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MCBC > SEC Filings for MCBC > Form 10-Q on 25-Oct-2012All Recent SEC Filings

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Form 10-Q for MACATAWA BANK CORP


25-Oct-2012

Quarterly Report


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 September 30, 2012, we had total assets of $1.52 billion, total loans of $1.02 billion, total deposits of $1.24 billion and shareholders' equity of $109.4 million. During the third quarter of 2012, we recognized net income of $6.6 million compared to net income of $1.05 million in the third quarter of 2011. This represented our tenth consecutive quarter of profitability. As described more fully below, continued reductions in net charge-offs and nonperforming loans led to a negative loan loss provision for the most recent quarter.

In response to our losses during 2008, 2009 and the first quarter of 2010, our Board of Directors implemented additional corporate governance practices and disciplined business and banking principles, including more conservative lending principles. The focus of our management team turned from growth in our business to executing these disciplined business and banking procedures and policies designed to limit future losses, preserve capital and improve operational efficiencies. In addition, the Board of Directors added experienced members to provide further oversight and guidance. These and other efforts were reflected in our results of operations for the past two years with lower levels of charge-offs and provision for loan losses, reductions in operating expenses and reduction in balance sheet totals resulting in improvement in our regulatory capital and liquidity ratios. We successfully completed our shareholder rights offering and public offering of common stock in June 2011 resulting in net proceeds of $20.3 million and contributed $10.0 million of the proceeds from the stock offering to the Bank retaining the remaining $10.3 million at the holding company. As of September 30, 2012, the Company's and the Bank's risk-based regulatory capital ratios were the highest they have ever been. The Bank was categorized as "well capitalized" at September 30, 2012.

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 entered into a Written Agreement with the FRB with an effective date of July 23, 2010. Upon completion of the Bank's 2011 joint examination, the FDIC and OFIR terminated the Bank's Consent Order effective March 2, 2012.

In connection with the termination of the Consent Order, the Bank reached an understanding with the regulators in the form of a Memorandum of Understanding ("MOU"). As of September 30, 2012, we believe that the Bank was in compliance in all material respects with all of the provisions of the MOU. As of the same date, we believe that the Company was in compliance in all material respects with all of the provisions of the Written Agreement. 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, MOU and the Written Agreement, are described in detail in our 2011 Annual Report on Form 10-K.

RESULTS OF OPERATIONS

Summary: Net income available to common shares for the quarter ended September 30, 2012 was $6.6 million, compared to net income of $1.05 million in the third quarter of 2011. Net income per common share on a diluted basis was $0.24 for the third quarter of 2012 and $0.04 for the third quarter of 2011. For the nine months ended September 30, 2012, net income was $14.3 million, compared to $4.7 million for the same period in 2011. Net income per common share on a diluted basis for the nine months ended September 30, 2012 was $0.53, compared to $0.22 for the same period in 2011.

The improvement in earnings in the third quarter and first nine months of 2012 was a continuation of improvement in the past several quarters, led by a significantly lower level of net charge-offs from $1.4 million in the third quarter of 2011 to a net recovery of $341,000 in the third quarter of 2012. This, coupled with a decline in non-performing and impaired loan levels, resulted in a negative provision for loan losses for the most recent quarter. The provision for loan losses was a negative $1.25 million for the three month periods ended September 30, 2012 and 2011. For the nine month period ended September 30, 2012, we recognized a negative $6.6 million provision for loan losses compared to a negative $4.7 million provision for loan losses for the same period in 2011. The increased negative provision for loan losses in the nine month period ended September 30, 2012 was largely attributable to a sizeable recovery recognized in the first quarter of 2012, as discussed in previous filings.

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Operating results in recent periods have been significantly impacted by the expense associated with problem loans and nonperforming assets. Apart from the provision for loan losses, expenses associated with nonperforming assets (including administration costs and losses) were $1.7 million for the third quarter of 2012 compared to $4.5 million for the third quarter of 2011. For the first nine months of 2012, these expenses totaled $8.0 million compared to $12.7 million for the same period in 2011. Valuation writedowns on other real estate owned and legal costs associated with nonperforming assets have significantly decreased in the three and nine month periods ended September 30, 2012 compared to the same periods in 2011. Lost interest from elevated levels of nonperforming assets was approximately $852,000 and $3.0 million, respectively, for the three and nine months ended September 30, 2012 compared to $1.6 million and $7.7 million, respectively, for the same periods in 2011. Each of these items is discussed more fully below.

Another factor positively impacting earnings for the three and nine month periods ending September 30, 2012 was the collection of a one-time prepayment penalty of $2.8 million on a commercial loan. This fee was reflected in net interest income.

