Isabella Bank Corp ISBA US Equity☆

isba-20201231

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2020

OR

For the transition period from to

Commission File Number: 0-18415

Isabella Bank Corporation

(Exact name of registrant as specified in its charter)

401 North Main Street, Mount Pleasant, Michigan48858

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code (989)772-9471

Securities registered pursuant to Section 12(b) of the Act:

Title of each class Trading Symbol(s) Name of each exchange on which registered

None N/A N/A

Securities registered pursuant to Section 12(g) of the Act:

Common Stock - No Par Value

(Title of Class)

Indicated by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ☐ Yes ☒No

Indicated by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ☐ Yes ☒No

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

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒Yes☐ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐ Accelerated filer ☐

Non-accelerated filer ☒ 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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No

The aggregate market value of the voting stock held by non-affiliates of the registrant was $139,668,000 as of the last business day of the registrant’s most recently completed second fiscal quarter.

The number of common shares outstanding of the registrant’s Common Stock (no par value) was 7,955,620 as of March 9, 2021.

DOCUMENTS INCORPORATED BY REFERENCE

(Such documents are incorporated herein only to the extent specifically set forth in response to an item herein.)

Portions of the Isabella Bank Corporation Proxy Statement for its Annual Meeting of Shareholders to be held May 4, 2021 are incorporated by reference in this Form 10-K in response to Part III. The Isabella Bank Corporation Proxy Statement will be mailed on or before March 26, 2021.

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ISABELLA BANK CORPORATION

ANNUAL REPORT ON FORM 10-K

Table of Contents

PART I 4

Item 1. Business 4

Item 1A. Risk Factors 6

Item 1B. Unresolved Staff Comments 9

Item 2. Properties 9

Item 3. Legal Proceedings 9

Item 4. Mine Safety Disclosures 9

Item 6. Selected Financial Data 12

Item 7A. Quantitative and Qualitative Disclosures about Market Risk 33

Item 8. Financial Statements and Supplementary Data 34

Item 9A. Controls and Procedures 85

Item 9B. Other Information 86

PART III 87

Item 10. Directors, Executive Officers and Corporate Governance 87

Item 11. Executive Compensation 87

Item 14. Principal Accountant Fees and Services 88

Item 15. Exhibits, Financial Statement Schedules 89

SIGNATURES 91

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Forward Looking Statements

This report contains certain forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended and Rule 3b-6 promulgated thereunder. We intend such forward looking statements to be covered by the safe harbor provisions for forward looking statements contained in the Private Securities Litigation Reform Act of 1995, and are included in this statement for purposes of these safe harbor provisions. Forward looking statements, which are based on certain assumptions and describe future plans, strategies and expectations, are generally identifiable by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on our operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, federal or state tax laws, monetary and fiscal policy, a health crisis, the quality or composition of our loan or investment portfolio, demand for loan products, fluctuation in the value of collateral securing our loan portfolio, deposit flows, competition, cybersecurity risk, demand for financial services in our market area, and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward looking statements and undue reliance should not be placed on such statements. Further information concerning our business, including additional factors that could materially affect our consolidated financial results, is included in our filings with the SEC.

Glossary of Acronyms and Abbreviations

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

ACL: Allowance for credit losses FTE: Fully taxable equivalent

AFS: Available-for-sale GAAP: U.S. generally accepted accounting principles

ALLL: Allowance for loan and lease losses IRR: Interest rate risk

ASC: FASB Accounting Standards Codification LIBOR: London Interbank Offered Rate

ASU: FASB Accounting Standards Update N/A: Not applicable

ATM: Automated teller machine N/M: Not meaningful

BHC Act: Bank Holding Company Act of 1956 NAV: Net asset value

CECL: Current expected credit losses OCI: Other comprehensive income (loss)

CIK: Central Index Key OREO: Other real estate owned

COVID-19: Coronavirus disease 2019 OTTI: Other-than-temporary impairment

CRA: Community Reinvestment Act PBO: Projected benefit obligation

DIF: Deposit Insurance Fund PCAOB: Public Company Accounting Oversight Board

Exchange Act: Securities Exchange Act of 1934 SBA: Small Business Administration

FDIC: Federal Deposit Insurance Corporation SOX: Sarbanes-Oxley Act of 2002

FRB: Federal Reserve Bank TDR: Troubled debt restructuring

FHLB: Federal Home Loan Bank XBRL: eXtensible Business Reporting Language

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PART I

Item 1. Business. (Dollars in thousands)

General

Isabella Bank Corporation is a registered financial services holding company that was incorporated in September 1988 under Michigan law. The Corporation's wholly owned subsidiary, Isabella Bank, has 30 banking offices located throughout Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties. The area includes significant agricultural production, manufacturing, retail, gaming and tourism, and several colleges and universities.

As used in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations as well as in Item 8. Financial Statements and Supplementary Data, references to “the Corporation”, “Isabella”, “we”, “our”, “us”, and similar terms refer to the consolidated entity consisting of Isabella Bank Corporation and its subsidiary. References to Isabella Bank or the “Bank” refers to Isabella Bank Corporation’s subsidiary, Isabella Bank.

We are a community bank with a focus on providing high quality, personalized service at a fair price. We offer a broad array of banking and wealth management services to businesses, institutions, individuals and their families. We compete with other commercial banks, savings and loan associations, mortgage brokers, finance companies, credit unions, retail brokerage firms, and other companies providing financial services.

Lending activities include loans for commercial and agricultural operations and real estate purposes, residential real estate loans, and consumer loans. We limit lending activities primarily to local markets and purchased loans from the secondary market are minimal. We do not make loans to fund leveraged buyouts, have no foreign corporate or government loans, and have limited holdings of corporate debt securities. Our general lending philosophy is to limit concentrations to individuals and business segments. For additional information related to our lending strategies and policies, see “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Deposit services offered include checking accounts, savings accounts, certificates of deposit, direct deposits, cash management services, mobile and internet banking, electronic bill pay services, and automated teller machines. We also offer full service investment management, trust and estate services.

As of December 31, 2020, we had 340 full-time equivalent employees. We provide group life, health, accident, disability, and other insurance programs as well as a number of other employee benefit programs. None of our workforce is subject to collective bargaining agreements.

Available Information

Our SEC filings (including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Definitive Proxy Statements, Current Reports on Form 8-K and amendments to those reports) are available through our website (www.isabellabank.com). We will provide paper copies of our SEC reports free of charge upon request by a shareholder.

The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements and other information regarding Isabella Bank Corporation (CIK #0000842517) and other issuers.

Supervision and Regulation

The earnings and growth of the banking industry are affected by the credit policies of monetary authorities, including the FRB. An important function of the FRB is to regulate the national supply of bank credit in order to combat recessions and respond to inflationary pressures. Among the instruments of monetary policy used by the FRB to implement these objectives are open market operations in U.S. Treasury and U.S. Government Agency securities, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These methods are used in varying combinations to influence overall growth of bank loans, investments and deposits and also affect interest rates charged on loans or paid for deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks and related financial service providers in the past and are expected to continue to do so in the future. The effect of such policies upon our future business and earnings cannot be predicted.

We, as a financial holding company, are regulated under the BHC Act, and are subject to the supervision of the FRB. We are registered as a financial services holding company with the FRB and are subject to reporting requirements and inspections and audits. Under FRB policy, we are expected to act as a source of financial strength to the Bank and to commit resources to support its subsidiaries. This support may be required at times when, in the absence of such FRB policy, it would not otherwise be required to provide support.

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Under Michigan law, if the capital of a Michigan state chartered bank has become impaired by losses or otherwise, the Commissioner of the DIFS may require that the deficiency in capital be met by assessment upon the bank’s shareholders. Each shareholder would be responsible for a pro rata share of the deficiency, based on the amount of capital stock held by each shareholder. If an assessment is not paid by any shareholder within 30 days of the date of notice to the shareholder, sale of their stock will occur in order to pay such assessment.

Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. This priority would apply to guarantees of capital plans under the FDIC Improvement Act of 1991.

SOX contains important requirements for public companies in the area of financial disclosure and corporate governance. In accordance with Section 302(a) of SOX, written certifications by our principal executive, financial, and accounting officers are required. These certifications attest that our quarterly and annual reports filed with the SEC do not contain any untrue statement of a material fact (see the certifications filed as Exhibits 31 (a) and (b) to this Form 10-K for such certification of consolidated financial statements and other information for this 2020 Form 10-K). We have also implemented a program designed to comply with Section 404 of SOX, which included the identification of significant processes and accounts, documentation of the design effectiveness over process and entity level controls, and testing of the operating effectiveness of key controls. See Item 9A. Controls and Procedures for our evaluation of disclosure controls and procedures and internal control over financial reporting.

