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, 2014
   
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 38-2659066
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer Identification No.)
   
109 East Division
Sparta, Michigan
49345
(Address of Principal Executive Offices) (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, 2014, the Registrant had outstanding 3,300,523 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)  2014  2013
   (Unaudited)  (Audited)
Assets          
Cash and due from banks  $10,793   $20,479 
           
Securities available for sale   141,017    136,082 
Federal Home Loan Bank stock   2,478    2,478 
Federal Reserve Bank stock   1,272    1,272 
           
Loans held for sale   1,987    931 
Loans   338,415    315,966 
Allowance for loan losses   (4,660)   (4,735)
Loans, net   333,755    311,231 
           
   Premises and equipment, net   11,864    11,995 
   Cash value of life insurance policies   10,487    10,269 
   Intangible assets, net   939    1,275 
   Goodwill   13,728    13,728 
   Other assets   5,099    4,835 
      Total assets  $533,419   $514,575 
           
Liabilities          
   Deposits – noninterest-bearing  $107,802   $102,243 
   Deposits – interest-bearing   314,748    315,884 
      Total deposits   422,550    418,127 
           
Federal funds purchased   2,149    —   
Repurchase agreements   19,654    26,033 
   Advances from Federal Home Loan Bank   20,370    6,392 
   Other liabilities   3,591    2,465 
      Total liabilities   468,314    453,017 
           
Shareholders' Equity          
   Preferred stock; shares authorized: 100,000;          
      shares outstanding: none   —      —   
   Common stock and paid in capital, no par value;          
      shares authorized: 7,000,000;  shares outstanding:          
      3,300,105 at September 30, 2014 and 3,295,463 at December 31, 2013   46,636    46,595 
   Retained earnings   17,503    14,815 
   Accumulated other comprehensive income, net   966    148 
      Total shareholders’ equity   65,105    61,558 
      Total liabilities and shareholders’ equity  $533,419   $514,575 

 

See accompanying notes to interim consolidated financial statements.

 

2
 

 

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,
   2014  2013  2014  2013
Interest income                    
   Loans, including fees  $4,008   $3,935   $11,772   $11,943 
   Securities:                    
      Taxable   458    448    1,394    1,365 
      Tax exempt   349    349    1,039    1,042 
   Other   2    3    6    8 
         Total interest income   4,817    4,735    14,211    14,358 
                     
Interest expense                    
   Deposits   258    317    800    1,031 
   Advances from Federal Home Loan Bank   15    14    41    29 
   Other   9    13    33    32 
         Total interest expense   282    344    874    1,092 
                     
Net interest income   4,535    4,391    13,337    13,266 
Provision for loan losses   —      —      100    300 
                     
Net interest income after provision for loan losses   4,535    4,391    13,237    12,966 
                     
Noninterest income                    
   Customer service charges   1,056    963    2,878    2,735 
   Insurance and investment commissions   242    288    678    631 
   Gains on sales of loans   276    295    726    1,269 
   Gains on sales of securities   89    13    182    89 
   Losses on sales and write-downs of other assets   (32)   (520)   (142)   (820)
   Earnings on life insurance policies   75    75    219    225 
   Other   130    160    362    427 
         Total noninterest income   1,836    1,274    4,903    4,556 
                     
Noninterest expense                    
   Salaries and benefits   2,127    2,119    6,288    6,236 
   Occupancy and equipment   599    580    1,812    1,742 
   Data processing   473    422    1,360    1,328 
   Professional fees   250    185    683    577 
   Supplies and postage   100    100    317    344 
   Advertising and promotional   57    44    191    156 
   Intangible amortization   112    112    336    336 
   Loan and collection expense   37    98    103    275 
   FDIC insurance   86    68    257    247 
   Other   388    350    1,151    1,234 
         Total noninterest expense   4,229    4,078    12,498    12,475 
                     
Income before income tax   2,142    1,587    5,642    5,047 
Income tax expense   588    386    1,503    1,299 
                     
Net income  $1,554   $1,201   $4,139   $3,748 
                     
Basic earnings per share  $0.47   $0.37   $1.25   $1.14 
Diluted earnings per share  $0.47   $0.36   $1.25   $1.13 
Dividends declared per share  $0.15   $0.14   $0.44   $0.40 


See accompanying notes to interim consolidated financial statements.


3
 

 

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

 

(Dollars in thousands)  Three Months Ended
September 30,
  Nine Months Ended
September 30,
   2014  2013  2014  2013
Net income  $1,554   $1,201   $4,139   $3,748 
                     
Other comprehensive income:                    
Unrealized holding gains/(losses) on available for sale securities   230    (735)   1,420    (3,013)
Less: Reclassification adjustment for gain recognized in earnings   (89)   (13)   (182)   (89)
Net unrealized gain/(loss)   141    (748)   1,238    (3,102)
Tax (expense)/benefit   (48)   254    (420)   1,055 
Other comprehensive income/(loss), net of tax   93    (494)   818    (2,047)
                     
Comprehensive income  $1,647   $707   $4,957   $1,701 

  

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,   
(Dollars in thousands)  Shares  Capital  Earnings  Net  Total
                          
Balance, January 1, 2013   3,298,081   $46,649   $11,501   $2,356   $60,506 
                          
Net income             3,748         3,748 
Other comprehensive loss                  (2,047)   (2,047)
Shares repurchased   (11,468)   (192)             (192)
Shares issued   7,165    104              104 
Change in ESOP repurchase obligation        (13)             (13)
Effect of employee stock purchases        9              9 
Issuance of restricted stock units        6              6 
Cash dividends declared ($0.40 per share)             (1,320)        (1,320)
                          
Balance, September 30, 2013   3,293,778   $46,563   $13,929   $309   $60,801 
                          
                          
Balance, January 1, 2014   3,295,463   $46,595   $14,815   $148   $61,558 
                          
Net income             4,139         4,139 
Other comprehensive income                  818    818 
Shares repurchased   (3,437)   (69)             (69)
Shares issued   7,137    101              101 
Change in ESOP repurchase obligation        (18)             (18)
Effect of employee stock purchases        9              9 
Restricted stock units issued   942    18              18 
Cash dividends declared ($0.44 per share)             (1,451)        (1,451)
                          
Balance, September 30, 2014   3,300,105   $46,636   $17,503   $966   $65,105 

  

See accompanying notes to interim consolidated financial statements.


