Choiceone Financial Services Inc: Form 10-Q for the period ended Sep 30, 2024

The following discussion is designed to provide a review of the consolidated financial condition and results of operations of ChoiceOne Financial Services, Inc. (“ChoiceOne”) and its wholly-owned subsidiaries. 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. Words such as “anticipates,” “believes,” “estimates,” “expects,” “forecasts,” “intends,” “is likely,” “plans,” “predicts,” “projects,” “may,” “could,” “look forward,” “continue,” “future,” “will” 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 credit losses, the carrying value of goodwill, loan servicing rights, other real estate owned, and the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary and the amount of any impairment) and management’s assumptions concerning pension and other post-retirement benefit plans involve judgments that are inherently forward-looking. All of the information concerning interest rate sensitivity is forward-looking. All statements with references to future time periods are 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. Such risks, uncertainties and assumptions, include, among others, the following:

• the failure to obtain necessary regulatory approvals when expected or at all (and the risk that such approvals may result in a materially burdensome regulatory condition (as defined in the merger agreement));
• the failure of Fentura to obtain shareholder approval, for ChoiceOne to obtain the shareholder approval, or for either party to satisfy any of the other closing conditions to the proposed transaction on a timely basis or at all;
• the occurrence of any event, change or other circumstances that could give rise to the right of one or both of the parties to terminate the merger agreement;
• the possibility that the anticipated benefits of the proposed transaction are not realized when expected or at all, including as a result of the impact of, or problems arising from, the integration of the two companies or as a result of the strength of the economy, competitive factors in the areas where ChoiceOne and Fentura do business, or as a result of other unexpected factors or events;
• the impact of purchase accounting with respect to the proposed transaction, or any change in the assumptions used regarding the assets purchased and liabilities assumed to determine their fair value;
• diversion of management’s attention from ongoing business operations and opportunities;
• potential adverse reactions or changes to business or employee relationships, including those resulting from the announcement or completion of the proposed transaction; or
• the outcome of any legal proceedings that may be instituted against ChoiceOne or Fentura.

Additional risk factors include, but are not limited to, the risk factors discussed in Item 1A of ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2023 and in Part II, Item 1A of ChoiceOne’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2024. These are representative of the risk factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.

RECENT EVENTS

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 (the “Common Stock Offering”). The aggregate gross proceeds of the Common Stock Offering were approximately $34.5 million before deducting underwriting discounts and estimated offering expenses. The proceeds from the Common Stock Offering will qualify as tangible common equity and Tier 1 common equity. ChoiceOne intends to use the net proceeds of the Common Stock Offering for general corporate purposes including supplementing regulatory capital ratios and in conjunction with its announced merger with Fentura Financial, Inc.

On July 25, 2024, ChoiceOne and Fentura Financial, Inc. (“Fentura”), the parent company of The State Bank, announced the signing of a definitive merger agreement (the “Merger Agreement”) pursuant to which ChoiceOne and Fentura will merge in an all-stock transaction. The agreement was unanimously approved by the boards of directors of both companies. Under the terms of the merger agreement, each share of Fentura common stock outstanding immediately prior to completion of the merger will be converted into the right to receive 1.35 shares of ChoiceOne common stock. Once completed, the combination will create the third largest publicly traded bank in Michigan with approximately $4.3 billion in consolidated total assets and 56 offices in Western, Central and Southeastern Michigan. The proposed transaction is expected to close in the first quarter of 2025, subject to the satisfaction of customary closing conditions, including receipt of approval from Fentura and ChoiceOne shareholders and receipt of all necessary regulatory approvals.

RESULTS OF OPERATIONS

ChoiceOne reported net income of $7,348,000 and $19,568,000 for the three and nine months ended September 30, 2024, compared to $5,122,000 and $15,968,000 for the same periods in 2023, representing growth of 43.5% and 22.5%, respectively. Net income adjusted for merger related expenses net of tax was $7,981,000 and $20,201,000 for the three and nine months ended September 30, 2024. Diluted earnings per share were $0.85 and $2.46 in the three and nine months ended September 30, 2024, compared to $0.68 and $2.12 per share in the same periods in the prior year. Earnings per share was negatively impacted by the sale of 1,380,000 shares of common stock in the Common Stock Offering.

