Monarch Community Bancorp (MCBF) 10-Q 2011 Q1 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 March 31, 2011

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). Yeso Noo

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 filero	Accelerated filero	Non-accelerated filero	Smaller reporting companyþ
		(Do not check if a smaller reporting company)

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 April 27, 2011, there were 2,049,485 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 — March 31, 2011
Condensed Consolidated Statements of Income — Three Months Ended March 31, 2011	2
Condensed Consolidated Statements of Cash Flows — Three Months Ended March 31, 2011	3
Notes to Condensed Consolidated Financial Statements	4-17
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations	17-23
Item 3 — Quantitative and Qualitative Disclosures about Market Risk	23
Item 4 — Controls and Procedures	24
PART II — OTHER INFORMATION
Item 1 — Legal Proceedings	24
Item 1A — Risk Factors	24
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 3 — Defaults Upon Senior Securities	24
Item 4 — [Reserved]	24
Item 5 — Other Information	24
Item 6 — Exhibits	24
SIGNATURES	25
CERTIFICATIONS	27-29
EX-31.1
EX-31.2
EX-32

PART I—FINANCIAL INFORMATION

Item 1. CONDENSED FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets

	(Unaudited)
	March 31,			December 31,
	2011			2010
	(Dollars in thousands,
	except per share data)
Assets
Cash and due from banks	$	18,164		$	7,065
Federal Home Loan Bank overnight time and other interest bearing deposits		32,257			34,909
Total cash and cash equivalents		50,421			41,974
Securities — Available for sale		10,645			11,466
Securities — Held to maturity		10			10
Other securities		3,865			3,865
Loans held for sale		291			693
Loans, net		174,554			182,768
Foreclosed assets, net		3,737			2,972
Premises and equipment		4,048			4,122
Core deposit intangible		354			390
Other assets		7,899			8,608
Total assets	$	255,824		$	256,868
Liabilities and Stockholders’ Equity
Liabilities
Deposits:
Non-interest bearing	$	25,447		$	15,394
Interest bearing		185,273			190,634
Total deposits		210,720			206,028
Federal Home Loan Bank advances		30,350			36,350
Accrued expenses and other liabilities		2,603			2,472
Total liabilities		243,673			244,850
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 March 31, 2011		6,753			6,750
Common stock — $0.01 par value, 20,000,000 shares authorized, 2,049,485 shares issued and outstanding at March 31, 2011 and December 31, 2010		20			20
Additional paid-in capital		21,149			21,146
Retained earnings		(15,481	)		(15,591	)
Accumulated other comprehensive income		271			257
Unearned compensation		(561	)		(564	)
Total stockholders’ equity		12,151			12,018
Total liabilities and stockholders’ equity	$	255,824		$	256,868

See accompanying notes to condensed consolidated financial statements.

Condensed Consolidated Statements of Income (Unaudited)

	Three Months		Three Months
	Ended		Ended
	March 31,		March 31,
	2011		2010
	(Dollars in thousands, except per share data)
Interest Income
Loans, including fees	$	2,689	$	3,336
Investment securities		118		151
Federal funds sold and overnight deposits		1		1
Total interest income		2,808		3,488
Interest Expense
Deposits		684		964
Federal Home Loan Bank advances		349		494
Total interest expense		1,033		1,458
Net Interest Income		1,775		2,030
Provision for Loan Losses		260		1,845
Net Interest Income After Provision for Loan Losses		1,515		185
Non-interest Income
Fees and service charges		447		546
Loan servicing fees		108		117
Net gain on sale of loans		158		199
Net gain (loss) on sale of securities		—		37
Other income		333		173
Total non-interest income		1,046		1,072
Non-interest Expense
Salaries and employee benefits		1,071		1,106
Occupancy and equipment		242		241
Data processing		213		209
Amortization of mortgage servicing rights		96		88
Professional services		157		150
Amortization of core deposit intangible		35		35
NOW account processing		50		51
ATM/Debit card processing		59		57
Foreclosed property expense		88		206
Other general and administrative		352		350
Total non-interest expense		2,363		2,493
Income (Loss) — Before income taxes		198		(1,236	)
Income Taxes		—		—
Net Income (Loss)	$	198	$	(1,236	)
Dividends and amortization of discount on preferred stock	$	88	$	88
Net Income (loss) available to common stock	$	110	$	(1,324	)
Earnings(Loss) Per Share
Basic	$	0.06	$	(0.67	)
Diluted	$	0.06	$	(0.67	)

See accompanying notes to condensed consolidated financial statements.

