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 September 30, 20212022

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 checkmark 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.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: 34,189,79934,246,283 shares of the Company’s Common Stock (no par value) were outstanding as of October 28, 202127, 2022.

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 the risks and uncertainties related to, and the impact of, the global coronavirus (COVID-19) pandemic on the business, financial condition and results of operations of our company and our customers, 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 and the future level of other revenue sources. 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, 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 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, 2020.2021. 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 IFinancial Information
Item 1.
MACATAWA BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
As of September 30, 20212022 (unaudited) and December 31, 20202021
(Dollars in thousands, except per share data)

 
September 30,
2021
  
December 31,
2020
  
September 30,
2022
  
December 31,
2021
 
ASSETS            
Cash and due from banks $30,413  $31,480  $33,205  $23,669 
Federal funds sold and other short-term investments  1,239,525   752,256   733,347   1,128,119 
Cash and cash equivalents  1,269,938   783,736   766,552   1,151,788 
Debt securities available for sale, at fair value  241,475   236,832   453,728   416,063 
Debt securities held to maturity (fair value 2021 - $140,412 and 2020 - $83,246)
  137,569   79,468 
Debt securities held to maturity (fair value 2022 - $330,882 and 2021 - $139,272)
  349,481   137,003 
Federal Home Loan Bank (FHLB) stock  11,558   11,558   10,211   11,558 
Loans held for sale, at fair value  2,635   5,422   234   1,407 
Total loans  1,136,613   1,429,331   1,138,645   1,108,993 
Allowance for loan losses  (16,532)  (17,408)  (14,821)  (15,889)
Net loans  1,120,081   1,411,923   1,123,824   1,093,104 
Premises and equipment – net  42,343   43,254   40,670   41,773 
Accrued interest receivable  4,005   5,625   7,202   4,088 
Bank-owned life insurance  52,781   42,516   53,193   52,468 
Other real estate owned - net  2,343   2,537   2,343   2,343 
Net deferred tax asset  2,126   2,059   10,185   2,163 
Other assets  14,646   17,096   17,415   14,993 
Total assets $2,901,500  $2,642,026  $2,835,038  $2,928,751 
LIABILITIES AND SHAREHOLDERS’ EQUITY                
Deposits                
Noninterest-bearing $934,477  $809,437  $855,744  $886,115 
Interest-bearing  1,618,698   1,489,150   1,700,453   1,691,843 
Total deposits  2,553,175   2,298,587   2,556,197   2,577,958 
Other borrowed funds  85,000   70,000   30,000   85,000 
Long-term debt  0   20,619 
Accrued expenses and other liabilities  11,112   12,977   12,287   11,788 
Total liabilities  2,649,287   2,402,183   2,598,484   2,674,746 
Commitments and contingent liabilities  0   0   —   — 
Shareholders’ equity                
Common stock, 0 par value, 200,000,000 shares authorized; 34,189,799 and 34,197,519 shares issued and outstanding at September 30, 2021 and December 31, 2020
  218,991   218,528 
Common stock, no par value, 200,000,000 shares authorized; 34,251,485 and 34,259,945 shares issued and outstanding at September 30, 2022 and December 31, 2021
  219,583   219,082 
Retained earnings  31,728   17,101   49,648   35,220 
Accumulated other comprehensive income  1,494   4,214 
Accumulated other comprehensive loss
  (32,677)  (297)
Total shareholders’ equity  252,213   239,843   236,554   254,005 
Total liabilities and shareholders’ equity $2,901,500  $2,642,026  $2,835,038  $2,928,751 

See accompanying notes to consolidated financial statements.

-4-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three and nine month periods ended September 30, 20212022 and 20202021
(unaudited)
(Dollars in thousands, except per share data)

 
Three Months
Ended
September 30,
2021
  
Three Months
Ended
September 30,
2020
  
Nine Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2020
  
Three Months
Ended
September 30,
2022
  
Three Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2022
  
Nine Months
Ended
September 30,
2021
 
Interest income                        
Loans, including fees $12,761  $13,854  $39,530  $43,194  $12,164  $12,761  $32,905  $39,530 
Securities                                
Taxable  786   867   2,365   2,881   3,323   786   7,375   2,365 
Tax-exempt  777   861   2,295   2,607   668   777   2,102   2,295 
FHLB Stock  44   100   162   339   53   44   155   162 
Federal funds sold and other short-term investments  474   140   948   802   4,667   474   6,915   948 
Total interest income  14,842   15,822   45,300   49,823   20,875   14,842   49,452   45,300 
Interest expense                                
Deposits  209   621   732   3,118   944   209   1,346   732 
Other borrowings  325   364   1,006   1,069   160   325   827   1,006 
Long-term debt  12   163   319   612   —   12   —   319 
Total interest expense  546   1,148   2,057   4,799   1,104   546   2,173   2,057 
Net interest income  14,296   14,674   43,243   45,024   19,771   14,296   47,279   43,243 
Provision for loan losses  (550)  500   (1,300)  2,200   —   (550)  (1,500)  (1,300)
Net interest income after provision for loan losses  14,846   14,174   44,543   42,824   19,771   14,846   48,779   44,543 
Noninterest income                                
Service charges and fees  1,183   987   3,240   2,957   1,263   1,183   3,693   3,240 
Net gains on mortgage loans  851   1,546   4,177   4,045   166   851   673   4,177 
Trust fees  1,079   921   3,217   2,801   969   1,079   3,153   3,217 
ATM and debit card fees  1,676   1,542   4,844   4,199   1,724   1,676   5,084   4,844 
Bank owned life insurance (“BOLI”) income  260   215   787   688   217   260   687   787 
Other  593   881   2,084   2,214   550   593   1,695   2,084 
Total noninterest income  5,642   6,092   18,349   16,904   4,889   5,642   14,985   18,349 
Noninterest expense                                
Salaries and benefits  6,278   6,480   19,192   18,937   6,639   6,278   19,331   19,192 
Occupancy of premises  992   1,026   3,023   2,984   989   992   3,232   3,023 
Furniture and equipment  1,014   967   2,929   2,704   1,014   1,014   3,017   2,929 
Legal and professional  272   260   768   798   268   272   733   768 
Marketing and promotion  175   239   525   716   196   175   586   525 
Data processing  839   761   2,602   2,309   984   839   2,792   2,602 
FDIC assessment  204   131   532   207   201   204   578   532 
Interchange and other card expense  391   367   1,137   1,041   405   391   1,184   1,137 
Bond and D&O Insurance  112   104   334   313   129   112   389   334 
Other  1,273   1,198   3,711   3,750   1,302   1,273   3,936   3,711 
Total noninterest expenses  11,550   11,533   34,753   33,759   12,127   11,550   35,778   34,753 
Income before income tax  8,938   8,733   28,139   25,969   12,533   8,938   27,986   28,139 
Income tax expense  1,736   1,613   5,341   4,800   2,488   1,736   5,372   5,341 
Net income $7,202  $7,120  $22,798  $21,169  $10,045  $7,202  $22,614  $22,798 
Basic earnings per common share $0.21  $0.21  $0.67  $0.62  $0.29  $0.21  $0.66  $0.67 
Diluted earnings per common share $0.21  $0.21  $0.67  $0.62  $0.29  $0.21  $0.66  $0.67 
Cash dividends per common share $0.08  $0.08  $0.24  $0.24  $0.08  $0.08  $0.24  $0.24 

See accompanying notes to consolidated financial statements.

-5-

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Three and nine month periods ended September 30, 20212022 and 20202021
(unaudited)
(Dollars in thousands)

 
Three Months
Ended
September 30,
2021
  
Three Months
Ended
September 30,
2020
  
Nine Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2020
  
Three Months
Ended
September 30,
2022
  
Three Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2022
  
Nine Months
Ended
September 30,
2021
 
Net income $7,202  $7,120  $22,798  $21,169  $10,045  $7,202  $22,614  $22,798 
Other comprehensive income:                
Other comprehensive income (loss):                
Unrealized gains (losses):                                
Net change in unrealized gains (losses) on debt securities available for sale  (792)  39   (3,443)  3,865   (17,714)  (792)  (41,085)  (3,443)
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)  —   (16)  — 
Tax effect  166   (8)  723   (814)  3,721   166   8,608   723 
Net change in unrealized gains (losses) on debt securities available for sale, net of tax  (626)  31   (2,720)  3,051   (13,998)  (626)  (32,380)  (2,720)
Less: reclassification adjustments:                                
Reclassification for gains included in net income  0   0   0   0   —   —   —   — 
Tax effect  0   0   0   0   —   —   —   — 
Reclassification for gains included in net income, net of tax  0   0   0   0   —   —   —   — 
Other comprehensive income (loss), net of tax  (626)  31   (2,720)  3,051   (13,998)  (626)  (32,380)  (2,720)
Comprehensive income $6,576  $7,151  $20,078  $24,220 
Comprehensive income (loss)
 $(3,953) $6,576  $(9,766) $20,078 

See accompanying notes to consolidated financial statements.

-6-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Three and nine month periods ended September 30, 20212022 and 20202021
(unaudited)
(Dollars in thousands, except per share data)

 
Common
Stock
  Retained Earnings  
Accumulated
Other
Comprehensive
Income (Loss)
  
Total
Shareholders’
Equity
 
Balance, July 1, 2020 $218,349  $6,425  $4,564  $229,338 
Net income for the three months ended September 30, 2020  0   7,120   0   7,120 
Cash dividends at $0.08 per share  0   (2,720)  0   (2,720)
Repurchase of 1,696 shares for taxes withheld on vested restricted stock
  (13)  0   0   (13)
Net change in unrealized gain on debt securities available for sale, net of tax  0   0   31   31 
Stock compensation expense  109   0   0   109 
Balance, September 30, 2020 $218,445  $10,825  $4,595  $233,865 
                
                 
Common
Stock
  Retained Earnings  
Accumulated
Other
Comprehensive
Income (Loss)
  
Total
Shareholders’
Equity
 
Balance, July 1, 2021 $218,846  $27,251  $2,120  $248,217  $218,846  $27,251  $2,120  $248,217 
Net income for the three months ended September 30, 2021  0   7,202   0   7,202   —   7,202   —   7,202 
Cash dividends at $0.08 per share  0   (2,725)  0   (2,725)  —   (2,725)  —   (2,725)
Repurchase of 2,518 shares for taxes withheld on vested restricted stock  (21)  0   0   (21)  (21)  —   —   (21)
Net change in unrealized gain on debt securities available for sale, net of tax  0   0   (626)  (626)
Other comprehensive income, net of tax
  —   —   (626)  (626)
Stock compensation expense  166   0   0   166   166   —   —   166 
Balance, September 30, 2021 $218,991  $31,728  $1,494  $252,213  $218,991  $31,728  $1,494  $252,213 
                
                
Balance, July 1, 2022 $219,456  $42,332  $(18,679) $243,109 
Net income for the three months ended September 30, 2022
  —   10,045   —   10,045 
Cash dividends at $0.08 per share  —   (2,729)  —   (2,729)
Repurchase of 1,662 shares for taxes withheld on vested restricted stock
  (15)  —   —   (15)
Other comprehensive income, net of tax
  —   —   (13,998)  (13,998)
Stock compensation expense  142   —   —   142 
Balance, September 30, 2022 $219,583  $49,648  $(32,677) $236,554 

Common
Stock
 Retained Earnings 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Shareholders’
Equity
 
Balance, January 1, 2020 $218,109  $(2,184) $1,544  $217,469 
Net income for the nine months ended September 30, 2020  0   21,169   0   21,169 
Cash dividends at $0.24 per share  0   (8,160)  0   (8,160)
Repurchase of 3,304 shares for taxes withheld on vested restricted stock  (24)  0   0   (24)
Net change in unrealized gain on debt securities available for sale, net of tax  0   0   3,051   3,051 
Stock compensation expense  360   0   0   360 
Balance, September 30, 2020 $218,445  $10,825  $4,595  $233,865 
                
                 
Common
Stock
  Retained Earnings  
Accumulated
Other
Comprehensive
Income (Loss)
  
Total
Shareholders’
Equity
 
Balance, January 1, 2021 $218,528  $17,101  $4,214  $239,843  $218,528  $17,101  $4,214  $239,843 
Net income for the nine months ended September 30, 2021  0   22,798   0   22,798   —   22,798   —   22,798 
Cash dividends at $0.24 per share  0   (8,171)  0   (8,171)  —   (8,171)  —   (8,171)
Repurchase of 3,859 shares for taxes withheld on vested restricted stock  (34)  0   0   (34)  (34)  —   —   (34)
Net change in unrealized gain on debt securities available for sale, net of tax  0   0   (2,720)  (2,720)
Other comprehensive income, net of tax  —   —   (2,720)  (2,720)
Stock compensation expense  497   0   0   497   497   —   —   497 
Balance, September 30, 2021 $218,991  $31,728  $1,494  $252,213  $218,991  $31,728  $1,494  $252,213 
                
                
Balance, January 1, 2022 $219,082  $35,220  $(297) $254,005 
Net income for the nine months ended September 30, 2022
  —   22,614   —   22,614 
Cash dividends at $0.24 per share  —   (8,186)  —   (8,186)
Repurchase of 3,815 shares for taxes withheld on vested restricted stock
  (35)  —   —   (35)
Other comprehensive income, net of tax  —   —   (32,380)  (32,380)
Stock compensation expense  536   —   —   536 
Balance, September 30, 2022 $219,583  $49,648  $(32,677) $236,554 

See accompanying notes to consolidated financial statements.

-7-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine month periods ended September 30, 20212022 and 20202021
(unaudited)
(Dollars in thousands)

 
Nine Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2020
  
Nine Months
Ended
September 30,
2022
  
Nine Months
Ended
September 30,
2021
 
Cash flows from operating activities            
Net income $22,798  $21,169  $22,614  $22,798 
Adjustments to reconcile net income to net cash from operating activities:                
Depreciation and amortization  1,863   2,105   1,493   1,863 
Stock compensation expense  497   360   536   497 
Provision for loan losses  (1,300)  2,200   (1,500)  (1,300)
Origination of loans for sale  (107,845)  (120,171)  (25,009)  (107,845)
Proceeds from sales of loans originated for sale  114,809   124,002   26,855   114,809 
Net gains on mortgage loans  (4,177)  (4,045)  (673)  (4,177)
Write-down of other real estate  4   32   —   4 
Net loss on sales of other real estate  20   0 
Deferred income tax expense (benefit)
  656  (1,174)
Net (gain) / loss on sales of other real estate  (47)  20 
Deferred income tax expense
  585   656 
Earnings in bank-owned life insurance  (687)  (787)
Change in accrued interest receivable and other assets  4,071   (7,450)  (5,536)  4,071 
Earnings in bank-owned life insurance  (787)  (688)
Change in accrued expenses and other liabilities  (1,865)  4,483   1,499   (1,865)
Net cash from operating activities  28,744   20,823   20,130   28,744 
Cash flows from investing activities                
Loan originations and payments, net  293,142   (159,550)  (29,220)  293,142 
Purchases of securities available for sale  (71,864)  (102,158)  (232,108)  (71,864)
Purchases of securities held to maturity  (72,916)  (29,745)  (160,481)  (72,916)
Purchase of bank-owned life insurance  (10,000)  0   —   (10,000)
Proceeds from:                
Maturities and calls of securities  47,220   86,667 
Principal paydowns on securities  31,317   27,423 
Maturities and calls of securities available for sale
  17,486   38,964 
Maturities and calls of securities held to maturity
  37,998   8,256 
Principal paydowns on securities available for sale
  12,003   24,758 
Principal paydowns on securities held to maturity
  33,149   6,559 
Sales of other real estate  170   92   47   170 
Proceeds from payout of bank-owned insurance claim  560   0 
Redemption of FHLB stock
  1,347   — 
Payout of bank-owned insurance claim  —   560 
Additions to premises and equipment  (935)  (2,103)  (605)  (935)
Net cash from investing activities  216,694   (179,374)  (320,384)  216,694 
Cash flows from financing activities                
Change in deposits  254,588   417,285   (21,761)  254,588 
Repayments and maturities of other borrowed funds  (30,619)  0   (80,000)  (30,619)
Proceeds from other borrowed funds  25,000   10,000   25,000   25,000 
Repurchase of shares for taxes withheld on vested restricted stock  (34)  (24)  (35)  (34)
Cash dividends paid  (8,171)  (8,160)  (8,186)  (8,171)
Net cash from financing activities  240,764   419,101   (84,982)  240,764 
Net change in cash and cash equivalents  486,202   260,550   (385,236)  486,202 
Cash and cash equivalents at beginning of period  783,736   272,450   1,151,788   783,736 
Cash and cash equivalents at end of period $1,269,938  $533,000  $766,552  $1,269,938 

See accompanying notes to consolidated financial statements.

-8-
Index
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Nine month periods ended September 30, 20212022 and 20202021
(unaudited)
(Dollars in thousands)

 
Nine Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2020
  
Nine Months
Ended
September 30,
2022
  
Nine Months
Ended
September 30,
2021
 
Supplemental cash flow information            
Interest paid $2,227  $5,043  $2,204  $2,227 
Income taxes paid  4,750   5,315   5,000   4,750 
Supplemental noncash disclosures:                
Security settlement  0   1,937   1,000   — 
Transfer of securities from available for sale to held to maturity  123,469   — 

See accompanying notes to consolidated financial statements.

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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. 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 Company previously owned alleffects 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 common stock of Macatawa Statutory Trust II. This was a grantor trust that issued trust preferred securities and was not consolidated withCompany’s customers, potentially impacting their ability to make payments to the Company under accounting principles generally acceptedas scheduled driving an increase in delinquencies and loan losses; result in additional material provision for loan losses; result in a decreased demand for the United StatesCompany’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 America.  On July 7, 2021, the Company redeemed all of the $20.0 million of outstanding trust preferred securities and $619,000 of common securities associated with this trust.
operations.

Recent Events: On March 22, 2020, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus.” The guidance explained that in consultation with the FASB staff the federal banking agencies concluded that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a modification are not Troubled Debt Restructurings (“TDRs”).  The Coronavirus Aid, Relief and Economic Security (“CARES”) Act was passed by Congress on March 27, 2020.  Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were not more than 30 days past due as of December 31, 2019 are not TDRs.  On December 27, 2020, another COVID-19 relief bill was signed that extended this guidance until the earlier of January 1, 2022 or 60 days after the date on which the national emergency declared as a result of COVID-19 is terminated.  Through September 30, 2021, the Bank had applied this guidance and modified 726 individual loans with aggregate principal balances totaling $337.2 million.  As of September 30, 2021, all of these modifications had expired and the loans returned to their contractual payment terms.

The CARES Act, as amended, included an allocation of $659 billion for loans to be issued by financial institutions throughBank was a participating lender in the Small Business AdministrationAdministration’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. Through December 31, 2020,Fees generated based on the Bank had originated 1,738origination of PPP loans totaling $346.7 million in principal, with an average loan size of $200,000.  Fees totaling $10.0 million were generated from the SBA for these loans in the year ended December 31, 2020.  These fees 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.  Participation

In 2020:
The Bank originated 1,738 PPP loans totaling $346.7 million in the PPP had a significant impact on the Bank’s asset mix and net interest income in 2020 and will continue to impact both asset mix and net interest income until these loans are forgiven or paid off.  The initial PPP expired on August 8, 2020.  Through December 31, 2020, principal.
Fees generated totaled $10.0 million.
765 PPP loans totaling $113.5 million had been forgiven by the SBA and a totalwere forgiven.
Total net fees of $5.4 million in PPP fees had been recognized by the Bank.were recognized.

In 2021: 
On December 27, 2020, another COVID-19 relief bill was signed that extended and modified several provisions of the PPP.  This included an additional allocation of $284 billion.  The SBA reactivated the PPP on January 11, 2021. 
The Bank originated additional1,000 PPP loans through thetotaling $128.1 million in principal.
Fees generated totaled $5.6 million.
1,722 PPP which expired on May 31, 2021.  loans totaling $318.4 million were forgiven.
Total net fees of $8.3 million were recognized.

In the nine months ended September 30, 2021, the Bank had generated and received SBA approval on 1,0002022:
251 PPP loans totaling $128.1$43.1 million and generated $5.6were forgiven.
Total net fees of $1.3 million in related deferred PPP fees.  In the nine months endedwere recognized.

As of September 30, 2021, 1,7422022, just one PPP loansloan totaling $279.9 million had been forgiven by the SBA$37,000 in principal remained outstanding and a total net fees of $7.1 million in PPP fees had been recognized by the Bank including fees recognized upon forgiveness and continuing amortization of fees from the 2020 and 2021 PPP originations.

While the Company continues to evaluate the disruption caused by the pandemic and impact of the CARES Act, these events may have a material adverse impact on the Company’s results of future operations, financial position, capital, and liquidity in fiscal year 2021 and beyond.$5,000 remained unrecognized.

-10-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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, 20212022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.2022. 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, 2020.2021.

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.

Bank-Owned Life Insurance (BOLI):The Bank has purchased life insurance policies on certain officers.  BOLI is recorded at its currently realizable cash surrender value.  Changes in cash surrender value are recorded in other income.  In early April 2021, the Bank purchased an additional $10.0 million in BOLI policies.

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, 2021,2022, 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.  At September 30, 2021, the qualitative factor allocations for economic trends related to the COVID-19 that had been increased significantly during 2020 were maintained reflecting continued uncertainty of economic conditions with the reopening of the economy and surges in COVID-19 cases associated with the Delta variant of the virus. PPP loans receive $0 allocation as they are fully guaranteed by the SBA and are subject to be forgiven under the SBA forgiveness criteria.

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.

-11-
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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.

-11-
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Income Taxes: Income tax expense is the sum of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

The Company recognizes a tax position as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The Company recognizes interest and penalties related to income tax matters in income tax expense.

Revenue RecognitionFrom Contracts With Customers: The Company recognizes revenues as theyrecords 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 based on contractual terms, as transactions occur, orloans, 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 providedrendered, and collectabilitythe 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 reasonably assured.  The Company’s primary sourcelittle judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue is interest income from the Bank’s loans and investment securities.  The Company also earns noninterest revenue from various banking services offered by the Bank.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 2two 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, 20212022 and December 31, 2020,2021, the total notional amount of such agreements was $143.2$127.3 million and $156.4$140.7 million, respectively, and resulted in a derivative asset with a fair value of $3.4$6.9 million and $4.2$3.3 million, respectively, which were included in other assets and a derivative liability of $3.4$6.9 million and $4.2$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.
-12-
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 $(28,000)$(19,000) at September 30, 20212022 and $103,000$25,000 at December 31, 2020.2021.  The net fair value of mortgage backed security derivatives was $43,000$74,000 at September 30, 20212022 and $(233,000)$(13,000) at December 31, 2020.

2021.
Reclassifications
Loans Held for Sale:  Some itemsMortgage loans originated and intended for sale in the prior year financial statements were reclassified to conform to the current presentation.

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

Newly Issued Not Yet Effective Standards:  FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial InstrumentsInstruments..  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 No. 2019-10 Financial Instruments – Credit Losses (Topic 326), Derivativesexpands the disclosure requirements regarding an entity’s assumptions, models and Hedging (Topic 815), and Leases (Topic 842) – Effective Dates updatedmethods for estimating the effective dateallowance for credit losses.  In addition, entities will need to disclose the amortized cost balance for each class of this ASU for smaller reporting companies, such as the Company, to fiscal years beginning after December 15, 2022.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.  During 2019, 2020 andIn the first nine months of 2021,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 and fine tune assumptions as it continues to evaluate the impact of adoption of the new standard.  The COVID-19 pandemic that broke out in the United States in the first quarter of 2020 and continued into 2021 may have a significant impact on allowance computations under the incurred loss model which could be amplified under 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.

