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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended June 30, 2023

 

OR

 

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

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading Symbol

Name of each exchange on which registered

Common stock

MCBC

NASDAQ

 

Indicate by check mark 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 ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer ☐

Accelerated filer ☐

Non-accelerated filer

Smaller reporting company

Emerging Growth Company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

The number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 34,291,487 shares of the Company's Common Stock (no par value) were outstanding as of July 27, 2023.

 

 

 

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 “could”, “may”, “should”, “will”, “is likely”, or is “possible” or “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”, “concern”, “going forward”, “focus”, “starting”, “initiative,” “trend” and variations of such words and similar expressions. Such statements are based upon current beliefs and expectations and involve substantial risks and uncertainties which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These statements include, among others, those related to future levels of earning assets, future composition of our loan portfolio, trends in credit quality metrics, future capital levels and capital needs, real estate valuation, future levels of repossessed and foreclosed properties and nonperforming assets, future levels of losses and costs associated with the administration and disposition of repossessed and foreclosed properties and nonperforming assets, future levels of loan charge-offs, future levels of other real estate owned, future levels of provisions for credit losses and reserve recoveries, the rate of asset dispositions, future dividends, future growth and funding sources, future cost of funds, future liquidity levels, future profitability levels, future interest rate levels, future net interest margin levels, the effects on earnings of changes in interest rates, future economic conditions, future effects of new or changed accounting standards, future loss recoveries, loan demand and loan growth, future amounts of unrecognized tax benefits, the future level of other revenue sources and future amounts of unrealized gains or losses in our investment securities portfolio. Management's determination of the provision and allowance for credit losses, the appropriate carrying value of intangible assets (including deferred tax assets) and other real estate owned, and the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary and the amount of any impairment) involves judgments that are inherently forward-looking. All statements with references to future time periods are forward-looking. All of the information concerning interest rate sensitivity is forward-looking. Our ability to sell other real estate owned at its carrying value or at all, successfully implement new programs and initiatives, increase efficiencies, maintain our current levels of deposits and other sources of funding, maintain liquidity, respond to declines in collateral values and credit quality, respond to a changing interest rate environment, increase loan volume, originate high quality loans, maintain or improve mortgage banking income, realize the benefit of our deferred tax assets, continue 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, interest rates 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, 2022. 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

10

 

 

 

 

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

41

 

 

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

55

 

 

 

 

Item 4. Controls and Procedures

56

 

 

 

Part II.

Other Information:

 

 

 

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

57

 

 

 

 

Item 6. Exhibits

57

 

 

 

Signatures

 

58

 

 

 
 

 

Part I Financial Information

Item 1.

 

MACATAWA BANK CORPORATION

CONSOLIDATED BALANCE SHEETS

As of June 30, 2023 (unaudited) and December 31, 2022

(Dollars in thousands, except per share data)


 

  

June 30,
2023

  

December 31,
2022

 

ASSETS

        

Cash and due from banks

 $40,255  $51,215 

Federal funds sold and other short-term investments

  343,676   703,955 

Cash and cash equivalents

  383,931   755,170 

Debt securities available for sale, at fair value

  512,837   499,257 

Debt securities held to maturity (fair value 2023 - $325,354 and 2022 - $332,650)

  340,400   348,765 

Federal Home Loan Bank (FHLB) stock

  10,211   10,211 

Loans held for sale, at fair value

     215 

Total loans

  1,271,576   1,177,748 

Allowance for credit losses

  (17,109

)

  (15,285

)

Net loans

  1,254,467   1,162,463 

Premises and equipment – net

  39,766   40,306 

Accrued interest receivable

  7,499   7,606 

Bank-owned life insurance

  53,791   53,345 

Other real estate owned - net

     2,343 

Net deferred tax asset

  9,636   9,712 

Other assets

  17,716   17,526 

Total assets

 $2,630,254  $2,906,919 

LIABILITIES AND SHAREHOLDERS' EQUITY

        

Deposits

        

