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 June 30, 2022March 31, 2023

OR

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission file number: 000-25927

MACATAWA BANK CORPORATION
(Exact name of registrant as specified in its charter)

Michigan

38-3391345
(State or other jurisdiction of  incorporation or organization)
(I.R.S. Employer Identification No.)

10753 Macatawa Drive, Holland, Michigan 49424
(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (616) 820-1444

Securities registered pursuant to Section 12(b) of the Act:


Title of each class
Trading Symbol
Name of each exchange on which registered

Common stock

MCBC

NASDAQ

Indicate by checkmarkcheck mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

Large accelerated filer ☐
Accelerated filer ☐
Non-accelerated filer ☒
Smaller reporting company ☒Emerging Growth Company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 34,253,14734,292,294 shares of the Company’s Common Stock (no par value) were outstanding as of April July 28, 202227, 2023.

Forward-Looking Statements

This report contains forward-looking statements that are based on management’s beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and Macatawa Bank Corporation. Forward-looking statements are identifiable by words or phrases such as “outlook”, “plan” or “strategy”; that an event or trend “could”, “may”, “should”, “will”, “is likely”, or is “possible” or “probable” to occur or “continue”, has “begun” or “is scheduled” or “on track” or that the Company or its management “anticipates”, “believes”, “estimates”, “plans”, “forecasts”, “intends”, “predicts”, “projects”, or “expects” a particular result, or is “committed”, “confident”, “optimistic” or has an “opinion” that an event will occur, or other words or phrases such as “ongoing”, “future”, “signs”, “efforts”, “tend”, “exploring”, “appearing”, “until”, “near term”, “concern”, “going forward”, “focus”, “starting”, “initiative,” “trend” and variations of such words and similar expressions. Such statements are based upon current beliefs and expectations and involve substantial risks and uncertainties which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These statements include, among others, those related to the risks and uncertainties related to, and the impact of, the  COVID-19 pandemic on the business, financial conditions 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.sources and future amounts of unrealized gains or losses in our investment securities portfolio. Management’s determination of the provision and allowance for loan losses, the appropriate carrying value of intangible assets (including deferred tax assets) and other real estate owned, and the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary and the amount of any impairment) involves judgments that are inherently forward-looking. All statements with references to future time periods are forward-looking. All of the information concerning interest rate sensitivity is forward-looking. Our ability to sell other real estate owned at its carrying value or at all, successfully implement new programs and initiatives, increase efficiencies, maintain our current levels of deposits and other sources of funding, maintain liquidity, respond to declines in collateral values and credit quality, respond to a changing interest rate environment, increase loan volume, originate high quality loans, maintain or improve mortgage banking income, realize the benefit of our deferred tax assets, continue payment of dividends and improve profitability is not entirely within our control and is not assured. The future effect of changes in the real estate, financial and credit markets, interest rates and the national and regional economy on the banking industry, generally, and Macatawa Bank Corporation, specifically, are also inherently uncertain. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“risk factors”) that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. Macatawa Bank Corporation does not undertake to update forward-looking statements to reflect the impact of circumstances or events that may arise after the date of the forward-looking statements.

Risk factors include, but are not limited to, the risk factors described in “Item 1A - Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2021.2022. These and other factors are representative of the risk factors that may emerge and could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.

Part IFinancial Information
Item 1.
MACATAWA BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
As of June 30, 2022March 31, 2023 (unaudited) and December 31, 20212022
(Dollars in thousands, except per share data)

 
June 30,
2022
  
December 31,
2021
  
March 31,
2023
  
December 31,
2022
 
ASSETS            
Cash and due from banks $38,376  $23,669  $29,402  $51,215 
Federal funds sold and other short-term investments  721,826   1,128,119   391,336   703,955 
Cash and cash equivalents  760,202   1,151,788   420,738   755,170 
Debt securities available for sale, at fair value  435,628   416,063   525,959   499,257 
Debt securities held to maturity (fair value 2022 - $341,274 and 2021 - $139,272)
  352,721   137,003 
Debt securities held to maturity (fair value 2023 - $335,559 and 2022 - $332,650)
  348,387   348,765 
Federal Home Loan Bank (FHLB) stock  10,211   11,558   10,211   10,211 
Loans held for sale, at fair value  1,163   1,407   87   215 
Total loans  1,111,915   1,108,993   1,220,939   1,177,748 
Allowance for loan losses  (14,631)  (15,889)
Allowance for credit losses  (16,794)  (15,285)
Net loans  1,097,284   1,093,104   1,204,145   1,162,463 
Premises and equipment – net  41,088   41,773   40,249   40,306 
Accrued interest receivable  5,108   4,088   8,782   7,606 
Bank-owned life insurance  52,963   52,468   53,557   53,345 
Other real estate owned - net  2,343   2,343   —   2,343 
Net deferred tax asset  6,516   2,163   8,471   9,712 
Other assets  15,981   14,993   16,567   17,526 
Total assets $2,781,208  $2,928,751  $2,637,153  $2,906,919 
LIABILITIES AND SHAREHOLDERS’ EQUITY                
Deposits                
Noninterest-bearing $903,334  $886,115  $690,444  $834,879 
Interest-bearing  1,591,249   1,691,843   1,640,451   1,780,263 
Total deposits  2,494,583   2,577,958   2,330,895   2,615,142 
Other borrowed funds  30,000   85,000   30,000   30,000 
Accrued expenses and other liabilities  13,516   11,788   15,690   14,739 
Total liabilities  2,538,099   2,674,746   2,376,585   2,659,881 
Commitments and contingent liabilities        —   — 
Shareholders’ equity                
Common stock, 0 par value, 200,000,000 shares authorized; 34,253,147 and 34,259,945 shares issued and outstanding at June 30, 2022 and December 31, 2021
  219,456   219,082 
Common stock, no par value, 200,000,000 shares authorized; 34,292,294 and 34,298,640 shares issued and outstanding at March 31, 2023 and December 31, 2022
  219,733   219,578 
Retained earnings  42,332   35,220   67,092   59,036 
Accumulated other comprehensive loss
  (18,679)  (297)  (26,257)  (31,576)
Total shareholders’ equity  243,109   254,005   260,568   247,038 
Total liabilities and shareholders’ equity $2,781,208  $2,928,751  $2,637,153  $2,906,919 

See accompanying notes to consolidated financial statements.

-4-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three and six month periods ended June 30,March 31, 2023 and 2022 and 2021
(unaudited)
(Dollars in thousands, except per share data)

 
Three Months
Ended
June 30,
2022
  
Three Months
Ended
June 30,
2021
  
Six Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2021
  
Three Months
Ended
March 31,
2023
  
Three Months
Ended
March 31,
2022
 
Interest income                  
Loans, including fees $10,344  $13,303  $20,741  $26,770  $15,660  $10,397 
Securities                        
Taxable  2,618   792   4,052   1,579   4,481   1,434 
Tax-exempt  702   760   1,434   1,518   698   732 
FHLB Stock  51   56   102   117   65   51 
Federal funds sold and other short-term investments  1,720   273   2,249   474   6,362   529 
Total interest income  15,435   15,184   28,578   30,458   27,266   13,143 
Interest expense                        
Deposits  245   244   403   523   4,494   158 
Other borrowings  347   328   667   681   156   320 
Long-term debt  0   155   0   307 
Total interest expense  592   727   1,070   1,511   4,650   478 
Net interest income  14,843   14,457   27,508   28,947   22,616   12,665 
Provision for loan losses  0   (750)  (1,500)  (750)
Net interest income after provision for loan losses  14,843   15,207   29,008   29,697 
Provision for credit losses
  —   (1,500)
Net interest income after provision for credit losses  22,616   14,165 
Noninterest income                        
Service charges and fees  1,218   1,065   2,430   2,057   994   1,211 
Net gains on mortgage loans  199   1,311   508   3,326   11   308 
Trust fees  1,096   1,133   2,184   2,138   1,033   1,088 
ATM and debit card fees  1,762   1,683   3,360   3,168   1,662   1,599 
Bank owned life insurance (“BOLI”) income  230   250   470   526   199   240 
Other  626   727   1,144   1,492   629   519 
Total noninterest income  5,131   6,169   10,096   12,707   4,528   4,965 
Noninterest expense                        
Salaries and benefits  6,402   6,502   12,691   12,914   6,698   6,289 
Occupancy of premises  1,071   994   2,243   2,031   1,137   1,172 
Furniture and equipment  988   978   2,004   1,915   1,031   1,016 
Legal and professional  271   274   465   496   348   194 
Marketing and promotion  195   175   390   350   219   195 
Data processing  924   855   1,808   1,762   955   884 
FDIC assessment  197   159   377   329   330   180 
Interchange and other card expense  406   388   779   746   384   373 
Bond and D&O Insurance  129   111   259   222   122   130 
Other  1,330   1,282   2,636   2,438   941   1,306 
Total noninterest expenses  11,913   11,718   23,652   23,203   12,165   11,739 
Income before income tax  8,061   9,658   15,452   19,201   14,979   7,391 
Income tax expense  1,493   1,840   2,884   3,605   2,975   1,391 
Net income $6,568  $7,818  $12,568  $15,596  $12,004  $6,000 
Basic earnings per common share $0.19  $0.23  $0.37  $0.46  $0.35  $0.18 
Diluted earnings per common share $0.19  $0.23  $0.37  $0.46  $0.35  $0.18 
Cash dividends per common share $0.08  $0.08  $0.16  $0.16  $0.08  $0.08 

See accompanying notes to consolidated financial statements.

-5-

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
Three and six month periods ended June 30,March 31, 2023 and 2022 and 2021
(unaudited)
(Dollars in thousands)

  
Three Months
Ended
June 30,
2022
  
Three Months
Ended
June 30,
2021
  
Six Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2021
 
Net income $6,568  $7,818  $12,568  $15,596 
Other comprehensive income (loss):                
Unrealized gains (losses):                
Net change in unrealized gains (losses) on debt securities available for sale  (8,251)  739   (23,371)  (2,651)
Net unrealized gain at time of transfer on securities transferred to held-to-maturity  0   0   113   0 
Amortization of net unrealized gains on securities transferred to held-to-maturity
  (6)  0   (10)  0 
Tax effect  1,734   (155)  4,886   557 
Net change in unrealized gains (losses) on debt securities available for sale, net of tax  (6,523)  584   (18,382)  (2,094)
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  (6,523)  584   (18,382)  (2,094)
Comprehensive income (loss)
 $45  $8,402  $(5,814) $13,502 
  
Three Months
Ended
March 31,
2023
  
Three Months
Ended
March 31,
2022
 
Net income $12,004  $6,000 
Other comprehensive income (loss):        
Unrealized gains (losses):        
Net change in unrealized gains (losses) on debt securities available for sale  6,738   (15,119)
Net unrealized gain at time of transfer on securities transferred to held-to-maturity
  —   113 
Amortization of net unrealized gains on securities transferred to held-to-maturity  (5)  (6)
Tax effect  (1,414)  3,153 
Net change in unrealized gains (losses) on debt securities available for sale, net of tax  5,319   (11,859)
Less: reclassification adjustments:        
Reclassification for gains included in net income  —   — 
Tax effect  —   — 
Reclassification for gains included in net income, net of tax  —   — 
Other comprehensive income (loss), net of tax  5,319   (11,859)
Comprehensive income (loss)
 $17,323  $(5,859)

See accompanying notes to consolidated financial statements.

-6-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Three and six month periods ended June 30,March 31, 2023 and 2022 and 2021
(unaudited)
(Dollars in thousands, except per share data)

  
Common
Stock
  Retained Earnings  
Accumulated
Other
Comprehensive
Income (Loss)
  
Total
Shareholders’
Equity
 
Balance, April 1, 2021 $218,687  $22,156  $1,536  $242,379 
Net income for the three months ended June 30, 2021
  0   7,818   0   7,818 
Cash dividends at $0.08 per share  0   (2,723)  0   (2,723)
Repurchase of 815 shares for taxes withheld on vested restricted stock
  (7)  0   0   (7)
Other comprehensive income, net of tax
  0   0   584   584 
Stock compensation expense  166   0   0   166 
Balance, June 30, 2021 $218,846  $27,251  $2,120  $248,217 
                 
                 
Balance, April 1, 2022 $219,266  $38,492  $(12,156) $245,602 
Net income for the three months ended June 30, 2022
  0   6,568   0   6,568 
Cash dividends at $0.08 per share  0   (2,728)  0   (2,728)
Repurchase of 815 shares for taxes withheld on vested restricted stock
  (7)  0   0   (7)
Other comprehensive income, net of tax
  0   0   (6,523)  (6,523)
Stock compensation expense  197   0   0   197 
Balance, June 30, 2022 $219,456  $42,332  $(18,679) $243,109 
  
Common
Stock
  
Retained
Earnings
  
Accumulated
Other
Comprehensive
Income (Loss)
  
Total
Shareholders’
Equity
 
Balance, January 1, 2022
 $219,082  $35,220  $(297) $254,005 
Net income for the three months ended March 31, 2022
  —   6,000   —   6,000 
Cash dividends at $0.08 per share
  —   (2,728)  —   (2,728)
Repurchase of 1,338 shares for taxes withheld on vested restricted stock
  (13)  —
   —
   (13)
Other comprehensive loss, net of tax
  —   —   (11,859)  (11,859)
Stock compensation expense  197   —   —   197 
Balance, March 31, 2022
 $219,266  $38,492  $(12,156) $245,602 

  
Common
Stock
  Retained Earnings  
Accumulated
Other
Comprehensive
Income (Loss)
  
Total
Shareholders’
Equity
 
Balance, January 1, 2021 $218,528  $17,101  $4,214  $239,843 
Net income for the six months ended June 30, 2021
  0   15,596   0   15,596 
Cash dividends at $0.16 per share  0   (5,446)  0   (5,446)
Repurchase of 1,341 shares for taxes withheld on vested restricted stock
  (12)  0   0   (12)
Other comprehensive income, net of tax  0   0   (2,094)  (2,094)
Stock compensation expense  330   0   0   330 
Balance, June 30, 2021 $218,846  $27,251  $2,120  $248,217 
                 
                 
Balance, January 1, 2022 $219,082  $35,220  $(297) $254,005 
Net income for the six months ended June 30, 2022
  0   12,568   0   12,568 
Cash dividends at $0.16 per share  0   (5,456)  0   (5,456)
Repurchase of 2,153 shares for taxes withheld on vested restricted stock
  (20)  0   0   (20)
Other comprehensive income, net of tax  0   0   (18,382)  (18,382)
Stock compensation expense  394   0   0   394 
Balance, June 30, 2022 $219,456  $42,332  $(18,679) $243,109 
Balance, January 1, 2023
 $219,578  $59,036  $(31,576) $247,038 
Adoption of ASU 2016-13, net of tax
  —  
(1,215)  —  
(1,215)
Net income for the three months ended March 31, 2023
  —   12,004   —   12,004 
Cash dividends at $0.08 per share
  —   (2,733)  —   (2,733)
Repurchase of 1,338 shares for taxes withheld on vested restricted stock
  (15)  —   —   (15)
Other comprehensive income, net of tax  —   —   5,319   5,319 
Stock compensation expense  170   —   —   170 
Balance, March 31, 2023
 $219,733  $67,092  $(26,257) $260,568 

See accompanying notes to consolidated financial statements.

-7-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
SixThree month periods ended June 30,March 31, 2023 and 2022 and 2021
(unaudited)
(Dollars in thousands)

 
Six Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2021
  
Three Months
Ended
March 31,
2023
  
Three Months
Ended
March 31,
2022
 
Cash flows from operating activities            
Net income $12,568  $15,596  $12,004  $6,000 
Adjustments to reconcile net income to net cash from operating activities:                
Depreciation and amortization  1,204   1,143   160   737 
Stock compensation expense  394   330   170   197 
Provision for loan losses  (1,500)  (750)
Provision for credit losses  —   (1,500)
Origination of loans for sale  (18,548)  (86,498)  (179)  (10,148)
Proceeds from sales of loans originated for sale  19,300   90,494   318   11,008 
Net gains on mortgage loans  (508)  (3,326)  (11)  (308)
Write-down of other real estate  0   4 
Net loss on sales of other real estate  0   20 
Deferred income tax expense (benefit)
  533   (144)
Net gain on sales of other real estate  (356)  — 
Deferred income tax expense
  150   456 
Earnings in bank-owned life insurance  (470)  (526)  (199)  (240)
Change in accrued interest receivable and other assets  (2,008)  1,384   (217)  504 
Change in accrued expenses and other liabilities  66   (803)  889   (551)
Net cash from operating activities  11,031   16,924   12,729   6,155 
Cash flows from investing activities                
Loan originations and payments, net  (2,680)  191,152   (43,158)  7,318 
Purchases of securities available for sale  (186,326)  (50,605)  (24,072)  (72,557)
Purchases of securities held to maturity  (137,355)  (51,232)  (3,966)  (28,120)
Purchase of bank-owned life insurance
  0   (10,000)
Proceeds from:                
Maturities and calls of securities  22,746   31,013 
Principal paydowns on securities  43,968   23,429 
Maturities and calls of securities available for sale
  1,626   5,187 
Maturities and calls of securities held to maturity
  1,126   31,238 
Principal paydowns on securities available for sale
  2,878   4,554 
Principal paydowns on securities held to maturity
  3,197   2,667 
Sales of other real estate  0   170   2,699   — 
Proceeds from redemption of FHLB stock
  1,347   0 
Proceeds from payout of bank-owned insurance claim  0   560 
Redemption of FHLB stock
  —   1,347 
Additions to premises and equipment  (466)  (861)  (496)  (235)
Net cash from investing activities  (258,766)  133,626   (60,166)  (48,601)
Cash flows from financing activities                
Change in deposits  (83,375)  301,489   (284,247)  4,339 
Repayments and maturities of other borrowed funds  (80,000)  (10,000)  —   (25,000)
Proceeds from other borrowed funds  25,000   0   —   25,000 
Repurchase of shares for taxes withheld on vested restricted stock  (20)  (12)  (15)  (13)
Cash dividends paid  (5,456)  (5,446)  (2,733)  (2,728)
Net cash from financing activities  (143,851)  286,031   (286,995)  1,598 
Net change in cash and cash equivalents  (391,586)  436,581   (334,432)  (40,848)
Cash and cash equivalents at beginning of period  1,151,788   783,736   755,170   1,151,788 
Cash and cash equivalents at end of period $760,202  $1,220,317  $420,738  $1,110,940 

See accompanying notes to consolidated financial statements.

-8-
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
SixThree month periods ended June 30,March 31, 2023 and 2022 and 2021
(unaudited)
(Dollars in thousands)

 
Six Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2021
  
Three Months
Ended
March 31,
2023
  
Three Months
Ended
March 31,
2022
 
Supplemental cash flow information            
Interest paid $1,106  $1,535  $4,307  $481 
Income taxes paid  3,000   4,000 
Supplemental noncash disclosures:                
Security settlement  1,662   736   —   5,747 
Transfer of securities from available for sale to held to maturity  123,469   0   —   123,469 

See accompanying notes to consolidated financial statements.

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.Corporation (“FDIC”). The Bank operates 26 full service branch offices providing a full range of commercial and consumer banking and trust services in Kent County, Ottawa County, and northern Allegan County, Michigan.

Recent Events:  In early March 2023, over the course of five days, three large financial institutions in the United States failed.  Silvergate Bank self liquidated and Silicon Valley Bank and Signature Bank were both closed by the FDIC. These bank failures were driven by rapid withdrawals by depositors with large uninsured balances held at these institutions and losses incurred by these banks in liquidating their bond portfolios to provide liquidity to fund these deposit outflows.   Silvergate Bank’s failure was also caused by its exposure to FTX and Alameda cryptocurrency firm failures.   The FDIC determined that Silicon Valley Bank and Signature Bank were systemically important and fully guaranteed their depositor balances above the $250,000 FDIC insurance limit.  Given the sharp increase in market interest rates during 2022 and into 2023, most financial institutions’ bond portfolios have significant unrealized loss positions.  In response to this, the COVID-19 pandemic, federal stateFederal Reserve Bank (“FRB”) created a new borrowing facility called the Bank Term Funding Program.  This program allows a bank to borrow against its investment portfolio, at par value, with no reduction for unrealized losses.  The term is for one year and local governments haveinterest rate is fixed at the time the advance is taken and continue to take actions designed to mitigatethere is no prepayment penalty.  Allowable investments for pledge are those the effect on public health and to address the economic impact from the virus.  The effects of COVID-19 and its related variants could, among other risks, result in a material increase in requests from the Company’s customers for loan deferrals, modifications to the terms of loans, or other borrower accommodations; have a material adverse impact on the financial conditionFRB can own.  This would include all of the Company’s customers, potentially impacting their ability to make payments toinvestment securities except municipal securities and corporate bonds.  At March 31, 2023, the Company as scheduled driving an increasehad no advances under this program and had $642.2 million in delinquencies and loan losses; result in additional material provision for loan losses; result in a decreased demand for the Company’s loans; or negatively impact the Company’s ability to access capitalunused borrowing capacity under this program.  The program expires on attractive terms or at all.  Those effects could have a material adverse impact on the Company’s and its customers’ business, financial condition, and results of operations.March 11, 2024.

