Changes in Financial Condition from December 31, 2007 to December 31, 2008 General. Monarch's total assets increased $12.6 million, or 4.5%, to $291.8 million at December 31, 2008 compared to $279.2 million at December 31, 2007. The most significant increase was in loans which increased $22.7 million. Loans. Monarch's net loan portfolio increased $22.7 million, or 10.1%, from $224.8 million at December 31, 2007 to $247.5 million at December 31, 2008. Gross loans increased $24.3 million, or 10.7%, from $227.2 million at December 31, 2007 to $251.4 million at December 31, 2008. The increase in the loan portfolio was the result of management's continued strategy to originate commercial loans. One-to-four family loans decreased $1.9 million as a result of this strategy. Commercial real estate loans increased $19.0 million and the Bank also experienced increases in the level of multifamily real estate, construction and commercial business loans due to the focus on commercial loan originations. Management expects future growth in the loan portfolio to come from increased originations of commercial real estate and commercial business loans. Securities. The Bank's security portfolio decreased $2.4 million, or 21.5%, to $9.0 million at December 31, 2008 from $11.3 million at December 31, 2007. Securities were 3.0% of total assets at December 31, 2008 as compared to 4.0% at December 31, 2007. Due to the Bank's dependence on borrowed funds and brokered CDs, Management did not consider growth in the investment portfolio to be prudent in 2008. Management purchases securities to maintain sufficient liquidity and to provide yield to offset declines in the loan portfolio when they occur.
Liabilities. Monarch's deposits increased $14.2 million, or 8.0%, to $192.2 million at December 31, 2008 compared to $177.9 million at December 31, 2007. This increase was primarily in money market accounts which increased $15.1 million. Brokered CDs increased from $38.2 million at December 31, 2007 to $39.4 million at December 31, 2008. The Bank has attempted to reduce its reliance on brokered and large, out of area CDs, although the success of this strategy is dependent on growing core deposits. Local CD deposits increased $489,000. Savings account balances decreased $940,000 million as we experience movement out of these types of accounts into higher yielding deposit account types. Other interest bearing checking accounts decreased $1.9 million. This decrease is seen as a normal balance fluctuation. Non-interest bearing deposit accounts increased $274,000. The Bank expects its non-interest bearing deposits to increase in the future as a result of strategies to attract more small business depositors and municipal depositors.
Federal Home Loan Bank advances increased $848,000, or 1.4%, to $60.2 million at December 31, 2008 from $59.3 million at December 31, 2007. We replaced maturing advances and increased our outstanding advances because the interest rates available on these borrowings were lower than the market interest rates for brokered CDs. For several years our strategy has been to replace borrowed funds and brokered CDs with lower costing core deposits. Our lack of growth in core deposits has made this a challenge.
Equity. Total equity amounted to $36.3 million at December 31, 2008 and $39.1 million at December 31, 2007, or 12.4% and 14.0%, respectively, of total assets at both dates. The decrease in equity resulted from the repurchase during 2008 of 272,000 shares of Company stock at a total cost of $2.7 million and dividends payments of $772,000. Net income for 2008 of $298,000 helped offset the equity reductions.

Average Balances, Net Interest Income, Yields Earned and Rates Paid The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made. All average balances are average daily balances.

                                                                Year Ended December 31,
                               2008                                                 2007
                              Average           Interest                           Average           Interest
                            Outstanding          Earned/         Yield/          Outstanding          Earned/         Yield/
                              Balance             Paid            Rate             Balance             Paid            Rate
                                                                 (dollars in thousands)
Fed Funds and
overnight deposits         $       8,170        $     102           1.25 %      $       7,373        $     389           5.28 %
Investment securities              9,951              428           4.30               13,445              599           4.46
Other securities                   4,174              209           5.01                4,174              188           4.50
Loans receivable (1)             238,838           16,457           6.89              229,451           16,369           7.13

Total earning assets       $     261,133        $  17,196           6.59        $     254,443        $  17,545           6.90


Demand and NOW
accounts                   $      32,032        $      95           0.30        $      32,619        $      78           0.24
Money market accounts             35,497            1,041           2.93               24,451              902           3.69
Savings accounts                  19,123               81           0.42               21,502               90           0.42
Certificates of
deposit                          103,569            4,644           4.48              103,970            5,037           4.84
Fed Funds Purchased                   56                -              -
Federal Home Loan
Bank advances                     55,106            2,675           4.85               57,268            3,115           5.44


Total interest
bearing liabilities        $     245,383            8,536           3.48              239,810            9,222           3.85

Net interest income                             $   8,660                                                8,323

Net interest spread                                                 3.11 %                                               3.05 %

Net interest margin                                                 3.32 %                                               3.27 %




