Macatawa Bank (MCBC) 10-Q 2006 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006

OR

¨ TRANSITION REPORT UNDER 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 issuer as specified in its charter)

Michigan	38-3391345
(State of 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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ¨    No  x

Indicate by check 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  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated file, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨ Accelerated filer  x Non-accelerated filer  ¨

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

The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 16,209,608 shares of the Company’s Common Stock (no par value) were outstanding as of August 3, 2006.

INDEX

		Page Number
Part I.	Financial Information:
	Item 1.
	Consolidated Financial Statements	3
	Notes to Consolidated Financial Statements	9
	Item 2.
	Management’s Discussion and Analysis of
	Results of Operations and Financial Condition	19
	Item 3.
	Quantitative and Qualitative Disclosures
	About Market Risk	27
	Item 4.
	Controls and Procedures	28
Part II.	Other Information:
	Item 1.
	Legal Proceedings	28
	Item 1.A.
	Risk Factors	30
	Item 2.
	Changes in Securities and Use of Proceeds	30
	Item 3.
	Defaults Upon Senior Securities	30
	Item 4.
	Submission of Matters to a Vote of Security Holders	30
	Item 5.
	Other Information	31
	Item6.
	Exhibits	31
Signatures		32

2

Part I Financial Information

Item 1.

MACATAWA BANK CORPORATION

CONSOLIDATED BALANCE SHEETS

As of June 30, 2006 (unaudited) and December 31, 2005

(dollars in thousands)	June 30, 2006			December 31, 2005
ASSETS
Cash and due from banks	$	43,346		$	49,101
Securities available for sale		165,964			156,696
Securities held to maturity		2,715			3,907
Federal Home Loan Bank stock		13,910			13,910
Loans held for sale		2,346			2,331
Total loans		1,653,035			1,547,879
Allowance for loan losses		(22,145	)		(20,992	)
		1,630,890			1,526,887
Premises and equipment – net		56,569			53,028
Accrued interest receivable		9,485			8,366
Goodwill		23,915			23,915
Acquisition intangibles		1,748			1,941
Bank-owned life insurance		21,279			20,814
Other assets		9,151			9,094
Total assets	$	1,981,318		$	1,869,990
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing	$	174,516		$	188,762
Interest-bearing		1,398,585			1,319,010
Total		1,573,101			1,507,772
Federal funds purchased		25,701			25,809
Federal Home Loan Bank advances		187,722			145,161
Long-term debt		41,238			41,238
Accrued expenses and other liabilities		5,657			8,266
Total liabilities		1,833,419			1,728,246
Shareholders’ equity
Preferred stock, no par value, 500,000 shares authorized; no shares issued and outstanding
Common stock, no par value, 40,000,000 shares authorized; 16,205,196 shares and 10,227,992 issued and outstanding as of June 30, 2006 and December 31, 2005, respectively		152,951			136,583
Retained earnings		42			8,040
Accumulated other comprehensive income (loss)		(5,094	)		(2,879	)
Total shareholders’ equity		147,899			141,744
Total liabilities and shareholders’ equity	$	1,981,318		$	1,869,990

See accompanying notes to consolidated financial statements

3

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

Three and Six Month Periods Ended June 30, 2006 and 2005

(unaudited)

(dollars in thousands, except per share data)	Three Months Ended June 30, 2006		Three Months Ended June 30, 2005		Six Months Ended June 30, 2006		Six Months Ended June 30, 2005
Interest income
Loans, including fees	$	30,889	$	23,565	$	59,268	$	45,124
Securities		1,799		1,652		3,484		3,154
FHLB Stock		191		138		362		267
Other		17		2		23		11
Total interest income		32,896		25,357		63,137		48,556
Interest expense
Deposits		12,833		7,011		24,313		13,336
Other		3,088		2,859		5,535		4,889
Total interest expense		15,921		9,870		29,848		18,225
Net interest income		16,975		15,487		33,289		30,331
Provision for loan losses		800		1,125		1,500		2,025
Net interest income after provision for loan losses		16,175		14,362		31,789		28,306
Noninterest income
Service charges and fees		1,300		1,155		2,386		1,879
Gain on sales of loans		511		536		923		1,094
Trust fees		796		716		1,622		1,432
Other		1,022		962		1,892		1,637
Total noninterest income		3,629		3,369		6,823		6,042
Noninterest expense
Salaries and benefits		6,293		5,430		12,330		10,834
Occupancy of premises		835		749		1,720		1,590
Furniture and equipment		774		720		1,572		1,423
Legal and professional fees		259		199		482		386
Marketing and promotion		321		249		677		462
Data processing fees		433		384		864		769
Other		2,418		2,341		4,773		4,459
Total noninterest expenses		11,333		9,962		22,418		19,923
Income before income tax expense		8,471		7,769		16,194		14,425
Income tax expense		2,715		2,507		5,217		4,628
Net income	$	5,756	$	5,262	$	10,977	$	9,797
Basic earnings per share Diluted earnings per share Cash dividends per share	$	.36 .35 .12	$	.33 .32 .10	$	.68 .66 .23	$	.61 .60 .18

See accompanying notes to consolidated financial statements

4

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

Three and Six Month Periods Ended June 30, 2006 and 2005

(unaudited)

(dollars in thousands)	Three Months Ended June 30, 2006			Three Months Ended June 30, 2005		Six Months Ended June 30, 2006			Six Months Ended June 30, 2005
Net income	$	5,756		$	5,262	$	10,977		$	9,797
Other comprehensive income/(loss), net of tax:
Net change in unrealized gains/(losses) on securities		(1,289	)		1,289		(1,585	)		(202	)
Net change in unrealized gains/(losses) on derivative instruments		(210	)		691		(630	)		(386	)
Comprehensive income	$	4,257		$	7,242	$	8,762		$	9,209

See accompanying notes to consolidated financial statements

5

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Six Month Periods Ended June 30, 2006 and 2005

(unaudited)

(dollars in thousands, except per share data)	Common Stock		Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Total Shareholders’ Equity
Balance, January 1, 2005	$	124,389	$	4,277		$	408		$	129,074
Net income for six months ended June 30, 2005				9,797						9,797
Other comprehensive income/(loss), net of tax:
Net change in unrealized gain/(loss) on securities							(202	)		(202	)
Net change in unrealized gain/(loss) on derivative instruments							(386	)		(386	)
Comprehensive income										9,209
Issued 42,294 shares for stock option exercises (net of 1,875 shares exchanged and including $41 of tax benefit)		576								576
Issued 1,328,409 shares in payment of 15% stock dividend		10,863		(10,898	)					(35	)
Cash dividends at $.18 per share				(2,856	)					(2,856	)
Balance, June 30, 2005	$	135,828	$	320		$	(180	)	$	135,968
Balance, January 1, 2006	$	136,583	$	8,040		$	(2,879	)	$	141,744
Net income for six months ended June 30, 2006				10,977						10,977
Other comprehensive income/(loss), net of tax:
Net change in unrealized gain/(loss) on securities							(1,585	)		(1,585	)
Net change in unrealized gain/(loss) on derivative instruments							(630	)		(630	)
Comprehensive income										8,762
Issued 62,731 shares for stock option exercises (net of 4,816 shares exchanged and including $79 of tax benefit)		868								868
Issued 513,283 shares in payment of 5% stock dividend		15,127		(15,180	)					(53	)
Issued 5,401,190 shares in payment of 3-for-2 stock split
Stock option compensation expense		373								373
Cash dividends at $.23 per share				(3,795	)					(3,795	)
Balance, June 30, 2006	$	152,951	$	42		$	(5,094	)	$	147,899

See accompanying notes to consolidated financial statements

6

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

Six Month Periods Ended June 30, 2006 and 2005

(unaudited)

