CHOICEONE FINANCIAL SERVICES INC - Quarter Report: 2017 June (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 June 30, 2017

☐	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 ☒

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.

Yes ☐ No ☐

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 July 31, 2017, the Registrant had outstanding 3,453,063 shares of common stock.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

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

	June 30,			December 31,
(Dollars in thousands)	2017			2016
	(Unaudited)			(Audited)
Assets
Cash and due from banks	$	17,050		$	14,809

Securities available for sale (Note 2)		180,448			174,388
Federal Home Loan Bank stock		1,994			1,994
Federal Reserve Bank stock		1,573			1,573

Loans held for sale		1,990			1,974
Loans to other financial institutions		4,162			—
Loans (Note 3)		379,448			369,000
Allowance for loan losses (Note 3)		(4,098	)		(4,277	)
Loans, net		375,350			364,723

Premises and equipment, net		12,473			12,588
Cash value of life insurance policies		14,315			14,117
Goodwill		13,728			13,728
Other assets		6,984			7,477
Total assets	$	630,067		$	607,371

Liabilities
Deposits – noninterest-bearing	$	133,956		$	127,611
Deposits – interest-bearing		390,388			384,775
Total deposits		524,344			512,386

Repurchase agreements		2,302			7,913
Advances from Federal Home Loan Bank		24,284			12,301
Other liabilities		3,609			3,073
Total liabilities		554,539			535,673

Shareholders’ Equity
Common stock and paid in capital, no par value; shares authorized: 7,000,000; shares outstanding: 3,452,354 at June 30, 2017 and 3,277,944 at December 31, 2016		50,295			46,299
Retained earnings		24,148			25,997
Accumulated other comprehensive income (loss), net		1,085			(598	)
Total shareholders’ equity		75,528			71,698
Total liabilities and shareholders’ equity	$	630,067		$	607,371

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 June 30,				Six Months Ended June 30,
	2017		2016		2017		2016
Interest income
Loans, including fees	$	4,401	$	4,087	$	8,565	$	8,083
Securities:
Taxable		663		584		1,284		1,137
Tax exempt		352		363		713		729
Other		9		3		24		9
Total interest income		5,425		5,037		10,586		9,958

Interest expense
Deposits		292		199		540		408
Advances from Federal Home Loan Bank		52		45		107		75
Other		4		3		7		5
Total interest expense		348		247		654		488

Net interest income		5,077		4,790		9,932		9,470
Provision for loan losses		25		—		25		—

Net interest income after provision for loan losses		5,052		4,790		9,907		9,470

Noninterest income
Customer service charges		1,049		1,030		2,023		1,990
Insurance and investment commissions		262		226		500		449
Gains on sales of loans		341		419		565		838
Gains on sales of securities		60		156		126		226
(Losses) gains on sales and write-downs of other assets		4		—		4		(23	)
Earnings on life insurance policies		99		89		198		177
Other		127		131		258		236
Total noninterest income		1,942		2,051		3,674		3,893

Noninterest expense
Salaries and benefits		2,591		2,565		5,106		4,976
Occupancy and equipment		689		692		1,397		1,333
Data processing		554		539		1,130		1,098
Professional fees		262		232		491		468
Supplies and postage		90		95		191		220
Advertising and promotional		73		89		127		132
Intangible amortization		—		112		—		224
FDIC insurance		46		73		100		140
Other		474		504		906		1,107
Total noninterest expense		4,779		4,901		9,448		9,698

Income before income tax		2,214		1,940		4,133		3,665
Income tax expense		580		495		1,052		947

Net income	$	1,635	$	1,445	$	3,081	$	2,719

Basic earnings per share (Note 4)	$	0.47	$	0.41	$	0.89	$	0.78
Diluted earnings per share (Note 4)	$	0.47	$	0.41	$	0.89	$	0.78
Dividends declared per share	$	0.17	$	0.16	$	0.33	$	0.32

See accompanying notes to interim consolidated financial statements.

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

(Dollars in thousands)	Three Months Ended June 30,						Six Months Ended June 30,
	2017			2016			2017			2016
Net income	$	1,635		$	1,445		$	3,081		$	2,719

Other comprehensive income:

Changes in net unrealized gains on investment securities available for sale, net of tax expense of $557 and $347 for the three months ended June 30, 2017 and June 30, 2016 respectively. Changes in net unrealized gains on investment securities available for sale, net of tax expense of $910 and $712 for the six months ended June 30, 2017 and June 30, 2016 respectively.		1,082			673			1,766			1,382

Less: Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax benefit of $21 and $53 for the three months ended June 30, 2017 and June 30, 2016 respectively. Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax benefit of $43 and $77 for the six months ended June 30, 2017 and June 30, 2016 respectively.		(39	)		(103	)		(83	)		(149	)

Other comprehensive income, net of tax		1,043			570			1,683			1,233

Comprehensive income	$	2,677		$	2,015		$	4,764		$	3,952

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 (Loss), Net			Total

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

Net income								2,719						2,719
Other comprehensive income											1,233			1,233
Shares issued		7,142			130									130
Shares repurchased		(30,000	)		(678	)								(678	)
Change in ESOP repurchase obligation					127									127
Effect of employee stock purchases					6									6
Restricted stock units issued		3,482			141									141
Cash dividends declared ($0.32 per share)								(1,123	)					(1,123	)

Balance, June 30, 2016		3,275,852		$	46,227		$	23,734		$	2,436		$	72,397

Balance, January 1, 2017		3,277,944		$	46,299		$	25,997		$	(598	)	$	71,698

Net income								3,081						3,081
Other comprehensive income											1,683			1,683
Shares issued		5,318			82									82
Effect of employee stock purchases					6									6
Stock options exercised		1,000			13									13
Stock-based compensation expense					116									116
Restricted stock units issued		4,104			—									—
Stock dividend declared (5%)		163,988			3,779			(3,779	)					—
Cash dividends declared ($0.33 per share)								(1,152	)					(1,152	)

Balance, June 30, 2017		3,452,354		$	50,295		$	24,148		$	1,085		$	75,528

See accompanying notes to interim consolidated financial statements.