                                                2006
                                               Average        Interest
                                             Outstanding       Earned/      Yield/
                                               Balance          Paid         Rate
       Fed Funds and overnight deposits
       Investment securities                $       6,913     $     380        5.50 %
       Other securities                            14,038           574        4.09

       Loans receivable (1)                         4,583           226        4.93
       Total earning assets                       228,613        16,107        7.05

                                            $     254,147     $  17,287        6.80


       Demand and NOW accounts
       Money market accounts                $      32,055     $      70        0.22
       Savings accounts                            19,304           617        3.20
       Certificates of deposit                     25,230           105        0.42
       Federal Home Loan Bank advances            105,179         4,626        4.40
       Total interest bearing liabilities          58,105         3,189        5.49

       Net interest income                  $     239,873         8,607        3.59

       Net interest spread                                    $   8,680

       Net interest margin                                                     3.21 %

                                                                               3.42 %

(1) Calculated net of deferred loan fees, loan discounts and loans in process. Nonaccrual loans are included in the average outstanding balance.

Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities. For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(1) changes in volume, which are changes in volume multiplied by the old rate,
and (2) changes in rate, which are changes in rate multiplied by the old volume.
Changes attributable to both rate and volume are shown as mixed.

                                      Year Ended December 31,                                     Year Ended December 31,
                                           2008 vs. 2007                                               2007 vs. 2006
                                                                     Total                                                      Total
                            Increase (Decrease) Due to             Increase             Increase (Decrease) Due to            Increase
                         Rate           Volume         Mix        (Decrease)         Rate          Volume         Mix        (Decrease)
                                                                        (in thousands)
Interest-earning
assets
Fed funds and
overnight deposits     $    (297 )     $      42         (32 )           (287 )    $    (15 )           25           (1 )              9
Investment
securities                   (21 )          (156 )         5             (171 )          51            (24 )         (2 )             25
Other securities              21               -           -               21           (20 )          (20 )          2              (38 )
Loans receivable            (559 )           670         (23 )             88           202            654         (594 )            262

Total
interest-earning
assets                 $    (855 )     $     556      $  (50 )    $      (349 )    $    219       $    635       $ (595 )    $       258


Interest-bearing
liabilities
Demand and NOW
accounts                      19              (1 )        (1 )             17             7              1            -                8
Money market
accounts                    (185 )           407         (84 )            139            95            165           25              285
Savings accounts               1             (10 )         -               (9 )           -            (15 )          -              (15 )
Certificates of
deposit                     (375 )           (19 )         1             (393 )         469            (53 )         (5 )            411
Fed Funds Purchased            -               -           -                -             -              -            -                -
Federal Home Loan
Bank advances               (335 )          (118 )        13             (440 )         (28 )          (46 )          0              (74 )

Total
interest-bearing
liabilities            $    (875 )     $     259      $  (71 )    $      (686 )    $    542       $     52       $   21      $       615

Net interest income                                               $       337                                                $      (357 )

Comparison of Results of Operations for the Years Ended December 31, 2008, 2007, and 2006
General. Monarch reported net income of $298,000 for the year ended December 31, 2008 compared to net income of $1.7 million for the year ended December 31, 2007 and net income of $1.5 million in 2006. The reasons for the change in net income for the years are discussed below.
Net Interest Income. Net interest income before provision for loan losses increased to $8.7 million for 2008 compared to $8.3 million in 2007 and matched $8.7 million in 2006. Our net interest margin has increased from 3.27% in 2007 to 3.32% in 2008 compared to the decline from 3.42% in 2006 to 3.27% 2007. The increase from 2007 to 2008 is primarily due to the bank's cost of funds decreasing more rapidly than its yield on earning assets. Management attributes this to the declining interest rate environment consistent throughout 2008. Previously the cost on interest-bearing liabilities increased more rapidly (3.59% in 2006 to 3.85 2007) than yields on interest-earning assets (6.80% in 2006 to 6.90% in 2007). Growing lower cost core deposits remains a challenge in our current market area. Our reliance on money market accounts, brokered CDs and FHLB borrowings continues to have an impact on our high cost of funds.

