Choiceone Financial Services Inc: Form 10-K for the period ended Dec 31, 2024

General

ChoiceOne Financial Services, Inc. (the “Company”) is a financial holding company registered under the Bank Holding Company Act of 1956, as amended (“BHC Act”). The Company was incorporated on February 24, 1986, as a Michigan corporation. The Company was formed to create a bank holding company for the purpose of acquiring all of the capital stock of ChoiceOne Bank, which became a wholly owned subsidiary of the Company on April 6, 1987. Effective November 1, 2006, Valley Ridge Financial Corp., a one-bank holding company for Valley Ridge Bank (“VRB”), merged with and into the Company. In December 2006, VRB was consolidated into ChoiceOne Bank. Effective October 1, 2019, County Bank Corp. ("County"), a one-bank holding company for Lakestone Bank & Trust (“Lakestone”), merged with and into the Company. Lakestone was consolidated into ChoiceOne Bank in May 2020. On July 1, 2020, Community Shores Bank Corporation ("Community Shores"), a one bank holding company for Community Shores Bank, merged with and into the Company. Community Shores Bank was consolidated into ChoiceOne Bank in October 2020. ChoiceOne Bank owns all of the outstanding common stock of ChoiceOne Insurance Agencies, Inc., an independent insurance agency headquartered in Sparta, Michigan (the "Insurance Agency"). On July 18, 2023, the Company organized 109 Technologies, LLC as a wholly owned subsidiary of the Company with the intent to own intellectual property for a fintech product licensed to third party banks and bank holding companies. Effective March 1, 2025, Fentura Financial, Inc., a one bank holding company for The State Bank, merged with and into the Company.

The Company's business is primarily concentrated in a single industry segment, banking. ChoiceOne Bank (referred to as the “Bank”) is a full-service banking institution that offers a variety of deposit, payment, credit and other financial services to all types of customers. These services include time, savings, and demand deposits, safe deposit services, and automated transaction machine services. Loans, both commercial and consumer, are extended primarily on a secured basis to commercial enterprises and individuals. Commercial lending covers such categories as business, industry, agricultural, construction, inventory, and real estate. The Bank’s consumer loan departments make direct and indirect loans to consumers and purchasers of residential and real property. In addition, the Bank offers trust and wealth management services. No material part of the business of the Company or the Bank is dependent upon a single customer or very few customers, the loss of which would have a materially adverse effect on the Company.

The Bank’s primary market areas lie within Kent, Muskegon, Newaygo, and Ottawa counties in western Michigan, and Lapeer, Macomb, and St. Clair counties in southeastern Michigan in the communities where the Bank's respective offices are located. The Bank serves these markets through 29 full-service offices and five loan production offices. The Company and the Bank have no foreign assets or income.

At December 31, 2024, the Company had consolidated total assets of $2.7 billion, net loans of $1.5 billion, total deposits excluding brokered deposits of $2.2 billion and total shareholders' equity of $260.4 million. For the year ended December 31, 2024, the Company recognized consolidated net income of $26.7 million. The principal source of revenue for the Company and the Bank is interest and fees on loans. On a consolidated basis, interest and fees on loans accounted for 64%, 60%, and 59% of total revenues in 2024, 2023, and 2022, respectively. Interest on securities accounted for 19%, 24%, and 24% of total revenues in 2024, 2023, and 2022, respectively. For more information about the Company's financial condition and results of operations, see the consolidated financial statements and related notes included in Item 8 of this report.

Competition

The Bank’s competition primarily comes from other financial institutions located within Kent, Muskegon, Newaygo, and Ottawa counties in western Michigan and Lapeer, Macomb, and St. Clair counties in southeastern Michigan. There are a number of larger commercial banks within the Bank’s primary market areas. The Bank also competes with a large number of other financial institutions, such as savings and loan associations, insurance companies, consumer finance companies, credit unions, internet banks and other financial technology companies, and commercial finance and leasing companies for deposits, loans and service business. Money market mutual funds, brokerage houses and nonfinancial institutions provide many of the financial services offered by the Bank. Many of these competitors have substantially greater resources than the Bank. The principal methods of competition for financial services are price (the rates of interest charged for loans, the rates of interest paid for deposits and the fees charged for services) and the convenience and quality of services rendered to customers.

Supervision and Regulation

Banks and bank holding companies are extensively regulated. The Company is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). The Company's activities are generally limited to owning or controlling banks and engaging in such other activities as the Federal Reserve Board may determine to be closely related to banking.

Prior approval of the Federal Reserve Board, and in some cases various other government agencies, is required for the Company to acquire control of any additional bank holding companies, banks or other operating subsidiaries. Under Federal Reserve Board policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support it.

The Bank is chartered under state law and is subject to regulation by the Michigan Department of Insurance and Financial Services (“DIFS”). State banking laws place restrictions on various aspects of banking, including permitted activities, loan interest rates, branching, payment of dividends and capital and surplus requirements. The Bank is a member of the Federal Reserve System and is also subject to regulation by the Federal Reserve Board. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (the “FDIC”) to the maximum extent provided by law. The Bank is a member of the Federal Home Loan Bank system, which provides certain advantages to the Bank, including favorable borrowing rates for certain funds.

The Company is a legal entity separate and distinct from the Bank. The Company's primary source of funds available to pay dividends to shareholders is dividends paid to it by the Bank. There are legal limitations on the extent to which the Bank can lend or otherwise supply funds to the Company. In addition, payment of dividends to the Company by the Bank is subject to various state and federal regulatory limitations.

The Deposit Insurance Funds Act of 1996 authorized the Financing Corporation (“FICO”) to impose periodic assessments on all depository institutions. The purpose of these periodic assessments is to spread the cost of the interest payments on the outstanding FICO bonds issued to recapitalize the Savings Association Insurance Fund (“SAIF”) over a larger number of institutions.

The federal banking agencies have adopted guidelines to promote the safety and soundness of federally-insured depository institutions. These guidelines establish standards for, among other things, internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.

The Company and the Bank are subject to regulatory “risk-based” capital guidelines. Failure to meet these capital guidelines could subject the Company or the Bank to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and other restrictions on its business. In addition, the Bank would generally not receive regulatory approval of any application that requires the consideration of capital adequacy, such as a branch or merger application, unless it could demonstrate a reasonable plan to meet the capital requirement within a reasonable period of time.

Under Federal Reserve Board policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank. In addition, if DIFS deems the Bank's capital to be impaired, DIFS may require the Bank to restore its capital by a special assessment on the Company as the Bank's sole shareholder. If the Company fails to pay any assessment, the Company’s directors will be required, under Michigan law, to sell the shares of the Bank's stock owned by the Company to the highest bidder at either a public or private auction and use the proceeds of the sale to restore the Bank's capital.

The Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) requires, among other things, federal banking agencies to take “prompt corrective action” in respect of depository institutions that do not meet minimum capital requirements. FDICIA sets forth the following five capital categories: “well-capitalized,” “adequately-capitalized,” “undercapitalized,” “significantly-undercapitalized” and “critically-undercapitalized.” A depository institution's capital category will depend upon how its capital levels compare with various relevant capital measures as established by regulation, which include a common equity Tier I risk-based capital ratio, Tier 1 risk-based and total risk-based capital ratio measures and a leverage capital ratio measure. In addition, a capital conservation buffer is required. Under certain circumstances, the appropriate banking agency may treat a well-capitalized, adequately-capitalized, or undercapitalized institution as if the institution were in the next lower capital category.

Federal banking regulators are required to take specified mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Subject to a narrow exception, the banking regulator must generally appoint a receiver or conservator for an institution that is critically undercapitalized. An institution in any of the undercapitalized categories is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. An undercapitalized institution is also generally prohibited from paying any dividends, increasing its average total assets, making acquisitions, establishing any branches, accepting or renewing any brokered deposits or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval.

Banks are subject to a number of federal and state laws and regulations, which have a material impact on their business. These include, among others, minimum capital requirements, state usury laws, state laws relating to fiduciaries, the Truth in Lending Act, the Truth in Savings Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Fair Credit Reporting Act, the Expedited Funds Availability Act, the Community Reinvestment Act, the Real Estate Settlement Procedures Act, the Service Members Civil Relief Act, the USA PATRIOT Act, the Bank Secrecy Act, regulations of the Office of Foreign Assets Controls, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, electronic funds transfer laws, redlining laws, predatory lending laws, antitrust laws, environmental laws, money laundering laws and privacy laws. The monetary policy of the Federal Reserve Board may influence the growth and distribution of bank loans, investments and deposits, and may also affect interest rates on loans and deposits. These policies may have a significant effect on the operating results of banks.

