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Loans and ALLL

12 Months Ended

Dec. 31, 2022

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, health care, 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 deferred fees or costs. Unless a loan has a nonaccrual status, 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 method.

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 at an earlier date if collection of principal or interest is considered doubtful.

When a loan is placed in nonaccrual status, 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 $18,000. Borrowers with direct credit needs of more than $18,000 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. Government agency guarantee may be required. Personal guarantees and/or life insurance beneficiary assignments 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. 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 currently are not committed to participate.

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. Full or partial loan balances are charged against the ALLL when we believe uncollectability 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 related to this portfolio. 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.

While we have experienced fluctuations in credit quality indicators in recent periods, credit quality remained strong at December 31, 2022. The COVID-19 pandemic led to the temporary and some permanent closures of businesses throughout the communities in which we serve, which also led to increased unemployment. We increased the ALLL during 2020 as a result of increased economic and environmental related risk factors, primarily driven by COVID-19. While these risk factors remain, improvement in credit quality indicators resulted in a reduction to the ALLL during 2021. There have been no material changes to the ALLL and credit quality remained strong throughout 2022.

A summary of changes in the ALLL and the recorded investment in loans by segments follows:


	Allowance for Loan Losses
	Year Ended December 31, 2022
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
January 1, 2022	$	1,740	$	289	$	747	$	908	$	5,419	$	9,103
Charge-offs	(77)		—		—		(542)		—		(619)
Recoveries	442		9		150		282		—		883
Provision for loan losses	(784)		279		(280)		313		955		483
December 31, 2022	$	1,321	$	577	$	617	$	961	$	6,374	$	9,850


	Allowance for Loan Losses
	Year Ended December 31, 2021
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
January 1, 2021	$	2,162	$	311	$	1,363	$	798	$	5,110	$	9,744
Charge-offs	(32)		(77)		(12)		(486)		—		(607)
Recoveries	133		12		162		177		—		484
Provision for loan losses	(523)		43		(766)		419		309		(518)
December 31, 2021	$	1,740	$	289	$	747	$	908	$	5,419	$	9,103


	Allowance for Loan Losses and Recorded Investment in Loans
	As of December 31, 2022
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
ALLL
Individually evaluated for impairment	$	12	$	—	$	439	$	—	$	—	$	451
Collectively evaluated for impairment	1,309		577		178		961		6,374		9,399
Total	$	1,321	$	577	$	617	$	961	$	6,374	$	9,850
Loans
Individually evaluated for impairment	$	8,342	$	10,935	$	2,741	$	—			$	22,018
Collectively evaluated for impairment	732,578		93,379		338,144		78,054				1,242,155
Total	$	740,920	$	104,314	$	340,885	$	78,054			$	1,264,173


	Allowance for Loan Losses and Recorded Investment in Loans
	As of December 31, 2021
	Commercial		Agricultural		Residential Real Estate		Consumer		Unallocated		Total
ALLL
Individually evaluated for impairment	$	13	$	—	$	565	$	—	$	—	$	578
Collectively evaluated for impairment	1,727		289		182		908		5,419		8,525
Total	$	1,740	$	289	$	747	$	908	$	5,419	$	9,103
Loans
Individually evaluated for impairment	$	9,267	$	14,189	$	3,454	$	—			$	26,910
Collectively evaluated for impairment	798,172		79,766		322,907		73,282				1,274,127
Total	$	807,439	$	93,955	$	326,361	$	73,282			$	1,301,037

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:


	2022
	Commercial								Agricultural
	Real Estate		Other		Advances to Mortgage Brokers		Total		Real Estate		Other		Total		Total
Rating
1 - Excellent	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
2 - High quality	9,045		4,533		—		13,578		342		100		442		14,020
3 - High satisfactory	68,133		36,608		—		104,741		9,757		4,608		14,365		119,106
4 - Low satisfactory	471,009		114,565		—		585,574		43,587		21,214		64,801		650,375
5 - Special mention	20,770		7,447		—		28,217		12,262		4,634		16,896		45,113
6 - Substandard	5,629		3,085		—		8,714		6,316		1,260		7,576		16,290
7 - Vulnerable	74		22		—		96		67		167		234		330
8 - Doubtful	—		—		—		—		—		—		—		—
9 - Loss	—		—		—		—		—		—		—		—
Total	$	574,660	$	166,260	$	—	$	740,920	$	72,331	$	31,983	$	104,314	$	845,234


	2021
	Commercial								Agricultural
	Real Estate		Other		Advances to Mortgage Brokers		Total		Real Estate		Other		Total		Total
Rating
1 - Excellent	$	—	$	300	$	—	$	300	$	—	$	—	$	—	$	300
2 - High quality	9,010		6,881		—		15,891		453		—		453		16,344
3 - High satisfactory	86,135		46,087		72,001		204,223		9,361		4,295		13,656		217,879
4 - Low satisfactory	448,489		104,375		—		552,864		36,483		15,986		52,469		605,333
5 - Special mention	13,212		1,351		—		14,563		13,096		3,452		16,548		31,111
6 - Substandard	13,519		5,738		—		19,257		6,252		3,803		10,055		29,312
7 - Vulnerable	222		119		—		341		499		275		774		1,115
8 - Doubtful	—		—		—		—		—		—		—		—
9 - Loss	—		—		—		—		—		—		—		—
Total	$	570,587	$	164,851	$	72,001	$	807,439	$	66,144	$	27,811	$	93,955	$	901,394

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:


	2022
	Accruing Interest and Past Due:								Total Past Due and Nonaccrual
	30-59 Days		60-89 Days		90 Days or More		Nonaccrual				Current		Total
Commercial
Commercial real estate	$	4,553	$	2,570	$	—	$	74	$	7,197	$	567,463	$	574,660
Commercial other	285		—		—		22		307		165,953		166,260
Advances to mortgage brokers	—		—		—		—		—		—		—
Total commercial	4,838		2,570		—		96		7,504		733,416		740,920
Agricultural
Agricultural real estate	—		—		—		67		67		72,264		72,331
Agricultural other	—		—		—		167		167		31,816		31,983
Total agricultural	—		—		—		234		234		104,080		104,314
Residential real estate
Senior liens	2,943		225		—		127		3,295		301,606		304,901
Junior liens	—		—		—		—		—		3,282		3,282
Home equity lines of credit	38		—		—		—		38		32,664		32,702
Total residential real estate	2,981		225		—		127		3,333		337,552		340,885
Consumer
Secured	47		8		—		—		55		74,886		74,941
Unsecured	4		—		—		—		4		3,109		3,113
Total consumer	51		8		—		—		59		77,995		78,054
Total	$	7,870	$	2,803	$	—	$	457	$	11,130	$	1,253,043	$	1,264,173


	2021
	Accruing Interest and Past Due:								Total Past Due and Nonaccrual
	30-59 Days		60-89 Days		90 Days or More		Nonaccrual				Current		Total
Commercial
Commercial real estate	$	135	$	—	$	—	$	222	$	357	$	570,230	$	570,587
Commercial other	85		—		—		119		204		164,647		164,851
Advances to mortgage brokers	—		—		—		—		—		72,001		72,001
Total commercial	220		—		—		341		561		806,878		807,439
Agricultural
Agricultural real estate	213		—		—		499		712		65,432		66,144
Agricultural other	—		—		—		275		275		27,536		27,811
Total agricultural	213		—		—		774		987		92,968		93,955
Residential real estate
Senior liens	2,016		37		97		93		2,243		290,900		293,143
Junior liens	—		—		—		—		—		2,439		2,439
Home equity lines of credit	7		—		—		37		44		30,735		30,779
Total residential real estate	2,023		37		97		130		2,287		324,074		326,361
Consumer
Secured	186		—		—		—		186		70,259		70,445
Unsecured	10		—		—		—		10		2,827		2,837
Total consumer	196		—		—		—		196		73,086		73,282
Total	$	2,652	$	37	$	97	$	1,245	$	4,031	$	1,297,006	$	1,301,037

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:


	2022
	Recorded Balance		Unpaid Principal Balance		Valuation Allowance		Average Recorded Balance		Interest Income Recognized
Impaired loans with a valuation allowance
Commercial real estate	$	183	$	184	$	12	$	189	$	12
Commercial other	—		—		—		1,724		62
Residential real estate senior liens	2,741		3,001		439		3,056		126
Total impaired loans with a valuation allowance	2,924		3,185		451		4,969		200
Impaired loans without a valuation allowance
Commercial real estate	5,366		5,682				5,514		338
Commercial other	2,793		2,793				626		58
Agricultural real estate	8,522		8,522				8,568		468
Agricultural other	2,413		2,413				2,984		157
Home equity lines of credit	—		—				5		—
Total impaired loans without a valuation allowance	19,094		19,410				17,697		1,021
Impaired loans
Commercial	8,342		8,659		12		8,053		470
Agricultural	10,935		10,935		—		11,552		625
Residential real estate	2,741		3,001		439		3,061		126
Total impaired loans	$	22,018	$	22,595	$	451	$	22,666	$	1,221


	2021
	Recorded Balance		Unpaid Principal Balance		Valuation Allowance		Average Recorded Balance		Interest Income Recognized
Impaired loans with a valuation allowance
Commercial real estate	$	192	$	193	$	9	$	1,668	$	69
Commercial other	2,802		2,802		4		1,909		103
Agricultural real estate	—		—		—		553		11
Agricultural other	—		—		—		169		—
Residential real estate senior liens	3,417		3,688		565		3,794		151
Total impaired loans with a valuation allowance	6,411		6,683		578		8,093		334
Impaired loans without a valuation allowance
Commercial real estate	5,829		6,145				6,313		398
Commercial other	444		444				1,963		68
Agricultural real estate	9,538		9,538				9,739		699
Agricultural other	4,651		4,651				4,269		235
Home equity lines of credit	37		37				5		—
Total impaired loans without a valuation allowance	20,499		20,815				22,289		1,400
Impaired loans
Commercial	9,267		9,584		13		11,853		638
Agricultural	14,189		14,189		—		14,730		945
Residential real estate	3,454		3,725		565		3,799		151
Total impaired loans	$	26,910	$	27,498	$	578	$	30,382	$	1,734

We had committed to advance $0 and $266 in additional funds to be disbursed in connection with impaired loans, which includes TDRs, as of December 31, 2022 and 2021, 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:


	2022					2021
	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	$	2,871	$	2,871	5	$	4,761	$	4,761
Agricultural other	—	—		—		6	3,712		3,712
Residential real estate	1	98		98		—	—		—
Total	4	$	2,969	$	2,969	11	$	8,473	$	8,473

The following table summarizes the nature of the concessions we granted to borrowers in financial difficulty in the years ended December 31:


	2022						2021
	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	$	2,871	—	$	—	1	$	3,189	4	$	1,572
Agricultural other	—	—		—	—		6	3,712		—	—
Residential real estate	—	—		1	98		—	—		—	—
Total	3	$	2,871	1	$	98	7	$	6,901	4	$	1,572

We did not restructure any loans by forgiving principal or accrued interest during 2022 or 2021.

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, 2022 and 2021, which were modified within 12 months prior to the default date.

The following is a summary of TDR loan balances as of December 31:


	2022		2021
TDRs	$	21,339	$	25,725