Monarch Community Bancorp (MCBF) 10-K 2005 FY Annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)
þ	ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005

Commission file number0-49814

MONARCH COMMUNITY BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland	04-3627031
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
375 North Willowbrook Road, Coldwater, Michigan	49036
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (517) 278-4566
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yeso Noþ.

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 of Section 15(d) of the Exchange Act. Yeso Noþ.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YESþ NOo

Indicate by check mark if disclosure of delinquent filers in response to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.o

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

Large Accelerated Filero           Accelerated Filero           Non-Accelerated Filerþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso Noþ.

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant, based on the average bid price market price of such stock as of June 30, 2005, was approximately $31.3 million based on the asked price as reported on the NASDAQ Capital Market. (The exclusion from such amount of the market value of the shares owned by any person shall not be deemed an admission by the issuer that such person is an affiliate of the issuer.)

As of February 14, 2006, the registrant had 2,710,596 shares of common stock issued and 2,670,596 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCEPART III of Form 10-K – Portions of the Registrant’s Proxy Statement for the Annual Meeting of Stockholders to be held in April 2006.

TABLE OF CONTENTS

PART I
	ITEM 1. Business
	ITEM 1A. Risk Factors
	ITEM 1B. Unresolved Staff Comments — None
	ITEM 2. Properties
	ITEM 3. Legal Proceedings
	ITEM 4. Submission of Matters to a Vote of Security Holders
PART II
	ITEM 5. Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
	ITEM 6. Selected Financial Data
	ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 7A. Quantitative and Qualitative Disclosures About Market Risk
	ITEM 8. Financial Statements
	ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
	ITEM 9A. Controls and Procedures
	ITEM 9B. Other Information — Not Applicable
PART III
	ITEM 10. Directors and Officers of the Registrant
	ITEM 11. Executive Compensation
	ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
	ITEM 13. Certain Relationships and Related Transactions
	ITEM 14. Principal Accountant Fees and Services
PART IV
	ITEM 15. Exhibits and Financial Statement Schedules
SIGNATURES
Exhibit Index
Management Continuity Agreement
2003 Recognition and Retention Plan Restricted Stock Agreement
Registrant's Conflict of Interest and Ethics Policy
Subsidiaries of the Registrant
Consent of Plante & Moran, PLLC
Rule 13a-14(a) Certification of the Company's President and Chief Executive Officer
Rule 13a-14(a) Certification of the Company's Chief Financial Officer
Section 1350 Certification

PART I

ITEM 1. Business

General

Monarch Community Bancorp, Inc. (“Company”) was incorporated in March 2002 under Maryland law to hold all of the common stock of Monarch Community Bank (“Monarch” or 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 Company sold 2,314,375 shares of its common stock in a subscription offering.

On April 15, 2004, the Company completed its acquisition of MSB Financial, Inc., parent company of Marshall Savings Bank. Accordingly, MSB Financial was merged with and into Monarch Community Bancorp, Inc. On June 7, 2004, Marshall Savings Bank was merged with and into Monarch Community Bank. The Company issued a total of 310,951 shares of its common stock and paid cash of $19.7 million to former MSB Financial stockholders. The cash paid in the transaction came from the Company’s existing liquidity. The acquisition was accounted for using the purchase method of accounting, and accordingly, the purchase price was allocated to the assets purchased and the liabilities assumed based upon the estimated fair values at the date of acquisition. The purchase accounting fair value adjustments are being amortized under various methods and over lives of the corresponding assets and liabilities. Goodwill recorded for the acquisition amounted to $9.6 million and is not amortized but evaluated for impairment at least annually. A core deposit intangible of $2.1 million was recorded as part of the acquisition and is being amortized on an accelerated basis over a period of 9.5 years.

Monarch Community Bank provides a broad range of banking services to its primary market area of Branch, Calhoun and Hillsdale counties, Michigan. The Bank owns 100% of Community Services Group, Inc., which invests in other entities, including 100% ownership of First Insurance Agency, a minority ownership in a limited liability company that operates a title insurance agency, and ownership of a limited liability company that reinsures private mortgage insurance. 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 is a federally chartered and insured stock savings institution with six full service offices and one drive-through only office. The Bank’s deposits are insured to the maximum extent allowed by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is examined and regulated by the Office of Thrift Supervision (“OTS”), its primary federal regulator. The Bank has a website at http://www.monarchcb.com. References in this Form 10-K to “we”, “us”, and “our” refer to the Company and/or the Bank as the context requires. Our common stock trades on The NASDAQ Capital Market under the symbol “MCBF.”

Our principal business consists of attracting retail deposits from the general public and investing those funds primarily in permanent loans secured by first mortgages on owner-occupied, one-to-four family residences, loans secured by commercial and multi-family real estate, commercial business loans and construction loans secured primarily by residential real estate. We also originate a variety of consumer loans.

Our revenues are derived principally from interest on loans, investment securities and overnight deposits, as well as from sales of loans and fees and charges on deposit accounts.

We offer a variety of deposit accounts having a wide range of interest rates and terms, which generally include passbook and statement savings accounts, money market deposit accounts, NOW and non-interest bearing checking accounts and certificates of deposit with varied terms ranging from six months to 60 months. We solicit deposits in our market area and utilize brokered deposits.

At December 31, 2005, we had assets of $277.1 million, deposits of $172.7 million and stockholders’ equity of $40.6 million.

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Forward-Looking Statements

This document, including information incorporated by reference, future filings by Monarch Community Bancorp on Form 10-Q and Form 8-K and future oral and written statements by Monarch Community Bancorp and its management may contain forward-looking statements which are based on assumptions and describe future plans, strategies and expectations of Monarch Community Bancorp and Monarch. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar words. Our ability to predict results or the actual effect of future plans or strategies is uncertain and we disclaim any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information or otherwise. 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.

Employees

The Bank employs 91 full-time and 3 part-time employees as of December 31, 2005. The Company does not have any employees.

Market Area

Headquartered in Coldwater, Michigan, our geographic market area for loans and deposits is principally Branch, Calhoun and Hillsdale counties. As of June 30, 2005, we had a 18.5% market share of FDIC-insured deposits in Branch County, a 6.6% market share of FDIC-insured deposits in Calhoun County and a 2.3% market share of FDIC-insured deposits in Hillsdale County, ranking us third, seventh and sixth, respectively, in those counties among all insured depository institutions.

The local economy is based primarily on manufacturing and agriculture. Most of the job growth, particularly in Hillsdale County, has been in automobile products-related manufacturing. Median household income and per capita income for our primary market are below statewide averages, reflecting the rural economy and limited economic growth opportunities.

Lending Activities

General.At December 31, 2005, our net loan portfolio totaled $213.1 million, which constituted 76.9% of our total assets.

Our mortgage loans carry either a fixed or an adjustable rate of interest. Mortgage loans are generally long-term and amortize on a monthly basis with principal and interest due each month. Mortgage loans up to $300,000 may be approved by certain loan officers and loans up to $500,000 may be approved by the President, within individual lending limits set by the Board of Directors. Loans up to $1.5 million may be approved by the Management Loan Committee which is comprised of several senior managers. Loans over $1.5 million must be approved by the Board of Directors’ Loan Committee. Applications for loans that would be considered sub-prime cannot be approved by individual loan officers and must be presented to the Management Loan Committee for review and approval. At December 31, 2005, the maximum amount which we could have loaned to any one borrower and the borrower’s related entities was $4.4 million. At that date we had 10 loan relationships in excess of $1.0 million.

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Loan Portfolio Composition.The following table presents information concerning the composition of our loan portfolio (before deductions for loans in process, deferred fees and discounts and allowances for losses) as of the dates indicated.

	December 31,
	2005		2004		2003		2002		2001
	(Dollars in thousands)
Real Estate Loans:
One-to-four family	$	138,473	$	141,251	$	93,056	$	100,235	$	95,445
Multi-family		3,534		4,042		485		172		245
Commercial		33,162		42,746		22,728		17,801		14,898
Construction or development		5,415		8,853		9,451		7,177		6,785
Total real estate loans		180,584		196,892		125,720		125,385		117,373
Other loans:
Consumer loans:
Automobile		2,447		2,631		1,546		2,233		3,287
Home equity		16,170		14,234		9,613		11,629		14,084
Manufactured housing		576		784		930		1,274		1,557
Other		7,745		6,645		3,795		4,655		1,800
Total consumer loans		26,938		24,294		15,884		19,791		20,728
Commercial Business Loans		9,086		5,330		2,695		2,130		1,884
Total other loans		36,024		29,624		18,579		21,921		22,612
Total Loans		216,608		226,516		144,299		147,306		139,985
Less:
Allowance for loan losses		2,895		6,385		2,618		1,735		1,683
Net deferred loan fees		640		808		454		406		563
Loans in process		—		6		2		2		18
Total Loans, net	$	213,073	$	219,317	$	141,225	$	145,163	$	137,721

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The following table shows the composition of our loan portfolio by fixed and adjustable-rate at the dates indicated.

	December 31, 2005					December 31,2004
	Amount		Percent			Amount		Percent
	(Dollars in thousands)
Fixed-Rate Loans
Real Estate Loans:
One-to-four family	$	79,858		36.9	%	$	78,937		34.8	%
Multi-family		1,906		0.9	%		1,669		0.7	%
Commercial		11,946		5.5	%		13,284		5.9	%
Construction or development		3,579		1.7	%		5,886		2.6	%
Total real estate loans		97,289		45.0	%		99,776		44.0	%
Consumer		16,886		7.8	%		14,836		6.5	%
Commercial Business		4,357		2.0	%		2,104		0.9	%
Total fixed-rate loans		118,532		54.7	%		116,716		51.4	%
Adjustable-Rate Loans
Real Estate Loans:
One-to-four family	$	58,615		27.1	%	$	62,314		27.5	%
Multi-family		1,628		0.7	%		2,373		1.0	%
Commercial		21,216		9.8	%		29,462		13.0	%
Construction or development		1,836		0.8	%		2,967		1.3	%
Total real estate loans		83,295		38.4	%		97,116		42.8	%
Consumer		10,052		4.6	%		9,458		4.4	%
Commercial Business		4,729		2.2	%		3,226		1.4	%
Total adjustable-rate loans		98,076		45.3	%		109,800		48.6	%
Total loans		216,608		100.0	%		226,516		100.0	%
Less:
Allowance for loan losses		2,895					6,385
Net deferred loan fees		640					808
Loans in process		—					6
Total Loans, net	$	213,073				$	219,317

5

The following table illustrates the contractual maturity of our loan portfolio at December 31, 2005. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The table does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

						Real Estate
						Multi-family and					Construction or
	One-to-Four Family					Commercial					Development					Consumer					Commercial Business					Total
			Weighted					Weighted					Weighted					Weighted					Weighted					Weighted
			Average					Average					Average					Average					Average					Average
	Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate			Amount		Rate
	(Dollars in Thousands)
Due to Mature:
One year or less (1)		5,996		6.64	%		1,160		6.88	%		4,323		5.80	%		1,302		8.34	%		2,069		7.90	%		14,850		6.74	%
After one year through five years		19,143		6.75	%		9,323		7.32	%		55		7.00	%		9,864		8.11	%		4,329		7.48	%		42,714		7.26	%
After five years		113,334		6.60	%		26,213		7.01	%		1,037		6.04	%		15,772		7.25	%		2,688		8.10	%		159,044		6.75	%

⁽¹⁾ Includes demand loans.

The total amount of loans due after December 31, 2006 which have predetermined interest rates is $115.2 million while the total amount of loans due after such date which have floating or adjustable rates is $86.6 million.

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One-to-Four Family Residential Real Estate Lending.We have focused our lending efforts primarily on the origination of loans secured by first mortgages on owner-occupied, one-to-four family residences in our market area. At December 31, 2005, one-to-four family residential mortgage loans totaled $138.5 million, or 63.9% of our gross loan portfolio.

Since 1985, we have originated sub-prime residential mortgage loans. Our definition of sub-prime lending is substantially similar to regulatory guidelines. We review a borrower’s credit score, debt-to-income ratio and the loan-to-value ratio of the collateral in determining whether a loan is sub-prime. We utilize a loan risk grading system for all one-to-four family residential loans. The risk grading system provides that all loans with a credit score of less than 660 shall be considered for potential sub-prime classification. For a loan with a credit score between 600 and 660, loan-to-value ratio, debt-to-income ratio and the borrower’s history with the Bank will determine whether or not the loan is classified as sub-prime.

At December 31, 2005, $16.8 million, or 12.1% of our residential mortgage loans were classified as sub-prime loans as compared to $20.7 million, or 14.7% at December 31, 2004. The decrease was primarily due to management’s efforts to reduce these types of loans in our portfolio. We charge higher interest rates on our sub-prime residential mortgage loans to attempt to compensate for the increased risk in these loans. Sub-prime lending entails a higher risk of delinquency, foreclosure and ultimate loss than residential loans made to more creditworthy borrowers. Delinquencies, foreclosure and losses generally increase during economic slowdowns or recessions as experienced in recent history. During 2005, $276,000, or 8.9%, of our total net charge-offs of $3.1 million were due to sub-prime loans as compared to $104,000, or 6.4% for 2004. See “Asset Quality.”

We generally underwrite our one-to-four family loans based on the applicant’s employment and credit history and the appraised value of the subject property. Presently, we lend up to 103% of the lesser of the appraised value or purchase price for one-to-four family residential loans. For loans with a loan-to-value ratio in excess of 85%, we generally require private mortgage insurance to reduce our credit exposure below 80%. Properties secured by one-to-four family loans are appraised by licensed appraisers. We obtain title insurance and require our borrowers to obtain hazard insurance and flood insurance, if necessary, in an amount not less than the value of the property improvements.

We currently originate one-to-four family mortgage loans on either a fixed rate or adjustable rate basis, as consumer demand dictates. Our pricing strategy for mortgage loans includes setting interest rates that are competitive with secondary market requirements and other local financial institutions, and consistent with our asset/liability strategies. Our pricing for sub-prime loans is higher, as we attempt to offset the increased risks and costs involved in dealing with a greater percentage of delinquencies and foreclosures.

Adjustable-rate mortgages, or ARM loans, are offered with either a one-year, three-year, five-year or seven-year term to the initial repricing date. After the initial period, the interest rate for each ARM loan adjusts annually for the remaining term of the loan. During the years ended December 31, 2005 and December 31, 2004, we originated $15.1 million and $19.6 million of one-to-four family ARM loans, respectively, and $51.5 million and $61.4 million of one-to-four family fixed-rate mortgage loans, respectively.

Fixed-rate loans secured by one-to-four family residences have contractual maturities of up to 30 years, and are generally fully amortizing, with payments due monthly. These loans normally remain outstanding, however, for a substantially shorter period of time because of refinancing and other prepayments. A significant change in the current level of interest rates could alter the average life of a residential loan in our portfolio considerably. Our one-to-four family loans are generally not assumable, do not contain prepayment penalties and do not permit negative amortization of principal. Most are written using secondary market underwriting guidelines, although we retain in our portfolio those loans which do not qualify for sale in the secondary market. Our real estate loans generally contain a “due on sale” clause allowing us to declare the unpaid principal balance due and payable upon the sale of the security property.

Our one-to-four family residential ARM loans are fully amortizing loans with contractual maturities of up to 30 years, with payments due monthly. Our ARM loans generally provide for a maximum 2% annual adjustment and 6% lifetime adjustment to the initial rate. As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as is our cost of funds.

In order to remain competitive in our market area, we may originate ARM loans at initial rates below the fully indexed rate.

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ARM loans generally pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower’s payment rises, increasing the potential for default. In past periods of rising interest rates, we have not experienced difficulty with the payment history for these loans. See “- Asset Quality — Non-performing Assets and Classified Assets.”

Multi-family and Commercial Real Estate Lending. We offer a variety of multi-family and commercial real estate loans. These loans are secured primarily by residential development projects, residential rental properties, commercial properties, retail establishments, churches and small office buildings located in our market area. At December 31, 2005, multi-family and commercial real estate loans totaled $36.7 million or 16.9% of our gross loan portfolio.

Our loans secured by multi-family and commercial real estate are originated with either a fixed or adjustable interest rate. The interest rate on adjustable-rate loans is based on the Wall Street Journal prime rate plus or minus a margin, generally determined through negotiation with the borrower. Loan-to-value ratios on our multi-family and commercial real estate loans typically do not exceed 80% of the appraised value of the property securing the loan. These loans typically require monthly payments, may not be fully amortizing and have maximum maturities of 25 years.

Loans secured by multi-family and commercial real estate are underwritten based on the income producing potential of the property and the financial strength of the borrower. We generally require personal guarantees of the principals of the borrower in addition to the security property as collateral for these loans. When legally permitted, we require an assignment of rents or leases in order to be assured that the cash flow from the project will be used to repay the debt. Appraisals on properties securing multi-family and commercial real estate loans are generally performed by independent state licensed fee appraisers approved by the Board of Directors. See “- Loan Originations, Purchases, Sales and Repayments.”

We do not generally maintain an insurance escrow account for loans secured by multi-family and commercial real estate, although we may maintain a tax escrow account for these loans. In order to monitor the adequacy of cash flows on income-producing properties, the borrower is requested or required to provide periodic financial information.

Loans secured by multi-family and commercial real estate properties are generally larger and involve a greater degree of credit risk than one-to-four family residential mortgage loans. These loans typically involve large balances to single borrowers or groups of related borrowers. Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation or management of the properties, repayment may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired. See “- Asset Quality — Non-performing Loans.”

Construction and Development Lending. We make construction loans to builders and to individuals for the construction of their residences as well as to businesses and individuals for commercial real estate construction projects. At December 31, 2005, we had $5.4 million in construction and development loans outstanding, representing 2.5% of our gross loan portfolio.

Construction and development loans are obtained through continued business with builders who have previously borrowed from us, from walk-in customers and through referrals from realtors and other customers. The application process includes submission of plans, specifications and costs of the project to be constructed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of current appraised value and/or the cost of construction, including the land and the building. We generally conduct regular inspections of the construction project being financed.

Loans secured by building lots are generally granted with terms of up to 18 months and are available with either fixed or adjustable interest rates and on individually negotiated terms. During the construction phase, the borrower generally pays interest only on a monthly basis. Loan-to-value ratios on our construction and development loans typically do not exceed 80% of the appraised value of the project on an as completed basis, although the Board of Directors has made limited exceptions to this policy where special circumstances exist.

8

Because of the uncertainties inherent in estimating construction and development costs and the market for the project upon completion, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project. These loans also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans. In addition, a few construction loans have been structured to allow payment of interest from loan proceeds which can make it difficult to monitor the progress of a project.

Consumer and Other Lending. Consumer loans generally have shorter terms to maturity, which reduces our exposure to changes in interest rates, and carry higher rates of interest than do one-to-four family residential mortgage loans. In addition, management believes that offering consumer loan products helps to expand and create stronger ties to our existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities. At December 31, 2005, our consumer loan portfolio totaled $26.9 million, or 12.4% of our gross loan portfolio. We offer a variety of secured consumer loans, including home equity loans and lines of credit, auto loans, boat and recreational vehicle loans, manufactured housing loans and loans secured by savings deposits. We also offer a limited amount of unsecured loans including home improvement loans. We originate our consumer loans in our market area.

Our home equity lines of credit totaled $16.2 million, and comprised 7.5% of our gross loan portfolio at December 31, 2005. These loans may be originated in amounts, together with the amount of the existing first mortgage, of up to 100% of the value of the property securing the loan. The term to maturity on our home equity lines of credit may be up to 15 years and have fixed and adjustable interest rates. No principal payments are required on home equity lines of credit during the loan term. Other consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower.

We originate auto loans, boat and recreational vehicle loans and manufactured housing loans on a direct basis and boat and recreational vehicle loans on an indirect basis. We generally buy indirect loans on a rate basis, paying the dealer a cash payment for loans with an interest rate in excess of the rate we require. This premium is expensed as the dealer is paid. Any prepayments within 180 days of the loan date are charged back to the dealer, with no dealer reserve or other guarantee of payment if the dealer stops doing business with us.

We underwrite indirect loans using the Fair-Isaacs credit scoring system, a widely used credit evaluation system. We generally do not approve indirect loans which would be considered “subprime” in accordance with our loan grading system. We had $6.2 million of indirect consumer loans at December 31, 2005 which reflects $2 million in annual growth and intend to continue indirect consumer lending.

Auto loans totaled $2.4 million at December 31, 2005, or 1.1% of our gross loan portfolio. Auto loans may be written for up to six years and have fixed rates of interest. Loan to value ratios can be up to 100% of the sales price for new autos and 100% of wholesale value on used cars, based on valuation from official used car guides.

Manufactured housing loans totaled $576,000 at December 31, 2005, or 0.3% of our gross loan portfolio. This amount remains low because manufactured housing loans are offered only on an exception basis with approval by the Management Loan Committee.

We originate direct sub-prime consumer loans, using the same definition as residential mortgage loans. At December 31, 2005, $974,000, or 3.6%, of our consumer loan portfolio were sub-prime loans.

