UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission file number: 000-25927

MACATAWA BANK CORPORATION
(Exact name of registrant as specified in its charter)

Michigan
38-3391345
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)

10753 Macatawa Drive, Holland, Michigan 49424
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (616) 820-1444
 

 
Indicate by checkmark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Smaller reporting company o
 
 
(Do not check if smaller
 
 
 
reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

The number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 27,261,325 shares of the Company's Common Stock (no par value) were outstanding as of October 24, 2013.
 


Forward-Looking Statements

This report contains forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and Macatawa Bank Corporation. Forward-looking statements are identifiable by words or phrases such as "outlook", "plan" or "strategy"; that an event or trend "may", "should", "will", "is likely", or is "probable" to occur or "continue", has "begun" or "is scheduled" or "on track" or that the Company or its management "anticipates", "believes", "estimates", "plans", "forecasts", "intends", "predicts", "projects", or "expects" a particular result, or is "committed", "confident", "optimistic" or has an "opinion" that an event will occur, or other words or phrases such as "ongoing", "future", "signs", "efforts", "tend", "exploring", "appearing", "until", "near term", "going forward", "starting", “initiative,” “trend” and variations of such words and similar expressions. Such statements are based upon current beliefs and expectations and involve substantial risks and uncertainties which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These statements include, among others, statements related to stabilization of our loan portfolio, trends in credit quality metrics, future capital levels and capital needs, including the impact of Basel III, real estate valuation, future levels of repossessed and foreclosed properties and nonperforming assets, future levels of losses and costs associated with the administration and disposition of repossessed and foreclosed properties and nonperforming assets, future levels of loan charge-offs, future levels of other real estate owned, future levels of provisions for loan losses, the rate of asset dispositions, future dividends, future growth and funding sources, future cost of funds, future liquidity levels, future profitability levels, future FDIC assessment levels, future net interest margin levels, building and improving our investment portfolio, diversifying our credit risk, the effects on earnings of changes in interest rates, future economic conditions, future effects of new or changed accounting standards, future loss recoveries, future balances of short-term investments, future loan demand and loan growth, future levels of mortgage banking revenue and the future level of other revenue sources. Management's determination of the provision and allowance for loan losses, the appropriate carrying value of intangible assets (including deferred tax assets) and other real estate owned, and the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary and the amount of any impairment) involves judgments that are inherently forward-looking. All statements with references to future time periods are forward-looking. All of the information concerning interest rate sensitivity is forward-looking. Our ability to sell other real estate owned at its carrying value or at all, successfully implement new programs and initiatives, increase efficiencies, maintain our current levels of deposits and other sources of funding, maintain liquidity, respond to declines in collateral values and credit quality, increase loan volume, originate high quality loans, maintain or improve mortgage banking income, realize the benefit of our deferred tax assets, resume payment of dividends and improve profitability is not entirely within our control and is not assured. The future effect of changes in the real estate, financial and credit markets and the national and regional economy on the banking industry, generally, and Macatawa Bank Corporation, specifically, are also inherently uncertain. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions ("risk factors") that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. Macatawa Bank Corporation does not undertake to update forward-looking statements to reflect the impact of circumstances or events that may arise after the date of the forward-looking statements.

Risk factors include, but are not limited to, the risk factors described in "Item 1A - Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2012. These and other factors are representative of the risk factors that may emerge and could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.


INDEX

 
 
Page
 
 
Number
 
 
 
Part I.
Financial Information:
 
 
 
 
 
Item 1.
 
 
4
 
 
 
 
9
 
 
 
 
Item 2.
 
 
37
 
 
 
 
Item 3.
 
 
52
 
 
 
 
Item 4.
 
 
53
 
 
 
Part II.
Other Information:
 
 
 
 
 
Item 6.
 
 
54
 
 
 
56


Part I Financial Information
Item 1.
 
MACATAWA BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
As of September 30, 2013 (unaudited) and December 31, 2012

 
 
 
September 30,
   
December 31,
 
(dollars in thousands, except per share data)
 
2013
   
2012
 
ASSETS
 
   
 
Cash and due from banks
 
$
35,592
   
$
33,556
 
Federal funds sold and other short-term investments
   
178,263
     
192,802
 
Cash and cash equivalents
   
213,855
     
226,358
 
Interest-bearing time deposits in other financial institutions
   
25,000
     
---
 
Securities available for sale, at fair value
   
135,439
     
123,497
 
Securities held to maturity (fair value 2013 - $19,444 and 2012 - $4,301)
   
18,995
     
4,300
 
Federal Home Loan Bank (FHLB) stock
   
11,236
     
11,236
 
Loans held for sale, at fair value
   
2,983
     
8,130
 
Total loans
   
1,028,793
     
1,052,348
 
Allowance for loan losses
   
(21,272
)
   
(23,739
)
Net loans
   
1,007,521
     
1,028,609
 
Premises and equipment – net
   
52,916
     
53,576
 
Accrued interest receivable
   
3,250
     
3,411
 
Bank-owned life insurance
   
27,343
     
26,804
 
Other real estate owned
   
42,796
     
51,582
 
Net deferred tax asset
   
16,859
     
18,780
 
Other assets
   
4,487
     
4,435
 
Total assets
 
$
1,562,680
   
$
1,560,718
 
 
               
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Deposits
               
Noninterest-bearing
 
$
352,879
   
$
339,520
 
Interest-bearing
   
935,162
     
946,741
 
Total deposits
   
1,288,041
     
1,286,261
 
Other borrowed funds
   
89,991
     
91,822
 
Long-term debt
   
41,238
     
41,238
 
Subordinated debt
   
---
     
1,650
 
Accrued expenses and other liabilities
   
7,903
     
9,240
 
Total liabilities
   
1,427,173
     
1,430,211
 
 
               
Commitments and contingent liabilities
   
---
     
---
 
 
               
Shareholders' equity
               
Preferred stock, no par value, 500,000 shares authorized;
               
Series A Noncumulative Convertible Perpetual Preferred Stock, liquidation value of $1,000 per share, 31,290 shares issued and outstanding at September 30, 2013 and   December 31, 2012
   
30,604
     
30,604
 
Series B Noncumulative Convertible Perpetual Preferred Stock, liquidation value of $1,000 per share, 2,300 shares issued and outstanding at September 30, 2013 and   2,600 shares issued and outstanding at December 31, 2012
   
2,260
     
2,560
 
Common stock, no par value, 200,000,000 shares authorized; 27,261,325 shares issued and outstanding at September 30, 2013 and 27,203,825 shares issued and outstanding at   December 31, 2012
   
188,112
     
187,718
 
Retained deficit
   
(84,020
)
   
(91,335
)
Accumulated other comprehensive income (loss)
   
(1,449
)
   
960
 
Total shareholders' equity
   
135,507
     
130,507
 
Total liabilities and shareholders' equity
 
$
1,562,680
   
$
1,560,718
 
 

See accompanying notes to consolidated financial statements.
- 4 -

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three and Nine Month Periods Ended September 30, 2013 and 2012
(unaudited)

 
 
 
Three Months
   
Three Months
   
Nine Months
   
Nine Months
 
 
 
Ended
   
Ended
   
Ended
   
Ended
 
 
 
September 30,
   
September 30,
   
September 30,
   
September 30,
 
(dollars in thousands, except per share data)
 
2013
   
2012
   
2013
   
2012
 
Interest income
 
   
   
   
 
Loans, including fees
 
$
10,995
   
$
15,532
   
$
34,156
   
$
42,295
 
Securities
                               
Taxable
   
476
     
414
     
1,352
     
1,116
 
Tax-exempt
   
211
     
102
     
508
     
210
 
FHLB Stock
   
98
     
84
     
294
     
252
 
Federal funds sold and other short-term investments
   
139
     
137
     
349
     
394
 
Total interest income
   
11,919
     
16,269
     
36,659
     
44,267
 
 
                               
Interest expense
                               
Deposits
   
953
     
1,396
     
3,020
     
4,570
 
Debt and other borrowed funds
   
842
     
981
     
2,568
     
3,203
 
Total interest expense
   
1,795
     
2,377
     
5,588
     
7,773
 
 
                               
Net interest income
   
10,124
     
13,892
     
31,071
     
36,494
 
Provision for loan losses
   
(1,500
)
   
(1,250
)
   
(3,250
)
   
(6,600
)
Net interest income after provision for loan losses
   
11,624
     
15,142
     
34,321
     
43,094
 
 
                               
Noninterest income
                               
Service charges and fees
   
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 on sale of securities
   
---
     
14
     
80
     
73
 
ATM and debit card fees
   
1,104
     
1,049
     
3,212
     
3,094
 
Other
   
622
     
698
     
1,974
     
2,275
 
Total noninterest income
   
3,951
     
4,106
     
12,125
     
11,817
 
 
                               
Noninterest expense
                               
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
 
Losses on repossessed and foreclosed properties
   
1,059
     
706
     
1,412
     
4,236
 
Administration and disposition of problem assets
   
752
     
1,018
     
2,660
     
3,737
 
Other
   
1,408
     
1,292
     
4,227
     
4,196
 
Total noninterest expenses
   
12,362
     
12,388
     
35,818
     
40,380
 
 
                               
Income before income tax
   
3,213
     
6,860
     
10,628
     
14,531
 
Income tax expense
   
975
     
275
     
3,313
     
275
 
Net income
   
2,238
     
6,585
     
7,315
     
14,256
 
Dividends declared on preferred shares
   
---
     
---
     
---
     
---
 
Net income available to common shares
 
$
2,238
   
$
6,585
   
$
7,315
   
$
14,256
 
 
                               
Basic earnings per common share
 
$
0.08
   
$
0.24
   
$
0.27
   
$
0.53
 
Diluted earnings per common share
 
$
0.08
   
$
0.24
   
$
0.27
   
$
0.53
 
Cash dividends per common share
 
$
---
   
$
---
   
$
---
   
$
---
 
 

See accompanying notes to consolidated financial statements.
 
- 5 -

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three and Nine Month Periods Ended September 30, 2013 and 2012
(unaudited)

 
 
 
   
   
   
 
 
 
   
   
   
 
 
 
Three Months
   
Three Months
   
Nine Months
   
Nine Months
 
 
 
Ended
   
Ended
   
Ended
   
Ended
 
 
 
September 30,
   
September 30,
   
September 30,
   
September 30,
 
(dollars in thousands)
 
2013
   
2012
   
2013
   
2012
 
 
 
   
   
   
 
Net income
 
$
2,238
   
$
6,585
   
$
7,315
   
$
14,256
 
 
                               
Other comprehensive income (loss):
                               
 
                               
Unrealized gains (losses):
                               
Net change in unrealized gains (losses) on securities available for sale
   
(23
)
   
703
     
(3,626
)
   
1,225
 
Tax effect
   
8
     
(246
)
   
1,269
     
(429
)
Net change in unrealized gains (losses) on securities available for sale, net of tax
   
(15
)
   
457
     
(2,357
)
   
796
 
 
                               
Less: reclassification adjustments:
                               
Reclassification for gains included in net income
   
---
     
14
     
80
     
73
 
Tax effect
   
---
     
(5
)
   
(28
)
   
(26
)
Reclassification for gains included in net income, net of tax
   
---
     
9
     
52
     
47
 
 
                               
Other comprehensive income (loss), net of tax
   
(15
)
   
448
     
(2,409
)
   
749
 
 
                               
Comprehensive income
 
$
2,223
   
$
7,033
   
$
4,906
   
$
15,005
 
 

See accompanying notes to consolidated financial statements.

- 6 -

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Nine Month Periods Ended September 30, 2013 and 2012
(unaudited)

 
 
 
   
   
   
   
Accumulated
   
 
 
 
   
   
   
   
Other
   
Total
 
 
 
Preferred Stock
   
Common
   
Retained
   
Comprehensive
   
Shareholders'
 
(dollars in thousands, except per share data)
 
Series A
   
Series B
   
Stock
   
(Deficit)
   
Income (Loss)
   
Equity
 
 
 
   
   
   
   
   
 
Balance, January 1, 2012
 
$
30,604
   
$
2,560
   
$
187,709
   
$
(126,825
)
 
$
378
   
$
94,426
 
 
                                               
Net income for nine months ended September 30, 2012
                           
14,256
             
14,256
 
 
                                               
Net change in unrealized gain (loss) on securities available for sale, net of tax
                                   
749
     
749
 
 
                                               
Balance, September 30, 2012
 
$
30,604
   
$
2,560
   
$
187,709
   
$
(112,569
)
 
$
1,127
   
$
109,431
 
 
                                               
Balance, January 1, 2013
 
$
30,604
   
$
2,560
   
$
187,718
   
$
(91,335
)
 
$
960
   
$
130,507
 
 
                                               
Net income for nine months ended September 30, 2013
                           
7,315
             
7,315
 
 
                                               
Conversion of 300 shares of Preferred Stock Series B to 50,000 shares of Common Stock
           
(300
)
   
300
                     
---
 
 
                                               
Net change in unrealized gain (loss) on securities available for sale, net of tax
                                   
(2,409
)
   
(2,409
)
 
                                               
Stock compensation expense
                   
94
                     
94
 
 
                                               
Balance, September 30, 2013
 
$
30,604
   
$
2,260
   
$
188,112
   
$
(84,020
)
 
$
(1,449
)
 
$
135,507
 
 

See accompanying notes to consolidated financial statements.
- 7 -

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Month Periods Ended September 30, 2013 and 2012
(unaudited)

 
 
 
Nine Months
   
Nine Months
 
 
 
Ended
   
Ended
 
 
 
September 30,
   
September 30,
 
(dollars in thousands)
 
2013
   
2012
 
Cash flows from operating activities
 
   
 
Net income
 
$
7,315
   
$
14,256
 
Adjustments to reconcile net income to net cash from operating activities:
               
Depreciation and amortization
   
2,261
     
2,171
 
Stock compensation expense
   
94
     
---
 
Provision for loan losses
   
(3,250
)
   
(6,600
)
Origination of loans for sale
   
(91,117
)
   
(100,885
)
Proceeds from sales of loans originated for sale
   
98,409
     
93,040
 
Net gains on mortgage loans
   
(2,145
)
   
(2,192
)
Gain on sales of securities
   
(80
)
   
(73
)
Write-down of other real estate
   
2,415
     
4,247
 
Net gain on sales of other real estate
   
(1,004
)
   
(11
)
Decrease in net deferred tax asset
   
3,218
     
---
 
FHLB advance prepayment penalty
   
---
     
322
 
Decrease in accrued interest receivable and other assets
   
109
     
1,050
 
Earnings in bank-owned life insurance
   
(539
)
   
(657
)
Increase in accrued expenses and other liabilities
   
289
     
1,445
 
Net cash from operating activities
   
15,975
     
6,113
 
 
               
Cash flows from investing activities
               
Loan originations and payments, net
   
21,168
     
44,018
 
Change in interest-bearing deposits in other financial institutions
   
(25,000
)
   
---
 
Purchases of securities available for sale
   
(34,450
)
   
(98,909
)
Purchases of securities held to maturity
   
(19,347
)
   
(4,000
)
Proceeds from:
               
Maturities and calls of securities available for sale
   
12,417
     
31,612
 
Sales of securities available for sale
   
3,778
     
4,595
 
Principal paydowns on securities
   
5,199
     
2,198
 
Sales of other real estate
   
10,545
     
13,426
 
Additions to premises and equipment
   
(1,087
)
   
(522
)
Net cash from investing activities
   
(26,777
)
   
(7,582
)
 
               
Cash flows from financing activities
               
Change in in-market deposits
   
1,780
     
29,459
 
Repayments of other borrowed funds and subordinated debt
   
(3,481
)
   
(36,781
)
Net cash from financing activities
   
(1,701
)
   
(7,322
)
Net change in cash and cash equivalents
   
(12,503
)
   
(8,791
)
Cash and cash equivalents at beginning of period
   
226,358
     
243,042
 
Cash and cash equivalents at end of period
 
$
213,855
   
$
234,251
 
Supplemental cash flow information
               
Interest paid
 
$
7,542
   
$
6,754
 
Income taxes paid
   
95
     
100
 
Supplemental noncash disclosures:
               
Transfers from loans to other real estate
   
3,170
     
9,002
 
Security settlement
   
(1,626
)
   
1,393
 
FHLB advance repayment not settled
   
---
     
20,000
 
 

See accompanying notes to consolidated financial statements.
- 8 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The accompanying consolidated financial statements include the accounts of Macatawa Bank Corporation ("the Company", "our", "we") and its wholly-owned subsidiary, Macatawa Bank ("the Bank"). All significant intercompany accounts and transactions have been eliminated in consolidation.

