U.S. SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1997 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission File Number: 1-9202 CHOICEONE FINANCIAL SERVICES, INC. (Exact Name of Small Business Issuer as Specified in its Charter) MICHIGAN 38-2659066 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 109 EAST DIVISION SPARTA, MICHIGAN 49345 (Address of Principal Executive Offices) (616) 887-7366 (Issuer's Telephone Number, Including Area Code) Check whether the Registrant: (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 _____ As of October 31, 1997, the Registrant had outstanding 511,443 shares of common stock having a par value of $10 per share. Transitional Small Business Disclosure Format (check one): Yes _____ No __X__
PART I. FINANCIAL INFORMATION Item 1. FINANCIAL STATEMENTS. <TABLE> ChoiceOne Financial Services, Inc. CONSOLIDATED BALANCE SHEETS September 30, 1997 and December 31, 1996 <CAPTION> SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------ ------------ (Unaudited) <S> <C> <C> ASSETS Cash and due from banks $ 4,077,000 $ 4,952,000 Securities available for sale (Note 3) 21,688,000 23,006,000 Loans (Note 4) 124,719,000 110,079,000 Allowance for loan losses (Note 5) (1,543,000) (1,487,000) ------------ ------------ Net loans 123,176,000 108,592,000 Premises and equipment - net 3,629,000 2,987,000 Accrued interest receivable 1,057,000 859,000 Other assets 1,802,000 1,335,000 ------------ ------------ Total assets $155,429,000 $141,731,000 ============ ============ </TABLE> See accompanying notes to the consolidated financial statements. -2-
<TABLE> ChoiceOne Financial Services, Inc. CONSOLIDATED BALANCE SHEETS - Continued September 30, 1997 and December 31, 1996 <CAPTION> SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------ ------------ (Unaudited) <S> <C> <C> LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Deposits Demand $ 12,205,000 $ 13,188,000 Interest-bearing transaction accounts 21,651,000 22,732,000 Savings 8,766,000 9,158,000 Time (Note 6) 63,024,000 50,528,000 ------------ ------------ Total deposits 105,646,000 95,606,000 Federal funds purchased and securities sold under agreements to repurchase 7,036,000 4,731,000 Accrued interest payable 527,000 435,000 Federal Home Loan Bank advances 24,747,000 25,200,000 Secured loan borrowings 1,166,000 0 Other liabilities 1,045,000 1,222,000 ------------ ------------ Total liabilities 140,167,000 127,194,000 COMMITMENTS AND CONTINGENCIES (NOTE 7) SHAREHOLDERS' EQUITY Common stock, $10 par value; shares authorized: 1,000,000; shares outstanding: 511,443 at September 30, 1997 and 482,710 at December 31, 1996 5,114,000 4,827,000 Surplus 6,182,000 5,292,000 Retained earnings 3,809,000 4,305,000 Net unrealized appreciation on securities available for sale, net of deferred tax effect 157,000 113,000 ------------ ------------ Total shareholders' equity 15,262,000 14,537,000 ------------ ------------ -3-
Total liabilities and shareholders' equity $155,429,000 $141,731,000 ============ ============ </TABLE> See accompanying notes to the consolidated financial statements. -4-
<TABLE> ChoiceOne Financial Services, Inc. CONSOLIDATED STATEMENTS OF INCOME (Unaudited) <CAPTION> THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------- ---------------------------- 1997 1996 1997 1996 ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> INTEREST INCOME Loans, including fees $2,922,000 $2,381,000 $8,191,000 $6,523,000 Securities Taxable 209,000 231,000 636,000 696,000 Nontaxable 118,000 105,000 370,000 317,000 Other 6,000 0 7,000 2,000 ---------- ---------- ---------- ---------- Total interest income 3,255,000 2,717,000 9,204,000 7,538,000 INTEREST EXPENSE Deposits 1,152,000 1,002,000 3,123,000 2,936,000 Federal Home Loan Bank advances 406,000 179,000 1,204,000 267,000 Other 77,000 44,000 255,000 98,000 ---------- ---------- ---------- ---------- Total interest expense 1,635,000 1,225,000 4,582,000 3,301,000 ---------- ---------- ---------- ---------- NET INTEREST INCOME 1,620,000 1,492,000 4,622,000 4,237,000 PROVISION FOR LOAN LOSSES 90,000 75,000 404,000 240,000 ---------- ---------- ---------- ---------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 1,530,000 1,417,000 4,218,000 3,997,000 NONINTEREST INCOME Service charges on deposit accounts 82,000 78,000 231,000 235,000 Other service charges and fees 33,000 25,000 92,000 84,000 Mortgage loan sales and servicing 42,000 21,000 97,000 63,000 Insurance commissions 242,000 191,000 673,000 573,000 Other income 60,000 39,000 129,000 112,000 ---------- ---------- ---------- ---------- -5-
Total noninterest income 459,000 354,000 1,222,000 1,067,000 NONINTEREST EXPENSE Salaries and wages 556,000 541,000 1,640,000 1,556,000 Pension and other employee benefits 201,000 106,000 223,000 310,000 Occupancy expense 102,000 66,000 270,000 193,000 Furniture and equipment expense 139,000 109,000 357,000 289,000 Other expenses (Note 8) 416,000 372,000 1,199,000 1,012,000 ---------- ---------- ---------- ---------- Total noninterest expense 1,414,000 1,194,000 3,689,000 3,360,000 ---------- ---------- ---------- ---------- INCOME BEFORE INCOME TAX 575,000 577,000 1,751,000 1,704,000 INCOME TAX EXPENSE (NOTE 9) 131,000 153,000 482,000 464,000 ---------- ---------- ---------- ---------- NET INCOME $ 444,000 $ 424,000 $1,269,000 $1,240,000 ========== ========== ========== ========== EARNINGS PER SHARE (NOTE 1) $ .87 $ .83 $ 2.48 $ 2.41 ========== ========== ========== ========== </TABLE> See accompanying notes to the consolidated financial statements. -6-