2

Condensed Consolidated Statements of Cash Flows (Unaudited)

	Three Months Ended
	March, 31
	2011			2010
	(Dollars in thousands)
Cash Flows From Operating Activities
Net Income (Loss)	$	198		$	(1,236	)
Adjustments to reconcile net income (loss) to net cash from operating activities
Depreciation and amortization		258			271
Provision for loan losses		260			1,845
Stock option expense		—			2
Gain on sale of foreclosed assets		(278	)		(116	)
Mortgage loans originated for sale		(5,935	)		(6,116	)
Proceeds from sale of mortgage loans		6,338			6,383
Gain on sale of mortgage loans		(158	)		(199	)
(Gain) Loss on sale of available for sale securities		—			(37	)
Earned Stock Compensation		15			—
Net change in:
Deferred loan fees		(34	)		28
Accrued interest receivable		220			(37	)
Other assets		394			77
Accrued expenses and other liabilities		35			58
Net cash provided by (used in) operating activities		1,313			923
Cash Flows From Investing Activities
Activity in available-for-sale securities:
Purchases		—			(3,716	)
Proceeds from maturities of securities		824			1,863
Proceeds from sale of securities		—			1,066
Loan originations and principal collections, net		6,890			2,269
Proceeds from sale of foreclosed assets		763			1,026
Purchase of premises and equipment		(35	)		(54	)
Net cash provided by investing activities		8,442			2,454
Cash Flows From Financing Activities
Net increase in deposits		4,692			5,045
Repayment of FHLB advances		(6,000	)		—
Net cash provided by financing activities		(1,308	)		5,045
Net Increase (Decrease) in Cash and Cash Equivalents		8,447			8,422
Cash and Cash Equivalents— Beginning		41,974			23,354
Cash and Cash Equivalents —End	$	50,421		$	31,776
Supplemental Cash Flow Information:
Cash paid for:
Interest		1,069			1,475
Income taxes		—			—
Noncash investing activities:
Loans transferred to foreclosed assets		1,255			308

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 five 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, 2010 filed with the Securities and Exchange Commission.

The results of operations for the three month period ended March 31, 2011 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 2011 presentation.

SECURITIES

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

			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Market
March 31, 2011	Cost		Gains		Losses		Value
Available-for-sale securities:
U.S. Treasury	$	—	$	—	$	—	$	—
U.S. government agency obligations		1,114		72		—		1,186
Mortgage-backed securities		3,580		125				3,705
Obligations of states and political subdivisions		5,539		215		—		5,754
Total available-for-sale securities	$	10,233	$	412	$	—	$	10,645
Held-to-maturity securities:
Municipal securities	$	10	$	—	$	—	$	10

			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Market
December 31, 2010	Cost		Gains		Losses		Value
Available-for-sale securities:
U.S. Treasury	$	—	$	—	$	—	$	—
U.S. government agency obligations		1,619		63		—		1,682
Mortgage-backed securities		3,914		110		—		4,024
Obligations of states and political subdivisions		5,543		217		—		5,760
Total available-for-sale securities	$	11,076	$	390	$	—	$	11,466
Held-to-maturity securities:
Municipal securities	$	10	$	—	$	—	$	10

Proceeds from sales of securities available for sale were $0 and $1.1 million for the three months ended March 31, 2011 and 2010, respectively. Gross gains of $0 and $37,000 were realized on these sales during 2011 and 2010, respectively.

5

The amortized cost and fair value of securities available for sale at March 31, 2011 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.

	March 31, 2011
	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	$	400	$	408
Due from one to five years		—		—		5,392		5,635
Due from five to ten years		—		—		861		897
Due after ten years		—		—		—		—
Total	$	10	$	10		6,653		6,940
Mortgage-backed securities						3,580		3,705
Total available-for-sale securities					$	10,233	$	10,645

There were no securities with unrealized losses at March 31, 2011.

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 March 31, 2011.

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
	Ended			Ended
	March 31, 2011			March 31, 2010
Basic earnings per share
Numerator:
Net income (loss)	$	198		$	(1,236	)
Dividends and amortization of discount on preferred stock	$	88		$	88
Net Income (Loss) available to common stock	$	110		$	(1,324	)
Denominator:
Weighted average common shares outstanding		2,050			2,045
Less: Average unallocated ESOP shares		(56	)		(65	)
Less: Average non-vested RRP shares		(1	)		(2	)
Weighted average common shares outstanding for basic earnings (loss) per share		1,993			1,978
Basic earnings (loss) per share	$	0.06		$	(0.67	)
Diluted earnings per share
Numerator:
Net Income (Loss) available to common stock	$	110		$	(1,324	)
Denominator:
Weighted average common shares outstanding for basic earnings per share		1,993			1,978
Add: Dilutive effects of restricted stock, stock options and warrants		—			—
Weighted average common shares and dilutive potential common shares outstanding		1,993			1,978
Diluted earnings (loss) per share	$	0.06		$	(0.67	)

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 has adopted the standard effective with our December 31, 2010 financial statements.

7

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.

