UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

 

FORM 10-Q
 

☒	Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended June 30, 2016
☐	Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the transition period from                 to

 

Commission File Number: 000-19202

 

ChoiceOne Financial Services, Inc.
(Exact Name of Registrant as Specified in its Charter)

Michigan (State or Other Jurisdiction of Incorporation or Organization)		38-2659066 (I.R.S. Employer Identification No.)
109 East Division Sparta, Michigan (Address of Principal Executive Offices)		49345 (Zip Code)
(616) 887-7366 (Registrant’s Telephone Number, including Area Code)

 

Indicate by 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).

Yes  ☒          No   ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☐

Accelerated filer ☐

 

Non-accelerated filer ☐

Smaller reporting company ☒

 

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 July 31, 2016, the Registrant had outstanding 3,277,035 shares of common stock.

 

 

 

PART I. FINANCIAL INFORMATION

 

Item 1.  Financial Statements.

ChoiceOne Financial Services, Inc.
CONSOLIDATED BALANCE SHEETS (Unaudited)

  

		June 30,				December 31,
(Dollars in thousands)		2016				2015
		(Unaudited)				(Audited)
Assets
Cash and due from banks		$	13,466			$	11,187
Securities available for sale (Note 2)			175,172				160,136
Federal Home Loan Bank stock			1,614				1,614
Federal Reserve Bank stock			1,573				1,573
Loans held for sale			2,734				4,957
Loans (Note 3)			357,242				349,304
Allowance for loan losses (Note 3)			(4,296	)			(4,194	)
Loans, net			352,946				345,110
Premises and equipment, net			11,872				12,120
Cash value of life insurance policies			12,438				12,261
Intangible assets, net			155				379
Goodwill			13,728				13,728
Other assets			4,725				4,681
Total assets		$	590,423			$	567,746
Liabilities
Deposits – noninterest-bearing		$	124,134			$	122,937
Deposits – interest-bearing			339,687				351,759
Total deposits			463,821				474,696
Repurchase agreements			5,379				9,460
Advances from Federal Home Loan Bank			45,317				11,332
Other liabilities			3,509				2,416
Total liabilities			518,026				497,904
Shareholders’ Equity
Common stock and paid in capital, no par value; shares authorized: 7,000,000; shares outstanding: 3,275,852 at June 30, 2016 and 3,295,228 at December 31, 2015			46,227				46,501
Retained earnings			23,734				22,138
Accumulated other comprehensive income, net			2,436				1,203
Total shareholders’ equity			72,397				69,842
Total liabilities and shareholders’ equity		$	590,423			$	567,746

 

See accompanying notes to interim consolidated financial statements.

 

 

ChoiceOne Financial Services, Inc.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

(Dollars in thousands, except per share data)		Three Months Ended June 30,								Six Months Ended June 30,
		2016				2015				2016				2015
Interest income
Loans, including fees		$	4,087			$	3,988			$	8,083			$	7,930
Securities:
Taxable			584				485				1,137				937
Tax exempt			363				357				729				706
Other			3				2				9				5
Total interest income			5,037				4,832				9,958				9,578
Interest expense
Deposits			199				215				408				440
Advances from Federal Home Loan Bank			45				28				75				47
Other			3				10				5				22
Total interest expense			247				253				488				509
Net interest income			4,790				4,579				9,470				9,069
Provision for loan losses			—				—				—				100
Net interest income after provision for loan losses			4,790				4,579				9,470				8,969
Noninterest income
Customer service charges			1,030				1,062				1,990				2,045
Insurance and investment commissions			226				292				449				633
Gains on sales of loans			419				309				838				812
Gains on sales of securities			156				45				226				53
Losses on sales and write-downs of other assets			—				(55	)			(23	)			(76	)
Earnings on life insurance policies			89				87				177				475
Other			131				111				236				202
Total noninterest income			2,051				1,851				3,893				4,144
Noninterest expense
Salaries and benefits			2,565				2,214				4,976				4,513
Occupancy and equipment			692				593				1,333				1,188
Data processing			539				578				1,098				1,132
Professional fees			232				236				468				513
Supplies and postage			95				73				220				178
Advertising and promotional			89				58				132				125
Intangible amortization			112				112				224				224
FDIC insurance			73				72				140				149
Other			504				549				1,107				1,022
Total noninterest expense			4,901				4,485				9,698				9,044
Income before income tax			1,940				1,945				3,665				4,069
Income tax expense			495				514				947				996
Net income		$	1,445			$	1,431			$	2,719			$	3,073
Basic earnings per share (Note 4)		$	0.43			$	0.43			$	0.82			$	0.93
Diluted earnings per share (Note 4)		$	0.43			$	0.43			$	0.82			$	0.93
Dividends declared per share		$	0.17			$	0.17			$	0.34			$	0.32

 

See accompanying notes to interim consolidated financial statements.

 

ChoiceOne Financial Services, Inc.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)

  

(Dollars in thousands)		Three Months Ended June 30,								Six Months Ended June 30,
		2016				2015				2016				2015
Net income		$	1,445			$	1,431			$	2,719			$	3,073
Other comprehensive income (loss):
Changes in net unrealized gains (losses) on investment securities available for sale, net of tax expense (benefit) of $347 and $(220) for the three months ended June 30, 2016 and  June 30, 2015 respectively.  Changes in net unrealized gains (losses) on investment securities available for sale, net of tax expense (benefit) of $712 and $70 for the six months ended June 30, 2016 and June 30, 2015 respectively			673				(428	)			1,382				126
Less: Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax expense (benefit) of $(53) and $(15) for the three months ended June 30, 2016 and  June 30, 2015 respectively.  Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax expense (benefit) of $(77) and $(18) for the six months ended June 30, 2016 and  June 30, 2015 respectively			(103	)			(30	)			(149	)			(35	)
Change in adjustment for pension and other postretirement benefits, net of tax benefit (expense)			—				—				—				—
Other comprehensive income (loss), net of tax			570				(458	)			1,233				91
Comprehensive income		$	2,015			$	973			$	3,952			$	3,164

 

See accompanying notes to interim consolidated financial statements

 

 

ChoiceOne Financial Services, Inc.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