Noninterest-bearing

 $704,409  $834,879 

Interest-bearing

  1,617,136   1,780,263 

Total deposits

  2,321,545   2,615,142 

Other borrowed funds

  30,000   30,000 

Accrued expenses and other liabilities

  14,890   14,739 

Total liabilities

  2,366,435   2,659,881 

Commitments and contingent liabilities

        

Shareholders' equity

        

Common stock, no par value, 200,000,000 shares authorized; 34,291,487 and 34,298,640 shares issued and outstanding at June 30, 2023 and December 31, 2022

  219,909   219,578 

Retained earnings

  74,670   59,036 

Accumulated other comprehensive loss

  (30,760

)

  (31,576

)

Total shareholders' equity

  263,819   247,038 

Total liabilities and shareholders' equity

 $2,630,254  $2,906,919 

 

See accompanying notes to consolidated financial statements.

 

-4-

 

 

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

Three and six month periods ended June 30, 2023 and 2022

(unaudited)

(Dollars in thousands, except per share data)


 

   

Three Months
Ended
June 30,
2023

   

Three Months
Ended
June 30,
2022

   

Six Months
Ended
June 30,
2023

   

Six Months
Ended
June 30,
2022

 

Interest income

                               

Loans, including fees

  $ 17,176     $ 10,344     $ 32,835     $ 20,741  

Securities

                               

Taxable

    4,596       2,618       9,077       4,052  

Tax-exempt

    678       702       1,376       1,434  

FHLB Stock

    71       51       137       102  

Federal funds sold and other short-term investments

    4,599       1,720       10,961       2,249  

Total interest income

    27,120       15,435       54,386       28,578  

Interest expense

                               

Deposits

    5,816       245       10,310       403  

Other borrowings

    158       347       314       667  

Total interest expense

    5,974       592       10,624       1,070  

Net interest income

    21,146       14,843       43,762       27,508  

Provision for credit losses

    300             300       (1,500

)

Net interest income after provision for credit losses

    20,846       14,843       43,462       29,008  

Noninterest income

                               

Service charges and fees

    1,018       1,218       2,012       2,430  

Net gains on mortgage loans

    21       199       32       508  

Trust fees

    1,136       1,096       2,168       2,184  

ATM and debit card fees

    1,740       1,762       3,403       3,360  

Bank owned life insurance ("BOLI") income

    221       230       420       470  

Other

    477       626       1,106       1,144  

Total noninterest income

    4,613       5,131       9,141       10,096  

Noninterest expense

                               

Salaries and benefits

    6,843       6,402       13,541       12,691  

Occupancy of premises

    1,098       1,071       2,235       2,243  

Furniture and equipment

    1,064       988       2,095       2,004  

Legal and professional

    271       271       619       465  

Marketing and promotion

    205       195       423       390  

Data processing

    1,006       924       1,961       1,808  

FDIC assessment

    330       197       660       377  

Interchange and other card expense

    402       406       786       779  

Bond and D&O Insurance

    122       129       243       259  

Other

    1,332       1,330       2,275       2,636  

Total noninterest expenses

    12,673       11,913       24,838       23,652  

Income before income tax

    12,786       8,061       27,765       15,452  

Income tax expense

    2,474       1,493       5,449       2,884  

Net income

  $ 10,312     $ 6,568     $ 22,316     $ 12,568  

Basic earnings per common share

  $ 0.30     $ 0.19     $ 0.65     $ 0.37  

Diluted earnings per common share

  $ 0.30     $ 0.19     $ 0.65     $ 0.37  

Cash dividends per common share

  $ 0.08     $ 0.08     $ 0.16     $ 0.16  

 

See accompanying notes to consolidated financial statements.