Consumer loans may entail greater risk than do one-to-four family residential mortgage loans, particularly in the case of consumer loans which are secured by rapidly depreciable assets, such as automobiles, boats, manufactured housing and recreational vehicles. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. As a result, consumer loan collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.

Commercial Business Lending. At December 31, 2005, commercial business loans comprised $9.1 million, or 4.2% of our gross loan portfolio. Most of our commercial business loans have been extended to finance local businesses and include short term loans to finance machinery and equipment purchases, inventory and accounts receivable. Commercial business loans also involve the extension of revolving credit for a combination of equipment acquisitions and working capital needs.

9

The terms of loans extended on the security of machinery and equipment are based on the projected useful life of the machinery and equipment, generally not to exceed seven years. Lines of credit generally are available to borrowers for up to 12 months, and may be renewed by Monarch. We issue a few standby letters of credit which are offered at competitive rates and terms and are generally issued on a secured basis. At December 31, 2005, there was $64,000 of standby letters of credit outstanding.

Our commercial business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis. Based on this underwriting information we assign a risk rating which assists management in evaluating the quality of the loan portfolio. We generally obtain personal guarantees on our commercial business loans. Nonetheless, these loans are believed to carry higher credit risk than more traditional single family loans.

Unlike residential mortgage loans, commercial business loans are typically made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself (which, in turn, is often dependent in part upon general economic conditions). Our commercial business loans are usually, but not always, secured by business assets. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.

Loan Originations, Purchases, Sales and Repayments. We originate loans through referrals from real estate brokers and builders and other customers, our marketing efforts, and our existing and walk-in customers. We also originate consumer loans through relationships with dealerships. While we originate adjustable-rate and fixed-rate loans, our ability to originate loans is dependent upon customer demand for loans in our market area. Demand is affected by local competition and the interest rate environment.

During the last several years up to 2005, due to low market interest rates, our dollar volume of fixed-rate, one-to-four family loans has substantially exceeded the dollar volume of the same type of adjustable-rate loans. This trend began to reverse in 2004 but did not show a significant change in 2005. Adjustable-rate loan originations as a percentage of total originations were 14.0% and 14.7% in 2005 and 2004 respectively. We sell a portion of the conforming, fixed-rate, one-to-four family residential loans we originate, primarily those with lower interest rates. We keep the sub-prime residential real estate loans we originate. We may purchase residential loans and commercial real estate loans from time to time.

In periods of economic uncertainty, the ability of financial institutions, including us, to originate or purchase large dollar volumes of real estate loans may be substantially reduced or restricted, with a resultant decrease in income.

10

The following table shows the loan origination, sale and repayment activities of Monarch for the periods indicated.

	Years Ended
	December 31,
	2005			2004
	(Dollars in thousands)
Originations by type:
Real Estate:
One-to-four family	$	66,638		$	80,961
Multi-family		719			845
Commercial		6,884			16,854
Construction or development		10,716			14,917
Total real estate loans		84,957			113,577
Consumer Loans:
Automobile		1,454			1,469
Home Equity		11,576			10,348
Mobile Homes		19			23
Other		4,194			4,580
Commercial business		5,822			3,666
Total loans originated		108,022			133,663
Sales and Repayments:
One-to-four family loans sold		26,635			29,808
Commercial real estate loans sold		4,793			—
Principal repayments		86,393			95,431
Total reductions		117,821			125,239
Loans acquired in acquisition		—			73,793
Increase (decrease) in other items, net		(3,555	)		4,125
Net increase (decrease)	$	(6,244	)	$	78,092

11

Asset Quality

When a borrower fails to make a payment on a mortgage loan on or before the due date, a late notice is mailed 10 to 15 days after the due date. All delinquent accounts are reviewed by a collector, who attempts to cure the delinquency by contacting the borrower once the loan is 30 days past due. Additionally, each week the collections department gives each loan officer a list of his or her loans that are 30 days past due. The loan officer attempts to contact the borrower to determine the reason for the delinquency and to urge the borrower to bring the loan current. Once the loan becomes 45 days delinquent, a letter is sent to the borrower requesting the borrower to bring the loan current, or, if that is not possible, to fill out and return a financial information update form. If the form is returned, the senior collector determines if the borrower exhibits an ability to repay, and, if so, brings the file to the Management Loan Committee for a decision whether to forbear collection action to allow the borrower to demonstrate the ability to make timely payments and/or establish an acceptable repayment plan to bring the loan current. If the borrower makes timely payments for a period of at least six months but does not appear to have the ability to bring the loan current, the file is given to a loan officer to obtain a new loan application from the borrower for the purpose of rewriting the loan in accordance with established loan policy. If the financial information update is not returned, or if the senior collector determines that the borrower no longer has the ability to repay the loan, or the Management Loan Committee declines to forbear collection activity, then when the loan becomes 60 days delinquent, the file is reviewed by the Management Loan Committee and the foreclosure process is begun by the sending of a notice of intent to foreclose. If during a period of forbearance the borrower fails to make timely payments, the Management Loan Committee reviews the loan and the foreclosure process commences unless extenuating circumstances exist. The notice of intent to foreclose allows the borrower up to 30 days to bring the account current. All loans over 60 days delinquent are handled by the senior collections officer until the delinquency is resolved or foreclosure occurs.

For consumer loans a similar collection process is followed. Follow-up contacts are generally on an accelerated basis compared to the mortgage loan procedure due to the nature of the collateral. Commercial loan collections are handled by our Management Loan Committee in conjunction with our Collection Department and the appropriate loan officer. The nature of these loans dictates that collection procedures are adjusted to suit each situation.

12

Delinquent Loans.The following tables set forth our loan delinquencies by type, number, amount and percentage of type at the dates indicated:

								December 31, 2005
								Loans Delinquent For:
	60-89 Days							90 Days and Over							Total Delinquent Loans
					Percent of							Percent of							Percent of
					Loan							Loan							Loan
	Number		Amount		Category			Number		Amount		Category			Number		Amount		Category
	(Dollars in Thousands)
Real Estate
One-to-four family		30	$	1,478		1.07	%		5	$	280		0.20	%		35	$	1,758		1.27	%
Multi-family		—		—		0.00	%		—		—		0.00	%		—		—		0.00	%
Commercial		2		119		0.36	%		—		—		0.00	%		2		119		0.36	%
Construction or development		—		—		0.00	%		—		—		0.00	%		—		—		0.00	%
Total real estate loans		32	$	1,597		0.88	%		5	$	280		0.16	%		37	$	1,877		1.04	%
Consumer		7		78		0.29	%		1		8		0.03	%		8		86		0.32	%
Commercial Business		3		453		4.99	%		—		—		0.00	%		3		453		4.99	%
Total		42	$	2,128		0.98	%		6	$	288		0.13	%		48	$	2,416		1.11	%

								December 31, 2004
								Loans Delinquent For:
	60-89 Days							90 Days and Over							Total Delinquent Loans
					Percent of							Percent of							Percent of
					Loan							Loan							Loan
	Number		Amount		Category			Number		Amount		Category			Number		Amount		Category
	(Dollars in Thousands)
Real Estate
One-to-four family		37	$	2,020		1.43	%		39	$	1,866		1.32	%		76	$	3,886		2.75	%
Multi-family		—		—		0.00	%		—		—		0.00	%		—		—		0.00	%
Commercial		1		14		0.03	%		6		1,563		3.66	%		7		1,577		3.69	%
Construction or development		1		189		2.13	%		1		220		2.49	%		2		409		4.62	%
Total real estate loans		39	$	2,223		1.13	%		46	$	3,649		1.85	%		85	$	5,872		2.98	%
Consumer		13		162		0.67	%		6		93		0.38	%		19		255		1.05	%
Commercial Business		2		137		2.57	%		3		344		6.45	%		5		481		9.02	%
Total		54	$	2,522		1.11	%		55	$	4,086		1.81	%		109	$	6,608		2.92	%

13

Non-Performing Assets.The table below sets forth the amounts and categories of the Bank’s non-performing assets. Loans are placed on non-accrual status when the loan is seriously delinquent and there is serious doubt that the Bank will collect all interest owing. Generally, all loans past due at least 90 days are placed on non-accrual status. For all years presented, the Bank had no troubled debt restructurings that involved forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates. Foreclosed assets include assets acquired in settlement of loans.

	December 31,
	2005			2004			2003			2002			2001
	(Dollars in Thousands)
Non-accruing loans:
One-to-four family	$	406		$	1,866		$	908		$	1,372		$	—
Multi-family		—			—			318			—			—
Commercial real estate		397			1,708			1,558			211			—
Construction or development		—			220			645			—			—
Consumer		8			93			101			55			—
Commercial business		—			344			89			—			—
Total		811			4,231			3,619			1,638			—
Accruing loans delinquent 90 days or more:
One-to-four family		—			—			—			864			2,251
Multi-family		—			—			—			—			—
Commercial real estate		—			—			—			342			161
Construction or development		—			—			—			—			257
Consumer		—			—			127			111			306
Commercial business		—			—			—			—			—
Total		—			—			127			1,317			2,975
Foreclosed assets:
One-to-four family (1)		2,239			1,560			2,177			2,022			2,437
Multi-family		—			—			—			—			—
Commercial real estate		480			400			—			—			—
Construction or development		—			—			—			—			—
Consumer		22			9			47			37			136
Commercial business		70			—			—			—			—
Total		2,811			1,969			2,224			2,059			2,573
Total non-performing assets	$	3,622		$	6,200		$	5,970		$	5,014		$	5,548
Total as a percentage of total assets		1.31	%		2.23	%		2.94	%		2.53	%		3.29	%

(1) Includes $1.3 million, $726,000 and $1.1 million in real estate in judgment and subject to redemption at December 31, 2005, 2004 and 2003, respectively.

For the years ended December 31, 2005, 2004 and 2003, respectively, there was $200,000, $211,000 and $166,000 of gross interest income which would have been recorded had non-accruing loans been current in accordance with their original terms.

14

Other Loans of Concern.In addition to the non-performing assets set forth in the table above, as of December 31, 2005, there were also the following loan relationships totaling an aggregate of $2.2 million with respect to which known information about the possible credit problems of the borrowers has caused management to have doubts as to the ability of the borrowers to comply with present loan repayment terms and which may result in the future inclusion of these loans in the non-performing asset categories. These loans have been considered in management’s determination of the adequacy of our allowance for loan losses and are included in the commercial category in the table.

The largest loan relationship totals $1.2 million at December 31, 2005 for the development of residential building lots in southwest Michigan. At December 31, 2005, this relationship was 19 days past due.

The second loan relationship is a loan on a commercial building, three rental properties and an owner occupied structure totaling $511,000 at December 31, 2005. This loan was over 30 days past due at December 31, 2005.

The third loan relationship totals $269,000 and is secured by a two apartment buildings and equipment. The two loans in this relationship were both over 60 days past due at December 31, 2005 and were subsequently foreclosed by the Bank in January 2006.

The fourth loan relationship is a commercial loan totaling $209,000. These loans are secured by commercial real estate, and were current as of December 31, 2005.

Classified Assets.Federal regulations provide for the classification of loans, foreclosed and repossessed assets and other assets, such as debt and equity securities considered by the OTS to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.

When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management and approved by the board of directors. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the OTS and the FDIC, which may order the establishment of additional general or specific loss allowances.

In connection with the filing of our periodic reports with the OTS and in accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management’s review of our assets, at December 31, 2005, we had classified $5.4 million of our assets as substandard, $415,000 as doubtful and none as loss. The total amount classified represented 14.3% of the Bank’s equity capital and 2.1% of the Bank’s assets at December 31, 2005. The allowance for loan losses at December 31, 2005 includes $714,000 related to substandard and doubtful loans. At December 31, 2005, $3.1 million and $410,000 of substandard and doubtful assets, respectively, have been included in the table of non-performing assets. See “- Asset Quality — Delinquent Loans.”

Provision for Loan Losses. We recorded a recovery of loan losses totaling $385,000 for the year ended December 31, 2005 compared to a $4.9 million provision for the year ended December 31, 2004. The provision for (recovery of) loan losses is charged (credited) to income to establish the allowance for loan losses to cover all known and inherent losses in the loan portfolio that are both probable and reasonable to estimate based on the factors discussed below under “— Allowance for Loan Losses.” See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Comparison of Operating Results for the Years Ended December 31, 2005 and 2004 - Provision for Loan Losses” for a discussion of the reasons for the change in our loan loss provision.

15

Allowance for Loan Losses. The allowance is based on regular, quarterly assessments of the estimated losses inherent in the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance and specific allowances for identified problem loans and portfolio segments. In addition, the allowance incorporates the results of measuring impaired loans as provided in SFAS No. 114, “Accounting by Creditors for Impairment of a Loan” and SFAS No. 118, “Accounting by Creditors for Impairment of a Loan — Income Recognition and Disclosures.” These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans.

The formula allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of these loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based both on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date.

The appropriateness of the allowance 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 such conditions were believed to have had on the collectibility of the loan. Senior management reviews these conditions 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 collectibility 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.

Assessing the adequacy of the allowance for loan losses is inherently subjective as it requires making material estimates, including the net realizable value of collateral expected to be received on impaired loans that may be susceptible to significant change. In the opinion of management, the allowance, when taken as a whole, covers all known and inherent losses in the loan portfolio that are both probable and reasonable to estimate.

16

The following table summarizes activity in the allowance for loan losses for the years ending (000s omitted):

	December 31,
	2005			2004			2003			2002			2001
Balance at beginning of year	$	6,385		$	2,618		$	1,735		$	1,683		$	857
Charge-offs:
One-to-four family		754			375			436			415			116
Multi-family		—			—			—			—			—
Commercial real estate		1,904			1,306			—			1			—
Construction or development		6			—			15			—			—
Consumer		204			118			122			152			206
Commercial business		386			—			—			—			—
Total		3,254			1,799			573			568			322
Recoveries:
One-to-four family		78			105			157			135			72
Multi-family		—			—			—			—			—
Commercial real estate		1			28			—			—			—
Construction or development		—			—			—			—			—
Consumer		46			45			32			88			37
Commercial business		24			—			—			—			—
Total		149			178			189			223			109
Net charge-offs		3,105			1,621			384			345			213
Allowance acquired in acquisition		—			513			—			—			—
Additions charged to operations		—			4,875			1,267			397			1,039
Provision recovered from operations		(385	)		—			—			—			—
Balance at end of year	$	2,895		$	6,385		$	2,618		$	1,735		$	1,683
Ratio of net charge-offs during the year to average loans outstanding during the year		1.42	%		0.82	%		0.26	%		0.24	%		0.15	%
Allowance as a percentage of non-performing loans		356.97	%		150.91	%		69.89	%		58.71	%		56.57	%
Allowance as a percentage of total loans (end of year)		1.34	%		2.82	%		1.81	%		1.18	%		1.22	%

17

The distribution of our allowance for losses on loans at the dates indicated is summarized as follows:

	December 31,
	2005					2004					2003
	Amount of		Percentage			Amount of		Percentage			Amount of		Percentage
	Loan Loss		of			Loan Loss		of			Loan Loss		of
	Allowance		Loans			Allowance		Loans			Allowance		Loans
One-to-four family	$	1,378		63.9	%	$	1,516		62.4	%	$	624		64.5	%
Multi-family and non-residential real estate		1,091		17.0	%		4,513		20.6	%		1,239		16.1	%
Construction or development		17		2.5	%		27		3.9	%		507		6.5	%
Consumer		254		12.4	%		261		10.7	%		173		11.0	%
Commercial business		155		4.2	%		68		2.4	%		75		1.9	%
Total	$	2,895		100.0	%	$	6,385		100.0	%	$	2,618		100.0	%

	2002					2001
	Amount of		Percentage			Amount of		Percentage
	Loan Loss		of			Loan Loss		of
	Allowance		Loans			Allowance		Loans
One-to-four family	$	805		68.0	%	$	821		68.2	%
Multi-family and non-residential real estate		686		12.2	%		10		10.8	%
Construction or development		33		4.9	%		27		4.8	%
Consumer		201		13.4	%		302		14.8	%
Commercial business		10		1.5	%		523		1.4	%
	$	1,735		100.0	%	$	1,683		100.0	%

Investment Activities

Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations and securities of various federal agencies, including callable securities, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.

The President/CEO has the basic responsibility for the management of our investment portfolio, under the guidance of the asset and liability management committee. The President/CEO considers various factors when making decisions, including the marketability, maturity and tax consequences of the proposed investment. The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.

The general objectives of our investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Asset and Liability Management and Market Risk.”

18

Our investment portfolio consists of U.S. government agency securities, municipal bonds and overnight deposits. This provides us with flexibility and liquidity. We also have a limited amount of mortgage-backed securities. See Notes 3 and 4 of the Notes to Consolidated Financial Statements.

In 2001, we invested in a limited partnership that was organized to construct, own and operate low and moderate income multi-family housing units located in Coldwater, Michigan. We have invested $1.5 million in this project and it was completed and occupied as of December 31, 2004. We expect the project to incur operating losses primarily due to the accelerated depreciation of assets. Accordingly, the return on this investment will be in the form of tax credits and deductions, which we began receiving in 2002. We are accounting for our investment in this project under the equity method. We will record our share of losses as reductions to our investment in the project. The tax credits will eventually reduce the recorded amount of the investment to zero. See Note 4 of the Notes to Consolidated Financial Statements for additional information regarding our limited partnership investment.

The following table sets forth the composition of our securities portfolio at the dates indicated.

	December 31, 2005							December 31, 2004
					Percent of							Percent of
			Fair		Total					Fair		Total
	Amortized		Market		Fair Market			Amortized		Market		Fair Market
	Cost		Value		Value			Cost		Value		Value
	(Dollars in Thousands)
Available-for-sale securities:
U.S. Treasury obligations	$	—	$	—		0.0	%	$	—	$	—		0.0	%
U.S. government agency obligations		11,961		11,773		80.8	%		3,984		3,989		47.9	%
Mortgage-backed securities		1,317		1,278		8.8	%		1,677		1,675		20.1	%
Obligations of states and political subdivisions		1,293		1,286		8.8	%		2,394		2,393		28.7	%
Total available-for-sale securities	$	14,571	$	14,337		98.4	%	$	8,055	$	8,057		96.8	%
Held-to-maturity securities:
Municipal security	$	247	$	236		1.6	%	$	267	$	268		3.2	%
Total investment securities	$	14,818	$	14,573		100.0	%	$	8,322	$	8,325		100.0	%

	December 31, 2003
					Percent of
			Fair		Total
	Amortized		Market		Fair Market
	Cost		Value		Value
Available-for-sale securities:
U.S. Treasury obligations	$	5,177	$	5,230		26.2	%
U.S. government agency obligations		9,616		9,653		48.4	%
Mortgage-backed securities		1,046		1,034		5.2	%
Obligations of states and political subdivisions		3,697		3,731		18.7	%
Total available-for-sale securities	$	19,536	$	19,648		98.5	%
Held-to-maturity securities:
Municipal security	$	286	$	302		1.5	%
Total investment securities	$	19,822	$	19,950		100.0	%

19

The maturities of the investment securities portfolio, excluding FHLB stock, as of December 31, 2005 are indicated in the following table.

	Less than 1 year					1 to 5 years					5 to 10 years					Over 10 years					Total Securities
			Wgt					Wgt					Wgt					Wgt					Wgt
	Amortized		Ave			Amortized		Ave			Amortized		Ave			Amortized		Ave			Amortized		Ave
	Cost		Yield			Cost		Yield			Cost		Yield			Cost		Yield			Cost		Yield
	(Dollars in Thousands)
Available-for-sale securities:
U.S. government agency obligations	$	3,990		3.87	%	$	7,972		3.81	%	$	—		0.00	%	$	—		0.00	%	$	11,962		3.83	%
Mortgage-backed securities		—		0.00	%		505		3.67	%		811		4.39	%		—		0.00	%		1,316		4.11	%
Obligations of states and political subdivisions		770		3.05	%		523		4.14	%		—		0.00	%		—		0.00	%		1,293		3.49	%
Total available-for-sale securities		4,760		3.74	%		9,000		3.82	%		811		4.39	%		—		0.00	%		14,571		3.83	%
Held-to-maturity securities:
Municipal security		—		0.00	%		—		0.00	%		—		0.00	%		247		6.55	%		247		6.55	%
Total investment securities	$	4,760		3.74	%	$	9,000		3.82	%	$	811		4.39	%	$	247		6.55	%	$	14,818		3.87	%

Sources of Funds

General.Our sources of funds are deposits, borrowings, receipt of principal and interest on loans, interest earned on or maturation of investment securities and overnight funds and funds provided from operations.

