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 September 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 October 31, 2016, the Registrant had outstanding 3,276,097 shares of common stock.

 

 

PART I. FINANCIAL INFORMATION

 

Item 1.  Financial Statements.

 

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

(Dollars in thousands)		September 30, 2016 (Unaudited)				December 31, 2015 (Audited)
Assets
Cash and due from banks		$	12,644			$	11,187
Securities available for sale (Note 2)			177,444				160,136
Federal Home Loan Bank stock			1,679				1,614
Federal Reserve Bank stock			1,573				1,573
Loans held for sale			2,838				4,957
Loans (Note 3)			362,603				349,304
Allowance for loan losses (Note 3)			(4,276	)			(4,194	)
Loans, net			358,327				345,110
Premises and equipment, net			12,394				11,847
Cash value of life insurance policies			12,526				12,261
Intangible assets, net			43				379
Goodwill			13,728				13,728
Other assets			5,468				4,954
Total assets		$	598,664			$	567,746
Liabilities
Deposits – noninterest-bearing		$	123,609			$	122,937
Deposits – interest-bearing			353,778				351,759
Total deposits			477,387				474,696
Federal funds purchased			624				—
Repurchase agreements			6,417				9,460
Advances from Federal Home Loan Bank			37,309				11,332
Other liabilities			3,348				2,416
Total liabilities			525,085				497,904
Shareholders’ Equity
Common stock and paid in capital, no par value; shares authorized: 7,000,000; shares outstanding: 3,275,201 at September 30, 2016 and 3,295,228 at December 31, 2015			46,228				46,501
Retained earnings			24,866				22,138
Accumulated other comprehensive income, net			2,485				1,203
Total shareholders’ equity			73,579				69,842
Total liabilities and shareholders’ equity		$	598,664			$	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 September 30,								Nine Months Ended September 30,
		2016				2015				2016				2015
Interest income
Loans, including fees		$	4,210			$	4,015			$	12,293			$	11,945
Securities:
Taxable			594				489				1,731				1,427
Tax exempt			358				361				1,088				1,067
Other			5				6				14				10
Total interest income			5,167				4,871				15,126				14,449
Interest expense
Deposits			190				222				599				663
Advances from Federal Home Loan Bank			44				17				119				64
Other			2				7				7				28
Total interest expense			236				246				725				755
Net interest income			4,931				4,625				14,401				13,694
Provision for loan losses			—				—				—				100
Net interest income after provision for loan losses			4,931				4,625				14,401				13,594
Noninterest income
Customer service charges			1,030				1,092				3,020				3,137
Insurance and investment commissions			290				219				740				852
Gains on sales of loans			508				308				1,345				1,120
Gains on sales of securities			28				155				255				208
Losses on sales and write-downs of other assets			(3	)			(21	)			(26	)			(97	)
Earnings on life insurance policies			88				87				265				562
Other			124				120				360				322
Total noninterest income			2,065				1,960				5,959				6,104
Noninterest expense
Salaries and benefits			2,542				2,323				7,519				6,835
Occupancy and equipment			626				598				1,959				1,786
Data processing			556				558				1,654				1,689
Professional fees			232				263				700				776
Supplies and postage			92				100				312				278
Advertising and promotional			52				54				184				179
Intangible amortization			112				112				336				336
Loan and collection expense			15				53				59				104
FDIC insurance			78				72				218				222
Other			364				469				1,426				1,441
Total noninterest expense			4,669				4,602				14,367				13,646
Income before income tax			2,327				1,983				5,993				6,052
Income tax expense			644				533				1,591				1,529
Net income		$	1,683			$	1,450			$	4,402			$	4,523
Basic earnings per share (Note 4)		$	0.52			$	0.44			$	1.34			$	1.37
Diluted earnings per share (Note 4)		$	0.52			$	0.44			$	1.34			$	1.37
Dividends declared per share		$	0.17			$	0.17			$	0.51			$	0.49

 

See accompanying notes to interim consolidated financial statements.

 

 

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

(Dollars in thousands)		Three Months Ended September 30,								Nine Months Ended September 30,
		2016				2015				2016				2015
Net income		$	1,683			$	1,450			$	4,402			$	4,523
Other comprehensive income:
Changes in net unrealized gains on investment securities available for sale, net of tax expense of $36 and $291 for the three months ended September 30, 2016 and  September 30, 2015 respectively.  Changes in net unrealized gains on investment securities available for sale, net of tax expense of $748 and $356 for the nine months ended September 30, 2016 and September 30, 2015 respectively.			68				564				1,450				688
Less: Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax benefit of $9 and $53 for the three months ended September 30, 2016 and  September 30, 2015 respectively.  Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax benefit of $87 and $71 for the nine months ended September 30, 2016 and  September 30, 2015 respectively.			(19	)			(102	)			(168	)			(137	)
Change in adjustment for pension and other postretirement benefits, net of tax benefit (expense).			—				—				—				—
Other comprehensive income (loss), net of tax			49				462				1,282				551
Comprehensive income		$	1,732			$	1,912			$	5,684			$	5,074

 

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											4,523								4,523
Other comprehensive income															551				551
Shares issued			10,010				153												153
Change in ESOP repurchase obligation							(4	)											(4	)
Shares repurchased			(16,200	)			(371	)											(371	)
Effect of employee stock purchases							9												9
Stock-based compensation			2,284				60												60
Cash dividends declared ($0.49 per share)											(1,610	)							(1,610	)
Balance, September 30, 2015			3,291,928			$	46,399			$	21,478			$	1,624			$	69,501
Balance, January 1, 2016			3,295,228			$	46,501			$	22,138			$	1,203			$	69,842
Net income											4,402								4,402
Other comprehensive income															1,282				1,282
Shares issued			11,559				137												137
Change in ESOP repurchase obligation							127												127
Shares repurchased			(35,000	)			(794	)											(794	)
Effect of employee stock purchases							9												9
Stock-based compensation			3,414				248												248
Cash dividends declared ($0.51 per share)											(1,674	)							(1,674	)
Balance, September 30, 2016			3,275,201			$	46,228			$	24,866			$	2,485			$	73,579

 

See accompanying notes to interim consolidated financial statements.

