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MFNC Mackinac Financial

Filed: 14 May 21, 10:29am

mac

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2021

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from <> to <>

Commission file number: 0-20167

MACKINAC FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

MICHIGAN

38-2062816

(State or other jurisdiction of

(I.R.S. Employer Identification No.)

incorporation or organization)

130 SOUTH CEDAR STREET, MANISTIQUE, MI

49854

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (888) 343-8147

Securities registered pursuant to Section 12(b) of the Act:

Title of each class:

    

Trading Symbol

    

Name of each exchange on which registered:

Commmon Stock, No par value

MFNC

The NASDAQ Stock Market, LLC

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes       No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes       No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer  

Accelerated Filer  

Non-accelerated Filer     

Smaller reporting company  

Emerging growth company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes       No  

As of May 12, 2021, there were outstanding 10,550,393 shares of the registrant’s common stock, no par value.

MACKINAC FINANCIAL CORPORATION

PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)

    

March 31,

    

December 31,

 

2021

2020

 

ASSETS

Cash and due from banks

$

239,831

$

218,901

Federal funds sold

 

3,661

 

76

Cash and cash equivalents

 

243,492

 

218,977

Interest-bearing deposits in other financial institutions

 

2,427

 

2,917

Securities available for sale

 

109,414

 

111,836

Federal Home Loan Bank stock

 

4,924

 

4,924

Loans:

Commercial

 

818,584

 

819,907

Mortgage

 

226,780

 

238,705

Consumer

 

18,392

 

18,980

Total Loans

 

1,063,756

 

1,077,592

Allowance for loan losses

 

(5,842)

 

(5,816)

Net loans

 

1,057,914

 

1,071,776

Premises and equipment

 

25,010

 

25,518

Other real estate held for sale

 

1,692

 

1,752

Deferred tax asset

 

2,492

 

3,303

Deposit based intangibles

4,200

4,368

Goodwill

19,574

19,574

Other assets

 

37,109

 

36,785

TOTAL ASSETS

$

1,508,248

$

1,501,730

LIABILITIES AND SHAREHOLDERS’ EQUITY

LIABILITIES:

Deposits:

Noninterest bearing deposits

$

443,956

$

414,804

NOW, money market, interest checking

 

478,181

 

450,556

Savings

 

137,134

 

130,755

CDs<$250,000

 

190,320

 

202,266

CDs>$250,000

 

10,337

 

15,224

Brokered

 

13,351

 

45,171

Total deposits

 

1,273,279

 

1,258,776

Federal funds purchased

Borrowings

 

53,459

 

63,479

Other liabilities

 

11,334

 

11,611

Total liabilities

 

1,338,072

 

1,333,866

SHAREHOLDERS’ EQUITY:

Common stock and additional paid in capital - NaN par value Authorized - 18,000,000 shares Issued and outstanding - 10,550,393 and 10,500,758 respectively

 

127,397

 

127,164

Retained earnings

 

41,721

 

39,318

Accumulated other comprehensive income

 

 

Unrealized gains on available for sale securities

1,641

1,965

Minimum pension liability

(583)

(583)

Total shareholders’ equity

 

170,176

 

167,864

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY

$

1,508,248

$

1,501,730

1

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except per Share Data)

Three Months Ended

March 31,

    

2021

    

2020

 

INTEREST INCOME:

Interest and fees on loans:

Taxable

$

14,121

$

14,613

Tax-exempt

20

74

Interest on securities:

Taxable

525

621

Tax-exempt

142

87

Other interest income

84

270

Total interest income

 

14,892

 

15,665

INTEREST EXPENSE:

Deposits

889

1,927

Borrowings

225

341

Total interest expense

 

1,114

 

2,268

Net interest income

 

13,778

 

13,397

Provision for loan losses

50

100

Net interest income after provision for loan losses

 

13,728

 

13,297

OTHER INCOME:

Deposit service fees

257

403

Income from mortgage loans sold on the secondary market

1,302

538

SBA/USDA loan sale gains

433

710

Net mortgage servicing fees

241

189

Realized security gains

36

Other

129

97

Total other income

 

2,398

 

1,937

OTHER EXPENSE:

Salaries and employee benefits

6,824

6,051

Occupancy

1,183

1,124

Furniture and equipment

842

802

Data processing

770

825

Advertising

113

212

Professional service fees

498

498

Loan origination expenses and deposit and card related fees

450

381

Writedowns and (gains) losses on other real estate held for sale

(52)

3

FDIC insurance assessment

140

150

Communications

241

213

Other

839

1,113

Total other expenses

 

11,848

 

11,372

Income before provision for income taxes

 

4,278

 

3,862

Provision for income taxes

398

811

NET INCOME

$

3,880

$

3,051

INCOME PER COMMON SHARE:

Basic

$

0.37

$

0.28

Diluted

$

0.37

$

0.28

2

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS COMPREHENSIVE INCOME

(Dollars in Thousands)

(Unaudited)

Three Months Ended

March 31,

2021

    

2020

Net income

$

3,880

$

3,051

Other comprehensive income

Change in securities available for sale:

Unrealized gains arising during the period

 

(375)

(1,106)

Reclassification adjustment for securities gains included in net income

 

(36)

Tax effect

 

87

232

Net change in unrealized gains on available for sale securities

(324)

(874)

Total comprehensive income

$

3,556

$

2,177

3

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in Thousands)

(Unaudited)

Three Months Ended

March 31,

2021

Common

Accumulated

Shares of

Stock and

Other

Common

Additional

Retained

Comprehensive

    

Stock

    

Paid in Capital

    

Earnings

    

Income (loss)

    

Total

 

Balance, beginning of period

10,500,758

 

$

127,164

 

$

39,318

 

$

1,382

 

$

167,864

Net income for period

 

 

3,880

 

 

3,880

Other comprehensive income

Net unrealized gain on securities available for sale

 

 

 

(324)

 

(324)

Total comprehensive income

 

 

3,880

 

(324)

 

3,556

Stock compensation

 

233

 

 

 

233

Issuance of common stock:

Restricted stock award vesting

49,635

 

 

 

 

Repurchase of common stock

Dividend on common stock

 

 

(1,477)

 

 

(1,477)

Balance, end of period

10,550,393

 

$

127,397

 

$

41,721

 

$

1,058

 

$

170,176

4

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in Thousands)

(Unaudited)

Three Months Ended

March 31,

2020

Common

Accumulated

Shares of

Stock and

Other

Common

Additional

Retained

Comprehensive

    

Stock

    

Paid in Capital

    

Earnings

    

Income

    

Total

 

Balance, beginning of period

10,748,712

$

129,564

$

31,740

$

615

$

161,919

Net income for period

 

