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EX-32.1 - CERTIFICATION OF TREASURER AND CEO - CHOICEONE FINANCIAL SERVICES INCex32-1.htm
EX-31.2 - CERTIFICATION OF TREASURER - CHOICEONE FINANCIAL SERVICES INCex31-2.htm
EX-31.1 - CERTIFICATION OF PRESIDENT AND CEO - CHOICEONE FINANCIAL SERVICES INCex31-1.htm

 

 

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, 2017
   
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  ☒

 

Emerging growth company ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. Yes ☐  No  ☐

 

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, 2017, the Registrant had outstanding 3,451,987 shares of common stock.

 

 

 

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

ChoiceOne Financial Services, Inc.
CONSOLIDATED BALANCE SHEETS

 

   September 30,   December 31, 
(Dollars in thousands)  2017   2016 
   (Unaudited)   (Audited) 
Assets        
Cash and due from banks  $12,725   $14,809 
           
Securities available for sale (Note 2)   173,306    174,388 
Federal Home Loan Bank stock   1,994    1,994 
Federal Reserve Bank stock   1,573    1,573 
           
Loans held for sale   2,378    1,974 
Loans to other financial institutions   13,293     
Loans (Note 3)   394,090    369,000 
Allowance for loan losses (Note 3)   (4,216)   (4,277)
Loans, net   389,874    364,723 
           
Premises and equipment, net   12,271    12,588 
Cash surrender value of life insurance policies   14,415    14,117 
Goodwill   13,728    13,728 
Other assets   6,495    7,477 
Total assets  $642,052   $607,371 
           
Liabilities          
Deposits – noninterest-bearing  $136,542   $127,611 
Deposits – interest-bearing   389,296    384,775 
Total deposits   525,838    512,386 
           
Federal funds purchased   2,650     
Repurchase agreements   3,794    7,913 
Advances from Federal Home Loan Bank   30,276    12,301 
Other liabilities   3,188    3,073 
Total liabilities   565,746    535,673 
           
Shareholders’ Equity          
Common stock and paid in capital, no par value; shares authorized: 7,000,000; shares outstanding: 3,451,445 at September 30, 2017 and 3,277,944 at December 31, 2016   50,307    46,299 
Retained earnings   25,281    25,997 
Accumulated other comprehensive income (loss), net   718    (598)
Total shareholders’ equity   76,306    71,698 
Total liabilities and shareholders’ equity  $642,052   $607,371 

 

See accompanying notes to interim consolidated financial statements.

 

2

 

 

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

 

   Three Months Ended   Nine Months Ended 
(Dollars in thousands, except per share data)  September 30,   September 30, 
   2017   2016   2017   2016 
Interest income                    
Loans, including fees  $4,592   $4,210   $13,157   $12,293 
Securities:                    
Taxable   651    594    1,935    1,731 
Tax exempt   355    358    1,068    1,088 
Other   26    5    50    14 
Total interest income   5,624    5,167    16,210    15,126 
                     
Interest expense                    
Deposits   320    190    860    599 
Advances from Federal Home Loan Bank   62    44    169    119 
Other   3    2    10    7 
Total interest expense   385    236    1,039    725 
                     
Net interest income   5,239    4,931    15,171    14,401 
Provision for loan losses   95        120     
                     
Net interest income after provision for loan losses   5,144    4,931    15,051    14,401 
                     
Noninterest income                    
Customer service charges   1,058    1,030    3,081    3,020 
Insurance and investment commissions   260    290    760    740 
Gains on sales of loans   355    508    920    1,345 
Gains on sales of securities   51    28    177    255 
(Losses) gains on sales and write-downs of other assets   17    (3)   21    (26)
Earnings on life insurance policies   101    88    299    265 
Other   141    124    399    360 
Total noninterest income   1,983    2,065    5,657    5,959 
                     
Noninterest expense                    
Salaries and benefits   2,619    2,542    7,725    7,519 
Occupancy and equipment   702    626    2,099    1,959 
Data processing   551    556    1,681    1,654 
Professional fees   287    232    778    700 
Supplies and postage   102    92    293    312 
Advertising and promotional   58    52    185    184 
Intangible amortization       112        336 
FDIC insurance   51    78    151    218 
Other   421    379    1,327    1,485 
Total noninterest expense   4,791    4,669    14,239    14,367 
                     
Income before income tax   2,336    2,327    6,470    5,993 
Income tax expense   616    644    1,668    1,591 
                     
Net income  $1,720   $1,683   $4,801   $4,402 
                     
Basic earnings per share (Note 4) *  $0.50   $0.50   $1.39   $1.28 
Diluted earnings per share (Note 4) *  $0.50   $0.50   $1.39   $1.28 
Dividends declared per share *  $0.17   $0.16   $0.50   $0.49 

 

See accompanying notes to interim consolidated financial statements. 

*Note that 2016 per-share amounts have been adjusted for the 5% stock dividend paid on May 31, 2017.

 

3

 

 

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

 

   Three Months Ended   Nine Months Ended 
(Dollars in thousands)  September 30,   September 30, 
   2017   2016   2017   2016 
Net income  $1,720   $1,683   $4,801   $4,402 
Other comprehensive income:                    
                     
Changes in net unrealized gains (loss) on investment securities available for sale, net of tax expense of $(171) and $35 for the three months ended September 30, 2017 and September 30, 2016 respectively. Changes in net unrealized gains on investment securities available for sale, net of tax expense of $738 and $747 for the nine months ended September 30, 2017 and September 30, 2016 respectively.   (333)   68    1,433    1,450 
                     
Less: Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax benefit of $17 and $9 for the three months ended September 30, 2017 and September 30,2016 respectively. Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax benefit of $60 and $87 for the nine months ended September 30, 2017 and September 30, 2016 respectively.   (34)   (19)   (117)   (168)
                     
Other comprehensive income, net of tax   (367)   49    1,316    1,282 
                     
Comprehensive income  $1,353   $1,732   $6,117   $5,684 

 

See accompanying notes to interim consolidated financial statements.