<TABLE> ChoiceOne Financial Services, Inc. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, ---------------------------- 1997 1996 ----------- ----------- <S> <C> <C> Cash flows from operating activities Net income $ 1,269,000 $ 1,240,000 Adjustments to reconcile net income to net cash from operating activities Net amortization on securities 56,000 63,000 Net gain on sales of loans (22,000) (11,000) Loans originated for sale (2,634,000) (881,000) Proceeds from loan sales 2,632,000 1,442,000 Provision for loan losses 404,000 240,000 Depreciation 290,000 218,000 Deferred income tax expense/(benefit) 41,000 (59,000) Changes in: Interest receivable and other assets (728,000) (491,000) Interest payable and other liabilities (85,000) 175,000 ----------- ----------- Net cash provided by operating activities 1,223,000 1,936,000 Cash flows from investing activities Securities available for sale: Proceeds from maturities of securities 1,897,000 1,999,000 Purchase of securities (569,000) (1,506,000) Net customer loan activity (16,454,000) (25,733,000) Loans sold 1,490,000 935,000 Loans purchased 0 (231,000) Net expenditures for premises and equipment (932,000) (541,000) ----------- ----------- Net cash used in investing activities (14,568,000) (25,077,000) -7-
Cash flows from financing activities Net increase in deposits 10,040,000 4,181,000 Increase in federal funds purchased and securities sold under agreements to repurchase 2,305,000 5,148,000 Increase/(decrease) in Federal Home Loan Bank advances (453,000) 14,000,000 Increase in secured loan borrowings 1,166,000 0 Repurchase of common stock (9,000) (115,000) Cash dividends paid (579,000) (495,000) ----------- ----------- Net cash provided by financing activities 12,470,000 22,719,000 ----------- ----------- Net change in cash and cash equivalents (875,000) (422,000) Cash and cash equivalents at beginning of period 4,952,000 4,806,000 ----------- ----------- Cash and cash equivalents at end of period $ 4,077,000 $ 4,384,000 =========== =========== Supplemental disclosure of cash flow information Cash paid during the period for: Interest $ 4,489,000 $ 3,221,000 Income taxes $ 460,000 $ 569,000 </TABLE> See accompanying notes to the consolidated financial statements. -8-
ChoiceOne Financial Services, Inc. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The consolidated financial statements include the accounts of ChoiceOne Financial Services, Inc., (the "Registrant") and its direct and indirect wholly owned subsidiaries, ChoiceOne Bank (the "Bank"), ChoiceOne Insurance Agencies, Inc. and Alpine Travel, Inc., after elimination of significant intercompany transactions and accounts. The Registrant's name was changed from 1st Community Bancorp, Inc. to ChoiceOne Financial Services, Inc. on May 30, 1997. The 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-QSB and Item 310 of Regulation S-B. 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 September 30, 1997, and December 31, 1996, the Consolidated Statements of Income for the three- and nine-month periods ended September 30, 1997, and September 30, 1996, and the Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 1997, and September 30, 1996. Operating results for the nine months ended September 30, 1997, are not necessarily indicative of the results that may be expected for the year ending December 31, 1997. 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-KSB for the year ended December 31, 1996. STOCK TRANSACTIONS, EARNINGS AND CASH DIVIDENDS PER SHARE Effective January 1, 1996, the Registrant issued 20,610 shares of ChoiceOne Financial Services, Inc. common stock to effect a business combination with Bradford Insurance Centre, Ltd. (the name was then changed to ChoiceOne Insurance Agencies, Inc. in May 1996). The Registrant repurchased 2,703 shares of its stock in August 1996. The purchase of the stock coincided with the Registrant's plans to adopt an employee stock ownership plan. A 6% stock dividend was declared by the Registrant on April 16, 1997. The -9-
stock dividend was paid on May 16, 1997, to shareholders of record on April 29, 1997. Earnings per share are based on the weighted average number of shares outstanding during the year. The weighted average number of shares has been adjusted for the 6% stock dividend declared in April 1997, the repurchase of stock in August 1996 and the issuance of stock in January 1996. The weighted average number of shares outstanding was 511,443 for the third quarter of 1997, 511,519 for the first nine months of 1997, 513,479 for the third quarter of 1996, and 514,182 for the first nine months of 1996. Cash dividends per share are based on the number of shares outstanding at the time the dividend was paid and have also been adjusted for the 6% stock dividend declared in April 1997. The number of shares outstanding was 511,673 for the cash dividend paid in the first quarter of 1997, 511,443 for the cash dividends paid in the second and third quarters of 1997, 514,538 for the cash dividend paid in the first and second quarters of 1996, and 511,672 for the cash dividend paid in the third quarter of 1996. NOTE 2 - ACQUISITION OF TRAVEL AGENCY Effective July 31, 1997, the Bank entered into an agreement to purchase Alpine Travel, Inc. (the "Travel Agency"), a travel agency located in Grand Rapids, Michigan. The Travel Agency became a wholly-owned subsidiary of the Bank as a result of the Bank's purchase of all of the outstanding common stock of the Travel Agency. The former owner of the Travel Agency was paid cash in consideration for his stock. The acquisition was accounted for under the purchase method of accounting. The transaction was closed into escrow, which had not been released as of November 12, 1997. NOTE 3 - SECURITIES Securities have been classified in the Consolidated Balance Sheets according to management's intent. The amortized cost and approximate fair value of securities at September 30, 1997, and December 31, 1996, were as follows: -10-
