CHOICEONE FINANCIAL SERVICES INC Management’s report and analysis of financial condition and operating results. (Form 10-Q)

The following discussion is designed to provide a review of the consolidated
financial condition and results of operations of ChoiceOne Financial Services,
Inc. ("ChoiceOne"), its wholly-owned subsidiary ChoiceOne Bank, and ChoiceOne
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.  Words such as "anticipates," "believes,"
"estimates," "expects," "forecasts," "intends," "is likely," "plans,"
"predicts," "projects," "may," "could," "look forward," "continue",
"future", "will" 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 that are inherently forward-looking.  All of the
information concerning interest rate sensitivity is forward-looking.  All
statements with references to future time periods are forward-looking.  These
statements are not guarantees of future performance and involve certain risks,
uncertainties and assumptions ("risk factors") that are difficult to predict
with regard to timing, extent, likelihood, and degree of occurrence.  Therefore,
actual results and outcomes may materially differ from what may be expressed,
implied or forecasted in such forward-looking statements.  Furthermore,
ChoiceOne undertakes no obligation to update, amend, or clarify forward-looking
statements, whether as a result of new information, future events, or otherwise.



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, 2021 and in Part II, Item 1A of this Quarterly Report on Form
10-Q.  These are representative of the risk factors that could cause a
difference between an ultimate actual outcome and a preceding forward-looking
statement.



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                             RESULTS OF OPERATIONS



Net income for the third quarter of 2022 was $5,813,000, which represented an
increase of $64,000 or 1% compared to the third quarter of 2021.  Basic and
diluted earnings per common share were $0.77 for the third quarter of 2022
compared to $0.75 for the third quarter of the prior year.  The increase in the
third quarter of 2022 is largely related to the increase in interest income due
to strong loan growth. Net income for the first nine months of 2022 was
$16,956,000, which represented a decline of $74,000 or less than 1% compared to
the first three quarters of 2021.  Basic and diluted earnings per common share
were $2.26 for the first three quarters of 2022 compared to $2.20 for the first
three quarters of the prior year.  The modest decline in net income in the first
nine months of 2022 compared to the same period in the prior year resulted in
part from a decline of refinancing activity within ChoiceOne's mortgage
portfolio due to a rise in mortgage rates since the first quarter of the prior
year.  Net income also declined as interest expense increased mostly due to
expense from a private placement of $32.5 million of fixed-to-floating rate
subordinated notes late in the third quarter of the prior year and organic
deposit interest expense.  These factors were largely offset by an increase of
$6.6 million in interest income as the balance of both core loans and securities
continued to grow.  Core loans (defined as loans excluding loans held for sale,
loans to other financial institutions, and Paycheck Protection Program ("PPP")
loans) increased by $52.8 million or 19.6% on an annualized basis in the third
quarter of 2022 and $205.2 million or 22.1% since the end of the third quarter
in 2021.



The return on average assets and return on average shareholders' equity were
0.98% and 12.67%, respectively, for the third quarter of 2022, compared to 1.03%
and 10.03%, respectively, for the same period in 2021. The return on average
assets and return on average shareholders' equity were 0.97% and 14.11%,
respectively, for the first nine months of 2022, compared to 1.08% and 10.01%,
respectively, for the same period in 2021.  The increase in the return on
average shareholders' equity is related to the decline in equity caused by the
increase in unrealized losses on available-for-sale securities during the first
nine months of 2022.



Paycheck Protection Program

ChoiceOne processed over $126 million in PPP loans in 2020, acquired an
additional $37 million in PPP loans in the merger with Community Shores Bank
Corporation ("Community Shores"), and originated $89.1 million in PPP loans
in 2021.  In the third quarter of 2022, the remaining $1.8 million of PPP loans
were forgiven resulting in $68,000 of fee income.  For the nine months ended
September 30, 2022, $33.1 million of PPP loans were forgiven resulting in $1.2
million of fee income. At September 30, 2022, no PPP loans remain in ChoiceOne's
loan portfolio.