In general, the BHC Act limits the business of bank holding companies to banking, managing or controlling banks and other activities that the Federal Reserve Board has determined to be closely related to the business of banking. In addition, bank holding companies that qualify and elect to be financial holding companies may engage in any activities that are financial in nature or complementary to a financial activity and do not pose a substantial risk to the safety and soundness of depository institutions or the financial system without prior approval of the Federal Reserve Board. Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments. The Company has elected to be a financial holding company.

In order for the Company to maintain financial holding company status, the Bank must be categorized as "well-capitalized" and "well-managed" under applicable regulatory guidelines. If the Company or the Bank ceases to meet these requirements, the Federal Reserve Board may impose corrective capital and/or managerial requirements and place limitations on the Company’s ability to conduct the broader financial activities permissible for financial holding companies. In addition, if the deficiencies persist, the Federal Reserve Board may require the Company to divest of the Bank. The Bank was categorized as "well-capitalized" and "well-managed" as of December 31, 2024.

Bank holding companies may acquire banks and other bank holding companies located in any state in the United States without regard to geographic restrictions or reciprocity requirements imposed by state banking law. Banks may also establish interstate branch networks through acquisitions of and mergers with other banks. The establishment of de novo interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed only if specifically authorized by state law.

Michigan banking laws do not significantly restrict interstate banking. The Michigan Banking Code permits, in appropriate circumstances and with the approval of DIFS, (1) acquisition of Michigan banks by FDIC-insured banks, savings banks or savings and loan associations located in other states, (2) sale by a Michigan bank of branches to an FDIC-insured bank, savings bank or savings and loan association located in a state in which a Michigan bank could purchase branches of the purchasing entity, (3) consolidation of Michigan banks and FDIC-insured banks, savings banks or savings and loan associations located in other states having laws permitting such consolidation, (4) establishment of branches in Michigan by FDIC-insured banks located in other states, the District of Columbia or U.S. territories or protectorates having laws permitting a Michigan bank to establish a branch in such jurisdiction, and (5) establishment by foreign banks of branches located in Michigan.

Banks are subject to the provisions of the Community Reinvestment Act ("CRA"). Under the terms of the CRA, the appropriate federal bank regulatory agency is required, in connection with its examination of a bank, to assess the bank's record in meeting the credit needs of the community served by that bank, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of the institution. Under the CRA, institutions are assigned a rating of "outstanding," "satisfactory," "needs to improve," or "substantial non-compliance." The regulatory agency's assessment of the bank's record is made available to the public. Further, a bank's federal regulatory agency is required to assess the CRA compliance record of any bank that has applied to establish a new branch office that will accept deposits, relocate an office, or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. In the case of a bank holding company applying for approval to acquire a bank or another bank holding company, the Federal Reserve Board will assess the CRA compliance record of each subsidiary bank of the applicant bank holding company, and such compliance records may be the basis for denying the application. Upon receiving notice that a subsidiary bank is rated less than "satisfactory," a financial holding company will be prohibited from additional activities that are permitted to be conducted by a financial holding company and from acquiring any company engaged in such activities. The CRA rating of the Bank was "Satisfactory" as of its most recent examination.

Effects of Compliance With Environmental Regulations

The nature of the business of the Bank is such that it holds title, on a temporary or permanent basis, to a number of parcels of real property. These include properties owned for branch offices and other business purposes as well as properties taken in or in lieu of foreclosure to satisfy loans in default. Under current state and federal laws, present and past owners of real property may be exposed to liability for the cost of cleanup of environmental contamination on or originating from those properties, even if they are wholly innocent of the actions that caused the contamination. These liabilities can be material and can exceed the value of the contaminated property. Management is not presently aware of any instances where compliance with these provisions will have a material effect on the capital expenditures, earnings or competitive position of the Company or the Bank, or where compliance with these provisions will adversely affect a borrower's ability to comply with the terms of loan contracts.

Employees

As of February 28, 2025, the Company, on a consolidated basis, employed 392 employees, of which 336 were full-time employees. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be good.

Available Information

Our internet address is www.choiceone.bank (http://www.choiceone.bank). We make available free of charge through this website our annual report on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after filing or furnishing such reports with the Securities and Exchange Commission. The information on our website address is not incorporated by reference into this report, and the information on the website is not part of this report.

Statistical Information

Additional statistical information describing the business of the Company appears on the following pages and in Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of this report and in the Consolidated Financial Statements and the notes thereto in Item 8 of this report. The following statistical information should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and notes in this report. Average balances used in statistical information are calculated using daily averages, unless otherwise specified.

The Company did not hold investment securities from any one issuer at December 31, 2024, that were greater than 10% of the Company's shareholders' equity, exclusive of U.S. Government and U.S. Government agency securities.

Presented below is the fair value of securities available for sale and amortized cost for held to maturity securities as of December 31, 2024, a schedule of maturities of securities as of December 31, 2024, and the weighted average yields of securities as of December 31, 2024. Callable securities in the money are presumed called and matured at the callable date.

(Dollars in thousands)

Security yields are shown before the impact of interest rate swaps. ChoiceOne holds pay fixed, receive variable swaps with a notional value of $201.0 million which effect the interest earned on securities. Further details can be found in Note 8 - Derivatives and Hedging Activities.

(Dollars in thousands)

Weighted average yields are calculated based on the fair value of securities available for sale and amortized cost of securities held to maturity which are denoted in the table above. Weighted average yields for tax-exempt securities is computed on a fully tax-equivalent basis at an incremental tax rate of 21% for 2024.

Maturities and Sensitivities of Loans to Changes in Interest Rates

The following schedule presents the maturities of loans as of December 31, 2024. Loans are also classified according to the sensitivity to changes in interest rates as of December 31, 2024. Note maturity dates are different than repricing dates used on call report.

(Dollars in thousands)

(Dollars in thousands)

7

Loan maturities are classified according to the contractual maturity date or the anticipated amortization period, whichever is appropriate. The anticipated amortization period is used in the case of loans where a balloon payment is due before the end of the loan’s normal amortization period. At the time the balloon payment is due, the loan can either be rewritten or payment in full can be requested. The decision regarding whether the loan will be rewritten or a payment in full will be requested will be based upon the loan’s payment history, the borrower’s current financial condition, and other relevant factors.

The following table reflects the composition of our allowance for credit losses, non-accrual loans, and nonperforming loans as a percentage of total loans represented by each class of loans as of the dates indicated:

(Dollars in thousands)

(Dollars in thousands)

NA – No non-accrual loans in the loan category.

Additions to the allowance for credit losses charged to operations during the periods shown were based on management’s judgment after considering the factors laid out in Note 1 “Allowance for Credit Losses” to the consolidated financial statements. ChoiceOne adopted the Financial Accounting Standards Board (the "FASB") Account Standards Update 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, commonly referred to as "CECL" effective January 1, 2023 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under CECL while prior period amounts are reported in accordance with the incurred loss accounting standard. The transition adjustment of the CECL adoption included an increase in the ACL of $7.2 million. The evaluation of the loan portfolio is based upon various risk factors such as the financial condition of the borrower, the value of collateral, reasonable and supportable forecasts, and other considerations, which, in the opinion of management, deserve current recognition in estimating credit losses.

The following schedule presents an allocation of the allowance for credit losses to the various loan categories as of the years ended December 31:

Deposits

The following schedule presents the average deposit balances by category and the average rates paid thereon for the respective years:

(Dollars in thousands)

At December 31, 2024, the aggregate balance of all deposits exceeding the FDIC insured limit of $250,000 for individual and $500,000 for joint accounts totaled $833.2 million, or 37.6% of total deposits, compared to $769.7 million, or 36.3% of total deposits and $823.2 million, or 38.9% of total deposits at December 31, 2023 and 2022, respectively. Certificate of Deposit Account Registry Service ("CDARs") and Insured Cash Sweep ("ICS") deposits are excluded from the above table as these deposits are 100% guaranteed.

Core deposits, which we define as insured branch deposits less certificates of deposit, totaled $1.1 billion or 51.2% of total deposits at December 31, 2024.

At December 31, 2024, the Bank had no material foreign deposits.

Return on Equity and Assets

The following schedule presents certain financial ratios of the Company for the years ended December 31:

The Company is subject to many risks and uncertainties. Although the Company seeks ways to manage these risks and develop programs to control risks to the extent that management can control them, the Company cannot predict the future. Actual results may differ materially from management’s expectations. Some of these significant risks and uncertainties are discussed below. The risks and uncertainties described below are not the only ones that the Company faces. Additional risks and uncertainties of which the Company is unaware, or that it currently does not consider to be material, also may become important factors that affect the Company and its business. If any of these risks were to occur, the Company’s business, financial condition or results of operations could be materially and adversely affected.

Risks Related to the Company’s Business

Asset quality could be less favorable than expected.