(Dollars in thousands)		Number of Shares				Common Stock and Paid in Capital				Retained Earnings				Accumulated Other Comprehensive Income, Net				Total
Balance, January 1, 2015			3,295,834			$	46,552			$	18,565			$	1,073			$	66,190
Net income											3,073								3,073
Other comprehensive income															91				91
Shares issued			7,217				102												102
Shares repurchased			(16,200	)			(371	)											(371	)
Change in ESOP repurchase obligation							(4	)											(4	)
Effect of employee stock purchases							6												6
Restricted stock units issued			100				68												68
Cash dividends declared ($0.32 per share)											(1,051	)							(1,051	)
Balance, June 30, 2015			3,286,951			$	46,353			$	20,587			$	1,164			$	68,104
Balance, January 1, 2016			3,295,228			$	46,501			$	22,138			$	1,203			$	69,842
Net income											2,719								2,719
Other comprehensive income															1,233				1,233
Shares issued			7,142				130												130
Shares repurchased			(30,000	)			(678	)											(678	)
Change in ESOP repurchase obligation							127												127
Effect of employee stock purchases							6												6
Restricted stock units issued			3,482				141												141
Cash dividends declared ($0.34 per share)											(1,123	)							(1,123	)
Balance, June 30, 2016			3,275,852			$	46,227			$	23,734			$	2,436			$	72,397

 

See accompanying notes to interim consolidated financial statements.

 

 

ChoiceOne Financial Services, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) 

(Dollars in thousands)		Six Months Ended June 30,
		2016				2015
Cash flows from operating activities:
Net income		$	2,719			$	3,073
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses			—				100
Depreciation			481				486
Amortization			799				752
Compensation expense on stock purchases and
restricted stock units			147				74
Gains on sales of securities			(226	)			(53	)
Gains on sales of loans			(838	)			(812	)
Loans originated for sale			(22,737	)			(7,544	)
Proceeds from loan sales			25,633				7,663
Earnings on bank-owned life insurance			(177	)			(475	)
Proceeds on bank-owned life insurance			—				461
Gains on sales of other real estate owned			3				—
Write-downs of other real estate owned			—				76
Proceeds from sales of other real estate owned			28				124
Deferred federal income tax expense/(benefit)			(86	)			(303	)
Net changes in other assets			25				(289	)
Net changes in other liabilities			670				(85	)
Net cash from operating activities			6,441				3,248
Cash flows from investing activities:
Securities available for sale:
Sales			11,157				4,633
Maturities, prepayments and calls			22,835				5,958
Purchases			(47,375	)			(18,969	)
Loan originations and payments, net			(7,849	)			9,926
Additions to premises and equipment			(288	)			(502	)
Net cash from investing activities			(21,520	)			1,046
Cash flows from financing activities:
Net change in deposits			(10,875	)			(12,040	)
Net change in repurchase agreements			(4,081	)			(5,703	)
Proceeds from Federal Home Loan Bank advances			202,000				88,575
Payments on Federal Home Loan Bank advances			(168,015	)			(75,065	)
Issuance of common stock			130				102
Repurchase of common stock			(678	)			(371	)
Cash dividends			(1,123	)			(1,051	)
Net cash from financing activities			17,358				(5,553	)
Net change in cash and cash equivalents			2,279				(1,259	)
Beginning cash and cash equivalents			11,187				16,650
Ending cash and cash equivalents		$	13,466			$	15,391
Supplemental disclosures of cash flow information:
Cash paid for interest		$	486			$	514
Cash paid for taxes		$	100			$	1,970
Loans transferred to other real estate owned		$	13			$	327

  

See accompanying notes to interim consolidated financial statements.

 

 

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 unaudited condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although the company believes that the disclosures made are adequate to make the information not misleading.

 

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 June 30, 2016 and December 31, 2015, the Consolidated Statements of Income for the three- and six-month periods ended June 30, 2016 and June 30, 2015, the Consolidated Statements of Comprehensive Income for the three- and six-month periods ended June 30, 2016 and June 30, 2015, the Consolidated Statements of Changes in Shareholders’ Equity for the six-month periods ended June 30, 2016 and June 30, 2015, and the Consolidated Statements of Cash Flows for the six-month periods ended June 30, 2016 and June 30, 2015. Operating results for the six months ended June 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.

 

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, 2015.

 

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 reported assets and net income.

 

Stock Transactions

A total of 3,304 shares of common stock were issued to ChoiceOne’s Board of Directors for a cash price of $77,000 under the terms of the Directors’ Stock Purchase Plan in the first six months of 2016. A total of 2,033 shares of common stock were issued upon the exercise of stock options in the first half of 2016. A total of 1,805 shares of common stock were issued to employees for a cash price of $42,000 under the Employee Stock Purchase Plan in the first half of 2016. A total of 3,482 shares of common stock were issued to employees for Restricted Stock Units that vested during the first six months of 2016. A total of 30,000 shares of common stock were repurchased by ChoiceOne in the first six months of 2016.

 

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.

 

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income or loss. Other comprehensive income or loss includes unrealized gains and losses on securities available for sale and changes in the funded status of post-retirement plans, net of tax, which are also recognized as a separate component of shareholders’ equity.

 

 

Accumulated other comprehensive income was as follows:

 

(Dollars in thousands)		As of June 30,
		2016				2015
Unrealized gains on available for sale securities		$	3,498			$	1,538
Unrecognized gains on post-retirement benefits			193				225
Tax effect			(1,255	)			(599	)
Accumulated other comprehensive income		$	2,436			$	1,164

 

Reclassifications

Certain amounts presented in prior periods have been reclassified to conform to the current presentation.

 

 

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:

 

						June 30, 2016
(Dollars in thousands)			Amortized Cost				Gross Unrealized Gains				Gross Unrealized  Losses				Fair Value
U.S. Government and federal agency		$	65,995			$	372			$	(52	)		$	66,315
U.S. Treasury			2,078				42				—				2,120
State and municipal			84,094				2,784				(22	)			86,856
Mortgage-backed			7,756				51				(3	)			7,804
Corporate			7,908				71				(2	)			7,977
Foreign debt			1,000				2				—				1,002
Equity securities			2,617				261				—				2,878
Asset-backed securities			226				—				(6	)			220
Total		$	171,674			$	3,583			$	(85	)		$	175,172

 

						December 31, 2015
						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
U.S. Government and federal agency		$	57,406			$	30			$	(229	)		$	57,207
U.S. Treasury			6,133				—				(33	)			6,100
State and municipal			76,005				1,858				(109	)			77,754
Mortgage-backed			6,989				26				(45	)			6,970
Corporate			8,418				8				(39	)			8,387
Foreign debt			1,000				—				(5	)			995
Equity securities			2,279				174				—				2,453
Asset-backed securities			274				—				(4	)			270
Total		$	158,504			$	2,096			$	(464	)		$	160,136

  

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 six months ended June 30, 2016. 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.

