form10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2012

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

For the transition period from _______ to _______

Commission file number: 000-25927

MACATAWA BANK CORPORATION

(Exact name of registrant as specified in its charter)

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

10753 Macatawa Drive, Holland, Michigan 49424

(Address of principal executive offices) (Zip Code)

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

Indicate by checkmark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

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

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

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

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

The number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 27,082,825 shares of the Company's Common Stock (no par value) were outstanding as of October 25, 2012.

Forward-Looking Statements

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

Risk factors include, but are not limited to, the risk factors described in "Item 1A - Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2011. These and other factors are representative of the risk factors that may emerge and could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.

INDEX

		Page
		Number

Part I.	Financial Information:

	Item 1.
	Consolidated Financial Statements	4
	Notes to Consolidated Financial Statements	9

	Item 2.
	Management's Discussion and Analysis of Financial Condition and Results of Operations	37

	Item 4.
	Controls and Procedures	52

Part II.	Other Information:

	Item 6.
	Exhibits	53

Signatures		55

Index

Part I Financial Information

Item 1.

MACATAWA BANK CORPORATION

CONSOLIDATED BALANCE SHEETS

As of September 30, 2012 (unaudited) and December 31, 2011

(dollars in thousands, except per share data)	September 30, 2012			December 31, 2011
ASSETS
Cash and due from banks	$	22,398		$	30,971
Federal funds sold and other short -term investments		211,853			212,071
Cash and cash equivalents		234,251			243,042

Securities available for sale, at fair value		116,128			54,746
Securities held to maturity (fair value 2012 - $4,300 and 2011 - $300)		4,300			300
Federal Home Loan Bank (FHLB) stock		11,236			11,236
Loans held for sale, at fair value		11,063			1,026
Total loans		1,019,185			1,070,975
Allowance for loan losses		(26,271	)		(31,641	)
Net loans		992,914			1,039,334

Premises and equipment – net		54,057			55,358
Accrued interest receivable		3,719			3,595
Bank-owned life insurance		26,614			25,957
Other real estate owned		57,778			66,438
Other assets		5,057			6,635
Total assets	$	1,517,117		$	1,507,667

LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing	$	348,120		$	324,253
Interest-bearing		896,628			891,036
Total deposits		1,244,748			1,215,289
Other borrowed funds		91,822			148,603
Long-term debt		41,238			41,238
Subordinated debt		1,650			1,650
Accrued expenses and other liabilities		28,228			6,461
Total liabilities		1,407,686			1,413,241

Commitments and contingent liabilities		---			---

Shareholders' equity
Preferred stock, no par value, 500,000 shares authorized;
Series A Noncumulative Convertible Perpetual Preferred Stock, liquidation value of $1,000 per share, 31,290 shares issued and outstanding		30,604			30,604
Series B Noncumulative Convertible Perpetual Preferred Stock, liquidation value of $1,000 per share, 2,600 shares issued and outstanding		2,560			2,560
Common stock, no par value, 200,000,000 shares authorized; 27,082,825 and 27,082,823 shares issued and outstanding at September 30, 2012 and December 31, 2011		187,709			187,709
Retained deficit		(112,569	)		(126,825	)
Accumulated other comprehensive income		1,127			378
Total shareholders' equity		109,431			94,426
Total liabilities and shareholders' equity	$	1,517,117		$	1,507,667

See accompanying notes to consolidated financial statements.

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Index

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

Three and Nine Month Periods Ended September 30, 2012 and 2011

(unaudited)

(dollars in thousands, except per share data)	Three Months Ended September 30, 2012			Three Months Ended September 30, 2011			Nine Months Ended September 30, 2012			Nine Months Ended September 30, 2011
Interest income
Loans, including fees	$	15,532		$	14,498		$	42,295		$	45,274
Securities
Taxable		414			156			1,116			267
Tax-exempt		102			10			210			11
FHLB Stock		84			73			252			223
Federal funds sold and other short-term investments		137			163			394			468
Total interest income		16,269			14,900			44,267			46,243

Interest expense
Deposits		1,396			2,104			4,570			7,431
Debt and other borrowed funds		981			1,295			3,203			3,931
Total interest expense		2,377			3,399			7,773			11,362

Net interest income		13,892			11,501			36,494			34,881
Provision for loan losses		(1,250	)		(1,250	)		(6,600	)		(4,700	)
Net interest income after provision for loan losses		15,142			12,751			43,094			39,581

Noninterest income
Service charges and fees		810			889			2,381			2,806
Net gains on mortgage loans		940			697			2,192			1,393
Trust fees		595			644			1,802			1,915
Gain on sale of securities		14			---			73			---
ATM and debit card fees		1,049			1,013			3,094			2,958
Other		698			684			2,275			2,149
Total noninterest income		4,106			3,927			11,817			11,221

Noninterest expense
Salaries and benefits		5,621			5,668			17,065			16,615
Occupancy of premises		948			961			2,860			2,961
Furniture and equipment		806			812			2,491			2,458
Legal and professional		160			187			551			779
Marketing and promotion		213			228			634			677
Data processing		269			314			988			952
FDIC assessment		504			842			1,692			2,660
ATM and debit card processing		316			337			912			918
Bond and D&O Insurance		213			379			696			1,136
FHLB Advance prepayment penalty		322			---			322			---
Losses on repossessed and foreclosed properties		706			2,544			4,236			7,157
Administration and disposition of problem assets		1,018			1,941			3,737			5,503
Other		1,292			1,413			4,196			4,243
Total noninterest expenses		12,388			15,626			40,380			46,059

Income before income tax		6,860			1,052			14,531			4,743
Income tax expense (benefit)		275			---			275			---

Net income		6,585			1,052			14,256			4,743
Dividends declared on preferred shares		---			---			---			---
Net income available to common shares	$	6,585		$	1,052		$	14,256		$	4,743

Basic earnings per common share	$	0.24		$	0.04		$	0.53		$	0.22
Diluted earnings per common share	$	0.24		$	0.04		$	0.53		$	0.22
Cash dividends per common share	$	---		$	---		$	---		$	---

See accompanying notes to consolidated financial statements.

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Index

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Three and Nine Month Periods Ended September 30, 2012 and 2011

(unaudited)

(dollars in thousands)	Three Months Ended September 30, 2012			Three Months Ended September 30, 2011		Nine Months Ended September 30, 2012			Nine Months Ended September 30, 2011

Net income	$	6,585		$	1,052	$	14,256		$	4,743

Other comprehensive income, net of tax:
Net unrealized gains on securities available for sale arising during period		462			174		822			326

Less: reclassification adjustment for securities gain recognized in earnings, net of tax		(14	)		---		(73	)		---
Other comprehensive income, net of tax		448			174		749			326


Comprehensive income	$	7,033		$	1,226	$	15,005		$	5,069

See accompanying notes to consolidated financial statements.

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Index

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

Nine Month Periods Ended September 30, 2012 and 2011

(unaudited)

	Preferred Stock				Common		Retained			Accumulated Other Comprehensive		Total Shareholders'
(dollars in thousands, except per share data)	Series A		Series B		Stock		Deficit			Income		Equity

Balance, January 1, 2011	$	30,604	$	2,560	$	167,321	$	(132,654	)	$	11	$	67,842

Net income for nine months ended September 30, 2011								4,743					4,743

Net change in unrealized gain on securities available for sale, net of tax											326		326


Net proceeds from sale of 8,912,372 shares of common stock on June 7, 2011 and June 29, 2011						19,358							19,358

Conversion of subordinated note to 491,830 shares of common stock on June 29, 2011						1,003							1,003

Stock compensation expense						57							57

Balance, September 30, 2011	$	30,604	$	2,560	$	187,739	$	(127,911	)	$	337	$	93,329

Balance, January 1, 2012	$	30,604	$	2,560	$	187,709	$	(126,825	)	$	378	$	94,426

Net income for nine months ended September 30, 2012								14,256					14,256

Net change in unrealized gain on securities available for sale, net of tax											749		749

Balance, September 30, 2012	$	30,604	$	2,560	$	187,709	$	(112,569	)	$	1,127	$	109,431

See accompanying notes to consolidated financial statements.

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Index

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

Nine Month Periods Ended September 30, 2012 and 2011

(unaudited)

(dollars in thousands)	Nine Months Ended September 30, 2012			Nine Months Ended September 30, 2011
Cash flows from operating activities
Net income	$	14,256		$	4,743
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		2,171			2,308
Stock compensation expense		---			57
Provision for loan losses		(6,600	)		(4,700	)
Origination of loans for sale		(100,885	)		(59,273	)
Proceeds from sales of loans originated for sale		93,040			57,847
Net gains on mortgage loans		(2,192	)		(1,393	)
Gain on sale of securities		(73	)		---
Write-down of other real estate		4,247			8,336
Net gain on sales of other real estate		(11	)		(1,191	)
FHLB advance prepayment penalty		322			---
Decrease (increase) in accrued interest receivable and other assets		1,050			(151	)
Earnings in bank-owned life insurance		(657	)		(711	)
Increase in accrued expenses and other liabilities		1,445			151
Net cash from operating activities		6,113			6,023

Cash flows from investing activities
Loan originations and payments, net		44,018			94,785
Purchases of securities available for sale		(98,909	)		(53,972	)
Purchases of securities held to maturity		(4,000	)		---
Proceeds from:
Maturities and calls of securities available for sale		31,612			21,494
Sale of securities available for sale		4,595			---
Principal paydowns on securities		2,198			107
Sales of other real estate		13,426			16,370
Redemption of FHLB stock		---			696
Additions to premises and equipment		(522	)		(634	)
Net cash from investing activities		(7,582	)		78,846

Cash flows from financing activities
Net increase (decrease) in in-market deposits		29,459			(31,546	)
Decrease in brokered deposits		---			(44,516	)
Proceeds from other borrowed funds		---			10,000
Repayments of other borrowed funds		(36,781	)		(21,733	)
Proceeds from issuance of subordinated note		---			1,000
Proceeds from sale of common stock, net		---			19,358
Net cash from financing activities		(7,322	)		(67,437	)

Net change in cash and cash equivalents		(8,791	)		17,432
Cash and cash equivalents at beginning of period		243,042			236,127
Cash and cash equivalents at end of period	$	234,251		$	253,559
Supplemental cash flow information
Interest paid	$	6,754		$	10,589
Federal income taxes		100			---
Supplemental noncash disclosures:
Transfers from loans to other real estate		9,002			32,015
Securities purchased not settled		1,393			---
Conversion of subordinated note to 491,830 shares of common stock		---			1,003
FHLB advance repayment not settled		20,000			---

See accompanying notes to consolidated financial statements.

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Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

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

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

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

Operating results for the three and nine month periods ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. For further information, refer to the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

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

Regulatory Developments:

Termination of Consent Order with Macatawa Bank and its Regulators

On February 22, 2010, the Bank entered into a Consent Order with the Federal Deposit Insurance Corporation (“FDIC”) and the Michigan Office of Financial and Insurance Regulation ("OFIR"), the primary banking regulators of the Bank. The Bank agreed to the terms of the negotiated Consent Order without admitting or denying any charges of unsafe or unsound banking practices. The Consent Order imposed no fines or penalties on the Bank. As a result of the improvement in our financial condition and results of operations, our implementation of additional corporate governance practices and disciplined business and banking principles, and our compliance with the Consent Order, upon completion of the Bank’s 2011 joint examination by the FDIC and OFIR, the FDIC and OFIR terminated the Consent Order effective March 2, 2012.

In connection with the termination of the Consent Order, the Bank reached an understanding with the regulators in the form of a memorandum of understanding (“MOU”), which maintains many of the controls and procedures put in place by the Bank in response to the Consent Order, including: maintenance of a Tier 1 Leverage Capital Ratio of at least 8%, formulating and submitting a written plan of action on each asset classified as Substandard in the Report of Examination (“ROE”), charge-off of all assets classified as “Loss” in the ROE, submission of a written profit plan, Board review of the adequacy of the allowance for loan losses each quarter and the receipt of prior written consent of the FDIC and OFIR before the Bank declares or pays any dividends. We believe the Bank was in compliance in all material respects with all of the provisions of the MOU as of September 30, 2012.

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Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Written Agreement with Macatawa and its Regulator

The Company has formally entered into a Written Agreement with the Federal Reserve Bank of Chicago ("FRB"). The Written Agreement became effective on July 29, 2010, when it was executed and published by the FRB, and was assigned an effective date of July 23, 2010. Among other things, the Written Agreement provides that: (i) the Company must take appropriate steps to fully utilize its financial and managerial resources to serve as a source of strength to Macatawa Bank; (ii) the Company may not declare or pay any dividends without prior FRB approval; (iii) the Company may not take dividends or any other payment representing a reduction in capital from Macatawa Bank without prior FRB approval; (iv) the Company may not make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities without prior FRB approval; (v) the Company may not incur, increase or guarantee any debt without prior FRB approval; (vi) the Company may not purchase or redeem any shares of its stock without prior FRB approval; (vii) the Company must submit a written capital plan to the FRB within 60 days of the Written Agreement; and (viii) the Company may not appoint any new director or senior executive officer, or change the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, without prior regulatory approval. The Company separately requested and received approval from the FRB to make the third quarter 2012 quarterly interest payments on its $1.65 million in outstanding subordinated debt. Each quarter the Company requests approval from the FRB to make the next quarter's interest payment on its subordinated debt and is continuing to accrue the interest amounts due. We believe that as of September 30, 2012, the Company was in compliance in all material respects with all of the provisions of the Written Agreement.

