CHOICEONE FINANCIAL SERVICES INC - Quarter Report: 2016 September (Form 10-Q)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

☒	Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

	For the quarterly period ended September 30, 2016

☐	Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

	For the transition period from to

Commission File Number: 000-19202

ChoiceOne Financial Services, Inc.
(Exact Name of Registrant as Specified in its Charter)

Michigan (State or Other Jurisdiction of Incorporation or Organization)		38-2659066 (I.R.S. Employer Identification No.)

109 East Division Sparta, Michigan (Address of Principal Executive Offices)		49345 (Zip Code)

(616) 887-7366 (Registrant’s Telephone Number, including Area Code)

Indicate by checkmark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☐

Non-accelerated filer ☐	Smaller reporting company ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐ No ☒

As of October 31, 2016, the Registrant had outstanding 3,276,097 shares of common stock.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

ChoiceOne Financial Services, Inc.
CONSOLIDATED BALANCE SHEETS (Unaudited)


(Dollars in thousands)	September 30, 2016 (Unaudited)			December 31, 2015 (Audited)
Assets
Cash and due from banks	$	12,644		$	11,187

Securities available for sale (Note 2)		177,444			160,136
Federal Home Loan Bank stock		1,679			1,614
Federal Reserve Bank stock		1,573			1,573

Loans held for sale		2,838			4,957
Loans (Note 3)		362,603			349,304
Allowance for loan losses (Note 3)		(4,276	)		(4,194	)
Loans, net		358,327			345,110

Premises and equipment, net		12,394			11,847
Cash value of life insurance policies		12,526			12,261
Intangible assets, net		43			379
Goodwill		13,728			13,728
Other assets		5,468			4,954
Total assets	$	598,664		$	567,746

Liabilities
Deposits – noninterest-bearing	$	123,609		$	122,937
Deposits – interest-bearing		353,778			351,759
Total deposits		477,387			474,696

Federal funds purchased		624			—
Repurchase agreements		6,417			9,460
Advances from Federal Home Loan Bank		37,309			11,332
Other liabilities		3,348			2,416
Total liabilities		525,085			497,904

Shareholders’ Equity
Common stock and paid in capital, no par value; shares authorized: 7,000,000; shares outstanding: 3,275,201 at September 30, 2016 and 3,295,228 at December 31, 2015		46,228			46,501
Retained earnings		24,866			22,138
Accumulated other comprehensive income, net		2,485			1,203
Total shareholders’ equity		73,579			69,842
Total liabilities and shareholders’ equity	$	598,664		$	567,746

See accompanying notes to interim consolidated financial statements.

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


(Dollars in thousands, except per share data)	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Interest income
Loans, including fees	$	4,210		$	4,015		$	12,293		$	11,945
Securities:
Taxable		594			489			1,731			1,427
Tax exempt		358			361			1,088			1,067
Other		5			6			14			10
Total interest income		5,167			4,871			15,126			14,449

Interest expense
Deposits		190			222			599			663
Advances from Federal Home Loan Bank		44			17			119			64
Other		2			7			7			28
Total interest expense		236			246			725			755

Net interest income		4,931			4,625			14,401			13,694
Provision for loan losses		—			—			—			100

Net interest income after provision for loan losses		4,931			4,625			14,401			13,594

Noninterest income
Customer service charges		1,030			1,092			3,020			3,137
Insurance and investment commissions		290			219			740			852
Gains on sales of loans		508			308			1,345			1,120
Gains on sales of securities		28			155			255			208
Losses on sales and write-downs of other assets		(3	)		(21	)		(26	)		(97	)
Earnings on life insurance policies		88			87			265			562
Other		124			120			360			322
Total noninterest income		2,065			1,960			5,959			6,104

Noninterest expense
Salaries and benefits		2,542			2,323			7,519			6,835
Occupancy and equipment		626			598			1,959			1,786
Data processing		556			558			1,654			1,689
Professional fees		232			263			700			776
Supplies and postage		92			100			312			278
Advertising and promotional		52			54			184			179
Intangible amortization		112			112			336			336
Loan and collection expense		15			53			59			104
FDIC insurance		78			72			218			222
Other		364			469			1,426			1,441
Total noninterest expense		4,669			4,602			14,367			13,646

Income before income tax		2,327			1,983			5,993			6,052
Income tax expense		644			533			1,591			1,529

Net income	$	1,683		$	1,450		$	4,402		$	4,523

Basic earnings per share (Note 4)	$	0.52		$	0.44		$	1.34		$	1.37
Diluted earnings per share (Note 4)	$	0.52		$	0.44		$	1.34		$	1.37
Dividends declared per share	$	0.17		$	0.17		$	0.51		$	0.49

See accompanying notes to interim consolidated financial statements.

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


(Dollars in thousands)	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Net income	$	1,683		$	1,450		$	4,402		$	4,523

Other comprehensive income:

Changes in net unrealized gains on investment securities available for sale, net of tax expense of $36 and $291 for the three months ended September 30, 2016 and September 30, 2015 respectively. Changes in net unrealized gains on investment securities available for sale, net of tax expense of $748 and $356 for the nine months ended September 30, 2016 and September 30, 2015 respectively.		68			564			1,450			688

Less: Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax benefit of $9 and $53 for the three months ended September 30, 2016 and September 30, 2015 respectively. Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax benefit of $87 and $71 for the nine months ended September 30, 2016 and September 30, 2015 respectively.		(19	)		(102	)		(168	)		(137	)

Change in adjustment for pension and other postretirement benefits, net of tax benefit (expense).		—			—			—			—

Other comprehensive income (loss), net of tax		49			462			1,282			551

Comprehensive income	$	1,732		$	1,912		$	5,684		$	5,074

See accompanying notes to interim consolidated financial statements.

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


(Dollars in thousands)	Number of Shares			Common Stock and Paid in Capital			Retained Earnings			Accumulated Other Comprehensive Income, Net		Total

Balance, January 1, 2015		3,295,834		$	46,552		$	18,565		$	1,073	$	66,190

Net income								4,523					4,523
Other comprehensive income											551		551
Shares issued		10,010			153								153
Change in ESOP repurchase obligation					(4	)							(4	)
Shares repurchased		(16,200	)		(371	)							(371	)
Effect of employee stock purchases					9								9
Stock-based compensation		2,284			60								60
Cash dividends declared ($0.49 per share)								(1,610	)				(1,610	)

Balance, September 30, 2015		3,291,928		$	46,399		$	21,478		$	1,624	$	69,501

Balance, January 1, 2016		3,295,228		$	46,501		$	22,138		$	1,203	$	69,842

Net income								4,402					4,402
Other comprehensive income											1,282		1,282
Shares issued		11,559			137								137
Change in ESOP repurchase obligation					127								127
Shares repurchased		(35,000	)		(794	)							(794	)
Effect of employee stock purchases					9								9
Stock-based compensation		3,414			248								248
Cash dividends declared ($0.51 per share)								(1,674	)				(1,674	)

Balance, September 30, 2016		3,275,201		$	46,228		$	24,866		$	2,485	$	73,579

See accompanying notes to interim consolidated financial statements.

