UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
FORM 10-Q
☒
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2021
☐
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from to
Commission File Number: 000-19202
ChoiceOne Financial Services, Inc.
(Exact Name of Registrant as Specified in its Charter)
Michigan (State or Other Jurisdiction of Incorporation or Organization)
38-2659066 (I.R.S. Employer Identification No.)
109 East Division Sparta, Michigan (Address of Principal Executive Offices)
49345 (Zip Code)
(616) 887-7366 (Registrant’s Telephone Number, including Area Code)
Indicate by check mark 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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted 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 such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐
Accelerated filer ☐
Non-accelerated filer ☒
Smaller reporting company ☒
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 ☒
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading symbol(s)
Name of each exchange on which registered
Common stock
COFS
NASDAQ Capital Market
As of July 31, 2021, the Registrant had outstanding 7,621,043 shares of common stock.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
ChoiceOne Financial Services, Inc. CONSOLIDATED BALANCE SHEETS
June 30,
December 31,
(Dollars in thousands)
2021
2020
(Unaudited)
(Audited)
Assets
Cash and due from banks
Time deposits in other financial institutions
Cash and cash equivalents
Equity securities at fair value (Note 2)
Securities available for sale (Note 2)
Federal Home Loan Bank stock
Federal Reserve Bank stock
Loans held for sale
Loans to other financial institutions
Loans (Note 3)
Allowance for loan losses (Note 3)
Loans, net
Premises and equipment, net
Other real estate owned, net
Cash value of life insurance policies
Goodwill
Core deposit intangible
Other assets
Total assets
Liabilities
Deposits – noninterest-bearing
Deposits – interest-bearing
Total deposits
Borrowings
Subordinated debentures
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: 12,000,000; shares outstanding: 7,692,537 at June 30, 2021 and 7,796,352 at December 31, 2020
Retained earnings
Accumulated other comprehensive income, net
Total shareholders’ equity
Total liabilities and shareholders’ equity
See accompanying notes to interim consolidated financial statements.
ChoiceOne Financial Services, Inc. CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
Three Months Ended
Six Months Ended
(Dollars in thousands, except per share data)
Interest income
Loans, including fees
Securities:
Taxable
Tax exempt
Other
Total interest income
Interest expense
Deposits
Advances from Federal Home Loan Bank
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
Net gains on sales of securities
Net gains (losses) on sales and write-downs of other assets
Earnings on life insurance policies
Trust income
Change in market value of equity securities
Total noninterest income
Noninterest expense
Salaries and benefits
Occupancy and equipment
Data processing
Professional fees
Supplies and postage
Advertising and promotional
Intangible amortization
FDIC insurance
Total noninterest expense
Income before income tax
Income tax expense
Net income
Basic earnings per share (Note 4)
Diluted earnings per share (Note 4)
Dividends declared per share
ChoiceOne Financial Services, Inc. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (Unaudited)
Other comprehensive income:
Changes in net unrealized gains on investment securities available for sale, net of tax expense of $2,449 and $1,272 for the three months ended June 30, 2021 and June 30, 2020, respectively. Changes in net unrealized gains (losses) on investment securities available for sale, net of tax (benefit) expense of ($1,111) and $1,730 for the six months ended June 30, 2021 and June 30, 2020, respectively.
Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax expense of $0 and $281 for the three months ended June 30, 2021 and June 30, 2020, respectively. Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax expense of $1 and $282 for the six months ended June 30, 2021 and June 30, 2020, respectively.
Other comprehensive income (loss), net of tax
Comprehensive income
ChoiceOne Financial Services, Inc. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)
For the three months ended June 30,
Accumulated
Common
Stock and
Comprehensive
Number of
Paid in
Retained
Income/(Loss),
Shares
Capital
Earnings
Net
Total
Balance, April 1, 2020
Other comprehensive income
Shares issued
Effect of employee stock purchases
Stock options exercised and issued (1)
Stock-based compensation expense
Restricted stock units issued
Cash dividends declared ($0.20 per share)
Balance, June 30, 2020
Balance, April 1, 2021
Shares repurchased
Cash dividends declared ($0.22 per share)
Balance, June 30, 2021
(1) The amount shown represents the number of shares issued upon exercise of options, net of shares withheld for payment of certain taxes.
For the six months ended June 30,
Balance, January 1, 2020
Cash dividends declared ($0.40 per share)
Balance, January 1, 2021
Cash dividends declared ($0.44 per share)
ChoiceOne Financial Services, Inc. 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 employee and director stock purchases, stock options, and restricted stock units
Net change in market value of equity securities
Loans originated for sale
Proceeds from loan sales
Earnings on bank-owned life insurance
(Gains)/losses on sales of other real estate owned
Proceeds from sales of other real estate owned
Costs capitalized to other real estate
Deferred federal income tax (benefit)/expense
Net change in:
Net cash provided by (used in) operating activities
Cash flows from investing activities:
Sales of securities available for sale
Maturities, prepayments and calls of securities available for sale
Purchases of securities
Loan originations and payments, net
Additions to premises and equipment
Net cash (used in) investing activities
Cash flows from financing activities:
Net change in deposits
Proceeds from borrowings
Payments on borrowings
Issuance of common stock
Repurchase of common stock
Cash dividends
Net cash provided by 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
ChoiceOne Financial Services, Inc. NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Explanatory Note
On July 1, 2020, ChoiceOne Financial Services, Inc. (“ChoiceOne” or the “Company”) completed the merger of Community Shores Bank Corporation ("Community Shores") with and into ChoiceOne with ChoiceOne surviving the merger. Accordingly, the reported consolidated financial condition and operating results as of and for periods ending after July 1, 2020 include the impact of the merger.
For additional details regarding the merger with Community Shores and the merger of County Bank Corp. ("County") with and into ChoiceOne, see Note 8 (Business Combination) of the Notes to the Consolidated Financial Statements included in this report.
Principles of Consolidation
The consolidated financial statements include ChoiceOne Financial Services, Inc. ("ChoiceOne"), its wholly-owned subsidiary, ChoiceOne Bank (the "Bank"), and ChoiceOne Bank’s wholly-owned subsidiary ChoiceOne Insurance Agencies, Inc. (the "Insurance Agency"). Intercompany transactions and balances have been eliminated in consolidation.
ChoiceOne owns all of the common securities of Community Shores Capital Trust I (the “Capital Trust”). Under U.S. generally accepted accounting principles ("GAAP"), the Capital Trust is not consolidated because it is a variable interest entity and ChoiceOne is not the primary beneficiary.
The accompanying unaudited consolidated financial statements and notes thereto 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 June 30, 2021 and December 31, 2020, the Consolidated Statements of Income for the three- and six-month periods ended June 30, 2021 and June 30, 2020, the Consolidated Statements of Comprehensive Income for the three- and six-month periods ended June 30, 2021 and June 30, 2020, the Consolidated Statements of Changes in Shareholders’ Equity for the three- and six-month periods ended June 30, 2021 and June 30, 2020, and the Consolidated Statements of Cash Flows for the six-month periods ended June 30, 2021 and June 30, 2020. Operating results for the six months ended June 30, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.