A significant source of risk for the Company arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements. Most loans originated by the Company are secured, but some loans are unsecured depending on the nature of the loan. With respect to secured loans, the collateral securing the repayment of these loans includes a wide variety of real and personal property that may be insufficient to cover the obligations owed under such loans. Collateral values may be adversely affected by changes in prevailing economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates, changes in monetary and fiscal policies of the federal government, terrorist activity, environmental contamination, public health crisis, and other external events.

The Company’s allowance for credit losses may not be adequate to cover actual credit losses.

The risk of nonpayment of loans is inherent in all lending activities and nonpayment of loans may have a material adverse effect on the Company’s earnings and overall financial condition, and the value of its common stock. The Company makes various assumptions and judgments about the collectability of its loan portfolio and provides an allowance for credit losses based on a number of factors. If its assumptions are wrong, the allowance for credit losses may not be sufficient to cover losses, which could have an adverse effect on the Company’s operating results and may cause it to increase the allowance in the future. The actual amount of future provisions for credit losses cannot now be determined and may exceed the amounts of past provisions for credit losses. Federal and state banking regulators, as an integral part of their supervisory function, periodically review the allowance for credit losses. These regulatory agencies may require the Company to increase its allowance for credit losses or to recognize further loan charge-offs based upon their judgments, which may be different from the Company’s judgments. Any increase in the allowance for credit losses could have a negative effect on the Company’s regulatory capital ratios, net income, financial condition and results of operations.

General economic conditions in the state of Michigan could have a material adverse effect on the Company’s results of operations or financial condition.

The Company is affected by general economic conditions in the United States, although most directly within Michigan. An economic downturn within Michigan caused by inflation, recession or a recessionary environment, trade tariffs, unemployment, changes in financial or capital markets or other factors, could negatively impact household and corporate incomes. This impact may lead to decreased demand for both loan and deposit products and increase the number of customers who fail to pay interest or principal on their loans.

We may be adversely affected by risks associated with future mergers and acquisitions, including execution risk, which could disrupt our business and dilute shareholder value.

We plan to grow our business both organically and through mergers and acquisitions. We periodically evaluate merger and acquisition opportunities and conduct due diligence activities related to possible transactions with other financial institutions and financial services companies. As a result, we may engage in discussions or negotiations that, if they were to result in a transaction, could have a material effect on our operating results and financial condition. Our merger and acquisition activities could be material and could require us to use a substantial amount of common stock, preferred stock, cash, other liquid assets, and/or incur debt. Furthermore, failure to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits from our merger and acquisition activities could have a material adverse effect on our financial condition and results of operations.

The Company could be adversely affected by the soundness of other financial institutions, including defaults by larger financial institutions.

The Company's ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of credit, trading, clearing, counterparty or other relationships between financial institutions. The Company has exposure to multiple counterparties, and it routinely executes transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, could lead to market-wide liquidity problems and losses or defaults by the Company or by other institutions. This is sometimes referred to as "systemic risk" and may adversely affect financial intermediaries, such as clearing agencies, clearing houses, banks, securities firms and exchanges, with which the Company interacts on a daily basis, and therefore could adversely affect the Company.

If the Company does not adjust to changes in the financial services industry, its financial performance may suffer.

The Company’s ability to maintain its financial performance and return on investment to shareholders will depend in part on its ability to maintain and grow its core deposit customer base and expand its financial services to its existing customers. In addition to other banks, competitors include credit unions, securities dealers, brokers, mortgage bankers, investment advisors, internet banks and other financial technology companies, and finance and insurance companies. The increasingly competitive environment is, in part, a result of changes in the economic environment within the state of Michigan, regulation, changes in technology and product delivery systems and consolidation among financial service providers. New competitors may emerge to increase the degree of competition for the Company’s customers and services. Financial services and products are also constantly changing. The Company’s financial performance will also depend in part upon customer demand for the Company’s products and services and the Company’s ability to develop and offer competitive financial products and services.

We are subject to significant government regulation, and any regulatory changes may adversely affect us.

We are subject to extensive government regulation under both federal and state law. We are subject to regulation by the Federal Reserve, the FDIC and the DIFS, in addition to other regulatory and self-regulatory organizations. Current laws and applicable regulations are subject to change and any new regulatory change could make compliance more expensive, difficult, or otherwise adversely affect our business. Specifically, regulation changes to overdraft fees could adversely affect our business. We cannot predict the ultimate effect of any changes to regulations affecting us, but such changes could have a material adverse effect on our results of operation or financial condition.

Changes in interest rates could reduce the Company’s income and cash flow.

The Company’s income and cash flow depends, to a great extent, on the difference between the interest earned on loans and securities, and the interest paid on deposits and other borrowings. Market interest rates are beyond the Company’s control, and they fluctuate in response to general economic conditions and the policies of various governmental and regulatory agencies including, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates and interest rate relationships, will influence the origination of loans, the purchase of investments, the generation of deposits and the rate received on loans and securities and paid on deposits and other borrowings.

The Company is subject to liquidity risk in its operations, which could adversely affect its ability to fund various obligations.

Liquidity risk is the possibility of being unable to meet obligations as they come due or capitalize on growth opportunities as they arise because of an inability to liquidate assets or obtain adequate funding on a timely basis, at a reasonable cost and within acceptable risk tolerances. Liquidity is required to fund various obligations, including credit obligations to borrowers, loan originations, withdrawals by depositors, repayment of debt, dividends to shareholders, operating expenses and capital expenditures. Liquidity is derived primarily from retail deposit growth and earnings retention, principal and interest payments on loans and investment securities, net cash provided from operations and access to other funding. If the Company is unable to maintain adequate liquidity, then its business, financial condition and results of operations would be negatively affected.

If the Company were required to sell investment securities in an unrealized loss position to meet liquidity needs and realize losses, that could have a material adverse impact on its results of operation and financial condition.

At December 31, 2024, the Company had $116.6 million in unrealized losses on its investment securities, including $61.1 million in unrealized losses on available for sale securities and $55.5 in unrealized losses on held to maturity securities. If the Company were required to sell investment securities in an unrealized loss position to meet liquidity needs and realize losses, that could have a material adverse impact on its results of operations and financial condition, including a negative impact on net income and a permanent reduction in equity capital. 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.

Evaluation of investment securities for an allowance for credit losses involves subjective determinations and could have a material adverse impact on our results of operations and financial condition.

The fair value evaluation of investment securities is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether declines in the fair value of investments require the establishment of an allowance for credit losses. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or future recovery prospects and the effects of changes in interest rates or credit spreads. Estimating future cash flows involves incorporating information received from third-party sources and making internal assumptions and judgments regarding the future performance of the underlying collateral and assessing the probability that an adverse change in future cash flows has occurred. The determination of an allowance for credit losses is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Our management considers a wide range of factors about the security issuer and uses reasonable judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for recovery. Inherent in management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Additions to the allowance for credit losses for our investment securities may need to be taken in the future, which could have a material adverse effect on our results of operations and financial condition.

The Company has significant exposure to risks associated with commercial and residential real estate.

A substantial portion of the Company’s loan portfolio consists of commercial and residential real estate-related loans, including real estate development, construction and residential and commercial mortgage loans. As of December 31, 2024, the Company had approximately $918.2 million of commercial and construction real estate loans outstanding, which represented approximately 59.4% of its loan portfolio. As of that same date, the Company had approximately $281.7 million in residential real estate loans outstanding, or approximately 18.2% of its loan portfolio. Consequently, real estate-related credit risks are a significant concern for the Company. The adverse consequences from real estate-related credit risks tend to be cyclical and are often driven by national economic developments that are not controllable or entirely foreseeable by the Company or its borrowers.

Commercial loans may expose the Company to greater financial and credit risk than other loans.

The Company’s commercial and industrial loan portfolio, including commercial mortgages, was approximately $228.3 million at December 31, 2024, comprising approximately 14.8% of its total loan portfolio. Commercial loans generally carry larger loan balances and can involve a greater degree of financial and credit risk than other loans. Any significant failure to pay on time by the Company’s customers would hurt the Company’s earnings. The increased financial and credit risk associated with these types of loans are a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the size of loan balances, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans.

Legislative or regulatory changes or actions could adversely impact the Company or the businesses in which it is engaged.

The Company and the Bank are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of their operations. Laws and regulations may change from time to time and are primarily intended for the protection of consumers, depositors and the deposit insurance fund, and not to benefit the Company’s shareholders. The impact of any changes to laws and regulations or other actions by regulatory agencies may negatively impact the Company or its ability to increase the value of its business. Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets by the institution and the adequacy of an institution’s allowance for credit losses. Future regulatory changes or accounting pronouncements may increase the Company’s regulatory capital requirements or adversely affect its regulatory capital levels. Additionally, actions by regulatory agencies against the Company or the Bank could require the Company to devote significant time and resources to defending its business and may lead to penalties that materially affect the Company.