Macatawa Bank is a Michigan chartered bank with depository accounts insured by the Federal Deposit Insurance Corporation. The Bank operates 26 full service branch offices providing a full range of commercial and consumer banking and trust services in Kent County, Ottawa County, and northern Allegan County, Michigan.

The Company owns all of the common stock of Macatawa Statutory Trust I and Macatawa Statutory Trust II. These are grantor trusts that issued trust preferred securities and are not consolidated with the Company under accounting principles generally accepted in the United States of America.

Basis of Presentation: The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) believed necessary for a fair presentation have been included.

Operating results for the three and nine month periods ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. For further information, refer to the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2012.

Use of Estimates:  To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information.  These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.  The allowance for loan losses, valuation of deferred tax assets, loss contingencies, fair value of other real estate owned and fair values of financial instruments are particularly subject to change.

Regulatory Developments:

Release of Memorandum of Understanding with Macatawa Bank and its Regulators

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.
- 9 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recission of Board Resolution

In connection with the termination of the Company’s Written Agreement by the Federal Reserve Bank of Chicago (“FRB”) on October 26, 2012, the Board of Directors of the Company adopted a resolution (the “Board Resolution”) requiring the Company to obtain written approval from the FRB before declaring or paying any dividends, increasing holding company debt, or redeeming any capital stock.  By letter dated August 1, 2013, the 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.

Reclassifications: Some items in the prior period financial statements were reclassified to conform to the current presentation.

Allowance for Loan Losses: The allowance for loan losses (allowance) is a valuation allowance for probable incurred credit losses inherent in our loan portfolio, increased by the provision for loan losses and recoveries, and decreased by charge-offs of loans. Management believes the allowance for loan losses balance to be adequate based on known and inherent risks in the portfolio, past loan loss experience, information about specific borrower situations and estimated collateral values, economic conditions and other relevant factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Management continues its collection efforts on previously charged-off balances and applies recoveries as additions to the allowance for loan losses.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-classified loans and is based on historical loss experience adjusted for current qualitative factors. The Company maintains a loss migration analysis that tracks loan losses and recoveries based on loan class and the loan risk grade assignment for commercial loans. At September 30, 2013, an 18 month annualized historical loss experience was used for commercial loans and a 12 month historical loss experience period was applied to residential mortgage loans and consumer loans. These historical loss percentages are adjusted (both upwards and downwards) for certain qualitative factors, including economic trends, credit quality trends, valuation trends, concentration risk, quality of loan review, changes in personnel, external factors and other considerations.

A loan is impaired when, based on current information and events, it is believed to be probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified and a concession has been made, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.

Commercial and commercial real estate loans with relationship balances exceeding $500,000 and an internal risk grading of 6 or worse are evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated and the loan is reported at the present value of estimated future cash flows using the loan’s existing interest rate or at the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment and they are not separately identified for impairment disclosures.

Troubled debt restructurings are also considered impaired with impairment generally measured at the present value of estimated future cash flows using the loan’s effective rate at inception or using the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral.

Foreclosed Assets: Assets acquired through or instead of loan foreclosure, primarily other real estate owned, are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed unless they add value to the property.

Income Taxes: Income tax expense is the sum of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
- 10 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

We recognize a tax position as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. We recognize interest and penalties related to income tax matters in income tax expense.

Adoption of New Accounting Standards: The Financial Accounting Standards Board (“FASB”) has issued ASU 2013-02, Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.  This ASU is intended to improve the reporting of reclassifications out of accumulated other comprehensive income.  The ASU requires an entity to report, either on the face of the statement where net income is presented or in the notes to the financial statements, the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in their entirety to net income.  For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts.  The amendments in this ASU apply to all entities that issue financial statements that are presented in conformity with U.S. GAAP and that report items of other comprehensive income.  For public entities, the amendments in this ASU are effective prospectively for reporting periods beginning after December 15, 2012.  The Company adopted this ASU on January 1, 2013 by including the required disclosures in Note 2 to the consolidated financial statements.

NOTE 2 – SECURITIES

The amortized cost and fair value of securities at period-end were as follows (dollars in thousands):
 
 
 
   
Gross
   
Gross
   
 
 
 
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
 
 
Cost
   
Gains
   
Losses
   
Value
 
September 30, 2013
 
   
   
   
 
 
 
   
   
   
 
Available for Sale:
 
   
   
   
 
U.S. Treasury and federal agency securities
 
$
53,606
   
$
92
   
$
(1,210
)
 
$
52,488
 
U.S. Agency MBS and CMOs
   
18,848
     
21
     
(267
)
   
18,602
 
Tax-exempt state and municipal bonds
   
25,455
     
56
     
(946
)
   
24,565
 
Taxable state and municipal bonds
   
27,821
     
352
     
(312
)
   
27,861
 
Corporate bonds and other debt securities
   
10,439
     
59
     
(63
)
   
10,435
 
Other equity securities
   
1,500
     
---
     
(12
)
   
1,488
 
 
 
$
137,669
   
$
580
   
$
(2,810
)
 
$
135,439
 
Held to Maturity
                               
State and municipal bonds
 
$
18,995
   
$
449
   
$
---
   
$
19,444
 
 
                               
December 31, 2012
                               
 
                               
Available for Sale:
                               
U.S. Treasury and federal agency securities
 
$
42,245
   
$
340
   
$
(21
)
 
$
42,564
 
U. S. Agency MBS and CMOs
   
23,495
     
272
     
(6
)
   
23,761
 
Tax-exempt state and municipal bonds
   
20,598
     
244
     
(49
)
   
20,793
 
Taxable state and municipal bonds
   
26,726
     
619
     
(49
)
   
27,296
 
Corporate bonds
   
7,456
     
77
     
(7
)
   
7,526
 
Other equity securities
   
1,500
     
57
     
---
     
1,557
 
 
 
$
122,020
   
$
1,609
   
$
(132
)
 
$
123,497
 
Held to Maturity:
                               
State and municipal bonds
 
$
4,300
   
$
1
   
$
---
   
$
4,301
 
- 11 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 2 – SECURITIES (Continued)

There were no sales of securities in the three month period ended September 30, 2013.  Proceeds from the sale of securities available for sale were $3.8 million in the nine month period ended September 30, 2013 resulting in net gains on sale of $80,000 as reported in the consolidated statements of income.  This resulted in reclassifications of $80,000 ($52,000 net of tax) from accumulated other comprehensive income to gain on sale of securities in the consolidated statements of income in the nine month period ended September 30, 2013.  Proceeds from the sale of securities available for sale were $540,000 and $4.6 million, respectively, for the three and nine month periods ended September 30, 2012, resulting in net gains on sale of $14,000 and $73,000, respectively, as reported in the consolidated statements of income.  This resulted in reclassifications of $14,000 ($9,000 net of tax) and $73,000 ($47,000 net of tax), respectively, from accumulated other comprehensive income to gain on sale of securities in the consolidated statements of income in the three and nine month periods ended September 30, 2012.

Contractual maturities of debt securities at September 30, 2013 were as follows (dollars in thousands):

 
Held–to-Maturity Securities
 
Available-for-Sale Securities
 
 
Amortized
 
Fair
 
Amortized
 
Fair
 
 
Cost
 
Value
 
Cost
 
Value
 
Due in one year or less
 
$
12,630
   
$
13,026
   
$
4,195
   
$
4,227
 
Due from one to five years
   
430
     
430
     
56,572
     
56,585
 
Due from five to ten years
   
5,655
     
5,708
     
44,609
     
43,265
 
Due after ten years
   
280
     
280
     
30,793
     
29,874
 
 
 
$
18,995
   
$
19,444
   
$
136,169
   
$
133,951
 

Securities with unrealized losses at September 30, 2013 and December 31, 2012, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (dollars in thousands):
 
 
 
Less than 12 Months
   
12 Months or More
   
Total
 
 
 
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
September 30, 2013
 
Value
   
Loss
   
Value
   
Loss
   
Value
   
Loss
 
U.S. Treasury and federal agency securities
 
$
43,255
   
$
(1,210
)
 
$
---
   
$
---
   
$
43,255
   
$
(1,210
)
U.S. Agency MBS and CMOs
   
15,930
     
(267
)
   
---
     
---
     
15,930
     
(267
)
Tax-exempt state and municipal bonds
   
20,051
     
(946
)
   
---
     
---
     
20,051
     
(946
)
Taxable state and municipal bonds
   
10,505
     
(285
)
   
756
     
(27
)
   
11,261
     
(312
)
Corporate bonds and other debt securities
   
4,157
     
(63
)
   
---
     
---
     
4,157
     
(63
)
Other equity securities
   
1,488
     
(12
)
   
---
     
---
     
1,488
     
(12
)
Total temporarily impaired
 
$
95,386
   
$
(2,783
)
 
$
756
   
$
(27
)
 
$
96,142
   
$
(2,810
)
 
 
 
Less than 12 Months
   
12 Months or More
   
Total
 
 
 
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
December 31, 2012
 
Value
   
Loss
   
Value
   
Loss
   
Value
   
Loss
 
U.S. Treasury and federal agency securities
 
$
10,977
   
$
(21
)
 
$
---
   
$
---
   
$
10,977
   
$
(21
)
U.S. Agency MBS and CMOs
   
3,373
     
(6
)
   
---
     
---
     
3,373
     
(6
)
Tax-exempt state and municipal bonds
   
4,613
     
(49
)
   
---
     
---
     
4,613
     
(49
)
Taxable state and municipal bonds
   
4,661
     
(49
)
   
---
     
---
     
4,661
     
(49
)
Corporate bonds
   
3,945
     
(7
)
   
---
     
---
     
3,945
     
(7
)
Other equity securities
   
---
     
---
     
---
     
---
     
---
     
---
 
Total temporarily impaired
 
$
27,569
   
$
(132
)
 
$
---
   
$
---
   
$
27,569
   
$
(132
)
- 12 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 2 – SECURITIES (Continued)

Other-Than-Temporary-Impairment

Management evaluates securities for other-than-temporary impairment ("OTTI") at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Management determined that no OTTI charges were necessary during the three and nine month periods ended September 30, 2013 and 2012.

No securities were pledged as security at September 30, 2013.  Securities with a carrying value of approximately $7.4 million were pledged as security for public deposits, letters of credit and for other purposes required or permitted by law at December 31, 2012.
 
NOTE 3 – LOANS

Portfolio loans were as follows (dollars in thousands):
 
 
 
September 30,
   
December 31,
 
 
 
2013
   
2012
 
Commercial and industrial
 
$
253,216
   
$
259,700
 
 
               
Commercial real estate:
               
Residential developed
   
20,805
     
26,090
 
Unsecured to residential developers
   
7,326
     
5,547
 
Vacant and unimproved
   
48,977
     
56,525
 
Commercial development
   
4,319
     
1,799
 
Residential improved
   
77,414
     
75,813
 
Commercial improved
   
243,688
     
255,738
 
Manufacturing and industrial
   
79,403
     
81,447
 
Total commercial real estate
   
481,932
     
502,959
 
 
               
Consumer
               
Residential mortgage
   
185,025
     
182,625
 
Unsecured
   
1,464
     
1,683
 
Home equity
   
96,790
     
92,764
 
Other secured
   
10,366
     
12,617
 
Total consumer
   
293,645
     
289,689
 
 
               
Total loans
   
1,028,793
     
1,052,348
 
Allowance for loan losses
   
(21,272
)
   
(23,739
)
 
               
 
 
$
1,007,521
   
$
1,028,609
 

- 13 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 3 – LOANS (Continued)
 
Activity in the allowance for loan losses by portfolio segment was as follows (dollars in thousands):
 
 
 
Commercial and
   
Commercial
   
   
   
 
Three months ended September 30, 2013:
 
Industrial
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Beginning balance
 
$
5,602
   
$
12,324
   
$
4,255
   
$
67
   
$
22,248
 
Charge-offs
   
(23
)
   
(202
)
   
(129
)
   
---
     
(354
)
Recoveries
   
585
     
253
     
40
     
---
     
878
 
Provision for loan losses
   
(446
)
   
(1,253
)
   
230
     
(31
)
   
(1,500
)
Ending Balance
 
$
5,718
   
$
11,122
   
$
4,396
   
$
36
   
$
21,272
 
 
 
 
Commercial and
   
Commercial
   
   
   
 
Three months ended September 30, 2012:
 
Industrial
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Beginning balance
 
$
6,638
   
$
15,239
   
$
5,254
   
$
49
   
$
27,180
 
Charge-offs
   
(239
)
   
(173
)
   
(203
)
   
---
     
(615
)
Recoveries
   
110
     
777
     
69
     
---
     
956
 
Provision for loan losses
   
(575
)
   
(552
)
   
(131
)
   
8
     
(1,250
)
Ending Balance
 
$
5,934
   
$
15,291
   
$
4,989
   
$
57
   
$
26,271
 
 
 
 
Commercial and
   
Commercial
   
   
   
 
Nine months ended September 30, 2013:
 
Industrial
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Beginning balance
 
$
6,459
   
$
13,457
   
$
3,787
   
$
36
   
$
23,739
 
Charge-offs
   
(272
)
   
(661
)
   
(762
)
   
---
     
(1,695
)
Recoveries
   
1,011
     
1,248
     
219
     
---
     
2,478
 
Provision for loan losses
   
(1,480
)
   
(2,922
)
   
1,152
     
---
     
(3,250
)
Ending Balance
 
$
5,718
   
$
11,122
   
$
4,396
   
$
36
   
$
21,272
 
 
 
 
Commercial and
   
Commercial
   
   
   
 
Nine months ended September 30, 2012:
 
Industrial
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Beginning balance
 
$
6,313
   
$
20,475
   
$
4,821
   
$
32
   
$
31,641
 
Charge-offs
   
(1,228
)
   
(2,679
)
   
(1,104
)
   
---
     
(5,011
)
Recoveries
   
390
     
5,662
     
189
     
---
     
6,241
 
Provision for loan losses
   
459
     
(8,167
)
   
1,083
     
25
     
(6,600
)
Ending Balance
 
$
5,934
   
$
15,291
   
$
4,989
   
$
57
   
$
26,271
 

- 14 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 3 – LOANS (Continued)
 
The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method (dollars in thousands):
 
 
 
Commercial and
   
Commercial
   
   
   
 
September 30, 2013:
 
Industrial
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Allowance for loan losses:
 
   
   
   
   
 
Ending allowance attributable to loans:
 
   
   
   
   
 
Individually reviewed for impairment
 
$
2,193
   
$
1,555
   
$
914
   
$
---
   
$
4,662
 
Collectively evaluated for impairment
   
3,525
     
9,567
     
3,482
     
36
     
16,610
 
Total ending allowance balance
 
$
5,718
   
$
11,122
   
$
4,396
   
$
36
   
$
21,272
 
 
                                       
Loans:
                                       
Individually reviewed for impairment
 
$
12,218
   
$
45,895
   
$
15,030
   
$
---
   
$
73,143
 
Collectively evaluated for impairment
   
240,998
     
436,037
     
278,615
     
---
     
955,650
 
Total ending loans balance
 
$
253,216
   
$
481,932
   
$
293,645
   
$
---
   
$
1,028,793
 
 
 
 
Commercial and
   
Commercial
   
   
   
 
December 31, 2012:
 
Industrial
   
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Allowance for loan losses:
 
   
   
   
   
 
Ending allowance attributable to loans:
 
   
   
   
   
 
Individually reviewed for impairment
 
$
2,920
   
$
2,418
   
$
716
   
$
---
   
$
6,054
 
Collectively evaluated for impairment
   
3,539
     
11,039
     
3,071
     
36
     
17,685
 
Total ending allowance balance
 
$
6,459
   
$
13,457
   
$
3,787
   
$
36
   
$
23,739
 
 
                                       
Loans:
                                       
