Performance Graph	10
Selected Consolidated Financial Data	11
Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Management’s Annual Report on Internal Control Over Financial Reporting	36
Report of Independent Registered Public Accounting Firm	37
Consolidated Financial Statements	39
Notes to Consolidated Financial Statements.	44
Quarterly Data	104

9

PERFORMANCE GRAPH

The graph below compares the total returns (assuming reinvestment of dividends) of Independent Bank Corporation common stock, the NASDAQ Composite Index and the NASDAQ Bank Stock Index. The graph assumes $100 invested in Independent Bank Corporation common stock (returns based on stock prices per the NASDAQ) and each of the indices on December 31, 2015, and the reinvestment of all dividends during the periods presented. The performance shown on the graph is not necessarily indicative of future performance.

	Period ending
Index	12/31/15		12/31/16		12/31/17		12/31/18		12/31/19		12/31/20
Independent Bank Corporation		100.00		145.53		152.84		147.40		164.21		140.76
NASDAQ Composite		100.00		108.87		141.13		137.12		187.44		271.64
NASDAQ Bank		100.00		126.54		149.82		125.25		171.82		149.83

10

SELECTED CONSOLIDATED FINANCIAL DATA

	Year Ended December 31,
	2020			2019			2018			2017			2016
	(Dollars in thousands, except per share amounts)
SUMMARY OF OPERATIONS
Interest income	$	139,829		$	148,928		$	130,773		$	98,309		$	86,523
Interest expense		16,217			26,347			17,491			9,123			6,882
Net interest income		123,612			122,581			113,282			89,186			79,641
Provision for loan losses		12,463			824			1,503			1,199			(1,309	)
Net gains on securities		267			307			138			260			563
Other non-interest income		80,478			47,429			44,677			42,273			41,735
Non-interest expense		122,413			111,733			107,461			92,082			90,347
Income before income tax		69,481			57,760			49,133			38,438			32,901
Income tax expense		13,329			11,325			9,294			17,963			10,135
Net income	$	56,152		$	46,435		$	39,839		$	20,475		$	22,766
PER COMMON SHARE DATA
Net income per common share
Basic	$	2.56		$	2.03		$	1.70		$	0.96		$	1.06
Diluted		2.53			2.00			1.68			0.95			1.05
Cash dividends declared and paid		0.80			0.72			0.60			0.42			0.34
Book Value		17.82			15.58			14.38			12.42			11.71
SELECTED BALANCES
Assets	$	4,204,013		$	3,564,694		$	3,353,281		$	2,789,355		$	2,548,950
Loans		2,733,678			2,725,023			2,582,520			2,018,817			1,608,248
Allowance for loan losses		35,429			26,148			24,888			22,587			20,234
Deposits		3,637,355			3,036,727			2,913,428			2,400,534			2,225,719
Shareholders’ equity		389,522			350,169			338,994			264,933			248,980
Other borrowings		30,012			88,646			25,700			54,600			9,433
Subordinated debt		39,281			—			—			—			—
Subordinated debentures		39,524			39,456			39,388			35,569			35,569
SELECTED RATIOS
Net interest income to average interest earning assets		3.34	%		3.80	%		3.88	%		3.65	%		3.52	%
Net income to
Average shareholders’ equity		15.68			13.63			12.38			7.82			9.21
Average assets		1.43			1.35			1.27			0.77			0.92
Average shareholders’ equity to average assets		9.10			9.90			10.27			9.88			9.98
Tier 1 capital to average assets		9.15			10.11			10.47			10.57			10.50
Non-performing loans to Portfolio Loans		0.29			0.35			0.33			0.39			0.75

11

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Disclaimer Regarding Forward-Looking Statements. Statements in this report that are not statements of historical fact, including statements that include terms such as “will,” “may,” “should,” “believe,” “expect,” “forecast,” “anticipate,” “estimate,” “project,” “intend,” “likely,” “optimistic” and “plan” and statements about future or projected financial and operating results, plans, projections, objectives, expectations, and intentions, are forward-looking statements. Forward-looking statements include, but are not limited to, descriptions of plans and objectives for future operations, products or services; projections of our future revenue, earnings or other measures of economic performance; forecasts of credit losses and other asset quality trends; statements about our business and growth strategies; and expectations about economic and market conditions and trends. These forward-looking statements express our current expectations, forecasts of future events, or long-term goals. They are based on assumptions, estimates, and forecasts that, although believed to be reasonable, may turn out to be incorrect. Actual results could differ materially from those discussed in the forward-looking statements for a variety of reasons, including:

● economic, market, operational, liquidity, credit, and interest rate risks associated with our business including the impact of the ongoing COVID-19 pandemic on each of these items;

● economic conditions generally and in the financial services industry, particularly economic conditions within Michigan and the regional and local real estate markets in which our bank operates including the economic impact of the ongoing COVID-19 pandemic in each of these areas;

● the failure of assumptions underlying the establishment of, and provisions made to, our allowance for loan losses;

● increased competition in the financial services industry, either nationally or regionally;

● our ability to achieve loan and deposit growth;

● volatility and direction of market interest rates;

● the continued services of our management team; and

● implementation of new legislation, which may have significant effects on us and the financial services industry.

This list provides examples of factors that could affect the results described by forward-looking statements contained in this report, but the list is not intended to be all-inclusive. The risk factors disclosed in Part I – Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2020, as updated by any new or modified risk factors disclosed in Part II – Item 1A of any subsequently filed Quarterly Report on Form 10-Q, include the primary risks our management believes could materially affect the results described by forward-looking statements in this report. However, those risks are not the only risks we face. Our results of operations, cash flows, financial position, and prospects could also be materially and adversely affected by additional factors that are not presently known to us, that we currently consider to be immaterial, or that develop after the date of this report. We cannot assure you that our future results will meet expectations. While we believe the forward-looking statements in this report are reasonable, you should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. We do not undertake, and expressly disclaim, any obligation to update or alter any statements, whether as a result of new information, future events, or otherwise, except as required by applicable law.

Introduction. The following section presents additional information to assess the financial condition and results of operations of Independent Bank Corporation (“IBCP”), its wholly-owned bank, Independent Bank (the “Bank”), and their subsidiaries. This section should be read in conjunction with the consolidated financial statements and the supplemental financial data contained elsewhere in this annual report. We also encourage you to read our Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission (“SEC”). That report includes a list of risk factors that you should consider in connection with any decision to buy or sell our securities.

Overview. We provide banking services to customers located primarily in Michigan’s Lower Peninsula and also have two loan production offices in Ohio (Columbus and Fairlawn). As a result, our success depends to a great extent upon the economic conditions in Michigan’s Lower Peninsula.

12

Significant Developments. On April 1, 2018, TCSB was merged with and into IBCP, with IBCP as the surviving corporation (the “Merger”). In connection with the Merger, on April 1, 2018, IBCP consolidated Traverse City State Bank, TCSB’s wholly-owned subsidiary bank, with and into Independent Bank (with Independent Bank as the surviving institution). See note #26 to the Consolidated Financial Statements.

On March 11, 2020, the World Health Organization declared COVID-19, the disease caused by the novel coronavirus, a pandemic as a result of the global spread of the coronavirus illness. In response to the outbreak, federal and state authorities in the U.S. introduced various measures to try to limit or slow the spread of the virus, including travel restrictions, nonessential business closures, stay-at-home orders, and strict social distancing. The Governor of Michigan issued her first “stay home, stay safe” executive order effective March 24, 2020. In general, that order and subsequent modifications required individuals in Michigan to stay at home or their place of residence, except for certain specified activities that were deemed necessary to sustain or protect life. That original executive order was amended several times and was later rescinded and replaced entirely by a series of “Safer at Home” executive orders, which generally extended certain social distancing restrictions, but lifted the requirement that individuals remain in their homes. The series of “Safer at Home” orders, along with all other executive orders relating to the pandemic issued by Michigan’s Governor after April 30, 2020, were then deemed unconstitutional by the Michigan Supreme Court on October 2, 2020. On October 4, 2020, Michigan’s Attorney General announced her office would no longer enforce the Governor’s executive orders that were ruled unconstitutional, effective immediately. Since then, the Michigan Department of Health and Human Services (MDHHS) and the Michigan Occupational Safety and Health Administration (MIOSHA) have issued orders imposing restrictions similar to the Governor’s former executive orders under authority granted to the MDHHS by the Michigan Public Health Code and to MIOSHA under the Michigan Occupational Safety and Health Act – different statutes than the law on which the Governor based her executive orders. Under the MDHHS and MIOSHA orders, social distancing and gathering restrictions remain in place; however, certain retail operations, restaurants and bars, and other businesses are permitted to conduct in-person operations, subject to capacity limitations and other workplace safety requirements. The degree to which businesses may resume operations varies based on the type of business operations being conducted. It is currently expected that various forms of state and local government restrictions similar to those described above will continue for the foreseeable future. As a result of these events, Michigan has experienced a significant increase in unemployment.

The COVID-19 pandemic, the related executive orders, and other government restrictions and guidance have had and continue to have a significant effect on us, our customers and the markets we serve. Our business, results of operations and financial condition may be adversely affected by a number of factors that could impact us and our customers, including but not limited to:

● restrictions on activity and high levels of unemployment may cause increases in loan delinquencies, foreclosures and defaults;

● increases in allowance for loan losses may be necessary;

● declines in collateral values may occur;

● third party disruptions, including outages at network providers, on-line banking vendors and other suppliers;

● increased cyber and payment fraud risk, as cybercriminals attempt to profit from the disruption, given increased online and remote activity;

● operational failures due to changes in our normal business practices necessitated by the pandemic and related governmental actions; and/or

● key personnel or significant numbers of our employees being unable to work effectively, including because of illness or restrictions in connection with COVID-19.

These factors may continue for a significant period of time.

The spread of COVID-19 has caused us to modify many of our business practices. Currently, approximately 40% of our total employees are working remotely. We have also expanded sick and vacation time for certain employees. We may take further actions as may be required or as we determine to be prudent. There is no certainty that such measures will be sufficient to mitigate the risks posed by COVID-19.

13

The extent to which the COVID-19 pandemic will impact our business, results of operations and financial condition will depend on future developments, which are highly uncertain and difficult to predict. Those developments and factors include the duration and spread of the pandemic, its severity, the actions to contain the pandemic or address its impact, and how quickly and to what extent normal economic and operating conditions can resume. We do not yet know the full extent of the impact. However, the effects could have a material adverse impact on our business, financial condition and results of operations. Material adverse impacts may include valuation impairments on our intangible assets, securities available for sale, loans, capitalized mortgage loan servicing rights and deferred tax assets.

It is against this backdrop that we discuss our results of operations and financial condition in 2020 as compared to earlier periods.

RESULTS OF OPERATIONS

Summary. We recorded net income of $56.2 million, or $2.53 per diluted share, in 2020, net income of $46.4 million, or $2.00 per diluted share, in 2019, and net income of $39.8 million, or $1.68 per diluted share, in 2018.

KEY PERFORMANCE RATIOS

	Year Ended December 31,
	2020			2019			2018
Net income to
Average shareholders’ equity		15.68	%		13.63	%		12.38	%
Average assets		1.43			1.35			1.27
Net income per common share
Basic	$	2.56		$	2.03		$	1.70
Diluted		2.53			2.00			1.68

Net interest income. Net interest income is the most important source of our earnings and thus is critical in evaluating our results of operations. Changes in our net interest income are primarily influenced by our level of interest-earning assets and the income or yield that we earn on those assets and the manner and cost of funding our interest-earning assets. Certain macro-economic factors can also influence our net interest income such as the level and direction of interest rates, the difference between short-term and long-term interest rates (the steepness of the yield curve) and the general strength of the economies in which we are doing business. Finally, risk management plays an important role in our level of net interest income. The ineffective management of credit risk and interest-rate risk in particular can adversely impact our net interest income.

Net interest income totaled $123.6 million during 2020, compared to $122.6 million and $113.3 million during 2019 and 2018, respectively. The increase in net interest income in 2020 compared to 2019 primarily reflects a $483.8 million increase in average interest-earning assets that was partially offset by a 46 basis point decrease in our tax equivalent net interest income as a percent of average interest-earning assets (the “net interest margin”).

The increase in net interest income in 2019 compared to 2018 primarily reflects a $302.1 million increase in average interest-earning assets that was partially offset by an eight basis point decrease in our net interest margin.

The increase in average interest-earning assets during 2020 primarily reflects an increase in securities available for sale and interest bearing deposits. The significant increases in these balances is primarily due to the deployment of funds from a substantial increase in deposits. The decrease in the net interest margin during 2020 as compared to 2019 primarily reflects reductions in short-term interest rates as well a flattening of the yield curve.

Due to the economic impact of COVID-19, the Federal Reserve Bank has taken a variety of actions to stimulate the economy, including lowering short-term interest rates. These actions, along with lower long-term interest rates have placed pressure on our net interest margin.

Interest and fees on loans in 2020 include $5.6 million of accretion of net loan fees on Payroll Protection Program (“PPP”) loans. No such accretion is included in the comparable prior year periods.

Interest expense in 2020 included $1.6 million of accelerated amortization of deferred loss on certain derivative financial instruments that were de-designated. No such amortization is included in the comparable prior year periods. See note #16 to the Consolidated Financial Statements for discussion regarding these derivative financial instruments.

14

The increase in average interest-earning assets during 2019 and 2018 primarily reflects the impact of the Merger as well as loan growth utilizing funds from increases in deposits. The decrease in the net interest margin during 2019 as compared to 2018 primarily reflects reductions in short-term interest rates during that year as well as a flattening of the yield curve.

2020, 2019 and 2018 interest income on loans includes $1.1 million, $1.5 million and $1.7 million, respectively, of accretion of the discount recorded on the TCSB loans acquired in the Merger.

Our net interest income is also impacted by our level of non-accrual loans. Average non-accrual loans totaled $11.2 million, $8.1 million and $8.4 million in 2020, 2019 and 2018, respectively.

AVERAGE BALANCES AND RATES

	2020							2019							2018
	Average Balance		Interest		Rate			Average Balance		Interest		Rate			Average Balance		Interest		Rate
	(Dollars in thousands)
ASSETS
Taxable loans	$	2,863,846	$	122,875		4.29	%	$	2,713,690	$	133,574		4.92	%	$	2,418,421	$	116,634		4.82	%
Tax-exempt loans(1)		7,145		360		5.04			7,937		391		4.93			6,118		292		4.77
Taxable securities		635,914		12,655		1.99			397,598		11,842		2.98			394,160		10,874		2.76
Tax-exempt securities(1)		137,330		3,673		2.67			52,324		1,683		3.22			67,574		2,192		3.24
Interest bearing cash		59,056		184		0.31			48,023		818		1.70			32,593		371		1.14
Other investments		18,410		905		4.92			18,359		1,043		5.68			16,936		920		5.43
Interest earning assets		3,721,701		140,652		3.78			3,237,931		149,351		4.61			2,935,802		131,283		4.48
Cash and due from banks		49,886							37,575							33,384
Other assets, net		162,068							164,726							162,750
Total assets	$	3,933,655						$	3,440,232						$	3,131,936
LIABILITIES
Savings and interest-bearing checking	$	1,821,115		3,882		0.21		$	1,453,061		10,228		0.70		$	1,218,243		4,696		0.39
Time deposits		516,306		8,784		1.70			655,718		13,197		2.01			632,330		9,782		1.55
Other borrowings		117,904		3,551		3.01			77,254		2,922		3.78			79,519		3,013		3.79
Interest bearing liabilities		2,455,325		16,217		0.66			2,186,033		26,347		1.21			1,930,092		17,491		0.91
Non-interest bearing deposits		1,054,230							867,314							846,718
Other liabilities		65,943							46,153							33,354
Shareholders’ equity		358,157							340,732							321,772
Total liabilities and shareholders’ equity	$	3,933,655						$	3,440,232						$	3,131,936
Net interest income			$	124,435						$	123,004						$	113,792
Net interest income as a percent of average interest earning assets						3.34	%						3.80	%						3.88	%

(1) Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 21%.

15

RECONCILIATION OF NET INTEREST MARGIN, FULLY TAXABLE EQUIVALENT (“FTE”)

	Year Ended December 31,
	2020			2019			2018
	(Dollars in thousands)
Net interest income	$	123,612		$	122,581		$	113,792
Add: taxable equivalent adjustment		823			423			510
Net interest income - taxable equivalent	$	124,435		$	123,004		$	113,792
Net interest margin (GAAP)		3.32	%		3.79	%		3.85	%
Net interest margin (FTE)		3.34	%		3.80	%		3.88	%

CHANGE IN NET INTEREST INCOME

	2020 compared to 2019									2019 compared to 2018
	Volume			Rate			Net			Volume			Rate			Net
	(In thousands)
Increase (decrease) in interest income(1)
Taxable loans	$	7,105		$	(17,804	)	$	(10,699	)	$	14,491		$	2,449		$	16,940
Tax-exempt loans(2)		(40	)		9			(31	)		89			10			99
Taxable securities		5,582			(4,769	)		813			96			872			968
Tax-exempt securities(2)		2,318			(328	)		1,990			(491	)		(18	)		(509	)
Interest bearing cash		154			(788	)		(634	)		218			229			447
Other investments		3			(141	)		(138	)		80			43			123
Total interest income		15,122			(23,821	)		(8,699	)		14,483			3,585			18,068
Increase (decrease) in interest expense(1)
Savings and interest bearing checking		2,109			(8,455	)		(6,346	)		1,047			4,485			5,532
Time deposits		(2,555	)		(1,858	)		(4,413	)		374			3,041			3,415
Other borrowings		1,311			(682	)		629			(86	)		(5	)		(91	)
Total interest expense		865			(10,995	)		(10,130	)		1,335			7,521			8,856
Net interest income	$	14,257		$	(12,826	)	$	1,431		$	13,148		$	(3,936	)	$	9,212

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

(2) Interest on tax-exempt loans and securities is presented on a fully tax equivalent basis assuming a marginal tax rate of 21%.

COMPOSITION OF AVERAGE INTEREST EARNING ASSETS AND INTEREST BEARING LIABILITIES

	Year Ended December 31,
	2020			2019			2018
As a percent of average interest earning assets
Loans		77.1	%		84.1	%		82.6	%
Other interest earning assets		22.9			15.9			17.4
Average interest earning assets		100.0	%		100.0	%		100.0	%
Savings and interest-bearing checking		48.9	%		44.9	%		41.5	%
Time deposits		13.9			20.3			21.5
Other borrowings		3.2			2.3			2.7
Average interest bearing liabilities		66.0	%		67.5	%		65.7	%
Earning asset ratio		94.6	%		94.1	%		93.7	%
Free-funds ratio(1)		34.0			32.5			34.3

(1) Average interest earning assets less average interest bearing liabilities.

16

Provision for loan losses. We have elected to delay the adoption of the Current Expected Credit Losses (“CECL”) accounting standard as permitted by Section 4014 of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, as amended and continue to utilize the existing incurred loss impairment methodology to calculate our allowance for loan losses (“AFLL”) and our provision for loan losses. See note #1 to the Consolidated Financial Statements for our discussion on CECL implementation.

The provision for loan losses was an expense of $12.5 million, $0.8 million and $1.5 million in 2020, 2019 and 2018, respectively. The provision reflects our assessment of the AFLL taking into consideration factors such as loan growth, loan mix, levels of non-performing and classified loans and loan net charge-offs. While we use relevant information to recognize losses on loans, additional provisions for related losses may be necessary based on changes in economic conditions, customer circumstances and other credit risk factors. In particular, the credit impact of the COVID-19 pandemic, and more specifically the periodic closing of various segments of the economy in order to contain it, may have a negative impact on our level of non-performing loans and assets in the future, but as of yet, the magnitude of that impact is uncertain. As a result of this potential adverse impact, we have increased the subjective portion of our AFLL by $11.2 million (or 128.3%) in 2020 compared to 2019. See “Portfolio Loans and asset quality” for a discussion of the various components of the AFLL and their impact on the provision for loan losses in 2020.

Non-interest income. Non-interest income is a significant element in assessing our results of operations. Non-interest income totaled $80.7 million during 2020 compared to $47.7 million and $44.8 million during 2019 and 2018, respectively.

NON-INTEREST INCOME

	Year Ended December 31,
	2020			2019			2018
	(In thousands)
Interchange income	$	11,230		$	10,297		$	9,905
Service charges on deposit accounts		8,517			11,208			12,258
Net gains on assets
Mortgage loans		62,560			19,978			10,597
Securities		267			307			138
Mortgage loan servicing, net		(9,350	)		(3,336	)		3,157
Investment and insurance commissions		1,971			1,658			1,971
Bank owned life insurance		910			1,111			970
Other		4,640			6,513			5,819
Total non-interest income	$	80,745		$	47,736		$	44,815

Interchange income totaled $11.2 million in 2020 compared to $10.3 million in 2019 and $9.9 million in 2018. The increases in interchange income is primarily due to increased transaction volume.

Service charges on deposit accounts totaled $8.5 million in 2020, as compared to $11.2 million in 2019 and $12.3 million during 2018. These yearly variations primarily reflect declines in non-sufficient funds fees. During 2020, non-sufficient funds fees were also impacted by contracted consumer spending and government stimulus payments related to COVID-19.

We realized net gains of $62.6 million on mortgage loans during 2020, compared to $20.0 million and $10.6 million during 2019 and 2018 respectively. Mortgage loan activity is summarized as follows:

MORTGAGE LOAN ACTIVITY

	Year Ended December 31,
	2020			2019			2018
	(Dollars in thousands)
Mortgage loans originated	$	1,820,697		$	1,011,141		$	807,408
Mortgage loans sold(1)		1,447,031			738,910			491,798
Net gains on mortgage loans		62,560			19,978			10,597
Net gains as a percent of mortgage loans sold (“Loan Sales Margin”)		4.32	%		2.70	%		2.15	%
Fair value adjustments included in the Loan Sales Margin		0.47			0.22			(0.02	)

(1) 2020 includes the securitization of $26.3 million of portfolio residential fixed rate loans and the sale of $2.4 million of portfolio residential fixed rate mortgage loans. 2019 includes the sale of $50.5 million of portfolio residential fixed and adjustable rate mortgage loans to other institutions and securitization of $65.1 million of portfolio residential fixed rate loans. 2018 includes the sale of $27.6 million of portfolio residential fixed and adjustable rate portfolio mortgage loans to another financial institution and securitization of $10.9 million of portfolio residential fixed rate loans.

17

The increase in mortgage loan originations, sales and net gains in 2020 as compared to 2019 and 2018 is due primarily to lower interest rates in 2020 that have spurred a significant increase in refinance volumes. Mortgage loans sold also increased in 2020 compared to 2019 and 2018 due to a higher mix of salable loans in our origination volumes. Net gains on mortgage loans also increased in 2020 as compared to 2019 and 2018 due to fair value adjustments as discussed below.

The volume of loans sold is dependent upon our ability to originate mortgage loans as well as the demand for fixed-rate obligations and other loans that we choose to not put into portfolio because of our established interest-rate risk parameters. (See “Portfolio Loans and asset quality.”) Net gains on mortgage loans are also dependent upon economic and competitive factors as well as our ability to effectively manage exposure to changes in interest rates and thus can often be a volatile part of our overall revenues.

Our Loan Sales Margin is impacted by several factors including competition and the manner in which the loan is sold. Net gains on mortgage loans are also impacted by recording fair value accounting adjustments. Excluding these fair value accounting adjustments, the Loan Sales Margin would have been 3.85% in 2020, 2.48% in 2019 and 2.17% in 2018. The increase in the Loan Sales Margin (excluding fair value adjustments) in 2020 was generally due to a substantial widening of primary-to-secondary market pricing spreads as market interest rates fell during 2020 and mortgage loan refinance volumes dramatically increased. Once mortgage loan refinance volumes abate, we would expect our Loan Sales Margin to decline to more normal levels. The changes in the fair value accounting adjustments are primarily due to changes in the amount of commitments to originate mortgage loans for sale during each year. In addition, in 2018, we recorded a loss on mortgage loans of $0.25 million in the fourth quarter on the pending sale of approximately $41.5 million of portfolio mortgage loans. This sale closed on January 30, 2019.

We generated net gains on securities of $0.27 million, $0.31 million and $0.14 million in 2020, 2019 and 2018, respectively. These net gains were due to the sales of securities and changes in the fair value of equity/trading securities as outlined in the table below. We recorded no net impairment losses in 2020, 2019 or 2018 for other than temporary impairment of securities available for sale.

GAINS AND LOSSES ON SECURITIES

	Year Ended December 31,
	Proceeds		Gains(1)		Losses(2)		Net
	(In thousands)
2020	$	38,095	$	271	$	4	$	267
2019		68,716		415		108		307
2018		48,736		336		198		138

(1) Gains in 2019 include $0.166 million related to equity securities at fair value. Gains in 2018 include $0.144 million related to the sale of 1,000 VISA Class B shares.

(2) Losses in 2018 include $0.062 million related to equity securities at fair value.

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Mortgage loan servicing, net, generated a loss of $9.4 million and $3.3 million in 2020 and 2019 respectively. Mortgage loan servicing, net, generated earnings of $3.2 million in 2018. The significant variances in mortgage loan servicing, net are primarily due to changes in the fair value of capitalized mortgage loan servicing rights associated with changes in mortgage loan interest rates and expected future prepayment levels. Mortgage loan servicing, net activity is summarized in the following table:

MORTGAGE LOAN SERVICING ACTIVITY

	2020			2019			2018
	(In thousands)
Mortgage loan servicing:
Revenue, net	$	6,874		$	6,196		$	5,480
Fair value change due to price		(10,833	)		(6,408	)		191
Fair value change due to pay-downs		(5,391	)		(3,124	)		(2,514	)
Total	$	(9,350	)	$	(3,336	)	$	3,157

Activity related to capitalized mortgage loan servicing rights is as follows:

CAPITALIZED MORTGAGE LOAN SERVICING RIGHTS

	2020			2019			2018
	(In thousands)
Balance at January 1,	$	19,171		$	21,400		$	15,699
Originated servicing rights capitalized		13,957			7,303			4,977
Servicing rights acquired		—			—			3,047
Change in fair value		(16,224	)		(9,532	)		(2,323	)
Balance at December 31,	$	16,904		$	19,171		$	21,400

At December 31, 2020, we were servicing approximately $3.0 billion in mortgage loans for others on which servicing rights have been capitalized. This servicing portfolio had a weighted average coupon rate of 3.77% and a weighted average service fee of approximately 25.7 basis points. Remaining capitalized mortgage loan servicing rights at December 31, 2020 totaled $16.9 million, representing approximately 56.7 basis points on the related amount of mortgage loans serviced for others.

Investment and insurance commissions totaled $2.0 million in 2020 as compared to $1.7 million and $2.0 million in 2019 and 2018. The increase in revenue in 2020 as compared to 2019 was primarily due to higher sales volume and an increase in fee based revenue. The lower level of revenue in 2019 as compared to the prior year was due primarily to lower sales volumes reflecting, in part, changes in and newer personnel in certain markets.

We earned $0.9 million, $1.1 million and $1.0 million in 2020, 2019 and 2018, respectively, on our separate account bank owned life insurance principally as a result of increases in the cash surrender value. Our separate account is primarily invested in agency mortgage-backed securities and managed by a fixed income investment manager. The crediting rate (on which the earnings are based) reflects the performance of the separate account. The total cash surrender value of our bank owned life insurance was $55.2 million and $55.7 million at December 31, 2020 and 2019, respectively. The decrease in earnings in 2020 compared to 2019 is due to a decrease in the crediting rate.

Other non-interest income totaled $4.6 million, $6.5 million and $5.8 million in 2020, 2019 and 2018, respectively. Several categories of fees have been reduced in 2020 due to the impact of the COVID-19 pandemic on transaction volumes, including ATM fees. In addition, we have elected to suspend certain electronic banking fees because of the COVID-19 pandemic and the increased need for our customers to access these channels. Fees related to interest rate swaps for commercial loan customers is also lower in 2020 as customers have not felt the need to execute such transactions given the low interest rate environment. The increase in 2019 as compared to 2018 is due primarily to growth in fees related to interest rate swaps for commercial loan customers.

Non-interest expense. Non-interest expense is an important component of our results of operations. We strive to efficiently manage our cost structure.

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Non-interest expense totaled $122.4 million in 2020, $111.7 million in 2019, and $107.5 million in 2018. Performance based compensation and expense related to the core data processing conversion are primarily responsible for the increase in 2020 compared to 2019. Many of the components of non-interest expense increased in 2019 and 2018 due to the Merger. The components of non-interest expense are as follows:

NON-INTEREST EXPENSE

	Year ended December 31,
	2020		2019			2018
	(In thousands)
Compensation	$	41,517	$	41,719		$	37,878
Performance-based compensation		19,725		12,066			11,942
Payroll taxes and employee benefits		13,539		13,716			12,258
Compensation and employee benefits		74,781		67,501			62,078
Occupancy, net		8,938		9,013			8,912
Data processing		8,534		8,905			8,262
Furniture, fixtures and equipment		4,089		4,113			4,080
Interchange expense		3,342		3,215			2,702
Communications		3,194		2,947			2,848
Loan and collection		3,037		2,685			2,682
Conversion related expenses		2,586		—			—
Advertising		2,230		2,450			2,155
Legal and professional		2,027		1,814			1,839
FDIC deposit insurance		1,596		685			1,081
Amortization of intangible assets		1,020		1,089			969
Supplies		680		638			689
Branch closure costs		417		—			—
Correspondent bank service fees		395		411			414
Costs related to unfunded lending commitments		263		246			171
Provision for loss reimbursement on sold loans		200		229			10
Net (gains) losses on other real estate and repossessed assets		64		(90	)		(672	)
Merger related expenses		—		—			3,465
Other		5,020		5,882			5,776
Total non-interest expense	$	122,413	$	111,733		$	107,461

Compensation expense, which is primarily salaries, totaled $41.5 million, $41.7 million and $37.9 million in 2020, 2019 and 2018, respectively. The comparative decrease in 2020 to 2019 is primarily due to an increased level of compensation that was deferred as direct loan origination costs (due to higher loan origination volumes) that was partially offset by salary increases that were predominantly effective on January 1, 2020. The increase in 2019 is primarily due to annual merit based salary increases, the Merger and additional staffing particularly in commercial lending and information technology (including data analytics).

