CHOICEONE FINANCIAL SERVICES INC - Quarter Report: 2019 June (Form 10-Q)

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

FORM 10-Q

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

	For the quarterly period ended June 30, 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)

Securities registered pursuant to Section 12(b) of the Act:

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

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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☒

Non-accelerated filer ☐	Smaller reporting company ☒

Emerging growth company ☐

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

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

As of July 31, 2019, the Registrant had outstanding 3,633,637 shares of common stock.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

ChoiceOne Financial Services, Inc.
CONSOLIDATED BALANCE SHEETS

	June 30,			December 31,
(Dollars in thousands)	2019			2018
	(Unaudited)			(Audited)
Assets
Cash and due from banks	$	13,687		$	19,690

Equity securities at fair value (Note 2)		3,113			2,847
Securities available for sale (Note 2)		162,684			166,602
Federal Home Loan Bank stock		1,994			1,994
Federal Reserve Bank stock		1,574			1,573

Loans held for sale		2,194			831
Loans to other financial institutions		28,950			20,644
Loans (Note 3)		397,227			409,073
Allowance for loan losses (Note 3)		(4,801	)		(4,673	)
Loans, net		392,426			404,400

Premises and equipment, net		15,502			15,879
Cash surrender value of life insurance policies		15,090			14,899
Goodwill		13,728			13,728
Other assets		7,555			7,457
Total assets	$	658,497		$	670,544

Liabilities
Deposits – noninterest-bearing	$	149,320		$	153,542
Deposits – interest-bearing		412,456			423,473
Total deposits		561,776			577,015

Federal funds purchased		2,000			4,800
Advances from Federal Home Loan Bank		5,216			5,233
Other liabilities		3,842			3,019
Total liabilities		572,834			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:
3,632,917 at June 30, 2019 and 3,616,483 at December 31, 2018		54,756			54,523
Retained earnings		28,359			26,686
Accumulated other comprehensive income (loss), net		2,548			(732	)
Total shareholders’ equity		85,663			80,477
Total liabilities and shareholders’ equity	$	658,497		$	670,544

See accompanying notes to interim consolidated financial statements.

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

	Three Months Ended June 30,				Six Months Ended June 30,
(Dollars in thousands, except per share data)	2019		2018		2019		2018
Interest income
Loans, including fees	$	5,390	$	5,028	$	10,670	$	9,624
Securities:
Taxable		767		713		1,527		1,398
Tax exempt		358		362		727		723
Other		39		12		107		69
Total interest income		6,554		6,115		13,031		11,814

Interest expense
Deposits		924		463		1,775		809
Advances from Federal Home Loan Bank		115		57		230		102
Other		14		25		29		26
Total interest expense		1,053		545		2,034		937

Net interest income		5,501		5,570		10,997		10,877
Provision for loan losses		—		—		—		35

Net interest income after provision for loan losses		5,501		5,570		10,997		10,842

Noninterest income
Customer service charges		1,148		1,120		2,181		2,175
Insurance and investment commissions		74		72		137		134
Gains on sales of loans		489		288		735		549
Gains on sales of securities		2		16		3		25
Gains on sales of other assets		2		—		15		8
Earnings on life insurance policies		95		98		191		192
Change in market value of equity securities		80		26		266		49
Other		139		101		258		237
Total noninterest income		2,029		1,721		3,786		3,369

Noninterest expense
Salaries and benefits		2,870		2,779		5,647		5,528
Occupancy and equipment		741		664		1,512		1,344
Data processing		582		555		1,138		1,089
Professional fees		678		311		1,195		528
Supplies and postage		75		97		175		213
Advertising and promotional		108		85		152		177
Other		708		623		1,277		1,199
Total noninterest expense		5,762		5,114		11,096		10,078

Income before income tax		1,767		2,177		3,687		4,133
Income tax expense		281		344		564		642

Net income	$	1,487	$	1,833	$	3,123	$	3,491

Basic earnings per share (Note 4)	$	0.41	$	0.51	$	0.86	$	0.97
Diluted earnings per share (Note 4)	$	0.41	$	0.50	$	0.86	$	0.96
Dividends declared per share	$	0.20	$	0.18	$	0.40	$	0.35

See accompanying notes to interim consolidated financial statements.

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

	Three Months Ended June 30,						Six Months Ended June 30,
(Dollars in thousands)
	2019			2018			2019			2018
Net income	$	1,487		$	1,833		$	3,123		$	3,491

Other comprehensive income:
Changes in net unrealized gains and losses on investment securities available for sale, net of tax benefit (expense) of ($549) and $86 for the three months ended June 30, 2019 and June 30, 2018 respectively. Changes in net unrealized gains on investment securities available for sale, net of tax benefit (expense) of ($872) and $569 for the six months ended June 30, 2019 and June 30, 2018 respectively.		2,067			(324	)		3,282			(2,140	)

Less: Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax expense of $1 and $3 for the three months ended June 30, 2019 and June 30, 2018 respectively. Reclassification adjustment for realized gain on sale of investment securities available for sale included in net income, net of tax expense of $1 and $5 for the six months ended June 30, 2019 and June 30, 2018 respectively.		(1	)		(12	)		(2	)		(20	)

Other comprehensive income (loss), net of tax		2,066			(336	)		3,280			(2,160	)

Comprehensive income	$	3,553		$	1,497		$	6,403		$	1,331

See accompanying notes to interim consolidated financial statements.

