CHOICEONE FINANCIAL SERVICES INC (COFS) FY 2024 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. 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 “Company”), and its wholly-owned subsidiaries. This discussion should be read in conjunction with the consolidated financial statements and related footnotes.
We have omitted discussion of 2023 results where it would be redundant to the discussion previously included in Part II, Item 7 of our 2023 Annual Report on Form 10-K.
Selected Financial Data
| (Dollars in thousands, except per share data) | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2024 | 2023 | 2022 | |||||||||||
| For the year | |||||||||||||
| Net interest income | $ | 74,442 | $ | 65,885 | $ | 67,314 | |||||||
| Provision for credit losses, net | 625 | 150 | 250 | ||||||||||
| Noninterest income | 17,995 | 14,906 | 14,072 | ||||||||||
| Noninterest expense | 58,723 | 55,074 | 53,478 | ||||||||||
| Income before income taxes | 33,089 | 25,567 | 27,658 | ||||||||||
| Income tax expense | 6,362 | 4,306 | 4,018 | ||||||||||
| Net income | 26,727 | 21,261 | 23,640 | ||||||||||
| Cash dividends declared | 9,012 | 7,910 | 7,578 | ||||||||||
| Per share | |||||||||||||
| Basic earnings | $ | 3.27 | $ | 2.82 | $ | 3.15 | |||||||
| Diluted earnings | 3.25 | 2.82 | 3.15 | ||||||||||
| Cash dividends declared | 1.09 | 1.05 | 1.01 | ||||||||||
| Shareholders' equity (at year end) | 29.05 | 25.92 | 22.47 | ||||||||||
| Average for the year | |||||||||||||
| Securities | $ | 981,454 | $ | 1,042,559 | $ | 1,094,559 | |||||||
| Gross loans | 1,456,434 | 1,265,261 | 1,104,030 | ||||||||||
| Deposits | 2,165,705 | 2,111,970 | 2,133,790 | ||||||||||
| Borrowings | 208,142 | 141,507 | 13,537 | ||||||||||
| Subordinated debt | 35,627 | 35,382 | 35,211 | ||||||||||
| Shareholders' equity | 226,547 | 177,201 | 178,415 | ||||||||||
| Assets | 2,668,556 | 2,493,840 | 2,373,374 | ||||||||||
| At year end | |||||||||||||
| Securities | $ | 896,123 | $ | 939,576 | $ | 972,802 | |||||||
| Gross loans | 1,552,928 | 1,415,363 | 1,194,616 | ||||||||||
| Deposits | 2,214,103 | 2,122,055 | 2,118,003 | ||||||||||
| Borrowings | 175,000 | 200,000 | 50,000 | ||||||||||
| Subordinated debt | 35,752 | 35,507 | 35,262 | ||||||||||
| Shareholders' equity | 260,415 | 195,634 | 168,874 | ||||||||||
| Assets | 2,723,243 | 2,576,706 | 2,385,915 | ||||||||||
| Selected financial ratios | |||||||||||||
| Return on average assets | 1.00 | % | 0.85 | % | 1.00 | % | |||||||
| Return on average shareholders' equity | 11.80 | 12.00 | 13.25 | ||||||||||
| Cash dividend payout as a percentage of net income | 33.72 | 37.21 | 32.06 | ||||||||||
| Shareholders' equity to assets (at year end) | 9.56 | 7.59 | 7.08 |
20
RECENT EVENTS
ChoiceOne and Fentura Financial, Inc., the parent company of The State Bank, entered into a definitive merger agreement on July 25, 2024 pursuant to which ChoiceOne and Fentura would merge in an all-stock transaction (the “Merger”). The Merger was effective on March 1, 2025.
On July 26, 2024, ChoiceOne completed an underwritten public offering of 1,380,000 shares of its common stock at a price to the public of $25.00 per share.
RESULTS OF OPERATIONS
Summary
ChoiceOne's net income for 2024 was $26.7 million, compared to $21.3 million in 2023. Diluted earnings per share were $3.25 in the twelve months ended December 31, 2024, compared to $2.82 per share in the twelve months ended December 31, 2023. Net income adjusted for merger related expenses (non-GAAP) was $27.7 million for the twelve months ended December 31, 2024 with adjusted diluted earnings per share of $3.37.
ChoiceOne's asset mix has shifted from loans held for investment of 66.5% of deposits at December 31, 2023 to 69.8% of deposits at December 31, 2024. As of December 31, 2024, total assets were $2.7 billion, an increase of $146.5 million compared to December 31, 2023. The growth is primarily attributed to an increase in core loans of $114.5 million and loans to other financial institutions of $20.5 million. This growth was offset by a $48.9 million reduction in securities during the same time period. ChoiceOne has actively managed its balance sheet to support organic loan growth, strategically shifting from lower-yielding assets to higher-yielding loans. This is reflected in the loan growth experienced.
Deposits, excluding brokered deposits increased $79.0 million or 3.8% during 2024. The increase in deposits in the twelve months ended December 31, 2024 is a combination of new business and recapture of deposit losses from the prior year. ChoiceOne continues to be proactive in managing its liquidity position by using brokered deposits and FHLB advances to ensure ample liquidity. At December 31, 2024, total available borrowing capacity secured by pledged assets was $837.2 million. ChoiceOne can increase its capacity by utilizing unsecured federal fund lines and pledging additional assets. Uninsured deposits totaled $833.2 million or 37.6% of deposits at December 31, 2024.
ChoiceOne's cost of deposits to average total deposits has increased from 1.14% in 2023 to 1.58% in 2024. During 2023 ChoiceOne was able to lag many of the increases to the federal funds rate which increased 425 basis points in 2022 and another 100 basis points in 2023. ChoiceOne's cost of deposits to average total deposits peaked in the first quarter of 2024, and declined slightly in subsequent quarters due to the Federal Reserve decreasing the federal funds rate by 100 basis points in the last four months of 2024. If rates continue to decline, we expect to see further reductions in deposit costs; however, these reductions will be muted by the decrease in cash flows from pay-fixed interest rate swaps collected. Interest expense on borrowings for the twelve months ended December 31, 2024, increased $3.1 million compared to the same period in the prior year, due to increases in the average balance borrowed. During the fourth quarter of 2024, ChoiceOne paid down its advance from the Bank Term Funding Program and replaced it with $135.0 million of FHLB borrowings. This increased ChoiceOne's total borrowed balance at the FHLB to $175.0 million at a weighted average fixed rate of 4.5%, with the earliest maturity in January 2025.
