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MACATAWA BANK CORP - Quarter Report: 2011 March (Form 10-Q)

Macatawa Bank Form 10-Q - 04/28/11

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

OR

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission file number: 000-25927

MACATAWA BANK CORPORATION
(Exact name of registrant as specified in its charter)

 

Michigan

 

38-3391345

 

 

(State of other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

 

 

 

 

 

 

 

10753 Macatawa Drive, Holland, Michigan 49424

 

 

(Address of principal executive offices)  (Zip Code)

 

 

 

 

 

Registrant's telephone number, including area code: (616) 820-1444
__________________

 

Indicate by check whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes [X]  No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [  ] No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer [   ]      Accelerated filer [   ]      Non-accelerated filer [ ]      Smaller reporting company [X]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

The number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 17,679,621 shares of the Company's Common Stock (no par value) were outstanding as of April 28, 2011.




Forward-Looking Statements

This report contains forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and Macatawa Bank Corporation. Forward-looking statements are identifiable by words or phrases such as "outlook", "plan" or "strategy" that an event or trend "may", "should", "will", "is likely", or is "probably" to occur or "continue", has "begun" or "is scheduled" or "on track" or that the Company or its management "anticipates", "believes", "estimates", "plans", "forecasts", "intends", "predicts", "projects", or "expects" a particular result, or is "committed", "confident", "optimistic" or has an "opinion" that an event will occur, or other words or phrases such as "ongoing", "future", "signs", "efforts", "tend", "exploring", "appearing", "until", "near term", "going forward", "starting" and variations of such words and similar expressions. Such statements are based upon current beliefs and expectations and involve substantial risks and uncertainties which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These statements include, among others, statements related to trends in credit quality metrics, real estate valuation, future levels of non-performing loans, future levels of loan charge-offs, future levels of provisions for loan losses, the rate of asset dispositions, capital raising activities, dividends, future growth and funding sources, future liquidity levels, future profitability levels, the effects on earnings of changes in interest rates and the future level of other revenue sources. Management's determination of the provision and allowance for loan losses, the appropriate carrying value of intangible assets (including goodwill, mortgage servicing rights and deferred tax assets) and other real estate owned, and the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary and the amount of any impairment) involves judgments that are inherently forward-looking. All statements with references to future time periods are forward-looking. All of the information concerning interest rate sensitivity is forward-looking. Our ability to fully comply with our Consent Order and Written Agreement, raise capital, improve regulatory capital ratios, sell other real estate owned at its carrying value or at all, successfully implement new programs and initiatives, increase efficiencies, address regulatory issues, improve internal controls over financial reporting, maintain our current level of deposits and other sources of funding, maintain liquidity, respond to declines in collateral values and credit quality, increase loan volume, maintain mortgage banking income, realize the benefit of our deferred tax assets, resume payment of dividends and improve profitability is not entirely within our control and is not assured. The future effect of changes in the real estate, financial and credit markets and the national and regional economy on the banking industry, generally, and Macatawa Bank Corporation, specifically, are also inherently uncertain. 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, extend, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. Macatawa Bank Corporation does not undertake to update forward-looking statements to reflect the impact of circumstances or events that may arise after the date of the forward-looking statements.

Risk factors include, but are not limited to, the risk factors described in "Item 1A - Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2010. These and other factors are representative of the risk factors that may emerge and could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.






INDEX

 

 

Page
Number

 

 

 

Part I.

Financial Information:

 

 

 

 

 

Item 1.

 

 

Consolidated Financial Statements

4

 

Notes to Consolidated Financial Statements

9

 

 

 

 

Item 2.

 

 

Management's Discussion and Analysis of

 

 

Financial Condition and Results of Operations

35

 

 

 

 

Item 4.

 

 

Controls and Procedures

48

 

 

 

Part II.

Other Information:

 

 

 

 

 

Item 1.

 

 

Legal Proceedings

48

 

 

 

 

Item 3.

 

 

Defaults Upon Senior Securities

48

 

 

 

 

Item 6.

 

 

Exhibits

49

 

 

 

Signatures

51






Table of Contents

Part I Financial Information
Item 1.

MACATAWA BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
As of March 31, 2011 (unaudited) and December 31, 2010

 

(dollars in thousands)

March 31,
2011

 

December 31,
2010

 

ASSETS

 

 

 

 

 

 

   Cash and due from banks

$

24,265

 

$

21,274

 

   Federal funds sold and other short-term investments

 

238,362

 

 

214,853

 

      Cash and cash equivalents

 

262,627

 

 

236,127

 

   Securities available for sale, at fair value

 

12,660

 

 

9,120

 

   Securities held to maturity (fair value 2010 - $83)

 

---

 

 

83

 

   Federal Home Loan Bank stock

 

11,932

 

 

11,932

 

   Loans held for sale, at fair value

 

942

 

 

2,537

 

   Total loans

 

1,153,992

 

 

1,217,196

 

   Allowance for loan losses

 

(42,343

)

 

(47,426

)

      Net loans

 

1,111,649

 

 

1,169,770

 

   Premises and equipment - net

 

56,410

 

 

56,988

 

   Accrued interest receivable

 

3,721

 

 

3,845

 

   Bank-owned life insurance

 

25,229

 

 

25,014

 

   Other real estate owned

 

64,992

 

 

57,984

 

   Other assets

 

7,073

 

 

4,861

 

      Total assets

$

1,557,235

 

$

1,578,261

 

LIABILITIES AND SHAREHOLDERS' EQUITY

 

 

 

 

 

 

   Deposits

 

 

 

 

 

 

      Noninterest-bearing

$

282,050

 

$

255,897

 

      Interest-bearing

 

982,615

 

 

1,020,723

 

         Total deposits

 

1,264,665

 

 

1,276,620

 

   Other borrowed funds

 

174,270

 

 

185,336

 

   Long-term debt

 

41,238

 

 

41,238

 

   Subordinated debt

 

1,650

 

 

1,650

 

   Accrued expenses and other liabilities

 

6,259

 

 

5,575

 

         Total liabilities

 

1,488,082

 

 

1,510,419

 

   Commitments and contingent liabilities

 

---

 

 

---

 

   Shareholders' equity

 

 

 

 

 

 

      Preferred stock, no par value, 500,000 shares authorized;
         Series A Noncumulative Convertible Perpetual  Preferred Stock, liquidation
            value of $1,000 per share, 31,290 shares issued and outstanding

 



30,604

 

 



30,604

 

         Series B Noncumulative Convertible Perpetual Preferred Stock, liquidation
            value of $1,000 per share, 2,600 shares issued and outstanding

 


2,560

 

 


2,560

 

      Common stock, no par value, 200,000,000 shares authorized; 17,679,621 shares
         issued and outstanding

 


167,338

 

 


167,321

 

      Retained deficit

 

(131,363

)

 

(132,654

)

      Accumulated other comprehensive income

 

14

 

 

11

 

         Total shareholders' equity

 

69,153

 

 

67,842

 

            Total liabilities and shareholders' equity

$

1,557,235

 

$

1,578,261

 


 


- 4 -


Table of Contents

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three Month Periods Ended March 31, 2011 and 2010 (unaudited)

 

(dollars in thousands, except per share data)

Three Months
Ended
March 31, 2011

 

Three Months
Ended
March 31, 2010

 

Interest income

 

 

 

 

 

 

   Loans, including fees

$

15,582

 

$

19,623

 

   Securities

 

27

 

 

1,191

 

   FHLB Stock

 

76

 

 

62

 

   Federal funds sold and other short-term investments

 

168

 

 

61

 

      Total interest income

 

15,853

 

 

20,937

 

Interest expense

 

 

 

 

 

 

   Deposits

 

2,912

 

 

5,408

 

   Debt and other borrowed funds

 

1,343

 

 

2,501

 

      Total interest expense

 

4,255

 

 

7,909

 

Net interest income

 

11,598

 

 

13,028

 

Provision for loan losses

 

(1,450

)

 

19,710

 

Net interest income (loss) after provision for loan losses

 

13,048

 

 

(6,682

)

Noninterest income

 

 

 

 

 

 

   Service charges and fees

 

949

 

 

1,065

 

   Net gains on mortgage loans

 

435

 

 

181

 

   Trust fees

 

651

 

 

890

 

   ATM and debit card fees

 

852

 

 

785

 

   Other

 

792

 

 

547

 

      Total noninterest income

 

3,679

 

 

3,468

 

Noninterest expense

 

 

 

 

 

 

   Salaries and benefits

 

5,347

 

 

5,450

 

   Occupancy of premises

 

1,011

 

 

1,052

 

   Furniture and equipment

 

817

 

 

981

 

   Legal and professional

 

270

 

 

769

 

   Marketing and promotion

 

224

 

 

215

 

   Data processing

 

304

 

 

346

 

   FDIC assessment

 

978

 

 

1,257

 

   ATM and debit card processing

 

271

 

 

310

 

   Bond and D&O Insurance

 

379

 

 

548

 

   Losses on repossessed and foreclosed properties

 

2,493

 

 

3,643

 

   Administration of problem assets

 

1,941

 

 

1,892

 

   Other

 

1,401

 

 

1,463

 

      Total noninterest expenses

 

15,436

 

 

17,926

 

Net income (loss) before income tax

 

1,291

 

 

(21,140

)

Income tax expense (benefit)

 

0

 

 

0

 

Net income (loss)

 

1,291

 

 

(21,140

)

Dividends declared on preferred shares

 

0

 

 

0

 

Net income (loss) available to common shares

$

1,291

 

$

(21,140

)

Basic earnings (loss) per common share

$

.07

 

$

(1.19

)

Diluted earnings (loss) per common share

$

.07

 

$

(1.19

)

Cash dividends per common share

$

0.00

 

$

0.00

 


 


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Table of Contents

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three Month Periods Ended March 31, 2011 and 2010
(unaudited)

 

(dollars in thousands)

Three Months
Ended
March 31, 2011

 

Three Months
Ended
March 31, 2010

 

Net income (loss)

$

1,291

 

$

(21,140

)

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

   Net change in unrealized gains on securities available for sale

 

3

 

 

38

 

Comprehensive income (loss)

$

1,294

 

$

(21,102

)








 


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Table of Contents

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Three Month Periods Ended March 31, 2011 and 2010
(unaudited)

 

(dollars in thousands, except per share data)


Preferred Stock

 

Common
Stock

 

Retained
Deficit

 

Accumulated
Other
Comprehensive
Income (Loss)

 

Total
Shareholders'
Equity

 

 

Series A

 

Series B

 

 

 

 

 

Balance, January 1, 2010

$30,604

 

$2,560

 

$167,183

 

$(114,800

)

$2,444

 

$87,991

 

Net loss for three months ended March 31, 2010

 

 

 

 

 

 

(21,140

)

 

 

(21,140

)

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

   Net change in unrealized gain (loss) on securities
      available for sale

 

 

 

 

 

 

 

 


38

 


38

 

         Comprehensive loss

 

 

 

 

 

 

 

 

 

 

(21,102

)

Stock compensation expense

 

 

 

 

28

 

 

 

 

 

28

 

Balance, March 31, 2010

$30,604

 

$2,560

 

$167,211

 

$(135,940

)

$2,482

 

$66,917

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, January 1, 2011

$30,604

 

$2,560

 

$167,321

 

(132,654

)

$     11

 

67,842

 

Net income for three months ended March 31, 2011

 

 

 

 

 

 

1,291

 

 

 

1,291

 

Other comprehensive income (loss), net of tax:

 

 

 

 

 

 

 

 

 

 

 

 

   Net change in unrealized gain (loss) on securities
      available for sale

 

 

 

 

 

 

 

 


3

 


3

 

         Comprehensive income

 

 

 

 

 

 

 

 

 

 

1,294

 

Stock compensation expense

 

 

 

 

17

 

 

 

 

 

17

 

Balance, March 31, 2011

$30,604

 

$2,560

 

$167,338

 

$(131,363

)

$     14

 

$69,153

 







 


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Table of Contents

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Month Periods Ended March 31, 2011 and 2010 (unaudited)

 

(dollars in thousands)

Three Months
Ended
March 31, 2011

 

Three Months
Ended
March 31, 2010

 

Cash flows from operating activities

 

 

 

 

 

 

   Net income (loss)

$

1,291

 

$

(21,140

)

   Adjustments to reconcile net income (loss) to net cash from
      operating activities:

 

 

 

 

 

 

         Depreciation and amortization

 

781

 

 

896

 

         Stock compensation expense

 

17

 

 

28

 

         Provision for loan losses

 

(1,450

)

 

19,710

 

         Origination of loans for sale

 

(16,671

)

 

(9,744

)

         Proceeds from sales of loans originated for sale

 

18,701

 

 

9,052

 

         Net gains on mortgage loans

 

(435

)

 

(181

)

         Write-down of other real estate

 

2,699

 

 

3,516

 

         Net (gain) loss on sales of other real estate

 

(212

)

 

120

 

         Decrease (increase) in accrued interest receivable and other assets

 

(2,157

)

 

80

 

         Earnings in bank-owned life insurance

 

(215

)

 

(200

)

         Increase (decrease) in accrued expenses and other liabilities

 

684

 

 

(473

)

               Net cash from operating activities

 

3,033

 

 

1,664

 

Cash flows from investing activities

 

 

 

 

 

 

   Loan originations and payments, net

 

45,092

 

 

41,204

 

   Purchases of securities available for sale

 

(10,549

)

 

0

 

   Proceeds from:

 

 

 

 

 

 

         Maturities and calls of securities available for sale

 

6,988

 

 

13,986

 

         Principal paydowns on securities

 

85

 

 

82

 

         Sales of other real estate

 

4,984

 

 

5,711

 

   Additions to premises and equipment

 

(112

)

 

(201

)

               Net cash from investing activities

 

46,488

 

 

60,782

 

Cash flows from financing activities

 

 

 

 

 

 

   Net decrease in in-market deposits

 

(6,360

)

 

(3,505

)

   Net decrease in brokered deposits

 

(5,595

)

 

(42,065

)

   Proceeds from other borrowed funds

 

---

 

 

20,000

 

   Repayments of other borrowed funds

 

(11,066

)

 

(66,020

)

               Net cash from financing activities

 

(23,021

)

 

(91,590

)

Net change in cash and cash equivalents

 

26,500

 

 

(29,144

)

Cash and cash equivalents at beginning of period

 

236,127

 

 

78,749

 

Cash and cash equivalents at end of period

$

262,627

 

$

49,605

 

Supplemental cash flow information

 

 

 

 

 

 

      Interest paid

$

3,950

 

$

7,805

 

Supplemental noncash disclosures:

 

 

 

 

 

 

      Transfers from loans to other real estate

 

14,479

 

 

17,954

 


 


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Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The accompanying consolidated financial statements include the accounts of Macatawa Bank Corporation ("the Company", "our", "we") and its wholly-owned subsidiary, Macatawa Bank ("the Bank").  All significant intercompany accounts and transactions have been eliminated in consolidation. 

Macatawa Bank is a Michigan chartered bank with depository accounts insured by the Federal Deposit Insurance Corporation.  The Bank operates 26 full service branch offices providing a full range of commercial and consumer banking and trust services in Kent County, Ottawa County, and northern Allegan County, Michigan.

The Company owns all of the common stock of Macatawa Statutory Trust I and Macatawa Statutory Trust II.  These are grantor trusts that issued trust preferred securities and are not consolidated with the Company under accounting principles generally accepted in the United States of America.

Basis of Presentation:The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  In the opinion of management, all adjustments (consisting only of normal recurring accruals) believed necessary for a fair presentation have been included. 