 

3,051

 

 

3,051

Other comprehensive income

Net unrealized gain on securities available for sale

 

 

 

(874)

 

(874)

Total comprehensive income

 

 

3,051

 

(874)

 

2,177

Stock compensation

 

168

 

 

168

Issuance of common stock:

Restricted stock award vesting

25,521

 

 

 

 

Repurchase of common stock

(240,644)

 

(2,729)

 

 

(2,729)

Dividend on common stock

 

 

(1,475)

 

 

(1,475)

Balance, end of period

10,533,589

$

127,003

$

33,316

$

(259)

$

160,060

5

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(Unaudited)

Three Months Ended

March 31,

    

2021

    

2020

 

Cash Flows from Operating Activities:

Net income

 

$

3,880

 

$

3,051

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation and amortization

 

812

 

687

Provision for loan losses

 

50

 

100

Deferred tax expense, net

 

179

 

456

Gain on sale of loans sold in the secondary market

 

(1,168)

 

(447)

Origination of loans held for sale in the secondary market

 

(35,131)

 

(18,997)

Proceeds from sale of loans in the secondary market

 

36,597

 

16,900

(Gain) on sale other real estate held for sale and fixed assets

 

(52)

 

Writedown of other real estate held for sale

 

 

3

Stock compensation

 

233

 

168

Change in other assets

 

(339)

 

2,090

Change in other liabilities

 

(277)

 

(667)

Net cash provided by operating activities

 

4,784

 

3,344

Cash Flows from Investing Activities:

Net increase in loans

 

13,962

17,200

Net decrease in interest bearing deposits in other financial institutions

 

490

1,470

Purchase of securities available for sale

 

(4,338)

(17,873)

Proceeds from maturities, sales, calls or paydowns of securities available for sale

 

6,279

9,988

Capital expenditures

 

(233)

(1,584)

Proceeds from sale of other real estate, premises and fixed assets

 

565

67

Net cash used in investing activities

 

16,725

 

9,268

Cash Flows from Financing Activities:

Net increase in deposits

 

14,503

19,704

Net activity on line of credit

 

3,000

Net decrease in fed funds purchased

16,565

New term debt issuance

10,000

Principal payments on borrowings

 

(10,020)

(10,431)

Repurchase of common stock

(2,729)

Dividend on common stock

 

(1,477)

(1,475)

Net cash provided by financing activities

 

3,006

 

34,634

Net increase in cash and cash equivalents

 

24,515

 

47,246

Cash and cash equivalents at beginning of period

 

218,977

 

49,826

Cash and cash equivalents at end of period

 

$

243,492

 

$

97,072

Supplemental Cash Flow Information:

Cash paid during the year for:

Interest

 

$

1,356

 

$

2,242

Income taxes

 

 

Noncash Investing and Financing Activities:

Transfers of Foreclosures from Loans to Other Real Estate Held for Sale

 

448

 

155

Transfers of Other Real Estate Held for Sale to Fixed Assets

6

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The unaudited condensed consolidated financial statements of Mackinac Financial Corporation (the “Corporation”) have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021. The unaudited consolidated financial statements and footnotes thereto should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2020.

In order to properly reflect some categories of other income and other expenses, reclassifications of expense and income items have been made to prior period numbers. The “net” other income and other expenses were unchanged by these reclassifications.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of investment securities, the valuation of foreclosed real estate, deferred tax assets, mortgage servicing rights, the assessment of goodwill for impairment, and the fair value of assets and liabilities acquired in business combinations.

Acquired Loans

Loans acquired with evidence of credit deterioration since inception and for which it is probable that all contractual payments will not be received are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”). These loans are recorded at fair value at the time of acquisition, with no carryover of the related allowance for loan losses. Fair value of acquired loans is determined using a discounted cash flow methodology based on assumptions about the amount and timing of principal and interest payments, principal prepayments and principal defaults and losses, and current market rates.

In recording the fair values of acquired impaired loans at acquisition date, management calculates a non-accretable difference (the credit component of the purchased loans) and an accretable difference (the yield component of the purchased loans).

Over the life of the acquired loans, management continues to estimate cash flows expected to be collected. We evaluate at each balance sheet date whether it is probable that we will be unable to collect all cash flows expected at acquisition and if so, recognize a provision for loan loss in our consolidated statement of operations. For any significant increases in cash flows expected to be collected, we adjust the amount of the accretable yield recognized on a prospective basis over the pool’s remaining life.

Performing acquired loans are accounted for under Financial Accounting Standards Board (“FASB”) Topic 310-20, Receivables – Nonrefundable Fees and Other Costs. Performance of certain loans may be monitored and based on management’s assessment of the cash flows and other facts available, portions of the accretable difference may be delayed or suspended if management deems appropriate. The Corporation’s policy for determining when to discontinue accruing interest on performing acquired loans and the subsequent accounting for such loans is essentially the same as the policy for originated loans.

7

Allowance for Loan Losses

The allowance for loan losses includes specific allowances related to loans, when they have been judged to be impaired. A loan is impaired when, based on current information, it is probable that the Corporation will not collect all amounts due in accordance with the contractual terms of the loan agreement. These specific allowances are based on discounted cash flows of expected future payments using the loan’s initial effective interest rate or the fair value of the collateral if the loan is collateral dependent.

The Corporation also has an unallocated allowance for loan losses for loans not considered impaired. The allowance for loan losses is maintained at a level which management believes is adequate to provide for probable loan losses. Management periodically evaluates the adequacy of the allowance using the Corporation’s past loan loss experience, known and inherent risks in the portfolio, composition of the portfolio, current economic conditions, and other factors. The allowance does not include the effects of expected losses related to future events or future changes in economic conditions. This evaluation is inherently subjective since it requires material estimates that may be susceptible to significant change. Loans are charged against the allowance for loan losses when management believes the collectability of the principal is unlikely. In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require additions to the allowance for loan losses based on their judgments of collectability.

In management’s opinion, the allowance for loan losses is adequate to cover probable losses relating to specifically identified loans, as well as probable losses inherent in the balance of the loan portfolio as of the balance sheet date.

Stock Compensation Plans

On May 22, 2012, the Corporation’s shareholders approved the Mackinac Financial Corporation 2012 Incentive Compensation Plan, under which current and prospective employees, non-employee directors and consultants may be awarded incentive stock options, non-statutory stock options, shares of restricted stock awards (“RSAs”), stock grants, or stock appreciation rights. The aggregate number of shares of the Corporation’s common stock issuable under the plan is 575,000. At March 31, 2021 there were 6,560 shares available for issuance under this plan. Awards are made to executive officers at the discretion of the compensation committee of the board of directors. Awards are made to certain other senior officers at the discretion of the Corporation’s management. Compensation cost equal to the fair value of the award is recognized over the vesting period.