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

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

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-classified loans and is based on historical loss experience adjusted for current qualitative factors. The Company maintains a loss migration analysis that tracks loan losses and recoveries based on loan class and the loan risk grade assignment for commercial loans. At September 30, 2012, an 18 month annualized historical loss experience was used for commercial loans and a 12 month historical loss experience period was applied to residential mortgage and consumer loan portfolios. These historical loss percentages are adjusted (both upwards and downwards) for certain qualitative factors, including economic trends, credit quality trends, valuation trends, concentration risk, quality of loan review, changes in personnel, external factors and other considerations.

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

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Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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

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

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

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

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

As of January 1, 2010, we no longer have the ability to carryback losses to prior years. The realization of our deferred tax assets is largely dependent on generating income in future years. At September 30, 2012, the need to maintain a full valuation allowance was based primarily on our net operating losses for recent years and the continuing weak economic conditions that could impact our ability to generate future earnings. 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.

Adoption of New Accounting Standards: The FASB has issued ASU 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The ASU is intended to improve financial reporting of repurchase agreements (“repos”) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. In a typical repo transaction, an entity transfers financial assets to a counterparty in exchange for cash with an agreement for the counterparty to return the same or equivalent financial assets for a fixed price in the future. Codification Topic 860, Transfers and Servicing, prescribes when an entity may or may not recognize a sale upon the transfer of financial assets subject to repo agreements. That determination is based, in part, on whether the entity has maintained effective control over the transferred financial assets. The amendments to the Codification in this ASU are intended to improve the accounting for these transactions by removing from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets. The guidance in the ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Adoption of this ASU did not have any effect as the Company does not currently hold any such repurchase agreements.

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Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

The FASB has issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance of the FASB and the IASB (the Boards) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs. The amendments to the Codification in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. Disclosure of the fair value levels of our financial assets and financial liabilities was added to Note 5 upon adoption of this standard in the first quarter of 2012.

The FASB has issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This ASU amends accounting standards to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. The amendments in the ASU do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. ASU 2011-05 should be applied retrospectively effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We early adopted this standard with our 2011 annual financial statements by adding a statement of comprehensive income.

- 12 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 2 – SECURITIES

The amortized cost and fair value of securities at period-end were as follows (dollars in thousands):

	Amortized		Gross Unrealized		Gross Unrealized			Fair
	Cost		Gains		Losses			Value
September 30, 2012
Available for Sale:
U.S. Treasury and federal agency securities	$	40,334	$	358	$	---		$	40,692
U.S. Agency MBS and CMOs		25,197		294		---			25,491
Tax-exempt state and municipal bonds		17,091		251		(23	)		17,319
Taxable state and municipal bonds		25,531		713		(8	)		26,236
Corporate bonds and other debt securities		4,741		74		---			4,815
Other equity securities		1,500		75		---			1,575
	$	114,394	$	1,765	$	(31	)	$	116,128
Held to Maturity
State and municipal bonds	$	4,300	$	---	$	---		$	4,300

December 31, 2011
U.Available for Sale:
U.S. Treasury and federal agency securities	$	27,408	$	205	$	---		$	27,613
U. S. Agency MBS and CMOs		3,853		33		---			3,886
Tax-exempt state and municipal bonds		4,292		116		---			4,408
Taxable state and municipal bonds		16,531		239		(54	)		16,716
Corporate bonds		1,081		1		(1	)		1,081
Other equity securities		1,000		42		---			1,042
	$	54,165	$	636	$	(55	)	$	54,746
Held to Maturity:
State and municipal bonds	$	300	$	---	$	---		$	300

Proceeds from the sale of securities available for sale were $540,000 and $4.6 million, respectively, for the three and nine month periods ended September 30, 2012, resulting in net gains of $14,000 and $73,000, respectively. There were no sales of securities in the three and nine month periods ended September 30, 2011.

Contractual maturities of debt securities at September 30, 2012 were as follows (dollars in thousands):

	Held–to-Maturity Securities				Available-for-Sale Securities
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value

Due in one year or less	$	4,000	$	4,000	$	1,400	$	1,400
Due from one to five years		---		---		39,645		40,520
Due from five to ten years		---		---		38,114		38,551
Due after ten years		300		300		33,735		34,082

	$	4,300	$	4,300	$	112,894	$	114,553

- 13 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 2 – SECURITIES (Continued)

Securities with unrealized losses at September 30, 2012 and December 31, 2011, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (dollars in thousands):

	Less than 12 Months					12 Months or More				Total
	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
September 30, 2012	Value		Loss			Value		Loss		Value		Loss

U.S. Treasury and federal agency securities	$	---	$	---		$	---	$	---	$	---	$	---
U.S. Agency MBS and CMOs		---		---			---		---		---		---
Tax-exempt state and municipal bonds		2,954		(23	)		---		---		2,954		(23	)
Taxable state and municipal bonds		2,109		(8	)		---		---		2,109		(8	)
Corporate bonds and other debt securities		---		---			---		---		---		---
Other equity securities		---		---			---		---		---		---

Total temporarily impaired	$	5,063	$	(31	)	$	---	$	---	$	5,063	$	(31	)

	Less than 12 Months					12 Months or More				Total
	Fair		Unrealized			Fair		Unrealized		Fair		Unrealized
December 31, 2011	Value		Loss			Value		Loss		Value		Loss

U.S. Treasury and federal agency securities	$	---	$	---		$	---	$	---	$	---	$	---
U.S. Agency MBS and CMOs		---		---			---		---		---		---
Tax-exempt state and municipal bonds		---		---			---		---		---		---
Taxable state and municipal bonds		6,196		(54	)		---		---		6,196		(54	)
Corporate bonds		539		(1	)						539		(1	)
Other equity securities		---		---			---		---		---		---

Total temporarily impaired	$	6,735	$	(55	)	$	---	$	---	$	6,735	$	(55	)

Other-Than-Temporary-Impairment

Management evaluates securities for other-than-temporary impairment ("OTTI") at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Management determined that no OTTI charges were necessary during the three and nine month periods ended September 30, 2012 and 2011.

At both September 30, 2012 and December 31, 2011, securities with a carrying value of approximately $2.0 million were pledged as security for public deposits, letters of credit and for other purposes required or permitted by law.

- 14 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS

Portfolio loans were as follows (dollars in thousands):

	September 30, 2012			December 31, 2011

Commercial and industrial	$	218,839		$	227,051

Commercial real estate:
Residential developed		29,004			33,829
Unsecured to residential developers		680			5,937
Vacant and unimproved		56,901			66,046
Commercial development		5,372			4,586
Residential improved		77,112			82,337
Commercial improved		264,041			304,070
Manufacturing and industrial		82,317			71,462
Total commercial real estate		515,427			568,267

Consumer
Residential mortgage		176,642			156,891
Unsecured		1,727			1,952
Home equity		93,407			101,074
Other secured		13,143			15,740
Total consumer		284,919			275,657

Total loans		1,019,185			1,070,975
Allowance for loan losses		(26,271	)		(31,641	)

	$	992,914		$	1,039,334

Activity in the allowance for loan losses by portfolio segment was as follows (dollars in thousands):

Three months ended September 30, 2012:	Commercial and Industrial			Commercial Real Estate			Consumer			Unallocated		Total
Beginning balance	$	6,638		$	15,239		$	5,254		$	49	$	27,180
Charge-offs		(239	)		(173	)		(203	)		---		(615	)
Recoveries		110			777			69			---		956
Provision for loan losses		(575	)		(552	)		(131	)		8		(1,250	)
Ending balance	$	5,934		$	15,291		$	4,989		$	57	$	26,271

Three months ended September 30, 2011:	Commercial and Industrial			Commercial Real Estate			Consumer			Unallocated			Total
Beginning balance	$	5,491		$	26,815		$	5,115		$	56		$	37,477
Charge-offs		(997	)		(2,190	)		(506	)		---			(3,693	)
Recoveries		87			2,113			108			---			2,308
Provision for loan losses		463			(980	)		(708	)		(25	)		(1,250	)
Ending balance	$	5,044		$	25,758		$	4,009		$	31		$	34,842

- 15 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

Nine months ended September 30, 2012:	Commercial and Industrial			Commercial Real Estate			Consumer			Unallocated		Total
Beginning balance	$	6,313		$	20,475		$	4,821		$	32	$	31,641
Charge-offs		(1,228	)		(2,679	)		(1,104	)		---		(5,011	)
Recoveries		390			5,662			189			---		6,241
Provision for loan losses		459			(8,167	)		1,083			25		(6,600	)
Ending balance	$	5,934		$	15,291		$	4,989		$	57	$	26,271

Nine months ended September 30, 2011:	Commercial and Industrial			Commercial Real Estate			Consumer			Unallocated		Total
Beginning balance	$	7,012		$	34,973		$	5,415		$	26	$	47,426
Charge-offs		(2,583	)		(7,716	)		(1,956	)		---		(12,255	)
Recoveries		1,364			2,750			257			---		4,371
Provision for loan losses		(749	)		(4,249	)		293			5		(4,700	)
Ending balance	$	5,044		$	25,758		$	4,009		$	31	$	34,842

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method (dollars in thousands):

September 30, 2012:

	Commercial and Industrial		Commercial Real Estate		Consumer		Unallocated		Total
Allowance for loan losses:
Ending allowance attributable to loans:
Individually reviewed for impairment	$	3,119	$	3,239	$	2,492	$	---	$	8,850
Collectively evaluated for impairment		2,815		12,052		2,497		57		17,421
Total ending allowance balance	$	5,934	$	15,291	$	4,989	$	57	$	26,271

Loans:
Individually reviewed for impairment	$	12,421	$	52,306	$	15,916	$	---	$	80,643
Collectively evaluated for impairment		206,418		463,121		269,003		---		938,542
Total ending loans balance	$	218,839	$	515,427	$	284,919	$	---	$	1,019,185

December 31, 2011:

	Commercial and Industrial		Commercial Real Estate		Consumer		Unallocated		Total
Allowance for loan losses:
Ending allowance attributable to loans:
Individually reviewed for impairment	$	3,478	$	4,367	$	1,752	$	---	$	9,597
Collectively evaluated for impairment		2,835		16,108		3,069		32		22,044
Total ending allowance balance	$	6,313	$	20,475	$	4,821	$	32	$	31,641

Loans:
Individually reviewed for impairment	$	17,331	$	52,195	$	15,085	$	---	$	84,611
Collectively evaluated for impairment		209,720		516,072		260,572		---		986,364
Total ending loans balance	$	227,051	$	568,267	$	275,657	$	---	$	1,070,975

- 16 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2012 (dollars in thousands):

	Unpaid Principal Balance		Recorded Investment		Allowance Allocated
With no related allowance recorded:
Commercial and industrial	$	2,415	$	2,123	$	---

Commercial real estate:
Residential developed		6,058		5,161		---
Unsecured to residential developers		---		---		---
Vacant and unimproved		1,362		1,321		---
Commercial development		215		215		---
Residential improved		3,982		3,195		---
Commercial improved		7,308		6,213		---
Manufacturing and industrial		4,774		4,774		---
		23,699		20,879		---
Consumer:
Residential mortgage		---		---		---
Unsecured		---		---		---
Home equity		200		200		---
Other secured		---		---		---
		200		200		---
	$	26,314	$	23,202	$	---

With an allowance recorded:
Commercial and industrial	$	10,298	$	10,298	$	3,119

Commercial real estate:
Residential developed		2,698		2,698		1,416
Unsecured to residential developers		---		---		---
Vacant and unimproved		2,613		2,613		239
Commercial development		---		---		---
Residential improved		8,983		8,983		760
Commercial improved		12,359		12,359		682
Manufacturing and industrial		4,774		4,774		142
		31,427		31,427		3,239
Consumer:
Residential mortgage		14,905		14,905		2,439
Unsecured		---		---		---
Home equity		811		811		53
Other secured		---		---		---
		15,716		15,716		2,492
	$	57,441	$	57,441	$	8,850

Total	$	83,755	$	80,643	$	8,850

- 17 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2011 (dollars in thousands):

	Unpaid Principal Balance		Recorded Investment		Allowance Allocated
With no related allowance recorded:
Commercial and industrial	$	3,485	$	3,485	$	---
Commercial real estate:
Residential developed		6,432		2,021		---
Unsecured to residential developers		---		---		---
Vacant and unimproved		5,226		4,265		---
Commercial development		---		---		---
Residential improved		1,943		1,858		---
Commercial improved		5,428		5,162		---
Manufacturing and industrial		3,997		3,997		---
		23,026		17,303		---
Consumer:
Residential mortgage		---		---		---
Unsecured		---		---		---
Home equity		200		200		---
Other secured		---		---		---
		200		200		---
	$	26,711	$	20,988	$	---

