| 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 appropriate amortization methods. The accrual of interest on commercial and agricultural loans, as well as residential real estate loans, is discontinued at the time a loan is 90 days or more past due unless the credit is well-secured and in the process of short-term collection. Upon transferring a loan to nonaccrual status, we perform an evaluation to determine the net realizable value of the underlying collateral. This evaluation is used to help determine if a charge-off is necessary. Consumer loans are typically charged-off no later than 180 days past due. Past due status is based on the contractual term of the loan. In all cases, a loan is placed in nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. When a loan is placed in 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 loans to 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 may be 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, property, or equipment. Personal guarantees are generally required from the owners of closely held corporations, partnerships, and sole proprietorships. In addition, we may 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 consolidated balance sheets. Under the participation agreement, we committed to a maximum outstanding aggregate amount of $50,000 . The difference between our outstanding balance 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, our liquidity needs, 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 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 are reviewed for appropriateness. Generally, mortgage loan requests are reviewed by our mortgage loan committee or through a secondary market underwriting system; loans in excess of $1,000 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 probable. Subsequent recoveries, if any, are credited to the ALLL . The ALLL is evaluated on a regular basis for appropriateness. Our periodic review of the collectability of a loan considers 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, or the fair value of the collateral, less costs to sell, if the loan is collateral dependent. 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. 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 Year Ended December 31, 2019 Commercial Agricultural Residential Real Estate Consumer Unallocated Total January 1, 2019 $ 2,563 $ 775 $ 1,992 $ 857 $ 2,188 $ 8,375 Charge-offs (143 ) (240 ) (99 ) (466 ) — (948 ) Recoveries 123 3 189 167 — 482 Provision for loan losses (629 ) 96 (35 ) 364 234 30 December 31, 2019 $ 1,914 $ 634 $ 2,047 $ 922 $ 2,422 $ 7,939 Allowance for Loan Losses Year Ended December 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 (575 ) (51 ) (151 ) (324 ) — (1,101 ) Recoveries 325 3 261 209 — 798 Provision for loan losses 1,107 212 (681 ) 72 268 978 December 31, 2018 $ 2,563 $ 775 $ 1,992 $ 857 $ 2,188 $ 8,375 Allowance for Loan Losses and Recorded Investment in Loans As of December 31, 2019 Commercial Agricultural Residential Real Estate Consumer Unallocated Total ALLL Individually evaluated for impairment $ 15 $ 26 $ 1,073 $ — $ — $ 1,114 Collectively evaluated for impairment 1,899 608 974 922 2,422 6,825 Total $ 1,914 $ 634 $ 2,047 $ 922 $ 2,422 $ 7,939 Loans Individually evaluated for impairment $ 7,865 $ 14,840 $ 5,486 $ — $ 28,191 Collectively evaluated for impairment 693,076 102,080 293,083 70,140 1,158,379 Total $ 700,941 $ 116,920 $ 298,569 $ 70,140 $ 1,186,570 Allowance for Loan Losses and Recorded Investment in Loans As of December 31, 2018 Commercial Agricultural Residential Real Estate Consumer Unallocated Total ALLL Individually evaluated for impairment $ 443 $ 132 $ 1,363 $ — $ — $ 1,938 Collectively evaluated for impairment 2,120 643 629 857 2,188 6,437 Total $ 2,563 $ 775 $ 1,992 $ 857 $ 2,188 $ 8,375 Loans Individually evaluated for impairment $ 9,899 $ 14,298 $ 6,893 $ 9 $ 31,099 Collectively evaluated for impairment 649,630 112,863 268,450 66,665 1,097,608 Total $ 659,529 $ 127,161 $ 275,343 $ 66,674 $ 1,128,707 The following tables display the credit quality indicators for commercial and agricultural credit exposures based on internally assigned credit risk ratings as of December 31 : 2019 Commercial Agricultural Real Estate Other Advances to Mortgage Brokers Total Real Estate Other Total Total Rating 1 - Excellent $ — $ 390 $ — $ 390 $ — $ — $ — $ 390 2 - High quality 2,582 8,844 — 11,426 1,452 99 1,551 12,977 3 - High satisfactory 109,737 42,858 35,523 188,118 16,765 6,769 23,534 211,652 4 - Low satisfactory 377,198 94,847 — 