10-K 1 d508894d10k.htm FORM 10-K Form 10-K
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Washington, D.C. 20549






(Mark One)


For the fiscal year ended December 31, 2012

Commission file number 0-49814




(Exact name of registrant as specified in its charter)




Maryland   04-3627031

(State or other jurisdiction of

incorporation or organization)


(I.R.S. Employer

Identification No.)


375 North Willowbrook Road, Coldwater, Michigan   49036
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (517) 278-4566

Securities Registered Pursuant to Section 12(b) of the Act:

Common Stock, par value $.01 per share registered on OTCQB



Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x.

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of Section 15(d) of the Exchange Act.    Yes  ¨    No  x.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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  ¨

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  ¨

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large Accelerated Filer   ¨    Accelerated Filer   ¨
Non-Accelerated Filer   ¨      Smaller reporting company   x

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

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant, based on the average of bid and ask price market price of such stock as of June 30, 2012 was approximately $1.741 million as reported on the OTCQB. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the issuer that such person is an affiliate of the issuer.)

As of February 22, 2013, the registrant had 2,049,485 shares of common stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE PART III of Form 10-K – Portions of the Registrant’s Proxy Statement for the Annual Meeting of Stockholders.




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ITEM 1. Business


Monarch Community Bancorp, Inc. (“Company”) was incorporated in March 2002 under Maryland law to hold all of the common stock of Monarch Community Bank (“Monarch” or the “Bank”), formerly known as Branch County Federal Savings and Loan Association. The Bank converted to a stock savings institution effective August 29, 2002. In connection with the conversion, the Company sold 2,314,375 shares of its common stock in a subscription offering.

On April 15, 2004, the Company completed its acquisition of MSB Financial, Inc., parent company of Marshall Savings Bank. Accordingly, MSB Financial was merged with and into Monarch Community Bancorp, Inc. On June 7, 2004, Marshall Savings Bank was merged with and into Monarch Community Bank. The Company issued a total of 310,951 shares of its common stock and paid cash of $19.7 million to former MSB Financial stockholders. The cash paid in the transaction came from the Company’s existing liquidity. The acquisition was accounted for using the purchase method of accounting, and accordingly, the purchase price was allocated to the assets purchased and the liabilities assumed based upon the estimated fair values at the date of acquisition. The purchase accounting fair value adjustments are being amortized under various methods and over the lives of the corresponding assets and liabilities. Goodwill recorded for the acquisition amounted to $9.6 million and was not amortized but evaluated for impairment at least annually. It was determined to be impaired and written off in 2009. A core deposit intangible of $2.1 million was recorded as part of the acquisition and is being amortized on an accelerated basis over a period of 9.5 years.

Monarch Community Bank provides a broad range of banking services to its primary market area of Branch, Calhoun and Hillsdale counties, Michigan. The Bank owns 100% ownership of First Insurance Agency. First Insurance Agency is a licensed insurance agency established to allow for the receipt of fees on insurance services provided to the Bank’s customers.

On June 3, 2006, the Company completed the conversion of the Bank from a federally chartered stock savings institution to a Michigan state chartered commercial bank. As a result of the conversion, the Company became a federal bank holding company regulated by the Board of Governors of the Federal Reserve. The Bank is regulated by the Michigan Office of Financial and Insurance Regulation (“OFIR”) and the Federal Deposit Insurance Corporation (“FDIC”). Prior to the conversion, both the Company and the Bank had been regulated by the federal Office of Thrift Supervision. The Bank’s deposits continue to be insured to the maximum extent allowed by the FDIC. The Bank has a website at http://www.monarchcb.com. References in this Form 10-K to “we”, “us”, and “our” refer to the Company and/or the Bank as the context requires. Our common stock trades on the OTCQB under the symbol “MCBF.”

Our principal business consists of attracting retail deposits from the general public and investing those funds primarily in permanent loans secured by first mortgages on owner-occupied, one-to-four family residences, loans secured by commercial and multi-family real estate, commercial business loans and construction loans secured primarily by residential real estate. We also originate home equity loans and a variety of consumer loans. Our originations of consumer loans have steadily declined over the last five years.

Our revenues are derived principally from interest on loans, investment securities and overnight deposits, as well as from sales of loans and fees and charges on deposit accounts.



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We offer a variety of deposit accounts having a wide range of interest rates and terms, which generally include passbook and statement savings accounts, money market deposit accounts, interest bearing and non-interest bearing checking accounts and certificates of deposit with varied terms ranging from six months to 60 months. We solicit deposits in our market area and utilize brokered deposits.

At December 31, 2012, we had assets of $190.3 million, including net loans of $128 million, deposits of $169.5 million and stockholders’ equity of $10.5 million.

Forward-Looking Statements

This document, including information incorporated by reference, future filings by Monarch Community Bancorp on Form 10-Q and Form 8-K and future oral and written statements by Monarch Community Bancorp and its management may contain forward-looking statements which are based on assumptions and describe future plans, strategies and expectations of Monarch Community Bancorp and Monarch. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar words. Our ability to predict results or the actual effect of future plans or strategies is uncertain and we disclaim any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information or otherwise. Factors which could have a material adverse effect on our operations include, but are not limited to, changes in interest rates, changes in the relative difference between short and long-term interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, including levels of non-performing assets, demand for loan products, deposit flows, competition, demand for financial services in our market area, our operating costs and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and you should not rely too much on these statements.

Market Area

Headquartered in Coldwater, Michigan, our geographic market area for loans and deposits is principally Branch, Calhoun and Hillsdale counties. As of June 30, 2012, we had an 16.09% market share of FDIC-insured deposits in Branch County, a 7.4% market share of FDIC-insured deposits in Calhoun County and a 4.2% market share of FDIC-insured deposits in Hillsdale County, ranking us third, seventh and sixth, respectively, in those counties among all insured depository institutions.

The local economy is based primarily on manufacturing and agriculture. Most of the job growth, particularly in Hillsdale County, has been in automobile products-related manufacturing. Median household income and per capita income for our primary market are below statewide averages, reflecting the rural economy and limited economic growth opportunities.

Lending Activities

General. At December 31, 2012, our net loan portfolio totaled $128 million, which constituted 67% of our total assets.

Our mortgage loans carry either a fixed or an adjustable rate of interest. Mortgage loans are generally long-term and amortize on a monthly basis with principal and interest due each month. All loans must be presented for approval at Management Loan Committee, which is comprised of several senior managers. Loans in which the total credit relationship with the borrower, directly and indirectly, exceeds $500,000 and up to $1.5 million also must be approved by the Board of Directors’ Loan Committee. Loans in which the total credit relationship with the borrower, directly and indirectly, exceeds $1.5 million also must be approved by the Board of Directors. Our legal lending limit is summarized in the Loans to One Borrower paragraph of the Regulation and Supervision section of this document.



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Loan Portfolio Composition. The following table presents information concerning the composition of our loan portfolio as of the dates indicated.


    December 31, 2012     December 31, 2011     December 31, 2010     December 31, 2009     December 31, 2008  
    Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent  
    (Dollars in thousands)                                

Real Estate Loans:


One-to four-family

  $ 69,043        52.60   $ 78,500        51.16   $ 93,294        49.10   $ 108,354        47.70   $ 124,855        49.80


    1,183        0.90        765        0.50        4,783        2.52        5,421        2.39        5,728        2.26   


    45,982        35.03        54,308        35.39        62,998        33.15        72,689        32.00        75,730        30.19   

Construction or development

    1,416        1.08        1,639        1.07        3,873        2.04        9,528        4.20        9,499        3.79   































Total real estate loans

    117,624        89.61        135,212        88.12        164,948        86.79        195,992        86.29        215,812        86.04   

Other loans:


Consumer loans:


Home equity

    8,058        6.14        10,499        6.84        14,814        7.80        18,174        8.00        20,677        8.24   


    1,885        1.43        2,516        1.64        3,403        1.79        4,706        2.07        5,737        2.29   































Total consumer loans

    9,943        7.57        13,015        8.48        18,217        9.59        22,880        10.07        26,414        10.53   

Commercial Business Loans

    3,709        2.82        5,212        3.40        6,882        3.62        8,266        3.64        8,609        3.43   































Total other loans

    13,652        10.39        18,227        11.88        25,099        13.21        31,146        13.71        35,023        13.96   































Total Loans

    131,276        100.00     153,439        100.00     190,047        100.00     227,138        100.00     250,835        100.00


















Allowance for loan losses

    3,035          4,656          6,850          5,783          2,719     

Net deferred loan fees

    241          288          429          480          574     










Loans in process

    —            —            —            —            —       
















Total Loans, net

  $ 128,000        $ 148,495        $ 182,768        $ 220,875        $ 247,542     


















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The following table shows the composition of our loan portfolio by fixed and adjustable-rate at the dates indicated.


     December 31, 2012     December 31, 2011  
     Amount      Percent     Amount      Percent  
     (Dollars in thousands)  

Fixed-Rate Loans


Real Estate Loans:


One-to-four family

   $ 49,507         37.7   $ 58,256         38.0


     1,183         0.9     747         0.5


     44,256         33.7     40,151         26.2

Construction or development

     1,416         1.1     686         0.4













Total real estate loans

     96,362         73.4     99,840         65.1


     5,761         4.4     8,102         5.3

Commercial Business

     3,044         2.3     4,465         2.9













Total fixed-rate loans

     105,167         80.1     112,407         73.3

Adjustable-Rate Loans


Real Estate Loans:


One-to-four family

   $ 19,536         14.9   $ 20,244         13.2


     —           0.0     18         0.0


     1,726         1.3     14,157         9.2

Construction or development

     —           0.0     953         0.6













Total real estate loans

     21,262         16.2     35,372         23.0


     4,182         3.2     4,913         3.2

Commercial Business

     665         0.5     747         0.5













Total adjustable-rate loans

     26,109         19.9     41,032         17.4













Total loans

     131,276         100     153,439         100



Allowance for loan losses

     3,035           4,656      

Net deferred loan fees

     241           288      

Loans in process

     —             —        







Total Loans, net

   $ 128,000         $ 148,495      









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The following table illustrates the contractual maturity of our loan portfolio at December 31, 2012. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The table does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.


    Real Estate                                      
                Multi-family and     Construction or                                      
    One-to-Four Family     Commercial     Development     Consumer     Commercial Business     Total  
          Weighted           Weighted           Weighted           Weighted           Weighted           Weighted  
          Average           Average           Average           Average           Average           Average  
    Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate     Amount     Rate  
    (Dollars in Thousands)  

Due to Mature:


One year or less (1)

    459        6.95     9,287        6.05     80        6.25     1,697        6.38     163        5.76     11,686        6.13

After one year through five years

    20,321        6.30     29,242        5.46     460        6.20     3,470        6.36     3,426        7.30     56,919        5.93

After five years

    48,263        5.74     8,636        4.90     876        5.44     4,776        4.74     120        5.75     62,671        5.54
    69,043          47,165          1,416          9,943          3,709          131,276     



Includes demand loans.

The total amount of loans due after December 31, 2013 which have predetermined interest rates is $100 million while the total amount of loans due after such date which have floating or adjustable rates is $19.6 million.



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One-to-Four Family Residential Real Estate Lending. We have focused our lending efforts primarily on the origination of loans secured by first mortgages on owner-occupied, one-to-four family residences in our market area. At December 31, 2012, one-to-four family residential mortgage loans totaled $69 million, or 52.6% of our gross loan portfolio.

We have originated sub-prime residential mortgage loans since 1985. However in more recent years we have moved away from this type of lending due to the higher risk associated with it. Our definition of sub-prime lending is substantially similar to regulatory guidelines. We review a borrower’s credit score, debt-to-income ratio and the loan-to-value ratio of the collateral in determining whether a loan is sub-prime. We utilize a loan risk grading system for all one-to-four family residential loans. The risk grading system provides that all loans with a credit score of less than 660 shall be considered for potential sub-prime classification. For a loan with a credit score between 600 and 660, loan-to-value ratio, debt-to-income ratio and the borrower’s history with the Bank will determine whether or not the loan is classified as sub-prime.

At December 31, 2012, $14.4 million, or 20.8% of our residential mortgage loans were classified as sub-prime loans as compared to $15.2 million, or 19.4% at December 31, 2011. The decrease is primarily due to normal repayments. We charge higher interest rates on our sub-prime residential mortgage loans to attempt to compensate for the increased risk in these loans. Sub-prime lending typically entails a higher risk of delinquency, foreclosure and ultimate loss than residential loans made to more creditworthy borrowers. Delinquencies, foreclosure and losses generally increase during economic slowdowns or recessions as experienced in recent history. During 2012, $192,000, or 33.1%, of our total net charge-offs of $579,000 were due to sub-prime loans as compared to $469,000, or 16.0% of our total net charge-offs of $2.9 million for 2011. During 2012, we have made significant efforts in assisting borrowers who are experiencing financial difficulty. See “Asset Quality.”

We generally underwrite our one-to-four family loans based on the applicant’s employment and credit history and the appraised value of the subject property. Presently, we lend up to 80% of the lesser of the appraised value or purchase price for one-to-four family residential loans. Properties secured by one-to-four family loans are appraised by licensed appraisers. We obtain title insurance and require our borrowers to obtain hazard insurance and flood insurance, if necessary, in an amount not less than the value of the property improvements.

We currently originate one-to-four family mortgage loans on either a fixed rate or adjustable rate basis, as consumer demand dictates. Our pricing strategy for mortgage loans includes setting interest rates that are competitive with secondary market requirements and other local financial institutions, and consistent with our asset/liability strategies. Our pricing for sub-prime loans is higher, as we attempt to offset the increased risks and costs involved in dealing with a greater percentage of delinquencies and foreclosures.

Adjustable-rate mortgages, or ARM loans, are offered with either a one-year, three-year, five-year or seven-year term to the initial repricing date. After the initial period, the interest rate for each ARM loan adjusts annually for the remaining term of the loan. During 2012 and 2011, we originated no one to four family ARM loans. During the years ended December 31, 2012 and 2011, we originated $58.1 million and $36.0 million of one-to-four family fixed-rate mortgage loans, respectively.

Fixed-rate loans secured by one-to-four family residences have contractual maturities of up to 30 years, and are generally fully amortizing, with payments due monthly. We also offer balloon loans with one, three, five and seven year maturities. These loans normally remain outstanding, however, for a substantially shorter period of time because of refinancing and other prepayments. A significant change in the current level of interest rates could alter the average life of a residential loan in our portfolio considerably. Our one-to-four family loans are generally not assumable, do not contain prepayment penalties and do not permit negative amortization of principal. Most are written using secondary market underwriting guidelines, although we retain in our portfolio those loans which do not qualify for sale in the secondary market. Our real estate loans generally contain a “due on sale” clause allowing us to declare the unpaid principal balance due and payable upon the sale of the security property.