Operating results for the three month period ended March 31, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.  For further information, refer to the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2010.

Reclassifications:  Some items in the prior period financial statements were reclassified to conform to the current presentation.

Adoption of New Accounting Standards:

In July 2010, FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The ASU amends FASB Accounting Standards Codification™ Topic 310, Receivables, to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate, by portfolio segment or class of financing receivable, certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses.  For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010 and have been added to Note 3. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010 and have been added to Note 3.   

In January 2010, the FASB issued ASU 2010-06, Improving Disclosure about Fair Value Measurements. This standard requires new disclosures on the amount and reason for transfers in and out of Level 1 and Level 2 recurring fair value measurements. The standard also requires disclosure of activities (i.e., on a gross basis), including purchases, sales, issuances, and settlements, in the reconciliation of Level 3 fair value recurring measurements. The standard clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. The new disclosures regarding Level 1 and Level 2 fair value measurements and clarification of existing disclosures are effective for periods beginning after December 15, 2009. The disclosures about the reconciliation of information in Level 3 recurring fair value measurements are required for periods beginning after December 15, 2010. Adoption of this standard did not have a significant impact on our quarterly disclosures. 


 


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Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Newly Issued Not Yet Effective Accounting Standards: 

The FASB has issued ASU 2011-02,  A Creditor's Determination of Whether a Restructuring Is a Troubled Debt Restructuring (April 2011).  This ASU provides guidance for companies when determining whether a loan modification is a troubled debt restructuring.  The ASU also provides additional disclosure requirements.  It is effective for public companies for interim and annual periods beginning on or after June 15, 2011. The guidance is to be applied retrospectively to restructurings occurring on or after the beginning of the fiscal year of adoption.  This guidance is not expected to have a material effect on our identification of troubled debt restructurings or disclosures.

Regulatory Developments:

Consent Order with Macatawa Bank and its Regulators

As discussed in our Annual Report on Form 10-K for the year ended December 31, 2010 (our "2010 Form 10-K"), on February 22, 2010, Macatawa Bank entered into a Consent Order (the "Consent Order") with the Federal Deposit Insurance Corporation ("FDIC") and the Michigan Office of Financial and Insurance Regulation ("OFIR"), the primary banking regulators of the Bank.  The Bank agreed to the terms of the negotiated Consent Order without admitting or denying any charges of unsafe or unsound banking practices.  The Consent Order imposes no fines or penalties on the Bank.  The Consent Order will remain in effect and enforceable until it is modified, terminated, suspended, or set aside by the FDIC and the OFIR.  The requirements of the Consent Order are summarized in our 2010 Form 10-K. 

The Consent Order covers various aspects of the Bank's financial condition and performance; loan administration; and capital planning.

The Consent Order requires the Bank to have and maintain a Tier 1 Leverage Capital Ratio of at least 8% and a Total Risk Based Capital Ratio of at least 11%.  At March 31, 2011, the Bank's Tier 1 Leverage Capital Ratio was 7.1% and the Total Risk Based Capital Ratio was 10.4%, which would ordinarily categorize the Bank as "well capitalized" under the regulatory capital standards absent the Consent Order.  The Bank needed a capital injection of approximately $14.0 million as of March 31, 2011 to comply with the Tier 1 Leverage Capital Ratio requirement and needed a capital injection of approximately $7.1 million to comply with the Total Risk Based Capital Ratio requirement of the Consent Order.  This has declined significantly since March 31, 2010, when the Company needed $43.2 million to comply with the Tier 1 Leverage Capital Ratio requirement.

The Company has developed a capital plan including evaluation of alternatives to reach and maintain the capital levels required by the Consent Order.  Achievement of these capital levels could be impacted, positively or negatively, by certain uncertainties, including, but not limited to, earnings levels, changing economic conditions, asset quality, property values and the receptiveness of capital markets to new capital offerings of the Company.

Strategies to increase the Bank's regulatory capital ratios in order to comply with the capital requirements of the Consent Order include reducing operating costs, shrinking assets of the Bank without weakening its liquidity position, preserving capital through suspension of dividends, and raising additional capital.  More information regarding these strategies is included in our 2010 Form 10-K.

The Company earlier increased its capital through the sale of $31.3 million of Series A Preferred Stock in the fourth quarter of 2008.  During second and third quarters of 2009, the Company increased its capital by $5.9 million through the issuance of Series B Preferred Stock, common stock and subordinated debt.

The Company also remains active at exploring alternatives to raise new capital.  In February 2011, the Company filed a registration statement with the Securities and Exchange Commission to offer shares of common stock in a rights offering and a public offering in order to raise equity capital. On March 25, 2011, the Company's shareholders approved an increase in authorized common shares from 40 million to 200 million.

We believe that, as of March 31, 2011, the Bank was in compliance in all material respects with all of the provisions of the Consent Order, other than the minimum capital requirements.

 


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MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Written Agreement with Macatawa Bank Corporation and its Regulator

As discussed in our 2010 Form 10-K, the Company formally entered into a Written Agreement with the Federal Reserve Bank of Chicago ("FRB") effective July 23, 2010.  Among other things, the Written Agreement provides that: (i) the Company must take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to Macatawa Bank; (ii) the Company may not declare or pay any dividends without prior FRB approval; (iii) the Company may not take dividends or any other payment representing a reduction in capital from Macatawa Bank without prior FRB approval; (iv) the Company may not make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior FRB approval; (v) the Company may not incur, increase or guarantee any debt without prior FRB approval; (vi) the Company may not purchase or redeem any shares of its stock without prior FRB approval; (vii) the Company must submit to the FRB an acceptable written plan to maintain sufficient capital on a consolidated basis; (viii) must submit to the FRB a written statement of the Company's planned sources and uses of cash for debt service, operating expenses, and other purposes for 2010 and subsequent years; and (ix) the Company may not appoint any new director or senior executive officer, or change the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, without prior regulatory approval.

The Company requested and received approval from the FRB to make its first quarter 2011 interest payments on its $1.65 million in outstanding subordinated debt.  Each quarter, the Company requests approval from the FRB to make the next quarter's interest payment on its subordinated debt and is continuing to accrue the amounts due.

Since the effective date of the Written Agreement, we have submitted our capital plan, cash flow projections and other reports in accordance with the timelines specified in the Written Agreement or agreed upon extensions.  In addition, our senior management has met with and spoken to FRB representatives several times since the Written Agreement became effective.  On November 15, 2010, we submitted a plan to maintain sufficient capital and have had several conversations with the FRB regarding the plan since that time.  At the FRB's request, we submitted an updated draft of the capital plan on March 31, 2011, with the final plan to be submitted by April 30, 2011.  On February 11, 2011, we submitted to the FRB a written statement of the Company's planned sources and uses of cash for 2011.  At the FRB's request, we submitted a plan for how the Company will meet its cash flow obligations for 2011 on March 31, 2011.

Other than acceptance by the FRB of a capital plan and a plan for meeting cash flow obligations for 2011, the Company believes that, as of March 31, 2011, it was in compliance in all material respects with all of the provisions of the Written Agreement.

Deposit Gathering Activities

Because the Bank is subject to the Consent Order, it cannot be categorized as "well-capitalized," regardless of actual capital levels.  As a result, the Bank is subject to the following restrictions regarding its deposit gathering activities:

 

Effective January 1, 2010, the interest rate paid for deposits by institutions that are categorized as less than "well capitalized" is limited to 75 basis points above the national rate for similar products unless the institution can support to the FDIC that prevailing rates in its market area exceed the national average.  During the first quarter of 2010, the Company received notification from the FDIC that the prevailing rates in our market area exceeded the national average.  Accordingly, the interest rates paid for deposits by the Bank are limited to 75 basis points above the average rate for similar products within our market area. Although this may impact our ability to compete for more rate sensitive deposits, we expect to continue to reduce our need to utilize rate sensitive deposits.

 

 

 

 

The Bank cannot accept, renew or rollover any brokered deposit unless it has applied for and been granted a waiver of this prohibition by the FDIC.  The Bank has not accepted or renewed brokered deposits since November of 2008.  The Bank expects it will be able to fund maturing brokered deposits under its current liquidity contingency program.


 


- 11 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Allowance for Loan Losses:  The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and recoveries, and decreased by charge-offs of loans.  Management believes the allowance for loan losses balance to be adequate based on known and inherent risks in the portfolio, past loan loss experience, information about specific borrower situations and estimated collateral values, economic conditions and other factors.  Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off.  Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.

The allowance consists of specific and general components.  The specific component relates to loans that are individually classified as impaired.  The general component covers non-classified loans and is based on historical loss experience adjusted for current qualitative environmental factors.  The Company maintains a loss migration analysis that tracks loan losses and recoveries based on loan class as well as the loan risk grade assignment for commercial loans.  At March 31, 2011, an 18 month annualized historical loss experience was used for commercial loans and a 12 month historical loss experience period was applied to residential mortgage and consumer loan portfolios.  These historical loss percentages are adjusted (both upwards and downwards) for certain qualitative environmental factors, including economic trends, credit quality trends, valuation trends, concentration risk, quality of loan review, changes in personnel, external factors and other considerations.

A loan is impaired when, based on current information and events, it is believed to be probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Loans for which the terms have been modified and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.

Commercial and commercial real estate loans with relationship balances exceeding $500,000 and an internal risk grading of 6 or worse are evaluated for impairment.  If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan's existing interest rate or at the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral.  Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans are collectively evaluated for impairment and, accordingly, they are not separately identified for impairment disclosures.  Troubled debt restructurings are also considered impaired with impairment generally measured at the present value of estimated future cash flows using the loan's effective rate at inception or using the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral.

Foreclosed Assets:  Assets acquired through or instead of loan foreclosure, primarily other real estate owned, are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.  If fair value declines, a valuation allowance is recorded through expense.  Costs after acquisition are expensed unless they add value to the property.

Income Taxes:  Income tax expense is the sum of the current year income tax due or refundable and the change in deferred tax assets and liabilities.  Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates.  A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

We recognize a tax position as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur.  The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination.  For tax positions not meeting the "more likely than not" test, no tax benefit is recorded.  We recognize interest and penalties related to income tax matters in income tax expense.

 


- 12 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The realization of deferred tax assets (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years.  In assessing the need for a valuation allowance, we consider all relevant positive and negative evidence, including taxable income in carry-back years, scheduled reversals of deferred tax liabilities, expected future taxable income and tax planning strategies. 

As of January 1, 2010, we no longer have the ability to carryback losses to prior years.  The realization of our deferred tax assets is largely dependent on generating income in future years.  At March 31, 2011, the need to maintain a full valuation allowance was based primarily on our net operating losses for in recent years and the continuing weak economic conditions that could impact our ability to generate future earnings.  The valuation allowance may be reversed to income in future periods to the extent that the related deferred tax assets are realized or the valuation allowance is no longer required.

NOTE 2 - SECURITIES

The amortized cost and fair value of securities at period-end were as follows (dollars in thousands):



March 31, 2011


Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 


Fair
Value

Available for Sale:

 

 

 

 

 

 

 

 

 

 

 

     U.S. Treasury and federal agency securities

$

11,638

 

$

27

 

$

(13

)

$

11,652

     Other equity securities

 

1,000

 

 

8

 

 

---

 

 

1,008

 

$

12,638

 

$

35

 

$

(13

)

$

12,660

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

Available for Sale:

 

 

 

 

 

 

 

 

 

 

 

     U.S. Treasury and federal agency securities

$

8,103

 

$

6

 

$

---

 

$

8,109

     Other equity securities

 

1,000

 

 

11

 

 

---

 

 

1,011

 

$

9,103

 

$

17

 

$

---

 

$

9,120

Held to Maturity:

 

 

 

 

 

 

 

 

 

 

 

     State and municipal bonds

$

83

 

$

---

 

$

---

 

$

83

 

$

83

 

$

---

 

$

---

 

$

83

There were no sales of securities in the three month periods ended March 31, 2011 and 2010.

Contractual maturities of debt securities at March 31, 2011 were as follows (dollars in thousands):

 

Available-for-Sale Securities

 

Amortized
Cost

 

Fair
Value

Due in one year or less

$

1,000

 

$

1,000

Due from one to five years

 

9,545

 

 

9,548

Due from five to ten years

 

1,019

 

 

1,028

Due after ten years

 

74

 

 

76

 

$

11,638

 

$

11,652



 


- 13 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 2 - SECURITIES(Continued)

Securities with unrealized losses at March 31, 2011, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (dollars in thousands):

 

Less than 12 Months

 

12 Months or More

 

Total

 

Description of Securities

Fair
Value

 

Unrealized
Loss

 

Fair
Value

 

Unrealized
Loss

 

Fair
Value

 

Unrealized
Loss

 

U.S federal agency securities

$

5,033

 

$

(13

)

$

---

 

$

---

 

$

5,033

 

$

(13

)

State and municipal bonds

 

---

 

 

---

 

 

---

 

 

---

 

 

---

 

 

---

 

Other equity securities

 

---

 

 

---

 

 

---

 

 

---

 

 

---

 

 

---

 

Total temporarily impaired

$

5,033

 

$

(13

)

$

---

 

$

---

 

$

5,033

 

$

(13

)

There were no securities with unrealized losses at December 31, 2010.

Other-Than-Temporary-Impairment

Management evaluates securities for other-than-temporary impairment ("OTTI") at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.  Management determined that no OTTI charges were necessary during the first quarter of 2011 and all of 2010.

At March 31, 2011 and December 31, 2010, securities with a carrying value of approximately $1,970,000 and $2,250,000, respectively, were pledged as security for public deposits, letters of credit and for other purposes required or permitted by law.








