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Loans and Allowance for Loan Losses

12 Months Ended

Dec. 31, 2018

Note 3 – Loans and Allowance for Loan Losses

The Bank’s loan portfolio as of December 31 was as follows:

(Dollars in thousands)
	2018			2017
Agricultural	$	49,109		$	48,464
Commercial and industrial		91,406			104,386
Consumer		24,382			24,513
Real estate - commercial		139,453			123,487
Real estate - construction		8,843			6,613
Real estate - residential		95,880			91,322
Loans, gross		409,073			398,785
Allowance for loan losses		(4,673	)		(4,577	)
Loans, net	$	404,400		$	394,208

ChoiceOne manages its credit risk through the use of its loan policy and its loan approval process and by monitoring of loan credit performance. The loan approval process for commercial loans involves individual and group approval authorities. Individual authority levels are based on the experience of the lender. Group authority approval levels can consist of an internal loan committee that includes the Bank’s President or Senior Lender and other loan officers for loans that exceed individual approval levels, or a loan committee of the Board of Directors for larger commercial loans. Most consumer loans are approved by individual loan officers based on standardized underwriting criteria, with larger consumer loans subject to approval by the internal loan committee.

Ongoing credit review of commercial loans is the responsibility of the loan officers. ChoiceOne’s internal credit committee meets at least monthly and reviews loans with payment issues and loans with a risk rating of 5, 6, or 7. Risk ratings of commercial loans are reviewed periodically and adjusted if needed. ChoiceOne’s consumer loan portfolio is primarily monitored on an exception basis. Loans where payments are past due are turned over to the Bank’s collection department, which works with the borrower to bring payments current or take other actions when necessary. In addition to internal reviews of credit performance, ChoiceOne contracts with a third party for independent loan review that monitors the loan approval process and the credit quality of the loan portfolio.

Activity in the allowance for loan losses and balances in the loan portfolio was as follows:


(Dollars in thousands)				Commercial						Commercial		Construction		Residential
	Agricultural			and Industrial			Consumer			Real Estate		Real Estate		Real Estate			Unallocated		Total
2018
Allowance for Loan Losses
Beginning balance	$	506		$	1,001		$	262		$	1,761	$	35	$	726		$	286	$	4,577
Charge-offs		—			(58	)		(282	)		—		—		(25	)		—		(365	)
Recoveries		33			107			112			61		—		113			—		426
Provision		(58	)		(158	)		162			104		3		(277	)		259		35
Ending balance	$	481		$	892		$	254		$	1,926	$	38	$	537		$	545	$	4,673

Individually evaluated for impairment	$	94		$	3		$	13		$	20	$	—	$	167		$	—	$	297

Collectively evaluated for impairment	$	387		$	889		$	241		$	1,906	$	38	$	370		$	545	$	4,376

Loans
Individually evaluated for impairment	$	578		$	21		$	90		$	623	$	—	$	2,712				$	4,024
Collectively evaluated for impairment		48,531			91,385			24,292			138,830		8,843		93,168					405,049
Ending balance	$	49,109		$	91,406		$	24,382		$	139,453	$	8,843	$	95,880				$	409,073

(Dollars in thousands)			Commercial						Commercial		Construction			Residential
	Agricultural		and Industrial			Consumer			Real Estate		Real Estate			Real Estate			Unallocated			Total
2017
Allowance for Loan Losses
Beginning balance	$	433	$	688		$	305		$	1,438	$	62		$	1,013		$	338		$	4,277
Charge-offs		—		(439	)		(253	)		—		—			(43	)		—			(735	)
Recoveries		—		21			169			258		40			62			—			550
Provision		73		731			41			65		(67	)		(306	)		(52	)		485
Ending balance	$	506	$	1,001		$	262		$	1,761	$	35		$	726		$	286		$	4,577

Individually evaluated for impairment	$	—	$	26		$	3		$	49	$	—		$	224		$	—		$	302

Collectively evaluated for impairment	$	506	$	975		$	259		$	1,712	$	35		$	502		$	286		$	4,275

