Annual report pursuant to Section 13 and 15(d)

SHAREHOLDERS' EQUITY

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SHAREHOLDERS' EQUITY
 12 Months Ended
Dec. 31, 2011
Shareholders' Equity [Abstract]  
SHAREHOLDERS' EQUITY
NOTE 17 - 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 would result in regulatory action that could have a direct material effect on the financial statements.

The prompt corrective action regulations provide five classifications, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition.  If the Bank is only adequately capitalized, regulatory approval is required to accept brokered deposits; and if the Bank is undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required.

Actual capital levels (dollars in thousands) and minimum required levels were as follows at year-end:

   
 
 
Actual
    
Minimum Required
For Capital
Adequacy Purposes
    
To Be Well
Capitalized Under
Prompt Corrective
Action Regulations
    
Minimum
Required Under
Consent Order
  
   
Amount
    
Ratio
    
Amount
    
Ratio
    
Amount
    
Ratio
    
Amount
    
Ratio
  
December 31, 2011
                                                
Total capital (to risk weighted assets)
                                                
Consolidated
   $ 149,905       13.2 %   $ 91,201       8.0 %     N/A       N/A    
N/AA
       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  
                                                                 
December 31, 2010
                                                                
Total capital (to risk weighted assets)
                                                                
Consolidated
   $ 125,483       9.7 %   $ 104,013       8.0 %     N/A       N/A    
N/AA
       N/A  
Bank
     125,797       9.7       103,970       8.0     $ 129,963       10.0 %     142,960       11.0 %
Tier 1 capital (to risk weighted assets)
                                                                
Consolidated
     89,585       6.9       52,007       4.0       N/A       N/A       N/A       N/A  
Bank
     109,160       8.4       51,985       4.0       77,978       6.0       N/A       N/A  
Tier 1 capital (to average assets)
                                                                
Consolidated
     89,585       5.8       61,605       4.0       N/A       N/A       N/A       N/A  
Bank
     109,160       7.1       61,520       4.0       76,901       5.0       123,041       8.0  

Approximately $31.3 million and $22.4 million of trust preferred securities outstanding at December 31, 2011 and 2010, respectively, qualified as Tier 1 capital for regulatory capital purposes.
 
The Bank was categorized as "adequately capitalized" at December 31, 2011 and 2010.  The Bank's total regulatory capital was $28.1 million above the level required to be categorized as "well capitalized" at December 31, 2011.  However, because the Bank was subject to the Consent Order, the Bank could not be categorized as "well capitalized" regardless of actual capital levels.  On March 2, 2012, the Bank's regulators terminated the Consent Order.  Had the Consent Order been terminated as of December 31, 2011, the Bank would have been categorized as “well capitalized.”  We expect the Bank to be categorized as “well capitalized” as of March 31, 2012. In connection with the termination of the Consent Order, the Bank reached an understanding with its regulators to maintain a Tier 1 Leverage Capital Ratio of at least 8%, which the Bank exceeded at December 31, 2011.
 
As part of the Consent Order, the Bank was required to have and maintain a Tier 1 Leverage Capital Ratio of at least 8% and a Total Risk Based Capital Ratio of at least 11%.  With the successful capital raise in 2011 along with positive earnings and asset shrinkage in 2011, at December 31, 2011, the Bank exceeded these capital ratios.  The Bank's Tier 1 capital exceeded the Consent Order requirement by $6.5 million and exceeded the total risk based requirement by $16.7 million at December 31, 2011.

The Consent Order also prohibited the Bank from declaring or paying any cash dividend without the prior written consent of its regulators.  In connection with the termination of the Consent Order, the Bank reached an understanding with its regulators to obtain prior written consent of its regulators before the Bank declares or pays any dividends.  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 $31.7 million at December 31, 2011.

Additional information about the termination of the Consent Order and the Bank's understanding with its regulators may be found in Note 1 under the heading "Regulatory Developments."

Issuance of Capital

A summary of the capital instruments issued to accredited investors during recent years is as follows:

Convertible Preferred Stock

In 2008, the Company completed a private offering of 31,290 shares of 12.0% Series A Non-cumulative Convertible Perpetual Preferred Stock (Series A Preferred Stock) with a liquidation preference of $1,000 per share, resulting in an aggregate liquidation preference of $31.3 million.  Proceeds of $30.6 million from issuance were net of $686,000 of costs.

