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MCBC > SEC Filings for MCBC > Form 10-Q on 24-Apr-2014All Recent SEC Filings

Show all filings for MACATAWA BANK CORP

Form 10-Q for MACATAWA BANK CORP


24-Apr-2014

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 March 31, 2014, we had total assets of $1.49 billion, total loans of $1.03 billion, total deposits of $1.22 billion and shareholders' equity of $135.2 million. During the first quarter of 2014, we recognized net income of $2.6 million compared to net income of $2.5 million in the first quarter of 2013. As of March 31, 2014, the Company's and the Bank's risk-based regulatory capital ratios were among the highest in the Company's history. The Bank was categorized as "well capitalized" at March 31, 2014.

By the end of 2013, we had resolved all regulatory actions and resumed payment of interest on our trust preferred securities and completed an exchange of all of our outstanding preferred stock for common shares and cash, at the election of the holder. With these actions completed, we paid a dividend of $0.02 per share on March 28, 2014 to shareholders of record on March 7, 2014 after a hiatus of over five years.

RESULTS OF OPERATIONS

Summary: Net income for the quarter ended March 31, 2014 was $2.6 million, compared to net income of $2.5 million in the first quarter of 2013. Net income per common share on a diluted basis was $0.08 for the first quarter of 2014 and $0.09 for the first quarter of 2013.

The increase in earnings in the first quarter of 2014 compared to the first quarter of 2013 was due to continued reductions in our nonperforming asset expenses. Nonperforming asset expenses (including administration costs and losses) were $471,000 for the first quarter of 2014 compared to $961,000 for the first quarter of 2013. In addition, we took a larger negative provision in the first quarter of 2014 than in 2013. The provision for loan losses was a negative $1.0 million for the three month period ended March 31, 2014 compared to a negative $750,000 for the same period in 2013. We again were in a net loan recovery position for the first quarter of 2014, with $585,000 in net loan recoveries, compared to $498,000 in net loan recoveries in the first quarter of 2013. These improvements more than offset the impact of the lower level of gains on sales of residential mortgages, which declined from $825,000 in the first quarter of 2013 to $258,000 in the first quarter of 2014. Lost interest from elevated levels of nonperforming assets was approximately $570,000 for the three months ended March 31, 2014 compared to $728,000 for the three months ended March 31, 2013. Each of these items is discussed more fully below.

Net Interest Income: Net interest income totaled $10.5 million for both the first quarter of 2014 and the first quarter of 2013.

The net interest income was positively impacted in the first quarter of 2014 due in part to a one-time recovery of interest of $337,000 on a previously charged off loan as well as a reduction in interest paid on deposits, which declined 14 basis points in the first quarter of 2014 compared to the same period in 2013. Our average yield on earning assets for the first quarter of 2014 decreased 13 basis points compared to the same period in 2013 from 3.72% to 3.59%. Average interest earning assets totaled $1.35 billion for the first quarters of 2014 and 2013. The net interest margin was 3.15% for the first quarter of 2014 compared to 3.14% for the first quarter of 2013. While net interest margin was virtually unchanged, offsetting dynamics influenced the margin as follows. An increase of $40.8 million in average securities between periods partially mitigated the impact of reduction in average loan yield from 4.42% in the first quarter of 2013 to 4.22% in the first quarter of 2014.

The decrease in yields on interest earning assets for the three month period ended March 31, 2014 was due primarily to the mix in our earning assets. Average securities increased $40.8 million while average loan balances decreased $17.0 million. A one-time recovery of interest on a previously charged off loan partially offset the decreases in the yield on our commercial, residential and consumer loan portfolios, which have continued to reprice at lower levels in the generally low 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 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 16 basis points to 0.58% in the first quarter of 2014 from 0.74% in the same period in 2013. 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 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 March 31, 2014 and 2013.

