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MCBC > SEC Filings for MCBC > Form 10-K on 20-Feb-2014All Recent SEC Filings

Show all filings for MACATAWA BANK CORP

Form 10-K for MACATAWA BANK CORP


20-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Results of Operations and
Financial Condition.

Management's discussion and analysis of results of operations and financial condition contains forward-looking statements. Please refer to the discussion of forward-looking statements at the beginning of this report.

The following section presents additional information to assess our results of operation and financial condition. This section should be read in conjunction with the consolidated financial statements and the supplemental financial data contained elsewhere in this report.

OVERVIEW

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 have 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 December 31, 2013, we had total assets of $1.52 billion, total loans of $1.04 billion, total deposits of $1.25 billion and shareholders' equity of $132.5 million. We recognized net income of $9.5 million in 2013 compared to net income of $35.5 million in 2012. With the reversal of our deferred tax asset valuation allowance at December 31, 2012, our earnings for 2013 reflected tax expense of $4.3 million, while 2012 reflected a tax benefit of $18.6 million. As of December 31, 2013, the Company's and the Bank's regulatory capital ratios were among the highest levels in the Company's history. The Bank was categorized as "well capitalized" at December 31, 2013.

On April 12, 2013, the FDIC and the Michigan 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.

Similiarly, by letter dated August 1, 2013, the Federal Reserve Bank of Chicago ("FRB") advised the Company that, based on the overall satisfactory condition of the organization, the FRB poses no objection should the Board of Directors choose to rescind the Board Resolution. Accordingly, the Company's Board of Directors rescinded the Board Resolution as of August 1, 2013.

During 2013, the Company improved its capital structure by prepaying and redeeming its $1.7 million of 11% unsecured subordinated debt, resuming interest payments on its trust preferred securities and completing an exchange of all of the Company's Series A and Series B Preferred Stock to Company common stock and cash, at the election of the holder. Each of these transactions are discussed in detail in Item 7 and in our consolidated financial statements and related notes included in this report.

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Over the past five years, much progress has been made at reducing our nonperforming assets. The following table reflects period end balances of these nonperforming assets as well as total loan delinquencies.

                                   December 31,       December 31,       December 31,       December 31,       December 31,
(Dollars in thousands)                 2013               2012               2011               2010               2009
Nonperforming loans               $       12,335     $       16,003     $       28,946     $       75,361     $      103,885
Other repossessed assets                      40                  6                ---                 50                124
Other real estate owned                   36,796             51,582             66,438             57,984             37,184
Total nonperforming assets        $       49,171     $       67,591     $       95,384     $      133,395     $      141,193

Total loan delinquencies 30
days or greater past due          $        5,520     $        7,887     $       13,138     $       55,748     $      118,568

Earnings in recent years have been impacted by high costs associated with administration and disposition of nonperforming assets. These costs, including losses on repossessed and foreclosed properties, were $5.5 million, $10.0 million and $15.6 million for the years ended December 31, 2013, 2012 and 2011, respectively. Going forward, as further reductions in nonperforming assets are accomplished, we expect the costs associated with these assets to continue to decline thereby allowing for improved earnings in future periods.

Our earnings in 2013, 2012 and 2011 were favorably impacted by negative provision for loan losses of $4.3 million, $7.1 million and $4.7 million, respectively. As discussed in detail later in Item 7 of this report under the heading "Allowance for Loan Losses", the large negative provision in 2012 was primarily a result of a large recovery taken in the first quarter of 2012. The negative provision in each period was also impacted by other recoveries from our collection efforts and a continual decline in our historical charge-off levels from prior years. We do not expect a similar level of negative provision for loan losses in 2014.

The following table reflects the provision for loan losses for the past five years along with certain metrics that impact the determination of the level of the provision for loan losses.

