ChoiceOne Financial Services, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. The consolidated results cover ChoiceOne Financial Services, ChoiceOne Bank and its insurance subsidiary; they do not include County Bank Corp. The merger with County closed October 1, 2019, after the reporting period.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $5.57 million | $5.57 million | $16.57 million | $16.45 million |
| Noninterest income | $1.94 million | $1.85 million | $5.72 million | $5.22 million |
| Noninterest expense | $6.38 million | $5.06 million | $17.47 million | $15.14 million |
| Net income | $1.02 million | $2.01 million | $4.14 million | $5.51 million |
| Diluted EPS | $0.28 | $0.55 | $1.14 | $1.52 |
- Q3 net income fell 49%; nine-month net income declined 25%. Net interest income was nearly flat in Q3 and increased modestly year to date.
- Tax-equivalent net interest margin was 3.73% for Q3 versus 3.86% a year earlier; the reported GAAP margin was 3.66% versus 3.79%. For the first nine months, tax-equivalent margin was 3.71% versus 3.87%.
- Management attributed margin pressure to funding costs rising faster than asset yields. Nine-month interest expense rose $1.40 million, largely from higher deposit rates and certificate-of-deposit balances.
- Q3 and nine-month merger expenses were $763,000 and $1.351 million before tax. Management’s non-GAAP adjusted net income was $1.642 million for Q3 and $5.338 million for nine months; adjusted diluted EPS was $0.45 and $1.46, respectively. These are company-defined non-GAAP measures.
Financial condition, cash flow and capital
- At September 30, total assets were $663.6 million, down from $670.5 million at December 31, 2018. Total loans were $406.8 million versus $409.1 million; deposits were $574.1 million versus $577.0 million.
- Cash and due from banks was $16.6 million, down from $19.7 million. Nine-month operating cash flow was $5.4 million, investing activities provided $8.5 million, and financing activities used $17.0 million.
- Borrowings were low at period end: $207,000 of FHLB advances and no federal funds purchased, compared with $5.2 million of FHLB advances and $4.8 million of federal funds purchased at year-end 2018.
- Shareholders’ equity was $84.6 million, up from $80.5 million. The improvement included a $3.8 million increase in accumulated other comprehensive income, primarily reflecting securities-market value gains.
- ChoiceOne Bank reported regulatory capital ratios of 13.0% total risk-based capital, 12.2% Common Equity Tier 1, and 9.8% Tier 1 leverage. Management stated capital was adequate and liquidity sufficient for normal needs.
- Cash dividends declared were $1.20 per share for the first nine months, including a $0.60-per-share special dividend connected with the merger. The special dividend lifted the reported payout ratio to 105%; management gave 53% excluding it.
Material changes, outlook and risks
- Merger-related costs and other expense growth weighed on earnings. Nine-month professional fees rose $1.2 million, primarily due to the merger; higher salaries and occupancy costs also reflected two new offices. Higher gains on loan sales partly offset expense growth.
- The County merger consideration was 2.0632 ChoiceOne shares per County share, plus cash for fractional shares. Approximately 3.604 million ChoiceOne shares were identified for issuance. County had approximately $673 million in assets, $428 million in loans and $574 million in deposits at the merger date; purchase accounting was not yet complete.
- Asset quality warrants attention: nonperforming loans were $5.6 million, up from $3.8 million at year-end 2018, while nonaccrual loans rose to $3.6 million from $1.5 million. The allowance was $4.1 million, or 1.01% of total loans, compared with 1.14% at year-end. Nine-month net charge-offs were $577,000; management cited a $670,000 charge-off on a large relationship in Q3.
- Loans to other financial institutions increased to $30.0 million from $20.6 million. The participations were concentrated among 13 mortgage bankers; the largest represented 19% of the balance. Seventeen of 184 participations, totaling $4.8 million, were over 30 days outstanding.
- Management provided no specific earnings or financial guidance. It cautioned that interim results are not necessarily indicative of full-year results and identified economic conditions, interest rates, loan losses, securities valuations and merger integration/accounting as relevant uncertainties.
- The company said it was eligible for the delayed credit-loss standard effective date of January 2023. It reported effective disclosure controls, no material change in internal control over financial reporting, and no material pending legal proceedings.
Important facts for investors to verify
- Reconcile reported earnings with merger-adjusted results and track whether merger costs or expected synergies differ from management’s assumptions.
- Review the completed merger’s purchase accounting, share issuance, integration costs and subsequent combined-company financial results.
- Monitor nonperforming and nonaccrual loans, charge-offs, allowance adequacy and the mortgage-participation portfolio’s concentration and past-due balances.
- Assess whether deposit pricing and funding costs continue to pressure net interest margin, and whether loan growth and loan-sale gains can offset that pressure.
- Confirm the sustainability of dividends, particularly after the merger-related special dividend, and monitor liquidity and capital after integration.