The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2020.
Use of Estimates
To prepare financial statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided; therefore, future results could differ. These estimates and assumptions are subject to many risks and uncertainties, including changes in interest rates and other general economic, business and political conditions, including the effects of the COVID-19 pandemic, and its potential effects on the economic environment, our customers and our operations, as well as any changes to federal, state and local government laws, regulations and orders in connection with the COVID-19 pandemic. Actual results may differ from those estimates.
Loans to Other Financial Institutions
ChoiceOne Bank entered into an agreement with another financial institution to fund mortgage loans. Loans to other financial institutions are purchased participating interests in individual advances made to mortgage bankers nation-wide from an unaffiliated originating bank. The originating bank services these loans and cash flows on the individual advances (principal, interest, and fees) which are allocated pro-rata based on ownership in the participating interest, less fees paid for the servicing activity. The underlying collateral is generally made up of 1-4 family first residential mortgages owned by the mortgage banker and held for sale in the secondary market and have been underwritten using secondary market underwriting standards prior to purchasing the participating interest. Once the mortgage banker delivers the loan to the secondary market, the advance is required to be paid off, including ChoiceOne Bank’s participating interest. If the advance (in which ChoiceOne Bank has a participating interest) is outstanding over 90 days, the originating bank has the right to request the participating interest be paid off by the mortgage banker. There was no participating interest as of June 30, 2021.
Credit risk associated with the participating interest is measured as an allowance for loan losses when necessary. Losses are charged off against the allowance when incurred and recoveries of loan charge-offs are recorded when received. At least quarterly, ChoiceOne Bank reviews the portfolios of participating interests for potential losses including any participating interest that is outstanding over 90 days (even if the advance and participating interest is current). Loans to other financial institutions are excluded from the loans described in Note 3 to the interim consolidated financial statements.
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 sheets as well as its net income.
Stock Transactions
A total of 8,929 shares of common stock were issued to ChoiceOne’s Board of Directors for a cash price of $ 247,000 under the terms of the Directors’ Stock Purchase Plan in the first half of 2021. A total of 2,957 shares for a cash price of $ 66,000 were issued under the Employee Stock Purchase Plan in the first six months of 2021.
Stock-Based Compensation
ChoiceOne grants restricted stock units to a select group of employees under the Stock Incentive Plan of 2012. All of the restricted stock units are initially unvested and vest three years after the grant date. Certain additional vesting provisions apply. Each unit, once vested, is settled by delivery of one share of ChoiceOne common stock.
Reclassifications
Certain amounts presented in prior periods have been reclassified to conform to the current presentation.
Recent Accounting Pronouncements
The Financial Accounting Standards Board ("FASB") issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU provides financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date by replacing the incurred loss impairment methodology in GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The new guidance attempts to reflect an entity’s current estimate of all expected credit losses and broadens the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually to include forecasted information, as well as past events and current conditions. There is no specified method for measuring expected credit losses, and an entity may apply methods that reasonably reflect its expectations of the credit loss estimate. Although an entity may still use its current systems and methods for recording the allowance for credit losses, under the new rules, the inputs used to record the allowance for credit losses generally will need to change to appropriately reflect an estimate of all expected credit losses and the use of reasonable and supportable forecasts. Additionally, credit losses on available-for-sale debt securities will have to be presented as an allowance rather than as a write-down. This ASU is effective for fiscal years beginning after December 15, 2022, and for interim periods within those years for companies considered a smaller reporting company with the Securities and Exchange Commission. ChoiceOne was classified as a smaller reporting company as of the determination date of November 15, 2019. Management is currently evaluating the impact of this new ASU on its consolidated financial statements which may be significant.
Goodwill is not amortized but is evaluated annually for impairment and on an interim basis if events or changes in circumstances indicate that goodwill might be impaired. The goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount, and an impairment charge would be recognized for any amount by which the carrying amount exceeds the reporting unit's fair value. Accounting pronouncements allow a company to first perform a qualitative assessment for goodwill prior to a quantitative assessment (Step 1 assessment). If the results of the qualitative assessment indicate that it is more likely than not that goodwill is impaired, then a quantitative assessment must be performed. If not, there is no further assessment required. ChoiceOne acquired Valley Ridge Financial Corp. in 2006, County in 2019, and Community Shores in 2020, which resulted in the recognition of goodwill of $13.7 million, $38.9 million and $7.3 million, respectively.
Due to the potential impact of COVID-19 and any long term economic fallout that might occur, ChoiceOne engaged a third-party valuation firm to perform a quantitative analysis of goodwill as of November 30, 2020 ("the valuation date"). In deriving the fair value of the reporting unit (ChoiceOne), the third-party firm assessed general economic conditions and outlook; industry and market considerations and outlook; the impact of recent events to financial performance; the market price of ChoiceOne’s common stock and other relevant events. In addition, the valuation relied on financial projections through 2025 and growth rates prepared by management. Based on the valuation prepared, it was determined that the estimated fair value of the reporting unit at the valuation date was greater than its book value and impairment of goodwill was not required.
Management performed its annual qualitative assessment of goodwill as of June 30, 2021. In evaluating whether it is more likely than not that the fair value of ChoiceOne's operations was less than the carrying amount, management assessed the relevant events and circumstances such as the ones noted in ASC 350-20-35-3c. The analysis consisted of a review of ChoiceOne’s current and expected future financial performance, the potential impact of COVID-19 on the ability of ChoiceOne’s borrowers to comply with loan terms, and the impact that reductions in both short-term and long-term interest rates have had and may continue to have on net interest margin and mortgage sales activity. The share price and book value of ChoiceOne’s stock were also compared to the prior year. Management also compared average deal values for recent closed bank transactions to ChoiceOne transactions. Despite ChoiceOne's market capitalization declining slightly from November 30, 2020 to June 30, 2021, ChoiceOne's financial performance remained positive. This was evidenced by the strong financial indicators, solid credit quality ratios, as well as the strong capital position of ChoiceOne. In addition, second quarter 2021 revenue reflected significant and continuing growth in ChoiceOne's interest income, as well as net Small Business Administration fees related to Payroll Protection Program ("PPP") loans. In assessing the totality of the events and circumstances, management determined that it was more likely than not that the fair value of ChoiceOne's operations, from a qualitative perspective, exceeded the carrying value as of June 30, 2021.
NOTE 2 – SECURITIES
The fair value of equity securities and the related gross unrealized gains (losses) recognized in noninterest income were as follows:
June 30, 2021
Gross
Amortized
Unrealized
Fair
Cost
Gains
Losses
Value
Equity securities
December 31, 2020
The fair value of securities available for sale and the related unrealized gains and losses recognized in accumulated other comprehensive income were as follows:
U.S. Government and federal agency
U.S. Treasury notes and bonds
State and municipal
Mortgage-backed
Corporate
Asset-backed securities
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 three and six months ended June 30, 2021 or in the same periods in2020. ChoiceOne believes 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.
