| 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. Some loans are unsecured. Loans that we have the intent and ability to hold in our portfolio are reported at their outstanding principal balance adjusted for any charge-offs , the ALLL , and any deferred fees or costs. Interest income is accrued over the term of the loan based on the principal amount outstanding. Loan origination fees and certain direct loan origination costs are capitalized and recognized as a component of interest income over the term of the loan using the level yield method. The accrual of interest on commercial, agricultural, and residential real estate loans is discontinued at the time the loan is 90 days or more past due unless the credit is well-secured and in the process of collection. Upon transferring the loans to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if any charge-offs are necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. For loans that are placed on nonaccrual status or charged-off , all interest accrued in the current calendar year, but not collected, is reversed against interest income while interest accrued in prior calendar years, but not collected, is charged against the ALLL . Loans may be returned to accrual status after six months of continuous performance and achievement of current payment status. Commercial and agricultural loans include loans for commercial real estate, commercial operating loans, advances to mortgage brokers, farmland and agricultural production, and states and political subdivisions. Repayment of these loans is dependent upon the successful operation and management of a business. We minimize our risk by limiting the amount of direct credit exposure to any one borrower to $15,000 . Borrowers with direct credit needs of more than $15,000 are serviced through the use of loan participations with other commercial banks. Commercial and agricultural real estate loans commonly require loan-to-value limits of 80% or less. Depending upon the type of loan, past credit history, and current operating results, we may require the borrower to pledge accounts receivable, inventory, and property and equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we require annual financial statements, prepare cash flow analyses, and review credit reports. We entered into a mortgage purchase program in 2016 with a financial institution where we participate in advances to mortgage brokers ("advances"). The mortgage brokers originate residential mortgage loans with the intent to sell them on the secondary market. We participate in the advance to the mortgage broker, which is secured by the underlying mortgage loan, until it is ultimately sold on the secondary market. As such, the average life of each participated advance is approximately 20 - 30 days. Funds from the sale of the loan are used to pay off our participation in the advance to the mortgage broker. We classify these advances as commercial loans and include the outstanding balance in commercial loans on our balance sheet. Under the participation agreement, we committed to a maximum outstanding aggregate amount of $30,000 . The difference between our outstanding balances and the maximum outstanding aggregate amount is classified as “ Unfunded commitments under lines of credit ” in the “ Contractual Obligations and Loan Commitments ” section of the Management's Discussion and Analysis of Financial Condition and Results of Operations of this report. We offer adjustable rate mortgages, construction loans, and fixed rate residential real estate loans which have amortization periods up to a maximum of 30 years. We consider the anticipated direction of interest rates, balance sheet duration, the sensitivity of our balance sheet to changes in interest rates, and overall loan demand to determine whether or not to sell fixed rate loans to Freddie Mac . Our lending policies generally limit the maximum loan-to-value ratio on residential real estate loans to 100% of the lower of the appraised value of the property or the purchase price. Private mortgage insurance is typically required on loans with loan-to-value ratios in excess of 80% unless the loan qualifies