$	15.43
Quoted market value
High	$	29.10		$	29.90		$	23.85		$	24.00		$	26.00
Low	$	27.60		$	27.25		$	22.00		$	21.73		$	21.55
Close*	$	29.00		$	27.70		$	23.69		$	23.60		$	24.85
Common shares outstanding*	7,856,664			7,833,481			7,765,333			7,740,730			7,709,781
PERFORMANCE RATIOS
Return on average total assets	0.79		%	0.80		%	1.00		%	0.90		%	0.89		%
Return on average shareholders' equity	7.18		%	6.90		%	8.80		%	8.13		%	7.84		%
Return on average tangible shareholders' equity	9.67		%	9.68		%	12.06		%	10.95		%	11.02		%
Net interest margin yield (FTE)	3.03		%	3.00		%	3.12		%	3.20		%	3.22		%
BALANCE SHEET DATA*
Gross loans	$	1,077,544		$	989,366		$	836,671		$	825,238		$	810,335
AFS securities	$	552,925		$	564,229		$	628,612		$	575,080		$	501,057
Total assets	$	1,791,967		$	1,706,498		$	1,619,250		$	1,553,974		$	1,459,341
Deposits	$	1,216,062		$	1,175,833		$	1,128,003		$	1,081,890		$	1,023,931
Borrowed funds	$	367,027		$	325,409		$	297,610		$	290,438		$	266,001
Shareholders' equity	$	196,463		$	195,184		$	182,998		$	172,076		$	161,305
Gross loans to deposits	88.61		%	84.14		%	74.17		%	76.28		%	79.14		%
ASSETS UNDER MANAGEMENT*
Loans sold with servicing retained	$	268,817		$	275,037		$	289,268		$	290,697		$	294,999
Assets managed by our Investment and Trust Services Department	$	467,601		$	424,573		$	392,124		$	374,878		$	351,505
Total assets under management	$	2,528,385		$	2,406,108		$	2,300,642		$	2,219,549		$	2,105,845
ASSET QUALITY*
Nonperforming loans to gross loans	0.21		%	0.16		%	0.10		%	0.56		%	0.53		%
Nonperforming assets to total assets	0.14		%	0.11		%	0.09		%	0.37		%	0.37		%
ALLL to gross loans	0.71		%	0.79		%	0.98		%	1.26		%	1.44		%
CAPITAL RATIOS*
Shareholders' equity to assets	10.96		%	11.44		%	11.30		%	11.07		%	11.05		%
Tier 1 leverage	8.50		%	8.59		%	8.54		%	8.47		%	8.45		%
Common equity tier 1 capital	12.20		%	12.41		%	13.57		%	N/A			N/A
Tier 1 risk-based capital	12.20		%	12.41		%	13.57		%	13.86		%	13.75		%
Total risk-based capital	12.84		%	13.10		%	14.20		%	15.11		%	15.00		%

* At end of period

43

Average Balances, Interest Rate, and Net Interest Income

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

	Three Months Ended
	September 30, 2017							June 30, 2017							September 30, 2016
	Average Balance			Tax Equivalent Interest		Average Yield / Rate		Average Balance			Tax Equivalent Interest		Average Yield / Rate		Average Balance			Tax Equivalent Interest		Average Yield / Rate
INTEREST EARNING ASSETS
Loans	$	1,062,439		$	11,297	4.25	%	$	1,028,875		$	10,685	4.15	%	$	948,465		$	9,965	4.20	%
Taxable investment securities	353,266			2,075		2.35	%	374,156			2,226		2.38	%	365,612			2,037		2.23	%
Nontaxable investment securities	202,180			2,302		4.55	%	206,668			2,314		4.48	%	203,236			2,312		4.55	%
Fed Funds Sold	4			—		—	%	95			—		—	%	—			—		—	%
Other	27,086			198		2.92	%	23,299			174		2.99	%	25,134			194		3.09	%
Total earning assets	1,644,975			15,872		3.86	%	1,633,093			15,399		3.77	%	1,542,447			14,508		3.76	%
NONEARNING ASSETS
Allowance for loan losses	(7,632		)					(7,554		)					(7,731		)
Cash and demand deposits due from banks	19,919							18,425							18,672
Premises and equipment	28,859							28,895							28,865
Accrued income and other assets	101,417							99,468							104,125
Total assets	$	1,787,538						$	1,772,327						$	1,686,378
INTEREST BEARING LIABILITIES
Interest bearing demand deposits	$	218,570		$	64	0.12	%	$	209,638		$	55	0.10	%	$	203,994		$	41	0.08	%
Savings deposits	360,689			303		0.34	%	360,870			259		0.29	%	330,872			178		0.22	%
Time deposits	428,758			1,348		1.26	%	436,716			1,301		1.19	%	433,591			1,277		1.18	%
Borrowed funds	361,706			1,485		1.64	%	356,096			1,413		1.59	%	314,218			1,251		1.59	%
Total interest bearing liabilities	1,369,723			3,200		0.93	%	1,363,320			3,028		0.89	%	1,282,675			2,747		0.86	%
NONINTEREST BEARING LIABILITIES
Demand deposits	208,078							202,597							196,682
Other	10,763							10,579							9,332
Shareholders’ equity	198,974							195,831							197,689
Total liabilities and shareholders’ equity	$	1,787,538						$	1,772,327						$	1,686,378
Net interest income (FTE)				$	12,672						$	12,371						$	11,761
Net yield on interest earning assets (FTE)						3.08	%						3.03	%						3.05	%

44

	Nine Months Ended
	September 30, 2017							September 30, 2016
	Average Balance			Tax Equivalent Interest		Average Yield / Rate		Average Balance			Tax Equivalent Interest		Average Yield / Rate
INTEREST EARNING ASSETS
Loans	$	1,029,824		$	32,102	4.16	%	$	900,021		$	28,320	4.20	%
Taxable investment securities	363,851			6,452		2.36	%	405,722			6,740		2.21	%
Nontaxable investment securities	204,728			6,929		4.51	%	207,769			7,091		4.55	%
Fed Funds Sold	823			4		0.65	%	—			—		—	%
Other	25,796			543		2.81	%	25,208			509		2.69	%
Total earning assets	1,625,022			46,030		3.78	%	1,538,720			42,660		3.70	%
NONEARNING ASSETS
Allowance for loan losses	(7,556		)					(7,576		)
Cash and demand deposits due from banks	19,003							18,130
Premises and equipment	28,996							28,495
Accrued income and other assets	99,537							102,072
Total assets	$	1,765,002						$	1,679,841
INTEREST BEARING LIABILITIES
Interest bearing demand deposits	$	213,960		$	172	0.11	%	$	205,444		$	123	0.08	%
Savings deposits	358,544			784		0.29	%	337,863			466		0.18	%
Time deposits	433,799			3,914		1.20	%	427,441			3,724		1.16	%
Borrowed funds	348,846			4,189		1.60	%	315,061			3,726		1.58	%
Total interest bearing liabilities	1,355,149			9,059		0.89	%	1,285,809			8,039		0.83	%
NONINTEREST BEARING LIABILITIES
Demand deposits	203,784							191,082
Other	10,729							9,435
Shareholders’ equity	195,340							193,515
Total liabilities and shareholders’ equity	$	1,765,002						$	1,679,841
Net interest income (FTE)				$	36,971						$	34,621
Net yield on interest earning assets (FTE)						3.03	%						3.00	%