Presented below is a schedule of maturities of securities as of June 30, 2021, the fair value of securities as of June 30, 2021 and December 31, 2020, and the weighted average yields of securities as of June 30, 2021:
Securities maturing within:
Less than
1 Year -
5 Years -
More than
at June 30,
at Dec. 31,
1 Year
5 Years
10 Years
-
Total debt securities
Mortgage-backed securities
Weighted average yields:
%
Following is information regarding unrealized gains and losses on equity securities for the three- and six-month periods ended June 30, 2021 and 2020:
Net gains and (losses) recognized during the period
Less: Net gains and (losses) recognized during the period on securities sold
Unrealized gains and losses recognized during the reporting period on securities still held at the reporting date
NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses and balances in the loan portfolio were as follows:
Commercial
and
Construction
Residential
Agricultural
Industrial
Consumer
Real Estate
Unallocated
Allowance for Loan Losses Three Months Ended June 30, 2021
Beginning balance
Charge-offs
Recoveries
Provision
Ending balance
Allowance for Loan Losses Six Months Ended June 30, 2021
Individually evaluated for impairment
Collectively evaluated for impairment
Loans
Acquired with deteriorated credit quality
Allowance for Loan Losses Three Months Ended June 30, 2020
Allowance for Loan Losses Six Months Ended June 30, 2020
June 30, 2020
The provision for loan losses was $166,000 in the second quarter of 2021 and $416,000 in the first half of 2021, compared to $1,000,000 and $1,775,000, respectively, in the same periods in the prior year. The second quarter and first half of 2021 provisions were deemed appropriate due to positive economic indicators in ChoiceOne's local market areas and the national economy compared to the prior year. While it is difficult to predict the impact that COVID-19 will have in future quarters, ChoiceOne estimates these losses have been incurred as of June 30, 2021, and expects that increased levels of past due loans, nonperforming loans and loan losses may occur.
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 9. A description of the characteristics of the ratings follows:
Risk Rating 1 through 5 or pass: 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 6 or special mention: Loans and other credit extensions bearing this grade are considered to be inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These obligations, even if apparently protected by collateral value, have well-defined weaknesses related to adverse financial, managerial, economic, market, or political conditions that have clearly jeopardized repayment of principal and interest as originally intended. Furthermore, there is the possibility that ChoiceOne Bank will sustain some future loss if such weaknesses are not corrected. Clear loss potential, however, does not have to exist in any individual assets classified as substandard. Loans falling into this category should have clear action plans and timelines with benchmarks to determine which direction the relationship will move.
Risk rating 7 or substandard: Loans and other credit extensions graded “7” have all the weaknesses inherent in those graded “6”, with the added characteristic that the severity of the weaknesses makes collection or liquidation in full highly questionable or improbable based upon currently existing facts, conditions, and values. Loans in this classification should be evaluated for non-accrual status. All nonaccrual commercial and Retail loans must be at a minimum graded a risk code “7”.
Risk rating 8 or doubtful: Loans and other credit extensions bearing this grade have been determined to have the extreme probability of some loss, but because of certain important and reasonably specific factors, the amount of loss cannot be determined. Such pending factors could include merger or liquidation, additional capital injection, refinancing plans, or perfection of liens on additional collateral.
Risk rating 9 or loss: Loans in this classification are considered uncollectible and cannot be justified as a viable asset of ChoiceOne Bank. This classification does not mean the loan has absolutely no recovery value, but that it is neither practical nor desirable to defer writing off this loan even though partial recovery may be obtained in the future.
Information regarding ChoiceOne Bank's credit exposure was as follows:
Corporate Credit Exposure - Credit Risk Profile By Creditworthiness Category
Commercial and Industrial
Commercial Real Estate
Pass
Special Mention
Substandard
Doubtful
Consumer Credit Exposure - Credit Risk Profile Based On Payment Activity
Construction Real Estate
Residential Real Estate
Performing
Nonperforming
Nonaccrual
The following table provides information on loans that were considered troubled debt restructurings ("TDRs") that were modified during the three and six months ended June 30, 2021 and June 30, 2020.
Three Months Ended June 30, 2021
Six Months Ended June 30, 2021
Pre-
Post-
Modification
Outstanding
Recorded
Investment
Three Months Ended June 30, 2020
Six Months Ended June 30, 2020
The following schedule provides information on TDRs as of June 30, 2021 where the borrower was past due with respect to principal and/or interest for 30 days or more during the three and six months ended June 30, 2021 and June 30, 2020, which loans had been modified and classified as TDRs during the year prior to the default.
Number
of Loans
Commercial and industrial
In March of 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was passed into law. Among other things, the CARES Act provides that certain loans subject to modifications related to the COVID-19 pandemic need not be classified as TDRs. Further, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” on March 22, 2020, followed by a revised statement on April 7, 2020, providing in part that short-term modifications to loans made on a good faith basis to borrowers who were current as of the implementation date of the statements are not considered TDRs. As a result of the pandemic, ChoiceOne provided a modification program to borrowers that included certain concessions such as interest only payments or payment deferrals. As of June 30, 2021, all deferments had resumed payments in accordance with loan terms.
Impaired loans by loan category follow:
Unpaid
Principal
Related
Balance
Allowance
With no related allowance recorded
Construction real estate
Commercial real estate
Residential real estate
Subtotal
With an allowance recorded
The following schedule provides information regarding average balances of impaired loans and interest recognized on impaired loans for the three- and six-month periods ended June 30, 2021 and 2020:
Average
Interest
Income
Recognized
An aging analysis of loans by loan category follows:
Past Due
Greater
90 Days Past
Than 90
Loans Not
Due and
Days (1)
Total (1)
Accruing
(1) Includes nonaccrual loans.
Nonaccrual loans by loan category follow:
The table below details the outstanding balances of the County Bank Corp. acquired loan portfolio and the acquisition fair value adjustments at acquisition date (dollars in thousands):
Impaired
Non-impaired
Loans acquired - contractual payments
Nonaccretable difference
Expected cash flows
Accretable yield
Carrying balance at acquisition date
The table below presents a roll forward of the accretable yield on County Bank Corp. acquired loan portfolio for the six months ended June 30, 2021 (dollars in thousands):
Acquired
Balance, January 1, 2019
Merger with County Bank Corp on October 1, 2019
Accretion October 1, 2019 through December 31, 2019
Accretion January 1, 2020 through December 31, 2020
Balance, December 31, 2020
Accretion January 1, 2021 through June 30, 2021
The table below details the outstanding balances of the Community Shores Bank Corporation acquired loan portfolio and the acquisition fair value adjustments at acquisition date (dollars in thousands):
The table below presents a roll forward of the accretable yield on Community Shores Bank Corporation acquired loan portfolio for the six months ended June 30, 2021 (dollars in thousands):
Merger with Community Shores Bank Corporation on July 1, 2020
Accretion July 1, 2020 through December 31, 2020
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:
(Dollars in thousands, except share data)
Basic
Weighted average common shares outstanding
Basic earnings per common shares
Diluted
Plus dilutive stock options and restricted stock units
Weighted average common shares outstanding and potentially dilutive shares
Diluted earnings per common share
There were 15,000 stock options that were considered anti-dilutive to earnings per share for the three months ended June 30, 2021 and 12,000 stock options that were considered anti-dilutive to earnings per share for the six months ended June 30, 2021. There were no stock options that were considered to be anti-dilutive to earnings per share for the three and six months ended June 30, 2020. There were 18,985 restricted stock units that were considered anti-dilutive for the three months ended June 30, 2021. There were no restricted stock units that were considered anti-dilutive for the six months ended June 30, 2021 or for the three and six months ended June 30, 2020.
