Macatawa Bank Corporation is a Michigan corporation and is the holding company for a wholly owned subsidiary, Macatawa Bank and for two trusts, Macatawa Statutory Trust I and Macatawa Statutory Trust II. Macatawa Bank is a Michigan chartered bank with depository accounts insured by the Federal Deposit Insurance Corporation. 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 and brokerage 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 the Company's financial statements. For further information regarding consolidation, see the Notes to the Consolidated Financial Statements included herein.

Since opening in November of 1997, Macatawa Bank has generally experienced rapid growth. We believe that growth in core deposits is key to our long-term success and it is our primary funding source for asset growth. Establishing a branching network in our markets has been of high importance in order to facilitate this core deposit growth. We have and continue to enjoy success in building new and existing relationships through our branch network in the Holland/Zeeland, greater Grand Rapids and Grand Haven markets. We have gained community awareness and acceptance in our markets through our branch network and high quality service standards.

Up until the end of 2007, the West Michigan markets within which we operate have historically provided significant expansion opportunities. The weak local and national economic conditions that have persisted during this time have resulted in slower growth or contraction within most industry segments within our markets. These poor economic conditions within our markets have contributed to the decline in our financial performance and asset quality. Accordingly, we have slowed our overall asset growth to focus on improving our financial condition, including asset quality amidst the weak economic conditions in West Michigan. When economic conditions and our financial performance improve, we will again assess the prospects for future branch expansion and growth in our balance sheet.

RESULTS OF OPERATIONS

Summary: Net loss available to common shares for the quarter ended September 30, 2009 was $20.9 million, compared to third quarter 2008 net income of $1.9 million. Loss per common share on a diluted basis was $1.18 for the third quarter of 2009 compared to earnings per common share of $0.11 for the same period in 2008. Net loss available to common shares for the nine months ended September 30, 2009 was $57.3 million compared to a net loss of $3.8 million for the same period in the prior year. Loss per common share on a diluted basis was $3.30 for the nine months ended September 30, 2009 compared to $0.22 for the same period in the prior year.

Both the three and nine month periods ended September 30, 2009 were significantly impacted by the cost associated with problem loans and non-performing assets. The provision for loan losses remained elevated and was $21.6 million and $52.7 million for the three and nine months ended September 30, 2009 compared to $2.4 million and $23.6 million for the three and nine months ended September 30, 2008. Costs associated with nonperforming assets were $3.1 million and $7.7 million for the three and nine months ended September 30, 2009 compared to $1.6 million and $3.4 million for the three and nine months ended September 30, 2008. Lost interest from rising balances of non-performing assets was approximately $2.2 million and $6.8 million for the three and nine months ended September 30, 2009 compared to $1.4 million and $4.1 million for the three and nine months ended September 30, 2008. Each of these items is discussed more fully below.

The decrease in net income for the three months ended September 30, 2009 compared to the same period in 2008 was also partly due to an additional $6.8 million non-cash charge included in federal income tax expense to increase the valuation allowance for deferred tax assets.

Net Interest Income: Third quarter net interest income totaled $13.2 million, a decrease of $1.6 million as compared to the third quarter of 2008. Net interest income for the first nine months of 2009 totaled $39.4 million, a decrease of $5.2 million as compared to $44.6 million for the same period in 2008.

The decrease in net interest income for both the three and nine month periods was primarily from a decline in the fully taxable equivalent net interest income as a percentage of average interest-earning assets (i.e. "net interest margin" or "margin"). As customary in the banking industry, interest income on tax-exempt securities is adjusted in the computation of the yield on tax-exempt securities and net interest margin using a 35% tax rate to report these items on a fully taxable equivalent basis.

The net interest margin decreased 15 basis points to 2.83% for the third quarter of 2009 and 26 basis points to 2.75% for the first nine months of 2009 when compared to the same periods in the prior year. The net interest margin has steadily improved during 2009 despite the pressure from higher balances of non-performing assets; from 2.66% in the first quarter to 2.79% in the second quarter to 2.83% in the third quarter.

Approximately 16 basis points of the decline in margin or $1.1 million of the decrease in net interest income, and 19 basis points of the decline in margin or $2.8 million of the decrease in net interest income, respectively, for the three and nine month periods was from lost interest from higher balances of non-performing assets and interest reversals on loans moved into a non-accrual status. Also contributing to the margin decline for the nine month period was the Federal funds and prime rate cuts that occurred throughout 2008.