Deposits.We offer a variety of deposit accounts to both consumers and businesses having a wide range of interest rates and terms. Our deposits consist of passbook and statement savings accounts, money market deposit accounts, NOW and demand accounts and certificates of deposit. We solicit deposits in our market area and have accepted and continue to utilize brokered deposits. At December 31, 2005, we had $28.6 million of brokered deposits. In our experience brokered deposits are an attractive and stable source of funds and are necessary to supplement our local market deposit gathering. However, brokered deposits may be less stable than local deposits if deposit brokers or investors lose confidence in us or find more attractive rates at other financial institutions. We primarily rely on competitive pricing policies, marketing and customer service to attract and retain these deposits.

The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition. The variety of deposit accounts we offer has allowed us to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. We have become more susceptible to short-term fluctuations in deposit flows, as customers have become more interest rate conscious. We try to manage the pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives, subject to competitive factors. Based on our experience, we believe that our deposits are relatively stable sources of funds. Despite this stability, our ability to attract and maintain these deposits and the rates paid on them has been and will continue to be significantly affected by market conditions.

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The following table sets forth our deposit flows during the periods indicated.

	Year Ended
	December 31,
	2005			2004
	(Dollars in Thousands)
Opening balance	$	167,733		$	107,240
Deposits acquired		—			70,216
Net deposits (withdrawals)		1,502			(12,683	)
Interest credited		3,511			2,960
Ending balance	$	172,746		$	167,733
Net increase	$	5,013		$	60,493
Percent increase		2.99	%		56.41	%

The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by Monarch at the dates indicated.

	Year Ended December 31,
	2005					2004
			Percent					Percent
	Amount		of Total			Amount		of Total
	(Dollars in Thousands)
Transaction and Savings Deposits:
Non-interest bearing accounts	$	7,426		4.3	%	$	5,198		3.1	%
Savings accounts		26,536		15.4	%		29,177		17.4	%
Checking & NOW accounts		26,083		15.1	%		27,843		16.6	%
Money market accounts		15,767		9.1	%		19,114		11.4	%
Total transaction and savings	$	75,812		43.9	%	$	81,332		48.5	%
Certificates:
0.00-1.99%		332		0.2	%		18,658		11.1	%
2.00-3.99%		44,413		25.7	%		49,714		29.6	%
4.00-5.99%		51,895		30.0	%		15,836		9.4	%
6.00-7.99%		294		0.2	%		2,193		1.3	%
Total certificates		96,934		56.1	%		86,401		51.5	%
Total deposits	$	172,746		100.0	%	$	167,733		100.0	%

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The following table indicates the amount of our certificates of deposit by time remaining until maturity as of December 31, 2005.

	Maturity
			Over		Over		Over
	3 Months		3 to 6		6 to 12		12
	or less		Months		Months		Months		Total
	(Dollars in Thousands)
Certificates of deposit less than $100,000	$	14,297	$	11,775	$	13,439	$	21,474	$	60,985
Certificates of deposit of $100,000 or more		3,365		7,735		9,440		15,409		35,949
Total certificates of deposit	$	17,662	$	19,510	$	22,879	$	36,883	$	96,934

The following table shows rate and maturity information for our certificates of deposit as of December 31, 2005.

															Percent
	0.00-1.99%			2.00-3.99%			4.00-5.99%			6.00-7.99%			Total		of Total
	(Dollars in Thousands)
Certificate accounts maturing in quarter ending:
March 31, 2006	$	177		$	15,277		$	1,914		$	294		$	17,662		18.2	%
June 30, 2006		99			12,655			6,753			—			19,507		20.1	%
September 30, 2006		43			4,469			7,559			—			12,071		12.5	%
December 31, 2006		—			859			9,949			—			10,808		11.1	%
March 31, 2007		13			2,716			4,348			—			7,077		7.3	%
June 30, 2007		—			963			3,000			—			3,963		4.1	%
September 30, 2007		—			551			4,083			—			4,634		4.8	%
December 31, 2007		—			506			2,732			—			3,238		3.3	%
March 31, 2008		—			2,469			97			—			2,566		2.6	%
June 30, 2008		—			1,402			274			—			1,676		1.7	%
September 30, 2008		—			531			3,376			—			3,907		4.0	%
December 31, 2008		—			433			3,040			—			3,473		3.6	%
Thereafter		—			1,582			4,770			—			6,352		6.6	%
Total	$	332		$	44,413		$	51,895		$	294		$	96,934		100.0	%
Percent of total		0.34	%		45.82	%		53.54	%		0.30	%

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Borrowings.Although deposits are our primary source of funds, we utilize borrowings when they are a less costly source of funds, when we desire additional capacity to fund loan demand or when they meet our asset/liability management goals. Our borrowings historically have consisted of advances from the Federal Home Loan Bank of Indianapolis.

We may obtain advances from the Federal Home Loan Bank of Indianapolis upon the security of certain of our mortgage loans and mortgage-backed securities. These advances may be made pursuant to several different credit programs, each of which has its own interest rate, range of maturities and call features. At December 31, 2005, we had $59.6 million in Federal Home Loan Bank advances outstanding. See Note 10 of the Notes to Consolidated Financial Statements for information on maturity dates and interest rates related to our Federal Home Loan Bank advances.

The following table sets forth the maximum month-end balance and average balance of Federal Home Loan Bank advances for the periods indicated.

	December 31,
	2005		2004
	(Dollars in Thousands)
Maximum Balance:
FHLB advances	$	65,787	$	66,253
Average Balance:
FHLB advances	$	61,842	$	62,643

The following table sets forth certain information concerning our borrowings at the dates indicated.

	December 31,
	2005			2004
	(Dollars in Thousands)
FHLB advances	$	59,562		$	65,955
Weighted average interest rate of FHLB
FHLB advances		5.36	%		5.34	%

Subsidiary and Other Activities

As a federally chartered savings bank, we are permitted by OTS regulations to invest up to 2% of our assets, or $5.5 million at December 31, 2005, in the stock of, or unsecured loans to, service corporation subsidiaries. We may invest an additional 1% of our assets in service corporations where such additional funds are used for inner-city or community development purposes.

At December 31, 2005, the Bank had one active subsidiary, Community Services Group, Inc., and our total investment in this subsidiary was $992,000 which consisted principally of deposits in Monarch. Community Services Group, Inc. invests in other entities, including 100% ownership of First Insurance Agency, a minority ownership in a limited liability company that operates a title insurance company, and a limited liability company that re-insures private mortgage insurance services provided to the Bank’s customers.

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Competition

We face strong competition in originating real estate and other loans and in attracting deposits. Competition in originating real estate loans comes primarily from mortgage brokers, other savings institutions, commercial banks, credit unions, including non-local Internet based and telephone-based competition. Other savings institutions, commercial banks, credit unions and finance companies, including non-local Internet based entities, also provide vigorous competition in consumer lending.

Employees

At December 31, 2005, we had a total of 94 employees, including three part-time employees. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be good.

Federal and State Taxation

Federal Taxation

General.The Company is subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to Monarch Community Bancorp. Our federal income tax returns for the past three years are open to audit by the IRS. In our opinion, any examination of still open returns would not result in a deficiency which could have a material adverse effect on our financial condition. No returns are being audited by the IRS at this time.

Method of Accounting.For federal income tax purposes, the Company reports its income and expenses on the accrual method of accounting and uses a fiscal year ending on December 31, for filing its federal income tax return.

Bad Debt Reserves.The Bank is on the experience method to determine its bad debt deduction for tax purposes. The Bank has made a conformity election and charges off bad debts for tax purposes in accordance with regulatory guidelines.

Taxable Distributions and Recapture.Prior to the Small Business Job Protection Act, bad debt reserves created prior to the year ended December 31, 1997, were subject to recapture into taxable income should the Bank fail to meet certain thrift asset and definitional tests. New federal legislation eliminated these thrift related recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should the Bank make certain non-dividend distributions or cease to maintain a thrift/bank charter.

Minimum Tax.The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, called alternative minimum taxable income. The alternative minimum tax is payable to the extent such alternative minimum taxable income is in excess of an exemption amount. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. The Bank has not been subject to the alternative minimum tax, nor do we have any such amounts available as credits for carryover.

Corporate Dividends-Received Deduction.Monarch Community Bancorp may eliminate from its income dividends received from the Bank if it elects to file a consolidated return with the Bank. The corporate dividends-received deduction is 100% or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock ownership of the payor of the dividend. Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf.

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State Taxation

The State of Michigan imposes a Single Business Tax (“SBT”), which is an annual value-added tax imposed on the privilege of doing business in the state. Every person with business activity in Michigan is subject to the tax. Most organizations exempt from federal income tax are also exempt from the SBT. The major components of the SBT base are compensation, depreciation and federal taxable income, increased by net operating losses, if any, utilized in arriving at federal taxable income. An investment tax credit is claimed for the acquisition of qualifying tangible assets physically located in Michigan. The SBT rate for 2005 was 1.9%. The rate is subject to change annually and is expected to decrease through 2021. The tax returns of the Bank for the past four years are open to audit by the Michigan taxation authorities. No returns are being audited by the Michigan taxation authority at the current time. Other applicable state taxes include generally applicable sales, use and real property taxes.

Regulation and Supervision

General.Monarch Community Bank is a federally chartered savings bank, the deposits of which are federally insured. Accordingly, the Bank is subject to broad federal regulation, primarily by the OTS, and oversight extending to all its operations. The Bank is a member of the Federal Home Loan Bank of Indianapolis and is subject to certain limited regulation by the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). As the holding company of the Bank, Monarch Community Bancorp is also subject to federal regulation by the OTS and oversight which is designed to protect subsidiary savings associations, like the Bank. The deposits of the Bank are insured by the FDIC. As a result, the FDIC has certain regulatory and examination authority over the Bank. Certain of these regulatory requirements and restrictions are discussed below or elsewhere in this document.

Federal Regulation of Savings Banks.The OTS has extensive authority over the operations of savings banks. As part of this authority, the Bank is required to file periodic reports with the OTS and is subject to periodic examinations by the OTS and the FDIC. When these examinations are conducted by the OTS and the FDIC, the examiners may require the Bank to provide for higher general or specific loan loss reserves. All savings associations are subject to a semi-annual assessment, based upon the association’s total assets, to fund the operations of the OTS. The Bank’s Office of Thrift Supervision assessment for the fiscal year ended December 31, 2005 was $114,628.

The OTS also has extensive enforcement authority over all federal savings banks and their holding companies, including the Bank and Monarch Community Bancorp. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders and to initiate injunctive actions. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OTS. Except under certain circumstances, public disclosure of final enforcement actions by the OTS is required.

Based on an examination completed in 2004 by the OTS, the Bank was fined $4,550 for violations of the Federal Flood Disaster Protection Act. This Act requires banks to require borrowers on real estate loans to obtain flood insurance where the property is located in a designated flood zone in participating communities. The Bank failed to do so in 13 instances and thus incurred the fine.

The investment, lending and branching authority of the Bank is prescribed by federal laws and it is prohibited from engaging in any activities not permitted by these laws. For instance, no savings bank may invest in non-investment grade corporate debt securities. In addition, the permissible level of investment by federal savings banks in loans secured by non-residential real property may not exceed 400% of total capital, except with approval of the OTS. Federal savings banks are also generally authorized to branch nationwide.

The Bank’s general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At December 31, 2005, the Bank’s lending limit under this restriction was $4.4 million. The Bank is in compliance with the loans-to-one-borrower limitation.

The OTS, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on matters like loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution which fails to comply with these standards must submit a compliance plan.

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Insurance of Accounts and Regulation by the FDIC.The Bank is currently a member of the Savings Association Insurance Fund (“SAIF”), which is administered by the FDIC. However, under the recently adopted Federal Deposit Insurance Reform Act of 2005 (“FDIRA”), the SAIF will be merged with the Bank Insurance Fund (“BIF”) during 2006. Deposits are insured up to applicable limits by the FDIC.

As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the SAIF or the BIF. The FDIC also has the authority to initiate enforcement actions against savings banks, after giving the OTS an opportunity to take action, and may terminate the deposit insurance if it determines that the bank has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

Currently, the FDIC’s deposit insurance premiums are assessed through a risk-based system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums based upon their level of capital and supervisory evaluation. Pursuant to the FDIRA, a new system for assessing insurance premiums based on risk will be adopted. The current assessment rates range from zero to 0.27% per $100 of assessable deposits. Assessments for subsequent periods will depend on the timetable for implementation of the FDIRA and the regulations adopted by the FDIC to implement the FDIRA. In addition to a new system for assessing insurance premiums based on risk, a number of other provisions of the FDIRA and the implementing regulations will impact future assessments. The FDIC will have flexibility to determine the level of reserves it will hold. Currently, the FDIC must hold reserves equal to 1.25% of insured deposits, but under the FDIRA, the FDIC will be able to set the reserve ratio annually between 1.15% and 1.50%. In addition, the FDIC will be required to pay dividends awarded on an historical basis to insured depository institutions whenever the reserve ratio exceeds 1.35%, although dividends may be suspended or limited if the FDIC determines there is significant risk to the deposit insurance fund. Insured depository institutions also will receive a one-time credit which can be applied against the payment of future premiums.

Until FDIRA is fully implemented, it is not possible for the Bank to determine how these changes will impact the amount of deposit premiums it will pay in the future.

FDIC-insured institutions also are subject to assessments to repay obligations issued by a federally chartered corporation to provide financing for resolving the thrift crisis in the 1980’s. Currently, the rate established by the FDIC for this purpose is 1.34 basis points per dollar of SAIF deposits and BIF deposits.

Regulatory Capital Requirements.Federally insured savings banks, such as the Bank, are required to maintain a minimum level of regulatory capital. The OTS has established capital standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement and a risk-based capital requirement applicable to such savings banks. These capital requirements must be generally as stringent as the comparable capital requirements for national banks. The OTS is also authorized to impose capital requirements in excess of these standards on individual banks on a case-by-case basis.

The OTS capital regulations require tangible capital of at least 1.5% of adjusted total assets (as defined by regulation). Tangible capital generally includes common stockholders’ equity and retained income, and certain noncumulative perpetual preferred stock and related income. In addition, all intangible assets, other than a limited amount of purchased mortgage servicing rights, must be deducted from tangible capital for calculating compliance with the requirement. At December 31, 2005, the Bank has intangible assets of $11.0 million.

At December 31, 2005, the Bank had tangible capital of $26.0 million, or 9.90% of adjusted total assets, which is approximately $22.0 million above the minimum requirement of 1.5% of adjusted total assets in effect on that date.

As a result of the prompt corrective action provisions discussed below, a savings bank must maintain a core capital ratio of at least 4% to be considered adequately capitalized unless its supervisory condition allows it to maintain a 3% ratio. Core capital generally consists of tangible capital plus certain intangible assets, including a limited amount of purchased credit card receivables. At December 31, 2005, the Bank had no intangible assets which were included in core capital.

At December 31, 2005, the Bank had core capital equal to $26.0 million, or 9.90% of adjusted total assets, which is $15.5 million above the requirement of 4% as in effect on that date.

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The OTS risk-based requirement requires savings banks to have total capital of at least 8% of risk-weighted assets. Total capital consists of core capital, as defined above and supplementary capital. Supplementary capital consists of certain permanent and maturing capital instruments that do not qualify as core capital and loan and lease loss allowances up to a maximum of 1.25% of risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only to the extent of core capital. The OTS is also authorized to require a savings bank to maintain an additional amount of total capital to account for concentration of credit risk and the risk of non-traditional activities. At December 31, 2005, the Bank had $2.9 million of loan and lease loss allowances which exceeded 1.25% of risk-weighted assets by $0.6 million.

Certain exclusions from capital and assets are required to be made for the purpose of calculating total capital. Such exclusions consist of equity investments (as defined by regulation) and reciprocal holdings of qualifying capital instruments. The Bank had no exclusions from capital and assets at December 31, 2005.

In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently underwritten permanent one-to-four family first lien mortgage loans not more than 90 days delinquent and having a loan-to-value ratio of not more than 90% at origination unless insured to such ratio by an insurer approved by Fannie Mae or Freddie Mac.

On December 31, 2005, the Bank had total risk-based capital of $28.3 million (including $26.0 million in core capital and $2.3 million in qualifying supplementary capital) and risk-weighted assets of $181.8 million, or total capital of 15.5% of risk-weighted assets. This amount is $13.7 million above the 8% requirement in effect on that date.

Under the prompt corrective action regulations, the OTS and the FDIC are authorized, and under certain circumstances required, to take certain actions against savings banks that fail to meet their capital requirements. The OTS is generally required to take action to restrict the activities of an “undercapitalized” bank (generally defined to be one with less than a 4% core capital ratio, a 4% Tier 1 risked-based capital ratio or an 8% risk-based capital ratio). Any undercapitalized bank must submit a capital restoration plan and until the plan is approved by the OTS may not increase its assets, acquire another bank, establish a branch or engage in any new activities, and generally may not make capital distributions. The OTS is authorized to impose the additional restrictions that are applicable to significantly undercapitalized banks.

The OTS is also generally authorized to reclassify a bank into a lower capital category and impose the restrictions applicable to such category if the association is engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

The imposition by the OTS or the FDIC of any of these measures on Monarch Community Bank may have a substantial adverse effect on its operations and profitability.

Limitations on Dividends and Other Capital Distributions.OTS regulations impose various restrictions on savings banks with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers and other transactions charged to the capital account. OTS regulations generally permit a federal savings bank to pay dividends in any calendar year equal to the sum of net profits for the preceding three years less any dividends paid during that same period (See Note 14 of the Consolidated Financial Statements). Monarch Community Bank is in compliance with this requirement.

Liquidity.All savings banks, including Monarch Community Bank, are required to maintain a sufficient level of liquid assets to ensure their safe and sound operation. For a discussion of what Monarch Community Bank includes in liquid assets, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Annual Report.

Qualified Thrift Lender Test.All savings banks, including Monarch Community Bank, are required to meet a qualified thrift lender (“QTL”) test to avoid certain restrictions on their operations. This test requires a savings bank to have at least 65% of its portfolio assets in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings association may maintain 60% of its assets in those assets specified in Section 7701(a)(19) of the Internal Revenue Code of 1986, as amended. Under either test, such assets primarily consist of residential housing related loans and investments. At December 31, 2005, Monarch Community Bank met the test and has always met the test since its inception.

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Any savings bank that fails to meet the QTL test must convert to a national bank charter, unless it requalifies as a QTL and thereafter remains a QTL. If a savings bank does not requalify and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to transfer to the BIF. If the savings bank has not yet requalified or converted to a national bank, its new investments and activities are limited to those permissible for both a savings bank and a national bank. It is limited to national bank branching rights and it is subject to national bank limits for payment of dividends. If the savings bank has not requalified or converted to a national bank within three years after the failure, it must divest all investments and cease all activities not permissible for a national bank. If any savings bank that fails the QTL test is controlled by a holding company, then within one year after the failure, the holding company must register as a bank holding company and become subject to all restrictions on bank holding companies. See “- Holding Company Regulation.”

Community Reinvestment Act.Under the Community Reinvestment Act (“CRA”), every FDIC insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community. The CRA requires the OTS, in connection with the examination of Monarch Community Bank, to assess the institution’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by Monarch Community Bank. An unsatisfactory rating may be used as the basis for the denial of an application by the OTS.

Due to the heightened attention being given to the CRA in recent years, Monarch Community Bank may be required to devote additional funds for investment and lending in its local community. The Bank was examined for CRA compliance in 2002 and received a rating of “satisfactory.”

Transactions with Affiliates.Generally, transactions between a savings bank or its subsidiaries and its affiliates are required to be on terms as favorable to the bank as transactions with non-affiliates. In addition, certain of these transactions, such as loans to an affiliate, are restricted to a percentage of the bank’s capital and must be secured by eligible collateral. Affiliates of the Bank include Monarch Community Bancorp and any company which is under common control with the Bank. In addition, a savings bank may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of most affiliates. The OTS has the discretion to treat subsidiaries of savings banks as affiliates on a case by case basis.

Certain transactions with directors, officers or controlling persons are also subject to restrictions under statutes and regulations enforced by the OTS. These statutes and regulations also impose restrictions on loans to such persons and their related interests. Among other things, such loans must be made on terms substantially the same as for loans to unaffiliated individuals.

Holding Company Regulation.Pursuant to regulations of the OTS and the terms of Monarch Community Bancorp’s Maryland charter, the purpose and powers of Monarch Community Bancorp are to pursue any or all of the lawful objectives of a savings and loan holding company and to exercise any of the powers accorded to a savings and loan holding company.

If the Bank fails the qualified thrift lender test, Monarch Community Bancorp must obtain the approval of the OTS prior to continuing after such failure, directly or through other subsidiaries, any business activity other than those approved for multiple savings and loan holding companies or their subsidiaries. In addition, within one year of such failure, (unless the Bank requalifies under the test) Monarch Community Bancorp must register as, and will become subject to, the restrictions applicable to bank holding companies. The activities authorized for a bank holding company are more limited than are the activities authorized for a unitary or multiple savings and loan holding company. See “- Qualified Thrift Lender Test.”

Federal Securities Law.The common stock of Monarch Community Bancorp is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Monarch Community Bancorp is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Securities and Exchange Commission under the Exchange Act.

