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MCBC > SEC Filings for MCBC > Form 10-Q on 24-Oct-2013All Recent SEC Filings

Show all filings for MACATAWA BANK CORP

Form 10-Q for MACATAWA BANK CORP


24-Oct-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 September 30, 2013, we had total assets of $1.56 billion, total loans of $1.03 billion, total deposits of $1.29 billion and shareholders' equity of $135.5 million. During the third quarter of 2013, we recognized net income of $2.2 million compared to net income of $6.6 million in the third quarter of 2012. With the reversal of our deferred tax asset valuation allowance at December 31, 2012, our earnings for the third quarter of 2013 reflected tax expense of $975,000, while the third quarter of 2012 reflected only $275,000 in tax expense, related to alternative minimum tax.

As of September 30, 2013, the Company's and the Bank's regulatory capital ratios were at levels consistent with the second quarter of 2013, which were at the highest in the Company's history. The Bank was categorized as "well capitalized" at September 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 September 30, 2013 was $2.2 million ($3.2 million on a pretax basis), compared to net income of $6.6 million ($6.9 million on a pretax basis) in the third quarter of 2012. Net income per common share on a diluted basis was $0.08 for the third quarter of 2013 and $0.24 for the third quarter of 2012. For the nine months ended September 30, 2013, net income was $7.3 million ($10.6 million on a pretax basis), compared to $14.3 million ($14.5 million on a pretax basis) for the same period in 2012. Net income per common share on a diluted basis for the nine months ended September 30, 2013 was $0.27, compared to $0.53 for the same period in 2012.

The reduction in pretax earnings in the third quarter of 2013 was due primarily to inclusion in net interest income of a one-time prepayment fee of $2.8 million on a commercial loan in the third quarter of 2012. We again were in a net recovery position for the third quarter of 2013 with net recoveries of $524,000 compared to net recoveries of $341,000 in the third quarter of 2012. We recorded a negative provision for loan losses of $1.5 million in the third quarter of 2013 compared to a negative $1.25 million in the third quarter of 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 $975,000 in federal income tax expense in the third quarter of 2013. Only $275,000 was recorded in the third quarter of 2012 and it related to the payment of alternative minimum tax.

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Index
The reduction in pretax earnings in the first nine months of 2013 compared to the same period in 2012 was partially 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 that same quarter. The provision for loan losses was a negative $3.25 million for the nine month period ended September 30, 2013 compared to a negative $6.6 million for the same period in 2012. Also impacting the comparison between the first nine month periods of 2013 and 2012 was the collection of a $2.8 million one-time prepayment fee on a large commercial loan in 2012. We recorded $3.3 million in federal income tax expense in the first nine months of 2013 and $275,000 in the first nine months of 2012.

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 $1.8 million for the third quarter of 2013 compared to $1.7 million for the third quarter of 2012. For the first nine months of 2013, such expenses totaled $4.1 million compared to $8.0 million for the same period in 2012. Lower valuation writedowns on other real estate owned and lower levels of legal costs associated with nonperforming assets in the first nine months of 2013 were the primary reasons for the change between periods. Lost interest from elevated levels of nonperforming assets was approximately $561,000 and $1.3 million, respectively, for the three and nine months ended September 30, 2013 compared to $852,000 and $3.0 million, respectively, for the three and nine months ended September 30, 2012. Each of these items is discussed more fully below.

Net Interest Income: Net interest income totaled $10.1 million for the third quarter of 2013 compared to $13.9 million for the third quarter of 2012. For the first nine months of 2013, net interest income was $31.1 million compared to $36.5 million for the same period in 2012.

The decrease in net interest income in the third quarter of 2013 was due primarily to the collection of the $2.8 million one-time prepayment fee in the third quarter of 2012. This fee alone generated an additional 82 basis points in yield on assets and net interest margin. However, our yield on assets declined by more than 82 basis points, decreasing by 123 basis points from 4.71% to 3.48% compared to the same period in 2012. Average interest earning assets totaled $1.36 billion for the third quarter of 2013 compared to $1.37 billion for the third quarter of 2012. The net interest margin was 2.96% for the third quarter of 2013 compared to 4.02% for the third quarter of 2012. While we had a reduction in our average yield on earning assets, this was partially offset by a reduction in the cost of average interest bearing liabilities. An increase of $45.9 million in average securities between periods partially mitigated the impact of reduction in average loan yield from 5.89% in the third quarter of 2012 to 4.25% in the third quarter of 2013.

Average interest earning assets decreased from $1.36 billion for the first nine months of 2012 to $1.35 billion for the same period in 2013. Our average yield on earning assets declined 69 basis points for the first nine months of 2013 in comparison with the same period in 2012. Our net interest margin was 3.08% for the first nine months of 2013 compared to 3.56% for the same period in 2012.

