ChoiceOne Financial COFS Form 10-Q filing Q3 FY2024

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

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

See accompanying notes to interim consolidated financial statements.

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ChoiceOne Financial Services, Inc.

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

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See accompanying notes to interim consolidated financial statements.

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

See accompanying notes to interim consolidated financial statements.

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ChoiceOne Financial Services, Inc.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

For the nine months ended September 30,

(1) The amount shown represents the number of shares issued in net exercise transactions where shares were surrendered in payment of taxes and/or payment of all or part of the exercise price.

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ChoiceOne Financial Services, Inc.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

For the three months ended September 30,

(1) The amount shown represents the number of shares issued in net exercise transactions where shares were surrendered in payment of taxes and/or payment of all or part of the exercise price.

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

See accompanying notes to interim consolidated financial statements.

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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”), its wholly-owned subsidiaries, ChoiceOne Bank (the “Bank”) and 109 Technologies, LLC, and ChoiceOne Bank’s wholly-owned subsidiary, ChoiceOne Insurance Agencies, Inc. (the “Insurance Agency”). Intercompany transactions and balances have been eliminated in consolidation.

ChoiceOne owns all of the common securities of Community Shores Capital Trust I (the “Capital Trust”). Under U.S. generally accepted accounting principles (“GAAP”), the Capital Trust is not consolidated because it is a variable interest entity and ChoiceOne is not the primary beneficiary.

The accompanying unaudited consolidated financial statements and notes thereto reflect all adjustments ordinary in nature which are, in the opinion of management, necessary for a fair presentation of such financial statements. Operating results for the nine months ended September 30, 2024, are not necessarily indicative of the results that may be expected for the year ending December 31, 2024.

The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in ChoiceOne’s Annual Report on Form 10-K for the year ended December 31, 2023.

Recent Events

On July 26, 2024, ChoiceOne completed an underwritten public offering of 1,380,000 shares of its common stock at a price to the public of $25.00 per share (the “Common Stock Offering”). The aggregate gross proceeds of the Common Stock Offering were approximately $34.5 million before deducting underwriting discounts and estimated offering expenses. The proceeds from the Common Stock Offering will qualify as tangible common equity and Tier 1 common equity. ChoiceOne intends to use the net proceeds of the Common Stock Offering for general corporate purposes including supplementing regulatory capital ratios and in conjunction with its announced merger with Fentura Financial, Inc.

On July 25, 2024, ChoiceOne and Fentura Financial, Inc. (“Fentura”), the parent company of The State Bank, announced the signing of a definitive merger agreement pursuant to which ChoiceOne and Fentura will merge in an all-stock transaction. The agreement was unanimously approved by the boards of directors of both companies. Under the terms of the merger agreement, each share of Fentura common stock outstanding immediately prior to completion of the merger will be converted into the right to receive 1.35 shares of ChoiceOne common stock. Once completed, the combination will create the third largest publicly traded bank in Michigan with approximately $4.3 billion in consolidated total assets and 56 offices in Western, Central and Southeastern Michigan. The proposed transaction is expected to close in the first quarter of 2025, subject to the satisfaction of customary closing conditions, including receipt of approval from Fentura and ChoiceOne shareholders and receipt of all necessary regulatory approvals.

Merger-related expenses

During the three and nine months ended September 30, 2024, the Company incurred merger-related expenses totaling $645,000. These expenses primarily consist of professional fees, including legal, accounting, advisory fees associated with the merger, and regulatory filing fees. These expenses are included in the Consolidated Statements of Income under Noninterest Expense. Merger related expenses are presented net of tax in the Non-GAAP reconciliation of Adjusted Net Income in the Management Discussion & Analysis.

Use of Estimates

To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, ChoiceOne’s management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided. These estimates and assumptions are subject to many risks and uncertainties, and actual results may differ from these estimates. Estimates associated with the allowance for credit losses and the unrealized gains and losses on securities available for sale and held to maturity are particularly susceptible to change.

Goodwill

Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of the acquired tangible assets and liabilities and identifiable intangible assets. Goodwill and intangible assets acquired in a purchase business combination and

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determined to have an indefinite useful life are not amortized, but tested for impairment at least annually or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed.

Core Deposit Intangible

Core deposit intangible represents the value of the acquired customer core deposit bases and is included as an asset on the consolidated balance sheets. The core deposit intangible has an estimated finite life, is amortized on an accelerated basis over a 120 month period and is subject to periodic impairment evaluation.

Stock Transactions

A total of 3,877 and 11,582 shares of common stock were issued to ChoiceOne’s Board of Directors for a cash price of $111,000 and $330,000 under the terms of the Directors’ Stock Purchase Plan in the third quarter and first nine months of 2024, respectively. A total of 2,037 and 6,943 shares for a cash price of $53,000 and $170,000 were issued under the Employee Stock Purchase Plan in the third quarter and first nine months of 2024, respectively. ChoiceOne's common stock repurchase program announced in April 2021 and amended in 2022, authorizes repurchases of up to 375,388 shares, representing 5% of the total outstanding shares of common stock as of the date the program was adopted. No shares were repurchased under this program in 2024.

Reclassifications

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

Allowance for Credit Losses (“ACL”)

The ACL is a valuation allowance for expected credit losses. The ACL is increased by the provision for credit losses and decreased by loans charged off less any recoveries of charged off loans. As ChoiceOne has had very limited loss experience since 2011, management elected to utilize benchmark peer loss history data to estimate historical loss rates. ChoiceOne identified an appropriate peer group for each loan cohort which shared similar characteristics. Management estimates the ACL required based on the selected peer group loan loss experience, the nature and volume of the loan portfolio, information about specific borrower situations and estimated collateral values, a reasonable and supportable economic forecast, and other factors. Allocations of the ACL may be made for specific loans, but the entire ACL is available for any loan that, in management’s judgment, should be charged off. Loan losses are charged against the ACL when management believes that collection of a loan balance is not possible.

The ACL consists of general and specific components. The general component covers loans collectively evaluated for credit losses and is based on peer historical loss experience adjusted for current and forecasted factors. Management’s adjustment for current and forecasted factors is based on trends in delinquencies, trends in charge-offs and recoveries, trends in the volume of loans, changes in underwriting standards, trends in loan review findings, the experience and ability of lending staff, and a reasonable and supportable economic forecast described further below.

The discounted cash flow methodology is utilized for all loan pools. This methodology is supported by our CECL software provider and allows management to calculate contractual life by factoring in all cash flows and adjusting them for behavioral and credit-related aspects.

Reasonable and supportable economic forecasts have to be incorporated in determining expected credit losses. The forecast period represents the time frame from the current period end through the point in time that we can reasonably forecast and support entity and environmental factors that are expected to impact the performance of our loan portfolio. Ideally, the economic forecast period would encompass the contractual terms of all loans; however, the ability to produce a forecast that is considered reasonable and supportable becomes more difficult or may not be possible in later periods. Subsequent to the end of the forecast period, we revert to historical loan data based on an ongoing evaluation of each economic forecast in relation to then current economic conditions as well as any developing loan loss activity and resulting historical data. As of September 30, 2024, we used a one-year reasonable and supportable economic forecast period, with a two year straight-line reversion period.

We are not required to develop and use our own economic forecast model, and we elected to utilize economic forecasts from third-party providers that analyze and develop forecasts of the economy for the entire United States at least quarterly.

