ChoiceOne Financial Services, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unless stated otherwise, dollar amounts are in millions; financial statements report dollars in thousands. ChoiceOne is a Michigan-based bank holding company whose consolidated business includes ChoiceOne Bank and ChoiceOne Insurance Agencies.
Financial performance and position
- Q2 earnings: Net income was $1.833 million, up 12% from $1.635 million a year earlier. Diluted EPS was $0.50 versus $0.45. Pretax income edged down to $2.177 million from $2.215 million; lower income tax expense supported the increase in net income.
- First-half earnings: Net income was $3.491 million, up 13% from $3.081 million; diluted EPS was $0.96 versus $0.85. Return on average assets was 1.12% and return on average equity was 9.20%, compared with 0.99% and 8.35%, respectively, in 2017.
- Interest income and margin: Q2 net interest income rose to $5.570 million from $5.077 million. First-half net interest income was $10.877 million versus $9.932 million. First-half tax-equivalent net interest margin was 3.85% versus 3.64%; the tax-equivalent interest spread was 3.71% versus 3.55%.
- Other income and expenses: Q2 noninterest income declined to $1.721 million from $1.942 million, while noninterest expense rose to $5.114 million from $4.779 million. For the first half, noninterest income was $3.369 million versus $3.674 million and expense was $10.078 million versus $9.448 million.
- Tax: First-half income tax expense fell to $0.642 million from $1.052 million; the effective tax rate was 15.5% versus 25.5%. Management attributed the reduction primarily to the Tax Cuts and Jobs Act lowering the statutory rate from 34% to 21% effective January 1, 2018.
- Balance sheet at June 30: Assets were $630.8 million, down from $646.5 million at December 31, 2017. Loans were $395.9 million, down $2.9 million; deposits were $527.9 million, down $11.9 million. Shareholders’ equity was $76.3 million, versus $76.6 million at year-end.
- Liquidity and cash flow: Cash and due from banks fell to $11.9 million from $36.8 million at year-end. First-half operating cash flow was $4.7 million, investing cash flow was negative $12.8 million, and financing cash flow was negative $16.9 million. Management said liquidity was sufficient for normal operating needs, citing deposits, security maturities, loan repayments, federal funds and available Federal Home Loan Bank and Federal Reserve facilities.
- Borrowings and capital: At quarter-end, ChoiceOne had $20.3 million of Federal Home Loan Bank advances and $4.0 million of federal funds purchased; repurchase agreements had declined to zero from $7.1 million at year-end. The Bank’s regulatory capital ratios were 13.1% total capital to risk-weighted assets, 12.2% common equity Tier 1, and 9.8% Tier 1 leverage. Management considered capital adequate for the foreseeable future.
Changes, outlook and risks
- Loan growth and higher earned rates contributed to first-half interest-income gains. Management reported average loans increased $17.5 million year over year and average loan yield rose 33 basis points. Higher deposit rates increased funding costs; total interest expense rose to $0.937 million from $0.654 million.
- Noninterest income was pressured by lower insurance and investment commissions following the sale of most of the Bank’s investment book of business in Q4 2017, and by lower securities-sale gains. Salaries and benefits increased, partly due to wage increases and staffing for two additional branch locations scheduled to open later in 2018. This was not quantified as formal earnings guidance.
- Loan quality indicators included $3.712 million of nonperforming loans, down from $4.250 million at December 31, 2017. The allowance for loan losses was $4.659 million, or 1.18% of loans, compared with $4.577 million, or 1.15%, at year-end. First-half net recoveries were $48,000. Management said the allowance was sufficient; it also noted that Michigan economic conditions may affect borrowers.
- Rising interest rates reduced the available-for-sale securities portfolio’s unrealized position from a $0.2 million gain at year-end to a $2.5 million loss at June 30. First-half other comprehensive loss was $2.160 million. Management considered the unrealized losses temporary and attributed them to rate changes and reduced market liquidity, not credit-quality issues; no other-than-temporary impairment charge was recorded.
- Deposits fell during the first half, particularly checking and savings balances, which management described as seasonal. Brokered certificates of deposit increased to supplement local deposit declines. The Bank’s participating interests in mortgage-banker advances had concentration exposure to eight mortgage bankers; the largest represented 44% of that portfolio, and one $254,000 participation was more than 30 days past due.
- The company adopted accounting standards for revenue recognition and equity investments in 2018. The latter reclassified $244,000 of unrealized equity-security gains from accumulated other comprehensive income to retained earnings. Management was evaluating the future expected-credit-loss standard; it expected the leases standard to have no material impact.
- No material change in risk factors from the 2017 Form 10-K was reported. Management reported effective disclosure controls, no material change in internal control over financial reporting, and no material pending legal proceedings, apart from ordinary-course matters. The filing provides no specific full-year earnings guidance and cautions that first-half results are not necessarily indicative of full-year results.
Important facts for investors to verify
- Whether deposit outflows and reliance on brokered deposits continue, and how funding costs respond to interest-rate changes.
- Whether loan growth resumes and whether credit quality, the allowance, nonperforming loans and the mortgage-banker participation concentration change.
- How securities valuation losses affect accumulated other comprehensive income, capital and future securities income.
- Whether the two planned branch openings increase expenses as expected and contribute to subsequent growth.
- Whether the reported liquidity and regulatory capital remain adequate as cash balances, deposits and interest rates change.