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Monarch Community Bancorp common stock held by persons who are affiliates (generally officers, directors and principal stockholders) of Monarch Community Bancorp may not be resold without registration unless sold in accordance with certain resale restrictions. If Monarch Community Bancorp meets specified current public information requirements, each affiliate of Monarch Community Bancorp is able to sell in the public market, without registration, a limited number of shares in any three-month period.

Federal Reserve System.The Federal Reserve Board requires all depository institutions to maintain noninterest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW and Super NOW checking accounts). At December 31, 2005, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements that may be imposed by the OTS. See “- Liquidity.”

Savings banks are authorized to borrow from the Federal Reserve Bank “discount window,” but Federal Reserve Board regulations require institutions to exhaust other reasonable alternative sources of funds, including Federal Home Loan Bank borrowings, before borrowing from the Federal Reserve Bank.

Federal Home Loan Bank System.Monarch Community Bank is a member of the Federal Home Loan Bank of Indianapolis, which is one of 12 regional Federal Home Loan Banks that administer the home financing credit function of savings banks. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes loans to members (i.e., advances) in accordance with policies and procedures, established by the board of directors of the Federal Home Loan Bank, which are subject to the oversight of the Federal Housing Finance Board. All advances from the Federal Home Loan Bank are required to be fully secured by sufficient collateral as determined by the Federal Home Loan Bank. In addition, all long-term advances are required to provide funds for residential home financing.

As a member, the Bank is required to purchase and maintain stock in the Federal Home Loan Bank of Indianapolis. At December 31, 2005, the Bank had $4.8 million in Federal Home Loan Bank stock, which was in compliance with this requirement.

Sarbanes-Oxley Act.On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the “SOA”). The stated goals of the SOA are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws.

The SOA is the most far-reaching U.S. securities legislation enacted in some time. The SOA generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the Securities and Exchange Commission under the Exchange Act. Given the extensive role of the Securities and Exchange Commission in implementing rules relating to many of the SOA’s new requirements, the final scope of many of these requirements remains to be determined.

The SOA includes very specific additional disclosure requirements and new corporate governance rules, requires the Securities and Exchange Commission and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the Securities and Exchange Commission and the Comptroller General. The SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.

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The SOA addresses, among other matters:

• audit committees;

• certification of financial statements by the chief executive officer and the chief financial officer;

• the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;

• a prohibition on insider trading during pension plan black out periods;

• disclosure of off-balance sheet transactions;

• expedited filing requirements for Form 4s;

• disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code;

• “real time” filing of periodic reports;

• the formation of a public accounting oversight board

• auditor independence

• various increased criminal penalties for violations of securities laws.

The SOA contains provisions which became effective upon enactment on July 30, 2002 and provisions which become effective for our Company no later than December 31, 2007. The Securities and Exchange Commission has been delegated the task of enacting rules to implement various of the provisions with respect to, among other matters, disclosure in periodic filings pursuant to the Exchange Act.

ITEM 1A. Risk Factors

You should consider these risk factors, in addition to the other information in this Form 10-K, before deciding whether to make an investment in our Company’s stock.

Our future profits may be affected by our inability to grow core deposits

We have had difficulty growing our core deposits. Competition in our market for core deposits is intense. Our net income is heavily dependent on net interest income. If we are unable to grow our core deposits, we will be required to obtain higher costing funds to facilitate asset growth. This could cause our future profits to be below peer.

We are making commercial real estate loans outside of our normal market area

In an attempt to grow our commercial real estate loan portfolio we have begun making these loans outside of our normal market area. We have done this because competition for Commercial Real Estate loans in our local markets is intense. Lending outside of our normal market area may cause increased loan losses in the future if we lend in an area that we are not familiar with and that local economy suffers a recession.

We are dependent on the strength of our local economy for our growth and profitability

The success of our business depends on our ability to generate profits and grow our franchise. Our three county market area has a population base of approximately 233,000, and an economy based primarily on manufacturing and agriculture. Our local economy has not grown, and is not projected to grow as rapidly as the national economy. Job losses and unemployment rates in all three counties exceed the state and national averages.

Our loan portfolio possesses increased risk due to our subprime residential lending

Up until a few years ago, a significant portion of our one-to-four family residential loan originations were considered subprime. At December 31, 2005, 12.2% of our residential mortgage loans were subprime loans. Our foreclosure rates on our residential loan portfolio are significantly higher than peer and we believe this is, to a significant extent, the result of our subprime residential lending and the economy in our market area. Future foreclosures will negatively impact profits because of higher loan loss provisions and expenses related to foreclosed properties.

30

If we lose our executive officers, it could adversely affect our operations

The successful operation of Monarch Community Bancorp and Monarch Community Bank is greatly dependent on the continued availability of capable executive officers. At present, the only executive officers of both Monarch Community Bancorp and Monarch Community Bank are Donald L. Denney, President and Chief Executive Officer, William C. Kurtz, Senior Vice President and Chief Operations Officer, Andrew Van Doren, Secretary and Corporate Counsel, Ralph Micalizzi, Chief Financial Officer and Treasurer, Eric Cook, Vice President and Vicki Bassage, Assistant Secretary. We have entered into a two-year employment agreement with Mr. Denney but not with the other executive officers. We do not have key man insurance on any of our executive officers.

The amount of common stock controlled by insiders, our articles of incorporation and bylaws and state and federal statutory and regulatory provisions could discourage hostile acquisitions of control

Purchases of common stock by directors and officers are for investment purposes and not necessarily for resale. Inside ownership of Monarch Community Bancorp (totaling 387,030 shares as of December 31, 2005) is significant and this inside ownership and provisions in our articles of incorporation and bylaws may have the effect of discouraging attempts to acquire Monarch Community Bancorp, a proxy contest for control of Monarch Community Bancorp, the assumption of control of Monarch Community Bancorp by a holder of a large block of common stock and the removal of Monarch Community Bancorp’s management, all of which certain shareholders might think are in their best interests. These provisions include among other things:

• the staggered terms of the members of the Board of Directors;

• an 80% shareholder vote requirement for the approval of any merger or consolidation of Monarch Community Bancorp into any entity that directly or indirectly owns 10% or more of Monarch Community Bancorp voting stock if the transaction is not approved in advance by at least a majority of the disinterested members of Monarch Community Bancorp’s Board of Directors;

• supermajority shareholder vote requirements for the approval of certain amendments to Monarch Community Bancorp’s articles of incorporation and bylaws;

• a prohibition of any holder of common stock voting more than 10% of the outstanding common stock;

• elimination of cumulative voting by shareholders in the election of directors;

• restrictions requiring Board members to live or work in Branch County’s market area;

• restrictions on the acquisition of our equity securities;

• the authorization of five million shares of preferred stock that could be issued without shareholder approval on terms or in circumstances that could deter a future takeover attempt; and

• the increase in the number of authorized shares and the reclassification of shares without stockholder approval.

In addition, the Maryland business corporation law, the state where Monarch Community Bancorp is incorporated, provides for certain restrictions on acquisition of Monarch Community Bancorp, and federal law contains restrictions on acquisitions of control of savings and loan holding companies such as Monarch Community Bancorp.

The low trading volume in our common stock may make the value of the stock volatile and may make it difficult for shareholders to sell their shares when they desire

Historically, there have been times when trading volume has been low. During those times the Company’s stock price has encountered some decline. Average daily trading volume for the years ending December 31, 2005 and 2004 were 1,658 and 2,859 shares respectively. The high and low levels of our stock price for each quarter of the last two fiscal years is disclosed in this document. A more detailed history of the Company’s stock price can be found under our stock symbol (MCBF).

ITEM 1B. Unresolved Staff Comments — None

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ITEM 2. Properties

At December 31, 2005, we had six full service offices and one drive-through only facility. At December 31, 2005, we owned all of our offices and the net book value of our investment in premises and equipment, excluding computer equipment, was $5.7 million. We believe that our current facilities are adequate to meet our present and immediately foreseeable needs.

The following table provides information regarding our office and other facilities:

		Owned/
Location	County	Leased
Main Office
375 North Willowbrook Road	Branch	Owned
Coldwater, Michigan 49036
Branch Offices
30 West Chicago Street	Branch	Owned
Coldwater, Michigan 49036
365 N. Broadway	Branch	Owned
Union City, Michigan 49094
1 West Carleton Road	Hillsdale	Owned
Hillsdale, Michigan 49242
15975 West Michigan Avenue	Calhoun	Owned
Marshall, Michigan 49068
107 North Park	Calhoun	Owned
Marshall, Michigan 49068
Other Facilities
34 Grand Street (Garage)	Branch	Owned
Coldwater, Michigan 49036
24 Grand Street (Drive through)	Branch	Owned
Coldwater, Michiagn 49036
87 Marshall Street (Leased to others)	Branch	Owned
Coldwater, Michigan 49036
119 Grand Street (Leased to others)	Calhoun	Owned
Marshall, Michigan 49068

We utilize a third party service provider to maintain our data base of depositor and borrower customer information.

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ITEM 3. Legal Proceedings

From time to time we are involved as plaintiff or defendant in various legal actions arising in the normal course of business. We do not anticipate incurring any material liability as a result of any current litigation.

ITEM 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of Monarch’s stockholders, through the solicitation of proxies or otherwise, during the fourth quarter of the 2005 fiscal year.

PART II

ITEM 5. Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The Company’s common stock commenced trading on August 29, 2002 on the NASDAQ Market under the symbol “MCBF.” The table below shows the high and low sales prices of the common stock for the periods indicated, as reported on the NASDAQ Capital Market. For the years ended December 31, 2005 and 2004, the Company paid dividends of $0.21 and $0.20 per share, respectively.

Year	Quarter ending	High		Low
2004	March 31	$	16.35	$	15.59
	June 30	$	15.95	$	13.00
	September 30	$	14.45	$	13.26
	December 31	$	14.23	$	12.60
2005	March 31	$	14.33	$	12.00
	June 30	$	14.33	$	11.00
	September 30	$	13.75	$	12.00
	December 31	$	12.59	$	10.50

As of February 14, 2006, there were 2,710,596 shares of the Company’s common stock issued and 2,670,596 shares outstanding and approximately 580 holders of record. The holders of record do include banks and brokers who act as nominees, each of whom may represent more than one stockholder.

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ITEM 6. Selected Financial Data

SELECTED FINANCIAL AND OTHER DATA

The summary information presented below under “Selected Financial Condition Data” and “Selected Operating Data” for, and as of the end of, each of the years ended December 31 is derived from our audited financial statements. The following information is only a summary and you should read it in conjunction with our consolidated financial statements, including notes thereto, included elsewhere in this document:

	December 31,
	2005		2004		2003		2002		2001
	(In Thousands)
Selected Financial Condition Data:
Total Assets	$	277,068	$	275,448	$	203,123	$	197,985	$	168,684
Loans receivable, net		213,073		219,317		141,225		145,162		137,721
Trading securities at fair value:
Mortgage-backed securities		—		—		—		—		258
Investment securities, at carrying value		14,584		8,324		19,934		17,434		0
Fed Funds sold and overnight deposits		6,988		6,120		20,974		16,063		12,035
Deposits		172,746		167,733		107,240		106,744		105,698
Federal Home Loan Bank Advances		59,562		65,955		57,384		52,500		45,500
Equity		40,576		39,419		37,430		36,949		15,365

	December 31,
	2005			2004			2003		2002		2001
	(In Thousands)
Selected Operations Data:
Total interest income	$	15,231		$	13,818		$	12,053	$	12,931	$	14,470
Total interest expense		6,567			6,173			6,060		6,466		8,117
Net interest income		8,664			7,645			5,993		6,465		6,353
Provision for loan losses		(385	)		4,875			1,266		397		1,039
Net interest income after provision for loan losses		9,049			2,770			4,727		6,068		5,314
Fees and service charges		2,496			2,333			1,167		1,154		1,227
Gains on sales of loans, mortgage-backed securities and investment securities		562			805			1,672		998		1,170
Other non-interest income		341			287			86		7		85
Total non-interest income		3,399			3,425			2,925		2,159		2,482
Total non-interest expense		10,503			9,978			6,737		6,798		6,738
Income before taxes		1,945			(3,783	)		915		1,429		1,058
Income tax provision		505			(1,272	)		251		415		299
Net income (loss)	$	1,440		$	(2,511	)	$	664	$	1,014	$	759

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	December 31,
	2005			2004			2003			2002			2001
Selected Financial Ratios and Other Data:
Performance Ratios:
Return on assets (ratio of net income to average total assets)		0.52	%		-0.97	%		0.32	%		0.54	%		0.44	%
Return on Equity (ratio of net income to average equity)		3.59	%		-6.53	%		1.80	%		4.08	%		5.05	%
Interest rate spread information:
Average during period		3.41	%		3.15	%		2.69	%		3.58	%		3.69	%
Net interest margin		3.56	%		3.33	%		3.11	%		3.85	%		3.89	%
Ratio of operating expense to average total assets		3.80	%		3.85	%		3.22	%		3.72	%		3.87	%
Ratio of average interest-earning assets to average interest-bearing liabilities		1.05			1.07			1.13			1.07			1.04
Efficiency ratio		85.39	%		88.18	%		74.14	%		75.10	%		74.10	%
Asset Quality Ratios:
Non-performing assets to total assets at end of period		1.31	%		2.23	%		2.94	%		2.53	%		3.29	%
Non-performing loans to total loans		0.37	%		1.87	%		2.60	%		2.04	%		2.16	%
Allowance for loan losses to non-performing loans		356.97	%		150.91	%		69.89	%		58.70	%		56.57	%
Allowance for loan losses to loans receivable, net		1.36	%		2.82	%		1.81	%		1.18	%		1.20	%
Capital ratios:
Equity to total assets at end of period		14.64	%		14.31	%		18.43	%		18.67	%		9.11	%
Other data:
Number of full-service offices		6			7			5			5			5

(1)	Net interest income divided by average-earning assets.
(2)	Total noninterest expenses, excluding real estate owned and repossessed property expense, as a percentage of net interest income and total noninterest income.

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ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

General

The following discussion is intended to assist in understanding the financial condition and results of operations of Monarch. The discussion and analysis does not include any comments relating to Monarch Community Bancorp since Monarch Community Bancorp has no significant operations. The information contained in this section should be read in conjunction with the consolidated financial statements.

Monarch’s results of operations depend primarily on its net interest income, which is the difference between interest income earned on loans, investments, and overnight deposits, and interest expense incurred on deposits and borrowings. Monarch’s results of operations also are significantly affected by the level of its gains from sales of mortgage loans.

Critical Accounting Policies

As described under “Regulation and Supervision,” the financial services industry is highly regulated. Other than described below, management does not believe the use of estimates and management judgment is 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.

Goodwill.The original value of Goodwill was determined by allocating the purchase price to the estimated fair values of assets acquired and liabilities assumed. Periodically, Goodwill is tested for impairment in accordance with SFAS No. 142. This test involves calculating the estimated fair value of the reporting unit. Thus, the carrying value of Goodwill is subject to a high degree of estimation and management judgment.

Management Strategy

Our strategy is to operate as an independent retail oriented financial institution dedicated to serving the needs of customers in our market area. We are committed to providing a broad range of products and services to meet the needs of our consumer and small business customers. As part of this commitment, we expect to continue our origination of higher credit quality residential and commercial real estate loans to borrowers in our market area and commercial real estate loans to borrowers outside our current market area.

Our focus in 2006 will be accelerated growth in commercial lending, maintaining a high level of customer service, growth of core deposits, continued improvement of credit quality, advancing our technology, and repositioning of our marketing and sales culture. We are dedicating resources to these initiatives that management believes will lead to a higher level of profitability and overall success. Management believes focusing on these areas in 2006 will serve the Company well into the future. We intend to continue to capitalize on the 2004 acquisition of MSB Financial, Inc. with further expansion of our lending activities in Calhoun County.

36

Changes in Financial Condition from December 31, 2004 to December 31, 2005

General.Monarch’s total assets increased by $1.6 million or 0.6% to $277.1 million at December 31, 2005 compared to $275.4 million at December 31, 2004. Increases in cash and securities in 2005 were offset by decreases in loans and premises and equipment.

Loans.Monarch’s net loan portfolio decreased by $6.2 million, or 2.8% from $219.3 million at December 31, 2004 to $213.1 million at December 31, 2005. Gross loans decreased $9.9 million or 4.4% from $226.5 million at December 31, 2004 to $216.6 million at December 31, 2005.

During the quarter ended June 30, 2005, the Bank sold $6.2 million of one-to-four family and commercial real estate loans and properties which had been foreclosed and had a recorded balance of $4.0 million. The Bank had a loss of $2.2 million on the sale but had previously established reserves for this group of assets so no additional loss provisions were necessary as a result of this transaction. The purpose of the loan sale was to reduce the amount of problem assets on the Bank’s books so management could continue to focus on returning the Bank to profitability.

In addition to the sale, the decreases in loan balances were due to repayments and payoffs on existing loans exceeding new loan production. These repayments include payoffs of certain problem loans that management encouraged. Total loan originations decreased from $133.7 million in 2004 to $108.0 million in 2005. One-to-four family originations have declined as new loan production has declined along with the mortgage market and as management has eliminated the origination of subprime loans. Commercial real estate loans have declined due to the loan sale, the payoff of some problem credits and the payoff of performing loans that were refinanced elsewhere. The commercial lending department and management spent a significant amount of time during 2005 working on improving the credit quality of the commercial loan portfolio and this has contributed to the lack of new commercial loan origination. Management expects future growth in the loan portfolio to come from increased originations of commercial real estate and business loans as well as expanded geographic outreach facilitated by the acquisition. The introduction of online mortgage origination is expected to expand the Bank’s mortgage lending activities within its current market area by offering convenience to borrowers and realtors and may lead to some originations in areas contiguous to the Bank’s current market.

Securities.The Bank’s security portfolio increased to $14.6 million at December 31, 2005 from $8.3 million at December 31, 2004, or 75.9%. Securities were 5.3% of total assets at December 31, 2005 as compared to 3.0% at December 31, 2004. During 2005, securities were purchased to offset the decline in the loan portfolio. Management purchases securities to maintain sufficient liquidity and to provide yield to offset declines in the loan portfolio.

Liabilities.Monarch’s deposits increased $5.0 million to $172.7 million at December 31, 2005 compared to $167.7 million at December 31, 2004. This increase was primarily in certificates of deposit (CDs) as the Bank increased its reliance on brokered CDs to maintain sufficient liquidity and to fund repayment of borrowings. Brokered CDs increased from $18.8 million at December 31, 2004 to $28.6 million at December 31, 2005. The Bank did experience a $2.2 million increase in non-interest bearing deposit accounts but did not experience deposit increases in other areas. The Bank continues to compete for core deposits and management understands the issues involved with maintaining control over its cost of funds.

Federal Home Loan Bank advances decreased $6.4 million to $59.6 million at December 31, 2005 from $66.0 million at December 31, 2004. The decrease was primarily due to repayment of outstanding advances and the replacement of these advances with brokered deposits. In an effort to manage our interest rate risk, Monarch has utilized longer term fixed rate Federal Home Loan Bank advances to extend the overall maturity of our liabilities as we try to increase our level of core deposits. While the interest rates paid on these advances is high relative to current market rates, the longer-term advances allow the Bank to better match the term of these advances against anticipated maturities of loans in an attempt to reduce future interest rate risk. We expect this strategy to help improve net interest margin as long as interest rates continue to rise.

Equity. Total equity amounted to $40.6 million at December 31, 2005 and $39.4 million at December 31, 2005, or 14.6% and 14.3%, respectively, of total assets at both dates. The increase in equity over the period was due primarily to 2005 net income of $1.4 million offset by the payment of $568,000 in dividends.

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Average Balances, Net Interest Income, Yields Earned and Rates Paid

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. All average balances are average daily balances.

	Year Ended December 31,
	2005							2004
	Average		Interest					Average		Interest
	Outstanding		Earned/		Yield/			Outstanding		Earned/		Yield/
	Balance		Paid		Rate			Balance		Paid		Rate
	(dollars in thousands)
Fed Funds and overnight deposits	$	6,834	$	269		3.94	%	$	9,349	$	123		1.32	%
Investment securities		13,494		500		3.71			17,643		442		2.51
Other securities		4,753		204		4.29			4,093		179		4.37
Loans receivable (1)		218,632		14,258		6.52			198,336		13,074		6.59
Total earning assets	$	243,713	$	15,231		6.25		$	229,421	$	13,818		6.02
Demand and NOW Accounts	$	33,811	$	78		0.23		$	28,880	$	94		0.33
Money market accounts		16,731		211		1.26			15,815		176		1.11
Savings accounts		28,535		119		0.42			24,215		117		0.48
Certificates of deposit		90,397		2,929		3.24			83,478		2,323		2.78
Federal Home Loan Bank Advances		61,842		3,230		5.22			62,643		3,463		5.53
Total interest bearing liabilities	$	231,316		6,567		2.84		$	215,031		6,173		2.87
Net interest income			$	8,664						$	7,645
Net interest spread						3.41	%						3.15	%
Net interest margin						3.56	%						3.33	%

	2003
	Average		Interest
	Outstanding		Earned/		Yield/
	Balance		Paid		Rate
Fed Funds and overnight deposits	$	23,745	$	253		1.07	%
Investment securities		18,063		457		2.53
Other securities		2,915		148		5.08
Loans receivable (1)		147,896		11,195		7.57
Total earning assets	$	192,619	$	12,053		6.26
Demand and NOW Accounts	$	14,082	$	79		0.56
Money market accounts		10,241		135		1.32
Savings accounts		15,996		137		0.86
Certificates of deposit		72,286		2,513		3.48
Federal Home Loan Bank Advances		57,111		3,196		5.60
Total interest bearing liabilities	$	169,716		6,060		3.57
Net interest income			$	5,993
Net interest spread						2.69	%
Net interest margin						3.11	%

(1) Calculated net of deferred loan fees, loan discounts and loans in process. Nonaccrual loans are included in the average outstanding balance.