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Our one-to-four family residential ARM loans are fully amortizing loans with contractual maturities of up to 30 years, with payments due monthly. Our ARM loans generally provide for a maximum 2% annual adjustment and 6% lifetime adjustment to the initial rate. As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as is our cost of funds.

In order to remain competitive in our market area, we may originate ARM loans at initial rates below the fully indexed rate, although that has not been a strategy in recent years.

ARM loans generally pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower’s payment rises, increasing the potential for default. In past periods of rising interest rates, we have not experienced difficulty with the payment history for these loans. See “- Asset Quality — Non-performing Assets and Classified Assets.”

Multi-family and Commercial Real Estate Lending. We offer a variety of multi-family and commercial real estate loans. These loans are secured primarily by residential rental properties, commercial properties, retail establishments, churches and small office buildings located in our market area. At December 31, 2012, multi-family and commercial real estate loans totaled $47.2 million or 35.9% of our gross loan portfolio.

Our loans secured by multi-family and commercial real estate are originated with either a fixed or variable interest rate. The interest rate on variable-rate loans is based on the Wall Street Journal prime rate plus or minus a margin, generally determined through negotiation with the borrower. Loan-to-value ratios on our multi-family and commercial real estate loans typically do not exceed 80% of the appraised value of the property securing the loan. These loans which are typically balloon loans, in general require monthly payments, may not be fully amortizing and have maximum maturities of 25 years.

Loans secured by multi-family and commercial real estate are underwritten based on the income producing potential of the property and the financial strength of the borrower. We generally require personal guarantees of the principals of the borrower in addition to the security property as collateral for these loans. When legally permitted, we require an assignment of rents or leases in order to be assured that the cash flow from the project will be used to repay the debt. Appraisals on properties securing multi-family and commercial real estate loans are generally performed by independent state licensed fee appraisers approved by the Board of Directors. See “- Loan Originations, Purchases, Sales and Repayments.”

We do not generally maintain an insurance escrow account for loans secured by multi-family and commercial real estate, although we may maintain a tax escrow account for these loans. In order to monitor the adequacy of cash flows on income-producing properties, the borrower is requested or required to provide periodic financial information.

Loans secured by multi-family and commercial real estate properties are generally larger and involve a greater degree of credit risk than one-to-four family residential mortgage loans. These loans typically involve large balances to single borrowers or groups of related borrowers. Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation or management of the properties, repayment may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired. See “- Asset Quality — Non-performing Loans.”



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Construction and Land Development Lending. We make construction loans to builders and to individuals for the construction of their residences as well as to businesses and individuals for commercial real estate construction projects. At December 31, 2012 we had $1.4 million in construction and land development loans outstanding, representing 1% of our gross loan portfolio.

Construction and land development loans are obtained through continued business with builders who have previously borrowed from us, from walk-in customers and through referrals from realtors and other customers. The application process includes submission of plans, specifications and costs of the project to be constructed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of current appraised value and/or the cost of construction, including the land and the building. We conduct regular inspections of the construction project being financed. During the construction phase, the borrower generally pays interest only on a monthly basis. Loan-to-value ratios on our construction and development loans typically do not exceed 80% of the appraised value of the project on an as completed basis, although the Board of Directors has made limited exceptions to this policy where special circumstances exist.

Because of the uncertainties inherent in estimating construction and development costs and the market for the project upon completion, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project. These loans also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans.

Consumer and Other Lending. Consumer loans generally have shorter terms to maturity, which reduces our exposure to changes in interest rates, and carry higher rates of interest than do one-to-four family residential mortgage loans. In addition, management believes that offering consumer loan products helps to expand and create stronger ties to our existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities. At December 31, 2012, our consumer loan portfolio totaled $9.9 million, or 7.6% of our gross loan portfolio. We offer a variety of secured consumer loans, including home equity loans and lines of credit, auto loans, manufactured housing loans and loans secured by savings deposits; however the majority of new originations are home equity loans and lines of credit. We also offer a limited amount of unsecured loans including home improvement loans. We originate our consumer loans in our market area.

Our home equity lines of credit totaled $8.1 million, and comprised 6.1% of our gross loan portfolio at December 31, 2012. These loans may be originated in amounts, together with the amount of the existing first mortgage, of up to 90% of the value of the property securing the loan. The term to maturity on our home equity lines of credit ranges from 3 to 5 years for fixed rate loans and 1 to 15 for variable rate loans. No principal payments are required on most home equity lines of credit during the loan term. Other consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower.

Consumer loans may entail greater risk than do one-to-four family residential mortgage loans, particularly in the case of consumer loans which are secured by rapidly depreciable assets, such as automobiles, boats, and manufactured housing. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. As a result, consumer loan collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.



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Commercial Business Lending. At December 31, 2012, commercial business loans comprised $3.7 million, or 2.8% of our gross loan portfolio. Most of our commercial business loans have been extended to finance local businesses and include short term loans to finance machinery and equipment purchases, inventory and accounts receivable. Commercial business loans also involve the extension of revolving credit for a combination of equipment acquisitions and working capital needs.

The terms of loans extended on the security of machinery and equipment are based on the projected useful life of the machinery and equipment, generally not to exceed seven years. Operating lines of credit generally are available to borrowers for up to 12 months, and may be renewed by Monarch. We issue a few standby letters of credit which are offered at competitive rates and terms and are generally issued on a secured basis. At December 31, 2012, there were no financial standby letters of credit outstanding.

Our commercial business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis. Based on this underwriting information we assign a risk rating which assists management in evaluating the quality of the loan portfolio. We generally obtain personal guarantees on our commercial business loans. Nonetheless, these loans are believed to carry higher credit risk than more traditional single family loans.

Unlike residential mortgage loans, commercial business loans are typically made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself (which, in turn, is often dependent in part upon general economic conditions). Our commercial business loans are usually, but not always, secured by business assets. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

Loan Originations, Purchases, Sales and Repayments. We originate loans through referrals from real estate brokers and builders and other customers, our marketing efforts, and our existing and walk-in customers. While we originate adjustable-rate and fixed-rate loans, our ability to originate loans is dependent upon customer demand for loans in our market area. Demand is affected by local competition and the interest rate environment.

During the last several years, due to low market interest rates, our dollar volume of fixed-rate, one-to-four family loans has substantially exceeded the dollar volume of the same type of adjustable-rate loans. Adjustable-rate loan originations as a percentage of total originations were 0% in 2012 and 2011. We sell a significant portion of the conforming, fixed-rate, one-to-four family residential loans we originate, primarily those with lower interest rates. We keep the sub-prime residential real estate loans we originate. We may purchase residential loans and commercial real estate loans from time to time.

In periods of economic uncertainty, the ability of financial institutions, including us, to originate or purchase large dollar volumes of real estate loans may be substantially reduced or restricted, with a resultant decrease in income.



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The following table shows the loan origination, sale and repayment activities of Monarch for the periods indicated.


    Years Ended  
    2012     2011  
    (Dollars in thousands)  

Originations by type:


Real Estate:


One-to-four family

  $ 58,054      $ 37,289   


    600        —     


    10,551        4,104   

Construction or development

    159        603   







Total real estate loans

    69,364        41,996   

Consumer Loans:


Home Equity

    653        722   


    —          57   

Commercial business

    889        422   







Total loans originated

    70,906        43,197   

Sales and Repayments:


One-to-four family loans sold

    53,340        32,397   

Commercial real estate loans sold

    —          —     

Principal repayments

    39,729        41,237   







Total reductions

    93,069        73,634   

Increase (decrease) in other items, net

    (1,668     3,836   







Net decrease

  $ (20,495   $ (34,273







Asset Quality

When a borrower fails to make a payment on a residential mortgage loan on or before the due date, a late notice is mailed 10 to 15 days after the due date. All delinquent accounts are reviewed by a collector, who attempts to cure the delinquency by contacting the borrower once the loan is 30 days past due. Additionally, each week the collections department contacts the borrower to determine the reason for the delinquency and to urge the borrower to bring the loan current. Once the loan becomes 30 days delinquent, a letter is sent to the borrower requesting the borrower to bring the loan current, or, if that is not possible, to fill out and return a financial information update form. If the form is returned, the senior collector determines if the borrower exhibits an ability to repay, and, if so, brings the file to the Delinquency Committee for a decision whether to forebear collection action to allow the borrower to demonstrate the ability to make timely payments and/or establish an acceptable repayment plan to bring the loan current. If the borrower makes timely payments for a period of at least six months but does not appear to have the ability to bring the loan current, the file is given to a loan officer to obtain a new loan application from the borrower for the purpose of rewriting the loan in accordance with established loan policy. If the financial information update is not returned, or if the senior collector determines that the borrower no longer has the ability to repay the loan, or the Delinquency Committee declines to forbear collection activity, then when the loan becomes 45 to 60 days delinquent, the file is reviewed by the Delinquency Committee and the foreclosure process is begun by the sending of a notice of intent to foreclose. If during a period of forbearance the borrower fails to make timely payments, the Delinquency Committee reviews the loan and the foreclosure process commences unless extenuating circumstances exist. The notice of intent to foreclose allows the borrower up to 30 days to bring the account current. All loans over 60 days delinquent are handled by the senior collections officer until the delinquency is resolved or foreclosure occurs.



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For consumer loans a similar collection process is followed. Follow-up contacts are generally on an accelerated basis compared to the mortgage loan procedure due to the nature of the collateral. Commercial loan collections are handled by our Delinquency Committee in conjunction with our Collection Department and the appropriate loan officer. The nature of these loans dictates that collection procedures are adjusted to suit each situation.

Delinquent Loans. The following tables set forth our loan delinquencies (60 days past due and over) by type, number, amount and percentage of type at the dates indicated:


     December 31, 2012  
     Loans Delinquent For:  
     60-89 Days     90 Days and Over     Total Delinquent Loans  
                   Percent of
                  Percent of

Percent of


     Number      Amount      Category     Number      Amount      Category     Number      Amount      Category  
     (Dollars in Thousands)  

Real Estate


One-to-four family

     15         855         1.24     5         316         0.46     20         1,171         1.70


     —           —           0.00     —           —           0.00     —           —           0.00


     —           —           0.00     4         1,560         3.39     4         1,560         3.39

Construction or development

     —           —           0.00     —           —           0.00     —           —           0.00




























Total real estate loans

     15         855         0.73     9         1,876         1.59     24         2,731         2.32


     1         7         0.07     1         10         0.10     2         17         0.17

Commercial Business

     —           —           0.00     1         120         3.24     1         120         3.24





























     16         862         0.66     11         2,006         1.53     27         2,868         2.18





























     December 31, 2011  
     Loans Delinquent For:  
     60-89 Days     90 Days and Over     Total Delinquent Loans  
                   Percent of
                  Percent of

Percent of


     Number      Amount      Category     Number      Amount      Category     Number      Amount      Category  
     (Dollars in Thousands)  

Real Estate


One-to-four family

     4       $ 228         0.29     6       $ 545         0.69     10       $ 773         0.98


     —           —           0.00     —           —           0.00     —           —           0.00


     1         246         0.45     5         3,016         5.55     6         3,262         6.01

Construction or development

     —           —           0.00     —           —           0.00     —           —           0.00




























Total real estate loans

     5       $ 474         0.35     11       $ 3,561         2.63     16       $ 4,035         2.98


     —           —           0.00     —           —           0        —           —           0   

Commercial Business

     —           —           0.00     4         1,166         22.37     4         1,166         22.37


























     5       $ 474         0.31     15       $ 4,727         3.08     20       $ 5,201         3.39






























Table of Contents

Non-performing Assets. The table below sets forth the amounts and categories of the Bank’s non-performing assets. Loans are placed on non-accrual status when the loan is seriously delinquent and there is serious doubt that the Bank will collect all interest owing. Generally, all loans past due at least 90 days are placed on non-accrual status. For all years presented, the Bank had no troubled debt restructurings that involved forgiving a portion of interest or principal on any loans. Foreclosed assets include assets acquired in settlement of loans.


     December 31,  
     2012     2011     2010     2009     2008  
     (Dollars in Thousands)  

Non-accruing loans:


One-to-four family

     2,437        966        3,106        3,484        622   


     —          —          803        874        164   

Commercial real estate

     5,008        6,278        8,288        7,139        459   

Construction or development

     —          —          —          2,507        1,298   


     9        —          253        —          28   

Commercial business

     316        1,521        1,625        1,566        —     

















     7,770        8,765        14,075        15,570        2,571   

Accruing loans delinquent 90 days or more:


One-to-four family

     —          —          —          —          —     


     —          —          —          —          —     

Commercial real estate

     —          —          —          —          —     

Construction or development

     —          —          —          —          —     


     —          —          —          —          —     

Commercial business

     —          —          —          —          —     

















     —          —          —          —          —     

Foreclosed assets:


One-to-four family (1)

     882        2,653        1,198        2,577        1,669   


     —          54        292        122        —     

Commercial real estate

     345        1,526        908        140        407   

Construction or development

     17        —          574        —          —     


     —          125        —          —          —     

Commercial business

     —          75        —          —          —     

















     1,244        4,433        2,972        2,839        2,076   
















Total non-performing assets

   $ 9,014      $ 13,198      $ 17,047      $ 18,409      $ 4,647   
















Total as a percentage of total assets

     4.74     6.34     6.64     6.50     1.59

















(1) Includes $434,000, $1.9 million, $1.4 million, $1.1 million and $1.3 million in real estate in judgment and subject to redemption at December 31, 2012, 2011, 2010, 2009 and 2008 respectively.

For the years ended December 31, 2012 and 2011, respectively, there was $397,000 and $621,000 of gross interest income which would have been recorded had non-accruing loans been current in accordance with their original terms.



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Classified Assets. Federal regulations provide for the classification of loans, foreclosed and repossessed assets and other assets, such as debt and equity securities considered by the FDIC and OFIR to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.

When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management and approved by the board of directors. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the FDIC and OFIR, which may order the establishment of additional general or specific loss allowances.

In accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management’s review of our assets, at December 31, 2012, we had classified $18.2 million of our assets as substandard, none as doubtful and none as loss. The total amount classified as substandard and doubtful represented 175% of the Bank’s equity capital and 9.5% of the Bank’s assets at December 31, 2012. The allowance for loan losses at December 31, 2012 includes $133,000 related to substandard loans and $0 related to doubtful loans. At December 31, 2012, $18.2 million and $0 of substandard and doubtful assets, respectively, have been included in the table of non-performing assets. See “- Asset Quality—Delinquent Loans.”