5
 

 

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

 

(Dollars in thousands)  Nine Months Ended
September 30,
   2014  2013
Cash flows from operating activities:          
   Net income  $4,139   $3,748 
   Adjustments to reconcile net income to net cash from          
      operating activities:          
      Provision for loan losses   100    300 
      Depreciation   746    686 
      Amortization   1,156    1,240 
      Compensation expense on stock purchases and          
restricted stock units   27    15 
      Gains on sales of securities   (182)   (89)
      Gains on sales of loans   (726)   (1,269)
      Loans originated for sale   (20,892)   (34,442)
      Proceeds from loan sales   20,506    36,437 
      Earnings on bank-owned life insurance   (219)   (225)
      Gains on sales of other real estate owned   (22)   (11)
      Write-downs of other real estate owned   154    831 
      Proceeds from sales of other real estate owned   761    701 
      Deferred federal income tax benefit   (250)   (317)
      Net changes in other assets   (724)   150 
      Net changes in other liabilities   937    104 
            Net cash from operating activities   5,511    7,859 
           
Cash flows from investing activities:          
   Securities available for sale:          
      Sales   17,386    4,371 
      Maturities, prepayments and calls   8,637    19,978 
      Purchases   (30,211)   (21,082)
   Loan originations and payments, net   (23,146)   (5,131)
   Additions to premises and equipment   (615)   (707)
            Net cash from investing activities   (27,949)   (2,571)
           
Cash flows from financing activities:          
   Net change in deposits   4,423    (17,845)
   Net change in repurchase agreements   (6,379)   (354)
   Net change in federal funds purchased   2,149    —   
   Proceeds from Federal Home Loan Bank advances   56,700    18,000 
   Payments on Federal Home Loan Bank advances   (42,722)   (9,021)
   Issuance of common stock   101    104 
   Repurchase of common stock   (69)   (192)
   Cash dividends   (1,451)   (1,320)
            Net cash from financing activities   12,752    (10,628)
           
Net change in cash and cash equivalents   (9,686)   (5,340)
Beginning cash and cash equivalents   20,479    19,034 
           
Ending cash and cash equivalents  $10,793   $13,694 
           
Supplemental disclosures of cash flow information:          
   Cash paid for income taxes  $980   $1,092 
   Cash paid for interest  $884   $1,025 
   Loans transferred to other real estate owned  $521   $472 

 

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” or the “Registrant”) and its wholly-owned subsidiary, ChoiceOne Bank (the “Bank”), and the Bank’s wholly-owned subsidiary, ChoiceOne Insurance Agencies, Inc. Intercompany transactions and balances have been eliminated in consolidation.

 

The consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, prevailing practices within the banking industry and the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

 

The accompanying consolidated financial statements reflect all adjustments ordinary in nature which are, in the opinion of management, necessary for a fair presentation of the Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013, the Consolidated Statements of Income for the three- and nine-month periods ended September 30, 2014 and September 30, 2013, the Consolidated Statements of Comprehensive Income for the three- and nine-month periods ended September 30, 2014 and September 30, 2013, the Consolidated Statements of Changes in Shareholders' Equity for the nine-month periods ended September 30, 2014 and September 30, 2013, and the Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2014 and September 30, 2013. Operating results for the nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.

 

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Registrant's Annual Report on Form 10-K for the year ended December 31, 2013.

 

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 2,740 shares of common stock were issued to the Registrant’s Board of Directors for a cash price of $48,000 under the terms of the Directors’ Stock Purchase Plan in the first nine months of 2014. A total of 3,284 shares were issued to employees for a cash price of $53,000 under the Employee Stock Purchase Plan in the first three quarters of 2014. A total of 1,113 shares were issued upon the exercise of stock options in the first three quarters of 2014. A total of 3,437 shares of common stock were repurchased in the first three quarters of 2014. A total of 942 shares were issued upon the vesting of Restricted Stock Units.

 

Stock-Based Compensation

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

 

Reclassifications

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

7
 

 

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, 2014  
       Gross    Gross      
(Dollars in thousands)   Amortized    Unrealized    Unrealized     Fair 
   Cost    Gains    Losses     Value 
U.S. Government and federal agency  $40,675   $73   $(251)  $40,497 
U.S. Treasury   13,224    —       (84)   13,140 
State and municipal   66,385    1,869    (368)   67,886 
Mortgage-backed   9,363    51    (80)   9,334 
Corporate   7,041    30    (19)   7,052 
Foreign debt   1,000    —      (6)   994 
Equity securities   1,707    10    —      1,717 
Asset-backed securities   400    —      (3)   397 
  Total  $139,795   $2,033   $(811)  $141,017 

  

     December 31, 2013  
         Gross    Gross      
   Amortized    Unrealized     Unrealized    Fair 
   Cost    Gains    Losses    Value 
U.S. Government and federal agency  $44,059   $166   $(503)  $43,722 
U.S. Treasury   7,285    17    (78)   7,224 
State and municipal   64,215    1,622    (1,062)   64,775 
Mortgage-backed   8,541    95    (166)   8,470 
Corporate   8,805    61    (51)   8,815 
Foreign debt   1,000    —      (10)   990 
Equity securities   1,707    7    (111)   1,603 
Asset-backed securities   486    —      (3)   483 
  Total  $136,098   $1,968   $(1,984)  $136,082 

 

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, 2014. 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
 

 

NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES

 

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

 

      Commercial                  
(Dollars in thousands)     and     Commercial  Construction   Residential      
   Agricultural  Industrial  Consumer  Real Estate  Real Estate  Real Estate  Unallocated  Total
Allowance for Loan Losses                                        
Three Months Ended                                        
September 30, 2014                                        
Beginning balance  $180   $677   $195   $1,743   $5   $1,269   $587   $4,656 
Charge-offs   —      —      (82)   —      —      (7)   —      (89)
Recoveries   6    23    39    16    —      9    —      93 
Provision   (47)   (78)   42    325    1    (120)   (123)   —   
Ending balance  $139   $622   $194   $2,084   $6   $1,151   $464   $4,660 
                                         
Nine Months Ended                                        
September 30, 2014                                        
Beginning balance  $179   $562   $192   $1,842   $12   $1,625   $323   $4,735 
Charge-offs   —      —      (199)   (185)   —      (117)   —      (501)
Recoveries   10    90    146    39    —      41    —      326 
Provision   (50)   (30)   55    388    (6)   (398)   141    100 
Ending balance  $139   $622   $194   $2,084   $6   $1,151   $464   $4,660 
                                         
Individually evaluated for impairment  $6   $18   $3   $1,053   $—     $301   $—     $1,381 
                                         