Note 5 – Financial Instruments
Financial instruments as of the dates indicated were as follows:
Quoted Prices
In Active
Significant
Markets for
Identical
Observable
Unobservable
Carrying
Estimated
Inputs
Amount
Fair Value
(Level 1)
(Level 2)
(Level 3)
Equity securities at fair value
Securities available for sale
Federal Home Loan Bank and Federal
Reserve Bank stock
Accrued interest receivable
Interest rate lock commitments
Noninterest-bearing deposits
Interest-bearing deposits
Accrued interest payable
NOTE 6 – FAIR VALUE MEASUREMENTS
The following tables present information about assets and liabilities measured at fair value on a recurring basis and the valuation techniques used 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 ChoiceOne 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. ChoiceOne 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 June 30, 2021 or December 31, 2020. Disclosures concerning assets measured at fair value are as follows:
Assets Measured at Fair Value on a Recurring Basis
at Date
Indicated
Equity Securities Held at Fair Value - June 30, 2021
Investment Securities, Available for Sale - June 30, 2021
U. S. Government and federal agency
U. S. Treasury notes and bonds
Equity Securities Held at Fair Value - December 31, 2020
Investment Securities, Available for Sale - December 31, 2020
Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis
Equity Securities Held at Fair Value
Balance, January 1
Total realized and unrealized gains included in noninterest income
Net purchases, sales, calls, and maturities
Net transfers into Level 3
Balance, June 30
Investment Securities, Available for Sale
Total unrealized gains included in other comprehensive income
Of the available for sale Level 3 assets that were held by ChoiceOne at June 30, 2021, the net unrealized gain as of June 30, 2021 was $643,000, which was recognized in accumulated other comprehensive income in the consolidated balance sheet.
Both observable and unobservable inputs may be used to determine the fair value of positions classified as Level 3 investment securities 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.
Securities categorized as Level 3 assets primarily consist of bonds issued by local municipalities and common and preferred equity securities of community banks. ChoiceOne estimates the fair value of these bonds and equity securities 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.
ChoiceOne 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:
Assets Measured at Fair Value on a Non-recurring Basis
Balances at
Dates
Impaired Loans
Other Real Estate
Mortgage Loan Servicing Rights
Impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. ChoiceOne estimates the fair value of the loans based on the present value of expected future cash flows using management’s 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.
NOTE 7 – REVENUE FROM CONTRACTS WITH CUSTOMERS
ChoiceOne has a variety of sources of revenue, which include interest and fees from customers as well as revenue from non-customers. ASC Topic 606, Revenue from Contracts With Customers, covers certain sources of revenue that are classified within noninterest income in the Consolidated Statements of Income. Sources of revenue that are included in the scope of ASC Topic 606 include service charges and fees on deposit accounts, interchange income, investment asset management income and transaction-based revenue, and other charges and fees for customer services.
Service Charges and Fees on Deposit Accounts
Revenue includes charges and fees to provide account maintenance, overdraft services, wire transfers, funds transfer, and other deposit-related services. Account maintenance fees such as monthly service charges are recognized over the period of time that the service is provided. Transaction fees such as wire transfer charges are recognized when the service is provided to the customer.
Interchange Income
Revenue includes debit card interchange and network revenues. This revenue is earned on debit card transactions that are conducted through payment networks such as MasterCard. The revenue is recorded as services are delivered and is presented net of interchange expenses.
Investment Commission Income
Revenue includes fees from the investment management advisory services and revenue is recognized when services are rendered. Revenue also includes commissions received from the placement of brokerage transactions for purchase or sale of stocks or other investments. Commission income is recognized when the transaction has been completed.
Trust Fee Income
Revenue includes fees from the management of trust assets and from other related advisory services. Revenue is recognized when services are rendered.
Following is noninterest income separated by revenue within the scope of ASC 606 and revenue within the scope of other GAAP topics:
Service charges and fees on deposit accounts
Interchange income
Investment commission income
Trust fee income
Other charges and fees for customer services
Noninterest income from contracts with customers within the scope of ASC 606
Noninterest income within the scope of other GAAP topics
NOTE 8 – BUSINESS COMBINATION
Community Shores Bank Corporation
ChoiceOne completed the acquisition of Community Shores Bank Corporation (“Community Shores”) with and into ChoiceOne, with ChoiceOne as the surviving entity, effective on July 1, 2020. Community Shores had 4 branch offices as of the date of the merger. Total assets of Community Shores as of July 1, 2020 were $244.5 million, including total loans of $174.8 million. Deposits acquired in the merger, the majority of which were core deposits, totaled $227.8 million. The impact of the merger has been included in ChoiceOne’s results of operations since the effective date of the merger. As consideration in the merger, ChoiceOne issued 524,139 shares of ChoiceOne common stock, which was net of 84 fractional shares not issued, and cash in the amount of $5,390,000 with an approximate total value of $20.9 million.
The table below presents the allocation of purchase price for the merger with Community Shores (dollars in thousands):
Purchase Price
Consideration
Net assets acquired:
Federal Home Loan Bank and Federal Reserve Bank stock
Originated loans
Premises and equipment
Other real estate owned
Deposit based intangible
Non-interest bearing deposits
Interest bearing deposits
Net assets acquired
County Bank Corp
ChoiceOne completed the merger of County Bank Corp (“County”) with and into ChoiceOne effective on October 1, 2019. County had 14 branch offices and one loan production office as of the date of the merger. Total assets of County as of October 1, 2019 were $673 million, including total loans of $424 million. Deposits acquired in the merger, the majority of which were core deposits, totaled $574 million. The impact of the merger has been included in ChoiceOne’s results of operations since the effective date of the merger. As consideration in the merger, ChoiceOne issued 3,603,872 shares of ChoiceOne common stock, which was net of 299 fractional shares not issued, with an approximate value of $108 million.
