UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
FORM 10-Q
Commission File Number: 000-19202
ChoiceOne Financial Services, Inc.(Exact Name of Registrant as Specified in its Charter)
Indicate by checkmark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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 ☒
As of April 30, 2017, the Registrant had outstanding 3,285,828 shares of common stock.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
ChoiceOne Financial Services, Inc.CONSOLIDATED BALANCE SHEETS (Unaudited)
See accompanying notes to interim consolidated financial statements.
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ChoiceOne Financial Services, Inc.CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
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ChoiceOne Financial Services, Inc.CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
See accompanying notes to interim consolidated financial statements
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ChoiceOne Financial Services, Inc.CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)
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ChoiceOne Financial Services, Inc.CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
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ChoiceOne Financial Services, Inc.NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include ChoiceOne Financial Services, Inc. (“ChoiceOne”) and its wholly-owned subsidiary, ChoiceOne Bank (the “Bank”), and the Bank’s wholly-owned subsidiary, ChoiceOne Insurance Agencies, Inc. Intercompany transactions and balances have been eliminated in consolidation.
The consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, prevailing practices within the banking industry and the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.
The accompanying consolidated financial statements reflect all adjustments ordinary in nature which are, in the opinion of management, necessary for a fair presentation of the Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016, the Consolidated Statements of Income for the three-month periods ended March 31, 2017 and March 31, 2016, the Consolidated Statements of Comprehensive Income for the three-month periods ended March 31, 2017 and March 31, 2016, the Consolidated Statements of Changes in Shareholders’ Equity for the three-month periods ended March 31, 2017 and March 31, 2016, and the Consolidated Statements of Cash Flows for the three-month periods ended March 31, 2017 and March 31, 2016. Operating results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.
The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2016.
Loans to Other Non-Financial Institutions
The Bank entered into an agreement with another financial institution this year to fund mortgage loans. Loans to other non-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 the Bank’s participating interest. If the advance (in which the 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. The participating interests are subject to concentration risk to 7 different mortgage bankers, with the largest creditor outstanding representing 60% of the total at March 31, 2017.
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, the Bank reviews the portfolio of participating interest for potential losses including any participating interest that is outstanding over 90 days (even if the advance and participating interest is current). At March 31, 2017, there was no participating interest with delinquent payments over 30 days and no participating interest in advances that was over 30 days. Year to date, there have been no losses or charge-offs of participating interest.
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.
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Stock Transactions
A total of 921 shares of common stock were issued to ChoiceOne’s Board of Directors for a cash price of $22,000 under the terms of the Directors’ Stock Purchase Plan in the first quarter of 2017. A total of 1,000 shares were issued upon the exercise of stock options and 1,031 shares were issued under the Employee Stock Purchase Plan in the first quarter of 2017.
Stock-Based Compensation
Effective July 1, 2013, ChoiceOne began granting 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 in three annual installments on each of the next three anniversaries of 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 Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU adopts a standardized approach for revenue recognition and was a joint effort with the International Accounting Standards Board (IASB). The new revenue recognition standard is based on a core principle of recognizing revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU does not apply to financial instruments. The ASU is effective for public entities for reporting periods beginning after December 15, 2017 (therefore, for the year ending December 31, 2018 for ChoiceOne). Early implementation is not allowed for public companies. Management is currently assessing the impact to the ChoiceOne’s consolidated financial statements but does not expect these changes to have a significant effect on the financial statements.
The FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The ASU covers various changes to the accounting, measurement, and disclosure related to certain financial instruments. The most significant change included in the update is the requirement for certain equity investments (excluding investments that are consolidated or accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. An entity may choose to measure equity investments that do not have readily determinable fair values at cost, minus impairment. When a qualitative assessment of equity investments without readily determinable fair values indicates that impairment exists, an entity is required to measure the investment at fair value. The update also eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The new standard is effective for ChoiceOne for the fiscal year beginning after December 15, 2017, including interim periods within this fiscal year. Management is currently assessing the impact to ChoiceOne’s consolidated financial statements. Other than the impact in the accounting for the change in fair value of equity securities discussed in Note 2, ChoiceOne does not expect any significant changes as a result of adopting this update.
