CHOICEONE FINANCIAL SERVICES INC - Quarter Report: 2019 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, 2019

☐	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, every Interactive Data File required to be submitted 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 such files).

Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

Title of each class	Trading symbol(s)	Name of each exchange on which registered
Common stock	COFS	OTC Pink Market

As of October 31, 2019, the Registrant had outstanding 7,246,068 shares of common stock.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

ChoiceOne Financial Services, Inc.
CONSOLIDATED BALANCE SHEETS

	September 30,			December 31,
(Dollars in thousands)	2019			2018
	(Unaudited)			(Audited)
Assets
Cash and due from banks	$	16,574		$	19,690

Equity securities at fair value (Note 2)		2,499			2,847
Securities available for sale (Note 2)		154,778			166,602
Federal Home Loan Bank stock		1,994			1,994
Federal Reserve Bank stock		1,574			1,573

Loans held for sale		1,202			831
Loans to other financial institutions		29,992			20,644
Loans (Note 3)		406,806			409,073
Allowance for loan losses (Note 3)		(4,096	)		(4,673	)
Loans, net		402,710			404,400

Premises and equipment, net		15,282			15,879
Cash surrender value of life insurance policies		15,189			14,899
Goodwill		13,728			13,728
Other assets		8,067			7,457
Total assets	$	663,589		$	670,544

Liabilities
Deposits – noninterest-bearing	$	152,579		$	153,542
Deposits – interest-bearing		421,496			423,473
Total deposits		574,075			577,015

Federal funds purchased		—			4,800
Advances from Federal Home Loan Bank		207			5,233
Other liabilities		4,681			3,019
Total liabilities		578,963			590,067

Shareholders’ Equity
Preferred stock; shares authorized: 100,000; shares outstanding: none		—			—
Common stock and paid in capital, no par value;
shares authorized: 7,000,000; shares outstanding:
3,634,388 at September 30, 2019 and 3,616,483 at December 31, 2018		55,058			54,523
Retained earnings		26,474			26,686
Accumulated other comprehensive income (loss), net		3,094			(732	)
Total shareholders’ equity		84,626			80,477
Total liabilities and shareholders’ equity	$	663,589		$	670,544

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,
	2019			2018		2019		2018
Interest income
Loans, including fees	$	5,394		$	5,111	$	16,064	$	14,735
Securities:
Taxable		728			736		2,255		2,134
Tax exempt		352			374		1,079		1,097
Other		87			40		194		109
Total interest income		6,561			6,261		19,592		18,075

Interest expense
Deposits		973			619		2,748		1,428
Advances from Federal Home Loan Bank		8			63		238		165
Other		10			8		39		34
Total interest expense		991			690		3,025		1,627

Net interest income		5,570			5,571		16,567		16,448
Provision for loan losses		—			—		—		35

Net interest income after provision for loan losses		5,570			5,571		16,567		16,413

Noninterest income
Customer service charges		1,094			1,165		3,275		3,340
Insurance and investment commissions		88			97		225		231
Gains on sales of loans		638			223		1,373		772
Gains on sales of securities available for sale		19			—		22		25
Gains on sales of other assets		8			61		23		69
Earnings on life insurance policies		99			97		290		289
Change in market value of equity securities		(146	)		113		119		161
Other		135			96		394		334
Total noninterest income		1,935			1,852		5,721		5,221

Noninterest expense
Salaries and benefits		3,268			2,780		8,915		8,308
Occupancy and equipment		755			661		2,267		2,005
Data processing		676			555		1,814		1,644
Professional fees		836			310		2,031		838
Supplies and postage		91			84		266		297
Advertising and promotional		145			58		297		235
Other		606			611		1,883		1,810
Total noninterest expense		6,377			5,059		17,473		15,137

Income before income tax		1,128			2,364		4,815		6,497
Income tax expense		106			350		671		992

Net income	$	1,021		$	2,014	$	4,144	$	5,505

Basic earnings per share (Note 4)	$	0.28		$	0.55	$	1.14	$	1.52
Diluted earnings per share (Note 4)	$	0.28		$	0.55	$	1.14	$	1.52
Dividends declared per share	$	0.80		$	0.18	$	1.20	$	0.53

See accompanying notes to interim consolidated financial statements.

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

(Dollars in thousands)	Three Months Ended September 30,						Nine Months Ended September 30,
	2019			2018			2019			2018
Net income	$	1,021		$	2,014		$	4,144		$	5,505

Other comprehensive income:
Changes in net unrealized gains (losses) on investment securities available for sale, net of tax (benefit) of $149 and $(198) for the three months ended September 30, 2019 and September 30, 2018 respectively. Changes in net unrealized gains (losses) on investment securities available for sale, net of tax (benefit) expense of $1,022 and $(767) for the nine months ended September 30, 2019 and September 30, 2018 respectively.		561			(745	)		3,844			(2,885	)

Less: Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax expense which was $4 for the three months ended September 30, 2019 and $0 for the three months ended September 30, 2018. Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax expense of $5 and $5 for the nine months ended September 30, 2019 and September 30, 2018 respectively.		(15	)		—			(18	)		(20	)

Other comprehensive income (loss), net of tax		546			(745	)		3,826			(2,905	)

Comprehensive income	$	1,567		$	1,269		$	7,970		$	2,600

See accompanying notes to interim consolidated financial statements.

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

THREE MONTHS ENDED SEPTEMBER 30, 2019 (Unaudited)

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

Balance, July 1, 2018		3,613,080		$	54,289	$	24,146		$	(2,167	)	$	76,268

Net income		—			—		2,014			—			2,014
Other comprehensive loss		—			—		—			(745	)		(745	)
Shares issued		1,590			33		—			—			33
Shares repurchased		(400	)		—		—			—			—
Effect of employee stock purchases		—			3		—			—			3
Stock options exercised and issued		431			—		—			—			—
Stock-based compensation expense		—			67		—			—			67
Cash dividends declared ($0.18 per share)		—			—		(651	)		—			(651	)

Balance, September 30, 2018		3,614,701		$	54,392	$	25,509		$	(2,912	)	$	76,989

Balance, July 1, 2019		3,632,917		$	54,756	$	28,359		$	2,548		$	85,663

Net income		—			—		1,021			—			1,021
Other comprehensive income		—			—		—			546			546
Shares issued		1,471			40		—			—			40
Effect of employee stock purchases		—			4		—			—			4
Stock-based compensation expense		—			258		—			—			258
Special cash dividends declared ($0.60 per share)		—			—		(2,180	)		—			(2,180	)
Cash dividends declared ($0.20 per share)		—			—		(726	)		—			(726	)

Balance, September 30, 2019		3,634,388			55,058	$	26,474		$	3,094		$	84,626

ChoiceOne Financial Services, Inc

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2019 (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, 2018		3,448,569		$	50,290		$	26,023		$	237		$	76,550

Net income		—			—			5,505			—			5,505
Other comprehensive loss		—			—			—			(2,905	)		(2,905	)
Shares issued		6,122			83			—			—			83
Shares repurchased		(20,628	)		(523	)		—			—			(523	)
Effect of employee stock purchases		—			9			—			—			9
Stock options exercised and issued		1,241			—			—			—			—
Stock-based compensation expense					198			—			—			198
Restricted stock units vested		7,303			—			—			—			—
Adoption effect of ASU 2016-01 (1)		—			—			244			(244	)		—
Stock dividend declared (5%)		172,094			4,335			(4,342	)		—			(7	)
Cash dividends declared ($0.53 per share)		—			—			(1,921	)		—			(1,921	)

Balance, September 30, 2018		3,614,701		$	54,392		$	25,509		$	(2,912	)	$	76,989

Balance, January 1, 2019		3,616,483		$	54,523		$	26,686		$	(732	)	$	80,477

Net income		—			—			4,144			—			4,144
Other comprehensive income		—			—			—			3,826			3,826
Shares issued		6,728			99			—			—			99
Effect of employee stock purchases		—			11			—			—			11
Stock options exercised and issued		3,390			46			—			—			46
Stock-based compensation expense		—			379			—			—			379
Restricted stock units issued		7,787			—			—			—			—
Special cash dividend declared ($0.60 per share)		—			—			(2,180	)		—			(2,180	)
Cash dividends declared ($0.60 per share)		—			—			(2,176	)		—			(2,176	)

Balance, September 30, 2019		3,634,388			55,058		$	26,474		$	3,094		$	84,626

(1) ASU 2016-01 is further addressed in Note 1 to the financial statements.

