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MCBC > SEC Filings for MCBC > Form 10-Q on 25-Jul-2013All Recent SEC Filings

Show all filings for MACATAWA BANK CORP

Form 10-Q for MACATAWA BANK CORP


25-Jul-2013

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 June 30, 2013, we had total assets of $1.48 billion, total loans of $1.01 billion, total deposits of $1.20 billion and shareholders' equity of $133.3 million. During the second quarter of 2013, we recognized net income of $2.6 million compared to net income of $3.2 million in the second quarter of 2012. This represented our thirteenth consecutive quarter (over three full years) of profitability. With the reversal of our deferred tax asset valuation allowance at December 31, 2012, our earnings for the second quarter of 2013 reflected tax expense while the second quarter of 2012 did not.

As of June 30, 2013, the Company's and the Bank's risk-based regulatory capital ratios were at the highest they have ever been. The Bank was categorized as "well capitalized" at June 30, 2013.

On April 12, 2013, the Federal Deposit Insurance Corporation ("FDIC") and the Michigan Department of Insurance and Financial Services ("DIFS"), the primary banking regulators of the Bank, notified the Bank that the Bank's Memorandum of Understanding ("MOU") with the FDIC and DIFS had served its purpose and was released. As a result, the Bank is no longer subject to any regulatory order, memorandum of understanding or other similar regulatory directive or proceeding and has returned to a normal regulatory operating environment.

The MOU documented an understanding the Bank reached with regulators in connection with termination of the Bank's former Consent Order on March 2, 2012.
The requirements of the MOU which are described in the Company's Annual Report on Form 10-K for the year ended December 31, 2012 are no longer applicable to the Bank. In particular, the enhanced regulatory capital requirements of the MOU no longer apply to the Bank and the Bank is no longer required to obtain the prior written consent of the FDIC and DIFS before the Bank declares or pays dividends.

We believe the FDIC and DIFS released the MOU as a result of: (i) the Bank's substantial compliance with the MOU, (ii) our implementation of enhanced corporate governance practices and disciplined business and banking principles,
(iii) substantial improvements in the Bank's asset quality, (iv) improved liquidity, (v) continued improvement in the Bank's financial condition and earnings performance, and (vi) Bank regulatory capital levels well in excess of the levels required to be classified as "well capitalized" for regulatory purposes and to comply with our MOU due to our successful capital raise and the Bank's retained earnings.

RESULTS OF OPERATIONS

Summary: Net income available to common shares for the quarter ended June 30, 2013 was $2.6 million ($3.8 million on a pretax basis), compared to net income of $3.2 million ($3.2 million on a pretax basis) in the second quarter of 2012. Net income per common share on a diluted basis was $0.10 for the second quarter of 2013 and $0.12 for the second quarter of 2012. For the six months ended June 30, 2013, net income was $5.1 million ($7.4 million on a pretax basis), compared to $7.7 million ($7.7 million on a pretax basis) for the same period in 2012.
Net income per common share on a diluted basis for the six months ended June 30, 2013 was $0.19, compared to $0.28 for the same period in 2012.

The improvement in pretax earnings in the second quarter of 2013 was a continuation of improvement in our nonperforming assets, with a reduction in nonperforming asset expenses of $1.9 million compared to the second quarter of 2012. Net chargeoffs for the second quarter 2013 were $239,000 compared to $521,000 in the second quarter of 2012. We recorded a negative provision for loan losses of $1.0 million in the second quarter 2013 compared to a negative $1.8 million in the second quarter 2012. With the reversal of the deferred tax asset valuation allowance at December 31, 2012, tax expense is no longer offset by valuation allowance reversals and we recorded $1.2 million in federal income tax expense in the second quarter of 2013 and none in the second quarter of 2012.

The reduction in pretax earnings in the first six months of 2013 compared to the same period in 2012 is due to an unusually large negative provision for loan loss expense taken in the first quarter of 2012 resulting from a large loan recovery collected in the first quarter of 2012. The provision for loan losses was a negative $1.75 million for the six month period ended June 30, 2013 compared to a negative $5.35 million for the same period in 2012. We recorded $2.3 million in federal income tax expense in the first six months of 2013 and none in the first six months of 2012.