 

 

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

(Dollars in thousands)		Nine Months Ended September 30,
		2016				2015
Cash flows from operating activities:
Net income		$	4,402			$	4,523
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses			—				100
Depreciation			757				736
Amortization			1,199				1,111
Compensation expense on stock purchases and restricted stock units			257				69
Gains on sales of securities			(255	)			(208	)
Gains on sales of loans			(1,345	)			(1,120	)
Loans originated for sale			(39,173	)			(36,402	)
Proceeds from loan sales			42,313				37,093
Earnings on bank-owned life insurance			(265	)			(562	)
Proceeds on bank-owned life insurance			—				461
(Gains) Losses on sales of other real estate owned			3				(11	)
Write-downs of other real estate owned			—				108
Proceeds from sales of other real estate owned			28				299
Deferred federal income tax benefit			(86	)			(209	)
Net changes in other assets			(135	)			(716	)
Net changes in other liabilities			481				(452	)
Net cash from operating activities			8,181				4,820
Cash flows from investing activities:
Securities available for sale:
Sales			14,538				23,329
Maturities, prepayments and calls			33,412				12,469
Purchases			(63,780	)			(47,171	)
Loan originations and payments, net			(13,700	)			2,733
Additions to premises and equipment			(1,112	)			(826	)
Net cash from investing activities			(30,642	)			(9,466	)
Cash flows from financing activities:
Net change in deposits			2,691				32,268
Net change in repurchase agreements			(3,043	)			(19,705	)
Net change in federal funds purchased			624				1,171
Proceeds from Federal Home Loan Bank advances			271,000				116,575
Payments on Federal Home Loan Bank advances			(245,023	)			(128,098	)
Issuance of common stock			137				153
Repurchase of common stock			(794	)			(371	)
Cash dividends			(1,674	)			(1,610	)
Net cash from financing activities			23,918				383
Net change in cash and cash equivalents			1,457				(4,263	)
Beginning cash and cash equivalents			11,187				16,650
Ending cash and cash equivalents		$	12,644			$	12,387
Supplemental disclosures of cash flow information:
Cash paid for interest		$	726			$	766
Cash paid for taxes		$	925			$	2,395
Loans transferred to other real estate owned		$	483			$	378

 

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 September 30, 2016 and December 31, 2015, the Consolidated Statements of Income for the three- and nine-month periods ended September 30, 2016 and September 30, 2015, the Consolidated Statements of Comprehensive Income for the three- and nine-month periods ended September 30, 2016 and September 30, 2015, the Consolidated Statements of Changes in Shareholders’ Equity for the nine-month periods ended September 30, 2016 and September 30, 2015, and the Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2016 and September 30, 2015. Operating results for the nine months ended September 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 assets reported on the balance sheets as well as its net income.

 

Stock Transactions

A total of 4,112 shares of common stock were issued to ChoiceOne’s Board of Directors for a cash price of $95,000 under the terms of the Directors’ Stock Purchase Plan in the first nine months of 2016. A total of 4,793 shares of common stock were issued upon the exercise of stock options in the first three quarters of 2016. A total of 2,654 shares of common stock were issued to employees for a cash price of $51,000 under the Employee Stock Purchase Plan in the first nine months of 2016. A total of 3,414 shares of common stock were issued to employees upon vesting of Restricted Stock Units during the first three quarters of 2016. A total of 35,000 shares of common stock were repurchased by ChoiceOne in the first nine 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 issuance of one share of ChoiceOne common stock.

 

 

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:

 

		September 30, 2016
							Gross				Gross
(Dollars in thousands)			Amortized				Unrealized				Unrealized				Fair
			Cost				Gains				Losses				Value
U.S. Government and federal agency		$	64,440			$	381			$	(17	)		$	64,804
U.S. Treasury			2,074				43				(1	)			2,116
State and municipal			87,661				2,878				(25	)			90,514
Mortgage-backed			8,511				62				(14	)			8,559
Corporate			7,370				64				(1	)			7,433
Foreign debt			1,000				2				—				1,002
Equity securities			2,614				204				—				2,818
Asset-backed securities			202				—				(4	)			198
Total		$	173,872			$	3,634			$	(62	)		$	177,444

 

		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				0				(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

 

 

Contractual maturities of securities available for sale at September 30, 2016 were as follows:

 

(Dollars in thousands)			Fair
			Value
Due within one year		$	31,758
Due after one year through five years			95,744
Due after five years through ten years			44,022
Due after ten years			3,103
Total debt securities			174,627
Equity securities			2,817
Total		$	177,444

 

Securities with unrealized losses at September 30, 2016 and year-end 2015, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, were as follows:

 