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,
	2019			2018
Cash flows from operating activities:
Net income	$	4,144		$	5,505
Adjustments to reconcile net income to net cash from operating activities:
Provision for loan losses		—			35
Depreciation		1,054			853
Amortization		672			701
Compensation expense on employee and director stock purchases, stock options, and restricted stock units		428			234
Gains on sales of securities		(22	)		(25	)
Net change in market value of equity securities		(119	)		(161	)
Gains on sales of loans		(1,373	)		(772	)
Loans originated for sale		(40,215	)		(19,837	)
Proceeds from loan sales		40,527			21,174
Earnings on bank-owned life insurance		(290	)		(289	)
Gains on sales of other real estate owned		(22	)		(69	)
Proceeds from sales of other real estate owned		187			308
Deferred federal income tax benefit		94			40
Net changes in other assets		(290	)		(1,321	)
Net changes in other liabilities		645			622
Net cash from operating activities		5,420			6,998

Cash flows from investing activities:
Securities available for sale:
Sales		1,233			2,716
Maturities, prepayments and calls		29,478			10,635
Purchases		(13,904	)		(27,476	)
Purchase of Federal Reserve Bank stock		(1	)		—
Loan originations and payments, net		(7,870	)		(12,799	)
Additions to premises and equipment		(457	)		(2,810	)
Net cash used in investing activities		8,479			(29,734	)

Cash flows from financing activities:
Net change in deposits		(2,940	)		4,494
Net change in repurchase agreements		—			(7,148	)
Net change in federal funds purchased		(4,800	)		9,400
Proceeds from Federal Home Loan Bank advances		85,000			93,500
Payments on Federal Home Loan Bank advances		(90,026	)		(97,526	)
Issuance of common stock		107			57
Repurchase of common stock		—			(523	)
Cash dividends and fractional shares from stock dividend		(4,356	)		(1,928	)
Net cash used in financing activities		(17,015	)		326

Net change in cash and cash equivalents		(3,116	)		(22,410	)
Beginning cash and cash equivalents		19,690			36,837
Ending cash and cash equivalents	$	16,574		$	14,427

Supplemental disclosures of cash flow information:
Cash paid for interest	$	3,000		$	1,532
Cash paid for income taxes	$	350		$	850
Loans transferred to other real estate owned	$	325		$	377

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 consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information, prevailing practices within the banking industry and the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

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, 2019 and December 31, 2018, the Consolidated Statements of Income for the three- and nine-month periods ended September 30, 2019 and September 30, 2018, the Consolidated Statements of Comprehensive Income for the three- and nine-month periods ended September 30, 2019 and September 30, 2018, the Consolidated Statements of Changes in Shareholders’ Equity for the three- and nine-month periods ended September 30, 2019 and September 30, 2018, and the Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and September 30, 2018. Operating results for the nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.

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, 2018.

Loans to Other Financial Institutions

The Bank entered into an agreement with another financial institution to fund mortgage loans. Loans to other financial institutions are purchased participating interests in individual advances made to mortgage bankers nation-wide from an unaffiliated originating bank. The originating bank services these loans and cash flows on the individual advances (principal, interest, and fees) which are allocated pro-rata based on ownership in the participating interest, less fees paid for the servicing activity. The underlying collateral is generally made up of 1-4 family first residential mortgages owned by the mortgage banker and held for sale in the secondary market and have been underwritten using secondary market underwriting standards prior to purchasing the participating interest. Once the mortgage banker delivers the loan to the secondary market, the advance is required to be paid off, including the Bank’s participating interest. If the advance (in which the Bank has a participating interest) is outstanding over 90 days, the originating bank has the right to request the participating interest be paid off by the mortgage banker. The participating interests are subject to concentration risk to 13 different mortgage bankers, with the largest creditor outstanding representing 19% of the total at September 30, 2019.

Credit risk associated with the participating interest is measured as an allowance for loan losses when necessary. Losses are charged off against the allowance when incurred and recoveries of loan charge-offs are recorded when received. At least quarterly, the Bank reviews the portfolio of participating interests for potential losses including any participating interest that is outstanding over 90 days (even if the advance and participating interest is current). At September 30, 2019, 17 of the 184 participating interests with principal balances totaling $4.8 million had balances outstanding over 30 days. During the first nine months of 2019 and 2018, there were no losses or charge-offs of participating interests.

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 3,390 shares of common stock were issued upon the exercise of stock options for a cash price of $46,000 in the first nine months of 2019. A total of 4,139 shares of common stock were issued to ChoiceOne’s Board of Directors for a cash price of $110,000 under the terms of the Directors’ Stock Purchase Plan in the first nine months of 2019. A total of 2,589 shares for a cash price of $61,000 were issued under the Employee Stock Purchase Plan in the first nine months of 2019. Shares of common stock issued upon the vesting of restricted stock units, net of shares withheld for payment of related taxes, totaled 7,787 in the first nine months of 2019.

Stock-Based Compensation

ChoiceOne grants 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.

Reclassifications

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

Recent Accounting Pronouncements

The FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. The ASU covers various changes to the accounting, measurement, and disclosure related to certain financial instruments. The most significant change included in the update is the requirement for certain equity investments (excluding investments that are consolidated or accounted for under the equity method of accounting) to be measured at fair value with changes in fair value recognized in net income. An entity may choose to measure equity investments that do not have readily determinable fair values at cost, minus impairment. When a qualitative assessment of equity investments without readily determinable fair values indicates that impairment exists, an entity is required to measure the investment at fair value. The update also eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. ChoiceOne implemented ASU 2016-01 effective January1, 2018. A cumulative-effect adjustment was recorded as of January 1, 2018 to reclassify $244,000 of unrealized gains on equity securities from accumulated other comprehensive income to retained earnings. Equity securities have also been presented separately from available for sale debt securities on the balance sheet and the fair value of loans has been estimated using an exit price notion in Note 5.

The FASB issued ASU 2016-02, Leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. Implementation of the new standard caused ChoiceOne to recognize $105,000 of a lease asset and liability as of January 1, 2019. The lease asset was included in premises and equipment and the lease liability in other liabilities in the consolidated balance sheet. The impact on ChoiceOne’s expense was not significant.

The FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU provides financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date by replacing the incurred loss impairment methodology in current generally accepted accounting principles (GAAP) with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The new guidance attempts to reflect an entity’s current estimate of all expected credit losses and broadens the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually to include forecasted information, as well as past events and current conditions. There is no specified method for measuring expected credit losses, and an entity may apply methods that reasonably reflect its expectations of the credit loss estimate. Although an entity may still use its current systems and methods for recording the allowance for credit losses, under the new rules, the inputs used to record the allowance for credit losses generally will need to change to appropriately reflect an estimate of all expected credit losses and the use of reasonable and supportable forecasts. Additionally, credit losses on available-for-sale debt securities will have to be presented as an allowance rather than as a write-down. In October 2019, FASB delayed the effective date for the credit loss standard to January 2023 for certain entities, including certain Securities and Exchange Commission filers, public business entities and private companies. As a smaller reporting company, ChoiceOne is eligible for the proposed delay under the updated language in the standard.

NOTE 2 – SECURITIES

The fair value of equity securities at fair value and the related gross unrealized gains recognized in noninterest income were as follows:

September 30, 2019

Gross

Amortized

Unrealized

Fair

(Dollars in thousands)

Cost

Gains

Losses

Value

Equity securities

2,164

335

—

2,499

			December 31, 2018
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(Dollars in thousands)	Cost		Gains		Losses			Value
Equity securities	$	2,502	$	459	$	(114	)	$	2,847

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, 2019
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(Dollars in thousands)	Cost		Gains		Losses			Value
U.S. Government and federal agency	$	23,035	$	23	$	(9	)	$	23,049
U.S. Treasury		1,994		18		—			2,012
State and municipal		97,824		2,932		(4	)		100,752
Mortgage-backed		24,542		747		(3	)		25,286
Corporate		2,648		34		(3	)		2,679
Foreign debt		500		—		—			500
Trust preferred securities		500		—		—			500
Total	$	151,043	$	3,754	$	(19	)	$	154,778

			December 31, 2018
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
U.S. Government and federal agency	$	34,079	$	1	$	(551	)	$	33,529
U.S. Treasury		1,992		—		(45	)		1,947
State and municipal		104,317		544		(933	)		103,928
Mortgage-backed		21,654		126		(205	)		21,575
Corporate		5,147		1		(46	)		5,102
Trust preferred securities		500		—		—			500
Asset-backed securities		21		—		—			21
Total	$	167,710	$	672	$	(1,780	)	$	166,602

