ChoiceOne Financial Services, Inc. — Q3 2018 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 nine months ended September 30, 2018; balance-sheet comparisons are to December 31, 2017. Amounts are in U.S. dollars; financial statement amounts below are in millions unless otherwise noted.
Financial performance and position
- Q3 earnings: Net income was $2.014 million, up 17% from $1.720 million a year earlier. Diluted EPS was $0.55 versus $0.46.
- Nine-month earnings: Net income was $5.505 million, up 15% from $4.801 million; diluted EPS was $1.52 versus $1.32.
- Interest income and margin: For the first nine months, GAAP net interest income rose to $16.448 million from $15.171 million. Tax-equivalent net interest margin was 3.87% versus 3.68%; tax-equivalent spread was 3.72% versus 3.59%. The filing does not provide a clear Q3 net interest margin.
- Other income and costs: Nine-month noninterest income declined to $5.221 million from $5.657 million, while noninterest expense increased to $15.137 million from $14.239 million. Provision for loan losses was $35,000 versus $120,000.
- Cash flow: Nine-month operating cash flow was $6.998 million, investing cash outflow was $29.734 million, and financing cash inflow was $326,000. Cash and due from banks ended at $14.427 million, down from $36.837 million at year-end 2017.
- Balance sheet: Total assets were $650.186 million versus $646.544 million at year-end. Loans, net, were $397.294 million versus $394.208 million; total deposits were $544.347 million versus $539.853 million. Shareholders’ equity was $76.989 million versus $76.550 million.
- Funding and capital: At September 30, borrowings included $9.4 million of federal funds purchased and $16.242 million of FHLB advances; repurchase agreements were zero. The Bank’s capital ratios were 12.9% total risk-based, 12.0% CET1, and 9.7% Tier 1 leverage. Management said liquidity was sufficient for normal operating needs.
- Credit quality: The allowance for loan losses was $4.622 million, or 1.15% of loans. Nonperforming loans were $3.735 million, down from $4.250 million at year-end; impaired loans were $4.927 million, up from $4.140 million.
Material changes versus comparable periods
- Higher loan balances and yields drove interest-income growth; the average loan rate increased 33 basis points year over year for the nine-month period. Deposit and certificate rates also rose, lifting interest expense.
- The effective tax rate fell to 15.3% from 25.8%, primarily reflecting the Tax Cuts and Jobs Act reduction in the federal statutory rate from 34% to 21%. Management identified this as a contributor to higher earnings.
- Noninterest income fell partly because the Bank sold most of its investment book of business in Q4 2017, and mortgage origination activity and loan-sale gains weakened. Customer service charges and equity-security valuation gains partly offset these declines.
- Noninterest expense increased, including higher salaries and benefits associated with wage increases and staffing for two planned branch openings. The Downtown Grand Rapids branch opened in October 2018; another was expected to open in December 2018.
- Available-for-sale securities’ unrealized position shifted from a $0.2 million gain at year-end 2017 to a $3.4 million loss at September 30, 2018, which reduced accumulated other comprehensive income and equity. Management attributed the losses to rising rates and reduced market liquidity, not credit concerns, and reported no other-than-temporary impairment charges.
- Deposits increased $4.5 million from year-end, but checking and savings declined while certificates of deposit grew; brokered CDs were used to supplement local funding. FHLB advances declined by $4.0 million.
Outlook, risks, contingencies, and unusual items
- The filing gives no quantitative earnings or revenue guidance. Management noted that nine-month results are not necessarily indicative of full-year results and said it would continue to review the allowance as portfolio conditions change.
- Management cited Michigan economic conditions as a factor affecting borrowers. The allowance is a critical estimate and could change with portfolio composition, economic conditions, and loss experience.
- Loans to other financial institutions totaled $16.237 million; these are participations in mortgage-banker advances. The largest mortgage-banker exposure was 38% of that portfolio. Eight participations totaling $2.3 million were over 30 days; none were over 90 days, and the filing reported no historical losses on the program.
- Interest-rate movements pose market-value and funding-cost risks. The securities portfolio had $4.066 million of gross unrealized losses at quarter-end; management considered the losses temporary.
- Management was evaluating the expected-credit-loss standard (ASU 2016-13), effective for the company in 2020, and the fair-value disclosure standard (ASU 2018-13). It expected the 2019 lease standard’s effect to be immaterial.
- No material pending legal proceedings or material change in the categories of risk factors from the 2017 Form 10-K were reported. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether loan growth, deposit mix, and reliance on brokered CDs remain sustainable, and how funding costs respond to rate changes.
- Developments in impaired and nonperforming loans, allowance adequacy, and the mortgage-participation portfolio’s largest counterparty exposure.
- Subsequent changes in securities values and accumulated other comprehensive loss as interest rates and market liquidity evolve.
- Branch-opening costs and progress, and whether expense growth is matched by revenue growth.
- The ongoing effect of the lower tax rate on earnings; 2018 comparisons include a significant tax-rate change.