2.

RECENT ACCOUNTING PRONOUNCEMENTS

In September 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income.

ASU 2016-13 requires an entity to measure expected credit losses for financial assets over the estimated lifetime of expected credit loss and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The standard includes the following core concepts in determining the expected credit loss.  The estimate must: (a) be based on an asset’s amortized cost (including premiums or discounts, net deferred fees and costs, foreign exchange and fair value hedge accounting adjustments), (b) reflect losses expected over the remaining contractual life of an asset (considering the effect of voluntary prepayments), (c) consider available relevant information about the estimated collectability of cash flows (including information about past events, current conditions, and reasonable and supportable forecasts), and (d) reflect the risk of loss, even when that risk is remote.

ASU 2016-13 also amends the recording of purchased credit-deteriorated assets. Under the new guidance, an allowance will be recognized at acquisition through a gross-up approach whereby an entity will record as the initial amortized cost the sum of (a) the purchase price and (b) an estimate of credit losses as of the date of acquisition. In addition, the guidance also requires immediate recognition in earnings of any subsequent changes, both favorable and unfavorable, in expected cash flows by adjusting this allowance.

ASU 2016-13 also amends the impairment model for available-for-sale debt securities and requires entities to determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. Management may not use the length of time a security has been in an unrealized loss position as a factor in concluding whether a credit loss exists, as is currently permitted. In addition, an entity will recognize an allowance for credit losses on available-for-sale

8

debt securities as a contra-account to the amortized cost basis rather than as a direct reduction of the amortized cost basis of the investment, as is currently required. As a result, entities will recognize improvements to credit losses on available-for-sale debt securities immediately in earnings rather than as interest income over time under current practice.

New disclosures required by ASU 2016-13 include: (a) for financial assets measured at amortized cost, an entity will be required to disclose information about how it developed its allowance, including changes in the factors that influenced management’s estimate of expected credit losses and the reasons for those changes, (b) for financial receivables and net investments in leases measured at amortized cost, an entity will be required to further disaggregate the information it currently discloses about the credit quality of these assets by year or the asset’s origination or vintage for as many as five annual periods, and (c) for available-for-sale debt securities, an entity will be required to provide a roll-forward of the allowance for credit losses and an aging analysis for securities that are past due.

Upon adoption of ASU 2016-13, a cumulative-effect adjustment to retained earnings will be recorded as of the beginning of the first reporting period in which the guidance is effective. The Corporation is currently evaluating the provisions of ASU 2016-13 to determine the potential impact on the Corporation's consolidated financial condition and results of operations.  The Corporation has formed a cross-functional implementation team consisting of individuals from finance, credit and information systems.  A project plan and timeline has been developed and the implementation team meets regularly to assess the project status to ensure adherence to the timeline.  The implementation team has also been working with a software vendor to assist in implementing required changes to credit loss estimation models and proceses, and is finalizing the historical data collected to be utilized in the credit loss models.  The Corporation expects to recognize a cumulative effect adjustment to the opening balance of retained earnings as of the beginning of the first reporting period in which ASU 2016-13 is effective.  The Corporation has not yet determined the magnitude of any such one-time adjustment or the potential impact of ASU 2016-13 on its condensed consolidated financial statements.  In October 2019 the Financial Accounting Standards Board (FASB) voted to defer the effective date of ASU 2016-13 to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, for smaller reporting companies (as defined by the Securities Exchange Commission).

3.

EARNINGS PER SHARE

Diluted earnings per share, which reflects the potential dilution that could occur if stock awards were fully vested and resulted in the issuance of common stock that then shared in our earnings, is computed by dividing net income by the weighted average number of common shares outstanding and common stock equivalents, after giving effect for dilutive shares issued.

The following shows the computation of basic and diluted earnings per share for the three months ended March 31, 2021 and 2020 (dollars in thousands, except per share data):

Three Months Ended March 31,

    

2021

    

2020

 

(Numerator):

Net income

$

3,880

$

3,051

(Denominator):

Weighted average shares outstanding

 

10,522,899

 

10,717,967

Effect of restricted stock awards

 

 

96,824

Diluted weighted average shares outstanding

 

10,522,899

 

10,814,791

Income per common share:

Basic

$

0.37

$

0.28

Diluted

$

0.37

$

0.28

9

4.

INVESTMENT SECURITIES

At March 31, 2021, the Corporation had an investment security portfolio totaling $109.414 million, a decrease of $2.422 million from the December 31, 2020 balance of $111.836 million. The amortized cost and estimated fair value of investment securities available for sale as of March 31, 2021 and December 31, 2020 are as follows (dollars in thousands):

Gross

Gross

 

Amortized

Unrealized

Unrealized

Estimated

 

    

Cost

    

Gains

    

Losses

    

Fair Value

 

March 31, 2021

US Treasury

$

1,067

$

3

$

$

1,070

Corporate

 

29,042

304

(222)

29,124

US Agencies

 

6,486

78

6,564

US Agencies - MBS

30,389

906

(3)

31,292

Obligations of states and political subdivisions

 

40,353

 

1,061

(50)

 

41,364

Total securities available for sale

 

$

107,337

 

$

2,352

 

$

(275)

 

$

109,414

December 31, 2020

US Treasury

 

$

$

$

$

Corporate

 

27,815

 

247

 

(19)

 

28,043

US Agencies

6,480

109

6,589

US Agencies - MBS

 

33,372

 

914

 

(6)

 

34,280

Obligations of states and political subdivisions

 

41,682

 

1,242

 

 

42,924

Total securities available for sale

 

$

109,349

 

$

2,512

 

$

(25)

 

$

111,836

10

The following table presents the amortized cost and estimated fair value of investment securities by contractual maturity as of March 31, 2021 and December 31, 2020 (dollars in thousands):

March 31,

December 31,

2021

2020

Amortized

Estimated

Amortized

Estimated

Cost

    

Fair Value

    

Cost

    

Fair Value

    

Available -for-sale securities

Under 1 year

$

14,366

$

14,518

$

15,645

$

15,820

After 1 year through 5 years

21,202

21,754

22,554

23,201

After 5 years through 10 years

27,548

27,724

24,965

25,261

After 10 years

13,832

14,126

12,813

13,274

Subtotal

76,948

78,122

75,977

77,556

US Agencies - MBS

30,389

31,292

33,372

34,280

Total available -for-sale securities

$

107,337

$

109,414

$

109,349

$

111,836

The following is information pertaining to securities with gross unrealized losses at March 31, 2021 and December 31, 2020 (dollars in thousands):