Average earning assets decreased $113.6 million to $1.87 billion for the third quarter of 2009 and $55.4 million to $1.92 billion for the nine month period ended September 30, 2009 compared to the same periods of the prior year.

During both the three and nine month periods, the decrease in the yield on earning assets exceeded the decrease in the cost of interest bearing funds and was the primary reason for the decline in the net interest margin. The yield on earning assets decreased by 72 basis points for the three months ended September 30, 2009 and 90 basis points for the nine months ended September 30, 2009 compared to the same periods in the prior year. The short-term interest rate cuts that began in the third quarter of 2007 and continued throughout 2008 caused a decrease in the yield on our variable rate loan portfolio and was the primary reason for the decrease in yield on earning assets. The decline was also impacted by an increase in lower yielding short-term investments and rising balances of non-accrual loans. The Company has chosen to hold excess investable funds in these lower yielding short-term investments to improve its balance sheet liquidity during the current economic downturn.

The rising balances of non-accrual loans throughout 2008 and into 2009 resulted in additional decline in the yield on earning assets of approximately 12 and 14 basis points, respectively, for the three and nine months ended September 30, 2009 compared to the same periods in the prior year. Average non-accrual loans were $96.7 million and $73.5 million for the three month periods ended September 30, 2009 and 2008, resulting in an estimated reduction of 39 basis points and 27 basis points, respectively, in the yield on earning assets for each period. Average non-accrual loans were $101.3 million and $75.6 million for the nine month periods September 30, 2009 and 2008, resulting in an estimated reduction of 40 basis points and 26 basis points, respectively, in the yield on earning assets for each period.

The cost of funds decreased 57 basis points for the three months ended September 30, 2009 and 67 basis points for the nine months ended September 30, 2009 compared to the same periods in the prior year. A decrease in the rates paid on our deposit accounts in response to declining market rates, the rollover of time deposits at lower rates, and the rollover and repositioning of other borrowings within the lower rate environment were the primary reasons for the decrease in the cost of funds.

The following table shows an analysis of net interest margin for the three month periods ending September 30, 2009 and 2008.

                                                                  For the three months ended September 30,
                                                          2009                                                2008
                                                           Interest       Average                             Interest       Average
                                                           Earned or      Yield or                            Earned or      Yield or
                                      Average Balance        paid           cost          Average Balance       paid           cost
                                                                           (Dollars in thousands)
Assets
Taxable securities                    $        101,553       $  1,002           3.94 %    $        114,099      $  1,210           4.24 %
Tax-exempt securities (1)                       51,144            537           6.47 %              51,355           542           6.49 %
Loans (2)                                    1,602,454         21,737           5.33 %           1,757,839        26,388           5.90 %
Federal Home Loan Bank stock                    12,275             99           3.17 %              12,275           164           5.22 %
Federal funds sold and other
short-term investments                         103,569            159           0.61 %              48,979           310           2.48 %
Total interest earning assets
(1)                                          1,870,995         23,534           5.01 %           1,984,547        28,614           5.73 %

Noninterest earning assets:
 Cash and due from banks                        25,035                                              27,947
 Other                                         105,385                                             129,571

Total assets                          $      2,001,415                                    $      2,142,065

Liabilities
Deposits:
  Interest bearing demand                      246,135            323           0.52 %    $        240,791           594           0.98 %
  Savings and money market
accounts                                       393,508            627           0.63 %             438,250         1,654           1.50 %
  Time deposits                                697,965          6,367           3.62 %             785,680         7,595           3.84 %
Borrowings:
  Other borrowed funds                         280,057          2,657           3.71 %             296,254         3,328           4.39 %
  Long-term debt                                41,238            366           3.48 %              41,238           600           5.69 %
  Federal funds purchased                          ---            ---            --- %               1,284             7           2.26 %
 Total interest bearing
liabilities                                  1,658,903         10,340           2.46 %           1,803,497        13,778           3.03 %

Noninterest bearing liabilities:
 Noninterest bearing demand
accounts                                       216,520                                             176,266
 Other noninterest bearing
liabilities                                      8,305                                              10,083
Shareholders' equity                           117,687                                             152,219

Total liabilities and
shareholders' equity                  $      2,001,415                                    $      2,142,065

Net interest income                                          $ 13,194                                           $ 14,836

Net interest spread (1)                                                         2.55 %                                             2.70 %
Net interest margin (1)                                                         2.83 %                                             2.98 %
Ratio of average interest
earning assets to
 average interest bearing
liabilities                                     112.79 %                                            110.04 %

(1) Yield adjusted to fully tax equivalent using a 35% tax rate.