 

 

NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES

Activity in the allowance for loan losses and balances in the loan portfolio was as follows:

 

						Commercial
(Dollars in thousands)						and								Commercial				Construction				Residential
		Agricultural				Industrial				Consumer				Real Estate				Real Estate				Real Estate				Unallocated				Total
Allowance for Loan Losses
Three Months Ended June 30, 2016
Beginning balance		$	382			$	691			$	272			$	1,138			$	43			$	1,350			$	249			$	4,124
Charge-offs			—				—				(29	)			—				—				—				—				(29	)
Recoveries			—				8				28				23				—				142				—				201
Provision			18				(42	)			6				(28	)			2				(270	)			315				—
Ending balance		$	400			$	657			$	277			$	1,133			$	45			$	1,222			$	563			$	4,296
Six Months Ended June 30, 2016
Beginning balance		$	420			$	586			$	297			$	1,030			$	46			$	1,388			$	427			$	4,194
Charge-offs			—				(33	)			(68	)			—				—				(69	)			—				(170	)
Recoveries			—				23				69				31				—				149				—				272
Provision			(20	)			81				(21	)			72				(2	)			(246	)			136				—
Ending balance		$	400			$	657			$	277			$	1,133			$	45			$	1,222			$	563			$	4,296
Individually evaluated for impairment		$	11			$	11			$	1			$	177			$	—			$	364			$	—			$	564
Collectively evaluated for impairment		$	389			$	646			$	276			$	956			$	45			$	858			$	563			$	3,732
Three Months Ended June 30, 2015
Beginning balance		$	201			$	613			$	193			$	1,498			$	39			$	1,482			$	295			$	4,321
Charge-offs			—				—				(55	)			—				—				(20	)			—				(75	)
Recoveries			1				20				42				14				—				30				—				107
Provision			77				(136	)			13				(228	)			(11	)			(116	)			401				—
Ending balance		$	279			$	497			$	193			$	1,284			$	28			$	1,376			$	696			$	4,353
Six Months Ended June 30, 2015
Beginning balance		$	187			$	527			$	183			$	1,641			$	9			$	1,193			$	433			$	4,173
Charge-offs			—				—				(106	)			—				—				(21	)			—				(127	)
Recoveries			1				48				79				21				—				58				—				207
Provision			91				(78	)			37				(378	)			19				146				263				100
Ending balance		$	279			$	497			$	193			$	1,284			$	28			$	1,376			$	696			$	4,353
Individually evaluated for impairment		$	—			$	—			$	1			$	333			$	—			$	332			$	—			$	666
Collectively evaluated for impairment		$	279			$	497			$	192			$	951			$	28			$	1,044			$	696			$	3,687
Loans
June 30, 2016
Individually evaluated for impairment		$	173			$	294			$	22			$	2,628			$	—			$	2,916							$	6,033
Collectively evaluated for impairment			34,500				97,436				20,887				103,606				5,427				89,353								351,209
Ending balance		$	34,673			$	97,730			$	20,909			$	106,234			$	5,427			$	92,269							$	357,242
December 31, 2015
Individually evaluated for impairment		$	50			$	192			$	24			$	2,790			$	—			$	2,529							$	5,585
Collectively evaluated for impairment			40,182				94,155				20,066				94,946				5,390				88,980								343,719
Ending balance		$	40,232			$	94,347			$	20,090			$	97,736			$	5,390			$	91,509							$	349,304

 

 

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.

 

 

Information regarding the Bank’s credit exposure is as follows:

 

Corporate Credit Exposure - Credit Risk Profile By Creditworthiness Category

 

		Agricultural								Commercial and Industrial								Commercial Real Estate
(Dollars in thousands)			June 30,				December 31,				June 30,				December 31,				June 30,				December 31,
			2016				2015				2016				2015				2016				2015
Risk ratings 1 and 2		$	7,979			$	10,416			$	11,315			$	10,480			$	6,505			$	3,875
Risk rating 3			18,758				25,189				67,159				66,921				56,179				57,540
Risk rating 4			6,053				3,086				18,310				16,169				38,213				29,826
Risk rating 5			1,837				1,491				825				574				3,433				3,776
Risk rating 6			46				50				121				129				1,904				2,719
Risk rating 7			—				—				—				74				—				—
		$	34,673			$	40,232			$	97,730			$	94,347			$	106,234			$	97,736

Corporate Credit Exposure - Credit Risk Profile Based On Payment Activity

		Consumer								Construction Real Estate								Residential Real Estate
(Dollars in thousands)			June 30,				December 31,				June 30,				December 31,				June 30,				December 31,
			2016				2015				2016				2015				2016				2015
Performing		$	20,909			$	20,090			$	5,427			$	5,390			$	91,687			$	90,796
Nonperforming			—				—				—				—				—				282
Nonaccrual			—				—				—				—				582				431
		$	20,909			$	20,090			$	5,427			$	5,390			$	92,269			$	91,509

 

The following schedule provides information on loans that were considered TDRs that were modified during the three- and six-months periods ended June 30, 2016:

		Three Months Ended June 30, 2016												Six Months Ended June 30, 2016
							Pre-				Post-								Pre-				Post-
							Modification				Modification								Modification				Modification
							Outstanding				Outstanding								Outstanding				Outstanding
(Dollars in thousands)			Number of				Recorded				Recorded				Number of				Recorded				Recorded
			Loans				Investment				Investment				Loans				Investment				Investment
Commercial real estate			—			$	—			$	—				1			$	128			$	128
Residential real estate			2				150				150				3				179				179
Total			2			$	150			$	150				4			$	307			$	307

 

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.

 

Loans are classified as performing when they are current as to principal and interest payments or are past due on payments less than 90 days. Loans are classified as nonperforming when they are past due 90 days or more as to principal and interest payments or are considered a troubled debt restructuring.

