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LOANS

12 Months Ended

Dec. 31, 2020

NOTE 4 — LOANS

The composition of loans at December 31 is as follows (dollars in thousands):


	December 31,		December 31,
	2020		2019

Commercial real estate	$	498,450	$	514,394
Commercial, financial, and agricultural		273,759		211,023
Commercial construction		47,698		40,107
One to four family residential real estate		227,044		253,918
Consumer		18,980		21,238
Consumer construction		11,661		18,096

Total loans	$	1,077,592	$	1,058,776

The Corporation completed the acquisition of Peninsula Financial Corporation, (“PFC”), on December 5, 2014, The First National Bank of Eagle River (“Eagle River”) on April 29, 2016, Niagara Bancorporation (“Niagara”) on August 31, 2016, First Federal of Northern Michigan Bancorp, Inc. (“FFNM”) on May 18, 2018, and Lincoln Community Bank (“Lincoln”) on October 1, 2018. The PFC acquired impaired loans totaled $13.290 million, the Eagle River acquired impaired loans totaled $3.401 million, and the Niagara acquired impaired loans totaled $2.105 million. The FFNM impaired loans totaled $5.440 million and the Lincoln impaired loans totaled $1.901 million. In 2020, the Corporation had positive resolution of acquired nonperforming loans, which resulted in the recognition of accretable interest of approximately $1.006 million. In 2019, The Corporation had positive resolution of acquired nonperforming loans, which resulted in the recognition of approximately $.404 million of accretable interest.

The table below details the outstanding balances of the PFC acquired portfolio and the acquisition fair value adjustments at acquisition date (dollars in thousands):


	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	13,290	$	53,849	$	67,139
Nonaccretable difference		(2,234)		—		(2,234)
Expected cash flows		11,056		53,849		64,905
Accretable yield		(744)		(2,100)		(2,844)
Carrying balance at acquisition date	$	10,312	$	51,749	$	62,061

Loans acquired with deteriorated credit quality in the PFC transaction carried a balance of $.793 million at December 31, 2020 and $1.718 million at December 31, 2019.

The table below details the outstanding balances of the Eagle River acquired portfolio and the acquisition fair value adjustments at acquisition date (dollars in thousands):


	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	3,401	$	80,737	$	84,138
Nonaccretable difference		(1,172)		—		(1,172)
Expected cash flows		2,229		80,737		82,966
Accretable yield		(391)		(1,700)		(2,091)
Carrying balance at acquisition date	$	1,838	$	79,037	$	80,875

Loans acquired with deteriorated credit quality in the Eagle River transaction carried a balance of $1.273 million at December 31, 2020 and $1.716 million at December 31, 2019.

The table below details the outstanding balances of the Niagara acquired portfolio and the acquisition fair value adjustments at acquisition date (dollars in thousands):


	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	2,105	$	30,555	$	32,660
Nonaccretable difference		(265)		—		(265)
Expected cash flows		1,840		30,555		32,395
Accretable yield		(88)		(600)		(688)
Carrying balance at acquisition date	$	1,752	$	29,955	$	31,707

Loans acquired with deteriorated credit quality in the Niagara transaction carried a balance of $.048 million at December 31, 2020 and $.075 million at December 31, 2019.

The table below details the outstanding balances of the FFNM acquired portfolio and the acquisition fair value adjustments at acquisition date (dollars in thousands):


	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	5,440	$	187,302	$	192,742
Nonaccretable difference		(2,100)		—		(2,100)
Expected cash flows		3,340		187,302		190,642
Accretable yield		(700)		(4,498)		(5,198)
Carrying balance at acquisition date	$	2,640	$	182,804	$	185,444

Loans acquired with deteriorated credit quality in the FFNM transaction carried a balance of $3.369 million at December 31, 2020 and $5.119 million at December 31, 2019.

The table below details the outstanding balances of the Lincoln acquired portfolio and the acquisition fair value adjustments at acquisition date (dollars in thousands):


	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	1,901	$	37,700	$	39,601
Nonaccretable difference		(421)		—		(421)
Expected cash flows		1,480		37,700		39,180
Accretable yield		(140)		(493)		(633)
Carrying balance at acquisition date	$	1,340	$	37,207	$	38,547

Loans acquired with deteriorated credit quality in the Lincoln transaction carried a balance of $.548 million at December 31, 2020 and $.897 million at December 31, 2019.