Provision for Loan Losses. We recorded a provision for loan losses totaling a negative $1.0 million for the year ended December 31, 2012 compared to $733,000 recorded for the year ended December 31, 2011. The provision for loan losses is charged to income to establish the allowance for loan losses to cover all known and inherent losses in the loan portfolio that are both probable and reasonable to estimate based on the factors discussed below under “Allowance for Loan Losses.” See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Comparison of Operating Results for the Years Ended December 31, 2012 and 2011—Provision for Loan Losses” for a discussion of the reasons for the change in our loan loss provision.

Allowance for Loan Losses. The allowance is based on regular, quarterly assessments of the estimated losses inherent in the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance and specific allowances for identified problem loans and portfolio segments. In addition, the allowance incorporates the results of measuring impaired loans.

The formula allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of these loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based both on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date.



Table of Contents

The appropriateness of the allowance is reviewed by management based upon our evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in delinquencies, nonperforming loans and foreclosed assets expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectability of the loan.

Senior management reviews these conditions quarterly. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of this condition may be reflected as a specific allowance applicable to this credit or portfolio segment.

The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology as described permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.

Assessing the adequacy of the allowance for loan losses is inherently subjective as it requires making material estimates, including the net realizable value of collateral expected to be received on impaired loans that may be susceptible to significant change. In the opinion of management, the allowance, when taken as a whole, covers all known and inherent losses in the loan portfolio that are both probable and reasonable to estimate.



Table of Contents

The following table summarizes activity in the allowance for loan losses for the years ending (000s omitted):


     December 31,  
     2012     2011     2010     2009     2008  

Balance at beginning of year

   $ 4,656      $ 6,850      $ 5,783      $ 2,719      $ 1,824   



One-to-four family

     1,120        2,116        3,901        2,288        879   


     —          286        372        10        —     

Commercial real estate

     579        590        4,801        4,299        321   

Construction or development

     6        3        1,319        3,075        50   


     345        441        389        533        532   

Commercial business

     22        81        110        352        239   

















     2,072        3,517        10,892        10,557        2,021   



One-to-four family

     23        120        62        20        4   


     1        4        32        1        —     

Commercial real estate

     1,241        235        9        14        2   

Construction or development

     —          —          36        —          —     


     221        196        213        215        198   

Commercial business

     7        35        5        22        —     

















     1,493        590        357        272        204   
















Net charge-offs:

     579        2,927        10,535        10,285        1,817   

Allowance acquired in acquisition

     —          —          —          —          —     

Additions charged to operations

     (1,042     733        11,602        13,349        2,712   

Provision recovered from operations

     —          —          —          —          —     
















Balance at end of year

   $ 3,035      $ 4,656      $ 6,850      $ 5,783      $ 2,719   
















Ratio of net charge-offs during the year to average loans outstanding during the year

     0.40     1.70     4.91     4.24     0.75
















Allowance as a percentage of non-performing loans

     39.06     53.12     48.67     37.14     105.76
















Allowance as a percentage of total loans (end of year)

     2.31     3.03     3.60     2.55     1.08


















Table of Contents

The distribution of our allowance for losses on loans at the dates indicated is summarized as follows:


December 31,

     2012     2011     2010  
     Amount of      Percentage     Amount of      Percentage     Amount of      Percentage  
     Loan Loss      of     Loan Loss      of     Loan Loss      of  
     Allowance      Allowance     Allowance      Allowance     Allowance      Allowance  

One-to-four family

   $ 1,965         64.7   $ 2,944         63.2   $ 3,953         57.7

Multi-family and non-residential real estate

     818         27.0     1,307         28.1     2,084         30.4

Construction or development

     10         0.3     101         2.2     130         1.9


     230         7.6     259         5.6     503         7.3

Commercial business

     12         0.4     45         0.9     180         2.6




















   $ 3,035         100.0   $ 4,656         100.0   $ 6,850         100.0




















     2009     2008  
     Amount of      Percentage     Amount of      Percentage  
     Loan Loss      of     Loan Loss      of  
     Allowance      Allowance     Allowance      Allowance  

One-to-four family

   $ 2,576         44.5   $ 1,618         59.5

Multi-family and non-residential real estate

     903         15.6     533         19.6

Construction or development

     10         0.2     75         2.8


     393         6.8     305         11.2

Commercial business

     1,901         32.9     188         6.9














   $ 5,783         100.0   $ 2,719         100.0













Investment Activities

Commercial banks have the authority to invest in various types of liquid assets, including United States Treasury obligations and securities of various federal agencies, including callable securities, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds. Subject to various restrictions, state chartered commercial banks may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to the investments that a state chartered commercial bank is otherwise authorized to make directly.

The President/CEO has the basic responsibility for the management of our investment portfolio, under the guidance of the asset and liability management committee. The President/CEO considers various factors when making decisions, including the marketability, maturity and tax consequences of the proposed investment. The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.

The general objectives of our investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Asset and Liability Management and Market Risk.”



Table of Contents

Our investment portfolio consists of U.S. government agency securities, municipal bonds and overnight deposits. This provides us with flexibility and liquidity. We also have a significant amount of collateralized mortgage obligation securities. See Note 4 of the Notes to Consolidated Financial Statements.

The following table sets forth the composition of our securities portfolio at the dates indicated (dollars in thousands):


     December 31, 2012     December 31, 2011  
                   Percent of                   Percent of  
            Fair      Total            Fair      Total  
     Amortized      Market      Fair Market     Amortized      Market      Fair Market  
     Cost      Value      Value     Cost      Value      Value  

Available-for-sale securities:


Collateralized Mortgage obligations

   $ 6,586       $ 6,699         55.7   $ 7,732       $ 7,780         53.6

U.S. government agency obligations

     2,007         2,031         16.9     3,423         3,426         23.6

Mortgage-backed securities

     609         653         5.4     938         998         6.9

Obligations of states and political subdivisions

     660         664         5.5     326         332         2.3



















Total available-for-sale securities

   $ 9,862       $ 10,047         83.5   $ 12,419       $ 12,536         86.4



















Held-to-maturity securities:


Certificates of Deposit

   $ 1,981       $ 1,981         16.5   $ 1,981       $ 1,981         13.6



















Total investment securities

   $ 11,843       $ 12,028         100.0   $ 14,400       $ 14,517         100.0





















Table of Contents

The maturities of the investment securities portfolio, excluding FHLB stock, as of December 31, 2012 are indicated in the following table:


     Less than 1 year     1 to 5 years     5 to 10 years     Over 10 years     Total Securities  
            Wgt            Wgt            Wgt            Wgt            Wgt  
     Amortized      Ave     Amortized      Ave     Amortized      Ave     Amortized      Ave     Amortized      Ave  
     Cost      Yield     Cost      Yield     Cost      Yield     Cost      Yield     Cost      Yield  
2012    (Dollars in Thousands)  

Available-for-sale securities:


Collateralized Mortgage obligations

   $ —           0.00   $ —           0.00   $ —           0.00   $ 6,586         3.00   $ 6,586         3.00

U.S. government agency obligations

     —           0.00     2,007         1.19     —           0.00     —           0.00     2,007         1.19

Mortgage-backed securities

     —           0.00     —           0.00     —           0.00     609         5.00     609         5.00

Obligations of states and political subdivisions

     —           0.00     492         1.75     168         3.89     —           0.00     660         2.29































Total available-for-sale securities

     —           0.00     2,499         1.30     168         3.89     7,195         3.17     9,862         2.71

Held-to-maturity securities:


Certificates of Deposit

     741         1.00     1,240         1.37     —           0.00     —           0.00     1,981         1.23































Total investment securities

   $ 741         1.00   $ 3,739         1.32   $ 168         3.89   $ 7,195         3.17   $ 11,843         2.46































Sources of Funds

General. Our sources of funds are deposits, borrowings, receipt of principal and interest on loans, interest earned on or maturation of investment securities and overnight funds and funds provided from operations.

Deposits. We offer a variety of deposit accounts to both consumers and businesses having a wide range of interest rates and terms. Our deposits consist of passbook and statement savings accounts, money market deposit accounts, NOW and demand accounts and certificates of deposit. We solicit deposits in our market area and have accepted brokered deposits in the past. At December 31, 2012, we had $2.2 million of brokered deposits. In our experience brokered deposits are an attractive and stable source of funds and are necessary to supplement our local market deposit gathering. However, brokered deposits may be less stable than local deposits if deposit brokers or investors lose confidence in us or find more attractive rates at other financial institutions. We primarily rely on competitive pricing policies, marketing and customer service to attract and retain these deposits.

The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition. The variety of deposit accounts we offer has allowed us to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. We have become more susceptible to short-term fluctuations in deposit flows, as customers have become more interest rate conscious. We try to manage the pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives, subject to competitive factors. Based on our experience, we believe that our deposits are relatively stable sources of funds. Despite this stability, our ability to attract and maintain these deposits and the rates paid on them has been and will continue to be significantly affected by market conditions.



Table of Contents

The following table sets forth our deposit flows during the periods indicated:



Year Ended

December 31,

     2012     2011  
     (Dollars in Thousands)  

Opening balance

   $ 174,185      $ 206,028   

Net deposits (withdrawals)

     (6,766     (34,337

Interest credited

     2,041        2,494   







Ending balance

     169,460        174,185   







Net decrease

   $ (4,725   $ (31,843







Percent (decrease)

     -2.71     -15.46







The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by Monarch at the dates indicated:


     Year Ended December 31,  
     2012            2011         
     Amount      Percent
of Total
    Amount      Percent
of Total
     (Dollars in Thousands)     (Dollars in Thousands)  

Transaction and Savings Deposits:


Non-interest bearing accounts

     17,610         10.4   $ 19,683         11.3

Savings accounts

     23,719         14.0     20,612         11.8

Checking & NOW accounts

     26,008         15.3     24,477         14.1

Money market accounts

     34,851         20.6     34,951         20.1













Total transaction and savings

     102,188         60.3   $ 99,723         57.3




     43,066         25.4     43,851         25.2


     18,053         10.7     21,118         12.1


     6,153         3.6     9,493         5.4

Total certificates

     67,272         39.7     74,462         42.7













Total deposits

     169,460         100.0   $ 174,185         100.0















Table of Contents

The following table indicates the amount of our certificates of deposit by time remaining until maturity as of December 31, 2012:


     3 Months
or less
3 to 6
6 to 12
     (Dollars in Thousands)  

Certificates of deposit less than $100,000

   $ 5,402       $ 8,273       $ 10,169       $ 13,033       $ 36,877   

Certificates of deposit of $100,000 or more

     3,437         4,783         8,565         13,610         30,395   
















Total certificates of deposit

   $ 8,839       $ 13,056       $ 18,734       $ 26,643       $ 67,272   
















The following table shows rate and maturity information for our certificates of deposit as of December 31, 2012:


     0.00-1.99%     2.00-3.99%     4.00-5.99%     6.00-7.99%     Total      of Total  
     (Dollars in Thousands)  

Certificate accounts maturing in quarter ending:


March 31, 2013

     5,697        2,331        811        —          8,839         13.1

June 30, 2013

     7,675        5,231        150        —          13,056         19.4

September 30, 2013

     5,910        1,370        1,926        —          9,206         13.7

December 31, 2013

     7,535        179        1,814        —          9,528         14.2

March 31, 2014

     1,632        1,659        316        —          3,607         5.4

June 30, 2014

     1,780        1,467        252        —          3,499         5.2

September 30, 2014

     2,608        1,111        —          —          3,719         5.5

December 31, 2014

     2,031        333        236        —          2,600         3.9


     8,198        4,372        648        —          13,218         22.0




















   $ 43,066      $ 18,053      $ 6,153      $ —        $ 67,272         100.0



















Percent of total

     64.02     26.84     9.15     0.00     













Borrowings. Although deposits are our primary source of funds, we utilize borrowings when they are a less costly source of funds, when we desire additional capacity to fund loan demand or when they meet our asset/liability management goals. Our borrowings historically have consisted of advances from the Federal Home Loan Bank of Indianapolis and Fed funds purchased from a correspondent bank.

We may obtain advances from the Federal Home Loan Bank of Indianapolis upon the security of certain of our mortgage loans and investment securities. These advances may be made pursuant to several different credit programs, each of which has its own interest rate, range of maturities and call features. At December 31, 2012, we had $7.1 million in Federal Home Loan Bank advances outstanding. See Note 10 of the Notes to Consolidated Financial Statements for information on maturity dates and interest rates related to our Federal Home Loan Bank advances.



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The following table sets forth the maximum month-end balance and average balance of Federal Home Loan Bank advances and fed funds purchased for the periods indicated:



Year Ended

December 31,

     2012      2011  
     (Dollars in Thousands)      (Dollars in Thousands)  

Maximum Balance:


FHLB advances

   $ 20,175       $ 35,092   







Fed funds purchased

   $ —         $ —     







Average Balance:


FHLB advances

   $ 13,268       $ 27,866   







Fed funds purchased

   $ —         $ —     







The following table sets forth certain information concerning our borrowings at the dates indicated.


     December 31,  
     2012     2011  
     (Dollars in Thousands)     (Dollars in Thousands)  

FHLB advances

   $ 7,059      $ 20,175   







Fed funds purchased

   $ —        $ —     







Weighted average interest rate of FHLB advances


FHLB advances

     4.10     4.74







Fed funds purchased

     0.00     0.00








We face strong competition in originating real estate and other loans and in attracting deposits. Competition comes from a wide array of sources including but not limited to mortgage brokers, savings institutions, other commercial banks, and credit unions including non-local Internet based and telephone-based competition.


At December 31, 2012, Monarch Community Bank had a total of 106 employees. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be good.

Federal and State Taxation

Federal Taxation

General. The Company is subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to Monarch Community Bancorp. Our federal income tax returns for the past three years are open to audit by the IRS. In our opinion, any examination of still open returns would not result in a deficiency which could have a material adverse effect on our financial condition.

Method of Accounting. For federal income tax purposes, the Company reports its income and expenses on the accrual method of accounting and uses a fiscal year ending on December 31, for filing its federal income tax return.



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Bad Debt Reserves. The Bank is on the experience method to determine its bad debt deduction for tax purposes. The Bank has made a conformity election and charges off bad debts for tax purposes in accordance with regulatory guidelines.

Taxable Distributions and Recapture. Prior to the Small Business Job Protection Act, bad debt reserves created prior to the year ended December 31, 1997, were subject to recapture into taxable income should the Bank fail to meet certain thrift asset and definitional tests. New federal legislation eliminated these thrift related recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should the Bank make certain non-dividend distributions or cease to maintain a bank charter.

Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, called alternative minimum taxable income. The alternative minimum tax is payable to the extent such alternative minimum taxable income is in excess of an exemption amount. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. The Bank has not been subject to the alternative minimum tax, nor do we have any such amounts available as credits for carryover.

