UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the quarterly period ended March 31, 2012
For the transition period from to
Commission File Number: 000-19202
ChoiceOne Financial Services, Inc.
(Exact Name of Registrant as Specified in its Charter)
38-2659066
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
109 East Division
Sparta, Michigan
(616) 887-7366
(Registrant’s Telephone Number, including Area Code)
Indicate by checkmark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of April 30, 2012, the Registrant had outstanding 3,295,829 shares of common stock.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
CONSOLIDATED BALANCE SHEETS
Assets
Cash and due from banks
Federal funds sold
Cash and cash equivalents
Securities available for sale
Federal Home Loan Bank stock
Federal Reserve Bank stock
Loans held for sale
Loans
Allowance for loan losses
Loans, net
Premises and equipment, net
Other real estate owned, net
Cash value of life insurance policies
Intangible assets, net
Goodwill
Other assets
Total assets
Liabilities
Deposits—noninterest-bearing
Deposits—interest-bearing
Total deposits
Repurchase agreements
Advances from Federal Home Loan Bank
Other liabilities
Total liabilities
Shareholders’ Equity
Preferred stock; shares authorized: 100,000; shares outstanding: none
Common stock and paid in capital, no par value; shares authorized: 7,000,000; shares outstanding: 3,295,041 at March 31, 2012 and 3,293,269 at December 31, 2011
Retained earnings
Accumulated other comprehensive income, net
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying notes to consolidated financial statements.
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CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
Interest income
Loans, including fees
Securities:
Taxable
Tax exempt
Other
Total interest income
Interest expense
Deposits
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
Noninterest income
Customer service charges
Insurance and investment commissions
Gains on sales of loans
Gains on sales of securities
Losses on sales and write-downs of other assets
Earnings on life insurance policies
Other income
Total noninterest income
Noninterest expense
Salaries and benefits
Occupancy and equipment
Data processing
Professional fees
Supplies and postage
Advertising and promotional
Intangible amortization
Loan and collection expense
FDIC insurance
Other expense
Total noninterest expense
Income before income tax
Income tax expense
Net income
Basic earnings per share
Diluted earnings per share
Dividends declared per share
3
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
Unrealized holding gains on available for sale securities
Comprehensive income
4
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)
Balance, January 1, 2011
Net change in unrealized gain on securities available for sale
Total comprehensive income
Shares issued
Change in ESOP repurchase obligation
Stock based compensation
Effect of employee stock purchases
Cash dividends declared ($0.12 per share)
Balance, March 31, 2011
Balance, January 1, 2012
Balance, March 31, 2012
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CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash from operating activities:
Depreciation
Amortization
Compensation expense on stock options and employee stock purchases
Loans originated for sale
Proceeds from loan sales
Earnings on bank-owned life insurance
Proceeds from life insurance
(Gains)/losses on sales of other real estate owned
Write-downs of other real estate owned
Proceeds from sales of other real estate owned
Deferred federal income tax benefit
Net changes in other assets
Net changes in other liabilities
Net cash from operating activities
Cash flows from investing activities:
Securities available for sale:
Sales
Maturities, prepayments and calls
Purchases
Loan originations and payments, net
Additions to premises and equipment
Net cash from investing activities
Cash flows from financing activities:
Net change in deposits
Net change in repurchase agreements
Payments on Federal Home Loan Bank advances
Issuance of common stock
Cash dividends
Net cash from financing activities
Net change in cash and cash equivalents
Beginning cash and cash equivalents
Ending cash and cash equivalents
Supplemental disclosures of cash flow information:
Cash paid for interest
Cash paid for income taxes
Loans transferred to other real estate owned
Securities transferred to other assets
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NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include ChoiceOne Financial Services, Inc. (“ChoiceOne” or the “Registrant”) and its wholly-owned subsidiary, ChoiceOne Bank (the “Bank”), and the Bank’s wholly-owned subsidiary, ChoiceOne Insurance Agencies, Inc. Intercompany transactions and balances have been eliminated in consolidation.
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, prevailing practices within the banking industry and the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
The accompanying consolidated financial statements reflect all adjustments ordinary in nature which are, in the opinion of management, necessary for a fair presentation of the Consolidated Balance Sheets as of March 31, 2012 and December 31, 2011, the Consolidated Statements of Income for the three-month periods ended March 31, 2012 and March 31, 2011, the Consolidated Statements of Changes in Shareholders’ Equity for the three-month periods ended March 31, 2012 and March 31, 2011, and the Consolidated Statements of Cash Flows for the three-month periods ended March 31, 2012 and March 31, 2011. Operating results for the three months ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.