Less Than Twelve Months

Over Twelve Months

Total

Number

Gross

Number

Gross

Number

Gross

    

of

    

Fair

    

Unrealized

of

    

Fair

    

Unrealized

of

    

Fair

    

Unrealized

March 31, 2021

Securities

Value

Loss

Securities

Value

Loss

Securities

Value

Loss

Corporate

8

14,753

$

(222)

$

8

$

14,753

$

(222)

US Agencies

US Agencies - MBS

4

150

(3)

4

150

(3)

Obligations of states and political subdivisions

2

1,373

(50)

2

1,373

(50)

Total

10

$

16,126

$

(272)

4

$

150

$

(3)

14

$

16,276

$

(275)

Less Than Twelve Months

Over Twelve Months

Total

Number

Gross

Number

Gross

Number

Gross

    

of

    

Fair

    

Unrealized

of

    

Fair

    

Unrealized

of

    

Fair

    

Unrealized

December 31, 2020

Securities

Value

Loss

Securities

Value

Loss

Securities

Value

Loss

Corporate

4

$

9,293

$

(19)

$

$

4

$

9,293

$

(19)

US Agencies

US Agencies - MBS

4

83

(2)

2

123

(4)

6

206

(6)

Obligations of states and political subdivisions

Total

8

$

9,376

$

(21)

2

$

123

$

(4)

10

$

9,499

$

(25)

The Corporation has evaluated gross unrealized losses that exist within the portfolio and considers them temporary in nature. The Corporation has both the ability and the intent to hold the investment securities until their respective maturities and therefore does not anticipate the realization of the temporary losses.

The amortized cost and estimated fair value of investment securities pledged to secure FHLB borrowings and customer relationships were $20.887 million and $2.285 million, respectively, at March 31, 2021.

11

5.

LOANS

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

    

March 31,

December 31,

2021

    

2020

    

Commercial real estate

$

496,257

$

498,450

Commercial, financial, and agricultural

 

273,087

 

273,759

Commercial construction

 

49,240

 

47,698

One to four family residential real estate

 

214,034

 

227,044

Consumer

 

18,392

 

18,980

Consumer construction

12,746

11,661

Total loans

$

1,063,756

$

1,077,592

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 (“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, the Niagara acquired impaired loans totaled $2.105 million, the FFNM acquired impaired loans totaled $5.440 million, and the Lincoln acquired impaired loans totaled $1.901 million.

The table below details the outstanding balances of the PFC acquired portfolio and the 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

The table below details the outstanding balances of the Eagle River acquired portfolio and the 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

The table below details the outstanding balances of the Niagara acquired portfolio and the 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

12

The table below details the outstanding balances of the FFNM acquired portfolio and the 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

The table below details the outstanding balances of the Lincoln acquired portfolio and the 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

13

The table below presents a rollforward of the accretable yield on acquired loans for the three months ended March 31, 2021 (dollars in thousands):

PFC

Eagle River

    

Acquired

    

Acquired

    

Acquired

    

Acquired

    

Acquired

    

Acquired

Impaired

Non-impaired

Total

Impaired

Non-impaired

Total

Balance, December 31, 2020

$

53

$

$

53

$

183

$

$

183

Accretion

(2)

 

(2)

 

Reclassification from nonaccretable difference

2

2

Balance, March 31, 2021

$

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, 2020

$

12

$

$

12

$

292

$

869

$

1,161

Accretion

 

(3)

(205)

 

(208)

Reclassification from nonaccretable difference

2

(1)

1

Balance, March 31, 2021

$

12

$

$

12

$

291

$

663

$

954

Lincoln Community Bank

Total

    

Acquired

    

Acquired

    

Acquired

Acquired

    

Acquired

    

Acquired

Impaired

Non-impaired

Total

Impaired

Non-impaired

Total

Balance, December 31, 2020

$

85

$

130

$

215

$

625

$

999

$

1,624

Accretion

(1)

(26)

 

(27)

(6)

(231)

 

(237)

Reclassification from nonaccretable difference

1

1

5

(1)

4

Balance, March 31, 2021

$

85

$

104

$

189

$

624

$

767

$

1,391

The table below presents a rollforward of the accretable yield on acquired loans for the three months ended March 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

(90)

 

(90)

(77)

 

(77)

Reclassification from nonaccretable difference

52

52

58

58

Balance, March 31, 2020

$

67

$

$

67

$

190

$

$

190

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

(4)

 

(4)

(237)

(310)

 

(547)

Reclassification from nonaccretable difference

3

3

177

177

Balance, March 31, 2020

$

18

$

$

18

$

458

$

1,643

$

2,101

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

(3)

(38)

 

(41)

(411)

(348)

 

(759)

Reclassification from nonaccretable difference

3

3

293

293

Balance, March 31, 2020

$

108

$

226

$

334

$

841

$

1,869

$

2,710

14

Allowance for Loan Losses

An analysis of the allowance for loan losses for the three months ended March 31, 2021 and March 30, 2020 is as follows (dollars in thousands):

March 31,

March 31,

    

2021

    

2020

    

Balance, January 1

$

5,816

$

5,308

Recoveries on loans previously charged off

 

31

 

29

Loans charged off

 

(55)

 

(145)

Provision

 

50

 

100

Balance at end of period

$

5,842

$

5,292

In the first three months of 2021, net charge-offs were $24,000, compared to net charge-offs of $116,000 in the same period in 2020. In the first three months of 2021, the Corporation recorded a provision for loan loss of $50,000 compared to a $100,000 provision for loan losses in the first three months of 2020. The Corporation’s allowance for loan loss reserve policy calls for a measurement of the adequacy of the reserve at each quarter end. This process includes an analysis of the loan portfolio to take into account increases in loans outstanding and portfolio composition, historical loss rates, and specific reserve requirements of nonperforming loans.