Dividends

Cash dividends of $1.9 million or $0.25 per share were declared in the third
quarter of 2022, and the third quarter of 2021.  Cash dividends declared in the
first nine months of 2022 were $5.6 million or $0.75 per share, compared to $5.3
million or $0.69 per share in the same period during the prior year.   The cash
dividend payout percentage was 33.2% for the first nine months of 2022, compared
to 31.3% in the same period in the prior year.



Interest income and expenses


Tables 1 and 2 on the following pages provide information regarding interest
income and expense for the three- and nine-month periods ended September 30,
2022 and 2021.  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



                                                          Three Months Ended September 30,
                                                   2022                                      2021
(Dollars in thousands)               Average                                   Average
                                     Balance       Interest       Rate         Balance       Interest       Rate
Assets:
Loans (1)(3)(4)(5)                 $ 1,128,679     $  13,622        4.83 %   $ 1,021,326     $  12,412        4.86 %
Taxable securities (2)                 774,040         3,943        2.04         641,430         2,821        1.76
Nontaxable securities (1)              305,661         1,853        2.43         281,223         1,850        2.63
Other                                   43,418           238        2.19         106,831            38        0.14
Interest-earning assets              2,251,798        19,656        3.49       2,050,810        17,121        3.34
Noninterest-earning assets             137,752                                   183,418
Total assets                       $ 2,389,550                               $ 2,234,228

Liabilities and Shareholders'
Equity:
Interest-bearing demand deposits   $   915,698     $     972        0.42 %   $   850,963     $     485        0.23 %
Savings deposits                       464,382           182        0.16         407,765           144        0.14
Certificates of deposit                196,160           410        0.84         183,103           208        0.45
Borrowings                               2,414             8        1.40           2,667            38        5.70
Subordinated debentures                 35,168           375        4.27           9,154           151        6.60
Interest-bearing liabilities         1,613,822         1,947        0.48       1,453,652         1,026        0.28
Demand deposits                        593,793                                   545,251
Other noninterest-bearing
liabilities                             17,177                                     5,956
Total liabilities                    2,224,792                                 2,004,859
Shareholders' equity                   164,758                                   229,369
Total liabilities and
shareholders' equity               $ 2,389,550                               $ 2,234,228

Net interest income
(tax-equivalent basis)
(Non-GAAP) (1)                                     $  17,709                                 $  16,095

Net interest margin
(tax-equivalent basis)
(Non-GAAP) (1)                                                      3.15 %                                    3.14 %

Reconciliation to Reported Net
Interest Income
Net interest income
(tax-equivalent basis)
(Non-GAAP) (1)                                     $  17,709                                 $  16,095
Adjustment for taxable
equivalent interest                                     (371 )                                    (395 )
Net interest income (GAAP)                         $  17,338                                 $  15,700
Net interest margin (GAAP)                                          3.08 %                                    3.06 %


(1) Adjusted in tax equivalent to facilitate comparison with the

taxable interest-bearing assets. Adjustment uses additional tax

rate of 21%. The presentation of these measures on a fiscal equivalent

is not in accordance with GAAP, but is customary in the banking sector

industry. These non-GAAP measures provide comparability with respect to

taxable and tax-exempt loans and securities.

(2) Taxable securities include dividend income Federal mortgage bank

and Federal Reserve Bank Stock.

(3) Loans include both loans to other financial institutions and loans held

for sale.

(4) Balances of unmatured loans and PPP loans are included in balances

average loans. Average unearned loan balances were $1.2 million and

        $1.5 million in the third quarter of 2022 and 2021, respectively.  PPP
        loan average balances were $879,000 and $85.5 million in the third
        quarter of 2022 and 2021, respectively. At September 30, 2022 no PPP
        loans remain in ChoiceOne's loan portfolio.
    (5) Interest on loans included net origination fees, accretion income, and
        PPP fees.  Accretion income was $440,000 and $253,000 in the third
        quarter of 2022 and 2021, respectively. PPP fees were approximately
        $68,000 and $1.6 million in the third quarter of 2022 and
        2021, respectively.




