| Loans and ALLL | Loans and ALLL We grant commercial, agricultural, residential real estate, and consumer loans to customers situated primarily in Clare, Gratiot, Isabella, Mecosta, Midland, Montcalm, and Saginaw counties in Michigan. The ability of the borrowers to honor their repayment obligations is often dependent upon the real estate, agricultural, manufacturing, retail, gaming, tourism, higher education, and general economic conditions of this region. Substantially all of our consumer and residential real estate loans are secured by various items of property, while commercial loans are secured primarily by real estate, business assets, and personal guarantees; a portion of loans are unsecured. Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs , the ALLL , and any deferred fees or costs. Interest income is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the level yield method. The accrual of interest on commercial, agricultural, and residential real estate loans is discontinued at the time the loan is 90 days or more past due unless the credit is well-secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. For loans that are placed on nonaccrual status or charged-off , all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the ALLL . Loans may be returned to accrual status after six months of continuous performance. Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, farmland and agricultural production, and states and political subdivisions. Repayment of these loans is dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of direct credit exposure to any one borrower to $15,000 . Borrowers with direct credit needs of more than $15,000 are serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans commonly require loan-to-value limits of 80% or less. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, and property and equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we require annual financial statements, prepare cash flow analyses, and review credit reports. We offer adjustable rate mortgages, construction loans, and fixed rate residential real estate loans which have amortization periods up to a maximum of 30 years. We consider the anticipated direction of interest rates, balance sheet duration, the sensitivity of our balance sheet to changes in interest rates, and overall loan demand to determine whether or not to sell fixed rate loans to Freddie Mac . Our lending policies generally limit the maximum loan-to-value ratio on residential real estate loans to 97% of the lower of the appraised value of the property or the purchase price, with the condition that private mortgage insurance is required on loans with loan-to-value ratios in excess of 80% . Underwriting criteria for residential real estate loans include: • Evaluation of the borrower’s ability to make monthly payments. • Evaluation of the value of the property securing the loan. • Ensuring the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower’s gross income. • Ensuring all debt servicing does not exceed 36% of income. • Verification of acceptable credit reports. • Verification of employment, income, and financial information. Appraisals are performed by independent appraisers and reviewed for appropriateness. All mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market underwriting system; loans in excess of $500 require the approval of our Internal Loan Committee, the Executive Loan Committee, the Board of Directors’ Loan Committee, or the Board of Directors. Consumer loans include secured and unsecured personal loans. Loans are amortized for a period of up to 12 years based on the age and value of the underlying collateral. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market. The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL . The appropriateness of the ALLL is evaluated on a quarterly basis and is based upon a periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. Specific allocations for impaired loans are primarily determined based on the difference between the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell. Historical loss allocations are calculated at the loan class and segment levels based on a migration analysis of the loan portfolio over the preceding five years. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. A summary of changes in the ALLL and the recorded investment in loans by segments follows: Allowance for Loan Losses Three months ended March 31, 2016 Commercial Agricultural Residential Real Estate Consumer Unallocated Total January 1, 2016 $ 2,171 $ 329 $ 3,330 $ 522 $ 1,048 $ 7,400 Charge-offs (16 ) — (241 ) (84 ) — (341 ) Recoveries 89 92 50 54 — 285 Provision for loan losses 177 (85 ) (9 ) 48 25 156 March 31, 2016 $ 2,421 $ 336 $ 3,130 $ 540 $ 1,073 $ 7,500 Allowance for Loan Losses and Recorded Investment in Loans March 31, 2016 Commercial Agricultural Residential Real Estate Consumer Unallocated Total ALLL Individually evaluated for impairment $ 908 $ — $ 1,823 $ — $ — $ 2,731 Collectively evaluated for impairment 1,513 336 1,307 540 1,073 4,769 Total $ 2,421 $ 336 $ 3,130 $ 540 $ 1,073 $ 7,500 Loans Individually evaluated for impairment $ 6,840 $ 4,065 $ 10,088 $ 34 $ 21,027 Collectively evaluated for impairment 463,465 111,621 239,230 34,948 849,264 Total $ 470,305 $ 115,686 $ 249,318 $ 34,982 $ 870,291 Allowance for Loan Losses Three Months Ended March 31, 2015 Commercial Agricultural Residential Real Estate Consumer Unallocated Total January 1, 2015 $ 3,821 $ 216 $ 4,235 $ 645 $ 1,183 $ 10,100 Charge-offs (17 ) — (50 ) (93 ) — (160 ) Recoveries 213 72 33 68 — 386 Provision for loan losses (209 ) (82 ) (490 ) 91 (36 ) (726 ) March 31, 2015 $ 3,808 $ 206 $ 3,728 $ 711 $ 1,147 $ 9,600 Allowance for Loan Losses and Recorded Investment in Loans December 31, 2015 Commercial Agricultural Residential Real Estate Consumer Unallocated Total ALLL Individually evaluated for impairment $ 829 $ 2 $ 1,989 $ — $ — $ 2,820 Collectively evaluated for impairment 1,342 327 1,341 522 1,048 4,580 Total $ 2,171 $ 329 $ 3,330 $ 522 $ 1,048 $ 7,400 Loans Individually evaluated for impairment $ 7,969 $ 4,068 $ 10,266 $ 35 $ 22,338 Collectively evaluated for impairment 440,412 111,843 241,235 34,664 828,154 Total $ 448,381 $ 115,911 $ 251,501 $ 34,699 $ 850,492 The following table displays the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit risk ratings as of: March 31, 2016 Commercial Agricultural Real Estate Other Total Real Estate Other Total Rating 1 - Excellent $ — $ 729 $ 729 $ — $ — $ — 2 - High quality 10,638 9,950 20,588 4,469 1,608 6,077 3 - High satisfactory 99,591 25,599 125,190 27,867 11,771 39,638 4 - Low satisfactory 238,565 72,438 311,003 37,292 21,809 59,101 5 - Special mention 4,069 483 4,552 3,742 4,266 8,008 6 - Substandard 7,834 241 8,075 2,113 603 2,716 7 - Vulnerable 168 — 168 146 — 146 8 - Doubtful — — — — — — Total $ 360,865 $ 109,440 $ 470,305 $ 75,629 $ 40,057 $ 115,686 December 31, 2015 Commercial Agricultural Real Estate Other Total Real Estate Other Total Rating 1 - Excellent $ — $ 499 $ 499 $ — $ — $ — 2 - High quality 7,397 11,263 18,660 4,647 2,150 6,797 3 - High satisfactory 99,136 29,286 128,422 28,886 13,039 41,925 4 - Low satisfactory 222,431 62,987 285,418 37,279 22,166 59,445 5 - Special mention 4,501 473 4,974 3,961 1,875 5,836 6 - Substandard 9,941 256 10,197 1,623 139 1,762 7 - Vulnerable 211 — 211 146 — 146 8 - Doubtful — — — — — — Total $ 343,617 $ 104,764 $ 448,381 $ 76,542 $ 39,369 $ 115,911 Internally assigned credit risk ratings are reviewed, at a minimum, when loans are renewed or when management has knowledge of improvements or deterioration of the credit quality of individual credits. Descriptions of the internally assigned credit risk ratings for commercial and agricultural loans are as follows: 1. EXCELLENT – Substantially Risk Free Credit has strong financial condition and solid earnings history, characterized by: • High liquidity, strong cash flow, low leverage. • Unquestioned ability to meet all obligations when due. • Experienced management, with management succession in place. • Secured by cash. 2. HIGH QUALITY – Limited Risk Credit with sound financial condition and a positive trend in earnings supplemented by: • Favorable liquidity and leverage ratios. • Ability to meet all obligations when due. • Management with successful track record. • Steady and satisfactory earnings history. • If loan is secured, collateral is of high quality and readily marketable. • Access to alternative financing. • Well defined primary and secondary source of repayment. • If supported by guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident. 