Performance-based compensation expense totaled $19.7 million, $12.1 million and $11.9 million in 2020, 2019 and 2018, respectively. The increase in 2020 as compared to 2019 was due to actual performance relative to the established incentive plan targets as well as $0.4 million in bonuses paid during the second quarter of 2020 to front-line personnel due to their extraordinary efforts during the COVID-19 pandemic. The increase in 2019 as compared to 2018 was primarily due to an increase in the employee stock ownership plan (“ESOP”) contribution accrual reflecting the aforementioned higher salaries.

We maintain performance-based compensation plans. In addition to commissions and cash incentive awards, such plans include an ESOP and a long-term equity based incentive plan. The amount of expense recognized in 2020, 2019 and 2018 for share-based awards under our long-term equity based incentive plan was $1.6 million, $1.6 million and $1.5 million, respectively. In each of those three years, the Board and Compensation Committee of the Board authorized the grant of restricted stock and performance share awards under the plan.

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Payroll taxes and employee benefits expense totaled $13.5 million, $13.7 million and $12.3 million in 2020, 2019 and 2018, respectively. The decrease in 2020 compared to 2019 is due primarily to a decline in health care costs (due to decreased claims in 2020) as well as a $0.3 million prescription drug rebate received and recorded in the second quarter of 2020 that related to our 2019 plan year. The decrease in 2020 health care claims is due in part to the COVID-19 pandemic that resulted in the closing of many medical and dental facilities except for emergency care during Michigan’s “stay home, stay safe” period. The increase in 2019 as compared to 2018 was primarily due to a $0.3 million increase in payroll taxes, a $0.5 million increase in health care insurance, a $0.2 million increase in 401(k) plan employer contributions and a $0.4 million increase in employee education and employee relations costs. A portion of the increases in 2019 and 2018 was due to the Merger. However, we maintain a self-insured health care plan (with an individual claim stop loss limit) and we experienced a significant rise in claims in 2019 and 2018.

Data processing expenses totaled $8.5 million, $8.9 million, and $8.3 million in 2020, 2019 and 2018, respectively. The comparative decrease in 2020 is primarily due to a cost savings agreement related to core data processing services that was executed in the second quarter of 2020. This expense reduction was partially offset by new software product additions and increased mobile banking costs. The increase in 2019 as compared to 2018 was primarily due to higher mobile banking activity and software costs for new applications in several departments.

Interchange expense, which totaled $3.3 million, $3.2 million, and $2.7 million in 2020, 2019 and 2018, respectively, primarily represents fees paid to our core information systems processor and debit card licensor related to debit card and ATM transactions. The increase in 2020 compared to 2019 was primarily due to increased debit card transaction volume. Increased debit card transaction volumes in 2019 compared to 2018 also contributed to the rise in this expense as well as the addition of a fraud detection service in early 2019.

Communications expense totaled $3.2 million, $2.9 million and $2.8 million in 2020, 2019 and 2018, respectively. The increase in 2020 relative to 2019 is primarily due to mailing costs related to the issuance of new contactless debit cards. The increase in 2019 as compared to 2018 was primarily due to the Merger.

Loan and collection expenses reflect costs related to new lending activity as well as the management and collection of non-performing loans and other problem credits. These expenses totaled $3.0 million, $2.7 million and $2.7 million in 2020, 2019 and 2018, respectively. These costs increased in 2020 due primarily to higher loan origination activity.

Conversion related expenses totaled $2.6 million in 2020. We are in the process of converting our core data processing system to a new system hosted by a different vendor. These 2020 expenses represent costs incurred for assistance from our existing vendor and fees from consultants who are assisting us in this conversion. We expect to continue to incur these costs through at least the second quarter of 2021. Also see Part II, Item 1A. Risk Factors of our Annual report on Form 10-K.

Advertising expense totaled $2.2 million, $2.5 million, and $2.2 million in 2020, 2019 and 2018, respectively. The decrease in 2020 compared to 2019 is due primarily to the receipt of a $0.2 million reimbursement from our debit card provider for certain eligible marketing costs that we incurred. The increase in 2019 as compared to 2018 was primarily due to increased outdoor advertising (billboards).

Legal and professional fees totaled $2.0 million, $1.8 million, and $1.8 million in 2020, 2019 and 2018, respectively. The increase in 2020 is due primarily to an increase in title search fees and bank examination fees (due to an increase in our asset size).

The amortization of intangible assets primarily relates to the Merger and branch acquisitions and the related amortization of the deposit customer relationship value, including core deposit value, which was acquired in connection with those transactions. We had remaining unamortized intangible assets of $4.3 million and $5.3 million at December 31, 2020 and 2019 respectively. See note #7 to the Consolidated Financial Statements for a schedule of future amortization of intangible assets.

FDIC deposit insurance expense totaled $1.6 million, $0.7 million, and $1.1 million in 2020, 2019 and 2018, respectively. FDIC deposit insurance expense increased in 2020 compared to 2019 due primarily due to the use of our FDIC Small Bank Assessment Credit (“the Assessment Credit”) in 2019 as well as an increase in our assessment rate and growth in our total assets. The decrease in 2019 as compared to 2018 was primarily due to the use of the Assessment Credit of approximately $0.7 million in 2019. We did not have any remaining Assessment Credit to apply against our 2020 FDIC deposit insurance expense.

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Branch closure costs totaled $0.4 million for 2020. We closed eight Bank branches in 2020 (two on June 26, 2020 and six on July 31, 2020). These costs primarily represent write-downs of fixed assets (buildings, furniture and equipment) and lease assets.

The changes in costs related to unfunded lending commitments are primarily impacted by changes in the amounts of such commitments to originate Portfolio Loans as well as (for commercial loan commitments) the grade (pursuant to our loan rating system) of such commitments.

The provision for loss reimbursement on sold loans was an expense of $0.20 million, $0.23 million and $0.01 million in 2020, 2019 and 2018, respectively. This provision represents our estimate of incurred losses related to mortgage loans that we have sold to investors (primarily Fannie Mae, Freddie Mac, Ginnie Mae and the Federal Home Loan Bank of Indianapolis). Since we sell mortgage loans without recourse, loss reimbursements only occur in those instances where we have breached a representation or warranty or other contractual requirement related to the loan sale. The reserve for loss reimbursements on sold mortgage loans totaled $1.0 million and $0.9 million at December 31, 2020 and 2019, respectively. This reserve is included in accrued expenses and other liabilities in our Consolidated Statements of Financial Condition. We believe that the amounts that we have accrued for incurred losses on sold mortgage loans are appropriate based upon our prior experience and other assumptions. However, future losses could exceed our current estimate.

Net gains (losses) on other real estate and repossessed assets represent the gain or loss on the sale or additional write downs on these assets subsequent to the transfer of the asset from our loan portfolio. This transfer occurs at the time we acquire the collateral that secured the loan. At the time of acquisition, the other real estate or repossessed asset is valued at fair value, less estimated costs to sell, which becomes the new basis for the asset. Any write-downs at the time of acquisition are charged to the allowance for loan losses. Net loss was $0.1 million in 2020 compared to net gain of $0.1 million and $0.7 million in 2019 and 2018 respectively. The net gain of $0.7 million in 2018 was primarily due to the sale of a commercial property in the fourth quarter of that year.

Merger related expenses totaled $3.5 million in 2018. These expenses included our investment banking fees, certain accounting and legal costs, various contract termination fees, data processing conversion costs, payments made on officer change-in-control contracts, and employee severance costs related to the Merger.

Other non-interest expenses totaled $5.0 million, $5.9 million, and $5.8 million in 2020, 2019 and 2018, respectively. The decrease in 2020 is primarily due to a decline in travel and entertainment costs due to COVID-19 pandemic related travel restrictions as well as a reduction in deposit account and debit card related fraud costs. The increase in 2019 as compared to 2018 was due to an increase in debit card and check fraud losses.

Income tax expense. We recorded an income tax expense of $13.3 million, $11.3 million and $9.3 million in 2020, 2019 and 2018, respectively. The 2020 increase in tax expense compared to 2019 and 2018 is due to higher taxable income.

Our actual federal income tax expense is different than the amount computed by applying our statutory federal income tax rate to our pre-tax income primarily due to tax-exempt interest income, share based compensation and tax-exempt income from the increase in the cash surrender value on life insurance.

We assess whether a valuation allowance should be established against our deferred tax asset, net (“DTA”) based on the consideration of all available evidence using a “more likely than not” standard. The ultimate realization of this asset is primarily based on generating future income. We concluded at December 31, 2020 and 2019 that the realization of substantially all of our DTA continues to be more likely than not.

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FINANCIAL CONDITION

Summary. Our total assets increased to $4.20 billion at December 31, 2020, compared to $3.56 billion at December 31, 2019, primarily due to growth in interest bearing deposits and securities available for sale. Loans, excluding loans held for sale (“Portfolio Loans”), totaled $2.73 billion at December 31, 2020 and December 31, 2019. Growth in commercial loans of $75.7 million and installment loans of $15.9 million were partially offset by a decline in mortgage loans of $83.0 million. The decline in mortgage loans was due in part to a securitization and/or sale of $28.7 million of portfolio mortgage loans during the first quarter of 2020 as well as a higher mix of salable loans in our origination volumes. (See “Portfolio Loans and asset quality.”)

Deposits totaled $3.64 billion at December 31, 2020, compared to $3.04 billion at December 31, 2019. The $600.6 million increase in deposits is primarily due to growth in non-interest bearing deposits, savings and interest bearing checking deposits and reciprocal deposits that were partially offset by a decline in time and brokered time deposits.

The increase in commercial loans in 2020 is due primarily to loans extended under the Paycheck Protection Program (“PPP”) administered by the U.S. Small Business Administration (“SBA”). The increase in deposits is due in part to the significant liquidity that has been injected into the economy through government programs, such as the PPP, as well as by monetary actions by the Federal Reserve Bank, all in response to the COVID-19 pandemic.

It is unclear as to when these various government stimulus programs may end and when ended, what the impact will be on our levels of Portfolio Loans and deposits. However, our liquidity and funding contingency plans take into account the possibility of significant reductions in commercial loans and deposits during 2021.

Securities. We maintain diversified securities portfolios, which include obligations of U.S. government- sponsored agencies, securities issued by states and political subdivisions, residential and commercial mortgage-backed securities, asset-backed securities, corporate securities, trust preferred securities and foreign government securities (that are denominated in U.S. dollars). We regularly evaluate asset/liability management needs and attempt to maintain a portfolio structure that provides sufficient liquidity and cash flow. Except as discussed below, we believe that the unrealized losses on securities available for sale are temporary in nature and are expected to be recovered within a reasonable time period. We believe that we have the ability to hold securities with unrealized losses to maturity or until such time as the unrealized losses reverse. (See “Asset/liability management.”) Securities available for sale increased by $553.8 million during 2020, reflecting the deployment of a portion of the funds generated from the growth in deposits.

Our portfolio of securities available for sale is reviewed quarterly for impairment in value. In performing this review, management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security, and (4) an assessment of whether we intend to sell, or it is more likely than not that we will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. For securities that do not meet these recovery criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income (loss). We recorded no net impairment losses related to other than temporary impairment on securities available for sale in 2020, 2019 or 2018.

SECURITIES

			Unrealized
	Amortized Cost		Gains		Losses		Fair Value
	(In thousands)
Securities available for sale
December 31, 2020	$	1,052,147	$	21,416	$	1,404	$	1,072,159
December 31, 2019	$	513,668		5,782		1,050		518,400

Portfolio Loans and asset quality. In addition to the communities served by our Bank branch and loan production office network, our principal lending markets also include nearby communities and metropolitan areas. Subject to established underwriting criteria, we also may participate in commercial lending transactions with certain non-affiliated banks and make whole loan purchases from other financial institutions.

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The senior management and board of directors of our Bank retain authority and responsibility for credit decisions and we have adopted uniform underwriting standards. Our loan committee structure and the loan review process attempt to provide requisite controls and promote compliance with such established underwriting standards. However, there can be no assurance that our lending procedures and the use of uniform underwriting standards will prevent us from incurring significant credit losses in our lending activities.

We generally retain loans that may be profitably funded within established risk parameters. (See “Asset/liability management.”) As a result, we may hold adjustable-rate conventional and fixed rate jumbo mortgage loans as Portfolio Loans, while 15- and 30-year fixed-rate non-jumbo mortgage loans are generally sold to mitigate exposure to changes in interest rates. (See “Non-interest income.”) Due primarily to the expansion of our mortgage-banking activities and a change in mix in our mortgage loan originations, we are now originating and putting into Portfolio Loans more fixed rate mortgage loans compared to past periods. These fixed rate mortgage loans generally have terms from 15 to 30 years, do not have prepayment penalties and expose us to more interest rate risk. To date, our interest rate risk profile has not changed significantly. However, we are carefully monitoring this change in the composition of our Portfolio Loans and the impact of potential future changes in interest rates on our changes in market value of portfolio equity and changes in net interest income. (See “Asset/liability management.”). As a result, we may utilize derivatives (interest rate swaps and interest rate caps) to manage interest rate risk and may continue to sell certain fixed rate and adjustable rate jumbo or other mortgage loans in the future.

In 2020 we sold or securitized $28.7 million of fixed and adjustable rate portfolio mortgage loans. In 2019, we sold or securitized $75.0 million (excludes the $40.6 million discussed below) of fixed and adjustable rate portfolio mortgage loans. In 2018, we sold $27.6 million of fixed and adjustable rate portfolio mortgage loans. In addition, in the fourth quarter of 2018 we reclassified $41.7 million (fair value of $41.5 million) of adjustable rate portfolio mortgage loans to held for sale. These loans (which totaled $40.6 million at the time of sale) were sold to another financial institution on a servicing released basis on January 30, 2019. All of these loan sales/securitizations were non-recourse (other than standard representations and warranties) and were executed primarily for asset/liability management purposes.

The PPP is a short-term, forgivable loan program primarily intended to help businesses impacted by COVID-19 to continue paying their employees. Also see Part II, Item 1A. Risk Factors below regarding the PPP.

A short summary of the PPP is as follows:

● Terms of two years (five years for loans originated after June 5, 2020) with payments automatically deferred to the date the SBA remits the borrower’s loan forgiveness amount to the lender (or, if the borrower does not apply for loan forgiveness, 10 months after the end of the borrower’s loan forgiveness covered period);

● One percent interest rate;

● No collateral or personal guarantees required;

● No fees paid by the borrower, rather lenders are paid a fee through the SBA according to a set schedule based on loan size;

● Loans are forgivable if at least 60% of the loan proceeds are used for payroll with the remainder being used for rent, mortgage interest and/or utilities; and

● Streamlined forgiveness application process for PPP loans of $50,000 or less.

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A summary of our participation in the PPP follows:

Paycheck Protection Program Volume

	As of December 31, 2020
	Amount (#)		Amount
	(Dollars in thousands)
Closed and outstanding		1,483	$	169,782
Loans $50,000 and under		921		16,878
Forgiveness applications submitted to the SBA		808		122,962
Fees accreted into interest income during the year		n/a		5,557
Unaccreted net fees remaining at year-end		n/a		3,216
Average loan yield for the year		n/a		4.31	%

Congress and the major bank regulatory agencies have encouraged banks to work with their borrowers to provide short-term loan payment relief during the COVID-19 national emergency. On March 22, 2020, an interagency statement was released by the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Consumer Financial Protection Bureau, the Conference of State Bank Supervisors, and the National Credit Union Administration that contained guidance regarding loan modifications made in response to the pandemic. In general, in order for a loan modification made in response to the pandemic to avoid being classified as a troubled debt restructuring (“TDR”):

● The modified loan must be current when the modification is made;

● The modification must be short term in nature (up to six months); and

● Modifications may include payment deferrals, fee waivers, extensions of repayment terms or other delays in payment that are insignificant.

In addition, Section 4013 of the CARES Act provides temporary relief from the accounting and reporting requirements for TDRs regarding certain loan modifications for our customers. Section 4013 specified that COVID-19 related modifications on loans that were current as of December 31, 2019 are not TDRs.

In response to our customers’ needs during this time of economic uncertainty, we have initiated forbearance programs for our retail (mortgage and installment loans) and our commercial customers. We also have similar programs for mortgage loans that we service for others. Commercial loan accommodations are typically a three month interest-only period while retail loan (mortgage and installment) forbearances have primarily been payment suspensions for three months. To date, there have not been a significant number of requests for additional modifications. See note #4 to the Consolidated Financial Statements included within this report.

A summary of accommodations as of December 31, 2020 follows:

Commercial and Retail Loan COVID-19 Accommodations

	Covid-19 Accommodations
Loan Category	Loans (#)		Loans ($)		Total Loans		% of Total Loans
	(Dollars in thousands)
Commercial		2	$	163	$	1,242,415		0.0	%
Mortgage		134		19,830		1,015,926		2.0
Installment		48		1,412		475,337		0.3
Total		184	$	21,405	$	2,733,678		0.8	%
Mortgage loans serviced for others(1)		288	$	42,897	$	2,984,088		1.4	%

(1) We have delegated authority from all investors to grant these deferrals on their behalf.

Certain industries (such as hotels and restaurants) have been more adversely impacted by the COVID-19 pandemic and related periodic shut downs of our economy. We believe that the following industry concentrations within our commercial loan portfolio represent greater potential risk in the current economic environment. The balances below are as of December 31, 2020.

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Commercial and industrial portfolio segment:

● Retail - $93 million

● Food service - $55 million

● Hotel - $44 million

Commercial real estate portfolio segment:

● Retail - $97 million

● Office - $67 million

● Multifamily - $58 million

We are closely monitoring these industry concentrations and at present do not foresee any significant losses relative to this portion of our loan portfolio given the current economic conditions in Michigan and the fact that many businesses have reopened. However, a high degree of uncertainty still exists with respect to the impact of the COVID-19 pandemic and the related economic disruptions on the future performance of our loan portfolio, including these concentrations.

LOAN PORTFOLIO COMPOSITION

	December 31,
	2020		2019
	(In thousands)
Real estate(1)
Residential first mortgages	$	792,762	$	843,746
Residential home equity and other junior mortgages		138,128		166,735
Construction and land development		232,693		249,747
Other(2)		669,150		693,580
Consumer		468,090		448,297
Commercial		429,011		318,504
Agricultural		3,844		4,414
Total loans	$	2,733,678	$	2,725,023

(1) Includes both residential and non-residential commercial loans secured by real estate.

(2) Includes loans secured by multi-family residential and non-farm, non-residential property.

NON-PERFORMING ASSETS⁽¹⁾

	December 31,
	2020			2019			2018
	(Dollars in thousands)
Non-accrual loans	$	8,312		$	10,178		$	9,029
Loans 90 days or more past due and still accruing interest		—			—			5
Sub total		8,312			10,178			9,034
Less: Government guaranteed loans		439			646			460
Total non-performing loans		7,873			9,532			8,574
Other real estate and repossessed assets		766			1,865			1,299
Total non-performing assets	$	8,639		$	11,397		$	9,873
As a percent of Portfolio Loans
Non-performing loans		0.29	%		0.35	%		0.33	%
Allowance for loan losses		1.30			0.96			0.96
Non-performing assets to total assets		0.21			0.32			0.29
Allowance for loan losses as a percent of non-performing loans		450.01			274.32			290.27

(1) Excludes loans classified as “troubled debt restructured” that are performing.

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TROUBLED DEBT RESTRUCTURINGS

	December 31, 2020
	Commercial		Retail(1)			Total
	(In thousands)
Performing TDR’s	$	7,956	$	36,385		$	44,341
Non-performing TDR’s(2)		1,148		1,584	(3)		2,732
Total	$	9,104	$	37,969		$	47,073

	December 31, 2019
	Commercial		Retail(1)			Total
	(In thousands)
Performing TDR’s	$	7,974	$	39,601		$	47,575
Non-performing TDR’s(2)		540		2,607	(3)		3,147
Total	$	8,514	$	42,208		$	50,722

(1) Retail loans include mortgage and installment loan portfolio segments.

(2) Included in non-performing loans table above.

(3) Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.

Non-performing loans totaled $7.9 million, $9.5 million and $8.6 million at December 31, 2020, 2019 and 2018, respectively. The decrease in 2020 compared to 2019 was primarily due to a $1.5 million decrease in the residential mortgage loan portfolio segment compared to year-end 2019. Our collection and resolution efforts have generally resulted in a stable trend in non-performing loans. However, the credit impact of the COVID-19 pandemic, and more specifically the periodic, government-mandated closing of various segments of the economy in order to contain it, may have a negative impact on the level of non-performing loans and assets in the future, but as yet, the magnitude of that impact is undeterminable. As a result of this potential adverse impact, we have increased the subjective portion of our allowance for loan losses (“AFLL”) by $11.2 million (or 128.2%) during 2020. (See the further discussion of our AFLL below.) The increase in non-performing loans in 2019 as compared to 2018 was primarily in the residential mortgage loan portfolio segment that was partially offset by the pay-off or liquidation of non-performing commercial loans.

Non-performing loans exclude performing loans that are classified as troubled debt restructurings (“TDRs”). Performing TDRs totaled $44.3 million, or 1.6% of total Portfolio Loans, and $47.6 million, or 1.7% of total Portfolio Loans, at December 31, 2020 and 2019, respectively. The decrease in the amount of performing TDRs during 2020 reflects a decline in mortgage loan TDRs due primarily to payoffs and paydowns.

ORE and repossessed assets totaled $0.8 million at December 31, 2020, compared to $1.9 million at December 31, 2019. The decrease in ORE during 2020 reflects the sale of a $0.6 million commercial property as well as certain other retail properties.

We will place a loan that is 90 days or more past due on non-accrual, unless we believe the loan is both well secured and in the process of collection. Accordingly, we have determined that the collection of the accrued and unpaid interest on any loans that are 90 days or more past due and still accruing interest is probable.

ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES

	December 31,
	2020		2019		2018
	(In thousands)
Specific allocations	$	5,581	$	6,155	$	6,310
Other adversely rated commercial loans		1,716		2,502		1,861
Historical loss allocations		8,214		8,764		7,792
Additional allocations based on subjective factors		19,918		8,727		8,925
Total	$	35,429	$	26,148	$	24,888

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Some loans will not be repaid in full. Therefore, an allowance for loan losses (“AFLL”) is maintained at a level which represents our best estimate of losses incurred. In determining the AFLL and the related provision for loan losses, we consider four principal elements: (i) specific allocations based upon probable losses identified during the review of the loan portfolio, (ii) allocations established for other adversely rated commercial loans, (iii) allocations based principally on historical loan loss experience, and (iv) additional allowances based on subjective factors, including local and general economic business factors and trends, portfolio concentrations and changes in the size and/or the general terms of the loan portfolios.

The first AFLL element (specific allocations) reflects our estimate of probable incurred losses based upon our systematic review of specific loans. These estimates are based upon a number of factors, such as payment history, financial condition of the borrower, discounted collateral exposure and discounted cash flow analysis. Impaired commercial, mortgage and installment loans are allocated AFLL amounts using this first element. The second AFLL element (other adversely rated commercial loans) reflects the application of our commercial loan rating system. This rating system is similar to those employed by state and federal banking regulators. Commercial loans that are rated below a certain predetermined classification are assigned a loss allocation factor for each loan classification category that is based upon a historical analysis of both the probability of default and the expected loss rate (“loss given default”). The lower the rating assigned to a loan or category, the greater the allocation percentage that is applied. The third AFLL element (historical loss allocations) is determined by assigning allocations to higher rated (“non-watch credit”) commercial loans using a probability of default and loss given default similar to the second AFLL element and to homogenous mortgage and installment loan groups based upon borrower credit score and portfolio segment. For homogenous mortgage and installment loans a probability of default for each homogenous pool is calculated by way of credit score migration. Historical loss data for each homogenous pool coupled with the associated probability of default is utilized to calculate an expected loss allocation rate. The fourth AFLL element (additional allocations based on subjective factors) is based on factors that cannot be associated with a specific credit or loan category and reflects our attempt to ensure that the overall AFLL appropriately reflects a margin for the imprecision necessarily inherent in the estimates of expected credit losses. We consider a number of subjective factors when determining this fourth element, including local and general economic business factors and trends, portfolio concentrations and changes in the size, mix and the general terms of the overall loan portfolio.

Increases in the AFLL are recorded by a provision for loan losses charged to expense. Although we periodically allocate portions of the AFLL to specific loans and loan portfolios, the entire AFLL is available for incurred losses. We generally charge-off commercial, homogenous residential mortgage and installment loans when they are deemed uncollectible or reach a predetermined number of days past due based on product, industry practice and other factors. Collection efforts may continue and recoveries may occur after a loan is charged against the AFLL. While we use relevant information to recognize losses on loans, additional provisions for related losses may be necessary based on changes in economic conditions, customer circumstances and other credit risk factors.

The AFLL increased $9.28 million to $35.43 million at December 31, 2020 from $26.15 million at December 31, 2019 and was equal to 1.30% and 0.96% of total Portfolio Loans at December 31, 2020 and 2019, respectively.

Three of the four components of the AFLL outlined above decreased in 2020 compared to 2019. The AFLL related to specific loans decreased $0.6 million in 2020 due primarily to a $5.3 million decline in the amount such loans. The AFLL related to other adversely rated commercial loans decreased $0.8 million in 2020, primarily due to a decrease in the balance of such loans included in this component to $37.6 million from $54.4 million at December 31, 2019. The AFLL related to historical losses decreased $0.6 million in 2020 primarily due to a decrease in the balance of such loans included in this component. The AFLL related to subjective factors increased $11.2 million in 2020. The significant increase in the AFLL related to subjective factors is due principally to the economic shock of COVID-19 and various executive orders suspending or restricting certain businesses and operations, the significant increase in unemployment claims, especially in the State of Michigan, and elevated requests for payment relief from our borrowers.

During the first quarter of 2019, we deployed a third-party software solution (we previously used spreadsheet software) to assist in the determination of our AFLL. This new third-party software has also assisted us in moving to the expected loss framework that we implemented on January 1, 2021. Although the use of this new third-party software did not have any material impact on our overall AFLL, it did result in some classification shifts from the AFLL related to subjective factors into the AFLL related to historical losses as the new software model allowed us to capture longer historical look-back periods (previously this was being captured in the subjective portion of the AFLL).

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Two of the four components of the AFLL outlined above increased during 2019. The AFLL related to specific loans decreased $0.2 million during 2019 due primarily to a $2.6 million decline in the amount of such loans. The AFLL related to other adversely rated commercial loans increased $0.6 million during 2019, primarily due to an increase in the balance of such loans included in this component to $54.4 million at December 31, 2019 from $44.7 million at December 31, 2018. The increase in other adversely rated commercial loans was primarily in early watch credit categories and these loans are largely performing. The AFLL related to historical losses increased $1.0 million during 2019, and the AFLL related to subjective factors decreased $0.2 million during 2019, due in part to the classification shifts discussed above, as well as loan growth, for the AFLL related to historical losses.

ALLOWANCE FOR LOSSES ON LOANS AND UNFUNDED COMMITMENTS

	2020					2019					2018
	Loan Losses			Unfunded Commitments		Loan Losses			Unfunded Commitments		Loan Losses			Unfunded Commitments
	(Dollars in thousands)
Balance at beginning of year	$	26,148		$	1,542	$	24,888		$	1,296	$	22,587		$	1,125
Additions (deductions)
Provision for loan losses		12,463			—		824			—		1,503			—
Recoveries credited to allowance		3,069			—		3,961			—		4,622			—
Loans charged against the allowance		(6,251	)		—		(3,525	)		—		(3,824	)		—
Additions included in non-interest expense		—			263		—			246		—			171
Balance at end of year	$	35,429		$	1,805	$	26,148		$	1,542	$	24,888		$	1,296
Net loans charged against the allowance to average Portfolio Loans		0.11	%				(0.02	)%				(0.03	)%

In 2020, we recorded loan net charge offs of $3.2 million compared to loan net recoveries in 2019 and 2018 of $0.4 million and $0.8 million, respectively. The increase in net charge-offs in 2020 was attributed to a $4.0 million charge down of one specific commercial loan relationship whose balance was zero at December 31, 2020. The net recoveries in 2019 and 2018 primarily reflect reduced levels of non-performing loans, improvement in collateral liquidation values and on-going collection efforts on previously charged-off loans.

Deposits and borrowings. Historically, the loyalty of our customer base has allowed us to price deposits competitively, contributing to a net interest margin that compares favorably to our peers. However, we still face a significant amount of competition for deposits within many of the markets served by our branch network, which limits our ability to materially increase deposits without adversely impacting the weighted-average cost of core deposits.

To attract new core deposits, we have implemented various account acquisition strategies as well as branch staff sales training. Account acquisition initiatives have historically generated increases in customer relationships. Over the past several years, we have also expanded our treasury management products and services for commercial businesses and municipalities or other governmental units and have also increased our sales calling efforts in order to attract additional deposit relationships from these sectors. We view long-term core deposit growth as an important objective. Core deposits generally provide a more stable and lower cost source of funds than alternative sources such as short-term borrowings. (See “Liquidity and capital resources.”)

Deposits totaled $3.64 billion and $3.04 billion at December 31, 2020 and 2019, respectively. The $600.6 million increase in deposits during 2020 is due to growth in non-interest bearing deposits, savings and interest bearing checking deposits and reciprocal deposits. Reciprocal deposits totaled $556.2 million and $431.0 million at December 31, 2020 and 2019, respectively. These deposits represent demand, money market and time deposits from our customers that have been placed through IntraFi Network (formerly Promontory Interfinancial Network’s Insured Cash Sweep^® service and Certificate of Deposit Account Registry Service^®). This service allows our customers to access multi-million dollar FDIC deposit insurance on deposit balances greater than the standard FDIC insurance maximum. The significant increase in reciprocal deposits is due in part to an automated sweep capability we introduced in mid-2018 as well as the marketing and sales efforts of our treasury management team.

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We cannot be sure that we will be able to maintain our current level of core deposits. In particular, those deposits that are uninsured may be susceptible to outflow. At December 31, 2020, we had an estimated $755.7 million of uninsured deposits. A reduction in core deposits would likely increase our need to rely on wholesale funding sources.

We have also implemented strategies that incorporate using federal funds purchased, other borrowings and Brokered CDs to fund a portion of our interest-earning assets. The use of such alternate sources of funds supplements our core deposits and is also a part of our asset/liability management efforts. Other borrowings, comprised primarily of federal funds purchased and advances from the Federal Home Loan Bank (the “FHLB”), totaled $30.0 million and $88.6 million at December 31, 2020 and 2019, respectively.

