Executive Summary / Key Takeaways

• ChoiceOne Financial recently completed a transformative merger with Fentura Financial, significantly expanding its asset base to over $4 billion and market presence across Michigan.
• The merger resulted in a reported net loss in Q1 2025 due to substantial one-time expenses and a required credit loss provision on acquired loans, but adjusted net income shows underlying profitability.
• Loan growth, driven by both the acquisition and solid organic activity, is a key driver of increased interest income, alongside accretion from purchased loans.
• While asset quality metrics remain strong overall, the merger introduced a notable increase in nonperforming assets, primarily classified as purchased credit deteriorated (PCD) loans with corresponding reserves.
• ChoiceOne faces competitive pressures from larger regional banks with more advanced digital capabilities and must successfully integrate operations and leverage its community focus to maintain profitability and market share.

A Community Bank's Strategic Expansion

ChoiceOne Financial Services, Inc. (NASDAQ: COFS) stands as a long-standing institution in Michigan's financial landscape, tracing its roots back to 1898. Over its history, the company has grown primarily through a series of strategic acquisitions, building out its presence and capabilities across the state. These business combinations, including notable deals like Valley Ridge Financial Corp. in 2006, County Bank Corp in 2019, and Community Shores in 2020, have been instrumental in shaping ChoiceOne into a significant regional player.

The company operates as a community bank, offering a full suite of financial services tailored to individuals and businesses. This includes traditional deposit accounts, a diverse range of lending products spanning agricultural, commercial, consumer, residential, and construction sectors, as well as mortgage banking, insurance, investment services, and trust and wealth management. This broad offering is delivered through a network of 56 offices across Western, Central, and Southeastern Michigan, emphasizing local relationships and personalized service.

The most recent and impactful strategic move was the all-stock merger with Fentura Financial, Inc. (FNTY), completed on March 1, 2025. This transaction was explicitly aimed at expanding ChoiceOne's market presence and enhancing its financial strength by integrating Fentura's substantial customer base. The subsequent consolidation of The State Bank, Fentura's banking subsidiary, into ChoiceOne Bank on March 14, 2025, solidified this integration, positioning the combined entity as the third-largest publicly traded bank headquartered in Michigan, with approximately $4.3 billion in consolidated total assets. As CEO Kelly Potes stated, "Our acquisition of Fentura is a natural geographical and cultural fit for ChoiceOne and allows us to expand our community bank franchise further into Central and Southeastern Michigan." He added that the combined company offers "greater range and capacity for commercial and consumer lending as well as leading advancements in technology."

ChoiceOne operates within a competitive Michigan banking market, facing off against larger regional players like Huntington Bancshares (HBAN), Fifth Third Bancorp (FITB), and Comerica Inc. (CMA), as well as New York Community Bancorp (NYCB), which absorbed Flagstar Bancorp (FBC). While these larger banks often possess more extensive branch networks and advanced digital platforms, potentially offering faster processing and lower costs per transaction, ChoiceOne leverages its deep community ties and localized decision-making. This community-centric model fosters higher customer loyalty and retention, particularly in niche areas like agricultural lending where local expertise is paramount.

The company's strategic focus on growth through targeted mergers allows it to expand its physical footprint and customer base, aiming for faster market expansion compared to purely organic methods. However, this strategy also introduces integration challenges and can lead to higher operational costs during the transition period. While ChoiceOne mentions owning intellectual property for a fintech product and aiming for "leading advancements in technology," specific details on this technology, its quantifiable benefits, or ongoing R&D initiatives are not discussed. Analysis of the competitive landscape suggests that larger peers like HBAN and FITB appear to hold an advantage in digital efficiency and innovation speed, suggesting that ChoiceOne's technological capabilities may currently lag, contributing to potentially higher operating costs per transaction compared to more digitally mature rivals. Addressing this technological gap is crucial for long-term efficiency and competitiveness against peers who can offer faster service delivery and potentially lower costs.

Financial Performance and Balance Sheet Dynamics

ChoiceOne's financial results for the first quarter of 2025 reflect the significant impact of the Fentura merger. The company reported a net loss of $13.91 million for the three months ended March 31, 2025, a notable shift from the net income of $5.63 million reported in the same period of 2024. This loss was primarily attributable to substantial merger-related expenses totaling $17.20 million and a $12.00 million provision for credit losses specifically related to the acquisition of non-PCD (Purchased Credit Deteriorated) loans from Fentura.

Excluding these one-time, merger-related impacts, ChoiceOne reported an adjusted net income of $9.31 million for the first quarter of 2025, translating to adjusted diluted earnings per share of $0.86. This adjusted view provides a clearer picture of the combined entity's underlying profitability, demonstrating that the core operations, post-merger, are generating positive earnings before accounting for the costs of the transaction itself.