TheAt March 31, 2023, the Company had $391.3 million in federal funds sold and overnight balances and had borrowing capacity of $951 million, including $242.3 million in unused availability with the Federal Home Loan Bank was a participating lender(“FHLB”), $65.0 million in available fed funds facilities with correspondent banks, $1.5 million in availability at the FRB Discount Window and the $642.2 million in the Small Business Administration’s (“SBA”) Paycheck ProtectionFRB Bank Term Funding 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 remitsdiscussed above.  At March 31, 2023, these liquidity sources exceeded the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness within that 10 month period. Fees generated based on the origination of PPP loans are deferred and amortized into interest income over the contractual period of 24 months or 60 months, as applicable. Upon SBA forgiveness, unamortized fees are then recognized into interest income.Company’s uninsured deposit balances.

In 2020:
The Bank originated 1,738 PPP loans totaling $346.7 million in principal.
Fees generated totaled $10.0 million.
765 PPP loans totaling $113.5 million were forgiven.
Total net fees of $5.4 million were recognized.
 
In 2021: 
The Bank originated 1,000 PPP loans totaling $128.1 million in principal.
Fees generated totaled $5.6 million.
1,722 PPP loans totaling $318.4 million were forgiven.
Total net fees of $8.3 million were recognized.

In the six months ended June 30, 2022:
217 PPP loans totaling $40.3 million were forgiven.
Total net fees of $1.2 million were recognized.

As of June 30, 2022, 21 PPP loans totaling $2.8 million in principal remained outstanding and total net fees of $94,000 remained unrecognized.

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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 six month periodsperiod ended June 30, 2022March 31, 2023 are not necessarily indicative of the results that may be expected for the year ending December 31, 2022.2023. For further information, refer to the consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2021.2022.

Use of Estimates:  To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information.  These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.  The allowance for loancredit 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.

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


FASB issued ASU No. 2016-13, as amended, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.  This ASU, commonly referred to as Current Expected Credit Loss (“CECL”), provides financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date by replacing the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.  The new guidance eliminates the probable initial recognition threshold and, instead, reflects an entity’s current estimate of all expected credit losses. The new guidance broadens the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually to include forecasted information, as well as past events and current conditions. There is no specified method for measuring expected credit losses, and an entity is allowed to apply methods that reasonably reflect its expectations of the credit loss estimate. Although an entity may still use its current systems and methods for recording the allowance for credit losses, under the new rules, the inputs used to record the allowance for credit losses generally will need to change to appropriately reflect an estimate of all expected credit losses and the use of reasonable and supportable forecasts. FASB also issued ASU 2022-02, Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures.  This standard eliminated the previous accounting guidance for troubled debt restructurings and added additional disclosure requirements for gross chargeoffs by year of origination.  It also prescribes guidance for reporting modifications of loans to borrowers experiencing financial difficulty. 

The Company adopted these standards as required on January 1, 2023 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures.  Results for reporting periods beginning after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with the probable incurred loss accounting standards.  The transition adjustment of the CECL adoption included an increase in the allowance for loans of $1.5 million and an increase of $62,000 to establish a reserve for unfunded commitments, with a $1.2 million decrease to retained earnings, with the $323,000 income tax portion being recorded as part of the deferred tax asset in the Company’s Consolidated Balance Sheet.

Allowance for LoanCredit Losses (“ACL”) - Loans: The allowance for loancredit losses (allowance) is a valuation account that is deducted from the loan portfolios’ amortized cost basis to present the net amount expected to be collected on loans.  The allowance for probable incurred credit losses inherent in our loan portfolio,is increased by the provision for loancredit 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, current and forecasted economic conditions and other relevant factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibilityuncollectability 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 specificis measured on a collective pool basis when similar risk characteristics exist.  Loans with similar risk characteristics are grouped into homogeneous segments, or pools, for allowance calculation.  Commercial loans are divided into eight segments based primarily on property type and general components. The specific component relates to loans thatrisk characteristics.  They are individually classified as impaired. The general component covers non-classified loans and isfurther segmented based on commercial loan risk grade. Retail loans are segmented into categories including residential mortgage, home equity, unsecured and other secured and then further segmented based on delinquency status.

The Company’s loan portfolio classes as of March 31, 2023 were as follows:
Commercial Loans:
Commercial and Industrial - Risks to this category include industry concentration and limitations associated with monitoring the adequacy and condition of collateral which can include inventory, accounts receivable, and other non-real estate assets.  Equipment and inventory obsolescence can also pose a risk.  Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.
Residential developed - Risks to this category include industry concentration, valuation of residential properties, inventory of homes for sale in the market area, inadequate long-term financing arrangements and velocity of sales.   Loans in this category are susceptible to weakening general economic conditions and increases in unemployment rates as well as market demand and supply of similar property.   Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.

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Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Unsecured to residential developers - Risks to this category include industry concentration, valuation of residential properties, inventory of homes for sale in the market area and velocity of sales.   Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.
Vacant and unimproved - Risks to this category include industry concentration, valuation of farm land, agricultural properties and residential properties as well as velocity of sales.   Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.  Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.
Commercial development - Risks to this category include industry concentration, valuation of commercial properties, lease terms, occupancy/vacancy rates and velocity of sales.   Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.  Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.
Residential improved - Risks to this category include industry concentration, valuation of residential properties, inventory of homes for sale in the market area and velocity of sales.   Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.  Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.
Commercial improved - Risks to this category include industry concentration, valuation of commercial properties, lease terms, occupancy/vacancy rates, cost overruns, changes in market demand for property or services and velocity of sales.   Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.  Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.
Manufacturing and industrial - Risks to this category include industry concentration, valuation of commercial properties,  changes in market demand for products produced and velocity of sales.   Declines in general economic conditions and other events can cause cash flows to fall to levels insufficient to service debt.  Declines in real estate values and lack of suitable alternative use for the properties are also risks for loans in this category.
Consumer Loans:
Residential mortgage - Residential mortgage loans are susceptible to weakening general economic conditions and increases in unemployment rates and declining real estate values.
Unsecured - Unsecured loans are susceptible to weakening general economic conditions and increases in unemployment rates.
Home equity - Home equity loans are susceptible to weakening general economic conditions and increases in unemployment rates and declining real estate values.
Other secured - Other secured loans are susceptible to weakening general economic conditions and increases in unemployment rates, regulatory risks as well as the inability to monitor collateral consisting of personal property.




The remaining life methodology is used for all loan pools.  This nondiscounted cash flow approach projects an estimated future amortized cost basis based on current loan balance and repayment terms.  Given the bank’s limited loss history over the past twelve years, a loss rate computed for a comparable sized peer group (banks with assets between $1-3 billion) is then applied to future loan balances at the instrument level based on the remaining contractual life adjusted for amortization, prepayment and default to develop a baseline lifetime loss.  The baseline lifetime loss is adjusted for changes in macroeconomic conditions over the reasonable and supportable forecast period and reversion periods.

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

Reasonable and supportable economic forecasts have to be incorporated in determining expected losses.  The forecast period represents the time frame from the current period end through the point in time that the Company can reasonably forecast. Ideally, the economic forecast period would cover the contractual terms of all loans; however, the ability to produce a forecast that is both reasonable and supportable becomes more difficult the longer the period is projected.

For periods beyond the forecast period, the loss rate reverts back to the long term historical loss experience adjustedaverage.  As of January 1, 2023 and March 31, 2023, the Company used a one-year reasonable and supportable economic forecast period, with a six-month straight-line reversion period for current qualitative factors.all loan segments.  In determining the reasonable and supportable economic forecast period, the Company used a consensus economic forecast from a third-party provider that provided forecasts from twenty five leading economists.  The Company maintainsconsidered the March 2023 report’s consensus/mean estimates for gross domestic product and unemployment rates and selected a loss migration analysisperiod for the reasonable and supportable forecast period that tracks loan lossesmost closely matched that consensus (December 2006 to September 2007).  At adoption of CECL on January 1, 2023, the Company considered the December 2022 report for these same metrics and recoveries based on loan class andused a loss period from September 2007 to December 2007.  The effect of changing the loan risk grade assignment for commercial loans. At June 30, 2022, an 18 month annualizedloss period from that used at January 1, 2023 to March 31, 2023 was a reduction in the historical loss experience wasrate 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 certainat March 31, 2023.
A number of qualitative factors are considered including economic trends,forecast uncertainty, credit quality trends, valuation trends, concentration risk, quality of loan review, changes in personnel, impact of rising interest rates, external factors and other considerations.  During each reporting period, management also considers the need to adjust the baseline lifetime loss rates for factors that may cause expected losses to differ from those experienced in the historical loss periods.

The Company is also required to consider expected credit losses associated with loan commitments over the contractual period in which it is exposed to credit risk on the underlying commitments.  Any allowance for off-balance sheet credit exposures is reported as an other liability on the Company’s Consolidated Balance Sheet and is increased or decreased via other noninterest expense on the Company’s Consolidated Statement of Income.  The calculation includes consideration of the likelihood that funding will occur and forecasted credit losses on commitments expected to be funded over their estimated lives.  The allowance is calculated using the same methodology, inputs and assumptions as the funded portion of loans at the segment level applied to the amount of commitments expected to be funded.

AInterest income is accrued on the unpaid principal balance.  Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income over the respective term of the loan using the level-yield method without anticipating prepayments.  Accrued interest on loans totaled $3.8 million at March 31, 2023 and $4.0 million at December 31, 2022.

Accrued interest receivable for loans is included as a separate line item on the Company’s Consolidated Balance Sheet.  The Company elected not to measure an allowance for accrued interest receivable and instead elected to reverse accrued interest income on loans that are placed on nonaccrual status.  The Company believes this policy results in the timely reversal of uncollectible interest.

Interest income on mortgage and commercial loans is discontinued at the time the loan is impaired when,90 days delinquent unless the loan is well-secured and in process of collection. Consumer loans are typically charged off no later than 120 days past due.  Past due status is based on 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 modifiedloan.  In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.  Nonaccrual loans and 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 ofpast due 90 days still on accrual include both smaller balance homogeneous loans such as consumer and residential real estate loans,that are collectively evaluated for impairment and they are not separately identified for impairment disclosures.
individually classified impaired loans.

All interest accrued but not received for loans placed on nonaccrual is reversed against interest income.  Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual.  Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Troubled debt restructurings
Securities: Securities are also considered impaired with impairment generally measuredclassified as held to maturity (“HTM”) and carried at amortized cost when management has the present valuepositive intent and ability to hold them to maturity. Securities available for sale (“AFS”) consist of estimated future cash flows using the loan’s effective ratethose securities which might be sold prior to maturity due to changes in interest rates, prepayment risks, yield and availability of alternative investments, liquidity needs or other factors.  Securities classified as AFS are reported at inception or using thetheir fair value and the related unrealized gain or loss is reported in other comprehensive income, net of collateral, less estimated costs to sell, if repayment is expected solely from the collateral.tax.

Foreclosed Assets: Assets acquired throughInterest income includes amortization of purchase premium or insteaddiscount.  Premiums and discounts on securities are amortized on the level yield method without anticipating prepayments.  Gains and losses on sales are based on the amortized cost of loan foreclosure, primarily other real estate owned, are initially recordedthe security sold.  Accrued interest receivable on securities totaled $4.5 million 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.March 31, 2023 and $3.4 million at December 31, 2022.

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Index
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 (Continued)

ACL - Securities Available for Sale - For securities AFS in an unrealized loss position, management determines whether they intend to sell or if it is more likely than not that the Company will be required to sell the security before recovery of the amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security’s amortized cost basis is written down to fair value through income with an allowance being established under CECL.  For securities AFS with unrealized losses not meeting these criteria, management evaluates whether any decline in fair value is due to credit loss factors.  In making this assessment, management considers any changes to the rating of the security by rating agencies and adverse conditions specifically related to the issuer of the security, among other factors.  If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security.  If the present value of the cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses (“ACL”) is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis.  Changes in the ACL under ASC 326-30 are recorded as provisions for (or reversal of) credit loss expense.  Losses are charged against the allowance when the collectability of a debt security AFS is confirmed or when either of the criteria regarding intent or requirement to sell is met.  Any impairment that has not been recorded through an ACL is recognized in other comprehensive income, net of income taxes.  At March 31, 2023 and at adoption of CECL on January 1, 2023, there was no ACL related to debt securities AFS.  Accrued interest receivable on debt securities was excluded from the estimate of credit losses.
ACL - Securities Held to Maturity - Since the adoption of CECL, the Company measures credit losses on HTM securities on a collective basis by major security type with each type sharing similar risk characteristics, and considers historical credit loss information that is adjusted for current conditions and reasonable and supportable forecasts. The ACL on securities HTM is a contra asset valuation account that is deducted from the carrying amount of HTM securities to present the net amount expected to be collected.  HTM securities are charged off against the ACL when deemed uncollectible.  Adjustments to the ACL are reported in the Company’s Consolidated Statements of Income in the provision for credit losses.  Accrued interest receivable on HTM securities is excluded from the estimate of credit losses.  With regard to US Treasury securities, these have an explicit government guarantee; therefore, no ACL is recorded for these securities.  With regard to obligations of states and political subdivisions and other HTM securities, management considers (1) issuer bond ratings, (2) historical loss rates for given bond ratings, (3) the financial condition of the issuer, and (4) whether issuers continue to make timely principal and interest payments under the contractual terms of the securities.  At March 31, 2023 and at adoption of CECL on January 1, 2023, there was no ACL related to securities HTM.

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

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

Revenue From Contracts With Customers: The Company records revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“Topic 606”).  Under Topic 606, the Company must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) it satisfies a performance obligation. No revenue has been recognized in the current reporting period that results from performance obligations satisfied in previous periods.

The Company’s primary sources of revenue are derived from interest and dividends earned on loans, securities and other financial instruments that are not within the scope of Topic 606.  The Company has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income iswas not necessary.

The Company generally satisfies its performance obligations on contracts with customers as services are rendered, and the transaction prices are typically fixed and charged either on a periodic basis (generally monthly) or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.

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

Interest Income: The Company’s largest source of revenue is interest income which is primarily recognized on an accrual basis based on contractual terms written into loans and investment contracts.

Noninterest Revenue:  The Company derives the majority of its noninterest revenue from: (1) service charges for deposit related services, (2) gains related to mortgage loan sales, (3) trust fees and (4) debit and credit card interchange income.  Most of these services are transaction based and revenue is recognized as the related service is provided.

Derivatives:  Certain of the Bank’s commercial loan customers have entered into interest rate swap agreements directly with the Bank.  At the same time the Bank enters into a swap agreement with its customer, the Bank enters into a corresponding interest rate swap agreement with a correspondent bank at terms mirroring the Bank’s interest rate swap with its commercial loan customer.   This is known as a back-to-back swap agreement.  Under this arrangement the Bank has 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. At June 30, 2022March 31,2023 and December 31, 2021,2022, the total notional amount of such agreements was $129.8$115.1 million and $140.7$125.3 million, respectively, and resulted in a derivative asset with a fair value of $4.6$5.3 million and $3.3$6.5 million, respectively, which were included in other assets and a derivative liability of $4.6$5.3 million and $3.3$6.5 million, respectively, which were included in other liabilities.

Mortgage Banking Derivatives: Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as derivatives not qualifying for hedge accounting.  Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest rate on the loan is locked.  The Bank enters into commitments to sell mortgage backed securities, which it later buys back in order to hedge its exposure to interest rate risk in its mortgage pipeline.  At times, the Bank also enters into forward commitments for the future delivery of mortgage loans when loans are closed but not yet sold, in order to hedge the change in interest rates resulting from its commitments to sell the loans.
    
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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 $(5,000)$4,000 at June 30, 2022March 31, 2023 and $25,000$0 at December 31, 2021.2022.  The net fair value of mortgage backed security derivatives was $300($3,000) at June 30, 2022March 31, 2023 and $(13,000)$0 at December 31, 2021.2022.

Loans Held for Sale:  Mortgage loans originated and intended for sale in the secondary market are carried at fair value, as determined by outstanding commitments from investors. As of June 30, 2022March 31, 2023 and December 31, 2021,2022, these loans had net unrealized gains of $16,000$5,000 and $51,000,$4,000, respectively, which are reflected in their carrying value.  Changes in fair value of loans held for sale are included in net gains on mortgage loans.  Loans are sold with servicing released; therefore no mortgage servicing right assets are established.
 
Newly Issued Not Yet Effective Standards:  FASB issued ASU No. 2016-13,2023-01, Financial Instruments—Investments - Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.Structures Using the Proportional Amortization Method.  This ASU provides financial statement users with more decision-useful information aboutstandard allows entities to elect to account for qualifying tax equity investments using 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 specifiedproportional amortization method, for measuring expected credit losses, and an entity is allowed to apply methods that reasonably reflect its expectationsregardless of the credit loss estimate. Although anprogram giving rise to the related income tax credits.  This election allows the 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 writedown of investment to federal income tax expense where income tax credits are recorded.  This also aligns the allowancetreatment of other tax equity investments with that allowed for low income housing tax 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.

ASU No. 2019-10 Financial Instruments – Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842) – Effective Dates updated the effective date of this ASU for smaller reporting companies, such as the Company, to fiscal years beginning after December 15, 2022.investments.  The Company selected a software vendor for applying this new ASU for Current Expected Credit Losses (“CECL”), began implementation of the software in the second quarter of 2018, completed integration during the third quarter of 2018 and ran parallel computations with both systems using the current GAAP incurred loss model in the fourth quarter of 2018.  The Company went live with this software beginning in January 2019 for its monthly incurred loss computations and began modeling the new current expected credit loss model assumptions to the allowance for loan losses computation.  In the periods since, the Company modeled the various methods prescribed in the ASU against the Company’s identified loan segments.  The Company anticipates continuing to run parallel computations as it continues to evaluate the impact of adoption of the new standard.

ASU 2020-04,Reference Rate Reform (Topic 848), Facilitation of the Effects of Reference Rate Reform on Financial Reporting provides temporary optional expedients and exceptions to GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from LIBOR and other interbank offered rates to alternative reference rates. Entities can elect not to apply certain modification accounting requirements to contracts affected by reference rate reform, if certain criteria are met. Entities that make such elections would not have to remeasure contracts at the modification date or reassess a previous accounting determination.  Entities can elect various optional expedients that would allow them to continue applying hedge accounting for hedging relationships affected by reference rate reform, if certain criteria are met. We are utilizing the timeline guidance published by the Alternative Reference Rates Committee to develop and achieve internal milestones during this transitional period.  We have discontinued the use of new LIBOR-based loans and interest rate derivatives, according to regulatory guidelines.  The amended guidance under Topic 848 and our ability to elect its temporary optional expedients and exceptions are effective for us through December 31,2022.  We expect to adopt 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.  This ASUstandard is effective for the Company for fiscal years beginning after December 15, 2022.2023, including interim periods within these fiscal years.  The Company already utilizes the proportional amortization method for its investments in low income housing tax credit investments and as it has no other types of investments in tax credit structures, adoption of this standard will not have any immediate impact.

FASB issued ASU 2023-01, Leases (Topic 842): Common Control Arrangements.  This standard requires entities to amortize leasehold improvements associated with common control leases over the useful life to the common control group.  The standard is effective for the Company for fiscal years beginning after December 15, 2023, including interim periods within these fiscal years.  As the Company does not believehave any such common control leases, adoption of this ASUstandard will not have a material impact on its financial results and will add the required disclosures for gross chargeoffs in its financial statements upon adoption of the new standard.any immediate impact.

-14--15-
Index
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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
 
June 30, 2022
            
March 31, 2023
            
Available for Sale                        
U.S. Treasury and federal agency securities $209,323  $29  $(9,396) $199,956  $255,211  $175  $(13,528) $241,858 
U.S. Agency MBS and CMOs  102,755   73   (8,699)  94,129   134,956   81   (12,793)  122,244 
Tax-exempt state and municipal bonds  39,567   97   (267)  39,397   37,142   77   (270)  36,949 
Taxable state and municipal bonds  99,040   13   (5,389)  93,664   119,862   149   (6,874)  113,137 
Corporate bonds and other debt securities  8,690   9   (217)  8,482   12,112   4   (345)  11,771 
 $459,375  $221  $(23,968) $435,628  $559,283  $486  $(33,810) $525,959 
                                
Held to Maturity                                
U.S. Treasury
 $231,935  $71  $(8,291) $223,715  $251,286  $—  $(11,274) $240,012 
Tax-exempt state and municipal bonds  120,786
   139
   (3,366)  117,559
   97,101
   552
   (2,106)  95,547
 

 $352,721  $210  $(11,657) $341,274  $348,387  $552  $(13,380) $335,559 

 
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Fair
Value
  
Amortized
Cost
  
Gross
Unrealized
Gains
  
Gross
Unrealized
Losses
  
Fair
Value
 
December 31, 2021
            
Available for Sale            
December 31, 2022
            
Available for Sale:            
U.S. Treasury and federal agency securities $208,153  $215  $(1,523) $206,845  $240,921  $23  $(16,310) $224,634 
U.S. Agency MBS and CMOs  87,343   416   (962)  86,797   128,165   —   (14,347)  113,818 
Tax-exempt state and municipal bonds  36,298   1,258   0   37,556   37,198   10   (498)  36,710 
Taxable state and municipal bonds  79,394   812   (645)  79,561   120,647   49   (8,525)  112,171 
Corporate bonds and other debt securities  5,251   63   (10)  5,304   12,387   —   (463)  11,924 
 $416,439  $2,764  $(3,140) $416,063  $539,318  $82  $(40,143) $499,257 
Held to Maturity                                
U.S. Treasury $
251,307  $
—  $
(13,677) $
237,630 
Tax-exempt state and municipal bonds $137,003  $2,484  $(215) $139,272   97,458   415   (2,853)  95,020 

 $348,765  $415  $(16,530) $332,650 

There were 0no sales of securities in the three and six month periods ended June 30, 2022March 31, 2023 and 2021.2022.

