EXHIBIT 13

To Our Shareholders:

        We thought 2006 was going to be a record year for Macatawa Bank.

        The results were in, and our numbers looked great. Even though we were in a market experiencing economic challenges, with a difficult interest rate environment causing shrinking margins, we had once again delivered across-the-board improvements in all key areas.

        But shortly before the end of the first quarter of 2007, we realized a fraud had been perpetrated against the bank by one of our commercial loan customers. With disbelief, we began to investigate.

        What we found was not pretty: About $5.2 million in loans had become impaired. That means it is unlikely that the borrower will be able to repay us and that the collateral used to secure the loans won’t be enough to cover them.

        As soon as we became aware of this situation, we determined that most of the loan balance was a loss and took a corresponding charge to earnings of $4.7 million in the fourth quarter of 2006. This reduced what would have been record net income to $19.8 million for the year, down approximately 5 percent over 2005.

        This is distressing to us and to you, our shareholders. It is also unacceptable. As part of our internal investigation, we began to review our loan policies and procedures. As a management team, we pledge that these procedures will be scrutinized and tightened to prevent a recurrence.

        This certainly is not easy news to deliver or to hear. But it is important to note that Macatawa Bank is financially strong and well-capitalized. We have a solid foundation and, with the support of shareholders and employees, will continue to grow.

        Despite this unwelcome fourth-quarter development, much happened according to our strategic plan in 2006:

Real Performers, Real Growth

Looking forward, our focus remains on building the strongest franchise in West Michigan. While we continued to make great strides in expanding our reach during 2006, we see significant opportunity ahead of us, especially in the greater Grand Rapids market. We have aggressive plans to increase our physical presence in the Grand Rapids metropolitan market. In January 2007, we opened a Breton Village branch, which will serve parts of both East Grand Rapids and Kentwood. In February, we relocated our Byron Center storefront to a new, free standing, full-service branch designed to better position us in this growing market. This summer, we will open a Cascade branch on 28th Street east of I-96, which will complement and strengthen our position in Kent County.

While our branch network is critical to our success, we are exploring alternative delivery systems and enhanced technology that allows us to engage customers in new and more convenient ways. Today’s technology enables our customers to become much more sophisticated product users. For example, last year the number of customers using Macatawa Connect for bill payment increased 50 percent. This activity is an indication of how future generations will do their banking. We are committed to being a leader in this area by providing expanded capabilities, comprehensive security, and a high level of user friendliness.

Treasury Management is another area where we have achieved significant growth. We’re able to offer our larger customers state-of-the-art technology, such as remote deposit capture, which saves time, money and improves their cash flow. We deliver these products with a high level of personal service, creating a very compelling product. The latest technology is only effective when backed by first-rate personnel support. We believe customers still want a real person to answer the phone, address a question or solve a problem quickly. Macatawa provides “high-touch technology,” a unique blend of personal service and state-of-the-art technology.

We have taken significant steps this past year to enhance our Financial Services Group with the addition of Asset Management services. This strengthens our portfolio management capabilities and provides our Trust and Financial Service customers with increased investment options and more in-depth counseling. We believe we have a great opportunity to increase our business in this area. Last year the Trust group delivered a 23 percent increase in revenue over the prior year, and we feel we can do even better in the future.

At the core of our success remains our people, our ‘Real Performers’ and the values and principles they live by. Day in and day out, they provide a level of service that engages customers and builds the long-term relationships that deliver continued growth. It’s not just the people who work face to face with our customers, but also those who provide the underlying foundation in products and technology that continue to drive our business forward. It is also about the countless hours our employees donate in support of their local communities. We invite you to learn more about a few of our “Real Performers” in the following pages, knowing that they represent the 480 other employees that we have employed throughout the Macatawa Bank market area.

/s/ Benjamin A. Smith

Benjamin A. Smith III
CHAIRMAN & CEO / MACATAWA BANK CORPORATION

/s/ Philip J. Koning

Philip J. Koning
PRESIDENT / MACATAWA BANK CORPORATION
PRESIDENT & CEO / MACATAWA BANK

Selected Consolidated Financial Data
The following selected consolidated financial and other data are derived from the Company’s Financial Statements and should be read with the Consolidated Financial Statements and Notes thereto, and Management’s Discussion and Analysis of Results of Operations and Financial Condition. The Consolidated Balance Sheets as of December 31, 2006 and 2005, and the Consolidated Statements of Income for the years ended December 31, 2006, 2005, and 2004, are included elsewhere in this Annual Report.

*Retroactively adjusted to reflect the effect of all stock splits and dividends.

Quarterly Financial Data (unaudited)

A summary of selected quarterly results of operations for the years ended December 31, 2006 and 2005 follows:

*Retroactively adjusted to reflect the effect of all stock splits and dividends.

Net income for the fourth quarter of 2006 includes the impact of a $4.7 million ($3.1 million after tax, or $0.18) per share charge against earnings related to a commercial borrower whose loans became impaired as described in Note 1 - Recent Developments and Note 4 of the financial statements.