Corporate Dividends-Received Deduction. The Company may eliminate from its income dividends received from the Bank if it elects to file a consolidated return with the Bank. The corporate dividends-received deduction is 100% or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock ownership of the payer of the dividend. Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf. Monarch Community Bancorp has elected to file a consolidated return with the Bank.

State Taxation

The Company and the Bank are subject to the Michigan Business Tax (MBT). The MBT is a consolidated tax based on equity of the corporation. The tax returns of the Bank for the past four years are open to audit by the Michigan taxation authorities. No returns are being audited by the Michigan taxation authority at the current time. Other applicable state taxes include generally applicable sales, use, real property taxes, and personal property taxes.

Regulation and Supervision


The growth and earnings performance of the Company and the Bank can be affected not only by management decisions and general economic conditions, but also by the policies of various governmental regulatory authorities including, but not limited to, the Federal Reserve, the FDIC, the OFIR, the Internal Revenue Service and state taxing authorities. Financial institutions and their holding companies are extensively regulated under federal and state law. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty.

Federal and state laws and regulations generally applicable to financial institutions, such as the Company and the Bank, regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds and the depositors, rather than the shareholders, of financial institutions.

The Company’s common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Therefore, the Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Securities and Exchange Commission under the Exchange Act.



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The Company’s common stock held by persons who are affiliates (generally officers, directors and principal stockholders) of the Company may not be resold without registration unless sold in accordance with certain resale restrictions. If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three-month period.

The following references to material statutes and regulations affecting the Company and the Bank are brief summaries and do not purport to be complete, and are qualified in their entirety by reference to such statues and regulations. Any change in applicable law or regulations may have a material effect on the business of the Company and the Bank. See “Recent Developments” contained in “Management’s Discussion and Analysis.”

The Company

General. The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, the Company is required to register with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the “BHCA”). In accordance with Federal Reserve regulations, the Company must act as a source of financial strength to the Bank and to commit resources to support the Bank. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve and is required to file periodic reports of its operations and such additional information as the Federal Reserve may require.

Investments and Activities. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company. The Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States without regard to geographic restrictions or reciprocity requirements imposed by state law, but subject to certain conditions, including limitations on the aggregate amount of deposits that may be held by the acquiring holding company and all of its insured depository institution affiliates.

The BHCA limits the activities of a bank holding company that has not qualified as a financial holding company to banking and the management of banking organizations, and to certain non-banking activities that are deemed to be so closely related to banking or managing or controlling banks as to be a proper incident to those activities. Such non-banking activities include, among other things: operating a mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; and providing securities brokerage services for customers.

In November 1999, the Gramm-Leach-Bliley Act (the “GLB Act”) was signed into law. Under the GLB Act, a bank holding company whose subsidiary depository institutions all are well-capitalized and well-managed and who have Community Reinvestment Act ratings of at least “satisfactory” may elect to become a financial holding company. A financial holding company is permitted to engage in a broader range of activities than are permitted to bank holding companies.

Those expanded activities include any activity which the Federal Reserve (in certain instances in consultation with the Department of the Treasury) determines, by order or regulation, to be financial in nature or incidental to such financial activity, or to be complementary to a financial activity and not to pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Such expanded activities include, among others: insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability or death, or issuing annuities, and acting as principal, agent, or broker for such purposes; providing financial, investment, or economic advisory services, including advising a mutual fund; and underwriting, dealing in, or making a market in securities. The Company has not elected to be treated as a financial holding company.

Federal law also prohibits the acquisition of control of a bank holding company, such as the Company, by a person or a group of persons acting in concert, without prior notice to the Federal Reserve. Control is defined in certain cases as the acquisition of 10% of the outstanding shares of a bank holding company.



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Capital Requirements. The Federal Reserve uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guideline levels, a bank holding company may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses.

The Federal Reserve capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: a risk-based requirement expressed as a percentage of total risk-weighted assets, and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least 4% must be Tier I capital (which consists principally of shareholders’ equity). The leverage requirement consists of a minimum ratio of Tier I capital to total assets of 3% for the most highly rated bank holding companies, with minimum requirements of 4% to 5% for all others.

The risk-based and leverage standards presently used by the Federal Reserve are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier I capital less all intangible assets), well above the minimum levels.

Pursuant to its Small Bank Holding Company Policy, the Federal Reserve exempts certain bank holding companies from the capital requirements discussed above. The exemption applies only to bank holding companies with less than $500 million in consolidated assets that: (i) are not engaged in significant nonbanking activities either directly or through a nonbank subsidiary; (ii) do not conduct significant off-balance sheet activities (including securitization and asset management or administration) either directly or through a nonbank subsidiary; and (iii) do not have a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the SEC. The Company qualifies for this exemption and, thus, is required to meet applicable capital standards on a bank-only basis. However, bank holding companies with assets of less than $500 million are subject to various restrictions on debt including requirements that debt is retired within 25 years of being incurred, that the debt to equity ratio is .30 to 1 within 12 years of the incurrence of debt and that dividends generally cannot be paid if the debt to equity ratio exceeds 1 to 1.

Regulatory Agreement. On September 21, 2010, the Company entered into a written agreement with the Federal Reserve (the “Written Agreement”). Among other things, the Written Agreement requires that the Company obtain the approval of the Federal Reserve prior to paying a dividend; prohibits the Company from purchasing or redeeming any shares of its stock without the prior written approval of the Federal Reserve, and; requires the Company to submit cash flow projections for the Company to the Federal Reserve on a quarterly basis.

Dividends. As described below under the heading “Recent Developments,” as a result of the Company’s issuance of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Preferred Shares”) to the U.S. Department of the Treasury (the “Treasury”) pursuant to the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”), the Company is restricted in the payment of dividends and, without the Treasury’s consent, may not declare or pay any dividend on the Company common stock. In addition, as long as the Preferred Shares are outstanding, dividend payments are prohibited until all accrued and unpaid dividends are paid on such Preferred Shares, subject to certain limited exceptions. As discussed above, the Written Agreement also requires the Company to obtain the approval of the Federal Reserve prior to paying a dividend.



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Recent Developments. The Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008. Pursuant to EESA, the Treasury has the authority to among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Pursuant to its authority under EESA, the Treasury created the TARP CPP under which the Treasury was authorized to invest in non-voting, senior preferred stock of U.S. banks and savings associations or their holding companies.

The Company elected to participate in the CPP and on February 6, 2009, completed the sale of $6.785 million in Preferred Shares to the Treasury. The Company issued 6,785 shares of Preferred Shares, with a $1,000 per share liquidation preference, and a warrant to purchase up to 260,962 shares of the Company’s common stock at an exercise price of $3.90 per share (the “Warrant”).

The Preferred Shares issued by the Company pay cumulative dividends of 5% a year for the first five years and 9% a year thereafter. The terms of the Preferred Shares, as amended by the American Recovery and Reinvestment Act of 2009 (“ARRA”), provide that the Preferred Shares may be redeemed by the Company, in whole or in part, upon approval of the Treasury and the Company’s primary banking regulators. Both the Preferred Shares and the Warrant will be accounted for as components of regulatory Tier 1 capital. Among other restrictions, the securities purchase agreement between the Company and the Treasury limits the Company’s ability to repurchase its stock and subjects the Company to certain executive compensation limitations. Pursuant to the Written Agreement, the Company may not purchase any of its shares of stock without the prior written approval of the Federal Reserve.

In April 2010, the Company announced that it would defer scheduled dividend payments on the principal outstanding on the Preferred Shares. Dividends are accrued based on the rates, liquidation preference and time since last quarterly dividend payment. Interest on dividends is accrued based on the rates and time since last scheduled quarterly dividend payment.

ARRA was enacted on February 17, 2009. Among other things, ARRA sets forth additional limits on executive compensation at all financial institutions receiving federal funds under any program, including the CPP, both retroactively and prospectively. The executive compensation restrictions in ARRA include among others: limits on compensation incentives, prohibitions on “Golden Parachute Payments”, the establishment by publicly registered CPP recipients of a board compensation committee comprised entirely of independent directors for the purpose of reviewing employee compensation plans, and the requirement of a non-binding vote on executive pay packages at each annual shareholder meeting until the government funds are repaid. In addition, if dividends on the Preferred Shares are not paid in full for six dividend periods, the Treasury will have the right to elect two directors to the Company’s Board of Directors. The Treasury’s right to elect directors ends when full dividends have been paid for four consecutive dividend periods. As discussed above, the Company has announced that it would defer scheduled dividend payments on the Preferred Shares.

In June 2010, the Federal Reserve issued final guidance to ensure that incentive compensation arrangements at financial institutions take into account risk and are consistent with safe and sound practices. The guidance does not set forth any formulas or pay caps, but sets forth certain principles which companies would be required to follow with respect to certain employees and groups of employees that may expose the institution to material amounts of risk.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) became law on July 21, 2010. The Dodd-Frank Act constitutes one of the most significant efforts in recent history to comprehensively overhaul the financial services industry and will affect large and small financial institutions alike. While some of the provisions of the Dodd-Frank Act take effect immediately, many of the provisions have delayed effective dates and their implementation will require the issuance of numerous new regulations.



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The Dodd-Frank Act deals with a wide range of regulatory issues including, but not limited to: mandating new capital requirements that would require certain bank holding companies to be subject to the same capital requirements as their depository institutions; eliminating (with certain exceptions) trust preferred securities; codifying the Federal Reserve’s Source of Strength doctrine; creating a Bureau of Consumer Financial Protection (the “CFPB”) which will have the power to exercise broad regulatory, supervisory and enforcement authority concerning both existing and new consumer financial protection laws; permanently increasing federal deposit insurance protection to $250,000 per depositor; extending the unlimited coverage for qualifying non-interest bearing transactional accounts until December 31, 2012; increasing the ratio of reserves to deposits minimum to 1.35 percent; assessing premiums for deposit insurance coverage on average consolidated total assets less average tangible equity, rather than on a deposit base; authorizing the assessment of examination fees; establishing new standards and restrictions on the origination of mortgages; permitting financial institutions to pay interest on business checking accounts; limiting interchange fees payable on debit card transactions; and implementing requirements on boards, corporate governance and executive compensation for public companies.

In July 2011, the CFPB took over many of the consumer financial functions that had been assigned to the federal banking agencies and other designated agencies. The CFPB has broad rulemaking authority and there is considerable uncertainty as to how the CFPB actually will exercise its regulatory, supervisory, examination and enforcement authority.

In June 2012 the federal banking regulators released three proposed rules relating to minimum capital requirements for U.S. banking organizations including all banks, savings associations, bank holding companies with greater than $500 million of assets and all savings and loan holding companies which closely track the requirements set forth by the Basel Committee on Banking Supervision, commonly known as Basel III. The proposed rules would require, among other provisions, that banks maintain higher capital reserves, primarily comprised of common equity capital meeting stringent new standards. Additionally, the proposed rules would enact requirements found in the Dodd-Frank Act that banks use alternative risk weighting, instead of “credit ratings,” for the calculation of risk-weighted assets. The third proposed rule would generally apply only to the largest U.S. banking organizations and would change standards related to securitizations, treatment of counterparty credit risk and disclosure requirements regarding capital instruments and securitization exposures. The Basel III rules were to go into effect on January 1, 2013, but due to numerous comments, the federal banking regulators announced in November 2012 that the effective date would be delayed. Final rules could change significantly from the proposed rules. Therefore, it is unclear how the Company and the Bank will be affected.

The complete impact of the Dodd-Frank Act is unknown since many of the substantive requirements will be contained in the many rules and regulations to be implemented. However, the Dodd-Frank Act has had and will have significant and immediate effects on banks and bank holding companies in many areas. It is expected that the Dodd-Frank Act will increase the cost of doing business in the banking industry.

The Bank

General. The Bank is a Michigan state-chartered bank, the deposit accounts of which are insured by the FDIC. As a state-chartered non-member bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the OFIR, as the chartering authority for state banks, and the FDIC, as administrator of the deposit insurance fund, and to the statutes and regulations administered by the OFIR and the FDIC governing such matters as capital standards, mergers, establishment of branch offices, subsidiary investments and activities and general investment authority. The Bank is required to file reports with the OFIR and the FDIC concerning its activities and financial condition and is required to obtain regulatory approvals prior to entering into certain transactions, including mergers with, or acquisitions of, other financial institutions.

Business Activities. The Bank’s activities are governed primarily by Michigan’s Banking Code of 1999 (the “Banking Code”) and the Federal Deposit Insurance Act (“FDI Act”). The FDI Act, among other things, requires that federal banking regulators intervene promptly when a depository institution experiences financial difficulties; mandates the establishment of a risk-based deposit insurance assessment system; and requires imposition of numerous additional safety and soundness operational standards and restrictions. The GLB Act, which amended the FDI Act, among other things, loosens the restrictions on affiliations between entities engaged in certain financial, securities, and insurance activities; imposes restrictions on the disclosure of consumers’ nonpublic personal information; and institutes certain reforms of the Federal Home Loan Bank System.



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The federal laws contain provisions affecting numerous aspects of the operation and regulation of federally insured banks and empower the FDIC, among other agencies, to promulgate regulations implementing their provisions.

Branching. Michigan banks, such as the Bank, have the authority under Michigan law to establish branches throughout Michigan and in any state, the District of Columbia, any U.S. territory or protectorate, and foreign countries, subject to the receipt of all required regulatory approvals.

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allows the FDIC and other federal bank regulators to approve applications for mergers of banks across state lines without regard to whether such activity is contrary to state law. After establishing branches in a state through an interstate merger, a bank can establish and acquire additional branches at any location in the state where any bank involved in the merger could have established or acquired branches under applicable federal or state law. Financial institutions utilized mergers for interstate branching purposes since some states prohibited de novo branching or had reciprocity requirements. However, the Dodd-Frank Act removed such restrictions on interstate branching. As a result of the Dodd-Frank Act, interstate branching authority has been expanded and a state or national bank may open a de novo branch in another state if the law of the state where the branch is to be located would permit a state bank chartered by that state to open the branch.

Loans to One Borrower. Under Michigan law, a bank’s total loans and extensions of credit and leases to one borrower is limited to 15% of the bank’s capital and surplus, subject to several exceptions. This limit may be increased to 25% of the bank’s capital and surplus upon approval by a 2/3 vote of its board of directors. Certain loans, including loans secured by bonds or other instruments of the United States and fully guaranteed by the United States as to principal and interest, are not subject to the limit just referenced. In addition, certain loans, including loans arising from the discount of nonnegotiable consumer paper which carries a full recourse endorsement or unconditional guaranty of the person transferring the paper, are subject to a higher limit of 30% of capital and surplus. At December 31, 2012, the Bank’s legal lending limit for loans to one borrower was $2.2 million; the Bank’s legal lending limit with approval of two-thirds of the Board of Directors was $3.7 million.

