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

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

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

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

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

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

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

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


	Location and Amount of Gain or (Loss)										Location and Amount of Gain or (Loss)
	Recognized in Income on Fair Value and Cash Flow Hedging Relationships										Recognized in Income on Fair Value and Cash Flow Hedging Relationships
	Three months ended September 30, 2024					Three months ended September 30, 2023					Nine months ended September 30, 2024					Nine months ended September 30, 2023
(Dollars in thousands)	Interest Income			Interest Expense		Interest Income			Interest Expense		Interest Income			Interest Expense		Interest Income			Interest Expense
Total amounts of income and expense line items presented in the consolidated statements of income in which the effects of fair value or cash flow hedges are recorded	$	1,180		$	1,327	$	(30	)	$	-	$	2,038		$	2,301	$	(534	)	$	-

Gain or (loss) on fair value hedging relationships:
Interest rate contracts:
Hedged items	$	9,827		$	-	$	(9,189	)	$	-	$	2,841		$	-	$	(9,920	)	$	-
Derivatives designated as hedging instruments	$	(9,665	)	$	-	$	9,097		$	-	$	(2,720	)	$	-	$	9,842		$	-
Amount excluded from effectiveness testing recognized in earnings based on amortization approach	$	-		$	-	$	-		$	-	$	-		$	-	$	-		$	-

Gain or (loss) on cash flow hedging relationships:
Interest rate contracts:
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income	$	-		$	-	$	(897	)	$	-	$	(1,092	)	$	-	$	(1,940	)	$	-
Amount excluded from effectiveness testing recognized in earnings based on amortization approach	$	-		$	-	$	-		$	-	$	-		$	-	$	-		$	-

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

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


	September 30, 2024
(Dollars in thousands)	Notional Amount		Balance Sheet Location	Fair Value
Derivative assets
Interest rate swaps	$	42,647	Other Assets	$	1,331
Derivative liabilities
Interest rate swaps	$	42,647	Other Liabilities	$	1,331

	December 31, 2023
(Dollars in thousands)	Notional Amount		Balance Sheet Location	Fair Value
Derivative assets
Interest rate swaps	$	-	Other Assets	$	-
Derivative liabilities
Interest rate swaps	$	-	Other Liabilities	$	-

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

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

NOTE 9 – Borrowings

Federal Home Loan Bank Advances


(Dollars in thousands)	September 30, 2024		December 31, 2023

Maturity of July 2025 with fixed interest rate of 4.88%	$	20,000	$	20,000
Maturity of January 2026 with fixed interest rate of 4.35%		10,000		-
Maturity of December 2026 with fixed interest rate of 4.20%		10,000		10,000
Total advances outstanding at period end	$	40,000	$	30,000

Bank Term Funding Program (“BTFP”)


(Dollars in thousands)	September 30, 2024		December 31, 2023

Maturity of May 2024 with fixed interest rate of 4.71%	$	-	$	160,000
Maturity of December 2024 with fixed interest rate of 4.83%		-		10,000
Maturity of January 2025 with fixed interest rate of 4.76%		170,000
Total BTFP outstanding at period end	$	170,000	$	170,000

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

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

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

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