(dollars in thousands)	Six Months Ended June 30, 2006			Six Months Ended June 30, 2005
Cash flows from operating activities
Net income	$	10,977		$	9,797
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		1,702			1,566
Stock option compensation expense		373			—
Provision for loan losses		1,500			2,025
Origination of loans for sale		(53,996	)		(62,594	)
Proceeds from sales of loans originated for sale		54,845			63,496
Gain on sales of loans		(923	)		(1,094	)
Net change in:
Accrued interest receivable and other assets		(816	)		(777	)
Bank-owned life insurance		(465	)		(333	)
Accrued expenses and other liabilities		(1,337	)		3,334
Net cash from operating activities		11,860			15,420
Cash flows from investing activities
Loan originations and payments, net		(106,772	)		(76,424	)
Purchases of securities available for sale		(13,881	)		(37,571	)
Purchases of FHLB stock		—			(1,422	)
Maturities and calls of securities available for sale		1,990			13,189
Principal paydowns on securities		1,342			98
Additions to premises and equipment		(5,017	)		(3,126	)
Net cash used in investing activities		(122,338	)		(105,256	)
Cash flows from financing activities
Net increase/(decrease) in deposits		65,329			(13,875	)
Net increase/(decrease) in short term borrowings		(108	)		20,434
Proceeds from Federal Home Loan Bank advances		75,000			360,000
Repayments of Federal Home Loan Bank advances		(32,439	)		(268,421	)
Cash dividends paid		(3,848	)		(2,891	)
Proceeds from exercises of stock options		789			535
Net cash from financing activities		104,723			95,782
Net change in cash and cash equivalents		(5,755	)		5,946
Cash and cash equivalents at beginning of period		49,101			31,711
Cash and cash equivalents at end of period	$	43,346		$	37,657

See accompanying notes to consolidated financial statements

7

MACATAWA BANK CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

Six Month Periods Ended June 30, 2006 and 2005

(unaudited)

(dollars in thousands)	Six Months Ended June 30, 2006		Six Months Ended June 30, 2005
Supplemental cash flow information
Interest paid	$	30,366	$	17,225
Income taxes paid		5,800		4,300
Supplemental noncash disclosures:
Transfers from loans to other real estate		1,328		2,151

See accompanying notes to consolidated financial statements

8

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 the Company and its wholly-owned subsidiaries, Macatawa Bank, and its wholly-owned subsidiary, Macatawa Bank Mortgage Company; and Macatawa Investment Services, Inc. All significant intercompany accounts and transactions have been eliminated in consolidation.

The Company also owns all of the common stock of Macatawa Statutory Trust I and Macatawa Statutory Trust II. These are grantor trusts that issued trust preferred securities and are not consolidated with the Company per FASB Interpretation No. 46.

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) considered necessary for a fair presentation have been included. Operating results for the three and six month periods ended June 30, 2006, are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s 2005 Annual Report containing financial statements for the year ended December 31, 2005.

All per share amounts and average shares outstanding have been adjusted for all periods presented to reflect the 5% stock dividend distributed on May 30, 2006, the 3-for-2 stock split distributed on June 29, 2006, and the 15% stock dividend distributed on May 27, 2005.

Stock Compensation: On January 1, 2006, the Company adopted FAS 123, Revised, which requires all public companies to record compensation cost for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options when granted, and this cost is expensed over the employee service period, which is normally the vesting period of the options. As amended, this applies to awards granted or modified beginning with the first quarter of 2006. Compensation cost was also recorded for prior option grants that vested after the date of adoption. For the three months ended June 30, 2006, the Company recorded compensation cost for stock options of $185,000, or $145,000 after tax, representing $0.01 per share. For the six month period ended June 30, 2006 the Company recorded compensation cost for stock options of $373,000, or $293,000 after tax, representing $0.02 per share. Future compensation cost for stock options is expected to be recognized as follows (in thousands):

Remainder of 2006	$	284
2007		319
2008		276
2009		3
Total	$	882

Employee compensation expense under stock option plans was reported using the intrinsic value method for the three and six month periods ended June 30, 2005. No compensation cost related to stock options was recognized during the three and six month periods ended June 30, 2005, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. Had compensation cost for stock options been measured using the fair value method, net income and basic and diluted earnings per share would have been the pro forma amounts indicated below (dollars in thousands, except per share data).

9

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

	Three Months Ended June 30, 2005			Six Months Ended June 30, 2005
Net income as reported	$	5,262		$	9,797
Stock-based compensation cost, net of tax		(87	)		(146	)
Pro forma net income		5,175			9,651
Basic earnings per share as reported		.33			.61
Pro forma basic earnings per share		.32			.60
Diluted earnings per share as reported		.32			.60
Pro forma diluted earnings per share		.31			.59

NOTE 2 – SECURITIES

The amortized cost and fair values of securities were as follows (in thousands):

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Values
June 30, 2006
Available for Sale:
U.S. Treasury and federal agency securities	$	121,932	$	33	$	(4,274	)	$	117,691
State and municipal bonds		47,756		340		(782	)		47,314
Other Equity Securities		1,000		—		(41	)		959
	$	170,688	$	373	$	(5,097	)	$	165,964
Held to Maturity:
State and municipal bonds	$	2,715	$	53	$	(13	)	$	2,755
December 31, 2005
Available for Sale:
U.S. Treasury and federal agency securities	$	111,102	$	103	$	(2,644	)	$	108,561
State and municipal bonds		46,878		609		(345	)		47,142
Other Equity Securities		1,000		—		(7	)		993
	$	158,980	$	712	$	(2,996	)	$	156,696
Held to Maturity:
State and municipal bonds	$	3,907	$	80	$	(13	)	$	3,974

10

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 2 – SECURITIES(Continued)

Securities with unrealized losses at June 30, 2006 and December 31, 2005, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (in thousands):

	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
June 30, 2006
U.S. Treasury and federal agency securities	$	36,854	$	(782	)	$	78,751	$	(3,492	)	$	115,605	$	(4,274	)
State and municipal bonds		28,713		(508	)		5,753		(287	)		34,466		(795	)
Other Equity Securities		959		(41	)		—		—			959		(41	)
Total temporarily impaired	$	66,526	$	(1,331	)	$	84,504	$	(3,779	)	$	151,030	$	(5,110	)
	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
December 31, 2005
U.S. Treasury and federal agency securities	$	70,531	$	(1,299	)	$	33,654	$	(1,345	)	$	104,185	$	(2,644	)
State and municipal bonds		16,419		(153	)		5,842		(205	)		22,261		(358	)
Other Equity Securities		993		(7	)		—		—			993		(7	)
Total temporarily impaired	$	87,943	$	(1,459	)	$	39,496	$	(1,550	)	$	127,439	$	(3,009	)

For unrealized losses on securities, no loss has been recognized into income because management has the intent and ability to hold these securities for the foreseeable future and the declines are largely due to differences in market interest rates as compared to those of the underlying securities. The declines in fair value are considered temporary and are expected to recover as the bonds approach their maturity date.