Individually reviewed for impairment
 
$
14,390
   
$
54,831
   
$
14,086
   
$
---
   
$
83,307
 
Collectively evaluated for impairment
   
245,310
     
448,128
     
275,603
     
---
     
969,041
 
Total ending loans balance
 
$
259,700
   
$
502,959
   
$
289,689
   
$
---
   
$
1,052,348
 

- 15 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 3 – LOANS (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2013 (dollars in thousands):
 
 
 
Unpaid
   
   
 
 
 
Principal
   
Recorded
   
Allowance
 
 
 
Balance
   
Investment
   
Allocated
 
With no related allowance recorded:
 
   
   
 
Commercial and industrial
 
$
3,250
   
$
3,247
   
$
---
 
 
                       
Commercial real estate:
                       
Residential developed
   
5,344
     
4,411
     
---
 
Unsecured to residential developers
   
---
     
---
     
---
 
Vacant and unimproved
   
413
     
413
     
---
 
Commercial development
   
586
     
586
     
---
 
Residential improved
   
1,089
     
1,089
     
---
 
Commercial improved
   
3,727
     
3,525
     
---
 
Manufacturing and industrial
   
808
     
808
     
---
 
 
   
11,967
     
10,832
     
---
 
Consumer:
                       
Residential mortgage
   
---
     
---
     
---
 
Unsecured
   
---
     
---
     
---
 
Home equity
   
---
     
---
     
---
 
Other secured
   
---
     
---
     
---
 
 
   
---
     
---
     
---
 
 
 
$
15,217
   
$
14,079
   
$
---
 
 
                       
With an allowance recorded:
                       
Commercial and industrial
 
$
8,971
   
$
8,971
   
$
2,193
 
 
                       
Commercial real estate:
                       
Residential developed
   
1,449
     
1,449
     
158
 
Unsecured to residential developers
   
---
     
---
     
---
 
Vacant and unimproved
   
1,943
     
1,943
     
85
 
Commercial development
   
2,061
     
2,061
     
37
 
Residential improved
   
9,776
     
9,776
     
328
 
Commercial improved
   
14,087
     
14,087
     
827
 
Manufacturing and industrial
   
5,747
     
5,747
     
120
 
 
   
35,063
     
35,063
     
1,555
 
Consumer:
                       
Residential mortgage
   
9,219
     
9,219
     
561
 
Unsecured
   
---
     
---
     
---
 
Home equity
   
5,811
     
5,811
     
353
 
Other secured
   
---
     
---
     
---
 
 
   
15,030
     
15,030
     
914
 
 
 
$
59,064
   
$
59,064
   
$
4,662
 
 
                       
Total
 
$
74,281
   
$
73,143
   
$
4,662
 

- 16 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2012 (dollars in thousands):

 
 
Unpaid
   
   
 
 
 
Principal
   
Recorded
   
Allowance
 
 
 
Balance
   
Investment
   
Allocated
 
With no related allowance recorded:
 
   
   
 
Commercial and industrial
 
$
2,515
   
$
2,512
   
$
---
 
 
                       
Commercial real estate:
                       
Residential developed
   
7,136
     
6,283
     
---
 
Unsecured to residential developers
   
---
     
---
     
---
 
Vacant and unimproved
   
2,321
     
2,136
     
---
 
Commercial development
   
213
     
213
     
---
 
Residential improved
   
3,293
     
3,019
     
---
 
Commercial improved
   
7,268
     
6,127
     
---
 
Manufacturing and industrial
   
3,686
     
3,686
     
---
 
 
   
23,917
     
21,464
     
---
 
Consumer:
                       
Residential mortgage
   
4,614
     
3,062
     
---
 
Unsecured
   
---
     
---
     
---
 
Home equity
   
---
     
---
     
---
 
Other secured
   
---
     
---
     
---
 
 
   
4,614
     
3,062
     
---
 
 
 
$
31,046
   
$
27,038
   
$
---
 
 
                       
With an allowance recorded:
                       
Commercial and industrial
 
$
11,878
   
$
11,878
   
$
2,920
 
 
                       
Commercial real estate:
                       
Residential developed
   
1,524
     
1,524
     
337
 
Unsecured to residential developers
   
---
     
---
     
---
 
Vacant and unimproved
   
1,688
     
1,688
     
34
 
Commercial development
   
---
     
---
     
---
 
Residential improved
   
10,063
     
10,063
     
842
 
Commercial improved
   
15,386
     
15,386
     
1,071
 
Manufacturing and industrial
   
4,706
     
4,706
     
134
 
 
   
33,367
     
33,367
     
2,418
 
Consumer:
                       
Residential mortgage
   
10,220
     
10,220
     
664
 
Unsecured
   
---
     
---
     
---
 
Home equity
   
804
     
804
     
52
 
Other secured
   
---
     
---
     
---
 
 
   
11,024
     
11,024
     
716
 
 
 
$
56,269
   
$
56,269
   
$
6,054
 
 
                       
Total
 
$
87,315
   
$
83,307
   
$
6,054
 
- 17 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents information regarding average balances of impaired loans and interest recognized on impaired loans for the three and nine month periods ended September 30, 2013 and 2012 (dollars in thousands):
 
 
 
Three
   
Three
   
Nine
   
Nine
 
 
 
Months
   
Months
   
Months
   
Months
 
 
 
Ended
   
Ended
   
Ended
   
Ended
 
 
 
September 30,
   
September 30,
   
September 30,
   
September 30,
 
 
 
2013
   
2012
   
2013
   
2012
 
Average of impaired loans during the period:
 
   
   
   
 
Commercial and industrial
 
$
12,325
   
$
12,415
   
$
14,794
   
$
15,388
 
 
                               
Commercial real estate:
                               
Residential developed
   
5,898
     
7,989
     
6,526
     
8,293
 
Unsecured to residential developers
   
---
     
---
     
---
     
---
 
Vacant and unimproved
   
2,542
     
4,219
     
3,073
     
3,854
 
Commercial development
   
1,233
     
215
     
421
     
217
 
Residential improved
   
11,072
     
12,707
     
11,759
     
13,564
 
Commercial improved
   
19,449
     
17,766
     
20,809
     
17,049
 
Manufacturing and industrial
   
6,105
     
9,104
     
6,420
     
9,291
 
 
                               
Consumer
   
14,984
     
15,992
     
14,599
     
16,018
 
 
                               
 
                               
Interest income recognized during impairment:
                               
Commercial and industrial
   
186
     
263
     
915
     
1,090
 
Commercial real estate
   
478
     
637
     
1,656
     
1,848
 
Consumer
   
141
     
141
     
409
     
419
 
 
                               
Cash-basis interest income recognized
                               
Commercial and industrial
   
194
     
250
     
914
     
1,065
 
Commercial real estate
   
465
     
637
     
1,648
     
1,852
 
Consumer
   
141
     
141
     
402
     
417
 

- 18 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

Nonaccrual loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of September 30, 2013:

 
 
   
Over 90
 
 
 
   
days
 
 
 
Nonaccrual
   
Accruing
 
Commercial and industrial
 
$
4,240
   
$
---
 
 
               
Commercial real estate:
               
Residential developed
   
2,216
     
---
 
Unsecured to residential developers
   
---
     
---
 
Vacant and unimproved
   
435
     
---
 
Commercial development
   
23
     
---
 
Residential improved
   
485
     
---
 
Commercial improved
   
1,603
     
172
 
Manufacturing and industrial
   
---
     
---
 
 
   
4,762
     
172
 
Consumer:
               
Residential mortgage
   
639
     
---
 
Unsecured
   
33
     
---
 
Home equity
   
374
     
---
 
Other secured
   
---
     
---
 
 
   
1,046
     
---
 
Total
 
$
10,048
   
$
172
 

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of December 31, 2012:

 
 
   
Over 90
 
 
 
   
days
 
 
 
Nonaccrual
   
Accruing
 
Commercial and industrial
 
$
7,657
   
$
---
 
 
               
Commercial real estate:
               
Residential developed
   
3,024
     
---
 
Unsecured to residential developers
   
---
     
---
 
Vacant and unimproved
   
706
     
---
 
Commercial development
   
2
     
196
 
Residential improved
   
1,159
     
---
 
Commercial improved
   
1,521
     
422
 
Manufacturing and industrial
   
225
     
---
 
 
   
6,637
     
618
 
Consumer:
               
Residential mortgage
   
447
     
---
 
Unsecured
   
19
     
---
 
Home equity
   
625
     
---
 
Other secured
   
---
     
---
 
 
   
1,091
     
---
 
Total
 
$
15,385
   
$
618
 
- 19 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 3 – LOANS (Continued)

The following table presents the aging of the recorded investment in past due loans as of September 30, 2013 by class of loans (dollars in thousands):

 
  30-90    
Greater Than
   
Total
   
Loans Not
   
 
 
 
Days
   
90 Days
   
Past Due
   
Past Due
   
Total
 
Commercial and industrial
 
$
103
   
$
17
   
$
120
   
$
253,096
   
$
253,216
 
 
                                       
Commercial real estate:
                                       
Residential developed
   
---
     
1,917
     
1,917
     
18,888
     
20,805
 
Unsecured to residential developers
   
---
     
---
     
---
     
7,326
     
7,326
 
Vacant and unimproved
   
---
     
407
     
407
     
48,570
     
48,977
 
Commercial development
   
---
     
23
     
23
     
4,296
     
4,319
 
Residential improved
   
174
     
124
     
298
     
77,116
     
77,414
 
Commercial improved
   
1,949
     
1,432
     
3,381
     
240,307
     
243,688
 
Manufacturing and industrial
   
---
     
---
     
---
     
79,403
     
79,403
 
 
   
2,123
     
3,903
     
6,026
     
475,906
     
481,932
 
Consumer:
                                       
Residential mortgage
   
395
     
636
     
1,031
     
183,994
     
185,025
 
Unsecured
   
---
     
---
     
---
     
1,464
     
1,464
 
Home equity
   
538
     
38
     
576
     
96,214
     
96,790
 
Other secured
   
78
     
---
     
78
     
10,288
     
10,366
 
 
   
1,011
     
674
     
1,685
     
291,960
     
293,645
 
Total
 
$
3,237
   
$
4,594
   
$
7,831
   
$
1,020,962
   
$
1,028,793
 

The following table presents the aging of the recorded investment in past due loans as of December 31, 2012 by class of loans (dollars in thousands):

 
 
30-90
   
Greater Than
   
Total
   
Loans Not
   
 
 
 
Days
   
90 Days
   
Past Due
   
Past Due
   
Total
 
Commercial and industrial
 
$
395
   
$
219
   
$
614
   
$
259,086
   
$
259,700
 
 
                                       
Commercial real estate:
                                       
Residential developed
   
---
     
35
     
35
     
26,055
     
26,090
 
Unsecured to residential developers
   
---
     
---
     
---
     
5,547
     
5,547
 
Vacant and unimproved
   
17
     
652
     
669
     
55,856
     
56,525
 
Commercial development
   
---
     
199
     
199
     
1,600
     
1,799
 
Residential improved
   
520
     
192
     
712
     
75,101
     
75,813
 
Commercial improved
   
2,502
     
1,436
     
3,938
     
251,800
     
255,738
 
Manufacturing and industrial
   
200
     
25
     
225
     
81,222
     
81,447
 
 
   
3,239
     
2,539
     
5,778
     
497,181
     
502,959
 
Consumer:
                                       
Residential mortgage
   
647
     
110
     
757
     
181,868
     
182,625
 
Unsecured
   
---
     
---
     
---
     
1,683
     
1,683
 
Home equity
   
415
     
264
     
679
     
92,085
     
92,764
 
Other secured
   
59
     
---
     
59
     
12,558
     
12,617
 
 
   
1,121
     
374
     
1,495
     
288,194
     
289,689
 
Total
 
$
4,755
   
$
3,132
   
$
7,887
   
$
1,044,461
   
$
1,052,348
 

- 20 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 3 – LOANS (Continued)

The Company had allocated $4,662,000 and $6,005,000 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings (“TDRs”) as of September 30, 2013 and December 31, 2012, respectively.  These loans involved the restructuring of terms to allow customers to mitigate the risk of foreclosure by meeting a lower loan payment requirement based upon their current cash flow.  These may also include loans that renewed at existing contractual rates, but below market rates for comparable credit.  The Company has been active at utilizing these programs and working with its customers to reduce the risk of foreclosure.  For commercial loans, these modifications typically include an interest only period and, in some cases, a lowering of the interest rate on the loan.  In some cases, the modification will include separating the note into two notes with the first note structured to be supported by current cash flows and collateral, and the second note made for the remaining unsecured debt.  The second note is charged off immediately and collected only after the first note is paid in full.  This modification type is commonly referred to as an A-B note structure.  For consumer mortgage loans, the restructuring typically includes a lowering of the interest rate to provide payment and cash flow relief.  For each restructuring, a comprehensive credit underwriting analysis of the borrower’s financial condition and prospects of repayment under the revised terms is performed to assess whether the structure can be successful and that cash flows will be sufficient to support the restructured debt.  An analysis is also performed to determine whether the restructured loan should be on accrual status.  Generally, if the loan is on accrual at the time of restructure, it will remain on accrual after the restructuring.  In some cases, a nonaccrual loan may be placed on accrual at the time of restructure if the loan’s actual payment history demonstrates it would have cash flowed under the restructured terms.  After six consecutive payments under the restructured terms, a nonaccrual restructured loan is reviewed for possible upgrade to accruing status.

Typically, once a loan is identified as a TDR, it will retain that designation until it is paid off, since the restructured loans generally are not at market rates at the time of restructuring.  An exception to this would be a loan that is modified under an A-B note structure.  If the remaining “A” note is at a market rate at the time of restructuring (taking into account the borrower’s credit risk and prevailing market conditions), the loan can be removed from TDR designation in a subsequent calendar year after six months of performance in accordance with the new terms.  The market rate relative to the borrower’s credit risk is determined through analysis of market pricing information gathered from peers and use of a loan pricing model.  The general objective of the model is to achieve a consistent return on equity from one credit to the next, taking into consideration their differences in credit risk.  In the model, credits with higher risk receive a higher potential loss allocation, and therefore require a higher interest rate to achieve the target return on equity.  In general, when a loan is removed from TDR status it would no longer be considered impaired.  As a result, allowance allocations for loans removed from TDR status would be based on the historical based allocation for the applicable loan grade and loan class.  During the three and nine months ended September 30, 2013 and throughout 2012, no loans were removed from TDR status.  Given the nature of the TDRs outstanding at September 30, 2013, it is unlikely that any such loans will be removed from TDR status in 2013.

As with other impaired loans, an allowance for loan loss is estimated for each TDR based on the most likely source of repayment for each loan.  For impaired commercial real estate loans that are collateral dependent, the allowance is computed based on the fair value of the underlying collateral.  For impaired commercial loans where repayment is expected from cash flows from business operations, the allowance is computed based on a discounted cash flow computation.  Certain groups of TDRs, such as residential mortgages, have common characteristics and for them the allowance is computed based on a discounted cash flow computation on the change in weighted rate for the pool.  The allowance allocations for commercial TDRs where we have reduced the contractual interest rate are computed by measuring cash flows using the new payment terms discounted at the original contractual rate.