The provision for credit losses expense on loans was $1.3 million in the full year 2024, due to the significant growth of core loans. Core loan growth was offset by slight improvements in the Federal Open Market Committee ("FOMC") forecast during the full year 2024. The ratio of the allowance for credit losses to total loans (excluding loans held for sale) was 1.07% on December 31, 2024 compared to 1.11% on December 31, 2023. Asset quality continues to remain strong, with net loan charge-offs to average loans of 0.03% and nonperforming loans to total loans (excluding loans held for sale) of 0.24% as of December 31, 2024. Nonperforming loans have increased since the historic lows in 2023, but still remain at low levels and consist entirely of residential loans with strong collateral positions.
21
Noninterest Income
Noninterest income increased $3.1 million in the twelve months ended December 31, 2024, compared to the same period in the prior year. The increase was largely due to an increase in credit and debit card fees of $1.1 million in the full year 2024 compared to the full year 2023 and earnings on life insurance policies in the twelve months ended December 31, 2024, compared to the same period in the prior year. ChoiceOne recognized earnings on two bank owned life insurance death benefit claims for a total of $700,000 during 2024. ChoiceOne also saw an increase in the market value of equity securities in the full year 2024, compared to the prior year. Equity securities include community bank stocks and CRA focused bond mutual funds. ChoiceOne additionally saw an uptick in gains on sales of loans during the fourth quarter of 2024 due in part to participation in the FHLB Rate Advantage program which provides incentives to home buyers in the low to moderate income bracket.
Noninterest Expense
Noninterest expense increased by $3.6 million or 6.6% in the twelve months ended December 31, 2024 compared to the same period in 2023. The increase in total noninterest expense was due in part to merger related expenses of $1.0 million during the twelve months ended December 31, 2024, compared to $0 in the same period in the prior year. Additionally, there was an increase to employee health insurance and other benefit costs, and an increase to FDIC insurance and other costs related to the inflationary environment. The increase in costs was offset by a decline in occupancy and equipment cost related to two branch closures during the first quarter of 2024. ChoiceOne seeks to strategically manage costs while still making thoughtful investments in order to maintain our competitive edge and deliver exceptional value to our customers, shareholders, and communities.
Dividends
Cash dividends of $9.0 million or $1.09 per common share were declared in 2024 compared to $7.9 million or $1.05 per common share in 2023. The dividend yield for ChoiceOne’s common stock was 3.06% as of the end of 2024, compared to 3.58% as of the end of 2023. The cash dividend payout as a percentage of net income was 33.7% as of December 31, 2024, compared to 37.2% as of December 31, 2023.
Income Taxes
Income tax expense was $2.1 million higher in 2024 than in 2023. The effective tax rate was 19.2% for the year ended December 31, 2024 compared to 16.8% for the same period in 2023. For 2024, income before income tax, disallowed interest expense (TEFRA) and nondeductible merger expenses increased compared to 2023. For further details, refer to Note 12 - Income Taxes of the Notes to the Consolidated Financial Statements included in Item 8 of this report.
22
Table 1 – Average Balances and Tax-Equivalent Interest Rates
Tables 1 and 2 on the following pages provide information regarding interest income and expense for the years ended December 31, 2024, 2023, and 2022. 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.
| Year Ended December 31, | |||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2024 | 2023 | 2022 | |||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Average | Average | Average | ||||||||||||||||||||||||||||||||||
| Balance | Interest | Rate | Balance | Interest | Rate | Balance | Interest | Rate | |||||||||||||||||||||||||||||
| Assets: | |||||||||||||||||||||||||||||||||||||
| Loans (1) (3)(4)(5)(6) | $ | 1,456,434 | $ | 89,645 | 6.16 | % | $ | 1,265,261 | $ | 68,437 | 5.41 | % | $ | 1,104,030 | $ | 52,861 | 4.79 | % | |||||||||||||||||||
| Taxable securities (2)(6) | 691,562 | 21,228 | 3.07 | 747,006 | 21,169 | 2.83 | 779,915 | 15,583 | 2.00 | ||||||||||||||||||||||||||||
| Nontaxable securities (1) | 289,892 | 7,089 | 2.45 | 295,553 | 7,106 | 2.40 | 314,644 | 7,790 | 2.48 | ||||||||||||||||||||||||||||
| Other | 88,576 | 4,681 | 5.29 | 70,826 | 3,797 | 5.36 | 34,255 | 491 | 1.43 | ||||||||||||||||||||||||||||
| Interest-earning assets | 2,526,464 | 122,643 | 4.85 | 2,378,646 | 100,509 | 4.23 | 2,232,844 | 76,725 | 3.44 | ||||||||||||||||||||||||||||
| Noninterest-earning assets | 142,092 | 115,194 | 140,530 | ||||||||||||||||||||||||||||||||||
| Total assets | $ | 2,668,556 | $ | 2,493,840 | $ | 2,373,374 | |||||||||||||||||||||||||||||||
| Liabilities and Shareholders' Equity: | |||||||||||||||||||||||||||||||||||||
| Interest-bearing demand deposits | $ | 896,060 | $ | 12,997 | 1.45 | % | $ | 852,927 | $ | 10,028 | 1.18 | % | $ | 902,090 | $ | 3,514 | 0.39 | % | |||||||||||||||||||
| Savings deposits | 334,310 | 2,828 | 0.85 | 370,074 | 1,609 | 0.43 | 452,542 | 711 | 0.16 | ||||||||||||||||||||||||||||
| Certificates of deposit | 388,724 | 17,033 | 4.38 | 306,999 | 10,621 | 3.46 | 196,063 | 1,618 | 0.83 | ||||||||||||||||||||||||||||
| Brokered deposit | 26,902 | 1,315 | 4.89 | 35,044 | 1,732 | 4.94 | 103 | 2 | 2.48 | ||||||||||||||||||||||||||||
| Borrowings | 208,142 | 9,885 | 4.75 | 141,507 | 6,818 | 4.82 | 13,537 | 410 | 3.02 | ||||||||||||||||||||||||||||
| Subordinated debentures | 35,627 | 1,642 | 4.61 | 35,382 | 1,636 | 4.62 | 35,211 | 1,491 | 4.23 | ||||||||||||||||||||||||||||
| Other | 18,355 | 961 | 5.23 | 12,258 | 651 | 5.31 | - | - | 0.00 | ||||||||||||||||||||||||||||
| Interest-bearing liabilities | 1,908,120 | 46,661 | 2.45 | 1,754,191 | 33,095 | 1.89 | 1,599,546 | 7,746 | 0.48 | ||||||||||||||||||||||||||||
| Demand deposits | 519,709 | 546,926 | 582,992 | ||||||||||||||||||||||||||||||||||
| Other noninterest-bearing liabilities | 14,180 | 15,522 | 12,421 | ||||||||||||||||||||||||||||||||||
| Total liabilities | 2,442,009 | 2,316,639 | 2,194,959 | ||||||||||||||||||||||||||||||||||
| Shareholders' equity | 226,547 | 177,201 | 178,415 | ||||||||||||||||||||||||||||||||||
| Total liabilities and shareholders' equity | $ | 2,668,556 | $ | 2,493,840 | $ | 2,373,374 | |||||||||||||||||||||||||||||||
| Net interest income (tax-equivalent basis) (Non-GAAP) (1) | $ | 75,981 | $ | 67,415 | $ | 68,979 | |||||||||||||||||||||||||||||||
| Net interest margin (tax-equivalent basis) (Non-GAAP) (1) | 3.01 | % | 2.83 | % | 3.09 | % | |||||||||||||||||||||||||||||||
| Reconciliation to Reported Net Interest Income | |||||||||||||||||||||||||||||||||||||
| Net interest income (tax-equivalent basis) (Non-GAAP) (1) | $ | 75,981 | $ | 67,415 | $ | 68,979 | |||||||||||||||||||||||||||||||
| Adjustment for taxable equivalent interest | (1,539 | ) | (1,530 | ) | (1665 | ) | |||||||||||||||||||||||||||||||
| Net interest income (GAAP) | $ | 74,442 | $ | 65,885 | $ | 67,314 | |||||||||||||||||||||||||||||||
| Net interest margin (GAAP) | 2.95 | % | 2.77 | % | 3.01 | % |
(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 21%. The presentation of these measures on a tax-equivalent basis is not in accordance with GAAP, but is customary in the banking industry. These non-GAAP measures ensure comparability with respect to both taxable and tax-exempt loans and securities.