Net Interest Income

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

Volume and Rate Variance Analysis

The following table sets forth the effect of volume and rate changes on interest income and expense for the periods indicated. For the purpose of this table, changes in interest due to volume and rate were determined as follows:

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

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

45

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

	Three Months Ended   September 30, 2017 Compared to   June 30, 2017   Increase (Decrease) Due to									Three Months Ended   September 30, 2017 Compared to    September 30, 2016    Increase (Decrease) Due to									Nine Months Ended   September 30, 2017 Compared to   September 30, 2016   Increase (Decrease) Due to
	Volume			Rate			Net			Volume			Rate			Net			Volume			Rate			Net
Changes in interest income
Loans	$	353		$	259		$	612		$	1,211		$	121		$	1,332		$	4,049		$	(267	)	$	3,782
Taxable investment securities	(123		)	(28		)	(151		)	(70		)	108			38			(724		)	436			(288		)
Nontaxable investment securities	(51		)	39			(12		)	(12		)	2			(10		)	(103		)	(59		)	(162		)
Fed Funds Sold	—			—			—			—			—			—			4			—			4
Other	28			(4		)	24			15			(11		)	4			12			22			34
Total changes in interest income	207			266			473			1,144			220			1,364			3,238			132			3,370
Changes in interest expense
Interest bearing demand deposits	2			7			9			3			20			23			5			44			49
Savings deposits	—			44			44			17			108			125			30			288			318
Time deposits	(24		)	71			47			(14		)	85			71			56			134			190
Borrowed funds	23			49			72			194			40			234			405			58			463
Total changes in interest expense	1			171			172			200			253			453			496			524			1,020
Net change in interest margin (FTE)	$	206		$	95		$	301		$	944		$	(33	)	$	911		$	2,742		$	(392	)	$	2,350

While our net yield on interest earning assets increased during the quarter, yields continue to be at low levels. The persistent low interest rate environment coupled with a high concentration of AFS securities as a percentage of earning assets has also placed downward pressure on net interest margin. While we do not anticipate significant improvement in our net yield on interest earning assets, we do expect marginal improvement as a result of loan growth throughout 2017.

	Average Yield / Rate for the Three Month Periods Ended:
	September 30 2017		June 30 2017		March 31 2017		December 31 2016		September 30 2016
Total earning assets	3.86	%	3.77	%	3.70	%	3.73	%	3.76	%
Total interest bearing liabilities	0.93	%	0.89	%	0.85	%	0.87	%	0.86	%
Net yield on interest earning assets (FTE)	3.08	%	3.03	%	2.99	%	3.01	%	3.05	%

	Quarter to Date Net Interest Income (FTE)
	September 30 2017		June 30 2017		March 31 2017		December 31 2016		September 30 2016
Total interest income (FTE)	$	15,872	$	15,399	$	14,759	$	14,642	$	14,508
Total interest expense	3,200		3,028		2,831		2,826		2,747
Net interest income (FTE)	$	12,672	$	12,371	$	11,928	$	11,816	$	11,761

46

Allowance for Loan and Lease Losses

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

The following table summarizes our charge-offs, recoveries, provisions for loan losses, and ALLL balances as of, and for the:

	Three Months Ended   September 30						Nine Months Ended   September 30
	2017			2016			2017			2016
ALLL at beginning of period	$	7,600		$	7,600		$	7,400		$	7,400
Charge-offs
Commercial and agricultural	8			—			60			48
Residential real estate	77			57			120			426
Consumer	72			74			190			206
Total charge-offs	157			131			370			680
Recoveries
Commercial and agricultural	134			118			322			488
Residential real estate	41			153			140			248
Consumer	33			43			123			159
Total recoveries	208			314			585			895
Net loan charge-offs (recoveries)	(51		)	(183		)	(215		)	(215		)
Provision for loan losses	49			17			85			185
ALLL at end of period	$	7,700		$	7,800		$	7,700		$	7,800
Net loan charge-offs (recoveries) to average loans outstanding	—		%	(0.02		)%	(0.02		)%	(0.02		)%

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

	September 30 2017			June 30 2017			March 31 2017			December 31 2016			September 30 2016
Total charge-offs	$	157		$	69		$	144		$	236		$	131
Total recoveries	208			160			217			156			314
Net loan charge-offs (recoveries)	(51		)	(91		)	(73		)	80			(183		)
Net loan charge-offs (recoveries) to average loans outstanding	—		%	(0.01		)%	(0.01		)%	0.01		%	(0.02		)%
Provision for loan losses	$	49		$	9		$	27		$	(320	)	$	17
Provision for loan losses to average loans outstanding	—		%	—		%	—		%	(0.03		)%	—		%
ALLL	$	7,700		$	7,600		$	7,500		$	7,400		$	7,800
ALLL as a % of loans at end of period	0.71		%	0.72		%	0.74		%	0.73		%	0.79		%

Net loan recoveries and the continuation of strong credit quality indicators have resulted in a reduction of the required ALLL as a percentage of loans over the past year. During this time, credit quality indicators, specifically historical loss factors, remain strong and have led to lower levels of required reserves. While the ALLL as a percentage of loans has declined, the balance of the ALLL has increased in recent periods as a result of our strong loan growth. The addition of advances to mortgage brokers contributed to the overall decline in the level of ALLL to gross loans as there are no historical losses requiring reserves. While these advances contribute to other qualitative factors, the impact is not significant on the required level of the ALLL.

47

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

	September 30 2017			June 30 2017			March 31 2017			December 31 2016			September 30 2016
ALLL
Individually evaluated for impairment	$	2,551		$	2,455		$	2,381		$	2,371		$	2,523
Collectively evaluated for impairment	5,149			5,145			5,119			5,029			5,277
Total	$	7,700		$	7,600		$	7,500		$	7,400		$	7,800
ALLL to gross loans
Individually evaluated for impairment	0.24		%	0.23		%	0.24		%	0.23		%	0.26		%
Collectively evaluated for impairment	0.47		%	0.49		%	0.50		%	0.50		%	0.53		%
Total	0.71		%	0.72		%	0.74		%	0.73		%	0.79		%

For further discussion of the allocation of the ALLL, see “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

Loans Past Due and Loans in Nonaccrual Status

Fluctuations in past due and nonaccrual status loans can have a significant impact on the ALLL. To determine the potential impact, and corresponding estimated losses, we analyze our historical loss trends on loans past due greater than 30 days and nonaccrual status loans. We monitor all loans that are past due and in nonaccrual status for indications of additional deterioration.