Collectively evaluated for impairment  $133   $604   $191   $1,031   $6   $850   $464   $3,279 
                                         
Three Months Ended                                        
September 30, 2013                         
Beginning balance  $140   $810   $215   $2,450   $20   $1,671   $558   $5,864 
Charge-offs   (88)   (5)   (102)   —      —      (148)   —      (343)
Recoveries   3    19    41    24    —      104    —      191 
Provision   83    (203)   51    74    (7)   126    (124)   —   
Ending balance  $138   $621   $205   $2,548   $13   $1,753   $434   $5,712 
                                         
Nine Months Ended                                        
September 30, 2013                         
Beginning balance  $140   $381   $250   $2,596   $15   $1,923   $547   $5,852 
Charge-offs   (88)   (54)   (286)   (166)   —      (431)   —      (1,025)
Recoveries   5    258    145    55    —      122    —      585 
Provision   81    36    96    63    (2)   139    (113)   300 
Ending balance  $138   $621   $205   $2,548   $13   $1,753   $434   $5,712 
                                         
Individually evaluated for impairment  $—     $174   $4   $1,145   $—     $492   $—     $1,815 
                                         
Collectively evaluated for impairment  $138   $447   $201   $1,403   $13   $1,261   $434   $3,897 
                                         
Loans                                        
September 30, 2014                                        
Individually evaluated for impairment  $61   $156   $32   $4,831   $—     $2,771        $7,851 
Collectively evaluated for impairment   33,758    87,914    21,009    96,338    1,992    89,553         330,564 
Ending balance  $33,819   $88,070   $21,041   $101,169   $1,992   $92,324        $338,415 
                                         
December 31, 2013                                        
Individually evaluated for impairment  $452   $776   $37   $4,195   $—     $2,827        $8,287 
Collectively evaluated for impairment   36,596    67,754    19,894    92,792    890    89,753         307,679 
Ending balance  $37,048   $68,530   $19,931   $96,987   $890   $92,580        $315,966 

 

9
 

 

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, 
    2014    2013    2014    2013    2014    2013 
Risk ratings 1 and 2  $6,035   $8,339   $8,939   $7,333   $2,689   $3,000 
Risk rating 3   21,614    23,036    64,255    46,943    59,259    53,681 
Risk rating 4   5,324    4,330    13,069    12,557    27,310    27,610 
Risk rating 5   783    1,193    1,293    1,025    7,040    6,813 
Risk rating 6   63    150    454    608    4,753    5,818 
Risk rating 7   —      —      60    64    118    65 
   $33,819   $37,048   $88,070   $68,530   $101,169   $96,987 

 

10
 

 

Corporate Credit Exposure - Credit Risk Profile Based On Payment Activity 

 

     Consumer    Construction Real Estate    Residential Real Estate 
     September 30,    December 31,    September 30,    December 31,    September 30,    December 31, 
     2014    2013    2014    2013    2014    2013 
Performing   $21,009   $19,900   $1,992   $890   $89,569   $89,959 
Nonperforming    32    31    —      —      2,755    2,621 
    $21,041   $19,931   $1,992   $890   $92,324   $92,580 

 

The following schedule provides information on loans that were considered TDRs that were modified during the three- and nine-month periods ended September 30, 2014:

 

   Three Months Ended September 30, 2014  Nine Months Ended September 30, 2014
         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   2   $731   $731    5   $1,165   $1,167 
Residential real estate   1    197    193    2    286    281 
    3   $928   $924    7   $1,451   $1,448 

 

The following schedule provides information on loans that were considered TDRs that were modified during the three- and nine-month periods ended September 30, 2013:

 

   Three Months Ended September 30, 2013  Nine Months Ended September 30, 2013
         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   $214   $214    1   $214   $214 

 

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.

 

 

11
 

 

The following schedule provides information on TDRs as of September 30, 2014 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, 2014 that had been modified during the year prior to the default:

 

   Three Months Ended  Nine Months Ended
   September 30, 2014  September 30, 2014
(Dollars in thousands)  Number  Recorded  Number  Recorded
   of Loans  Investment  of Loans  Investment
Commercial real estate   6   $1,315    6   $1,315 
Residential real estate   2    111    2    111 
    8   $1,426    8   $1,426 

 

The following schedule provides information on TDRs as of September 30, 2013 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, 2013 that had been modified during the year prior to the default:

 

   Three Months Ended  Nine Months Ended
   September 30, 2013  September 30, 2013
(Dollars in thousands)  Number  Recorded  Number  Recorded
   of Loans  Investment  of Loans  Investment
Commercial and industrial   —     $—      1   $88 
Commercial real estate   1    246    2    368 
Consumer   —      —      1    29 
    1   $246    4   $485 

 

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 follow:

 

      Unpaid   
(Dollars in thousands)  Recorded  Principal  Related
   Investment  Balance  Allowance
September 30, 2014               
With no related allowance recorded               
  Agricultural  $—     $—     $—   
  Commercial and industrial   7    9    —   
  Consumer   3    4    —   
  Commercial real estate   3    3    —   
  Residential real estate   232    232    —   
Subtotal   245    248    —   
With an allowance recorded               
  Agricultural   61    64    6 
  Commercial and industrial   149    153    18 
  Consumer   29    29    3 
  Commercial real estate   4,828    5,610    1,053 
  Residential real estate   2,539    2,553    301 
Subtotal   7,606    8,409    1,381 
Total               
  Agricultural   61    64    6 
  Commercial and industrial   156    162    18 
  Consumer   32    33    3 
  Commercial real estate   4,831    5,613    1,053 
  Residential real estate   2,771    2,785    301 
Total  $7,851   $8,657   $1,381 
                
December 31, 2013               
With no related allowance recorded               
  Agricultural  $452   $455   $—   
  Commercial and industrial   229    300    —   
  Consumer   2    3    —   
  Commercial real estate   782    843    —   
  Residential real estate   891    1,128    —   
Subtotal   2,356    2,729    —   
With an allowance recorded               
  Agricultural   —      —      —   
  Commercial and industrial   547    554    53 
  Consumer   35    35    3 
  Commercial real estate   3,413    3,997    699 
  Residential real estate   1,936    1,936    308 
Subtotal   5,931    6,522    1,063 
Total               
  Agricultural   452    455    —   
  Commercial and industrial   776    854    53 
  Consumer   37    38    3 
  Commercial real estate   4,195    4,840    699 
  Residential real estate   2,827    3,064    308 
Total  $8,287   $9,251   $1,063 