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

(Dollars in thousands)	Six Months Ended June 30,

	2017			2016
Cash flows from operating activities:
Net income	$	3,081		$	2,719
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		25			—
Depreciation		643			481
Amortization		549			799
Compensation expense on stock purchases and restricted stock units		163			147
Gains on sales of securities		(126	)		(226	)
Gains on sales of loans		(565	)		(838	)
Loans originated for sale		(14,456	)		(22,737	)
Proceeds from loan sales		14,180			25,633
Earnings on bank-owned life insurance		(198	)		(177	)
Gains on sales of other real estate owned		—			3
Proceeds from sales of other real estate owned		172			28
Deferred federal income tax expense/(benefit)		138			(86	)
Net changes in other assets		309			25
Net changes in other liabilities		(468	)		670
Net cash from operating activities		3,447			6,441

Cash flows from investing activities:
Securities available for sale:
Sales		12,520			11,157
Maturities, prepayments and calls		8,011			22,835
Purchases		(24,301	)		(47,375	)
Loan originations and payments, net		(14,378	)		(7,849	)
Additions to premises and equipment		(291	)		(288	)
Net cash from investing activities		(18,439	)		(21,520	)

Cash flows from financing activities:
Net change in deposits		11,958			(10,875	)
Net change in repurchase agreements		(5,611	)		(4,081	)
Proceeds from Federal Home Loan Bank advances		117,500			202,000
Payments on Federal Home Loan Bank advances		(105,517	)		(168,015	)
Issuance of common stock		55			130
Repurchase of common stock		—			(678	)
Cash dividends		(1,152	)		(1,123	)
Net cash from financing activities		17,233			17,358

Net change in cash and cash equivalents		2,241			2,279
Beginning cash and cash equivalents		14,809			11,187

Ending cash and cash equivalents	$	17,050		$	13,466

Supplemental disclosures of cash flow information:
Cash paid for interest	$	596		$	486
Cash paid for taxes	$	800		$	100
Loans transferred to other real estate owned	$	207		$	13

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 June 30, 2017 and December 31, 2016, the Consolidated Statements of Income for the three- and six-month periods ended June 30, 2017 and June 30, 2016, the Consolidated Statements of Comprehensive Income for the three- and six-month periods ended June 30, 2017 and June 30, 2016, the Consolidated Statements of Changes in Shareholders’ Equity for the six-month periods ended June 30, 2017 and June 30, 2016, and the Consolidated Statements of Cash Flows for the six-month periods ended June 30, 2017 and June 30, 2016. Operating results for the six months ended June 30, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.

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, 2016.

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 reported assets and net income.

Stock Transactions

A total of 3,172 shares of common stock were issued to ChoiceOne’s Board of Directors for a cash price of $73,379 under the terms of the Directors’ Stock Purchase Plan in the first six months of 2017. A total of 1,000 shares of common stock were issued upon the exercise of stock options in the first half of 2017. A total of 2,146 shares of common stock were issued to employees for a cash price of $41,564 under the Employee Stock Purchase Plan in the first half of 2017. A total of 4,104 shares of common stock were issued to employees for Restricted Stock Units that vested during the first six months of 2017.

Stock-Based Compensation

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

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income or loss. Other comprehensive income or loss includes unrealized gains and losses on securities available for sale and changes in the funded status of post-retirement plans, net of tax, which are also recognized as a separate component of shareholders’ equity.

Reclassifications

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

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:

			June 30, 2017
			Gross		Gross
(Dollars in thousands)	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
U.S. Government and federal agency	$	55,202	$	38	$	(292	)	$	54,948
U.S. Treasury		4,097		7		(10	)		4,094
State and municipal		94,269		1,744		(172	)		95,841
Mortgage-backed		10,165		37		(84	)		10,118
Corporate		7,500		22		(14	)		7,508
Foreign debt		4,512		—		(57	)		4,455
Equity securities		3,083		269		—			3,352
Asset-backed securities		133		—		(1	)		132
Total	$	178,961	$	2,117	$	(630	)	$	180,448

			December 31, 2016
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
U.S. Government and federal agency	$	59,864	$	34	$	(846	)	$	59,052
U.S. Treasury		4,111		—		(39	)		4,072
State and municipal		89,169		748		(944	)		88,973
Mortgage-backed		7,925		19		(155	)		7,789
Corporate		7,069		12		(40	)		7,041
Foreign debt		4,514		—		(114	)		4,400
Equity securities		2,617		266		—			2,883
Asset-backed securities		182		—		(4	)		178
Total	$	175,451	$	1,079	$	(2,142	)	$	174,388

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 in the six months ended June 30, 2017. 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.