Contractual maturities of debt securities at June 30, 2006 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	$	715	$	709	$	7,000		6,897
Due from one to five years		383		376		117,257		113,165
Due from five to ten years		—		—		17,333		17,436
Due after ten years		1,617		1,670		28,098		27,507
	$	2,715	$	2,755	$	169,688	$	165,005

11

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 3 – LOANS

Loans were as follows (in thousands):

	June 30, 2006			December 31, 2005
Commercial	$	402,967		$	359,036
Commercial mortgage		840,091			793,919
Residential mortgage		230,637			223,390
Consumer		179,340			171,534
		1,653,035			1,547,879
Allowance for loan losses		(22,145	)		(20,992	)
	$	1,630,890		$	1,526,887

Activity in the allowance for loan losses was as follows (in thousands):

	Three Months Ended June 30, 2006			Three Months Ended June 30, 2005			Six months Ended June 30, 2006			Six months Ended June 30, 2005
Balance at beginning of period	$	21,391		$	19,534		$	20,992		$	19,251
Provision for loan losses		800			1,125			1,500			2,025
Charge-offs		(248	)		(693	)		(579	)		(1,350	)
Recoveries		202			44			232			84
Balance at end of period	$	22,145		$	20,010		$	22,145		$	20,010

NOTE 4 – DEPOSITS

Deposits are summarized as follows (in thousands):

	June 30, 2006		December 31, 2005
Noninterest-bearing demand	$	174,516	$	188,762
Money market		410,996		380,216
NOW and Super NOW		236,450		207,947
Savings		43,021		40,612
Certificates of deposit		708,118		690,235
	$	1,573,101	$	1,507,772

12

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 5 – FEDERAL HOME LOAN BANK ADVANCES

Advances from the Federal Home Loan Bank were as follows (in thousands):

Principal Terms	Advance Amount		Range of Maturities	Weighted Average Interest Rate
June 30, 2006
Single maturity fixed rate advances	$	147,000	July 2006 to May 2010	4.46	%
Putable advances		31,000	September 2009 to December 2010	5.80	%
Amortizable mortgage advances		9,722	February 2008 to July 2018	3.85	%
	$	187,722
December 31, 2005
Single maturity fixed rate advances	$	104,200	January 2006 to May 2010	3.25	%
Putable advances		31,000	September 2009 to December 2010	5.80	%
Amortizable mortgage advances		9,961	February 2008 to July 2018	3.90	%
	$	145,161

Each advance is payable at its maturity date and contains a prepayment penalty. These advances were collateralized by securities totaling $113,755,000 and $107,581,000 at June 30, 2006 and December 31, 2005, and residential and commercial real estate loans totaling $554,997,000 and $526,066,000 under a blanket lien arrangement at June 30, 2006 and December 31, 2005.

Maturities as of June 30, 2006 were as follows (in thousands):

2006	$	15,000
2007		47,000
2008		70,712
2009		5,343
2010		41,000
Thereafter		8,667
	$	187,722

13

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 6 – STOCK OPTIONS

Options to buy stock are granted to officers and employees under Employee Stock Option Plans (the Employees’ Plans), which provide for issue of up to 1,825,890 options. Options are also granted to directors under Directors’ Stock Option Plans (the Directors’ Plans), which provide for issuance of up to 450,741 options. The exercise price is the market price at the date of grant for all plans. The maximum option term is ten years. The vesting schedule is over a one-year period for both the Employees’ Plans and the Directors’ Plans for all grants through the third quarter of 2005. Beginning with grants in the fourth quarter of 2005, the vesting schedule was increased to three years. Upon exercise of stock options, the Company issues new shares from its authorized but unissued shares. The amount of options available for future grant at June 30, 2006 is 1,026,817. All per share amounts and average shares outstanding have been adjusted for all periods presented to reflect the 5% stock dividend distributed on May 30, 2006, the 3-for-2 stock split distributed on June 29, 2006, and the 15% stock dividend distributed on May 27, 2005.

A summary of option activity in the plans is as follows, except per option data: (dollars in thousands)

Options	Number Outstanding		Weighted- Average Exercise Price		Weighted-Average Remaining Contractual Life in Years	Aggregate Intrinsic Value
Outstanding at January 1, 2006	1,019,559		$	13.75
Granted	4,487			23.28
Exercised	(106,649	)		9.18
Forfeited	(2,643	)		17.54
Outstanding at June 30, 2006	914,754		$	14.32	6.94	$	8,297
Exercisable at June 30, 2006	685,247		$	11.25	6.12	$	8,319

The weighted-average fair value of the 4,487 options granted during the six months ended June 30, 2006 was $5.93 per option. The weighted-average fair value of the 1,810 and 7,242 options granted during the three and six months ended June 30, 2005 was $4.65 and $4.45 per option, respectively. The total intrinsic value of options exercised during the three months ended June 30, 2006 and 2005 was $248,000 and $262,000, respectively. The total intrinsic value of options exercised during the six months ended June 30, 2006 and 2005 was $1.5 million and $965,000, respectively. The total fair value of options vested during the three and six months ended June 30, 2006 was $8,417 and $32,276, respectively. No options vested during the three and six months ended June 30, 2005.

14

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 7 – EARNINGS PER SHARE

A reconciliation of the numerators and denominators of basic and diluted earnings per share for the three and six month periods ended June 30, 2006 and 2005 are as follows (dollars in thousands, except per share data):

	Three Months Ended June 30, 2006		Three Months Ended June 30, 2005		Six Months Ended June 30, 2006		Six Months Ended June 30, 2005
Basic earnings per share
Net income	$	5,756	$	5,262	$	10,977	$	9,797
Weighted average common shares outstanding		16,200,172		16,051,168		16,181,716		16,032,349
Basic earnings per share	$	0.36	$	0.33	$	0.68	$	0.61
Diluted earnings per share
Net income	$	5,756	$	5,262	$	10,977	$	9,797
Weighted average common shares outstanding		16,200,172		16,051,168		16,181,716		16,032,349
Add: Dilutive effects of assumed exercise of stock options		341,959		404,235		380,902		397,478
Weighted average common and dilutive potential common shares outstanding		16,542,131		16,455,403		16,562,618		16,429,827
Diluted earnings per share	$	0.35	$	0.32	$	0.66	$	0.60

Stock options for 229,979 shares of common stock were not considered in computing diluted earnings per share for the three months ended June 30, 2006. There were no antidilutive shares for the three months ended June 30, 2005. Stock options for 229,979 and 1,810 shares of common stock were not considered in computing diluted earnings per share for the six months ended June 30, 2006 and 2005, respectively, because they were antidilutive.

15

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 8 – CONTINGENCIES

The Company and its subsidiaries periodically become defendants in certain claims and legal actions arising in the ordinary course of business.

On July 8, 2003, the Company filed a Form 8-K (dated July 1, 2003) with the Securities and Exchange Commission reporting events related to a former trust customer, Trade Partners, Inc. (“Trade Partners”), of the former Grand Bank, which the Company acquired effective April 1, 2002. Trade Partners was involved in purchasing and selling interests in viaticals, which are interests in life insurance policies of the terminally ill or elderly. Beginning in 1996, Grand Bank served as a custodian and escrow agent with respect to viaticals purchased by Trade Partners and sold to investors. Two lawsuits were filed, one in December 2002 and another in March 2003, against Trade Partners, Grand Bank and the Company alleging that Grand Bank breached certain escrow agreements related to viatical settlement contracts. Both of these lawsuits have been dismissed although the plaintiffs reserved the right to pursue the claims in the future. A third lawsuit was filed in April 2003 by two individual investors against Grand Bank, the Company, Trade Partners and certain individuals and entities associated with Trade Partners. The claims against Grand Bank and the Company in this lawsuit have been settled and dismissed with prejudice. In May 2003 a purported class action complaint was filed against the Company. As amended, this suit alleges that Grand Bank breached escrow agreements and fiduciary duties and violated the Michigan Uniform Securities Act with respect to the investments secured by the purported class in viaticals and in interests in limited partnerships which made loans to Trade Partners secured by viaticals, and with respect to loans made by purported class members directly to Trade Partners. The Company has answered the complaint denying the material allegations and raising certain affirmative defenses. Management believes the Company has strong defenses and will vigorously defend the cases.