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

Management’s discussion and analysis of results of operations and financial condition contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in such forward-looking statements.

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

Overview

Macatawa Bank Corporation is a Michigan corporation and is the holding company for a wholly owned subsidiary, Macatawa Bank and for two trusts, Macatawa Statutory Trust I and Macatawa Statutory Trust II. Effective November 1, 2006, Macatawa Investment Services, Inc., a wholly owned subsidiary of Macatawa Bank Corporation, ceased doing business as a registered broker-dealer. Macatawa Bank Corporation is a financial holding company pursuant to Title I of the Gramm-Leach-Bliley Act. Macatawa Bank is a Michigan chartered bank with depository accounts insured by the Federal Deposit Insurance Corporation. The bank operates twenty-four branch offices and a lending and operational service facility, providing a full range of commercial and consumer banking and trust services in Kent County, Ottawa County, and northern Allegan County, Michigan. On November 1, 2006, Macatawa Bank began offering brokerage services to its customers through an arrangement with Infinex Investments, Inc. (“Infinex”). Infinex is a full service investment provider, a registered broker-dealer and a member of the National Association of Securities Dealers (NASD) and the Securities Investor Protection Corporation (SIPC). As more fully discussed in our Form 8-K dated October 11, 2006, Macatawa Bank Corporation entered into an Agreement and Plan of Merger with the Smith & Associates investment advisory firm based in Holland, Michigan. The Smith & Associates acquisition became effective on January 1, 2007 and that business is now part of Macatawa Bank. Macatawa Statutory Trusts I and II are grantor trusts and issued $20.0 million each of pooled trust preferred securities. These trusts are not consolidated in the Corporation’s financial statements. For further information regarding consolidation, see the Notes to the Consolidated Financial Statements included herein. Macatawa Bank Mortgage Company, a subsidiary of Macatawa Bank, originates and sells residential mortgage loans into the secondary market on a servicing released basis.

While maintaining asset quality and improving profitability, we have experienced rapid and substantial growth since opening Macatawa Bank in November of 1997. We first became profitable in 1999 and have increased earnings each year since then with 2006 net income reaching $22.9 million. Since our inception in 1997, we have raised approximately $100.6 million in capital through private and public common stock offerings and trust preferred offerings to facilitate our growth and progress over these years.

We believe that growth in core deposits is key to our long-term success and is our primary funding source for asset growth. Establishing a branching network in our markets has been of high importance in order to facilitate this core deposit growth. We have gained community awareness and acceptance in our markets through this expanding branch network and our high quality service standards.

The West Michigan markets within which we operate continue to provide significant expansion opportunities for us. We opened our twenty-fourth branch during the second quarter of 2006 on the southeast side of the greater Grand Rapids area. Because of the significance of the greater Grand Rapids market and as it represents the greatest opportunity for market share growth, we anticipate additional branch openings in this market within the next few years. We also continue to enjoy success in building new and existing relationships in the Holland/Zeeland and Grand Haven markets. We anticipate that we will continue to experience growth in our balance sheet and in our earnings due to these expansion opportunities.

RESULTS OF OPERATIONS

Summary: Net income totaled $19.8 million, or $1.20 per diluted share for 2006 as compared to $20.9 million, or $1.27 per diluted share for 2005, and $12.8 million, or $.79 per diluted share for 2004. The results for 2006 include a charge against earnings of $4.7 million ($3.1 million after tax, or $0.18) per share. The results for 2004 include a charge against earnings of $2.3 million ($1.5 million after tax, or $0.09) per share. These losses are associated with two separate impaired commercial loan relationships described under Loan Portfolio and Asset Quality and Allowance for Loan Losses.

The trends in net income principally reflect strong growth in our net interest income due to our continuing growth in interest earning assets and growth in noninterest income, partially offset by increases in noninterest expense and provisions for loan losses.

Net Interest Income: Net interest income totaled $67.4 million during 2006 compared to $62.8 million during 2005 and $52.0 million during 2004. The growth in net interest income during 2006 compared to 2005 was driven by strong growth in average interest earning assets and partially offset by a decline in the net interest margin. Average interest earning assets increased by $180.5 million, or 11%, to $1.83 billion for 2006. The net interest margin decreased 14 basis points to 3.67% for 2006 as the increase in the cost of funds exceeded the increase in the yield on earning assets.

The yield on earning assets increased 89 basis points to 7.26% for 2006 from 6.37% for 2005. The primary reason for this increase was the rise in the yield on our variable rate loan portfolio during the first half of 2006. The increases in short-term interest rates that began in mid-2004 continued through June of 2006 causing the increase in variable rate loan yields. The addition of new loans at generally higher rates during this period also contributed to the increase in asset yield. The increase in the yield on earning assets was offset by a 114 basis point increase in our overall cost of funds to 4.01% for 2006. The primary reasons for the increase can be attributed to increasing the rates paid on our deposit accounts consistent with market increases, the rollover of time deposits to higher rates within the rising rate environment during 2006, and a shift to higher costing sources of funds. The rates paid on higher yielding checking accounts, money market accounts and retail time deposits reached levels in 2006 that had not been seen in the past few years, causing deposit customers to shift funds from low or no yield checking accounts into these higher rate accounts.