The FASB issued ASU 2016-02, Leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. As ChoiceOne owns most of its branch locations, the impact of this ASU is not expected to be material.
The 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 current generally accepted accounting principles (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, 2019, and for interim periods within those years. Management is currently evaluating the impact of this new ASU on its consolidated financial statements.
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NOTE 2 - SECURITIES
The fair value of securities available for sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
(Dollars in thousands)
ChoiceOne reviews its securities portfolio on a quarterly basis to determine whether unrealized losses are considered to be temporary or other-than-temporary. No other-than-temporary impairment charges were recorded in the first quarter of 2017. ChoiceOne believed that unrealized losses on securities were temporary in nature and were due to changes in interest rates and reduced market liquidity and not as a result of credit quality issues.
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NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES
Activity in the allowance for loan losses and balances in the loan portfolio were as follows:
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The process to monitor the credit quality of ChoiceOne’s loan portfolio includes tracking (1) the risk ratings of business loans, (2) the level of classified business loans, and (3) delinquent and nonperforming consumer loans. Business loans are risk rated on a scale of 1 to 8. A description of the characteristics of the ratings follows:
Risk ratings 1 and 2: These loans are considered pass credits. They exhibit good to exceptional credit risk and demonstrate the ability to repay the loan from normal business operations.
Risk rating 3: These loans are considered pass credits. They exhibit acceptable credit risk and demonstrate the ability to repay the loan from normal business operations.
Risk rating 4: These loans are considered pass credits. However, they have potential developing weaknesses that, if not corrected, may cause deterioration in the ability of the borrower to repay the loan. While a loss is possible for a loan with this rating, it is not anticipated.
Risk rating 5: These loans are considered special mention credits. Loans in this risk rating are considered to be inadequately protected by the net worth and debt service coverage of the borrower or of any pledged collateral. These loans have well defined weaknesses that may jeopardize the borrower’s ability to repay the loan. If the weaknesses are not corrected, loss of principal and interest could be probable.
Risk rating 6: These loans are considered substandard credits. These loans have well defined weaknesses, the severity of which makes collection of principal and interest in full questionable. Loans in this category may be placed on nonaccrual status.
Risk rating 7: These loans are considered doubtful credits. Some loss of principal and interest has been determined to be probable. The estimate of the amount of loss could be affected by factors such as the borrower’s ability to provide additional capital or collateral. Loans in this category are on nonaccrual status.
Risk rating 8: These loans are considered loss credits. They are considered uncollectible and will be charged off against the allowance for loan losses.
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Information regarding the Bank’s credit exposure is as follows:
Corporate Credit Exposure - Credit Risk Profile By Creditworthiness Category
Corporate Credit Exposure - Credit Risk Profile Based On Payment Activity
Consumer
The following schedule provides information on loans that were considered TDRs that were modified during the three months ended March 31, 2017 and March 31, 2016:
The pre-modification and post-modification outstanding recorded investment represents amounts as of the date of loan modification. If a difference exists between the pre-modification and post-modification outstanding recorded investment, it represents impairment recognized through the provision for loan losses computed based on a loan’s post-modification present value of expected future cash flows discounted at the loan’s original effective interest rate. If no difference exists, a loss is not expected to be incurred based on an assessment of the borrower’s expected cash flows.
The following schedule provides information on TDRs as of March 31, 2017 and 2016 where the borrower was past due with respect to principal and/or interest for 30 days or more during the three-month periods ended March 31, 2017 and March 31, 2016 that had been modified during the year prior to the default:
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Impaired loans by loan category follow:
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The following schedule provides information regarding average balances of impaired loans and interest recognized on impaired loans for the three months ended March 31, 2017 and 2016:
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An aging analysis of loans by loan category follows:
(1) Includes nonaccrual loans.
Nonaccrual loans by loan category follow:
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NOTE 4 - EARNINGS PER SHARE
Earnings per share are based on the weighted average number of shares outstanding during the period. A computation of basic earnings per share and diluted earnings per share follows:
Net income available to common shareholders
There were 30,000 stock options as of March 31, 2017 and March 31, 2016 that are considered to be anti-dilutive to earnings per share for the three-month periods ended March 31, 2017 and March 31, 2016. These stock options have been excluded from the calculation above.