Certain additional information concerning regulatory guidelines for capital adequacy and other regulatory matters is presented herein under the caption “Capital” in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations and in “Note 10 – Off-Balance-Sheet Activities, Commitments and Other Matters” and “Note 11 – Minimum Regulatory Capital Requirements” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Isabella Bank

The Bank is supervised and regulated by DIFS and the FRB. These agencies and federal and state laws extensively regulate various aspects of the banking business including, among other things, permissible types and amounts of loans, investments and other activities, capital adequacy, branching, interest rates on loans and deposits, and the safety and soundness of banking practices.

Our deposits are insured up to applicable limits by the DIF of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The FDIC assesses insurance premiums based upon a financial ratios method that takes into account asset and capital levels and supervisory ratings.

Banking laws and regulations restrict transactions by insured banks owned by a bank holding company. These restrictions include loans to and certain purchases from the parent holding company, non-bank and bank subsidiaries of the parent holding company. Additional restrictions apply to principal shareholders, officers, directors and their affiliates, and investments by the subsidiary bank in the shares or securities of the parent holding company (or any of the other non-bank or bank affiliates), or acceptance of such shares or securities as collateral security for loans to any borrower.

The Bank is subject to legal limitations on the frequency and amount of dividends that can be paid to Isabella Bank Corporation. For example, a Michigan state chartered bank may not declare a cash dividend or a dividend in kind except out of net profits then on hand after deducting all losses and bad debts, and then only if it will have a surplus amounting to not less than 20% of its capital after the payment of the dividend. Moreover, a Michigan state chartered bank may not declare or pay any cash dividend or dividend in kind until the cumulative dividends on its preferred stock, if any, have been paid in full. Further, if the surplus of a Michigan state chartered bank is at any time less than the amount of its capital, before the declaration of a cash dividend or dividend in kind, it must transfer to surplus not less than 10% of its net profits for the preceding six months (in the case of quarterly or semi-annual dividends) or the preceding two consecutive six month periods (in the case of annual dividends).

The payment of dividends by Isabella Bank Corporation and the Bank is also affected by various regulatory requirements and policies, such as the requirement to keep adequate capital in compliance with regulatory guidelines. Federal laws impose further restrictions on the payment of dividends by insured banks that fail to meet specified capital levels. The FDIC may prevent an insured bank from paying dividends if the bank is in default of payment of any assessment due to the FDIC. In addition, payment of dividends by a bank may be prevented by the applicable federal regulatory authority if such payment is determined, by reason of the financial condition of such bank, to be an unsafe and unsound banking practice. The FRB and the

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FDIC have issued policy statements providing that bank holding companies and insured banks should generally pay dividends only out of current operating earnings. Additionally, the FRB Board of Governors requires a bank holding company to notify the FRB prior to increasing its cash dividend by more than 10% over the prior year.

The aforementioned regulations and restrictions may limit our ability to obtain funds from the Bank for our cash needs, including payment of dividends and operating expenses.

The activities and operations of the Bank are also subject to various federal and state laws and regulations.

Item 1A. Risk Factors.

In the normal course of business, we are exposed to various risks. These risks, if not managed correctly, could have a significant impact on our earnings, capital, share price, and ability to pay dividends. In order to effectively monitor and control the following risks, we utilize an enterprise risk model. We balance our strategic goals, including revenue and profitability objectives, with associated risks through the use of policies, systems, and procedures which have been adopted to identify, assess, control, monitor, and manage each risk area. We continually review the adequacy and effectiveness of these policies, systems, and procedures.

Our enterprise risk process covers each of the following areas.

The COVID-19 pandemic may adversely affect our business

Unexpected and unprecedented changes have occurred during 2020 and into 2021 as the result of COVID-19. This aggressive and persistent virus causes a respiratory disease and can result in serious illness or death. The World Health Organization has declared the situation a global pandemic.

The pandemic has created significant market volatility, economic uncertainty, and disruption to normal business operations around the world, with slowdowns and shutdowns affecting entire industries. The Michigan governor issued on March 23, 2020 a stay-at-home order, which limited gatherings and travel, and required those working, or required individuals working in select businesses who were not deemed essential to sustain or protect life to stay home. The Michigan stay-at-home order was in effect until early June. The orders led to financial stress for many businesses and their employees throughout the communities we serve. Additional executive and Michigan State Health Department orders have been put in place since June 2020.

The extent to which COVID-19 impacts our business will depend on future developments, which are highly uncertain and cannot be predicted with any accuracy. Future developments include new information which may emerge concerning the severity of COVID-19 and the actions to contain the coronavirus or treat its impact, among others. We expect the significance of the COVID-19 pandemic, including the extent of its effect on our financial and operational results, to be dictated by, among other factors, its duration, the success of efforts to contain it and the impact of actions taken in response, including the development and distribution of effective vaccines. Uncertainty created by the COVID-19 pandemic is pervasive, and has impacted our financial results, operations, customers, vendors and various areas of risk. Areas of risk may include, but are not limited to, cybersecurity, credit, interest rate, litigation and risk related to vendor services. With the uncertainty created by COVID-19, it's challenging to determine the full impact on our ongoing financial and operational results. We continue to closely monitor external events and are in continual discussion with our customers to assess, prepare and respond to conditions as they evolve.

Changes in credit quality and required allowance for loan and lease losses

To manage the credit risk arising from lending activities, our most significant source of credit risk, we maintain sound underwriting policies and procedures. We continuously monitor asset quality in order to determine the appropriateness of valuation allowances. These valuation allowances take into consideration various factors including, but not limited to, local, regional, and national economic conditions.

We maintain an ALLL to reserve for estimated incurred loan losses within our loan portfolio. The level of the ALLL reflects our evaluation of industry concentrations; specific credit risks; loan loss experience; loan portfolio quality; and economic, political and regulatory conditions. The determination of the appropriate level of the ALLL inherently involves a high degree of subjectivity and requires us to make significant estimates, all of which may undergo material changes.

Changes in economic conditions

An economic downturn within our local markets, as well as downturns in the state, national, or global markets, could negatively impact household and corporate incomes. This could lead to decreased demand for both loan and deposit products and lead to

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an increase of customers who fail to pay interest or principal on their loans. We continually monitor key economic indicators in an effort to anticipate the possible effects of downturns in the local, regional, and national economies.

Our success depends primarily on the general economic conditions of the State of Michigan and the specific local markets in which we operate. We provide banking and financial services to customers located primarily in theClare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties in Michigan. The local economic conditions in these areas have a significant impact on the demand for our products and services, as well as the ability of our customers to repay loans, the value of the collateral securing loans, and the stability of our deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, international or domestic occurrences, a health crisis, unemployment, changes in securities markets or other factors could impact these local economic conditions and, in turn, could have a material adverse effect on our financial condition and results of operations.

Interest rate risk

IRR results from the timing differences in the maturity or repricing frequency of a financial institution’s interest earning assets and its interest bearing liabilities. We monitor the potential effects of changes in interest rates through simulations and gap analyses. To help mitigate the effects of changes in interest rates, we make significant efforts to stagger projected cash flows and maturities of interest sensitive assets and liabilities.

Liquidity risk

Liquidity risk is the risk to earnings or capital arising from our inability to meet our obligations when they come due without incurring unacceptable and significant costs. Liquidity risk includes the inability to manage unplanned changes in funding sources, or failure to address changes in market conditions that affect the ability to liquidate assets quickly and with minimal loss in value. We have significant borrowing capacity through correspondent banks and the ability to sell certain investments to fund potential cash shortages, which we may use to help mitigate this risk.

The value of investment securities may be negatively impacted by fluctuations in the market

A volatile, illiquid market or decline in credit quality could require us to recognize an OTTI loss related to the investment securities held in our portfolio. We consider many factors in determining whether an OTTI exists including the length of time and extent to which fair value has been less than cost, the investment credit rating, and the probability that the issuer will be unable to pay the amount when due. The presence of these factors could lead to impairment charges. These risks are mitigated by the fact that we do not intend to sell the security in an unrealized loss position and it is more likely than not that we will not have to sell the security before recovery of its cost basis.

Operational risk

Operational risk is the risk of loss resulting from failed or inadequate internal processes, staffing, systems, or external events and includes reputation risk and transaction risk. Reputation risk is managed by developing and retaining marketplace confidence in handling customers’ financial transactions in an appropriate manner and protecting our safety and soundness. Transaction risk includes losses from fraud, error, the inability to deliver products or services, and loss or theft of information. Transaction risk also encompasses product development and delivery, transaction processing, information technology systems, and the internal control environment.

To minimize potential losses due to operational risks, we have established a robust system of internal controls that are regularly tested by our internal audit department in conjunction with the services of certified public accounting firms who assist in performing such internal audit work. The focus of these internal audit procedures is to verify the validity and appropriateness of various transactions, processes, and controls. The results of these procedures are reported to our Audit Committee.