As described above, we utilize wholesale funding, including federal funds purchased, FHLB borrowings and Brokered CDs to augment our core deposits and fund a portion of our assets. At December 31, 2020, our use of such wholesale funding sources (including reciprocal deposits) amounted to approximately $700.0 million, or 19.1% of total funding (deposits and total borrowings, excluding subordinated debt and debentures). Because wholesale funding sources are affected by general market conditions, the availability of such funding may be dependent on the confidence these sources have in our financial condition and operations. The continued availability to us of these funding sources is not certain, and Brokered CDs may be difficult for us to retain or replace at attractive rates as they mature. Our liquidity may be constrained if we are unable to renew our wholesale funding sources or if adequate financing is not available in the future at acceptable rates of interest or at all. Our financial performance could also be affected if we are unable to maintain our access to funding sources or if we are required to rely more heavily on more expensive funding sources. In such case, our net interest income and results of operations could be adversely affected.

We have historically employed derivative financial instruments to manage our exposure to changes in interest rates. During 2020, 2019 and 2018, we entered into $16.7 million, $74.5 million and $23.9 million (original aggregate notional amounts), respectively, of interest rate swaps with commercial loan customers, which were offset with interest rate swaps that the Bank entered into with a broker-dealer. We recorded $0.26 million, $0.94 million and $0.46 million of fee income related to these transactions during 2020, 2019 and 2018, respectively. In 2020 we entered into $42.0 million (notional amount) of pay fixed interest rate swaps to hedge the fair value of municipal bond securities. In 2019 we entered into a $7.1 million (notional amount) pay fixed interest rate swap to hedge the fair value of a fixed rate commercial loan. In 2018, we entered into (notional amounts): $10.0 million of pay fixed interest rate swaps and $105.0 million of interest rate caps. These swaps and caps were hedging short-term wholesale funding. See note #16 to our Consolidated Financial Statements.

Liquidity and capital resources. Liquidity risk is the risk of being unable to timely meet obligations as they come due at a reasonable funding cost or without incurring unacceptable losses. Our liquidity management involves the measurement and monitoring of a variety of sources and uses of funds. Our Consolidated Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus our liquidity management on maintaining adequate levels of liquid assets (primarily funds on deposit with the FRB and certain investment securities) as well as developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for purchasing investment securities or originating Portfolio Loans as well as to be able to respond to unforeseen liquidity needs.

Our primary sources of funds include our deposit base, secured advances from the FHLB, federal funds purchased borrowing facilities with other commercial banks, and access to the capital markets (for Brokered CDs).

At December 31, 2020, we had $370.5 million of time deposits (see note #8 to the Consolidated Financial Statements) that mature in the next 12 months. Historically, a majority of these maturing time deposits are renewed by our customers. Additionally, $3.20 billion of our deposits at December 31, 2020, were in account types from which the customer could withdraw the funds on demand. Changes in the balances of deposits that can be withdrawn upon demand are usually predictable and the total balances of these accounts have generally grown or have been stable over time as a result of our marketing and promotional activities. However, there can be no assurance that historical patterns of renewing time deposits or overall growth or stability in deposits will continue in the future.

We have developed contingency funding plans that stress test our liquidity needs that may arise from certain events such as an adverse change in our financial metrics (for example, credit quality or regulatory capital ratios). Our liquidity management also includes periodic monitoring that measures quick assets (defined generally as highly

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liquid or short-term assets) to total assets, short-term liability dependence and basic surplus (defined as quick assets less volatile liabilities to total assets). Policy limits have been established for our various liquidity measurements and are monitored on a quarterly basis. In addition, we also prepare cash flow forecasts that include a variety of different scenarios.

We believe that we currently have adequate liquidity at our Bank because of our cash and cash equivalents, our portfolio of securities available for sale, our access to secured advances from the FHLB, and our ability to issue Brokered CDs.

We also believe that the available cash on hand at the parent company (including time deposits) of approximately $50.5 million as of December 31, 2020, provides sufficient liquidity resources at the parent company to meet operating expenses, to make interest payments on the subordinated debt and debentures and to pay a cash dividend on our common stock for the foreseeable future.

In the normal course of business we enter into certain contractual obligations. Such obligations include requirements to make future payments on debt and lease arrangements, contractual commitments for capital expenditures, and service contracts. The table below summarizes our significant contractual obligations at December 31, 2020.

CONTRACTUAL COMMITMENTS⁽¹⁾

	1 Year or Less		1-3 Years		3-5 Years		After 5 Years		Total
	(In thousands)
Time deposit maturities	$	370,497	$	57,388	$	10,529	$	603	$	439,017
FHLB advances		—		—		—		30,000		30,000
Subordinated debt		—		—		—		39,281		39,281
Subordinated debentures		—		—		—		39,524		39,524
Operating lease obligations		1,669		2,711		1,624		2,525		8,529
Purchase obligations(2)		4,332		10,680		10,680		17,800		43,492
Total	$	376,498	$	70,779	$	22,833	$	129,733	$	599,843

(1) Excludes approximately $0.2 million of accrued tax and interest relative to uncertain tax benefits due to the high degree of uncertainty as to when, or if, those amounts would be paid.

(2) Includes contracts with a minimum annual payment of $1.0 million and are not cancellable within one year.

Effective management of capital resources is critical to our mission to create value for our shareholders. In addition to common stock, our capital structure also currently includes cumulative trust preferred securities.

CAPITALIZATION

	December 31,
	2020			2019
	(In thousands)
Subordinated debt	$	39,281		$	—
Subordinated debentures		39,524			39,456
Amount not qualifying as regulatory capital		(505	)		(1,224	)
Amount qualifying as regulatory capital		78,300			38,232
Shareholders’ equity
Common stock		339,353			352,344
Retained earnings		40,145			1,611
Accumulated other comprehensive income (loss)		10,024			(3,786	)
Total shareholders’ equity		389,522			350,169
Total capitalization	$	467,822		$	388,401

In May 2020, we issued $40.0 million of fixed to floating subordinated notes with a ten year maturity and a five year call option. The initial coupon rate is 5.95% fixed for five years and then floats at the Secured Overnight

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Financing Rate (“SOFR”) plus 5.825%. These notes are presented in the Consolidated Statement of Financial Condition under the caption “Subordinated debt” and the December 31, 2020 balance of $39.3 million is net of remaining unamortized deferred issuance costs of approximately $0.7 million that are being amortized through the maturity date into interest expense on other borrowings and subordinated debt and debentures in our Consolidated Statement of Operations.

We currently have four special purpose entities with $39.5 million of outstanding cumulative trust preferred securities. These special purpose entities issued common securities and provided cash to our parent company that in turn issued subordinated debentures to these special purpose entities equal to the trust preferred securities and common securities. The subordinated debentures represent the sole asset of the special purpose entities. The common securities and subordinated debentures are included in our Consolidated Statements of Financial Condition.

The FRB has issued rules regarding trust preferred securities as a component of the Tier 1 capital of bank holding companies. The aggregate amount of trust preferred securities (and certain other capital elements) is limited to 25 percent of Tier 1 capital elements, net of goodwill (net of any associated deferred tax liability). The amount of trust preferred securities and certain other elements in excess of the limit can be included in Tier 2 capital, subject to restrictions. Although the Dodd-Frank Act further limited Tier 1 treatment for trust preferred securities, those new limits did not apply to our outstanding trust preferred securities. Further, the new capital rules that went into effect in 2015 grandfathered the treatment of our trust preferred securities as qualifying regulatory capital.

Common shareholders’ equity increased to $389.5 million at December 31, 2020 from $350.2 million at December 31, 2019, due primarily to our net income and the change in our accumulated other comprehensive income (loss) that were partially offset by share repurchases and by dividends that we paid. Our tangible common equity (“TCE”) totaled $356.9 million and $316.5 million, respectively, at those same dates. Our ratio of TCE to tangible assets was 8.56% and 8.96% at December 31, 2020 and 2019, respectively. TCE and the ratio of TCE to tangible assets are non-GAAP measures. TCE represents total common equity less intangible assets.

In December 2019, our Board of Directors authorized a 2020 share repurchase plan. Under the terms of the 2020 share repurchase plan, we were authorized to buy back 1,120,000 shares, or approximately 5%, of our outstanding common stock. During the first three months of 2020, we repurchased 678,929 shares at a weighted average purchase price of $20.30 per share. Due primarily to the economic uncertainty brought on by the COVID-19 pandemic, we suspended share repurchase activity on March 16, 2020. However, primarily as a result our strong financial performance and improved economic conditions, we reactivated the share repurchase plan in the fourth quarter of 2020 and acquired 30,027 shares at a weighted average price of $14.90. We repurchased a total of 708,956 shares at a weighted average price of $20.07 in 2020.

In December 2018, our Board of Directors authorized the 2019 share repurchase plan. Under the original terms of the share repurchase plan, we were authorized to buy back up to 5% of our outstanding common stock. In June 2019, our Board of Directors supplemented the 2019 share repurchase plan and authorized the repurchase of up to 300,000 additional common shares. These share repurchase plans expired on December 31, 2019. We repurchased 1,204,688 shares during 2019 at an average cost of $21.82 per share.

In December 2020, our Board of Directors authorized the 2021 share repurchase plan. Under the terms of the 2021 share repurchase plan, we are authorized to buy back up to 1,100,000 shares, or approximately 5%, of our outstanding common stock. This repurchase plan commenced on January 1, 2021, and is expected to last through December 31, 2021.

We currently pay a quarterly cash dividend on our common stock. The annual total dividends paid were $0.80, $0.72 and $0.60 per share for 2020, 2019 and 2018, respectively. We currently favor a dividend payout ratio between 30% and 50% of net income.

As of December 31, 2020 and 2019, our Bank (and holding company) continued to meet the requirements to be considered “well-capitalized” under federal regulatory standards (also see note #20 to the Consolidated Financial Statements).

Asset/liability management. Interest-rate risk is created by differences in the cash flow characteristics of our assets and liabilities. Options embedded in certain financial instruments, including caps on adjustable-rate loans as well as borrowers’ rights to prepay fixed-rate loans, also create interest-rate risk.

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Our asset/liability management efforts identify and evaluate opportunities to structure our statement of financial condition in a manner that is consistent with our mission to maintain profitable financial leverage within established risk parameters. We evaluate various opportunities and alternate asset/liability management strategies carefully and consider the likely impact on our risk profile as well as the anticipated contribution to earnings. The marginal cost of funds is a principal consideration in the implementation of our asset/liability management strategies, but such evaluations further consider interest-rate and liquidity risk as well as other pertinent factors. We have established parameters for interest-rate risk. We regularly monitor our interest-rate risk and report at least quarterly to our board of directors.

We employ simulation analyses to monitor our interest-rate risk profile and evaluate potential changes in our net interest income and market value of portfolio equity that result from changes in interest rates. The purpose of these simulations is to identify sources of interest-rate risk inherent in our Consolidated Statements of Financial Condition. The simulations do not anticipate any actions that we might initiate in response to changes in interest rates and, accordingly, the simulations do not provide a reliable forecast of anticipated results. The simulations are predicated on immediate, permanent and parallel shifts in interest rates and generally assume that current loan and deposit pricing relationships remain constant. The simulations further incorporate assumptions relating to changes in customer behavior, including changes in prepayment rates on certain assets and liabilities.

CHANGES IN MARKET VALUE OF PORTFOLIO EQUITY AND NET INTEREST INCOME

Change in Interest Rates	Market Value of Portfolio Equity(1)		Percent Change			Net Interest Income(2)		Percent Change
	(Dollars in thousands)
December 31, 2020
200 basis point rise	$	494,600		15.02	%	$	125,200		4.16	%
100 basis point rise		483,200		12.37			123,700		2.91
Base-rate scenario		430,000		—			120,200		—
100 basis point decline		395,500		(8.02	)		114,900		(4.41	)
December 31, 2019
200 basis point rise	$	472,500		1.13	%	$	123,900		1.23	%
100 basis point rise		478,800		2.48			123,300		0.74
Base-rate scenario		467,200		—			122,400		—
100 basis point decline		412,100		(11.79	)		118,100		(3.51	)

(1) Simulation analyses calculate the change in the net present value of our assets and liabilities, including debt and related financial derivative instruments, under parallel shifts in interest rates by discounting the estimated future cash flows using a market-based discount rate. Cash flow estimates incorporate anticipated changes in prepayment speeds and other embedded options.

(2) Simulation analyses calculate the change in net interest income under immediate parallel shifts in interest rates over the next twelve months, based upon a static Consolidated Statement of Financial Condition, which includes debt and related financial derivative instruments, and do not consider loan fees.

Accounting Standards Update. See note #1 to the Consolidated Financial Statements included elsewhere in this report for details on recently issued accounting pronouncements and their impact on our financial statements.

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FAIR VALUATION OF FINANCIAL INSTRUMENTS

Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) topic 820 - “Fair Value Measurements and Disclosures” (“FASB ASC topic 820”) defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

We utilize fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. FASB ASC topic 820 differentiates between those assets and liabilities required to be carried at fair value at every reporting period (“recurring”) and those assets and liabilities that are only required to be adjusted to fair value under certain circumstances (“nonrecurring”). Securities available for sale, loans held for sale, derivatives and capitalized mortgage loan servicing rights are financial instruments recorded at fair value on a recurring basis. Additionally, from time to time, we may be required to record at fair value other financial assets on a nonrecurring basis, such as loans held for investment and certain other assets. These nonrecurring fair value adjustments typically involve application of lower of cost or fair value accounting or write-downs of individual assets. See note #21 to the Consolidated Financial Statements for a complete discussion on our use of fair valuation of financial instruments and the related measurement techniques.

LITIGATION MATTERS

We are involved in various litigation matters in the ordinary course of business. At the present time, we do not believe any of these matters will have a significant impact on our consolidated financial position or results of operations. The aggregate amount we have accrued for losses we consider probable as a result of these litigation matters is immaterial. However, because of the inherent uncertainty of outcomes from any litigation matter, we believe it is reasonably possible we may incur losses in addition to the amounts we have accrued. At this time, we estimate the maximum amount of additional losses that are reasonably possible is insignificant. However, because of a number of factors, including the fact that certain of these litigation matters are still in their early stages, this maximum amount may change in the future.

The litigation matters described in the preceding paragraph primarily include claims that have been brought against us for damages, but do not include litigation matters where we seek to collect amounts owed to us by third parties (such as litigation initiated to collect delinquent loans). These excluded, collection-related matters may involve claims or counterclaims by the opposing party or parties, however we have excluded such matters from the disclosure contained in the preceding paragraph in all cases where we believe the possibility of us paying damages to any opposing party is remote.

CRITICAL ACCOUNTING POLICIES

Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Accounting and reporting policies for the allowance for loan losses and capitalized mortgage loan servicing rights are deemed critical since they involve the use of estimates and require significant management judgments. Application of assumptions different than those that we have used could result in material changes in our financial position or results of operations.

Our methodology for determining the allowance and related provision for loan losses is described above in “Portfolio Loans and asset quality.” In particular, this area of accounting requires a significant amount of judgment because a multitude of factors can influence the ultimate collection of a loan or other type of credit. It is extremely difficult to precisely measure the amount of probable incurred losses in our loan portfolio. We use a rigorous process to attempt to accurately quantify the necessary allowance and related provision for loan losses, but there can be no assurance that our modeling process will successfully identify all of the probable incurred losses in our loan portfolio. As a result, we could record future provisions for loan losses that may be significantly different than the levels that we recorded in prior periods. In June 2016, the FASB issued ASU No. 2016-13 “Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”). See note #1 to the Consolidated Financial Statements for a description of our implementation of ASU 2016-13. In particular, since ASU 2016-13 requires a current expected (rather than incurred) credit loss model, our provision for loan losses may be more volatile in future periods.

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At December 31, 2020 and 2019, we had approximately $16.9 million and $19.2 million, respectively, of mortgage loan servicing rights capitalized on our Consolidated Statements of Financial Condition. There are several critical assumptions involved in establishing the value of this asset including estimated future prepayment speeds on the underlying mortgage loans, the interest rate used to discount the net cash flows from the mortgage loan servicing, the estimated amount of ancillary income that will be received in the future (such as late fees) and the estimated cost to service the mortgage loans. We believe the assumptions that we utilize in our valuation are reasonable based upon accepted industry practices for valuing mortgage loan servicing rights and represent neither the most conservative or aggressive assumptions.

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MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER

FINANCIAL REPORTING

The management of Independent Bank Corporation is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system was designed to provide reasonable assurance to us and the board of directors regarding the preparation and fair presentation of published financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

We assessed the effectiveness of our internal control over financial reporting as of December 31, 2020. In making this assessment, we used the criteria established in the 2013 Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on our assessment, management has concluded that as of December 31, 2020, the Company’s internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

There were no changes in our internal control over financial reporting during the quarter ended December 31, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Our independent registered public accounting firm has issued an audit report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2020. Their report immediately follows our report.

William B. Kessel	Gavin A. Mohr
President and Chief Executive Officer	Executive Vice President and Chief Financial Officer
Independent Bank Corporation March 5, 2021

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Shareholders and the Board of Directors of Independent Bank Corporation

Grand Rapids, Michigan

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated statements of financial condition of Independent Bank Corporation (the “Corporation”) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income, shareholders’ equity, 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 the Corporation’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Corporation as of December 31, 2020 and 2019, and the results of its operations and its 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, the Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control – Integrated Framework: (2013) issued by COSO.

Basis for Opinions

The Corporation’s management is responsible for these 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 Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Corporation’s financial statements and an opinion on the Corporation’s internal control over financial reporting based on our 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 the 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 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 financial statements included performing procedures to assess the risks of material misstatement of the 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 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 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 weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

Definition and Limitations of Internal Control Over Financial Reporting

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

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.

37

Critical Audit Matter

The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters 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 accounts or disclosures to which it relates.

Allowance for Loan Losses – Subjective Factors

As described in Notes 1 and 4 to the consolidated financial statements, the Corporation’s allowance for loan losses is a valuation account that reflects the Corporation’s estimation of probable incurred losses in its loan portfolio. The allowance for loan losses was $35,429,000 at December 31, 2020, which consists of two components: the valuation allowance for loans individually evaluated for impairment (“specific component”), representing $5,581,000, and the valuation allowance for loans collectively evaluated for impairment (“general component”), representing $29,848,000. The general component includes allocations using historical analysis based on probability of default and loss given default methodologies and additional allocations based on subjective factors.

The subjective factors include consideration of the following: local and general economic business factors and trends, portfolio concentrations and changes in the size, mix and the general terms of the overall loan portfolio. Due to the significant judgment applied by management to determine the effect of the subjective factors, we identified the effect of the subjective factors on the allowance for loan losses as a critical audit matter as it involved especially subjective auditor judgment to audit management’s determination of the subjective factors and also required the use of senior level audit personnel.

The primary procedures we performed to address this critical audit matter included:

● Testing the effectiveness of controls over the evaluation of the items used to estimate the subjective factors, including controls addressing:

○ Management’s review of the completeness and accuracy of data inputs used as the basis for the allowance allocations resulting from the subjective factors.

○ Management’s review of the reasonableness of the judgments and assumptions used to develop the subjective factors for the general component of the allowance for loan losses and the relevance to the loan segment in which it is applied.

● Substantively testing management’s process, including evaluating their judgments and assumptions, for developing the subjective factors, which included:

○ Evaluation of the completeness and accuracy of data inputs used as a basis for the subjective factors.

○ Evaluation of the reasonableness of management’s judgments related to the qualitative and quantitative assessment of the data used in the determination of the subjective factors and the resulting allocation to the allowance. Among other procedures, our evaluation considered, evidence from internal and external sources, loan portfolio performance and whether such assumptions were applied consistently from period to period, including the relevance of the factors to the loan segment in which it is applied.

○ Evaluating the subjective factors year over year for directional consistency, testing for reasonableness, and obtaining evidence for significant changes.

 

Crowe LLP

We have served as the Corporation’s auditor since 2005.

Grand Rapids, Michigan

March 5, 2021

38

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

	December 31,
	2020			2019
	(In thousands, except share amounts)
Assets
Cash and due from banks	$	56,006		$	53,295
Interest bearing deposits		62,699			12,009
Cash and Cash Equivalents		118,705			65,304
Interest bearing deposits - time		-			350
Securities available for sale		1,072,159			518,400
Federal Home Loan Bank and Federal Reserve Bank stock, at cost		18,427			18,359
Loans held for sale, carried at fair value		92,434			69,800
Loans
Commercial		1,242,415			1,166,695
Mortgage		1,015,926			1,098,911
Installment		475,337			459,417
Total Loans		2,733,678			2,725,023
Allowance for loan losses		(35,429	)		(26,148	)
Net Loans		2,698,249			2,698,875
Other real estate and repossessed assets, net		766			1,865
Property and equipment, net		36,127			38,411
Bank-owned life insurance		55,180			55,710
Capitalized mortgage loan servicing rights, carried at fair value		16,904			19,171
Other intangibles		4,306			5,326
Goodwill		28,300			28,300
Accrued income and other assets		62,456			44,823
Total Assets	$	4,204,013		$	3,564,694
Liabilities and Shareholders’ Equity
Deposits
Non-interest bearing	$	1,153,473		$	852,076
Savings and interest-bearing checking		1,526,465			1,186,745
Reciprocal		556,185			431,027
Time		287,402			376,877
Brokered time		113,830			190,002
Total Deposits		3,637,355			3,036,727
Other borrowings		30,012			88,646
Subordinated debt		39,281			-
Subordinated debentures		39,524			39,456
Accrued expenses and other liabilities		68,319			49,696
Total Liabilities		3,814,491			3,214,525
Commitments and contingent liabilities
Shareholders’ Equity
Preferred stock, no par value, 200,000 shares authorized;  none issued or outstanding		-			-
Common stock, no par value, 500,000,000 shares authorized; issued and outstanding: 21,853,800 shares at December 31, 2020 and 22,481,643 shares at December 31, 2019		339,353			352,344
Retained earnings		40,145			1,611
Accumulated other comprehensive income (loss)		10,024			(3,786	)
Total Shareholders’ Equity		389,522			350,169
Total Liabilities and Shareholders’ Equity	$	4,204,013		$	3,564,694

See accompanying notes to consolidated financial statements

39

CONSOLIDATED STATEMENTS OF OPERATIONS

	Year Ended December 31,
	2020			2019			2018
	(In thousands, except per share amounts)
INTEREST INCOME
Interest and fees on loans	$	123,159		$	133,883		$	116,865
Interest on securities available for sale
Taxable		12,655			11,842			10,874
Tax-exempt		2,926			1,342			1,743
Other investments		1,089			1,861			1,291
Total Interest Income		139,829			148,928			130,773
INTEREST EXPENSE
Deposits		12,666			23,425			14,478
Other borrowings and subordinated debt and debentures		3,551			2,922			3,013
Total Interest Expense		16,217			26,347			17,491
Net Interest Income		123,612			122,581			113,282
Provision for loan losses		12,463			824			1,503
Net Interest Income After Provision for Loan Losses		111,149			121,757			111,779
NON-INTEREST INCOME
Interchange income		11,230			10,297			9,905
Service charges on deposit accounts		8,517			11,208			12,258
Net gains on assets
Mortgage loans		62,560			19,978			10,597
Securities available for sale		267			307			138
Mortgage loan servicing, net		(9,350	)		(3,336	)		3,157
Other		7,521			9,282			8,760
Total Non-interest Income		80,745			47,736			44,815
NON-INTEREST EXPENSE
Compensation and employee benefits		74,781			67,501			62,078
Occupancy, net		8,938			9,013			8,912
Data processing		8,534			8,905			8,262
Furniture, fixtures and equipment		4,089			4,113			4,080
Interchange expense		3,342			3,215			2,702
Communications		3,194			2,947			2,848
Loan and collection		3,037			2,685			2,682
Conversion related expense		2,586			-			-
Advertising		2,230			2,450			2,155
Legal and professional		2,027			1,814			1,839
FDIC deposit insurance		1,596			685			1,081
Net (gains) losses on other real estate and repossessed assets		64			(90	)		(672	)
Merger related expense		-			-			3,465
Other		7,995			8,495			8,029
Total Non-interest Expense		122,413			111,733			107,461
Income Before Income Tax		69,481			57,760			49,133
Income tax expense		13,329			11,325			9,294
Net Income	$	56,152		$	46,435		$	39,839
Net income per common share
Basic	$	2.56		$	2.03		$	1.70
Diluted	$	2.53		$	2.00		$	1.68

See accompanying notes to consolidated financial statements

40

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

	Year Ended December 31,
	2020			2019			2018
	(In thousands)
Net income	$	56,152		$	46,435		$	39,839
Other comprehensive income (loss)
Securities available for sale
Unrealized gain (loss) arising during period		15,611			10,235			(4,594	)
Change in unrealized gains and losses for which a portion of other than temporary impairment has been recognized in earnings		(49	)		(65	)		(53	)
Reclassification adjustments for gains included in earnings		(267	)		(140	)		(56	)
Unrealized gains (losses) recognized in other comprehensive income (loss) on securities available for sale		15,295			10,030			(4,703	)
Income tax expense (benefit)		3,212			2,106			(988	)
Unrealized gains (losses) recognized in other comprehensive income (loss) on securities available for sale, net of tax		12,083			7,924			(3,715	)
Derivative instruments
Unrealized losses arising during period		(354	)		(1,603	)		(262	)
Reclassification adjustment for (income) expense recognized in earnings		2,539			(425	)		(237	)
Unrealized gains (losses) recognized in other comprehensive income (loss) on derivative instruments		2,185			(2,028	)		(499	)
Income tax expense (benefit)		458			(426	)		(105	)
Unrealized gains (losses) recognized in other comprehensive income (loss) on derivative instruments, net of tax		1,727			(1,602	)		(394	)
Other comprehensive income (loss)		13,810			6,322			(4,109	)
Comprehensive income	$	69,962		$	52,757		$	35,730

See accompanying notes to consolidated financial statements

41

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

	Common Stock			Retained Earnings (Accumulated Deficit)			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
	(Dollars in thousands, except per share amounts)
Balances at January 1, 2018	$	324,986		$	(54,054	)	$	(5,999	)	$	264,933
Net income for 2018		-			39,839			-			39,839
Cash dividends declared, $0.60 per share		-			(14,055	)		-			(14,055	)
Repurchase of 587,969 shares of common stock		(12,681	)		-			-			(12,681	)
Acquistion of TCSB Bancorp, Inc.		64,536			-			-			64,536
Issuance of 152,549 shares of common stock		267			-			-			267
Share based compensation (issuance of 80,028 shares of common stock)		1,731			-			-			1,731
Share based compensation withholding obligation (withholding of 108,185 shares of common stock)		(1,467	)		-			-			(1,467	)
Other comprehensive loss		-			-			(4,109	)		(4,109	)
Balances at December 31, 2018		377,372			(28,270	)		(10,108	)		338,994
Net income for 2019		-			46,435			-			46,435
Cash dividends declared, $0.72 per share		-			(16,554	)		-			(16,554	)
Repurchase of 1,204,688 shares of common stock		(26,284	)		-			-			(26,284	)
Issuance of 71,799 shares of common stock		284			-			-			284
Share based compensation (issuance of 92,275 shares of common stock)		1,854			-			-			1,854
Share based compensation withholding obligation (withholding of 57,468 shares of common stock)		(882	)		-			-			(882	)
Other comprehensive income		-			-			6,322			6,322
Balances at December 31, 2019		352,344			1,611			(3,786	)		350,169
Net income for 2020		-			56,152			-			56,152
Cash dividends declared, $0.80 per share		-			(17,618	)		-			(17,618	)
Repurchase of 708,956 shares of common stock		(14,231	)		-			-			(14,231	)
Issuance of 17,317 shares of common stock		15			-			-			15
Share based compensation (issuance of 103,429 shares of common stock)		1,980			-			-			1,980
Share based compensation withholding obligation (withholding of 39,633 shares of common stock)		(755	)		-			-			(755	)
Other comprehensive income		-			-			13,810			13,810
Balances at December 31, 2020	$	339,353		$	40,145		$	10,024		$	389,522

See accompanying notes to consolidated financial statements

42

CONSOLIDATED STATEMENTS OF CASH FLOWS

	Year Ended December 31,
	2020			2019			2018
	(In thousands)
Net Income	$	56,152		$	46,435		$	39,839
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FROM OPERATING ACTIVITIES
Proceeds from the sale of equity securities at fair value		-			560			-
Proceeds from sales of loans held for sale		1,478,908			642,537			463,699
Disbursements for loans held for sale		(1,438,982	)		(647,606	)		(457,077	)
Provision for loan losses		12,463			824			1,503
Deferred income tax (benefit) expense		(2,130	)		1,088			9,294
Net deferred loan fees (costs)		1,686			(2,936	)		(4,044	)
Net depreciation, amortization of intangible assets and premiums and accretion of discounts on securities, loans and interest bearing deposits - time		9,161			6,059			6,033
Net gains on mortgage loans		(62,560	)		(19,978	)		(10,597	)
Net gains on securities available for sale		(267	)		(307	)		(138	)
Net (gains) losses on other real estate and repossessed assets		64			(90	)		(672	)
Share based compensation		1,980			1,854			1,731
Increase in accrued income and other assets		(8,477	)		(6,573	)		(4,890	)
Increase in accrued expenses and other liabilities		10,175			12,113			240
Total Adjustments		2,021			(12,455	)		5,082
Net Cash From Operating Activities		58,173			33,980			44,921
CASH FLOW USED IN INVESTING ACTIVITIES
Proceeds from the sale of securities available for sale		38,095			68,716			48,736
Proceeds from maturities, prepayments and calls of securities available for sale		306,691			153,938			160,627
Purchases of securities available for sale		(859,068	)		(237,672	)		(103,493	)
Proceeds from the sale of interest bearing deposits - time		-			-			2,474
Proceeds from the maturity of interest bearing deposits - time		350			250			3,728
Purchase of Federal Home Loan Bank stock		(68	)		-			-
Purchase of Federal Reserve Bank stock		-			-			(2,038	)
Net increase in portfolio loans (loans originated, net of principal payments)		(41,861	)		(215,276	)		(344,330	)
Proceeds from the sale of portfolio loans		2,395			50,516			27,658
Cash received in the acquisition of TCSB Bancorp Inc.		-			-			23,516
Proceeds from the collection of vehicle service contract counterparty receivables		511			512			511
Proceeds from the sale of other real estate and repossessed assets		1,367			1,766			2,526
Proceeds from bank-owned life insurance		1,441			470			474
Proceeds from the sale of property and equipment		1,133			74			106
Capital expenditures		(4,383	)		(4,936	)		(3,862	)
Net Cash Used in Investing Activities		(553,397	)		(181,642	)		(183,367	)
CASH FLOW FROM FINANCING ACTIVITIES
Net increase in total deposits		600,628			123,299			225,185
Net increase (decrease) in other borrowings		(24,994	)		25,002			(6,600	)
Proceeds from Federal Home Loan Bank advances		239,254			111,000			1,272,000
Payments of Federal Home Loan Bank advances		(272,910	)		(73,143	)		(1,308,697	)
Proceeds from issuance of subordinated debt, net of issuance costs		39,236			-			-
Dividends paid		(17,618	)		(16,554	)		(14,055	)
Proceeds from issuance of common stock		15			284			267
Repurchase of common stock		(14,231	)		(26,284	)		(12,681	)
Share based compensation withholding obligation		(755	)		(882	)		(1,467	)
Net Cash From Financing Activities		548,625			142,722			153,952
Net Increase (Decrease) in Cash and Cash Equivalents		53,401			(4,940	)		15,506
Cash and Cash Equivalents at Beginning of Year		65,304			70,244			54,738
Cash and Cash Equivalents at End of Year	$	118,705		$	65,304		$	70,244
Cash paid during the year for
Interest	$	16,912		$	26,697		$	16,737
Income taxes		15,500			9,534			120
Operating leases		1,785			2,201			-
Transfers to other real estate and repossessed assets		332			2,242			1,510
Transfer of mortgage loans to held for sale		-			36,622			41,471
Securitization of portfolio loans		26,324			65,070			10,869
Right of use assets obtained in exchange for lease obligations		1,587			9,906			-
Purchase of securities available for sale not yet settled		1,000			-			-
Common stock and stock options issued in TCSB Bancorp, Inc. acquisition		-			-			64,536

See accompanying notes to consolidated financial statements

43

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 – ACCOUNTING POLICIES

The accounting and reporting policies and practices of Independent Bank Corporation and subsidiaries (‘‘IBCP’’) conform to accounting principles generally accepted in the United States of America and prevailing practices within the banking industry. Our critical accounting policies include the determination of the allowance for loan losses (‘‘AFLL’’) and the valuation of capitalized mortgage loan servicing rights. We are required to make material estimates and assumptions that are particularly susceptible to changes in the near term as we prepare the consolidated financial statements and report amounts for each of these items. Actual results may vary from these estimates.