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 March 31, 2011, and December 31, 2010, 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
	Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)		March 31, 2011
Assets:
March 31, 2011-Investment Securities
U.S. government agency obligations		—		1,186		—		1,186
Mortgage-backed securities		—		3,705		—		3,705
Obligations of states and political subdivisions		—		5,754		—		5,754
	$	—	$	10,645	$	—	$	10,645

			Significant
	Quoted Prices in Active		Other		Significant
	Markets for Identical		Observable		Unobservable		Balance at
	Assets (Level 1)		Inputs (Level 2)		Inputs (Level 3)		December 31, 2010
Assets:
December 31, 2010-Investment Securities
U.S. government agency obligations		—		1,682		—		1,682
Mortgage-backed securities		—		4,024		—		4,024
Obligations of states and political subdivisions		—		5,760		—		5,760
	$	—	$	11,466	$	—	$	11,466

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). Adjustments in 2011 and 2010 to the impaired loans were recorded as additional allocations to the allowance for loan and lease losses. Adjustments in 2011 to foreclosed assets were recorded as additional allocations to the allowance for loan and lease losses. The following table presents the Corporation’s assets at fair value on a nonrecurring basis as of March 31, 2011 and December 31, 2010 (000s omitted):

	Assets Measured at Fair Value on a Nonrecurring Basis
	Balance at		Quoted Prices in Active		Significant Other		Significant
	March 31,		Markets for Identical		Observable Inputs		Unobservable Inputs
	2011		Assets (Level 1)		(Level 2)		(Level 3)
Impaired Loans accounted for under FASB ASC 310	$	10,508	$	—	$	—	$	10,508
Foreclosed Assets	$	3,737	$	—	$	—	$	3,737

	Assets Measured at Fair Value on a Nonrecurring Basis
	Balance at		Quoted Prices in Active		Significant Other		Significant
	December 31,		Markets for Identical		Observable Inputs		Unobservable Inputs
	2010		Assets (Level 1)		(Level 2)		(Level 3)
Impaired Loans accounted for under FASB ASC 310	$	11,433	$	—	$	—	$	11,433
Foreclosed Assets	$	2,972	$	—	$	—	$	2,972

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 March 31, 2011 and December 31, 2010. The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments:

Securities- Fair values for securities are based on quoted market prices.

Mortgage 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):

	March 31,				December 31,
	2011				2010
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Assets:
Cash and cash equivalents	$	50,421	$	50,421	$	41,974	$	41,974
Securities — Held to maturity		10		10		10		10
Securities — Available for sale		10,645		10,645		11,466		11,466
Other securities		3,865		3,865		3,865		3,865
Loans held for sale		291		297		693		827
Net loans		174,554		177,063		182,768		185,268
Accrued interest and late charges receivable		519		519		264		264
Liabilities:
Deposits		210,720		210,885		206,028		206,400
Federal Home Loan Bank advances		30,350		32,353		36,350		38,532
Accrued interest payable		306		306		341		341

LOANS

The following table presents information concerning the composition of our loan portfolio in dollar amounts as of the dates indicated:

	March 31, 2011		December 31, 2010
	Amount		Amount
	(Dollars in thousands)
Real Estate Loans:
One-to-four family	$	89,150	$	93,294
Multi-family		4,579		4,783
Commercial		61,367		62,998
Construction or development		2,587		3,873
Total real estate loans		157,683		164,948
Other loans:
Consumer loans:
Home equity		13,720		14,814
Other		3,122		3,403
Total consumer loans		16,842		18,217
Commercial Business Loans		7,169		6,882
Total other loans		24,011		25,099
Total Loans		181,694		190,047

10

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Our delinquent loans consist largely of commercial real estate loans. An age analysis of past due loans including nonaccrual loans, segregated by class of loans, as of March 31, 2011 are as follows:

					Loans 90
	30-69		60-89		Days or
	Days Past		Days Past		More Past		Total Past		Current
	Due		Due		Due		due Loans		Loans		Total Loans
Commercial	$	225	$	—	$	1,206	$	1,431	$	5,738	$	7,169
Commercial Real Estate:
Multi-family		—		—		—	$	—		4,579		4,579
Commercial Real Estate — other		177		2,719		3,744	$	6,640		54,727		61,367
Consumer:
Consumer — other		227		—		85	$	312		16,278		16,590
Consumer — auto		—		—		—	$	—		252		252
Residential:
Residential — prime		1,301		747		1,400	$	3,448		69,085		72,533
Residential — subprime		74		190		288	$	552		16,065		16,617
Construction:
Construction — prime		19		—		—	$	19		2,058		2,077
Construction — subprime		—		236		—	$	236		—		510
Total	$	2,023	$	3,892	$	6,723	$	12,638	$	168,782	$	181,694

All commercial loans will be assigned a risk rating by the Credit Analyst at inception. The risk rating system is composed of eight levels of quality and utilizes the following definitions.