3. HIGH SATISFACTORY – Reasonable Risk Credit with satisfactory financial condition and further characterized by: • Working capital adequate to support operations. • Cash flow sufficient to pay debts as scheduled. • Management experience and depth appear favorable. • Loan performing according to terms. • If loan is secured, collateral is acceptable and loan is fully protected. 4. LOW SATISFACTORY – Acceptable Risk Credit with bankable risks, although some signs of weaknesses are shown: • Would include most start-up businesses. • Occasional instances of trade slowness or repayment delinquency – may have been 10 - 30 days slow within the past year. • Management’s abilities are apparent, yet unproven. • Weakness in primary source of repayment with adequate secondary source of repayment. • Loan structure generally in accordance with policy. • If secured, loan collateral coverage is marginal. • Adequate cash flow to service debt, but coverage is low. To be classified as less than satisfactory, only one of the following criteria must be met. 5. SPECIAL MENTION – Criticized Credit constitutes an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific loan: • Downward trend in sales, profit levels, and margins. • Impaired working capital position. • Cash flow is strained in order to meet debt repayment. • Loan delinquency ( 30 - 60 days) and overdrafts may occur. • Shrinking equity cushion. • Diminishing primary source of repayment and questionable secondary source. • Management abilities are questionable. • Weak industry conditions. • Litigation pending against the borrower. • Collateral or guaranty offers limited protection. • Negative debt service coverage, however the credit is well collateralized and payments are current. 6. SUBSTANDARD – Classified Credit where the borrower’s current net worth, paying capacity, and value of the collateral pledged is inadequate. There is a distinct possibility that we will implement collection procedures if the loan deficiencies are not corrected. In addition, the following characteristics may apply: • Sustained losses have severely eroded the equity and cash flow. • Deteriorating liquidity. • Serious management problems or internal fraud. • Original repayment terms liberalized. • Likelihood of bankruptcy. • Inability to access other funding sources. • Reliance on secondary source of repayment. • Litigation filed against borrower. • Collateral provides little or no value. • Requires excessive attention of the loan officer. • Borrower is uncooperative with loan officer. 7. VULNERABLE – Classified Credit is considered “Substandard” and warrants placing on nonaccrual status. Risk of loss is being evaluated and exit strategy options are under review. Other characteristics that may apply: • Insufficient cash flow to service debt. • Minimal or no payments being received. • Limited options available to avoid the collection process. • Transition status, expect action will take place to collect loan without immediate progress being made. 8. DOUBTFUL – Workout Credit has all the weaknesses inherent in a “Substandard” loan with the added characteristic that collection and/or liquidation is pending. The possibility of a loss is extremely high, but its classification as a loss is deferred until liquidation procedures are completed, or reasonably estimable. Other characteristics that may apply: • Normal operations are severely diminished or have ceased. • Seriously impaired cash flow. • Original repayment terms materially altered. • Secondary source of repayment is inadequate. • Survivability as a “going concern” is impossible. • Collection process has begun. • Bankruptcy petition has been filed. • Judgments have been filed. • Portion of the loan balance has been charged-off . Our primary credit quality indicator for residential real estate and consumer loans is the individual loan’s past due aging. The following tables summarize the past due and current loans as of: March 31, 2016 Accruing Interest Total Past Due and Nonaccrual 30-59 60-89 90 Days Nonaccrual Current Total