Net Interest Income: Net interest income totaled $13.9 million for the third quarter of 2012 compared to $11.5 million for the third quarter of 2011. For the first nine months of 2012, net interest income was $36.5 million compared to $34.9 million for the same period in 2011.

The increase in net interest income in the third quarter of 2012 was due primarily to the collection of a one-time prepayment penalty of $2.8 million on a commercial loan. The net interest margin was 4.02% for the third quarter of 2012, of which 82 basis points related to the prepayment penalty, compared to 3.25% for the third quarter of 2011. Average interest earning assets decreased from $1.39 billion for the third quarter of 2011 to $1.37 billion for the same period in 2012. Our average yield on earning assets for the third quarter of 2012 increased 49 basis points compared to the same period in 2011 from 4.22% to 4.71%. Average interest bearing liabilities decreased $58.9 million from $1.11 billion for the third quarter of 2011 to $1.06 billion for the same period in 2012. The cost of average interest bearing liabilities decreased 31 basis points compared to the same period in 2011 from 1.20% to 0.89%.

Average interest earning assets decreased from $1.40 billion for the first nine months of 2011 to $1.36 billion for the same period in 2012. Our average yield on earning assets declined 5 basis points for the first nine months of 2012 in comparison with the same period in 2011. Our net interest margin was 3.56% for the first nine months in 2012 compared to 3.29% for the same period in 2011. The increase in margin was primarily due to the $2.8 million one-time prepayment penalty discussed above. Also positively affecting margin was a 34 basis points decline in the average cost of interest bearing liabilities, as we continued to payoff wholesale funding upon maturity.

Absent the $2.8 million one-time prepayment fee, our yields on interest earning assets would have decreased for the three and nine month periods ended September 30, 2012 due to decreases in the yield on our commercial, residential and consumer loan portfolios, which have repriced in the generally lower rate environment during this period. Our margin has been negatively impacted by our decision to hold significant balances in liquid and short-term investments during the past two years. As we deploy these balances in building our investment portfolio and booking high quality loans, we expect our margin to be positively impacted.

The declines in cost of funds for the three and nine month periods ended September 30, 2012 were due to 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. 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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Index

The following table shows an analysis of net interest margin for the three month periods ended September 30, 2012 and 2011.

                                               For the three months ended September 30,
                                          2012                                         2011
                                         Interest      Average                        Interest       Average
                          Average         Earned        Yield          Average         Earned         Yield
                          Balance         or paid      or cost         Balance        or paid        or cost
                                                        (Dollars in thousands)
Assets
Taxable securities      $    85,939     $     414           1.93 %   $    29,769     $      156           2.09 %
Tax-exempt securities
(1)                          16,685           102           4.05 %         1,165             10           5.70 %
Loans (2)                 1,038,704        15,532           5.89 %     1,090,465         14,498           5.22 %
Federal Home Loan
Bank stock                   11,236            84           2.92 %        11,236             73           2.56 %
Federal funds sold
and other short-term
investments                 214,602           137           0.25 %       255,601            163           0.25 %
Total interest
earning assets (1)        1,367,166        16,269           4.71 %     1,388,236         14,900           4.22 %

Noninterest earning
assets:
Cash and due from
banks                        25,191                                       24,912
Other                       124,017                                      118,547

Total assets            $ 1,516,374                                  $ 1,531,695

Liabilities
Deposits:
Interest bearing
demand                  $   230,246     $      82           0.14 %   $   185,619     $      106           0.22 %
Savings and money
market accounts             423,513           487           0.46 %       360,263            488           0.54 %
Time deposits               243,877           827           1.35 %       352,339          1,510           1.70 %
Borrowings:
Other borrowed funds        117,005           594           1.99 %       175,355            944           2.10 %
Long-term debt               41,238           387           3.68 %        41,238            351           3.34 %
Total interest
bearing liabilities       1,055,879         2,377           0.89 %     1,114,814          3,399           1.20 %

Noninterest bearing
liabilities:
Noninterest bearing
demand accounts             347,476                                      316,916
Other noninterest
bearing liabilities           8,411                                        6,875
Shareholders' equity        104,608                                       93,090

Total liabilities and
shareholders' equity    $ 1,516,374                                  $ 1,531,695

Net interest income                     $  13,892                                    $   11,501

Net interest spread
(1)                                                         3.82 %                                        3.02 %
Net interest margin
(1)                                                         4.02 %                                        3.25 %
Ratio of average
interest earning
assets to average
interest bearing
liabilities                  129.48 %                                     124.53 %

(1) Yield adjusted to fully tax equivalent.

(2) Includes non-accrual loans of approximately $20.8 million and $39.9 million for the three months ended September 30, 2012 and 2011, respectively.

