ChoiceOne Financial Services, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; comparisons are primarily with 2017. Amounts are in U.S. dollars; financial statement amounts below are generally in millions unless noted.
Business context
ChoiceOne is a Michigan financial holding company whose principal business is community banking in western Michigan, with an insurance agency subsidiary. It operated 14 full-service offices after opening two in 2018. Loan interest and fees were its largest revenue source. The financial statements received an unqualified audit opinion; the auditor also opined that internal control over financial reporting was effective.
Financial performance and condition
| Metric | 2018 | 2017 | Change / context |
|---|---|---|---|
| Net income | $7.333m | $6.168m | Up 19% |
| Basic / diluted EPS | $2.03 / $2.02 | $1.70 / $1.70 | Per-share figures adjusted for 5% stock dividends |
| Net interest income | $22.064m | $20.563m | Up 7% |
| Tax-equivalent net interest margin | 3.86% | 3.67% | Up 19 basis points |
| Return on average assets / equity | 1.15% / 9.55% | 0.98% / 8.22% | Both improved |
| Total assets | $670.5m | $646.5m | Up 3.7% |
| Gross loans / net loans | $409.1m / $404.4m | $398.8m / $394.2m | Gross loans up $10.3m |
| Total deposits | $577.0m | $539.9m | Up $37.2m |
| Shareholders’ equity | $80.5m | $76.6m | Equity-to-assets ratio was 12.00% |
| Cash from operating activities | $10.0m | $8.1m | Investing cash use was $43.9m; financing cash inflow was $16.8m |
Profitability drivers: Net interest income benefited from asset growth and improved spread as loan yields rose faster than funding costs. The 2018 effective tax rate fell to 14% from 28%, principally reflecting the federal corporate tax rate reduction to 21%. Provision for loan losses fell to $35,000 from $485,000. These benefits were partly offset by noninterest income declining $891,000 and noninterest expense rising $1.127m.
Credit quality: The allowance for loan losses was $4.673m, or 1.14% of gross loans, versus $4.577m, or 1.15%, in 2017. Net recoveries were $61,000, compared with $185,000 in net charge-offs. Nonperforming loans were $3.786m, down from $4.250m; nonaccrual loans rose to $1.532m from $1.096m. Allowance coverage of nonperforming loans was 123%.
Funding and liquidity: Year-end borrowings included $5.233m of Federal Home Loan Bank advances and $4.8m of federal funds purchased; there were no repurchase agreements, compared with $7.148m in 2017. Brokered certificates of deposit increased to $34.370m from $10.172m. Management reported $58.5m available through correspondent-bank federal funds lines, a $67.4m Federal Reserve Bank line, and approximately $45.5m of additional FHLB borrowing capacity. The Bank was categorized as well-capitalized; its total risk-based capital ratio was 12.9% and leverage ratio was 9.8%.
Material changes and unusual items
- Commercial real estate loans rose 13% to $139.5m and represented 34% of gross loans. Commercial and industrial loans declined to $91.4m from $104.4m.
- Deposits grew, including $24.2m of additional brokered certificates of deposit; FHLB advances fell $15.0m. Management said local deposit growth would remain a focus in 2019.
- 2017 noninterest income included a $908,000 gain on sale of part of the investment business. The 2017 securities sale generated a $457,000 loss; ChoiceOne said the repositioning supported loan growth and reduced reliance on wholesale funding.
- Two branches opened in 2018, contributing to higher staffing costs and capital spending. Professional fees also rose, partly due to audit work on internal controls.
- Available-for-sale securities moved from a net unrealized gain to a net unrealized loss position; accumulated other comprehensive income fell to a $732,000 loss. Management considered the securities losses temporary and recorded no other-than-temporary impairment.
- Quarterly data show fourth-quarter 2018 net income of $1.828m and diluted EPS of $0.50, compared with $1.367m and $0.37 in fourth-quarter 2017.
Outlook, risks and contingencies
No earnings or growth guidance was provided. Management expected regular quarterly cash dividends in 2019, subject to market conditions, cash and capital needs, and regulatory limits. It planned to pursue local deposit growth and use FHLB advances or brokered deposits if needed to fund asset growth. The annual cash dividend was $0.71 per share, and the payout ratio was 35%.
Key disclosed risks include credit losses and collateral values, Michigan economic conditions, competition, deposit funding and liquidity, interest-rate changes, regulatory requirements, cybersecurity and third-party systems, and environmental exposure on foreclosed or collateral properties. The filing identifies the forthcoming expected-credit-loss standard (CECL) as under evaluation, with a potentially significant impact. Interest-rate simulations showed net interest income increasing 2% under an immediate 400-basis-point rise and falling 15% under a 400-basis-point decline. Estimated market value of equity fell 32% in the 300- and 400-basis-point decline scenarios; those outcomes were slightly outside policy guidelines. Management reported no significant pending legal proceedings expected to materially affect consolidated condition.
Important facts for investors to verify
- Whether growth in commercial real estate lending and the $20.6m warehouse lending balance to other financial institutions change credit concentration or liquidity risk.
- Whether nonaccrual residential loans, troubled debt restructurings, and the allowance remain manageable as the loan portfolio expands.
- How deposit growth, brokered certificates, and rising deposit costs affect funding stability and net interest margin.
- Whether the disclosed downside interest-rate sensitivity and policy-limit exceptions are addressed in subsequent periods.
- The eventual impact of CECL adoption, and whether the company maintains well-capitalized status and its dividend under regulatory constraints.