-13-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.

-14-
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
  
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Fair
Value
 
September 30, 2021
            
September 30, 2022
            
Available for Sale                        
U.S. Treasury and federal agency securities $69,488  $85  $(701) $68,872  $222,223  $—  $(16,960) $205,263 
U.S. Agency MBS and CMOs  64,353   691   (535)  64,509   109,385   —   (14,173)  95,212 
Tax-exempt state and municipal bonds  38,624   1,384   0   40,008   39,431   —   (1,226)  38,205 
Taxable state and municipal bonds  63,723   1,170   (300)  64,593   109,511   —   (8,576)  100,935 
Corporate bonds and other debt securities  3,396   97   0   3,493   14,639   —   (526)  14,113 
 $239,584  $3,427  $(1,536) $241,475  $495,189  $—  $(41,461) $453,728 
                
Held to Maturity                                
U.S. Treasury
 $251,329  $—  $(14,401) $236,928 
Tax-exempt state and municipal bonds $137,569  $2,890  $(47) $140,412   98,152
   66
   (4,264)  93,954
 

 $349,481  $66  $(18,665) $330,882 

 
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Fair
Value
  
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Fair
Value
 
December 31, 2020
            
December 31, 2021
            
Available for Sale                        
U.S. Treasury and federal agency securities $63,993  $287  $(170) $64,110  $208,153  $215  $(1,523) $206,845 
U.S. Agency MBS and CMOs  63,652   1,376   (45)  64,983   87,343   416   (962)  86,797 
Tax-exempt state and municipal bonds  43,739   1,903   0   45,642   36,298   1,258   —   37,556 
Taxable state and municipal bonds  55,383   1,801   (7)  57,177   79,394   812   (645)  79,561 
Corporate bonds and other debt securities  4,731   189   0   4,920   5,251   63   (10)  5,304 
 $231,498  $5,556  $(222) $236,832  $416,439  $2,764  $(3,140) $416,063 
Held to Maturity                                
Tax-exempt state and municipal bonds $79,468  $3,778  $0  $83,246  $137,003  $2,484  $(215) $139,272 

There were 0no sales of securities in the three and nine month periods ended September 30, 20212022 and 2020.2021.

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

Contractual maturities of debt securities at September 30, 20212022 were as follows (dollars in thousands):

 Held–to-Maturity Securities  Available-for-Sale Securities  Held–to-Maturity Securities  Available-for-Sale Securities 
 
Amortized
Cost
  
Fair
Value
  
Amortized
Cost
  
Fair
Value
  
Amortized
Cost
  
Fair
Value
  
Amortized
Cost
  
Fair
Value
 
Due in one year or less $31,503  $31,569  $22,681  $22,881  $32,069  $31,534  $13,800  $13,729 
Due from one to five years  69,127   70,077   66,771   68,448   295,170   278,658   312,058   293,127 
Due from five to ten years  19,359   20,425   87,960   87,899   22,242   20,690   61,476   53,113 
Due after ten years  17,580   18,341   62,172   62,247   —   —   107,855   93,759 
 $137,569  $140,412  $239,584  $241,475  $349,481  $330,882  $495,189  $453,728 

-14--15-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 2 – SECURITIES (Continued)

Securities with unrealized losses at September 30, 20212022 and December 31, 2020,2021, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows (dollars in thousands):

 Less than 12 Months  12 Months or More  Total  Less than 12 Months  12 Months or More  Total 
September 30, 2021
 
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
 
September 30, 2022
 
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
 
Available for Sale                                    
U.S. Treasury and federal agency securities $53,249  $(655) $4,953  $(46) $58,202  $(701) $156,862  $(8,233) $50,150  $(8,754) $207,012  $(16,987)
U.S. Agency MBS and CMOs  34,332   (510)  1,563   (25)  35,895   (535)  71,741   (8,464)  23,472   (5,709)  95,213   (14,173)
Tax-exempt state and municipal bonds  250   0   0   0   250   0   37,576   (1,218)  —   —   37,576   (1,218)
Taxable state and municipal bonds  21,919   (285)  490   (15)  22,409   (300)  82,149   (5,335)  19,025   (3,249)  101,174   (8,584)
Corporate bonds and other debt securities  0   0   0   0   0   0   12,363   (499)  —   —   12,363   (499)
Total $109,750  $(1,450) $7,006  $(86) $116,756  $(1,536) $360,691  $(23,749) $92,647  $(17,712) $453,338  $(41,461)
                                                
Held to Maturity                                                
U.S. Treasury $236,927  $(14,401) $—  $—  $236,927  $(14,401)
Tax-exempt state and municipal bonds $20,390  $(47) $0  $0  $20,390  $(47)  84,863   (4,243)  2,804   (21)  87,667   (4,264)
 $321,790  $(18,644) $2,804  $(21) $324,594  $(18,665)

 Less than 12 Months  12 Months or More  Total  Less than 12 Months  12 Months or More  Total 
December 31, 2020
 
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
 
December 31, 2021
 
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
 
Available for Sale                                    
U.S. Treasury and federal agency securities $22,830  $(170) $0  $0  $22,830  $(170) $77,066  $(955) $18,432  $(568) $95,498  $(1,523)
U.S. Agency MBS and CMOs  9,299   (45)  0   0   9,299   (45)  52,254   (830)  4,190   (132)  56,444   (962)
Tax-exempt state and municipal bonds  0   0   0   0   0   0   —   —   —   —   —   — 
Taxable state and municipal bonds  2,336   (7)  0   0   2,336   (7)  37,648   (638)  498   (7)  38,146   (645)
Corporate bonds and other debt securities  0   0   0   0   0   0   1,352   (10)  —   —   1,352   (10)
Total $34,465  $(222) $0  $0  $34,465  $(222) $168,320  $(2,433) $23,120  $(707) $191,440  $(3,140)
                                                
Held to Maturity                                                
Tax-exempt state and municipal bonds $0  $0  $0  $0  $0  $0  $61,166  $(215) $—  $—  $61,166  $(215)

Other-Than-Temporary-Impairment

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. At September 30, 2021, 882022, 457 securities available for sale with fair values totaling $116.8$453.3 million had unrealized losses totaling $1.5$41.5 million. At September 30, 2021, 72022, 97 securities held to maturity with fair values totaling $20.4$324.6 million had unrealized losses totaling $47,000.$18.7 million. Management has the intent and ability to hold the securities classified as held to maturity until they mature, at which time the Company will receive full value for the securities. In addition, management believes it is more likely than not that the Company will not be required to sell any of its investment securities before a recovery of cost.  Management determined that the unrealized losses for the threeeach period and nine month periods ended September 30, 2021 and 2020each investment were attributable to changes in interest rates and not due to credit quality.  As such, 0no OTTI charges were necessary during each period.

Securities with a carrying value of approximately $5.0$3.5 million and $6.1$4.9 million were pledged as security for public deposits, letters of credit and for other purposes required or permitted by law at September 30, 20212022 and December 31, 2020,2021, respectively.


-15--16-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS



Portfolio loans were as follows (dollars in thousands):


 
September 30,
2021
  
December 31,
2020
  
September 30 ,
2022
  
December 31,
2021
 
Commercial and industrial:            
Commercial and industrial, excluding PPP $356,812  $436,331  $427,034  $378,318 
PPP  77,571   229,079   32   41,939 
Total commercial and industrial  434,383   665,410   427,066   420,257 
Commercial real estate:                
Residential developed  6,184   8,549   6,830   4,862 
Unsecured to residential developers  19   0   —   5,000 
Vacant and unimproved  36,616   47,122   34,737   36,240 
Commercial development  403   857   107   171 
Residential improved  100,608   114,392   107,782   100,077 
Commercial improved  267,910   266,006   257,144   259,039 
Manufacturing and industrial  115,470   115,247   115,624   110,712 
Total commercial real estate  527,210   552,173   522,224   516,101 
Consumer:                
Residential mortgage  119,106   149,556   130,138   117,800 
Unsecured  103   161   111   210 
Home equity  52,127   57,975   55,618   51,269 
Other secured  3,684   4,056   3,488   3,356 
Total consumer  175,020   211,748   189,355   172,635 
Total loans  1,136,613   1,429,331   1,138,645   1,108,993 
Allowance for loan losses  (16,532
)
  (17,408
)
  (14,821
)
  (15,889
)
 $1,120,081  $1,411,923  $1,123,824  $1,093,104 


-16-The totals above are shown net of deferred fees and costs.  Deferred fees on loans totaled $1.3 million and $2.6 million at September 30, 2022 and December 31, 2021, respectively.  Deferred costs on loans totaled $1.4 million and $1.3 million at September 30, 2022 and December 31, 2021, respectively.

-17-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 – LOANS (Continued)

Activity in the allowance for loan losses by portfolio segment was as follows (dollars in thousands):


Three months ended September 30, 2021 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Beginning balance $5,206  $8,740  $2,856  $4  $16,806 
Charge-offs  0   0   (22)  0   (22)
Recoveries  265   11   22   0   298 
Provision for loan losses  (259)  (250)  (68)  27   (550)
Ending Balance $5,212  $8,501  $2,788  $31  $16,532 


Three months ended September 30, 2020 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Three months ended September 30, 2022 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Beginning balance $5,431  $7,262  $3,138  $24  $15,855  $5,256  $7,022  $2,316  $37  $14,631 
Charge-offs  0  0  (24)  0   (24)  —   —   (46)  —   (46)
Recoveries  22   168   37   0   227   175   5   56   —   236 
Provision for loan losses  513  237   (242)  (8)  500   179   (147)  (14)  (18)  — 
Ending Balance $5,966  $7,667  $2,909  $16  $16,558  $5,610  $6,880  $2,312  $19  $14,821 


Three months ended September 30, 2021
 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Beginning balance $5,206  $8,740  $2,856  $4  $16,806 
Charge-offs  —   —   (22)  —   (22)
Recoveries  265   11   22   —   298 
Provision for loan losses  (259)  (250)  (68)  27   (550)
Ending Balance $5,212  $8,501  $2,788  $31  $16,532 


Nine months ended September 30, 2022 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Beginning balance $5,176  $8,051  $2,633  $29  $15,889 
Charge-offs  (38)  —   (103)  —   (141)
Recoveries  185   276   112   —   573 
Provision for loan losses  287   (1,447)  (330)  (10)  (1,500)
Ending Balance $5,610  $6,880  $2,312  $19  $14,821 


Nine months ended September 30, 2021 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Beginning balance $6,632  $7,999  $2,758  $19  $17,408 
Charge-offs  —   —   (102)  —   (102)
Recoveries  320   122   84   —   526 
Provision for loan losses  (1,740)  380   48   12  (1,300)
Ending Balance $5,212  $8,501  $2,788  $31  $16,532 


Nine months ended September 30, 2021 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Beginning balance $6,632  $7,999  $2,758  $19  $17,408 
Charge-offs  0   0   (102)  0   (102)
Recoveries  320   122   84   0   526 
Provision for loan losses  (1,740)  380   48   12  (1,300)
Ending Balance $5,212  $8,501  $2,788  $31  $16,532 


Nine months ended September 30, 2020 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Beginning balance $7,658  $6,521  $3,009  $12  $17,200 
Charge-offs  (1,192)  (2,957)  (97)  0   (4,246)
Recoveries  124   1,159   121   0   1,404 
Provision for loan losses  (624)  2,944   (124)  4   2,200 
Ending Balance $5,966  $7,667  $2,909  $16  $16,558 




-17--18-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 – LOANS (Continued)

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method (dollars in thousands):


September 30, 2021 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
September 30, 2022
 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Allowance for loan losses:                              
Ending allowance attributable to loans:                              
Individually reviewed for impairment $303  $10  $261  $0  $574  $54  $17  $223  $—  $294 
Collectively evaluated for impairment  4,909   8,491   2,527   31   15,958   5,556   6,863   2,089   19   14,527 
Total ending allowance balance $5,212  $8,501  $2,788  $31  $16,532  $5,610  $6,880  $2,312  $19  $14,821 
Loans:                                        
Individually reviewed for impairment $969  $1,165  $3,296  $0  $5,430  $1,823  $568  $2,942  $—  $5,333 
Collectively evaluated for impairment  433,414   526,045   171,724   0   1,131,183   425,243   521,656   186,413   —   1,133,312 
Total ending loans balance $434,383  $527,210  $175,020  $0  $1,136,613  $427,066  $522,224  $189,355  $—  $1,138,645 


December 31, 2020 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
December 31, 2021 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Allowance for loan losses:                              
Ending allowance attributable to loans:                              
Individually reviewed for impairment $587  $313  $310  $0  $1,210  $303  $24  $238  $—  $565 
Collectively evaluated for impairment  6,045   7,686   2,448   19   16,198   4,873   8,027   2,395   29   15,324 
Total ending allowance balance $6,632  $7,999  $2,758  $19  $17,408  $5,176  $8,051  $2,633  $29  $15,889 
Loans:                                        
Individually reviewed for impairment $3,957  $2,613  $4,049  $0  $10,619  $3,375  $1,127  $3,024  $—  $7,526 
Collectively evaluated for impairment  661,453   549,560   207,699   0   1,418,712   416,882   514,974   169,611   —   1,101,467 
Total ending loans balance $665,410  $552,173  $211,748  $0  $1,429,331  $420,257  $516,101  $172,635  $—  $1,108,993 


-18--19-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 – LOANS (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 20212022 (dollars in thousands):


September 30, 2021 
Unpaid
Principal
Balance
  
Recorded
Investment
  
Allowance
Allocated
 
September 30, 2022
 
Unpaid
Principal
Balance
  
Recorded
Investment
  
Allowance
Allocated
 
With no related allowance recorded:                  
Commercial and industrial $72  $72  $—  $1,476  $1,476  $— 
Commercial real estate:                        
Residential improved  42   42   —   32   32   — 
Commercial improved  929   929   —   42   42   — 
  971   971   —   74   74   — 
Consumer  0   0   —   —   —   — 
Total with no related allowance recorded $1,043  $1,043  $—  $1,550  $1,550  $— 
                        
With an allowance recorded:                        
Commercial and industrial $897  $897  $303  $347  $347  $54 
Commercial real estate:                        
Commercial improved  0   0   0   311   311   6 
Manufacturing and industrial  194   194   10   183   183   11 
  194   194   10   494   494   17 
Consumer:                        
Residential mortgage  2,944   2,944   233   2,686   2,686   204 
Unsecured  84   84   7   31   31   2 
Home equity  267   267   21   225   225   17 
Other secured  1   1   0 
  3,296   3,296   261   2,942   2,942   223 
Total with an allowance recorded $4,387  $4,387  $574  $3,783  $3,783  $294 
Total $5,430  $5,430  $574  $5,333  $5,333  $294 


-19--20-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 – LOANS (Continued)


The following table presents loans individually evaluated for impairment by class of loans as of December 31, 20202021 (dollars in thousands):


December 31, 2020 
Unpaid
Principal
Balance
  
Recorded
Investment
  
Allowance
Allocated
 
December 31, 2021 
Unpaid
Principal
Balance
  
Recorded
Investment
  
Allowance
Allocated
 
With no related allowance recorded:                  
Commercial and industrial $156  $156  $—  $669  $669  $— 
Commercial real estate:                        
Residential improved  107   107   —   41   41   — 
Commercial improved  714   714   —   577   577   — 
  821   821   —   618   618   — 
Consumer  0   0   —   —   —   — 
Total with no related allowance recorded $977  $977  $—  $1,287  $1,287  $— 
                        
With an allowance recorded:                        
Commercial and industrial $3,801  $3,801  $587  $2,706  $2,706  $303 
Commercial real estate:                        
Residential developed  67   67   3 
Commercial improved  1,524   1,524   301   318   318   14 
Manufacturing and industrial  201   201   9   191   191   10 
  1,792   1,792   313   509   509   24 
Consumer:                        
Residential mortgage  3,484   3,484   266   2,726   2,726   214 
Unsecured  123   123   10   64   64   5 
Home equity  419   419   32   234   234   19 
Other secured  23   23   2 
  4,049   4,049   310   3,024   3,024   238 
Total with an allowance recorded $9,642  $9,642  $1,210  $6,239  $6,239  $565 
Total $10,619  $10,619  $1,210  $7,526  $7,526  $565 




-20--21-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 – LOANS (Continued)

The following table presents information regarding average balances of impaired loans and interest recognized on impaired loans for the three and nine month periods ended September 30, 20212022 and 20202021 (dollars in thousands):


 
Three
Months
Ended
September 30,
2021
  
Three
Months
Ended
September 30,
2020
  
Nine
Months
Ended
September 30,
2021
  
Nine
Months
Ended
September 30,
2020
  
Three
Months
Ended
September 30,
2022
  
Three
Months
Ended
September 30,
2021
  
Nine
Months
Ended
September 30,
2022
  
Nine
Months
Ended
September 30,
2021
 
Average of impaired loans during the period:                        
Commercial and industrial $749  $2,208  $2,417  $4,362  $1,277  $749  $2,580  $2,417 
Commercial real estate:                                
Residential developed  0   71   15   72   —   —   —   15 
Residential improved  18   168   46   211   52   18   44   46 
Commercial improved  1,349   1,650   1,909   4,652   356   1,349   420   1,909 
Manufacturing and industrial  195   347   197   352   184   195   187   197 
Consumer  3,362   4,441   3,641   4,687   3,005   3,362   2,884   3,641 
Interest income recognized during impairment:                                
Commercial and industrial  40   23   336   303   30   40   300   336 
Commercial real estate  22   33   88   193   9   22   31   88 
Consumer  28   41   97   153   32   28   86   97 
Cash-basis interest income recognized                                
Commercial and industrial  37   13   356   298   22   37   313   356 
Commercial real estate  22   33   88   218   9   22   31   88 
Consumer  30   43   98   148   34   30   60   98 


-21--22-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 – LOANS (Continued)

Nonaccrual loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.  The following tables present the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of September 30, 20212022 and December 31, 2020:2021:


September 30, 2021 Nonaccrual  
Over 90
days
Accruing
 
September 30, 2022
 Nonaccrual  
Over 90
days
Accruing
 
Commercial and industrial $0  $0  $—  $— 
Commercial real estate:                
Residential improved  5   0   —   — 
Commercial improved  327   0 
  332   0   —   — 
Consumer:                
Residential mortgage  88   0   85   — 
  88   0   85   — 
Total $420  $0  $85  $— 


December 31, 2020 Nonaccrual  
Over 90 days
Accruing
 
December 31, 2021 Nonaccrual  
Over 90 days
Accruing
 
Commercial and industrial $0  $0  $—  $— 
Commercial real estate:                
Residential improved  87   0   5   — 
Commercial improved  351   0 
  438   0   5   — 
Consumer:                
Residential mortgage  95   0   86   — 
  95   0   86   — 
Total $533  $0  $91  $— 


-22--23-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 – LOANS (Continued)

The following table presents the aging of the recorded investment in past due loans as of September 30, 20212022 and December 31, 20202021 by class of loans (dollars in thousands):


September 30, 2021 
30-90
Days
  
Greater Than
90 Days
  
Total
Past Due
  
Loans Not
Past Due
  Total 
September 30, 2022
 
30-90
Days
  
Greater Than
90 Days
  
Total
Past Due
  
Loans Not
Past Due
  Total 
Commercial and industrial $0  $0  $0  $434,383  $434,383  $—  $—  $—  $427,066  $427,066 
Commercial real estate:                                        
Residential developed  0   0   0   6,184   6,184   —   —   —   6,830   6,830 
Unsecured to residential developers  0   0   0   19   19   —   —   —   —   — 
Vacant and unimproved  0   0   0   36,616   36,616   —   —   —   34,737   34,737 
Commercial development  0   0   0   403   403   —   —   —   107   107 
Residential improved  0   5   5   100,603   100,608   —   —   —   107,782   107,782 
Commercial improved  344   0   344   267,566   267,910   —   —   —   257,144   257,144 
Manufacturing and industrial  0   0   0   115,470   115,470   —   —   —   115,624   115,624 
  344   5   349   526,861   527,210   —   —   —   522,224   522,224 
Consumer:                                        
Residential mortgage  0   87   87   119,019   119,106   —   84   84   130,054   130,138 
Unsecured  0   0   0   103   103   —   —   —   111   111 
Home equity  0   0   0   52,127   52,127   —   —   —   55,618   55,618 
Other secured  1   0   1   3,683   3,684   —   —   —   3,488   3,488 
  1   87   88   174,932   175,020   —   84   84   189,271   189,355 
Total $345  $92  $437  $1,136,176  $1,136,613  $—  $84  $84  $1,138,561  $1,138,645 


December 31, 2020 
30-90
Days
  
Greater Than
90 Days
  
Total
Past Due
  
Loans Not
Past Due
  Total 
December 31, 2021 
30-90
Days
  
Greater Than
90 Days
  
Total
Past Due
  
Loans Not
Past Due
  Total 
Commercial and industrial $45  $0  $45  $665,365  $665,410  $39  $1  $40  $420,217  $420,257 
Commercial real estate:                                        
Residential developed  0   0   0   8,549   8,549   —   —   —   4,862   4,862 
Unsecured to residential developers  0   0   0   0   0   —   —   —   5,000   5,000 
Vacant and unimproved  0   0   0   47,122   47,122   —   —   —   36,240   36,240 
Commercial development  0   0   0   857   857   —   —   —   171   171 
Residential improved  0   87   87   114,305   114,392   —   5   5   100,072   100,077 
Commercial improved  353   0   353   265,653   266,006   —   —   —   259,039   259,039 
Manufacturing and industrial  0   0   0   115,247   115,247   —   —   —   110,712   110,712 
  353   87   440   551,733   552,173   —   5   5   516,096   516,101 
Consumer:                                        
Residential mortgage  0   94   94   149,462   149,556   —   84   84   117,716   117,800 
Unsecured  0   0   0   161   161   —   —   —   210   210 
Home equity  0   0   0   57,975   57,975   —   —   —   51,269   51,269 
Other secured  2   0   2   4,054   4,056   —   —   —   3,356   3,356 
  2   94   96   211,652   211,748   —   84   84   172,551   172,635 
Total $400  $181  $581  $1,428,750  $1,429,331  $39  $90  $129  $1,108,864  $1,108,993 


-23--24-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 – LOANS (Continued)


The Company had allocated $574,000$294,000 and $1,210,000$565,000 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings (“TDRs”) as of September 30, 20212022 and December 31, 2020,2021, respectively. These loans may have involved the restructuring of terms to allow customers to mitigate the risk of foreclosure by meeting a lower loan payment requirement based upon their current cash flow.  These may also include loans that renewed at existing contractual rates, but below market rates for comparable credit.  The Company has been active at utilizing these programs and working with its customers to reduce the risk of foreclosure.  For commercial loans, these modifications typically include an interest only period and, in some cases, a lowering of the interest rate on the loan.  In some cases, the modification will include separating the note into 2two notes with the first note structured to be supported by current cash flows and collateral, and the second note made for the remaining unsecured debt. The second note is charged off immediately and collected only after the first note is paid in full. This modification type is commonly referred to as an A-B note structure.  For consumer mortgage loans, the restructuring typically includes a lowering of the interest rate to provide payment and cash flow relief.  For each restructuring, a comprehensive credit underwriting analysis of the borrower’s financial condition and prospects of repayment under the revised terms is performed to assess whether the structure can be successful and that cash flows will be sufficient to support the restructured debt. An analysis is also performed to determine whether the restructured loan should be on accrual status.  Generally, if the loan is on accrual at the time of restructure, it will remain on accrual after the restructuring. In some cases, a nonaccrual loan may be placed on accrual at restructuring if the loan’s actual payment history demonstrates it would have cash flowed under the restructured terms. After 6six consecutive payments under the restructured terms, a nonaccrual restructured loan is reviewed for possible upgrade to accruing status.