Other inputs to the calculation are also updated or reviewed quarterly. Prepayment speeds are updated on a one quarter lag based on the asset liability model from the previous quarter. This model is performed at the loan level. Curtailment is updated quarterly within the ACL model based on our peer group average. The reversion period is reviewed by management quarterly with consideration of the current economic climate.

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We are also required to consider expected credit losses associated with loan commitments over the contractual period in which we are exposed to credit risk on the underlying commitments unless the obligation is unconditionally cancellable by us. Any allowance for off-balance sheet credit exposures is reported as an other liability on our Consolidated Balance Sheet and is increased or decreased via the provision for credit losses account on our Consolidated Statement of Income. The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives. The allowance is calculated using the same aggregate reserve rates calculated for the funded portion of loans at the portfolio level applied to the amount of commitments expected to be funded.

Loans that do not share risk characteristics are evaluated on an individual basis and are excluded from the collective evaluation. ChoiceOne has determined that any loans which have been placed on non-performing status, loans with a risk rating of 6 or higher, and loans past due more than 60 days will be assessed individually for evaluation. Management’s judgment will be used to determine if the loan should be migrated back to pool on an individual basis. Individual analysis will establish a specific reserve for loans in scope. Specific reserves on non-performing loans are typically based on management’s best estimate of the fair value of collateral securing these loans, adjusted for selling costs as appropriate or based on the present value of the expected cash flows from that loan.

Securities

Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. ​ Debt securities are classified as available for sale because they might be sold before maturity. Debt securities classified as available for sale are carried at fair value, with unrealized holding gains and losses reported separately in the accumulated other comprehensive income or loss section of shareholders’ equity, net of tax effect. Restricted investments in Federal Reserve Bank stock and Federal Home Loan Bank stock are carried at cost. Equity securities consist of investments in preferred stock and investments in common stock of other financial institutions. Equity securities are reported at their fair value with changes in market value reported through current earnings.

Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized using the level-yield method without anticipating prepayments. Gains or losses on sales are recorded on the trade date based on the amortized cost of the security sold.

Securities Available for Sale ("AFS") – For securities AFS in an unrealized loss position, management determines whether they intend to sell or if it is more likely than not that ChoiceOne will be required to sell the security before recovery of the amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income with an allowance being established under CECL. For securities AFS with unrealized losses not meeting these criteria, management evaluates whether any decline in fair value is due to credit loss factors. In making this assessment, management considers any changes to the rating of the security by rating agencies and adverse conditions specifically related to the issuer of the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses (“ACL”) is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Changes in the ACL under ASC 326-30 are recorded as provisions for (or reversal of) credit loss expense. Losses are charged against the allowance when the collectability of a security AFS is confirmed or when either of the criteria regarding intent or requirement to sell is met. Any impairment that has not been recorded through an ACL is recognized in other comprehensive income, net of income taxes. At September 30, 2024, there was no ACL related to securities AFS. Accrued interest receivable on securities AFS was excluded from the estimate of credit losses.

Securities Held to Maturity ("HTM") – Since the adoption of CECL, ChoiceOne measures credit losses on securities HTM on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The ACL on HTM securities is a contra asset valuation account that is deducted from the carrying amount of securities HTM to present the net amount expected to be collected. HTM securities are charged off against the ACL when deemed uncollectible. Adjustments to the ACL are reported in ChoiceOne’s Consolidated Statements of Income in the provision for credit losses. Accrued interest receivable on securities HTM is excluded from the estimate of credit losses. With regard to US Treasury securities, these have an explicit government guarantee; therefore, no ACL is recorded for these securities. With regard to obligations of states and political subdivisions and other HTM securities, management considers (1) issuer bond ratings, (2) historical loss rates for given bond ratings, (3) the financial condition of the issuer, and (4) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities. A discounted cash flow method will be used to determine the reserve required for any credit losses on HTM securities. At September 30, 2024, the ACL related to securities HTM is insignificant.

Recent Accounting Pronouncements

Improvements to Income Tax Disclosure

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ASU 2023-09 enhances transparency by requiring consistent categorization, greater disaggregation, and detailed disclosure related to income taxes paid. These changes aim to help users of financial statements understand factors contributing to differences between effective and statutory tax rates. The disclosure is effective for annual reporting periods beginning after December 15, 2024.

Reportable Segment Disclosures

In 2023, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2023-07, which introduces improvements to reportable segment disclosures under Topic 280. This update aims to enhance the transparency and usefulness of segment information for financial statement users. The key changes include requiring public entities to disclose significant segment expenses and segment profit or loss measures that are regularly reviewed by management. ASU 2023-07 is effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024.

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NOTE 2 – SECURITIES

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

The following tables present the amortized cost and fair value of securities available for sale and the gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) and the amortized cost and fair value of securities held to maturity and the related gross unrealized gains and losses:

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Available for sale securities with unrealized losses as of September 30, 2024 and December 31, 2023, aggregated by investment category and length of time the individual securities have been in an unrealized loss position, were as follows:

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Held to maturity securities with unrealized losses as of September 30, 2024 and December 31, 2023, aggregated by investment category and length of time the individual securities have been in an unrealized loss position, were as follows:

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ChoiceOne evaluates all securities on a quarterly basis to determine if an ACL and corresponding impairment charge should be recorded. Consideration is given to the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of ChoiceOne to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value of amortized cost basis. ChoiceOne believes that unrealized losses on securities were temporary in nature and were caused primarily by changes in interest rates, increased credit spreads, and reduced market liquidity and were not caused by the credit status of the issuer. No ACL was recorded in the three and nine months ended September 30, 2024 and 2023.

At September 30, 2024 and December 31, 2023, there were 541 and 569 securities with an unrealized loss, respectively. Unrealized losses have not been recognized into income because the issuers’ bonds are of high credit quality, and management does not intend to sell prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates and other market conditions. The issuers continue to make timely principal and interest payments on the bonds. The fair value is expected to recover as the bonds approach maturity.

The majority of unrealized losses at September 30, 2024, are related to U.S. Treasury notes and bonds, state and municipal bonds and mortgage backed securities. The U.S. Treasury notes are guaranteed by the U.S. government and 100% of the notes are rated AA or better. State and municipal bonds are backed by the taxing authority of the bond issuer or the revenues from the bond. On September 30, 2024, 86% of state and municipal bonds held are rated AA or better, 10% are A rated and 4% are not rated. Of the mortgage-backed securities held on September 30, 2024, 42% were issued by US government sponsored entities and agencies, and rated AA, 43% are AAA rated private issue and collateralized mortgage obligation, and 15% are unrated privately issued mortgage-backed securities with structured credit enhancement and collateralized mortgage obligation.

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Presented below is a schedule of maturities of securities as of September 30, 2024. Available for sale securities are reported at fair value and held to maturity securities are reported at amortized cost. Callable securities in the money are presumed called and matured at the callable date.

Following is information regarding unrealized gains and losses on equity securities for the three and nine months ended September 30, 2024 and 2023:

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NOTE 3 – LOANS AND ALLOWANCE FOR CREDIT LOSSES Loans by type as a percentage of the portfolio were as follows:

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

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The provision for credit losses on loans was an expense of $425,000 in the third quarter of 2024, compared to an expense of $438,000 in the same period in the prior year. The provision expense was deemed necessary due to loan growth during the third quarter and changes in the forecast used in estimating the reserve.