	Total Past Due and Nonaccrual Loans
	September 30 2017			June 30 2017			March 31 2017			December 31 2016			September 30 2016
Commercial and agricultural	$	3,600		$	4,920		$	5,758		$	4,598		$	3,148
Residential real estate	2,201			2,358			3,168			2,716			2,436
Consumer	52			64			35			115			51
Total	$	5,853		$	7,342		$	8,961		$	7,429		$	5,635
Total past due and nonaccrual loans to gross loans	0.54		%	0.70		%	0.88		%	0.74		%	0.57		%

While past due and nonaccrual status loans have fluctuated over the last year, they continue to be at low levels and are the result of strong loan performance. A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual status loans by type, is included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

48

Troubled Debt Restructurings

We have taken a proactive approach to avoid foreclosures on borrowers who are willing to work with us in modifying their loans, thus making them more affordable. While this approach has permitted certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure, it has contributed to a significant level of loans classified as TDR. The modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. At the time of the TDR, the loan is reviewed to determine whether or not to classify the loan as accrual or nonaccrual status. The majority of new modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed on nonaccrual status may be placed back on accrual status after six months of continued performance and achievement of current payment status.

We restructure debt with borrowers who, due to financial difficulties, are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, allow interest only payment structures, forgive principal, forgive interest, or a combination of these modifications. Typically, the modifications are for a period of five years or less. There were no TDRs that were government sponsored as of September 30, 2017 or December 31, 2016.

Losses associated with TDRs, if any, are included in the estimation of the ALLL in the quarter in which a loan is identified as a TDR, and we review the analysis of the ALLL estimation each reporting period to ensure its continued appropriateness.

The following tables provide a roll-forward of TDRs for the:

	Three Months Ended September 30, 2017
	Accruing Interest					Nonaccrual					Total
	Number of Loans		Balance			Number of Loans		Balance			Number of Loans		Balance
July 1, 2017	155		$	25,182		5		$	1,159		160		$	26,341
New modifications	3		1,354			2		210			5		1,564
Principal advances (payments)	—		(165		)	—		(12		)	—		(177		)
Loans paid-off	(6	)	(460		)	—		—			(6	)	(460		)
Partial charge-offs	—		—			—		—			—		—
Balances charged-off	(1	)	(9		)	—		—			(1	)	(9		)
Transfers to OREO	—		—			—		—			—		—
Transfers to accrual status	1		51			(1	)	(51		)	—		—
Transfers to nonaccrual status	—		—			—		—			—		—
September 30, 2017	152		$	25,953		6		$	1,306		158		$	27,259

	Nine Months Ended September 30, 2017
	Accruing Interest					Nonaccrual					Total
	Number of Loans		Balance			Number of Loans		Balance			Number of Loans		Balance
January 1, 2017	153		$	20,593		5		$	789		158		$	21,382
New modifications	16		6,909			3		676			19		7,585
Principal advances (payments)	—		(587		)	—		(34		)	—		(621		)
Loans paid-off	(16	)	(987		)	—		—			(16	)	(987		)
Partial charge-offs	—		—			—		—			—		—
Balances charged-off	(1	)	(9		)	—		—			(1	)	(9		)
Transfers to OREO	—		—			(2	)	(91		)	(2	)	(91		)
Transfers to accrual status	2		126			(2	)	(126		)	—		—
Transfers to nonaccrual status	(2	)	(92		)	2		92			—		—
September 30, 2017	152		$	25,953		6		$	1,306		158		$	27,259

49

	Three Months Ended September 30, 2016
	Accruing Interest					Nonaccrual					Total
	Number of Loans		Balance			Number of Loans		Balance			Number of Loans		Balance
July 1, 2016	151		$	18,843		6		$	587		157		$	19,430
New modifications	3		1,634			—		—			3		1,634
Principal advances (payments)	—		(204		)	—		(9		)	—		(213		)
Loans paid-off	(5	)	(272		)	—		—			(5	)	(272		)
Partial charge-offs	—		—			—		—			—		—
Balances charged-off	(1	)	(57		)	—		—			(1	)	(57		)
Transfers to OREO	—		—			—		—			—		—
Transfers to accrual status	3		218			(3	)	(218		)	—		—
Transfers to nonaccrual status	(2	)	(103		)	2		103			—		—
September 30, 2016	149		$	20,059		5		$	463		154		$	20,522

	Nine Months Ended September 30, 2016
	Accruing Interest					Nonaccrual					Total
	Number of Loans		Balance			Number of Loans		Balance			Number of Loans		Balance
January 1, 2016	155		$	20,931		5		$	394		160		$	21,325
New modifications	9		1,863			—		—			9		1,863
Principal advances (payments)	—		(831		)	—		(26		)	—		(857		)
Loans paid-off	(11	)	(1,348		)	(1	)	(221		)	(12	)	(1,569		)
Partial charge-offs	—		—			—		(133		)	—		(133		)
Balances charged-off	(2	)	(72		)	—		—			(2	)	(72		)
Transfers to OREO	—		—			(1	)	(35		)	(1	)	(35		)
Transfers to accrual status	3		218			(3	)	(218		)	—		—
Transfers to nonaccrual status	(5	)	(702		)	5		702			—		—
September 30, 2016	149		$	20,059		5		$	463		154		$	20,522

The following table summarizes our TDRs as of:

	September 30, 2017						December 31, 2016
	Accruing Interest		Nonaccrual		Total		Accruing Interest		Nonaccrual		Total		Total Change
Current	$	24,641	$	233	$	24,874	$	17,557	$	559	$	18,116	$	6,758
Past due 30-59 days	1,086		216		1,302		2,898		230		3,128		(1,826		)
Past due 60-89 days	3		—		3		138		—		138		(135		)
Past due 90 days or more	223		857		1,080		—		—		—		1,080
Total	$	25,953	$	1,306	$	27,259	$	20,593	$	789	$	21,382	$	5,877

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

50

Impaired Loans

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

	September 30, 2017						December 31, 2016
	Recorded Balance		Unpaid Principal Balance		Valuation Allowance		Recorded Balance		Unpaid Principal Balance		Valuation Allowance
TDRs
Commercial real estate	$	6,062	$	6,181	$	766	$	6,264	$	6,383	$	713
Commercial other	2,324		2,324		167		1,444		1,455		25
Agricultural real estate	7,834		7,834		—		4,037		4,037		—
Agricultural other	3,014		3,014		—		1,380		1,380		1
Residential real estate senior liens	7,854		8,234		1,524		8,058		8,437		1,539
Residential real estate junior liens	70		70		13		71		71		13
Home equity lines of credit	83		383		—		102		402		—
Consumer secured	18		18		—		26		26		—
Total TDRs	27,259		28,058		2,470		21,382		22,191		2,291
Other impaired loans
Commercial real estate	136		210		—		151		226		3
Commercial other	3		3		—		—		—		—
Agricultural real estate	—		—		—		—		—		—
Agricultural other	128		128		—		128		128		—
Residential real estate senior liens	419		669		81		406		612		76
Residential real estate junior liens	—		—		—		1		11		1
Home equity lines of credit	—		—		—		—		—		—
Consumer secured	—		—		—		—		—		—
Total other impaired loans	686		1,010		81		686		977		80
Total impaired loans	$	27,945	$	29,068	$	2,551	$	22,068	$	23,168	$	2,371