		September 30, 2016
		Less than 12 months								More than 12 months								Total
(Dollars in thousands)		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
U.S. Government and federal agency		$	7,551			$	(18	)		$	—			$	—			$	7,551			$	(18	)
State and municipal			3,506				(19	)			260				(5	)			3,766				(24	)
Mortgage-backed			2,827				(12	)			280				(1	)			3,107				(13	)
Corporate			501				(1	)			399				(1	)			900				(2	)
Asset-backed securities			—				—				198				(5	)			198				(5	)
Total temporarily impaired		$	14,385			$	(50	)		$	1,137			$	(12	)		$	15,522			$	(62	)

 

		December 31, 2015
		Less than 12 months								More than 12 months								Total
(Dollars in thousands)		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
		Value				Losses				Value				Losses				Value				Losses
U.S. Government and federal agency		$	38,567			$	(216	)		$	986			$	(13	)		$	39,553			$	(229	)
U.S. Treasury notes and bonds			6,101				(33	)			—				—				6,101				(33	)
State and municipal			10,382				(69	)			2,906				(40	)			13,288				(109	)
Mortgage-backed			4,459				(41	)			382				(4	)			4,841				(45	)
Corporate			4,284				(33	)			896				(6	)			5,180				(39	)
Foreign debt			995				(5	)			—				—				995				(5	)
Asset-backed securities			—				—				270				(4	)			270				(4	)
Total temporarily impaired		$	64,788			$	(397	)		$	5,440			$	(67	)		$	70,228			$	(464	)

 

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 during the nine months ended September 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 were as follows:

(Dollars in thousands)		Agricultural				Commercial and Industrial				Consumer				Commercial Real Estate				Construction Real Estate				Residential Real Estate				Unallocated				Total
Allowance for Loan Losses
Three Months Ended September 30, 2016
Beginning balance		$	399			$	656			$	279			$	1,133			$	44			$	1,222			$	563			$	4,296
Charge-offs			—				—				(68	)			—				—				(25	)			—				(93	)
Recoveries			—				8				49				5				—				11				—				73
Provision			(11	)			(55	)			30				340				(3	)			(205	)			(96	)			—
Ending balance		$	388			$	609			$	290			$	1,478			$	41			$	1,003			$	467			$	4,276
Nine Months Ended September 30, 2016
Beginning balance		$	420			$	586			$	297			$	1,030			$	46			$	1,388			$	427			$	4,194
Charge-offs			—				(33	)			(136	)			—				—				(94	)			—				(263	)
Recoveries			—				31				119				35				—				160				—				345
Provision			(32	)			26				10				412				(5	)			(451	)			40				—
Ending balance		$	388			$	610			$	290			$	1,477			$	41			$	1,003			$	467			$	4,276
Individually evaluated for impairment		$	4			$	8			$	1			$	167			$	—			$	321			$	—			$	501
Collectively evaluated for impairment		$	384			$	602			$	289			$	1,310			$	41			$	682			$	467			$	3,775
Three Months Ended September 30, 2015
Beginning balance		$	279			$	498			$	193			$	1,284			$	28			$	1,375			$	695			$	4,352
Charge-offs			—				—				(65	)			—				—				(25	)			—				(90	)
Recoveries			—				11				25				15				—				4				—				55
Provision			10				(14	)			57				(179	)			15				(2	)			113				—
Ending balance		$	289			$	495			$	210			$	1,120			$	43			$	1,352			$	808			$	4,317
Nine Months Ended September 30, 2015
Beginning balance		$	187			$	527			$	183			$	1,641			$	9			$	1,193			$	433			$	4,173
Charge-offs			—				—				(172	)			—				—				(46	)			—				(218	)
Recoveries			1				59				104				36				—				62				—				262
Provision			101				(91	)			95				(557	)			34				143				375				100
Ending balance		$	289			$	495			$	210			$	1,120			$	43			$	1,352			$	808			$	4,317
Individually evaluated for impairment		$	3			$	1			$	29			$	296			$	—			$	355			$	—			$	684
Collectively evaluated for impairment		$	286			$	494			$	181			$	824			$	43			$	997			$	808			$	3,633
Loans
September 30, 2016
Individually evaluated for impairment		$	534			$	450			$	26			$	1,459			$	—			$	3,109							$	5,578
Collectively evaluated for impairment			37,744				95,221				21,427				107,608				6,027				88,998								357,025
Ending balance		$	38,278			$	95,671			$	21,453			$	109,067			$	6,027			$	92,107							$	362,603
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)		September 30,				December 31,				September 30,				December 31,				September 30,				December 31,
		2016				2015				2016				2015				2016				2015
Risk ratings 1 and 2		$	8,072			$	10,416			$	11,672			$	10,480			$	7,305			$	3,875
Risk rating 3			21,626				25,189				63,450				66,921				57,355				57,540
Risk rating 4			7,269				3,086				19,242				16,169				40,692				29,826
Risk rating 5			1,267				1,491				1,227				574				3,153				3,776
Risk rating 6			44				50				80				129				562				2,719
Risk rating 7			—				—				—				74				—				—
		$	38,278			$	40,232			$	95,671			$	94,347			$	109,067			$	97,736
Corporate Credit Exposure - Credit Risk Profile Based On Payment Activity:
		Consumer								Construction Real Estate								Residential Real Estate
(Dollars in thousands)		September 30,				December 31,				September 30,				December 31,				September 30,				December 31,
		2016				2015				2016				2015				2016				2015
Performing		$	21,448			$	20,090			$	6,027			$	5,390			$	91,317			$	90,796
Nonperforming			5				—				—				—				336				282
Nonaccrual			—				—				—				—				454				431
		$	21,453			$	20,090			$	6,027			$	5,390			$	92,107			$	91,509

 

 

The following schedule provides information on loans that were considered TDRs that were modified during the three- and nine-month periods ended September 30, 2016:

 

		Three Months Ended September 30, 2016												Nine Months Ended September 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
Agricultural			—			$	—			$	—				1			$	113			$	113
Residential real estate			—				—				—				2				156				156
			—			$	—			$	—				3			$	269			$	269

 

The following schedule provides information on loans that were considered TDRs that were modified during the three- and nine-month periods ended September 30, 2015:

 

		Three Months Ended September 30, 2015												Nine Months Ended September 30, 2015
						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			—			$	—			$	—				4			$	448			$	448
Residential real estate			1				85				85				2				193				193
			1			$	85			$	85				6			$	641			$	641

 

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 September 30, 2016 where the borrower was past due with respect to principal and/or interest for 30 days or more during the three months and nine months ended September 30, 2016 that had been modified during the year prior to the default:

 

Three Months Ended

Nine Months Ended

September 30, 2016

September 30, 2016

(Dollars in thousands)

Number

Recorded

Number

Recorded

of Loans

Investment

of Loans

Investment

Agricultural

—

$

—

1

$

113

 

The following schedule provides information on TDRs as of September 30, 2015 where the borrower was past due with respect to principal and/or interest for 30 days or more during the three months and nine months ended September 30, 2015 that had been modified during the year prior to the default:

 

Three Months Ended

Nine Months Ended

September 30, 2015

September 30, 2015

(Dollars in thousands)

Number

Recorded

Number

Recorded

of Loans

Investment

of Loans

Investment

Commercial real estate

2

$

293

3

$

409

 

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

 

 

Impaired loans by loan category follow:

 

						Unpaid
(Dollars in thousands)		Recorded				Principal				Related
		Investment				Balance				Allowance
September 30, 2016
With no related allowance recorded
Agricultural		$	489			$	493			$	—
Commercial and industrial			177				177				—
Consumer			5				5				—
Commercial real estate			230				351				—
Residential real estate			266				266				—
Subtotal			1,167				1,292				—
With an allowance recorded
Agricultural			45				45				4
Commercial and industrial			273				247				8
Consumer			21				21				1
Commercial real estate			1,229				1,799				167
Residential real estate			2,843				2,859				321
Subtotal			4,411				4,971				501
Total
Agricultural			534				538				4
Commercial and industrial			450				424				8
Consumer			26				26				1
Commercial real estate			1,459				2,150				167
Residential real estate			3,109				3,125				321
Total		$	5,578			$	6,263			$	501
December 31, 2015
With no related allowance recorded
Agricultural		$	—			$	—			$	—
Commercial and industrial			74				103				—
Consumer			—				—				—
Commercial real estate			1,540				1,540				—
Residential real estate			13				13				—
Subtotal			1,627				1,656				—
With an allowance recorded
Agricultural			50				50				3
Commercial and industrial			118				118				15
Consumer			24				24				1
Commercial real estate			1,250				1,755				191
Residential real estate			2,516				2,516				296
Subtotal			3,958				4,463				506
Total
Agricultural			50				50				3
Commercial and industrial			192				221				15
Consumer			24				24				1
Commercial real estate			2,790				3,295				191
Residential real estate			2,529				2,529				296
Total		$	5,585			$	6,119			$	506

 

 

The following schedule provides information regarding average balances of impaired loans and interest recognized on impaired loans for the nine months ended September 30, 2016 and 2015:

 

		Average				Interest
(Dollars in thousands)		Recorded				Income
		Investment				Recognized
September 30, 2016
With no related allowance recorded
Agricultural		$	154			$	(1	)
Commercial and industrial			63				—
Consumer			1				—
Commercial real estate			1,071				33
Residential real estate			134				46
Subtotal			1,423				78
With an allowance recorded
Agricultural			79				16
Commercial and industrial			242				4
Consumer			22				3
Commercial real estate			1,426				116
Residential real estate			2,670				308
Subtotal			4,439				447
Total
Agricultural			233				15
Commercial and industrial			305				4
Consumer			23				3
Commercial real estate			2,497				149
Residential real estate			2,804				354
Total		$	5,862			$	525
September 30, 2015
With no related allowance recorded
Agricultural		$	—			$	—
Commercial and industrial			13				—
Consumer			2				—
Commercial real estate			941				23
Residential real estate			236				(1	)
Subtotal			1,192				22
With an allowance recorded
Agricultural			65				(6	)
Commercial and industrial			26				1
Consumer			37				2
Commercial real estate			2,190				53
Residential real estate			2,402				64
Subtotal			4,720				114
Total
Agricultural			65				(6	)
Commercial and industrial			39				1
Consumer			39				2
Commercial real estate			3,131				76
Residential real estate			2,638				63
Total		$	5,912			$	136

 

 

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
September 30, 2016
Agricultural		$	—			$	—			$	113			$	113			$	38,165			$	38,278			$	—
Commercial and industrial			97				—				249				346				95,325				95,671				—
Consumer			40				6				5				51				21,402				21,453				5
Commercial real estate			—				256				260				516				108,551				109,067				—
Construction real estate			—				—				—				—				6,027				6,027				—
Residential real estate			230				614				487				1,331				90,776				92,107				346
		$	367			$	876			$	1,114			$	2,357			$	360,246			$	362,603			$	351
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)		September 30,				December 31,
		2016				2015
Agricultural		$	489			$	50
Commercial and industrial			320				77
Consumer			—				—
Commercial real estate			471				1,640
Construction real estate			—				—
Residential real estate			455				431
		$	1,735			$	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								Nine Months Ended
(Dollars in thousands, except per share data)		September 30,								September 30,
		2016				2015				2016				2015
Basic Earnings Per Share
Net income available to common shareholders		$	1,683			$	1,450			$	4,402			$	4,523
Weighted average common shares outstanding			3,275,841				3,289,146				3,290,610				3,287,765
Basic earnings per share		$	0.52			$	0.44			$	1.34			$	1.37
Diluted Earnings Per Share
Net income available to common shareholders		$	1,683			$	1,450			$	4,402			$	4,523
Weighted average common shares outstanding			3,275,841				3,289,146				3,290,610				3,287,765
Plus dilutive stock options and restricted stock units			3,949				6,686				4,171				6,841
Weighted average common shares outstanding and potentially dilutive shares			3,279,790				3,295,832				3,294,781				3,294,606
Diluted earnings per share		$	0.52			$	0.44			$	1.34			$	1.37

