ChoiceOne Financial Services - 10-Q quarterly report FY

PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements.

ChoiceOne Financial Services, Inc.
CONSOLIDATED BALANCE SHEETS

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

ChoiceOne Financial Services, Inc.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited)

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

ChoiceOne Financial Services, Inc.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation
The consolidated financial statements include ChoiceOne Financial Services, Inc. (the "Registrant") and its wholly-owned subsidiary, ChoiceOne Bank (the "Bank"), and the Bank's wholly-owned subsidiaries ChoiceOne Insurance Agencies, Inc., and, with respect to 2008, ChoiceOne Mortgage Company of Michigan (the "Mortgage Company"). Intercompany transactions and balances have been eliminated in consolidation. Effective December 31, 2008, ChoiceOne consolidated the operations of the Mortgage Company into the Bank and eliminated the mortgage company subsidiary.

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

The accompanying consolidated financial statements reflect all adjustments ordinary in nature which are, in the opinion of management, necessary for a fair presentation of the Consolidated Balance Sheets as of March 31, 2009 and December 31, 2008, the Consolidated Statements of Income for the three-month periods ended March 31, 2009 and March 31, 2008, the Consolidated Statements of Changes in Shareholders' Equity for the three-month periods ended March 31, 2009 and March 31, 2008, and the Consolidated Statements of Cash Flows for the three-month periods ended March 31, 2009 and March 31, 2008. Operating results for the three months ended March 31, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes thereto included in the Registrant's Annual Report on Form 10-K for the year ended December 31, 2008.

Allowance for Loan Losses
The allowance for loan losses is maintained at a level believed adequate by management to absorb probable incurred losses inherent in the consolidated loan portfolio. Management's evaluation of the adequacy of the allowance is an estimate based on reviews of individual loans, assessments of the impact of current economic conditions on the portfolio and historical loss experience of seasoned loan portfolios. See Note 2 to the interim consolidated financial statements for additional information.

Management believes the accounting estimate related to the allowance for loan losses is a "critical accounting estimate" because (1) the estimate is highly susceptible to change from period to period because of assumptions concerning the changes in the types and volumes of the portfolios and economic conditions and (2) the impact of recognizing an impairment or loan loss could have a material effect on ChoiceOne's assets reported on the balance sheet as well as its net income.

Stock Transactions
A total of 1,321 shares of common stock were issued to the Registrant's Board of Directors for a cash price of $11,000 under the terms of the Directors' Stock Purchase Plan in the first quarter of 2009. A total of 3,320 shares were issued to employees for a cash price of $16,000 under the Employee Stock Purchase Plan for the quarter ended March 31, 2009.

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

ChoiceOne Financial Services, Inc.
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS (Continued)

NOTE 2 - ALLOWANCE FOR LOAN LOSSES

An analysis of changes in the allowance for loan losses follows:

NOTE 3 - EARNINGS PER SHARE

Earnings per share are based on the weighted average number of shares outstanding during the period. A computation of basic earnings per share and diluted earnings per share follows:

Assets Measured at Fair Value on a Recurring Basis at March 31, 2009
(Dollars in Thousands)

best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals). The losses indicated for the period ended March 31, 2009 consisted of charge-downs that were posted to the allowance for loan losses.

Other assets, including other real estate, bank-owned life insurance, goodwill, intangible assets and other assets acquired in business combinations, may be carried at fair value or are subject to periodic impairment assessments under other accounting principles generally accepted in the United States of America that could result in reporting at fair value. These assets are not considered financial instruments. Effective February 12, 2008, the Financial Accounting Standards Board issued a staff position that delayed the applicability of Statement of Financial Accounting Standards 157, "Fair Value Measurements," to non-financial instruments. Accordingly, these assets have been omitted from the above disclosures.

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion is designed to provide a review of the consolidated financial condition and results of operations of ChoiceOne Financial Services, Inc. ("ChoiceOne" or the "Registrant") and its wholly-owned subsidiary, ChoiceOne Bank (the "Bank"), and the Bank's wholly-owned subsidiary, ChoiceOne Insurance Agencies, Inc. This discussion should be read in conjunction with the consolidated financial statements and related notes.