 

-5-

 

 

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

Three and six month periods ended June 30, 2023 and 2022

(unaudited)

(Dollars in thousands)


 

   

Three
Months
Ended
June 30,
2023

   

Three
Months
Ended
June 30,
2022

   

Six
Months
Ended
June 30,
2023

   

Six
Months
Ended
June 30,
2022

 

Net income

  $ 10,312     $ 6,568     $ 22,316     $ 12,568  

Other comprehensive income (loss):

                               

Unrealized gains (losses):

                               

Net change in unrealized gains (losses) on debt securities available for sale

    (5,694

)

    (8,251

)

    1,044       (23,371

)

Net unrealized gain at time of transfer on securities transferred to held-to-maturity

                      113  

Amortization of net unrealized gains on securities transferred to held-to-maturity

    (6

)

    (6

)

    (11

)

    (10

)

Tax effect

    1,197       1,734       (217

)

    4,886  

Net change in unrealized gains (losses) on debt securities available for sale, net of tax

    (4,503

)

    (6,523

)

    816       (18,382

)

Less: reclassification adjustments:

                               

Reclassification for gains included in net income

                       

Tax effect

                       

Reclassification for gains included in net income, net of tax

                       

Other comprehensive income (loss), net of tax

    (4,503

)

    (6,523

)

    816       (18,382

)

Comprehensive income (loss)

  $ 5,809     $ 45     $ 23,132     $ (5,814

)

 

See accompanying notes to consolidated financial statements.

 

-6-

 

 

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

Three and six month periods ended June 30, 2023 and 2022

(unaudited)

(Dollars in thousands, except per share data)


 

  

Common
Stock

  

Retained Earnings

  

Accumulated
Other
Comprehensive
Income (Loss)

  

Total
Shareholders'
Equity

 

Balance, April 1, 2022

 $219,266  $38,492  $(12,156

)

 $245,602 

Net income for the three months ended June 30, 2022

     6,568      6,568 

Cash dividends at $0.08 per share

     (2,728

)

     (2,728

)

Repurchase of 815 shares for taxes withheld on vested restricted stock

  (7

)

        (7

)

Other comprehensive loss, net of tax

        (6,523

)

  (6,523

)

Stock compensation expense

  197         197 

Balance, June 30, 2022

 $219,456  $42,332  $(18,679

)

 $243,109 
                 
                 

Balance, April 1, 2023

 $219,733  $67,092  $(26,257

)

 $260,568 

Net income for the three months ended June 30, 2023

     10,312      10,312 

Cash dividends at $0.08 per share

     (2,734

)

     (2,734

)

Repurchase of 807 shares for taxes withheld on vested restricted stock

  (7

)

        (7

)

Other comprehensive loss, net of tax

        (4,503

)

  (4,503

)

Stock compensation expense

  183         183 

Balance, June 30, 2023

 $219,909  $74,670  $(30,760

)

 $263,819 

 

  

Common
Stock

  

Retained Earnings

  

Accumulated
Other
Comprehensive
Income (Loss)

  

Total
Shareholders'
Equity

 

Balance, January 1, 2022

 $219,082  $35,220  $(297

)

 $254,005 

Net income for the six months ended June 30, 2022

     12,568      12,568 

Cash dividends at $0.16 per share

     (5,456

)

     (5,456

)

Repurchase of 2,153 shares for taxes withheld on vested restricted stock

  (20

)

        (20

)

Other comprehensive loss, net of tax

        (18,382

)

  (18,382

)

Stock compensation expense

  394         394 

Balance, June 30, 2022

 $219,456  $42,332  $(18,679

)

 $243,109 
                 
                 

Balance, January 1, 2023

 $219,578  $59,036  $(31,576

)

 $247,038 

Adoption of ASU 2016-13, net of tax

     (1,215

)

     (1,215

)

Net income for the six months ended June 30, 2023

     22,316      22,316 

Cash dividends at $0.16 per share

     (5,467

)

     (5,467

)

Repurchase of 2,145 shares for taxes withheld on vested restricted stock

  (22

)

        (22

)

Other comprehensive income, net of tax

        816   816 

Stock compensation expense

  353         353 

Balance, June 30, 2023

 $219,909  $74,670  $(30,760

)

 $263,819 

 

See accompanying notes to consolidated financial statements.