The following table presents information regarding troubled debt restructurings as of September 30, 2013 and December 31, 2012 (dollars in thousands):

 
 
September 30, 2013
   
December 31, 2012
 
 
 
Number of
Loans
   
Outstanding
 Recorded
Balance
   
Number of
Loans
   
Outstanding
Recorded
Balance
 
Commercial and industrial
   
55
   
$
12,218
     
58
   
$
14,485
 
Commercial real estate
   
121
     
43,321
     
142
     
49,936
 
Consumer
   
112
     
15,075
     
86
     
13,634
 
 
   
288
   
$
70,614
     
286
   
$
78,055
 

- 21 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents information regarding troubled debt restructurings executed during the three month periods ended September 30, 2013 and 2012 (dollars in thousands):

 
Three Months Ended
 
Three Months Ended
 
 
September 30, 2013
 
September 30, 2012
 
 
Number of
Loans
 
Outstanding
Recorded
Balance
 
Principal
Writedown
upon
Modification
 
Number of
Loans
 
Outstanding
Recorded
Balance
 
Principal
Writedown
upon
Modification
 
Commercial and industrial
   
2
   
$
823
   
$
---
     
1
   
$
15
   
$
---
 
Commercial real estate
   
2
     
186
     
---
     
5
     
2,538
     
---
 
Consumer
   
3
     
137
     
---
     
---
     
---
     
---
 
 
   
7
   
$
1,146
   
$
---
     
6
   
$
2,553
   
$
---
 

The following table presents information regarding troubled debt restructurings executed during the nine month periods ended September 30, 2013 and 2012 (dollars in thousands):

 
Nine Months Ended
 
Nine Months Ended
 
 
September 30, 2013
 
September 30, 2012
 
 
   
   
 
   
   
 
 
Number of
Loans
 
Outstanding
Recorded
Balance
 
Principal
Writedown
upon
Modification
 
Number of
Loans
 
Outstanding
Recorded
Balance
 
Principal
Writedown
upon
Modification
 
Commercial and industrial
   
5
   
$
1,085
   
$
---
     
14
   
$
1,351
   
$
9
 
Commercial real estate
   
11
     
2,903
     
---
     
44
     
10,236
     
86
 
Consumer
   
33
     
5,606
     
1,770
     
9
     
1,462
     
260
 
 
   
49
   
$
9,594
   
$
1,770
     
67
   
$
13,049
   
$
355
 

According to the accounting standards, not all loan modifications are TDRs.  TDRs are modifications or renewals where the Company has granted a concession to a borrower in financial distress.  The Company reviews all modifications and renewals for determination of TDR status.  In some situations a borrower may be experiencing financial distress, but the Company does not provide a concession.  These modifications are not considered TDRs.  In other cases, the Company might provide a concession, such as a reduction in interest rate, but the borrower is not experiencing financial distress.  This could be the case if the Company is matching a competitor’s interest rate.  These modifications would also not be considered TDRs.  Finally, any renewals at existing terms for borrowers not experiencing financial distress would not be considered TDRs.  The following table presents information regarding modifications and renewals executed during the three month periods ended September 30, 2013 and 2012 that are not considered TDRs (dollars in thousands):

  
 
Three Months Ended
   
Three Months Ended
 
 
 
September 30, 2013
   
September 30, 2012
 
 
 
Number of
Loans
 
Outstanding
Recorded
Balance
   
Number of
Loans
 
Outstanding
Recorded
Balance
 
Commercial and industrial
   
141
   
$
24,425
     
166
   
$
27,615
 
Commercial real estate
   
80
     
19,422
     
112
     
40,784
 
Consumer
   
10
     
271
     
50
     
2,320
 
 
   
231
   
$
44,118
     
328
   
$
70,719
 
- 22 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 3 – LOANS (Continued)

The following table presents information regarding modifications and renewals executed during the nine month periods ended September 30, 2013 and 2012 that are not considered TDRs (dollars in thousands):
 
  
 
Nine Months Ended
   
Nine Months Ended
 
 
 
September 30, 2013
   
September 30, 2012
 
 
 
Number of
Loans
 
Outstanding
Recorded
Balance
   
Number of
Loans
 
Outstanding
Recorded
Balance
 
Commercial and industrial
   
351
   
$
72,878
     
398
   
$
88,059
 
Commercial real estate
   
277
     
95,058
     
256
     
97,583
 
Consumer
   
38
     
1,203
     
66
     
2,701
 
 
   
666
   
$
169,139
     
720
   
$
188,343
 

The table below presents, by class, information regarding troubled debt restructurings which had payment defaults during the three month periods ended September 30, 2013 and 2012 (dollars in thousands). Included are loans that became delinquent more than 90 days past due or transferred to nonaccrual within 12 months of restructuring.
 
  
 
Three Months Ended
   
Three Months Ended
 
 
 
September 30, 2013
   
September 30, 2012
 
 
 
Number of
Loans
 
Outstanding
Recorded
Balance
   
Number of
Loans
 
Outstanding
Recorded
Balance
 
Commercial and industrial
   
---
   
$
---
     
---
   
$
---
 
Commercial real estate
   
---
     
---
     
1
     
136
 
Consumer
   
---
     
---
     
1
     
114
 

The table below presents, by class, information regarding troubled debt restructurings which had payment defaults during the nine month periods ended September 30, 2013 and 2012 (dollars in thousands). Included are loans that became delinquent more than 90 days past due or transferred to nonaccrual within 12 months of restructuring.
 
  
 
Nine Months Ended
   
Nine Months Ended
 
 
 
September 30, 2013
   
September 30, 2012
 
 
 
Number of
Loans
 
Outstanding
Recorded
Balance
   
Number of
Loans
 
Outstanding
Recorded
Balance
 
Commercial and industrial
   
---
   
$
---
     
3
   
$
112
 
Commercial real estate
   
---
     
---
     
2
     
212
 
Consumer
   
---
     
---
     
2
     
184
 

- 23 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 3 – LOANS (Continued)

Credit Quality Indicators: The Company categorizes loans into risk categories based on relevant information about the ability of the borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors.  The Company analyzes commercial loans individually and classifies these relationships by credit risk grading.  The Company uses an eight point grading system, with grades 5 through 8 being considered classified, or watch, credits.  All commercial loans are assigned a grade at origination, at each renewal or any amendment.  When a credit is first downgraded to a watch credit (either through renewal, amendment, loan officer identification or the loan review process), an Administrative Loan Review (“ALR”) is generated by credit and the loan officer.  All watch credits have an ALR completed monthly which analyzes the collateral position and cash flow of the borrower and its guarantors.  The loan officer is required to complete both a short term and long term plan to rehabilitate or exit the credit and to give monthly comments on the progress to these plans.  Management meets quarterly with loan officers to discuss each of these credits in detail and to help formulate solutions where progress has stalled.  When necessary, the loan officer proposes changes to the assigned loan grade as part of the ALR.  Additionally, Loan Review reviews all loan grades upon origination, renewal or amendment and again as loans are selected though the loan review process.  The credit will stay on the ALR until either its grade has improved to a 4 or better or the credit relationship is at a zero balance.  The Company uses the following definitions for the risk grades:

1. Excellent - Loans supported by extremely strong financial condition or secured by the Bank’s own deposits. Minimal risk to the Bank and the probability of serious rapid financial deterioration is extremely small.

2. Above Average - Loans supported by sound financial statements that indicate the ability to repay or borrowings secured (and margined properly) with marketable securities. Nominal risk to the Bank and probability of serious financial deterioration is highly unlikely. The overall quality of these credits is very high.

3. Good Quality - Loans supported by satisfactory asset quality and liquidity, good debt capacity coverage, and good management in all critical positions. Loans are secured by acceptable collateral with adequate margins. There is a slight risk of deterioration if adverse market conditions prevail.

4. Acceptable Risk - Loans carrying an acceptable risk to the Bank, which may be slightly below average quality. The borrower has limited financial strength with considerable leverage. There is some probability of deterioration if adverse market conditions prevail. These credits should be monitored closely by the Relationship Manager.

5. Marginally Acceptable - Loans are of marginal quality with above normal risk to the Bank. The borrower shows acceptable asset quality but very little liquidity with high leverage. There is inconsistent earning performance without the ability to sustain adverse market conditions. The primary source of repayment is questionable, but the secondary source of repayment still remains an option. Very close attention by the Relationship Manager and management is needed.

6. Substandard - Loans are inadequately protected by the net worth and paying capacity of the borrower or the collateral pledged. The primary and secondary sources of repayment are questionable. Heavy debt condition may be evident and volume and earnings deterioration may be underway. It is possible that the Bank will sustain some loss if the deficiencies are not immediately addressed and corrected.

7. Doubtful - Loans supported by weak or no financial statements that indicate the ability to repay the entire loan is questionable. Loans in this category are normally characterized less than adequate collateral, insolvent, or extremely weak financial condition. A loan classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses makes collection or liquidation in full highly questionable. The possibility of loss is extremely high, however, activity may be underway to minimize the loss or maximize the recovery.

8. Loss - Loans are considered uncollectible and of little or no value as a bank asset.  These loans should be charged off.
- 24 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 3 – LOANS (Continued)

As of September 30, 2013, the risk grade category of commercial loans by class of loans was as follows (dollars in thousands):
 
 
   
1
     
2
     
3
     
4
     
5
     
6
     
7
     
8
 
Commercial and industrial
 
$
1,207
   
$
13,835
   
$
69,640
   
$
152,822
   
$
9,683
   
$
1,790
   
$
4,239
   
$
---
 
 
                                                               
Commercial real estate:
                                                               
Residential developed
   
---
     
---
     
1,144
     
5,720
     
6,890
     
4,835
     
2,216
     
---
 
Unsecured to residential developers
   
---
     
---
     
---
     
7,318
     
8
     
---
     
---
     
---
 
Vacant and unimproved
   
---
     
---
     
12,570
     
27,224
     
8,293
     
455
     
435
     
---
 
Commercial development
   
---
     
---
     
---
     
1,479
     
2,609
     
209
     
22
     
---
 
Residential improved
   
---
     
111
     
15,971
     
41,708
     
12,034
     
7,105
     
485
     
---
 
Commercial improved
   
---
     
3,843
     
49,762
     
151,735
     
29,160
     
7,585
     
1,603
     
---
 
Manufacturing and industrial
   
---
     
337
     
24,623
     
43,528
     
8,820
     
2,095
     
---
     
---
 
 
                                                               
 
 
$
1,207
   
$
18,126
   
$
173,710
   
$
431,534
   
$
77,497
   
$
24,074
   
$
9,000
   
$
---
 

As of December 31, 2012, the risk grade category of commercial loans by class of loans was as follows (dollars in thousands):
 
 
   
1
     
2
     
3
     
4
     
5
     
6
     
7
     
8
 
Commercial and industrial
 
$
1,349
   
$
20,630
   
$
72,723
   
$
141,425
   
$
12,027
   
$
3,884
   
$
7,662
   
$
---
 
 
                                                               
Commercial real estate:
                                                               
Residential developed
   
---
     
---
     
715
     
6,240
     
9,772
     
6,339
     
3,024
     
---
 
Unsecured to residential developers
   
---
     
---
     
---
     
5,535
     
12
     
---
     
---
     
---
 
Vacant and unimproved
   
---
     
---
     
12,532
     
29,654
     
12,412
     
1,221
     
706
     
---
 
Commercial development
   
---
     
---
     
---
     
482
     
1,102
     
213
     
2
     
---
 
Residential improved
   
---
     
115
     
9,973
     
41,578
     
14,471
     
8,517
     
1,159
     
---
 
Commercial improved
   
---
     
2,009
     
40,253
     
159,353
     
37,449
     
15,153
     
1,521
     
---
 
Manufacturing and industrial
   
---
     
2,087
     
17,795
     
48,061
     
9,592
     
3,687
     
225
     
---
 
 
                                                               
 
 
$
1,349
   
$
24,841
   
$
153,991
   
$
432,328
   
$
96,837
   
$
39,014
   
$
14,299
   
$
---
 

Commercial loans rated a 6 or worse per the Company’s internal risk rating system are considered substandard, doubtful or loss. Commercial loans classified as substandard or worse were as follows at period-end (dollars in thousands):
 
   
September 30,
   
December 31,
 
   
2013
   
2012
 
Not classified as impaired
 
$
8,780
   
$
13,015
 
Classified as impaired
   
24,294
     
40,298
 
Total commercial loans classified substandard or worse
 
$
33,074
   
$
53,313
 
- 25 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 3 – LOANS (Continued)

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For consumer loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in consumer loans based on payment activity (dollars in thousands):

 
Residential
 
Consumer
 
Home
 
Consumer
 
September 30, 2013
Mortgage
 
Unsecured
 
Equity
 
Other
 
Performing
 
$
184,389
   
$
1,464
   
$
96,752
   
$
10,366
 
Nonperforming
   
636
     
---
     
38
     
---
 
Total
 
$
185,025
   
$
1,464
   
$
96,790
   
$
10,366
 
 
 
Residential
 
Consumer
 
Home
 
Consumer
 
December 31, 2012
Mortgage
 
Unsecured
 
Equity
 
Other
 
Performing
 
$
182,515
   
$
1,683
   
$
92,500
   
$
12,617
 
Nonperforming
   
110
     
---
     
264
     
---
 
Total
 
$
182,625
   
$
1,683
   
$
92,764
   
$
12,617
 
 
NOTE 4 – OTHER REAL ESTATE OWNED

Other real estate owned was as follows (dollars in thousands):
 
 
 
Nine
   
Year
   
Nine
 
 
 
Months Ended
   
Ended
   
Months Ended
 
 
 
September 30,
   
December 31,
   
September 30,
 
 
 
2013
   
2012
   
2012
 
Beginning balance
 
$
69,743
   
$
83,663
   
$
83,663
 
Additions, transfers from loans and fixed assets
   
3,170
     
9,168
     
9,002
 
Proceeds from sales of other real estate owned
   
(10,545
)
   
(18,729
)
   
(13,426
)
Valuation allowance reversal upon sale
   
(2,794
)
   
(4,300
)
   
(2,962
)
Gain (loss) on sale of other real estate owned
   
1,004
     
(59
)
   
11
 
 
   
60,578
     
69,743
     
76,288
 
Less: valuation allowance
   
(17,782
)
   
(18,161
)
   
(18,510
)
Ending balance
 
$
42,796
   
$
51,582
   
$
57,778
 

- 26 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 4 – OTHER REAL ESTATE OWNED (Continued)

Activity in the valuation allowance was as follows (dollars in thousands):
 
 
Nine Months
 
Nine Months
 
 
Ended
 
Ended
 
 
September 30,
 
September 30,
 
 
2013
 
2012
 
Beginning balance
 
$
18,161
   
$
17,225
 
Additions charged to expense
   
2,415
     
4,247
 
Reversals upon sale
   
(2,794
)
   
(2,962
)
Ending balance
 
$
17,782
   
$
18,510
 
 
NOTE 5 – FAIR VALUE

ASC Topic 820, Fair Value Measurements and Disclosures, establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The three levels of inputs that may be used to measure fair value include:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity's own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Investment Securities: The fair values of investment securities are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs).  The fair values of certain securities held to maturity are determined by computing discounted cash flows using observable and unobservable market inputs (Level 3 inputs).

Loans Held for Sale: The fair value of loans held for sale is based upon binding quotes from third party investors (Level 2 inputs).

Impaired Loans: Loans identified as impaired are measured using one of three methods: the loan’s observable market price, the fair value of collateral or the present value of expected future cash flows.  For each period presented, no impaired loans were measured using the loan’s observable market price.  If an impaired loan has had a chargeoff or if the fair value of the collateral is less than the recorded investment in the loan, we establish a specific reserve and report the loan as nonrecurring Level 3.  The fair value of collateral of impaired loans is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other Real Estate Owned: Other real estate owned (OREO) properties are initially recorded at fair value, less estimated costs to sell when acquired, establishing a new cost basis.  Adjustments to OREO are measured at fair value, less costs to sell. Fair values are generally based on third party appraisals or realtor evaluations of the property. These appraisals and evaluations may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.  Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available.  Such adjustments are usually significant and typically result in a Level 3 classification.  In cases where the carrying amount exceeds the fair value, less estimated costs to sell, an impairment loss is recognized through a valuation allowance, and the property is reported as nonrecurring Level 3.
- 27 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 5 – FAIR VALUE (Continued)

Assets measured at fair value on a recurring basis are summarized below (in thousands):
 
 
 
Fair
   
Quoted Prices
in Active
Markets for
Identical
Assets
   
Significant Other
Observable
   
Significant
Unobservable
Inputs
 
 
 
Value
   
(Level 1)
   
Inputs (Level 2)
   
(Level 3)
 
September 30, 2013
 
   
   
   
 
U.S. Treasury and federal agency securities
 
$
52,488
   
$
---
   
$
52,488
   
$
---
 
U.S. Agency MBS and CMOs
   
18,602
     
---
     
18,602
     
---
 
Tax-exempt state and municipal bonds
   
24,565
     
---
     
24,565
     
---
 
Taxable state and municipal bonds
   
27,861
     
---
     
27,861
     
---
 
Corporate bonds and other debt securities
   
10,435
     
---
     
10,435
     
---
 
Other equity securities
   
1,488
     
---
     
1,488
     
---
 
Loans held for sale
   
2,983
     
---
     
2,983
     
---
 
 
                               
December 31, 2012
                               
U.S. Treasury and federal agency securities
 
$
42,564
   
$
---
   
$
42,564
   
$
---
 
U.S. Agency MBS and CMOs
   
23,761
     
---
     
23,761
     
---
 
Tax-exempt state and municipal bonds
   
20,793
     
---
     
20,793
     
---
 
Taxable state and municipal bonds
   
27,296
     
---
     
27,296
     
---
 
Corporate bonds
   
7,526
     
---
     
7,526
     
---
 
Other equity securities
   
1,557
     
---
     
1,557
     
---
 
Loans held for sale
   
8,130
     
---
     
8,130
     
---
 
 
Assets measured at fair value on a non-recurring basis are summarized below (in thousands):
 
 
 
Fair
   
Quoted Prices
in Active
Markets for
Identical
Assets
   
Significant Other
Observable
   
Significant
Unobservable
Inputs
 
 
 
Value
   
(Level 1)
   
Inputs (Level 2)
   
(Level 3)
 
September 30, 2013
 
   
   
   
 
Impaired loans
 
$
24,087
   
$
---
   
$
---
   
$
24,087
 
Other real estate owned
   
34,564
     
---
     
---
     
34,564
 
 
                               
December 31, 2012
                               
Impaired loans
 
$
34,668
   
$
---
   
$
---
   
$
34,668
 
Other real estate owned
   
41,594
     
---
     
---
     
41,594
 

- 28 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 5 – FAIR VALUE (Continued)

The carrying amounts and estimated fair values of financial instruments, not previously presented, were as follows at September 30, 2013 and December 31, 2012 (dollars in thousands).

