Monarch Community Bancorp (MCBF) 10-Q 2010 Q2 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

þ  Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2010

or

o Transition report under Section 13 or 15(d) of the Exchange Act

For the transition period from                    to                    

Commission file number: 000-49814

MONARCH COMMUNITY BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland	04-3627031
(State or other jurisdiction	(I.R.S. employer
of incorporation or organization)	identification no.)

375 North Willowbrook Road, Coldwater, MI 49036
(Address of principal executive offices)

517-278-4566
(Registrant’s telephone number)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for 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: þ     No: o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o     No o

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

Large Accelerated Filer o Accelerated Filer o  Non-Accelerated Filer o
(Do not check if a smaller reporting company) Smaller reporting company þ

Indicate by check mark whether the registrant is a shell Company (as defined in Rule 12b-2 of the Exchange Act). Yes: o     No: þ

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practical date: At July 30, 2010, there were 2,044,606 shares of the issuer’s Common Stock outstanding.

Monarch Community Bancorp, Inc.
Index

PART I — FINANCIAL INFORMATION
Item 1 — Condensed Financial Statements:
Condensed Consolidated Balance Sheets — June 30, 2010 and December 31, 2009	1
Condensed Consolidated Statements of Income — Three and Six Months Ended June 30, 2010 and 2009	2
Condensed Consolidated Statements of Cash Flows — Six Months Ended June 30, 2010 and 2010	3
Notes to Condensed Consolidated Financial Statements	4 - 10
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations	10 - 19
Item 3 — Quantitative and Qualitative Disclosures about Market Risk	20
Item 4T— Controls and Procedures	20
PART II — OTHER INFORMATION
Item 1 — Legal Proceedings	21
Item 1A — Risk Factors	21
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds	21
Item 3 — Defaults Upon Senior Securities	21
Item 4 — [Reserved]	21
Item 5 — Other Information	21
Item 6 — Exhibits	21
SIGNATURES	22
CERTIFICATIONS
EX-31.1
EX-31.2
EX-32

PART I—FINANCIAL INFORMATION

Item 1. CONDENSED FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets

	(Unaudited)
	June 30,			December 31,
	2010			2009
	(Dollars in thousands,
	except per share data)
Assets
Cash and due from banks	$	12,174		$	12,631
Federal Home Loan Bank overnight time and other interest bearing deposits		7,097			10,723
Total cash and cash equivalents		19,271			23,354
Securities — Available for sale		16,538			16,063
Securities — Held to maturity		10			23
Other securities		4,237			4,237
Loans held for sale		755			809
Loans, net		204,324			220,875
Foreclosed assets, net		3,659			2,839
Premises and equipment		4,309			4,467
Core deposit intangible		462			532
Other assets		10,018			10,005
Total assets	$	263,583		$	283,204
Liabilities and Stockholders’ Equity
Liabilities
Deposits:
Non-interest bearing	$	15,836		$	14,422
Interest bearing		185,649			198,946
Total deposits		201,485			213,368
Federal Home Loan Bank advances		44,518			44,518
Accrued expenses and other liabilities		2,527			2,155
Total liabilities		248,530			260,041
Stockholders’ Equity
Preferred stock-$.01 par value, 5,000,000 shares authorized, and 6,785 shares, fixed rate cumulative perpetual preferred stock, series A, $1,000 per share liquidation preference, issued and outstanding as of June 30, 2010		6,745			6,739
Common stock — $0.01 par value, 20,000,000 shares authorized, 2,044,606 shares issued and outstanding at June 30, 2010 and December 31, 2009		20			20
Additional paid-in capital		21,221			21,216
Accumulated deficit		(12,583	)		(4,355	)
Accumulated other comprehensive income		330			223
Unearned compensation		(680	)		(680	)
Total stockholders’ equity		15,053			23,163
Total liabilities and stockholders’ equity	$	263,583		$	283,204

See accompanying notes to condensed consolidated financial statements.

1

Condensed Consolidated Statements of Income (Unaudited)

	Three Months			Three Months			Six Months			Six Months
	Ended			Ended			Ended			Ended
	June 30,			June 30,			June 30,			June 30,
	2010			2009			2010			2009
(Dollars in thousands, except per share data)
Interest Income
Loans, including fees	$	3,092		$	3,873		$	6,428		$	7,827
Investment securities		143			162			294			280
Federal funds sold and overnight deposits		—			1			1			3
Total interest income		3,235			4,036			6,723			8,110
Interest Expense
Deposits		886			1,274			1,851			2,593
Federal Home Loan Bank advances		499			643			992			1,302
Total interest expense		1,385			1,917			2,843			3,895
Net Interest Income		1,850			2,119			3,880			4,215
Provision for Loan Losses		7,040			3,441			8,884			4,163
Net Interest Income After Provision for Loan Losses		(5,190	)		(1,322	)		(5,004	)		52
Non-interest Income
Fees and service charges		563			549			1,108			1,064
Loan servicing fees		122			111			239			217
Net gain on sale of loans		149			748			349			1,457
Net gain (loss) on sale of securities		—			2			37			2
Other income		20			58			193			102
Total non-interest income		854			1,468			1,926			2,842
Non-interest Expense
Salaries and employee benefits		1,099			1,129			2,205			2,278
Occupancy and equipment		224			239			465			511
Data processing		199			200			407			407
Amortization of mortgage servicing rights		81			136			169			335
Professional services		245			123			396			252
Amortization of core deposit intangible		35			35			71			78
NOW account processing		53			40			104			79
ATM/Debit card processing		60			57			117			118
Foreclosed property expense		59			77			265			110
Other general and administrative		425			540			775			917
Total non-interest expense		2,480			2,576			4,974			5,085
Loss — Before income taxes		(6,816	)		(2,430	)		(8,052	)		(2,191	)
Income Taxes		—			(607	)		—			(547	)
Net Loss	$	(6,816	)	$	(1,823	)	$	(8,052	)	$	(1,644	)
Dividends and amortization of discount on preferred stock	$	88		$	87		$	176		$	138
Net Income (loss) available to common stock	$	(6,904	)	$	(1,910	)	$	(8,228	)	$	(1,782	)
Loss Per Share
Basic	$	(3.49	)	$	(0.97	)	$	(4.16	)	$	(0.91	)
Diluted	$	(3.49	)	$	(0.97	)	$	(4.16	)	$	(0.91	)

See accompanying notes to condensed consolidated financial statements.