(2)
Interest on taxable securities includes dividends on Federal Home Loan Bank and Federal Reserve Bank stock.
(3)
Loans include both loans to other financial institutions and loans held for sale.
(4)
Non-accruing loan balances are included in the balances of average loans. Non-accruing loan average balances were $2.3 million, $1.6 million, and $1.3 million for the year ended 2024, 2023, and 2022, respectively.
(5)
Interest on loans included net origination fees and accretion income. Accretion income was $1.2 million, $1.7 million, and $2.0 million for the full year 2024, 2023, and 2022, respectively.
(6)
Interest income for 2024 and 2023 was reduced by $1.1 million and $2.8 million, respectively, due to amortization expense related to the March 2023 sale of the pay floating swap derivative.
23
Table 2 – Changes in Tax-Equivalent Net Interest Income
| Year Ended December 31, | ||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (Dollars in thousands) | 2024 Over 2023 | 2023 Over 2022 | ||||||||||||||||||||||
| Total | Volume | Rate | Total | Volume | Rate | |||||||||||||||||||
| Increase (decrease) in interest income (1) | ||||||||||||||||||||||||
| Loans (2) | $ | 21,208 | $ | 11,095 | $ | 10,113 | $ | 15,576 | $ | 8,264 | $ | 7,312 | ||||||||||||
| Taxable securities | 59 | (1,645 | ) | 1,704 | 5,586 | (682 | ) | 6,268 | ||||||||||||||||
| Nontaxable securities (2) | (17 | ) | (144 | ) | 127 | (684 | ) | (455 | ) | (229 | ) | |||||||||||||
| Other | 884 | 938 | (54 | ) | 3,306 | 925 | 2,381 | |||||||||||||||||
| Net change in interest income | $ | 22,134 | $ | 10,244 | $ | 11,890 | $ | 23,784 | $ | 8,052 | $ | 15,732 | ||||||||||||
| Increase (decrease) in interest expense (1) | ||||||||||||||||||||||||
| Interest-bearing demand deposits | $ | 2,969 | $ | 537 | $ | 2,432 | $ | 6,514 | $ | (202 | ) | $ | 6,716 | |||||||||||
| Savings deposits | 1,219 | (169 | ) | 1,388 | 898 | (152 | ) | 1,050 | ||||||||||||||||
| Certificates of deposit | 6,412 | 3,205 | 3,207 | 9,003 | 1,364 | 7,639 | ||||||||||||||||||
| Brokered deposit | (417 | ) | (399 | ) | (18 | ) | 1,730 | 1,725 | 5 | |||||||||||||||
| Borrowings | 3,067 | 3,169 | (102 | ) | 6,408 | 6,029 | 379 | |||||||||||||||||
| Subordinated debentures | 6 | 10 | (4 | ) | 145 | 7 | 138 | |||||||||||||||||
| Other | 310 | 319 | (9 | ) | 651 | 651 | - | |||||||||||||||||
| Net change in interest expense | $ | 13,566 | $ | 6,672 | $ | 6,894 | $ | 25,349 | $ | 9,422 | $ | 15,927 | ||||||||||||
| Net change in tax-equivalent net interest income | $ | 8,568 | $ | 3,572 | $ | 4,996 | $ | (1,565 | ) | $ | (1,370 | ) | $ | (195 | ) |
(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 tax-exempt securities and loans has been adjusted to a fully tax-equivalent basis using an incremental tax rate of 21% for 2024, 2023, and 2022.
Net Interest Income
GAAP based net interest income increased $8.6 million, and tax-equivalent net interest income increased $8.6 million, respectively, for the full year 2024, compared to the same period in 2023. GAAP based net interest margin increased 18 basis points, and tax equivalent net interest margin increased 18 basis points, respectively, in 2024 compared to 2023.
ChoiceOne has experienced substantial core loan growth from December 31, 2023 to December 31, 2024, leading to an increase in interest income from loans of $21.2 million in the twelve months ended December 31, 2024, compared to the same period in the prior year. Average core loans grew $191.2 million for the twelve months ended December 31, 2024, compared to the same period in the prior year. In addition, the average rate earned on loans increased 75 basis points for the twelve months ended December 31, 2024, compared to the same period in the prior year.
The average balance of total securities decreased $61.1 million in 2024, compared to the same period in 2023. The decrease was due to the paydowns, maturities, and redemptions during 2024. Interest income on securities remained flat in 2024 compared to 2023 despite the decline in average balance as the average rate earned on securities increased 17 basis points for the full year 2024, compared to the same period in the prior year.
Interest expense increased $13.6 million for the full year 2024, compared to the same period in the prior year. The average rate paid on interest bearing-demand deposits and savings deposits increased 33 basis points in the twelve months ended December 31, 2024, compared to the same period in the prior year. This was compounded by the increase in the average balance of interest bearing-demand deposits and savings deposits, of $7.4 million during 2024. The increase in the average balance of certificates of deposit of $81.7 million during 2024, combined with a 92 basis point increase in the rate paid on certificates of deposits during 2024, compared to the same period in the prior year, led to an increase in interest expense of $6.4 million during 2024.