 

-7-

 

 

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

Six month periods ended June 30, 2023 and 2022

(unaudited)

(Dollars in thousands)


 

 

   

Six Months
Ended
June 30,
2023

   

Six Months
Ended
June 30,
2022

 

Cash flows from operating activities

               

Net income

  $ 22,316     $ 12,568  

Adjustments to reconcile net income to net cash from operating activities:

               

Depreciation and amortization

    242       1,204  

Stock compensation expense

    353       394  

Provision for credit losses

    300       (1,500

)

Origination of loans for sale

    (2,620

)

    (18,548

)

Proceeds from sales of loans originated for sale

    2,867       19,300  

Net gains on mortgage loans

    (32

)

    (508

)

Net gain on sales of other real estate

    (356

)

     

Deferred income tax expense

    182       533  

Earnings in bank-owned life insurance

    (420

)

    (470

)

Change in accrued interest receivable and other assets

    (83

)

    (2,008

)

Change in accrued expenses and other liabilities

    89       66  

Net cash from operating activities

    22,838       11,031  

Cash flows from investing activities

               

Loan originations and payments, net

    (93,780

)

    (2,680

)

Purchases of securities available for sale

    (24,072

)

    (186,326

)

Purchases of securities held to maturity

    (6,505

)

    (137,355

)

Proceeds from:

               

Maturities and calls of securities available for sale

    5,546       13,265  

Maturities and calls of securities held to maturity

    10,014       9,481  

Principal paydowns on securities available for sale

    6,829       8,586  

Principal paydowns on securities held to maturity

    4,816       35,382  

Sales of other real estate

    2,699        

Redemption of FHLB stock

          1,347  

Additions to premises and equipment

    (538

)

    (466

)

Net cash for investing activities

    (94,991

)

    (258,766

)

Cash flows from financing activities

               

Change in deposits

    (293,597

)

    (83,375

)

Repayments and maturities of other borrowed funds

          (80,000

)

Proceeds from other borrowed funds

          25,000  

Repurchase of shares for taxes withheld on vested restricted stock

    (22

)

    (20

)

Cash dividends paid

    (5,467

)

    (5,456

)

Net cash for financing activities

    (299,086

)

    (143,851

)

Net change in cash and cash equivalents

    (371,239

)

    (391,586

)

Cash and cash equivalents at beginning of period

    755,170       1,151,788  

Cash and cash equivalents at end of period

  $ 383,931     $ 760,202  

 

See accompanying notes to consolidated financial statements.

 

-8-

 

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)

Six month periods ended June 30, 2023 and 2022

(unaudited)

(Dollars in thousands)


 

   

Six Months
Ended
June 30,
2023

   

Six Months
Ended
June 30,
2022

 

Supplemental cash flow information

               

Interest paid

  $ 10,144     $ 1,106  

Income taxes paid

    4,950       3,000  

Supplemental noncash disclosures:

               

Security settlement

          1,662  

Transfer of securities from available for sale to held to maturity

          123,469  

 

See accompanying notes to consolidated financial statements.

 

 

-9-

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 ("FDIC"). 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.

 

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 six months period ended June 30, 2023 are not necessarily indicative of the results that may be expected for the year ending December 31, 2023. 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, 2022.

 

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 credit losses and fair values of financial instruments are particularly subject to change.

 

FASB issued ASU No. 2016-13, as amended, Financial InstrumentsCredit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU, commonly referred to as Current Expected Credit Loss ("CECL"), provides financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date by replacing the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The new guidance eliminates the probable initial recognition threshold and, instead, reflects an entity’s current estimate of all expected credit losses. The new guidance broadens the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually to include forecasted information, as well as past events and current conditions. There is no specified method for measuring expected credit losses, and an entity is allowed to apply methods that reasonably reflect its expectations of the credit loss estimate. Although an entity may still use its current systems and methods for recording the allowance for credit losses, under the new rules, the inputs used to record the allowance for credit losses generally will need to change to appropriately reflect an estimate of all expected credit losses and the use of reasonable and supportable forecasts. FASB also issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This standard eliminated the previous accounting guidance for troubled debt restructurings and added additional disclosure requirements for gross chargeoffs by year of origination. It also prescribes guidance for reporting modifications of loans to borrowers experiencing financial difficulty.

 

The Company adopted these standards as required on January 1, 2023 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures. Results for reporting periods beginning after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with the probable incurred loss accounting standards. The transition adjustment of the CECL adoption included an increase in the allowance for loans of $1.5 million and an increase of $62,000 to establish a reserve for unfunded commitments, with a $1.2 million decrease to retained earnings, with the $323,000 income tax portion being recorded as part of the deferred tax asset in the Company's Consolidated Balance Sheet.