Enforcement. The OFIR and FDIC each have enforcement authority with respect to the Bank. The Commissioner of the OFIR has the authority to issue cease and desist orders to address unsafe and unsound practices and actual or imminent violations of law and to remove from office bank directors and officers who engage in unsafe and unsound banking practices and who violate applicable laws, orders, or rules. The Commissioner of the OFIR also has authority in certain cases to take steps for the appointment of a receiver or conservator of a bank.

The FDIC has similar broad authority, including authority to bring enforcement actions against all “institution-affiliated parties” (including shareholders, directors, officers, employees, attorneys, consultants, appraisers and accountants) who knowingly or recklessly participate in any violation of law or regulation or any breach of fiduciary duty, or other unsafe or unsound practice likely to cause financial loss to, or otherwise have an adverse effect on, an insured institution. Civil penalties under federal law cover a wide range of violations and actions. Criminal penalties for most financial institution crimes include monetary fines and imprisonment. In addition, the FDIC has substantial discretion to impose enforcement action on banks that fail to comply with its regulatory requirements, particularly with respect to capital levels. Possible enforcement actions range from requiring the preparation of a capital plan or imposition of a capital directive, to receivership, conservatorship, or the termination of deposit insurance.

Assessments and Fees. The Bank pays a supervisory fee to the OFIR of not less than $5,000 and not more than 25 cents for each $1,000 of total assets. The fee incurred in 2012 was $47,637. This fee is invoiced prior to July 1 each year and is due no later than August 15. The OFIR imposes additional fees, in addition to those charged for normal supervision, for applications, special evaluations and analyses, and examinations.



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Regulatory Capital Requirements. The Bank is required to comply with capital adequacy standards set by the FDIC. The FDIC may establish higher minimum requirements if, for example, a bank has previously received special attention or has a high susceptibility to interest rate risk. Banks with capital ratios below the required minimum are subject to certain administrative actions. More than one capital adequacy standard applies, and all applicable standards must be satisfied for an institution to be considered to be in compliance. There are three basic measures of capital adequacy: a total risk-based capital measure, a Tier 1 risk-based capital ratio; and a leverage ratio.

The risk-based framework was adopted to assist in the assessment of capital adequacy of financial institutions by, (i) making regulatory capital requirements more sensitive to differences in risk profiles among organizations; (ii) introducing off-balance-sheet items into the assessment of capital adequacy; (iii) reducing the disincentive to holding liquid, low-risk assets; and (iv) achieving greater consistency in evaluation of capital adequacy of major banking organizations throughout the world. The risk-based guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items to different risk categories. An institution’s risk-based capital ratios are calculated by dividing its qualifying capital by its risk-weighted assets.

Qualifying capital consists of two types of capital components: “core capital elements” (or Tier 1 capital) and “supplementary capital elements” (or Tier 2 capital). Tier 1 capital is generally defined as the sum of core capital elements less goodwill and certain other intangible assets. Core capital elements consist of (i) common shareholders’ equity, (ii) noncumulative perpetual preferred stock (subject to certain limitations), and (iii) minority interests in the equity capital accounts of consolidated subsidiaries. Tier 2 capital consists of (i) allowance for loan and lease losses (subject to certain limitations); (ii) perpetual preferred stock which does not qualify as Tier 1 capital (subject to certain conditions); (iii) hybrid capital instruments and mandatory convertible debt securities; (iv) term subordinated debt and intermediate term preferred stock (subject to limitations); and (v) net unrealized holding gains on equity securities.

Under current capital adequacy standards, the Bank must meet a minimum ratio of qualifying total capital to risk-weighted assets of 8%. Of that ratio, at least half, or 4%, must be in the form of Tier 1 capital.

The Bank must also meet a leverage capital requirement. In general, the minimum leverage capital requirement is not less than 3% Tier 1 capital to total assets if the bank has the highest regulatory rating and is not anticipating or experiencing any significant growth. All other banks should have a minimum leverage capital ratio of not less than 4%.

The Dodd-Frank Act requires the FDIC to establish minimum leverage and risk-based capital requirements to apply to insured depository institutions. The Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness.

As described above, in June 2012 the federal banking regulators released three proposed rules relating to minimum capital requirements for U.S. banking organizations which closely track the requirements commonly known as Basel III. The proposals do not apply to bank holding companies with less than $500 million in assets; however, many of the proposed requirements would apply to the Bank. Namely, the proposed rules would modify standards for risk-weighted assets calculation, set new minimum capital requirements and refine capital quality through various eligibility restrictions. Since the rules have not been finalized, it is unclear how the Company and the Bank will be affected; however, it is anticipated that capital requirements will be raised.

As described below, the Bank is required to meet higher capital requirements due to the existence of the Consent Order (as defined below).

Prompt Corrective Regulatory Action. The FDIC is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization. Generally, a bank is considered “well capitalized” if its risk-based capital ratio is at least 10%, its Tier 1 risk-based capital ratio is at least 6%, its leverage ratio is at least 5%, and the bank is not subject to any written agreement, order, or directive by the FDIC.

A bank generally is considered “adequately capitalized” if it does not meet each of the standards for well-capitalized institutions, and its risk-based capital ratio is at least 8%, its Tier 1 risk-based capital ratio is at least 4%, and its leverage ratio is at least 4% (or 3% if the institution receives the highest rating under the Uniform Financial Institution Rating System). A bank that has a risk-based capital ratio less than 8%, or a



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Tier 1 risk-based capital ratio less than 4%, or a leverage ratio less than 4% (3% or less for institutions with the highest rating under the Uniform Financial Institution Rating System) is considered to be “undercapitalized”. A bank that has a risk-based capital ratio less than 6%, or a Tier 1 capital ratio less than 3%, or a leverage ratio less than 3% is considered to be “significantly undercapitalized,” and a bank is considered “critically undercapitalized” if its ratio of tangible equity to total assets is equal to or less than 2%.

Subject to a narrow exception, the FDIC is required to appoint a receiver or conservator for a bank that is “critically undercapitalized.” In addition, a capital restoration plan must be filed with the FDIC within 45 days of the date a bank receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Compliance with the plan must be guaranteed by each company that controls a bank that submits such a plan, up to an amount equal to 5% of the bank’s assets at the time it was notified regarding its deficient capital status. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions, and expansion. The FDIC could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.

Deposit Insurance. The Bank’s deposits are insured up to applicable limitations by a deposit insurance fund administered by the FDIC. As an FDIC insured institution, the Bank is required to pay deposit insurance premium assessments to the deposit insurance fund pursuant to a risk-based assessment system. In October 2008, the basic limit on federal deposit insurance coverage was raised from $100,000 to $250,000 per depositor on a temporary basis. However, the Dodd-Frank Act permanently raised the basic limit on deposit insurance coverage from $100,000 to $250,000 per depositor. In addition, in November 2010, pursuant to the Dodd-Frank Act, the FDIC issued a final rule to provide temporary unlimited deposit insurance coverage for non-interest bearing accounts from December 31, 2010 through December 31, 2012. This coverage was not extended and expired on December 31, 2012.

Under the FDIC’s risk based assessment regulations there are four risk categories, and each insured institution is assigned to a risk category based on capital levels and supervisory ratings. Well-capitalized institutions with CAMELS composite ratings of 1 or 2 are placed in Risk Category I while other institutions are placed in Risk Categories II, III or IV depending on their capital levels and CAMELS composite ratings. The assessment rates may be changed by the FDIC as necessary to maintain the insurance fund at the reserve ratio designated by the FDIC.

A bank’s initial assessment rate is based upon the risk category to which it is assigned. Adjustments may be made to a bank’s initial assessment rate based certain factors including levels of long-term unsecured debt, levels of secured liabilities above a threshold amount, and, for certain institutions, brokered deposit levels. Effective through March 31, 2011, initial assessment rates ranged from 12 to 45 basis points of assessable deposits. As required by the Dodd-Frank Act, in February 2011, the FDIC adopted a final rule that redefines its deposit insurance premium assessment base to be an insured depository institution’s average consolidated total assets minus average tangible equity capital, rather than on deposits. In addition, the FDIC has revised its deposit insurance rate schedules as a consequence of the changes to the assessment base. The new rate schedule and other revisions became effective on April 1, 2011. Initial base assessment rates now range between 5 and 35 basis points of the new assessment base.

Due to a decrease in the reserve ratio of the deposit insurance fund, in October 2008, the FDIC established a restoration plan to restore the reserve ratio to at least 1.15%. However, the Dodd-Frank Act raised the minimum reserve ratio to 1.35% and removed the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC. The Dodd-Frank Act also requires that the reserve ratio reach 1.35% by September 30, 2020. Effective January 1, 2011, the FDIC set the long term reserve ratio at 2%.

On May 22, 2009, the FIDC imposed a special assessment of five basis points on each FDIC-insured depository institution’s assets, minus its Tier 1 capital, as of June 30, 2009. The special assessment was collected on September 30, 2009, and the Bank paid an additional assessment of $136,526.

On November 12, 2009 the FDIC adopted a final rule that required insured institutions to prepay on December 31, 2009, estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. For purposes of calculating the prepayment amount, the institution’s third quarter 2009 assessment base was increased quarterly at five percent annual growth rate through the end of 2012.



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On September 29, 2009, the FDIC also increased annual assessment rates uniformly by three basis points beginning January 1, 2011. On December 31, 2009 the Bank prepaid estimated assessments of $1.3 million.

Bank Regulatory Agreement. On May 6, 2010, the Bank entered into a stipulation and consent to the issuance of a consent order with the FDIC and OFIR (the “Consent Order”). The Consent Order, among other things, requires the Bank to increase the Bank’s level of Tier 1 capital as a percentage of total assets to at least 9% and its total capital as a percentage of risk-weighted assets at a minimum of 11% and to retain an independent third party to develop an analysis of the Bank’s management needs for the purpose of providing qualified management for the Bank.

Payment of Dividends by the Bank. There are state and federal requirements limiting the amount of dividends which the Bank may pay. Generally, a bank’s payment of cash dividends must be consistent with its capital needs, asset quality, and overall financial condition. Additionally, OFIR and the FDIC have the authority to prohibit the Bank from engaging in any business practice (including the payment of dividends) which they consider to be unsafe or unsound.

Under Michigan law, the payment of dividends is subject to several additional restrictions. The Bank cannot declare or pay a cash dividend or dividend in kind unless the Bank will have a surplus amounting to not less than 20% of its capital after payment of the dividend. The Bank will be required to transfer 10% of net income to surplus until its surplus is equal to its capital before the declaration of any cash dividend or dividend in kind. In addition, the Bank may pay dividends only out of net income then on hand, after deducting its losses and bad debts. These limitations can affect the Bank’s ability to pay dividends. As discussed above, the Consent Order requires the Bank to obtain the prior written consent of the FDIC and OFIR for the payment of dividends. During 2013, the Bank is not expected to pay dividends.

Loans to Directors, Executive Officers, and Principal Shareholders. Under FDIC regulations, the Bank’s authority to extend credit to executive officers, directors, and principal shareholders is subject to substantially the same restrictions set forth in Federal Reserve Regulation O. Among other things, Regulation O (i) requires that any such loans be made on terms substantially similar to those offered to nonaffiliated individuals, (ii) places limits on the amount of loans the Bank may make to such persons based, in part, on the Bank’s capital position, and (iii) requires that certain approval procedures be followed in connection with such loans.

Certain Transactions With Related Parties. Under Michigan law, the Bank may purchase securities or other property from a director, or from an entity of which the director is an officer, manager, director, owner, employee, or agent, only if such purchase (i) is made in the ordinary course of business, (ii) is on terms not less favorable to the Bank than terms offered by others, and (iii) the purchase is authorized by a majority of the board of directors not interested in the sale. The Bank may also sell securities or other property to its directors, subject to the same restrictions (except in the case of a sale by the Bank, the terms may not be more favorable to the director than those offered to others).

In addition, the Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company and its non-bank subsidiaries, on investments in the stock or other securities of the Company and its non-bank subsidiaries, and on the acceptance of stock or other securities of the Company or its non-bank subsidiaries as collateral for loans. Various transactions, including contracts, between the Bank and the Company or its non-bank subsidiaries must be on substantially the same terms as would be available to unrelated parties.

Standards for Safety and Soundness. The FDIC has established safety and soundness standards applicable to the Bank regarding such matters as internal controls, loan documentation, credit underwriting, interest-rate risk exposure, asset growth, compensation and other benefits, and asset quality and earnings. If the Bank were to fail to meet these standards, the FDIC could require it to submit a written compliance plan describing the steps the Bank will take to correct the situation and the time within which such steps will be taken. The FDIC has authority to issue orders to secure adherence to the safety and soundness standards.



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Reserve Requirement. Under a regulation promulgated by the Federal Reserve, depository institutions, including the Bank, are required to maintain cash reserves against a stated percentage of their net transaction accounts. Effective October 9, 2008, the Federal Reserve Banks are now authorized to pay interest on such reserves. The current reserve requirements are as follows:



for transaction accounts totaling $12.4 million or less, a reserve of 0%; and



for transaction accounts in excess of $12.4 million up to and including $79.5 million, a reserve of 3%; and



for transaction accounts totaling in excess of $79.5 million, a reserve requirement of $2.013 million plus 10% of that portion of the total transaction accounts greater than $79.5 million.

The dollar amounts and percentages reported here are all subject to adjustment by the Federal Reserve.

ITEM 1A. Risk Factors

This item is not required for smaller reporting companies.

ITEM 1B. Unresolved Staff Comments—None

ITEM 2. Properties

At December 31, 2012, we had five full service offices. At December 31, 2012, we owned all of our offices and the net book value of our investment in premises and equipment, excluding computer equipment, was $3.9 million. We believe that our current facilities are adequate to meet our present and immediately foreseeable needs.



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The following table provides information regarding our office and other facilities:








Main Office      
375 North Willowbrook Road    Branch    Owned
Coldwater, Michigan 49036      
Branch Offices      
365 N. Broadway    Branch    Owned
Union City, Michigan 49094      
1 West Carleton Road    Hillsdale    Owned
Hillsdale, Michigan 49242      
15975 West Michigan Avenue    Calhoun    Owned
Marshall, Michigan 49068      
107 North Park    Calhoun    Owned
Marshall, Michigan 49068      
Other Facilities      
34 Grand Street (Garage)    Branch    Owned
Coldwater, Michigan 49036      
24 Grand Street (Drive through)    Branch    Owned
Coldwater, Michigan 49036      
87 Marshall Street    Branch    Owned
Coldwater, Michigan 49036      
123 S. Main Street    Branch    Leased
Adrian, Michigan 49221      
7055 Tower Road, Suite D    Branch    Leased
Battle Creek, Michigan 49014      
113 W. Grand River, Suite A    Branch    Leased
Brighton, Michigan 48116      
3496 Lake Lansing Road, Suite 120    Branch    Leased
East Lansing, Michigan 48823      
2301 East Paris, SE, Suite 300    Branch    Leased
Grand Rapids, Michigan 49546      
1035 Laurence Avenue, Suite 5    Branch    Leased
Jackson, Michigan 40202      
800 Ship Street    Branch    Leased
St. Joseph, Michigan 49085      
606 North 9th Street, Suite 9    Branch    Leased
Kalamazoo, Michigan 49009      
402 North Wayne Street, Suite 3    Branch    Leased

Angola, Indiana 46703


We utilize a third party service provider to maintain our data base of depositor and borrower customer information.