Commercial Commercial real estate $ 859 $ — $ 55 $ 168 $ 1,082 $ 359,783 $ 360,865 Commercial other 231 — — — 231 109,209 109,440 Total commercial 1,090 — 55 168 1,313 468,992 470,305 Agricultural Agricultural real estate 629 — — 146 775 74,854 75,629 Agricultural other 79 — — — 79 39,978 40,057 Total agricultural 708 — — 146 854 114,832 115,686 Residential real estate Senior liens 1,665 134 — 702 2,501 199,836 202,337 Junior liens 43 — — — 43 8,941 8,984 Home equity lines of credit 303 — — — 303 37,694 37,997 Total residential real estate 2,011 134 — 702 2,847 246,471 249,318 Consumer Secured 24 — — — 24 31,500 31,524 Unsecured 4 — — — 4 3,454 3,458 Total consumer 28 — — — 28 34,954 34,982 Total $ 3,837 $ 134 $ 55 $ 1,016 $ 5,042 $ 865,249 $ 870,291 December 31, 2015 Accruing Interest Total Past Due and Nonaccrual 30-59 60-89 90 Days Nonaccrual Current Total Commercial Commercial real estate $ 505 $ 281 $ — $ 211 $ 997 $ 342,620 $ 343,617 Commercial other 18 — — — 18 104,746 104,764 Total commercial 523 281 — 211 1,015 447,366 448,381 Agricultural Agricultural real estate 196 890 — 146 1,232 75,310 76,542 Agricultural other — — — — — 39,369 39,369 Total agricultural 196 890 — 146 1,232 114,679 115,911 Residential real estate Senior liens 1,551 261 — 429 2,241 199,622 201,863 Junior liens 40 8 — 6 54 9,325 9,379 Home equity lines of credit 225 — — — 225 40,034 40,259 Total residential real estate 1,816 269 — 435 2,520 248,981 251,501 Consumer Secured 27 — — — 27 30,839 30,866 Unsecured 4 — — — 4 3,829 3,833 Total consumer 31 — — — 31 34,668 34,699 Total $ 2,566 $ 1,440 $ — $ 792 $ 4,798 $ 845,694 $ 850,492 Impaired Loans Loans may be classified as impaired if they meet one or more of the following criteria: 1. There has been a charge-off of its principal balance (in whole or in part); 2. The loan has been classified as a TDR ; or 3. The loan is in nonaccrual status. Impairment is measured on a loan-by-loan basis for commercial and agricultural loans by comparing the loan’s outstanding balance to the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell, if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Impairment is measured on a loan-by-loan basis for residential real estate and consumer loans by comparing the loan’s unpaid principal balance to the present value of expected future cash flows discounted at the loan’s effective interest rate. We do not recognize interest income on impaired loans in nonaccrual status. For impaired loans not classified as nonaccrual , interest income is recognized daily, as earned, according to the terms of the loan agreement and the principal amount outstanding. The following is a summary of information pertaining to impaired loans as of: March 31, 2016 December 31, 2015 Outstanding Balance Unpaid Principal Balance Valuation Allowance Outstanding Balance Unpaid Principal Balance Valuation Allowance Impaired loans with a valuation allowance Commercial real estate $ 5,856 $ 5,976 $ 906 $ 5,659 $ 5,777 $ 818 Commercial other 96 96 2 8 8 11 Agricultural real estate — — — — — — Agricultural other — — — 335 335 2 Residential real estate senior liens 9,832 10,596 1,796 9,996 10,765 1,959 Residential real estate junior liens 135 145 27 143 163 30 Home equity lines of credit — — — — — — Consumer secured — — — — — — Total impaired loans with a valuation allowance 15,919 16,813 2,731 16,141 17,048 2,820 Impaired loans without a valuation allowance Commercial real estate 807 940 2,122 2,256 Commercial other 81 92 180 191 Agricultural real estate 3,546 3,546 3,549 3,549 Agricultural other 519 519 184 184 Home equity lines of credit 121 421 127 434 Consumer secured 34 34 35 35 Total impaired loans without a valuation allowance 5,108 5,552 6,197 6,649 Impaired loans Commercial 6,840 7,104 908 7,969 8,232 829 Agricultural 4,065 4,065 — 4,068 4,068 2 Residential real estate 10,088 11,162 1,823 10,266 11,362 1,989 Consumer 34 34 — 35 35 — Total impaired loans $ 21,027 $ 22,365 $ 2,731 $ 22,338 $ 23,697 $ 2,820 The following is a summary of information pertaining to impaired loans for the three month periods ended: March 31, 2016 March 31, 2015 Average Outstanding Balance Interest Income Recognized Average Outstanding Balance Interest Income Recognized