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Index
Operating results in recent periods have been significantly impacted by the expense associated with problem loans and nonperforming assets. These expenses remain elevated but continue to show significant improvement. Apart from the provision for loan losses, expenses associated with nonperforming assets (including administration costs and losses) were $1.3 million for the second quarter 2013 compared to $3.2 million for the second quarter 2012. For the first half of 2013, such expenses totaled $2.3 compared to $6.2 million for the same period in 2012. Larger valuation writedowns on other real estate owned and higher levels of legal costs associated with nonperforming assets in the first half of 2012 were the primary reasons for the change between periods. Lost interest from elevated levels of nonperforming assets was approximately $639,000 and $1.4 million, respectively, for the three and six months ended June 30, 2013 compared to $970,000 and $2.1 million, respectively, for the three and six months ended June 30, 2012. Each of these items is discussed more fully below.

Net Interest Income: Net interest income totaled $10.5 million for the second quarter of 2013 compared to $11.3 million for the second quarter of 2012. For the first half of 2013, net interest income was $20.9 million compared to $22.6 million for the same period in 2012.

The decrease in net interest income in the second quarter of 2013 was due primarily to a decline in yield on our average interest earning assets. Our average yield on earning assets for the second quarter of 2013 declined 38 basis points from 4.08% to 3.70% compared to the same period in 2012. Average interest earning assets totaled $1.33 billion for the second quarter of 2013 compared to $1.36 billion for the second quarter of 2012. The net interest margin was 3.15% for the second quarter of 2013 compared to 3.32% for the second quarter of 2012. The decline in the margin for the most recent quarter was driven by the reduction in our average yield on earning assets, partially offset by a reduction in the cost of average interest bearing liabilities. An increase of $47.9 million in average securities between periods partially mitigated the impact of reduction in average loan yield from 4.98% in the second quarter of 2012 to 4.39% in the second quarter of 2013.

Average interest earning assets decreased from $1.35 billion for the first six months of 2012 to $1.34 billion for the same period in 2013. Our average yield on earning assets declined 41 basis points for the first half of 2013 in comparison with the same period in 2012. Our net interest margin was 3.14% for the six month period in 2013 compared to 3.32% for the same period in 2012.

The declines in yields on interest earning assets for the three and six month periods ended June 30, 2013 were from decreases in the yield on our commercial, residential and consumer loan portfolios, which have repriced at lower levels in the generally low rate environment during this period. Our margin has been negatively impacted by the significant balances in liquid and short-term investments held during the past three 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 cost of funds decreased 25 basis points to 0.70% in the second quarter of 2013 from 0.95% in the same period in 2012. The cost of funds decreased 27 basis points to 0.72% for the six months ended June 30, 2013 compared to 0.99% for the same period in 2012. For both the three and six month periods ended June 30, 2013, decreases 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 caused 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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Index
The following table shows an analysis of net interest margin for the three month periods ended June 30, 2013 and 2012.

                                                  For the three months ended June 30,
                                          2013                                          2012
                                         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      $   105,866     $      448           1.69 %   $    75,987     $      384           2.02 %
Tax-exempt securities
(1)                          27,968            155           3.63 %         9,955             65           4.47 %
Loans (2)                 1,039,771         11,493           4.39 %     1,055,624         13,237           4.98 %
Federal Home Loan
Bank stock                   11,236             97           3.41 %        11,236             84           2.95 %
Federal funds sold
and other short-term
investments                 146,716            114           0.31 %       203,251            130           0.25 %
Total interest
earning assets (1)        1,331,557         12,307           3.70 %     1,356,053         13,900           4.08 %

Noninterest earning
assets:
Cash and due from
banks                        23,595                                        22,140
Other                       134,735                                       127,024
Total assets            $ 1,489,887                                   $ 1,505,217

Liabilities
Deposits:
Interest bearing
demand                  $   279,109             96           0.21 %   $   223,439             86           0.15 %
Savings and money
market accounts             457,151            471           0.41 %       419,097            505           0.48 %
Time deposits               174,965            415           0.95 %       272,149            935           1.38 %
Borrowings:
Other borrowed funds         92,307            490           2.10 %       132,326            672           2.01 %
Long-term debt               41,238            372           3.57 %        41,238            380           3.65 %
Total interest
bearing liabilities       1,044,770          1,844           0.70 %     1,088,249          2,578           0.95 %

Noninterest bearing
liabilities:
Noninterest bearing
demand accounts             300,864                                       308,152
Other noninterest
bearing liabilities           9,716                                         7,580
Shareholders' equity        134,537                                       101,236
Total liabilities and
shareholders' equity    $ 1,489,887                                   $ 1,505,217

Net interest income                     $   10,463                                    $   11,322

Net interest spread
(1)                                                          3.00 %                                        3.13 %
Net interest margin
(1)                                                          3.15 %                                        3.32 %
Ratio of average
interest earning
assets to average
interest bearing
liabilities                  127.45 %                                      124.61 %

(1) Yield adjusted to fully tax equivalent.