During 2023, ChoiceOne was able to lag many of the increases to the federal funds rate which increased 425 basis points in 2022 and another 100 basis points in 2023. ChoiceOne's cost of deposits to average total deposits peaked in the first quarter of 2024, and has slightly declined in subsequent quarters due to the Federal Reserve decreasing the federal funds rate by 100 basis points in the last four months of 2024. If rates continue to decline, we expect to see further reductions in deposit costs; however, these reductions will be
24
muted by the decrease in cash flows from pay-fixed interest rate swaps collected. ChoiceOne has been able to outpace the increased cost of deposits by increased loan originations at higher average interest rates.
ChoiceOne held $170.0 million in borrowings from the Bank Term Funding Program ("BTFP") during the first three quarters of 2024 and during the fourth quarter of 2024, ChoiceOne paid down its advance from the Bank Term Funding Program and replaced it with $135.0 million of FHLB borrowings. This increased the total borrowed balance at the FHLB to $175.0 million at a weighted average fixed rate of 4.5%. The net effect of these additional borrowed funds was an increase in interest expense of $3.1 million for the year ended December 31, 2024, compared to the same period in 2023.
In September 2021, ChoiceOne completed a private placement of $32.5 million in aggregate principal amount of 3.25% fixed-to-floating rate subordinated notes due 2031. In addition, ChoiceOne holds certain subordinated debentures issued in connection with a trust preferred securities offering that were obtained as part of the merger with Community Shores. The average balance of subordinated debentures was relatively flat in 2024 compared to the same period in the prior year.
The following table presents the cost of deposits and the cost of funds for the years ended December 31, 2024, December 31, 2023, and December 31, 2022.
| Year Ended December 31, | ||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2024 | 2023 | 2022 | ||||||||||
| Cost of deposits | 1.58 | % | 1.14 | % | 0.27 | % | ||||||
| Cost of funds | 1.92 | % | 1.44 | % | 0.35 | % |
Provision and Allowance For Credit Losses
Table 3 – Provision and Allowance For Credit Losses
25
| (Dollars in thousands) | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 2024 | 2023 | 2022 | |||||||||||
| Allowance for credit losses at beginning of year | $ | 15,685 | $ | 7,619 | $ | 7,688 | |||||||
| Cumulative effect of change in accounting principle | - | 7,165 | - | ||||||||||
| Charge-offs: | |||||||||||||
| Agricultural | - | - | - | ||||||||||
| Commercial and industrial | 7 | 158 | 177 | ||||||||||
| Consumer | 800 | 554 | 496 | ||||||||||
| Commercial real estate | - | - | |||||||||||
| Construction real estate | - | - | - | ||||||||||
| Residential real estate | 30 | 27 | - | ||||||||||
| Total | 837 | 739 | 673 | ||||||||||
| Recoveries: | |||||||||||||
| Agricultural | - | - | - | ||||||||||
| Commercial and industrial | 15 | 66 | 143 | ||||||||||
| Consumer | 374 | 283 | 206 | ||||||||||
| Commercial real estate | - | 13 | 3 | ||||||||||
| Construction real estate | - | - | - | ||||||||||
| Residential real estate | 15 | 13 | 2 | ||||||||||
| Total | 404 | 375 | 354 | ||||||||||
| Net charge-offs (recoveries) | 433 | 364 | 319 | ||||||||||
| Provision for credit losses | 1,300 | 1,265 | 250 | ||||||||||
| Allowance for credit losses at end of year | $ | 16,552 | $ | 15,685 | $ | 7,619 | |||||||
| Allowance for credit losses as a percentage of: | |||||||||||||
| Total loans as of year end | 1.07 | % | 1.11 | % | 0.64 | % | |||||||
| Nonaccrual loans, accrual loans past due 90 days or more and troubled debt restructurings | 447 | % | 820 | % | 286 | % | |||||||
| Ratio of net charge-offs during the period to average loans outstanding during the period | 0.03 | % | 0.03 | % | 0.03 | % | |||||||
| Loan recoveries as a percentage of prior year's charge-offs | 55 | % | 56 | % | 52 | % |
Note: In the table above, "consumer" includes deposit account charge-offs and recoveries.
The ACL consists of general and specific components. The general component covers loans collectively evaluated for credit loss and is based on peer historical loss experience adjusted for current and forecasted factors. Management's adjustment for current and forecasted factors is based on trends in delinquencies, trends in charge-offs and recoveries, trends in the volume of loans, changes in underwriting standards, trends in loan review findings, the experience and ability of lending staff, and a reasonable and supportable economic forecast described further below.
The determination of our loss factors is based, in part, upon benchmark peer loss history adjusted for qualitative factors that, in management's judgment, affect the collectability of the portfolio as of the analysis date. ChoiceOne's lookback period of benchmark peer net charge-off history was from January 1, 2004 through December 31, 2019 for this analysis.
Loans individually evaluated for credit losses increased by $2.0 million to $4.1 million during the year ended December 31, 2024, and the ACL related to these individually evaluated loans increased by $108,000 during the same period largely due to the balance increase.
Nonperforming loans, which includes Other Real Estate Owned ("OREO") but excludes performing troubled loan modifications ("TLM"), increased by $1.9 million to $3.8 million at December 31, 2024, compared to a historically low balance on December 31, 2023. All non-performing loans are retail in nature. The ACL was 1.07% of total loans, excluding loans held for sale, at December 31, 2024, compared to 1.11% as of December 31, 2023. The liability for expected credit losses on unfunded loans and other commitments was $1.5 million on December 31, 2024, compared to $2.2 million as of December 31, 2023.
26
Net charge-offs were $433,000 during the full year 2024, compared to net charge-offs of $364,000 during the same period in 2023. Net charge-offs for checking accounts during the full year 2024 were $237,000 compared to $226,000 for the same period in the prior year. Net charge-offs as a percentage of average loans were 0.03% during the full year 2024 and 2023.
The provision for credit losses on loans was $1.3 million during the full year 2024 and 2023, due to core loan growth, which was partially offset by slight improvements in the Federal Open Market Committee ("FOMC") forecast during the full year 2024. The loan provision expense was offset by the decrease in unfunded commitments provision expense of $675,000 in the full year 2024 due to changes in mix and expected funding rates during the year. Total unfunded commitments decreased $15.9 million in the full year 2024 compared to December 31, 2023.
Net provision for credit losses was $625,000 for the full year 2024.