In situations where there is a subsequent modification or renewal and the loan is brought to market terms, including a contractual interest rate not less than a market interest rate for new debt with similar credit risk characteristics, the TDR and impaired loan designations may be removed. In addition, the TDR designation may also be removed from loans modified under an A-B note structure.  If the remaining “A” note is at a market rate at the time of restructuring (taking into account the borrower’s credit risk and prevailing market conditions), the loan can be removed from TDR designation in a subsequent calendar year after six months of performance in accordance with the new terms. The market rate relative to the borrower’s credit risk is determined through analysis of market pricing information gathered from peers and use of a loan pricing model.  The general objective of the model is to achieve a consistent return on equity from one credit to the next, taking into consideration differences in credit risk.  In the model, credits with higher risk receive a higher potential loss allocation, and therefore require a higher interest rate to achieve the target return on equity.



As with other impaired loans, an allowance for loan loss is estimated for each TDR based on the most likely source of repayment for each loan. For impaired commercial real estate loans that are collateral dependent, the allowance is computed based on the fair value of the underlying collateral, less estimated costs to sell. For impaired commercial loans where repayment is expected from cash flows from business operations, the allowance is computed based on a discounted cash flow computation. Certain groups of TDRs, such as residential mortgages, have common characteristics and for them the allowance is computed based on a discounted cash flow computation on the change in weighted rate for the pool.  The allowance allocations for commercial TDRs where we have reduced the contractual interest rate are computed by measuring cash flows using the new payment terms discounted at the original contractual rate.



The following table presents information regarding troubled debt restructurings as of September 30, 20212022 and December 31, 20202021 (dollars in thousands):


 September 30, 2021  December 31, 2020  September 30, 2022  December 31, 2021 
 
Number of
Loans
  
Outstanding
Recorded
Balance
  
Number of
Loans
  
Outstanding
Recorded
Balance
  
Number of
Loans
  
Outstanding
Recorded
Balance
  
Number of
Loans
  
Outstanding
Recorded
Balance
 
Commercial and industrial  5  $969   7  $3,957   4  $1,823   4  $3,375 
Commercial real estate  6   1,165   9   1,439   4   568   6   1,127 
Consumer  48   3,296   60   4,049   33   2,942   44   3,024 
  59  $5,430   76  $9,445   41  $5,333   54  $7,526 


-24--25-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 – LOANS (Continued)


The following table presents information related to accruing TDRs as of September 30, 20212022 and December 31, 2020.2021. The table presents the amount of accruing troubled debt restructurings that were on nonaccrual status prior to the restructuring, accruing at the time of restructuring and those that were upgraded to accruing status after receiving six consecutive monthly payments in accordance with the restructured terms as of each period reported (dollars in thousands):


 
September 30,
2021
  
December 31,
2020
  
September 30,
2022
  
December 31,
2021
 
Accruing TDR - nonaccrual at restructuring $0  $0  $—  $— 
Accruing TDR - accruing at restructuring  4,554   5,479   4,982   4,552 
Accruing TDR - upgraded to accruing after six consecutive payments  544   3,529   351   2,968 
 $5,098  $9,008  $5,333  $7,520 



There were 0 TDRs executed during the three month and nine month periods ended September 30, 2021.  There were 0 TDRswas one mortgage loan TDR executed during the three month period ended September 30, 20202022.  The pre-TDR balance of this loan totaled $278,000 and 2there were no writedowns upon TDR. There was one consumer TDRs totaling $30,000loan TDR and one mortgage loan TDR executed during the nine month period ended September 30, 2020.2022.  The pre-TDR balance of these loans totaled $377,000 and there were no writedowns upon TDR. There were no TDRs executed during the three and nine month periods ended September 30,  2021.



According to the accounting standards, not all loan modifications are TDRs.  TDRs are modifications or renewals where the Company has granted a concession to a borrower in financial distress. The Company reviews all modifications and renewals for determination of TDR status.  In some situations a borrower may be experiencing financial distress, but the Company does not provide a concession. These modifications are not considered TDRs. In other cases, the Company might provide a concession, such as a reduction in interest rate, but the borrower is not experiencing financial distress. This could be the case if the Company is matching a competitor’s interest rate.  These modifications would also not be considered TDRs.  Finally, any renewals at existing terms for borrowers not experiencing financial distress would not be considered TDRs.  As with other loans not considered TDR or impaired, allowance allocations are based on the historical based allocation for the applicable loan grade and loan class.



Payment defaults on TDRs have been minimal and during the three and nine month periods ended September 30, 2022 and 2021 and 2020, the balance of loans that became delinquent by more than 90 days past due or that were transferred to nonaccrual within 12 months of restructuring were not material.



In late March 2020, guidance issued by the federal banking regulators issued guidanceagencies in consultation with FASB and the Coronavirus Aid, Relief and Economic Security (“CARES”) Act collectively specified that modifications made to a borrower affected by the COVID-19 pandemic and governmental shutdown orders do not need to be identified as a TDR if the loan was current at the time a modification plan was implemented.  Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that such modifications made on loans that were currentnot more than 30 days past due as of December 31, 2019 are not TDRs. On December 27, 2020, President Trump signed another COVID-19 relief bill that extends this guidance until the earlier of January 1, 2022 or 60 days after the national emergency termination date.  Through September 30, 2021,2022, the Bank had applied this guidance and had mademodified 726 such modificationsindividual loans with aggregate principal balances totaling $337.2 million.  The Bank continues to follow the guidance issued by the banking regulators in making any TDR determinations.  AtAs of September 30, 2021, there were 0 such2022, all of these modifications had expired and the loans still inhad returned to their modification period.

contractual payment terms.

-25--26-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 – LOANS (Continued)


Credit Quality Indicators:   The Company categorizes loans into risk categories based on relevant information about the ability of the borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors.  The Company analyzes commercial loans individually and classifies these relationships by credit risk grading. The Company uses an 8eight point grading system, with grades 5 through 8 being considered classified, or watch, credits.  All commercial loans are assigned a grade at origination, at each renewal or any amendment.  When a credit is first downgraded to a watch credit (either through renewal, amendment, loan officer identification or the loan review process), an Administrative Loan Review (“ALR”) is generated by the credit department and the loan officer. All watch credits have an ALR completed quarterly which analyzes the collateral position and cash flow of the borrower and its guarantors.  Management meets quarterly with loan officers to discuss each of these credits in detail and to help formulate solutions where progress has stalled. When necessary, the loan officer proposes changes to the assigned loan grade as part of the ALR.  Additionally, Loan Review reviews all loan grades upon origination, renewal or amendment and again as loans are selected though the loan review process.  The credit will stay on the ALR until either its grade has improved to a 4 or the credit relationship is at a zero balance. The Company uses the following definitions for the risk grades:



1. Excellent - Loans supported by extremely strong financial condition or secured by the Bank’s own deposits. Minimal risk to the Bank and the probability of serious rapid financial deterioration is extremely small.



2. Above Average - Loans supported by sound financial statements that indicate the ability to repay or borrowings secured (and margined properly) with marketable securities. Nominal risk to the Bank and probability of serious financial deterioration is highly unlikely. The overall quality of these credits is very high.



3. Good Quality - Loans supported by satisfactory asset quality and liquidity, good debt capacity coverage, and good management in all critical positions. Loans are secured by acceptable collateral with adequate margins. There is a slight risk of deterioration if adverse market conditions prevail.



4. Acceptable Risk - Loans carrying an acceptable risk to the Bank, which may be slightly below average quality. The borrower has limited financial strength with considerable leverage. There is some probability of deterioration if adverse market conditions prevail. These credits should be monitored closely by the Relationship Manager.



5. Marginally Acceptable - Loans are of marginal quality with above normal risk to the Bank. The borrower shows acceptable asset quality but very little liquidity with high leverage. There is inconsistent earning performance without the ability to sustain adverse market conditions. The primary source of repayment is questionable, but the secondary source of repayment still remains an option. Very close attention by the Relationship Manager and management is needed.



6. Substandard - Loans are inadequately protected by the net worth and paying capacity of the borrower or the collateral pledged. The primary and secondary sources of repayment are questionable. Heavy debt condition may be evident and volume and earnings deterioration may be underway. It is possible that the Bank will sustain some loss if the deficiencies are not immediately addressed and corrected.



7. Doubtful - Loans supported by weak or no financial statements, as well as the ability to repay the entire loan, are questionable. Loans in this category are normally characterized less than adequate collateral, insolvent, or extremely weak financial condition. A loan classified doubtful has all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses makes collection or liquidation in full highly questionable. The possibility of loss is extremely high, however, activity may be underway to minimize the loss or maximize the recovery.



8. Loss - Loans are considered uncollectible and of little or no value as a bank asset.

-26--27-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 – LOANS (Continued)

As of September 30, 20212022 and December 31, 2020,2021, the risk grade category of commercial loans by class of loans were as follows (dollars in thousands):


September 30, 2021
 1
  2
  3
  4
  5
  6
  7
  8
  Total 
September 30, 2022
  1
   2
   3
   4
   5
   6
   7
   8
  Total 
Commercial and industrial $92,615  $13,376  $94,433  $230,163  $2,862  $934  $0  $0  $434,383  $15,063  $13,129  $181,578  $208,693  $8,312  $291  $—  $—  $427,066 
                                                                        
Commercial real estate:                                                                        
Residential developed  0   0   0   6,184   0   0   0   0   6,184   —   —   —   6,830   —   —   —   —   6,830 
Unsecured to residential developers  0   0   19   0   0   0   0   0   19   —   —   —   —   —   —   —   —   — 
Vacant and unimproved  0   1,791   9,028   25,797   0   0   0   0   36,616   —   429   17,151   17,157   —   —   —   —   34,737 
Commercial development  0   0   220   183   0   0   0   0   403   —   —   107   —   —   —   —   —   107 
Residential improved  0   —   22,774   77,705   124   0   5   0   100,608   —   —   24,867   82,858   57   —   —   —   107,782 
Commercial improved  0   13,713   64,208   182,085   7,577   0   327   0   267,910   —   18,122   79,871   152,189   6,651   311   —   —   257,144 
Manufacturing & industrial  0   3,563   42,672   66,440   2,795   0   0   0   115,470   —   9,029   28,264   74,284   1,715   2,332   —   —   115,624 
 $92,615  $32,443  $233,354  $588,557  $13,358  $934  $332  $0  $961,593  $15,063  $40,709  $331,838  $542,011  $16,735  $2,934  $—  $—  $949,290 


December 31, 2020
 1
  2
  3  4
  5
  6
  7
  8
  Total 
December 31, 2021
  1
   2
   3   4
   5
   6
   7
   8
  Total 
Commercial and industrial $244,079  $14,896  $111,611  $276,728  $13,957  $4,139  $0  $0  $665,410  $56,979  $19,300  $110,877  $227,087  $2,700  $3,314  $—  $—  $420,257 
                                                                        
Commercial real estate:                                                                        
Residential developed  0   0   0   8,549   0   0   0   0   8,549   —   —   —   4,862   —   —   —   —   4,862 
Unsecured to residential developers  —   —   —   5,000   —   —   —   —   5,000 
Vacant and unimproved  0   3,473   9,427   32,751   1,471   0   0   0   47,122   —   1,763   13,492   20,985   —   —   —   —   36,240 
Commercial development  0   0   302   555   0   0   0   0   857   —   —   171   —   —   —   —   —   171 
Residential improved  0   0   23,706   90,372   227   0   87   0   114,392   —   —   24,450   75,503   119   —   5   —   100,077 
Commercial improved  0   6,328   58,483   192,030   7,641   1,174   350   0   266,006   —   15,115   71,211   165,268   7,127   318   —   —   259,039 
Manufacturing & industrial  0   0   31,451   80,075   3,721   0   0   0   115,247   —   —   41,757   65,601   3,354   —   —   —   110,712 
 $244,079  $24,697  $234,980  $681,060  $27,017  $5,313  $437  $0  $1,217,583  $56,979  $36,178  $261,958  $564,306  $13,300  $3,632  $5  $—  $936,358 



Commercial loans rated a 6 or worse per the Company’s internal risk rating system are considered substandard, doubtful or loss. Commercial loans classified as substandard or worse were as follows at period-end (dollars in thousands):


 
September 30,
2021
  
December 31,
2020
  
September 30,
2022
  
December 31,
2021
 
Not classified as impaired $263  $591  $2,551  $233 
Classified as impaired  1,003   5,159   383   3,404 
Total commercial loans classified substandard or worse $1,266  $5,750  $2,934  $3,637 



The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For consumer loan classes, the Company also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the recorded investment in consumer loans based on payment activity (dollars in thousands):


September 30, 2021 
Residential
Mortgage
  
Consumer
Unsecured
  
Home
Equity
  
Consumer
Other
 
September 30, 2022 
Residential
Mortgage
  
Consumer
Unsecured
  
Home
Equity
  
Consumer
Other
 
Performing $119,018  $103  $52,127  $3,684  $130,054  $111  $55,618  $3,488 
Nonperforming  88   0   0   0   84   —   —   — 
Total $119,106  $103  $52,127  $3,684  $130,138  $111  $55,618  $3,488 


December 31, 2020 
Residential
Mortgage
  
Consumer
Unsecured
  
Home
Equity
  
Consumer
Other
 
Performing $149,461  $161  $57,975  $4,056 
Nonperforming  95   0   0   0 
Total $149,556  $161  $57,975  $4,056 

-27--28-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 –  LOANS (Continued)

December 31, 2021 
Residential
Mortgage
  
Consumer
Unsecured
  
Home
Equity
  
Consumer
Other
 
Performing $117,716  $210  $51,269  $3,356 
Nonperforming  84   —   —   — 
Total $117,800  $210  $51,269  $3,356 

NOTE 4 – 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 charge-off 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.appraisals, less costs to sell. 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.

-28--29-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 4 – FAIR VALUE (Continued)

Assets and liabilities 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)
  
Fair
Value
  
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
  
Significant Other
Observable
Inputs
(Level 2)
  
Significant
Unobservable
Inputs
(Level 3)
 
September 30, 2021
            
September 30, 2022
            
Available for sale securities            
U.S. Treasury and federal agency securities $68,872  $0  $68,872  $0  $205,263  $—  $205,263  $— 
U.S. Agency MBS and CMOs  64,509   0   64,509   0   95,212   —   95,212   — 
Tax-exempt state and municipal bonds  40,008   0   40,008   0   38,205   —   38,205   — 
Taxable state and municipal bonds  64,593   0   64,593   0   100,935   —   100,935   — 
Corporate bonds and other debt securities  3,493   0   3,493   0   14,113   —   14,113   — 
Other equity securities  1,484   0   1,484   0   1,297   —   1,297   — 
Loans held for sale  2,635   0   2,635   0   234   —   234   — 
Interest rate swaps  3,446   0   0   3,446   6,920   —   —   6,920 
Interest rate swaps  (3,446)  0   0   (3,446)  (6,920)  —   —   (6,920)
                                
December 31, 2020
                
December 31, 2021
                
Available for sale securities                                
U.S. Treasury and federal agency securities $64,110  $0  $64,110  $0  $206,845  $—  $206,845  $— 
U.S. Agency MBS and CMOs  64,983   0   64,983   0   86,797   —   86,797   — 
Tax-exempt state and municipal bonds  45,642   0   45,642   0   37,556   —   37,556   — 
Taxable state and municipal bonds  57,177   0   57,177   0   79,561   —   79,561   — 
Corporate bonds and other debt securities  4,920   0   4,920   0   5,304   —   5,304   — 
Other equity securities  1,513   0   1,513   0   1,470   —   1,470   — 
Loans held for sale  5,422   0   5,422   0   1,407   —   1,407   — 
Interest rate swaps  4,217   0   0   4,217   3,277   —   —   3,277 
Interest rate swaps  (4,217)  0   0   (4,217)  (3,277)  —   —   (3,277)

The items identified as measured under Level 3 do not impact other comprehensive income.  There were no items transferred in or out of Level 3 classification between December 31, 2021 and September 30, 2022, nor were there any new swap agreements entered into during that period.  There was one swap terminated during that period.  That swap had a fair value of $168,000 at December 31, 2021.

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)
 
September 30, 2021
            
Impaired loans $794  $0  $0  $794 
                 
December 31, 2020
                
Impaired loans $4,686  $0  $0  $4,686 
Other real estate owned  194   0   0   194 
 
 
Fair
Value
  
Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
  
Significant Other
Observable
Inputs
(Level 2)
  
Significant
Unobservable
Inputs
(Level 3)
 
September 30, 2022
            
Impaired loans $336  $—  $—  $336 
                 
December 31, 2021
                
Impaired loans $2,903  $—  $—  $2,903 

-29--30-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 4 – FAIR VALUE (Continued)

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

 
Asset Fair
Value
 
Valuation
Technique
 
Unobservable
Inputs
 Range (%) 
Asset Fair
Value
 
Valuation
Technique
 
Unobservable
Inputs
 Range (%)
September 30, 2021               
September 30, 2022         
Impaired Loans $794 Sales comparison approach Adjustment for differences between comparable sales 1.0 to 7.0 $336 Sales comparison approach 
Adjustment for differences
between comparable sales
 1.5 to 20.0
    Income approach Capitalization rate 9.5 to 11.0

  
Asset Fair
Value
 
Valuation
Technique
 
Unobservable
Inputs
 Range (%)
December 31, 2020               
Impaired Loans $4,686 Sales comparison approach Adjustment for differences between comparable sales 1.5 to 20.0
     Income approach Capitalization rate 9.5 to 11.0
Other real estate owned  194 Sales comparison approach Adjustment for differences between comparable sales 3.0 to 20.0
     Income approach Capitalization rate 9.5 to 11.0

 
Asset Fair
Value
 
Valuation
Technique
 
Unobservable
Inputs
 Range (%)
December 31, 2021         
Impaired Loans $2,903 Sales comparison approach 
Adjustment for differences
between comparable sales
 1.5 to 20.0
     Income approach Capitalization rate 9.5 to 11.0

-30-
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 4 – FAIR VALUE (Continued)

The carrying amounts and estimated fair values of financial instruments, not previously presented, were as follows at September 30, 20212022 and December 31, 20202021 (dollars in thousands):


Level in September 30, 2021  December 31, 2020 
 September 30, 2022  December 31, 2021 

Fair Value
Hierarchy
 
Carrying
Amount
  
Fair
Value
  
Carrying
Amount
  
Fair
Value
 
Level in
Fair Value
Hierarchy
 
Carrying
Amount
  
Fair
Value
  
Carrying
Amount
  
Fair
Value
 
Financial assets                          
Cash and due from banksLevel 1 $30,413  $30,413  $31,480  $31,480 Level 1
 $33,205  $33,205  $23,669  $23,669 
Cash equivalentsLevel 2  1,239,525   1,239,525   752,256   752,256 
Federal funds sold and other short-term investments
Level 1
  733,347   733,347   1,128,119   1,128,119 
Securities held to maturityLevel 3  137,569   140,412   79,468   83,246 Level 3
  349,481   330,882   137,003   139,272 
FHLB stock   11,558  NA   11,558  NA  Level 3
  10,211   10,211   11,558   11,558 
Loans, netLevel 2  1,119,287   1,140,169   1,407,236   1,448,874  Level 2
  1,123,488   1,094,345   1,090,201   1,106,324 
Bank owned life insuranceLevel 3  52,781   52,781   42,516   42,516  Level 3
  53,193   53,193   52,468   52,468 
Accrued interest receivableLevel 2  4,005   4,005   5,625   5,625  Level 2
  7,202   7,202   4,088   4,088 
Financial liabilities                                  
DepositsLevel 2  (2,553,175)  (2,553,148)  (2,298,587)  (2,298,867) Level 2
  (2,556,197)  (2,556,011)  (2,577,958)  (2,577,885)
Other borrowed fundsLevel 2  (85,000)  (86,973)  (70,000)  (73,010) Level 2
  (30,000)  (28,950)  (85,000)  (86,322)
Long-term debtLevel 2  0  0  (20,619)  (18,011)
Accrued interest payableLevel 2  (72)  (72)  (242)  (242) Level 2  (41)  (41)  (72)  (72)
Off-balance sheet credit-related items                                  
Loan commitments   0   0   0   0    —   —   —   — 

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, or 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.transferability, so fair value approximates its cost. The fair value of off-balance sheet credit-related items is not significant.

The estimated fair values of financial instruments disclosed above as follow the guidance in ASU 2016-01 which prescribes an “exit price” approach in estimating and disclosing fair value of financial instruments incorporating discounts for credit, liquidity and marketability factors.


-31-
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 5 - DERIVATIVES

Derivatives not designated as hedges are not speculative and result from a service provided to certain commercial loan borrowers. The Company executes interest rate swaps with commercial banking customers desiring longer-term fixed rate loans, while simultaneously entering into interest rate swaps with a correspondent bank to offset the impact of the interest rate swaps with the commercial banking customers. The net result is the desired floating rate loans and a minimization of the risk exposure of the interest rate swap transactions. As the interest rate swaps associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the commercial banking customer interest rate swaps and the offsetting interest rate swaps with the correspondent bank are recognized directly to earnings. Since they offset perfectly, there is no net impact to earnings.

The notional and fair value of derivative instruments as of September 30, 2022 and December 31, 2021 are reflected in the following table (dollars in thousands):

  Notional Amount Balance Sheet Location Fair Value 
September 30, 2022
       
Derivative assets       
Interest rate swaps $63,650
 Other Assets $6,920
 
          
Derivative liabilities         
Interest rate swaps  63,650
 Other Liabilities  6,920
 

  Notional Amount Balance Sheet Location Fair Value 
December 31, 2021
         
Derivative assets         
Interest rate swaps $70,356
 Other Assets $3,277
 
          
Derivative liabilities         
Interest rate swaps  70,356
 Other Liabilities  3,277
 

The fair value of interest rate swaps in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $6.9 million and $3.3 million as of September 30, 2022 and December 31, 2021, respectively. Securities pledged as collateral totaling $3.5 million and $3.0 million were provided to the counterparty correspondent bank as of September 30, 2022 and December 31, 2021, respectively. These pledged securities were held at the correspondent bank.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $63.7 million as of September 30, 2022 and $70.4 million at December 31, 2021. Associated credit exposure is generally mitigated by securing the interest rate swaps with the underlying collateral of the loan instrument that has been hedged.

-32-
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 56 – DEPOSITS

Deposits are summarized as follows (dollars in thousands):

 
September 30,
2021
  
December 31,
2020
  
September 30,
2022
  
December 31,
2021
 
Noninterest-bearing demand $934,477  $809,437  $855,744  $886,115 
Interest bearing demand  706,247   642,918   731,796   736,573 
Savings and money market accounts  818,525   742,685   891,675   865,528 
Certificates of deposit  93,926   103,547   76,982   89,742 
 $2,553,175  $2,298,587  $2,556,197  $2,577,958 

Time deposits that exceed the FDIC insurance limit of $250,000 were approximately $29.7$22.4 million at September 30, 20212022 and $28.8$28.2 million at December 31, 2020.2021.

-31-
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 67 - OTHER BORROWED FUNDS

Other borrowed funds include advances from the Federal Home Loan Bank and borrowings from the Federal Reserve Bank.