-16-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 2 – SECURITIES (Continued)

On January 1, 2022, the Company reclassified 10ten 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 June 30, 2022March 31, 2023 were as follows (dollars in thousands):

  Held–to-Maturity Securities  Available-for-Sale Securities 
  
Amortized
Cost
  
Fair
Value
  
Amortized
Cost
  
Fair
Value
 
Due in one year or less $20,307  $20,126  $15,795  $15,795 
Due from one to five years  310,172   299,759   267,490   258,879 
Due from five to ten years  22,242   21,389   74,995   68,458 
Due after ten years  0   0   101,095   92,496 
  $352,721  $341,274  $459,375  $435,628 

-15-
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 2 – SECURITIES (Continued)
  Held–to-Maturity Securities  Available-for-Sale Securities 
  
Amortized
Cost
  
Fair
Value
  
Amortized
Cost
  
Fair
Value
 
Due in one year or less $58,157  $57,487  $22,431  $22,106 
Due from one to five years  272,386   260,375   369,226   352,338 
Due from five to ten years  17,844   17,697   34,295   30,814 
Due after ten years  —   —   133,331   120,701 
  $348,387  $335,559  $559,283  $525,959 

Securities with unrealized losses at June 30, 2022March 31, 2023 and December 31, 2021,2022, 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 
June 30, 2022
 
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
 
March 31, 2023
 
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
 
Available for Sale                                    
U.S. Treasury and federal agency securities $156,760  $(5,059) $34,712  $(4,337) $191,472  $(9,396) $90,278  $(2,249) $125,775  $(11,279) $216,053  $(13,528)
U.S. Agency MBS and CMOs  71,643   (6,522)  12,257   (2,177)  83,900   (8,699)  31,574   (1,021)  64,296   (11,772)  95,870   (12,793)
Tax-exempt state and municipal bonds  14,305   (267)  0   0   14,305   (267)  17,744   (103)  5,541   (167)  23,285   (270)
Taxable state and municipal bonds  79,673   (4,298)  8,070   (1,091)  87,743   (5,389)  41,608   (989)  58,236   (5,885)  99,844   (6,874)
Corporate bonds and other debt securities  6,748   (217)  0   0   6,748   (217)  7,462   (148)  3,839   (197)  11,301   (345)
Total $329,129  $(16,363) $55,039  $(7,605) $384,168  $(23,968) $188,666  $(4,510) $257,687  $(29,300) $446,353  $(33,810)
                                                
Held to Maturity                                                
U.S. Treasury $213,866  $(8,291) $0  $0  $213,866  $(8,291) $114,386  $(5,063) $125,626  $(6,211) $240,012  $(11,274)
Tax-exempt state and municipal bonds  94,354   (3,366)  0   0  94,354   (3,366)  26,395   (384)  49,855   (1,722)  76,250   (2,106)
 $308,220  $(11,657) $0  $0 $308,220  $(11,657) $140,781  $(5,447) $175,481  $(7,933) $316,262  $(13,380)

  Less than 12 Months  12 Months or More  Total 
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 $77,066  $(955) $18,432  $(568) $95,498  $(1,523)
U.S. Agency MBS and CMOs  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  37,648   (638)  498   (7)  38,146   (645)
Corporate bonds and other debt securities  1,352   (10)  0   0   1,352   (10)
Total $168,320  $(2,433) $23,120  $(707) $191,440  $(3,140)
                         
Held to Maturity                        
Tax-exempt state and municipal bonds $61,166  $(215) $0  $0  $61,166  $(215)
-17-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 2 – SECURITIES (Continued)

  Less than 12 Months  12 Months or More  Total 
December 31, 2022
 
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
  
Fair
Value
  
Unrealized
Loss
 
Available for Sale:                  
U.S. Treasury and federal agency securities $144,796  $(6,230) $66,008  $(10,080) $210,804  $(16,310)
U.S. Agency MBS and CMOs  64,427   (4,789)  41,340   (9,558)  105,767   (14,347)
Tax-exempt state and municipal bonds  31,337   (498)  —   —   31,337   (498)
Taxable state and municipal bonds  71,165   (3,337)  33,452   (5,188)  104,617   (8,525)
Corporate bonds and other debt securities  10,668   (357)  1,256   (106)  11,924   (463)

 $322,393  $(15,211) $142,056  $(24,932) $464,449  $(40,143)
                         
Held to Maturity:                        
U.S. Treasury $
237,630  $
(13,677) $
—  $
—  $
237,630  $
(13,677)
Tax-exempt state and municipal bonds  57,671   (2,314)  21,721   (539)  79,392   (2,853)
  $295,301  $(15,991) $21,721  $(539) $317,022  $(16,530)

Other-Than-Temporary-Impairment

Management evaluates securities for other-than-temporary impairment (“OTTI”)in an unrealized loss position at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.  In analyzing an issuer’s financial condition, Management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred and the results of reviews of the issuer’s financial condition.

At June 30, 2022, 355March 31, 2023, 413 securities available for sale with fair values totaling $384.2$446.4 million had unrealized losses totaling $24.0$33.8 million. For securities available for sale with unrealized losses, management considered the financial condition of the issuer and the Company’s intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value. At June 30, 2022, 57March 31, 2023, 66 securities held to maturity with fair values totaling $308.2$316.3 million had unrealized losses totaling $11.7$13.4 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 each period and each investment were attributable to changes in interest rates and not due to credit quality.  As such, 0 OTTI charges were necessary during each period.no allowance for credit losses on securities available for sale or held to maturity have been established as of March 31, 2023.

Securities with a carrying value of approximately $3.7$3.6 million and $4.9$3.5 million were pledged as security for public deposits, letters of credit and for other purposes required or permitted by law at June 30, 2022March 31, 2023 and December 31, 2021,2022, respectively.
-18-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


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

NOTE 3 –LOANS



Portfolio loans were as follows (dollars in thousands):

  
March 31,
2023
  
December 31,
2022
 
Commercial and industrial $
473,354  $
441,716 
         
Commercial real estate:        
Residential developed  7,001   7,234 
Unsecured to residential developers
  —
   —
 
Vacant and unimproved  38,700   36,270 
Commercial development  99   103 
Residential improved  116,177   112,791 
Commercial improved  255,894   259,281 
Manufacturing and industrial  125,477   121,924 
Total commercial real estate  543,348   537,603 
Consumer:        
Residential mortgage  148,676   139,148 
Unsecured  106   121 
Home equity  52,647   56,321 
Other secured  2,808   2,839 
Total consumer  204,237   198,429 
Total loans  1,220,939   1,177,748 
Allowance for credit losses  (16,794)  (15,285)
  $1,204,145  $1,162,463 


  
June 30,
2022
  
December 31,
2021
 
Commercial and industrial:      
Commercial and industrial, excluding PPP $407,788  $378,318 
PPP  2,791   41,939 
Total commercial and industrial  410,579   420,257 
Commercial real estate:        
Residential developed  4,094   4,862 
Unsecured to residential developers  0   5,000 
Vacant and unimproved  35,912   36,240 
Commercial development  112   171 
Residential improved  102,885   100,077 
Commercial improved  258,676   259,039 
Manufacturing and industrial  117,424   110,712 
Total commercial real estate  519,103   516,101 
Consumer:        
Residential mortgage  125,771   117,800 
Unsecured  168   210 
Home equity  52,671   51,269 
Other secured  3,623   3,356 
Total consumer  182,233   172,635 
Total loans  1,111,915   1,108,993 
Allowance for loan losses  (14,631
)
  (15,889
)
  $1,097,284  $1,093,104 


The totals above are shown net of deferred fees and costs.  Deferred fees on loans totaled $1.4$1.3 million and $2.6$1.3 million at June 30, 2022March 31, 2023 and December 31, 2021,2022, respectively.  Deferred costs on loans totaled $1.4 million and $1.3$1.4 million at June 30, 2022March 31, 2023 and December 31, 2021,2022, respectively.


-17--19-
Index
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 –LOANS (Continued)

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

Three months ended March 31, 2023
 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Beginning balance, prior to adoption of ASU 2016-03 $5,596  $7,180  $2,458  $51  $15,285 
Impact of adoption of ASU 2016-03  1,299   (212)  389   —   1,476 
Charge-offs  —   —   (21)  —   (21)
Recoveries  9   3   42   —   54 
Provision for credit losses (1)
  220   (201)  (50)  31   — 
Ending Balance $7,124  $6,770  $2,818  $82  $16,794 

Three months ended March 31, 2022
 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Beginning balance $5,176  $8,051  $2,633  $29  $15,889 
Charge-offs  —   —   (35)  —   (35)
Recoveries  5   233   24   —   262 
Provision for credit losses (1)
  148   (1,213)  (469)  34   (1,500)
Ending Balance $5,329  $7,071  $2,153  $63  $14,616 

Three months ended June 30, 2022 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Beginning balance $5,329  $7,071  $2,153  $63  $14,616 
Charge-offs  (38)  0   (22)  0   (60)
Recoveries  5   38   32   0   75 
Provision for loan losses  (40)  (87)  153   (26)  0 
Ending Balance $5,256  $7,022  $2,316  $37  $14,631 


Three months ended June 30, 2021
 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Beginning balance $5,801  $8,898  $2,718  $35  $17,452 
Charge-offs  0   0   (30)  0   (30)
Recoveries  35   72   27   0   134 
Provision for loan losses  (630)  (230)  141   (31)  (750)
Ending Balance $5,206  $8,740  $2,856  $4  $16,806 


Six months ended June 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)  0   (57)  0   (95)
Recoveries  10   271   56   0   337 
Provision for loan losses  108   (1,300)  (316)  8   (1,500)
Ending Balance $5,256  $7,022  $2,316  $37  $14,631 


Six months ended June 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   (80)  0   (80)
Recoveries  55   111   62   0   228 
Provision for loan losses  (1,481)  630   116   (15)  (750)
Ending Balance $5,206  $8,740  $2,856  $4  $16,806 

(1)Beginning January 1, 2023, calculation is based on CECL methodology.  Prior to January 1, 2023, calculation was based on probable incurred loss methodology.

-18-The following table presents gross chargeoffs for the three months ended March 31, 2023 by portfolio class and origination year (dollars in thousands):

  Term Loans By Origination Year       
March 31, 2023 2023  2022  2021  2020  2019  Prior  
Revolving
Loans
  Total 
                         
                         
Commercial and industrial $—  $—  $—  $—  $—  $—  $—  $— 
Commercial development  —   —   —   —   —   —   —   — 
Commercial improved  —   —   —   —   —   —   —   — 
Manufacturing and industrial  —   —   —   —   —   —   —   — 
Residential development  —   —   —   —   —   —   —   — 
Residential improved  —   —   —   —   —   —   —   — 
Vacant and unimproved  —   —   —   —   —   —   —   — 
Total commercial  —   —   —   —   —   —   —   — 
                                 
Residential mortgage  —   —   —   —   —   —   —   — 
Consumer unsecured  —   —   —   —   —   —   —   — 
Home equity  —   —   —   —   —   —   —   — 
Other  —   —   —   —   —   —   21   21 
Total consumer  —   —   —   —   —   —   21   21 
                                 
Total loans  —   —   —   —   —   —   21   21 

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

Collateral dependent loans are loans for which the repayment is expected to be provided substantially through the operation or sale of the collateral and the borrower is experiencing financial difficulty.  Under CECL for collateral dependent loans, the Company has adopted the practical expedient to measure the allowance on the fair value of collateral.

The allowance is calculated on an individual loan basis based on the shortfall between the fair value of the loan’s collateral, which is adjusted for liquidation costs/discounts, and the loan’s amortized cost.  If the fair value of the collateral exceeds the loan’s amortized cost, no allowance is necessary.  The Company’s policy is to obtain appraisals on any significant pieces of collateral.  For real estate collateral that is in industries that are undergoing significant stress, or properties that are specialized use or have limited marketability, higher discounts are applied in determining fair value.

There have been no significant changes to the types of collateral securing our collateral dependent loans.

The amortized cost of collateral-dependent loans by class as of March 31, 2023 was as follows (dollars in thousands):

  Collateral Type    
March 31, 2023 Real Estate  Other  
Allowance
Allocated
 
          
Commercial and industrial $—  $—  $— 
Commercial real estate:            
Residential developed  —   —   — 
Unsecured to residential developers  —   —   — 
Vacant and unimproved  —   —   — 
Commercial development  —   —   — 
Residential improved  30   —   — 
Commercial improved  303   —   6 
Manufacturing and industrial  —   —   — 
   333   —   6 
Consumer            
Residential mortgage  —   —   — 
Unsecured  —   —   — 
Home equity  —   —   — 
Other secured  —   —   — 
Consumer  —   —   — 
Total $333  $—  $6 

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

December 31, 2022
 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Allowance for credit losses:               
Ending allowance attributable to loans:               
Individually reviewed for impairment $55  $20  $220  $—  $295 
Collectively evaluated for impairment  5,541   7,160   2,238   51   14,990 
Total ending allowance balance $5,596  $7,180  $2,458  $51  $15,285 
Loans:                    
Individually reviewed for impairment $3,603  $518  $2,886  $—  $7,007 
Collectively evaluated for impairment  438,113   537,085   195,543   —   1,170,741 
Total ending loans balance $441,716  $537,603  $198,429  $—  $1,177,748 

June 30, 2022
 
Commercial
and
Industrial
  
Commercial
Real Estate
  Consumer  Unallocated  Total 
Allowance for loan losses:               
Ending allowance attributable to loans:               
Individually reviewed for impairment $59  $21  $216  $0  $296 
Collectively evaluated for impairment  5,197   7,001   2,100   37   14,335 
Total ending allowance balance $5,256  $7,022  $2,316  $37  $14,631 
Loans:                    
Individually reviewed for impairment $829  $584  $2,840  $0  $4,253 
Collectively evaluated for impairment  409,750   518,519   179,393   0   1,107,662 
Total ending loans balance $410,579  $519,103  $182,233  $0  $1,111,915 


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 $303  $24  $238  $0  $565 
Collectively evaluated for impairment  4,873   8,027   2,395   29   15,324 
Total ending allowance balance $5,176  $8,051  $2,633  $29  $15,889 
Loans:                    
Individually reviewed for impairment $3,375  $1,127  $3,024  $0  $7,526 
Collectively evaluated for impairment  416,882   514,974   169,611   0   1,101,467 
Total ending loans balance $420,257  $516,101  $172,635  $0  $1,108,993 


-19--21-
Index
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 June 30, 2022 (dollars in thousands):


June 30, 2022
 
Unpaid
Principal
Balance
  
Recorded
Investment
  
Allowance
Allocated
 
With no related allowance recorded:         
Commercial and industrial $460  $460  $— 
Commercial real estate:            
Residential improved  38   38   — 
Commercial improved  46   46   — 
   84   84   — 
Consumer  0   0   — 
Total with no related allowance recorded $544  $544  $— 
             
With an allowance recorded:            
Commercial and industrial $369  $369  $59 
Commercial real estate:            
Commercial improved  314   314   10 
Manufacturing and industrial  186   186   11 
   500   500   21 
Consumer:            
Residential mortgage  2,519   2,519   192 
Unsecured  32   32   2 
Home equity  289   289   22 
   2,840   2,840   216 
Total with an allowance recorded $3,709  $3,709  $296 
Total $4,253  $4,253  $296 


-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, 20212022 (dollars in thousands):

December 31, 2022
 
Unpaid
Principal
Balance
  
Recorded
Investment
  
Allowance
Allocated
  Year-To-Date Average Recorded Investment 
With no related allowance recorded:            
Commercial and industrial $3,278  $3,278  $—  $2,338 
Commercial real estate:                
Residential improved  31   31   —   33 
   31   31   —   33 
Consumer  —   —   —   — 
Total with no related allowance recorded $3,309  $3,309  $—  $2,371 
                 
With an allowance recorded:                
Commercial and industrial $325  $325  $55  $365 
Commercial real estate:                
Commercial improved  307   307   9   313 
Manufacturing and industrial  180   180   11   185 
   487   487   20   498 
Consumer:                
Residential mortgage  2,653   2,653   202   2,619 
Unsecured  29   29   2   29 
Home equity  204   204   16   234 
   2,886   2,886   220   2,882 
Total with an allowance recorded $3,698  $3,698  $295  $3,745 
Total $7,007  $7,007  $295  $6,116 

December 31, 2021 
Unpaid
Principal
Balance
  
Recorded
Investment
  
Allowance
Allocated
 
With no related allowance recorded:         
Commercial and industrial $669  $669  $— 
Commercial real estate:            
Residential improved  41   41   — 
Commercial improved  577   577   — 
   618   618   — 
Consumer  0   0   — 
Total with no related allowance recorded $1,287  $1,287  $— 
             
With an allowance recorded:            
Commercial and industrial $2,706  $2,706  $303 
Commercial real estate:            
Commercial improved  318   318   14 
Manufacturing and industrial  191   191   10 
   509   509   24 
Consumer:            
Residential mortgage  2,726   2,726   214 
Unsecured  64   64   5 
Home equity  234   234   19 
   3,024   3,024   238 
Total with an allowance recorded $6,239  $6,239  $565 
Total $7,526  $7,526  $565 


-21--22-
Index
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 six month periods ended June 30, 2022 and 2021 (dollars in thousands):


  
Three
Months
Ended
June 30,
2022
  
Three
Months
Ended
June 30,
2021
  
Six
Months
Ended
June 30,
2022
  
Six
Months
Ended
June 30,
2021
 
Average of impaired loans during the period:            
Commercial and industrial $2,284  $1,916  $3,232  $3,251 
Commercial real estate:                
Residential developed  0   0   0   22 
Residential improved  39   33   39   60 
Commercial improved  362   2,170   453   2,190 
Manufacturing and industrial  187   197   188   198 
Consumer  2,793   3,619   2,824   3,780 
Interest income recognized during impairment:                
Commercial and industrial  26   9   165   143 
Commercial real estate  18   35   28   66 
Consumer  55   31   81   69 
Cash-basis interest income recognized                
Commercial and industrial  27   8   158   134 
Commercial real estate  21   35   34   66 
Consumer  56   32   82   68 


-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 June 30, 2022March 31, 2023 and December 31, 2021:2022:

March 31, 2023 Nonaccrual with No Allowance  Nonaccrual with Allowance  Total Nonaccrual  
Over 90
days
Accruing
  Total Nonperforming Loans 
Commercial and industrial $—  $—  $—  $—  $— 
                     
Commercial real estate:                    
Residential developed  —   —   —   —   — 
Unsecured to residential developers  —   —   —   —   — 
Vacant and unimproved  —   —   —   —   — 
Commercial development  —   —   —   —   — 
Residential Improved  —   —   —   —   — 
Commercial improved  —   —   —   —   — 
Manufacturing and industrial  —   —   —   —   — 
   —   —   —   —   — 
Consumer:                    
Residential mortgage  —   75   75   —   75 
Unsecured  —   —   —   —   — 
Home equity  —   —   —   —   — 
Other secured  —   —   —   —   — 
   —   75   75   —   75 
Total $—  $75  $75  $—  $75 

December 31, 2022 Nonaccrual with No Allowance  Nonaccrual with Allowance  Total Nonaccrual  
Over 90
days
Accruing
  Total Nonperforming Loans 
Commercial and industrial $—  $—  $—  $—  $— 
                     
Commercial real estate:                    
Residential developed  —   —   —   —   — 
Unsecured to residential developers  —   —   —   —   — 
Vacant and unimproved  —   —   —   —   — 
Commercial development  —   —   —   —   — 
Residential improved  —   —   —   —   — 
Commercial improved  —   —   —   —   — 
Manufacturing and industrial  —   —   —   —   — 
   —   —   —   —   — 
Consumer:                    
Residential mortgage  —   78   78   —   78 
Unsecured  —   —   —   —   — 
Home equity  —   —   —   —   — 
Other secured  —   —   —   —   — 
   —   78   78   —   78 
Total $—  $78  $78  $—  $78 


No interest income was recognized on nonaccrual loans during the three months ended March 31, 2023.
June 30, 2022
 Nonaccrual  
Over 90
days
Accruing
 
Commercial and industrial $0  $0 
Commercial real estate:        
Residential improved  5   0 
   5   0 
Consumer:        
Residential mortgage  85   0 
   85   0 
Total $90  $0 


December 31, 2021 Nonaccrual  
Over 90 days
Accruing
 
Commercial and industrial $0  $0 
Commercial real estate:        
Residential improved  5   0 
   5   0 
Consumer:        
Residential mortgage  86   0 
   86   0 
Total $91  $0 