<TABLE> <CAPTION> GROSS GROSS APPROXIMATE AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ----------- ---------- ---------- ----------- <S> <C> <C> <C> <C> SECURITIES AVAILABLE FOR SALE SEPTEMBER 30, 1997 U.S. Treasury and U.S. Government agencies $ 4,836,000 $ 24,000 $ (5,000) $ 4,855,000 Obligations of states and political subdivisions 9,220,000 212,000 (8,000) 9,424,000 U.S. Government agencies backed by mortgages 4,491,000 36,000 (24,000) 4,503,000 Other 2,905,000 1,000 0 2,906,000 ----------- -------- -------- ----------- Total $21,452,000 $273,000 $(37,000) $21,688,000 =========== ======== ======== =========== DECEMBER 31, 1996 U.S. Treasury and U.S. Government agencies $ 4,831,000 $ 36,000 $(14,000) $ 4,853,000 Obligations of states and political subdivisions 10,276,000 191,000 (39,000) 10,428,000 U.S. Government agencies backed by mortgages 4,869,000 32,000 (35,000) 4,866,000 Other 2,859,000 0 0 2,859,000 ----------- -------- -------- ----------- Total $22,835,000 $259,000 $(88,000) $23,006,000 =========== ======== ======== =========== </TABLE> There were no sales of securities for the nine months ended September 30, 1997 and 1996. For the nine months ended September 30, 1997, the net unrealized holding gain on securities available for sale increased by $65,000 resulting in a net unrealized gain of $236,000 on securities available for sale as of September 30, 1997, before any deferred tax effect. The book values of securities pledged as collateral at September 30, 1997, and December 31, 1996, were as follows: -11-
<TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------ <S> <C> <C> Securities sold under agreements to repurchase $2,003,000 $2,007,000 Public deposits 502,000 251,000 Federal Home Loan Bank advances 0 5,306,000 ---------- ---------- Total $2,505,000 $7,564,000 ========== ========== </TABLE> NOTE 4 - LOANS Loans at September 30, 1997, and December 31, 1996, were classified as follows: <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------ ------------ <S> <C> <C> Commercial $ 41,826,000 $ 34,583,000 Agricultural 9,957,000 10,113,000 Real estate mortgage - construction 2,916,000 2,215,000 Real estate mortgage - residential 41,587,000 37,168,000 Consumer 28,433,000 26,000,000 ------------ ------------ Total $124,719,000 $110,079,000 ============ ============ </TABLE> Loans held for sale included $50,000 of residential real estate mortgage loans at September 30, 1997. Loans held for sale were accounted for at the lower of aggregate cost or market value. Certain residential real estate mortgage loans were pledged as collateral for Federal Home Loan Bank advances. The balance pledged as of September 30, 1997, was $37,294,000. Information regarding impaired loans as of September 30, 1997, and December 31, 1996 follows: -12-
<TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------ <S> <C> <C> Loans classified as impaired $398,000 $599,000 Less impaired loans for which no allowance for credit losses had been established 239,000 450,000 -------- -------- Impaired loans for which an allowance for credit losses had been determined $159,000 $149,000 ======== ======== Allowance determined for above impaired loans $ 56,000 $ 6,000 ======== ======== </TABLE> Information regarding impaired loans for the nine months ended September 30, 1997 and 1996 follows: <TABLE> <CAPTION> 1997 1996 -------- -------- <S> <C> <C> Average balance of impaired loans $760,000 $328,000 Interest income recognized on impaired loans 21,000 23,000 Interest income recognized on a cash-basis on impaired loans 17,000 17,000 </TABLE> NOTE 5 - ALLOWANCE FOR LOAN LOSSES An analysis of changes in the allowance for loan losses for the nine months ended September 30, 1997 and 1996 follows: <TABLE> <CAPTION> 1997 1996 ---------- ---------- <S> <C> <C> Balance at beginning of period $1,487,000 $1,121,000 Provision charged to operating expense 404,000 240,000 Recoveries credited to the allowance 51,000 55,000 Loans charged-off (399,000) (172,000) ---------- ---------- Balance at end of period $1,543,000 $1,244,000 ========== ========== </TABLE> -13-
NOTE 6 - TIME DEPOSITS As of September 30, 1997, time deposits included $7,135,000 obtained from a national time deposit rate service. The weighted average interest rate on these deposits was 6.33% as of September 30, 1997. Approximately $5,943,000 of the deposits had maturities of one year or less, while the remainder had a maximum maturity of two years. NOTE 7 - COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF CREDIT RISK Noninterest-bearing deposits totaling approximately $2,406,000 were held at NBD Bank, N.A. at September 30, 1997. As of September 30, 1997, the Registrant had outstanding commitments to make loans totaling $15,107,000, the majority of which have variable interest rates. The Registrant had issued approximately $2,557,000 in unused lines of credit and $38,000 in letters of credit at September 30, 1997. NOTE 8 - NONINTEREST EXPENSE Noninterest expense for the nine months ended September 30, 1997 and 1996 was as follows: <TABLE> <CAPTION> 1997 1996 ---------- ---------- <S> <C> <C> Legal and professional $ 176,000 $ 104,000 Supplies and postage 171,000 176,000 Computer processing 117,000 121,000 Advertising and marketing 74,000 47,000 State single business tax expense 71,000 84,000 Training and seminars 62,000 36,000 Other 528,000 444,000 ---------- ---------- Total $1,199,000 $1,012,000 ========== ========== </TABLE> NOTE 9 - INCOME TAX EXPENSE The components of income tax expense for the nine months ended September 30, 1997 and 1996 were as follows: -14-