Risk Rating Scores by definition:

1.	Zero (0) Unclassified. Any loan which has not been assigned a classification.
2.	One (1) Excellent. A well structured credit relationship to an established borrower. Loans to entities with a strong financial condition and solid earnings history, characterized by:

• High liquidity, strong cash flow, low leverage.

• Unquestioned ability to meet all obligations when due.

• Experienced management, with management succession in place.

• Debt to worth ratio of 1:1 or less.

• Steady and above average earnings history.

• If loan is secured, collateral is of high quality and readily marketable.

• Readily accessible to capital markets and alternative financing.

• Industry is mature with favorable outlook.

• Loan structure within policy guidelines.

• Loan is performing as agreed.

• The probability of serious, rapid financial deterioration is extremely small.

• Outstanding primary and secondary sources of repayment.

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3. Two (2) Above Average Quality. Loans to borrowers with a sound financial condition and positive trend in earnings supplemented by:

• Favorable liquidity and leverage and strong cash flow.

• Ability to meet all obligations when due.

• Management has successful track record.

• Debt to worth ratio of 1.5:1 or less.

• Steady and satisfactory earnings history.

• If loan is secured, collateral is of high quality and readily marketable.

• Access to alternative financing.

• Excellent prospects for continued growth.

• Industry outlook is favorable.

• Loan structure is within policy guidelines.

• Loan is performing to terms.

• Probability of serious financial deterioration is unlikely.

• Well defined primary and secondary source of repayment.

• If supported by a guaranty, the financial strength and liquidity of the guarantor(s) are clearly evident.

4. Three (3) Acceptable. Loans to entities with a satisfactory financial condition and further characterized by:

• Working capital adequate to support operations.

• Cash flow sufficient to pay debts as scheduled.

• Management experience and depth appear favorable.

• Debt to worth ratio of 2.50:1 or less.

• Acceptable sales and steady earning history.

• Industry outlook is stable.

• Loan structure within policy guidelines.

• Loan performing according to terms.

• If loan is secured, collateral is acceptable and loan is fully protected.

5. Four (4) Average. Loans to entities which are considered bankable risks, although some signs of weaknesses are shown:

• Marginal liquidity and working capital.

• Short or unstable earnings history.

• Would include most start-up businesses.

• Would be enrolled in Small Business Administration or Michigan Strategic Fund programs.

• Occasional instances of trade slowness or repayment delinquency — may have been 10-30 days slow within the past 12 months.

• Management abilities are apparent yet unproven.

• Debt to worth ratio of 3.50 or less.

• Weakness in primary source of repayment with adequate secondary source of repayment.

• If secured, loan is protected but collateral is marginal.

• Industry outlook is uncertain; may be cyclical or highly competitive.

• Loan structure generally in accordance with policy.

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6. Five (5) Special Mention. Special Mention loans have potential weaknesses which may, if not checked or corrected, weaken the asset or inadequately protect the Bank’s credit position at some future date. Loans to entities that constitute an undue and unwarranted credit risk but not to the point of justifying or classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific loan. The following characteristics may apply:

• Downward trend in sales, profit levels and margins.

• Impaired working capital positions.

• Cash flow is strained in order to meet debt repayment.

• Loan delinquency (30-60 days) and overdrafts may occur.

• Management abilities are questionable.

• Highly leveraged, debt to worth ratio over 3.50:1.

• Industry conditions are weak.

• Inadequate or outdated financial information.

• Litigation pending against borrower.

• Loan may need to be restructured to improve collateral position and/or reduce payment amount.

• Collateral / guaranty offers limited protection.

7. Six (6) Substandard. A substandard loan is inadequately protected by the current sound worth and repayment capacity of the borrower. Loans so classified must have a well-defined weakness that jeopardizes the liquidation of the debt. There is a distinct possibility that the Bank will implement collection procedures if the loan deficiencies are not corrected. The following characteristics may apply:

• Sustained losses have severely eroded the equity and cash flow.

• Deteriorating liquidity.

• Serious management problems.

• Chronic trade slowness; may be placed on COD by vendors.

• Likelihood of bankruptcy.

• Inability to access other funding sources.

• Reliance on secondary source of repayment.

• Interest non-accrual may be warranted.

• Collateral provided is of little or no value.

• Repayment dependent upon the liquidation of non-current assets.

• Repayment may require litigation.

8. Seven (7) Doubtful. A doubtful loan has all the weakness inherent in a substandard loan with the added characteristic that collection and/or liquidation is pending. Loans or portions of loans with one or more weaknesses which, on the basis of currently existing facts, conditions, and values, makes ultimate collection of all principal highly questionable. The possibility of loss is high and specific loan loss reserve allocations should be made or charge offs taken on anticipated collateral shortfalls. However, the amount or the certainty of eventual loss may not allow for a specific reserve or charge off because of specific pending factors. Pending factors include proposed merger or acquisition, completion or liquidation in progress, injection of new capital in progress, refinancing plans in progress, etc. “Pending Factors” not resolved after six months must be disregarded. The following characteristics may apply:

• Normal operations are severely diminished or have ceased.