 

 

Impaired loans by loan category as of June 30, 2016 and 2015 were as follows:

 

						Unpaid								Average				Interest
(Dollars in thousands)		Recorded				Principal				Related				Recorded				Income
		Investment				Balance				Allowance				Investment				Recognized
June 30, 2016
With no related allowance recorded
Agricultural		$	—			$	—			$	—			$	43			$	—
Commercial and industrial			—				—				—				25				—
Consumer			—				—				—				—				—
Commercial real estate			1,253				1,450				—				1,351				5
Residential real estate			170				170				—				89				—
Subtotal			1,423				1,620				—				1,508				5
With an allowance recorded
Agricultural			173				175				11				90				14
Commercial and industrial			295				295				11				241				1
Consumer			22				22				1				23				1
Commercial real estate			1,375				1,917				177				1,482				54
Residential real estate			2,745				2,633				364				2,612				58
Subtotal			4,610				5,042				564				4,448				128
Total
Agricultural			173				175				11				133				14
Commercial and industrial			294				295				11				266				1
Consumer			22				22				1				23				1
Commercial real estate			2,628				3,367				177				2,833				59
Residential real estate			2,916				2,803				364				2,701				58
Total		$	6,033			$	6,662			$	564			$	5,956			$	133
June 30, 2015
With no related allowance recorded
Agricultural		$	—			$	—			$	—			$	—			$	—
Commercial and industrial			74				103				—				16				—
Consumer			—				—				—				3				—
Commercial real estate			1,540				1,540				—				658				5
Residential real estate			13				13				—				300				—
Subtotal			1,627				1,656				—				977				5
With an allowance recorded
Agricultural			50				50				3				70				(6	)
Commercial and industrial			118				118				15				—				—
Consumer			24				24				1				26				1
Commercial real estate			1,250				1,755				191				2,408				39
Residential real estate			2,516				2,516				296				2,393				41
Subtotal			3,958				4,463				506				4,897				75
Total
Agricultural			50				50				3				70				(6	)
Commercial and industrial			192				221				15				16				—
Consumer			24				24				1				29				1
Commercial real estate			2,790				3,295				191				3,066				44
Residential real estate			2,529				2,529				296				2,693				41
Total		$	5,585			$	6,119			$	506			$	5,874			$	80

 

 

An aging analysis of loans by loan category follows:

 

										Greater																90 Days Past
(Dollars in thousands)		30 to 59				60 to 89				Than 90								Loans Not								Due and
		Days				Days				Days (1)				Total				Past Due				Total Loans				Accruing
June 30, 2016
Agricultural		$	—			$	—			$	—			$	—			$	34,673			$	34,673			$	—
Commercial and industrial			—				73				290				363				97,367				97,730				—
Consumer			22				12				—				34				20,875				20,909				—
Commercial real estate			265				261				280				806				105,428				106,234				—
Construction real estate			—				—				—				—				5,427				5,427				—
Residential real estate			83				810				238				1,131				91,138				92,269				102
		$	370			$	1,156			$	808			$	2,334			$	354,908			$	357,242			$	102
December 31, 2015
Agricultural		$	3			$	—			$	—			$	3			$	40,229			$	40,232			$	—
Commercial and industrial			90				322				77				489				93,858				94,347				—
Consumer			115				—				—				115				19,975				20,090				—
Commercial real estate			505				297				1,233				2,035				95,701				97,736				—
Construction real estate			299				—				—				299				5,091				5,390				—
Residential real estate			1,012				364				200				1,576				89,933				91,509				29
		$	2,024			$	983			$	1,510			$	4,517			$	344,787			$	349,304			$	29

 

(1) Includes nonaccrual loans.

 

Nonaccrual loans by loan category follow:

 

(Dollars in thousands)		June 30,				December 31,
		2016				2015
Agricultural		$	46			$	50
Commercial and industrial			289				77
Consumer			—				—
Commercial real estate			1,719				1,640
Construction real estate			—				—
Residential real estate			582				431
		$	2,636			$	2,198

 

 

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:

 

		Three Months Ended								Six Months Ended
(Dollars in thousands, except per share data)		June 30,								June 30,
		2016				2015				2016				2015
Basic Earnings Per Share
Net income available to common shareholders		$	1,445			$	1,431			$	2,719			$	3,073
Weighted average common shares outstanding			3,299,836				3,285,290				3,298,037				3,287,063
Basic earnings per share		$	0.43			$	0.43			$	0.82			$	0.93
Diluted Earnings Per Share
Net income available to common shareholders		$	1,445			$	1,431			$	2,719			$	3,073
Weighted average common shares outstanding			3,299,836				3,285,290				3,298,037				3,287,063
Plus dilutive stock options and restricted stock units			5,178				9,256				5,286				9,300
Weighted average common shares outstanding and potentially dilutive shares			3,305,014				3,294,546				3,303,323				3,296,363
Diluted earnings per share		$	0.43			$	0.43			$	0.82			$	0.93

 

There were 30,000 stock options as of June 30, 2016 and zero as of June 30, 2015 with an exercise price more than the current market price. These stock options have been excluded from the calculation of diluted earnings above.

 

 

NOTE 5 – FINANCIAL INSTRUMENTS

 

Financial instruments as of the dates indicated were as follows:

 

 

										Quoted Prices
										in Active				Significant
										Markets for				Other				Significant
										Identical				Observable				Unobservable
(Dollars in thousands)		Carrying				Estimated				Assets				Inputs				Inputs
		Amount				Fair Value				(Level 1)				(Level 2)				(Level 3)
June 30, 2016
Assets:
Cash and due from banks		$	13,466			$	13,466			$	13,466			$	—			$	—
Securities available for sale			175,172				175,172				1,378				161,795				11,999
Federal Home Loan Bank and Federal
Reserve Bank stock			3,187				3,187				—				3,187				—
Loans held for sale			2,734				2,816				—				—				2,816
Loans, net			352,946				355,062				—				—				355,062
Liabilities:
Noninterest-bearing deposits			124,134				124,134				—				124,134				—
Interest-bearing deposits			339,687				319,200				—				319,200				—
Repurchase agreements			5,379				5,379				—				5,379				—
Federal Home Loan Bank advances			45,317				45,360				—				45,360				—
December 31, 2015
Assets:
Cash and due from banks		$	11,187			$	11,187			$	11,187			$	—			$	—
Securities available for sale			160,136				160,136				953				147,384				11,799
Federal Home Loan Bank and Federal
Reserve Bank stock			3,187				3,187				—				3,187				—
Loans held for sale			4,957				5,109				—				5,109				—
Loans, net			345,110				349,875				—				—				349,875
Liabilities:
Noninterest-bearing deposits			122,937				122,937				—				122,937				—
Interest-bearing deposits			351,759				353,113				—				353,113				—
Repurchase agreements			9,460				9,460				—				9,460				—
Federal Home Loan Bank advances			11,332				12,028				—				12,028				—

 

The estimated fair values approximate the carrying amounts for all financial instruments 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 June 30, 2016 and December 31, 2015 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 June 30, 2016 and December 31, 2015 for new deposits or FHLB advances, applied until maturity. The estimated fair values for other financial instruments and off-balance sheet loan commitments are considered nominal.