Our subsidiary, Independent Bank (‘‘Bank’’), transacts business in the single industry of commercial banking. Our Bank’s activities cover traditional phases of commercial banking, including checking and savings accounts, commercial lending, direct and indirect consumer financing and mortgage lending. Our principal markets are the rural and suburban communities across Lower Michigan that are served by our Bank’s branches and loan production offices as well as two loan productions offices we have in Ohio. At December 31, 2020, 67.0% of our Bank’s loan portfolio was secured by real estate.

PRINCIPLES OF CONSOLIDATION — The consolidated financial statements include the accounts of Independent Bank Corporation and its subsidiaries. The income, expenses, assets and liabilities of the subsidiaries are included in the respective accounts of the consolidated financial statements, after elimination of all intercompany accounts and transactions.

STATEMENTS OF CASH FLOWS — For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, interest bearing deposits and federal funds sold. Generally, federal funds are sold for one-day periods. We report net cash flows for customer loan and deposit transactions and for short-term borrowings.

INTEREST BEARING DEPOSITS — Interest bearing deposits consist of overnight deposits with the Federal Reserve Bank.

INTEREST BEARING DEPOSITS - TIME — Interest bearing deposits - time consist of deposits with original maturities of 3 months or more.  All of these deposits are FDIC insured.

LOANS HELD FOR SALE — Mortgage loans originated and intended for sale in the secondary market are carried at fair value. Fair value adjustments, as well as realized gains and losses, are recorded in current earnings.

OPERATING SEGMENTS — While chief decision-makers monitor the revenue streams of our various products and services, operations are managed and financial performance is evaluated as one single unit. Discrete financial information is not available other than on a consolidated basis for material lines of business.

CAPITALIZED MORTGAGE LOAN SERVICING RIGHTS — We account for our capitalized mortgage loan servicing rights under the fair value method of accounting. We recognize as separate assets the rights to service mortgage loans for others. The fair value of capitalized mortgage loan servicing rights has been determined based upon fair value indications for similar servicing. Under the fair value method we measure capitalized mortgage loan servicing rights at fair value at each reporting date and report changes in fair value of capitalized mortgage loan servicing rights in earnings in the period in which the changes occur and are included in mortgage loan servicing, net in the Consolidated Statements of Operations. The fair values of capitalized mortgage loan servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.

Mortgage loan servicing income is recorded for fees earned for servicing loans previously sold. The fees are generally based on a contractual percentage of the outstanding principal and are recorded as income when earned. Mortgage loan servicing fees, excluding fair value changes of capitalized mortgage loan servicing rights, totaled $6.9 million, $6.2 million and $5.5 million for the years ended December 31, 2020, 2019 and 2018, respectively. Late fees and ancillary fees related to loan servicing are not material.

TRANSFERS OF FINANCIAL ASSETS — Transfers of financial assets are accounted for as sales when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets

44

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

have been isolated from us, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and we do not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

SECURITIES — We classify our securities as equity, trading, held to maturity or available for sale. Equity securities are investments in certain equity stocks and are reported at fair value with realized and unrealized gains and losses included in earnings. Trading securities are bought and held principally for the purpose of selling them in the near term and are reported at fair value with realized and unrealized gains and losses included in earnings. Securities held to maturity represent those securities for which we have the positive intent and ability to hold until maturity and are reported at cost, adjusted for amortization of premiums and accretion of discounts computed on the level-yield method. We did not have any equity securities, trading securities or securities held to maturity at December 31, 2020 and 2019. Securities available for sale represent those securities not classified as equity, trading or held to maturity and are reported at fair value with unrealized gains and losses, net of applicable income taxes reported in other comprehensive income (loss).

We evaluate securities for other than temporary impairment (‘‘OTTI’’) at least on a quarterly basis and more frequently when economic or market conditions warrant such an evaluation. In performing this evaluation, management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether we intend to sell, or it is more likely than not that we will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis. For securities that do not meet the aforementioned recovery criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income (loss). The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.

Gains and losses realized on the sale of securities available for sale are determined using the specific identification method and are recognized on a trade-date basis.

FEDERAL HOME LOAN BANK (‘‘FHLB’’) STOCK — Our Bank subsidiary is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income in interest income-other investments on the Consolidated Statements of Operations.

FEDERAL RESERVE BANK (‘‘FRB’’) STOCK — Our Bank subsidiary is a member of its regional Federal Reserve Bank. FRB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income in interest income-other investments on the Consolidated Statements of Operations.

LOAN REVENUE RECOGNITION — Interest on loans is accrued based on the principal amounts outstanding. In general, the accrual of interest income is discontinued when a loan becomes 90 days past due for commercial loans and installment loans and when a loan misses four consecutive payments for mortgage loans and the borrower’s capacity to repay the loan and collateral values appear insufficient for each loan class. However, loans may be placed on non-accrual status regardless of whether or not such loans are considered past due if, in management’s opinion, the borrower is unable to meet payment obligations as they become due or as required by regulatory provisions. All interest accrued but not received for all loans placed on non-accrual is reversed from interest income. Payments on such loans are generally applied to the principal balance until qualifying to be returned to accrual status. A non-accrual loan may be restored to accrual status when interest and principal payments are current and the loan appears otherwise collectible. Delinquency status for all classes in the commercial and installment loan segments is based on the actual number of days past due as required by the contractual terms of the loan agreement while delinquency status for mortgage loan segment classes is based on the number of payments past due.

Certain loan fees and direct loan origination costs are deferred and recognized as an adjustment of yield generally over the contractual life of the related loan. Fees received in connection with loan commitments are

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

deferred until the loan is advanced and are then recognized generally over the contractual life of the loan as an adjustment of yield. Fees on commitments that expire unused are recognized at expiration. Fees received for letters of credit are recognized as revenue over the life of the commitment.

ALLOWANCE FOR LOAN LOSSES — Portfolios are disaggregated into segments for purposes of determining the allowance for loan losses (‘‘AFLL’’) which include commercial, mortgage and installment loans. These segments are further disaggregated into classes for purposes of monitoring and assessing credit quality based on certain risk characteristics. Classes within the commercial loan segment include (i) commercial and industrial and (ii) commercial real estate. Classes within the mortgage loan segment include (i) 1-4 family owner occupied - jumbo, (ii) 1-4 family owner occupied - non-jumbo, (iii) 1-4 family non-owner occupied (iv) 1-4 family - 2nd lien and (v) resort lending. Classes within the installment loan segment include  (i) boat lending, (ii) recreational vehicle lending, and (iii) other. Commercial loans are subject to adverse market conditions which may impact the borrower’s ability to make repayment on the loan or could cause a decline in the value of the collateral that secures the loan. Mortgage and installment loans are subject to adverse employment conditions in the local economy which could increase default rates. In addition, mortgage loans and real estate based installment loans are subject to adverse market conditions which could cause a decline in the value of collateral that secures the loan. For an analysis of the AFLL by portfolio segment and credit quality information by class, see note #4.

Some loans will not be repaid in full. Therefore, an AFLL is maintained at a level which represents our best estimate of losses incurred. In determining the AFLL and the related provision for loan losses, we consider four principal elements: (i) specific allocations based upon probable losses identified during the review of the loan portfolio, (ii) allocations established for other adversely rated commercial loans, (iii) allocations based principally on historical loan loss experience, and (iv) additional allocations based on subjective factors, including local and general economic business factors and trends, portfolio concentrations and changes in the size and/or the general terms of the loan portfolios.

The first AFLL element (specific allocations) reflects our estimate of probable incurred losses based upon our systematic review of specific loans. These estimates are based upon a number of objective factors, such as payment history, financial condition of the borrower, discounted collateral exposure and discounted cash flow analysis. Impaired commercial, mortgage and installment loans are allocated AFLL amounts using this first element. The second AFLL element (other adversely rated commercial loans) reflects the application of our loan rating system. This rating system is similar to those employed by state and federal banking regulators. Commercial loans that are rated below a certain predetermined classification are assigned a loss allocation factor for each loan classification category that is based upon a historical analysis of both the probability of default and the expected loss rate (‘‘loss given default’’). The lower the rating assigned to a loan or category, the greater the allocation percentage that is applied. The third AFLL element (historical loss allocations) is determined by assigning allocations to higher rated (‘‘non-watch credit’’) commercial loans using a probability of default and loss given default similar to the second AFLL element and to homogenous mortgage and installment loan groups based upon borrower credit score and portfolio segment. For homogenous mortgage and installment loans a probability of default for each homogenous pool is calculated by way of credit score migration. Historical loss data for each homogenous pool coupled with the associated probability of default is utilized to calculate an expected loss allocation rate. The fourth AFLL element (additional allocations based on subjective factors) is based on factors that cannot be associated with a specific credit or loan category and reflects our attempt to reasonably ensure that the overall AFLL appropriately reflects a margin for the imprecision necessarily inherent in the estimates of expected credit losses. We consider a number of subjective factors when determining this fourth element, including local and general economic business factors and trends, portfolio concentrations and changes in the size, mix and the general terms of the overall loan portfolio.

During the first quarter of 2019, we deployed a third-party software solution (we previously used spreadsheet software) to assist in the determination of our AFLL. This new third-party software also has assisted us in moving to the expected loss framework that we plan to adopt on January 1, 2021. Although the use of this new third-party software did not have any material impact on our overall AFLL, it did result in some classification shifts from the AFLL related to subjective factors into the AFLL related to historical losses as the new software model allowed us to capture longer historical look-back periods (previously this was being captured in the subjective portion of the AFLL).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Increases in the AFLL are recorded by a provision for loan losses charged to expense. Although we periodically allocate portions of the AFLL to specific loans and loan portfolios, the entire AFLL is available for incurred losses.

We generally charge-off commercial, homogenous residential mortgage and installment loans when they are deemed uncollectible or reach a predetermined number of days past due based on loan product, industry practice and other factors. Collection efforts may continue and recoveries may occur after a loan is charged against the AFLL.

While we use relevant information to recognize losses on loans, additional provisions for related losses may be necessary based on changes in economic conditions, customer circumstances and other credit risk factors.

A loan is impaired when full payment under the loan terms is not expected. Generally, those loans included in each commercial loan class that are rated substandard, classified as non-performing or were classified as non-performing in the preceding quarter, are evaluated for impairment. Those loans included in each mortgage loan or installment loan class whose terms have been modified and considered a troubled debt restructuring are also impaired. Loans which have been modified resulting in a concession, and which the borrower is experiencing financial difficulties, are considered troubled debt restructurings (‘‘TDR’’) and classified as impaired. We measure our investment in an impaired loan based on one of three methods: the loan’s observable market price, the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. Large groups of smaller balance homogeneous loans, such as those loans included in each installment and mortgage loan class, are collectively evaluated for impairment and accordingly, they are not separately identified for impairment disclosures. TDR loans are measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception of the loan. If a TDR is considered to be a collateral dependent loan, the loan is reported net, at the fair value of collateral. A loan can be removed from TDR status if it is subsequently restructured and the borrower is no longer experiencing financial difficulties and the newly restructured agreement does not contain any concessions to the borrower. The new agreement must specify market terms, including a contractual interest rate not less than a market interest rate for a new loan with similar credit risk characteristics, and other terms no less favorable to us than those we would offer for a similar new loan.

PROPERTY AND EQUIPMENT — Property and equipment is stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed using the straight-line method over the estimated useful lives of the related assets. Buildings are generally depreciated over a period not exceeding 39 years and equipment  is generally depreciated over periods not exceeding 7 years. Leasehold improvements are depreciated over the shorter of their estimated useful life or lease period.

BANK OWNED LIFE INSURANCE — We have purchased a group flexible premium non-participating variable life insurance contract on approximately 265 lives (who were salaried employees at the time we purchased the contract) in order to recover the cost of providing certain employee benefits. Bank owned life insurance is recorded at its cash surrender value or the amount that can be currently realized.

OTHER REAL ESTATE AND REPOSSESSED ASSETS — Other real estate at the time of acquisition is recorded at fair value, less estimated costs to sell, which becomes the property’s new basis. Fair value is typically determined by a third party appraisal of the property. Any write-downs at date of acquisition are charged to the AFLL. Expense incurred in maintaining other real estate and subsequent write-downs to reflect declines in value and gains or losses on the sale of other real estate are recorded in non-interest expense in the Consolidated Statements of Operations. Non-real estate repossessed assets are treated in a similar manner.

OTHER INTANGIBLES — Other intangible assets consist of core deposits. They are initially measured at fair value and then are amortized on both straight-line and accelerated methods over their estimated useful lives, which range from 10 to 15 years.

GOODWILL — Goodwill arises from business combinations and is generally determined as the excess of the fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill acquired in a purchase business combination and determined to have an indefinite useful life is not amortized, but tested for impairment at least annually or more frequently if events and circumstances exists that indicate that a goodwill impairment test should be performed. We have selected December 31 as the date to perform the annual impairment test. Goodwill is the only intangible asset with an indefinite life on our Consolidated Statements of Financial Condition.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

INCOME TAXES — We employ the asset and liability method of accounting for income taxes. This method establishes deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities at tax rates expected to be in effect when such amounts are realized or settled. Under this method, the effect of a change in tax rates is recognized in the period that includes the enactment date. The deferred tax asset is subject to a valuation allowance for that portion of the asset for which it is more likely than not that it will not be realized.

A tax position is recognized as a benefit only if it is ‘‘more likely than not’’ that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination.

We recognize interest and/or penalties related to income tax matters in income tax expense in the Consolidated Statements of Operations.

We file a consolidated federal income tax return. Intercompany tax liabilities are settled as if each subsidiary filed a separate return.

COMMITMENTS TO EXTEND CREDIT AND RELATED FINANCIAL INSTRUMENTS — Financial instruments may include commitments to extend credit and standby letters of credit. Financial instruments involve varying degrees of credit and interest-rate risk in excess of amounts reflected in the Consolidated Statements of Financial Condition. Exposure to credit risk in the event of non-performance by the counterparties to the financial instruments for loan commitments to extend credit and letters of credit is represented by the contractual amounts of those instruments. In general, we use a similar methodology to estimate our liability for these off-balance sheet credit exposures as we do for our AFLL. For commercial related commitments, we estimate liability using our loan rating system and for mortgage and installment commitments we estimate liability principally upon historical loss experience. Our estimated liability for off balance sheet commitments is included in accrued expenses and other liabilities in our Consolidated Statements of Financial Condition and any charge or recovery is recorded in non-interest expense - other in our Consolidated Statements of Operations.

DERIVATIVE FINANCIAL INSTRUMENTS — We record derivatives on our Consolidated Statements of Financial Condition as assets and liabilities measured at their fair value. The accounting for increases and decreases in the value of derivatives depends upon the use of derivatives and whether the derivatives qualify for hedge accounting.

At the inception of the derivative we designate the derivative as one of three types based on our intention and belief as to likely effectiveness as a hedge. These three types are (1) a hedge of the fair value of a recognized asset  or liability or of an unrecognized firm commitment (‘‘Fair Value Hedge’’), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (‘‘Cash Flow Hedge’’), or (3) an instrument with no hedging designation. For a Fair Value Hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item, are recognized in interest income in our Consolidated Statements of Operations. For a Cash Flow Hedge, the gain or loss on the derivative is reported in other comprehensive income (loss) and is reclassified into earnings in the same periods during which the hedged transaction affects earnings. For instruments with no hedging designation, the gain or loss on the derivative is reported in earnings. These free standing instruments currently consist of (i) mortgage banking related derivatives and include rate-lock loan commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and mandatory forward commitments for the future delivery of these mortgage loans, (ii) certain pay-fixed and pay-variable interest rate swap agreements related to commercial loan customers and (iii) certain purchased and written options related to a time deposit product. The fair value of rate-lock mortgage loan commitments is based on agency cash window loan pricing for comparable assets and the fair value of mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets. We enter into mandatory forward commitments for the future delivery of mortgage loans generally when interest rate locks are entered into in order to hedge the change in interest rates resulting from our commitments to fund the loans. Changes in the fair values of these derivatives are included in net gains on mortgage loans in the Consolidated Statements of Operations. Fair values of the pay-fixed and pay-variable interest rate swap agreements are derived from proprietary models which utilize current market data and are included in net interest income in the Consolidated Statements of Operations. Fair values of the purchased and written options are based on prices of financial instruments with similar characteristics and are included in net interest income in the Consolidated Statements of Operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest expense in the Consolidated Statements of Operations. Net cash settlements on derivatives that do not qualify for hedge accounting are reported in non-interest income (mortgage banking related derivatives) or net interest income (interest rate swap agreements and options) in the Consolidated Statements of Operations. Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.

We formally document the relationship between derivatives and hedged items, as well as the risk- management objective and the strategy for undertaking hedge transactions, at the inception of the hedging relationship. This documentation includes linking Fair Value or Cash Flow Hedges to specific assets and liabilities on the Consolidated Statements of Financial Condition or to specific firm commitments or forecasted transactions. We discontinue hedge accounting when it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.

When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded in earnings. When a Fair Value  Hedge is discontinued, the hedged asset or liability is no longer adjusted for changes  in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability. When a Cash Flow Hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income (loss) are amortized into earnings over the same periods which the hedged transactions will affect earnings.

COMPREHENSIVE INCOME — Comprehensive income consists of net income and unrealized gains and losses, net of tax, on securities available for sale and derivative instruments classified as cash flow hedges.

NET INCOME PER COMMON SHARE — Basic net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period and participating share awards. All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for this calculation. For diluted net income per common share, net income is divided by the weighted average number of common shares outstanding during the period plus the assumed exercise of stock options, restricted stock units, performance share units and stock units for a deferred compensation plan for non-employee directors.

SHARE BASED COMPENSATION — Cost is recognized for non-vested share awards issued to employees based on the fair value of these awards at the date of grant. A simulation analysis which considers potential outcomes for a large number of independent scenarios is utilized to estimate the fair value of performance share units and the market price of our common stock at the date of grant is used for other non-vested share awards. Cost is recognized over the required service period, generally defined as the vesting period. Forfeitures are recognized as they occur. Cost is also recognized for stock issued to non-employee directors. These shares vest immediately and cost is recognized during the period they are issued.

COMMON STOCK — At December 31, 2020, 0.1 million shares of common stock were reserved for issuance under the dividend reinvestment plan and 0.6 million shares of common stock were reserved for issuance under our long-term incentive plans.

RECLASSIFICATION — Certain amounts in the 2019 and 2018 consolidated financial statements have been reclassified to conform to the 2020 presentation.

ADOPTION OF NEW ACCOUNTING STANDARDS — In August 2018, the Financial Accounting Standards Board (‘‘FASB’’) issued Accounting Standards Update (‘‘ASU’’) 2018-13, ‘‘Fair Value Measurement (Topic 820), Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement’’. This new ASU amends disclosure requirements in Topic 820 to eliminate, add and modify certain disclosure requirements for fair value measurements as part of its disclosure framework project. The amended guidance eliminates the requirements to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the entity’s policy for the timing of transfers between levels of the fair value hierarchy and the entity’s valuation processes for Level 3 fair value measurements. The amended guidance adds the requirements to disclose the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements of instruments held at the end of the reporting period and for recurring and nonrecurring Level 3 fair value

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

measurements, the range and weighted average used to develop significant unobservable inputs and how the weighted average was calculated, with certain exceptions. This amended guidance was effective for us on January 1, 2020, and did not have a material impact on our consolidated operating results or financial condition.

In June 2016, the FASB issued ASU 2016-13, ‘‘Financial Instruments — Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments’’. This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. This ASU:

• Replaces the existing incurred loss impairment guidance and establishes a single allowance framework for financial assets carried at amortized cost, which will reflect our estimate of credit losses over the full remaining expected life of the financial assets and will consider expected future changes in macroeconomic conditions.

• Eliminates existing guidance for purchase credit impaired (‘‘PCI’’) loans, and requires recognition of the nonaccretable difference as an increase to the allowance for expected credit losses on financial assets purchased with more than insignificant credit deterioration since origination, which will be offset by an increase in the recorded investment of the related loans.

• Requires inclusion of expected recoveries, limited to the cumulative amount of prior write-offs, when estimating the allowance for credit losses for in scope financial assets (including collateral dependent assets).

• Amends existing impairment guidance for securities available for sale to incorporate an allowance, which will allow for reversals of credit impairments in the event that the credit of an issuer improves. Credit losses on securities available for sale are limited to the amount of the decline in fair value regardless of what the credit loss model would show for impairment.

• Generally requires a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption.

We began evaluating this ASU in 2016 and established a company-wide, cross-discipline governance structure, which provides implementation oversight. We continued to test and refine our current expected credit loss models that satisfied the requirements of this ASU. Oversight and testing, as well as efforts to meet expanded disclosure requirements, extended through the end of 2020. We currently expect to estimate losses over approximately a one year forecast period using external economic forecast sources, including the Federal Open Market Committee median economic projections, and then revert to longer term historical loss experience to estimate losses over more extended periods. We were originally required to adopt this ASU on January 1, 2020 but section 4014 of the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act allowed for temporary relief from applying this ASU.  Under the amended CARES Act we were allowed to delay the adoption of this ASU until the earlier of the termination of the national emergency that was declared on March 13, 2020, or January 1, 2022.  Early adoption is also allowed on either January 1, 2020 or January 1, 2021. As such, we chose to delay the adoption of this ASU during 2020 and continue to utilize the existing incurred loss impairment methodology to calculate our allowance for loan losses and our provision for loan losses as required under Accounting Standards Codification 310 (Receivables). We plan to adopt this ASU as allowed under the amended CARES Act on January 1, 2021.

We expect to recognize a one-time cumulative effect adjustment to beginning retained earnings at January 1, 2021 increasing the allowance for loan losses.  We are estimating an increase to the allowance for loan losses at that time to be in the range of $10.5 million to $12.5 million primarily driven by the longer contractual maturities of our mortgage and consumer installment loan portfolio segments. In addition, we currently expect this ASU to increase the allowance for losses related to unfunded loan commitments between $0.5 million and $1.5 million. The ultimate impact of adopting this ASU, and at each subsequent reporting period, is highly dependent on credit quality, economic forecasts and conditions, composition of our loan portfolios and securities available for sale, along with other management judgments. The transition adjustment to record the allowance for credit losses may fall outside of our estimated increase based on the finalization of assumptions including qualitative adjustments and the economic forecast used in calculating the allowance for credit losses upon the adoption of CECL.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

We do not expect a material allowance for credit losses to be recorded on securities available for sale upon adoption of this ASU.

In March 2020, the FASB issued ASU 2020-04, ‘‘Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting’’. This new ASU provides temporary optional expedients and exceptions to GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates. Entities can elect not to apply certain modification accounting requirements to contracts affected by reference rate reform, if certain criteria are met. Entities that make such elections would not have to remeasure contracts at the modification date or reassess a previous accounting determination.  Entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met.  This amended guidance and our ability to elect its temporary optional expedients and exceptions are effective for us as of March 12, 2020 through December 31, 2022.

NOTE 2 – RESTRICTIONS ON CASH AND DUE FROM BANKS

During March 2020 the FRB, in response to the COVID-19 pandemic, reduced our Bank’s reserve balance requirements to zero. Prior to that time our Bank was required to maintain reserve balances in the form of vault cash and balances with the FRB. The average reserve balances to be maintained during 2020 and 2019 were $9.2 million and $26.6 million, respectively. We do not maintain compensating balances with correspondent banks. We are also required to maintain reserve balances related to certain mortgage banking related derivatives not classified as hedges and to our merchant payment processing operations and for certain investment security transactions. These balances are held at unrelated financial institutions and totaled $0.74 million and $0.01 million at December 31, 2020 and 2019, respectively.

NOTE 3 – SECURITIES

Securities available for sale consist of the following at December 31:

	Amortized		Unrealized
	Cost		Gains		Losses		Fair Value
	(In thousands)
2020
U.S. agency	$	10,456	$	305	$	13	$	10,748
U.S. agency residential mortgage-backed		340,224		4,951		593		344,582
U.S. agency commercial mortgage-backed		6,869		326		-		7,195
Private label mortgage-backed		41,429		1,539		139		42,829
Other asset backed		252,596		1,796		211		254,181
Obligations of states and political subdivisions		315,795		8,676		178		324,293
Corporate		82,307		3,807		97		86,017
Trust preferred		1,971		-		173		1,798
Foreign government		500		16		-		516
Total	$	1,052,147	$	21,416	$	1,404	$	1,072,159

2019
U.S. agency	$	14,591	$	89	$	19	$	14,661
U.S. agency residential mortgage-backed		226,130		1,910		278		227,762
U.S. agency commercial mortgage-backed		10,671		113		28		10,756
Private label mortgage-backed		39,248		544		99		39,693
Other asset backed		94,158		103		375		93,886
Obligations of states and political subdivisions		94,499		1,724		121		96,102
Corporate		31,904		1,296		5		33,195
Trust preferred		1,968		-		125		1,843
Foreign government		499		3		-		502
Total	$	513,668	$	5,782	$	1,050	$	518,400

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

At December 31, 2020 we have entered into a pay-fixed interest rate swap to protect a portion of the fair value of certain securities available for sale. The fair value adjustment to securities available for sale was an unrealized loss of $0.015 million at December 31, 2020.  See note 16 - Derivative Financial Instruments.

Total OTTI recognized in accumulated other comprehensive income (loss) for securities available for sale was zero at both December 31, 2020 and 2019, respectively.

Our investments’ gross unrealized losses and fair values aggregated by investment type and length of time that individual securities have been at a continuous unrealized loss position, at December 31 follows:

	Less Than Twelve Months				Twelve Months or More				Total
	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
	(In thousands)
2020
U.S. agency	$	1,469	$	3	$	2,329	$	10	$	3,798	$	13
U.S. agency residential mortgage-backed		96,839		592		83		1		96,922		593
Private label mortgage-backed		11,838		95		2,050		44		13,888		139
Other asset backed		7,142		25		21,197		186		28,339		211
Obligations of states and political subdivisions		28,957		177		800		1		29,757		178
Corporate		1,924		97		-		-		1,924		97
Trust preferred		-		-		1,798		173		1,798		173
Total	$	148,169	$	989	$	28,257	$	415	$	176,426	$	1,404

2019
U.S. agency	$	2,782	$	8	$	2,712	$	11	$	5,494	$	19
U.S. agency residential mortgage-backed		56,377		126		13,551		152		69,928		278
U.S. agency commercial mortgage-backed		3,284		24		659		4		3,943		28
Private label mortgage-backed		16,387		55		343		44		16,730		99
Other asset backed		34,027		233		13,839		142		47,866		375
Obligations of states and political subdivisions		15,666		84		5,396		37		21,062		121
Corporate		2,125		5		-		-		2,125		5
Trust preferred		-		-		1,843		125		1,843		125
Total	$	130,648	$	535	$	38,343	$	515	$	168,991	$	1,050

Our portfolio of securities available for sale is reviewed quarterly for impairment in value. In performing this review, management considers (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether we intend to sell, or it is more likely than not that we will be required to sell a security in an unrealized loss position before recovery of its amortized cost basis. For securities that do not meet the aforementioned recovery criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income (loss).

U.S. agency, U.S. agency residential mortgage-backed securities and U.S. agency commercial mortgage backed securities — at December 31, 2020, we had 25 U.S. agency, and 37 U.S. agency residential mortgage-backed securities whose fair value is less than amortized cost. The  unrealized losses are largely attributed to widening spreads to Treasury bond since acquisition.

Private label mortgage backed, other asset backed and corporate securities — at December 31, 2020, we had 20 private label mortgage backed, 33 other asset backed and four corporate securities whose fair value is less than amortized cost. Unrealized losses are primarily due to credit spread since their acquisition.

Two private label mortgage-backed securities (discussed further below) were reviewed for other than temporary impairment (‘‘OTTI’’) utilizing a cash flow projection. The cash flow analysis forecasts cash flow from the underlying loans in each transaction and then applies these cash flows to the bonds in the securitization.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Obligations of states and political subdivisions — at December 31, 2020, we had 27 municipal securities whose fair value is less than amortized cost. The unrealized losses are primarily due to wider benchmark pricing spreads since acquisition.