The Company relies heavily on its management and other key personnel, and the loss of any of them may adversely affect its operations.

The Company is and will continue to be dependent upon the services of its management team and other key personnel. Losing the services of one or more key members of the Company’s management team could adversely affect its operations.

The Company’s controls and procedures may fail or be circumvented.

Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. If the Company fails to identify and remediate control deficiencies, it is possible that a material misstatement of interim or annual financial statements will not be prevented or detected on a timely basis. In addition, any failure or circumvention of the Company’s other controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.

The Company may be a defendant in a variety of litigation and other actions, which may have a material adverse effect on the Company’s financial condition and results of operations.

The Company and the Bank are regularly involved in a variety of litigation arising out of the normal course of business. The Company’s insurance may not cover all claims that may be asserted against it, and any claims asserted against it, regardless of merit or eventual outcome, may harm its reputation or cause the Company to incur unexpected expenses, which could be material in amount. Should the ultimate expenses, judgments or settlements in any litigation exceed the Company’s insurance coverage, they could have a material adverse effect on the Company’s financial condition and results of operations. In addition, the Company may not be able to obtain appropriate types or levels of insurance in the future, nor may it be able to obtain adequate replacement policies with acceptable terms, if at all.

If the Company cannot raise additional capital when needed, its ability to further expand its operations through organic growth or acquisitions could be materially impaired.

The Company is required by federal and state regulatory authorities to maintain specified levels of capital to support its operations. The Company may need to raise additional capital to support its current level of assets or its growth. The Company’s ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside its control, and on its financial performance. The Company cannot assure that it will be able to raise additional capital in the future on terms acceptable to it or at all. If the Company cannot raise additional capital when needed, its ability to maintain its current level of assets or to expand its operations through organic growth or acquisitions could be materially limited.

Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of computer systems or otherwise, could severely harm the Company’s business.

As part of its business, the Company collects, processes and retains sensitive and confidential client and customer information on behalf of itself and other third parties. Despite the security measures the Company has in place for its facilities and systems, and the security measures of its third party service providers, the Company may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming and/or human errors or other similar events. Any security breach involving the misappropriation, loss or other unauthorized disclosure of confidential customer information, whether by the Company or by its vendors, could severely damage the Company’s reputation, expose it to the risks of litigation and liability, disrupt the Company’s operations and have a material adverse effect on the Company’s business.

The Company's information systems may experience an interruption or breach in security.

The Company relies heavily on communications and information systems to conduct its business and deliver its products. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the Company’s customer relationship management, general ledger, deposit, loan and other systems. While the Company has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches of the Company’s information systems or its customers’ information or computer systems would not damage the Company’s reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny, or expose the Company to civil litigation and financial liability, any of which could have a material adverse effect on the Company’s financial condition and results of operations.

Cybersecurity incidents could disrupt business operations, result in the loss of critical and confidential information, and adversely impact our reputation and results of operations.

Global cybersecurity threats and incidents can range from uncoordinated individual attempts to gain unauthorized access to information technology (IT) systems to sophisticated and targeted measures known as advanced persistent threats, directed at the Company and/or its third party service providers. Although we employ reasonably comprehensive measures to prevent, detect, address and mitigate these threats (including access controls, employee training, data encryption, vulnerability assessments, continuous monitoring of our IT networks and systems and maintenance of backup and protective systems), cybersecurity incidents, depending on their nature and scope, could potentially result in the misappropriation, destruction, corruption or unavailability of critical data and confidential or proprietary information (our own or that of third parties) and the disruption of business operations. The potential consequences of a material cybersecurity incident include reputational damage, litigation with third parties and increased cybersecurity protection and remediation costs, which in turn could materially adversely affect our results of operations.

Employee misconduct could adversely impact our reputation and results of operations.

Our reputation is crucial to maintaining and developing relationships with our customers. There is a risk our employees could engage in misconduct that adversely affects our business. For example, if an employee were to engage (or be accused of engaging) in fraudulent, illegal, or suspicious activities, including fraud or theft, we could be subject to regulatory sanctions or penalties, or litigation, and suffer significant harm to our reputation, financial position, and customer relationships as a result. Additionally, our business often requires that we deal with sensitive customer information. If our employees were to improperly use or disclose this information, even inadvertently, we could suffer significant harm to our reputation, financial position and current and future business relationships. We may not be able to deter all employee misconduct, and the precautions we take to detect and prevent this misconduct may not be effective in all circumstances. Misconduct or harassment by our employees (or unsubstantiated allegations of the same), or improper use or disclosure of confidential information by our employees, even inadvertently, could result in a material adverse effect on our business, reputation, or results of operations.

Environmental liability associated with commercial lending could result in losses.

In the course of its business, the Company may acquire, through foreclosure, properties securing loans that are in default. Particularly in commercial real estate lending, there is a risk that hazardous substances could be discovered on these properties. In this event, the Company might be required to remove these substances from the affected properties at the Company’s sole cost and expense. The cost of this removal could substantially exceed the value of affected properties. The Company may not have adequate remedies against the prior owner or other responsible parties and could find it difficult or impossible to sell the affected properties. These events could have an adverse effect on the Company’s business, results of operations and financial condition.

The Company depends upon the accuracy and completeness of information about customers.

In deciding whether to extend credit to customers, the Company relies on information provided to it by its customers, including financial statements and other financial information. The Company may also rely on representations of customers as to the accuracy and completeness of that information and on reports of independent auditors on financial statements. The Company’s financial condition and results of operations could be negatively impacted to the extent that the Company extends credit in reliance on financial statements that do not comply with generally accepted accounting principles or that are misleading or other information provided by customers that is false or misleading.

Our reliance on third party vendors could cause operational losses or business interruptions.

We rely on third party service providers for certain components of our business activity. If these third party service providers experience difficulties or terminate their services and we are unable to replace them with other service providers, our operations could be interrupted. Even if we are able to replace them with another service provider, the replacement may be more expensive or offer an inferior service. Any of these outcomes could have a material adverse effect on our business, financial condition or results of operations.

The Company operates in a highly competitive industry and market area.

The Company faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national and regional banks within the various markets where the Company operates, as well as internet banks and other financial technology companies. The Company also faces competition from many other types of financial institutions, including savings and loan associations, credit unions, finance companies, brokerage firms, insurance companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. The Company competes with these institutions both in attracting deposits and in making new loans. Technology has lowered barriers to entry into the market and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of the Company’s competitors have fewer regulatory constraints and may have lower cost structures, such as credit unions that are not subject to federal income tax. Due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than the Company can.

Severe weather, natural disasters, acts of war or terrorism, a public health crisis, and other external events could significantly impact the Company’s business.

Severe weather, natural disasters, acts of war or terrorism, risks posed by an outbreak of a widespread epidemic or pandemic of disease (or widespread fear thereof) or other public health crisis, and other adverse external events could have a significant impact on the Company’s ability to conduct business. Such events could affect the stability of the Company’s deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause the Company to incur additional expenses.

The Company relies on dividends from the Bank for most of its revenue.

The Company is a separate and distinct legal entity from the Bank. It receives substantially all of its revenue from dividends from the Bank. These dividends are the principal source of funds to pay cash dividends on the Company’s common stock. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to the Company. If the Bank is unable to pay dividends to the Company, the Company may not be able to pay cash dividends on its common stock. The earnings of the Bank have been the principal source of funds to pay cash dividends to shareholders. Over the long-term, cash dividends to shareholders are dependent upon earnings, as well as capital requirements, regulatory restraints and other factors affecting the Company and the Bank.

Additional risks and uncertainties could have a negative effect on financial performance.

Additional factors could have a negative effect on the financial performance of the Company and the Company’s common stock. Some of these factors are financial market conditions, changes in financial accounting and reporting standards, new litigation or changes in existing litigation, regulatory actions and losses.

Risks Related to the Company’s Common Stock

Investments in the Company’s common stock involve risk.

The market price of the Company’s common stock may fluctuate significantly in response to a number of factors, including:

• Variations in quarterly or annual operating results
• Changes in dividends per share
• Changes in interest rates
• Changes in inflation levels
• Trade tariffs
• New developments, laws or regulations in the banking industry
• Acquisitions or business combinations involving the Company or its competition
• Regulatory actions, including changes to regulatory capital levels, the components of regulatory capital and how regulatory capital is calculated
• Volatility of stock market prices and volumes
• Changes in market valuations of similar companies
• New litigation or contingencies or changes in existing litigation or contingencies
• Changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or other regulatory agencies
• Rumors or erroneous information
• Credit and capital availability
• Issuance of additional shares of common stock or other debt or equity securities of the Company
• Market conditions
• General economic conditions
• Turbulence, uncertainty or a lack of confidence within the banking industry

The Company’s common stock, while publicly traded, has less liquidity than the average liquidity of stocks listed on the Nasdaq Stock Market.