472,045 42,798 20,861 63,659 535,704 5 - Special mention 15,372 3,470 — 18,842 7,165 3,754 10,919 29,761 6 - Substandard 4,874 3,625 — 8,499 9,136 3,836 12,972 21,471 7 - Vulnerable 390 1,231 — 1,621 2,711 1,574 4,285 5,906 8 - Doubtful — — — — — — — — 9 - Loss — — — — — — — — Total $ 510,153 $ 155,265 $ 35,523 $ 700,941 $ 80,027 $ 36,893 $ 116,920 $ 817,861 2018 Commercial Agricultural Real Estate Other Advances to Mortgage Brokers Total Real Estate Other Total Total Rating 1 - Excellent $ 21 $ 31 $ — $ 52 $ 51 $ 28 $ 79 $ 131 2 - High quality 4,564 13,473 — 18,037 2,729 613 3,342 21,379 3 - High satisfactory 127,573 43,199 11,793 182,565 18,325 7,039 25,364 207,929 4 - Low satisfactory 344,920 84,634 — 429,554 46,636 19,344 65,980 495,534 5 - Special mention 12,847 5,287 — 18,134 10,520 5,624 16,144 34,278 6 - Substandard 7,428 2,002 — 9,430 6,343 4,960 11,303 20,733 7 - Vulnerable 334 1,423 — 1,757 2,716 2,233 4,949 6,706 8 - Doubtful — — — — — — — — 9 - Loss — — — — — — — — Total $ 497,687 $ 150,049 $ 11,793 $ 659,529 $ 87,320 $ 39,841 $ 127,161 $ 786,690 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. 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 constitutes 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. • Loan may need to be restructured to improve collateral position or reduce payments. • Collateral or guaranty offers limited protection. • Negative debt service coverage, however the credit is well collateralized and payments are current. 6. SUBSTANDARD – Classified Credit is inadequately protected by the current net worth and paying capacity of the borrower or of the collateral pledged. There is a distinct possibility we will implement collection procedures if the loan deficiencies are not corrected. Any commercial loan placed in nonaccrual status will be rated “7” or worse. 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. • Interest non-accrual may be warranted. • 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 in 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 . 9. LOSS – Charge-off Credit is considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification is for charged-off loans but does not mean that the asset has absolutely no recovery or salvage value. These loans are further characterized by: • Liquidation or reorganization under Bankruptcy, with poor prospects of collection. • Fraudulently overstated assets and/or earnings. • Collateral has marginal or no value. • Debtor cannot be located. • Over 120 days delinquent. 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 for the entire loan portfolio as of December 31 : 2019 Accruing Interest Total Past Due and Nonaccrual 30-59 60-89 90 Days Nonaccrual Current Total Commercial Commercial real estate $ 139 $ 30 $ — $ 390 $ 559 $ 509,594 $ 510,153 Commercial other 531 156 — 1,231 1,918 153,347 155,265 Advances to mortgage brokers — — — — — 35,523 35,523 Total commercial 670 186 — 1,621 2,477 698,464 700,941 Agricultural Agricultural real estate — — — 2,711 2,711 77,316 80,027 Agricultural other — — — 1,574 1,574 35,319 36,893 Total agricultural — — — 4,285 4,285 112,635 116,920 Residential real estate Senior liens 3,463 258 — 557 4,278 253,894 258,172 Junior liens 65 — — — 65 5,766 5,831 Home equity lines of credit 157 — — 72 229 34,337 34,566 Total residential real estate 3,685 258 — 629 4,572 293,997 298,569 Consumer Secured 68 — — — 68 66,547 66,615 Unsecured 3 — — — 3 3,522 3,525 Total consumer 71 — — — 71 70,069 70,140 Total $ 4,426 $ 444 $ — $ 6,535 $ 11,405 $ 1,175,165 $ 1,186,570 2018 Accruing Interest Total Past Due and Nonaccrual 30-59 60-89 90 Days Nonaccrual Current Total Commercial Commercial real estate $ 60 $ — $ — $ 334 $ 394 $ 497,293 $ 497,687 Commercial other 277 628 — 1,423 2,328 147,721 150,049 Advances to mortgage brokers — — — — — 11,793 11,793 Total commercial 337 628 — 1,757 2,722 656,807 659,529 Agricultural Agricultural real estate 428 — — 2,716 3,144 84,176 87,320 Agricultural other — — — 2,233 2,233 37,608 39,841 Total agricultural 428 — — 4,949 5,377 121,784 127,161 Residential real estate Senior liens 2,254 203 113 554 3,124 233,438 236,562 Junior liens 2 6 — — 8 6,001 6,009 Home equity lines of credit 76 — — — 76 32,696 32,772 Total residential real estate 2,332 209 113 554 3,208 272,135 275,343 Consumer Secured 95 — — — 95 62,721 62,816 Unsecured 10 — — — 10 3,848 3,858 Total consumer 105 — — — 105 66,569 66,674 Total $ 3,202 $ 837 $ 113 $ 7,260 $ 11,412 $ 1,117,295 $ 1,128,707 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, or the fair value of the