                                       30
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                                                           Nine Months Ended September 30,
                                                   2022                                      2021
(Dollars in thousands)               Average                                   Average
                                     Balance       Interest       Rate         Balance       Interest       Rate
Assets:
Loans (1)(3)                       $ 1,081,943     $  38,454        4.74 %   $ 1,047,326     $  36,666        4.67 %
Taxable securities (2)                 782,378        11,001        1.87         542,216         7,073        1.74
Nontaxable securities (1)              319,381         5,921        2.47         253,565         5,070        2.67
Other                                   40,217           314        1.04          81,912            70        0.11
Interest-earning assets              2,223,919        55,691        3.34       1,925,019        48,879        3.39
Noninterest-earning assets             149,813                                   180,522
Total assets                       $ 2,373,732                               $ 2,105,541

Liabilities and Shareholders'
Equity:
Interest-bearing demand deposits   $   918,644     $   2,034        0.30 %   $   772,950     $   1,379        0.24 %
Savings deposits                       455,816           485        0.14         385,160           391        0.14
Certificates of deposit                185,857           823        0.59         187,873           786        0.56
Borrowings                               5,708            35        0.83           4,608            95        2.76
Subordinated debentures                 35,205         1,099        4.16           5,147           253        6.55
Interest-bearing liabilities         1,601,230         4,477        0.37       1,355,738         2,904        0.29
Demand deposits                        575,483                                   518,327
Other noninterest-bearing
liabilities                             13,528                                     4,745
Total liabilities                    2,190,241                                 1,878,810
Shareholders' equity                   183,491                                   226,731
Total liabilities and
shareholders' equity               $ 2,373,732                               $ 2,105,541

Net interest income
(tax-equivalent basis)
(Non-GAAP) (1)                                     $  51,214                                 $  45,975

Net interest margin
(tax-equivalent basis)
(Non-GAAP) (1)                                                      3.07 %                                    3.18 %

Reconciliation to Reported Net
Interest Income
Net interest income
(tax-equivalent basis)
(Non-GAAP) (1)                                     $  51,214                                 $  45,975
Adjustment for taxable
equivalent interest                                   (1,265 )                                   (1079 )
Net interest income (GAAP)                         $  49,948                                 $  44,896
Net interest margin (GAAP)                                          2.99 %                                    3.11 %


(1) Adjusted in tax equivalent to facilitate comparison with the

taxable interest-bearing assets. Adjustment uses additional tax

rate of 21%. The presentation of these measures on a fiscal equivalent

is not in accordance with GAAP, but is customary in the banking sector

industry. These non-GAAP measures provide comparability with respect to

taxable and tax-exempt loans and securities.

(2) Taxable securities include dividend income Federal mortgage bank

and Federal Reserve Bank Stock.

(3) Loans include both loans to other financial institutions and loans held

for sale.

(4) Balances of unmatured loans and PPP loans are included in balances

average loans. Average unearned loan balances were $1.3 million and

$3.7 million in the first nine months of 2022 and 2021, respectively.

        PPP loan average balances were $10.8 million and $111.6 million in the
        first nine months of 2022 and 2021, respectively. At September 30, 2022
        no PPP loans remain in ChoiceOne's loan portfolio.

(5) Interest on loans includes net origination fees, revaluation income and

PPP Fees. The incremental income was $1.7 million and $924,000 first

nine months of 2022 and 2021, respectively. PPP fees were around

        $1.2 million and $4.0 million in the first nine months of 2022 and
        2021, respectively.




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Table 2 – Evolution of tax-equivalent net interest income



                                                     Three Months Ended September 30,
(Dollars in thousands)                                        2022 Over 2021
                                              Total                Volume              Rate
Increase (decrease) in interest income
(1)
Loans (2)                                 $        1,210       $        1,354      $        (144 )
Taxable securities                                 1,122                  942      $         180
Nontaxable securities (2)                              3                  238      $        (235 )
Other                                                200                 (125 )    $         325
Net change in interest income                      2,535                2,409                126