The process to monitor the credit quality of ChoiceOne’s loan portfolio includes tracking (1) the risk ratings of business loans and (2) delinquent and nonperforming consumer loans. Business loans are risk rated on a scale of 1 to 9. A description of the characteristics of the ratings follows:

Risk Rating 1 through 5 or pass: 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 6 or special mention: Loans and other credit extensions bearing this grade are considered to be inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These obligations, even if apparently protected by collateral value, have well-defined weaknesses related to adverse financial, managerial, economic, market, or political conditions that have clearly jeopardized repayment of principal and interest as originally intended. Furthermore, there is the possibility that ChoiceOne Bank will sustain some future loss if such weaknesses are not corrected. Clear loss potential, however, does not have to exist in any individual assets classified as substandard. Loans falling into this category should have clear action plans and timelines with benchmarks to determine which direction the relationship will move.

Risk rating 7 or substandard: Loans and other credit extensions graded “7” have all the weaknesses inherent in those graded “6”, with the added characteristic that the severity of the weaknesses makes collection or liquidation in full highly questionable or improbable based upon currently existing facts, conditions, and values. Loans in this classification should be evaluated for non-accrual status. All nonaccrual commercial and Retail loans must be at a minimum graded a risk code “7”.

Risk rating 8 or doubtful: Loans and other credit extensions bearing this grade have been determined to have the extreme probability of some loss, but because of certain important and reasonably specific factors, the amount of loss cannot be determined. Such pending factors could include merger or liquidation, additional capital injection, refinancing plans, or perfection of liens on additional collateral.

Risk rating 9 or loss: Loans in this classification are considered uncollectible and cannot be justified as a viable asset of ChoiceOne Bank. This classification does not mean the loan has absolutely no recovery value, but that it is neither practical nor desirable to defer writing off this loan even though partial recovery may be obtained in the future.

The following table reflects the amortized cost basis of loans as of September 30, 2024 based on year of origination (dollars in thousands):

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(1) It is noted that write-offs in the tables above do not include checking account write-offs. Checking account write-offs during the first nine months of 2024 were $473,000 or an annualized $631,000 compared to $480,000 during the full year 2023 and $377,000 or an annualized $503,000 during the first nine months of 2023.

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The following table reflects the amortized cost basis of loans as of December 31, 2023 based on year of origination (dollars in thousands):

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(1) It is noted that write-offs in the tables above do not include checking account write-offs. Checking account write-offs during the first nine months of 2024 were $473,000 or an annualized $631,000 compared to $480,000 during the full year 2023 and $377,000 or an annualized $503,000 during the first nine months of 2023.

The following tables present the amortized cost basis of the loans modified to borrowers experiencing financial difficulty disaggregated by class of financing receivable and type of concession granted during the first nine months of 2024 and the full year 2023.

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The following table presents the financial effect by type of modification made to borrowers experiencing financial difficulty and class of financing receivable during the first nine months of 2024 and the full year 2023.

For the period ended: September 30, 2024

Term Extension

Residential real estate Provided with new five year payment plan based on bankruptcy

For the period ended: December 31, 2023

Term Extension

Commercial and industrial Termed out line of credit & termed out draw note

Residential real estate Provided with new twelve month payment plan to catch up on past due balance.

The following table presents the period-end amortized cost basis of financing receivables that had a payment default during the period and were modified in the 12 months before default to borrowers experiencing financial difficulty.

The following table presents the period-end amortized cost basis of loans that have been modified in the past 12 months to borrowers experiencing financial difficulty by payment status and class of financing receivable.

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Nonaccrual loans by loan category were as follows:

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An aging analysis of loans by loan category follows:

(1) Includes nonaccrual loans.

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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:

There were no stock options that were considered anti-dilutive to earnings per share for the three months ended September 30, 2024 and 3,000 stock options that were considered anti-dilutive to earnings per share for the nine months ended September 30, 2024. There were 15,000 stock options that were considered anti-dilutive to earnings per share for the three and nine months ended September 30, 2023.

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Note 5 – Financial Instruments

Financial instruments as of the dates indicated were as follows:

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NOTE 6 – FAIR VALUE MEASUREMENTS

The following tables present information about the Company’s assets and liabilities measured at fair value on a recurring basis at September 30, 2024 and December 31, 2023, and the valuation techniques used by the Company 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 Company 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 Company’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.

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Disclosures concerning assets and liabilities measured at fair value are as follows:

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Securities classified as available for sale are generally reported at fair value utilizing Level 2 inputs. ChoiceOne’s external investment advisor obtained fair value measurements from an independent pricing service that uses matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs). The fair value measurements considered observable data that may include dealer quotes, market spreads, cash flows and the bonds' terms and conditions, among other things. Securities classified in Level 2 included U.S. Government and federal agency securities, state and municipal securities, mortgage-backed securities, corporate bonds, and asset backed securities. The Company classified certain state and municipal securities and corporate bonds, and equity securities as Level 3. Based on the lack of observable market data, estimated fair values were based on the observable data available and reasonable unobservable market data.

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

Of the Level 3 assets that were held by the Company at September 30, 2024, the net unrealized gain as of September 30, 2024 was $283,000, compared to $208,000 as of September 30, 2023. The change in the net unrealized gain or loss is recognized in noninterest income or other comprehensive income in the consolidated balance sheets and income statements. Amounts recognized in noninterest income relate to changes in equity securities. A total of $70,000 and $110,000 of Level 3 securities were purchased during the nine months ended 2024 and 2023, respectively.

Both observable and unobservable inputs may be used to determine the fair value of positions classified as Level 3 assets 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.

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

Collateral dependent loans classified as Level 3 are loans for which the repayment is expected to be provided substantially through the sale or operation of the collateral when the borrower is experiencing financial difficulty. The fair value of the collateral should be adjusted for estimated costs to sell if the repayment depends on the sale of the collateral. The net carrying amount of the loan should not exceed the fair value of the collateral (less costs to sell, if applicable).

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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 ASC 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 service 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 the 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.

Trust Fee Income

Revenue includes fees from the management of trust assets and from other related advisory services. Revenue is recognized when services are rendered.

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

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NOTE 8 – DERIVATIVE AND HEDGING ACTIVITIES

ChoiceOne is exposed to certain risks relating to its ongoing business operations. ChoiceOne utilizes interest rate derivatives as part of its asset liability management strategy to help manage its interest rate risk position. Derivative instruments represent contracts between parties that result in one party delivering cash to the other party based on a notional amount and an underlying term (such as a rate, security price or price index) as specified in the contract. The amount of cash delivered from one party to the other is determined based on the interaction of the notional amount of the contract with the underlying term. Derivatives are also implicit in certain contracts and commitments.

ChoiceOne recognizes derivative financial instruments in the consolidated financial statements at fair value regardless of the purpose or intent for holding the instrument. ChoiceOne records derivative assets and derivative liabilities on the balance sheet within other assets and other liabilities, respectively. Changes in the fair value of derivative financial instruments are either recognized in income or in shareholders’ equity as a component of accumulated other comprehensive income or loss depending on whether the derivative financial instrument qualifies for hedge accounting and, if so, whether it qualifies as a fair value hedge or cash flow hedge.