Interest Income. Total interest income in 2008 decreased $349,000 primarily from the decline in interest rates consistent through 2008. This followed a $258,000 increase in 2007 compared to 2006 due to increased interest income on loans. The modest increase in loan interest income in 2007 compared to 2006 was due to minimal growth in average loans outstanding and average yields. The decline in the average yield in 2008, (from 7.13% in 2007 to 6.89% in 2008) significantly offset the increase of $9.4 million in average loans outstanding from 2007 to 2008.
Interest Expense. Total interest expense increased $337,000 in 2008 compared to 2007. This followed an increase of $615,000 in 2007 compared to 2006. The increase in 2008 was primarily due to an increase in average money market accounts of $11.0 million from 2007 to 2008. The increase in 2007 was primarily the result of higher interest cost for money market accounts and CDs. Despite a decline in the average cost from 3.85% in 2007 to 3.48% in 2008. The Bank has seen its cost of funds increase because of increased market rates for CDs and further competition for money market deposits which has also resulted in higher rates being paid.
Provision for Loan Losses. The Bank recorded a provision for loan losses of $2.7 million in for the year ended December 31, 2008 compared to $971,000 for the same period in 2007. No provision for loan losses was recorded for 2006. The increased provision for 2008 was necessitated by net charge-offs of $1.8 million in 2008 and increased loan delinquencies at December 31, 2008 as compared to December 31, 2007. Nonperforming assets increased to 1.59% of assets at December 31, 2008 compared to .85% at December 31, 2007. These levels have increased over the previous two years (see "Selected Financial and Other Data"). The Bank did not record a provision in 2006 despite net charge-offs of $901,000 as Management believed its Allowance for Loan Losses to be adequate. Maintaining asset quality remains a priority and while Management believes our new loan originations over the last three years are of higher quality than those originated previously, more losses can be expected due to the economic conditions statewide and in the markets we operate in and provisions for loan losses in 2009 could approach the level of 2008. See "Loans" discussion above. Non-interest Income. Non-interest income decreased slightly to $3.6 million for the year ended December 31, 2008 compared to $3.9 million for 2007. 2007 saw an increase in income to $3.9 from $3.1 million for the year ended December 31, 2006. This represented a decrease of 9% in 2008 compared to 2007 which increased 26% compared to 2006.
Fees and service charges were $2.3 million for 2008, $2.5 million for 2007, $2.2 million for 2006. Income from the Bounce Protection program has increased from $1.3 million in 2006 to $1.4 million in 2008 due to increased customer usage, an increase in the per transaction fee which took effect in 2006 and a decrease in 2007 in the charge from the third party service provider of the program. Future increases in this source of income are dependent on the Bank increasing the number of checking account customers. Management does not expect significant increases in Bounce Protection income from its existing customer base. Income from brokering residential mortgage loans decreased to $41,000 in 2008 compared to $166,000 in 2007 compared to $64,000 in 2006. During 2006, the Bank developed new mortgage banking relationships with several brokerage companies. The Bank has continued to utilize these companies as a resource for lending opportunities. The Bank does not expect brokered loan income to be a significant source of income in the future. Loan fees have declined from $176,000 in 2006 to $94,000 in 2008 due to competitive pressures as well as lower originations of construction and consumer loans.
Gain on sale of loans decreased $41,000 in 2008 to $627,000 from $668,000 in 2007. Our strategy, which began in 2007 has been to sell as many of the residential mortgage originations as possible to manage the Bank's interest rate risk, credit risk and liquidity. This is a continuing strategy; management expects similar results in 2009 as seen in 2008 due to the decline in interest rates. Gains in 2008 represented a $265,000 increase over gains in 2006. Net gain on sale of premises and equipment was $0 in 2008, $49,000 in 2007 and $0 in 2006 as the Company closed and disposed of one of its branch locations in Coldwater in 2007.