  

13
 

 

The following schedule provides information regarding average balances of impaired loans and interest recognized on impaired loans for the nine months ended September 30, 2014 and 2013: 

 

   Average  Interest
(Dollars in thousands)  Recorded  Income
   Investment  Recognized
September 30, 2014          
With no related allowance recorded          
  Agricultural  $113   $—   
  Commercial and industrial   91    —   
  Consumer   1    —   
  Commercial real estate   338    5 
  Residential real estate   490    5 
Subtotal   1,033    10 
With an allowance recorded          
  Agricultural   162    —   
  Commercial and industrial   365    4 
  Consumer   32    2 
  Commercial real estate   4,055    71 
  Residential real estate   2,289    69 
Subtotal   6,903    146 
Total          
  Agricultural   275    —   
  Commercial and industrial   457    4 
  Consumer   33    2 
  Commercial real estate   4,392    76 
  Residential real estate   2,779    74 
Total  $7,936   $156 
           
September 30, 2013          
With no related allowance recorded          
  Agricultural  $142   $7 
  Commercial and industrial   49    —   
  Consumer   3    —   
  Commercial real estate   670    (1)
  Residential real estate   348    3 
Subtotal   1,212    9 
With an allowance recorded          
  Agricultural   140    1 
  Commercial and industrial   334    7 
  Consumer   45    3 
  Commercial real estate   4,305    200 
  Residential real estate   2,275    61 
Subtotal   7,099    272 
Total          
  Agricultural   282    8 
  Commercial and industrial   383    7 
  Consumer   48    3 
  Commercial real estate   4,975    199 
  Residential real estate   2,623    64 
Total  $8,311   $281 

 

 

14
 

 

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, 2014                                                        
Agricultural   $ 288     $ —       $ —       $ 288     $ 33,531     $ 33,819     $ —    
Commercial and
industrial
    306       —         —         306       87,764       88,070       —    
Consumer     38       2       5       45       20,996       21,041       5  
Commercial real estate     1,621       53       474       2,148       99,021       101,169       —    
Construction real estate     —         —         —         —         1,992       1,992       —    
Residential real estate     1,939       168       461       2,568       89,756       92,324       192  
    $ 4,192     $ 223     $ 940     $ 5,355     $ 333,060     $ 338,415     $ 197  

 

December 31, 2013                                                        
Agricultural   $ 9     $ 1     $ 428     $ 438     $ 36,610     $ 37,048     $ —    
Commercial and
industrial
    93       352       73       518       68,012       68,530       —    
Consumer     60       7       —         67       19,864       19,931       —    
Commercial real estate     901       884       242       2,027       94,960       96,987       —    
Construction real estate     —         —         —         —         890       890       —    
Residential real estate     673       186       167       1,026       91,554       92,580       11  
    $ 1,736     $ 1,430     $ 910     $ 4,076     $ 311,890     $ 315,966     $ 11  

(1)   Includes nonaccrual loans.

 

Nonaccrual loans by loan category follow:

 

(Dollars in thousands)  September 30,  December 31,
   2014  2013
  Agricultural  $61   $452 
  Commercial and industrial   156    372 
  Consumer   —      2 
  Commercial real estate   3,274    1,606 
  Residential real estate   604    691 
   $4,095   $3,123 

 

 

15
 

 

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,
   2014  2013  2014  2013
Basic Earnings Per Share            
  Net income available to common                    
    shareholders  $1,554   $1,201   $4,139   $3,748 
                     
  Weighted average common shares outstanding   3,300,139    3,294,480    3,298,321    3,298,607 
                     
  Basic earnings per share  $0.47   $0.37   $1.25   $1.14 
                     
Diluted Earnings Per Share                    
  Net income available to common                    
    shareholders  $1,554   $1,201   $4,139   $3,748 
                     
  Weighted average common shares outstanding   3,300,139    3,294,480    3,298,321    3,298,607 
  Plus dilutive stock options and restricted stock units   9,129    6,135    8,662    5,850 
                     
  Weighted average common shares outstanding                    
    and potentially dilutive shares   3,309,268    3,300,615    3,306,983    3,304,457 
                     
  Diluted earnings per share  $0.47   $0.36   $1.25   $1.13 

 

There were 6,038 stock options as of September 30, 2014 and 24,800 stock options as of September 30, 2013, that are considered to be anti-dilutive to earnings per share for the three-month and nine-month periods ended September 30, 2014 and 2013. These stock options have been excluded from the calculation above.

 

 

16
 

 

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, 2014                         
Assets:                         
  Cash and due from banks  $10,793   $10,793   $10,793   $—     $—   
  Securities available for sale   141,017    141,017    217    129,608    11,192 
  Federal Home Loan Bank and Federal                         
    Reserve Bank stock   3,750    3,750    —      3,750    —   
  Loans held for sale   1,987    2,048    —      2,048    —   
  Loans, net   333,755    334,809    —      —      334,809 
                          
Liabilities:                         
  Noninterest-bearing deposits   107,802    107,802    —      107,802    —   
  Interest-bearing deposits   314,748    314,748    —      314,748    —   
  Federal funds purchased   2,149    2,149    —      2,149    —   
  Repurchase agreements   19,654    19,654    —      19,654    —   
  Federal Home Loan Bank advances   20,370    20,409    —      20,409    —   
                          
                          
December 31, 2013                         
Assets:                         
  Cash and due from banks  $20,479   $20,479   $20,479   $—     $—   
  Securities available for sale   136,082    136,082    214    124,540    11,328 
  Federal Home Loan Bank and Federal                         
    Reserve Bank stock   3,750    3,750    —      3,750    —   
  Loans held for sale   931    957    —      957    —   
  Loans, net   311,231    313,659    —      —      313,659 
                          
Liabilities:                         
  Noninterest-bearing deposits   102,243    102,243    —      102,243    —   
  Interest-bearing deposits   315,884    316,222    —      316,222    —   
  Repurchase agreements   26,033    26,033    —      26,033    —   
  Federal Home Loan Bank advances   6,392    6,428    —      6,428    —   

  

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, 2014 and December 31, 2013 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, 2014 and December 31, 2013 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.