                                                   For the year ended December 31,
(Dollars in thousands)              2013          2012          2011          2010          2009
Provision for loan losses         $  (4,250 )   $  (7,100 )   $  (4,700 )   $  22,460     $  74,340
Net charge-offs (recoveries)         (1,309 )         802        11,085        29,657        59,942
Net charge-offs to average                  )
loans                                 (0.13 %        0.08 %        0.99 %        2.18 %        3.54 %
Nonperforming loans to total
loans                                  1.18 %        1.52 %        2.70 %        6.19 %        6.88 %
Loans transferred to ORE to
average loans                          0.34 %        0.88 %        3.42 %        3.32 %        1.80 %
Performing troubled debt
restructurings to average loans        5.61 %        6.24 %        5.15 %        1.91 %        1.62 %

The State of Michigan entered into a recession earlier than the rest of the country and has experienced heavy job loss as a result of the concentration the State has related to the automotive industry. Our market areas of Grand Rapids and Holland fared better than the state as a whole, but nevertheless the impact of our local economy on our results was profound. The recession and job loss impacted housing values, commercial real estate values and consumer activity. Improvement has been evident during the past three years. The state's unemployment rate at the end of 2013 was 8.8%, no longer the highest in the country and down dramatically from 15.2% in June 2009. The Holland area unemployment was 5.8%, and the Grand Rapids area unemployment was 5.6% at the end of 2013. Residential housing values and commercial real estate property values decreased significantly during the recession, but have shown signs of stabilization, with some of our newer appraisals tending to reflect values at or above prior year values.

It also appears that the housing market in our primary market area has stabilized and is now improving. In the Grand Rapids market during 2013, there were 23% more single family home starts than in 2012. Similarly, in the Holland-Grand Haven/Lakeshore region, there were 32% more single family home starts in 2013 than in 2012. Also, these markets are now also seeing activity in duplex, condominium and apartment starts after years of virtually no activity.

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In recent years, we have continued to diversify our loan portfolio structure by de-emphasizing commercial real estate loans and cautiously increasing volumes of commercial and industrial loans, residential mortgages and other consumer loans. Commercial real estate loans have decreased from $503.0 million at December 31, 2012 to $472.3 million at December 31, 2013. Consumer loans have increased in 2013, totaling $295.9 million at December 31, 2013, compared to $289.7 million at December 31, 2012. With our improved financial condition, successful capital raise in 2011, and retained earnings growth, our focus has shifted from shrinkage in our loan portfolio to stabilizing our loan balances and growing certain portfolios in 2014.

RESULTS OF OPERATIONS

Summary: Net income was $9.5 million ($13.8 million on a pretax basis) for 2013, compared to net income of $35.5 million ($16.9 million on a pretax basis) for 2012 and $5.8 million ($5.8 million on a pretax basis) for 2011. Earnings
(loss) per common share on a diluted basis was $(0.29) for 2013, $1.31 for 2012 and $0.26 for 2011. Earnings (loss) per share for 2013 was affected by a one-time, non-cash reduction to net income available to common shares of $17.6 million representing the impact of the preferred stock exchange completed on December 30, 2013.

The results for 2012 were significantly impacted by the reversal of an $18.9 million valuation allowance on our deferred tax assets ("DTA") as we determined it to be more likely than not that we will be able to utilize the DTA against future taxable income. Also contributing to the higher 2012 income was the collection of a large prepayment fee of $2.8 million on an individual loan. Earnings in each period were positively impacted by negative provision for loan losses ($4.3 million in 2013, $7.1 million in 2012 and $4.7 million in 2011). These negative provisions resulted from reduced levels of nonperforming loans, improved asset quality and reduced levels of chargeoffs. The negative provision in 2012 was higher due to the recovery of $4.4 million on an individual loan previously charged off. These items are discussed more fully below.

We continued our improvement in nonperforming asset expenses in 2013. Costs associated with nonperforming assets were $5.5 million in 2013, compared to $10.0 million in 2012 and $15.6 million in 2011. Lost interest from nonperforming assets decreased to approximately $2.4 million for 2013, compared to $6.7 million for 2012 and $7.5 million for 2011. Each of these items are discussed more fully below.