collateral, less costs to sell, if the loan is collateral dependent. Large groups of smaller-balance, homogeneous residential real estate and consumer loans are collectively evaluated for impairment 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 summarizes information pertaining to impaired loans as of, and for the years ended, December 31 : 2019 Recorded Balance Unpaid Principal Balance Valuation Allowance Average Recorded Balance Interest Income Recognized Impaired loans with a valuation allowance Commercial real estate $ 517 $ 635 $ 15 $ 2,044 $ 61 Commercial other — — — 10 — Agricultural real estate 1,509 1,509 12 1,091 100 Agricultural other 1,355 1,355 14 832 55 Residential real estate senior liens 5,401 5,830 1,073 6,210 114 Residential real estate junior liens — — — 11 — Total impaired loans with a valuation allowance 8,782 9,329 1,114 10,198 330 Impaired loans without a valuation allowance Commercial real estate 4,961 5,224 4,247 91 Commercial other 2,387 2,387 2,697 46 Agricultural real estate 8,372 8,422 7,404 171 Agricultural other 3,604 3,604 4,623 258 Home equity lines of credit 85 385 58 6 Consumer secured — — 5 — Total impaired loans without a valuation allowance 19,409 20,022 19,034 572 Impaired loans Commercial 7,865 8,246 15 8,998 198 Agricultural 14,840 14,890 26 13,950 584 Residential real estate 5,486 6,215 1,073 6,279 120 Consumer — — — 5 — Total impaired loans $ 28,191 $ 29,351 $ 1,114 $ 29,232 $ 902 2018 Recorded Balance Unpaid Principal Balance Valuation Allowance Average Recorded Balance Interest Income Recognized Impaired loans with a valuation allowance Commercial real estate $ 3,969 $ 4,211 $ 437 $ 4,589 $ 129 Commercial other 12 12 6 1,040 55 Agricultural real estate 392 392 112 606 50 Agricultural other 44 44 20 168 46 Residential real estate senior liens 6,834 7,289 1,361 7,545 126 Residential real estate junior liens 12 12 2 25 — Total impaired loans with a valuation allowance 11,263 11,960 1,938 13,973 406 Impaired loans without a valuation allowance Commercial real estate 2,794 2,947 2,728 74 Commercial other 3,124 3,231 1,533 43 Agricultural real estate 7,618 7,618 7,559 585 Agricultural other 6,244 6,287 4,636 279 Home equity lines of credit 47 347 64 5 Consumer secured 9 9 12 — Total impaired loans without a valuation allowance 19,836 20,439 16,532 986 Impaired loans Commercial 9,899 10,401 443 9,890 301 Agricultural 14,298 14,341 132 12,969 960 Residential real estate 6,893 7,648 1,363 7,634 131 Consumer 9 9 — 12 — Total impaired loans $ 31,099 $ 32,399 $ 1,938 $ 30,505 $ 1,392 We had committed to advance $175 and $542 in additional funds to be disbursed in connection with impaired loans, which includes TDRs , as of December 31, 2019 and 2018 , respectively. Troubled Debt Restructurings A loan modification is considered to be a TDR 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. Agreeing to an interest only payment structure and delaying principal payments. 4. Forgiving principal. 5. 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 is not granted. 3. The borrower’s cash flow is insufficient to service all of their debt if the concession is 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 in the years ended December 31 : 2019 2018 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 $ 1,188 $ 1,188 4 $ 1,360 $ 1,360 Agricultural other 7 3,286 3,286 31 6,318 6,295 Residential real estate 1 17 17 10 701 701 Total 11 $ 4,491 $ 4,491 45 $ 8,379 $ 8,356 The following table summarizes the nature of the concessions we granted to borrowers in financial difficulty in the years ended December 31 : 2019 2018 Below Market Interest Rate Below Market Interest Rate and Extension of Amortization Period Below Market Interest Rate Below Market Interest Rate and Extension of Amortization Period Number of Loans Pre-Modification Recorded Investment Number of Loans Pre-Modification Recorded Investment Number of Loans Pre-Modification Recorded Investment Number of Loans Pre-Modification Recorded Investment Commercial other — $ — 3 $ 1,188 1 $ 174 3 $ 1,186 Agricultural other 2 1,189 5 2,097 18 2,625 13 3,693 Residential real estate — — 1 17 3 203 7 498 Total 2 $ 1,189 9 $ 3,302 22 $ 3,002 23 $ 5,377 We did not restructure any loans by forgiving principal or accrued interest during 2019 or 2018 . 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 years ended December 31, 2019 and 2018 , which were modified within 12 months prior to the default date. The following is a summary of TDR loan balances as of December 31 : 2019 2018 TDRs $ 24,737 $ 26,951 |