 

- 10-

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Allowance for Credit Losses ("ACL") - Loans: The allowance for credit losses (allowance) is a valuation account that is deducted from the loan portfolios' amortized cost basis to present the net amount expected to be collected on loans.  The allowance is increased by the provision for credit losses and recoveries, and decreased by charge-offs of loans. Management believes the allowance 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, current and forecasted 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 uncollectability of a loan balance is confirmed. Management continues its collection efforts on previously charged-off balances and applies recoveries as additions to the allowance.

 

The allowance is measured on a collective pool basis when similar risk characteristics exist.  Loans with similar risk characteristics are grouped into homogeneous classes, or pools, for allowance calculation.  Commercial loans are divided into eight classes based primarily on property type and risk characteristics.  They are further segmented based on commercial loan risk grade.  Retail loans are segmented into categories including residential mortgage, home equity, unsecured and other secured and then further segmented based on delinquency status.

 

The Company's loan portfolio classes as of June 30, 2023 were as follows:

 

Commercial Loans:

 

Commercial and Industrial - Risks to this category include industry concentration and limitations associated with monitoring the adequacy and condition of collateral which can include inventory, accounts receivable, and other non-real estate assets. Equipment and inventory obsolescence can also pose a risk. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.

 

Residential developed - Risks to this category include industry concentration, valuation of residential properties, inventory of homes for sale in the market area, inadequate long-term financing arrangements and velocity of sales. Loans in this category are susceptible to weakening general economic conditions and increases in unemployment rates as well as market demand and supply of similar property. Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.

 

Unsecured to residential developers - Risks to this category include industry concentration, valuation of residential properties, inventory of homes for sale in the market area and velocity of sales. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.

 

Vacant and unimproved - Risks to this category include industry concentration, valuation of farm land, agricultural properties and residential properties as well as velocity of sales. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt. Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.

 

Commercial development - Risks to this category include industry concentration, valuation of commercial properties, lease terms, occupancy/vacancy rates and velocity of sales. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt. Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.

 

Residential improved - Risks to this category include industry concentration, valuation of residential properties, inventory of homes for sale in the market area and velocity of sales. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt. Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.

 

Commercial improved - Risks to this category include industry concentration, valuation of commercial properties, lease terms, occupancy/vacancy rates, cost overruns, changes in market demand for property or services and velocity of sales. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt. Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.

 

- 11-

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Manufacturing and industrial - Risks to this category include industry concentration, valuation of commercial properties, changes in market demand for products produced and velocity of sales. Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt. Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.

 

Consumer Loans:

 

Residential mortgage - Residential mortgage loans are susceptible to weakening general economic conditions and increases in unemployment rates and declining real estate values.

 

Unsecured - Unsecured loans are susceptible to weakening general economic conditions and increases in unemployment rates.

 

Home equity - Home equity loans are susceptible to weakening general economic conditions and increases in unemployment rates and declining real estate values.

 

Other secured - Other secured loans are susceptible to weakening general economic conditions and increases in unemployment rates, regulatory risks as well as the inability to monitor collateral consisting of personal property.

 

The remaining life methodology is used for all loan pools. This nondiscounted cash flow approach projects an estimated future amortized cost basis based on current loan balance and repayment terms. Given the bank's limited loss history over the past twelve years, a loss rate computed for a comparable sized peer group (banks with assets between $1-3 billion) is then applied to future loan balances at the instrument level based on the remaining contractual life adjusted for amortization, prepayment and default to develop a baseline lifetime loss. The baseline lifetime loss is adjusted for changes in macroeconomic conditions over the reasonable and supportable forecast period and reversion periods.

 

Reasonable and supportable economic forecasts have to be incorporated in determining expected losses. The forecast period represents the time frame from the current period end through the point in time that the Company can reasonably forecast. Ideally, the economic forecast period would cover the contractual terms of all loans; however, the ability to produce a forecast that is both reasonable and supportable becomes more difficult the longer the period is projected.