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ITEM 3. Legal Proceedings

From time to time we are involved as plaintiff or defendant in various legal actions arising in the normal course of business. We do not anticipate incurring any material liability as a result of any current litigation.

ITEM 4. Reserved


ITEM 5. Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s common stock commenced trading on September 19, 2012 on the OTCQB market place operated by the OTC Markets Group under the symbol “MCBF.” The table below shows the high and low sales prices of the common stock for the periods indicated, as reported on the NASDAQ Capital Market for periods prior to September 2012 and the OTCQB for periods after September 2012. For the years ended December 31, 2012 and 2011, the Company paid no dividends.




Quarter ending

   High      Low      Dividends  


   March 31    $ 1.54       $ 1.46       $ —     
   June 30    $ 1.24       $ 1.10       $ —     
   September 30    $ 1.14       $ 1.14       $ —     
   December 31    $ 1.09       $ 1.03       $ —     


   March 31    $ 1.92       $ 1.05       $ —     
   June 30    $ 1.93       $ 0.95       $ —     
   September 30    $ 1.31       $ 0.80       $ —     
   December 31    $ 1.38       $ 0.67       $ —     

Please refer to Note 13 to the Financial Statements for a discussion of certain restrictions which impact the Company’s ability to pay dividends. Because the Company has no significant operations, it depends upon dividends from the bank in order to pay dividends to its stockholders.

As of March 22, 2013, there were 2,049,485 shares of the Company’s common stock issued and outstanding and approximately 527 holders of record. The holders of record do include banks and brokers who act as nominees, each of whom may represent more than one stockholder.

The Company did not redeem equity securities during the fourth quarter of 2012.

The Performance Graph required by item 201 (e) of Regulation S-K is not applicable to smaller reporting companies.

ITEM 6. Selected Financial Data


The summary information presented below under “Selected Financial Condition Data” and “Selected Operations Data” for, and as of the end of, each of the years ended December 31 is derived from our audited financial statements. The following information is only a summary and you should read it in conjunction with our consolidated financial statements, including notes thereto, included elsewhere in this document:



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     December 31,  
     2012      2011      2010      2009      2008  
     (In Thousands)  

Selected Financial Condition Data:


Total Assets

   $ 190,323       $ 208,106       $ 256,868       $ 283,204       $ 291,807   

Loans receivable, net

     128,000         148,495         182,768         220,875         247,542   

Investment securities, at carrying value

     10,047         12,536         11,476         16,086         8,953   

Fed Funds sold and overnight deposits

     19,766         16,410         34,909         10,723         677   


     169,460         174,185         206,028         213,368         192,156   

Federal Home Loan Bank Advances

     7,059         20,175         36,350         44,518         60,178   


     10,467         11,142         12,118         23,163         36,270   


     December 31,                    
     2012     2011     2010     2009     2008  
     (In Thousands)  

Selected Operations Data:


Total interest income

   $ 8,635      $ 10,486      $ 12,837      $ 15,836      $ 17,196   

Total interest expense

     2,106        3,638        5,372        7,339        8,536   
















Net interest income

     6,529        6,848        7,465        8,497        8,660   

Provision for loan losses

     (1,042     733        11,602        13,349        2,712   
















Net interest income after provision for loan losses

     7,571        6,115        (4,137     (4,852     5,948   

Fees and service charges

     2,238        2,311        2,496        2,682        2,757   

Gains on sales of loans, mortgage-backed securities and investment securities

     1,844        1,450        1,082        2,100        629   

Other non-interest income

     238        209        119        211        217   
















Total non-interest income

     4,320        3,970        3,697        4,993        3,603   

Total non-interest expense

     12,244        10,337        10,237        20,085        9,152   
















Income (loss) before taxes

     (353     (252     (10,677     (19,944     399   

Income tax provision

     —          101        205        (548     101   
















Net income (loss)

   $ (353   $ (353   $ (10,882   $ (19,396   $ 298   


















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ITEM 6. Selected Financial Data, continued


     December 31,  
     2012     2011     2010     2009     2008  

Selected Financial Ratios and Other Data:


Performance Ratios:


Return on assets (ratio of net income (loss) to average total assets)

     -0.17     -0.15     -4.00     -6.41     0.10

Return on Equity (ratio of net income (loss) to average equity)

     -3.40     -2.92     -59.86     -46.88     0.78

Interest rate spread information:


Average during period

     3.40     3.04     2.96     2.94     3.11

Net interest margin

     3.40     3.04     2.96     3.10     3.32

Ratio of operating expense to average total assets

     5.96     4.32     3.77     6.64     3.20

Ratio of average interest-earning assets to average interest-bearing liabilities

     1.12        1.10        1.07        1.06        1.06   

Efficiency ratio

     106.09     95.46     88.26     71.67     73.25

Asset Quality Ratios:


Non-performing assets to total assets at end of period

     4.74     6.34     6.64     6.50     1.59

Non-performing loans to total loans, net

     6.07     5.90     7.70     7.05     1.04

Allowance for loan losses to non-performing loans

     39.06     53.12     48.67     37.14     105.76

Allowance for loan losses to loans receivable, net

     2.37     3.14     3.75     2.62     1.10

Capital ratios:


Equity to total assets at end of period

     5.50     5.35     4.67     8.19     12.43

Other data:


Number of full-service offices

     5        5        5        6        6   

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations


The following discussion is intended to assist in understanding the financial condition and results of operations of the Bank. The discussion and analysis does not include any comments relating to the Corporation since the Corporation has no significant operations.

The Corporation, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, the Corporation is required to register with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the “BHCA”). In accordance with Federal Reserve policy, the Corporation is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank. The Corporation, however, has no significant assets other than the Bank. It is typically dependent upon dividends from the Bank for revenue.



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Following the Bank’s 2010 Safety and Soundness examination, the Board of Directors of the Bank stipulated to the terms of a formal enforcement action (“Consent Order”) with Federal Deposit Insurance Corporation (“FDIC”) and the Office of Financial and Insurance Regulation for the State of Michigan (“OFIR”). The Consent Order, which was effective May 6, 2010, requires among other things, that the Bank obtain the approval of the FDIC prior to paying a dividend. The Corporation’s ability to pay dividends is also currently prohibited by the Written Agreement entered into the Federal Reserve Bank of Chicago (the “FRB”). For details regarding the Written Agreement, refer to Note 14 in the financial statements. Effective February 2010, the Corporation deferred regularly scheduled dividend payments on the $6.7 million in principal outstanding on its Series A fixed rate, cumulative perpetual preferred stock (aggregate liquidation preference of $6.8 million) which was issued to the U.S. Treasury in February 2009. The suspension of dividend payments is permissible under the terms of the TARP Capital Purchase Program, but the dividend is a cumulative dividend and failure to pay dividends for six dividend periods would trigger board of director appointment rights for the holder of the Series A Preferred Stock.

As mentioned in Notes 13 and 14 the Bank and the Corporation are restricted from paying dividends without prior consent from respective regulatory agencies. The information contained in this section should be read in conjunction with the consolidated financial statements.

The Bank’s results of operations depend primarily on its net interest income, which is the difference between interest income earned on loans, investments, and overnight deposits, and interest expense incurred on deposits and borrowings. The Bank’s results of operations also are significantly affected by the level of its gains from sales of mortgage loans.

Critical Accounting Policies

Our Consolidated Financial Statements were prepared in accordance with U.S. generally accepted accounting principles and follow general practices within the industries in which we operate. The most significant accounting policies we follow are presented in Note 1 to the Consolidated Financial Statements. Application of these principles requires us to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. Critical accounting estimates are defined as those that require assumptions or judgments to be made based on information available as of the date of the financial statements. Certain policies inherently have a greater reliance on the use of estimates. Those policies have a greater possibility of producing results that could be materially different than reported if there is a change to any of the estimates, assumptions, or judgments made by us. Based on the potential impact to the financial statements of the valuation methods, estimates, assumptions, and judgments used, we identified the determination of the allowance for loan losses to be the accounting estimate that is the most subjective or judgmental.

Allowance for Loan Losses

The allowance for loan losses is calculated with the objective of maintaining an allowance sufficient to absorb estimated probable loan losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss content for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of the collateral.



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We have established a systematic method of periodically reviewing credit quality of the loan portfolio in order to establish an allowance for loan losses. The allowance for loan losses is based on our current judgments about credit quality of individual loans and segments of the loan portfolio. The allowance for loan losses is established through a provision for loan losses based on our evaluation of the losses inherent in the loan portfolio, and considers all known internal and external factors that affect loan collectability as of the reporting date. Our evaluation, which includes a review of all loans on which full collectability may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience our knowledge of inherent losses in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance. Management believes this is a critical accounting policy because the evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters.

The analysis of the allowance for loan losses has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is generally measured by determining the present value of expected future cash flows or, the fair value of the collateral adjusted for the market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting, (if applicable) and payment history. We also analyze delinquency trends, general economic conditions and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general reserve. The principal assumption used in deriving the allowance for loan losses is the estimate of loss content for each risk rating. Actual loan losses may be significantly more than the allowances we have established, which could have a material negative effect on our financial results. See Note 5 to the Consolidated Financial Statements for more information on the allowance for loan losses.

Other Real Estate Owned and Foreclosed Assets

Other Real Estate Owned and Foreclosed Assets are acquired through or instead of loan foreclosure. They are initially recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed. See Note 7 to the financial statements for additional information regarding other real estate owned.

Income Taxes

We determine our liabilities for income taxes based on current tax regulation and interpretations in tax jurisdictions where our income is subject to taxation. In estimating income taxes payable or receivable, we assess the relative merits and risks of the appropriate tax treatment considering statutory, judicial, and regulatory guidance in the context of each tax position. Accordingly, previously estimated liabilities are regularly reevaluated and adjusted, through the provision for income taxes.

Changes in the estimate of income taxes payable or receivable occur periodically due to changes in tax rates, interpretations of tax law, the status of examinations being conducted by various taxing authorities, and newly enacted statutory, judicial and regulatory guidance that impact the relative merits and risks of each tax position. These changes, when they occur, affect accrued income taxes and can be significant to our operating results. See Note 11 to the Consolidated Financial Statements for more information on income taxes.



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Deferred tax assets generally represent items that can be used as a tax deduction or credit in future income tax returns, for which a financial statement tax benefit has already been recognized. The realization of the net deferred tax asset generally depends upon future levels of taxable income and the existence of prior years’ taxable income to which “carry back” refund claims could be made. Valuation allowances are established against those deferred tax assets determined not likely to be realized. The valuation allowance may be reversed to income in future periods to the extent that the related deferred tax assets are realized or the valuation allowance is no longer required. The realization of our deferred tax assets is largely dependent upon our ability to generate future taxable income. The Corporation had an $8.2 million tax valuation allowance as of December 31, 2012.

Management Strategy

Our primary focus is on increasing market share and profitability by incorporating the mission of making banking fun and easy and by helping our customers retire wealthy. Primary areas of growth will be residential mortgage origination, wealth management and core deposits. Commercial lending will center on loans guaranteed by the US Small Business Administration. We have now opened nine residential loan production offices (LPOs) in leased facilities at the following locations in Michigan; St. Joseph, Kalamazoo, Grand Rapids, Battle Creek, Jackson, East Lansing, Brighton, and Adrian. We have also opened an LPO in Angola, Indiana. These locations provide residential mortgage services to customers in these markets, and will be a source for deposit gathering as we implement our mobile banking remote consumer deposit capture product. This product will allow consumers to make deposits into their accounts at the Bank by taking a photograph of a check using an IPhone or an Android based phone. We have also placed commercial lenders in the Grand Rapids and East Lansing LPOs. While incurring initial expenses for the build out of the leased spaces and for the hiring of residential loan originators, we anticipate that these LPOs will provide an increasing source of fee income for the Bank.

Continued emphasis will be placed on; 1) the development of a dynamic customer service and relationship model, 2) the reduction of non-performing and classified loans, 3) the prudent reduction of non-interest expenses, 4) the implementation of enhanced banking controls, policies and procedures and, 5) the raising of capital sufficient to comply with regulatory requirements. As previously announced, we anticipate the inception of a formal capital raise effort in the spring of 2013.

Changes in Financial Condition from December 31, 2011 to December 31, 2012

General. Monarch’s total assets decreased $17.8 million, or 8.55%, to $190.3 million at December 31, 2012 compared to $208.1 million at December 31, 2011. The decline in assets is largely attributable to the decrease in loans which decreased from $148.5 million at December 31, 2011 to $128.0 at December 31, 2012.

Loans. Loans remain our largest category of interest earning assets and the largest source of revenue. The net loan portfolio decreased $20.5 million, or 13.8%. Gross loans decreased $22.2 million, or 14.4%, from $153.4 million at December 31, 2011 to $131.3 million at December 31, 2012.

Commercial business loans decreased $1.5 million in 2012 as compared to 2011. Commercial real estate loans including multi family loans decreased $7.9 million due to scheduled maturities and specific plans to reduce substandard assets and credit concentrations. With the hiring of two additional lenders in 2012, we anticipate growth in the commercial loan portfolio in 2013.

Residential loans decreased $9.5 million in 2012, primarily as a result of the migration of one to four family residential loans to the secondary market due to the attractive interest rates available as a result of the decline in interest rates consistent throughout 2012. The decrease in home equity loans of $2.4 million from 2011 to 2012 is also mainly attributable to the refinancing activity seen in the residential market and the declining real estate values.



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Installment loans or “Other loans” as categorized in Note 5 include primarily automobile and recreational vehicle loans. Other consumer loans and construction and land development loans decreased $854,000 in 2012 mainly due to normal repayments. Please refer to Note 5 to our financial statements for additional information on the composition of our loan portfolio.

Credit Risk. Credit Risk is defined as the risk that borrowers or counter-parties will not be able to repay their obligations to us. Credit exposures reflect legally binding commitments for loans, leases, banker’s acceptances, standby and commercial letters of credit, and deposit account overdrafts. Our overall credit risk position has improved significantly during the last twelve months, with a decline in delinquencies, charge off activity and nonperforming assets. While there has been overall improvement, our nonperforming assets are still elevated as compared to periods prior to the recession and we remain focused on continued reduction of these assets.