 

There were 30,000 stock options as of September 30, 2016 and zero stock options as of September 30, 2015, that were considered to be anti-dilutive to earnings per share for the three-month and nine-month periods ended September 30, 2016 and 2015. These stock options have been excluded from the calculation 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)
September 30, 2016
Assets:
Cash and due from banks		$	12,644			$	12,644			$	12,644			$	—			$	—
Securities available for sale			177,444				177,444				1,318				161,598				14,528
Federal Home Loan Bank and Federal
Reserve Bank stock			3,252				3,252				—				3,252				—
Loans held for sale			2,838				2,828				—				—				2,828
Loans, net			358,327				362,465				—				—				362,465
Liabilities:
Noninterest-bearing deposits			123,609				123,609				—				123,609				—
Interest-bearing deposits			353,778				353,470				—				353,470				—
Federal funds purchased			624				624				—				624				—
Repurchase agreements			6,417				6,417				—				6,417				—
Federal Home Loan Bank advances			37,309				37,283				—				37,283				—
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 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 September 30, 2016 and December 31, 2015 for new loans with similar maturities, applied until the loan is assumed to reprice or be paid off. 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 September 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 September 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

(Dollars in thousands)		Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)				Balance at Date Indicated
Investment Securities, Available for Sale – September 30, 2016
U.S. Treasury notes and bonds		$	—			$	2,116			$	—			$	2,116
U.S. Government and federal agency			—				64,804				—				64,804
State and municipal			—				77,885				12,629				90,514
Mortgage-backed			—				8,559				—				8,559
Corporate			—				7,034				399				7,433
Foreign debt			—				1,002				—				1,002
Equity securities			1,318				—				1,500				2,818
Asset backed securities			—				198				—				198
Total		$	1,318			$	161,598			$	14,528			$	177,444
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			131				946
Net purchases, sales, calls, and maturities			2,598				(2,075	)
Net transfers into Level 3			—				—
Balance, September 30		$	14,528			$	10,513

 

Of the Level 3 assets that were held by the Bank at September 30, 2016, the net unrealized gain for the nine months ended September 30, 2016 was $131,000, which is recognized in other comprehensive income in the consolidated balance sheet. Purchases of Level 3 securities during the first three quarters of 2016 and 2015 consisted of local municipal issues. During the first nine months of 2016, $5.1 million of Level 3 securities were purchased. There were no sales of Level 3 securities in the first nine months of 2016.

 

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
		Balance at				Assets				Inputs				Inputs
(Dollars in thousands)		Dates Indicated				(Level 1)				(Level 2)				(Level 3)
Impaired Loans
September 30, 2016		$	5,578			$	—			$	—			$	5,578
December 31, 2015		$	5,585			$	—			$	—			$	5,585
Other Real Estate
September 30, 2016		$	483			$	—			$	—			$	483
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 third quarter of 2016 was $1,683,000, which represented an increase of $233,000 or 16.1% compared to the same period in 2015. Net income for the first nine months of 2016 was $4,402,000, which represented a decrease of $121,000 or 2.7% compared to the same period in 2015. Increases in net interest income and noninterest income were partially offset by an increase in noninterest expense for the third quarter of 2016 compared to the third quarter of 2015. Basic earnings per common share were $0.52 for the third quarter and $1.34 for the first nine months of 2016, compared to $0.44 and $1.37, respectively, for the same periods in 2015. Diluted earnings per common share were the same during the time periods noted. The return on average assets and return on average shareholders’ equity percentages were 1.01% and 8.15%, respectively, for the first three quarters of 2016, compared to 1.10% and 8.86%, respectively, for the same periods in 2015.

 

Dividends

Cash dividends of $551,000 or $0.17 per share were declared in the third quarter of 2016, compared to $559,000 or $0.17 per share in the third quarter of 2015. The cash dividends declared in the first nine months of 2016 were $1,674,000 or $0.51 per share, compared to $1,610,000 or $0.49 per share declared in the same period in 2015. The cash dividend payout percentage was 38.0% for the first nine months of 2016 and 35.6% for the first nine months of 2015.