 

For periods beyond the forecast period, the loss rate reverts back to the baseline lifetime loss.  As of June 30, 2023, the Company used a one-year reasonable and supportable economic forecast period, with a six-month straight-line reversion period for all loan classes.  In determining the reasonable and supportable economic forecast period, the Company used a consensus economic forecast from a third-party provider that provided forecasts from twenty five leading economists.  The Company considered the June 2023 report's consensus/mean estimates for gross domestic product and unemployment rates and selected a loss period for the reasonable and supportable forecast period that most closely matched that consensus ( December 2006 to September 2007).  The forecast period used at June 30, 2023 was not materially different from the one used in the March 31, 2023 calculation.

 

A number of qualitative factors are considered including economic forecast uncertainty, credit quality trends, valuation trends, concentration risk, quality of loan review, changes in personnel, impact of rising interest rates, external factors and other considerations. During each reporting period, management also considers the need to adjust the baseline lifetime loss rates for factors that may cause expected losses to differ from those experienced in the historical loss periods.

 

The Company is also required to consider expected credit losses associated with loan commitments over the contractual period in which it is exposed to credit risk on the underlying commitments. Any allowance for off-balance sheet credit exposures is reported as an other liability on the Company's Consolidated Balance Sheet and is increased or decreased via other noninterest expense on the Company's Consolidated Statement of Income. The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives. The allowance is calculated using the same methodology, inputs and assumptions as the funded portion of loans at the segment level applied to the amount of commitments expected to be funded.

 

- 12-

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income over the respective term of the loan using the level-yield method without anticipating prepayments. Accrued interest on loans totaled $3.9 million at June 30, 2023 and $4.0 million at December 31, 2022.

 

Accrued interest receivable for loans is included as a separate line item on the Company's Consolidated Balance Sheet. The Company elected not to measure an allowance for accrued interest receivable and instead elected to reverse accrued interest income on loans that are placed on nonaccrual status. The Company believes this policy results in the timely reversal of uncollectible interest.

 

Interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer loans are typically charged off no later than 120 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

 

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Securities: Securities are classified as held to maturity ("HTM") and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities available for sale ("AFS") consist of those securities which might be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs or other factors. Securities classified as AFS are reported at their fair value and the related unrealized gain or loss is reported in other comprehensive income, net of tax.

 

Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level yield method without anticipating prepayments. Gains and losses on sales are based on the amortized cost of the security sold. Accrued interest receivable on securities totaled $3.5 million at June 30, 2023 and $3.4 million at December 31, 2022.

 

ACL - Securities Available for Sale - For securities AFS in an unrealized loss position, management determines whether they intend to sell or if it is more likely than not that the Company will be required to sell the security before recovery of the amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security's amortized cost basis is written down to fair value through income with an allowance being established under CECL.  For securities AFS with unrealized losses not meeting these criteria, management evaluates whether any decline in fair value is due to credit loss factors.  In making this assessment, management considers any changes to the rating of the security by rating agencies and adverse conditions specifically related to the issuer of the security, among other factors.  If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security.  If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses ("ACL") is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis.  Changes in the ACL under ASC 326-30 are recorded as provisions for (or reversal of) credit loss expense.  Losses are charged against the allowance when the collectability of a debt security AFS is confirmed or when either of the criteria regarding intent or requirement to sell is met.  Any impairment that has not been recorded through an ACL is recognized in other comprehensive income, net of income taxes.  The Company has never experienced a loss on any debt securities AFS.  At June 30, 2023, there was no ACL related to debt securities AFS.  Accrued interest receivable on debt securities was excluded from the estimate of credit losses.

 

ACL - Securities Held to Maturity - Since the adoption of CECL, the Company measures credit losses on HTM securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The ACL on securities HTM is a contra asset valuation account that is deducted from the carrying amount of HTM securities to present the net amount expected to be collected.  HTM securities are charged off against the ACL when deemed uncollectible.  Adjustments to the ACL are reported in the Company's Consolidated Statements of Income in the provision for credit losses.  Accrued interest receivable on HTM securities is excluded from the estimate of credit losses.  With regard to US Treasury securities, these have an explicit government guarantee; therefore, no ACL is recorded for these securities.  With regard to obligations of states and political subdivisions and other HTM securities, management considers (1) issuer bond ratings, (2) historical loss rates for given bond ratings, (3) the financial condition of the issuer, and (4) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities.  The Company has never experienced any loss on HTM securities.  At June 30, 2023, there was no ACL related to securities HTM.