The table below presents the allocation of purchase price for the merger with County (dollars in thousands):
Bank owned life insurance
Federal funds purchased
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”), its wholly-owned subsidiary ChoiceOne Bank, and ChoiceOne Bank’s wholly-owned subsidiaries, ChoiceOne Insurance Agencies, Inc., Lakestone Financial Services, Inc., and Community Shores’ Financial Services, Inc. This discussion should be read in conjunction with the interim 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. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “is likely,” “plans,” “predicts,” “projects,” “may,” “could,” “look forward,” “continue”, “future”, and 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, loan servicing rights, other real estate owned, and the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary and the amount of any impairment) and management’s assumptions concerning pension and other postretirement benefit plans involve judgments that are inherently forward-looking. Examples of forward-looking statements also include, but are not limited to, statements related to risks and uncertainties related to, and the impact of, the COVID-19 pandemic on the businesses, financial condition and results of operations of ChoiceOne and its customers and statements regarding the outlook and expectations of ChoiceOne and its customers. The COVID-19 pandemic is adversely affecting ChoiceOne and its customers, counterparties, employees, and third-party service providers, and the ultimate extent of the impacts on ChoiceOne's business, financial position, results of operations, liquidity, and prospects is uncertain. All of the information concerning interest rate sensitivity is forward-looking. All statements with references to future time periods are 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.
Additional risk factors include, but are not limited to, the risk factors discussed in Item 1A of ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2020 and in Part II, Item 1A of this Quarterly Report on Form 10-Q. These are representative of the risk factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.
RESULTS OF OPERATIONS
Net income for the second quarter of 2021 was $5,043,000, which represented an increase of $613,000 or 14% compared to the second quarter of 2020. Basic and diluted earnings per common share were $0.65 for the second quarter of 2021 compared to $0.61 for the second quarter of the prior year. Net income for the first six months of 2021 was $11,281,000 or $1.45 per diluted share, compared to $7,684,000 or $1.06 per diluted share in the first half of 2020. Growth in net income in the first half of 2021 compared to the same period in the prior year resulted in part from the effects of the Coronavirus Aid, Relief, and Economic Security ("CARES") Act and Paycheck Protection Program ("PPP") fees and deposit dollars resulting from the CARES Act. The merger with Community Shores Bank Corporation ("Community Shores") that was effective on July 1, 2020 also had an impact on ChoiceOne's financial results. There were no merger expenses in the first half of 2021. Net income for the second quarter and first half of 2020, excluding $462,000 and $744,000 of tax-effected merger expenses, respectively was $4,892,000 or $0.67 per diluted share and $8,428,000 or $1.16 per diluted share, respectively.
The return on average assets and return on average shareholders’ equity percentages were 1.10% and 10.01%, respectively, for the first six months of 2021, compared to 1.22% and 9.04%, respectively, for the same period in 2020.
Net income, basic earnings per share, and diluted earnings per share excluding tax-effected merger-related expenses are non-GAAP financial measures. Please refer to the section below titled “Non-GAAP Financial Measures” for a reconciliation to the most directly comparable GAAP financial measures.
Acquisition of Community Shores Bank Corporation
ChoiceOne completed the acquisition of Community Shores Bank Corporation (“Community Shores”) with and into ChoiceOne effective on July 1, 2020. Community Shores had 4 branch offices as of the date of the acquisition. Total assets of Community Shores as of July 1, 2020 were $244.5 million, including total loans of $174.8 million. Deposits acquired in the merger, the majority of which were core deposits, totaled $227.8 million. The impact of the merger has been included in ChoiceOne’s results of operations since the effective date of the merger. As consideration in the merger, ChoiceOne issued 524,139 shares of ChoiceOne common stock and cash in the amount of $5,390,000 with an approximate total value of $20.9 million. The consolidation of Community Shores Bank with and into ChoiceOne Bank was completed on October 16, 2020.
The COVID-19 Pandemic
The COVID-19 pandemic has had a substantial impact on numerous aspects of life in the United States, including threats to public health, government imposed restrictions on business and gatherings, increased volatility in markets, and severe effects on national and local economies.
Although there were no material increases in delinquencies or net charge-offs in the second quarter of 2021, ChoiceOne has designated a portion of our allowance for loan losses for the losses we believe may be realized from the impacts of the COVID-19 pandemic. Consistent with federal banking agencies' “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus,” ChoiceOne is working with its borrowers affected by COVID-19. ChoiceOne granted deferrals on numerous loans to borrowers affected by the pandemic; however, as of June 30, 2021, all deferments had resumed payments in accordance with loan terms.
In addition, ChoiceOne processed over $126 million in PPP loans in 2020 and acquired an additional $37 million in PPP loans in the merger with Community Shores. ChoiceOne originated $89.1 million in PPP loans in the first half of 2021. PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP. PPP loans carry a fixed rate of 1.00% and a term of two years (loans made before June 5, 2020) or five years (loans made on or after June 5, 2020), if not forgiven in whole or in part. Payments are deferred until either the date on which the Small Business Administration ("SBA") remits the amount of forgiveness proceeds to the lender or the date that is ten months after the last day of the covered period if the borrower does not apply for forgiveness within that ten-month period. The loans are 100% guaranteed by the SBA. The SBA pays the originating bank a processing fee ranging from 1% to 5%, based on the size of the loan. Upon SBA forgiveness, unrecognized fees are recognized into interest income. In the second quarter and first half of 2021, $37.7 million and $115.8 million of PPP loans were forgiven resulting in $756,000 and $2.4 million of fee income, respectively. $3.9 million in PPP fee income remains deferred as of June 30, 2021.
Dividends
Cash dividends of $1,703,000 or $0.22 per share were declared in the second quarter of 2021, compared to $1,451,000 or $0.20 per share declared in the second quarter of 2020. Cash dividends declared in the first six months of 2021 were $3,419,000 or $0.44 per share, compared to $2,900,000 or $0.40 per share in the prior year. The cash dividend payout percentage was 30% for the first six months of 2021, compared to 38% in the same period in the prior year.
Interest Income and Expense
Tables 1 and 2 on the following pages provide information regarding interest income and expense for the three- and six-month periods ended June 30, 2021 and 2020. 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
Three Months Ended June 30,
Rate
Assets:
Loans (1)
Taxable securities (2)
Nontaxable securities (1)
Interest-earning assets
Noninterest-earning assets
Liabilities and Shareholders' Equity:
Interest-bearing demand deposits
Savings deposits
Certificates of deposit
Interest-bearing liabilities
Demand deposits
Other noninterest-bearing liabilities
Shareholders' equity
Total liabilities and shareholders' equity
Net interest income (tax-equivalent basis) (Non-GAAP) (1)
Net interest margin (tax-equivalent basis) (Non-GAAP) (1)
Reconciliation to Reported Net Interest Income
Adjustment for taxable equivalent interest
Net interest income (GAAP)
Net interest margin (GAAP)
(1)
Adjusted to a fully tax-equivalent basis to facilitate comparison to the taxable interest-earning assets. The adjustment uses an incremental tax rate of 21%. The presentation of these measures on a tax-equivalent basis is not in accordance with GAAP, but is customary in the banking industry. These non-GAAP measures ensure comparability with respect to both taxable and tax-exempt loans and securities.
