SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
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| SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES [Abstract] | |||||||||||||||||||||||||||||||
| SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
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.
Recent Events: In response to the COVID-19 pandemic, federal state and local governments have
taken and continue to take actions designed to mitigate the effect on public health and to address the economic impact from the virus. The effects of COVID-19 and its related variants could, among other risks, result in a material
increase in requests from the Company’s customers for loan deferrals, modifications to the terms of loans, or other borrower accommodations; have a material adverse impact on the financial condition of the Company’s customers,
potentially impacting their ability to make payments to the Company as scheduled driving an increase in delinquencies and loan losses; result in additional material provision for loan losses; result in a decreased demand for the
Company’s loans; or negatively impact the Company’s ability to access capital on attractive terms or at all. Those effects could have a material adverse impact on the Company’s and its customers’ business, financial condition, and
results of operations.
The Bank was a participating lender in the
Small Business Administration’s (“SBA”) Paycheck Protection Program (“PPP”). PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the
PPP. These loans carry a fixed rate of 1.00% and a term of two years (loans made before June 5, 2020) or five years (loans made on or after June 5, 2020), if not forgiven, in whole or in part. Payments are deferred until either the
date on which the SBA remits the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness within that 10 month period. Fees
generated based on the origination of PPP loans are deferred and amortized into interest income over the contractual period of 24
months or 60 months, as applicable. Upon SBA forgiveness, unamortized fees are then recognized into interest income.
In 2020:
In 2021:
In the nine months ended September 30, 2022:
As of September 30, 2022, just one PPP loan totaling $37,000 in principal remained outstanding and total net fees of $5,000 remained unrecognized.
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (Continued)
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, 2022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2022. 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, 2021.
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.
Allowance for Loan Losses: The allowance
for loan losses (allowance) 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, 2022, 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 loans and consumer loans. 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.
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 loan foreclosure, primarily other real estate owned, are initially recorded at fair value less estimated 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.
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 is 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. The Bank has a master netting arrangement with its correspondent bank and
has opted to record the fair value of these instruments on a gross basis. At September 30, 2022 and December 31, 2021, the total notional amount of such agreements was $127.3 million and $140.7 million, respectively, and resulted in
a derivative asset with a fair value of $6.9 million and $3.3 million, respectively, which were included in other assets and a derivative liability of $6.9 million and $3.3 million, respectively, which were included
in other liabilities. The net fair value position of these instruments was $6.9 million at September 30, 2022 and $1.0 million at December 31, 2021.
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.
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
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 $(19,000)
at September 30, 2022 and $25,000 at December 31, 2021. The net fair value of mortgage backed security derivatives
was $74,000 at September 30, 2022 and $(13,000) at December 31, 2021.
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 September 30,
2022 and December 31, 2021, these loans had net unrealized gains (losses) of $(17,000) and $51,000, 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 No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU 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 in current GAAP 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. Additionally, credit losses on available-for-sale debt securities will now have to be presented as an allowance rather than as a write-down.
This ASU expands the disclosure requirements
regarding an entity’s assumptions, models and methods for estimating the allowance for credit losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality
indicator, disaggregated by year of origination. The Company selected a software vendor for applying this new ASU for Current Expected Credit Losses (“CECL”), began implementation of the software in the second quarter of 2018,
completed integration during the third quarter of 2018 and ran parallel computations with both systems using the current GAAP incurred loss model in the fourth quarter of 2018. The Company went live with this software beginning
in January 2019 for its monthly incurred loss computations and began modeling the new current expected credit loss model assumptions to the allowance for loan losses computation. In the periods since, the Company modeled the
various methods prescribed in the ASU against the Company’s identified loan segments. Based on the modeling conducted through September 30, 2022, the Company does not believe the effect of adoption of the new standard will
materially affect the level of the allowance for loan losses or valuation reserves on available-for-sale debt securities or debt securities held to maturity. The Company anticipates continuing to run parallel computations as it
continues to evaluate the impact of adoption of the new standard.
ASU 2020-04, Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial
Reporting provides temporary optional expedients and exceptions to GAAP guidance on contract modifications and hedge accounting to ease the
financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates. Entities can elect not to apply certain modification accounting requirements to
contracts affected by reference rate reform, if certain criteria are met. Entities that make such elections would not have to remeasure contracts at the modification date or reassess a previous accounting determination.
Entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met. We are utilizing the timeline
guidance published by the Alternative Reference Rates Committee to develop and achieve internal milestones during this transitional period. We have discontinued the use of new LIBOR-based loans and interest rate derivatives,
according to regulatory guidelines. The amended guidance under Topic 848 and our ability to elect its temporary optional expedients and exceptions are effective for us through December 31, 2022. We have adopted the LIBOR transition relief allowed under this standard.
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
ASU No. 2022-01 Derivatives and Hedging (Topic 815): Fair Value Hedging - Portfolio Layer Method. This ASU expands the current last-of-layer method of hedge accounting that permits only one hedged layer to allow multiple hedged
layers of a single closed portfolio. To reflect this expansion, the last-of-layer method is renamed the portfolio layer method. This ASU expands the scope of the portfolio layer method to include nonprepayable assets, specifies
eligible hedging instruments in a single-layer hedge, provides additional guidance on the accounting for and disclosure of hedge basis adjustments and specifies how hedge basis adjustments should be considered when determining
credit losses for the assets included in the closed portfolio. This ASU is effective for public business entities for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. As the Company
does not engage in this type of hedging activity, the Company does not believe adoption of this ASU will have any impact on its financial results or disclosures.
ASU No. 2022-02 Financial Instruments -
Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. This ASU eliminates the accounting guidance for troubled debt restructurings (TDRs) by creditors in Subtopic 310-40, Receivables -
Troubled Debt Restructurings by Creditors, while adding disclosures for certain loan restructurings by creditors when a borrower is experiencing financial difficulty. This guidance requires an entity to determine whether the
modification results in a new loan or a continuation of an existing loan. Additionally, the ASU requires disclosure of current period gross writeoffs by year of origination for financing receivables. The ASU also requires
disclosure of current period gross writeoffs by year of origination for financing receivables and disclosure of certain modifications of receivables made to borrowers experiencing financial difficulty. This ASU is effective for
the Company for fiscal years beginning after December 15, 2022. The Company does not believe adoption of this ASU will have a material impact on its financial results and will add the required disclosures for gross writeoffs in
its financial statements upon adoption of the new standard.
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