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

THREE MONTHS ENDED JUNE 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, April 1, 2018		3,439,837		$	50,139		$	27,306		$	(1,831	)	$	75,614

Net income								1,833						1,833
Other comprehensive loss											(336	)		(336	)
Shares issued		3,036			17									17
Shares repurchased		(10,000	)		(271	)								(271	)
Effect of employee stock purchases					3									3
Stock options exercised and issued		809			—									—
Stock-based compensation expense					66									66
Restricted stock units vested		7,304												—
Stock dividend declared (5%)		172,094			4,335			(4,342	)					(7	)
Cash dividends declared ($0.18 per share)								(651	)					(651	)

Balance, June 30, 2018		3,613,080		$	54,289		$	24,146		$	(2,167	)	$	76,268


Balance, April 1, 2019		3,619,510		$	54,621		$	27,598		$	482		$	82,701

Net income								1,487						1,487
Other comprehensive income											2,066			2,066
Shares issued		3,253			12									12
Effect of employee stock purchases					3									3
Stock options exercised and issued		3,390			46									46
Stock-based compensation expense					64									64
Restricted stock units issued		6,764			10									10
Cash dividends declared ($0.20 per share)								(726	)					(726	)

Balance, June 30, 2019		3,632,917			54,756		$	28,359		$	2,548		$	85,663

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

SIX MONTHS ENDED JUNE 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								3,491						3,491
Other comprehensive loss											(2,160	)		(2,160	)
Shares issued		4,532			50									50
Shares repurchased		(20,228	)		(523	)								(523	)
Effect of employee stock purchases					6									6
Stock options exercised and issued		809												—
Stock-based compensation expense					131									131
Restricted stock units vested		7,304												—
Adoption effect of ASU 2016-01 (1)								244			(244	)		—
Stock dividend declared (5%)		172,094			4,335			(4,342	)					(7	)
Cash dividends declared ($0.35 per share)								(1,270	)					(1,270	)

Balance, June 30, 2018		3,613,080		$	54,289		$	24,146		$	(2,167	)	$	76,268


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

Net income								3,123						3,123
Other comprehensive income											3,280			3,280
Shares issued		5,257			59									59
Effect of employee stock purchases					7									7
Stock options exercised and issued		3,390			46									46
Stock-based compensation expense					121									121
Restricted stock units issued		7,787												—
Cash dividends declared ($0.40 per share)								(1,450	)					(1,450	)

Balance, June 30, 2019		3,632,917			54,756		$	28,359		$	2,548		$	85,663

(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)

	Six Months Ended June 30,
(Dollars in thousands)
	2019			2018
Cash flows from operating activities:
Net income	$	3,123		$	3,491
Adjustments to reconcile net income to net cash from
operating activities:
Provision for loan losses		—			35
Depreciation		700			579
Amortization		445			460
Compensation expense on employee and director stock purchases,
stock options, and restricted stock units		145			148
Gains on sales of securities		(3	)		(25	)
Net change in market value of equity securities		(266	)		(49	)
Gains on sales of loans		(735	)		(549	)
Loans originated for sale		(11,166	)		(17,835	)
Proceeds from loan sales		10,110			19,120
Earnings on bank-owned life insurance		(191	)		(192	)
Gains on sales of other real estate owned		(15	)		(8	)
Proceeds from sales of other real estate owned		104			114
Deferred federal income tax benefit		94			40
Net changes in other assets		160			(804	)
Net changes in other liabilities		(49	)		219
Net cash from operating activities		2,456			4,744

Cash flows from investing activities:
Securities available for sale:
Sales		—			2,716
Maturities, prepayments and calls		17,581			6,072
Purchases		(9,755	)		(21,177	)
Purchase of Federal Reserve Bank stock		(1	)		—
Loan originations and payments, net		3,457			686
Additions to premises and equipment		(323	)		(1,143	)
Net cash used in investing activities		10,959			(12,846	)

Cash flows from financing activities:
Net change in deposits		(15,239	)		(11,932	)
Net change in repurchase agreements		—			(7,148	)
Net change in federal funds purchased		(2,800	)		4,000
Proceeds from Federal Home Loan Bank advances		75,000			30,000
Payments on Federal Home Loan Bank advances		(75,017	)		(30,017	)
Issuance of common stock		88			40
Repurchase of common stock		—			(523	)
Cash dividends and fractional shares from stock dividend		(1,450	)		(1,278	)
Net cash used in financing activities		(19,418	)		(16,858	)

Net change in cash and cash equivalents		(6,003	)		(24,960	)
Beginning cash and cash equivalents		19,690			36,837

Ending cash and cash equivalents	$	13,687		$	11,877

Supplemental disclosures of cash flow information:
Cash paid for interest	$	2,043		$	889
Cash paid for income taxes	$	185		$	700
Loans transferred to other real estate owned	$	347		$	179

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 June 30, 2019 and December 31, 2018, the Consolidated Statements of Income for the three and six-month periods ended June 30, 2019 and June 30, 2018, the Consolidated Statements of Comprehensive Income for the three and six-month periods ended June 30, 2019 and June 30, 2018, the Consolidated Statements of Changes in Shareholders’ Equity for the three and six-month periods ended June 30, 2019 and June 30, 2018, and the Consolidated Statements of Cash Flows for the six months ended June 30, 2019 and June 30, 2018. Operating results for the six months ended June 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 24% of the total at June 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 June 30, 2019, 27 of the 184 participating interests with principal balances totaling $5.8 million had balances outstanding over 30 days. During the first six 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

Shares totaling 3,390 were issued upon the exercise of stock options for a cash price of $46,000 in the first six months of 2019. A total of 3,419 shares of common stock were issued to ChoiceOne’s Board of Directors for a cash price of $89,000 under the terms of the Directors’ Stock Purchase Plan in the first half of 2019. A total of 1,838 shares for a cash price of $42,000 were issued under the Employee Stock Purchase Plan in the first six months of 2019. Shares issued upon the vesting of restricted stock units, net of shares withheld for payment of related taxes, totaled 7,787 in the first half 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. The company implemented ASU 2016-01 effective January 1, 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 July 2019, FASB made a decision to propose delaying 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 would be eligible for the proposed delay under the updated language in the standard. ChoiceOne is currently evaluating the impact of the proposed delay on its implementation project plan.