The adoption of, violations of, or nonconformance with laws, rules, regulations, or prescribed practices

The financial services industry and public companies are extensively regulated and must meet regulatory standards set by the FDIC, DIFS, FRB, FASB, SEC, PCAOB, CFPB, and other regulatory bodies. Federal and state laws and regulations are designed primarily to protect deposit insurance funds and consumers, and not necessarily to benefit our shareholders. The nature, extent, and timing of the adoption of significant new laws, changes in existing laws, or repeal of existing laws may have a material impact on our business, results of operations, and financial condition, the effect of which is impossible to predict at this time.

Our compliance department annually assesses the adequacy and effectiveness of our processes for controlling and managing our principal compliance risks.

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Changes to the financial services industry as a result of regulatory changes or actions, or significant litigation

The financial services industry is extensively regulated by state and federal regulation that governs almost all aspects of our operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors, and the deposit insurance fund. The impact of any changes to laws and regulations or other actions by regulatory agencies may negatively impact us or our ability to increase the value of our business. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution, and the appropriateness of an institution’s ALLL. Future regulatory changes or accounting pronouncements may increase our regulatory capital requirements or adversely affect our regulatory capital levels. Additionally, actions by regulatory agencies or significant litigation against us could require the dedication of significant time and resources to defend our business and may lead to penalties.

We may not adjust to changes in the financial services industry

Our financial performance depends in part on our ability to maintain and grow our core deposit customer base and expand our financial services to our existing and new customers. The increasingly competitive environment is, in part, a result of changes in technology and product delivery systems and the accelerating pace of consolidation among financial service providers. New competitors may emerge to increase the degree of competition for our products and services. Financial services and products are also constantly changing. Our financial performance is dependent upon customer demand for our products and services, our ability to develop and offer competitive financial products and services, and our ability to adapt to enhancements in financial technology.

We may be required to recognize an impairment of goodwill

Goodwill represents the excess of the amounts paid to acquire subsidiaries over the fair value of their net assets at the date of acquisition. The majority of the recorded goodwill is related to acquisitions of other banks, which were subsequently merged into Isabella Bank. If it is determined that the goodwill is impaired, we must write-down the goodwill by the amount of the impairment.

We may face pressure from purchasers of our residential mortgage loans to repurchase loans sold or reimburse purchasers for losses related to such loans

We generally sell the fixed rate long-term residential mortgage loans we originate to the secondary market. The purchasers of residential mortgage loans, such as government sponsored entities, increased their efforts to require sellers of residential mortgage loans to either repurchase loans previously sold, or reimburse the purchasers for losses incurred on foreclosed loans due to actual or alleged failure to strictly conform to the terms of the contract.

Consumers may decide not to use banks to complete their financial transactions

Technology and other changes are allowing customers to complete financial transactions without the involvement of banks. For example, consumers can now pay bills and transfer funds directly without banks. The process of diminishing or removing banks as intermediaries in financial transactions could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits.

Unauthorized disclosure of sensitive or confidential client or customer information, whether through cyber attacks, breach of computer systems or other means

Our products, services and systems are accessed through critical company or third-party operations. This involves the storage, processing and transmission of sensitive data, including proprietary or confidential data, regulated data, and personal information of employees and customers. Successful breaches, employee wrongdoing, or human or technological error could result in unauthorized access to, disclosure, modification, misuse, loss, or destruction of company, customer, or other third party data or systems. Examples include theft of sensitive, regulated, or confidential data including personal information; loss of access to critical data or systems through ransomware, destructive attacks or other means; and business delays, service or system disruptions or denials of service.

Cybersecurity incidents have increased in number and severity and it is expected that these trends will continue. Should we, or third parties we do business with, fall victim to successful cyber attacks or experience other cybersecurity incidents, including the loss of personally identifiable customer or other sensitive data, the result could severely damage our reputation, expose us to the risks of litigation and liability, disrupt our operations and increase cybersecurity or other insurance premiums.

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We have cybersecurity insurance, in the event a cybersecurity attack were to occur, covering expenses related to notification, credit monitoring, investigation, crisis management, public relations, and legal advice. In addition, we maintain insurance to cover restoration of data, certain physical damage or third-party injuries caused by potential cybersecurity incidents. However, damage and claims arising from such incidents may not be covered or may exceed the amount of any insurance available. Insurance policies are reviewed annually in detail.

A strong reputation is vital and requires utmost protection. An operating incident, significant cybersecurity disruption, or other adverse events may have a negative impact on our reputation which could make it more difficult for us to compete successfully for new opportunities, obtain necessary regulatory approvals, or severely reduce consumer demand for our products.

Our estimates and assumptions may be incorrect

Our consolidated financial statements conform with GAAP, which require us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements. Estimates are based on information available to us at the time the estimates are made. Actual results could differ from estimates. For further discussion regarding significant accounting estimates, see “Note 1 – Nature of Operations and Summary of Significant Accounting Policies” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Disruption of infrastructure

Our operations depend upon our technological and physical infrastructure, including our equipment and facilities. Extended disruption of our vital infrastructure by fire, power loss, natural disaster, telecommunications failure, computer hacking and viruses, or other events outside of our control, could have a significant impact on our operations. We have developed and tested disaster recovery plans for all significant aspects of our operations.

Anti-takeover provisions

Our articles of incorporation include anti-takeover provisions that require a two-thirds majority vote of our shareholders to approve a sale of the Corporation. Additionally, changes to our articles of incorporation must be approved by a two-thirds majority vote of our shareholders. These provisions may make our common stock less attractive to potential shareholders.

Item 1B. Unresolved Staff Comments.

None.

Item 2. Properties.

Our executive offices are located at 401 North Main Street in Mount Pleasant, Michigan. In addition to this location, we own 29 branches, two operations centers, our previous main office building and vacant land. We also lease property in Saginaw, Michigan which serves as a full-service branch. Our facilities' current, planned, and best use is for conducting our current activities, with the exception of our previous main office location which is vacant. We continually monitor and assess the need for expansion and/or improvement of all facilities. In our opinion, each facility has sufficient capacity and is in good condition.

Item 3. Legal Proceedings.

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

Item 4. Mine Safety Disclosures.

Not applicable.

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PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Common Stock and Dividend Information

Our authorized common stock consists of 15,000,000 shares, of which 7,997,247 shares are issued and outstanding as of December 31, 2020. As of that date, there were 2,998 shareholders of record.

Our common stock is traded in the over-the-counter market. Our common stock is quoted on the OTCQX market tier of the OTC Markets Group Inc.’s ("OTC Markets") electronic quotation system (www.otcmarkets.com) under the symbol “ISBA”. Other trades in our common stock occur in privately negotiated transactions from time to time of which we may have little or no information.

We have reviewed the information available as to the range of reported high and low transactions as reported by OTC Markets. The following table sets forth our compilation of that information for the periods indicated. Price information obtained from OTC Markets reflects inter-dealer prices, without retail mark up, mark down, or commissions and may not necessarily represent actual transactions. The following compiled data is provided for information purposes only and should not be viewed as indicative of the actual or market value of our common stock.

Number ofCommon Shares Sale Price

Low High

The following table sets forth the cash dividends paid for the quarters indicated:

Per Share

We have adopted and publicly announced a common stock repurchase plan. The plan was last amended on December 23, 2019, to allow for the repurchase of an additional 250,000 shares of common stock after that date. These authorizations do not have expiration dates. As shares are repurchased under this plan, they are retired with the status of authorized, but unissued, shares.

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The following table provides information for the unaudited three-month period ended December 31, 2020, with respect to our common stock repurchase plan:

Number Average PricePer Common Share

Information concerning securities authorized for issuance under equity compensation plans appears under Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

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Item 6. Selected Financial Data.

Results of Operations (Dollars in thousands except per share amounts)

The following table outlines the results of operations and provides certain key performance measures as of, and for the years ended, December 31:

INCOME STATEMENT DATA

PER SHARE

Quoted market value

PERFORMANCE RATIOS

Return on average total assets 0.57 % 0.72 % 0.77 %

Return on average shareholders' equity 4.93 % 6.25 % 7.26 %

Return on average tangible shareholders' equity 6.34 % 8.17 % 9.74 %

Net interest margin yield (FTE) 2.96 % 3.07 % 2.98 %

BALANCE SHEET DATA (1)

ASSETS UNDER MANAGEMENT (1)

ASSET QUALITY (1)

Nonperforming loans to gross loans 0.43 % 0.55 % 0.65 %

Nonperforming assets to total assets 0.31 % 0.40 % 0.42 %

CAPITAL RATIOS (1)

(1) At end of year

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The following table outlines our interim results of operations and key performance measures as of, and for the unaudited periods ended:

Quarter to Date

PER SHARE

Quarter to Date

PER SHARE

(1) At end of period

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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

ISABELLA BANK CORPORATION FINANCIAL REVIEW

(Dollars in thousands except per share amounts)

The following is management’s discussion and analysis of our financial condition and results of operations. This discussion and analysis is intended to provide a better understanding of the consolidated financial statements and statistical data included elsewhere in this Annual Report on Form 10-K.