The table below presents a rollforward of the accretable yield on acquired loans for year ended December 31, 2020 (dollars in thousands):


	PFC						Eagle River
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total

Balance, December 31, 2019	$	105	$	—	$	105	$	209	$	—	$	209
Accretion		(207)		—		(207)		(104)		—		(104)
Reclassification from nonaccretable difference		155		—		155		78		—		78
Balance, December 31, 2020	$	53	$	—	$	53	$	183	$	—	$	183

	Niagara						First Federal Northern Michigan
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total

Balance, December 31, 2019	$	19	$	—	$	19	$	518	$	1,953	$	2,471
Accretion		(27)		—		(27)		(903)		(1,085)		(1,988)
Reclassification from nonaccretable difference		20		—		20		677		1		678
Balance, December 31, 2020	$	12	$	—	$	12	$	292	$	869	$	1,161

	Lincoln Community Bank						Total
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total

Balance, December 31, 2019	$	108	$	264	$	372	$	959	$	2,217	$	3,176
Accretion		(95)		(134)		(229)		(1,336)		(1,219)		(2,555)
Reclassification from nonaccretable difference		72		—		72		1,002		1		1,003
Balance, December 31, 2020	$	85	$	130	$	215	$	625	$	999	$	1,624

The table below presents a rollforward of the accretable yield on acquired loans for year ended December 31, 2019 (dollars in thousands):


	PFC						Eagle River
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total

Balance, December 31, 2018	$	128	$	—	$	128	$	213	$	16	$	229
Accretion		(90)		—		(90)		(17)		(16)		(33)
Reclassification from nonaccretable difference		67		—		67		13		—		13
Balance, December 31, 2019	$	105	$	—	$	105	$	209	$	—	$	209

	Niagara						First Federal Northern Michigan
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total

Balance, December 31, 2018	$	26	$	69	$	95	$	571	$	3,446	$	4,017
Accretion		(30)		(69)		(99)		(214)		(1,493)		(1,707)
Reclassification from nonaccretable difference		23		—		23		161		—		161
Balance, December 31, 2019	$	19	$	—	$	19	$	518	$	1,953	$	2,471

	Lincoln Community Bank						Total
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total

Balance, December 31, 2018	$	140	$	442	$	582	$	1,078	$	3,973	$	5,051
Accretion		(128)		(178)		(306)		(479)		(1,756)		(2,235)
Reclassification from nonaccretable difference		96		—		96		360		—		360
Balance, December 31, 2019	$	108	$	264	$	372	$	959	$	2,217	$	3,176

A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2020 is as follows (dollars in thousands):


			Commercial,				One to four
	Commercial		financial and		Commercial		family residential		Consumer
	real estate		agricultural		construction		real estate		construction		Consumer		Unallocated		Total
Allowance for loan loss reserve:
Beginning balance ALLR	$	1,189	$	1,197	$	71	$	148	$	11	$	13	$	2,679	$	5,308
Charge-offs		(17)		(500)		(8)		(117)		—		(117)		—		(759)
Recoveries		105		1		81		19		—		61		—		267
Provision		1,706		1,036		65		555		(6)		51		(2,407)		1,000
Ending balance ALLR	$	2,983	$	1,734	$	209	$	605	$	5	$	8	$	272	$	5,816

Loans:
Ending balance	$	498,450	$	273,759	$	47,698	$	227,044	$	11,661	$	18,980	$	—	$	1,077,592
Ending balance ALLR		(2,983)		(1,734)		(209)		(605)		(5)		(8)		(272)		(5,816)
Net loans	$	495,467	$	272,025	$	47,489	$	226,439	$	11,656	$	18,972	$	(272)	$	1,071,776

Ending balance ALLR:
Individually evaluated	$	476	$	703	$	—	$	—	$	—	$	—	$	—	$	1,179
Collectively evaluated		2,507		1,031		209		605		5		8		272		4,637
Total	$	2,983	$	1,734	$	209	$	605	$	5	$	8	$	272	$	5,816

Ending balance Loans:
Individually evaluated	$	2,396	$	3,633	$	362	$	—	$	—	$	—	$	—	$	6,391
Collectively evaluated		494,890		269,891		47,161		226,175		11,661		18,964		—		1,068,742
Acquired with deteriorated credit quality		1,164		235		175		869		—		16		—		2,459
Total	$	498,450	$	273,759	$	47,698	$	227,044	$	11,661	$	18,980	$	—	$	1,077,592

Impaired loans, by definition, are individually evaluated.