Increase (decrease) in interest expense
(1)
Interest-bearing demand deposits                     487                  129                358
Savings deposits                                      38                   31                  7
Certificates of deposit                              202                   50                152
Borrowings                                           (30 )                (10 )              (20 )
Subordinated debentures                              224                  321                (97 )
Net change in interest expense                       921                  521                400
Net change in tax-equivalent net
interest income                           $        1,614       $        1,888      $        (274 )




                                                     Nine Months Ended September 30,
(Dollars in thousands)                                       2022 Over 2021
                                              Total                Volume             Rate
Increase (decrease) in interest income
(1)
Loans (2)                                 $        1,789       $        1,329     $         460
Taxable securities                                 3,928                3,470               458
Nontaxable securities (2)                            851                1,313              (462 )
Other                                                244                  (69 )             313
Net change in interest income                      6,812                6,043               769

Increase (decrease) in interest expense
(1)
Interest-bearing demand deposits                     655                  334               321
Savings deposits                                      94                   79                15
Certificates of deposit                               37                  (11 )              48
Borrowings                                           (60 )                 23               (83 )
Subordinated debentures                              847                  985              (138 )
Net change in interest expense                     1,573                1,410               163
Net change in tax-equivalent net
interest income                           $        5,239       $        4,633     $         606





(1) The volume deviation is calculated as the variation in volume (average balance)

multiplied by the interest rate of the previous year. The rate difference is

corresponds to the change in the interest rate multiplied by the rate of the previous year

volume (average balance). The shift in interest due to both volume and

rate was allocated to volume and rate changes on a pro rata basis of

the relationship between the absolute dollar amounts of the change in each.

(2) Interest on non-taxable 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 $1.6 million and $5.2 million in
the third quarter and first nine months of 2022, respectively, compared to the
same periods in 2021.  Growth in the three months ended and nine months ended
September 30, 2022 compared to the same time periods in 2021 were affected by an
increased average balance of securities as ChoiceOne deployed excess deposit
dollars into securities with the intent to transition to loans as good credits
become available.  ChoiceOne has also experienced core loan growth during 2022
leading to growth in interest income from loans of $1.2 million and $1.8 million
during the three and nine months ended September 30, 2022, respectively,
compared to the same periods in the prior year.  Core loans exclude PPP loans,
loans held for sale, and loans to other financial institutions. Net interest
margin on a tax-equivalent basis increased by 1 basis points and declined by 11
basis points in the third quarter and first nine months of 2022, respectively,
compared to the same periods in 2021. The Federal Reserve increased the federal
funds rate by 3.00% during the first nine months of 2022 in response to
published inflation rates, causing interest rates to increase on all new loan
originations.  This led to the modest increase in net interest margin in the
third quarter of 2022 compared to the third quarter of 2021.  The decline in net
interest margin on a tax-equivalent basis for the nine months ended September
30, 2022 compared to the same time period in the prior year, is due the asset
mix as ChoiceOne grew securities faster than it grew loans.



The average balance of loans increased $107.4 million in the third
quarter of 2022 and $34.6 million in the first nine months of 2022 compared to
the same periods in 2021, as core loans grew offset by a decline in PPP loans.
Average core loans increased $195.1 million in the third
quarter of 2022 and $140.9 million in the first nine months of 2022 compared to
the same periods in 2021.  Average PPP loans declined $84.7 million in the third
quarter of 2022 and $100.8 million in the first nine months of 2022 compared to
the same periods in 2021.  The rate earned on loans in the third quarter of 2022
declined slightly due to a reduction in PPP fees which declined $1.6 million
in the third quarter of 2022 compared to the third quarter of 2021.  The rate
earned on loans increased by 7 basis points during the nine months ended
September 30, 2022 compared to the same time period in 2021 as new loan
originations have been at higher rates due to market conditions offset by a $2.8
million decline in PPP fees earned during nine months ended September 30, 2022
compared to the same period in 2021.



The average balance of total securities increased $157.0 million, and the
average rate earned increased 12 basis points in the third quarter of 2022
compared to the same period in 2021.  The average balance of total securities
increased $306.0 million and the average rate earned increased 1 basis point in
the first nine months of 2022 compared to the same period in 2021.