Trust preferred securities — at December 31, 2020, we had two trust preferred securities whose fair value is less than amortized cost. Both of our trust preferred securities are single issue securities issued by a trust subsidiary of a bank holding company. The pricing of trust preferred securities has suffered from credit spread widening. One of the securities is rated by a major rating agency as investment grade while the other one is non-rated. The non-rated issue is a relatively small bank and was never rated. The issuer of this non-rated trust preferred security, which had a total amortized cost of $1.0 million and total fair value of $0.87 million as of December 31, 2020, continues to have satisfactory credit metrics and make interest payments.

As management does not intend to liquidate any of the securities discussed above and it is more likely than not that we will not be required to sell these securities prior to recovery of these unrealized losses, no declines discussed above (other than certain declines related to the two private label mortgage-backed securities currently being reviewed for OTTI) are deemed to be other than temporary.

We recorded zero credit related OTTI charges in the Consolidated Statements of Operations on securities available for sale during 2020, 2019, and 2018.

At December 31, 2020, two private label mortgage-backed securities had credit related OTTI and are summarized as follows:

	Senior Security		Super Senior Security		Total
	(In thousands)
As of December 31, 2020
Fair value	$	373	$	505	$	878
Amortized cost		350		326		676
Non-credit unrealized loss		-		-		-
Unrealized gain		23		179		202
Cumulative credit related OTTI		757		457		1,214

Both of these securities are receiving principal and interest payments similar to principal reductions in the underlying collateral and have unrealized gains at December 31, 2020. The original amortized cost (current amortized cost excluding cumulative credit related OTTI) for each of these securities has been permanently adjusted downward for previously recorded credit related OTTI. The unrealized loss (based on original amortized cost) for these securities is now less than previously recorded credit related OTTI amounts.

A roll forward of credit losses recognized in earnings on securities available for sale for the years ending December 31 follow:

	2020		2019			2018
	(In thousands)
	$	1,214	$	1,594		$	1,594
Additions to credit losses on securities for which no previous OTTI was recognized		-		-			-
Increases to credit losses on securities for which OTTI was previously recognized		-		-			-
Reduction(1)		-		(380	)		-
Total	$	1,214	$	1,214		$	1,594

(1) During 2019 one security with previously recorded OTTI was settled and balance is now zero.

53

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The amortized cost and fair value of securities available for sale at December 31, 2020, by contractual maturity, follow:

	Amortized Cost		Fair Value
	(In thousands)
Maturing within one year	$	21,244	$	21,412
Maturing after one year but within five years		79,837		82,725
Maturing after five years but within ten years		76,454		80,060
Maturing after ten years		233,494		239,175
		411,029		423,372
U.S. agency residential mortgage-backed		340,224		344,582
U.S. agency commercial mortgage-backed		6,869		7,195
Private label mortgage-backed		41,429		42,829
Other asset backed		252,596		254,181
Total	$	1,052,147	$	1,072,159

The actual maturity may differ from the contractual maturity because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

A summary of proceeds from the sale of securities available for sale and gains and losses for the years ended December 31 follow:

			Realized
	Proceeds		Gains (1)		Losses
	(In thousands)
2020	$	38,095	$	271	$	4
2019		68,716		248		108
2018		48,736		192		136

(1) 2018 excludes a $0.144 million gain on the sale of 1,000 VISA Class B shares.

Certain preferred stocks which were all sold during 2019 had been classified as equity securities at fair value in our Consolidated Statement of Financial Condition. During 2019 and 2018, we recognized gains (losses) on these preferred stocks of $0.17 million and $(0.06) million, respectively, that are included in net gains on securities in the Consolidated Statements of Operations. Zero and $(0.06) million of these amounts relate to gains (losses) recognized on preferred stock still held at each respective year end.

Securities available for sale with a book value of $14.0 million and $8.7 million at December 31, 2020 and 2019, respectively, were pledged to secure borrowings, derivatives, public deposits and for other purposes as required by law. There were no investment obligations of state and political subdivisions that were payable from or secured by the same source of revenue or taxing authority that exceeded 10% of consolidated total shareholders’ equity  at  December 31, 2020 or 2019.

NOTE 4 – LOANS

Our loan portfolios at December 31 follow:

	2020		2019
	(In thousands)
Real estate (1)
Residential first mortgages	$	792,762	$	843,746
Residential home equity and other junior mortgages		138,128		166,735
Construction and land development		232,693		249,747
Other (2)		669,150		693,580
Consumer		468,090		448,297
Commercial		429,011		318,504
Agricultural		3,844		4,414
Total loans	$	2,733,678	$	2,725,023

(1) Includes both residential and non-residential commercial loans secured by real estate.

(2) Includes loans secured by multi-family residential and non-farm, non-residential property.

54

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Loans include net deferred loan costs of $14.6 million and $16.3 million at December 31, 2020 and 2019, respectively.

During 2020, we securitized $26.3 million of portfolio residential fixed rate mortgage loans servicing retained with Freddie Mac and recognized a gain on sale of $0.72 million.  We also sold $2.4 million of portfolio residential fixed rate mortgage loans servicing retained into the secondary market and recognized a gain on sale of $0.07 million.  These transactions were done primarily for asset/liability management purposes.

During 2019, we sold $40.6 million of residential adjustable rate mortgage loans servicing released (classified on the Consolidated Statements of Financial Condition as held for sale, carried at the lower of cost or fair value at December 31, 2018) to another financial institution and recognized a gain on sale of $0.01 million. We also securitized $65.1 million of portfolio residential fixed rate mortgage loans servicing retained with Freddie Mac and recognized a gain on sale of $1.7 million. In addition, we sold $9.9 million of residential fixed and adjustable rate portfolio mortgage loans servicing retained to another financial institution and recognized a gain on sale of $0.07 million. These transactions were done primarily for asset/liability management purposes.

During 2018, we sold $27.6 million of residential fixed and adjustable rate portfolio mortgage loans servicing retained to another financial institution and recognized a gain on sale of $0.04 million. We also securitized $10.9 million of portfolio residential fixed rate mortgage loans servicing retained with Freddie Mac recognizing a loss on sale of approximately $0.1 million. These transactions were done primarily for asset/liability management purposes.

An analysis of the allowance for loan losses by portfolio segment for the years ended December 31 follows:

	Commercial			Mortgage			Installment			Subjective Allocation		Total
	(In thousands)
2020
Balance at beginning of period	$	7,922		$	8,216		$	1,283		$	8,727	$	26,148
Additions (deductions)
Provision for loan losses		1,751			(915	)		436			11,191		12,463
Recoveries credited to  allowance		1,804			513			752			-		3,069
Loans charged against  the allowance		(4,076	)		(816	)		(1,359	)		-		(6,251	)
Balance at end of period	$	7,401		$	6,998		$	1,112		$	19,918	$	35,429

2019
Balance at beginning of period	$7,090	$7,978	$895	$8,925	$24,888
Additions (deductions)
Provision for loan losses	(651)	526	1,147	(198)	824
Recoveries credited to  allowance	2,165	933	863	-	3,961
Loans charged against  the allowance	(682)	(1,221)	(1,622)	-	(3,525)
Balance at end of period	$7,922	$8,216	$1,283	$8,727	$26,148

2018
Balance at beginning of period	$5,595	$8,733	$864	$7,395	$22,587
Additions (deductions)
Provision for loan losses	(946)	457	462	1,530	1,503
Recoveries credited to  allowance	2,889	734	999	-	4,622
Loans charged against  the allowance	(448)	(1,946)	(1,430)	-	(3,824)
Balance at end of period	$7,090	$7,978	$895	$8,925	$24,888

55

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Allowance for loan losses and recorded investment in loans by portfolio segment at December 31 follows:

	Commercial		Mortgage		Installment		Subjective Allocation		Total
	(In thousands)
2020
Allowance for loan losses:
Individually evaluated for impairment	$	1,266	$	4,124	$	191	$	-	$	5,581
Collectively evaluated for impairment		6,135		2,874		921		19,918		29,848
Loans acquired with deteriorated credit quality		-		-		-		-		-
Total ending allowance for loan losses balance	$	7,401	$	6,998	$	1,112	$	19,918	$	35,429
Loans
Individually evaluated for impairment	$	9,431	$	39,245	$	1,996			$	50,672
Collectively evaluated for impairment		1,236,052		980,449		474,379				2,690,880
Loans acquired with deteriorated credit quality		468		410		147				1,025
Total loans recorded investment		1,245,951		1,020,104		476,522				2,742,577
Accrued interest included in recorded investment		3,536		4,178		1,185				8,899
Total loans	$	1,242,415	$	1,015,926	$	475,337			$	2,733,678

2019
Allowance for loan losses:
Individually evaluated for impairment	$1,031	$4,863	$261	$-	$6,155
Collectively evaluated for impairment	6,891	3,353	1,022	8,727	19,993
Loans acquired with deteriorated credit quality	-	-	-	-	-
Total ending allowance for loan losses balance	$7,922	$8,216	$1,283	$8,727	$26,148
Loans
Individually evaluated for impairment	$9,393	$43,574	$2,925		$55,892
Collectively evaluated for impairment	1,158,906	1,058,917	457,370		2,675,193
Loans acquired with deteriorated credit quality	1,394	575	316		2,285
Total loans recorded investment	1,169,693	1,103,066	460,611		2,733,370
Accrued interest included in recorded investment	2,998	4,155	1,194		8,347
Total loans	$1,166,695	$1,098,911	$459,417		$2,725,023

Non-performing loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. If these loans had continued to accrue interest in accordance with their original terms, approximately $0.5 million, $0.4 million and $0.4 million of interest income would have been recognized in each of the years ended 2020, 2019 and 2018, respectively. Interest income recorded on these loans was approximately zero during each of the years ended 2020, 2019 and 2018.

56

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Loans on non-accrual status and past due more than 90 days (‘‘Non-performing Loans’’) at December 31 follow⁽¹⁾:

	90+ and Still Accruing		Non- Accrual		Total Non- Performing Loans
	(In thousands)
2020
Commercial
Commercial and industrial (2)	$	-	$	1,387	$	1,387
Commercial real estate		-		-		-
Mortgage
1-4 family owner occupied - jumbo		-		623		623
1-4 family owner occupied - non-jumbo (3)		-		2,281		2,281
1-4 family non-owner occupied		-		1,112		1,112
1-4 family - 2nd lien		-		1,344		1,344
Resort lending		-		607		607
Installment
Boat lending		-		52		52
Recreational vehicle lending		-		74		74
Other		-		393		393
Total recorded investment	$	-	$	7,873	$	7,873
Accrued interest included in recorded investment	$	-	$	-	$	-
2019
Commercial
Commercial and industrial (2)	$	-	$	565	$	565
Commercial real estate		-		735		735
Mortgage
1-4 family owner occupied - jumbo		-		1,179		1,179
1-4 family owner occupied - non-jumbo (3)		-		3,540		3,540
1-4 family non-owner occupied		-		1,039		1,039
1-4 family - 2nd lien		-		979		979
Resort lending		-		690		690
Installment
Boat lending		-		332		332
Recreational vehicle lending		-		3		3
Other		-		470		470
Total recorded investment	$	-	$	9,532	$	9,532
Accrued interest included in recorded investment	$	-	$	-	$	-

(1) Non-performing loans exclude purchase credit impaired loans.

(2) Non-performing commercial and industrial loans exclude $0.053 million and $0.077 million of government guaranteed loans at December 31, 2020 and 2019, respectively.

(3) Non-performing 1-4 family owner occupied – non jumbo loans exclude $0.386 million and $0.569 million of government guaranteed loans at December 31, 2020 and 2019, respectively.

57

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

An aging analysis of loans by class at December 31 follows:

	Loans Past Due								Loans not		Total
	30-59 days		60-89 days		90+ days		Total		Past Due		Loans
	(In thousands)
2020
Commercial
Commercial and industrial	$	5,003	$	131	$	70	$	5,204	$	671,115	$	676,319
Commercial real estate		2,600		-		-		2,600		567,032		569,632
Mortgage
1-4 family owner occupied - jumbo		761		-		623		1,384		438,794		440,178
1-4 family owner occupied - non-jumbo		1,888		453		502		2,843		264,730		267,573
1-4 family non-owner occupied		1,184		139		476		1,799		157,977		159,776
1-4 family - 2nd lien		710		228		732		1,670		92,860		94,530
Resort lending		32		195		358		585		57,462		58,047
Installment
Boat lending		95		101		-		196		207,317		207,513
Recreational vehicle lending		207		37		48		292		169,282		169,574
Other		337		162		199		698		98,737		99,435
Total recorded investment	$	12,817	$	1,446	$	3,008	$	17,271	$	2,725,306	$	2,742,577
Accrued interest included in recorded investment	$	147	$	22	$	-	$	169	$	8,730	$	8,899
2019
Commercial
Commercial and industrial	$	-	$	289	$	102	$	391	$	564,480	$	564,871
Commercial real estate		177		-		735		912		603,910		604,822
Mortgage
1-4 family owner occupied - jumbo		1,757		1,037		-		2,794		398,759		401,553
1-4 family owner occupied - non-jumbo		2,672		852		1,387		4,911		342,349		347,260
1-4 family non-owner occupied		695		136		623		1,454		168,083		169,537
1-4 family - 2nd lien		909		90		386		1,385		115,157		116,542
Resort lending		364		53		565		982		67,192		68,174
Installment
Boat lending		337		107		88		532		202,750		203,282
Recreational vehicle lending		161		97		3		261		153,184		153,445
Other		377		275		202		854		103,030		103,884
Total recorded investment	$	7,449	$	2,936	$	4,091	$	14,476	$	2,718,894	$	2,733,370
Accrued interest included in recorded investment	$	74	$	34	$	-	$	108	$	8,239	$	8,347

58

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Impaired loans are as follows:

	December 31,
	2020		2019
	(In thousands)
Impaired loans with no allocated allowance for loan losses
TDR	$	93	$	337
Non - TDR		1,367		1,550
Impaired loans with an allocated allowance for loan losses
TDR - allowance based on collateral		9,027		1,587
TDR - allowance based on present value cash flow		37,953		48,798
Non - TDR - allowance based on collateral		1,873		3,365
Total impaired loans	$	50,313	$	55,637
Amount of allowance for loan losses allocated
TDR - allowance based on collateral	$	1,058	$	542
TDR - allowance based on present value cash flow		3,755		4,641
Non - TDR - allowance based on collateral		768		972
Total amount of allowance for loan losses allocated	$	5,581	$	6,155

Impaired loans by class as of December 31 are as follows:

	2020						2019
	Recorded Investment		Unpaid Principal Balance		Related Allowance for Loan Losses		Recorded Investment		Unpaid Principal Balance		Related Allowance for Loan Losses
	(In thousands)
With no related allowance for loan losses recorded:
Commercial
Commercial and industrial	$	77	$	80	$	-	$	257	$	257	$	-
Commercial real estate		-		-		-		796		796		-
Mortgage
1-4 family owner occupied - jumbo		623		629		-		-		-		-
1-4 family owner occupied - non-jumbo		-		-		-		212		217		-
1-4 family non-owner occupied		305		473		-		214		366		-
1-4 family - 2nd lien		301		304		-		407		438		-
Resort lending		154		379		-		-		-		-
Installment
Boat lending		-		-		-		-		-		-
Recreational vehicle lending		-		-		-		-		-		-
Other		-		-		-		1		41		-
		1,460		1,865		-		1,887		2,115		-

59

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

	2020			2019
	Recorded Investment	Unpaid Principal Balance	Related Allowance for Loan Losses	Recorded Investment	Unpaid Principal Balance	Related Allowance for Loan Losses
	(In thousands)
With an allowance for loan losses recorded:
Commercial
Commercial and industrial	2,227	2,370	756	1,655	1,706	453
Commercial real estate	7,127	7,096	510	6,685	6,661	578
Mortgage
1-4 family owner occupied - jumbo	506	880	50	1,447	1,445	91
1-4 family owner occupied - non-jumbo	21,655	22,311	2,300	10,163	10,695	1,031
1-4 family non-owner occupied	4,335	4,704	495	4,962	5,542	572
1-4 family - 2nd lien	811	829	200	14,059	15,243	1,695
Resort lending	10,555	10,764	1,079	12,110	12,263	1,474
Installment
Boat lending	7	11	2	-	-	-
Recreational vehicle lending	87	100	19	-	-	-
Other	1,902	2,040	170	2,924	3,153	261
	49,212	51,105	5,581	54,005	56,708	6,155
Total
Commercial
Commercial and industrial	2,304	2,450	756	1,912	1,963	453
Commercial real estate	7,127	7,096	510	7,481	7,457	578
Mortgage
1-4 family owner occupied - jumbo	1,129	1,509	50	1,447	1,445	91
1-4 family owner occupied - non-jumbo	21,655	22,311	2,300	10,375	10,912	1,031
1-4 family non-owner occupied	4,640	5,177	495	5,176	5,908	572
1-4 family - 2nd lien	1,112	1,133	200	14,466	15,681	1,695
Resort lending	10,709	11,143	1,079	12,110	12,263	1,474
Installment
Boat lending	7	11	2	-	-	-
Recreational vehicle lending	87	100	19	-	-	-
Other	1,902	2,040	170	2,925	3,194	261
Total	$50,672	$52,970	$5,581	$55,892	$58,823	$6,155
Accrued interest included in recorded investment	$359			$255

60

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Average recorded investment in and interest income earned (of which the majority of these amounts were received in cash and related primarily to performing TDR’s) on impaired loans by class for the years ended December 31 follows:

	2020				2019				2018
	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(In thousands)
With no related allowance for loan losses recorded:
Commercial
Commercial and industrial	$	125	$	9	$	51	$	-	$	378	$	20
Commercial real estate		159		-		278		5		961		-
Mortgage
1-4 family owner occupied - jumbo		408		-		-		-		41		-
1-4 family owner occupied - non-jumbo		252		4		201		-		15		27
1-4 family non-owner occupied		308		10		123		-		-		-
1-4 family - 2nd lien		380		-		136		7		-		-
Resort lending		92		-		-		-		-		-
Installment
Boat lending		-		-		-		-		-		-
Recreational vehicle lending		-		-		-		-		-		-
Other		-		-		-		1		1		11
		1,724		23		789		13		1,396		58
With an allowance for loan losses recorded:
Commercial
Commercial and industrial		2,230		242		2,256		72		2,641		127
Commercial real estate		10,751		1,043		5,778		315		5,199		288
Mortgage
1-4 family owner occupied - jumbo		1,083		84		995		39		1,335		69
1-4 family owner occupied - non-jumbo		19,624		2,033		15,183		594		28,183		1,408
1-4 family non-owner occupied		4,664		375		2,874		291		5,475		314
1-4 family - 2nd lien		3,376		22		13,383		809		284		12
Resort lending		11,316		799		11,697		669		14,687		606
Installment
Boat lending		59		1		54		-		1		-
Recreational vehicle lending		81		4		22		-		84		4
Other		2,416		225		3,186		189		3,640		224
		55,600		4,828		55,428		2,978		61,529		3,052
Total
Commercial
Commercial and industrial		2,355		251		2,307		72		3,019		147
Commercial real estate		10,910		1,043		6,056		320		6,160		288
Mortgage
1-4 family owner occupied - jumbo		1,491		84		995		39		1,376		69
1-4 family owner occupied - non-jumbo		19,876		2,037		15,384		594		28,198		1,435
1-4 family non-owner occupied		4,972		385		2,997		291		5,475		314
1-4 family - 2nd lien		3,756		22		13,519		816		284		12
Resort lending		11,408		799		11,697		669		14,687		606
Installment
Boat lending		59		1		54		-		1		-
Recreational vehicle lending		81		4		22		-		84		4
Other		2,416		225		3,186		190		3,641		235
Total	$	57,324	$	4,851	$	56,217	$	2,991	$	62,925	$	3,110

61

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Troubled debt restructurings at December 31 follow:

	2020
	Commercial		Retail (1)			Total
	(In thousands)
Performing TDR’s	$	7,956	$	36,385		$	44,341
Non-performing TDR’s (2)		1,148		1,584	(3)		2,732
Total	$	9,104	$	37,969		$	47,073

	2019
	Commercial		Retail (1)			Total
	(In thousands)
Performing TDR’s	$	7,974	$	39,601		$	47,575
Non-performing TDR’s (2)		540		2,607	(3)		3,147
Total	$	8,514	$	42,208		$	50,722

(1) Retail loans include mortgage and installment loan portfolio segments.

(2) Included in non-performing loans table above.

(3) Also includes loans on non-accrual at the time of modification until six payments are received on a timely basis.

We have allocated $4.8 million and $5.2 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2020 and 2019, respectively. We have committed to lend additional amounts totaling up to $0.07 million and $0.05 million at December 31, 2020 and 2019, respectively, to customers with outstanding loans that are classified as troubled debt restructurings.

The terms of certain loans were modified as troubled debt restructurings and generally included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at  a stated rate of interest lower than the current market rate for a new loan with similar risk; or a permanent reduction  of the recorded investment in the loan.

Modifications involving a reduction of the stated interest rate of the loan have generally been for periods ranging from 9 months to 36 months but have extended to as much as 480 months in certain circumstances. Modifications involving an extension of the maturity date have generally been for periods ranging from 1 month to 60 months but have extended to as much as 230 months in certain circumstances.

Loans that have been classified as troubled debt restructurings during the years ended December 31 follow:

	Number of Contracts		Pre-modification Recorded Balance		Post-modification Recorded Balance
	(Dollars in thousands)
2020
Commercial
Commercial and industrial		7	$	1,207	$	1,207
Commercial real estate		4		7,012		7,012
Mortgage
1-4 family owner occupied - jumbo		-		-		-
1-4 family owner occupied - non-jumbo		5		357		374
1-4 family non-owner occupied		2		111		116
1-4 family - 2nd lien		2		44		46
Resort lending		-		-		-
Installment
Boat lending		-		-		-
Recreational vehicle lending		-		-		-
Other		4		91		93
Total		24	$	8,822	$	8,848

62

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

	Number of Contracts	Pre-modification Recorded Balance	Post-modification Recorded Balance
	(Dollars in thousands)
2019
Commercial
Commercial and industrial	8	$1,609	$1,609
Commercial real estate	3	1,479	1,479
Mortgage
1-4 family owner occupied - jumbo	-	-	-
1-4 family owner occupied - non-jumbo	2	478	483
1-4 family non-owner occupied	1	507	505
1-4 family - 2nd lien	3	75	75
Resort lending	-	-	-
Installment
Boat lending	-	-	-
Recreational vehicle lending	-	-	-
Other	7	188	191
Total	24	$4,336	$4,342
2018
Commercial
Commercial and industrial	7	$652	$652
Commercial real estate	2	204	204
Mortgage
1-4 family owner occupied - jumbo	1	419	419
1-4 family owner occupied - non-jumbo	9	991	994
1-4 family non-owner occupied	-	-	-
1-4 family - 2nd lien	-	-	-
Resort lending	1	115	114
Installment
Boat lending	-	-	-
Recreational vehicle lending	-	-	-
Other	14	708	709
Total	34	$3,089	$3,092

The troubled debt restructurings described above increased (decreased) the AFLL by $0.04 million, $0.50 million and $(0.19) million during the years ended December 31, 2020, 2019 and 2018, respectively and resulted in charge offs of zero during each of the years ended December 31, 2020, 2019 and 2018, respectively.

63

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Loans that have been classified as troubled debt restructured during the past twelve months and that have subsequently defaulted during the years ended December 31 follows:

	Number of Contracts		Recorded Balance
2020	(Dollars in thousands)
Commercial
Commercial and industrial		-	$	-
Commercial real estate		-		-
Mortgage
1-4 family owner occupied - jumbo		-		-
1-4 family owner occupied - non-jumbo		-		-
1-4 family non-owner occupied		-		-
1-4 family - 2nd lien		-		-
Resort lending		-		-
Installment
Boat lending		-		-
Recreational vehicle lending		-		-
Other		-		-
Total		-	$	-
2019
Commercial
Commercial and industrial		1	$	19
Commercial real estate		-		-
Mortgage
1-4 family owner occupied - jumbo		-		-
1-4 family owner occupied - non-jumbo		1		12
1-4 family non-owner occupied		-		-
1-4 family - 2nd lien		-		-
Resort lending		-		-
Installment
Boat lending		-		-
Recreational vehicle lending		-		-
Other		-		-
Total		2	$	31
2018
Commercial
Commercial and industrial		-	$	-
Commercial real estate		-		-
Mortgage
1-4 family owner occupied - jumbo		-		-
1-4 family owner occupied - non-jumbo		-		-
1-4 family non-owner occupied		-		-
1-4 family - 2nd lien		-		-
Resort lending		-		-
Installment
Boat lending		-		-
Recreational vehicle lending		-		-
Other		1		13
Total		1	$	13

64

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

A loan is generally considered to be in payment default once it is 90 days contractually past due under the modified terms for commercial loans and installment loans and when four consecutive payments are missed for mortgage loans.

The troubled debt restructurings that subsequently defaulted described above increased (decreased) the AFLL by zero during each of the years ended December 31, 2020, 2019 and 2018 and resulted in charge offs of zero during each of the years ended December 31, 2020, 2019 and 2018.

The terms of certain other loans were modified during the years ending December 31, 2020, 2019 and 2018 that did not meet the definition of a troubled debt restructuring. The modification of these loans could have included modification of the terms of a loan to borrowers who were not experiencing financial difficulties or a delay in a payment that was considered to be insignificant.

In order to determine whether a borrower is experiencing financial difficulty, we perform an evaluation of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under our internal underwriting policy.

Non-TDR Loan Modifications and Paycheck Protection Program (“PPP”) due to COVID-19 - On March 22, 2020, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus”.  This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19.  The guidance goes on to explain that in consultation with the Financial Accounting Standards Board staff that the federal banking agencies conclude that short-term modifications (e.g. six months or less) made on a good faith basis to borrowers who were current (less than 30 days past due) as of the implementation date of a relief program are not TDRs.  In addition, on March 27, 2020, the CARES Act was signed into law.  Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were current (less than 30 days past due) as of December 31, 2019 are not TDRs.  We are assisting both commercial and retail (mortgage and installment) borrowers with reduced or suspended payments. Commercial loan accommodations are typically a three month interest-only period while retail loan (mortgage and installment) forbearances have primarily been payment suspensions for three months. For loans subject to these forbearance agreements each borrower is required to resume making regularly scheduled loan payments at the end of the forbearance period.  The deferred principal and interest will be repaid based upon individualized agreements.  Options for repayment include separate repayment plans, extending the term of the loan or re-amortizing the loan based upon the affordability of the payment in relationship to a reduced income.  While some borrowers may elect to make a lump sum payment, we anticipate the majority will require some type of repayment plan.  During the forbearance period, the loan will not be reported as past due in keeping with the guidance discussed previously.

A summary of remaining accommodations that had been entered into under this guidance as of December 31, 2020 follows:

Commercial and Retail Loan COVID-19 Accomodations

	Covid-19 Accomodations					Total		% of Total
Loan Category		Loans (#)		Loans ($)		Loans		Loans
	(Dollars in thousands)
Commercial			2	$	163	$	1,242,415		0.0	%
Mortgage			134		19,830		1,015,926		2.0	%
Installment			48		1,412		475,337		0.3	%
Total			184	$	21,405	$	2,733,678		0.8	%
Mortgage loans serviced for others(1)			288	$	42,897	$	2,984,088		1.4	%

1) We have delegated authority from all investors to grant these deferrals on their behalf.

65

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Information on subsequent accommodation extensions for portfolio loans follows:

Commercial and Retail Loan COVID-19 Subsequent Accomodations (1)

Loan Category	Loans (#)		Loans ($)
	(Dollars in thousands)
Commercial		2	$	163
Mortgage		100		15,004
Installment		35		1,045
Total		137	$	16,212

(1) Subsequent accommodations are extensions of the original accommodations that were given as summarized in the paragraph above.

The CARES Act also included an initial $349 billion loan program administered through the U.S. Small Business Administration (“SBA”) referred to as the PPP. Under the PPP, small businesses and other entities and individuals can apply for loans from existing SBA lenders and other approved regulated lenders that enroll in the program, subject to numerous limitations and eligibility criteria. We are participating as a lender in the PPP. The PPP opened on April 3, 2020 intending to provide American small businesses with eight weeks of cash-flow assistance through 100 percent federally guaranteed loans through the SBA. In late April 2020 the Paycheck Protection Program and Health Care Enhancement Act, added another $310 billion in funding while the Paycheck Protection Program Flexibility Act made certain changes to the program, by allowing for more time to spend the funds, and making it easier to get a loan fully forgiven.  The PPP initially closed on August 8, 2020.  On December 27, 2020, the Economic Aid to Hard-Hit Small Businesses, Nonprofits, and Venues Act (“Economic Aid Act”) was signed into law which allocates an additional $284 billion in funding for the PPP.  The Economic Aid Act reopens the PPP through March 31, 2021 with generally the same terms and conditions as originally enacted under the CARES Act while clarifying eligibility and ineligibility for certain entities and expanding the permitted uses of PPP funds.  In addition, the Economic Aid Act simplifies the loan forgiveness process for PPP loans of $150,000 or less. The Economic Aid Act also establishes second draw loans for entities that have already used the initial PPP funds, subject to numerous limitations and eligibility criteria. PPP second draw loans are eligible for forgiveness similar to initial PPP loans, subject to limitations set forth in the Economic Aid Act.  As of December 31, 2020, we had 1,483 initial PPP loans outstanding with a total balance of $169.8 million.  PPP loans are included in the commercial and industrial class of the commercial loan portfolio segment.  As these loans are 100% guaranteed through the SBA the allowance for loan losses recorded on these loans is zero.  As of December 31, 2020, 755 forgiveness applications had been processed and approved for initial PPP loans totaling $92.0 million (we expect to receive these forgiveness proceeds during the first quarter of 2021).  Interest and fees on loans in our consolidated statement of operations includes $5.6 million for the twelve month period of 2020, related to the accretion of net loan fees on initial PPP loans.  No such accretion is included in the comparable prior year periods.  At December 31, 2020 we had $3.2 million of remaining unaccreted net fees related to initial PPP loans. We had no PPP second draw loans outstanding as of December 31, 2020.

Credit Quality Indicators – As part of our on-going monitoring of the credit quality of our loan portfolios, we track certain credit quality indicators including (a) risk grade of commercial loans, (b) the level of classified commercial loans, (c) credit scores of mortgage and installment loan borrowers, and (d) delinquency history and non-performing loans.

For commercial loans, we use a loan rating system that is similar to those employed by state and federal banking regulators. Loans are graded on a scale of 1 to 12. A description of the general characteristics of the ratings follows:

Rating 1 through 6: These loans are generally referred to as our ‘‘non-watch’’ commercial credits that include very high or exceptional credit fundamentals through acceptable credit fundamentals.