Trade Partners is now in receivership. The supervising court authorized the receiver to borrow money from Macatawa Bank to pay premiums, if needed. Macatawa Bank extended a $4 million line of credit to the receiver, conditioned upon obtaining a security interest in the viaticals. No draws were made against the line, and the line expired during the fourth quarter of 2004.

It is possible that one or more additional legal actions may be initiated involving the custodial and escrow agent services provided by Grand Bank in connection with Trade Partners. If any such legal actions are commenced, the Company intends to defend them vigorously. To the extent any pending or future claims allege errors or omissions on the part of Grand Bank or Macatawa Bank, management believes that some or all liability, if any is proven or established, will be covered by errors and omissions insurance maintained by Grand Bank and Macatawa Bank. The Company has reported the Trade Partners matter to its two insurance carriers. Federal Insurance Company has assumed the Company’s defense and has advanced a portion of its defense costs pursuant to a reservation of rights letter asserting certain coverage defenses, and an Interim Funding Agreement. This carrier on July 21, 2006 notified the Company that it was seeking through arbitration a declaration that based on its asserted coverage defenses its policy does not cover this matter. On or about July 21, 2006, Federal Insurance Company notified the Company that it has filed an Arbitration Demand with the American Arbitration Association. In the Arbitration Demand Federal Insurance Company seeks a declaration that based upon its asserted coverage defenses its policy does not cover this matter. The Company believes that Federal Insurance Company is obligated to provide coverage, and the Company intends to vigorously pursue its rights under the insurance policy. The other carrier has taken the position that the duty of defense rests solely with the first carrier, and reserves its rights with respect to indemnity.

The legal actions involving Trade Partners have not progressed to trial and the outcome of such actions is uncertain. While we are therefore unable to determine at this time whether or to what extent these actions may impact the Company, the Company believes it has strong defenses and fully intends to defend any and all such actions vigorously.

16

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 9 – HEDGING ACTIVITIES

The Company’s asset/liability management policy includes guidelines for measuring and monitoring interest rate risk. Within these guidelines, parameters have been established for maximum fluctuations in net interest income. Possible fluctuations are measured and monitored using simulation analysis. The policies provide for the use of derivative instruments and hedging activities to aid in managing interest rate risk to within the policy parameters.

The Company’s assets are comprised of a large portion of loans on which the interest rates are variable. As such, the Company may periodically enter into derivative financial instruments to mitigate exposure to fluctuations in cash flows resulting from changes in interest rates. Interest rate swap arrangements may be utilized to hedge against these fluctuations in cash flows.

The Company has entered into interest rate swap arrangements (“swaps”), all of which are classified as cash flow hedges that convert the variable rate cash inflows on certain of its loans to fixed rates of interest. These swaps pay interest to the Company at a fixed rate and require interest payments from the Company at a variable rate. All of these swaps were fully effective during 2005 and the first six months of 2006. At June 30, 2006, it is anticipated that approximately $889,000, net of tax, of net unrealized losses on these cash flow hedges will be reclassified to earnings over the next twelve months.

Summary information about interest rate swaps were as follows (dollars in thousands).

	June 30, 2006			December 31, 2005
Notional amounts	$	80,000		$	80,000
Weighted average pay rates		8.25	%		7.25	%
Weighted average receive rates		6.42	%		6.42	%
Weighted average maturity		2.5 years			3.0 years
Unrealized loss related to interest rate swaps	$	(3,115	)	$	(2,146	)

NOTE 10 – ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with SFAS 109, Accounting for Income Taxes. FIN 48 prescribes a recognition and measurement threshold for a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company has not completed its evaluation of the impact of the adoption of FIN 48.

17

MACATAWA BANK CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

NOTE 11 – REGULATORY MATTERS

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

At June 30, 2006 and December 31, 2005, actual capital levels and minimum required levels were (in thousands):

	Actual				Minimum Required For Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Regulations
	Amount		Ratio		Amount		Ratio		Amount		Ratio
June 30, 2006
Total capital (to risk weighted assets)
Consolidated	$	189,831	10.9	%	$	139,919	8.0	%	$	174,899	10.0	%
Bank		182,792	10.5			139,366	8.0			174,207	10.0
Tier 1 capital (to risk weighted assets)
Consolidated		165,969	9.5			69,960	4.0			104,939	6.0
Bank		161,016	9.2			69,683	4.0			104,524	6.0
Tier 1 capital (to average assets)
Consolidated		165,969	8.6			77,114	4.0			96,392	5.0
Bank		161,016	8.4			76,965	4.0			96,206	5.0
December 31, 2005
Total capital (to risk weighted assets)
Consolidated	$	179,756	11.1	%	$	129,959	8.0	%	$	162,448	10.0	%
Bank		173,481	10.7			129,733	8.0			162,167	10.0
Tier 1 capital (to risk weighted assets)
Consolidated		157,450	9.7			64,979	4.0			97,469	6.0
Bank		153,210	9.5			64,867	4.0			97,300	6.0
Tier 1 capital (to average assets)
Consolidated		157,450	8.7			72,799	4.0			90,999	5.0
Bank		153,210	8.4			72,677	4.0			90,846	5.0

The Company and the Bank were categorized as well capitalized at June 30, 2006 and December 31, 2005. There are no conditions or events since June 30, 2006 that management believes have changed either institution’s category.

18

Item 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

Macatawa Bank Corporation is a Michigan corporation and is the holding company for two wholly owned subsidiaries, Macatawa Bank and Macatawa Investment Services, Inc. and for two trusts, Macatawa Statutory Trust I and Macatawa Statutory Trust II. Macatawa Bank Corporation is a financial holding company pursuant to Title I of the Gramm-Leach-Bliley Act. Macatawa Bank is a Michigan chartered bank with depository accounts insured by the Federal Deposit Insurance Corporation. The bank operates twenty-four 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. Macatawa Investment Services is a broker/dealer that provides various services including discount brokerage and consultation regarding mutual funds and annuities. Macatawa Statutory Trusts I and II are grantor trusts and issued $20.0 million each of pooled trust preferred securities. These trusts are not consolidated in the Corporation’s financial statements. For further information regarding consolidation, see the Notes to the Consolidated Financial Statements included herein. Macatawa Bank Mortgage Company, a subsidiary of Macatawa Bank, originates and sells residential mortgage loans into the secondary market on a servicing released basis.

While maintaining asset quality and improving profitability, we have experienced rapid and substantial growth since opening Macatawa Bank in November of 1997. We first became profitable in 1999 and have increased earnings each year since then with 2005 net income reaching $20.9 million. Since our inception in 1997, we have raised approximately $100.6 million in capital through private and public common stock offerings and trust preferred offerings to facilitate our growth and progress over these years.

We believe that growth in core deposits is key to our long-term success and is our primary funding source for asset growth. Establishing a branching network in our markets has been of high importance in order to facilitate this core deposit growth. We have gained community awareness and acceptance in our markets through this expanding branch network and our high service quality standards.

The West Michigan markets within which we operate continue to provide significant expansion opportunities for us. We opened our twenty-fourth branch on the west side of the greater Grand Rapids area during the second quarter of 2006. Because of the significance of the greater Grand Rapids market and the great opportunity for market share growth, we anticipate additional branch openings in this market. We also continue to enjoy success in building new and existing relationships in both our Holland/Zeeland and Grand Haven markets. We anticipate that we will continue to experience growth in our balance sheet and in our earnings due to these expansion opportunities.

19

RESULTS OF OPERATIONS

Summary:Net income for the quarter ended June 30, 2006 was $5.8 million, an increase of 9% as compared to second quarter 2005 net income of $5.3 million. Earnings per share on a diluted basis were $0.35 for the second quarter of 2006 compared to $0.32 for the same period in 2005. Net income for the six months ended June 30, 2006 was $11.0 million, an increase of 12% over the $9.8 million for the same period in the prior year. Earnings per share on a diluted basis were $0.66 for the six months ended June 30, 2006 compared to $0.60 for the same period in the prior year.