Additional disclosure related to impaired loans is included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

51

Nonperforming Assets

The following table summarizes our nonperforming assets as of:

	September 30 2017			June 30 2017			March 31 2017			December 31 2016			September 30 2016
Nonaccrual status loans	$	1,605		$	1,563		$	1,138		$	1,060		$	690
Accruing loans past due 90 days or more	646			1,203			1,339			633			847
Total nonperforming loans	2,251			2,766			2,477			1,693			1,537
Foreclosed assets	240			229			158			231			284
Total nonperforming assets	$	2,491		$	2,995		$	2,635		$	1,924		$	1,821
Nonperforming loans as a % of total loans	0.21		%	0.26		%	0.24		%	0.17		%	0.16		%
Nonperforming assets as a % of total assets	0.14		%	0.17		%	0.15		%	0.11		%	0.11		%

Typically after a loan is 90 days past due, it is placed on nonaccrual status unless it is well secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Loans may be placed back on accrual status after six months of continued performance and achievement of current payment status. Nonperforming loans have declined in recent periods with current levels of nonperforming loans continuing to be at low levels.

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

	September 30 2017		December 31 2016
Commercial and agricultural	$	1,068	$	405
Residential real estate	238		384
Total	$	1,306	$	789

Additional disclosures about nonaccrual status loans are included in “Note 5 – Loans and ALLL” of our interim condensed consolidated financial statements.

We continue to devote considerable attention to identifying impaired loans and adjusting the net carrying value of these loans to their current net realizable values through the establishment of a specific reserve or the recording of a charge-off. We believe that we have identified all impaired loans as of September 30, 2017.

We believe that the level of the ALLL is appropriate as of September 30, 2017. We will continue to closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at the appropriate level.

52

Noninterest Income and Noninterest Expenses

Significant noninterest income account balances are highlighted in the following table with additional descriptions of significant fluctuations:

	Three Months Ended September 30
							Change
	2017			2016			$			%
Service charges and fees
ATM and debit card fees	$	667		$	606		$	61		10.07	%
NSF and overdraft fees	481			480			1			0.21	%
Freddie Mac servicing fee	169			172			(3		)	(1.74	)%
Service charges on deposit accounts	88			92			(4		)	(4.35	)%
Net OMSR income (loss)	(77		)	(108		)	31			28.70	%
All other	107			34			73			214.71	%
Total service charges and fees	1,435			1,276			159			12.46	%
Net gain on sale of mortgage loans	153			263			(110		)	(41.83	)%
Earnings on corporate owned life insurance policies	174			183			(9		)	(4.92	)%
Net gains (losses) on sale of AFS securities	—			—			—			—	%
Other
Trust and brokerage advisory fees	724			1,000			(276		)	(27.60	)%
Corporate Settlement Solutions joint venture	84			145			(61		)	(42.07	)%
Other	128			79			49			62.03	%
Total other	936			1,224			(288		)	(23.53	)%
Total noninterest income	$	2,698		$	2,946		$	(248	)	(8.42	)%

	Nine Months Ended September 30
						Change
	2017		2016			$			%
Service charges and fees
ATM and debit card fees	$	1,945	$	1,840		$	105		5.71	%
NSF and overdraft fees	1,383		1,360			23			1.69	%
Freddie Mac servicing fee	508		529			(21		)	(3.97	)%
Service charges on deposit accounts	259		263			(4		)	(1.52	)%
Net OMSR income (loss)	107		(437		)	544			124.49	%
All other	168		97			71			73.20	%
Total service charges and fees	4,370		3,652			718			19.66	%
Net gain on sale of mortgage loans	507		472			35			7.42	%
Earnings on corporate owned life insurance policies	537		566			(29		)	(5.12	)%
Net gains (losses) on sale of AFS securities	142		245			(103		)	(42.04	)%
Other
Trust and brokerage advisory fees	1,961		2,135			(174		)	(8.15	)%
Corporate Settlement Solutions joint venture	171		362			(191		)	(52.76	)%
Other	414		489			(75		)	(15.34	)%
Total other	2,546		2,986			(440		)	(14.74	)%
Total noninterest income	$	8,102	$	7,921		$	181		2.29	%

53

Significant changes in noninterest income are detailed below:

• Offering rates on residential mortgage loans and prepayment speeds have been the most significant drivers behind fluctuations in net OMSR income (loss). We anticipate increases in mortgage rates and decreased prepayment speeds; therefore, we anticipate year-to-date net OMSR income to be positive during the remainder of 2017.

• We anticipate increases in our originations in purchase money mortgage activity as a result of our various initiatives to drive growth. As a result, we expect net gains on the sale of mortgage loans to increase during the remainder of 2017.

• We continue to invest considerable efforts to increase our market share in trust and brokerage advisory services. These efforts have translated into increases in such fee income. We anticipate that fee income will continue to increase during the remainder of 2017; however, 2017 year-to-date income will remain lower than income in 2016 due to a fee income assessment change during the third quarter of 2016 which resulted in higher earnings in 2016.

• Corporate Settlement Solutions income is down in 2017 compared to 2016 resulting from decreased revenue related to lower levels of loan origination and refinancing activities. Year-to-date income for 2017 is expected to continue to fall below 2016 levels.

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

54

Significant noninterest expense account balances are highlighted in the following table with additional descriptions of significant fluctuations:

	Three Months Ended September 30
					Change
	2017		2016		$			%
Compensation and benefits
Employee salaries	$	4,005	$	3,610	$	395		10.94	%
Employee benefits	1,355		1,330		25			1.88	%
Total compensation and benefits	5,360		4,940		420			8.50	%
Furniture and equipment
Service contracts	814		825		(11		)	(1.33	)%
Depreciation	511		483		28			5.80	%
All other	52		45		7			15.56	%
Total furniture and equipment	1,377		1,353		24			1.77	%
Occupancy
Depreciation	212		195		17			8.72	%
Outside services	178		171		7			4.09	%
Property taxes	142		141		1			0.71	%
Utilities	132		168		(36		)	(21.43	)%
All other	145		170		(25		)	(14.71	)%
Total occupancy	809		845		(36		)	(4.26	)%
Other
ATM and debit card fees	253		210		43			20.48	%
Audit and related fees	322		319		3			0.94	%
Consulting fees	259		198		61			30.81	%
Director fees	212		207		5			2.42	%
Loan underwriting fees	237		142		95			66.90	%
Donations and community relations	190		134		56			41.79	%
FDIC insurance premiums	172		224		(52		)	(23.21	)%
Marketing costs	172		101		71			70.30	%
Education and travel	143		73		70			95.89	%
Printing and supplies	110		105		5			4.76	%
Postage and freight	85		96		(11		)	(11.46	)%
All other	438		486		(48		)	(9.88	)%
Total other	2,593		2,295		298			12.98	%
Total noninterest expenses	$	10,139	$	9,433	$	706		7.48	%