                                                 For the three months ended March 31,
                                          2014                                          2013
                                         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      $   118,299     $      500           1.68 %   $   102,318     $      428           1.67 %
Tax-exempt securities
(1)                          49,750            255           3.23 %        24,889            142           3.73 %
Loans (2)                 1,038,624         10,943           4.22 %     1,055,578         11,668           4.42 %
Federal Home Loan
Bank stock                   11,236            156           5.55 %        11,236             99           3.52 %
Federal funds sold
and other short-term
investments                 132,062            116           0.35 %       154,682             96           0.25 %
Total interest
earning assets (1)        1,349,971         11,970           3.59 %     1,348,703         12,433           3.72 %

Noninterest earning
assets:
Cash and due from
banks                        25,173                                        21,615
Other                       118,057                                       136,404
Total assets            $ 1,493,201                                   $ 1,506,722

Liabilities
Deposits:
Interest bearing
demand                  $   279,825             78           0.12 %   $   257,241             81           0.12 %
Savings and money
market accounts             470,962            317           0.27 %       483,091            548           0.46 %
Time deposits               149,503            345           0.94 %       188,513            457           0.98 %
Borrowings:
Other borrowed funds         89,788            431           1.92 %        93,252            495           2.12 %
Long-term debt               41,238            324           3.15 %        41,238            369           3.58 %
Total interest
bearing liabilities       1,031,316          1,495           0.58 %     1,063,335          1,950           0.74 %

Noninterest bearing
liabilities:
Noninterest bearing
demand accounts             323,638                                       303,644
Other noninterest
bearing liabilities           3,759                                         7,802
Shareholders' equity        134,488                                       131,941
Total liabilities and
shareholders' equity    $ 1,493,201                                   $ 1,506,722

Net interest income                     $   10,475                                    $   10,483

Net interest spread
(1)                                                          3.01 %                                        2.98 %
Net interest margin
(1)                                                          3.15 %                                        3.14 %
Ratio of average
interest earning
assets to average
interest bearing
liabilities                  130.90 %                                      126.84 %

(1) Yield adjusted to fully tax equivalent.

(2) Includes average nonaccrual loans of approximately $12.5 million and $15.4 million for the three months ended March 31, 2014 and 2013.

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Index
Provision for Loan Losses: The provision for loan losses for the first quarter of 2014 was a negative $1.0 million compared to a negative $750,000 for the first quarter of 2013. The negative provision for loan losses for both periods was caused by stabilizing real estate values on problem credits, continued shrinkage in the overall loan portfolio and net loan recoveries of $585,000 in the first quarter of 2014 and $498,000 in the first quarter of 2013. At March 31, 2014, we had experienced net loan recoveries in four of the past five quarters.

Net loan recoveries were $585,000 in the first quarter of 2014 compared to net loan recoveries of $498,000 for the first quarter of 2013. In the first quarter of 2014, we had $82,000 in charge-offs, compared to $642,000 in the first quarter of 2013. The charge-offs for each period were largely 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. We are also experiencing positive results from our collection efforts with loan recoveries increasing as evidenced by our net loan recovery positions in the first quarters of 2013 and 2014. Loan recoveries were $667,000 for the first quarter of 2014 and $1.1 million for the same period in 2013. While we expect our collection efforts to produce further recoveries, they may not continue at the same level we have experienced the past several 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 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 month period ended March 31, 2014 decreased to $3.5 million compared to $4.0 million for the same period in 2013. The components of noninterest income are shown in the table below (in thousands):

                                               Three Months      Three Months
                                                   Ended             Ended
                                                 March 31,         March 31,
                                                   2014              2013
Service charges and fees on deposit accounts   $         991     $         952
Net gains on mortgage loans                              258               825
Trust fees                                               631               588
Gain as sales of securities                               10                20
ATM and debit card fees                                1,052               976
Bank owned life insurance ("BOLI") income                154               170
Investment services fees                                 245               215
Other income                                             169               217
Total noninterest income                       $       3,510     $       3,963

Service charges on deposit accounts increased for the three month period ended March 31, 2014 due to changes in our pricing of certain deposit related services. Trust fees and investment service fees were also up in the first quarter of 2014 due to investment market improvement. ATM and debit card fees increased over 2013 due to higher level of usage from our customers in the first quarter of 2014, partially due to our rollout of the uChoose Rewards incentive program. These increases were offset by a significant reduction in gains on sales of mortgage loans for the first quarter of 2014 due to a decrease in our residential mortgage loan origination volume. This volume decreased as a result of market increases in mortgage loan rates in the quarter. We also recognized a reduction in other income, due to lower level of rental income on other real estate owned, as we continued to reduce our holdings of such properties.