 

Interest Income and Expense

Tables 1 and 2 on the following pages provide information regarding interest income and expense for the nine-month periods ended September 30, 2016 and 2015. 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

 

		Nine Months Ended September 30,
		2016												2015
(Dollars in thousands)		Average Balance				Interest				Rate				Average Balance				Interest				Rate
Assets:
Loans (1)		$	355,281			$	12,301				4.62	%		$	339,157			$	11,953				4.70	%
Taxable securities (2) (3)			117,635				1,731				1.96				101,884				1,427				1.87
Nontaxable securities (1) (2)			53,685				1,643				4.08				49,513				1,613				4.34
Other			3,915				14				0.48				5,857				10				0.23
Interest-earning assets			530,516				15,689				3.94				496,411				15,003				4.03
Noninterest-earning assets			53,913												51,820
Total assets		$	584,429											$	548,231
Liabilities and Shareholders’ Equity:
Interest-bearing demand deposits		$	193,675				190				0.13	%		$	159,342				163				0.14	%
Savings deposits			72,619				16				0.03				67,351				19				0.04
Certificates of deposit			86,707				393				0.60				96,343				481				0.67
Advances from Federal Home Loan Bank			25,127				119				0.63				21,023				64				0.41
Other			8,698				7				0.11				21,475				28				0.17
Interest-bearing liabilities			386,826				725				0.25				365,534				755				0.28
Noninterest-bearing demand deposits			122,641												112,737
Other noninterest-bearing liabilities			2,945												1,932
Total liabilities			512,412												480,203
Shareholders’ equity			72,017												68,028
Total liabilities and shareholders’ equity		$	584,429											$	548,231
Net interest income (tax-equivalent basis)-interest spread (Non-GAAP)							14,964				3.69	%							14,248				3.75	%
Tax-equivalent adjustment (1)							(563	)											(554	)
Net interest income (GAAP)						$	14,401											$	13,694
Net interest income as a percentage of earning assets (tax-equivalent basis) (Non-GAAP)											3.76	%											3.83	%

  

 

	(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

 

		Nine Months Ended September 30,
(Dollars in thousands)		2016 Over 2015
		Total				Volume				Rate
Increase (decrease) in interest income (1)
Loans (2)		$	348			$	666			$	(318	)
Taxable securities			304				231				73
Nontaxable securities (2)			30				168				(138	)
Other			4				(6	)			10
Net change in tax-equivalent interest income			686				1,059				(373	)
Increase (decrease) in interest expense (1)
Interest-bearing demand deposits			27				43				(16	)
Savings deposits			(3	)			3				(6	)
Certificates of deposit			(88	)			(44	)			(44	)
Advances from Federal Home Loan Bank			55				15				40
Other			(21	)			(13	)			(8	)
Net change in interest expense			(30	)			4				(34	)
Net change in tax-equivalent net interest income		$	716			$	1,055			$	(339	)

 

 

	(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

For the nine months ended September 30, 2016 and 2015, net interest income was $14,401,000 and $13,694,000, respectively, and net interest income on a tax-equivalent basis was $14,964,000 and $14,248,000, respectively.

 

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 $563,000 and $554,000 for the nine months ended September 30, 2016 and 2015, respectively. These adjustments were computed using a 34% federal income tax rate. For a reconciliation of net interest income on a tax-equivalent basis, Table 1 - Average Balances and Tax-Equivalent Interest Rates.

 

As shown in Tables 1 and 2, tax-equivalent net interest income increased $716,000 in the first nine months of 2016 compared to the same period in 2015. The relationship between growth in average interest-earning assets and average interest-bearing liabilities caused net interest income to increase $1,055,000 in the first three quarters of 2016 compared to the same period in the prior year. A decrease of 6 basis points in the net interest spread from 3.75% in the first nine months of 2015 to 3.69% in the first nine months of 2016 resulted in a $339,000 decrease in net interest income.

 

The average balance of loans increased $16.1 million in the first nine months of 2016 compared to the same period in 2015. Average commercial loans increased $11.9 million and average residential mortgage loans increased $3.9 million in the first three quarters of 2016 compared to the same period in 2015. The average interest rate earned on loans declined 8 basis points from the first nine months of 2015 to the same period in 2016. This was the result of existing loan renewals and new loan production at lower rates than in the existing portfolio. The increase in the average loans balance partially offset by the decrease in the average rate earned caused tax-equivalent interest income from loans to increase $348,000 in the first three quarters of 2016 compared to the same period in the prior year. The average balance of total securities grew $19.9 million in the first nine months of 2016 compared to the same period in 2015. Additional securities were purchased during the first nine months of 2016 to provide earning asset growth. Growth in average securities, partially offset by the effect of a 5 basis point decline in interest rates earned caused tax-equivalent interest income to increase $334,000 in the first nine months of 2016 compared to the same period in 2015.

 

 

The average balance of interest-bearing demand deposits increased $34.3 million in the first nine months of 2016 compared to the same period in 2015. The effect of the higher average balance, offset by a 1 basis point decline in the average rate paid, caused interest expense to increase $27,000 in the first three quarters of 2016 compared to the same period in 2015. The average balance of savings deposits increased $5.3 million in the first nine months of 2016 compared to the same period in the prior year. The impact of the savings deposit growth offset by a 1 basis point decrease in the average rate paid caused interest expense to decrease $3,000 in the first nine months of 2016 compared to the same period in 2015. The average balance of certificates of deposit was down $9.6 million in the first nine months of 2016 compared to the same period in 2015. The decline in certificates of deposit plus a 7 basis point reduction in the average rate paid on certificates caused interest expense to fall $88,000 in the first nine months of 2016 compared to the same period in 2015. A $4.1 million increase in the average balance and a 22 basis point increase in the average rate paid caused interest expense from Federal Home Loan Bank advances to increase $55,000 in the first nine months of 2016 compared to the same period in the prior year. A decrease of $12.8 million in the average balance of other interest-bearing liabilities in the first nine months of 2016 compared to the first nine months of 2015 and the effect of a 6 basis point decrease in the average rate paid caused a $21,000 decrease in other interest expense.