for government guarantees. Underwriting criteria for originated residential real estate loans generally include: • Evaluation of the borrower’s ability to make monthly payments. • Evaluation of the value of the property securing the loan. • Ensuring the payment of principal, interest, taxes, and hazard insurance does not exceed 28% of a borrower’s gross income. • Ensuring all debt servicing does not exceed 40% of income. • Verification of acceptable credit reports. • Verification of employment, income, and financial information. Appraisals are performed by independent appraisers and reviewed for appropriateness. All 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 15 years based on the age and value of the underlying collateral. The underwriting emphasis is on a borrower’s perceived intent and ability to pay rather than collateral value. No consumer loans are sold to the secondary market. The ALLL is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the ALLL when we believe the uncollectability of the loan balance is confirmed. Subsequent recoveries, if any, are credited to the ALLL . The appropriateness of the ALLL is evaluated on a quarterly basis and is based upon a periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The primary factors behind the determination of the level of the ALLL are specific allocations for impaired loans, historical loss percentages, as well as unallocated components. Specific allocations for impaired loans are primarily determined based on the difference between the loan’s outstanding balance and the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral, less cost to sell. Historical loss allocations are calculated at the loan class and segment levels based on a migration analysis of the loan portfolio, with the exception of advances to mortgage brokers, over the preceding five years. With no historical losses on advances to mortgage brokers, there is no allocation in the commercial segment displayed in the following tables based on historical loss factors. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. A summary of changes in the ALLL and the recorded investment in loans by segments follows: Allowance for Loan Losses Three Months Ended March 31, 2018 Commercial Agricultural Residential Real Estate Consumer Unallocated Total January 1, 2018 $ 1,706 $ 611 $ 2,563 $ 900 $ 1,920 $ 7,700 Charge-offs (5 ) — (10 ) (88 ) — (103 ) Recoveries 103 — 56 60 — 219 Provision for loan losses 36 613 (127 ) (77 ) (61 ) 384 March 31, 2018 $ 1,840 $ 1,224 $ 2,482 $ 795 $ 1,859 $ 8,200 Allowance for Loan Losses and Recorded Investment in Loans March 31, 2018 Commercial Agricultural Residential Real Estate Consumer Unallocated Total ALLL Individually evaluated for impairment $ 842 $ 141 $ 1,520 $ — $ — $ 2,503 Collectively evaluated for impairment 998 1,083 962 795 1,859 5,697 Total $ 1,840 $ 1,224 $ 2,482 $ 795 $ 1,859 $ 8,200 Loans Individually evaluated for impairment $ 11,675 $ 11,468 $ 7,940 $ 12 $ 31,095 Collectively evaluated for impairment 631,961 110,862 262,210 56,874 1,061,907 Total $ 643,636 $ 122,330 $ 270,150 $ 56,886 $ 1,093,002 Allowance for Loan Losses Three Months Ended March 31, 2017 Commercial Agricultural Residential Real Estate Consumer Unallocated Total January 1, 2017 $ 1,814 $ 884 $ 2,664 $ 624 $ 1,414 $ 7,400 Charge-offs (27 ) — (43 ) (74 ) — (144 ) Recoveries 133 — 36 48 — 217 Provision for loan losses (149 ) (357 ) 441 73 19 27 March 31, 2017 $ 1,771 $ 527 $ 3,098 $ 671 $ 1,433 $ 7,500 Allowance for Loan Losses and Recorded Investment in Loans December 31, 2017 Commercial Agricultural Residential Real Estate Consumer Unallocated Total ALLL Individually evaluated for impairment $ 650 $ — $ 1,480 $ — $ — $ 2,130 Collectively evaluated for impairment 1,056 611 1,083 900 1,920 5,570 Total $ 1,706 $ 611 $ 2,563 $ 900 $ 1,920 $ 7,700 Loans Individually evaluated for impairment $ 8,099 $ 10,598 $ 7,939 $ 17 $ 26,653 Collectively evaluated for impairment 626,660 117,671 264,429 56,106 1,064,866 Total $ 634,759 $ 128,269 $ 272,368 $ 56,123 $ 1,091,519 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, 2018 Commercial Agricultural Real Estate Other Advances to