 

4

 

 

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

 

               Accumulated     
       Common       Other     
       Stock and       Comprehensive     
   Number of   Paid in   Retained   Income (Loss),     
(Dollars in thousands)  Shares   Capital   Earnings   Net   Total 
                     
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 
Shares repurchased   (35,000)   (794)             (794)
Change in ESOP repurchase obligation        127              127 
Effect of employee stock purchases        9              9 
Stock-based compensation   3,414    248              248 
Cash dividends declared ($0.49 per share) *             (1,674)        (1,674)
                          
Balance, September 30, 2016   3,275,201   $46,228   $24,866   $2,485   $73,579 
                          
Balance, January 1, 2017   3,277,944   $46,299   $25,997   $(598)  $71,698 
Net income             4,801         4,801 
Other comprehensive income                  1,316    1,316 
Shares issued   7,115    115              115 
Shares repurchased   (3,800)   (88)             (88)
Effect of employee stock purchases        9              9 
Stock options exercised   1,000    13              13 
Stock-based compensation expense        180              180 
Restricted stock units issued   5,197                   
Stock dividend declared (5%)   163,989    3,779    (3,779)         
Cash dividends declared ($0.50 per share)             (1,738)        (1,738)
                          
Balance, September 30, 2017   3,451,445   $50,307   $25,281   $718   $76,306 

 

See accompanying notes to interim consolidated financial statements.

*Note that 2016 per-share amounts have been adjusted for the 5% stock dividend paid on May 31, 2017.

 

5

 

 

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

 

   Nine Months Ended 
(Dollars in thousands)  September 30, 
   2017   2016 
Cash flows from operating activities:          
Net income  $4,801   $4,402 
Adjustments to reconcile net income to net cash from operating activities:          
Provision for loan losses   120     
Depreciation   944    757 
Amortization   814    1,199 
Compensation expense on stock purchases and restricted stock units   241    257 
Gains on sales of securities   (177)   (255)
Gains on sales of loans   (920)   (1,345)
Loans originated for sale   (28,356)   (39,173)
Proceeds from loan sales   27,922    42,313 
Earnings on bank-owned life insurance   (299)   (265)
Gains on sales of other real estate owned   (10)   3 
Proceeds from sales of other real estate owned   579    28 
Deferred federal income tax benefit   (29)   (86)
Net changes in other assets   572    (135)
Net changes in other liabilities   (532)   481 
Net cash from operating activities   5,670    8,181 
Cash flows from investing activities:          
Securities available for sale:          
Sales   22,521    14,538 
Maturities, prepayments and calls   14,163    33,412 
Purchases   (33,998)   (63,780)
Loan originations and payments, net   (38,235)   (13,700)
Additions to premises and equipment   (413)   (1,112)
Net cash from investing activities   (35,962)   (30,642)
Cash flows from financing activities:          
Net change in deposits   13,452    2,691 
Net change in repurchase agreements   (4,119)   (3,043)
Net change in federal funds purchased   2,650    624 
Proceeds from Federal Home Loan Bank advances   166,500    271,000 
Payments on Federal Home Loan Bank advances   (148,525)   (245,023)
Issuance of common stock   76    137 
Repurchase of common stock   (88)   (794)
Cash dividends   (1,738)   (1,674)
Net cash from financing activities   28,208    23,918 
Net change in cash and cash equivalents   (2,084)   1,457 
Beginning cash and cash equivalents   14,809    11,187 
Ending cash and cash equivalents  $12,725   $12,644 
Supplemental disclosures of cash flow information:          
Cash paid for interest  $1,029   $726 
Cash paid for taxes  $1,150   $925 
Loans transferred to other real estate owned  $314   $483 

 

See accompanying notes to interim consolidated financial statements.

 

6

 

 

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 U.S. 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, 2017 and December 31, 2016, the Consolidated Statements of Income for the three- and nine-month periods ended September 30, 2017 and September 30, 2016, the Consolidated Statements of Comprehensive Income for the three- and nine-month periods ended September 30, 2017 and September 30, 2016, the Consolidated Statements of Changes in Shareholders’ Equity for the nine-month periods ended September 30, 2017 and September 30, 2016, and the Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2017 and September 30, 2016. Operating results for the nine months ended September 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.

 

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2016.

 

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 3,881 shares of common stock were issued to ChoiceOne’s Board of Directors for a cash price of $89,000 under the terms of the Directors’ Stock Purchase Plan in the first nine months of 2017. A total of 1,000 shares of common stock were issued upon the exercise of stock options in the first three quarters of 2017. A total of 3,234 shares of common stock were issued to employees for a cash price of $62,000 under the Employee Stock Purchase Plan in the first nine months of 2017. A total of 5,197 shares of common stock were issued to employees for Restricted Stock Units that vested during the first nine months of 2017.

 

Stock-Based Compensation

Effective July 1, 2013, ChoiceOne began granting Restricted Stock Units to a select group of employees under the Stock Incentive Plan of 2012. All of the Restricted Stock Units are initially unvested and vest in three annual installments on each of the next three anniversaries of the grant date. Certain additional vesting provisions apply. Each unit, once vested, is settled by delivery of one share of ChoiceOne common stock.

 

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.

 

 7

 

 

Revenue Recognition

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). The ASU adopts a standardized approach for revenue recognition and was a joint effort with the International Accounting Standards Board (IASB). The new revenue recognition standard is based on a core principle of recognizing revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU does not apply to financial instruments. The ASU is effective for public entities for reporting periods beginning after December 15, 2017 (therefore, for the year ending December 31, 2018 for the Corporation). Early implementation is not allowed for public companies. Management is completing an overall assessment of noninterest revenue streams and evaluating the expanded disclosure requirements.

