ChoiceOne Financial Services, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. ChoiceOne is a Michigan-based bank holding company. Unless otherwise stated, amounts below are in U.S. dollars; financial statement amounts are in millions.
Financial performance
- Second quarter: Net interest income was $5.501 million, compared with $5.570 million a year earlier. Noninterest income increased to $2.029 million from $1.721 million, while noninterest expense rose to $5.762 million from $5.114 million. Net income was $1.487 million, down 19%; diluted EPS was $0.41 versus $0.50.
- First half: Net interest income was $10.997 million versus $10.877 million; noninterest income was $3.786 million versus $3.369 million; and noninterest expense was $11.096 million versus $10.078 million. Net income was $3.123 million, down 11%; diluted EPS was $0.86 versus $0.96.
- Margins: GAAP net interest margin was 3.64% in Q2, versus 3.87% in Q2 2018. For the first half it was 3.63%, versus 3.85%. On a tax-equivalent basis, first-half net interest spread declined to 3.43% from 3.74%, as funding costs rose faster than asset yields.
- Drivers: First-half interest income increased, supported by loan growth and higher earning-asset yields, but interest expense rose faster, particularly on certificates of deposit and Federal Home Loan Bank advances. Noninterest income benefited from higher loan-sale gains and equity-security valuation gains.
- Cash flow: For the first six months, operating activities provided $2.456 million, investing activities provided $10.959 million, and financing activities used $19.418 million. Cash and cash equivalents declined $6.003 million to $13.687 million.
Financial condition and asset quality
- Total assets were $658.497 million at June 30, 2019, down from $670.544 million at December 31, 2018. Shareholders’ equity increased to $85.663 million from $80.477 million, including a $3.280 million first-half improvement in other comprehensive income, primarily from securities valuation changes.
- Gross loans were $397.227 million, compared with $409.073 million at year-end; net loans were $392.426 million. Loans to other financial institutions increased to $28.950 million from $20.644 million.
- Total deposits declined to $561.776 million from $577.015 million. Federal funds purchased were $2.000 million and FHLB advances were $5.216 million at quarter-end.
- The allowance for loan losses was $4.801 million, or 1.21% of loans, versus $4.673 million, or 1.14%, at year-end. No provision expense was recorded in the first half; net recoveries were $128,000.
- Nonperforming loans increased to $6.315 million from $3.786 million at year-end, primarily due to one commercial real estate relationship placed on nonaccrual in Q2. Management allocated approximately $670,000 of allowance to that relationship and stated the allowance was sufficient.
- The Bank reported capital ratios above the stated regulatory minimums. At June 30, its total risk-based capital ratio was 13.5%, Common Equity Tier 1 ratio was 12.5%, and Tier 1 leverage ratio was 9.9%.
Material changes, outlook and risks
- Merger-related costs were $350,000 pretax in Q2 and $588,000 pretax in the first half. Management reported adjusted first-half net income of $3.696 million and adjusted diluted EPS of $1.02, excluding the after-tax merger costs; these are non-GAAP measures.
- ChoiceOne agreed to acquire County Bank Corp, parent of Lakestone Bank & Trust, on March 22, 2019. Closing remained subject to shareholder and regulatory approvals and other customary conditions. Management expected completion in the second half of 2019. County reported approximately $620 million in assets, $360 million in loans and $540 million in deposits as of December 31, 2018.
- No specific earnings or margin guidance is provided. Management said current liquidity was sufficient for normal operating needs and capital levels were adequate for the foreseeable future. It cited deposits, securities maturities, loan repayments, correspondent federal funds and FHLB borrowing capacity as liquidity sources.
- Merger risks include failure to obtain approvals or satisfy closing conditions, termination rights, integration challenges, failure to realize expected savings or strategic benefits, purchase-accounting impacts, management distraction, relationship changes and potential litigation. Other risks include economic and competitive conditions, interest-rate sensitivity and credit-loss estimates.
- Management noted that the allowance estimate is judgmental and may change with portfolio mix, economic conditions and loan performance. It also disclosed a concentration in purchased mortgage-loan participations: the largest mortgage banker represented 24% of the balance at quarter-end; 27 of 184 participations, totaling $5.8 million, were over 30 days outstanding.
- The company was evaluating implementation timing for the expected-credit-loss standard after a proposed effective-date delay was announced. It recognized a $105,000 lease asset and liability upon adopting the lease standard in January 2019; the expense impact was not significant. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Merger approval status, expected closing timing, total transaction costs, and whether anticipated savings and benefits are realized.
- Performance and credit quality of the relationship newly placed on nonaccrual, including the adequacy of its specific reserve and any subsequent developments.
- Whether deposit trends and higher funding costs continue to pressure net interest margin and earnings.
- Underlying operating performance apart from merger costs, with attention to the company’s non-GAAP reconciliations and the sustainability of loan-sale and securities valuation gains.
- Liquidity and capital after any merger-related funding needs, dividend payments and changes in deposits or borrowings.