Rating 7 and 8: These loans are generally referred to as our ‘‘watch’’ commercial credits. These ratings include loans to borrowers that exhibit potential credit weakness or downward trends. If not checked or cured these trends could weaken our asset or credit position. While potentially weak, no loss of principal or interest is envisioned with these ratings.

66

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Rating 9: These loans are generally referred to as our ‘‘substandard accruing’’ commercial credits. This rating includes loans to borrowers that exhibit a well-defined weakness where payment default is probable and loss is possible if deficiencies are not corrected. Generally, loans with this rating are considered collectible as to both principal and interest primarily due to collateral coverage.

Rating 10 and 11: These loans are generally referred to as our ‘‘substandard - non-accrual’’ and ‘‘doubtful’’ commercial credits. These ratings include loans to borrowers with weaknesses that make collection of debt in full, on the basis of current facts, conditions and values at best questionable and at worst improbable. All of these loans are placed in non-accrual.

Rating 12: These loans are generally referred to as our ‘‘loss’’ commercial credits. This rating includes loans to borrowers that are deemed incapable of repayment and are charged-off.

The following table summarizes loan ratings by loan class for our commercial loan portfolio segment at December 31:

	Commercial
	Non-watch 1-6		Watch 7-8		Substandard Accrual 9		Non- Accrual 10-11		Total
					(In thousands)
2020
Commercial and industrial	$	637,826	$	32,765	$	4,341	$	1,387	$	676,319
Commercial real estate		561,382		5,978		2,272		-		569,632
Total	$	1,199,208	$	38,743	$	6,613	$	1,387	$	1,245,951
Accrued interest included in total	$	3,408	$	105	$	23	$	-	$	3,536
2019
Commercial and industrial	$	515,955	$	44,384	$	3,967	$	565	$	564,871
Commercial real estate		580,516		23,036		535		735		604,822
Total	$	1,096,471	$	67,420	$	4,502	$	1,300	$	1,169,693
Accrued interest included in total	$	2,763	$	205	$	30	$	-	$	2,998

For each of our mortgage and installment portfolio segment classes we generally monitor credit quality based on the credit scores of the borrowers. These credit scores are generally updated semi-annually. The following tables summarize credit scores by loan class for our mortgage and installment loan portfolio segments at December 31:

	Mortgage (1)
	1-4 Family Owner Occupied - Jumbo		1-4 Family Owner Occupied - Non-jumbo		1-4 Family Non-owner Occupied		1-4 Family 2nd Lien		Resort Lending		Total
	(In thousands)
2020
800 and above	$	61,077	$	40,187	$	25,468	$	12,490	$	9,546	$	148,768
_750-799		223,177		70,642		82,124		42,138		27,530		445,611
_700-749		101,086		75,489		30,326		22,962		11,726		241,589
_650-699		40,296		44,344		13,182		11,269		6,393		115,484
_600-649		11,146		18,519		4,303		2,703		1,670		38,341
_550-599		-		11,021		2,388		1,608		917		15,934
_500-549		3,396		5,129		1,580		1,012		192		11,309
Under 500		-		2,242		405		348		73		3,068
Unknown		-		-		-		-		-		-
Total	$	440,178	$	267,573	$	159,776	$	94,530	$	58,047	$	1,020,104
Accrued interest included in total	$	1,301	$	1,641	$	587	$	373	$	276	$	4,178

67

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

	Mortgage (1)
	1-4 Family Owner Occupied - Jumbo	1-4 Family Owner Occupied - Non-jumbo	1-4 Family Non-owner Occupied	1-4 Family 2nd Lien	Resort Lending	Total
	(In thousands)
2019
800 and above	$48,486	$43,848	$24,315	$13,905	$11,076	$141,630
_750-799	198,491	111,521	84,656	50,012	29,364	474,044
_700-749	106,609	95,064	34,839	30,697	14,626	281,835
_650-699	31,553	51,174	13,995	14,267	8,063	119,052
_600-649	13,230	21,938	5,897	4,097	2,074	47,236
_550-599	514	12,308	1,863	1,703	673	17,061
_500-549	1,519	7,940	1,870	1,281	889	13,499
Under 500	641	2,208	533	511	79	3,972
Unknown	510	1,259	1,569	69	1,330	4,737
Total	$401,553	$347,260	$169,537	$116,542	$68,174	$1,103,066
Accrued interest included in total	$1,139	$1,662	$586	$502	$266	$4,155

(1) Credit scores have been updated within the last twelve months.

	Installment (1)
	Boat Lending		Recreational Vehicle Lending		Other		Total
	(In thousands)
2020
800 and above	$	32,231	$	29,223	$	9,154	$	70,608
_750-799		123,689		95,890		37,512		257,091
_700-749		38,223		33,476		25,262		96,961
_650-699		10,189		8,794		21,138		40,121
_600-649		2,083		1,305		3,730		7,118
_550-599		661		551		1,299		2,511
_500-549		342		283		767		1,392
Under 500		95		52		63		210
Unknown		-		-		510		510
Total	$	207,513	$	169,574	$	99,435	$	476,522
Accrued interest included in total	$	572	$	457	$	156	$	1,185
2019
800 and above	$	28,041	$	24,470	$	7,611	$	60,122
_750-799		118,380		88,164		37,583		244,127
_700-749		41,490		31,055		27,204		99,749
_650-699		11,485		7,267		22,517		41,269
_600-649		2,254		1,411		4,470		8,135
_550-599		946		592		1,884		3,422
_500-549		377		464		1,127		1,968
Under 500		309		22		284		615
Unknown		-		-		1,204		1,204
Total	$	203,282	$	153,445	$	103,884	$	460,611
Accrued interest included in total	$	490	$	378	$	326	$	1,194

(1) Credit scores have been updated within the last twelve months.

68

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Mortgage loans serviced for others are not reported as assets on the Consolidated Statements of Financial Condition. The principal balances of these loans at December 31 follow:

	2020		2019
	(In thousands)
Mortgage loans serviced for :
Fannie Mae	$	1,656,060	$	1,449,935
Freddie Mac		1,095,877		852,123
Ginnie Mae		181,615		180,941
FHLB		39,294		69,149
Other		11,242		29,018
Total	$	2,984,088	$	2,581,166

Custodial deposit accounts maintained in connection with mortgage loans serviced for others totaled $40.5 million and $29.9 million, at December 31, 2020 and 2019, respectively.

If we do not remain well capitalized for regulatory purposes (see note #20), meet certain minimum capital levels or certain profitability requirements or if we incur a rapid decline in net worth, we could lose our ability to sell and/or service loans to these investors. This could impact our ability to generate net gains on mortgage loans and generate servicing income. A forced liquidation of our servicing portfolio could also impact the value that could be recovered on this asset. Fannie Mae has the most stringent eligibility requirements covering capital levels, profitability and decline in net worth. Fannie Mae requires seller/servicers to be well capitalized for regulatory purposes. For the profitability requirement, we cannot record four or more consecutive quarterly losses and experience a 30% decline in net worth over the same period. Our net worth cannot decline by more than 25% in one quarter or more than 40% over two consecutive quarters. The highest level of capital we are required to maintain is at least $2.5 million plus 0.25% of all loans serviced for others.

An analysis of capitalized mortgage loan servicing rights for the years ended December 31 follows:

	2020			2019			2018
	(In thousands)
Balance at beginning of period	$	19,171		$	21,400		$	15,699
Originated servicing rights capitalized		13,957			7,303			4,977
Servicing rights acquired		-			-			3,047
Change in fair value due to price		(10,833	)		(6,408	)		191
Change in fair value due to pay downs		(5,391	)		(3,124	)		(2,514	)
Balance at end of year	$	16,904		$	19,171		$	21,400
Loans sold and serviced that have had servicing rights capitalized	$	2,982,833		$	2,580,705		$	2,333,081

Fair value of capitalized mortgage loan servicing rights was determined using an average coupon rate of 3.77%, average servicing fee of 0.257%, average discount rate of 10.09% and an average Public Securities Association (‘‘PSA’’) prepayment rate of 348 for December 31, 2020; and average coupon rate of 4.22%, average servicing fee of 0.258%, average discount rate of 10.14% and an average PSA prepayment rate of 250 for December 31, 2019.

Purchase Credit Impaired (‘‘PCI’’) Loans

Loans acquired in a business combination are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan losses. In determining the estimated fair value of purchased loans, management considers a number of factors including, among others, the remaining life of the acquired loans, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and net present value of cash flows expected to be received. Purchased loans are accounted for in accordance with guidance for certain loans acquired in a transfer (ASC 310-30), when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the acquirer will not collect all contractually required principal and interest payments. The difference between contractually required payments and the cash flows expected to be collected at

69

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

acquisition is referred to as the non-accretable difference. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in expected cash flows will result in a reversal  of the provision for loan losses to the extent of prior charges and then an adjustment to accretable yield, which would have a positive impact on interest income.

As a result of our acquisition of TCSB Bancorp, Inc. (‘‘TCSB’’) (see note #26) we purchased loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. For these loans that meet the criteria of ASC 310-30 treatment, the carrying amount was as follows:

	December 31,
	2020		2019
	(In thousands)
Commercial	$	468	$	1,394
Mortgage		410		575
Installment		147		316
Total carrying amount		1,025		2,285
Allowance for loan losses		-		-
Carrying amount, net of allowance for loan losses	$	1,025	$	2,285

The accretable difference on PCI loans is the difference between the expected cash flows and the net present value of expected cash flows with such difference accreted into earnings using the effective yield method over the term of the loans. Accretion recorded as loan interest income is included in the table below. Accretable yield of PCI loans, or income expected to be collected follows:

	Year ended December 31,
	2020			2019
	(In thousands)
Balance at beginning of period	$	640		$	462
New loans purchased		-			-
Accretion of income		(280	)		(187	)
Reclassification from (to) nonaccretable difference		-			365
Displosals/other adjustments		-			-
Balance at end of period	$	360		$	640

NOTE 5 – OTHER REAL ESTATE

A summary of other real estate activity for the years ended December 31 follows ⁽¹⁾:

	2020			2019			2018
	(In thousands)
Balance at beginning of year, net of valuation allowance	$	1,715		$	1,178		$	1,628
Loans transferred to other real estate		332			2,242			1,510
Sales of other real estate		(1,161	)		(1,438	)		(1,822	)
Additions to valuation allowance charged to expense		(148	)		(267	)		(138	)
Balance at end of year, net of valuation allowance	$	738		$	1,715		$	1,178

(1) Table excludes other repossessed assets totaling $0.03 million and $0.15 million at December 31, 2020 and 2019, respectively.

70

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

We periodically review our real estate properties and establish valuation allowances on these properties if values have declined since the date of acquisition. An analysis of our valuation allowance for other real estate follows:

	2020			2019			2018
	(In thousands)
Balance at beginning of year	$	92		$	144		$	123
Additions charged to expense		148			267			138
Direct write-downs upon sale		(150	)		(319	)		(117	)
Balance at end of year	$	90		$	92		$	144

At December 31, 2020 and 2019, the balance of other real estate includes $0.7 million and $1.2 million, respectively of foreclosed residential real estate properties. Retail mortgage loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements totaled $0.3 million and $0.7 million at December 31, 2020 and 2019, respectively.

Other real estate and repossessed assets totaling $0.8 million and $1.9 million at December 31, 2020 and 2019, respectively, are presented net of the valuation allowance on the Consolidated Statements of Financial Condition. 

NOTE 6 – PROPERTY AND EQUIPMENT

A summary of property and equipment at December 31 follows:

	2020			2019
	(In thousands)
Land and land improvements	$	17,083		$	17,478
Buildings		57,208			57,363
Equipment		72,542			71,194
		146,833			146,035
Accumulated depreciation and amortization		(110,706	)		(107,624	)
Property and equipment, net	$	36,127		$	38,411

Depreciation expense was $5.3 million, $5.2 million and $5.1 million in 2020, 2019 and 2018, respectively.

NOTE 7 – GOODWILL AND OTHER INTANGIBLES

Intangible assets, net of amortization, at December 31 follows:

	2020				2019
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
	(In thousands)
Amortized intangible assets - core deposits	$	11,916	$	7,610	$	11,916	$	6,590
Unamortized intangible assets - goodwill	$	28,300			$	28,300

At December 31, 2020, the Bank (our reporting unit) had positive equity and we elected to perform a qualitative assessment to determine if it was more likely than not that the fair value of the Bank exceeds its carrying value, including goodwill. The qualitative assessment indicated that it was more likely than not that the fair value of the Bank exceeded its carrying value, resulting in no impairment.

Intangible amortization expense was $1.0 million, $1.1 million and $1.0 million during the years ended 2020, 2019 and 2018, respectively.

71

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

A summary of estimated core deposit intangible amortization at December 31, 2020, follows:

	(In thousands)
2021	$	970
2022		785
2023		547
2024		516
2025		487
2026 and thereafter		1,001
Total	$	4,306

NOTE 8 – DEPOSITS

A summary of interest expense on deposits for the years ended December 31 follows:

	2020		2019		2018
	(In thousands)
Savings and interest-bearing checking	$	2,264	$	5,371	$	4,146
Reciprocal		2,158		6,024		1,292
Time		7,073		7,148		5,343
Brokered time		1,171		4,882		3,697
Total	$	12,666	$	23,425	$	14,478

Aggregate time deposits in denominations of $0.25 million or more amounted to $50.0 million and $71.5 million at December 31, 2020 and 2019, respectively.

A summary of the maturity of time deposits at December 31, 2020, follows:

	(In thousands)
2021	$	370,497
2022		40,671
2023		16,717
2024		5,072
2025		5,457
2026 and thereafter		603
Total	$	439,017

Reciprocal deposits represent demand, money market and time deposits from our customers that have been placed through IntraFi Network (formerly Promontory Interfinancial Network’s Insured Cash Sweep® service and Certificate of Deposit Account Registry Service®). This service allows our customers to access multi-million dollar FDIC deposit insurance on deposit balances greater than the standard FDIC insurance maximum.

A summary of reciprocal deposits at December 31 follows:

	2020		2019
	(In thousands)
Demand	$	515,092	$	383,953
Money market		3,308		4,416
Time		37,785		42,658
Total	$	556,185	$	431,027

72

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

NOTE 9 – OTHER BORROWINGS

A summary of other borrowings at December 31 follows:

	2020		2019
	(In thousands)
Advances from the FHLB	$	30,000	$	63,640
Federal funds purchased		-		25,000
Other		12		6
Total	$	30,012	$	88,646

Advances from the FHLB are secured by unencumbered qualifying mortgage and home equity loans with a market value equal to at least 132% to 165%, respectively, of outstanding advances. Advances are also secured by FHLB stock that we own, which totaled $8.6 million at December 31, 2020. Unused borrowing capacity with the FHLB (subject to the FHLB’s credit requirements and policies) was $772.8 million at December 31, 2020. Interest expense on advances amounted to $0.5 million, $0.7 million and $1.0 million for the years ended December 31, 2020, 2019 and 2018, respectively. No FHLB advances were prepaid during 2020, 2019 or 2018.

As a member of the FHLB, we must own FHLB stock equal to the greater of 0.75% of the unpaid principal balance of residential mortgage assets or 4.5% of our outstanding advances. At December 31, 2020, we were in compliance with the FHLB stock ownership requirements.

The maturity dates, weighted average interest rates and contractually required repayments of FHLB advances at December 31 follow:

	2020					2019
	Amount		Rate			Amount		Rate
	(Dollars in thousands)
Fixed-rate advances
2020						$	28,645		2.19	%
2022	$	-		-	%		4,995		1.69
2026 and thereafter		30,000		0.74			30,000		0.74
Total advances	$	30,000		0.74	%	$	63,640		1.47	%

Borrowings with the FRB at December 31, 2020 and 2019 were zero. Average borrowings with the FRB during the years ended December 31, 2020, 2019 and 2018 totaled $1.546 million, $0.305 million and $0.003 million. We had unused borrowing capacity with the FRB (subject to the FRB’s credit requirements and policies) of $492.0 million at December 31, 2020. Collateral for FRB borrowings are certain commercial and installment loans.

Interest expense on federal funds purchased totaled $0.01 million, $0.08 million and $0.10 million for the years ended December 31, 2020, 2019 and 2018, respectively.

Assets, consisting of FHLB stock and loans, pledged to secure other borrowings and unused borrowing capacity totaled $1.9 billion at December 31, 2020.

NOTE 10 – SUBORDINATED DEBT AND DEBENTURES

Subordinated Debt

In May 2020, we issued $40.0 million of fixed to floating subordinated notes with a ten year maturity (May 31, 2030 maturity date) and a five year call option.  The initial coupon rate is 5.95% fixed for five years and then floats at the Secured Overnight Financing Rate (“SOFR”) plus 5.825%.  These notes are presented in the Consolidated Statement of Financial Condition under the caption “Subordinated debt” and the December 31, 2020 balance of $39.3 million is net of remaining unamortized deferred issuance costs of approximately $0.7 million that are being amortized through the maturity date into interest expense on other borrowings and subordinated debt and debentures in our Consolidated Statement of Operations. We may redeem the notes, in whole or in part, on or after May 31, 2025, and redeem the notes at any time in whole upon certain other events. Any redemption of the notes will be subject to prior regulatory approval to the extent required.

73

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Subordinated Debentures

We have formed various special purpose entities (the ‘‘trusts’’) for the purpose of issuing trust preferred securities in either public or pooled offerings or in private placements. Independent Bank Corporation owns all of the common stock of each trust and has issued subordinated debentures to each trust in exchange for all of the proceeds from  the  issuance  of  the common stock and the trust preferred securities. Trust preferred securities totaling $38.3 million and $38.2 million at December 31, 2020 and 2019, respectively qualified as Tier 1 regulatory capital.

These trusts are not consolidated with Independent Bank Corporation and accordingly, we report the common securities of the trusts held by us in accrued income and other assets and the subordinated debentures that we have issued to the trusts in the liability section of our Consolidated Statements of Financial Condition.

As a result of our acquisition of TCSB (see note #26) we acquired TCSB Statutory Trust I as summarized in the tables below at a discount. The discount at acquisition totaled $1.4 million and is being amortized through its maturity date and is included in interest expense – other borrowings and subordinated debt and debentures in the Consolidated Statements of Operations.

Summary information regarding subordinated debentures as of December 31 follows:

		2020
Entity Name	Issue Date
		Subordinated Debentures			Trust Preferred Securities Issued			Common Stock Issued
		(In thousands)
IBC Capital Finance III	May 2007	$	12,372		$	12,000		$	372
IBC Capital Finance IV	September 2007		15,465			15,000			465
Midwest Guaranty Trust I	November 2002		7,732			7,500			232
TCSB Statutory Trust I	March 2005		5,155			5,000			155
Discount on TCSB Statutory Trust I			(1,200	)		(1,200	)		-
		$	39,524		$	38,300		$	1,224

		2019
Entity Name	Issue Date
		Subordinated Debentures			Trust Preferred Securities Issued			Common Stock Issued
		(In thousands)
IBC Capital Finance III	May 2007	$	12,372		$	12,000		$	372
IBC Capital Finance IV	September 2007		15,465			15,000			465
Midwest Guaranty Trust I	November 2002		7,732			7,500			232
TCSB Statutory Trust I	March 2005		5,155			5,000			155
Discount on TCSB Statutory Trust I			(1,268	)		(1,268	)		-
		$	39,456		$	38,232		$	1,224

Other key terms for the subordinated debentures and trust preferred securities that were outstanding at December 31, 2020 and 2019 follow:

Entity Name	Maturity Date	Interest Rate	First Permitted Redemption Date
IBC Capital Finance III	July 30, 2037	3 month LIBOR plus 1.60%	July 30, 2012
IBC Capital Finance IV	September 15, 2037	3 month LIBOR plus 2.85%	September 15, 2012
Midwest Guaranty Trust I	November 7, 2032	3 month LIBOR plus 3.45%	November 7, 2007
TCSB Statutory Trust I	March 17, 2035	3 month LIBOR plus 2.20%	March 17, 2010

74

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The subordinated debentures and trust preferred securities are cumulative and have a feature that permits us to defer distributions (payment of interest) from time to time for a period not to exceed 20 consecutive quarters. Interest is payable quarterly on each of the subordinated debentures and trust preferred securities and no distributions were deferred at December 31, 2020 and 2019.

We have the right to redeem the subordinated debentures and trust preferred securities (at par) in whole or in part from time to time on or after the first permitted redemption date specified above or upon the occurrence of specific events defined within the trust indenture agreements.

Distributions (payment of interest) on the trust preferred securities are included in interest expense – other borrowings and subordinated debt and debentures in the Consolidated Statements of Operations. 

NOTE 11 – COMMITMENTS AND CONTINGENT LIABILITIES

In the normal course of business, we enter into financial instruments with off-balance sheet risk to meet the financing needs of customers or to reduce exposure to fluctuations in interest rates. These financial instruments may include commitments to extend credit and standby letters of credit. Financial instruments involve varying degrees of credit and interest-rate risk in excess of amounts reflected in the Consolidated Statements of Financial Condition. Exposure to credit risk in the event of non-performance by the counterparties to the financial instruments for loan commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments.

A summary of financial instruments with off-balance sheet risk at December 31 follows:

	2020		2019
	(In thousands)
Financial instruments whose risk is represented by contract amounts
Commitments to extend credit	$	644,815	$	582,457
Standby letters of credit		9,361		7,207

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and generally require payment of a fee. Since commitments may expire without being drawn upon, the commitment amounts do not represent future cash requirements. Commitments are issued subject to similar underwriting standards, including collateral requirements, as are generally involved in the extension of credit facilities.

Standby letters of credit are written conditional commitments issued to guarantee the performance of a customer to a third party. The credit risk involved in such transactions is essentially the same as that involved in extending loan facilities and, accordingly, standby letters of credit are issued subject to similar underwriting standards, including collateral requirements, as are generally involved in the extension of credit facilities. The majority of the standby  letters of credit are on-demand with no stated maturity date and have variable rates that range from 2.50% to 12.00%.

COVID-19 Pandemic

On March 11, 2020, the World Health Organization declared COVID-19, the disease caused by the novel coronavirus, a pandemic as a result of the global spread of the coronavirus illness. In response to the outbreak, federal and state authorities in the U.S. introduced various measures to try to limit or slow the spread of the virus, including travel restrictions, nonessential business closures, stay-at-home orders, and strict social distancing. The degree to which businesses may resume operations varies based on the type of business operations being conducted. It is currently expected that various forms of state and local government restrictions similar to those described above will continue for the foreseeable future. As a result of these events, Michigan has experienced a significant increase in unemployment.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The COVID-19 pandemic, the related executive orders, and other government restrictions and guidance have had and continue to have a significant effect on us, our customers and the markets we serve. Our business, results of operations and financial condition may be adversely affected by a number of factors that could impact us and our customers, including but not limited to:

• restrictions on activity and high levels of unemployment may cause increases in loan delinquencies, foreclosures and defaults;

• increases in allowance for loan losses may be necessary;

• declines in collateral values may occur;

• third party disruptions, including outages at network providers, on-line banking vendors and other suppliers;

• increased cyber and payment fraud risk, as cybercriminals attempt to profit from the disruption, given increased online and remote activity;

• operational failures due to changes in our normal business practices necessitated by the pandemic and related governmental actions; and/or

• key personnel or significant numbers of our employees being unable to work effectively, including because of illness or restrictions in connection with COVID-19.

These factors may continue for a significant period of time.

The spread of COVID-19 has caused us to modify many of our business practices.  We have also expanded sick and vacation time for certain employees.  We may take further actions as may be required or as we determine to be prudent.  There is no certainty that such measures will be sufficient to mitigate the risks posed by COVID-19.

The extent to which the COVID-19 pandemic will impact our business, results of operations and financial condition will depend on future developments, which are highly uncertain and difficult to predict.  Those developments and factors include the duration and spread of the pandemic, its severity, the actions to contain the pandemic or address its impact, and how quickly and to what extent normal economic and operating conditions can resume. We do not yet know the full extent of the impact.   However, the effects could have a material adverse impact on our business, financial condition and results of operations. Material adverse impacts may include valuation impairments on our intangible assets, securities available for sale, loans, capitalized mortgage loan servicing rights and deferred tax assets.

Litigation

We are involved in various litigation matters in the ordinary course of business. At the present time, we do not believe any of these matters will have a significant impact on our consolidated financial position or results of operations. The aggregate amount we have accrued for losses we consider probable as a result of these litigation matters is immaterial. However, because of the inherent uncertainty of outcomes from any litigation matter, we believe it is reasonably possible we may incur losses in addition to the amounts we have accrued. At this time, we estimate the maximum amount of additional losses that are reasonably possible is insignificant. However, because of a number of factors, including the fact that certain of these litigation matters are still in their early stages, this maximum amount may change in the future.

The litigation matters described in the preceding paragraph primarily include claims that have been brought against us for damages, but do not include litigation matters where we seek to collect amounts owed to us by third parties (such as litigation initiated to collect delinquent loans). These excluded, collection-related matters may involve claims or counterclaims by the opposing party or parties, but we have excluded such matters from the disclosure contained in the preceding paragraph in all cases where we believe the possibility of us paying damages to any opposing party is remote.

Loss Reimbursement Obligations

The provision for loss reimbursement on sold loans represents our estimate of incurred losses related to mortgage loans that we have sold to investors (primarily Fannie Mae, Freddie Mac, Ginnie Mae and the FHLB). Since we sell mortgage loans without recourse, loss reimbursements only occur in those instances where we have

76

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

breached a representation or warranty or other contractual requirement related to the loan sale. The provision for loss reimbursement on sold loans was an expense of $0.20 million, $0.23 million and $0.01 million for the years ended December 31, 2020, 2019 and 2018, respectively. The reserve for loss reimbursements on sold mortgage loans totaled $1.0 million and $0.9 million at December 31, 2020 and 2019, respectively. This reserve is included in accrued expenses and other liabilities in our Consolidated Statements of Financial Condition. This reserve is based on an analysis of mortgage loans that we have sold which are further categorized by delinquency status, loan to value, and year of origination. The calculation includes factors such as probability of default, probability of loss reimbursement (breach of representation or warranty) and estimated loss severity. We believe that the amounts that we have accrued for incurred losses on sold mortgage loans are appropriate given our analyses. However, future losses could exceed our current estimate.

Visa Stock

We own 12,566 shares of VISA Class B common stock. At the present time, these shares can only be sold to other Class B shareholders. As a result, there has generally been limited transfer activity in private transactions between buyers and sellers. Given the limited activity that we have become aware of  and the continuing uncertainty regarding the likelihood, ultimate timing and eventual exchange rate for Class B shares into Class A shares, we continue to carry these shares at zero, representing cost basis less impairment. However, given the current conversion ratio of 1.6228 Class A shares for every 1 Class B share and the closing price of VISA Class A shares on February 26, 2021 of $212.39 per share, our 12,566 Class B shares would have a current “value” of approximately $4.3 million. We continue to monitor Class B trading activity and the status of the resolution of certain litigation matters at VISA that would trigger the conversion of Class B common shares into Class A common shares, which would not have any trading restrictions.

NOTE 12 – SHAREHOLDERS’ EQUITY AND INCOME PER COMMON SHARE

Our Board of Directors authorized share repurchase plans to buy back up to 5% of our outstanding common stock during 2020, 2019 and 2018. In addition, in June, 2019 our Board of Directors authorized a 300,000 share expansion of the 2019 repurchase plan. During 2020, 2019 and 2018 repurchases were made through open market and negotiated transactions and totaled 708,956, 1,204,688 and 587,969 shares of common stock, respectively for an aggregate purchase price of $14.2 million, $26.3 million and $12.7 million, respectively.

A reconciliation of basic and diluted net income per common share for the years ended December 31 follows:

	2020		2019		2018
	(In thousands, except per share amounts)
Net income	$	56,152	$	46,435	$	39,839
Weighted average shares outstanding (1)		21,977		22,894		23,412
Stock units for deferred compensation plan for non-employee directors		121		132		128
Effect of stock options		90		115		176
Performance share units		33		42		53
Weighted average shares outstanding for calculation of diluted earnings per share		22,221		23,183		23,769
Net income per common share
Basic (1)	$	2.56	$	2.03	$	1.70
Diluted	$	2.53	$	2.00	$	1.68

(1) Basic net income per common share includes weighted average common shares outstanding during the period and participating share awards.

Weighted average stock options outstanding that were not considered in computing diluted net income per common share because they were anti-dilutive were zero for each year ended 2020, 2019 and 2018, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

NOTE 13 – INCOME TAX

The composition of income tax expense for the years ended December 31 follows:

	2020			2019		2018
	(In thousands)
Current expense	$	15,459		$	10,237	$	-
Deferred expense (benefit)		(2,130	)		1,088		9,294
Income tax expense	$	13,329		$	11,325	$	9,294

The deferred income tax benefit of $2.1 million in 2020 can be primarily attributed to the increase in our allowance for loan losses while the deferred income tax expense of $1.1 million during 2019 can be primarily attributed to the utilization of our net operating loss (‘‘NOL’’) carryfoward and alternative minimum tax credit carryforward while the deferred income tax expense of $9.3 million during 2018 can be primarily attributed to the utilization of our NOL carryfoward.

A reconciliation of income tax expense to the amount computed by applying the statutory federal income tax rate of 21% for 2020, 2019 and 2018 to the income before income tax for the years ended December 31 follows:

	2020			2019			2018
	(In thousands)
Statutory rate applied to income before income tax	$	14,591		$	12,130		$	10,318
Tax-exempt income		(690	)		(375	)		(383	)
Unrecognized tax benefit		(206	)		(134	)		(162	)
Share-based compensation		(204	)		(204	)		(367	)
Bank owned life insurance		(196	)		(233	)		(229	)
Non-deductible meals, entertainment and memberships		57			86			85
Other, net		(23	)		55			32
Income tax expense	$	13,329		$	11,325		$	9,294

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31 follow:

	2020		2019
	(In thousands)
Deferred tax assets
Allowance for loan losses	$	7,363	$	5,355
Lease liabilities		1,652		1,744
Property and equipment		1,047		1,528
Share-based compensation		742		808
Reserve for unfunded lending commitments		379		324
Deferred compensation		321		285
Loss reimbursement on sold loans reserve		214		185
Non accrual loan interest income		203		173
Other than temporary impairment charge on securities available for sale		144		147
Vehicle service contract counterparty contingency reserve		26		38
Unrealized loss on derivative financial instruments		-		459
Gross deferred tax assets		12,091		11,046
Deferred tax liabilities
Capitalized mortgage loan servicing rights		3,550		4,026
Deferred loan fees		1,901		1,852
Lease right of use asset		1,606		1,739
Unrealized gain on securities available for sale		4,206		994
Purchase premiums, net		509		293
Federal Home Loan Bank stock		27		27
Other		17		43
Gross deferred tax liabilities		11,816		8,974
Deferred tax assets, net	$	275	$	2,072

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

We assess whether a valuation allowance should be established against our deferred tax assets based on the consideration of all available evidence using a ‘‘more likely than not’’ standard. The ultimate realization of this asset is primarily based on generating future income. We concluded at both December 31, 2020 and 2019, that the realization of substantially all of our deferred tax assets continues to be more likely than not.