Interest rate swaps

ChoiceOne uses interest rate swaps as part of its interest rate risk management strategy to add stability to net interest income and to manage its exposure to interest rate movements. Interest rate swaps designated as hedges involve the receipt of variable-rate amounts from a counterparty in exchange for ChoiceOne making fixed-rate payments or the receipt of fixed-rate amounts from a counterparty in exchange for ChoiceOne making variable rate payments, over the life of the agreements without the exchange of the underlying notional amount.

In the second quarter of 2022, ChoiceOne entered into two pay-floating/receive-fixed interest rate swaps (the “Pay Floating Swap Agreements”) for a total notional amount of $200.0 million that were designated as cash flow hedges. These derivatives hedge the variable cash flows of specifically identified available-for-sale securities, cash and loans. The Pay Floating Swap Agreements were determined to be highly effective during the periods presented and therefore no amount of ineffectiveness has been included in net income. The Pay Floating Swap Agreements pay a coupon rate equal to SOFR while receiving a fixed coupon rate of 2.41%. In March 2023, ChoiceOne terminated all Pay Floating Swap Agreements for a cash payment of $4.2 million. The loss was amortized into interest income over 13 months, which was the remaining period of the swap agreements. As of April 2024, the loss was fully amortized.

In the second quarter of 2022, ChoiceOne entered into one forward starting pay-fixed/receive-floating interest rate swap (the “Pay Fixed Swap Agreement”) for a notional amount of $200.0 million that was designated as a cash flow hedge. This derivative hedges the risk of variability in cash flows attributable to forecasted payments on future deposits or floating rate borrowings indexed to the SOFR Rate. The Pay Fixed Swap Agreement is two years forward starting with an eight-year term set to expire in 2032. The Pay Fixed Swap Agreement will pay a fixed coupon rate of 2.75% while receiving the SOFR Rate, which began in April 2024. Net settlements on the Pay Fixed Swap Agreement were $1.3 million and $2.3 million for the three and nine months ended September 30, 2024, which reduced interest expense.

In the fourth quarter of 2022, ChoiceOne entered into four pay-fixed/receive-floating interest rate swaps for a total notional amount of $201.0 million that were designated as fair value hedges. These derivatives hedge the risk of changes in fair value of certain available for sale securities for changes in the SOFR benchmark interest rate component of the fixed rate bonds. All four of these hedges were effective immediately on December 22, 2022. Of the total notional value, $101.9 million has a ten-year term set to expire in 2032, with the benchmark SOFR interest rate risk component of the fixed rate bonds equal to 3.390%. Of the total notional value, $50.0 million has a nine-year term set to expire in 2031, with the benchmark SOFR interest rate risk component of the fixed rate bonds equal to 3.4015%. The remaining notional value of $49.1 million has a nine-year term set to expire in 2031, with the benchmark SOFR interest rate risk component of the fixed rate bond equal to 3.4030%. ChoiceOne adopted ASC2022-01, as of December 20, 2022, to use the portfolio layer method. The fair value basis adjustment associated with available-for-sale fixed rate bonds initially results in an adjustment to AOCI. For available-for-sale securities subject to fair value hedge accounting, the changes in the fair value of the fixed rate bonds related to the hedged risk (the benchmark interest rate component and the partial term) are then reclassed from AOCI to current earnings offsetting the fair value measurement change of the interest rate swap, which is also recorded in current earnings. Net cash settlements are received/paid semi-annually, with the first starting in March 2023, and are included in interest income.

Net settlements on these four pay-fixed/receive-floating swaps were $1.0 million and $959,000 for the three months ended September 30, 2024 and 2023, respectively, and $3.0 million and $2.3 million for the nine months ended September 30, 2024 and 2023, respectively, which were included in interest income.

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The table below presents the fair value of derivative financial instruments as well as the classification within the consolidated statements of financial condition:

The table below presents the effect of fair value and cash flow hedge accounting on the consolidated statements of operations for the periods presented:

The table below presents the cumulative basis adjustments on hedged items designated as fair value hedges and the related amortized cost of those items as of the periods presented:

Back to Back Loan Swaps

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Derivatives not designated as hedges are not speculative and result from a service provided to certain commercial loan borrowers. ChoiceOne executes interest rate swaps with commercial banking customers desiring longer-term fixed rate loans, while simultaneously entering into interest rate swaps with a correspondent bank to offset the impact of the interest rate swaps with the commercial banking customers. This is known as a back to back loan swap agreement. The net result is the desired floating rate loan and a minimization of the risk exposure of the interest rate swap transactions. Under this arrangement the Bank has three freestanding interest rate swaps, each of which is carried at fair value. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the commercial banking customer interest rate swaps and the offsetting interest rate swaps with the correspondent bank are recognized directly to earnings. As the terms mirror each other, there is no income statement impact to the Bank.

The table below presents the notional and fair value of these derivative instruments as of September 30, 2024 and December 31, 2023:

The fair value of interest rate swaps in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements was $1.3 million and $0 as of September 30, 2024 and December 31, 2023, respectively. ChoiceOne has a master netting agreement with the correspondent bank and has the right to offset, however, ChoiceOne has elected to present the assets and liabilities gross. ChoiceOne is required to pledge collateral to the correspondent bank equal to or in excess of the net liability position. ChoiceOne's derivative liability with the correspondent bank was $1.3 million and $0 at September 30, 2024 and December 31, 2023, respectively. Cash pledged as collateral to the correspondent bank was $1.4 million and $0 at September 30, 2024 and December 31, 2023, respectively.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $42.6 million as of September 30, 2024 and $0 at December 31, 2023. Associated credit exposure is generally mitigated by securing the interest rate swaps with the underlying collateral of the loan instrument that has been hedged.

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NOTE 9 – Borrowings

Federal Home Loan Bank Advances

Bank Term Funding Program (“BTFP”)

Advances from the FHLB were secured by residential real estate loans with a carrying value of approximately $201.0 million at September 30, 2024, compared to residential real estate loans with a carrying value of approximately $191.1 million and securities with a carrying value of approximately $278.5 million at December 31, 2023. Based on this collateral, the Bank was eligible to borrow an additional $89.8 million at September 30, 2024.

Advances from the Federal Reserve Bank were secured by securities with a carrying value of approximately $515.7 million and loans with a carrying value of approximately $467.6 million at September 30, 2024, compared to securities with a carrying value of approximately $526.4 million and loans with a carrying value of approximately $433.2 million at December 31, 2023. Based on this collateral, the Bank was eligible to borrow an additional $689.5 million at September 30, 2024.

In June 2021, ChoiceOne obtained a $20 million line of credit with an annual renewal. The line carries a floating rate of prime rate with a floor of 3.25% and current rate of 8.0% at September 30, 2024. The credit agreement includes certain financial covenants, including minimum capital ratios, asset quality ratios, and the requirements of achieving certain profitability thresholds.

ChoiceOne was in compliance with all covenants as of September 30, 2024. The line of credit balance was $0 at September 30, 2024.

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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 subsidiaries. This discussion should be read in conjunction with the interim consolidated financial statements and related notes.

RECENT EVENTS

On July 26, 2024, ChoiceOne completed an underwritten public offering of 1,380,000 shares of its common stock at a price to the public of $25.00 per share (the “Common Stock Offering”). The aggregate gross proceeds of the Common Stock Offering were approximately $34.5 million before deducting underwriting discounts and estimated offering expenses. The proceeds from the Common Stock Offering will qualify as tangible common equity and Tier 1 common equity. ChoiceOne intends to use the net proceeds of the Common Stock Offering for general corporate purposes including supplementing regulatory capital ratios and in conjunction with its announced merger with Fentura Financial, Inc.