27
Financial Condition
Summary
Total assets grew $146.5 million in the twelve months ended December 31, 2024. Core loans grew $114.5 million or 8.2% and were offset by a decline in investment securities of $48.9 million. Deposits, excluding brokered deposits, increased by $79.0 million during 2024, while borrowings declined by $25.0 million. Deposit costs rose steadily in the first half of the year followed by a decline in the second half of the year which coincided with the decreases to the federal funds rate starting in September of 2024.
Securities
The Company’s securities balances as of December 31 were as follows:
| (Dollars in thousands) | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| Equity securities | $ | 7,782 | $ | 7,505 | ||
| Available for Sale Securities at fair value | ||||||
| U.S. Government and federal agency | $ | - | $ | - | ||
| U.S. Treasury notes and bonds | 80,502 | 80,194 | ||||
| State and municipal | 228,236 | 234,682 | ||||
| Mortgage-backed | 160,970 | 188,501 | ||||
| Corporate | 212 | 204 | ||||
| Asset-backed securities | 9,197 | 11,017 | ||||
| Total | $ | 479,117 | $ | 514,598 | ||
| Held to Maturity Securities at amortized cost | ||||||
| U.S. Government and federal agency | $ | 2,978 | $ | 2,972 | ||
| U.S. Treasury notes and bonds | - | |||||
| State and municipal | 196,510 | 196,098 | ||||
| Mortgage-backed | 174,323 | 188,329 | ||||
| Corporate | 20,495 | 20,013 | ||||
| Asset-backed securities | 228 | 547 | ||||
| Total | $ | 394,534 | $ | 407,959 |
Total investment securities declined $48.9 million from December 31, 2023 to December 31, 2024. ChoiceOne purchased $16.8 million of securities in 2024. Securities totaling $11.8 million were called or matured in 2024. ChoiceOne received principal payments for municipal and mortgage-backed securities totaling $48.0 million during 2024.
At December 31, 2024, the Company had $116.6 million in unrealized losses on its investment securities, including $61.1 million in unrealized losses on available for sale securities and $55.5 million in unrealized losses on held to maturity securities. Unrealized losses on corporate and municipal bonds have not been recognized into income because management believes the issuers are of high credit quality, and management does not intend to sell prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates and other market conditions. The issuers continue to make timely principal and interest payments on the bonds. The fair value is expected to recover as the bonds approach maturity.
ChoiceOne utilizes interest rate derivatives as part of its asset liability management strategy to help manage its interest rate risk position. In order to hedge the risk of rising rates and unrealized losses on securities resulting from the rising rates, ChoiceOne currently holds pay fixed, receive variable interest rate swaps with a total notional value of $401.0 million. These derivative instruments increase in value as long-term interest rates rise, which partially offsets the reduction in shareholders' equity due to unrealized losses on securities available for sale. Refer to Note 8 - Derivatives and Hedging Activities of the consolidated financial statements for more discussion on ChoiceOne’s derivative position.
Equity securities included a money market preferred security ("MMP") of $1.0 million and common stock of $6.8 million as of December 31, 2024. As of December 31, 2023, equity securities included a MMP of $1.0 million and common stock of $6.5 million.
28
Per U.S. generally accepted accounting principles, unrealized gains or losses on securities available for sale are reflected on the balance sheet in accumulated other comprehensive income (loss), while unrealized gains or losses on securities held to maturity are not reflected on the balance sheet in accumulated other comprehensive income (loss).
Loans
The Company’s loan portfolio by call report code was as follows:
| December 31, 2024 | December 31, 2023 | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| (Dollars in thousands) | Call Report Codes | Balance | % | Balance | % | |||||||||
| Construction & Development Loans | 1A2 | 61,740 | 4.0 | % | 112,877 | 8.0 | % | |||||||
| 1-4 Family Loans | 1A1, 1C1, 1C2A, 1C2B | 380,139 | 24.6 | % | 347,036 | 24.6 | % | |||||||
| Multifamily Loans | 1D | 83,766 | 5.4 | % | 56,563 | 4.0 | % | |||||||
| Owner Occupied CRE Loans | 1E1 | 325,966 | 21.1 | % | 281,515 | 20.0 | % | |||||||
| Non-Owner Occupied CRE Loans | 1E2 | 387,102 | 25.0 | % | 298,265 | 21.1 | % | |||||||
| Commercial & Industrial Loans | 2A2, 4A | 216,376 | 14.0 | % | 219,849 | 15.6 | % | |||||||
| Farm & Agriculture Loans | 1B, 3 | 48,246 | 3.1 | % | 46,515 | 3.3 | % | |||||||
| Consumer & Other Loans | 6B, 6C, 6D, 8, 9b2,10B | 42,305 | 2.7 | % | 48,033 | 3.4 | % | |||||||
| Total Loans | 1,545,640 | 1,410,653 |
Average loan balances increased $191.2 million in the full year 2024 compared to the same period in 2023. Core loans grew organically by $114.5 million or 8.2% during 2024, with growth concentrated in Non-Owner Occupied CRE loans, which grew by $88.8 million, Owner Occupied CRE loans, which grew by $44.5 million, and 1-4 Family Loans, which grew by $33.1 million. The growth in 1-4 Family loans was largely related to growth in loans to other financial institutions which were $39.9 million as of December 31, 2024, compared to $19.4 million as of December 31, 2023. Loans to other financial institutions is comprised of a warehouse line of credit to facilitate mortgage loan originations and the interest rate fluctuates with the national mortgage market. This balance is short term in nature with an average life of under 30 days. Management believes the short-term structure and low credit risk of this asset is advantageous in the current rate environment; however, this balance is volatile and could change based on the third party origination volume or discretion. Loan interest including fee income increased $21.2 million in the full year 2024, compared to the same period in the prior year.
ChoiceOne recorded accretion income related to acquired loans in the amount of $1.2 million in 2024 and $1.7 million during 2023. Remaining credit and yield mark on acquired loans from the mergers with County Bank Corp. and Community Shores will accrete into income as the acquired loans mature. ChoiceOne estimates that roughly $1.3 million will accrete into income over the next one to three years.
As part of its review of the loan portfolio, management also monitors the various nonperforming loans. Nonperforming loans are comprised of loans accounted for on a nonaccrual basis, loans not included in nonaccrual loans, which are contractually past due 90 days or more as to interest or principal payments, and troubled loan modifications which are accruing and initiated in the past year.