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:

			June 30, 2019
			Gross		Gross
(Dollars in thousands)	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value
Equity securities	$	2,502	$	634	$	(23	)	$	3,113

			December 31, 2018
				Gross		Gross
(Dollars in thousands)		Amortized		Unrealized		Unrealized			Fair
		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:

			June 30, 2019
				Gross		Gross
(Dollars in thousands)	Amortized			Unrealized		Unrealized			Fair
	Cost			Gains		Losses			Value
U.S. Government and federal agency	$	30,065		$	23	$	(18	)	$	30,070
U.S. Treasury		1,993			9		—			2,002
State and municipal		99,514			2,371		(12	)		101,873
Mortgage-backed		24,419			656		(3	)		25,072
Corporate		2,647			25		(5	)		2,667
Foreign debt		500			—		—			500
Trust preferred securities		500			—		—			500
Total	$	159,638		$	3,084	$	(38	)	$	162,684

			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 six-months ended June 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 June 30, 2019, the fair value of securities as of June 30, 2019 and December 31, 2018, and the weighted average yields of securities as of June 30, 2019:

	Securities maturing within:
														Fair Value			Fair Value
		Less than			1 Year -			5 Years -			More than			at June 30,			at Dec. 31,
(Dollars in thousands)		1 Year			5 Years			10 Years			10 Years			2019			2018

U.S. Government and federal agency	$	21,048		$	7,025		$	1,997		$	—		$	30,070		$	33,529
U.S. Treasury notes and bonds		—			2,002			—			—			2,002			1,947
State and municipal		12,503			51,177			36,244			1,949			101,873			103,928
Corporate		—			2,667			—			—			2,667			5,102
Foreign debt		500			—			—			—			500			—
Trust preferred securities		500			—			—			—			500			500
Asset-backed securities		—			—			—			—			—			21
Total debt securities		34,551			62,871			38,241			1,949			137,612			145,027

Mortgage-backed securities		16			19,400			5,656			—			25,072			21,575
Equity securities (1)		—			—			977			2,136			3,113			2,847
Total	$	34,567		$	82,271		$	44,874		$	4,085		$	165,797		$	169,449

	Weighted average yields:
		Less than			1 Year -			5 Years -			More than
		1 Year			5 Years			10 Years			10 Years			Total
U.S. Government and federal agency		2.00	%		2.33	%		2.73	%		—	%		2.12	%
U.S. Treasury notes and bonds		—			1.85			—			—			1.85
State and municipal (2)		2.61			2.82			3.20			0.65			2.89
Corporate		—			2.66			—			—			2.66
Foreign debt		2.27			—			—			—			2.27
Trust preferred securities		6.00			—			—			—			6.00
Mortgage-backed securities		4.45			3.09			3.07			—			3.08
Equity securities (1)		—			—			4.51			—			1.22

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

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


	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018

Net gains and losses recognized during the period	$	80	$	26	$	266	$	58
Less: Net gains and losses recognized during the period on securities sold		—		—		—		9
Unrealized gains and losses recognized during the reporting period on securities still held at the reporting date	$	80	$	26	$	266	$	49

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
June 30, 2019
Beginning balance	$	424		$	857		$	336		$	1,863	$	40		$	558		$	652		$	4,730
Charge-offs		—			(1	)		(45	)		—		—			(15	)		—			(61	)
Recoveries		65			3			39			4		—			21			—			132
Provision		(127	)		(41	)		5			531		3			(42	)		(329	)		—
Ending balance	$	362		$	818		$	335		$	2,398	$	43		$	522		$	323		$	4,801

Six Months Ended
June 30, 2019
Beginning balance	$	481		$	892		$	254		$	1,926	$	38		$	537		$	545		$	4,673
Charge-offs		—			(2	)		(151	)		—		—			(14	)		—			(167	)
Recoveries		65			20			88			6		—			116			—			295
Provision		(184	)		(92	)		144			466		5			(117	)		(222	)		—
Ending balance	$	362		$	818		$	335		$	2,398	$	43		$	522		$	323		$	4,801

Individually evaluated for impairment	$	80		$	84		$	10		$	605	$	—		$	159		$	—		$	938

Collectively evaluated for impairment	$	282		$	734		$	325		$	1,793	$	43		$	363		$	323		$	3,863

Three Months Ended
June 30, 2018
Beginning balance	$	350		$	1,005		$	245		$	1,786	$	18		$	625		$	680		$	4,709
Charge-offs		—			(57	)		(50	)		—		—			(9	)		—			(116	)
Recoveries		—			—			15			3		—			48			—			66
Provision		9			22			(5	)		122		(2	)		(44	)		(102	)		—
Ending balance	$	359		$	970		$	205		$	1,911	$	16		$	620		$	578		$	4,659

Six Months Ended
June 30, 2018
Beginning balance	$	506		$	1,001		$	262		$	1,761	$	35		$	726		$	286		$	4,577
Charge-offs		—			(58	)		(118	)		—		—			(13	)		—			(189	)
Recoveries		—			53			51			59		—			73			—			236
Provision		(147	)		(26	)		10			91		(19	)		(166	)		292			35
Ending balance	$	359		$	970		$	205		$	1,911	$	16		$	620		$	578		$	4,659

Individually evaluated for impairment	$	—		$	76		$	1		$	28	$	—		$	221		$	—		$	326

Collectively evaluated for impairment	$	359		$	894		$	204		$	1,883	$	16		$	399		$	578		$	4,333

Loans
June 30, 2019
Individually evaluated for impairment	$	389		$	362		$	54		$	2,937	$	—		$	2,613					$	6,355
Collectively evaluated for impairment		40,492			84,720			24,628			138,005		9,948			93,079						390,872
Ending balance	$	40,881		$	85,082		$	24,682		$	140,942	$	9,948		$	95,692					$	397,227

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)	June 30,		December 31,		June 30,		December 31,		June 30,		December 31,
	2019		2018		2019		2018		2019		2018
Risk ratings 1 and 2	$	12,032	$	15,300	$	12,759	$	11,972	$	9,208	$	7,962
Risk rating 3		17,950		23,938		41,464		50,266		88,377		89,173
Risk rating 4		9,829		9,082		27,666		23,961		37,280		36,193
Risk rating 5		681		211		2,846		5,204		2,469		4,850
Risk rating 6		389		578		347		3		3,608		1,275
	$	40,881	$	49,109	$	85,082	$	91,406	$	140,942	$	139,453

Corporate Credit Exposure - Credit Risk Profile Based On Payment Activity

	Consumer				Construction Real Estate				Residential Real Estate
(Dollars in thousands)	June 30,		December 31,		June 30,		December 31,		June 30,		December 31,
	2019		2018		2019		2018		2019		2018
Performing	$	24,640	$	24,320	$	9,948	$	8,843	$	94,775	$	94,925
Nonperforming		—		—		—		—		—		—
Nonaccrual		42		62		—		—		917		955
	$	24,682	$	24,382	$	9,948	$	8,843	$	95,692	$	95,880