-23-
Index
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 June 30, 2022March 31, 2023 and December 31, 20212022 by class of loans (dollars in thousands):


June 30, 2022
 
30-90
Days
  
Greater Than
90 Days
  
Total
Past Due
  
Loans Not
Past Due
  Total 
March 31, 2023 
30-90
Days
  
Greater Than
90 Days
  
Total
Past Due
  
Loans Not
Past Due
  Total 
Commercial and industrial $0  $0  $0  $410,579  $410,579  $— $
— $— $473,354 $473,354 
Commercial real estate:                               
Residential developed  0   0   0   4,094   4,094  — — — 7,001 7,001 
Unsecured to residential developers  0   0   0   0   0  —
 —
 —
 —
 —
 
Vacant and unimproved  0   0   0   35,912   35,912  — — — 38,700 38,700 
Commercial development  0   0   0   112   112  — — — 99 99 
Residential improved  0   5   5   102,880   102,885  — — — 116,177 116,177 
Commercial improved  0   0   0   258,676   258,676  83 — 83 255,811 255,894 
Manufacturing and industrial  0   0   0   117,424   117,424   —  —  —  125,477  125,477 
  0   5   5   519,098   519,103   83  —  83  543,265  543,348 
Consumer:                               
Residential mortgage  75   84   159   125,612   125,771  120 74 194 148,482 148,676 
Unsecured  0   0   0   168   168  — — — 106 106 
Home equity  33   0   33   52,638   52,671  — — — 52,647 52,647 
Other secured  0   0   0   3,623   3,623   —  —  —  2,808  2,808 
  108   84   192   182,041   182,233   120  74  194  204,043  204,237 
Total $108  $89  $197  $1,111,718  $1,111,915  $203 $74 $277 $1,220,662 $1,220,939 

December 31, 2022
 
30-90
Days
  
Greater Than
90 Days
  
Total
Past Due
  
Loans Not
Past Due
  Total 
Commercial and industrial $—  $—  $—  $441,716  $441,716 
Commercial real estate:                    
Residential developed  —   —   —   7,234   7,234 
Unsecured to residential developers
  —
   —
   —
   —
   —
 
Vacant and unimproved  —   —   —   36,270   36,270 
Commercial development  —   —   —   103   103 
Residential improved  —   —   —   112,791   112,791 
Commercial improved  71   —   71   259,210   259,281 
Manufacturing and industrial  —   —   —   121,924   121,924 
   71   —   71   537,532   537,603 
Consumer:                    
Residential mortgage  —   77   77   139,071   139,148 
Unsecured  —   —   —   121   121 
Home equity  24   —   24   56,297   56,321 
Other secured  —   —   —   2,839   2,839 
   24   77   101   198,328   198,429 
Total $95  $77  $172  $1,177,576  $1,177,748 

December 31, 2021 
30-90
Days
  
Greater Than
90 Days
  
Total
Past Due
  
Loans Not
Past Due
  Total 
Commercial and industrial $39  $1  $40  $420,217  $420,257 
Commercial real estate:                    
Residential developed  0   0   0   4,862   4,862 
Unsecured to residential developers  0   0   0   5,000   5,000 
Vacant and unimproved  0   0   0   36,240   36,240 
Commercial development  0   0   0   171   171 
Residential improved  0   5   5   100,072   100,077 
Commercial improved  0   0   0   259,039   259,039 
Manufacturing and industrial  0   0   0   110,712   110,712 
   0   5   5   516,096   516,101 
Consumer:                    
Residential mortgage  0   84   84   117,716   117,800 
Unsecured  0   0   0   210   210 
Home equity  0   0   0   51,269   51,269 
Other secured  0   0   0   3,356   3,356 
   0   84   84   172,551   172,635 
Total $39  $90  $129  $1,108,864  $1,108,993 


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


The
At times, the Company had allocated $296,000 and $565,000will modify terms of specific reserves to customers whosea loan terms have been modified in troubled debt restructurings (“TDRs”) as of June 30, 2022 and December 31, 2021, respectively. These loans may have involved the restructuring of terms to allow customersthe customer 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 impairedindividually reviewed loans, an allowance for loan loss is estimated for each TDRsuch modification made to borrowers experiencing financial difficulty 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 impairedindividually reviewed 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 loans, 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 TDRsmodifications to borrowers experiencing financial difficulty 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 restructuringsmodifications to borrowers experiencing financial difficulty as of June 30, 2022 and DecemberMarch 31, 20212023 (dollars in thousands):

  March 31, 2023 
  
Number of
Loans
  
Outstanding
Recorded
Balance
  
Percentage to
Total
Loans
 
Commercial and industrial  3  $309   0.07%
Commercial real estate  3   509   0.09%
Consumer  32   2,847   1.39%
   38  $3,665   0.30%

  June 30, 2022  December 31, 2021 
  
Number of
Loans
  
Outstanding
Recorded
Balance
  
Number of
Loans
  
Outstanding
Recorded
Balance
 
Commercial and industrial  3  $830   4  $3,375 
Commercial real estate  5   584   6   1,127 
Consumer  37   2,840   44   3,024 
   45  $4,254   54  $7,526 


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


TheThe following table presents information related to accruing TDRsmodifications to borrowers experiencing financial difficulty as of June 30, 2022 and DecemberMarch 31, 2021.2023.  The table presents the amount of accruing troubled debt restructuringsmodifications that were on nonaccrual status prior to the restructuring,modification, accruing at the time of restructuringmodification and those that were upgraded to accruing status after receiving six consecutive monthly payments in accordance with the restructuredmodified terms as of eachthe period reported (dollars in thousands):


  
June 30,
2022
  
December 31,
2021
 
Accruing TDR - nonaccrual at restructuring $0  $0 
Accruing TDR - accruing at restructuring  3,789   4,552 
Accruing TDR - upgraded to accruing after six consecutive payments  460   2,968 
  $4,249  $7,520 


  
March 31,
2023
 
Accruing - nonaccrual at modification
 $— 
Accruing - accruing at modification
  3,665 
Accruing - upgraded to accruing after six consecutive payments  — 
  $3,665 

There was 1 consumer loan TDR executed during the three month period ended June 30, 2022. The pre-TDR balance of the loan was $99,000 and there was 0 writedown upon TDR. There were 0 TDRs executedno modifications made to borrowers experiencing financial difficulty during the three month period ended March 31, 2022 or2023.

There were no defaults on loans with modifications to borrowers experiencing financial difficulty during the three and six month periods ended June 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 six month periods ended June 30, 2022 and 2021March 31, 2023 and the balance of loans that became delinquent by more than 90 days past due or that were transferred to nonaccrual within 12 months of restructuringmodification were not material.material.


In March 2020, guidance issued by the federal banking agencies in consultation with FASB and the Coronavirus Aid, Relief and Economic Security (“CARES”) Act collectively 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. Through June 30, 2022, the Bank had applied this guidance and modified 726 individual loans with aggregate principal balances totaling $337.2 million.  As of June 30, 2022, all of these modifications had expired and the loans had returned to their contractual payment terms.

-26-
Index
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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.  The higher the risk grade, the stronger likelihood of loss.  At grade 7, a loan is placed on nonaccrual status.  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:grades in ascending order of likelihood of loss:



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.

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

As of June 30, 2022 and December 31, 2021,2022, the risk grade category of commercial loans by class of loans were as follows (dollars in thousands):

December 31, 2022
  1   2   3   4   5   6   7   8  Total 
Commercial and industrial $15,040  $21,451  $175,762  $220,987  $8,309  $167  $—  $—  $441,716 
                                     
Commercial real estate:                                    
Residential developed  —   —   —   7,234   —   —   —   —   7,234 
Unsecured to residential developers
  —
   —
   —
   —
   —
   —
   —
   —
   —
 
Vacant and unimproved  —   1,231   18,406   16,633   —   —   —   —   36,270 
Commercial development  —   —   103   —   —   —   —   —   103 
Residential improved  —   —   25,585   87,176   30   —   —   —   112,791 
Commercial improved  —   17,802   83,769   151,641   5,762   307   —   —   259,281 
Manufacturing & industrial  —   11,422   32,977   73,566   1,646   2,313   —   —   121,924 
  $15,040  $51,906  $336,602  $557,237  $15,747  $2,787  $—  $—  $979,319 

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


June 30, 2022
  1
   2
   3
   4
   5
   6
   7
   8
  Total 
Commercial and industrial $17,825  $11,677  $145,802  $230,669  $4,412  $194  $0  $0  $410,579 
                                     
Commercial real estate:                                    
Residential developed  0   0   0   4,094   0   0   0   0   4,094 
Unsecured to residential developers  0   0   0   0   0   0   0   0   0 
Vacant and unimproved  0   1,708   15,804   18,400   0   0   0   0   35,912 
Commercial development  0   0   112   0   0   0   0   0   112 
Residential improved  0   0   22,706   80,141   33   0   5   0   102,885 
Commercial improved  0   18,166   68,671   164,785   6,740   314   0   0   258,676 
Manufacturing & industrial  0   3,361   36,259   74,523   3,281   0   0   0   117,424 
  $17,825  $34,912  $289,354  $572,612  $14,466  $508  $5  $0  $929,682 


December 31, 2021
  1
   2
   3   4
   5
   6
   7
   8
  Total 
Commercial and industrial $56,979  $19,300  $110,877  $227,087  $2,700  $3,314  $0  $0  $420,257 
                                     
Commercial real estate:                                    
Residential developed  0   0   0   4,862   0   0   0   0   4,862 
Unsecured to residential developers  0   0   0   5,000   0   0   0   0   5,000 
Vacant and unimproved  0   1,763   13,492   20,985   0   0   0   0   36,240 
Commercial development  0   0   171   0   0   0   0   0   171 
Residential improved  0   0   24,450   75,503   119   0   5   0   100,077 
Commercial improved  0   15,115   71,211   165,268   7,127   318   0   0   259,039 
Manufacturing & industrial  0   0   41,757   65,601   3,354   0   0   0   110,712 
  $56,979  $36,178  $261,958  $564,306  $13,300  $3,632  $5  $0  $936,358 



CommercialThe following table summarizes loan ratings by grade for 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):

  Term Loans Amortized Cost Basis By Origination Year and Risk Grades       
March 31, 2023 2023  2022  2021  2020  2019  Prior  Revolving  Total 
Commercial                        
Commercial and industrial                        
Grades 1-3 $14,305  $60,752  $18,955  $7,346  $14,878  $47,073  $70,542  $233,851 
Grade 4  12,017   46,095   24,990   26,313   10,486   30,408   77,814   228,123 
Grade 5  —   342   43   407   99   115   10,246   11,252 
Grade 6  —   41   49   —   —   38   —   128 
Grade 7-8  —   —   —   —   —   —   —   — 
  $26,322  $107,230  $44,037  $34,066  $25,463  $77,634  $158,602  $473,354 
Commercial development                                
Grades 1-3 $—  $99  $—  $—  $—  $—  $—  $99 
Grade 4  —   —   —   —   —   —   —   — 
Grade 5  —   —   —   —   —   —   —   — 
Grade 6  —   —   —   —   —   —   —   — 
Grade 7-8  —   —   —   —   —   —   —   — 
  $—  $99  $—  $—  $—  $—  $—  $99 
Commercial improved                                
Grades 1-3 $6,992  $18,654  $33,327  $10,894  $14,484  $17,925  $2,915  $105,191 
Grade 4  1,778   37,516   37,376   43,647   17,937   3,321   3,200   144,775 
Grade 5  —   148   —   29   2,227   3,171   50   5,625 
Grade 6  —   —   303   —   —   —   —   303 
Grade 7-8  —   —   —   —   —   —   —   — 
  $8,770  $56,318  $71,006  $54,570  $34,648  $24,417  $6,165  $255,894 
Manufacturing and industrial                                
Grades 1-3 $786  $17,839  $4,829  $8,562  $4,370  $7,459  $430  $44,275 
Grade 4  6,709   27,464   15,090   7,933   5,805   14,188   145   77,334 
Grade 5  —   177   94   —   —   810   495   1,576 
Grade 6  —   —   —   —   —   2,292   —   2,292 
Grade 7-8  —   —   —   —   —   —   —   — 
  $7,495  $45,480  $20,013  $16,495  $10,175  $24,749  $1,070  $125,477 
Residential development                                
Grades 1-3 $—  $—  $—  $—  $—  $—  $—  $— 
Grade 4  322   3,837   1,455   —   —   —   1,387   7,001 
Grade 5  —   —   —   —   —   —   —   — 
Grade 6  —   —   —   —   —   —   —   — 
Grade 7-8  —   —   —   —   —   —   —   — 
  $322  $3,837  $1,455  $—  $—  $—  $1,387  $7,001 
Residential improved                                
Grades 1-3 $4,587  $7,574  $1,442  $9,544  $258  $5,442  $401  $29,248 
Grade 4  4,037   568   30,241   1,988   7,233   15,710   27,122   86,899 
Grade 5  —   —   30   —   —   —   —   30 
Grade 6  —   —   —   —   —   —   —   — 
Grade 7-8  —   —   —   —   —   —   —   — 
  $8,624  $8,142  $31,713  $11,532  $7,491  $21,152  $27,523  $116,177 
Vacant and unimproved                                
Grades 1-3 $—  $4,503  $7,725  $7,210  $—  $110  $646  $20,194 
Grade 4  952   2,897   3,721   8,332   163   117   982   17,164 
Grade 5  1,342   —   —   —   —   —   —   1,342 
Grade 6  —   —   —   —   —   —   —   — 
Grade 7-8  —   —   —   —   —   —   —   — 
  $2,294  $7,400  $11,446  $15,542  $163  $227  $1,628  $38,700 
                                 
Total Commercial      
   
   
   
   
   
   
 
Grades 1-3 $26,670  $109,421  $66,278  $43,556  $33,990  $78,009  $74,934  $432,858 
Grade 4  25,815   118,377   112,873   88,213   41,624   63,744   110,650   561,296 
Grade 5  1,342   667   167   436   2,326   4,096   10,791   19,825 
Grade 6  —   41   352   —   —   2,330   —   2,723 
Grade 7-8  —   —   —   —   —   —   —   — 
  $53,827  $228,506  $179,670  $132,205  $77,940  $148,179  $196,375  $1,016,702 

-29-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 3 –LOANS (Continued)


  
June 30,
2022
  
December 31,
2021
 
Not classified as impaired $108  $233 
Classified as impaired  405   3,404 
Total commercial loans classified substandard or worse $513  $3,637 



The Company considers the performance of the loan portfolio and its impact on the allowance for loancredit 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 by year of origination and based on payment activitydelinquency status at March 31, 2023 (dollars in thousands):


  Term Loans Amortized Cost Basis By Origination Year       
March 31, 2023 2023  2022  2021  2020  2019  Prior  Revolving  Total 
Retail                        
Residential mortgage                        
Performing $17,336  $42,826  $27,298  $10,419  $5,322  $33,520  $11,880  $148,601 
Nonperforming  —   —   —   —   —   75   —   75 
  $17,336  $42,826  $27,298  $10,419  $5,322  $33,595  $11,880  $148,676 
Consumer unsecured                                
Performing $—  $—  $—  $13  $15  $26  $52  $106 
Nonperforming  —   —   —   —   —   —   —   — 
  $—  $—  $—  $13  $15  $26  $52  $106 
Home equity                                
Performing $71  $901  $233  $489  $249  $2,324  $48,380  $52,647 
Nonperforming  —   —   —   —   —   —   —   — 
  $71  $901  $233  $489  $249  $2,324  $48,380  $52,647 
Other                                
Performing $304  $1,133  $687  $360  $100  $224  $—  $2,808 
Nonperforming  —   —   —   —   —   —   —   — 
  $304  $1,133  $687  $360  $100  $224  $—  $2,808 
                                 
Total Retail $17,711  $44,860  $28,218  $11,281  $5,686  $36,169  $60,312  $204,237 


The following table presents the recorded investment in consumer loans based on payment status at December 31, 2022 (dollars in thousands):
June 30, 2022 
Residential
Mortgage
  
Consumer
Unsecured
  
Home
Equity
  
Consumer
Other
 
Performing $125,686  $168  $52,671  $3,623 
Nonperforming  85   0   0   0 
Total $125,771  $168  $52,671  $3,623 

-28-
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
December 31, 2022
 
Residential
Mortgage
  
Consumer
Unsecured
  
Home
Equity
  
Consumer
Other
 
Performing $139,071  $121  $56,321  $2,839 
Nonperforming  77   —   —   — 
Total $139,148  $121  $56,321  $2,839 
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   0   0   0 
Total $117,800  $210  $51,269  $3,356 


-30-
Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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, 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.

-29--31-
Index
Index
MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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  
Quoted Prices in
Active Markets
for Identical
Assets
  
Significant Other
Observable
Inputs
  
Significant
Unobservable
Inputs
 
June 30, 2022
            
 Value
  (Level 1)
  (Level 2)
  (Level 3)
 
March 31, 2023
            
Available for sale securities                        
U.S. Treasury and federal agency securities $199,956  $0  $199,956  $0  $241,858  $—  $241,858  $— 
U.S. Agency MBS and CMOs  94,129   0   94,129   0   122,244   —   122,244   — 
Tax-exempt state and municipal bonds  39,397   0   39,397   0   36,949   —   36,949   — 
Taxable state and municipal bonds  93,664   0   93,664   0   113,137   —   113,137   — 
Corporate bonds and other debt securities  8,482   0   8,482   0   11,771   —   11,771   — 
Other equity securities  1,354   0   1,354   0   1,321   —   1,321   — 
Loans held for sale  1,163   0   1,163   0   87   —   87   — 
Interest rate swaps  4,556   0   0   4,556   5,294   —   5,294   — 
Total assets measured at fair value on recurring basis $532,661  $—  $532,661  $— 
                
Interest rate swaps  (4,556)  0   0   (4,556)  (5,294)  —   (5,294)  — 
Total liabilities measured at fair value on recurring basis $(5,294) $—  $(5,294) $— 
                                
December 31, 2021
                
December 31, 2022
                
Available for sale securities                                
U.S. Treasury and federal agency securities $206,845  $0  $206,845  $0  $224,634  $—  $224,634  $— 
U.S. Agency MBS and CMOs  86,797   0   86,797   0   113,818   —   113,818   — 
Tax-exempt state and municipal bonds  37,556   0   37,556   0   36,710   —   36,710   — 
Taxable state and municipal bonds  79,561   0   79,561   0   112,171   —   112,171   — 
Corporate bonds and other debt securities  5,304   0   5,304   0   11,924   —   11,924   — 
Other equity securities  1,470   0   1,470   0   1,304   —   1,304   — 
Loans held for sale  1,407   0   1,407   0   215   —   215   — 
Interest rate swaps  3,277   0   0   3,277   6,463   —   6,463   — 
Total assets measured at fair value on recurring basis $507,239  $—  $507,239  $— 
                
Interest rate swaps  (3,277)  0   0   (3,277)  (6,463)  —   (6,463)  — 
Total liabilities measured at fair value on recurring basis $(6,463) $—  $(6,463) $— 

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)
  Fair  
Quoted Prices in
Active Markets
for Identical
Assets
  
Significant Other
Observable
Inputs
  
Significant
Unobservable
Inputs
 
June 30, 2022
            
 Value
  (Level 1)
  (Level 2)
  (Level 3)
 
March 31, 2023
            
Collateral dependent loans
 $327
  $—
  $—
  $327
 
                
December 31, 2022
                
Impaired loans $337  $0  $0  $337  $328  $—  $—  $328 
                
December 31, 2021
                
Impaired loans $2,903  $0  $0  $2,903 

-30--32-
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MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 (%)
June 30, 2022         
Impaired Loans $337 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 (%)
March 31, 2023         
Collateral dependent loans
 $327 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 (%) 
Asset Fair
Value
 
Valuation
Technique
 
Unobservable
Inputs
 Range (%)
December 31, 2021         
December 31, 2022         
Impaired Loans $2,903 Sales comparison approach 
Adjustment for differences
between comparable sales
 1.5 to 20.0 $328 Sales comparison approach 
Adjustment for differences
between comparable sales
 1.5 to 20.0
    Income approach Capitalization rate 9.5 to 11.0    Income approach Capitalization rate 9.5 to 11.0


The carrying amounts and estimated fair values of financial instruments, not previously presented, were as follows at June 30, 2022March 31, 2023 and December 31, 20212022 (dollars in thousands):



 June 30, 2022  December 31, 2021 Level in March 31, 2023  December 31, 2022 

Level in
Fair Value
Hierarchy
 
Carrying
Amount
  
Fair
Value
  
Carrying
Amount
  
Fair
Value
 
Fair Value
Hierarchy
 
Carrying
Amount
  
Fair
Value
  
Carrying
Amount
  
Fair
Value
 
Financial assets                          
Cash and due from banksLevel 1
 $38,376  $38,376  $23,669  $23,669 Level 1
 $29,402  $29,402  $51,215  $51,215 
Federal funds sold and other short-term investments
Level 1
  721,826   721,826   1,128,119   1,128,119 Level 1
  391,336   391,336   703,955   703,955 
Securities held to maturityLevel 3
  352,721   341,274   137,003   139,272 
Securities held to maturity - U.S. TreasuryLevel 2  251,286   240,012   251,307   237,630 
Securities held to maturity - tax-exempt and muniLevel 3
  97,101   95,547   97,458   95,020 
FHLB stock Level 3
  10,211   10,211   11,558   11,558  Level 3
  10,211   10,211   10,211   10,211 
Loans, net Level 2
  1,096,946   1,082,028   1,090,201   1,106,324  Level 2
  1,203,818   1,185,925   1,162,135   1,131,387 
Bank owned life insurance Level 3
  52,963   52,963   52,468   52,468  Level 3
  53,557   53,557   53,345   53,345 
Accrued interest receivable Level 2
  5,108   5,108   4,088   4,088  Level 2
  8,782   8,782   7,606   7,606 
Financial liabilities                                  
Deposits Level 2
  (2,494,583)  (2,494,501)  (2,577,958)  (2,577,885) Level 2
  (2,330,895)  (2,331,330)  (2,615,142)  (2,615,860)
Other borrowed funds Level 2
  (30,000)  (29,117)  (85,000)  (86,322) Level 2
  (30,000)  (28,824)  (30,000)  (28,666)
Accrued interest payable Level 2  (35)  (35)  (72)  (72) Level 2  (228)  (228)  (114)  (114)
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, 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--33-
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MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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 June 30, 2022March 31, 2023 and December 31, 20212022 are reflected in the following table (dollars in thousands):

 
Notional
Amount
 Balance Sheet Location Fair Value  Notional Amount Balance Sheet Location Fair Value 
June 30, 2022       
March 31, 2023
       
Derivative assets              
Interest rate swaps $64,898
 Other Assets $4,556
  $57,560
 Other Assets $5,294
 
              
Derivative liabilities              
Interest rate swaps 64,898
 Other Liabilities 4,556
  57,560
 Other Liabilities 5,294
 

 
Notional
Amount
 Balance Sheet Location Fair Value  Notional Amount Balance Sheet Location Fair Value 
December 31, 2021       
December 31, 2022
       
Derivative assets              
Interest rate swaps $70,356
 Other Assets $3,277
  $62,661
 Other Assets $6,463
 
              
Derivative liabilities              
Interest rate swaps 70,356
 Other Liabilities 3,277
  62,661
 Other Liabilities 6,463
 

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 $4.6$5.3 million and $3.3$6.5 million as of June 30, 2022March 31, 2023 and December 31, 2021,2022, respectively. The Bank has a master netting arrangement with the correspondent bank and has the right to offset, however it has elected to present the assets and liabilities gross. The Bank is required to pledge collateral to the correspondent bank equal to or in excess of the net liability position. Securities pledged as collateral totaling $1.8 million and $3.0$1.7 million were provided to the counterparty correspondent bank as of June 30, 2022March 31, 2023 and December 31, 2021,2022, respectively.