The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2011.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level believed adequate by management to absorb probable incurred losses inherent in the consolidated loan portfolio. Management’s evaluation of the adequacy of the allowance is an estimate based on reviews of individual loans, assessments of the impact of current economic conditions on the portfolio and historical loss experience of seasoned loan portfolios. See Note 3 to the interim consolidated financial statements for additional information.
Management believes the accounting estimate related to the allowance for loan losses is a “critical accounting estimate” because (1) the estimate is highly susceptible to change from period to period because of assumptions concerning the changes in the types and volumes of the portfolios and economic conditions and (2) the impact of recognizing an impairment or loan loss could have a material effect on ChoiceOne’s assets reported on the balance sheet as well as its net income.
Stock Transactions
A total of 357 shares of common stock were issued to the Registrant’s Board of Directors for a cash price of $4,000 under the terms of the Directors’ Stock Purchase Plan in the first quarter of 2012. A total of 1,415 shares were issued to employees for a cash price of $15,000 under the Employee Stock Purchase Plan for the quarter ended March 31, 2012.
Reclassifications
Certain amounts presented in prior periods have been reclassified to conform to the current presentation.
New Accounting Pronouncements
In September 2011, the FASB issued ASU No. 2011-08, Intangibles – Goodwill and Other: Testing Goodwill for Impairment (“ASU 2011-08”), to simplify how entities test goodwill for impairment. Prior to ASU 2011-08, an entity was required to perform a two-step test to assess goodwill for impairment. The first step compared the fair value of a reporting unit to its carrying amount, including goodwill. If the fair value of the reporting unit was less than its carrying value, the second step was used to measure the amount of the impairment loss, if any. ASU 2011-08 permits an entity to assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing appropriate events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then it is not required to perform the two-step impairment test for the reporting unit. ASU 2011-08 applies to both an entity’s annual and interim goodwill impairment tests. ASU 2011-08 is effective for fiscal years beginning after December 15, 2011 and early adoption is permitted. ChoiceOne adopted ASU 2011-08 as of January 1, 2012. The adoption of ASU 2011-08 is not expected to have a material impact on ChoiceOne’s consolidated financial condition or results of operations.
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NOTE 2—SECURITIES
The fair value of securities available for sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
U.S. Treasury
U.S. Government and federal agency
State and municipal
Mortgage-backed
Corporate
FDIC-guaranteed financial institution debt
Equity securities
Total
ChoiceOne reviews its securities portfolio on a quarterly basis to determine whether unrealized losses are considered to be temporary or other-than-temporary. No other-than-temporary impairment charges were recorded in the first quarter of 2012. ChoiceOne believed that unrealized losses on securities were temporary in nature and were due to changes in interest rates and reduced market liquidity and not as a result of credit quality issues. One municipal security with a fair value of $311,000 was considered to be other than temporarily impaired as of December 31, 2011. The issuer of the security defaulted upon its maturity of September 1, 2009. Impairment losses totaling $141,000 had been recorded through the end of 2011 due to uncertainty as to how much and when principal repayment would be received. Settlement was reached with the security’s issuer in December 2011 and the bond’s carrying value was reclassified from securities to other assets in January 2012 upon termination of the bond’s contractual agreement. ChoiceOne anticipates that it will receive the carrying value in the second quarter of 2012.
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NOTE 3—LOANS AND ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses and balances in the loan portfolio were as follows:
Three Months Ended March 31, 2012
Beginning balance
Charge-offs
Recoveries
Provision
Ending balance
Individually evaluated for impairment
Collectively evaluated for impairment
Three Months Ended March 31, 2011
March 31, 2012
December 31, 2011
The process to monitor the credit quality of ChoiceOne’s loan portfolio includes tracking (1) the risk ratings of business loans, (2) the level of classified business loans, and (3) delinquent and nonperforming consumer loans. Business loans are risk rated on a scale of 1 to 8. A description of the characteristics of the ratings follows:
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Risk rating 1 and 2: These loans are considered pass credits. They exhibit good to exceptional credit risk and demonstrate the ability to repay the loan from normal business operations.
Risk rating 3: These loans are considered pass credits. They exhibit acceptable credit risk and demonstrate the ability to repay the loan from normal business operations.