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NOTE 5 – FINANCIAL INSTRUMENTS
Financial instruments as of the dates indicated were as follows:
The estimated fair values approximate the carrying amounts for all assets and liabilities except those described later in this paragraph. The methodology for determining the estimated fair value for securities available for sale is described in Note 6. The estimated fair value for loans is based on the rates charged at March 31, 2017 and December 31, 2016 for new loans with similar maturities, applied until the loan is assumed to reprice or be paid. The allowance for loan losses is considered to be a reasonable estimate of discount for credit quality concerns. The estimated fair values for time deposits and Federal Home Loan Bank (“FHLB”) advances are based on the rates paid at March 31, 2017 and December 31, 2016 for new deposits or FHLB advances, applied until maturity. The estimated fair values for other financial instruments and off-balance sheet loan commitments are considered nominal.
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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 the Bank has the ability to access.
Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability.
In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Bank’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.
There were no liabilities measured at fair value as of March 31, 2017 or December 31, 2016. Disclosures concerning assets measured at fair value are as follows:
Assets Measured at Fair Value on a Recurring Basis
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Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis
Of the Level 3 assets that were held by the Bank at March 31, 2017, the net unrealized gain as of March 31, 2017 was $196,000, which is recognized in other comprehensive income in the consolidated balance sheet. There were no purchases or sales of Level 3 securities in the first quarter of 2017.
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.
Available for sale investment securities categorized as Level 3 assets primarily consist of bonds issued by local municipalities and equity securities of community banks. The Bank estimates the fair value of these bonds based on the present value of expected future cash flows using management’s best estimate of key assumptions, including forecasted interest yield and payment rates, credit quality and a discount rate commensurate with the current market and other risks involved.
The Bank also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets are not normally measured at fair value, but can be subject to fair value adjustments in certain circumstances, such as impairment. Disclosures concerning assets measured at fair value on a non-recurring basis are as follows:
Assets Measured at Fair Value on a Non-recurring Basis
Impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. The Bank estimates the fair value of the loans based on the present value of expected future cash flows using management’s 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.
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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”) and its wholly-owned subsidiary, ChoiceOne Bank (the “Bank”), and the Bank’s wholly-owned subsidiary, ChoiceOne Insurance Agencies, Inc. This discussion should be read in conjunction with the 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 itself. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “is likely,” “plans,” “predicts,” “projects,” “may,” “could,” 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 and loan servicing rights, the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary) and management’s assumptions concerning pension and other postretirement benefit plans involve judgments that are inherently forward-looking. All of the information concerning interest rate sensitivity is forward-looking. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“risk factors”) that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed, implied or forecasted in such forward-looking statements. Furthermore, ChoiceOne undertakes no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events, or otherwise.
Risk factors include, but are not limited to, the risk factors discussed in Item 1A of ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2016. 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
Summary
Net income for the first quarter of 2017 was $1,446,000, which represented an increase of $172,000 or 14% compared to the same period in 2016. Growth in net interest income and a reduction in noninterest expense was partially offset by lower noninterest income in the first quarter of 2017 compared to the first quarter of 2016. Basic and diluted earnings per common share were both $0.44 for the first quarter of 2017 compared to $0.39 for both in the same period in 2016. The return on average assets and return on average shareholders’ equity percentages were 0.94% and 7.95%, respectively, for the first quarter of 2017, compared to 0.88% and 7.18%, respectively, for the same period in 2016.
Dividends
Cash dividends of $557,000 or $0.17 per share were declared in the first quarter of 2017, compared to $561,000 or $0.17 per share in the first quarter of 2016. The cash dividend payout percentage was 39% for the first three months of 2017, compared to 44% in the same period a year ago.
Interest Income and Expense
Tables 1 and 2 on the following pages provide information regarding interest income and expense for the three-month periods ended March 31, 2017 and 2016. 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.