(2)
Taxable securities include dividend income from Federal Home Loan Bank and Federal Reserve Bank stock.
Six Months Ended June 30,
Table 2 – Changes in Tax-Equivalent Net Interest Income
2021 Over 2020
Volume
Increase (decrease) in interest income (1)
Loans (2)
Taxable securities
Nontaxable securities (2)
Net change in interest income
Increase (decrease) in interest expense (1)
Net change in interest expense
Net change in tax-equivalent net interest income
The volume variance is computed as the change in volume (average balance) multiplied by the previous year’s interest rate. The rate variance is computed as the change in interest rate multiplied by the previous year’s volume (average balance). The change in interest due to both volume and rate has been allocated to the volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
Interest on nontaxable investment securities and loans has been adjusted to a fully tax-equivalent basis using an incremental tax rate of 21%.
Net Interest Income
Tax-equivalent net interest income increased $2.9 million in the second quarter and $6.6 million in the first half of 2021 compared to the same periods in 2020. This was partially due to $756,000 in PPP loan fees recognized during the second quarter and $2.4 million in PPP loan fees recognized in the first half of 2021 and the impact of the Community Shores merger. Net interest margin on a tax-equivalent basis declined by 44 and 35 basis points in the three and six months ended June 30, 2021, respectively, compared to the same periods in the prior year due to a lower interest rate environment and low interest rate PPP loans.
The average balance of loans increased $175.6 million in the first six months of 2021 compared to the same period in 2020. $173.9 million of the increase was due to the impact of the merger with Community Shores which closed on July 1, 2020. The increase in the average loans balance was partially offset by a 19 basis point decline in the average rate earned. Loan rates have partially been affected by PPP loans with an interest rate of 1.00% which has reduced the overall rate earned on loans during the first half of 2021. The combination of these factors caused tax-equivalent interest income from loans to increase $3.2 million in the first half of 2021 compared to the same period in the prior year. The average balance of total securities increased $371.4 million in the first six months of 2021 compared to the same period in 2020. The securities portfolio has grown as ChoiceOne has deployed excess deposit dollars into sufficiently short-term securities to allow loans to grow organically as good credits become available. The effect of the average balance growth, partially offset by a combined 45 basis point reduction in the average rate earned on securities, caused tax-equivalent securities income to increase $3.0 million in the first six months of 2021 compared to the same period in 2020.
Growth of $377.0 million in the average balance of interest-bearing demand deposits and savings deposits, partially offset by a combined 8 basis point decrease in the average rate paid, caused interest expense to be $95,000 higher in the first six months of 2021 compared to the first six months of the prior year. The average balance of certificates of deposit increased $16.6 million in the first six months of 2021 compared to the same period in 2020. The growth was offset by a reduction of 81 basis points in the average rate paid on certificates which caused interest expense to decrease $659,000 in the first six months of 2021 compared to the same period in 2020. A reduction of $18.1 million in the average balance of borrowings in the first half of 2021 compared to the same period in the prior year partially offset by a 14 basis point increase in the average rate caused interest expense to decline $167,000. Subordinated debentures issued in connection with a trust preferred securities offering were obtained as part of the merger with Community Shores.
Provision and Allowance for Loan Losses
The provision for loan losses was $166,000 in the second quarter and $416,000 in the first half of 2021, compared to $1,000,000 and $1,775,000 in the same periods in the prior year. The provision in the second quarter and first six months of 2021 was deemed prudent due to changes in the risk profile of ChoiceOne’s loan portfolio and the economic impact on ChoiceOne's local market areas and the national economy resulting from the COVID-19 pandemic. Nonperforming loans were $6.9 million as of June 30, 2021, compared to $10.0 million as of March 31, 2021 and $8.2 million as of December 31, 2020. The allowance for loan losses was 0.79% of total loans at June 30, 2021, compared to 0.75% at March 31, 2021 and 0.71% at December 31, 2020. Loans acquired in the mergers with County and Community Shores were recorded at fair value and as a result do not have an allowance for loan losses allocated to them unless credit deteriorates subsequent to acquisition. If the credit mark associated with the loans acquired in the mergers were added to the allowance for loan losses, the total would have represented 1.53% of total loans at June 30, 2021, compared to 1.52% at March 31, 2021 and 1.60% at December 31, 2020.
Charge-offs and recoveries for respective loan categories for the six months ended June 30, 2021 and 2020 were as follows:
Net recoveries were $44,000 in the second quarter and net charge-offs were $59,000 in the first half of 2021, compared to net charge-offs of $40,000 and $82,000 during the same periods in 2020. Net charge-offs on an annualized basis as a percentage of average loans were 0.01% in the first half of 2021 compared to 0.02% of average loans in the same period in the prior year. Management is aware that the economic climate in Michigan will continue to affect business and individual borrowers. Management believes that COVID-19 will also have an impact in the remainder of 2021 and beyond. Management has worked and intends to continue to work with delinquent borrowers in an attempt to lessen the impact of COVID-19 on ChoiceOne.
ChoiceOne has allocated approximately $1.7 million in the allowance for loan losses to borrowers falling into industry classification codes that management believes to be highly or moderately affected by the pandemic, as follows:
Loans highly affected and moderately affected based on their commercial industry category have been allocated an additional 30 basis points and 20 basis points, respectively. ChoiceOne has also allocated 20 basis points to all retail loan categories. It is noted that this allowance amount is in addition to the regularly calculated allowance based on risk rating and qualitative factors. ChoiceOne will continue to monitor concentrations as part of its analysis on an ongoing basis. Management will continue to monitor charge-offs, changes in the level of nonperforming loans, changes within the composition of the loan portfolio and the impact of COVID-19, and it will adjust the provision and allowance for loan losses as determined to be necessary.
Noninterest Income
Total noninterest income was $4.7 million in the second quarter and $10.3 million in the first half of 2021 compared to $6.8 million and $10.7 million in the same periods in the prior year. Customer service charges grew $732,000 in the second quarter and $807,000 in the first half of 2021 compared to the same periods in 2020 as a result of increased business activity as the economy recovered from the pandemic and the merger with Community Shores. Total noninterest income in the second quarter of 2020 was elevated by an investment portfolio restructuring which created $1.3 million in noninterest income. Gains on sales of loans declined $1.2 million in the three months ended June 30, 2021 and $822,000 in the six months ended June 30, 2021 compared to the same periods in 2020. Although mortgage rates are still low, ChoiceOne experienced lower loan refinancing activity in the three months ended June 30, 2021 than in the same period in the prior year, in contrast to the first quarter of 2021 where loan originations were higher than the first quarter of 2020. Gains on sales of loans were also affected by a lower gain rate in 2021 than in 2020. Future originations will be affected by housing inventory as it continues to be less than demand in ChoiceOne's market areas. The stock market dipped sharply in March 2020 related to the COVID-19 pandemic which affected securities held by ChoiceOne. Since that time ChoiceOne has seen the value of equity investments held climb to pre-pandemic levels. The market value of equity securities saw a decline in the three months ended June 30, 2021, and an increase in the six months ended June 30, 2021, in each case when compared to the same time periods in 2020.