On July 25, 2024, ChoiceOne and Fentura Financial, Inc. (“Fentura”), the parent company of The State Bank, announced the signing of a definitive merger agreement (the “Merger Agreement”) pursuant to which ChoiceOne and Fentura will merge in an all-stock transaction. The agreement was unanimously approved by the boards of directors of both companies. Under the terms of the merger

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agreement, each share of Fentura common stock outstanding immediately prior to completion of the merger will be converted into the right to receive 1.35 shares of ChoiceOne common stock. Once completed, the combination will create the third largest publicly traded bank in Michigan with approximately $4.3 billion in consolidated total assets and 56 offices in Western, Central and Southeastern Michigan. The proposed transaction is expected to close in the first quarter of 2025, subject to the satisfaction of customary closing conditions, including receipt of approval from Fentura and ChoiceOne shareholders and receipt of all necessary regulatory approvals.

RESULTS OF OPERATIONS

ChoiceOne reported net income of $7,348,000 and $19,568,000 for the three and nine months ended September 30, 2024, compared to $5,122,000 and $15,968,000 for the same periods in 2023, representing growth of 43.5% and 22.5%, respectively. Net income adjusted for merger related expenses net of tax was $7,981,000 and $20,201,000 for the three and nine months ended September 30, 2024. Diluted earnings per share were $0.85 and $2.46 in the three and nine months ended September 30, 2024, compared to $0.68 and $2.12 per share in the same periods in the prior year. Earnings per share was negatively impacted by the sale of 1,380,000 shares of common stock in the Common Stock Offering.

As of September 30, 2024, total assets were $2.7 billion, an increase of $149.3 million compared to December 31, 2023. The growth is primarily attributed to an increase in core loans of $74.2 million and loans to other financial institutions of $19.1 million and an increase in cash and due from banks of $90.5 million compared to December 31, 2023. This growth was partially offset by a $33.1 million reduction in securities during the same time period. ChoiceOne has actively managed its balance sheet to support organic loan growth, strategically shifting from lower-yielding assets to higher-yielding loans. This is reflected in the loan growth observed during the nine months ended September 30, 2024.

Deposits, excluding brokered deposits, increased $102.1 million or an annualized 19.5% in the third quarter of 2024 and $103.0 million or 4.9% compared to December 31, 2023. The increase in deposits in the third quarter was driven by public funds including schools and townships which historically increase in the third quarter of each year due to the timing of tax collection. The increase in deposits compared to December 31, 2023 is a combination of new business and recapture of deposit losses from the prior year. ChoiceOne continues to be proactive in managing its liquidity position by using brokered deposits, the Bank Term Funding Program (“BTFP”), and FHLB advances to ensure ample liquidity. At September 30, 2024, total available borrowing capacity secured by pledged assets was $780.6 million. ChoiceOne can increase its capacity by utilizing unsecured federal fund lines and pledging additional assets, if necessary. Uninsured deposits totaled $863.3 million or 39.1% of deposits at September 30, 2024.

ChoiceOne's cost of deposits to average total deposits has declined since peaking in the first quarter of 2024 due to positive cash flow from pay-fixed interest rate swaps, hedged against deposits, decreasing deposit expenses. In addition, the Federal Reserve decreased the federal funds rate by 50 basis points in September 2024 and signaled potential further rate drops in the future. The cost of deposits to average total deposits has increased slightly to an annualized 1.53% in the third quarter of 2024 compared to an annualized 1.36% in the third quarter of 2023. Due to hedge instruments we have in place, our balance sheet is asset sensitive. If rates decline, we expect to see slight declines in deposit costs; however these declines will be muted by the decrease in cash flows from pay-fixed interest rate swaps collected. Interest expense on borrowings for the three and nine months ended September 30, 2024 increased $239,000 and $3.4 million, respectively, compared to the same periods in the prior year, due to increases in borrowing amounts and interest rates. Borrowings include $170 million from the BTFP and $40 million of FHLB borrowings at a weighted average fixed rate of 4.7%, with the earliest maturity in January 2025. Total cost of funds increased to an annualized 1.87% in the third quarter of 2024 compared to an annualized 1.70% in the third quarter of 2023.

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The annualized return on average assets and annualized return on average shareholders’ equity were 1.09% and 12.36%, respectively, for the third quarter of 2024, compared to an annualized 0.80% and an annualized 11.31%, respectively, for the same period in 2023. The annualized return on average assets and annualized return on average shareholders’ equity were 0.98% and 12.00%, respectively, for the first nine months of 2024, compared to 0.87% and 12.26%, respectively, for the same period in 2023.

Dividends

Cash dividends of $2.4 million or $0.27 per share were declared in the third quarter of 2024, compared to $2.0 million or $0.26 per share in the third quarter of 2023. Cash dividends declared in the first nine months of 2024 were $6.5 million or $0.81 per share, compared to $5.9 million or $0.78 per share in the same period during the prior year. The cash dividend payout percentage was 33.2% for the first nine months of 2024, compared to 36.8% 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 nine months ended September 30, 2024 and 2023. 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.

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Table 1 – Average Balances and Tax-Equivalent Interest Rates

(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 of 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)

Taxable securities include dividend income from Federal Home Loan Bank and Federal Reserve Bank stock.

(3)

Loans include both loans to other financial institutions and loans held for sale.

(4)

Non-accruing loan balances are included in the balances of average loans. Non-accruing loan average balances were $2.2 million and $1.9 million in the third quarter of 2024 and 2023, respectively.

(5)

Interest on loans included net origination fees and accretion income. Accretion income was $275,000 and $362,000 in the third quarter of 2024 and 2023, respectively.

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(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 of 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)

Taxable securities include dividend income from Federal Home Loan Bank and Federal Reserve Bank stock.

(3)

Loans include both loans to other financial institutions and loans held for sale.

(4)

Non-accruing loan balances are included in the balances of average loans. Non-accruing loan average balances were $2.1 million and $1.5 million in the first nine months of 2024 and 2023, respectively.

(5)

Interest on loans included net origination fees and accretion income related to acquired loans. Accretion income related to acquired loans was $944,000 and $1.4 million in the first nine months of 2024 and 2023, respectively.

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Table 2 – Changes in Tax-Equivalent Net Interest Income

(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%.

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Net Interest Income

Tax-equivalent net interest income increased $4.0 million and $5.8 million in the three and nine months ended September 30, 2024, compared to the same periods in 2023. The primary factor contributing to the increase in interest income was the higher interest rates on new loans and the impact of fixed rate swaps (see note 8). Tax equivalent net interest margin increased 53 basis points and 13 basis points in the three and nine months ended September 30, 2024, respectively, compared to the same periods in 2023. GAAP based net interest margin increased 53 basis points and 14 basis points in the three and nine months ended September 30, 2024, respectively, compared to the same periods in 2023.

The following table presents the annualized cost of deposits and the annualized cost of funds for the three and nine months ended September 30, 2024 and 2023.