38

Rate/Volume Analysis

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in volume, which are changes in volume multiplied by the old rate, and (2) changes in rate, which are changes in rate multiplied by the old volume. Changes attributable to both rate and volume are shown as mixed.

	Year Ended December 31,												Year Ended December 31,
	2005 vs. 2004												2004 vs. 2003
										Total												Total
	Increase (Decrease) Due to									Increase			Increase (Decrease) Due to									Increase
	Rate			Volume			Mix			(Decrease)			Rate			Volume			Mix			(Decrease)
	(in thousands)
Interest earning Assets
Fed funds and overnight deposits	$	245		$	(33	)	$	(36	)	$	146		$	59		$	(153	)	$	(36	)	$	(130	)
Investment securities		212			(104	)		(50	)		58			(4	)		(11	)		—			(15	)
Other securities		(3	)		29			(2	)		25			(21	)		60			(8	)		31
Loans receivable		(140	)		1,338			(14	)		1,184			(1,446	)		3,818			(493	)		1,879
Total interest-earning assets	$	314		$	1,230		$	(102	)	$	1,413		$	(1,412	)	$	3,714		$	(537	)	$	1,765
Interest-bearing liabilities
Demand and NOW Accounts	$	(27	)	$	16		$	(5	)	$	(16	)	$	(33	)	$	83		$	(35	)	$	15
Money market accounts		23			10			3			35			(21	)		73			(11	)		41
Savings accounts		(16	)		21			(3	)		2			(60	)		70			(30	)		(20	)
Certificates of deposit		382			193			32			606			(501	)		389			(78	)		(190	)
Federal Home Loan Bank Advances		(191	)		(44	)		2			(233	)		(39	)		310			(4	)		267
Total interest bearing liabilities	$	171		$	195		$	30		$	394		$	(654	)	$	925		$	(158	)	$	113
Net interest income										$	1,019											$	1,652

39

The following table presents the weighted average yields earned on loans, overnight deposits and other interest-earning assets, and the weighted average rates paid on interest-bearing deposits and borrowings and the resultant interest rate spreads at the dates indicated.

	December 31,
	2005			2004
Weighted average yield on:
Fed Funds and overnight deposits		3.75	%		1.85	%
Investment securities		3.87	%		3.53	%
Federal Home Loan Bank stock		4.75	%		4.25	%
Loans:
One-to-four family		6.62	%		6.51	%
Multi-family and nonresidential real estate		7.08	%		6.29	%
Construction or development		5.86	%		5.75	%
Total real estate loans		6.69	%		6.42	%
Other loans:
Consumer loans		7.62	%		7.17	%
Commercial business loans		7.76	%		6.66	%
Total Loans		6.85	%		6.51	%
Combined weighted average yield on interest earning assets		6.54	%		6.25	%
Weighted average rate paid on:
Demand and NOW accounts		0.27	%		0.25	%
Money market accounts		2.36	%		0.96	%
Savings deposits		0.41	%		0.51	%
Certificates of deposit		3.95	%		3.05	%
Federal Home Loan Bank advances		5.36	%		5.34	%
Combined weighted average rate paid on interest-bearing liabilities		3.32	%		2.82	%
Spread		3.22	%		3.43	%

Comparison of Results of Operations for the Years Ended December 31, 2005, 2004, and 2003

General. Monarch reported net income of $1.4 million for the year ended December 31, 2005 compared to a net loss of $2.5 million for the year ended December 31, 2004 and net income of $664,000 in 2003. The increase in earnings in 2005 was primarily due to higher net interest income and the recovery of previous provisions for loan losses resulting from improved commercial credit quality.

Net Interest Income.Net interest income before provision for loan losses increased 13.3% to $8.7 million for 2005 compared to $7.6 million in 2004. Interest income increased $1.4 million and interest expense increased $394,000. Our net interest margin increased from 3.33% in 2004 to 3.56% in 2005 due to yields on interest earning assets increasing more rapidly than costs of interest bearing liabilities.

Our net interest margin increased from 3.11% in 2003 to 3.33% in 2004 primarily from acquiring deposits that reduced the Bank’s cost of funds. Increases in interest income and interest expense are further explained in the Interest Income and Interest Expense sections that follow.

40

Interest Income.Interest income increased $1.4 million during the year ended December 31, 2005. The four key factors contributing to this growth were $11.2 million in commercial loan growth, a $1.2 million increase in home equity lines of credit, $1.0 million in home equity loan growth and an increase of $6.3 million in investment securities. The average yield on earning assets increased as a result of these factors as well as much higher yields on Fed funds, overnight deposits and investment securities.

Interest income increased $1.8 million in 2004 as a result of increased earning assets from the acquisition of MSB Financial, Inc. The average yield on earning assets declined due to the lower yielding loans acquired as well as increased origination of adjustable-rate loans.

Management believes the increased weighting of adjustable-rate loans in the loan portfolio will help increase interest income in the future as market interest rates rise.

Interest Expense.Total interest expense increased $394,000 in 2005. This was primarily due to a $627,000 increase in our cost of funds for deposits which was partially offset by a $233,000 decrease in our cost of funds resulting from repayments of $10.2 million of Federal Home Loan Bank advances. The overall yield on advances is expected to decline in subsequent years and these advances are projected to be replaced with deposits that have a lower cost of funds.

Total interest expense increased $113,000 in 2004. This was primarily due to a $154,000 decrease in our cost of funds which was offset by a $267,000 increase in interest on fixed-rate Federal Home Loan Bank advances assumed in the acquisition. Deposits acquired from MSB Financial, Inc. were significantly lower costing that our existing deposit balances.

Provision for Loan Losses.The Bank recorded a recovery of loan losses of $385,000 for the year ended December 31, 2005 compared to a $4.9 million provision for the year ended December 31, 2004.

The recovery of provisions was possible due to the Bank receiving payoffs in 2005 on two loan relationships totaling $1.5 million for which the Bank had previously provided loan loss allowances of $535,000.

The Bank’s net charge-offs were $3.1 million in 2005 compared to $1.6 million for 2004. The increased chargeoffs in 2005 (provided for in 2004) are primarily the result of losses incurred on the sale of loans completed during the second quarter of 2005 as well as the Bank continuing to aggressively deal with problem loans. During the past several years we have continued to be aggressive in foreclosing on delinquent one-to-four family loans in an attempt to improve the credit quality of our loan portfolio and the result has been higher than historical chargeoffs, as well as decreased delinquencies on this type of loans. The improvement of asset quality remains a priority of management and may affect the Bank’s ability to grow its portfolio in the future. See “Loans” discussion above.

The Bank’s net charge-offs were $1.6 million in 2004 compared to $383,000 for 2003. The increased provision for 2004 was due to the chargeoffs we have experienced, increases in our nonperforming loans, management identifying certain commercial loans as “watch” credits, and the resulting impact on the determination of the adequacy of the allowance for loan losses. During 2004, the Bank charged off $1.2 million of a $1.6 million loan relationship secured by a commercial building in southwest Michigan. The relationship included two loans which were made to fund the construction of a commercial building in southwest Michigan that was completed in 2003. Both loans were placed into nonaccrual status as of June 30, 2003. In June 2004, the Bank foreclosed on the property in an attempt to satisfy the debt. The foreclosure was subject to redemption rights by the borrower that expired in June 2005. The borrower has contested the expiration of redemption rights and the Bank not taken possession of the property. This property is recorded in Real Estate Owned as of December 31, 2005.

Also, late in 2004, management became aware of financial stress being experienced by two related borrowers whose indebtedness to the Bank totals $5.2 million. Due to the deteriorating financial strength of the borrowers, management deemed it prudent and necessary to establish loss allowances totaling $2.3 million resulting from these two relationships. Also, management has determined that within the loan portfolio acquired from MSB Financial, Inc. there is an indication that future losses may exceed those experienced by Marshall Savings Bank prior to the acquisition. During 2003 and 2004, we have experienced higher than historical chargeoffs on one-to-four family and consumer loans. While a larger portion of our chargeoffs has been related to subprime loans, in 2004, we began to realize the benefits of controls implemented with regard to subprime loans.

41

Noninterest Income.Noninterest income was $3.4 million for the years ended December 31, 2005 and 2004, respectively. Fees and service charges on deposit accounts increased $101,000 due to higher fee levels from our overdraft protection program. Loan servicing fees increased $62,000 as a result of a larger loan servicing portfolio. Other remaining noninterest income increased $114,000 due to larger net gains on the sale of foreclosed properties ($54,000 in 2005 compared to $16,000 in 2004), higher rental income ($49,000 in 2005 compared to $20,000 in 2004), and no gains or losses on investment securities for 2005 compared to $60,000 in losses on the sale of investments in 2004. The increased fees helped offset a decrease in gains from sale of loans which decreased to $562,000 compared to $865,000 for the year ended December 31, 2004 as mortgage banking activities continued to decline. Management will be placing greater emphasis on originating loans held for sale in 2006 in an effort to improve these results.

Noninterest income was $3.4 million and $2.9 million for the years ended December 31, 2004 and 2003, respectively. The increase was primarily the result of increased fees and service charges on deposit accounts. Fees and service charges on deposit accounts have increased significantly due to the number of savings and checking accounts acquired. Also, during 2004, the Bank began an overdraft protection program which has been successful in increasing fees earned. The increased fees helped offset a decline in gains from sale of loans which decreased to $865,000 from $1.7 million for the year ended December 31, 2003 as mortgage banking activities declined significantly in 2004 compared to the same period in 2003. Losses on sales of investment securities were $60,000 for 2004 whereas the Company had no significant securities activity in the past. These losses were the result of a strategy to increase the yield on the investment portfolio by selling securities that carried below market coupon rates and reinvesting in securities at market rates. Other income increased $201,000 in 2004, primarily due to income from our investment services activity of $72,000. We started offering investment services during 2004 as MSB Financial had previously offered the service. Earnings on Company-owned life insurance also helped increase 2004 Other Income by $57,000. The life insurance policies which produced the income were acquired as part of the acquisition of MSB Financial Inc. Net gains on sales of foreclosed properties amounted to $16,000 during 2004 as compared to a net loss of $40,000 during 2003.

Noninterest Expenses.Noninterest expenses increased $525,000 for the year ended December 31, 2005 compared to the year ended December 31, 2004. Foreclosed property expense increased to $521,000 in 2005 from $216,000 in 2004 as a result of the Bank taking $318,000 in writedowns based on recent assessments of the appraised value of repossessions. Data processing expense increased to $689,000 in 2005 from $622,000 in 2004 as we continue to stay current with advancing technology which involved a $32,000 increase in service bureau expense, a $27,000 increase in licenses and software expense data processing expense and a $10,000 increase other related expense most of which were data maintenance expenses. Amortization of Core Deposit Intangible amounted to $369,000 for 2005 compared to $329,000 in 2004. We expect the expense to be approximately $290,000 in 2006 and will carefully monitor whether additional amortization is needed. Amortization of mortgage servicing rights amounted to $438,000 for 2005 compared to $385,000 in 2004. We expect the expense for 2006 to be higher than in 2005 as our portfolio continues to grow. All other increases in noninterest expense were not significant.

Noninterest expenses increased $3.2 million for the year ended December 31, 2004 compared to the year ended December 31, 2003. The increase is primarily due to the cost of the operations acquired. In addition, the Company incurred costs related to the termination of its former CEO. Severance costs were $487,000 and legal fees in connection with the severance were $47,000. The Company does not anticipate any additional expense in connection with this matter. We also incurred an additional $50,000 in costs related to a data processing conversion necessitated by the acquisition. Professional services increased $223,000 in 2004 due to additional costs related to being a public company, employee recruitment, employee benefit administration, legal assistance in connection with problem loans and the CEO termination mentioned above. Management expects to continue increased spending for professional fees as well as additional costs related to staffing due to compliance with the Sarbanes-Oxley Act, specifically Section 404 compliance. Amortization of core deposit intangible amounted to $329,000 in 2004 compared to $0 in 2003.

Income Taxes.Monarch recorded an income tax expense for the year ended December 31, 2005 of $505,000 on income before tax of $1.9 million which represented an effective tax rate of 26.0% of income before tax. In 2004, we recorded an income tax recovery of $1.3 million which represented an effective tax rate of 33.6% of income before tax. In 2003, we recorded an income tax expense of $251,000 on income before tax of $915,000 for an effective tax rate of 27.4%. The difference between the effective tax rates and the federal corporate income tax rate of 34% is attributable to the low income housing credits available to the Bank from the investment in the limited partnership as well as fluctuation of permanent book and tax differences such as non-taxable income and non-deductible expenses.

42

Liquidity and Commitments

We are required to maintain appropriate levels of liquid assets under OTS regulations. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. Historically, we have maintained liquid assets at levels above those believed to be adequate to meet the requirements of normal operations, including potential deposit outflows. At December 31, 2005, our liquidity ratio, which is our liquid assets as a percentage of net withdrawable savings deposits with a maturity of one year or less and current borrowings, was 12.1%. This level of liquidity is higher than that maintained last year. Management is confident they will be able to effectively address the Bank’s liquidity issues while facilitating increased profitability.

Monarch’s liquidity, represented by cash and cash equivalents, is a product of our operating, investing and financing activities. Monarch’s primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans, overnight deposits and funds provided from operations. While scheduled payments from the amortization of loans and overnight deposits are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Monarch also generates cash through borrowings. Monarch 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.

Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in overnight deposits and short-term treasury and governmental agency securities. On a longer term basis, Monarch maintains a strategy of investing in various investments and lending products. Monarch 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 December 31, 2005, totaled $60.1 million. Based on historical experience, management believes that a significant portion of these certificates of deposit can be retained by continuing to pay competitive interest rates.

If necessary, additional funding sources include additional deposits and Federal Home Loan Bank advances. Management is committed to increase our core deposit balances and is willing to offer interest rates higher than those of the competition. Based on current collateral levels, at December 31, 2005, Monarch could borrow an additional $22.3 million from the Federal Home Loan Bank at prevailing interest rates. This borrowing capacity can be increased in the future if Monarch pledges additional collateral, such as securities, to the Federal Home Loan Bank. Monarch anticipates that it will continue to have sufficient funds, through deposits and borrowings, to meet its current commitments. For the year ended December 31, 2005, Monarch had a net increase in cash and cash equivalents of $637,000 as compared to a decrease of $11.7 million for the year ended December 31, 2004.

The Bank’s primary sources of funds during 2005 were net income of $1.4 million, a net increase in deposits of $5.0 million, proceeds from Federal Home Loan Bank advances of $4.0 million, proceeds from the sale of foreclosed assets of $2.8 million and proceeds from the maturity of securities of $1.9 million. The primary uses of funds in 2005 were for purchases of investments of $8.4 million and repayments of Federal Home Loan Bank advances totaling $10.2 million.

The Bank’s primary sources of funds during 2004 were the net effect of securities transactions of $11.2 million and operating activities including the sale of mortgage loans which provided $7.9 million. The primary use of funds in 2004 was the acquisition of MSB Financial, Inc. which used $13.1 million, a decrease of deposits of $9.7 million and loan originations, net of collections of $11.2 million.

Off-Balance Sheet Arrangements

At December 31, 2005, the total unused commercial and consumer lines of credit were $19.8 million. As of December 31, 2005 there were outstanding commitments under letters of credit of $64,000. The Company has no arrangements with any other entities that have or are reasonably likely to have a material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

43

Contractual Obligations

The Company has certain obligations and commitments to make future payments under contracts. At December 31, 2005, 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	$	96,934	$	60,051	$	30,529	$	6,354	$	—
FHLB advances		59,562		11,585		26,299		6,328		15,350
Total	$	156,496	$	71,636	$	56,828	$	12,682	$	15,350

	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	$	12,854	$	12,854	$	—	$	—	$	—
Unfunded commitments under HELOCs		15,916		1,071		3,457		2,998		8,390
Unfunded commitments under Commercial LOCs		476		50		55		4		367
Letters of credit		64		14		50		—		—
Total	$	29,310	$	13,989	$	3,562	$	3,002	$	8,757

Long-term obligations also include the liability under the Company’s Director Deferred Compensation Plans. See Note 15 in the Notes to Consolidated Financial Statements for additional information on the plans.

Capital

Consistent with its goals to operate a sound and profitable financial organization, Monarch actively seeks to maintain a “well capitalized” institution in accordance with regulatory standards. As of December 31, 2005, Monarch exceeded all capital requirements of the OTS. Monarch’s regulatory capital ratios at that date were as follows: tangible capital 9.90%; leverage capital, 9.90%; and total risk-based capital, 15.54%. These levels are higher than at December 31, 2004 due to net income for the year ended December 31, 2005. The regulatory capital requirements to be considered well capitalized are 3.0%, 5.0% and 10.0%, respectively. In 2006, management does not anticipate seeking additional capital. On January 24, 2006, management issued a press release announcing an intention to repurchase 270,000 of its outstanding shares in the open market in block trades or privately negotiated transactions. The repurchase program was effective January 30, 2006 and repurchased shares will be held as treasury stock available for general corporate purposes.

Impact of Inflation

The consolidated financial statements presented herein have been prepared in accordance with generally accepted accounting principles. These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.

Our primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates, however, do not necessarily move in the same direction or with the same magnitude as the price of goods and services, since such prices are affected by inflation. In a period of rapidly rising interest rates, the liquidity and maturities structures of our assets and liabilities are critical to the maintenance of acceptable performance levels.

44

The principal effect of inflation, as distinct from levels of interest rates, on earnings is in the area of noninterest expense. Such expense items as employee compensation, employee benefits and occupancy and equipment costs may be subject to increases as a result of inflation. An additional effect of inflation is the possible increase in the dollar value of the collateral securing loans that we have made. We are unable to determine the extent, if any, to which properties securing our loans have appreciated in dollar value due to inflation.

45

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Asset and Liability Management and Market Risk

Our Risk When Interest Rates Change.The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk. We previously employed a strategy of fixed rate long-term borrowing to guard against rising interest rates. The rising interest rate environment in 2005 led to an increased net interest income.

How We Measure Our Risk of Interest Rate Changes.As part of our attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we monitor our interest rate risk. In monitoring interest rate risk we continually analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities, and their sensitivity to actual or potential changes in market interest rates.

The Board of Directors sets and recommends the asset and liability policies of the Bank which are implemented by the asset and liability management committee. The asset and liability management committee is comprised of members of our senior management. The purpose of the asset and liability management committee is to communicate, coordinate and control asset/liability management consistent with our business plan and board approved policies. The asset and liability management committee establishes and monitors the volume and mix of assets and funding sources taking into account relative costs and spreads, interest rate sensitivity and liquidity needs.

The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk and profitability goals. The asset and liability management committee generally meets on a monthly basis to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital position, anticipated changes in the volume and mix of assets and liabilities and interest rate risk exposure limits versus current projections. The chief financial officer is responsible for reviewing and reporting on the effects of the policy implementation and strategies to the Board of Directors, at least quarterly.

In order to manage our assets and liabilities and achieve the desired liquidity, credit quality, interest rate risk, profitability and capital targets, we have focused our strategies on:

• originating shorter-term consumer loans, commercial construction and commercial permanent real estate loans for retention in our portfolio;

• selling a significant portion of the long-term, fixed rate residential mortgage loans we make;

• managing our deposits to establish stable deposit relationships with an emphasis on core, non-certificate deposits, supplementing these with brokered deposits, as appropriate; and

• maintaining longer-term borrowings at fixed interest rates to offset the negative impact of longer-term fixed rate loans in our loan portfolio. Future borrowings are expected to be short-term to reduce the average maturity of our borrowings.

At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the asset and liability management committee may determine to increase Monarch’s interest rate risk position somewhat in order to maintain the net interest margin. In addition, in an effort to manage our interest rate risk and liquidity, in 2005 and 2004 we sold $25.4 million and $29.8 million, respectively, of fixed-rate, one-to-four family mortgage loans in the secondary market. We expect to continue to sell a significant portion of our originated long term, fixed-rate, one-to-four family loans but may retain some portion of our 15 year and shorter, fixed-rate loans.