Risk rating 4: These loans are considered pass credits. However, they have potential developing weaknesses that, if not corrected, may cause deterioration in the ability of the borrower to repay the loan. While a loss is possible for a loan with this rating, it is not anticipated.
Risk rating 5: These loans are considered special mention credits. Loans in this risk rating are considered to be inadequately protected by the net worth and debt service coverage of the borrower or of any pledged collateral. These loans have well defined weaknesses that may jeopardize the borrower’s ability to repay the loan. If the weaknesses are not corrected, loss of principal and interest could be probable.
Risk rating 6: These loans are considered substandard credits. These loans have well defined weaknesses, the severity of which makes collection of principal and interest in full questionable. Loans in this category may be placed on nonaccrual status.
Risk rating 7: These loans are considered doubtful credits. Some loss of principal and interest has been determined to be probable. The estimate of the amount of loss could be affected by factors such as the borrower’s ability to provide additional capital or collateral. Loans in this category are on nonaccrual status.
Risk rating 8: These loans are considered loss credits. They are considered uncollectible and will be charged off against the allowance for loan losses.
Information regarding the Bank’s credit exposure was as follows:
(Dollars in thousands)
Corporate Credit Exposure—Credit Risk Profile By Creditworthiness Category
Risk ratings 1 and 2
Risk rating 3
Risk rating 4
Risk rating 5
Risk rating 6
Risk rating 7
Consumer Credit Exposure—Credit Risk Profile Based On Payment Activity
Performing
Nonperforming
The following schedule provides information on loans that were considered troubled debt restructurings (“TDRs”) as of March 31, 2012 that were modified during the three months ended March 31, 2012:
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Agricultural
Commercial and industrial
Commercial real estate
The pre-modification and post-modification outstanding recorded investment represents amounts as of the date of loan modification. If a difference exists between the pre-modification and post-modification outstanding recorded investment, it represents impairment recognized through the provision for loan losses computed based on a loan’s post-modification present value of expected future cash flows discounted at the loan’s original effective interest rate. If no difference exists, a loss is not expected to be incurred based on an assessment of the borrower’s expected cash flows.
The following schedule provides information on TDRs as of March 31, 2012 where the borrower was past due with respect to principal and/or interest for 30 days or more during the quarter ended March 31, 2012 that had been modified during the year prior to the default:
Residential real estate
Loans are classified as performing when they are current as to principal and interest payments or are past due on payments less than 90 days. Loans are classified as nonperforming when they are past due 90 days or more as to principal and interest payments or are considered a troubled debt restructuring.
Impaired loans by loan category follow:
With no related allowance recorded
Subtotal
With an allowance recorded
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An aging analysis of loans by loan category follows:
Consumer
Construction real estate
Nonaccrual loans by loan category follow:
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NOTE 4—EARNINGS PER SHARE
Earnings per share are based on the weighted average number of shares outstanding during the period. A computation of basic earnings per share and diluted earnings per share follows:
Basic Earnings Per Share
Net income available to common shareholders
Weighted average common shares outstanding
Diluted Earnings Per Share
Plus dilutive stock options
and potentially dilutive shares
There were 43,350 stock options as of March 31, 2012 and 46,656 as of March 31, 2011, that are considered to be anti-dilutive to earnings per share for the three-month periods ended March 31, 2012 and 2011. These stock options have been excluded from the calculation above.
NOTE 5—FINANCIAL INSTRUMENTS
Financial instruments as of the dates indicated were as follows (dollars in thousands):
Assets:
Federal Home Loan Bank and Federal
Reserve Bank stock
Accrued interest receivable
Liabilities:
Noninterest-bearing deposits
Interest-bearing deposits
Federal Home Loan Bank advances
Accrued interest payable
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The estimated fair values approximate the carrying amounts for all assets and liabilities except those described later in this paragraph. The methodology for determining the estimated fair value for securities available for sale is described in Note 6. The estimated fair value for loans is based on the rates charged at March 31, 2012 for new loans with similar maturities, applied until the loan is assumed to reprice or be paid. The allowance for loan losses is considered to be a reasonable estimate of discount for credit quality concerns. The estimated fair values for time deposits and Federal Home Loan Bank (“FHLB”) advances are based on the rates paid at March 31, 2012 for new deposits or FHLB advances, applied until maturity. The estimated fair values for other financial instruments and off-balance sheet loan commitments are considered nominal.