 
Level in  
September 30, 2013
   
December 31, 2012
 
 
Fair Value  
Carrying
   
Fair
   
Carrying
   
Fair
 
 
Hierarchy  
Amount
   
Value
   
Amount
   
Value
 
Financial assets
 
 
   
   
   
 
Cash and due from banks
Level 1
 
$
35,592
   
$
35,592
   
$
33,556
   
$
33,556
 
Cash equivalents
Level 2
   
178,263
     
178,263
     
192,802
     
192,802
 
Interest-bearing time deposits in other financial institutions
Level 2
   
25,000
     
25,000
     
---
     
---
 
Securities held to maturity
Level 3
   
18,995
     
19,444
     
4,300
     
4,301
 
FHLB stock
 
   
11,236
   
NA
     
11,236
   
NA
 
Loans, net
Level 2
   
983,434
     
976,296
     
993,941
     
999,619
 
Bank owned life insurance
Level 3
   
27,343
     
27,343
     
26,804
     
26,804
 
Accrued interest receivable
Level 2
   
3,250
     
3,250
     
3,411
     
3,411
 
 
 
                               
Financial liabilities
 
                               
Deposits
Level 2
   
(1,288,041
)
   
(1,289,388
)
   
(1,286,261
)
   
(1,285,819
)
Other borrowed funds
Level 2
   
(89,991
)
   
(90,513
)
   
(91,822
)
   
(95,213
)
Long-term debt
Level 2
   
(41,238
)
   
(35,099
)
   
(41,238
)
   
(30,463
)
Subordinated debt
Level 2
   
---
     
---
     
(1,650
)
   
(1,650
)
Accrued interest payable
Level 2
   
(7,903
)
   
(7,903
)
   
(4,858
)
   
(4,858
)
 
 
                               
Off-balance sheet credit-related items
 
                               
Loan commitments
 
   
---
     
---
     
---
     
---
 

The methods and assumptions used to estimate fair value are described as follows.

Carrying amount is the estimated fair value for cash and cash equivalents, interest-bearing time deposits in other financial institutions, bank owned life insurance, accrued interest receivable and payable, demand deposits, short-term borrowings and variable rate loans or deposits that reprice frequently and fully. Security fair values are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities as discussed above. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk (including consideration of widening credit spreads). Fair value of debt is based on current rates for similar financing. It was not practicable to determine the fair value of FHLB stock due to restrictions placed on its transferability. The fair value of off-balance sheet credit-related items is not significant.

NOTE 6 – DEPOSITS

Deposits are summarized as follows (in thousands):

 
 
September 30,
   
December 31,
 
 
 
2013
   
2012
 
Noninterest-bearing demand
 
$
352,879
   
$
339,520
 
Interest bearing demand
   
302,822
     
278,765
 
Savings and money market accounts
   
475,895
     
476,803
 
Certificates of deposit
   
156,445
     
191,173
 
 
 
$
1,288,041
   
$
1,286,261
 

Approximately $58.8 million and $69.2 million in certificates of deposit were in denominations of $100,000 or more at September 30, 2013 and December 31, 2012, respectively.
- 29 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 7 - OTHER BORROWED FUNDS

Other borrowed funds include advances from the Federal Home Loan Bank and borrowings from the Federal Reserve Bank.

Federal Home Loan Bank Advances

At period-end, advances from the Federal Home Loan Bank were as follows (dollars in thousands):

 
 
 
    
Weighted
 
 
Advance
 
 
Average
 
Principal Terms
Amount
 
Range of Maturities
Interest Rate
 
September 30, 2013
 
 
 
Single maturity fixed rate advances
 
$
80,000
 
August 2016 to February 2019
   
1.69
%
Amortizable mortgage advances
   
9,991
 
March 2018 to July 2018
   
3.78
%
 
 
$
89,991
 
 
       
 
 
 
 
    
Weighted
 
 
Advance
 
 
Average
 
Principal Terms
Amount
 
Range of Maturities
Interest Rate
 
December 31, 2012
 
 
 
Single maturity fixed rate advances
 
$
80,000
 
May 2015 to September 2016
   
1.70
%
Amortizable mortgage advances
   
11,822
 
March 2018 to July 2018
   
3.78
%
 
 
$
91,822
 
 
       

Each advance is subject to a prepayment fee if paid prior to its maturity date.  Fixed rate advances are payable at maturity.   Amortizable mortgage advances are fixed rate advances with scheduled repayments based upon amortization to maturity.  These advances were collateralized by residential and commercial real estate loans totaling $416,405,000 and $413,482,000 under a blanket lien arrangement at September 30, 2013 and December 31, 2012, respectively.

During the second quarter of 2013, the Bank modified the terms of six of its existing FHLB advances (totaling $60.0 million) having the effect of extending the weighted average maturity for all outstanding advances from 3.22 years to 4.86 years and reducing the weighted average interest rate from 1.95% to 1.94%.  As the modifications did not result in the terms being substantially different (as defined in ASC 470-50-40-10), the transaction was accounted for as a modification, not extinguishment of debt.  Accordingly, the prepayment fees incurred are amortized as an adjustment of the yield over the remaining life of each advance.

Scheduled repayments of FHLB advances as of September 30, 2013 were as follows (in thousands):

2013
 
$
---
 
2014
   
1,884
 
2015
   
1,938
 
2016
   
21,996
 
2017
   
2,055
 
Thereafter
   
62,118
 
 
 
$
89,991
 

Federal Reserve Bank Borrowings

The Company has a financing arrangement with the Federal Reserve Bank.  There were no borrowings outstanding at September 30, 2013 and December 31, 2012, and the Company had approximately $27.7 million and $30.3 million in unused borrowing capacity based on commercial and mortgage loans pledged to the Federal Reserve Bank totaling $33.2 million and $37.2 million at September 30, 2013 and December 31, 2012, respectively.
- 30 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 8 - EARNINGS PER COMMON SHARE

A reconciliation of the numerators and denominators of basic and diluted earnings per common share for the three and nine month periods ended September 30, 2013 and 2012 are as follows (dollars in thousands, except per share data):
 
 
 
Three Months
   
Three Months
   
Nine Months
   
Nine Months
 
 
 
Ended
   
Ended
   
Ended
   
Ended
 
 
 
September 30,
   
September 30,
   
September 30,
   
September 30,
 
 
 
2013
   
2012
   
2013
   
2012
 
Net income
 
$
2,238
   
$
6,585
   
$
7,315
   
$
14,256
 
Dividends declared on preferred shares
   
---
     
---
     
---
     
---
 
Net income available to common shares
 
$
2,238
   
$
6,585
   
$
7,315
   
$
14,256
 
 
                               
Weighted average shares outstanding, including participating stock awards - Basic
   
27,261,325
     
27,082,825
     
27,244,741
     
27,082,823
 
 
                               
Dilutive potential common shares:
                               
Stock options
   
---
     
---
     
---
     
---
 
Conversion of preferred stock
   
---
     
---
     
---
     
---
 
Stock warrants
   
---
     
---
     
---
     
---
 
Weighted average shares outstanding - Diluted
   
27,261,325
     
27,082,825
     
27,244,741
     
27,082,823
 
 
                               
Basic earnings per common share
 
$
0.08
   
$
0.24
   
$
0.27
   
$
0.53
 
Diluted earnings per common share
 
$
0.08
   
$
0.24
   
$
0.27
   
$
0.53
 

Stock options for 445,392 shares of common stock for both the three and nine month periods ended September 30, 2013 were not considered in computing diluted earnings per share because they were antidilutive.  Stock options for 534,444 shares of common stock for both the three and nine month periods ended September 30, 2012 were not considered in computing diluted earnings per share because they were antidilutive.  Potential common shares associated with convertible preferred stock and stock warrants were not considered in computing diluted earnings per share in each period because they were antidilutive.
 
NOTE 9 - FEDERAL INCOME TAXES

Income tax expense (benefit) was as follows (dollars 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
 
Current
 
$
40
   
$
275
   
$
95
   
$
275
 
Deferred (benefit) expense
   
935
     
---
     
3,218
     
---
 
 
 
$
975
   
$
275
   
$
3,313
   
$
275
 

- 31 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 9 - FEDERAL INCOME TAXES (Continued)

The difference between the financial statement tax expense and amount computed by applying the statutory federal tax rate to pretax income was reconciled as follows (dollars 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
 
Statutory rate
   
35
%
   
35
%
   
35
%
   
35
%
Statutory rate applied to income before taxes
   
1,124
     
2,401
   
$
3,720
   
$
5,086
 
Add (deduct)
                               
Change in valuation allowance
   
---
     
(1,761
)
   
---
     
(4,056
)
Tax-exempt interest income
   
(70
)
   
(32
)
   
(166
)
   
(64
)
Bank-owned life insurance
   
(63
)
   
(73
)
   
(188
)
   
(230
)
Other, net
   
(16
)
   
(260
)
   
(53
)
   
(461
)
 
 
$
975
   
$
275
   
$
3,313
   
$
275
 

The realization of deferred tax assets (net of a recorded valuation allowance) is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years. In assessing the need for a valuation allowance, we consider positive and negative evidence, including taxable income in carry-back years, scheduled reversals of deferred tax liabilities, expected future taxable income and tax planning strategies.

We established an $18.0 million valuation allowance on deferred tax assets in 2009 based primarily on our net operating losses for 2009 and 2008.

Throughout 2012, the positive evidence increased, while the negative evidence decreased.  The most significant negative evidence at December 31, 2012 was the level of other real estate owned at $51.6 million, which was down $14.8 million from December 31, 2011.  We achieved our 11th consecutive quarter of profitability as of December 31, 2012.  With the positive results of the fourth quarter of 2012, we moved into a cumulative income position for the most recent three year period.  In the first quarter of 2012, the FDIC and DIFS terminated the Bank’s Consent Order and, in the fourth quarter of 2012, the FRB terminated its Written Agreement with the Company, reducing regulatory uncertainty.  Based on this, sustained improvement in asset quality and our projected results, our analysis at December 31, 2012 concluded that it was “more likely than not” that we will continue to produce earnings and that the positive evidence outweighed the negative evidence regarding our ability to utilize our deferred tax assets.  As such, the full valuation allowance of $18.9 million was reversed to federal income tax expense at December 31, 2012.  In the second quarter of 2013, the FDIC and DIFS released the Bank’s MOU and we achieved our 14th consecutive quarter of profitability in the third quarter of 2013.  We concluded that no valuation allowance on our net deferred tax asset was necessary at September 30, 2013.
- 32 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 9 - FEDERAL INCOME TAXES (Continued)

The net deferred tax asset recorded included the following amounts of deferred tax assets and liabilities (dollars in thousands):
 
 
 
September 30,
   
December 31,
 
 
 
2013
   
2012
 
Deferred tax assets
 
   
 
Allowance for loan losses
 
$
7,445
   
$
8,309
 
Nonaccrual loan interest
   
828
     
1,023
 
Valuation allowance on other real estate owned
   
6,224
     
6,356
 
Net operating loss carryforward
   
2,088
     
4,188
 
Unrealized loss on securities available for sale
   
780
     
---
 
Other
   
1,776
     
1,794
 
Gross deferred tax assets
   
19,141
     
21,670
 
Valuation allowance
   
---
     
---
 
Total net deferred tax assets
   
19,141
     
21,670
 
 
               
Deferred tax liabilities
               
Depreciation
   
(1,592
)
   
(1,693
)
Unrealized gain on securities available for sale
   
---
     
(517
)
Prepaid expenses
   
(308
)
   
(308
)
Other
   
(382
)
   
(372
)
Gross deferred tax liabilities
   
(2,282
)
   
(2,890
)
Net deferred tax asset
 
$
16,859
   
$
18,780
 

At September 30, 2013, we had federal income tax net operating loss carry forwards of $6.0 million that expire through 2030.

There were no unrecognized tax benefits at September 30, 2013 or December 31, 2012 and the Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. The Company is no longer subject to examination by the Internal Revenue Service for years before 2009.

NOTE 10 – COMMITMENTS AND OFF BALANCE-SHEET RISK

Some financial instruments are used to meet customer financing needs and to reduce exposure to interest rate changes.  These financial instruments include commitments to extend credit and standby letters of credit.  These involve, to varying degrees, credit and interest rate risk in excess of the amount reported in the financial statements.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment, and generally have fixed expiration dates.  Standby letters of credit are conditional commitments to guarantee a customer’s performance to a third party.  Exposure to credit loss if the other party does not perform is represented by the contractual amount for commitments to extend credit and standby letters of credit.  Collateral or other security is normally not obtained for these financial instruments prior to their use and many of the commitments are expected to expire without being used.

A summary of the contractual amounts of financial instruments with off‑balance‑sheet risk was as follows at period-end (dollars in thousands):

 
September 30,
 
December 31,
 
 
2013
 
2012
 
Commitments to make loans
 
$
116,893
   
$
75,319
 
Letters of credit
   
8,883
     
8,200
 
Unused lines of credit
   
284,181
     
276,620
 

The notional amount of commitments to fund mortgage loans to be sold into the secondary market was approximately $17.5 million and $26.9 million at September 30, 2013 and December 31, 2012, respectively.
- 33 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 10 – COMMITMENTS AND OFF BALANCE-SHEET RISK (Continued)

At September 30, 2013, approximately 32% of the Bank’s commitments to make loans were at fixed rates, offered at current market rates.  The remainder of the commitments to make loans were at variable rates tied to the prime rate and generally expire within 30 days.  The majority of the unused lines of credit were at variable rates tied to the prime rate.

NOTE 11 – CONTINGENCIES

We and our subsidiaries periodically become defendants in certain claims and legal actions arising in the ordinary course of business. As of September 30, 2013, there were no material pending legal proceedings to which we or any of our subsidiaries are a party or which any of our properties are the subject.

NOTE 12 – LONG-TERM DEBT

The Company has outstanding $40,000,000 aggregate liquidation amount of pooled trust preferred securities ("TRUPs") issued through its wholly-owned subsidiary grantor trusts, Macatawa Statutory Trust I (issued $20,000,000 aggregate liquidation amount with a floating interest rate of three-month LIBOR plus 3.05%) and Macatawa Statutory Trust II (issued $20,000,000 aggregate liquidation amount with a floating interest rate of three-month LIBOR plus 2.75%). In December 2009, the Company exercised its right to defer interest payments on the TRUPs for 20 consecutive quarters or until such earlier time as is determined by further action of the Board of Directors. Through June 30, 2013, the Company had deferred interest payments on the TRUPs for 15 quarters. The Company continued to accrue interest during the deferral period. Interest on unpaid interest is required to be accrued and compounded quarterly at the stated interest rate.  Upon termination of the deferral, all accrued and unpaid interest is due and payable.