Loans are carried at an amount which management believes will be collected. A balance considered not collectible is charged against the allowance for loan losses. Charge-offs for loan losses were $579,000 for 2012, compared to $2.9 million for 2011. The decrease in charge off activity in 2012 was largely due to a significant recovery associated with the sale of a large commercial real estate credit. We have also seen a decrease in charge offs related to one to four family residential mortgages as a result of a decrease in foreclosure activity in 2012.

After evaluating the level of the allowance for loan losses in the fourth quarter, and upon receiving the one-time recovery of the previously charged off loan, we reversed the provision for loan losses by $1.0 million in 2012. A loan loss provision of $733,000 was recorded for 2011. The decreased level of provision for loan losses in 2012 was due to the decreased level of charge offs and nonperforming assets.

Nonperforming assets include nonaccrual loans, and other real estate. Our policy is to discontinue the accrual of interest on loans where principal or interest is past due and remains unpaid for 90 days or more, or when an individual analysis of a borrower’s credit worthiness indicates a credit should be placed on nonperforming status, except for residential mortgage loans, which are placed on nonaccrual at the time the loan is placed in foreclosure and consumer loans that are both well secured and in the process of collection.

Nonperforming assets decreased to $9.0 million as of December 31, 2012 from $13.2 million as of December 31, 2011, mainly due to decreases in foreclosed assets. Total foreclosed assets were $4.4 million as of December 31, 2011 compared to $1.2 million as of December 31, 2012. Nonaccrual loans decreased as well in 2012, from $8.8 million as of December 31, 2011 to $7.8 million as of December 31, 2012. The elevated levels of nonaccrual loans seen during 2011 were largely due to economic stresses being felt in Michigan and nationally. Borrowers who normally would be able to fulfill their obligations had been unable to do so in that environment. Impaired loans are commercial loans for which we believe it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. The average investment in impaired loans was $27.9 million during 2012 compared to $29.1 million during 2011. At December 31, 2012, impaired loans were $22.3 million compared to $23.6 million as of December 31, 2011. Given the present state of the economy, we have determined that it is necessary to work with some borrowers to reduce potential losses to the Bank. At December 31, 2012, we had $13.9 million restructured loans where the borrower was in compliance with the terms of agreement or delinquent less than 90 days.



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Securities. The Bank’s securities portfolio decreased $2.5 million, or 17.24%, to $12.0 million at December 31, 2012 from $14.5 million at December 31, 2011. Securities were 6.32% of total assets at December 31, 2012 as compared to 7.0% at December 31, 2011. The decrease was largely attributable to several securities being called and not replaced. In 2011 the Bank sold a significant portion of its securities portfolio and reinvested in mainly collateralized mortgage obligations (CMO). The yield on investment securities has decreased to 1.9% at December 31, 2012 from 3.40% for the same period a year ago. We have continued to maintain a diversified securities portfolio, which includes obligations of U.S. government-sponsored agencies, securities issued by states and political subdivisions and mortgage-backed securities. We regularly evaluate asset/liability management needs and attempt to maintain a portfolio structure that provides sufficient liquidity and cash flow.

Liabilities. The Bank’s deposits decreased $4.7 million, or 2.7%, to $169.5 million at December 31, 2012 compared to $174.2 million at December 31, 2011. This decrease was primarily in certificates of deposits which decreased $7.2 million. Brokered CDs decreased $1.6 million from $3.8 million at December 31, 2011 to $2.2 million at December 31, 2012. The Bank has attempted to reduce its reliance on brokered and large, out of area CDs, although the success of this strategy is dependent on growing core deposits. Retail CD deposits decreased $5.6 million. Non-interest bearing deposit accounts decreased $2.0 million. Interest bearing checking accounts including money markets accounts increased $1.4 million. Savings accounts increased $3.1 million. The Bank expects its low cost core deposits to increase in the future as a result of strategies to attract more small business depositors and municipal depositors.

Due to the fact that the Bank’s regulatory capital ratios are less than the levels necessary to be considered “well capitalized”, it may not obtain new brokered funds as a funding source without prior approval of the FDIC and is subject to rate restrictions that limit the amount that can be paid on all types of retail deposits (See Note 13 for further discussion on the requirements of the Consent Order). The maximum rates the Bank can pay on all types of retail deposits are limited to the national average rate, plus 75 basis points. We have compared the Bank’s current rates with the national rate caps and reduced any rates over the rate cap to fall within those caps. There has been no material impact to our deposit balances resulting from the rate caps.

Federal Home Loan Bank advances decreased $13.1 million, or 64.9%, to $7.1 million at December 31, 2012 from $20.2 million at December 31, 2011. We have used brokered certificates of deposit to diversify our sources of funds and improve pricing at certain terms compared to the local market and advances available from Federal Home Loan Bank of Indianapolis. For several years our strategy has been to replace borrowed funds and brokered CDs with lower cost core deposits. With the movement of customers from the stock market into more conservative types of investments including deposit products we have been able to take advantage of the shift and significantly reduce our reliance on whole sale funding. We expect this trend to continue even when customers move back to riskier types of investing due to the retention of staff specifically focused on building and broadening customer relationships.

Equity. Total equity amounted to $10.5 million at December 31, 2012 and $11.1 million at December 31, 2011, or 5.5% and 5.4%, respectively, of total assets at both dates. The decrease in equity resulted from the net loss for 2012 of $353,000 and dividend payments of $388,000, which consisted of dividends accrued but not paid on the Preferred Stock. The annual 5% dividend on the Preferred Stock, which increases to 9% in 2014, together with the amortization of the discount will reduce net income (or increase the net loss) applicable to common stock by approximately $350,000 annually.



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Average Balances, Net Interest Income, Yields Earned and Rates Paid

The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made. All average balances are average daily balances.


     Year Ended December 31,  
     2012     2011  
     Average      Interest            Average      Interest         
     Outstanding      Earned/      Yield/     Outstanding      Earned/      Yield/  
     Balance      Paid      Rate     Balance      Paid      Rate  
     (dollars in thousands)     (dollars in thousands)  

Fed Funds and overnight deposits

   $ 28,058       $ 41         0.15   $ 38,511       $ 32         0.08

Investment securities

     14,374         270         1.88        10,502         354         3.37   

Other securities

     3,317         108         3.26        3,526         94         2.67   

Loans receivable

     146,121         8,216         5.62        172,402         10,006         5.80   













Total earning assets

   $ 191,870       $ 8,635         4.50      $ 224,941       $ 10,486         4.66   













Demand and NOW accounts

   $ 46,732       $ 8         0.02      $ 43,948       $ 29         0.07   

Money market accounts

     35,806         101         0.28        38,752         181         0.47   

Savings accounts

     22,803         16         0.07        21,614         25         0.12   

Certificates of deposit

     73,267         1,396         1.91        92,319         2,157         2.34   

Federal Home Loan Bank advances

     13,268         585         4.41        27,896         1,246         4.47   













Total interest bearing liabilities

   $ 191,876         2,106         1.10      $ 224,529         3,638         1.62   













Net interest income

      $ 6,529            $ 6,848      







Net interest spread

           3.40           3.04







Net interest margin

           3.40           3.04








(1) Calculated net of deferred loan fees, loan discounts and loans in process. Nonaccrual loans are included in the average outstanding balance.



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Rate/Volume Analysis

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume, which are changes in volume multiplied by the old rate, and (2) changes in rate, which are changes in rate multiplied by the old volume. Changes attributable to both rate and volume are shown as mixed.


     Year Ended December 31,     Year Ended December 31,  
     2012 vs. 2011     2011 vs. 2010  
                       Total                       Total  
     Increase (Decrease) Due to     Increase     Increase (Decrease) Due to     Increase  
     Rate     Volume     Mix     (Decrease)     Rate     Volume     Mix     (Decrease)  
     (in thousands)           (in thousands)        

Interest-earning assets


Fed funds and overnight deposits

   $ 24      $ (9     (7     9      $ 11      $ 4        12        28   

Investment securities

   $ (125   $ 64        (22     (84   $ 9      $ (138     (3     (132

Other securities

   $ (22   $ 47        (11     14      $ 13      $ (14     (2     (3

Loans receivable

   $ (312   $ (1,525     48        (1,790   $ 204      $ (2,408     (40     (2,244

























Total interest-earning assets

   $ (435   $ (1,423   $ 7      $ (1,851   $ 237      $ (2,556   $ (32   $ (2,351

























Interest-bearing liabilities


Demand and NOW accounts

   $ (23   $ 2        —          (21   $ (67   $ 8        (5     (65

Money market accounts

   $ (66   $ (14     —          (80   $ (179   $ (92     40        (231

Savings accounts

   $ (10   $ 1        —          (9   $ (26   $ 2        (1     (25

Certificates of deposit

   $ (316   $ (445     —          (761   $ (609   $ (104     22        (691

Federal Home Loan Bank advances

   $ (8   $ (653     —          (661   $ (10   $ (716     4        (722

























Total interest-bearing liabilities

   $ (423   $ (1,109   $ —        $ (1,532   $ (890   $ (903   $ 60      $ (1,734

























Net interest income

         $ (319         $ (617







Comparison of Results of Operations for the Years Ended December 31, 2012 and 2011

General. The Bank reported a net loss of $353,000 for the year ended December 31, 2012 and a net loss of $353,000 for the year ended December 31, 2011.

Net Interest Income. Our primary source of earnings is net interest income, the difference between income on earning assets and the cost of funds supporting those assets. Significant categories of earning assets are loans and securities while deposits and borrowings represent the major portion of interest-bearing liabilities. Net interest income before provision for loan losses decreased to $6.5 million for 2012 compared to $6.8 million in 2011.

Net interest margin (the ratio of net interest income to average earning assets) is affected by movements in interest rates and changes in the mix of earning assets and the liabilities that fund those assets. Our net interest margin has increased from 3.04% in 2011 to 3.40% in 2012. The increase from 2011 to 2012 is primarily due to the repayment of high cost wholesale funds.



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Interest Income. Total interest income in 2012 decreased $1.9 million primarily due to a decline in outstanding average earning assets and the low interest rates consistent since 2010. This followed a $2.3 million decrease in 2011 which is also attributable to declining interest rates. In 2012 the decline in average balances significantly offset the decline in average yield on earning assets.

Interest Expense. Total interest expense decreased $1.5 million in 2012 compared to 2011. This followed a decrease of $1.8 million in 2011. The decrease in 2011 and 2012 was primarily the result of a reduction in the rates we paid on deposits, sustained by the continued low interest rate environment and the decrease in the average balance of FHLB’s borrowings and brokered deposits. As a result, our average cost of funds, including the effect of interest-free demand deposits, decreased to 1.10% in 2012 from 1.62% in 2011. In the past the Bank has had difficulty in reducing its cost of funds because of increased market rates for CDs and further competition for money market deposits which has also resulted in higher rates being paid. Growing lower cost core deposits remains a challenge in our current market area. Our reliance on money market accounts, internet CDs and FHLB borrowings continues to have an impact on our higher cost of funds.

Provision for Loan Losses. The Bank recorded a reverse provision for loan losses of $1.0 million which was due to a one-time recovery on a previously charged off loan for the year ended December 31, 2012 compared to a provision for loan losses of $733,000 in 2011.

The decreased provision for 2012 was attributable to a decreased level of net charge-offs in the amount of $579,000 as of December 31, 2012 compared to $2.9 million as of December 31, 2011 and decreased loan delinquencies at December 31, 2012 as compared to December 31, 2011. Nonperforming assets which include loans that are nonaccrual and real estate in judgment and other repossessed property decreased to 4.74% of assets at December 31, 2012 compared to 6.34% at December 31, 2011. These levels have been elevated over the previous two years (see “Selected Financial and Other Data” and Credit Risk”). Please refer to Note 5 to our financial statements for additional information on our provision for loan losses.

Non-interest Income. Non-interest income increased to $4.3 million for the year ended December 31, 2012 compared to $4.0 million for the same period in 2011 largely due to an increase in gain on sale of loans. Non-interest income increased to $4.0 million in 2011 primarily due to an increase in gain on sale of securities.

Fees and service charges were $1.8 million for 2012 and $1.9 million for 2011. The decline in fees and service charges is a result of a decline in income for the Bounce Protection Program and loan fees offset by an increase in income from fees associated with ATM usage. Income from the Bounce Protection Program has decreased from $1.1 million in 2011 to $969,000 in 2012 due to decreased customer usage. Future increases in this source of income are dependent on the Bank increasing the number of checking account customers. Management does not expect significant increases in Bounce Protection income from its existing customer base due to the increased regulatory changes that became effective July 1, 2010. ATM income has increased from $367,000 in 2011 to $407,000 in 2012 as customer usage continues to increase.

Gain on sale of loans increased to $1.8 million in 2012 compared to $1.0 million in 2011. The elevated level of gain on sale of loans in 2012 was largely due to the falling rate environment which generated a significant amount of one to four family residential mortgage refinancing. Loan servicing income decreased to $413,000 in 2012 from $437,000 in 2011. Our strategy, which began in 2007, has been to sell as many of the residential mortgage originations as possible to manage the Bank’s interest rate risk, credit risk and liquidity.

Gain on sale of securities decreased from $469,000 in 2011 to $12,000 in 2012 primarily due to the Bank previously selling a significant portion of the portfolio to improve overall quality of the portfolio.



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Other income increased slightly to $238,000 in 2012 compared to $209,000 in 2011. Other income increased to $209,000 in 2011 from $119,000 in 2010 primarily due to an increase in the gain on the sale of foreclosed assets. The gain on the sale of foreclosed property increased $97,000 in 2011 compared to 2010. The gain on sale of foreclosed property decreased in 2012 by $232,000 compared to 2011. Impairment charges of $335,000 in 2010 and $318,000 in 2011 taken against an investment in a low cost housing that provided tax credits offset the increase in gain on the sale of foreclosed assets. The Bank does occasionally experience a gain on sale of foreclosed property, as it has become increasingly more conservative in valuing these properties upon acquisition. Management expects 2013 to be comparable to prerecession periods in terms of foreclosure activity and thus modest potential gains or losses on subsequent sales of the foreclosed properties.

Non-interest Expense. Non-interest expense increased to $12.2 million in 2012 from $10.3 million in 2011, following an increase from $10.2 million in 2010 to $10.3 million in 2011. The increase in non-interest expense in 2011 and 2012 was primarily due to increases in salaries and employee benefits associated with the hiring of additional staff for the new mortgage loan offices.

