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.

This discussion and other sections of this quarterly report contain forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and ChoiceOne itself. Words such as "anticipates," "believes," "estimates," "expects," "forecasts," "intends," "is likely," "plans," "predicts," "projects," "may," "could," variations of such words and similar expressions are intended to identify such forward-looking statements. Management's determination of the provision and allowance for loan losses, the carrying value of goodwill and loan servicing rights, and the fair value of investment securities (including whether any impairment on any investment security is temporary or other than temporary) and management's assumptions concerning pension and other postretirement benefit plans involve judgments that are inherently forward-looking. All of the information concerning interest rate sensitivity is forward-looking. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("risk factors") that are difficult to predict with regard to timing, extent, likelihood, and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed, implied or forecasted in such forward-looking statements. Furthermore, ChoiceOne undertakes no obligation to update, amend, or clarify forward-looking statements, whether as a result of new information, future events, or otherwise.

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; 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 level and timing of asset growth; various other local and global uncertainties such as acts of terrorism and military actions; and current uncertainties and fluctuations in the financial markets and stocks of financial services providers due to concerns about capital and 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.

Summary

Net income for the first quarter of 2012 was $1,015,000, which represented an increase of $311,000 or 44% compared to the same period in 2011. Growth in net interest income and noninterest income and a reduction in the provision for loan losses were offset by higher noninterest expense in the first quarter of 2012 compared to the same period in the prior year. Basic and diluted earnings per common share were $0.31 for the first quarter of 2012, compared to $0.21 for the same quarter in 2012. The return on average assets and return on average shareholders' equity percentages were 0.81% and 6.97%, respectively, for the first quarter of 2012, compared to 0.58% and 5.16%, respectively, for the same period in 2011.

Dividends

Cash dividends of $395,000 or $0.12 per share were declared in the first quarter of 2012, compared to $393,000 or $0.12 per share in the first quarter of 2011. The cash dividend payout percentage was 39% for the first three months of 2012, compared to 56% 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, 2012 and 2011, 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



                                                                  Three Months Ended March 31,
                                                         2012                                      2011
                                          Average                                   Average
(Dollars in thousands)                    Balance       Interest        Rate        Balance       Interest        Rate
Assets:
Loans (1)                                $ 313,566     $    4,350        5.55 %    $ 314,835     $    4,554        5.79 %
Taxable securities (2) (3)                  85,155            503        2.36         64,061            400        2.50
Nontaxable securities (1) (2)               33,908            484        5.71         34,052            493        5.79
Other                                          358              5        5.59          3,747              6        0.64

Interest-earning assets                    432,987          5,342        4.93        416,695          5,453        5.23
Noninterest-earning assets                  65,597                                    68,884

Total assets                             $ 498,584                                 $ 485,579

Liabilities and Shareholders' Equity:
Interest-bearing demand deposits         $ 136,416            118        0.35 %    $ 122,633            132        0.43 %
Savings deposits                            47,213              9        0.08         44,042             14        0.13
Certificates of deposit                    145,991            485        1.33        160,063            642        1.60
Advances from Federal Home Loan Bank         8,444             76        3.60          8,470             76        3.59
Other                                       21,235             68        1.28         21,860             73        1.34

Interest-bearing liabilities               359,299            756        0.84        357,068            937        1.05

Noninterest-bearing demand deposits         77,151                                    68,960
Other noninterest-bearing liabilities        3,892                                     4,955

Total liabilities                          440,342                                   430,983
Shareholders' equity                        58,242                                    54,596

Total liabilities and shareholders'
equity                                   $ 498,584                                 $ 485,579

Net interest income (tax-equivalent
basis)- interest spread                                     4,586        4.09 %                       4,516        4.18 %

Tax-equivalent adjustment (1)                                (167 )                                    (171 )

Net interest income                                    $    4,419                                $    4,345

Net interest income as a percentage of
earning assets (tax-equivalent basis)                                    4.24 %                                    4.34 %

(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 34% for the periods presented.

(2) Includes the effect of unrealized gains or losses on securities.