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


(Dollars in thousands)	Nine Months Ended September 30,
	2016			2015
Cash flows from operating activities:
Net income	$	4,402		$	4,523
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		—			100
Depreciation		757			736
Amortization		1,199			1,111
Compensation expense on stock purchases and restricted stock units		257			69
Gains on sales of securities		(255	)		(208	)
Gains on sales of loans		(1,345	)		(1,120	)
Loans originated for sale		(39,173	)		(36,402	)
Proceeds from loan sales		42,313			37,093
Earnings on bank-owned life insurance		(265	)		(562	)
Proceeds on bank-owned life insurance		—			461
(Gains) Losses on sales of other real estate owned		3			(11	)
Write-downs of other real estate owned		—			108
Proceeds from sales of other real estate owned		28			299
Deferred federal income tax benefit		(86	)		(209	)
Net changes in other assets		(135	)		(716	)
Net changes in other liabilities		481			(452	)
Net cash from operating activities		8,181			4,820

Cash flows from investing activities:
Securities available for sale:
Sales		14,538			23,329
Maturities, prepayments and calls		33,412			12,469
Purchases		(63,780	)		(47,171	)
Loan originations and payments, net		(13,700	)		2,733
Additions to premises and equipment		(1,112	)		(826	)
Net cash from investing activities		(30,642	)		(9,466	)

Cash flows from financing activities:
Net change in deposits		2,691			32,268
Net change in repurchase agreements		(3,043	)		(19,705	)
Net change in federal funds purchased		624			1,171
Proceeds from Federal Home Loan Bank advances		271,000			116,575
Payments on Federal Home Loan Bank advances		(245,023	)		(128,098	)
Issuance of common stock		137			153
Repurchase of common stock		(794	)		(371	)
Cash dividends		(1,674	)		(1,610	)
Net cash from financing activities		23,918			383

Net change in cash and cash equivalents		1,457			(4,263	)
Beginning cash and cash equivalents		11,187			16,650

Ending cash and cash equivalents	$	12,644		$	12,387

Supplemental disclosures of cash flow information:
Cash paid for interest	$	726		$	766
Cash paid for taxes	$	925		$	2,395
Loans transferred to other real estate owned	$	483		$	378

See accompanying notes to interim consolidated financial statements.

ChoiceOne Financial Services, Inc.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include ChoiceOne Financial Services, Inc. (“ChoiceOne”) and its wholly-owned subsidiary, ChoiceOne Bank (the “Bank”), and the Bank’s wholly-owned subsidiary, ChoiceOne Insurance Agencies, Inc. Intercompany transactions and balances have been eliminated in consolidation.

The unaudited condensed financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations, although the company believes that the disclosures made are adequate to make the information not misleading.

The accompanying consolidated financial statements reflect all adjustments ordinary in nature which are, in the opinion of management, necessary for a fair presentation of the Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015, the Consolidated Statements of Income for the three- and nine-month periods ended September 30, 2016 and September 30, 2015, the Consolidated Statements of Comprehensive Income for the three- and nine-month periods ended September 30, 2016 and September 30, 2015, the Consolidated Statements of Changes in Shareholders’ Equity for the nine-month periods ended September 30, 2016 and September 30, 2015, and the Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2016 and September 30, 2015. Operating results for the nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2015.

Allowance for Loan Losses

The allowance for loan losses is maintained at a level believed adequate by management to absorb probable incurred losses inherent in the consolidated loan portfolio. Management’s evaluation of the adequacy of the allowance is an estimate based on reviews of individual loans, assessments of the impact of current economic conditions on the portfolio and historical loss experience of seasoned loan portfolios. See Note 3 to the interim consolidated financial statements for additional information.

Management believes the accounting estimate related to the allowance for loan losses is a “critical accounting estimate” because (1) the estimate is highly susceptible to change from period to period because of assumptions concerning the changes in the types and volumes of the portfolios and economic conditions and (2) the impact of recognizing an impairment or loan loss could have a material effect on ChoiceOne’s assets reported on the balance sheets as well as its net income.

Stock Transactions

A total of 4,112 shares of common stock were issued to ChoiceOne’s Board of Directors for a cash price of $95,000 under the terms of the Directors’ Stock Purchase Plan in the first nine months of 2016. A total of 4,793 shares of common stock were issued upon the exercise of stock options in the first three quarters of 2016. A total of 2,654 shares of common stock were issued to employees for a cash price of $51,000 under the Employee Stock Purchase Plan in the first nine months of 2016. A total of 3,414 shares of common stock were issued to employees upon vesting of Restricted Stock Units during the first three quarters of 2016. A total of 35,000 shares of common stock were repurchased by ChoiceOne in the first nine months of 2016.

Stock-Based Compensation

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

NOTE 2 - SECURITIES

The fair value of securities available for sale and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

	September 30, 2016
				Gross		Gross
(Dollars in thousands)		Amortized		Unrealized		Unrealized			Fair
		Cost		Gains		Losses			Value
U.S. Government and federal agency	$	64,440	$	381	$	(17	)	$	64,804
U.S. Treasury		2,074		43		(1	)		2,116
State and municipal		87,661		2,878		(25	)		90,514
Mortgage-backed		8,511		62		(14	)		8,559
Corporate		7,370		64		(1	)		7,433
Foreign debt		1,000		2		—			1,002
Equity securities		2,614		204		—			2,818
Asset-backed securities		202		—		(4	)		198
Total	$	173,872	$	3,634	$	(62	)	$	177,444

	December 31, 2015
				Gross		Gross
		Amortized		Unrealized		Unrealized			Fair
		Cost		Gains		Losses			Value
U.S. Government and federal agency	$	57,406	$	30	$	(229	)	$	57,207
U.S. Treasury		6,133		0		(33	)		6,100
State and municipal		76,005		1,858		(109	)		77,754
Mortgage-backed		6,989		26		(45	)		6,970
Corporate		8,418		8		(39	)		8,387
Foreign debt		1,000		—		(5	)		995
Equity securities		2,279		174		—			2,453
Asset-backed securities		274		—		(4	)		270
Total	$	158,504	$	2,096	$	(464	)	$	160,136

Contractual maturities of securities available for sale at September 30, 2016 were as follows:


(Dollars in thousands)		Fair
		Value
Due within one year	$	31,758
Due after one year through five years		95,744
Due after five years through ten years		44,022
Due after ten years		3,103
Total debt securities		174,627
Equity securities		2,817
Total	$	177,444

Securities with unrealized losses at September 30, 2016 and year-end 2015, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, were as follows:

	September 30, 2016
	Less than 12 months					More than 12 months					Total
(Dollars in thousands)	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
U.S. Government and federal agency	$	7,551	$	(18	)	$	—	$	—		$	7,551	$	(18	)
State and municipal		3,506		(19	)		260		(5	)		3,766		(24	)
Mortgage-backed		2,827		(12	)		280		(1	)		3,107		(13	)
Corporate		501		(1	)		399		(1	)		900		(2	)
Asset-backed securities		—		—			198		(5	)		198		(5	)
Total temporarily impaired	$	14,385	$	(50	)	$	1,137	$	(12	)	$	15,522	$	(62	)

	December 31, 2015
	Less than 12 months					More than 12 months					Total
(Dollars in thousands)	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
	Value		Losses			Value		Losses			Value		Losses
U.S. Government and federal agency	$	38,567	$	(216	)	$	986	$	(13	)	$	39,553	$	(229	)
U.S. Treasury notes and bonds		6,101		(33	)		—		—			6,101		(33	)
State and municipal		10,382		(69	)		2,906		(40	)		13,288		(109	)
Mortgage-backed		4,459		(41	)		382		(4	)		4,841		(45	)
Corporate		4,284		(33	)		896		(6	)		5,180		(39	)
Foreign debt		995		(5	)		—		—			995		(5	)
Asset-backed securities		—		—			270		(4	)		270		(4	)
Total temporarily impaired	$	64,788	$	(397	)	$	5,440	$	(67	)	$	70,228	$	(464	)

ChoiceOne reviews its securities portfolio on a quarterly basis to determine whether unrealized losses are considered to be temporary or other-than-temporary. No other-than-temporary impairment charges were recorded during the nine months ended September 30, 2016. ChoiceOne believed that unrealized losses on securities were temporary in nature and were due to changes in interest rates and reduced market liquidity and not as a result of credit quality issues.

NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES

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


(Dollars in thousands)	Agricultural			Commercial and Industrial			Consumer			Commercial Real Estate			Construction Real Estate			Residential Real Estate			Unallocated			Total
Allowance for Loan Losses
Three Months Ended September 30, 2016
Beginning balance	$	399		$	656		$	279		$	1,133		$	44		$	1,222		$	563		$	4,296
Charge-offs		—			—			(68	)		—			—			(25	)		—			(93	)
Recoveries		—			8			49			5			—			11			—			73
Provision		(11	)		(55	)		30			340			(3	)		(205	)		(96	)		—
Ending balance	$	388		$	609		$	290		$	1,478		$	41		$	1,003		$	467		$	4,276

Nine Months Ended September 30, 2016
Beginning balance	$	420		$	586		$	297		$	1,030		$	46		$	1,388		$	427		$	4,194
Charge-offs		—			(33	)		(136	)		—			—			(94	)		—			(263	)
Recoveries		—			31			119			35			—			160			—			345
Provision		(32	)		26			10			412			(5	)		(451	)		40			—
Ending balance	$	388		$	610		$	290		$	1,477		$	41		$	1,003		$	467		$	4,276

Individually evaluated for impairment	$	4		$	8		$	1		$	167		$	—		$	321		$	—		$	501

Collectively evaluated for impairment	$	384		$	602		$	289		$	1,310		$	41		$	682		$	467		$	3,775

Three Months Ended September 30, 2015
Beginning balance	$	279		$	498		$	193		$	1,284		$	28		$	1,375		$	695		$	4,352
Charge-offs		—			—			(65	)		—			—			(25	)		—			(90	)
Recoveries		—			11			25			15			—			4			—			55
Provision		10			(14	)		57			(179	)		15			(2	)		113			—
Ending balance	$	289		$	495		$	210		$	1,120		$	43		$	1,352		$	808		$	4,317

Nine Months Ended September 30, 2015
Beginning balance	$	187		$	527		$	183		$	1,641		$	9		$	1,193		$	433		$	4,173
Charge-offs		—			—			(172	)		—			—			(46	)		—			(218	)
Recoveries		1			59			104			36			—			62			—			262
Provision		101			(91	)		95			(557	)		34			143			375			100
Ending balance	$	289		$	495		$	210		$	1,120		$	43		$	1,352		$	808		$	4,317

Individually evaluated for impairment	$	3		$	1		$	29		$	296		$	—		$	355		$	—		$	684

Collectively evaluated for impairment	$	286		$	494		$	181		$	824		$	43		$	997		$	808		$	3,633

Loans
September 30, 2016
Individually evaluated for impairment	$	534		$	450		$	26		$	1,459		$	—		$	3,109					$	5,578
Collectively evaluated for impairment		37,744			95,221			21,427			107,608			6,027			88,998						357,025
Ending balance	$	38,278		$	95,671		$	21,453		$	109,067		$	6,027		$	92,107					$	362,603

December 31, 2015
Individually evaluated for impairment	$	50		$	192		$	24		$	2,790		$	—		$	2,529					$	5,585
Collectively evaluated for impairment		40,182			94,155			20,066			94,946			5,390			88,980						343,719
Ending balance	$	40,232		$	94,347		$	20,090		$	97,736		$	5,390		$	91,509					$	349,304

The process to monitor the credit quality of ChoiceOne’s loan portfolio includes tracking (1) the risk ratings of business loans, (2) the level of classified business loans, and (3) delinquent and nonperforming consumer loans. Business loans are risk rated on a scale of 1 to 8. A description of the characteristics of the ratings follows:

Risk ratings 1 and 2: These loans are considered pass credits. They exhibit good to exceptional credit risk and demonstrate the ability to repay the loan from normal business operations.

Risk rating 3: These loans are considered pass credits. They exhibit acceptable credit risk and demonstrate the ability to repay the loan from normal business operations.

Risk rating 4: These loans are considered pass credits. However, they have potential developing weaknesses that, if not corrected, may cause deterioration in the ability of the borrower to repay the loan. While a loss is possible for a loan with this rating, it is not anticipated.

Risk rating 5: These loans are considered special mention credits. Loans in this risk rating are considered to be inadequately protected by the net worth and debt service coverage of the borrower or of any pledged collateral. These loans have well defined weaknesses that may jeopardize the borrower’s ability to repay the loan. If the weaknesses are not corrected, loss of principal and interest could be probable.

Risk rating 6: These loans are considered substandard credits. These loans have well defined weaknesses, the severity of which makes collection of principal and interest in full, questionable. Loans in this category may be placed on nonaccrual status.

Risk rating 7: These loans are considered doubtful credits. Some loss of principal and interest has been determined to be probable. The estimate of the amount of loss could be affected by factors such as the borrower’s ability to provide additional capital or collateral. Loans in this category are on nonaccrual status.

Risk rating 8: These loans are considered loss credits. They are considered uncollectible and will be charged off against the allowance for loan losses.

Information regarding the Bank’s credit exposure is as follows:

Corporate Credit Exposure - Credit Risk Profile By Creditworthiness Category:


	Agricultural				Commercial and Industrial				Commercial Real Estate
(Dollars in thousands)	September 30,		December 31,		September 30,		December 31,		September 30,		December 31,
	2016		2015		2016		2015		2016		2015
Risk ratings 1 and 2	$	8,072	$	10,416	$	11,672	$	10,480	$	7,305	$	3,875
Risk rating 3		21,626		25,189		63,450		66,921		57,355		57,540
Risk rating 4		7,269		3,086		19,242		16,169		40,692		29,826
Risk rating 5		1,267		1,491		1,227		574		3,153		3,776
Risk rating 6		44		50		80		129		562		2,719
Risk rating 7		—		—		—		74		—		—
	$	38,278	$	40,232	$	95,671	$	94,347	$	109,067	$	97,736

Corporate Credit Exposure - Credit Risk Profile Based On Payment Activity:

	Consumer				Construction Real Estate				Residential Real Estate
(Dollars in thousands)	September 30,		December 31,		September 30,		December 31,		September 30,		December 31,
	2016		2015		2016		2015		2016		2015
Performing	$	21,448	$	20,090	$	6,027	$	5,390	$	91,317	$	90,796
Nonperforming		5		—		—		—		336		282
Nonaccrual		—		—		—		—		454		431
	$	21,453	$	20,090	$	6,027	$	5,390	$	92,107	$	91,509

The following schedule provides information on loans that were considered TDRs that were modified during the three- and nine-month periods ended September 30, 2016:

	Three Months Ended September 30, 2016						Nine Months Ended September 30, 2016
			Pre-		Post-				Pre-		Post-
			Modification		Modification				Modification		Modification
			Outstanding		Outstanding				Outstanding		Outstanding
(Dollars in thousands)	Number of		Recorded		Recorded		Number of		Recorded		Recorded
	Loans		Investment		Investment		Loans		Investment		Investment
Agricultural		—	$	—	$	—		1	$	113	$	113
Residential real estate		—		—		—		2		156		156
		—	$	—	$	—		3	$	269	$	269

The following schedule provides information on loans that were considered TDRs that were modified during the three- and nine-month periods ended September 30, 2015:

	Three Months Ended September 30, 2015						Nine Months Ended September 30, 2015
			Pre-		Post-				Pre-		Post-
			Modification		Modification				Modification		Modification
			Outstanding		Outstanding				Outstanding		Outstanding
(Dollars in thousands)	Number of		Recorded		Recorded		Number of		Recorded		Recorded
	Loans		Investment		Investment		Loans		Investment		Investment
Commercial real estate		—	$	—	$	—		4	$	448	$	448
Residential real estate		1		85		85		2		193		193
		1	$	85	$	85		6	$	641	$	641

The pre-modification and post-modification outstanding recorded investment represents amounts as of the date of loan modification. If a difference exists between the pre-modification and post-modification outstanding recorded investment, it represents impairment recognized through the provision for loan losses computed based on a loan’s post-modification present value of expected future cash flows discounted at the loan’s original effective interest rate. If no difference exists, a loss is not expected to be incurred based on an assessment of the borrower’s expected cash flows.