Presented below is a schedule of maturities of securities as of June 30, 2017, the fair value of securities as of June 30, 2017 and December 31, 2016, and the weighted average yields of securities as of June 30, 2017:


	Securities maturing within:
										Fair Value		Fair Value
		Less than		1 Year -		5 Years -		More than		at June 30,		at Dec. 31,
(Dollars in thousands)		1 Year		5 Years		10 Years		10 Years		2017		2016

U.S. Government and federal agency	$	22,353	$	30,639	$	1,956	$	—	$	54,948	$	59,052
U.S. Treasury notes and bonds		—		4,094		—		—		4,094		4,072
State and municipal		9,360		47,344		36,353		2,784		95,841		88,973
Corporate		1,800		5,206		502		—		7,508		7,041
Foreign debt securities		999		3,456		—		—		4,455		4,400
Asset-backed securities		132		—		—		—		132		178
Total debt securities		34,644		90,739		38,811		2,784		166,978		163,716

Mortgage-backed securities		—		9,435		682		—		10,117		7,789
Equity securities (2)		—		—		1,001		2,351		3,352		2,883
Total	$	34,644	$	100,174	$	40,494	$	5,135	$	180,447	$	174,388


	Weighted average yields:
	Less than			1 Year -			5 Years -			More than
	1 Year			5 Years			10 Years			10 Years			Total
U.S. Government and federal agency		1.92	%		1.56	%		1.78	%		—	%		1.71	%
U.S. Treasury notes and bonds		—			1.54			—			—			1.54
State and municipal (1)		2.93			3.11			3.45			2.00			3.19
Corporate		1.28			2.18			—			—			1.82
Foreign debt securities		1.10			1.44			—			—			1.37
Asset-backed securities		1.40			—			—			—			1.40
Mortgage-backed securities		—			2.15			2.05			—			2.14
Equity securities (2)		—			—			4.61			0.96			2.05

(1) The yield is computed for tax-exempt securities on a fully tax-equivalent basis at an incremental tax rate of 34%.

(2) Equity securities are preferred and common stock that may or may not have a stated maturity.

NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES

Activity in the allowance for loan losses and balances in the loan portfolio was 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 June 30, 2017
Beginning balance	$	406		$	745		$	286		$	1,414		$	23		$	727		$	724		$	4,325
Charge-offs		—			(352	)		(57	)		—			—			—			—			(409	)
Recoveries		—			—			39			49			40			29			—			157
Provision		(11	)		511			26			88			(39	)		(7	)		(543	)		25
Ending balance	$	395		$	904		$	294		$	1,551		$	24		$	749		$	181		$	4,098

Six Months Ended June 30, 2017
Beginning balance	$	433		$	688		$	305		$	1,438		$	62		$	1,014		$	337		$	4,277
Charge-offs		—			(362	)		(137	)		—			—			(34	)		—			(533	)
Recoveries		—			—			91			161			40			37			—			329
Provision		(38	)		578			35			(48	)		(78	)		(268	)		(156	)		25
Ending balance	$	395		$	904		$	294		$	1,551		$	24		$	749		$	181		$	4,098

Individually evaluated for impairment	$	—		$	27		$	4		$	65		$	—		$	271		$	—		$	367

Collectively evaluated for impairment	$	395		$	877		$	290		$	1,486		$	24		$	478		$	181		$	3,731

Three Months Ended June 30, 2016
Beginning balance	$	382		$	691		$	272		$	1,138		$	43		$	1,350		$	249		$	4,124
Charge-offs		—			—			(29	)		—			—			—			—			(29	)
Recoveries		—			8			28			23			—			142			—			201
Provision		18			(42	)		6			(28	)		2			(270	)		315			0
Ending balance	$	400		$	657		$	277		$	1,133		$	45		$	1,222		$	563		$	4,296

Six Months Ended June 30, 2016
Beginning balance	$	420		$	586		$	297		$	1,030		$	46		$	1,388		$	427		$	4,194
Charge-offs		—			(33	)		(68	)		—			—			(69	)		—			(170	)
Recoveries		—			23			69			31			—			149			—			272
Provision		(20	)		81			(21	)		72			(2	)		(246	)		136			0
Ending balance	$	400		$	657		$	277		$	1,133		$	45		$	1,222		$	563		$	4,296

Individually evaluated for impairment	$	11		$	11		$	1		$	177		$	—		$	364		$	—		$	564

Collectively evaluated for impairment	$	389		$	646		$	276		$	956		$	45		$	858		$	563		$	3,732

Loans June 30, 2017
Individually evaluated for impairment	$	442		$	309		$	30		$	887		$	—		$	2,715					$	4,383
Collectively evaluated for impairment		41,303			101,185			23,373			116,065			5,437			87,702						375,065
Ending balance	$	41,745		$	101,494		$	23,403		$	116,952		$	5,437		$	90,417					$	379,448

December 31, 2016
Individually evaluated for impairment	$	526		$	301		$	28		$	1,073		$	—		$	2,983					$	4,911
Collectively evaluated for impairment		44,088			95,787			21,568			109,689			6,153			86,804						364,089
Ending balance	$	44,614		$	96,088		$	21,596		$	110,762		$	6,153		$	89,787					$	369,000

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)	June 30,		December 31,		June 30,		December 31,		June 30,		December 31,
	2017		2016		2017		2016		2017		2016
Risk ratings 1 and 2	$	11,046	$	12,005	$	12,442	$	12,135	$	6,741	$	8,013
Risk rating 3		22,173		23,852		60,843		56,714		69,070		59,343
Risk rating 4		7,715		7,505		27,402		25,895		37,610		39,641
Risk rating 5		369		726		515		1,267		1,904		1,867
Risk rating 6		442		526		292		77		1,627		1,898
Risk rating 7		—		—		—		—		—		—
	$	41,745	$	44,614	$	101,494	$	96,088	$	116,952	$	110,762

Corporate Credit Exposure - Credit Risk Profile Based On Payment Activity

	Consumer				Construction Real Estate				Residential Real Estate
(Dollars in thousands)	June 30,		December 31,		June 30,		December 31,		June 30,		December 31,
	2017		2016		2017		2016		2017		2016
Performing	$	23,392	$	21,590	$	5,437	$	6,153	$	89,469	$	88,767
Nonperforming		6		—		—		—		504		229
Nonaccrual		5		6		—		—		444		791
	$	23,403	$	21,596	$	5,437	$	6,153	$	90,417	$	89,787

The following schedule provides information on loans that were considered TDRs that were modified during the three and six month periods ended June 30, 2016. There were no loans that were considered TDRs that were modified during the three and six month periods ended June 30, 2017.