2

Condensed Consolidated Statements of Cash Flows (Unaudited)

	Six Months Ended
	June, 30
	2010			2009
	(Dollars in thousands)
Cash Flows From Operating Activities
Net Loss	$	(8,052	)	$	(1,644	)
Adjustments to reconcile net income (loss) to net cash from operating activities
Depreciation and amortization		542			693
Provision for loan losses		8,884			4,163
Stock option expense		5			4
Gain (loss) on sale of foreclosed assets		(105	)		24
Mortgage loans originated for sale		(10,868	)		(65,280	)
Proceeds from sale of mortgage loans		10,923			66,370
Gain on sale of mortgage loans		(349	)		(1,458	)
Gain on sale of available for sale securities		(37	)		(2	)
Earned stock compensation		—			9
Net change in:
Deferred loan fees		49			62
Accrued interest receivable		(53	)		(50	)
Other assets		(129	)		(1,980	)
Accrued expenses and other liabilities		316			(416	)
Net cash provided by (used in) operating activities		1,126			495
Cash Flows From Investing Activities
Activity in available-for-sale securities:
Purchases		(4,216	)		(17,814	)
Proceeds from maturities of securities		2,288			6,141
Proceeds from sale of securities		1,566			—
Activity in held-to-maturity securities:
Proceeds from maturities of securities		13			14
Loan originations and principal collections, net		5,408			5,370
Proceeds from sale of foreclosed assets		1,850			508
Purchase of premises and equipment		(59	)		(133	)
Net cash provided by investing activities		6,850			(5,914	)
Cash Flows From Financing Activities
Net increase in deposits		(11,883	)		10,226
Issuance of Preferred Stock		—			6,734
Issuance of Warrants		—			56
Dividends paid		(176	)		(465	)
Repayment of FHLB advances		—			(3,500	)
Repayment of Fed Funds purchased		—			(1,000	)
Net cash provided by financing activities		(12,059	)		12,051
Net Increase (Decrease) in Cash and Cash Equivalents		(4,083	)		6,632
Cash and Cash Equivalents— Beginning		23,354			6,272
Cash and Cash Equivalents —End	$	19,271		$	12,904
Supplemental Cash Flow Information:
Cash paid for:
Interest		2,886			3,932
Income taxes		—			215
Noncash investing activities:
Loans transferred to foreclosed assets		2,558			1,800

See accompanying notes to condensed consolidated financial statements.

3

MONARCH COMMUNITY BANCORP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION

Monarch Community Bancorp, Inc. (the “Corporation”) was incorporated in 2002 under Maryland law to hold all of the common stock of Monarch Community Bank (the “Bank”), formerly known as Branch County Federal Savings and Loan Association. The Bank converted to a stock savings institution effective August 29, 2002. In connection with the conversion, the Corporation sold 2,314,375 shares of its common stock in a subscription offering.

Monarch Community Bank provides a broad range of banking services to its primary market area of Branch, Calhoun and Hillsdale counties in Michigan. The Bank operates six full service offices. The Bank owns 100% of First Insurance Agency. First Insurance Agency is a licensed insurance agency established to allow for the receipt of fees on insurance services provided to the Bank’s customers. The Bank also owns a 24.98% interest in a limited partnership formed to construct and operate multi-family housing units.

BASIS OF PRESENTATION

The condensed consolidated financial statements of the Corporation include the accounts of Monarch Community Bank and First Insurance Agency. All significant intercompany balances and transactions have been eliminated in consolidation. The condensed consolidated financial statements for interim periods are unaudited; however, in the opinion of the Corporation’s management, all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of the Corporation’s financial position and results of operations have been included.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates and assumptions.

The accompanying financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes required by generally accepted accounting principles in annual consolidated financial statements. These condensed consolidated financial statements should be read in conjunction with the Corporation’s Form 10-K for the year ended December 31, 2009 filed with the Securities and Exchange Commission.

The results of operations for the three and six month period ended June 30, 2010 are not necessarily indicative of the results to be expected for the full year period.

ALLOWANCE FOR LOAN LOSSES

The appropriateness of the allowance for loan losses is reviewed by management based upon our evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in delinquencies, nonperforming loans and foreclosed assets expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that these conditions were believed to have had on the collectability of the loan. Senior management reviews these conditions at least quarterly.

To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of this condition may be reflected as a specific allowance applicable to this credit or portfolio segment.

The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology as described permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in management’s judgment, significant factors which affect the collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.

4

RECLASSIFICATIONS

Certain 2010 amounts have been reclassified to conform to the 2009 presentation.

SECURITIES

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

			Gross		Gross
			Unrealized		Unrealized		Estimated
June 30, 2010	Amortized Cost		Gains		Losses		Market Value
Available-for-sale securities:
U.S. Treasury	$	3,184	$	31	$	—	$	3,215
U.S. government agency obligations		2,631		69		—		2,700
Mortgage-backed securities		4,673		171				4,844
Obligations of states and political subdivisions		5,550		229		—		5,779
Total available-for-sale securities	$	16,038	$	500	$	—	$	16,538
Held-to-maturity securities:
Municipal securities	$	10	$	—	$	—		10

			Gross		Gross
			Unrealized		Unrealized		Estimated
December 31, 2009	Amortized Cost		Gains		Losses		Market Value
Available-for-sale securities:
U.S. Treasury	$	1,055	$	16	$	—	$	1,071
U.S. government agency obligations		3,155		41		—		3,196
Mortgage-backed securities		5,454		82				5,536
Obligations of states and political subdivisions		6,061		199		—		6,260
Total available-for-sale securities	$	15,725	$	338	$	—	$	16,063
Held-to-maturity securities:
Municipal securities	$	23	$	—	$	—		23

Proceeds from sales of securities available for sale were $1.6 million and $0 for the six months ended June 30, 2010 and 2009, respectively. Gross gains of $37,000 and $0 were realized on these sales during 2010 and 2009, respectively.

5

The amortized cost and fair value of securities available for sale at June 30, 2010 by contractual maturity follow (dollars in thousands). The actual maturity may differ from the contractual maturity because issuers may have a right to call or prepay obligations.