The following schedule provides information on TDRs as of September 30, 2016 where the borrower was past due with respect to principal and/or interest for 30 days or more during the three months and nine months ended September 30, 2016 that had been modified during the year prior to the default:

Three Months Ended

Nine Months Ended

September 30, 2016

(Dollars in thousands)

Number

Recorded

Number

Recorded

of Loans

Investment

of Loans

Investment

Agricultural

—

113

The following schedule provides information on TDRs as of September 30, 2015 where the borrower was past due with respect to principal and/or interest for 30 days or more during the three months and nine months ended September 30, 2015 that had been modified during the year prior to the default:

Three Months Ended

Nine Months Ended

September 30, 2015

(Dollars in thousands)

Number

Recorded

Number

Recorded

of Loans

Investment

of Loans

Investment

Commercial real estate

293

409

Loans are classified as performing when they are current as to principal and interest payments or are past due on payments less than 90 days. Loans are classified as nonperforming when they are past due 90 days or more as to principal and interest payments or are considered a troubled debt restructuring.

Impaired loans by loan category follow:

			Unpaid
(Dollars in thousands)	Recorded		Principal		Related
	Investment		Balance		Allowance
September 30, 2016
With no related allowance recorded
Agricultural	$	489	$	493	$	—
Commercial and industrial		177		177		—
Consumer		5		5		—
Commercial real estate		230		351		—
Residential real estate		266		266		—
Subtotal		1,167		1,292		—
With an allowance recorded
Agricultural		45		45		4
Commercial and industrial		273		247		8
Consumer		21		21		1
Commercial real estate		1,229		1,799		167
Residential real estate		2,843		2,859		321
Subtotal		4,411		4,971		501
Total
Agricultural		534		538		4
Commercial and industrial		450		424		8
Consumer		26		26		1
Commercial real estate		1,459		2,150		167
Residential real estate		3,109		3,125		321
Total	$	5,578	$	6,263	$	501

December 31, 2015
With no related allowance recorded
Agricultural	$	—	$	—	$	—
Commercial and industrial		74		103		—
Consumer		—		—		—
Commercial real estate		1,540		1,540		—
Residential real estate		13		13		—
Subtotal		1,627		1,656		—
With an allowance recorded
Agricultural		50		50		3
Commercial and industrial		118		118		15
Consumer		24		24		1
Commercial real estate		1,250		1,755		191
Residential real estate		2,516		2,516		296
Subtotal		3,958		4,463		506
Total
Agricultural		50		50		3
Commercial and industrial		192		221		15
Consumer		24		24		1
Commercial real estate		2,790		3,295		191
Residential real estate		2,529		2,529		296
Total	$	5,585	$	6,119	$	506

The following schedule provides information regarding average balances of impaired loans and interest recognized on impaired loans for the nine months ended September 30, 2016 and 2015:

	Average		Interest
(Dollars in thousands)	Recorded		Income
	Investment		Recognized
September 30, 2016
With no related allowance recorded
Agricultural	$	154	$	(1	)
Commercial and industrial		63		—
Consumer		1		—
Commercial real estate		1,071		33
Residential real estate		134		46
Subtotal		1,423		78
With an allowance recorded
Agricultural		79		16
Commercial and industrial		242		4
Consumer		22		3
Commercial real estate		1,426		116
Residential real estate		2,670		308
Subtotal		4,439		447
Total
Agricultural		233		15
Commercial and industrial		305		4
Consumer		23		3
Commercial real estate		2,497		149
Residential real estate		2,804		354
Total	$	5,862	$	525

September 30, 2015
With no related allowance recorded
Agricultural	$	—	$	—
Commercial and industrial		13		—
Consumer		2		—
Commercial real estate		941		23
Residential real estate		236		(1	)
Subtotal		1,192		22
With an allowance recorded
Agricultural		65		(6	)
Commercial and industrial		26		1
Consumer		37		2
Commercial real estate		2,190		53
Residential real estate		2,402		64
Subtotal		4,720		114
Total
Agricultural		65		(6	)
Commercial and industrial		39		1
Consumer		39		2
Commercial real estate		3,131		76
Residential real estate		2,638		63
Total	$	5,912	$	136

An aging analysis of loans by loan category follows:

					Greater								90 Days Past
(Dollars in thousands)	30 to 59		60 to 89		Than 90				Loans Not				Due and
	Days		Days		Days (1)		Total		Past Due		Total Loans		Accruing
September 30, 2016
Agricultural	$	—	$	—	$	113	$	113	$	38,165	$	38,278	$	—
Commercial and industrial		97		—		249		346		95,325		95,671		—
Consumer		40		6		5		51		21,402		21,453		5
Commercial real estate		—		256		260		516		108,551		109,067		—
Construction real estate		—		—		—		—		6,027		6,027		—
Residential real estate		230		614		487		1,331		90,776		92,107		346
	$	367	$	876	$	1,114	$	2,357	$	360,246	$	362,603	$	351

December 31, 2015
Agricultural	$	3	$	—	$	—	$	3	$	40,229	$	40,232	$	—
Commercial and industrial		90		322		77		489		93,858		94,347		—
Consumer		115		—		—		115		19,975		20,090		—
Commercial real estate		505		297		1,233		2,035		95,701		97,736		—
Construction real estate		299		—		—		299		5,091		5,390		—
Residential real estate		1,012		364		200		1,576		89,933		91,509		29
	$	2,024	$	983	$	1,510	$	4,517	$	344,787	$	349,304	$	29

(1) Includes nonaccrual loans.

Nonaccrual loans by loan category follow:

(Dollars in thousands)	September 30,		December 31,
	2016		2015
Agricultural	$	489	$	50
Commercial and industrial		320		77
Consumer		—		—
Commercial real estate		471		1,640
Construction real estate		—		—
Residential real estate		455		431
	$	1,735	$	2,198

NOTE 4 - EARNINGS PER SHARE

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

	Three Months Ended				Nine Months Ended
(Dollars in thousands, except per share data)	September 30,				September 30,
	2016		2015		2016		2015
Basic Earnings Per Share
Net income available to common shareholders	$	1,683	$	1,450	$	4,402	$	4,523

Weighted average common shares outstanding		3,275,841		3,289,146		3,290,610		3,287,765

Basic earnings per share	$	0.52	$	0.44	$	1.34	$	1.37

Diluted Earnings Per Share
Net income available to common shareholders	$	1,683	$	1,450	$	4,402	$	4,523

Weighted average common shares outstanding		3,275,841		3,289,146		3,290,610		3,287,765
Plus dilutive stock options and restricted stock units		3,949		6,686		4,171		6,841

Weighted average common shares outstanding and potentially dilutive shares		3,279,790		3,295,832		3,294,781		3,294,606

Diluted earnings per share	$	0.52	$	0.44	$	1.34	$	1.37

There were 30,000 stock options as of September 30, 2016 and zero stock options as of September 30, 2015, that were considered to be anti-dilutive to earnings per share for the three-month and nine-month periods ended September 30, 2016 and 2015. These stock options have been excluded from the calculation above.