The 21% growth in net interest income during 2005 compared to 2004 was also largely driven by significant growth in average interest earning assets which increased by $219.0 million, or 15%, to $1.65 billion for 2005. The net interest margin increased by 17 basis points to 3.81% for 2005, also contributing to the growth in net interest income.

The increases in short-term interest rates described above caused an increase in the yield on assets and the overall cost of funds in 2005 compared to 2004. The yield on earning assets increased 90 basis points and was largely offset by an 80 basis point increase in the overall cost of funds during 2005 when compared to 2004.

Anticipated growth in earning assets is expected to continue to increase levels of net interest income. We expect, however, that compression in the net interest margin that began when the Federal Open Market Committee stopped raising short-term interest rates during the third quarter of 2006, will continue as long as short-term and long-term rates remain within a narrow range. We continue to maintain derivative instruments, as discussed in the Notes to the Consolidated Financial Statements, to help balance our interest rate risk sensitivity considering our significant variable rate loan portfolio. This is discussed in further detail under the section Sensitivity to Market Risk.

The following table shows an analysis of net interest margin for the years ended December 31, 2006, 2005 and 2004.

___________________________

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

Provision for Loan Losses: The provision for loan losses for 2006 was $7.7 million as compared to $3.7 million for 2005 and $7.9 million for 2004. For 2006 and 2004, the provision for loan losses included $4.7 million and $2.3 million, respectively, of additional provisions related to two separate commercial borrowers described below under Loan Portfolio and Asset Quality and Allowance for Loan losses. The amount of the loan loss provision in all periods is a byproduct of establishing our allowance for loan losses at levels deemed necessary in our methodology for determining the adequacy of the allowance. For more information about our allowance for loan losses and our methodology for establishing its level, see the discussion under the section Allowance for Loan Losses.

Noninterest Income: Noninterest income totaled $14.2 million during 2006, as compared to $13.0 million during 2005 and $10.0 million in 2004. The $1.2 million increase over 2005 was a result of improvements in all individual components except gains on sold loans which decreased from $2.3 million to $1.7 million due to a decline in mortgage loan origination volume. The $3.0 million or 30% improvement over 2004 included increases in all individual components with the exception of trust fees which were unchanged.

Revenues from trust services increased $668,000 or 23% to $3.6 million for 2006. Trust fees are primarily based on the underlying values of trust assets managed. An increase in both the market valuation of assets held in trust accounts and a continued increase in new trust customers contributed to the strong increase in 2006. Despite also gaining new trust customers in 2005, trust fees remained relatively flat at $2.9 million for 2005 compared to 2004 due to a decline in the market valuation of assets held in the trust accounts.

Deposit service charge income increased $551,000 or 13% to $4.9 million for 2006 compared to $4.3 million for 2005 and $3.0 million for 2004. The increase in 2006 and 2005 reflects the continued expansion of our deposit customer account base as we have grown. An overdraft privilege service implemented at the beginning of the second quarter of 2005 was well received and was also a large contributor to the increase in deposit service charge income in 2005.

Other income increased $569,000 in 2006 and $1.5 million in 2005. The increase in other income for both years included increases in miscellaneous fee categories associated with volume increases as we have grown. These fee categories include debit card and ATM processing income and revenues from mutual fund and annuity sales. The increase in 2006 and 2005 also included an additional $373,000 and $499,000, respectively, of income earned on bank-owned life insurance purchased during the fourth quarter of 2004. Also included in other income for 2005 was $348,000 in gains on the sale of two commercial properties, one previously held as other real estate.

Gain on sales of loans primarily includes gains on the sale of real estate mortgage loans, and to a lesser extent, gains on the sale of the SBA guaranteed portion of certain commercial loans. We sell the majority of the fixed-rate mortgage loans we originate. We do not retain the servicing rights for the loans we sell. A summary of gain on sales of loans and related volume is as follows:

Gain on sales of loans decreased $615,000 in 2006 compared to 2005, while 2005 increased $129,000 compared to 2004. Mortgage interest rate levels have steadily increased since 2004, resulting in a continued decline in the level of residential refinancing and loan originations. An improvement in the loan sales margin received on residential loans sold during 2005 offset the decline in volume from 2004. The general improvement in our loan sales margin since 2004 reflects an improvement in our competitive position with our secondary market investors and greater discipline in our pricing practices. Considering the higher level of mortgage interest rates, we expect the volume of originations going forward to be more consistent with 2006 levels.