Impaired loans with a valuation allowance Commercial real estate $ 5,758 $ 84 $ 7,277 $ 91 Commercial other 52 1 594 10 Agricultural real estate — — 44 1 Agricultural other 168 — — — Residential real estate senior liens 9,914 100 11,611 118 Residential real estate junior liens 139 1 258 2 Home equity lines of credit — — 125 — Consumer secured — — 52 1 Total impaired loans with a valuation allowance 16,031 186 19,961 223 Impaired loans without a valuation allowance Commercial real estate 1,465 19 3,405 61 Commercial other 131 2 130 3 Agricultural real estate 3,548 45 1,481 21 Agricultural other 352 6 56 1 Home equity lines of credit 124 4 120 6 Consumer secured 35 1 5 — Total impaired loans without a valuation allowance 5,655 77 5,197 92 Impaired loans Commercial 7,406 106 11,406 165 Agricultural 4,068 51 1,581 23 Residential real estate 10,177 105 12,114 126 Consumer 35 1 57 1 Total impaired loans $ 21,686 $ 263 $ 25,158 $ 315 As of March 31, 2016 and December 31, 2015 , we had no commitments to advance in connection with impaired loans, which include TDRs . Troubled Debt Restructurings Loan modifications are considered to be TDRs when the modification includes terms outside of normal lending practices to a borrower who is experiencing financial difficulties. Typical concessions granted include, but are not limited to: 1. Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics. 2. Extending the amortization period beyond typical lending guidelines for loans with similar risk characteristics. 3. Forgiving principal. 4. Forgiving accrued interest. To determine if a borrower is experiencing financial difficulties, factors we consider include: 1. The borrower is currently in default on any of their debt. 2. The borrower would likely default on any of their debt if the concession was not granted. 3. The borrower’s cash flow was insufficient to service all of their debt if the concession was not granted. 4. The borrower has declared, or is in the process of declaring, bankruptcy. 5. The borrower is unlikely to continue as a going concern (if the entity is a business). The following is a summary of information pertaining to TDRs granted for the: Three Months Ended March 31, 2016 Three Months Ended March 31, 2015 Number of Loans Pre-Modification Recorded Investment Post-Modification Recorded Investment Number of Loans Pre-Modification Recorded Investment Post-Modification Recorded Investment Commercial other — $ — $ — 4 $ 514 $ 514 Residential real estate Senior liens 2 26 26 2 238 238 Home equity lines of credit — — — 1 94 94 Total residential real estate 2 26 26 3 332 332 Consumer unsecured 1 2 2 — — — Total 3 $ 28 $ 28 7 $ 846 $ 846 The following tables summarize concessions we granted to borrowers in financial difficulty for the: Three Months Ended March 31, 2016 Three Months Ended March 31, 2015 Below Market Interest Rate Below Market Interest Rate and Extension of Amortization Period Below Market Interest Rate Below Market Interest Rate and Extension of Amortization Period Number of Loans Pre-Modification Recorded Investment Number of Loans Pre-Modification Recorded Investment Number of Loans Pre-Modification Recorded Investment Number of Loans Pre-Modification Recorded Investment Commercial other — $ — — $ — 2 $ 183 2 $ 331 Residential real estate Senior liens 2 26 — — 1 49 1 189 Home equity lines of credit — — — — — — 1 94 Total residential real estate 2 26 — — 1 49 2 283 Consumer unsecured — — 1 2 — — — — Total 2 $ 26 1 $ 2 3 $ 232 4 $ 614 We did not restructure any loans by forgiving principal or accrued interest in the three month periods ended March 31, 2016 or 2015 . Based on our historical loss experience, losses associated with TDRs are not significantly different than other impaired loans within the same loan segment. As such, TDRs , including TDRs that have been modified in the past 12 months that subsequently defaulted, are analyzed in the same manner as other impaired loans within their respective loan segment. We had no loans that defaulted in the three month periods ended March 31, 2016 and 2015 which were modified within 12 months prior to the default date. The following is a summary of TDR loan balances as of: March 31 December 31 TDRs $ 19,988 $ 21,325 |