Noninterest Expense
Total noninterest expense increased $979,000 and $3.1 million in the second quarter and first half of 2021, respectively, compared to the same periods in 2020. All categories included expenses as a result of the merger with Community Shores that was effective on July 1, 2020. Salaries and benefits included a higher level of commission expense in the second quarter and first half of 2021 compared to the same periods in the prior year as a result of the additional mortgage lenders hired during the last year. Supplies and postage declined in the second quarter and first half of 2021 compared to the same period in the prior year as ChoiceOne continues to move mailings digital when possible. The intangible amortization expense in 2021 represented the amortization of the core deposit intangible that resulted from the mergers with County and Community Shores.
Income Tax Expense
Income tax expense was $2,174,000 in the first six months of 2021 compared to $1,675,000 for the same period in 2020. The increase was due to a higher level of income before income tax. The effective tax rate was 16.2% for the first half of 2021 and 17.9% for the first half of 2020.
FINANCIAL CONDITION
Securities
In an effort to deploy deposit growth ChoiceOne grew its securities portfolio $286.3 million in the first half of 2021. We believe our portfolio will provide a natural hedge for floating rate loans and investments are sufficiently short-term to allow us to grow loans organically as good credits become available. Various securities totaling $322.0 million were purchased in the first six months of 2021. There were no sales in the first half of 2021; however, $5.1 million of securities were called or matured during that same time period. Principal repayments on securities totaled $23.0 million in the first six months of 2021.
Loans declined $65.1 million in the six months ended June 30, 2021, a result of $28.1 million in PPP loans forgiven net of new originations and $37.0 million of core loans. In an effort to grow loans ChoiceOne hired five experienced commercial lenders and bolstered its credit department in the first half of 2021. In the second quarter and first half of 2021, $37.7 million and $115.8 million of PPP loans were forgiven resulting in $756,000 and $2.4 million of fee income, respectively. $3.9 million in PPP fee income remains deferred as of June 30, 2021. During the second quarter and first half of 2021, ChoiceOne recorded accretion income related to acquired loans in the amount of $320,000 and $671,000, respectively. ChoiceOne saw declines of $38.5 million in commercial and industrial loans, $22.3 million in residential real estate loans, and $7.2 million of agricultural loans in the first half of 2021. The other changes resulted from normal fluctuations in borrower activity.
Asset Quality
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 was $6.8 million at June 30, 2021, compared to $10.4 million as of March 31, 2021 and $7.9 million as of December 31, 2020. The change in the first half of 2021 was primarily comprised of a decrease of $1.9 million in impaired commercial real estate impaired loans and a $1.5 million decline in commercial and industrial impaired loans offset by a $2.8 million increase in agricultural impaired loans.
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 ("TDRs").
The balances of these nonperforming loans were as follows:
Loans accounted for on a nonaccrual basis
Accruing loans which are contractually past due 90 days or more as to principal or interest payments
Loans defined as "troubled debt restructurings " which are not included above
The reduction in the balance of nonaccrual loans in the first six months of 2021 was primarily due to loans that were paid off. The increase in the TDR loans balance in the first half of 2021 was primarily due to a $2.3 million increase in TDR agricultural loans. Approximately 93% of the balance of loans considered TDRs were performing according to their restructured terms as of June 30, 2021. Management believes the allowance for loan losses allocated to its nonperforming loans is sufficient at June 30, 2021.
In March of 2020, the CARES Act was passed into law. Among other things, the CARES Act provides that certain loans subject to modifications related to the COVID-19 pandemic need not be classified as TDRs. Further, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus” on March 22, 2020, followed by a revised statement on April 7, 2020, providing in part that short-term modifications to loans made on a good faith basis to borrowers who were current as of the implementation date of the statements are not considered TDRs. As a result of the COVID-19 pandemic, the Company provided a modification program to borrowers that included certain concessions such as interest only payments or payment deferrals. As of June 30, 2021, all deferments had resumed payments in accordance with loan terms.
Goodwill is not amortized but is evaluated annually for impairment and on an interim basis if events or changes in circumstances indicate that goodwill might be impaired. The goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount, and an impairment charge would be recognized for any amount by which the carrying amount exceeds the reporting unit's fair value. Accounting pronouncements allow a company to first perform a qualitative assessment for goodwill prior to a quantitative assessment (Step 1 assessment). If the results of the qualitative assessment indicate that it is more likely than not that goodwill is impaired, then a quantitative assessment must be performed. If not, there is no further assessment required. The ChoiceOne acquired Valley Ridge Financial Corp. in 2006, County in 2019, and Community Shores in 2020, which resulted in the recognition of goodwill of $13.7 million, $38.9 million and $7.3 million, respectively.
Management performed its annual qualitative assessment of goodwill as of June 30, 2021. In evaluating whether it is more likely than not that the fair value of ChoiceOne's operations was less than the carrying amount, management assessed the relevant events and circumstances such as the ones noted in ASC 350-20-35-3c. The analysis consisted of a review of ChoiceOne’s current and expected future financial performance, the potential impact of the COVID-19 pandemic on the ability of ChoiceOne’s borrowers to comply with loan terms, and the impact that reductions in both short-term and long-term interest rates have had and may continue to have on net interest margin and mortgage sales activity. The share price and book value of ChoiceOne’s stock were also compared to the prior year. Management also compared average deal values for recent closed bank transactions to ChoiceOne transactions. Despite ChoiceOne's market capitalization declining slightly from November 30, 2020 to June 30, 2021, ChoiceOne's financial performance remained positive. This was evidenced by the strong financial indicators, solid credit quality ratios, as well as the strong capital position of ChoiceOne. In addition, second quarter and the first half of 2021 revenue reflected significant and continuing growth in ChoiceOne's interest income, as well as net SBA fees related to PPP loans. In assessing the totality of the events and circumstances, management determined that it was more likely than not that the fair value of the ChoiceOne’s operations, from a qualitative perspective, exceeded the carrying value as of June 30, 2021.
Deposits and Borrowings
Total borrowings declined $6.7 million in the first half of 2021 as ChoiceOne made payments on its holding company term loan. ChoiceOne also holds $3.1 million in subordinated debentures obtained in the merger with Community Shores issued in connection with a $4.5 million subordinated debentures offering, offset by the merger mark-to-market adjustment. ChoiceOne may use Federal Home Loan Bank advances and advances from the Federal Reserve Bank Discount Window to meet short-term funding needs if needed in the remainder of 2021.
Regulatory Capital Requirements
Following is information regarding compliance of ChoiceOne and the Bank with regulatory capital requirements:
Minimum Required
to be Well
Capitalized Under
for Capital
Prompt Corrective
Actual
Adequacy Purposes
Action Regulations
Ratio
ChoiceOne Financial Services Inc.