Federal Home Loan Bank Advances

At period-end, advances from the Federal Home Loan Bank were as follows (dollars in thousands):

Principal Terms 
Advance
Amount
 Range of Maturities 
Weighted
Average
Interest Rate
  
Advance
Amount
 Range of Maturities 
Weighted
Average
Interest Rate
 
September 30, 2021       
September 30, 2022       
Single maturity fixed rate advances $30,000 
May 2023 to July 2024
  2.87% $10,000 
February 2024
  2.63%
Putable advances  55,000 
November 2024 to July 2031
  0.74%  20,000 
November 2024
  1.81%
 $85,000       $30,000      

Principal Terms 
Advance
Amount
 Range of Maturities 
Weighted
Average
Interest Rate
  
Advance
Amount
 Range of Maturities 
Weighted
Average
Interest Rate
 
December 31, 2020       
December 31, 2021       
Single maturity fixed rate advances $40,000 
April 2021 to July 2024
  2.50% $30,000 
May 2023 to July 2024
  2.87%
Putable advances  30,000 
November 2024 to February 2030
  1.36%  55,000 
November 2024 to July 2031
  0.74%
 $70,000       $85,000      

Each advance is subject to a prepayment fee if paid prior to its maturity date. Fixed rate advances are payable at maturity. Amortizable mortgage advances are fixed rate advances with scheduled repayments based upon amortization to maturity. These advances were collateralized by residential and commercial real estate loans totaling $389.8$442.6 million and $427.9$361.9 million under a blanket lien arrangement at September 30, 20212022 and December 31, 2020,2021, respectively.
-33-
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 7 - OTHER BORROWED FUNDS (Continued)

Scheduled repayments of FHLB advances as of September 30, 20212022  were as follows (in thousands):

2021
 $0 
2022
  0  $— 
2023
  10,000   — 
2024
  40,000   30,000 
2025
  0   — 
2026  — 
Thereafter
  35,000   — 
 $85,000  $30,000 

On January 21, 2022, the FHLB exercised its option to put an advance totaling $25.0 million to the Company. This advance carried an interest rate of 0.01% and had a maturity date of July 21, 2031.  The Company paid off this advance as required on January 21, 2022. On January 21, 2022, the Company executed a new $25.0 million advance with the FHLB with similar terms.  This advance carried an interest rate of 0.05% and a maturity date of January 21, 2032. The first put date for this advance was April 21, 2022.  The FHLB exercised its put option on this advance and it was paid off by the Company as required on April 21, 2022. On May 27, 2022, the FHLB exercised its put option on a $10.0 million advance that carried an interest rate of 0.45% and the Company paid the advance off as required on May 27, 2022.  On May 27, 2022, the Company prepaid three other advances, totaling $20.0 million, with rates ranging from 2.91% to 3.05%, resulting in a prepayment penalty of $87,000, which is included in interest expense in the nine months ended September 30, 2022.

Federal Reserve Bank borrowings

The Company has a financing arrangement with the Federal Reserve Bank. There were 0no borrowings outstanding at September 30 2021, 2022 and December 31, 2020,2021, and the Company had approximately $4.8$3.6 million and $12.9$4.0 million in unused borrowing capacity based on commercial and mortgage loans pledged to the Federal Reserve Bank totaling $5.2$3.9 million and $13.8$4.4 million at September 30, 20212022 and December 31, 2020,2021, respectively.

-32-
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 78 - EARNINGS PER COMMON SHARE



A reconciliation of the numerators and denominators of basic and diluted earnings per common share for the three and nine month periods ended September 30, 20212022 and 20202021 are as follows (dollars in thousands, except per share data):


 
Three Months
Ended
September 30, 2021
  
Three Months
Ended
September 30, 2020
  
Nine Months
Ended
September 30, 2021
  
Nine Months
Ended
September 30, 2020
  
Three Months
Ended
September 30,
2022
  
Three Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2022
  
Nine Months
Ended
September 30,
2021
 
Net income available to common shares $7,202  $7,120  $22,798  $21,169  $10,045  $7,202  $22,614  $22,798 
Weighted average shares outstanding, including participating stock awards - Basic  34,190,264   34,109,901   34,192,916   34,108,676   34,251,792   34,190,264   34,253,459   34,192,916 
Dilutive potential common shares:                                
Stock options  0   0   0   0   —   —   —   — 
Weighted average shares outstanding - Diluted  34,190,264   34,109,901   34,192,916   34,108,676   34,251,792   34,190,264   34,253,459   34,192,916 
Basic earnings per common share $0.21  $0.21  $0.67  $0.62  $0.29  $0.21  $0.66  $0.67 
Diluted earnings per common share $0.21  $0.21  $0.67  $0.62  $0.29  $0.21  $0.66  $0.67 



There were 0no antidilutive shares of common stock in the three and nine month periods ended September 30, 20212022 and 2020.2021.

-33--34-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 89 - FEDERAL INCOME TAXES



Income tax expense was as follows (dollars in thousands):


 
Three Months
Ended
September 30, 2021
  
Three Months
Ended
September 30, 2020
  
Nine Months
Ended
September 30, 2021
  
Nine Months
Ended
September 30, 2020
  
Three Months
Ended
September 30,
2022
  
Three Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2022
  
Nine Months
Ended
September 30,
2021
 
Current $936  $1,304  $4,685  $5,974  $2,436  $936  $4,787  $4,685 
Deferred  800   309  656  (1,174)  52   800  585   656
 $1,736  $1,613  $5,341  $4,800  $2,488  $1,736  $5,372  $5,341 



The difference between the financial statement tax expense and amount computed by applying the statutory federal tax rate to pretax income was reconciled as follows (dollars in thousands):


 
Three Months
Ended
September 30, 2021
  
Three Months
Ended
September 30, 2020
  
Nine Months
Ended
September 30, 2021
  
Nine Months
Ended
September 30, 2020
  
Three Months
Ended
September 30,
2022
  
Three Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2022
  
Nine Months
Ended
September 30,
2021
 
Statutory rate  21%  21%  21%  21%  21%  21%  21%  21%
Statutory rate applied to income before taxes $1,877  $1,834  $5,909  $5,454  $2,632  $1,877  $5,877  $5,909 
Deduct                                
Tax-exempt interest income  (162)  (178)  (477)  (533)  (137)  (162)  (434)  (477)
Bank-owned life insurance  (54)  (45)  (165)  (144)  (45)  (54)  (144)  (165)
Other, net  75   2   74  23   38   75   73   74 
 $1,736  $1,613  $5,341  $4,800  $2,488  $1,736  $5,372  $5,341 



The realization of deferred tax assets is largely dependent upon future taxable income, future reversals of existing taxable temporary differences and the ability to carryback losses to available tax years. In assessing the need for a valuation allowance, we consider positive and negative evidence, including taxable income in carry-back years, scheduled reversals of deferred tax liabilities, expected future taxable income and tax planning strategies. Management believes it is more likely than not that all of the deferred tax assets  at September 30, 2022 will be realized against deferred tax liabilities and projected future taxable income.



The net deferred tax asset recorded included the following amounts of deferred tax assets and liabilities (dollars in thousands):


 
September 30,
2021
  
December 31,
2020
  
September 30,
2022
  
December 31,
2021
 
Deferred tax assets            
Allowance for loan losses $3,472  $3,656  $3,113  $3,337 
Net deferred loan fees  519  
822   —   275 
Nonaccrual loan interest  69   120   16   57 
Valuation allowance on other real estate owned  5   41   —   6 
Unrealized loss on securities available for sale and transferred to held to maturity  8,686   79 
Other  389   499   347   311 
Gross deferred tax assets  4,454   5,138   12,162   4,065 
Valuation allowance  0   0   —   — 
Total net deferred tax assets  4,454   5,138   12,162   4,065 
Deferred tax liabilities                
Depreciation  (1,260)  (1,285)  (1,123)  (1,199)
Net deferred loan fees  (12)  — 
Prepaid expenses  (262)  (170)  (284)  (288)
Unrealized gain on securities available for sale  (397)  (1,120)
Other  (409)  (504)  (558)  (415)
Gross deferred tax liabilities  (2,328)  (3,079)  (1,977)  (1,902)
Net deferred tax asset $2,126  $2,059  $10,185  $2,163 



There were 0no unrecognized tax benefits at September 30, 20212022 or December 31, 20202021 and the Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. The Company is no longer subject to examination by the Internal Revenue Service for years before 2018.

-34--35-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 910 – COMMITMENTS AND OFF BALANCE-SHEET RISK

Some financial instruments are used to meet customer financing needs and to reduce exposure to interest rate changes. These financial instruments include commitments to extend credit and standby letters of credit. These involve, to varying degrees, credit and interest rate risk in excess of the amount reported in the financial statements.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the commitment, and generally have fixed expiration dates. Collateral or other security is normally not obtained for these financial instruments prior to their use and many of the commitments are expected to expire without being used.  Standby letters of credit are conditional commitments to guarantee a customer’s performance to a third party. Exposure to credit loss if the other party does not perform is represented by the contractual amount for commitments to extend credit and standby letters of credit.

A summary of the contractual amounts of financial instruments with off‑balance‑sheet risk was as follows at period-end (dollars in thousands):

 
September 30,
2021
  
December 31,
2020
  
September 30,
2022
  
December 31,
2021
 
Commitments to make loans $103,595  $88,022  $88,937  $128,648 
Letters of credit  11,784   11,751   15,847   10,141 
Unused lines of credit  691,928   596,298   740,310   677,902 

The notional amount of commitments to fund mortgage loans to be sold into the secondary market was $0 and approximately $3.7$1.3 million and $0 at September 30, 20212022 and December 31, 2020,2021, respectively.

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. These commitments were approximately $8.5$2.5 million and $21.0$9.5 million at September 30, 20212022 and December 31, 2020,2021, respectively.

At September 30, 2021,2022, approximately 40.3%67.5% of the Bank’s commitments to make loans were at fixed rates, offered at current market rates. The remainder of the commitments to make loans were at variable rates tied to prime or one month LIBORterm SOFR and generally expire within 30 days. The majority of the unused lines of credit were at variable rates tied to prime.

NOTE 1011 – CONTINGENCIES

The Company and its subsidiaries periodically become defendants in certain claims and legal actions arising in the ordinary course of business. As of September 30, 2021,2022, there were no material pending legal proceedings to which the Company or any of its subsidiaries are a party or which any of its properties are the subject.

NOTE 1112 – 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 can initiate regulatory action that could have a direct material effect on the financial statements.

The prompt corrective action regulations provide 5five categories, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is only adequately capitalized, regulatory approval is required to, among other things, accept, renew or roll-over brokered deposits. If a bank is undercapitalized, capital distributions and growth and expansion are limited, and plans for capital restoration are required.

-36-
In July 2013, the Board of Governors of the Federal Reserve Board and the FDIC approved the rules implementing the Basel Committee on Banking Supervision’s
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 12 – SHAREHOLDERS’ EQUITY(Continued)

The regulatory capital guidelines for U.S. banks (commonly known as Basel III). The rulesrequirements include a common equity Tier 1 capital to risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, which effectively results in a minimum CET1 ratio of 7.0%. The minimum ratio of Tier 1 capital to risk-weighted assets is 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5%), which effectively results in a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer), and requires a. The minimum leverage ratio ofis 4.0%.

-35-
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 11 – SHAREHOLDERS' EQUITY (Continued)

At September 30, 20212022  and December 31, 2020,2021, actual capital levels and minimum required levels were (dollars in thousands):

       
Minimum
Capital
  
Minimum Capital
Adequacy With
  
To Be Well
Capitalized Under
Prompt Corrective
        
Minimum
Capital
  
Minimum Capital
Adequacy With
  
To Be Well
Capitalized Under
Prompt Corrective
 
 Actual  Adequacy  Capital Buffer  Action Regulations  Actual  Adequacy  Capital Buffer  Action Regulations 
 Amount  Ratio  Amount  Ratio  Amount  Ratio  Amount  Ratio  Amount  Ratio  Amount  Ratio  Amount  Ratio  Amount  Ratio 
September 30, 2021
                        
September 30, 2022                        
CET1 capital (to risk weighted assets)                                                
Consolidated $250,719   17.4% $64,714   4.5% $100,666   7.0%  N/A   N/A  $269,231   16.7
% $72,455   4.5% $112,708   7.0%  N/A   N/A 
Bank  242,635
   16.9   64,703   4.5   100,648   7.0  $93,459   6.5%  261,445   16.2
   72,442   4.5   112,688   7.0  $104,639   6.5%
Tier 1 capital (to risk weighted assets)                                                                
Consolidated  250,719
   17.4   86,285   6.0   122,237   8.5   N/A   N/A   269,231   16.7
   96,607   6.0   136,860   8.5   N/A   N/A 
Bank  242,635
   16.9   86,270   6.0   122,216   8.5   115,027   8.0   261,445   16.2
   96,589   6.0   136,835   8.5   128,786   8.0 
Total capital (to risk weighted assets)                                                                
Consolidated  267,251   18.6   115,046   8.0   150,998   10.5   N/A   N/A   284,052   17.6
   128,810   8.0   169,063   10.5   N/A   N/A 
Bank  259,167   18.0   115,027   8.0   150,973   10.5   143,783   10.0   276,266   17.2
   128,786   8.0   169,031   10.5   160,982   10.0 
Tier 1 capital (to average assets)                                                                
Consolidated  250,719   8.5   117,813   4.0   N/A   N/A   N/A   N/A   269,331   9.3
   115,941   4.0   N/A   N/A   N/A   N/A 
Bank  242,635   8.2   117,801   4.0   N/A   N/A   147,251   5.0   261,445   9.0
   115,930   4.0   N/A   N/A   144,912   5.0 
                                                                
December 31, 2020
                                
December 31, 2021                                
CET1 capital (to risk weighted assets)                                                                
Consolidated $235,629   15.8% $67,170   4.5% $104,487   7.0%  N/A   N/A  $254,302   17.2% $66,381   4.5% $103,259   7.0%  N/A   N/A 
Bank  248,829   16.7   67,161   4.5   104,473   7.0  $97,010   6.5%  246,239   16.7   66,370   4.5   103,242   7.0  $95,867   6.5%
Tier 1 capital (to risk weighted assets)                                                                
Consolidated  255,629   17.1   89,561   6.0   126,877   8.5   N/A   N/A   254,302   17.2   88,508   6.0   125,386   8.5   N/A   N/A 
Bank  248,829   16.7   89,548   6.0   126,860   8.5   119,397   8.0   246,239   16.7   88,493   6.0   125,365   8.5   117,991   8.0 
Total capital (to risk weighted assets)                                                                
Consolidated  273,037   18.3   119,414   8.0   156,731   10.5   N/A   N/A   270,191   18.3   118,011   8.0   154,889   10.5   N/A   N/A 
Bank  266,237   17.8   119,397   8.0   156,709   10.5   149,247   10.0   262,128   17.8   117,991   8.0   154,863   10.5   147,488   10.0 
Tier 1 capital (to average assets)                                                                
Consolidated  255,629   9.9   103,420   4.0   N/A   N/A   N/A   N/A   254,302   8.7   116,664   4.0   N/A   N/A   N/A   N/A 
Bank  248,829   9.6   103,391   4.0   N/A   N/A   129,238
   5.0   246,239   8.4   116,654   4.0   N/A   N/A   145,818
   5.0 

All $20.0 million of trust preferred securities outstanding at  December 31, 2020 qualified as Tier 1 capital. On July 7, 2021, the Company redeemed all of the outstanding trust preferred securities.  Refer to our 2020 Form 10-K for more information on the trust preferred securities.

The Bank was categorized as “well capitalized” at September 30, 20212022 and December 31, 2020.2021.

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Item 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Macatawa Bank Corporation is a Michigan corporation and a registered bank holding company. It wholly-owns Macatawa Bank.  Macatawa Bank is a Michigan chartered bank with depository accounts insured by the FDIC. The Bank operates twenty-six branch offices and a lending and operational service facility, providing a full range of commercial and consumer banking and trust services in Kent County, Ottawa County, and northern Allegan County, Michigan. The Company previously owned all of the common stock of Macatawa Statutory Trust II, a grantor trust that issued trust preferred securities and was not consolidated with the Company under accounting principles generally accepted in the United States of America.  On July 7, 2021, the Company redeemed all of the $20.0 million of outstanding trust preferred securities and $619,000 of common securities associated with this trust.  For further information regarding consolidation, see the Notes to Consolidated Financial Statements.
 
At September 30, 2021,2022, we had total assets of $2.90$2.84 billion, total loans of $1.14 billion, total deposits of $2.55$2.56 billion and shareholders' equity of $252.2$236.6 million.  For the three months ended September 30, 2021,2022, we recognized net income of $7.2$10.0 million compared to $7.1$7.2 million for the same period in 2020.2021. For the nine months ended September 30, 2021,2022, we recognized net income of $22.8$22.6 million compared to $21.2$22.8 million for the same period in 2020.2021.  The Bank was categorized as “well capitalized” under regulatory capital standards at September 30, 2021.2022.
 
We paid a dividend of $0.08 per share in each quarter in 20202021 and in each of the first three quarters of 2022.
RESULTS OF OPERATIONS
Summary: Net income for the three months ended September 30, 2022 was $10.0 million, compared to $7.2 million for the same period in 2021.  Net income per share on a diluted basis for the three months ended September 30, 2022 was $0.29 compared to $0.21 for the same period in 2021.  Net income for the nine months ended September 30, 2022 was $22.6 million compared to $22.8 million for the same period in 2021.  Net income per share on a diluted basis for the nine months ended September 30, 2022 was $0.66 compared to $0.67 for the same period in 2021.

On March 22, 2020,Earnings in the three and nine month periods ended September 30, 2022 improved over the same periods in the prior year primarily through growth in net interest income which was positively impacted by the 300 basis point increase in the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected byfunds rates during 2022.  This offset the Coronavirus.”  The guidance explained thatimpact of lower income from PPP loans during the first nine months of 2022.  Net interest income increased to $19.8 million in consultation with the FASB staffthree months ended September 30, 2022 compared to $14.3 million in the same period in 2021.   Net interest income increased to $47.3 million in the nine months ended September 30, 2022 compared to $43.2 million in the same period in 2021.   As federal banking agencies concluded that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current asfunds rates increase, our net interest income improves given the asset-sensitive profile of the implementation date of a modification are not Troubled Debt Restructurings (“TDRs”).  The Coronavirus Aid, Relief and Economic Security (“CARES”) Act was passed by Congress on March 27, 2020.  Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were not more than 30 days past due as of December 31, 2019 are not TDRs.  On December 27, 2020, another COVID-19 relief bill was signed that extended this guidance until the earlier of January 1, 2022 or 60 days after the date on which the national emergency declaredour balance sheet.  We anticipate further improvement in net interest income as a result of these and future expected federal funds rate increases.  Net interest income also benefitted in the 2022 periods from growth in our investment portfolio, which was up $250.1 million since December 31, 2021.  Net gains on sales of mortgage loans decreased to $166,000 in the three months ended September 30, 2022 compared to $851,000 in the same period in 2021.  Net gains on sales of mortgage loans decreased to $673,000 in the nine months ended September 30, 2022 compared to $4.2 million in the same period in 2021.
The provision for loan losses was $0 for the three months ended September 30, 2022, compared to a benefit of  $550,000 for the same period in 2021.  We were in a net loan recovery position for the three months ended September 30, 2022, with $190,000 in net loan recoveries, compared to $276,000 in net loan recoveries in the same period in 2021.  The provision for loan losses was a benefit of $1.5 million for the nine months ended September 30, 2022 compared to a benefit of $1.3 million for the same period in 2021.  We were also in a net loan recovery position for the nine months ended September 30, 2022, with $432,000 in net recoveries compared to $424,000 in net recoveries in the same period in 2021.  The provision for loan losses in 2021 was also impacted by higher levels of qualitative environmental factors to address uncertainty and increased risk of loss attributable to the COVID-19 is terminated.  Throughpandemic.  Several of these factors were reduced in the first nine months of 2022, reflecting improvement in economic conditions and mitigating effects of the COVID-19 pandemic.
Net Interest Income: Net interest income totaled $19.8 million for the three months ended September 30, 2022 compared to $14.3 million for the same period in 2021.   Net interest income increased to $47.3 million in the nine months ended September 30, 2022 compared to $43.2 million in the nine months ended September 30, 2021.  Net interest income for the three and nine month periods ended September 30, 2022 benefitted from increases in the federal funds rate and growth in our investment securities portfolio.  The federal funds rate increased by 300 basis points from March 2022 through September 2022.

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Net interest income for the third quarter of 2022 increased $5.5 million compared to the same period in 2021.  Of this increase, $5.6 million was from changes in rates earned or paid, partially offset by a decrease of $170,000 from changes in the volume of average interest earning assets and interest bearing liabilities.  The largest positive change in interest income occurred in our federal funds sold and other short-term investments.  The net change in interest income for federal funds sold and other short-term investments was an increase of $4.2 million, of which $4.4 million was due to an increase in rate, partially offset by a reduction of $217,000 due to a decrease in volume. The net change in interest income for taxable securities was an increase of $2.5 million, with $2.3 million due to an increase in average balances and an increase of $260,000 due to rate.  The net change in interest income for commercial loans (excluding PPP loans) was an increase of $2.2 million, of which an increase of $620,000 was due to portfolio growth, and an increase of $1.5 million due to rate.  Compared to the third quarter of 2021, PPP loans caused a reduction of $3.0 million in net interest income in the third quarter of 2022 primarily due to significant principal forgiveness and lower PPP fee recognition.  Consumer loan interest income increased by $191,000 in the third quarter of 2022 compared to the same period in 2021.  Of the $191,000 increase in interest income on consumer loans, $34,000 was due to an increase in average balances and $157,000 was due to higher loan rates.  Interest expense changes in the third quarter of 2022 were primarily rate related as we did make some changes to interest rates paid on our deposit balances in response to increased federal funds rates.

Net interest income for the nine months ended September 30, 2022 increased $4.0 million compared to the same period in 2021.  Of this increase, $6.8 million was from changes in the rates earned or paid, partially offset by a decrease of $2.7 million from changes in volume of average interest earning assets and interest bearing liabilities.  The largest changes occurred in interest income on federal funds, interest income on PPP loans and interest income in our investment portfolio as we deployed some of our excess investable funds primarily into taxable securities.  Interest income from federal funds sold and other short-term investments increased by $6.0 million in the first nine months of 2022 compared to the same period in 2021 due to the 300 basis point increase in federal funds rate from March 2022 through September 2022.  This caused a $6.1 million increase in interest income, partially offset by a decrease in average balances of federal funds sold and other short-term investments in the first nine months of 2022, which subtracted $90,000.  The net change in interest income for PPP loans was a decrease of $7.3 million in the first nine months of 2022 as compared to the same period in 2021. The net change in interest income for commercial loans (excluding PPP loans) was a $1.1 million increase with $698,000 due to rate and $410,000 due to portfolio growth. The net change in interest income for taxable securities was an increase of $5.0 million with $4.7 million due to an increase in average balances and $262,000 due to rate. Of the $507,000 decrease in interest income on residential mortgage loans, $361,000 was due to a decrease in average balances and $146,000 was due to rate.

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The cost of funds increased to 0.26% in the third quarter of 2022 compared to 0.13% in the third quarter of 2021.  For the first nine months of 2022, the cost of funds increased to 0.17% compared to 0.16% for the same period in 2021. Increases in the rates paid on our interest bearing demand deposits and our savings and money market deposits in response to the increase in market rates over the last several months caused the increase in our cost of funds.