NOTE 6—FAIR VALUE MEASUREMENTS
The following tables present information about the Bank’s assets and liabilities measured at fair value on a recurring basis and the valuation techniques used by the Bank to determine those fair values.
In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the Bank has the ability to access.
Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability.
In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Bank’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.
There were no liabilities measured at fair value as of March 31, 2012 or December 31, 2011. Disclosures concerning assets measured at fair value are as follows:
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Assets Measured at Fair Value on a Recurring Basis
(Dollars in Thousands)
Investment Securities, Available for Sale—March 31, 2012
Investment Securities, Available for Sale—December 31, 2011
Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis
Investment Securities, Available for Sale
Balance, January 1
Total realized and unrealized gains included in income
Total unrealized gains included in other comprehensive income
Net purchases, sales, calls, and maturities
Net transfers into/(out of) Level 3
Balance, March 31
Of the Level 3 assets that were held by the Bank at March 31, 2012, the net unrealized loss for the three months ended March 31, 2012 was $2,000, which is recognized in other comprehensive income in the consolidated balance sheet. There were no sales or purchases of Level 3 securities in the first quarter of 2012. One municipal security was reclassified to other assets in the first quarter of 2012. The issuer of the security defaulted upon its maturity of September 1, 2009. Settlement was reached with the security’s issuer in December 2011 and the bond’s carrying value was reclassified upon termination of the bond’s contractual agreement. One municipal security was reclassified from a Level 2 measurement of fair value to a Level 3 measurement in the first quarter of 2011 as a result of a change in the marketability of the security.
Both observable and unobservable inputs may be used to determine the fair value of positions classified as Level 3 assets and liabilities. As a result, the unrealized gains and losses for these assets and liabilities presented in the tables above may include changes in fair value that were attributable to both observable and unobservable inputs.
Available-for-sale investment securities categorized as Level 3 assets primarily consist of bonds issued by local municipalities. The Bank estimates the fair value of these bonds based on the present value of expected future cash flows using management’s best estimate of key assumptions, including forecasted interest yield and payment rates, credit quality and a discount rate commensurate with the current market and other risks involved.
The Bank also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets are not normally measured at fair value, but can be subject to fair value adjustments in certain circumstances, such as impairment. Disclosures concerning assets measured at fair value on a non-recurring basis are as follows:
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Assets Measured at Fair Value on a Non-recurring Basis
Impaired Loans
Other Real Estate
Impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. The Bank estimates the fair value of the loans based on the present value of expected future cash flows using management’s best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals). The changes in fair value consisted of charge-downs of impaired loans that were posted to the allowance for loan losses and write-downs of other real estate that were posted to a valuation account.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion is designed to provide a review of the consolidated financial condition and results of operations of ChoiceOne Financial Services, Inc. (“ChoiceOne” or the “Registrant”) and its wholly-owned subsidiary, ChoiceOne Bank (the “Bank”), and the Bank’s wholly-owned subsidiary, ChoiceOne Insurance Agencies, Inc. This discussion should be read in conjunction with the consolidated financial statements and related notes.
FORWARD-LOOKING STATEMENTS
This discussion and other sections of this quarterly report contain forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and ChoiceOne itself. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “is likely,” “plans,” “predicts,” “projects,” “may,” “could,” variations of such words and similar expressions are intended to identify such forward-looking statements. Management’s determination of the provision and allowance for loan losses, the carrying value of goodwill and loan servicing rights, and the fair value of investment securities (including whether any impairment on any investment security is temporary or other than temporary) and management’s assumptions concerning pension and other postretirement benefit plans involve judgments that are inherently forward-looking. All of the information concerning interest rate sensitivity is forward-looking. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“risk factors”) that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed, implied or forecasted in such forward-looking statements. Furthermore, ChoiceOne undertakes no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events, or otherwise.
Risk factors include, but are not limited to, the risk factors discussed in Item 1A of the Company’s Annual Report on Form 10-K; changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking laws and regulations; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of pending and future litigation and contingencies; trends in customer behavior as well as their abilities to repay loans; changes in the local and national economies; changes in market conditions; the level and timing of asset growth; various other local and global uncertainties such as acts of terrorism and military actions; and current uncertainties and fluctuations in the financial markets and stocks of financial services providers due to concerns about capital and credit availability and concerns about the Michigan economy in particular. These are representative of the risk factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.