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

	Three Months Ended June 30, 2019						Six Months Ended June 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	$	2,471	$	2,471		2	$	2,471	$	2,471
Residential real estate		1		17		17		1		17		17
		3	$	2,488	$	2,488		3	$	2,488	$	2,488

Three Months Ended June 30, 2018

Six Months Ended June 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 June 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 six-month periods ended June 30, 2019 and June 30, 2018 that had been modified during the year prior to the default:

Three Months Ended

Six Months Ended

June 30, 2019

(Dollars in thousands)

Number

Recorded

Number

Recorded

of Loans

Investment

of Loans

Investment

Commercial real estate

2,471

Three Months Ended

Six Months Ended

June 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
June 30, 2019
With no related allowance recorded
Agricultural	$	—	$	—	$	—
Commercial and industrial		—		—		—
Consumer		—		—		—
Commercial real estate		—		—		—
Construction real estate		—		—		—
Residential real estate		115		115		—
Total		115		115		—
With an allowance recorded
Agricultural		389		469		80
Commercial and industrial		362		446		84
Consumer		54		64		10
Commercial real estate		2,937		3,542		605
Construction real estate		—		—		—
Residential real estate		2,498		2,656		159
Total		6,240		7,177		938
Total
Agricultural		389		469		80
Commercial and industrial		362		446		84
Consumer		54		64		10
Commercial real estate		2,937		3,542		605
Construction real estate		—		—		—
Residential real estate		2,613		2,771		159
Total	$	6,355	$	7,292	$	938

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 the six months ended June 30, 2019 and 2018:

	Average		Interest
(Dollars in thousands)	Recorded		Income
	Investment		Recognized
June 30, 2019
With no related allowance recorded
Agricultural	$	62	$	—
Commercial and industrial		—		10
Consumer		—		—
Commercial real estate		49		75
Residential real estate		174		54
Total		285		139
With an allowance recorded
Agricultural		390		—
Commercial and industrial		136		—
Consumer		69		—
Commercial real estate		1,340		—
Residential real estate		2,498		—
Total		4,433		0
Total
Agricultural		452		—
Commercial and industrial		136		10
Consumer		69		—
Commercial real estate		1,389		75
Residential real estate		2,672		54
Total	$	4,718	$	139

	Average		Interest
(Dollars in thousands)	Recorded		Income
	Investment		Recognized
June 30, 2018
With no related allowance recorded
Agricultural	$	423	$	—
Commercial and industrial		20		2
Consumer		3		—
Commercial real estate		79		—
Residential real estate		137		1
Total		662		3
With an allowance recorded
Agricultural		—		—
Commercial and industrial		215		8
Consumer		43		1
Commercial real estate		733		22
Residential real estate		2,633		63
Total		3,624		94
Total
Agricultural		423		—
Commercial and industrial		235		10
Consumer		46		1
Commercial real estate		812		22
Residential real estate		2,770		64
Total	$	4,286	$	97

An aging analysis of loans by loan category follows:

					Greater								90 Days Past
(Dollars in thousands)	30 to 59		60 to 89		Than 90				Loans Not				Due and
	Days		Days		Days (1)		Total		Past Due		Total Loans		Accruing
June 30, 2019
Agricultural	$	—	$	—	$	—	$	—	$	40,881	$	40,881	$	—
Commercial and industrial		—		—		—		—		85,082		85,082		—
Consumer		77		6		5		88		24,594		24,682		—
Commercial real estate		1,372		1,099		—		2,471		138,471		140,942		—
Construction real estate		—		—		—		—		9,948		9,948		—
Residential real estate		660		250		124		1,034		94,658		95,692		—
	$	2,109	$	1,355	$	129	$	3,593	$	393,634	$	397,227	$	—

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)	June 30,		December 31,
	2019		2018
Agricultural	$	389	$	393
Commercial and industrial		346		—
Consumer		42		62
Commercial real estate		2,516		123
Construction real estate		—		—
Residential real estate		917		954
	$	4,210	$	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				Six Months Ended
(Dollars in thousands, except per share data)	June 30,				June 30,
	2019		2018		2019		2018
Basic Earnings Per Share
Net income available to common shareholders	$	1,487	$	1,833	$	3,123	$	3,491

Weighted average common shares outstanding		3,628,916		3,613,398		3,623,651		3,614,197

Basic earnings per share	$	0.41	$	0.51	$	0.86	$	0.97

Diluted Earnings Per Share
Net income available to common shareholders	$	1,487	$	1,833	$	3,123	$	3,491

Weighted average common shares outstanding		3,628,916		3,613,398		3,623,651		3,614,197
Plus dilutive stock options and restricted stock units		12,549		12,550		9,572		10,463

Weighted average common shares outstanding and potentially dilutive shares		3,641,465		3,625,948		3,633,223		3,624,660

Diluted earnings per share	$	0.41	$	0.50	$	0.86	$	0.96

There were no stock options that were considered to be anti-dilutive to earnings for the second quarter of 2019 and 13,500 that were considered to be anti-dilutive to earnings for the first half of 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 second quarter of 2018 and 15,000 that were considered to be anti-dilutive for the first half of 2018 and were excluded from the calculation above.

NOTE 5 – FINANCIAL INSTRUMENTS

Financial instruments as of the dates indicated were as follows:

					Quoted
					in Active		Significant
					Markets for		Other		Significant
					Identical		Observable		Unobservable
(Dollars in thousands)	Carrying		Estimated		Assets		Inputs		Inputs
	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
June 30, 2019
Assets:
Cash and due from banks	$	13,687	$	13,687	$	13,687	$	—	$	—
Equity securities at fair value		3,113		3,113		2,136		—		977
Securities available for sale		162,684		162,684		—		154,412		8,272
Federal Home Loan Bank and Federal
Reserve Bank stock		3,568		3,568		—		3,568		—
Loans held for sale		2,194		2,194		—		2,194		—
Loans to other financial
institutions		28,950		28,950		—		28,950		—
Loans, net		392,426		388,307		—		—		388,307
Accrued interest receivable		2,300		2,300		—		2,300		—

Liabilities:
Noninterest-bearing deposits		149,320		149,320		—		149,320		—
Interest-bearing deposits		412,456		412,404		—		412,404		—
Federal funds purchased		2,000		2,000		—		2,000		—
Federal Home Loan Bank advances		5,216		5,229		—		5,229		—
Accrued interest payable		201		201		—		201		—