(In Thousands, Except Per Share Data)

As of September 30, 2024, total assets were $2.7 billion, an increase of $149.3 million compared to December 31, 2023. The growth is primarily attributed to an increase in core loans of $74.2 million and loans to other financial institutions of $19.1 million and an increase in cash and due from banks of $90.5 million compared to December 31, 2023. This growth was partially offset by a $33.1 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 observed during the nine months ended September 30, 2024.

Deposits, excluding brokered deposits, increased $102.1 million or an annualized 19.5% in the third quarter of 2024 and $103.0 million or 4.9% compared to December 31, 2023. The increase in deposits in the third quarter was driven by public funds including schools and townships which historically increase in the third quarter of each year due to the timing of tax collection. The increase in deposits compared to December 31, 2023 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, the Bank Term Funding Program (“BTFP”), and FHLB advances to ensure ample liquidity. At September 30, 2024, total available borrowing capacity secured by pledged assets was $780.6 million. ChoiceOne can increase its capacity by utilizing unsecured federal fund lines and pledging additional assets, if necessary. Uninsured deposits totaled $863.3 million or 39.1% of deposits at September 30, 2024.

ChoiceOne's cost of deposits to average total deposits has declined since peaking in the first quarter of 2024 due to positive cash flow from pay-fixed interest rate swaps, hedged against deposits, decreasing deposit expenses. In addition, the Federal Reserve decreased the federal funds rate by 50 basis points in September 2024 and signaled potential further rate drops in the future. The cost of deposits to average total deposits has increased slightly to an annualized 1.53% in the third quarter of 2024 compared to an annualized 1.36% in the third quarter of 2023. Due to hedge instruments we have in place, our balance sheet is asset sensitive. If rates decline, we expect to see slight declines in deposit costs; however these declines will be muted by the decrease in cash flows from pay-fixed interest rate swaps collected. Interest expense on borrowings for the three and nine months ended September 30, 2024 increased $239,000 and $3.4 million, respectively, compared to the same periods in the prior year, due to increases in borrowing amounts and interest rates. Borrowings include $170 million from the BTFP and $40 million of FHLB borrowings at a weighted average fixed rate of 4.7%, with the earliest maturity in January 2025. Total cost of funds increased to an annualized 1.87% in the third quarter of 2024 compared to an annualized 1.70% in the third quarter of 2023.

The annualized return on average assets and annualized return on average shareholders’ equity were 1.09% and 12.36%, respectively, for the third quarter of 2024, compared to an annualized 0.80% and an annualized 11.31%, respectively, for the same period in 2023. The annualized return on average assets and annualized return on average shareholders’ equity were 0.98% and 12.00%, respectively, for the first nine months of 2024, compared to 0.87% and 12.26%, respectively, for the same period in 2023.

Dividends

Cash dividends of $2.4 million or $0.27 per share were declared in the third quarter of 2024, compared to $2.0 million or $0.26 per share in the third quarter of 2023. Cash dividends declared in the first nine months of 2024 were $6.5 million or $0.81 per share, compared to $5.9 million or $0.78 per share in the same period during the prior year. The cash dividend payout percentage was 33.2% for the first nine months of 2024, compared to 36.8% in the same period in the prior year.

Interest Income and Expense

Tables 1 and 2 on the following pages provide information regarding interest income and expense for the three and nine months ended September 30, 2024 and 2023. Table 1 documents ChoiceOne’s average balances and interest income and expense, as well as the average rates earned or paid on assets and liabilities. Table 2 documents the effect on interest income and expense of changes in volume (average balance) and interest rates. These tables are referred to in the discussion of interest income, interest expense and net interest income.

Table 1 – Average Balances and Tax-Equivalent Interest Rates

(Dollars in thousands)

(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) Taxable securities include dividend income from 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 $2.2 million and $1.9 million in the third quarter of 2024 and 2023, respectively.