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Table 1 – Average Balances and Tax-Equivalent Interest Rates
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Table 2 – Changes in Tax-Equivalent Net Interest Income
Net Interest Income
The presentation of net interest income on a tax-equivalent basis is not in accordance with generally accepted accounting principles (“GAAP”), but is customary in the banking industry. This non-GAAP measure ensures comparability of net interest income arising from both taxable and tax-exempt loans and investment securities. The adjustments to determine net interest income on a tax-equivalent basis were $187,000 and $189,000 for the three months ended March 31, 2017 and 2016, respectively. These adjustments were computed using a 34% federal income tax rate.
Tax-equivalent net interest income increased $173,000 in the first three months of 2017 compared to the same period in 2016. The effect of growth in average interest-earning assets was partially offset by an increase in average interest-bearing liabilities and Federal Home Loan Bank advances in the first quarter of 2017 compared to the same quarter in the prior year. Despite a reduction of 12 basis points in the net interest spread from 3.64% in the first quarter of 2016 to 3.52% in the same quarter in 2017, net interest income increased $175,000 during the first quarter of 2017 compared to the first quarter of 2016.
The average balance of loans increased $18.8 million in the first quarter of 2017 compared to the same period in 2016. Average commercial and industrial loans drove this growth with an increase of $18.7 million during the first quarter of 2017 compared to the first quarter of 2016. An increase of $1.9 million in consumer loans was virtually offset by a decline in residential mortgage loans. The increase in the average loans balance was offset by a 4 basis point decrease in the average rate earned. This caused tax-equivalent interest income from loans to increase $168,000 in the first quarter of 2017 compared to the same period in the prior year. The average balance of total securities grew $13.7 million in the first three months of 2017 compared to the same period in 2016. Additional securities were purchased in 2016 and in the first quarter of 2017 to provide liquidity and earning asset growth. As a result, tax-equivalent securities income grew $61,000 in the first quarter of 2017 compared to the same quarter in 2016.
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The average balance of interest-bearing demand deposits increased $17.3 million in the first three months of 2017 compared to the same period in 2016. In addition to the higher average balance, an increase of 6 basis points in the average rate paid caused interest expense to increase $37,000 in the first quarter of 2017 compared to the same quarter in 2016. The average balance of savings deposits increased $5.4 million in the first quarter of 2017 compared to the same quarter in the prior year. The impact of the savings deposit growth was offset by a 2 basis point drop in the average rate paid, resulting in a decrease in interest expense of $3,000 in the first three months of 2017 compared to the same period in 2016. The average balance of certificates of deposit was up $3.6 million in the first quarter of 2017 compared to the same period in 2016. The growth in certificates of deposit less a 1 basis point reduction in the average rate paid on certificates caused interest expense to increase $4,000 in the first quarter of 2017 compared to the same period in 2016. The effect of $4.3 million of growth in the average balance of Federal Home Loan Bank advances plus the impact of a 32 basis point increase in the average rate paid caused interest expense to increase $26,000 in the first quarter of 2017 compared to the same quarter in 2016.
ChoiceOne’s net interest income spread was 3.52% in the first quarter of 2017, compared to 3.64% for the first quarter of 2016. The decline in the interest spread was due to a 7 basis point decrease in the average rate earned on interest earning assets in the first quarter of 2017 compared to the same quarter in 2016, plus a 5 basis point increase in the average rate paid on interest-bearing liabilities. The reduction in the average rate earned on interest-earning assets was caused by relatively low general market rates on new loan originations and securities purchased in 2016 and the first quarter of 2017. Interest rates on loans are also being impacted by rate pressure from some of ChoiceOne’s competing financial institutions. The increase in the rate paid on interest-bearing liabilities resulted primarily from recent increases in short-term interest rates which affected ChoiceOne’s borrowing costs.
Provision and Allowance for Loan Losses
Total loans increased $7.8 million in the first quarter of 2017, while the allowance for loan losses increased $48,000 during the same period. The provision for loan losses was $0 in both the first quarter of 2017 and the first quarter of 2016. Nonperforming loans were $4.3 million as of March 31, 2017, compared to $5.1 million as of December 31, 2016 and $6.3 million as of March 31, 2016. The decline in nonperforming loans in the first quarter of 2017 was primarily due to a reduction in nonaccrual loans. The allowance for loan losses was 1.15% of total loans at March 31, 2017, compared to 1.16% at December 31, 2016 and 1.17% at March 31, 2016.