With an allowance recorded:
Commercial and industrial	$	17,052	$	13,846	$	3,478
Commercial real estate:
Residential developed		4,941		4,941		1,960
Unsecured to residential developers		---		---		---
Vacant and unimproved		3,378		2,462		154
Commercial development		220		220		17
Residential improved		12,312		11,809		1,176
Commercial improved		10,590		10,555		844
Manufacturing and industrial		4,905		4,905		216
		36,346		34,892		4,367
Consumer:
Residential mortgage		14,235		14,114		1,713
Unsecured		---		---		---
Home equity		771		771		39
Other secured		---		---		---
		15,006		14,885		1,752
	$	68,404	$	63,623	$	9,597

Total	$	95,115	$	84,611	$	9,597

- 18 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents information regarding average balances of impaired loans and interest recognized on impaired loans for the three and nine month periods ended September 30, 2012 and 2011 (dollars in thousands):

	Three Months Ended September 30, 2012		Three Months Ended September 30, 2011		Nine Months Ended September 30, 2012		Nine Months Ended September 30, 2011
Average of impaired loans during the period:
Commercial and industrial	$	12,415	$	5,920	$	15,388	$	5,661

Commercial real estate:
Residential developed		7,989		10,917		8,293		13,443
Unsecured to residential developers		---		406		---		727
Vacant and unimproved		4,219		5,705		3,854		5,700
Commercial development		215		223		217		463
Residential improved		12,707		9,741		13,564		9,576
Commercial improved		17,766		17,008		17,049		19,679
Manufacturing and industrial		9,104		6,767		9,291		7,464

Consumer		15,992		12,119		16,018		12,452


Interest income recognized during impairment:
Commercial and industrial		263		91		1,090		157
Commercial real estate		637		536		1,848		1,505
Consumer		141		101		419		308

Cash-basis interest income recognized
Commercial and industrial		250		97		1,065		220
Commercial real estate		637		560		1,852		1,467
Consumer		141		103		417		315

- 19 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

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

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of September 30, 2012:

	Nonaccrual		Over 90 days Accruing

Commercial and industrial	$	6,606	$	600

Commercial real estate:
Residential developed		5,046		---
Unsecured to residential developers		---		---
Vacant and unimproved		893		---
Commercial development		---		---
Residential improved		1,373		36
Commercial improved		1,533		133
Manufacturing and industrial		32		---
		8,877		169
Consumer:
Residential mortgage		771		---
Unsecured		19		---
Home equity		294		26
Other secured		---		---
		1,084		26
Total	$	16,567	$	795

The following table presents the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of December 31, 2011:

	Nonaccrual		Over 90 days Accruing

Commercial and industrial	$	9,270	$	290

Commercial real estate:
Residential developed		3,577		126
Unsecured to residential developers		---		---
Vacant and unimproved		3,715		---
Commercial development		49		---
Residential improved		5,144		286
Commercial improved		2,654		1,255
Manufacturing and industrial		134		---
		15,273		1,667
Consumer:
Residential mortgage		1,777		111
Unsecured		22		---
Home equity		534		---
Other secured		---		2
		2,333		113
Total	$	26,876	$	2,070

- 20 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents the aging of the recorded investment in past due loans as of September 30, 2012 by class of loans (dollars in thousands):

	30-90 Days		Greater Than 90 Days		Total Past Due		Loans Not Past Due		Total

Commercial and industrial	$	315	$	678	$	993	$	217,846	$	218,839

Commercial real estate:
Residential developed		79		35		114		28,890		29,004
Unsecured to residential developers		---		---		---		680		680
Vacant and unimproved		382		832		1,214		55,687		56,901
Commercial development		---		---		---		5,372		5,372
Residential improved		370		382		752		76,360		77,112
Commercial improved		316		1,149		1,465		262,576		264,041
Manufacturing and industrial		---		32		32		82,285		82,317
		1,147		2,430		3,577		511,850		515,427
Consumer:
Residential mortgage		130		230		360		176,282		176,642
Unsecured		10		---		10		1,717		1,727
Home equity		436		286		722		92,685		93,407
Other secured		51		---		51		13,092		13,143
		627		516		1,143		283,776		284,919
Total	$	2,089	$	3,624	$	5,713	$	1,013,472	$	1,019,185

The following table presents the aging of the recorded investment in past due loans as of December 31, 2011 by class of loans (dollars in thousands):

	30-90 Days		Greater Than 90 Days		Total Past Due		Loans Not Past Due		Total

Commercial and industrial	$	218	$	1,230	$	1,448	$	225,603	$	227,051

Commercial real estate:
Residential developed		472		613		1,085		32,744		33,829
Unsecured to residential developers		---		---		---		5,937		5,937
Vacant and unimproved		442		388		830		65,216		66,046
Commercial development		---		49		49		4,537		4,586
Residential improved		549		1,343		1,892		80,445		82,337
Commercial improved		1,355		3,266		4,621		299,449		304,070
Manufacturing and industrial		---		134		134		71,328		71,462
		2,818		5,793		8,611		559,656		568,267
Consumer:
Residential mortgage		313		1,517		1,830		155,061		156,891
Unsecured		35		---		35		1,917		1,952
Home equity		663		498		1,161		99,913		101,074
Other secured		51		2		53		15,687		15,740
		1,062		2,017		3,079		272,578		275,657
Total	$	4,098	$	9,040	$	13,138	$	1,057,837	$	1,070,975

- 21 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

The Company had allocated $7,491,000 and $6,905,000 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings (“TDRs”) as of September 30, 2012 and December 31, 2011, respectively. These loans involved the restructuring of terms to allow customers to mitigate the risk of foreclosure by meeting a lower loan payment requirement based upon their current cash flow. These may also include loans that renewed at existing contractual rates, but below market rates for comparable credit. The Company has been active at utilizing these programs and working with its customers to reduce the risk of foreclosure. For commercial loans, these modifications typically include an interest only period and, in some cases, a lowering of the interest rate on the loan. In some cases, the modification will include separating the note into two notes with the first note structured to be supported by current cash flows and collateral, and the second note made for the remaining unsecured debt. The second note is charged off immediately and collected only after the first note is paid in full. This modification type is commonly referred to as an A-B note structure. For consumer mortgage loans, the restructuring typically includes a lowering of the interest rate to provide payment and cash flow relief. For each restructuring, a comprehensive credit underwriting analysis of the borrower’s financial condition and prospects of repayment under the revised terms is performed to assess whether the structure can be successful and that cash flows will be sufficient to support the restructured debt. An analysis is also performed to determine whether the restructured loan should be on accrual status. Generally if the loan is on accrual at the time of restructure, it will remain on accrual after the restructuring. In some cases, a nonaccrual loan may be placed on accrual at restructuring if the loan’s actual payment history demonstrates it would have cash flowed under the restructured terms. After six consecutive payments under the restructured terms, a nonaccrual restructured loan is reviewed for possible upgrade to accruing status.

Typically, once a loan is identified as a TDR, it will retain that designation until it is paid off, since the restructured loans generally are not at market rates at the time of restructuring. An exception to this would be a loan that is modified under an A-B note structure. If the remaining “A” note is at a market rate at the time of restructuring (taking into account the borrower’s credit risk and prevailing market conditions), the loan can be removed from TDR designation in a subsequent calendar year after six months of performance in accordance with the new terms. The market rate relative to the borrower’s credit risk is determined through analysis of market pricing information gathered from peers and use of a loan pricing model. The general objective of the model is to achieve a consistent return on equity from one credit to the next, taking into consideration their differences in credit risk. In the model, credits with higher risk receive a higher potential loss allocation, and therefore require a higher interest rate to achieve the target return on equity. In general, when a loan is removed from TDR status it would no longer be considered impaired. As a result, allowance allocations for loans removed from TDR status would be based on the historical based allocation for the applicable loan grade and loan class. During the three and nine month periods ended September 30, 2012 and throughout 2011, no loans were removed from TDR status. Given the nature of the TDRs outstanding at September 30, 2012, it is unlikely that any such loans will be removed from TDR status in 2012.

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

The following table presents information regarding troubled debt restructurings as of September 30, 2012 and December 31, 2011 (dollars in thousands):

	September 30, 2012				December 31, 2011
	Number of Loans		Outstanding Recorded Balance		Number of Loans		Outstanding Recorded Balance
Commercial and industrial		55	$	12,630		98	$	15,395
Commercial real estate		139		47,147		120		46,414
Consumer		97		15,414		90		15,373
		291	$	75,191		308	$	77,182

- 22 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents information regarding TDRs executed during the three month periods ended September 30, 2012 and 2011 (dollars in thousands):

	Three Months Ended September 30, 2012						Three Months Ended September 30, 2011
	Number of Loans		Outstanding Recorded Balance		Principal Writedown upon Modification		Number of Loans		Outstanding Recorded Balance		Principal Writedown upon Modification

Commercial and industrial		1	$	15	$	---		12	$	3,876	$	51
Commercial real estate		5		2,538		---		23		8,908		144
Consumer		---		---		---		1		213		---
		6	$	2,553	$	---		36	$	12,997	$	195

The following table presents information regarding TDRs executed during the nine month periods ended September 30, 2012 and 2011 (dollars in thousands):

	Nine Months Ended September 30, 2012						Nine Months Ended September 30, 2011
	Number of Loans		Outstanding Recorded Balance		Principal Writedown upon Modification		Number of Loans		Outstanding Recorded Balance		Principal Writedown upon Modification

Commercial and industrial		14	$	1,351	$	9		32	$	6,124	$	51
Commercial real estate		44		10,236		86		73		24,858		698
Consumer		9		1,462		260		12		1,883		---
		67	$	13,049	$	355		117	$	32,865	$	749

According to the accounting standards, not all loan modifications are TDRs. TDRs are modifications or renewals where the Company has granted a concession to a borrower in financial distress. The Company reviews all modifications and renewals for determination of TDR status. In some situations a borrower may be experiencing financial distress, but the Company does not provide a concession. These modifications are not considered TDRs. In other cases, the Company might provide a concession, such as a reduction in interest rate, but the borrower is not experiencing financial distress. This could be the case if the Company is matching a competitor’s interest rate. These modifications would also not be considered TDRs. Finally, any renewals at existing terms for borrowers not experiencing financial distress would not be considered TDRs. The following table presents information regarding modifications and renewals executed during the three month periods ended September 30, 2012 and 2011 that are not considered TDRs (dollars in thousands):

	Three Months Ended September 30, 2012					Three Months Ended September 30, 2011
	Number of Loans		Outstanding Recorded Balance			Number of Loans		Outstanding Recorded Balance

Commercial and industrial		148		$	27,141		166		$	27,615
Commercial real estate		92			31,877		112			40,784
Consumer		20			1,014		50			2,320
		260		$	60,032		328		$	70,719

- 23 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents information regarding modifications and renewals executed during the nine month periods ended September 30, 2012 and 2011 that are not considered TDRs (dollars in thousands):

	Nine Months Ended September 30, 2012					Nine Months Ended September 30, 2011
	Number of Loans		Outstanding Recorded Balance			Number of Loans		Outstanding Recorded Balance

Commercial and industrial		398		$	88,059		471		$	85,276
Commercial real estate		256			97,583		339			120,875
Consumer		66			2,701		81			3,234
		720		$	188,343		891		$	209,385

The table below presents by class, information regarding TDRs which had payment defaults during the three month periods ended September 30, 2012 and 2011 (dollars in thousands). Included are loans that became delinquent more than 90 days past due or transferred to nonaccrual within 12 months of restructuring.

	Three Months Ended September 30, 2012					Three Months Ended September 30, 2011
	Number of Loans		Outstanding Recorded Balance			Number of Loans		Outstanding Recorded Balance

Commercial and industrial		---		$	---		1		$	66
Commercial real estate		1			136		9			1,925
Consumer		1			114		2			402

The table below presents by class, information regarding TDRs which had payment defaults during the nine month periods ended September 30, 2012 and 2011 (dollars in thousands). Included are loans that became delinquent more than 90 days past due or transferred to nonaccrual within 12 months of restructuring.