FORWARD-LOOKING STATEMENTS

This discussion and other sections of this report contain forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates, and projections about the financial services industry, the economy, and the Registrant itself. Words such as "anticipates," "believes," "estimates," "expects," "forecasts," "intends," "is likely," "plans," "predicts," "projects," variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties, and assumptions ("risk factors") that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed, implied or forecasted in such forward-looking statements. Furthermore, the Registrant undertakes no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events, or otherwise.

Risk factors include, but are not limited to, the risk factors discussed in Item 1A of the Company's Annual Report on Form 10-K for the year ended December 31, 2008; changes in interest rates and interest rate relationships; demand for products and services; the degree of competition by traditional and non-traditional competitors; changes in banking laws and regulations; changes in tax laws; changes in prices, levies, and assessments; the impact of technological advances; governmental and regulatory policy changes; the outcomes of pending and future litigation and contingencies; trends in customer behavior as well as their abilities to repay loans; changes in the local and national economies; changes in market conditions; the possibility that anticipated cost savings and revenue enhancements from the merger with Valley Ridge Financial Corp. may not be realized in full or at all or within the expected time frames; the level and timing of asset growth; various other local and global uncertainties such as ac ts of terrorism and military actions; and current uncertainties and fluctuations in the financial markets and stocks of financial services providers due to concerns about credit availability and concerns about the Michigan economy in particular. These are representative of the risk factors that could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.

RESULTS OF OPERATIONS

Summary
Net income for the first quarter of 2009 was $741,000, which represented a decrease of $18,000 or 2% compared to the same period in 2008. Growth in net interest income and noninterest income was offset by a higher provision for loan losses and higher noninterest expense in the first quarter of 2009 compared to the same period in the prior year. Basic and diluted earnings per common share were $0.23 for both the first quarter of 2009 and the same quarter in 2008. The return on average assets and return on average shareholders' equity percentages were .65% and 5.62%, respectively, for the first quarter of 2009, compared to .65% and 5.66%, respectively, for the same period in 2008.

Dividends
Cash dividends of $390,000 or $0.12 per share were declared in the first quarter of 2009, compared to $550,000 or $0.17 per share in the first quarter of 2008. The cash dividend payout percentage was 53% for the first three months of 2009, compared to 72% in the same period a year ago.

Interest Income and Expense
Tables 1 and 2 on the following pages provide information regarding interest income and expense for the three-month periods ended March 31, 2009 and 2008, respectively. Table 1 documents ChoiceOne's average balances and interest income and expense, as well as the average rates earned or paid on assets and liabilities. Table 2 documents the effect on interest income and expense of changes in volume (average balance) and interest rates. These tables are referred to in the discussion of interest income, interest expense and net interest income.

Table 1 - Average Balances and Tax-Equivalent Interest Rates

Table 2 - Changes in Tax-Equivalent Net Interest Income

deposits increased $6.3 million in the first quarter of 2009 compared to the same quarter in the prior year. The impact of the savings deposit growth was offset by a 17 basis point drop in the average rate paid, which caused interest expense to decrease $7,000 in the first three months of 2009 compared to the same period in 2008. The average balance of certificates of deposit was down $4.5 million in the first quarter of 2009 compared to the same period in 2008. The average balance of local certificates was $7.1 million lower while the average balance of brokered certificates was $2.6 million higher in 2009 than in 2008. The decline in certificates of deposit plus a 148 basis point reduction in the average rate paid on certificates caused interest expense to fall $694,000 in 2009 compared to 2008. The average balance of advances from the Federal Home Loan Bank ("FHLB") was $6.5 million lower in the first three months of 2009 than in the same period of the prior year. The decline in FHLB advances, along with the effect of a 40 basis point decrease in the average rate paid, caused interest expense to decrease $107,000 in the first three months of 2009 compared to the same period in 2008. A small amount of growth in the average balance of other interest-bearing liabilities in the first quarter of 2009 compared to the first quarter of 2008 was offset by a 159 basis point drop in the average rate paid and caused an $80,000 decrease in interest expense.

