ChoiceOne Financial Services, Inc. — Q2 2022 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 quarterly report covers the three and six months ended June 30, 2022; balance-sheet comparisons are with December 31, 2021. Dollar figures below are in millions unless otherwise stated.
Financial performance and condition
- Q2 earnings: Net income was $5.615 million, up 11% from $5.043 million in Q2 2021. Basic and diluted EPS were $0.75 versus $0.65.
- First-half earnings: Net income was $11.143 million, down 1% from $11.281 million; EPS was $1.49 versus $1.45. The filing attributes the income decline principally to lower mortgage refinancing gains and higher expenses, partly offset by increased interest income.
- Interest income and margin: Q2 net interest income was $16.289 million versus $14.508 million; first-half net interest income was $32.610 million versus $29.196 million. GAAP net interest margin was 2.94% for Q2 (3.02% prior year) and 2.95% for the first half (3.12% prior year). Tax-equivalent margins were 3.02% and 3.03%, respectively, versus 3.10% and 3.21%.
- Noninterest income and expense: Noninterest income was $3.430 million in Q2 and $7.276 million in the first half, down from $4.732 million and $10.332 million. Noninterest expense was $13.157 million in Q2 and $26.847 million in the first half, compared with $13.129 million and $25.657 million.
- Loans and credit: Total loans were $1.081 billion at June 30, up from $1.017 billion at year-end; management reported core loan growth of $184.9 million year over year. The allowance was $7.416 million, or 0.69% of loans, versus 0.76% at year-end. Nonperforming loans were $2.714 million versus $5.543 million. First-half net charge-offs were $272,000, compared with $59,000 a year earlier; no loan-loss provision was recorded in the first half.
- Assets, deposits, and funding: Total assets were $2.360 billion versus $2.367 billion at year-end. Deposits were $2.139 billion, up from $2.052 billion; borrowings declined to $7 million from $50 million. Subordinated debentures were $35.140 million. Cash and cash equivalents were $40.296 million.
- Cash flow and liquidity: For the first half, operating activities provided $22.304 million, investing activities used $52.755 million, and financing activities provided $38.861 million. Cash increased $8.409 million. Management stated that liquidity was sufficient for normal operating needs and identified deposits, security maturities, loan repayments, and available FHLB and Federal Reserve facilities as funding sources.
- Equity and capital: Shareholders’ equity fell to $166.460 million from $221.669 million, primarily reflecting accumulated other comprehensive losses. At June 30, the bank’s total risk-based capital ratio was 12.7%, common equity Tier 1 ratio 12.2%, and Tier 1 leverage ratio 8.1%; each exceeded the stated well-capitalized thresholds.
Material changes, outlook, and risks
- Rising interest rates drove a substantial decline in securities values: the pre-tax unrealized loss on available-for-sale securities was $73.9 million at June 30, versus $3.3 million at year-end. Accumulated other comprehensive loss was $65.072 million, compared with $2.576 million at year-end. Management considered the securities losses temporary and attributed them to rates and reduced market liquidity, not credit quality.
- On January 1, ChoiceOne transferred $428.4 million of securities from available-for-sale to held-to-maturity. At June 30, held-to-maturity securities had $429.675 million amortized cost and $372.667 million fair value.
- The company entered into interest-rate swaps and caps with aggregate notional amounts described in the filing, including $200 million pay-floating swaps, a $200 million forward-starting pay-fixed swap, and $200 million of caps. Management said the strategies were designed to manage rate risk and protect tangible capital; the combined strategies were expected to be neutral to 2022 net income.
- Q2 included a $427,000 realized loss from selling $31.5 million of securities for redeployment into higher-yielding assets. First-half noninterest income also reflected weaker mortgage loan-sale gains and losses on equity securities.
- PPP loan forgiveness generated $1.2 million of fee income in the first half. $1.8 million of PPP loans and $68,000 of deferred fees remained at June 30; management expected the remaining loans to be forgiven in the second half of 2022.
- Management cited continued core-loan growth, staffing investment in commercial lending and wealth management, expense control, and automation. No formal earnings or financial guidance was provided. Management planned a quantitative goodwill assessment in Q3 2022.
- Risks include further interest-rate changes, economic conditions affecting Michigan borrowers, credit-loss estimate uncertainty, deposit behavior and funding costs, and the potential effect of the upcoming expected-credit-loss accounting standard (CECL). Management said CECL’s impact was under evaluation and could be significant. The filing reported no material pending legal proceedings and no issuer share repurchases in Q2.
Important facts for investors to verify
- How further rate moves affect securities values, accumulated other comprehensive loss, capital, and the performance of the new hedges.
- Whether core-loan growth continues and whether credit quality, delinquencies, charge-offs, and the allowance remain consistent with management’s assumptions.
- Deposit trends, funding costs, liquidity sources, and the ability to maintain margins as rates rise.
- Realization of the expected remaining PPP forgiveness and related fee income, and the trajectory of mortgage banking and noninterest revenue.
- The outcome of the Q3 goodwill assessment and management’s CECL implementation estimate.