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

Table 2 -Changes in Tax-Equivalent Net Interest Income



                                                           Three Months Ended March  31,
                                                                  2012 Over 2011
(Dollars in thousands)                                 Total            Volume           Rate
Increase (decrease) in interest income (1)
Loans (2)                                            $    (204 )       $    (18 )       $ (186 )
Taxable securities                                         103              237           (134 )
Nontaxable securities (2)                                   (9 )             (2 )           (7 )
Other                                                       (1 )            (39 )           38

Net change in tax-equivalent income                       (111 )            178           (289 )

Increase (decrease) in interest expense (1)
Interest-bearing demand deposits                           (14 )             71            (85 )
Savings deposits                                            (5 )              6            (11 )
Certificates of deposit                                   (157 )            (53 )         (104 )
Advances from Federal Home Loan Bank                         -               (1 )            1
Other                                                       (5 )             (2 )           (3 )

Net change in interest expense                            (181 )             21           (202 )

Net change in tax-equivalent net interest income     $      70         $    157         $  (87 )

(1) The volume variance is computed as the change in volume (average balance) multiplied by the previous year's interest rate. The rate variance is computed as the change in interest rate multiplied by the previous year's volume (average balance). The change in interest due to both volume and rate has been allocated to the volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

(2) Interest on nontaxable investment securities and loans has been adjusted to a fully tax-equivalent basis using an incremental tax rate of 34% for the periods presented.

Net Interest Income

The presentation of net interest income on a tax-equivalent basis is not in accordance with generally accepted accounting principles ("GAAP"), but is customary in the banking industry. This non-GAAP measure ensures comparability of net interest income arising from both taxable and tax-exempt loans and investment securities. The adjustments to determine net interest income on a tax-equivalent basis were $167,000 and $171,000 for the three months ended March 31, 2012 and 2011, respectively. These adjustments were computed using a 34% federal income tax rate.

As shown in Tables 1 and 2, tax-equivalent net interest income increased $70,000 in the first three months of 2012 compared to the same period in 2011. The relationship between growth in average interest-earning assets and a smaller amount of growth in average interest-bearing liabilities caused net interest income to increase $157,000 in the first quarter of 2012 compared to the same quarter in the prior year. A reduction of 9 basis points in the net interest spread from 4.18% in the first quarter of 2011 to 4.09% in the same quarter in 2012 resulted in an $87,000 decrease in net interest income.

The average balance of loans decreased $1.3 million in the first quarter of 2012 compared to the same period in 2011. Average commercial and industrial and commercial real estate loans were $3.9 million lower in the first quarter of 2012 than in the same quarter of 2011. This was offset by a $2.3 million increase in the average balance of consumer loans and $0.3 million increase in the average balance of residential real estate loans in the first quarter of 2012 compared to the same quarter in the prior year. The decrease in the average loans balance combined with a 24 basis point decrease in the average rate earned caused tax-equivalent interest income from loans to decline $204,000 in the first quarter of 2012 compared to the same period in the prior year. The average balance of total securities grew $21.0 million in the first three months of 2012 compared to the same period in 2011. Additional securities were purchased in the year of 2011 and in the first quarter of 2012 due to the declining balance in loans and to provide earning asset growth. The growth in securities, partially offset by the effect of lower interest rates earned, caused interest income to increase $94,000 in the first quarter of 2012 compared to the same quarter in 2011.

ChoiceOne's net interest income spread was 4.09% in the first quarter of 2012, compared to 4.18% for the first quarter of 2011. The decline in the interest spread was due to a 30 basis point decrease in the average rate earned on interest earning assets in the first quarter of 2012 compared to the same quarter in 2011, which was partially offset by a 21 basis point decrease in the average rate paid on interest-bearing liabilities. The reduction in the average rate earned on interest-earning assets was caused by relatively low general market rates which affected new loan originations and securities purchases in 2011 and the first quarter of 2012. Interest rates on loans are also being impacted by rate pressure from some of ChoiceOne's competing financial institutions. The lower rate paid on interest-bearing liabilities resulted from repricing of local deposits as general market interest rates remained low during 2011 and the first quarter of 2012.