	Nine Months Ended September 30, 2012					Nine Months Ended September 30, 2011
	Number of Loans		Outstanding Recorded Balance			Number of Loans		Outstanding Recorded Balance

Commercial and industrial		3		$	112		4		$	830
Commercial real estate		2			212		9			1,925
Consumer		2			184		2			402

- 24 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

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

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

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

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

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

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

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

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

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

- 25 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

As of September 30, 2012, the risk grade category of commercial loans by class of loans was as follows (dollars in thousands):

	1		2		3		4		5		6		7		8

Commercial and industrial	$	1,259	$	13,920	$	61,112	$	115,291	$	16,893	$	3,757	$	6,607	$	---
Commercial real estate:
Residential developed		---		---		739		8,025		8,684		6,510		5,046		---
Unsecured to residential developers		---		---		100		567		13		---		---		---
Vacant and unimproved		---		1,000		12,810		25,976		14,869		1,354		892		---
Commercial development		---		---		---		2,068		3,089		215		---		---
Residential improved		---		117		9,622		40,958		15,536		9,505		1,374		---
Commercial improved		---		2,473		49,328		153,656		40,932		16,119		1,533		---
Manufacturing and industrial		---		2,173		17,019		46,576		7,450		9,067		32		---

	$	1,259	$	19,683	$	150,730	$	393,117	$	107,466	$	46,527	$	15,484	$	---

As of December 31, 2011, the risk grade category of commercial loans by class of loans was as follows (dollars in thousands):

	1		2		3		4		5		6		7		8

Commercial and industrial	$	595	$	8,447	$	56,457	$	117,015	$	27,674	$	7,593	$	9,270	$	---
Commercial real estate:
Residential developed		---		---		283		9,688		11,410		8,725		3,723		---
Unsecured to residential developers		---		---		4,773		647		177		340		---		---
Vacant and unimproved		---		---		14,707		24,344		21,362		1,918		3,715		---
Commercial development		---		---		60		2,261		1,109		1,107		49		---
Residential improved		---		121		2,650		45,813		18,642		9,968		5,143		---
Commercial improved		---		5		62,510		173,697		43,493		21,712		2,653		---
Manufacturing and industrial		---		2,242		12,209		38,533		11,344		7,000		134		---

	$	595	$	10,815	$	153,649	$	411,998	$	135,211	$	58,363	$	24,687	$	---

Commercial loans rated a 6 or worse per the Company’s internal risk rating system are considered substandard, doubtful or loss. Commercial loans classified as substandard or worse were as follows at period-end (dollars in thousands):

	September 30, 2012		December 31, 2011

Not classified as impaired	$	19,599	$	29,687
Classified as impaired		42,412		53,363

Total commercial loans classified substandard or worse	$	62,011	$	83,050

- 26 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 3 – LOANS (Continued)

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

September 30, 2012	Residential Mortgage		Consumer Unsecured		Home Equity		Consumer Other
Performing	$	176,412	$	1,727	$	93,121	$	13,143
Nonperforming		230		---		286		---
Total	$	176,642	$	1,727	$	93,407	$	13,143

December 31, 2011	Residential Mortgage		Consumer Unsecured		Home Equity		Consumer Other
Performing	$	155,374	$	1,952	$	100,576	$	15,738
Nonperforming		1,517		---		498		2
Total	$	156,891	$	1,952	$	101,074	$	15,740

NOTE 4 – OTHER REAL ESTATE OWNED

Period-end other real estate owned was as follows (dollars in thousands):

	Nine Months Ended September 30, 2012			Year Ended December 31, 2011			Nine Months Ended September 30, 2011

Beginning balance	$	83,663		$	68,388		$	68,388
Additions, transfers from loans		9,002			38,358			32,015
Proceeds from sales of other real estate owned		(13,426	)		(21,540	)		(16,370	)
Valuation allowance reversal upon sale		(2,962	)		(3,058	)		(2,031	)
Gain on sale of other real estate owned		11			1,515			1,191
		76,288			83,663			83,193
Less: valuation allowance		(18,510	)		(17,225	)		(16,709	)
Ending balance	$	57,778		$	66,438		$	66,484

- 27 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 4 – OTHER REAL ESTATE OWNED (Continued)

Activity in the valuation allowance for other real estate owned was as follows (dollars in thousands):

	Three Months Ended September 30, 2012			Three Months Ended September 30, 2011			Nine Months Ended September 30, 2012			Nine Months Ended September 30, 2011
Beginning balance	$	18,777		$	14,025		$	17,225		$	10,404
Additions charged to expense		697			2,985			4,247			8,336
Reversals upon sale		(964	)		(301	)		(2,962	)		(2,031	)
Ending balance	$	18,510		$	16,709		$	18,510		$	16,709

NOTE 5 – FAIR VALUE

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

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

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

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

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

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

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other Real Estate Owned: Adjustments to commercial and residential real estate properties classified as other real estate owned (OREO) are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized through a valuation allowance.

- 28 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5 – FAIR VALUE (Continued)

Assets measured at fair value on a recurring basis are summarized below (in thousands):

	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2012
U.S. Treasury and federal agency securities	$	40,692	$	---	$	40,692	$	---
U.S. Agency MBS and CMOs		25,491		---		25,491		---
Tax-exempt state and municipal bonds		17,319		---		17,319		---
Taxable state and municipal bonds		26,236		---		26,236		---
Corporate bonds and other debt securities		4,815		---		4,815		---
Other equity securities		1,575		---		1,575		---
Loans held for sale		11,063		---		11,063		---

December 31, 2011
U.S. Treasury and federal agency securities	$	27,613	$	---	$	27,613	$	---
U.S. Agency MBS and CMOs		3,886		---		3,886		---
Tax-exempt state and municipal bonds		4,408		---		4,408		---
Taxable state and municipal bonds		16,716		---		16,716		---
Corporate bonds		1,081		---		1,081		---
Other equity securities		1,042		---		1,042		---
Loans held for sale		1,026		---		1,026		---

Assets measured at fair value on a non-recurring basis are summarized below (in thousands):

	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2012
Impaired loans	$	35,114	$	---	$	---	$	35,114
Other real estate owned		42,333		---		---		42,333

December 31, 2011
Impaired loans	$	22,525	$	---	$	---	$	22,525
Other real estate owned		39,730		---		---		39,730

- 29 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 5 – FAIR VALUE (Continued)

The carrying amounts and estimated fair values of financial instruments, not previously presented, were as follows at September 30, 2012 and December 31, 2011 (dollars in thousands).

	Level in	September 30, 2012						December 31, 2011
	Fair Value	Carrying			Fair			Carrying			Fair
	Hierarchy	Amount			Value			Amount			Value
Financial assets
Cash and due from banks	Level 1	$	22,398		$	22,398		$	30,971		$	30,971
Cash equivalents	Level 2		211,853			211,853			212,071			212,071
Securities held to maturity	Level 3		4,300			4,300			300			300
FHLB stock			11,236			NA			11,236			NA
Loans, net	Level 2		957,800			965,558			1,016,809			1,024,766
Bank owned life insurance	Level 3		26,614			26,614			25,957			25,957
Accrued interest receivable	Level 2		3,719			3,719			3,595			3,595

Financial liabilities
Deposits	Level 2		(1,244,748	)		(1,244,506	)		(1,215,289	)		(1,216,452	)
Other borrowed funds	Level 2		(91,822	)		(95,380	)		(148,603	)		(151,566	)
Long-term debt	Level 2		(41,238	)		(34,857	)		(41,238	)		(34,820	)
Subordinated debt	Level 2		(1,650	)		(1,650	)		(1,650	)		(1,650	)
Accrued interest payable	Level 2		(4,535	)		(4,535	)		(3,517	)		(3,517	)

Off-balance sheet credit-related items
Loan commitments			---			---			---			---

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

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

NOTE 6 – DEPOSITS

Deposits are summarized as follows (in thousands):

	September 30, 2012		December 31, 2011
Noninterest-bearing demand	$	348,120	$	324,253
Interest bearing demand		241,115		204,402
Savings and money market accounts		433,305		381,498
Certificates of deposit		222,208		305,136
	$	1,244,748	$	1,215,289

Approximately $79.9 million and $106.3 million in certificates of deposit were in denominations of $100,000 or more at September 30, 2012 and December 31, 2011, respectively.

The Bank had no brokered deposits at September 30, 2012 and December 31, 2011.

- 30 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 7 - OTHER BORROWED FUNDS

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

Federal Home Loan Bank Advances

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

Principal Terms	Advance Amount		Range of Maturities	Weighted Average Interest Rate

September 30, 2012
Single maturity fixed rate advances	$	80,000	May 2015 to September 2016		1.70	%
Amortizable mortgage advances		11,822	March 2018 to July 2018		3.78	%
	$	91,822

Principal Terms	Advance Amount		Range of Maturities	Weighted Average Interest Rate

December 31, 2011
Single maturity fixed rate advances	$	135,000	March 2012 to September 2016		1.79	%
Amortizable mortgage advances		13,603	March 2018 to July 2018		3.77	%
	$	148,603

Each advance is subject to a prepayment penalty if paid prior to its maturity date. Fixed rate advances are payable at maturity. Amortizable mortgage advances are fixed rate advances with scheduled repayments based upon amortization to maturity. These advances were collateralized by residential and commercial real estate loans totaling $409.0 million under a blanket lien arrangement at September 30, 2012 and $389.8 million under a physical loan collateral delivery arrangement at December 31, 2011.

On September 28, 2012, advances totaling $20 million were paid off early, resulting in a prepayment penalty of $322,000 which is included in other expense for the quarter ended September 30, 2012. The transaction settled on October 2, 2012 so the prepayment penalty and the advance payment were carried in other liabilities at September 30, 2012.

Scheduled repayments of FHLB advances as of September 30, 2012 were as follows (in thousands):

2012	$	---
2013		1,831
2014		1,884
2015		21,938
2016		61,996
Thereafter		4,173
	$	91,822

- 31 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 8 - EARNINGS PER COMMON SHARE

A reconciliation of the numerators and denominators of basic and diluted earnings per common share for the three and nine month periods ended September 30, 2012 and 2011 are as follows (dollars in thousands, except per share data):

	Three Months Ended September 30, 2012		Three Months Ended September 30, 2011		Nine Months Ended September 30, 2012		Nine Months Ended September 30, 2011

Net income	$	6,585	$	1,052	$	14,256	$	4,743
Dividends declared on preferred shares		---		---		---		---
Net income available to common shares	$	6,585	$	1,052	$	14,256	$	4,743

Weighted average shares outstanding, including participating stock awards - Basic		27,082,825		27,082,823		27,082,823		21,276,467

Dilutive potential common shares:
Stock options		---		---		---		---
Conversion of preferred stock		---		---		---		---
Stock warrants		---		---		---		---
Weighted average shares outstanding - Diluted		27,082,825		27,082,823		27,082,823		21,276,467

Basic earnings per common share	$	0.24	$	0.04	$	0.53	$	0.22
Diluted earnings per common share	$	0.24	$	0.04	$	0.53	$	0.22

Stock options for 534,444 shares of common stock for both the three and nine month periods ended September 30, 2012 were excluded from dilutive potential common shares because they were antidilutive. Stock options for 692,919 and 704,590 shares of common stock for the three and nine month periods ended September 30, 2011, respectively, were excluded from dilutive potential common shares because they were antidilutive. Common shares associated with convertible preferred stock and stock warrants were excluded from dilutive potential common shares in each period as they were antidilutive.

NOTE 9 - FEDERAL INCOME TAXES

Income tax expense (benefit) was as follows (dollars in thousands):

	Three Months Ended September 30, 2012		Three Months Ended September 30, 2011			Nine Months Ended September 30, 2012		Nine Months Ended September 30, 2011

Current	$	275	$	(94	)	$	275	$	(176	)
Deferred (benefit) expense		---		94			---		176
	$	275	$	---		$	275	$	---

- 32 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 9 - FEDERAL INCOME TAXES (Continued)

The difference between the financial statement tax expense (benefit) and amount computed by applying the statutory federal tax rate to pretax income was reconciled as follows (dollars in thousands):

	Three Months Ended September 30, 2012			Three Months Ended September 30, 2011			Nine Months Ended September 30, 2012			Nine Months Ended September 30, 2011

Statutory rate		35	%		35	%		35	%		35	%
Statutory rate applied to income before taxes	$	2,401		$	368		$	5,086		$	1,660
Add (deduct)
Change in valuation allowance		(1,761	)		(251	)		(4,056	)		(1,260	)
Tax-exempt interest income		(32	)		(4	)		(64	)		(4	)
Bank-owned life insurance		(73	)		(86	)		(230	)		(249	)
Other, net		(260	)		(27	)		(461	)		(147	)
	$	275		$	---		$	275		$	---

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

We established an $18.0 million valuation allowance on deferred tax assets in 2009 based primarily on the Company’s net operating losses for 2009 and 2008. As a result of losses incurred in 2010, the Company increased the valuation allowance to $25.6 million at December 31, 2010. At December 31, 2011 and September 30, 2012, a valuation allowance of $24.0 million and $19.6 million, respectively, was maintained as the Company continued to face a challenging economic environment currently confronting banks that could negatively impact future operating results. The valuation allowance may be reversed to income in future periods to the extent that the related deferred tax assets are realized or when the Company returns to consistent, sustained profitability.

The Company has recorded federal income tax expense of $275,000 for the three and nine month periods ended September 30, 2012 for estimated alternative minimum tax (AMT) as the Company projects it will have positive taxable income for the full year 2012 and AMT limits the amount of net operating loss carryforwards that can be applied for AMT each year. At September 30, 2012, the Company has established a valuation allowance against this deferred tax asset consistent with its other deferred tax assets.

