10-Q 1 brhc20051966_10q.htm 10-Q
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 March 31, 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: 34,292,294 shares of the Company’s Common Stock (no par value) were outstanding as of April 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 loan 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 loan 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.

Part I
Financial Information
Item 1.
MACATAWA BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
As of March 31, 2023 (unaudited) and December 31, 2022
(Dollars in thousands, except per share data)

   
March 31,
2023
    
December 31,
2022
  
ASSETS
            
Cash and due from banks
  
$
29,402
    
$
51,215
  
Federal funds sold and other short-term investments
    
391,336
      
703,955
  
Cash and cash equivalents
    
420,738
      
755,170
  
Debt securities available for sale, at fair value
    
525,959
      
499,257
  
Debt securities held to maturity (fair value 2023 - $335,559 and 2022 - $332,650)
    
348,387
      
348,765
  
Federal Home Loan Bank (FHLB) stock
    
10,211
      
10,211
  
Loans held for sale, at fair value
    
87
      
215
  
Total loans
    
1,220,939
      
1,177,748
  
Allowance for credit losses
    
(16,794
)
    
(15,285
)
Net loans
    
1,204,145
      
1,162,463
  
Premises and equipment – net
    
40,249
      
40,306
  
Accrued interest receivable
    
8,782
      
7,606
  
Bank-owned life insurance
    
53,557
      
53,345
  
Other real estate owned - net
    
—
      
2,343
  
Net deferred tax asset
    
8,471
      
9,712
  
Other assets
    
16,567
      
17,526
  
Total assets
  
$
2,637,153
    
$
2,906,919
  
LIABILITIES AND SHAREHOLDERS’ EQUITY
                
Deposits
                
Noninterest-bearing
  
$
690,444
    
$
834,879
  
Interest-bearing
    
1,640,451
      
1,780,263
  
Total deposits
    
2,330,895
      
2,615,142
  
Other borrowed funds
    
30,000
      
30,000
  
Accrued expenses and other liabilities
    
15,690
      
14,739
  
Total liabilities
    
2,376,585
      
2,659,881
  
Commitments and contingent liabilities
    
—
      
—
  
Shareholders’ equity
                
Common stock, no par value, 200,000,000 shares authorized; 34,292,294 and 34,298,640 shares issued and outstanding at March 31, 2023 and December 31, 2022
    
219,733
      
219,578
  
Retained earnings
    
67,092
      
59,036
  
Accumulated other comprehensive loss
    
(26,257
)
    
(31,576
)
Total shareholders’ equity
    
260,568
      
247,038
  
Total liabilities and shareholders’ equity
  
$
2,637,153
    
$
2,906,919
  

See accompanying notes to consolidated financial statements.

-4-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three month periods ended March 31, 2023 and 2022
(unaudited)
(Dollars in thousands, except per share data)

   
Three Months
Ended
March 31,
2023
    
Three Months
Ended
March 31,
2022
  
Interest income
            
Loans, including fees
  
$
15,660
    
$
10,397
  
Securities
                
Taxable
    
4,481
      
1,434
  
Tax-exempt
    
698
      
732
  
FHLB Stock
    
65
      
51
  
Federal funds sold and other short-term investments
    
6,362
      
529
  
Total interest income
    
27,266
      
13,143
  
Interest expense
                
Deposits
    
4,494
      
158
  
Other borrowings
    
156
      
320
  
Total interest expense
    
4,650
      
478
  
Net interest income
    
22,616
      
12,665
  
Provision for credit losses
    
—
      
(1,500
)
Net interest income after provision for credit losses
    
22,616
      
14,165
  
Noninterest income
                
Service charges and fees
    
994
      
1,211
  
Net gains on mortgage loans
    
11
      
308
  
Trust fees
    
1,033
      
1,088
  
ATM and debit card fees
    
1,662
      
1,599
  
Bank owned life insurance (“BOLI”) income
    
199
      
240
  
Other
    
629
      
519
  
Total noninterest income
    
4,528
      
4,965
  
Noninterest expense
                
Salaries and benefits
    
6,698
      
6,289
  
Occupancy of premises
    
1,137
      
1,172
  
Furniture and equipment
    
1,031
      
1,016
  
Legal and professional
    
348
      
194
  
Marketing and promotion
    
219
      
195
  
Data processing
    
955
      
884
  
FDIC assessment
    
330
      
180
  
Interchange and other card expense
    
384
      
373
  
Bond and D&O Insurance
    
122
      
130
  
Other
    
941
      
1,306
  
Total noninterest expenses
    
12,165
      
11,739
  
Income before income tax
    
14,979
      
7,391
  
Income tax expense
    
2,975
      
1,391
  
Net income
  
$
12,004
    
$
6,000
  
Basic earnings per common share
  
$
0.35
    
$
0.18
  
Diluted earnings per common share
  
$
0.35
    
$
0.18
  
Cash dividends per common share
  
$
0.08
    
$
0.08
  

See accompanying notes to consolidated financial statements.