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Index

The following table shows an analysis of net interest margin for the nine month periods ended September 30, 2012 and 2011.

                                               For the nine months ended September 30,
                                          2012                                         2011
                                         Interest      Average                        Interest       Average
                          Average         Earned        Yield          Average         Earned         Yield
                          Balance         or paid      or cost         Balance        or paid        or cost
                                                        (Dollars in thousands)
Assets
Taxable securities      $    73,984     $   1,116           2.01 %   $    19,462     $      267           1.83 %
Tax-exempt securities
(1)                          10,966           210           4.32 %           425             11           5.70 %
Loans (2)                 1,054,402        42,295           5.29 %     1,137,818         45,274           5.26 %
Federal Home Loan
Bank stock                   11,236           252           2.95 %        11,641            223           2.53 %
Federal funds sold
and other short-term
investments                 207,280           394           0.25 %       230,936            468           0.27 %
Total interest
earning assets (1)        1,357,868        44,267           4.32 %     1,400,282         46,243           4.37 %

Noninterest earning
assets:
Cash and due from
banks                        22,906                                       23,127
Other                       125,797                                      113,461

Total assets            $ 1,506,571                                  $ 1,536,870

Liabilities
Deposits:
Interest bearing
demand                  $   221,429     $     264           0.16 %   $   183,208     $      317           0.23 %
Savings and money
market accounts             412,675         1,500           0.49 %       367,965          1,558           0.57 %
Time deposits               270,628         2,806           1.39 %       388,904          5,557           1.91 %
Borrowings:
Other borrowed funds        132,847         2,045           2.02 %       178,611          2,886           2.13 %
Long-term debt               41,238         1,158           3.69 %        41,238          1,044           3.34 %
Total interest
bearing liabilities       1,078,817         7,773           0.96 %     1,159,926         11,362           1.30 %

Noninterest bearing
liabilities:
Noninterest bearing
demand accounts             319,755                                      291,583
Other noninterest
bearing liabilities           7,528                                        7,083
Shareholders' equity        100,471                                       78,278

Total liabilities and
shareholders' equity    $ 1,506,571                                  $ 1,536,870

Net interest income                     $  36,494                                    $   34,881

Net interest spread
(1)                                                         3.36 %                                        3.06 %
Net interest margin
(1)                                                         3.56 %                                        3.29 %
Ratio of average
interest earning
assets to average
interest bearing
liabilities                  125.87 %                                     120.72 %

(1) Yield adjusted to fully tax equivalent.

(2) Includes non-accrual loans of approximately $25.6 million and $56.0 million for the nine months ended September 30, 2012 and 2011, respectively.

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Index

Provision for Loan Losses: The provision for loan losses for the third quarter of 2012 and 2011 was a negative $1.25 million. The negative provision for loan losses in both periods resulted from continued significant declines in the level of net charge-offs, reduction in the balances and required reserves on nonperforming loans, and stabilizing real estate values on problem credits. The provision for loan losses for the first nine months of 2012 was a negative $6.6 million, compared to a negative $4.7 million for the same period in 2011. The larger negative provision for loan losses in the first nine months of 2012 was primarily associated with a $4.4 million recovery on a previously charged-off loan in the first quarter of 2012.

Net recoveries were $341,000 for the third quarter of 2012 compared to net charge-offs of $1.4 million for the third quarter of 2011. Our charge-offs have largely been driven by declines in the value of real estate securing our loans. The pace of the decline in real estate values, however, has been slowing, translating into a decline in charge-offs and resulting in net recoveries for the first and third quarters of 2012. We are also experiencing positive results from our collection efforts as evidenced by the $4.4 million recovery collected in the first quarter of 2012 and net recoveries again in the third quarter of 2012. For the third quarter of 2012, total recoveries were $956,000 compared to $2.3 million for the same period in 2011. For the nine months ended September 30, 2012, we experienced net recoveries of $1.2 million compared to net charge-offs of $7.9 million for the same period in 2011. For the nine months ended September 30, 2012, total recoveries were $6.2 million, compared to $4.4 million for the same period in 2011. While we expect our collection efforts to produce further recoveries, the amount achieved in 2012, particularly in the first quarter of 2012, was unusually high and may not recur at this level in future quarters.

We have also experienced a decline in the pace of commercial loans migrating to a worse loan grade, which receive higher allocations in our loan loss reserve, as more fully discussed under the heading "Allowance for Loan Losses" below. In addition to experiencing fewer downgrades of credits, we continue to see an increase in the quality of some credits resulting in an improved loan grade. Over the past seven quarters, we have experienced improvements in our weighted average 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 in 2012.

The amounts of loan loss provision in all periods presented 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 had 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 under the heading "Allowance for Loan Losses" below.