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 June 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 (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at Date Indicated
Equity Securities Held at Fair Value - June 30, 2019
Equity securities	$	2,136	$	—	$	977	$	3,113

Investment Securities, Available for Sale – June 30, 2019
U.S. Treasury notes and bonds	$	—	$	2,002	$	—	$	2,002
U.S. Government and federal agency		—		30,070		—		30,070
State and municipal		—		94,101		7,772		101,873
Mortgage-backed		—		25,072		—		25,072
Corporate		—		2,667		—		2,667
Foreign debt		—		500		—		500
Trust preferred securities		—		—		500		500
Total	$	—	$	154,412	$	8,272	$	162,684

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

	Six months ended
(Dollars in thousands)	June 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		91			—
Net purchases, sales, calls, and maturities		—			—
Net transfers into Level 3		—			—
Balance, June 30	$	977		$	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		259			(246	)
Net purchases, sales, calls, and maturities		(485	)		(313	)
Net transfers into Level 3		—			—
Balance, June 30	$	8,272		$	11,839

Of the available for sale Level 3 assets that were held by the company at June 30, 2019, the net unrealized gain as of June 30, 2019 was $404,000, which was recognized in other comprehensive income in the consolidated balance sheet. Of the equity securities held at fair value Level 3 assets that were held by the company at June 30, 2019, the net realized gain as of June 30, 2019 was $90,000 which was recognized in income. There were no purchases or sales of Level 3 securities in the second quarter or first six months of 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. The company estimates the fair value of these bonds based on the present value of expected future cash flows using management’s best estimate of key assumptions, including forecasted interest yield and payment rates, credit quality and a discount rate commensurate with the current market and other risks involved.

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

Assets Measured at Fair Value on a Non-recurring Basis

			Quoted Prices		Significant
			in Active		Other		Significant
			Markets for		Observable		Unobservable
(Dollars in thousands)	Balance at		Identical Assets		Inputs		Inputs
	Dates Indicated		(Level 1)		(Level 2)		(Level 3)
Impaired Loans
June 30, 2019	$	6,355	$	—	$	—	$	6,355
December 31, 2018	$	4,024	$	—	$	—	$	4,024

Other Real Estate
June 30, 2019	$	359	$	—	$	—	$	359
December 31, 2018	$	102	$	—	$	—	$	102

Impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. The company 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				Six months ended
	June 30,				June 30,
(Dollars in thousands)	2019		2018		2019		2018

Service charges and fees on deposit accounts	$	670	$	669	$	1,297	$	1,292
Interchange income		478		451		884		884
Investment commission income		56		57		105		107
Other charges and fees for customer services		56		47		120		112
Noninterest income from contracts with customers within the scope of ASC 606		1,260		1,224		2,406		2,395
Noninterest income within the scope of other GAAP topics		769		496		1,380		975
Total noninterest income	$	2,029	$	1,721	$	3,786	$	3,369

NOTE 8 – BUSINESS COMBINATION

On March 22, 2019, ChoiceOne entered into an Agreement and Plan of Merger with County Bank Corp (“County”), the holding company for Lakestone Bank & Trust. Under the terms of the merger agreement, County will be merged with and into ChoiceOne, with ChoiceOne as the surviving corporation. Completion of the merger is subject to receipt of shareholder approval of both ChoiceOne and County, receipt of regulatory approval, and the satisfaction of other customary closing conditions. Management expects the merger to become effective in the second half of 2019. As of December 31, 2018, County had total assets of approximately $620 million, total loans of approximately $360 million, and total deposits of approximately $540 million.

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. Examples of forward-looking statements also include, but are not limited to, statements regarding the outlook and expectations of ChoiceOne and County Bank Corp (“County”) with respect to their planned merger, the strategic benefits and financial benefits of the merger, including the expected impact of the transaction on the combined company’s future financial performance (including anticipated accretion of earnings per share, cost savings, the tangible book value earn-back period and other operating and return metrics), and the timing of the closing of the transaction. All of the information concerning interest rate sensitivity is forward-looking. All statements with references to future time periods are forward-looking. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“risk factors”) that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed, implied or forecasted in such forward-looking statements. Furthermore, ChoiceOne undertakes no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events, or otherwise. Such risks, uncertainties, and assumptions include, among others, the following:

●

the failure of either ChoiceOne or County to obtain shareholder approval, or to satisfy any of the other closing conditions to the transaction on a timely basis or at all;

●

the occurrence of any event, change or other circumstances that could give rise to the right of one or both of the parties to terminate the merger agreement;

●

the possibility that the anticipated benefits of the transaction, including anticipated cost savings and strategic gains, are not realized when expected or at all, including as a result of the impact of, or problems arising from, the integration of the two companies or as a result of the strength of the economy, competitive factors in the areas where ChoiceOne and County do business, or as a result of other unexpected factors or events;

●

the impact of purchase accounting with respect to the transaction, or any change in the assumptions used regarding the assets purchased and liabilities assumed to determine their fair value;

●

diversion of management’s attention from ongoing business operations and opportunities;

●

potential adverse reactions or changes to business or employee relationships, including those resulting from the announcement or completion of the transaction; and

●

the outcome of any legal proceedings that may be instituted against ChoiceOne or County.

Additional risk factors include, but are not limited to, the risk factors discussed in Item 1A of ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 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 second quarter of 2019 was $1,487,000, which represented a decrease of $346,000 or 19% compared to the same period in 2018. Net income for the first six months of 2019 was $3,123,000, which represented a decrease of $368,000 or 11% compared to the first half of the prior year. Growth in interest income and noninterest income was offset by higher noninterest expense in the first half of 2019 compared to the first half of 2018. Noninterest expense for the first six months of 2019 was impacted by $588,000 of expense related to the proposed merger of ChoiceOne and County. The federal income tax effect of the merger expenses was estimated to be $15,000 as only a portion of the expenses are expected to be tax deductible. Net income adjusted to exclude tax-effected merger expenses of $573,000 was $3,696,000 in the first half of 2019.