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 three and nine months ended September 30, 2019 or in the same periods in 2018. ChoiceOne believes 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 September 30, 2019, the fair value of securities as of September 30, 2019 and December 31, 2018, and the weighted average yields of securities as of September 30, 2019:

	Securities maturing within:
									Fair Value		Fair Value
	Less than		1 Year -		5 Years -		More		at September 30,		at December 31,
(Dollars in thousands)	1 Year		5 Years		10 Years		10 Years		2019		2018
U.S. Government and federal agency	$	21,017	$	2,032	$	—	$	—	$	23,049	$	33,529
U.S. Treasury notes and bonds		—		2,012		—		—		2,012		1,947
State and municipal		13,709		49,671		35,367		2,005		100,752		103,928
Corporate		—		2,679		—		—		2,679		5,102
Foreign debt		500		—		—		—		500		—
Trust preferred securities		500		—		—		—		500		500
Asset-backed securities		—		—		—		—		—		21
Total debt securities		35,726		56,394		35,367		2,005		129,492		145,027

Mortgage-backed securities		—		19,164		6,122		—		25,286		21,575
Equity securities (1)		—		—		1,000		1,499		2,499		2,847
Total	$	35,726	$	75,558	$	42,489	$	3,504	$	157,277	$	169,449

	Weighted average yields:
	Less than			1 Year -			5 Years -			More
	1 Year			5 Years			10 Years			10 Years			Total
U.S. Government and federal agency		1.99	%		1.98	%		—	%		—	%		1.99	%
U.S. Treasury notes and bonds		—			1.85			—			—			1.85
State and municipal (2)		2.73			2.85			3.21			0.64			2.91
Corporate		—			2.66			—			—			2.66
Foreign debt		2.27			—			—			—			2.27
Trust preferred securities		6.00			—			—			—			6.00
Mortgage-backed securities		—			3.24			2.97			—			3.18
Equity securities (1)		—			—			4.61			—			1.54

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

(2) The yield is computed for tax-exempt securities on a fully tax-equivalent basis at an incremental rate of 21%.

Following is information regarding unrealized gains and losses on equity securities for the three- and nine-month periods ending September 30:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2019			2018		2019		2018

Net gains and losses recognized during the period	$	(146	)	$	113	$	119	$	161
Less: Net gains and losses recognized during the period on securities sold		(2	)		—		4		9
Unrealized gains and losses recognized during the reporting period on securities still held at the reporting date	$	(144	)	$	113	$	115	$	152

NOTE 3 – LOANS AND ALLOWANCE FOR LOAN LOSSES

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

				Commercial
(Dollars in thousands)				and						Commercial			Construction			Residential
	Agricultural			Industrial			Consumer			Real Estate			Real Estate			Real Estate			Unallocated			Total
Allowance for Loan Losses Three Months Ended September 30, 2019
Beginning balance	$	362		$	818		$	335		$	2,398		$	43		$	522		$	323		$	4,801
Charge-offs		—			(81	)		(71	)		(589	)		—			(11	)		—			(752	)
Recoveries		—			1			25			16			—			5			—			47
Provision		111			(87	)		(27	)		(182	)		5			(80	)		260			—
Ending balance	$	473		$	651		$	262		$	1,643		$	48		$	436		$	583		$	4,096

Nine Months Ended September 30, 2019
Beginning balance	$	481		$	892		$	254		$	1,926		$	38		$	537		$	545		$	4,673
Charge-offs		—			(83	)		(222	)		(589	)		—			(25	)		—			(919	)
Recoveries		65			21			113			22			—			121			—			342
Provision		(73	)		(179	)		117			284			10			(197	)		38			—
Ending balance	$	473		$	651		$	262		$	1,643		$	48		$	436		$	583		$	4,096

Individually evaluated for impairment	$	85		$	2		$	4		$	14		$	—		$	186		$	—		$	291

Collectively evaluated for impairment	$	388		$	649		$	258		$	1,629		$	48		$	250		$	583		$	3,805

Three Months Ended September 30, 2018
Beginning balance	$	359		$	970		$	205		$	1,911		$	16		$	620		$	578		$	4,659
Charge-offs		—			—			(62	)		—			—			(13	)		—			(75	)
Recoveries		—			4			22			2			—			10			—			38
Provision		5			(25	)		59			37			15			—			(91	)		—
Ending balance	$	364		$	949		$	224		$	1,950		$	31		$	617		$	487		$	4,622

Nine Months Ended September 30, 2018
Beginning balance	$	506		$	1,001		$	262		$	1,761		$	35		$	726		$	286		$	4,577
Charge-offs		—			(58	)		(180	)		—			—			(25	)		—			(263	)
Recoveries		—			57			73			61			—			82			—			273
Provision		(142	)		(51	)		69			128			(4	)		(166	)		201			35
Ending balance	$	364		$	949		$	224		$	1,950		$	31		$	617		$	487		$	4,622

Individually evaluated for impairment	$	13		$	18		$	19		$	27		$	—		$	180		$	—		$	257

Collectively evaluated for impairment	$	351		$	931		$	205		$	1,923		$	31		$	437		$	487		$	4,365

Loans September 30, 2019
Individually evaluated for impairment	$	389		$	279		$	20		$	2,331		$	—		$	2,646					$	5,665
Collectively evaluated for impairment		49,668			81,252			24,388			141,975			11,188			92,670						401,141
Ending balance	$	50,057		$	81,531		$	24,408		$	144,306		$	11,188		$	95,316					$	406,806

December 31, 2018
Individually evaluated for impairment	$	578		$	21		$	90		$	623		$	—		$	2,712					$	4,024
Collectively evaluated for impairment		48,531			91,385			24,292			138,830			8,843			93,168						405,049
Ending balance	$	49,109		$	91,406		$	24,382		$	139,453		$	8,843		$	95,880					$	409,073

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,
	2019		2018		2019		2018		2019		2018
Risk ratings 1 and 2	$	14,214	$	15,300	$	7,138	$	11,972	$	9,137	$	7,962
Risk rating 3		16,376		23,938		39,317		50,266		89,117		89,173
Risk rating 4		18,074		9,082		32,002		23,961		40,952		36,193
Risk rating 5		1,004		211		2,795		5,204		2,156		4,850
Risk rating 6		389		578		279		3		2,944		1,275
	$	50,057	$	49,109	$	81,531	$	91,406	$	144,306	$	139,453

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,
	2019		2018		2019		2018		2019		2018
Performing	$	24,400	$	24,320	$	11,188	$	8,843	$	94,343	$	94,925
Nonperforming		—		—		—		—		—		—
Nonaccrual		8		62		—		—		973		955
	$	24,408	$	24,382	$	11,188	$	8,843	$	95,316	$	95,880

The following schedule provides information on loans that were considered TDRs that were modified during the nine-month periods ended September 30, 2019 and September 30, 2018:


	Three Months Ended September 30, 2019						Nine Months Ended September 30, 2019
			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		—	$	—	$	—		2	$	1,882	$	1,882
Residential real estate		—		—		—		1		17		17
		—	$	—	$	—		3	$	1,899	$	1,899

Three Months Ended September 30, 2018

Nine Months Ended September 30, 2018

Pre-

Post-

Pre-

Post-

Modification

Outstanding

(Dollars in thousands)

Number of

Recorded

Number of

Recorded

Loans

Investment

Loans

Investment

Commercial and industrial

—

The pre-modification and post-modification outstanding recorded investments represent 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, 2019 and 2018 where the borrower was past due with respect to principal and/or interest for 30 days or more during the three- and nine-month periods ended September 30, 2019 and September 30, 2018 that had been modified during the year prior to the default:

Three Months Ended

Nine Months Ended

September 30, 2019

(Dollars in thousands)

Number

Recorded

Number

Recorded

of Loans

Investment

of Loans

Investment

Commercial real estate

1,882

Three Months Ended

Nine Months Ended

September 30, 2018

(Dollars in thousands)

Number

Recorded

Number

Recorded

of Loans

Investment

of Loans

Investment

Commercial and industrial

—

Impaired loans by loan category follow:


