ChoiceOne Financial Services, Inc. — 2017 Form 10-K
Reporting period: Fiscal year ended December 31, 2017. The company is a Michigan community banking holding company, operating primarily through ChoiceOne Bank in western Michigan. Figures below are consolidated unless otherwise indicated; dollar amounts are in millions except per-share data.
Financial performance and condition
| Metric | 2017 | 2016 | Change/comment |
|---|---|---|---|
| Net interest income | $20.56 | $19.34 | Up about 6.3% |
| Provision for loan losses | $0.49 | $0 | Higher loan growth and net charge-offs |
| Noninterest income | $7.81 | $7.88 | Down $0.07 |
| Noninterest expense | $19.33 | $18.97 | Up $0.36 |
| Net income | $6.17 | $6.09 | Up 1.3%; diluted EPS was $1.78 versus $1.76 |
| Return on average assets / equity | 0.98% / 8.22% | 1.04% / 8.44% | Both declined |
| Tax-equivalent net interest margin / spread | 3.67% / 3.57% | 3.72% / 3.66% | Both narrowed |
| Total assets | $646.5 | $607.4 | Up 6.5% |
| Gross loans / net loans | $398.8 / $394.2 | $369.0 / $364.7 | Gross loans up 8.1%; growth concentrated in commercial real estate and commercial and industrial |
| Deposits | $539.9 | $512.4 | Up 5.4% |
| Shareholders’ equity | $76.6 | $71.7 | Up $4.9; year-end equity/assets ratio was 11.84% |
Operating cash flow was $8.1 million, investing cash outflow $18.3 million, and financing cash inflow $32.2 million. Cash and due from banks ended at $36.8 million, up from $14.8 million. The filing does not present a conventional industrial-company debt measure; bank funding included $20.3 million of FHLB advances and $7.1 million of repurchase agreements at year-end. No federal funds were outstanding.
Asset quality improved by some measures: nonperforming loans totaled $4.25 million, down from $5.07 million; nonaccrual loans were $1.10 million versus $1.98 million. Net charge-offs were $0.19 million, compared with net recoveries of $0.08 million in 2016. The allowance was $4.58 million, 1.15% of gross loans and 108% of nonperforming loans. Management also identified $3.6 million of additional potential problem loans.
Material changes and unusual items
- Average earning assets grew about $40.0 million, supporting higher net interest income, but deposit and borrowing costs rose faster than asset yields, compressing spread and margin.
- In the fourth quarter, the bank sold approximately $35 million of securities to fund loan growth and reduce wholesale funding dependence. It recorded a $0.46 million loss on that sale; management said the action was expected to benefit 2018 income and provide tax benefits.
- The company recorded a $0.91 million gain from selling part of its investment book of business. Lower mortgage loan-sale volume reduced gains on loan sales by $0.48 million.
- The Tax Cuts and Jobs Act led to a $0.21 million deferred-tax charge as deferred tax balances were remeasured at the lower enacted corporate tax rate. The reported effective tax rate was 28%, up from 26%.
- Noninterest expense growth reflected higher compensation, headquarters remodeling, and professional fees, including costs related to two planned branches.
Outlook, liquidity, risks and contingencies
- Management planned to open two additional full-service branches in 2018 and continue pursuing local deposit growth. If local deposits did not support asset growth, management expected to use FHLB advances and brokered certificates of deposit as funding alternatives.
- Management expected regular quarterly cash dividends in 2018, but stated the amount would depend on market conditions, cash needs and capital requirements. The 2017 dividend was $0.67 per share; payout was about 38% of net income.
- Year-end available liquidity included approximately $63 million of correspondent federal-funds lines, an $82.5 million Federal Reserve Bank credit line designated for short-term needs, and $28.2 million of additional FHLB borrowing capacity. Management considered liquidity sufficient for normal operations.
- Interest-rate exposure is material. The one-year rate-sensitive asset/liability ratio was 63%. In the company’s modeled immediate rate shocks, net interest income changed by +6% under a 400-basis-point increase and −16% under a 400-basis-point decrease; modeled market value of equity declined 33% in the 400-basis-point-down scenario. The filing says certain down-rate equity scenarios exceeded policy guidelines.
- Key risks include borrower credit quality and collateral values, Michigan economic conditions, deposit and liquidity needs, changing interest rates, competition, regulatory requirements, cybersecurity and information-system disruption, and environmental exposure from foreclosed property. The company reported no significant pending litigation expected to materially affect its financial condition.
- Management said the new expected-credit-loss standard (CECL) could have a significant impact; it was effective for the company in fiscal years beginning after December 15, 2019. Other recently issued accounting changes were not expected to have significant effects.
Investor facts to verify
- Whether loan growth, particularly commercial real estate and commercial and industrial lending, is matched by stable local deposits and appropriate underwriting.
- Trends in the $3.6 million of potential problem loans, nonperforming assets, charge-offs, and the adequacy of the $4.58 million allowance.
- Whether the securities-sale strategy delivers the expected 2018 earnings benefit, and how higher funding costs affect net interest margin.
- Branch-opening costs and deposit, loan and earnings contribution from the two planned locations; also monitor the CECL implementation estimate.
- Capital and dividend capacity: the bank was categorized as well-capitalized, with a 12.0% common equity Tier 1 ratio and approximately $8.3 million then available for dividends to the parent, subject to regulatory limits.
- Trading and valuation constraints: shares traded infrequently on the OTC Pink market, and quoted bid prices may not represent actual transactions.
Audit: Plante & Moran, PLLC issued an unqualified opinion on the financial statements. Management reported effective disclosure controls and internal control over financial reporting; the auditor did not provide an internal-control attestation.