 


- 14 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 3 -LOANS

Portfolio loans were as follows (dollars in thousands):

 

March 31,
2011

 

December 31,
2010

 

Commercial and industrial

$

260,669

 

$

264,679

 

Commercial real estate:

 

 

 

 

 

 

     Residential developed

 

47,663

 

 

46,835

 

     Unsecured to residential developers

 

2,621

 

 

7,631

 

     Vacant and unimproved

 

68,193

 

 

71,528

 

     Commercial development

 

5,576

 

 

8,952

 

     Residential improved

 

91,690

 

 

96,784

 

     Commercial improved

 

330,842

 

 

355,899

 

     Manufacturing and industrial

 

79,162

 

 

81,560

 

          Total commercial real estate

 

625,747

 

 

669,189

 

Consumer

 

 

 

 

 

 

     Residential mortgage

 

127,405

 

 

135,227

 

     Unsecured

 

2,300

 

 

2,867

 

     Home equity

 

119,166

 

 

125,866

 

     Other secured

 

18,705

 

 

19,368

 

          Total consumer

 

267,576

 

 

283,328

 

Total loans

 

1,153,992

 

 

1,217,196

 

Allowance for loan losses

 

(42,343

)

 

(47,426

)

 

$

1,111,649

 

$

1,169,770

 

Activity in the allowance for loan losses by portfolio segment was as follows (dollars in thousands):

Three months ended March 31, 2011:

Commercial and
Industrial

 

Commercial
Real Estate

 


Consumer

 


Unallocated

 


Total

 

Beginning balance

$

7,012

 

$

34,973

 

$

5,415

 

$

26

 

$

47,426

 

Charge-offs

 

(804

)

 

(2,397

)

 

(931

)

 

---

 

 

(4,132

)

Recoveries

 

193

 

 

250

 

 

56

 

 

---

 

 

499

 

Provision for loan losses

 

790

 

 

(2,119

)

 

(117

)

 

(4

)

 

(1,450

)

Ending Balance

$

7,191

 

$

30,707

 

$

4,423

 

$

22

 

$

42,343

 



Three months ended March 31, 2010:

Commercial and
Industrial

 

Commercial
Real Estate

 


Consumer

 


Unallocated

 


Total

 

Beginning balance

$

6,086

 

$

45,759

 

$

2,767

 

$

11

 

$

54,623

 

Charge-offs

 

(3,721

)

 

(9,620

)

 

(895

)

 

---

 

 

(14,236

)

Recoveries

 

271

 

 

391

 

 

23

 

 

---

 

 

685

 

Provision for loan losses

 

3,353

 

 

14,838

 

 

1,518

 

 

1

 

 

19,710

 

Ending Balance

$

5,989

 

$

51,368

 

$

3,413

 

$

12

 

$

60,782

 


 


- 15 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 3 - LOANS (Continued)

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method (dollars in thousands):

March 31, 2011:

 

Commercial and
Industrial

 

Commercial
Real Estate

 


Consumer

 


Unallocated

 


Total

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

      Ending allowance attributable to loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

          Individually reviewed for impairment

$

2,152

 

$

5,910

 

$

533

 

$

---

 

$

8,595

          Collectively evaluated for impairment

 

5,039

 

 

24,797

 

 

3,890

 

 

22

 

 

33,748

               Total ending allowance balance

$

7,191

 

$

30,707

 

$

4,423

 

$

22

 

$

42,343

      Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

          Individually reviewed for impairment

$

4,556

 

$

57,755

 

$

14,388

 

$

---

 

$

76,699

          Collectively evaluated for impairment

 

256,113

 

 

567,992

 

 

253,188

 

 

---

 

 

1,077,293

               Total ending loans balance

$

260,669

 

$

625,747

 

$

267,576

 

$

---

 

$

1,153,992

December 31, 2010:

 

Commercial and
Industrial

 

Commercial
Real Estate

 


Consumer

 


Unallocated

 


Total

Allowance for loan losses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

      Ending allowance attributable to loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

          Individually reviewed for impairment

$

1,576

 

$

5,334

 

$

458

 

$

---

 

$

7,368

          Collectively evaluated for impairment

 

5,436

 

 

29,639

 

 

4,957

 

 

26

 

 

40,058

               Total ending allowance balance

$

7,012

 

$

34,973

 

$

5,415

 

$

26

 

$

47,426

      Loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

          Individually reviewed for impairment

$

7,757

 

$

70,677

 

$

13,752

 

$

---

 

$

92,186

          Collectively evaluated for impairment

 

256,922

 

 

598,512

 

 

269,576

 

 

---

 

 

1,125,010

               Total ending loans balance

$

264,679

 

$

669,189

 

$

283,328

 

$

---

 

$

1,217,196




 


- 16 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 3 - LOANS (Continued)

Impaired loans were as follows (dollars in thousands)

 

March 31,
2011

 

December 31,
2010

Impaired commercial loans with no allocated allowance for loan losses

$

26,030

 

$

48,519

Impaired loans with allocated allowance for loan losses:

 

 

 

 

 

     Impaired commercial loans

 

36,281

 

 

29,915

     Consumer mortgage loans modified under a troubled debt restructuring

 

14,388

 

 

13,752

 

 

50,669

 

 

43,667

     Total impaired loans

$

76,699

 

$

92,186

     Amount of the allowance for loan losses allocated

$

8,595

 

$

7,368



 

Three
Months
Ended
March 31,
2011

 

Three
Months
Ended
March 31,
2010

Average of impaired loans during the period:

 

 

 

 

 

     Commercial and industrial

$

4,725

 

$

12,179

     Commercial real estate:

 

 

 

 

 

          Residential developed

 

16,141

 

 

22,536

          Unsecured to residential developers

 

915

 

 

1,278

          Vacant and unimproved

 

4,948

 

 

6,908

          Commercial development

 

825

 

 

1,152

          Residential improved

 

8,695

 

 

12,140

          Commercial improved

 

21,909

 

 

30,589

          Manufacturing and industrial

 

8,349

 

 

11,657

     Consumer

 

12,755

 

 

11,098

Interest income recognized during impairment:

 

 

 

 

 

     Commercial and industrial

 

(14

)

 

154

     Commercial real estate

 

523

 

 

60

     Consumer

 

110

 

 

100

Cash-basis interest income recognized

 

 

 

 

 

     Commercial and industrial

 

52

 

 

118

     Commercial real estate

 

509

 

 

358

     Consumer

 

110

 

 

121



 


- 17 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 3 - LOANS (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of March 31, 2011 (dollars in thousands):

 

Unpaid
Principal
Balance

 


Recorded
Investment

 


Allowance
Allocated

With no related allowance recorded:

 

 

 

 

 

 

 

 

     Commercial and industrial

$

---

 

$

---

 

$

---

     Commercial real estate:

 

 

 

 

 

 

 

 

          Residential developed

 

24,221

 

 

6,903

 

 

---

          Unsecured to residential developers

 

2,550

 

 

279

 

 

---

          Vacant and unimproved

 

3,541

 

 

3,541

 

 

---

          Commercial development

 

---

 

 

---

 

 

---

          Residential improved

 

3,616

 

 

3,616

 

 

---

          Commercial improved

 

10,900

 

 

10,100

 

 

---

          Manufacturing and industrial

 

2,061

 

 

1,591

 

 

---

 

 

46,889

 

 

26,030

 

 

 

     Consumer:

 

 

 

 

 

 

 

 

          Residential mortgage

 

---

 

 

---

 

 

---

          Unsecured

 

---

 

 

---

 

 

---

          Home equity

 

---

 

 

---

 

 

---

          Other secured

 

---

 

 

---

 

 

---

 

 

---

 

 

---

 

 

---

 

$

46,889

 

$

26,030

 

$

---

With an allowance recorded:

 

 

 

 

 

 

 

 

     Commercial and industrial

$

4,556

 

$

4,556

 

$

2,152

     Commercial real estate:

 

 

 

 

 

 

 

 

          Residential developed

 

7,470

 

 

7,470

 

 

2,343

          Unsecured to residential developers

 

2,364

 

 

609

 

 

227

          Vacant and unimproved

 

2,322

 

 

2,322

 

 

3

          Commercial development

 

223

 

 

223

 

 

22

          Residential improved

 

5,798

 

 

5,780

 

 

1,009

          Commercial improved

 

6,913

 

 

6,736

 

 

1,258

          Manufacturing and industrial

 

8,585

 

 

8,585

 

 

1,048

 

 

33,675

 

 

31,725

 

 

5,910

     Consumer:

 

 

 

 

 

 

 

 

          Residential mortgage

 

14,388

 

 

14,388

 

 

533

          Unsecured

 

---

 

 

---

 

 

---

          Home equity

 

---

 

 

---

 

 

---

          Other secured

 

---

 

 

---

 

 

---

 

 

14,388

 

 

14,388

 

 

533

     Total

$

57,175

 

$

50,669

 

$

8,595


 


- 18 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 3 - LOANS (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2010 (dollars in thousands):

 

Unpaid
Principal
Balance

 


Recorded
Investment

 


Allowance
Allocated

With no related allowance recorded:

 

 

 

 

 

 

 

 

     Commercial and industrial

$

5,394

 

$

4,286

 

$

---

     Commercial real estate:

 

 

 

 

 

 

 

 

          Residential developed

 

28,289

 

 

8,205

 

 

---

          Unsecured to residential developers

 

315

 

 

315

 

 

---

          Vacant and unimproved

 

6,219

 

 

5,693

 

 

---

          Commercial development

 

3,176

 

 

1,055

 

 

---

          Residential improved

 

4,396

 

 

4,378

 

 

---

          Commercial improved

 

24,566

 

 

22,749

 

 

---

          Manufacturing and industrial

 

2,239

 

 

1,838

 

 

---

 

 

69,200

 

 

44,233

 

 

 

     Consumer:

 

 

 

 

 

 

 

 

          Residential mortgage

 

---

 

 

---

 

 

---

          Unsecured

 

---

 

 

---

 

 

---

          Home equity

 

---

 

 

---

 

 

---

          Other secured

 

---

 

 

---

 

 

---

 

 

---

 

 

---

 

 

---

 

$

74,594

 

$

48,519

 

$

---

With an allowance recorded:

 

 

 

 

 

 

 

 

     Commercial and industrial

$

3,517

 

$

3,470

 

$

1,576

     Commercial real estate:

 

 

 

 

 

 

 

 

          Residential developed

 

6,373

 

 

6,373

 

 

2,402

          Unsecured to residential developers

 

2,364

 

 

609

 

 

84

          Vacant and unimproved

 

266

 

 

266

 

 

44

          Commercial development

 

199

 

 

199

 

 

15

          Residential improved

 

4,806

 

 

4,662

 

 

1,381

          Commercial improved

 

6,710

 

 

6,172

 

 

1,096

          Manufacturing and industrial

 

8,163

 

 

8,164

 

 

312

 

 

28,881

 

 

26,445

 

 

5,334

     Consumer:

 

 

 

 

 

 

 

 

          Residential mortgage

 

13,752

 

 

13,752

 

 

458

          Unsecured

 

---

 

 

---

 

 

---

          Home equity

 

---

 

 

---

 

 

---

          Other secured

 

---

 

 

---

 

 

---

 

 

13,752

 

 

13,752

 

 

458

     Total

$

46,150

 

$

43,667

 

$

7,368



 


- 19 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 3 - LOANS (Continued)

Nonaccrual loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of March 31, 2011:

 



Nonaccrual

 

Over 90
days
Accruing

Commercial and industrial

$

10,769

 

$

---

Commercial real estate:

 

 

 

 

 

     Residential developed

 

10,085

 

 

---

     Unsecured to residential developers

 

888

 

 

---

     Vacant and unimproved

 

7,043

 

 

411

     Commercial development

 

833

 

 

---

     Residential improved

 

9,234

 

 

---

     Commercial improved

 

14,544

 

 

---

     Manufacturing and industrial

 

412

 

 

---

 

 

43,039

 

 

411

Consumer:

 

 

 

 

 

     Residential mortgage

 

1,489

 

 

---

     Unsecured

 

24

 

 

---

     Home equity

 

291

 

 

71

     Other secured

 

---

 

 

3

 

 

1,804

 

 

74

Total

$

55,612

 

$

485

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of December 31, 2010:

 



Nonaccrual

 

Over 90
days
Accruing

Commercial and industrial

$

11,583

 

$

---

Commercial real estate:

 

 

 

 

 

     Residential developed

 

10,848

 

 

---

     Unsecured to residential developers

 

925

 

 

390

     Vacant and unimproved

 

7,517

 

 

---

     Commercial development

 

1,652

 

 

---

     Residential improved

 

9,858

 

 

---

     Commercial improved

 

27,816

 

 

---

     Manufacturing and industrial

 

1,570

 

 

197

 

 

60,186

 

 

587

Consumer:

 

 

 

 

 

     Residential mortgage

 

1,830

 

 

---

     Unsecured

 

25

 

 

---

     Home equity

 

1,127

 

 

13

    Other secured

 

10

 

 

---

 

 

2,992

 

 

13

Total

$

74,761

 

$

600


 


- 20 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 3 - LOANS (Continued)

The following table presents the aging of the recorded investment in past due loans as of March 31, 2011 by class of loans (dollars in thousands):

 

30-90
Days

 

Greater Than
90 Days

 

Total
Past Due

 

Loans Not
Past Due

 


Total

Commercial and industrial

$

783

 

$

4,824

 

$

5,607

 

$

255,062

 

$

260,669

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Residential developed

 

1,022

 

 

3,647

 

 

4,669

 

 

42,994

 

 

47,663

     Unsecured to residential developers

 

279

 

 

609

 

 

888

 

 

1,733

 

 

2,621

     Vacant and unimproved

 

161

 

 

4,251

 

 

4,412

 

 

63,781

 

 

68,193

     Commercial development

 

---

 

 

808

 

 

808

 

 

4,768

 

 

5,576

     Residential improved

 

1,130

 

 

5,683

 

 

6,813

 

 

84,877

 

 

91,690

     Commercial improved

 

3,787

 

 

9,724

 

 

13,511

 

 

317,331

 

 

330,842

     Manufacturing and industrial

 

169

 

 

412

 

 

581

 

 

78,581

 

 

79,162

 

 

6,548

 

 

25,134

 

 

31,682

 

 

594,065

 

 

625,747

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Residential mortgage

 

1,485

 

 

1,027

 

 

2,512

 

 

124,893

 

 

127,405

     Unsecured

 

48

 

 

---

 

 

48

 

 

2,252

 

 

2,300

     Home equity

 

1,101

 

 

151

 

 

1,252

 

 

117,914

 

 

119,166

     Other secured

 

117

 

 

2

 

 

119

 

 

18,586

 

 

18,705

 

 

2,751

 

 

1,180

 

 

3,931

 

 

263,645

 

 

267,576

Total

$

10,082

 

$

31,138

 

$

41,220

 

$

1,112,772

 

$

1,153,992

The following table presents the aging of the recorded investment in past due loans as of December 31, 2010 by class of loans (dollars in thousands):

 

30-90
Days

 

Greater Than
90 Days

 

Total
Past Due

 

Loans Not
Past Due

 


Total

Commercial and industrial

$

825

 

$

5,389

 

$

6,214

 

$

258,465

 

$

264,679

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Residential developed

 

438

 

 

4,568

 

 

5,006

 

 

41,829

 

 

46,835

     Unsecured to residential developers

 

---

 

 

999

 

 

999

 

 

6,632

 

 

7,631

     Vacant and unimproved

 

670

 

 

4,367

 

 

5,037

 

 

66,491

 

 

71,528

     Commercial development

 

---

 

 

1,144

 

 

1,144

 

 

7,808

 

 

8,952

     Residential improved

 

1,929

 

 

6,353

 

 

8,282

 

 

88,502

 

 

96,784

     Commercial improved

 

901

 

 

21,440

 

 

22,341

 

 

333,558

 

 

355,899

     Manufacturing and industrial

 

1,084

 

 

613

 

 

1,697

 

 

79,863

 

 

81,560

 

 

5,022

 

 

39,484

 

 

44,506

 

 

624,683

 

 

669,189

Consumer:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Residential mortgage

 

1,293

 

 

1,489

 

 

2,782

 

 

132,445

 

 

135,227

     Unsecured

 

45

 

 

---

 

 

45

 

 

2,822

 

 

2,867

     Home equity

 

1,207

 

 

927

 

 

2,134

 

 

123,732

 

 

125,866

     Other secured

 

57

 

 

10

 

 

67

 

 

19,301

 

 

19,368

 

 

2,602

 

 

2,426

 

 

5,028

 

 

278,300

 

 

283,328

Total

$

8,449

 

$

47,299

 

$

55,748

 

$

1,161,448

 

$

1,217,196


 


- 21 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 3 - LOANS (Continued)

The Company has allocated $996,000 and $1,361,000 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of March 31, 2011 and December 31, 2010, respectively.  These loans involved the restructuring of terms to allow customers to mitigate foreclosure by meeting a lower loan payment requirement based upon their current cash flow.  The Company has been active at utilizing these programs and working with its customers to reduce the risk of foreclosure.