Net Interest Income: Net interest income totaled $41.3 million during 2013, compared to $47.5 million during 2012 and $46.3 million in 2011.

The decrease in net interest income during 2013 compared to 2012 was largely due to the collection of a one-time prepayment fee of $2.8 million related to prepayment on a commercial loan in the third quarter of 2012. Our net interest income as a percentage of average interest-earning assets (i.e. "net interest margin" or "margin") decreased by 44 basis points compared to 2012. The prepayment fee contributed 21 basis points to the margin in 2012. As is 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. Average interest earning assets increased slightly from $1.35 billion in 2012 to $1.36 billion in 2013.

The increase in net interest income during 2012 compared to 2011 was due primarily to the collection of a one-time prepayment fee of $2.8 million related to prepayment on a commercial loan in the third quarter of 2012. Partially offsetting this was the impact of a $41.6 million decrease in average earning assets as a result of our focus on reducing credit exposure within certain segments of our loan portfolio and liquidity improvement. Our net interest margin increased by 20 basis points compared to 2011. The prepayment fee contributed 21 basis points to the margin in 2012. Average interest earning assets decreased from $1.39 billion in 2011 to $1.35 billion in 2012.

The yield on earning assets decreased 63 basis points from 4.21% for 2012 to 3.58% for 2013, and decreased 11 basis points to 4.21% for 2012 from 4.32% for 2011. The decreases were due to decreases in the yield on our commercial, residential and consumer loan portfolios, which repriced in the generally lower rate environment during 2012 and 2013. Our margin was negatively impacted by our decision to hold significant balances in liquid and short-term investments in the past three years. Going forward, as we deploy these balances into higher yielding assets within the investment securities and loan portfolios, we expect our net interest margin to be positively impacted.

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Our net interest margin for 2013 benefitted from a 23 basis point decrease in our cost of funds from 0.92% for 2012 to 0.69% for 2013. Average interest bearing liabilities decreased from $1.06 billion in 2012 to $1.05 billion in 2013. Our net interest margin for 2012 benefitted from a 34 basis point decrease in our cost of funds from 1.26% for 2011 to 0.92% for 2012. Average interest bearing liabilities decreased from $1.15 billion in 2011 to $1.06 billion in 2012. 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 for each period.

Margin continued to be dampened by the impact of our elevated levels of nonperforming assets, including other real estate owned and nonaccrual loans. However, as we work to further reduce these levels, our margin is expected to benefit. The estimated negative impact of these nonperforming assets on net interest margin decreased from 54 basis points in 2011 to 37 basis points in 2012 and 18 basis points in 2013.

We are encouraged by the slight increase in average earning assets in 2013 and expect these balances to continue to increase in 2014, which should positively affect net interest income.

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The following table shows an analysis of net interest margin for the years ended December 31, 2013, 2012 and 2011.

                                                                      For the years ended December 31,
                                        2013                                        2012                                        2011
                                       Interest       Average                      Interest       Average                      Interest       Average
                         Average        Earned         Yield         Average        Earned         Yield         Average        Earned         Yield
                         Balance        or paid       or cost        Balance        or paid       or cost        Balance        or paid       or cost
                                                                           (Dollars in thousands)
       Assets
Taxable securities     $   108,079     $   1,798          1.67 %   $    79,379     $   1,544          1.94 %   $    25,452     $     497          1.95 %
Tax-exempt
securities (1)              33,930           742          3.44 %        13,769           330          4.03 %         1,235            38          5.24 %
Loans (2)                1,034,775        45,201          4.32 %     1,049,501        54,549          5.14 %     1,123,295        59,334          5.23 %
Federal Home Loan
Bank stock                  11,236           393          3.45 %        11,236           351          3.08 %        11,539           294          2.51 %
Federal funds sold
and other short-term
investments                167,833           486          0.29 %       197,423           502          0.25 %       231,417           616          0.26 %
Total interest
earning assets (1)       1,355,853        48,620          3.58 %     1,351,308        57,276          4.21 %     1,392,938        60,779          4.32 %