- 33 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 9 - FEDERAL INCOME TAXES (Continued)

The net deferred tax asset recorded included the following amounts of deferred tax assets and liabilities (dollars in thousands):

	September 30, 2012			December 31, 2011
Deferred tax assets
Allowance for loan losses	$	9,194		$	11,074
Nonaccrual loan interest		996			839
Valuation allowance on other real estate owned		6,479			6,029
Net operating loss carryforward		4,325			7,673
Other		1,933			1,137
Gross deferred tax assets		22,927			26,752
Valuation allowance		(19,567	)		(24,026	)
Total net deferred tax assets		3,360			2,726

Deferred tax liabilities
Depreciation		(1,734	)		(1,758	)
Purchase accounting adjustments		---			(22	)
Unrealized gain on securities available for sale		(607	)		(204	)
Prepaid expenses		(669	)		(407	)
Other		(350	)		(335	)
Gross deferred tax liabilities		(3,360	)		(2,726	)
Net deferred tax asset	$	---		$	---

At September 30, 2012, we had federal net operating loss carry forwards of $12.4 million that expire through 2030.

There were no unrecognized tax benefits at September 30, 2012 or December 31, 2011 and the Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. The Company is no longer subject to examination by the Internal Revenue Service for years before 2008.

NOTE 10 – CONTINGENCIES

We and our subsidiaries periodically become defendants in certain claims and legal actions arising in the ordinary course of business. As of September 30, 2012, there were no material pending legal proceedings to which we or any of our subsidiaries are a party or which any of our properties are the subject.

NOTE 11 – SHAREHOLDERS' EQUITY

Regulatory Capital

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

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Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – SHAREHOLDERS' EQUITY (Continued)

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

At September 30, 2012 and December 31, 2011, actual and minimum required capital levels were (in thousands):

	Actual					Minimum Required For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Regulations					Minimum Required Under MOU/Consent Order (1)
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
September 30, 2012
Total capital (to risk weighted assets)
Consolidated	$	163,887		14.9	%	$	87,942		8.0	%		N/A		N/A			N/A		N/A
Bank		157,726		14.4			87,932		8.0		$	109,915		10.0	%		N/A		N/A
Tier 1 capital (to risk weighted assets)
Consolidated		144,405		13.1			43,971		4.0			N/A		N/A			N/A		N/A
Bank		143,795		13.1			43,966		4.0			65,949		6.0			N/A		N/A
Tier 1 capital (to average assets)
Consolidated		144,405		9.5			60,598		4.0			N/A		N/A			N/A		N/A
Bank		143,795		9.5			60,527		4.0			75,659		5.0		$	121,055		8.0

December 31, 2011
Total capital (to risk weighted assets)
Consolidated	$	149,905		13.2	%	$	91,201		8.0	%		N/A		N/A			N/A		N/A
Bank		142,059		12.5			91,193		8.0		$	113,991		10.0	%	$	125,390		11.0	%
Tier 1 capital (to risk weighted assets)
Consolidated		125,028		11.0			45,601		4.0			N/A		N/A			N/A		N/A
Bank		127,576		11.2			45,596		4.0			68,394		6.0			N/A		N/A
Tier 1 capital (to average assets)
Consolidated		125,028		8.3			60,598		4.0			N/A		N/A			N/A		N/A
Bank		127,576		8.4			60,528		4.0			75,660		5.0			121,056		8.0

(1)

The MOU is applicable to the September 30, 2012 information presented in these columns, and the Consent Order is applicable to the December 31, 2011 information presented in these columns.

Approximately $36.2 million and $31.3 million of trust preferred securities outstanding at September 30, 2012 and December 31, 2011, respectively, qualified as Tier 1 capital. Refer to our 2011 Form 10-K for more information on the trust preferred securities.

The Bank was categorized as "well capitalized" at September 30, 2012 and “adequately capitalized” at December 31, 2011. The Bank’s regulatory capital ratios exceeded the levels ordinarily required to be categorized as "well capitalized" at December 31, 2011. However, because the Bank was subject to the Consent Order at the time, the Bank could not be categorized as "well capitalized" regardless of actual capital levels. The Consent Order was terminated on March 2, 2012.

- 35 -

Index

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE 11 – SHAREHOLDERS' EQUITY (Continued)

The MOU prohibits the Bank from declaring or paying any cash dividend without the prior written consent of its regulators. The payment of future cash dividends by the Company is largely dependent upon dividends received from the Bank out of its earnings. Under Michigan law, the Bank is also restricted from paying dividends to the Company until its deficit retained earnings has been restored. The Bank had a retained deficit of approximately $15.8 million at September 30, 2012.

Additional information about the Consent Order and the MOU may be found in Note 1 under the heading "Regulatory Developments”.

- 36 -

Index

Item 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Macatawa Bank Corporation is a Michigan corporation and a registered bank holding company. It wholly-owns Macatawa Bank, Macatawa Statutory Trust I and Macatawa Statutory Trust II. Macatawa Bank is a Michigan chartered bank with depository accounts insured by the FDIC. The Bank operates twenty-six branch offices and a lending and operational service facility, providing a full range of commercial and consumer banking and trust services in Kent County, Ottawa County, and northern Allegan County, Michigan. Macatawa Statutory Trusts I and II are grantor trusts and issued $20.0 million each of pooled trust preferred securities. These trusts are not consolidated in our Consolidated Financial Statements. For further information regarding consolidation, see the Notes to the Consolidated Financial Statements.

At September 30, 2012, we had total assets of $1.52 billion, total loans of $1.02 billion, total deposits of $1.24 billion and shareholders' equity of $109.4 million. During the third quarter of 2012, we recognized net income of $6.6 million compared to net income of $1.05 million in the third quarter of 2011. This represented our tenth consecutive quarter of profitability. As described more fully below, continued reductions in net charge-offs and nonperforming loans led to a negative loan loss provision for the most recent quarter.

In response to our losses during 2008, 2009 and the first quarter of 2010, our Board of Directors implemented additional corporate governance practices and disciplined business and banking principles, including more conservative lending principles. The focus of our management team turned from growth in our business to executing these disciplined business and banking procedures and policies designed to limit future losses, preserve capital and improve operational efficiencies. In addition, the Board of Directors added experienced members to provide further oversight and guidance. These and other efforts were reflected in our results of operations for the past two years with lower levels of charge-offs and provision for loan losses, reductions in operating expenses and reduction in balance sheet totals resulting in improvement in our regulatory capital and liquidity ratios. We successfully completed our shareholder rights offering and public offering of common stock in June 2011 resulting in net proceeds of $20.3 million and contributed $10.0 million of the proceeds from the stock offering to the Bank retaining the remaining $10.3 million at the holding company. As of September 30, 2012, the Company’s and the Bank’s risk-based regulatory capital ratios were the highest they have ever been. The Bank was categorized as “well capitalized” at September 30, 2012.

On February 22, 2010, Macatawa Bank entered into a Consent Order with the FDIC and OFIR, the primary banking regulators of the Bank. The Company also entered into a Written Agreement with the FRB with an effective date of July 23, 2010. Upon completion of the Bank’s 2011 joint examination, the FDIC and OFIR terminated the Bank’s Consent Order effective March 2, 2012.

In connection with the termination of the Consent Order, the Bank reached an understanding with the regulators in the form of a Memorandum of Understanding (“MOU”). As of September 30, 2012, we believe that the Bank was in compliance in all material respects with all of the provisions of the MOU. As of the same date, we believe that the Company was in compliance in all material respects with all of the provisions of the Written Agreement. See Note 1 to the Consolidated Financial Statements for more information.

Additional information further describing changes in our business, including those in response to the Consent Order, MOU and the Written Agreement, are described in detail in our 2011 Annual Report on Form 10-K.

RESULTS OF OPERATIONS

Summary: Net income available to common shares for the quarter ended September 30, 2012 was $6.6 million, compared to net income of $1.05 million in the third quarter of 2011. Net income per common share on a diluted basis was $0.24 for the third quarter of 2012 and $0.04 for the third quarter of 2011. For the nine months ended September 30, 2012, net income was $14.3 million, compared to $4.7 million for the same period in 2011. Net income per common share on a diluted basis for the nine months ended September 30, 2012 was $0.53, compared to $0.22 for the same period in 2011.

The improvement in earnings in the third quarter and first nine months of 2012 was a continuation of improvement in the past several quarters, led by a significantly lower level of net charge-offs from $1.4 million in the third quarter of 2011 to a net recovery of $341,000 in the third quarter of 2012. This, coupled with a decline in non-performing and impaired loan levels, resulted in a negative provision for loan losses for the most recent quarter. The provision for loan losses was a negative $1.25 million for the three month periods ended September 30, 2012 and 2011. For the nine month period ended September 30, 2012, we recognized a negative $6.6 million provision for loan losses compared to a negative $4.7 million provision for loan losses for the same period in 2011. The increased negative provision for loan losses in the nine month period ended September 30, 2012 was largely attributable to a sizeable recovery recognized in the first quarter of 2012, as discussed in previous filings.

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Index

Operating results in recent periods have been significantly impacted by the expense associated with problem loans and nonperforming assets. Apart from the provision for loan losses, expenses associated with nonperforming assets (including administration costs and losses) were $1.7 million for the third quarter of 2012 compared to $4.5 million for the third quarter of 2011. For the first nine months of 2012, these expenses totaled $8.0 million compared to $12.7 million for the same period in 2011. Valuation writedowns on other real estate owned and legal costs associated with nonperforming assets have significantly decreased in the three and nine month periods ended September 30, 2012 compared to the same periods in 2011. Lost interest from elevated levels of nonperforming assets was approximately $852,000 and $3.0 million, respectively, for the three and nine months ended September 30, 2012 compared to $1.6 million and $7.7 million, respectively, for the same periods in 2011. Each of these items is discussed more fully below.

Another factor positively impacting earnings for the three and nine month periods ending September 30, 2012 was the collection of a one-time prepayment penalty of $2.8 million on a commercial loan. This fee was reflected in net interest income.

Net Interest Income: Net interest income totaled $13.9 million for the third quarter of 2012 compared to $11.5 million for the third quarter of 2011. For the first nine months of 2012, net interest income was $36.5 million compared to $34.9 million for the same period in 2011.

The increase in net interest income in the third quarter of 2012 was due primarily to the collection of a one-time prepayment penalty of $2.8 million on a commercial loan. The net interest margin was 4.02% for the third quarter of 2012, of which 82 basis points related to the prepayment penalty, compared to 3.25% for the third quarter of 2011. Average interest earning assets decreased from $1.39 billion for the third quarter of 2011 to $1.37 billion for the same period in 2012. Our average yield on earning assets for the third quarter of 2012 increased 49 basis points compared to the same period in 2011 from 4.22% to 4.71%. Average interest bearing liabilities decreased $58.9 million from $1.11 billion for the third quarter of 2011 to $1.06 billion for the same period in 2012. The cost of average interest bearing liabilities decreased 31 basis points compared to the same period in 2011 from 1.20% to 0.89%.

Average interest earning assets decreased from $1.40 billion for the first nine months of 2011 to $1.36 billion for the same period in 2012. Our average yield on earning assets declined 5 basis points for the first nine months of 2012 in comparison with the same period in 2011. Our net interest margin was 3.56% for the first nine months in 2012 compared to 3.29% for the same period in 2011. The increase in margin was primarily due to the $2.8 million one-time prepayment penalty discussed above. Also positively affecting margin was a 34 basis points decline in the average cost of interest bearing liabilities, as we continued to payoff wholesale funding upon maturity.

Absent the $2.8 million one-time prepayment fee, our yields on interest earning assets would have decreased for the three and nine month periods ended September 30, 2012 due to decreases in the yield on our commercial, residential and consumer loan portfolios, which have repriced in the generally lower rate environment during this period. Our margin has been negatively impacted by our decision to hold significant balances in liquid and short-term investments during the past two years. As we deploy these balances in building our investment portfolio and booking high quality loans, we expect our margin to be positively impacted.

The declines in cost of funds for the three and nine month periods ended September 30, 2012 were due to a decrease in the rates paid on our deposit accounts in response to declining market rates and the rollover of time deposits and other borrowings at lower rates within the current rate environment. Also contributing to the reduction was a shift in our deposit mix from higher costing time deposits to lower costing demand and savings accounts.

- 38 -

Index

The following table shows an analysis of net interest margin for the three month periods ended September 30, 2012 and 2011.

	For the three months ended September 30,
	2012								2011
				Interest		Average						Interest		Average
	Average			Earned		Yield			Average			Earned		Yield
	Balance			or paid		or cost			Balance			or paid		or cost
	(Dollars in thousands)
Assets
Taxable securities	$	85,939		$	414		1.93	%	$	29,769		$	156		2.09	%
Tax-exempt securities (1)		16,685			102		4.05	%		1,165			10		5.70	%
Loans (2)		1,038,704			15,532		5.89	%		1,090,465			14,498		5.22	%
Federal Home Loan Bank stock		11,236			84		2.92	%		11,236			73		2.56	%
Federal funds sold and other short-term investments		214,602			137		0.25	%		255,601			163		0.25	%
Total interest earning assets (1)		1,367,166			16,269		4.71	%		1,388,236			14,900		4.22	%

Noninterest earning assets:
Cash and due from banks		25,191								24,912
Other		124,017								118,547

Total assets	$	1,516,374							$	1,531,695

Liabilities
Deposits:
Interest bearing demand	$	230,246		$	82		0.14	%	$	185,619		$	106		0.22	%
Savings and money market accounts		423,513			487		0.46	%		360,263			488		0.54	%
Time deposits		243,877			827		1.35	%		352,339			1,510		1.70	%
Borrowings:
Other borrowed funds		117,005			594		1.99	%		175,355			944		2.10	%
Long-term debt		41,238			387		3.68	%		41,238			351		3.34	%
Total interest bearing liabilities		1,055,879			2,377		0.89	%		1,114,814			3,399		1.20	%

Noninterest bearing liabilities:
Noninterest bearing demand accounts		347,476								316,916
Other noninterest bearing liabilities		8,411								6,875
Shareholders' equity		104,608								93,090

Total liabilities and shareholders' equity	$	1,516,374							$	1,531,695

Net interest income				$	13,892							$	11,501

Net interest spread (1)							3.82	%							3.02	%
Net interest margin (1)							4.02	%							3.25	%
Ratio of average interest earning assets to average interest bearing liabilities		129.48	%							124.53	%

(1)

Yield adjusted to fully tax equivalent.