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Growth of $121.4 million in the average balance of interest-bearing demand
deposits and savings deposits and a combined 13 basis point increase in the
average rate paid, caused interest expense to increase $525,000 in the
third quarter of 2022 compared to the third quarter of the prior year.  Growth
of $216.4 million in the average balance of interest-bearing demand deposits and
savings deposits and a combined 4 basis point increase in the average rate paid,
caused interest expense to increase $749,000 in the first nine months of 2022
compared to the first nine months of the prior year. The average balance of
certificates of deposit increased $13.1 million and declined $2.0 million in the
third quarter and first nine months of 2022, respectively, compared to the same
period in 2021. The increase in balances and a 39 basis points increase in the
average rate paid on certificates of deposit caused interest expense to
increase $202,000 in the third quarter 2022, compared to the same periods in
2021.  The decline in balances offset by a 3 basis points increase in the
average rate paid on certificates of deposit caused interest expense to
increase $37,000 in the first nine months of 2022, compared to the same periods
in 2021.  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. These increased the
average balance of subordinated debentures by $26.0 million and $30.0 million in
the third quarter and first nine months of 2022, respectively, compared to the
same period in the prior year and caused interest expense to increase by
$224,000 and $847,000 in the third quarter and first nine months of 2022,
respectively, compared to the same periods in 2021.



Allowance and provision for loan losses




The provision for loan losses was $100,000 in the first nine months of 2022,
compared to $416,000 in the same period in the prior year.  Provision expense
was deemed necessary to reserve for core loan growth of $52.8 million in the
third quarter of 2022.  Based on our assessment of the probable estimated losses
inherent in the loan portfolio no additional provision was necessary for
existing loans. Our methodology for measuring the appropriate level of allowance
for loan losses and related provision for loan losses involves specific
allocations for loans considered impaired, and general allocations for
homogeneous loans based on historical loss experience.



Loans classified as impaired loans declined by $2.8 million during the nine
months ended September 30, 2022.  The specific allowance for loan losses for
impaired loans decreased by $346,000 during the nine months ended September 30,
2022 largely due to the decrease in balance of impaired loans compared to
December 31, 2021.



The determination of our loss factors is based, in part, upon our actual loss
history adjusted for significant qualitative factors that, in management's
judgment, affect the collectability of the portfolio as of the analysis date.
ChoiceOne uses a rolling 20 quarter actual net charge-off history as the basis
for the computation.



Nonperforming loans were $2.6 million as of September 30, 2022, compared to $5.5
million as of December 31, 2021.  The allowance for loan losses was 0.66% of
total loans at September 30, 2022, compared to 0.76% at December 31, 2021.
Loans acquired in the mergers with County Bank Corp. and Community Shores were
recorded at fair value and as a result do not have an allowance for loan losses
allocated to them unless credit deteriorates subsequent to acquisition.
ChoiceOne has $1.8 million in credit mark remaining on loans acquired in the
mergers.


Write-offs and recoveries for the respective loan categories for the nine months ended September 30, 2022 and 2021 were as follows:



(Dollars in thousands)                   2022                               2021
                             Charge-offs       Recoveries       Charge-offs       Recoveries
Agricultural                $           -     $          -     $           -     $          -
Commercial and industrial             177               62               195               80
Consumer                              383              162               244              168
Commercial real estate                  -                3               111               43
Construction real estate                -                -                 -                -
Residential real estate                 -                2                 -                5
                            $         560     $        229     $         550     $        296




Net charge-offs were $331,000 in the first nine months of 2022, compared to net
charge-offs of $254,000 during the same period in 2021. Checking account
charge-off and recovery activity is included in the consumer charge-off activity
above.  Net charge-offs for checking accounts for the third quarter and first
nine months of 2022 were $73,000 and $186,000, respectively, compared to $49,000
and $90,000 for the same periods in the prior year. Net charge-offs on an
annualized basis as a percentage of average loans were 0.04% in the first nine
months of 2022 compared to annualized net charge-offs of 0.03% of average loans
in the same period in the prior year. Management is aware that the economic
climate in Michigan will continue to affect businesses 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 2022, the provision and
allowance for loan losses will be reviewed by ChoiceOne's management and
adjusted as determined to be necessary.