Interest rate swaps entered into with commercial loan customers had notional amounts aggregating $64.9$57.6 million as of June 30, 2022March 31, 2023 and $70.4$62.7 million at December 31, 2021.2022. 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--34-
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MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 6 – DEPOSITS

Deposits are summarized as follows (dollars in thousands):

 
June 30,
2022
  
December 31,
2021
  
March 31,
2023
  
December 31,
2022
 
Noninterest-bearing demand $903,334  $886,115  $690,444  $834,879 
Interest bearing demand  640,277   736,573   608,967   760,889 
Savings and money market accounts  868,222   865,528   858,895   922,418 
Certificates of deposit  82,750   89,742   172,589   96,956 
 $2,494,583  $2,577,958  $2,330,895  $2,615,142 

Time deposits that exceedexceeded the FDIC insurance limit of $250,000 were approximately $26.8$56.1 million at June 30, 2022March 31, 2023 and $28.2$29.7 million at December 31, 2021.2022.

NOTE 7 - 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
 
June 30, 2022       
March 31, 2023       
Single maturity fixed rate advances $10,000 
July 2024
  2.63% $10,000 
February 2024
  2.63%
Putable advances  20,000 
November 2024
  1.81%  20,000 
November 2024
  1.81%
 $30,000       $30,000      

Principal Terms 
Advance
Amount
 Range of Maturities 
Weighted
Average
Interest Rate
  
Advance
Amount
 Range of Maturities 
Weighted
Average
Interest Rate
 
December 31, 2021       
December 31, 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      

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 $393.6$453.2 million and $361.9$446.1 million under a blanket lien arrangement at June 30, 2022March 31, 2023 and December 31, 2021,2022, respectively. The remaining $20.0 million putable advance at March 31, 2023 and December 31, 2022 had a one-time put option on November 13, 2020. The FHLB did not exercise this option.
-33--35-
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MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 7 - OTHER BORROWED FUNDS (Continued)

Scheduled repayments of FHLB advances as of June 30, 2022March 31, 2023  were as follows (in thousands):

2022 $0 
2023  0  $— 
2024  30,000   30,000 
2025  0   — 
2026  0   — 
2027
  — 
Thereafter
  0   — 
 $30,000  $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 3 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 three months ended June 30, 2022.

Federal Reserve Bank borrowings

The Company has a financing arrangement with the Federal Reserve Bank. There were 0no borrowings outstanding at June 30March 31, 20222023 and December 31, 20212022, and the Company had approximately $6.7$1.5 million and $4.0$5.5 million in unused borrowing capacity based on commercial and mortgage loans pledged to the Federal Reserve Bank totaling $7.2$1.6 million and $4.4$5.8 million at June 30, 2022March 31, 2023 and December 31, 20212022, respectively. In March 2023, the Federal Reserve Bank implemented a new lending facility called the Bank Term Funding Program.  This program allows a bank to borrow against its investment portfolio, at par value, with no reduction for unrealized losses. The term is for one year and interest rate is fixed at the time the advance is taken and there is no prepayment penalty.  Allowable investments for pledge are those the Federal Reserve Bank can own. This would include all of the Company’s investments except municipal securities and corporate bonds. At March 31, 2023, the Company had no advances under this program and had $642.2 million in unused borrowing capacity under this program.  The program expires on March 11, 2024.


NOTE 8 - EARNINGS PER COMMON SHARE




A reconciliation of the numerators and denominators of basic and diluted earnings per common share for the three and six month periods ended June 30,March 31, 2023 and 2022 and 2021 are as follows (dollars in thousands, except per share data):


  
Three Months
Ended
June 30,
2022
  
Three Months
Ended
June 30,
2021
  
Six Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2021
 
Net income available to common shares $6,568  $7,818  $12,568  $15,596 
Weighted average shares outstanding, including participating stock awards - Basic  34,253,846   34,193,016   34,254,306   34,194,264 
Dilutive potential common shares:                
Stock options  0   0   0   0 
Weighted average shares outstanding - Diluted  34,253,846   34,193,016   34,254,306   34,194,264 
Basic earnings per common share $0.19  $0.23  $0.37  $0.46 
Diluted earnings per common share $0.19  $0.23  $0.37  $0.46 


  
Three Months
Ended
March 31,
2023
  
Three Months
Ended
March 31,
2022
 
Net income available to common shares $12,004  $6,000 
Weighted average shares outstanding, including participating stock awards - Basic  34,297,221   34,254,772 
Dilutive potential common shares:        
Stock options  —   — 
Weighted average shares outstanding - Diluted  34,297,221   34,254,772 
Basic earnings per common share $0.35  $0.18 
Diluted earnings per common share $0.35  $0.18 

There were 0no antidilutive shares of common stock in the three and six month periods ended June 30, 2022March 31, 2023 and 2021.2022.

-34--36-
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MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 9 - FEDERAL INCOME TAXES



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


  
Three Months
Ended
June 30,
2022
  
Three Months
Ended
June 30,
2021
  
Six Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2021
 
Current $1,416  $1,456  $2,351  $3,749 
Deferred  77   384  533   (144)
  $1,493  $1,840  $2,884  $3,605 


  
Three Months
Ended
March 31,
2023
  
Three Months
Ended
March 31,
2022
 
Current $2,825  $935 
Deferred  150  456 
  $2,975  $1,391 

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
June 30,
2022
  
Three Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2021
  
Three Months
Ended
March 31,
2023
  
Three Months
Ended
March 31,
2022
 
Statutory rate  21%  21%  21%  21%  21%  21%
Statutory rate applied to income before taxes $1,693  $2,028  $3,245  $4,032  $3,146  $1,552 
Deduct                        
Tax-exempt interest income  (143)  (156)  (297)  (315)  (147)  (154)
Bank-owned life insurance  (49)  (53)  (99)  (111)  (42)  (50)
Other, net  (8)  21   35   (1)  18   43 
 $1,493  $1,840  $2,884  $3,605  $2,975  $1,391 



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 June 30, 2022March 31, 2023 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):


  
June 30,
2022
  
December 31,
2021
 
Deferred tax assets      
Allowance for loan losses $3,072  $3,337 
Net deferred loan fees  10  
275 
Nonaccrual loan interest  30   57 
Valuation allowance on other real estate owned  6   6 
Unrealized loss on securities available for sale and transferred to held to maturity  4,965   79 
Other  340   311 
Gross deferred tax assets  8,423   4,065 
Valuation allowance  0   0 
Total net deferred tax assets  8,423   4,065 
Deferred tax liabilities        
Depreciation  (1,163)  (1,199)
Prepaid expenses  (288)  (288)
Other  (456)  (415)
Gross deferred tax liabilities  (1,907)  (1,902)
Net deferred tax asset $6,516  $2,163 


  
March 31,
2023
  
December 31,
2022
 
Deferred tax assets      
Allowance for loan losses $3,527  $3,210 
Net deferred loan fees  —   — 
Nonaccrual loan interest  12   12 
Valuation allowance on other real estate owned  —   — 
Unrealized loss on securities available for sale and transferred to held to maturity
  
6,980
   
8,394
 
Other  297   257 
Gross deferred tax assets  10,816   11,873 
Valuation allowance  —   — 
Total net deferred tax assets  10,816   11,873 
Deferred tax liabilities        
Depreciation  (1,104)  (1,098)
Net deferred loan fees  (20)  (309)
Prepaid expenses  (309)  (21)
Other  (912)  (733)
Gross deferred tax liabilities  (2,345)  (2,161)
Net deferred tax asset $8,471  $9,712 

There were 0no unrecognized tax benefits at June 30, 2022March 31, 2023 or December 31, 20212022 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 2018.2020.

-35--37-
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MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 10 – 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.  At March 31, 2023, the reserve for unfunded commitments was $61,000 and was included in other liabilities in the Company’s consolidated balance sheet.

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

 
June 30,
2022
  
December 31,
2021
  
March 31,
2023
  
December 31,
2022
 
Commitments to make loans $101,807  $128,648 
Commitments to extend credit
 $115,100  $77,384 
Letters of credit  14,404   10,141   11,937   13,455 
Unused lines of credit  769,114   677,902   719,013   745,674 

The notional amount of commitments to fund mortgage loans to be sold into the secondary market was approximately $321,000$82,000 and $1.3 million$0 at June 30, 2022March 31, 2023 and December 31, 2021,2022, 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 $3.8$1.1 million and $9.5 million$0 at June 30, 2022March 31, 2023 and December 31, 2021,2022, respectively.

At June 30, 2022,March 31, 2023, approximately 68.4%67.2% 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 term SOFR and generally expire within 30 days. The majority of the unused lines of credit were at variable rates tied to prime.prime or SOFR.

NOTE 11 – CONTINGENCIES

The Company and its subsidiaries periodically become defendants in certain claims and legal actions arising in the ordinary course of business. As of June 30, 2022,March 31, 2023, 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 12 – 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.

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MACATAWA BANK CORPORATION
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 12 – SHAREHOLDERS’ EQUITY (Continued)

The regulatory capital requirements 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). The minimum leverage ratio is 4.0%.

At June 30, 2022March 31, 2023  and December 31, 20212022, 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 
June 30, 2022                        
March 31, 2023                        
CET1 capital (to risk weighted assets)                                                
Consolidated $261,788   16.5
% $71,209   4.5% $110,769   7.0%  N/A   N/A  $286,826   17.1
% $75,561   4.5% $117,539   7.0%  N/A   N/A 
Bank  253,830   16.0
   71,196   4.5   110,750   7.0  $102,839   6.5%  278,347   16.6
   75,558   4.5   117,535   7.0  $109,139   6.5%
Tier 1 capital (to risk weighted assets)                                                                
Consolidated  261,788   16.5
   94,945   6.0   134,505   8.5   N/A   N/A   286,826   17.1
   100,748   6.0   142,726   8.5   N/A   N/A 
Bank  253,830   16.0
   94,928   6.0   134,482   8.5   126,571   8.0   278,347   16.6
   100,744   6.0   142,720   8.5   134,325   8.0 
Total capital (to risk weighted assets)                                                                
Consolidated  276,419   17.5
   126,593   8.0   166,154   10.5   N/A   N/A   303,620   18.1
   134,331   8.0   176,309   10.5   N/A   N/A 
Bank  268,461   17.0
   126,571   8.0   166,124   10.5   158,214   10.0   295,141   17.6
   134,325   8.0   176,302   10.5   167,906   10.0 
Tier 1 capital (to average assets)                                                                
Consolidated  261,788   9.1
   114,682   4.0   N/A   N/A   N/A   N/A   286,826   10.3
   111,845   4.0   N/A   N/A   N/A   N/A 
Bank  253,830   8.9
   114,675   4.0   N/A   N/A   143,344   5.0   278,347   10.0
   111,839   4.0   N/A   N/A   139,799   5.0 
                                                                
December 31, 2021                                
December 31, 2022                                
CET1 capital (to risk weighted assets)                                                                
Consolidated $254,302   17.2% $66,381   4.5% $103,259   7.0%  N/A   N/A  $278,615   16.9% $74,003   4.5% $115,116   7.0%  N/A   N/A 
Bank  246,239   16.7   66,370   4.5   103,242   7.0  $95,867   6.5%  270,274   16.4   73,992   4.5   115,098   7.0  $106,877   6.5%
Tier 1 capital (to risk weighted assets)                                                                
Consolidated  254,302   17.2   88,508   6.0   125,386   8.5   N/A   N/A   278,615   16.9   98,670   6.0   139,783   8.5   N/A   N/A 
Bank  246,239   16.7   88,493   6.0   125,365   8.5   117,991   8.0   270,274   16.4   98,655   6.0   139,762   8.5   131,540   8.0 
Total capital (to risk weighted assets)                                                                
Consolidated  270,191   18.3   118,011   8.0   154,889   10.5   N/A   N/A   293,900   17.9   131,561   8.0   172,673   10.5   N/A   N/A 
Bank  262,128   17.8   117,991   8.0   154,863   10.5   147,488   10.0   285,559   17.4   131,540   8.0   172,647   10.5   164,426   10.0 
Tier 1 capital (to average assets)                                                                
Consolidated  254,302   8.7   116,664   4.0   N/A   N/A   N/A   N/A   278,615   9.7   114,589   4.0   N/A   N/A   N/A   N/A 
Bank  246,239   8.4   116,654   4.0   N/A   N/A   145,818
   5.0   270,274   9.4   114,582   4.0   N/A   N/A   143,227
   5.0 

The Bank was categorized as “well capitalized” at June 30, 2022March 31, 2023 and December 31, 2021.2022.

-37--39-
Item 2.MANAGEMENT'SMANAGEMENT’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. For further information regarding consolidation, see the Notes to Consolidated Financial Statements.
 
At June 30, 2022,March 31, 2023, we had total assets of $2.78$2.64 billion, total loans of $1.11$1.22 billion, total deposits of $2.49$2.33 billion and shareholders'shareholders’ equity of $243.1$260.6 million.  For the three months ended June 30, 2022,March 31, 2023, we recognized net income of $6.6$12.0 million compared to $7.8$6.0 million for the same period in 2021. For the six months ended June 30, 2022, we recognized net income of $12.6 million compared to $15.6 million for the same period in 2021.2022. The Bank was categorized as “well capitalized” under regulatory capital standards at June 30, 2022.March 31, 2023.
 
We paid a dividend of $0.08 per share in each quarter in 20212022 and in eachthe first quarter of 2023.

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

At March 31, 2023, the Company had $391.3 million in federal funds sold and overnight balances and had total additional borrowing capacity of 2022.$951 million, including $242.3 million in unused availability with the FHLB, $65.0 million in available fed funds facilities with correspondent banks, $1.5 million in availability at the FRB’s Discount Window and the $642.2 million availability in the FRB Bank Term Funding Program discussed above.  Given the flexibility of borrowing structure options with the FHLB, if the Company needed to borrow, we would likely utilize our FHLB capacity first.  At March 31, 2023, our uninsured deposits totaled approximately $962.7 million, or 41% of total deposits, and our liquidity sources exceeded the amount of uninsured deposit balances by over $300 million.

While the Bank experienced a decline in deposit balances during the three months ended March 31, 2023, most of the decline took place prior to the early March 2023 bank failures noted.  Our deposit base is primarily made up of many small accounts, and balances at March 31, 2023 were comprised of 48% personal customers and 52% business customers.  Our core deposits - which we define as deposits we have sourced within our local markets - represented 100% of our total deposits at March 31, 2023.  Our total deposit balances of $2.33 billion at March 31, 2023 remain elevated, reflecting a $625.5 million increase, or 37%, over pre-pandemic totals of $1.71 billion as of March 31, 2020.

-40-
RESULTS OF OPERATIONS
 
Summary: Net income for the three months ended June 30, 2022March 31, 2023 was $6.6$12.0 million, compared to $7.8$6.0 million for the same period in 2021.2022.  Net income per share on a diluted basis for the three months ended June 30, 2022March 31, 2023 was $0.19$0.35 compared to $0.23$0.18 for the same period in 2021.  Net income for the six months ended June 30, 2022 was $12.6 million compared to $15.6 million for the same period in 2021.  Net income per share on a diluted basis for the six months ended June 30, 2022 was $0.37 compared to $0.46 for the same period in 2021.2022.
 
The decreaseincrease in earnings in the three and six months ended June 30, 2022March 31, 2023 compared to the same periodsperiod in 20212022 was due primarily to lowerhigher levels of net interest income from lower PPP fee amortization and interest andpartially offset by lower mortgage banking income partially offset by largerand a provision for loan loss benefitscredit losses benefit recorded in the six month period.first quarter of 2022.  Throughout 2022, beginning in March, the Federal Reserve Bank increased the federal funds rate several times, bringing the high end of their rate range rate from 0.25% at the beginning of 2022 to 4.50% at the end of 2022.  The Federal Reserve Bank raised this rate an additional 50 basis points to 5.00% during the three months ended March 31, 2023.  Given our asset sensitive balance sheet posture, this had a significant positive impact on our net interest income.  Net interest income increased to $14.8$22.6 million in the three months ended June 30, 2022March 31, 2023 compared to $14.5$12.7 million in the same period in 2021.   Net interest income decreased to $27.5 million in the six months ended June 30, 2022 compared to $28.9 million in the same period in 2021.   While down for the first six months of 2022, net interest income increased in the three months ended June 30, 2022 as a result of our asset sensitive position and the 25 basis point increase to the federal funds rate in March 2022, the 50 basis point increase in May 2022 and the 75 basis point increase in June 2022.   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 $235.3 million since December 31, 2021.  Net gainsGains on sales of mortgage loans decreased to $199,000$11,000 in the three months ended June 30, 2022March 31, 2023 compared to $1.3 million$308,000 in the same period in 2021.  Net gains on sales of mortgage loans decreased to $508,000 in the six months ended June 30, 2022 compared to $3.3 million in the same period in 2021.2022.
 
The provision for loancredit losses was $0 for the three months ended June 30, 2022,March 31, 2023, compared to a benefit (income) of $750,000$1.5 million for the same period in 2021.2022.  We were in a net loan recovery position for the three months ended June 30, 2022,March 31, 2023, with $15,000$33,000 in net loan recoveries, compared to $104,000$227,000 in net loan recoveries in the same period in 2021.  The provision was a benefit2022.  Several of $1.5 million for the six months ended June 30, 2022 compared to a benefit of $750,000 for the same period in 2021.  We were also in a net loan recovery position for the six months ended June 30, 2022, with $242,000 in net recoveries compared to $148,000 in net recoveries in the same period in 2021.  The provision for loan losses in 2021 was also impacted by higher levels ofprevious qualitative environmental factors to address uncertainty and increased risk of loss attributablerelated to the COVID-19 pandemic.  Several of these factorspandemic were reduced in the first six monthsquarter of 2022, reflecting improvement in economic conditions and success at mitigating the effects of the COVID-19 pandemic.pandemic, resulting in the net provision benefit recorded in the first quarter of 2022.  Also impacting comparability between periods is our adoption of ASU 2016-13, commonly referred to as CECL, effective January 1, 2023.  At adoption, we increased the allowance for credit losses by $1.5 million.  Provision for the first quarter 2023 was determined under CECL while the first quarter 2022 was determined under the probable incurred loss model.
 
Net Interest Income: Net interest income totaled $14.8$22.6 million for the three months ended June 30, 2022March 31, 2023 compared to $14.5$12.7 million for the same period in 2021.   Net interest income decreased to $27.5 million in the six months ended June 30, 2022 compared to $28.9 million in the six months ended June 30, 2021.  Net interest income for the three and six month periods ended June 30, 2022 benefitted from increases in the federal funds rate and growth in our investment securities portfolio.  The federal funds rate increased 25 basis points in March 2022, 50 basis points in May 2022 and 75 basis points in June 2022.