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RESULTS OF OPERATIONS
Summary
Net income for the first quarter of 2012 was $1,015,000, which represented an increase of $311,000 or 44% compared to the same period in 2011. Growth in net interest income and noninterest income and a reduction in the provision for loan losses were offset by higher noninterest expense in the first quarter of 2012 compared to the same period in the prior year. Basic and diluted earnings per common share were $0.31 for the first quarter of 2012, compared to $0.21 for the same quarter in 2012. The return on average assets and return on average shareholders’ equity percentages were 0.81% and 6.97%, respectively, for the first quarter of 2012, compared to 0.58% and 5.16%, respectively, for the same period in 2011.
Dividends
Cash dividends of $395,000 or $0.12 per share were declared in the first quarter of 2012, compared to $393,000 or $0.12 per share in the first quarter of 2011. The cash dividend payout percentage was 39% for the first three months of 2012, compared to 56% in the same period a year ago.
Interest Income and Expense
Tables 1 and 2 on the following pages provide information regarding interest income and expense for the three-month periods ended March 31, 2012 and 2011, respectively. Table 1 documents ChoiceOne’s average balances and interest income and expense, as well as the average rates earned or paid on assets and liabilities. Table 2 documents the effect on interest income and expense of changes in volume (average balance) and interest rates. These tables are referred to in the discussion of interest income, interest expense and net interest income.
Table 1—Average Balances and Tax-Equivalent Interest Rates
Loans (1)
Taxable securities (2) (3)
Nontaxable securities (1) (2)
Interest-earning assets
Noninterest-earning assets
Liabilities and Shareholders’ Equity:
Interest-bearing demand deposits
Savings deposits
Certificates of deposit
Interest-bearing liabilities
Noninterest-bearing demand deposits
Other noninterest-bearing liabilities
Shareholders’ equity
Net interest income (tax-equivalent basis)— interest spread
Tax-equivalent adjustment (1)
Net interest income as a percentage of earning assets (tax-equivalent basis)
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Table 2 —Changes in Tax-Equivalent Net Interest Income
Increase (decrease) in interest income (1)
Loans (2)
Taxable securities
Nontaxable securities (2)
Net change in tax-equivalent income
Increase (decrease) in interest expense (1)
Net change in interest expense
Net change in tax-equivalent net interest income
Net Interest Income
The presentation of net interest income on a tax-equivalent basis is not in accordance with generally accepted accounting principles (“GAAP”), but is customary in the banking industry. This non-GAAP measure ensures comparability of net interest income arising from both taxable and tax-exempt loans and investment securities. The adjustments to determine net interest income on a tax-equivalent basis were $167,000 and $171,000 for the three months ended March 31, 2012 and 2011, respectively. These adjustments were computed using a 34% federal income tax rate.
As shown in Tables 1 and 2, tax-equivalent net interest income increased $70,000 in the first three months of 2012 compared to the same period in 2011. The relationship between growth in average interest-earning assets and a smaller amount of growth in average interest-bearing liabilities caused net interest income to increase $157,000 in the first quarter of 2012 compared to the same quarter in the prior year. A reduction of 9 basis points in the net interest spread from 4.18% in the first quarter of 2011 to 4.09% in the same quarter in 2012 resulted in an $87,000 decrease in net interest income.
The average balance of loans decreased $1.3 million in the first quarter of 2012 compared to the same period in 2011. Average commercial and industrial and commercial real estate loans were $3.9 million lower in the first quarter of 2012 than in the same quarter of 2011. This was offset by a $2.3 million increase in the average balance of consumer loans and $0.3 million increase in the average balance of residential real estate loans in the first quarter of 2012 compared to the same quarter in the prior year. The decrease in the average loans balance combined with a 24 basis point decrease in the average rate earned caused tax-equivalent interest income from loans to decline $204,000 in the first quarter of 2012 compared to the same period in the prior year. The average balance of total securities grew $21.0 million in the first three months of 2012 compared to the same period in 2011. Additional securities were purchased in the year of 2011 and in the first quarter of 2012 due to the declining balance in loans and to provide earning asset growth. The growth in securities, partially offset by the effect of lower interest rates earned, caused interest income to increase $94,000 in the first quarter of 2012 compared to the same quarter in 2011.