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Noninterest Income



Total noninterest income declined $1.7 million and $4.7 million in the third
quarter and first nine months of 2022 compared to the same periods in the prior
year.  Total noninterest income in 2021 was bolstered by heightened levels of
refinancing activity within ChoiceOne's mortgage portfolio, with gains on sales
of loans $1.4 million and $3.6 million larger than in the third quarter and
first nine months of 2022.  Customer service charges increased $203,000 and
$691,000 in the third quarter and first nine months of 2022 compared to the same
periods in the prior year.  Service charges were depressed by the effects of the
COVID 19 pandemic.  The change in the market value of equity securities declined
$295,000 and $1.5 million during the third quarter and first nine months of 2022
compared to the same periods in the prior year consistent with general market
conditions.  Equity securities include local community bank stocks and Community
Reinvestment Act bond mutual funds.  During the third quarter and first nine
months of 2022, ChoiceOne has liquidated $15.3 million and $47.2 million in
securities respectively, resulting in $378,000 and $805,000 of realized loss,
respectively, in order to redeploy the funds into higher yielding loans and
reduce the risk of extension on certain fixed income securities which include a
call option.



Noninterest Expense



Total noninterest expense decreased $90,000 and increased $1.1 million in the
third quarter and first nine months of 2022, respectively, compared to the same
time periods in 2021.  The increase during the first nine months of 2022 is
related to an increase in salaries and wages due to annual wage increases and
the addition of new commercial loan production and wealth management staff. This
investment in people will increase expenses in the short term but is expected to
drive long term value to ChoiceOne through the building of new relationships.
Other expenses have also increased in the first nine months of 2022 compared to
the same period in the prior year due to an increase to our FDIC insurance
related expenses, business travel expenses which were still being affected by
the pandemic last year.  ChoiceOne continues to monitor expenses and looks to
improve our efficiency through automation and use of digital tools.



Income Tax Expense



Income tax expense was $3.0 million in the first nine months of 2022 compared to
$3.3 million for the same period in 2021. The decrease was due to a higher level
of income before income tax in 2021 and a $65.8 million dollar increase in the
average balance of nontaxable securities in the first nine months of 2022
compared to the same period in 2021. The effective tax rate was 14.8% for
the first nine months of 2022 compared to 16.4% for the first nine months of
2021.



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                              FINANCIAL CONDITION



Securities

In the last two years ChoiceOne has grown its securities portfolio
substantially.  Total available for sale securities on December 31, 2020,
amounted to $577.7 million and grew steadily to an available for sale balance
on December 31, 2021, of $1.1 billion.  Many of the securities making up this
balance include local municipals and other securities ChoiceOne has no intent to
sell prior to maturity.  During the first quarter of 2022, ChoiceOne elected to
move $428.4 million of the portfolio into a held to maturity status.  Management
believes the $530.1 million in available for sale securities at September 30,
2022 to be sufficient for any future liquidity needs.



$47.2 million of securities were sold in the nine months ended September 30,
2022 to be replaced with higher yielding assets. $13.7 million of securities
were called or matured during that same period. Principal repayments on
securities totaled $31.6 million in the nine months ended September 30, 2022.



Loans



Core loans, which exclude PPP loans, held for sale loans, and loans to other
financial institutions, grew organically by $205.2 million from September 30,
2021 to September 30, 2022.  Excluding PPP loans, ChoiceOne saw growth of
$160.2 million in commercial loans and $40.4 million in retail loans from
September 30, 2021 to September 30, 2022. Additions to our commercial lending
staff in 2021 and investments in the automation of our commercial loan
process have helped drive our pipeline of commercial loans and corresponding
growth. ChoiceOne has ample on balance sheet liquidity to fund future loan
growth, including an expected $183.1 million of cash flow from securities
over the next two years.