<TABLE> <CAPTION> 1997 1996 -------- -------- <S> <C> <C> Current income tax expense $441,000 $523,000 Deferred income tax expense/(benefit) 41,000 (59,000) -------- -------- Income tax expense $482,000 $464,000 ======== ======== </TABLE> The difference between the financial statement tax provision and amounts computed by applying the federal income tax rate to pre-tax income is principally attributable to tax-exempt interest income. The components of deferred tax assets and liabilities at September 30, 1997, and December 31, 1996, were as follows: <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------ <S> <C> <C> Deferred tax assets: Allowance for loan losses $420,000 $401,000 Deferred compensation 59,000 62,000 Postretirement benefits obligation 50,000 50,000 Deferred loan fees 44,000 53,000 Other 68,000 68,000 -------- -------- Total deferred tax assets 641,000 634,000 Deferred tax liabilities: Depreciation 172,000 188,000 Pension fund asset 148,000 96,000 Unrealized appreciation on securities available for sale 80,000 58,000 Other 24,000 12,000 -------- -------- Total deferred tax liabilities 424,000 354,000 -------- -------- Net deferred tax asset $217,000 $280,000 ======== ======== </TABLE> -15-
A valuation allowance related to a deferred tax asset is recognized when it is considered more likely than not that part or all of the deferred tax benefits will not be realized. Management has determined that no such allowance was required at September 30, 1997, or December 31, 1996. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION. The following discussion is designed to provide a review of the financial condition and results of operations of ChoiceOne Financial Services, Inc. (the "Registrant") and its direct and indirect wholly owned subsidiaries, ChoiceOne Bank (the "Bank"), ChoiceOne Insurance Agencies, Inc. (the "Insurance Agency") and Alpine Travel, Inc. (the "Travel Agency"). This discussion should be read in conjunction with the consolidated financial statements and related footnotes. ACQUISITION OF TRAVEL AGENCY As was stated in Note 2 to the consolidated financial statements, the Bank entered into an agreement to purchase Alpine Travel, Inc. on July 31, 1997. The Bank purchased all of the outstanding common stock of the Travel Agency and the Travel Agency became a wholly owned subsidiary of the Bank. The former owner of the Travel Agency will continue to work in the business and will serve as its president. The Bank's management believes that the purchase of the Travel Agency will enable the Bank to offer a new line of products to its customers and will generate additional fee income. The transaction was closed into escrow, which had not been released as of November 12, 1997. NET INCOME AND RETURN ON AVERAGE ASSETS AND SHAREHOLDERS' EQUITY The Registrant's net income increased $20,000 or 5% in the third quarter of 1997 compared to the same period of 1996 and has risen $29,000 or 2% in the first nine months of 1997 compared to the same period of the prior year. The increase in net income in the third quarter and first nine months of 1997 was due to higher net interest income and noninterest income, the effect of which was offset by growth in the provision for loan losses and noninterest expense. The increase in net interest income in 1997 was caused by growth in average interest-earning assets. Part of the effect of such growth was offset by a reduction in the spread between interest rates earned on interest-earning assets and interest rates paid on interest-bearing liabilities. The change in noninterest income was primarily caused by a higher level of insurance commission income in the first nine months of 1997 than in the same period of the prior year. The increase in the provision for loan losses was due to higher loan balances in 1997 than in the prior year and to a higher level of loan chargeoffs in 1997 than in 1996. The change in noninterest -16-
expense resulted from expenses related to the Registrant's two new branches which opened in the middle of 1996 and from increases in various other expenses. The increase in pension and other employee benefits in the third quarter of 1997 was due to the recognition of $109,000 of expense related to a partial payout of the Bank's defined benefit plan. The Registrant's management anticipates that the Bank's defined benefit plan (the "Plan") will be settled in the fourth quarter of 1997 and that the assets of the Plan due to participants will be distributed. Management anticipates that Plan assets in excess of amounts due to participants will be contributed to the Bank's 401(k) plan in early 1998. It is anticipated that the termination of the Plan will cause $286,000 of after-tax expense to be recorded in the fourth quarter of 1997. When amounts recorded in previous quarters in 1997 are netted against the fourth quarter expense, the estimated total effect on 1997's net income of the curtailment, settlement and termination of the Plan will be a negative $187,000. Management believes termination of the Plan will have a long-term benefit for the Registrant because retirement benefits will be offered more cost- effectively through the Bank's 401(k) plan. The return on average assets was 