			Unpaid
(Dollars in thousands)	Recorded		Principal		Related
	Investment		Balance		Allowance
September 30, 2019
With no related allowance recorded
Agricultural	$	—	$	—	$	—
Commercial and industrial		259		259		—
Consumer		—		—		—
Commercial real estate		1,882		1,882		—
Construction real estate		—		—		—
Residential real estate		103		103		—
Total		2,244		2,244		—
With an allowance recorded
Agricultural		389		474		85
Commercial and industrial		20		22		2
Consumer		20		24		4
Commercial real estate		449		462		14
Construction real estate		—		—		—
Residential real estate		2,543		2,729		186
Total		3,421		3,711		291
Total
Agricultural		389		474		85
Commercial and industrial		279		281		2
Consumer		20		24		4
Commercial real estate		2,331		2,344		14
Construction real estate		—		—		—
Residential real estate		2,646		2,832		186
Total	$	5,665	$	5,955	$	291

December 31, 2018
With no related allowance recorded
Agricultural	$	185	$	185	$	—
Commercial and industrial		—		—		—
Consumer		1		1		—
Construction real estate		—		—		—
Commercial real estate		73		109		—
Residential real estate		250		261		—
Total		509		556		—
With an allowance recorded
Agricultural		393		440		94
Commercial and industrial		21		21		3
Consumer		89		89		13
Construction real estate		—		—		—
Commercial real estate		550		609		20
Residential real estate		2,462		2,494		167
Total		3,515		3,653		297
Total
Agricultural		578		625		94
Commercial and industrial		21		21		3
Consumer		90		90		13
Construction real estate		—		—		—
Commercial real estate		623		718		20
Residential real estate		2,712		2,755		167
Total	$	4,024	$	4,209	$	297

The following schedule provides information regarding average balances of impaired loans and interest recognized on impaired loans for three- and nine-month periods ended September 30, 2019 and 2018:


	Average		Interest
(Dollars in thousands)	Recorded		Income
	Investment		Recognized
Three months ended September 30, 2019
With no related allowance recorded
Agricultural	$	—	$	—
Commercial and industrial		129		—
Consumer		—		—
Commercial real estate		941		—
Residential real estate		109		1
Total		1,179		1
With an allowance recorded
Agricultural		389		—
Commercial and industrial		191		—
Consumer		37		1
Commercial real estate		1,693		13
Residential real estate		2,521		48
Total		4,831		62
Total
Agricultural		389		—
Commercial and industrial		320		—
Consumer		37		1
Commercial real estate		2,634		13
Residential real estate		2,630		49
Total	$	6,010	$	63

	Average		Interest
(Dollars in thousands)	Recorded		Income
	Investment		Recognized
Three months ended September 30, 2018
With no related allowance recorded
Agricultural	$	211	$	—
Commercial and industrial		73		3
Consumer		—		—
Commercial real estate		134		—
Construction real estate		65		—
Residential real estate		168		—
Total		651		3
With an allowance recorded
Agricultural		206		—
Commercial and industrial		521		8
Consumer		68		3
Commercial real estate		739		20
Construction real estate		—		—
Residential real estate		2,418		52
Total		3,952		83
Total
Agricultural		417		—
Commercial and industrial		594		11
Consumer		68		3
Commercial real estate		873		20
Construction real estate		65		—
Residential real estate		2,586		52
Total	$	4,603	$	86

	Average		Interest
(Dollars in thousands)	Recorded		Income
	Investment		Recognized
Nine months ended September 30, 2019
With no related allowance recorded
Agricultural	$	46	$	—
Commercial and industrial		65		9
Consumer		—		—
Commercial real estate		507		61
Residential real estate		156		4
Total		774		74
With an allowance recorded
Agricultural		390		—
Commercial and industrial		107		2
Consumer		56		1
Commercial real estate		1,117		27
Residential real estate		2,510		112
Total		4,180		142
Total
Agricultural		436		—
Commercial and industrial		172		11
Consumer		56		1
Commercial real estate		1,624		88
Residential real estate		2,666		116
Total	$	4,954	$	216

	Average		Interest
(Dollars in thousands)	Recorded		Income
	Investment		Recognized
Nine months ended September 30, 2018
With no related allowance recorded
Agricultural	$	317	$	—
Commercial and industrial		37		6
Consumer		2		—
Commercial real estate		67		—
Construction real estate		79		—
Residential real estate		159		2
Total		661		8
With an allowance recorded
Agricultural		103		—
Commercial and industrial		364		23
Consumer		52		2
Commercial real estate		728		42
Construction real estate		—		—
Residential real estate		2,539		112
Total		3,786		179
Total
Agricultural		420		—
Commercial and industrial		401		29
Consumer		54		2
Commercial real estate		795		42
Construction real estate		79		—
Residential real estate		2,698		114
Total	$	4,447	$	187

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, 2019
Agricultural	$	—	$	—	$	—	$	—	$	50,057	$	50,057	$	—
Commercial and industrial		284		—		259		543		80,988		81,531		—
Consumer		43		3		2		48		24,360		24,408		—
Commercial real estate		—		—		1,882		1,882		142,424		144,306		—
Construction real estate		—		—		—		—		11,188		11,188		—
Residential real estate		102		644		201		947		94,369		95,316		—
	$	429	$	647	$	2,344	$	3,420	$	403,386	$	406,806	$	—

December 31, 2018
Agricultural	$	—	$	—	$	—	$	—	$	49,109	$	49,109	$	—
Commercial and industrial		5		—		—		5		91,401		91,406		—
Consumer		149		40		11		200		24,182		24,382		—
Commercial real estate		—		—		73		73		139,380		139,453		—
Construction real estate		—		—		—		—		8,843		8,843		—
Residential real estate		1,493		486		648		2,627		93,253		95,880		—
	$	1,647	$	526	$	732	$	2,905	$	406,168	$	409,073	$	—

(1) Includes nonaccrual loans.

Nonaccrual loans by loan category follow:

(Dollars in thousands)	September 30,		December 31,
	2019		2018
Agricultural	$	389	$	393
Commercial and industrial		279		—
Consumer		7		62
Commercial real estate		1,925		123
Construction real estate		—		—
Residential real estate		973		954
	$	3,573	$	1,532

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,
	2019		2018		2019		2018
Basic Earnings Per Share
Net income available to common shareholders	$	1,021	$	2,014	$	4,144	$	5,505

Weighted average common shares outstanding		3,633,474		3,613,516		3,626,961		3,613,891

Basic earnings per share	$	0.28	$	0.55	$	1.14	$	1.52

Diluted Earnings Per Share
Net income available to common shareholders	$	1,021	$	2,014	$	4,144	$	5,505

Weighted average common shares outstanding		3,633,474		3,613,516		3,626,961		3,613,891
Plus dilutive stock options and restricted stock units		23,964		16,535		19,870		13,497

Weighted average common shares outstanding and potentially dilutive shares		3,657,438		3,630,051		3,646,831		3,627,388

Diluted earnings per share	$	0.28	$	0.55	$	1.14	$	1.52

There were no stock options that were considered to be anti-dilutive to earnings for the three months ended September 30, 2019 and 13,500 that were considered to be anti-dilutive to earnings for the nine months ended September 30, 2019 and were excluded from the calculation above. There were no stock options that were considered to be anti-dilutive to earnings per share for the three or nine months ended September 30, 2018.

All share and per share amounts have been adjusted for the 5% stock dividend issued on May 31, 2018 and the 5% stock dividend issued on May 31, 2017, where applicable.

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, 2019
Assets:
Cash and due from banks	$	16,574	$	16,574	$	16,574	$	—	$	—
Equity securities at fair value		2,499		2,499		1,499		—		1,000
Securities available for sale		154,778		154,778		—		144,501		10,277
Federal Home Loan Bank and Federal
Reserve Bank stock		3,568		3,568		—		3,568		—
Loans held for sale		1,202		1,202		—		1,202		—
Loans to other financial
institutions		29,992		29,992		—		29,992		—
Loans, net		402,710		398,450		—		—		398,450
Accrued interest receivable		2,663		2,663		—		2,663		—

Liabilities:
Noninterest-bearing deposits		152,579		152,579		—		152,579		—
Interest-bearing deposits		421,496		421,611		—		421,611		—
Federal Home Loan Bank advances		207		220		—		220		—
Accrued interest payable		235		235		—		235		—


December 31, 2018
Assets:
Cash and due from banks	$	19,690	$	19,690	$	19,690	$	—	$	—
Equity securities at fair value		2,847		2,847		1,961		—		886
Securities available for sale		166,602		166,602		—		158,104		8,498
Federal Home Loan Bank and Federal
Reserve Bank stock		3,567		3,567		—		3,567		—
Loans held for sale		831		856		—		856		—
Loans to other financial institutions		20,644		20,644		—		20,644		—
Loans, net		404,400		399,091		—		—		399,091
Accrued interest receivable		2,267		2,267		—		2,267		—