A breakdown of the allowance for loan losses and recorded balances in loans at March 31, 2021 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

$

2,983

$

1,734

$

209

$

605

$

8

$

5

$

272

$

5,816

Charge-offs

 

(8)

(18)

(29)

 

(55)

Recoveries

 

3

11

5

12

 

31

Provision

 

(240)

331

(32)

17

1

(27)

 

50

Ending balance ALLR

$

2,738

$

2,076

$

209

$

560

$

8

$

6

$

245

$

5,842

Loans:

Ending balance

$

496,257

$

273,087

$

49,240

$

214,034

$

12,746

$

18,392

$

$

1,063,756

Ending balance ALLR

 

(2,738)

 

(2,076)

 

(209)

(560)

 

(8)

 

(6)

 

(245)

 

(5,842)

Net loans

$

493,519

$

271,011

$

49,031

$

213,474

$

12,738

$

18,386

$

(245)

$

1,057,914

Ending balance ALLR:

Individually evaluated

$

277

$

594

$

$

$

$

$

$

871

Collectively evaluated

 

2,461

 

1,482

 

209

 

560

 

8

 

6

 

245

 

4,971

Total

$

2,738

$

2,076

$

209

$

560

$

8

$

6

$

245

$

5,842

Ending balance Loans:

Individually evaluated

$

1,975

$

3,887

$

261

$

$

$

$

$

6,123

Collectively evaluated

 

493,125

268,972

48,890

213,231

12,730

18,392

 

1,055,340

Acquired with deteriorated credit quality

1,157

228

89

803

16

2,293

Total

$

496,257

$

273,087

$

49,240

$

214,034

$

12,746

$

18,392

$

$

1,063,756

Impaired loans, by definition, are individually evaluated.

In the first three months of 2021, the Corporation booked a provision for loan losses of $50,000 as a result of changes in environmental factors.

15

A breakdown of the allowance for loan losses and recorded balances in loans at March 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

 

(66)

 

 

(22)

 

(8)

 

(49)

 

 

(145)

Recoveries

 

6

 

 

10

 

 

13

 

 

29

Provision

 

623

502

 

27

 

291

 

7

 

33

 

(1,383)

 

100

Ending balance ALLR

$

1,818

$

1,633

$

98

$

427

$

10

$

10

$

1,296

$

5,292

Loans:

Ending balance

$

522,659

$

207,727

$

29,971

$

244,059

$

19,386

$

20,375

$

$

1,044,177

Ending balance ALLR

 

(1,818)

(1,633)

 

(98)

 

(427)

 

(10)

 

(10)

 

(1,296)

 

(5,292)

Net loans

$

520,841

$

206,094

$

29,873

$

243,632

$

19,376

$

20,365

$

(1,296)

$

1,038,885

Ending balance ALLR:

Individually evaluated

$

913

$

476

$

$

$

$

$

$

1,389

Collectively evaluated

 

905

 

1,157

 

98

 

427

 

10

 

10

 

1,296

 

3,903

Total

$

1,818

$

1,633

$

98

$

427

$

10

$

10

$

1,296

$

5,292

Ending balance Loans:

Individually evaluated

$

2,278

$

1,454

$

$

$

$

$

$

3,732

Collectively evaluated

 

518,642

 

203,857

 

29,604

 

243,251

 

19,386

 

20,374

 

 

1,035,114

Acquired with deteriorated credit quality

1,739

2,416

367

808

1

5,331

Total

$

522,659

$

207,727

$

29,971

$

244,059

$

19,386

$

20,375

$

$

1,044,177

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, and other relevant characteristics.

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, and other relevant characteristics.

16

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 is 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.

17

Below is a breakdown of loans by risk category as of March 31, 2021 (dollars in thousands):

(1)

(2)

(3)

(4)

(44)

(6)

(7)

Rating

    

Strong

    

Good

    

Average

    

Acceptable

    

Acceptable Watch

    

Substandard

    

Doubtful

    

Unassigned

    

Total

Commercial real estate

$

7,621

$

10,114

$

225,610

$

246,287

$

2,632

$

3,993

$

$

$

496,257

Commercial, financial and agricultural

 

120,509

 

12,715

48,855

 

86,331

 

597

 

4,080

 

 

 

273,087

Commercial construction

 

 

37

 

20,465

 

16,530

 

488

 

381

 

 

11,339

 

49,240

One-to-four family residential real estate

 

 

2,120

 

4,698

 

16,766

 

365

1,605

 

188,480

 

214,034

Consumer construction

 

 

 

 

 

 

12,746

 

12,746

Consumer

 

 

60

114

 

1,234

 

 

51

 

16,933

 

18,392

Total loans

$

128,130

$

25,046

$

299,742

$

367,148

$

4,082

$

10,110

$

$

229,498

$

1,063,756

At March 31, 2021, $109.733 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, 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

 

 

40

 

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

 

11,661

Consumer

 

 

79

 

128

 

1,141

 

 

67

 

 

17,565

 

18,980

Total loans

$

123,532

$

20,539

$

299,830

$

380,578

$

4,977

$

10,727

$

$

237,409

$

1,077,592

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 loan 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.

18

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

March 31, 2021

Commercial real estate

$

1,587

$

1,545

$

3,132

$

5,343

$

277

Commercial, financial and agricultural

 

2,885

 

1,230

 

4,115

 

4,247

 

594

Commercial construction

 

350

 

 

350

 

480

 

One to four family residential real estate

 

803

 

 

803

 

2,057

 

Consumer construction

 

 

 

 

 

Consumer

 

16

 

 

16

 

17

 

Total

$

5,641

$

2,775

$

8,416

$

12,144

$

871

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

Individually Evaluated Impaired Loans

March 31, 2021

December 31, 2020

    

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

$

5,671

$

62

$

6,860

$

270

Commercial, financial and agricultural

883

4

1,204

13

Commercial construction

117

6

541

27

One to four family residential real estate

2,571

31

3,064

135

Consumer construction

Consumer

28

37

1

Total

$

9,270

$

103

$

11,706

$

446

A summary of past due loans at March 31, 2021 and December 31, 2020 is as follows (dollars in thousands):

March 31,

December 31,

 

2021

2020

 

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

$

$

$

1,446

$

1,446

$

24

$

$

1,481

$

1,505

Commercial, financial and agricultural

 

384

 

384

 

42

 

 

478

 

520

Commercial construction

 

61

 

61

 

 

 

79

 

79

One to four family residential real estate

 

1,230

3,100

 

4,330

 

1,925

 

 

3,371

 

5,296

Consumer construction

 

 

 

 

 

 

Consumer

 

51

33

 

84

 

78

 

 

49

 

127

Total past due loans

$

1,281

$

$

5,024

$

6,305

$

2,069

$

$

5,458

$

7,527

19

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 a 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 6 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.

The Corporation has, in accordance with generally accepted accounting principles and applicable 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 0 TDRs that occurred during the three months ended March 31, 2021 and 3 TDRs during the three months ended March 31, 2020.

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):

    

Three Months Ended

Three Months Ended

    

March 31,

March 31,

2021

    

2020

Loans outstanding, January 1

$

11,778

$

12,196

New loans

 

500

 

Net activity on revolving lines of credit

 

(18)

 

(354)

Repayment

 

(69)

 

(100)

Loans outstanding at end of period

$

12,191

$

11,742

There were 0 loans to related parties classified as substandard as of March 31, 2021 or March 31, 2020. In addition to the outstanding balances above, there were 0 unfunded commitments to related parties at March 31, 2021.