 

17
 

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, 2014 or December 31, 2013. Disclosures concerning assets measured at fair value are as follows:

Assets Measured at Fair Value on a Recurring Basis

 

    Quoted Prices  Significant      
   in Active  Other  Significant   
   Markets for Identical  Observable  Unobservable   
(Dollars in thousands)  Assets  Inputs  Inputs  Balance at
   (Level 1)  (Level 2)  (Level 3)  Date Indicated
Investment Securities, Available for                    
Sale – September 30, 2014                    
U.S. Treasury  $—     $13,140   $—     $13,140 
U.S. Government and federal agency   —      40,497    —      40,497 
State and municipal   —      58,592    9,294    67,886 
Mortgage-backed   —      9,334    —      9,334 
Corporate   —      6,654    398    7,052 
Foreign debt   —      994    —      994 
Equity securities   217    —      1,500    1,717 
Asset backed securities   —      397    —      397 
     Total  $217   $129,608   $11,192   $141,017 
                     
Investment Securities, Available for                    
Sale - December 31, 2013                    
U.S. Treasury  $—     $7,224   $—     $7,224 
U.S. Government and federal agency   —      43,722    —      43,722 
State and municipal   —      55,234    9,541    64,775 
Mortgage-backed   —      8,470    —      8,470 
Corporate   —      8,417    398    8,815 
Foreign debt   —      990         990 
Equity securities   214    —      1,389    1,603 
Asset backed securities   —      483    —      483 
     Total  $214   $124,540   $11,328   $136,082 

18
 

 

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

 

(Dollars in thousands)      
   2014  2013
Investment Securities, Available for Sale          
Balance, January 1  $11,328   $2,599 
Total realized and unrealized losses included in income   (11)   —   
Total unrealized gains (losses) included in other comprehensive income   (115)   8 
Net purchases, sales, calls, and maturities   (84)   1,551 
Net transfers into Level 3   74    —   
Balance, September 30  $11,192   $4,158 

  

Of the Level 3 assets that were held by the Bank at September 30, 2014, the net unrealized gain for the nine months ended September 30, 2014 was $138,000, which is recognized in other comprehensive income in the consolidated balance sheet. Purchases of level 3 securities during the first three quarters of 2014 and 2013 consisted of local municipal issues. During the first nine months of 2014, a $600,000 Level 3 bond was sold. There were no sales of Level 3 securities in the first nine months of 2013.

 

Both observable and unobservable inputs may be used to determine the fair value of positions classified as Level 3 investment securities and liabilities. As a result, the unrealized gains and losses for these assets and liabilities presented in the tables above may include changes in fair value that were attributable to both observable and unobservable inputs.

Available for sale investment securities categorized as Level 3 assets primarily consist of bonds issued by local municipalities. The Bank estimates the fair value of these bonds based on the present value of expected future cash flows using management’s best estimate of key assumptions, including forecasted interest yield and payment rates, credit quality and a discount rate commensurate with the current market and other risks involved.

The Bank also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets are not normally measured at fair value, but can be subject to fair value adjustments in certain circumstances, such as impairment. Disclosures concerning assets measured at fair value on a non-recurring basis are as follows:

 

Assets Measured at Fair Value on a Non-recurring Basis

 

        Quoted Prices  Significant   
        in Active  Other  Significant
        Markets for Identical  Observable  Unobservable
(Dollars in thousands)  Balance at    Assets  Inputs  Inputs
   Date Indicated    (Level 1)  (Level 2)  (Level 3)
Impaired Loans                    
September 30, 2014  $7,851   $ —    $—     $7,851 
December 31, 2013  $8,287   $ —   $—     $8,287 

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 best 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).

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” or the “Registrant”) and its wholly-owned subsidiary, ChoiceOne Bank (the "Bank"), and the Bank’s wholly-owned subsidiary, ChoiceOne Insurance Agencies, Inc. This discussion should be read in conjunction with the interim consolidated financial statements and related notes.

 

FORWARD-LOOKING STATEMENTS

 

This discussion and other sections of this quarterly report contain forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and ChoiceOne itself. Words such as "anticipates," "believes," "estimates," "expects," "forecasts," "intends," "is likely," "plans," "predicts," "projects," "may," "could," and variations of such words and similar expressions are intended to identify such forward-looking statements. Management’s determination of the provision and allowance for loan losses, the carrying value of goodwill and loan servicing rights, the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary) and management’s assumptions concerning pension and other postretirement benefit plans involve judgments that are inherently forward-looking. All of the information concerning interest rate sensitivity is forward-looking. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("risk factors") that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed, implied or forecasted in such forward-looking statements. Furthermore, ChoiceOne undertakes no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events, or otherwise.

 

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Risk factors include, but are not limited to, the risk factors discussed in Item 1A of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2013; changes in banking laws and regulations; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of pending and future litigation and contingencies; trends in customer behavior as well as their abilities to repay loans; changes in the local and national economies; changes in market conditions; the level and timing of asset growth; various other local and global uncertainties such as acts of terrorism and military actions; and current uncertainties and fluctuations in the financial markets and stocks of financial services providers due to concerns about capital and concerns about the Michigan economy in particular. 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 2014 was $1,554,000, which represented an increase of $353,000 or 29% compared to the same period in 2013. Net income for the first nine months of 2014 was $4,139,000, which represented an increase of $391,000 or 10% over the same period in 2013. Increases in net interest income and noninterest income were partially offset by an increase in noninterest expense and income tax expense for the third quarter of 2014 compared to the third quarter of 2013. Basic earnings per common share were $0.47 for the third quarter of 2014 and $1.25 for the first nine months of 2014, compared to $0.37 and $1.14, respectively, for the same periods in 2013. Diluted earnings per common share were $0.47 for the third quarter of 2014 and $1.25 for the first nine months of 2014, compared to $0.36 and $1.13, respectively, for the same periods in 2013. The return on average assets and return on average shareholders’ equity percentages were 1.06% and 8.68%, respectively, for the first three quarters of 2014, compared to 1.00% and 8.18%, respectively, for the same periods in 2013.

 

Dividends

Cash dividends of $495,000 or $0.15 per share were declared in the third quarter of 2014, compared to $462,000 or $0.14 per share in the third quarter of 2013. The cash dividends declared in the first nine months of 2014 were $1,451,000 or $0.44 per share, compared to $1,320,000 or $0.40 per share declared in the same period in 2013. The cash dividend payout percentage was 35% for the first nine months of 2014 as well as 2013.

 

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, 2014 and 2013. Table 1 documents ChoiceOne’s average balances and interest income and expense, as well as the average rates earned or paid on assets and liabilities. Table 2 documents the effect on interest income and expense of changes in volume (average balance) and interest rates. These tables are referred to in the discussion of interest income, interest expense and net interest income.