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Index
Noninterest Expense: Noninterest expense decreased to $11.2 million for the three month period ended March 31, 2014, from $11.6 million for the same period in 2013. The components of noninterest expense are shown in the table below (in thousands):

                                                    Three Months       Three Months
                                                       Ended              Ended
                                                     March 31,          March 31,
                                                        2014               2013
Salaries and benefits                              $        5,823     $        5,794
Occupancy of premises                                       1,008                946
Furniture and equipment                                       840                749
Legal and professional                                        205                189
Marketing and promotion                                       239                247
Data processing                                               589                546
FDIC assessment                                               328                471
Interchange and other card expense                            271                291
Bond and D&O insurance                                        163                186
Administration and disposition of problem assets              471                961
Outside services                                              417                369
Other noninterest expense                                     815                832
Total noninterest expense                          $       11,169     $       11,581

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 first quarter of 2014 from the first quarter of 2013. We had 354 full-time equivalent employees at March 31, 2014 compared to 365 at March 31, 2013. The increased expense for the first quarter of 2014 was primarily attributable to a higher level of 401(k) plan matching contributions and expenses associated with restricted stock vesting.

Over the past several years, the next largest noninterest expense has been 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 gains and 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 first quarter of 2014 compared to the same period in the prior year.

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

                                                                Three Months      Three Months
                                                                   Ended              Ended
                                                                 March 31,          March 31,
                                                                    2014              2013
Legal and professional - nonperforming assets                  $          102     $         166
Repossessed and foreclosed property administration                        555               736
Net (gains) losses on repossessed and foreclosed properties              (186 )              59
Total                                                          $          471     $         961

Losses on repossessed assets and foreclosed properties decreased significantly for the three month period ended March 31, 2014, decreasing $245,000 from the same period in 2013. The writedowns for each period have largely been driven by declines in the value of real estate. The pace of the decline in real estate values, however, has been slowing, translating into a decline in writedowns. During the first quarter of 2014, we realized net gains on sales of foreclosed properties of $484,000, more than offsetting the $298,000 in valuation writedowns during the quarter.

Costs associated with administration and disposition of problem assets decreased due to the decrease in the level of other real estate owned. Other real estate owned decreased from $51.6 million at March 31, 2013 to $34.0 million at March 31, 2014. As our level of problem loans and other real estate owned decreases, we believe we will experience more reductions in these costs going forward.

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Index
FDIC assessments decreased by $143,000 to $328,000 for the first quarter of 2014 compared to $471,000 for the first quarter of 2013 as a result of the first quarter of 2014 including the full effect of the change in our assessment category resulting from the termination of our previous regulatory orders.

Federal Income Tax Expense: We recorded $1.2 million in federal income tax expense for the three month period ended March 31, 2014 compared to $1.1 million in the same period in 2013. At December 31, 2012 and since that time, we have concluded that a valuation allowance on our deferred tax asset was not required. As a result, the financial results for the first quarter of 2014 reflect federal income tax expense, at an effective tax rate of 30.85% compared to 31.59% for first quarter of 2013.

FINANCIAL CONDITION

Summary: Due to the continuing soft economic conditions, we have been focused on improving our loan portfolio, reducing exposure in higher loan concentration types, and improving our financial condition through increased liquidity, diversification of credit risk, improved capital ratios, and reduced reliance on non-core funding. We have experienced positive results in each of these areas over the past four years.

Total assets were $1.49 billion at March 31, 2014, a decrease of $26.5 million from $1.52 billion at December 31, 2013. This change reflected increases of $13.7 million in securities available for sale and $7.5 million of interest-bearing time deposits in other financial institutions, offset by declines of $29.6 million in cash and equivalents and $12.3 million in our loan portfolio. Total deposits declined by $33.0 million due to normal seasonal deposit usage and other borrowed funds were down by $1.2 million at March 31, 2014 compared to December 31, 2013.

Cash and Cash Equivalents: Our cash and cash equivalents, which include federal funds sold and short-term investments, were $127.3 million at March 31, 2014 compared to $156.9 million at December 31, 2013. The $29.6 million decrease was primarily the result of normal outflow of the seasonal build-up in deposits we typically experience toward year end. These balances have also been elevated due to high short term balances maintained by our large deposit customers. We expect our balances of short term investments to remain elevated until loan demand materially increases and more attractive investment opportunities emerge.