20

6.

GOODWILL AND OTHER INTANGIBLE ASSETS

The Corporation through the acquisition of Peninsula in 2014, Eagle River and Niagara in 2016, and FFNM and Lincoln in 2018, has recorded goodwill and core deposit intangibles as presented below (dollars in thousands):

Deposit Based

Amortization Expense

Intangible

for the

Future Annual

March 31, 2021

period end

Amortization

Balance

    

March 31, 2021

Expense

Peninsula

$

443

 

$

30

$

121

Eagle River

 

505

 

 

25

 

99

Niagara

 

163

 

 

8

 

30

FFNM

2,074

72

290

Lincoln

1,015

34

135

Total

$

4,200

$

169

$

675

Deposit Based

Intangible

2020

December 31, 2020

Amortization

Balance

    

Expense

Peninsula

$

473

 

$

121

Eagle River

 

529

 

 

99

Niagara

 

170

 

 

30

FFNM

2,147

290

Lincoln

1,049

135

Total

$

4,368

$

675

The deposit based intangible asset is reported net of accumulated amortization at $4.200 million at March 31, 2021. Amortization expense in the first three months of 2021 is $.169 million. Amortization expense for the next five years is expected to be at $.675 million per year.

The Corporation, in accordance with GAAP, evaluates goodwill annually for impairment.

7.

SERVICING RIGHTS

Mortgage Loans

Mortgage servicing rights (“MSRs”) are recorded when loans are sold in the secondary market with servicing retained. As of March 31, 2021, the Corporation had obligations to service approximately $191.363 million of residential first mortgage loans. The valuation of MSRs is based upon the net present value of the projected revenues over the expected life of the loans being serviced, as reduced by estimated internal costs to service these loans. On a quarterly basis, management evaluates the MSRs for impairment. The key economic assumptions used in determining the fair value of the MSRs include an annual constant prepayment speed of 19.01% and a discount rate of 7.75% as of March 31, 2021.

21

The following table summarizes MSRs capitalized and amortized (dollars in thousands) for the three month periods ending March 31, 2021 and March 31, 2020:

March 31,

March 31,

    

2021

    

2020

    

Balance at beginning of period

$

1,359

$

1,499

Additions from loans sold with servicing retained

 

75

 

Amortization

 

(38)

 

(35)

Balance at end of period

$

1,396

$

1,464

Balance of loan servicing portfolio

$

191,363

$

246,370

Mortgage servicing rights as % of portfolio

.73%

.59%

Fair value of servicing rights

1,436

2,159

Commercial Loans

The Corporation periodically retains the servicing on certain commercial loans that have been sold. These loans were originated and underwritten under the SBA and USDA government guarantee programs, in which the guaranteed portion of the loan was sold to a third party with servicing retained. The balance of these sold loans with servicing retained at March 31, 2021 was approximately $53 million. The Corporation valued these servicing rights at $12,000 as of March 31, 2021 and at $42,000 as of March 31, 2020. This valuation was established in consideration of the discounted cash flow of net expected servicing income over the life of the loans.

8.

BORROWINGS

Borrowings consist of the following at March 31, 2021 and December 31, 2020 (dollars in thousands):

    

March 31,

December 31,

    

2021

    

2020

    

Federal Home Loan Bank fixed rate advances

$

53,135

$

63,155

USDA Rural Development note

 

324

 

324

$

53,459

$

63,479

The Federal Home Loan Bank borrowings bear a weighted average rate of 1.64% and mature at various dates through 2026. They are collateralized at March 31, 2021 by the following: a collateral agreement on the Corporation’s one to four family residential real estate loans with a book value of approximately $66.740 million; mortgage related and municipal securities with an amortized cost and estimated fair value of $20.318 million and $20.887 million, respectively; and Federal Home Loan Bank stock owned by the Bank totaling $4.924 million. Prepayment of the advances is subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank of Indianapolis in effect as of March 31, 2021.

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), created the Paycheck Protection Program to support lending to small businesses that have been affected by the disruption caused by COVID-19. The Federal Reserve created the Paycheck Protection Program Lending Facility (PPPLF) to offer a source of liquidity to the financial institution lenders who lend to small businesses through the Small Business Administration’s (SBA) Paycheck Protection Program. The PPPLF bears an interest rate of 0.35% and is collateralized by the PPP loans pledged. There were 0 PPP loans pledged as of March 31, 2021 as the PPPLF was repaid during the third quarter of 2020.

The Corporation currently has 1 correspondent banking borrowing relationship. As of March 31, 2021 the relationship consisted of a $15.0 million revolving line of credit, which had 0 balance. The line of credit bears an interest rate of LIBOR plus 2.00%, with a floor rate of 3.00% and a ceiling of 22%. The line of credit expires April 30, 2022. LIBOR at March 31, 2021 was 0.20%. This relationship is secured by all of the outstanding mBank stock.

The USDA Rural Development borrowing bears an interest rate of 1.00% and matures in August, 2024. It is collateralized by an assignment of a demand deposit account held by the Corporation’s wholly owned subsidiary, First Rural Relending, in the amount of $.389 million, and guaranteed by the Corporation.

22

9.

DEFINED BENEFIT PENSION PLAN

The Corporation acquired the Peninsula Financial Corporation noncontributory defined benefit pension plan in 2014. Effective December 31, 2005, the plan was amended to freeze participation in the plan; therefore, no additional employees are eligible to become participants in the plan. The benefits are based on years of service and the employee’s compensation at the time of retirement. The Plan was amended effective December 31, 2010, to freeze benefit accrual for all participants. Expected contributions to the Plan in 2021 are $57,000.

The anticipated distributions over the next 5 years and through December 31, 2030 are detailed in the table below (dollars in thousands):

2021

    

$

133

 

2022

 

140

2023

 

144

2024

 

142

2025

 

157

2026-2030

 

901

Total

$

1,617

The Corporation receives a valuation of the Plan annually. As such, at March 31, 2021, the plan’s assets had a fair value of $2.264 million and the Corporation had a net unfunded liability of $1.370 million. The accumulated benefit obligation at March 31, 2021 was $3.634 million.

Assumptions in the actuarial valuation are:

    

2021

    

2020

 

Weighted average discount rate

2.45%

2.45%

Rate of increase in future compensation levels

 

N/A

N/A

Expected long-term rate of return on plan assets

2.00%

2.00%

The expected long-term rate of return on plan assets reflects management’s expectations of long-term average rates of return on funds invested to provide for benefits included in the projected benefit obligation. The expected return is based on the outlook for inflation, fixed income returns and equity returns, while also considering historical returns, asset allocation and investment strategy. The discount rate assumption is based on investment yields available on AA rated long-term corporate bonds.

