ChoiceOne Financial Services, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Unaudited consolidated results include County Bank Corp. from its October 1, 2019 merger; Lakestone Bank & Trust was consolidated into ChoiceOne Bank on May 15, 2020. Comparisons with 2019 are therefore materially affected by the larger combined company.
Key financial results
Amounts below are in millions of dollars, except per-share data and ratios.
| Metric | Q2 2020 | Q2 2019 | First half 2020 | First half 2019 |
|---|---|---|---|---|
| Net interest income | $11.879 | $5.501 | $23.017 | $10.997 |
| Provision for loan losses | $1.000 | $0 | $1.775 | $0 |
| Noninterest income | $6.751 | $2.029 | $10.683 | $3.786 |
| Noninterest expense | $12.150 | $5.762 | $22.566 | $11.096 |
| Net income | $4.430 | $1.487 | $7.684 | $3.123 |
| Diluted EPS | $0.61 | $0.41 | $1.06 | $0.86 |
- Q2 net income rose 198% year over year; first-half net income rose 146%. Management attributed much of first-half growth to the County merger.
- First-half revenue growth also reflected strong residential mortgage activity, PPP-related fees, and a securities-portfolio restructuring. Q2 noninterest income included $1.341 million of securities-sale gains and $2.996 million of loan-sale gains.
- GAAP net interest margin was 3.59% in Q2 versus 3.71% a year earlier, and 3.62% for the first half versus 3.70%. Lower market rates pressured asset yields; the increase in net interest income primarily reflected merger-related balance-sheet growth.
- First-half operating cash flow was negative $5.299 million, investing cash flow negative $131.324 million, and financing cash flow positive $143.856 million. Cash and cash equivalents rose $7.233 million to $66.791 million.
Financial position, liquidity and capital
- At June 30, total assets were $1.545 billion, up from $1.386 billion at December 31, 2019. Loans were $907.993 million, compared with $802.048 million; deposits were $1.324 billion, compared with $1.155 billion.
- Cash and cash equivalents were $66.791 million. Available-for-sale securities totaled $372.525 million.
- Borrowings declined to $10.179 million from $33.198 million at year-end. The company obtained a $10 million term note in Q2 to help fund the cash consideration for the Community Shores transaction; FHLB advances declined by $33 million in the first half.
- Shareholders’ equity was $202.623 million, up from $192.139 million. The increase included $5.448 million of other comprehensive income, largely from higher unrealized gains on available-for-sale securities.
- At June 30, ChoiceOne Bank reported total capital to risk-weighted assets of 14.5%, common equity Tier 1 of 13.9%, and Tier 1 leverage of 9.1%. Management considered capital adequate for the foreseeable future. Management stated current liquidity was sufficient for normal operating needs and cited deposits, securities maturities, loan repayments, and available FHLB and Federal Reserve facilities.
Material changes and notable items
- ChoiceOne processed more than $120 million of PPP loans through June 30, including approximately 1,000 loans. Gross associated fees were $4.748 million; after $188,000 of costs, $4.560 million was to be recognized over the loan terms. Q2 PPP fee income recognized was $814,000. PPP loans are SBA-guaranteed and may be forgiven if program conditions are met.
- The company granted approximately 750 COVID-19 payment deferrals covering $148 million of loans. These were not reported as TDRs under applicable agency guidance and CARES Act provisions. Management reported significantly fewer requests for a second round of deferrals.
- Community Shores Bank Corporation merged into ChoiceOne effective July 1, 2020, after quarter-end. At June 30, Community Shores had approximately $249 million of assets, $177 million of loans, and $227 million of deposits.
- Cash dividends declared were $0.20 per share for Q2 and $0.40 per share for the first half, unchanged per-share amounts from the comparable 2019 periods. The first-half payout ratio was 38%, versus 46%.
- Management’s non-GAAP first-half results excluding after-tax merger costs were net income of $8.428 million and diluted EPS of $1.16, compared with $3.696 million and $1.02, respectively, in 2019. These are management-adjusted measures, not GAAP results.
Outlook, risks and contingencies
- No quantified earnings or financial guidance was provided. Management expects COVID-19 may lead to higher past-due loans, nonperforming loans, and loan losses, and stated that the pandemic’s duration and economic effects remain uncertain.
- The allowance for loan losses was $5.750 million, or 0.63% of loans, versus $4.057 million and 0.51% at year-end. Management said the first-half provision was prudent given portfolio growth and pandemic uncertainty. Net charge-offs were $82,000 for the first half, compared with net recoveries of $128,000 in 2019.
- Nonperforming loans were $6.010 million at June 30, down from $6.413 million at December 31. Management expects credit quality could deteriorate as the effect of COVID-19 becomes clearer. It also allocated additional reserves to loans with deferrals and to industries considered more exposed to the pandemic.
- Management’s June goodwill assessment found no impairment was necessary, but the company plans a third-party goodwill assessment in the next year because of COVID-19 and possible longer-term economic effects.
- Management cited lower short- and long-term interest rates as risks to net interest margin, while lower mortgage rates had increased refinancing and mortgage-sale activity. The filing warns that actual outcomes may differ materially from forward-looking statements.
- The company reported no material pending legal proceedings outside the ordinary course of business. Management said disclosure controls were effective and no material change in internal control over financial reporting occurred during the quarter.
Important facts for investors to verify
- How much of the reported earnings growth reflects County/Lakestone consolidation versus sustainable organic growth, and how merger costs and other non-GAAP adjustments are defined.
- PPP fee recognition, loan forgiveness and repayment timing, and the extent to which PPP activity contributed to reported interest and noninterest income.
- Performance of the $148 million of deferred loans after deferral periods, subsequent deferral requests, and changes in delinquencies, nonperforming loans, charge-offs, and allowance adequacy.
- Post-quarter integration of Community Shores, including actual acquired balances, purchase accounting, and any resulting merger costs or goodwill effects.
- Interest-rate sensitivity, deposit stability and funding needs, and the sustainability of liquidity and capital levels as the loan portfolio and acquired operations change.