 

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:

 

   September 30, 2017 
(Dollars in thousands)  Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair
Value
 
U.S. Government and federal agency  $51,086   $11   $(444)  $50,653 
U.S. Treasury   4,025        (10)   4,015 
State and municipal   94,360    1,459    (224)   95,595 
Mortgage-backed   9,501    17    (98)   9,420 
Corporate   5,696    16    (17)   5,695 
Foreign debt   4,512        (72)   4,440 
Equity securities   3,083    294        3,377 
Asset-backed securities   112        (1)   111 
Total  $172,375   $1,797   $(866)  $173,306 

  

   December 31, 2016 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair
Value
 
U.S. Government and federal agency  $59,864   $34   $(846)  $59,052 
U.S. Treasury   4,111        (39)   4,072 
State and municipal   89,169    748    (944)   88,973 
Mortgage-backed   7,925    19    (155)   7,789 
Corporate   7,069    12    (40)   7,041 
Foreign debt   4,514        (114)   4,400 
Equity securities   2,617    266        2,883 
Asset-backed securities   182        (4)   178 
Total  $175,451   $1,079   $(2,142)  $174,388 

 

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 nine months ended September 30, 2017. ChoiceOne believed that unrealized losses on securities were temporary in nature and were due to changes in interest rates and reduced market liquidity and not as a result of credit quality issues. 

 

 8

 

 

Presented below is a schedule of maturities of securities as of September 30, 2017, the fair value of securities as of September 30, 2017 and December 31, 2016, and the weighted average yields of securities as of September 30, 2017:

 

    Securities maturing within:           
(Dollars in thousands)   

Less than

1 Year

    

1 Year -

5 Years

    

5 Years -

10 Years

    

More than

10 Years

    

Fair Value

at September 30,

2017

    

Fair Value

at Dec. 31,

2016

 
                               
U.S. Government and federal agency  $20,250   $28,460   $1,943   $   $50,653   $59,052 
U.S. Treasury notes and bonds       4,015            4,015    4,072 
State and municipal   8,362    47,395    36,016    3,822    95,595    88,973 
Corporate   5,302    393            5,695    7,041 
Foreign debt securities   1,000    3,440            4,440    4,400 
Asset-backed securities   111                111    178 
Total debt securities   35,025    83,703    37,959    3,822    160,509    163,716 
Mortgage-backed securities       9,330    90        9,420    7,789 
Equity securities (1)           1,000    2,377    3,377    2,883 
Total  $35,025   $93,033   $39,049   $6,199   $173,306   $174,388 

 

(1) Equity securities are preferred and common stock that may or may not have a stated maturity.

 

 9

 

 

NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES

Activity in the allowance for loan losses and balances in the loan portfolio was 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, 2017                                        
Beginning balance  $395   $904   $294   $1,551   $25   $748   $181   $4,098 
Charge-offs       (12)   (52)           (9)       (73)
Recoveries       4    16    65        11        96 
Provision   (1)   (98)   1    (152)   1    (140)   484    95 
Ending balance  $394   $798   $259   $1,464   $26   $610   $665   $4,216 
                                         
Nine Months Ended September 30, 2017                                        
Beginning balance  $433   $688   $305   $1,438   $62   $1,014   $337   $4,277 
Charge-offs       (374)   (189)           (44)       (607)
Recoveries       4    107    226    40    49        426 
Provision   (39)   480    36    (200)   (76)   (409)   328    120 
Ending balance  $394   $798   $259   $1,464   $26   $610   $665   $4,216 
                                         
Individually evaluated for impairment  $   $5   $4   $54   $   $228   $   $291 
                                         
Collectively evaluated for impairment  $394   $793   $255   $1,410   $26   $382   $665   $3,925 
                                         
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 
                                         
                                        
Loans
September 30, 2017
                                        
Individually evaluated for impairment  $424   $192   $34   $936   $   $2,472        $4,058 
Collectively evaluated for Impairment   45,682    101,244    23,977    122,480    7,298    89,351         390,032 
Ending balance  $46,106   $101,436   $24,011   $123,416   $7,298   $91,823        $394,090 
                                         
December 31, 2016                                        
Individually evaluated for impairment  $526   $301   $28   $1,073   $   $2,983        $4,911 
Collectively evaluated for impairment   44,088    95,787    21,568    109,689    6,153    86,804         364,089 
Ending balance  $44,614   $96,088   $21,596   $110,762   $6,153   $89,787        $369,000 

 

 10

 

 

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.

 

 11

 

 

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, 
   2017   2016   2017   2016   2017   2016 
Risk ratings 1 and 2  $12,488   $12,005   $12,691   $12,135   $8,069   $8,013 
Risk rating 3   23,957    23,852    64,953    56,714    72,370    59,343 
Risk rating 4   8,865    7,505    23,141    25,895    39,920    39,641 
Risk rating 5   373    726    484    1,267    1,530    1,867 
Risk rating 6   423    526    167    77    1,527    1,898 
Risk rating 7                        
   $46,106   $44,614   $101,436   $96,088   $123,416   $110,762 

 

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, 
   2017   2016   2017   2016   2017   2016 
Performing  $23,995   $21,590   $7,298   $6,153   $91,252   $88,767 
Nonperforming                   132    229 
Nonaccrual   16    6            439    791 
   $24,011   $21,596   $7,298   $6,153   $91,823   $89,787 

 

There were no loans that were considered troubled debt restructurings (“TDRs”) that were modified during the three- and nine-month periods ended September 30, 2017. 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 
Commercial Real estate      $   $    1   $113   $113 
Residential Real Estate               2    156    156 
Total      $   $    3   $269   $269 

 

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.

 

There were no TDRs as of September 30, 2017 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, 2017 that had been modified during the year prior to the default. 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 
Commercial real estate      $    1   $113 

 

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.