Liabilities:
Noninterest-bearing deposits		153,542		153,542		—		153,542		—
Interest-bearing deposits		423,473		422,381		—		422,381		—
Federal funds purchased		4,800		4,800		—		4,800		—
Federal Home Loan Bank advances		5,233		5,241		—		5,241		—
Accrued interest payable		210		210		—		210		—

NOTE 6 – FAIR VALUE MEASUREMENTS

The following tables present information about assets and liabilities measured at fair value on a recurring basis and the valuation techniques used 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, 2019 or December 31, 2018. 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		Significant Other Observable Inputs		Significant Unobservable Inputs		Balance at Date
	(Level 1)		(Level 2)		(Level 3)		Indicated
Equity Securities Held at Fair Value - September 30, 2019
Equity securities	$	1,499	$	—	$	1,000	$	2,499

Investment Securities, Available for Sale – September 30, 2019
U.S. Treasury notes and bonds	$	—	$	2,012	$	—	$	2,012
U.S. Government and federal agency		—		23,049		—		23,049
State and municipal		—		90,975		9,777		100,752
Mortgage-backed		—		25,286		—		25,286
Corporate		—		2,679		—		2,679
Foreign debt		—		500		—		500
Trust preferred securities		—		—		500		500
Total	$	—	$	144,501	$	10,277	$	154,778

Equity Securities Held at Fair Value - December 31, 2018
Equity securities	$	1,961	$	—	$	886	$	2,847

Investment Securities, Available for Sale - December 31, 2018
U.S. Treasury notes and bonds	$	—	$	1,947	$	—	$	1,947
U.S. Government and federal agency		—		33,529		—		33,529
State and municipal		—		95,930		7,998		103,928
Mortgage-backed		—		21,575		—		21,575
Corporate		—		5,102		—		5,102
Trust preferred securities		—		—		500		500
Asset backed securities		—		21		—		21
Total	$	—	$	158,104	$	8,498	$	166,602

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

	Nine months ended
(Dollars in thousands)	September 30,
	2019		2018
Equity Securities Held at Fair Value
Balance, January 1	$	886	$	—
Reclassification due to implementation of ASU 2016-01		—		1,000
Total realized and unrealized gains included in noninterest income		114		—
Net purchases, sales, calls, and maturities		—		—
Net transfers into Level 3		—		—
Balance, September 30	$	1,000	$	1,000

Investment Securities, Available for Sale
Balance, January 1	$	8,498	$	13,398
Reclassification due to implementation of ASU 2016-01		—		(1,000	)
Total unrealized gains (losses) included in other comprehensive income		350		(347	)
Net purchases, sales, calls, and maturities		1,429		(3,656	)
Net transfers into Level 3		—		—
Balance, September 30	$	10,277	$	8,395

Of the available for sale Level 3 assets that were held by ChoiceOne at September 30, 2019, the net unrealized gain as of September 30, 2019 was $495,000, which was recognized in accumulated other comprehensive income in the consolidated balance sheet. Of the equity securities classified as Level 3 assets that were held by ChoiceOne at September 30, 2019, the fair value was consistent with par as of September 30, 2019. ChoiceOne purchased two bonds from municipalities in our market area at a purchase price of $2.1 million that are considered Level 3 securities in the nine months ended September 30, 2019.

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.

Securities categorized as Level 3 assets primarily consist of bonds issued by local municipalities and equity securities of community banks. ChoiceOne 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.

ChoiceOne 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

(Dollars in thousands)	Balance at Dates		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Indicated		(Level 1)		(Level 2)		(Level 3)
Impaired Loans
September 30, 2019	$	5,665	$	—	$	—	$	5,665
December 31, 2018	$	4,024	$	—	$	—	$	4,024

Other Real Estate
September 30, 2019	$	284	$	—	$	—	$	284
December 31, 2018	$	102	$	—	$	—	$	102

Impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. ChoiceOne 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.

NOTE 7 – REVENUE FROM CONTRACTS WITH CUSTOMERS

ChoiceOne has a variety of sources of revenue, which include interest and fees from customers as well as revenue from non-customers. ASC Topic 606, Revenue from Contracts With Customers, covers certain sources of revenue that are classified within noninterest income in the Consolidated Statements of Income. Sources of revenue that are included in the scope of ACS Topic 606 include service charges and fees on deposit accounts, interchange income, investment asset management income and transaction-based revenue, and other charges and fees for customer services.

Service Charges and Fees on Deposit Accounts

Revenue includes charges and fees to provide account maintenance, overdraft services, wire transfers, funds transfer, and other deposit-related services. Account maintenance fees such as monthly services charges are recognized over the period of time that the service is provided. Transaction fees such as wire transfer charges are recognized when the service is provided to the customer.

Interchange Income

Revenue includes debit card interchange and network revenues. This revenue is earned on debit card transactions that are conducted through payment networks such as MasterCard. The revenue is recorded as services are delivered and is presented net of interchange expenses.

Investment Commission Income

Revenue includes fees from investment management advisory services and revenue is recognized when services are rendered. Revenue also includes commissions received from the placement of brokerage transactions for purchase or sale of stocks or other investments. Commission income is recognized when the transaction has been completed.

Following is noninterest income separated by revenue within the scope of ASC 606 and revenue within the scope of other GAAP topics:

	Three months ended				Nine months ended
	September 30,				September 30,
(Dollars in thousands)	2019		2018		2019		2018

Service charges and fees on deposit accounts	$	690	$	715	$	1,987	$	2,007
Interchange income		404		449		1,288		1,333
Investment commission income		72		80		177		187
Other charges and fees for customer services		57		46		177		158
Noninterest income from contracts with customers within the scope of ASC 606		1,223		1,290		3,629		3,685
Noninterest income within the scope of other GAAP topics		712		562		2,092		1,536
Total noninterest income	$	1,935	$	1,852	$	5,721	$	5,221

NOTE 8 – BUSINESS COMBINATION

On October 1, 2019, ChoiceOne completed the merger of County Bank Corp (“County”), the holding company for Lakestone Bank and Trust, with and into ChoiceOne pursuant to an Agreement and Plan of Merger dated March 22, 2019. Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each share of County common stock was converted into the right to receive 2.0632 shares of ChoiceOne common stock plus cash in lieu of any fractional shares. As a result of the Merger, a total of 3,603,872 shares of ChoiceOne common stock were identified that would be issued to County shareholders. The consolidated financial statements as of and for the nine months ended September 30, 2019 do not include financial results for County. As of the merger date, County had total assets of approximately $673 million, total loans of approximately $428 million, and total deposits of approximately $574 million. The initial accounting for the merger is not yet complete.

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,” “look forward,” “continue”, “future”, 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, loan servicing rights, other real estate owned, and the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary and the amount of any impairment) and management’s assumptions concerning pension and other postretirement benefit plans involve judgments that are inherently forward-looking. All of the information concerning interest rate sensitivity is forward-looking. All statements with references to future time periods are forward-looking. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“risk factors”) that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed, implied or forecasted in such forward-looking statements. Furthermore, ChoiceOne undertakes no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events, or otherwise.

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, 2018. 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 2019 was $1,021,000, which represented a decrease of $993,000 or 49% compared to the same period in 2018. Net income for the first nine months of 2019 was $4,144,000, which represented a decrease of $1,361,000 or 25% compared to the first nine months of the prior year. Growth in noninterest expense in both the third quarter and first nine months of 2019 compared to the same periods in 2018 was partially offset by higher noninterest income in the third quarter and higher net interest income and noninterest income in the first three quarters of 2019 compared to the same period in the prior year. Noninterest expense for the first nine months of 2019 was impacted by $1.4 million of expense related to the merger of County Bank Corp (“County”) with and into ChoiceOne, completed on October 1, 2019. The federal income tax effect of the merger expenses for the first nine months of 2019 is estimated to be $157,000 as only a portion of the expenses are expected to be tax deductible. Net income adjusted to exclude tax-effected merger expenses of $1,194,000 was $5,338,000 in the first nine months of 2019.

Basic and diluted earnings per common share were $0.28 for the third quarter and $1.14 for the first nine months of 2019, compared to $0.55 for the third quarter and $1.52 for the first three quarters of the prior year. Diluted earnings per share, adjusted to exclude the tax-effected merger expenses, would have been $0.45 in the third quarter and $1.46 in the first nine months of 2019. Earnings per share for 2018 was adjusted for the 5% stock dividend paid in May 2018. The return on average assets and return on average shareholders’ equity were 0.83% and 6.62%, respectively, for the first nine months of 2019, compared to 1.16% and 9.63%, respectively, for the same period in 2018.