The following table shows an analysis of net interest margin for the three month periods ended September 30, 2022 and 2021 (dollars in thousands):

  For the three months ended September 30, 
  2022  2021 
  
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
  
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
 
Assets                  
Taxable securities $670,832  $3,323   1.98% $200,981  $786   1.56%
Tax-exempt securities (1)  137,645   668   2.50   172,372   777   2.32 
Commercial loans (2)  937,125   10,223   4.27   873,248   8,055   3.61 
PPP loans (3)  1,745   94   21.08   133,413   3,104   9.10 
Residential mortgage loans  128,611   1,093   3.39   123,574   1,039   3.36 
Consumer loans  57,724   754   5.18   54,591   563   4.09 
Federal Home Loan Bank stock  10,211   53   2.04   11,558   44   1.51 
Federal funds sold and other short-term investments  803,082   4,667   2.27   1,234,420   474   0.15 
Total interest earning assets (1)  2,746,975   20,875   3.02   2,804,157   14,842   2.12 
Noninterest earning assets:                        
Cash and due from banks  42,454           39,725         
Other  84,914           104,782         
Total assets $2,874,343          $2,948,664         
Liabilities                        
Deposits:                        
Interest bearing demand $713,913  $247   0.14% $723,516  $49   0.03%
Savings and money market accounts  871,508   636   0.29   817,307   60   0.03 
Time deposits  83,192   61   0.29   99,312   100   0.40 
Borrowings:                        
Other borrowed funds  30,000   160   2.08   79,565   325   1.60 
Long-term debt  —   —   —   1,345   12   3.42 
Total interest bearing liabilities  1,698,613   1,104   0.26   1,721,045   546   0.13 
Noninterest bearing liabilities:                        
Noninterest bearing demand accounts  917,552           964,908         
Other noninterest bearing liabilities  13,321           12,717         
Shareholders' equity  244,857           249,994         
Total liabilities and shareholders' equity $2,874,343          $2,948,664         
Net interest income     $19,771          $14,296     
Net interest spread (1)          2.76%          1.99%
Net interest margin (1)          2.86%          2.04%
Ratio of average interest earning assets to average
interest bearing liabilities
  161.72%          162.93%        

(1)Yields are presented on a tax equivalent basis using an assumed tax rate of 21% at September 30, 2022 and 2021.
(2)Includes loan fees of $178,000 and $103,000 for the three months ended September 30, 2022 and 2021, respectively.  Includes average nonaccrual loans of approximately $87,000 and $426,000 for the three months ended September 30, 2022 and 2021, respectively.  Excludes PPP loans.
(3)Includes loan fees of $90,000 and $2.8 million for the three months ended September 30, 2022 and 2021, respectively.

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The following table shows an analysis of net interest margin for the nine month periods ended September 30, 2022 and 2021 (dollars in thousands):

  For the nine months ended September 30, 
  2022  2021 
  
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
  
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
 
Assets                  
Taxable securities $554,670  $7,375   1.77% $195,867  $2,365   1.61%
Tax-exempt securities (1)  157,095   2,101   2.30   145,571   2,295   2.71 
Commercial loans (2)  920,883   26,698   3.82   906,493   25,590   3.72 
PPP loans (3)  8,980   1,345   19.75   206,941   8,690   5.54 
Residential mortgage loans  122,029   3,019   3.29   136,435   3,526   3.44 
Consumer loans  55,912   1,843   4.41   56,373   1,724   4.09 
Federal Home Loan Bank stock  10,478   155   1.95   11,558   162   1.84 
Federal funds sold and other short-term investments  923,153   6,916   0.99   1,012,179   948   0.12 
Total interest earning assets (1)  2,753,200   49,452   2.41   2,671,417   45,300   2.28 
Noninterest earning assets:                        
Cash and due from banks  36,979           35,084         
Other  89,392           102,849         
Total assets $2,879,571          $2,809,350         
Liabilities                        
Deposits:                        
Interest bearing demand $700,010  $341   0.06% $670,029  $122   0.02%
Savings and money market accounts  879,368   846   0.13   811,381   183   0.03 
Time deposits  87,892   159   0.24   103,271   428   0.55 
Borrowings:                        
Other borrowed funds  56,234   827   1.94   70,623   1,005   1.88 
Long-term debt  —   —   —   14,123   319   2.98 
Total interest bearing liabilities  1,723,504   2,173   0.17   1,669,427   2,057   0.16 
Noninterest bearing liabilities:                        
Noninterest bearing demand accounts  896,989           881,177         
Other noninterest bearing liabilities  12,499           13,535         
Shareholders' equity  246,579           245,211         
Total liabilities and shareholders' equity $2,879,571          $2,809,350         
Net interest income     $47,279          $43,243     
Net interest spread (1)          2.24%          2.12%
Net interest margin (1)          2.30%          2.18%
Ratio of average interest earning assets to average
interest bearing liabilities
  159.74%          160.02%        

(1)Yields are presented on a tax equivalent basis using an assumed tax rate of 21% at September 30, 2022 and 2021.
(2)Includes loan fees of $435,000 and $628,000 for the nine months ended September 30, 2022 and 2021, respectively.  Includes average nonaccrual loans of approximately $89,000 and $472,000 for the nine months ended September 30, 2022 and 2021, respectively.  Excludes PPP loans.
(3)Includes loan fees of $1.3 million and $7.1 million for the nine months ended September 30, 2022 and 2021, respectively.

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The following table presents the dollar amount of changes in net interest income due to changes in volume and rate (dollars in thousands):

  
For the three months ended September 30,
2022 vs 2021
Increase (Decrease) Due to
  
For the nine months ended September 30,
2022 vs 2021
Increase (Decrease) Due to
 
  Volume  Rate  Total  Volume  Rate  Total 
                   
Interest income                  
Taxable securities $2,277  $260  $2,537  $4,748  $262  $5,010 
Tax-exempt securities  (190)  81   (109)  240   (434)  (194)
Commercial loans, excluding PPP loans  620   1,548   2,168   410   698   1,108 
PPP loans  (2,997)  (13)  (3,010)  (8,222)  877   (7,345)
Residential mortgage loans  43   11   54   (361)  (146)  (507)
Consumer loans  34   157   191   (14)  133   119 
Federal Home Loan Bank stock  (5)  14   9   (16)  9   (7)
Federal funds sold and other short-term investments  (217)  4,410   4,193   (90)  6,058   5,968 
Total interest income  (435)  6,468   6,033   (3,305)  7,457   4,152 
Interest expense                        
Interest bearing demand $(1) $199  $198  $6  $213   219 
Savings and money market accounts  4   572   576   17   646   663 
Time deposits  (15)  (24)  (39)  (56)  (213)  (269)
Other borrowed funds  (241)  76   (165)  (210)  32   (178)
Long-term debt  (12)  —   (12)  (319)  —   (319)
Total interest expense  (265)  823   558   (562)  678   116 
Net interest income $(170) $5,645  $5,475  $(2,743) $6,779  $4,036 

Provision for Loan Losses: The provision for loan losses for the three months ended September 30, 2022 was $0 compared to a benefit of $550,000 for the same period in 2021.  The provision for loan losses for the first nine months of 2022 was a benefit of $1.5 million compared to a benefit of $1.3 million for the same period in 2021.  Net loan recoveries were $190,000 in the three months ended September 30, 2022 compared to net loan recoveries of $276,000 in the same period in 2021.  Net loan recoveries were $432,000 in the nine months ended September 30, 2022 compared to $424,000 in the same period in 2021.
Gross loan recoveries were $236,000 for the three months ended September 30, 2022 and $298,000 for the same period in 2021.  In the three months ended September 30, 2022, we had $46,000 in gross loan charge-offs, compared to $22,000 in the same period in 2021.  For the nine months ended September 30, 2022, we experienced gross loan recoveries of $573,000 compared to $526,000 for the same period in 2021.  Gross loan charge-offs for the nine months ended September 30, 2022 were $141,000 compared to $102,000 for the same period in 2021.
The amounts of loan loss provision in each period were the result of establishing our allowance for loan losses at levels believed necessary based upon our methodology for determining the adequacy of the allowance.  The provision for loan losses for the three and nine month periods ended September 30, 2022 was impacted by net reductions to certain qualitative factors.  More information about our allowance for loan losses and our methodology for establishing its level may be found under the heading "Allowance for Loan Losses" below.
Noninterest Income: Noninterest income for the three and nine month periods ended September 30, 2022 was $4.9 million and $15.0 million compared to $5.6 million and $18.3 million for the same periods in 2021, respectively.   The components of noninterest income are shown in the table below (in thousands):

  
Three Months
Ended
September 30,
2022
  
Three Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2022
  
Nine Months
Ended
September 30,
2021
 
Service charges and fees on deposit accounts $1,263  $1,183  $3,693  $3,240 
Net gains on mortgage loans  166   851   673   4,177 
Trust fees  969   1,079   3,153   3,217 
ATM and debit card fees  1,724   1,676   5,084   4,844 
Bank owned life insurance (“BOLI”) income  217   260   687   787 
Investment services fees  339   330   997   1,146 
Other income  211   263   698   938 
Total noninterest income $4,889  $5,642  $14,985  $18,349 

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Service charges on deposit accounts increased in the three and nine month periods ended September 30, 2022 as compared to the same periods in 2021 as customers returned to more normal behaviors in 2022 after having curtailed spending in 2021 due to uncertainty related to the COVID-19 pandemic.  Service charges were up $80,000 in the three months ended September 30, 2022 and were up $453,000 in the nine months ended September 30, 2022 compared to the same periods in 2021.
Net gains on mortgage loans were down $685,000 in the three months ended September 30, 2022  and were down $3.5 million in the nine months ended September 30, 2022 compared to the same periods in 2021 as a result of changes in the volume of loans originated for sale.  In the previous two years, volumes had been high due to a lower interest rate environment, spurring more refinancing of fixed rate loans which we sell into the secondary market.  Mortgage rates increased in the latter part of 2021 and the first nine months of 2022, causing a sharp reduction in mortgage volume, and a shift to variable rate products, which we place in portfolio rather than sell in the secondary market.  Mortgage loans originated for sale in the three months ended September 30, 2022 were $6.5 million, compared to $21.3 million in the same period in 2021.  For the first nine months of 2022, mortgage loans originated for sale were $25.0 million, compared to $107.8 million for the same period in 2021.
Trust fees were down $110,000 in the three months ended September 30, 2022 and were down $64,000 in the nine months ended September 30, 2022 compared to the same periods in 2021. The changes for the three and nine months ended September 30, 2022 were largely due to fluctuations in market valuations of trust assets resulting from overall stock market conditions.  ATM and debit card fees were up in the three and nine months ended September 30, 2022 as compared to the same periods in 2021 due to higher volume of usage by our customers.  These volumes and resulting income have returned to more normal levels in the 2022 period following the COVID-19 related economic slowdown.
Noninterest Expense: Noninterest expense increased by $577,000 to $12.1 million for the three month period ended September 30, 2022 as compared to $11.6 million in the same period in 2021.  Noninterest expense increased by $1.0 million to $35.8 million for the nine month period ended September 30, 2022 compared to $34.8 million for the same period in 2021.  The components of noninterest expense are shown in the table below (in thousands):

  
Three Months
Ended
September 30,
2022
  
Three Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2022
  
Nine Months
Ended
September 30,
2021
 
Salaries and benefits $6,639  $6,278  $19,331  $19,192 
Occupancy of premises  989   992   3,232   3,023 
Furniture and equipment  1,014   1,014   3,017   2,929 
Legal and professional  268   272   733   768 
Marketing and promotion  196   175   586   525 
Data processing  984   839   2,792   2,602 
FDIC assessment  201   204   578   532 
Interchange and other card expense  405   391   1,184   1,137 
Bond and D&O insurance  129   112   389   334 
Outside services  502   510   1,516   1,434 
Other noninterest expense  800   763   2,420   2,277 
Total noninterest expense $12,127  $11,550  $35,778  $34,753 

Most categories of noninterest expense were relatively unchanged compared to the three and nine months ended September 30, 2021 due to our ongoing efforts to manage expenses and scale our operations. Our largest component of noninterest expense, salaries and benefits, increased by $361,000 in the Bankthree months ended September 30, 2022 from the same period in 2021. This increase is primarily due to higher annual merit and inflationary increases in base pay, higher 401k matching contributions and higher medical insurance costs more than offsetting a decrease in variable-based compensation due to lower mortgage origination volume.  Salaries and benefits increased by $139,000 for the nine months ended September 30, 2022 compared to the same period in 2021 due to the same combination of factors.  The table below identifies the primary components of salaries and benefits (in thousands):

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Three Months
Ended
September 30,
2022
  
Three Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2022
  
Nine Months
Ended
September 30,
2021
 
Salaries and other compensation $5,878   5,708  $17,277   17,174 
Salary deferral from commercial loan originations  (211)  (204)  (644)  (825)
Bonus accrual  344   289   786   688 
Mortgage production - variable comp  91   187   376   903 
401k matching contributions  187   98   586   327 
Medical insurance costs  350   200   950   925 
Total salaries and benefits $6,639  $6,278  $19,331  $19,192 
Occupancy expenses were down $3,000 in the three months ended September 30, 2022 and were up $209,000 in the nine month period ended September 30, 2022 compared to the same periods in 2021 due to fluctuations in maintenance costs incurred.  Furniture and equipment expenses were unchanged in the three months ended September 30, 2022 and were up $88,000 in the nine months ended September 30, 2022 compared to the same periods in 2021 due to costs associated with equipment and service contracts primarily to improve information security.
Data processing costs were up $145,000 and $190,000 in the three and nine month periods ended September 30, 2022, respectively, compared to the same periods in 2021 due to higher usage of electronic banking services and debit cards by our customers.
Interchange and other card expenses were up $14,000 and $47,000 in the three and nine month periods ended September 30, 2022, respectively, compared to the same periods in 2021 due to a higher number of debit cards issued and higher usage by our deposit customers.   The increase in expense correlates to the increase in our debit card interchange income in these periods.
Outside services were down $8,000 in the three months ended September 30, 2022 and were up $82,000 in the nine month period ended September 30, 2022, respectively, compared to the same periods in 2021.  The increase for the nine month period was due to increased vendor costs and consultation related to improving efficiency in certain departments.
Federal Income Tax Expense: We recorded $2.5 million and $5.4 million in federal income tax expense for the three and nine month periods ended September 30, 2022 compared to $1.7 million and $5.3 million for the same periods in 2021.  Our effective tax rates for the three and nine month periods ended September 30, 2022 were 19.85%  and 19.20% compared to 19.42%  and 18.98% for the same periods in 2021.   The increase in our effective tax rate in the 2022 periods was due to higher levels of taxable income from both growth in taxable securities held in our investment portfolio and growth in taxable income from rising interest rates while our tax-exempt income has remained relatively flat.
FINANCIAL CONDITION
Total assets were $2.84 billion at September 30, 2022, a decrease of $93.7 million from December 31, 2021. This change reflected increases of $37.7 million in debt securities available for sale, $212.5 million in debt securities held to maturity and $29.7 million in our loan portfolio more than offset by a decrease of $385.2 million in cash and cash equivalents. Total deposits decreased by $21.8 million at September 30, 2022 compared to December 31, 2021 and FHLB borrowings decreased by $55.0 million from December 31, 2021 to September 30, 2022.
Cash and Cash Equivalents: Our cash and cash equivalents, which include federal funds sold and short-term investments, were $766.6 million at September 30, 2022 compared to $1.15 billion at December 31, 2021.  The decrease in these balances primarily related to an increase in our investment portfolio and decreases in deposit balances and other borrowings.
Securities: Debt securities available for sale were $453.7 million at September 30, 2022 compared to $416.1 million at December 31, 2021. The balance at September 30, 2022 primarily consisted of U.S. agency securities, agency mortgage backed securities and various municipal investments. Our held to maturity portfolio was $349.5 million at September 30, 2022 compared to $137.0 million at December 31, 2021.  Our held to maturity portfolio is comprised of U.S. Treasury securities and state, municipal and privately placed commercial bonds.

On January 1, 2022, we reclassified ten U.S. Treasury securities with an amortized cost of $123.5 million from available for sale to held to maturity, as we have the intent and ability to hold these securities to maturity.  All ten of these U.S. Treasury securities were purchased within the fourth quarter of 2021.  Subsequently and upon further analysis of these purchases, management decided to reclassify them to held to maturity given their short-term nature.  These securities had applied this guidancenet unrealized gains of $113,000 at the date of transfer, which will continue to be reported in accumulated comprehensive income, and modified 726 individualwill be amortized over the remaining life of the securities as an adjustment of yield.  The effect on interest income of the amortization of net unrealized gains is offset by the amortization of the premium on the securities transferred. Total securities increased $250.1 million from $553.1 million at December 31, 2021 to $803.2 million at September 30, 2022 as we continued to deploy excess liquidity into higher yielding assets. We plan further growth of our investment portfolio in the fourth quarter of 2022.

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We classify privately placed municipal and commercial bonds as held to maturity as they are typically non-transferable in the bond market.  In addition, going forward we will generally classify short-term U.S. Treasury securities as held to maturity.  Typically the final maturity on these short-term Treasury securities will be three years or less.  Longer-term Treasury securities and all other marketable debt securities are generally classified as available for sale.
Portfolio Loans and Asset Quality: Total portfolio loans with aggregate principal balancesincreased by $29.7 million in the first nine months of 2022 and were $1.14 billion at September 30, 2022 compared to $1.11 billion at December 31, 2021. During the first nine months of 2022, our commercial portfolio decreased by $12.9 million.  We received forgiveness proceeds on 236 PPP loans totaling $337.2 million.  As$43.1 million in the nine months ended September 30, 2022.  Excluding the PPP loans, our commercial loans increased by $54.8 million in the first nine months of 2022.  Our consumer portfolio increased by $4.4 million and our residential mortgage portfolio increased by $12.4 million in the first nine months of 2022.
Mortgage loans originated for portfolio are typically adjustable rate loans as well as fixed rate loans that conform to secondary market requirements and have a term of fifteen years or less.  Mortgage loans originated for portfolio in the first nine months of 2022 increased $13.0 million compared to the same period in 2021, from $30.4 million in the first nine months of 2021 to $43.4 million in the same period in 2022.
The table below shows the breakout of our portfolio residential mortgage loans between fixed and variable as of September 30, 2021, all of these modifications had expired2022 and the loans returned to their contractual payment terms.December 31, 2022 (dollars in thousands):

  
September 30,
2022
  
December 31,
2021
 
Fixed rate residential mortgage loans $63,664  $65,011 
Variable rate residential mortgage loans  66,474   52,789 
Total residential mortgage loans $130,138  $117,800 
The CARES Act, as amended, included an allocationvolume of $659 billionresidential mortgage loans originated for sale in the first nine months of 2022 decreased $82.8 million compared to the same period in 2021. Residential mortgage loans originated for sale were $25.0 million in the first nine months of 2022 compared to $107.8 million in the first nine months of 2021.
The following table shows our loan origination activity for loans to be issuedheld in portfolio during the first nine months of 2022 and 2021, broken out by financial institutions throughloan type and also shows average originated loan size (dollars in thousands):

  Nine months ended September 30, 2022  Nine months ended September 30, 2021 
  
Portfolio
Originations
  
Percent of
Total
Originations
  
Average
Loan Size
  
Portfolio
Originations
  
Percent of
Total
Originations
  
Average
Loan Size
 
Commercial real estate:                  
Residential developed $6,177   1.7% $562  $6,369   1.4% $490 
Unsecured to residential
developers
  —   —   —   —   —   — 
Vacant and unimproved  10,162   2.8   1,270   8,345   1.9   642 
Commercial development  —   —   —   —   —   — 
Residential improved  46,652   12.6   583   75,223   16.9   607 
Commercial improved  45,620   12.4   1,342   54,609   12.2   1,187 
Manufacturing and
industrial
  55,138   14.9   2,506   24,962   5.6   960 
Total commercial real estate  163,749   44.4   1,056   169,508   38.0   764 
Commercial and industrial, excluding PPP  115,730   31.3   827   77,019   17.3   770 
PPP loans  —   —   —   128,052   28.7   127 
Total commercial and commercial real estate  279,479   75.7   947   374,579   84.0   282 
Consumer                        
Residential mortgage  43,381   11.8   319   30,415   6.8   295 
Unsecured  —   —   —   —   —   — 
Home equity  44,765   12.1   129   39,884   8.9   126 
Other secured  1,616   0.4   39   1,452   0.3   25 
Total consumer  89,762   24.3   172   71,751   16.0   150 
Total loans $369,241   100.0% $451  $446,330   100.0% $247 

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Overall, the commercial loan portfolio increased $12.9 million in the first nine months of 2022 with growth more than offsetting forgiveness of PPP loans of $41.9 million in that time period.  Excluding PPP forgiveness, commercial loans grew by $54.8 million in the first nine months of 2022 comprised of commercial and industrial portfolio growth of $48.7 million and commercial real estate loan growth of $6.1 million.  Included in the commercial production for the first nine months of 2021 is $128.1 million in PPP loans, while there were no such loans originated in the first nine months of 2022.  Our overall production of commercial loans decreased by $95.1 million from $374.6 million in the first nine months of 2021 to $279.5 million in the same period of 2022 mostly due to the significantly lower production of PPP loans (down $128.1 million).  Excluding PPP production, our commercial loan originations in the first nine months of 2022 were $33.0 million higher than in the first nine months of 2021.  This growth came largely from commercial and industrial originations which were up $38.7 million.  Commercial real estate originations were down $5.8 million in the first nine months of 2022, primarily in the residential improved category, which were down $28.6 million, and commercial improved, which were down $9.0 million, The manufacturing and industrial category was up $30.2 million and vacant and improved was up $1.8 million as these businesses expand following the pandemic slowdown.
We also have a significant amount of unfunded commercial lines of credit, that can be drawn on by our commercial loan customers.  The table below shows the total commitment, the unused portion and the percentage of unused to total commitment at September 30, 2022 and December 31, 2021 (dollars in thousands):

  
September 30,
2022
  
December 31,
2021
 
Commercial - Lines of credit commitments $1,016,707  $886,577 
Commercial - Unused portion of lines of credit  608,291   526,725 
Commercial - Unused lines of credit to total commitment  59.83%  59.41%

Total commercial lines of credit commitments increased by $130.1 million from December 31, 2021 to September 30, 2022.
Commercial and commercial real estate loans remained our largest loan segment and accounted for approximately 83.4% and 84.4% of the total loan portfolio at September 30, 2022 and December 31, 2021, respectively. Residential mortgage and consumer loans comprised approximately 16.6% and 15.6% of total loans at September 30, 2022 and December 31, 2021, respectively.
A further breakdown of the composition of the loan portfolio is shown in the table below (in thousands):

  September 30, 2022  December 31, 2021 
  Balance  
Percent of
Total Loans
  Balance  
Percent of
Total Loans
 
Commercial real estate: (1)            
Residential developed $6,830   0.6% $4,862   0.4%
Unsecured to residential developers  —   —   5,000   0.4 
Vacant and unimproved  34,737   3.1   36,240   3.3 
Commercial development  107   —   171   — 
Residential improved  107,782   9.5   100,077   9.0 
Commercial improved  257,144   22.6   259,039   23.4 
Manufacturing and industrial  115,624   10.1   110,712   10.0 
Total commercial real estate  522,224   45.9   516,101   46.5 
Commercial and industrial, excluding PPP  427,034   37.5   378,318   34.1 
PPP loans  32   —   41,939   3.8 
Total commercial and commercial real estate  949,290   83.4   936,358   84.4 
Consumer                
Residential mortgage  130,138   11.4   117,800   10.7 
Unsecured  111   —   210   — 
Home equity  55,618   4.9   51,269   4.6 
Other secured  3,488   0.3   3,356   0.3 
Total consumer  189,355   16.6   172,635   15.6 
Total loans $1,138,645   100.0% $1,108,993   100.0%


(1)Includes both owner occupied and non-owner occupied commercial real estate.
Commercial real estate loans accounted for 45.9% and 46.5% of the total loan portfolio at September 30, 2022 and December 31, 2021, respectively, and consisted primarily of loans to business owners and developers of owner and non-owner occupied commercial properties and loans to developers of single and multi-family residential properties. In the table above, we show our commercial real estate portfolio by loans secured by residential and commercial real estate, and by stage of development. Improved loans are generally secured by properties that are under construction or completed and placed in use. Development loans are secured by properties that are in the process of development or fully developed. Vacant and unimproved loans are secured by raw land for which development has not yet begun and agricultural land.