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The average balance of interest-bearing demand deposits increased $13.8 million in the first three months of 2012 compared to the same period in 2011. The effect of the higher average balance, offset by an 8 basis point decline in the average rate paid, caused interest expense to decrease $14,000 in the first quarter of 2012 compared to the same quarter in 2011. The average balance of savings deposits increased $3.2 million in the first quarter of 2012 compared to the same quarter in the prior year. The impact of the savings deposit growth was offset by a 5 basis point drop in the average rate paid, which caused interest expense to decrease $5,000 in the first three months of 2012 compared to the same period in 2011. The average balance of certificates of deposit was down $14.1 million in the first quarter of 2012 compared to the same period in 2011. The average balance of local certificates was $12.1 million lower while the average balance of nonlocal certificates was $2.0 million lower in 2012 than in 2011. The decline in certificates of deposit plus a 27 basis point reduction in the average rate paid on certificates caused interest expense to fall $157,000 in the first quarter of 2012 compared to the same period in 2011. A decrease of $0.6 million in the average balance of other interest-bearing liabilities in the first quarter of 2012 compared to the first quarter of 2011 plus the effect of a 6 basis point decrease in the average rate paid caused a $5,000 decrease in interest expense.
ChoiceOne’s net interest income spread was 4.09% in the first quarter of 2012, compared to 4.18% for the first quarter of 2011. The decline in the interest spread was due to a 30 basis point decrease in the average rate earned on interest earning assets in the first quarter of 2012 compared to the same quarter in 2011, which was partially offset by a 21 basis point decrease in the average rate paid on interest-bearing liabilities. The reduction in the average rate earned on interest-earning assets was caused by relatively low general market rates which affected new loan originations and securities purchases in 2011 and the first quarter of 2012. Interest rates on loans are also being impacted by rate pressure from some of ChoiceOne’s competing financial institutions. The lower rate paid on interest-bearing liabilities resulted from repricing of local deposits as general market interest rates remained low during 2011 and the first quarter of 2012.
Provision and Allowance for Loan Losses
Despite a reduction of $12.9 million in total loans since the end of 2011, the allowance for loan losses grew $123,000 from December 31, 2011 to March 31, 2012. The provision for loan losses was $825,000 in the first quarter of 2012, compared to $1,000,000 in the same period in 2011. Nonperforming loans were $7.4 million as of March 31, 2012, compared to $6.7 million as of December 31, 2011. The increase in nonperforming loans since the end of 2011 was primarily due to growth of $0.5 million in nonaccrual loans. The allowance for loan losses was 1.74% of total loans at March 31, 2012, compared to 1.63% at December 31, 2011 and 1.52% at March 31, 2011.
Charge-offs and recoveries for respective loan categories for the three months ended March 31 were as follows:
Real estate, commercial
Real estate, residential
Net charge-offs in the first quarter of 2012 were $702,000, compared to $998,000 in the first quarter of 2011. Net charge-offs on an annualized basis as a percentage of average loans were 0.90% in the first three months of 2012 compared to 1.27% for the same period in the prior year. Management is aware that the economic climate in Michigan will continue to affect business and personal borrowers and may cause charge-offs to remain at heightened levels in future quarters. Management has worked and intends to continue to work with delinquent borrowers in an attempt to lessen the negative impact to ChoiceOne. As charge-offs, changes in the level of nonperforming loans, and changes within the composition of the loan portfolio occur throughout 2012, the provision and allowance for loan losses will be reviewed by the Bank’s management and adjusted as necessary.
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Noninterest Income
Total noninterest income increased $293,000 or 21% in the first quarter of 2012 compared to the same period in 2011. Growth of $235,000 in gains on sales of loans came from increased residential mortgage refinancing activity which supported $11.5 million of loan sales in the first quarter of 2012, compared to $6.7 million in the first quarter of 2011. An increase of $133,000 in gains on sales of securities resulted from more sales activity in the first three months of 2012 than in the same period of the prior year and higher percentage gains on sales due to the relatively low general market rates. Earnings on life insurance policies included $135,000 in the first quarter of 2012 from a death benefit received. The $131,000 increase in losses on sales and write-downs of other assets in the first quarter of 2012 compared to the same period in 2011 resulted from more write-downs of foreclosed properties.
Noninterest Expense
Total noninterest expense increased $148,000 or 4% in the first quarter of 2012 compared to the same period in 2011. The increase of $61,000 in salaries and benefits in the first quarter of 2012 compared to the same period in 2011 resulted from higher incentive bonus accruals, commission expense from mortgage loan originations, and health insurance costs. Growth of $43,000 in occupancy and equipment expense resulted from higher building rental expense and equipment repairs. Professional fees were $29,000 higher in the first three months of 2012 than in the same period in 2011 primarily as a result of an increase in consulting expenses. An increase of $52,000 in other noninterest expense in the first quarter of 2012 compared to the first quarter in the prior year was primarily caused by higher training costs and costs related to secondary market mortgage originations.