• Seriously impaired cash flow.

• Secondary source of repayment is inadequate.

• Survivability as a “going concern” is impossible.

• Placement on interest non-accrual

• Collection process has begun.

• Bankruptcy petition has been filed.

• Judgments have been filed.

• Portion of the loan balance has been charged-off.

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9. Eight (8) Loss. Loans classified loss are considered uncollectible and of such little value that their continuance as bankable asset is not warranted. This classification is for charged-off loans but does not mean that the asset has absolutely no recovery or salvage value. Further characterized by:

• Liquidation or reorganization under bankruptcy, with poor prospects of collection.

• Fraudulently overstated assets and/or earnings.

• Collateral has marginal or no value.

• Debtor cannot be located.

The following table represents the risk category of loans by class based on the most recent analysis performed as of March 31, 2011 (in thousands):

			Commercial Real Estate		Commercial Real Estate
	Commercial		Multi-family		Other
	2011		2011		2011
0-2		—		36		3,198
3		12		209		3,687
4		3,554		130		23,482
5		1,638		3,584		11,503
6		757		454		17,440
7		1,208		166		2,057
Total	$	7,169	$	4,579	$	61,367

For consumer residential real estate, and other, the Company also evaluates credit quality based on the aging status of the loan which was previously stated, and by payment activity. The following tables present the recorded investment in those classes based on payment activity and assigned grades as of March 31, 2011.

	Residential - Prime		Residential - Subprime
	2011
Grade
Pass		71,475		16,297
Substandard		1,285		93
Total	$	72,760	$	16,390

	Consumer - Other		Consumer - Auto
	2011
Performing		16,422		252
Nonperforming		168		—
Total	$	16,590	$	252

	Construction - Prime
	2011
Performing		2,587
Nonperforming		—
Total	$	2,587

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The following table presents loans individually evaluated for impairment by class of loans as of March 31, 2011 (in thousands).

			Unpaid				Average
	Recorded		Principal		Related		Recorded		Interest
	Investment		Balance		Allowance		Investment		Income
With no related allowance recorded:
Commercial	$	1,619	$	1,645	$	—	$	1,648	$	—
Commercial Real Estate:
Commercial Real Estate — Multi-family		620		806		—		793		23
Commercial Real Estate — other		15,065		21,303		—		21,331		399
Consumer:
Consumer — other		449		449		—		454		22
Consumer — auto		—		—		—		—		—
Residential:
Residential — prime		2,908		3,506		—		3,510		137
Residential — subprime		4,827		4,827		—		4,744		340
With an allowance recorded:
Commercial		225		225		57		225		—
Commercial Real Estate:
Commercial Real Estate — Multi-family		—		—		—		—		—
Commercial Real Estate — other		586		610		191		611		—
Consumer:
Consumer — other		—		—		—		—		—
Consumer — auto		—		—		—		—		—
Residential:
Residential — prime		557		710		301		714		—
Residential — subprime		—		—		—		—		—
Total
Commercial	$	18,115	$	24,589	$	248	$	24,608	$	422
Consumer	$	449	$	449	$	—	$	454	$	22
Residental	$	8,292	$	9,043	$	301	$	8,968	$	477

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The following presents by class, the recorded investment in loans and leases on non-accrual status as of March 31, 2011.

Commercial	$	1,844
Commercial real estate:
Commercial Real Estate — multi-family		166
Commercial Real Estate — other		7,482
Consumer:
Consumer — other		85
Consumer — auto		—
Residential:
Residential — prime		2,488
Residential — subprime		288
Construction
Construction — prime		331
Construction — subprime		—
Total	$	12,684

ALLOWANCE FOR LOAN LOSSES

Changes in the allowance for loan losses were as follows for the three months ended March 31, 2011.

Summary of Allowance for Loan Losses

	Three Months Ended
	March 31
	2011			2010
Beginning Balance	$	6,850		$	5,783
Loans Charged off		(913	)		(1,436	)
Recoveries		314			76
Provision for loan losses		260			1,845
Ending Balance	$	6,511		$	6,268

The allowance for loan losses was $6.5 million at March 31, 2011 representing 3.7% of total loans, compared to $6.9 million at December 31, 2010 or 3.74% of total loans and $6.3 million at March 31, 2010 or 2.81% of total loans. The allowance for loan losses to non-performing loans ratio was 51.3% at March 31, 2011 compared to 48.7% at December 31, 2010 and 35.8% at March 31, 2010. At March 31, 2011 we believe that our allowance appropriately considers incurred losses in our loan portfolio.