Basic earnings per common share were $0.41 for the second quarter and $0.86 for the first six months of 2019, compared to $0.51 for the second quarter and $0.97 for the first half of the prior year. Diluted earnings per share were $0.41 for the second quarter and $0.86 for the first six months of 2019, compared to $0.50 for the second quarter and $0.96 for the first half of the prior year. Diluted earnings per share, adjusted to exclude the tax-effected merger expenses, would have been $0.50 in the second quarter and $1.02 in the first half 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 percentages were 0.94% and 7.55%, respectively, for the first six months of 2019, compared to 1.12% and 9.20%, 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.

Dividends

Cash dividends of $726,000 or $0.20 per share were declared in the second quarter of 2019, compared to $651,000 or $0.18 per share in the second quarter of 2018. Cash dividends declared in the first six months of 2019 were $1,450,000 or $0.40 per share, compared to $1,270,000 or $0.35 per share in the same period in the prior year. The per share amounts for 2018 were adjusted for the 5% stock dividend paid in May 2018. The cash dividend payout percentage was 46% for the first six months of 2019, compared to 36% in the same period in the prior year.

Interest Income and Expense

Tables 1 and 2 on the following pages provide information regarding interest income and expense for the three- and six-month periods ended June 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 June 30,
	2019								2018
(Dollars in thousands)	Average								Average
	Balance		Interest			Rate			Balance		Interest			Rate
Assets:
Loans (1)	$	424,691	$	5,393			5.08	%	$	396,985	$	5,029			5.07	%
Taxable securities (2) (3)		117,017		767			2.62			114,301		713			2.50
Nontaxable securities (1) (2)		54,209		454			3.35			55,823		459			3.29
Other		8,083		39			1.91			8,088		12			0.59
Interest-earning assets		604,000		6,653			4.41			575,197		6,213			4.32
Noninterest-earning assets		59,499								47,691
Total assets	$	663,499							$	622,888

Liabilities and Shareholders’ Equity:
Interest-bearing demand deposits	$	202,833	$	267			0.53	%	$	197,684	$	137			0.28	%
Savings deposits		74,319		10			0.05			77,239		3			0.02
Certificates of deposit		128,108		647			2.02			106,348		323			1.21
Advances from Federal Home Loan Bank		16,485		114			2.78			12,014		58			1.93
Other		2,121		15			2.82			5,660		25			1.77
Interest-bearing liabilities		423,866		1,053			0.99			398,945		546			0.55
Noninterest-bearing demand deposits		154,127								147,560
Other noninterest-bearing liabilities		1,541								535
Total liabilities		579,534								547,040
Shareholders’ equity		83,965								75,848
Total liabilities and shareholders’ equity	$	663,499							$	622,888

Net interest income (tax-equivalent basis)-interest spread (Non-GAAP) (1)			$	5,600			3.42	%			$	5,667			3.77	%
Net interest income as a percentage of earning assets (tax-equivalent basis) (Non-GAAP) (1)							3.71	%							3.94	%

Reconciliation to Reported Net Interest Income
Net interest income (tax-equivalent basis) (Non-GAAP) (1)			$	5,600							$	5,667
Adjustment for taxable equivalent interest				(99	)							(96	)
Net interest income (GAAP)			$	5,501							$	5,571

Net interest margin (GAAP)				3.64	%							3.87	%

	Six Months Ended June 30,
	2019								2018
(Dollars in thousands)	Average								Average
	Balance		Interest			Rate			Balance		Interest			Rate
Assets:
Loans (1)	$	424,916	$	10,675			5.02	%	$	395,951	$	9,626			4.86	%
Taxable securities (2) (3)		117,227		1,527			2.60			111,969		1,398			2.50
Nontaxable securities (1) (2)		54,750		922			3.37			55,752		917			3.29
Other		8,625		107			2.47			7,529		69			1.84
Interest-earning assets		605,518		13,231			4.37			571,201		12,010			4.21
Noninterest-earning assets		60,065								54,467
Total assets	$	665,583							$	625,668

Liabilities and Shareholders’ Equity:
Interest-bearing demand deposits	$	211,048	$	535			0.51	%	$	207,443	$	253			0.24	%
Savings deposits		74,399		19			0.05			76,964		7			0.02
Certificates of deposit		126,088		1,221			1.94			100,879		549			1.09
Advances from Federal Home Loan Bank		16,939		230			2.72			12,415		102			1.64
Other		2,020		29			2.87			5,123		26			1.02
Interest-bearing liabilities		430,494		2,034			0.94			402,824		937			0.47
Noninterest-bearing demand deposits		151,020								145,803
Other noninterest-bearing liabilities		1,338								1,151
Total liabilities		582,852								549,778
Shareholders’ equity		82,731								75,890
Total liabilities and shareholders’ equity	$	665,583							$	625,668

Net interest income (tax-equivalent basis)-interest spread (Non-GAAP) (1)			$	11,197			3.43	%			$	11,073			3.74	%
Net interest income as a percentage of earning assets (tax-equivalent basis) (Non-GAAP) (1)							3.70	%							3.88	%

Reconciliation to Reported Net Interest Income
Net interest income (tax-equivalent basis) (Non-GAAP) (1)			$	11,197							$	11,073
Adjustment for taxable equivalent interest				(201	)							(196	)
Net interest income (GAAP)			$	10,996							$	10,877

Net interest margin (GAAP)				3.63	%							3.85	%

	(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 June 30,
(Dollars in thousands)	2019 Over 2018
	Total			Volume			Rate
Increase (decrease) in interest income (1)
Loans (2)	$	364		$	352		$	12
Taxable securities		54			17			37
Nontaxable securities (2)		(5	)		(46	)		41
Other		27			—			27
Net change in tax-equivalent interest income		440			323			117

Increase (decrease) in interest expense (1)
Interest-bearing demand deposits		130			4			126
Savings deposits		7			(1	)		8
Certificates of deposit		324			77			247
Advances from Federal Home Loan Bank		56			26			30
Other		(10	)		(66	)		56
Net change in interest expense		507			40			467

Net change in tax-equivalent net interest income	$	(67	)	$	283		$	(350	)

	Six Months Ended June 30,
(Dollars in thousands)	2019 Over 2018
	Total		Volume			Rate
Increase (decrease) in interest income (1)
Loans (2)	$	1,049	$	719		$	330
Taxable securities		129		68			61
Nontaxable securities (2)		5		(36	)		41
Other		38		11			27
Net change in tax-equivalent interest income		1,221		762			459

Increase (decrease) in interest expense (1)
Interest-bearing demand deposits		282		5			277
Savings deposits		12		(1	)		13
Certificates of deposit		672		163			509
Advances from Federal Home Loan Bank		128		46			82
Other		3		(47	)		50
Net change in interest expense		1,097		166			931

Net change in tax-equivalent net interest income	$	124	$	596		$	(472	)

	(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 $124,000 in the first six months of 2019 compared to the same period in 2018. The benefit from growth in average interest-earning assets was partially offset by increases in the average balance of certificates of deposit and advances from the Federal Home Loan Bank. The net interest spread on a tax-equivalent basis declined by 31 basis points from 3.74% in the first six months of 2018 to 3.43% in the same period in 2019, which had a $472,000 negative impact on tax-equivalent net interest income in the first half of 2019 compared to the same period in the prior year.

