Monarch Community Bancorp (MCBF) 10-K 2012 FY Annual report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2012

Commission file number 0-49814

MONARCH COMMUNITY BANCORP, INC.

(Exact name of registrant as specified in its charter)

Maryland	04-3627031
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer 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:

Common Stock, par value $.01 per share registered on OTCQB

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

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

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.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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.  ¨

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

Large Accelerated Filer	¨	Accelerated Filer	¨
Non-Accelerated Filer	¨	Smaller reporting company	x

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

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant, based on the average of bid and ask price market price of such stock as of June 30, 2012 was approximately $1.741 million as reported on the OTCQB. (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 22, 2013, the registrant had 2,049,485 shares of common stock issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE PART III of Form 10-K – Portions of the Registrant’s Proxy Statement for the Annual Meeting of Stockholders.

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 the lives of the corresponding assets and liabilities. Goodwill recorded for the acquisition amounted to $9.6 million and was not amortized but evaluated for impairment at least annually. It was determined to be impaired and written off in 2009. 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% ownership of First Insurance Agency. First Insurance Agency is a licensed insurance agency established to allow for the receipt of fees on insurance services provided to the Bank’s customers.

On June 3, 2006, the Company completed the conversion of the Bank from a federally chartered stock savings institution to a Michigan state chartered commercial bank. As a result of the conversion, the Company became a federal bank holding company regulated by the Board of Governors of the Federal Reserve. The Bank is regulated by the Michigan Office of Financial and Insurance Regulation (“OFIR”) and the Federal Deposit Insurance Corporation (“FDIC”). Prior to the conversion, both the Company and the Bank had been regulated by the federal Office of Thrift Supervision. The Bank’s deposits continue to be insured to the maximum extent allowed by the FDIC. 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 OTCQB 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 home equity loans and a variety of consumer loans. Our originations of consumer loans have steadily declined over the last five years.

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.

2

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, interest bearing 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, 2012, we had assets of $190.3 million, including net loans of $128 million, deposits of $169.5 million and stockholders’ equity of $10.5 million.

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.

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, 2012, we had an 16.09% market share of FDIC-insured deposits in Branch County, a 7.4% market share of FDIC-insured deposits in Calhoun County and a 4.2% 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, 2012, our net loan portfolio totaled $128 million, which constituted 67% 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. All loans must be presented for approval at Management Loan Committee, which is comprised of several senior managers. Loans in which the total credit relationship with the borrower, directly and indirectly, exceeds $500,000 and up to $1.5 million also must be approved by the Board of Directors’ Loan Committee. Loans in which the total credit relationship with the borrower, directly and indirectly, exceeds $1.5 million also must be approved by the Board of Directors. Our legal lending limit is summarized in the Loans to One Borrower paragraph of the Regulation and Supervision section of this document.

3

Loan Portfolio Composition. The following table presents information concerning the composition of our loan portfolio as of the dates indicated.

	December 31, 2012					December 31, 2011					December 31, 2010					December 31, 2009					December 31, 2008
	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent
	(Dollars in thousands)
Real Estate Loans:
One-to four-family	$	69,043		52.60	%	$	78,500		51.16	%	$	93,294		49.10	%	$	108,354		47.70	%	$	124,855		49.80	%
Multi-family		1,183		0.90			765		0.50			4,783		2.52			5,421		2.39			5,728		2.26
Commercial		45,982		35.03			54,308		35.39			62,998		33.15			72,689		32.00			75,730		30.19
Construction or development		1,416		1.08			1,639		1.07			3,873		2.04			9,528		4.20			9,499		3.79
Total real estate loans		117,624		89.61			135,212		88.12			164,948		86.79			195,992		86.29			215,812		86.04
Other loans:
Consumer loans:
Home equity		8,058		6.14			10,499		6.84			14,814		7.80			18,174		8.00			20,677		8.24
Other		1,885		1.43			2,516		1.64			3,403		1.79			4,706		2.07			5,737		2.29
Total consumer loans		9,943		7.57			13,015		8.48			18,217		9.59			22,880		10.07			26,414		10.53
Commercial Business Loans		3,709		2.82			5,212		3.40			6,882		3.62			8,266		3.64			8,609		3.43
Total other loans		13,652		10.39			18,227		11.88			25,099		13.21			31,146		13.71			35,023		13.96
Total Loans		131,276		100.00	%		153,439		100.00	%		190,047		100.00	%		227,138		100.00	%		250,835		100.00	%
Less:
Allowance for loan losses		3,035					4,656					6,850					5,783					2,719
Net deferred loan fees		241					288					429					480					574
Loans in process		—					—					—					—					—
Total Loans, net	$	128,000				$	148,495				$	182,768				$	220,875				$	247,542

4

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

	December 31, 2012					December 31, 2011
	Amount		Percent			Amount		Percent
	(Dollars in thousands)
Fixed-Rate Loans
Real Estate Loans:
One-to-four family	$	49,507		37.7	%	$	58,256		38.0	%
Multi-family		1,183		0.9	%		747		0.5	%
Commercial		44,256		33.7	%		40,151		26.2	%
Construction or development		1,416		1.1	%		686		0.4	%
Total real estate loans		96,362		73.4	%		99,840		65.1	%
Consumer		5,761		4.4	%		8,102		5.3	%
Commercial Business		3,044		2.3	%		4,465		2.9	%
Total fixed-rate loans		105,167		80.1	%		112,407		73.3	%
Adjustable-Rate Loans
Real Estate Loans:
One-to-four family	$	19,536		14.9	%	$	20,244		13.2	%
Multi-family		—		0.0	%		18		0.0	%
Commercial		1,726		1.3	%		14,157		9.2	%
Construction or development		—		0.0	%		953		0.6	%
Total real estate loans		21,262		16.2	%		35,372		23.0	%
Consumer		4,182		3.2	%		4,913		3.2	%
Commercial Business		665		0.5	%		747		0.5	%
Total adjustable-rate loans		26,109		19.9	%		41,032		17.4	%
Total loans		131,276		100	%		153,439		100	%
Less:
Allowance for loan losses		3,035					4,656
Net deferred loan fees		241					288
Loans in process		—					—
Total Loans, net	$	128,000				$	148,495

5

The following table illustrates the contractual maturity of our loan portfolio at December 31, 2012. 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)		459		6.95	%		9,287		6.05	%		80		6.25	%		1,697		6.38	%		163		5.76	%		11,686		6.13	%
After one year through five years		20,321		6.30	%		29,242		5.46	%		460		6.20	%		3,470		6.36	%		3,426		7.30	%		56,919		5.93	%
After five years		48,263		5.74	%		8,636		4.90	%		876		5.44	%		4,776		4.74	%		120		5.75	%		62,671		5.54	%
		69,043					47,165					1,416					9,943					3,709					131,276

⁽¹⁾  Includes demand loans.

The total amount of loans due after December 31, 2013 which have predetermined interest rates is $100 million while the total amount of loans due after such date which have floating or adjustable rates is $19.6 million.

6

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, 2012, one-to-four family residential mortgage loans totaled $69 million, or 52.6% of our gross loan portfolio.

We have originated sub-prime residential mortgage loans since 1985. However in more recent years we have moved away from this type of lending due to the higher risk associated with it. 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, 2012, $14.4 million, or 20.8% of our residential mortgage loans were classified as sub-prime loans as compared to $15.2 million, or 19.4% at December 31, 2011. The decrease is primarily due to normal repayments. 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 typically 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 2012, $192,000, or 33.1%, of our total net charge-offs of $579,000 were due to sub-prime loans as compared to $469,000, or 16.0% of our total net charge-offs of $2.9 million for 2011. During 2012, we have made significant efforts in assisting borrowers who are experiencing financial difficulty. 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 80% of the lesser of the appraised value or purchase price for one-to-four family residential loans. 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 2012 and 2011, we originated no one to four family ARM loans. During the years ended December 31, 2012 and 2011, we originated $58.1 million and $36.0 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. We also offer balloon loans with one, three, five and seven year maturities. 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.

7

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, although that has not been a strategy in recent years.

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 rental properties, commercial properties, retail establishments, churches and small office buildings located in our market area. At December 31, 2012, multi-family and commercial real estate loans totaled $47.2 million or 35.9% of our gross loan portfolio.

Our loans secured by multi-family and commercial real estate are originated with either a fixed or variable interest rate. The interest rate on variable-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 which are typically balloon loans, in general 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.”

8

Construction and Land 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, 2012 we had $1.4 million in construction and land development loans outstanding, representing 1% of our gross loan portfolio.

Construction and land 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 conduct regular inspections of the construction project being financed. 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.

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.

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, 2012, our consumer loan portfolio totaled $9.9 million, or 7.6% of our gross loan portfolio. We offer a variety of secured consumer loans, including home equity loans and lines of credit, auto loans, manufactured housing loans and loans secured by savings deposits; however the majority of new originations are home equity loans and lines of credit. 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 $8.1 million, and comprised 6.1% of our gross loan portfolio at December 31, 2012. These loans may be originated in amounts, together with the amount of the existing first mortgage, of up to 90% of the value of the property securing the loan. The term to maturity on our home equity lines of credit ranges from 3 to 5 years for fixed rate loans and 1 to 15 for variable rate loans. No principal payments are required on most 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.

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, and manufactured housing. 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.

9

Commercial Business Lending. At December 31, 2012, commercial business loans comprised $3.7 million, or 2.8% 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.

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. Operating 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, 2012, there were no financial 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. 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, 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. Adjustable-rate loan originations as a percentage of total originations were 0% in 2012 and 2011. We sell a significant 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
	2012			2011
	(Dollars in thousands)
Originations by type:
Real Estate:
One-to-four family	$	58,054		$	37,289
Multi-family		600			—
Commercial		10,551			4,104
Construction or development		159			603
Total real estate loans		69,364			41,996
Consumer Loans:
Home Equity		653			722
Other		—			57
Commercial business		889			422
Total loans originated		70,906			43,197
Sales and Repayments:
One-to-four family loans sold		53,340			32,397
Commercial real estate loans sold		—			—
Principal repayments		39,729			41,237
Total reductions		93,069			73,634
Increase (decrease) in other items, net		(1,668	)		3,836
Net decrease	$	(20,495	)	$	(34,273	)

Asset Quality

When a borrower fails to make a payment on a residential 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 contacts the borrower to determine the reason for the delinquency and to urge the borrower to bring the loan current. Once the loan becomes 30 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 Delinquency Committee for a decision whether to forebear 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 Delinquency Committee declines to forbear collection activity, then when the loan becomes 45 to 60 days delinquent, the file is reviewed by the Delinquency 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 Delinquency 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.

11

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 Delinquency 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.

Delinquent Loans. The following tables set forth our loan delinquencies (60 days past due and over) by type, number, amount and percentage of type at the dates indicated:

	December 31, 2012
	Loans Delinquent For:
	60-89 Days							90 Days and Over							Total Delinquent Loans
					Percent of Loan							Percent of Loan							Percent of Loan
	Number		Amount		Category			Number		Amount		Category			Number		Amount		Category
	(Dollars in Thousands)
Real Estate
One-to-four family		15		855		1.24	%		5		316		0.46	%		20		1,171		1.70	%
Multi-family		—		—		0.00	%		—		—		0.00	%		—		—		0.00	%
Commercial		—		—		0.00	%		4		1,560		3.39	%		4		1,560		3.39	%
Construction or development		—		—		0.00	%		—		—		0.00	%		—		—		0.00	%
Total real estate loans		15		855		0.73	%		9		1,876		1.59	%		24		2,731		2.32	%
Consumer		1		7		0.07	%		1		10		0.10	%		2		17		0.17	%
Commercial Business		—		—		0.00	%		1		120		3.24	%		1		120		3.24	%
Total		16		862		0.66	%		11		2,006		1.53	%		27		2,868		2.18	%

	December 31, 2011
	Loans Delinquent For:
	60-89 Days							90 Days and Over							Total Delinquent Loans
					Percent of Loan							Percent of Loan							Percent of Loan
	Number		Amount		Category			Number		Amount		Category			Number		Amount		Category
	(Dollars in Thousands)
Real Estate
One-to-four family		4	$	228		0.29	%		6	$	545		0.69	%		10	$	773		0.98	%
Multi-family		—		—		0.00	%		—		—		0.00	%		—		—		0.00	%
Commercial		1		246		0.45	%		5		3,016		5.55	%		6		3,262		6.01	%
Construction or development		—		—		0.00	%		—		—		0.00	%		—		—		0.00	%
Total real estate loans		5	$	474		0.35	%		11	$	3,561		2.63	%		16	$	4,035		2.98	%
Consumer		—		—		0.00	%		—		—		0			—		—		0
Commercial Business		—		—		0.00	%		4		1,166		22.37	%		4		1,166		22.37	%
Total		5	$	474		0.31	%		15	$	4,727		3.08	%		20	$	5,201		3.39	%

12

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. Foreclosed assets include assets acquired in settlement of loans.

	December 31,
	2012			2011			2010			2009			2008
	(Dollars in Thousands)
Non-accruing loans:
One-to-four family		2,437			966			3,106			3,484			622
Multi-family		—			—			803			874			164
Commercial real estate		5,008			6,278			8,288			7,139			459
Construction or development		—			—			—			2,507			1,298
Consumer		9			—			253			—			28
Commercial business		316			1,521			1,625			1,566			—
Total		7,770			8,765			14,075			15,570			2,571
Accruing loans delinquent 90 days or more:
One-to-four family		—			—			—			—			—
Multi-family		—			—			—			—			—
Commercial real estate		—			—			—			—			—
Construction or development		—			—			—			—			—
Consumer		—			—			—			—			—
Commercial business		—			—			—			—			—
Total		—			—			—			—			—
Foreclosed assets:
One-to-four family (1)		882			2,653			1,198			2,577			1,669
Multi-family		—			54			292			122			—
Commercial real estate		345			1,526			908			140			407
Construction or development		17			—			574			—			—
Consumer		—			125			—			—			—
Commercial business		—			75			—			—			—
Total		1,244			4,433			2,972			2,839			2,076
Total non-performing assets	$	9,014		$	13,198		$	17,047		$	18,409		$	4,647
Total as a percentage of total assets		4.74	%		6.34	%		6.64	%		6.50	%		1.59	%

(1) Includes $434,000, $1.9 million, $1.4 million, $1.1 million and $1.3 million in real estate in judgment and subject to redemption at December 31, 2012, 2011, 2010, 2009 and 2008 respectively.

For the years ended December 31, 2012 and 2011, respectively, there was $397,000 and $621,000 of gross interest income which would have been recorded had non-accruing loans been current in accordance with their original terms.

13

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 FDIC and OFIR 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 FDIC and OFIR, which may order the establishment of additional general or specific loss allowances.

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, 2012, we had classified $18.2 million of our assets as substandard, none as doubtful and none as loss. The total amount classified as substandard and doubtful represented 175% of the Bank’s equity capital and 9.5% of the Bank’s assets at December 31, 2012. The allowance for loan losses at December 31, 2012 includes $133,000 related to substandard loans and $0 related to doubtful loans. At December 31, 2012, $18.2 million and $0 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 provision for loan losses totaling a negative $1.0 million for the year ended December 31, 2012 compared to $733,000 recorded for the year ended December 31, 2011. The provision for loan losses is charged 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, 2012 and 2011—Provision for Loan Losses” for a discussion of the reasons for the change in our loan loss provision.

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.

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 collectability of the portfolio as of the evaluation date.

14

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 collectability 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 collectability of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.

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.