 

- 13-

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

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.

 

The Company recognizes 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. The Company recognizes interest and penalties related to income tax matters in income tax expense.

 

Revenue From Contracts With Customers: The Company records revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, "Revenue from Contracts with Customers" ("Topic 606"). Under Topic 606, the Company must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) it satisfies a performance obligation. No revenue has been recognized in the current reporting period that results from performance obligations satisfied in previous periods.

 

The Company's primary sources of revenue are derived from interest and dividends earned on loans, securities and other financial instruments that are not within the scope of Topic 606. The Company has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary.

 

The Company generally satisfies its performance obligations on contracts with customers as services are rendered, and the transaction prices are typically fixed and charged either on a periodic basis (generally monthly) or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.

 

Interest Income: The Company’s largest source of revenue is interest income which is primarily recognized on an accrual basis based on contractual terms written into loans and investment contracts.

 

Noninterest Revenue: The Company derives the majority of its noninterest revenue from: (1) service charges for deposit related services, (2) gains related to mortgage loan sales, (3) trust fees and (4) debit and credit card interchange income. Most of these services are transaction based and revenue is recognized as the related service is provided.

 

Derivatives: Certain of the Bank’s commercial loan customers have entered into interest rate swap agreements directly with the Bank. At the same time the Bank enters into a swap agreement with its customer, the Bank enters into a corresponding interest rate swap agreement with a correspondent bank at terms mirroring the Bank’s interest rate swap with its commercial loan customer. This is known as a back-to-back swap agreement. Under this arrangement the Bank has two freestanding interest rate swaps, each of which is carried at fair value. As the terms mirror each other, there is no income statement impact to the Bank. At June 30, 2023 and December 31, 2022, the total notional amount of such agreements was $112.7 million and $125.3 million, respectively, and resulted in a derivative asset with a fair value of $6.0 million and $6.5 million, respectively, which were included in other assets and a derivative liability of $6.0 million and $6.5 million, respectively, which were included in other liabilities.

 

Mortgage Banking Derivatives: Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as derivatives not qualifying for hedge accounting. Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest rate on the loan is locked. The Bank enters into commitments to sell mortgage backed securities, which it later buys back in order to hedge its exposure to interest rate risk in its mortgage pipeline. At times, the Bank also enters into forward commitments for the future delivery of mortgage loans when loans are closed but not yet sold, in order to hedge the change in interest rates resulting from its commitments to sell the loans.

 

Changes in the fair values of these interest rate lock and mortgage backed security and forward commitment derivatives are included in net gains on mortgage loans.  The fair value of interest rate lock commitments was $0 at June 30, 2023 and $0 at December 31, 2022.  The net fair value of mortgage backed security derivatives was $6,000 at June 30, 2023 and $0 at December 31, 2022.

 

- 14-

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

 

Loans Held for Sale:  Mortgage loans originated and intended for sale in the secondary market are carried at fair value, as determined by outstanding commitments from investors. As of June 30, 2023 and December 31, 2022, these loans had net unrealized gains of $0 and $4,000, respectively, which are reflected in their carrying value.  Changes in fair value of loans held for sale are included in net gains on mortgage loans.  Loans are sold with servicing released; therefore no mortgage servicing right assets are established.

 

Newly Issued Not Yet Effective Standards:  FASB issued ASU 2023-01, Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method.  This standard allows entities to elect to account for qualifying tax equity investments using the proportional amortization method, regardless of the program giving rise to the related income tax credits.  This election allows the entity to record a writedown of investment to federal income tax expense where income tax credits are recorded.  This also aligns the treatment of other tax equity investments with that allowed for low income housing tax credit investments.  The standard is effective for the Company for fiscal years beginning after December 15, 2023, including interim periods within these fiscal years.  The Company already utilizes the proportional amortization method for its investments in low income housing tax credit investments and as it has no other types of investments in tax credit structures, adoption of this standard will not have any immediate impact.