(2) Includes non-accrual loans of approximately $96.7 million for the three months ended September 30, 2009 and approximately $73.5 million for the three months ended September 30, 2008.

                                                                  For the nine months ended September 30,
                                                          2009                                                2008
                                                           Interest       Average                             Interest       Average
                                                           Earned or      Yield or                            Earned or      Yield or
                                      Average Balance        paid           cost          Average Balance       paid           cost
                                                                           (Dollars in thousands)
Assets
Taxable securities                    $        112,020       $  3,368           4.01 %    $        131,620      $  4,350           4.41 %
Tax-exempt securities (1)                       51,393          1,618           6.46 %              51,400         1,627           6.49 %
Loans (2)                                    1,674,124         67,581           5.34 %           1,763,110        82,287           6.15 %
Federal Home Loan Bank stock                    12,275            291           3.13 %              12,275           491           5.25 %
Federal funds sold and other
short-term
 investments                                    73,437            331           0.60 %              20,218           375           2.44 %
 Total interest earning assets
(1)                                          1,923,249         73,189           5.10 %           1,978,623        89,130           6.00 %

Noninterest earning assets:
 Cash and due from banks                        23,507                                              27,216
 Other                                         108,947                                             124,420

Total assets                          $      2,055,703                                    $      2,130,259

Liabilities
Deposits:
  Interest bearing demand             $        237,249          1,078           0.61 %    $        250,971         2,448           1.30 %
  Savings and money market
accounts                                       404,027          2,194           0.73 %             413,605         5,629           1.82 %
  Time deposits                                756,778         21,127           3.73 %             761,409        23,683           4.15 %
Borrowings:
  Other borrowed funds                         275,243          8,165           3.91 %             314,925        10,562           4.42 %
  Long-term debt                                41,238          1,237           3.95 %              41,238         1,970           6.28 %
  Federal funds purchased                           68            ---            --- %               9,548           217           2.98 %
 Total interest bearing
liabilities                                  1,714,603         33,801           2.63 %           1,791,696        44,509           3.30 %

Noninterest bearing liabilities:
 Noninterest bearing demand
accounts                                       197,754                                             168,465
 Other noninterest bearing
liabilities                                      7,137                                               9,811
Shareholders' equity                           136,209                                             160,287

Total liabilities and
shareholders' equity                  $      2,055,703                                    $      2,130,259

Net interest income                                          $ 39,388                                           $ 44,621

Net interest spread (1)                                                         2.47 %                                             2.70 %
Net interest margin (1)                                                         2.75 %                                             3.01 %
Ratio of average interest
earning assets to
 average interest bearing
liabilities                                     112.17 %                                            110.43 %

(1) Yield adjusted to fully tax equivalent using a 35% tax rate.

(2) Includes non-accrual loans of approximately $101.3 million for the nine months ended September 30, 2009 and approximately $75.6 million for the nine months ended September 30, 2008.

The amounts of loan loss provision in both the current and prior year period were a byproduct of establishing our allowance for loan losses at levels deemed necessary in our methodology for determining the adequacy of the allowance. For more information about our allowance for loan losses and our methodology for establishing its level, see the discussion below under Portfolio Loans and Asset Quality.

Noninterest Income:Noninterest income for the three and nine month periods ended September 30, 2009 decreased to $3.6 million and $13.2 million, respectively, from $4.1 million and $14.2 million for the same periods in the prior year. Non-interest income for the nine month period ended September 30, 2008 included approximately $412,000, $243,000 and $832,000, respectively, of gains on the sale of securities, gains on the termination of certain borrowings and gains on the settlement of interest rate swaps.

Declines in revenue from deposit, trust and brokerage services during the third quarter of 2009 were the primary reasons for the $504,000 decline in noninterest income compared to the same period in the prior year. Revenue from deposit, trust and brokerage services was also down for the first nine months of 2009 compared to the same periods in the prior year. The decline in revenue from deposit services is related to a decrease in non-sufficient fund revenue, consistent with a decline across the entire banking industry. This decline was partially offset by an increase in other revenue sources from continued growth in core checking accounts and expansion of services to business customers. The decline in trust and brokerage service revenue is related to both a challenging market for account growth and retention and volatility in equity market valuations.