Executive Summary

We reported net income of $10,885 and earnings per common share of $1.37 for the year ended December 31, 2020. Net income and earnings per common share for the year ended December 31, 2019 were $13,024 and $1.65, respectively. A decline in the interest rate environment was a large driver of a $3,134 decrease in interest income for 2020 when compared to 2019. Interest expense on deposits and borrowings decreased $4,036 for the year ended December 31, 2020 when compared to the same period in 2019 primarily due to reduced interest rates and reduced reliance on higher-cost borrowings. Net interest income increased by $902 for the year ended December 31, 2020 in comparison to the prior year. The provision for loan losses increased by $1,635 in 2020 when compared to 2019 as the result of increased economic and environmental risk factors, predominantly driven by COVID-19. Noninterest income for the year ended December 31, 2020 increased $6,384 when compared to 2019 mainly as a result of net gain on sold mortgage loans and the redemption of corporate owned life insurance policies. Our joint venture investment in Corporate Settlement Solutions, LLC (“CSS”) also contributed to the variance in noninterest income. We sold our membership interest in CSS during the fourth quarter of 2020, which resulted in a $394 reduction in income. During the fourth quarter of 2019, we recorded a reduction of $3,566 in our joint venture investment in CSS due to CSS' recorded impairment of intangible assets. Noninterest expenses for the year ended December 31, 2020 increased $8,183 when compared to 2019, which can be attributed to a $7,643 cost to extinguish $100,000 of FHLB advances. As a result of this debt extinguishment, future interest expense and net yields are expected to be impacted favorably.

As of December 31, 2020, total assets and assets under management were $1,957,378 and $2,702,722, respectively. Assets under management include loans sold and serviced of $301,377 and investment and trust assets managed by Isabella Wealth of $443,967, in addition to assets on our consolidated balance sheet. In the first half of 2020, the Bank’s investment and trust services business was re-engineered and rebranded as Isabella Wealth to enhance the client experience, build scalability, and expand market awareness.

Loans outstanding as of December 31, 2020 totaled $1,238,311. During 2020, gross loans increased $51,741 which was largely the result of SBA PPP loans in the commercial loan portfolio. Our securities portfolio declined $90,611 since December 31, 2019, predominantly as a result of increased monthly prepayments and payoffs of AFS securities. Due to the flat yield curve that has existed for the last few years, the opportunity to identify new investment securities for purchase at an acceptable yield has been minimal. Based on strategic objectives, we utilized this available cash flow to reduce higher-cost funding sources and other borrowings as they matured. Total deposits increased $252,466 during the year, driven by growth in demand and savings deposits, and totaled $1,566,317 as of December 31, 2020. All regulatory capital ratios for the Bank exceeded the minimum thresholds to be considered a “well capitalized” institution.

Our net yield on interest earning assets (FTE) was 2.96% for 2020 which declined from 3.07% in 2019. Management implemented strategic programs focused on improving our net yield on interest earning assets, which includes enhanced pricing related to loans and a reduced reliance on higher-cost borrowed funds and brokered deposits as funding sources. While these efforts have helped, the current interest rate environment has had a negative impact on the yield of interest earning assets and future improvements may be gradual. We are committed to increasing earnings and shareholder value through growth in our loan portfolio while maintaining strong underwriting standards, growth in our wealth management services, managing operating costs and increasing our presence within our geographical footprint.

Recent Events and Legislation

Restricted Stock Plan: On June 24, 2020, the Board of Directors adopted the RSP, an equity-based bonus plan. The RSP authorizes the issuance of unvested restricted stock to an eligible employee with a maximum award ranging from 25% to 40% of the employee’s annual salary, on a calendar year basis. Under the RSP, the Board of Directors may grant restricted stock awards to eligible employees on an annual basis based on the satisfactory achievement of performance targets and measures established by the Board of Directors. If these grant conditions are not satisfied, then the award of restricted shares will lapse or be adjusted appropriately, at the discretion of the Board of Directors. Restricted stock awards granted are not fully transferable or vested until certain conditions are met, as stated in the plan. In connection with the adoption of the RSP, the Isabella Bank Corporation Stock Award Incentive Plan was terminated.

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Also on June 24, 2020, we made initial awards under the RSP to Isabella Bank's CEO, President, and CFO. As of December 31, 2020, certain targets specified in the award agreements pursuant to the RSP were achieved and therefore, we recognized compensation expense of $14 pursuant to the RSP. Additional disclosures about the RSP are included in “Note 13 – Benefit Plans” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Executive Cash Incentive Plan: Also on June 24, 2020, we amended and restated the Isabella Bank Corporation Employee Cash Incentive Plans to create two separate plans: one for non-executive employees and the other, the Isabella Bank Corporation Executive Cash Incentive Plan for executive employees. The executive plan provides separate potential payouts for Isabella Bank's CEO, President and CFO based on achievement of personal and corporate goals. The potential payouts under the plan range from 20% to 30% of the employee's annual salary.

Impact of COVID-19: Unexpected and unprecedented changes have occurred during 2020 and into 2021 as the result of COVID-19. This aggressive and persistent virus causes a respiratory disease and can result in serious illness or death. The World Health Organization has declared the situation a global pandemic.

The pandemic has created significant market volatility, economic uncertainty, and disruption to normal business operations around the world, with slowdowns and shutdowns affecting entire industries. The Michigan governor issued on March 23, 2020 a stay-at-home order, which limited gatherings and travel, and required those in select businesses who were not deemed essential to sustain or protect life to stay home. The Michigan stay-at-home order was in effect until early June. Additional executive and Michigan State Health Department orders have been put in place since June 2020. During the fourth quarter of 2020, certain restrictions were put in place on industries within our communities and continued through December 31, 2020. The orders, as the result of COVID-19, led to financial stress for many businesses and their employees throughout the communities we serve.

The CARES Act, an unprecedented federal government support program, was enacted on March 27, 2020 in response to the COVID-19 pandemic. It is a $2 trillion stimulus package intended to provide financial relief across the country. The CARES Act included the PPP, which enabled businesses to obtain a forgivable SBA loan to meet payroll, rent, utility, and mortgage interest obligations for the 24-week period following the loan origination, and re-open quickly once the public health crisis ends. The first applications for PPP funds, with a term of two years, were accepted April 3, 2020. During 2020, we were privileged to have facilitated more than 950 SBA PPP loans for a total of $99,459 and we are pleased to have the opportunity to provide additional funding in 2021 under an additional government stimulus program. Bank regulators issued an interim rule that neutralizes the regulatory capital effects by allowing a zero percent risk weight, for capital purposes, to loans originated under the PPP. The capital rule was issued April 9, 2020, with an immediate effective date.

During 2020, many of our customers expressed their general concern about the uncertain economic conditions, but it is still premature to reasonably predict the magnitude of the impact. One measure we took to assist our customers included reduced service charges and fees on deposit accounts. Since the COVID-19 pandemic led to an increase in the need for electronic services and products, we elected to temporarily waive certain charges and fees, and permanently remove some charges and fees, to ease the financial stress on our customers. Other measures we have taken to assist our customers include loan programs that provide short-term payment relief. Under these programs, borrowers whose loans were in good standing as of March 1, 2020 could elect to defer full or partial payments for a period not to exceed 180 days. Loan payment deferrals totaled $306,103, or 23.8% of gross loans, as of June 30, 2020. As of September 30, 2020, active loan payment deferrals declined to $103,858, or 8.0% of gross loans, as the majority of borrowers granted loan payment deferrals had reverted back to contractual payments. As of December 31, 2020, active loan payment deferrals declined even further and totaled $6,048, or 0.5% of gross loans.

Bank regulators issued a statement on March 22, 2020, and a revised statement on April 7, 2020, which provided confirmation that short-term loan modifications made on a good faith basis in response to COVID-19 to borrowers with a current payment status are not categorized as TDRs. Pursuant to this guidance, borrowers granted a short-term loan modification meeting this criteria were not categorized as TDR as of December 31, 2020. These programs, along with the SBA PPP, could mask or delay the detection or reporting of deterioration in credit quality indicators.