The increases in net income for both the three and six months ended June 30, 2006 compared to the same periods in the prior year were primarily due to increases in net interest income and noninterest income and partially offset by an increase in noninterest expense. Also contributing to the overall increases in net income for both the three and six months ended June 30, 2006 was a decrease in the provision for loan losses.

Net Interest Income:Net interest income totaled $17.0 million for the second quarter of 2006, an increase of $1.5 million or 10%, as compared to the second quarter of 2005. Net interest income for the first six months of 2006 totaled $33.3 million, an increase of 10% as compared to $30.3 million for the same period in 2005. The improvement in net interest income for both the three and six month periods was the result of strong growth in average earning assets. Average earning assets increased $185.3 million to $1.82 billion for the second quarter of 2006 compared to $1.63 billion for the second quarter of 2005. Average earning assets increased $180.4 million to $1.78 billion for the six month period ended June 30, 2006 compared to $1.60 billion for the same period of the prior year. The increases in average earning assets for both the three and six months ended June 30, 2006 represent an 11% increase when compared to the same periods of the prior year. The net interest margin decreased 8 basis points to 3.74% for the second quarter of 2006 and 7 basis points to 3.76% for the first six months of 2006 when compared to the same periods in the prior year.

During both the three and six month periods, the increase in the cost of funds exceeded the increase in the yield on earning assets and is the primary reason for the decrease in the net interest margin. The yield on earning assets increased by 101 basis points for both the three and six months ended June 30, 2006 as compared to the same periods in the prior year. The cost of funds increased 120 basis points and 121 basis points, respectively, for the three and six months ended June 30, 2006 as compared to the same periods in the prior year. The increases in short-term rates that began in mid-2004 and have continued into 2006 have caused an increase in the yield on our variable rate loan portfolio and are the primary reasons for the increase in the yield on earning assets. An increase in the rates paid on our deposit accounts, the rollover of time deposits at higher rates and a shift to higher costing sources of funds are the primary reasons for the increase in the cost of funds. The rates paid on time deposits and other rate sensitive products have reached attractive levels causing deposit customers to shift funds from transaction accounts, primarily money market accounts, into these higher rate accounts.

Anticipated growth in earning assets is expected to continue to increase levels of net interest income. We do not, however, expect future changes in short-term interest rates to have a significant impact on our net interest margin considering the Company’s move to a more balanced sensitivity to interest rate changes.

20

The following table shows an analysis of net interest margin for the three-month periods ending June 30, 2006 and 2005.

	For the three months ended June 30,
	2006							2005
	Average Balance			Interest Earned or paid		Average Yield Or cost		Average Balance			Interest Earned Or paid		Average Yield or cost
	(Dollars in thousands)
Assets
Taxable securities	$	122,195		$	1,265	4.14	%	$	111,939		$	1,136	4.06	%
Tax-exempt securities (1)		50,811			534	6.47	%		48,762			516	6.54	%
Loans		1,627,407			30,889	7.52	%		1,456,499			23,565	6.42	%
Federal Home Loan Bank stock		13,910			191	5.42	%		13,024			138	4.20	%
Federal funds sold		1,484			17	4.67	%		254			2	3.96	%
Total interest earning assets (1)		1,815,807			32,896	7.25	%		1,630,478			25,357	6.24	%
Noninterest earning assets:
Cash and due from banks		35,949							26,363
Other		97,643							99,016
Total assets	$	1,949,399						$	1,755,857
Liabilities
NOWs and MMDAs	$	629,203			4,890	3.12	%	$	605,170			2,748	1.82	%
Savings		42,118			61	0.58	%		41,592			48	0.47	%
IRAs		36,013			378	4.21	%		30,214			264	3.50	%
Time deposits		683,121			7,504	4.40	%		494,987			3,951	3.20	%
Federal Home Loan Bank advances		175,667			2,004	4.51	%		207,486			1,944	3.71	%
Long-term debt		41,238			824	7.91	%		41,238			625	6.00	%
Federal funds borrowed and other borrowings		20,531			260	5.01	%		36,622			290	3.13	%
Total interest bearing liabilities		1,627,891			15,921	3.91	%		1,457,309			9,870	2.70	%
Noninterest bearing liabilities:
Noninterest bearing demand accounts		166,257							158,722
Other noninterest bearing liabilities		6,999							5,807
Shareholders’ equity		148,252							134,019
Total liabilities and shareholders’ equity	$	1,949,399						$	1,755,857
Net interest income				$	16,975						$	15,487
Net interest spread (1)						3.34	%						3.54	%
Net interest margin (1)						3.74	%						3.82	%
Ratio of average interest earning assets to average interest bearing liabilities		111.54	%						111.88	%

(1) Yield adjusted to fully tax equivalent.

21

The following table shows an analysis of net interest margin for the six-month periods ending June 30, 2006 and 2005.

	For the six months ended June 30,
	2006							2005
	Average Balance			Interest Earned or paid		Average Yield Or cost		Average Balance			Interest Earned Or paid		Average Yield or cost
	(Dollars in thousands)
Assets
Taxable securities	$	118,057		$	2,411	4.08	%	$	105,372		$	2,132	4.05	%
Tax-exempt securities (1)		50,940			1,073	6.48	%		48,157			1,022	6.56	%
Loans		1,596,188			59,268	7.40	%		1,432,484			45,124	6.28	%
Federal Home Loan Bank stock		13,910			362	5.18	%		12,678			267	4.18	%
Federal funds sold		983			23	4.56	%		1,010			11	2.25	%
Total interest earning assets (1)		1,780,078			63,137	7.13	%		1,599,701			48,556	6.12	%
Noninterest earning assets:
Cash and due from banks		36,085							35,278
Other		97,094							91,508
Total assets	$	1,913,257						$	1,726,487
Liabilities
NOWs and MMDAs	$	616,015			8,978	2.94	%	$	633,357			5,388	1.72	%
Savings		41,424			119	0.58	%		40,325			82	0.41	%
IRAs		34,957			710	4.10	%		29,502			500	3.42	%
Time deposits		681,083			14,506	4.29	%		483,958			7,366	3.07	%
Federal Home Loan Bank advances		159,035			3,425	4.28	%		175,217			3,255	3.70	%
Long-term debt		41,238			1,594	7.69	%		41,238			1,192	5.75	%
Federal funds borrowed and other borrowings		21,244			516	4.83	%		29,977			442	2.93	%
Total interest bearing liabilities		1,594,996			29,848	3.76	%		1,433,574			18,225	2.55	%
Noninterest bearing liabilities:
Noninterest bearing demand accounts		163,716							153,262
Other noninterest bearing liabilities		7,592							6,616
Shareholders’ equity		146,953							133,035
Total liabilities and shareholders’ equity	$	1,913,257						$	1,726,487
Net interest income				$	33,289						$	30,331
Net interest spread (1)						3.37	%						3.57	%
Net interest margin (1)						3.76	%						3.83	%
Ratio of average interest earning assets to average interest bearing liabilities		111.60	%						111.59	%

(1) Yield adjusted to fully tax equivalent.

22

Provision for Loan Losses: The provision for loan losses for the three and six month periods ended June 30, 2006 was $800,000 and $1.5 million compared to $1.1 million and $2.0 million for the same periods in the prior year. The amounts of loan loss provision in both the current and prior year periods were a byproduct of establishing our allowance for loan losses at levels deemed necessary in our methodology for determining the adequacy of the allowance. For more information about our allowance for loan losses and our methodology for establishing its level, see the discussion below under Portfolio Loans and Asset Quality.