(2)

Includes non-accrual loans of approximately $20.8 million and $39.9 million for the three months ended September 30, 2012 and 2011, respectively.

- 39 -

Index

The following table shows an analysis of net interest margin for the nine month periods ended September 30, 2012 and 2011.

	For the nine months ended September 30,
	2012								2011
				Interest		Average						Interest		Average
	Average			Earned		Yield			Average			Earned		Yield
	Balance			or paid		or cost			Balance			or paid		or cost
	(Dollars in thousands)
Assets
Taxable securities	$	73,984		$	1,116		2.01	%	$	19,462		$	267		1.83	%
Tax-exempt securities (1)		10,966			210		4.32	%		425			11		5.70	%
Loans (2)		1,054,402			42,295		5.29	%		1,137,818			45,274		5.26	%
Federal Home Loan Bank stock		11,236			252		2.95	%		11,641			223		2.53	%
Federal funds sold and other short-term investments		207,280			394		0.25	%		230,936			468		0.27	%
Total interest earning assets (1)		1,357,868			44,267		4.32	%		1,400,282			46,243		4.37	%

Noninterest earning assets:
Cash and due from banks		22,906								23,127
Other		125,797								113,461

Total assets	$	1,506,571							$	1,536,870

Liabilities
Deposits:
Interest bearing demand	$	221,429		$	264		0.16	%	$	183,208		$	317		0.23	%
Savings and money market accounts		412,675			1,500		0.49	%		367,965			1,558		0.57	%
Time deposits		270,628			2,806		1.39	%		388,904			5,557		1.91	%
Borrowings:
Other borrowed funds		132,847			2,045		2.02	%		178,611			2,886		2.13	%
Long-term debt		41,238			1,158		3.69	%		41,238			1,044		3.34	%
Total interest bearing liabilities		1,078,817			7,773		0.96	%		1,159,926			11,362		1.30	%

Noninterest bearing liabilities:
Noninterest bearing demand accounts		319,755								291,583
Other noninterest bearing liabilities		7,528								7,083
Shareholders' equity		100,471								78,278

Total liabilities and shareholders' equity	$	1,506,571							$	1,536,870

Net interest income				$	36,494							$	34,881

Net interest spread (1)							3.36	%							3.06	%
Net interest margin (1)							3.56	%							3.29	%
Ratio of average interest earning assets to average interest bearing liabilities		125.87	%							120.72	%

(1)	Yield adjusted to fully tax equivalent.

(2)	Includes non-accrual loans of approximately $25.6 million and $56.0 million for the nine months ended September 30, 2012 and 2011, respectively.

- 40 -

Index

Provision for Loan Losses: The provision for loan losses for the third quarter of 2012 and 2011 was a negative $1.25 million. The negative provision for loan losses in both periods resulted from continued significant declines in the level of net charge-offs, reduction in the balances and required reserves on nonperforming loans, and stabilizing real estate values on problem credits. The provision for loan losses for the first nine months of 2012 was a negative $6.6 million, compared to a negative $4.7 million for the same period in 2011. The larger negative provision for loan losses in the first nine months of 2012 was primarily associated with a $4.4 million recovery on a previously charged-off loan in the first quarter of 2012.

Net recoveries were $341,000 for the third quarter of 2012 compared to net charge-offs of $1.4 million for the third quarter of 2011. Our charge-offs have largely been driven by declines in the value of real estate securing our loans. The pace of the decline in real estate values, however, has been slowing, translating into a decline in charge-offs and resulting in net recoveries for the first and third quarters of 2012. We are also experiencing positive results from our collection efforts as evidenced by the $4.4 million recovery collected in the first quarter of 2012 and net recoveries again in the third quarter of 2012. For the third quarter of 2012, total recoveries were $956,000 compared to $2.3 million for the same period in 2011. For the nine months ended September 30, 2012, we experienced net recoveries of $1.2 million compared to net charge-offs of $7.9 million for the same period in 2011. For the nine months ended September 30, 2012, total recoveries were $6.2 million, compared to $4.4 million for the same period in 2011. While we expect our collection efforts to produce further recoveries, the amount achieved in 2012, particularly in the first quarter of 2012, was unusually high and may not recur at this level in future quarters.

We have also experienced a decline in the pace of commercial loans migrating to a worse loan grade, which receive higher allocations in our loan loss reserve, as more fully discussed under the heading "Allowance for Loan Losses" below. In addition to experiencing fewer downgrades of credits, we continue to see an increase in the quality of some credits resulting in an improved loan grade. Over the past seven quarters, we have experienced improvements in our weighted average loan grade. We believe efforts that began in late 2009 and in early 2010 to improve loan administration and loan risk management practices have had a significant impact, ultimately allowing for the reduction in the level of the provision for loan losses in 2012.

The amounts of loan loss provision in all periods presented were the result of establishing our allowance for loan losses at levels believed necessary based upon our methodology for determining the adequacy of the allowance. The sustained lower level of quarterly net charge-offs over the past several quarters had a significant effect on the historical loss component of our methodology. More information about our allowance for loan losses and our methodology for establishing its level may be found under the heading "Allowance for Loan Losses" below.

Noninterest Income: Noninterest income for the three and nine month periods ended September 30, 2012 increased to $4.1 million and $11.8 million, respectively, from $3.9 million and $11.2 million, respectively, for the same periods in 2011. The components of noninterest income are shown in the table below (in thousands):

	Three Months Ended September 30, 2012		Three Months Ended September 30, 2011		Nine Months Ended September 30, 2012		Nine Months Ended September 30, 2011

Service charges and fees on deposit accounts	$	810	$	889	$	2,381	$	2,806
Net gains on mortgage loans		940		697		2,192		1,393
Trust fees		595		644		1,802		1,915
Gain on sale of securities		14		---		73		---
ATM and debit card fees		1,049		1,013		3,094		2,958
Bank owned life insurance income		210		245		657		711
Investment services fees		196		157		585		644
Other income		292		282		1,033		794
Total noninterest income	$	4,106	$	3,927	$	11,817	$	11,221

Service charges on deposit accounts decreased for the three and nine month periods ended September 30, 2012 as a result of declines in overdraft fee income, consistent with banking industry-wide trends. We recognized substantial increases in gains on sales of mortgage loans for the third quarter of 2012 and for the first nine months of 2012, due in part to increased focus on growth in our residential mortgage loan origination volume. The low interest rate environment and recent Federal Reserve actions have also contributed significantly to this increase in sales volume. Trust income is down slightly for the three and nine month periods ended September 30, 2012 compared to the same periods in 2011 due primarily to a decline in trust asset balances and market conditions. We sold one security in the second quarter of 2012 and one in the third quarter of 2012, resulting in gains of $59,000 and $14,000 respectively. No securities were sold in the 2011 periods presented. Income from ATM and debit card fees was up for the most recent quarter and the first nine months of 2012 compared to the same periods in 2011 due to increased volume of activity during 2012. The increase in other income in the three and nine month periods ended September 30, 2012 compared to the same periods in 2011 was primarily attributable to rental income on other real estate owned. Rental income from these properties increased $28,000 and $265,000, respectively, for the three and nine month periods ended September 30, 2012 compared to the same periods in 2011.

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Noninterest Expense: Noninterest expense decreased to $12.4 million for the three month period and decreased to $40.4 million for the nine month period ended September 30, 2012, respectively, from $15.6 million and $46.1 million, respectively, for the same periods in 2011. The components of noninterest expense are shown in the table below (in thousands):

	Three Months Ended September 30, 2012		Three Months Ended September 30, 2011		Nine Months Ended September 30, 2012		Nine Months Ended September 30, 2011

Salaries and benefits	$	5,621	$	5,668	$	17,065	$	16,615
Occupancy of premises		948		961		2,860		2,961
Furniture and equipment		806		812		2,491		2,458
Legal and professional		160		187		551		779
Marketing and promotion		213		228		634		677
Data processing		269		314		988		952
FDIC assessment		504		842		1,692		2,660
ATM and debit card processing		316		337		912		918
Bond and D&O insurance		213		379		696		1,136
FHLB advance prepayment penalty		322		---		322		---
Administration and disposition of problem assets		1,724		4,485		7,973		12,660
Outside services		289		412		1,048		1,238
Other noninterest expense		1,003		1,001		3,148		3,005
Total noninterest expense	$	12,388	$	15,626	$	40,380	$	46,059

Several components of noninterest expense experienced a decline due to our ongoing efforts to manage expenses and scale our operations. Our largest component of noninterest expense, salaries and benefits, decreased in the third quarter of 2012 by $47,000 from the third quarter of 2011. We had 364 full-time equivalent employees at September 30, 2012 compared to 396 at September 30, 2011. The decreased expense for the third quarter of 2012 was primarily attributable the decrease in full-time equivalent employees, partially offset by an increase in commissions paid for mortgage origination activity, which was more than two times greater in the third quarter of 2012 compared to the third quarter of 2011. Also, in March 2012, our board authorized a cost of living increase for the first time in several years, which resulted in an increase in compensation expense beginning in the second quarter of 2012. In addition, our medical insurance costs increased by $176,000 for the third quarter of 2012 compared to the third quarter of 2011. For the first nine month periods, salaries and benefits increased by $450,000 from $16.6 million in 2011 to $17.1 million in 2012. The increase for the first nine months of 2012 compared to the first nine months of 2011 is also due to the cost of living adjustments made in the second quarter of 2012, the increased mortgage commissions from higher loan origination volume and a $339,000 increase in medical insurance costs.

The next largest noninterest expense was the cost related to administration and disposition of problem assets. Costs associated with administration and disposition of problem assets include legal costs, repossessed and foreclosed property administration expense and losses on repossessed and foreclosed properties. Repossessed and foreclosed property administration expense includes survey and appraisal, property maintenance and management and other disposition and carrying costs. Losses on repossessed and foreclosed properties include both net losses on the sale of properties and unrealized losses from value declines for outstanding properties.

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

	Three Months Ended September 30, 2012		Three Months Ended September 30, 2011		Nine Months Ended September 30, 2012		Nine Months Ended September 30, 2011

Legal and professional – nonperforming assets	$	209	$	583	$	917	$	1,953
Repossessed and foreclosed property administration		809		1,358		2,820		3,550
Losses on repossessed and foreclosed properties		706		2,544		4,236		7,157
Total	$	1,724	$	4,485	$	7,973	$	12,660

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Costs associated with administration and disposition of problem assets remained elevated, but have decreased significantly in both the three and nine month periods ended September 30, 2012 as compared to the same periods in 2011. For the three and nine month periods ended September 30, 2012, we recognized reductions from the same periods in 2011 in each category of these costs as we have had fewer properties moving into the problem asset category and as property values have begun to stabilize. As there have been fewer properties moving into nonperforming asset status, we are incurring less legal and professional costs. In addition, we are beginning to see stabilization in property values and thus fewer valuation writedowns. As our level of problem loans and other real estate owned continues to decrease, we believe we will continue to experience meaningful reductions in these costs.

FDIC assessments decreased by $338,000 to $504,000 for the third quarter of 2012 compared to $842,000 for the third quarter of 2011 as a result of our reduced level of deposits, changes to the assessment base implemented by the FDIC and due to a change in our assessment category resulting from the termination of our Consent Order effective March 2, 2012. We estimate an annual FDIC assessment cost savings of $1.2 million related to the Consent Order termination. Because the Consent Order was not terminated until March 2, 2012, we will not realize the full amount of estimated annual savings in 2012. For the nine months ended September 30, 2012, our FDIC assessments were $1.7 million, compared to $2.7 million for the same period in 2011.

We realized a reduction in our bond and D&O insurance costs in the three and nine month periods ended September 30, 2012 compared to the same periods of 2011 as a result of our improving financial condition and the decreased risk perceived by our insurance carriers. We paid off $20 million in FHLB advances in the third quarter of 2012 using proceeds from an early payoff of a $15 million commercial loan. This early payoff of the FHLB advance resulted in a prepayment penalty of $322,000.