 

 

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Table 1 – Average Balances and Tax-Equivalent Interest Rates

 

(Dollars in thousands)  Nine Months Ended September 30,
   2014  2013
   Average        Average      
    Balance    Interest    Rate    Balance    Interest    Rate 
Assets:                              
  Loans (1)  $324,145   $11,782    4.85%  $312,528   $11,954    5.10%
  Taxable securities (2) (3)   98,082    1,394    1.90    91,296    1,364    1.99 
  Nontaxable securities (1) (2)   44,025    1,569    4.75    42,290    1,575    4.97 
  Other   3,734    6    0.21    4,455    8    0.24 
    Interest-earning assets   469,986    14,751    4.18    450,569    14,901    4.41 
  Noninterest-earning assets   52,041              51,608           
    Total assets  $522,027             $502,177           
                               
Liabilities and Shareholders' Equity:                              
  Interest-bearing demand deposits  $138,824    174    0.17%  $134,178    200    0.20%
  Savings deposits   68,179    32    0.06    65,739    30    0.06 
  Certificates of deposit   107,693    594    0.74    120,392    801    0.89 
  Advances from Federal Home Loan Bank   11,472    41    0.48    6,165    29    0.63 
  Other   21,130    33    0.21    18,175    32    0.23 
    Interest-bearing liabilities   347,298    874    0.34    344,649    1,092    0.42 
  Noninterest-bearing demand deposits   109,238              93,073           
  Other noninterest-bearing liabilities   1,931              3,387           
    Total liabilities   458,467              441,109           
  Shareholders' equity   63,560              61,068           
    Total liabilities and                              
      shareholders' equity  $522,027             $502,177           
                               
Net interest income (tax-equivalent basis) -                         
  interest spread        13,877    3.85%        13,809    3.99%
Tax-equivalent adjustment (1)        (540)             (543)     
Net interest income       $13,337             $13,266      
Net interest income as a percentage of earning                         
  assets (tax-equivalent basis)             3.94%             4.09%

 

_____________________

 

  (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

 

(Dollars in thousands)  Nine Months Ended September 30,
   2014 Over 2013
    Total    Volume    Rate 
Increase (decrease) in interest income (1)               
  Loans (2)  $(172)  $605   $(777)
  Taxable securities   30    124    (94)
  Nontaxable securities (2)   (6)   86    (92)
  Other   (2)   (1)   (1)
    Net change in tax-equivalent interest income   (150)   814    (964)
                
Increase (decrease) in interest expense (1)               
  Interest-bearing demand deposits   (26)   11    (37)
  Savings deposits   2    1    1 
  Certificates of deposit   (207)   (79)   (128)
  Advances from Federal Home Loan Bank   12    24    (12)
  Other   1    6    (5)
    Net change in interest expense   (218)   (37)   (181)
    Net change in tax-equivalent               
      net interest income  $68   $851   $(783)

 

_______________

 

  (1) The volume variance is computed as the change in volume (average balance) multiplied by the previous year's interest rate.  The rate variance is computed as the change in interest rate multiplied by the previous year's volume (average balance).  The change in interest due to both volume and rate has been allocated to the volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
  (2) Interest on nontaxable investment securities and loans has been adjusted to a fully tax-equivalent basis using an incremental tax rate of 34% for the periods presented.

 

Net Interest Income

The presentation of net interest income on a tax-equivalent basis is not in accordance with generally accepted accounting principles (“GAAP”), but is customary in the banking industry. This non-GAAP measure ensures comparability of net interest income arising from both taxable and tax-exempt loans and investment securities. The adjustments to determine net interest income on a tax-equivalent basis were $540,000 and $543,000 for the nine months ended September 30, 2014 and 2013, 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 $68,000 in the first nine months of 2014 compared to the same period in 2013. The relationship between growth in average interest-earning assets and average interest-bearing liabilities caused net interest income to increase $850,000 in the first three quarters of 2014 compared to the same period in the prior year. A decrease of 14 basis points in the net interest spread from 3.99% in the first nine months of 2013 to 3.85% in the first nine months of 2014 resulted in a $782,000 decrease in net interest income.

 

The average balance of loans increased $11.6 million in the first nine months of 2014 compared to the same period in 2013. Average commercial loans increased $15.4 million and average consumer loans grew $1.0 million while average residential mortgage loans declined $4.8 million in the first three quarters of 2014 compared to the same period in 2013. The average interest rate earned on loans declined 25 basis points from the first nine months of 2013 to the same period in 2014 as a result of renewals of existing loans and new loan production at lower rates than in the existing portfolio. The increase in the average loans balance, offset by the decrease in the average rate earned, caused tax-equivalent interest income from loans to decline $172,000 in the first three quarters of 2014 compared to the same period in the prior year. The average balance of total securities grew $8.5 million in the first nine months of 2014 compared to the same period in 2013. Additional securities were purchased during the first nine months of 2014 to provide earning asset growth. Growth in average securities, offset by the effect of lower interest rates earned, caused tax-equivalent interest income to increase $24,000 in the first nine months of 2014 compared to the same period in 2013.

 

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The average balance of interest-bearing demand deposits increased $4.6 million in the first nine months of 2014 compared to the same period in 2013. The effect of the higher average balance, offset by a 3 basis point decline in the average rate paid, caused interest expense to decrease $26,000 in the first three quarters of 2014 compared to the same period in 2013. The average balance of savings deposits increased $2.4 million in the first nine months of 2014 compared to the same period in the prior year. The impact of the savings deposit growth and a less than 1 basis point increase in the average rate paid caused interest expense to increase $2,000 in the first nine months of 2014 compared to the same period in 2013. The average balance of certificates of deposit was down $12.7 million in the first nine months of 2014 compared to the same period in 2013. The decline in certificates of deposit plus a 15 basis point reduction in the average rate paid on certificates caused interest expense to fall $207,000 in the first nine months of 2014 compared to the same period in 2013. A $5.3 million increase in the average balance of Federal Home Loan Bank advances was partially offset by a 15 basis point reduction in the average rate paid and caused interest expense to increase $12,000 in the first nine months of 2014 compared to the same period in the prior year. Growth of $3.0 million in the average balance of other interest-bearing liabilities in the first nine months of 2014 compared to the first nine months of 2013 and the effect of a 2 basis point decrease in the average rate paid caused a $1,000 increase in interest expense.