Charge-offs and recoveries for respective loan categories for the three months ended March 31 were as follows:
Net recoveries were $48,000 in the first quarter of 2017, compared to net charge-offs of $69,000 during the same time period in 2016. Net recoveries on an annualized basis as a percentage of average loans were 0.05% in the first three months of 2017 compared to net charge-offs of 0.08% for 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 has worked and intends to continue to work with delinquent borrowers in an attempt to lessen the negative impact to ChoiceOne. As charge-offs, changes in the level of nonperforming loans, and changes within the composition of the loan portfolio occur throughout 2017, the provision and allowance for loan losses will be reviewed by the Bank’s management and adjusted as determined to be necessary.
Noninterest Income
Total noninterest income decreased $111,000 in the first quarter of 2017 compared to the same period in 2016. Gains on sales of loan were $195,000 lower in the first quarter of 2017 than in the first quarter of the prior year. Increases in residential mortgage rates in late 2016 has caused loan originations volume to decrease in early 2017. Losses on sales and write-downs of other assets showed $23,000 of improvement in the first quarter of 2017 compared to the same period in 2016 as activity was limited in early 2017. An increase of $25,000 in other noninterest income in 2017 compared to 2016 was due to a number of small fluctuations.
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Noninterest Expense
Total noninterest expense decreased $128,000 in the first quarter of 2017 compared to the same period in 2016. The increase of $104,000 in salaries and benefits in the first quarter of 2017 compared to the same period in 2016 resulted from higher salaries from raises and additional personnel as well as other compensation items. Growth of $67,000 in occupancy and equipment expense was caused by higher depreciation expense from asset additions in late 2016 and early 2017. Intangible amortization expense was $112,000 lower in the first quarter of 2017 than in the same quarter in the prior year as intangible assets were fully amortized at the end of 2016. The decline of $155,000 in other noninterest expense was due to lower training, donations, and FDIC insurance expense as well as fluctuations in other expense areas.
Income Tax Expense
Income tax expense was $472,000 in the first quarter of 2017 compared to $452,000 for the same period in 2016. The effective tax rate was 24.6% for the first quarter of 2017 and 26.2% for the first quarter of 2016.
FINANCIAL CONDITION
Securities
The securities available for sale portfolio increased $5.9 million from December 31, 2016 to March 31, 2017. The increase in the securities portfolio resulted from ChoiceOne’s desire to supplement growth in earning assets. Various securities totaling $13.2 million were purchased in the first three months of 2017 offset by approximately $0.8 million called or matured during that same time period. Principal repayments on securities totaled $0.5 million in the first three months of 2017. Approximately $6.7 million of securities were sold in the first three months of 2017 for a net gain of $66,000.
Loans
The loan portfolio (excluding loans held for sale and loans to other financial institutions) increased $4.3 million from December 31, 2016 to March 31, 2017. Increases of $5.0 million, $5.5 million, $0.8 million, and $0.2 million in commercial and industrial loans, commercial real estate loans, consumer loans, and residential real estate loans, respectively were offset partially by reductions of $6.1 million and $1.1 million in agricultural and construction real estate loans, respectively. The decrease in agricultural loans was caused in part by seasonal pay downs by borrowers. The increase in commercial and industrial loans and commercial real estate loans was due in part to a new lending office in downtown Grand Rapids and increased calling efforts in ChoiceOne’s established markets.
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 $4.7 million at March 31, 2017, compared to $4.9 million as of December 31, 2016. A decline of $437,000 in impaired residential real estate loans was partially offset by smaller fluctuations in the other loan categories in the first quarter of 2017.
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.