	Held to Maturity Securities				Available for Sale Securities
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
	(Dollars in Thousands)
Due in one year or less	$	10	$	10	$	1,236	$	1,246
Due from one to five years		—		—		12,381		12,757
Due from five to ten years				—		2,421		2,535
Due after ten years
Total securities	$	10	$	10	$	16,038	$	16,538

There were no securities with unrealized losses at June 30, 2010.

Other-Than Temporary-Impairment

Our portfolio of available for sale securities reviewed quarterly for other-than-temporary-impairment (OTTI) in value. In performing this review many factors are considered including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near term prospect of the issuer, (3) the impact of changes in market interest rates on the market value of the security and (4) an assessment of whether management intends to sell the security, or it is more likely than not that management will be required to sell the security at a loss before anticipated recovery.

Management determined that there were no securities with OTTI at June 30, 2010.

6

EARNINGS PER SHARE

A reconciliation of the numerators and denominators used in the computation of the basic earnings per share and diluted earnings per share is presented below (000s omitted except per share data):

	Three Months			Three Months			Six Months			Six Months
	Ended			Ended			Ended			Ended
	June 30, 2010			June 30, 2009			June 30, 2010			June 30, 2009
Basic earnings per share
Numerator:
Net income	$	(6,816	)	$	(1,823	)	$	(8,052	)	$	(1,644	)
Dividends and amortization of discount on preferred stock	$	88		$	87		$	176		$	138
Net Income (Loss) available to common stock	$	(6,904	)	$	(1,910	)	$	(8,228	)	$	(1,782	)
Denominator:
Weighted average common shares outstanding		2,045			2,046			2,045			2,046
Less: Average unallocated ESOP shares		(65	)		(74	)		(65	)		(74	)
Less: Average non-vested RRP shares		(2	)		(7	)		(2	)		(7	)
Weighted average common shares outstanding for basic earnings (loss) per share		1,978			1,965			1,978			1,965
Basic earnings (loss) per share	$	(3.49	)	$	(0.97	)	$	(4.16	)	$	(0.91	)
Diluted earnings per share
Numerator:
Net Income (Loss) available to common stock	$	(6,904	)	$	(1,910	)	$	(8,228	)	$	(1,782	)
Denominator:
Weighted average common shares outstanding for basic earnings per share		1,978			1,965			1,978			1,965
Add: Dilutive effects of restricted stock, stock options and warrants		—			—			—			—
Weighted average common shares and dilutive potential common shares outstanding		1,978			1,965			1,978			1,965
Diluted earnings (loss) per share	$	(3.49	)	$	(0.97	)	$	(4.16	)	$	(0.91	)

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2010, FASB issued a statement which expands disclosures about credit quality of financing receivables and allowance for credit losses. The standard will require the Company to expand disclosures about the credit quality of our loans and the related reserves against them. The extra disclosures will include details on our past due loans, credit quality indicators, and modifications of loans. The Company will adopt the standard beginning with our December 31, 2010 financial statements.

FAIR VALUE MEASUREMENTS

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access.

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset or liability.

7

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Corporation’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset or liability.

The following table presents information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at June 30, 2010, and December 31, 2009, and the valuation techniques used by the Corporation to determine those fair values. Investment securities with fair value determined by level 1 input include U.S. Treasury securities. Investment securities with fair value determined by level 2 inputs include mortgage backed securities, obligations of states and political subdivisions and U.S Government Agency obligations.

			Significant
	Quoted Prices in Active		Other		Significant
	Markets for Identical		Observable		Unobservable		Balance at June 30,
	Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)		2010
Assets:
June 30, 2010
U.S. Treasury	$	3,215	$	—	$	—	$	3,215
U.S. government agency obligations		—		2,700		—		2,700
Mortgage-backed securities		—		4,844		—		4,844
Obligations of states and political subdivisions		—		5,779		—		5,779

			Significant
	Quoted Prices in Active		Other		Significant
	Markets for Identical		Observable		Unobservable		Balance at June 30,
	Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)		2010
Assets:
December 31, 2009
U.S. Treasury	$	1,071	$	—	$	—	$	1,071
U.S. government agency obligations		—		3,196		—		3,196
Mortgage-backed securities		—		5,536		—		5,536
Obligations of states and political subdivisions		—		6,260		—		6,260

8

The Corporation also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets include loans and foreclosed assets. These assets are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table presents the Corporation’s assets at fair value on a nonrecurring basis as of June 30, 2010 and December 31, 2009 (000s omitted):

	Assets Measured at Fair Value on a Nonrecurring Basis
	Balance at		Quoted Prices in Active		Significant Other		Significant		Change in Fair Value for the
	June 30,		Markets for Identical		Observable Inputs		Unobservable Inputs		six months ended June 30,
	2010		Assets (Level 1)		(Level 2)		(Level 3)		2010
Impaired Loans accounted for under FASB ASC 310	$	19,199	$	—	$	—	$	19,199	$	(4,684	)
Foreclosed Assets	$	3,659	$	—	$	—	$	3,659	$	(885	)

	Assets Measured at Fair Value on a Nonrecurring Basis
	Balance at		Quoted Prices in Active		Significant Other		Significant		Change in Fair Value for
	December		Markets for Identical		Observable Inputs		Unobservable Inputs		the year ended December 31,
	31, 2010		Assets (Level 1)		(Level 2)		(Level 3)		2010
Impaired Loans accounted for under FASB ASC 310	$	18,653	$	—	$	—	$	18,653	$	(7,895	)
Foreclosed Assets	$	2,839	$	—	$	—	$	2,839	$	(1,819	)

Fair Value of Financial Instruments

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Financial Accounting Standards Board (FASB), Accounting Standards Codification (ASC), FASB ASC 820-10-50, Fair Value Measurements and Disclosures, excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation.

The fair value of all financial instruments not discussed below (Cash and cash equivalents, Federal funds sold, Federal Home Loan Bank stock, Accrued interest receivable, Federal funds purchased and Interest payable) are estimated to be equal to their carrying amounts as of June 30, 2010 and December 31, 2009. The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments:

Securities— Fair values for securities are described above.

Loans Held for Sale— Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.