 

12 

 

 

  

Impaired loans by loan category as of September 30, 2017 and 2016 were as follows:

 

       Unpaid       Average   Interest 
(Dollars in thousands)  Recorded   Principal   Related   Recorded   Income 
   Investment   Balance   Allowance   Investment   Recognized 
September 30, 2017                         
With no related allowance recorded                         
Agricultural  $424   $455   $   $288   $ 
Commercial and industrial   58    69        137     
Consumer                    
Commercial real estate   113    245        104     
Residential real estate   136    147        103     
Subtotal   731    916        632     
With an allowance recorded                         
Agricultural               161     
Commercial and industrial   134    134    5    195    1 
Consumer   34    35    4    33    1 
Commercial real estate   823    904    54    884    26 
Residential real estate   2,336    2,354    228    2,475    75 
Subtotal   3,327    3,427    291    3,748    103 
                          
Agricultural   424    455        449     
Commercial and industrial   192    203    5    332    1 
Consumer   34    35    4    33    1 
Commercial real estate   936    1,149    54    988    26 
Residential real estate   2,472    2,501    228    2,578    75 
Total  $4,058   $4,343   $291   $4,380   $103 
                          
September 30, 2016                         
With no related allowance recorded                         
Agricultural  $489   $493   $   $154   $(1)
Commercial and industrial   177    177        63     
Consumer   5    5        1     
Commercial real estate   230    351        1,071    33 
Residential real estate   266    266        134    46 
Subtotal   1,167    1,292        1,423    78 
With an allowance recorded                         
Agricultural   45    45    4    79    16 
Commercial and industrial   273    247    8    242    4 
Consumer   21    21    1    22    3 
Commercial real estate   1,229    1,799    167    1,426    116 
Residential real estate   2,843    2,859    321    2,670    308 
Subtotal   4,411    4,971    501    4,439    447 
                          
Agricultural   534    538    4    233    15 
Commercial and industrial   449    424    8    305    4 
Consumer   26    26    1    23    3 
Commercial real estate   1,459    2,150    167    2,497    149 
Residential real estate   3,110    3,125    321    2,804    354 
Total  $5,578   $6,263   $501   $5,862   $525 

 

 13

 

 

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, 2017                                   
Agricultural  $   $   $83   $83   $46,023   $46,106   $ 
Commercial and industrial           58    58    101,378    101,436     
Consumer   132    1    11    144    23,867    24,011     
Commercial real estate           113    113    123,303    123,416     
Construction real estate                   7,298    7,298     
Residential real estate   625    24    221    870    90,953    91,823    132 
   $757   $25   $486   $1,268   $392,822   $394,090   $132 
                                    
December 31, 2016                                   
Agricultural  $   $   $   $   $44,614   $44,614   $ 
Commercial and industrial       30    245    275    95,813    96,088     
Consumer   99    2    6    107    21,489    21,596     
Commercial real estate           260    260    110,502    110,762     
Construction real estate                   6,153    6,153     
Residential real estate   1,027    109    646    1,782    88,005    89,787    229 
   $1,126   $141   $1,157   $2,424   $366,576   $369,000   $229 

 

(1) Includes nonaccrual loans.

 

Nonaccrual loans by loan category follow: 

(Dollars in thousands)  September 30,   December 31, 
   2017   2016 
Agricultural  $423   $482 
Commercial and industrial   59    245 
Consumer   17    6 
Commercial real estate   211    458 
Construction real estate        
Residential real estate   439    792 
   $1,149   $1,983 

 

 14

 

 

NOTE 4 - EARNINGS PER SHARE

 

Earnings per share are based on the weighted average number of shares outstanding during the period. A computation of basic earnings per share and diluted earnings per share follows:

 

(Dollars in thousands, except per share data)  Three Months Ended
September 30,
   Nine Months Ended
September 30,
 
   2017   2016   2017   2016 
Basic Earnings Per Share                
Net income available to common shareholders  $1,720   $1,683   $4,801   $4,402 
                     
Weighted average common shares outstanding   3,452,278    3,439,633    3,448,341    3,455,141 
                     
Basic earnings per share  $0.50   $0.50   $1.39   $1.28 
                     
Diluted Earnings Per Share                    
Net income available to common shareholders  $1,720   $1,683   $4,801   $4,402 
                     
Weighted average common shares outstanding   3,452,278    3,439,633    3,448,341    3,455,141 
Plus dilutive stock options and restricted stock units   6,370    4,146    4,744    4,380 
                     
Weighted average common shares outstanding and potentially dilutive shares   3,458,648    3,443,780    3,453,085    3,459,520 
                     
Diluted earnings per share  $0.50   $0.50   $1.39   $1.28 

 

Note that 2016 share amounts have been adjusted for the 5% stock dividend paid on May 31, 2017.

 

There were 31,500 stock options for the three months ended September 30, 2017 and 32,550 for the three months ended September 30, 2016 with an exercise price more than the average market price which have been excluded from the calculation of diluted earnings above.

 

 15

 

 

NOTE 5 – FINANCIAL INSTRUMENTS

 

Financial instruments as of the dates indicated were as follows:

 

(Dollars in thousands)  Carrying Amount   Estimated Fair Value   Quoted Prices in Active Markets for Identical Assets (Level 1)   Significant Other Observable Inputs (Level 2)   Significant Unobservable Inputs (Level 3) 
                     
September 30, 2017                    
Assets:                    
Cash and due from banks  $12,725   $12,725   $12,725   $   $ 
Securities available for sale   173,306    173,306    1,877    157,886    13,543 
Federal Home Loan Bank and Federal Reserve Bank stock   3,567    3,567        3,567     
Loans held for sale   2,378    2,451        2,451     
Loans to other financial institutions   13,293    13,699            13,699 
Loans, net   389,874    391,408            391,408 
                          
Liabilities:                         
Noninterest-bearing deposits   136,542    136,542        136,542     
Interest-bearing deposits   389,296    388,603        388,603     
Federal funds purchased   2,650    2,650        2,650     
Repurchase agreements   3,794    3,794        3,794     
Federal Home Loan Bank advances   30,276    30,298        30,298     
                          
December 31, 2016                         
Assets:                         
Cash and due from banks  $14,809   $14,809   $14,809   $   $ 
Securities available for sale   174,388    174,388    1,383    157,902    15,103 
Federal Home Loan Bank and Federal Reserve Bank stock   3,567    3,567        3,567     
Loans held for sale   1,974    2,044        2,044     
Loans, net   364,723    365,780            365,780 
                          