The balances of these nonperforming loans as of December 31 were as follows:
| (Dollars in thousands) | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| Loans accounted for on a nonaccrual basis | $ | 3,704 | $ | 1,723 | ||
| Loans contractually past due 90 days or more as to principal or interest payments | - | - | ||||
| Loans modified to borrowers experiencing financial difficulty at December 31, 2024 and December 31, 2023. | - | 189 | ||||
| Total | $ | 3,704 | $ | 1,912 |
Nonaccrual loans included $3.5 million in residential real estate loans, $229,000 in construction real estate loans, and $8,000 in consumer loans as of December 31, 2024, compared to $1.7 million in residential real estate loans as of December 31, 2023. There were no troubled loan modifications ("TLM") at December 31, 2024, compared to $60,000 of commercial and industrial TLM loans and $129,000 of residential real estate TLM loans at December 31, 2023.
29
Management also maintains a list of loans that are not classified as nonperforming loans but where some concern exists as to the borrowers’ abilities to comply with the original loan terms. There were 19 loans totaling $375,000 fitting this description as of December 31, 2024, and 22 loans totaling $357,000 fitting this description as of December 31, 2023.
Deposits and Other Funding Sources
The Company’s deposit balances as of December 31 were as follows:
| (Dollars in thousands) | ||||||
|---|---|---|---|---|---|---|
| 2024 | 2023 | |||||
| Noninterest-bearing demand deposits | $ | 524,945 | $ | 547,625 | ||
| Interest-bearing demand deposits | 630,155 | 599,681 | ||||
| Money market deposits | 290,012 | 247,602 | ||||
| Savings deposits | 338,109 | 336,851 | ||||
| Local certificates of deposit | 394,371 | 366,851 | ||||
| Brokered certificates of deposit | 36,511 | 23,445 | ||||
| Total deposits | $ | 2,214,103 | $ | 2,122,055 |
Deposits, excluding brokered deposits increased $79.0 million or 3.8% during 2024. The increase in deposits in the twelve months ended December 31, 2024 is a combination of new business and recapture of deposit losses from the prior year. ChoiceOne continues to be proactive in managing its liquidity position by using brokered deposits and FHLB advances to ensure ample liquidity.
At December 31, 2024, total available borrowing capacity secured by pledged assets was $837.2 million. ChoiceOne can increase its capacity by utilizing unsecured federal fund lines and pledging additional assets. Uninsured deposits totaled $833.2 million or 37.6% of deposits at December 31, 2024. Core deposits, which we define as insured branch deposits less certificates of deposit, totaled $1.1 billion or 51.2% of total deposits at December 31, 2024.
ChoiceOne's cost of deposits to average total deposits has increased from 1.14% in 2023 to 1.58% in 2024. During 2023 ChoiceOne was able to lag many of the increases to the federal funds rate which increased 425 basis points in 2022 and another 100 basis points in 2023. ChoiceOne's cost of deposits to average total deposits peaked in the first quarter of 2024, and has slightly declined in subsequent quarters due to the Federal Reserve decreasing the federal funds rate by 100 basis points in the last four months of 2024. If rates continue to decline, we expect to see further reductions in deposit costs; however, these reductions will be muted by the decrease in cash flows from pay-fixed interest rate swaps collected. Interest expense on borrowings for the twelve months ended December 31, 2024, increased $3.1 million compared to the same period in the prior year, due to increases in the average balance borrowed. During the fourth quarter of 2024, ChoiceOne paid down its advance from the Bank Term Funding Program and replaced it with $135.0 million of FHLB borrowings. This increased ChoiceOne's total borrowed balance at the FHLB to $175.0 million at a weighted average fixed rate of 4.5%, with the earliest maturity in January 2025.
In September 2021, ChoiceOne completed a private placement of $32.5 million in aggregate principal amount of 3.25% fixed-to-floating rate subordinated notes due 2031. ChoiceOne used a portion of net proceeds from the private placement to redeem senior debt, fund common stock repurchases, and support bank-level capital ratios. ChoiceOne also holds $3.5 million in subordinated debentures issued in connection with a $4.5 million trust preferred securities offering, which were obtained in the merger with Community Shores, offset by the mark-to-market adjustment.
Shareholders’ Equity
Shareholders’ equity totaled $260.4 million as of December 31, 2024, up from $195.6 million as of December 31, 2023, due in large part to the $34.5 million in aggregate gross proceeds (before deducting discounts and estimated offering expenses) received from the sale of 1,380,000 shares of common at a price to the public of $25.00 per share on July 26, 2024. The additional increase is due to retained earnings and an improvement in accumulated other compressive loss (AOCI) of $13.8 million compared to December 31, 2023. The improvement in AOCI is due to both the shortening duration and maturing (paydowns) of the securities portfolio, offset by the change in unrealized gain of the pay-fixed swap derivatives. The pay-fixed swap derivatives are designed to offset swings in AOCI due to changes in interest rates. ChoiceOne Bank remains “well-capitalized” with a total risk-based capital ratio of 12.7% as of December 31, 2024, compared to 12.4% on December 31, 2023.
ChoiceOne uses interest rate swaps to manage interest rate exposure to certain fixed rate assets and variable rate liabilities. On December 31, 2024, ChoiceOne had pay-fixed interest rate swaps with a total notional value of $401.0 million, a weighted average coupon of 3.07%, a fair value of $23.6 million and an average remaining contract length of 7 to 8 years. These derivative instruments increase in value as long-term interest rates rise, which offsets the reduction in equity due to unrealized losses on securities available for sale.
30
Note 21 to the consolidated financial statements presents regulatory capital information for ChoiceOne and the Bank at the end of 2024 and 2023. Management will monitor these capital ratios during 2025 as they relate to asset growth and earnings retention. ChoiceOne’s Board of Directors and management do not plan to allow capital to decrease below those levels necessary to be considered "well capitalized" by regulatory guidelines.
Table 4 – Contractual Obligations
The following table discloses information regarding the maturity of ChoiceOne’s contractual obligations at December 31, 2024:
| Payment Due by Period | ||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Less | More | |||||||||||||||||
| than | 1 - 3 | 3 - 5 | than | |||||||||||||||
| (Dollars in thousands) | Total | 1 year | Years | Years | 5 Years | |||||||||||||
| Time deposits | $ | 430,882 | $ | 413,786 | $ | 13,110 | $ | 3,719 | $ | 267 | ||||||||
| Borrowings | 175,000 | 155,000 | 20,000 | - | - | |||||||||||||
| ChoiceOne Capital Trust (1) | 4,500 | - | - | - | 4,500 | |||||||||||||
| ChoiceOne Subordinated Debenture (2) | 32,500 | - | - | - | 32,500 | |||||||||||||
| Operating leases | 759 | 310 | 280 | 50 | 119 | |||||||||||||
| Other obligations | 43 | 11 | 18 | 14 | - | |||||||||||||
| Total | $ | 643,684 | $ | 569,107 | $ | 33,408 | $ | 3,783 | $ | 37,386 |
(1)
Cumulative preferred securities on the balance sheet include $1.0 million of discount due to a mark to market adjustment which is not reflected in the table above.