Loans Receivable— For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flows analyses using current market rates applied to the estimated life. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

9

Deposit Liabilities— The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Federal Home Loan Bank Advances— The fair values of the Corporation’s Federal Home Loan Bank advances are estimated using discounted cash flow analyses based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements.

The estimated fair values, and related carrying or notional amounts, of the Corporation’s financial instruments are as follows (000s omitted):

	June 30,				December 31,
	2010				2009
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Assets:
Cash and cash equivalents	$	19,271	$	19,271	$	23,354	$	23,354
Securities — Held to maturity		10		10		23		23
Securities — Available for sale		16,538		16,538		16,063		16,063
Other securities		4,237		4,237		4,237		4,237
Loans held for sale		755		771		809		827
Net loans		204,324		207,208		220,875		230,866
Accrued interest and late charges receivable		933		933		1,154		1,154
Liabilities:
Deposits		201,485		200,393		213,368		214,581
Federal Home Loan Bank advances		44,518		47,439		44,518		48,260
Accrued interest payable		354		354		397		397

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

The following discussion and analysis should be read in conjunction with the condensed consolidated financial statements of the Corporation and the accompanying notes.

FORWARD-LOOKING STATEMENTS

In addition to historical information, the following discussion contains “forward-looking statements” that involve risks and uncertainties. All statements regarding the expected financial position, business and strategies are forward-looking statements and the Corporation intends for them to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. The words “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends,” and similar expressions, as they relate to the Corporation or management, are intended to identify forward-looking statements. The Corporation believes that the expectations reflected in these forward-looking statements are reasonable based on our current beliefs and assumptions; however, these expectations may prove to be incorrect.

Factors which could have a material adverse effect on our operations include, but are not limited to, changes in interest rates, changes in the relative difference between short and long-term 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, including levels of non-performing assets, demand for loan products, deposit flows, competition, demand for financial services in our market area, our operating costs and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and you should not rely too much on these statements.

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CRITICAL ACCOUNTING POLICIES

The nature of the financial services industry is such that, other than described below, the use of estimates and management judgment is not likely to present a material risk to the financial statements. In cases where estimates or management judgment are required, internal controls and processes are established to provide assurance that such estimates and management judgments are materially correct to the best of management’s knowledge.

Allowance for Loan Losses. Accounting for loan classifications, accrual status, and determination of the allowance for loan losses is based on regulatory guidance. This guidance includes, but is not limited to, generally accepted accounting principles, the uniform retail credit classification and account management policy issued by the Federal Financial Institutions Examination Council, the joint policy statement on the allowance for loan losses methodologies issued by the Federal Financial Institutions Examination Council and guidance issued by the Securities and Exchange Commission. Accordingly, the allowance for loan losses includes a reserve calculation based on an evaluation of loans determined to be impaired, risk ratings, historical losses, loans past due, collateral values and cost of disposal and other subjective factors.

Foreclosed Assets.Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of the foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated selling expenses, which consist primarily of commissions that will be paid to an independent real estate agent upon sale of the property. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.

Income Taxes—Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the various temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. A valuation allowance, if needed, reduces deferred tax assets to the amount expect to be realized.

OVERVIEW

Following Monarch Community Bank’s most recent Safety and Soundness examination, the Board of Directors of Monarch Community Bank stipulated to the terms of a formal enforcement action (“Consent Order”) with Federal Deposit Insurance Corporation (“FDIC”) and the Office of Financial and Insurance Regulation for the State of Michigan (“OFIR”). The Consent Order, which was effective May 6, 2010, contains specific actions needed to address certain findings from their examination and to address our current financial condition.

We have made substantive progress in implementation of provisions identified within the Consent Order. Our progress includes:

1)	Hiring a new President & CEO.
2)	Hiring a new Chief Lending Officer.
3)	The development and initial execution of plans to reduce classified assets and concentrations of credit. This includes the completion of a loan review by an outside consulting firm. The firm reviewed approximately 79% of the total loan portfolio and made no recommendations for charge-offs or special reserves on the loans they reviewed. In addition, they reviewed the methodology and adequacy of the Allowance for Loan and Lease Losses and found them to be reasonable.
4)	The completion of a management review by an outside consultant. The results of this review determined that management staffing and skills were adequate for the ongoing operation of the bank.
5)	The enhancement of loan policies and procedures.

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FINANCIAL CONDITION

Assets

Total assets decreased $19.6 million, or 7.4%, to $263.6 million at June 30, 2010 compared to $283.2 million at December 31, 2009. The decrease in assets is largely due to a decrease in loans of $16.6 million or 7.5%, which is attributable to the refinancing of one to four residential mortgages into the secondary market and the write downs of commercial real estate loans.

Securities

Securities increased to $16.5 million at June 30, 2010 compared to $16.1 million at December 31, 2009. The increase was attributable to the replacement of securities to reposition maturities and improve overall credit quality of the portfolio. The yield on investment securities has decreased to 2.9% during the three months ended June 30, 2010 from 3.36% for the same period a year ago. Management has continued to maintain a diversified securities portfolio, which includes obligations of U.S. government-sponsored agencies, securities issued by states and political subdivisions and mortgage-backed securities. Management regularly evaluates asset/liability management needs and attempts to maintain a portfolio structure that provides sufficient liquidity and cash flow.

Loans

The Bank’s net loan portfolio decreased by $16.5 million, or 7.5%, from $220.9 million at December 31, 2009 to $204.3 million at June 30, 2010. The following table presents information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated:

	June 30, 2010					December 31, 2009
	Amount		Percent			Amount		Percent
			(Dollars in thousands)
Real Estate Loans:
One-to-four family	$	101,968		47.5		$	108,354		47.7
Multi-family		5,074		2.4			5,421		2.2
Commercial		68,991		32.2			72,689		32.0
Construction or development		8,556		4.0			9,528		4.2
Total real estate loans		184,589		86.0			195,992		86.3
Other loans:
Consumer loans:
Home equity		17,286		8.1			18,174		8.0
Other		4,036		2.0			4,706		2.1
Total consumer loans		21,322		10.0			22,880		10.1
Commercial Business Loans		8,627		4.0			8,266		3.5
Total other loans		29,949		14.0			31,146		13.6
Total Loans		214,538		100.0	%		227,138		100.0	%
Allowance for loan losses		9,782					5,783
Less: Net deferred loan fees		432					480
Total Loans, net	$	204,324				$	220,875

One-to-four family loans decreased $6.4 million from year end 2009 as a result of the Bank’s continued strategy to sell a large portion of new one to four family loan originations. Historically low rates on residential mortgages provided us the opportunity to refinance loans and our gains on the sale of mortgages increased substantially in 2009. Management does not expect to see similar gains in 2010. Commercial real estate loans and construction loans decreased $3.7 million or 5.1%. The Bank expects future loan origination to come primarily from in-market lending.