Salaries and employee benefits expense increased to $5.7 million in 2012 from $4.5 million in 2011. The increase in personnel expense was primarily attributable to the addition of loan originators for the new offices opened during the year. Salaries and employee benefits expense increased to $4.5 million in 2011 as compared to $4.3 million in 2010. Retaining qualified staff continues to be a priority of Management.

Repossessed property expense increased to $820,000 in 2012 from $745,000 in 2011 primarily due to an elevated level of properties and an increase in disposition costs. Repossessed property expense has also increased from $631,000 in 2010 to $745,000 in 2011. Management continues to focus on better management of properties during the holding period and better sales efforts that have led to shorter holding periods.

Professional services expenses increased to $902,000 in 2012 compared to $721,000 in 2011. The increase was due to increased fees associated with SEC filing, additional required quality control review of mortgages originated for the secondary market and costs related to hiring staff for the mortgage loan production offices. Professional services expenses decreased to $721,000 in 2011 compared to $809,000 in 2010 primarily due to decreases in legal fees. We expect professional services expense to remain elevated in 2013 due to the additional costs associated with working with problem loans.

Amortization expense of intangible assets remained the same year over year from 2011 to 2012. As indicated in Note 3 to the Corporation’s financial statements, this expense will continually decline over the remaining life of the related asset and will expire in 2013.

Mortgage banking expense (which is the amortization of capitalized mortgage servicing rights) increased slightly in 2012 to $442,000 compared to $425,000 in 2011 due to an increase in amortization of mortgage servicing rights associated with the refinancing of residential mortgages. Mortgage banking expense remained relatively unchanged year over year from 2010 to 2011. Other general and administrative expense increased to $1.8 million in 2012 compared to $1.6 million in 2011, this is primarily due to an increase in costs associated with opening the additional offices. Other general and administrative expense decreased to $1.6 million in 2011 from $1.8 million in 2010, primarily due to a decrease in FDIC insurance.

Federal Income Taxes. Our effective tax rate for purposes of the tax provision was 0% in 2012 compared to -40.1% in 2011. In prior years the difference between the effective tax rates and the federal corporate income tax rate of 34% is attributable to the low income housing credits available to the Bank from the investment in the limited partnership as well as fluctuation of permanent book and tax differences such as non-taxable income and non-deductible expenses.



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Liquidity and Commitments

We are required to maintain appropriate levels of liquid assets under FDIC regulations. Appropriate levels are determined by our Board of Directors and Management and are included in our asset and liability management policy. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. We have maintained liquidity at levels above those believed to be adequate to meet the requirements of normal operations, including new loan funding and potential deposit outflows. At December 31, 2012, our liquidity ratio, which is our liquid assets as a percentage of total deposits less certificates of deposit maturing in more than one year and increased by borrowings maturing in one year or less, was 19.8%. This level of liquidity is higher than that maintained last year. Management has taken steps to increase liquidity and is confident it will be able to effectively address the Bank’s liquidity needs.

The Bank’s liquidity, represented by cash and cash equivalents, is a product of our operating, investing and financing activities. The Bank’s primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans, overnight deposits and funds provided from operations. While scheduled payments from the amortization of loans and overnight deposits are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Bank also generates cash through borrowings. The Bank utilizes Federal Home Loan Bank advances to leverage its capital base and provide funds for its lending and investment activities, and to enhance its interest rate risk management.

Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in overnight deposits, including fed funds, and short-term treasury and governmental agency securities. On a longer term basis, the Bank maintains a strategy of investing in various investments and lending products. The Bank uses its sources of funds primarily to meet its ongoing commitments, to pay maturing certificates of deposit and savings withdrawals and to fund loan commitments. Certificates of deposit scheduled to mature in one year or less at December 31, 2012, totaled $40.6 million. Based on historical experience, management believes that a significant portion of these certificates of deposit can be retained by continuing to pay competitive interest rates.

If necessary, additional funding sources include additional deposits (including core deposits) and Federal Home Loan Bank advances. Based on current collateral levels, at December 31, 2012, the Bank could borrow an additional $20.9 million from the Federal Home Loan Bank at prevailing interest rates. We anticipate we will continue to have sufficient funds, through deposits and borrowings, to meet our current commitments. For the year ended December 31, 2012, the Bank had a net increase in cash and cash equivalents of $4.6 million as compared to a net decrease of $17.9 million for the year ended December 31, 2011.

The Bank’s primary sources of funds during 2012 were $4.8 million in proceeds from the maturities of securities and $18.3 million in principal loan collections in excess of loan originations. The primary uses of funds in 2012 were the repayment of $13.1 million of FHLB advances and purchases of securities of $2.6 million and a decrease in deposits of $4.7 million.



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Off-Balance Sheet Arrangements

At December 31, 2012, the total unused commercial and consumer lines of credit were $8.6 million and there were no outstanding commitments under letters of credit. At December 31, 2011, the total unused commercial and consumer lines of credit were $11.1 million and there were no outstanding commitments under letters of credit.

The Corporation has no arrangements with any other entities that have or are reasonably likely to have a material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.


Consistent with its goals to operate a sound and profitable financial organization, the Corporation actively seeks to maintain a “well capitalized” institution in accordance with regulatory standards. Note 13 to the Financial Statements details the capital position of the Bank as well as the capital levels necessary to remain well capitalized. At December 31, 2012 the equity to assets ratio of the Company was 5.5%. See also “Regulatory Orders” below.

Impact of Inflation

The consolidated financial statements presented herein have been prepared in accordance with generally accepted accounting principles. These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.

Our primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates, however, do not necessarily move in the same direction or with the same magnitude as the price of goods and services, since such prices are affected by inflation. In a period of rapidly rising interest rates, the liquidity and maturity structures of our assets and liabilities are critical to the maintenance of acceptable performance levels.

The principal effect of inflation, as distinct from levels of interest rates, on earnings is in the area of non-interest expense. Such expense items as employee compensation, employee benefits and occupancy and equipment costs may be subject to increases as a result of inflation. An additional effect of inflation is the possible increase in the dollar value of the collateral securing loans that we have made. We are unable to determine the extent, if any, to which properties securing our loans have appreciated in dollar value due to inflation.



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Regulatory Orders

On September 21, 2010 the Corporation entered into a Written Agreement with the Federal Reserve Bank of Chicago (the “FRB”). Among other things, the Written Agreement requires that the Corporation obtain the approval of the FRB prior to paying a dividend; prohibits the Corporation from purchasing or redeeming any shares of its stock without the prior written approval of the FRB; and requires the Corporation to submit cash flow projections for the Corporation to the FRB on a quarterly basis. A Form 8-K was filed with the complete details of the Written Agreement. In response to these requirements, no preferred stock dividends or common stock dividends have been made since and we have been submitting cash flow projections quarterly.

Following the Bank’s most recent Safety and Soundness examination, the Bank’s Board of Directors stipulated to the terms of a formal enforcement action (“Consent Order”) with Federal Deposit Insurance Corporation (“FDIC”) and the Office of Financial and Insurance Regulation for the State of Michigan (“OFIR”). The Consent Order, which was effective May 6, 2010, contains specific actions needed to address certain findings from their examination and to address our current financial condition. The Consent Order, among other things, requires the following:



The Bank is required to have and retain qualified management.



The Bank is required to retain an independent third party to develop an analysis and assessment of the Bank’s management needs for the purpose of providing qualified management for the Bank.



The board of directors is required to assume responsibility for the supervision of all of the Bank’s activities.



The Bank must increase the Bank’s level of Tier 1 capital as a percentage of total assets to at least nine percent and its total capital as a percentage of risk-weighted assets at a minimum of eleven percent.



The Bank is required to charge off any loans classified as loss.



The Bank may not extend credit to borrowers that have had loans with the Bank that were classified substandard, doubtful or special mention without prior board approval.



The Bank may not extend credit to borrowers that have had loans charged off or classified as loss.



The Bank is required to adopt a plan to reduce the Bank’s risk position in each asset in excess of $250,000 which is more than sixty days delinquent or classified substandard or doubtful.



The Bank may not declare or pay any cash dividend without prior written consent of the FDIC and OFIR.



Prior to submission or publication of all Reports of Condition, the board is required to review the adequacy of the Bank’s allowance for loan losses.



The Bank is required to adopt written lending and collection policies to provide effective guidance and control over the Bank’s lending function.



The Bank is required to implement revised comprehensive loan grading review procedures.



Within sixty days of the Consent Order, the Bank was required to adopt a written profit plan and comprehensive budget.



Within sixty days of the Consent Order, the Bank was required to adopt a written plan to manage concentrations of credit in a safe and sound manner.



Within sixty days of the Consent Order, the Bank was required to formulate a written plan to reduce the Bank’s reliance on brokered deposits.



While the Consent Order is in effect, the Bank is required to prepare and submit quarterly progress reports the FDIC and OFIR.

Since stipulating to the terms of the Consent Order, we have made substantive progress in implementation of provisions identified within the Consent Order. The Bank believes that it is in compliance with all of the terms of the Consent Order with the exception of the requirement that the Bank



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increase the Bank’s level of Tier 1 capital as a percentage of total assets to at least nine percent and its total capital as a percentage of risk-weighted assets at a minimum of eleven percent. The Board of Directors and management remain committed to reaching the capital requirements and continue to evaluate different capital raising alternatives.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Asset and Liability Management and Market Risk

Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.

How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we monitor our interest rate risk. In monitoring interest rate risk, we continually analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities, and their sensitivity to actual or potential changes in market interest rates.

The Board of Directors sets and recommends the asset and liability policies of the Bank which are implemented by the asset and liability management committee. The asset and liability management committee is comprised of members of our senior management. The purpose of the asset and liability management committee is to communicate, coordinate and control asset/liability management consistent with our business plan and board approved policies. The asset and liability management committee establishes and monitors the volume and mix of assets and funding sources taking into account relative costs and spreads, interest rate sensitivity and liquidity needs.

The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk and profitability goals. The asset and liability management committee generally meets on a quarterly basis to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital position, anticipated changes in the volume and mix of assets and liabilities and interest rate risk exposure limits versus current projections. The Chief Financial Officer is responsible for reviewing and reporting on the effects of the policy implementation and strategies to the Board of Directors, each quarter.

In order to manage our assets and liabilities and achieve the desired liquidity, credit quality, interest rate risk, profitability and capital targets, we have focused our strategies on:



originating shorter-term commercial real estate loans for retention in our portfolio;



selling a significant portion of the long-term, fixed rate residential mortgage loans we make;



managing our deposits to establish stable deposit relationships with an emphasis on core, non-certificate deposits, supplementing these with brokered deposits, as appropriate; and



maintaining longer-term borrowings at fixed interest rates to offset the negative impact of longer-term fixed rate loans in our loan portfolio. Future borrowings are expected to be short-term to reduce the average maturity of our borrowings.



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At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the asset and liability management committee may determine to increase Monarch’s interest rate risk position somewhat in order to maintain the net interest margin. In addition, in an effort to manage our interest rate risk and liquidity, in 2012 and 2011 we sold $53.3 million and $32.4 million, respectively, of fixed-rate, one-to-four family mortgage loans in the secondary market. We expect to continue to sell a significant portion of our originated long term, fixed-rate, one-to-four family loans but may retain some portion of our 15 year and shorter, fixed-rate loans.

Monarch uses an internally generated model that uses scenario analysis to evaluate the IRR exposure of the Bank by estimating the sensitivity of the Bank’s portfolios of assets, liabilities, and off-balance sheet contracts to changes in market interest rates. The information presented in the following table presents the expected change in Monarch’s net portfolio value at December 31, 2012 that would occur upon an immediate change in interest rates.


Change in Interest Rates

Basis Points (“bp”)

   Net Portfolio Value     Net Portfolio Value as %
of Present Value of Assets

(Rate Shock in Rates) (1)

   $ Amount      $ Change      % Change     NPV Ratio     Change  

+ 300 bp

     12,435         -2,019         -14     6.68     -75bp   

+ 200 bp

     12,473         -1,982         -14     6.58     -65bp   

+100 bp

     13,097         -1,358         -9     6.81     -62bp   

0 bp

     14,455         0         0     7.43     0bp   

-100 bp

     16,233         1,778         12     8.24     81bp   

-200 bp

     18,321         3,866         27     9.20     177bp   

-300 bp

     21,290         6,835         47     10.58     315bp   


(1) Assumes an instantaneous uniform change in interest rates at all maturities.

Based on the data from the model, management believes that the Bank’s IRR level remains minimal.

As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, if interest rates change, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table.

The Bank, like other financial institutions, is affected by changes in market interest rates. Our net interest margin can change, either positively or negatively, as the result of increases or decreases in market interest rates. Some factors affecting net interest margin are outside of our control; market interest rates are but one factor affecting the Bank’s net interest margin. However, management has the ability, through its asset/liability management and pricing policies to affect the Bank’s net interest margin notwithstanding the level of market interest rates. The preceding table indicates the Bank’s net portfolio value will decrease in an increasing interest rate scenario and increase in a decreasing interest rate scenario. Management believes that its net interest margin will behave similarly.

If rising interest rates stifle loan demand or create additional competitive pressures in attracting and retaining deposits, the Bank’s desire for growth in total assets may cause management to alter its strategy that could negatively impact the net interest margin. The timing and magnitude of interest rate changes, as well as the sector affected (short-term vs. long-term) will have an impact on the Bank’s net interest margin.



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The following table provides information about the Company’s financial instruments that are sensitive to changes to interest rates as of December 31, 2012. The Company had no derivative instruments, or trading portfolio as of that date. The expected maturity date values for loans receivable, mortgage-backed securities and investment securities were calculated without adjusting the contractual maturity dates for expectations of repayments. Expected maturity date values for non-maturity, interest bearing deposits were based on the opportunity for repricing.


                                   2018 and            Fair Value  
     2013     2014     2015     2016     2017     beyond     Total      12/31/2012  

Rate-sensitive assets


Fed funds and overnight deposits

   $ —        $ —        $ —        $ —        $ —        $ —        $ —         $ —     

Average interest rate



   $ 741      $ 1,240      $ 81      $ 2,445      $ —        $ 7,521      $ 12,028       $ 13,273   

Average interest rate

     1.00     1.37     5.50     1.14       3.48     

Gross loans

   $ 11,686      $ 7,517      $ 18,593      $ 14,124      $ 16,685      $ 62,671      $ 131,276       $ 134,944   

Average interest rate

     7.16     6.82     6.90     6.95     6.61     6.18     

Rate-sensitive liabilities


Savings & interest-bearing demand deposits

   $ 84,578      $ —        $ —        $ —        $ —          $ 84,578       $ 84,578   

Average interest rate


Certificates of deposit

   $ 40,629      $ 13,426      $ 8,687      $ 2,915      $ 1,615      $ —        $ 67,272       $ 68,453   

Average interest rate

     1.48     2.01     2.03     1.40