ChoiceOne Financial Services, Inc. — 2020 Q3 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Unaudited interim results; financial statements are consolidated.
Business context and reporting period
ChoiceOne is a Michigan-based bank holding company. Results reflect the October 1, 2019 County Bank merger and, from July 1, 2020, the Community Shores merger. Community Shores had approximately $244 million of assets, including $174 million of loans and $228 million of deposits, at acquisition. The banks were consolidated operationally on October 16, 2020. Accordingly, comparisons with 2019 are substantially affected by the acquisitions.
Key financial metrics
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $14.1 million | $5.6 million | $37.1 million | $16.6 million |
| Provision for loan losses | $1.2 million | — | $3.0 million | — |
| Noninterest income | $6.3 million | $1.9 million | $17.0 million | $5.7 million |
| Noninterest expense | $14.5 million | $6.4 million | $37.1 million | $17.5 million |
| Net income | $3.8 million | $1.0 million | $11.5 million | $4.1 million |
| Diluted EPS | $0.49 | $0.28 | $1.55 | $1.14 |
- Nine-month net interest margin was 3.42% on a tax-equivalent basis (3.43% in 2019); GAAP net interest margin was 3.56% (3.64% in 2019).
- For the first nine months, return on average assets was 0.87% and return on average equity was 7.50%, versus 0.83% and 6.62%, respectively, in 2019.
- At September 30, total assets were $1.829 billion, loans were $1.079 billion, and the allowance for loan losses was $6.7 million. Total deposits were $1.586 billion and borrowings were $13.2 million. Shareholders’ equity was $222.9 million.
- Cash and cash equivalents were $117.9 million, up from $59.6 million at December 31, 2019. Nine-month operating cash flow was negative $20.3 million, investing cash flow negative $98.0 million, and financing cash flow positive $176.6 million.
- Regulatory capital ratios at September 30 included 13.4% total capital and 12.4% common equity Tier 1 at the holding company; ChoiceOne Bank reported 13.7% and 13.0%, respectively.
Material changes versus the prior comparable period
- Nine-month net income increased 178% to $11.5 million; Q3 net income rose 275% to $3.8 million. Management attributed much of the increase to the County and Community Shores mergers, rather than solely to underlying organic growth.
- Nine-month net interest income increased $20.5 million, primarily reflecting the larger merged balance sheet. Lower interest rates reduced asset yields; higher average balances drove much of the growth. Nine-month PPP loan fees of $1.8 million were included in interest income.
- Noninterest income rose $11.3 million for the nine months, including higher loan-sale gains from mortgage refinancing, securities-sale gains, and trust income added through the County merger. Noninterest expense increased $19.6 million, reflecting acquired operations, merger costs, mortgage commissions, and systems-conversion costs.
- Merger-related expenses were $2.5 million for the first nine months of 2020. Excluding their tax effect, management reported non-GAAP adjusted net income of $13.7 million and adjusted diluted EPS of $1.84, compared with $5.3 million and $1.46 in 2019.
- Loans excluding loans held for sale and loans to financial institutions increased $276.7 million from year-end; the Community Shores acquisition contributed $174.0 million. Deposits rose $431.8 million, including $227.8 million acquired. Cash dividends were $0.60 per share for the nine months, versus $1.20 in 2019, which included a $0.60 special dividend.
Outlook, commentary, risks, and unusual items
- Management said the COVID-19 impact remained uncertain and expected increased past-due loans, nonperforming loans, and loan losses. The company recorded a $3.0 million year-to-date loan-loss provision, including $1.225 million in Q3, despite no material Q3 increase in delinquencies or net charge-offs.
- Approximately 750 borrowers had received payment deferrals on $148 million of loans. At September 30, fewer than 50 deferrals, totaling $10.3 million, remained active; most borrowers had resumed scheduled payments. COVID-related modifications treated as eligible under applicable guidance and the CARES Act were not reported as troubled debt restructurings.
- ChoiceOne originated more than $126 million of PPP loans and acquired another $37 million in the Community Shores merger. PPP gross fees were $4.7 million, net of approximately $0.2 million in costs; $1.8 million had been recognized in interest income through September. PPP loans carry a 1% fixed rate and are SBA-guaranteed.
- Nonperforming loans were $7.0 million at September 30, compared with $6.4 million at year-end 2019. The allowance was 0.62% of loans; management said it would equal 1.52% if acquired-loan credit marks were included. Net charge-offs were $0.372 million for the nine months, or 0.05% annualized of average loans.
- Management considered liquidity sufficient for normal operating needs, citing deposits, securities maturities, loan repayments, and available borrowing facilities. Goodwill passed a June qualitative impairment assessment; a third-party assessment was planned for the following year. The filing provides no quantified earnings or revenue guidance.
- Risks include COVID-19 effects on borrowers, collateral values, the Michigan economy, and operations; the uncertain legal requirements following Michigan court decisions on pandemic-related executive orders; low interest rates and potential pressure on margins; and merger integration and provisional purchase accounting. No material pending legal proceedings were disclosed.
Most important facts for investors to verify
- How much of earnings and balance-sheet growth is sustainable organically versus attributable to the two mergers, and how actual merger integration costs compare with management’s adjustments.
- Whether active deferrals, PPP exposures, and borrowers in pandemic-affected industries lead to rising delinquencies, nonperforming loans, charge-offs, or further provisions.
- Whether the $6.7 million allowance and acquired-loan credit marks remain adequate as economic conditions and loan performance evolve.
- How mortgage refinancing and loan-sale gains, PPP fee recognition, and securities gains affect recurring revenue and net interest margin.
- Final purchase accounting for Community Shores, including provisional loan and deposit-intangible values and goodwill, and the outcome of the planned goodwill assessment.
- Whether deposit growth and available funding support liquidity needs, and how capital, dividends, and post-merger performance develop.