NOTE 5 – FINANCIAL INSTRUMENTS

Financial instruments as of the dates indicated were as follows:

					Quoted Prices
					in Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
(Dollars in thousands)	Carrying		Estimated		Assets		Inputs		Inputs
	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
September 30, 2016
Assets:
Cash and due from banks	$	12,644	$	12,644	$	12,644	$	—	$	—
Securities available for sale		177,444		177,444		1,318		161,598		14,528
Federal Home Loan Bank and Federal
Reserve Bank stock		3,252		3,252		—		3,252		—
Loans held for sale		2,838		2,828		—		—		2,828
Loans, net		358,327		362,465		—		—		362,465

Liabilities:
Noninterest-bearing deposits		123,609		123,609		—		123,609		—
Interest-bearing deposits		353,778		353,470		—		353,470		—
Federal funds purchased		624		624		—		624		—
Repurchase agreements		6,417		6,417		—		6,417		—
Federal Home Loan Bank advances		37,309		37,283		—		37,283		—


December 31, 2015
Assets:
Cash and due from banks	$	11,187	$	11,187	$	11,187	$	—	$	—
Securities available for sale		160,136		160,136		953		147,384		11,799
Federal Home Loan Bank and Federal
Reserve Bank stock		3,187		3,187		—		3,187		—
Loans held for sale		4,957		5,109		—		5,109		—
Loans, net		345,110		349,875		—		—		349,875

Liabilities:
Noninterest-bearing deposits		122,937		122,937		—		122,937		—
Interest-bearing deposits		351,759		353,113		—		353,113		—
Repurchase agreements		9,460		9,460		—		9,460		—
Federal Home Loan Bank advances		11,332		12,028		—		12,028		—

The estimated fair values approximate the carrying amounts for all assets and liabilities except those described later in this paragraph. The methodology for determining the estimated fair value for securities available for sale is described in Note 6. The estimated fair value for loans is based on the rates charged at September 30, 2016 and December 31, 2015 for new loans with similar maturities, applied until the loan is assumed to reprice or be paid off. The allowance for loan losses is considered to be a reasonable estimate of discount for credit quality concerns. The estimated fair values for time deposits and Federal Home Loan Bank (“FHLB”) advances are based on the rates paid at September 30, 2016 and December 31, 2015 for new deposits or FHLB advances, applied until maturity. The estimated fair values for other financial instruments and off-balance sheet loan commitments are considered nominal.

NOTE 6 – FAIR VALUE MEASUREMENTS

The following tables present information about the Bank’s assets and liabilities measured at fair value on a recurring basis and the valuation techniques used by the Bank to determine those fair values.

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the Bank has the ability to access.

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Bank’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.

There were no liabilities measured at fair value as of September 30, 2016 or December 31, 2015. Disclosures concerning assets measured at fair value are as follows:

Assets Measured at Fair Value on a Recurring Basis


(Dollars in thousands)	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at Date Indicated
Investment Securities, Available for Sale – September 30, 2016
U.S. Treasury notes and bonds	$	—	$	2,116	$	—	$	2,116
U.S. Government and federal agency		—		64,804		—		64,804
State and municipal		—		77,885		12,629		90,514
Mortgage-backed		—		8,559		—		8,559
Corporate		—		7,034		399		7,433
Foreign debt		—		1,002		—		1,002
Equity securities		1,318		—		1,500		2,818
Asset backed securities		—		198		—		198
Total	$	1,318	$	161,598	$	14,528	$	177,444

Investment Securities, Available for Sale - December 31, 2015
U.S. Treasury notes and bonds	$	—	$	6,100	$	—	$	6,100
U.S. Government and federal agency		—		57,207		—		57,207
State and municipal		—		67,852		9,902		77,754
Mortgage-backed		—		6,970		—		6,970
Corporate		—		7,990		397		8,387
Foreign debt		—		995		—		995
Equity securities		953		—		1,500		2,453
Asset backed securities		—		270		—		270
Total	$	953	$	147,384	$	11,799	$	160,136

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


(Dollars in thousands)	2016		2015
Investment Securities, Available for Sale
Balance, January 1	$	11,799	$	11,642
Total realized and unrealized gains included in income		—		—
Total unrealized gains (losses) included in other comprehensive income		131		946
Net purchases, sales, calls, and maturities		2,598		(2,075	)
Net transfers into Level 3		—		—
Balance, September 30	$	14,528	$	10,513

Of the Level 3 assets that were held by the Bank at September 30, 2016, the net unrealized gain for the nine months ended September 30, 2016 was $131,000, which is recognized in other comprehensive income in the consolidated balance sheet. Purchases of Level 3 securities during the first three quarters of 2016 and 2015 consisted of local municipal issues. During the first nine months of 2016, $5.1 million of Level 3 securities were purchased. There were no sales of Level 3 securities in the first nine months of 2016.

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

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

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

Assets Measured at Fair Value on a Non-recurring Basis

			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for Identical		Observable		Unobservable
	Balance at		Assets		Inputs		Inputs
(Dollars in thousands)	Dates Indicated		(Level 1)		(Level 2)		(Level 3)
Impaired Loans
September 30, 2016	$	5,578	$	—	$	—	$	5,578
December 31, 2015	$	5,585	$	—	$	—	$	5,585

Other Real Estate
September 30, 2016	$	483	$	—	$	—	$	483
December 31, 2015	$	31	$	—	$	—	$	31

Impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. The Bank estimates the fair value of the loans based on the present value of expected future cash flows using management’s estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals). The changes in fair value consisted of charge-downs of impaired loans that were posted to the allowance for loan losses and write-downs of other real estate that were posted to a valuation account.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion is designed to provide a review of the consolidated financial condition and results of operations of ChoiceOne Financial Services, Inc. (“ChoiceOne”) and its wholly-owned subsidiary, ChoiceOne Bank (the “Bank”), and the Bank’s wholly-owned subsidiary, ChoiceOne Insurance Agencies, Inc. This discussion should be read in conjunction with the interim consolidated financial statements and related notes.

FORWARD-LOOKING STATEMENTS

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

Risk factors include, but are not limited to, the risk factors discussed in Item 1A of ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2015. These are representative of the risk factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.

RESULTS OF OPERATIONS

Summary

Net income for the third quarter of 2016 was $1,683,000, which represented an increase of $233,000 or 16.1% compared to the same period in 2015. Net income for the first nine months of 2016 was $4,402,000, which represented a decrease of $121,000 or 2.7% compared to the same period in 2015. Increases in net interest income and noninterest income were partially offset by an increase in noninterest expense for the third quarter of 2016 compared to the third quarter of 2015. Basic earnings per common share were $0.52 for the third quarter and $1.34 for the first nine months of 2016, compared to $0.44 and $1.37, respectively, for the same periods in 2015. Diluted earnings per common share were the same during the time periods noted. The return on average assets and return on average shareholders’ equity percentages were 1.01% and 8.15%, respectively, for the first three quarters of 2016, compared to 1.10% and 8.86%, respectively, for the same periods in 2015.