Noninterest earning
assets:
Cash and due from
banks                       24,033                                      23,042                                      23,011
Other                      129,954                                     124,510                                     115,552
Total assets           $ 1,509,840                                 $ 1,498,860                                 $ 1,531,501

Liabilities
Deposits:
Interest bearing
demand                 $   272,689           369          0.13 %   $   225,250           346          0.15 %   $   185,591           424          0.23 %
Savings and money
market accounts            472,920         1,999          0.43 %       420,553         2,003          0.48 %       369,758         2,063          0.56 %
Time deposits              171,657         1,625          0.94 %       254,796         3,372          1.32 %       371,870         6,786          1.83 %
Borrowings:
Other borrowed funds        90,580         1,781          1.94 %       121,300         2,374          1.92 %       175,063         3,609          2.03 %
Long-term debt              41,238         1,450          3.47 %        41,238         1,537          3.67 %        41,238         1,413          3.38 %
Subordinated debt            1,013           113         11.10 %         1,650           182         11.00 %         1,839           185         10.05 %
Total interest
bearing liabilities      1,050,097         7,337          0.69 %     1,064,787         9,814          0.92 %     1,145,359        14,480          1.26 %

Noninterest bearing
liabilities:
Noninterest bearing
demand accounts            317,332                                     323,368                                     296,926
Other noninterest
bearing liabilities          8,070                                       7,507                                       6,934
Shareholders' equity       134,341                                     103,198                                      82,282
Total liabilities
and shareholders'
equity                 $ 1,509,840                                 $ 1,498,860                                 $ 1,531,501

Net interest income                    $  41,283                                   $  47,462                                   $  46,299

Net interest spread
(1)                                                       2.89 %                                      3.29 %                                      3.06 %
Net interest margin
(1)                                                       3.05 %                                      3.49 %                                      3.29 %
Ratio of average
interest earning
assets to average
interest bearing
liabilities                 129.12 %                                    126.91 %                                    121.62 %

(1) Yields are presented on a tax equivalent basis using a 35% tax rate.

(2) Loan fees of $548,000, $4.0 million and $678,000 for 2013, 2012 and 2011 are included in interest income. Includes average nonaccrual loans of approximately $14.7 million, $24.1 million and $51.1 million for 2013, 2012 and 2011.

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The following table presents the dollar amount of changes in net interest income due to changes in volume and rate.

                                                For the years ended December 31,
                                     2013 vs 2012                               2012 vs 2011
                              Increase (Decrease) Due to                 Increase (Decrease) Due to
                          Volume         Rate          Total         Volume         Rate          Total

                                                     (Dollars in thousands)
Interest income
Taxable securities      $      501     $    (247 )   $     254     $    1,049     $      (2 )   $   1,047
Tax-exempt securities          473           (61 )         412            311           (19 )         292
Loans                         (756 )      (8,592 )      (9,348 )       (3,848 )        (937 )      (4,785 )
Federal Home Loan
Bank stock                     ---            42            42             (8 )          65            57
Federal funds sold
and other short-term
investments                    (80 )          64           (16 )          (87 )         (27 )        (114 )
Total interest income          138        (8,794 )      (8,656 )       (2,583 )        (920 )      (3,503 )