46

The OTS provides Monarch with the information presented in the following table. It presents the expected change in Monarch’s net portfolio value at September 30, 2005 that would occur upon an immediate change in interest rates based on OTS assumptions, but without giving effect to any steps that management might take to counteract that change.

Change in Interest Rates
Basis Points ("bp")										Net Portfolio Value as %
(Rate Shock in Rates) (1)	Net Portfolio Value									of Present Value of Assets
	$ Amount			$ Change			% Change			NPV Ratio			Change
+ 300 bp		34,641			-2,761			-7	%		13.22	%	- 51 bp
+ 200 bp		36,179			-1,223			-3	%		13.60	%	- 13 bp
+100 bp		37,119			-283			-1	%		13.77	%	+ 4 bp
0 bp		37,402									13.73	%
-100 bp		36,666			-736			-2	%		13.36	%	- 37 bp
-200 bp		35,171			-2,231			-6	%		12.75	%	- 98 bp
-300 bp		n/m	(2)		n/m	(2)		n/m	(2)		n/m	(2)		n/m	(2)

(1)	Assumes an instantaneous uniform change in interest rates at all maturities.
(2)	Not meaningful because some market rates would compute to a rate less than 0.

The OTS uses certain assumptions in assessing the interest rate risk of savings institutions. These assumptions relate to interest rates, loan prepayment rates, deposit decay rates, and the market values of certain assets under differing interest rate scenarios, among others.

As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, if interest rates change, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table.

The Bank, like other financial institutions, is affected by changes in market interest rates. Our net interest margin can change, either positively or negatively, as the result of increases or decreases in market interest rates. Some factors affecting net interest margin are outside of our control; market interest rates are but one factor affecting the Bank’s net interest margin. However, management has the ability, through its asset/liability management and pricing policies to affect the Bank’s net interest margin notwithstanding the level of market interest rates. The preceding table indicates the Bank’s net portfolio value will decrease in a moderately increasing or decreasing interest rate scenario (plus or minus 200 basis points) and management believes that its net interest margin will behave similarly.

If rising interest rates stifle loan demand or create additional competitive pressures in attracting and retaining deposits, the Bank’s desire for growth in total assets may cause management to alter its strategy that could negatively impact the net interest margin. While the Bank saw its net interest margin decline during the period of low interest rates, the net interest margin has increased during the rising interest rate environment of the last 12 months. The timing and magnitude of interest rate changes, as well as the sector affected (short-term vs. long-term) will have an impact on the Bank’s net interest margin.

47

The following table provides information about the Company’s financial instruments that are sensitive to changes to interest rates as of December 31, 2005. The Company had no derivative instruments, or trading portfolio as of that date. The expected maturity date values for loans receivable, mortgage-backed securities and investment securities were calculated without adjusting the contractual maturity dates for expectations of repayments. Expected maturity date values for non-maturity, interest bearing deposits were based on the opportunity for repricing.

	Principal Amount Maturing In:
																2011 and					Fair Value
	2006			2007			2008			2009			2010			beyond			Total		12/31/2005
Rate-sensitive assets
Fed funds and overnight deposits	$	6,988		$	—		$	—		$	—		$	—		$	—		$	6,988	$	6,988
Average interest rate		3.75	%
Securities	$	4,760		$	4,051		$	2,450		$	1,993		$	505		$	1,058		$	14,817	$	14,573
Average interest rate		3.73	%		3.55	%		4.07	%		4.11	%		3.67	%		4.89	%
Gross loans	$	14,850		$	6,676		$	10,927		$	8,809		$	16,302		$	159,044		$	216,608	$	218,731
Average interest rate		6.74	%		7.18	%		7.47	%		7.22	%		7.17	%		6.75	%
Rate-sensitive liabilities
Savings & interest-bearing demand deposits	$	68,386		$	—		$	—		$	—		$	—		$	—		$	68,386	$	68,386
Average interest rate		0.80	%
Certificates of deposit	$	60,050		$	18,795		$	11,735		$	3,665		$	2,689		$	—		$	96,934	$	97,107
Average interest rate		3.81	%		4.25	%		4.02	%		4.23	%		4.46	%
FHLB advances	$	11,585		$	6,146		$	20,153		$	160		$	6,168		$	15,350		$	59,562	$	59,953
Average interest rate		4.98	%		6.43	%		5.67	%		5.64	%		6.19	%		4.48	%

48

ITEM 8. Financial Statements

Monarch Community Bancorp, Inc.
and Subsidiaries

Consolidated Financial Report

December 31, 2005

49

Monarch Community Bancorp, Inc. and Subsidiaries

	Contents
Report Letter		51
Consolidated Financial Statements
Balance Sheet		52
Statement of Operations		53
Statement of Stockholders’ Equity		54
Statement of Cash Flows		55
Notes to Consolidated Financial Statements		56-91

50

Monarch Community Bancorp, Inc. and Subsidiaries

Report of Independent Registered Public Accounting Firm

To the Board of Directors
Monarch Community Bancorp, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheet of Monarch Community Bancorp, Inc. and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each year in the three-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Monarch Community Bancorp, Inc. and Subsidiaries as of December 31, 2005 and 2004, and the consolidated results of their operations and their cash flows for each year in the three-year period ended December 31, 2005, in conformity with accounting principles generally accepted in the United States of America.

Grand Rapids, Michigan
February 13, 2006

51

Monarch Community Bancorp, Inc. and Subsidiaries

Consolidated Balance Sheet
(000s omitted, except per share data)

	December 31
	2005			2004
Assets
Cash and due from banks	$	9,298		$	9,529
Federal funds sold and overnight deposits		6,988			6,120
Total cash and cash equivalents		16,286			15,649
Securities — Available for sale (Note 3)		14,337			8,057
Securities — Held to maturity (Note 3)		247			267
Other securities (Note 3)		4,837			4,720
Real estate investment — Limited partnership (Note 4)		1,129			1,278
Loans held for sale		168			361
Loans, net (Note 5)		213,073			219,317
Foreclosed assets, net (Note 7)		2,811			1,960
Premises and equipment (Note 8)		5,706			6,444
Goodwill (Note 2)		9,606			9,606
Core deposit intangible (Note 2)		1,383			1,752
Other assets (Notes 6 and 11)		7,485			6,037
Total assets	$	277,068		$	275,448
Liabilities and Stockholders’ Equity
Liabilities
Deposits (Note 9):
Noninterest-bearing	$	7,426		$	5,198
Interest-bearing		165,320			162,535
Total deposits		172,746			167,733
Federal Home Loan Bank advances (Note 10)		59,562			65,955
Accrued expenses and other liabilities (Note 15)		4,184			2,341
Total liabilities		236,492			236,029
Commitments and Contingencies(Notes 12 and 20)		—			—
Stockholders’ Equity(Notes 13 and 14)
Common stock — $0.01 par value authorized — 20,000,000 shares issued and outstanding — 2,710,596 and 2,709,220 shares at December 31, 2005 and 2004, respectively		27			27
Additional paid-in capital		28,150			28,059
Retained earnings		14,401			13,529
Accumulated other comprehensive income (loss)		(155	)		2
Unearned compensation (Notes 18 and 19)		(1,847	)		(2,198	)
Total stockholders’ equity		40,576			39,419
Total liabilities and stockholders’ equity	$	277,068		$	275,448

See Notes to Consolidated
Financial Statements.

52

Monarch Community Bancorp, Inc. and Subsidiaries

Consolidated Satatement of Operations
(000s omitted, except per share data)

	Year Ended December 31
	2005			2004			2003
Interest Income
Loans, including fees	$	14,258		$	13,074		$	11,195
Investment securities		704			621			605
Federal funds sold and overnight deposits		269			123			253
Total interest income		15,231			13,818			12,053
Interest Expense
Deposits (Note 9)		3,337			2,710			2,864
Federal Home Loan Bank advances		3,230			3,463			3,196
Total interest expense		6,567			6,173			6,060
Net Interest Income		8,664			7,645			5,993
Provision for Loan Losses(Note 5)		(385	)		4,875			1,266
Net Interest Income After Provision for Loan Losses		9,049			2,770			4,727
Noninterest Income
Fees and service charges		2,034			1,933			954
Loan servicing fees		462			400			213
Net gain on sale of loans		562			865			1,672
Net gain (loss) on sale of investment securities (Note 3)		—			(60	)		—
Other income (Note 4)		341			287			86
Total noninterest income		3,399			3,425			2,925
Noninterest Expenses
Salaries and employee benefits (Notes 15, 18 and 19)		5,103			5,084			3,662
Occupancy and equipment		1,081			1,060			724
Data processing		689			622			359
Amortization of mortgage servicing rights		438			385			353
Professional services		602			632			409
Amortization of core deposit intangible (Note 2)		369			329			—
NOW account processing		182			179			141
ATM/Debit card processing		221			219			76
Foreclosed property expense (Note 7)		521			216			126
Other general and administrative		1,297			1,252			887
Total noninterest expense		10,503			9,978			6,737
Income (Loss)- Before income taxes		1,945			(3,783	)		915
Income Taxes (Recovery)(Note 11)		505			(1,272	)		251
Net Income (Loss)	$	1,440		$	(2,511	)	$	664
Earnings (Loss) Per Share (Note 1)
Basic	$	0.57		$	(1.05	)	$	0.31
Diluted	$	0.57		$	(1.05	)	$	0.31

See Notes to Consolidated
Financial Statements.

53

Monarch Community Bancorp, Inc. and Subsidiaries

Consolidated Statement of Stockholders’ Equity
(000s omitted, except per share data)

	Common Stock											Accumulated
						Additional						Other
	Number of					Paid in			Retained			Comprehensive			Unearned
	Shares			Amount		Capital			Earnings			Income			Compensation			Total
Balance- January 1, 2003		2,314			23		22,149			16,379			64			(1,666	)		36,949
Issuance of 88,875 shares of common stock at $13/share awarded in connection with Restricted Stock Plan, net of forfeitures of 3,700 shares		85			1		1,106									(1,107	)		—
Allocation of ESOP shares (Note 18)							97									185			282
Comprehensive income:
Net income										664									664
Change in unrealized gain on securities available-for-sale,													11						11
Total comprehensive income		—			—		—			—			—			—			675
Dividends paid ($0.20/share)		—			—		—			(476	)		—			—			(476	)
Balance- December 31, 2003		2,399			24		23,352			16,567			75			(2,588	)		37,430
Issuance of 310,951 shares of common stock at $14.75/share in connection with acquisition of MSB Financial, Inc. (Note 2)		311			3		4,583												4,586
797 shares repurchased at $14.15/share		(1	)				(11	)											(11	)
Issuance of 18,000 shares of common stock at $14.26/share awarded in connection with Restricted Stock Plan, net of forfeitures of 18,484 shares at $13/share					—		16									(16	)		—
Vesting of 17,040 restricted shares																221			221
Allocation of ESOP shares (Note 18)							119					��				185			304
Comprehensive income:
Net Loss										(2,511	)								(2,511	)
Change in unrealized gain on securities available-for-sale,													(73	)					(73	)
Total comprehensive income																			(2,584	)
Dividends paid ($0.20/share)		—			—		—			(527	)		—			—			(527	)
Balance- December 31, 2004		2,709		$	27	$	28,059		$	13,529		$	2		$	(2,198	)	$	39,419
Issuance of 4,000 shares of common stock at an average price of $11.57/share in connection with Restricted Stock Plan		4					46									(46	)	$	—
2,624 shares repurchased at average price of $12.27/share		(3	)				(32	)											(32	)
Vesting of 16,018 restricted shares																212			212
Allocation of ESOP shares (Note 18)							77									185			262
Comprehensive Income:
Net Income										1,440									1,440
Change in unrealized gain on securities available-for-sale,													(157	)					(157	)
Total comprehensive income																			1,283
Dividends paid ($0.21/share)		—			—		—			(568	)		—			—			(568	)
Balance- December 31, 2005		2,710		$	27	$	28,150		$	14,401		$	(155	)	$	(1,847	)	$	40,576

See Notes to Consolidated
Financial Statements.

54

Monarch Community Bancorp, Inc. and Subsidiaries

Consolidated Statement of Cash Flows
(000s omitted)

	Year Ended December 31
	2005			2004			2003
Cash Flows From Operating Activities
Net income (loss)	$	1,440		$	(2,511	)	$	664
Adjustments to reconcile net income (loss) to net cash from operating activities
Depreciation and amortization		1,029			1,448			1,139
Provision for loan loss		(385	)		4,875			1,266
Stock dividends on other securities		(100	)		(171	)		(111	)
(Gain) loss on sale of foreclosed assets		(53	)		(16	)		40
Deferred income taxes		323			599			(329	)
Mortgage loans originated for sale		(25,217	)		(29,553	)		(59,447	)
Proceeds from sale of mortgage loans		25,973			30,670			62,225
Gain on sale of mortgage loans		(562	)		(865	)		(1,672	)
(Gain) loss on sale of available for sale securities		—			60			—
(Gain) loss on sale of premises and equipment		(39	)		—			—
Earned stock compensation		474			525			282
Net change in:
Deferred loan fees		168			(333	)		(41	)
Accrued interest receivable		79			229			234
Other assets		(2,060	)		4,844			(842	)
Accrued expenses and other liabilities		1,843			(2,025	)		(723	)
Net cash provided by operating activities		2,913			7,776			2,685
Cash Flows From Investing Activities
Activity in available-for-sale securities:
Purchases		(8,408	)		(8,545	)		(7,635	)
Proceeds from sale of securities		—			16,946			—
Proceeds from maturities of securities		1,909			2,823			4,798
Activity in held-to-maturity securities:
Purchases		(17	)		(21	)		(291	)
Proceeds from maturities of securities		—			19			279
Activity in other securities:
Purchase of other securities		—			(18	)		(111	)
Loan originations and principal collections, net		2,852			(11,254	)		(132	)
Proceeds from sale of foreclosed assets		2,810			3,819			2,649
Proceeds on sale of premises and equipment		345			—			—
Purchase of premises and equipment		(129	)		(373	)		(22	)
Acquisition, net of cash acquired (Note 2)		—			(13,192	)		—
Net cash used in investing activities		(638	)		(9,796	)		(465	)
Cash Flows From Financing Activities
Net increase (decrease) in deposits		5,187			(9,723	)		496
Repurchase of Common Stock		(32	)		(11	)		—
Dividends paid		(568	)		(527	)		(476	)
Proceeds from FHLB advances		4,000			4,000			5,000
Repayment of FHLB advances		(10,225	)		(3,401	)		(116	)
Net cash provided by (used in) financing activities		(1,638	)		(9,662	)		4,904
Net Increase (Decrease) in Cash and Cash Equivalents		637			(11,682	)		7,124
Cash and Cash Equivalents— Beginning		15,649			27,331			20,207
Cash and Cash Equivalents —End	$	16,286		$	15,649		$	27,331

See Notes to Consolidated
Financial Statements.

55

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 1 — 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. Prior to August 29, 2002, the Bank was a federally charted and insured mutual savings institution, which converted to a stock savings institution effective August 29, 2002. In connection with the conversion, on August 29, 2002, the Corporation sold 2,314,375 shares of its common stock in a subscription offering. Fifty percent of the net proceeds from this offering were used to purchase all of the shares of the common stock of the Bank.

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 and one drive-through only office. The Bank owns 100 percent of Community Services Group, Inc., which invests in other entities, including 100 percent ownership of First Insurance Agency, a minority ownership in a limited liability company that operates a title insurance company, and a minority ownership in a limited liability company that re-insures private mortgage insurance services provided to the Bank’s customers. The Bank also owns a 25% interest in a limited partnership formed to construct and operate multi-family housing units.

Basis of Presentation and Consolidation- The consolidated financial statements include the accounts of Monarch Community Bancorp, Inc., Monarch Community Bank, and Community Services Group, Inc. All significant intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates —The accounting and reporting policies of the Corporation and its subsidiaries conform to accounting principles generally accepted in the United States of America. Management is required to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates and assumptions. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, identification and valuation of impaired loans, valuation of the mortgage servicing asset, valuation of intangible assets and the valuation of the other real estate.

Significant Group Concentrations of Credit Risk— Most of the Corporation’s activities are with customers located within its primary market areas in Michigan. Note 3 discusses the types of securities the Corporation invests in. Note 4 discusses the Corporation’s investment in an unconsolidated partnership. Note 5 discusses the types of lending that the Corporation engages in. The Corporation has a significant concentration of loans secured by residential real estate located in Branch, Calhoun and Hillsdale counties.

Cash and Cash Equivalents— For the purpose of the consolidated statement of cash flows, cash and cash equivalents include cash and balances due from banks, interest-bearing deposits and overnight time deposits with the Federal Home Loan Bank and fed funds sold. The Bank is required to maintain average balances on hand or with the Federal Reserve Bank. At December 31, 2005 and 2004, these reserve balances amounted to approximately $649,000 and $565,000, respectively.

56

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 1 — Summary of Significant Accounting Policies (Continued)

Securities- Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity or trading including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses, net of deferred income taxes, excluded from earnings and reported in other comprehensive income.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held-to-maturity securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (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 prospects of the issuer, and (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Loans Held for Sale— Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized in a valuation allowance by charges to income.

Loans —The Corporation grants mortgage, commercial and consumer loans to customers. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans.

The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses — The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

57

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 1 — Summary of Significant Accounting Policies (Continued)

The allowance consists of specific, general and unallocated components. The specific components relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower that the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. The unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Large groups of homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential loans for impairment disclosures.

Servicing— Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into noninterest expense in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the capitalized amount for the stratum.

Credit Related Financial Instruments— In the ordinary course of business, the Corporation has entered into commitments to extend credit, including commitments under commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded.

58

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 1 — Summary of Significant Accounting Policies (Continued)

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.

Premises and Equipment— Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets.

Goodwill and Other Intangible Assets— Goodwill represents the excess of the cost of an acquisition over the fair value of net identifiable tangible and intangible assets acquired. Under the provisions of SFAS 142, goodwill is no longer amortized into the income statement over an estimated life, but rather is tested at least annually for impairment. Impairment of goodwill is evaluated by reporting unit and is based on a comparison of the recorded balance of goodwill to the applicable market value or discounted cash flows. To the extent that impairment may exist, the current carrying amount is reduced by the estimated shortfall.

Intangible assets which have finite lives are amortized over their estimated useful lives and are subject to impairment testing.

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.

Comprehensive Income— Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income.

59

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 1 — Summary of Significant Accounting Policies (Continued)

The components of other comprehensive income and related tax effects are as follows (000s omitted):

	2005			2004			2003
Unrealized holding gain (loss) on available-for-sale securities	$	(236	)	$	(170	)	$	16
Reclassification adjustment for losses (gains) realized in income		—			60			—
Net unrealized gains (losses)	$	(236	)	$	(110	)	$	16
Tax effect		79			37			(5	)
Net-of-tax amount	$	(157	)	$	(73	)	$	11

Earnings (Loss) Per Common Share- Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustments to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate to outstanding stock options and Recognition and Retention Plan shares, and are determined using the treasury stock method.

60

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 1 — Summary of Significant Accounting Policies (Continued)

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

	2005			2004			2003
Basic earnings (loss) per share
Numerator:
Net income (loss)	$	1,440		$	(2,511	)	$	664
Denominator:
Weighted average common shares outstanding		2,709			2,619			2,373
Less: Average unallocated ESOP shares		(130	)		(148	)		(167	)
Less: Average non-vested RRP shares		(59	)		(73	)		(59	)
Weighted average common shares outstanding for basic earnings (loss) per share		2,520			2,398			2,147
Basic earnings (loss) per share	$	0.57		$	(1.05	)	$	0.31
Diluted earnings (loss) per share
Numerator:
Net income (loss)	$	1,440		$	(2,511	)	$	664
Denominator:
Weighted average common shares outstanding for basic earnings (loss) per share		2,520			2,398			2,147
Add: Dilutive effects of assumed exercises of stock options		—			—			8
Add: Dilutive effects of average non-vested RRP shares		—			—			16
Weighted average common shares and dilutive potential common shares outstanding		2,520			2,398			2,171
Diluted earnings (loss) per share	$	0.57		$	(1.05	)	$	0.31

At December 31, 2005, stock options not considered in computing diluted loss per share because they were antidilutive totaled 185,487 and non-vested RRP shares not considered in computing diluted earnings per share because they were antidilutive totaled 55,633. At December 31, 2004, there were 192,000 antidilutive stock options and 68,000 non-vested RRP shares. At December 31, 2003, there were no antidilutive stock options or non-vested RRP shares.

61

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 1 — Summary of Significant Accounting Policies (Continued)

Employee Stock Ownership Plan (ESOP)- Compensation expense is recognized as ESOP shares are committed to be released. Allocated and committed to be released ESOP shares are considered outstanding for earnings per share calculation based on debt service payments. Other ESOP shares are excluded from earnings per share calculation. Dividends declared on allocated ESOP shares are charged to retained earnings. Dividends declared on unallocated ESOP shares are used for debt service. The Corporation has committed to make contributions to the ESOP sufficient to service the debt to the extent not paid through dividends. The cost of unearned shares to be allocated to ESOP participants for future services not yet performed is reflected as a reduction of stockholders’ equity.