On August 18, 2013, the Company announced its intention to discontinue the deferral and resume regular quarterly interest payments on the TRUPs beginning with the next regularly scheduled interest payment dates and pay all accrued and unpaid interest that becomes due and payable upon the discontinuance of the deferral. For Macatawa Statutory Trust I, the next regularly scheduled interest payment date was September 30, 2013 and a total of $3.0 million was distributed, representing all of the deferred and current interest payment due. For Macatawa Statutory Trust II, the next regularly scheduled interest payment date was October 7, 2013 and a total of $2.7 million was distributed, representing all of the deferred and current interest payment due.

NOTE 13 – SHAREHOLDERS' EQUITY

In connection with the October 26, 2012 termination of the Company’s Written Agreement with the Federal Reserve Bank of Chicago (the "FRB"), the Board of Directors of the Company adopted a resolution (the "Board Resolution") requiring the Company to obtain written approval from the FRB before declaring or paying any dividends, increasing holding company debt or redeeming any capital stock. By letter dated August 1, 2013, the 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 effective August 1, 2013. The payment of future cash dividends by the Company is largely dependent upon dividends received from the Bank out of its earnings. The Bank had retained earnings of approximately $11.9 million at September 30, 2013.

On April 12, 2013, the FDIC and DIFS, the primary banking regulators of the Bank, notified the Bank that the Bank’s 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 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.

Subordinated Notes
In 2009, the Company received proceeds of $1,650,000 from the issuance of unsecured subordinated debt in the form of 11% subordinated notes due in 2017. On August 13, 2013, the Company prepaid and redeemed all of the subordinated notes for $1,650,000 plus interest accrued through the prepayment date.
- 34 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 13 – SHAREHOLDERS' EQUITY (Continued)

Regulatory Capital

The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.

The prompt corrective action regulations provide five categories, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is only adequately capitalized, regulatory approval is required to, among other things, accept, renew or roll-over brokered deposits. If a bank is undercapitalized, capital distributions and growth and expansion are limited, and plans for capital restoration are required.

At September 30, 2013 and December 31, 2012, actual capital levels and minimum required levels were (in thousands):

 
 
   
   
   
   
To Be Well
   
   
 
 
 
   
   
Minimum Required
   
Capitalized Under
   
   
 
 
 
   
   
For Capital
   
Prompt Corrective
   
Minimum Required
 
 
 
Actual
   
Adequacy Purposes
   
Action Regulations
   
Under MOU (1)
 
 
 
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
September 30, 2013
 
   
   
   
   
   
   
   
 
Total capital (to risk weighted assets)
 
   
   
   
   
   
   
   
 
Consolidated
 
$
177,037
     
16.0
%
 
$
88,285
     
8.0
%
   
N/
A
   
N/
A
   
N/
A
   
N/
A
Bank
   
175,541
     
15.9
     
88,336
     
8.0
   
$
110,421
     
10.0
%
   
N/
A
   
N/
A
Tier 1 capital (to risk weighted assets)
                                                               
Consolidated
   
163,150
     
14.8
     
44,143
     
4.0
     
N/
A
   
N/
A
   
N/
A
   
N/
A
Bank
   
161,646
     
14.6
     
44,168
     
4.0
     
66,252
     
6.0
     
N/
A
   
N/
A
Tier 1 capital (to average assets)
                                                               
Consolidated
   
163,150
     
10.9
     
59,922
     
4.0
     
N/
A
   
N/
A
   
N/
A
   
N/
A
Bank
   
161,646
     
10.8
     
59,887
     
4.0
     
74,859
     
5.0
     
N/
A
   
N/
A
 
                                                               
December 31, 2012
                                                               
Total capital (to risk weighted assets)
                                                               
Consolidated
 
$
168,929
     
15.0
%
 
$
90,244
     
8.0
%
   
N/
A
   
N/
A
   
N/
A
   
N/
A
Bank
   
164,214
     
14.5
     
90,299
     
8.0
   
$
112,874
     
10.0
%
   
N/
A
   
N/
A
Tier 1 capital (to risk weighted assets)
                                                               
Consolidated
   
150,857
     
13.4
     
45,122
     
4.0
     
N/
A
   
N/
A
   
N/
A
   
N/
A
Bank
   
149,960
     
13.3
     
45,150
     
4.0
     
67,724
     
6.0
     
N/
A
   
N/
A
Tier 1 capital (to average assets)
                                                               
Consolidated
   
150,857
     
10.4
     
58,312
     
4.0
     
N/
A
   
N/
A
   
N/
A
   
N/
A
Bank
   
149,960
     
10.3
     
58,371
     
4.0
     
72,964
     
5.0
   
$
116,742
     
8.0
%

(1) The MOU is applicable only to the December 31, 2012 information presented in these columns.

Approximately $40.0 million and $37.7 million of trust preferred securities outstanding at September 30, 2013 and December 31, 2012, respectively, qualified as Tier 1 capital. Refer to our 2012 Form 10-K for more information on the trust preferred securities.
- 35 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 13 – SHAREHOLDERS' EQUITY (Continued)

The Bank was categorized as "well capitalized" at September 30, 2013 and December 31, 2012.

On July 3, 2013, the FDIC Board of Directors approved the Regulatory Capital Interim Final Rule, implementing Basel III.  This rule redefines Tier 1 capital as two components (Common Equity Tier 1 and Additional Tier 1), creates a new capital ratio (Common Equity Tier 1 Risk-based Capital Ratio) and implements a capital conservation buffer.  It also revises the prompt corrective action thresholds and makes changes to risk weights for certain assets and off-balance-sheet exposures.  Banks are required to transition into the new rule beginning on January 1, 2015.  Based on our capital levels and balance sheet composition at September 30, 2013, we  believe implementation of the new rule will have no material impact on our capital needs.
 
- 36 -

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.
- 37 -

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.

- 38 -

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.
- 39 -

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.

- 40 -

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.
- 41 -

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 problem assets
   
1,811
     
1,724
     
4,072
     
7,973
 
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, we experienced significant decreases in each of these expense categories in the nine months ended September 2013 compared to the same period in 2012.

These costs are itemized in the following table (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
 
Legal and professional – nonperforming assets
 
$
161
   
$
209
   
$
662
   
$
917
 
Repossessed and foreclosed property administration
   
591
     
809
     
1,997
     
2,820
 
Losses on repossessed and foreclosed properties
   
1,059
     
706
     
1,412
     
4,236
 
Total
 
$
1,811
   
$
1,724
   
$
4,072
   
$
7,973
 
- 42 -

Losses on repossessed assets and foreclosed properties increased slightly for the three month period ended September 30, 2013, increasing $353,000 from the same period in 2012.  For the first nine months of 2013, losses on repossessed assets and foreclosed properties were down $2.8 million from the same period in 2012.  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 significant decline in writedowns. During the third quarter of 2013, we realized net gains on sales of foreclosed properties of $390,000, partially offsetting the $1.4 million in valuation writedowns during the quarter.  For the nine months ended September 30, 2013, we realized net gains of $1.0 million on sales of foreclosed properties, significantly offsetting the $2.4 million in valuation writedowns for the period.

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 $57.8 million at September 30, 2012 and $51.6 million at December 31, 2012 to $42.8 million at September 30, 2013.  As our level of problem loans and other real estate owned decreases, we believe we will experience more reductions in these costs going forward.

FDIC assessments decreased by $187,000 to $317,000 for the third quarter of 2013 compared to $504,000 for the third quarter of 2012 as a result of our reduced level of deposits and due to a change in our assessment category resulting from the termination of the Bank’s MOU by the FDIC and DIFS effective April 12, 2013.  For the nine months ended September 30, 2012, our FDIC assessments were $1.1 million, compared to $1.7 million for the same period in 2012.

We realized a $26,000 reduction in our bond and D&O insurance costs in the third quarter of 2013 compared to the third quarter of 2012 and a reduction of $140,000 for the nine month period ended September 30, 2013 compared to the same period in 2012 as a result of our improving financial condition and the decreased risk perceived by our insurance carriers.  In the third quarter of 2012, we paid off $20 million in FHLB advances using proceeds from an early payoff of a $15 million commercial loan.  The early payoff of the FHLB advances resulted in a prepayment fee of $322,000.

Federal Income Tax Expense: We recorded $975,000 and $3.3 million in federal income tax expense for the three and nine month periods ended September 30, 2013, respectively, compared to $275,000 in the same periods in 2012.  The expense in the 2012 periods was due to payment of alternative minimum tax.  From June 30, 2009 to December 31, 2012, we had concluded that a full valuation allowance needed to be maintained for all of our net deferred tax assets based primarily on our net operating losses in 2008 and 2009 and the continued challenging environment confronting banks that could negatively impact future operating results.  With the termination of the Bank’s Consent Order and the Company’s Written Agreement, cumulative earnings in the most recent three year period and projections showing future taxable income at December 31, 2012, we concluded that the valuation allowance was no longer required and the $18.9 million valuation allowance was reversed at that time.  As a result, the financial results for the third quarter and first nine months of 2013 reflect federal income tax expense, at an effective tax rate of 30.34% and 31.17%, respectively.

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 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 three years.

Total assets were $1.563 billion at September 30, 2013, an increase of $2.0 million from $1.561 billion at December 31, 2012. This change reflected increases of $11.9 million in securities available for sale and $25.0 million of interest-bearing time deposits in other financial institutions, offset by declines of $23.6 million in our loan portfolio and $12.5 million in cash and cash equivalents. Total deposits increased by $1.8 million due to normal seasonal deposits, and other borrowed funds were down by $1.8 million at September 30, 2013 compared to December 31, 2012.

Cash and Cash Equivalents: Our cash and cash equivalents, which include federal funds sold and short-term investments, were $213.9 million at September 30, 2013 compared to $226.4 million at December 31, 2012. The $12.5 million decrease was partially due to investing $25.0 million of these funds in interest-bearing time deposits with other financial institutions as discussed below. At these levels, these balances remain elevated due to the normal build-up in deposits we typically experience in the latter part of the year, and 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 matures within 12 months and the other within 18 months, and both provide a higher interest rate than federal funds sold or other short-term investments.
- 43 -

Securities Available for Sale: Securities available for sale were $135.4 million at September 30, 2013 compared to $123.5 million at December 31, 2012. We began rebuilding our investment portfolio during the second quarter of 2011. The balance at September 30, 2013 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 $23.6 million in the first nine months of 2013 and were $1.03 billion at September 30, 2013 compared to $1.05 billion at December 31, 2012. During the first nine months of 2013, our commercial  portfolio decreased by $27.5 million, while our residential and consumer portfolios increased by $2.4 million and $1.5 million, respectively.

We saw a comparable level of volume of residential mortgage loans originated for sale in the first nine months of 2013 compared to the same period in 2012. Residential mortgage loans originated for sale were $91.1 million in the first nine months of 2013 compared to $100.9 million for the same period in 2012.  Long term residential mortgage rates began to increase at the end of the second quarter of 2013 and continued into the third quarter of 2013, reducing originating volume in the third quarter of 2013.  We expect this trend to continue in the fourth quarter of 2013.

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.  While this portfolio decreased during the first two quarters of 2013, growth returned in the third quarter when the portfolio increased by $12.7 million. We plan to continue measured, high quality loan portfolio growth through the remainder of 2013.

Commercial and commercial real estate loans remained our largest loan segment and accounted for approximately 71% of the total loan portfolio at September 30, 2013 and 73% at December 31, 2012. Residential mortgage and consumer loans comprised approximately 29% of total loans at September 30, 2013 and 27% at December 31, 2012.

A further breakdown of the composition of the loan portfolio is shown in the table below (in thousands):
 
 
 
September 30,
   
Percent of
   
December 31,
   
Percent of
 
 
 
2013
   
Total Loans
   
2012
   
Total Loans
 
Commercial real estate: (1)
 
   
   
   
 
Residential developed
 
$
20,805
     
2.0
%
 
$
26,090
     
2.5
%
Unsecured to residential developers
   
7,326
     
0.7
     
5,547
     
0.5
 
Vacant and unimproved
   
48,977
     
4.8
     
56,525
     
5.3
 
Commercial development
   
4,319
     
0.4
     
1,799
     
0.2
 
Residential improved
   
77,414
     
7.5
     
75,813
     
7.2
 
Commercial improved
   
243,688
     
23.7
     
255,738
     
24.4
 
Manufacturing and industrial
   
79,403
     
7.7
     
81,447
     
7.7
 
Total commercial real estate
   
481,932
     
46.8
     
502,959
     
47.8
 
Commercial and industrial
   
253,216
     
24.7
%
   
259,700
     
24.7
%
Total commercial
   
735,148
     
71.5
     
762,659
     
72.5
 
 
                               
Consumer
                               
Residential mortgage
   
185,025
     
18.0
     
182,625
     
17.3
 
Unsecured
   
1,464
     
0.1
     
1,683
     
0.2
 
Home equity
   
96,790
     
9.4
     
92,764
     
8.8
 
Other secured
   
10,366
     
1.0
     
12,617
     
1.2
 
Total consumer
   
293,645
     
28.5
     
289,689
     
27.5
 
Total loans
 
$
1,028,793
     
100.0
%
 
$
1,052,348
     
100.0
%

(1)            Includes both owner occupied and non-owner occupied commercial real estate.
- 44 -

Commercial real estate loans accounted for approximately 46.8% of the total loan portfolio at September 30, 2013 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 $21.0 million since December 31, 2012. Our commercial and industrial loan portfolio decreased by $6.5 million to $253.2 million at September 30, 2013 and represented 34.4% of our commercial portfolio.

Our consumer residential mortgage loan portfolio, which also includes residential construction loans made to individual homeowners, comprised approximately 18% of portfolio loans at September 30, 2013 and 17% at December 31, 2012 as we continue to execute our strategy to diversify our credit risk from commercial real estate.  During the remainder of 2013, we expect to continue to retain in our loan portfolio certain types of residential mortgage loans (primarily high quality, low loan to value loans) in an effort to continue to diversify our credit risk and deploy our excess liquidity. A large portion of our residential mortgage loan production continues to be sold on the secondary market with servicing released.

We saw a decrease in the volume of residential mortgage loans originated for sale during 2013 compared to 2012 as discussed above, however the decrease began in the third quarter of 2013 as interest rates increased beginning late in the second quarter of 2013. We expect this trend to continue in the fourth quarter of 2013.  We have not yet had to repurchase any residential mortgage loans sold; however, due to market conditions many banks are being required to repurchase loans resulting from actual or alleged failure to strictly conform to the investor’s purchase criteria.

Our portfolio of other consumer loans includes loans secured by personal property and home equity fixed term and line of credit loans. These types of loans increased by $1.5 million to $108.6 million at September 30, 2013 from $107.1 million at December 31, 2012 due to an increase in home equity loans.  Consumer loans comprised approximately 11% of our portfolio loans at September 30, 2013 and 10% at December 31, 2012.

The following table shows our loan origination activity for portfolio loans during the first nine months of 2013, broken out by loan type and also shows average originated loan size (dollars in thousands):
 
 
 
Portfolio
   
Percent of
   
Average
 
 
 
Originations
   
Total
   
Loan
 
 
 
2013
   
Originations
   
Size
 
Commercial real estate:
 
   
   
 
Residential developed
 
$
4,303
     
1.1
%
 
$
331
 
Unsecured to residential developers
   
---
     
---
     
---
 
Vacant and unimproved
   
10,683
     
2.9
     
445
 
Commercial development
   
48
     
---
     
48
 
Residential improved
   
39,921
     
10.8
     
231
 
Commercial improved
   
50,599
     
13.7
     
569
 
Manufacturing and industrial
   
12,854
     
3.5
     
494
 
Total commercial real estate
   
118,408
     
32.0
     
363
 
Commercial and industrial
   
168,451
     
45.5
%
   
42
 
Total commercial
   
286,859
     
77.5
     
66
 
 
                       
Consumer
                       
Residential mortgage
   
47,188
     
12.7
     
211
 
Unsecured
   
302
     
0.1
     
19
 
Home equity
   
33,581
     
9.1
     
69
 
Other secured
   
2,346
     
0.6
     
12
 
Total consumer
   
83,417
     
22.5
     
91
 
Total loans
 
$
370,276
     
100.0
%
 
$
70
 

- 45 -

Our loan portfolio is reviewed regularly by our senior management, our loan officers, and an internal loan review team that is independent of our loan originators and credit administration. An administrative loan committee consisting of senior management and seasoned lending and collections personnel meets monthly to manage our internal watch list and proactively manage high risk loans.