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Changes in the allowance for loan losses were as follows for the three and six months ended June 30, 2010 and 2009.

Summary of Allowance for Loan Losses

	Three Months Ended						Six Months Ended
	June 30						June 30
	2010			2009			2010			2009
Beginning Balance	$	6,269		$	3,210		$	5,783		$	2,719
Loans Charged off		(3,575	)		(1,148	)		(5,011	)		(1,467	)
Recoveries		49			47			126			135
Provision for loan losses		7,040			3,441			8,885			4,163
Ending Balance	$	9,783		$	5,550		$	9,783		$	5,550

The allowance for loan losses was $9.8 million at June 30, 2010 representing 4.79% of total loans, compared to $5.8 million at December 31, 2009, or 2.62% of total loans and $5.5 million at June 30, 2009 or 2.35% of total loans. The increase of $4.0 million during the six months ended June 30, 2010 was necessitated by the increases in net charge offs and nonperforming assets which are directly related to the continued overall weakness in the Michigan economy. Net charge offs totaled $4.9 million compared to $1.3 million for the same period a year ago. Net charge offs year to date consisted of 26% construction loans, 44% one to four family residential mortgages, 26% commercial real estate, and the remaining 4% included consumer, commercial and industrial and home equity lines of credit. The allowance for loan losses to non-performing loans ratio was 41.4% at June 30, 2010 compared to 37.14% at December 31, 2009 and 69.6% at June 30, 2009. See “Provision for Loan Losses” below for further explanation regarding charge-offs and non-performing loans. The current level of the allowance for loan losses is the result of management’s assessment of the risks within the portfolio based on the information revealed in credit monitoring processes.

The allowance balance is established after considering past loan loss experience, current economic conditions, composition of the loan portfolio, delinquencies, and other relevant factors. We continue to be diligent in reviewing our loan portfolios for problem loans and believe that early detection of troubled credits is critical. We maintain the allowance for loan losses at a level considered adequate to cover losses within the loan portfolio.

Deposits

Total deposits decreased $11.9 million, or 5.6%, from $213.4 million at December 31, 2009 to $201.5 million at June 30, 2010. The decline in deposits included decreases of $9.7 million in money market deposits, $4.9 million in brokered certificates of deposits and $3.5 million in local certificates of deposit. The Bank continues to be committed to increasing its core deposit balances during 2010 and saw increases in demand deposits of $1.4 million and in interest bearing checking and savings accounts of $4.8 million.

We have used brokered certificates of deposit to diversity our sources of funds and improve pricing at certain terms compared to the local market and advances available from Federal Home Loan Bank of Indianapolis. Due to the fact that Bank’s regulatory capital ratios are less than the levels necessary to be considered “well capitalized”, it may not obtain new brokered funds as a funding source and is subject to rate restrictions that limit the amount that can be paid on all types of retail deposits. The maximum rates the Bank can pay on all types of retail deposits are limited to the national average rate, plus 75 basis points. We have compared the Bank’s current rates with the national rate caps and reduced any rates over the rate cap to fall within those caps. There has been no material impact to our deposit balances resulting from the rate caps.

Federal Home Loan Bank Advances

Total Federal Home Loan Bank (FHLB) advances remained unchanged during the six months ended June 30, 2010 compared December 31, 2009. Management is attempting to reduce its reliance on borrowed funds through the growth of low cost core deposits. Should this strategy not succeed, management anticipates the need for future borrowings to fund loan growth. See “Net Interest Income” below, and also see “Liquidity” later in this report regarding available borrowings.

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Equity

Total equity was $15.1 million at June 30, 2010 compared to $23.2 million at December 31, 2009. This represents 5.7% and 8.2% of total assets at June 30, 2010 and December 31, 2009, respectively. Decreases in equity for the six months ended June 30, 2010 included a net loss of $8.1 million and $170,000 in accrued dividend payments on the Preferred Stock. The annual 5% dividend on the Preferred Stock together with the amortization of the discount will reduce net income (or increase the net loss) applicable to common stock by approximately $350,000 annually. Effective February 2010, the Corporation deferred regularly scheduled dividend payments on the $6.7 million in principal outstanding on its Series A fixed rate, cumulative perpetual preferred stock (aggregate liquidation preference of $6.8 million) which was issued to the U.S. Treasury in February 2009.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income before any provision for loan losses decreased $269,000 for the quarter ended June 30, 2010 compared to the same period in 2009. Net interest income before any provision for loan losses decreased $335,000 for the six months ended June 30, 2010 compared to the same period in 2009.

The net interest margin for the second quarter of 2010 decreased 24 basis points to 2.83% compared to 3.07% for the same period in 2009. The decline in the margin is largely due to the decline in earning assets. The Bank has seen runoff in the mortgage portfolio as loan originations have moved into the secondary market, (see further discussion below). The increased level of nonperforming loans and the associated nonaccrual interest adjustment have also significantly impacted the margin. The yield on loans has decreased to 5.67% for the quarter compared to 6.44% for the same period in 2009.

The net interest margin decreased 10 basis points to 2.96% for the six months ending June 30, 2010 compared to 3.06% for the same period in 2009. The decline in margin year over year is mainly due to the reasons mentioned previously. Cost of funds continues to decrease to 2.2% as the Corporation remains focused on deposit pricing strategies and growing core deposits to reduce its reliance on whole sale funding.

The Bank’s ability to maintain its net interest margin is heavily dependent on future loan demand and its ability to attract core deposits to offset the effect of higher cost certificates of deposits and borrowings. The Bank continues to be challenged in its efforts to increase lower costing core deposits. Management continues to put its efforts towards meeting this challenge.

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The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made.