The following table presents information regarding troubled debt restructurings as of March 31, 2011 (dollars in thousands):

 


Number of
Loans

 

Outstanding
Recorded
Balance

   Commercial and industrial

 

15

 

$

2,644

   Commercial real estate

 

43

 

 

22,666

   Consumer

 

76

 

 

14,388

Included in these totals are $458,000 of nonperforming commercial and industrial restructurings, $1,534,000 of nonperforming commercial real estate restructurings and $1,295,000 of nonperforming consumer loan restructurings as of March 31, 2011.







 


- 22 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 3 - LOANS (Continued)

Credit Quality Indicators:   The Company categorizes loans into risk categories based on relevant information about the ability of the borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors.  The Company analyzes commercial loans individually and classifies these relationships by credit risk grading.  The Company uses an eight point grading system, with grades 5 through 8 being considered classified, or watch, credits.  All commercial loans are assigned a grade at origination, at each renewal or any amendment.  When a credit is first downgraded to a watch credit (either through renewal, amendment, lender identification or the loan review process), an Administrative Loan Review ("ALR") is generated by credit and the lender.  All watch credits have an ALR completed monthly which analyzes the collateral position and cash flow of the borrower and its guarantors.  The lender is required to complete both a short term and long term plan to rehabilitate or exit the credit and to give monthly comments on the progress to these plans.  Management meets quarterly with lenders to discuss each of these credits in detail and to help formulate solutions where progress has stalled.  When necessary, the loan officer proposes changes to the assigned loan grade as part of the ALR.  Additionally, Loan Review reviews all loan grades upon origination, renewal or amendment and again as loans are selected though the loan review process.  The credit will stay on the ALR until either its grade has improved to a 4 or the credit relationship is at a zero balance.  The Company uses the following definitions for the risk grades:

1. Excellent - Borrowings supported by extremely strong financial condition or secured by the Bank's own deposits. Minimal risk to the Bank and the probability of serious rapid financial deterioration is extremely small.

2. Above Average - Borrowings supported by sound financial statements that indicate the ability to repay or borrowings secured (and margined properly) with marketable securities. Nominal risk to the Bank and probability of serious financial deterioration is highly unlikely. The overall quality of these credits is very high.

3. Good Quality - Average borrowings supported by satisfactory asset quality and liquidity, good debt capacity coverage, and good management in all critical positions. Loans are secured by acceptable collateral with adequate margins. There is a slight risk of deterioration if adverse market conditions prevail. 

4. Acceptable Risk - This is an acceptable risk to the Bank, which may be slightly below average quality. The borrower has limited financial strength with considerable leverage. There is some probability of deterioration if adverse market conditions prevail. These credits should be monitored closely by the Relationship Manager.

5. Marginally Acceptable - Loans are of marginal quality with above normal risk to the Bank. The borrower shows acceptable asset quality but very little liquidity with high leverage. There is inconsistent earning performance without the ability to sustain adverse market conditions. The primary source of repayment is questionable, but the secondary source of repayment still remains an option. Very close attention by the Relationship Manager and management is needed.

6. Substandard - Loans are inadequately protected by the net worth and paying capacity of the borrower or the collateral pledged. The primary and secondary sources of repayment are questionable. Heavy debt condition may be evident and volume and earnings deterioration may be underway. It is possible that the Bank will sustain some loss if the deficiencies are not immediately addressed and corrected.

7. Doubtful - Borrowings supported by weak or no financial statements.  The ability to repay the entire loan is questionable. Loans in this category are normally characterized less than adequate collateral, insolvent, or extremely weak financial condition. A loan classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses makes collection or liquidation in full highly questionable. The possibility of loss is extremely high, however, activity may be underway to minimize the loss or maximize the recovery.

8. Loss - Loan are considered uncollectible and of little or no value as a bank asset. 

 


- 23 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 3 - LOANS (Continued)

As of March 31, 2011, the risk grade category of commercial loans by class of loans is as follows (dollars in thousands):

 

1

 

2

 

3

 

4

 

5

 

6

 

7

 

8

Commercial and industrial

$

381

 

$

1,369

 

$

52,939

 

$

148,891

 

$

37,292

 

$

9,027

 

$

10,770

 

$

---

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Residential developed

 

---

 

 

---

 

 

1,319

 

 

9,935

 

 

15,039

 

 

11,285

 

 

10,085

 

 

---

     Unsecured to residential developers

 

---

 

 

---

 

 

237

 

 

858

 

 

173

 

 

465

 

 

888

 

 

---

     Vacant and unimproved

 

---

 

 

---

 

 

6,444

 

 

37,527

 

 

13,467

 

 

3,712

 

 

7,043

 

 

---

     Commercial development

 

---

 

 

---

 

 

---

 

 

3,022

 

 

1,523

 

 

198

 

 

833

 

 

---

     Residential improved

 

---

 

 

---

 

 

2,909

 

 

49,396

 

 

15,939

 

 

14,213

 

 

9,234

 

 

---

     Commercial improved

 

---

 

 

---

 

 

69,936

 

 

181,791

 

 

41,315

 

 

23,256

 

 

14,544

 

 

---

     Manufacturing and industrial

 

---

 

 

238

 

 

14,809

 

 

37,481

 

 

20,974

 

 

5,247

 

 

412

 

 

---

 

$

381

 

$

1,607

 

$

148,593

 

$

468,901

 

$

145,722

 

$

67,403

 

$

53,809

 

$

---

As of December 31, 2010, the risk grade category of commercial loans by class of loans is as follows (dollars in thousands):

 

1

 

2

 

3

 

4

 

5

 

6

 

7

 

8

Commercial and industrial

$

442

 

$

1,583

 

$

51,558

 

$

148,880

 

$

41,467

 

$

9,165

 

$

11,584

 

$

---

Commercial real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

     Residential developed

 

---

 

 

---

 

 

240

 

 

6,682

 

 

14,705

 

 

14,360

 

 

10,848

 

 

---

     Unsecured to residential developers

 

---

 

 

---

 

 

4,784

 

 

907

 

 

500

 

 

515

 

 

925

 

 

---

     Vacant and unimproved

 

---

 

 

794

 

 

5,450

 

 

38,808

 

 

14,978

 

 

3,982

 

 

7,516

 

 

---

     Commercial development

 

---

 

 

---

 

 

---

 

 

4,240

 

 

2,765

 

 

295

 

 

1,652

 

 

---

     Residential improved

 

---

 

 

---

 

 

3,321

 

 

49,905

 

 

18,715

 

 

14,985

 

 

9,858

 

 

---

     Commercial improved

 

---

 

 

---

 

 

71,622

 

 

191,772

 

 

41,490

 

 

23,199

 

 

27,816

 

 

---

     Manufacturing and industrial

 

---

 

 

246

 

 

14,299

 

 

37,487

 

 

22,261

 

 

5,697

 

 

1,570

 

 

---

 

$

442

 

$

2,623

 

$

151,274

 

$

478,681

 

$

156,881

 

$

72,198

 

$

71,769

 

$

---

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses.  For consumer loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity.  The following table presents the recorded investment in consumer loans based on payment activity (dollars in thousands):


March 31, 2011

Residential
Mortgage

 

Consumer
Unsecured

 

Home
Equity

 

Consumer
Other

     Performing

$

126,378

 

$

2,300

 

$

119,015

 

$

18,703

     Nonperforming

 

1,027

 

 

---

 

 

151

 

 

2

     Total

$

127,405

 

$

2,300

 

$

119,166

 

$

18,705

 

 

 

 

 

 

 

 


December 31, 2010

Residential
Mortgage

 

Consumer
Unsecured

 

Home
Equity

 

Consumer
Other

     Performing

$

133,738

 

$

2,867

 

$

124,939

 

$

19,358

     Nonperforming

 

1,489

 

 

---

 

 

927

 

 

10

     Total

$

135,227

 

$

2,867

 

$

125,866

 

$

19,368


 


- 24 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 3 - LOANS (Continued)

Loans rated a 6 or worse per the Company's internal risk rating system are considered substandard, doubtful or loss.  Loans classified as substandard or worse were as follows at period-end (dollars in thousands):

 

March 31,
2011

 

December 31,
2010

Not classified as impaired

$

58,901

 

$

65,533

Classified as impaired

 

62,311

 

 

78,434

Total loans classified substandard or worse

$

121,212

 

$

143,967

At March 31, 2011, approximately $53.8 million of the $121.2 million of loans classified as substandard or worse were on nonaccrual status, while the remaining $71.4 million of these loans were on accrual status.

At December 31, 2010, approximately $74.8 million of the $144.0 million of loans classified as substandard or worse were on nonaccrual status, while the remaining $69.2 million of these loans were on accrual status.


NOTE 4 - OTHER REAL ESTATE OWNED

Period-end other real estate owned was as follows (dollars in thousands):

 

Three
Months
Ended
March 31,
2011

 


Year
Ended
December 31,
2010

 

Three
Months
Ended
March 31,
2010

 

Beginning balance

$

68,388

 

$

41,987

 

$

41,987

 

Additions, transfers from loans

 

14,479

 

 

45,248

 

 

17,954

 

Proceeds from sales of other real estate owned

 

(4,984

)

 

(16,003

)

 

(5,711

)

Valuation allowance reversal upon sale

 

(1,083

)

 

(2,677

)

 

(710

)

Gain (loss) on sale of other real estate owned

 

212

 

 

(167

)

 

(120

)

 

 

77,012

 

 

68,388

 

 

53,400

 

Less: valuation allowance

 

(12,020

)

 

(10,404

)

 

(7,610

)

Ending balance

$

64,992

 

$

57,984

 

$

45,790

 

Activity in the valuation allowance was as follows (dollars in thousands):

 

Three Months
Ended
March 31,
2011

 

Three Months
Ended
March 31,
2010

 

Beginning balance

$

10,404

 

$

4,804

 

     Additions charged to expense

 

2,699

 

 

3,516

 

     Deletions upon disposition

 

(1,083

)

 

(710

)

Ending balance

$

12,020

 

$

7,610

 

Net realized gains on sales of other real estate were $212,000 for the three month period ended March 31, 2011.  Net realized losses on sales of other real estate were $120,000 for the three month period ended March 31, 2010. 

 


- 25 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 5 - FAIR VALUE

ASC Topic 820, Fair Value Measurements and Disclosures, establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The three levels of inputs that may be used to measure fair value include:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Investment Securities:  The fair values of investment securities are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs).

Loans Held for Sale:  The fair value of loans held for sale is based upon binding quotes from 3rd party investors (Level 2 inputs).

Impaired Loans:  The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other Real Estate Owned:  Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification.  In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.



 


- 26 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 5 - FAIR VALUE (Continued)

Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):

 



Fair
Value

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 


Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

Assets:

 

 

 

 

 

 

 

 

 

 

 

March 31, 2011

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury and federal
   agency securities


$


11,652

 


$


---

 


$


11,652

 


$


---

Other equity securities

 

1,008

 

 

---

 

 

1,008

 

 

---

Loans held for sale

 

942

 

 

---

 

 

942

 

 

---

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

U.S. federal agency securities

$

8,109

 

$

---

 

$

8,109

 

$

---

State and municipal bonds

 

---

 

 

---

 

 

---

 

 

---

Other equity securities

 

1,011

 

 

---

 

 

1,011

 

 

---

Loans held for sale

 

2,537

 

 

---

 

 

2,537

 

 

---

Assets and liabilities measured at fair value on a non-recurring basis are summarized below (in thousands):

 



Fair
Value

 

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

 


Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

Assets:

 

 

 

 

 

 

 

 

 

 

 

March 31, 2011

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

$

25,050

 

$

---

 

$

---

 

$

25,050

Other real estate owned

 

45,019

 

 

---

 

 

---

 

 

45,019

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

Impaired loans

$

37,173

 

$

---

 

$

---

 

$

37,173

Other real estate owned

 

32,262

 

 

---

 

 

---

 

 

32,262



 


- 27 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 5 - FAIR VALUE (Continued)

The carrying amounts and estimated fair values of financial instruments, not previously presented, were as follows at March 31, 2011 and December 31, 2010 (dollars in thousands).

 

March 31, 2011

 

December 31, 2010

 

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

Financial assets

 

 

 

 

 

 

 

 

 

 

 

 

     Cash and cash equivalents

$

262,627

 

$

262,627

 

$

236,127

 

$

236,127

 

     Securities held to maturity

 

---

 

 

---

 

 

83

 

 

83

 

     FHLB stock

 

11,932

 

 

N/A

 

 

11,932

 

 

N/A

 

     Loans, net

 

1,111,649

 

 

1,118,394

 

 

1,169,770

 

 

1,169,497

 

     Accrued interest receivable

 

3,721

 

 

3,721

 

 

3,845

 

 

3,845

 

Financial liabilities

 

 

 

 

 

 

 

 

 

 

 

 

     Deposits

 

(1,264,665

)

 

(1,267,213

)

 

(1,276,620

)

 

(1,280,238

)

     Other borrowed funds

 

(174,270

)

 

(175,455

)

 

(185,336

)

 

(187,104

)

     Long-term debt

 

(41,238

)

 

(34,555

)

 

(41,238

)

 

(34,506

)

     Subordinated debt

 

(1,650

)

 

(1,650

)

 

(1,650

)

 

(1,650

)

     Accrued interest payable

 

(2,706

)

 

(2,706

)

 

(2,401

)

 

(2,401

)

Off-balance sheet credit-related items

 

 

 

 

 

 

 

 

 

 

 

 

     Loan commitments

 

---

 

 

---

 

 

---

 

 

---

 

The methods and assumptions used to estimate fair value are described as follows.

Carrying amount is the estimated fair value for cash and cash equivalents, short‑term borrowings, accrued interest receivable and payable, demand deposits, and variable rate loans or deposits that reprice frequently and fully.  Security fair values are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities as discussed above. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk (including consideration of widening credit spreads).  Fair value of debt is based on current rates for similar financing.  It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability.  The fair value of off-balance sheet credit-related items is not significant.

NOTE 6 - DEPOSITS

Deposits are summarized as follows (in thousands):

 

March 31,
2011

 

December 31,
2010

Noninterest-bearing demand

$

282,050

 

$

255,897

Interest bearing demand

 

182,700

 

 

216,827

Savings and money market accounts

 

384,932

 

 

355,657

Certificates of deposit

 

414,983

 

 

448,239

 

$

1,264,665

 

$

1,276,620

Approximately $175.6 million and $192.7 million in certificates of deposit were in denominations of $100,000 or more at March 31, 2011 and December 31, 2010, respectively.

Brokered deposits totaled approximately $42.6 million and $48.2 million at March 31, 2011 and December 31, 2010, respectively.  At both March 31, 2011 and December 31, 2010, brokered deposits had interest rates ranging from 3.75% to 4.55%.  The remaining balance of $42.6 million in brokered deposits will mature in 2011.

Additional information about restrictions on the Bank's deposit gathering activities may be found in Note 1 under the heading "Regulatory Developments."

 


- 28 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 7 - OTHER BORROWED FUNDS

Other borrowed funds include advances from the Federal Home Loan Bank and borrowings from the Federal Reserve Bank.