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Analysis related to the allowance for credit losses (in thousands) as of March 31, 2011 is as follows:

				Comercial
				Real Estate									Residential -			Residential -
	Commercial			Other			Multi Family			Consumer			Prime			Subprime			Construction			Total
ALLOWANCE FOR CREDIT LOSSES:
Beginning Balance	$	71		$	1,790		$	474		$	503		$	3,495		$	458		$	59		$	6,850
Charge-Offs		(3	)		(18	)		(177	)		(100	)		(413	)		(189	)		(13	)		(913	)
Recoveries		7			228			—			69			4			6			—			314
Provision		55			(396	)		(8	)		(93	)		508			183			11			260
Ending Balance		130			1,604			289			379			3,594			458			57			6,511
Ending Balance: individually evaluated for impairment		57			191			—			—			301			—			—			549
Ending Balance: collectively evaluated for impairment		73			1,413			289			379			3,293			458			57			5,962
Ending Balance: loans acquired with deteriorated credit quality		—			—			—			—			—			—			—			—
FINANCING RECEIVABLES:
Ending Balance		7,169			61,367			4,579			16,842			72,533			16,617			2,587			181,694
Ending Balance: individually evaluated for impairment		1,844			15,320			620			449			3,465			4,827			331			26,856
Ending Balance: collectively evaluated for impairment		5,325			46,047			3,959			16,393			69,068			11,790			2,256			154,838
Ending Balance: loans acquired with deteriorated credit quality		—			—			—			—			—			—			—			—

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.

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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.

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.

Since stipulating to the terms of the Consent Order, we have complied with all of the provisions of the Consent Order, with the exception of raising the capital ratios to the required levels of 11.0% and 9.0% for Total Risk Based Capital and Tier 1 Capital, respectively. We continue to evaluate options for raising capital, and anticipate retaining an investment banking firm in the second quarter to assist in that process.

In addition, we have made significant progress in reducing the level of non-performing assets, which totaled $16.4 million of March 31, 2011 versus $27.3 million at June 30, 2010. We have likewise completed two external commercial loans reviews during 2010, neither of which made recommendations for additional provisions or charge-offs. The bank has also retained the services of Rehmann CPA firm to serve as our internal auditor. They have completed their first internal audit and found no material weaknesses.

We continue to maintain our focus on the reduction of problem loans and the generation of fee income through secondary market mortgage originations and wealth management activities.

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FINANCIAL CONDITION

Summary.Our total assets decreased by $1.1 million, or .41%, to $255.8 million at March 31, 2011 compared to $256.9 million at December 31, 2010. Loans, excluding loans held for sale, totaled $174.6 million at March 31, 2011, down 4.5% from $$182.8 million at December 31, 2010.

Securities

Securities decreased to $10.6 million at March 31, 2011 compared to $11.4 million at December 31, 2010. The decrease was attributable to the scheduled maturities of $500,000 in U.S. agency securities and scheduled repayment of $333,000 in Mortgage Backed securities. The yield on investment securities has increased to 3.57% during the three months ended March 31, 2011 from 3.11% 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 $8.2 million, or 4.5%, from $182.8 million at December 31, 2010 to $174.6 million at March 31, 2011. The following table presents information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated:

	March 31, 2011					December 31, 2010
	Amount		Percent			Amount		Percent
	(Dollars in thousands)
Real Estate Loans:
One-to-four family	$	89,150		49.1		$	93,294		49.1
Multi-family		4,579		2.5			4,783		2.5
Commercial		61,367		33.8			62,998		33.1
Construction or development		2,587		1.4			3,873		2.0
Total real estate loans		157,683		86.8			164,948		86.8
Other loans:
Consumer loans:
Home equity		13,720		7.6			14,814		7.8
Other		3,122		1.7			3,403		1.8
Total consumer loans		16,842		9.3			18,217		9.6
Commercial Business Loans		7,169		3.9			6,882		3.6
Total other loans		24,011		13.2			25,099		13.2
Total Loans		181,694		100.0	%		190,047		100.0	%
Allowance for loan losses		6,511					6,850
Less: Net deferred loan fees		338					429
Total Loans, net	$	174,845				$	182,768

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One-to-four family loans decreased $4.1 million from year end 2010 as a result of the Bank’s continued strategy to sell a large portion of new one to four family loan originations. Commercial real estate loans and construction loans decreased $2.9 million or 4.36%.

The allowance for loan losses was $6.5 million at March 31, 2011 compared to $6.9 million at December 31, 2010, a decrease of $400,000. Net charge offs totaled $599,000 compared to $1.4 million for the same period a year ago. Net charge offs year to date consisted of primarily one to four family residential mortgages. 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 increased $4.7 million, or 2.3%, from $206.0 million at December 31, 2010 to $210.7 million at March 31, 2011. The rise in deposits included increases of $11.7 million in demand checking and savings accounts. Decreases in certificates of deposits of $5.2 million and in interest bearing checking and money market accounts of $1.9 million offset the movement in demand and savings accounts.