Net income, basic earnings per share, diluted earnings per share, return on average assets and return on average shareholders’ equity, excluding tax-effected merger expenses are non-GAAP financial measures. Please refer to the section below titled “Non-GAAP Financial Measures” for a reconciliation to the most directly-comparable GAAP financial measures.

Business Combination

On October 1, 2019, ChoiceOne completed the merger of County, the holding company for Lakestone Bank and Trust, with and into ChoiceOne pursuant to an Agreement and Plan of Merger dated March 22, 2019. Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each share of County common stock was converted into the right to receive 2.0632 shares of ChoiceOne common stock plus cash in lieu of any fractional shares. The consolidated financial statements as of and for the nine months ended September 30, 2019 do not include financial results for County.

Dividends

Cash dividends of $2,906,000 or $0.80 per share were declared in the third quarter of 2019, compared to $651,000 or $0.18 per share in the third quarter of 2018. Cash dividends declared in the first nine months of 2019 were $4,356,000 or $1.20 per share, compared to $1,921,000 or an adjusted $0.53 per share in the same period in the prior year. The per share amount for the first nine months of 2018 was adjusted for the 5% stock dividend paid in May 2018. Cash dividends in the third quarter and first nine months of 2019 included a special dividend of $2,180,000 or $0.60 per share, paid in connection with the merger of County with and into ChoiceOne. The cash dividend payout percentage was 105% for the first nine months of 2019, compared to 35% in the same period in the prior year. The cash dividend percentage for the first nine months of 2019, if adjusted for the special dividend, would have been 53%.

Interest Income and Expense

Tables 1 and 2 on the following pages provide information regarding interest income and expense for the three month and nine month periods ended September 30, 2019 and 2018. 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

	Three Months Ended September 30,
	2019								2018
(Dollars in thousands)	Average								Average
	Balance		Interest			Rate			Balance		Interest			Rate
Assets:
Loans (1)	$	429,448	$	5,396			5.03	%	$	407,157	$	5,111			5.02	%
Taxable securities (2) (3)		107,689		728			2.70			115,662		736			2.55
Nontaxable securities (1) (2)		53,581		447			3.33			56,823		475			3.34
Other		17,471		87			2.00			8,639		40			1.85
Interest-earning assets		608,189		6,658			4.38			588,281		6,362			4.33
Noninterest-earning assets		64,757								55,738
Total assets	$	672,946							$	644,019

Liabilities and Shareholders’ Equity:
Interest-bearing demand deposits	$	217,717		274			0.50	%	$	214,629		190			0.35	%
Savings deposits		75,471		12			0.06			75,091		4			0.02
Certificates of deposit		131,989		687			2.08			115,409		425			1.48
Advances from Federal Home Loan Bank		1,027		8			3.02			11,095		63			2.27
Other		1,360		10			3.05			1,521		8			2.10
Interest-bearing liabilities		427,564		991			0.93			417,745		690			0.66
Noninterest-bearing demand deposits		157,182								147,863
Other noninterest-bearing liabilities		2,812								1,522
Total liabilities		587,558								567,130
Shareholders’ equity		85,388								76,889
Total liabilities and shareholders’ equity	$	672,946							$	644,019

Net interest income (tax-equivalent basis)- interest spread (Non-GAAP) (1)			$	5,667			3.46	%			$	5,672			3.66	%
Net interest income as a percentage of earning assets (tax-equivalent basis) (Non-GAAP) (1)							3.73	%							3.86	%

Reconciliation to Reported Net Interest Income
Net interest income (tax-equivalent basis) (Non-GAAP) (1)			$	5,667							$	5,672
Adjustment for taxable equivalent interest				(97	)							(101	)
Net interest income (GAAP)			$	5,570							$	5,571

Net interest margin (GAAP)				3.66	%							3.79	%

	Nine Months Ended September 30,
	2019								2018
(Dollars in thousands)	Average								Average
	Balance		Interest			Rate			Balance		Interest			Rate
Assets:
Loans (1)	$	426,444	$	16,072			5.03	%	$	399,729	$	14,737			4.92	%
Taxable securities (2) (3)		114,004		2,255			2.64			113,213		2,134			2.51
Nontaxable securities (1) (2)		54,356		1,368			3.36			56,113		1,392			3.31
Other		11,551		194			2.24			7,723		109			1.88
Interest-earning assets		606,355		19,889			4.37			576,778		18,372			4.25
Noninterest-earning assets		61,710								55,132
Total assets	$	668,065							$	631,910

Liabilities and Shareholders’ Equity:
Interest-bearing demand deposits	$	213,295		809			0.51	%	$	209,865		442			0.28	%
Savings deposits		74,760		31			0.06			76,333		11			0.02
Certificates of deposit		128,077		1,908			1.99			105,776		975			1.23
Advances from Federal Home Loan Bank		11,576		238			2.74			11,970		165			1.84
Other		1,797		39			2.92			3,909		34			1.16
Interest-bearing liabilities		429,505		3,025			0.94			407,853		1,627			0.53
Noninterest-bearing demand deposits		153,097								146,598
Other noninterest-bearing liabilities		1,963								1,207
Total liabilities		584,565								555,658
Shareholders’ equity		83,500								76,252
Total liabilities and shareholders’ equity	$	668,065							$	631,910

Net interest income (tax-equivalent basis)-interest spread (Non-GAAP) (1)			$	16,864			3.43	%			$	16,745			3.72	%
Net interest income as a percentage of earning assets (tax-equivalent basis) (Non-GAAP) (1)							3.71	%							3.87	%

Reconciliation to Reported Net Interest Income
Net interest income (tax-equivalent basis) (Non-GAAP) (1)			$	16,864							$	16,745
Adjustment for taxable equivalent interest				(297	)							(297	)
Net interest income (GAAP)			$	16,567							$	16,448

Net interest margin (GAAP)				3.64	%							3.87	%

	(1)	Adjusted to a fully tax-equivalent basis to facilitate comparison to the taxable interest-earning assets. The adjustment uses an incremental tax rate of 21%. The presentation these measures on a tax-equivalent basis is not in accordance with GAAP, but is customary in the banking industry. These non-GAAP measures ensure comparability with respect to both taxable and tax-exempt loans and securities.
	(2)	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

	Three Months Ended September 30,
(Dollars in thousands)	2019 Over 2018
	Total			Volume			Rate
Increase (decrease) in interest income (1)
Loans (2)	$	285		$	280		$	5
Taxable securities		(8	)		(197	)		189
Nontaxable securities (2)		(28	)		(27	)		(1	)
Other		47			44			3
Net change in tax-equivalent interest income		296			100			196

Increase (decrease) in interest expense (1)
Interest-bearing demand deposits		84			3			81
Savings deposits		8			—			8
Certificates of deposit		261			68			193
Advances from Federal Home Loan Bank		(55	)		(162	)		107
Other		2			(5	)		7
Net change in interest expense		300			(96	)		396

Net change in tax-equivalent net interest income	$	(4	)	$	196		$	(200	)

	Nine Months Ended September 30,
(Dollars in thousands)	2019 Over 2018
	Total			Volume			Rate
Increase (decrease) in interest income (1)
Loans (2)	$	1,335		$	1,001		$	334
Taxable securities		121			15			106
Nontaxable securities (2)		(24	)		(54	)		30
Other		85			61			24
Net change in tax-equivalent interest income		1,517			1,023			494

Increase (decrease) in interest expense (1)
Interest-bearing demand deposits		367			8			359
Savings deposits		20			—			20
Certificates of deposit		933			238			695
Advances from Federal Home Loan Bank		73			(9	)		82
Other		5			(35	)		40
Net change in interest expense		1,398			202			1,196

Net change in tax-equivalent net interest income	$	119		$	821		$	(702	)

	(1)	The volume variance is computed as the change in volume (average balance) multiplied by the previous year’s interest rate. The rate variance is computed as the change in interest rate multiplied by the previous year’s volume (average balance). The change in interest due to both volume and rate has been allocated to the volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
	(2)	Interest on nontaxable investment securities and loans has been adjusted to a fully tax-equivalent basis using an incremental tax rate of 21%.