 

The reduction in the average rate earned on interest-earning assets was caused by relatively low general market rates which affected new loan originations and securities purchases in the first nine months 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 nine months of 2016. If market interest rates continue to remain low, ChoiceOne’s net interest spread may continue to decrease in future quarters.

 

Provision and Allowance for Loan Losses

Total loans increased $13.3 million while the allowance for loan losses increased $82,000 from December 31, 2015 to September 30, 2016. The provision for loan losses was $0 in the third quarter and first nine months of 2016, compared to $0 and $100,000, respectively, in the same periods in 2015. Nonperforming loans were $5.6 million as of September 30, 2016, compared to $6.0 million as of June 30, 2016 and $5.5 million as of December 31, 2015. The allowance for loan losses was 1.18% of total loans at September 30, 2016, compared to 1.20% at June 30, 2016 and 1.20% at December 31, 2015.

 

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

 

(Dollars in thousands)		2016								2015
			Charge-offs				Recoveries				Charge-offs				Recoveries
Agricultural		$	—			$	—			$	—			$	1
Commercial and industrial			33				31				—				59
Consumer			136				119				172				104
Real estate, commercial			—				35				—				36
Real estate, residential			94				160				46				62
		$	263			$	345			$	218			$	262

 

Net charge-offs were $20,000 in the third quarter of 2016 and net recoveries of $82,000 were experienced in the first nine months of 2016, compared to net charge-offs of $35,000 in the third quarter of 2015 and net recoveries of $44,000 in the first nine months of 2015. Management is aware that the economic climate in Michigan will continue to affect business and personal 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 in the remainder of 2016, the provision and allowance for loan losses will be reviewed by the Bank’s management and adjusted as believed to be necessary.

 

 

Noninterest Income

Total noninterest income increased $105,000 in the third quarter of 2016 and decreased $145,000 in the first nine months of 2016 compared to the same periods in 2015. A decrease in customer service charges of $62,000 in the third quarter and $117,000 in the first nine months of 2016 compared to the same periods in the prior year was due to lower overdraft fees and fees from deposit account charges. Insurance and investment commissions increased $71,000 in the third quarter of 2016, but have decreased $112,000 in the first three quarters of 2016 compared to the same periods in 2015. The decline in the first nine months of 2016 was caused by lower commissions from sales of real estate investment trusts. Gains on loan sales increased $200,000 in the third quarter and $225,000 in the first nine months of 2016 compared to the same periods in 2015. While residential mortgage refinancing activity has slowed in 2016, purchase activity has increased which has caused the increase. A decrease of $127,000 in the third quarter and an increase of $47,000 in the first nine months of 2016 in gains on sales of securities when compared to the same periods in 2015 resulted from less sales activity in the third quarter of 2016 than in the same period of the prior year. A death benefit of $308,000 received on a bank owned life insurance policy in the first quarter of 2015 caused a decrease in earnings on life insurance policies in the first three quarters of 2016 compared to the same period in 2015.

 

Noninterest Expense

Total noninterest expense increased $67,000 in the third quarter of 2016 and $721,000 in the first nine months of 2016 compared to the same periods in 2015. The increase of $219,000 in salaries and benefits in the third quarter of 2016 and $684,000 in the first nine months of 2016 compared to the same periods in 2015 resulted in part from higher salaries driven by the new loan production office and stock compensation expense. Professional fees decreased $31,000 in the third quarter of 2016 and $76,000 in the first three quarters of 2016 compared to the same periods in 2015 because of decreased consulting fees.

 

Income Tax Expense

Income tax expense was $1,591,000 in the first nine months of 2016 compared to $1,529,000 for the same period in 2015. The effective tax rate was 26.5% and 25.3%, respectively, for the first nine months of 2016 and 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 $2.3 million in the third quarter of 2016 and $17.3 million in the first nine months of 2016. Various securities totaling $63.8 million were purchased in the first nine months of 2016 to provide earning assets and to replace maturities, principal repayments, and calls within the securities portfolio. Approximately $31.6 million in various securities were called or matured since the end of 2015. Principal repayments on securities totaled $1.8 million in the first nine months of 2016. Approximately $14.5 million of securities were sold in the first three quarters of 2016 for a net gain of $255,000.

 

Loans

The loan portfolio (excluding loans held for sale) increased $5.4 million in the third quarter of 2016 and increased $13.3 million in the first nine months of 2016. Agricultural loans increased $3.6 million in the third quarter, but declined $2.0 million in the first nine months of 2016. Commercial and industrial loans declined $2.1 million in the third quarter of 2016 but grew $1.3 million in the first three quarters of 2016. Consumer loans increased $544,000 and $1.4 million, respectively, in the third quarter and first nine months of 2016. Commercial real estate loans increased $2.8 million in the third quarter and $11.3 in the first three quarters of 2016. Residential real estate loans declined $683,000 and grew $598 in the third quarter and first nine months of 2016, respectively. 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 interim consolidated financial statements included in this report. The total balance of loans classified as impaired was $5.6 million at September 30, 2016, $6.0 million as of June 30, 2016 and $5.5 million as of December 31, 2015. The balance of commercial real estate loans classified as impaired has declined $1.3 million in the first nine months of 2016. This decline is offset by increases in impaired loans in the other loan categories.

 

As part of its review of the loan portfolio, management also monitors the various nonperforming loans. Nonperforming loans are comprised of: (1) loans accounted for on a nonaccrual basis; (2) loans, not included in nonaccrual loans, which are contractually past due 90 days or more as to interest or principal payments; and (3) loans, not included in nonaccrual or loans past due 90 days or more, which are considered troubled debt restructurings.