Provision and Allowance for Loan Losses

Despite a reduction of $12.9 million in total loans since the end of 2011, the allowance for loan losses grew $123,000 from December 31, 2011 to March 31, 2012. The provision for loan losses was $825,000 in the first quarter of 2012, compared to $1,000,000 in the same period in 2011. Nonperforming loans were $7.4 million as of March 31, 2012, compared to $6.7 million as of December 31, 2011. The increase in nonperforming loans since the end of 2011 was primarily due to growth of $0.5 million in nonaccrual loans. The allowance for loan losses was 1.74% of total loans at March 31, 2012, compared to 1.63% at December 31, 2011 and 1.52% at March 31, 2011.

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

                                         2012                               2011
(Dollars in thousands)       Charge-offs       Recoveries       Charge-offs       Recoveries
Agricultural                $          -      $          1     $          -      $         -
Commercial and industrial              20               20                -                 4
Consumer                               71               66                97               66
Real estate, commercial               187                9               553               36
Real estate, residential              584               64               496               42

                            $         862     $        160     $       1,146     $        148

Net charge-offs in the first quarter of 2012 were $702,000, compared to $998,000 in the first quarter of 2011. Net charge-offs on an annualized basis as a percentage of average loans were 0.90% in the first three months of 2012 compared to 1.27% for the same period in the prior year. Management is aware that the economic climate in Michigan will continue to affect business and personal borrowers and may cause charge-offs to remain at heightened levels in future quarters. Management has worked and intends to continue to work with delinquent borrowers in an attempt to lessen the negative impact to ChoiceOne. As charge-offs, changes in the level of nonperforming loans, and changes within the composition of the loan portfolio occur throughout 2012, the provision and allowance for loan losses will be reviewed by the Bank's management and adjusted as necessary.

Total noninterest income increased $293,000 or 21% in the first quarter of 2012 compared to the same period in 2011. Growth of $235,000 in gains on sales of loans came from increased residential mortgage refinancing activity which supported $11.5 million of loan sales in the first quarter of 2012, compared to $6.7 million in the first quarter of 2011. An increase of $133,000 in gains on sales of securities resulted from more sales activity in the first three months of 2012 than in the same period of the prior year and higher percentage gains on sales due to the relatively low general market rates. Earnings on life insurance policies included $135,000 in the first quarter of 2012 from a death benefit received. The $131,000 increase in losses on sales and write-downs of other assets in the first quarter of 2012 compared to the same period in 2011 resulted from more write-downs of foreclosed properties.

Noninterest Expense

Total noninterest expense increased $148,000 or 4% in the first quarter of 2012 compared to the same period in 2011. The increase of $61,000 in salaries and benefits in the first quarter of 2012 compared to the same period in 2011 resulted from higher incentive bonus accruals, commission expense from mortgage loan originations, and health insurance costs. Growth of $43,000 in occupancy and equipment expense resulted from higher building rental expense and equipment repairs. Professional fees were $29,000 higher in the first three months of 2012 than in the same period in 2011 primarily as a result of an increase in consulting expenses. An increase of $52,000 in other noninterest expense in the first quarter of 2012 compared to the first quarter in the prior year was primarily caused by higher training costs and costs related to secondary market mortgage originations.

Income Tax Expense

Income tax expense was $257,000 in the first quarter of 2012 compared to $174,000 for the same quarter in 2011. The effective tax rate was 20.2% for 2012 and 19.8% for 2011.

Securities

The securities available for sale portfolio increased $12.1 million from December 31, 2011 to March 31, 2012. Various securities totaling $29.2 million were purchased in the first three months of 2012 to provide earning assets and to replace maturities, principal repayments, and calls within the securities portfolio. Approximately $11.9 million in various securities were called or matured since the end of 2011. Principal repayments on securities totaled $0.7 million in the first three months of 2012. Approximately $3.7 million of securities were sold in the first quarter of 2012 for a net gain of $169,000.