	Six Months Ended June 30,							Six Months Ended June 30,
	2010							2009
	Average		Interest					Average		Interest
	Outstanding		Earned/		Yield/			Outstanding		Earned/		Yield/
	Balance		Paid		Rate			Balance		Paid		Rate
	(dollars in thousands)
Fed Funds and overnight deposits	$	18,429	$	1		0.01	%	$	9,779	$	3		0.06	%
Investment securities	$	16,886	$	252		3.01			14,654	$	261		3.59
Other securities	$	4,174	$	42		2.03			4,174	$	19		0.92
Loans receivable	$	223,174	$	6,428		5.81			246,448	$	7,827		6.40
Total earning assets	$	262,663	$	6,723		5.16		$	275,055	$	8,110		5.95
Demand and NOW Accounts	$	39,843	$	57		0.29		$	32,788	$	43		0.26
Money market accounts	$	55,668	$	262		0.95		$	42,290	$	417		1.99
Savings accounts	$	21,285	$	28		0.27		$	18,914	$	37		0.39
Certificates of deposit	$	96,213	$	1,503		3.15		$	105,506	$	2,097		4.01
Federal Home Loan Bank Advances	$	44,518	$	992		4.49		$	57,672	$	1,301		4.55
Fed Funds Purchased	$	5	$	—		0.00		$	—	$	—		0.00
Total interest bearing liabilities	$	257,532	$	2,842		2.23		$	257,170	$	3,895		3.05
Net interest income			$	3,881						$	4,215
Net interest spread						2.94	%						2.89	%
Net interest margin						2.96	%						3.06	%

Provision for Loan Losses

The provision for loan losses was $7.0 million in the second quarter of 2010 compared to $3.4 million for the second quarter of 2009. The significant increase in the provision was primarily driven by the continued deteriorating economic conditions in Michigan and weaknesses in the local real estate markets which resulted in downgrades to the credit ratings of certain loans in the portfolio and a significant increase in the balances of nonperforming loans. The Company continues to monitor real estate dependent loans and focus on asset quality. Non-performing assets totaled $27.3 million at the end of the second quarter of 2010, an increase of $8.9 million from December 31, 2009. Net charge offs for the quarter ended June 30, 2010 were $3.5 million compared to $1.1 million for the same period in 2009. Year to date 2010 net charge offs totaled $4.9 million compared to $1.3 million for the same period a year ago. Net charge offs year to date consisted of 46% one to four family residential mortgages, 26% construction, 26% commercial real estate, and the remaining 3% included consumer, commercial and industrial and home equity lines of credit.

Nonperforming assets including the amount of real estate in judgment and foreclosed and repossessed properties, increased from $18.4 million at the end of 2009 to $27.3 million as of June 30, 2010. This increase was largely due to an increase nonperforming loans, specifically in commercial real estate loans. Management classified two large commercial loan relationships in the amount of $7.3 million as non-performing during the second quarter.

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The following table presents non-performing assets and certain asset quality ratios at June 30, 2010 and December 31, 2009.

	June 30, 2010			December 31, 2009
	(In thousands)
Non-performing loans	$	23,620		$	15,570
Real estate in judgement		2,425			1,126
Foreclosed and repossessed assets		1,233			1,713
Total non-performing assets	$	27,278		$	18,409
Non-performing loans to total loans		11.56	%		6.85	%
Non-performing assets to total assets		10.35	%		6.50	%
Allowance for loan losses to non-performing loans		41.40	%		37.14	%
Allowance for loan losses to net loans receivable		4.79	%		2.54	%

Non-interest Income

Non-interest income for the quarter ended June 30, 2010 decreased $614,000, or 42.0%, from $1.5 million to $854,000 compared to the same period a year ago. This decrease is attributable to a decrease in gain on sale of loans offset by an increase in other income.

Net gain on of sale loans decreased $599,000 for the quarter ended June 30, 2010 from $748,000 to $149,000 compared to the same period a year ago. The decrease is largely due to the decline in one to four family residential mortgage refinancing activity. Management expects current trends to continue through the remainder of the year and be more consistent with the gains recognized in 2008.

Non-interest income for the six months ended June 30, 2010 decreased $916,000, or 32.2%, from $2.8 million to $1.9 million for the same period in 2009. Net gain on sale loans decreased $1.1 million for the six months ended June 30, 2009 from $1.5 million to $349,000 compared to the same period a year ago. Fees and Service charges increased $44,000 for the six months ended June 30, 2010 compared to the same period a year ago. The increase in fees and service charges is primarily due to an increase in deposit related fees of $24,000 which consists of an increase in ATM income of $28,000 and in early withdrawal penalties of $18,000. Overdraft fees decreased $18,000 as a result of customers managing their finances more closely in order to reduce overdraft fees because of the current challenging economic conditions. All other deposit fees decreased $4,000. An increase in loan related fees of $20,000 which consisted of an increase in Brokered loan income of $16,000 also significantly impacted fees and service charges.

A gain of $37,000 on the sale of investments was recognized in the six months of 2010 as management replaced securities to reposition maturities and improve overall credit quality of the portfolio. Other income increased $91,000 primarily due to a $34,000 increase in gain on sale of other repossessed property.

Non-interest Expense

Noninterest expense decreased $96,000, or 3.7%, for the three months ended June 30, 2010 compared to the same period ending a year ago. Salaries and employee benefits decreased $30,000. The decline in personnel expense was primarily attributable to a decline in general staffing, the discontinuance of our 401k match and the increased employee match for health insurance coverage. Amortization of mortgage servicing rights decreased $55,000 as a result of the slow down in residential mortgage refinancing activity mentioned previously. Foreclosed property expense decreased $18,000. Other operating expenses decreased $115,000. Professional services increased $122,000 primarily due to increases in legal fees associated with non-performing loans.

Noninterest expense decreased $111,000, or 2.2%, for the six months ended June 30, 2010 compared to the same period ending a year ago. Salaries and employee benefits decreased $73,000, in 2010. Cost control remains a focus of the Corporation and early in the third quarter the Corporation completed a reduction-in-staff initiative and a branch consolidation that will significantly reduce the Bank’s salaries and employee benefits expenses. Approximately 20 full-time equivalent positions were eliminated as a result of the reduction-in-staff initiative, with pre-tax savings estimated to be approximately $800,000 on an annual basis. Management will continue to reduce staffing levels, where possible, through attrition, throughout 2010.