The extent to which COVID-19 impacts our business will depend on future developments, which are highly uncertain and cannot be predicted with any accuracy. Future developments include new information which may emerge concerning the severity of COVID-19 and the actions to contain the coronavirus or treat its impact, among others. We expect the significance of the pandemic, including the extent of its effect on our financial and operational results, to be dictated by, among other factors, its duration, the success of efforts to contain it and the impact of actions taken in response, including the development and distribution of effective vaccines. Uncertainty created by the pandemic is pervasive, and has impacted our operations, customers, and various areas of risk. With the uncertainty created by COVID-19, it's challenging to determine the full impact

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

Reclassifications

Certain amounts reported in management's discussion and analysis of financial condition and results of operations for 2019 and 2018 have been reclassified to conform with the 2020 presentation. Other assets and other liabilities on the consolidated balance sheets were decreased by $1,555 as of December 31, 2019 to reclassify pension liabilities. This resulted in a $1,555 decrease in total assets and total liabilities as of December 31, 2019. All other balances and ratios were not materially impacted.

Subsequent Events

We evaluated subsequent events after December 31, 2020 through the date our consolidated financial statements were issued for potential recognition and disclosure. No subsequent events require financial statement recognition or disclosure between December 31, 2020 and the date our consolidated financial statements were issued.

Other

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

CRITICAL ACCOUNTING POLICIES

Our significant accounting policies are set forth in “Note 1 – Nature of Operations and Summary of Significant Accounting Policies” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data. Of these significant accounting policies, we consider our policies regarding the ALLL, acquisition intangibles and goodwill, and the determination of the fair value and assessment of OTTI of investment securities to be our most critical accounting policies.

The ALLL requires our most subjective and complex judgment. Changes in economic conditions and other external factors can have a significant impact on the ALLL and, therefore, the provision for loan losses and results of operations. We have developed policies and procedures for assessing the appropriateness of the ALLL, recognizing that this process requires a number of assumptions and estimates with respect to our loan portfolio. Our assessments may be impacted in future periods by changes in economic conditions, and the discovery of information with respect to borrowers which is not known to us at the time of the issuance of the consolidated financial statements. For additional discussion concerning our ALLL and related matters, see “Allowance for Loan and Lease Losses” and “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

U.S. generally accepted accounting principles require that we determine the fair value of the assets and liabilities of an acquired entity, and record the fair value on the date of acquisition. We employ a variety of measures in the determination of the fair value, including the use of discounted cash flow analysis, market appraisals, and projected future revenue streams. For certain items that we believe we have the appropriate expertise to determine the fair value, we may choose to use our own calculations of the value. In other cases, where the value is not easily determined, we consult with independent experts to determine the fair value of the identified asset or liability. Once valuations have been determined, the net difference between the price paid for the acquired entity and the net value of assets acquired on our balance sheet, including identifiable intangibles, is recorded as goodwill. Acquisition intangibles and goodwill are qualitatively evaluated to determine if it is more likely than not that the carrying balance is impaired on at least an annual basis.

During the fourth quarter of 2020, we engaged a third-party valuation firm to perform a quantitative analysis of goodwill as of December 31, 2020. In determining the fair value of the Bank and Isabella Bank Corporation, the third-party firm assessed general economic conditions, industry and market considerations, the impact of recent events to financial performance, the market price of our common stock, and other relevant events. Based on the valuation prepared, it was determined that our estimated fair values of the Bank and Isabella Bank Corporation at December 31, 2020 were greater than our recorded book value and no impairment of goodwill was identified. The carrying amount of goodwill as of December 31, 2020 relied on assumptions and use of estimates pursuant to the valuations obtained.

AFS securities are carried at fair value with changes in the fair value included as a component of other comprehensive income. Declines in the fair value of AFS securities below their cost that are other-than-temporary are reflected as realized losses in the consolidated statements of income. We evaluate AFS securities for indications of losses that are considered other-than-temporary, if any, on a regular basis. The market values for most AFS investment securities are typically obtained from outside sources and applied to individual securities within the portfolio. Municipal securities for which no readily determinable market values are available are priced using fair value curves which most closely match the securities' characteristics.

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Average Balances, Interest Rates, and Net Interest Income

The following schedules present the daily average amount outstanding for each major category of interest earning assets, non-earning assets, interest bearing liabilities, and noninterest bearing liabilities for the last three years. These schedules also present an analysis of interest income and interest expense for the periods indicated. All interest income is reported on a FTE basis using a federal income tax rate of 21%. 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 other interest earning assets.

Year Ended December 31

INTEREST EARNING ASSETS

NONEARNING ASSETS

INTEREST BEARING LIABILITIES

NONINTEREST BEARING LIABILITIES

Net yield on interest earning assets (FTE) 2.96 % 3.07 % 2.98 %

(1) Includes taxable AFS securities and equity securities

Net interest income is the amount by which interest income on earning assets exceeds the interest expense on interest bearing liabilities. Net interest income is influenced by changes in the balance and mix of assets and liabilities, as well as 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 including the income tax savings from interest on tax exempt loans and nontaxable investment securities, thus making year to year comparisons more meaningful. The FTE adjustment is based on a federal income tax rate of 21%.

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Volume and Rate Variance Analysis

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

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

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

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

Volume Rate Net Volume Rate Net

Changes in interest income

Fed Funds Sold (1) (1) (2) — 2 2

Changes in interest expense

The flattening of the yield curve continues to place pressure on our net interest margin. Despite this pressure, we experienced improvement as a result of a decline in higher-cost deposits and borrowings.

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

Net yield on interest earning assets (FTE) 3.04 % 2.89 % 2.92 % 2.98 % 3.06 %

Quarter to Date Net Interest Income (FTE)

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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 within each loan segment. Our assessments include allocations based on specific impairment valuation allowances, historical charge-offs, internally assigned credit risk ratings, and past due and nonaccrual balances. A portion of the ALLL is not allocated to any one loan segment, but is instead a representation of other qualitative risks that reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

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

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

Charge-offs

Recoveries

While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong at December 31, 2020. The COVID-19 pandemic led to some temporary and permanent closures of businesses throughout the communities in which we serve, which resulted in increased unemployment. We increased the ALLL during the year as a result of increased economic and environmental related risk factors, primarily driven by COVID-19.

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The economic impact from the COVID-19 pandemic could pose significant credit risk due to the potential inability of consumer and commercial borrowers to make contractual payments. In late March 2020, we implemented payment programs for borrowers to alleviate the financial setback due to the temporary closure of businesses and lost wages. These programs, along with the SBA PPP, could mask or delay the detection and reporting of deterioration in credit quality indicators. We continue to monitor the economic impact from COVID-19 as it relates to credit risk to ensure the ALLL is appropriate.

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

ALLL

ALLL to gross loans

While we utilize our best judgment and information available, the ultimate adequacy of the ALLL is dependent upon a variety of factors beyond our control, including the performance of our borrowers, the economy, and changes in interest rates. We closely monitor overall credit quality indicators and our policies and procedures related to the analysis of the ALLL to ensure that the ALLL remains at an appropriate level.

For further discussion of the allocation of the ALLL, see “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Loans Past Due and Loans in Nonaccrual Status

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

Total Past Due and Nonaccrual Loans as of December 31

Past due and nonaccrual status loans, as a percentage of gross loans, have improved over the last year and continue to be at low levels as a result of strong repayment performance.

A summary of loans past due and in nonaccrual status, including the composition of the ending balance of nonaccrual status loans by type, is included in “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

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Troubled Debt Restructurings

We have taken a proactive approach to modifying loans to assist borrowers who are willing to work with us, thus making them less likely to default, and to avoid foreclosure. This approach has permitted certain borrowers to develop a payment structure that will allow them to continue making payments in lieu of foreclosure. Modifications have been successful for us and our customers as very few of the modified loans have resulted in foreclosures. The majority of new modifications result in terms that satisfy our criteria for continued interest accrual. TDRs that have been placed in nonaccrual status may be placed back on accrual status after six months of continued performance and achievement of current payment status.

We restructure debt with borrowers who due to financial difficulties are unable to service their debt under the original terms. We may extend the amortization period, reduce interest rates, allow temporary interest-only payment structures, forgive principal, forgive interest, or grant a combination of these modifications. Typically, the modifications are for a period of three years or less. There were no TDRs that were government sponsored as of December 31, 2020 or December 31, 2019.

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

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

Accruing Interest Nonaccrual Total

NumberofLoans Balance NumberofLoans Balance NumberofLoans Balance

Principal advances (payments) — (1,295) — (382) — (1,677)

Partial charge-offs — — — (65) — (65)

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

Transfers to accrual status 9 1,219 (9) (1,219) — —

Transfers to nonaccrual status (6) (3,302) 6 3,302 — —

Principal advances (payments) — (1,690) — (148) — (1,838)

Partial charge-offs — — — — — —

Transfers to OREO — — (2) (356) (2) (356)

Transfers to accrual status 1 104 (1) (104) — —

Transfers to nonaccrual status — — — — — —

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The following table summarizes our TDRs as of December 31:

AccruingInterest Nonaccrual Total AccruingInterest Nonaccrual Total

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

Impaired Loans

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

TDRs

Home equity lines of credit — — — 12 312 —

Other impaired loans

Home equity lines of credit — — — 73 73 —

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.