15

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

	December 31,
	2012			2011			2010			2009			2008
Balance at beginning of year	$	4,656		$	6,850		$	5,783		$	2,719		$	1,824
Charge-offs:
One-to-four family		1,120			2,116			3,901			2,288			879
Multi-family		—			286			372			10			—
Commercial real estate		579			590			4,801			4,299			321
Construction or development		6			3			1,319			3,075			50
Consumer		345			441			389			533			532
Commercial business		22			81			110			352			239
Total		2,072			3,517			10,892			10,557			2,021
Recoveries:
One-to-four family		23			120			62			20			4
Multi-family		1			4			32			1			—
Commercial real estate		1,241			235			9			14			2
Construction or development		—			—			36			—			—
Consumer		221			196			213			215			198
Commercial business		7			35			5			22			—
Total		1,493			590			357			272			204
Net charge-offs:		579			2,927			10,535			10,285			1,817
Allowance acquired in acquisition		—			—			—			—			—
Additions charged to operations		(1,042	)		733			11,602			13,349			2,712
Provision recovered from operations		—			—			—			—			—
Balance at end of year	$	3,035		$	4,656		$	6,850		$	5,783		$	2,719
Ratio of net charge-offs during the year to average loans outstanding during the year		0.40	%		1.70	%		4.91	%		4.24	%		0.75	%
Allowance as a percentage of non-performing loans		39.06	%		53.12	%		48.67	%		37.14	%		105.76	%
Allowance as a percentage of total loans (end of year)		2.31	%		3.03	%		3.60	%		2.55	%		1.08	%

16

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

December 31,
	2012					2011					2010
	Amount of		Percentage			Amount of		Percentage			Amount of		Percentage
	Loan Loss		of		��	Loan Loss		of			Loan Loss		of
	Allowance		Allowance			Allowance		Allowance			Allowance		Allowance
One-to-four family	$	1,965		64.7	%	$	2,944		63.2	%	$	3,953		57.7	%
Multi-family and non-residential real estate		818		27.0	%		1,307		28.1	%		2,084		30.4	%
Construction or development		10		0.3	%		101		2.2	%		130		1.9	%
Consumer		230		7.6	%		259		5.6	%		503		7.3	%
Commercial business		12		0.4	%		45		0.9	%		180		2.6	%
Total	$	3,035		100.0	%	$	4,656		100.0	%	$	6,850		100.0	%

	2009					2008
	Amount of		Percentage			Amount of		Percentage
	Loan Loss		of			Loan Loss		of
	Allowance		Allowance			Allowance		Allowance
One-to-four family	$	2,576		44.5	%	$	1,618		59.5	%
Multi-family and non-residential real estate		903		15.6	%		533		19.6	%
Construction or development		10		0.2	%		75		2.8	%
Consumer		393		6.8	%		305		11.2	%
Commercial business		1,901		32.9	%		188		6.9	%
Total	$	5,783		100.0	%	$	2,719		100.0	%

Investment Activities

Commercial banks 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, state chartered commercial banks 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 state chartered commercial bank 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.”

17

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 significant amount of collateralized mortgage obligation securities. See Note 4 of the Notes to Consolidated Financial Statements.

The following table sets forth the composition of our securities portfolio at the dates indicated (dollars in thousands):

	December 31, 2012							December 31, 2011
					Percent of							Percent of
			Fair		Total					Fair		Total
	Amortized		Market		Fair Market			Amortized		Market		Fair Market
	Cost		Value		Value			Cost		Value		Value
Available-for-sale securities:
Collateralized Mortgage obligations	$	6,586	$	6,699		55.7	%	$	7,732	$	7,780		53.6	%
U.S. government agency obligations		2,007		2,031		16.9	%		3,423		3,426		23.6	%
Mortgage-backed securities		609		653		5.4	%		938		998		6.9	%
Obligations of states and political subdivisions		660		664		5.5	%		326		332		2.3	%
Total available-for-sale securities	$	9,862	$	10,047		83.5	%	$	12,419	$	12,536		86.4	%
Held-to-maturity securities:
Certificates of Deposit	$	1,981	$	1,981		16.5	%	$	1,981	$	1,981		13.6	%
Total investment securities	$	11,843	$	12,028		100.0	%	$	14,400	$	14,517		100.0	%

18

The maturities of the investment securities portfolio, excluding FHLB stock, as of December 31, 2012 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
2012	(Dollars in Thousands)
Available-for-sale securities:
Collateralized Mortgage obligations	$	—		0.00	%	$	—		0.00	%	$	—		0.00	%	$	6,586		3.00	%	$	6,586		3.00	%
U.S. government agency obligations		—		0.00	%		2,007		1.19	%		—		0.00	%		—		0.00	%		2,007		1.19	%
Mortgage-backed securities		—		0.00	%		—		0.00	%		—		0.00	%		609		5.00	%		609		5.00	%
Obligations of states and political subdivisions		—		0.00	%		492		1.75	%		168		3.89	%		—		0.00	%		660		2.29	%
Total available-for-sale securities		—		0.00	%		2,499		1.30	%		168		3.89	%		7,195		3.17	%		9,862		2.71	%
Held-to-maturity securities:
Certificates of Deposit		741		1.00	%		1,240		1.37	%		—		0.00	%		—		0.00	%		1,981		1.23	%
Total investment securities	$	741		1.00	%	$	3,739		1.32	%	$	168		3.89	%	$	7,195		3.17	%	$	11,843		2.46	%

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 brokered deposits in the past. At December 31, 2012, we had $2.2 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.

19

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

	Year Ended December 31,
	2012			2011
	(Dollars in Thousands)
Opening balance	$	174,185		$	206,028
Net deposits (withdrawals)		(6,766	)		(34,337	)
Interest credited		2,041			2,494
Ending balance		169,460			174,185
Net decrease	$	(4,725	)	$	(31,843	)
Percent (decrease)		-2.71	%		-15.46	%

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,
	2012					2011
	Amount		Percent of Total			Amount		Percent of Total
	(Dollars in Thousands)					(Dollars in Thousands)
Transaction and Savings Deposits:
Non-interest bearing accounts		17,610		10.4	%	$	19,683		11.3	%
Savings accounts		23,719		14.0	%		20,612		11.8	%
Checking & NOW accounts		26,008		15.3	%		24,477		14.1	%
Money market accounts		34,851		20.6	%		34,951		20.1	%
Total transaction and savings		102,188		60.3	%	$	99,723		57.3	%
Certificates:
0.00-1.99%		43,066		25.4	%		43,851		25.2	%
2.00-3.99%		18,053		10.7	%		21,118		12.1	%
4.00-5.99%		6,153		3.6	%		9,493		5.4	%
Total certificates		67,272		39.7	%		74,462		42.7	%
Total deposits		169,460		100.0	%	$	174,185		100.0	%

20

The following table indicates the amount of our certificates of deposit by time remaining until maturity as of December 31, 2012:

	Maturity
	3 Months or less		Over 3 to 6 Months		Over 6 to 12 Months		Over 12 Months		Total
	(Dollars in Thousands)
Certificates of deposit less than $100,000	$	5,402	$	8,273	$	10,169	$	13,033	$	36,877
Certificates of deposit of $100,000 or more		3,437		4,783		8,565		13,610		30,395
Total certificates of deposit	$	8,839	$	13,056	$	18,734	$	26,643	$	67,272

The following table shows rate and maturity information for our certificates of deposit as of December 31, 2012:

	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, 2013		5,697			2,331			811			—			8,839		13.1	%
June 30, 2013		7,675			5,231			150			—			13,056		19.4	%
September 30, 2013		5,910			1,370			1,926			—			9,206		13.7	%
December 31, 2013		7,535			179			1,814			—			9,528		14.2	%
March 31, 2014		1,632			1,659			316			—			3,607		5.4	%
June 30, 2014		1,780			1,467			252			—			3,499		5.2	%
September 30, 2014		2,608			1,111			—			—			3,719		5.5	%
December 31, 2014		2,031			333			236			—			2,600		3.9	%
Thereafter		8,198			4,372			648			—			13,218		22.0	%
Total	$	43,066		$	18,053		$	6,153		$	—		$	67,272		100.0	%
Percent of total		64.02	%		26.84	%		9.15	%		0.00	%

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 and Fed funds purchased from a correspondent bank.

We may obtain advances from the Federal Home Loan Bank of Indianapolis upon the security of certain of our mortgage loans and investment 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, 2012, we had $7.1 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.

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

	Year Ended December 31,
	2012		2011
	(Dollars in Thousands)		(Dollars in Thousands)
Maximum Balance:
FHLB advances	$	20,175	$	35,092
Fed funds purchased	$	—	$	—
Average Balance:
FHLB advances	$	13,268	$	27,866
Fed funds purchased	$	—	$	—

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

	December 31,
	2012			2011
	(Dollars in Thousands)			(Dollars in Thousands)
FHLB advances	$	7,059		$	20,175
Fed funds purchased	$	—		$	—
Weighted average interest rate of FHLB advances
FHLB advances		4.10	%		4.74	%
Fed funds purchased		0.00	%		0.00	%

Competition

We face strong competition in originating real estate and other loans and in attracting deposits. Competition comes from a wide array of sources including but not limited to mortgage brokers, savings institutions, other commercial banks, and credit unions including non-local Internet based and telephone-based competition.

Employees

At December 31, 2012, Monarch Community Bank had a total of 106 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.

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.

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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 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. The Company 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 payer 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. Monarch Community Bancorp has elected to file a consolidated return with the Bank.

State Taxation

The Company and the Bank are subject to the Michigan Business Tax (MBT). The MBT is a consolidated tax based on equity of the corporation. 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, real property taxes, and personal property taxes.

Regulation and Supervision

General

The growth and earnings performance of the Company and the Bank can be affected not only by management decisions and general economic conditions, but also by the policies of various governmental regulatory authorities including, but not limited to, the Federal Reserve, the FDIC, the OFIR, the Internal Revenue Service and state taxing authorities. Financial institutions and their holding companies are extensively regulated under federal and state law. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty.

Federal and state laws and regulations generally applicable to financial institutions, such as the Company and the Bank, regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds and the depositors, rather than the shareholders, of financial institutions.

The Company’s common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Therefore, the Company 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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The Company’s common stock held by persons who are affiliates (generally officers, directors and principal stockholders) of the Company may not be resold without registration unless sold in accordance with certain resale restrictions. If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three-month period.

The following references to material statutes and regulations affecting the Company and the Bank are brief summaries and do not purport to be complete, and are qualified in their entirety by reference to such statues and regulations. Any change in applicable law or regulations may have a material effect on the business of the Company and the Bank. See “Recent Developments” contained in “Management’s Discussion and Analysis.”

The Company

General. The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, the Company is required to register with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the “BHCA”). In accordance with Federal Reserve regulations, the Company must act as a source of financial strength to the Bank and to commit resources to support the Bank. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve and is required to file periodic reports of its operations and such additional information as the Federal Reserve may require.

Investments and Activities. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company. The Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States without regard to geographic restrictions or reciprocity requirements imposed by state law, but subject to certain conditions, including limitations on the aggregate amount of deposits that may be held by the acquiring holding company and all of its insured depository institution affiliates.

The BHCA limits the activities of a bank holding company that has not qualified as a financial holding company to banking and the management of banking organizations, and to certain non-banking activities that are deemed to be so closely related to banking or managing or controlling banks as to be a proper incident to those activities. Such non-banking activities include, among other things: operating a mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; and providing securities brokerage services for customers.

In November 1999, the Gramm-Leach-Bliley Act (the “GLB Act”) was signed into law. Under the GLB Act, a bank holding company whose subsidiary depository institutions all are well-capitalized and well-managed and who have Community Reinvestment Act ratings of at least “satisfactory” may elect to become a financial holding company. A financial holding company is permitted to engage in a broader range of activities than are permitted to bank holding companies.

Those expanded activities include any activity which the Federal Reserve (in certain instances in consultation with the Department of the Treasury) determines, by order or regulation, to be financial in nature or incidental to such financial activity, or to be complementary to a financial activity and not to pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Such expanded activities include, among others: insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability or death, or issuing annuities, and acting as principal, agent, or broker for such purposes; providing financial, investment, or economic advisory services, including advising a mutual fund; and underwriting, dealing in, or making a market in securities. The Company has not elected to be treated as a financial holding company.

Federal law also prohibits the acquisition of control of a bank holding company, such as the Company, by a person or a group of persons acting in concert, without prior notice to the Federal Reserve. Control is defined in certain cases as the acquisition of 10% of the outstanding shares of a bank holding company.

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Capital Requirements. The Federal Reserve uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guideline levels, a bank holding company may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses.

The Federal Reserve capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: a risk-based requirement expressed as a percentage of total risk-weighted assets, and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least 4% must be Tier I capital (which consists principally of shareholders’ equity). The leverage requirement consists of a minimum ratio of Tier I capital to total assets of 3% for the most highly rated bank holding companies, with minimum requirements of 4% to 5% for all others.

The risk-based and leverage standards presently used by the Federal Reserve are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier I capital less all intangible assets), well above the minimum levels.

Pursuant to its Small Bank Holding Company Policy, the Federal Reserve exempts certain bank holding companies from the capital requirements discussed above. The exemption applies only to bank holding companies with less than $500 million in consolidated assets that: (i) are not engaged in significant nonbanking activities either directly or through a nonbank subsidiary; (ii) do not conduct significant off-balance sheet activities (including securitization and asset management or administration) either directly or through a nonbank subsidiary; and (iii) do not have a material amount of debt or equity securities outstanding (other than trust preferred securities) that are registered with the SEC. The Company qualifies for this exemption and, thus, is required to meet applicable capital standards on a bank-only basis. However, bank holding companies with assets of less than $500 million are subject to various restrictions on debt including requirements that debt is retired within 25 years of being incurred, that the debt to equity ratio is .30 to 1 within 12 years of the incurrence of debt and that dividends generally cannot be paid if the debt to equity ratio exceeds 1 to 1.

Regulatory Agreement. On September 21, 2010, the Company entered into a written agreement with the Federal Reserve (the “Written Agreement”). Among other things, the Written Agreement requires that the Company obtain the approval of the Federal Reserve prior to paying a dividend; prohibits the Company from purchasing or redeeming any shares of its stock without the prior written approval of the Federal Reserve, and; requires the Company to submit cash flow projections for the Company to the Federal Reserve on a quarterly basis.

Dividends. As described below under the heading “Recent Developments,” as a result of the Company’s issuance of Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Preferred Shares”) to the U.S. Department of the Treasury (the “Treasury”) pursuant to the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”), the Company is restricted in the payment of dividends and, without the Treasury’s consent, may not declare or pay any dividend on the Company common stock. In addition, as long as the Preferred Shares are outstanding, dividend payments are prohibited until all accrued and unpaid dividends are paid on such Preferred Shares, subject to certain limited exceptions. As discussed above, the Written Agreement also requires the Company to obtain the approval of the Federal Reserve prior to paying a dividend.

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Recent Developments.The Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008. Pursuant to EESA, the Treasury has the authority to among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. Pursuant to its authority under EESA, the Treasury created the TARP CPP under which the Treasury was authorized to invest in non-voting, senior preferred stock of U.S. banks and savings associations or their holding companies.

The Company elected to participate in the CPP and on February 6, 2009, completed the sale of $6.785 million in Preferred Shares to the Treasury. The Company issued 6,785 shares of Preferred Shares, with a $1,000 per share liquidation preference, and a warrant to purchase up to 260,962 shares of the Company’s common stock at an exercise price of $3.90 per share (the “Warrant”).

The Preferred Shares issued by the Company pay cumulative dividends of 5% a year for the first five years and 9% a year thereafter. The terms of the Preferred Shares, as amended by the American Recovery and Reinvestment Act of 2009 (“ARRA”), provide that the Preferred Shares may be redeemed by the Company, in whole or in part, upon approval of the Treasury and the Company’s primary banking regulators. Both the Preferred Shares and the Warrant will be accounted for as components of regulatory Tier 1 capital. Among other restrictions, the securities purchase agreement between the Company and the Treasury limits the Company’s ability to repurchase its stock and subjects the Company to certain executive compensation limitations. Pursuant to the Written Agreement, the Company may not purchase any of its shares of stock without the prior written approval of the Federal Reserve.

In April 2010, the Company announced that it would defer scheduled dividend payments on the principal outstanding on the Preferred Shares. Dividends are accrued based on the rates, liquidation preference and time since last quarterly dividend payment. Interest on dividends is accrued based on the rates and time since last scheduled quarterly dividend payment.

ARRA was enacted on February 17, 2009. Among other things, ARRA sets forth additional limits on executive compensation at all financial institutions receiving federal funds under any program, including the CPP, both retroactively and prospectively. The executive compensation restrictions in ARRA include among others: limits on compensation incentives, prohibitions on “Golden Parachute Payments”, the establishment by publicly registered CPP recipients of a board compensation committee comprised entirely of independent directors for the purpose of reviewing employee compensation plans, and the requirement of a non-binding vote on executive pay packages at each annual shareholder meeting until the government funds are repaid. In addition, if dividends on the Preferred Shares are not paid in full for six dividend periods, the Treasury will have the right to elect two directors to the Company’s Board of Directors. The Treasury’s right to elect directors ends when full dividends have been paid for four consecutive dividend periods. As discussed above, the Company has announced that it would defer scheduled dividend payments on the Preferred Shares.

In June 2010, the Federal Reserve issued final guidance to ensure that incentive compensation arrangements at financial institutions take into account risk and are consistent with safe and sound practices. The guidance does not set forth any formulas or pay caps, but sets forth certain principles which companies would be required to follow with respect to certain employees and groups of employees that may expose the institution to material amounts of risk.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) became law on July 21, 2010. The Dodd-Frank Act constitutes one of the most significant efforts in recent history to comprehensively overhaul the financial services industry and will affect large and small financial institutions alike. While some of the provisions of the Dodd-Frank Act take effect immediately, many of the provisions have delayed effective dates and their implementation will require the issuance of numerous new regulations.