The Company’s common stock is listed for trading on the Nasdaq Capital Market. However, the Company’s common stock has less liquidity than the average liquidity for companies listed in the Nasdaq Stock Market. The public trading market for the Company’s common stock depends on a marketplace of willing buyers and sellers at any given time, which in turn depends on factors outside of the Company’s control, including general economic and market conditions and the decisions of individual investors. The limited market for the Company’s common stock may affect a shareholder’s ability to sell their shares at any given time, and the sale of a large number of shares at one time could temporarily adversely affect the market price of our common stock.

The Company's common stock is not insured by any government entity.

The Company’s common stock is not insured by the FDIC or any other government entity. Investment in the Company’s common stock is subject to risk and potential loss.

A shareholder’s ownership of common stock may be diluted if the Company issues additional shares of common stock in the future.

The Company’s articles of incorporation authorize the Company’s Board of Directors to issue additional shares of common stock or preferred stock without shareholder approval. To the extent the Company issues additional shares of common stock or preferred stock, or issues options or warrants permitting the holder to purchase or acquire common stock in the future and such warrants or options are exercised, the Company’s shareholders may experience dilution in their ownership of the Company’s common stock. Holders of the Company’s common stock do not have any preemptive or similar rights to purchase a pro rata share of any additional shares offered or issued by the Company.

The value of the Company's common stock may be adversely affected if the Company issues debt and equity securities that are senior to the Company's common stock in liquidation or as to distributions.

The Company may increase its capital by issuing debt or equity securities or by entering into debt or debt-like financing. This may include the issuance of common stock, preferred stock, senior notes, or subordinated notes. Upon any liquidation of the Company, the Company’s lenders and holders of its debt securities would be entitled to distribution of the Company’s available assets before distributions to the holders of the Company’s common stock, and holders of preferred stock may be granted rights to similarly receive a distribution upon liquidation prior to distribution to holders of the Company’s common stock. The Company cannot predict the amount, timing or nature of any future debt financings or stock offerings, and the decision of whether to incur debt or issue securities will depend on market conditions and other factors beyond the Company’s control. Future offerings could dilute a shareholder’s interests in the Company or reduce the per-share value of the Company’s common stock.

The Company's articles of incorporation and bylaws, and certain provisions of Michigan law, contain provisions that could make a takeover effort more difficult.

The Michigan Business Corporation Act, and the Company’s articles of incorporation and bylaws, include provisions intended to protect shareholders and prohibit, discourage, or delay certain types of hostile takeover activities. In addition, federal law requires the Federal Reserve Board’s prior approval for acquisition of “control” of a bank holding company such as the Company, including acquisition of 10% or more of the Company’s outstanding securities by any person not defined as a company under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). These provisions and requirements could discourage potential acquisition proposals, delay or prevent a change in control, diminish the opportunities for a shareholder to participate in tender offers, prevent transactions in which our shareholders might otherwise receive a premium for their shares, or limit the ability for our shareholders to approve transactions that they may believe to be in their best interests.

An entity or group holding a certain percentage of the Company's outstanding securities could become subject to regulation as a "bank holding company" or may be required to obtain prior approval of the Federal Reserve Board.

Any bank holding company or foreign bank with a presence in the United States may be required to obtain approval of the Federal Reserve Board under the BHC Act to acquire or retain 5% or more of the Company’s outstanding securities. Further, if any entity (including a “group” comprised of individual persons) owns or controls the power to vote 25% or more of the Company’s outstanding securities, or 5% or more of the outstanding securities if the entity otherwise exercises a “controlling influence” over the Company, the entity may become subject to regulation as a “bank holding company” under the BHC Act. An entity that is subject to regulation as a bank holding company would be subject to regulatory and statutory obligations and restrictions, and could be required to divest all or a portion of the entity’s investment in the Company’s securities or in other investments that are not permitted for a bank holding company.

We face various cybersecurity threats, including unauthorized access, malware, ransomware, and phishing attacks. These threats could compromise the security of our information systems and the data we store and process. While we have experienced, and expect to continue to experience, cybersecurity threats, we have not experienced a material cybersecurity incident in the three year period ended December 31, 2024. The potential consequences of a material cybersecurity incident could include reputational damage, litigation with third parties, regulatory criticism or proceedings and increased cybersecurity protection and remediation costs, which in turn could materially adversely affect our results of operations.

We have established an information security third party risk management program to identify and manage these risks. This program includes regular risk assessments, third party risk provider reviews, and implementation of security measures such as encryption and firewalls, and ongoing monitoring of our systems for potential threats. We also engage with industry consultants to assist with our risk assessments.

On a regular basis, the technology steering committee, led by management, receives comprehensive reports summarizing cybersecurity threat monitoring and incident management activities. These reports also include details about remediation efforts to address identified threats and incidents. Additionally, both internal and external assessments of our company’s cybersecurity threat monitoring capabilities are shared with the committee. Meeting minutes from these committee sessions are diligently maintained and provided to the Board of Directors.

The Board of Directors has responsibility for approving and overseeing management’s policies related to information system security and cybersecurity threats and incidents. They also supervise management’s overall approach to securing the company’s information systems. The Board of Directors delegates the oversight of cybersecurity risk management to the Information Technology Committee of the Board.

The Information Technology Committee, in turn, reviews reports on our cybersecurity risk management processes. These reports cover assessments of management’s handling of cybersecurity threats and incident management functions. The committee receives periodic updates from the Chief Information Officer, including information on social engineering risks, the effectiveness of cybersecurity training, and results from vulnerability and penetration assessments conducted both internally and by external parties. Audit reports related to information systems and cybersecurity threat monitoring are also part of this reporting process.

ChoiceOne recognizes the importance of cybersecurity and has established a comprehensive framework to assess and manage material risks from cybersecurity threats. The Company's cybersecurity risk management program is overseen by the Information Technology Committee, which is responsible for developing and implementing policies and procedures to protect the Company's information assets. Key members of ChoiceOne’s cybersecurity team include:

Chief Information Officer (“CIO”) has extensive experience in managing complex IT environments and mitigating cybersecurity risks. The CIO is responsible for overseeing cybersecurity and technology vendors, assessing risks in these areas, and ensuring the effective execution of the information security program.

Vice President of Network Security is a Certified Information System Security Professional (CISSP) with over 10 years of experience in managing IT and cybersecurity operations.

The cybersecurity team has several other members with expertise in network security, technology, and administration. The cybersecurity team meets regularly to review and assess the Company's cybersecurity posture, identify potential threats, and implement appropriate measures to mitigate risks. The committee also collaborates with external cybersecurity experts to stay informed about the latest threats and best practices in the industry.

The Company’s headquarters are located at 109 East Division, Sparta, Michigan 49345. The headquarters location is owned by the Company and is not subject to any mortgage.

29 of the Company’s 35 locations are designed for use and operation as a bank branch office, are well maintained, and are suitable for current operations. The remaining six locations are comprised of loan production and wealth management offices. Offices generally range in size from 1,200 to 3,200 square feet, based on the location and number of employees located at the facility. All of our offices are owned by the Bank except for seven that are leased under various operating lease agreements. The Company’s management believes all offices are adequately covered by property insurance.

As of December 31, 2024, there were no significant pending legal proceedings to which the Company or the Bank is a party or to which any of their properties were subject, except for legal proceedings arising in the ordinary course of business. In the opinion of management, pending legal proceedings will not have a material adverse effect on the consolidated financial condition of the Company.

The following discussion is designed to provide a review of the consolidated financial condition and results of operations of ChoiceOne Financial Services, Inc. (“ChoiceOne” or the “Company”), and its wholly-owned subsidiaries. This discussion should be read in conjunction with the consolidated financial statements and related footnotes.

We have omitted discussion of 2023 results where it would be redundant to the discussion previously included in Part II, Item 7 of our 2023 Annual Report on Form 10-K.

Selected Financial Data

(Dollars in thousands, except per share data)

20

RECENT EVENTS

ChoiceOne and Fentura Financial, Inc., the parent company of The State Bank, entered into a definitive merger agreement on July 25, 2024 pursuant to which ChoiceOne and Fentura would merge in an all-stock transaction (the “Merger”). The Merger was effective on March 1, 2025.

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.

RESULTS OF OPERATIONS

Summary

ChoiceOne's net income for 2024 was $26.7 million, compared to $21.3 million in 2023. Diluted earnings per share were $3.25 in the twelve months ended December 31, 2024, compared to $2.82 per share in the twelve months ended December 31, 2023. Net income adjusted for merger related expenses (non-GAAP) was $27.7 million for the twelve months ended December 31, 2024 with adjusted diluted earnings per share of $3.37.