Liabilities:                         
Noninterest-bearing deposits   127,611    127,611        127,611     
Interest-bearing deposits   384,775    383,879        383,879     
Repurchase agreements   7,913    7,913        7,913     
Federal Home Loan Bank advances   12,301    12,323        12,323     

 

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 September 30, 2017 and December 31, 2016 for new loans with similar maturities, applied until the loan is assumed to reprice or be paid. The allowance for loan losses is considered to be a reasonable estimate of discount for credit quality concerns. The estimated fair values for time deposits and Federal Home Loan Bank (“FHLB”) advances are based on the rates paid at September 30, 2017 and December 31, 2016 for new deposits or FHLB advances, applied until maturity. The estimated fair values for other financial instruments and off-balance sheet loan commitments are considered nominal.

 

16 

 

 

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, 2017 or December 31, 2016. 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, 2017                
U.S. Treasury notes and bonds  $   $4,015   $   $4,015 
U.S. Government and federal agency       50,653        50,653 
State and municipal       83,552    12,043    95,595 
Mortgage-backed       9,420        9,420 
Corporate       5,695        5,695 
Foreign debt       4,440        4,440 
Equity securities   1,877        1,500    3,377 
Asset backed securities       111        111 
Total  $1,877   $157,886   $13,543   $173,306 
                     
Investment Securities, Available for Sale - December 31, 2016                    
U.S. Treasury notes and bonds  $   $4,072   $   $4,072 
U.S. Government and federal agency       59,052        59,052 
State and municipal       75,370    13,603    88,973 
Mortgage-backed       7,789        7,789 
Corporate       7,041        7,041 
Foreign debt       4,400        4,400 
Equity securities   1,383        1,500    2,883 
Asset backed securities       178        178 
Total  $1,383   $157,902   $15,103   $174,388 

 

17 

 

 

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

 

(Dollars in thousands)        
   2017   2016 
Investment Securities, Available for Sale          
Balance, January 1  $15,103   $11,799 
Total realized and unrealized gains included in income        
Total unrealized gains (losses) included in other comprehensive income   271    131 
Net purchases, sales, calls, and maturities   (1,831)   2,598 
Net transfers into Level 3        
Balance, September 30  $13,543   $14,528 

 

Of the Level 3 assets that were held by the Bank at September 30, 2017, the net unrealized gain for the nine months ended September 30, 2017 was $271,000, which is recognized in other comprehensive income in the consolidated balance sheet. $3.2 million of Level 3 securities were purchased during the first nine months of 2017, $4.8 million of Level 3 securities matured or were called, and there were $204,000 in principal paydowns in the same period. 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. $5.1 million of Level 3 securities were purchased during the first nine months of 2016, $2.2 million of Level 3 securities matured or were called, and there were $267,000 in principal payments in the same period.

 

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

 

(Dollars in thousands)  Balance at Dates Indicated   Quoted Prices in Active Markets for Identical Assets (Level 1)   Significant Other Observable Inputs (Level 2)   Significant Unobservable Inputs (Level 3) 
                 
Impaired Loans                
September 30, 2017  $4,058   $   $   $4,058 
December 31, 2016  $4,911   $   $   $4,911 
                     
Other Real Estate                    
September 30, 2017  $182   $   $   $182 
December 31, 2016  $437   $   $   $437 

 

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.

 

NOTE 7 – SUBSEQUENT EVENTS

 

On October 3, 2017 ChoiceOne Insurance Agencies Inc (“the Agency”) entered into an agreement with Ridgetown Investments LLC (“Ridgetown”), to sell a portion of the investment book of business previously managed by the Agency. Per the agreement, Ridgetown agreed to pay $908,000 to the Agency for future revenue generated by the book of business. This transaction would result in a $908,000 gain which will be reported in the fourth quarter of 2017.

 

18 

 

 

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, 2016. These are representative of the risk factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.

 

RESULTS OF OPERATIONS

Summary

Net income for the third quarter of 2017 was $1,720,000, which represented an increase of $37,000 compared to the same period in 2016. Net income for the first nine months of 2017 was $4,801,000, which represented an increase of $399,000 or 9% over the same period in 2016. Growth in net interest income and a relatively small reduction in noninterest expense were partially offset by a higher provision for loan losses and lower noninterest income in the first nine months of 2017 than in the same period in the prior year. Basic and diluted earnings per common share were $0.50 for the third quarter and $1.39 for the first nine months of 2017, compared to adjusted amounts of $0.50 and $1.28, respectively, for the same periods in 2016. Earnings per share amounts for the prior year have been adjusted for the 5% stock dividend paid on May 31, 2017. The return on average assets (“ROAA”) and return on average shareholders’ equity (“ROAE”) percentages were 1.02% and 8.59%, respectively, for the first nine months of 2017, compared to 1.01% and 8.15%, respectively, for the same period in 2016. ROAA and ROAE percentages are non-GAAP financial measures management believes to be useful to investors.

 

Dividends

Cash dividends of $585,000 or $0.17 per share were declared in the third quarter of 2017, compared to $557,000 or an adjusted $0.16 per share in the third quarter of 2016. The cash dividends declared in the first nine months of 2017 were $1,738,000 or an adjusted $0.50 per share, compared to $1,674,000 or an adjusted $0.49 per share declared in the same period in 2016. Dividends per share amounts for the prior year have been adjusted for the 5% stock dividend paid on May 31, 2017.

 

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, 2017 and 2016, 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.