ChoiceOne's net interest income spread was 3.80% in the first quarter of 2009, compared to 3.26% for the first quarter of 2008. The growth in the interest spread was due to a 128 basis point decrease in the average rate paid on interest-bearing liabilities in the first quarter of 2009 compared to the same quarter of 2008, which was partially offset by a drop in the average rate earned on interest-earning assets of 74 basis points. The reduction in the rate paid on liabilities was due in part to aggressive repricing of local deposits as general market interest rates fell during 2008 and the first quarter of 2009. The rate paid was also affected by wholesale funding, which repriced into lower interest rates at maturity. The decline in general market interest rates over the last twelve months also impacted the rates earned on interest-earning assets as the rates earned on new assets were less than the maturing assets that they replaced.

Provision and Allowance for Loan Losses
The allowance for loan losses has grown $459,000 from December 31, 2008 to March 31, 2009. The allowance growth occurred in spite of a decline in total loans of $7.0 million since the end of 2008. The provision for loan losses was $600,000 in the first quarter of 2009, compared to $550,000 in the same period in 2008. The allowance increase resulted from the provision for loan losses exceeding the net charge-offs in the first quarter of 2009 and was believed necessary due to continued concerns over the Michigan economy. The allowance for loan losses was 1.27% of total loans at March 31, 2009, compared to 1.10% at December 31, 2008 and 1.19% at March 31, 2008.

Charge-offs and recoveries for respective loan categories for the three months ended March 31 were as follows:

resulted from a $62,000 decline in overdraft charges in the first quarter of 2009 compared to the same period in 2008. The reduction in other noninterest income was primarily due to a $70,000 increase in losses on sales of other real estate properties.

Noninterest Expense
Total noninterest expense increased $225,000 or 6% in the first quarter of 2009 compared to the same period in 2008. Compensation and benefits expense was down slightly due to reductions in bonus accruals in 2009 compared to 2008. The increase in data processing expense was due to higher ATM processing costs in 2009, which was partially due to a bonus received upon signing of a new contract in the first quarter of 2008. The increase in FDIC insurance expense was due to a doubling of assessment rates in 2009 compared to 2008. The higher level of other noninterest expense in the first quarter of 2009 compared to the same period in 2008 resulted from an increase of $42,000 in costs of carrying other real estate properties and $55,000 of loan collection expenses.

In February 2009, the FDIC announced an amendment of its plan to restore the Deposit Insurance Fund. The FDIC adopted an interim rule imposing a 20 basis point emergency special assessment on deposits on June 30, 2009 with collection of the assessment to occur on September 30, 2009. An assessment of 20 basis points would cost the Bank approximately $700,000. Recent proposed legislative action, which would increase the FDIC's Treasury borrowing authority from $30 billion to $100 billion, would allow the FDIC to decrease the special assessment from 20 to 10 basis points. The interim rule also permitted an additional assessment after June 30, 2009 of up to 10 basis points if necessary to maintain public confidence in federal deposit insurance.

FINANCIAL CONDITION

Securities
The securities available for sale portfolio decreased $4.9 million from December 31, 2008 to March 31, 2009. Government agency and municipal securities totaling $4.0 million were purchased in the first three months of 2009 to replace maturities, principal repayments, and calls within the securities portfolio. Approximately $5.7 million in various securities were called or matured since the end of 2008. Principal repayments on securities totaled $1.0 million in the first three months of 2009. Approximately $2.7 million of securities were sold in the first quarter of 2009 for a net gain of $103,000.

Loans
The loan portfolio (excluding loans held for sale) declined $7.0 million from December 31, 2008 to March 31, 2009. Loan demand in the first quarter of 2009 has been sluggish due to the lackluster Michigan economy and reduced real estate values. Balances in all of ChoiceOne's loan categories were reduced since the end of 2008, with a decrease of $2.9 million in commercial real estate loans and $1.8 million in agricultural loans contributing most of the decline.