-5-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Three month periods ended March 31, 2023 and 2022
(unaudited)
(Dollars in thousands)

   
Three Months
Ended
March 31,
2023
    
Three Months
Ended
March 31,
2022
  
Net income
  
$
12,004
    
$
6,000
  
Other comprehensive income (loss):
                
Unrealized gains (losses):
                
Net change in unrealized gains (losses) on debt securities available for sale
    
6,738
      
(15,119
)
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
     (5 )     (6 )
Tax effect
    
(1,414
)
    
3,153
  
Net change in unrealized gains (losses) on debt securities available for sale, net of tax
    
5,319
      
(11,859
)
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
    
5,319
      
(11,859
)
Comprehensive income (loss)
  
$
17,323
    
$
(5,859
)

See accompanying notes to consolidated financial statements.

-6-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Three month periods ended March 31, 2023 and 2022
(unaudited)
(Dollars in thousands, except per share data)

   
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 three months ended March 31, 2022
    
—
      
6,000
      
—
      
6,000
  
Cash dividends at $0.08 per share
    
—
      
(2,728
)
    
—
      
(2,728
)
Repurchase of 1,338 shares for taxes withheld on vested restricted stock
    
(13
)
    
—
      
—
      
(13
)
Other comprehensive loss, net of tax
    
—
      
—
      
(11,859
)
    
(11,859
)
Stock compensation expense
    
197
      
—
      
—
      
197
  
Balance, March 31, 2022
  
$
219,266
    
$
38,492
    
$
(12,156
)
  
$
245,602
  

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 three months ended March 31, 2023
    
—
      
12,004
      
—
      
12,004
  
Cash dividends at $0.08 per share
    
—
      
(2,733
)
    
—
      
(2,733
)
Repurchase of 1,338 shares for taxes withheld on vested restricted stock
    
(15
)
    
—
      
—
      
(15
)
Other comprehensive income, net of tax
     —       —      
5,319
      
5,319
  
Stock compensation expense
    
170
      
—
      
—
      
170
  
Balance, March 31, 2023
  
$
219,733
    
$
67,092
    
$
(26,257
)
  
$
260,568
  

See accompanying notes to consolidated financial statements.

-7-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three month periods ended March 31, 2023 and 2022
(unaudited)
(Dollars in thousands)

   
Three Months
Ended
March 31,
2023
    
Three Months
Ended
March 31,
2022
  
Cash flows from operating activities
            
Net income
  
$
12,004
    
$
6,000
  
Adjustments to reconcile net income to net cash from operating activities:
                
Depreciation and amortization
    
160
      
737
  
Stock compensation expense
    
170
      
197
  
Provision for credit losses
    
—
      
(1,500
)
Origination of loans for sale
    
(179
)
    
(10,148
)
Proceeds from sales of loans originated for sale
    
318
      
11,008
  
Net gains on mortgage loans
    
(11
)
    
(308
)
Net gain on sales of other real estate
    
(356
)
    
—
  
Deferred income tax expense
    
150
      
456
  
Earnings in bank-owned life insurance
    
(199
)
    
(240
)
Change in accrued interest receivable and other assets
    
(217
)
    
504
  
Change in accrued expenses and other liabilities
    
889
      
(551
)
Net cash from operating activities
    
12,729
      
6,155
  
Cash flows from investing activities
                
Loan originations and payments, net
    
(43,158
)
    
7,318
  
Purchases of securities available for sale
    
(24,072
)
    
(72,557
)
Purchases of securities held to maturity
    
(3,966
)
    
(28,120
)
Proceeds from:
                
Maturities and calls of securities available for sale
     1,626       5,187  
Maturities and calls of securities held to maturity
     1,126       31,238  
Principal paydowns on securities available for sale
     2,878       4,554  
Principal paydowns on securities held to maturity
     3,197       2,667  
Sales of other real estate
    
2,699
      
—
  
Redemption of FHLB stock
     —       1,347  
Additions to premises and equipment
    
(496
)
    
(235
)
Net cash from investing activities
    
(60,166
)
    
(48,601
)
Cash flows from financing activities
                
Change in deposits
    
(284,247
)
    
4,339
  
Repayments and maturities of other borrowed funds
     —       (25,000 )
Proceeds from other borrowed funds
    
—
      
25,000
  
Repurchase of shares for taxes withheld on vested restricted stock
    
(15
)
    
(13
)
Cash dividends paid
    
(2,733
)
    
(2,728
)
Net cash from financing activities
    
(286,995
)
    
1,598
  
Net change in cash and cash equivalents
    
(334,432
)
    
(40,848
)
Cash and cash equivalents at beginning of period
    
755,170
      
1,151,788
  
Cash and cash equivalents at end of period
  
$
420,738
    
$
1,110,940
  

See accompanying notes to consolidated financial statements.