1.17% for the first nine months of 1997, compared to 1.38% for the same period in 1996. The return on average shareholders' equity was 11.45% for the first three quarters of 1997, compared to 11.78% for the comparable period of the prior year. CASH AND STOCK DIVIDENDS Cash dividends declared in the third quarter of 1997 were $205,000 or $.40 per common share, which represents a $.07 per share or 21% increase compared to the dividend paid in the same period of the prior year. The cash dividends paid in the first nine months of 1997 were $579,000 or $1.13 per share, which was $.17 per share or 18% more than the dividends paid in the same period in 1996. The cash dividend payout percentage in the first nine months of 1997 was 45.55%, compared to 39.85% in the same period of 1996. The Registrant declared a 6% stock dividend on April 16, 1997. The dividend was payable on May 16, 1997 to shareholders of record on April 29, 1997. The cash dividend per share amounts for both 1997 and 1996 have been adjusted for the effect of the stock dividend. INTEREST INCOME AND EXPENSE Tables 1 and 2 on the following pages provide information regarding interest income and expense for the nine-month periods ended September 30, 1997 and September 30, 1996. Table 1 documents 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 below. -17-
<TABLE> Table 1 - Average Balances and Tax Equivalent Interest Rates <CAPTION> FOR THE NINE MONTHS ENDED SEPTEMBER 30, ------------------------------------------------------------------------------------ 1997 1996 -------------------------------------- -------------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE BALANCE INTEREST RATE BALANCE INTEREST RATE -------- -------- ------- ------- -------- ------- (Dollars in Thousands) <S> <C> <C> <C> <C> <C> <C> Assets Loans <F1> $115,944 $8,213 9.44% $ 89,948 $6,552 9.71% Taxable securities <F2> 12,859 636 6.59 14,421 696 6.45 Nontaxable securities <F1><F2> 9,496 560 7.86 8,187 480 7.97 Other 218 7 4.28 63 2 6.35 -------- ------ -------- ------ Interest-earning assets 138,517 9,416 9.06 112,619 7,730 9.15 ------ ------ Noninterest-earning assets 6,891 6,382 -------- -------- Total assets $145,408 $119,001 ======== ======== Liabilities and shareholders' equity Interest-bearing transaction accounts $ 22,065 527 3.18 $ 25,200 612 3.24 Savings deposits 8,973 123 1.83 9,376 131 1.86 Time deposits 56,665 2,473 5.82 49,813 2,193 5.87 Federal Home Loan Bank advances 25,260 1,204 6.36 5,796 267 6.14 Other 6,212 255 5.47 2,403 98 5.44 -------- ------ -------- ------ Interest-bearing liabilities 119,175 4,582 5.13 92,588 3,301 4.75 ------ ---- ------ ---- Noninterest-bearing liabilities 11,374 12,394 Shareholders' equity 14,859 14,019 -------- -------- Total liabilities and shareholders' equity $145,408 $119,001 ======== ======== Net interest income (tax-equivalent basis) - interest spread 4,834 3.93% 4,429 4.40% ==== ==== -18-
Tax equivalent adjustment <F1> (212) (192) ------ ------ Net interest income $4,622 $4,237 ====== ====== Net interest income as a percentage of earning assets (tax-equivalent basis) 4.65% 5.24% ==== ==== <FN> <F1> Interest on nontaxable securities and loans has been adjusted to a fully tax-equivalent basis to facilitate comparison to the taxable interest-earning assets. The adjustment uses an incremental tax rate of 34% for the years presented. <F2> The average balance includes the effect of unrealized appreciation/depreciation on securities, while the average rate was computed on the average amortized cost of the securities. </FN> </TABLE> -19-
<TABLE> Table 2 - Changes in Tax Equivalent Net Interest Income <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, ------------------------------- 1997 OVER 1996 -------------- TOTAL VOLUME RATE ----- ------ ---- (Dollars in Thousands) <S> <C> <C> <C> Increase (decrease) in interest income <F1> Loans <F2> $1,661 $1,845 $(184) Taxable securities (60) (76) 16 Nontaxable securities <F2> 80 86 (6) Other 5 6 (1) ------ ------ ----- Net change in tax-equivalent income 1,686 1,861 (175) Increase (decrease) in interest expense <F1> Interest-bearing transaction accounts (85) (75) (10) Savings deposits (8) (6) (2) Time deposits 280 299 (19) Federal Home Loan Bank advances 937 927 10 Other 157 156 1 ------ ------ ----- Net change in interest expense 1,281 1,301 (20) ------ ------ ----- Net change in tax-equivalent net interest income $ 405 $ 560 $(155) ====== ====== ===== <FN> <F1> 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. <F2> Interest on nontaxable investment securities and loans has been adjusted to a fully tax-equivalent basis using an incremental tax rate of 34% for the periods presented. </FN> </TABLE> -20-
NET INTEREST INCOME As shown in Tables 1 and 2, tax equivalent net interest income increased $405,000 in the first nine months of 1997 compared to the same period of 1996. The increase resulted from growth in the Registrant's loan portfolio from 1996 to 1997. Average loans increased $25,996,000 from the first three quarters of 1996 to the same period in 1997. This growth caused interest income from loans to be $1,661,000 higher in the first three quarters of 1997. The other interest-earning asset categories experienced small differences between 1997 and 1996. The mix of interest-bearing liabilities has changed significantly from 1996 to 1997. The average balance of time deposits increased $6,852,000 in the first nine months of 1997 compared to the same period in the prior year. Approximately one-half of the time deposits increase was due to the Bank's entry onto a national time