Information regarding impaired loans can be found in Note 2 to the consolidated financial statements included in this report. The total balance of loans classified as impaired has decreased from $7.7 million as of December 31, 2008 to $6.2 million as of March 31, 2009. The balance of loans with no allowance allocated decreased approximately $2.3 million in the first quarter of 2009 while the balance of loans with an allowance allocated increased $0.9 million. Part of the change in the loans with no allowance allocated resulted from the transfer of a $1.1 million loan to other real estate in the first quarter of 2009.

As part of its review of the loan portfolio, management also monitors the various nonperforming loans. Nonperforming loans are comprised of: (1) loans accounted for on a nonaccrual basis; (2) loans, not included in nonaccrual loans, which are contractually past due 90 days or more as to interest or principal payments; and (3) loans, not included in nonaccrual or loans past due 90 days or more, which are considered troubled debt restructurings.

The balances of these nonperforming loans were as follows:

At March 31, 2009, nonaccrual loans included $4.3 million in commercial industrial and commercial real estate loans and $3.1 million in residential real estate loans. At December 31, 2008, nonaccrual loans included $5.8 million in commercial industrial and commercial real estate loans and $2.5 million in residential real estate loans. Management believes the specific reserves allocated to its nonperforming loans are sufficient at March 31, 2009; however, management believes future credit deterioration is possible given the status of the Michigan economy.

Other Real Estate Owned
The balance of other real estate owned ("OREO") increased $610,000 from December 31, 2008 to March 31, 2009. Commercial and residential real estate loans totaling $1,266,000 were transferred into OREO during the first quarter of 2009 while sales of properties or payments upon them or write-downs of the value of other real estate properties were $656,000 for the same time period. Due to the current state of the Michigan economy, there may be continuing transfers from loans into OREO during the remainder of 2009. Management is continuing to work with borrowers in an attempt to mitigate potential losses for ChoiceOne.

Deposits and Borrowings
Total deposits increased $6.4 million from December 31, 2008 to March 31, 2009. Local deposits grew $4.9 million in the first quarter of 2009 and brokered certificates of deposit increased $1.5 million. Since the end of 2008, money market account balances have risen $5.6 million and savings account balances grew $3.3 million, in contrast to local certificates of deposit that declined $2.5 million. Management is continuing to emphasize growth in checking, money market, and savings accounts.

Federal Home Loan Bank advances decreased $13.5 million in the first quarter of 2009. Some maturing advances were replaced by growth in deposits during the first quarter. Other advances were paid off with funds provided from payments received from securities and loans. The $1.6 million decline in the balance of securities sold under agreements to repurchase was due to normal fluctuations in funds provided by bank customers. Certain securities are sold under agreements to repurchase them the following day or over a certain fixed term. Management plans to continue this practice as a low-cost source of funding.

Shareholders' Equity
Total shareholders' equity increased $650,000 from December 31, 2008 to March 31, 2009. Growth in equity resulted primarily from current year's net income, an increase in accumulated other comprehensive income, and proceeds from the sale of ChoiceOne's stock, offset by cash dividends paid. ChoiceOne did not repurchase any of its common stock in either the first quarter of 2009 or the first quarter of 2008. Shares of common stock may be repurchased in the future if management deems it to be a prudent use of capital.

Management reviews the capital levels of ChoiceOne and the Bank on a regular basis. The Board of Directors (the "Board") and management believe that the capital levels as of March 31, 2009 are adequate for the foreseeable future. However, due to the challenges caused by current economic conditions, the Board decided to reduce the quarterly dividend per share from $.17 per share paid in the fourth quarter of 2008 to $.12 per share paid in the first quarter of 2009.

Liquidity and Sensitivity to Interest Rates
Net cash provided from operating activities was $1.6 million for the three months ended March 31, 2009 compared to $.9 million provided in the same period a year ago. An increase in proceeds from sales of other real estate and a positive change in other liabilities was partially offset by increased gains on sales of securities and loans in 2009 compared to 2008. Net cash from investing activities was $10.9 million for the first quarter of 2009 compared to $3.4 million for the same period in 2008. More cash was provided from securities maturities, prepayments and calls and less cash was used for securities purchases in 2009 than in 2008. Net cash used in financing activities was $9.0 million in the quarter ended March 31, 2009 compared to $4.6 million in the same period in the prior year. The effect of a reduction in Federal Home Loan Bank advances was partially offset by more growth in deposits and a smaller decline in securities sold under agreements to repurchase in 2009 than in 2008.