Dividends

Cash dividends of $551,000 or $0.17 per share were declared in the third quarter of 2016, compared to $559,000 or $0.17 per share in the third quarter of 2015. The cash dividends declared in the first nine months of 2016 were $1,674,000 or $0.51 per share, compared to $1,610,000 or $0.49 per share declared in the same period in 2015. The cash dividend payout percentage was 38.0% for the first nine months of 2016 and 35.6% for the first nine months of 2015.

Interest Income and Expense

Tables 1 and 2 on the following pages provide information regarding interest income and expense for the nine-month periods ended September 30, 2016 and 2015. 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

	Nine Months Ended September 30,
	2016								2015
(Dollars in thousands)	Average Balance		Interest			Rate			Average Balance		Interest			Rate
Assets:
Loans (1)	$	355,281	$	12,301			4.62	%	$	339,157	$	11,953			4.70	%
Taxable securities (2) (3)		117,635		1,731			1.96			101,884		1,427			1.87
Nontaxable securities (1) (2)		53,685		1,643			4.08			49,513		1,613			4.34
Other		3,915		14			0.48			5,857		10			0.23
Interest-earning assets		530,516		15,689			3.94			496,411		15,003			4.03
Noninterest-earning assets		53,913								51,820
Total assets	$	584,429							$	548,231

Liabilities and Shareholders’ Equity:
Interest-bearing demand deposits	$	193,675		190			0.13	%	$	159,342		163			0.14	%
Savings deposits		72,619		16			0.03			67,351		19			0.04
Certificates of deposit		86,707		393			0.60			96,343		481			0.67
Advances from Federal Home Loan Bank		25,127		119			0.63			21,023		64			0.41
Other		8,698		7			0.11			21,475		28			0.17
Interest-bearing liabilities		386,826		725			0.25			365,534		755			0.28
Noninterest-bearing demand deposits		122,641								112,737
Other noninterest-bearing liabilities		2,945								1,932
Total liabilities		512,412								480,203
Shareholders’ equity		72,017								68,028
Total liabilities and shareholders’ equity	$	584,429							$	548,231

Net interest income (tax-equivalent basis)-interest spread (Non-GAAP)				14,964			3.69	%				14,248			3.75	%
Tax-equivalent adjustment (1)				(563	)							(554	)
Net interest income (GAAP)			$	14,401							$	13,694
Net interest income as a percentage of earning assets (tax-equivalent basis) (Non-GAAP)							3.76	%							3.83	%

	(1)	Adjusted to a fully tax-equivalent basis to facilitate comparison to the taxable interest-earning assets. The adjustment uses an incremental tax rate of 34% for the periods presented.
	(2)	Includes the effect of unrealized gains or losses on securities.
	(3)	Taxable securities include dividend income from Federal Home Loan Bank and Federal Reserve Bank stock.

Table 2 – Changes in Tax-Equivalent Net Interest Income

	Nine Months Ended September 30,
(Dollars in thousands)	2016 Over 2015
	Total			Volume			Rate
Increase (decrease) in interest income (1)
Loans (2)	$	348		$	666		$	(318	)
Taxable securities		304			231			73
Nontaxable securities (2)		30			168			(138	)
Other		4			(6	)		10
Net change in tax-equivalent interest income		686			1,059			(373	)

Increase (decrease) in interest expense (1)
Interest-bearing demand deposits		27			43			(16	)
Savings deposits		(3	)		3			(6	)
Certificates of deposit		(88	)		(44	)		(44	)
Advances from Federal Home Loan Bank		55			15			40
Other		(21	)		(13	)		(8	)
Net change in interest expense		(30	)		4			(34	)
Net change in tax-equivalent net interest income	$	716		$	1,055		$	(339	)

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

Net Interest Income

For the nine months ended September 30, 2016 and 2015, net interest income was $14,401,000 and $13,694,000, respectively, and net interest income on a tax-equivalent basis was $14,964,000 and $14,248,000, respectively.

The presentation of net interest income on a tax-equivalent basis is not in accordance with generally accepted accounting principles (“GAAP”), but is customary in the banking industry. This non-GAAP measure ensures comparability of net interest income arising from both taxable and tax-exempt loans and investment securities. The adjustments to determine net interest income on a tax-equivalent basis were $563,000 and $554,000 for the nine months ended September 30, 2016 and 2015, respectively. These adjustments were computed using a 34% federal income tax rate. For a reconciliation of net interest income on a tax-equivalent basis, Table 1 - Average Balances and Tax-Equivalent Interest Rates.

As shown in Tables 1 and 2, tax-equivalent net interest income increased $716,000 in the first nine months of 2016 compared to the same period in 2015. The relationship between growth in average interest-earning assets and average interest-bearing liabilities caused net interest income to increase $1,055,000 in the first three quarters of 2016 compared to the same period in the prior year. A decrease of 6 basis points in the net interest spread from 3.75% in the first nine months of 2015 to 3.69% in the first nine months of 2016 resulted in a $339,000 decrease in net interest income.

The average balance of loans increased $16.1 million in the first nine months of 2016 compared to the same period in 2015. Average commercial loans increased $11.9 million and average residential mortgage loans increased $3.9 million in the first three quarters of 2016 compared to the same period in 2015. The average interest rate earned on loans declined 8 basis points from the first nine months of 2015 to the same period in 2016. This was the result of existing loan renewals and new loan production at lower rates than in the existing portfolio. The increase in the average loans balance partially offset by the decrease in the average rate earned caused tax-equivalent interest income from loans to increase $348,000 in the first three quarters of 2016 compared to the same period in the prior year. The average balance of total securities grew $19.9 million in the first nine months of 2016 compared to the same period in 2015. Additional securities were purchased during the first nine months of 2016 to provide earning asset growth. Growth in average securities, partially offset by the effect of a 5 basis point decline in interest rates earned caused tax-equivalent interest income to increase $334,000 in the first nine months of 2016 compared to the same period in 2015.

The average balance of interest-bearing demand deposits increased $34.3 million in the first nine months of 2016 compared to the same period in 2015. The effect of the higher average balance, offset by a 1 basis point decline in the average rate paid, caused interest expense to increase $27,000 in the first three quarters of 2016 compared to the same period in 2015. The average balance of savings deposits increased $5.3 million in the first nine months of 2016 compared to the same period in the prior year. The impact of the savings deposit growth offset by a 1 basis point decrease in the average rate paid caused interest expense to decrease $3,000 in the first nine months of 2016 compared to the same period in 2015. The average balance of certificates of deposit was down $9.6 million in the first nine months of 2016 compared to the same period in 2015. The decline in certificates of deposit plus a 7 basis point reduction in the average rate paid on certificates caused interest expense to fall $88,000 in the first nine months of 2016 compared to the same period in 2015. A $4.1 million increase in the average balance and a 22 basis point increase in the average rate paid caused interest expense from Federal Home Loan Bank advances to increase $55,000 in the first nine months of 2016 compared to the same period in the prior year. A decrease of $12.8 million in the average balance of other interest-bearing liabilities in the first nine months of 2016 compared to the first nine months of 2015 and the effect of a 6 basis point decrease in the average rate paid caused a $21,000 decrease in other interest expense.

The reduction in the average rate earned on interest-earning assets was caused by relatively low general market rates which affected new loan originations and securities purchases in the first nine months of 2016. Interest rates on loans are also being impacted by rate pressure from some of ChoiceOne’s competing financial institutions. The lower rate paid on interest-bearing liabilities resulted from repricing of local deposits as general market interest rates remained low during 2015 and the first nine months of 2016. If market interest rates continue to remain low, ChoiceOne’s net interest spread may continue to decrease in future quarters.