	Three Months Ended June 30, 2016						Six Months Ended June 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
Commercial real estate		—	$	—	$	—	1	$	128	$	128
Residential Real Estate		2		150		150	3		179		179
Total		2	$	150	$	150	4	$	307	$	307

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.

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 as of June 30, 2017 and 2016 were as follows:

			Unpaid
(Dollars in thousands)	Recorded		Principal		Related
	Investment		Balance		Allowance
June 30, 2017
With no related allowance recorded
Agricultural	$	442	$	461	$	—
Commercial and industrial		176		176		—
Consumer		—		—		—
Commercial real estate		97		227		—
Residential real estate		173		173		—
Subtotal		888		1,037		—
With an allowance recorded
Agricultural		—		—		—
Commercial and industrial		133		374		27
Consumer		30		30		4
Commercial real estate		790		868		65
Residential real estate		2,542		2,564		271
Subtotal		3,495		3,836		367
Total
Agricultural		442		461		—
Commercial and industrial		309		550		27
Consumer		30		30		4
Commercial real estate		887		1,095		65
Residential real estate		2,715		2,737		271
Total	$	4,383	$	4,873	$	367

December 31, 2016
With no related allowance recorded
Agricultural	$	482	$	485	$	—
Commercial and industrial		206		207		—
Consumer		—		—		—
Commercial real estate		342		939		—
Residential real estate		301		292		—
Subtotal		1,331		1,923		—
With an allowance recorded
Agricultural		44		44		3
Commercial and industrial		95		95		11
Consumer		28		28		2
Commercial real estate		731		804		91
Residential real estate		2,682		2,711		296
Subtotal		3,580		3,682		403
Total
Agricultural		526		529		3
Commercial and industrial		301		302		11
Consumer		28		28		2
Commercial real estate		1,073		1,743		91
Residential real estate		2,983		3,003		296
Total	$	4,911	$	5,605	$	403

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
June 30, 2017
Agricultural	$	—	$	—	$	—	$	—	$	41,745	$	41,745	$	—
Commercial and industrial		73		—		235		308		101,186		101,494		—
Consumer		30		49		6		85		23,318		23,403		6
Commercial real estate		106		—		24		130		116,822		116,952		—
Construction real estate		—		—		—		—		5,437		5,437		—
Residential real estate		172		579		619		1,370		89,047		90,417		504
	$	381	$	628	$	884	$	1,893	$	377,555	$	379,448	$	510

December 31, 2016
Agricultural	$	—	$	—	$	—	$	—	$	44,614	$	44,614	$	—
Commercial and industrial		—		30		245		275		95,813		96,088		—
Consumer		99		2		6		107		21,489		21,596		—
Commercial real estate		—		—		260		260		110,502		110,762		—
Construction real estate		—		—		—		—		6,153		6,153		—
Residential real estate		1,027		109		646		1,782		88,005		89,787		229
	$	1,126	$	141	$	1,157	$	2,424	$	366,576	$	369,000	$	229

(1) Includes nonaccrual loans.

Nonaccrual loans by loan category follow:

(Dollars in thousands)	June 30,		December 31,
	2017		2016
Agricultural	$	442	$	482
Commercial and industrial		285		245
Consumer		5		6
Commercial real estate		250		458
Construction real estate		—		—
Residential real estate		443		792
	$	1,425	$	1,983

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				Six Months Ended
(Dollars in thousands, except per share data)	June 30,				June 30,
	2017		2016		2017		2016
Basic Earnings Per Share
Net income available to common shareholders	$	1,635	$	1,445	$	3,081	$	2,719

Weighted average common shares outstanding		3,449,800		3,464,828		3,446,409		3,462,939

Basic earnings per share	$	0.47	$	0.41	$	0.89	$	0.78

Diluted Earnings Per Share
Net income available to common shareholders	$	1,635	$	1,445	$	3,081	$	2,719

Weighted average common shares outstanding		3,449,800		3,464,828		3,446,409		3,462,939
Plus dilutive stock options and restricted stock units		4,049		5,437		3,482		5,550

Weighted average common shares outstanding and potentially dilutive shares		3,453,849		3,470,265		3,449,891		3,468,489

Diluted earnings per share	$	0.47	$	0.41	$	0.89	$	0.78

Note that 2016 share amounts have been adjusted for the 5% stock dividend occurring during 2017.

There were 31,500 stock options for the three months ended June 30, 2017 and 30,000 for the three months ended June 30, 2016 with an exercise price more than the current market price. These stock options have been excluded from the calculation of diluted earnings above. There were 47,250 stock options for the six months ended June 30, 2017 and 30,000 for the six months ended June 30, 2016 with an exercise price more than the current market price. These stock options have been excluded from the calculation of diluted earnings 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)
June 30, 2017
Assets:
Cash and due from banks	$	17,050	$	17,050	$	17,050	$	—	$	—
Securities available for sale		180,448		180,448		1,852		163,738		14,858

Federal Home Loan Bank and Federal Reserve Bank stock		3,567		3,567		—		3,567		—
Loans held for sale		1,990		2,051		—		—		2,051
Loans to other financial institutions		4,162		4,162						4,162
Loans, net		375,350		382,827		—		—		382,827

Liabilities:
Noninterest-bearing deposits		133,956		133,956		—		133,956		—
Interest-bearing deposits		390,388		389,473		—		389,473		—
Repurchase agreements		2,302		2,302		—		2,302		—
Federal Home Loan Bank advances		24,284		24,308		—		24,308		—