Management believes that the current level of liquidity is sufficient to meet the Bank's normal operating needs. This belief is based upon the availability of deposits from both the local and national markets, maturities of securities, normal loan repayments, income retention, federal funds purchased from correspondent banks, and advances available from the Federal Home Loan Bank. The Bank also has a secured line of credit available from the Federal Reserve Bank.

The Bank's sensitivity to changes in interest rates is monitored by the Bank's Asset/Liability Management Committee ("ALCO"). ALCO uses a simulation model to subject rate-sensitive assets and liabilities to interest rate shocks. Assets and liabilities are subjected to an immediate 300 basis point shock up and down and the effect on net income and shareholders' equity is measured. The Bank's Interest Rate Risk Policy states that changes in interest rates cannot cause net interest income to decrease more than 10% and the market value of shareholders' equity to decrease more than 20% if rates are instantaneously shocked 200 basis points upward or downward. The rate shock computation as of March 31, 2009 increased net interest income 3% if rates rose 200 basis points and decreased net interest income 5% if rates fell 200 basis points. The economic value of shareholders' equity declined 10% when rates

were shocked 200 basis points upward and increased 13% if rates were shocked 200 basis points downward. The impact of these interest rate shocks is within the allowable policy limits established by ALCO. ALCO will continue to monitor the effect each month of changes in interest rates upon the Registrant's interest margin and financial condition.

Item 4T.  Controls and Procedures.

An evaluation was performed under the supervision and with the participation of the Registrant's management, including the Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Registrant's disclosure controls and procedures. Based on and as of the time of that evaluation, the Registrant's management, including the Chief Executive Officer and Principal Financial Officer, concluded that the Registrant's disclosure controls and procedures were effective as of the end of the period covered by this report to ensure that material information required to be disclosed in the reports that ChoiceOne files or submits under the Securities Exchange Act of 1934 (the "Exchange Act") is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be d isclosed in the reports that ChoiceOne files or submits under the Exchange Act is accumulated and communicated to management, including ChoiceOne's principal executive and principal financial officers as appropriate to allow for timely decisions regarding required disclosure. There was no change in the Registrant's internal control over financial reporting that occurred during the three months ended March 31, 2009 that has materially affected, or that is reasonably likely to materially affect, the Registrant's internal control over financial reporting.

PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings.

There are no material pending legal proceedings to which the Registrant or the Bank is a party to or to which any of their properties are subject, except for proceedings that arose in the ordinary course of business. In the opinion of management, pending or current legal proceedings will not have a material effect on the consolidated financial condition of the Registrant.

Item 1A.  Risk Factors.

There has been no material change in the risk factors reported in Item 1A of the Registrant's Annual Report on Form 10-K for the year ended December 31, 2008.

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

On January 22, 2009, the Registrant issued 1,321 shares of common stock, without par value, to the directors of the Registrant pursuant to the Directors' Stock Purchase Plan for an aggregate cash price of $11,000. The Registrant relied on the exemption contained in Section 4(6) of the Securities Act of 1933 in connection with these sales.

ISSUER PURCHASES OF EQUITY SECURITIES

There were no purchases of equity securities by the Registrant in the first quarter of 2009. As of March 31, 2009, there are 135,668 shares remaining that may yet be purchased under approved plans or programs. The repurchase plan was adopted and announced on July 21, 2004. There is no stated expiration date. The plan authorized the repurchase of up to 50,000 shares. The Registrant's Board of Directors authorized an additional repurchase plan on July 26, 2007. There is no stated expiration date and this plan authorized ChoiceOne to repurchase an additional 100,000 shares.

Item 3.  Defaults Upon Senior Securities.

None.

Item 4.  Submission of Matters to a Vote of Security Holders.

None.

Item 5.  Other Information.

None.

Item 6.  Exhibits

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

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

INDEX TO EXHIBITS

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