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The Bank was a participating lender in the Small Business AdministrationAdministration'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. Through December 31, 2020,Fees generated based on the Bank had originated 1,738origination of PPP loans totaling $346.7 million in principal, with an average loan size of $200,000.  Fees totaling $10.0 million were generated from the SBA for these loans in the year ended December 31, 2020.  These fees 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.  Participation

In 2020:
The Bank originated 1,738 PPP loans totaling $346.7 million in the PPP had a significant impact on the Bank’s asset mix and net interest income in 2020 and will continue to impact both asset mix and net interest income until these loans are forgiven or paid off.  The initial PPP expired on August 8, 2020.  Through December 31, 2020, principal.
Fees generated totaled $10.0 million.
765 PPP loans totaling $113.5 million had been forgiven by the SBA and a totalwere forgiven.
Total net fees of $5.4 million in PPP fees had been recognized by the Bank.were recognized.

On December 27, 2020, another COVID-19 relief bill was signed that extended and modified several provisions of the PPP.  This included an additional allocation of $284 billion.  The SBA reactivated the PPP on January 11, 2021.  In 2021:
The Bank originated additional1,000 PPP loans through thetotaling $128.1 million in principal.
Fees generated totaled $5.6 million.
1,722 PPP which expired on May 31, 2021.  loans totaling $318.4 million were forgiven.
Total net fees of $8.3 million were recognized.

In the nine months ended September 30, 2021, the Bank had generated and received SBA approval on 1,0002022:
251 PPP loans totaling $128.1$43.1 million and generated $5.6 million in related deferred PPP fees.  In the nine months ended September 30, 2021, 1,742 PPP loans totaling $279.9 million had been forgiven by the SBA and a total of $7.1 million in PPPwere forgiven.
Total net fees had been recognized by the Bank including fees recognized upon forgiveness and continuing amortization of fees from the 2020 and 2021 PPP originations.

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RESULTS OF OPERATIONS
Summary: Net income for the three months ended September 30, 2021 was $7.2 million, compared to $7.1 million for the same period in 2020.  Net income per share on a diluted basis for the three months ended September 30, 2021 was $0.21 compared to $0.21 for the same period in 2020.  Net income for the nine months ended September 30, 2021 was $22.8 million, compared to $21.2 million for the same period in 2020.  Net income per share on a diluted basis for the nine months ended September 30, 2021 was $0.67 compared to $0.62 for the same period in 2020.
The increase in earnings in both the three and nine months ended September 30, 2021 compared to the same periods in 2020 was due primarily to lower provision for loan losses more than offsetting the impact of lower levels of net interest income.  Net interest income decreased to $14.3 million in the three months ended September 30, 2021 compared to $14.7 million in the same period in 2020.  Net interest income decreased to $43.2 million in the nine months ended September 30, 2021 compared to $45.0 million in the nine months ended September 30, 2020.  These decreases in net interest income were primarily attributable to the decreases in volumes of interest-earning assets and, to a lesser extent, decreases in short-term interest rates instituted by the Federal Reserve in March 2020.
The provision for loan losses was a benefit of $550,000 for the three months ended September 30, 2021, compared to an expense of $500,000 for the same period in 2020.  The provision for loan losses was a benefit of $1.3 million for the nine months endedwere recognized.

As of September 30, 2021 compared to an expense of $2.2 million for the same period in 2020.  We were in a net loan recovery position for the three months ended September 30, 2021, with $276,000 in net loan recoveries, compared to $203,000 in net loan recoveries in the same period in 2020.  We were also in a net loan recovery position for the nine months ended September 30, 2021, with $424,000 in net loan recoveries compared to $2.8 million in net loan charge-offs in the same period in 2020.  The nine month period ended September 30, 2020 was impacted by a $4.1 million charge-off taken in June 2020 related to a single loan relationship with a movie theater business where the underlying assets were sold through bankruptcy proceedings.  The provision for loan losses in the 2020 periods was also impacted by increases to qualitative environmental factors to address increased risk of loss attributable to the COVID-19 pandemic.
Net Interest Income: Net interest income totaled $14.3 million for the three months ended September 30, 2021 compared to $14.7 million for the same period in 2020.  Net interest income decreased to $43.2 million in the nine months ended September 30, 2021 compared to $45.0 million in the nine months ended September 30, 2020.

Net interest income for the third quarter of 2021 decreased $378,000 compared to the same period in 2020.  Of this decrease, $2.5 million was from changes in the volume of average interest earning assets and interest bearing liabilities, partially offset by a $2.1 million increase from changes in rates earned or paid.  The largest changes occurred in interest income on commercial loans (excluding PPP loans) and in PPP loans which fluctuated significantly in the third quarter of 2021 compared to the same period in 2020.  The net change in interest income for commercial loans (excluding PPP loans) was $1.4 million with a decrease of $639,000 due to rate and a decrease of $786,000 due to portfolio contraction.  PPP loans contributed an additional $1.0 million in net interest income in the third quarter of 2021 primarily due to higher PPP fee recognition tied to loan principal forgiveness.  Additionally, residential mortgage loan interest income decreased by $565,000 in the third quarter of 2021 compared to the same period in 2020.  Of the $565,000 decrease in interest income on residential mortgage loans, $448,000 was due to a decrease in average balances resulting from a high volume of originations of refinanced loans which are sold versus retained in portfolio. Rate reductions in the deposit portfolio served to partially offset the net negative effects of the changes noted above in interest income.

Net interest income for the nine months ended September 30, 2021 decreased $1.8 million compared to the same period in 2020.  Of this decrease, $4.0 million was from changes in the volume of average interest earning assets and interest bearing liabilities, partially offset by a $2.2 million increase due to changes in rates earned or paid.  The largest changes occurred in interest income on commercial loans (excluding PPP loans) and in PPP loans which fluctuated significantly in the first nine months of 2021 compared to the same period in 2020.  The net change for commercial loans (excluding PPP loans) was a $6.3 million decrease with a decrease in interest income of $2.5 million due to rate and a decrease in interest income of $3.8 million due to portfolio contraction.  PPP loans contributed an additional $5.0 million in net interest income in the first nine months of 2021 due to slightly higher average balances and significantly higher levels of PPP fee recognition upon forgiveness.  Of the $1.7 million decrease in interest income on residential mortgage loans, $1.4 million was due to a decrease in average balances resulting from a high volume of originations of refinanced loans which are sold versus retained in portfolio and $326,000 was due to lower loan rates. Rate reductions in the deposit portfolio served to partially offset the net negative effects of the changes noted above in interest income.
As we are in an asset-sensitive position, reductions in market interest rates have a negative impact on margin as our interest earning assets reprice faster than its interest-bearing liabilities. Much of our asset-sensitivity is due to commercial and consumer loans that have variable interest rates.  For both loan types we established floor rates several years ago.  These floors provide protection to net interest income when short-term interest rates decline.

The cost of funds decreased to 0.13% in the third quarter of 2021 compared to 0.29% in the third quarter of 2020. For the first nine months of 2021, the cost of funds decreased to 0.16% compared to 0.44% for the same period in 2020.  Decreases in the rates paid on our interest-bearing checking, savings and money market accounts in response to the federal funds rate decreases over the past year caused the decrease in our cost of funds.

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The following table shows an analysis of net interest margin for the three month periods ended September 30, 2021 and 2020 (dollars in thousands):


 For the three months ended September 30, 

 2021  2020 

 
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
  
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
 
Assets                  
Taxable securities $200,981  $786   1.56% $179,887  $867   1.92%
Tax-exempt securities (1)  172,372   777   2.32   137,351   861   3.23 
Commercial loans (2)  873,248   8,055   3.61   955,695   9,480   3.88 
PPP loans (3)  133,413   3,104   9.10   346,073   2,067   2.34 
Residential mortgage loans  123,574   1,039   3.36   175,978   1,604   3.64 
Consumer loans  54,591   563   4.09   67,549   703   4.14 
Federal Home Loan Bank stock  11,558   44   1.51   11,558   100   3.41 
Federal funds sold and other short-term investments  1,234,420   474   0.15   541,981   140   0.10 
Total interest earning assets (1)  2,804,157   14,842   2.12   2,416,072   15,822   2.62 
Noninterest earning assets:                        
Cash and due from banks  39,725           35,737         
Other  104,782           102,389         
Total assets $2,948,664          $2,554,198         
Liabilities                        
Deposits:                        
Interest bearing demand $723,516  $49   0.03% $587,356  $78   0.05%
Savings and money market accounts  817,307   60   0.03   743,612   121   0.07 
Time deposits  99,312   100   0.40   128,551   422   1.31 
Borrowings:                        
Other borrowed funds  79,565   325   1.60   72,057   364   1.97 
Long-term debt  1,345   12   3.42   20,619   163   3.10 
Total interest bearing liabilities  1,721,045   546   0.13   1,552,195   1,148   0.29 
Noninterest bearing liabilities:                        
Noninterest bearing demand accounts  964,908           755,990         
Other noninterest bearing liabilities  12,717           14,311         
Shareholders' equity  249,994           231,702         
Total liabilities and shareholders' equity $2,948,664          $2,554,198         
Net interest income     $14,296          $14,674     
Net interest spread (1)          1.99%          2.33%
Net interest margin (1)          2.04%          2.43%
Ratio of average interest earning assets to average interest bearing liabilities  162.93%          155.66%        

(1)Yields are presented on a tax equivalent basis using an assumed tax rate of 21% at September 30, 2021 and 2020.
(2)Includes loan fees of $103,000 and $152,000 for the three months ended September 30, 2021 and 2020, respectively.  Includes average nonaccrual loans of approximately $426,000 and $196,000 for the three months ended September 30, 2021 and 2020, respectively.  Excludes PPP loans.
(3)Includes loan fees of $2.8 million and $1.2 million for the three months ended September 30, 2021 and 2020, respectively.

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The following table shows an analysis of net interest margin for the nine month periods ended September 30, 2021 and 2020 (dollars in thousands):
  For the nine months ended September 30, 
  2021  2020 
  
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
  
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
 
Assets                  
Taxable securities $195,867  $2,365   1.61% $184,809  $2,882   2.08%
Tax-exempt securities (1)  145,571   2,295   2.71   132,471   2,607   3.38 
Commercial loans (2)  906,493   25,590   3.72   1,035,247   31,882   4.06 
PPP loans (3)  206,941   8,690   5.54   203,875   3,682   2.38 
Residential mortgage loans  136,435   3,526   3.44   190,782   5,275   3.69 
Consumer loans  56,373   1,724   4.09   71,732   2,354   4.38 
Federal Home Loan Bank stock  11,558   162   1.84   11,558   339   3.86 
Federal funds sold and other short-term investments  1,012,179   948   0.12   346,900   802   0.30 
Total interest earning assets (1)  2,671,417   45,300   2.28   2,177,374   49,823   3.07 
Noninterest earning assets:                        
Cash and due from banks  35,084           30,572         
Other  102,849           96,605         
Total assets $2,809,350          $2,304,551         
Liabilities                        
Deposits:                        
Interest bearing demand $670,029  $122   0.02% $510,181  $356   0.09%
Savings and money market accounts  811,381   183   0.03   698,097   1,050   0.20 
Time deposits  103,271   428   0.55   141,762   1,712   1.62 
Borrowings:                        
Other borrowed funds  70,623   1,005   1.88   68,610   1,069   2.06 
Long-term debt  14,123   319   2.98   20,619   612   3.90 
Total interest bearing liabilities  1,669,427   2,057   0.16   1,439,269   4,799   0.44 
Noninterest bearing liabilities:                        
Noninterest bearing demand accounts  881,177           625,759         
Other noninterest bearing liabilities  13,535           13,327         
Shareholders' equity  245,211           226,196         
Total liabilities and shareholders' equity $2,809,350          $2,304,551         
Net interest income     $43,243          $45,024     
Net interest spread (1)          2.12%          2.63%
Net interest margin (1)          2.18%          2.77%
Ratio of average interest earning assets to average interest bearing liabilities  160.02%          151.28%        
(1)Yields are presented on a tax equivalent basis using an assumed tax rate of 21% at September 30, 2021 and 2020.
(2)Includes loan fees of $628,000 and $612,000 for the nine months ended September 30, 2021 and 2020, respectively. Includes average nonaccrual loans of approximately $472,000 and $2.8 million for the nine months ended September 30, 2021 and 2020, respectively. Excludes PPP loans.
(3)Includes loan fees of $7.1 million and $2.1 million for the nine months ended September 30, 2021 and 2020, respectively.

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The following table presents the dollar amount of changes in net interest income due to changes in volume and rate (dollars in thousands):

  
For the three months ended September 30,
2021 vs 2020
Increase (Decrease) Due to
  
For the nine months ended September 30,
2021 vs 2020
Increase (Decrease) Due to
 
  Volume  Rate  Total  Volume  Rate  Total 
                   
Interest income                  
Taxable securities $94  $(175) $(81) $164  $(681) $(517)
Tax-exempt securities  255   (339)  (84)  338   (650)  (312)
Commercial loans, excluding PPP loans  (786)  (639)  (1,425)  (3,767)  (2,525)  (6,292)
PPP loans  (1,868)  2,905   1,037   56   4,952   5,008 
Residential mortgage loans  (448)  (117)  (565)  (1,423)  (326)  (1,749)
Consumer loans  (134)  (6)  (140)  (484)  (146)  (630)
Federal Home Loan Bank stock  —   (56)  (56)  —   (177)  (177)
Federal funds sold and other short-term investments  240   94   334   828   (682)  146 
Total interest income  (2,647)  1,667   (980)  (4,288)  (235)  (4,523)
Interest expense                        
Interest bearing demand $15  $(44) $(29) $87  $(321)  (234)
Savings and money market accounts  11   (72)  (61)  147   (1,014)  (867)
Time deposits  (80)  (242)  (322)  (376)  (908)  (1,284)
Other borrowed funds  34   (73)  (39)  30   (94)  (64)
Long-term debt  (166)  15   (151)  (167)  (126)  (293)
Total interest expense  (186)  (416)  (602)  (279)  (2,463)  (2,742)
Net interest income $(2,461) $2,083  $(378) $(4,009) $2,228  $(1,781)

Provision for Loan Losses: The provision for loan losses for the three months ended September 30, 2021 was a benefit of $550,000 compared to an expense of $500,000 for the same period in 2020.  The provision for loan losses for the first nine months of 2021 was a benefit of $1.3 million compared to an expense of $2.2 million for the same period in 2020.  The provisions for loan losses for the 2020 periods were impacted by additional qualitative adjustments made to provide for estimated losses associated with the COVID-19 pandemic as well as a $4.1 million charge-off taken in June 2020 related to a single loan relationship with a movie theater business for which the underlying assets were sold through bankruptcy proceedings, some of which was specifically reserved for previously.  No other loans of this industry type remain in our portfolio.  This was partially offset by continued strong asset quality metrics and loan portfolio contraction.  When excluding PPP loans, which are 100% guaranteed by the SBA, total loans decreased by $9.6 million in the three months ended September 30, 2021.  This was a partial factor in determining the provision for loan losses in the third quarter of 2021.  Net loan recoveries were $276,000 in the three months ended September 30, 2021 compared to net loan recoveries of $203,000 in the same period in 2020.
Gross loan recoveries were $298,000 for the three months ended September 30, 2021 and $227,000 for the same period in 2020.  In the three months ended September 30, 2021, we had $22,000 in gross loan charge-offs, compared to $24,000 in the same period in 2020.  For the nine months ended September 30, 2021, we experienced gross loan recoveries of $526,000 compared to $1.4 million for the same period in 2020.  Gross charge-offs for the nine months ended September 30, 2021 were $102,000 compared to $4.2 million for the same period in 2020.
The amounts of loan loss provision in both the most recent quarter and comparable prior year period were the result of establishing our allowance for loan losses at levels believed necessary based upon our methodology for determining the adequacy of the allowance.  More information about our allowance for loan losses and our methodology for establishing its level may be found under the heading "Allowance for Loan Losses" below.
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Noninterest Income: Noninterest income for the three and nine month periods ended September 30, 2021 was $5.6 million and $18.3 million compared to $6.1 million and $16.9 million for the same periods in 2020, respectively.   The components of noninterest income are shown in the table below (in thousands):

  
Three Months
Ended
September 30,
2021
  
Three Months
Ended
September 30,
2020
  
Nine Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2020
 
Service charges and fees on deposit accounts $1,183  $987  $3,240  $2,957 
Net gains on mortgage loans  851   1,546   4,177   4,045 
Trust fees  1,079   921   3,217   2,801 
ATM and debit card fees  1,676   1,542   4,844   4,199 
Bank owned life insurance (“BOLI”) income  260   215   787   688 
Investment services fees  330   328   1,146   980 
Other income  263   553   938   1,234 
Total noninterest income $5,642  $6,092  $18,349  $16,904 

Net gains on mortgage loans were down $695,000 in the three months ended September 30, 2021 and were up $132,000 in the nine months ended September 30, 2021 compared to the same periods in 2020 as a result of changes in the volume of loans originated for sale.  In the past two years volumes have been high due to a lower interest rate environment, spurring more refinancing of fixed rate loans which we sell into the secondary market.  Mortgage loans originated for sale in the three months ended September 30, 2021 were $21.3 million, compared to $40.8 million in the same period in 2020.  For the first nine months of 2021, mortgages originated for sale were $107.8 million, compared to $120.2 million for the same period in 2020.
Trust fees were up $158,000 in the three months ended September 30, 2021 and were up $416,000 in the nine months ended September 30, 2021 compared to the three and nine months ended September 30, 2020, respectively. The increase for the three and nine months ended September 30, 2021 was largely due to the 2020 periods reflecting lower market valuations of trust assets resulting from the COVID-19 shutdown of the economy.  ATM and debit card fees were also up in the three and nine months ended September 30, 2021 as compared to the three and nine months ended September 30, 2020, respectively, due to reduced volume of usage by our customers during the COVID-19 shutdown of the economy in the 2020 periods.  These volumes and resulting income have returned to more normal levels in the 2021 periods.  Service charges on deposit accounts increased in the three and nine months ended September 30, 2021 as compared to the same periods in 2020 as customers returned to more normal behaviors in 2021 after having curtailed spending in 2020 due to uncertainty related to the COVID-19 pandemic.  Additionally, customers’ account balances in 2020 were bolstered by economic impact payments, thereby resulting in fewer overdrafts.
Noninterest Expense: Noninterest expense increased by $17,000 to $11.6 million for the three month period ended September 30, 2021 as compared to the same period in 2020.  Noninterest expense increased by $994,000 to $34.8 million for the nine months ended September 30, 2021 compared to $33.8 million for the same period in 2020.  The components of noninterest expense are shown in the table below (in thousands):

  
Three Months
Ended
September 30,
2021
  
Three Months
Ended
September 30,
2020
  
Nine Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2020
 
Salaries and benefits $6,278  $6,480  $19,192  $18,937 
Occupancy of premises  992   1,026   3,023   2,984 
Furniture and equipment  1,014   967   2,929   2,704 
Legal and professional  272   260   768   798 
Marketing and promotion  175   239   525   716 
Data processing  839   761   2,602   2,309 
FDIC assessment  204   131   532   207 
Interchange and other card expense  391   367   1,137   1,041 
Bond and D&O insurance  112   104   334   313 
Outside services  510   491   1,434   1,322 
Other noninterest expense  763   707   2,277   2,428 
Total noninterest expense $11,550  $11,533  $34,753  $33,759 

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Most categories of noninterest expense were relatively unchanged compared to the three months ended September 30, 2020 due to our ongoing efforts to manage expenses and scale our operations. Our largest component of noninterest expense, salaries and benefits, decreased by $202,000 in the three months ended September 30, 2021 from same period in 2020. This decrease is primarily due to a decrease in variable-based compensation due to lower mortgage origination volume and a reduction in 401k matching contributions. Salaries and benefits increased by $255,000 for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020 due primarily to a higher level of stock-based compensation and variable-based compensation tied to brokerage services. The table below identifies the primary components of salaries and benefits (in thousands):
  
Three Months
Ended
September 30,
2021
  
Three Months
Ended
September 30,
2020
  
Nine Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2020
 
Salaries and other compensation $
5,708  $
5,678  $
17,174  $
16,919 
Salary deferral from commercial loan originations  (204)  (229)  (825)  (899)
Bonus accrual  289   296   688   619 
Mortgage production - variable comp  187   316   903   834 
401k matching contributions  98   194   327   464 
Medical insurance costs  200   225   925   1,000 
Total salaries and benefits $6,278  $6,480  $19,192  $18,937 
Occupancy expenses were down $34,000 in the three months ended September 30, 2021 and were up $39,000 in the nine months ended September 30, 2021 compared to the same periods in 2020 due to fluctuations in maintenance costs incurred.  Furniture and equipment expenses were up $47,000 in the three months ended September 30, 2021 and were up $225,000 in the nine months ended September 30, 2021 compared to the same periods in 2020 due to costs associated with equipment and service contracts primarily to improve information security.
Our FDIC assessment costs increased by $73,000 in the three months ended September 30, 2021 compared to the same period in 2020 due to the significant increase in deposit balances between these periods.  In January 2019, the FDIC notified us that the Bank would receive an assessment credit of approximately $438,000 to offset future assessment as the FDIC Deposit Insurance Fund had exceeded its target ratio of 1.35%.  Assessment credits totaling $172,000 were applied in the nine months ended September 30, 2020, contributing to the increase in FDIC assessment costs of $325,000 in the first nine months of 2021 compared to the same period in 2020.
Data processing costs were up $78,000 and $293,000 in the three and nine month periods ended September 30, 2021, respectively, compared to the same periods in 2020 due to higher usage of electronic banking services and debit cards by our customers.
Outside services were up $19,000 and $112,000 in the three and nine months ended September 30, 2021, respectively, compared to the same periods in 2020 due to certain increased vendor costs including a periodic business process review of our customer onboarding process.
Federal Income Tax Expense: We recorded $1.7 million and $5.3 million in federal income tax expense for the three and nine month periods ended September 30, 2021 compared to $1.6 million and $4.8 million for the same periods in 2020.  Our effective tax rates for the three and nine month periods ended September 30, 2021 were 19.42% and 18.98%, respectively, compared to 18.47% and 18.48% for the same periods in 2020.
FINANCIAL CONDITION
Total assets were $2.90 billion at September 30, 2021, an increase of $259.5 million from December 31, 2020. This change reflected increases of $486.2 million in cash and cash equivalents, $4.6 million in debt securities available for sale, $58.1 million in debt securities held to maturity, and $10.3 in bank-owned life insurance, partially offset by a decrease of $292.7 million in our loan portfolio including PPP loans. Total deposits increased by $254.6 million at September 30, 2021 compared to December 31, 2020.  FHLB advances increased by $15 million from December 31, 2020 to September 30, 2021, while long term debt decreased by $20.6 million with the redemption of the remaining trust preferred securities on July 7, 2021.
Cash and Cash Equivalents: Our cash and cash equivalents, which include federal funds sold and short-term investments, were $1.27 billion at September 30, 2021 compared to $783.7 million at December 31, 2020.  The increase in these balances primarily related to an increase in our total deposits combined with a decrease in our loan portfolio.
Securities: Debt securities available for sale were $241.5 million at September 30, 2021 compared to $236.8 million at December 31, 2020. The balance at September 30, 2021 primarily consisted of U.S. agency securities, agency mortgage backed securities and various municipal investments. Our held to maturity portfolio was $137.6 million at September 30, 2021 compared to $79.5 million at December 31, 2020.  Our held to maturity portfolio is comprised of state, municipal and privately placed commercial bonds.
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Portfolio Loans and Asset Quality: Total portfolio loans decreased by $292.7 million in the first nine months of 2021 and were $1.14 billion at September 30, 2021 compared to $1.43 billion at December 31, 2020. During the first nine months of 2021, our commercial portfolio decreased by $256.0 million.  We originated a total of 1,000 PPP loans totaling $128.1 million in the nine months ended September 30, 2021 and received forgiveness proceeds in the amount of $279.9 million from the SBA in the same time period.  As a result, PPP loans decreased by $151.5 million during the first nine months of 2021.  Excluding the PPP loans, our commercial loans decreased by $104.5 million in the first nine months of 2021 as customers substituted PPP loans for drawing on their lines of credit.  Our consumer portfolio decreased by $6.3 million and our residential mortgage portfolio decreased by $30.4 million in the first nine months of 2021.
Mortgage loans originated for portfolio are typically adjustable rate loans as well as fixed rate loans that conform to secondary market requirements and have a term of fifteen years or less.  Mortgage loans originated for portfolio in the first nine months of 2021 increased $1.1 million compared to the same period in 2020, from $29.3 million in the first nine months of 2020 to $30.4 million in the same period in 2021.  However, this increase in volume was not enough to offset paydowns on mortgage portfolio loans.
The volume of residential mortgage loans originated for sale in the first nine months of 2021 decreased $12.3 million compared to the same period in 2020. Residential mortgage loans originated for sale were $107.8 million in the first nine months of 2021 compared to $120.2 million in the first nine months of 2020.
The following table shows our loan origination activity for loans to be held in portfolio during the first nine months of 2021 and 2020, broken out by loan type and also shows average originated loan size (dollars in thousands):