December 31, 2016
Assets:
Cash and due from banks	$	14,809	$	14,809	$	14,809	$	—	$	—
Securities available for sale		174,388		174,388		1,383		157,902		15,103
Federal Home Loan Bank and Federal Reserve Bank stock		3,567		3,567		—		3,567		—
Loans held for sale		1,974		2,044		—		2,044		—
Loans, net		364,723		365,780		—		—		365,780

Liabilities:
Noninterest-bearing deposits		127,611		127,611		—		127,611		—
Interest-bearing deposits		384,775		383,879		—		383,879		—
Repurchase agreements		7,913		7,913		—		7,913		—
Federal Home Loan Bank advances		12,301		12,323		—		12,323		—

The estimated fair values approximate the carrying amounts for all financial instruments 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 June 30, 2017 and December 31, 2016 for new loans with similar maturities, applied until the loan is assumed to reprice or be paid. The allowance for loan losses is considered to be a reasonable estimate of discount for credit quality concerns. The estimated fair values for time deposits and Federal Home Loan Bank (“FHLB”) advances are based on the rates paid at June 30, 2017 and December 31, 2016 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 June 30, 2017 or December 31, 2016. 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 – June 30, 2017
U.S. Treasury notes and bonds	$	—	$	4,094	$	—	$	4,094
U.S. Government and federal agency		—		54,948		—		54,948
State and municipal		—		82,483		13,358		95,841
Mortgage-backed		—		10,118		—		10,118
Corporate		—		7,508		—		7,508
Foreign debt		—		4,455		—		4,455
Equity securities		1,852		—		1,500		3,352
Asset backed securities		—		132		—		132
Total	$	1,852	$	163,738	$	14,858	$	180,448

Investment Securities, Available for Sale - December 31, 2016
U.S. Treasury notes and bonds	$	—	$	4,072	$	—	$	4,072
U.S. Government and federal agency		—		59,052		—		59,052
State and municipal		—		75,370		13,603		88,973
Mortgage-backed		—		7,789		—		7,789
Corporate		—		7,041		—		7,041
Foreign debt		—		4,400		—		4,400
Equity securities		1,383		—		1,500		2,883
Asset backed securities		—		178		—		178
Total	$	1,383	$	157,902	$	15,103	$	174,388

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

(Dollars in thousands)
	2017			2016
Investment Securities, Available for Sale
Balance, January 1	$	15,103		$	11,799
Total realized and unrealized gains included in income		—			—
Total unrealized gains (losses) included in other comprehensive income		162			(187	)
Net purchases, sales, calls, and maturities		(407	)		387
Net transfers into Level 3		—			—
Balance, June 30	$	14,858		$	11,999

Of the Level 3 assets that were held by the Bank at June 30, 2017, the net unrealized gain for the six months ended June 30, 2017 was $162,000, which is recognized in other comprehensive income in the consolidated balance sheet. No level 3 securities were purchased during the first half of 2017, $401,000 of Level 3 securities matured or were called, and there were $6,000 in principal paydowns in the same period. Of the Level 3 assets that were held by the Bank at June 30, 2016, the net unrealized loss for the six months ended June 30, 2016 was $187,000, which is recognized in other comprehensive income in the consolidated balance sheet. $750,000 of Level 3 securities were purchased during the first half of 2016, $182,000 of Level 3 securities matured or were called, and there were $181,000 in principal payments in the same period.

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

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

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

Assets Measured at Fair Value on a Non-recurring Basis

			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for Identical		Observable		Unobservable
(Dollars in thousands)	Balance at		Assets		Inputs		Inputs
	Dates Indicated		(Level 1)		(Level 2)		(Level 3)
Impaired Loans
June 30, 2017	$	4,383	$	—	$	—	$	4,383
December 31, 2016	$	4,911	$	—	$	—	$	4,911

Other Real Estate
June 30, 2017	$	472	$	—	$	—	$	472
December 31, 2016	$	437	$	—	$	—	$	437

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, 2016. 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 second quarter of 2017 was $1,635,000, which represented an increase of $190,000 or 13% compared to the same period in 2016. Net income for the first six months of 2017 was $3,081,000, which represented an increase of $362,000 or 13% over the same period in 2016. Growth in net interest income and a reduction in noninterest expense was partially offset by lower noninterest income in both the second quarter and first half of 2017 compared to the same periods in the prior year. Basic and diluted earnings per common share were $0.47 for the second quarter of 2017 and $0.89 for the first six months of 2017, compared to adjusted amounts of $0.41 and $0.78, respectively, for the same periods in 2016. Earnings per share amounts for the prior year have been adjusted for the 5% stock dividend paid on May 31, 2017. The return on average assets (ROAA) and return on average shareholders' equity (ROAE) percentages were 0.99% and 8.35%, respectively, for the first half of 2017, compared to 0.94% and 7.62%, respectively, for the same period in 2016. ROAA and ROAE ratios are non-GAAP measures which are provided as commonly used metrics in the banking industry.

Dividends

Cash dividends of $587,000 or $0.17 per share were declared in the second quarter of 2017, compared to $562,000 or $0.16 per share in the second quarter of 2016. The cash dividends declared in the first six months of 2017 were $1,153,000 or $0.33 per share, compared to $1,123,000 or an adjusted $0.32 per share declared in the same period in 2016. Dividends per share amounts for the first quarter of 2017 and the prior year have been adjusted for the 5% stock dividend paid on May 31, 2017. The cash divided payout percentage was 37% for the first six months of 2017, compared to 41% in the same period a year ago.