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The Dodd-Frank Act deals with a wide range of regulatory issues including, but not limited to: mandating new capital requirements that would require certain bank holding companies to be subject to the same capital requirements as their depository institutions; eliminating (with certain exceptions) trust preferred securities; codifying the Federal Reserve’s Source of Strength doctrine; creating a Bureau of Consumer Financial Protection (the “CFPB”) which will have the power to exercise broad regulatory, supervisory and enforcement authority concerning both existing and new consumer financial protection laws; permanently increasing federal deposit insurance protection to $250,000 per depositor; extending the unlimited coverage for qualifying non-interest bearing transactional accounts until December 31, 2012; increasing the ratio of reserves to deposits minimum to 1.35 percent; assessing premiums for deposit insurance coverage on average consolidated total assets less average tangible equity, rather than on a deposit base; authorizing the assessment of examination fees; establishing new standards and restrictions on the origination of mortgages; permitting financial institutions to pay interest on business checking accounts; limiting interchange fees payable on debit card transactions; and implementing requirements on boards, corporate governance and executive compensation for public companies.

In July 2011, the CFPB took over many of the consumer financial functions that had been assigned to the federal banking agencies and other designated agencies. The CFPB has broad rulemaking authority and there is considerable uncertainty as to how the CFPB actually will exercise its regulatory, supervisory, examination and enforcement authority.

In June 2012 the federal banking regulators released three proposed rules relating to minimum capital requirements for U.S. banking organizations including all banks, savings associations, bank holding companies with greater than $500 million of assets and all savings and loan holding companies which closely track the requirements set forth by the Basel Committee on Banking Supervision, commonly known as Basel III. The proposed rules would require, among other provisions, that banks maintain higher capital reserves, primarily comprised of common equity capital meeting stringent new standards. Additionally, the proposed rules would enact requirements found in the Dodd-Frank Act that banks use alternative risk weighting, instead of “credit ratings,” for the calculation of risk-weighted assets. The third proposed rule would generally apply only to the largest U.S. banking organizations and would change standards related to securitizations, treatment of counterparty credit risk and disclosure requirements regarding capital instruments and securitization exposures. The Basel III rules were to go into effect on January 1, 2013, but due to numerous comments, the federal banking regulators announced in November 2012 that the effective date would be delayed. Final rules could change significantly from the proposed rules. Therefore, it is unclear how the Company and the Bank will be affected.

The complete impact of the Dodd-Frank Act is unknown since many of the substantive requirements will be contained in the many rules and regulations to be implemented. However, the Dodd-Frank Act has had and will have significant and immediate effects on banks and bank holding companies in many areas. It is expected that the Dodd-Frank Act will increase the cost of doing business in the banking industry.

The Bank

General. The Bank is a Michigan state-chartered bank, the deposit accounts of which are insured by the FDIC. As a state-chartered non-member bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the OFIR, as the chartering authority for state banks, and the FDIC, as administrator of the deposit insurance fund, and to the statutes and regulations administered by the OFIR and the FDIC governing such matters as capital standards, mergers, establishment of branch offices, subsidiary investments and activities and general investment authority. The Bank is required to file reports with the OFIR and the FDIC concerning its activities and financial condition and is required to obtain regulatory approvals prior to entering into certain transactions, including mergers with, or acquisitions of, other financial institutions.

Business Activities.The Bank’s activities are governed primarily by Michigan’s Banking Code of 1999 (the “Banking Code”) and the Federal Deposit Insurance Act (“FDI Act”). The FDI Act, among other things, requires that federal banking regulators intervene promptly when a depository institution experiences financial difficulties; mandates the establishment of a risk-based deposit insurance assessment system; and requires imposition of numerous additional safety and soundness operational standards and restrictions. The GLB Act, which amended the FDI Act, among other things, loosens the restrictions on affiliations between entities engaged in certain financial, securities, and insurance activities; imposes restrictions on the disclosure of consumers’ nonpublic personal information; and institutes certain reforms of the Federal Home Loan Bank System.

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The federal laws contain provisions affecting numerous aspects of the operation and regulation of federally insured banks and empower the FDIC, among other agencies, to promulgate regulations implementing their provisions.

Branching. Michigan banks, such as the Bank, have the authority under Michigan law to establish branches throughout Michigan and in any state, the District of Columbia, any U.S. territory or protectorate, and foreign countries, subject to the receipt of all required regulatory approvals.

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allows the FDIC and other federal bank regulators to approve applications for mergers of banks across state lines without regard to whether such activity is contrary to state law. After establishing branches in a state through an interstate merger, a bank can establish and acquire additional branches at any location in the state where any bank involved in the merger could have established or acquired branches under applicable federal or state law. Financial institutions utilized mergers for interstate branching purposes since some states prohibited de novo branching or had reciprocity requirements. However, the Dodd-Frank Act removed such restrictions on interstate branching. As a result of the Dodd-Frank Act, interstate branching authority has been expanded and a state or national bank may open a de novo branch in another state if the law of the state where the branch is to be located would permit a state bank chartered by that state to open the branch.

Loans to One Borrower. Under Michigan law, a bank’s total loans and extensions of credit and leases to one borrower is limited to 15% of the bank’s capital and surplus, subject to several exceptions. This limit may be increased to 25% of the bank’s capital and surplus upon approval by a 2/3 vote of its board of directors. Certain loans, including loans secured by bonds or other instruments of the United States and fully guaranteed by the United States as to principal and interest, are not subject to the limit just referenced. In addition, certain loans, including loans arising from the discount of nonnegotiable consumer paper which carries a full recourse endorsement or unconditional guaranty of the person transferring the paper, are subject to a higher limit of 30% of capital and surplus. At December 31, 2012, the Bank’s legal lending limit for loans to one borrower was $2.2 million; the Bank’s legal lending limit with approval of two-thirds of the Board of Directors was $3.7 million.

Enforcement. The OFIR and FDIC each have enforcement authority with respect to the Bank. The Commissioner of the OFIR has the authority to issue cease and desist orders to address unsafe and unsound practices and actual or imminent violations of law and to remove from office bank directors and officers who engage in unsafe and unsound banking practices and who violate applicable laws, orders, or rules. The Commissioner of the OFIR also has authority in certain cases to take steps for the appointment of a receiver or conservator of a bank.

The FDIC has similar broad authority, including authority to bring enforcement actions against all “institution-affiliated parties” (including shareholders, directors, officers, employees, attorneys, consultants, appraisers and accountants) who knowingly or recklessly participate in any violation of law or regulation or any breach of fiduciary duty, or other unsafe or unsound practice likely to cause financial loss to, or otherwise have an adverse effect on, an insured institution. Civil penalties under federal law cover a wide range of violations and actions. Criminal penalties for most financial institution crimes include monetary fines and imprisonment. In addition, the FDIC has substantial discretion to impose enforcement action on banks that fail to comply with its regulatory requirements, particularly with respect to capital levels. Possible enforcement actions range from requiring the preparation of a capital plan or imposition of a capital directive, to receivership, conservatorship, or the termination of deposit insurance.

Assessments and Fees. The Bank pays a supervisory fee to the OFIR of not less than $5,000 and not more than 25 cents for each $1,000 of total assets. The fee incurred in 2012 was $47,637. This fee is invoiced prior to July 1 each year and is due no later than August 15. The OFIR imposes additional fees, in addition to those charged for normal supervision, for applications, special evaluations and analyses, and examinations.

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Regulatory Capital Requirements. The Bank is required to comply with capital adequacy standards set by the FDIC. The FDIC may establish higher minimum requirements if, for example, a bank has previously received special attention or has a high susceptibility to interest rate risk. Banks with capital ratios below the required minimum are subject to certain administrative actions. More than one capital adequacy standard applies, and all applicable standards must be satisfied for an institution to be considered to be in compliance. There are three basic measures of capital adequacy: a total risk-based capital measure, a Tier 1 risk-based capital ratio; and a leverage ratio.

The risk-based framework was adopted to assist in the assessment of capital adequacy of financial institutions by, (i) making regulatory capital requirements more sensitive to differences in risk profiles among organizations; (ii) introducing off-balance-sheet items into the assessment of capital adequacy; (iii) reducing the disincentive to holding liquid, low-risk assets; and (iv) achieving greater consistency in evaluation of capital adequacy of major banking organizations throughout the world. The risk-based guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items to different risk categories. An institution’s risk-based capital ratios are calculated by dividing its qualifying capital by its risk-weighted assets.

Qualifying capital consists of two types of capital components: “core capital elements” (or Tier 1 capital) and “supplementary capital elements” (or Tier 2 capital). Tier 1 capital is generally defined as the sum of core capital elements less goodwill and certain other intangible assets. Core capital elements consist of (i) common shareholders’ equity, (ii) noncumulative perpetual preferred stock (subject to certain limitations), and (iii) minority interests in the equity capital accounts of consolidated subsidiaries. Tier 2 capital consists of (i) allowance for loan and lease losses (subject to certain limitations); (ii) perpetual preferred stock which does not qualify as Tier 1 capital (subject to certain conditions); (iii) hybrid capital instruments and mandatory convertible debt securities; (iv) term subordinated debt and intermediate term preferred stock (subject to limitations); and (v) net unrealized holding gains on equity securities.

Under current capital adequacy standards, the Bank must meet a minimum ratio of qualifying total capital to risk-weighted assets of 8%. Of that ratio, at least half, or 4%, must be in the form of Tier 1 capital.

The Bank must also meet a leverage capital requirement. In general, the minimum leverage capital requirement is not less than 3% Tier 1 capital to total assets if the bank has the highest regulatory rating and is not anticipating or experiencing any significant growth. All other banks should have a minimum leverage capital ratio of not less than 4%.

The Dodd-Frank Act requires the FDIC to establish minimum leverage and risk-based capital requirements to apply to insured depository institutions. The Dodd-Frank Act additionally requires capital requirements to be countercyclical so that the required amount of capital increases in times of economic expansion and decreases in times of economic contraction, consistent with safety and soundness.

As described above, in June 2012 the federal banking regulators released three proposed rules relating to minimum capital requirements for U.S. banking organizations which closely track the requirements commonly known as Basel III. The proposals do not apply to bank holding companies with less than $500 million in assets; however, many of the proposed requirements would apply to the Bank. Namely, the proposed rules would modify standards for risk-weighted assets calculation, set new minimum capital requirements and refine capital quality through various eligibility restrictions. Since the rules have not been finalized, it is unclear how the Company and the Bank will be affected; however, it is anticipated that capital requirements will be raised.

As described below, the Bank is required to meet higher capital requirements due to the existence of the Consent Order (as defined below).

Prompt Corrective Regulatory Action. The FDIC is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization. Generally, a bank is considered “well capitalized” if its risk-based capital ratio is at least 10%, its Tier 1 risk-based capital ratio is at least 6%, its leverage ratio is at least 5%, and the bank is not subject to any written agreement, order, or directive by the FDIC.

A bank generally is considered “adequately capitalized” if it does not meet each of the standards for well-capitalized institutions, and its risk-based capital ratio is at least 8%, its Tier 1 risk-based capital ratio is at least 4%, and its leverage ratio is at least 4% (or 3% if the institution receives the highest rating under the Uniform Financial Institution Rating System). A bank that has a risk-based capital ratio less than 8%, or a

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Tier 1 risk-based capital ratio less than 4%, or a leverage ratio less than 4% (3% or less for institutions with the highest rating under the Uniform Financial Institution Rating System) is considered to be “undercapitalized”. A bank that has a risk-based capital ratio less than 6%, or a Tier 1 capital ratio less than 3%, or a leverage ratio less than 3% is considered to be “significantly undercapitalized,” and a bank is considered “critically undercapitalized” if its ratio of tangible equity to total assets is equal to or less than 2%.

Subject to a narrow exception, the FDIC is required to appoint a receiver or conservator for a bank that is “critically undercapitalized.” In addition, a capital restoration plan must be filed with the FDIC within 45 days of the date a bank receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Compliance with the plan must be guaranteed by each company that controls a bank that submits such a plan, up to an amount equal to 5% of the bank’s assets at the time it was notified regarding its deficient capital status. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions, and expansion. The FDIC could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.

Deposit Insurance. The Bank’s deposits are insured up to applicable limitations by a deposit insurance fund administered by the FDIC. As an FDIC insured institution, the Bank is required to pay deposit insurance premium assessments to the deposit insurance fund pursuant to a risk-based assessment system. In October 2008, the basic limit on federal deposit insurance coverage was raised from $100,000 to $250,000 per depositor on a temporary basis. However, the Dodd-Frank Act permanently raised the basic limit on deposit insurance coverage from $100,000 to $250,000 per depositor. In addition, in November 2010, pursuant to the Dodd-Frank Act, the FDIC issued a final rule to provide temporary unlimited deposit insurance coverage for non-interest bearing accounts from December 31, 2010 through December 31, 2012. This coverage was not extended and expired on December 31, 2012.

Under the FDIC’s risk based assessment regulations there are four risk categories, and each insured institution is assigned to a risk category based on capital levels and supervisory ratings. Well-capitalized institutions with CAMELS composite ratings of 1 or 2 are placed in Risk Category I while other institutions are placed in Risk Categories II, III or IV depending on their capital levels and CAMELS composite ratings. The assessment rates may be changed by the FDIC as necessary to maintain the insurance fund at the reserve ratio designated by the FDIC.

A bank’s initial assessment rate is based upon the risk category to which it is assigned. Adjustments may be made to a bank’s initial assessment rate based certain factors including levels of long-term unsecured debt, levels of secured liabilities above a threshold amount, and, for certain institutions, brokered deposit levels. Effective through March 31, 2011, initial assessment rates ranged from 12 to 45 basis points of assessable deposits. As required by the Dodd-Frank Act, in February 2011, the FDIC adopted a final rule that redefines its deposit insurance premium assessment base to be an insured depository institution’s average consolidated total assets minus average tangible equity capital, rather than on deposits. In addition, the FDIC has revised its deposit insurance rate schedules as a consequence of the changes to the assessment base. The new rate schedule and other revisions became effective on April 1, 2011. Initial base assessment rates now range between 5 and 35 basis points of the new assessment base.

Due to a decrease in the reserve ratio of the deposit insurance fund, in October 2008, the FDIC established a restoration plan to restore the reserve ratio to at least 1.15%. However, the Dodd-Frank Act raised the minimum reserve ratio to 1.35% and removed the 1.5% maximum fund ratio, instead leaving it to the discretion of the FDIC. The Dodd-Frank Act also requires that the reserve ratio reach 1.35% by September 30, 2020. Effective January 1, 2011, the FDIC set the long term reserve ratio at 2%.

On May 22, 2009, the FIDC imposed a special assessment of five basis points on each FDIC-insured depository institution’s assets, minus its Tier 1 capital, as of June 30, 2009. The special assessment was collected on September 30, 2009, and the Bank paid an additional assessment of $136,526.

On November 12, 2009 the FDIC adopted a final rule that required insured institutions to prepay on December 31, 2009, estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. For purposes of calculating the prepayment amount, the institution’s third quarter 2009 assessment base was increased quarterly at five percent annual growth rate through the end of 2012.

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On September 29, 2009, the FDIC also increased annual assessment rates uniformly by three basis points beginning January 1, 2011. On December 31, 2009 the Bank prepaid estimated assessments of $1.3 million.

Bank Regulatory Agreement. On May 6, 2010, the Bank entered into a stipulation and consent to the issuance of a consent order with the FDIC and OFIR (the “Consent Order”). The Consent Order, among other things, requires the Bank to increase the Bank’s level of Tier 1 capital as a percentage of total assets to at least 9% and its total capital as a percentage of risk-weighted assets at a minimum of 11% and to retain an independent third party to develop an analysis of the Bank’s management needs for the purpose of providing qualified management for the Bank.

Payment of Dividends by the Bank. There are state and federal requirements limiting the amount of dividends which the Bank may pay. Generally, a bank’s payment of cash dividends must be consistent with its capital needs, asset quality, and overall financial condition. Additionally, OFIR and the FDIC have the authority to prohibit the Bank from engaging in any business practice (including the payment of dividends) which they consider to be unsafe or unsound.

Under Michigan law, the payment of dividends is subject to several additional restrictions. The Bank cannot declare or pay a cash dividend or dividend in kind unless the Bank will have a surplus amounting to not less than 20% of its capital after payment of the dividend. The Bank will be required to transfer 10% of net income to surplus until its surplus is equal to its capital before the declaration of any cash dividend or dividend in kind. In addition, the Bank may pay dividends only out of net income then on hand, after deducting its losses and bad debts. These limitations can affect the Bank’s ability to pay dividends. As discussed above, the Consent Order requires the Bank to obtain the prior written consent of the FDIC and OFIR for the payment of dividends. During 2013, the Bank is not expected to pay dividends.

Loans to Directors, Executive Officers, and Principal Shareholders. Under FDIC regulations, the Bank’s authority to extend credit to executive officers, directors, and principal shareholders is subject to substantially the same restrictions set forth in Federal Reserve Regulation O. Among other things, Regulation O (i) requires that any such loans be made on terms substantially similar to those offered to nonaffiliated individuals, (ii) places limits on the amount of loans the Bank may make to such persons based, in part, on the Bank’s capital position, and (iii) requires that certain approval procedures be followed in connection with such loans.