(2)
ChoiceOne subordinated debenture on the balance sheet includes $240,000 of capitalized issuance cost which is not reflected in the table above.
Liquidity and Interest Rate Risk
Net cash provided by operating activities was $48.5 million in 2024 compared to $46.5 million in 2023. The change was due to higher net proceeds from loan sales and an increase in other liabilities in 2024 compared to 2023. Net cash used in investing activities was $97.9 million in 2024 compared to $181.4 million in 2023. ChoiceOne had loan originations and payments of $136.1 million in the full year 2024, compared to $221.2 million in the full year 2023. Net cash provided by financing activities was $90.7 million in 2024, compared to $146.4 million in 2023. The change was largely due to $150.0 million of higher borrowings in 2023, offset by $32.1 million in net proceeds received from our common stock offering completed on July 26, 2024.
ChoiceOne's market risk exposure occurs in the form of interest rate risk and liquidity risk. ChoiceOne's business is transacted in U.S. dollars with no foreign exchange risk exposure. Agricultural loans comprise a relatively small portion of ChoiceOne's total assets. Management believes that ChoiceOne's exposure to changes in commodity prices is insignificant.
Liquidity risk deals with ChoiceOne's ability to meet its cash flow requirements. These requirements include depositors desiring to withdraw funds and borrowers seeking credit. Longer-term liquidity needs may be met through core deposit growth, maturities of and cash flows from investment securities, normal loan repayments, advances from the FHLB and the Federal Reserve Bank, brokered certificates of deposit, and income retention. ChoiceOne had $175.0 million in outstanding borrowings from the FHLB as of December 31, 2024. The acceptance of brokered certificates of deposit is not limited as long as the Bank is categorized as “well capitalized” under regulatory guidelines. At December 31, 2024, total available borrowing capacity from the FHLB and the Federal Reserve Bank was $837.2 million.
ChoiceOne continues to review its liquidity management and has taken steps in an effort to ensure adequacy. These steps include limiting bond purchases in 2024, pledging securities to FHLB and the Federal Reserve Bank in order to increase borrowing capacity and using alternative funding sources such as brokered deposits.
31
NON-GAAP FINANCIAL MEASURES
This report contains financial measures that are not defined in U.S. generally accepted accounting principles ("GAAP"). Management believes these non-GAAP financial measures provide additional information that is useful to investors in helping to understand the underlying financial performance of ChoiceOne.
Non-GAAP financial measures have inherent limitations. Readers should be aware of these limitations and should be cautious with respect to the use of such measures. To compensate for these limitations, we use non-GAAP financial measures as comparative tools, together with GAAP financial measures, to assist in the evaluation of our operating performance or financial condition. Also, we ensure that these measures are calculated using the appropriate GAAP or regulatory components in their entirety and that they are computed in a manner intended to facilitate consistent period-to-period comparisons. ChoiceOne’s method of calculating these non-GAAP financial measures may differ from methods used by other companies. These non-GAAP financial measures should not be considered in isolation or as a substitute for those financial measures prepared in accordance with GAAP or in-effect regulatory requirements.
Income Adjusted for Merger Expenses - Non-GAAP Reconciliation
| 2024 | |||
|---|---|---|---|
| (In Thousands, Except Per Share Data) | |||
| Net income | $ | 26,727 | |
| Merger related expenses net of tax | 1,006 | ||
| Adjusted net income (Non-GAAP) | $ | 27,733 | |
| Weighted average number of shares | 8,166,472 | ||
| Diluted average shares outstanding | 8,221,065 | ||
| Basic earnings per share | $ | 3.27 | |
| Diluted earnings per share | $ | 3.25 | |
| Adjusted basic earnings per share (Non-GAAP) | $ | 3.40 | |
| Adjusted diluted earnings per share (Non-GAAP) | $ | 3.37 |
32
Critical Accounting Policies And Estimates
Management’s discussion and analysis of financial condition and results of operations as well as disclosures found elsewhere in this report are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the market value of securities, the amount of the allowance for credit losses, loan servicing rights, carrying value of goodwill, and income taxes. Actual results could differ from those estimates.
Allowance for Credit Losses ("ACL")
The ACL is a valuation allowance for expected credit losses. The ACL is increased by the provision for credit losses and decreased by loans charged off less any recoveries of charged off loans. As ChoiceOne has had very limited loss experience since 2011, management elected to utilize benchmark peer loss history data to estimate historical loss rates. ChoiceOne identified an appropriate peer group for each loan cohort which shared similar characteristics. Management estimates the ACL required based on the selected peer group loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, a reasonable and supportable economic forecast, and other factors. Allocations of the ACL may be made for specific loans, but the entire ACL is available for any loan that, in management’s judgment, should be charged off. Loan losses are charged against the ACL when management believes that collection of a loan balance is not possible.
The ACL consists of general and specific components. The general component covers loans collectively evaluated for credit losses and is based on peer historical loss experience adjusted for current and forecasted factors. Management's adjustment for current and forecasted factors is based on trends in delinquencies, trends in charge-offs and recoveries, trends in the volume of loans, changes in underwriting standards, trends in loan review findings, the experience and ability of lending staff, and a reasonable and supportable economic forecast described further below.
The discounted cash flow methodology is utilized for all loan pools. This methodology is supported by our CECL software provider and allows management to automatically calculate contractual life by factoring in all cash flows and adjusting them for behavioral and credit-related aspects.
Reasonable and supportable economic forecasts have to be incorporated in determining expected credit losses. The forecast period represents the time frame from the current period end through the point in time that we can reasonably forecast and support entity and environmental factors that are expected to impact the performance of our loan portfolio. Ideally, the economic forecast period would encompass the contractual terms of all loans; however, the ability to produce a forecast that is considered reasonable and supportable becomes more difficult or may not be possible in later periods. Subsequent to the end of the forecast period, we revert to historical loan data based on an ongoing evaluation of each economic forecast in relation to then current economic conditions as well as any developing loan loss activity and resulting historical data. As of December 31, 2024, we used a one-year reasonable and supportable economic forecast period, with a two year straight-line reversion period.
We are not required to develop and use our own economic forecast model, and we elected to utilize economic forecasts from third-party providers that analyze and develop forecasts of the economy for the entire United States at least quarterly.
Other inputs to the calculation are also updated or reviewed quarterly. Prepayment speeds are updated on a one quarter lag based on the asset liability model from the previous quarter. This model is performed at the loan level. Curtailment is updated quarterly within the ACL model based on our peer group average. The reversion period is reviewed by management quarterly with consideration of the current economic climate. Prepayment speeds and curtailment were updated during the fourth quarter of 2024; however, the effect was insignificant.