Interest Income and Expense

Tables 1 and 2 on the following pages provide information regarding interest income and expense for the six-month periods ended June 30, 2017 and 2016, respectively. 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

	Six Months Ended June 30,
	2017								2016
(Dollars in thousands)	Average								Average
	Balance		Interest			Rate			Balance		Interest			Rate
Assets:
Loans (1)	$	378,420	$	8,570			4.53	%	$	353,998	$	8,089			4.57	%
Taxable securities (2) (3)		126,906		1,284			2.02			116,184		1,137			1.96
Nontaxable securities (1) (2)		55,252		1,076			3.90			53,650		1,101			4.10
Other		5,331		24			0.90			3,591		9			0.50
Interest-earning assets		565,909		10,954			3.87			527,423		10,336			3.92
Noninterest-earning assets		55,704								51,841
Total assets	$	621,613							$	579,264

Liabilities and Shareholders’ Equity:
Interest-bearing demand deposits	$	205,396		181			0.18	%	$	191,672		131			0.14	%
Savings deposits		77,210		7			0.02			72,618		13			0.04
Certificates of deposit		105,133		354			0.68			86,772		264			0.61
Advances from Federal Home Loan Bank		20,918		107			1.02			24,910		75			0.60
Other		5,813		7			0.24			9,635		5			0.10
Interest-bearing liabilities		414,470		656			0.32			385,607		488			0.25
Noninterest-bearing demand deposits		130,775								121,227
Other noninterest-bearing liabilities		2,607								1,023
Total liabilities		547,852								507,857
Shareholders’ equity		73,761								71,407
Total liabilities and shareholders’ equity	$	621,613							$	579,264

Net interest income (tax-equivalent basis)-interest spread (Non-GAAP)				10,298			3.55	%				9,848			3.67	%
Tax-equivalent adjustment (1)				(366	)							(378	)
Net interest income (GAAP)			$	9,932							$	9,470
Net interest income as a percentage of earning assets (tax-equivalent basis) (Non-GAAP)							3.64	%							3.73	%

	(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

	Six Months Ended June 30,
(Dollars in thousands)	2017 Over 2016
	Total			Volume			Rate
Increase (decrease) in interest income (1)
Loans (2)	$	481		$	681		$	(200	)
Taxable securities		147			108			39
Nontaxable securities (2)		(24	)		74			(98	)
Other		15			6			9
Net change in tax-equivalent interest income		619			869			(250	)

Increase (decrease) in interest expense (1)
Interest-bearing demand deposits		50			10			40
Savings deposits		(6	)		2			(8	)
Certificates of deposit		89			60			29
Advances from Federal Home Loan Bank		32			(33	)		65
Other		4			(4	)		8
Net change in interest expense		169			35			134
Net change in tax-equivalent net interest income	$	450		$	834		$	(384	)

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

Net Interest Income

The presentation of net interest income on a tax-equivalent basis is not in accordance with generally accepted accounting principles (“GAAP”), but is customary in the banking industry. This non-GAAP measure ensures comparability of net interest income arising from both taxable and tax-exempt loans and investment securities. The adjustments to determine net interest income on a tax-equivalent basis were $366,000 and $378,000 for the six months ended June 30, 2017 and 2016, respectively. These adjustments were computed using a 34% federal income tax rate.

As shown in Tables 1 and 2, tax-equivalent net interest income increased $450,000 in the first six months of 2017 compared to the same period in 2016. The effect of growth in average interest-earning assets was partially offset by an increase in average interest-bearing liabilities, which caused tax-equivalent net interest income to increase $834,000 in the first half of 2017 compared to the same period in the prior year. The tax-equivalent net interest spread was reduced 12 basis points from 3.67% in the first six months of 2016, to 3.55% in the first half in 2017, which caused a decrease in net interest income of $384,000.

The decline in the interest spread was due to a 5 basis point decrease in the average rate earned on interest-earning assets in the first half of 2017 compared to the same six months in 2016 plus the effect of a 7 basis point increase in the average rate paid on interest-bearing liabilities. The reduction in the average rate earned on interest-earning assets was caused by relatively low general market rates on new loan originations and securities purchased in 2016 and the first half of 2017. Interest rates on loans are also being impacted by rate pressure from competing financial institutions in the markets in which ChoiceOne operates. The higher rate paid on interest-bearing liabilities resulted from growth in brokered certificates of deposit which increased the overall average rate on this deposit type as well as increases in short-term interest rates in the second half of 2016 and the first half of 2017 which increased the average rate paid on advances from the Federal Home Loan Bank.

The average balance of loans increased $24.4 million in the first six months of 2017 compared to the same period in 2016. Average commercial and industrial and commercial real estate loans were $20.4 million higher, while average consumer and residential mortgage loans grew $2.1 million and $1.9 million, respectively, in the same time period. The increase in the average loans balance was offset by a 4 basis point decrease in the average rate earned. This caused tax-equivalent net interest income from loans to increase $481,000 in the first half of 2017 compared to the same period in the prior year. The average balance of total securities grew $12.3 million in the first half of 2017 compared to the same period in 2016. Additional securities were purchased in 2016 and in the first half of 2017 to provide added liquidity and to provide earning asset growth. Growth in the average balance of securities and the interest rates earned caused tax-equivalent net interest income to increase $123,000 in the first six months of 2017 compared to the same period in 2016.

The average balance of interest-bearing demand deposits increased $13.7 million in the first six months of 2017 compared to the same period in 2016. This growth, plus the effect of a 4 basis point increase in the rate paid, caused interest expense to grow $50,000 in the first half of 2017 compared to the first half in the prior year. The average balance of certificates of deposit increased $18.4 million in the first six months of 2017 compared to the same period in 2016. The average balance of brokered certificates of deposit was $25.4 million higher in 2017 and the balance of local certificates of deposit was $7.0 million lower. The impact of growth in the average certificates balance and a 7 basis point increase in the average rate paid caused interest expense to grow $89,000 in the first half of 2017 compared to the first half of 2016. The effect of a $4.0 million decline in the average balance of Federal Home Loan Bank advances and a 42 basis point increase in the average rate paid caused interest expense to increase $32,000 in the first six months of 2017 compared to the same period in the prior year.