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 the 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 without prior approval of the FDIC 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 decreased $6.0 million to $30.3 million during the three months ended March 31, 2011 compared $36.3 million at December 31, 2010. 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.

Equity

Total equity was $12.2 million at March 31, 2011 compared to $12.0 million at December 31, 2010. This represents 4.75% and 4.67% of total assets at March 31, 2011 and December 31, 2010, respectively. Increases in equity for the three months ended March 31, 2011 included net earnings $110,000 and $85,000 in accrued dividend payments on the Preferred stock. The annual 5% dividend on the Preferred Stock 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 par 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. At March 31, 2011 the dividend payable to the Treasury Department totaled $471,000. The suspension of dividend payments is permissible under the terms of the TARP Capital Purchase Program, but the dividend is a cumulative dividend and failure to pay dividends for six dividend periods would trigger board of director appointment rights for the holder of the Series A Preferred Stock, (see further discussion under “Capital Resources”).

RESULTS OF OPERATIONS

Net Interest Income

Net interest income before any provision for loan losses decreased $255,000 for the quarter ended March 31, 2011 compared to the same period in 2010.

The net interest margin for the first quarter of 2011 decreased 11 basis points to 2.97% compared to 3.08% for the same period in 2010. The decline in the margin is largely due to a shift in the composition of earning assets. The Balance Sheet reflects elevated levels of liquidity in anticipation of repayment of scheduled maturities of whole sale funding including Federal Home Loan Bank advances and brokered deposits. The Bank anticipates the deployment of excess liquidity investment and lending opportunities. 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 5.85% for the quarter compared to 6.00% for the same period in 2010.

The Bank’s ability to maintain its net interest margin is heavily dependent on reduction of non-performing loans, 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.

	Three Months Ended March 31,							Three Months Ended March 31,
	2011							2010
	Average		Interest					Average		Interest
	Outstanding		Earned/		Yield/			Outstanding		Earned/		Yield/
	Balance		Paid		Rate			Balance		Paid		Rate
	(dollars in thousands)
Fed Funds and overnight deposits	$	38,120		1		0.01	%	$	17,771		1		0.02	%
Investment securities		11,023		97		3.57			16,692		128		3.11
Other securities		3,802		21		2.24			4,174		23		2.23
Loans receivable		186,362	$	2,689		5.85			225,328	$	3,336		6.00
Total earning assets	$	239,307	$	2,808		4.76		$	263,965	$	3,488		5.36
Demand and NOW Accounts	$	42,407	$	9		0.09		$	37,688	$	30		0.32
Money market accounts		40,139		49		0.50			59,616		157		1.07
Savings accounts		21,081		6		0.12			20,817		16		0.31
Certificates of deposit		101,519		619		2.47			96,641		761		3.19
Federal Home Loan Bank Advances		32,716		349		4.33			44,518		493		4.49
Fed Funds Purchased		—		—		0.00			11		—		0.00
Total interest bearing liabilities	$	237,862		1,032		1.76		$	259,291		1,457		2.28
Net interest income			$	1,776						$	2,031
Net interest spread						3.00	%						3.08	%
Net interest margin						2.97	%						3.08	%

Provision for Loan Losses

The provision for loan losses was $260,000 in the first quarter of 2011 compared to $1.8 million for the first quarter of 2010. The reduced level of provision is reflective of management’s efforts in previous periods to identify potential problem loans and establish adequate reserves and/or charge-offs to address those problems. The Company continues to monitor real estate dependent loans and focus on asset quality. Non-performing loans totaled $12.7 million at the end of the first quarter of 2011, a decrease of $1.4 million from December 31, 2010. Net charge offs for the quarter ended March 31, 2011 were $599,000 compared to $1.4 million for the same period in 2010.

Nonperforming assets including the amount of real estate in judgment and foreclosed and repossessed properties, decreased from $17.0 million at the end of 2010 to $16.4 million as of March 31, 2011. This increase was largely due to a decrease nonperforming loans, specifically in commercial real estate loans.

The following table presents non-performing assets and certain asset quality ratios at March 31, 2011 and December 31, 2010.

	March 31, 2011			December 31, 2010
Non-performing loans	$	12,684		$	14,075
Real estate in judgement		2,183			1,430
Foreclosed and repossessed assets		1,554			1,542
Total non-performing assets	$	16,421		$	17,047
Non-performing loans to total loans		7.25	%		7.70	%
Non-performing assets to total assets		6.42	%		6.64	%
Allowance for loan losses to non-performing loans		51.30	%		48.70	%
Allowance for loan losses to net loans receivable		3.71	%		3.75	%

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Non-interest Income Non-interest income for the quarter ended March 31, 2011 decreased $26,000, or 2.43%, from $1.1 million to $1.04 compared to the same period a year ago. This decrease is attributable to a decrease in gain on sale of loans, other loan related fee income and in fees from overdraft protection offset by an increase in gain on sale of other repossessed property.