deposit rate service in March 1997. The average balance of Federal Home Loan Bank (the "FHLB") advances for the nine months ended September 30, 1997 reflects an increase of $19,464,000 over the balance for the same period of 1996. This increase, however, was primarily due to advances obtained during the last three quarters of 1996. No additional advances were obtained from the FHLB in the first three quarters of 1997. The average balance of other interest-bearing liabilities increased by $3,809,000 in the first nine months of 1997 compared to the same period in 1996. The increases in national market time deposits, FHLB advances and other interest-bearing liabilities reflect the extent to which these sources were used to fund loan growth in 1996. Core deposit growth, available funds from securities maturities, and retained earnings were not sufficient to meet the loan demand experienced in 1996 and 1997. Table 1 shows that the net interest income spread was 3.93% for the first nine months of 1997, compared to 4.40% for the same period of the prior year. The reduction in net interest income spread was caused by a 9-basis- point decrease in the average rate earned on interest-earning assets, while the average rate paid on interest-bearing liabilities went up 38 basis points. The decrease in the average rate earned on interest-earning assets was caused by a decline in the average rate earned on loans. The decline in the rate earned on loans resulted from loan growth at lower interest rates than had previously existed in the portfolio. These lower rates were caused by the competitive interest rate environment in the Registrant's market areas. The increase in the average rate paid on interest-bearing liabilities was attributable to the growth in non-core deposits, advances from the FHLB and other interest-bearing liabilities. The interest rates paid on these liabilities were higher than those paid on core deposits. PROVISION AND ALLOWANCE FOR LOAN LOSSES The allowance for loan losses increased $56,000 from December 31, 1996, to September 30, 1997. The allowance was 1.24% of total loans at September 30, -21-
1997, compared to 1.35% at December 31, 1996. The allowance for loan losses as a percentage of nonperforming loans was 120% as of September 30, 1997, compared to 149% as of the end of 1996. The provision for loan losses was $164,000 higher in the first nine months of 1997 than in the same period of 1996. The increase in the provision was due to the funding of the allowance for loan growth in 1997 and 1996 and to higher net chargeoffs experienced in 1997 than in the prior year. Chargeoffs and recoveries for those loan categories with activity in the periods ended September 30, 1997 and 1996 were as follows: <TABLE> <CAPTION> 1997 1996 ---- ---- CHARGEOFFS RECOVERIES CHARGEOFFS RECOVERIES ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Commercial $180,000 $13,000 $ 35,000 $10,000 Agricultural 7,000 0 0 10,000 Real estate mortgage - residential 5,000 0 0 0 Consumer 207,000 38,000 137,000 35,000 -------- ------- -------- ------- $399,000 $51,000 $172,000 $55,000 ======== ======= ======== ======= </TABLE> The amount of chargeoffs which the Bank will experience in the remainder of 1997 will be dependent on the extent to which business and consumer borrowers are affected by the local economy and on many other economic factors. As chargeoffs, changes in the level of nonperforming loans and loan growth occur in the remainder of 1997, the provision and allowance for loan losses will be reviewed by the Bank's management and adjusted as believed necessary. NONINTEREST EXPENSE Total noninterest expense increased $220,000 in the third quarter of 1997 compared to the same quarter in 1996. Approximately $109,000 of the increase resulted from expense related to a partial payout of the Bank's defined benefit plan. As discussed above, the Registrant's management anticipates that the Bank's defined benefit plan (the "Plan") will be settled in the fourth quarter of 1997 and the assets of the Plan due to participants will be distributed. Management anticipates Plan assets in excess of amounts due to participants will be contributed to the Bank's 401(k) plan in early 1998. It is anticipated that the termination of the -22-
Plan will cause $286,000 of after-tax expense to be recorded in the fourth quarter of 1997. Total noninterest expense increased $329,000 in the first nine months of 1997 compared to the same period of 1996. Additional expenses related to the Registrant's two new branches totaled $202,000 in the first nine months of 1997. The remaining difference was due to general expense growth which was offset by the net effect of entries recorded in 1997 related to curtailment and settlement of the Bank's defined benefit plan. SECURITIES The balance of total securities has decreased $1,318,000 from December 31, 1996, to September 30, 1997. The decrease resulted from $1,897,000 of maturities in the first nine months of 1997, which were partially offset by $569,000 of purchases. The low level of securities purchases was caused by continued loan growth in 1997 which has used funds obtained from deposit growth. Securities will continue to be used as collateral for public funds and securities sold under agreements to repurchase. Securities which had been pledged as collateral for Federal Home Loan Bank advances at the end of 1996 were released in January 1997 when the Registrant starting using specific residential real estate mortgage loans for collateral purposes. The Registrant's securities portfolio may also serve as a source of