We are also required to consider expected credit losses associated with loan commitments over the contractual period in which we are exposed to credit risk on the underlying commitments unless the obligation is unconditionally cancellable by us. Any allowance for off-balance sheet credit exposures is reported as an other liability on our Consolidated Balance Sheet and is increased or decreased via the provision for credit losses account on our Consolidated Statement of Income. The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives. The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to be funded.
Loans that do not share risk characteristics are evaluated on an individual basis and are excluded from the collective evaluation. ChoiceOne has determined that any loans which have been placed on non-performing status, loans with a risk rating of 6 or higher, and loans past due more than 60 days will be assessed individually for evaluation. Management's judgment will be used to determine if the
33
loan should be migrated back to pool on an individual basis. Individual analysis will establish a specific reserve for loans in scope. Specific reserves on non-performing loans are typically based on management’s best estimate of the fair value of collateral securing these loans, adjusted for selling costs as appropriate or based on the present value of the expected cash flows from that loan.
ACL for Securities
Securities Available for Sale – For securities AFS in an unrealized loss position, management determines whether they intend to sell or if it is more likely than not that ChoiceOne will be required to sell the security before recovery of the amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income. For securities AFS with unrealized losses not meeting these criteria, management evaluates whether any decline in fair value is due to credit loss factors. In making this assessment, management considers any changes to the rating of the security by rating agencies and adverse conditions specifically related to the issuer of the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses (“ACL”) is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Changes in the ACL under ASC 326-30 are recorded as provisions for (or reversal of) credit loss expense. Losses are charged against the allowance when the collectability of a debt security AFS is confirmed or when either of the criteria regarding intent or requirement to sell is met. Any impairment that has not been recorded through an ACL is recognized in other comprehensive income, net of income taxes. At December 31, 2024, there was no ACL related to debt securities AFS.
Securities Held to Maturity – Since the adoption of CECL, ChoiceOne measures credit losses on HTM securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The ACL on securities HTM is a contra asset valuation account that is deducted from the carrying amount of HTM securities to present the net amount expected to be collected. HTM securities are charged off against the ACL when deemed uncollectible. Adjustments to the ACL are reported in ChoiceOne’s Consolidated Statements of Income in the provision for credit losses. Accrued interest receivable totaled $2.0 million and $2.1 million at December 31, 2024, and 2023, respectively, and was reported in other assets on the consolidated balance sheets and is excluded from the estimate of credit losses. With regard to US Treasury securities, these have an explicit government guarantee; therefore, no ACL is recorded for these securities. With regard to obligations of states and political subdivisions and other HTM securities, management considers (1) issuer bond ratings, (2) historical loss rates for given bond ratings, (3) the financial condition of the issuer, and (4) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities. At December 31, 2024, the ACL related to securities HTM is insignificant.
Troubled Loan Modifications
FASB also issued ASU 2022-02, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This standard eliminated the previous accounting guidance for troubled debt restructurings and added additional disclosure requirements for gross chargeoffs by year of origination. It also prescribes guidance for reporting modifications of loans to borrowers experiencing financial difficulty.
Loan Servicing Rights
Loan servicing rights represent the estimated value of servicing loans that are sold with servicing retained by ChoiceOne and are initially recorded at estimated fair value. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Management’s accounting treatment of loan servicing rights is estimated based on current prepayment speeds that are typically market driven.
Management believes the accounting estimate related to loan servicing rights is a “critical accounting estimate” because (1) the estimate is highly susceptible to change from period to period because of significant changes within long-term interest rates affecting the prepayment speeds for current loans being serviced and (2) the impact of recognizing an impairment loss could have a material effect on ChoiceOne’s net income. Management has obtained a third-party valuation of its loan servicing rights to corroborate its current carrying value at the end of each reporting period.
Goodwill
Goodwill is not amortized but is evaluated annually for impairment and on an interim basis if events or changes in circumstances indicate that goodwill might be impaired. The goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount, and an impairment charge would be recognized for any amount by which the carrying amount exceeds the reporting unit’s fair value. The Company acquired Valley Ridge Financial Corp. in 2006, County Bank Corp in 2019, and Community Shores in 2020, which resulted in the recognition of goodwill of $13.7 million, $38.9 million and $7.3 million, respectively.
34
ChoiceOne engaged a third party valuation firm to assist in performing a quantitative analysis of goodwill as of June 30, 2024 ("the measurement date"). In deriving the fair value of the reporting unit (the Bank), the third-party firm assessed general economic conditions and outlook; industry and market considerations and outlook; the impact of recent events to financial performance; the market price of ChoiceOne’s common stock and other relevant events. In addition, the valuation relied on financial projections through 2029 and growth rates prepared by management. Based on the valuation prepared, it was determined that ChoiceOne's estimated fair value of the reporting unit at the measurement date was greater than its book value and impairment of goodwill was not required. As of the measurement date and December 31, 2024 the stock price was greater than the book value. No material changes and no triggering events have occurred that indicated impairment from the measurement date through December 31, 2024.
Deferred Tax Assets and Liabilities
Income taxes include both a current and deferred portion. Deferred tax assets and liabilities are recorded to account for differences in the timing of the recognition of revenues and expenses for financial reporting and tax purposes. Generally accepted accounting principles require that deferred tax assets be reviewed to determine whether a valuation allowance should be established using a “more likely than not” standard. Based on its review of ChoiceOne’s deferred tax assets as of December 31, 2024, management determined that no valuation allowance was necessary. The valuation of current and deferred income tax assets and liabilities is considered critical, as it requires management to make estimates based on provisions of the enacted tax laws. The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and the federal tax code.
Identification and Classification of Merger-Related Expenses
Merger-related expenses are costs incurred directly in connection with the company's merger and acquisition activities. These expenses include legal fees for negotiation and drafting of merger agreements, accounting and auditing fees related to due diligence and financial statement preparation, consulting fees for strategic advisory services specific to the merger, costs related to regulatory filings and compliance, expenses for integration planning and execution (including IT and systems integration), severance and retention bonuses for employees affected by the merger, and travel and accommodation expenses directly related to merger activities.
To ensure accurate classification and segregation of these expenses, detailed documentation supporting the nature and purpose of each expense is maintained, including invoices, contracts, and internal memos. All merger-related expenses must be reviewed and approved by the CFO or an authorized delegate to ensure they meet the criteria for classification as merger-related. The Accounting Department conducts periodic reviews of these expenses to ensure proper classification and segregation, promptly addressing and correcting any discrepancies. Merger-related expenses are disclosed separately in the financial statements and accompanying notes to provide transparency to investors and stakeholders.
35