 

19 

 

 

Table 1 – Average Balances and Tax-Equivalent Interest Rates

   Nine Months Ended September 30,  
   2017    2016  
(Dollars in thousands)  Average
Balance
  Interest  Rate    Average
Balance
  Interest  Rate  
Assets:                  
Loans (1)  $382,478    13,165    4.59%  $355,281    12,301    4.62%
Taxable securities (2) (3)   126,288    1,935    2.04    117,635    1,731    1.96 
Nontaxable securities (1) (2)   55,229    1,613    3.89    53,685    1,643    4.08 
Other   6,345    50    1.06    3,915    14    0.18 
Interest-earning assets   570,340    16,763    3.92    530,516    15,689    3.94 
Noninterest-earning assets   56,682              53,913           
Total assets  $627,022             $584,429           
                               
Liabilities and Shareholders’ Equity:                              
Interest-bearing demand deposits  $207,642    275    0.18%  $193,675    190    0.13%
Savings deposits   76,369    11    0.02    72,619    16    0.03 
Certificates of deposit   106,695    574    0.72    86,707    393    0.60 
Advances from Federal Home Loan Bank   19,963    169    1.13    25,127    119    0.63 
Other   5,453    10    0.24    8,698    7    0.11 
Interest-bearing liabilities   416,122    1,039    0.33    386,826    725    0.25 
Noninterest-bearing demand deposits   133,636              122,641           
Other noninterest-bearing liabilities   2,775              2,945           
Total liabilities   552,533              512,412           
Shareholders’ equity   74,489              72,017           
Total liabilities and shareholders’ equity  $627,022             $584,429           
                               
Net interest income (tax-equivalent basis) - interest spread (Non-GAAP)        15,724    3.59%        14,964    3.69%
Tax-equivalent adjustment (1)        (553)             (563)     
Net interest income (GAAP)       $15,171             $14,401      
Net interest income as a percentage of earning assets (tax-equivalent basis) (Non-GAAP)             3.68%             3.76%

 

 

 

  (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.

 

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Table 2 – Changes in Tax-Equivalent Net Interest Income

 

   Nine Months Ended September 30, 
(Dollars in thousands)  2017 Over 2016 
   Total   Volume   Rate 
Increase (decrease) in interest income (1)               
Loans (2)  $864   $981   $(117)
Taxable securities   204    131    73 
Nontaxable securities (2)   (30)   66    (96)
Other   36    12    24 
Net change in tax-equivalent interest income   1,074    1,190    (116)
                
Increase (decrease) in interest expense (1)               
Interest-bearing demand deposits   85    15    70 
Savings deposits   (5)   1    (6)
Certificates of deposit   181    100    81 
Advances from Federal Home Loan Bank   50    (41)   91 
Other   3    (5)   8 
Net change in interest expense   314    69    245 
Net change in tax-equivalent net interest income  $760   $1,121   $(361)

 

 

 

  (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 U.S. 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 $553,000 and $563,000 for the nine months ended September 30, 2017 and 2016, 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 $760,000 in the first nine months of 2017 compared to the same period in 2016. The effect of growth in average interest-earning assets, partially offset by an increase in average interest-bearing liabilities, caused tax-equivalent net interest income to increase $1.1 million in the first nine months of 2017 compared to the same period in the prior year. The net interest spread was reduced 10 basis points from 3.69% in the first nine months of 2016, to 3.59% in the first nine months in 2017, which caused a decrease in net interest income of $361,000.

 

The decline in the interest spread was due to a 2 basis point decrease in the average rate earned on interest-earning assets in the first nine months of 2017 compared to the same nine months in 2016 plus the effect of an 8 basis point increase in the average rate paid on interest-bearing liabilities. The reduction in the average rate earned on interest-earning assets was caused by relatively low general market rates on new loan originations and securities purchased in 2016 and the first nine months of 2017. Interest rates on loans are also being impacted by rate pressure from competing financial institutions in the markets in which ChoiceOne operates. The higher rate paid on interest-bearing liabilities resulted from growth in brokered certificates of deposit, which increased the overall average rate on this deposit type, as well as increases in short-term interest rates in 2016 and the first nine months of 2017 which increased the average rate paid on advances from the Federal Home Loan Bank.

 

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The average balance of loans increased $27.2 million in the first nine months of 2017 compared to the same period in 2016. Average commercial and industrial and commercial real estate loans were $22.1 million higher, while average consumer and residential mortgage loans grew $2.2 million and $2.9 million, respectively, in the first nine months of 2017. The increase in the average loans balance was offset by a 3 basis point decrease in the average rate earned. The combination of the loan growth and interest rate decline caused tax-equivalent interest income from loans to increase $864,000 in the first nine months of 2017 compared to the same period in the prior year. The average balance of total securities grew $10.2 million in the first nine months of 2017 compared to the same period in 2016. Additional securities were purchased in 2016 and in the first nine months of 2017 to provide added liquidity and to provide earning asset growth. Growth in the average balance of securities, offset by a small decline in the overall average interest rate earned, caused interest income on securities to increase $174,000 in the first nine months of 2017 compared to the same period in 2016.

 

The average balance of interest-bearing demand deposits increased $14.0 million in the first nine months of 2017 compared to the same period in 2016. This growth, plus the effect of a 5 basis point increase in the rate paid, caused interest expense to grow $85,000 in the first three quarters of 2017 compared to the same period in the prior year. The average balance of certificates of deposit increased $20.0 million in the first nine months of 2017 compared to the same period in 2016. The average balance of brokered certificates of deposit was $26.4 million higher in the first nine months of 2017 and the balance of local certificates of deposit was $6.4 million lower in the first nine months of 2017 compared to the same period in the prior year. The impact of growth in the average certificates balance and a 12 basis point increase in the average rate paid caused interest expense to grow $181,000 in the first three quarters of 2017 compared to the same period in 2016. The effect of a $5.2 million decline in the average balance of Federal Home Loan Bank advances was more than offset by a 50 basis point increase in the average rate paid which caused growth of $50,000 in interest expense in the first nine months of 2017 compared to the same period in the prior year.