Mortgage Brokers Total Real Estate Other Total Total Rating 1 - Excellent $ 23 $ — $ — $ 23 $ — $ 34 $ 34 $ 57 2 - High quality 5,417 14,939 — 20,356 2,783 814 3,597 23,953 3 - High satisfactory 117,378 44,538 17,974 179,890 20,474 6,094 26,568 206,458 4 - Low satisfactory 337,859 84,149 — 422,008 46,040 18,066 64,106 486,114 5 - Special mention 8,615 1,562 — 10,177 9,618 5,192 14,810 24,987 6 - Substandard 5,424 2,191 — 7,615 6,435 4,887 11,322 18,937 7 - Vulnerable 2,364 1,203 — 3,567 1,529 364 1,893 5,460 8 - Doubtful — — — — — — — — Total $ 477,080 $ 148,582 $ 17,974 $ 643,636 $ 86,879 $ 35,451 $ 122,330 $ 765,966 December 31, 2017 Commercial Agricultural Real Estate Other Advances to Mortgage Brokers Total Real Estate Other Total Total Rating 1 - Excellent $ 24 $ 316 $ — $ 340 $ — $ 34 $ 34 $ 374 2 - High quality 8,402 12,262 — 20,664 2,909 1,024 3,933 24,597 3 - High satisfactory 131,826 46,668 12,081 190,575 21,072 8,867 29,939 220,514 4 - Low satisfactory 326,166 75,591 — 401,757 47,835 18,467 66,302 468,059 5 - Special mention 8,986 3,889 — 12,875 10,493 8,546 19,039 31,914 6 - Substandard 5,521 2,298 — 7,819 4,325 2,747 7,072 14,891 7 - Vulnerable 729 — — 729 1,531 419 1,950 2,679 8 - Doubtful — — — — — — — — Total $ 481,654 $ 141,024 $ 12,081 $ 634,759 $ 88,165 $ 40,104 $ 128,269 $ 763,028 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, 2018 Accruing Interest Total Past Due and Nonaccrual 30-59 60-89 90 Days Nonaccrual Current Total Commercial Commercial real estate $ 95 $ 30 $ 51 $ 2,364 $ 2,540 $ 474,540 $ 477,080 Commercial other 1,331 49 — 1,203 2,583 145,999 148,582 Advances to mortgage brokers — — — — — 17,974 17,974 Total commercial 1,426 79 51 3,567 5,123 638,513 643,636 Agricultural Agricultural real estate 805 804 463 1,529 3,601 83,278 86,879 Agricultural other 250 42 18 364 674 34,777 35,451 Total agricultural 1,055 846 481 1,893 4,275 118,055 122,330 Residential real estate Senior liens 3,020 300 22 754 4,096 225,033 229,129 Junior liens 23 — 10 23 56 6,422 6,478 Home equity lines of credit 189 173 100 — 462 34,081 34,543 Total residential real estate 3,232 473 132 777 4,614 265,536 270,150 Consumer Secured 103 — — — 103 52,958 53,061 Unsecured 12 — — — 12 3,813 3,825 Total consumer 115 — — — 115 56,771 56,886 Total $ 5,828 $ 1,398 $ 664 $ 6,237 $ 14,127 $ 1,078,875 $ 1,093,002 December 31, 2017 Accruing Interest Total Past Due and Nonaccrual 30-59 60-89 90 Days Nonaccrual Current Total Commercial Commercial real estate $ 295 $ 325 $ 54 $ 729 $ 1,403 $ 480,251 $ 481,654 Commercial other 1,069 28 18 — 1,115 139,909 141,024 Advances to mortgage brokers — — — — — 12,081 12,081 Total commercial 1,364 353 72 729 2,518 632,241 634,759 Agricultural Agricultural real estate 84 190 — 1,531 1,805 86,360 88,165 Agricultural other 39 — 104 419 562 39,542 40,104 Total agricultural 123 190 104 1,950 2,367 125,902 128,269 Residential real estate Senior liens 3,718 234 132 325 4,409 225,007 229,416 Junior liens 69 10 — 23 102 6,812 6,914 Home equity lines of credit 293 — 77 — 370 35,668 36,038 Total residential real estate 4,080 244 209 348 4,881 267,487 272,368 Consumer Secured 37 10 10 — 57 52,005 52,062 Unsecured 13 — — — 13 4,048 4,061 Total consumer 50 10 10 — 70 56,053 56,123 Total $ 5,617 $ 797 $ 395 $ 3,027 $ 9,836 $ 1,081,683 $ 1,091,519 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, 2018 December 31, 2017 Recorded Balance Unpaid Principal Balance Valuation Allowance Recorded Balance Unpaid Principal Balance Valuation Allowance Impaired loans with a valuation allowance Commercial real estate $ 5,946 $ 6,234 $ 639 $ 4,089 $ 4,378 $ 626 Commercial other 2,099 2,099 203 995 995 24 Agricultural real estate 881 881 141 — — — Agricultural other — — — — — — Residential real estate senior liens 7,831 8,459 1,514 7,816 8,459 1,473 Residential real estate junior liens 36 36 6 44 44 7 Total impaired loans with a valuation allowance 16,793 17,709 2,503 12,944 13,876 2,130 Impaired loans without a valuation allowance Commercial real estate 2,466 2,540 1,791 1,865 Commercial other 1,164 1,164 1,224 1,224 Agricultural real estate 8,082 8,082 7,913 7,913 Agricultural other 2,505 2,505 2,685 2,685 