The average balance of loans increased $32.9 million in the first six months of 2019 compared to the same period in 2018. Loans to other financial institutions provided $17.2 million of the growth. Average residential real estate loans increased $12.2 million, while average commercial and industrial loans and commercial real estate loans were $3.3 million higher in the first half of 2019 than the first half of the prior year. The increase in the average loans balance was bolstered by a 12 basis point increase in the average rate earned. This caused tax-equivalent interest income from loans to increase $1.0 million in the first half of 2019 compared to the same period in the prior year. The average balance of total securities increased $4.3 million in the first six months of 2019 compared to the same period in 2018. The effect of the average balance growth, reinforced by a 9 basis point increase in the average rate earned on securities, caused tax-equivalent securities income to increase $134,000 in the first six months of 2019 compared to the same period in 2018.

The average balance of interest-bearing demand deposits increased $3.6 million in the first six months of 2019 compared to the same period in 2018. The growth plus the impact of an increase of 27 basis points in the average rate paid on interest-bearing demand deposits caused interest expense to increase $282,000 in the first half of 2019 compared to the same period in 2018. The average balance of certificates of deposit was up $25.2 million in the first six months of 2019 compared to the same period in 2018. Brokered certificates of deposit provided $15.4 million of the average balance increase in 2019. The growth in certificates of deposit plus an 85 basis point increase in the average rate paid on certificates caused interest expense to increase $672,000 in the first half of 2019 compared to the same period in 2018. The effect of a $4.5 million increase in the average balance of Federal Home Loan Bank advances and the impact of a 108 basis point increase in the average rate paid caused interest expense to increase $128,000 in the first six months of 2019 compared to the first half of 2018.

ChoiceOne’s net interest income spread on a tax-equivalent basis was 3.43% in the first six months of 2019, compared to 3.74% for the first half of 2018. The decline in the interest spread was due to an increase of 47 basis points in the average rate paid on interest-bearing liabilities, which was partially offset by growth of 16 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. Competition in ChoiceOne’s market areas for loans and deposits caused the increase in 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 $11.8 million in the first six months of 2019, while the allowance for loan losses increased $128,000 during the same period. No provision expense was recorded in the first six months of the year due to the decline in loans and because ChoiceOne remained in a net loan recoveries position. Nonperforming loans were $6.3 million as of June 30, 2019, compared to $3.7 million as March 31, 2019 and $3.8 million as of December 31, 2018. The increase in nonperforming loans was related to a single loan relationship that was placed in nonaccrual status during the second quarter of 2019. A specific reserve was allocated for this relationship. The allowance for loan losses was 1.21% of total loans at June 30, 2019, compared to 1.18% at March 31, 2019 and 1.14% at December 31, 2018.

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

(Dollars in thousands)	2019				2018
	Charge-offs		Recoveries		Charge-offs		Recoveries
Agricultural	$	—	$	65	$	—	$	—
Commercial and industrial		2		20		58		53
Consumer		151		88		118		51
Commercial real estate		—		6		—		59
Construction real estate		—		—		—		—
Residential real estate		14		116		13		73
	$	167	$	295	$	189	$	236

Net recoveries of $71,000 and $128,000 were recorded in the second quarter and first six months of 2019, respectively, compared to net charge-offs of $50,000 and net recoveries of $47,000 during the same periods in 2018, respectively. Net recoveries on an annualized basis as a percentage of average loans were 0.06% in the first six months of 2019 and 0.02% 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 $308,000 in the second quarter and $417,000 in the first half of 2019 compared to the same periods in 2018. The positive change in the market value of equity securities was $217,000 higher in the first half of the current year than the same period in the prior year. With a decline in long term rates, which reduced residential real estate loan rates, gains on sales of loans increased $186,000 in the first six months of 2019 compared to the first half of 2018.

Noninterest Expense

Total noninterest expense increased $648,000 in the second quarter and $1,018,000 in the first half of 2019 compared to the same periods in 2018. The $667,000 increase in professional fees in the first six months of 2019 compared to the same period in the prior year was due in part to $588,000 of expense related to the proposed merger of ChoiceOne and County. An increase of $168,000 in occupancy and equipment expense in the first six months of 2019 compared to the first half of 2018 was caused by higher depreciation expense related to ChoiceOne’s two new offices opened in late 2018 and higher repairs and maintenance costs. These two new branch openings also contributed to an increase in salaries and benefits expense of $119,000 in the first six months of 2019 compared to the same period in 2018.

Income Tax Expense

Income tax expense was $564,000 in the first six months of 2019 compared to $642,000 for the same period in 2018. The effective tax rate was 15.3% for the first half of 2019 and 15.5% for the first half of 2018.

FINANCIAL CONDITION

Securities

The securities available for sale portfolio decreased $3.9 million from December 31, 2018 to June 30, 2019. Due to current market rates available for securities, management limited securities purchases in the first half of 2019. Various securities totaling $9.8 million were purchased in the first six months of 2019 and were offset by approximately $15.6 million called or matured during that same time period. Principal repayments on securities totaled $2.0 million in the first six months of 2019. Due to lower interest rates in the first half 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 $3.0 million as of June 30, 2019.