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Additional disclosures related to impaired loans are included in “Note 4 – Loans and ALLL” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Nonperforming Assets

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

Nonperforming loans as a % of total loans 0.43 % 0.55 % 0.65 % 0.31 % 0.17 %

Nonperforming assets as a % of total assets 0.31 % 0.40 % 0.42 % 0.20 % 0.11 %

The accrual of interest on commercial and agricultural loans, as well as residential real estate loans, is discontinued at the time a loan is 90 days or more past due unless the credit is well-secured and in the process of short-term collection. Upon transferring a loan to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if a charge-off is necessary. Consumer loans are typically charged-off no later than 180 days past due. Loans may be placed back on accrual status after six months of continued performance and achievement of current payment status. While the level of nonperforming loans has fluctuated in recent periods, it remains low in comparison to peer banks.

The following table summarizes nonaccrual loans as of December 31:

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

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

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Noninterest Income and Noninterest Expenses

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

Change Change

Service charges and fees

Significant changes in noninterest income are detailed below:

ATM and debit card fees fluctuate from period to period based primarily on their usage. While we do not anticipate significant changes to our ATM and debit card fee structure, we do expect that fee income will continue to increase in 2021 as the usage of ATM and debit cards continues to increase.

Service charges and fees on deposit accounts declined in 2020 as a result of waived fees. In response to COVID-19, which has led to an increase in the need for electronic services and products, we elected to temporarily waive certain charges and fees, and permanently remove some charges and fees, to ease the financial stress of our customers. As such, we expect service charges and fees in 2021 to approximate 2020 levels.

OMSR income results are driven, in part, by changes in offering rates on residential mortgage loans, anticipated prepayments in the servicing-retained portfolio, and the volume of loans within the servicing-retained portfolio. Increased prepayment speeds, as a result of a decline in interest rates during the first quarter of 2020, were the primary driver of the losses recognized during the first half of 2020. During the second half of 2020, the volume of loans serviced increased which resulted in an increase in the value of the servicing rights. OMSR income during 2021 may continue to experience fluctuations and could vary from 2020 levels.

Net gain on sale of mortgage loans fluctuates as the result of a change in the amount of loans sold and pricing. The amount of loans sold is driven by customer demand and balance sheet management strategies. We experienced a significant increase in loan demand during 2020 which led to an increase in the number and dollar amount of loans sold during the year. As such, net gain on sale of mortgage loans increased significantly. As demand is expected to slow during 2021, net gain on sale of mortgage loans is not expected to exceed 2020 levels.

The decrease in wealth management fees, primarily during the first quarter of 2020, was driven by a decline in the stock market causing the value of investment assets under management to decrease. While strategic additions in staffing have already led to new business within Isabella Wealth, wealth management fees during 2021 may not exceed 2020 levels due to the uncertainty in the stock market as a result of COVID-19.

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

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We sold our membership interest in our joint venture investment in CSS during the fourth quarter of 2020, which resulted in a $394 reduction in income. As a result of a valuation during the fourth quarter of 2019, CSS recognized a $7,133 impairment related to intangible assets as of December 31, 2019. Since we accounted for our investment in CSS under the equity method of accounting, we reduced our investment in CSS by $3,566 during the fourth quarter of 2019.

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

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

Change Change

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

Other

Significant changes in noninterest expenses are detailed below:

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

Audit, consulting, and legal fees in 2018 included one-time charges related to income tax strategies. As a result, 2020 and 2019 expenses were less than 2018 expenses.

We have experienced increased usage of ATM and debit cards which has resulted in increased income and also increased ATM and debit card expenses. Based on the anticipated continuation of increased ATM and debit card usage, we expect expenses to increase in 2021.

Loan underwriting fees increased during the second half of 2018 and continued in the first quarter of 2019 as a result of new loan products, including first time home buyer and down payment assistance programs designed to generate residential mortgage growth. Loan underwriting fees in 2019 did not exceed 2018 levels based on the nature of products offered during 2019. Additionally, loan underwriting fees in 2020 did not exceed 2019 levels. Fees in 2021 are expected to approximate 2020 levels.

Donations and community relations increased during 2019 as a result of initiatives designed to deepen and strengthen our relationship with the communities in which we operate and serve. In addition to providing monetary contributions, some of these initiatives include volunteering our time, which is not a component of donations and community relations costs. Government restrictions and temporary business closures related to COVID-19 impacted our ability to maintain their level of support in 2020. Donations and community relations is expected to approximate 2020 levels in 2021.

As a result of an assessment credit of $440 received during the third quarter of 2019, FDIC insurance premiums declined in 2019 as compared to 2020 and 2018 expenses. FDIC insurance premiums in 2021 are expected to approximate 2020 levels.

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All other expenses declined during 2020 primarily as a result of reduced employee education and travel expenses. Due to COVID-19, many events were cancelled or offered at no cost. While education and travel expenses in 2021 are expected to exceed 2020 levels, expenses are not expected to resume normal levels and as a result, total all other expenses are not expected to resume normal levels.

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

Analysis of Changes in Financial Condition

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

Change

ASSETS

AFS securities

Loans

LIABILITIES AND SHAREHOLDERS’ EQUITY

Liabilities

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

Cash and cash equivalents

Included in cash and cash equivalents are funds held with the FRB which fluctuate from period to period. Cash levels increased significantly during 2020 as a result of increased monthly prepayments and payoffs of AFS securities, funding from the SBA for PPP loan forgiveness, and an increase in customer deposits. During 2020, excess funds were used to pay maturing long-term borrowings, extinguish long-term borrowings, and pay other short-term liabilities. Payments for maturing borrowings is expected to continue in 2021.

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AFS securities

The primary objective of our investing activities is to provide for safety of the principal invested. Secondary considerations include providing earnings and liquidity while managing our overall exposure to changes in interest rates. Over the last two years, the flat yield curve encouraged the use of excess funds to reduce higher-cost borrowings as opposed to investing in AFS securities. However, based on balance sheet strategies, excess funds above what is required to retire higher-cost funding sources may prudently be deployed to purchase of AFS securities in future periods.

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

Government sponsored enterprises $ — $ — $ 170

Excluding those holdings in government sponsored enterprises and municipalities within the State of Michigan, there were no investments in securities of any one issuer that exceeded 10% of shareholders’ equity during 2020, 2019, and 2018. We have a policy prohibiting investments in securities that we deem unsuitable due to their inherent credit or market risks. Prohibited investments include stripped mortgage-backed securities, zero coupon bonds, nongovernment agency asset-backed securities, and structured notes. Our holdings in mortgage-backed securities and collateralized mortgage obligations include only government agencies and government sponsored agencies as we hold no investments in private label mortgage-backed securities or collateralized mortgage obligations.

The following is a schedule of maturities of AFS securities and their weighted average yields as of December 31, 2020. Weighted average yields have been computed on an FTE basis using a tax rate of 21%. Our auction rate money market preferred investments are long-term floating rate instruments. The issuers of auction rate securities generally have the right to redeem or refinance the debt. Because of their lack of contractual maturities, auction rate money market preferred stocks are not reported by a specific maturity group. Mortgage-backed securities and collateralized mortgage obligations are not reported by a specific maturity group due to their variable monthly payments. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations.

Maturing

Mortgage-backed securities — — — — — — — — 88,652 2.06

Collateralized mortgage obligations — — — — — — — — 101,983 2.28

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

Corporate — — — — 1,700 5.00 — — — —

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Loans

Loans are the largest component of earning assets. The proper management of credit and market risk inherent in the loan portfolio is critical to our financial stability. To control these risks, we have adopted strict underwriting standards, lending limits to a single borrower, loan to collateral value limits, and a defined market area. We also monitor and limit loan concentrations to specific industries. We have no foreign loans and there were no concentrations greater than 10% of total loans that are not disclosed as a separate category in the following table.

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

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

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

Loan demand has been negatively impacted by the pandemic and competition for new commercial loan opportunities continues to be strong. Growth in the commercial loan portfolio during 2020 was driven by SBA PPP loans. While we expect loan forgiveness on the remaining SBA PPP loans during 2021, we are still expecting overall growth during 2021 within the commercial portfolio as we continue to provide attractive and competitive loan products. Agricultural loans continued to decline in 2020 due to the competitive environment. Residential real estate and consumer loans have experienced growth over the last year and continued growth is expected in 2021.