 

ChoiceOne’s net interest income spread was 3.85% in the first nine months of 2014, compared to 3.99% for the first nine months of 2013. The decrease in the interest spread was due to a 22 basis point decrease in the average rate earned on interest-earning assets, which was partially offset by an 8 basis point decrease in the average rate paid on interest-bearing liabilities in the first nine months of 2014 compared to the same period in 2013. 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 2013 and the first nine months of 2014. 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 2013 and the first nine months of 2014. If market interest rates continue to remain low, ChoiceOne’s net interest spread may decrease in future quarters if reductions in the average rate on interest-earning assets exceed the ability to reprice local deposits.

 

Provision and Allowance for Loan Losses

Total loans increased $22.4 million since the end of 2013, while the allowance for loan losses declined $75,000 from December 31, 2013 to September 30, 2014. The provision for loan losses was $0 in the third quarter and $100,000 in the first nine months of 2014, compared to $0 and $300,000, respectively, in the same periods in 2013. The reduction in the provision for loan losses was due to a lower level of net charge-offs in the first nine months of 2014 than in the same period in 2013. Nonperforming loans were $7.8 million as of September 30, 2014, compared to $7.1 million as of June 30, 2014 and $7.7 million as of December 31, 2013. The increase in nonperforming loans in the third quarter of 2014 was due to an increase of $755,000 in nonaccrual loans. Nonaccrual commercial real estate loans increased $909,000 during the third quarter of 2014, which was partially offset by the net effect of changes in the other loan categories. The allowance for loan losses was 1.38% of total loans at September 30, 2014, compared to 1.41% at June 30, 2014 and 1.50% at December 31, 2013.

 

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

 

(Dollars in thousands)  2014  2013
    Charge-offs    Recoveries    Charge-offs    Recoveries 
Agricultural  $—     $10   $88   $5 
Commercial and industrial   —      90    54    258 
Consumer   199    146    286    145 
Real estate, commercial   185    39    166    55 
Real estate, residential   117    41    431    122 
   $501   $326   $1,025   $585 

  

Net recoveries were $4,000 in the third quarter of 2014 and net charge-offs were $175,000 in the first nine months of 2014, compared to net charge-offs of $152,000 in the third quarter of 2013 and $440,000 in the first nine months of 2013. Net charge-offs on an annualized basis as a percentage of average loans were 0.07% in the first nine months of 2014 compared to 0.19% for the same period in the prior year. 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 2014, the provision and allowance for loan losses will be reviewed by the Bank's management and adjusted as believed to be necessary.

 

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Noninterest Income

Total noninterest income increased $562,000 in the third quarter of 2014 and $347,000 in the first nine months of 2014 compared to the same periods in 2013. An increase in customer service charges of $93,000 in the third quarter and $143,000 in the first nine months of 2014 compared to the same periods in the prior year was due to changes in pricing and a higher volume of overdraft and debit card fees. Insurance and investment commissions decreased $46,000 in the third quarter of 2014 and increased $47,000 in the first three quarters of 2014 compared to the same periods in 2013. Gains on loan sales decreased $19,000 in the third quarter and $543,000 in the first nine months of 2014 compared to the same periods in 2013. Residential mortgage refinancing activity has slowed in 2014, causing the significant decrease. Increases of $76,000 in the third quarter and $93,000 in the first nine months of 2014 in gains on sales of securities when compared to the same periods in 2013 resulted from higher sales activity in the first nine months of 2014 than in the same period of the prior year. Decreases of $488,000 in the third quarter and $678,000 in the first nine months of 2014 in losses on sales and write-downs of other assets when compared to the same periods in 2013 resulted from less write-downs of foreclosed properties.

 

Noninterest Expense

Total noninterest expense increased $151,000 in the third quarter of 2014 and $23,000 in the first nine months of 2014 compared to the same periods in 2013. The increase of $8,000 in salaries and benefits in the third quarter of 2014 and $52,000 in the first nine months of 2014 compared to the same periods in 2013 resulted primarily from higher salaries and health insurance costs. Occupancy and equipment expense increased $19,000 and $70,000 in the third quarter and first nine months of 2014, respectively, compared the same periods in 2013 as a result of higher utility costs and investment in information technology equipment. Data processing expense increased $51,000 in the third quarter of 2014 and $32,000 in the first nine months of 2014 compared to the same periods in the prior year. In the third quarter of 2014, ChoiceOne incurred higher data communication expenses than in the first six months of 2014 and in the prior year. Professional fees increased $65,000 in the third quarter of 2014 and $106,000 in the first three quarters of 2014 compared to the same periods in 2013 as a result of higher legal and consulting fees. The $61,000 decrease in loan and collection expense in the third quarter of 2014 and the decrease of $172,000 year to date compared to the same periods in 2013 was due to a lower level of other real estate properties.

 

Income Tax Expense

Income tax expense was $1,503,000 in the first nine months of 2014 compared to $1,299,000 for the same period in 2013. The effective tax rate was 26.6% for 2014 and 25.7% for 2013. The increase in the effective tax rate in 2014 compared to 2013 was due to a lower percentage of nontaxable income from municipal securities.

 

FINANCIAL CONDITION

 

Securities

The securities available for sale portfolio increased $1.7 million in the third quarter of 2014 and $4.9 million in the first nine months of 2014. The increase in the securities portfolio was due to growth in deposits in the first nine months of 2014. Various securities totaling $30.2 million were purchased in the first nine months of 2014 to provide earning assets and to replace maturities, principal repayments, and calls within the securities portfolio. Approximately $6.9 million in various securities were called or matured since the end of 2013. Principal repayments on securities totaled $1.7 million in the first nine months of 2014. Approximately $17.4 million of securities were sold in the first three quarters of 2014 for a net gain of $182,000.

 

Loans

The loan portfolio (excluding loans held for sale) increased $8.7 million in the third quarter of 2014 and $22.4 million in the first nine months of 2014. Commercial and industrial loans and consumer loans increased $5.1 million and $0.5 million, respectively, in the third quarter of 2014 and $19.5 million and $1.1 million, respectively, in the first nine months of 2014. Mortgage loans increased $1.6 million and $0.8 million in the third quarter and first nine months of 2014, respectively. Commercial real estate loans decreased less than $0.1 million in the third quarter but increased $4.2 million in the first three quarters of 2014. Agricultural loans increased $1.7 million in the third quarter, but declined $3.2 million in the first nine months of 2014.

 

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 $7.9 million at September 30, 2014, $7.3 million as of June 30, 2014 and $8.3 million as of December 31, 2013. The balance of commercial real estate loans classified as impaired has grown $636,000, the balance of commercial and industrial loans classified as impaired has decreased $620,000, and the balance of agricultural loans classified as impaired has decreased $391,000 since the end of 2013.