Loans
Individually evaluated for impairment	$	423	$	124		$	36		$	778	$	—		$	2,779					$	4,140
Collectively evaluated for impairment		48,041		104,262			24,477			122,709		6,613			88,543						394,645
Ending balance	$	48,464	$	104,386		$	24,513		$	123,487	$	6,613		$	91,322					$	398,785


(Dollars in thousands)			Commercial						Commercial		Construction		Residential
	Agricultural		and Industrial			Consumer			Real Estate		Real Estate		Real Estate			Unallocated			Total
2016
Allowance for Loan Losses
Beginning balance	$	420	$	586		$	297		$	1,030	$	46	$	1,388		$	427		$	4,194
Charge-offs		—		(37	)		(218	)		—		—		(102	)		—			(357	)
Recoveries		—		31			149			89		—		171			—			440
Provision		13		108			77			319		16		(444	)		(89	)		—
Ending balance	$	433	$	688		$	305		$	1,438	$	62	$	1,013		$	338		$	4,277

Individually evaluated for impairment	$	3	$	11		$	2		$	91	$	—	$	296		$	—		$	403

Collectively evaluated for impairment	$	430	$	677		$	303		$	1,347	$	62	$	717		$	338		$	3,874

Loans
Individually evaluated for impairment	$	526	$	301		$	28		$	1,073	$	—	$	2,983					$	4,911
Collectively evaluated for impairment		44,088		95,787			21,568			109,689		6,153		86,804						364,089
Ending balance	$	44,614	$	96,088		$	21,596		$	110,762	$	6,153	$	89,787					$	369,000

The process to monitor the credit quality of ChoiceOne’s loan portfolio includes tracking (1) the risk ratings of business loans, (2) the level of classified business loans, and (3) delinquent and nonperforming consumer loans. Business loans are risk rated on a scale of 1 to 8. A description of the characteristics of the ratings follows:

Risk ratings 1 and 2: These loans are considered pass credits. They exhibit good to exceptional credit risk and demonstrate the ability to repay the loan from normal business operations.

Risk rating 3: These loans are considered pass credits. They exhibit acceptable credit risk and demonstrate the ability to repay the loan from normal business operations.

Risk rating 4: These loans are considered watch credits. They have potential developing weaknesses that, if not corrected, may cause deterioration in the ability of the borrower to repay the loan. While a loss is possible for a loan with this rating, it is not anticipated.

Risk rating 5: These loans are considered special mention credits. Loans in this risk rating are considered to be inadequately protected by the net worth and debt service coverage of the borrower or of any pledged collateral. These loans have well defined weaknesses that may jeopardize the borrower’s ability to repay the loan. If the weaknesses are not corrected, loss of principal and interest could be probable.

Risk rating 6: These loans are considered substandard credits. These loans have well defined weaknesses, the severity of which makes collection of principal and interest in full questionable. Loans in this category may be placed on nonaccrual status.

Risk rating 7: These loans are considered doubtful credits. Some loss of principal and interest has been determined to be probable. The estimate of the amount of loss could be affected by factors such as the borrower’s ability to provide additional capital or collateral. Loans in this category are on nonaccrual status. No loans are classified as risk rating 7 and the category has been omitted from the table below.

Risk rating 8: These loans are considered loss credits. They are considered uncollectible and will be charged off against the allowance for loan losses. No loans are classified as risk rating 8 and the category has been omitted from the table below.