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 our joint venture investment in CSS accounted for under the equity method of accounting. We sold our membership interest in CSS during the fourth quarter of 2020, which reduced equity securities without readily determinable fair values $4,246 when compared to December 31, 2019. For more information related to this investment, refer to “Note 1 – Nature of Operations and Summary of Significant Accounting Policies”, “Note 6 – Investment in Joint Venture”, and “Note 18 – Fair Value” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Goodwill and other intangible assets

Goodwill represents the excess of the amounts paid to acquire subsidiaries over the fair value of their net assets at the date of acquisition. The majority of the recorded goodwill is related to acquisitions of other banks, which were subsequently merged into Isabella Bank. If it is determined that the goodwill is impaired, a write-down of goodwill by the amount of the impairment would be required.

The decline in economic conditions, as a result of the COVID-19 pandemic and other factors, led to a significant decline in the stock market causing the value of investments, including our stock, to decline. Our stock price was negatively impacted in March 2020, which continued during most of 2020. Since the price of our stock increased but had not fully recovered through the fourth quarter, we decided to engage a reputable, third-party valuation firm to perform a quantitative analysis of goodwill as of December 31, 2020. In determining the fair value of the Bank and Isabella Bank Corporation, the third-party firm assessed general economic conditions, industry and market considerations, the impact of recent events to financial performance, the market price of our common stock, and other relevant events. Based on the valuation prepared, it was determined that our

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

Furthermore, management noted that despite the decline of the market capitalization as a result of the COVID-19 pandemic, our financial performance remained positive. This is evidenced by our financial results, strong credit quality indicators, increased liquidity position, as well as the strong capital position. Finally, by the end of the fourth quarter, our stock price had increased to levels consistent with prices prior to the second quarter of 2020. Based on these factors and the results of the independent quantitative analysis of goodwill, management concluded that it was more likely than not that there was no goodwill impairment as of December 31, 2020.

Other assets

Other assets consist primarily of prepaid expenses, OMSR, receivables, and net deferred tax assets. As a result of the sale in our joint venture investment in CSS, we recorded a $3,227 receivable related to this transaction. For more information related to estimates and deferred taxes, refer to “Note 1 – Nature of Operations and Summary of Significant Accounting Policies” and “Note 16 – Federal Income Taxes” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Deposits

Deposits are our primary source of funding. The following table presents the composition of the deposit portfolio as of December 31:

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

$ Change % Change $ Change % Change

Total deposits have increased over the past 12 months with significant growth in non-contractual deposits, such as demand and savings deposits. This trend is anticipated to continue during 2021 as the financial markets continue to exhibit significant signs of instability. Additionally, government stimulus programs have driven growth in deposits. We experienced a decline in certificates of deposit over the past year as a result of the low interest rate environment. Brokered certificates of deposit offer another source of funding and may fluctuate from period to period based on our funding needs, including changes in assets such as loans and investments. During 2019 and 2020, we used excess funds to reduce higher-cost deposits, such as brokered certificates of deposit. This trend is expected to continue into 2021.

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

Maturity

Borrowed Funds

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

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

During the fourth quarter of 2020, we elected to extinguish $100,000 of FHLB advances based on our level of cash reserves and strategic initiatives. Due to a significant increase in deposit accounts during the fourth quarter of 2020, our level of securities sold under agreements to repurchase increased as of December 31, 2020. We believe this to be a short-term increase and expect the balance of securities sold under agreements to repurchase to decline in the first half of 2021. We had no fed funds purchased for the years ended December 31, 2020, 2019, or 2018. For additional disclosure related to borrowed funds, see “Note 9 – Borrowed Funds” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Accrued interest payable and other liabilities

Included in accrued interest payable and other liabilities are obligations related to our defined benefit pension plan and other employee benefits. For more information on the defined benefit pension plan and other employee benefits, see “Note 13 – Benefit Plans” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Contractual Obligations and Loan Commitments

We have various financial obligations, including contractual obligations and commitments related to deposits and borrowings, which may require future cash payments. We also have loan related commitments that may impact liquidity. The commitments include unused lines of credit, commercial and standby letters of credit, and commitments to grant loans. These commitments to grant loans include residential mortgage loans with the majority committed to be sold to the secondary market. Many of these commitments historically have expired without being drawn upon and do not necessarily represent our future cash requirements.

For additional disclosure related to Contractual Obligations and Loan Commitments, see “Note 10 – Off-Balance-Sheet Activities, Commitments and Other Matters” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

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Capital

Capital consists 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 231,393 shares or $4,185 of common stock during 2020, and 209,583 shares or $4,876 of common stock in 2019. We offer the Directors Plan in which participants purchase stock units through deferred fees, in lieu of cash payments. Pursuant to this plan, we increased shareholders’ equity by $413 and $523 during 2020 and 2019, respectively. We also grant restricted stock awards pursuant to the RSP, effective June 24, 2020. Pursuant to this plan, we increased shareholders’ equity by $14 during 2020.

We have a publicly announced common stock repurchase plan. Pursuant to this plan, we repurchased 144,950 shares or $2,702 of common stock during 2020 and 169,748 shares or $4,003 during 2019. As of December 31, 2020, we were authorized to repurchase up to an additional 102,956 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.

The common equity tier 1 capital ratio has a minimum requirement of 4.50%. The minimum standard for primary, or Tier 1 capital is 6.00% and the minimum standard for total capital is 8.00%. The minimum requirements presented below include the minimum required capital levels based on the Basel III Capital Rules. Capital requirements to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules. The following table sets forth these requirements and our ratios as of December 31:

There are no significant regulatory constraints placed on our capital. At December 31, 2020, the Bank exceeded minimum capital requirements. For further information regarding the Bank’s capital requirements, see “Note 11 – Minimum Regulatory Capital Requirements” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Fair Value

We utilize fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. AFS securities, 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 1 – Nature of Operations and Summary of Significant Accounting Policies” and “Note 18 – Fair Value” of “Notes to Consolidated Financial Statements” in Item 8. Financial Statements and Supplementary Data.

Liquidity

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

Our primary sources of liquidity are cash and cash equivalents and unencumbered AFS securities. These categories totaled $444,051 or 22.69% of assets as of December 31, 2020 as compared to $291,190 or 16.06% as of December 31, 2019. The increase in both the amount and percentage of primary liquidity is a direct result of an increase in market deposits and a

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deliberate reduction in non-market funding which required collateralization. Liquidity is important for financial institutions because of their need to meet loan funding commitments, depositor withdrawal requests, and various other commitments including expansion of operations, investment opportunities, and payment of cash dividends. Based on these same factors, daily liquidity could vary significantly.

Deposit accounts are our primary source of funds. Our secondary sources include the ability to borrow from the FHLB, from the FRB, and through various correspondent banks in the form of federal funds purchased and a line of credit. These funding methods typically carry a higher interest rate than traditional market deposit accounts. In recent periods, we have elected to use excess funds and proceeds from the sale of AFS securities to reduce borrowings and other higher-cost funding sources. Some borrowed funds, including FHLB advances, FRB Discount Window advances, and repurchase agreements, require us to pledge assets, typically in the form of AFS securities or loans, as collateral. As of December 31, 2020, we had available lines of credit of $214,625.

Our stress testing of liquidity increased during 2020 and continues to evolve due to economic uncertainly as a result of COVID-19. Our liquidity position remained strong at the end of 2020 which is illustrated in the following table:

Total cash and cash equivalents $ 246,640

Available lines of credit

Fed funds lines with correspondent banks 93,000

FRB Discount Window 9,987

Other lines of credit 5,000

Total available lines of credit 214,625

Unencumbered lendable value of FRB collateral, estimated1 160,000

Total cash and liquidity $ 621,265

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

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

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

Market Risk

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

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

The primary technique to measure IRR is simulation analysis. Simulation analysis forecasts the effects on the balance sheet structure and net interest income under a variety of scenarios that incorporate changes in interest rates, the shape of yield curves, interest rate relationships, loan prepayments, and funding sources. These forecasts are compared against net interest income projected in a stable interest rate environment. While many assets and liabilities reprice either at maturity or in

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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 rate 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. We regularly monitor our projected net interest income sensitivity to ensure that it remains within established limits.

Gap analysis, the secondary method to measure IRR, measures the cash flows and/or the earliest repricing of our interest bearing assets and liabilities. This analysis is useful for measuring trends in the repricing characteristics of the balance sheet. Significant assumptions are required in this process because of the embedded repricing options contained in assets and liabilities. Residential real estate and consumer loans allow the borrower to repay the balance prior to maturity without penalty, while commercial and agricultural loans may have prepayment penalties. The amount of prepayments is dependent upon many factors, including the interest rate of a given loan in comparison to the current offering rates, the level of home sales, and the overall availability of credit in the market place. Generally, a decrease in interest rates will result in an increase in cash flows from these assets. A significant portion of our securities are callable or have prepayment options. The call and prepayment options are more likely to be exercised in a period of decreasing interest rates. Savings and demand accounts may generally be withdrawn on request without prior notice. The timing of cash flows from these deposits is estimated based on historical experience. Certificates of deposit have penalties that discourage early withdrawals.