Interest expense
Interest bearing
demand                  $       67           (44 )   $      23     $       79          (157 )   $     (78 )
Savings and money
market accounts                235          (239 )          (4 )          263          (323 )         (60 )
Time deposits                 (933 )        (814 )      (1,747 )       (1,822 )      (1,592 )      (3,414 )
Other borrowed funds          (604 )          11          (593 )       (1,060 )        (175 )      (1,235 )
Long-term debt                 ---           (87 )         (87 )          ---           124           124
Subordinated debt              (37 )         (32 )         (69 )           (7 )           4            (3 )
Total interest
expense                     (1,272 )      (1,205 )      (2,477 )       (2,547 )      (2,119 )      (4,666 )
Net interest income     $    1,410     $  (7,589 )   $  (6,179 )   $      (36 )   $   1,199     $   1,163

Provision for Loan Losses: The provision for loan losses for 2013 was a negative $4.3 million compared to a negative $7.1 million for 2012 and a negative $4.7 million for 2011. The negative provisions in each period 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 2012 was affected by a $4.4 million recovery on a previously charged-off loan in the first quarter of 2012. Net charge-offs were $58.0 million in 2009, $29.7 million in 2010, $11.1 million in 2011, and $802,000 in 2012 and a net recovery of $1.3 million in 2013. The lower level of net charge-offs was a result of a slowing in the rate of declines in real estate values, success at reducing our levels of nonperforming loans and positive results from our aggressive collection recovery efforts.

We have experienced a decline in the pace of commercial loans migrating to a worse loan grade, which receive higher allocations in our loan loss reserve. 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 3.88 at December 31, 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 each 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 three years has 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 in this Item 7 of the report under the heading "Allowance for Loan Losses" below and in Item 8 of this report in Note 3 of the Consolidated Financial Statements.

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Noninterest Income: Noninterest income totaled $16.1 million in 2013, compared to $15.6 million in 2012 and $14.9 million in 2011. The components of noninterest income are shown in the table below (in thousands):

                                                 2013         2012         2011
Service charges and fees on deposit accounts   $  3,963     $  3,323     $  3,692
Net gains on mortgage loans                       2,554        2,882        1,728
Trust fees                                        2,413        2,389        2,543
Gain as sales of securities                         120           73          ---
ATM and debit card fees                           4,325        4,130        3,963
Bank owned life insurance ("BOLI") income           713          847          942
Investment services fees                            943          771          796
Other income                                      1,110        1,213        1,228
Total noninterest income                       $ 16,141     $ 15,628     $ 14,892

Revenue from deposit services was $4.0 million in 2013, compared to $3.3 million in 2012 and $3.7 million in 2011. The increase from 2012 to 2013 was due primarily to increased levels of returned check fees from changes to the overdraft privilege feature of our checking accounts implemented in late 2012. The decrease from 2011 to 2012 was related primarily to decreases in fees driven from account balances, as our average deposit balances were lower in 2012 than in 2011.

Net gains on mortgage loans included gains on the sale of real estate mortgage loans in the secondary market. We sell the majority of the fixed-rate mortgage loans we originate. We do not retain the servicing rights for the loans we sell.

A summary of gain on sales of loans and related loan volume was as follows (in thousands):

                                                        For the Year Ended December 31,
                                                        2013           2012          2011

Gain on sales of loans                                $     2,554     $   2,882     $   1,728

Real estate mortgage loans originated for sale        $   107,988     $ 140,151     $  84,470
Real estate mortgage loans sold                           116,757       135,929        87,709
Net gain on the sale of mortgage loans as a
percent of real estate mortgage loans sold ("Loan
sale margin")                                                2.19 %        2.12 %        1.97 %

As demonstrated in the table above, we realized significant volumes of activity the past few years, peaking in 2012. Mortgage rates increased in the second half of 2013, reducing the residential mortgage volume and thus reducing gains on mortgage loans in the latter half of 2013. This income was up significantly during 2012 as a result of our renewed focus on residential mortgage volume and the addition of experienced mortgage professionals during 2011, and the low interest rate environment that existed throughout 2011 and 2012. During 2013, we saw a shift in our mortgage production from refinance activity to purchase activity. We expect this trend to continue in 2014.

. . .

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