Interest-bearing Time Deposits with Other Financial Institutions: We opened two time deposit accounts with our primary correspondent bank in the first quarter of 2013, each in equal amounts totaling $25.0 million. One of these deposits matured in March 2014 and the other matures in September 2014. We opened another time deposit of $20.0 million in the first quarter of 2014 which matures in February 2016. These time deposits provide a higher interest rate than federal funds sold or other short-term investments.

Securities Available for Sale: Securities available for sale were $153.3 million at March 31, 2014 compared to $139.7 million at December 31, 2013. We began rebuilding our investment portfolio during the second quarter of 2011. The balance at March 31, 2014 primarily consisted of U.S. agency securities, agency mortgage backed securities and various municipal investments. We expect to continue to reinvest excess liquidity and selectively rebuild our investment portfolio.

Portfolio Loans and Asset Quality: Total portfolio loans declined by $12.3 million in the first quarter of 2014 and were $1.03 billion at March 31, 2014 compared to $1.04 billion at December 31, 2013. During the first quarter of 2014, our commercial portfolio decreased by $11.3 million while our consumer portfolio decreased by $2.3 million and our residential mortgage portfolio increased by $1.3 million. We have been focusing efforts to increase our consumer and residential mortgage portfolio segments to further diversify our credit risk.

Our commercial loan portfolio balances declined in recent years reflecting the continuing weak economic conditions in West Michigan and our interest in improving the quality of our loan portfolio through reducing our exposure to these generally higher credit risk assets. We have focused our efforts on reducing our exposure to residential land development loans, diversifying our commercial loan portfolio and improving asset quality. We believe our loan portfolio has stabilized. During the fourth quarter of 2012, we achieved growth in our commercial loan portfolio for the first time since the fourth quarter of 2008 and balances held relatively steady since, with much of the reduction in balances due to resolution of problem credits. We believe we are poised for high quality loan portfolio growth in 2014.

Commercial and commercial real estate loans remained our largest loan segment and accounted for approximately 71% of the total loan portfolio at March 31, 2014 and 72% at December 31, 2013. Residential mortgage and consumer loans comprised approximately 29% of total loans at March 31, 2014 and 28% at December 31, 2013.

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Index
A further breakdown of the composition of the loan portfolio is shown in the table below (in thousands):

                                                  March 31, 2014                 December 31, 2013
                                                            Percent of                       Percent of
                                             Balance       Total Loans        Balance       Total Loans
Commercial real estate: (1)
Residential developed                      $    15,204              1.5 %   $    18,130              1.8 %
Unsecured to residential developers              7,112              0.7           7,315              0.7
Vacant and unimproved                           44,538              4.4          42,988              4.1
Commercial development                           2,236              0.2           2,434              0.2
Residential improved                            73,341              7.1          76,294              7.3
Commercial improved                            244,261             23.7         247,195             23.7
Manufacturing and industrial                    76,505              7.4          77,984              7.5
Total commercial real estate                   463,197             45.0         472,340             45.3
Commercial and industrial                      271,924             26.4 %       274,099             26.3 %
Total commercial                               735,121             71.4         746,439             71.6

Consumer
Residential mortgage                           189,926             18.4         188,648             18.1
Unsecured                                        1,285              0.1           1,337              0.1
Home equity                                     94,148              9.2          95,961              9.2
Other secured                                    9,631              0.9           9,992              1.0
Total consumer                                 294,990             28.6         295,938             28.4
Total loans                                $ 1,030,111            100.0 %   $ 1,042,377            100.0 %

(1) Includes both owner occupied and non-owner occupied commercial real estate.

Commercial real estate loans accounted for approximately 45% of the total loan portfolio at March 31, 2014 and consisted primarily of loans to business owners and developers of owner and non-owner occupied commercial properties and loans to developers of single and multi-family residential properties. In the table above, we show our commercial real estate portfolio by loans secured by residential and commercial real estate, and by stage of development. Improved loans are generally secured by properties that are under construction or completed and placed in use. Development loans are secured by properties that are in the process of development or fully developed. Vacant and unimproved loans are secured by raw land for which development has not yet begun and agricultural land.

Total commercial real estate loans declined $9.1 million since December 31, 2013. Our commercial and industrial loan portfolio decreased by $2.2 million to $271.9 million at March 31, 2014 and represented 26% of our commercial portfolio.

. . .

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