ChoiceOne's asset mix has shifted from loans held for investment of 66.5% of deposits at December 31, 2023 to 69.8% of deposits at December 31, 2024. As of December 31, 2024, total assets were $2.7 billion, an increase of $146.5 million compared to December 31, 2023. The growth is primarily attributed to an increase in core loans of $114.5 million and loans to other financial institutions of $20.5 million. This growth was offset by a $48.9 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 experienced.

Deposits, excluding brokered deposits increased $79.0 million or 3.8% during 2024. The increase in deposits in the twelve months ended December 31, 2024 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 and FHLB advances to ensure ample liquidity. At December 31, 2024, total available borrowing capacity secured by pledged assets was $837.2 million. ChoiceOne can increase its capacity by utilizing unsecured federal fund lines and pledging additional assets. Uninsured deposits totaled $833.2 million or 37.6% of deposits at December 31, 2024.

ChoiceOne's cost of deposits to average total deposits has increased from 1.14% in 2023 to 1.58% in 2024. During 2023 ChoiceOne was able to lag many of the increases to the federal funds rate which increased 425 basis points in 2022 and another 100 basis points in 2023. ChoiceOne's cost of deposits to average total deposits peaked in the first quarter of 2024, and declined slightly in subsequent quarters due to the Federal Reserve decreasing the federal funds rate by 100 basis points in the last four months of 2024. If rates continue to decline, we expect to see further reductions in deposit costs; however, these reductions will be muted by the decrease in cash flows from pay-fixed interest rate swaps collected. Interest expense on borrowings for the twelve months ended December 31, 2024, increased $3.1 million compared to the same period in the prior year, due to increases in the average balance borrowed. During the fourth quarter of 2024, ChoiceOne paid down its advance from the Bank Term Funding Program and replaced it with $135.0 million of FHLB borrowings. This increased ChoiceOne's total borrowed balance at the FHLB to $175.0 million at a weighted average fixed rate of 4.5%, with the earliest maturity in January 2025.

The provision for credit losses expense on loans was $1.3 million in the full year 2024, due to the significant growth of core loans. Core loan growth was offset by slight improvements in the Federal Open Market Committee ("FOMC") forecast during the full year 2024. The ratio of the allowance for credit losses to total loans (excluding loans held for sale) was 1.07% on December 31, 2024 compared to 1.11% on December 31, 2023. Asset quality continues to remain strong, with net loan charge-offs to average loans of 0.03% and nonperforming loans to total loans (excluding loans held for sale) of 0.24% as of December 31, 2024. Nonperforming loans have increased since the historic lows in 2023, but still remain at low levels and consist entirely of residential loans with strong collateral positions.

Noninterest Income

Noninterest income increased $3.1 million in the twelve months ended December 31, 2024, compared to the same period in the prior year. The increase was largely due to an increase in credit and debit card fees of $1.1 million in the full year 2024 compared to the full year 2023 and earnings on life insurance policies in the twelve months ended December 31, 2024, compared to the same period in the prior year. ChoiceOne recognized earnings on two bank owned life insurance death benefit claims for a total of $700,000 during 2024. ChoiceOne also saw an increase in the market value of equity securities in the full year 2024, compared to the prior year. Equity securities include community bank stocks and CRA focused bond mutual funds. ChoiceOne additionally saw an uptick in gains on sales of loans during the fourth quarter of 2024 due in part to participation in the FHLB Rate Advantage program which provides incentives to home buyers in the low to moderate income bracket.

Noninterest Expense

Noninterest expense increased by $3.6 million or 6.6% in the twelve months ended December 31, 2024 compared to the same period in 2023. The increase in total noninterest expense was due in part to merger related expenses of $1.0 million during the twelve months ended December 31, 2024, compared to $0 in the same period 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 the inflationary environment. The increase in costs was offset by a decline in occupancy and equipment cost related to two branch closures during the first quarter of 2024. ChoiceOne seeks to strategically manage costs while still making thoughtful investments in order to maintain our competitive edge and deliver exceptional value to our customers, shareholders, and communities.

Dividends

Cash dividends of $9.0 million or $1.09 per common share were declared in 2024 compared to $7.9 million or $1.05 per common share in 2023. The dividend yield for ChoiceOne’s common stock was 3.06% as of the end of 2024, compared to 3.58% as of the end of 2023. The cash dividend payout as a percentage of net income was 33.7% as of December 31, 2024, compared to 37.2% as of December 31, 2023.

Income Taxes

Income tax expense was $2.1 million higher in 2024 than in 2023. The effective tax rate was 19.2% for the year ended December 31, 2024 compared to 16.8% for the same period in 2023. For 2024, income before income tax, disallowed interest expense (TEFRA) and nondeductible merger expenses increased compared to 2023. For further details, refer to Note 12 - Income Taxes of the Notes to the Consolidated Financial Statements included in Item 8 of this report.

Table 1 – Average Balances and Tax-Equivalent Interest Rates

Tables 1 and 2 on the following pages provide information regarding interest income and expense for the years ended December 31, 2024, 2023, and 2022. 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.

(Dollars in thousands)

(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) Interest on taxable securities includes dividends on 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 $2.3 million, $1.6 million, and $1.3 million for the year ended 2024, 2023, and 2022, respectively.

(5) Interest on loans included net origination fees and accretion income. Accretion income was $1.2 million, $1.7 million, and $2.0 million for the full year 2024, 2023, and 2022, respectively.

(6) Interest income for 2024 and 2023 was reduced by $1.1 million and $2.8 million, respectively, due to amortization expense related to the March 2023 sale of the pay floating swap derivative.

Table 2 – Changes in Tax-Equivalent Net Interest Income

(Dollars in thousands)

(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 tax-exempt securities and loans has been adjusted to a fully tax-equivalent basis using an incremental tax rate of 21% for 2024, 2023, and 2022.

Net Interest Income

GAAP based net interest income increased $8.6 million, and tax-equivalent net interest income increased $8.6 million, respectively, for the full year 2024, compared to the same period in 2023. GAAP based net interest margin increased 18 basis points, and tax equivalent net interest margin increased 18 basis points, respectively, in 2024 compared to 2023.

ChoiceOne has experienced substantial core loan growth from December 31, 2023 to December 31, 2024, leading to an increase in interest income from loans of $21.2 million in the twelve months ended December 31, 2024, compared to the same period in the prior year. Average core loans grew $191.2 million for the twelve months ended December 31, 2024, compared to the same period in the prior year. In addition, the average rate earned on loans increased 75 basis points for the twelve months ended December 31, 2024, compared to the same period in the prior year.

The average balance of total securities decreased $61.1 million in 2024, compared to the same period in 2023. The decrease was due to the paydowns, maturities, and redemptions during 2024. Interest income on securities remained flat in 2024 compared to 2023 despite the decline in average balance as the average rate earned on securities increased 17 basis points for the full year 2024, compared to the same period in the prior year.

Interest expense increased $13.6 million for the full year 2024, compared to the same period in the prior year. The average rate paid on interest bearing-demand deposits and savings deposits increased 33 basis points in the twelve months ended December 31, 2024, compared to the same period in the prior year. This was compounded by the increase in the average balance of interest bearing-demand deposits and savings deposits, of $7.4 million during 2024. The increase in the average balance of certificates of deposit of $81.7 million during 2024, combined with a 92 basis point increase in the rate paid on certificates of deposits during 2024, compared to the same period in the prior year, led to an increase in interest expense of $6.4 million during 2024.

During 2023, ChoiceOne was able to lag many of the increases to the federal funds rate which increased 425 basis points in 2022 and another 100 basis points in 2023. ChoiceOne's cost of deposits to average total deposits peaked in the first quarter of 2024, and has slightly declined in subsequent quarters due to the Federal Reserve decreasing the federal funds rate by 100 basis points in the last four months of 2024. If rates continue to decline, we expect to see further reductions in deposit costs; however, these reductions will be muted by the decrease in cash flows from pay-fixed interest rate swaps collected. ChoiceOne has been able to outpace the increased cost of deposits by increased loan originations at higher average interest rates.

ChoiceOne held $170.0 million in borrowings from the Bank Term Funding Program ("BTFP") during the first three quarters of 2024 and during the fourth quarter of 2024, ChoiceOne paid down its advance from the Bank Term Funding Program and replaced it with $135.0 million of FHLB borrowings. This increased the total borrowed balance at the FHLB to $175.0 million at a weighted average fixed rate of 4.5%. The net effect of these additional borrowed funds was an increase in interest expense of $3.1 million for the year ended December 31, 2024, compared to the same period 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 relatively flat in 2024 compared to the same period in the prior year.

The following table presents the cost of deposits and the cost of funds for the years ended December 31, 2024, December 31, 2023, and December 31, 2022.

Provision and Allowance For Credit Losses

Table 3 – Provision and Allowance For Credit Losses

(Dollars in thousands)

Note: In the table above, "consumer" includes deposit account charge-offs and recoveries.