Other income decreased $108,000 (from $325,000 in 2007 to $217,000 in 2008) after increasing $187,000 in 2007 compared to 2006. This is due to a net gain of $68,000 on sales of foreclosed properties in 2008 compared to a net gain $139 in 2007 compared to a net loss of $67,000 in 2006. These fluctuations were created by the Bank selling more foreclosed properties in 2008 as compared to either 2007 or 2006. The net gain on sales of foreclosed properties for 2008 compared to 2007 was also impacted by the decline in the housing market in 2008. The Bank does occasionally experience a gain on sale of foreclosed property, as it has become increasingly more conservative in valuing these properties upon acquisition. Management expects 2009 to be similar to 2008 in terms of foreclosure activity and thus potential gains or losses on subsequent sales of the foreclosed properties. The soft real estate market may lead to longer holding periods as well as larger losses on disposal as compared to recent years.
Non-interest Expense. Non-interest expenses have decreased since 2006 by 6%. We have sought to reduce certain expenses and slow the growth of other operating expenses in an attempt to improve our profitability. Management is confident that the actions taken to control expenses will not affect the Company's ability to fulfill its obligations to its customers and shareholders.
Salaries and employee benefits expense increased slightly from $4.5 million in 2007 to $4.6 million in 2008 as a result of normal increases in salaries and wages. There has been a decrease in expense from $5.0 million in 2006 to 4.6 million 2008 due to cost reduction measures implemented in 2006 including a 10% staff reduction, modifications to certain employee benefit programs and changes to the employee health program . These are expected to stabilize salaries and employee benefit costs in the future. Recruiting and retaining qualified staff continues to be a priority of Management.
Repossessed property expense has increased slightly from $207,000 in 2007 to $219,000 in 2008. Management attributes this increase to increased foreclosures and expects increases in 2009 due to the downturn in the economy. Repossessed property expense has decreased from $346,000 in 2006 to $219,000 in 2008. This is attributed management's continued focus on better management of properties during the holding period, better sales efforts that have led to shorter holding periods and decreased impairment write-downs due to better valuation techniques at the time of foreclosure.
Professional services expenses decreased to $401,000 in 2008 compared to $591,000 in 2007 as the expenses moved to similar levels previously experienced in 2006 and 2005. For the year ended December 31, 2007 we did experience an increase in professional services expense of $150,000 due to the costs incurred in the Company's attempt at going private. These costs in 2007 offset decreases the Company has experienced since 2006 in auditing expense, loan related legal fees and supervisory expenses. The Bank's supervisory expense has been reduced because of a charter conversion in 2006 which changed the Bank's primary regulator. We expect professional services expenses to increase in 2009 and beyond due to the Company's need to continue to comply with provisions of Sarbanes-Oxley.
Amortization expense of intangible assets has decreased consistent with the aging of the Core Deposit Intangible established upon the acquisition of MSB Financial in 2004. As indicated in Note 2 to the Company's financial statements, this expense will continually decline over the remaining life of the related asset.
Other general and administrative expense has decreased from $1.2 million in 2006 to $973,000 in 2007 compared to an increase to $1.2 million 2008. The increase from 2007 to 2008 is due to additional FDIC insurance coverage and an increase in advertising and marketing which was primarily attributable to costs incurred in conjunction with a more aggressive marketing strategy for 2008 that did not occur in 2007.
Federal Income Taxes. Our effective tax rate for purposes of the tax provision was 25.3% in 2008 compared to 24.3% in 2007, and 26% in 2006. The difference between the effective tax rates and the federal corporate income tax rate of 34% is attributable to the low income housing credits available to the Bank from the investment in the limited partnership as well as fluctuation of permanent book and tax differences such as non-taxable income and non-deductible expenses.

Liquidity and Commitments
We are required to maintain appropriate levels of liquid assets under FDIC regulations. Appropriate levels are determined by our Board of Directors and Management and are included in our asset liability management policy. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. We have maintained liquidity at levels above those believed to be adequate to meet the requirements of normal operations, including new loan funding and potential deposit outflows. At December 31, 2008, our liquidity ratio, which is our liquid assets as a percentage of total deposits less certificates of deposit maturing in more than one year and plus borrowings maturing in one year or less, was 5.0%. This level of liquidity is lower than that maintained last year. Management has taken steps to increase liquidity and is confident they will be able to effectively address the Bank's liquidity needs while facilitating increased profitability.
Monarch's liquidity, represented by cash and cash equivalents, is a product of our operating, investing and financing activities. Monarch's primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans, overnight deposits and funds provided from operations. While scheduled payments from the amortization of loans and overnight deposits are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Monarch also generates cash through borrowings. Monarch utilizes Federal Home Loan Bank advances to leverage its capital base and provide funds for its lending and investment activities, and to enhance its interest rate risk management.
Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in overnight deposits, including fed funds, and short-term treasury and governmental agency securities. On a longer term basis, Monarch maintains a strategy of investing in various investments and lending products. Monarch uses its sources of funds primarily to meet its ongoing commitments, to pay maturing certificates of deposit and savings withdrawals and to fund loan commitments. Certificates of deposit scheduled to mature in one year or less at December 31, 2008, totaled $58.8 million. Based on historical experience, management believes that a significant portion of these certificates of deposit can be retained by continuing to pay competitive interest rates.
If necessary, additional funding sources include additional deposits (including core deposits), brokered deposits, and Federal Home Loan Bank advances. Management is committed to increasing our core deposit balances but we have had difficulty doing so and core deposit growth may not be a significant source of liquidity in the future. Based on current collateral levels, at December 31, 2008, Monarch could borrow an additional $19.8 million from the Federal Home Loan Bank at prevailing interest rates. We anticipate we will continue to have sufficient funds, through deposits and borrowings, to meet our current commitments. For the year ended December 31, 2008, Monarch had a net decrease in cash and cash equivalents of $7.5 million as compared to a net decrease of $1.5 million for the year ended December 31, 2007.
The Company's primary sources of funds during 2008 were operations of $3.7 million, increase in deposits of $14.2 million and net proceeds from Federal Home Loan Bank advances of $1.8 million. The primary uses of funds in 2008 were an increase in net loan originations of $27.7 million and repurchases of the Company's stock of $2.7 million. . . .