Noninterest Income: Noninterest income for the three and six month periods ended June 30, 2006 was $3.6 million and $6.8 million, respectively, from $3.4 million and $6.0 million for the same periods in the prior year. An increase in revenue from service charges on deposits accounted for the majority of the increase for both the three and six month periods. Continued growth in the number of demand deposit accounts was the primary reason for the $145,000 increase for the second quarter. In addition to this growth, an overdraft privilege service implemented for deposit customers during the second quarter of 2005 was the primary reason for the $507,000 increase for the six month period end June 30, 2006. Gains on loans sold decreased $25,000 and $171,000, respectively, during the three and six month periods due to a decline in mortgage loan origination volume as mortgage interest rate levels have increased. Trust fees and other income, including brokerage fees and other financial service fees, increased modestly during the three and six month periods as a result of continued expansion of our customer base. Included in other income for the three and six months ended June 30, 2005 was a $200,000 gain on the sale of a commercial property held as other real estate.

Noninterest Expense: Noninterest expense for the three and six month periods ended June 30, 2006 increased to $11.3 million and $22.4 million, respectively, from $10.0 million and $19.9 for the same periods in the prior year. Salaries and benefits, which represented the largest category of the increase, increased by $863,000 and $1.5 million, respectively, compared to the same periods in the prior year. Effective January 1, 2006, we adopted FAS 123, Revised, and accordingly, we recorded stock option compensation expense of $185,000 and $373,000 for the three and six months ended June 30, 2006. The remaining increase related to additional staffing for new branch locations and in each line of business and in support departments consistent with growth of the Bank. These increased costs reflect our attention to properly managing and supporting our growth and our interest in creating a platform for strong future growth. Occupancy and furniture and equipment expense has increased along with our branch expansion, which included one new location and a relocation of one of our branch sites since the second quarter of last year. In general, other expense categories have remained relatively flat or increased consistent with growth of the Bank. Although we expect noninterest expense levels to generally rise with our growth, we expect efficiency to improve by better utilizing our capacity as we grow. We believe the additional capacity within our branch network will continue to provide future growth opportunities without significant additional costs.

FINANCIAL CONDITION

Summary: Our total assets were $1.98 billion at June 30, 2006, an increase of $111.3 million from $1.87 billion at December 31, 2005. The growth in assets was primarily from an increase of $105.2 million in total portfolio loans and $9.3 million in securities available for sale. Cash and cash equivalents decreased $5.8 million slightly offsetting the increases in portfolio loans and securities available for sale. Cash levels were higher than normal at December 31, 2005 due to a large inflow of customer deposits that occurred at year-end. The growth in assets was funded by an increase of $65.3 million in deposits and $42.6 million in Federal Home Loan Bank borrowings.

Securities Available for Sale:Securities available for sale were $166.0 million at June 30, 2006 compared to $156.7 million at December 31, 2005. The increase was from purchases of U.S. Government Agency securities and reflects our interest in maintaining the diversity in our asset base.

Portfolio Loans and Asset Quality: Total portfolio loans were $1.65 billion at June 30, 2006 compared to $1.55 billion at December 31, 2005. Commercial loans continue to be the driver of our loan portfolio growth. Of the $105.2 million in growth during the first six months of 2006, $90.1 million or 86% was from our commercial loan portfolios. Commercial and commercial real estate loans accounted for approximately 75% of the total loan portfolio at June 30, 2006 and approximately 74% at December 31, 2005. Residential mortgage loans comprised 14% of the portfolio, while consumer loans were 11% of total loans at June 30, 2006.

23

The loan growth we have experienced continues to reflect the acceptance of our community banking philosophy in the communities we serve. During the second quarter of 2006, loans grew approximately $62.9 million after $42.3 million of growth in the first quarter of 2006, and compared to $43.7 million of growth in the second quarter of 2005. We continue to see slow improvement in the West Michigan economy and accordingly, we have seen recent signs of favorable new business activity among our business customers. We expect our growth rates to continue for the remainder of 2006.

Nonperforming assets are comprised of nonperforming loans, foreclosed assets and repossessed assets. Our nonperforming loans include loans on non-accrual status, restructured loans, as well as loans delinquent more than 90 days, but still accruing. Foreclosed and repossessed assets include assets acquired in settlement of loans. Nonperforming loans to total loans increased to 0.35% at June 30, 2006 from 0.27% at December 31, 2005 and nonperforming assets to total assets increased to 0.38% at June 30, 2006 from 0.26% at December 31, 2005. The balance in nonperforming loans at June 30, 2006 is a number of smaller commercial relationships for which we are considered to be well collateralized or adequately reserved.

The following table shows the composition and amount of our nonperforming assets.

(Dollars in thousands)	June 30, 2006			December 31, 2005
Nonaccrual loans	$	5,529		$	3,977
Loans 90 days past due and still accruing		252			227
Total nonperforming loans		5,781			4,204
Foreclosed assets		1,673			527
Repossessed assets		52			165
Total nonperforming assets	$	7,506		$	4,896
Nonperforming loans to total loans		0.35	%		0.27	%
Nonperforming assets to total assets		0.38	%		0.26	%

Allowance for loan losses: The allowance for loan losses as of June 30, 2006 was $22.1 million, or 1.34% of total portfolio loans, compared to $21.0 million, or 1.36% of total portfolio loans at December 31, 2005. The provision for loan losses declined $525,000 to $1.5 million for the six months ended 2006 compared to $2.0 million for the same period of the prior year primarily due to the decline in net charge-offs. Net charge-offs for the six months ended June 30, 2006 totaled $347,000 as compared to $1.3 million for the same period in 2005. The ratio of net charge-offs to average loans was 0.04% on an annualized basis for the first six months of 2006 compared to 0.18% for the first six months of 2005.

Our allowance for loan losses is maintained at a level management considers appropriate based upon our regular, quarterly assessments of the probable estimated losses inherent in the loan portfolio. Our methodology for measuring the appropriate level of allowance relies on several key elements, which include specific allowances for loans considered impaired, a formula allowance for graded loans, and general allocations based on historical trends for pools of similar loan types.

Specific allowances are established in cases where senior credit management has identified significant conditions or circumstances related to an individually impaired credit that we believe indicates the probability that a loss has been incurred. This amount is determined by methods prescribed by SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”. The specific allowance for impaired loans was $320,000 at June 30, 2006 and $333,000 at December 31, 2005.

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The formula allowance is calculated by applying loss factors to outstanding loans based on the internal risk grade of such loans. We use a loan rating method based upon an eight point system. Loans are assigned a loss allocation factor for each loan classification category. The lower the grading assigned to a loan category, the greater the allocation percentage that is applied. Changes in risk grade of both performing and nonperforming loans affect the amount of the formula allowance. Because of the relatively unseasoned nature of our loan portfolio and the rapid loan growth we have experienced since inception, our actual historical loan loss experience remains limited. Accordingly, our loss factors are primarily based upon our analysis of the banking industry’s historical loan loss experience, including the historical loan loss experience within the current markets we operate. These factors are monitored against our loss experience as our portfolios’ age, and may be adjusted for significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the analysis date. The formula allowance was $20.1 million at June 30, 2006 compared to $18.6 million at December 31, 2005. The increase in the formula allowance for the period is primarily associated with the continuing growth in the commercial loan portfolio.

Groups of homogeneous loans, such as residential real estate, open- and closed-end consumer loans, etc., receive general allowance allocations based on loss trends. In lieu of an established loan loss trend for Macatawa Bank, we use historical loss trends based on industry experience and peers in determining an adequate allowance for probable losses associated with these pools of loans. General economic and business conditions, credit quality trends, collateral values, seasoning of the portfolios and recent loss experience are conditions considered in connection with allocation factors for these similar pools of loans. The general allowance was $1.7 million at June 30, 2006 compared to $2.1 million at December 31, 2005. The decline in the general allowance was due to improvement in past due consumer loan balances.