Income Tax Expense
Income tax expense was $257,000 in the first quarter of 2012 compared to $174,000 for the same quarter in 2011. The effective tax rate was 20.2% for 2012 and 19.8% for 2011.
FINANCIAL CONDITION
Securities
The securities available for sale portfolio increased $12.1 million from December 31, 2011 to March 31, 2012. Various securities totaling $29.2 million were purchased in the first three months of 2012 to provide earning assets and to replace maturities, principal repayments, and calls within the securities portfolio. Approximately $11.9 million in various securities were called or matured since the end of 2011. Principal repayments on securities totaled $0.7 million in the first three months of 2012. Approximately $3.7 million of securities were sold in the first quarter of 2012 for a net gain of $169,000.
The loan portfolio (excluding loans held for sale) declined $12.9 million from December 31, 2011 to March 31, 2012. Loan demand in the first quarter of 2012 was sluggish due to the lackluster Michigan economy and reduced real estate values. Balances in all loan categories except for residential mortgage loans declined since the end of 2011, with a decrease of $9.7 million in agricultural loans and $2.7 million in commercial and industrial loans contributing most of the decline. Much of the decrease in agricultural loans in the first quarter of 2012 resulted from seasonal pay-downs on lines of credit.
Information regarding impaired loans can be found in Note 3 to the consolidated financial statements included in this report. The total balance of loans classified as impaired increased from $4.5 million as of December 31, 2011 to $5.1 million as of March 31, 2012. The balance of commercial real estate loans classified as impaired grew by $0.6 million in the first quarter. Changes in the balance of nonaccrual loans and loans considered troubled debt restructured in the first quarter of 2012 impacted both loan categories.
As part of its review of the loan portfolio, management also monitors the various nonperforming loans. Nonperforming loans are comprised of: (1) loans accounted for on a nonaccrual basis; (2) loans, not included in nonaccrual loans, which are contractually past due 90 days or more as to interest or principal payments; and (3) loans, not included in nonaccrual or loans past due 90 days or more, which are considered troubled debt restructurings.
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The balances of these nonperforming loans were as follows:
Loans accounted for on a nonaccrual basis
Accruing loans contractually past due 90 days or more as to principal or interest payments
Loans considered troubled debt restructurings
At March 31, 2012, nonaccrual loans included $3.1 million in commercial real estate loans, $1.3 million in residential real estate loans, and $0.3 million in commercial and industrial loans. At December 31, 2011, nonaccrual loans included $2.8 million in commercial real estate loans, $1.2 million in residential real estate loans, and $0.1 million in commercial and industrial loans. The increase in nonaccrual loans was due to loans transferred into nonaccrual status in the first quarter of 2012. Management believes the allowance allocated to its nonperforming loans is sufficient at March 31, 2012; however, management believes future credit deterioration is possible given the status of the Michigan economy.
Other Real Estate Owned
The balance of other real estate owned (“OREO”) decreased $426,000 from December 31, 2011 to March 31, 2012. Only $15,000 of residential real estate loans were transferred into OREO during the first quarter of 2012 while sales of properties or payments upon them or write-downs of the value of other real estate properties were $441,000 for the same time period. Due to the current state of the Michigan economy, management believes there will be continuing transfers from loans into OREO during the remainder of 2012. The OREO balance may also be affected by troubled debt restructurings in future quarters as loans can be restructured as an alternative to foreclosure. Management is continuing to work with borrowers in an attempt to mitigate potential losses for ChoiceOne.
Deposits and Borrowings
Total deposits increased $9.5 million from December 31, 2011 to March 31, 2012. Local deposits provided all of the growth in the first quarter of 2012 as the balance of nonlocal deposits was unchanged. Since the end of 2011, money market account balances have risen $15.5 million and noninterest-bearing checking and savings deposits have both grown $2.0 million. Local certificates of deposit decreased $9.8 million in the first quarter of 2012 as management emphasized growth in checking, money market, and savings accounts.
A decline of $2.9 million in repurchase agreements in the first quarter of 2012 was due to normal fluctuations in funds provided by bank customers. Certain securities are sold under agreements to repurchase them the following day or over a certain fixed term. Management plans to continue this practice as a low-cost source of funding. Federal Home Loan Bank advances decreased $7,000 in the first quarter of 2012 due to payments on an amortizing advance.