Federal Home Loan Bank Advances

At period-end, advances from the Federal Home Loan Bank were as follows (dollars in thousands):


Principal Terms

Advance
Amount

 


Range of Maturities

Weighted Average
Interest Rate

March 31, 2011

 

 

 

 

     Single maturity fixed rate advances

$  160,000

 

May 2011 to November 2015

1.94%

     Amortizable mortgage advances

14,270

 

March 2018 to July 2018

3.77%

 

$  174,270

 

 

 



Principal Terms

Advance
Amount

 


Range of Maturities

Weighted Average
Interest Rate

December 31, 2010

 

 

 

 

     Single maturity fixed rate advances

$  170,000

 

March 2011 to November 2015

1.95%

     Amortizable mortgage advances

15,336

 

March 2018 to July 2018

3.77%

 

$  185,336

 

 

 

Each advance is subject to a prepayment penalty if paid prior to its maturity date.  Fixed rate advances are payable at maturity.  Amortizable mortgage advances are fixed rate advances with scheduled repayments based upon amortization to maturity.  Putable advances are fixed rate advances that can be changed to a variable rate at the option of the FHLB.  If the FHLB exercises that option, these advances may be repaid without penalty.  These advances were collateralized by residential and commercial real estate loans totaling $373.7 million and $420.5 million under a physical loan collateral delivery arrangement at March 31, 2011 and December 31, 2010, respectively.

Scheduled repayments of FHLB advances as of March 31, 2011 were as follows (in thousands):

2011

$

35,667

2012

 

66,781

2013

 

31,831

2014

 

21,884

2015

 

11,938

Thereafter

 

6,169

 

$

174,270


 


- 29 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 8 - EARNINGS (LOSS) PER COMMON SHARE

A reconciliation of the numerators and denominators of basic and diluted earnings (loss) per common share for the three month periods ended March 31, 2011 and 2010 are as follows (dollars in thousands, except per share data):

 

Three Months
Ended
March 31,
2011

 

Three Months
Ended
March 31,
2010

 

   Net income (loss)

$

1,291

 

$

(21,140

)

   Dividends declared on preferred shares

 

---

 

 

---

 

   Net income (loss) available to common shares

$

1,291

 

$

(21,140

)

Weighted average shares outstanding, including
      participating stock awards - Basic

 


17,679,621

 

 


17,696,922

 

   Dilutive potential common shares:

 

 

 

 

 

 

      Stock options

 

---

 

 

---

 

      Conversion of preferred stock

 

---

 

 

---

 

      Stock warrants

 

---

 

 

---

 

   Weighted average shares outstanding - Diluted

 

17,679,621

 

 

17,696,922

 

   Basic earnings (loss) per common share

$

0.07

 

$

(1.19

)

   Diluted earnings (loss) per common share (1)

 

0.07

 

 

(1.19

)


(1)

For any period in which a loss is recorded, the assumed exercise of stock options would have an anti-dilutive impact on loss per share and thus are ignored in the diluted per common share calculation.

Stock options for 714,766 and 918,437 shares of common stock for the three month periods ended March 31, 2011 and 2010, respectively, were not considered in computing diluted earnings per share because they were antidilutive.   Potential common shares associated with convertible preferred stock and stock warrants were excluded from dilutive potential common shares as they were antidilutive.

NOTE 9 - FEDERAL INCOME TAXES

Income tax expense (benefit) was as follows (dollars in thousands):

 

Three
Months
Ended
March 31,
2011

 

Three
Months
Ended
March 31,
2010

 

Current

$

(2

)

$

(21

)

Deferred (benefit) expense

 

2

 

 

21

 

 

$

---

 

$

---

 


 


- 30 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 9 - FEDERAL INCOME TAXES (Continued)

The difference between the financial statement tax expense (benefit) and amount computed by applying the statutory federal tax rate to pretax income was reconciled as follows (dollars in thousands):

 

2011

 

2010

 

Statutory rate

 

35%

 

 

35%

 

Statutory rate applied to income (loss) before taxes

$

452

 

$

(7,399

)

Add (deduct)

 

 

 

 

 

 

     Change in valuation allowance

 

(355

)

 

7,652

 

     Tax-exempt interest income

 

---

 

 

(167

)

     Bank-owned life insurance

 

(75

)

 

(70

)

     Other, net

 

(22

)

 

(16

)

 

$

---

 

$

---

 

The realization of deferred tax assets (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years.  In assessing the need for a valuation allowance, we consider all positive and negative evidence, including taxable income in carry-back years, scheduled reversals of deferred tax liabilities, expected future taxable income and tax planning strategies. 

At March 31, 2011, the need for a valuation allowance was based primarily on the Company's net operating loss for 2009 and 2008, and the challenging environment currently confronting banks that could impact future operating results.  As a result, an $18.0 million valuation allowance on deferred tax assets was charged to federal income tax expense in 2009.  As a result of losses incurred in 2010, the Company increased the valuation allowance to $25.6 million at December 31, 2010.  At March 31, 2011, the valuation allowance was $25.3 million.  The valuation allowance may be reversed to income in future periods to the extent that the related deferred tax assets are realized or the valuation allowance is no longer required. If the Company returns to consistent, sustained profitability, the need for the valuation allowance would diminish.

The net deferred tax asset recorded included the following amounts of deferred tax assets and liabilities (dollars in thousands):

 

March 31,
2011

 

December 31,
2010

 

Deferred tax asset

 

 

 

 

 

 

     Allowance for loan losses

$

14,820

 

$

16,599

 

     Nonaccrual loan interest

 

387

 

 

548

 

     Valuation allowance on other real estate owned

 

4,207

 

 

3,641

 

     Net operating loss carryforward

 

7,744

 

 

6,656

 

     Other

 

885

 

 

975

 

        Gross deferred tax assets

 

28,043

 

 

28,419

 

     Valuation allowance

 

(25,294

)

 

(25,649

)

        Total net deferred tax assets

 

2,749

 

 

2,770

 

Deferred tax liabilities

 

 

 

 

 

 

     Depreciation

 

(1,932

)

 

(1,984

)

     Purchase accounting adjustments

 

(89

)

 

(113

)

     Unrealized gain on securities available for sale

 

(8

)

 

(6

)

     Prepaid expenses

 

(407

)

 

(347

)

     Other

 

(313

)

 

(320

)

       Gross deferred tax liabilities

 

(2,749

)

 

(2,770

)

Net deferred tax asset

$

---

 

$

---

 


 


- 31 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 9 - FEDERAL INCOME TAXES (Continued)

At March 31, 2011, we had federal net operating loss carryforwards of $22.1 million that expire in 2030. 

There were no unrecognized tax benefits at March 31, 2011 or December 31, 2010 and the Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months.  The Company is no longer subject to examination by the Internal Revenue Service for years before 2007.

NOTE 10 - CONTINGENCIES

We and our subsidiaries periodically become defendants in certain claims and legal actions arising in the ordinary course of business.  As of March 31, 2011, there were no material pending legal proceedings, other than routine litigation incidental to the business of banking, to which we or any of our subsidiaries are a party or which any of our properties are the subject.

NOTE 11 - SHAREHOLDERS' EQUITY

Regulatory Capital

The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies.  Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off‑balance sheet items calculated under regulatory accounting practices.  Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases.  Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.

The prompt corrective action regulations provide five categories, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition.  If a bank is only adequately capitalized, regulatory approval is required to, among other things, accept, renew or roll-over brokered deposits.  If a bank is undercapitalized, capital distributions and growth and expansion are limited, and plans for capital restoration are required.







 


- 32 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 11 - SHAREHOLDERS' EQUITY (Continued)

At March 31, 2011 and December 31, 2010, actual capital levels and minimum required levels were (in thousands):

 




Actual

 


Minimum Required
For Capital
Adequacy Purposes

 

To Be Well
Capitalized Under
Prompt Corrective
Action Regulations

 


Minimum
Required Under
Consent Order

 

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

Amount

 

Ratio

 

March 31, 2011

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital (to risk weighted
assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Consolidated

$

125,730

 

10.3

%

$

97,266

 

8.0

%

 

N/A

 

N/A

 

 

N/A

 

N/A

 

   Bank

 

126,578

 

10.4

 

 

97,201

 

8.0

 

$

121,502

 

10.0

%

$

133,652

 

11.0

%

Tier 1 capital (to risk weighted
assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Consolidated

 

91,389

 

7.5

 

 

48,633

 

4.0

 

 

N/A

 

N/A

 

 

N/A

 

N/A

 

   Bank

 

111,050

 

9.1

 

 

48,601

 

4.0

 

 

72,901

 

6.0

 

 

N/A

 

N/A

 

Tier 1 capital (to average
assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Consolidated

 

91,389

 

5.8

 

 

62,608

 

4.0

 

 

N/A

 

N/A

 

 

N/A

 

N/A

 

   Bank

 

111,050

 

7.1

 

 

62,518

 

4.0

 

 

78,148

 

5.0

 

 

125,037

 

8.0

 

December 31, 2010

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total capital (to risk weighted
assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Consolidated

$

125,483

 

9.7

%

$

104,013

 

8.0

%

 

N/A

 

N/A

 

 

N/A

 

N/A

 

   Bank

 

125,797

 

9.7

 

 

103,970

 

8.0

 

$

129,963

 

10.0

%

$

142,960

 

11.0

%

Tier 1 capital (to risk weighted
assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Consolidated

 

89,585

 

6.9

 

 

52,007

 

4.0

 

 

N/A

 

N/A

 

 

N/A

 

N/A

 

   Bank

 

109,160

 

8.4

 

 

51,985

 

4.0

 

 

77,978

 

6.0

 

 

N/A

 

N/A

 

Tier 1 capital (to average assets)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Consolidated

 

89,585

 

5.8

 

 

61,605

 

4.0

 

 

N/A

 

N/A

 

 

N/A

 

N/A

 

   Bank

 

109,160

 

7.1

 

 

61,520

 

4.0

 

 

76,901

 

5.0

 

 

123,041

 

8.0

 

Approximately $22.8 million and $22.4 million of trust preferred securities outstanding at March 31, 2011 and December 31, 2010, respectively, qualified as Tier 1 capital.  Refer to our 2010 Form 10-K for more information on the trust preferred securities. 

The Bank was categorized as "adequately capitalized" at March 31, 2011 and December 31, 2010.  The Bank's regulatory capital ratios exceeded the levels ordinarily required to be categorized as "well capitalized" at March 31, 2011.  However, because the Bank is subject to the Consent Order, the Bank cannot be categorized as "well capitalized" regardless of actual capital levels.

As part of the Consent Order, the Bank is required to have and maintain a Tier 1 Leverage Capital Ratio of at least 8% and a Total Risk Based Capital Ratio of at least 11%.  The Bank needed a capital injection of approximately $14.0 million as of March 31, 2011 to comply with the Tier 1 Leverage Capital Ratio requirement and needed a capital injection of approximately $7.1 million at March 31, 2011 to comply with the Total Risk Based Ratio requirement of the Consent Order.  The ability of the Bank to achieve these requirements is largely dependent on the success of capital raising initiatives in process by the Company as discussed previously.  The Consent Order also prohibits the Bank from declaring or paying any cash dividend without the prior written consent of its regulators. The payment of future cash dividends by the Company is largely dependent upon dividends received from the Bank out of its earnings.  Under Michigan law, the Bank is also restricted from paying dividends to the Company until its deficit retained earnings has been restored.  The Bank had a retained deficit of approximately $37.9 million at March 31, 2011.

 


- 33 -


Table of Contents

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 11 - SHAREHOLDERS' EQUITY (Continued)

Additional information about the Consent Order may be found in Note 1 under the heading "Regulatory Developments."

In order to temporarily replenish the Company's liquidity pending the Company's planned public offering of common stock, on April 21, 2011, the Company issued and sold a 2% Subordinated Note due 2018 in the aggregate principal amount of $1,000,000 to a director of the Company.  The note has an interest rate of 2%, compounded quarterly in arrears.  Accrued interest is payable in full at maturity, or at the date the principal is paid in full.  The note has a maturity date of April 30, 2018.  The Company may prepay the note in whole or in part at any time from and after September 30, 2011.  If and when the Company conducts a registered public offering of its common stock prior to April 30, 2012, the note allows the holder to purchase shares offered in the public offering and to pay the cash price of shares purchased in the public offering by delivering the note to the Company at a value equal to the principal and interest accrued.  The holder also has a continuing right to convert the note in full into common stock with the stock to be valued at book value and the note to be valued at principal and interest accrued.













 


- 34 -


Table of Contents

Item 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Macatawa Bank Corporation is a Michigan corporation and a registered bank holding company.  It wholly-owns Macatawa Bank, Macatawa Statutory Trust I and Macatawa Statutory Trust II.  Macatawa Bank is a Michigan chartered bank with depository accounts insured by the FDIC.  The Bank operates twenty-six branch offices and a lending and operational service facility, providing a full range of commercial and consumer banking and trust services in Kent County, Ottawa County, and northern Allegan County, Michigan.  Macatawa Statutory Trusts I and II are grantor trusts and issued $20.0 million each of pooled trust preferred securities.  These trusts are not consolidated in our Consolidated Financial Statements.  For further information regarding consolidation, see the Notes to the Consolidated Financial Statements.

At March 31, 2011, we had total assets of $1.56 billion, total loans of $1.15 billion, total deposits of $1.26 billion and shareholders' equity of $69.2 million.  During the first quarter of 2011, we recognized net income of $1.3 million compared to a net loss of $21.1 million in the first quarter of 2010.  This represented our fourth consecutive quarter of profitability following six consecutive quarters of net losses.  As described more fully below, a meaningful reduction in charge-offs and nonperforming loans led to a negative loan loss provision for the most recent quarter.  As of March 31, 2011, the Bank's capital ratios returned to levels ordinarily required to be categorized "well capitalized" under applicable regulatory guidelines, but are below the requirements in our Consent Order.  As a result, we remained categorized as "adequately capitalized" at March 31, 2011. 

The weak local and national economic conditions that persisted over the past few years contributed to the 2010 operating loss and the $38.9 million and $63.6 million of annual operating losses reported by us during 2008 and 2009.  The losses for these prior periods were largely attributable to loan losses, lost interest on non-performing assets and costs of administering problem assets associated with problem loans and other real estate assets.  We also incurred a non-cash charge of $18.0 million included in federal income tax expense in 2009 associated with a valuation allowance for deferred tax assets and non-cash, after tax impairment charges for goodwill and intangible assets of $27 million in 2008.  There will be no further negative affect on our results of operations associated with deferred tax assets or goodwill, as these assets have been written off or reserved for in their entirety.  Under certain conditions according to accounting standards, as we return to sustained profitability it could be possible to reverse the established valuation on our deferred tax assets through earnings. 

Our Board of Directors and management remain focused on efforts to improve our internal operations and to work out of our problem loans and assets.  We believe our improved results over the past four quarters reflect the impact of these efforts.  The Bank's Board of Directors has implemented additional corporate governance practices and disciplined business and banking principles, including more conservative lending principles intended to comply with regulatory standards.  Our management team continues to execute these disciplined business and banking procedures and policies intended to limit future losses, preserve capital and improve operational efficiencies. 

We have also worked closely with our regulators at the FRB and the Bank's regulators at the FDIC and the OFIR to put in place improved controls and procedures.  On February 22, 2010, Macatawa Bank entered into a Consent Order with the FDIC and OFIR, the primary banking regulators of the Bank.  The Company also formally entered into a Written Agreement with the FRB with an effective date of July 23, 2010.  As of March 31, 2011, we believe that the Bank was in compliance in all material respects with all of the provisions of the Consent Order, other than the minimum capital requirements.  As of the same date, we believe that we were in compliance in all material respects with all of the provisions of the Written Agreement, other than acceptance by the FRB of a capital plan and a plan for meeting cash flow obligations for 2011.  See Note 1 to the Consolidated Financial Statements for more information.

Additional information further describing changes in our business, including those in response to the Consent Order and the Written Agreement, are described in detail in our 2010 Form 10-K. 