Federal Income Tax Expense/Benefit: We recorded federal income tax expense for the three and nine month periods ended September 30, 2012. As a result of projecting positive taxable income for the year ended December 31, 2012, we determined that we would be subject to Alternative Minimum Tax (AMT), which limits the amount of NOL carryforward that we can apply to our 2012 taxes. This created a deferred tax asset at September 30, 2012. We have expensed $275,000 related to AMT for the three and nine month periods ended September 30, 2012 to increase the valuation allowance to cover the AMT deferred tax asset. We recorded no federal income tax expense for the three and nine month periods ended September 30, 2011. Since June 30, 2009, we have concluded that a full valuation allowance must be maintained for all of our net deferred tax assets based primarily on our net operating losses in 2008, 2009 and the first quarter of 2010 and the continued challenging environment confronting banks that could negatively impact future operating results. As required under accounting standards, each quarter we evaluate positive and negative evidence in determining whether to maintain the valuation allowance. Over the past several quarters, the positive evidence has been increasing, while the negative evidence has been decreasing. However, at September 30, 2012, we remained subject to the Written Agreement and are in a cumulative loss position for the most recent three year period. As such, we have maintained a valuation allowance of $19.6 million on our deferred tax assets at September 30, 2012. If the valuation allowance had been reversed at September 30, 2012, net income and shareholders’ equity would have increased by $19.6 million while earnings per share and book value per share would have increased by $0.72 per share. There would have been no impact on cash flows.

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FINANCIAL CONDITION

Summary: Due to the continuing soft economic conditions and having been under the Consent Order through March of 2012, in recent periods we had been focused on reducing our loan portfolio, including reducing exposure in higher loan concentration types, to improve our financial condition through increased liquidity, diversification of credit risk, improved capital ratios, and reduced reliance on non-core funding. With the successful capital raise in the second quarter of 2011, our improving financial condition and the termination of the Consent Order, we are beginning to focus on high quality, measured growth in our investment and loan portfolios.

Total assets were $1.52 billion at September 30, 2012, an increase of $9.5 million from $1.51 billion at December 31, 2011. This change reflected an increase of $61.4 million in securities available for sale, partially offset by a decline of $51.8 million in our loan portfolio. Total deposits increased $29.5 million and other borrowed funds were paid down by $56.8 million during the first nine months of 2012.

Federal Funds Sold and Other Short Term Investments: Federal funds sold and other short-term investments decreased $218,000 from $212.1 million at December 31, 2011 to $211.9 million at September 30, 2012. We expect these balances to continue to decrease in the fourth quarter of 2012 as we focus on loan growth and continue to rebuild our investment portfolio.

Securities Available for Sale: Securities available for sale were $116.1 million at September 30, 2012 compared to $54.7 million at December 31, 2011. We began rebuilding our investment portfolio during the second quarter of 2011. The balance at September 30, 2012 primarily consisted of U.S. agency securities, agency mortgage backed securities and various municipal investments. We expect to continue to reinvest excess liquidity and selectively rebuild our investment portfolio to continue our diversification of asset quality throughout the remainder of 2012.

Portfolio Loans and Asset Quality: Total portfolio loans declined by $51.8 million to $1.02 billion at September 30, 2012 compared to $1.07 billion at December 31, 2011. During the first nine months of 2012, our commercial and consumer loan portfolios (excluding residential mortgages) decreased by $61.1 million and $10.5 million, respectively, while our residential mortgage portfolio increased by $19.8 million as a result of our initiative to increase this portfolio segment to further diversify our credit risk.

We also had a significant increase in the volume of residential mortgage loans originated for sale in the first nine months of 2012 compared to the same period in 2011. Residential mortgage loans originated for sale nearly doubled to $100.9 million in the first nine months of 2012 compared to $59.3 million for the same period in 2011. This increase was primarily due to market conditions and our focus on increasing our residential mortgage lending volume.

The decline in the commercial loan portfolio balances in recent quarters reflected the continuing weak economic conditions in West Michigan and our interest in improving the quality of our loan portfolio through reducing our exposure to these generally higher credit risk assets. We have focused our efforts on reducing our exposure to residential land development loans, diversifying our commercial loan portfolio and improving asset quality. As discussed earlier, we believe our loan portfolio has stabilized and we expect to begin measured high quality loan portfolio growth in future periods.

Commercial and commercial real estate loans remained our largest loan segment and accounted for approximately 72% of the total loan portfolio at September 30, 2012 and 74% at December 31, 2011. Residential mortgage and consumer loans comprised approximately 28% and 26% of total loans at September 30, 2012 and December 31, 2011, respectively.

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

	September 30, 2012		Percent of Total Loans			December 31, 2011		Percent of Total Loans
Commercial real estate:(1)
Residential developed	$	29,004		2.8	%	$	33,829		3.2	%
Unsecured to residential developers		680		0.1			5,937		0.5
Vacant and unimproved		56,901		5.6			66,046		6.2
Commercial development		5,372		0.5			4,586		0.4
Residential improved		77,112		7.6			82,337		7.7
Commercial improved		264,041		25.9			304,070		28.4
Manufacturing and industrial		82,317		8.1			71,462		6.7
Total commercial real estate loans		515,427		50.6			568,267		53.1
Commercial and industrial		218,839		21.5			227,051		21.2
Total commercial loans	$	734,266		72.1	%	$	795,318		74.3	%

(1)

Includes both owner occupied and non-owner occupied commercial real estate.

Commercial real estate accounted for approximately 51% of the total loan portfolio at September 30, 2012 and consisted primarily of loans to business owners and developers of owner and non-owner occupied commercial properties and loans to developers of single and multi-family residential properties. In the table above, we show our commercial real estate portfolio by loans secured by residential and commercial real estate, and by stage of development. Improved loans are generally secured by properties that are under construction or completed and placed in use. Development loans are secured by properties that are in the process of development or fully developed. Vacant land loans are secured by raw land for which development has not yet begun and agricultural land.

Total commercial real estate loans declined $52.8 million since December 31, 2011 as we continued to focus on reducing our real estate loan concentrations and balances. Commercial loans secured by residential real estate, the portfolio that had created the majority of stress within our loan portfolio, declined $15.3 million. The balance of loans secured by nonresidential real estate declined $37.5 million since December 31, 2011.

The following table shows our loan origination activity for portfolio loans during the first nine months of 2012, broken out by loan type and also shows average originated loan size (dollars in thousands):

	Portfolio Originations Nine Months Ended September 30, 2012		Percent of Total Originations			Average Loan Size
Commercial real estate:
Residential developed	$	4,081		1.2	%	$	510
Unsecured to residential developers		---		---			---
Vacant and unimproved		5,526		1.6			307
Commercial development		---		---			---
Residential improved		32,744		9.8			205
Commercial improved		29,512		8.8			461
Manufacturing and industrial		24,154		7.2			604
Total commercial real estate		96,017		28.6			331
Commercial and industrial		173,943		51.8			34
Total commercial		269,960		80.4			50
Consumer:
Residential mortgage		48,789		14.5			160
Unsecured		230		0.1			13
Home equity		14,381		4.3			66
Other secured		2,550		0.7			12
Total consumer		65,950		19.6			87
Total portfolio loan originations	$	335,910		100.0	%		55

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

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

Nonperforming assets are comprised of nonperforming loans, foreclosed assets and repossessed assets. At September 30, 2012, nonperforming assets totaled $75.1 million compared to $95.4 million at December 31, 2011. Significant progress has been made to accelerate workout strategies with problem assets, leading to several properties moving to other real estate owned. Additions to other real estate owned in the first nine months of 2012 were $9.0 million compared to $32.0 million of additions in the first nine months of 2011. Based on the loans currently in their redemption period, we expect significantly reduced levels of loans moving into other real estate owned in the fourth quarter of 2012 compared to the fourth quarter of 2011. Proceeds from sales of foreclosed properties were $13.4 million in the first nine months of 2012 resulting in a net gain of $11,000. The volume of sales in the same period of 2011 generated proceeds of $16.4 million and a net gain of $1.2 million.

Nonperforming loans include loans on non-accrual status and loans delinquent more than 90 days but still accruing. As of September 30, 2012, nonperforming loans totaled $17.4 million, or 1.7% of total portfolio loans, compared to $28.9 million, or 2.70% of total portfolio loans, at December 31, 2011.

Loans for development or sale of 1-4 family residential properties comprised a large portion of nonperforming loans. They were approximately $5.2 million, or 30.0% of total nonperforming loans, at September 30, 2012 compared to $8.5 million, or 29.4% of total nonperforming loans, at December 31, 2011. The remaining balance of nonperforming loans at September 30, 2012 consisted of $3.7 million of commercial real estate loans secured by various types of non-residential real estate, $6.6 million of commercial and industrial loans, and $1.9 million of consumer and residential mortgage loans.

Foreclosed and repossessed assets include assets acquired in settlement of loans. Foreclosed assets totaled $57.8 million at September 30, 2012 compared to $66.4 million at December 31, 2011. Of this balance, there were 123 commercial real estate properties totaling approximately $53.0 million. The remaining balance was comprised of 60 residential properties totaling approximately $4.8 million. All properties acquired through or in lieu of foreclosure are initially transferred at their fair value less estimated costs to sell and then evaluated for impairment after transfer using a lower of cost or market approach. Updated property valuations are obtained at least annually on all foreclosed assets to ensure proper carrying values are maintained.

At September 30, 2012, our foreclosed asset portfolio had a weighted average age held in portfolio of 1.9 years. Below is a breakout of our foreclosed asset portfolio at September 30, 2012 by property type and the percentages by which the property has been written down since taken into our possession and the combined writedown percentage, including losses taken when the property was loan collateral (dollars in thousands):

Foreclosed Asset Property type	Carrying Value at September 30, 2012		Foreclosed Asset Writedown			Combined Writedown (Loan and Foreclosed Asset)

Single Family	$	3,637		6.4	%		46.0	%
Residential Lot		1,145		33.2	%		61.1	%
Multi-Family		448		8.7	%		37.3	%
Vacant Land		7,516		30.9	%		50.2	%
Residential Development		17,860		32.0	%		68.7	%
Commercial Office		5,122		27.3	%		55.7	%
Commercial Industrial		1,244		5.9	%		26.6	%
Commercial Improved		20,806		15.4	%		29.5	%
	$	57,778		23.2	%		55.6	%

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The following table shows the composition and amount of our nonperforming assets (dollars in thousands):

	September 30, 2012			December 31, 2011
Nonaccrual loans	$	16,567		$	26,876
Loans 90 days past due and still accruing		795			2,070
Total nonperforming loans (NPLs)		17,362			28,946
Foreclosed assets		57,778			66,438
Repossessed assets		4			---
Total nonperforming assets (NPAs)		75,144			95,384
Accruing restructured loans (ARLs) (1)		63,209			55,679
Total NPAs and ARLs	$	138,353		$	151,063

NPLs to total loans		1.70	%		2.70	%
NPAs to total assets		4.95	%		6.33	%

(1)

Comprised of approximately $48.0 million and $40.9 million of commercial loans and $15.2 million and $14.8 million of consumer loans whose terms have been restructured at September 30, 2012 and December 31, 2011, respectively. Interest is being accrued on these loans under their restructured terms as they are less than 90 days past due.

Allowance for loan losses: The allowance for loan losses at September 30, 2012 was $26.3 million, a decrease of $5.4 million, compared to $31.6 million at December 31, 2011. The balance of the allowance for loan losses represented 2.58% of total portfolio loans compared to 2.95% of total portfolio loans at December 31, 2011. While this ratio decreased, the allowance for loan losses to nonperforming loan coverage ratio continued to increase, from 109.31% at December 31, 2011 to 151.31% at September 30, 2012.

The continued reduction in net charge-offs over the past several quarters had a significant effect on the historical loss component of our allowance for loan losses computation, as did the improvements in our credit quality metrics. The table below shows the changes in these metrics over the past five quarters:

(in millions)	Quarter Ended September 30, 2012			Quarter Ended June 30, 2012		Quarter Ended March 31, 2011			Quarter Ended December 31, 2011		Quarter Ended September 30, 2011

Commercial loans	$	734.3		$	753.6	$	773.1		$	795.3	$	819.6
Nonperforming loans		17.4			18.9		23.5			28.9		35.0
Other real estate owned and repo assets		57.8			62.0		66.2			66.4		66.5
Total nonperforming assets		75.1			80.9		89.7			95.4		101.5
Net charge-offs (recoveries)		(.3	)		0.5		(1.4	)		3.2		1.4
Total delinquencies		5.7			6.9		8.9			13.1		20.7

Nonperforming loans have continually declined since the first quarter of 2010 to $17.4 million at September 30, 2012, which was our lowest level of nonperforming loans since the second quarter of 2007. As discussed earlier, we had net recoveries of $341,000 for the third quarter of 2012, compared to the third quarter of 2011 when we incurred $1.4 million in net charge-offs. Our total delinquencies have continued to decline, from $20.7 million at September 30, 2011 to just $5.7 million at September 30, 2012.

As discussed earlier, the sustained reduced level of quarterly net charge-offs has had a significant effect on our 18 month historical loss ratios, which are the base for our allowance for loan losses computation. The change in the 18 month historical loss ratios at September 30, 2012 reduced the historical loss allocations in our allowance computation by $779,000 million for the quarter ended September 30, 2012 and by $2.6 million for the nine months ended September 30, 2012.