Loans to other financial institutions declined $38.8 million from September 30,
2021 to September 30, 2022 as management chose to suspend the program at the end
of the third quarter 2022. During the nine months ended September 30, 2022, the
remaining $33.1 million of PPP loans were forgiven resulting in $1.2 million of
fee income.  At September 30, 2022 all PPP loans have been fully forgiven, and
the associated fee income has been recognized.



In the first nine months of 2022, ChoiceOne recorded accretion income related to acquired loans for an amount of $1.7 million. The remaining credit mark on loans acquired from recent mergers with County Bank Corp. and community banks totaled $1.8 million of the September 30, 2022.

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 $2.6 million on September 30, 2022, compared to $5.5
million as of December 31, 2021.  The change in the first nine months of
2022 was primarily comprised of a decrease of $2.3 million in
impaired agricultural loans.



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 ("TDRs").



The balances of these non-performing loans were as follows:



(Dollars in thousands)                                  September 30,       December 31,
                                                            2022                2021
Loans accounted for on a nonaccrual basis              $         1,197     

$1,727
Accrued loans that are contractually 90 days or more in arrears with respect to payment of principal or interest

                    -                  -
Loans defined as "troubled debt restructurings "
which are not included above                                     1,431              3,816
Total                                                  $         2,628     $        5,543




The reduction in the balance of nonaccrual loans in the first nine months of
2022 was primarily due to loans that were paid off.  It is also noted that 82%
of loans considered TDRs were performing according to their restructured terms
as of September 30, 2022.  Management believes the allowance for loan losses
allocated to its nonperforming loans is sufficient at September 30, 2022.



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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.
ChoiceOne 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’s management performs an annual qualitative assessment and periodically performs a quantitative assessment. Management will perform a quantitative assessment of goodwill during the fourth quarter of 2022.

Deposits and borrowings


Deposits in the third quarter of 2022 continue to hold strong with an increase
of $18.1 million compared to the second quarter of 2022, which is attributed to
organic growth of new relationships, seasonal fluctuations in our municipal
clients and some modest deposit runoff as ChoiceOne has held deposit rates.
Despite the rapidly rising rate environment, deposit costs have only increased
12 basis points since the third quarter of 2021, as ChoiceOne is actively
managing these costs and will continue to lag the expected increases in the
federal funds rate.



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 $3.2 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.   ChoiceOne may use Federal Home Loan Bank advances
and advances from the Federal Reserve Bank Discount Window to meet short-term
funding needs in the remainder of 2022.



Equity


Total shareholders' equity declined $65.0 million in the first nine months of
2022.  As previously referenced the Federal Reserve increased the federal
funds rate by 3.00% during the first nine months of 2022 in response to
published inflation rates, causing interest rates to increase.  This change in
interest rates increased ChoiceOne's unrealized pre-tax loss on the available
for sale securities portfolio from $3.3 million on December 31, 2021 to $102.9
million on September 30, 2022.  Additionally, meeting minutes from the Federal
Open Market Committee indicated that additional increases in the federal
funds rate are expected in order to combat inflation in the coming quarters. As
such, ChoiceOne elected to utilize interest rate derivatives in order to better
manage its interest rate risk position.  On April 21, 2022, ChoiceOne purchased
four 2-year forward-starting interest rate caps with a total notional amount of
$200.0 million and entered into a $200.0 million 2-year forward-starting
pay-fixed interest rate swap.  All forward starting instruments have an 8-year
term expiring in 2032.  These strategies provide $400 million of notional value
protection and also create accounting symmetry between available for sale
securities and other comprehensive income (equity), thus protecting tangible
capital from further increases in interest rates.  ChoiceOne also entered into
multiple received-fixed interest rate swaps with a total notional amount
of $200.0 million with a 2-year term, which, in the current environment, offsets
the cost of the rising rate protection. These three strategies, in the
aggregate, are expected to be neutral to net income in 2022 and better position
ChoiceOne Bank should rates continue to rise and remain elevated.  Importantly,
the transactions were structured to qualify for hedge accounting, which means
that changes in the fair value of certain instruments flow through other
comprehensive income (equity).  Refer to further details in Note 8 to the
consolidated financial statements included in this report.