 


- 35 -


Table of Contents

RESULTS OF OPERATIONS

Summary:  Net income available to common shares for the quarter ended March 31, 2011 was $1.3 million, compared to first quarter 2010 net loss of $21.1 million.  Net income per common share on a diluted basis was $0.07 for the first quarter of 2011 compared to a net loss per common share of $1.19 for the same period in 2010. 

The improvement in earnings in the first quarter of 2011 was due primarily to a significantly lower level of net chargeoffs from $13.6 million in the first quarter of 2010 to $3.6 million in the first quarter of 2011, our lowest quarterly level of net chargeoffs since the third quarter of 2008.  This, coupled with a decline in non-performing and impaired loan levels, resulted in a decrease of $21.1 million in the provision for loan losses.  The provision for loan losses was a negative $1.45 million for the three month period ended March 31, 2011 compared to $19.7 million for the same period in 2010. 

Operating results in recent periods have been significantly impacted by the cost associated with problem loans and nonperforming assets.  Apart from the provision for loan losses, costs associated with nonperforming assets were $4.4 million for the first quarter of 2011 compared to $5.5 million for the first quarter of 2010.  Lost interest from elevated levels of nonperforming assets was approximately $2.1 million and $2.6 million for the first quarter of 2011 and 2010, respectively.  Each of these items is discussed more fully below.

Net Interest Income:  Net interest income totaled $11.6 million for the first quarter of 2011 compared to $13.0 million for the first quarter of 2010. 

The decrease in net interest income was due primarily to a $211.5 million reduction in our average interest earning assets as a result of our focus on reducing credit exposure within certain segments of our loan portfolio, liquidity improvement and capital preservation.  The net interest margin was 3.22% for the first quarters of both 2011 and 2010.

Average interest earning assets decreased from $1.65 billion for the first three months of 2010 to $1.44 billion for the same period in 2011.  Our average yield on earning assets for the first three months of 2011 declined 73 basis points from 5.15% to 4.42%.

The declines were from slight decreases in the yield on our residential and consumer loan portfolios, which have repriced in the generally lower rate environment during this period and a reduction in the balance of our securities portfolio relative to total earning assets.  We sold nearly our entire securities portfolio during the second quarter of 2010.  The majority of these funds have been initially reinvested in lower yielding liquid money market balances. We expect these higher than normal liquid balances will continue to put downward pressure on margin in the near term.

The cost of funds decreased 74 basis points to 1.42% in the first quarter of 2011 from 2.16% in 2010. A decrease in the rates paid on our deposit accounts in response to declining market rates and the rollover of time deposits and other borrowings at lower rates within the current rate environment impacted the reduction in our cost of funds.  Also contributing to the reduction was a shift in our deposit mix from higher costing time deposits to lower costing demand and savings accounts.




 


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The following table shows an analysis of net interest margin for the three month periods ended March 31, 2011 and 2010.

 

For the three months ended March 31,

 

 

2011

 

2010

 

 


Average
Balance

 

Interest
Earned
or paid

 

Average
Yield
or cost

 


Average
Balance

 

Interest
Earned
or paid

 

Average
Yield
or cost

 

 

(Dollars in thousands)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Taxable securities

$

11,632

 

$

26

 

0.91

%

$

68,221

 

$

666

 

3.91

%

Tax-exempt securities (1)

 

76

 

 

1

 

6.95

%

 

50,115

 

 

525

 

6.46

%

Loans (2)

 

1,184,429

 

 

15,582

 

5.27

%

 

1,474,356

 

 

19,623

 

5.23

%

Federal Home Loan Bank stock

 

11,932

 

 

76

 

2.56

%

 

12,275

 

 

62

 

2.02

%

Federal funds sold and other short-term
investments

 


229,569

 

 


168

 


0.29


%

 


44,154

 

 


61

 


0.56


%

   Total interest earning assets (1)

 

1,437,638

 

 

15,853

 

4.42

%

 

1,649,121

 

 

20,937

 

5.15

%

Noninterest earning assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Cash and due from banks

 

21,868

 

 

 

 

 

 

 

23,712

 

 

 

 

 

 

   Other

 

106,276

 

 

 

 

 

 

 

112,453

 

 

 

 

 

 

Total assets

$

1,565,782

 

 

 

 

 

 

$

1,785,286

 

 

 

 

 

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deposits:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Interest bearing demand

$

178,942

 

$

103

 

0.23

%

$

245,394

 

$

231

 

0.38

%

   Savings and money market accounts

 

370,640

 

 

543

 

0.59

%

 

335,423

 

 

487

 

0.59

%

   Time deposits

 

434,534

 

 

2,266

 

2.11

%

 

600,840

 

 

4,690

 

3.17

%

Borrowings:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Other borrowed funds

 

186,340

 

 

1,000

 

2.15

%

 

258,981

 

 

2,180

 

3.37

%

   Long-term debt

 

41,238

 

 

343

 

3.34

%

 

41,238

 

 

321

 

3.12

%

   Total interest bearing liabilities

 

1,211,694

 

 

4,255

 

1.42

%

 

1,481,876

 

 

7,909

 

2.16

%

Noninterest bearing liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   Noninterest bearing demand accounts

 

278,998

 

 

 

 

 

 

 

213,044

 

 

 

 

 

 

   Other noninterest bearing liabilities

 

6,166

 

 

 

 

 

 

 

6,674

 

 

 

 

 

 

Shareholders' equity

 

68,924

 

 

 

 

 

 

 

83,692

 

 

 

 

 

 

Total liabilities and shareholders' equity

$

1,565,782

 

 

 

 

 

 

$

1,785,286

 

 

 

 

 

 

Net interest income

 

 

 

$

11,598

 

 

 

 

 

 

$

13,028

 

 

 

Net interest spread (1)

 

 

 

 

 

 

3.00

%

 

 

 

 

 

 

2.99

%

Net interest margin (1)

 

 

 

 

 

 

3.22

%

 

 

 

 

 

 

3.22

%

Ratio of average interest earning assets to

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   average interest bearing liabilities

 

118.65

%

 

 

 

 

 

 

111.29

%

 

 

 

 

 


 

(1)

Yield adjusted to fully tax equivalent.

 

(2)

Includes non-accrual loans of approximately $73.5 million and $89.6 million for the three months ended March 31, 2011 and 2010.


 


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Provision for Loan Losses:  The provision for loan losses for the first quarter of 2011 was a negative $1.45 million compared to $19.7 million for the first quarter of 2010.  The reduction in the provision for loan losses was primarily associated with a significant decline in charge-offs and a reduction in the balance and required reserves on nonperforming loans, stabilizing real estate values on problem credits and continued shrinkage in the overall loan portfolio.

Net charge-offs were $3.6 million for the first quarter of 2011 compared to $13.6 million for the first quarter of 2010.  This is the lowest quarterly level of net charge-offs since the third quarter of 2008.  Most of the charge-offs taken during the first quarter of 2011 were from impaired loans with previously established reserves.  The charge-offs for each period have largely been driven by declines in the value of real estate securing our loans.  The pace of the value decline, however, has been slowing, thereby translating into a decline in charge-offs.   

We have also seen a decline in the pace of commercial loans migrating to a lower loan grade, which receive higher allocations in our loan loss reserve, as more fully discussed in this Item 2 under the heading "Allowance for Loan Losses."  In addition to experiencing fewer downgrades of credits, we are beginning to see an increase in the quality of some credits resulting in an improved loan grade.  We believe efforts that began in late 2009 and in early 2010 to improve loan administration and loan risk management practices have had a significant impact, ultimately allowing for the reduction in the level of the provision for loan losses for the first quarter of 2011.

The amounts of loan loss provision in both the most recent and comparable prior year periods were the result of establishing our allowance for loan losses at levels believed necessary based upon our methodology for determining the adequacy of the allowance.  The sustained lower level of quarterly net charge-offs over the past several quarters has a significant effect on the historical loss component of our methodology.  More information about our allowance for loan losses and our methodology for establishing its level may be found in this Item 2 under the heading "Allowance for Loan Losses" below.

Noninterest Income:  Noninterest income for the first quarter 2011 increased to $3.7 million from $3.5 million for the same period in 2010.  The components of noninterest income are shown in the table below (in thousands):

 

2011

 

2010

Service charges and fees on deposit accounts

$

949

 

$

1,065

Net gains on mortgage loans

 

435

 

 

181

Trust fees

 

651

 

 

890

ATM and debit card fees

 

852

 

 

785

Bank owned life insurance income

 

215

 

 

200

Investment services fees

 

233

 

 

140

Other income

 

344

 

 

207

     Total noninterest income

$

3,679

 

$

3,468

Increases in net gains on mortgage loans, investment services fees and ATM and debit card fees were the primary reasons for the $211,000 increase in noninterest income for the first quarter of 2011.  Net gains on mortgage loans increased by $254,000, as we have increased focus on growth in our residential mortgage loan origination volume and added experienced mortgage professionals over the past two quarters to our lending team.  The increases in net gains on mortgage loans, investment service fees and ATM and debit card fees were offset by decreases in trust fees and deposit services fees. The decrease in trust fees is the result of a decline in trust asset balances.  The decline in revenue from deposit services was related to a decrease in non-sufficient fund fees, consistent with a decline across the banking industry.

 


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Noninterest Expense:  Noninterest expense for the first quarter 2011 decreased to $15.4 million from $17.9 million for the same period in 2010.  The components of noninterest expense are shown in the table below (in thousands):

 

Three Months
Ended
March 31,
2011

 

Three Months
Ended
March 31,
2010

Salaries and benefits

$

5,347

 

$

5,450

Occupancy of premises

 

1,011

 

 

1,052

Furniture and equipment

 

817

 

 

981

Legal and professional

 

270

 

 

769

Marketing and promotion

 

224

 

 

215

Data processing

 

304

 

 

346

FDIC assessment

 

978

 

 

1,257

ATM and debit card processing

 

271

 

 

310

Bond and D&O insurance

 

379

 

 

548

Administration and disposition of problem assets

 

4,434

 

 

5,535

Outside services

 

421

 

 

485

Other noninterest expense

 

980

 

 

978

     Total noninterest expense

$

15,436

 

$

17,926

Decreases in costs associated with administration and disposition of problem assets and legal and professional fees were the primary reasons for the decline in noninterest expense of $2.5 million.  However, nearly all components of noninterest expense experienced a decline due to our ongoing efforts to manage expenses and scale our operations in response to prolonged economic weakness.

Costs associated with administration and disposition of problem assets include legal costs, repossessed and foreclosed property administration expense and losses on repossessed and foreclosed properties. Repossessed and foreclosed property administration expense includes survey and appraisal, property maintenance and management and other disposition and carrying costs. Losses on repossessed and foreclosed properties include both net losses on the sale of properties and unrealized losses from value declines for outstanding properties.

These costs are itemized in the following table (in thousands):

 

Three Months
Ended
March 31, 2011

 

Three Months
Ended
March 31, 2010

Legal and professional - nonperforming assets

$

825

 

$

687

Repossessed and foreclosed property administration

 

1,116

 

 

1,205

Losses on repossessed and foreclosed properties

 

2,493

 

 

3,643

     Total

$

4,434

 

$

5,535

Losses on repossessed assets and foreclosed properties decreased to $2.5 million for the first quarter 2011 from $3.6 million for the first quarter 2010.  The decrease is due to less rapid market declines in valuations.  The overall level remains elevated due to the level of other real estate owned.

Our legal and professional expenses decreased for the first quarter of 2011 compared to the same period in 2010.  The first quarter of 2010 included legal fees for consultation related to the Consent Order, the material weakness reported in our 2009 Form 10-K and our implementation of additional corporate governance procedures, including more consultation with corporate legal counsel.

 


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Our largest component of noninterest expense, salaries and benefits, declined in the first quarter of 2011 by $103,000 from the first quarter of 2010.  We had 385 full-time equivalent employees at March 31, 2011 compared to 375 at March 31, 2010.  Over the past three quarters, we hired personnel in our risk management functions, including our Special Assets, Credit Administration and Loan Review departments, as we continue to focus on improvement in our lending discipline and loan risk management practices and additional personnel in our retail lending group as we increase our focus on consumer lending.  Accordingly, we expect the level of salaries and benefits to stabilize and may even increase as we move through the remainder of 2011.

FDIC assessments decreased by $279,000 to $978,000 for the first quarter of 2011 compared to $1.3 million for the first quarter of 2010 as a result of our reduced level of deposits and changes to the assessment base implemented by the FDIC.

When excluding FDIC assessments and nonperforming asset costs, non-interest expense would have been approximately $10.0 million for the three month period ended March 31, 2011, down 10.0%, from $11.1 million for the same period of 2010.

Federal Income Tax Expense/Benefit:  We recorded no federal income tax expense for the three month period ended March 31, 2011 and 2010.  Since June 30, 2009, we have concluded that a full valuation allowance must be maintained for all of our net deferred tax assets based primarily on our net operating losses and the continued challenging environment confronting banks that could impact our ability to generate future earnings.  Under certain conditions according to accounting standards, as we return to sustained profitability it could be possible to reverse the established valuation on our deferred tax assets through earnings.


FINANCIAL CONDITION

Summary:  In light of the persistent weak economic conditions, we have been focused on reducing our loan portfolio, including reducing exposure in higher loan concentration types, to improve our financial condition through increased liquidity, diversification of credit risk, improved capital ratios, and reduced reliance on non-core funding.  We have experienced positive results in each of these areas over the past four quarters.

Total assets were $1.56 billion at March 31, 2011, a decrease of $21.0 million from $1.58 billion at December 31, 2010.  The decrease reflected declines of $58.1 million in our loan portfolio, partially offset by an increase of $23.5 million in short-term investments.  The decline in assets was primarily offset on the funding side of the balance sheet by a decline in deposits generated through brokers and the maturity of certain other borrowed funds. 

Federal Funds Sold and Other Short Term Investments:  The increase in federal funds sold and other short-term investments to $238.4 million at March 31, 2011 was primarily the result of elevated seasonal deposits, and from a reduction in the Bank's loan portfolio. We expect these balances to decrease in the second quarter of 2011 as the seasonal deposits are drawn down and as we experience further maturities of brokered deposits.

Securities Available for Sale:  Securities available for sale were $12.7 million at March 31, 2011 compared to $9.1 million at December 31, 2010.  The balance at March 31, 2011 primarily consisted of U.S. Treasury securities held for collateral purposes.  If conditions continue to improve during 2011, we expect to reinvest excess liquidity and selectively rebuild our investment portfolio to diversify our asset quality.

Portfolio Loans and Asset Quality:  Total portfolio loans declined by $63.2 million to $1.15 billion at March 31, 2011 compared to $1.22 billion at December 31, 2010.   During the first three months of 2011, our commercial,  residential mortgage and consumer loan portfolios decreased by $47.5 million, $7.8 million and $7.9 million, respectively. 

While we experienced a decline in the residential mortgage loan portfolio from December 31, 2010 to March 31, 2011, we saw an increase in the volume of residential mortgage loans originated for sale in the first three months of 2011 compared to the same period in 2010.  Residential mortgage loans originated for sale were $16.7 million in the first three months of 2011 compared to $9.7 million for the same period in 2010.  This increase is due to market

 


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conditions as well as our focus on increasing our residential mortgage lending volume.  Going forward, we expect to retain for our own portfolio certain types of our residential mortgage loan production volume in order to stabilize the recent decreases we have experienced in our residential mortgage portfolio.