 

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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,
   2014  2013
Loans accounted for on a nonaccrual basis  $4,095   $3,123 
Accruing loans contractually past due 90 days          
or more as to principal or interest payments   197    11 
Loans considered troubled debt restructurings   3,543    4,523 
Total  $7,835   $7,657 

At September 30, 2014, nonaccrual loans included $3.3 million in commercial real estate loans, $604,000 in residential real estate loans, $156,000 in commercial and industrial loans, and $61,000 in agricultural loans. At December 31, 2013, nonaccrual loans included $1.6 million in commercial real estate loans, $691,000 in residential real estate loans, $372,000 in commercial and industrial loans and $452,000 in agricultural loans. The increase in nonaccrual loans was due to the deterioration of certain credits. Management believes the allowance allocated to its nonperforming loans was sufficient at September 30, 2014; however, management believes future credit deterioration is possible depending on conditions in the Michigan economy.

 

Deposits and Borrowings

Total deposits decreased $5.2 million in the third quarter of 2014 and increased $4.4 million since the end of 2013. Checking and savings deposits decreased $3.9 million in the third quarter of 2014 but increased $10.6 million in the first nine months of 2014. Local certificates of deposit decreased $1.2 million in the third quarter and $4.2 million in the first nine months of 2014. Nonlocal certificates of deposit were reduced $2.0 million in the first nine months of 2014.

 

A decrease of $6.4 million in repurchase agreements in the first nine months of 2014 was due to normal fluctuations in funds provided by bank customers. Certain securities are sold under agreements to repurchase them the following day. Management plans to continue this practice as a low-cost source of funding. Federal Home Loan Bank advances increased $14.0 million in the first nine months of 2014 due to short-term advances taken and federal funds purchased from correspondent banks in the third quarter of 2014.

 

Shareholders' Equity

Total shareholders' equity increased $3.5 million from December 31, 2013 to September 30, 2014. 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 $819,000 increase in accumulated other comprehensive income since the end of 2013 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 2014, which increased the market value of the Bank’s securities.

 

 

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

 

         Total
(Dollars in thousands)  Leverage  Tier 1  Risk - Based
   Capital  Capital  Capital
Capital balances at September 30, 2014  $47,752   $47,752   $52,163 
Required regulatory capital to be considered "well capitalized"   25,834    22,493    37,488 
Capital in excess of "well capitalized" minimum   21,918    25,259    14,675 
Capital ratios at September 30, 2014   9.24%   12.74%   13.91%
Regulatory capital ratios - minimum requirement               
to be considered "well capitalized"   5.00%   6.00%   10.00%

 

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, 2014 are adequate for the foreseeable future. The Board’s determination of appropriate cash dividends for future periods will be based on market conditions and ChoiceOne’s requirements for cash and capital.

 

Liquidity

Net cash provided from operating activities was $5.5 million for the nine months ended September 30, 2014 compared to $7.9 million provided in the same period a year ago. Lower proceeds from loan sales were offset by lower loans originated for sale. A lower provision for loan losses in 2014, lower gains on sales of loans, and lower write-downs of other real estate owned (“OREO”) properties also affected operating activities. Net cash used in investing activities was $27.9 million for the first nine months of 2014 compared to $2.6 million in the same period in 2013. The change was due to a higher level of net loan originations and net securities purchases. Net cash provided from financing activities was $12.8 million in the nine months ended September 30, 2014, compared to $10.6 million in cash used by financing activities in the same period in the prior year. An increase in deposits, , net proceeds from the Federal Home Loan Bank advances, and federal funds purchased from correspondent banks in the first nine months of 2014 compared to the same period of 2013 was partially offset by a decrease in repurchase agreements.

 

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 the Registrant’s management, including the Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Registrant's disclosure controls and procedures. Based on and as of the time of that evaluation, the Registrant’s management, including the Chief Executive Officer and Principal Financial Officer, concluded that the Registrant’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 the Registrant’s internal control over financial reporting that occurred during the quarter ended September 30, 2014 that has materially affected, or that is reasonably likely to materially affect, the Registrant’s internal control over financial reporting.

PART II.  OTHER INFORMATION

 

Item 1.  Legal Proceedings.

 

There are no material pending legal proceedings to which the Registrant 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 the Registrant.

 

 

26
 

 Item 1A.  Risk Factors.

 

Information concerning risk factors is contained in the discussion in Item 1A, “Risk Factors,” in the Registrant's Annual Report on Form 10-K for the year ended December 31, 2013. 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 the Registrant's Annual Report on Form 10-K for the year ended December 31, 2013.

 

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

 

On July 23, 2014 the Registrant issued 470 shares of common stock, without par value, to the directors of the Registrant pursuant to the Directors’ Stock Purchase Plan for an aggregate cash price of $9,000. The Registrant 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 the Registrant’s purchases of its own common stock during the quarter ended September 30, 2014.

 

            Maximum
         Total Number of  Number of
         Shares Purchased  Shares that May
   Total Number  Average  as Part of a  Yet be
   of Shares  Price Paid  Publicly  Purchased
Period  Purchased  per Share  Announced Plan  Under the Plan
                     
July 1 - July 31, 2014                    
Employee Transactions   —     $—             
Repurchase Program   —     $—      —      84,920 
August 1 - August 31, 2014                    
Employee Transactions   —     $—             
Repurchase Program (1)   3,437   $20.00    3,437    81,483 
September 1 - September 30, 2014                    
Employee Transactions (2)   258   $18.45           
Repurchase Program   —     $—      —      81,483 

(1)On August 21, 2014, the Registrant purchased 3,437 shares of common stock for an aggregate cash price of $69,000. As of September 30, 2014, there are 81,483 shares remaining that may yet be purchased under approved plans or programs. 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.
(2)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.

 

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 the Registrant. Previously filed as an exhibit to the Registrant’s Form 10-K Annual Report for the year ended December 31, 2013.  Here incorporated by reference.

 

  3.2   Bylaws of the Registrant as currently in effect and any amendments thereto.  Previously filed as an exhibit to the Registrant’s Form 10-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

Certification pursuant to 18 U.S.C. § 1350.

       
  101.1   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 12, 2014 /s/ James A. Bosserd
  James A. Bosserd
President and Chief Executive Officer
(Principal Executive Officer)
   
   
   
Date:   November 12, 2014 /s/ Thomas L. Lampen
  Thomas L. Lampen
Treasurer
(Principal Financial and Accounting Officer)

 

 

 

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