Apart from the impact of the one-time fee noted above, the declines in yields on interest earning assets for the three and nine month periods ended September 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 20 basis points to 0.69% in the third quarter of 2013 from 0.89% in the same period in 2012. The cost of funds decreased 25 basis points to 0.71% for the nine months ended September 30, 2013 compared to 0.96% for the same period in 2012. For both the three and nine month periods ended September 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 September 30, 2013 and 2012.

                                               For the three months ended September 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      $   110,927     $      476           1.72 %   $    85,939     $      414           1.93 %
Tax-exempt securities
(1)                          37,619            211           3.42 %        16,685            102           4.05 %
Loans (2)                 1,016,008         10,995           4.25 %     1,038,704         15,532           5.89 %
Federal Home Loan
Bank stock                   11,236             98           3.41 %        11,236             84           2.92 %
Federal funds sold
and other short-term
investments                 186,433            139           0.29 %       214,602            137           0.25 %
Total interest
earning assets (1)        1,362,223         11,919           3.48 %     1,367,166         16,269           4.71 %

Noninterest earning
assets:
Cash and due from
banks                        26,229                                        25,191
Other                       126,103                                       124,017
Total assets            $ 1,514,555                                   $ 1,516,374

Liabilities
Deposits:
Interest bearing
demand                  $   271,084             91           0.14 %   $   230,246             82           0.14 %
Savings and money
market accounts             465,470            479           0.41 %       423,513            487           0.46 %
Time deposits               164,785            384           0.93 %       243,877            827           1.35 %
Borrowings:
Other borrowed funds         90,864            465           2.01 %       117,005            594           1.99 %
Long-term debt               41,238            376           3.57 %        41,238            387           3.68 %
Total interest
bearing liabilities       1,033,441          1,795           0.69 %     1,055,879          2,377           0.89 %

Noninterest bearing
liabilities:
Noninterest bearing
demand accounts             336,963                                       347,476
Other noninterest
bearing liabilities          10,033                                         8,411
Shareholders' equity        134,118                                       104,608
Total liabilities and
shareholders' equity    $ 1,514,555                                   $ 1,516,374

Net interest income                     $   10,124                                    $   13,892

Net interest spread
(1)                                                          2.79 %                                        3.82 %
Net interest margin
(1)                                                          2.96 %                                        4.02 %
Ratio of average
interest earning
assets to average
interest bearing
liabilities                  131.81 %                                      129.48 %

(1) Yield adjusted to fully tax equivalent.

(2) Includes average nonaccrual loans of approximately $10.1 million and $20.8 million for the three months ended September 30, 2013 and 2012.

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

                                                For the nine months ended September 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      $   106,402     $    1,352           1.69 %   $    73,984     $    1,116           2.01 %
Tax-exempt securities
(1)                          30,205            508           3.56 %        10,966            210           4.32 %
Loans (2)                 1,036,974         34,156           4.36 %     1,054,402         42,295           5.29 %
Federal Home Loan
Bank stock                   11,236            294           3.45 %        11,236            252           2.95 %
Federal funds sold
and other short-term
investments                 162,727            349           0.28 %       207,280            394           0.25 %
Total interest
earning assets (1)        1,347,544         36,659           3.63 %     1,357,868         44,267           4.32 %

Noninterest earning
assets:
Cash and due from
banks                        23,830                                        22,906
Other                       132,376                                       125,797
Total assets            $ 1,503,750                                   $ 1,506,571

Liabilities
Deposits:
Interest bearing
demand                  $   269,196            268           0.13 %   $   221,429            264           0.16 %
Savings and money
market accounts             468,506          1,497           0.43 %       412,675          1,500           0.49 %
Time deposits               176,001          1,256           0.96 %       270,628          2,806           1.39 %
Borrowings:
Other borrowed funds         92,132          1,450           2.07 %       132,847          2,045           2.02 %
Long-term debt               41,238          1,117           3.58 %        41,238          1,158           3.69 %
Total interest
bearing liabilities       1,047,073          5,588           0.71 %     1,078,817          7,773           0.96 %

Noninterest bearing
liabilities:
Noninterest bearing
demand accounts             313,946                                       319,755
Other noninterest
bearing liabilities           9,191                                         7,528
Shareholders' equity        133,540                                       100,471
Total liabilities and
shareholders' equity    $ 1,503,750                                   $ 1,506,571

Net interest income                     $   31,071                                    $   36,494

Net interest spread
(1)                                                          2.92 %                                        3.36 %
Net interest margin
(1)                                                          3.08 %                                        3.56 %
Ratio of average
interest earning
assets to average
interest bearing
liabilities                  128.70 %                                      125.87 %

(1) Yield adjusted to fully tax equivalent.