Increases in net gains from mortgage lending activities that happened in the first half of 2009 and revenue from ATM and debit card processing for the nine month period ended September 30, 2009 offset the declines in revenue noted above when compared to the same period in the prior year. The decline in mortgage rates that began in the first quarter of 2009 led to a significant increase in refinancing activity and is the primary reason for the $1.3 million increase in net gains on mortgage loans for the nine months ended September 30, 2009 compared to the same periods in the prior year.

Noninterest Expense:Noninterest expense for the three and nine month periods ended September 30, 2009 increased to $15.7 million and $51.5 million, respectively, from $14.0 million and $42.1 million for the same periods in the prior year. The increase for the nine month period ended September 30, 2009 included a $5.5 million one-time charge associated with the Trade Partners litigation settlement discussed in the Notes to the financial statements.

For the three and nine month periods ended September 30, 2009 costs associated with nonperforming assets increased to $3.1 million and $7.7 million, respectively, from $1.6 million and $3.4 million for the same periods in the prior year. Costs associated with nonperforming 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 subsequent reductions from value declines for outstanding properties.

                                   Three Months    Three Months     Nine Months     Nine Months
                                       Ended           Ended           Ended           Ended
                                   September 30,   September 30,   September 30,   September 30,
                                       2009            2008            2009            2008
Legal and professional               $       348     $       153     $     1,016     $       359
Repossessed and foreclosed
  property administration                  2,215             898           4,307           1,402
Losses on repossessed and
foreclosed
  properties                                 565             515           2,403           1,667
   Total                             $     3,128     $     1,566     $     7,726     $     3,428

FDIC assessments increased by $671,000 to $1.0 million for the third quarter of 2009 compared to $359,000 for the third quarter of 2008 and by $2.4 million to $3.5 million for the nine month period ended September 30, 2009 compared to the same period in the prior year. The increase for the nine month period includes an industry-wide special assessment, which amounted to $960,000 for Macatawa Bank. The remaining increase in FDIC assessments was from higher assessment rates implemented by the FDIC in late 2008.

When excluding the Trade Partners litigation settlement charge, nonperforming asset costs and FDIC assessments, non-interest expense would have been approximately $11.6 million for the three month period ended September 30, 2009, down 5% from $12.1 million for the same period of 2008; and would have been approximately $34.7 million for the nine month period ended September 30, 2009, down 8% from $37.6 million for the same period of 2008.

Expense reduction initiatives that began in early 2008 have allowed the Company to manage costs in nearly all other areas of non-interest expense to offset the increases driven by higher nonperforming asset levels. Salaries and benefit expense decreased $364,000, or 6%, and $1.7 million, or 9% for the three and nine month periods ended September 30, 2009 compared to the same periods of 2008 largely due to staff reductions that occurred in 2008 and a curtailment of bonuses and wage increases in response to the deteriorating economic conditions. We expect controllable expense reduction to continue to improve for the remainder 2009 in response to these initiatives.

Federal Income Tax Expense (Benefit): The Company recorded a federal income tax benefit of $600,000 for the three month period ended September 30, 2009 and federal income tax expense of $2.8 million for the nine month period ended September 30, 2009 compared to federal income tax expense of $639,000 and a federal income tax benefit of $3.1 million for the same periods in the prior year. Federal income tax expense for the three and nine month periods ended September 30, 2009 included a $6.8 and $21.7 million valuation allowance on deferred tax assets as described in the Notes to the financial statements. The impact of the valuation allowance was primarily offset by a tax benefit associated with the net operating loss recorded for each period.

FINANCIAL CONDITION

Summary: In light of the persistent weak economic conditions that began in 2008, management has focused its efforts in 2009 on reducing its loan portfolio in higher concentration areas to improve its financial condition through preservation of capital, improved on-balance sheet liquidity and reduced reliance on non-core funding. Total assets were $1.98 billion at September 30, 2009 a decrease of $167.6 million from $2.15 billion at December 31, 2008. The overall decrease in total assets reflected a decline of $217.2 million in our loan portfolio and $42.9 million in available for sale securities partially used to increase short-term investments by $108.4 million. The decline in assets was primarily offset by a decline in deposits generated through brokers and rate sensitive in-market deposits.

Securities Available for Sale: Securities available for sale were $141.8 million at September 30, 2009 compared to $184.7 million at December 31, 2008. The decrease was primarily due to calls and maturities of approximately $55.3 million of U.S. Government Agency bonds. The additional cash flow has been temporarily reinvested in liquid money market investments as discussed above. As conditions improve, the Company expects to reinvest excess liquidity and . . .