Deposits and Other Borrowings: Total deposits increased $65.3 million to $1.57 billion at June 30, 2006 compared to $1.51 billion at December 31, 2005. The growth for the first six months of 2006 has been primarily in certain interest bearing checking and money market accounts and certificates of deposit, as market rates on these deposit types have begun to increase from historic lows and become more attractive to our customers. We opened approximately 5,546 new checking accounts during the first six months of 2006. It is expected that as these new accounts develop into more full relationships, they will further contribute to deposit growth. With our continued focus on quality customer service, the desire of customers to deal with a local bank, and the convenience of our expanding and maturing branch network, we expect further growth in our core transaction deposits.

The increase in other borrowings of $42.6 million was related to an increase in Federal Home Loan Bank advances to support the asset growth we experienced during the first half of 2006.

CAPITAL RESOURCES AND LIQUIDITY

Capital Resources: Total shareholders’ equity increased $6.2 million during the first six months to $147.9 million at June 30, 2006, as the retention of earnings was partially offset by a reduction in accumulated other comprehensive income.

Net income generated during the first six months of 2006 of $11.0 million was partially offset by cash dividends of $3.8 million, or $.23 per share. We began paying cash dividends at the end of 2000 and have increased the amount of the dividend each year since then. It is anticipated that we will continue to pay quarterly cash dividends in the future. We have also paid a stock dividend each year beginning in 2001. On May 30, 2006, a 5% stock dividend was paid to shareholders of record as of May 12, 2006, representing our sixth consecutive annual stock dividend. In addition, a 3-for-2 stock split was paid June 29, 2006 to shareholders of record as of June 9, 2006. All per share and average share information in this report has been adjusted to reflect the effect of the dividend and the split.

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The change in accumulated other comprehensive income was due to a decrease in both the market value of securities available for sale and the derivative instruments associated with the Company’s interest rate swap arrangements due principally to the general rise in interest rates during the first six months of 2006. For more information regarding our interest rate swap arrangements see the Notes to the consolidated financial statements.

At June 30, 2006 and December 31, 2005, our total capital to risk-weighted assets was 10.9% and 11.1%, respectively. Our Tier 1 Capital as a percent of average assets was 8.6% and 8.7% at June 30, 2006 and December 31, 2005, respectively. Both ratios continue to be maintained at levels in excess of the regulatory minimums forwell capitalized institutions. The ratios remained relatively stable since the beginning of the year as our strong earnings during the quarter kept pace with the growth in our assets.

Liquidity:The liquidity of a financial institution reflects its ability to measure and monitor 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 growing our investment and loan portfolios. Our sources of liquidity include our borrowing capacity with the Federal Home Loan Bank and federal funds purchased lines with our correspondent banks, loan payments by our borrowers, maturities and sales of our securities available for sale, growth of our deposits and deposit equivalents, federal funds sold, and the various capital resources discussed above. 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. We feel our liquidity position is sufficient to meet these needs.

Forward Looking Statements

This report includes “forward-looking statements” as that term is used in the securities laws. All statements regarding our expected financial position, business and strategies are forward-looking statements. In addition, the words “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends,” and similar expressions, as they relate to us or our management, are intended to identify forward-looking statements. The presentation and discussion of the provision and allowance for loan losses, statements concerning future profitability or future growth or increases, and statements about the adequacy of our capital resources are examples of inherently forward looking statements in that they involve judgments and statements of belief as to the outcome of future events. Our ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on our operations and our future prospects include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in our market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning us and our business, including additional factors that could materially affect our financial results, is included in our filings with the Securities and Exchange Commission.

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Item 3:QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market Risk Analysis

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 market risk exposure is mainly comprised of our sensitivity to interest rate risk. 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.

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, 2006 (dollars in thousands).

Interest Rate Scenario	Economic Value of Equity		Percent Change		Net Interest Income		Percent Change
Interest rates up 200 basis points	$	185,815	(8.98	)%	$	74,890	3.84	%
Interest rates up 100 basis points		193,704	(5.12	)		73,565	2.01
No change in interest rates		204,150	—			72,118	—
Interest rates down 100 basis points		210,077	2.90			70,432	(2.34	)
Interest rates down 200 basis points		213,604	4.63			68,613	(4.86	)

If interest rates were to increase, this analysis suggests that we are positioned for a slight improvement in net interest income over the next twelve months. Further, our balanced sensitivity in time horizons beyond one year results in little fluctuation in EVE under the various rate shock scenarios.

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.

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.

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Item 4:CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. The Company’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Form 10-Q Quarterly Report, have concluded that the Company’s disclosure controls and procedures were adequate and effective to ensure that material information relating to the Company would be made known to them by others within the company, particularly during the period in which this Form 10-Q Quarterly Report was being prepared.

(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.

PART II – OTHER INFORMATION

Item 1.Legal Proceedings.

Please refer to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, (Part II, Item 1 Legal Proceedings) for information concerning legal proceedings related to Trade Partners, Inc.

A lawsuit was filed in April 2003 by John and Kathryn Brand in Oklahoma state court against Grand Bank, the Company, Trade Partners and certain individuals and entities associated with Trade Partners. The complaint seeks damages for the asserted breach of certain escrow agreements for which Grand Bank served as custodian and escrow agent. The claims asserted against the Company and Grand Bank in this action have been settled and dismissed with prejudice.

In May 2003, a purported class action complaint was filed by Forrest W. Jenkins and Russell S. Vail against the Company in the United States District Court for the District of Western Michigan. As amended, this suit alleges that Grand Bank breached escrow agreements and fiduciary duties and violated the Michigan Uniform Securities Act with respect to the investments secured by the purported class in viaticals and in interests in limited partnerships which made loans to Trade Partners secured by viaticals, and with respect to loans made by purported class members directly to Trade Partners. The class has not been certified. A hearing on plaintiffs’ motion for certification is scheduled to be held in September 2006. The Company has answered this complaint denying the material allegations and raising certain affirmative defenses.

In late July 2005 counsel to the Trade Partners Receiver filed another purported class action on behalf of Kelly Priest and certain trusts controlled by Gary Towle and his wife, making substantially the same allegations as in the Jenkins complaint, but on behalf of a class which was asserted to comprise all investors who are holders of allowed claims in the Trade Partners receivership. This case has been subsumed within and superseded by the Jenkins case, described above, and the operative class allegations are those now set forth in the Jenkins case. Counsel to the Trade Partners receiver has withdrawn from this litigation, though the Trade Partners receiver has stated that he is cooperating with class counsel.

The Company believes it has meritorious defenses and intends to vigorously defend these cases.

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On April 15, 2003, the United States District Court for the Western District of Michigan appointed a receiver for Trade Partners. In order to prevent or minimize any loss to investors in the viaticals sold by Trade Partners to investors, the court-appointed receiver has been coordinating the payment of premiums on the approximately 1,000 outstanding viaticated insurance policies in the Trade Partners portfolio so that the policies do not lapse. The receiver informed the Company that nine policies with a total face value of approximately $1.4 million lapsed for failure to pay premiums prior to the receiver’s coordination efforts. In addition, the receiver unsuccessfully contested a partial lapse totaling about $700,000.