A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2019 is as follows (dollars in thousands):


			Commercial,				One to four
	Commercial		financial and		Commercial		family residential		Consumer
	real estate		agricultural		construction		real estate		construction		Consumer		Unallocated		Total
Allowance for loan loss reserve:
Beginning balance ALLR	$	1,682	$	648	$	101	$	199	$	6	$	8	$	2,539	$	5,183
Charge-offs		(27)		(103)		—		(152)		—		(228)		—		(510)
Recoveries		159		4		2		49		—		36		—		250
Provision		(625)		648		(32)		52		5		197		140		385
Ending balance ALLR	$	1,189	$	1,197	$	71	$	148	$	11	$	13	$	2,679	$	5,308

Loans:
Ending balance	$	514,394	$	211,023	$	40,107	$	253,918	$	18,096	$	21,238	$	—	$	1,058,776
Ending balance ALLR		(1,189)		(1,197)		(71)		(148)		(11)		(13)		(2,679)		(5,308)
Net loans	$	513,205	$	209,826	$	40,036	$	253,770	$	18,085	$	21,225	$	(2,679)	$	1,053,468

Ending balance ALLR:
Individually evaluated	$	497	$	770	$	—	$	—	$	—	$	—	$	—	$	1,267
Collectively evaluated		692		427		71		148		11		13		2,679		4,041
Total	$	1,189	$	1,197	$	71	$	148	$	11	$	13	$	2,679	$	5,308

Ending balance Loans:
Individually evaluated	$	2,374	$	1,475	$	—	$	—	$	—	$	—	$	—	$	3,849
Collectively evaluated		507,702		207,194		39,734		251,998		18,096		21,229		—		1,045,953
Acquired with deteriorated credit quality		4,318		2,354		373		1,920		—		9		—		8,974
Total	$	514,394	$	211,023	$	40,107	$	253,918	$	18,096	$	21,238	$	—	$	1,058,776

Impaired loans, by definition, are individually evaluated.

As part of the management of the loan portfolio, risk ratings are assigned to all commercial loans. Through the loan review process, ratings are modified as believed to be appropriate to reflect changes in the credit. Our ability to manage credit risk depends in large part on our ability to properly identify and manage problem loans.

To do so, we operate a credit risk rating system under which our credit management personnel assign a credit risk rating to each loan at the time of origination and review loans on a regular basis to determine each loan’s credit risk rating on a scale of 1 through 8, with higher scores indicating higher risk. The credit risk rating structure used is shown below.

In the context of the credit risk rating structure, the term Classified is defined as a problem loan which may or may not be in a nonaccrual status, dependent upon current payment status and collectability.

Strong (1)

Borrower is not vulnerable to sudden economic or technological changes. They have “strong” balance sheets and are within an industry that is very typical for our markets or type of lending culture. Borrowers also have “strong” financial and cash flow performance and excellent collateral (low loan to value or readily available to liquidate collateral) in conjunction with an impeccable repayment history.

Good (2)

Borrower shows limited vulnerability to sudden economic change. These borrowers have “above average” financial and cash flow performance and a very good repayment history. The balance sheet of the company is also very good as compared to peer and the company is in an industry that is familiar to our markets or our type of lending. The collateral securing the deal is also very good in terms of its type, loan to value, etc.

Average (3)

Borrower is typically a well-seasoned business, however may be susceptible to unfavorable changes in the economy, and could be somewhat affected by seasonal factors. The borrowers within this category exhibit financial and cash flow performance that appear “average” to “slightly above average” when compared to peer standards and they show an adequate payment history. Collateral securing this type of credit is good, exhibiting above average loan to values, etc.

Acceptable (4)

A borrower within this category exhibits financial and cash flow performance that appear adequate and satisfactory when compared to peer standards and they show a satisfactory payment history. The collateral securing the request is within supervisory limits and overall is acceptable. Borrowers rated acceptable could also be newer businesses that are typically susceptible to unfavorable changes in the economy, and more than likely could be affected by seasonal factors.

Acceptable Watch (44)

The borrower may have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date. Acceptable watch assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification. Examples of this type of credit include a start-up company fully based on projections, a documentation issue that needs to be corrected or a general market condition that the borrower is working through to get corrected.

Substandard (6)

Substandard loans are classified assets exhibiting a number of well-defined weaknesses that jeopardize normal repayment. The assets are no longer adequately protected due to declining net worth, lack of earning capacity, or insufficient collateral offering the distinct possibility of the loss of a portion of the loan principal. Loans classified as substandard clearly represent troubled and deteriorating credit situations requiring constant supervision.