  

 

NOTE 6 – FAIR VALUE MEASUREMENTS

 

The following tables present information about the Bank’s assets and liabilities measured at fair value on a recurring basis and the valuation techniques used by the Bank to determine those fair values.

 

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the Bank has the ability to access.

 

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

 

Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability.

 

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Bank’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.

 

There were no liabilities measured at fair value as of June 30, 2016 or December 31, 2015. Disclosures concerning assets measured at fair value are as follows:

 

Assets Measured at Fair Value on a Recurring Basis

 

		Quoted Prices				Significant
		in Active				Other				Significant
		Markets for Identical				Observable				Unobservable
(Dollars in thousands)		Assets				Inputs				Inputs				Balance at
		(Level 1)				(Level 2)				(Level 3)				Date Indicated
Investment Securities, Available for Sale – June 30, 2016
U.S. Treasury notes and bonds		$	—			$	2,120			$	—			$	2,120
U.S. Government and federal agency			—				66,315				—				66,315
State and municipal			—				76,756				10,100				86,856
Mortgage-backed			—				7,804				—				7,804
Corporate			—				7,578				399				7,977
Foreign debt			—				1,002				—				1,002
Equity securities			1,378				—				1,500				2,878
Asset backed securities			—				220				—				220
Total		$	1,378			$	161,795			$	11,999			$	175,172
Investment Securities, Available for Sale - December 31, 2015
U.S. Treasury notes and bonds		$	—			$	6,100			$	—			$	6,100
U.S. Government and federal agency			—				57,207				—				57,207
State and municipal			—				67,852				9,902				77,754
Mortgage-backed			—				6,970				—				6,970
Corporate			—				7,990				397				8,387
Foreign debt			—				995				—				995
Equity securities			953				—				1,500				2,453
Asset backed securities			—				270				—				270
Total		$	953			$	147,384			$	11,799			$	160,136

 

 

Changes in Level 3 Assets Measured at Fair Value on a Recurring Basis

 

(Dollars in thousands)
		2016				2015
Investment Securities, Available for Sale
Balance, January 1		$	11,799			$	11,642
Total realized and unrealized gains included in income			—				—
Total unrealized (gains) losses included in other comprehensive income			(187	)			772
Net purchases, sales, calls, and maturities			387				(368	)
Net transfers into Level 3			—				—
Balance, June 30		$	11,999			$	12,046

  

Of the Level 3 assets that were held by the Bank at June 30, 2016, the net unrealized gain for the six months ended June 30, 2016 was $187,000, which is recognized in other comprehensive income in the consolidated balance sheet. $750,000 of Level 3 securities were purchased during the first half of 2016 and $182,000 of Level 3 securities matured or were called in the same period. There were no sales or purchases of Level 3 securities during the first and second quarters of 2015.

 

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. 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

 

						Quoted Prices				Significant
						in Active				Other				Significant
						Markets for Identical				Observable				Unobservable
(Dollars in thousands)		Balance at				Assets				Inputs				Inputs
		Dates Indicated				(Level 1)				(Level 2)				(Level 3)
Impaired Loans
June 30, 2016		$	6,033			$	—			$	—			$	6,033
December 31, 2015		$	5,585			$	—			$	—			$	5,585
Other Real Estate
June 30, 2016		$	13			$	—			$	—			$	13
December 31, 2015		$	31			$	—			$	—			$	31

 

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.

 

 

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 the amount of any impairment) 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, 2015. 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 second quarter of 2016 was $1,445,000, which represented an increase of $14,000 or 1% compared to the same period in 2015. Net income for the first six months of 2016 was $2,719,000, which represented a decrease of $354,000 or 12% over the same period in 2015. The first quarter of 2015 included a bank owned life insurance payout of roughly $308,000 in nontaxable income that explains a large portion of the year over year difference in noninterest income. Strong growth in net interest income was offset by an increase in noninterest expense for the first half of 2016 compared to the same period in 2015. Basic and diluted earnings per common share were both $0.43 for the second quarter of 2016 and $0.82 for the first six months of 2016, compared to $0.43 and $0.93, respectively, for the same periods in 2015. The return on average assets and return on average shareholders’ equity percentages were 0.94% and 7.62%, respectively, for the first half of 2016, compared to 1.13% and 9.11%, respectively, for the same period in 2015.

 

Dividends

Cash dividends of $562,000 or $0.17 per share were declared in the second quarter of 2016, compared to $559,000 or $0.17 per share in the second quarter of 2015. The cash dividends declared in the first six months of 2016 were $1,123,000 or $0.34 per share, compared to $1,051,000 or $0.32 per share declared in the same period in 2015. The cash dividend payout percentage was 41% for the first six months of 2016, compared to 34% 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 six-month periods ended June 30, 2016 and 2015, respectively. Table 1 documents ChoiceOne’s average balances and interest income and expense, as well as the average rates earned or paid on assets and liabilities. Table 2 documents the effect on interest income and expense of changes in volume (average balance) and interest rates. These tables are referred to in the discussion of interest income, interest expense and net interest income.