Noninterest Expense: Noninterest expense totaled $44.9 million for 2006 as compared to $41.4 million for 2005 and $35.4 million for 2004. Salaries and benefits increased $2.4 million in 2006 over 2005 and $3.2 million in 2005 over 2004, comprising the majority of the increase in both years.

The increase in salaries and benefits for 2006 and 2005 is primarily related to additional staffing in each line of business and in support departments consistent with growth of the Bank. Effective January 1, 2006, we adopted FAS 123, Revised, and accordingly, we recorded stock option compensation expense of $657,000 in 2006. Increased incentives associated with strong performance also contributed to the increase in salaries and benefits during 2005. The consistent increase in salaries and benefits reflects our attention to properly managing and supporting our growth and our interest in creating a platform for strong future growth.

The increase in occupancy expense of $319,000 in 2006 and $586,000 in 2005 and the increase in furniture and equipment expense of $246,000 in 2006 and $207,000 in 2005 are consistent with our branch and facilities expansion during these periods. We would expect the level of increase in these expense categories to be commensurate with our plans for future branch expansion.

Data processing fees were up $172,000 in 2006 and $510,000 in 2005. In September of 2004, we outsourced our item processing function which was the primary reason for the increase in 2005. We expect future increases to be consistent with the Company’s growth.

Other expense increased $279,000 in 2006 and $1.3 million in 2005. The increase in both periods includes increases in various expense categories consistent with the growth of our company. These categories include expenses associated with debit card and ATM processing, customer and internal courier, and various outside service contracts. The level of the increase in most expense categories moderated in 2006 as a result of our expense control and the continued improvement in the efficiency of our bank’s operations as we have grown.

The level of the increase in most expense categories moderated in 2006 as a result of our expense control and the continued improvement in the efficiency of our bank’s operations as we have grown.

Federal Income Tax Expense: Our federal income tax expense has increased generally commensurate with our increase in pre-tax earnings. Our federal income tax expense is lower than the amount computed by applying our statutory federal income tax rate to our pre-tax earnings primarily due to tax-exempt interest income. Our effective tax rate was 31.5%, 32.1% and 31.9% in 2006, 2005 and 2004, respectively.

FINANCIAL CONDITION

Summary: Our total assets were $2.07 billion at December 31, 2006, an increase of $204.8 million from $1.87 billion in total assets at December 31, 2005. We believe the continued strong asset growth reflects the acceptance of our full-service community banking philosophy in the growing communities we serve. Our asset growth consists primarily of growth in our loan portfolio as we continue to attract new loan customers and deepen relationships with existing customers despite the strong competition from other locally based community banks and larger regional banks. Total portfolio loans increased $163.6 million or 11% during 2006. The growth in total assets also included growth in our investment securities portfolio and premises and equipment.

The increase in total assets was principally funded by deposit growth. Deposits grew by $159.8 million during 2006, an 11% growth rate. We attribute the deposit growth to our quality customer service, the desire of our customers to bank with a locally run bank, and convenient accessibility through the expansion of our branch network and other delivery channels.

Cash and Cash Equivalents: Our cash and cash equivalents, which include federal funds sold and short-term investments, were $39.9 million at December 31, 2006, as compared to $49.1 million at December 31, 2005. The balance at the end of 2005 was elevated due to a large inflow of customer deposits that occurred right at the end of the year.

Securities: Securities increased $40.7 million or 25% to $201.3 million at December 31, 2006 from $160.6 million at December 31, 2005. We maintain our security portfolio at a level to provide diversity in the risk nature of our assets, to support our liquidity needs and to balance our interest rate risk. Our portfolio consists primarily of high quality U.S government agency and state and local municipal bonds classified as available for sale. These securities are generally purchased at fixed rates to help offset the interest sensitivity of our variable rate loan portfolio. We expect continued growth of our securities portfolio generally consistent with the growth of our company to maintain the diversity of our assets and support our liquidity and interest rate risk management.

Loan Portfolio and Asset Quality: Our total loan portfolio increased to $1.71 billion at December 31, 2006 from $1.55 billion at December 31, 2005. The $163.6 million increase in portfolio loans continues our consistent pattern of growth. Each of our loan portfolios, including commercial and commercial real estate, residential real estate and consumer loans grew during 2006. The strongest growth was in the commercial and commercial real estate portfolios, which grew by 12%. We believe the continued growth we have experienced in each of our loan portfolios is a result of our focus on providing high quality customer service and reflects the acceptance of our full-service community banking philosophy in the growing communities we serve.

The majority of loans that we retain in our portfolio are to small and mid-sized businesses in the form of commercial and commercial real estate loans. Our combined commercial loan portfolios accounted for approximately 76% and 74% of our total portfolio loans at December 31, 2006 and 2005, respectively. The $1.29 billion in commercial and commercial real estate loans at December 31, 2006 represents an increase of $138.9 million over the $1.15 billion at December 31, 2005. A further breakdown in the composition of the commercial real estate loan portfolio is shown in the table below (in thousands):

Approximately two-thirds of the balance in the construction and land development category and the entire balance in the multi-family category are comprised of non-owner occupied loans as of both December 31, 2006 and December 31, 2005.