55

	Nine Months Ended September 30
					Change
	2017		2016		$			%
Compensation and benefits
Employee salaries	$	12,127	$	10,387	$	1,740		16.75	%
Employee benefits	3,742		4,025		(283		)	(7.03	)%
Total compensation and benefits	15,869		14,412		1,457			10.11	%
Furniture and equipment
Service contracts	2,386		2,323		63			2.71	%
Depreciation	1,531		1,533		(2		)	(0.13	)%
All other	156		132		24			18.18	%
Total furniture and equipment	4,073		3,988		85			2.13	%
Occupancy
Depreciation	632		583		49			8.40	%
Outside services	577		555		22			3.96	%
Property taxes	434		429		5			1.17	%
Utilities	390		429		(39		)	(9.09	)%
All other	428		447		(19		)	(4.25	)%
Total occupancy	2,461		2,443		18			0.74	%
Other
ATM and debit card fees	873		627		246			39.23	%
Audit and related fees	757		664		93			14.01	%
Consulting fees	672		567		105			18.52	%
Director fees	634		630		4			0.63	%
Loan underwriting fees	546		377		169			44.83	%
Donations and community relations	488		399		89			22.31	%
FDIC insurance premiums	480		646		(166		)	(25.70	)%
Marketing costs	361		359		2			0.56	%
Education and travel	332		309		23			7.44	%
Printing and supplies	320		325		(5		)	(1.54	)%
Postage and freight	304		293		11			3.75	%
All other	1,427		1,692		(265		)	(15.66	)%
Total other	7,194		6,888		306			4.44	%
Total noninterest expenses	$	29,597	$	27,731	$	1,866		6.73	%

Significant changes in noninterest expenses are detailed below:

• Employee salaries have increased in 2017 as a result of new positions required for future growth within our new markets, normal merit increases and increased incentive compensation. As such, we anticipate employee salaries expense to continue to trend higher for the remainder of 2017 compared to the expense levels of 2016.

• Employee benefits have declined in 2017 due to a settlement with an insurance claim administrator in favor of Isabella Bank.

• ATM and debit card fees have increased in 2017 due to an early contract termination fee.

• Consulting fees have increased in 2017 due to compliance related services due to staff vacancies. Fees are expected to exceed 2016 levels for the remainder of 2017.

• Loan underwriting fees have increased due to increased consumer loan originations. Fees are expected to increase during the remainder of 2017 and exceed 2016 levels.

56

• FDIC insurance premiums have declined in 2017 as a result of changes to the premium calculation set forth by the FDIC in 2016; therefore, 2017 expenses are expected to be lower than 2016 for the remainder of the year.

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

Analysis of Changes in Financial Condition

	September 30 2017		December 31 2016		$ Change			% Change (unannualized)
ASSETS
Cash and cash equivalents	$	21,067	$	22,894	$	(1,827	)	(7.98	)%
AFS securities
Amortized cost of AFS securities	548,468		557,648		(9,180		)	(1.65	)%
Unrealized gains (losses) on AFS securities	4,457		448		4,009			N/M
AFS securities	552,925		558,096		(5,171		)	(0.93	)%
Mortgage loans AFS	1,237		1,816		(579		)	(31.88	)%
Loans
Gross loans	1,077,544		1,010,615		66,929			6.62	%
Less allowance for loan and lease losses	7,700		7,400		300			4.05	%
Net loans	1,069,844		1,003,215		66,629			6.64	%
Premises and equipment	28,761		29,314		(553		)	(1.89	)%
Corporate owned life insurance policies	26,837		26,300		537			2.04	%
Accrued interest receivable	7,388		6,580		808			12.28	%
Equity securities without readily determinable fair values	23,461		21,694		1,767			8.15	%
Goodwill and other intangible assets	48,575		48,666		(91		)	(0.19	)%
Other assets	11,872		13,576		(1,704		)	(12.55	)%
TOTAL ASSETS	$	1,791,967	$	1,732,151	$	59,816		3.45	%
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities
Deposits	$	1,216,062	$	1,195,040	$	21,022		1.76	%
Borrowed funds	367,027		337,694		29,333			8.69	%
Accrued interest payable and other liabilities	12,415		11,518		897			7.79	%
Total liabilities	1,595,504		1,544,252		51,252			3.32	%
Shareholders’ equity	196,463		187,899		8,564			4.56	%
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,791,967	$	1,732,151	$	59,816		3.45	%

As shown above, total assets have increased $59,816 since December 31, 2016 which was primarily driven by loan growth of $66,929. This growth was funded by an increase in deposits and in borrowed funds of $21,022 and $29,333, respectively, since December 31, 2016. While generating quality loans will continue to be competitive, we expect that loans will continue to grow in 2017.

The following table outlines the changes in loans:

	September 30 2017		December 31 2016		$ Change		% Change (unannualized)
Commercial	$	620,135	$	575,664	$	44,471	7.73	%
Agricultural	132,998		126,492		6,506		5.14	%
Residential real estate	271,480		266,050		5,430		2.04	%
Consumer	52,931		42,409		10,522		24.81	%
Total	$	1,077,544	$	1,010,615	$	66,929	6.62	%

57

The following table displays loan balances as of:

	September 30 2017		June 30 2017		March 31 2017		December 31 2016		September 30 2016
Commercial	$	620,135	$	600,584	$	576,822	$	575,664	$	554,847
Agricultural	132,998		130,954		126,049		126,492		133,637
Residential real estate	271,480		270,207		267,141		266,050		260,122
Consumer	52,931		46,752		42,908		42,409		40,760
Total	$	1,077,544	$	1,048,497	$	1,012,920	$	1,010,615	$	989,366

While competition for commercial loans continues to be strong, we experienced significant growth in these segments of the portfolio during 2016 and 2017 and anticipate continued growth in the remainder of 2017. Residential real estate and consumer loans have also experienced growth over the last year and are both expected to increase for the remainder of 2017.

The following table outlines the changes in deposits:

	September 30 2017		December 31 2016		$ Change			% Change (unannualized)
Noninterest bearing demand deposits	$	212,608	$	205,071	$	7,537		3.68	%
Interest bearing demand deposits	220,601		209,325		11,276			5.39	%
Savings deposits	358,358		347,230		11,128			3.20	%
Certificates of deposit	309,778		321,914		(12,136		)	(3.77	)%
Brokered certificates of deposit	95,979		88,632		7,347			8.29	%
Internet certificates of deposit	18,738		22,868		(4,130		)	(18.06	)%
Total	$	1,216,062	$	1,195,040	$	21,022		1.76	%

The following table displays deposit balances as of:

	September 30 2017		June 30 2017		March 31 2017		December 31 2016		September 30 2016
Noninterest bearing demand deposits	$	212,608	$	210,122	$	207,448	$	205,071	$	201,804
Interest bearing demand deposits	220,601		212,365		216,975		209,325		205,817
Savings deposits	358,358		357,756		365,287		347,230		331,414
Certificates of deposit	309,778		314,482		320,345		321,914		324,910
Brokered certificates of deposit	95,979		94,948		98,442		88,632		87,583
Internet certificates of deposit	18,738		20,479		22,564		22,868		24,305
Total	$	1,216,062	$	1,210,152	$	1,231,061	$	1,195,040	$	1,175,833

Deposit demand continues to be driven by non-contractual deposits, such as demand and savings deposits, while certificates of deposit and Internet certificates of deposit have gradually declined. Brokered certificates of deposit offer another source of funding and fluctuate from period-to-period based on our funding needs, including changes in assets such as loans and investments.

