Macatawa Bank Corporation Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

FAIR VALUE

FAIR VALUE

12 Months Ended

Dec. 31, 2016

NOTE 5 – FAIR VALUE

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

Level 1:

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

Level 2:

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

Level 3:

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

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

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

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

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

Interest Rate Swaps: For interest rate swap agreements, we measure fair value utilizing pricing provided by a third-party pricing source that that uses market observable inputs, such as forecasted yield curves, and other unobservable inputs and accordingly, interest rate swap agreements are classified as Level 3.

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)
December 31, 2016
U.S. Treasury and federal agency securities	$	84,350		$	---	$	84,350	$	---
U.S. Agency MBS and CMOs		11,817			---		11,817		---
Tax-exempt state and municipal bonds		39,187			---		39,187		---
Taxable state and municipal bonds		33,883			---		33,883		---
Corporate bonds and other debt securities		13,726			---		13,726		---
Other equity securities		1,470			---		1,470		---
Loans held for sale		2,181			---		2,181		---
Interest rate swaps		494			---		---		494
Interest rate swaps		(494	)		---		---		(494	)

December 31, 2015
U.S. Treasury and federal agency securities	$	74,392		$	---	$	74,392	$	---
U.S. Agency MBS and CMOs		13,755			---		13,755		---
Tax-exempt state and municipal bonds		33,598			---		33,598		---
Taxable state and municipal bonds		28,763			---		28,763		---
Corporate bonds and other debt securities		14,813			---		14,813		---
Other equity securities		1,494			---		1,494		---
Loans held for sale		2,776			---		2,776		---
Interest rate swaps		790			---		---		790
Interest rate swaps		(790	)		---		---		(790	)

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)
December 31, 2016
Impaired loans	$	3,436	$	---	$	---	$	3,436
Other real estate owned		9,542		---		---		9,542

December 31, 2015
Impaired loans	$	6,573	$	---	$	---	$	6,573
Other real estate owned		13,602		---		---		13,602

Quantitative information about Level 3 fair value measurements measured on a non-recurring basis were as follows at year end (dollars in thousands).

Asset

Fair

Value

Valuation

Technique

Unobservable

Inputs

Range (%)

December 31, 2016

Impaired Loans

3,436

Sales comparison approach

Adjustment for differences between comparable sales

1.0

35.0

Income approach

Capitalization rate

9.5

11.5

Other real estate owned

9,542

Sales comparison approach

Adjustment for differences between comparable sales

2.0

32.5

Income approach

Capitalization rate

9.5

11.5

Asset

Fair

Value

Valuation

Technique

Unobservable

Inputs

Range (%)

December 31, 2015

Impaired Loans

6,573

Sales comparison approach

Adjustment for differences between comparable sales

1.0

19.0

Income approach

Capitalization rate

9.5

11.0

Other real estate owned

13,602

Sales comparison approach

Adjustment for differences between comparable sales

4.5

32.5

Income approach

Capitalization rate

9.5

11.0

The carrying amounts and estimated fair values of financial instruments, not previously presented, were as follows at year end (dollars in thousands).

	Level in Fair Value Hierarchy	2016						2015
	Level in Fair Value Hierarchy	Carrying Amount			Fair Value			Carrying Amount			Fair Value
Financial assets
Cash and due from banks	Level 1	$	27,690		$	27,690		$	29,104		$	29,104
Cash equivalents	Level 2		62,129			62,129			152,372			152,372
Interest-bearing time deposits in other financial institutions	Level 2		---			---			20,000			20,008
Securities held to maturity	Level 3		69,378			69,849			51,856			52,837
FHLB stock			11,558		NA				11,558		NA
Loans, net	Level 2		1,260,414			1,247,842			1,187,423			1,177,527
Bank owned life insurance	Level 3		39,274			39,274			28,858			28,858
Accrued interest receivable	Level 2		4,092			4,092			3,622			3,622

Financial liabilities
Deposits	Level 2		(1,448,724	)		(1,448,724	)		(1,435,512	)		(1,435,473	)
Other borrowed funds	Level 2		(84,173	)		(84,051	)		(96,169	)		(96,465	)
Long-term debt	Level 2		(41,238	)		(36,112	)		(41,238	)		(35,757	)
Accrued interest payable	Level 2		(282	)		(282	)		(273	)		(273	)

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, interest-bearing time deposits in other financial institutions and 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.

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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