We feel the consistent growth in commercial loans that we have been able to achieve reflects the acceptance of our lending approach by our customers and the ability of our lending team to respond to their needs effectively. Our commercial loan department is built around a well-seasoned officer team and our lending approach involves an efficient loan approval process focused around local decision-making.

The residential real estate portfolio increased from $223.4 million at December 31, 2005 to $224.8 million at December 31, 2006. Our residential real estate loan portfolio, which also includes residential construction loans made to individual homeowners, comprised approximately 13% of portfolio loans at the end of 2006. Our residential real estate portfolio represents only a small portion of our residential origination loan volume, as we sell the majority of our fixed-rate obligations on the secondary market with servicing released to reduce our exposure to interest rate risk. We originated for sale $103.7 million in residential mortgages in 2006, $137.0 million in 2005, and $141.7 million in 2004. Loans held for sale were $1.5 million at December 31, 2006 as compared to $2.3 million at December 31, 2005. The gradual decline in residential refinancing and loan originations is a result of the generally rising level of longer-term interest rates that has occurred since 2004.

Our consumer loan portfolio includes both loans secured by personal property, as well as home equity fixed term and line of credit loans. Our consumer loan portfolio increased to $194.8 million at December 31, 2006 from $171.5 million at December 31, 2005. Consumer loans comprised approximately 11% of our portfolio loans at the end of both 2006 and 2005.

As we continue to leverage our expansive branch network and strengthen our presence in the markets we serve, we anticipate further growth in each of our loan portfolios consistent with our historical growth patterns.

Nonperforming assets are comprised of nonperforming loans, foreclosed assets and repossessed assets. Our nonperforming loans include loans on non-accrual status, restructured loans and loans delinquent more than 90 days but still accruing. Nonperforming loans as of December 31, 2006 totaled $22.3 million or 1.30% of total portfolio loans compared to $4.2 million or 0.27% of total portfolio loans at December 31, 2005.

The balance of nonperforming loans at the end of 2006 includes one large commercial relationship totaling approximately $15.2 million. The loans for this relationship came due in September 2006 but were not renewed as of December 31, 2006 due to their size and complexity. The loans continued to accrue interest as we expected to collect all amounts owed. The Bank and the borrower, a land development partnership, have entered into an agreement and the new loans closed on January 31, 2007. The remaining balance of nonperforming loans at the end of 2006 and the balance of nonperforming loans at the end of 2005 consist of a number of smaller commercial loans most of which are on nonaccrual for which we consider to be well collateralized or adequately reserved. The majority of nonperforming loans at the end of 2004 related to one commercial borrower. The loans associated with this borrower became impaired due to fraud perpetrated by the borrower. The borrower has since ceased operations. Proceeds from the liquidation of collateral, payments on outstanding receivables and additional charge-offs reduced our balances from this relationship to zero at the end of 2006 and approximately $229,000 at the end of 2005, from $2.3 million at year-end 2004.

Our loan portfolio is reviewed regularly by an external loan review team, our own loan officers, and our senior management. When reasonable doubt exists concerning collectibility of interest or principal of one of our loans, that loan is placed in non-accrual status. Any interest previously accrued but not collected is reversed and charged against current earnings.

Foreclosed assets include assets acquired in settlement of loans. As of December 31, 2006 foreclosed assets totaled $3.2 million compared to $527,000 as of December 31, 2005. The balance at the end of 2006 is comprised of several real estate properties for which no loss is expected upon disposition.

Total nonperforming assets amounted to $25.6 million or 1.23% of total assets as of December 31, 2006 compared to $4.9 million or 0.26% of total assets as of December 31, 2005. The following table shows the composition and amount of our nonperforming assets.

Allowance for Loan Losses: Our allowance for loan losses as of December 31, 2006 was $23.3 million, representing approximately 1.36% of total portfolio loans outstanding, compared to $21.0 million or 1.36% of total loans at December 31, 2005.

Our allowance for loan losses is maintained at a level considered appropriate based upon our regular, quarterly assessments of the probable estimated losses inherent in the loan portfolio. Our methodology for measuring the appropriate level of allowance relies on several key elements, which include specific allowances for loans considered impaired, formula allowance for graded loans, general allocations based on historical trends for pools of similar loan types and under certain circumstances, an unallocated reserve related to current market conditions that are pertinent to certain aspects of the loan portfolio.

During the fourth quarter of 2006, regulatory authorities reached a conceptual consensus on the method for determining the allowance. In addition to reaffirming the importance of experience grounded, objectively determinable amounts, they acknowledged the appropriateness of considering other subjective factors in determining the proper level of the allowance. We believe our process conforms to this guidance.

Specific allowances are established in cases where senior credit management has identified significant conditions or circumstances related to an individually impaired credit that we believe indicates the probability that a loss may be incurred. This amount is determined by methods prescribed by SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”. The specific allowance for impaired loans was $400,000 at December 31, 2006 and $333,000 at December 31, 2005.