Total capital (to risk weighted assets)
Common equity Tier 1 capital (to risk weighted assets) weighted assets)
Tier 1 capital (to risk weighted assets)
Tier 1 capital (to average assets)
ChoiceOne Bank
Management reviews the capital levels of ChoiceOne and ChoiceOne Bank on a regular basis. The Board of Directors and management believe that the capital levels as of June 30, 2021 are adequate for the foreseeable future. The Board of Directors’ determination of appropriate cash dividends for future periods will be based on, among other things, market conditions and ChoiceOne’s requirements for cash and capital.
Liquidity
Net cash provided by operating activities was $17.1 million for the six months ended June 30, 2021 compared to net cash used of $5.3 million in the same period a year ago. The change was primarily due to a $7.6 million positive change in other assets and a $7.0 million higher balance in net proceeds from loan sales in 2021 compared to 2020. Net cash used in investing activities was $194.6 million for the first half of 2021 compared to $131.3 million in the same period in 2020. ChoiceOne had $322.0 million of securities purchases in the first half of 2021 compared to $144.9 in the same period last year. A decline in net loan originations led to cash provided of $100.8 million in the first half of 2021 compared to cash used of $105.2 million in the same period during the prior year. Cash used in the prior year period related to loan originations was largely due to PPP loans. Net cash provided by financing activities was $193.2 million in the six months ended June 30, 2021, compared to $143.9 million in the same period in the prior year. Higher growth of $36.5 million in deposits in the first half of 2021 and $16.3 million less in net payments on borrowings contributed to the change.
ChoiceOne believes that the current level of liquidity is sufficient to meet ChoiceOne 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, advances available from the Federal Home Loan Bank, and secured lines of credit available from the Federal Reserve Bank.
NON-GAAP FINANCIAL MEASURES
This report contains references to certain financial measures excluding tax-effected merger expenses, each of which is a financial measure that is not defined in U.S. generally accepted accounting principles (“GAAP”). Management believes these non-GAAP financial measures provide additional information that is useful to investors in helping to understand the underlying financial performance of ChoiceOne.
Non-GAAP financial measures have inherent limitations. Readers should be aware of these limitations and should be cautious with respect to the use of such measures. To compensate for these limitations, we use non-GAAP measures as comparative tools, together with GAAP measures, to assist in the evaluation of our operating performance or financial condition. Also, we ensure that these measures are calculated using the appropriate GAAP or regulatory components in their entirety and that they are computed in a manner intended to facilitate consistent period-to-period comparisons. ChoiceOne’s method of calculating these non-GAAP financial measures may differ from methods used by other companies. These non-GAAP financial measures should not be considered in isolation or as a substitute for those financial measures prepared in accordance with GAAP or in-effect regulatory requirements.
A reconciliation of these non-GAAP financial measures follows:
Non-GAAP Reconciliation
The non-GAAP measures presented in the table below reflect the adjustments of the reported U.S. GAAP results for significant items that management does not believe are reflective of ChoiceOne’s current and ongoing operations.
(In Thousands, Except Per Share Data)
Adjustment for pre-tax merger expenses
Adjusted income before income tax
Tax impact of adjustment for pre-tax merger expenses
Adjusted income tax expense
Adjustment for pre-tax merger expenses, net of tax impact
Adjusted net income
Basic earnings per share
Effect of merger expenses, net of tax impact
Adjusted basic earnings per share
Diluted earnings per share
Adjusted diluted earnings per share
Item 4. Controls and Procedures.
An evaluation was performed under the supervision and with the participation of ChoiceOne’s management, including the Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of ChoiceOne’s disclosure controls and procedures as of June 30, 2021. Based on and as of the time of that evaluation, ChoiceOne’s management, including the Chief Executive Officer and Principal Financial Officer, concluded that ChoiceOne’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 ChoiceOne’s internal control over financial reporting that occurred during the three months ended June 30, 2021 that has materially affected, or that is reasonably likely to materially affect, ChoiceOne’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
There are no material pending legal proceedings to which ChoiceOne or ChoiceOne Bank is a party or to which any of their properties are subject, except for proceedings that arose in the ordinary course of business. In the belief of management, pending or current legal proceedings should not have a material effect on the consolidated financial condition of ChoiceOne.
Item 1A. Risk Factors.
Information concerning risk factors is contained in the discussion in Item 1A, “Risk Factors,” in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2020.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
There were no unregistered sales of equity securities in the second quarter of 2021.
ISSUER PURCHASES OF EQUITY SECURITIES
The following table provides information regarding ChoiceOne's purchases of its common stock during the quarter ended June 30, 2021.
Total Number
Maximum
of Shares
Purchased as
Shares that
Part of a
May Yet be
Price Paid
Publicly
Purchased
Period
per Share
Announced Plan
Under the Plan (1)
April 1 - April 30, 2021
Employee Transactions
Repurchase Plan
May 1 - May 31, 2021
June 1 - June 30, 2021
(1) As of June 30, 2021, there are 274,413 shares remaining that may yet be purchased under approved plans. The repurchase plan was adopted and announced in April 2021. There was no stated expiration date. The plan authorized the repurchase of up to 390,114 shares, representing 5% of the total outstanding shares of common stock as of the date the plan was adopted.
Item 5. Other Information
None.
Item 6. Exhibits
The following exhibits are filed or incorporated by reference as part of this report:
Exhibit Number
Document
2.1
Agreement and Plan of Merger between ChoiceOne Financial Services, Inc. and County Bank Corp dated March 22, 2019. Previously filed as an exhibit to ChoiceOne’s Form 8-K filed March 25, 2019. Here incorporated by reference.
2.2
Agreement and Plan of Merger between ChoiceOne Financial Services, Inc. and Community Shores Bank Corporation dated January 6, 2020. Previously filed as an exhibit to ChoiceOne’s Form 8-K filed January 6, 2020. Here incorporated by reference.
3.1
Restated Articles of Incorporation of ChoiceOne Financial Services, Inc. Previously filed as an exhibit to ChoiceOne’s Form 8-A filed February 4, 2020. Here incorporated by reference.
3.2
Bylaws of ChoiceOne as currently in effect and any amendments thereto. Previously filed as an exhibit to ChoiceOne’s Form 8-K filed April 21, 2021. Here incorporated by reference.
4.1
Advances, Pledge and Security Agreement between ChoiceOne Bank and the Federal Home Loan Bank of Indianapolis. Previously filed as an exhibit to ChoiceOne Financial Services, Inc.’s Form 10-K Annual Report for the year ended December 31, 2013. Here incorporated by reference.
31.1
Certification of Chief Executive Officer
31.2
Certification of Treasurer
32.1
Certification pursuant to 18 U.S.C. § 1350.
101.INS
Inline XBRL Instance Document
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.
CHOICEONE FINANCIAL SERVICES, INC.
Date: August 12, 2021
/s/ Kelly J. Potes
Kelly J. Potes Chief Executive Officer (Principal Executive Officer)
/s/ Thomas L. Lampen
Thomas L. Lampen Treasurer (Principal Financial and Accounting Officer)