The 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 $2.0 million to $4.1 million during the year ended December 31, 2024, and the ACL related to these individually evaluated loans increased by $108,000 during the same period largely due to the balance increase.

Nonperforming loans, which includes Other Real Estate Owned ("OREO") but excludes performing troubled loan modifications ("TLM"), increased by $1.9 million to $3.8 million at December 31, 2024, compared to a historically low balance on December 31, 2023. All non-performing loans are retail in nature. The ACL was 1.07% of total loans, excluding loans held for sale, at December 31, 2024, compared to 1.11% as of December 31, 2023. The liability for expected credit losses on unfunded loans and other commitments was $1.5 million on December 31, 2024, compared to $2.2 million as of December 31, 2023.

Net charge-offs were $433,000 during the full year 2024, compared to net charge-offs of $364,000 during the same period in 2023. Net charge-offs for checking accounts during the full year 2024 were $237,000 compared to $226,000 for the same period in the prior year. Net charge-offs as a percentage of average loans were 0.03% during the full year 2024 and 2023.

The provision for credit losses on loans was $1.3 million during the full year 2024 and 2023, due to core loan growth, which was partially offset by slight improvements in the Federal Open Market Committee ("FOMC") forecast during the full year 2024. The loan provision expense was offset by the decrease in unfunded commitments provision expense of $675,000 in the full year 2024 due to changes in mix and expected funding rates during the year. Total unfunded commitments decreased $15.9 million in the full year 2024 compared to December 31, 2023.

Net provision for credit losses was $625,000 for the full year 2024.

Financial Condition

Summary

Total assets grew $146.5 million in the twelve months ended December 31, 2024. Core loans grew $114.5 million or 8.2% and were offset by a decline in investment securities of $48.9 million. Deposits, excluding brokered deposits, increased by $79.0 million during 2024, while borrowings declined by $25.0 million. Deposit costs rose steadily in the first half of the year followed by a decline in the second half of the year which coincided with the decreases to the federal funds rate starting in September of 2024.

Securities

The Company’s securities balances as of December 31 were as follows:

(Dollars in thousands)

Total investment securities declined $48.9 million from December 31, 2023 to December 31, 2024. ChoiceOne purchased $16.8 million of securities in 2024. Securities totaling $11.8 million were called or matured in 2024. ChoiceOne received principal payments for municipal and mortgage-backed securities totaling $48.0 million during 2024.

At December 31, 2024, the Company had $116.6 million in unrealized losses on its investment securities, including $61.1 million in unrealized losses on available for sale securities and $55.5 million in unrealized losses on held to maturity 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 December 31, 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 in accumulated other comprehensive income (loss).

Loans

The Company’s loan portfolio by call report code was as follows:

(Dollars in thousands)

Average loan balances increased $191.2 million in the full year 2024 compared to the same period in 2023. Core loans grew organically by $114.5 million or 8.2% during 2024, with growth concentrated in Non-Owner Occupied CRE loans, which grew by $88.8 million, Owner Occupied CRE loans, which grew by $44.5 million, and 1-4 Family Loans, which grew by $33.1 million. The growth in 1-4 Family loans was largely related to growth in loans to other financial institutions which were $39.9 million as of December 31, 2024, compared to $19.4 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; however, this balance is volatile and could change based on the third party origination volume or discretion. Loan interest including fee income increased $21.2 million in the full year 2024, compared to the same period in the prior year.

ChoiceOne recorded accretion income related to acquired loans in the amount of $1.2 million in 2024 and $1.7 million during 2023. 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. ChoiceOne estimates that roughly $1.3 million will accrete into income over the next one to three years.

As part of its review of the loan portfolio, management also monitors the various nonperforming loans. Nonperforming loans are comprised of loans accounted for on a nonaccrual basis, loans not included in nonaccrual loans, which are contractually past due 90 days or more as to interest or principal payments, and troubled loan modifications which are accruing and initiated in the past year.

The balances of these nonperforming loans as of December 31 were as follows:

(Dollars in thousands)

Nonaccrual loans included $3.5 million in residential real estate loans, $229,000 in construction real estate loans, and $8,000 in consumer loans as of December 31, 2024, compared to $1.7 million in residential real estate loans as of December 31, 2023. There were no troubled loan modifications ("TLM") at December 31, 2024, compared to $60,000 of commercial and industrial TLM loans and $129,000 of residential real estate TLM loans at December 31, 2023.

Management also maintains a list of loans that are not classified as nonperforming loans but where some concern exists as to the borrowers’ abilities to comply with the original loan terms. There were 19 loans totaling $375,000 fitting this description as of December 31, 2024, and 22 loans totaling $357,000 fitting this description as of December 31, 2023.

Deposits and Other Funding Sources

The Company’s deposit balances as of December 31 were as follows:

(Dollars in thousands)

Deposits, excluding brokered deposits increased $79.0 million or 3.8% during 2024. The increase in deposits in the twelve months ended December 31, 2024 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 and FHLB advances to ensure ample liquidity.

At December 31, 2024, total available borrowing capacity secured by pledged assets was $837.2 million. ChoiceOne can increase its capacity by utilizing unsecured federal fund lines and pledging additional assets. Uninsured deposits totaled $833.2 million or 37.6% of deposits at December 31, 2024. Core deposits, which we define as insured branch deposits less certificates of deposit, totaled $1.1 billion or 51.2% of total deposits at December 31, 2024.

ChoiceOne's cost of deposits to average total deposits has increased from 1.14% in 2023 to 1.58% in 2024. During 2023 ChoiceOne was able to lag many of the increases to the federal funds rate which increased 425 basis points in 2022 and another 100 basis points in 2023. ChoiceOne's cost of deposits to average total deposits peaked in the first quarter of 2024, and has slightly declined in subsequent quarters due to the Federal Reserve decreasing the federal funds rate by 100 basis points in the last four months of 2024. If rates continue to decline, we expect to see further reductions in deposit costs; however, these reductions will be muted by the decrease in cash flows from pay-fixed interest rate swaps collected. Interest expense on borrowings for the twelve months ended December 31, 2024, increased $3.1 million compared to the same period in the prior year, due to increases in the average balance borrowed. During the fourth quarter of 2024, ChoiceOne paid down its advance from the Bank Term Funding Program and replaced it with $135.0 million of FHLB borrowings. This increased ChoiceOne's total borrowed balance at the FHLB to $175.0 million at a weighted average fixed rate of 4.5%, with the earliest maturity in January 2025.

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 used a portion of net proceeds from the private placement to redeem senior debt, fund common stock repurchases, and support bank-level capital ratios. 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 mark-to-market adjustment.

Shareholders’ Equity

Shareholders’ equity totaled $260.4 million as of December 31, 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 from the sale of 1,380,000 shares of common at a price to the public of $25.00 per share on July 26, 2024. The additional increase is due to retained earnings and an improvement in accumulated other compressive loss (AOCI) of $13.8 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. The pay-fixed swap derivatives are designed to offset swings in AOCI due to changes in interest rates. ChoiceOne Bank remains “well-capitalized” with a total risk-based capital ratio of 12.7% as of December 31, 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 December 31, 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 $23.6 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.

Note 21 to the consolidated financial statements presents regulatory capital information for ChoiceOne and the Bank at the end of 2024 and 2023. Management will monitor these capital ratios during 2025 as they relate to asset growth and earnings retention. ChoiceOne’s Board of Directors and management do not plan to allow capital to decrease below those levels necessary to be considered "well capitalized" by regulatory guidelines.

Table 4 – Contractual Obligations

The following table discloses information regarding the maturity of ChoiceOne’s contractual obligations at December 31, 2024:

(Dollars in thousands)

(1) Cumulative preferred securities on the balance sheet include $1.0 million of discount due to a mark to market adjustment which is not reflected in the table above.

(2) ChoiceOne subordinated debenture on the balance sheet includes $240,000 of capitalized issuance cost which is not reflected in the table above.

Liquidity and Interest Rate Risk

Net cash provided by operating activities was $48.5 million in 2024 compared to $46.5 million in 2023. The change was due to higher net proceeds from loan sales and an increase in other liabilities in 2024 compared to 2023. Net cash used in investing activities was $97.9 million in 2024 compared to $181.4 million in 2023. ChoiceOne had loan originations and payments of $136.1 million in the full year 2024, compared to $221.2 million in the full year 2023. Net cash provided by financing activities was $90.7 million in 2024, compared to $146.4 million in 2023. The change was largely due to $150.0 million of higher borrowings in 2023, offset by $32.1 million in net proceeds received from our common stock offering completed on July 26, 2024.

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 $175.0 million in outstanding borrowings from the FHLB as of December 31, 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 December 31, 2024, total available borrowing capacity from the FHLB and the Federal Reserve Bank was $837.2 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 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.