(5) Interest on loans included net origination fees and accretion income. Accretion income was $275,000 and $362,000 in the third quarter of 2024 and 2023, respectively.

(Dollars in thousands)

(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) Taxable securities include dividend income from 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 $2.1 million and $1.5 million in the first nine months of 2024 and 2023, respectively.

(5) Interest on loans included net origination fees and accretion income related to acquired loans. Accretion income related to acquired loans was $944,000 and $1.4 million in the first nine months of 2024 and 2023, respectively.

Table 2 – Changes in Tax-Equivalent Net Interest Income

(Dollars in thousands)

(Dollars in thousands)

(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 21%.

Net Interest Income

Tax-equivalent net interest income increased $4.0 million and $5.8 million in the three and nine months ended September 30, 2024, compared to the same periods in 2023. The primary factor contributing to the increase in interest income was the higher interest rates on new loans and the impact of fixed rate swaps (see note 8). Tax equivalent net interest margin increased 53 basis points and 13 basis points in the three and nine months ended September 30, 2024, respectively, compared to the same periods in 2023. GAAP based net interest margin increased 53 basis points and 14 basis points in the three and nine months ended September 30, 2024, respectively, compared to the same periods in 2023.

The following table presents the annualized cost of deposits and the annualized cost of funds for the three and nine months ended September 30, 2024 and 2023.

ChoiceOne has experienced loan growth, leading to an increase in interest income from loans of $5.5 million and $17.4 million in the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year. Average loans grew $181.6 million and $202.8 million in the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year. In addition, the average rate earned on loans increased 82 basis points and 88 basis points in the three and nine months ended September 30, 2024, respectively, compared to the same period in the prior year. Interest income on loans for the three and nine months ended September 30, 2024 increased by $673,000 and $1.3 million, respectively, compared to the same periods in 2023, due to amortization expense related to the March 2023 sale of the pay floating swap derivative and a decline in accretion income related to acquired loans of $87,000 and $333,000, respectively.

The average balance of total securities decreased $64.9 million and $63.6 million for the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year. The decrease is due to paydowns and a decline in the fair value of available for sale securities. The average rate earned on securities increased 25 basis points and 27 basis points for the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year. Interest income on securities increased by $196,000 and $719,000 for the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year.

Interest expense increased $1.4 million in the three months ended September 30, 2024 and increased $13.3 million in the nine months ended September 30, 2024, compared to the same periods in the prior year. The average rate paid on interest bearing-demand deposits and savings deposits increased 13 basis points and 46 basis points in the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year. This was partly due to an increase in the average balance of interest bearing-demand deposits and savings deposits of $31.9 million for the three months ended September 30, 2024 and offset by the decline in the average balance of interest bearing-demand deposits and savings deposits of $2.0 million for the nine months ended September 30, 2024, compared to the same time periods in the prior year. The increase in the average balance of certificates of deposit of $51.8 million and $95.7 million in the three and nine months ended September 30, 2024, respectively, combined with a 50 basis point and 128 basis point increase in the rate paid on certificates of deposits in the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year, led to an increase in interest expense of $988,000 and $5.9 million during the respective time periods.

In order to bolster liquidity, ChoiceOne borrowed a total of $170.0 million from the Bank Term Funding Program ("BTFP") during the second and fourth quarters of 2023 and held $6.6 million in brokered deposits and $40.0 million in FHLB advances on September 30, 2024. The net effect of these additional borrowed funds and brokered deposits was neutral to interest expense for the three months ended September 30, 2024 and an increase in interest expense of $2.7 million for the nine months ended September 30, 2024, compared to the same periods 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 flat in the third quarter of 2024 and the nine months ended September 30, 2024, compared to the same periods in the prior year.

Provision and Allowance for Credit Losses

The allowance for credit losses ("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 $656,000 to $2.7 million during the first nine months of 2024, and the ACL related to these individually evaluated loans increased by $28,000 during the same period.