ChoiceOne has experienced loan growth, leading to an increase in interest income from loans of $5.5 million and $17.4 million in the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year. Average loans grew $181.6 million and $202.8 million in the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year. In addition, the average rate earned on loans increased 82 basis points and 88 basis points in the three and nine months ended September 30, 2024, respectively, compared to the same period in the prior year. Interest income on loans for the three and nine months ended September 30, 2024 increased by $673,000 and $1.3 million, respectively, compared to the same periods in 2023, due to amortization expense related to the March 2023 sale of the pay floating swap derivative and a decline in accretion income related to acquired loans of $87,000 and $333,000, respectively.

The average balance of total securities decreased $64.9 million and $63.6 million for the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year. The decrease is due to paydowns and a decline in the fair value of available for sale securities. The average rate earned on securities increased 25 basis points and 27 basis points for the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year. Interest income on securities increased by $196,000 and $719,000 for the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year.

Interest expense increased $1.4 million in the three months ended September 30, 2024 and increased $13.3 million in the nine months ended September 30, 2024, compared to the same periods in the prior year. The average rate paid on interest bearing-demand deposits and savings deposits increased 13 basis points and 46 basis points in the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year. This was partly due to an increase in the average balance of interest bearing-demand deposits and savings deposits of $31.9 million for the three months ended September 30, 2024 and offset by the decline in the average balance of interest bearing-demand deposits and savings deposits of $2.0 million for the nine months ended September 30, 2024, compared to the same time periods in the prior year. The increase in the average balance of certificates of deposit of $51.8 million and $95.7 million in the three and nine months ended September 30, 2024, respectively, combined with a 50 basis point and 128 basis point increase in the rate paid on certificates of deposits in the three and nine months ended September 30, 2024, respectively, compared to the same periods in the prior year, led to an increase in interest expense of $988,000 and $5.9 million during the respective time periods.

In order to bolster liquidity, ChoiceOne borrowed a total of $170.0 million from the Bank Term Funding Program ("BTFP") during the second and fourth quarters of 2023 and held $6.6 million in brokered deposits and $40.0 million in FHLB advances on September 30, 2024. The net effect of these additional borrowed funds and brokered deposits was neutral to interest expense for the three months ended September 30, 2024 and an increase in interest expense of $2.7 million for the nine months ended September 30, 2024, compared to the same periods in 2023.

In September 2021, ChoiceOne completed a private placement of $32.5 million in aggregate principal amount of 3.25% fixed-to-floating rate subordinated notes due 2031. In addition, ChoiceOne holds certain subordinated debentures issued in connection with a trust preferred securities offering that were obtained as part of the merger with Community Shores. The average balance of subordinated debentures was flat in the third quarter of 2024 and the nine months ended September 30, 2024, compared to the same periods in the prior year.

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Provision and Allowance for Credit Losses

The allowance for credit losses ("ACL") consists of general and specific components. The general component covers loans collectively evaluated for credit loss and is based on peer historical loss experience adjusted for current and forecasted factors. Management's adjustment for current and forecasted factors is based on trends in delinquencies, trends in charge-offs and recoveries, trends in the volume of loans, changes in underwriting standards, trends in loan review findings, the experience and ability of lending staff, and a reasonable and supportable economic forecast described further below.

The determination of our loss factors is based, in part, upon benchmark peer loss history adjusted for qualitative factors that, in management's judgment, affect the collectability of the portfolio as of the analysis date. ChoiceOne's lookback period of benchmark peer net charge-off history was from January 1, 2004 through December 31, 2019 for this analysis.

Loans individually evaluated for credit losses increased by $656,000 to $2.7 million during the first nine months of 2024, and the ACL related to these individually evaluated loans increased by $28,000 during the same period.

Nonperforming loans, which includes Other Real Estate Owned ("OREO") but excludes performing troubled loan modifications ("TLM"), remained low at $2.9 million as of September 30, 2024, compared to $1.9 million as of December 31, 2023, and $1.8 million as of September 30, 2023. The ACL was 1.10% of total loans, excluding loans held for sale, at September 30, 2024, compared to 1.11% on December 31, 2023, and 1.14% on September 30, 2023. The liability for expected credit losses on unfunded loans and other commitments was $1.5 million on September 30, 2024, compared to $2.2 million on December 31, 2023, and $2.7 million on September 30, 2023.

Charge-offs and recoveries for respective loan categories for the nine months ended September 30, 2024 and 2023 were as follows:

Net charge-offs were $295,000 during the first nine months of 2024, compared to net charge-offs of $244,000 during the same period in 2023. Net charge-offs for checking accounts during the first nine months of 2024 were $155,000 or an annualized $206,000 compared to $178,000 or an annualized $238,000 for the same period in the prior year. Annualized net loan charge-offs as a percentage of average loans were 0.02% for the third quarter of 2024 compared to 0.05% for the same period in the prior year.

The provision for credit losses on loans was $1.1 million during the first nine months of 2024, compared to $332,000 in the same period in the prior year. The provision expense was deemed necessary due to growth in total loans held for investment of $93.3 million during the first nine months of 2024 and minor deteriorations in the forecast used in ChoiceOne's CECL model.

The loan provision expense was offset by the decrease in unfunded commitments provision expense of $675,000 in the first nine months of 2024, due to changes in mix, historical average funding rate declines, and a decline in balance. Total unfunded commitments decreased $28.7 million in the first nine months of 2024 compared to December 31, 2023.

Net provision for credit losses was $425,000 for the third quarter and first nine months of 2024.

Noninterest Income

Noninterest income increased $1.2 million and $2.1 million in the three and nine months ended September 30, 2024, compared to the same periods in the prior year. The increase was largely due to an increase in customer service charges of $391,000 and $920,000 in the three and nine months ended September 30, 2024 and changes in the market value of equity securities in the three and nine months ended September 30, 2024, compared to the same periods in the prior year. Equity securities include community bank stocks and CRA

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focused bond mutual funds. In addition, ChoiceOne recognized earnings on a bank owned life insurance death benefit claim in the amount of $196,000 during the first quarter of 2024.

Noninterest Expense

Noninterest expense increased by $1.7 million or 12.3% and $2.1 million or 5.0% in the three and nine months ended September 30, 2024 compared to the same periods in 2023. The increase in total noninterest expense was due in part to merger related expenses of $645,000 during the third quarter 2024 compared to $0 in the prior year. Additionally, there was an increase to employee health insurance and other benefit costs, and an increase to FDIC insurance and other costs related to inflationary pressures. The year to date increase in costs were offset by a decline in occupancy and equipment related to two branch closures during the first quarter of 2024. Management continues to seek out ways to manage costs, but also recognizes the value of investing in innovation and attracting the best talent in our industry to compete effectively in our markets.

Income Tax Expense

Income tax expense was $1.9 million and $4.7 million in the three and nine months ended September 30, 2024, respectively, compared to $1.1 million and $3.2 million for the same periods in 2023. The effective tax rate was 20.8% and 19.4% for the three and nine months ended September 30, 2024, respectively, compared to 17.4% and 16.5% for the same periods in 2023. During the first nine months of 2024, disallowed interest expense and non deductible merger expenses increased compared to the same period in 2023.

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FINANCIAL CONDITION

At September 30, 2024, ChoiceOne had consolidated total assets of $2.7 billion, net loans of $1.5 billion, total deposits of $2.2 billion and total shareholders' equity of $247.7 million.