-38-
Net interest income for the second quarter of 2022 increased $386,000 compared to the same period in 2021.  Of this increase, $1.1 million was from changes in rates earned or paid, partially offset by a decrease of $758,000 from changes in the volume of average interest earning assets and interest bearing liabilities.  The largest changes occurred in interest income on our investment portfolio as we deployed some of our excess investable funds.  The net change in interest income for taxable securities was an increase of $1.8 million, with $1.7 million due to an increase in average balances and an increase of $92,000 due to rate. The net change in our federal funds sold and other short-term investments was an increase of $1.4 million, of which $1.5 million was due to an increase in rate, partially offset by a reduction of $41,000 due to a decrease in volume.  The net change in interest income for commercial loans (excluding PPP loans) was an increase of $46,000, of which an increase of $238,000 was due to portfolio growth, partially offset by a decrease of $192,000 due to rate.  PPP loans caused a reduction of $2.8 million in net interest income in the second quarter of 2022 primarily due to lower PPP fee recognition and significant principal forgiveness between the second quarter of 2021 and the second quarter of 2022.  Additionally, residential mortgage loan interest income decreased by $176,000 in the second quarter of 2022 compared to the same period in 2021.  Of the $176,000 decrease in interest income on residential mortgage loans, $120,000 was due to a decrease in average balances and $56,000 was due to lower loan rates.  Interest expense changes in the second quarter of 2022 were primarily volume related as very little change was made to interest rates paid on our deposit balances in response to changes in federal funds rates.

Net interest income for the six months ended June 30, 2022 decreased $1.4first quarter of 2023 increased $10.0 million compared to the same period in 2021.2022.  Of this decrease, $2.6increase, $1.4 million was from changes in the volume of average interest earning assets and interest bearing liabilities partially offset by an increase of $1.2and $8.6 million was from increases from changes in rates earned or paid.  The largest changes occurred in interest income on PPPcommercial loans which fluctuated significantly in the first six months of 2022 compared to the same period in 2021, and in our investment portfolio as we deployed some of our excess investableovernight funds.  The net change in interest income for PPP loans was a decrease of $4.3 million in the first six 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 $1.1an increase of $5.4 million decrease with $859,000an increase of $4.6 million due to rate and $203,000an increase of $782,000 due to portfolio contraction. The net change in interest income for taxable securities wasgrowth.  Overnight funds contributed an increase of $2.5$6.2 million due to an increasechanges in rate, partially offset by a reduction of $394,000 due to lower average balances. Interest incomebalances compared to the first quarter of 2022 as excess funds were deployed into loans and investment securities.    The average balance of our investment portfolio grew by $326.0 million from federal funds sold and other short-term investments increased by $1.8$572.7 million in the first six monthsquarter of 2022 compared to the same period in 2021 due to the 25 basis point increase in the federal funds rate in March 2022, the 50 basis point increase in May 2022 and the 75 basis point increase in June 2022.  This caused a $1.7$898.7 million increase in interest income, along with the positive impact of increases in average balances of federal funds sold and other short-term investments in the first six monthsquarter of 2022, which  added $49,000 .  Of the $560,000 decrease2023.  This growth resulted in an additional $1.6 million of interest income on residential mortgage loans, $402,000 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 and $158,000 was due to lower loan rates.
As we are in an asset-sensitive position, increases in market interest rates have a positive impact on margin as our interest earning assets reprice faster than our 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.  This asset sensitivity, however, will serve to enhance net interest income as the Federal Reserve has begun raising short-term interest rates.  The Federal Reserve's first rate increase since 2018 of 25 basis points in March 2022 was too late in the quarter to have a meaningful impact on our first quarter 2022 interest income but did positively affect our second quarter 2022 interest income, along with the Federal Reserve's 50 basis point increase in May 2022.  The 75 basis point increase in June 2022 along with the earlier increases will positively affect third quarter interest income.of 2023.

-39-
The cost of funds decreasedincreased to 0.14%1.07% in the secondfirst quarter of 20222023 compared to 0.17%0.11% in the secondfirst quarter of 2021.  For the first six months of 2022, the cost of funds decreased to 0.12% compared to 0.18% for the same period in 2021.  Decreases2022.  Increases in the rates paid on our time depositsinterest-bearing checking, savings, money market and certificate of deposit accounts in response to the lowfederal funds rate environmentincreases over the past couple of years along with the impact of our redemption of the remaining trust preferred securities in the third quarter of 2021year and prepayment of certain Federal Home Loan Bank ("FHLB") advancesmarket conditions caused the decreaseincrease in our cost of funds.

The asset yield improvement to 4.15% in the first quarter of 2023 from 1.92% in the first quarter of 2022, far outweighed the increase in cost of funds.  As a result, net interest margin improved to 3.44% for the first quarter 2023 compared to 1.85% for the first quarter of 2022.

-41-
The following table shows an analysis of net interest margin for the three month periods ended June 30,March 31, 2023 and 2022 and 2021 (dollars in thousands):

 For the three months ended June 30,  For the three months ended March 31, 
 2022  2021  2023  2022 
 
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
  
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
  
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
  
Average
Balance
  
Interest
Earned
or Paid
  
Average
Yield
or Cost
 
Assets                                    
Taxable securities $587,263  $2,618  1.78% $196,479  $792  1.61% $765,999  $4,481  2.35% $402,863  $1,434  1.43%
Tax-exempt securities (1) 164,148  702  2.20  139,771  760  2.80  132,692  698  2.71  169,845  731  2.22 
Commercial loans (2) 922,796  8,587  3.72  890,750  8,541  3.79  985,258  13,300  5.40  902,347  7,888  3.50 
PPP loans (3) 5,037  199  15.80  248,042  3,034  4.84  —  —  —  20,364  1,052  20.66 
Residential mortgage loans 120,838  988  3.27  135,329  1,164  3.43  143,839  1,343  3.73  116,504  939  3.22 
Consumer loans 55,876  570  4.09  55,449  564  4.08  57,303  1,017  7.20  54,096  519  3.89 
Federal Home Loan Bank stock 10,211  51  1.97  11,558  56  1.93  10,211  65  2.55  11,019  51  1.84 
Federal funds sold and other short-term investments  858,545   1,720   0.79   992,484   273   0.11   555,670   6,362   4.58   1,111,216   529   0.19 
Total interest earning assets (1) 2,724,714  15,435  2.28  2,669,862  15,184  2.29  2,650,972  27,266  4.15  2,788,254  13,143  1.92 
Noninterest earning assets:                                    
Cash and due from banks 35,869        34,276        34,615        32,505       
Other  86,798         105,349         72,007         96,703       
Total assets $2,847,381        $2,809,487        $2,757,594        $2,917,462       
Liabilities                                    
Deposits:                                    
Interest bearing demand $679,168  $54  0.03% $658,842  $39  0.02% $690,246  $742  0.43% $706,872  $40  0.02%
Savings and money market accounts 871,875  146  0.07  819,030  62  0.03  903,236  3,017  1.35  894,976  65  0.03 
Time deposits 88,341  45  0.20  102,967  143  0.56  134,401  735  2.22  92,244  53  0.23 
Borrowings:                                    
Other borrowed funds 54,305  347  2.53  62,198  328  2.09   30,000   156   2.08   85,002   320   1.51 
Long-term debt  —   —   —   20,619   155   2.97 
Total interest bearing liabilities 1,693,689  592  0.14  1,663,656  727  0.17  1,757,883  4,650  1.07  1,779,094  478  0.11 
Noninterest bearing liabilities:                                    
Noninterest bearing demand accounts 897,727        887,559        732,434        875,223       
Other noninterest bearing liabilities 12,613        13,756        17,117        11,545       
Shareholders' equity  243,352         244,516       
Total liabilities and shareholders' equity $2,847,381         $2,809,487        
Shareholders’ equity  250,160         251,600       
Total liabilities and shareholders’ equity $2,757,594         $2,917,462        
Net interest income    $14,843        $14,457        $22,616        $12,665    
Net interest spread (1)       2.14%       2.12%       3.08%       1.81%
Net interest margin (1)       2.19%       2.19%       3.44%       1.85%
Ratio of average interest earning assets to average interest bearing liabilities 160.87%       160.48%       150.80%       156.72%      

(1)Yields are presented on a tax equivalent basis using an assumed tax rate of 21% at June 30, 2022March 31, 2023 and 2021.2022.
(2)Includes loan fees of $158,000$148,000 and $356,000$99,000 for the three months ended June 30,March 31, 2023 and 2022, and 2021, respectively.  Includes average nonaccrual loans of approximately $90,000$75,000 and $463,000$90,000 for the three months ended June 30,March 31, 2023 and 2022, and 2021, respectively.  Excludes PPP loans.
(3)Includes loan fees of $187,000$0 and $2.4$1.0 million for the three months ended June 30,March 31, 2023 and 2022, and 2021, respectively.

-40--42-
The following table shows an analysis of net interest margin for the six month periods ended June 30, 2022 and 2021 (dollars in thousands):

  For the six months ended June 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 $495,627  $4,053   1.64% $193,267  $1,579   1.63%
Tax-exempt securities (1)  166,981   1,433   2.21   131,949   1,518   2.97 
Commercial loans (2)  912,628   16,475   3.59   923,392   17,537   3.78 
PPP loans (3)  12,658   1,251   19.66   244,314   5,586   4.55 
Residential mortgage loans  118,682   1,926   3.24   142,972   2,486   3.48 
Consumer loans  54,991   1,089   3.99   57,279   1,161   4.09 
Federal Home Loan Bank stock  10,613   102   1.90   11,558   117   2.01 
Federal funds sold and other short-term investments  984,183   2,249   0.45   899,217   474   0.11 
Total interest earning assets (1)  2,756,363   28,578   2.10   2,603,948   30,458��  2.37 
Noninterest earning assets:                        
Cash and due from banks  34,196           32,725         
Other  91,669           101,866         
Total assets $2,882,228          $2,738,539         
Liabilities                        
Deposits:                        
Interest bearing demand $692,943  $94   0.03% $642,842  $73   0.02%
Savings and money market accounts  883,362   211   0.05   808,370   123   0.03 
Time deposits  90,281   98   0.22   105,283   327   0.63 
Borrowings:                        
Other borrowed funds  69,569   667   1.91   66,077   681   2.05 
Long-term debt  —   —   —   20,619   307   2.96 
Total interest bearing liabilities  1,736,155   1,070   0.12   1,643,191   1,511   0.18 
Noninterest bearing liabilities:                        
Noninterest bearing demand accounts  886,537           838,618         
Other noninterest bearing liabilities  12,083           13,951         
Shareholders' equity  247,453           242,779         
Total liabilities and shareholders' equity $2,882,228          $2,738,539         
Net interest income     $27,508          $28,947     
Net interest spread (1)          1.98%          2.19%
Net interest margin (1)          2.02%          2.25%
Ratio of average interest earning assets to average
interest bearing liabilities
  158.76%          158.47%        

(1)Yields are presented on a tax equivalent basis using an assumed tax rate of 21% at June 30, 2022 and 2021.
(2)Includes loan fees of $257,000 and $525,000 for the six months ended June 30, 2022 and 2021, respectively.  Includes average nonaccrual loans of approximately $90,000 and $496,000 for the six months ended June 30, 2022 and 2021, respectively.  Excludes PPP loans.
(3)Includes loan fees of $1.2 and $4.4 million for the six months ended June 30, 2022 and 2021, respectively.

-41-
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 June 30,
2022 vs 2021
Increase (Decrease) Due to
  
For the six months ended June 30,
2022 vs 2021
Increase (Decrease) Due to
  
For the three months ended March 31,
2023 vs 2022
Increase (Decrease) Due to
 
 Volume  Rate  Total ��Volume  Rate  Total  Volume  Rate  Total 
                           
Interest income                           
Taxable securities $1,734  $92  $1,826  $2,473  $1  $2,474  $1,778  $1,269  $3,047 
Tax-exempt securities 161  (219) (58) 462  (547) (85) (223) 190  (33)
Commercial loans, excluding PPP loans 238  (192) 46  (203) (859) (1,062) 782  4,630  5,412 
PPP loans (2,940) 105  (2,835) (5,267) 932  (4,335) (1,052) —  (1,052)
Residential mortgage loans (120) (56) (176) (402) (158) (560) 241  163  404 
Consumer loans 4  2  6  (46) (26) (72) 32  466  498 
Federal Home Loan Bank stock (6) 1  (5) (9) (6) (15) (4) 18  14 
Federal funds sold and other short-term investments  (41)  1,488   1,447   49   1,726   1,775   (394)  6,227   5,833 
Total interest income (970) 1,221  251  (2,943) 1,063  (1,880) 1,160  12,963  14,123 
Interest expense                           
Interest bearing demand $1  $14  $15  $6  $15  21  $(1) $703  $702 
Savings and money market accounts 4  80  84  12  76  88  1  2,951  2,952 
Time deposits (18) (80) (98) (41) (188) (229) 35  647  682 
Other borrowed funds (44) 63  19  35  (49) (14) (257) 93  (164)
Long-term debt  (155)  —   (155)  (307)  —   (307)  —   —   — 
Total interest expense  (212)  77   (135)  (295)  (146)  (441)  (222)  4,394   4,172 
Net interest income $(758) $1,144  $386  $(2,648) $1,209  $(1,439) $1,382  $8,569  $9,951 

Provision for LoanCredit Losses: The provision for loancredit losses for the three months ended June 30, 2022March 31, 2023 was $0 compared to a benefit of  $750,000$1.5 million for the same period in 2021.  The provision for loan losses for the first half of 2022 was a benefit of $1.52022.  Total loans increased by $43.2 million compared to a benefit of $750,000 for the same period in 2021.  Net loan recoveries were $15,000 in the three months ended June 30, 2022March 31, 2023 which, on its own, creates a need for provision expense; however, the economic forecast used in our calculation improved slightly from January 1, 2023 to March 31, 2023, thereby offsetting the need to record provision expense due to loan portfolio growth.  Net loan recoveries were $33,000 in the three months ended March 31, 2023 compared to net loan recoveries of $104,000$227,000 in the same period in 2021.  Net loan recoveries were $242,000 in the six months ended June 30, 2022 compared to $148,000 in the same period in 2021.2022.
 
Gross loan recoveries were $75,000$54,000 for the three months ended June 30, 2022March 31, 2023 and $134,000$262,000 for the same period in 2021.2022.  In the three months ended June 30, 2022,March 31, 2023, we had $60,000$21,000 in gross loan charge-offs, compared to $30,000$35,000 in the same period in 2021.  For the six months ended June 30, 2022, we experienced gross loan recoveries of $337,000 compared to $228,000 for the same period in 2021.  Gross loan charge-offs for the six months ended June 30, 2022 were $95,000 compared to $80,000 for the same period in 2021.2022.
 
We adopted CECL effective January 1, 2023 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures.  Results for reporting periods beginning after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with the probable incurred loss accounting standards.  The transition adjustment of the CECL adoption included an increase in the allowance for credit losses of $1.5 million, $62,000 to establish a reserve for unfunded commitments and a $1.2 million decrease to retained earnings to reflect the cumulative effect of adoption of CECL, with the $323,000 tax impact portion being recorded as part of the deferred tax asset on our Consolidated Balance Sheet.  The amounts of loan loss provision for credit losses in eachboth the most recent quarter and comparable prior year period were the result of establishing our allowance for loancredit losses at levels believed necessary based upon our methodology for determining the adequacy of the allowance.  The provision for loancredit losses for the three and six month periodsmonths ended June 30,March 31, 2022 was impacted by net reductions to certain qualitative factors.factors that had been elevated in response to the COVID-19 pandemic.  More information about our allowance for loan losses and our methodology for establishing its level may be found under the heading "Allowance“Allowance for Loan Losses"Credit Losses” below.

-43-
Noninterest Income: Noninterest income for the three and six month periodsperiod ended June 30, 2022March 31, 2023 was $5.1 million and $10.1$4.5 million compared to $6.2 million and $12.7$5.0 million for the same periodsperiod in 2021, respectively.2022.   The components of noninterest income are shown in the table below (in thousands):

 
Three Months
Ended
June 30,
2022
  
Three Months
Ended
June 30,
2021
  
Six Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2021
  
Three Months
Ended
March 31,
2023
  
Three Months
Ended
March 31,
2022
 
Service charges and fees on deposit accounts $1,218  $1,065  $2,430  $2,057  $994  $1,211 
Net gains on mortgage loans 199  1,311  508  3,326  11  308 
Trust fees 1,096  1,133  2,184  2,138  1,033  1,088 
ATM and debit card fees 1,762  1,683  3,360  3,168  1,662  1,599 
Bank owned life insurance (“BOLI”) income 230  250  470  526  199  240 
Investment services fees 345  339  658  816  411  313 
Other income  281   388   486   676   218   206 
Total noninterest income $5,131  $6,169  $10,096  $12,707  $4,528  $4,965 

-42-
Net gains on mortgage loans were down $1.1 million$297,000 in the three months ended June 30, 2022  and were down $2.8 million in the six months ended June 30, 2022March 31, 2023 compared to the same periodsperiod in 20212022 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 2021sharply throughout 2022 and into the first halfquarter of 2022,2023, causing a reduction in mortgage volume and a shiftcompared to the first quarter of 2022.  In addition, more of our origination volume in the first three months of 2023 was in variable rate products, which we placehold in portfolio rather than sell.portfolio.  Mortgage loans originated for sale in the three months ended June 30, 2022March 31, 2023 were $8.4 million,$179,000, compared to $39.2$10.1 million in the same period in 2021.  For the first six months of 2022, mortgage loans originated for sale were $18.5 million, compared to $86.5 million for the same period in 2021.2022.
 
Trust fees were down $37,000Service charges on deposit accounts decreased by $217,000 in the three months ended June 30, 2022 and were up $46,000 in the six months ended June 30, 2022March 31, 2023 as compared to the same periodsperiod in 2021.2022 largely due to higher earnings credit offsets for treasury management accounts.  Trust fees were down $55,000 in the three months ended March 31, 2023 compared to the three months ended March 31, 2022. The changesdecrease for the three and six months ended June 30, 2022 wereMarch 31, 2023 was largely due to fluctuations inlower market valuations of underlying trust assets resulting from overall stock market conditions.investments.  ATM and debit card fees were up $63,000 in the three and six months ended June 30, 2022March 31, 2023 as compared to the same periods in 2021three months ended March 31, 2022 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.  Service charges on deposit accounts increased in the three and six month periods ended June 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.
 
Noninterest Expense: Noninterest expense increased by $195,000$426,000 to $11.9$12.2 million for the three month period ended June 30, 2022March 31, 2023 as compared to $11.7 million in the same period in 2021.  Noninterest expense increased by $449,000 to $23.7 million for the six month period ended June 30, 2022 compared to $23.2 million for the same period in 2021.2022.  The components of noninterest expense are shown in the table below (in thousands):

 
Three Months
Ended
June 30,
2022
  
Three Months
Ended
June 30,
2021
  
Six Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2021
  
Three Months
Ended
March 31,
2023
  
Three Months
Ended
March 31,
2022
 
Salaries and benefits $6,402  $6,502  $12,691  $12,914  $6,698  $6,289 
Occupancy of premises 1,071  994  2,243  2,031  1,137  1,172 
Furniture and equipment 988  978  2,004  1,915  1,031  1,016 
Legal and professional 271  274  465  496  348  194 
Marketing and promotion 195  175  390  350  219  195 
Data processing 924  855  1,808  1,762  955  884 
FDIC assessment 197  159  377  329  330  180 
Interchange and other card expense 406  388  779  746  384  373 
Bond and D&O insurance 129  111  259  222  122  130 
Outside services 520  491  1,014  925  469  494 
Other noninterest expense  810   791   1,622   1,513   472   812 
Total noninterest expense $11,913  $11,718  $23,652  $23,203  $12,165  $11,739 

Most categories of noninterest expense were relatively unchanged compared to the three and six months ended June 30, 2021March 31, 2022 due to our ongoing efforts to manage expenses and scale our operations. Our largest component of noninterest expense, salaries and benefits, decreasedincreased by $100,000$409,000 in the three months ended June 30, 2022March 31, 2023 from the same period in 2021.2022. This decreaseincrease is primarily due to higher annual meritbase compensation, higher variable compensation, higher medical costs and inflationary increases and higher 401k matching contributions being more thanlower salary deferral from commercial loan originations partially offset by a decrease in variable-basedlower variable compensation duetied to lower mortgage origination volume.  Salaries and benefits decreased by $223,000 for the six months ended June 30, 2022 compared to the same period in 2021 due to the same combination of factors.production. The table below identifies the primary components of salaries and benefits (in thousands):
  
Three Months
Ended
June 30,
2022
  
Three Months
Ended
June 30,
2021
  
Six Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2021
 
Salaries and other compensation $5,772   5,683  $11,398   11,467 
Salary deferral from commercial loan originations  (219)  (269)  (433)  (621)
Bonus accrual  220   217   442   399 
Mortgage production - variable comp  141   381   285   715 
401k matching contributions  188   127   399   229 
Medical insurance costs  300   363   600   725 
Total salaries and benefits $6,402  $6,502  $12,691  $12,914 

-43--44-
  
Three Months
Ended
March 31,
2023
  
Three Months
Ended
March 31,
2022
 
Salaries and other compensation $5,912  $5,627 
Salary deferral from commercial loan originations  (145)  (215)
Bonus accrual  287   221 
Mortgage production - variable comp  58   144 
401k matching contributions  211   212 
Medical insurance costs  375   300 
Total salaries and benefits $6,698  $6,289 
Occupancy expenses
Legal and professional fees were up $77,000$154,000 in the three months ended June 30, 2022 and were up $212,000 in the six month period ended June 30, 2022March 31, 2023 compared to the same periodsperiod in 20212022 due to fluctuations in maintenance costs incurred.  Furnitureassociated with new accounting and equipment expensesproxy disclosures as well as regulatory compliance matters related to loan and deposit accounts referred to legal counsel during the quarter.  FDIC assessment costs were up $10,000$150,000 in the three months ended June 30, 2022 and were up $89,000 in the six months ended June 30, 2022March 31, 2023 compared to the same periodsperiod in 20212022 due to costs associated with equipment and service contracts primarily to improve information security.
Data processing costs were up $69,000 and $46,000higher assessment rates imposed by the FDIC on all banks.  Other noninterest expense was down $340,000 in the three and six month periodsmonths ended June 30, 2022, respectively,March 31, 2023 compared to the same periodsperiod in 20212022 due to higher usage$356,000 net gain recognized on the sale of electronic banking services and debit cards by our customers.
Interchange andlast remaining other card expenses were up $18,000 and $33,000 inreal estate owned property during the three and six month periods ended June 30, 2022, respectively, compared to the same periods in 2021 due to a higher numberfirst quarter 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 up $29,000 and $89,000 in the three and six month periods ended June 30, 2022, respectively, compared to the same periods in 2021 due to increased vendor costs and consultation related to efficiency in certain departments.2023.
 