Stock Based Compensation —The Corporation accounts for stock option plans using the intrinsic value method. No compensation cost related to stock options was recognized during 2005, 2004 or 2003, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at the date of the grant. Had compensation cost for stock options been measured using the fair value method, the Corporation’s net income and basic and diluted earnings per share would have been the pro forma amounts indicated below (000s omitted except per share data):

	2005		2004			2003
As reported net income (loss)	$	1,440	$	(2,511	)	$	664
less: additional stock-based compensation determined under the fair value method, net of tax		85		63			59
	$	1,355	$	(2,574	)	$	605
As reported earnings (loss) per share	$	0.57	$	(1.05	)	$	0.31
Proforma earnings (loss) per share	$	0.54	$	(1.07	)	$	0.28
As reported earnings (loss) per diluted share	$	0.57	$	(1.05	)	$	0.31
Proforma earnings (loss) per diluted share	$	0.54	$	(1.07	)	$	0.28

Compensation expense in the pro forma disclosures is not indicative of future amounts, as options vest over several years and additional grants are generally made each year.

There were no options granted in 2005. The fair value of each option granted in 2004 and 2003 is $2.93 and $2.69, respectively. The fair value is estimated on the date of the grant using the Black Scholes option pricing model with the following weighted average assumptions:

	2004			2003
Dividend yield		1.4	%		1.4	%
Expected life	7 years			7 years
Expected volatility		17.5	%		17.2	%
Risk-free interest rate		3.0	%		3.0	%

62

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 1 — Summary of Significant Accounting Policies (Continued)

Recent Accounting Pronouncement— In December 2004, the FASB re-issued SFAS No. 123 “Accounting for Stock-Based Compensation” which becomes effective for periods beginning after December 15, 2005. This Statement supersedes APB Opinion No. 25 “Accounting for Stock Issued to Employees” and its related implementation guidance. Under Opinion No. 25, issuing stock options to employees generally resulted in recognition of no compensation cost. This statement requires entities to recognize the cost of employee services received in exchange for these stock options. The Corporation is evaluating the transition provisions allowed by SFAS No. 123. Existing options that are scheduled to vest after the adoption date are expected to result in additional compensation expense of approximately $85,000 in 2006.

Supplemental Cash Flow Information (000s omitted)

	December 31,
	2005			2004			2003
Cash paid (received) for:
Interest	$	6,470		$	6,115		$	6,069
Income taxes		(63	)		(315	)		635
Noncash investing activities -
Loans transferred to real estate owned		3,608			2,221			2,844
Issuance of common stock in connection with the 2003 Recognition and Retention Plan		46			16			1,107
Issuance of common stock in connection with the acquisition of MSB Financial, Inc.		—			4,586			—

Reclassification —Certain prior year amounts have been reclassified to conform with current year presentation.

Note 2 — Acquisition

On April 15, 2004 the Corporation completed its acquisition of MSB Financial, Inc., parent company of Marshall Savings Bank. On June 7, 2004 Marshall Savings Bank was merged with and into Monarch Community Bank. The acquisition was accounted for using the purchase method of accounting, and accordingly, the purchase price was allocated to the assets purchased and the liabilities assumed based upon the estimated fair values at the date of acquisition.

The aggregate purchase price was $24,922,000, including $679,000 of acquisition costs. The Corporation issued a total of 310,951 shares of its common stock and paid cash of $19.7 million to former MSB Financial stockholders. The cash paid in the transaction came from the Corporation’s existing liquidity.

63

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 2 — Acquisition (Continued)

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition (000s omitted):

Cash and cash equivalents	$	7,144
Other securities		1,500
Loans, net		73,793
Premises and equipment		2,452
Core deposit intangible		2,081
Goodwill		9,606
Other assets		9,861
Total assets acquired		106,437
Deposits		70,216
Federal Home Loan Bank advances		8,002
Other liabilities		3,297
Total liabilities assumed		81,515
Net assets acquired	$	24,922

The purchase accounting fair value adjustments are being amortized under various methods and over lives of the corresponding assets and liabilities. Goodwill recorded for the acquisition amounted to $9.6 million. A Core Deposit Intangible of $2.1 million was recorded as part of the acquisition and is being amortized on an accelerated basis over a period of 9.5 years. Amortization for the year ended December 31, 2005 and 2004 was $369,000 and $329,000, respectively. Accumulated amortization thru December 31, 2005 is $698,000. The estimated amortization expense for the next five years ended December 31 is as follows (000s omitted):

2006	$	291
2007		230
2008		181
2009		149
2010		142
Thereafter		390
Total	$	1,383

64

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 2 — Acquisition (Continued)

The following pro forma disclosures, including the effect of the purchase accounting adjustments, depict the results of operations as though the merger had taken place at the beginning of each period.

	2004			2003
Net interest income	$	3,698		$	8,399
Noninterest income		3,874			5,406
Total income		7,572			13,805
Net income (loss)	$	(4,102	)	$	1,781
Basic earnings per share	$	(1.71	)	$	0.74
Diluted earnings per share	$	(1.71	)	$	0.74

MSB Financial was acquired to expand our geographic presence into Calhoun County, Michigan. The 2004 operations include the results of operations for MSB Financial, Inc. beginning on April 16, 2004.

65

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 3 — Securities

The amortized cost and fair value of securities, with gross unrealized gains and losses, follows (000s omitted):

			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Market Value
2005
Available-for-sale securities:
U.S. government agency obligations		11,961		—		(188	)		11,773
Mortgage-backed securities		1,317		—		(39	)		1,278
Obligations of states and political subdivisions		1,293		—		(7	)		1,286
Total available-for-sale securities	$	14,571	$	—	$	(234	)	$	14,337
Held-to-maturity securities:
Municipal security	$	247	$	—	$	(11	)	$	236
2004
Available-for-sale securities:
U.S. government agency obligations		3,984		5		—			3,989
Mortgage-backed securities		1,677		6		(8	)		1,675
Obligations of states and political subdivisions		2,394		1		(2	)		2,393
Total available-for-sale securities	$	8,055	$	12	$	(10	)	$	8,057
Held-to-maturity securities:
Municipal security	$	267	$	1	$	—		$	268

66

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 3 — Securities (Continued)

The amortized cost and estimated market values of securities at December 31, 2005, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers will have the right to call or prepay obligations with or without call or prepayment penalties (000s omitted):

	Held to Maturity				Available for Sale
	Amortized				Amortized
	Cost		Market Value		Cost		Market Value
Due in one year or less	$	—	$	—	$	4,760	$	4,739
Due in one through five years		—		—		8,494		8,320
Due after five years through ten years		—		—		—		—
Due after ten years		247		236		—		—
Total	$	247	$	236		13,254		13,059
Mortgage-backed securities						1,317		1,278
Total available-for-sale securities					$	14,571	$	14,337

For the years ended December 31, 2005, 2004 and 2003, proceeds from sales of securities available for sale amounted to $0, $16,946,000, and $0, respectively. Gross realized gains amounted to $0, $17,000, and $0, respectively. Gross realized losses amounted to $0, $77,000, and $0, respectively. The tax benefit (provision) applicable to these net realized gains and losses amounted to $0, $20,000, and 0, respectively.

67

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 3 — Securities (Continued)

Information pertaining to securities with gross unrealized losses at December 31, 2005 and 2004, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

	Less than Twelve Months				Twelve Months and Over
	Gross				Gross
	Unrealized		Estimated		Unrealized		Estimated
	Losses		Market Value		Losses		Market Value
2005
Available-for-sale securities:
U.S. government agency obligations	$	102	$	8,376	$	86	$	3,397
Mortgage-backed securities		39		1,278		—		—
Obligations of states and political subdivisions		7		1,286		—		—
Total available-for-sale securities	$	148	$	10,940	$	86	$	3,397
Held-to-maturity securities:
Municipal security	$	11	$	236	$	—	$	—
2004
Available-for-sale securities:
Mortgage-backed securities	$	—	$	—	$	8	$	698
Obligations of states and political subdivisions		2		419		—		—
Total available-for-sale securities	$	2	$	419	$	8	$	698

Management evaluates securities for other-than-temporary impairment on a periodic basis as economic or market concerns warrant such evaluation. Consideration is given to the length of time the security has been in a loss position, the financial condition and near-term prospects of the issuer and the intent and ability of the Corporation to retain its investment in the issuer to allow for recovery of fair value.

Other securities, consisting primarily of restricted Federal Home Loan Bank stock, are recorded at cost, which approximates market value.

Note 4 — Real Estate Investment — Limited Partnership

In June of 2001, the Corporation acquired a 24.98 percent interest in a limited partnership formed to construct and operate multi-family housing units. All income, expenses and tax credits will be allocated to the Corporation based upon ownership percentage. The Corporation accounts for the investment in the limited partnership using the effective yield method. Under the effective yield method, the Corporation recognizes tax credits as they are allocated and amortizes the initial cost of the investment to provide a constant effective yield over the period the tax credits are allocated to the Corporation. The tax credit allocated to the Corporation is recognized in the income statement as a component of income taxes, net of the amortization of the investment in the limited partnership.

68

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 4 — Real Estate Investment — Limited Partnership (Continued)

The Corporation as an investor is able to exercise influence over operating and financial policies of the management through provisions of the partnership agreement that require a majority approval of the limited partners. At such time the project is sold, the limited partners will receive a share of the net proceeds proportionate to the limited partners outstanding capital balance. Under the terms of the limited partnership agreement, the Corporation has made a total capital contribution of approximately $1,500,000, in cash, and is allocated tax losses and affordable housing federal income tax credits.

The Corporation has recorded an estimate of the tax credit through December 31, 2005. The Corporation’s share of tax credits generated by the investee partnership approximated $191,000, $191,000, and $175,000 in 2005, 2004, 2003, respectively.

69

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 5 — Loans

A summary of the balances of loans follows (000s omitted):

	December 31,
	2005		2004
Mortgage loans on real estate:
One-to-four family	$	138,473	$	141,251
Multi-family		3,534		4,042
Commercial		33,162		42,746
Construction or development		5,415		8,853
Total real estate loans		180,584		196,892
Consumer loans:
Automobile		2,447		2,631
Home equity		16,170		14,234
Manufactured housing		576		784
Other		7,745		6,645
Total consumer loans		26,938		24,294
Commercial business loans		9,086		5,330
Subtotal		216,608		226,516
Less: Allowance for loan losses		2,895		6,385
Net deferred loan fees		640		808
Loans in process		—		6
Loans, net	$	213,073	$	219,317

70

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 5 — Loans (Continued)

An analysis of the allowance for loan losses follows (000s omitted):

	December 31,
	2005			2004			2003
Balance — Beginning	$	6,385		$	2,618		$	1,735
Allowance acquired in acquisition		—			513			—
Provision for loan losses		(385	)		4,875			1,266
Loans charged-off		(3,254	)		(1,799	)		(571	)
Recoveries of loans previously charged off		149			178			188
Balance — Ending	$	2,895		$	6,385		$	2,618

The following is a summary of information pertaining to impaired loans (000s omitted):

	December 31,
	2005		2004
Impaired loans with a valuation allowance	$	2,570	$	10,205
Valuation allowance related to impaired loans	$	670	$	3,727
Total non-accrual loans	$	397	$	4,231
Total loans past-due ninety days or more and still accruing	$	—	$	—

There are no impaired loans without a valuation allowance as of December 31, 2005 and 2004 (000s omitted).

	December 31,
	2005		2004		2003
Average investment in impaired loans	$	4,177	$	4,905	$	1,777

Interest income recognized on impaired loans was not significant for the years ended December 31, 2005, 2004, and 2003. No additional funds are committed to be advanced in connection with impaired loans.

71

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 6 — Servicing

Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage loans serviced for others were $184,370,000 and $188,915,000 at December 31, 2005 and 2004, respectively.

The fair value of mortgage servicing rights approximates $1,522,000 and $1,586,000 at December 31, 2005 and 2004, respectively. The fair value was determined by discounting estimated net future cash flows from mortgage servicing activities using an 8.50 percent discount rate and estimated prepayment speeds of 8.4 to 20.1 based on current Freddie Mac experience as well as Freddie Mac projections of slower prepayment speeds due to rising interest rates. The impairment valuation allowance is $0 as of December 31, 2005, 2004, and 2003. There has been no activity in the impairment valuation allowance during the years ended December 31, 2005, 2004, and 2003.

The following summarizes mortgage servicing rights capitalized and amortized (000s omitted):

	December 31,
	2005			2004			2003
Mortgage servicing rights — Beginning	$	1,539		$	667		$	428
Mortgage servicing rights acquired in acquisition		—			940			—
Mortgage servicing rights capitalized		257			316			592
Mortgage servicing rights — amortization and direct writedown for loan payoffs		(438	)		(384	)		(353	)
Mortgage servicing rights — Ending	$	1,358		$	1,539		$	667

72

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 7 — Foreclosed Assets

Foreclosed assets consisted of the following (000s omitted):

	December 31,
	2005		2004
Real estate owned	$	1,462	$	1,234
Real estate in judgment and subject to redemption		1,349		726
Total	$	2,811	$	1,960

Expenses applicable to foreclosed assets include the following (000s omitted):

	December 31,
	2005			2004			2003
Net loss (gain) on sales of real estate	$	(54	)	$	(16	)	$	40
Operating expenses		515			205			114
Total	$	461		$	189		$	154

73

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 8 — Premises and Equipment

A summary of the cost and accumulated depreciation of premises and equipment follows (000s omitted):

	December 31,				Depreciable
					Life
	2005		2004		(in Years)
Land	$	598	$	646
Buildings and improvements		5,890		6,233		7-40
Furniture, fixtures and equipment		2,803		4,083		2-7
Total bank premises and equipment		9,291		10,962
Less accumulated depreciation and amortization		3,585		4,518
Net carrying amount	$	5,706	$	6,444

Depreciation expense totaled $561,000, $549,000, and $423,000 in 2005, 2004, and 2003, respectively.

74

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 9 — Deposits

The following is a summary of interest bearing deposit accounts (000s omitted):

	December 31,
	2005		2004
Balances by account type:
Demand and NOW accounts	$	26,083	$	27,843
Money market		15,767		19,114
Passbook and statement savings		26,536		29,177
Total transactional accounts		68,386		76,134
Certificates of deposit:
$100,000 and over		35,949		17,844
Under $100,000		60,985		68,557
Total certificates of deposit		96,934		86,401
Total	$	165,320	$	162,535

Generally, deposit amounts in excess of $100,000 are not federally insured.

The remaining maturities of certificates of deposit outstanding are as follows (000s omitted):

	December 31,
	2005
	Less than		$100,000 &
	$100,000		greater
Less than one year	$	39,511	$	20,539
One to two years		11,997		6,798
Two to three years		5,636		6,099
Three to four years		1,565		2,100
Four to five years		2,276		413
Total	$	60,985	$	35,949

75

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 9 — Deposits (Continued)

The following is a summary of interest expense by deposit account type (000s omitted):

	December 31,
	2005		2004		2003
Demand and NOW accounts	$	78	$	94	$	79
Money market		211		176		135
Passbook and statement savings		120		117		137
Certificates of deposit		2,928		2,323		2,513
Total deposit interest expense	$	3,337	$	2,710	$	2,864

Note 10 — Federal Home Loan Bank Advances

The Bank has Federal Home Loan Bank advances of $59,562,000 and $65,955,000 at December 31, 2005 and 2004, respectively, which mature through 2013. At December 31, 2005 and 2004, the interest rates on fixed rate advances ranged from 3.34% to 6.73%, respectively. The Bank had one floating rate advance of $3,000,000 with an interest rate of 4.29% and 2.54% as of December 31, 2005 and 2004, respectively. The weighted average interest rate of all advances was 5.36% and 5.34% at December 31, 2005 and 2004. At December 31, 2005, the Bank had three putable advances totaling $7,000,000 with a weighted average interest rate of 3.62%. Two of the advances, totaling $1,000,000 each can be put on February 15, 2006 and March 16, 2006 and the third advance can be put on January 28, 2008.

The Bank has provided a blanket pledge of all of the Bank’s eligible residential mortgage loans as collateral for all FHLB debt. The amount of these mortgage loans totaled $103,588,000 as of December 31, 2005.

76

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 10 — Federal Home Loan Bank Advances (Continued)

The contractual maturities of advances are as follows (000s omitted):

	December 31,
	2005
Less than one year	$	11,585
One to two years		6,146
Two to three years		20,153
Three to four years		160
Four to five years		6,168
Thereafter		15,350
Total	$	59,562

Note 11 — Income Taxes

Allocation of income taxes between current and deferred portions is as follows (000s omitted):

	December 31,
	2005		2004			2003
Current expense (recovery)	$	182	$	(1,871	)	$	590
Deferred expense (recovery)		323		599			(339	)
Total tax expense (recovery)	$	505	$	(1,272	)	$	251

77

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 11 — Income Taxes (Continued)

The reasons for the differences between the statutory federal income tax rate and the effective tax rates are summarized as follows:

	Percent of Pretax Income (Loss)
	December 31,
	2005			2004			2003
Statutory federal tax rate		34.00	%		34.00	%		34.00	%
Increase (decrease) resulting from:
Nondeductible expenses		0.20	%		0.30	%		8.90	%
Dividend received deduction		0.00	%		-0.30	%		-5.20	%
Tax exempt income		-1.90	%		-1.10	%		-4.80	%
Low income housing credit		-9.80	%		-4.00	%		-8.40	%
Other		3.50	%		4.70	%		2.90	%
Reported tax expense (recovery)		26.00	%		33.60	%		27.40	%

78

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 11 — Income Taxes (Continued)

The components of the net deferred tax asset are as follows (000s omitted):

	December 31,
	2005		2004
Deferred tax assets:
Provision for loan losses	$	530	$	1,719
Net deferred loan fees		217		273
Deferred compensation		365		288
Employee benefits		23		52
Net operating loss carryforward		209		—
Unrealized loss on available for sale securities		79		—
General business tax credit carryforward		557
Other		227		53
Total deferred tax assets		2,207		2,385
Deferred tax liabilities:
Mortgage servicing rights		429		483
Original issue discount		120		111
Net purchase premiums		1,090		1,030
Stock dividends		167		133
Other		33		16
Total deferred tax liabilities		1,839		1,773
Net deferred tax asset	$	368	$	612

The Corporation has qualified under a provision of the Internal Revenue Code which permits it to deduct from taxable income a provision for bad debts in excess of such provision charged to income in the consolidated financial statements. Accordingly, retained earnings at December 31, 2005 and 2004 include approximately $1,592,000 for which no provision for federal income taxes has been made. Unrecognized deferred taxes on this amount are approximately $541,000. If, in the future, this portion of retained earnings is used for any purpose other than to absorb bad debt losses, federal income taxes would be imposed at the then applicable rates.

The Corporation has a net operating loss carryforward of approximately $615,000 which expire between 2024 and 2025. The general business credits of $557,000 expire between 2022 and 2025.

79

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 12 — Off-Balance Sheet Activities

Credit Related Financial Instruments— The Corporation is a party to credit related financial instruments with off-balance sheet risk in the normal course of business to meet the financing need of its customer. These financial instruments include commitments to extend credit, and unfunded commitments under lines of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.

The Corporation’s exposure to credit loss is represented by the contractual amount of these commitments. The Corporation follows the same credit policies in making commitments as it does for on-balance sheet instruments.

The following financial instruments were outstanding whose contract amounts represent credit risk (000s omitted):

	Contract Amount
	December 31,
	2005		2004
Commitments to grant loans	$	12,854	$	257
Unfunded commitments under lines of credit		19,838		18,672
Unfunded commitments under letters of credit		64		97

The above commitments include fixed rate and variable rate loan commitments and lines of credit with interest rates ranging between 4.75% and 12.25% at December 31, 2005, and 3.875% and 12.75% at December 31, 2004.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Corporation, is based on management’s credit evaluation of the customer.

Unfunded commitments under commercial lines of credit and revolving credit lines are commitments for possible future extensions of credit to existing customers. These lines of credit are collateralized and usually do not contain a specified maturity date and may be drawn upon to the total extent to which the Corporation is committed.

Collateral Requirements— To reduce credit risk related to the use of credit related financial instruments, the Corporation might deem it necessary to obtain collateral. The amount and nature of the collateral obtained is based on the Corporation’s credit evaluation of the customer. Collateral held varies but may include cash, securities, accounts receivable, inventory, property, plant, and equipment and real estate.

80

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 13 — Regulatory Matters

The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios, which are shown in the table below. Management believes, as of December 31, 2005 and 2004, that the Bank has met all of the capital adequacy requirements to which they are subject.