  Nine months ended September 30, 2021  Nine months ended September 30, 2020 
  
Portfolio
Originations
  
Percent of
Total
Originations
  
Average
Loan Size
  
Portfolio
Originations
  
Percent of
Total
Originations
  
Average
Loan Size
 
Commercial real estate:                  
Residential developed $6,369   1.4% $
490  $3,035   0.5% $
217 
Unsecured to residential developers  —   —   —   170   —   170 
Vacant and unimproved  8,345   1.9   642   23,943   3.7   2,394 
Commercial development  —   —   —   —   —   — 
Residential improved  75,223   16.9   607   45,463   7.0   425 
Commercial improved  54,609   12.2   1,187   45,493   7.0   1,379 
Manufacturing and industrial  24,962   5.6   960   12,098   1.9   432 
Total commercial real estate  169,508   38.0   764   130,202   20.1   675 
Commercial and industrial, excluding PPP  77,019   17.3   770   112,312   17.3   913 
PPP loans  128,052   28.7   127   346,276   53.4   199 
Total commercial and commercial real estate  374,579   84.0   282   588,790   90.9   287 
Consumer                        
Residential mortgage  30,415   6.8   295   29,327   4.5   333 
Unsecured  —   —   —   21   —   11 
Home equity  39,884   8.9   126   28,727   4.4   112 
Other secured  1,452   0.3   25   1,003   0.2   15 
Total consumer  71,751   16.0   150   59,078   9.1   142 
Total loans $446,330   100.0% $
247  $647,868   100.0% $
262 

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The following table shows a breakout of our commercial loan activity during the first nine months of 2021 and 2020 (dollars in thousands):

  
Nine Months
Ended
September 30,
2021
  
Nine Months
Ended
September 30,
2020
 
Commercial loans originated $374,579  $588,790 
Repayments of commercial loans  (543,287)  (288,049)
Change in undistributed - available credit  (87,282)  (86,930)
Net increase (decrease) in total commercial loans $(255,990) $213,811 

Overall, the commercial loan portfolio decreased $256.0 million in the first nine months of 2021.  Our commercial and industrial portfolio decreased by $231.0 million while our commercial real estate loans decreased by $25.0 million.  As discussed above, included in the commercial production for the first nine months of 2021 is $128.1 million in PPP loans.  Our overall production of commercial loans decreased by $214.2 million from $588.8 million in the first nine months of 2020 to $374.6 million in the same period of 2021 mostly due to the significantly lower production of PPP loans (down $218.2 million).  Beyond the effect of the2022, just one PPP loan production, our commercialtotaling $37,000 in principal remained outstanding and industrial portfolio was impacted by fluctuations in floor plan loan lines to vehicle dealers.  The decline in borrowings in this sector was primarily the resulttotal net fees of our dealers selling through their inventory but not being able to buy new inventory due to supply shortages from the COVID-19 shutdown of the economy.$5,000 remained unrecognized.
 
Commercial and commercial real estate loans remained our largest loan segment and accounted for approximately 84.6% and 85.2% of the total loan portfolio at September 30, 2021 and December 31, 2020, respectively. Residential mortgage and consumer loans comprised approximately 15.4% and 14.8% of total loans at September 30, 2021 and December 31, 2020, respectively.
A further breakdown of the composition of the loan portfolio is shown in the table below (in thousands):

  September 30, 2021  December 31, 2020 
  Balance  
Percent of
Total Loans
  Balance  
Percent of
Total Loans
 
Commercial real estate: (1)            
Residential developed $6,184   0.5% $8,549   0.6%
Unsecured to residential developers  19   —   —   — 
Vacant and unimproved  36,616   3.2   47,122   3.3 
Commercial development  403   —   857   — 
Residential improved  100,608   8.9   114,392   8.0 
Commercial improved  267,910   23.6   266,006   18.6 
Manufacturing and industrial  115,470   10.2   115,247   8.1 
Total commercial real estate  527,210   46.4   552,173   38.6 
Commercial and industrial, excluding PPP  356,812   31.4   436,331   30.6 
PPP loans  77,571   6.8   229,079   16.0 
Total commercial and commercial real estate  961,593   84.6   1,217,583   85.2 
Consumer                
Residential mortgage  119,106   10.5   149,556   10.5 
Unsecured  103   —   161   — 
Home equity  52,127   4.6   57,975   4.0 
Other secured  3,684   0.3   4,056   0.3 
Total consumer  175,020   15.4   211,748   14.8 
Total loans $1,136,613   100.0% $1,429,331   100.0%

(1)Includes both owner occupied and non-owner occupied commercial real estate.
Commercial real estate loans accounted for 46.4% and 38.6% of the total loan portfolio at September 30, 2021 and December 31, 2020, respectively, and consisted primarily of loans to business owners and developers of owner and non-owner occupied commercial properties and loans to developers of single and multi-family residential properties. In the table above, we show our commercial real estate portfolio by loans secured by residential and commercial real estate, and by stage of development. Improved loans are generally secured by properties that are under construction or completed and placed in use. Development loans are secured by properties that are in the process of development or fully developed. Vacant and unimproved loans are secured by raw land for which development has not yet begun and agricultural land.
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Our consumer residential mortgage loan portfolio, which also includes residential construction loans made to individual homeowners, comprised 10.5%11.4% of portfolio loans at September 30, 20212022 and 10.5%10.7% at December 31, 2020.2021.  We expect to continue to retain in our loan portfolio certain types of residential mortgage loans (primarily high quality, low loan-to-value adjustable rate loans) in an effort to continue to diversify our credit risk and deploy our excess liquidity.
 
Our portfolio of other consumer loans includes loans secured by personal property and home equity fixed term and line of credit loans. This portfolio decreasedincreased by $6.3$4.4 million to $55.9$59.2 million at September 30, 20212022 from $62.2$54.8 million at December 31, 2020, due primarily to a decrease in home equity loans.2021.  These other consumer loans comprised 4.9%5.2% of our portfolio loans at September 30, 20212022 and 4.3%4.9% at December 31, 2020.2021.
 
Our loan portfolio is reviewed regularly by our senior management, our loan officers, and an internal loan review team that is independent of our loan originators and credit administration. An administrative loan committee consisting of senior management and seasoned lending and collections personnel meets quarterly to manage our internal watch list and proactively manage high risk loans.
 
When reasonable doubt exists concerning collectability of interest or principal of one of our loans, the loan is placed in nonaccrual status. Any interest previously accrued but not collected is reversed and charged against current earnings.
 
Nonperforming assets are comprised of nonperforming loans, foreclosed assets and repossessed assets. At September 30, 2021,2022, nonperforming assets totaled $2.8$2.4 million, compared to $3.1unchanged from $2.4 million at December 31, 2020.2021. There were no additions to other real estate owned in the first nine months of 20212022 or in the first nine months of 2020.2021.  At September 30, 2021,2022, there were no loans in foreclosure, so we expect there to be few, if any, additions to other real estate owned in the remainder of 2021.2022.  Proceeds from sales of foreclosed properties were $47,000 in the first nine months of 2022, resulting in net realized gain on sales of $47,000.  Proceeds from sales of foreclosed properties were $170,000 in the first nine months of 2021, resulting in net realized loss on sales of $20,000.  Proceeds from sales of foreclosed properties were $92,000 in the first nine months of 2020 with no realized gains or losses.
 
Nonperforming loans include loans on nonaccrual status and loans delinquent more than 90 days but still accruing.  Nonperforming loans at September 30, 2021 consisted of $332,000 of commercial real estate loans and $88,000 of consumer and residential mortgage loans.  As of September 30, 2021,2022, nonperforming loans totaled $420,000,$85,000, or 0.04%0.01% of total portfolio loans, compared to $533,000,$92,000, or 0.04%0.01% of total portfolio loans, at December 31, 2020.2021.  The balance at September 30, 2022 consisted of one residential mortgage loan.

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Foreclosed and repossessed assets include assets acquired in settlement of loans. Foreclosed assets totaled $2.3 million at September 30, 20212022 and $2.5$2.3 million at December 31, 2020.2021. The entire balance at September 30, 20212022 was comprised of one commercial real estate property. All properties acquired through or in lieu of foreclosure are initially transferred at their fair value less estimated costs to sell and then evaluated monthly for impairment after transfer using a lower of cost or market approach. Updated property valuations are obtained at least annually on all foreclosed assets.
 
The following table shows the composition and amount of our nonperforming assets (dollars in thousands):

 
September 30,
2021
  
December 31,
2020
  
September 30,
2022
  
December 31,
2021
 
Nonaccrual loans $420  $533  $85  $91 
Loans 90 days or more delinquent and still accruing  —   —   —   1 
Total nonperforming loans (NPLs) 420  533  85  92 
Foreclosed assets 2,343  2,537  2,343  2,343 
Repossessed assets  —   —   —   — 
Total nonperforming assets (NPAs) $2,763  $3,070  $2,428  $2,435 
NPLs to total loans 0.04% 0.04% 0.01% 0.01%
NPAs to total assets 0.10% 0.12% 0.09% 0.08%

The following table shows the composition and amount of our troubled debt restructurings (TDRs) at September 30, 20212022 and December 31, 20202021 (dollars in thousands):

 September 30, 2021  December 31, 2020  September 30, 2022  December 31, 2021 
 Commercial  Consumer  Total  Commercial  Consumer  Total  Commercial  Consumer  Total  Commercial  Consumer  Total 
Performing TDRs $1,802  $3,296  $5,098  $4,959  $4,049  $9,008  $2,391  $2,942  $5,333  $4,497  $3,024  $7,521 
Nonperforming TDRs (1)  332   —   332   437   —   437   —   —   —   5   —   5 
Total TDRs $2,134  $3,296  $5,430  $5,396  $4,049  $9,445  $2,391  $2,942  $5,333  $4,502  $3,024  $7,526 

(1)Included in nonperforming asset table above

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We had a total of $5.4$5.3 million and $9.4$7.5 million of loans whose terms have been modified inclassified as TDRs as of September 30, 20212022 and December 31, 2020,2021, respectively.  These loans may have involved the restructuring of terms to allow customers to mitigate the risk of foreclosure by meeting a lower loan payment requirement based upon their current cash flow.  These may also include loans that renewed at existing contractual rates, but below market rates for comparable credit.  For each restructuring, a comprehensive credit underwriting analysis of the borrower’s financial condition and prospects of repayment under the revised terms is performed to assess whether the structure can be successful and whether cash flows will be sufficient to support the restructured debt.  An analysis is also performed to determine whether the restructured loan should be on accrual status.  Generally, if the loan is on accrual at the time of restructure, it will remain on accrual after the restructuring.  In some cases, a nonaccrual loan may be placed on accrual at restructuring if the loan’s actual payment history demonstrates it would have cash flowed under the restructured terms.  After six consecutive payments under the restructured terms, a nonaccrual restructured loan is reviewed for possible upgrade to accruing status.  In situations where there is a subsequent modification or renewal and the loan is brought to market terms, including a contractual interest rate not less than a market interest rate for new debt with similar credit risk characteristics, the TDR and impaired designations may be removed.  Total TDRs decreased by $4.0$2.2 million from December 31, 20202021 to September 30, 20212022 due primarily to payoffs and paydownsseasonal repayments on existing TDRs.one commercial TDR operating line.  There were 5941 loans identifiedclassified as TDRs at September 30, 20212022 compared to 7654 loans at December 31, 2020.2021.
 
As with other impaired loans, an allowance for loan loss is estimated for each TDR based on the most likely source of repayment for each loan.  For impaired commercial real estate loans that are collateral dependent, the allowance is computed based on the fair value of the underlying collateral, less estimated costs to sell.  For impaired commercial loans where repayment is expected from cash flows from business operations, the allowance is computed based on a discounted cash flow computation.  Certain groups of TDRs, such as residential mortgages, have common characteristics and for them the allowance is computed based on a discounted cash flow computation on the change in weighted rate for the pool.  The allowance allocations for commercial TDRs where we have reduced the contractual interest rate are computed by measuring cash flows using the new payment terms discounted at the original contractual rate.

On March 22, 2020, the federal banking agencies issued an “Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus”.  This guidance encourages financial institutions to work prudently with borrowers that may be unable to meet their contractual obligations because of the effects of COVID-19.  The guidance goes on to explain that in consultation with the FASB staff that the federal banking agencies conclude that short-term modifications (e.g. six months) made on a good faith basis to borrowers who were current as of the implementation date of a relief program are not Troubled Debt Restructurings (“TDRs”).  The Coronavirus Aid, Relief and Economic Security (“CARES”) Act was passed by Congress on March 27, 2020.  Section 4013 of the CARES Act also addressed COVID-19 related modifications and specified that COVID-19 related modifications on loans that were current as of December 31, 2019 are not TDRs.  The Economic Aid Act passed by Congress on December 27, 2020 extended the date for such modifications to not be treated as TDRs to the earlier of 60 days after date on which the national emergency declared as a result of COVID-19 is terminated or January 1, 2022.  Through September 30, 2021, the Bank had applied this guidance and modified 726 individual loans with aggregate principal balances totaling $337.2 million.  The majority of these modifications involved three-month extensions. By September 30, 2021, all of these modifications had expired and the loans returned to their contractual payment terms.

Allowance for loan losses: The allowance for loan losses at September 30, 20212022 was $16.5$14.8 million, a decrease of $876,000$1.1 million from December 31, 2020.2021.  The allowance for loan losses represented 1.45%1.30% of total portfolio loans at September 30, 20212022 and 1.22%1.43% at December 31, 2020.2021.  The ratios at September 30, 20212022 and December 31, 20202021 are impacted by $77.6 million$32,000 and $229.1$41.9 million of remaining PPP loans, respectively, which are fully guaranteed and receive no allowance allocation.  The ratios excluding these loans were 1.56%1.30% and 1.45%1.49% at September 30, 20212022 and December 31, 2020,2021, respectively.  The allowance for loan losses to nonperforming loan coverage ratio increased from 3266.0%17270.7% at December 31, 20202021 to 3936.2%17436.5% at September 30, 2021.2022.

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The table below shows the changes in certain credit metrics over the past five quarters (dollars in thousands):

 
Quarter Ended
September 30,
2021
  
Quarter Ended
June 30,
2021
  
Quarter Ended
March 31,
2021
  
Quarter Ended
December 31,
2020
  
Quarter Ended
September 30,
2020
  
Quarter Ended
September 30,
2022
  
Quarter Ended
June 30,
2022
  
Quarter Ended
March 31,
2022
  
Quarter Ended
December 31,
2021
  
Quarter Ended
September 30,
2021
 
Nonperforming loans $
420  $
433  $
525  $
533  $
195  $85  $90  $90  $92  $420 
Other real estate owned and repo assets 2,343  2,343  2,371  2,537  2,624  2,343  2,343  2,343  2,343  2,343 
Total nonperforming assets 2,763  2,776  2,896  3,070  2,819  2,428  2,433  2,433  2,435  2,763 
Net charge-offs (recoveries) (276) (104) (44) (50) (203) (190) (15) (227) (107) (276)
Total delinquencies 437  126  217  581  524  84  197  171  129  437 

At September 30, 2021,2022, we had net loan recoveries in twenty-fivetwenty-nine of the past twenty-seventhirty-one quarters.  Our total delinquencies were $437,000$84,000 at September 30, 20212022 and $581,000$129,000 at December 31, 2020.2021.  Our delinquency percentage at September 30, 20212022 was 0.04%0.01%.
 
These factors all impact our necessary level of allowance for loan losses and our provision for loan losses. The allowance for loan losses decreased $876,000$1.1 million in the first nine months of 2021.2022.  We recorded a provision for loan lossesloss benefit of $1.3$1.5 million for the nine months ended September 30, 20212022 compared to $2.2a benefit of  $1.3 million in provision expense for the same period of 2020.2021.  Net loan recoveries were $424,000$432,000 for the nine months ended September 30, 2021,2022, compared to net loan charge-offsrecoveries of $2.8 million$424,000 for the same period in 2020.2021. The ratio of net charge-offs (recoveries) to average loans was -0.04%-0.05% on an annualized basis for the first nine months of 20212022 and 0.25%-0.04% for the first nine months of 2020.2021.
 
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Despite the large charge-off taken in the second quarter of 2020,While we are encouraged by the reduced levelhave experienced low levels of gross charge-offs over recent quarters. We do, however,quarters, we recognize that future charge-offs and resulting provisions for loan losses are expected to be impacted by the timing and extent of changes in the overall economy and the real estate markets.
 
Our allowance for loan losses is maintained at a level believed appropriate based upon our assessment of the probable estimated losses inherent in the loan portfolio. Our methodology for measuring the appropriate level of allowance and related provision for loan losses relies on several key elements, which include specific allowances for loans considered impaired, general allowance for commercial loans not considered impaired based upon applying our loan rating system, and general allocations based on historical trends for homogeneous loan groups with similar risk characteristics.
 
Overall, impaired loans declineddecreased by $5.2$2.2 million to $5.4$5.3 million at September 30, 20212022 compared to $10.6$7.5 million at December 31, 2020.2021.  The specific allowance for impaired loans decreased $636,000by $271,000 to $574,000$294,000 at September 30, 2021,2022, compared to $1.2 million$565,000 at December 31, 2020.2021.  The specific allowance for impaired loans represented 10.6%5.5% of total impaired loans at September 30, 20212022 and 11.4%7.5% at December 31, 2020.2021.
 
The general allowance allocated to commercial loans that were not considered to be impaired was based upon the internal risk grade of such loans.  We use a loan rating method based upon an eight point system.  Loans are stratified between real estate secured and non-real estate secured.  The real estate secured portfolio is further stratified by the type of real estate.  Each stratified portfolio is assigned a loss allocation factor.  A higher numerical grade assigned to a loan category generally results in a greater allocation percentage.  Changes in risk grade of loans affect the amount of the allowance allocation.
 
The determination of our loss factors is based upon our actual loss history by loan grade and adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the analysis date.  We use a rolling 18 month actual net charge-off history as the base for our computation.  Over the past few years, the 18 month period computations have reflected sizeable decreases in net charge-off experience.  We addressed this volatility in the qualitative factor considerations applied in our allowance for loan losses computation. We also considered the extended period of strong asset quality in assessing the overall qualitative component.
 
We also have considered the effect of COVID-19 on our loan borrowers and our local economy.  While significant stimulusWith the widespread vaccination efforts, coupled with reduction in infection rates, we determined that adjustments to certain qualitative factors were appropriate in the first nine months of 2022.  We also considered the economic conditions, including changes in unemployment and mitigation efforts were expectedactions taken by the Federal Reserve in response to softenemployment and inflation.  As a result, we reduced the impact, we believed a downgrade to our economic qualitative factor was appropriate and we added 7by 3 basis points to this qualitative factor at March 31, 2020. Additional allocations were provided in the second, third and fourth quarters of 2020.  In the first quarter of 2021,2022.  No additional changes were made for this factor was decreased by 2 basis points in recognition of improved economic conditions but additional allocations were made to other factors for a net increase of 8 basis points in the quarter.second quarter of 2022 as the continued high inflation and related concerns offset the positive impact of an improving labor market.  In the second quarter 2021, we added 20 basis points to our consumer loan portfolio qualitative factors to address the risk that economic impactgovernment stimulus payments may be masking consumer delinquency and default.  We removed this 20 basis point allocation in the first quarter of 2022 as we did not experience losses or increased delinquency in these portfolios.  We also reduced the qualitative factor for changes in lending personnel by 4 basis points in the first quarter of 2022.  Slightly offsetting this was the addition of 2 basis points for our qualitative factor related to the effect of rising interest rates in the first quarter of 2022 and another 3 basis points added in the second quarter of 2022.  One additional change to the allowance calculation in the first quarter of 2022 was the removal of a loan pool we had maintained for loans receiving three modifications during the pandemic.  These loans have all returned to contractual payment terms over an extended period of time and have returned to their normal loan pools.  In the third quarter of 2022, we reduced the qualitative factor for credit quality trends by 2 basis points, decreased the factor related to loan review quality by 1 basis point, decreased the factor related to changes in lending personnel by 1 basis point, reduced the factor for external conditions by 2 basis points and increased the factor for effects of rising interest rates by 2 basis points.  The net effect of these changes was a 4 basis point reduction in qualitative factors in the third quarter of 2021.2022.

Certain industry sectors have been more negatively impacted by the economic effects of COVID-19 than others such as hospitality, restaurants and sporting events. 
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We believe our commercial portfolio is adequately diversified, with our largest commercial concentrations in Real Estate, Rental and Leasing (28.6%(30%), followed by Manufacturing (15.0%(14%) and Retail Trade (8.1%(10%).