Federal Income Tax Expense: We recorded $1.5 million and $2.9$3.0 million in federal income tax expense for the three and six month periodsperiod ended June 30, 2022March 31, 2023 compared to $1.8 million and $3.6$1.4 million for the same periodsperiod in 2021.2022.  Our effective tax ratesrate for the three and six monthsmonth period ended June 30, 2022 were 18.52%  and 18.66%March 31, 2023 was 19.86%  compared to 19.05%  and 18.78%18.82% for the same periodsperiod in 2021.2022.
 
FINANCIAL CONDITION
 
Total assets were $2.78$2.64 billion at June 30, 2022,March 31, 2023, a decrease of $147.5$269.8 million from December 31, 2021.2022. This change reflected increases of $19.6 million in debt securities available for sale, $215.7 million in debt securities held to maturity, $2.9 million in our loan portfolio, $988,000 in other assets and $495,000 in bank-owned life insurance, more than offsetdecrease was caused primarily by a decrease in total deposits of $391.6 million in cash and cash equivalents and $1.3 million in FHLB stock. Total deposits decreased by $83.4$284.2 million at June 30, 2022March 31, 2023 compared to December 31, 2021 and FHLB borrowings decreased by $55.0 million from December 31, 2021 to June 30, 2022.
 
Cash and Cash Equivalents: Our cash and cash equivalents, which include federal funds sold and short-term investments, were $760.2$420.7 million at June 30, 2022March 31, 2023 compared to $1.15 billion$755.2 million at December 31, 2021.2022.  The decrease in these balances primarily related to an increase in our loan and investment portfolio and decreasesportfolios as well as a reduction in deposit balances and other borrowings.balances.
 
Securities: Debt securities available for sale were $435.6$526.0 million at June 30, 2022March 31, 2023 compared to $416.1$499.3 million at December 31, 2021.2022. The balance at June 30, 2022March 31, 2023 primarily consisted of U.S. agency securities, agency mortgage backed securities and various municipal investments. Our held to maturity portfolio was $352.7$348.4 million at June 30, 2022March 31, 2023 compared to $137.0$348.8 million at December 31, 2021.2022.  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 net unrealized gains of $113,000 at the date of transfer, which will continue to be reported in accumulated 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. Total securities increased $235.3 million from $553.1 million at December 31, 2021 to $788.3 million at June 30, 2022 as we continued to deploy excess liquidity into higher yielding assets. We plan further growth of our investment portfolio in the third quarter of 2022.

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 beis three years or less.  Longer-term Treasury securities and all other marketable debt securities are generally classified as available for sale.

At March 31, 2023, the overall duration of our debt security available for sale portfolio was 3.11 years and the overall duration of our debt security held to maturity portfolio was 2.18 years and were similar to durations for these portfolios before the pandemic.  Net unrealized losses on debt securities available for sale decreased by $6.7 million from $40.1 million at December 31, 2022 to $33.7 million at March 31, 2023.  Net unrealized losses on debt securities held to maturity decreased by $3.3 million from $16.1 million at December 31, 2022 to $12.8 million at March 31, 2023.  Our overall bond portfolio will provide nearly $400 million in liquidity through maturities and scheduled paydowns over the next 24 months ending March 31, 2025.

Per U.S. generally accepted accounting principles, unrealized gains or losses on debt securities available for sale are reflected on the balance sheet in accumulated other comprehensive income (loss), while unrealized gains or losses on debt securities held to maturity are not reflected on the balance sheet in accumulated other comprehensive income (loss).
 
Portfolio Loans and Asset Quality: Total portfolio loans increased by $2.9$43.2 million in the first sixthree months of 20222023 and were $1.11$1.22 billion at June 30, 2022March 31, 2023 compared to $1.11$1.18 billion at December 31, 2021.2022. During the first sixthree months of 2022,2023, our commercial portfolio increased by $37.4 million.  During the same period, our consumer portfolio decreased by $6.7 million.  We received forgiveness proceeds on 217 PPP loans totaling $40.3 million in the six months ended June 30, 2022.  Excluding the PPP loans, our commercial loans increased by $33.6 million in the first six months of 2022.  Our consumer portfolio increased by $1.6$3.7 million and our residential mortgage portfolio increased by $8.0 million in the first six months of 2022.$9.5 million.

-44--45-
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.  However, given the significant increase in residential mortgage rates, we have increased the percentage of our longer term fixed rate mortgage production that we hold in portfolio as they will typically have lower duration due to refinancings that occur when interest rates decline.  Mortgage loans originated for portfolio in the first sixthree months of 2022 increased $6.82023 decreased $1.7 million compared to the same period in 2021,2022, from $23.8$14.8 million in the first sixthree months of 20212022 to $30.7$13.1 million in the same period in 2022.2023.
 
The volume of residential mortgage loans originated for sale in the first sixthree months of 20222023 decreased $68.0$10.0 million compared to the same period in 2021.2022. Residential mortgage loans originated for sale were $18.5$179,000 in the first three months of 2023 compared to $10.1 million in the first sixthree months of 2022 compared to $86.5 million in the first six months of 2021.2022.
 
The following table shows our loan origination activity for loans to be held in portfolio during the first sixthree months of 20222023 and 2021,2022, broken out by loan type and also shows average originated loan size (dollars in thousands):

 Six months ended June 30, 2022  Six months ended June 30, 2021  Three months ended March 31, 2023  Three months ended March 31, 2022 
 
Portfolio
Originations
  
Percent of
Total
Originations
  
Average
Loan Size
  
Portfolio
Originations
  
Percent of
Total
Originations
  
Average
Loan Size
  
Portfolio
Originations
  
Percent of
Total
Originations
  
Average
Loan Size
  
Portfolio
Originations
  
Percent of
Total
Originations
  
Average
Loan Size
 
Commercial real estate:                                    
Residential developed $5,126  1.9% $641  $6,187  2.0% 562  $125  0.1% $63  $4,322  2.7% $1,080 
Unsecured to residential developers —  —  —  —  —  —  —  —  —  —  —  — 
Vacant and unimproved 9,262  3.5  1,323  6,301  2.0  788  2,779  3.1  463  1,570  1.0  523 
Commercial development —  —  —  —  —  —  —  —  —  —  —  — 
Residential improved 39,227  14.7  665  51,854  16.6  535  11,852  13.1  539  23,944  15.1  684 
Commercial improved 32,168  12.0  1,340  25,792  8.3  955  3,161  3.5  316  22,907  14.5  1,909 
Manufacturing and
industrial
  49,246   18.5  2,736   11,565   3.7  964   5,364   5.9  894   44,128   27.8  4,413 
Total commercial real estate 135,029  50.6  1,164  101,699  32.5  656  23,281  25.7  506  96,871  61.1  1,514 
Commercial and industrial, excluding PPP 68,250  25.6  644  30,203  9.7  408 
PPP loans  —   —  —   128,420   41.1  128 
Commercial and industrial  47,097   52.0  1,002   32,371   20.4  549 
Total commercial and commercial real estate 203,279  76.2  915  260,322  83.3  211  70,378  77.7  757  129,242  81.5  1,051 
Consumer                                    
Residential mortgage 30,690  11.5  320  23,844  7.6  346  13,084  14.4  262  14,829  9.4  362 
Unsecured —  —  —  —  —  —  —  —  —  —  —  — 
Home equity 31,428  11.8  133  27,353  8.8  120  6,818  7.5  114  13,372  8.4  131 
Other secured  1,306   0.5  57   1,024   0.3  26   348   0.4  29   1,080   0.7  154 
Total consumer  63,424   23.8  178   52,221   16.7  155   20,250   22.3  166   29,281   18.5  195 
Total loans $266,703   100.0% $461  $312,543   100.0% 199  $90,628   100.0% $422  $158,523   100.0% $581 

The following table shows a breakout of our commercial loan activity during the first six months of 2022 and 2021 (dollars in thousands):

  
Six Months
Ended
June 30,
2022
  
Six Months
Ended
June 30,
2021
 
Commercial loans originated $203,279  $260,322 
Repayments of commercial loans  (129,407)  (345,088)
Change in undistributed - available credit  (80,548)  (73,418)
Net increase (decrease) in total commercial loans $(6,676) $(158,184)

Overall, the commercial loan portfolio decreased $6.7increased $37.4 million in the first sixthree months of 2022 reflecting forgiveness of PPP loans of $39.1 million in that time period.  Excluding PPP forgiveness, commercial loans grew by $32.5 million in the first six months of 2022.2023.  Our commercial and industrial portfolio decreasedincreased by $9.7$31.7 million while our commercial real estate loans increased by $3.0$5.7 million.  IncludedWhile overall originations as shown in the commercial production fortable above were down compared to the first sixthree months of 2021 is $128.4 million2022, our on-balance-sheet commercial loan balances grew since year end 2022.  This largely resulted from the funding of various construction projects originating in PPP loans, while there were no such loans originated in the first six months2022 and higher usage of 2022.  Our overall production ofapproved commercial loans decreasedlines by $57.0our commercial borrowers.  This utilization was up $22.2 million from $260.3 million in the first six monthsDecember 31, 2022 to March 31, 2023.
We also have a significant amount of 2021 to $203.3 million in the same periodunfunded commercial lines of 2022 mostly due to the significantly lower production of PPP loans (down $128.4 million).  Excluding PPP production,credit, that can be drawn on by our commercial loan originationscustomers.  The table below shows the total commitment, the unused portion and the percentage of unused to total commitment at March 31, 2023 and December 31, 2022 (dollars in the first six monthsthousands):

  
March 31,
2023
  
December 31,
2022
 
Commercial - Lines of credit commitments $1,011,846  $1,021,795 
Commercial - Unused portion of lines of credit  580,120   612,317 
Commercial - Unused lines of credit to total commitment  57.33%  60.07%

Total commercial lines of credit commitments decreased by $9.9 million from December 31, 2022 were $71.4 million higher than in the first six months of 2021.  This growth came largely from commercial and industrial originations which were up $38.0 million.  Commercial real estate originations were up $33.3 million in the first six months of 2022, primarily in the manufacturing and industrial category, which were up $37.7 million, and commercial improved, which were up $6.4 million, as these businesses expand following the pandemic slowdown.to March 31, 2023.

-45--46-
Commercial and commercial real estate loans remained our largest loan segment and accounted for approximately 83.6%83.3% and 84.4%83.2% of the total loan portfolio at June 30, 2022March 31, 2023 and December 31, 2021,2022, respectively. Residential mortgage and consumer loans comprised approximately 16.3%16.7% and 15.6%16.8% of total loans at June 30, 2022March 31, 2023 and December 31, 2021,2022, respectively.
 
A further breakdown of the composition of the loan portfolio is shown in the table below (in thousands):

 June 30, 2022  December 31, 2021  March 31, 2023  December 31, 2022 
 Balance  
Percent of
Total Loans
  Balance  
Percent of
Total Loans
  Balance  
Percent of
Total Loans
  Balance  
Percent of
Total Loans
 
Commercial real estate: (1)                        
Residential developed $4,094  0.4% $4,862  0.4% $7,001  0.6% $7,234  0.6%
Unsecured to residential developers —  —  5,000  —  —  —  —  — 
Vacant and unimproved 35,912  3.2  36,240  3.3  38,700  3.2  36,270  3.1 
Commercial development 112  —  171  —  99  —  103  — 
Residential improved 102,885  9.2  100,077  9.0  116,177  9.5  112,791  9.6 
Commercial improved 258,676  23.3  259,039  23.4  255,894  20.9  259,281  22.0 
Manufacturing and industrial  117,424   10.6   110,712   10.0   125,477   10.3   121,924   10.4 
Total commercial real estate 519,103  46.7  516,101  46.5  543,348  44.5  537,603  45.7 
Commercial and industrial, excluding PPP 407,788  36.7  378,318  34.1 
PPP loans  2,791   0.2   41,939   3.8 
Commercial and industrial  473,354   38.8   441,716   37.5 
Total commercial and commercial real estate 929,682  83.6  936,358  84.4  1,016,702  83.3  979,319  83.2 
Consumer                        
Residential mortgage 125,771  11.3  117,800  10.7  148,676  12.2  139,148  11.8 
Unsecured 168  —  210  —  106  —  121  — 
Home equity 52,671  4.7  51,269  4.6  52,647  4.3  56,321  4.8 
Other secured  3,623   0.3   3,356   0.3   2,808   0.2   2,839   0.2 
Total consumer  182,233   16.3   172,635   15.6   204,237   16.7   198,429   16.8 
Total loans $1,111,915   100.0% $1,108,993   100.0% $1,220,939   100.0% $1,177,748   100.0%


(1)Includes both owner occupied and non-owner occupied commercial real estate.
 
Commercial real estate loans accounted for 46.7%44.5% and 46.5%45.7% of the total loan portfolio at June 30, 2022March 31, 2023 and December 31, 2021,2022, 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.

The Bank was a participating lender in the Small Business Administration's (“SBA”) Paycheck Protection Program (“PPP”). PPP loans are forgivable, in whole or in part, if the proceeds are used for payroll and other permitted purposes in accordance with the requirements of the PPP. These loans carry a fixed rate of 1.00% and a term of two years (loans made before June 5, 2020) or five years (loans made on or after June 5, 2020), if not forgiven, in whole or in part. Payments are deferred until either the date on which the SBA remits the amount of forgiveness proceeds to the lender or the date that is 10 months after the last day of the covered period if the borrower does not apply for forgiveness within that 10 month period. Fees generated based on the origination of PPP loans are deferred and amortized into interest income over the contractual period of 24 months or 60 months, as applicable. Upon SBA forgiveness, unamortized fees are then recognized into interest income.

In 2020:
The Bank originated 1,738 PPP loans totaling $346.7 million in principal.
Fees generated totaled $10.0 million.
765 PPP loans totaling $113.5 million were forgiven.
Total net fees of $5.4 million were recognized.

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In 2021:
The Bank originated 1,000 PPP loans totaling $128.1 million in principal.
Fees generated totaled $5.6 million.
1,722 PPP loans totaling $318.4 million were forgiven.
Total net fees of $8.3 million were recognized.

In the six months ended June 30, 2022:
217 PPP loans totaling $40.3 million were forgiven.
Total net fees of $1.2 million were recognized.

As of June 30, 2022, 21 PPP loans totaling $2.8 million in principal remained outstanding and total net fees of $94,000 remained unrecognized.
 
Our consumer residential mortgage loan portfolio, which also includes residential construction loans made to individual homeowners, comprised 11.3%12.2% of portfolio loans at June 30, 2022March 31, 2023 and 10.7%11.8% at December 31, 2021.2022.  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 increaseddecreased by $1.6$3.7 million to $56.5$55.6 million at June 30, 2022March 31, 2023 from $54.8$59.3 million at December 31, 2021.2022.  These other consumer loans comprised 5.0%4.5% of our portfolio loans at June 30, 2022March 31, 2023 and 4.9%5.0% at December 31, 2021.2022.
Given that current industry credit conditions are tightening, we expect industry pricing will increase in response to cost of funds increases and we will respond accordingly.
 
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.

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Nonperforming assets are comprised of nonperforming loans, foreclosed assets and repossessed assets. At June 30, 2022,March 31, 2023, nonperforming assets totaled $2.4just $75,000, down $2.3 million unchanged from $2.4 million at December 31, 2021.2022. There were no additions to other real estate owned in the first sixthree months of 20222023 or in the first sixthree months of 2021.2022.  At June 30, 2022,March 31, 2023, 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 2022.2023.  Proceeds from sales of foreclosed properties were $2.7 million in the first three months of 2023, resulting in net realized gains on sales of $356,000.  Proceeds from sales of foreclosed properties were $0 in the first sixthree months of 2022, resulting in net realized loss on sales of $0.  Proceeds from salesWith the sale of foreclosed properties were $170,000 in the first six monthsquarter of 2021, resulting in net realized loss on sales of $20,000.2023, we have no remaining other real estate owned at March 31, 2023.
 
Nonperforming loans include loans on nonaccrual status and loans delinquent more than 90 days but still accruing.  Nonperforming loans at June 30, 2022March 31, 2023 consisted of $5,000$75,000 of commercial real estate loans and $85,000 of consumer and residential mortgage loans.  As of June 30, 2022,March 31, 2023, nonperforming loans totaled $90,000,$75,000, or 0.01% of total portfolio loans, compared to $92,000,$78,000, or 0.01% of total portfolio loans, at December 31, 2021.2022.
 
Foreclosed and repossessed assets include assets acquired in settlement of loans. Foreclosed assets totaled $2.3 million$0 at June 30, 2022March 31, 2023 and $2.3 million at December 31, 2021. The entire balance at June 30, 2022 was comprised of one commercial real estate property.2022. 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):

 
June 30,
2022
  
December 31,
2021
  
March 31,
2023
  
December 31,
2022
 
Nonaccrual loans $90  $91  $75  $78 
Loans 90 days or more delinquent and still accruing  —   1   —   — 
Total nonperforming loans (NPLs) 90  92  75  78 
Foreclosed assets 2,343  2,343  —  2,343 
Repossessed assets  —   —   —   — 
Total nonperforming assets (NPAs) $2,433  $2,435  $75  $2,421 
NPLs to total loans 0.01% 0.01% 0.01% 0.01%
NPAs to total assets 0.09% 0.08% 0.00% 0.08%

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We adopted ASU 2022-02 effective January 1, 2023.  This standard eliminated the previous troubled debt restructuring (“TDR”) accounting model and replaced it with guidance and disclosure requirements for identifying modifications to loans to borrowers experiencing financial difficulty.  The following table shows the composition and amountbalance of our troubled debt restructurings (TDRs) at June 30, 2022 and Decemberloans modified to borrowers experiencing financial difficulty as of March 31, 20212023 (dollars in thousands):

  June 30, 2022  December 31, 2021 
  Commercial  Consumer  Total  Commercial  Consumer  Total 
Performing TDRs $1,409  $2,840  $4,249  $4,497  $3,024  $7,521 
Nonperforming TDRs (1)  5   —   5   5   —   5 
Total TDRs $1,414  $2,840  $4,254  $4,502  $3,024  $7,526 
  March 31, 2023 
  
Number of
Loans
  
Outstanding
Recorded
Balance
  
Percentage to
Total
Loans
 
Commercial and industrial  3  $309   0.07%
Commercial real estate  3   509   0.09%
Consumer  32   2,847   1.39%
   38  $3,665   0.30%

(1)Included in nonperforming asset table above
We had a totalAllowance for credit losses: The allowance for credit losses at March 31, 2023 was $16.8 million, an increase of $4.3 million and $7.5 million of loans whose terms have been modified in TDRs as of June 30, 2022 and December 31, 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 $3.3$1.5 million from December 31, 2021 to June 30, 2022 due primarily to seasonal repayments on one commercial TDR operating line.  There were 45 loans identified as TDRs at June 30, 2022 compared to 54 loans at December 31, 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.

In March 2020, guidance issued by the federal banking agencies in consultation with FASB and the Coronavirus Aid, Relief and Economic Security (“CARES”) Act collectively 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. Through June 30, 2022, the Bank had applied this guidance and modified 726 individual loans with aggregate principal balances totaling $337.2 million.  As of June 30, 2022, all of these modifications had expired and the loans had returned to their contractual payment terms.