A reduction in common stock and paid in capital resulted from ChoiceOne's
repurchase of 25,899 shares for $682,000, or a weighted average all-in cost per
share of $26.35, during the first quarter of 2022. No shares of common stock
were repurchased during the second or third quarters of 2022; however, ChoiceOne
may strategically repurchase shares of common stock in the future depending on
market and other conditions.



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Regulatory capital requirements

Below you will find information regarding the compliance of ChoiceOne and
ChoiceOne Bank with regulatory capital requirements:



                                                                                               Minimum Required
                                                                                                  to be Well
                                                                 Minimum Required             Capitalized Under
                                                                    for Capital               Prompt Corrective
(Dollars in thousands)                    Actual                 Adequacy Purposes            Action Regulations
                                    Amount        Ratio         Amount         Ratio          Amount         Ratio
September 30, 2022
ChoiceOne Financial Services
Inc.
Total capital (to risk weighted
assets)                            $ 216,524        13.7 %   $    126,267          8.0 %            N/A         N/A
Common equity Tier 1 capital (to
risk weighted assets)                172,632        10.9           71,025          4.5              N/A         N/A
Tier 1 capital (to risk weighted
assets)                              177,132        11.2           94,700          6.0              N/A         N/A
Tier 1 capital (to average
assets)                              177,132         7.6           93,179          4.0              N/A         N/A

ChoiceOne Bank
Total capital (to risk weighted
assets)                            $ 201,500        12.8 %   $    126,071          8.0 %   $    157,589        10.0 %
Common equity Tier 1 capital (to
risk weighted assets)                194,043        12.3           70,915          4.5          102,433         6.5
Tier 1 capital (to risk weighted
assets)                              194,043        12.3           94,553          6.0          126,071         8.0
Tier 1 capital (to average
assets)                              194,043         8.3           93,081          4.0          116,351         5.0


December 31, 2021
ChoiceOne Financial Services
Inc.
Total capital (to risk weighted
assets)                            $ 204,353        14.4 %   $    113,604          8.0 %            N/A         N/A
Common equity Tier 1 capital (to
risk weighted assets)                160,338        11.3           63,902          4.5              N/A         N/A
Tier 1 capital (to risk weighted
assets)                              164,838        11.6           85,203          6.0              N/A         N/A
Tier 1 capital (to average
assets)                              164,838         7.4           89,415          4.0              N/A         N/A

ChoiceOne Bank
Total capital (to risk weighted
assets)                            $ 182,275        12.9 %   $    113,444          8.0 %   $    141,806        10.0 %
Common equity Tier 1 capital (to
risk weighted assets)                174,587        12.3           63,813          4.5           92,174         6.5
Tier 1 capital (to risk weighted
assets)                              174,587        12.3           85,083          6.0          113,444         8.0
Tier 1 capital (to average
assets)                              174,587         7.8           89,289          4.0          111,611         5.0




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, 2022 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 by operating activities was $32.0 million for the nine months
ended September 30, 2022 compared to $29.6 million in the same period a year
ago.  The change was due to lower net proceeds from loan sales in 2022 compared
to 2021, which was offset by the change in other assets and liabilities. Net
cash used in investing activities was $60.5 million for the nine months ended
September 30, 2022 compared to $398.6 million in the same period in 2021.
ChoiceOne purchased $61.9 million of securities and had maturities or sales of
securities of $92.5 million in the first nine months of 2022 compared to
$514.2 million and $39.8 million in the same periods in 2021, respectively. 

A

increase in net loan originations led to cash used of $73.3 million in the first
nine months of 2022 compared to cash provided of $78.1 million in the same
period during the prior year.  Net cash provided by financing activities was
$48.1 million for the first nine months of 2022, compared to $349.3 million in
the same period in the prior year. ChoiceOne experienced growth of $104.4
million in deposits in the first nine months of 2022 compared to $337.6 million
in 2021, while also seeing a $72.5 million decrease in borrowings, which led to
the change.



ChoiceOne believes that the current level of liquidity is sufficient to meet
ChoiceOne 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, advances available from the Federal Home Loan Bank,
and secured lines of credit available from the Federal Reserve Bank.



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