(2) Includes average nonaccrual loans of approximately $11.3 million and $24.9 million for the three months ended June 30, 2013 and 2012.

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Index
The following table shows an analysis of net interest margin for the six month periods ended June 30, 2013 and 2012.

                                                   For the six months ended June 30,
                                          2013                                          2012
                                         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      $   104,101     $      877           1.68 %   $    67,941     $      701           2.06 %
Tax-exempt securities
(1)                          26,437            296           3.67 %         8,075            108           4.61 %
Loans (2)                 1,047,631         23,161           4.41 %     1,062,338         26,763           5.01 %
Federal Home Loan
Bank stock                   11,236            196           3.47 %        11,236            169           2.97 %
Federal funds sold
and other short-term
investments                 150,677            210           0.28 %       203,578            257           0.25 %
Total interest
earning assets (1)        1,340,082         24,740           3.71 %     1,353,168         27,998           4.12 %

Noninterest earning
assets:
Cash and due from
banks                        22,610                                        21,751
Other                       135,566                                       126,697
Total assets            $ 1,498,258                                   $ 1,501,616

Liabilities
Deposits:
Interest bearing
demand                  $   268,235            177           0.13 %   $   216,973            182           0.17 %
Savings and money
market accounts             470,049          1,018           0.43 %       407,196          1,014           0.50 %
Time deposits               181,702            872           0.97 %       284,150          1,979           1.40 %
Borrowings:
Other borrowed funds         92,777            985           2.11 %       140,855          1,451           2.04 %
Long-term debt               41,238            741           3.58 %        41,238            770           3.70 %
Total interest
bearing liabilities       1,054,001          3,793           0.72 %     1,090,412          5,396           0.99 %

Noninterest bearing
liabilities:
Noninterest bearing
demand accounts             302,246                                       305,742
Other noninterest
bearing liabilities           8,765                                         7,082
Shareholders' equity        133,246                                        98,380
Total liabilities and
shareholders' equity    $ 1,498,258                                   $ 1,501,616

Net interest income                     $   20,947                                    $   22,602

Net interest spread
(1)                                                          2.99 %                                        3.13 %
Net interest margin
(1)                                                          3.14 %                                        3.32 %
Ratio of average
interest earning
assets to average
interest bearing
liabilities                  127.14 %                                      124.10 %

(1) Yield adjusted to fully tax equivalent.

(2) Includes average nonaccrual loans of approximately $13.4 million and $28.1 million for the six months ended June 30, 2013 and 2012.

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Index
Provision for Loan Losses: The provision for loan losses for the second quarter of 2013 was a negative $1.0 million compared to a negative $1.75 million for the second quarter of 2012. The negative provisions in both periods were the result of 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 half of 2013 was a negative $1.75 compared to a negative $5.35 million for the same period in 2012. The larger negative provision in the first half of 2012 was primarily associated with a $4.4 million recovery on a previously charged-off loan in the first quarter of 2012.

Net charge-offs were $239,000 for the second quarter of 2013 compared to $521,000 for the second quarter of 2012. 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 decline in real estate values, however, has been slowing, translating into a significant decline in charge-offs. We are also experiencing positive results from our collection efforts with loan recoveries increasing as evidenced by our net loan recovery positions in recent quarters. For the second quarter of 2013, loan recoveries were $459,000 compared to $378,000 for the same period in 2012. For the six months ended June 30, 2013, we experienced net recoveries of $259,000 compared to net recoveries of $889,000 for the same period in 2012. Loan recoveries for the six months ended June 30, 2013 were $1.6 million compared to $5.3 million for the same period in 2012. While we expect our collection efforts to produce further recoveries, the amount achieved in the first quarter of 2012 was unusually high.