Information regarding the Bank’s credit exposure as of December 31 was as follows:

Corporate Credit Exposure - Credit Risk Profile By Creditworthiness Category

(Dollars in thousands)	Agricultural				Commercial and Industrial				Commercial Real Estate
	2018		2017		2018		2017		2018		2017
Risk ratings 1 and 2	$	15,300	$	14,813	$	11,972	$	13,491	$	7,962	$	8,227
Risk rating 3		23,938		22,721		50,266		63,366		89,173		78,868
Risk rating 4		9,082		10,199		23,961		26,943		36,193		33,429
Risk rating 5		211		308		5,204		491		4,850		1,533
Risk rating 6		578		423		3		95		1,275		1,430
	$	49,109	$	48,464	$	91,406	$	104,386	$	139,453	$	123,487

Consumer Credit Exposure - Credit Risk Profile Based On Payment Activity

(Dollars in thousands)	Consumer				Construction Real Estate				Residential Real Estate
	2018		2017		2018		2017		2018		2017
Performing	$	24,320	$	24,497	$	8,843	$	6,613	$	94,925	$	90,629
Nonperforming		—		1		—		—		—		257
Nonaccrual		62		15		—		—		955		436
	$	24,382	$	24,513	$	8,843	$	6,613	$	95,880	$	91,322

Included within the loan categories above were loans in the process of foreclosure. As of December 31, 2018 and 2017, loans in the process of foreclosure totaled $156,000 and $131,000, respectively.

Loans are classified as performing when they are current as to principal and interest payments or are past due on payments less than 90 days. Loans are classified as nonperforming when they are past due 90 days or more as to principal and interest payments or are considered a troubled debt restructuring.

The following schedule provides information on loans that were considered troubled debt restructurings (“TDRs”) that were modified during the twelve months ended December 31, 2018 and December 31, 2017. The Bank may agree to modify the terms of a loan in order to improve the Bank’s ability to collect amounts due. These modifications may include reduction of the interest rate, extension of the loan term, or in some cases, reduction of the principal balance.

December 31, 2018

December 31, 2017

Pre-

Post-

Pre-

Post-

Modification

Outstanding

(Dollars in thousands)

Number of

Recorded

Number of

Recorded

Loans

Investment

Loans

Investment

Residential real estate

—

296

The pre-modification and post-modification outstanding recorded investment represents amounts as of the date of loan modification. If a difference exists between the pre-modification and post-modification outstanding recorded investment, it represents impairment recognized through the provision for loan losses computed based on a loan’s post-modification present value of expected future cash flows discounted at the loan’s original effective interest rate. If no difference exists, a loss is not expected to be incurred based on an assessment of the borrower’s expected cash flows.

As of December 31, 2018 and December 31, 2017 there were no instances of a borrower who was past due with respect to principal and/or interest for 30 days or more during the twelve months ended December 31, 2018 and December 31, 2017 that had been modified during the 12-month period prior to the default. Loans modified in a TDR may already be on nonaccrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. As a result, loans modified in a TDR for the Bank may have the financial effect of increasing the specific allowance associated with the loan. The allowance for impaired loans that have been modified in a TDR is measured based on the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent or on the present value of expected future cash flows discounted at the loan’s effective interest rate. Management exercises significant judgment in developing these estimates. At December 31, 2018 the Corporation had no commitments to lend additional funds to the related debtors whose terms have been modified in a TDR.

Impaired loans by loan category as of December 31 were as follows:

			Unpaid				Average		Interest
(Dollars in thousands)	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
2018
With no related allowance recorded
Agricultural	$	185	$	185	$	—	$	291	$	—
Commercial and industrial		—		—		—		29		2
Consumer		1		1		—		2		8
Construction real estate		—		—		—		54		—
Commercial real estate		74		109		—		78		30
Residential real estate		250		261		—		177		114
Subtotal		510		556		—		631		154
With an allowance recorded
Agricultural		393		440		94		161		13
Commercial and industrial		21		21		3		296		—
Consumer		88		88		13		59		—
Construction real estate		—		—		—		—		—
Commercial real estate		550		609		20		692		—
Residential real estate		2,462		2,494		167		2,523		6
Subtotal		3,514		3,652		297		3,731		19
Total
Agricultural		578		625		94		452		13
Commercial and industrial		21		21		3		325		2
Consumer		90		90		13		61		8
Construction real estate		—		—		—		54		—
Commercial real estate		623		718		20		770		30
Residential real estate		2,712		2,755		167		2,700		120
Total	$	4,024	$	4,209	$	297	$	4,362	$	173

