CHOICEONE FINANCIAL SERVICES INC quarterly report, Q3 FY2022

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ChoiceOne Financial Services, Inc. — Q3 2022 Form 10-Q

Reporting period: Three and nine months ended September 30, 2022. Dollar amounts are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise. The filing covers ChoiceOne Financial Services and its banking and insurance subsidiaries.

Financial performance and position

  • Q3 earnings: Net income was $5.813 million, up 1% from $5.749 million a year earlier. Diluted EPS was $0.77 versus $0.75. Nine-month net income was $16.956 million, down slightly from $17.029 million; diluted EPS increased to $2.26 from $2.20.
  • Interest income and revenue: Q3 interest income rose to $19.285 million from $16.726 million, while net interest income increased to $17.338 million from $15.700 million. Nine-month net interest income was $49.948 million versus $44.896 million. Noninterest income declined to $3.047 million from $4.718 million in Q3 and to $10.323 million from $15.050 million for nine months.
  • Margins and returns: GAAP net interest margin was 3.08% in Q3 versus 3.06%; for nine months it was 2.99% versus 3.11%. Q3 return on average assets and equity were 0.98% and 12.67%, respectively; nine-month returns were 0.97% and 14.11%.
  • Expenses and credit costs: Q3 noninterest expense was $13.416 million, down slightly year over year; nine-month expense rose to $40.263 million from $39.163 million. The nine-month loan-loss provision was $0.100 million, compared with $0.416 million in 2021. The allowance was $7.457 million, or 0.66% of loans, at September 30.
  • Assets, loans, deposits: Total assets were $2.364 billion, roughly unchanged from year-end 2021. Loans were $1.132 billion, up from $1.017 billion; management reported core loans grew $205.2 million year over year. Deposits were $2.157 billion, up from $2.052 billion.
  • Liquidity and cash flow: Cash and cash equivalents were $51.494 million, up from $31.887 million at year-end. Nine-month operating cash flow was $32.0 million; investing cash outflow was $60.5 million and financing cash inflow was $48.1 million. Management stated liquidity was sufficient for normal operating needs and cited securities cash flows, deposits, loan repayments, and available borrowing facilities.
  • Debt and capital: There were no borrowings outstanding at quarter-end, versus $50 million at year-end 2021. Subordinated debentures were $35.2 million, including $32.5 million of notes issued in 2021. ChoiceOne Bank’s total risk-based capital ratio was 12.8%, and its common equity Tier 1 ratio was 12.3%; both exceeded the disclosed “well-capitalized” thresholds.
  • Equity and dividends: Shareholders’ equity fell to $156.7 million from $221.7 million at year-end, principally reflecting accumulated other comprehensive loss of $79.0 million. Dividends declared were $0.25 per share in Q3 and $0.75 per share for nine months.

Material changes versus comparable periods

  • Higher loan and securities balances lifted interest income and net interest income. Deposit and subordinated-debt interest costs also increased.
  • Mortgage refinancing slowed as rates rose, reducing gains on loan sales: $0.432 million in Q3 versus $1.798 million, and $2.123 million for nine months versus $5.715 million.
  • ChoiceOne recorded securities-sale losses of $0.378 million in Q3 and $0.805 million for nine months while selling securities to redeploy funds into higher-yielding assets. Equity-security market-value losses also weighed on noninterest income.
  • Rising market rates drove substantial unrealized securities losses. At September 30, available-for-sale securities had $98.6 million of gross unrealized losses; held-to-maturity securities had $76.3 million of unrealized losses based on fair value. Management attributed losses to interest rates and reduced market liquidity, not credit quality, and reported no other-than-temporary impairment charges.
  • On January 1, 2022, $428.4 million of securities were transferred from available-for-sale to held-to-maturity. The transfer did not recognize a gain or loss at the time; related unrealized loss remains in accumulated other comprehensive income and is amortized over the securities’ remaining lives.

Outlook, risks, contingencies, and unusual items

  • The filing provides no quantified earnings or margin guidance. Management expects to continue managing deposit costs and interest-rate exposure; it stated the securities and derivatives strategies were expected to be neutral to 2022 net income and intended to help protect against further rate increases.
  • ChoiceOne entered into interest-rate swaps and caps with $600 million total notional amount, using both cash-flow and fair-value hedge accounting. Their effectiveness, valuation, and impact under changing rates remain relevant risks.
  • Management cited rising interest rates, inflation, economic conditions affecting Michigan borrowers, and uncertainty in credit-loss estimates. It was evaluating adoption of CECL, effective for the company in 2023, and said the impact could be significant.
  • Nonperforming loans were $2.628 million, down from $5.543 million at year-end 2021. Management said 82% of TDR loans were performing under modified terms. Net charge-offs were $0.331 million for the first nine months, versus $0.254 million.
  • ChoiceOne suspended its warehouse lending line to other financial institutions at the end of Q3; the remaining balance was described as immaterial and expected to pay off quickly. All PPP loans had been forgiven by quarter-end.
  • Management planned a quantitative goodwill impairment assessment in Q4 2022. It reported no material pending legal proceedings outside the ordinary course and no material control changes during the quarter.

Important facts for investors to verify

  • How rising rates, deposit repricing, and the company’s hedges affect future net interest margin and earnings.
  • The size, duration, and capital implications of unrealized securities losses, including the held-to-maturity portfolio’s fair-value deficit and liquidity flexibility.
  • Whether strong reported core-loan growth is maintained without deterioration in delinquencies, nonperforming loans, charge-offs, or allowance adequacy.
  • The eventual CECL adoption impact and the outcome of the planned goodwill impairment assessment.
  • Whether deposit growth and available liquidity can support loan growth as deposit competition and funding costs change.