Nonperforming loans, which includes Other Real Estate Owned ("OREO") but excludes performing troubled loan modifications ("TLM"), remained low at $2.9 million as of September 30, 2024, compared to $1.9 million as of December 31, 2023, and $1.8 million as of September 30, 2023. The ACL was 1.10% of total loans, excluding loans held for sale, at September 30, 2024, compared to 1.11% on December 31, 2023, and 1.14% on September 30, 2023. The liability for expected credit losses on unfunded loans and other commitments was $1.5 million on September 30, 2024, compared to $2.2 million on December 31, 2023, and $2.7 million on September 30, 2023.

Charge-offs and recoveries for respective loan categories for the nine months ended September 30, 2024 and 2023 were as follows:

(Dollars in thousands)

Net charge-offs were $295,000 during the first nine months of 2024, compared to net charge-offs of $244,000 during the same period in 2023. Net charge-offs for checking accounts during the first nine months of 2024 were $155,000 or an annualized $206,000 compared to $178,000 or an annualized $238,000 for the same period in the prior year. Annualized net loan charge-offs as a percentage of average loans were 0.02% for the third quarter of 2024 compared to 0.05% for the same period in the prior year.

The provision for credit losses on loans was $1.1 million during the first nine months of 2024, compared to $332,000 in the same period in the prior year. The provision expense was deemed necessary due to growth in total loans held for investment of $93.3 million during the first nine months of 2024 and minor deteriorations in the forecast used in ChoiceOne's CECL model.

The loan provision expense was offset by the decrease in unfunded commitments provision expense of $675,000 in the first nine months of 2024, due to changes in mix, historical average funding rate declines, and a decline in balance. Total unfunded commitments decreased $28.7 million in the first nine months of 2024 compared to December 31, 2023.

Net provision for credit losses was $425,000 for the third quarter and first nine months of 2024.

Noninterest Income

Noninterest income increased $1.2 million and $2.1 million in the three and nine months ended September 30, 2024, compared to the same periods in the prior year. The increase was largely due to an increase in customer service charges of $391,000 and $920,000 in the three and nine months ended September 30, 2024 and changes in the market value of equity securities in the three and nine months ended September 30, 2024, compared to the same periods in the prior year. Equity securities include community bank stocks and CRA focused bond mutual funds. In addition, ChoiceOne recognized earnings on a bank owned life insurance death benefit claim in the amount of $196,000 during the first quarter of 2024.

Noninterest Expense

Noninterest expense increased by $1.7 million or 12.3% and $2.1 million or 5.0% in the three and nine months ended September 30, 2024 compared to the same periods in 2023. The increase in total noninterest expense was due in part to merger related expenses of $645,000 during the third quarter 2024 compared to $0 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 inflationary pressures. The year to date increase in costs were offset by a decline in occupancy and equipment related to two branch closures during the first quarter of 2024. Management continues to seek out ways to manage costs, but also recognizes the value of investing in innovation and attracting the best talent in our industry to compete effectively in our markets.

Income Tax Expense

Income tax expense was $1.9 million and $4.7 million in the three and nine months ended September 30, 2024, respectively, compared to $1.1 million and $3.2 million for the same periods in 2023. The effective tax rate was 20.8% and 19.4% for the three and nine months ended September 30, 2024, respectively, compared to 17.4% and 16.5% for the same periods in 2023. During the first nine months of 2024, disallowed interest expense and non deductible merger expenses increased compared to the same period in 2023.

FINANCIAL CONDITION

At September 30, 2024, ChoiceOne had consolidated total assets of $2.7 billion, net loans of $1.5 billion, total deposits of $2.2 billion and total shareholders' equity of $247.7 million.

Securities

Total available for sale securities on September 30, 2024 were $497.6 million compared to $514.6 million on December 31, 2023, with the decrease caused by $25.1 million of principal repayments, calls and maturities. The unrealized loss on securities available for sale declined by $17.0 million in the first nine months of 2024. Total held to maturity securities on September 30, 2024 were $392.0 million compared to $408.0 million on December 31, 2023. ChoiceOne's held to maturity securities declined during the first nine months of 2024 due to $16.0 million of principal repayments, calls and maturities.