58

The balance of AFS securities fluctuates from period-to-period based on changes in loans and deposits. While loan growth has been strong over the last year, we purchased AFS securities in periods when deposit growth outpaced loan demand. Conversely, we have sold AFS securities in periods when loan demand has outpaced deposit growth. We remain active in investments with our local schools and municipalities. Potential future growth is anticipated in state and political subdivisions and purchases of mortgage-backed securities and collateralized mortgage obligations. The following table displays fair values of AFS securities as of:

	September 30 2017		June 30 2017		March 31 2017		December 31 2016		September 30 2016
Government sponsored enterprises	$	232	$	281	$	10,264	$	10,259	$	344
States and political subdivisions	213,457		222,093		222,777		212,919		219,689
Auction rate money market preferred	3,172		3,095		2,977		2,794		3,145
Preferred stocks	3,651		3,665		3,597		3,425		3,588
Mortgage-backed securities	215,914		221,957		229,774		227,256		226,649
Collateralized mortgage obligations	116,499		116,771		120,725		101,443		110,814
Total	$	552,925	$	567,862	$	590,114	$	558,096	$	564,229

Borrowed funds include FHLB advances, securities sold under agreements to repurchase, and federal funds purchased. The balance of borrowed funds fluctuates from period-to-period based on our funding needs including changes in loans, investments, and deposits. To provide balance sheet growth, we utilize borrowings and brokered deposits to fund earning assets. The following table displays borrowed funds balances as of:

	September 30 2017		June 30 2017		March 31 2017		December 31 2016		September 30 2016
FHLB advances	$	310,000	$	310,000	$	270,000	$	270,000	$	250,000
Securities sold under agreements to repurchase without stated maturity dates	54,977		49,950		57,375		60,894		54,809
Federal funds purchased	2,050		990		—		6,800		20,600
Total	$	367,027	$	360,940	$	327,375	$	337,694	$	325,409

Capital

Capital consists solely of common stock, retained earnings, and accumulated other comprehensive income (loss). We are authorized to raise capital through dividend reinvestment, employee and director stock purchases, and shareholder stock purchases. Pursuant to these authorizations, we issued 178,712 shares or $4,999 of common stock during the first nine months of 2017, as compared to 131,697 shares or $3,683 of common stock during the same period in 2016. We also offer the Directors Plan in which participants either directly purchase stock or purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $502 and $443 during the nine month periods ended September 30, 2017 and 2016, respectively.

We have a publicly announced common stock repurchase plan. Pursuant to this plan, we repurchased 143,117 shares or $4,005 of common stock during the first nine months of 2017 and 98,083 shares or $2,749 during the first nine months of 2016. As of September 30, 2017, we were authorized to repurchase up to an additional 56,839 shares of common stock.

The FRB has established minimum risk based capital guidelines. Pursuant to these guidelines, a framework has been established that assigns risk weights to each category of on and off-balance-sheet items to arrive at risk adjusted total assets. Regulatory capital is divided by the risk adjusted assets with the resulting ratio compared to the minimum standard to determine whether a corporation has adequate capital. On July 2, 2013, the FRB published revised BASEL III Capital standards for banks. The final rules redefine what is included or deducted from equity capital, changes risk weighting for certain on and off-balance sheet assets, increases the minimum required equity capital to be considered well capitalized, and introduces a capital conservation buffer. The rules, which are being gradually phased in between 2015 and 2019, are not expected to have a material impact on the Corporation but will require us to hold more capital than has historically been required.

There are no significant regulatory constraints placed on our capital. The FRB’s current recommended minimum primary capital to assets requirement is 6.00%. Our primary capital to adjusted average assets, or tier 1 leverage ratio, was 8.50% as of September 30, 2017.

59

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 will further increase the required levels each year through 2019. The following table sets forth the percentages required under the Risk Based Capital guidelines and our ratios as of:

	September 30 2017				December 31 2016
	Actual		Minimum Required		Actual		Minimum Required
Common equity tier 1 capital	12.200	%	5.750	%	12.390	%	5.125	%
Tier 1 capital	12.200	%	7.250	%	12.390	%	6.625	%
Tier 2 capital	0.640	%	2.000	%	0.650	%	2.000	%
Total Capital	12.840	%	9.250	%	13.040	%	8.625	%

Tier 2 capital, or secondary capital, includes only the ALLL. The percentage for the secondary capital under the required column is the maximum amount allowed from all sources.

The FRB and FDIC also prescribe minimum capital requirements for Isabella Bank. At September 30, 2017, the Bank exceeded these minimum capital requirements.

Contractual Obligations and Loan Commitments

We are party to credit related financial instruments with off-balance-sheet risk. These financial instruments are entered into in the normal course of business to meet the financing needs of our customers. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of these instruments reflect the extent of involvement we have in a particular class of financial instrument.

The following table summarizes our credit related financial instruments with off-balance-sheet risk as of:

	September 30 2017		December 31 2016
Unfunded commitments under lines of credit	$	165,768	$	168,840
Commitments to grant loans	43,353		29,339
Commercial and standby letters of credit	1,622		1,223
Total	$	210,743	$	199,402

Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. These commitments may expire without being drawn upon and do not necessarily represent future cash requirements. Advances to mortgage brokers are also included in unfunded commitments under lines of credit. The unfunded commitment amount is the difference between our outstanding balances and the maximum outstanding aggregate amount.

Commitments to grant loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The amount of collateral obtained, if it is deemed necessary, is based on management’s credit evaluation of the customer. Commitments to grant loans include residential mortgage loans with the majority being loans committed to be sold to the secondary market.

Commercial and standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements, including commercial paper, bond financing, and similar transactions. These commitments to extend credit and letters of credit generally mature within one year. The credit risk involved in these transactions is essentially the same as that involved in extending loans to customers. We evaluate each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon the extension of credit, is based on a credit evaluation of the borrower. While we consider standby letters of credit to be guarantees, the amount of the liability related to such guarantees on the commitment date is not significant and a liability related to such guarantees is not recorded on the consolidated balance sheets.

60

Our exposure to credit-related loss in the event of nonperformance by the counter parties to the financial instruments for commitments to extend credit and standby letters of credit could be up to the contractual notional amount of those instruments. We use the same credit policies as we do for extending loans to customers. No significant losses are anticipated as a result of these commitments.