 

The balances of these nonperforming loans were as follows:

 

(Dollars in thousands)		September 30,				December 31,
		2016				2015
Loans accounted for on a nonaccrual basis		$	1,735			$	2,198
Accruing loans contractually past due 90 days or more as to principal or interest payments			351				29
Loans considered troubled debt restructurings			3,476				3,271
Total		$	5,562			$	5,498

 

At September 30, 2016, nonaccrual loans included $489,000 in agricultural loans, $320,000 in commercial and industrial loans, $471,000 in commercial real estate loans, and $454,000 in residential real estate loans. At December 31, 2015, nonaccrual loans included $50,000 in agricultural loans, $77,000 in commercial and industrial loans, $1.6 million in commercial real estate loans, and $431,000 in residential real estate loans. The decrease in nonaccrual loans was primarily due to credits paid off during the first nine months of 2016. Management believes the allowance allocated to its nonperforming loans was sufficient at September 30, 2016.

 

Deposits and Borrowings

Total deposits increased $13.6 million in the third quarter of 2016 and increased $2.7 million since the end of 2015. Checking and savings deposits increased $15.2 million in the third quarter of 2016 and $0.7 million in the first nine months of 2016. Money market deposits increased $1.4 million in the third quarter of 2016 and increased $5.6 million in the first nine months of 2016. Local certificates of deposit decreased $3.0 million in the third quarter of 2016 and $3.6 million in the first nine months of 2016. ChoiceOne continued to place an emphasis on building its core deposits base in 2016.

 

An increase in federal funds purchased of $624,000 since December 31, 2015 was used to fund short term liquidity needs of the Bank. Repurchase agreements have declined by $3.0 million in the first nine months of 2016 due to normal fluctuations in funds provided by bank customers. Management plans to continue this practice as a low-cost source of funding. Federal Home Loan Bank advances increased $26.0 million in the first nine months of 2016 to fund both loans and growth in the securities portfolio.

 

Shareholders’ Equity

Total shareholders’ equity increased $3.7 million from December 31, 2015 to September 30, 2016. Growth in equity resulted from current year’s net income, proceeds from the issuance of ChoiceOne stock and an increase in accumulated other comprehensive income offset by cash dividends paid and repurchases of shares. The $1.3 million increase in accumulated 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 mid- and short-term rates in 2016, 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
September 30, 2016
ChoiceOne Financial Services, Inc.
Total capital (to risk weighted assets)		$	61,573				14.3	%		$	34,436				8.0	%			N/A				N/A
Tier 1 capital (to risk weighted assets)			57,323				13.3				17,218				6.0				N/A				N/A
Common Equity Tier 1 Capital (to risk weighted assets)			57,323				13.3				19,370				4.5				N/A				N/A
Tier 1 capital (to average assets)			57,323				9.9				23,129				4.0				N/A				N/A
ChoiceOne Bank
Total capital (to risk weighted assets)		$	57,952				13.5	%		$	34,376				8.0	%		$	42,970				10.0	%
Tier 1 capital (to risk weighted assets)			53,702				12.5				17,188				6.0				25,782				8.0
Common Equity Tier 1 Capital (to risk weighted assets)			53,702				12.5				19,337				4.5				27,931				6.5
Tier 1 capital (to average assets)			53,702				9.3				23,003				4.0				28,754				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
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	%
Tier 1 capital (to risk weighted assets)			51,574				13.0				16,800				4.0				25,102				6.0
Tier 1 capital (to average assets)			51,574				9.7				22,434				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 September 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 $8.2 million for the nine months ended September 30, 2016 compared to $4.8 million provided in the same period a year ago. Higher proceeds from loan sales were partially offset by a higher balance of loans originated for sale. Net cash used in investing activities was $30.6 million for the first nine months of 2016 compared to $9.5 million in the same period in 2015. The change was due to additional net securities purchases offset by security sales and maturities and due to a higher level of loan growth than in the prior year. Net cash provided from financing activities was $23.9 million in the nine months ended September 30, 2016, compared to $0.4 million in the same period in the prior year. A decline in the level of deposit growth in the first nine months of 2016 compared to the same period in 2015 was offset by a smaller decrease in the balance of repurchase agreements in 2016 than in 2015 and growth in Federal Home Loan Bank advances in 2016 in contrast with a decline in the prior year.

 

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 September 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.

 

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

 

On July 26, 2016 ChoiceOne issued 808 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 $19,000. 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 September 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
July 1 - July 31, 2016
Employee Transactions (1)			258			$	23.10
Repurchase Plan			—			$	—				—				29,224
August 1 - August 31, 2016
Employee Transactions (1)			259			$	23.74
Repurchase Plan (2)			5,000			$	23.25				5,000				24,224
September 1 - September 30, 2016
Employee Transactions			—			$	—
Repurchase Plan			—			$	—				—				24,224

 

(1)

Shares submitted for cancellation to satisfy tax withholding obligations that occur upon the vesting of restricted units. The value of the shares delivered or withheld is determined by the applicable stock compensation plan.

 

(2)

On August 10, 2016, ChoiceOne purchased 5,000 shares of common stock for an aggregate cash price of $116,000. As of September 30, 2016, there are 24,224 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 Chief Executive Officer
	31.2		Certification of Treasurer
	32.1		Certification pursuant to 18 U.S.C. § 1350.
	101.1		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:   November 14, 2016	/s/ Kelly Potes
	Kelly Potes Chief Executive Officer (Principal Executive Officer)
Date:   November 14, 2016	/s/ Thomas L. Lampen
	Thomas L. Lampen Treasurer (Principal Financial and Accounting Officer)