 

Provision and Allowance for Loan Losses

Total loans increased $25.1 million in the first nine months of 2017, while the allowance for loan losses decreased $61,000 during the same period. A provision for loan losses of $95,000 was recorded in the third quarter and $120,000 for the first nine months of 2017, compared to $0 for the same periods in 2016. Nonperforming loans were $3.9 million as of September 30, 2017, compared to $4.6 million as of June 30, 2017 and $5.1 million as of December 31, 2016. The decrease in nonperforming loans in the third quarter was due to lower balances of nonaccrual loans and loans past due 90 days or more and still accruing. The allowance for loan losses was 1.07% of total loans at September 30, 2017, compared to 1.08% at June 30, 2017, and 1.16% at December 31, 2016.

 

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

 

(Dollars in thousands)  2017   2016 
   Charge-offs   Recoveries   Charge-offs   Recoveries 
Agricultural  $   $   $   $ 
Commercial and industrial   374    4    33    31 
Consumer   189    107    136    119 
Commercial real estate       226        35 
Construction real estate       40         
Residential real estate   44    49    94    160 
   $607   $426   $263   $345 

 

Net recoveries were $23,000 in the third quarter and net charge-offs were $181,000 in the first nine months of 2017, compared to net charge-offs of $20,000 and net recoveries of $82,000 in the same periods in the prior year. Net charge-offs on an annualized basis as a percentage of average loans were 0.06% in the first nine months of 2017, compared to net recoveries of 0.03% 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 in the remainder of 2017, the provision and allowance for loan losses will be reviewed by the Bank’s management and adjusted as determined to be necessary.

 

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Noninterest Income

Total noninterest income decreased $82,000 in the third quarter and $302,000 in the first nine months of 2017 compared to the same periods in 2016. The decline was caused by lower gains on sales of loans in the first nine months of 2017 when compared to the same period in 2016. The reduction in mortgage income was primarily due to higher interest rates in the current year and a relatively low inventory of homes available for sale in the Bank’s primary market areas. Gains on sales of securities were also lower in the first three quarters of 2017 compared to the same period in the prior year as a result of higher interest rates in the current year which impacted ChoiceOne’s ability to recognize gains.

 

Noninterest Expense

Total noninterest expense increased $122,000 in the third quarter and decreased $128,000 in the first nine months of 2017 compared to the same periods in 2016. An increase in salaries and benefits expense in both the third quarter and first nine months of 2017 compared to the same periods in 2016 resulted from higher salaries from raises and personnel additions and higher bonus accruals. Occupancy and equipment expense grew in the third quarter and first three quarters of 2017 compared to the same periods in the prior year due to higher building and equipment depreciation. The growth in salaries and benefits and occupancy and equipment expenses was partially offset by reductions of $112,000 and $336,000 in intangible amortization expense in the third quarter and the first nine months of 2017, respectively, compared to the same periods in the prior year. The Bank’s intangible assets were completely amortized in the fourth quarter of 2016.

 

Income Tax Expense

Income tax expense was $1,668,000 in the first nine months of 2017 compared to $1,591,000 for the same period in 2016. The effective tax rate was 25.8% for the first nine months of 2017 and 26.5% for the same period in 2016. Income tax expense for the third quarter of 2017 was slightly lower than the same period in the prior year due to a larger impact from nontaxable income in the current year and slightly higher tax credits.

 

FINANCIAL CONDITION

 

Securities

The securities available for sale portfolio decreased $7.1 million in the third quarter and declined $1.1 million in the first nine months of 2017. The decrease in the securities portfolio helped to fund ChoiceOne’s loan growth in the first three quarters of 2017. Various securities totaling $34.0 million were purchased in the first nine months of 2017 to replace maturities, principal repayments, and calls within the securities portfolio. Approximately $12.4 million of securities were called or matured in the first nine months of 2017. Principal repayments on securities totaled $1.8 million in the first nine months of 2017. Approximately $22.5 million of securities were sold in the first nine months of 2017 for a net gain of $177,000.

 

Loans

Loans increased $14.6 million in the third quarter of 2017 and $25.1 million in the first nine months of 2017. Commercial real estate loans grew $6.5 million, agricultural loans grew $4.3 million, residential construction loans grew $1.8 million, residential real estate loans grew $1.4 million, and consumer loans grew $0.6 million in the most recent quarter while commercial and industrial loans were unchanged. 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 $4.1 million as of September 30, 2017, compared to $4.4 million as of June 30, 2017 and $4.9 million as of December 31, 2016. The impaired loans balance was steady or declined in all loan categories in the third quarter except for commercial real estate loans which were up slightly.

 

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,
2017
   December 31,
2016
 
Loans accounted for on a nonaccrual basis  $1,149   $1,983 
Accruing loans contractually past due 90 days or more as to principal or interest payments   132    229 
Loans considered troubled debt restructurings   2,637    2,853 
Total  $3,918   $5,065 

 

 

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At September 30, 2017, nonaccrual loans included $423,000 in agricultural loans, $59,000 in commercial and industrial loans, $17,000 in consumer loans, $211,000 in commercial real estate loans, and $439,000 in residential real estate loans. At December 31, 2016, nonaccrual loans included $482,000 in agricultural loans, $245,000 in commercial and industrial loans, $6,000 in consumer loans, $458,000 in commercial real estate loans, and $792,000 in residential real estate loans. Management believes the allowance allocated to its nonperforming loans is sufficient at September 30, 2017.

 

Deposits and Borrowings

Total deposits increased $1.5 million in the third quarter of 2017 and $13.5 million in the last nine months of 2016. Checking and savings deposits declined $3.7 million in the first nine months of 2017, while local certificates of deposit increased $4.2 million and brokered certificates of deposit grew $13.0 million. Brokered deposits were obtained in the first three quarters of 2017 to supplement funding of asset growth. ChoiceOne continued to place an emphasis on building its core deposits base in the first nine months of 2017. The small decrease in checking and savings deposits in the first nine months of 2017 was a normal seasonal fluctuation for ChoiceOne.

 

Federal funds purchased grew to $2.7 million as of September 30, 2017 as ChoiceOne used this as a short-term funding source. Repurchase agreements declined $4.1 million in the first nine months of 2017 due to normal fluctuations in funds provided by bank customers and movement of certain funds into other types of accounts. 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 $18.0 million in the first three quarters of 2017 as advances were used to supplement the funding for earning asset growth.