Fair Value

We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. AFS securities, cash flow hedge derivative instruments and certain liabilities are recorded at fair value on a recurring basis. Additionally, from time-to-time, we may be required to record at fair value other assets on a nonrecurring basis, such as mortgage loans AFS, impaired loans, goodwill, foreclosed assets, OMSR, and certain other assets and liabilities. These nonrecurring fair value adjustments typically involve the application of lower of cost or market accounting or write-downs of individual assets.

For further information regarding fair value measurements see “Note 11 – Fair Value” of our notes to the interim condensed consolidated financial statements.

Liquidity

Liquidity is monitored regularly by our Market Risk Committee, which consists of members of senior management. The committee reviews projected cash flows, key ratios, and liquidity available from both primary and secondary sources.

Our primary sources of liquidity are cash and cash equivalents and unencumbered AFS securities. These categories totaled $269,687 or 15.05% of assets as of September 30, 2017, compared to $307,112 or 17.73% as of December 31, 2016. The decrease in primary liquidity is a direct result of our unencumbered AFS securities activity during 2017. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Liquidity varies significantly daily, based on customer activity.

Our primary source of funds is through deposit accounts. We also have the ability to borrow from the FHLB, the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As of September 30, 2017, we had available lines of credit of $114,839.

The following table summarizes our sources and uses of cash for the nine month period ended September 30:

	2017			2016			$ Variance
Net cash provided by (used in) operating activities	$	13,728		$	15,565		$	(1,837	)
Net cash provided by (used in) investing activities	(60,627		)	(37,704		)	(22,923		)
Net cash provided by (used in) financing activities	45,072			21,905			23,167
Increase (decrease) in cash and cash equivalents	(1,827		)	(234		)	(1,593		)
Cash and cash equivalents January 1	22,894			21,569			1,325
Cash and cash equivalents September 30	$	21,067		$	21,335		$	(268	)

Market Risk

Our primary market risks are interest rate risk and liquidity risk. We have no significant foreign exchange risk in the management of IRR. Any changes in foreign exchange rates or commodity prices would have an insignificant impact on our interest income and cash flows.

IRR is the exposure of our net interest income to changes in interest rates. IRR results from the difference in the maturity or repricing frequency of a financial institution's interest earning assets and its interest bearing liabilities. IRR is the fundamental method by which financial institutions earn income and create shareholder value. Excessive exposure to IRR could pose a significant risk to our earnings and capital.

The FRB has adopted a policy requiring us to effectively manage the various risks that can have a material impact on our safety and soundness. The risks include credit, interest rate, liquidity, operational, and reputational. We have policies, procedures, and internal controls for measuring and managing these risks. Specifically, our Funds Management policy and procedures include defining acceptable types and terms of investments and funding sources, liquidity requirements, limits on investments in long

61

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

The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield curves, interest rate relationships, loan prepayments, and changes in funding sources. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in accordance with their contractual terms, several balance sheet components demonstrate characteristics that require an evaluation to more accurately reflect their repricing behavior. Key assumptions in the simulation analysis include prepayments on loans, probable calls of investment securities, changes in market conditions, loan volumes and loan pricing, deposit sensitivity, and customer preferences. These assumptions are inherently uncertain as they are subject to fluctuation and revision in a dynamic environment. As a result, the simulation analysis cannot precisely forecast the impact of rising and falling interest rates on net interest income. Actual results will differ from simulated results due to many other factors, including changes in balance sheet components, interest rate changes, changes in market conditions, and management strategies.

Our interest rate sensitivity is estimated by first forecasting the next 12 and 24 months of net interest income under an assumed environment of a constant balance sheet and constant market interest rates (base case). We then compare the results of various simulation analyses to the base case. At September 30, 2017, we projected the change in net interest income during the next 12 and 24 months assuming market interest rates were to immediately decrease by 100 basis points and increase by 100, 200, 300, and 400 basis points in a parallel fashion over the entire yield curve during the same time period. We did not project scenarios showing decreases in interest rates beyond 100 basis points as this is considered extremely unlikely given current interest rate levels. These projections were based on our assets and liabilities remaining static over the next 12 and 24 months, while factoring in probable calls and prepayments of certain investment securities and residential real estate and consumer loans. While it is extremely unlikely that interest rates would immediately increase to these levels, we feel that these extreme scenarios help us identify potential gaps and mismatches in the repricing characteristics of assets and liabilities. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits. As of September 30, 2017, our interest rate sensitivity results were within Board approved limits.

The following tables summarize our interest rate sensitivity for the next 12 and 24 months as of:

	September 30, 2017
	12 Months										24 Months
Immediate basis point change assumption (short-term)	-100		+100		+200		+300		+400		-100		+100		+200		+300		+400
Percent change in net interest income vs. constant rates	(1.48	)%	1.90	%	3.67	%	5.28	%	7.15	%	(1.57	)%	2.37	%	4.35	%	5.85	%	7.12	%

	December 31, 2016
	12 Months										24 Months
Immediate basis point change assumption (short-term)	-100		+100		+200		+300		+400		-100		+100		+200		+300		+400
Percent change in net interest income vs. constant rates	(4.49	)%	2.19	%	4.31	%	5.68	%	6.67	%	(5.32	)%	2.64	%	5.01	%	6.33	%	6.75	%

62

The following tables provide information about assets and liabilities that are sensitive to changes in interest rates as of September 30, 2017 and December 31, 2016. The principal amounts of investments, loans, other interest earning assets, borrowings, and time deposits maturing were calculated based on the contractual maturity dates. Estimated cash flows for savings and NOW accounts are based on our estimated deposit decay rates.

	September 30, 2017
	2018			2019			2020			2021			2022			Thereafter			Total			Fair Value
Rate sensitive assets
Other interest bearing assets	$	317		$	—		$	100		$	—		$	—		$	—		$	417		$	413
Average interest rates	0.13		%	—		%	0.35		%	—		%	—		%	—		%	0.19		%
AFS securities	$	97,221		$	76,245		$	75,047		$	64,571		$	57,336		$	182,505		$	552,925		$	552,925
Average interest rates	2.31		%	2.43		%	2.56		%	2.57		%	2.37		%	2.51		%	2.46		%
Fixed interest rate loans (1)	$	165,818		$	115,736		$	111,844		$	128,218		$	118,105		$	210,925		$	850,646		$	830,014
Average interest rates	4.04		%	4.33		%	4.25		%	4.19		%	4.25		%	4.03		%	4.16		%
Variable interest rate loans (1)	$	74,253		$	34,336		$	23,884		$	21,932		$	25,710		$	46,783		$	226,898		$	226,898
Average interest rates	5.07		%	4.60		%	4.81		%	4.20		%	4.28		%	3.88		%	4.55		%
Rate sensitive liabilities
Fixed rate borrowed funds	$	137,027		$	95,000		$	20,000		$	35,000		$	50,000		$	20,000		$	357,027		$	357,873
Average interest rates	1.08		%	1.82		%	1.85		%	1.78		%	1.97		%	2.54		%	1.60		%
Variable rate borrowed funds	$	—		$	—		$	—		$	10,000		$	—		$	—		$	10,000		$	10,000
Average interest rates	—		%	—		%	—		%	1.61		%	—		%	—		%	1.61		%
Savings and NOW accounts	$	147,447		$	42,087		$	37,635		$	33,677		$	30,159		$	287,954		$	578,959		$	578,959
Average interest rates	0.49		%	0.21		%	0.21		%	0.20		%	0.20		%	0.18		%	0.26		%
Fixed interest rate certificates of deposit	$	201,000		$	73,091		$	35,115		$	49,089		$	39,561		$	21,022		$	418,878		$	417,919
Average interest rates	0.96		%	1.25		%	1.58		%	1.70		%	1.81		%	2.02		%	1.28		%
Variable interest rate certificates of deposit	$	2,346		$	3,269		$	2		$	—		$	—		$	—		$	5,617		$	5,617
Average interest rates	1.07		%	1.26		%	—		%	—		%	—		%	—		%	1.18		%