At September 30, 2024, ChoiceOne had $107.7 million in unrealized losses on its investment securities, including $61.4 million in unrealized losses on available for sale securities, $46.1 million in unrealized losses on held to maturity securities, and $214,000 in unrealized losses on equity 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 September 30, 2024. As of December 31, 2023, equity securities included a MMP of $1.0 million and common stock of $6.5 million.

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.

Loans

The company's loan portfolio by call report code was as follows:

(Dollars in thousands)

Average loan balances increased to $1.46 billion in the third quarter of 2024 compared to $1.36 billion in the fourth quarter of 2023 and $1.28 billion in the third quarter of 2023. Core loans grew organically by $74.2 million or 7.1% on an annualized basis during the first nine months of 2024. Loan growth during the first nine months of 2024 was concentrated in Non-Owner Occupied CRE loans, which grew by $75.3 million. ChoiceOne also saw healthy growth in Multifamily Loans, which grew by $27.9 million, 1-4 Family loans which grew $25.4 million, and Owner Occupied CRE, which grew by $22.1 million. The growth in 1-4 Family loans was largely related to growth in loans to other financial institutions which were $38.5 million as of September 30, 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. Loan interest including fee income increased $5.5 million and $17.4 million in the three and nine months ended September 30, 2024, respectively, compared to the same time periods in the prior year.

During the first nine months of 2024 and 2023, ChoiceOne recorded accretion income related to acquired loans in the amount of $944,000 and $1.3 million, respectively. 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. The remaining yield mark on acquired loans from the mergers with County Bank Corp. and Community Shores totaled $1.6 million as of September 30, 2024.

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. Accounting pronouncements allow a company to first perform a qualitative assessment for goodwill prior to a quantitative assessment (Step 1 assessment). If the results of the qualitative assessment indicate that it is more likely than not that goodwill is impaired, then a quantitative assessment must be performed. If not, there is no further assessment required. 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.

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. No material changes and no triggering events have occurred that indicated impairment from the measurement date through September 30, 2024.

Deposits and Borrowings

Deposits, excluding brokered deposits, increased $102.1 million or an annualized 19.5% in the third quarter of 2024 and $103.0 million or 4.9% compared to December 31, 2023. The increase in deposits in the third quarter was driven by public funds including schools and townships which historically increase in the third quarter of each year due to the timing of tax collection. The increase in deposits compared to December 31, 2023 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, the Bank Term Funding Program (“BTFP”), and FHLB advances to ensure ample liquidity.

Uninsured deposits totaled $863.3 million or 39.1% of deposits on September 30, 2024 compared to $769.7 million, or 36.3% of total deposits at December 31, 2023. At September 30, 2024, total available borrowing capacity from all sources was $780.6 million. ChoiceOne can increase its capacity by utilizing unsecured federal fund lines and pledging additional assets, if necessary.

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 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 merger mark-to-market adjustment.

At September 30, 2024, ChoiceOne has borrowed $170 million from the BTFP. This program provides a 1-year term at a fixed rate with the ability to prepay at any time without penalty. The interest rate on the BTFP borrowings as of September 30, 2024 was 4.76% and fixed through January of 2025. Collateral pledged is U.S. Treasuries, agency debt and mortgage-backed securities valued at par. At September 30, 2024, ChoiceOne had $40 million of borrowings from the FHLB with a weighted average rate of 4.58% with maturities through 2026. Total cost of funds increased to an annualized 1.87% in the third quarter of 2024 compared to an annualized 1.70% in the third quarter of 2023.