Home equity lines of credit 73 373 79 379 Consumer secured 12 12 17 17 Total impaired loans without a valuation allowance 14,302 14,676 13,709 14,083 Impaired loans Commercial 11,675 12,037 842 8,099 8,462 650 Agricultural 11,468 11,468 141 10,598 10,598 — Residential real estate 7,940 8,868 1,520 7,939 8,882 1,480 Consumer 12 12 — 17 17 — Total impaired loans $ 31,095 $ 32,385 $ 2,503 $ 26,653 $ 27,959 $ 2,130 The following is a summary of information pertaining to impaired loans for the: Three Months Ended March 31 2018 2017 Average Recorded Balance Interest Income Recognized Average Recorded Balance Interest Income Recognized Impaired loans with a valuation allowance Commercial real estate $ 5,018 $ 91 $ 5,015 $ 73 Commercial other 1,547 24 1,275 24 Agricultural real estate 441 4 — — Agricultural other — — 67 — Residential real estate senior liens 7,824 74 8,420 83 Residential real estate junior liens 40 — 75 — Total impaired loans with a valuation allowance 14,870 193 14,852 180 Impaired loans without a valuation allowance Commercial real estate 2,129 35 1,326 33 Commercial other 1,194 17 114 2 Agricultural real estate 7,998 40 4,042 62 Agricultural other 2,595 36 1,438 13 Home equity lines of credit 76 5 133 5 Consumer secured 15 — 25 — Total impaired loans without a valuation allowance 14,007 133 7,078 115 Impaired loans Commercial 9,888 167 7,730 132 Agricultural 11,034 80 5,547 75 Residential real estate 7,940 79 8,628 88 Consumer 15 — 25 — Total impaired loans $ 28,877 $ 326 $ 21,930 $ 295 We had committed to advance $637 and $472 in connection with impaired loans, which includes TDRs , as of March 31, 2018 and December 31, 2017 , respectively. Troubled Debt Restructurings Loan modifications are considered to be TDRs when the modification includes terms outside of normal lending practices to a borrower who is experiencing financial difficulties. Typical concessions granted include, but are not limited to: • Agreeing to interest rates below prevailing market rates for debt with similar risk characteristics. • Extending the amortization period beyond typical lending guidelines for loans with similar risk characteristics. • Agreeing to an interest only payment structure and delaying principal payments. • Forgiving principal. • Forgiving accrued interest. To determine if a borrower is experiencing financial difficulties, factors we consider include: • The borrower is currently in default on any of their debt. • The borrower would likely default on any of their debt if the concession was not granted. • The borrower’s cash flow was insufficient to service all of their debt if the concession was not granted. • The borrower has declared, or is in the process of declaring, bankruptcy. • The borrower is unlikely to continue as a going concern (if the entity is a business). The following is a summary of information pertaining to TDRs granted for the: Three Months Ended March 31 2018 2017 Number of Loans Pre-Modification Recorded Investment Post-Modification Recorded Investment Number of Loans Pre-Modification Recorded Investment Post-Modification Recorded Investment Commercial other 3 $ 1,255 $ 1,255 2 $ 227 $ 227 Agricultural other 2 1,061 1,061 — — — Residential real estate Senior liens 2 167 167 — — — Junior liens — — — 1 8 8 Total residential real estate 2 167 167 1 8 8 Total 7 $ 2,483 $ 2,483 3 $ 235 $ 235 The following table summarizes concessions we granted to borrowers in financial difficulty for the: Three Months Ended March 31 2018 2017 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 1 $ 174 2 $ 1,081 — $ — 2 $ 227 Agricultural other 1 98 1 963 — — — — Residential real estate Senior liens — — 2 167 — — — — Junior liens — — — — 1 8 — — Total residential real estate — — 2 167 1 8 — — Total 2 $ 272 5 $ 2,211 1 $ 8 2 $ 227 We did not restructure any loans by forgiving principal or accrued interest in the three month periods ended March 31, 2018 or 2017 . 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, 2018 and March 31, 2017 which were modified within 12 months prior to the default date. The following is a summary of TDR loan balances as of: March 31, 2018 December 31, 2017 TDRs $ 27,540 $ 26,197 |