63

	December 31, 2016
	2017			2018			2019			2020			2021			Thereafter			Total			Fair Value
Rate sensitive assets
Other interest bearing assets	$	2,727		$	—		$	—		$	—		$	—		$	—		$	2,727		$	2,727
Average interest rates	0.34		%	—		%	—		%	—		%	—		%	—		%	0.34		%
AFS securities	$	114,247		$	71,220		$	64,931		$	63,150		$	66,976		$	177,572		$	558,096		$	558,096
Average interest rates	2.35		%	2.38		%	2.45		%	2.64		%	2.57		%	2.50		%	2.47		%
Fixed interest rate loans (1)	$	159,964		$	115,741		$	103,514		$	107,185		$	112,811		$	199,160		$	798,375		$	778,769
Average interest rates	4.15		%	4.25		%	4.34		%	4.16		%	4.15		%	4.10		%	4.18		%
Variable interest rate loans (1)	$	69,024		$	29,179		$	38,248		$	16,179		$	23,632		$	35,978		$	212,240		$	212,240
Average interest rates	4.83		%	4.32		%	4.16		%	3.62		%	3.74		%	3.86		%	4.26		%
Rate sensitive liabilities
Fixed rate borrowed funds	$	137,694		$	50,000		$	60,000		$	10,000		$	50,000		$	20,000		$	327,694		$	326,975
Average interest rates	0.83		%	2.16		%	1.99		%	1.98		%	1.91		%	2.54		%	1.55		%
Variable rate borrowed funds	$	—		$	—		$	—		$	—		$	10,000		$	—		$	10,000		$	10,000
Average interest rates	—		%	—		%	—		%	—		%	1.21		%	—		%	1.21		%
Savings and NOW accounts	$	84,972		$	42,596		$	38,220		$	34,326		$	30,858		$	325,583		$	556,555		$	556,555
Average interest rates	0.57		%	0.12		%	0.11		%	0.11		%	0.11		%	0.11		%	0.18		%
Fixed interest rate certificates of deposit	$	195,389		$	80,139		$	45,110		$	33,929		$	50,978		$	24,881		$	430,426		$	427,100
Average interest rates	0.86		%	1.18		%	1.35		%	1.58		%	1.68		%	1.84		%	1.18		%
Variable interest rate certificates of deposit	$	1,078		$	1,910		$	—		$	—		$	—		$	—		$	2,988		$	2,988
Average interest rates	0.62		%	0.99		%	—		%	—		%	—		%	—		%	0.85		%

⁽¹⁾ The fair value reported is exclusive of the allocation of the ALLL.

We do not believe that there has been a material change in the nature or categories of our primary market risk exposure, or the particular markets that present the primary risk of loss. As of the date of this report, we do not know of or expect there to be any material change in the general nature of our primary market risk exposure in the near term and we do not expect to make material changes in those methods used to measure and assess market risk in the near term. We may change those methods in the future to adapt to changes in circumstances or to implement new techniques.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

The information presented in the section captioned “Market Risk” in Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.

Item 4. Controls and Procedures.

DISCLOSURE CONTROLS AND PROCEDURES

We carried out an evaluation, under the supervision and with the participation of the Principal Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15(d)-15(e) under the Exchange Act) as of September 30, 2017, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that our disclosure controls and procedures as of September 30, 2017, were effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

During the most recent fiscal quarter, no change occurred in our internal control over financial reporting that materially affected, or is likely to materially affect, our internal control over financial reporting.

64

PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

We are not involved in any material legal proceedings. We are involved in ordinary, routine litigation incidental to our business; however, no such routine proceedings are expected to result in any material adverse effect on operations, earnings, financial condition, or cash flows.

Item 1A. Risk Factors.

There have been no material changes to the risk factors disclosed in Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2016.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

(A) None

(B) None

(C) Repurchases of Common Stock

We have adopted and publicly announced a common stock repurchase plan. The plan was last amended on December 21, 2016, to allow for the repurchase of an additional 200,000 shares of common stock after that date. These authorizations do not have expiration dates. As common shares are repurchased under this plan, they are retired and revert back to the status of authorized, but unissued common shares.

The following table provides information for the three month period ended September 30, 2017, with respect to this plan:

	Common Shares Repurchased			Total Number of Common Shares Purchased as Part of Publicly Announced Plan or Program	Maximum Number of Common Shares That May Yet Be Purchased Under the Plans or Programs
	Number	Average Price Per Common Share
Balance, June 30					105,875
July 1 -31	10,431	$	27.99	10,431	95,444
August 1 - 31	31,647	28.19		31,647	63,797
September 1 - 30	6,958	28.60		6,958	56,839
Balance, September 30	49,036	$	28.20	49,036	56,839

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

Not applicable.

65

Item 6. Exhibits.

(a) Exhibits

Exhibit Number	Exhibits
31(a)	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Executive Officer
31(b)	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by the Principal Financial Officer
32	Section 1350 Certification of Principal Executive Officer and Principal Financial Officer
101.1*	101.INS (XBRL Instance Document)
	101.SCH (XBRL Taxonomy Extension Schema Document)
	101.CAL (XBRL Calculation Linkbase Document)
	101.LAB (XBRL Taxonomy Label Linkbase Document)
	101.DEF (XBRL Taxonomy Linkbase Document)
	101.PRE (XBRL Taxonomy Presentation Linkbase Document)

* In accordance with Rule 406T of Regulations S-T, the XBRL related information shall not be deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

66

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		Isabella Bank Corporation
Date:	November 3, 2017		/s/ Jae A. Evans
			Jae A. Evans
			President, Chief Executive Officer
			(Principal Executive Officer)
Date:	November 3, 2017		/s/ Rhonda S. Tudor
			Rhonda S. Tudor
			Interim Chief Financial Officer
			(Principal Accounting Officer)

67