Certain Transactions With Related Parties. Under Michigan law, the Bank may purchase securities or other property from a director, or from an entity of which the director is an officer, manager, director, owner, employee, or agent, only if such purchase (i) is made in the ordinary course of business, (ii) is on terms not less favorable to the Bank than terms offered by others, and (iii) the purchase is authorized by a majority of the board of directors not interested in the sale. The Bank may also sell securities or other property to its directors, subject to the same restrictions (except in the case of a sale by the Bank, the terms may not be more favorable to the director than those offered to others).

In addition, the Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company and its non-bank subsidiaries, on investments in the stock or other securities of the Company and its non-bank subsidiaries, and on the acceptance of stock or other securities of the Company or its non-bank subsidiaries as collateral for loans. Various transactions, including contracts, between the Bank and the Company or its non-bank subsidiaries must be on substantially the same terms as would be available to unrelated parties.

Standards for Safety and Soundness. The FDIC has established safety and soundness standards applicable to the Bank regarding such matters as internal controls, loan documentation, credit underwriting, interest-rate risk exposure, asset growth, compensation and other benefits, and asset quality and earnings. If the Bank were to fail to meet these standards, the FDIC could require it to submit a written compliance plan describing the steps the Bank will take to correct the situation and the time within which such steps will be taken. The FDIC has authority to issue orders to secure adherence to the safety and soundness standards.

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Reserve Requirement. Under a regulation promulgated by the Federal Reserve, depository institutions, including the Bank, are required to maintain cash reserves against a stated percentage of their net transaction accounts. Effective October 9, 2008, the Federal Reserve Banks are now authorized to pay interest on such reserves. The current reserve requirements are as follows:

• for transaction accounts totaling $12.4 million or less, a reserve of 0%; and

• for transaction accounts in excess of $12.4 million up to and including $79.5 million, a reserve of 3%; and

• for transaction accounts totaling in excess of $79.5 million, a reserve requirement of $2.013 million plus 10% of that portion of the total transaction accounts greater than $79.5 million.

The dollar amounts and percentages reported here are all subject to adjustment by the Federal Reserve.

ITEM 1A. Risk Factors

This item is not required for smaller reporting companies.

ITEM 1B. Unresolved Staff Comments—None

ITEM 2. Properties

At December 31, 2012, we had five full service offices. At December 31, 2012, we owned all of our offices and the net book value of our investment in premises and equipment, excluding computer equipment, was $3.9 million. We believe that our current facilities are adequate to meet our present and immediately foreseeable needs.

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

Location	County	Owned/ Leased
Main Office
375 North Willowbrook Road	Branch	Owned
Coldwater, Michigan 49036
Branch Offices
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, Michigan 49036
87 Marshall Street	Branch	Owned
Coldwater, Michigan 49036
123 S. Main Street	Branch	Leased
Adrian, Michigan 49221
7055 Tower Road, Suite D	Branch	Leased
Battle Creek, Michigan 49014
113 W. Grand River, Suite A	Branch	Leased
Brighton, Michigan 48116
3496 Lake Lansing Road, Suite 120	Branch	Leased
East Lansing, Michigan 48823
2301 East Paris, SE, Suite 300	Branch	Leased
Grand Rapids, Michigan 49546
1035 Laurence Avenue, Suite 5	Branch	Leased
Jackson, Michigan 40202
800 Ship Street	Branch	Leased
St. Joseph, Michigan 49085
606 North 9th Street, Suite 9	Branch	Leased
Kalamazoo, Michigan 49009
402 North Wayne Street, Suite 3	Branch	Leased
Angola, Indiana 46703

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. Reserved

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 September 19, 2012 on the OTCQB market place operated by the OTC Markets Group 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 periods prior to September 2012 and the OTCQB for periods after September 2012. For the years ended December 31, 2012 and 2011, the Company paid no dividends.

Year	Quarter ending	High		Low		Dividends
2011	March 31	$	1.54	$	1.46	$	—
	June 30	$	1.24	$	1.10	$	—
	September 30	$	1.14	$	1.14	$	—
	December 31	$	1.09	$	1.03	$	—
2012	March 31	$	1.92	$	1.05	$	—
	June 30	$	1.93	$	0.95	$	—
	September 30	$	1.31	$	0.80	$	—
	December 31	$	1.38	$	0.67	$	—

Please refer to Note 13 to the Financial Statements for a discussion of certain restrictions which impact the Company’s ability to pay dividends. Because the Company has no significant operations, it depends upon dividends from the bank in order to pay dividends to its stockholders.

As of March 22, 2013, there were 2,049,485 shares of the Company’s common stock issued and outstanding and approximately 527 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.

The Company did not redeem equity securities during the fourth quarter of 2012.

The Performance Graph required by item 201 (e) of Regulation S-K is not applicable to smaller reporting companies.

ITEM 6. Selected Financial Data

SELECTED FINANCIAL AND OTHER DATA

The summary information presented below under “Selected Financial Condition Data” and “Selected Operations 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:

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	December 31,
	2012		2011		2010		2009		2008
	(In Thousands)
Selected Financial Condition Data:
Total Assets	$	190,323	$	208,106	$	256,868	$	283,204	$	291,807
Loans receivable, net		128,000		148,495		182,768		220,875		247,542
Investment securities, at carrying value		10,047		12,536		11,476		16,086		8,953
Fed Funds sold and overnight deposits		19,766		16,410		34,909		10,723		677
Deposits		169,460		174,185		206,028		213,368		192,156
Federal Home Loan Bank Advances		7,059		20,175		36,350		44,518		60,178
Equity		10,467		11,142		12,118		23,163		36,270

	December 31,
	2012			2011			2010			2009			2008
	(In Thousands)
Selected Operations Data:
Total interest income	$	8,635		$	10,486		$	12,837		$	15,836		$	17,196
Total interest expense		2,106			3,638			5,372			7,339			8,536
Net interest income		6,529			6,848			7,465			8,497			8,660
Provision for loan losses		(1,042	)		733			11,602			13,349			2,712
Net interest income after provision for loan losses		7,571			6,115			(4,137	)		(4,852	)		5,948
Fees and service charges		2,238			2,311			2,496			2,682			2,757
Gains on sales of loans, mortgage-backed securities and investment securities		1,844			1,450			1,082			2,100			629
Other non-interest income		238			209			119			211			217
Total non-interest income		4,320			3,970			3,697			4,993			3,603
Total non-interest expense		12,244			10,337			10,237			20,085			9,152
Income (loss) before taxes		(353	)		(252	)		(10,677	)		(19,944	)		399
Income tax provision		—			101			205			(548	)		101
Net income (loss)	$	(353	)	$	(353	)	$	(10,882	)	$	(19,396	)	$	298

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ITEM 6. Selected Financial Data, continued

	December 31,
	2012			2011			2010			2009			2008
Selected Financial Ratios and Other Data:
Performance Ratios:
Return on assets (ratio of net income (loss) to average total assets)		-0.17	%		-0.15	%		-4.00	%		-6.41	%		0.10	%
Return on Equity (ratio of net income (loss) to average equity)		-3.40	%		-2.92	%		-59.86	%		-46.88	%		0.78	%
Interest rate spread information:
Average during period		3.40	%		3.04	%		2.96	%		2.94	%		3.11	%
Net interest margin		3.40	%		3.04	%		2.96	%		3.10	%		3.32	%
Ratio of operating expense to average total assets		5.96	%		4.32	%		3.77	%		6.64	%		3.20	%
Ratio of average interest-earning assets to average interest-bearing liabilities		1.12			1.10			1.07			1.06			1.06
Efficiency ratio		106.09	%		95.46	%		88.26	%		71.67	%		73.25	%
Asset Quality Ratios:
Non-performing assets to total assets at end of period		4.74	%		6.34	%		6.64	%		6.50	%		1.59	%
Non-performing loans to total loans, net		6.07	%		5.90	%		7.70	%		7.05	%		1.04	%
Allowance for loan losses to non-performing loans		39.06	%		53.12	%		48.67	%		37.14	%		105.76	%
Allowance for loan losses to loans receivable, net		2.37	%		3.14	%		3.75	%		2.62	%		1.10	%
Capital ratios:
Equity to total assets at end of period		5.50	%		5.35	%		4.67	%		8.19	%		12.43	%
Other data:
Number of full-service offices		5			5			5			6			6

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

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 the Bank. The discussion and analysis does not include any comments relating to the Corporation since the Corporation has no significant operations.

The Corporation, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, the Corporation is required to register with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the “BHCA”). In accordance with Federal Reserve policy, the Corporation is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank. The Corporation, however, has no significant assets other than the Bank. It is typically dependent upon dividends from the Bank for revenue.

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Following the Bank’s 2010 Safety and Soundness examination, the Board of Directors of the Bank stipulated to the terms of a formal enforcement action (“Consent Order”) with Federal Deposit Insurance Corporation (“FDIC”) and the Office of Financial and Insurance Regulation for the State of Michigan (“OFIR”). The Consent Order, which was effective May 6, 2010, requires among other things, that the Bank obtain the approval of the FDIC prior to paying a dividend. The Corporation’s ability to pay dividends is also currently prohibited by the Written Agreement entered into the Federal Reserve Bank of Chicago (the “FRB”). For details regarding the Written Agreement, refer to Note 14 in the financial statements. Effective February 2010, the Corporation deferred regularly scheduled dividend payments on the $6.7 million in principal outstanding on its Series A fixed rate, cumulative perpetual preferred stock (aggregate liquidation preference of $6.8 million) which was issued to the U.S. Treasury in February 2009. The suspension of dividend payments is permissible under the terms of the TARP Capital Purchase Program, but the dividend is a cumulative dividend and failure to pay dividends for six dividend periods would trigger board of director appointment rights for the holder of the Series A Preferred Stock.

As mentioned in Notes 13 and 14 the Bank and the Corporation are restricted from paying dividends without prior consent from respective regulatory agencies. The information contained in this section should be read in conjunction with the consolidated financial statements.

The Bank’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. The Bank’s results of operations also are significantly affected by the level of its gains from sales of mortgage loans.

Critical Accounting Policies

Our Consolidated Financial Statements were prepared in accordance with U.S. generally accepted accounting principles and follow general practices within the industries in which we operate. The most significant accounting policies we follow are presented in Note 1 to the Consolidated Financial Statements. Application of these principles requires us to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. Critical accounting estimates are defined as those that require assumptions or judgments to be made based on information available as of the date of the financial statements. Certain policies inherently have a greater reliance on the use of estimates. Those policies have a greater possibility of producing results that could be materially different than reported if there is a change to any of the estimates, assumptions, or judgments made by us. Based on the potential impact to the financial statements of the valuation methods, estimates, assumptions, and judgments used, we identified the determination of the allowance for loan losses to be the accounting estimate that is the most subjective or judgmental.

Allowance for Loan Losses

The allowance for loan losses is calculated with the objective of maintaining an allowance sufficient to absorb estimated probable loan losses. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss content for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of the collateral.

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We have established a systematic method of periodically reviewing credit quality of the loan portfolio in order to establish an allowance for loan losses. The allowance for loan losses is based on our current judgments about credit quality of individual loans and segments of the loan portfolio. The allowance for loan losses is established through a provision for loan losses based on our evaluation of the losses inherent in the loan portfolio, and considers all known internal and external factors that affect loan collectability as of the reporting date. Our evaluation, which includes a review of all loans on which full collectability may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience our knowledge of inherent losses in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance. Management believes this is a critical accounting policy because the evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters.

The analysis of the allowance for loan losses has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is generally measured by determining the present value of expected future cash flows or, the fair value of the collateral adjusted for the market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting, (if applicable) and payment history. We also analyze delinquency trends, general economic conditions and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general reserve. The principal assumption used in deriving the allowance for loan losses is the estimate of loss content for each risk rating. Actual loan losses may be significantly more than the allowances we have established, which could have a material negative effect on our financial results. See Note 5 to the Consolidated Financial Statements for more information on the allowance for loan losses.

Other Real Estate Owned and Foreclosed Assets

Other Real Estate Owned and Foreclosed Assets are acquired through or instead of loan foreclosure. They are initially recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed. See Note 7 to the financial statements for additional information regarding other real estate owned.

Income Taxes

We determine our liabilities for income taxes based on current tax regulation and interpretations in tax jurisdictions where our income is subject to taxation. In estimating income taxes payable or receivable, we assess the relative merits and risks of the appropriate tax treatment considering statutory, judicial, and regulatory guidance in the context of each tax position. Accordingly, previously estimated liabilities are regularly reevaluated and adjusted, through the provision for income taxes.

Changes in the estimate of income taxes payable or receivable occur periodically due to changes in tax rates, interpretations of tax law, the status of examinations being conducted by various taxing authorities, and newly enacted statutory, judicial and regulatory guidance that impact the relative merits and risks of each tax position. These changes, when they occur, affect accrued income taxes and can be significant to our operating results. See Note 11 to the Consolidated Financial Statements for more information on income taxes.

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Deferred tax assets generally represent items that can be used as a tax deduction or credit in future income tax returns, for which a financial statement tax benefit has already been recognized. The realization of the net deferred tax asset generally depends upon future levels of taxable income and the existence of prior years’ taxable income to which “carry back” refund claims could be made. Valuation allowances are established against those deferred tax assets determined not likely to be realized. The valuation allowance may be reversed to income in future periods to the extent that the related deferred tax assets are realized or the valuation allowance is no longer required. The realization of our deferred tax assets is largely dependent upon our ability to generate future taxable income. The Corporation had an $8.2 million tax valuation allowance as of December 31, 2012.

Management Strategy

Our primary focus is on increasing market share and profitability by incorporating the mission of making banking fun and easy and by helping our customers retire wealthy. Primary areas of growth will be residential mortgage origination, wealth management and core deposits. Commercial lending will center on loans guaranteed by the US Small Business Administration. We have now opened nine residential loan production offices (LPOs) in leased facilities at the following locations in Michigan; St. Joseph, Kalamazoo, Grand Rapids, Battle Creek, Jackson, East Lansing, Brighton, and Adrian. We have also opened an LPO in Angola, Indiana. These locations provide residential mortgage services to customers in these markets, and will be a source for deposit gathering as we implement our mobile banking remote consumer deposit capture product. This product will allow consumers to make deposits into their accounts at the Bank by taking a photograph of a check using an IPhone or an Android based phone. We have also placed commercial lenders in the Grand Rapids and East Lansing LPOs. While incurring initial expenses for the build out of the leased spaces and for the hiring of residential loan originators, we anticipate that these LPOs will provide an increasing source of fee income for the Bank.

Continued emphasis will be placed on; 1) the development of a dynamic customer service and relationship model, 2) the reduction of non-performing and classified loans, 3) the prudent reduction of non-interest expenses, 4) the implementation of enhanced banking controls, policies and procedures and, 5) the raising of capital sufficient to comply with regulatory requirements. As previously announced, we anticipate the inception of a formal capital raise effort in the spring of 2013.

Changes in Financial Condition from December 31, 2011 to December 31, 2012

General.Monarch’s total assets decreased $17.8 million, or 8.55%, to $190.3 million at December 31, 2012 compared to $208.1 million at December 31, 2011. The decline in assets is largely attributable to the decrease in loans which decreased from $148.5 million at December 31, 2011 to $128.0 at December 31, 2012.

Loans.Loans remain our largest category of interest earning assets and the largest source of revenue. The net loan portfolio decreased $20.5 million, or 13.8%. Gross loans decreased $22.2 million, or 14.4%, from $153.4 million at December 31, 2011 to $131.3 million at December 31, 2012.

Commercial business loans decreased $1.5 million in 2012 as compared to 2011. Commercial real estate loans including multi family loans decreased $7.9 million due to scheduled maturities and specific plans to reduce substandard assets and credit concentrations. With the hiring of two additional lenders in 2012, we anticipate growth in the commercial loan portfolio in 2013.

Residential loans decreased $9.5 million in 2012, primarily as a result of the migration of one to four family residential loans to the secondary market due to the attractive interest rates available as a result of the decline in interest rates consistent throughout 2012. The decrease in home equity loans of $2.4 million from 2011 to 2012 is also mainly attributable to the refinancing activity seen in the residential market and the declining real estate values.

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Installment loans or “Other loans” as categorized in Note 5 include primarily automobile and recreational vehicle loans. Other consumer loans and construction and land development loans decreased $854,000 in 2012 mainly due to normal repayments. Please refer to Note 5 to our financial statements for additional information on the composition of our loan portfolio.

Credit Risk.Credit Risk is defined as the risk that borrowers or counter-parties will not be able to repay their obligations to us. Credit exposures reflect legally binding commitments for loans, leases, banker’s acceptances, standby and commercial letters of credit, and deposit account overdrafts. Our overall credit risk position has improved significantly during the last twelve months, with a decline in delinquencies, charge off activity and nonperforming assets. While there has been overall improvement, our nonperforming assets are still elevated as compared to periods prior to the recession and we remain focused on continued reduction of these assets.