Securities

Total available for sale securities on September 30, 2024 were $497.6 million compared to $514.6 million on December 31, 2023, with the decrease caused by $25.1 million of principal repayments, calls and maturities. The unrealized loss on securities available for sale declined by $17.0 million in the first nine months of 2024. Total held to maturity securities on September 30, 2024 were $392.0 million compared to $408.0 million on December 31, 2023. ChoiceOne's held to maturity securities declined during the first nine months of 2024 due to $16.0 million of principal repayments, calls and maturities.

At September 30, 2024, ChoiceOne had $107.7 million in unrealized losses on its investment securities, including $61.4 million in unrealized losses on available for sale securities, $46.1 million in unrealized losses on held to maturity securities, and $214,000 in unrealized losses on equity securities. Unrealized losses on corporate and municipal bonds have not been recognized into income because management believes the issuers are of high credit quality, and management does not intend to sell prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates and other market conditions. The issuers continue to make timely principal and interest payments on the bonds. The fair value is expected to recover as the bonds approach maturity.

ChoiceOne utilizes interest rate derivatives as part of its asset liability management strategy to help manage its interest rate risk position. In order to hedge the risk of rising rates and unrealized losses on securities resulting from the rising rates, ChoiceOne currently holds pay fixed, receive variable interest rate swaps with a total notional value of $401.0 million. These derivative instruments increase in value as long-term interest rates rise, which partially offsets the reduction in shareholders' equity due to unrealized losses on securities available for sale. Refer to Note 8 - Derivatives and Hedging Activities of the consolidated financial statements for more discussion on ChoiceOne’s derivative position.

Equity securities included a money market preferred security ("MMP") of $1.0 million and common stock of $6.8 million as of September 30, 2024. As of December 31, 2023, equity securities included a MMP of $1.0 million and common stock of $6.5 million.

Per U.S. generally accepted accounting principles, unrealized gains or losses on securities available for sale are reflected on the balance sheet in accumulated other comprehensive income (loss), while unrealized gains or losses on securities held to maturity are not reflected on the balance sheet.

Loans

The company's loan portfolio by call report code was as follows:

Average loan balances increased to $1.46 billion in the third quarter of 2024 compared to $1.36 billion in the fourth quarter of 2023 and $1.28 billion in the third quarter of 2023. Core loans grew organically by $74.2 million or 7.1% on an annualized basis during the first nine months of 2024. Loan growth during the first nine months of 2024 was concentrated in Non-Owner Occupied CRE loans, which grew by $75.3 million. ChoiceOne also saw healthy growth in Multifamily Loans, which grew by $27.9 million, 1-4 Family loans which grew $25.4 million, and Owner Occupied CRE, which grew by $22.1 million. The growth in 1-4 Family loans was largely related to growth in loans to other financial institutions which were $38.5 million as of September 30, 2024, compared to $19.4

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million as of December 31, 2023. Loans to other financial institutions is comprised of a warehouse line of credit to facilitate mortgage loan originations and the interest rate fluctuates with the national mortgage market. This balance is short term in nature with an average life of under 30 days. Management believes the short-term structure and low credit risk of this asset is advantageous in the current rate environment. Loan interest including fee income increased $5.5 million and $17.4 million in the three and nine months ended September 30, 2024, respectively, compared to the same time periods in the prior year.

During the first nine months of 2024 and 2023, ChoiceOne recorded accretion income related to acquired loans in the amount of $944,000 and $1.3 million, respectively. Remaining credit and yield mark on acquired loans from the mergers with County Bank Corp. and Community Shores will accrete into income as the acquired loans mature. The remaining yield mark on acquired loans from the mergers with County Bank Corp. and Community Shores totaled $1.6 million as of September 30, 2024.

Goodwill

Goodwill is not amortized but is evaluated annually for impairment and on an interim basis if events or changes in circumstances indicate that goodwill might be impaired. The goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount, and an impairment charge would be recognized for any amount by which the carrying amount exceeds the reporting unit’s fair value. Accounting pronouncements allow a company to first perform a qualitative assessment for goodwill prior to a quantitative assessment (Step 1 assessment). If the results of the qualitative assessment indicate that it is more likely than not that goodwill is impaired, then a quantitative assessment must be performed. If not, there is no further assessment required. The Company acquired Valley Ridge Financial Corp. in 2006, County Bank Corp in 2019, and Community Shores in 2020, which resulted in the recognition of goodwill of $13.7 million, $38.9 million and $7.3 million, respectively.

ChoiceOne engaged a third party valuation firm to assist in performing a quantitative analysis of goodwill as of June 30, 2024 ("the measurement date"). In deriving the fair value of the reporting unit (the Bank), the third-party firm assessed general economic conditions and outlook; industry and market considerations and outlook; the impact of recent events to financial performance; the market price of ChoiceOne’s common stock and other relevant events. In addition, the valuation relied on financial projections through 2029 and growth rates prepared by management. Based on the valuation prepared, it was determined that ChoiceOne's estimated fair value of the reporting unit at the measurement date was greater than its book value and impairment of goodwill was not required. No material changes and no triggering events have occurred that indicated impairment from the measurement date through September 30, 2024.

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Deposits and Borrowings

Deposits, excluding brokered deposits, increased $102.1 million or an annualized 19.5% in the third quarter of 2024 and $103.0 million or 4.9% compared to December 31, 2023. The increase in deposits in the third quarter was driven by public funds including schools and townships which historically increase in the third quarter of each year due to the timing of tax collection. The increase in deposits compared to December 31, 2023 is a combination of new business and recapture of deposit losses from the prior year. ChoiceOne continues to be proactive in managing its liquidity position by using brokered deposits, the Bank Term Funding Program (“BTFP”), and FHLB advances to ensure ample liquidity.

Uninsured deposits totaled $863.3 million or 39.1% of deposits on September 30, 2024 compared to $769.7 million, or 36.3% of total deposits at December 31, 2023. At September 30, 2024, total available borrowing capacity from all sources was $780.6 million. ChoiceOne can increase its capacity by utilizing unsecured federal fund lines and pledging additional assets, if necessary.

In September 2021, ChoiceOne completed a private placement of $32.5 million in aggregate principal amount of 3.25% fixed-to-floating rate subordinated notes due 2031. ChoiceOne also holds $3.5 million in subordinated debentures issued in connection with a $4.5 million trust preferred securities offering, which were obtained in the merger with Community Shores, offset by the merger mark-to-market adjustment.

At September 30, 2024, ChoiceOne has borrowed $170 million from the BTFP. This program provides a 1-year term at a fixed rate with the ability to prepay at any time without penalty. The interest rate on the BTFP borrowings as of September 30, 2024 was 4.76% and fixed through January of 2025. Collateral pledged is U.S. Treasuries, agency debt and mortgage-backed securities valued at par. At September 30, 2024, ChoiceOne had $40 million of borrowings from the FHLB with a weighted average rate of 4.58% with maturities through 2026. Total cost of funds increased to an annualized 1.87% in the third quarter of 2024 compared to an annualized 1.70% in the third quarter of 2023.

Shareholders' Equity

Shareholders’ equity totaled $247.7 million as of September 30, 2024, up from $195.6 million as of December 31, 2023, due in large part to the $34.5 million in aggregate gross proceeds (before deducting discounts and estimated offering expenses) received in the Common Stock Offering. The additional increase is due to retained earnings and an improvement in accumulated other compressive loss (AOCI) of $6.1 million compared to December 31, 2023. The improvement in AOCI, is due to both the shortening duration and maturing (paydowns) of the securities portfolio, offset by the change in unrealized gain of the pay-fixed swap derivatives. ChoiceOne Bank remains “well-capitalized” with a total risk-based capital ratio of 13.1% as of September 30, 2024, compared to 12.4% on December 31, 2023.