liquidity for deposit needs and as collateral for additional advances from the Federal Home Loan Bank. LOANS Total loans grew $5,932,000 in the third quarter of 1997 and have increased $14,640,000 since December 31, 1996. Commercial and residential real estate mortgage loans comprised most of the growth in the third quarter of 1997 as they increased $3,315,000 and $1,806,000, respectively. Growth in these two loan areas resulted in part from a continued strong economy in the Bank's market areas and business development activities. The mortgage loan area was also affected by two new loan originators in the third quarter of 1997. Minimal growth was experienced in the other three loan categories in the third quarter of 1997. The Bank's management believes that interest rate competition has hampered loan demand in these areas. Loan growth in the remainder of 1997 will continue to be affected by interest rates and by competition within the Bank's market areas. The Bank's loan officers plan to continue using calling programs in all loan areas to attempt to continue and stimulate demand. New marketing strategies are planned to enhance the Bank's effectiveness in remaining competitive in residential real estate mortgage lending. In the consumer loan category, management intends to continue its use of direct mail advertising and telemarketing to stimulate demand for direct loans while management will continue to emphasize development of its indirect loan portfolio. -23-
Information regarding impaired loans can be found in Note 4 to the consolidated financial statements. In addition to its review of the loan portfolio for impaired loans, management also monitors the various loan categories for 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. The balances of the three nonperforming categories as of September 30, 1997, and December 31, 1996, were as follows: <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 1997 1996 ------------- ------------ <S> <C> <C> Loans accounted for on a nonaccrual basis $787,000 $ 288,000 Loans, not included in nonaccrual loans, which are contractually past due 90 days or more as to interest or principal payments 179,000 686,000 Loans, not included in nonaccrual or loans past due 90 days or more, which are considered troubled debt restructurings 4,000 26,000 -------- ---------- Total $970,000 $1,000,000 ======== ========== </TABLE> In addition to the above loans, there were $316,000 of nonperforming assets in other real estate as of September 30, 1997. There was no nonperforming other real estate as of December 31, 1996. DEPOSITS AND OTHER FUNDING SOURCES Total deposits increased $1,882,000 in the third quarter of 1997 and have grown $10,040,000 since December 31, 1996. The level of growth in the third quarter of 1997 was much less than the $10,548,000 increase experienced in the previous quarter. The growth in the second quarter was primarily due to $7,732,000 of time deposits which resulted from the Bank's entry onto a national time deposit rate service in March 1997. In contrast, the Bank's level of the national time deposits decreased almost $600,000 in the third quarter of 1997. This change reflected management's desire to more strongly emphasize core deposit growth in the third quarter of 1997. -24-
Demand deposits and time deposits were the two deposit categories that experienced growth in the third quarter of 1997. The Bank's management has stressed the development of deposit relationships which bear no interest or a low interest rate. The Bank's branches have also offered competitive interest rates on their time deposit products. The level of core deposits obtained from the Bank's market areas grew almost $2,500,000 in the third quarter of 1997 after increasing less than $500,000 in the first half of 1997. The Bank's deposit officers will attempt to continue this positive trend in the rest of 1997 and into 1998. The Bank plans to continue to pay competitive interest rates on its interest-bearing accounts. The Bank's deposit officers are planning to review both the pricing and the features of the deposit products in an attempt to develop products which will generate core deposit growth. The Bank's level of federal funds purchased and securities sold under agreements to repurchase increased $5,186,000 in the third quarter of 1997. The increase related to federal funds purchased was $4,750,000. The increase resulted from loan growth which was not fully funded by deposit growth and a higher balance in the Bank's correspondent bank accounts as of September 30, 1997. SHAREHOLDERS' EQUITY Total shareholders' equity increased $312,000 in the third quarter of 1997 and has grown $725,000 since December 31, 1996. Equity growth in 1997 resulted from retained earnings and a small increase in net unrealized appreciation on securities available for sale. Total shareholders' equity as a percentage of assets was 9.82% as of September 30, 1997, compared to 10.26% as of December 31, 1996. The Registrant's management intends to further decrease the equity to assets ratio to more effectively use shareholders' equity by leveraging it through asset growth. Based on risk-based capital guidelines established by the Bank's regulators, the Registrant's risk-based capital was categorized as well capitalized at September 30, 1997. CAPITAL RESOURCES The Registrant issued 20,610 shares of its common stock effective January 1, 1996, to facilitate the business combination with Bradford Insurance Centre, Ltd. (now ChoiceOne Insurance Agencies, Inc.). The Bank completed the construction of its new branch office in Cedar Springs in March 1997. The cost of land, building and equipment for that branch approximated $750,000. Management believes that the current level of capital is adequate to take advantage of potential opportunities that may arise for the Registrant or the Bank. -25-