Loans are carried at an amount which management believes will be collected. A balance considered not collectible is charged against the allowance for loan losses. Charge-offs for loan losses were $579,000 for 2012, compared to $2.9 million for 2011. The decrease in charge off activity in 2012 was largely due to a significant recovery associated with the sale of a large commercial real estate credit. We have also seen a decrease in charge offs related to one to four family residential mortgages as a result of a decrease in foreclosure activity in 2012.

After evaluating the level of the allowance for loan losses in the fourth quarter, and upon receiving the one-time recovery of the previously charged off loan, we reversed the provision for loan losses by $1.0 million in 2012. A loan loss provision of $733,000 was recorded for 2011. The decreased level of provision for loan losses in 2012 was due to the decreased level of charge offs and nonperforming assets.

Nonperforming assets include nonaccrual loans, and other real estate. Our policy is to discontinue the accrual of interest on loans where principal or interest is past due and remains unpaid for 90 days or more, or when an individual analysis of a borrower’s credit worthiness indicates a credit should be placed on nonperforming status, except for residential mortgage loans, which are placed on nonaccrual at the time the loan is placed in foreclosure and consumer loans that are both well secured and in the process of collection.

Nonperforming assets decreased to $9.0 million as of December 31, 2012 from $13.2 million as of December 31, 2011, mainly due to decreases in foreclosed assets. Total foreclosed assets were $4.4 million as of December 31, 2011 compared to $1.2 million as of December 31, 2012. Nonaccrual loans decreased as well in 2012, from $8.8 million as of December 31, 2011 to $7.8 million as of December 31, 2012. The elevated levels of nonaccrual loans seen during 2011 were largely due to economic stresses being felt in Michigan and nationally. Borrowers who normally would be able to fulfill their obligations had been unable to do so in that environment. Impaired loans are commercial loans for which we believe it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. The average investment in impaired loans was $27.9 million during 2012 compared to $29.1 million during 2011. At December 31, 2012, impaired loans were $22.3 million compared to $23.6 million as of December 31, 2011. Given the present state of the economy, we have determined that it is necessary to work with some borrowers to reduce potential losses to the Bank. At December 31, 2012, we had $13.9 million restructured loans where the borrower was in compliance with the terms of agreement or delinquent less than 90 days.

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Securities.The Bank’s securities portfolio decreased $2.5 million, or 17.24%, to $12.0 million at December 31, 2012 from $14.5 million at December 31, 2011. Securities were 6.32% of total assets at December 31, 2012 as compared to 7.0% at December 31, 2011. The decrease was largely attributable to several securities being called and not replaced. In 2011 the Bank sold a significant portion of its securities portfolio and reinvested in mainly collateralized mortgage obligations (CMO). The yield on investment securities has decreased to 1.9% at December 31, 2012 from 3.40% for the same period a year ago. We have continued to maintain a diversified securities portfolio, which includes obligations of U.S. government-sponsored agencies, securities issued by states and political subdivisions and mortgage-backed securities. We regularly evaluate asset/liability management needs and attempt to maintain a portfolio structure that provides sufficient liquidity and cash flow.

Liabilities.The Bank’s deposits decreased $4.7 million, or 2.7%, to $169.5 million at December 31, 2012 compared to $174.2 million at December 31, 2011. This decrease was primarily in certificates of deposits which decreased $7.2 million. Brokered CDs decreased $1.6 million from $3.8 million at December 31, 2011 to $2.2 million at December 31, 2012. The Bank has attempted to reduce its reliance on brokered and large, out of area CDs, although the success of this strategy is dependent on growing core deposits. Retail CD deposits decreased $5.6 million. Non-interest bearing deposit accounts decreased $2.0 million. Interest bearing checking accounts including money markets accounts increased $1.4 million. Savings accounts increased $3.1 million. The Bank expects its low cost core deposits to increase in the future as a result of strategies to attract more small business depositors and municipal depositors.

Due to the fact that the Bank’s regulatory capital ratios are less than the levels necessary to be considered “well capitalized”, it may not obtain new brokered funds as a funding source without prior approval of the FDIC and is subject to rate restrictions that limit the amount that can be paid on all types of retail deposits (See Note 13 for further discussion on the requirements of the Consent Order). The maximum rates the Bank can pay on all types of retail deposits are limited to the national average rate, plus 75 basis points. We have compared the Bank’s current rates with the national rate caps and reduced any rates over the rate cap to fall within those caps. There has been no material impact to our deposit balances resulting from the rate caps.

Federal Home Loan Bank advances decreased $13.1 million, or 64.9%, to $7.1 million at December 31, 2012 from $20.2 million at December 31, 2011. We have used brokered certificates of deposit to diversify our sources of funds and improve pricing at certain terms compared to the local market and advances available from Federal Home Loan Bank of Indianapolis. For several years our strategy has been to replace borrowed funds and brokered CDs with lower cost core deposits. With the movement of customers from the stock market into more conservative types of investments including deposit products we have been able to take advantage of the shift and significantly reduce our reliance on whole sale funding. We expect this trend to continue even when customers move back to riskier types of investing due to the retention of staff specifically focused on building and broadening customer relationships.

Equity. Total equity amounted to $10.5 million at December 31, 2012 and $11.1 million at December 31, 2011, or 5.5% and 5.4%, respectively, of total assets at both dates. The decrease in equity resulted from the net loss for 2012 of $353,000 and dividend payments of $388,000, which consisted of dividends accrued but not paid on the Preferred Stock. The annual 5% dividend on the Preferred Stock, which increases to 9% in 2014, together with the amortization of the discount will reduce net income (or increase the net loss) applicable to common stock by approximately $350,000 annually.

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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,
	2012							2011
	Average		Interest					Average		Interest
	Outstanding		Earned/		Yield/			Outstanding		Earned/		Yield/
	Balance		Paid		Rate			Balance		Paid		Rate
	(dollars in thousands)							(dollars in thousands)
Fed Funds and overnight deposits	$	28,058	$	41		0.15	%	$	38,511	$	32		0.08	%
Investment securities		14,374		270		1.88			10,502		354		3.37
Other securities		3,317		108		3.26			3,526		94		2.67
Loans receivable		146,121		8,216		5.62			172,402		10,006		5.80
Total earning assets	$	191,870	$	8,635		4.50		$	224,941	$	10,486		4.66
Demand and NOW accounts	$	46,732	$	8		0.02		$	43,948	$	29		0.07
Money market accounts		35,806		101		0.28			38,752		181		0.47
Savings accounts		22,803		16		0.07			21,614		25		0.12
Certificates of deposit		73,267		1,396		1.91			92,319		2,157		2.34
Federal Home Loan Bank advances		13,268		585		4.41			27,896		1,246		4.47
Total interest bearing liabilities	$	191,876		2,106		1.10		$	224,529		3,638		1.62
Net interest income			$	6,529						$	6,848
Net interest spread						3.40	%						3.04	%
Net interest margin						3.40	%						3.04	%

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

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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,
	2012 vs. 2011												2011 vs. 2010
										Total												Total
	Increase (Decrease) Due to									Increase			Increase (Decrease) Due to									Increase
	Rate			Volume			Mix			(Decrease)			Rate			Volume			Mix			(Decrease)
	(in thousands)												(in thousands)
Interest-earning assets
Fed funds and overnight deposits	$	24		$	(9	)		(7	)		9		$	11		$	4			12			28
Investment securities	$	(125	)	$	64			(22	)		(84	)	$	9		$	(138	)		(3	)		(132	)
Other securities	$	(22	)	$	47			(11	)		14		$	13		$	(14	)		(2	)		(3	)
Loans receivable	$	(312	)	$	(1,525	)		48			(1,790	)	$	204		$	(2,408	)		(40	)		(2,244	)
Total interest-earning assets	$	(435	)	$	(1,423	)	$	7		$	(1,851	)	$	237		$	(2,556	)	$	(32	)	$	(2,351	)
Interest-bearing liabilities
Demand and NOW accounts	$	(23	)	$	2			—			(21	)	$	(67	)	$	8			(5	)		(65	)
Money market accounts	$	(66	)	$	(14	)		—			(80	)	$	(179	)	$	(92	)		40			(231	)
Savings accounts	$	(10	)	$	1			—			(9	)	$	(26	)	$	2			(1	)		(25	)
Certificates of deposit	$	(316	)	$	(445	)		—			(761	)	$	(609	)	$	(104	)		22			(691	)
Federal Home Loan Bank advances	$	(8	)	$	(653	)		—			(661	)	$	(10	)	$	(716	)		4			(722	)
Total interest-bearing liabilities	$	(423	)	$	(1,109	)	$	—		$	(1,532	)	$	(890	)	$	(903	)	$	60		$	(1,734	)
Net interest income										$	(319	)										$	(617	)

Comparison of Results of Operations for the Years Ended December 31, 2012 and 2011

General. The Bank reported a net loss of $353,000 for the year ended December 31, 2012 and a net loss of $353,000 for the year ended December 31, 2011.

Net Interest Income.Our primary source of earnings is net interest income, the difference between income on earning assets and the cost of funds supporting those assets. Significant categories of earning assets are loans and securities while deposits and borrowings represent the major portion of interest-bearing liabilities. Net interest income before provision for loan losses decreased to $6.5 million for 2012 compared to $6.8 million in 2011.

Net interest margin (the ratio of net interest income to average earning assets) is affected by movements in interest rates and changes in the mix of earning assets and the liabilities that fund those assets. Our net interest margin has increased from 3.04% in 2011 to 3.40% in 2012. The increase from 2011 to 2012 is primarily due to the repayment of high cost wholesale funds.

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Interest Income.Total interest income in 2012 decreased $1.9 million primarily due to a decline in outstanding average earning assets and the low interest rates consistent since 2010. This followed a $2.3 million decrease in 2011 which is also attributable to declining interest rates. In 2012 the decline in average balances significantly offset the decline in average yield on earning assets.

Interest Expense.Total interest expense decreased $1.5 million in 2012 compared to 2011. This followed a decrease of $1.8 million in 2011. The decrease in 2011 and 2012 was primarily the result of a reduction in the rates we paid on deposits, sustained by the continued low interest rate environment and the decrease in the average balance of FHLB’s borrowings and brokered deposits. As a result, our average cost of funds, including the effect of interest-free demand deposits, decreased to 1.10% in 2012 from 1.62% in 2011. In the past the Bank has had difficulty in reducing its cost of funds because of increased market rates for CDs and further competition for money market deposits which has also resulted in higher rates being paid. Growing lower cost core deposits remains a challenge in our current market area. Our reliance on money market accounts, internet CDs and FHLB borrowings continues to have an impact on our higher cost of funds.

Provision for Loan Losses.The Bank recorded a reverse provision for loan losses of $1.0 million which was due to a one-time recovery on a previously charged off loan for the year ended December 31, 2012 compared to a provision for loan losses of $733,000 in 2011.

The decreased provision for 2012 was attributable to a decreased level of net charge-offs in the amount of $579,000 as of December 31, 2012 compared to $2.9 million as of December 31, 2011 and decreased loan delinquencies at December 31, 2012 as compared to December 31, 2011. Nonperforming assets which include loans that are nonaccrual and real estate in judgment and other repossessed property decreased to 4.74% of assets at December 31, 2012 compared to 6.34% at December 31, 2011. These levels have been elevated over the previous two years (see “Selected Financial and Other Data” and Credit Risk”). Please refer to Note 5 to our financial statements for additional information on our provision for loan losses.

Non-interest Income. Non-interest income increased to $4.3 million for the year ended December 31, 2012 compared to $4.0 million for the same period in 2011 largely due to an increase in gain on sale of loans. Non-interest income increased to $4.0 million in 2011 primarily due to an increase in gain on sale of securities.

Fees and service charges were $1.8 million for 2012 and $1.9 million for 2011. The decline in fees and service charges is a result of a decline in income for the Bounce Protection Program and loan fees offset by an increase in income from fees associated with ATM usage. Income from the Bounce Protection Program has decreased from $1.1 million in 2011 to $969,000 in 2012 due to decreased customer usage. Future increases in this source of income are dependent on the Bank increasing the number of checking account customers. Management does not expect significant increases in Bounce Protection income from its existing customer base due to the increased regulatory changes that became effective July 1, 2010. ATM income has increased from $367,000 in 2011 to $407,000 in 2012 as customer usage continues to increase.

Gain on sale of loans increased to $1.8 million in 2012 compared to $1.0 million in 2011. The elevated level of gain on sale of loans in 2012 was largely due to the falling rate environment which generated a significant amount of one to four family residential mortgage refinancing. Loan servicing income decreased to $413,000 in 2012 from $437,000 in 2011. Our strategy, which began in 2007, has been to sell as many of the residential mortgage originations as possible to manage the Bank’s interest rate risk, credit risk and liquidity.

Gain on sale of securities decreased from $469,000 in 2011 to $12,000 in 2012 primarily due to the Bank previously selling a significant portion of the portfolio to improve overall quality of the portfolio.

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Other income increased slightly to $238,000 in 2012 compared to $209,000 in 2011. Other income increased to $209,000 in 2011 from $119,000 in 2010 primarily due to an increase in the gain on the sale of foreclosed assets. The gain on the sale of foreclosed property increased $97,000 in 2011 compared to 2010. The gain on sale of foreclosed property decreased in 2012 by $232,000 compared to 2011. Impairment charges of $335,000 in 2010 and $318,000 in 2011 taken against an investment in a low cost housing that provided tax credits offset the increase in gain on the sale of foreclosed assets. The Bank does occasionally experience a gain on sale of foreclosed property, as it has become increasingly more conservative in valuing these properties upon acquisition. Management expects 2013 to be comparable to prerecession periods in terms of foreclosure activity and thus modest potential gains or losses on subsequent sales of the foreclosed properties.

Non-interest Expense.Non-interest expense increased to $12.2 million in 2012 from $10.3 million in 2011, following an increase from $10.2 million in 2010 to $10.3 million in 2011. The increase in non-interest expense in 2011 and 2012 was primarily due to increases in salaries and employee benefits associated with the hiring of additional staff for the new mortgage loan offices.

Salaries and employee benefits expense increased to $5.7 million in 2012 from $4.5 million in 2011. The increase in personnel expense was primarily attributable to the addition of loan originators for the new offices opened during the year. Salaries and employee benefits expense increased to $4.5 million in 2011 as compared to $4.3 million in 2010. Retaining qualified staff continues to be a priority of Management.

Repossessed property expense increased to $820,000 in 2012 from $745,000 in 2011 primarily due to an elevated level of properties and an increase in disposition costs. Repossessed property expense has also increased from $631,000 in 2010 to $745,000 in 2011. Management continues to focus on better management of properties during the holding period and better sales efforts that have led to shorter holding periods.

Professional services expenses increased to $902,000 in 2012 compared to $721,000 in 2011. The increase was due to increased fees associated with SEC filing, additional required quality control review of mortgages originated for the secondary market and costs related to hiring staff for the mortgage loan production offices. Professional services expenses decreased to $721,000 in 2011 compared to $809,000 in 2010 primarily due to decreases in legal fees. We expect professional services expense to remain elevated in 2013 due to the additional costs associated with working with problem loans.

Amortization expense of intangible assets remained the same year over year from 2011 to 2012. As indicated in Note 3 to the Corporation’s financial statements, this expense will continually decline over the remaining life of the related asset and will expire in 2013.

Mortgage banking expense (which is the amortization of capitalized mortgage servicing rights) increased slightly in 2012 to $442,000 compared to $425,000 in 2011 due to an increase in amortization of mortgage servicing rights associated with the refinancing of residential mortgages. Mortgage banking expense remained relatively unchanged year over year from 2010 to 2011. Other general and administrative expense increased to $1.8 million in 2012 compared to $1.6 million in 2011, this is primarily due to an increase in costs associated with opening the additional offices. Other general and administrative expense decreased to $1.6 million in 2011 from $1.8 million in 2010, primarily due to a decrease in FDIC insurance.

Federal Income Taxes. Our effective tax rate for purposes of the tax provision was 0% in 2012 compared to -40.1% in 2011. In prior years 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.

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Liquidity and Commitments

We are required to maintain appropriate levels of liquid assets under FDIC regulations. Appropriate levels are determined by our Board of Directors and Management and are included in our asset and liability management policy. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. We have maintained liquidity at levels above those believed to be adequate to meet the requirements of normal operations, including new loan funding and potential deposit outflows. At December 31, 2012, our liquidity ratio, which is our liquid assets as a percentage of total deposits less certificates of deposit maturing in more than one year and increased by borrowings maturing in one year or less, was 19.8%. This level of liquidity is higher than that maintained last year. Management has taken steps to increase liquidity and is confident it will be able to effectively address the Bank’s liquidity needs.

The Bank’s liquidity, represented by cash and cash equivalents, is a product of our operating, investing and financing activities. The Bank’s primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans, 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. The Bank also generates cash through borrowings. The Bank utilizes Federal Home Loan Bank advances to leverage its capital base and provide funds for its lending and investment activities, and to enhance its interest rate risk management.

Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in overnight deposits, including fed funds, and short-term treasury and governmental agency securities. On a longer term basis, the Bank maintains a strategy of investing in various investments and lending products. The Bank uses its sources of funds primarily to meet its ongoing commitments, to pay maturing certificates of deposit and savings withdrawals and to fund loan commitments. Certificates of deposit scheduled to mature in one year or less at December 31, 2012, totaled $40.6 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 (including core deposits) and Federal Home Loan Bank advances. Based on current collateral levels, at December 31, 2012, the Bank could borrow an additional $20.9 million from the Federal Home Loan Bank at prevailing interest rates. We anticipate we will continue to have sufficient funds, through deposits and borrowings, to meet our current commitments. For the year ended December 31, 2012, the Bank had a net increase in cash and cash equivalents of $4.6 million as compared to a net decrease of $17.9 million for the year ended December 31, 2011.

The Bank’s primary sources of funds during 2012 were $4.8 million in proceeds from the maturities of securities and $18.3 million in principal loan collections in excess of loan originations. The primary uses of funds in 2012 were the repayment of $13.1 million of FHLB advances and purchases of securities of $2.6 million and a decrease in deposits of $4.7 million.

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Off-Balance Sheet Arrangements

At December 31, 2012, the total unused commercial and consumer lines of credit were $8.6 million and there were no outstanding commitments under letters of credit. At December 31, 2011, the total unused commercial and consumer lines of credit were $11.1 million and there were no outstanding commitments under letters of credit.

The Corporation 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.

Capital

Consistent with its goals to operate a sound and profitable financial organization, the Corporation actively seeks to maintain a “well capitalized” institution in accordance with regulatory standards. Note 13 to the Financial Statements details the capital position of the Bank as well as the capital levels necessary to remain well capitalized. At December 31, 2012 the equity to assets ratio of the Company was 5.5%. See also “Regulatory Orders” below.

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 maturity structures of our assets and liabilities are critical to the maintenance of acceptable performance levels.

The principal effect of inflation, as distinct from levels of interest rates, on earnings is in the area of non-interest 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.

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Regulatory Orders

On September 21, 2010 the Corporation entered into a Written Agreement with the Federal Reserve Bank of Chicago (the “FRB”). Among other things, the Written Agreement requires that the Corporation obtain the approval of the FRB prior to paying a dividend; prohibits the Corporation from purchasing or redeeming any shares of its stock without the prior written approval of the FRB; and requires the Corporation to submit cash flow projections for the Corporation to the FRB on a quarterly basis. A Form 8-K was filed with the complete details of the Written Agreement. In response to these requirements, no preferred stock dividends or common stock dividends have been made since and we have been submitting cash flow projections quarterly.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Since stipulating to the terms of the Consent Order, we have made substantive progress in implementation of provisions identified within the Consent Order. The Bank believes that it is in compliance with all of the terms of the Consent Order with the exception of the requirement that the Bank

48

increase the Bank’s level of Tier 1 capital as a percentage of total assets to at least nine percent and its total capital as a percentage of risk-weighted assets at a minimum of eleven percent. The Board of Directors and management remain committed to reaching the capital requirements and continue to evaluate different capital raising alternatives.

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.

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 quarterly 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, each quarter.

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 commercial 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.

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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 2012 and 2011 we sold $53.3 million and $32.4 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.

Monarch uses an internally generated model that uses scenario analysis to evaluate the IRR exposure of the Bank by estimating the sensitivity of the Bank’s portfolios of assets, liabilities, and off-balance sheet contracts to changes in market interest rates. The information presented in the following table presents the expected change in Monarch’s net portfolio value at December 31, 2012 that would occur upon an immediate change in interest rates.

Change in Interest Rates Basis Points (“bp”)	Net Portfolio Value							Net Portfolio Value as % of Present Value of Assets
(Rate Shock in Rates) (1)	$ Amount		$ Change		% Change			NPV Ratio			Change
+ 300 bp		12,435		-2,019		-14	%		6.68	%		-75bp
+ 200 bp		12,473		-1,982		-14	%		6.58	%		-65bp
+100 bp		13,097		-1,358		-9	%		6.81	%		-62bp
0 bp		14,455		0		0	%		7.43	%		0bp
-100 bp		16,233		1,778		12	%		8.24	%		81bp
-200 bp		18,321		3,866		27	%		9.20	%		177bp
-300 bp		21,290		6,835		47	%		10.58	%		315bp

(1) Assumes an instantaneous uniform change in interest rates at all maturities.

Based on the data from the model, management believes that the Bank’s IRR level remains minimal.

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 an increasing interest rate scenario and increase in a decreasing interest rate scenario. 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. 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.

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The following table provides information about the Company’s financial instruments that are sensitive to changes to interest rates as of December 31, 2012. 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.

																2018 and					Fair Value
	2013			2014			2015			2016			2017			beyond			Total		12/31/2012
Rate-sensitive assets
Fed funds and overnight deposits	$	—		$	—		$	—		$	—		$	—		$	—		$	—	$	—
Average interest rate
Securities	$	741		$	1,240		$	81		$	2,445		$	—		$	7,521		$	12,028	$	13,273
Average interest rate		1.00	%		1.37	%		5.50	%		1.14	%					3.48	%
Gross loans	$	11,686		$	7,517		$	18,593		$	14,124		$	16,685		$	62,671		$	131,276	$	134,944
Average interest rate		7.16	%		6.82	%		6.90	%		6.95	%		6.61	%		6.18	%
Rate-sensitive liabilities
Savings & interest-bearing demand deposits	$	84,578		$	—		$	—		$	—		$	—					$	84,578	$	84,578
Average interest rate		0.04	%
Certificates of deposit	$	40,629		$	13,426		$	8,687		$	2,915		$	1,615		$	—		$	67,272	$	68,453
Average interest rate		1.48	%		2.01	%		2.03	%		1.40	%		1.11	%		0.00	%
FHLB advances	$	7,059		$	—		$	—		$	—		$	—					$	7,059	$	7,194
Average interest rate		4.60	%

ITEM 8. Financial Statements and Supplementary Data

See Financial Statement file.

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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, 2012
	1st Qtr			2nd Qtr			3rd Qtr			4th Qtr
	(Dollars in thousands, except per share data)
Interest income	$	2,305		$	2,204		$	2,101		$	2,025
Interest expense		633			564			495			414
Net interest income		1,672			1,640			1,606			1,611
Provision for loan losses		28			24			5			(1,099	)
Net interest income after provision for loan losses		1,644			1,616			1,601			2,710
Noninterest income		840			1,163			1,030			1,287
Noninterest expense		2,885			3,053			3,144			3,162
Income before income taxes		(401	)		(274	)		(513	)		835
Income tax expense		—			—			—			—
Net Income	$	(401	)	$	(274	)	$	(513	)	$	835
Dividends and amortization of discount on preferred stock		100			98			102			88
Net Income available to common stock	$	(501	)	$	(372	)	$	(615	)	$	747
Earnings per share:
Basic	$	(0.25	)	$	(0.19	)	$	0.31		$	0.38
Diluted	$	(0.25	)	$	(0.19	)	$	0.31		$	0.38

	Year Ended December 31, 2011
	1st Qtr		2nd Qtr			3rd Qtr		4th Qtr
	(Dollars in thousands, except per share data)
Interest income		2,808		2,743			2,541		2,394
Interest expense		1,033		976			879		750
Net interest income		1,775		1,767			1,662		1,644
Provision for loan losses		260		3			41		429
Net interest income after provision for loan losses		1,515		1,764			1,621		1,215
Noninterest income		1,046		728			1,211		985
Noninterest expense		2,363		2,472			2,664		2,838
Income before income taxes		198		20			168		(638	)
Income tax expense		0		0			0		101
Net Income		198		20			168		(739	)
Dividends and amortization of discount on preferred stock		88		89			89		124
Net Income available to common stock		110		(69	)		79		(863	)
Earnings per share:
Basic	$	0.06	$	(0.04	)	$	0.04	$	(0.43	)
Diluted	$	0.06	$	(0.04	)	$	0.04	$	(0.43	)

52

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, 2012 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 Securities 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, 2012 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.

Monarch Community Bancorp, Inc. and Subsidiaries Management’s Report on Internal Control Over Financial Reporting

The management of Monarch Community Bancorp, Inc. and Subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting. Monarch Community Bancorp, Inc. and Subsidiaries internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of its financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective, provide only reasonable assurance with respect to financial statement preparation and presentation.

Management of Monarch Community Bancorp, Inc. and Subsidiaries assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2012. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) inInternal Control—Integrated Framework. Based on our assessment we believe that, as of December 31, 2012, the Company’s internal control over financial reporting is effective based on those criteria.

Dated: March 29, 2013

Richard J. DeVries

President and Chief Executive Officer

Rebecca S. Crabill

Executive Vice President and Chief Financial Officer

53

ITEM 9B. Other Information –Not Applicable

PART III

ITEM 10. Directors, Executive Officers and Corporate Governance

Information required by this Item 10 is incorporated herein by reference from the definitive proxy statement for the annual meeting of shareholders under the captions “Item 1. Election of Directors”, “The Audit Committee”, “Audit Committee Financial Expert”, “Compliance with Section 16”, “Code of Conduct”, and “Role and Composition of the Board of Directors”, 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 under the caption “Executive Compensation”, a copy of which will be filed not later than 120 days after the close of the fiscal year. The “Compensation Committee Report”, and “Compensation Committee Interlocks and Insider Participation”, are not required for smaller reporting companies.

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 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, 2012:

Plan Category	Number of securities to be issued upon exercise of outstanding options warrants and rights		Weighted-average exercise price of outstanding options warrants and rights		Number of securities remaining available for future issuance under equity compensation plans
Equity compensation plans approved by security holders (1)		152,837		10.67		78,601
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

54

ITEM 13. Certain Relationships and Related Transactions, and Director Independence

Information concerning certain relationships and related transactions is incorporated herein by reference from the definitive proxy statement for the annual meeting of stockholders under the captions “Transactions with Certain Related Persons” and “Role and Composition of the Board of Directors”, 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 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.

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.

55

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 29, 2013	By:	/s/ Richard J. DeVries
		Richard J. DeVries, President and Chief Executive Officer

56

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/ Richard J. DeVries	President and Chief Executive Officer	March 29, 2013
Richard J. DeVries	(Principal Executive Officer)
/s/ Stephen M. Ross	Chairman of the Board	March 29, 2013
Stephen M. Ross
/s/ Rebecca S. Crabill	Executive Vice President and Chief Financial Officer	March 29, 2013
Rebecca S. Crabill	(Principal Financial and Accounting Officer)
/s/ Harold A. Adamson	Director	March 29, 2013
Harold A. Adamson
/s/ Karl F. Loomis	Director	March 29, 2013
Karl F. Loomis
/s/ James W. Gordon	Director	March 29, 2013
James W. Gordon
/s/ Martin L. Mitchell	Director	March 29, 2013
Martin L. Mitchell
/s/ Gordon L. Welch	Director	March 29, 2013
Gordon L. Welch
/s/ Craig W. Dally	Director	March 29, 2013
Craig W. Dally
/s/ Richard L. Dobbins	Director	March 29, 2013
Richard L. Dobbins

57

Exhibit Index

Exhibit Number	Document	Reference to Prior Filing or Exhibit Number Attached Hereto
3.1 (i)	Registrant’s Articles of Incorporation	*
3.1 (ii)	Articles Supplementary (Incorporated by reference from Form 8-K filed 2/9/09)
3.2 (i)	Registrant’s Bylaws ( Incorporated by reference from Form 8-K filed on 12/23/09)
4.1	Registrant’s Specimen Stock Certificate	*
4.2	Warrant to Purchase 260,962 shares of Common Stock issued to the U.S. Treasury (Incorporated by reference from Form 8-K filed on 2/12/09)
10.1	Management Continuity Agreement between Monarch Community Bancorp, Inc. and Andrew J. Van Doren (incorporated by reference from Form 8-K filed on 12/21/2004)
10.2	Registrant’s Employee Stock Ownership Plan	*
10.3	Registrant’s 2003 Stock Option and Incentive Plan	**
10.4	Registrant’s Recognition and Retention Plan	**
10.5	Form of Stock Option Agreement	***
10.6	Management Continuity Agreement with Rebecca S. Crabill (Incorporated by reference from Form 8-K filed on 02/27/08)
10.7	Letter Agreement dated February 6, 2009 including the Securities Purchase Agreement –Standard Terms Incorporated by reference therein between the Company and the U.S. Treasury (incorporated by reference from Form 8-K filed on 2/12/09)
10.8	Form of Waiver of Senior Executive Officers (incorporated by reference from Form 8-K, filed on 2/12/09)
10.9	Form of Amendment Agreement (incorporated by reference from Form 8-K filed on 2/12/09)
10.10	Amendment to Employment Agreement with Andrew J. Van Doren
10.11	Amendment to Employment Agreement with Rebecca S. Crabill
10.12	Consent Order with OFIR and the FDIC (incorporated by reference from Form 8-K filed on 5/2/10).
10.13	Employment term sheet with Richard J. DeVries (incorporated by reference from Form 8-K filed on 7/16/10).
10.14	Written agreement with the FRB (incorporated by reference from Form 8-K filed on 9/27/10).
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 Code of Conduct	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	23
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
99.1	31 C.F.R. Section 30.15 Certification of Principal Executive Officer	99.1
99.2	31 C.F.R Section 30.15 Certification of Principal Financial Officer	99.2

* 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 the 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

58

MONARCH COMMUNITY BANCORP, INC. AND SUBSIDIARIES

Contents

Report Letter	3
Consolidated Financial Statements
Balance Sheet	3
Statement of Operations	4
Statement of Stockholders’ Equity	5
Statement of Cash Flows	6
Notes to Consolidated Financial Statements	7-61

Plante & Moran, PLLC Suite 400 634 Front Avenue N.W. Grand Rapids, MI 49504 Tel: 616.774.8221 Fax: 616.774.0702 plantemoran.com

Report of Independent Registered Public Accounting Firm

Board of Directors

Monarch Community Bancorp, Inc. and Subsidiaries

We have audited the consolidated balance sheet of Monarch Community Bancorp, Inc. and Subsidiaries as of December 31, 2012 and 2011 and the related consolidated statements of operations and comprehensive income, changes in stockholders’ equity, and cash flows for each year in the two-year period ended December 31, 2012. 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 auditing standards established by 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. The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Corporation’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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, 2012 and 2011 and the consolidated results of their operations and their cash flows for each year in the two-year period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Corporation will continue as a going concern. As discussed in Note 2 to the consolidated financial statements, the Corporation has suffered recurring losses from operations and as of December 31, 2012 did not meet the minimum capital requirements as established by its regulators, which raises substantial doubt about the Corporation’s ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 2. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

/s/ Plante & Moran, PLLC

Grand Rapids, Michigan

March 28, 2013

2

MONARCH COMMUNITY BANCORP, INC. AND SUBSIDIARIES

Consolidated Balance Sheet

(000s omitted, except per share data)

	December 31,			December 31,
	2012			2011
Assets
Cash and due from banks	$	8,978		$	7,701
Federal Home Loan Bank overnight time and other interest bearing deposits		19,766			16,410
Total cash and cash equivalents		28,744			24,111
Securities—Available for sale (Note 4)		10,047			12,536
Securities—Held to maturity (Note 4)		1,981			1,981
Other securities (Note 4)		3,370			3,370
Loans held for sale		2,045			653
Loans, net (Note 5)		128,000			148,495
Foreclosed assets, net (Note 7)		1,244			4,433
Premises and equipment (Note 8)		3,980			4,004
Core deposit (Note 3)		107			248
Other assets (Notes 6 and 11)		10,805			8,275
Total assets	$	190,323		$	208,106
Liabilities and Stockholders’ Equity
Liabilities
Deposits
Noninterest-bearing	$	17,610		$	19,683
Interest-bearing (Note 9):		151,850			154,502
Total deposits		169,460			174,185
Federal Home Loan Bank advances (Note 10)		7,059			20,175
Accrued expenses and other liabilities (Note 16)		3,337			2,604
Total liabilities		179,856			196,964
Stockholders’ Equity (Notes 13, 14, 15 and 20)
Preferred stock-$.01 par value, 5,000,000 shares authorized, and 6,785 shares, fixed rate cumulative perpetual preferred stock, series A, $1,000 per share liquidation preference, issued and outstanding as of December 31, 2012 and 2011		6,773			6,762
Common stock—$0.01 par value, 20,000,000 shares authorized, 2,049,485 shares issued and outstanding at December 31, 2012 and 2011		20			20
Additional paid-in capital		20,994			21,077
(Accumulated deficit)		(17,075	)		(16,334	)
Accumulated other comprehensive income		122			77
Unearned compensation		(367	)		(460	)
Total stockholders’ equity		10,467			11,142
Total liabilities and stockholders’ equity	$	190,323		$	208,106

See Notes to Consolidated Financial Statements.