 

FASB issued ASU 2023-01, Leases (Topic 842): Common Control Arrangements. This standard requires entities to amortize leasehold improvements associated with common control leases over the useful life to the common control group. The standard is effective for the Company for fiscal years beginning after December 15, 2023, including interim periods within these fiscal years. As the Company does not have any such common control leases, adoption of this standard will not have any immediate impact.

 

- 15-

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):

 

June 30, 2023 

Amortized
Cost

  

Gross
Unrealized
Gains

  

Gross
Unrealized
Losses

  

Fair
Value

 

Available for Sale

                

U.S. Treasury and federal agency securities

 $255,547  $  $(15,366

)

 $240,181 

U.S. Agency MBS and CMOs

  130,977      (14,828

)

  116,149 

Tax-exempt state and municipal bonds

  35,218   5   (612

)

  34,611 

Taxable state and municipal bonds

  117,976   36   (7,831

)

  110,181 

Corporate bonds and other debt securities

  12,136      (421

)

  11,715 
  $551,854  $41  $(39,058

)

 $512,837 

Held to Maturity

                

U.S. Treasury

 $251,266  $  $(13,162

)

 $238,104 

Tax-exempt state and municipal bonds

  89,134   199   (2,083

)

  87,250 
  $340,400  $199  $(15,245

)

 $325,354 

 

December 31, 2022 

Amortized
Cost

  

Gross
Unrealized
Gains

  

Gross
Unrealized
Losses

  

Fair
Value

 

Available for Sale:

                

U.S. Treasury and federal agency securities

 $240,921  $23  $(16,310

)

 $224,634 

U.S. Agency MBS and CMOs

  128,165      (14,347

)

  113,818 

Tax-exempt state and municipal bonds

  37,198   10   (498

)

  36,710 

Taxable state and municipal bonds

  120,647   49   (8,525

)

  112,171 

Corporate bonds and other debt securities

  12,387      (463

)

  11,924 
  $539,318  $82  $(40,143

)

 $499,257 

Held to Maturity

                

U.S. Treasury

 $251,307  $  $(13,677

)

 $237,630 

Tax-exempt state and municipal bonds

  97,458   415   (2,853

)

  95,020 
  $348,765  $415  $(16,530

)

 $332,650 

 

There were no sales of securities in the three and six month periods ended June 30, 2023 and 2022.

 

- 16-

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

NOTE 2 SECURITIES (Continued)

 

On January 1, 2022, the Company reclassified ten U.S. Treasury securities with an amortized cost of $123.5 million from available for sale to held to maturity, as it has the intent and ability to hold these securities to maturity. These securities had net unrealized gains of $113,000 at the date of transfer, which will continue to be reported in accumulated other comprehensive income, and will be amortized over the remaining life of the securities as an adjustment of yield. The effect on interest income of the amortization of net unrealized gains is offset by the amortization of the premium on the securities transferred.

 

Contractual maturities of debt securities at June 30, 2023 were as follows (dollars in thousands):

 

  

Held–to-Maturity Securities

  

Available-for-Sale Securities

 
  

Amortized
Cost

  

Fair
Value

  

Amortized
Cost

  

Fair
Value

 

Due in one year or less

 $115,991  $113,729  $60,850  $59,717 

Due from one to five years

  206,975   194,472   336,794   316,350 

Due from five to ten years

  17,434   17,153   24,734   22,027 

Due after ten years

        129,476   114,743 
  $340,400  $325,354  $551,854  $512,837 

 

Securities with unrealized losses at June 30, 2023 and December 31, 2022, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows (dollars in thousands):

 

  

Less than 12 Months

  

12 Months or More

  

Total

 

June 30, 2023

 

Fair
Value

  

Unrealized
Loss

  

Fair
Value

  

Unrealized
Loss

  

Fair
Value

  

Unrealized
Loss

 

Available for Sale

                        

U.S. Treasury and federal agency securities

 $53,921  $(1,053

)

 $182,058  $