CHOICEONE FINANCIAL SERVICES INC annual report, FY2022

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ChoiceOne Financial Services, Inc. — FY2022 Form 10-K

Reporting period: Fiscal year ended December 31, 2022. This is an annual filing, not a standalone fourth-quarter report. ChoiceOne is a Michigan community banking holding company operating primarily in western and southeastern Michigan.

Financial results and condition

  • Profitability: Net income was $23.6 million, up from $22.0 million in 2021; diluted EPS was $3.15 versus $2.86. Return on average assets was 1.00% (1.02% in 2021), and return on average equity was 13.25% (9.79%).
  • Revenue and margins: Net interest income rose to $67.3 million from $60.6 million. GAAP net interest margin declined to 3.01% from 3.08% (tax-equivalent margin: 3.09% versus 3.14%). Noninterest income fell to $14.1 million from $19.2 million, mainly reflecting lower mortgage-related income and a less favorable change in equity-security values.
  • Expenses and credit costs: Noninterest expense increased 1.1% to $53.5 million. Provision for loan losses was $250,000, down from $416,000. Net charge-offs were $319,000; nonperforming loans declined to $2.7 million from $5.5 million. The allowance was $7.6 million, or 0.64% of loans, versus 0.76% a year earlier.
  • Growth and balance sheet: Total assets were $2.386 billion, up less than 1%; deposits were $2.118 billion, up $65.7 million; gross loans were $1.190 billion. Core loans grew organically by $206.1 million, or 21%. Total shareholders’ equity fell to $168.9 million from $221.7 million, principally due to investment-security valuation losses recorded in accumulated other comprehensive income.
  • Cash flow: Operating activities provided $45.0 million, investing activities used $90.5 million, and financing activities provided $57.5 million. Cash and cash equivalents ended the year at $43.9 million.
  • Debt, liquidity, and capital: Year-end borrowings were $50.0 million and subordinated debentures were $35.3 million. The Bank’s total risk-based capital ratio was 13.0%, up from 12.9%, and it was categorized as well-capitalized. Management reported ample liquidity, including securities cash flows, borrowing facilities, and other funding sources.

Material changes versus 2021

  • Higher loan and securities interest income lifted net interest income, but deposit and borrowing costs rose as market rates increased; net interest margin narrowed.
  • Core loan growth and deposit growth were partly offset by a $143.2 million decline in securities and a $42.6 million decline in loans to other financial institutions. The warehouse lending program was suspended in the third quarter to preserve liquidity for loan growth.
  • Noninterest income declined by $5.1 million, including a $4.4 million decrease tied to the mortgage sales environment. PPP loans were fully forgiven by year-end, and none remained in the portfolio.
  • Unrealized securities losses contributed to a $69.2 million decline in accumulated other comprehensive income and the reduction in shareholders’ equity. The filing reports $161.0 million of unrealized investment-security losses at year-end: $89.0 million on available-for-sale securities and $72.0 million on held-to-maturity securities.
  • Deposits declined $38.7 million in the fourth quarter, which management attributed to municipal-deposit seasonality and increased competition. Uninsured deposits were $823.2 million, or 39% of total deposits.

Outlook, risks, and unusual items

  • Management expected to continue regular quarterly cash dividends in 2023, subject to market conditions, cash needs, and capital requirements; no earnings or revenue guidance was provided. The 2022 dividend was $1.01 per share.
  • ChoiceOne adopted CECL on January 1, 2023. Management estimated an increase of $6.5–$7.0 million in the loan-loss allowance, bringing estimated coverage to 1.15%–1.25%, plus a $2.5–$3.0 million liability for expected losses on unfunded commitments. The after-tax effect was expected to reduce retained earnings.
  • On March 15, 2023, after year-end, the company terminated $200 million of pay-floating/receive-fixed swaps, recording a $4.2 million loss to be amortized into interest income over 13 months. Four other swaps remained, with total notional value of about $400.1 million.
  • Management considered the securities losses temporary, citing interest-rate and market changes, issuer credit quality, and its intent and ability to hold the securities. A forced sale to meet liquidity needs could crystallize losses and adversely affect earnings and capital.
  • Key risks include rising funding costs and deposit competition, interest-rate sensitivity, real-estate and commercial-credit concentration, economic weakness in Michigan, liquidity needs, cybersecurity and third-party operational risks, and extensive banking regulation. The filing also identifies CECL estimation uncertainty.
  • The independent auditor gave an unqualified opinion on the financial statements. The allowance for loan losses was identified as a critical audit matter. Management concluded disclosure controls and internal control over financial reporting were effective; the auditor did not express an opinion on internal control.

Important facts for investors to verify

  • How the CECL adoption affected reported reserves, unfunded-commitment liabilities, and retained earnings in 2023.
  • Deposit trends, uninsured-deposit concentration, deposit pricing, and the company’s actual borrowing capacity and use of liquidity facilities.
  • Subsequent-period performance and impairment assessment of the securities portfolio, including available-for-sale and held-to-maturity positions.
  • Loan growth, commercial and real-estate credit quality, delinquencies, and allowance adequacy under the new expected-loss methodology.
  • The accounting and earnings effects of the terminated swaps, and whether dividends remain supportable given capital, liquidity, and regulatory constraints.