The allowance allocated to commercial loans that are not considered to be impaired is calculated by applying loss factors to outstanding loans based on the internal risk grade of such loans. We use a loan rating method based upon an eight point system. Loans are assigned a loss allocation factor for each loan classification category. The lower the grade assigned to a loan category, the greater the allocation percentage that is applied. Changes in risk grade of loans affect the amount of the allowance allocation. Our loan portfolio has grown rapidly since our inception. As a result, a significant portion of our loan portfolio remains relatively unseasoned and our actual historical loan loss experience is limited. Accordingly, the determination of our loss factors includes consideration of the banking industry’s historical loan loss experience by loan type and the historical loan loss experience within our geographic markets, as well as our own loan loss experience and trends. These factors are regularly monitored and adjusted for significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the analysis date. The commercial loan allowance was $21.0 million at December 31, 2006 compared to $18.6 million at December 31, 2005 and increased primarily in response to the continuing growth in the commercial loan portfolio. The increase of $2.3 million in the total allowance for loan losses during 2006 was primarily related to this $2.4 million increase in the commercial loan allowance.

Groups of homogeneous loans, such as residential real estate, open- and closed-end consumer loans, etc., receive general allowance allocations based on loss trends. In lieu of an established loan loss trend for Macatawa Bank, we use historical loss trends based on industry experience and peers in determining an adequate allowance for probable losses associated with these pools of loans. General economic and business conditions, credit quality trends, collateral values, seasoning of the portfolios and recent loss experience are conditions considered in connection with allocation factors for these similar pools of loans. The general allowance was $1.8 million at December 31, 2006 and $2.1 million at December 31, 2005.

The continued increase in the allowance was deemed necessary given the significant growth in loans. However, the allowance for loan losses as a percent of total loans remained unchanged at 1.36%. Based upon our internal analysis, in our judgment, we have provided adequate allowances for loan losses, although there can be no assurance that the allowance for losses on loans will be adequate to cover all losses.

The following table shows the allocation of the allowance for loan loss at the dates indicated to the extent specific allocations have been determined relative to particular loans.

The above allocations are not intended to imply limitations on usage of the allowance. The entire allowance is available for any loan losses without regard to loan type. The allowance amounted to $23.3 million at December 31, 2006. Of this total, 2% related to specific allocations on impaired loans, 90% related to commercial loan portfolio allocations and 8% related to general allocations.

Net charge-offs totaled $5.4 million, or 0.33% of average loans for 2006 compared to $1.9 million, or 0.13% of average loans for 2005 and $4.7 million, or 0.37% of average loans for 2004. Net charge-offs in 2006 include a $4.7 million charge-off related to $5.2 million in outstanding loans to one commercial borrower. The impairment of the loans to this borrower was discovered in March 2007 through internal investigations relating to the collateral. The collateral was not of sufficient value to cover the outstanding principal on these loans and it is likely that the borrower will be unable to meet the repayment terms of the loans. The internal investigation suggests that the borrower may have made misrepresentations to the Bank regarding the loan collateral and its financial condition. Because of these misrepresentations and the timing of our discovery of them, the allowance for loan losses did not contain sufficient allocations related to this borrower. As such, an additional provision for loan losses amounting to $4.7 million was recorded as of December 31, 2006 in order to maintain the allowance for loan losses at a level considered adequate in our judgment. The remaining balance of the loans to this borrower, amounting to $495,000, was included in non-accrual loans as of December 31, 2006. Net charge-offs in 2006, excluding this large single charge-off were low compared to the prior two years. Strong collateral positions on nonperforming loans that were resolved during 2006 allowed for this low level of net charge-offs. As previously noted under the section Loan Portfolio and Asset Quality, the level of net charge-offs for 2004 relates primarily to a $2.8 million charge-off associated with the impaired loans to one commercial borrower. The following is a summary of our loan balances, changes in the allowance for loan losses and related ratios.

(Dollars in thousands)			December 31
			2006			2005			2004
Loans:
Average daily balance of loans for the year			$	1,636,710		$	1,473,558		$	1,295,887
Amount of loans outstanding at end of period				1,711,450			1,547,879			1,396,387
Allowance for loan losses:
Balance at beginning of year			$	20,992		$	19,251		$	16,093
Addition to allowance charged to operations				7,715			3,675			7,890
Loans charged-off:
Commercial				(5,601	)		(1,842	)		(4,833	)
Residential real estate				(43	)		(24	)		(21	)
Consumer				(410	)		(371	)		(91	)
Recoveries:
Commercial				399			261			180
Residential real estate				10			17			11
Consumer				197			25			22
Balance at end of year			$	23,259		$	20,992		$	19,251
Ratios:
Net charge-offs to average loans outstanding				.33	%		.13	%		.37	%
Allowance for loan losses to loans outstanding
at year end				1.36	%		1.36	%		1.38	%

Premises and Equipment: Premises and equipment totaled $60.7 million at December 31, 2006, an increase of $7.7 million from December 31, 2005. The increase included costs associated with the construction of a new regional facility in downtown Holland and a new branch site in Grand Rapids. Both are expected to open in the first quarter of 2007.