The receiver has received court permission to pool the death benefits of any of the Trade Partners viaticated policies that mature and use the benefits to pay premiums on other viaticated policies. As of July 15, 2006, the receiver reported that he has received since the inception of the receivership cash payments for death benefit claims aggregating approximately $29.2 million. He reported at the same time that all premium payments were current. He also reported at that time that he had paid premiums on the portfolio approximating $14.0 million since the inception of the receivership. As of July 15, 2006 the receiver reported cash on hand of approximately $36.3 million. As additional viaticated policies mature, death benefits from those policies could provide a source of funding for continued premium payments, though the receiver’s ability to so use such benefits may be limited or eliminated by the terms of the sale of the portfolio to Universal Settlements International, Inc., described below.

On July 1, 2003, the United States District Court for the Western District of Michigan authorized the receiver to borrow money from Macatawa Bank to pay premiums, if needed. Macatawa Bank agreed to extend a $4 million line of credit to the receiver, conditioned upon obtaining a security interest in the viaticals. No draws were made against the line, and the line expired during the fourth quarter of 2004.

The receiver in June 2004 proposed a plan of distribution of the assets of Trade Partners. No hearing was ever set on that plan. The receiver received authorization from the Court in July 2005 to sell the entire portfolio, which the receiver said had a face value of approximately $170 million, to Universal Settlements International, Inc., a Canadian company, for an amount equal to 26.58% of face value, or approximately $43 million. Under the terms of the sale, payments are to be made by Universal Settlements to the receivership as policy transfers are processed by the issuing insurance companies. The receiver has reported that as of July 15, 2006 payments aggregating approximately $24.4 million had been received on policies transferred pursuant to the sale agreement, plus another $714,148.46 on policies that matured after the sale but before transfer.

The receiver on July 21, 2006 filed a proposed amended plan of distribution and related disclosure statement, contemplating a complete liquidation of the assets of Trade Partners. The receiver reported as of July 15, 2006 that claims against the receivership estate totaling $158,276,599.98 have been approved, and reported total active claims of $178,993,717.57. The receiver further reported that as of July 15, 2006 “emergency distributions” totaling $344,844.25 had been made as advances to certain investors.

The proposed disclosure statement that accompanied the July 21, 2006 proposed amended plan of distribution states that the receiver estimates that he will have approximately $42.5 million available for distribution when he proposes to commence distributions in late 2006. The receiver proposes to complete distributions in 2007. The disclosure statement estimates that approved claims will total approximately $162,052,663.83. The disclosure statement indicates that Trade Partners investors should therefore expect to receive initial distributions totaling about 26.39% of their approved claims, and estimates that another 8% of such approved claims will ultimately be distributed.

It is possible that one or more additional legal actions may be initiated involving the custodial and escrow agent services provided by Grand Bank in connection with Trade Partners. If any such legal actions are commenced, the Company intends to defend them vigorously. To the extent any pending or future claims allege errors or omissions on the part of Grand Bank or Macatawa Bank, Management believes that some or all liability, if any is proven or established, will be covered by errors and omissions insurance

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maintained by Grand Bank and Macatawa Bank. The Company has reported the Trade Partners matter to its two insurance carriers. Federal Insurance Company has assumed the Company’s defense and has advanced a portion of its defense costs pursuant to a reservation of rights letter asserting certain coverage defenses, and an Interim Funding Agreement. On or about July 21, 2006, Federal Insurance Company notified the Company that it has filed an Arbitration Demand with the American Arbitration Association. In the Arbitration Demand Federal Insurance Company seeks a declaration that based upon its asserted coverage defenses its policy does not cover this matter. The Company believes that Federal Insurance Company is obligated to provide coverage, and the Company intends to vigorously pursue its rights under the insurance policy. The other carrier has taken the position that the duty of defense rests solely with the first carrier, and reserves its rights with respect to indemnity pursuant to a reservation letter asserting certain coverage defenses.

As of the date hereof, except as disclosed above, there were no material pending legal proceedings, other than routine litigation incidental to the business of banking to which we or any of our subsidiaries are a party of or which any of our properties are the subject.

Item 1A.Risk Factors.

There have been no material changes in the risk factors applicable to the Company from those disclosed in its Annual Report on Form 10-K for the year ended December 31, 2005.

Item 2.Changes in Securities and Use of Proceeds.None.

Item 3.Defaults Upon Senior Securities.None.

Item 4.Submission of Matters to a Vote of Securities Holders.

The annual meeting of shareholders was held on April 20, 2006, at which the shareholders of Macatawa Bank Corporation voted to:

a) Elect two directors for a term of three years. The results are as follows:

Director Nominee	For	Withheld
Benj. A. Smith, III	8,145,968	993,240
G. Thomas Boylan	8,748,440	390,768

b) Approve the Macatawa Bank Corporation 2006 Stock Compensation Plan. The results are as follows:

For	Against	Abstain
8,834,424	281,073	23,710

c) Approve the Macatawa Bank Corporation 2006 Directors Stock Compensation Plan. The results are as follows:

For	Against	Abstain
8,578,975	468,671	91,560

d) Amend the Amended and Restated Articles of Incorporation of the Company to increase the authorized common stock from 20,000,000 shares to 40,000,000 shares, no par value. The results are as follows:

For	Against	Abstain
8,603,318	515,428	20,461

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Item 5.Other Information.None.

Item 6.Exhibits.

3.1	Amendment to Articles of Incorporation of Macatawa Bank Corporation.
10.1	Macatawa Bank Corporation 2006 Stock Compensation Plan (incorporated by reference to Appendix A to the Macatawa Bank Corporation Proxy Statement on Form DEF 14A for the 2006 Annual Meeting as filed with the Securities and Exchange Commission on March 9, 2006).
10.2	Macatawa Bank Corporation 2006 Directors Stock Compensation Plan (incorporated by reference to Appendix B to the Macatawa Bank Corporation Proxy Statement on Form DEF 14A for the 2006 Annual Meeting as filed with the Securities and Exchange Commission on March 9, 2006).
10.3	Form of Stock Option Agreement for non-qualified stock options.
10.4	Form of Stock Option Agreement for incentive stock options.
10.5	Form of Stock Option Agreement under the Directors’ Stock Compensation Plan.
31.1	Certificate of the Chief Executive Officer of Macatawa Bank Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certificate of the Chief Financial Officer of Macatawa Bank Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certificate of the Chief Executive Officer and the Senior Vice President and Chief Financial Officer of Macatawa Bank Corporation pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

In accordance with the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, to be signed on its behalf by the undersigned, thereunto duly authorized.

MACATAWA BANK CORPORATION

/s/ Benj. A. Smith, III

Benj. A. Smith, III

Chairman and Chief Executive Officer

/s/ Jon W. Swets

Jon W. Swets

Chief Financial Officer

(Principal Financial and Accounting Officer)

DATE: August 3, 2006

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EXHIBIT INDEX

Exhibit	Description
3.1	Amendment to Articles of Incorporation of Macatawa Bank Corporation.
10.1	Macatawa Bank Corporation 2006 Stock Compensation Plan (incorporated by reference to Appendix A to the Macatawa Bank Corporation Proxy Statement on Form DEF 14A for the 2006 Annual Meeting as filed with the Securities and Exchange Commission on March 9, 2006).
10.2	Macatawa Bank Corporation 2006 Directors Stock Compensation Plan (incorporated by reference to Appendix B to the Macatawa Bank Corporation Proxy Statement on Form DEF 14A for the 2006 Annual Meeting as filed with the Securities and Exchange Commission on March 9, 2006).
10.3	Form of Stock Option Agreement for non-qualified stock options.
10.4	Form of Stock Option Agreement for incentive stock options.
10.5	Form of Stock Option Agreement under the Directors’ Stock Compensation Plan.
31.1	Certificate of the Chief Executive Officer of Macatawa Bank Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certificate of the Chief Financial Officer of Macatawa Bank Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	Certificate of the Chief Executive Officer and the Senior Vice President and Chief Financial Officer of Macatawa Bank Corporation pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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