The merger significantly boosted ChoiceOne's balance sheet, with total assets increasing by $1.6 billion to $4.30 billion as of March 31, 2025, compared to March 31, 2024. Net loans grew substantially to $2.90 billion, including approximately $1.4 billion acquired through the merger. Beyond the acquisition, core loans (excluding held for sale and loans to other financial institutions) also showed healthy organic growth, increasing by $40.1 million, or 10.6% on an annualized basis, during the first quarter of 2025. This loan growth, coupled with higher interest rates on new originations and $2.8 million in purchased loan interest accretion income from the merger, drove a significant $11.9 million increase in loan interest income compared to the prior year quarter.

Total deposits, excluding brokered deposits, increased by $1.4 billion to $3.6 billion, primarily due to the $1.4 billion in deposits acquired from Fentura, supplemented by $15.0 million in organic growth during Q1 2025. While interest expense increased by $1.7 million year-over-year due to higher deposit balances, the cost of deposits to average total deposits has decreased since peaking in Q1 2024. This decline, influenced by the Federal Reserve's rate reduction since September 2024 and positive cash flow from pay-fixed interest rate swaps hedging deposits, stood at an annualized 1.59% in Q1 2025, down from 1.65% in Q1 2024. Management anticipates further reductions in deposit costs if rates continue to decline, though this will be partially offset by decreased cash flows from these swaps.

ChoiceOne actively manages its liquidity and interest rate risk. The company utilized the sale of $78.9 million in acquired securities from the merger to pay down higher-cost wholesale funding, reducing outstanding FHLB borrowings to $130.0 million at a weighted average fixed rate of 4.03% as of March 31, 2025. Total available borrowing capacity secured by pledged assets stood at a robust $945.3 million. The company also uses interest rate swaps, holding $351.0 million in notional value of pay-fixed, receive-variable swaps to hedge against rising rates and unrealized losses on its investment portfolio.

Asset quality metrics, while still strong, reflect the impact of the acquired portfolio. The allowance for credit losses (ACL) increased to 1.18% of total loans (excluding HFS) at March 31, 2025, up from 1.07% at December 31, 2024. Nonperforming assets, including Other Real Estate Owned (OREO), increased by $15.1 million to $19.3 million, largely due to $12.9 million in non-accrual loans and $1.7 million in OREO acquired in the merger. Importantly, all non-accrual loans from the merger are classified as PCD loans, meaning they were acquired with a corresponding credit reserve ($4.9 million of the total ACL increase). Overall asset quality remains solid, with annualized net loan charge-offs to average loans at 0.01% and nonperforming loans to total loans (excluding HFS) at 0.65% as of March 31, 2025.

The investment securities portfolio held $116.5 million in total unrealized losses at March 31, 2025, primarily on available-for-sale ($65.6 million) and held-to-maturity ($50.2 million) securities. Management believes these losses are temporary, driven by changes in interest rates and market conditions rather than credit quality, and does not intend to sell these high-credit-quality bonds prior to anticipated recovery.

Outlook and Risks

Looking ahead, ChoiceOne anticipates approximately $7.5 million in additional accretion income from purchased loans related to the Fentura merger for the remainder of 2025, though this is subject to prepayment speeds. The company expects continued benefits from integrating the Fentura operations, including potential further reductions in deposit costs if the interest rate environment remains favorable or declines.

However, the integration process itself presents risks. While the initial accounting for the business combination is provisional, finalizing these valuations could result in adjustments. The significant increase in nonperforming assets, albeit largely covered by PCD reserves, requires careful monitoring to ensure performance does not deteriorate beyond expectations. The company's exposure to the automotive sector, representing 3.4% ($99.3 million) of gross loans (excluding HFS), warrants close attention, particularly in light of potential tariff impacts, although management views this exposure as low relative to the total portfolio.

Competition remains a persistent factor. Larger regional banks with greater scale and technological resources pose a challenge to ChoiceOne's efficiency and ability to attract digitally-focused customers. ChoiceOne's strategy relies on leveraging its expanded community presence and local service model to differentiate itself. The success of the Fentura integration in achieving anticipated synergies and effectively cross-selling products to the expanded customer base will be critical in driving future profitability and offsetting competitive pressures.

Conclusion

ChoiceOne Financial is in a period of significant transformation following its merger with Fentura Financial. While the first quarter of 2025 results were heavily impacted by one-time transaction costs and related provisions, the underlying performance, as reflected in adjusted net income, demonstrates the earnings power of the combined entity. The strategic rationale of expanding market presence and leveraging increased scale appears sound, driving substantial growth in loans and deposits.

The investment thesis for COFS hinges on the successful integration of the Fentura operations, the realization of anticipated synergies, and the ability to maintain strong asset quality in the expanded portfolio. While facing competitive headwinds from larger, more technologically advanced peers and managing risks associated with integration and specific sector exposures, ChoiceOne's enhanced scale and deep community roots provide a foundation for future growth. Investors should closely monitor the progress of the integration, trends in asset quality, and the company's ability to enhance operational efficiency and technological capabilities to sustain profitability in a dynamic market.