These factors all provide for a reduction in our provision for loan losses. The provision for loan losses was unchanged at a negative $1.25 million for the three month periods ended September 30, 2012 and 2011. For the first nine month periods, the provision for loan losses decreased $1.9 million from a negative $4.7 million in 2011 to a negative $6.6 million in 2012. Net recoveries were $341,000 for the three months ended September 30, 2012 compared to net charge-offs of $1.4 million for the same period in 2011. For the first nine months of 2012, we had net recoveries of $1.2 million compared to net charge-offs of $7.9 million for the same period in 2011. The ratio of net recoveries to average loans was 0.13% on an annualized basis for the third quarter of 2012, compared to net charge-offs to average loans of 1.19% for the fourth quarter of 2011 and 0.51% for the third quarter of 2011.

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

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

Overall, impaired loans decreased to $80.6 million at September 30, 2012, from $84.6 million at December 31, 2011. The specific allowance for impaired loans decreased $747,000 to $8.9 million, or 11.0% of total impaired loans, at September 30, 2012 compared to $9.6 million, or 11.3% of total impaired loans, at December 31, 2011. The decrease in impaired loans was primarily attributable to loans migrating to other real estate owned, loan payoffs and upgrades more than offsetting loans moving into an impaired status.

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

The determination of our loss factors is based upon our actual loss history by loan grade and adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the analysis date. We use a rolling 18 month actual net chargeoff history as the base for our computation. The 18 month period ended September 30, 2012 reflected a sizeable decrease in net chargeoff experience. We addressed this volatility in the qualitative factor considerations applied in our allowance for loan losses computation. Adjustments to the qualitative factors also involved consideration of different loss periods for the Bank, including 12 and 24 month periods. Considering the change in our qualitative factors and the decrease in our commercial loan portfolio balances, the general allowance allocated to commercial loans decreased to $14.9 million at September 30, 2012 compared to $18.9 million at December 31, 2011. This resulted in a general reserve percentage allocated at September 30, 2012 of 2.20% of commercial loans, a decrease from 2.61% at December 31, 2011. The qualitative component of our general allowance allocated to commercial loans decreased from $14.3 million at December 31, 2011 to $13.0 million at September 30, 2012.

Groups of homogeneous loans, such as residential real estate and open- and closed-end consumer loans, receive allowance allocations based on loan type. As with commercial loans that are not considered impaired, the determination of the allowance allocation percentage is based principally on our historical loss experience. These allocations are adjusted for consideration of general economic and business conditions, credit quality and delinquency trends, collateral values, and recent loss experience for these similar pools of loans. The homogeneous loan allowance was $2.5 million at September 30, 2012 compared to $3.1 million at December 31, 2011. The decrease was related to significant improvements in delinquencies in both residential mortgage and consumer loan portfolios.

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

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Deposits and Other Borrowings: Total deposits increased $29.5 million to $1.24 billion at September 30, 2012 compared to $1.22 billion at December 31, 2011. During the first nine months of 2012, we had increases in lower cost product types including a $23.9 million increase in noninterest checking, a $36.7 million increase in interest bearing checking, and a $51.8 million increase in savings and money market deposits. Partially offsetting this was a $82.9 million decrease in certificates of deposit which is our most rate sensitive category of deposits. Much of this decline in certificates of deposit was intentional and encouraged through our rate setting process in response to our high on-balance sheet liquidity.

The overall stability of in-market deposits is particularly noteworthy considering the financial challenges we have experienced, the lack of economic expansion in western Michigan and the competition for core deposit growth in our markets. We believe the stability in balances of personal and business checking and savings accounts was primarily attributable to our focus on quality customer service, the desire of customers to deal with a local bank, the convenience of our maturing branch network and the breadth and depth of our product line.

Other borrowed funds, consisting of Federal Home Loan Bank advances, decreased $56.8 million during the first nine months of 2012 as a result of scheduled maturities and an early payoff of $20 million in advances in the third quarter of 2012. As discussed previously, we incurred a prepayment penalty of $322,000 which is included in other noninterest expense for the quarter ended September 30, 2012

Accrued expenses and other liabilities: Accrued expenses and other liabilities increased $21.8 million to $28.2 million at September 30, 2012 compared to $6.5 million at December 31, 2011. The primary reason for the increase was a liability of $20.3 million created to account for the commitment to prepay FHLB advances discussed above at September 30, 2012 that settled in early October 2012.

CAPITAL RESOURCES

Total shareholders' equity of $109.4 million at September 30, 2012 increased $15.0 million from $94.4 million at December 31, 2011. The increase was primarily from net income of $14.3 million earned in the first nine months of 2012.

Our regulatory capital ratios improved again in the third quarter of 2012 and the Bank was categorized as “well capitalized” at September 30, 2012 under applicable regulatory guidelines. The following table shows our regulatory capital ratios (on a consolidated basis) for the past several quarters:

	Sept 30, 2012			June 30, 2012			March 31, 2012			Dec 31, 2011			Sept 30, 2011			June 30, 2011			March 31, 2011

Total capital to risk weighted assets		14.9	%		14.2	%		13.7	%		13.2	%		12.9	%		12.7	%		10.3	%

Tier 1 capital to average assets		9.5	%		9.0	%		8.8	%		8.3	%		8.1	%		8.1	%		5.8	%

Approximately $36.2 million of the $40.0 million of trust preferred securities outstanding at September 30, 2012 qualified as Tier 1 capital. The remaining $3.8 million qualified as Tier II capital, a component of total risk-based capital. The ratios have increased each quarter since March 31, 2010 due to declines in risk weighted assets, positive earnings for each quarter and the stock offering completed in the second quarter of 2011.

We continued to suspend payments of cash dividends on our preferred stock during the quarter and until further action by the Board of Directors. During any period that we do not declare and pay cash dividends on our preferred stock, we may not declare and pay cash dividends on our common stock. During the quarter, we also continued to exercise our right to defer interest payments on our trust preferred securities for 20 consecutive quarters or until such earlier time as is determined by further action of the Board of Directors. During any deferral period, we may not declare or pay any dividends on our common stock or preferred stock or make any payment on any outstanding debt obligations that rank equally with or junior to the trust preferred securities.

LIQUIDITY

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

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

The Bank made significant progress during 2010 and 2011 to intentionally reduce its reliance on non-core funding sources, including brokered deposits, and remains focused on maintaining a non-core funding dependency ratio below its peer group average. During 2010, we reduced our brokered deposits by $158.4 million and other borrowed funds by $92.7 million. During 2011, we paid off $48.2 million in brokered deposits and had no such deposits outstanding at December 31, 2011 or at September 30, 2012. Since December 31, 2008, we reduced our brokered deposits by $337.8 million. We also reduced other borrowed funds by $36.7 million in 2011 and an additional $56.8 million in the first nine months of 2012.

The Bank also held $211.9 million of short-term investments and had available borrowing capacity from correspondent banks of approximately $179.1 million as of September 30, 2012 to provide additional liquidity as needed.

Liquidity of Holding Company: The primary sources of liquidity for the Company are dividends from the Bank, existing cash resources and the various capital resources discussed above. Banking regulations and the laws of the State of Michigan in which our Bank is chartered limit the amount of dividends the Bank may declare to the Company in any calendar year. Under Michigan law, the Bank is restricted from paying dividends to the Company until its deficit retained earnings has been restored. At September 30, 2012, the retained deficit of the Bank was approximately $15.8 million, down from its peak of $41.8 million at March 31, 2010. Throughout 2009, 2010, 2011 and the first nine months of 2012, the Company has not received dividends from the Bank and we have not paid any dividends to our common shareholders. Under the MOU and the Written Agreement, the Bank and the Company may not pay any dividends without prior regulatory approval.

The Company continued to suspend payments of cash dividends on its preferred stock during 2010, 2011 and the first nine months of 2012 until further action is taken by the Board of Directors. During the period that the Company does not declare and pay cash dividends on its preferred stock, it may not declare and pay cash dividends on its common stock.

During 2010, 2011 and the first nine months of 2012, the Company also continued to exercise its right to defer interest payments on its trust preferred securities for 20 consecutive quarters or until such earlier time as is determined by further action of the Board of Directors. During the deferral period, the Company may not declare or pay any dividends on its common stock or preferred stock or make any payment on any outstanding debt obligations that rank equally with or junior to the trust preferred securities.

In June 2011, the Company closed its shareholder rights and public offerings and conversion of our 2% Subordinated Note due 2018, resulting in the issuance of 9,404,202 shares of common stock and net proceeds of $20.3 million. The Company contributed $10.0 million of the proceeds to the Bank in 2011 and retained the remaining $10.3 million at the holding company level. The Company’s cash balance at September 30, 2012 was $10.0 million. The Company believes it has sufficient liquidity to meet its cash flow requirements for the remainder of 2012.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES:

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

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

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

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

Our accounting for income taxes involves the valuation of deferred tax assets and liabilities primarily associated with differences in the timing of the recognition of revenues and expenses for financial reporting and tax purposes. At September 30, 2012, we had gross deferred tax assets of $22.9 million, gross deferred tax liabilities of $3.4 million and a valuation allowance of $19.6 million for the entire amount of net deferred tax assets. Accounting standards require that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a "more likely than not" standard. Based upon a number of factors, including our net operating losses in previous years and the challenging environment currently confronting banks that could negatively impact future operating results, we concluded that we needed to continue to maintain a valuation allowance as of September 30, 2012 for our net deferred tax assets. Changes in tax laws, changes in tax rates, changes in ownership and our future level of earnings can impact the ultimate realization of our net deferred tax asset as well as the valuation allowance that we established.

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Item 4:

CONTROLS AND PROCEDURES

(a)

Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Exchange Act Rules 13a-15(e) and 15d-15(e), as of September 30, 2012, the end of the period covered by this report.

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

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

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

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Item 6.

Exhibits.

3.1	Restated Articles of Incorporation. Previously filed with the Commission on April 28, 2011 in Macatawa Bank Corporation’s Quarterly Report on Form 10-Q, Exhibit 3.1. Here incorporated by reference.

3.2	Bylaws. Previously filed with the Commission on November 24, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 3.1. Here incorporated by reference.

3.3	Certificate of Designation of Series A Noncumulative Convertible Perpetual Preferred Stock. Previously filed with the Commission on November 5, 2008 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.

3.4	Certificate of Designation of Series B Noncumulative Convertible Perpetual Preferred Stock. Previously filed with the Commission on July 2, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.

4.1	Restated Articles of Incorporation. Exhibit 3.1 is here incorporated by reference.

4.2	Bylaws. Exhibit 3.2 is here incorporated by reference.

4.3	Certificate of Designation of Series A Noncumulative Convertible Perpetual Preferred Stock. Exhibit 3.3 is here incorporated by reference.

4.4	Certificate of Designation of Series B Noncumulative Convertible Perpetual Preferred Stock. Exhibit 3.4 is here incorporated by reference.

4.5	First Amended Settlement and Release and Warrant Issuance Agreement dated January 30, 2009. Previously filed with the Commission on January 30, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 10.1. Here incorporated by reference.

4.6	Second Amendment to Settlement and Release and Warrant Issuance Agreement dated April 30, 2009. Previously filed with the Commission on May 8, 2009 in Macatawa Bank Corporation's Quarterly Report on Form 10-Q, Exhibit 10. Here incorporated by reference.

4.7	Warrant Agreement between the Company and Registrar and Transfer Company dated June 16, 2009. Previously filed with the Commission on June 19, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.

4.8	Warrant Agreement Addendum between the Company and Registrar and Transfer Company dated July 27, 2009. Previously filed with the Commission on July 31, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.

4.9	Form of Warrant Certificate (first series). Previously filed with the Commission on June 19, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.2. Here incorporated by reference.

4.10	Form of Warrant Certificate (second series). Previously filed with the Commission on July 31, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.2. Here incorporated by reference.

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4.11	Form of 11% Subordinated Note Due 2017. Previously filed with the Commission on July 2, 2009 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.2. Here incorporated by reference.

4.12	Form of Subscription Rights Certificate. Previously filed with the Commission on May 11, 2011 in Macatawa Bank Corporation's Amendment No. 2 to Form S-1 registration statement, Exhibit 4.13. Here incorporated by reference.

4.13	Form of 2% Subordinated Note Due 2018. Previously filed with the Commission on April 22, 2011 in Macatawa Bank Corporation's Current Report on Form 8-K, Exhibit 4.1. Here incorporated by reference.

4.14	Long-Term Debt. The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets. The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the SEC upon request.

31.1	Certification of Chief Executive Officer.

31.2	Certification of Chief Financial Officer.

32.1	Certification pursuant to 18 U.S.C. Section 1350.

101.INS	XBRL Instance Document

101.SCH	XBRL Taxonomy Extension Schema Document

101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF	XBRL Taxonomy Extension Definition Linkbase Document

101.LAB	XBRL Taxonomy Extension Label Linkbase Document

101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

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SIGNATURES

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

	MACATAWA BANK CORPORATION

	/s/ Ronald L. Haan
	Ronald L. Haan
	Chief Executive Officer
	(Principal Executive Officer)

	/s/ Jon W. Swets
	Jon W. Swets
	Senior Vice President and
	Chief Financial Officer
	(Principal Financial and Accounting Officer)

Dated: October 25, 2012

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