The decline in the commercial loan portfolio in recent quarters reflected the continuing weak economic conditions in West Michigan and our interest in improving the quality of our loan portfolio through reducing our exposure to these generally higher credit risk assets.  We have focused our efforts on reducing our exposure to residential land development loans, diversifying our commercial loan portfolio and improving asset quality.  We expect continued shrinkage in our real estate development portfolios to continue to diversify our credit exposure. 

Commercial and commercial real estate loans still remained our largest loan segment and accounted for approximately 77% of the total loan portfolio at both March 31, 2011 and December 31, 2010.  Residential mortgage and consumer loans comprised approximately 11% and 12%, respectively, of total loans at both March 31, 2011 and  December 31, 2010.

A further breakdown of the composition of the commercial loan portfolio is shown in the table below (in thousands):

 

March 31,
2011

 

December 31,
2010

Commercial real estate:

 

 

 

 

 

Residential Developed

$

47,663

 

$

46,835

Unsecured to  residential developers

 

2,621

 

 

7,631

Vacant and unimproved

 

68,193

 

 

71,528

Commercial development

 

5,576

 

 

8,952

Residential improved

 

91,690

 

 

96,784

Commercial improved

 

330,842

 

 

355,899

Manufacturing and industrial

 

79,162

 

 

81,560

     Total commercial real estate loans

 

625,747

 

 

669,189

Commercial and industrial

 

260,669

 

 

264,679

     Total commercial loans

$

886,416

 

$

933,868


 

(1)

Includes both owner occupied and non-owner occupied commercial real estate.

Commercial real estate accounted for approximately 71% of the commercial loan portfolio at March 31, 2011 and consisted primarily of loans to business owners and developers of owner and non-owner occupied commercial properties and loans to developers of single and multi-family residential properties.  In the table above, we show our commercial real estate portfolio by loans secured by residential and commercial real estate, and further by stage of development.  Improved loans are generally secured by properties that are under construction or completed and placed in use.  Development loans are secured by properties that are in the process of development or fully developed.  Vacant land loans are secured by raw land for which development has not yet begun. 

Total commercial real estate loans declined $43.4 million since December 31, 2010 as we continue to focus on reducing our real estate loan concentrations and balances.  Commercial loans secured by residential real estate, the portfolio that has created the majority of stress within our loan portfolio, declined $9.7 million.  The balance of loans secured by nonresidential real estate declined $34.2 million since December 31, 2010.  We expect continued reductions, though at a slower pace in 2011, in our real estate portfolios as we maintain and improve our capital ratios.

Our loan portfolio is reviewed regularly by our senior management, our loan officers, and an internal loan review team that is independent of our loan originators and credit administration. An administrative loan committee consisting of senior management and seasoned lending and collections personnel meets monthly to manage our internal watch list and proactively manage high risk loans.

 


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When reasonable doubt exists concerning collectability of interest or principal of one of our loans, that loan is placed in non-accrual status. Any interest previously accrued but not collected is reversed and charged against current earnings. 

Nonperforming assets are comprised of nonperforming loans, foreclosed assets and repossessed assets.  At March 31, 2011, nonperforming assets totaled $121.1 million compared to $133.4 million at December 31, 2010.  The relative level of new loans moving to a nonperforming status has declined as our efforts to proactively address credit risks have taken hold.  During 2010, we completed an independent re-evaluation of our commercial loan portfolio.  At the same time, significant progress has been made to accelerate workout strategies with problem assets which led to several properties moving to other real estate owned which increased by $7.0 million in the first quarter of 2011.

Based on the loans currently in their redemption period, we expect reduced levels of loans moving into other real estate owned in the remaining quarters of 2011.  Proceeds from sales of foreclosed properties were $5.0 million in the first quarter 2011 resulting in a net gain of $212,000.  This is a decrease from the volume of sales in the first quarter of 2010 when we experienced proceeds of $5.7 million.

Nonperforming loans include loans on non-accrual status and loans delinquent more than 90 days but still accruing.  Foreclosed and repossessed assets include assets acquired in settlement of loans.  As of March 31, 2011, nonperforming loans totaled $56.1 million or 4.86% of total portfolio loans, compared to $75.4 million, or 6.19% of total portfolio loans, at December 31, 2010. 

Loans for development or sale of 1-4 family residential properties comprised the largest portion of non-performing loans.  They were approximately $20.7 million, or 36.9% of total non-performing loans, at March 31, 2011 compared to $22.1 million, or 29.3% of total non-performing loans, at December 31, 2010.  The remaining balance of non-performing loans at March 31, 2011 consisted of $22.3 million of commercial real estate loans secured by various types of non-residential real estate, $11.2 million of commercial and industrial loans, and $1.9 million of consumer and residential mortgage loans.

Foreclosed assets totaled $65.0 million at March 31, 2011 compared to $58.0 million at December 31, 2010.  Of this balance, there were properties from 152 commercial real estate loan relationships totaling approximately $57.3 million. The remaining balance was comprised of 58 residential mortgage properties totaling approximately $7.7 million.  All properties acquired through or in lieu of foreclosure are initially transferred at their fair value less costs to sell and then evaluated for impairment after transfer using a lower of cost or market approach.

The following table shows the composition and amount of our nonperforming assets (dollars in thousands):

 

March 31,
2011

 

December 31,
2010

Nonaccrual loans

$

55,612

 

$

74,761

Loans 90 days past due and still accruing

 

485

 

 

600

  Total nonperforming loans (NPLs)

 

56,097

 

 

75,361

Foreclosed assets

 

64,992

 

 

57,984

Repossessed assets

 

22

 

 

50

Other real estate held for sale

 

0

 

 

0

  Total nonperforming assets (NPAs)

 

121,111

 

 

133,395

Accruing restructured loans (ARLs) (1)

 

28,616

 

 

25,395

  Total NPAs and ARLs

$

149,727

 

$

158,790

NPLs to total loans

 

4.86%

 

 

6.19%

NPAs to total assets

 

7.79%

 

 

8.45%


 

(1)

Comprised of approximately $14.6 million and $12.1 million of commercial loans and $14.0 million and $13.3 million of consumer loans whose terms have been  restructured at March 31, 2011 and December 31, 2010, respectively.  Interest is being accrued on these loans under their restructured terms as they are less than 90 days past due.


 


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Allowance for loan losses:  The allowance for loan losses at March 31, 2011 was $42.3 million, a decrease of $5.1 million compared to $47.2 million at December 31, 2010.  The balance of the allowance for loan losses represented 3.67% of total portfolio loans compared to 3.90% of total portfolio loans at December 31, 2010.  While this ratio decreased, the more important allowance to nonperforming loan coverage ratio increased significantly from 62.93% at December 31, 2010 to 75.48% at March 31, 2011. 

The continued reduction in net charge-offs over the past four quarters has a significant effect on the historical loss component of our allowance for loan loss computation as does the improvements in our credit quality metrics.  The table below shows the changes in these metrics over the past five quarters:



(in millions)

Quarter Ended
March 31,
2011

 

Quarter Ended
December 31,
2010

 

Quarter Ended
September 30,
2010

 

Quarter Ended
June 30,
2010

 

Quarter Ended
March 31,
2010

Commercial loans

$  886.4

 

$  933.9

 

 

$  973.6

 

 

$  1,047.4

 

 

$  1,112.6

 

Nonperforming loans

56.1

 

75.4

 

 

84.4

 

 

95.1

 

 

102.5

 

Other real estate owned and repo
  assets


65.0

 


58.0

 

 


54.1

 

 


48.8

 

 


45.9

 

Total nonperforming assets

121.1

 

133.4

 

 

138.6

 

 

143.8

 

 

148.4

 

Net charge-offs

3.6

 

5.2

 

 

4.6

 

 

6.3

 

 

13.6

 

Total delinquencies

41.2

 

55.7

 

 

81.1

 

 

94.2

 

 

124.8

 

Nonperforming loans have continually declined since the first quarter of 2010 ending at $56.1 million at March 31, 2011, which is our lowest level of nonperforming loans since the third quarter of 2007.  As discussed earlier, our net charge-offs for the first quarter 2011 were $3.6 million, our lowest level since the third quarter of 2008.  Perhaps even more importantly, our total delinquencies have continued to decline as well, going from $124.8 million at March 31, 2010 to $41.2 million at March 31, 2011.  Recent appraisals and market trends associated with real estate valuations have shown some stabilization in real estate values, contributing to a reduction in loan charge-offs on collateral dependent loans. 

As discussed earlier, the sustained reduced level of quarterly net charge-offs have a significant effect on our 18 month historical loss ratios, which are the base for our allowance for loan loss computation.  The change in the 18 month historical loss ratios from December 31, 2010 to March 31, 2011 reduced the historical loss allocations in our allowance computation by $5 million.

These factors all provide for a reduction in our provision for loan losses.  The provision for loan losses decreased $21.2 million to a negative $1.45 million for the three months ended March 31, 2011 compared to $19.7 million for the same period of 2010.  Net charge-offs were $3.6 million and $13.6 million for the three months ended March 31, 2011 and 2010, respectively.  The ratio of net charge-offs to average loans was 1.23% on an annualized basis for the first quarter of 2011 compared to 1.66% for the fourth quarter of 2010, 1.41% for the third quarter of 2010, 1.79% for the second quarter of 2010 and 3.68% for the first quarter of 2010.

We are encouraged by the reduced level of charge-offs over the past year.  We do, however, recognize that future chargeoffs and resulting provisions for loan losses are expected to be impacted by the timing and extent of changes in the overall economy and the real estate markets.  We believe that we are beginning to see some stabilization in the pace of decline in economic conditions and real estate markets.  However, we expect it to take additional time for sustained improvement in the economy and real estate markets in order for us to reduce our non-performing and impaired loans to acceptable levels. 

Our allowance for loan losses is maintained at a level believed appropriate based upon our monthly assessment of the probable estimated losses inherent in the loan portfolio.  Our methodology for measuring the appropriate level of allowance and related provision for loan losses relies on several key elements, which include specific allowances for loans considered impaired, general allowance for commercial loans not considered impaired based upon applying

 


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our loan rating system, and general allocations based on historical trends for homogeneous loan groups with similar risk characteristics.

Overall impaired loans decreased to $76.7 million at March 31, 2011 down from $92.2 million at December 31, 2010 and $111.7 million at March 31, 2010.  The specific allowance for impaired loans increased $1.2 million to $8.6 million, or 11.2% of total impaired loans, at March 31, 2011 compared to $7.4 million, or 7.8% of total impaired loans, at December 31, 2010.  The decline in impaired loans was from migration to other real estate owned, payoffs and upgrades more than offsetting new loans moving into an impaired status.  As previously discussed in this Item 2 under the heading "Portfolio Loans and Asset Quality", this decline was consistent with a relative decline in the level of loans moving to a nonperforming status.  Charge-offs totaling $23.4 million had previously been taken on impaired loans, bringing the balance to $76.7 million as of March 31, 2011.  Combined with the $8.6 million specific reserves at March 31, 2011, these loans have been written down 29%.

The general allowance allocated to commercial loans that were not considered to be impaired was based upon the internal risk grade of such loans.  We use a loan rating method based upon an eight point system. Loans are stratified between real estate secured and non real estate secured.  The real estate secured portfolio is further stratified by the type of real estate.  Each stratified portfolio is assigned a loss allocation factor.  A lower grade assigned to a loan category generally results in a greater allocation percentage.  Changes in risk grade of loans affect the amount of the allowance allocation. 

The determination of our loss factors is based upon our actual loss history by loan grade and adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the analysis date. We use a rolling 18 month actual net chargeoff history as the base for our computation.  The 18 month period ended March 31, 2011 reflected a sizeable decrease in net chargeoff experience.  We addressed this volatility in the qualitative factor considerations applied in our allowance computation as discussed above.  Adjustments to the qualitative factors also involved consideration of different loss periods for the Bank, including 18 and 24 month periods.  Considering the change in our qualitative factors and the decrease in our commercial loan portfolio balances, the general commercial loan allowance decreased to $37.9 million at March 31, 2011 compared to $42.0 million at December 31, 2010.  This resulted in a general reserve percentage allocated at March 31, 2011 of 4.28% of commercial loans, a decrease from 4.50% at December 31, 2010.

Groups of homogeneous loans, such as residential real estate and open- and closed-end consumer loans, receive allowance allocations based on loan type.  As with commercial loans that are not considered impaired, the determination of the allowance allocation percentage is based principally on our historical loss experience.  These allocations are adjusted for consideration of general economic and business conditions, credit quality and delinquency trends, collateral values, and recent loss experience for these similar pools of loans.  The homogeneous loan allowance was $3.9 million at March 31, 2011 compared to $5.0 million at December 31, 2010.  The decrease was related to significant improvements in delinquencies in both residential mortgage and consumer loan portfolios in the first quarter. 

The allowance allocations are not intended to imply limitations on usage of the allowance. The entire allowance is available for any loan losses without regard to loan type. 

The Bank's Special Asset Group remains active at accelerating workout strategies and right-sizing troubled credits through debt restructuring.  The Bank's Loan Review Department is focused on the evaluation of all credits upon renewal, inception, or modification, all credits upon request for downgrade or upgrade within the Bank's loan rating system and independently reviewing all commercial credits on an annual basis.  These efforts, coupled with the impact of the lasting economic slowdown, may result in additional losses.

Although we believe our allowance for loan losses has captured the losses that are probable in our portfolio as of March 31, 2011, there can be no assurance that all losses have been identified or that the amount of the allowance is sufficient.

 


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Deposits and Other Borrowings:  Because of the decline in assets during the first quarter of 2011, we were able to continue to reduce our level of higher cost deposits. Total deposits decreased $12.0 million to $1.26 billion at March 31, 2011 compared to $1.28 billion at December 31, 2010.  The decline was primarily due to a $5.6 million decrease in deposits generated through brokers and a $27.4 million decrease in local certificates of deposit, offset partially by increases in other local deposits types. 

For our in-market deposits, we continued to experience a shift from interest bearing transaction accounts to noninterest bearing checking accounts.  We have had a decline in more rate sensitive interest bearing personal checking balances offset by an increase in commercial checking balances.  The overall stability of in-market deposits is particularly noteworthy considering the financial challenges we have experienced, the lack of economic expansion in western Michigan and the intense competition for core deposit growth in our markets.  We believe the stability in balances of personal and business checking and savings accounts was primarily attributable to our focus on quality customer service, the desire of customers to deal with a local bank, the convenience of our maturing branch network and the breadth and depth of our product line.

Other borrowed funds, consisting of Federal Home Loan Bank advances, decreased $11.1 million during the first quarter of 2011 as a result of scheduled maturities.

CAPITAL RESOURCES

Total shareholders' equity of $69.2 million at March 31, 2011 increased $1.3 million from $67.8 million at December 31, 2010.  The increase was primarily from the $1.3 million net income earned in the first quarter of 2011.

Our regulatory capital ratios improved in the first quarter of 2011.  On a consolidated basis, our total capital to risk-weighted assets was 10.3% at March 31, 2011 compared to 9.7% at December 31, 2010, 9.3% at September 30, 2010, 8.8% at June 30, 2010 and 8.3% at March 31, 2010. Our Tier 1 Capital as a percent of average assets was 5.8%, 5.8%, 5.4%, 5.3% and 4.8%, respectively at March 31, 2011, December 31, 2010, September 30, 2010, June 30, 2010 and March 31, 2010.  The ratios have increased each quarter since March 31, 2010 from both a decline in risk weighted assets and the positive earnings for each quarter.  Approximately $22.8 million of the $40.0 million of trust preferred securities outstanding at March 31, 2011 qualified as Tier 1 capital.  The remaining $17.2 million qualified as Tier II capital, a component of total risk-based capital. 