The primary investment objective is to maximize growth of the pension plan assets to meet the projected obligations to the beneficiaries over a long period of time, and to do so in a manner that is consistent with the Corporation’s risk tolerance. The intention of the plan sponsor is to invest the plan assets in mutual funds with the following asset allocation; which was in place at both March 31, 2021 and December 31, 2020.

    

Target

    

Actual

 

Allocation 

Allocation

Equity securities

 

50% to 70%

36%

Fixed income securities

 

30% to 50%

64%

10.

STOCK COMPENSATION PLANS

Restricted Stock Awards

The Corporation’s restricted stock awards are service-based and awarded based on performance. Each award has a vesting period of four years. Compensation expense is recognized on a straight-line basis over the vesting period. Shares are subject to certain restrictions and risk of forfeiture by the participants.

23

The Corporation has historically granted RSAs to members of the Board of Directors and management. Awards granted are set to vest equally over their award terms and are issued at no cost to the recipient. The table below summarizes each of the grant awards:

Market Value at

Date of Award

    

Units Granted

    

grant date

    

Vesting Term

February, 2017

28,427

13.39

4 years

February, 2018

18,643

16.30

4 years

April, 2018

8,000

16.00

Immediate

February, 2019

27,790

15.70

4 years

October, 2019

8,000

15.40

Immediate

February, 2020

132,000

15.46

4 years

October, 2020

8,000

9.46

Immediate

January, 2021

64,000

13.43

4 years

In the first three months of 2021, the Corporation issued 49,635 shares of its common stock for vested RSAs. In the first three months of 2020, the Corporation issued 25,521 shares of its common stock for vested RSAs.

A summary of changes in our nonvested shares for the period follows:

    

    

Weighted Average

 

Number

Grant Date

Outstanding

Fair Value

 

Nonvested balance at January 1, 2021

 

$

Granted during the period

 

170,153

 

14.90

Forfeited during the period

64,000

13.43

Vested during the period

 

(49,635)

 

12.91

Nonvested balance at March 31, 2021

 

184,518

$

14.94

11.

INCOME TAXES

The Corporation has reported deferred tax assets of $2.492 million at March 31, 2021.

A valuation allowance is provided against deferred tax assets when it is more likely than not that some or all of the deferred tax asset will not be realized.  The Corporation, as of March 31, 2021 had a net operating loss carryforwards for tax purposes of approximately $8.0 million. The carryforwards, if not utilized, will begin to expire in the year 2023. A portion of the NOL and credit carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code. The annual limitation is $2.0 million for the NOL and the equivalent value of tax credits, which is approximately $.420 million.  These limitations for use were established in conjunction with the recapitalization of the Corporation in December 2004.  The Corporation will continue to evaluate the future benefits from these carryforwards in order to determine if any adjustment to the deferred tax asset is warranted.

The Corporation recognized a federal income tax expense of approximately $.398 million for the three months ended March 31, 2021 and $.811 million for the three months ended March 31, 2020.  

12.

FAIR VALUE MEASUREMENTS

Fair value estimates, methods, and assumptions are set forth below for the Corporation’s financial instruments.

Cash, cash equivalents, and interest-bearing deposits - The carrying values approximate the fair values for these assets.

Securities - Fair values are based on quoted market prices where available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

Federal Home Loan Bank stock – Federal Home Loan Bank stock is carried at cost, which is its redeemable value and approximates its fair value, since the market for this stock is limited.

24

Loans - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type such as commercial, residential mortgage, and other consumer. The fair value of loans is calculated by discounting scheduled cash flows using discount rates reflecting the credit and interest rate risk inherent in the loan.

The methodology in determining fair value of nonaccrual loans is to average them into the blended interest rate at 0% interest. This has the effect of decreasing the carrying amount below the risk-free rate amount and, therefore, discounts the estimated fair value.

Impaired loans are measured at the estimated fair value of the expected future cash flows at the loan’s effective interest rate or the fair value of the collateral for loans which are collateral dependent. Therefore, the carrying values of impaired loans approximate the estimated fair values for these assets.

Deposits - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits and savings, is equal to the amount payable on demand at the reporting date. The fair value of time deposits is based on the discounted value of contractual cash flows applying interest rates currently being offered on similar time deposits.

Borrowings - Rates currently available for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt. The fair value of borrowed funds due on demand is the amount payable at the reporting date.

Accrued interest - The carrying amount of accrued interest approximates fair value.

Off-balance-sheet instruments - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the current interest rates, and the present creditworthiness of the counterparties. Since the differences in the current fees and those reflected to the off-balance-sheet instruments at year-end are immaterial, 0 amounts for fair value are presented.

The following table presents information for financial instruments at March 31, 2021 and December 31, 2020 (dollars in thousands):

March 31, 2021

December 31, 2020

    

Level in Fair

    

Carrying

    

Estimated

    

Carrying

    

Estimated

 

Value Hierarchy

Amount

Fair Value

Amount

Fair Value

Financial assets:

Cash and cash equivalents

 

Level 1

$

243,492

$

243,492

$

218,977

$

218,977

Interest-bearing deposits

 

Level 2

 

2,427

2,427

 

2,917

 

2,917

Securities available for sale

 

Level 2

 

108,083

108,083

 

110,505

 

110,505

Securities available for sale

Level 3

1,331

1,331

1,331

1,331

Federal Home Loan Bank stock

 

Level 2

 

4,924

4,924

 

4,924

 

4,924

Net loans

 

Level 3

 

1,057,914

1,061,119

 

1,071,776

 

1,072,770

Accrued interest receivable

 

Level 3

 

4,176

4,176

 

4,310

 

4,310

Total financial assets

$

1,422,347

$

1,425,552

$

1,414,740

$

1,415,734

Financial liabilities:

Deposits

 

Level 2

$

1,273,279

$

1,288,686

$

1,258,776

$

1,262,930

Borrowings

 

Level 2

 

53,459

52,427

 

63,479

 

61,975

Accrued interest payable

 

Level 3

 

211

211

 

453

 

453

Total financial liabilities

$

1,326,949

$

1,341,324

$

1,322,708

$

1,325,358

Limitations - Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Corporation’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various

25

financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on-and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include premises and equipment, other assets, and other liabilities. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

The following is information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at March 31, 2021, and the valuation techniques used by the Corporation to determine those fair values.

Level 1:

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access.