ChoiceOne uses interest rate swaps to manage interest rate exposure to certain fixed rate assets and variable rate liabilities. On September 30, 2024, ChoiceOne had pay-fixed interest rate swaps with a total notional value of $401.0 million, a weighted average coupon of 3.07%, a fair value of $4.4 million and an average remaining contract length of 7 to 8 years. These derivative instruments increase in value as long-term interest rates rise, which offsets the reduction in equity due to unrealized losses on securities available for sale. Included in the total is $200.0 million of forward starting pay-fixed, receive floating interest rate swaps used to hedge interest bearing liabilities. These forward starting swaps pay a fixed coupon of 2.75% while receiving SOFR. Settlements from these swaps amounted to $1.3 million for the third quarter of 2024 and were a contributing factor to the increase in net interest margin during the third quarter of 2024. Fully tax equivalent net interest margin excluding the swaps was 39 basis points lower than tax equivalent net interest margin reported for the third quarter of 2024. In addition to the pay-fixed interest rate swaps, ChoiceOne also employs back-to-back swaps on a commercial loans, with the impact reflected in interest income.

On January 1, 2023, ChoiceOne adopted ASU 2016-13 CECL which caused an increase in the ACL of $7.2 million and booked a liability for expected credit losses on unfunded loans and other commitments of $3.3 million. The increase in the ACL and the cost of the liability resulted in a decrease in the retained earnings account on our Consolidated Balance Sheet equal to the after-tax impact, with the tax impact portion being recorded in deferred taxes in our Consolidated balance Sheet in accordance with FASB guidance. This reduction in retained earnings was offset by first quarter 2023 earnings and recovery of accumulated other comprehensive loss.

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Regulatory Capital Requirements

Following is information regarding compliance of ChoiceOne and ChoiceOne Bank with regulatory capital requirements:

Management reviews the capital levels of ChoiceOne and ChoiceOne Bank on a regular basis. The Board of Directors and management believe that the capital levels as of September 30, 2024 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.

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Liquidity

Net cash provided by operating activities was $25.0 million for the nine months ended September 30, 2024 compared to $57.3 million in the same period in 2023. The change was due to the change in proceeds from loan sales and other liabilities, partially offset by other assets in the nine months ended September 30, 2024 compared to the same period in 2023. Net cash used in investing activities was $56.3 million for the nine months ended September 30, 2024 compared to $96.1 million used in the same period in 2023. The change was due to a decrease in net loan originations that led to cash used of $94.1 million in the first nine months of 2024 compared to $120.3 million used in the same period during the prior year. Net maturities, payments and calls of available for sale and held to maturity securities was $41.8 million for the nine months ended September 30, 2024 compared to $32.2 million in the same period in 2023. Net cash provided by financing activities was $122.2 million for the nine months ended September 30, 2024, compared to $139.5 million in the same period in the prior year. ChoiceOne had $86.2 million in deposit growth in the first nine months of 2024 compared to a decrease of $15.2 million in the same period in 2023. ChoiceOne also increased borrowing by $10.0 million in the first nine months of 2024 compared to an increase of $130.0 million in the same period during the prior year.

ChoiceOne's market risk exposure occurs in the form of interest rate risk and liquidity risk. ChoiceOne's business is transacted in U.S. dollars with no foreign exchange risk exposure. Agricultural loans comprise a relatively small portion of ChoiceOne's total assets. Management believes that ChoiceOne's exposure to changes in commodity prices is insignificant.

Liquidity risk deals with ChoiceOne's ability to meet its cash flow requirements. These requirements include depositors desiring to withdraw funds and borrowers seeking credit. Longer-term liquidity needs may be met through core deposit growth, maturities of and cash flows from investment securities, normal loan repayments, advances from the FHLB and the Federal Reserve Bank, brokered certificates of deposit, and income retention. ChoiceOne had $170.0 million in outstanding borrowings from the BTFP as of September 30, 2024. ChoiceOne had $40.0 million in outstanding borrowings at the FHLB as of September 30, 2024. The acceptance of brokered certificates of deposit is not limited as long as the Bank is categorized as “well capitalized” under regulatory guidelines. At September 30, 2024, total available borrowing capacity from the FHLB and the Federal Reserve Bank was $780.6 million.

ChoiceOne continues to review its liquidity management and has taken steps in an effort to ensure adequacy. These steps include limiting bond purchases in the first nine months of 2024, pledging securities to FHLB and the Federal Reserve Bank in order to increase borrowing capacity and using alternative funding sources such as brokered deposits.

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 Chief Financial Officer, of the effectiveness of the design and operation of ChoiceOne’s disclosure controls and procedures as of September 30, 2024. Based on and as of the time of that evaluation, ChoiceOne’s management, including the Chief Executive Officer and Chief 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, 2024 that has materially affected, or that is reasonably likely to materially affect, ChoiceOne’s internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

There are no material pending legal proceedings to which ChoiceOne or ChoiceOne Bank is a party or to which any of their properties are subject, except for proceedings that arose in the ordinary course of business.

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, 2023 and Item 1A, “Risk Factors,” in ChoiceOne’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2024.

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

There were no unregistered sales of equity securities in the third quarter of 2024.

There were no issuer purchases of equity securities during the third quarter of 2024.

Item 5. Other Information

None.

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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 by and between ChoiceOne Financial Services, Inc. and Fentura Financial, Inc. dated July 25, 2024. Previously filed with the Commission on July 25, 2024 in ChoiceOne Financial Services, Inc.’s Current Report on Form 8-K, Exhibit 2.1. Here incorporated by reference. 3.1 Restated Articles of Incorporation of ChoiceOne Financial Services, Inc. Previously filed as an exhibit to ChoiceOne’s Form 10-K Annual Report for the year ended December 31, 2022. 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 Form 8-K filed April 21, 2021. Here incorporated by reference. 4.1 Advances, Pledge and Security Agreement between ChoiceOne Bank and the Federal Home Loan Bank of Indianapolis. Previously filed as an exhibit to ChoiceOne Financial Services, Inc.’s Form 10-K Annual Report for the year ended December 31, 2013. Here incorporated by reference. 4.2 Form of 3.25% Fixed-to-Floating Rate Subordinated Note due September 3, 2031. Previously filed as an exhibit to ChoiceOne Financial Services, Inc.'s Form 8-K filed September 7, 2021. Here incorporated by reference. 4.3 Form of 3.25% Fixed-to-Floating Rate Global Subordinated Note due September 3, 2031. Previously filed as an exhibit to ChoiceOne Financial Services, Inc.'s Form 8-K filed September 7, 2021. Here incorporated by reference. 31.1 Certification of Chief Executive Officer 31.2 Certification of Chief Financial Officer 32.1 Certification pursuant to 18 U.S.C. § 1350. 101.INS Inline XBRL Instance Document 101.SCH Inline XBRL Taxonomy Extension Schema Document 101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase Document 101.DEF Inline XBRL Taxonomy Extension Definition Linkbase Document 101.LAB Inline XBRL Taxonomy Extension Label Linkbase Document 101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase Document (104) Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

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