Doubtful (7)

Loans in this category exhibit the same, if not more pronounced weaknesses used to describe the substandard credit. Loans are frozen with collection improbable. Such loans are not yet rated as Charge-off because certain actions may yet occur which would salvage the loan.

Charge-off/Loss (8)

Loans in this category are largely uncollectible and should be charged against the loan loss reserve immediately.

General Reserves:

For loans with a credit risk rating of 44 or better and any loans with a risk rating of 6 or 7 not considered impaired, reserves are established based on the type of loan collateral, if any, and the assigned credit risk rating. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogenous loans based on historical loss experience, and consideration of current environmental factors and economic trends, all of which may be susceptible to significant change.

Using a historical average loss by loan type as a base, each loan graded as higher risk is assigned a specific percentage. The residential real estate and consumer loan portfolios are assigned a loss percentage as a homogenous group. If, however, on an individual loan the projected loss based on collateral value and payment histories are in excess of the computed allowance, the allocation is increased for the higher anticipated loss. These computations provide the basis for the allowance for loan losses as recorded by the Corporation.

Commercial construction loans in the amount of $10.939 million and $3.525 million at December 31, 2020, and 2019, respectively did not receive a specific risk rating. These amounts represent loans made for land development and unimproved land purchases.

Below is a breakdown of loans by risk category as of December 31, 2020 (dollars in thousands):

(1)

(2)

(3)

(4)

(44)

(6)

(7)

Rating

Strong

Good

Average

Acceptable

Acceptable Watch

Substandard

Doubtful

Unassigned

Total

Commercial real estate

7,425

10,521

223,875

249,159

3,352

4,118

—

498,450

Commercial, financial and agricultural

116,107

6,760

51,150

94,743

656

4,343

—

273,759

Commercial construction

—

19,063

16,671

600

385

—

10,939

47,698

One-to-four family residential real estate

—

3,139

5,614

18,864

369

1,814

—

197,244

227,044

Consumer construction

—

11,661

Consumer

—

128

1,141

—

17,565

18,980

Total loans

123,532

20,539

299,830

380,578

4,977

10,727

—

237,409

1,077,592

At December 31, 2020, $105.492 million of Paycheck Protection Program (“PPP”) loans are included with a risk rating of “1” in the Commercial, financial and agricultural category.

Below is a breakdown of loans by risk category as of December 31, 2019 (dollars in thousands)


	(1)		(2)		(3)		(4)		(44)		(6)		(7)		Rating
	Strong		Good		Average		Acceptable		Acceptable Watch		Substandard		Doubtful		Unassigned		Total

Commercial real estate	$	9,979	$	17,516	$	228,962	$	248,177	$	4,468	$	5,292	$	—	$	—	$	514,394
Commercial, financial and agricultural		15,126		4,510		70,748		115,229		930		4,480		—		—		211,023
Commercial construction		—		292		6,390		28,893		400		607		—		3,525		40,107
One-to-four family residential real estate		40		2,145		4,937		15,168		634		2,632		—		228,362		253,918
Consumer construction		—		—		—		—		—		—		—		18,096		18,096
Consumer		—		158		250		640		—		41		—		20,149		21,238

Total loans	$	25,145	$	24,621	$	311,287	$	408,107	$	6,432	$	13,052	$	—	$	270,132	$	1,058,776

Impaired Loans

Impaired loans are those which are contractually past due 90 days or more as to interest or principal payments, on nonaccrual status, or loans, the terms of which have been renegotiated to provide a reduction or deferral on interest or principal.

Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loans basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

The following is a summary of impaired loans and their effect on interest income (dollars in thousands):


	Impaired Loans		Impaired Loans		Total		Unpaid		Related
	with No Related		with Related		Impaired		Principal		Allowance for
	Allowance		Allowance		Loans		Balance		Loan Losses
December 31, 2020

Commercial real estate	$	1,251	$	2,309	$	3,560	$	5,786	$	476
Commercial, financial and agricultural		2,423		1,445		3,868		3,946		679
Commercial construction		537		—		537		678		—
One to four family residential real estate		869		—		869		1,993		—
Consumer construction		—		—		—		—		—
Consumer		16		—		16		19		—
Total	$	5,096	$	3,754	$	8,850	$	12,422	$	1,155