Loans

The loan portfolio (excluding loans held for sale) declined $12.9 million from December 31, 2011 to March 31, 2012. Loan demand in the first quarter of 2012 was sluggish due to the lackluster Michigan economy and reduced real estate values. Balances in all loan categories except for residential mortgage loans declined since the end of 2011, with a decrease of $9.7 million in agricultural loans and $2.7 million in commercial and industrial loans contributing most of the decline. Much of the decrease in agricultural loans in the first quarter of 2012 resulted from seasonal pay-downs on lines of credit.

Information regarding impaired loans can be found in Note 3 to the consolidated financial statements included in this report. The total balance of loans classified as impaired increased from $4.5 million as of December 31, 2011 to $5.1 million as of March 31, 2012. The balance of commercial real estate loans classified as impaired grew by $0.6 million in the first quarter. Changes in the balance of nonaccrual loans and loans considered troubled debt restructured in the first quarter of 2012 impacted both loan categories.

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.

                                                             March 31,          December
(Dollars in thousands)                                         2012             31, 2011
Loans accounted for on a nonaccrual basis                   $     4,692        $    4,155
Accruing loans contractually past due 90 days or more
as to principal or interest payments                                 11                70
Loans considered troubled debt restructurings                     2,652             2,448

Total                                                       $     7,355        $    6,673

At March 31, 2012, nonaccrual loans included $3.1 million in commercial real estate loans, $1.3 million in residential real estate loans, and $0.3 million in commercial and industrial loans. At December 31, 2011, nonaccrual loans included $2.8 million in commercial real estate loans, $1.2 million in residential real estate loans, and $0.1 million in commercial and industrial loans. The increase in nonaccrual loans was due to loans transferred into nonaccrual status in the first quarter of 2012. Management believes the allowance allocated to its nonperforming loans is sufficient at March 31, 2012; 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") decreased $426,000 from December 31, 2011 to March 31, 2012. Only $15,000 of residential real estate loans were transferred into OREO during the first quarter of 2012 while sales of properties or payments upon them or write-downs of the value of other real estate properties were $441,000 for the same time period. Due to the current state of the Michigan economy, management believes there will be continuing transfers from loans into OREO during the remainder of 2012. The OREO balance may also be affected by troubled debt restructurings in future quarters as loans can be restructured as an alternative to foreclosure. Management is continuing to work with borrowers in an attempt to mitigate potential losses for ChoiceOne.

Deposits and Borrowings

Total deposits increased $9.5 million from December 31, 2011 to March 31, 2012. Local deposits provided all of the growth in the first quarter of 2012 as the balance of nonlocal deposits was unchanged. Since the end of 2011, money market account balances have risen $15.5 million and noninterest-bearing checking and savings deposits have both grown $2.0 million. Local certificates of deposit decreased $9.8 million in the first quarter of 2012 as management emphasized growth in checking, money market, and savings accounts.

A decline of $2.9 million in repurchase agreements in the first quarter of 2012 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. Federal Home Loan Bank advances decreased $7,000 in the first quarter of 2012 due to payments on an amortizing advance.

Shareholders' Equity

Total shareholders' equity increased $339,000 from December 31, 2011 to March 31, 2012. Growth in equity resulted from current year's net income and proceeds from the sale of ChoiceOne stock, offset by a decrease in accumulated other comprehensive income and cash dividends paid.

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

                                                                                      Total
                                                                                      Risk-
                                                    Leverage          Tier 1          Based
(Dollars in thousands)                               Capital         Capital         Capital
Capital balances at March 31, 2012                  $  39,720        $ 39,720        $ 43,667
Required regulatory capital to be considered
"well capitalized"                                     23,963          19,980          33,300
Capital in excess of "well capitalized" minimum        15,757          19,740          10,367
Capital ratios at March 31, 2012                         8.29 %         11.93 %         13.11 %
Regulatory capital ratios - minimum requirement
to be considered "well capitalized"                      5.00 %          6.00 %         10.00 %

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, 2012 are adequate for the foreseeable future. The Board's determination of appropriate cash dividends for future periods will be based on market conditions and ChoiceOne's requirements for cash and capital.

Net cash provided from operating activities was $3.1 million for the three months ended March 31, 2012 compared to $2.6 million provided in the same period a year ago. Higher proceeds from loan sales were offset by higher loans . . .