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Amortization of mortgage servicing rights decreased $166,000 for reasons mentioned previously. Occupancy and equipment decreased $46,000. Other operating expenses decreased $125,000. Professional services increased $144,000 primarily due to increases in legal fees associated with non-performing loans and legal fees associated with the Consent Order. Foreclosed property expense increased $155,000, due to increases in loan collection costs, and losses and impairment charges associated with the disposition of other real estate.

Federal Income Tax Expense

An income tax benefit was not recognized for the first six month of 2010. A $2.0 million tax benefit for the six months of 2010, primarily associated with the $8.1 million net operating loss before income taxes, was offset by a corresponding increase in the valuation allowance on deferred tax assets. A significant component of income tax expense is made up of general tax credits generated each year. Due to the current year loss, these tax credits may not be fully utilized.

LIQUIDITY

The Bank’s liquidity, represented by cash, overnight funds and investments, is a product of our operating, investing, and financing activities. The Bank’s primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans, and funds provided from operations. While scheduled payments from the amortization of loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Bank also generates cash through borrowings. The Bank utilizes Federal Home Loan Bank advances to leverage its capital base and provide funds for its lending and investment activities, and to enhance its interest rate risk management.

At June 30, 2010, the Bank was considered “adequately capitalized” under regulatory guidelines which subjects the Bank to restrictions under the FDIC. These restrictions prohibit the Bank from accepting, renewing, or rolling over brokered deposits except with a waiver from the FDIC. This act also subjects the Bank to restrictions on the interest rates that can be paid on deposits.

Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in short-term investments such as overnight deposits. On a longer-term basis, the Bank maintains a strategy of investing in various investments and lending products. The Bank uses its sources of funds primarily to meet its ongoing commitments, to pay maturing certificates of deposit and savings withdrawals and to fund loan commitments. Certificates of deposit scheduled to mature in one year or less at June 30, 2010 totaled $46.3 million. Management believes that a significant portion of these certificates of deposit will remain with the Bank provided the Bank pays a rate of interest that is competitive both in the local and national markets.

If necessary, additional funding sources include additional deposits, Federal Home Loan Bank advances and securities available for sale. Deposits can be obtained in the local market area. At June 30, 2010 and based on current collateral levels, the Bank could borrow an additional $15.1 million from the Federal Home Loan Bank at prevailing interest rates. This borrowing capacity can be increased in the future if the Bank pledges additional collateral to the Federal Home Loan Bank. The Corporation anticipates that it will continue to have sufficient funds, through deposits, and borrowings, to meet its current commitments.

The Bank’s total cash and cash equivalents decreased by $4.1 million during the six months ended June 30, 2010 compared to a $6.6 million increase for the same period in 2009. The primary sources of cash for the six months ended June 30, 2010 were $10.9 million in proceeds from the sale of mortgage loans, $3.9 million in sales and maturities of available-for-sale investment securities and $5.4 of principal loan collections in excess of loan originations compared to $6.8 million increase in cash generated by the issuance of preferred stock, $10.2 million increase in deposits, $66.3 million in proceeds from the sale of mortgage loans, $6.1 million in maturities of available-for-sale investment securities. The primary uses of cash for the six months ended June 30, 2010 were $10.9 million of mortgage loans originated for sale, decrease in deposits of $11.9 million and $4.2 million in purchases of available-for-sale investment securities compared to $65.3 million of mortgage loans originated for sale, $3.5 million in repayments of FHLB advances, $1.0 million in repayment of Fed funds purchased and $17.8 million in purchases of available-for-sale investment securities.

Effective February 2010, the Corporation deferred regularly scheduled dividend payments on the $6.7 million in principal outstanding on its Series A fixed rate, cumulative perpetual preferred stock (aggregate liquidation preference of $6.8 million) which was issued to the U.S. Treasury in February 2009. By taking this action, the Corporation expects to save approximately $339,250 in annual cash payments.

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CONTRACTUAL OBLIGATIONS AND OFF BALANCE SHEET ARRANGEMENTS

The Corporation has certain obligations and commitments to make future payments under contracts. At June 30, 2010, the aggregate contractual obligations and commitments are:

	Payments Due by Period
			Less than		1-3		3-5		After
	Total		1 year		years		years		5 years
	(Dollars in Thousands)
Certificates of deposit	$	90,045	$	46,248	$	31,979	$	11,818	$	—
FHLB advances		44,518		19,168		18,291		7,059		—
Total	$	134,563	$	65,416	$	50,270	$	18,877	$	—

	Amount of commitment expiration per period
			Less than		1-3		3-5		After
	Total		1 year		years		years		5 years
	(Dollars in Thousands)
Commitments to grant loans	$	1,945	$	1,945	$	—	$	—	$	—
Unfunded commitments under HELOCs		13,753		1,461		3,878		2,671		5,743
Unfunded commitments under Contruction loans		1,275		665		59		—		551
Unfunded commitments under Commercial LOCs		1,987		1,216		758		—		13
Letters of credit		150		150		—		—		—
Total	$	19,110	$	5,437	$	4,695	$	2,671	$	6,307

Commitments to grant loans are governed by the Bank’s credit underwriting standards, as established by the Bank’s Loan Policy. The Bank’s policy is to grant Home Equity Lines of Credits (HELOCs) for periods of up to 15 years.

CAPITAL RESOURCES

The Bank is subject to various regulatory capital requirement administered by federal and state banking agencies. The Bank’s regulatory capital ratios as of June 30, 2010 were as follows: Tier 1 leverage ratio 4.9%, Tier 1 risk-based capital ratio 6.80%; and total risk-based capital, 8.04%. As of June 30, 2010, the Bank is considered “adequately capitalized”.

In May 2010, the Bank agreed with the FDIC to increase the Bank’s Tier 1 risk-based capital ratio to at least 9%, and its total risk-based capital ratio to at least 11.0%. At June 30, 2010, these capital ratio requirements had not been met. The Board of Directors and management remain committed to reaching the capital requirements and continue to evaluate different capital raising alternatives.

Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that if undertaken could have a material adverse effect. Under the FDIC’s prompt corrective action framework, banks with less than a 4% Tier 1 leverage ratio are considered undercapitalized, banks with less than a 3% Tier 1 leverage ratio are considered significantly undercapitalized, and banks with a tangible equity to total assets ratio of less than 2% are considered critically undercapitalized. Each of these categories subjects such bank to increasing levels of regulatory scrutiny which may include increased supervision; restrictions on operations, expansion of activities and growth; potential civil penalties; and in the case of critically undercapitalized banks, the appointment of a conservator.