 

Table 1 – Average Balances and Tax-Equivalent Interest Rates

 

		Six Months Ended June 30,
		2016													2015
(Dollars in thousands)		Average												Average
		Balance				Interest				Rate				Balance				Interest					Rate
Assets:
Loans (1)		$	353,998			$	8,089				4.57	%		$	342,249			$	7,935				4.64	%
Taxable securities (2) (3)			116,184				1,137				1.96				100,687				937				1.86
Nontaxable securities (1) (2)			53,650				1,101				4.10				48,996				1,066				4.35
Other			3,591				9				0.50				3,374				5				0.30
Interest-earning assets			527,423				10,336				3.92				495,306				9,943				4.01
Noninterest-earning assets			51,841												48,262
Total assets		$	579,264											$	543,568
Liabilities and Shareholders’ Equity:
Interest-bearing demand deposits		$	191,672				131				0.14	%		$	151,451				101				0.13	%
Savings deposits			72,618				13				0.04				67,683				13				0.04
Certificates of deposit			86,772				264				0.61				96,943				326				0.67
Advances from Federal Home Loan Bank			24,910				75				0.60				23,273				47				0.40
Other			9,635				5				0.10				23,547				22				0.19
Interest-bearing liabilities			385,607				488				0.25				362,897				509				0.28
Noninterest-bearing demand deposits			121,227												110,792
Other noninterest-bearing liabilities			1,023												2,442
Total liabilities			507,857												476,131
Shareholders’ equity			71,407												67,437
Total liabilities and shareholders’ equity		$	579,264											$	543,568
Net interest income (tax-equivalent basis)- interest spread							9,848				3.67	%							9,434				3.73	%
Tax-equivalent adjustment (1)							(378	)											(365	)
Net interest income						$	9,470											$	9,069
Net interest income as a percentage of earning assets (tax-equivalent basis)											3.73	%											3.81	%

 

	(1)	Adjusted to a fully tax-equivalent basis to facilitate comparison to the taxable interest-earning assets. The adjustment uses an incremental tax rate of 34% for the periods presented.
	(2)	Includes the effect of unrealized gains or losses on securities.
	(3)	Taxable securities include dividend income from Federal Home Loan Bank and Federal Reserve Bank stock.

 

 

Table 2 – Changes in Tax-Equivalent Net Interest Income

 

		Six Months Ended June 30,
(Dollars in thousands)		2016 Over 2015
			Total				Volume				Rate
Increase (decrease) in interest income (1)
Loans (2)		$	154			$	431			$	(277	)
Taxable securities			200				150				50
Nontaxable securities (2)			35				174				(139	)
Other			4				—				4
Net change in tax-equivalent interest income			393				755				(362	)
Increase (decrease) in interest expense (1)
Interest-bearing demand deposits			30				27				3
Savings deposits			—				2				(2	)
Certificates of deposit			(62	)			(33	)			(29	)
Advances from Federal Home Loan Bank			28				4				24
Other			(17	)			(10	)			(7	)
Net change in interest expense			(21	)			(10	)			(11	)
Net change in tax-equivalent net interest income		$	414			$	765			$	(351	)

 

 

	(1)	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.
	(2)	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.

 

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 $377,000 and $365,000 for the six months ended June 30, 2016 and 2015, respectively. These adjustments were computed using a 34% federal income tax rate.

 

As shown in Tables 1 and 2, tax-equivalent net interest income increased $413,000 in the first six months of 2016 compared to the same period in 2015. The effect of growth in average interest-earning assets was partially offset by an increase in average interest-bearing liabilities, which caused net interest income to increase $765,000 in the first half of 2016 compared to the same period in the prior year. Net interest spread was reduced 6 basis points from 3.73% in the first six months of 2015, to 3.67% in the first half in 2016, which caused a decline in net interest income of $352,000.

 

The decline in the interest spread was due to a 9 basis point decrease in the average rate earned on interest-earning assets in the first half of 2016 compared to the same six months in 2015, which was partially offset by a 3 basis point decrease in the average rate paid on interest-bearing liabilities. The reduction in the average rate earned on interest-earning assets was caused by relatively low general market rates on new loan originations and securities purchased in 2015 and the first half of 2016. Interest rates on loans are also being impacted by rate pressure from some of ChoiceOne’s competing financial institutions. The lower rate paid on interest-bearing liabilities resulted from repricing of local deposits as general market interest rates remained low during 2015 and the first six months of 2016.

 

The average balance of loans increased $11.7 million in the first six months of 2016 compared to the same period in 2015. Average commercial and industrial and commercial real estate loans were $7.3 million higher, while average residential mortgage and consumer loans grew $4.3 million and $0.1 million, respectively, in the same time period. The increase in the average loans balance was offset by a 7 basis point decrease in the average rate earned. This caused tax-equivalent interest income from loans to increase $154,000 in the first half of 2016 compared to the same period in the prior year. The average balance of total securities grew $20.2 million in the first six months of 2016 compared to the same period in 2015. Additional securities were purchased in 2015 and in the first half of 2016 to provide added liquidity and to provide earning asset growth. Growth in average securities, partially offset by the effect of lower interest rates earned, caused interest income to increase $235,000 in the first six months of 2016 compared to the same period in 2015.

 

 

The average balance of interest-bearing demand deposits increased $40.2 million in the first six months of 2016 compared to the same period in 2015. The effect of $1.6 million of growth in the average balance of Federal Home Loan Bank advances and a 20 basis point increase in the average rate paid caused interest expense to increase $28,000 in the first six months of 2016 compared to the same period in the prior year. Although interest bearing liabilities had a higher average balance during the first six months of 2016 compared to the same period in 2015, interest expense decreased by $20,000 due to a 3 basis point decrease in the average rate paid.

 

Provision and Allowance for Loan Losses

Total loans increased $5.7 million in the first half of 2016, while the allowance for loan losses increased $102,000 during the same period. There was no provision for loan losses in the first half of 2016 compared to $100,000 in the first half of 2015. Nonperforming loans were $6.0 million as of June 30, 2016, compared to $6.3 million as of March 31, 2016 and $5.5 million as of December 31, 2015. The increase in nonperforming loans in the first six months of 2016 was comprised primarily of an increase of $438,000 in nonaccrual loans. The allowance for loan losses was 1.20% of total loans at June 30, 2016, compared to 1.17% at March 31, 2016, and 1.20% at December 31, 2015.