3

MONARCH COMMUNITY BANCORP, INC. AND SUBSIDIARIES

Consolidated Statement of Operations

(000s omitted)

	Year Ended December 31,
	2012			2011
Interest Income
Loans, including fees	$	8,216		$	10,006
Investment securities		378			448
Federal funds sold and overnight deposits		41			32
Total interest income		8,635			10,486
Interest Expense
Deposits		1,521			2,392
Federal Home Loan Bank advances		585			1,246
Total interest expense		2,106			3,638
Net Interest Income		6,529			6,848
Provision for Loan Losses (Note 5)		(1,042	)		733
Net Interest Income (Loss) After Provision for Loan Losses		7,571			6,115
Noninterest Income
Fees and service charges		1,825			1,874
Loan servicing fees		413			437
Net gain on sale of loans		1,832			981
Net gain (loss) on sale of investment securities (Note 4)		12			469
Other income (Note 7)		238			209
Total noninterest income		4,320			3,970
Noninterest Expense
Salaries and employee benefits (Note 16, 20 and 21)		5,748			4,505
Occupancy and equipment (Note 8)		1,088			879
Data processing		797			870
Mortgage banking		442			425
Professional services		902			721
Amortization of intangible assets (Note 3)		142			142
NOW account processing		191			198
ATM/Debit card processing		273			247
Repossessed property expense (Note 7)		820			745
Other general and administrative		1,841			1,605
Total noninterest expense		12,244			10,337
(Loss)- Before income taxes		(353	)		(252	)
Income Taxes (Note 11)		—			101
Net (Loss)	$	(353	)	$	(353	)
Dividends and accretion of discount on preferred stock	$	388		$	390
Net (Loss) available to common stockholders	$	(741	)	$	(743	)
Comprehensive Loss
Net Loss	$	(353	)	$	(353	)
Change in unrealized gain on securities, net of tax and reclassification effects (Note 1)	$	45		$	(180	)
Comprehensive Loss	$	(308	)	$	(533	)
(Loss) Per Share
Basic	$	(0.37	)	$	(0.37	)
Diluted	$	(0.37	)	$	(0.37	)

See Notes to Consolidated Financial Statements.

4

MONARCH COMMUNITY BANCORP, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholder’s Equity

(000s omitted)

	Preferred Stock Number of Shares		Amount		Common Stock Number of Shares		Amount		Additional Paid in Capital			(Accumulated deficit) Retained Earnings			Accumulated Other Comprehensive Income (Loss)			Unearned Compensation			Total
Balance—January 1, 2011		6,785	$	6,750		2,049,485	$	20	$	21,147		$	(15,591	)	$	257		$	(565)		$	12,018
Allocation of ESOP shares (Note 20)										(81	)								93			12
Vesting of 772 restricted shares																			12			12
Stock option expenses										11												11
Net (Loss)													(353	)								(353	)
Other comprehensive gain (loss) (Note 1)																(180	)					(180	)
Dividends on preferred stock and accretion of discount		—		12		—		—		—			(390	)		—			—			(378	)
Balance—December 31, 2011		6,785	$	6,762		2,049,485	$	20	$	21,077		$	(16,334	)	$	77		$	(460	)	$	11,142
Allocation of ESOP shares (Note 20)										(83	)								93			10
Net (Loss)													(353	)								(353	)
Other comprehensive gain (loss) (Note 1)																45						45
Dividends on preferred stock and accretion of discount		—		11		—		—		—			(388	)		—			—			(377	)
Balance—December 31, 2012		6,785	$	6,773		2,049,485	$	20	$	20,994		$	(17,075	)	$	122		$	(367	)	$	10,467

See Notes to Consolidated Financial Statements.

5

MONARCH COMMUNITY BANCORP, INC. AND SUBSIDIARIES

Statement of Cash Flows

(000s omitted)

	Year Ended December 31,
	2012			2011
Cash Flows From Operating Activities
Net (loss)	$	(353	)	$	(353	)
Adjustments to reconcile net (loss) to net cash provided by operating activities:
Depreciation and amortization		1,087			1,032
Provision for loan loss		(1,042	)		733
Write down on foreclosed assets		1,320			—
Gain on sale of foreclosed assets		(68	)		(300	)
Mortgage loans originated for sale		(54,732	)		(32,356	)
Proceeds from sale of mortgage loans		53,340			32,397
Gain on sale of mortgage loans		(1,832	)		(981	)
(Gain) on sale of available for sale securities		(12	)		(469	)
Loss on sale of premises and equipment		—			(5	)
Earned stock compensation		10			35
Net change in:
Accrued interest receivable		(70	)		89
Other assets		(2,907	)		(242	)
Accrued expenses and other liabilities		710			321
Net cash provided by operating activities		(4,549	)		(99	)
Cash Flows From Investing Activities
Activity in available-for-sale securities:
Purchases		(2,591	)		(11,575	)
Repurchase of FHLB Stock		—			495
Proceeds from sale of securities		255			8,550
Proceeds from maturities of securities		4,820			2,094
Activity in held-to-maturity securities:
Purchases		—			(1,981	)
Loan originations and principal collections, net		18,266			30,420
Proceeds from sale of foreclosed assets		7,056			2,917
Purchase of premises and equipment		(395	)		(276	)
Net cash provided by (used in) investing activities		27,411			30,644
Cash Flows From Financing Activities
Net (decrease) increase in deposits		(4,725	)		(31,843	)
Dividends accrued		(388	)		(390	)
Repayment of FHLB advances		(13,116	)		(16,175	)
Net cash (used in) provided by financing activities		(18,229	)		(48,408	)
Net Increase (Decrease) in Cash and Cash Equivalents		4,633			(17,863	)
Cash and Cash Equivalents—Beginning		24,111			41,974
Cash and Cash Equivalents—End	$	28,744		$	24,111

See Notes to Consolidated Financial Statements.

6

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.

Monarch Community Bank provides a broad range of banking services to its primary market area of Branch, Calhoun and Hillsdale counties in Michigan. The Bank operates five full service offices. The Bank owns 100% of First Insurance Agency. The Bank also owns a 24.98% interest in a limited partnership formed to construct and operate multi-family housing units.

On June 3, 2006, the Corporation completed the conversion of the Bank from a federally chartered stock savings institution to a Michigan state chartered commercial bank. As a result of the conversion, the Corporation became a federal bank holding company regulated by the Board of Governors of the Federal Reserve and the Bank became regulated by the State of Michigan Office of Financial and Insurance Regulation (“OFIR”) and the Federal Deposit Insurance Corporation (“FDIC”). Prior to the conversion, both the Corporation and the Bank had been regulated by the Office of Thrift Supervision.

Basis of Presentation and Consolidation— The consolidated financial statements include the accounts of Monarch Community Bancorp, Inc., Monarch Community Bank, and First Insurance Agency, 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 investment securities, valuation of deferred taxes, and the valuation of the foreclosed assets.

Significant Group Concentrations of Credit Risk—Most of the Corporation’s activities are with customers located within its primary market areas in Michigan. Note 4 summarizes the types of securities the Corporation invests in. Note 5 summarizes 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, 2012 and 2011, these reserve balances amounted to approximately $740,000 and $717,000, respectively.

7

Note 1—Summary of Significant Accounting Policies (Continued)

Securities—Debt securities that management has the 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 at least six months of payments have been made and 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.

8

Note 1—Summary of Significant Accounting Policies (Continued)

The allowance consists of specific, general and unallocated components. The specific components relate 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.

Troubled Debt Restructuring—Troubled debt restructuring of loans is undertaken to improve the likelihood that the loan will be repaid in full under the modified terms in accordance with a reasonable repayment schedule. All modified loans are evaluated to determine whether the loans should be reported as a Troubled Debt Restructure (TDR). A loan is a TDR when the Corporation, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower by modifying or renewing a loan that the Corporation would not otherwise consider. To make this determination, the Corporation must determine whether (a) the borrower is experiencing financial difficulties and (b) the Corporation granted the borrower a concession. This determination requires consideration of all of the facts and circumstances surrounding the modification. An overall general decline in the economy or some deterioration in a borrower’s financial condition does not automatically mean the borrower is experiencing financial difficulties.

9

Note 1—Summary of Significant Accounting Policies (Continued)

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.

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.

Other Intangible Assets — Other intangible assets consist of core deposit, acquired customer relationship intangible assets arising from whole bank acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives. See further discussion of intangible assets in Note 3.

Income Taxes — We record income tax expense based on the amount of taxes due on our tax return plus the change in deferred taxes, computed based on the future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

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.

10

Note 1—Summary of Significant Accounting Policies (Continued)

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

	2012			2011
Change in unrealized holding gain on available-for-sale securities	$	80		$	196
Reclassification adjustment for (gains) realized in income		(12	)		(469	)
Net unrealized gains (losses)	$	68		$	(273	)
Tax effect		(23	)		93
Net other comprehensive income	$	45		$	(180	)
	��

(Loss) Per Common Share—Basic (loss) per share represents (loss) available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted (loss) 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 (loss) that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate to outstanding stock options, Recognition and Retention Plan shares and warrants, and are determined using the treasury stock method.

11

Note 1—Summary of Significant Accounting Policies (Continued)

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

	2012			2011
Basic (loss) per share
Numerator:
Net (loss)	$	(353	)	$	(353	)
Dividends and accretion of discount on preferred stock	$	388		$	390
Net (loss) available to common stockholders	$	(741	)	$	(743	)
Denominator:
Weighted average common shares outstanding		2,049			2,049
Less: Average unallocated ESOP shares		(46	)		(55	)
Less: Average non-vested RRP shares		—			—
Weighted average common shares outstanding for basic earnings per share		2,003			1,994
Basic (loss) per share	$	(0.37	)	$	(0.37	)
Diluted (loss) per share
Numerator:
Net (loss) available to common stockholders		(741	)		(743	)
Denominator:
Weighted average common shares outstanding		2,003			1,994
Add: Dilutive effects of assumed exercises of stock options		—			—
Add: Dilutive effects of average non-vested RRP shares		—			—
Weighted average common shares and dilutive potential common shares outstanding		2,003			1,994
Diluted (loss) per share	$	(0.37	)	$	(0.37	)

12

Note 1—Summary of Significant Accounting Policies (Continued)

At December 31, 2012 and 2011 stock options and warrants not considered in computing diluted earnings per share because they were antidilutive, totaled 413,799.

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. 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 value 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 —All companies measure the cost for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options granted and recognized over the employee service period, which is usually the vesting period for the options. The effect on the Corporation’s net income will depend on the level of future option grants and the calculation of the fair value of the options granted, as well as the vesting periods provided.

Recent Accounting Pronouncements —During 2012, the Corporation adopted new guidance related to the presentation of comprehensive income in the financial statements. Among other changes, the new guidance eliminated the option to only present comprehensive income in the statement of equity. The Corporation has elected to report comprehensive income in a single statement of operations and comprehensive income. The change in presentation has been applied retrospectively and the 2011 financial statements have been restated to conform to the new presentation method. Other than the change in presentation of comprehensive income and related disclosures, the new guidance did not have a material effect on the financial statements.

In 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This update applies to all creditors, both public and non-public, and was introduced to provide clarification surrounding troubled debt restructurings (“TDR”). The primary characteristics that previously caused a restructuring to qualify as a TDR still exist: (1) the restructuring constitutes a concession to the borrower and (2) the borrower is experiencing financial difficulties. The update provides additional details and examples to provide clarity surrounding these items. The update also prohibits the use of the effective interest rate test when determining whether the restructuring constitutes a concession. The update became effective for annual reporting periods ending on or after December 15, 2012 (therefore, December 31, 2012, for the Corporation). Other than the additional disclosures, these updates did not have a significant impact on the financial statements.

13

Note 1—Summary of Significant Accounting Policies (Continued)

In 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820)—Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. This update to Fair Value Measurement (Topic 820) results in common fair value measurement and disclosure requirements in U.S. GAAP and IFRS. The amendments in this update explain how to measure fair value. They do not require additional fair value measurements and are not intended to establish valuation standards or affect valuation practices outside of financial reporting. However, this update does require expanded disclosure related to the nature and significance of inputs that are used in estimating and measuring the fair value of financial instruments. The amendments in this update are to be applied prospectively and are effective for annual reporting periods beginning after December 15, 2011 (therefore, December 31, 2012, for the Corporation). This update did not have a significant impact on the financial statements.

Supplemental Cash Flow Information (000s omitted)

	December 31,
	2012		2011
Cash paid for:
Interest	$	2,041	$	3,766
Income taxes	$	—	$	7
Noncash investing activities -
Loans transferred to real estate in judgment	$	3,725	$	4,966
Real estate in judgment transferred to real estate owned	$	2,093	$	5,444

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

Note 2—Management’s Plan

The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business for the foreseeable future. However, the events and circumstances described below create uncertainty about the Corporation’s ability to continue as a going concern.

14

Note 2—Management’s Plan (Continued)

The Corporation recorded net losses to common shareholders of $741,000 in 2012 and $743,000 in 2011. The loss in 2012 was largely attributable to the cost of operations, including the impact of opening the mortgage loan production offices and a continued decline in net interest income as the bank shrinks to manage capital levels and ratios. Losses in 2011 were largely due to losses from the loan portfolio. During 2012 and 2011 the Corporation recorded provisions for loan losses of ($1.0) million and $733,000 respectively. Total nonperforming assets amounted to $9.0 million at December 31, 2012 compared to $13.2 million at December 31, 2011. The levels of nonperforming assets improved significantly during 2012.

As a result of losses during 2010 and the level of non-performing assets, the Board of Directors of the Corporation has significantly changed the strategic direction and focus of the Bank to improve its internal operations and to work out of its problem loans and assets. During the second quarter of 2010, the Board of Directors elected a new President of the Bank. The Corporation has since worked closely with its regulators at the FRB and the Bank’s regulators at the FDIC and OFIR to put in place improved controls and procedures. The Board has implemented additional corporate governance practices and disciplined business and banking principles, including additional Board oversight, specific plans to reduce substandard assets and credit concentrations, more conservative lending principles that comply with regulatory standards, the appointment of experienced and disciplined lending and compliance personnel, the engagement of a third party loan review and the replacement of the existing internal audit function with a comprehensive internal audit performed by an independent external CPA firm. The focus of our management team turned from growth in our business to executing these disciplined business and banking procedures and policies designed to limit future losses, preserve capital and improve operational efficiencies.

As discussed in Note 13, in May 2010 Monarch Community Bank entered into a Consent Order with the FDIC and OFIR. The Consent Order covers various aspects of the Bank’s financial condition and performance; loan administration; and capital planning. The Bank has already addressed or taken steps to address the requirements of the Consent Order and manages its comprehensive plan to address all of the requirements of the Consent Order. We believe we have complied with all the provisions of the Consent Order, except with respect to the capital requirements.

The Consent Order required the Bank to have and maintain a Tier 1 Leverage Capital Ratio of at least 9% and a Total Risk Based Capital Ratio of at least 11%. At December 31, 2012, the Bank’s Tier 1 Leverage Ratio was 5.95% and the Total Risk Based Ratio was 10.49%, which would qualify the Bank as “well capitalized” under the regulatory capital standards, absent the Consent Order. The Bank needed a capital injection of approximately $6.0 million as of December 31, 2012 in order to comply with the Tier 1 Ratio requirement and needed a capital injection of approximately $500,000 in order to comply with the Total Risk Based Ratio requirement of the Consent Order.

15

Note 2—Management’s Plan (Continued)

The Corporation has developed a capital plan including evaluation of alternatives to reach and maintain the capital levels required by the Consent Order. Achievement of these capital levels could be impacted, positively or negatively by a variety of uncertainties including, but not limited to, earnings levels, changing economic conditions, asset quality, property values and the receptiveness of capital markets to the Corporation‘s new capital offerings.

Strategies to increase the Bank’s regulatory capital ratios in order to comply with the capital requirements of the Consent Order include improving earnings, improving asset quality, preserving capital through suspension of dividends, and raising additional capital. Following is more information regarding these strategies:

Earnings improvements. While net interest income continued to decline in 2012, the Bank has worked on reducing costs of funds and holding the rates on interest earnings assets. Accordingly, the net interest spread (difference between interest percentage earned on assets and interest expense paid on Liabilities) expanded to 3.40% as of December 31, 2012 from 3.04% at December 31, 2011. We also have implemented strategies to improve non-interest income sources, including mortgage banking and investment advisory and referral services. New residential loan production offices have been opened in higher growth markets with favorable demographic factors. These locations include East Lansing, Kalamazoo, St. Joseph, Grand Rapids, Battle Creek, Jackson, Adrian, Brighton and Angola, Indiana. We are currently pursuing the identification of sites in other key locations with similar demographic factors. These offices are normally staffed with two to three residential mortgage originators who generate loans that are sold immediately into the secondary market, generating fee income for the bank. Cross-selling activity of these lenders includes making referrals for deposit and investment services.