Net Interest Income

Tax-equivalent net interest income increased $119,000 in the first nine months of 2019 compared to the same period in 2018. The benefit from growth in average interest-earning assets was mostly offset by a decline in the net interest spread in 2019 compared to 2018. The net interest spread on a tax-equivalent basis declined by 29 basis points from 3.72% in the first nine months of 2018 to 3.43% in the same period in 2019, which had a $702,000 negative impact on tax-equivalent net interest income in the first nine months of 2019 compared to the same period in the prior year.

The average balance of loans increased $26.7 million in the first nine months of 2019 compared to the same period in 2018. Loans to other financial institutions provided $16.6 million of the growth. Average residential real estate loans increased $7.8 million, while average commercial and industrial loans and commercial real estate loans were $2.2 million higher in the first nine months of 2019 than the first nine months of the prior year. The increase in the average loans balance was bolstered by an 11 basis point increase in the average rate earned. This caused tax-equivalent interest income from loans to increase $1.3 million in the first three quarters of 2019 compared to the same period in the prior year. The average balance of total securities decreased $1.0 million in the first nine months of 2019 compared to the same period in 2018. The effect of the average balance decline, offset by a 9 basis point increase in the average rate earned on securities, caused tax-equivalent securities income to increase $97,000 in the first nine months of 2019 compared to the same period in 2018.

The average balance of interest-bearing demand deposits increased $3.4 million in the first nine months of 2019 compared to the same period in 2018. The growth plus the impact of an increase of 23 basis points in the average rate paid on interest-bearing demand deposits caused interest expense to increase $367,000 in the first nine months of 2019 compared to the same period in 2018. The average balance of certificates of deposit was up $22.3 million in the first nine months of 2019 compared to the same period in 2018. Brokered certificates of deposit provided $10.5 million of the average balance increase in 2019. The growth in certificates of deposit plus a 76 basis point increase in the average rate paid on certificates caused interest expense to increase $933,000 in the first nine months of 2019 compared to the same period in 2018. The impact of a 90 basis point increase in the average rate paid on Federal Home Loan Bank advances caused interest expense to increase $73,000 in the first nine months of 2019 compared to the first nine months of 2018.

ChoiceOne’s net interest income spread on a tax-equivalent basis was 3.43% in the first nine months of 2019, compared to 3.72% for the same period in 2018. The decline in the interest spread was due to an increase of 41 basis points in the average rate paid on interest-bearing liabilities, which was partially offset by growth of 12 basis points in the average rate earned on interest earning assets. Increases in short-term interest rates that began in 2018 and continued in early 2019 was the primary factor for the higher average rates in both interest earning assets and interest-bearing liabilities. The rate earned on ChoiceOne’s floating rate loans was also impacted by decreases in the federal funds rate of 25 basis points on July 31, 2019 and September 18, 2019. Competition in ChoiceOne’s market areas for loans and deposits caused the interest rates that could be obtained on new loan originations to be less than the increase in rates necessary to retain local deposits and to grow wholesale funding.

Provision and Allowance for Loan Losses

Total loans decreased $2.3 million in the first nine months of 2019, while the allowance for loan losses decreased $577,000 during the same period. No provision expense was recorded in the first nine months of 2019 due to the small decline in loans that occurred since the end of 2018. Nonperforming loans were $5.6 million as of September 30, 2019, compared to $6.3 million as of June 30, 2019 and $3.8 million as of December 31, 2018. The decline in nonperforming loans in the third quarter of 2019 was due to a $670,000 charge-off of a portion of a large loan relationship. A specific reserve had been allocated to this relationship in the second quarter of 2019. The allowance for loan losses was 1.01% of total loans at September 30, 2019, compared to 1.21% at June 30, 2019 and 1.14% at December 31, 2018.

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

(Dollars in thousands)	2019				2018
	Charge-offs		Recoveries		Charge-offs		Recoveries
Agricultural	$	—	$	65	$	—	$	—
Commercial and industrial		83		21		58		57
Consumer		222		113		180		73
Commercial real estate		589		22		—		61
Construction real estate		—		—		—		—
Residential real estate		25		121		25		82
	$	919	$	342	$	263	$	273

Net charge-offs of $705,000 and $577,000 were recorded in the third quarter and first nine months of 2019, respectively, compared to net charge-offs of $37,000 and net recoveries of $10,000 during the same periods in 2018, respectively. Net charge-offs on an annualized basis as a percentage of average loans were 0.18% in the first nine months of 2019 and 0.00% 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 2019, 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 increased $83,000 in the third quarter and $500,000 in the first nine months of 2019 compared to the same periods in 2018. As a result of lower long-term interest rates, gains on sales of loans increased $415,000 in the third quarter and $601,000 in the first three quarters of 2019 compared to the same periods in the prior year. The negative change in the market value of equity securities in the third quarter of 2019 compared to a positive change in the third quarter of 2018 represented a reversal of market value appreciation that occurred in the first two quarters of 2019.

Noninterest Expense

Total noninterest expense increased $1.3 million in the third quarter and $2.3 million in the first nine months of 2019 compared to the same periods in 2018. Growth in professional fees of $526,000 and $1.2 million in the third quarter and first nine months of 2019, respectively, was primarily due to the merger of County with and into ChoiceOne. Part of the increase in data processing expenses in 2019 compared to 2018 was also related to the merger. ChoiceOne’s two new offices contributed to the growth in salaries and benefits and occupancy and equipment expense in 2019 compared to 2018.

Income Tax Expense

Income tax expense was $671,000 in the first nine months of 2019 compared to $992,000 for the same period in 2018. The effective tax rate was 13.9% for the first nine months of 2019 and 15.3% for the first nine months of 2018.

FINANCIAL CONDITION

Securities

The securities available for sale portfolio decreased $11.8 million from December 31, 2018 to September 30, 2019. Due to current market rates available for securities, management limited securities purchases in the first three quarters of 2019. Various securities totaling $13.9 million were purchased in the first nine months of 2019 and were offset by approximately $26.1 million of securities called or matured during that same time period. Principal repayments on securities totaled $3.4 million in the first nine months of 2019. Approximately $1.2 million of securities were sold in the first nine months of 2019 for a net gain of $22,000. Due to lower interest rates in the first nine months of 2019, the Bank’s market value adjustment on securities available for sale improved from a net unrealized loss of $1.1 million as of December 31, 2018 to a net unrealized gain of $3.7 million as of September 30, 2019.

Loans

The balance of loans to other financial institutions was $9.3 million higher at September 30, 2019 than at December 31, 2018. The increase resulted from more activity in this loan program during the first three quarters of 2019. Loans, excluding loans held for sale and loans to other financial institutions, declined $2.3 million from December 31, 2018 to September 30, 2019. Decreases of $9.9 million and $0.6 million in commercial and industrial loans and residential real estate loans, respectively, were partially offset by growth of $4.9 million in commercial real estate loans, $2.3 million in construction real estate loans, and $0.9 million in agricultural loans. The balance changes resulted from normal fluctuations in borrower activity.

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 $5.7 million at September 30, 2019, compared to $6.4 million as of June 30, 2019 and $4.0 million as of December 31, 2018. The change from the end of 2018 to June 30, 2019 was primarily comprised of a single relationship that was placed in nonaccrual status in the second quarter of 2019. A charge-off of approximately $670,000 of this loan relationship was recorded in the third quarter of 2019. An allowance of the same amount was allocated to the loan as of June 30, 2019.

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,
	2019		2018
Loans accounted for on a nonaccrual basis	$	3,573	$	1,532
Accruing loans contractually past due 90 days or more as to principal or interest payments		—		—
Loans considered troubled debt restructurings		2,062		2,254
Total	$	5,635	$	3,786

At September 30, 2019, nonaccrual loans included $389,000 in agricultural loans, $279,000 in commercial and industrial loans, $7,000 in consumer loans, $1.9 million in commercial real estate loans, and $973,000 in residential real estate loans. At December 31, 2018, nonaccrual loans included $393,000 in agricultural loans, $62,000 in consumer loans, $123,000 in commercial real estate loans, and $954,000 in residential real estate loans. Approximately 51% of the balance of loans considered troubled debt restructurings were performing according to their restructured terms as of September 30, 2019. Management believes the allowance allocated to its nonperforming loans is sufficient at September 30, 2019.

Deposits and Borrowings

Total deposits increased $12.3 million in the third quarter and declined $2.9 million in the first nine months of 2019. Interest-bearing deposits decreased $1.9 million and noninterest-bearing deposits decreased $1.0 million in the first nine months of 2019 primarily due to seasonal fluctuations for ChoiceOne’s depositors. The total of demand deposits, money market deposits, and savings deposits decreased $2.6 million in the first three quarters of 2019 while growth of $13.8 million in local certificates of deposit virtually offset a reduction of $14.1 million in brokered certificates of deposit.