Shareholders' Equity

Shareholders’ equity totaled $247.7 million as of September 30, 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 in the Common Stock Offering. The additional increase is due to retained earnings and an improvement in accumulated other compressive loss (AOCI) of $6.1 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. ChoiceOne Bank remains “well-capitalized” with a total risk-based capital ratio of 13.1% as of September 30, 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 September 30, 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 $4.4 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. Included in the total is $200.0 million of forward starting pay-fixed, receive floating interest rate swaps used to hedge interest bearing liabilities. These forward starting swaps pay a fixed coupon of 2.75% while receiving SOFR. Settlements from these swaps amounted to $1.3 million for the third quarter of 2024 and were a contributing factor to the increase in net interest margin during the third quarter of 2024. Fully tax equivalent net interest margin excluding the swaps was 39 basis points lower than tax equivalent net interest margin reported for the third quarter of 2024. In addition to the pay-fixed interest rate swaps, ChoiceOne also employs back-to-back swaps on a commercial loans, with the impact reflected in interest income.

On January 1, 2023, ChoiceOne adopted ASU 2016-13 CECL which caused an increase in the ACL of $7.2 million and booked a liability for expected credit losses on unfunded loans and other commitments of $3.3 million. The increase in the ACL and the cost of the liability resulted in a decrease in the retained earnings account on our Consolidated Balance Sheet equal to the after-tax impact, with the tax impact portion being recorded in deferred taxes in our Consolidated balance Sheet in accordance with FASB guidance. This reduction in retained earnings was offset by first quarter 2023 earnings and recovery of accumulated other comprehensive loss.

Regulatory Capital Requirements

Following is information regarding compliance of ChoiceOne and ChoiceOne Bank with regulatory capital requirements:

(Dollars in thousands)

Management reviews the capital levels of ChoiceOne and ChoiceOne Bank on a regular basis. The Board of Directors and management believe that the capital levels as of September 30, 2024 are adequate for the foreseeable future. The Board of Directors’ determination of appropriate cash dividends for future periods will be based on, among other things, market conditions and ChoiceOne’s requirements for cash and capital.

Liquidity

Net cash provided by operating activities was $25.0 million for the nine months ended September 30, 2024 compared to $57.3 million in the same period in 2023. The change was due to the change in proceeds from loan sales and other liabilities, partially offset by other assets in the nine months ended September 30, 2024 compared to the same period in 2023. Net cash used in investing activities was $56.3 million for the nine months ended September 30, 2024 compared to $96.1 million used in the same period in 2023. The change was due to a decrease in net loan originations that led to cash used of $94.1 million in the first nine months of 2024 compared to $120.3 million used in the same period during the prior year. Net maturities, payments and calls of available for sale and held to maturity securities was $41.8 million for the nine months ended September 30, 2024 compared to $32.2 million in the same period in 2023. Net cash provided by financing activities was $122.2 million for the nine months ended September 30, 2024, compared to $139.5 million in the same period in the prior year. ChoiceOne had $86.2 million in deposit growth in the first nine months of 2024 compared to a decrease of $15.2 million in the same period in 2023. ChoiceOne also increased borrowing by $10.0 million in the first nine months of 2024 compared to an increase of $130.0 million in the same period during the prior year.

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 $170.0 million in outstanding borrowings from the BTFP as of September 30, 2024. ChoiceOne had $40.0 million in outstanding borrowings at the FHLB as of September 30, 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 September 30, 2024, total available borrowing capacity from the FHLB and the Federal Reserve Bank was $780.6 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 the first nine months of 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.

An evaluation was performed under the supervision and with the participation of ChoiceOne’s management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of ChoiceOne’s disclosure controls and procedures as of September 30, 2024. Based on and as of the time of that evaluation, ChoiceOne’s management, including the Chief Executive Officer and Chief Financial Officer, concluded that ChoiceOne’s disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that material information required to be disclosed in the reports that ChoiceOne files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that ChoiceOne files or submits under the Exchange Act is accumulated and communicated to management, including ChoiceOne’s principal executive and principal financial officers, as appropriate to allow for timely decisions regarding required disclosure.

There was no change in ChoiceOne’s internal control over financial reporting that occurred during the nine months ended September 30, 2024 that has materially affected, or that is reasonably likely to materially affect, ChoiceOne’s internal control over financial reporting.

Information concerning risk factors is contained in the discussion in Item 1A, “Risk Factors,” in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2023 and Item 1A, “Risk Factors,” in ChoiceOne’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2024.