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The table below breaks down our commercial loan portfolio by industry type at September 30, 20212022 and identifies the percentage of loans in each type that have a pass rating within our grading system (4 or better) and criticized rating (5 or worse) (dollars in thousands):

 September 30, 2021  September 30, 2022 
 Excluding PPP  PPP Loans  Total  
Percent of
Total Loans
  
Percent Grade
4 or Better
  
Percent Grade
5 or Worse
  Excluding PPP  PPP Loans  Total  
Percent of
Total Loans
  
Percent Grade 4
or Better
  
Percent Grade 5
or Worse
 
Industry:                                    
Agricultural Products $41,605  $394  $41,999   4.37%  98.71%  1.29% $33,529  $—  $33,529  3.53% 95.60% 4.40%
Mining and Oil Extraction  947   63   1,010   0.11%  100.00%  0.00% 1,288  —  1,288  0.14% 95.73% 4.27%
Construction  68,309   8,803   77,112   8.02%  98.60%  1.40% 81,577  —  81,577  8.59% 97.38% 2.62%
Manufacturing  128,466   16,682   145,148   15.09%  97.51%  2.49% 134,218  —  134,218  14.14% 94.92% 5.08%
Wholesale Trade  61,267   704   61,971   6.44%  100.00%  0.00% 69,642  —  69,642  7.34% 100.00% 0.00%
Retail Trade  75,009   2,744   77,753   8.09%  99.89%  0.11% 95,196  —  95,196  10.03% 99.93% 0.07%
Transportation and Warehousing  43,367   3,998   47,365   4.93%  98.11%  1.89% 60,959  —  60,959  6.42% 98.70% 1.30%
Information  682   323   1,005   0.10%  37.21%  62.79% 557  —  557  0.06% 6.28% 93.72%
Finance and Insurance  32,592   187   32,779   3.41%  100.00%  0.00% 46,324  —  46,324  4.88% 100.00% 0.00%
Real Estate and Rental and Leasing  274,304   900   275,204   28.62%  99.77%  0.23% 280,415  —  280,415  29.54% 99.93% 0.07%
Professional, Scientific and Technical Services  7,042   3,241   10,283   1.07%  97.77%  2.23% 3,768  —  3,768  0.40% 94.56% 5.44%
Management of Companies and Enterprises  —   —   —   0.00%  0.00%  0.00% 6,519  —  6,519  0.69% 100.00% 0.00%
Administrative and Support Services  17,265   10,187   27,452   2.85%  99.62%  0.38% 20,687  —  20,687  2.18% 99.55% 0.45%
Education Services  2,645   1,882   4,527   0.47%  98.08%  1.92% 4,461  —  4,461  0.47% 98.30% 1.70%
Health Care and Social Assistance  50,709   16,366   67,075   6.98%  100.00%  0.00% 33,728  —  33,728  3.55% 100.00% 0.00%
Arts, Entertainment and Recreation  7,720   473   8,193   0.85%  96.01%  3.99% 4,188  —  4,188  0.44% 92.57% 7.43%
Accommodations and Food Services  40,830   6,326   47,156   4.90%  86.85%  13.15% 39,882  32  39,914  4.20% 82.67% 17.33%
Other Services  31,265   4,296   35,561   3.70%  99.47%  0.53%  32,320   —   32,320   3.40% 100.00% 0.00%
Total commercial loans $884,024  $77,569  $961,593   100.00%  98.48%  1.52% $949,258  $32  $949,290   100.00% 97.93% 2.07%
 
Considering the change in our qualitative factors and our commercial loan portfolio balances, the general allowance allocated to commercial loans was $13.2$12.3 million at September 30, 20212022 and $13.8$12.9 million at December 31, 2020.2021.  The qualitative component of our allowance allocated to commercial loans was $13.3$12.3 million at September 30, 2021,2022, down $399,000$624,000 from $13.7$12.9 million at December 31, 2020.2021.
 
Groups of homogeneous loans, such as residential real estate and open- and closed-end consumer loans, receive allowance allocations based on loan type.  A rolling 12 month (four quarter) historical loss experience period was applied to residential mortgage and consumer loan portfolios.  As with commercial loans that are not considered impaired, the determination of the allowance allocation percentage is based principally on our historical loss experience.  These allocations are adjusted for consideration of general economic and business conditions, credit quality and delinquency trends, collateral values, and recent loss experience for these similar pools of loans.  The homogeneous loan allowance was $2.5$2.1 million at September 30, 20212022 and $2.4 million at December 31, 2020.2021.
 
The allowance allocations are not intended to imply limitations on usage of the allowance for loan losses.  The entire allowance for loan losses is available for any loan losses without regard to loan type.
 
Bank-Owned Life Insurance:  Bank-owned life insurance increased $10.3 million$725,000 from December 31, 20202021 to September 30, 20212022 due to an additional $10.0 million in policies acquired in the second quarter of 2021 and earnings on the underlying policies.
 
Premises and Equipment:   Premises and equipment totaled $42.3$40.7 million at September 30, 2021,2022, down $911,000$1.1 million from $43.3$41.8 million at December 31, 2020.2021.
 
Deposits and Other Borrowings: Total deposits increased $254.6decreased $21.8 million to $2.55$2.56 billion at September 30, 2021,2022, as compared to $2.30$2.58 billion at December 31, 2020.2021.  Non-interest bearing checking account balances increased $125.0decreased $30.4 million during the first nine months of 2021.2022.  Interest bearing demand account balances increased $63.3decreased $4.8 million and savings and money market account balances increased $75.8$25.7 million in the first nine months of 2021 as2022.  The overall decrease in deposits so far in 2022 has related to our business and municipal and business customers have heldbeginning to withdraw the higher balances they have retained during the COVID-19 pandemic.  Certificates of deposits decreased by $9.6$12.8 million in the first nine months of 20212022 reflecting the continued low market interest rates.rates for time deposits.  We believe our success in maintaining the balances of personal and business checking and savings accounts was primarily attributable to our focus on quality customer service, the desire of customers to deal with a local bank, the convenience of our branch network and the breadth and depth of our sophisticated product line.

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Noninterest bearing demand accounts comprised 36%33% of total deposits at September 30, 20212022 and 35%34% of total deposits at December 31, 2020.2021.  These balances typically increase at year end for many of our commercial customers, then decline in the first half of the next year.  This didn’t happen in the first half of 2021 due to customers of all types holding higher balances duringdue to the COVID-19 pandemic.  In addition, because of the generally low rates paid on interest bearing account alternatives, many of our business customers chose to keep their balances in these more liquid noninterest bearing demand account types.  We also see a seasonal increase in deposits in the third quarter each year from municipal customers from property tax collections.  Interest bearing demand accounts, including money market and savings accounts, comprised 60%64% of total deposits at September 30, 20212022 and 60%62% at December 31, 2020.2021. Time accounts as a percentage of total deposits were 4%3% at September 30, 20212022 and 5%3% at December 31, 2020.2021.
 
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Borrowed funds at September 30, 2022 consisted of $30.0 million of FHLB advances.  Borrowed funds at December 31, 2021 consisted of $85.0 million of Federal Home Loan Bank (“FHLB”)FHLB advances.  Borrowed funds totaled $90.6On January 21, 2022, the FHLB exercised its option to put an advance totaling $25.0 million at December 31, 2020, including $70.0to the Company.  This advance carried an interest rate of 0.01% and had a maturity date of July 21, 2031.  The Company paid off this advance as required on January 21, 2022.  On January 21, 2022, we executed a new $25.0 million advance with the FHLB with similar terms.  This advance carried an interest rate of 0.05% and a maturity date of January 21, 2032.  The first put date for this advance was April 21, 2022.  The FHLB advancesexercised its put option on this advance and $20.6 million in long-term debt associated with trust preferred securities.  On July 7, 2021,it was paid off by the Company redeemed allas required on April 21, 2022. The FHLB also exercised its put option on an advance totaling $10.0 million that carried an interest rate of 0.45% and a maturity date of February 27, 2030.  We paid off this advance as required on May 27, 2022.    Also on May 27, 2022, we prepaid three other advances totaling $20.0 million.  These advances had maturities ranging from May 24, 2023 to July 25, 2024 and interest rates ranging from 2.91% to 3.05%.   We incurred prepayment fees totaling $87,000, which are included in interest expense.  The reduction in future period interest expense from paying off these advances is such that the long-term debt associated with trust preferred securities.payback period is less than one quarter.
 
CAPITAL RESOURCES
 
Total shareholders' equity of $252.2$236.6 million at September 30, 2021 represented an increase2022 reflected a decrease of $12.4$17.5 million from $239.8$254.0 million at December 31, 2020.2021. The increasedecrease was primarily a result of net incomea negative swing of $22.8 million earned in the first nine months of 2021, partially offset by a decrease of $2.7$32.4 million in accumulated other comprehensive income ("AOCI") and a payment of $8.2 million in cash dividends to shareholders.shareholders more than offsetting our net income of $22.6 million earned in the first nine months of 2022.    The negative swing in AOCI was attributable to a sharp increase in market interest rates on bonds during the first nine months of 2022 causing a devaluation in market value on our investment securities available for sale.  The Bank was categorized as “well capitalized” at September 30, 2021.2022.
 
Capital guidelines for U.S. banks are commonly known as Basel III guidelines. The rules include a common equity Tier 1 capital to risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, effectively resulting in a minimum CET1 ratio of 7.0%. The Basel III minimum ratio of Tier 1 capital to risk-weighted assets is 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5%), and the minimum total capital to risk-weighted assets ratio is 10.5% (with the capital conservation buffer), and Basel III requires a. The minimum leverage ratio ofis 4.0%. The capital ratios for the Company and the Bank under Basel III have continued to exceed the well capitalized minimum capital requirements.
 
The following table shows our regulatory capital ratios (on a consolidated basis) for the past several quarters:

Macatawa Bank Corporation 
Sept 30,
2021
  
June 30,
2021
  
March 31,
2021
  
Dec 31,
2020
  
Sept 30,
2020
  
Sept 30,
2022
  
June 30,
2022
  
March 31,
2022
  
Dec 31,
2021
  
Sept 30,
2021
 
Total capital to risk weighted assets 18.6% 19.7% 19.3% 18.3% 17.7% 17.6% 17.5% 17.9% 18.3% 18.6%
Common Equity Tier 1 to risk weighted assets 17.4  17.1  16.7  15.8  15.3  16.7  16.5  16.9  17.2  17.4 
Tier 1 capital to risk weighted assets 17.4  18.5  18.1  17.1  16.6  16.7  16.5  16.9  17.2  17.4 
Tier 1 capital to average assets 8.5  9.5  9.8  9.9  9.8  9.3  9.1  8.8  8.7  8.5 

On July 7, 2021, the Company redeemed all of the remaining outstanding trust preferred securities.
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LIQUIDITY
 
Liquidity of Macatawa Bank: The liquidity of a financial institution reflects its ability to manage a variety of sources and uses of funds. Our Consolidated Statements of Cash Flows categorize these sources and uses into operating, investing and financing activities. We primarily focus on developing access to a variety of borrowing sources to supplement our deposit gathering activities and provide funds for our investment and loan portfolios. Our sources of liquidity include our borrowing capacity with the FRB'sFederal Reserve Board's discount window, the Federal Home Loan Bank, federal funds purchased lines of credit and other secured borrowing sources with our correspondent banks, loan payments by our borrowers, maturity and sales of our securities available for sale, growth of our deposits, federal funds sold and other short-term investments, and the various capital resources discussed above.

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Liquidity management involves the ability to meet the cash flow requirements of our customers. Our customers may be either borrowers with credit needs or depositors wanting to withdraw funds. Our liquidity management involves periodic monitoring of our assets considered to be liquid and illiquid, and our funding sources considered to be core and non-core and short-term (less than 12 months) and long-term. We have established parameters that monitor, among other items, our level of liquid assets to short-term liabilities, our level of non-core funding reliance and our level of available borrowing capacity. We maintain a diversified wholesale funding structure and actively manage our maturing wholesale sources to reduce the risk to liquidity shortages. We have also developed a contingency funding plan to stress test our liquidity requirements arising from certain events that may trigger liquidity shortages, such as rapid loan growth in excess of normal growth levels or the loss of deposits and other funding sources under extreme circumstances.
 
We have actively pursued initiatives to maintain a strong liquidity position.  The Bank has reduced its reliance on non-core funding sources, including brokered deposits, and focused on achieving a non-core funding dependency ratio below its peer group average.  We have had no brokered deposits on our balance sheet since December 2011.  We continue to maintain significant on-balance sheet liquidity.  At September 30, 2021,2022, the Bank held $1.24 billion$733.3 million of federal funds sold and other short-term investments.  In addition, the Bank had available borrowing capacity from correspondent banks of approximately $242.5$304.7 million as of September 30, 2021.2022.
In the normal course of business, we enter into certain contractual obligations, including obligations which are considered in our overall liquidity management.  The table below summarizes our significant contractual obligations at September 30, 2021 (dollars in thousands):

  
Less than
1 year
  1-3 years  3-5 years  
More than
5 years
 
Long term debt $—  $—  $—  $— 
Time deposit maturities  77,814   14,807   1,247   58 
Other borrowed funds  —   30,000   20,000   35,000 
Operating lease obligations  310   364   144   — 
Total $78,124  $45,171  $21,391  $35,058 

In addition to normal loan funding, we also maintain liquidity to meet customer financing needs through unused lines of credit, unfunded loan commitments and standby letters of credit.  The level and fluctuation of these commitments is also considered in our overall liquidity management.  At September 30, 2021,2022, we had a total of $691.9$740.3 million in unused lines of credit, $103.6$88.9 million in unfunded loan commitments and $11.8$15.8 million in standby letters of credit.

Liquidity of Holding Company: The primary sources of liquidity for the Company are dividends from the Bank, existing cash resources and the capital markets if the need to raise additional capital arises.  Banking regulations and the laws of the State of Michigan in which our Bank is chartered limit the amount of dividends the Bank may declare and pay to the Company in any calendar year.  Under the state law limitations, the Bank is restricted from paying dividends to the Company in excess of retained earnings.  In 2020,2021, the Bank paid dividends to the Company totaling $11.7$33.1 million.  In the same period, the Company paid $10.9 million in dividends to its shareholders.shareholders and $20.6 million to redeem outstanding trust preferred securities.  On February 24, 2021,23, 2022, the Bank paid a dividend totaling $3.7$2.9 million to the Company in anticipation of the common share cash dividend of $0.08 per share paid on February 25, 202124, 2022 to shareholders of record on February 10, 2021.2022.  The cash distributed for this cash dividend payment totaled $2.7 million.   On May 26, 2021,25, 2022, the Bank paid a dividend totaling $3.2$2.8 million to the Company in anticipation of the common share cash dividend of $0.08 per share paid on May 27, 202126, 2022 to shareholders of record on May 12, 2021.2022.  The cash distributed for this cash dividend payment totaled $2.7 million.   On July 6, 2021,August 24, 2022, the Bank paid a dividend totaling $20.0 million to the Company in anticipation of the redemption of its trust preferred securities.  On July 7, 2021, the Company redeemed all of the outstanding trust preferred securities.  On August 25, 2021, the Bank paid a dividend totaling $3.2$2.7 million to the Company in anticipation of the common share cash dividend of $0.08 per share paid on August 26, 202125, 2022 to shareholders of record on August 11, 2021.12, 2022.  The cash distributed for this cash dividend payment totaled $2.7 million.  The Company retained the remaining balance in each period for general corporate purposes.  At September 30, 2021,2022, the Bank had a retained earnings balance of $79.7$97.9 million.

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The Company’s cash balance at September 30, 20212022 was $7.9$7.5 million.  The Company believes that it has sufficient liquidity to meet its cash flow obligations.
 
CRITICAL ACCOUNTING POLICIES AND 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 future results could differ.  The allowance for loan losses, other real estate owned valuation, loss contingencies, revenue recognition and income taxes are deemed critical due to the required level of management judgment and the use of estimates, making them particularly subject to change.
 
Our methodology for determining the allowance for loan losses and the related provision for loan losses is described above in the "Allowance for Loan Losses" discussion.  This area of accounting requires significant judgment due to the number of factors which can influence the collectability of a loan.  Unanticipated changes in these factors could significantly change the level of the allowance for loan losses and the related provision for loan losses.  Although, based upon our internal analysis, and in our judgment, we believe that we have provided an adequate allowance for loan losses, there can be no assurance that our analysis has properly identified all of the probable losses in our loan portfolio.  As a result, we could record future provisions for loan losses that may be significantly different than the levels that we recorded in the first nine months of 2021.2022.
 
Assets acquired through or instead of foreclosure, primarily other real estate owned, are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis.  New real estate appraisals are generally obtained at the time of foreclosure and are used to establish fair value.  If fair value declines, a valuation allowance is recorded through expense.  Estimating the initial and ongoing fair value of these properties involves a number of factors and judgments including holding time, costs to complete, holding costs, discount rate, absorption and other factors.

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Loss contingencies are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated.  This, too, is an accounting area that involves significant judgment.  Although, based upon our judgment, internal analysis, and consultations with legal counsel we believe that we have properly accounted for loss contingencies, future changes in the status of such contingencies could result in a significant change in the level of contingent liabilities and a related impact to operating earnings.
 
Noninterest revenue is recognized in accordance with contractual requirements and as we fulfill our obligations under contractual terms.  Most of our noninterest revenue comes from services that are transaction based and such revenue is recognized as the related service is provided.
 
Our accounting for income taxes involves the valuation of deferred tax assets and liabilities primarily associated with differences in the timing of the recognition of revenues and expenses for financial reporting and tax purposes.  At September 30, 2021,2022, we had gross deferred tax assets of $4.5$12.2 million and gross deferred tax liabilities of $2.3$2.0 million resulting in a net deferred tax asset of $2.1$10.2 million.  Accounting standards require that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a "more likely than not" standard.  We concluded at September 30, 20212022 that no valuation allowance on our net deferred tax asset was required.  Changes in tax laws, changes in tax rates, changes in ownership and our future level of earnings can impact the ultimate realization of our net deferred tax asset.

Item 3.QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
Our primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk. All of our transactions are denominated in U.S. dollars with no specific foreign exchange exposure. Macatawa Bank has only limited agricultural-related loan assets, and therefore has no significant exposure to changes in commodity prices.
 
Our balance sheet has sensitivity, in various categories of assets and liabilities, to changes in prevailing rates in the U.S. for prime rate, mortgage rates, U.S. Treasury rates and various money market indexes. Our asset/liability management process aids us in providing liquidity while maintaining a balance between interest earning assets and interest bearing liabilities.
 
We utilize a simulation model as our primary tool to assess the direction and magnitude of variations in net interest income and the economic value of equity (“EVE”) resulting from potential changes in market interest rates. Key assumptions in the model include contractual cash flows and maturities of interest-sensitive assets and interest-sensitive liabilities, prepayment speeds on certain assets, and changes in market conditions impacting loan and deposit pricing. We also include pricing floors on discretionary priced liability products which limit how low various checking and savings products could go under declining interest rates. These floors reflect our pricing philosophy in response to changing interest rates.
 
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We forecast the next twelve months of net interest income under an assumed environment of gradual changes in market interest rates under various scenarios. The resulting change in net interest income is an indication of the sensitivity of our earnings to directional changes in market interest rates. The simulation also measures the change in EVE, or the net present value of our assets and liabilities, under an immediate shift, or shock, in interest rates under various scenarios, as calculated by discounting the estimated future cash flows using market-based discount rates.
 
The following table shows the impact of changes in interest rates on net interest income over the next twelve months and EVE based on our balance sheet as of September 30, 20212022 (dollars in thousands):

Interest Rate Scenario 
Economic
Value of
Equity
  
Percent
Change
  
Net Interest
Income
  
Percent
Change
  
Economic
Value of
Equity
  
Percent
Change
  
Net Interest
Income
  
Percent
Change
 
Interest rates up 200 basis points 
$
326,003
   
9.20
%
 
$
54,796
   
19.82
%
 $379,237  (1.93)% $102,058  4.74%
Interest rates up 100 basis points  
312,041
   
4.52
   
50,116
   
9.58
  383,317  (0.87) 99,761  2.38 
No change  
298,538
   
—
   
45,733
   
—
  386,683  —  97,442  — 
Interest rates down 100 basis points  
276,628
   
(7.34
)
  
44,824
   
(1.99
)
 376,484  (2.64) 93,478  (4.07)
Interest rates down 200 basis points  
276,703
   
(7.31
)
  
44,547
   
(2.59
)
 347,299  (10.19) 87,202  (10.51)

If interest rates were to increase, this analysis suggests that we are positioned for an improvement in net interest income over the next twelve months.  If interest rates were to decrease, this analysis suggests we would experience a reduction in net interest income over the next twelve months.
 
We also forecast the impact of immediate and parallel interest rate shocks on net interest income under various scenarios to measure the sensitivity of our earnings under extreme conditions.

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The quarterly simulation analysis is monitored against acceptable interest rate risk parameters by the Asset/Liability Committee and reported to the Board of Directors.
 
In addition to changes in interest rates, the level of future net interest income is also dependent on a number of other variables, including: the growth, composition and absolute levels of loans, deposits, and other earning assets and interest-bearing liabilities; economic and competitive conditions; potential changes in lending, investing and deposit gathering strategies; and client preferences.
 
Item 4:CONTROLS AND PROCEDURES
 
(a)
Evaluation of Disclosure Controls and Procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e) as of September 30, 2021,2022, the end of the period covered by this report.
 
In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, as the Company's are designed to do, and management necessarily was required to apply its judgment in evaluating whether the benefits of the controls and procedures that the Company adopts outweigh their costs.
 
Our CEO and CFO, after evaluating the effectiveness of the Company's disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this report, have concluded that the Company's disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Commission's rules and forms.
 
(b)
Changes in Internal Controls. During the period covered by this report, there have been no changes in the Company’s internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

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PART II – OTHEROTHER INFORMATION

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

The following table provides information regarding the Company’s purchase of its own common stock during the third quarter of 2021.2022.  All employee transactions are under stock compensation plans.  These include shares of Macatawa Bank Corporation common stock surrendered to satisfy tax withholding obligations that occur upon the vesting of restricted shares.  The value of the shares withheld is determined based on the closing price of Macatawa Bank Corporation common stock at the date of vesting.  The Company has no publicly announced repurchase plans or programs.

 
Total
Number of
Shares
Purchased
  
Average
Price Paid
Per Share
  
Total
Number of
Shares
Purchased
  
Average
Price Paid
Per Share
 
Period            
July 1 - July 31, 2021      
July 1 - July 31, 2022      
Employee Transactions 2,518  $8.55  1,662  $8.94 
August 1 - August 31, 2021      
August 1 - August 31, 2022      
Employee Transactions —  —  —  $— 
September 1 - September 30, 2021      
September 1 - September 30, 2022      
Employee Transactions —  —  —  $— 
Total for Third Quarter ended September 30, 2021      
Total for Third Quarter ended September 30, 2022      
Employee Transactions 2,518  $8.55  1,662  $8.94 

Item 6.EXHIBITS.

3.1
Restated Articles of Incorporation. Previously filed with the Commission on October 27, 2016 in Macatawa Bank Corporation’s Quarterly Report on Form 10-Q, Exhibit 3.1. Here incorporated by reference.
3.2
Bylaws. Previously filed with the Commission on February 19, 2015 in Macatawa Bank Corporation's Annual Report on Form 10-K for the year ended December 31, 2014, Exhibit 3.2. Here incorporated by reference.
4.1
Restated Articles of Incorporation. Exhibit 3.1 is here incorporated by reference.
4.2
Bylaws. Exhibit 3.2 is here incorporated by reference.
4.3Long-Term Debt. The registrant has outstanding long-term debt which at the time of this report does not exceed 10% of the registrant's total consolidated assets. The registrant agrees to furnish copies of the agreements defining the rights of holders of such long-term debt to the SEC upon request.
31.1
Certification of Chief Executive Officer.
31.2
Certification of Chief Financial Officer.
32.1
Certification pursuant to 18 U.S.C. Section 1350.
101.INSInline XBRL Instance Document
101.SCHInline XBRL Taxonomy Extension Schema Document
101.CALInline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEFInline XBRL Taxonomy Extension Definition Linkbase Document
101.LABInline XBRL Taxonomy Extension Label Linkbase Document
101.PREInline XBRL Taxonomy Extension Presentation Linkbase Document
104Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)

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SIGNATURESSIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 MACATAWA BANK CORPORATION
  
 /s/ Ronald L. Haan
 Ronald L. Haan
 Chief Executive Officer
 (Principal Executive Officer)
  
 /s/ Jon W. Swets
 Jon W. Swets
 Senior Vice President and
 Chief Financial Officer
 (Principal Financial and Accounting Officer)
  
Dated: October 28, 202127, 2022


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