Noninterest Income: Noninterest income for the three and nine month periods ended September 30, 2012 increased to $4.1 million and $11.8 million, respectively, from $3.9 million and $11.2 million, respectively, for the same periods in 2011. The components of noninterest income are shown in the table below (in thousands):

                                                Three Months        Three Months         Nine Months         Nine Months
                                                    Ended               Ended               Ended               Ended
                                                September 30,       September 30,       September 30,       September 30,
                                                    2012                2011                2012                2011

Service charges and fees on deposit accounts   $           810     $           889     $         2,381     $         2,806
Net gains on mortgage loans                                940                 697               2,192               1,393
Trust fees                                                 595                 644               1,802               1,915
Gain on sale of securities                                  14                 ---                  73                 ---
ATM and debit card fees                                  1,049               1,013               3,094               2,958
Bank owned life insurance income                           210                 245                 657                 711
Investment services fees                                   196                 157                 585                 644
Other income                                               292                 282               1,033                 794
Total noninterest income                       $         4,106     $         3,927     $        11,817     $        11,221

Service charges on deposit accounts decreased for the three and nine month periods ended September 30, 2012 as a result of declines in overdraft fee income, consistent with banking industry-wide trends. We recognized substantial increases in gains on sales of mortgage loans for the third quarter of 2012 and for the first nine months of 2012, due in part to increased focus on growth in our residential mortgage loan origination volume. The low interest rate environment and recent Federal Reserve actions have also contributed significantly to this increase in sales volume. Trust income is down slightly for the three and nine month periods ended September 30, 2012 compared to the same periods in 2011 due primarily to a decline in trust asset balances and market conditions. We sold one security in the second quarter of 2012 and one in the third quarter of 2012, resulting in gains of $59,000 and $14,000 respectively. No securities were sold in the 2011 periods presented. Income from ATM and debit card fees was up for the most recent quarter and the first nine months of 2012 compared to the same periods in 2011 due to increased volume of activity during 2012. The increase in other income in the three and nine month periods ended September 30, 2012 compared to the same periods in 2011 was primarily attributable to rental income on other real estate owned. Rental income from these properties increased $28,000 and $265,000, respectively, for the three and nine month periods ended September 30, 2012 compared to the same periods in 2011.

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Index

Noninterest Expense: Noninterest expense decreased to $12.4 million for the three month period and decreased to $40.4 million for the nine month period ended September 30, 2012, respectively, from $15.6 million and $46.1 million, respectively, for the same periods in 2011. The components of noninterest expense are shown in the table below (in thousands):

                                            Three Months        Three Months         Nine Months         Nine Months
                                                Ended               Ended               Ended               Ended
                                            September 30,       September 30,       September 30,       September 30,
                                                2012                2011                2012                2011

Salaries and benefits                      $         5,621     $         5,668     $        17,065     $        16,615
Occupancy of premises                                  948                 961               2,860               2,961
Furniture and equipment                                806                 812               2,491               2,458
Legal and professional                                 160                 187                 551                 779
Marketing and promotion                                213                 228                 634                 677
Data processing                                        269                 314                 988                 952
FDIC assessment                                        504                 842               1,692               2,660
ATM and debit card processing                          316                 337                 912                 918
Bond and D&O insurance                                 213                 379                 696               1,136
FHLB advance prepayment penalty                        322                 ---                 322                 ---
Administration and disposition of
problem assets                                       1,724               4,485               7,973              12,660
Outside services                                       289                 412               1,048               1,238
Other noninterest expense                            1,003               1,001               3,148               3,005
Total noninterest expense                  $        12,388     $        15,626     $        40,380     $        46,059

Several components of noninterest expense experienced a decline due to our ongoing efforts to manage expenses and scale our operations. Our largest component of noninterest expense, salaries and benefits, decreased in the third quarter of 2012 by $47,000 from the third quarter of 2011. We had 364 full-time equivalent employees at September 30, 2012 compared to 396 at September 30, 2011. The decreased expense for the third quarter of 2012 was primarily attributable the decrease in full-time equivalent employees, partially offset by an increase in commissions paid for mortgage origination activity, which was more than two times greater in the third quarter of 2012 compared to the third quarter of 2011. Also, in March 2012, our board authorized a cost of living increase for the first time in several years, which resulted in an increase in compensation expense beginning in the second quarter of 2012. In addition, our medical insurance costs increased by $176,000 for the third quarter of 2012 compared to the third quarter of 2011. For the first nine month periods, salaries and benefits increased by $450,000 from $16.6 million in 2011 to $17.1 million in 2012. The increase for the first nine months of 2012 compared to the first nine months of 2011 is also due to the cost of living adjustments made in the second quarter of 2012, the increased mortgage commissions from higher loan . . .

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