Loans

The balance of loans to other financial institutions was $8.3 million higher at June 30, 2019 than at December 31, 2018. The increase resulted from more activity in this loan program during the first half of 2019. Loans, excluding loans held for sale and loans to other financial institutions, declined $11.8 million from December 31, 2018 to June 30, 2019. Decreases of $8.2 million and $6.3 million in agricultural loans and commercial and industrial loans, respectively, were partially offset by growth of $1.5 million in commercial real estate loans and $1.1 million in construction real estate loans. The decrease in agricultural loans was primarily due to seasonal pay downs by borrowers. The other 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 $6.4 million at June 30, 2019, compared to $3.8 million as of March 31, 2019 and $4.0 million as of December 31, 2018. The change was primarily comprised of a single relationship that was placed in nonaccrual status in the second quarter of 2019. Approximately $670,000 of allowance had been allocated to this loan relationship 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)	June 30,		December 31,
	2019		2018
Loans accounted for on a nonaccrual basis	$	4,210	$	1,532
Accruing loans contractually past due 90 days or more as to principal or interest payments		—		—
Loans considered troubled debt restructurings		2,105		2,254
Total	$	6,315	$	3,786

At June 30, 2019, nonaccrual loans included $389,000 in agricultural loans, $346,000 in commercial and industrial loans, $42,000 in consumer loans, $2.5 million in commercial real estate loans, and $917,000 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 45% of the balance of loans considered troubled debt restructurings were performing according to their restructured terms as of June 30, 2019. Management believes the allowance allocated to its nonperforming loans is sufficient at June 30, 2019.

Deposits and Borrowings

Total deposits decreased $2.7 million in the second quarter and $15.2 million in the first half of 2019. Interest-bearing deposits decreased $11.0 million and noninterest-bearing deposits decreased $4.2 million in the first six months of 2019 primarily due to seasonal fluctuations for ChoiceOne’s depositors. The interest-bearing balance change was comprised of a $23.0 million decline in interest-bearing checking, savings, and money market accounts, which was partially offset by $11.5 million of growth in local certificates of deposit.

Shareholders’ Equity

Total shareholders’ equity increased $5.2 million from December 31, 2018 to June 30, 2019. A change in accumulated other comprehensive income of $3.3 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 half of 2019 in mid- to long-term interest rates. Net income for the first half of 2019, net of cash dividends declared, also contributed $1.7 million to the equity balance growth.

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

											Minimum Required
											to be Well
						Minimum Required					Capitalized Under
						for Capital					Prompt Corrective
(Dollars in thousands)	Actual					Adequacy Purposes					Action Regulations
	Amount		Ratio			Amount		Ratio			Amount		Ratio
June 30, 2019
ChoiceOne Financial Services Inc.
Total capital (to risk weighted assets)	$	74,180		14.5	%	$	41,026		8.0	%		N/A		N/A
Common Equity Tier 1 Capital (to risk weighted assets)		69,387		13.5			23,077		4.5			N/A		N/A
Tier 1 capital (to risk weighted assets)		69,387		13.5			20,513		6.0			N/A		N/A
Tier 1 capital (to average assets)		69,387		10.7			26,018		4.0			N/A		N/A

ChoiceOne Bank
Total capital (to risk weighted assets)	$	68,649		13.5	%	$	40,799		8.0	%	$	50,999		10.0	%
Common Equity Tier 1 Capital (to risk weighted assets)		63,856		12.5			22,949		4.5			33,149		6.5
Tier 1 capital (to risk weighted assets)		63,856		12.5			20,399		6.0			30,599		8.0
Tier 1 capital (to average assets)		63,856		9.9			25,863		4.0			32,328		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 June 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 $2.5 million for the six months ended June 30, 2019 compared to $4.7 million provided in the same period a year ago. The decrease was caused by $9.0 million less net proceeds from loan sales in the first half of 2019 compared to the same period in the prior year. This decrease was offset by a $6.7 million increase in loans originated for sale during the same time period. Net cash provided by investing activities was $11.0 million for the first half of 2019 compared to $12.8 million used in the same period in 2018. The change was primarily due to a net reduction in securities in the first six months of 2019 compared to net purchases in the same period in the prior year. Net cash used in financing activities was $19.4 million in the six months ended June 30, 2019, compared to $16.9 million in the same period in the prior year. The change was due to the net changes in federal funds purchased and deposits, which were partially offset by the net change in repurchase agreements 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 June 30,				Six Months Ended June 30,
(In Thousands, Except Per Share Data)	2019		2018		2019		2018

Income before income tax	$	1,767	$	2,177	$	3,687	$	4,133
Adjustment for pre-tax merger expenses		350		—		588		—
Adjusted income before income tax	$	2,117	$	2,177	$	4,275	$	4,133

Income tax expense	$	281	$	344	$	564	$	642
Tax impact of adjustment for pre-tax merger expenses		—		—		15		—
Adjusted income tax expense	$	281	$	344	$	579	$	642

Net income	$	1,487	$	1,833	$	3,123	$	3,491
Adjustment for pre-tax merger expenses, net of tax impact		350		—		573		—
Adjusted net income	$	1,837	$	1,833	$	3,696	$	3,491

Basic earnings per share	$	0.41	$	0.51	$	0.86	$	0.97
Effect of merger expenses, net of tax impact		0.10		—		0.16		—
Adjusted basic earnings per share	$	0.51	$	0.51	$	1.02	$	0.97

Diluted earnings per share	$	0.41	$	0.50	$	0.86	$	0.96
Effect of merger expenses, net of tax impact		0.09		—		0.16		—
Adjusted diluted earnings per share	$	0.50	$	0.50	$	1.02	$	0.96

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 June 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 three months ended June 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 April 24, 2019, ChoiceOne issued 1,082 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 $28,000. On May 22, 2019, ChoiceOne issued 1,191 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 $33,000. 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. Previously filed as an exhibit to ChoiceOne’s Form 10-K Annual Report for the year ended December 31, 2013. Here incorporated by reference.

	3.2		Bylaws of ChoiceOne as currently in effect and any amendments thereto. Previously filed as an exhibit to ChoiceOne’s Registration Statement on Form S-4 filed June 17, 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: August 9, 2019	/s/ Kelly J. Potes
	Kelly J. Potes Chief Executive Officer (Principal Executive Officer)

Date: August 9, 2019	/s/ Thomas L. Lampen
	Thomas L. Lampen Treasurer (Principal Financial and Accounting Officer)