Changes in unrecognized tax benefits for the years ended December 31 follow:

	2020			2019			2018
	(In thousands)
Balance at beginning of year	$	438		$	588		$	724
Additions based on tax positions related to the current year		15			20			26
Reductions due to the statute of limitations		(273	)		(170	)		(162	)
Reductions due to settlements		-			-			-
Balance at end of year	$	180		$	438		$	588

If recognized, the entire amount of unrecognized tax benefits, net of $0.04 million of federal tax on state benefits, would affect our effective tax rate. We do not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. No amounts were expensed for interest and penalties for the years ended December 31, 2020, 2019 and 2018. No amounts were accrued for interest and penalties at December 31, 2020, 2019 and 2018. At December 31, 2020, U.S. Federal tax years 2017 through the present remain open to examination. 

NOTE 14 – SHARE BASED COMPENSATION AND BENEFIT PLANS

We maintain share based payment plans that include a non-employee director stock purchase plan and a long-term incentive plan that permits the issuance of share based compensation, including stock options and non-vested share awards. The long-term incentive plan, which is shareholder approved, permits the grant of additional share based awards for up to 0.4 million shares of common stock as of December 31, 2020. The non-employee director stock purchase plan permits the grant of additional share based payments for up to 0.1 million shares of common stock as of December 31, 2020. Share based awards and payments are measured at fair value at the date of grant and are expensed over the requisite service period. Common shares issued upon exercise of stock options come from currently authorized but unissued shares.

During 2020, 2019 and 2018 pursuant to our long-term incentive plan, we granted 0.06 million, 0.06 million and 0.05 million shares, respectively of restricted stock and 0.02 million during each year of performance stock units (‘‘PSUs’’), to certain officers. Except for 0.010 million shares and 0.002 million shares of restricted stock issued in 2019 and 2018, respectively that vest ratably over three years, all shares of restricted stock and PSUs cliff vest after a period of three years.  The performance feature of the PSUs is based on a comparison of our total shareholder return over the vesting period starting on the grant date to the total shareholder return over that period for a banking index of our peers.  We have not issued stock options since 2013, other than in connection with the Merger (see note #26).

Our directors may elect to receive all or a portion of their cash retainer fees in the form of common stock (either on a current basis or on a deferred basis) pursuant to the non-employee director stock purchase plan referenced above. Shares equal in value to that portion of each director’s fees that he or she has elected to receive   in stock on a current basis are issued each quarter and vest immediately. Shares issued on a deferred basis are credited at the rate of 90% of the current fair value of our common stock and vest immediately. We issued 0.02 million, 0.01 million and 0.01 million shares to directors pursuant to this plan during the years ending 2020, 2019 and 2018, respectively and expensed their value during those same periods.

Total compensation expense recognized for grants pursuant to our long-term incentive plan was $1.6 million, $1.6 million and $1.5 million in 2020, 2019 and 2018, respectively. The corresponding tax benefit relating to this expense was $0.3 million during each year. Total expense recognized for non-employee director share based payments was $0.4 million, $0.3 million and $0.2 million in 2020, 2019 and 2018, respectively. The corresponding tax benefit relating to this expense was $0.07 million, $0.05 million and $0.04 million in 2020, 2019 and 2018, respectively.

79

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

At December 31, 2020, the total expected compensation cost related to non-vested restricted stock and PSUs not yet recognized was $1.7 million. The weighted-average period over which this amount will be recognized is 1.7 years.

A summary of outstanding stock option grants and related transactions follows:

	Number of Shares			Average Exercise Price		Weighted- Average Remaining Contractual Term (Years)		Aggregated Intrinsic Value
								(In thousands)
Outstanding at January 1,2020		138,506		$	4.62
Granted		-
Exercised		(17,317	)		3.27
Forfeited		-
Expired		-
Outstanding at December 31, 2020		121,189		$	4.81		2.1	$	1,658
Vested and expected to vest at December 31, 2020		121,189		$	4.81		2.1	$	1,658
Exercisable at December 31, 2020		121,189		$	4.81		2.1	$	1,658

A summary of outstanding non-vested stock and related transactions follows:

	Number of Shares			Weighted- Average Grant Date Fair Value
Outstanding at January 1, 2020		245,726		$	21.72
Granted		76,893			22.46
Vested		(94,342	)		19.96
Forfeited		(21,160	)		22.63
Outstanding at December 31, 2020		207,117		$	22.70

Certain information regarding options exercised during the periods ending December 31 follows:

	2020		2019		2018
	(In thousands)
Intrinsic value	$	293	$	897	$	2,333
Cash proceeds received	$	57	$	706	$	1,420
Tax benefit realized	$	61	$	188	$	490

We maintain 401(k) and employee stock ownership plans covering substantially all of our full-time employees. We matched 50% of employee contributions to the 401(k) plan up to a maximum of 8% of participating employees’ eligible wages for 2020, 2019 and 2018. Contributions to the employee stock ownership plan are determined annually and require approval of our Board of Directors. The maximum contribution is 6% of employees’ eligible wages. Contributions to the employee stock ownership plan were 2% for 2020, 2019 and 2018. Amounts expensed for these retirement plans were $3.2 million, $2.6 million and $2.3 million in 2020, 2019 and 2018, respectively.

Our employees participate in various performance-based compensation plans. Amounts expensed for all incentive plans totaled $15.7 million, $9.5 million and $9.8 million in 2020, 2019 and 2018, respectively.

We also provide certain health care and life insurance programs to substantially all full-time employees. Amounts expensed for these programs totaled $4.8 million, $5.7 million and $5.2 million in 2020, 2019 and 2018 respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

 These insurance programs are also available to retired employees at their own expense.

NOTE 15 – OTHER NON-INTEREST INCOME

Other non-interest income for the years ended December 31 follows:

	2020		2019		2018
	(In thousands)
Investment and insurance commissions	$	1,971	$	1,658	$	1,971
ATM fees		1,197		1,403		1,457
Bank owned life insurance		910		1,111		970
Other		3,443		5,110		4,362
Total other non-interest income	$	7,521	$	9,282	$	8,760

NOTE 16 – DERIVATIVE FINANCIAL INSTRUMENTS

We are required to record derivatives on our Consolidated Statements of Financial Condition as assets and liabilities measured at their fair value. The accounting for increases and decreases in the value of derivatives depends upon the use of derivatives and whether the derivatives qualify for hedge accounting.

Our derivative financial instruments according to the type of hedge in which they are designated at December 31 follow:

	2020
	Notional Amount		Average Maturity (years)		Fair Value
	(Dollars in thousands)
Fair value hedge designation
Pay-fixed interest rate swap agreements - commercial	$	7,088		8.4	$	(776	)
Pay-fixed interest rate swap agreements - securities available for sale		41,950		7.1		15
Total	$	49,038		7.3	$	(761	)
No hedge designation
Rate-lock mortgage loan commitments	$	168,816		0.1	$	7,020
Mandatory commitments to sell mortgage loans		186,092		0.1		(941	)
Pay-fixed interest rate swap agreements - commercial		147,456		4.5		(9,700	)
Pay-variable interest rate swap agreements - commercial		147,456		4.5		9,700
Pay-fixed interest rate swap agreements		25,000		0.6		(295	)
Interest rate cap agreements		135,000		1.8		5
Purchased options		2,908		0.5		42
Written options		2,848		0.5		(42	)
Total	$	815,576		2.0	$	5,789

81

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

	2019
	Notional Amount		Average Maturity (years)		Fair Value
	(Dollars in thousands)
Fair value hedge designation - Pay-fixed interest rate swap agreements	$	7,117		9.4	$	(242	)
Cash flow hedge designation
Pay-fixed interest rate swap agreements	$	25,000		1.6	$	(174	)
Interest rate cap agreements		150,000		2.6		214
Total	$	175,000		2.5	$	40
No hedge designation
Rate-lock mortgage loan commitments	$	49,268		0.1	$	1,412
Mandatory commitments to sell mortgage loans		95,363		0.1		(150	)
Pay-fixed interest rate swap agreements - commercial		153,946		5.5		(3,641	)
Pay-variable interest rate swap agreements - commercial		153,946		5.5		3,641
Purchased options		2,908		1.5		141
Written options		2,848		1.5		(139	)
Total	$	458,279		3.7	$	1,264

We have established management objectives and strategies that include interest-rate risk parameters for maximum fluctuations in net interest income and market value of portfolio equity. We monitor our interest rate risk position via simulation modeling reports. The goal of our asset/liability management efforts is to maintain profitable financial leverage within established risk parameters.

 To meet our asset/liability management objectives, we may periodically enter into derivative financial instruments to mitigate exposure to fluctuations in cash flows resulting from changes in interest rates (‘‘Cash Flow Hedges’’). Cash Flow Hedges included certain pay-fixed interest rate swaps and interest rate cap agreements.  Pay-fixed interest rate swaps convert the variable-rate cash flows on debt obligations to fixed-rates.  Under interest-rate cap agreements, we will receive cash if interest rates rise above a predetermined level. As a result, we effectively have variable-rate debt with an established maximum rate. We paid an upfront premium on interest rate caps which was recognized in earnings in the same period in which the hedged item affected earnings.  During the first and third quarters of 2020 we transferred all of our Cash Flow Hedge interest rate cap agreements and pay-fixed interest rate swaps, respectively to a no hedge designation. The $2.0 million and $0.5 million unrealized loss on our Cash Flow Hedge interest rate cap agreements and pay-fixed interest rate swaps, respectively which were included as a component of accumulated other comprehensive income (loss) at the time of the transfers were being reclassified into earnings over the remaining life of the interest rate cap agreements and pay-fixed interest rate swap agreements.  In the fourth quarter of 2020 it became probable that the forecasted transactions being hedged by these interest rate cap agreements and pay-fixed interest rate swap agreements would not occur by the end of the originally specified time period.  As a result, all remaining unrealized losses included as a component of accumulated other comprehensive income (loss) were reclassified into earnings.  The interest rate cap agreements and pay-fixed interest rate swaps are now classified as a no hedge designation at December 31, 2020 and any changes in fair value since the transfers to the no hedge designation are recorded in earnings.

We have entered into a pay-fixed interest rate swap to protect a portion of the fair value of a certain fixed rate commercial loan (‘‘Fair Value Hedge – Commercial Loan’’). As a result, changes in the fair value of the pay-fixed interest rate swap is expected to offset changes in the fair value of the fixed rate commercial loan due to fluctuations in interest rates. We record the fair value of Fair Value Hedge – Commercial Loan in accrued income and other assets and accrued expenses and other liabilities on our Consolidated Statements of Financial Condition. The hedged item (fixed rate commercial loan) is also recorded at fair value which offsets the adjustment to the Fair Value Hedge –

82

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Commercial Loan. On an ongoing basis, we adjust our Consolidated Statements of Financial Condition to reflect the then current fair value of both the Fair Value Hedge – Commercial Loan and the hedged item. The related gains or losses are reported in interest income – interest and fees on loans in our Consolidated Statements of Operations.

During 2020 we entered into pay-fixed interest rate swaps to protect a portion of the fair value of certain securities available for sale (‘‘Fair Value Hedge – AFS Securities’’). As a result, the change in the fair value of the pay-fixed interest rate swaps is expected to offset a portion of the change in the fair value of the fixed rate securities available for sale due to fluctuations in interest rates. We record the fair value of Fair Value Hedge – AFS Securities in accrued income and other assets and accrued expenses and other liabilities on our Consolidated Statements of Financial Condition. The hedged item (fixed rate securities available for sale) is also recorded at fair value which offsets the adjustment to the Fair Value Hedge – AFS Securities. On an ongoing basis, we adjust our Consolidated Statements of Financial Condition to reflect the then current fair value of both the Fair Value Hedge – AFS Securities and the hedged item. The related gains or losses are reported in interest income – interest on securities available for sale – tax-exempt in our Consolidated Statements of Operations.

Certain derivative financial instruments have not been designated as hedges. The fair value of these derivative financial instruments has been recorded on our Consolidated Statements of Financial Condition and is adjusted on an ongoing basis to reflect their then current fair value. The changes in fair value of derivative financial instruments not designated as hedges are recognized in earnings.

In the ordinary course of business, we enter into rate-lock mortgage loan commitments with customers (‘‘Rate-Lock Commitments’’). These commitments expose us to interest rate risk. We also enter into mandatory commitments to sell mortgage loans (‘‘Mandatory Commitments’’) to reduce the impact of price fluctuations of mortgage loans held for sale and Rate-Lock Commitments. Mandatory Commitments help protect our loan sale profit margin from fluctuations in interest rates. The changes in the fair value of Rate Lock Commitments and Mandatory Commitments are recognized currently as part of net gains on mortgage loans in the Consolidated Statements of Operations. We obtain market prices on Mandatory Commitments and Rate-Lock Commitments. Net gains on mortgage loans, as well as net income, may be more volatile as a result of these derivative instruments, which are  not designated as hedges.

In prior periods we offered to our deposit customers an equity linked time deposit product (‘‘Altitude CD’’). The Altitude CD was a time deposit that provided the customer a guaranteed return of principal at maturity plus a potential equity return (a written option), while we receive a like stream of funds based on the equity return (a purchased option). The written and purchased options will generally move in opposite directions resulting in little or no net impact on our Consolidated Statements of Operations. All of the written and purchased options in the table above  relate to this Altitude CD product.

We have a program that allows commercial loan customers to lock in a fixed rate for a longer period of time than we would normally offer for interest rate risk reasons. We will enter into a variable rate commercial loan and  an interest rate swap agreement with a customer and then enter into an offsetting interest rate swap agreement with an unrelated party. The interest rate swap agreement fair values will generally move in opposite directions resulting in little or no net impact on our Consolidated Statements of Operations. All of the interest rate swap agreements-commercial with no hedge designation in the table above relate to this program.

83

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The following tables illustrate the impact that the derivative financial instruments discussed above have on individual line items in the Consolidated Statements of Financial Condition for the periods presented:

Fair Values of Derivative Instruments

	Asset Derivatives								Liability Derivatives
	December 31,								December 31,
	2020				2019				2020				2019
	Balance Sheet Location		Fair Value		Balance Sheet Location		Fair Value		Balance Sheet Location		Fair Value		Balance Sheet Location		Fair Value
	(In thousands)
Derivatives designated as hedging instruments		-				-				-				-
Pay-fixed interest rate swap agreements	Other assets		$	15	Other assets		$	-	Other liabilities		$	776	Other liabilities		$	416
Interest rate cap agreements	Other assets			-	Other assets			214	Other liabilities			-	Other liabilities			-
				15				214				776				416
Derivatives not designated as hedging instruments
Rate-lock mortgage loan commitments	Other assets			7,020	Other assets			1,412	Other liabilities		$	-	Other liabilities			-
Mandatory commitments to sell mortgage loans	Other assets			-	Other assets			-	Other liabilities			941	Other liabilities			150
Pay-fixed interest rate swap agreements - commercial	Other assets			-	Other assets			28	Other liabilities			9,700	Other liabilities			3,669
Pay-variable interest rate swap agreements - commercial	Other assets			9,700	Other assets			3,669	Other liabilities			-	Other liabilities			28
Pay-fixed interest rate swap agreements	Other assets			-	Other assets			-	Other liabilities			295	Other liabilities			-
Interest rate cap agreements	Other assets			5	Other assets			-	Other liabilities			-	Other liabilities			-
Purchased options	Other assets			42	Other assets			141	Other liabilities			-	Other liabilities			-
Written options	Other assets			-	Other assets			-	Other liabilities			42	Other liabilities			139
				16,767				5,250				10,978				3,986
Total derivatives			$	16,782			$	5,464			$	11,754			$	4,402

84

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The effect of derivative financial instruments on the Consolidated Statements of Operations follows:

Year Ended December 31,
	Gain (loss) Recognized in Other Comprehensive Income (Loss) (Effective Portion)									Location  Gain (Loss)  Reclassified  from  Accumulated  Other  Comprehensive Income (Loss)  into Income  (Effective  Portion)	Gain (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Effective Portion)							Location of  Gain (Loss) Recognized  in Income(1)	Gain (Loss) Recognized in Income(1)
	2020			2019			2018				2020			2019		2018			2020			2019			2018
	(In thousands)
Fair Value Hedges
Pay-fixed interest rate swap ageement - Commercial loan																		Interest and fees on loans	$	(534	)	$	(242	)	$	-
Pay-fixed interest rate swap agreements - Securities available for sale																		Interest on securities available for sale - tax-exempt		15			-			-
Total																			$	(519	)	$	(242	)	$	-
Cash Flow Hedges
Interest rate cap agreements	$	125		$	(1,211	)	$	(340	)	Interest expense	$	(1,885	)	$	363	$	206	Interest expense	$	-		$	-		$	-
Pay-fixed interest rate swap agreements		(479	)		(392	)		78		Interest expense		(654	)		62		31	Interest expense		-			-			(12	)
Total	$	(354	)	$	(1,603	)	$	(262	)		$	(2,539	)	$	425	$	237		$	-		$	-		$	(12	)
No hedge designation
Rate-lock mortgage loan commitments																		Net gains on mortgage loans	$	5,608		$	725		$	157
Mandatory commitments to sell mortgage loans																		Net gains on mortgage loans		(791	)		233			(420	)
Pay-fixed interest rate swap agreements - commercial																		Interest income		(6,059	)		(4,046	)		113
Pay-variable interest rate swap agreements -commercial																		Interest income		6,059			4,046			(113	)
Pay-fixed interest rate swap agreements																		Interest expense		231			-			-
Interest rate cap agreements																		Interest expense		(57	)		-			-
Purchased options																		Interest expense		(99	)		25			(206	)
Written options																		Interest expense		97			(23	)		206
Total																			$	4,989		$	960		$	(263	)

(1) For cash flow hedges, this location and amount refers to the ineffective portion.

NOTE 17 – RELATED PARTY TRANSACTIONS

Certain of our directors and executive officers, including companies in which they are officers or have significant ownership, were loan and deposit customers during 2020 and 2019.

85

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

A summary of loans to our directors and executive officers (which includes loans to entities in which the individual owns a 10% or more voting interest) for the years ended December 31 follows:

	2020			2019
	(In thousands)
Balance at beginning of year	$	13,077		$	14,205
New loans and advances		417			713
Repayments		(11,078	)		(1,841	)
Balance at end of year	$	2,416		$	13,077

Deposits held by us for directors and executive officers totaled $2.0 million at both December 31, 2020 and 2019. 

NOTE 18 – LEASES

We have entered into leases in the normal course of business primarily for office facilities, some of which include renewal options and escalation clauses. Certain leases also include both lease components (fixed payments including rent, taxes and insurance costs) and non-lease components (common area or other maintenance costs) which are accounted for as a single lease component as we have elected the practical expedient to group lease and non-lease components together for all leases. We have also elected not to recognize leases with original lease terms of 12 months or less (short-term leases) on our Consolidated Statements of Financial Condition. Most of our leases include one or more options to renew. The exercise of lease renewal options is typically at our sole discretion and are included in our right of use (“ROU”) assets and lease liabilities if they are reasonably certain of exercise.

Leases are classified as operating or finance leases at the lease commencement date (we did not have any finance leases as of December 31, 2020). Lease expense for operating leases and short-term leases is recognized on a straight-line basis over the lease term. The ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. ROU assets and lease liabilities are recognized at the lease commencement date based on the estimated present value of the lease payment over the lease term.

As most of our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at the lease commencement date in determining the present value of the lease payments.

The cost components of our operating leases follows:

	2020		2019
	(In thousands)
Operating lease cost	$	1,780	$	2,217
Variable lease cost		69		142
Short-term lease cost		36		19
Total	$	1,885	$	2,378

Variable lease costs consist primarily of taxes, insurance, and common area or other maintenance costs for our leased facilities.

Supplemental balance sheet information related to our operating leases follows:

	2020			2019
	(In thousands)
Lease right of use asset (1)	$	7,646		$	8,282
Lease liabilities (2)	$	7,868		$	8,304
Weighted average remaining lease term (years)		7.12			7.47
Weighted average discount rate		2.4	%		2.8	%

(1) Included in Accrued income and other assets in our Consolidated Statements of Financial Condition.

(2) Included in Accrued expenses and other liabilities in our Consolidated Statements of  Financial Condition.

86

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Maturity analysis of our lease liabilities at December 31, 2020 based on required contractual payments follows:

	(In thousands)
2021	$	1,669
2022		1,489
2023		1,222
2024		815
2025		809
2026 and thereafter		2,525
Total lease payments		8,529
Less imputed interest		(661	)
Total	$	7,868

NOTE 19 – CONCENTRATIONS OF CREDIT RISK

Credit risk is the risk to earnings and capital arising from an obligor’s failure to meet the terms of any contract with our organization or otherwise failing to perform as agreed. Credit risk can occur outside of our traditional lending activities and can exist in any activity where success depends on counterparty, issuer or borrower performance. Concentrations of credit risk (whether on- or off-balance sheet) arising from financial instruments can exist in relation to individual borrowers or groups of borrowers, certain types of collateral, certain types of industries or certain geographic regions. Credit risk associated with these concentrations could arise when a significant amount of loans or other financial instruments, related by similar characteristics, are simultaneously impacted by changes in economic or other conditions that cause their probability of repayment or other type of settlement to be adversely affected. Our major concentrations of credit risk arise by collateral type and by industry. The significant concentrations by collateral type at December 31, 2020, include $930.9 million of loans secured by residential real estate and $232.7 million of construction and development loans.

Additionally, within our commercial real estate and commercial loan portfolio, we had significant standard industry classification concentrations in the following categories as of December 31, 2020: Lessors of Nonresidential Real Estate ($301.8 million); Lessors of Residential Real Estate ($119.6 million); Construction ($130.4 million); Manufacturing ($99.4 million); Accommodation and Food Services ($99.1 million) and Health Care and Social Assistance ($87.2 million). A geographic concentration arises because we primarily conduct our lending activities in the State of Michigan.

NOTE 20 – REGULATORY MATTERS

Capital guidelines adopted by federal and state regulatory agencies and restrictions imposed by law limit the amount of cash dividends our Bank can pay to us. Under these guidelines, the amount of dividends that may be paid in any calendar year is limited to the Bank’s current year net profits, combined with the retained net profits of the preceding two years. Further, the Bank cannot pay a dividend at any time that it has negative undivided profits. As of December 31, 2020, the Bank had positive undivided profits of $77.8 million. It is not our intent to have dividends paid in amounts that would reduce the capital of our Bank to levels below those which we consider prudent or that would not be in accordance with guidelines of regulatory authorities.

We are also subject to various regulatory capital requirements. The prompt corrective action regulations establish quantitative measures to ensure capital adequacy and require minimum amounts and ratios of total, Tier 1, and common equity Tier 1 capital to risk-weighted assets and Tier 1 capital to average assets. Failure to meet minimum capital requirements can result in certain mandatory, and possibly discretionary, actions by regulators that could have a material effect on our consolidated financial statements. In addition, capital adequacy rules include a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that applies to all supervised financial institutions. To avoid limits on capital distributions and certain discretionary bonus payments we must meet the minimum ratio for adequately capitalized institutions plus the buffer. Under capital adequacy guidelines, we must meet specific capital requirements that involve quantitative measures as well as qualitative judgments by the regulators. The most recent regulatory filings as of December 31, 2020 and 2019, categorized our Bank as well capitalized. Management is not aware of any conditions or events that would have changed the most recent Federal Deposit Insurance Corporation (‘‘FDIC’’) categorization.

87

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Our actual capital amounts and ratios at December 31 follow⁽¹⁾:

	Actual					Minimum for Adequately Capitalized Institutions					Minimum for Well-Capitalized Institutions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
2020
Total capital to risk-weighted assets
Consolidated	$	455,072		15.95	%	$	228,214		8.00	%	NA		NA
Independent Bank		401,005		14.06			228,111		8.00		$	285,139		10.00	%
Tier 1 capital to risk-weighted assets
Consolidated	$	379,395		13.30	%	$	171,161		6.00	%	NA		NA
Independent Bank		365,343		12.81			171,083		6.00		$	228,111		8.00	%
Common equity tier 1 capital to risk-weighted assets
Consolidated	$	341,095		11.96	%	$	128,370		4.50	%	NA		NA
Independent Bank		365,343		12.81			128,312		4.50		$	185,340		6.50	%
Tier 1 capital to average assets
Consolidated	$	379,395		9.15	%	$	165,825		4.00	%	NA		NA
Independent Bank		365,343		8.81			165,828		4.00		$	207,285		5.00	%
2019
Total capital to risk-weighted assets
Consolidated	$	380,454		13.74	%	$	221,562		8.00	%	NA		NA
Independent Bank		358,914		12.96			221,482		8.00		$	276,852		10.00	%
Tier 1 capital to risk-weighted assets
Consolidated	$	352,764		12.74	%	$	166,171		6.00	%	NA		NA
Independent Bank		331,224		11.96			166,111		6.00		$	221,482		8.00	%
Common equity tier 1 capital to risk-weighted assets
Consolidated	$	314,532		11.36	%	$	124,628		4.50	%	NA		NA
Independent Bank		331,224		11.96			124,583		4.50		$	179,954		6.50	%
Tier 1 capital to average assets
Consolidated	$	352,764		10.11	%	$	139,632		4.00	%	NA		NA
Independent Bank		331,224		9.49			139,615		4.00		$	174,519		5.00	%

(1) These ratios do not reflect a capital conservation buffer of 2.50% at December 31, 2020 and 2019.

NA - Not applicable

88

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The components of our regulatory capital are as follows:

	Consolidated						Independent Bank
	December 31,						December 31,
	2020			2019			2020			2019
	(In thousands)
Total shareholders’ equity	$	389,522		$	350,169		$	413,770		$	366,861
Add (deduct)
Accumulated other comprehensive loss for regulatory purposes		(15,821	)		(2,011	)		(15,821	)		(2,011	)
Goodwill and other intangibles		(32,606	)		(33,626	)		(32,606	)		(33,626	)
Common equity tier 1 capital		341,095			314,532			365,343			331,224
Qualifying trust preferred securities		38,300			38,232			-			-
Tier 1 capital		379,395			352,764			365,343			331,224
Subordinated debt		40,000			-			-			-
Allowance for loan losses and allowance for unfunded lending commitments limited to 1.25% of total risk-weighted assets		35,677			27,690			35,662			27,690
Total risk-based capital	$	455,072		$	380,454		$	401,005		$	358,914

NOTE 21 – FAIR VALUE DISCLOSURES

FASB ASC topic 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC topic 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Valuation is based upon quoted prices for identical instruments traded in active markets. Level 1 instruments include securities traded on active exchange markets, such as the New York Stock Exchange, as well as U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets.

Level 2: Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. Level 2 instruments include securities traded in less active dealer or broker markets.

Level 3: Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

We used the following methods and significant assumptions to estimate fair value:

Securities: Where quoted market prices are available in an active market, securities available for sale are classified as Level 1 of the valuation hierarchy. We currently do not have any Level 1 securities. If quoted market prices are not available for the specific security, then fair values are estimated by (1) using quoted market prices of securities with similar characteristics, (2) matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for specific securities but rather by relying on the securities’ relationship to other benchmark quoted prices, or (3) a discounted cash flow analysis whose significant fair value inputs can generally be verified and do not typically involve judgment by management. These securities are classified as Level 2 of the valuation hierarchy and primarily include agency securities, private label mortgage-backed securities, other asset backed securities, obligations of states and political subdivisions, trust preferred securities, corporate securities and foreign government securities.

89

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Loans held for sale: The fair value of mortgage loans held for sale, carried at fair value is based on agency cash window loan pricing for comparable assets (recurring Level 2).

Impaired loans with specific loss allocations based on collateral value: From time to time, certain loans are considered impaired and an AFLL is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. We measure our investment in an impaired loan based on one of three methods: the loan’s observable market price, the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At December 31, 2020 and 2019, all of our total impaired loans were evaluated based on either the fair value of the collateral or the present value of expected future cash flows discounted at the loan’s effective interest rate. When the fair value of the collateral is based on an appraised value we record the impaired loan as nonrecurring Level 3. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant and thus will typically result in a Level 3 classification of the inputs for determining fair value.

Other real estate: At the time of acquisition, other real estate is recorded at fair value, less estimated costs to sell, which becomes the property’s new basis. Subsequent write-downs to reflect declines in value since the time of acquisition may occur from time to time and are recorded in net (gains) losses on other real estate and repossessed assets in the Consolidated Statements of Operations. The fair value of the property used at and subsequent to the time of acquisition is typically determined by a third party appraisal of the property. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent impaired loans and other real estate are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by us. Once received, an independent third party, or a member of our Collateral Evaluation Department (for commercial properties), or a member of our Special Assets/ORE Group (for residential properties) reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. We compare the actual selling price of collateral that has been sold to the most recent appraised value of our properties to determine what additional adjustment, if any, should be made to the appraisal value to arrive at fair value. For commercial and residential properties we typically discount an appraisal to account for various factors that the appraisal excludes in its assumptions. These additional discounts generally do not result in material adjustments to the appraised value.

Capitalized mortgage loan servicing rights: The fair value of capitalized mortgage loan servicing rights is based on a valuation model used by an independent third party that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income. Certain model assumptions are generally unobservable and are based upon the best information available including data relating to our own servicing portfolio, reviews of mortgage servicing assumption and valuation surveys and input from various mortgage servicers and, therefore, are recorded as Level 3. Management evaluates the third party valuation for reasonableness each quarter as part of our financial reporting control processes.

Derivatives: The fair value of rate-lock mortgage loan commitments is based on agency cash window loan pricing for comparable assets and the fair value of mandatory commitments to sell mortgage loans is based on mortgage backed security pricing for comparable assets (recurring Level 2). The fair value of interest rate swap and interest rate cap agreements are derived from proprietary models which utilize current market data. The significant fair value inputs can generally be observed in the market place and do not typically involve judgment by management (recurring Level 2). The fair value of purchased and written options is based on prices of financial instruments with similar characteristics and do not typically involve judgment by management (recurring Level 2).