NON-GAAP FINANCIAL MEASURES

This report contains financial measures that are not defined in U.S. generally accepted accounting principles ("GAAP"). Management believes these non-GAAP financial measures provide additional information that is useful to investors in helping to understand the underlying financial performance of ChoiceOne.

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

Income Adjusted for Merger Expenses - Non-GAAP Reconciliation

(In Thousands, Except Per Share Data)

32

Critical Accounting Policies And Estimates

Management’s discussion and analysis of financial condition and results of operations as well as disclosures found elsewhere in this report are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the market value of securities, the amount of the allowance for credit losses, loan servicing rights, carrying value of goodwill, and income taxes. Actual results could differ from those estimates.

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 automatically 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 December 31, 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. Prepayment speeds and curtailment were updated during the fourth quarter of 2024; however, the effect was insignificant.

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.

ACL for Securities

Securities Available for Sale – 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. 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 debt 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 December 31, 2024, there was no ACL related to debt securities AFS.

Securities Held to Maturity – Since the adoption of CECL, ChoiceOne measures credit losses on HTM securities 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 securities HTM is a contra asset valuation account that is deducted from the carrying amount of HTM securities 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 totaled $2.0 million and $2.1 million at December 31, 2024, and 2023, respectively, and was reported in other assets on the consolidated balance sheets and 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. At December 31, 2024, the ACL related to securities HTM is insignificant.

Troubled Loan Modifications

FASB also issued ASU 2022-02, Financial Instruments – Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This standard eliminated the previous accounting guidance for troubled debt restructurings and added additional disclosure requirements for gross chargeoffs by year of origination. It also prescribes guidance for reporting modifications of loans to borrowers experiencing financial difficulty.

Loan Servicing Rights

Loan servicing rights represent the estimated value of servicing loans that are sold with servicing retained by ChoiceOne and are initially recorded at estimated fair value. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Management’s accounting treatment of loan servicing rights is estimated based on current prepayment speeds that are typically market driven.

Management believes the accounting estimate related to loan servicing rights is a “critical accounting estimate” because (1) the estimate is highly susceptible to change from period to period because of significant changes within long-term interest rates affecting the prepayment speeds for current loans being serviced and (2) the impact of recognizing an impairment loss could have a material effect on ChoiceOne’s net income. Management has obtained a third-party valuation of its loan servicing rights to corroborate its current carrying value at the end of each reporting period.

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. 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. As of the measurement date and December 31, 2024 the stock price was greater than the book value. No material changes and no triggering events have occurred that indicated impairment from the measurement date through December 31, 2024.

Deferred Tax Assets and Liabilities

Income taxes include both a current and deferred portion. Deferred tax assets and liabilities are recorded to account for differences in the timing of the recognition of revenues and expenses for financial reporting and tax purposes. Generally accepted accounting principles require that deferred tax assets be reviewed to determine whether a valuation allowance should be established using a “more likely than not” standard. Based on its review of ChoiceOne’s deferred tax assets as of December 31, 2024, management determined that no valuation allowance was necessary. The valuation of current and deferred income tax assets and liabilities is considered critical, as it requires management to make estimates based on provisions of the enacted tax laws. The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and the federal tax code.

Identification and Classification of Merger-Related Expenses

Merger-related expenses are costs incurred directly in connection with the company's merger and acquisition activities. These expenses include legal fees for negotiation and drafting of merger agreements, accounting and auditing fees related to due diligence and financial statement preparation, consulting fees for strategic advisory services specific to the merger, costs related to regulatory filings and compliance, expenses for integration planning and execution (including IT and systems integration), severance and retention bonuses for employees affected by the merger, and travel and accommodation expenses directly related to merger activities.

To ensure accurate classification and segregation of these expenses, detailed documentation supporting the nature and purpose of each expense is maintained, including invoices, contracts, and internal memos. All merger-related expenses must be reviewed and approved by the CFO or an authorized delegate to ensure they meet the criteria for classification as merger-related. The Accounting Department conducts periodic reviews of these expenses to ensure proper classification and segregation, promptly addressing and correcting any discrepancies. Merger-related expenses are disclosed separately in the financial statements and accompanying notes to provide transparency to investors and stakeholders.

Interest rate risk is related to liquidity because each is affected by maturing assets and sources of funds. ChoiceOne’s Risk Committee attempts to stabilize the interest rate spread and avoid possible adverse effects when unusual or rapid changes in interest rates occur. The Risk Committee uses a simulation model to measure the Bank’s interest rate risk. The model incorporates changes in interest rates on rate-sensitive assets and liabilities. The degree of rate sensitivity is affected by prepayment assumptions that exist in the assets and liabilities. One method the Risk Committee uses of measuring interest rate sensitivity is the ratio of rate-sensitive assets to rate-sensitive liabilities. An asset or liability is considered to be rate-sensitive if it matures or otherwise reprices within a given time frame.

Table 5 documents the maturity or repricing schedule for ChoiceOne’s rate-sensitive assets and liabilities for selected time periods:

Table 5 – Maturities and Repricing Schedule

(Dollars in thousands)

(1) Interest rate derivative contracts include pay fixed, receive variable swaps with a notional value of $401.0 million. Further details can be found in Note 8 – Derivatives and Hedging Activities.

Under this method, the Risk Committee measures interest rate sensitivity by focusing on the one-year repricing gap. ChoiceOne’s ratio of rate-sensitive assets to rate-sensitive liabilities that matured or repriced within a one-year time frame was 41% at December 31, 2024, compared to 38% at December 31, 2023. Table 5 above shows the entire balance of interest-bearing demand deposits, savings deposits, and money market deposits in the shortest repricing term. Although these categories have the ability to reprice immediately, management has some control over the actual timing or extent of the changes in interest rates on these liabilities. The Risk Committee plans to continue to monitor the ratio of rate-sensitive assets to rate-sensitive liabilities on a quarterly basis in 2025. As interest rates change, the Risk Committee will attempt to match its maturing assets with corresponding liabilities to maximize ChoiceOne’s net interest income.

Another method the Risk Committee uses to monitor its interest rate sensitivity is to subject rate-sensitive assets and liabilities to interest rate shocks. At December 31, 2024, management used a simulation model to subject its assets and liabilities up to an immediate 200 basis point increase and decline. The maturities of loans and mortgage-backed securities were affected by certain prepayment assumptions. Maturities for interest-bearing core deposits were based on an estimate of the period over which they would be outstanding. The maturities of advances from the borrowings were based on their contractual maturity dates. In the case of variable rate assets and liabilities, repricing dates were used to determine their values. The simulation model measures the effect of immediate interest rate changes on both net interest income and shareholders’ equity.

Table 6 provides an illustration of hypothetical interest rate changes as of December 31, 2024 and 2023:

Table 6 – Sensitivity to Changes in Interest Rates

(Dollars in thousands)

(Dollars in thousands)

As of December 31, 2024, the Bank was within its guidelines for immediate rate shocks of 100 and 200 basis points up and down for net interest income and market value of shareholders’ equity scenarios. As of December 31, 2023, the Bank was within its guidelines for immediate rate shocks of 100 and 200 basis points up and down for net interest income scenarios and was within its guidelines for immediate rate shocks of 100 and 200 basis points up and 100 basis points down for market value of shareholders’ equity scenarios. The immediate rate shock of 200 basis points down for market value of shareholders’ equity scenarios was higher than the policy guidelines. The Risk Committee plans to continue to monitor the effect of changes in interest rates on both net interest income and shareholders’ equity and will make changes in the duration of its rate-sensitive assets and rate-sensitive liabilities where necessary.

(a) Evaluation of Controls and Procedures

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and principal financial officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures. Based on and as of the time of that evaluation, the Company’s management, including the Chief Executive Officer and principal financial officer, concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the required time periods.

(b) Changes in Internal Controls

There was no change in the Company’s internal control over financial reporting that occurred during the three months ended December 31, 2024 that has materially affected, or that is reasonably likely to materially affect, the Company’s internal control over financial reporting.

(c) Management’s Report on Internal Control over Financial Reporting

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting that is designed to produce reliable financial statements in conformity with United States generally accepted accounting principles. The system of internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability through a program of internal audits. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.

Management assessed the effectiveness of the Company’s system of internal control over financial reporting as of December 31, 2024, as required by Section 404 of the Sarbanes-Oxley Act of 2002. Management’s assessment is based on the criteria for effective internal control over financial reporting as described in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, management has concluded that, as of December 31, 2024, its system of internal control over financial reporting was effective and meets the criteria of the “Internal Control – Integrated Framework."

(d) Report of Independent Registered Public Accounting Firm

Plante & Moran, PLLC, an independent registered public accounting firm that audited the consolidated financial statements included herein, has issued an audit report on our internal control over financial reporting as of December 31, 2024, as stated in their report above under Part II, Item 8 of this report.