(2) Includes average nonaccrual loans of approximately $12.3 million and $25.6 million for the nine months ended September 30, 2013 and 2012.

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Index
Provision for Loan Losses: The provision for loan losses for the third quarter of 2013 was a negative $1.5 million compared to a negative $1.25 million for the third 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 nine months of 2013 was a negative $3.25 million compared to a negative $6.6 million for the same period in 2012. 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 $524,000 for the third quarter of 2013 compared to net recoveries of $341,000 for the third 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 third quarter of 2013, total loan recoveries were $878,000 compared to $956,000 for the same period in 2012. For the nine months ended September 30, 2013, we experienced net recoveries of $783,000 compared to net recoveries of $1.2 million for the same period in 2012. Total loan recoveries for the nine months ended September 30, 2013 were $2.5 million compared to $6.2 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 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 two years, we have experienced improvements in our weighted average loan grade. Our weighted average commercial loan grade was 3.92 at September 30, 2013 reflecting improvement compared to 4.01 at December 31, 2012 and 4.19 at December 31, 2011. 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 nine month periods ended September 30, 2013 was $4.0 million and $12.1 million, respectively, compared to $4.1 million and $11.8 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       Nine Months        Nine Months
                                                   Ended              Ended              Ended              Ended
                                               September 30,      September 30,      September 30,      September 30,
                                                    2013               2012               2013               2012
Service charges and fees on deposit accounts   $        1,029     $          810     $        2,917     $        2,381
Net gains on mortgage loans                               612                940              2,145              2,192
Trust fees                                                584                595              1,797              1,802
Gain as sales of securities                               ---                 14                 80                 73
ATM and debit card fees                                 1,104              1,049              3,212              3,094
Bank owned life insurance ("BOLI") income                 180                210                539                657
Investment services fees                                  198                196                670                585
Other income                                              244                292                765              1,033
Total noninterest income                       $        3,951     $        4,106     $       12,125     $       11,817

Service charges on deposit accounts increased for the three and nine month periods ended September 30, 2013 due, primarily, to an increase in overdraft activity from our customer base. Mortgage gains have declined in the third quarter of 2013, reflecting the impact of increased mortgage rates during the quarter. However, for the first nine months of 2013, mortgage gains were comparable to 2012 due to the low interest rate environment during the first half of 2013.

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Index
Noninterest Expense: Noninterest expense was $12.4 million and $35.8 million for the three and nine month periods ended September 30, 2013, compared to $12.4 million and $40.4 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       Nine Months        Nine Months
                                               Ended              Ended              Ended              Ended
                                           September 30,      September 30,      September 30,      September 30,
                                                2013               2012               2013               2012
Salaries and benefits                      $        5,834     $        5,621     $       17,359     $       17,065
Occupancy of premises                                 908                948              2,759              2,860
Furniture and equipment                               819                806              2,414              2,491
Legal and professional                                192                160                565                551
Marketing and promotion                               245                213                738                634
Data processing                                       326                269              1,029                988
FDIC assessment                                       317                504              1,133              1,692
ATM and debit card processing                         315                316                967                912
Bond and D&O insurance                                187                213                555                696
FHLB advance prepayment penalty                       ---                322                ---                322
Administration and disposition of                   1,811              1,724              4,072              7,973
problem assets
Outside services                                      383                289              1,106              1,048
Other noninterest expense                           1,025              1,003              3,121              3,148
Total noninterest expense                  $       12,362     $       12,388     $       35,818     $       40,380

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 third quarter of 2013 from the third quarter of 2012. We had 363 full-time equivalent employees at September 30, 2013 compared to 364 at September 30, 2012. The increased expense for the third quarter of 2013 was partially attributable to the reinstatement of our 401k plan matching contributions beginning with the first quarter of 2013. This expense totaled $157,000 for the third quarter of 2013. In addition, incentive compensation programs have been implemented for certain departments in 2013, which have also increased compensation expense. Incentive compensation expense totaled $280,000 for the third quarter of 2013. Salaries and benefits increased by $295,000 from $17.1 million for the first nine months of 2012 to $17.4 million for the same period of 2013. The increase for the first nine months of 2013 was due to the reinstatement of our 401k plan matching contributions discussed above and also due to the introduction of additional incentive compensation in 2013, as noted above. The increases in salaries and benefits were partially offset by lower medical insurance expense resulting from lower claims experience in the three and nine month periods ended September 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 a slight increase in these expenses in the third quarter of 2013 compared to the same period in 2012. Despite this, . . .

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