90

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Assets and liabilities measured at fair value, including financial assets for which we have elected the fair value option, were as follows:

			Fair Value Measurements Using
	Fair Value Measure- ments		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Un- observable Inputs (Level 3)
	(In thousands)
December 31, 2020:
Measured at Fair Value on a Recurring Basis
Assets
Securities available for sale
U.S. agency	$	10,748	$	-	$	10,748	$	-
U.S. agency residential mortgage-backed		344,582		-		344,582		-
U.S. agency commercial mortgage-backed		7,195		-		7,195		-
Private label mortgage-backed		42,829		-		42,829		-
Other asset backed		254,181		-		254,181		-
Obligations of states and political subdivisions		324,293		-		324,293		-
Corporate		86,017		-		86,017		-
Trust preferred		1,798		-		1,798		-
Foreign government		516		-		516		-
Loans held for sale, carried at fair value		92,434		-		92,434		-
Capitalized mortgage loan servicing rights		16,904		-		-		16,904
Derivatives (1)		16,782		-		16,782		-
Liabilities
Derivatives (2)		11,754		-		11,754		-
Measured at Fair Value on a Non-recurring Basis:
Assets
Impaired loans (3)
Commercial
Commercial and industrial		1,468		-		-		1,468
Commercial real estate		6,586		-		-		6,586
Mortgage
1-4 family owner occupied - jumbo		-		-		-		-
1-4 family owner occupied - non-jumbo		321		-		-		321
1-4 family non-owner occupied		155		-		-		155
1-4 family - 2nd lien		324		-		-		324
Resort lending		61		-		-		61
Installment
Boat lending		4		-		-		4
Recreational vehicle lending		31		-		-		31
Other		124		-		-		124
Other real estate (4)
1-4 family owner occupied - non-jumbo		102		-		-		102

(1) Included in accrued income and other assets in the Consolidated Statements of Financial Condition.

(2) Included in accrued expenses and other liabilities in the Consolidated Statements of Financial Condition.

(3) Only includes impaired loans with specific loss allocations based on collateral value.

(4) Only includes other real estate with subsequent write downs to fair value.

91

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

			Fair Value Measurements Using
	Fair Value Measure- ments		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Un- observable Inputs (Level 3)
	(In thousands)
December 31, 2019:
Measured at Fair Value on a Recurring Basis
Assets
Securities available for sale
U.S. agency	$	14,661	$	-	$	14,661	$	-
U.S. agency residential mortgage-backed		227,762		-		227,762		-
U.S. agency commercial mortgage-backed		10,756		-		10,756		-
Private label mortgage-backed		39,693		-		39,693		-
Other asset backed		93,886		-		93,886		-
Obligations of states and political subdivisions		96,102		-		96,102		-
Corporate		33,195		-		33,195		-
Trust preferred		1,843		-		1,843		-
Foreign government		502		-		502		-
Loans held for sale, carried at fair value		69,800		-		69,800		-
Capitalized mortgage loan servicing rights		19,171		-		-		19,171
Derivatives (1)		5,464		-		5,464		-
Liabilities
Derivatives (2)		4,402		-		4,402		-
Measured at Fair Value on a Non-recurring Basis:
Assets
Impaired loans (3)
Commercial
Commercial and industrial		655		-		-		655
Commercial real estate		316		-		-		316
Mortgage
1-4 family owner occupied - jumbo		987		-		-		987
1-4 family owner occupied - non-jumbo		470		-		-		470
1-4 family non-owner occupied		281		-		-		281
1-4 family - 2nd lien		294		-		-		294
Resort lending		245		-		-		245
Installment
Boat lending		67		-		-		67
Recreational vehicle lending		2		-		-		2
Other		121		-		-		121
Other real estate (4)
Mortgage 1-4 family owner occupied - non-jumbo		31		-		-		31
Installment - other		28		-		-		28

(1) Included in accrued income and other assets in the Consolidated Statements of Financial Condition.

(2) Included in accrued expenses and other liabilities in the Consolidated Statements of Financial Condition.

(3) Only includes impaired loans with specific loss allocations based on collateral value.

(4) Only includes other real estate with subsequent write downs to fair value.

92

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Changes in fair values of financial assets for which we have elected the fair value option for the years ended December 31 were as follows:

	Net Gains (Losses) on Assets								Total Change in Fair Values Included
	Securities Available For Sale			Mortgage Loans		Mortgage Loan Servicing, net			in Current Period Earnings
	(In thousands)
2020
Loans held for sale	$	-		$	1,962	$	-		$	1,962
Capitalized mortgage loan servicing rights		-			-		(16,224	)		(16,224	)
2019
Equity securities at fair value	$	167		$	-	$	-		$	167
Loans held for sale		-			637		-			637
Capitalized mortgage loan servicing rights		-			-		(9,532	)		(9,532	)
2018
Trading securities	$	(62	)	$	-	$	-		$	(62	)
Loans held for sale		-			413		-			413
Capitalized mortgage loan servicing rights		-			-		(2,323	)		(2,323	)

For those items measured at fair value pursuant to our election of the fair value option, interest income is recorded within the Consolidated Statements of Operations based on the contractual amount of interest income earned on these financial assets and dividend income is recorded based on cash dividends received.

The following represent impairment charges recognized during the years ended December 31, 2020, 2019 and 2018 relating to assets measured at fair value on a non-recurring basis:

• Loans which are measured for impairment using the fair value of collateral for collateral dependent loans had a carrying amount of $9.1 million, which is net of a valuation allowance of  $1.8 million  at December 31, 2020, and had a carrying amount of $3.4 million, which is net of a valuation allowance of  $1.5 million at December 31, 2019. An additional provision for loan losses relating to these impaired loans of $0.7 million, $1.3 million and $1.3 million was included in our results of operations for the years ending December 31, 2020, 2019 and 2018, respectively.

• Other real estate, which is measured using the fair value of the property, had a carrying amount of $0.10 million which is net of a valuation allowance of $0.09 million at December 31, 2020, and a carrying amount of $0.06 million which is net of a valuation allowance of $0.09 million, at December 31, 2019. An additional charge relating to other real estate measured at fair value of $0.03 million, $0.03 million and $0.09 million was included in our results of operations during the years ended December 31, 2020, 2019 and 2018, respectively.

93

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

A reconciliation for all assets and (liabilities) measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the years ended December 31 follows:

	Capitalized Mortgage Loan Servicing Rights
	2020			2019			2018
	(In thousands)
Beginning balance	$	19,171		$	21,400		$	15,699
Total losses realized and unrealized:
Included in results of operations		(16,224	)		(9,532	)		(2,323	)
Included in other comprehensive income (loss)		-			-			-
Purchases, issuances, settlements, maturities and calls		13,957			7,303			8,024
Transfers in and/or out of Level 3		-			-			-
Ending balance	$	16,904		$	19,171		$	21,400
Amount of total losses for the period included in earnings attributable to the change in unrealized losses relating to assets and liabilities still held at December 31	$	(16,224	)	$	(9,532	)	$	(2,323	)

The fair value of our capitalized mortgage loan servicing rights has been determined based on a valuation model used by an independent third party as discussed above. The significant unobservable inputs used in the fair value measurement of the capitalized mortgage loan servicing rights are discount rate, cost to service, ancillary income, float rate and prepayment rate. Significant changes in all five of these assumptions in isolation would result in significant changes to the value of our capitalized mortgage loan servicing rights. Quantitative information about our Level 3 fair value measurements measured on a recurring basis follows:

	Asset Fair Value		Valuation Technique		Unobservable Inputs		Range			Weighted Average
	(In thousands)			-		-		-			-
2020
Capitalized mortgage loan servicing rights	$	16,904	Present value of net		Discount rate		10.00% to 13.00%				10.09	%
			servicing revenue		Cost to service		$	69 to $289		$	79
					Ancillary income		20 to 37				22
					Float rate			0.43	%		0.43	%
					Prepayment rate		7.92% to 64.70%				20.85
2019
Capitalized mortgage loan servicing rights	$	19,171	Present value of net		Discount rate		10.00% to 13.00%				10.14	%
			servicing revenue		Cost to service		$	66 to $316		$	81
					Ancillary income		20 to 37				22
					Float rate			1.73	%		1.73	%
					Prepayment rate		7.01% to 69.34%				14.96

94

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

Quantitative information about Level 3 fair value measurements measured on a non-recurring basis follows:

	Asset Fair Value		Valuation Technique		Unobservable Inputs		Range		Weighted Average
	(In thousands)			-		-		-		-
2020
Impaired loans
Commercial	$	8,054	Sales comparison		Adjustment for differences
			approach		between comparable sales		(40.0)% to 75.0%			3.8	%
Mortgage and Installment (1)		1,020	Sales comparison		Adjustment for differences
			approach		between comparable sales		(73.3) to 104.6			(1.5	)
Other real estate
Mortgage		102	Sales comparison		Adjustment for differences
			approach		between comparable sales		(13.1) to 2.4			(3.6	)
2019
Impaired loans
Commercial	$	971	Sales comparison		Adjustment for differences
			approach		between comparable sales		(48.0)% to 19.2%			(5.6	)%
Mortgage and Installment (1)		2,467	Sales comparison		Adjustment for differences
			approach		between comparable sales		(25.2) to 49.2			11.5
Other real estate
Mortgage and Installment		59	Sales comparison		Adjustment for differences
			approach		between comparable sales		(11.6) to 5.0			(5.1	)

(1) In addition to the valuation techniques and unobservable inputs discussed above, at December 31, 2020 and 2019 certain impaired collateral dependent installment loans totaling approximately $0.16 million and $0.14 million are secured by collateral other than real estate.  For the majority of these loans, we apply internal discount rates to industry valuation guides.

The following table reflects the difference between the aggregate fair value and the aggregate remaining contractual principal balance outstanding for loans held for sale for which the fair value option has been elected at December 31:

	Aggregate Fair Value		Difference		Contractual Principal
	(In thousands)
Loans held for sale
2020	$	92,434	$	3,856	$	88,578
2019		69,800		1,894		67,906
2018		44,753		1,257		43,496

95

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

NOTE 22 – FAIR VALUES OF FINANCIAL INSTRUMENTS

Most of our assets and liabilities are considered financial instruments. Many of these financial instruments lack an available trading market and it is our general practice and intent to hold the majority of our financial instruments to maturity. Significant estimates and assumptions were used to determine the fair value of financial instruments. These estimates are subjective in nature, involving uncertainties and matters of judgment, and therefore, fair values may not be a precise estimate. Changes in assumptions could significantly affect the estimates.

Estimated fair values have been determined using available data and methodologies that are considered suitable for each category of financial instrument. For instruments with adjustable interest rates which reprice frequently and without significant credit risk, it is presumed that estimated fair values approximate the recorded book balances.

The estimated recorded book balances and fair values at December 31 follow:

					Fair Value Using
	Recorded Book Balance		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Un- observable Inputs (Level 3)
	(In thousands)
2020
Assets
Cash and due from banks	$	56,006	$	56,006	$	56,006	$	-	$	-
Interest bearing deposits		62,699		62,699		62,699		-		-
Securities available for sale		1,072,159		1,072,159		-		1,072,159		-
Federal Home Loan Bank and Federal Reserve Bank Stock		18,427	NA		NA		NA		NA
Net loans and loans held for sale		2,790,683		2,794,058		-		92,434		2,701,624
Accrued interest receivable		12,315		12,315		3		3,414		8,898
Derivative financial instruments		16,782		16,782		-		16,782		-
Liabilities
Deposits with no stated maturity (1)	$	3,198,338	$	3,198,338	$	3,198,338	$	-	$	-
Deposits with stated maturity (1)		439,017		441,457		-		441,457		-
Other borrowings		30,012		30,844		-		30,844		-
Subordinated debt		39,281		41,417		-		41,417		-
Subordinated debentures		39,524		30,265		-		30,265		-
Accrued interest payable		601		601		59		542		-
Derivative financial instruments		11,754		11,754		-		11,754		-
2019
Assets
Cash and due from banks	$	53,295	$	53,295	$	53,295	$	-	$	-
Interest bearing deposits		12,009		12,009		12,009		-		-
Interest bearing deposits - time		350		350		-		350		-
Securities available for sale		518,400		518,400		-		518,400		-
Federal Home Loan Bank and Federal Reserve Bank Stock		18,359	NA		NA		NA		NA
Net loans and loans held for sale		2,768,675		2,768,817		-		69,800		2,699,017
Accrued interest receivable		10,108		10,108		8		1,752		8,348
Derivative financial instruments		5,464		5,464		-		5,464		-
Liabilities
Deposits with no stated maturity (1)	$	2,427,190	$	2,427,190	$	2,427,190	$	-	$	-
Deposits with stated maturity (1)		609,537		610,235		-		610,235		-
Other borrowings		88,646		88,680		-		88,680		-
Subordinated debentures		39,456		33,149		-		33,149		-
Accrued interest payable		1,296		1,296		97		1,199		-
Derivative financial instruments		4,402		4,402		-		4,402		-

NA – Not applicable

(1) Deposits with no stated maturity include reciprocal deposits with a recorded book balance of $518.400 million and $388.369 million at December 31, 2020 and 2019, respectively. Deposits with a stated maturity include reciprocal deposits with a recorded book balance of $37.785 million and $42.658 million at December 31, 2020 and 2019, respectively.

96

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

The fair values for commitments to extend credit and standby letters of credit are estimated to approximate their aggregate book balance, which is nominal, and therefore are not disclosed.

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale the entire holdings of a particular financial instrument.

Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business, the value of future earnings attributable to off-balance sheet activities and the value of assets and liabilities that are not considered financial instruments.

Fair value estimates for deposit accounts do not include the value of the core deposit intangible asset resulting from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.

NOTE 23 – ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

A summary of changes in accumulated other comprehensive income (loss) (‘‘AOCIL’’), net of tax during the years ended December 31 follows:

	Unrealized Gains (Losses) on Securities Available for Sale			Dispropor- tionate Tax Effects from Securities Available for Sale			Unrealized Gains (Losses) on Cash Flow Hedges			Total
	(In thousands)
2020
Balances at beginning of period	$	3,739		$	(5,798	)	$	(1,727	)	$	(3,786	)
Other comprehensive income (loss) before reclassifications		12,294			-			(279	)		12,015
Amounts reclassified from AOCIL		(211	)		-			2,006			1,795
Net current period other comprehensive income		12,083			-			1,727			13,810
Balances at end of period	$	15,822		$	(5,798	)	$	-		$	10,024
2019
Balances at beginning of period	$	(4,185	)	$	(5,798	)	$	(125	)	$	(10,108	)
Other comprehensive income (loss) before reclassifications		8,035			-			(1,266	)		6,769
Amounts reclassified from AOCIL		(111	)		-			(336	)		(447	)
Net current period other comprehensive income (loss)		7,924			-			(1,602	)		6,322
Balances at end of period	$	3,739		$	(5,798	)	$	(1,727	)	$	(3,786	)
2018
Balances at beginning of period	$	(470	)	$	(5,798	)	$	269		$	(5,999	)
Other comprehensive loss before reclassifications		(3,671	)		-			(207	)		(3,878	)
Amounts reclassified from AOCIL		(44	)		-			(187	)		(231	)
Net current period other comprehensive loss		(3,715	)		-			(394	)		(4,109	)
Balances at end of period	$	(4,185	)	$	(5,798	)	$	(125	)	$	(10,108	)

The disproportionate tax effects from securities available for sale arose primarily due to tax effects of other comprehensive income (‘‘OCI’’) in the presence of a valuation allowance against our deferred tax assets and a pretax loss from operations. Generally, the amount of income tax expense or benefit allocated to operations is determined without regard to the tax effects of other categories of income or loss, such as OCI. However, an exception to the general rule is provided when, in the presence of a valuation allowance against deferred tax assets, there is a pretax loss from operations and pretax income from other categories in the current period. In such instances, income from other categories must offset the current loss from operations, the tax benefit of such offset being reflected in operations. Release of material disproportionate tax effects from other comprehensive income to earnings is done by the portfolio method whereby the effects will remain in AOCIL as long as we carry a more than inconsequential portfolio of securities available for sale.

97

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

A summary of reclassifications out of each component of AOCIL for the years ended December 31 follows:

AOCIL Component	Reclassified From AOCIL			Affected Line Item in  Consolidated Statements of Operations
	(In thousands)
2020
Unrealized gains (losses) on securities available for sale	$	267		Net gains on securities
		-		Net impairment loss recognized in earnings
		267		Total reclassifications before tax
		56		Income tax expense
	$	211		Reclassifications, net of tax
Unrealized gains (losses) on cash flow hedges	$	2,539		Interest expense
		533		Income tax expense
	$	2,006		Reclassification, net of tax
	$	(1,795	)	Total reclassifications for the period, net of tax
2019
Unrealized gains (losses) on securities available for sale	$	140		Net gains on securities
		-		Net impairment loss recognized in earnings
		140		Total reclassifications before tax
		29		Income tax expense
	$	111		Reclassifications, net of tax
Unrealized gains (losses) on cash flow hedges	$	(425	)	Interest expense
		(89	)	Income tax expense
	$	(336	)	Reclassification, net of tax
	$	447		Total reclassifications for the period, net of tax
2018
Unrealized gains (losses) on securities available for sale	$	56		Net gains on securities
		-		Net impairment loss recognized in earnings
		56		Total reclassifications before tax
		12		Income tax expense
	$	44		Reclassifications, net of tax
Unrealized gains (losses) on cash flow hedges	$	(237	)	Interest expense
		(50	)	Income tax expense
	$	(187	)	Reclassification, net of tax
	$	231		Total reclassifications for the period, net of tax

98

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

NOTE 24 – INDEPENDENT BANK CORPORATION (PARENT COMPANY ONLY) FINANCIAL INFORMATION

Presented below are condensed financial statements for our parent company.

CONDENSED STATEMENTS OF FINANCIAL CONDITION
	December 31,
	2020		2019
	(In thousands)
ASSETS
Cash and due from banks	$	10,466	$	10,505
Interest bearing deposits - time		40,000		10,000
Investment in subsidiaries		418,465		369,861
Accrued income and other assets		805		463
Total Assets	$	469,736	$	390,829
LIABILITIES AND SHAREHOLDERS’ EQUITY
Subordinated debt	$	39,281	$	-
Subordinated debentures		39,524		39,456
Accrued expenses and other liabilities		684		575
Shareholders’ equity		390,247		350,798
Total Liabilities and Shareholders’ Equity	$	469,736	$	390,829

CONDENSED STATEMENTS OF OPERATIONS

	Year Ended December 31,
	2020			2019			2018
	(In thousands)
OPERATING INCOME
Dividends from subsidiary	$	24,000		$	29,000		$	33,500
Interest income		99			230			160
Other income		42			61			56
Total Operating Income		24,141			29,291			33,716
OPERATING EXPENSES
Interest expense		2,893			2,104			1,924
Administrative and other expenses		733			655			748
Total Operating Expenses		3,626			2,759			2,672
Income Before Income Tax and Equity in Undistributed Net Income of Subsidiaries		20,515			26,532			31,044
Income tax benefit		(937	)		(423	)		(515	)
Income Before Equity in Undistributed Net Income of Subsidiaries		21,452			26,955			31,559
Equity in undistributed net income of subsidiaries		34,700			19,480			8,280
Net Income	$	56,152		$	46,435		$	39,839

99

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

CONDENSED STATEMENTS OF CASH FLOWS

	Year Ended December 31,
	2020			2019			2018
	(In thousands)
Net Income	$	56,152		$	46,435		$	39,839
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH FROM OPERATING ACTIVITIES
Deferred income tax (benefit) expense		(34	)		1,503			6,620
Share based compensation		89			65			53
Accretion of discount on subordinated debt and debentures		113			68			51
(Increase) decrease in accrued income and other assets		(307	)		891			(1,307	)
Increase in accrued expenses and other liabilities		109			45			21
Equity in undistributed net income of subsidiaries		(34,700	)		(19,480	)		(8,280	)
Total Adjustments		(34,730	)		(16,908	)		(2,842	)
Net Cash From Operating Activities		21,422			29,527			36,997
CASH FLOW FROM (USED IN) INVESTING ACTIVITIES
Purchases of interest bearing deposits - time		(85,000	)		(20,000	)		(30,000	)
Maturity of interest bearing deposits - time		55,000			35,000			10,000
Acquisition of business, less cash received		-			-			431
Net Cash From (Used In) Investing Activities		(30,000	)		15,000			(19,569	)
CASH FLOW FROM (USED IN) FINANCING ACTIVITIES
Proceeds from issuance of subordinated debt, net of issuance costs		39,236			-			-
Dividends paid		(17,618	)		(16,554	)		(14,055	)
Proceeds from issuance of common stock		1,907			2,074			1,945
Share based compensation withholding obligation		(755	)		(882	)		(1,467	)
Repurchase of common stock		(14,231	)		(26,284	)		(12,681	)
Net Cash From (Used In) Financing Activities		8,539			(41,646	)		(26,258	)
Net Increase (Decrease) in Cash and Cash Equivalents		(39	)		2,881			(8,830	)
Cash and Cash Equivalents at Beginning of Year		10,505			7,624			16,454
Cash and Cash Equivalents at End of Year	$	10,466		$	10,505		$	7,624

NOTE 25 – REVENUE FROM CONTRACTS WITH CUSTOMERS

We account for revenue in accordance with ASC Topic 606, Revenue from Contracts with Customers. We derive the majority of our revenue from financial instruments and their related contractual rights and obligations which for the most part are excluded from the scope of this topic. These sources of revenue that are excluded from the scope of this topic include interest income, net gains on mortgage loans, net gains on securities, mortgage loan servicing, net and bank owned life insurance and were approximately 88.1% and 84.9% of total revenues at December 31, 2020 and 2019, respectively.

Material sources of revenue that are included in the scope of ASC Topic 606 include service charges on deposits, other deposit related income, interchange income and investment and insurance commissions and are discussed in the following paragraphs. Generally these sources of revenue are earned at the time the service is delivered or over the course of a monthly period and do not result in any contract asset or liability balance at any given period end. As a result, there were no contract assets or liabilities recorded as of December 31, 2020.

Service charges on deposit accounts and other deposit related income: Revenues are earned on depository accounts for commercial and retail customers and include fees for transaction-based, account maintenance and overdraft services. Transaction-based fees, which includes services such as ATM use fees, stop payment charges and

100

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

ACH fees are recognized at the time the transaction is executed as that is the time we fulfill our customer’s request. Account maintenance fees, which includes monthly maintenance services are earned over the course of a month representing the period over which the performance obligation is satisfied. Our obligation for overdraft services is satisfied at the time of the overdraft.

Interchange income: Interchange income primarily includes debit card interchange and network revenues. Debit card interchange and network revenues are earned on debit card transactions conducted through payment networks such as MasterCard and NYCE. Interchange income is recognized concurrently with the delivery of services on a daily basis. Interchange and network revenues are presented gross of interchange expenses, which are presented separately as a component of non-interest expense.

Investment and insurance commissions: Investment and insurance commissions include fees and commissions from asset management, custody, recordkeeping, investment advisory and other services provided to our customers. Revenue is recognized on an accrual basis at the time the services are performed and are generally based on either the market value of the assets managed or the services provided. We have an agent relationship with a third party  provider of these services and net certain direct costs charged by the third party provider associated with providing these services to our customers.

Net gains on other real estate and repossessed assets: We record a gain or loss from the sale of other real estate when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. If we were to finance the sale of other real estate to the buyer, we would assess whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction is probable. Once these criteria are met, the other real estate asset would be derecognized and the gain or loss on sale would be recorded upon the transfer of control of the property to the buyer. There were no other real estate properties sold during 2020 that were financed by us.

Disaggregation of our revenue sources by attribute for the years ended December 31 follow:

2020
	Service Charges on Deposit Accounts		Other Deposit Related Income		Interchange Income		Investment and Insurance Commissions		Total
	(In thousands)
Retail
Overdraft fees	$	5,627	$	-	$	-	$	-	$	5,627
Account service charges		2,017		-		-		-		2,017
ATM fees		-		1,173		-		-		1,173
Other		-		769		-		-		769
Business
Overdraft fees		873		-		-		-		873
ATM fees		-		24		-		-		24
Other		-		342		-		-		342
Interchange income		-		-		11,230		-		11,230
Asset management revenue		-		-		-		1,283		1,283
Transaction based revenue		-		-		-		688		688
Total	$	8,517	$	2,308	$	11,230	$	1,971	$	24,026
Reconciliation to Consolidated Statement of Operations:
Non-interest income - other:
Other deposit related income									$	2,308
Investment and insurance commissions										1,971
Bank owned life insurance										910
Other										2,332
Total									$	7,521

101

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

2019
	Service Charges on Deposit Accounts		Other Deposit Related Income		Interchange Income		Investment and Insurance Commissions		Total
	(In thousands)
Retail
Overdraft fees	$	7,590	$	-	$	-	$	-	$	7,590
Account service charges		2,103		-		-		-		2,103
ATM fees		-		1,368		-		-		1,368
Other		-		965		-		-		965
Business
Overdraft fees		1,515		-		-		-		1,515
ATM fees		-		35		-		-		35
Other		-		422		-		-		422
Interchange income		-		-		10,297		-		10,297
Asset management revenue		-		-		-		1,123		1,123
Transaction based revenue		-		-		-		535		535
Total	$	11,208	$	2,790	$	10,297	$	1,658	$	25,953
Reconciliation to Consolidated Statement of Operations:
Non-interest income - other:
Other deposit related income									$	2,790
Investment and insurance commissions										1,658
Bank owned life insurance										1,111
Other										3,723
Total									$	9,282

2018
	Service Charges on Deposit Accounts		Other Deposit Related Income		Interchange Income		Investment and Insurance Commissions		Total
	(In thousands)
Retail
Overdraft fees	$	8,285	$	-	$	-	$	-	$	8,285
Account service charges		2,406		-		-		-		2,406
ATM fees		-		1,423		-		-		1,423
Other		-		941		-		-		941
Business
Overdraft fees		1,567		-		-		-		1,567
ATM fees		-		34				-		34
Other		-		594				-		594
Interchange income		-		-		9,905		-		9,905
Asset management revenue		-		-		-		1,100		1,100
Transaction based revenue		-		-		-		871		871
Total	$	12,258	$	2,992	$	9,905	$	1,971	$	27,126
Reconciliation to Consolidated Statement of Operations:
Non-interest income - other:
Other deposit related income									$	2,992
Investment and insurance commissions										1,971
Bank owned life insurance										970
Other										2,827
Total									$	8,760

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

NOTE 26 – RECENT ACQUISITION

Effective April 1, 2018, we completed the acquisition of all of the issued and outstanding shares of common stock of TCSB through a merger of TCSB into Independent Bank Corporation (‘‘IBCP’’), with IBCP as the surviving corporation (the ‘‘Merger’’). On that same date we also consolidated Traverse City State Bank, TCSB’s wholly-owned subsidiary bank, into Independent Bank (with Independent Bank as the surviving institution). Under the terms of the merger agreement each holder of TCSB common stock received 1.1166 shares of IBCP common stock plus cash in lieu of fractional shares totaling $0.005 million. TCSB option holders had their options converted into IBCP stock options. As a result we issued 2.71 million shares of common stock and 0.19 million stock options with a fair value of approximately $64.5 million to the shareholders and option holders of TCSB. The fair value of common stock and stock options issued as the consideration paid for TCSB was determined using the closing price of our common stock on the acquisition date. This acquisition was accounted for under the acquisition method of accounting. Accordingly, we recognized amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair values. TCSB results of operations are included in our results beginning April 1, 2018. Non-interest expense includes zero, zero and $3.5 million of costs incurred during the years ended December 31, 2020, 2019 and 2018, respectively related to the Merger.

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QUARTERLY FINANCIAL DATA (UNAUDITED)

A summary of selected quarterly results of operations for the years ended December 31 follows:

	Three Months Ended
	March 31,		June 30,		September 30,			December 31,
	(In thousands, except per share amounts)
2020
Interest income	$	35,579	$	33,754	$	35,034		$	35,462
Net interest income		30,191		30,462		31,966			30,993
Provision for loan losses		6,721		5,188		975			(421	)
Income before income tax		5,755		18,295		24,361			21,070
Net income		4,810		14,772		19,584			16,986
Net income per common share
Basic		0.22		0.67		0.90			0.78
Diluted		0.21		0.67		0.89			0.77
2019
Interest income	$	36,636	$	37,573	$	37,811		$	36,908
Net interest income		30,243		30,756		30,872			30,710
Provision for loan losses		664		652		(271	)		(221	)
Income before income tax		11,548		13,417		15,570			17,225
Net income		9,381		10,730		12,445			13,879
Net income per common share
Basic		0.40		0.47		0.55			0.62
Diluted		0.39		0.46		0.55			0.61

During the fourth quarter of 2020, we recognized $1.6 million of losses in interest expense relating to cash flow hedges that had been transferred to a no hedge designation (see note #16), $1.5 million of core data processing conversion related expenses and a negative fair value adjustment due to price on our capitalized mortgage loan servicing rights of $0.9 million (see note #4). During the fourth quarter of 2019, we recognized a positive fair value adjustment due to price on our capitalized mortgage loan servicing rights of $0.6 million (see note #4).

QUARTERLY SUMMARY (UNAUDITED)

	Reported Sales Prices of Common Shares
	2020						2019						Cash Dividends Declared
	High		Low		Close		High		Low		Close		2020		2019
First quarter	$	22.98	$	9.19	$	12.87	$	23.64	$	20.40	$	21.50	$	0.20	$	0.18
Second quarter		16.92		10.91		14.85		22.42		20.60		21.79		0.20		0.18
Third quarter		16.20		12.14		12.57		22.25		18.94		21.32		0.20		0.18
Fourth quarter		19.28		12.42		18.47		23.93		20.40		22.65		0.20		0.18

We have approximately 1,400 holders of record of our common stock. Our common stock trades on the NASDAQ Global Select Market System under the symbol “IBCP.” The prices shown above are supplied by NASDAQ and reflect the inter-dealer prices and may not include retail markups, markdowns or commissions. There may have been transactions or quotations at higher or lower prices of which we are not aware.

In addition to limitations imposed by the provisions of the Michigan Business Corporation Act (which, among other things, limits us from paying dividends to the extent we are insolvent), our ability to pay dividends is limited by our ability to obtain funds from our Bank and by regulatory capital guidelines applicable to us (see note #20).

104