Net gain on sale of loans decreased $41,000 for the quarter ended March 31, 2011 from $199,000 to $158,000 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. Fees and Service charges decreased $99,000 for the three months ended March 31, 2011 compared to the same period a year ago primarily due to a decrease in fees from overdraft protection program which decreased $46,000, to $249,000 as of March 31, 2011 from $295,000 for the same period a year ago. Management expects income from this program to be less than 2010 due to the regulatory changes that became effective August 15, 2010 with the amendment to Regulation E and the need for customers to “opt in” to the Overdraft Program. Other income increased $160,000 due to an increase in the gain of other repossessed property of $162,000.

Non-interest Expense Noninterest expense decreased $130,000 for the quarter ended March 31, 2011 compared to the same period a year ago. Salaries and employee benefits decreased $35,000. The decline in personnel expense was primarily attributable to a decline in general staffing. Foreclosed property expense decreased $118,000. Professional services increased $7,000 primarily due to increases in audit fees as the Bank began utilizing an external CPA firm for internal audit. All other expenses increased $16,000.

Federal Income Tax Expense An income tax benefit was not recognized for the first three months of 2011. A $51,500 tax benefit for the three months of 2011, primarily associated with the $198,000 net earnings before income taxes, was offset by a corresponding decrease 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.

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 March 31, 2011, 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 March 31, 2010 totaled $52.3 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 local core deposits, certificates of deposit gathered via the internet, Federal Home Loan Bank advances and securities available for sale. At March 31, 2011 and based on current collateral levels, the Bank could borrow an additional $11.2 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 increased by $8.4 million during the three months ended March 31, 2011 and March 31, 2010. The primary sources of cash for the three months ended March 31, 2011 were $6.3 million in proceeds from the sale of mortgage loans, $824,000 maturities of available-for-sale investment securities and $6.9 million of principal loan collections in excess of loan originations and an increase in deposits of $4.7 million compared to $5.0 million increase in deposits, $6.4 million in proceeds from the sale of mortgage loans, $2.9 million in the sale and maturities of available-for-sale investment securities. The primary uses of cash for the three months ended March 31, 2011 were $5.9 million of mortgage loans originated for sale, and $6.0 million in repayments of FHLB advances, compared to $6.1 million of mortgage loans originated for sale and $3.7 million in purchases of available-for-sale investment securities.

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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.

CONTRACTUAL OBLIGATIONS AND OFF BALANCE SHEET ARRANGEMENTS

The Corporation has certain obligations and commitments to make future payments under contracts. At March 31, 2011, 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	$	99,904	$	52,090	$	36,233	$	11,581	$	—
FHLB advances		30,350		13,175		17,175		—		—
Total	$	130,254	$	65,265	$	53,408	$	11,581	$	—

	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	$	1,239	$	1,239	$	—	$	—	$	—
Unfunded commitments under HELOCs		12,206		2,301		2,551		2,016		5,338
Unfunded commitments under Contruction loans		791		742		11		9		29
Unfunded commitments under
Commercial LOCs		741		660		81		—		—
Letters of credit		—		—		—		—		—
Total	$	14,977	$	4,942	$	2,643	$	2,025	$	5,367

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 March 31, 2011 were as follows: Tier 1 leverage ratio 4.67%, Tier 1 risk-based capital ratio 7.18%; and total risk-based capital 8.46%.

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 March 31, 2011, 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. For additional information, please refer to Note 2 to the company’s financial statements included in it’s Form 10K for the year ended December 31, 2010 in connection with uncertainty about the company’s ability to continue as a going concern.

RECENT DEVELOPMENTS

On September 21, 2010 the Company entered into a Written Agreement with the Federal Reserve Bank of Chicago (the “FRB”). Among other things, the Written Agreement requires that the Company obtain the approval of the FRB prior to paying a dividend; prohibits the Company from purchasing or redeeming any shares of its stock without the prior written approval of the FRB, and; requires the Company to submit cash flow projections for the Company to the FRB on a quarterly basis. A Form 8-K was issued on May 12, 2010 with the complete details of the Written Agreement.

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

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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 4. 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 March 31, 2011 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 March 31, 2011, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The Corporation intends to continually review and evaluates 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.

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

This item is not required from smaller reporting companies.

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: May 16, 2011	By:	/s/ Richard J. DeVries
		Richard J. DeVries
		President and Chief Executive Officer
Date: May 16, 2011	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
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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