Each share of the Series A Preferred Stock is non-voting and may be convertible at any time, at the option of the holder, into 111.73 shares of common stock of the Company, which represents an approximate initial conversion price of $8.95 per share of common stock.  On or after the third anniversary of the issue date, at the option of the Company, the Series A Preferred Stock will be subject to mandatory conversion into common stock at the prevailing conversion rate, if the closing price of the Company's common stock exceeds 130% of the then applicable conversion price for 20 trading days during any 30 consecutive trading day period and the Company has paid full dividends on the Series A Preferred Stock for four consecutive quarters. The conversion rate and conversion price will be subject to adjustments in certain circumstances.

In 2009, the Company issued 2,600 shares of 9.0% Series B Non-cumulative Convertible Perpetual Preferred Stock (Series B Preferred Stock) with a liquidation preference of $1,000 per share, resulting in an aggregate liquidation preference of $2.6 million.  Proceeds of $2.6 million from issuance were net of $40,000 of costs.

Each share of the Series B Preferred Stock is non-voting and may be convertible at any time, at the option of the holder, into 166.67 shares of common stock of the Company, which represents an approximate initial conversion price of $6.00 per share of common stock.  On or after the third anniversary of the issue date, at the option of the Company, the Series B Preferred Stock will be subject to mandatory conversion into common stock at the prevailing conversion rate, if the closing price of the Company's common stock exceeds 120% of the then applicable conversion price for 20 trading days during any 30 consecutive trading day period and the Company has paid full dividends on the Series B Preferred Stock for four consecutive quarters.  The conversion rate and conversion price will be subject to adjustments in certain circumstances.  The Series B Preferred Stock is subordinate to the Series A Preferred Stock.  If all of the outstanding shares of the Series A and Series B Preferred Stock were converted into common stock, the shares of Series A and Series B Preferred Stock would convert into a total of approximately 3.9 million shares of common stock at December 31, 2011.

On December 4, 2009, the Board of Directors of the Company resolved that it will not declare or pay any cash dividends on the Series A or Series B Preferred Stock until further action by the Board of Directors. During the period that the Company does not declare and pay cash dividends on its Series A or Series B Preferred Stock, it may not declare or pay any cash dividends on the Company's common stock.
 
Both the Series A and Series B Preferred Stock qualified as Tier I capital for the Company.

Subordinated Notes

In 2009, the Company received proceeds of $1,650,000 from the issuance of unsecured subordinated debt.  The subordinated debt was in the form of 11% subordinated notes due 2017 and redeemable three years after issued.  The subordinated notes are not convertible into common stock or preferred stock.

In order to temporarily replenish the Company's liquidity pending the Company's planned public offering of common stock, on April 21, 2011, the Company issued and sold a 2% Subordinated Note due 2018 in the aggregate principal amount of $1,000,000 to a director of the Company. The note had a maturity date of April 30, 2018. The note holder had a continuing right to convert the note in full into common stock with the stock to be valued at book value and the note to be valued at principal and interest accrued.  On June 29, 2011, the director executed his right to convert the 2% Subordinated Note into 491,830 shares of common stock.

Common Stock

In 2009, the Company issued 538,386 shares of common stock to accredited investors as part of the private offering.  The shares were issued at an average price of $3.06 per share resulting in total proceeds of $1.7 million.

On June 7, 2011, the Company closed on a rights offering to existing shareholders, issuing 4,456,186 shares of common stock for $2.30 per share. On June 29, 2011, the Company closed on its public offering, issuing 4,456,186 shares of common stock for $2.30 per share. As indicated above, on June 29, 2011, the director discussed above executed his right to convert the 2% Subordinated Note into 491,830 shares of common stock. The net proceeds from the offerings and subordinated note conversion were $20.3 million. The Company contributed $10.0 million to the Bank on June 30, 2011 and held the remaining proceeds at the holding company.
 
Warrants

As previously disclosed, in 2009 the Company and Macatawa Bank entered into a Settlement and Release and Stock and Warrant Issuance Agreement in connection with legal precedings related to Trade Partners, Inc.  In connection with the Settlement, the Company issued warrants to purchase a total of 1,478,811 shares of common stock at an exercise price of $9.00 per share.  The fair value of the warrants issued was $806,000 and was recorded in Common Stock based upon $0.54 per warrant as determined using a Black-Scholes model.