When reasonable doubt exists concerning collectability of interest or principal of one of our loans, the loan is placed in nonaccrual status. Any interest previously accrued but not collected is reversed and charged against current earnings.

Nonperforming assets are comprised of nonperforming loans, foreclosed assets and repossessed assets. At September 30, 2013, nonperforming assets totaled $53.0 million compared to $67.6 million at December 31, 2012. Additions to other real estate owned in the first nine months of 2013 were just $3.2 million.  Based on the loans currently in their redemption period, we expect few properties to move into other real estate owned over the next three months.  Proceeds from sales of foreclosed properties were $10.5 million in the first nine months of 2013 resulting in a net gain of $1.0 million. Proceeds from sales of foreclosed properties were $13.4 million in the first nine months of 2012, resulting in a net gain of $11,000.  We expect the level of sales of foreclosed properties for the remainder of 2013 to be similar to the quarterly pace experienced so far in 2013 and in 2012.

Nonperforming loans include loans on nonaccrual status and loans delinquent more than 90 days but still accruing. As of September 30, 2013, nonperforming loans totaled $10.2 million, or 0.99% of total portfolio loans, compared to $16.0 million, or 1.52% of total portfolio loans, at December 31, 2012.

Loans for development or sale of 1-4 family residential properties comprised a large portion of nonperforming loans. They were approximately $2.7 million, or 25.9% of total nonperforming loans, at September 30, 2013 compared to $3.2 million, or 19.7% of total nonperforming loans, at December 31, 2012. The remaining balance of nonperforming loans at September 30, 2013 consisted of $2.3 million of commercial real estate loans secured by various types of non-residential real estate, $4.2 million of commercial and industrial loans, and $1.0 million of consumer and residential mortgage loans.

Foreclosed and repossessed assets include assets acquired in settlement of loans. Foreclosed assets totaled $42.8 million at September 30, 2013 and $51.6 million at December 31, 2012. Of this balance at September 30, 2013, there were 97 commercial real estate properties totaling approximately $40.4 million. The remaining balance was comprised of 25 residential properties totaling approximately $2.4 million.  Five commercial real estate properties comprised $17.1 million, or 40%, of total other real estate owned at September 30, 2013.  All properties acquired through or in lieu of foreclosure are initially transferred at their fair value less estimated costs to sell and then evaluated monthly for impairment after transfer using a lower of cost or market approach. Updated property valuations are obtained at least annually on all foreclosed assets.

At September 30, 2013, our foreclosed asset portfolio had a weighted average age held in portfolio of 2.85 years. Below is a breakout of our foreclosed asset portfolio at September 30, 2013 by property type and the percentages the property has been written down since taken into our possession and the combined writedown percentage, including losses taken when the property was loan collateral (dollars in thousands):
 
 
 
 
Combined
 
 
Carrying
 
 
Writedown
 
 
Value at
 
Foreclosed
 
(Loan and
 
 
September 30,
 
Asset
 
Foreclosed
 
Foreclosed Asset Property Type
2013
 
Writedown
 
Asset)
 
Single Family
 
$
1,836
     
3.4
%
   
32.1
%
Residential Lot
   
577
     
31.8
%
   
48.9
%
Multi-Family
   
150
     
---
%
   
14.9
%
Vacant Land
   
6,649
     
32.6
%
   
48.8
%
Residential Development
   
15,752
     
33.7
%
   
69.3
%
Commercial Office
   
1,867
     
37.0
%
   
56.9
%
Commercial Industrial
   
293
     
25.5
%
   
40.1
%
Commercial Improved
   
15,672
     
24.0
%
   
38.9
%
 
 
$
42,796
     
29.3
%
   
56.6
%
- 46 -

The following table shows the composition and amount of our nonperforming assets (dollars in thousands):
 
 
 
September 30,
   
December 31,
 
 
 
2013
   
2012
 
Nonaccrual loans
 
$
10,048
   
$
15,385
 
Loans 90 days past due and still accruing
   
172
     
618
 
Total nonperforming loans (NPLs)
   
10,220
     
16,003
 
Foreclosed assets
   
42,796
     
51,582
 
Repossessed assets
   
---
     
6
 
Total nonperforming assets (NPAs)
   
53,016
     
67,591
 
Accruing restructured loans (ARLs) (1)
   
62,223
     
65,024
 
Total NPAs and ARLs
 
$
115,239
   
$
132,615
 
 
               
NPLs to total loans
   
0.99
%
   
1.52
%
NPAs to total assets
   
3.39
%
   
4.33
%
 
  (1) Comprised of approximately $47.6 million and $51.8 million of commercial loans and $14.7 million and $13.2 million of consumer loans whose terms have been restructured at September 30, 2013 and December 31, 2012, respectively. Interest is being accrued on these loans under their restructured terms as they are less than 90 days past due.

Allowance for loan losses: The allowance for loan losses at September 30, 2013 was $21.3 million, a decrease of $2.5 million, compared to $23.7 million at December 31, 2012. The balance of the allowance for loan losses was 2.07% of total portfolio loans at September 30, 2013 compared to 2.26% of total portfolio loans at December 31, 2012. While this ratio decreased slightly, the allowance for loan losses to nonperforming loan coverage ratio continued to increase, from 148.34% at December 31, 2012 to 208.14% at September 30, 2013.

The table below shows the changes in these metrics over the past five quarters:
 
 
 
Quarter Ended
   
Quarter Ended
   
Quarter Ended
   
Quarter Ended
   
Quarter Ended
 
 
 
September 30,
   
June 30,
   
March 31,
   
December 31,
   
September 30,
 
(in millions)
 
2013
   
2013
   
2013
   
2012
   
2012
 
Commercial loans
 
$
735.1
   
$
722.4
   
$
756.7
   
$
762.7
   
$
734.3
 
Nonperforming loans
   
10.2
     
10.8
     
14.2
     
16.0
     
17.4
 
Other real estate owned and repo assets
   
42.8
     
45.8
     
51.6
     
51.6
     
57.8
 
Total nonperforming assets
   
53.0
     
56.6
     
65.8
     
67.6
     
75.1
 
Net charge-offs (recoveries)
   
(0.5
)
   
0.2
     
(0.5
)
   
2.0
     
(0.3
)
Total delinquencies
   
7.8
     
6.7
     
6.6
     
7.9
     
5.7
 

Nonperforming loans have continually declined since the first quarter of 2010 to $10.2 million at September 30, 2013, which was our lowest level of nonperforming loans since the second quarter of 2007. As discussed earlier, we have had net loan recoveries in several quarters over the last year and a half.  While increasing from recent quarters, our total delinquencies remain low at $7.8 million at September 30, 2013.

These factors all provide for a reduction in our allowance for loan losses, and thus impacts our provision for loan losses. The provision for loan losses was a negative $1.5 million for the three months ended September 30, 2013 compared to a negative $1.25 million for the same period of 2012.  The negative provision in each period was partially due to a smaller level of nonperforming loans as they continue to stabilize at a more reasonable level.  Net recoveries were $524,000 for the three months ended September 30, 2013 compared to net recoveries of $341,000 for the same period in 2012. We have had net recoveries in three of the last five quarters. The ratio of net charge-offs to average loans was -0.21% on an annualized basis for the third quarter of 2013, compared to 0.09% for the second quarter of 2013 and -0.13% for the third quarter of 2012.

We are encouraged by the reduced level of charge-offs over recent quarters. We do, however, recognize that future chargeoffs and resulting provisions for loan losses are expected to be impacted by the timing and extent of changes in the overall economy and the real estate markets. We believe we have seen some stabilization in economic conditions and real estate markets. However, we expect it to take additional time for sustained improvement in the economy and real estate markets in order for us to reduce our nonperforming and impaired loans to acceptable levels.
- 47 -

Our allowance for loan losses is maintained at a level believed appropriate based upon our assessment of the probable estimated losses inherent in the loan portfolio. Our methodology for measuring the appropriate level of allowance and related provision for loan losses relies on several key elements, which include specific allowances for loans considered impaired, general allowance for commercial loans not considered impaired based upon applying our loan rating system, and general allocations based on historical trends for homogeneous loan groups with similar risk characteristics.

Impaired loans declined $10.2 million to $73.1 million at September 30, 2013 compared to $83.3 million at December 31, 2012.  The specific allowance for impaired loans decreased $1.4 million to $4.7 million, or 6.4% of total impaired loans, at September 30, 2013 compared to $6.1 million, or 7.3% of total impaired loans, at December 31, 2012.  The overall balance of impaired loans remained elevated due to an accounting rule (ASU 2011-02) adopted in 2011 that requires us to identify classified loans that renew at existing contractual rates as troubled debt restructurings (“TDRs”) if the contractual rate is less than market rates for similar loans at the time of renewal.  As TDRs are also considered impaired, this increased our impaired loan balance for each period presented as most of our classified loans renewed in this time period.

The general allowance allocated to commercial loans that were not considered to be impaired was based upon the internal risk grade of such loans.  We use a loan rating method based upon an eight point system.  Loans are stratified between real estate secured and non real estate secured.  The real estate secured portfolio is further stratified by the type of real estate.  Each stratified portfolio is assigned a loss allocation factor.  A higher numerical grade assigned to a loan category generally results in a greater allocation percentage.  Changes in risk grade of loans affect the amount of the allowance allocation.

The determination of our loss factors is based upon our actual loss history by loan grade and adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the analysis date.  We use a rolling 18 month actual net chargeoff history as the base for our computation.  Over the past two years, the 18 month period computations have reflected sizeable decreases in net chargeoff experience.  We addressed this volatility in the qualitative factor considerations applied in our allowance for loan losses computation. Adjustments to the qualitative factors also involved consideration of different loss periods for the Bank, including 12 and 24 month periods. Considering the change in our qualitative factors and our commercial loan portfolio balances, the general allowance allocated to commercial loans decreased to $13.1 million at September 30, 2013 compared to $14.6 million at December 31, 2012.  This resulted in a general reserve percentage allocated at September 30, 2013 of 1.93% of commercial loans,  a decrease from 2.12% at December 31, 2012.  The qualitative component of our general allowance allocated to commercial loans decreased from $13.8 million at December 31, 2012 to $12.9 million at September 30, 2013.

Groups of homogeneous loans, such as residential real estate and open- and closed-end consumer loans, receive allowance allocations based on loan type.  A rolling 12 month (4 quarter) historical loss experience period was applied to residential mortgage and consumer loan portfolios.  As with commercial loans that are not considered impaired, the determination of the allowance allocation percentage is based principally on our historical loss experience.  These allocations are adjusted for consideration of general economic and business conditions, credit quality and delinquency trends, collateral values, and recent loss experience for these similar pools of loans.  The homogeneous loan allowance was $3.5 million at September 30, 2013 and $3.1 million at December 31, 2012.

The allowance allocations are not intended to imply limitations on usage of the allowance for loan losses.  The entire allowance for loan losses is available for any loan losses without regard to loan type.

Premises and Equipment:  Premises and equipment totaled $52.9 million at September 30, 2013, representing a decrease of $660,000 from $53.6 million at December 31, 2012.  The decline was largely from depreciation of current facilities in excess of capital additions during the first nine months of 2013.

Deposits and Other Borrowings: Total deposits increased $1.8 million to $1.288 billion at September 30, 2013, as compared to $1.286 billion at December 31, 2012.  Non-interest checking account balances increased $13.4 million during the first nine months of 2013.  Interest bearing demand account balances increased $24.1 million and savings and money market account balance decreased $2.1 million in the first nine months of 2013.  We decreased higher costing certificates of deposits by $33.6 million in the first nine months of 2013.  The increase in balances of checking accounts was caused by normal seasonal inflows from municipalities and some shifting between deposit types.  We believe our success in maintaining the balances of personal and business checking and savings accounts was primarily attributable to our focus on quality customer service, the desire of customers to deal with a local bank, the convenience of our maturing branch network and the breadth and depth of our product line.

Noninterest bearing demand accounts comprised 27% of total deposits at September 30, 2013 compared to 26% of total deposits at December 31, 2012.  Because of the generally low rates paid on interest bearing account alternatives, many of our business customers chose to keep their balances in these more liquid account types.  Interest bearing demand, including money market and savings accounts, comprised 60% of total deposits at September 30, 2013 and December 31, 2012. Time accounts as a percentage of total deposits were 13% at September 30, 2013 and 15% at December 31, 2012.
- 48 -

Borrowed funds totaled $131.2 million at September 30, 2013; including $90.0 million of Federal Home Loan Bank advances and $41.2 million in long-term debt associated with trust preferred securities.  During the third quarter of 2013, we prepaid and redeemed $1.65 million in subordinated debt.  Borrowed funds totaled $134.7 million at December 31, 2012; including $91.8 million of Federal Home Loan Bank advances, $41.2 million in long-term debt associated with trust preferred securities and $1.65 million in subordinated debt.  Borrowed funds decreased by $3.5 million in the first nine months of 2013 as a result of an annual payment on an amortizing Federal Home Loan Bank advance in the first quarter of 2013 and the prepayment and redemption of subordinated debt in the third quarter of 2013.

During the second quarter of 2013, we modified the terms of six of our existing FHLB advances (totaling $60.0 million) having the effect of extending the weighted average maturity for all outstanding advances from 3.22 years to 4.86 years and reducing the weighted average interest rate from 1.95% to 1.94%.  As the modifications did not result in the terms being substantially different (as defined in ASC 470-50-40-10), the transaction was accounted for as a modification, not extinguishment of debt.  Accordingly, the prepayment fees that were incurred are amortized as an adjustment of the yield over the remaining life of each advance.

The Company has outstanding $40.0 million aggregate liquidation amount of pooled trust preferred securities (“TRUPs”) issued through its wholly-owned subsidiary grantor trusts, Macatawa Statutory Trust I (issued $20.0 million aggregate liquidation amount with floating interest rate of three-month LIBOR plus 3.05%) and Macatawa Statutory Trust II (issued $20.0 million aggregate liquidation amount with  a floating interest rate of three-month LIBOR plus 2.75%).  In December 2009, the Company exercised its right to defer interest payments on the TRUPs for 20 consecutive quarters or until such earlier time as is determined by further action of the Board of Directors.    Through June 30, 2013, the Company had deferred interest payments on the TRUPs for 15 quarters.  The Company continued to accrue interest during the deferral period.  Interest on unpaid interest is required to be accrued and compounded quarterly at the stated interest rate.  Upon termination of the deferral, all accrued and unpaid interest is due and payable.

On August 18, 2013, the Company announced its intention to discontinue the deferral and resume regular quarterly interest payments on the TRUPs beginning with the next regularly scheduled interest payment dates and pay all accrued and unpaid interest that becomes due and payable upon the discontinuance of the deferral. For Macatawa Statutory Trust I, the next regularly scheduled interest payment date was September 30, 2013 and a total of $3.0 million was distributed, representing all of the deferred and current interest payment due. For Macatawa Statutory Trust II, the next regularly scheduled interest payment date was October 7, 2013 and a total of $2.7 million was distributed, representing all of the deferred and current interest payment due.
 
CAPITAL RESOURCES

Total shareholders' equity of $135.5 million at September 30, 2013 increased $5.0 million from $130.5 million at December 31, 2012. The increase was primarily a result of net income of $7.3 million earned in the first nine months of 2013.

Our regulatory capital ratios (on a consolidated basis) were stable in the third quarter of 2013 and ended the quarter at levels consistent with the second quarter of 2013, which were at the highest levels in the Company’s history.  The Bank was categorized as “well capitalized” at September 30, 2013. The following table shows our regulatory capital ratios (on a consolidated basis) for the past several quarters:
 
 
Sept 30,
 
June 30,
 
March 31,
 
Dec 31,
 
Sept 30,
 
June 30,
 
 
2013
 
2013
 
2013
 
2012
 
2012
 
2012
 
Total capital to risk weighted assets
   
16.0
%
   
16.1
%
   
15.4
%
   
15.0
%
   
14.9
%
   
14.2
%
Tier 1 capital to average assets
   
10.9
%
   
10.9
%
   
10.5
%
   
10.4
%
   
9.5
%
   
9.0
%

All of the $40.0 million of trust preferred securities outstanding at September 30, 2013 qualified as Tier 1 capital.  The ratios have increased each quarter since March 31, 2010 through June 30, 2013 due to declines in risk weighted assets, positive earnings for each quarter and the stock offering completed in the second quarter of 2011.