December 31, 2019
Commercial real estate	$	4,318	$	2,374	$	6,692	$	7,937	$	497
Commercial, financial and agricultural		2,354		1,475		3,829		4,892		770
Commercial construction		373		—		373		386		—
One to four family residential real estate		1,920		—		1,920		2,881		—
Consumer construction		—		—		—		—		—
Consumer		9		—		9		33		—
Total	$	8,974	$	3,849	$	12,823	$	16,129	$	1,267


	Individually Evaluated Impaired Loans
	December 31, 2020				December 31, 2019
	Average		Interest Income		Average		Interest Income
	Balance for		Recognized for		Balance for		Recognized for
	the Period		the Period		the Period		the Period
Commercial real estate	$	6,860	$	270	$	8,374	$	301
Commercial, financial and agricultural		1,204		13		1,144		2
Commercial construction		541		27		396		—
One to four family residential real estate		3,064		135		3,508		219
Consumer construction		—		—		—		—
Consumer		37		1		44		2
Total	$	11,706	$	446	$	13,466	$	524

A summary of past due loans at December 31, is as follows (dollars in thousands):


	December 31,								December 31,
	2020								2019
	30-89 days		90+ days						30-89 days		90+ days
	Past Due		Past Due						Past Due		Past Due
	(accruing)		(accruing)		Nonaccrual		Total		(accruing)		(accruing)		Nonaccrual		Total

Commercial real estate	$	24	$	—	$	1,481	$	1,505	$	1,055	$	—	$	671	$	1,726
Commercial, financial and agricultural		42		—		478		520		829		—		527		1,356
Commercial construction		—		—		79		79		59		—		105		164
One to four family residential real estate		1,925		—		3,371		5,296		4,357		11		3,850		8,218
Consumer construction		—		—		—		—		—		—		—		—
Consumer		78		—		49		127		83		—		19		102

Total past due loans	$	2,069	$	—	$	5,458	$	7,527	$	6,383	$	11	$	5,172	$	11,566

Troubled Debt Restructuring

Troubled debt restructurings (“TDR”) are determined on a loan-by-loan basis. Generally, restructurings are related to interest rate reductions, loan term extensions and short term payment forbearance as means to maximize collectability of troubled credits. If a portion of the TDR loan is uncollectible (including forgiveness of principal), the uncollectible amount will be charged off against the allowance at the time of the restructuring. In general, a borrower must make at least six consecutive timely payments before the Corporation would consider a return of a restructured loan to accruing status in accordance with FDIC guidelines regarding restoration of credits to accrual status. More recent regulatory guidelines and accounting standards indicate that loan modifications or forbearances related to the COVID-19 pandemic will generally not be considered TDRs. COVID-19 loan modifications resided at a nominal $2.4 million, or .25% of total loans with no commercial loans remaining in total payment deferral at December 31, 2020. This is compared to peak levels of $201 million in the second quarter of 2020. Subsequent to the end of 2020, the bank has modified an additional $16 million of commercial loans under the COVID framework. All modifications still require interest

payments and there were no changes to interest rate. The modification period of the loans is expected to be completed before the end of the first quarter of 2021.

The Corporation has, in accordance with generally accepted accounting principles and per recently enacted accounting standard updates, evaluated all loan modifications to determine the fair value impact of the underlying asset. The carrying amount of the loan is compared to the expected payments to be received, discounted at the loan’s original rate, or for collateral dependent loans, to the fair value of the collateral.

There were four new troubled debt restructuring that occurred during the year ended December 31, 2020 with a balance of $.535 million, and four new troubled debt restructurings for the year ended December 31, 2019 with a balance of $1.952 million. There are no existing troubled debt restructurings that have defaulted as of December 31, 2020 and 2019. The four TDRs are not COVID-19 related.

Insider Loans

The Bank, in the ordinary course of business, grants loans to the Corporation’s executive officers and directors, including their families and firms in which they are principal owners. Activity in such loans is summarized below (dollars in thousands):


	Year Ended		Year Ended
	December 31,		December 31,
	2020		2019
Loans outstanding, January 1	$	12,196	$	9,817
New loans		500		1,872
Net activity on revolving lines of credit		(764)		1,200
Change in status of insiders		—		(289)
Repayment		(154)		(404)
Loans outstanding at end of period	$	11,778	$	12,196

There were no loans to related-parties classified substandard as of December 31, 2020 and 2019. In addition to the outstanding balances above, there were unfunded commitments of $.500 million to related parties at December 31, 2020.