 

Charge-offs and recoveries for respective loan categories for the six months ended June 30 were as follows:

 

(Dollars in thousands)		2016								2015
			Charge-offs				Recoveries				Charge-offs				Recoveries
Agricultural		$	—			$	—			$	—			$	1
Commercial and industrial			33				23				—				48
Consumer			68				69				106				79
Real estate, commercial			—				31				—				21
Real estate, residential			69				149				21				58
		$	170			$	272			$	127			$	207

 

Net recoveries were $172,000 in the second quarter of 2016 and $102,000 in the first six months of 2016 compared to $32,000 of net recoveries in the second quarter of 2015 and net recoveries of $80,000 in the first six months of 2015. Net charge-offs on an annualized basis as a percentage of average loans were a negative 0.06% in the first six months of 2016 compared to a negative 0.05% 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 2016, 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 increased $200,000 in the second quarter of 2016 and declined $251,000 in the first six months of 2016 compared to the same periods in 2015. The small decrease in customer service charges in both the second quarter and first half of 2016 compared to the same periods in the prior year was caused primarily by lower overdraft fees. The decline in insurance and investment commissions in the second quarter and the first six months of 2016 compared to the same periods in 2015 resulted primarily from lower commissions from sales of real estate investment trusts. Gains on sales of loans grew $110,000 in the second quarter and $26,000 in the first half of 2016 compared to the same periods in the prior year as a result of increased residential mortgage originations. An increase of $111,000 in the second quarter and $173,000 in the first six months of 2016 in gains on sales of securities when compared to the same periods in 2015 resulted from higher sales activity in the current year. A lower loss on sales of other assets in the second quarter and first half of 2016 compared to the same periods in 2015 resulted from less write-downs of other real estate owned property in those periods. A death benefit of $308,000 received on a bank owned life insurance policy in the first quarter of 2015 was the cause of the decline in earnings on life insurance policies in the first six months of 2016 compared to the similar period in the prior year.

 

 

Noninterest Expense

Total noninterest expense increased $416,000 in the second quarter of 2016 and $654,000 in the first six months of 2016 compared to the same periods in 2015. Salaries and benefits expense increased $351,000 in the second quarter and $463,000 in the first six months of 2016 compared to the same periods in the prior year. The increase in salaries and benefits was the result of higher costs related to salaries and stock compensation expense, which were partially offset by lower commission expenses. An increase of $145,000 in occupancy and equipment expense in the first half of 2016 compared to the same period in 2015 was partially due to the opening of a new loan production office and higher expenses related to general repairs and maintenance. Other noninterest expense increases in the first half of 2016 compared to the first six months of 2015 were caused primarily by higher donation and recruiting expenses.

 

Income Tax Expense

Income tax expense was $947,000 in the first six months of 2016 compared to $996,000 for the same period in 2015. The effective tax rate was 25.8% for 2016 and 24.5% for 2015. The increase in the effective tax rate in 2016 compared to 2015 was due to the effect of a $308,000 nontaxable death benefit received in the first quarter of 2015 from a bank owned life insurance policy.

 

FINANCIAL CONDITION

 

Securities

The securities available for sale portfolio increased $3.9 million in the second quarter and increased $15.0 million in the first six months of 2016. The increase in the securities portfolio resulted from ChoiceOne’s desire to grow earning assets. Various securities totaling $47.4 million were purchased in the first half of 2016 to provide earning assets and to replace maturities, principal repayments, and calls within the securities portfolio. Approximately $21.7 million in various securities were called or matured since the end of 2015. Principal repayments on securities totaled $1.1 million in the first six months of 2016. Approximately $11.2 million of securities were sold in the first six months of 2016 for a net gain of $226,000.

 

Loans

The loan portfolio (excluding loans held for sale) increased $5.9 million in the second quarter of 2016 and increased $7.9 million in the first six months of 2016. Commercial real estate loans increased $8.5 million, agriculture loans decreased by $5.6 million and commercial and industrial loans increased by $3.4 million during the first half of 2016. The decrease in agricultural loans was caused in part by seasonal pay downs by borrowers. Consumer and residential real estate loans have also increased in the first six months of 2016 with growth of $0.8 million and $0.8 million, respectively since the end of December. The environment for loan originations in ChoiceOne’s market area has become increasingly competitive.

 

Asset Quality

Information regarding impaired loans can be found in Note 3 to the consolidated financial statements included in this report. The total balance of loans classified as impaired was $6.0 million as of June 30, 2016, compared to $6.3 million as of March 31, 2016 and $5.6 million as of December 31, 2015. A decline in the balance of impaired commercial real estate loans of $455,000 during the second quarter of 2016 was offset by an increase of $256,000 in residential real estate loans classified as impaired.

 

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:

 

(Dollars in thousands)		June 30,				December 31,
		2016				2015
Loans accounted for on a nonaccrual basis		$	2,636			$	2,198
Accruing loans contractually past due 90 days or more as to principal or interest payments			102				29
Loans considered troubled debt restructurings			3,290				3,271
Total		$	6,028			$	5,498

 

At June 30, 2016, nonaccrual loans included $46,000 in agricultural loans, $289,000 in commercial and industrial loans, $1,719,000 in commercial real estate loans, and $582,000 in residential real estate loans. At December 31, 2015, nonaccrual loans included $50,000 in agricultural loans, $77,000 in commercial and industrial loans, $1,640,000 in commercial real estate loans, and $431,000 in residential real estate loans. Management believes the allowance allocated to its nonperforming loans is sufficient at June 30, 2016.

 

 

Deposits and Borrowings

Total deposits decreased $16.0 million in the second quarter of 2016 and $10.9 million since the end of 2015. Checking and savings deposits declined $10.3 million in the first six months of 2016, while certificates of deposit decreased $0.6 million. ChoiceOne continued to place an emphasis on building its core deposits base in 2016. The decrease in deposits in the first half of 2016 was a normal seasonal fluctuation for ChoiceOne.

 

A decrease of $4.1 million in repurchase agreements in the first six months of 2016 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 Home Loan Bank advances grew $34.0 million in the first half of 2016 as advances were used to provide funding for earning asset growth and to replace the decline in deposits.

 

Shareholders’ Equity

Total shareholders’ equity increased $2.6 million from December 31, 2015 to June 30, 2016. Growth in equity resulted from current year’s net income, an increase in accumulated other comprehensive income, and proceeds from the issuance of ChoiceOne stock, which were offset by cash dividends paid and repurchases of stock. The $1.2 million in other comprehensive income since the end of 2015 was caused by an increase in net unrealized gains on available for sale securities. The change in unrealized gains resulted from decreases in certain interest rate terms since December 31, 2015, which increased the market value of the Bank’s securities.