LIQUIDITY AND RATE SENSITIVITY Cash and cash equivalents increased $497,000 in the third quarter of 1997 and have decreased $875,000 since December 31, 1996. The Registrant's 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 deposit growth from both the local and national markets, maturities of securities, normal loan repayments, income retention, federal funds which can be purchased from correspondent banks and advances available from the Federal Home Loan Bank of Indianapolis. Table 3 presents the maturity and repricing schedule for the Registrant's rate-sensitive assets and liabilities for selected time periods. The Registrant's cumulative rate-sensitive liabilities exceeded its cumulative rate-sensitive assets by $23,744,000 at the one-year repricing point as of September 30, 1997. The negative amount at the end of the third quarter was due primarily to the classification of all interest-bearing transaction accounts and savings deposits in the 0-to-3-month repricing category. The rates paid on these deposit types can be immediately repriced. However, the Bank's management believes that these types of accounts are not as sensitive to changes in interest rates in the short term as this presentation would indicate and that the positive funding gap in the 1 to 5 year period is more reflective of the Registrant's experience. Management will determine the rates necessary based on competitive rates and the need for deposited funds. The Registrant's management is aware of the inherent interest rate risk associated with gap management. As interest rate fluctuations occur, the relationship between rate-sensitive assets and liabilities will be monitored by management and changes in assets and liabilities will be made when deemed necessary. It is the goal of the Registrant's Asset/Liability Management Committee to maintain a desired interest rate spread through its pricing of both loans and deposits. -26-
<TABLE> Table 3 - Maturities and Repricing Schedule <CAPTION> AS OF SEPTEMBER 30, 1997 -------------------------------------------------------------- 0 - 3 3 - 12 1 - 5 OVER MONTHS MONTHS YEARS 5 YEARS TOTAL ------ ------ ----- ------- ----- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Assets Loans $39,152 $ 20,872 $39,429 $25,266 $124,719 Interest-bearing deposits with banks 10 0 0 0 10 Taxable securities 2,957 2,843 6,569 277 12,646 Nontaxable securities 245 535 3,956 4,306 9,042 ------- -------- ------- ------- -------- Rate-sensitive assets 42,364 24,250 49,954 29,849 146,417 Liabilities Interest-bearing transaction accounts 21,651 0 0 0 21,651 Savings deposits 8,766 0 0 0 8,766 Time deposits 11,577 32,782 18,534 131 63,024 Federal funds purchased and securities sold under agreements to repurchase 7,036 0 0 0 7,036 Federal Home Loan Bank advance 633 7,852 15,234 1,028 24,747 Secured loan borrowings 0 62 1,104 0 1,166 ------- -------- ------- ------- -------- Rate-sensitive liabilities 49,663 40,696 34,872 1,159 126,390 ------- -------- ------- ------- -------- Rate-sensitive assets less rate-sensitive liabilities Asset (liability) gap for the period $(7,299) $(16,446) $15,082 $28,690 $ 20,027 ======= ======== ======= ======= ======== Cumulative asset (liability) gap $(7,299) $(23,745) $(8,663) $20,027 ======= ======== ======= ======= -27-
Cumulative rate- sensitive assets as a percentage of cumulative rate- sensitive liabilities 85.30% 73.72% 93.08% 115.85% ======= ======== ======= ======= </TABLE> -28-
PART II. OTHER INFORMATION Item 6. EXHIBITS AND REPORTS ON FORM 8-K. 1. Exhibits. The following exhibits are filed or incorporated by reference as part of this report: EXHIBIT NUMBER DOCUMENTS ------ --------- 3.1 Amended and Restated Articles of Incorporation of the Registrant. Previously filed as Appendix A to the Registrant's Definitive Proxy Statement with respect to its Annual Meeting of Shareholders held on April 29, 1997. Here incorporated by reference. 3.2 Bylaws of the Registrant as currently in effect and any amendments thereto. Previously filed as an exhibit to the Registrant's Form 10-KSB Annual Report for its fiscal year ended December 31, 1993. Here incorporated by reference. 27 Financial Data Schedule. 2. Reports on Form 8-K. No reports on Form 8-K were filed during the three months ended September 30, 1997. -29-
SIGNATURES In accordance with the requirements of the Exchange Act, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHOICEONE FINANCIAL SERVICES, INC. Date NOVEMBER 13, 1997 /S/ JAE M. MAXFIELD Jae M. Maxfield President and Chief Executive Officer Date NOVEMBER 13, 1997 /S/ THOMAS L. LAMPEN Thomas L. Lampen Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) -30-
INDEX TO EXHIBITS The following exhibits are filed or incorporated by reference as part of this report: EXHIBIT NUMBER DOCUMENTS ------ --------- 3.1 Amended and Restated Articles of Incorporation of the Registrant. Previously filed as Appendix A to the Registrant's Definitive Proxy Statement with respect to its Annual Meeting of Shareholders held on April 29, 1997. Here incorporated by reference. 3.2 Bylaws of the Registrant as currently in effect and any amendments thereto. Previously filed as an exhibit to the Registrant's Form 10-KSB Annual Report for its fiscal year ended December 31, 1993. Here incorporated by reference. 27 Financial Data Schedule.