Deposits: Total deposits increased $159.8 million to $1.67 billion at December 31, 2006, as compared to $1.51 billion at December 31, 2005. The majority of growth during the year was in interest bearing deposits, including interest bearing checking, money market and time deposit accounts, as deposit customers preferred such accounts within the generally high rate environment. Interest bearing checking accounts increased $57.7 million to $265.7 million, money market accounts grew $79.0 million to $459.0 million and time deposits within our markets increased $43.5 million to $449.6 million at the end of 2006. Because of the strong growth from deposits within our markets, we were able to rely less on brokered deposits during 2006. Brokered deposits declined $11.3 million to $272.9 million at the end of 2006. With our continued focus on quality customer service, the desire of customers to deal with a local bank, and the convenience of our expanding and maturing branch network, we expect further growth from deposits within our markets.

Noninterest bearing demand accounts comprised approximately 11% of total deposits at December 31, 2006, as compared to approximately 12% of total deposits at the end of 2005. Interest bearing demand, including money market, and savings accounts comprised approximately 46% of total deposits at December 31, 2006, as compared to 42% at the end of last year. Time accounts as a percentage of total deposits were approximately 43% at December 31, 2006, as compared to 46% at December 31, 2005.

Borrowed Funds: Borrowed funds consist of advances from the Federal Home Loan Bank, securities sold under agreements to repurchase (“repo borrowings”), long-term debt associated with the issuance of trust preferred securities and federal funds purchased provided by our correspondent banks. Additionally, we have a $10.0 million credit facility available for general corporate needs including contributing capital to our subsidiary bank to enable it to maintain regulatory capital at well-capitalized levels. This credit facility was unused during all of 2006 and 2005.

Borrowed funds totaled $245.2 million at December 31, 2006, including $172.0 million of Federal Home Loan Bank advances, $20.0 million in repo borrowings, $41.2 million in long-term debt associated with trust preferred securities and $12.0 million in federal funds purchased. Borrowed funds totaled $212.2 million at December 31, 2005 including $145.2 million of Federal Home Loan Bank advances, $41.2 million in long-term debt associated with trust preferred securities and $25.8 million in federal funds purchased. The increase in borrowed funds in 2006 was used to support growth in assets.

CAPITAL RESOURCES AND LIQUIDITY

Capital Resources: Total shareholders’ equity was $156.8 million at December 31, 2006 compared to $141.7 million at December 31, 2005. The increase of $15.1 million was primarily the result of retained net income (net of cash dividends paid). Net income generated during 2006 of $19.8 million was partially offset by cash dividends of $7.9 million, or $.48 per share. We began paying cash dividends at the end of 2000 and have increased the amount of the dividend each year since. It is anticipated that we will continue to pay quarterly cash dividends in the future. We have also paid a stock dividend each year beginning in 2001. A 5% stock dividend was paid in May 2006, resulting in a transfer of $15.1 million from retained earnings to common stock. In addition, a 3-for-2 stock split was paid in June 2006.

The change in accumulated other comprehensive income was due to an increase in both the market value of securities available for sale and the derivative instruments associated with the Company’s interest rate swap arrangements due principally to the changes in interest rates during 2006. For more information regarding our interest rate swap arrangements, see the Notes to the Consolidated Financial Statements.

The Corporation was categorized as “well capitalized” for regulatory capital purposes at December 31, 2006 and 2005. The following table shows the Company’s various capital ratios for 2006 and 2005.

Growth in capital from strong earnings in 2006 was consistent with the growth in assets resulting in the stable capital ratios from 2005 to 2006. Of the $40.0 million of trust preferred securities outstanding at December 31, 2006, approximately $38.0 million qualified as Tier 1 capital with the remaining qualifying as Tier 2 capital. For more information regarding the trust preferred securities, please refer to the Notes to the Consolidated Financial Statements.

We believe the additional regulatory capital provided by the trust preferred security issuances, as supplemented by our improvement in earnings, will support our growth plans in the near future. Additional capital may be necessary within the next three to four years if our growth continues at its current pace. Capital sources include, but are not limited to, additional common stock offerings, trust preferred securities offerings and subordinated debt.

Liquidity: The liquidity of a financial institution reflects its ability to manage a variety of sources and uses of funds. Our Consolidated Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus on developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for growing our investment and loan portfolios. Our sources of liquidity include our borrowing capacity with the Federal Home Loan Bank, federal funds purchased lines and other secured borrowing sources with our correspondent banks, loan payments by our borrowers, maturity and sales of our securities available for sale, growth of our deposits and deposit equivalents, federal funds sold, and the various capital resources discussed above. Liquidity management involves the ability to meet the cash flow requirements of our customers. Our customers may be either borrowers with credit needs or depositors wanting to withdraw funds. We feel our liquidity position is sufficient to meet these needs.