Provision and Allowance for Loan Losses

Total loans increased $10.4 million in the first half of 2017, while the allowance for loan losses decreased $179,000 during the same period. Provision for loan losses of $25,000 was recorded in the second quarter and first six months of 2017, compared to $0 for the same periods in 2016. Nonperforming loans were $4.6 million as of June 30, 2017, compared to $4.3 million as of March 31, 2017 and $5.1 million as of December 31, 2016. The increase in nonperforming loans in the second quarter was due to a higher balance of loans past due 90 days or more and still accruing. The allowance for loan losses was 1.08% of total loans at June 30, 2017, compared to 1.16% at March 31, 2017, and 1.20% at December 31, 2016.

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

(Dollars in thousands)	2017				2016
	Charge-offs		Recoveries		Charge-offs		Recoveries
Agricultural	$	—	$	—	$	—	$	—
Commercial and industrial		362		—		33		23
Consumer		137		91		68		69
Real estate, commercial		—		161		—		31
Real estate, residential		34		77		69		149
	$	533	$	329	$	170	$	272

Net charge-offs were $252,000 in the second quarter and $204,000 in the first six months of 2017, compared to net recoveries of $172,000 and $102,000 of net recoveries in the same periods in the prior year. Net charge-offs on an annualized basis as a percentage of average loans were 0.11% in the first six months of 2017, compared to a negative 0.06% for the same period in the prior year. Management is aware that the economic climate in Michigan will continue to affect business and individual 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 throughout 2017, the provision and allowance for loan losses will be reviewed by the Bank’s management and adjusted as determined to be necessary.

Noninterest Income

Total noninterest income decreased $109,000 in the second quarter and $219,000 in the first six months of 2017 compared to the same periods in 2016. The decline was caused by lower gains on sales of loans and securities in 2017 when compared to 2016. The reduction in mortgage income was primarily due to higher interest rates in the current year and a relatively low inventory of homes available for sale in the Bank’s primary market areas. The lower level of gains on sales of securities resulted from higher interest rates in the current year which reduced the market value of securities and gains available from them. Growth in insurance and investment commissions in the second quarter and first half of 2017 compared to the prior year was due to higher commission and advisory fee income.

Noninterest Expense

Total noninterest expense decreased $122,000 in the second quarter and $250,000 in the first six months of 2017 compared to the same periods in 2016. The decline was primarily due to reductions of $112,000 and $224,000 in intangible amortization expense in the second quarter and the first half of 2017, respectively compared to the prior year. The Bank’s intangible assets were completely amortized in the fourth quarter of 2016. An increase in salaries and benefits expense in both the second quarter and first six months of 2017 compared to the same periods in 2016 resulted from higher salaries from raises and personnel additions and higher bonus accruals. The decline in FDIC insurance expense in the second quarter and first six months of 2017 compared to the same periods in 2016 resulted from a reduced assessment rate beginning in the third quarter of 2016 after the Deposit Insurance Fund reached a 1.15% reserve threshold on June 30, 2016. The reduction in other noninterest expense in both the current quarter and first half of 2017 compared the same periods in the prior year was due to lower balances in a number of expense categories.

Income Tax Expense

Income tax expense was $1,052,000 in the first six months of 2017 compared to $947,000 for the same period in 2016. The effective tax rate was 25.5% for 2017 and 25.8% for 2016. Income tax expense for the second quarter of 2017 was $108,000 higher compared to the first quarter of 2017 due to better financial results. Due in part to the purchase of additional taxable securities during 2017 and better financial results noted previously, the effective tax rate increased from 24.6% in the first quarter of 2017 to 26.2% in the second quarter of 2017.

FINANCIAL CONDITION

Securities

The securities available for sale portfolio increased $134,000 in the second quarter and $6.1 million in the first six months of 2017. The increase in the securities portfolio resulted from ChoiceOne’s desire to grow earning assets. Various securities totaling $24.3 million were purchased in the first half of 2017 to provide earning assets and to replace maturities, principal repayments, and calls within the securities portfolio. Approximately $6.9 million of securities were called or matured since the end of 2016. Principal repayments on securities totaled $1.1 million in the first six months of 2017. Approximately $12.5 million of securities were sold in the first six months of 2017 for a net gain of $125,000.

Loans

Loans increased $6.2 million in the second quarter of 2017 and $10.4 million in the first six months of 2017. Commercial real estate loans grew $6.2 million, commercial and industrial loans grew $5.4 million, and consumer loans grew $1.8 million, while agricultural loans declined $2.9 million. The decrease in agricultural loans was caused in part by seasonal pay- downs by borrowers. 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 consolidated financial statements included in this report. The total balance of loans classified as impaired was $4.4 million as of June 30, 2017, compared to $4.7 million as of March 31, 2017 and $4.9 million as of December 31, 2016. The impaired loans balance declined in all loan categories in the second quarter except for residential real estate loans which were up slightly.

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)	June 30,		December 31,
	2017		2016
Loans accounted for on a nonaccrual basis	$	1,425	$	1,983
Accruing loans contractually past due 90 days or more as to principal or interest payments		510		229
Loans considered troubled debt restructurings		2,367		2,853
Total	$	4,302	$	5,065

At June 30, 2017, nonaccrual loans included $442,000 in agricultural loans, $285,000 in commercial and industrial loans, $5,000 in consumer loans, $250,000 in commercial real estate loans, and $443,000 in residential real estate loans. At December 31, 2016, nonaccrual loans included $482,000 in agricultural loans, $245,000 in commercial and industrial loans, $6,000 in consumer loans, $458,000 in commercial real estate loans, and $792,000 in residential real estate loans. Management believes the allowance allocated to its nonperforming loans is sufficient at June 30, 2017.