Provision and Allowance for Loan Losses

Total loans increased $13.3 million while the allowance for loan losses increased $82,000 from December 31, 2015 to September 30, 2016. The provision for loan losses was $0 in the third quarter and first nine months of 2016, compared to $0 and $100,000, respectively, in the same periods in 2015. Nonperforming loans were $5.6 million as of September 30, 2016, compared to $6.0 million as of June 30, 2016 and $5.5 million as of December 31, 2015. The allowance for loan losses was 1.18% of total loans at September 30, 2016, compared to 1.20% at June 30, 2016 and 1.20% at December 31, 2015.

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

(Dollars in thousands)	2016				2015
		Charge-offs		Recoveries		Charge-offs		Recoveries
Agricultural	$	—	$	—	$	—	$	1
Commercial and industrial		33		31		—		59
Consumer		136		119		172		104
Real estate, commercial		—		35		—		36
Real estate, residential		94		160		46		62
	$	263	$	345	$	218	$	262

Net charge-offs were $20,000 in the third quarter of 2016 and net recoveries of $82,000 were experienced in the first nine months of 2016, compared to net charge-offs of $35,000 in the third quarter of 2015 and net recoveries of $44,000 in the first nine months of 2015. Management is aware that the economic climate in Michigan will continue to affect business and personal borrowers. Management has worked and intends to continue to work with delinquent borrowers in an attempt to lessen the negative impact to ChoiceOne. As charge-offs, changes in the level of nonperforming loans, and changes within the composition of the loan portfolio occur in the remainder of 2016, the provision and allowance for loan losses will be reviewed by the Bank’s management and adjusted as believed to be necessary.

Noninterest Income

Total noninterest income increased $105,000 in the third quarter of 2016 and decreased $145,000 in the first nine months of 2016 compared to the same periods in 2015. A decrease in customer service charges of $62,000 in the third quarter and $117,000 in the first nine months of 2016 compared to the same periods in the prior year was due to lower overdraft fees and fees from deposit account charges. Insurance and investment commissions increased $71,000 in the third quarter of 2016, but have decreased $112,000 in the first three quarters of 2016 compared to the same periods in 2015. The decline in the first nine months of 2016 was caused by lower commissions from sales of real estate investment trusts. Gains on loan sales increased $200,000 in the third quarter and $225,000 in the first nine months of 2016 compared to the same periods in 2015. While residential mortgage refinancing activity has slowed in 2016, purchase activity has increased which has caused the increase. A decrease of $127,000 in the third quarter and an increase of $47,000 in the first nine months of 2016 in gains on sales of securities when compared to the same periods in 2015 resulted from less sales activity in the third quarter of 2016 than in the same period of the prior year. A death benefit of $308,000 received on a bank owned life insurance policy in the first quarter of 2015 caused a decrease in earnings on life insurance policies in the first three quarters of 2016 compared to the same period in 2015.

Noninterest Expense

Total noninterest expense increased $67,000 in the third quarter of 2016 and $721,000 in the first nine months of 2016 compared to the same periods in 2015. The increase of $219,000 in salaries and benefits in the third quarter of 2016 and $684,000 in the first nine months of 2016 compared to the same periods in 2015 resulted in part from higher salaries driven by the new loan production office and stock compensation expense. Professional fees decreased $31,000 in the third quarter of 2016 and $76,000 in the first three quarters of 2016 compared to the same periods in 2015 because of decreased consulting fees.

Income Tax Expense

Income tax expense was $1,591,000 in the first nine months of 2016 compared to $1,529,000 for the same period in 2015. The effective tax rate was 26.5% and 25.3%, respectively, for the first nine months of 2016 and 2015. The increase in the effective tax rate in 2016 compared to 2015 was due to the effect of a $308,000 nontaxable death benefit received in the first quarter of 2015 from a bank owned life insurance policy.

FINANCIAL CONDITION

Securities

The securities available for sale portfolio increased $2.3 million in the third quarter of 2016 and $17.3 million in the first nine months of 2016. Various securities totaling $63.8 million were purchased in the first nine months of 2016 to provide earning assets and to replace maturities, principal repayments, and calls within the securities portfolio. Approximately $31.6 million in various securities were called or matured since the end of 2015. Principal repayments on securities totaled $1.8 million in the first nine months of 2016. Approximately $14.5 million of securities were sold in the first three quarters of 2016 for a net gain of $255,000.

Loans

The loan portfolio (excluding loans held for sale) increased $5.4 million in the third quarter of 2016 and increased $13.3 million in the first nine months of 2016. Agricultural loans increased $3.6 million in the third quarter, but declined $2.0 million in the first nine months of 2016. Commercial and industrial loans declined $2.1 million in the third quarter of 2016 but grew $1.3 million in the first three quarters of 2016. Consumer loans increased $544,000 and $1.4 million, respectively, in the third quarter and first nine months of 2016. Commercial real estate loans increased $2.8 million in the third quarter and $11.3 in the first three quarters of 2016. Residential real estate loans declined $683,000 and grew $598 in the third quarter and first nine months of 2016, respectively. The environment for loan originations in ChoiceOne’s market area has become increasingly competitive.

Asset Quality

Information regarding impaired loans can be found in Note 3 to the interim consolidated financial statements included in this report. The total balance of loans classified as impaired was $5.6 million at September 30, 2016, $6.0 million as of June 30, 2016 and $5.5 million as of December 31, 2015. The balance of commercial real estate loans classified as impaired has declined $1.3 million in the first nine months of 2016. This decline is offset by increases in impaired loans in the other loan categories.

As part of its review of the loan portfolio, management also monitors the various nonperforming loans. Nonperforming loans are comprised of: (1) loans accounted for on a nonaccrual basis; (2) loans, not included in nonaccrual loans, which are contractually past due 90 days or more as to interest or principal payments; and (3) loans, not included in nonaccrual or loans past due 90 days or more, which are considered troubled debt restructurings.

The balances of these nonperforming loans were as follows:

(Dollars in thousands)	September 30,		December 31,
	2016		2015
Loans accounted for on a nonaccrual basis	$	1,735	$	2,198

Accruing loans contractually past due 90 days or more as to principal or interest payments		351		29
Loans considered troubled debt restructurings		3,476		3,271
Total	$	5,562	$	5,498

At September 30, 2016, nonaccrual loans included $489,000 in agricultural loans, $320,000 in commercial and industrial loans, $471,000 in commercial real estate loans, and $454,000 in residential real estate loans. At December 31, 2015, nonaccrual loans included $50,000 in agricultural loans, $77,000 in commercial and industrial loans, $1.6 million in commercial real estate loans, and $431,000 in residential real estate loans. The decrease in nonaccrual loans was primarily due to credits paid off during the first nine months of 2016. Management believes the allowance allocated to its nonperforming loans was sufficient at September 30, 2016.

Deposits and Borrowings

Total deposits increased $13.6 million in the third quarter of 2016 and increased $2.7 million since the end of 2015. Checking and savings deposits increased $15.2 million in the third quarter of 2016 and $0.7 million in the first nine months of 2016. Money market deposits increased $1.4 million in the third quarter of 2016 and increased $5.6 million in the first nine months of 2016. Local certificates of deposit decreased $3.0 million in the third quarter of 2016 and $3.6 million in the first nine months of 2016. ChoiceOne continued to place an emphasis on building its core deposits base in 2016.