We have also experienced 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 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 two years, 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 allowance for loan losses since then.

The amounts of loan loss provision in both the most recent quarter and comparable prior year period 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 six month periods ended June 30, 2013 increased to $4.2 million and $8.2 million, respectively, from $4.0 million and $7.7 million, respectively, for the same periods in 2012. The components of noninterest income are shown in the table below (in thousands):

                                               Three Months      Three Months       Six Months       Six Months
                                                   Ended             Ended            Ended            Ended
                                                 June 30,          June 30,          June 30,         June 30,
                                                   2013              2012              2013             2012

Service charges and fees on deposit accounts   $         976     $         776     $      1,888     $      1,571
Net gains on mortgage loans                              708               780            1,533            1,251
Trust fees                                               625               598            1,213            1,207
Gain as sales of securities                               61                59               80               59
ATM and debit card fees                                1,132             1,064            2,109            2,045
Bank owned life insurance ("BOLI") income                188               224              358              447
Investment services fees                                 257               160              472              389
Other income                                             264               339              521              742
Total noninterest income                       $       4,211     $       4,000     $      8,174     $      7,711

Service charges on deposit accounts increased for the three month and six periods ended June 30, 2013 due, primarily, to an increase in overdraft activity from our customer base. Mortgage gains continued to be elevated in the second quarter and first six months of 2013 and were comparable to the second quarter and first six months of 2012. The low interest rate environment has contributed significantly to the elevated level of mortgage originations and resulting gains on sales.

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Index
Noninterest Expense: Noninterest expense decreased to $11.9 million and $23.5 million for the three and six month periods ended June 30, 2013, from $13.9 million and $28.0 million, respectively, for the same periods in 2012. The components of noninterest expense are shown in the table below (in thousands):

                                            Three Months       Three Months       Six Months       Six Months
                                               Ended              Ended             Ended            Ended
                                              June 30,           June 30,          June 30,         June 30,
                                                2013               2012              2013             2012

Salaries and benefits                      $        5,732     $        5,723     $     11,525     $     11,443
Occupancy of premises                                 905                941            1,851            1,912
Furniture and equipment                               845                858            1,595            1,685
Legal and professional                                183                180              373              392
Marketing and promotion                               246                210              492              420
Data processing                                       352                368              704              719
FDIC assessment                                       345                479              817            1,188
ATM and debit card processing                         361                308              652              596
Bond and D&O insurance                                183                215              368              483
Administration and disposition of                   1,299
problem assets                                                         3,190            2,260            6,249
Outside services                                      354                381              723              759
Other noninterest expense                           1,070              1,033            2,096            2,146
Total noninterest expense                  $       11,875     $       13,886     $     23,456     $     27,992

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, increased slightly in the second quarter of 2013 from the second quarter of 2012. We had 360 full-time equivalent employees at June 30, 2013 compared to 373 at June 30, 2012. The increased expense for the second quarter of 2013 was primarily attributable to the reinstatement of our 401k plan matching contributions beginning with the first quarter of 2013. This expense totaled $136,000 for the second quarter of 2013. Incentive compensation programs have been implemented for certain departments in 2013, which have also increased compensation expense. Salaries and benefits increased by $82,000 from $11.4 million for the first six months of 2012 to $11.5 million for the same period of 2013. The increase for the first half of 2013 was due to the reinstatement of our 401k plan matching contributions discussed above and also due to increased mortgage commissions from higher loan origination volume in 2013. The increases in salaries and benefits were partially offset by lower medical insurance expense resulting from lower claims experience in the three and six month periods ended June 30, 2013 compared to the same periods in 2012.

The next largest noninterest expense was our cost related to administration and disposition of problem assets. 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. We experienced significant decreases in each of these expense categories in the second quarter and first six months of 2013 compared to the same period in 2012.

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

                                           Three Months      Three Months       Six Months       Six Months
                                               Ended             Ended            Ended            Ended
                                             June 30,          June 30,          June 30,         June 30,
                                               2013              2012              2013             2012

Legal and professional - nonperforming
assets                                     $         335     $         266     $        501     $        707
Repossessed and foreclosed property
administration                                       670               990            1,406            2,011
Losses on repossessed and foreclosed
properties                                           294             1,934              353            3,531
Total                                      $       1,299     $       3,190     $      2,260     $      6,249

. . .

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