Deposits and Borrowings

Total deposits increased $16.0 million in the second quarter of 2017 and $12.0 million since the end of 2016. Checking and savings deposits declined $24.3 million in the first six months of 2017, while local certificates of deposit increased $2.1 million and brokered certificates of deposit grew $34.2 million. Brokered deposits were obtained in the first half of 2017 to supplement funding of asset growth. ChoiceOne continued to place an emphasis on building its core deposits base in 2017. The decrease in checking and savings deposits in the first half of 2017 was a normal seasonal fluctuation for ChoiceOne.

A decrease of $5.6 million in repurchase agreements in the first six months of 2017 was due to normal fluctuations in funds provided by bank customers and movement of certain funds into other types of accounts. Certain securities are sold under agreements to repurchase them the following day. Management plans to continue this practice as a low-cost source of funding. Federal Home Loan Bank advances grew $12.0 million in the first half of 2017 as advances were used to provide funding for earning asset growth and to replace the decline in deposits.

Shareholders’ Equity

Total shareholders’ equity increased $3.8 million from December 31, 2016 to June 30, 2017. Growth in equity resulted from current year’s net income, an increase in accumulated other comprehensive income, and proceeds from the issuance of ChoiceOne stock, which were offset by cash dividends paid. The $1.7 million increase in other comprehensive income since the end of 2016 was caused by an increase in net unrealized gains on available for sale securities. The improvement in unrealized gains resulted from decreases in certain interest rate terms since December 31, 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
June 30, 2017
ChoiceOne Financial Services Inc.
Total capital (to risk weighted assets)	$	64,807		13.8	%	$	37,680		8.0	%		N/A		N/A
Tier 1 capital (to risk weighted assets)		60,715		12.9			18,840		6.0			N/A		N/A
Common Equity Tier 1 Capital (to risk weighted assets)		60,715		12.9			21,195		4.5			N/A		N/A
Tier 1 capital (to average assets)		60,715		9.9			24,653		4.0			N/A		N/A

ChoiceOne Bank
Total capital (to risk weighted assets)	$	60,343		12.9	%	$	37,507		8.0	%	$	46,884		10.0	%
Tier 1 capital (to risk weighted assets)		56,251		12.0			18,754		6.0			28,130		8.0
Common Equity Tier 1 Capital (to risk weighted assets)		56,251		12.0			21,098		4.5			30,474		6.5
Tier 1 capital (to average assets)		56,251		9.2			24,509		4.0			30,636		5.0

December 31, 2016
ChoiceOne Financial Services Inc.
Total capital (to risk weighted assets)	$	59,644		13.0	%	$	35,289		8.0	%		N/A		N/A
Common Equity Tier 1 Capital (to risk weighted assets)		55,324		12.1			19,850		4.5			N/A		N/A
Tier 1 capital (to risk weighted assets)		55,324		12.1			26,467		6.0			N/A		N/A
Tier 1 capital (to average assets)		55,324		9.2			23,641		4.0			N/A		N/A

ChoiceOne Bank
Total capital (to risk weighted assets)	$	58,963		14.2	%	$	35,119		8.0	%	$	43,899		10.0	%
Common Equity Tier 1 Capital (to risk weighted assets)		54,709		13.3			19,754		4.5			28,534		6.5
Tier 1 capital (to risk weighted assets)		54,709		13.3			26,339		6.0			35,119		8.0
Tier 1 capital (to average assets)		54,709		9.9			23,504		4.0			29,380		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 June 30, 2017 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 $4.7 million for the six months ended June 30, 2017 compared to $6.4 million provided in the same period a year ago. The change was caused by a decrease in net cash flows provided by loans originated for sale in the secondary market. Net cash used for investing activities was $19.7 million for the first half of 2017, compared to $21.5 million in the same period in 2016. A decline in the level of growth in securities available for sale was offset by a higher level of growth in loans. Net cash provided from financing activities was $17.2 million in the first six months of 2017, compared to $17.4 million during the same period in the prior year. The impact of more growth in deposits was offset by a lower level of net growth in Federal Home Loan Bank advances.

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 $24.5 million in 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 June 30, 2017 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, 2016. As of the date of this report, ChoiceOne does not believe that there has been a material change in the nature or categories of ChoiceOne’s risk factors, as compared to the information disclosed in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2016.

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

On April 26, 2017, ChoiceOne issued 828 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 $19,060. On May 22, 2017, ChoiceOne issued 1,423 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 $22,600. 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 June 30, 2017.

(Dollars in thousands, except per share data) Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of a Publicly Announced Plan		Maximum Number of Shares that May Yet be Purchased Under the Plan (2)

April 1 - April 30, 2017
Employee Transactions (1)		1,396	$	23.00
Repurchase Plan		—	$	—		—		24,224
May 1 - May 31, 2017
Employee Transactions		—	$	—
Repurchase Plan		—	$	—		—		24,224
June 1 - June 30, 2017
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)	As of June 30, 2017, 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 President and Chief Executive Officer

	31.2		Certification of Treasurer

	32.1 101.1		Certification pursuant to 18 U.S.C. § 1350. 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: August 10, 2017	/s/ Kelly J. Potes
	Kelly J. Potes Chief Executive Officer (Principal Executive Officer)

Date: August 10, 2017	/s/ Thomas L. Lampen
	Thomas L. Lampen Treasurer (Principal Financial and Accounting Officer)