Allowance for loan losses:2022.  The allowance for loan losses at June 30, 2022 was $14.6 million, a decrease of $1.3 million from December 31, 2021.  The allowance for loancredit losses represented 1.32%1.38% of total portfolio loans at June 30, 2022March 31, 2023 and 1.43%1.30% at December 31, 2021.  The ratios at June 30, 2022 and December 31, 2021 are impacted by $2.8 million and $41.9 million of remaining PPP loans, respectively, which are fully guaranteed and receive no allowance allocation.  The ratios excluding these loans were 1.32% and 1.49% at June 30, 2022 and December 31, 2021, respectively.2022.   The allowance for loancredit losses to nonperforming loan coverage ratio decreasedincreased from 17270.7%19596.2% at December 31, 20212022 to 16256.7%22392.0% at June 30, 2022.March 31, 2023.

We adopted the Current Expected Credit Loss (“CECL”) standard effective January 1, 2023 using the modified retrospective method for all financial assets measured at amortized cost and off-balance sheet credit exposures.  Results for reporting periods after January 1, 2023 are presented under CECL while prior period amounts continue to be reported in accordance with the probable incurred loss accounting standards.  The transition adjustment of the CECL adoption included an increase in the allowance for credit losses of $1.5 million, $62,000 to establish a reserve for unfunded commitments and a $1.2 million decrease to retained earnings to reflect the cumulative effect of adoption of CECL, with the $323,000 tax impact portion being recorded as part of the deferred tax asset on our Consolidated Balance Sheet.

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

 
Quarter Ended
June 30,
2022
  
Quarter Ended
March 31,
2022
  
Quarter Ended
December 31,
2021
  
Quarter Ended
September 30,
2021
  
Quarter Ended
June 30,
2021
  
Quarter Ended
March 31,
2023
  
Quarter Ended
December 31,
2022
  
Quarter Ended
September 30,
2022
  
Quarter Ended
June 30,
2022
  
Quarter Ended
March 31,
2022
 
Nonperforming loans $90  $90  $92  $420  $433  $75  $78  $85  $90  $90 
Other real estate owned and repo assets 2,343  2,343  2,343  2,343  2,343  —  2,343  2,343  2,343  2,343 
Total nonperforming assets 2,433  2,433  2,435  2,763  2,776  75  2,421  2,428  2,433  2,433 
Net charge-offs (recoveries) (15) (227) (107) (276) (104) (33) (89) (190) (15) (227)
Total delinquencies 197  171  129  437  126  277  172  84  197  171 

At June 30, 2022,March 31, 2023, we had net loan recoveries in twenty-eightthirty-one of the past thirtythirty-three quarters.  Our total delinquencies were $197,000$277,000 at June 30, 2022March 31, 2023 and $129,000$172,000 at December 31, 2021.2022.  Our delinquency percentage at June 30, 2022March 31, 2023 was 0.02%.

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These factors all impact our necessary level of allowance for loan losses and our provision for loan losses. The allowance for loancredit losses decreased $1.3increased $1.5 million in the first sixthree months of 2022.2023.  As discussed above, the increase in the first three months of 2023 was due to the effect of adopting CECL on January 1, 2023.  We recorded a provision for loan losscredit losses expense of $0 for the three months ended March 31, 2023 compared to a provision benefit of $1.5 million for the six months ended June 30, 2022 compared to a benefit of  $750,000 for the same period of 2021.2022.  Net loan recoveries were $242,000$33,000 for the sixthree months ended June 30, 2022,March 31, 2023, compared to net loan recoveries of $148,000$227,000 for the same period in 2021.2022. The ratio of net charge-offs (recoveries) to average loans was -0.06%-0.01% on an annualized basis for the first sixthree months of 20222023 and -0.02%-0.03% for the first sixthree months of 2021.2022.
 
While we have experienced low levels of gross charge-offs over recent quarters, we recognize that future charge-offs and resulting provisions for loancredit losses are expected to be impacted by the timing and extent of changes in the overall economy and the real estate markets.
 
OurThe allowance for credit loss accounting in effect at December 31, 2022 and all prior periods was based on our estimate of probable incurred loan losses is maintained at a level believed appropriate based upon our assessmentas of the probable estimatedreporting date (“incurred loss” methodology).  Under the CECL methodology, our allowance is based on the total amount of credit losses inherent inthat are expected over the remaining life of the loan portfolio.  Our methodology for measuring the appropriate levelestimate of allowance and related provision for loancredit losses under CECL is determined using a complex model that relies on historical loss information including our own history as well as peer loss history, reasonable and supportable economic forecasts, and various qualitative factors.
The primary risk elements with respect to our commercial loans are the financial condition of the borrower, sufficiency of collateral and timeliness of scheduled payments.  We have a policy of reviewing periodic financial statements from commercial loan customers and have a disciplined and formalized review of the existence of collateral and its value.  The primary risk element with respect to residential and consumer loans is the timeliness of scheduled payments.  We have a reporting process that monitors past due loans and have adopted policies to pursue creditors’ rights in order to preserve our collateral position.  Over the past several key elements, which include specific allowances for loans considered impaired, general allowanceyears, consumer delinquency has been nominal.
Under CECL, for commercial loans not considered impairedidentified as collateral dependent, we estimate the CECL reserve 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 decreased by $3.3 million to $4.3 million at June 30, 2022 compared to $7.5 million at December 31, 2021.  The specific allowance for impaired loans decreased by $269,000 to $296,000 at June 30, 2022, compared to $565,000 at December 31, 2021.  The specific allowance for impaired loans represented 7.0% of total impaired loans at June 30, 2022 and 7.5% at December 31, 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.  With the widespread vaccination efforts, coupled with reduction in infection rates in the first and second quarters of 2022, we determined that adjustments to certain qualitative factors were appropriate in the first half of 2022.  We also considered the improving economic conditions, including sharp reductions in unemployment and actions taken by the Federal Reserve in response to employment and inflation.  As a result, we reduced the economic qualitative factor by 3 basis points in the first quarter of 2022.  No additional changes were made for this factor in the 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 impact 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.
Certain industry sectors have been more negatively impacted by the economic effects of COVID-19 than others such as hospitality, restaurants and sporting events.  We believe our commercial portfolio is adequately diversified, with our largest commercial concentrations in Real Estate, Rental and Leasing (31%(27.5%), followed by Manufacturing (14%(13.3%) and Retail Trade (10%(11.7%).

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The table below breaks down our commercial loan portfolio by industry type at June 30, 2022March 31, 2023 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):

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  June 30, 2022 
  Excluding PPP  PPP Loans  Total  
Percent of
Total Loans
  Percent Grade 4 or Better  Percent Grade 5 or Worse 
Industry:                  
Agricultural Products $32,505   —  $32,505   3.50%  98.58%  1.42%
Mining and Oil Extraction  1,302   —   1,302   0.14%  95.31%  4.69%
Construction  81,385   49   81,434   8.76%  97.44%  2.56%
Manufacturing  134,539   17   134,556   14.47%  97.53%  2.47%
Wholesale Trade  77,861   —   77,861   8.38%  100.00%  0.00%
Retail Trade  89,528   15   89,543   9.63%  99.92%  0.08%
Transportation and Warehousing  48,533   15   48,548   5.22%  98.31%  1.69%
Information  692   —   692   0.07%  6.07%  93.93%
Finance and Insurance  39,166   —   39,166   4.21%  100.00%  0.00%
Real Estate and Rental and Leasing  287,149   546   287,695   30.95%  99.92%  0.08%
Professional, Scientific and Technical Services  3,918   258   4,176   0.45%  94.95%  5.05%
Management of Companies and Enterprises  3,400   —   3,400   0.37%  100.00%  0.00%
Administrative and Support Services  14,981   13   14,994   1.61%  99.35%  0.65%
Education Services  3,849   —   3,849   0.41%  97.92%  2.08%
Health Care and Social Assistance  32,696   39   32,735   3.52%  100.00%  0.00%
Arts, Entertainment and Recreation  3,988   313   4,301   0.46%  92.70%  7.30%
Accommodations and Food Services  39,078   1,114   40,192   4.32%  83.61%  16.39%
Other Services  32,321   412   32,733   3.52%  100.00%  0.00%
Total commercial loans $926,891  $2,791  $929,682   100.00%  98.39%  1.61%
  Total  
Percent of
Total Loans
  
Percent Grade 4 or
Better
  
Percent Grade 5 or
Worse
 
Industry:            
Agricultural Products $47,478   4.67%  85.04%  14.96%
Mining and Oil Extraction  397   0.04%  89.17%  10.83%
Construction  86,876   8.54%  97.56%  2.44%
Manufacturing  134,851   13.26%  96.34%  3.66%
Wholesale Trade  68,215   6.71%  100.00%  0.00%
Retail Trade  119,262   11.73%  99.95%  0.05%
Transportation and Warehousing  68,983   6.78%  99.94%  0.06%
Information  567   0.06%  5.47%  94.53%
Finance and Insurance  44,467   4.37%  100.00%  0.00%
Real Estate and Rental and Leasing  279,131   27.45%  99.98%  0.02%
Professional, Scientific and Technical Services  5,807   0.57%  96.68%  3.32%
Management of Companies and Enterprises  756   0.07%  100.00%  0.00%
Administrative and Support Services  24,246   2.38%  98.41%  1.59%
Education Services  4,639   0.46%  100.00%  0.00%
Health Care and Social Assistance  37,907   3.73%  100.00%  0.00%
Arts, Entertainment and Recreation  3,588   0.35%  91.56%  8.44%
Accommodations and Food Services  51,198   5.04%  86.78%  13.22%
Other Services  38,334   3.77%  100.00%  0.00%
Total commercial loans $1,016,702   100.00%  97.78%  2.22%
 
Considering the change in our qualitative factors and our commercial loan portfolio balances, the general allowance allocated to commercial loans was $12.1$13.8 million at June 30, 2022March 31, 2023 (under CECL) and $12.9$12.8 million at December 31, 2021.2022 (under incurred loss).  The qualitative component of our allowance allocated to commercial loans was $12.1$11.2 million at June 30, 2022, down $755,000 from $12.9March 31, 2023 (under CECL) compared to $12.7 million at December 31, 2021.2022 (under incurred loss).  Under CECL, we use historical peer loss history so the quantitative component receives a higher allocation and, with the addition of reasonable and supportable forecast assumption under CECL in choosing the historical loss period, less qualitative allocations related to economic conditions are necessary.
 
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, theThe determination of the allowance allocation percentage is based principally on ourpeer historical loss experience.experience under CECL.  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 for credit losses for consumer loans was $2.1$2.8 million at June 30, 2022March 31, 2023 (under CECL) and $2.4$2.2 million at December 31, 2021.2022 (under incurred loss).
Allowance for credit losses allocated to loans identified as collateral dependent were $6,000 at March 31, 2023 (under CECL).  Allowance allocations for loans identified as impaired at December 31, 2022 (under incurred loss) were $295,000.
 
The allowance allocations are not intended to imply limitations on usage of the allowance for loan losses.  The entire allowance for loancredit losses is available for any loan lossesloss without regard to loan type.
See Note 1 - Significant Accounting Policies in this Form 10-Q for further descriptions of our allowance for credit loss estimation process.  See also Note 3 - Loans in this Form 10-Q for further information regarding our loan portfolio and allowance.
 
Bank-Owned Life Insurance:  Bank-owned life insurance increased $495,000$212,000 from December 31, 20212022 to June 30, 2022March 31, 2023 due to earnings on the underlying policies.
 
Premises and Equipment:   Premises and equipment totaled $41.1$40.2 million at June 30, 2022,March 31, 2023, down $685,000$57,000 from $41.8$40.3 million at December 31, 2021.2022.
 
Deposits and Other Borrowings: Total deposits decreased $83.4$284.2 million to $2.49$2.33 billion at June 30, 2022,March 31, 2023, as compared to $2.58$2.62 billion at December 31, 2021.  2022.   While the Bank experienced a decline in deposit balances during the three months ended March 31, 2023, most of the decline took place prior to the early March 2023 bank failures noted earlier.  We experienced a seasonal run up in business deposits of about $90 million in December 2022, which came back out in January 2023.  In addition, a couple of large business customers removed deposits totaling nearly $90 million in early March 2023 for specific designated purposes.  We saw very little change in our deposit balances overall following the news of the bank failures and banking system disruption.

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Our deposit base is primarily made up of many small accounts, and balances at March 31, 2023 were comprised of 48% personal customers and 52% business customers.  Our core deposits - which we define as deposits we have sourced within our local markets - represented 100% of our total deposits at March 31, 2023.  Our total balances of $2.33 billion at March 31, 2023 remain elevated, reflecting a $625.5 million increase, or 37%, over pre-pandemic totals of $1.71 billion as of March 31, 2020.
Non-interest bearing checking account balances increased $17.2decreased $144.4 million during the first sixthree months of 2022.2023.  Interest bearing demand account balances decreased $96.3$151.9 million and savings and money market account balances increased $2.7decreased $63.5 million in the first sixthree months of 2022.  The overall decrease in deposits so far in 2022 has related to our2023 as municipal and business and municipal customers beginning to release the higherhave begun deploying their excess balances they have retainedcarried during the COVID-19 pandemic.pandemic, including stimulus funding.  Certificates of deposits decreasedincreased by $7.0$75.6 million in the first sixthree months of 20222023 reflecting our increases in offered interest rates, particularly in the continued low market interest rates.12-18 month term.  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.
 
Noninterest bearing demand accounts comprised 36%30% of total deposits at June 30, 2022March 31, 2023 and 34%31% of total deposits at December 31, 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 2021 due to customers of all types holding higher balances due to the COVID-19 pandemic.2022.   In addition,recent years, 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 have begun to see some of these balances move to higher earning deposit types.  Interest bearing demand, accounts, including money market and savings accounts, comprised 60%63% of total deposits at June 30, 2022March 31, 2023 and 62%64% at December 31, 2021.2022. Time accounts as a percentage of total deposits were 3%7% at June 30, 2022March 31, 2023 and 3%4% at December 31, 2021.2022.

-50-Deposit balances in excess of the $250,000 FDIC insured limit totaled approximately $962.7 million, or 41% of total deposits, at March 31, 2023 and approximately $1.21 billion, or 45% of total deposits, at December 31, 2022.  As discussed previously, we have sufficient liquid resources to cover all of the uninsured balances at March 31, 2023.
Borrowed funds at June 30,March 31, 2023 consisted of $30.0 million of Federal Home Loan Bank (“FHLB”) advances.  Borrowed funds at December 31, 2022 consisted of $30.0 million of FHLB advances.  Borrowed fundsAt March 31, 2023, we had $242.3 million in available borrowing capacity at December 31, 2021 consisted of $85.0 million of FHLB advances.  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, 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 exercised its put option on this advance and it was paid off by the Company as 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 payback period is less than one quarter.FHLB.
 
CAPITAL RESOURCES
 
Total shareholders'shareholders’ equity of $243.1$260.6 million at June 30, 2022March 31, 2023 reflected a decreasean increase of $10.9$13.5 million from $254.0$247.0 million at December 31, 2021.2022. The decreaseincrease was primarily a result of net income of $12.0 million earned in the first three months of 2023 and a negativepositive swing of $18.4$5.3 million in accumulated other comprehensive income ("AOCI"(“AOCI”) and, partially offset by a payment of $5.5$2.7 million in cash dividends to shareholders more than offsetting our net incomeand $1.2 million reduction from adoption of $12.6 million earned in the first six months of 2022.ASU 2016-13 CECL standard on January 1, 2023.  The negativepositive swing in AOCI was attributable to a sharp increasedecrease in market interest rates on bonds during the first half of 2022quarter 2023 causing a devaluationan increase in market value on our investment securities available for sale.  The Bank was categorized as “well capitalized” at June 30, 2022.March 31, 2023.  The amount of capital retained by the Bank in excess of well capitalized minimums was $127.2 million at March 31, 2023.
 
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). The, and Basel III requires a minimum leverage ratio isof 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 
June 30,
2022
  
March 31,
2022
  
Dec 31,
2021
  
Sept 30,
2021
  
June 30,
2021
  
March 31,
2023
  
Dec 31,
2022
  
Sept 30,
2022
  
June 30,
2022
  
March 31,
2022
 
Total capital to risk weighted assets 17.5% 17.9% 18.3% 18.6% 19.7% 18.1% 17.9% 17.6% 17.5% 17.9%
Common Equity Tier 1 to risk weighted assets 16.5  16.9  17.2  17.4  17.1  17.1  16.9  16.7  16.5  16.9 
Tier 1 capital to risk weighted assets 16.5  16.9  17.2  17.4  18.5  17.1  16.9  16.7  16.5  16.9 
Tier 1 capital to average assets 9.1  8.8  8.7  8.5  9.5  10.3  9.7  9.3  9.1  8.8 

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 Federal Reserve Board'sFRB’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, maturities of our securities held to maturity, growth of our deposits, federal funds sold and other short-term investments, and the various capital resources discussed above.  In March 2023, the Federal Reserve Bank introduced a new borrowing facility named the Bank Term Funding Program.  This program allows an institution to borrow against its investment portfolio at a fixed rate for up to one year and to use their investment portfolio for liquidity without incurring losses by liquidating those investments.  At March 31, 2023, we would qualify for approximately $642.2 million in such borrowing capacity.
 
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.

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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 June 30, 2022,March 31, 2023, the Bank held $721.8$391.3 million of federal funds sold and other short-term investments.  In addition, the Bank had available borrowing capacity from correspondent banks, including the Bank Term Funding Program discussed above, of approximately $277.3$951.0 million as of June 30, 2022.March 31, 2023.  Finally, because we have maintained the discipline of buying shorter-term bond durations in our investment securities portfolio, we have $393.0 million in bond maturities and paydowns coming into the Bank in the next 24 months ending March 31, 2025.

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 June 30, 2022,March 31, 2023, we had a total of $769.1$719.0 million in unused lines of credit, $101.8$115.1 million in unfunded loan commitments and $14.4$11.9 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 2021,2022, the Bank paid dividends to the Company totaling $33.1$11.9 million.  In the same period, the Company paid $10.9 million in dividends to its shareholders and $20.6 million to redeem outstanding trust preferred securities.shareholders.  On February 23, 2022,27, 2023, the Bank paid a dividend totaling $2.9$3.1 million to the Company in anticipation of the common share cash dividend of $0.08 per share paid on February 24, 202228, 2023 to shareholders of record on February 10, 2022.  The cash distributed for this cash dividend payment totaled $2.7 million.   On May 25, 2022, the Bank paid a dividend totaling $2.8 million to the Company in anticipation of the common share cash dividend of $0.08 per share paid on May 26, 2022 to shareholders of record on May 12, 2022.13, 2023.  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 June 30, 2022,March 31, 2023, the Bank had a retained earnings balance of $90.4$114.5 million.
 
The Company’s cash balance at June 30, 2022March 31, 2023 was $7.7$8.1 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 loancredit 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 loancredit losses and the related provision for loancredit losses is described above in the "Allowance“Allowance for Loan Losses"Credit 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 loancredit losses and the related provision for loancredit losses.  Although, based upon our internal analysis, and in our judgment, we believe that we have provided an adequate allowance for loancredit 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 loancredit losses that may be significantly different than the levels that we recorded in the first sixthree months of 2022.2023.

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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.
 
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.

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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 June 30, 2022,March 31, 2023, we had gross deferred tax assets of $8.4$10.8 million and gross deferred tax liabilities of $1.9$2.3 million resulting in a net deferred tax asset of $6.5$8.5 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“more likely than not"not” standard.  We concluded at June 30, 2022March 31, 2023 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.
 
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.

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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 June 30, 2022March 31, 2023 (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 $386,896  (1.84)% $80,374  5.67% $380,272  (6.13)% $92,806  1.64%
Interest rates up 100 basis points 389,272  (1.24) 77,835  2.33  392,526  (3.10) 92,049  0.81 
No change 394,164  —  76,064  —  405,104  —  91,313  — 
Interest rates down 100 basis points 374,406  (5.01) 69,758  (8.29) 412,343  1.79  90,291  (1.12)
Interest rates down 200 basis points 345,688  (12.30) 63,861  (16.04) 402,802  (0.57) 87,957  (3.68)

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.
 
The quarterly simulation analysis is monitored against acceptable interest rate risk parameters by the Asset/Liability Committee and reported to the Board of Directors.

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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"(“CEO”) and Chief Financial Officer ("CFO"(“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 June 30, 2022,March 31, 2023, 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'sCompany’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'sCompany’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'sCompany’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'sCommission’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 – OTHER 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 secondfirst quarter of 2022.2023.  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            
April 1 - April 30, 2022      
January 1 - January 31, 2023      
Employee Transactions —  $—  1,338  $10.92 
May 1 - May 31, 2022      
February 1 - February 28, 2023      
Employee Transactions —  $—  —  $— 
June 1 - June 30, 2022      
March 1 - March 31, 2023      
Employee Transactions 815  $8.68  —  $— 
Total for Second Quarter ended June 30, 2022      
Total for First Quarter ended March 31, 2023      
Employee Transactions 815  $8.68  1,338  $10.92 

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'sCorporation’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'sregistrant’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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SIGNATURES
 
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: July 28, 2022April 27, 2023


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