Cash dividends of $2.9 million were declared on preferred shares during 2009.  Following this, we suspended payment of cash dividends on our common and preferred stock for the remainder of 2009 and ever since then in an effort to preserve capital.  During the period that we do not declare and pay cash dividends on our preferred stock, we may not declare and pay cash dividends on our common stock.  We expect to reassess our ability to resume the payment of dividends on our preferred and common stock if and when current levels of cash, earnings and capital are at acceptable levels and the prospects are positive for sustained economic growth and improved performance.
- 49 -

On July 3, 2013, the FDIC Board of Directors approved the Regulatory Capital Interim Final Rule, implementing Basel III.  This rule redefines Tier 1 capital as two components (Common Equity Tier 1 and Additional Tier 1), creates a new capital ratio (Common Equity Tier 1 Risk-based Capital Ratio) and implements a capital conservation buffer.  It also revises the prompt corrective action thresholds and makes changes to risk weights for certain assets and off-balance-sheet exposures.  Banks are required to transition into the new rule beginning on January 1, 2015.  Based on our capital levels and balance sheet composition at September 30, 2013, we believe implementation of the new rule will have no material impact on our capital needs.
 
LIQUIDITY

Liquidity of Macatawa Bank: The liquidity of a financial institution reflects its ability to manage a variety of sources and uses of funds. Our Consolidated Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus on developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for our investment and loan portfolios. Our sources of liquidity include our borrowing capacity with the FRB's discount window, the Federal Home Loan Bank, federal funds purchased lines of credit and other secured borrowing sources with our correspondent banks, loan payments by our borrowers, maturity and sales of our securities available for sale, growth of our deposits, federal funds sold and other short-term investments, and the various capital resources discussed above.

Liquidity management involves the ability to meet the cash flow requirements of our customers. Our customers may be either borrowers with credit needs or depositors wanting to withdraw funds. Our liquidity management involves periodic monitoring of our assets considered to be liquid and illiquid, and our funding sources considered to be core and non-core and short-term (less than 12 months) and long-term. We have established parameters that monitor, among other items, our level of liquid assets to short-term liabilities, our level of non-core funding reliance and our level of available borrowing capacity. We maintain a diversified wholesale funding structure and actively manage our maturing wholesale sources to reduce the risk to liquidity shortages. We have also developed a contingency funding plan to stress test our liquidity requirements arising from certain events that may trigger liquidity shortages, such as rapid loan growth in excess of normal growth levels or the loss of deposits and other funding sources under extreme circumstances.

In response to the volatile conditions in the national markets since 2008, we actively pursued initiatives to further strengthen our liquidity position.  The Bank reduced its reliance on non-core funding sources, including brokered deposits, and focused on achieving a non-core funding dependency ratio below its peer group average.  We have had no brokered deposits on our balance sheet since December 2011.  We also reduced other borrowed funds by $56.8 million in 2012 and by $1.8 million in the first nine months of 2013.  We continue to maintain significant on-balance sheet liquidity.  At September 30, 2013, the Bank held $178.3 million of federal funds sold and other short-term investments and $25.0 million in time deposits with other financial institutions with maturities of less than 18 months.  In addition, the Bank’s borrowing capacity from correspondent banks has been improved and was approximately $189.2 million as of September 30, 2013.

In the normal course of business, we enter into certain contractual obligations, including obligations which are considered in our overall liquidity management.  The table below summarizes our significant contractual obligations at September 30, 2013.
 
 
 
Less than
   
   
   
More than
 
(Dollars in thousands)
 
1 year
   
1-3 years
   
3-5 years
   
5 years
 
Long term debt
 
$
---
   
$
---
   
$
---
   
$
41,238
 
Time deposit maturities
   
89,558
     
55,762
     
11,125
     
---
 
Other borrowed funds
   
1,884
     
23,934
     
44,173
     
20,000
 
Total
 
$
91,442
   
$
79,696
   
$
55,298
   
$
61,238
 

In addition to normal loan funding, we also maintain liquidity to meet customer financing needs through unused lines of credit, unfunded loan commitments and standby letters of credit.  The level and fluctuation of these commitments is also considered in our overall liquidity management.  At September 30, 2013, we had a total of $284.2 million in unused lines of credit, $116.9 million in unfunded loan commitments and $8.9 million in standby letters of credit.

Liquidity of Holding Company: The primary sources of liquidity for the Company are dividends from the Bank, existing cash resources and the various capital resources discussed above.  Banking regulations and the laws of the state of Michigan in which our Bank is chartered limit the amount of dividends the Bank may declare and pay to the Company in any calendar year.  Under the state law limitations, the Bank is restricted from paying dividends to the Company in excess of retained earnings. Throughout 2010, 2011, 2012, and the first nine months of 2013, the Company has not received dividends from the Bank, and the Company has suspended payment of dividends on its common and preferred stock.  At September 30, 2013, the Bank had a retained earnings balance of approximately $11.9 million. With the release of the Bank’s MOU by its regulators effective April 12, 2013, the Bank is no longer required to obtain prior regulatory approval to pay dividends to the Company.
- 50 -

 
The Company continued to suspend payments of cash dividends on its preferred stock during 2010, 2011, 2012 and the first nine months of 2013 until further action by the Board of Directors.  During the period that the Company does not declare and pay cash dividends on its preferred stock, it may not declare and pay cash dividends on its common stock.
 
During 2010, 2011, 2012 and the first six months of 2013, the Company also continued to exercise its right to defer interest payments on its trust preferred securities for 20 consecutive quarters or until such earlier time as is determined by further action of the Board of Directors.  As discussed above, in the third quarter of 2013, the Company made the current and deferred interest distributions on Macatawa Statutory Trust I and made the current and deferred interest distributions on Macatawa Statutory Trust II on October 7, 2013.  As the interest is now current on the trust preferred securities, the Company again has the right to defer interest payments for 20 consecutive quarters if necessary for liquidity purposes.  During the deferral period, the Company may not declare or pay any dividends on its common stock or preferred stock or make any payment on any outstanding debt obligations that rank equally with or junior to the trust preferred securities.

In June 2011, the Company closed its shareholder rights and public offerings and conversion of our 2% Subordinated Note due 2018, resulting in the issuance of 9,404,202 shares of common stock and net proceeds of $20.4 million.  The Company contributed $10.0 million of the proceeds to the Bank in 2011 and retained the remaining $10.3 million at the holding company level. The Company’s cash balance at September 30, 2013 was $4.6 million.  The Company believes it has sufficient liquidity to meet its cash flow requirements.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES:

To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information.  These estimates and assumptions affect the amounts reported in the financial statements and future results could differ.  The allowance for loan losses, other real estate owned valuation, loss contingencies and income taxes are deemed critical due to the required level of management judgment and the use of estimates, making them particularly subject to change.

Our methodology for determining the allowance for loan losses and the related provision for loan losses is described above in the "Allowance for Loan Losses" discussion.  This area of accounting requires significant judgment due to the number of factors which can influence the collectability of a loan.  Unanticipated changes in these factors could significantly change the level of the allowance for loan losses and the related provision for loan losses.  Although, based upon our internal analysis, and in our judgment, we believe that we have provided an adequate allowance for loan losses, there can be no assurance that our analysis has properly identified all of the probable losses in our loan portfolio.  As a result, we could record future provisions for loan losses that may be significantly different than the levels that we recorded in the third quarter of 2013.

Assets acquired through or instead of foreclosure, primarily other real estate owned, are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis.  New real estate appraisals are generally obtained at the time of foreclosure and are used to establish fair value.  If fair value declines, a valuation allowance is recorded through expense.  Estimating the initial and ongoing fair value of these properties involves a number of factors and judgments including holding time, costs to complete, holding costs, discount rate, absorption and other factors.

Loss contingencies are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.  This, too, is an accounting area that involves significant judgment.  Although, based upon our judgment, internal analysis, and consultations with legal counsel we believe that we have properly accounted for loss contingencies, future changes in the status of such contingencies could result in a significant change in the level of contingent liabilities and a related impact to operating earnings.

Our accounting for income taxes involves the valuation of deferred tax assets and liabilities primarily associated with differences in the timing of the recognition of revenues and expenses for financial reporting and tax purposes.  At September 30, 2013, we had gross deferred tax assets of $19.1 million and gross deferred tax liabilities of $2.3 million resulting in a net deferred tax asset of $16.8 million.  Accounting standards require that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a "more likely than not" standard.  Since mid 2009, we had maintained a full valuation allowance on our net deferred tax asset.  At December 31, 2012, we considered all reasonably available positive and negative evidence and determined that with completing our eleventh consecutive profitable quarter, continued significant improvement in asset quality measures for the third straight year, the termination of Bank’s Consent Order in the first quarter of 2012, the termination of the Company’s Written Agreement in the fourth quarter of 2012 and our moving to a cumulative income position in the most recent three year period, that it was “more likely than not” that we will be able to realize our deferred tax assets and, as such, the full $18.9 million valuation allowance was reversed as of December 31, 2012.  With the positive results in the first, second and third quarters of 2013 and the release of the Bank’s MOU in the second quarter of 2013, we concluded at September 30, 2013 that no valuation allowance on our net deferred tax asset was required.  Changes in tax laws, changes in tax rates, changes in ownership and our future level of earnings can impact the ultimate realization of our net deferred tax asset.
- 51 -

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of our transactions are denominated in U.S. dollars with no specific foreign exchange exposure. Macatawa Bank has only limited agricultural-related loan assets, and therefore has no significant exposure to changes in commodity prices.

Our balance sheet has sensitivity, in various categories of assets and liabilities, to changes in prevailing rates in the U.S. for prime rate, mortgage rates, U.S. Treasury rates and various money market indexes. Our asset/liability management process aids us in providing liquidity while maintaining a balance between interest earning assets and interest bearing liabilities.

We utilize a simulation model as our primary tool to assess the direction and magnitude of variations in net interest income and the economic value of equity (“EVE”) resulting from potential changes in market interest rates. Key assumptions in the model include contractual cash flows and maturities of interest-sensitive assets and interest-sensitive liabilities, prepayment speeds on certain assets, and changes in market conditions impacting loan and deposit pricing. We also include pricing floors on discretionary priced liability products which limit how low various checking and savings products could go under declining interest rates. These floors reflect our pricing philosophy in response to changing interest rates.

We forecast the next twelve months of net interest income under an assumed environment of gradual changes in market interest rates under various scenarios. The resulting change in net interest income is an indication of the sensitivity of our earnings to directional changes in market interest rates. The simulation also measures the change in EVE, or the net present value of our assets and liabilities, under an immediate shift, or shock, in interest rates under various scenarios, as calculated by discounting the estimated future cash flows using market-based discount rates.

The following table shows the impact of changes in interest rates on net interest income over the next twelve months and EVE based on our balance sheet as of September 30, 2013 (dollars in thousands).
 
 
Economic
 
 
 
 
 
Value of
 
Percent
 
Net Interest
 
Percent
 
Interest Rate Scenario
Equity
 
Change
 
Income
 
Change
 
Interest rates up 200 basis points
 
$
138,276
     
(3.43
)%
 
$
43,314
     
5.06
%
Interest rates up 100 basis points
   
142,289
     
(0.63
)
   
42,309
     
2.62
 
No change
   
143,193
     
---
     
41,228
     
---
 
Interest rates down 100 basis points
   
145,928
     
1.91
     
40,929
     
(0.73
)
Interest rates down 200 basis points
   
146,519
     
2.32
     
40,742
     
(1.18
)

If interest rates were to increase, this analysis suggests that we are positioned for an improvement in net interest income over the next twelve months.

We also forecast the impact of immediate and parallel interest rate shocks on net interest income under various scenarios to measure the sensitivity of our earnings under extreme conditions.

The quarterly simulation analysis is monitored against acceptable interest rate risk parameters by the Asset/Liability Committee and reported to the Board of Directors.

In addition to changes in interest rates, the level of future net interest income is also dependent on a number of other variables, including: the growth, composition and absolute levels of loans, deposits, and other earning assets and interest-bearing liabilities; economic and competitive conditions; potential changes in lending, investing and deposit gathering strategies; and client preferences.

- 52 -

Item 4: CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), as of September 30, 2013, the end of the period covered by this report.

In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as the Company's are designed to do, and management necessarily was required to apply its judgment in evaluating whether the benefits of the controls and procedures that the Company adopts outweigh their costs.

Our CEO and CFO, after evaluating the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report, have concluded that the Company's disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms.

(b) Changes in Internal Controls. During the period covered by this report, there have been no changes in the Company’s internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

- 53 -

PART II – OTHER INFORMATION

Item 6. Exhibits.

3.1
 
Restated Articles of Incorporation. Previously filed with the Commission on April 28, 2011 in Macatawa Bank Corporation’s Quarterly Report on Form 10-Q, Exhibit 3.1. Here incorporated by reference.
 
 
 
3.2
 
Bylaws. Previously filed with the Commission on November 24, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 3.1. Here incorporated by reference.
 
 
 
3.3
 
Certificate of Designation of Series A Noncumulative Convertible Perpetual Preferred Stock. Previously filed with the Commission on November 5, 2008 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.
 
 
 
3.4
 
Certificate of Designation of Series B Noncumulative Convertible Perpetual Preferred Stock. Previously filed with the Commission on July 2, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.
 
 
 
4.1
 
Restated Articles of Incorporation. Exhibit 3.1 is here incorporated by reference.
 
 
 
4.2
 
Bylaws. Exhibit 3.2 is here incorporated by reference.
 
 
 
4.3
 
Certificate of Designation of Series A Noncumulative Convertible Perpetual Preferred Stock. Exhibit 3.3 is here incorporated by reference.
 
 
 
4.4
 
Certificate of Designation of Series B Noncumulative Convertible Perpetual Preferred Stock. Exhibit 3.4 is here incorporated by reference.
 
 
 
4.5
 
First Amended Settlement and Release and Stock and Warrant Issuance Agreement dated January 30, 2009. Previously filed with the Commission on January 30, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 10.1. Here incorporated by reference.
 
 
 
4.6
 
Second Amended Settlement and Release and Stock and Warrant Issuance Agreement dated April 30, 2009. Previously filed with the Commission on May 8, 2009 in Macatawa Bank Corporation's Quarterly Report on Form 10-Q, Exhibit 10.1. Here incorporated by reference.
 
 
 
4.7
 
Warrant Agreement between Macatawa Bank Corporation and Registrar and Transfer Company dated June 16, 2009. Previously filed with the Commission on June 19, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.
 
 
 
4.8
 
Warrant Agreement Addendum between Macatawa Bank Corporation and Registrar and Transfer Company dated July 27, 2009. Previously filed with the Commission on July 31, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.
 
 
 
4.9
 
Form of Warrant Certificate (first series). Previously filed with the Commission on June 19, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.2. Here incorporated by reference.
 
 
 
4.10
 
Form of Warrant Certificate (second series). Previously filed with the Commission on July 31, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.2. Here incorporated by reference.

- 54 -

4.11
 
Form of 11% Subordinated Note Due 2017. Previously filed with the Commission on July 2, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.2. Here incorporated by reference.
 
 
 
4.12
 
Long-Term Debt. The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets. The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the Commission upon request.
 
 
 
 
Certification of Chief Executive Officer.
 
 
 
 
Certification of Chief Financial Officer.
 
 
 
 
Certification pursuant to 18 U.S.C. Section 1350.
 
 
 
101.INS
 
XBRL Instance Document
 
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document

- 55 -

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
MACATAWA BANK CORPORATION
 
 
 
/s/ Ronald L. Haan
 
Ronald L. Haan
 
Chief Executive Officer
 
(Principal Executive Officer)
 
 
 
/s/ Jon W. Swets
 
Jon W. Swets
 
Senior Vice President and
 
Chief Financial Officer
 
(Principal Financial and Accounting Officer)
 
 
Dated: October 24, 2013
 
 
- 56 -