Shareholders’ Equity

Total shareholders’ equity increased $4.1 million from December 31, 2018 to September 30, 2019. A change in accumulated other comprehensive income of $3.8 million resulted from improvement in the market value of ChoiceOne’s available for sale securities. The improvement was caused by a reduction in the first nine months of 2019 in mid- to long-term interest rates. Net income for the first nine months of 2019 was slightly lower than cash dividends declared during the same time period due to the special dividend paid in connection with the merger of County with and into ChoiceOne.

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, 2019
ChoiceOne Financial Services Inc.
Total capital (to risk weighted assets)	$	71,891		13.6	%	$	42,197		8.0	%		N/A		N/A
Common Equity Tier 1 Capital (to risk weighted assets)		67,803		12.9			23,736		4.5			N/A		N/A
Tier 1 capital (to risk weighted assets)		67,803		12.9			21,099		6.0			N/A		N/A
Tier 1 capital (to average assets)		67,803		10.3			26,396		4.0			N/A		N/A

ChoiceOne Bank
Total capital (to risk weighted assets)	$	68,371		13.0	%	$	42,010		8.0	%	$	52,513		10.0	%
Common Equity Tier 1 Capital (to risk weighted assets)		64,283		12.2			23,631		4.5			34,133		6.5
Tier 1 capital (to risk weighted assets)		64,283		12.2			21,005		6.0			31,508		8.0
Tier 1 capital (to average assets)		64,283		9.8			26,253		4.0			32,816		5.0

December 31, 2018
ChoiceOne Financial Services Inc.
Total capital (to risk weighted assets)	$	72,148		13.8	%	$	41,811		8.0	%		N/A		N/A
Common Equity Tier 1 Capital (to risk weighted assets)		67,481		12.9			23,519		4.5			N/A		N/A
Tier 1 capital (to risk weighted assets)		67,481		12.9			31,359		6.0			N/A		N/A
Tier 1 capital (to average assets)		67,481		10.5			25,658		4.0			N/A		N/A

ChoiceOne Bank
Total capital (to risk weighted assets)	$	66,976		12.9	%	$	41,599		8.0	%	$	51,999		10.0	%
Common Equity Tier 1 Capital (to risk weighted assets)		62,309		12.0			23,399		4.5			33,799		6.5
Tier 1 capital (to risk weighted assets)		62,309		12.0			31,199		6.0			41,599		8.0
Tier 1 capital (to average assets)		62,309		9.8			25,512		4.0			31,890		5.0

Management reviews the capital levels of ChoiceOne and the Bank on a regular basis. The Board of Directors and management believe that the capital levels as of September 30, 2019 are adequate for the foreseeable future. The Board of Directors’ determination of appropriate cash dividends for future periods will be based on, among other things, market conditions and ChoiceOne’s requirements for cash and capital.

Liquidity

Net cash provided from operating activities was $5.4 million for the nine months ended September 30, 2019 compared to $7.0 million provided in the same period a year ago. The decrease was caused by $1.4 million decrease in net income during the first nine months of 2019 compared to the same period in the prior year. Net cash provided by investing activities was $8.5 million for the first nine months of 2019 compared to $29.7 million used in the same period in 2018. The change was primarily due to a net reduction in securities in the first nine months of 2019 compared to net purchases in the same period in the prior year. Net cash used in financing activities was $17.0 million in the nine months ended September 30, 2019, compared to $326,000 provided in the same period in the prior year. The change was due to the net changes in federal funds purchased, a decrease in proceeds from FHLB advances, and deposits, which were partially offset by the net change in repurchase agreements and a decrease in payments on FHLB advances in 2019 compared to 2018.

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.

NON-GAAP FINANCIAL MEASURES

This report contains references to net income, basic earnings per share, and diluted earnings per share excluding tax-effected merger expenses, each of which is a financial measure that is not defined in U.S. generally accepted accounting principles (“GAAP”). Management believes this non-GAAP financial measure provides additional information that is useful to investors in helping to understand the underlying financial performance of ChoiceOne.

Non-GAAP financial measures have inherent limitations. Readers should be aware of these limitations and should be cautious with respect to the use of such measures. To compensate for these limitations, we use non-GAAP measures as comparative tools, together with GAAP measures, to assist in the evaluation of our operating performance or financial condition. Also, we ensure that these measures are calculated using the appropriate GAAP or regulatory components in their entirety and that they are computed in a manner intended to facilitate consistent period-to-period comparisons. ChoiceOne’s method of calculating these non-GAAP financial measures may differ from methods used by other companies. These non-GAAP financial measures should not be considered in isolation or as a substitute for those financial measures prepared in accordance with GAAP or in-effect regulatory requirements.

A reconciliation of these non-GAAP financial measures follows:

Non-GAAP Reconciliation

(Unaudited)

In addition to analyzing the Company’s results on a reported basis, management reviews the Company’s results on an adjusted basis. The non-GAAP measures presented in the table below reflect the adjustments of the reported U.S. GAAP results for significant items that management does not believe are reflective of the Company’s current and ongoing operations.

	Three Months Ended September 30,				Nine Months Ended September 30,
(In Thousands, Except Per Share Data)	2019		2018		2019		2018

Income before income tax	$	1,128	$	2,364	$	4,815	$	6,497
Adjustment for pre-tax merger expenses		763		—		1,351		—
Adjusted income before income tax	$	1,891	$	2,364	$	6,166	$	6,497

Income tax expense	$	106	$	350	$	671	$	992
Tax impact of adjustment for pre-tax merger expenses		142		—		157		—
Adjusted income tax expense	$	248	$	350	$	828	$	992

Net income	$	1,021	$	2,014	$	4,144	$	5,505
Adjustment for pre-tax merger expenses, net of tax impact		621				1,194
Adjusted net income	$	1,642	$	2,014	$	5,338	$	5,505

Basic earnings per share	$	0.28	$	0.55	$	1.14	$	1.52
Effect of merger expenses, net of tax impact		0.17		—		0.33		—
Adjusted basic earnings per share	$	0.45	$	0.55	$	1.47	$	1.52

Diluted earnings per share	$	0.28	$	0.55	$	1.14	$	1.52
Effect of merger expenses, net of tax impact		0.17		—		0.32		—
Adjusted diluted earnings per share	$	0.45	$	0.55	$	1.46	$	1.52

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 as of September 30, 2019. 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 nine months ended September 30, 2019 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, 2018. 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, 2018.

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

On July 24, 2019, ChoiceOne issued 720 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 $21,000. 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

There were no issuer purchases of equity securities during the second quarter of 2019.

Item 5. Other Information

None.

Item 6. Exhibits

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

	Exhibit Number		Document

	2.1		Agreement and Plan of Merger between County Bank Corp, and ChoiceOne Financial Services, Inc. dated March 22, 2019. Previously filed as an exhibit to ChoiceOne’s Form 8-K filed March 25, 2019 . Here incorporated by reference.

	3.1		Amended and Restated Articles of Incorporation of ChoiceOne.

	3.2		Bylaws of ChoiceOne as currently in effect and any amendments thereto. Previously filed as an exhibit to ChoiceOne‘s Form 8-K filed October 1, 2019. Here incorporated by reference.

	10.1		Employment Agreement between ChoiceOne Financial Services, Inc. and Kelly J. Potes, dated as of September 30, 2019. Previously filed as an exhibit to ChoiceOne’s Form 8-K filed October 1, 2019. Here incorporated by reference.

	10.2		Employment Agreement between ChoiceOne Financial Services, Inc. and Michael J. Burke, Jr., dated as of March 22, 2019. Previously filed as Exhibit 10.7 to ChoiceOne’s Pre-Effective Amendment No. 2 to Form S-4 filed August 5, 2019. Here incorporated by reference.

	10.3		Transition Agreement between ChoiceOne Financial Services, Inc. and Bruce J. Cady, dated as of March 22, 2019. Previously filed as Exhibit 10.8 to ChoiceOne’s Pre-Effective Amendment No. 2 to Form S-4 filed August 5, 2019. Here incorporated by reference.

	31.1		Certification of President and 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 12, 2019	/s/ Kelly J. Potes
	Kelly J. Potes Chief Executive Officer (Principal Executive Officer)

Date: November 12, 2019	/s/ Thomas L. Lampen
	Thomas L. Lampen Treasurer (Principal Financial and Accounting Officer)