As of December 31, 2005, the most recent notification from the Office of Thrift Supervision (“OTS”) categorized the Bank as well capitalized, under the regulatory framework for prompt corrective action. To be categorized as well capitalized, minimum capital amounts and ratios must be maintained as shown in the following tables. There are no conditions or events since that notification that management believes have changed the Bank’s capital category.

81

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 13 — Regulatory Matters (Continued)

A reconciliation of the Bank’s equity to major categories of capital is as follows (000s omitted):

	December 31,
	2005			2004
Equity per consolidated balance sheet	$	37,420		$	35,090
Less: intangible assets and deferred tax asset		(11,448	)		(11,361	)
Tangible and leverage capital		25,972			23,729
Plus: Allowance for loan losses **		2,280			1,747
Risk based capital	$	28,252		$	25,476

** Limited to 1.25 percent of risk weighted assets

Regulatory capital balances and ratios are as follows (000s omitted):

											To be Well Capitalized
						For Capital Adequacy					Under Prompt Corrective
	Actual					Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2005:
Tangible capital	$	25,972		9.90	%	$	3,933		1.50	%	$	7,867		3.00	%
Leverage capital		25,972		9.90	%		10,489		4.00	%		13,111		5.00	%
Total risk-based capital		28,252		15.54	%		14,544		8.00	%		18,180		10.00	%
As of December 31, 2004:
Tangible capital	$	23,729		9.06	%	$	3,928		1.50	%	$	7,857		3.00	%
Leverage capital		23,729		9.06	%		10,475		4.00	%		13,094		5.00	%
Risk-based capital		25,476		13.62	%		14,959		8.00	%		18,699		10.00	%

82

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 14 — Restrictions on Dividends, Loans and Advances

OTS regulations impose limitations upon all capital distributions by the Bank including cash dividends. The Bank would need to file an application to, and receive the approval of, the OTS prior to any capital distribution. In the event the Bank’s capital falls below its regulatory requirements or the OTS notifies it that is was in need of more than normal supervision, the Bank’s ability to make capital distributions could be further restricted. In addition, the OTS could prohibit a proposed capital distribution by the Bank, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. The total amount of dividends which may be paid by the Bank is generally limited to the sum of the net profits of the bank for the preceding three years, less any dividends paid during the same period. Accordingly, all of the Corporation’s investment in the Bank was restricted at December 31, 2005.

Note 15 — Retirement Plans

The Corporation is part of a non-contributory, multi-employer defined benefit pension plan covering substantially all employees. Effective April 1, 2004 employees’ benefits under the plan were frozen. The plan is administered by the trustees of the Financial Institutions Retirement Fund. Because it is a multi-employer plan, there is no separate valuation of plan benefits or segregation of plan assets specifically for the Corporation. During 2005, 2004 and 2003, the Corporation recognized pension expense for this plan of $226,000, $246,000, and $242,000, respectively.

The Corporation has a Defined Contribution Retirement plan for all eligible employees. The Corporation has a matching contribution agreement to match 50 percent of the first 6 percent of an employee’s salary. During 2005, 2004 and 2003, the Corporation recognized pension expense for this plan of $64,000, $64,000, and $54,000, respectively.

The Corporation has a nonqualified deferred-compensation plan (included as part of the other liabilities section of the consolidated balance sheet) to provide retirement benefits to the Directors, at their option, in lieu of annual directors’ fees and meeting fees. Undistributed benefits are increased by an annual earnings rate which is based on the lower of the Company’s return on average assets or 5.0 percent. The value of benefits accrued to participants was $402,000 and $394,000 at December 31, 2005 and 2004, respectively. The expense for the plan, including the increase due to the annual earnings credit was $8,000, $41,000, and $39,600, for 2005, 2004, and 2003, respectively.

Upon acquisition, the Corporation assumed the liability for the directors’ deferred compensation plan of MSB Financial, Inc. This plan does not allow for future deferrals and all benefits are being paid out to participants over a 180 month term. Undistributed benefits are increased by an annual earnings rate based on an index which was 5.49 percent as of December 31, 2005. The present value of benefits accrued to participants (also included as part of the other liabilities section of the balance sheet) is $669,000 and $702,000 at December 31, 2005 and 2004, respectively.

Note 16 — Related Party Transactions

In the ordinary course of business, the Bank has granted loans to principal officers and directors and their affiliates with balances of $449,000 and $1,192,000 at December 31, 2005 and 2004, respectively. During the year ended December 31, 2005, total principal additions were $125,000 and total principal payments were $868,000. Deposits from related parties held by the Bank at December 31, 2005 and 2004 amounted to $252,830 and $713,880 respectively.

83

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 17 — 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. SFAS 107 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 following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments:

Cash and Cash Equivalents— The carrying amounts of cash and short-term instruments approximate fair values. The carrying amounts of interest-bearing deposits maturing within ninety days approximate their fair values. Fair values of other interest-bearing deposits are estimated using discounted cash flow analyses based on current rates for similar types of deposits.

Securities— Fair values for securities, excluding Federal Home Loan Bank stock, are based on quoted market prices. The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.

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.

84

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 17 — Fair Value of Financial Instruments (Continued)

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 interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

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.

Accrued Interest — The carrying amounts of accrued interest approximate fair value.

85

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 17 — Fair Value of Financial Instruments (Continued)

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

	December 31,
	2005				2004
	Carrying				Carrying
	Amount		Fair Value		Amount		Fair Value
Assets:
Cash and cash equivalents	$	16,286	$	16,286	$	15,649	$	15,649
Securities — Held to maturity		247		236		267		268
Securities — Available for sale		14,337		14,337		8,057		8,057
Other securities		4,837		4,837		4,720		4,720
Loans held for sale		168		169		361		367
Net loans		213,073		215,196		219,317		221,929
Accrued interest and late charges receivable		1,217		1,217		1,138		1,138
Liabilities:
Federal Home Loan Bank advances		59,562		59,953		65,955		68,155
Deposits		172,746		172,919		167,733		168,712
Accrued interest payable		430		430		333		333

Note 18 — Employee Stock Ownership Plan (ESOP)

As part of the conversion (Note 1), the Corporation implemented an employee stock ownership plan (ESOP) covering substantially all employees. The Corporation provided a loan to the ESOP, which was used to purchase 185,150 shares of the Corporation’s outstanding stock at $10 per share. The loan bears interest equal to 5.58% and will be repaid over a period of ten years ending on December 31, 2011. Dividends on the allocated shares are distributed to participants and the dividends on the unallocated shares are used to pay debt service. The scheduled maturities of the loan are as follows (000’s omitted):

Year Ending December 31
2006	$	172
2007		181
2008		191
2009		202
2010		214
Thereafter		225
	$	1,185

86

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 18 — Employee Stock Ownership Plan (ESOP) (Continued)

The Corporation has committed to make contributions to the ESOP sufficient to support debt service of the loan. The ESOP shares initially were pledged as collateral for its debt. As the debt is repaid, shares are released from collateral and allocated to active participants. The shares pledged as collateral are included in unearned compensation in the equity section of the balance sheet. As shares are released they become outstanding for earnings per share computations.

The ESOP shares as of December 31 were as follows (000s omitted except shares):

	2005			2004
Allocated shares		55,545			37,030
Shares released for allocation		18,515			18,515
Shares distributed		(11,284	)		(3,841	)
Unreleased shares		111,090			129,605
Total ESOP shares		173,866			181,309
Fair value of unallocated shares	$	1,465		$	1,876

Total compensation expense applicable to the ESOP amounted to approximately $234,000 $266,000, and $258,000 for the years ended December 31, 2005, 2004, and 2003, respectively.

Note 19 — Stock Compensation Plans

The Corporation has a Recognition and Retention Plan (RRP) under which 88,875 shares of restricted stock were issued to employees and directors during 2003. Under the plan, the shares vest 20% per year for five years. No shares were forfeited during 2005, and 18,484 shares were forfeited during 2004. During 2005, 4,000 shares of restricted stock were issued to employees. During 2005, 33,058 shares vested and were thus no longer restricted. Compensation expense applicable to the RRP amounted to $215,000 and $194,000 for the years ended December 31, 2005 and 2004, respectively.

Under the Corporation’s Employee Stock Option Plan, the Corporation may grant options to its directors, officers and employees for up to 231,438 shares of common stock. Both incentive stock options and non-qualified stock options may be granted under the plan. The exercise price of each option equals the market price of the Corporation’s stock on the date of grant and an option’s maximum term is ten years.

Under APB Opinion no. 25, because the exercise price of the Corporation’s stock option grants equal the market price of the underlying stock on the date of the grant, no compensation cost is recognized.

87

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 19 — Stock Compensation Plans (Continued)

A summary of the status of the Corporation’s stock option plan is presented below (000s omitted except per share data):

	2005				2004
			Weighted				Weighted
			Average				Average
			Exercise				Exercise
	Shares		Price		Shares		Price
Outstanding at beginning of year		192	$	13.21		183	$	13.00
Granted		—		—		45		13.90
Exercised		—		—		—		—
Forfeited/expired		7		13.00		36		13.00
Outstanding at end of year		185	$	13.22		192	$	13.21
Exercisable at year-end		65	$	13.12		30	$	13.00

The weighted average remaining contractual life of the outstanding options is 7.9 years at December 31, 2005.

Note 20 — Subsequent Event

Subsequent to year end, the Company adopted a stock repurchase program effective January 30, 2006. The Company intends to repurchase up to 270,000 shares, or approximately 10% of its outstanding shares, over a twelve month period.

88

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 21 — Condensed Financial Statements of Parent Company

The following represents the condensed financial statements of Monarch Community Bancorp, Inc. (“Parent”) only. The Parent-only financial information should be read in conjunction with the Corporation’s consolidated financial statements.

Condensed Balance Sheet (000s omitted)

	December 31,		December 31,
	2005		2004
Assets
Cash	$	2,614	$	1,007
Investments		667		1,283
Investment in Monarch Community Bank		37,420		35,089
Other assets		157		2,350
Total assets	$	40,858	$	39,729
Liabilities and Stockholders’ Equity
Accrued expenses	$	282	$	310
Stockholders’ equity		40,576		39,419
Total liabilities and stockholders’ equity	$	40,858	$	39,729

89

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 21 — Condensed Financial Statements of Parent Company (Continued)

Condensed Statement of Income (000s omitted)

	December 31,			December 31,			December 31,
	2005			2004			2003
Income — Interest on investments	$	84		$	106		$	120
Dividends from Monarch Community Bank		—			10,000			—
Operating expense		170			233			220
Income (loss) — Before equity in undistributed net income of subsidiary		(86	)		9,873			(100	)
Equity in undistributed net income of subsidiary		1,526			(12,384	)		764
Net income (loss)	$	1,440		$	(2,511	)	$	664

90

Monarch Community Bancorp, Inc. and Subsidiaries

Notes to Consolidated Financial Statements
December 31, 2005, 2004 and 2003

Note 21 — Condensed Financial Statements of Parent Company (Continued)

Condensed Statements of Cash Flows (000s omitted)

	December 31,			December 31,			December 31,
	2005			2004			2003
Cash flows from operating activities:
Net income (loss)	$	1,440		$	(2,511	)		664
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization		7			25			34
Allocation of ESOP and RRP		474			525			282
(Increase) decrease in other assets		1,230			4,001			(404	)
Increase (decrease) in accrued expenses		(24	)		(133	)		11
Undistributed net (income) loss of subsidiary		(1,526	)		12,384			(764	)
Net cash provided by (used in) operating activities		1,601			14,291			(177	)
Cash flows from investing activities:
Purchase of securities		—			—			(624	)
Proceeds from maturities of securities		606			964			75
Acquisition, net of cash		—			(20,120	)		—
Net cash provided by (used in) investing activities		606			(19,156	)		(549	)
Cash flows from financing activities:
Repurchase of common stock		(32	)		(11	)		—
Dividends paid		(568	)		(527	)		(476	)
Net cash used in financing activities		(600	)		(538	)		(476	)
Net increase (decrease) in cash		1,607			(5,403	)		(1,202	)
Cash at beginning of year		1,007			6,410			7,612
Cash at end of year	$	2,614		$	1,007		$	6,410

91

QUARTERLY RESULTS OF OPERATIONS

The following table sets forth certain income and expense and per share data on a quarterly basis for the three-month periods indicated:

	Year Ended December 31, 2005
	1st Qtr			2nd Qtr		3rd Qtr		4th Qtr
	(Dollars in thousands, except per share data)
Interest income	$	3,766		$	3,763	$	3,818	$	3,884
Interest expense		1,546			1,596		1,666		1,759
Net interest income		2,220			2,167		2,152		2,125
Provision for loan losses		(385	)		—		—		—
Net interest income after provision for loan losses		2,605			2,167		2,152		2,125
Noninterest income		780			844		884		891
Noninterest expense		2,821			2,540		2,541		2,601
Income before income taxes		564			471		495		415
Income tax expense		152			120		129		104
Net Income	$	412		$	351	$	366	$	311
Earnings per share:
Basic	$	0.16		$	0.13	$	0.14	$	0.14
Diluted	$	0.16		$	0.13	$	0.14	$	0.14
Cash dividends declared per share	$	0.05		$	0.05	$	0.05	$	0.06

	Year Ended December 31, 2004
	1st Qtr		2nd Qtr			3rd Qtr			4th Qtr
	(Dollars in thousands, except per share data)
Interest income	$	2,743	$	3,554		$	3,787		$	3,734
Interest expense		1,404		1,585			1,602			1,582
Net interest income		1,339		1,969			2,185			2,152
Provision for loan losses		—		450			375			4,050
Net interest income after provision for loan losses		1,339		1,519			1,810			(1,898	)
Noninterest income		485		966			1,080			894
Noninterest expense		1,677		2,408			3,195			2,698
Income before income taxes		147		77			(305	)		(3,702	)
Income tax expense		44		(19	)		(45	)		(1,252	)
Net Income	$	103	$	96		$	(260	)	$	(2,450	)
Earnings per share:
Basic	$	0.04	$	0.04		$	(0.10	)	$	(1.03	)
Diluted	$	0.04	$	0.04		$	(0.10	)	$	(1.03	)
Cash dividends declared per share	$	0.05	$	0.05		$	0.05		$	0.05

92

ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     None

ITEM 9A. Controls and Procedures

An evaluation of the Registrant’s disclosure controls and procedures (as defined in Section 13(a)-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”) as of December 31, 2005 was carried out under the supervision and with the participation of the Registrant’s Chief Executive Officer, Chief Financial Officer and several other members of the Registrant’s senior management. The Registrant’s Chief Executive Officer and Chief Financial Officer concluded that the Registrant’s disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Registrant in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Registrant’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the Security and Exchange Commission’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 December 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The Registrant 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 Registrant’s business. While the Registrant believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Registrant to modify its disclosure controls and procedures.

ITEM 9B. Other Information —Not Applicable

PART III

ITEM 10. Directors and Officers of the Registrant

Information required by this Item 10 is incorporated herein by reference from the definitive proxy statement for the annual meeting of shareholders, to be held in April 2006, under the captions “Election of Directors”, ”The Audit Committee”, ”Audit Committee Financial Expert”, ”Compliance with Section 16”, and “Code of Ethics”, a copy of which will be filed not later than 120 days after the close of the fiscal year.

ITEM 11. Executive Compensation

Information concerning executive compensation is incorporated herein by reference from the definitive proxy statement for the annual meeting of shareholders, to be held in April 2006, under the captions “Executive Compensation”, “Compensation Committee Interlocks and Insider Participation”, “Directors’ Compensation”, “Deferred Compensation Plan”, and “Other Compensation Arrangements”, a copy of which will be filed not later than 120 days after the close of the fiscal year.

93

ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the definitive proxy statement for the annual meeting of shareholders, to be held in April 2006, under the captions “Security Ownership of Shareholder Holding 5% or More” and “Security Ownership of Directors, Nominees for Directors, Most Highly Compensated Executive Officers and All Directors and Officers as a Group”, a copy of which will be filed not later than 120 days after the close of the fiscal year.

Equity Compensation Plan Information

The following table summarizes our equity compensation plans as of December 31, 2005.

	Number of securities
	to be issued upon		Weighted-average		Number of securities
	exercise of		exercise price of		remaining available for
	outstanding options		outstanding options		future issuance under
Plan Category	warrants and rights		warrants and rights		equity compensation plans
Equity compensation plans approved by security holders (1)		185,487		13.22		45,951
Equity compensation plans not approved by security holders		—		—		—

(1) Includes 2003 Stock Option and Incentive Plan and 2003 Recognition and Retention Plan approved at the 2003 Annual Meeting of Shareholders

ITEM 13. Certain Relationships and Related Transactions

Information concerning certain relationships and related transactions is incorporated herein by reference from the definitive proxy statement for the annual meeting of stockholders, to be held in April 2006, under the caption “Transactions with Certain Related Persons”, a copy of which will be filed not later than 120 days after the close of the fiscal year.

ITEM 14. Principal Accountant Fees and Services

Information concerning principal accountant fees and services is incorporated herein by reference from the definitive proxy statement for the annual meeting of stockholders, to be held in April 2006, under the caption “Item 2. Ratification of Auditors”, a copy of which will be filed not later than 120 days after the close of the fiscal year.

94

PART IV

ITEM 15. Exhibits and Financial Statement Schedules

Documents Filed As Part Of This Annual Report on Form 10-K

1.	Financial Statement — See the Financial Statements included in Item 8.
2.	Financial Statement Schedules — Financial statement schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the financial statements.
3.	Exhibits — The exhibits filed as part of this Annual Report on Form 10-K are identified in the Exhibit Index, which Exhibit Index specifically identifies those exhibits that describe or evidence all management contracts and compensation plans or arrangements required to be filed as exhibits to this report. Such Exhibit Index is incorporated herein by reference.

95

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	MONARCH COMMUNITY BANCORP, INC.
Dated: March 21, 2006	By:	/s/ Donald L. Denney
		Donald L. Denney, President
		and Chief Executive Officer

     Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the date indicated.

Signature	Title	Date
/s/ Donald L. DenneyDonald L. Denney	President and Chief Executive Officer (Principal Executive Officer)	March 21, 2006
/s/ Stephen M. RossStephen M. Ross	Chairman of the Board	March 21, 2006
/s/ Ralph A. Micalizzi, Jr.Ralph A. Micalizzi, Jr.	Vice President and Chief Financial Officer (Principal Accounting Officer)	March 21, 2006
/s/ Harold A. AdamsonHarold A. Adamson	Director	March 21, 2006
/s/ Lauren L. BracyLauren L. Bracy	Director	March 21, 2006
/s/ James R. VozarJames R. Vozar	Director	March 21, 2006
/s/ Martin L. MitchellMartin L. Mitchell	Director	March 21, 2006
/s/ Gordon L. WelchGordon L. Welch	Director	March 21, 2006
/s/ Craig W. DallyCraig W. Dally	Director	March 21, 2006
/s/ Richard L. DobbinsRichard L. Dobbins	Director	March 21, 2006

96

Exhibit Index

		Reference to
		Prior Filing or
Exhibit		Exhibit Number
Number	Document	Attached Hereto
3.1	Registrant’s Articles of Incorporation		*
3.2	Registrant’s Bylaws		*
4	Registrant’s Specimen Stock Certificate		*
10.1	Employment Agreement between Monarch Community Bancorp, Inc and Donald L. Denney (incorporated by reference from Form 8-K filed on 9/23/2004)
10.2	Management Continuity Agreement between Monarch Community Bancorp, Inc. and William C. Kurtz and Andrew J. Van Doren (incorporated by reference from Form 8-K filed on 12/21/2004)
10.3	Registrant’s Employee Stock Ownership Plan		*
10.4	Registrant’s 2003 Stock Option and Incentive Plan		**
10.5	Registrant’s Recognition and Retention Plan		**
10.6	Form of Stock Option Agreement		***
10.7	Management Continuity Agreement between Monarch Community Bancorp, Inc. and Ralph A. Micalizzi, Jr.
10.8	2003 Recognition and Retention Plan Restricted Stock Agreement
11	Statement re computation of per share earnings	See Note 1 of the Notes to Consolidated Financial Statements contained in this report
12	Statements re computation of ratios	None
13	Annual Report to Security Holders	Not required
14	Registrant’s Conflict of Interest and Ethics Policy		14
16	Letter re: change in certifying accountant	None
18	Letter re: change in accounting principles	None
21	Subsidiaries of the registrant		21
22	Published report regarding matters submitted to vote of security holders	None
23	Consent of Plante & Moran, PLLC
24	Power of Attorney	Not required
31.1	Rule 13a-14(a) Certification of the Company’s President and Chief Executive Officer		31.1
31.2	Rule 13a-14(a) Certification of the Company’s Chief Financial Officer		31.2
32	Section 1350 Certification.		32

*	Filed on March 27, 2002 as an exhibit to the Registrant’s Registration Statement on Form SB-2 (File No. 333-85018), and incorporated herein by reference
**	Filed on March 19, 2003 as part of Registrant’s Schedule 14A (File No. 000-49814), and incorporated by reference
***	Incorporated by reference from Annual Report on Form 10-KSB for the year ended December 31, 2004

97