			Unpaid				Average		Interest
(Dollars in thousands)	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
2017
With no related allowance recorded
Agricultural	$	423	$	455	$	—	$	322	$	—
Commercial and industrial		—		—		—		103		—
Consumer		—		—		—		—		—
Commercial real estate		127		258		—		110		—
Residential real estate		115		126		—		106		4
Subtotal		665		839		—		641		4
With an allowance recorded
Agricultural		—		—		—		121		—
Commercial and industrial		124		124		26		177		1
Consumer		36		36		3		33		1
Commercial real estate		651		734		49		826		34
Residential real estate		2,664		2,690		224		2,522		110
Subtotal		3,475		3,584		302		3,679		146
Total
Agricultural		423		455		—		443		—
Commercial and industrial		124		124		26		280		1
Consumer		36		36		3		33		1
Commercial real estate		778		992		49		936		34
Residential real estate		2,779		2,816		224		2,628		114
Total	$	4,140	$	4,423	$	302	$	4,320	$	150

			Unpaid				Average		Interest
(Dollars in thousands)	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
2016
With no related allowance recorded
Agricultural	$	482	$	485	$	—	$	220	$	13
Commercial and industrial		206		207		—		91		3
Consumer		—		—		—		1		—
Commercial real estate		342		939		—		925		2
Residential real estate		301		292		—		167		5
Subtotal		1,331		1,923		—		1,404		23
With an allowance recorded
Agricultural		44		44		3		72		3
Commercial and industrial		95		95		11		218		—
Consumer		28		28		2		24		2
Commercial real estate		731		804		91		1,281		33
Residential real estate		2,682		2,711		296		2,672		108
Subtotal		3,580		3,682		403		4,267		146
Total
Agricultural		526		529		3		292		16
Commercial and industrial		301		302		11		309		3
Consumer		28		28		2		25		2
Commercial real estate		1,073		1,743		91		2,206		35
Residential real estate		2,983		3,003		296		2,839		113
Total	$	4,911	$	5,605	$	403	$	5,671	$	169

An aging analysis of loans by loan category as of December 31 follows:

					Loans
	Loans		Loans		Past Due								Loans
	Past Due		Past Due		Greater								90 Days Past
(Dollars in thousands)	30 to 59		60 to 89		Than 90				Loans Not		Total		Due and
	Days (1)		Days (1)		Days (1)		Total (1)		Past Due		Loans		Accruing
2018
Agricultural	$	—	$	—	$	—	$	—	$	49,109	$	49,109	$	—
Commercial and industrial		5		—		—		5		91,401		91,406		—
Consumer		149		40		11		200		24,182		24,382		—
Commercial real estate		—		—		73		73		139,380		139,453		—
Construction real estate		—		—		—		—		8,843		8,843		—
Residential real estate		1,493		486		648		2,627		93,253		95,880		—
	$	1,647	$	526	$	732	$	2,905	$	406,168	$	409,073	$	—

2017
Agricultural	$	—	$	—	$	83	$	83	$	48,381	$	48,464	$	—
Commercial and industrial		20		—		—		20		104,366		104,386		—
Consumer		142		38		1		181		24,332		24,513		—
Commercial real estate		95		58		69		222		123,265		123,487		—
Construction real estate		—		—		—		—		6,613		6,613		—
Residential real estate		585		272		296		1,153		90,169		91,322		258
	$	842	$	368	$	449	$	1,659	$	397,126	$	398,785	$	258

(1) Includes nonaccrual loans.

Nonaccrual loans by loan category as of December 31 as follows:

(Dollars in thousands)
	2018		2017
Agricultural	$	393	$	423
Commercial and industrial		—		—
Consumer		62		15
Commercial real estate		123		222
Construction real estate		—		—
Residential real estate		954		436
	$	1,532	$	1,096