Total shareholders’ equity increased $339,000 from December 31, 2011 to March 31, 2012. Growth in equity resulted from current year’s net income and proceeds from the sale of ChoiceOne stock, offset by a decrease in accumulated other comprehensive income and cash dividends paid.
Following is information regarding the Bank’s compliance with regulatory capital requirements:
Capital balances at March 31, 2012
Required regulatory capital to be considered “well capitalized”
Capital in excess of “well capitalized” minimum
Capital ratios at March 31, 2012
Regulatory capital ratios – minimum requirement to be considered “well capitalized”
Management reviews the capital levels of ChoiceOne and the Bank on a regular basis. The Board of Directors (the “Board”) and management believe that the capital levels as of March 31, 2012 are adequate for the foreseeable future. The Board’s determination of appropriate cash dividends for future periods will be based on market conditions and ChoiceOne’s requirements for cash and capital.
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Liquidity
Net cash provided from operating activities was $3.1 million for the three months ended March 31, 2012 compared to $2.6 million provided in the same period a year ago. Higher proceeds from loan sales were offset by higher loans originated for sale. Net cash used in investing activities was $0.7 million for the first quarter of 2012 compared to $8.2 million in the same period in 2011. The change was due to a lower level of net loan originations. Net cash provided from financing activities was $6.2 million in the quarter ended March 31, 2012, compared to $10.7 million in the same period in the prior year. The decrease resulted from less deposit growth in 2012 than in 2011 as well as a larger decrease in repurchase agreements.
Management believes that the current level of liquidity is sufficient to meet the Bank’s normal operating needs. This belief is based upon the availability of deposits from both the local and national markets, maturities of securities, normal loan repayments, income retention, federal funds purchased from correspondent banks, and advances available from the Federal Home Loan Bank. The Bank also has a secured line of credit available from the Federal Reserve Bank.
Item 4. Controls and Procedures.
An evaluation was performed under the supervision and with the participation of the Registrant’s management, including the Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Registrant’s disclosure controls and procedures. Based on and as of the time of that evaluation, the Registrant’s management, including the Chief Executive Officer and Principal Financial Officer, concluded that the Registrant’s disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that material information required to be disclosed in the reports that ChoiceOne files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that ChoiceOne files or submits under the Exchange Act is accumulated and communicated to management, including ChoiceOne’s principal executive and principal financial officers, as appropriate to allow for timely decisions regarding required disclosure. There was no change in the Registrant’s internal control over financial reporting that occurred during the three months ended March 31, 2012 that has materially affected, or that is reasonably likely to materially affect, the Registrant’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
There are no material pending legal proceedings to which the Registrant or the Bank is a party to or to which any of their properties are subject, except for proceedings that arose in the ordinary course of business. In the opinion of management, pending or current legal proceedings will not have a material effect on the consolidated financial condition of the Registrant.
Item 1A. Risk Factors.
Information concerning risk factors is contained in the discussion in Item 1A, “Risk Factors,” in the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2011. As of the date of this report, ChoiceOne does not believe that there has been a material change in the nature or categories of ChoiceOne’s risk factors, as compared to the information disclosed in the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2011.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On January 25, 2012, the Registrant issued 357 shares of common stock, without par value, to the directors of the Registrant pursuant to the Directors’ Stock Purchase Plan for an aggregate cash price of $4,000. The Registrant relied on the exemption contained in Section 4(5) of the Securities Act of 1933 in connection with these sales.
ISSUER PURCHASES OF EQUITY SECURITIES
There were no purchases of equity securities by the Registrant in the first quarter of 2012. As of March 31, 2012, there are 135,668 shares remaining that may yet be purchased under approved plans or programs. The repurchase plan was adopted and announced on July 21, 2004. There is no stated expiration date. The plan authorized the repurchase of up to 50,000 shares. The Registrant’s Board of Directors authorized an additional repurchase plan on July 26, 2007. There is no stated expiration date and this plan authorized ChoiceOne to repurchase an additional 100,000 shares.
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Item 6. Exhibits
The following exhibits are filed or incorporated by reference as part of this report:
ExhibitNumber
Document
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
/s/ James A. Bosserd
James A. Bosserd
President and Chief Executive Officer
(Principal Executive Officer)
/s/ Thomas L. Lampen
Thomas L. Lampen
Treasurer
(Principal Financial and Accounting Officer)
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INDEX TO EXHIBITS
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