An increase in federal funds purchased of $624,000 since December 31, 2015 was used to fund short term liquidity needs of the Bank. Repurchase agreements have declined by $3.0 million in the first nine months of 2016 due to normal fluctuations in funds provided by bank customers. Management plans to continue this practice as a low-cost source of funding. Federal Home Loan Bank advances increased $26.0 million in the first nine months of 2016 to fund both loans and growth in the securities portfolio.

Shareholders’ Equity

Total shareholders’ equity increased $3.7 million from December 31, 2015 to September 30, 2016. Growth in equity resulted from current year’s net income, proceeds from the issuance of ChoiceOne stock and an increase in accumulated other comprehensive income offset by cash dividends paid and repurchases of shares. The $1.3 million increase in accumulated other comprehensive income since the end of 2015 was caused by an increase in net unrealized gains on available for sale securities. The change in unrealized gains resulted from decreases in mid- and short-term rates in 2016, which increased the market value of the Bank’s securities.

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

									Minimum Required
									to be Well
					Minimum Required				Capitalized Under
					for Capital				Prompt Corrective
(Dollars in thousands)	Actual				Adequacy Purposes				Action Regulations
		Amount	Ratio			Amount	Ratio			Amount	Ratio
September 30, 2016
ChoiceOne Financial Services, Inc.
Total capital (to risk weighted assets)	$	61,573	14.3	%	$	34,436	8.0	%		N/A	N/A
Tier 1 capital (to risk weighted assets)		57,323	13.3			17,218	6.0			N/A	N/A
Common Equity Tier 1 Capital (to risk weighted assets)		57,323	13.3			19,370	4.5			N/A	N/A
Tier 1 capital (to average assets)		57,323	9.9			23,129	4.0			N/A	N/A

ChoiceOne Bank
Total capital (to risk weighted assets)	$	57,952	13.5	%	$	34,376	8.0	%	$	42,970	10.0	%
Tier 1 capital (to risk weighted assets)		53,702	12.5			17,188	6.0			25,782	8.0
Common Equity Tier 1 Capital (to risk weighted assets)		53,702	12.5			19,337	4.5			27,931	6.5
Tier 1 capital (to average assets)		53,702	9.3			23,003	4.0			28,754	5.0

December 31, 2015
ChoiceOne Financial Services, Inc.
Total capital (to risk weighted assets)	$	59,737	14.2	%	$	33,600	8.0	%		N/A	N/A
Tier 1 capital (to risk weighted assets)		54,532	13.0			16,800	4.0			N/A	N/A
Tier 1 capital (to average assets)		54,532	9.7			22,434	4.0			N/A	N/A

ChoiceOne Bank
Total capital (to risk weighted assets)	$	55,723	13.3	%	$	33,470	8.0	%	$	41,837	10.0	%
Tier 1 capital (to risk weighted assets)		51,574	13.0			16,800	4.0			25,102	6.0
Tier 1 capital (to average assets)		51,574	9.7			22,434	4.0			27,937	5.0

Management reviews the capital levels of ChoiceOne and the Bank on a regular basis. The Board of Directors (the “Board”) and management believe that the capital levels as of September 30, 2016 are adequate for the foreseeable future. The Board’s determination of appropriate cash dividends for future periods will be based on, among other things, market conditions and ChoiceOne’s requirements for cash and capital.

Liquidity

Net cash provided from operating activities was $8.2 million for the nine months ended September 30, 2016 compared to $4.8 million provided in the same period a year ago. Higher proceeds from loan sales were partially offset by a higher balance of loans originated for sale. Net cash used in investing activities was $30.6 million for the first nine months of 2016 compared to $9.5 million in the same period in 2015. The change was due to additional net securities purchases offset by security sales and maturities and due to a higher level of loan growth than in the prior year. Net cash provided from financing activities was $23.9 million in the nine months ended September 30, 2016, compared to $0.4 million in the same period in the prior year. A decline in the level of deposit growth in the first nine months of 2016 compared to the same period in 2015 was offset by a smaller decrease in the balance of repurchase agreements in 2016 than in 2015 and growth in Federal Home Loan Bank advances in 2016 in contrast with a decline in the prior year.

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

Item 4. Controls and Procedures.

An evaluation was performed under the supervision and with the participation of ChoiceOne’s management, including the Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of ChoiceOne’s disclosure controls and procedures. Based on and as of the time of that evaluation, ChoiceOne’s management, including the Chief Executive Officer and Principal Financial Officer, concluded that ChoiceOne’s disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that material information required to be disclosed in the reports that ChoiceOne files or submits under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that ChoiceOne files or submits under the Exchange Act is accumulated and communicated to management, including ChoiceOne’s principal executive and principal financial officers, as appropriate to allow for timely decisions regarding required disclosure. There was no change in ChoiceOne’s internal control over financial reporting that occurred during the three months ended September 30, 2016 that has materially affected, or that is reasonably likely to materially affect, ChoiceOne’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

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

Item 1A. Risk Factors.

Information concerning risk factors is contained in the discussion in Item 1A, “Risk Factors,” in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2015.

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

On July 26, 2016 ChoiceOne issued 808 shares of common stock, without par value, to the directors of ChoiceOne pursuant to the Directors’ Stock Purchase Plan for an aggregate cash price of $19,000. ChoiceOne relied on the exemption contained in Section 4(a)(5) of the Securities Act of 1933 in connection with these sales.

ISSUER PURCHASES OF EQUITY SECURITIES

The following table provides information regarding ChoiceOne’s purchases of its common stock during the quarter ended September 30, 2016.

					Total Number		Maximum
					of Shares		Number of
					Purchased as		Shares that
(Dollars in thousands, except per share data)	Total Number		Average		Part of a		May Yet be
	of Shares		Price Paid		Publicly		Purchased
Period	Purchased		per Share		Announced Plan		Under the Plan

July 1 - July 31, 2016
Employee Transactions (1)		258	$	23.10
Repurchase Plan		—	$	—		—		29,224
August 1 - August 31, 2016
Employee Transactions (1)		259	$	23.74
Repurchase Plan (2)		5,000	$	23.25		5,000		24,224
September 1 - September 30, 2016
Employee Transactions		—	$	—
Repurchase Plan		—	$	—		—		24,224

(1)

Shares submitted for cancellation to satisfy tax withholding obligations that occur upon the vesting of restricted units. The value of the shares delivered or withheld is determined by the applicable stock compensation plan.

(2)

On August 10, 2016, ChoiceOne purchased 5,000 shares of common stock for an aggregate cash price of $116,000. As of September 30, 2016, there are 24,224 shares remaining that may yet be purchased under approved plans. The repurchase plan was adopted and announced on July 26, 2007. There is no stated expiration date. The plan authorized the repurchase of up to 100,000 shares.

Item 6. Exhibits

The following exhibits are filed or incorporated by reference as part of this report:

Exhibit Number		Document

3.1	Amended and Restated Articles of Incorporation of ChoiceOne. Previously filed as an exhibit to ChoiceOne’s Form 10-K Annual Report for the year ended December 31, 2013. Here incorporated by reference.

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

31.1	Certification of Chief Executive Officer

31.2	Certification of Treasurer

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

101.1	Interactive Data File.

SIGNATURES

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

	CHOICEONE FINANCIAL SERVICES, INC.

Date: November 14, 2016	/s/ Kelly Potes
	Kelly Potes Chief Executive Officer (Principal Executive Officer)

Date: November 14, 2016	/s/ Thomas L. Lampen
	Thomas L. Lampen Treasurer (Principal Financial and Accounting Officer)