ChoiceOne Financial Services, Inc. — Q1 2019 Form 10-Q
Business context and reporting period
ChoiceOne Financial Services, Inc. is a Michigan bank holding company whose subsidiaries include ChoiceOne Bank and ChoiceOne Insurance Agencies. This unaudited report covers the three months ended March 31, 2019; balance-sheet comparisons are with December 31, 2018. Amounts below are in U.S. dollars, generally thousands unless stated otherwise.
Financial performance and condition
- Earnings and revenue: Net income was $1.637 million, down 1% from $1.658 million in Q1 2018. Basic and diluted EPS were $0.45, versus $0.46. Net interest income was $5.496 million, up $189,000; noninterest income was $1.758 million, up $110,000. Total interest income was $6.477 million and interest expense was $981,000.
- Margins and returns: GAAP net interest margin was 3.61%, down from 3.71%. Tax-equivalent net interest spread declined to 3.43% from 3.66%, while tax-equivalent net interest margin was 3.68% versus 3.78%. Return on average assets was 0.98% and return on average equity was 8.03%, compared with 1.06% and 8.74%.
- Costs and credit: Noninterest expense increased 7% to $5.334 million, including $238,000 of proposed-merger expenses. No loan-loss provision was recorded, compared with $35,000 in Q1 2018. The allowance was $4.730 million, or 1.18% of loans, versus 1.14% at year-end. Nonperforming loans were $3.749 million, slightly below $3.786 million at year-end; about 91% of troubled debt restructurings were performing under restructured terms.
- Assets, deposits and funding: Total assets were essentially unchanged at $670.420 million. Total deposits fell $12.564 million to $564.451 million. Loans, excluding loans held for sale and loans to other financial institutions, declined $7.0 million; loans to other financial institutions increased $7.5 million to $28.119 million. Cash and due from banks was $16.296 million, down from $19.690 million. Federal Home Loan Bank advances rose to $20.225 million from $5.233 million; federal funds purchased declined from $4.800 million to zero.
- Cash flow and capital: Operating cash flow was $727,000, compared with $1.684 million in Q1 2018; investing activities used $1.044 million and financing activities used $3.077 million. Cash declined $3.394 million during the quarter. Shareholders’ equity rose to $82.702 million, including a $1.214 million increase in other comprehensive income, largely reflecting improved securities values. The Bank’s regulatory capital ratios exceeded the stated well-capitalized thresholds.
Material changes versus the prior comparable period
- Higher average loan balances and yields lifted interest income, but interest expense increased $589,000 as deposit and FHLB funding costs rose. Management attributed margin pressure to competition and the pass-through of higher market rates to depositors and wholesale funding.
- Noninterest income grew, largely because the gain from changes in the market value of equity securities was $164,000 higher year over year. Noninterest expense increased $370,000, principally reflecting merger-related professional fees and higher occupancy and equipment costs.
- Management reported adjusted net income of $1.860 million and adjusted EPS of $0.51, excluding $223,000 of merger expenses after tax. These are non-GAAP measures; reported GAAP net income and EPS were $1.637 million and $0.45.
- Cash dividends declared increased to $0.20 per share from $0.17; the cash dividend payout ratio was 44%, versus 37%.
Outlook, commentary and risks
- On March 22, 2019, ChoiceOne agreed to acquire County Bank Corp, parent of Lakestone Bank & Trust. Closing was expected in the second half of 2019, subject to shareholder and regulatory approvals and other customary conditions. County had approximately $620 million of assets, $360 million of loans and $540 million of deposits at December 31, 2018. The filing does not provide a quantified earnings or cost-savings outlook in this excerpt.
- Management said current liquidity was sufficient for normal operating needs, citing deposits, securities maturities, loan repayments and available borrowing sources, including FHLB advances and a secured Federal Reserve line.
- Risks include merger approval, closing and integration; whether expected merger benefits materialize; deposit competition and funding costs; credit deterioration and the allowance estimate; and interest-rate, market-liquidity and valuation risks. Management said Michigan economic conditions could affect borrowers and that it would continue to review the allowance. No other-than-temporary securities impairment was recorded in Q1; management considered unrealized losses temporary and related to rates and reduced market liquidity, not credit concerns.
- Management was evaluating the expected-credit-loss accounting standard (CECL), effective for the company in 2020. The filing reports no material change in risk-factor categories from the 2018 Form 10-K, no material pending legal proceedings, and effective disclosure controls as of quarter-end.
Important facts for investors to verify
- Progress toward merger approvals and closing, and the transaction’s eventual terms, integration costs and realized benefits.
- Whether deposit outflows, higher deposit costs and increased FHLB borrowing persist, and the resulting impact on net interest margin and liquidity.
- Trends in past-due, nonaccrual and restructured loans, particularly residential real estate and the mortgage-participation exposure; the largest mortgage banker represented 25% of that participation portfolio.
- Whether the $238,000 merger expense and $223,000 after-tax adjustment reconcile to reported results, and how the non-GAAP presentation compares with GAAP performance.
- Future allowance requirements and the effect of CECL adoption; the filing states management was still evaluating the impact.