In the normal course of business, we enter into certain contractual obligations including obligations which are considered in our overall liquidity management. The table below summarizes our significant contractual obligations as December 31, 2006.

In addition to normal loan funding, we also maintain liquidity to meet customer financing needs through unused lines of credit, unfunded loan commitments and standby letters of credit. The level and fluctuation of these commitments is also considered in our overall liquidity management. At December 31, 2006, we had a total of $470.9 million in unused lines of credit, $25.9 million in unfunded loan commitments, and $27.3 million in standby letters of credit.

SENSITIVITY TO MARKET RISK

Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of our transactions are denominated in U.S. dollars with no specific foreign exchange exposure. Macatawa Bank has only limited agricultural-related loan assets, and therefore has no significant exposure to changes in commodity prices. Our market risk exposure is mainly comprised of our sensitivity to interest rate risk. Our balance sheet has sensitivity, in various categories of assets and liabilities, to changes in prevailing rates in the U.S., including the Federal funds rate, the prime rate, mortgage rates, U.S. Treasury rates and various money market indexes. Our asset/liability management process aids us in providing liquidity while maintaining a balance between interest earning assets and interest bearing liabilities.

We use two interest rate risk measurement techniques in our interest rate risk management. We first use a static gap analysis to identify overall changes in the repricing periods of assets and liabilities. This measures the difference between the dollar amounts of interest sensitive assets and liabilities that may be refinanced or repriced during a given time period. A significant repricing gap could result in a negative impact to our net interest margin during periods of changing market interest rates. The following table illustrates our interest rate repricing gaps for selected maturity periods at December 31, 2006.

Static Gap Analysis (dollars in thousands)			0 to 3 months			4 to 12 months			1 to 5 years			Over 5 Years			Total
Assets:
Taxable securities			$	---		$	7,944		$	138,966		$	981		$	147,891
Tax exempt securities				---			715			3,257			49,394			53,366
FHLB stock				12,275			---			---			---			12,275
Loans-fixed (a)				49,874			95,359			533,001			94,714			772,948
Loans-variable (a)				779,876			35,378			115,532			1,905			932,691
Other assets, net				---			---			---			---			155,645
Total assets			$	842,025		$	139,396		$	790,756		$	146,994		$	2,074,816
Liabilities:
Noninterest bearing deposits			$	---		$	---		$	---		$	---		$	180,032
Other interest bearing deposits				724,909			---			---			---			724,909
Savings				40,160			---			---			---			40,160
Time deposits				205,720			275,271			241,345			120			722,456
Other borrowings				73,228			47,000			117,018			8,000			245,246
Other liabilities & equity				---			---			---			---			162,013
Total liabilities & equity			$	1,044,017		$	322,271		$	358,363		$	8,120		$	2,074,816
Period gap			$	(201,497	)	$	(182,875	)	$	432,393		$	138,874
Cumulative gap			$	(201,497	)	$	(384,372	)	$	48,021		$	186,895
Cumulative gap/total assets				(9.71	)%		(18.53	)%		2.31	%		9.01	%

(a)     Does not include loans on non-accrual.

The above table shows that total liabilities maturing or repricing within three months exceeded assets maturing within the same time period. The analysis, however, does not consider the different rate sensitivities of certain assets or liabilities to changes in market rates or reflect the magnitude of interest rate changes on net interest income. In addition, cash flows and repricing characteristics for various categories of assets and liabilities are subject to competitive pressures, consumer sentiments and other influences that are beyond our control and are not reflected in this static analysis. As a result, various assets and liabilities indicated as maturing or repricing within a stated period may reprice at different levels and mature or reprice in other periods or at different volumes.

Accordingly, we also utilize a simulation model to assess the direction and magnitude of variations in net interest income and the economic value of equity (“EVE”) resulting from potential changes in market interest rates. Key assumptions in the model include the repricing of cash flows and maturities of interest-sensitive assets and interest-sensitive liabilities at current market rates, prepayment speeds on certain assets, and changes in market conditions impacting loan and deposit pricing. We also assume certain levels of rate sensitivity to changes in market rates of our non-maturing transaction deposits based upon our historical sensitivity under previous interest rate cycles, and we include pricing floors on discretionary priced liability products which limit how low various checking and savings products could go under declining interest rates. These assumptions reflect our pricing philosophy in response to changing interest rates.

The simulation analysis also considers the interest rate swaps we have entered into which have the effect of converting $80.0 million in variable rate loans repricing immediately into fixed rate loans repricing in one to five years. The interest rate swaps are more fully discussed in the Notes to the Consolidated Financial Statements.

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

The following table shows the impact of changes in interest rates on net interest income over the next twelve months and EVE based on our balance sheet as of December 31, 2006 (dollars in thousands).