The balances of these nonperforming loans were as follows:
At March 31, 2017, nonaccrual loans included $482,000 in agricultural loans, $374,000 in commercial and industrial loans, $261,000 in commercial real estate loans, $5,000 in consumer loans, and $314,000 in residential real estate loans. At December 31, 2016, nonaccrual loans included $482,000 in agricultural loans, $245,000 in commercial and industrial loans, $6,000 in consumer loans, $458,000 in commercial real estate loans, and $792,000 in residential real estate loans. Approximately 93% of the balance of loans considered troubled debt restructurings was performing according to their restructured terms as of March 31, 2017. Management believes the allowance allocated to its nonperforming loans is sufficient at March 31, 2017.
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Deposits and Borrowings
Total deposits decreased $4.0 million in the first quarter of 2017. Checking and savings deposits decreased $13.3 million, while certificates of deposit grew $9.4 million in the first three months of 2017. The decline in checking and savings accounts was primarily due to seasonal fluctuations for ChoiceOne’s depositors. $7.0 million of the growth in certificates of deposit in the first quarter of 2017 was caused by increased brokered certificates.
A decrease of $3.3 million in repurchase agreements in the first three months of 2017 was due to normal fluctuations in funds provided by bank customers. Certain securities are sold under agreements to repurchase them the following day. Management plans to continue this practice as a low-cost source of funding. Federal funds purchased increased $3.9 million and Federal Home Loan Bank advances grew $12.0 million in the first quarter of 2017 as deposit growth was insufficient to fund loan and securities growth during the time period.
Shareholders’ Equity
Total shareholders’ equity increased $1.6 million from December 31, 2016 to March 31, 2017. Growth in equity resulted from the current quarter’s net income, an increase in accumulated other comprehensive income, and proceeds from the issuance of ChoiceOne stock, which was partially offset by cash dividends paid. The $607,000 increase in accumulated other comprehensive income since the end of 2016 was caused by an increase in net unrealized gains on available for sale securities.
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Following is information regarding the Bank’s compliance with regulatory capital requirements:
Management reviews the capital levels of ChoiceOne and the Bank on a regular basis. The Board of Directors (the “Board”) and management believe that the capital levels as of March 31, 2017 are adequate for the foreseeable future. The Board’s 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 from operating activities was $2.1 million for the three months ended March 31, 2017 compared to $5.3 million provided in the same period a year ago. The decrease was caused by a decline in net proceeds from loans originated for sale. Net cash used for investing activities was $13.6 million for the first three months of 2017 compared to $12.5 million in the same period in 2016. The change was a lower level of purchases of securities offset by a higher level of loan growth. Net cash provided from financing activities was $8.0 million in the three months ended March 31, 2017 compared to $8.6 million in the same period in the prior year. This small decline resulted from a decline in deposits in the current year in contrast with growth in the prior year. The effect of this was offset by a higher level of net proceeds from Federal Home Loan Bank advances.
Management believes that the current level of liquidity is sufficient to meet the Bank’s normal operating needs. This belief is based upon the availability of deposits from both the local and national markets, maturities of securities, normal loan repayments, income retention, federal funds purchased from correspondent banks, and advances available from the Federal Home Loan Bank. The Bank also has a secured line of credit available from the Federal Reserve Bank.
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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. 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 March 31, 2017 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 the 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, 2016. As of the date of this report, ChoiceOne does not believe that there has been a material change in the nature or categories of ChoiceOne’s risk factors, as compared to the information disclosed in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2016.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On January 25, 2017 ChoiceOne issued 921 shares of common stock, without par value, to the directors of ChoiceOne pursuant to the Directors’ Stock Purchase Plan for an aggregate cash price of $22,000. ChoiceOne relied on the exemption contained in Section 4(a)(5) of the Securities Act of 1933 in connection with these sales.
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ISSUER PURCHASES OF EQUITY SECURITIES
ChoiceOne did not repurchase any of its common stock during the first quarter of 2017.
Item 5. Other Information
None.
Item 6. Exhibits
The following exhibits are filed or incorporated by reference as part of this report:
Bylaws of ChoiceOne as currently in effect and any amendments thereto. Previously filed as an exhibit to ChoiceOne’s Form 10-K Annual Report for the year ended December 31, 2013. Here incorporated by reference.
32.1
101.1
Certification pursuant to 18 U.S.C. § 1350.
Interactive Data File.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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