 

 

Following is information regarding the Bank’s compliance with regulatory capital requirements:

																		Minimum Required
																		to be Well
										Minimum Required								Capitalized Under
										for Capital								Prompt Corrective
(Dollars in thousands)		Actual								Adequacy Purposes								Action Regulations
			Amount				Ratio				Amount				Ratio				Amount				Ratio
June 30, 2016
ChoiceOne Financial Services Inc.
Total capital (to risk weighted assets)		$	60,347				13.8	%		$	35,018				8.0	%			N/A				N/A
Tier 1 capital (to risk weighted assets)			56,077				12.8				17,509				6.0				N/A				N/A
Common Equity Tier 1 Capital (to risk weighted assets)			56,077				12.8				19,698				4.5				N/A				N/A
Tier 1 capital (to average assets)			56,077				9.8				22,779				4.0				N/A				N/A
ChoiceOne Bank
Total capital (to risk weighted assets)		$	57,067				13.1	%		$	34,955				8.0	%		$	43,694				10.0	%
Tier 1 capital (to risk weighted assets)			52,797				12.1				17,478				6.0				26,216				8.0
Common Equity Tier 1 Capital (to risk weighted assets)			52,797				12.1				19,662				4.5				28,401				6.5
Tier 1 capital (to average assets)			52,797				9.3				22,659				4.0				28,324				5.0
December 31, 2015
ChoiceOne Financial Services Inc.
Total capital (to risk weighted assets)		$	59,737				14.2	%		$	33,600				8.0	%			N/A				N/A
Common Equity Tier 1 Capital (to risk weighted assets)			54,532				13.0				18,900				4.5				N/A				N/A
Tier 1 capital (to risk weighted assets)			54,532				13.0				16,800				4.0				N/A				N/A
Tier 1 capital (to average assets)			54,532				9.7				22,434				4.0				N/A				N/A
ChoiceOne Bank
Total capital (to risk weighted assets)		$	55,723				13.3	%		$	33,470				8.0	%		$	41,837				10.0	%
Common Equity Tier 1 Capital (to risk weighted assets)			51,574				12.3				18,827				4.5				27,194				6.5
Tier 1 capital (to risk weighted assets)			51,574				12.3				16,735				4.0				25,102				6.0
Tier 1 capital (to average assets)			51,574				9.2				22,350				4.0				27,937				5.0

 

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 June 30, 2016 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 $6.4 million for the six months ended June 30, 2016 compared to $3.2 million provided in the same period a year ago. The change was caused by an increase in net cash flows provided by loans originated for sale in the secondary market. Net cash used for investing activities was $21.5 million for the first half of 2016, compared to net cash provided of $1.0 million in the same period in 2015. The change was due to an increase in loan balances in the first half of 2016 in contrast with a decrease in the same period in 2015. Also contributing to the change was a higher level of securities growth in 2016 than in 2015. Net cash provided from financing activities was $17.4 million in the first six months of 2016 compared to net cash used from financing activities of $5.6 million during the same period in the prior year. A higher level of net proceeds from Federal Home Loan Bank advances was partially offset by a decline in deposits in the first half of 2016.

 

Management believes that the current level of liquidity is sufficient to meet the Bank’s normal operating needs. This belief is based upon the availability of deposits from both the local and national markets, maturities of securities, normal loan repayments, income retention, federal funds purchased from correspondent banks, and advances available from the Federal Home Loan Bank. The Bank also has a secured line of credit available from the Federal Reserve Bank.

 

 

Item 4.  Controls and Procedures.

 

An evaluation was performed under the supervision and with the participation of 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 June 30, 2016 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, 2015. 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, 2015.

 

Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds.

 

On April 27, 2016, ChoiceOne issued 731 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 $17,000. On May 18, 2016, ChoiceOne issued 1,789 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 $41,000. ChoiceOne relied on the exemption contained in Section 4(a)(5) of the Securities Act of 1933 in connection with these sales.

 

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

The following table provides information regarding ChoiceOne’s purchases of its common stock during the quarter ended June 30, 2016.

 

										Total Number				Maximum
										of Shares				Number of
										Purchased as				Shares that
(Dollars in thousands, except per share data)		Total Number				Average				Part of a				May Yet be
		of Shares				Price Paid				Publicly				Purchased
Period		Purchased				per Share				Announced Plan				Under the Plan
April 1 - April 30, 2016
Employee Transactions			—			$	—
Repurchase Plan			—			$	—				—				59,224
May 1 - May 31, 2016
Employee Transactions			—			$	—
Repurchase Plan (1)			30,000			$	22.60				30,000				29,224
June 1 - June 30, 2016
Employee Transactions			—			$	—
Repurchase Plan			—			$	—				—				29,224

 

(1)

On May 4, 2016, ChoiceOne purchased 30,000 shares of common stock for an aggregate cash price of $678,000. As of June 30, 2016, there are 29,224 shares remaining that may yet be purchased under approved plans. The repurchase plan was adopted and announced on July 26, 2007. There is no stated expiration date. The plan authorized the repurchase of up to 100,000 shares.

 

Item 6.  Exhibits

 

The following exhibits are filed or incorporated by reference as part of this report:

 

	Exhibit Number		Document
	3.1		Amended and Restated Articles of Incorporation of ChoiceOne. Previously filed as an exhibit to ChoiceOne’s Form 10-K Annual Report for the year ended December 31, 2013.  Here incorporated by reference.
	3.2		Bylaws of ChoiceOne.  Previously filed as an exhibit to ChoiceOne’s Form 10-K Annual Report for the year ended December 31, 2013.  Here incorporated by reference.
	31.1		Certification of President and Chief Executive Officer
	31.2		Certification of Treasurer
	32.1   101.1		Certification pursuant to 18 U.S.C. § 1350.   Interactive Data File.

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

	CHOICEONE FINANCIAL SERVICES, INC.
Date:   August 12, 2016	/s/ Kelly J. Potes
	Kelly J. Potes Chief Executive Officer (Principal Executive Officer)
Date:   August 12, 2016	/s/ Thomas L. Lampen
	Thomas L. Lampen Treasurer (Principal Financial and Accounting Officer)