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

Gap analysis is also utilized as a method to measure interest rate sensitivity. Interest rate sensitivity is determined by the amount of earning assets and interest bearing liabilities repricing within a specific time period, and their relative sensitivity to a change in interest rates. We strive to achieve reasonable stability in the net interest margin through periods of changing interest rates. One specific focus of interest rate sensitivity is the loan portfolio, primarily with commercial and agricultural loans. The following table shows the maturity of commercial and agricultural loans outstanding at December 31, 2020. Also provided are the amounts due after one year, classified according to the sensitivity to changes in interest rates.

1 Yearor Less 1 to 5Years Over 5Years Total

Interest sensitivity

Loans maturing after one year that have:

Our primary market risk exposures related to the COVID-19 pandemic remain uncertain. A review of our market risk methods are ongoing and modeling is incorporating additional assumptions to account for this uncertainty related to this crisis. Repricing, cash flows, and prepayment projections for loans and mortgage-backed securities are not expected to behave as they would be expected to in a more stable interest rate environment. The SBA PPP loan is a new instrument and has payment characteristics that are still uncertain. In late March 2020, we implemented loan repayment programs for customers to alleviate the financial setback caused by the temporary closure of businesses and lost wages. Under these programs, borrowers whose loans were in good standing as of March 1, 2020 could elect to defer full or partial payments for a short period of time. Customer deposit levels may experience unusual fluctuations due to government support programs, customer and business needs, and general money supply. We continue to closely monitor customer and economic indicators to develop more precise market risk assumptions as the economic impact of this crisis begins to reveal itself.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

The information presented in the section captioned “Market Risk” in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations is incorporated herein by reference.

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Item 8. Financial Statements and Supplementary Data.

The following consolidated financial statements accompanied by the report of our independent registered public accounting firm are set forth beginning on the following page of this report:

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets

Consolidated Statements of Changes in Shareholders’ Equity

Consolidated Statements of Income

Consolidated Statements of Comprehensive Income (Loss)

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Supplementary data regarding quarterly results of operations is included in Item 6. Selected Financial Data.

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Report of Independent Registered Public Accounting Firm

Shareholders and Board of Directors

Isabella Bank Corporation

Mount Pleasant, Michigan

Opinion on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated balance sheets of Isabella Bank Corporation as of December 31, 2020 and 2019, and the related consolidated statements of changes in shareholders’ equity, income, comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively referred to as the financial statements). We also have audited Isabella Bank Corporation’s internal control over financial reporting as of December 31, 2020, based on criteria established in the Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria).

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Isabella Bank Corporation as of December 31, 2020 and 2019, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion Isabella Bank Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria.

Basis for Opinions

Isabella Bank Corporation’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on Isabella Bank Corporation’s consolidated financial statements and on Isabella Bank Corporation’s internal control over financial reporting based on our integrated audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to Isabella Bank Corporation in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.

Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material misstatement exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control over Financial Reporting

A corporation’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in accordance with generally accepted accounting principles. A corporation’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the corporation; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the corporation are being made only in accordance with authorizations of management and directors of the corporation; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the corporation’s assets that could have a material effect on the consolidated financial statements.

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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

One Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or is required to be communicated to the corporation's audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the account or disclosures to which it relates.

Allowance for Loan Losses

Description of the Matter

The Corporation’s loan portfolio totaled $1.238 billion as of December 31, 2020 and the associated allowance for loan and lease losses (ALLL) was $9.744 million. As described in Notes 1 and 4 to the consolidated financial statements, the ALLL is established to absorb inherent losses that have been incurred or are probable within the existing portfolio of loans. Management’s estimate of inherent losses within the loan portfolio is established using quantitative, as well as qualitative, considerations. The Corporation’s methodology to determine the ALLL considers quantitative calculations including: specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans, historical valuation allowances determined in accordance with ASC topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, supplemented, as necessary, by credit judgment to address observed changes in trends and conditions, and other relevant environmental and economic factors such as concentrations of credit risk, economic trends and conditions, changes in underwriting standards, experience and depth of lending staff, trends in delinquencies, and the level of net charge-offs (qualitative factor adjustments).

Auditing the Corporation’s ALLL involved a high degree of subjectivity due to the judgement involved in the management’s determination of commercial and agricultural loan credit risk ratings and identification and measurement of qualitative factor adjustments included in the estimate of the ALLL.

How We Addressed the Matter in Our Audit

We obtained an understanding of the Corporation’s process for establishing the ALLL and evaluated the design and tested the operating effectiveness of controls that address the risk of material misstatement related to the measurement of the ALLL. We tested controls over management’s review of commercial and agricultural loan credit risk ratings, the data inputs utilized in the ALLL calculation, management’s identification and review of the qualitative factor adjustments, and management’s review and approval process over the final determination of the ALLL.

To test the commercial and agricultural loan credit risk ratings included in management’s estimate of the ALLL, we evaluated the methodology used, including management’s consideration of the individual commercial and agricultural loan portfolio segments, and tested the completeness and accuracy of data from underlying systems that was used in the determination of credit risk. We performed procedures on a sample of commercial and agricultural loans to test the Corporation’s credit risk ratings by comparing key attributes used in the determination of the credit risk rating to supporting documentation such as borrowers’ financial statements, underlying collateral, financial health of the guarantor and loan payment history.

To test the measurement of qualitative factor adjustments included in management’s estimate of the ALLL, we evaluated the methodology and metrics, including testing the completeness and accuracy of data from underlying systems and other information. We further evaluated management’s assessment of the qualitative factor adjustments by obtaining an understanding of the basis for any changes in underlying qualitative factor adjustments and giving consideration to prior period qualitative factor adjustments and other information available within the Corporation and from external sources focusing on both corroborating and contrary evidence.

/s/Rehmann Robson LLC

We have served as Isabella Bank Corporation's independent auditor since 1996.

Saginaw, Michigan

March 10, 2021

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CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

December 31

ASSETS

Cash and cash equivalents

Cash and demand deposits due from banks $ 31,296 $ 20,311

Loans

Less allowance for loan and lease losses 9,744 7,939

Corporate owned life insurance policies 28,292 28,455

Equity securities without readily determinable fair values 17,383 21,629

LIABILITIES AND SHAREHOLDERS’ EQUITY

Deposits

Accrued interest payable and other liabilities 13,726 12,611

Shareholders’ equity

Shares to be issued for deferred compensation obligations 4,183 5,043

Accumulated other comprehensive income (loss) 7,698 1,971

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in thousands except per share amounts)

Common Stock

Share-based payment awards under the Directors Plan — — 612 — — 612

Common stock purchased for deferred compensation obligations — (401) — — — (401)

Cash dividends paid ($1.04 per common share) — — — (8,169) — (8,169)

Share-based payment awards under the Directors Plan — — 523 — — 523

Cash dividends paid ($1.05 per common share) — — — (8,282) — (8,282)

Share-based payment awards under the Directors Plan — — 413 — — 413

Cash dividends paid ($1.08 per common share) — — — (8,524) — (8,524)

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands except per share amounts)

Year Ended December 31

Interest income

AFS securities

Interest expense

Noninterest income

Gains from redemption of corporate owned life insurance policies 891 — —

Earnings on corporate owned life insurance policies 755 764 742

Net income (loss) on joint venture investment 577 (3,108) 274

Noninterest expenses

Loss on extinguishment of debt 7,643 — —

Earnings per common share

Cash dividends per common share $ 1.08 $ 1.05 $ 1.04

The accompanying notes are an integral part of these consolidated financial statements.

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CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

Year Ended December 31

Unrealized gains (losses) on AFS securities

Unrealized gains (losses) arising during the period 7,474 12,276 (7,229)

Unrealized gains (losses) on AFS securities, net of tax 5,873 9,812 (5,814)

Unrealized gains (losses) on derivative instruments

Unrealized gains (losses) on derivative instruments, net of tax (96) (202) 26

Change in unrecognized pension cost on defined benefit pension plan

Change in unrecognized pension cost arising during the period (238) (210) 265

Net change in unrecognized pension cost (62) 58 610

Change in unrealized pension cost, net of tax (50) 46 482

Other comprehensive income (loss), net of tax 5,727 9,656 (5,306)

(1)See “Note 17 – Accumulated Other Comprehensive Income (Loss)” in the accompanying notes to consolidated financial statements for tax effect reconciliation.