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RECENT DEVELOPMENTS

     Following Monarch Community Bank’s most recent Safety and Soundness examination, the Board of Directors of Monarch Community Bank stipulated to the terms of a formal enforcement action (“Consent Order”) with Federal Deposit Insurance Corporation (“FDIC”) and the Office of Financial and Insurance Regulation for the State of Michigan (“OFIR”). The Consent Order, which was effective May 6, 2010, contains specific actions needed to address certain findings from their examination and to address our current financial condition. The Consent Order, among other things, requires the following:

• The Bank is required to have and retain qualified management.

• The Bank is required to retain an independent third party to develop an analysis and assessment of the Bank’s management needs for the purpose of providing qualified management for the Bank.

• The board of directors is required to assume responsibility for the supervision of all of the Bank’s activities.

• The Bank must increase the Bank’s level of Tier 1 capital as a percentage of total assets to at least nine percent and its total capital as a percentage of risk-weighted assets at a minimum of eleven percent.

• The Bank is required to charge off any loans classified as loss.

• The Bank may not extend credit to borrowers that have had loans with the Bank that were classified substandard, doubtful or special mention without prior board approval.

• The Bank may not extend credit to borrowers that have had loans charged off or classified as loss.

• The Bank is required to adopt a plan to reduce the Bank’s risk position in each asset in excess of $250,000 which is more than sixty days delinquent or classified substandard or doubtful.

• The Bank may not declare or pay any cash dividend without prior written consent of the FDIC and OFIR.

• Prior to submission or publication of all Reports of Condition, the board is required to review the adequacy of the Bank’s allowance for loan and lease losses.

• The Bank is required to adopt written lending and collection policies to provide effective guidance and control over the Bank’s lending function.

• The Bank is required to implement revised comprehensive loan grading review procedures.

• Within sixty days of the Consent Order, the Bank is required to adopt a written profit plan and comprehensive budget.

• Within sixty days of the Consent Order, the Bank is required to adopt a written plan to manage concentrations of credit in a safe and sound manner.

• Within sixty days of the Consent Order, the Bank is required to formulate a written plan to reduce the Bank’s reliance on brokered deposits.

• While the Consent Order is in effect, the Bank is required to prepare and submit quarterly progress reports the FDIC and OFIR.

          The Bank believes that it is in compliance with all of the terms of the Consent Order with the exception of the requirement that the Bank increase the Bank’s level of Tier 1 capital as a percentage of total assets to at least nine percent and its total capital as a percentage of risk-weighted assets at a minimum of eleven percent. The Board of Directors and management remain committed to reaching the capital requirements and continue to evaluate different capital raising alternatives.

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ITEM 3. QUANTITATIVE AND QUALITIVE DISCLOSURES ABOUT MARKET RISK

The Corporation’s primary market risk exposure is interest rate risk (“IRR”). Interest rate risk refers to the risk that changes in market interest rates might adversely affect the Corporation’s net interest income or the economic value of its portfolio of assets, liabilities, and off-balance sheet contracts. Interest rate risk is primarily the result of an imbalance between the price sensitivity of the Corporation’s assets and its liabilities (including off-balance sheet contracts). Such imbalances can be caused by differences in the maturity, repricing and coupon characteristics of assets and liabilities, and options, such as loan prepayment options, interest rate caps and floors, and deposit withdrawal options. These imbalances, in combination with movement in interest rates, will alter the pattern of the Corporation’s cash inflows and outflows, affecting the earnings and economic value of the Corporation.

The Corporation’s primary tool for assessing IRR is a model that uses scenario analysis to evaluate the IRR exposure of the Bank by estimating the sensitivity of the Bank’s portfolios of assets, liabilities, and off-balance sheet contracts to changes in market interest rates. To measure the sensitivity of the Bank’s Net Portfolio Value (NPV) to changes in interest rates, the (NPV) model estimates what would happen to the economic value of each type of asset, liability, and off-balance sheet contract under six different interest rate scenarios. The model estimates the NPV that would result following instantaneous, parallel shifts in the Treasury yield curve of -300, -200, -100, +100, +200, +300 basis points. Management then compares the resulting NPV and the magnitude of change in NPA to regulatory and industry guidelines to determine if the Corporation’s IRR is acceptable.

ITEM 4T. CONTROLS AND PROCEDURES

An evaluation of the Corporation’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of June 30, 2010 was carried out under the supervision and with the participation of the Corporation’s Chief Executive Officer, Chief Financial Officer and several other members of the Corporation’s senior management. The Corporation’s Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Corporation in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Corporation’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within time periods specified in the SEC’s rules and forms. There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the quarter ended June 30, 2010, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The Corporation intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Corporation’s business. While the Corporation believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Corporation to modify its disclosure controls and procedures.

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PART II-OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS

The Corporation and the Bank are from time-to-time involved in legal proceedings arising out of, and incidental to, their business. Management, based on its review with counsel of all actions and proceedings affecting the Corporation and the Bank, has concluded that the aggregate loss, if any, resulting from the disposition of these proceedings should not be material to the Corporation’s financial condition or results of operations.

Item 1A. RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Corporation. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable

Item 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable

Item 4. [RESERVED]

Item 5. OTHER INFORMATION

Not applicable

Item 6. EXHIBITS

See the index to exhibits.

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SIGNATURES

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

	MONARCH COMMUNITY BANCORP, INC.
Date: August 16, 2010	By:	/s/ Richard J. DeVries
		Richard J. DeVries
		President and Chief Executive Officer
Date: August 16, 2010	And:	/s/ Rebecca S. Crabill
		Rebecca S. Crabill
		Senior Vice President, Chief Financial Officer

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INDEX TO EXHIBITS

Exhibit No.	Description of Exhibit
10.1	Consent Order (Incorporated by reference from the Form 8-K filed on May 12, 2010).
31.1	Rule 13a-14(a) Certification of the Corporation’s President and Chief Executive Officer.
31.2	Rule 13a-14(a) Certification of the Corporation’s Chief Financial Officer.
32	Section 1350 Certification.

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