 

Shareholders’ Equity

Total shareholders’ equity increased $4.6 million from December 31, 2016 to September 30, 2017. 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 partially offset by a stock repurchase and cash dividends paid. The $1.3 million increase in other comprehensive income in the first nine months of 2017 was caused by an increase in net unrealized gains on available for sale securities. The improvement in unrealized gains resulted from decreases in certain interest rate terms since December 31, 2016, which increased the market value of the Bank’s securities.

 

24

 

 

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

 

(Dollars in thousands)  Actual   Minimum Required
for Capital
Adequacy Purposes
   Minimum Required
to be Well
Capitalized Under
Prompt Corrective
Action Regulations
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
September 30, 2017                        
ChoiceOne Financial Services Inc.                              
Total capital (to risk weighted assets)  $66,071    13.5%  $39,033    8.0%   N/A    N/A 
Common Equity Tier 1 Capital (to risk weighted assets)   61,859    12.7    21,956    4.5    N/A    N/A 
Tier 1 capital (to risk weighted assets)   61,859    12.7    19,516    6.0    N/A    N/A 
Tier 1 capital (to average assets)   61,859    9.8    25,350    4.0    N/A    N/A 
                               
ChoiceOne Bank                              
Total capital (to risk weighted assets)  $61,468    12.7%  $38,827    8.0%  $48,534    10.0%
Common Equity Tier 1 Capital (to risk weighted assets)   57,256    11.8    21,840    4.5    31,547    6.5 
Tier 1 capital (to risk weighted assets)   57,256    11.8    19,414    6.0    29,120    8.0 
Tier 1 capital (to average assets)   57,256    9.1    25,204    4.0    31,505    5.0 
                               
December 31, 2016                              
ChoiceOne Financial Services Inc.                              
Total capital (to risk weighted assets)  $59,644    13.0%  $35,289    8.0%   N/A    N/A 
Common Equity Tier 1 Capital (to risk weighted assets)   55,324    12.1    19,850    4.5    N/A    N/A 
Tier 1 capital (to risk weighted assets)   55,324    12.1    26,467    6.0    N/A    N/A 
Tier 1 capital (to average assets)   55,324    9.2    23,641    4.0    N/A    N/A 
                               
ChoiceOne Bank                              
Total capital (to risk weighted assets)  $58,963    14.2%  $35,119    8.0%  $43,899    10.0%
Common Equity Tier 1 Capital (to risk weighted assets)   54,709    13.3    19,754    4.5    28,534    6.5 
Tier 1 capital (to risk weighted assets)   54,709    13.3    26,339    6.0    35,119    8.0 
Tier 1 capital (to average assets)   54,709    9.9    23,504    4.0    29,380    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, 2017 are adequate for the foreseeable future. The Board’s determination of appropriate cash dividends for future periods will be based on, among other things, market conditions and ChoiceOne’s requirements for cash and capital.

 

Liquidity

Net cash provided from operating activities was $5.7 million for the nine months ended September 30, 2017 compared to $8.2 million provided in the same period a year ago. The change was caused by a decrease in net proceeds provided by loans originated for sale in the secondary market. Net cash used for investing activities was $36.0 million for the first nine months of 2017, compared to $30.6 million in the same period in 2016. A higher level of growth in loans in the first nine months of 2017 compared to the same period in the prior year was partially offset by lower growth in securities available for sale. Net cash provided by financing activities was $28.2 million in the first nine months of 2017, compared to $23.9 million during the same period in the prior year. The impact of more growth in deposits was offset by a lower level of net growth in Federal Home Loan Bank advances.

 

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

 

25

 

 

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 nine months ended September 30, 2017 that has materially affected, or that is reasonably likely to materially affect, ChoiceOne’s internal control over financial reporting.

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

There are no material pending legal proceedings to which ChoiceOne or the Bank is a party or to which any of their properties are subject, except for proceedings that arose in the ordinary course of business. In the belief of management, pending or current legal proceedings should not have a material effect on the consolidated financial condition of ChoiceOne.

 

Item 1A. Risk Factors.

 

Information concerning risk factors is contained in the discussion in Item 1A, “Risk Factors,” in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2016. As of the date of this report, ChoiceOne does not believe that there has been a material change in the nature or categories of ChoiceOne’s risk factors, as compared to the information disclosed in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2016.

 

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

 

On July 28, 2017, ChoiceOne issued 709 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 $16,000. ChoiceOne relied on the exemption contained in Section 4(a)(5) of the Securities Act of 1933 in connection with these sales.

 

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ISSUER PURCHASES OF EQUITY SECURITIES

 

The following table provides information regarding ChoiceOne’s purchases of its common stock during the quarter ended September 30, 2017.

 

(Dollars in thousands, except per share data)

Period
   Total Number
of Shares
Purchased
    Average
Price Paid
per Share
    Total Number
of Shares
Purchased as
Part of a
Publicly
Announced Plan
    Maximum Number of
Shares that
May Yet be
Purchased
Under the Plan
 
                     
July 1 - July 31, 2017                    
Employee Transactions      $           
Repurchase Plan      $        24,224 
August 1 - August 31, 2017                    
Employee Transactions (1)   200   $22.88           
Repurchase Plan   3,800   $23.25    3,800    20,424 
September 1 - September 30, 2017                    
Employee Transactions      $           
Repurchase Plan      $        20,424 

 

(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) As of September 30, 2017, there are 20,424 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.

 

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SIGNATURES

 

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

 

    CHOICEONE FINANCIAL SERVICES, INC.  
       
Date: November 14, 2017  /s/ Kelly J. Potes  
    Kelly J. Potes
Chief Executive Officer
(Principal Executive Officer)
 
       
Date: November 14, 2017 /s/ Thomas L. Lampen  
   

Thomas L. Lampen
Treasurer
(Principal Financial and Accounting Officer)

 

 

 

 

 

 

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