-8-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Three month periods ended March 31, 2023 and 2022
(unaudited)
(Dollars in thousands)

   
Three Months
Ended
March 31,
2023
    
Three Months
Ended
March 31,
2022
  
Supplemental cash flow information
            
Interest paid
  
$
4,307
    
$
481
  
Supplemental noncash disclosures:
                
Security settlement
    
—
      
5,747
  
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.

Recent Events:   In early March 2023, over the course of five days, three large financial institutions in the United States failed.  Silvergate Bank self liquidated and Silicon Valley Bank and Signature Bank were both closed by the FDIC. These bank failures were driven by rapid withdrawals by depositors with large uninsured balances held at these institutions and losses incurred by these banks in liquidating their bond portfolios to provide liquidity to fund these deposit outflows.   Silvergate Bank’s failure was also caused by its exposure to FTX and Alameda cryptocurrency firm failures.   The FDIC determined that Silicon Valley Bank and Signature Bank were systemically important and fully guaranteed their depositor balances above the $250,000 FDIC insurance limit.  Given the sharp increase in market interest rates during 2022 and into 2023, most financial institutions’ bond portfolios have significant unrealized loss positions.  In response to this, the Federal Reserve Bank (“FRB”) created a new borrowing facility called the Bank Term Funding Program.  This program allows a bank to borrow against its investment portfolio, at par value, with no reduction for unrealized losses.  The term is for one year and interest rate is fixed at the time the advance is taken and there is no prepayment penalty.  Allowable investments for pledge are those the FRB can own.  This would include all of the Company’s investment securities except municipal securities and corporate bonds.  At March 31, 2023, the Company had no advances under this program and had $642.2 million in unused borrowing capacity under this program.  The program expires on March 11, 2024.

At March 31, 2023, the Company had $391.3 million in federal funds sold and overnight balances and had borrowing capacity of $951 million, including $242.3 million in unused availability with the Federal Home Loan Bank (“FHLB”), $65.0 million in available fed funds facilities with correspondent banks, $1.5 million in availability at the FRB Discount Window and the $642.2 million in the FRB  Bank Term Funding Program discussed above.  At March 31, 2023, these liquidity sources exceeded the amount of the Company’s uninsured deposit balances.

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 month period ended March 31, 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.

-10-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
FASB issued ASU No. 2016-13, as amended, Financial Instruments—Credit 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.

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 for loan losses.

The allowance is measured on a collective pool basis when similar risk characteristics exist.  Loans with similar risk characteristics are grouped into homogeneous segments, or pools, for allowance calculation.  Commercial loans are divided into eight segments 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 March 31, 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.
-11-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
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.
 
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.

-12-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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 long term historical loss average.  As of January 1, 2023 and March 31, 2023, the Company used a one-year reasonable and supportable economic forecast period, with a six-month straight-line reversion period for all loan segments.  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 March 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).  At adoption of CECL on January 1, 2023, the Company considered the December 2022 report for these same metrics and used a loss period from September 2007 to December 2007.  The effect of changing the loss period from that used at January 1, 2023 to March 31, 2023 was a reduction in the historical loss rate used at March 31, 2023.
 
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.

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 $3.8 million at March 31, 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 $4.5 million at March 31, 2023 and $3.4 million at December 31, 2022.

-13-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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.  At March 31, 2023 and at adoption of CECL on January 1, 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.  At March 31, 2023 and at adoption of CECL on January 1, 2023, there was no ACL related to securities HTM.

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.

-14-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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 March 31,2023 and December 31, 2022, the total notional amount of such agreements was $115.1 million and $125.3 million, respectively, and resulted in a derivative asset with a fair value of $5.3 million and $6.5 million, respectively, which were included in other assets and a derivative liability of $5.3 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 $4,000 at March 31, 2023 and $0 at December 31, 2022.  The net fair value of mortgage backed security derivatives was ($3,000) at March 31, 2023 and $0 at December 31, 2022.

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 March 31, 2023 and December 31, 2022, these loans had net unrealized gains of $5,000 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 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-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 2 – SECURITIES

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

   
Amortized
Cost
    
Gross
Unrealized
Gains
    
Gross
Unrealized
Losses
    
Fair
Value
  
March 31, 2023
                        
Available for Sale
                        
U.S. Treasury and federal agency securities
  
$
255,211
    
$
175
    
$
(13,528
)
  
$
241,858
  
U.S. Agency MBS and CMOs
    
134,956
      
81
      
(12,793
)
    
122,244
  
Tax-exempt state and municipal bonds
    
37,142
      
77
      
(270
)
    
36,949
  
Taxable state and municipal bonds
    
119,862
      
149
      
(6,874
)
    
113,137
  
Corporate bonds and other debt securities