Level 2:

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3:

Level 3 inputs are unobservable inputs, including inputs available in situations where there is little, if any, market activity for the related asset or liability.

The fair value of all investment securities at March 31, 2021 and December 31, 2020 were based on level 2 and level 3 inputs. There are 0 other assets or liabilities measured on a recurring basis at fair value. For additional information regarding investment securities, please refer to “Note 4 - Investment Securities.”

The table below shows investment securities measured at fair value on a recurring basis (dollars in thousands):

Quoted Prices

Significant

Significant

Total (Gains)

in Active Markets

Other Observable

Unobservable

Losses for

Balance at

for Identical Assets

Inputs

Inputs

Three Months Ended

(dollars in thousands)

  

March 31, 2021

  

(Level 1)

  

(Level 2)

  

(Level 3)

  

March 31, 2021

    

Assets

Corporate

$

29,124

$

$

28,624

$

500

$

US Treasury

1,070

1,070

US Agencies

6,564

6,564

US Agencies - MBS

31,292

31,292

Obligations of state and political subdivisions

41,364

40,533

831

2

$

109,414

$

2

    

    

Quoted Prices

    

Significant

    

Significant

    

in Active Markets

Other Observable

Unobservable

Total (Gains) Losses for

Balance at

for Identical Assets

Inputs

Inputs

Twelve Months Ended

(dollars in thousands)

December 31, 2020

(Level 1)

(Level 2)

(Level 3)

December 31, 2020

Assets

Corporate

$

28,043

$

$

27,543

$

500

$

US Agencies

6,589

6,589

US Agencies - MBS

34,280

34,280

Obligations of state and political subdivisions

42,924

42,093

831

2

$

111,836

$

2

The Corporation had 0 Level 3 assets or liabilities measured at fair value on a recurring basis as of March 31, 2021, or December 31, 2020 other than as described above.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Corporation’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.

26

The Corporation also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets include certain impaired loans and other real estate owned. The Corporation has estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

Assets Measured at Fair Value on a Nonrecurring Basis at March 31, 2021

Quoted Prices

Significant

Significant

Total (Gains)

in Active Markets

Other Observable

Unobservable

Losses for

Balance at

for Identical Assets

Inputs

Inputs

Three Months Ended

(dollars in thousands)

    

March 31, 2021

    

(Level 1)

    

(Level 2)

    

(Level 3)

    

March 31, 2021

Assets

Impaired loans

$

8,416

$

$

$

8,416

$

Other real estate owned

1,692

1,692

(52)

��

$

(52)

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2020

    

    

Quoted Prices

    

Significant

    

Significant

    

in Active Markets

Other Observable

Unobservable

Total (Gains) Losses for

Balance at

for Identical Assets

Inputs

Inputs

Year Ended

(dollars in thousands)

December 31, 2020

(Level 1)

(Level 2)

(Level 3)

December 31, 2020

Assets

Impaired loans

$

8,850

$

$

$

8,850

$

186

Other real estate held for sale

 

1,752

1,752

(22)

$

164

Impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. The Corporation estimates the fair value of the loans based on the present value of expected future cash flows using management’s best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals).

13.

SHAREHOLDERS’ EQUITY

The Corporation currently has 1 active share repurchase program and 1 repurchase program that has since expired. All share repurchase programs are conducted under authorizations by the Board of Directors. Under the now expired program, the Corporation repurchased 1,661 shares in 2020, 14,000 shares in 2016, 102,455 shares in 2015, 13,700 shares in 2014 and 55,594 shares in 2013. The share repurchases were conducted under Board authorizations made and publicly announced of $.600 million on February 27, 2013, $.600 million on December 17, 2013 and an additional $.750 million on April 28, 2015.

On August 28, 2019, the Corporation, under the authorization of the Board of Directors announced a new common stock repurchase program. Under the Repurchase Program, the Company is authorized to repurchase up to approximately 5% of the Company’s outstanding common stock, and has no expiration date. During 2020, the Corporation repurchased 283,779 shares under this plan. The Corporation has formally paused any repurchase activity, with 0 repurchases made during 2021.

14.COMMITMENTS, CONTINGENCIES AND CREDIT RISK

Financial Instruments With Off-Balance-Sheet Risk

The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.

The Corporation’s exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit, is represented by the contractual amount of those

27

instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. These commitments are as follows (dollars in thousands):

    

March 31,

December 31,

2021

    

2020

    

Commitments to extend credit:

Variable rate

$

121,102

$

114,458

Fixed rate

 

53,659

 

58,175

Standby letters of credit - Variable rate

 

8,003

 

8,781

Credit card commitments - Fixed rate

 

7,569

 

7,136

$

190,333

$

188,550

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The commitments are structured to allow for 100% collateralization on all standby letters of credit.

Credit card commitments are commitments on credit cards issued by the Corporation’s subsidiary and serviced by other companies. These commitments are unsecured.

Legal Proceedings and Contingencies

In the normal course of business, the Corporation is involved in various legal proceedings. For an expanded discussion on the Corporation’s legal proceedings, see Part II, Item 1, “Legal Proceedings” in this report.

Concentration of Credit Risk

The Bank grants commercial, residential, agricultural, and consumer loans throughout Michigan and Northeastern Wisconsin. The Bank’s most prominent concentration in the loan portfolio relates to commercial real estate loans to operators of nonresidential buildings. This concentration at March 31, 2021 represents $137.356 million, or 16.78%, compared to $138.992 million, or 16.95%, of the commercial loan portfolio on December 31, 2020. The remainder of the commercial loan portfolio is diversified in such categories as hospitality and tourism, real estate agents and managers, new car dealers, gas stations and convenience stores, petroleum, forestry, agriculture and construction. Due to the diversity of the Bank’s locations, the ability of debtors of residential and consumer loans to honor their obligations is not tied to any particular economic sector.

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NOTE 15SUBSEQUENT EVENT

On April 12, 2021, the Corporation announced that it entered into an Agreement and Plan of Merger (“the Merger Agreement”) with Nicolet Bankshares, Inc (“Nicolet”). Pursuant to the terms of the agreement, the Corporation’s shareholders will receive 0.22 shares of Nicolet common stock and $4.64 in cash for each share of the Corporation common stock with total consideration to consist of approximately 80% stock and 20% cash. Further pursuant to the Agreement, the Corporation’s wholly owned subsidiary, mBank, will merge with and into Nicolet National Bank, which will be the surviving bank, with all bank branches operating under the Nicolet National Bank brand. Consummation of the merger is subject to the approval of the shareholders of the Corporation and Nicolet, regulatory agency approvals, and customary closing conditions contained in the Merger Agreement.

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MACKINAC FINANCIAL CORPORATION