We continued to suspend payments of cash dividends on our preferred stock during the quarter and until further action by the Board of Directors.  During any period that we do not declare and pay cash dividends on our preferred stock, we may not declare and pay cash dividends on our common stock.  During the quarter, we also continued to exercise our right to defer interest payments on our trust preferred securities for 20 consecutive quarters or until such earlier time as is determined by further action of the Board of Directors.  During any deferral period, we may not declare or pay any dividends on our common stock or preferred stock or make any payment on any outstanding debt obligations that rank equally with or junior to the trust preferred securities.

The Bank was categorized as "adequately capitalized" at March 31, 2011.  The Bank's regulatory capital ratios exceeded the levels ordinarily required to be categorized as "well capitalized' at March 31, 2011.  However, because the Bank is subject to the Consent Order, the Bank cannot be categorized as "well capitalized" regardless of its actual capital levels.  Under the Consent Order, the Bank is required to have and maintain a Tier 1 Leverage Capital Ratio of at least 8% and a Total Risk Based Capital Ratio of at least 11%.  At March 31, 2011, the Bank was not in compliance with these capital ratios.  The Bank needed a capital injection of approximately $14.0 million as of March 31, 2011 to comply with the Tier 1 Leverage Capital Ratio requirement and needed a capital injection of approximately $7.1 million to comply with the Total Risk Based Capital Ratio requirement of the Consent Order.  This has improved significantly since March 31, 2010 when the Company needed a capital injection of $43.2 million to comply with the Tier 1 Leverage Capital Ratio requirement.

 


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The Company also remains active at exploring alternatives to raise new capital.  In February 2011, the Company filed a registration statement with the Securities and Exchange Commission to offer shares of common stock in a rights offering and a public offering in order to raise equity capital. On March 25, 2011, the Company's shareholders approved an increase in authorized common shares from 40 million to 200 million.


LIQUIDITY

Liquidity of Macatawa Bank:  The liquidity of a financial institution reflects its ability to manage a variety of sources and uses of funds.  Our Consolidated Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus on developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for our investment and loan portfolios.  Our sources of liquidity include our borrowing capacity with the FRB's discount window, the Federal Home Loan Bank, federal funds purchased lines of credit and other secured borrowing sources with our correspondent banks, loan payments by our borrowers, maturity and sales of our securities available for sale, growth of our deposits and deposit equivalents, federal funds sold, and the various capital resources discussed above.

Liquidity management involves the ability to meet the cash flow requirements of our customers.  Our customers may be either borrowers with credit needs or depositors wanting to withdraw funds.  Our liquidity management involves periodic monitoring of our assets considered to be liquid and illiquid, and our funding sources considered to be core and non-core and short-term (less than 12 months) and long-term.  We have established parameters that monitor, among other items, our level of liquid assets to short-term liabilities, our level of non-core funding reliance and our level of available borrowing capacity.  We maintain a diversified wholesale funding structure and actively manage our maturing wholesale sources to reduce the risk to liquidity shortages.  We have also developed a contingency funding plan to stress test our liquidity requirements arising from certain events that may trigger liquidity shortages, such as rapid loan growth in excess of normal growth levels or the loss of deposits and other funding sources under extreme circumstances.

As described in Note 1 of the Consolidated Financial Statements under the heading "Regulatory Developments," we are subject to certain deposit gathering restrictions, including our ability to accept, renew or rollover brokered deposits.  Because of this, and in response to the volatile conditions in the national markets, we have actively pursued initiatives to further strengthen our liquidity position. 

The Bank continued to make significant progress during 2010 and the first quarter of 2011 to intentionally reduce its reliance on non-core funding sources, including brokered deposits, and remains focused on maintaining a non-core funding dependency ratio below its peer group average.  During 2010, we reduced our brokered deposits by $158.4 million and other borrowed funds by $92.7 million. In the first quarter of 2011, brokered deposits declined another $5.6 million and other borrowed funds declined by $11.1 million.  Since December 31, 2008, we have reduced our brokered deposits by $295.3 million.  The Bank had $42.6 million of brokered deposits outstanding at March 31, 2011, all of which mature in 2011.

Further decreases in the loan portfolio and total assets are planned and are expected to provide adequate funds to pay off the brokered deposits upon maturity.

The Bank also held $238.4 million of short-term investments and had available borrowing capacity from correspondent banks of approximately $117.2 million as of March 31, 2011 to provide additional liquidity as needed.

Liquidity of Holding Company:  The primary sources of liquidity for the Company are dividends from the Bank, existing cash resources and the various capital resources discussed above.  Banking regulations and the laws of the State of Michigan in which our Bank is chartered limit the amount of dividends the Bank may declare to the Company in any calendar year.  Under the state law limitations, the Bank is restricted from paying dividends to the Company until its deficit retained earnings has been restored.  At March 31, 2011, the retained earnings deficit of the Bank was approximately $37.9 million.  Throughout 2009, 2010 and the first quarter of 2011, the Company has

 


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not received dividends from the Bank and we have not paid any dividends to our common shareholders.  Under the Consent Order and the Written Agreement, the Bank and the Company may not pay any dividends without prior regulatory approval.

The Company continued to suspend payments of cash dividends on its preferred stock during 2010 and the first quarter of 2011 until further action is taken by the Board of Directors.  During the period that the Company does not declare and pay cash dividends on its preferred stock, it may not declare and pay cash dividends on its common stock.

During 2010 and the first quarter of 2011, the Company also continued to exercise its right to defer interest payments on its trust preferred securities for 20 consecutive quarters or until such earlier time as is determined by further action of the Board of Directors.  During the deferral period, the Company may not declare or pay any dividends on its common stock or preferred stock or make any payment on any outstanding debt obligations that rank equally with or junior to the trust preferred securities.

In order to temporarily replenish the Company's liquidity pending the Company's planned public offering of common stock, on April 21, 2011, the Company issued and sold a 2% Subordinated Note due 2018 in the aggregate principal amount of $1,000,000 to a director of the Company.  The note has an interest rate of 2%, compounded quarterly in arrears.  Accrued interest is payable in full at maturity, or at the date the principal is paid in full.  The note has a maturity date of April 30, 2018.  The Company may prepay the note in whole or in part at any time from and after September 30, 2011.  If and when the Company conducts a registered public offering of its common stock prior to April 30, 2012, the note allows the holder to purchase shares offered in the public offering and to pay the cash price of shares purchased in the public offering by delivering the note to the Company at a value equal to the principal and interest accrued.  The holder also has a continuing right to convert the note in full into common stock with the stock to be valued at book value and the note to be valued at principal and interest accrued.

The Company continues to believe it has a prudent liquidity plan to meet its cash-flow requirements during 2011.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES:

To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information.  These estimates and assumptions affect the amounts reported in the financial statements and future results could differ.  The allowance for loan losses, other real estate owned valuation, loss contingencies and income taxes are deemed critical due to the required level of management judgment and the use of estimates, making them particularly subject to change.

Our methodology for determining the allowance for loan losses and the related provision for loan losses is described above in the "Allowance for Loan Losses" discussion.  This area of accounting requires significant judgment due to the number of factors which can influence the collectability of a loan.  Unanticipated changes in these factors could significantly change the level of the allowance for loan losses and the related provision for loan losses.  Although, based upon our internal analysis, and in our judgment, we believe that we have provided an adequate allowance for loan losses, there can be no assurance that our analysis has properly identified all of the probable losses in our loan portfolio.  As a result, we could record future provisions for loan losses that may be significantly different than the levels that we recorded in the first quarter of 2011.

Assets acquired through or instead of foreclosure, primarily other real estate owned, are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis.  New real estate appraisals are generally obtained at the time of foreclosure and are used to establish fair value.  If fair value declines, a valuation allowance is recorded through expense.  Estimating the initial and ongoing fair value of these properties involves a number of factors and judgments including holding time, costs to complete, holding costs, discount rate, absorption and other factors.

Loss contingencies are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.  This, too, is an accounting area that involves significant judgment.  Although, based

 


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upon our judgment, internal analysis, and consultations with legal counsel we believe that we have properly accounted for loss contingencies, future changes in the status of such contingencies could result in a significant change in the level of contingent liabilities and a related impact to operating earnings.

Our accounting for income taxes involves the valuation of deferred tax assets and liabilities primarily associated with differences in the timing of the recognition of revenues and expenses for financial reporting and tax purposes.  At March 31, 2011, we had gross deferred tax assets of $28.0 million, gross deferred tax liabilities of $2.7 million and a valuation allowance of $25.3 million for the entire amount of net deferred tax assets.  Accounting standards require that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a "more likely than not" standard.  Based upon a number of factors, including our net operating loss in recent years and the challenging environment currently confronting banks that could negatively impact future operating results, we concluded that we needed to continue to maintain a valuation allowance during the first quarter of 2011 for our net deferred tax assets. Changes in tax laws, changes in tax rates, changes in ownership and our future level of earnings can impact the ultimate realization of our net deferred tax asset as well as the valuation allowance that we established.

Item 4:

CONTROLS AND PROCEDURES

 

 

(a)

Evaluation of Disclosure Controls and Procedures.  Under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), as of March 31, 2011, the end of the period covered by this report.

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as the Company's are designed to do, and management necessarily was required to apply its judgment in evaluating whether the benefits of the controls and procedures that the Company adopts outweigh their costs.

Our CEO and CFO, after evaluating the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d‑15(e)) as of the end of the period covered by this report, have concluded that the Company's disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms.

 

 

(b)

Changes in Internal Controls.  During the period covered by this report, there have been no changes in the Company's internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company's internal control over financial reporting.



PART II - OTHER INFORMATION

Item 1.

Legal Proceedings.

As of the date hereof, there were no material pending legal proceedings, other than routine litigation incidental to the business of banking, to which we or any of our subsidiaries are a party or of which any of our properties are the subject.


Item 3.

Defaults Upon Senior Securities.

None.

 


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Item 6.

Exhibits.

 

 

3.1

Restated Articles of Incorporation.

 

 

3.2

Bylaws.  Previously filed with the Commission on November 24, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 3.1.  Here incorporated by reference.

 

 

3.3

Certificate of Designation of Series A Noncumulative Convertible Perpetual Preferred Stock.  Previously filed with the Commission on November 5, 2008 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.

 

 

3.4

Certificate of Designation of Series B Noncumulative Convertible Perpetual Preferred Stock.  Previously filed with the Commission on July 2, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.

 

 

4.1

Restated Articles of Incorporation.  Exhibit 3.1 is here incorporated by reference.

 

 

4.2

Bylaws.  Exhibit 3.2 is here incorporated by reference.

 

 

4.3

Certificate of Designation of Series A Noncumulative Convertible Perpetual Preferred Stock.  Exhibit 3.3 is here incorporated by reference.

 

 

4.4

Certificate of Designation of Series B Noncumulative Convertible Perpetual Preferred Stock.  Exhibit 3.4 is here incorporated by reference.

 

 

4.5

First Amended Settlement and Release and Warrant Issuance Agreement dated January 30, 2009.  Previously filed with the Commission on January 30, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 10.1.  Here incorporated by reference.

 

 

4.6

Second Amendment to Settlement and Release and Warrant Issuance Agreement dated April 30, 2009.  Previously filed with the Commission on May 8, 2009 in Macatawa Bank Corporation's Quarterly Report on Form 10-Q, Exhibit 10. Here incorporated by reference.

 

 

4.7

Warrant Agreement between the Company and Registrar and Transfer Company dated June 16, 2009.  Previously filed with the Commission on June 19, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1.  Here incorporated by reference.

 

 

4.8

Warrant Agreement Addendum between the Company and Registrar and Transfer Company dated July 27, 2009.  Previously filed with the Commission on July 31, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.

 

 

4.9

Form of Warrant Certificate (first series).  Previously filed with the Commission on June 19, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.2. Here incorporated by reference.

 

 

4.10

Form of Warrant Certificate (second series).  Previously filed with the Commission on July 31, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.2. Here incorporated by reference.

 

 

4.11

Long-Term Debt.  The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets.  The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the SEC upon request.


 


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10.1

Written Agreement with the Federal Reserve Bank of Chicago.  Previously filed with the Commission on July 29, 2010 in Macatawa Bank Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, Exhibit 10.1.  Here incorporated by reference.

 

 

31.1

Certification of Chief Executive Officer.

 

 

31.2

Certification of Chief Financial Officer.

 

 

32.1

Certification pursuant to 18 U.S.C. Section 1350.













 


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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.


 

MACATAWA BANK CORPORATION

 

 

 

 

 

 

 

 

 

/s/ Ronald L. Haan

 

Ronald L. Haan
Chief Executive Officer
(Principal Executive Officer)

 

 

 

 

 

/s/ Jon W. Swets

 

Jon W. Swets
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)



Dated:  April 28, 2011










 


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EXHIBIT INDEX

Exhibit

Description

 

 

3.1

Restated Articles of Incorporation.

 

 

3.2

Bylaws.  Previously filed with the Commission on November 24, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 3.1.  Here incorporated by reference.

 

 

3.3

Certificate of Designation of Series A Noncumulative Convertible Perpetual Preferred Stock.  Previously filed with the Commission on November 5, 2008 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.

 

 

3.4

Certificate of Designation of Series B Noncumulative Convertible Perpetual Preferred Stock.  Previously filed with the Commission on July 2, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.

 

 

4.1

Restated Articles of Incorporation.  Exhibit 3.1 is here incorporated by reference.

 

 

4.2

Bylaws.  Exhibit 3.2 is here incorporated by reference.

 

 

4.3

Certificate of Designation of Series A Noncumulative Convertible Perpetual Preferred Stock.  Exhibit 3.3 is here incorporated by reference.

 

 

4.4

Certificate of Designation of Series B Noncumulative Convertible Perpetual Preferred Stock.  Exhibit 3.4 is here incorporated by reference.

 

 

4.5

First Amended Settlement and Release and Warrant Issuance Agreement dated January 30, 2009.  Previously filed with the Commission on January 30, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 10.1.  Here incorporated by reference.

 

 

4.6

Second Amendment to Settlement and Release and Warrant Issuance Agreement dated April 30, 2009.  Previously filed with the Commission on May 8, 2009 in Macatawa Bank Corporation's Quarterly Report on Form 10-Q, Exhibit 10. Here incorporated by reference.

 

 

4.7

Warrant Agreement between the Company and Registrar and Transfer Company dated June 16, 2009.  Previously filed with the Commission on June 19, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1.  Here incorporated by reference.

 

 

4.8

Warrant Agreement Addendum between the Company and Registrar and Transfer Company dated July 27, 2009.  Previously filed with the Commission on July 31, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.

 

 

4.9

Form of Warrant Certificate (first series).  Previously filed with the Commission on June 19, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.2. Here incorporated by reference.

 

 

4.10

Form of Warrant Certificate (second series).  Previously filed with the Commission on July 31, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.2. Here incorporated by reference.

 

 

4.11

Long-Term Debt.  The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets.  The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the SEC upon request.


 


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10.1

Written Agreement with the Federal Reserve Bank of Chicago.  Previously filed with the Commission on July 29, 2010 in Macatawa Bank Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, Exhibit 10.1.  Here incorporated by reference.

 

 

31.1

Certification of Chief Executive Officer.

 

 

31.2

Certification of Chief Financial Officer.

 

 

32.1

Certification pursuant to 18 U.S.C. Section 1350.












 


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