We have also established a new partnership with Investment Professionals, Inc. out of San Antonio, Texas, who will provide sales, research and compliance services to financial advisors operating under the name of Monarch Investment Services. These financial advisors will assist the Bank’s customers in the management and investment of their funds in non-FDIC insured products and services. This new partnership replaces the partnership previously established with Prudential Insurance, and will allow for the branding of the Monarch name while providing enhanced services to our customers.

New business development goals have been established for commercial lenders, residential loan originators and branch employees, addressing growth plans for commercial loans, residential loans, investment advisory services and deposit growth.

Improving asset quality. Management has focused significant resources toward improving asset quality over 2010, 2011 and 2012. This included the engagement of an external loan review company to conduct independent reviews of the Bank’s commercial loan portfolio. All loans greater than $500,000 have been reviewed over the past three years, along with a significant selection of loans with balances less than $500,000. Four such external loan reviews have been conducted since May of 2010, resulting in no additional charge-offs or loan loss provisions being recommended by the loan review company. In addition, the most recent external loan review, conducted in the 4^th quarter of 2012, resulted in no risk rating downgrades. There were no recommendations for changes in policies, practices or procedures.

16

Note 2—Management’s Plan (Continued)

Likewise, in 2010 management replaced the internal audit function, previously performed by Bank employees, with internal audits now performed by an independent, external CPA firm, Rehmann. As part of the 2010 internal audit function, the CPA firm assisted the Bank in developing a new, comprehensive Sarbanes Oxley Key Control Matrix, which is updated as part of each semiannual audit. The audit is then performed based on, among other things, these key controls. No material weaknesses were identified through this audit process in 2010, 2011 and 2012.

During 2012, non-accrual loans declined from $8.8 at December 31, 2011 to $7.8 million at December 31, 2012. Nonaccrual loans declined from $14.1 million at December 31, 2010 to $8.8 million at December 31, 2011. The continued decline in nonaccrual reflects the implementation of weekly problem loan meetings that focus on the development and execution of detailed plans for the mitigation or elimination of each problem loan in the portfolio. It also reflects the restructuring and additional staffing in our credit administration department, which provides support for the commercial lenders. This increased focus on credit quality will remain a constant part of our Bank’s culture.

The decrease in total assets was largely from a reduction of $20.5 million in the Corporation’s loan portfolio from efforts to reduce concentration in certain loan types. We implemented a concentration reduction plan to measure and monitor concentrations of credit on an ongoing basis. Execution of that plan included curtailing the origination of hospitality and land development loans, the portfolios primarily responsible for loan losses in 2010. Increased emphasis has been placed on obtaining updated property valuations and “right- sizing” of loan balances either through pay downs or by obtaining additional collateral in order to protect the Bank.

As part of improving asset quality, we have plans to grow the commercial loan portfolio, as allowed by the availability of capital, with a focus on SBA guaranteed loans. To this end, all commercial lenders have received significant training on SBA products and services, and have monthly goals for the development of new loan relationships. The effort to grow well-structured SBA loans, while concurrently eliminating the higher risk loans from the portfolio, will lead to a healthier, well-balanced loan portfolio, and will create opportunities for the generation of fee income through the sale of the SBA guaranteed portions of the loans.

Preserving capital. The Bank did not pay dividends to the Corporation during 2010, 2011 or 2012. In previous periods, dividends from the Bank to the Corporation were primarily utilized by the Corporation to pay dividends on its common and preferred stock and to repurchase common stock. To preserve Bank capital, the Corporation has suspended payment of dividends on common and preferred stock. The Bank may not resume payments of dividends without the consent of the FDIC and OFIR.

The Corporation also remains active at exploring alternatives to raising new capital and has established relationships with investment bankers who are assisting in this process. Due to past losses, the Bank has a deferred tax asset of approximately $8.2 million and a full valuation against the asset that if retained could be utilized in years when the Corporation becomes profitable.

17

Note 2—Management’s Plan (Continued)

Given this valuable deferred tax asset, we are pursuing recapitalization alternatives that, among other things, would allow us to preserve and recapture this tax asset. Our tentative goal is to undertake a formal capital raise sometime in the first half of 2013.

These financial statements do not include any adjustments that might be necessary if the Corporation is unable to continue as a going concern.

Note 3—Intangible Assets

	(In thousands of Dollars)
	Gross		Accumulated		Net
2012
Amortized intangible assets:
Core deposit premium resulting from bank and branch acquistions
Total	$	2,081	$	1,974	$	107
2011
Amortized intangible assets:
Core deposit premium resulting from bank and branch acquistions
Total	$	2,081	$	1,833	$	248

Aggregate amortization expense was $141,000 and $142,000 for 2012 and 2011, respectively.

Year Ending
December 31
2013	$	107
2014		—
2015		—
Total	$	107

18

Note 4—Securities

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

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Market Value
2012
Available-for-sale securities:
Collateralized Mortgage obligations	$	6,586	$	113	$	—	$	6,699
U.S. government agency obligations		2,007		24		—		2,031
Mortgage-backed securities		609		44				653
Obligations of states and political subdivisions		660		4		—		664
Total available-for-sale securities	$	9,862	$	185	$	—	$	10,047
Held-to-maturity securities:
Certificates of Deposit	$	1,981	$	—	$	—	$	1,981
2011
Available-for-sale securities:
Collateralized Mortgage obligations	$	7,732	$	48	$	—	$	7,780
U.S. government agency obligations		3,423		3		—		3,426
Mortgage-backed securities		938		60				998
Obligations of states and political subdivisions		326		6		—		332
Total available-for-sale securities	$	12,419	$	117	$	—	$	12,536
Held-to-maturity securities:
Certificates of Deposit	$	1,981	$	—	$	—	$	1,981

19

Note 4—Securities (Continued)

The amortized cost and estimated market values of securities at December 31, 2012, 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 Cost		Market Value		Amortized Cost		Market Value
Due in one year or less	$	741	$	741	$	—	$	—
Due in one through five years		1,240		1,240		2,499		2,527
Due after five years through ten years		—		—		168		168
Due after ten years		—		—		6,586		6,699
Total	$	1,981	$	1,981		9,253		9,394
Mortgage-backed securities						609		653
Total available-for-sale securities					$	9,862	$	10,047

For the years ended December 31, 2012 and 2011 proceeds from sales of securities available for sale amounted to $255,000 and $8,550,000, respectively. Gross realized gains amounted to $12,000 and $469,000, respectively. There were no gross realized losses recognized in 2012 or 2011.

The Corporation had no gross unrealized losses as of December 31, 2012 and 2011.

Management evaluates securities for other-than-temporary impairment (OTTI) 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. Management determined that there were no securities with OTTI at December 31, 2012.

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

Monarch Community Bank had $7.4 million and $3.6 million in pledged securities as collateral for Federal Home Loan Bank Advances at December 31, 2012 and 2011, respectively.

20

Note 5—Loans And Allowance For Loan Loss

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

	December 31,
	2012		2011
Mortgage loans on real estate:
One-to-four family	$	69,043	$	78,500
Multi-family		1,183		765
Commercial		45,982		54,308
Construction or land development		1,416		1,639
Total real estate loans		117,624		135,212
Consumer loans:
Home equity		8,058		10,499
Other		1,885		2,516
Total consumer loans		9,943		13,015
Commercial business loans		3,709		5,212
Subtotal		131,276		153,439
Less: Allowance for loan losses		3,035		4,656
Net deferred loan fees		241		288
Loans, net	$	128,000	$	148,495

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Our delinquent loans consist largely of commercial real estate loans. All loan classes on which principal or interest is in default for 90 days or more are put on nonaccrual status, unless there is sufficient documentation to conclude that the loan is well secured and in the process of collection. Loans will also be placed on nonaccrual status if the Bank cannot reasonably expect full and timely repayment. All nonaccrual loans are also deemed to be impaired unless they are residential loans whose status as nonaccrual loans is based solely on having reached 90 days past due, are in the process of collection, but whose status as well secured has not yet been established.

A loan is considered impaired when it is probable that the Corporation will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the agreement. All impaired loans are also classified as nonaccrual loans unless they are deemed to be impaired solely due to their status as a troubled debt restructure and, 1) the borrower is not past due or, 2) there is verifiable adequate cash flow to support the restructured debt service or, 3) there is an adequate collateral valuation supporting the restructured loan.

21

Note 5—Loans And Allowance For Loan Loss (Continued)

An age analysis of past due loans including nonaccrual loans, segregated by class of loans, as of December 31, 2012 and 2011 is as follows (000s omitted):

December 31, 2012	30-60 Days Past Due		60-89 Days Past Due		Loans 90 Days or More Past Due		Total Past due Loans		Current Loans		Total Loans
Commercial	$	197	$	—	$	120	$	317	$	3,392	$	3,709
Commercial Real Estate:
Multi-family		450		—		—		450		733		1,183
Commercial Real Estate—other		18		—		1,560		1,578		44,404		45,982
Consumer:
Consumer—Helocs and other		184		7		10		201		9,742		9,943
Residential:
Residential—prime		993		619		203		1,815		52,856		54,671
Residential—subprime		702		236		113		1,051		13,321		14,372
Construction:
Construction—prime		80		—		—		80		1,336		1,416
Construction—subprime		—		—		—		—		—		—
Total	$	2,624	$	862	$	2,006	$	5,492	$	125,784	$	131,276

December 31, 2011	30-60 Days Past Due		60-89 Days Past Due		Loans 90 Days or More Past Due		Total Past due Loans		Current Loans		Total Loans
Commercial	$	147	$	—	$	1,166	$	1,313	$	3,899	$	5,212
Commercial Real Estate:
Multi-family		—		—		—		—		765		765
Commercial Real Estate—other		105		246		3,016		3,367		50,941		54,308
Consumer:
Consumer—Helocs and other		74		—		—		74		12,941		13,015
Residential:
Residential—prime		632		105		478		1,215		62,094		63,309
Residential—subprime		216		123		67		406		14,785		15,191
Construction:
Construction—prime		—		—		—		—		1,639		1,639
Construction—subprime		—		—		—		—		—		—
Total	$	1,174	$	474	$	4,727	$	6,375	$	147,064	$	153,439

22

Note 5—Loans And Allowance For Loan Loss (Continued)

All commercial loans are assigned a risk rating by the credit analyst at inception. Risk ratings are reviewed periodically thereafter and modified as necessary. The risk rating system is composed of eight levels of quality and utilizes the following definitions.

Risk Rating Scores by definition:

1. Zero (0) Unclassified. Any loan which has not been assigned a classification.

2. One (1) Excellent. A well structured credit relationship to an established borrower. Loans to entities with a strong financial condition and solid earnings history.

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

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

• Working capital adequate to support operations.

• Cash flow sufficient to pay debts as scheduled.

• Management experience and depth appear favorable.

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

• Acceptable sales and steady earning history.

• Industry outlook is stable.

• Loan structure within policy guidelines.

• Loan performing according to terms.

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

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

• Marginal liquidity and working capital.

• Short or unstable earnings history.

• Would include most start-up businesses.

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

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

• Management abilities are apparent yet unproven.

• Debt to worth ratio of 3.50 or less.

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

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

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

• Loan structure generally in accordance with policy.

23

Note 5—Loans And Allowance For Loan Loss (Continued)

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

• Downward trend in sales, profit levels and margins.

• Impaired working capital positions.

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

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

• Management abilities are questionable.

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

• Industry conditions are weak.

• Inadequate or outdated financial information.

• Litigation pending against borrower.

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

• Collateral / guaranty offers limited protection.

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

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

• Deteriorating liquidity.

• Serious management problems.

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

• Likelihood of bankruptcy.

• Inability to access other funding sources.

• Reliance on secondary source of repayment.

• Interest non-accrual may be warranted.

• Collateral provided is of little or no value.

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

• Repayment may require litigation.

24

Note 5—Loans And Allowance For Loan Loss (Continued)

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

• Normal operations are severely diminished or have ceased.

• Seriously impaired cash flow.

• Secondary source of repayment is inadequate.

• Survivability as a “going concern” is impossible.

• Placement on interest non-accrual.

• Collection process has begun.

• Bankruptcy petition has been filed.

• Judgments have been filed.

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

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

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

• Fraudulently overstated assets and/or earnings.

• Collateral has marginal or no value.

• Debtor cannot be located.

25

Note 5—Loans And Allowance For Loan Loss (Continued)

The following table represents the risk category of loans by class based on the most recent analysis performed as of December 31, 2012 and 2011 (000s omitted):

			December 31, 2012
Credit Rating	Commercial		Commercial Real Estate Multi-family		Commercial Real Estate Other
0	$	—	$	31	$	2,006
1-2		—		—		6
3		521		—		2,890
4		2,610		601		24,602
5		163		101		2,135
6		415		450		14,343
7		—		—		—
Total	$	3,709	$	1,183	$	45,982
			December 31, 2011
	Commercial		Commercial Real Estate Multi-family		Commercial Real Estate Other
0	$	—	$	34	$	2,542
1-2		—		—		—
3		112		154		2,548
4		3,082		18		29,583
5		435		105		2,376
6		466		454		15,551
7		1,117		—		1,708
Total	$	5,212	$	765	$	54,308

26

Note 5—Loans And Allowance For Loan Loss (Continued)

For consumer residential real estate, and other, the Corporation also evaluates credit quality based on the aging status of the loan which was previously stated, and by payment activity. The following tables present the recorded investment in those classes based on payment activity and assigned grades as of December 31, 2012 and 2011 (000s omitted):

	December 31, 2012
	Residential - Prime		Residential - Subprime
Grade
Pass	$	52,980	$	13,325
Substandard		1,691		1,047
Total	$	54,671	$	14,372
			Consumer - Helocs and other
Performing			$	9,641
Nonperforming				302
Total			$	9,943
			Construction - Prime
Performing			$	1,336
Nonperforming				80
Total			$	1,416
	December 31, 2011
	Residential - Prime		Residential - Subprime
Grade
Pass	$	62,895	$	15,027
Substandard		414		164
Total	$	63,309	$	15,191
			Consumer - Helocs and other
Performing			$	12,925
Nonperforming				90
Total			$	13,015
			Construction - Prime
Performing			$	1,639
Nonperforming				—
Total			$	1,639

27

Note 5—Loans And Allowance For Loan Loss (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2012 and 2011 (000s omitted):

December 31, 2012
	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial	$	315	$	382	$	—
Commercial Real Estate:
Commercial Real Estate—Mulit-family		—		—		—
Commercial Real Estate—other		10,724		16,429		—
Consumer:
Consumer—Helocs and other		—		—		—
Residential:
Residential—prime		62		78		—
Residential—subprime		—		—		—
With an allowance recorded:
Commercial		50		50		5
Commercial Real Estate:
Commercial Real Estate—Multi-family		450		464		71
Commercial Real Estate—other		408		408		63
Consumer:
Consumer—Helocs and others		—		—		—
Residential:
Residential—prime		1,790		1,820		313
Residential—subprime		—		—		—
Total
Commercial	$	11,947	$	17,733	$	139
Consumer	$	—	$	—	$	—
Residental	$	1,852	$	1,898	$	313

28

Note 5—Loans And Allowance For Loan Loss (Continued)

December 31, 2011
	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial	$	404	$	454	$	—
Commercial Real Estate:
Commercial Real Estate—Mulit-family		—		—		—
Commercial Real Estate—other		8,820		13,350		—
Consumer:
Consumer—Helocs and others		—		—		—
Residential:
Residential—prime		72		81		—
Residential—subprime		—		—		—
With an allowance recorded:
Commercial		—		—		—
Commercial Real Estate:
Commercial Real Estate—Multi-family		454		467		35
Commercial Real Estate—other		6,445		6,958		480
Consumer:
Consumer—Helocs and others		—		—		—
Residential:
Residential—prime		131		149		81
Residential—subprime		—		—		—
Total
Commercial	$	15,523	$	21,229	$	515
Consumer	$	—	$	—	$	—
Residental	$	203	$	230	$	81

29

Note 5—Loans And Allowance For Loan Loss (Continued)

The following table presents the average recorded investment in loans individually evaluated for impairment by class of loans for the twelve months ended December 31, 2012 and December 31, 2011 (000s omitted):

	Twelve Months Ended December 31, 2012
	Average Recorded Investment		Interest Income
With no related allowance recorded:
Commercial	$	389	$	—
Commercial Real Estate:
Commercial Real Estate—Mulit-family		—		—
Commercial Real Estate—other		16,482		203
Consumer:
Consumer—Helocs and other		—		—
Residential:
Residential—prime		80		—
Residential—subprime		—		—
With an allowance recorded:
Commercial		50		3
Commercial Real Estate:
Commercial Real Estate—Multi-family		465		23
Commercial Real Estate—other		419		12
Consumer:
Consumer—Helocs and others		—		—
Residential:
Residential—prime		1,797		23
Residential—subprime		—		—
Total
Commercial	$	17,805	$	241
Consumer	$	—	$	—
Residental	$	1,877	$	23

30

Note 5—Loans And Allowance For Loan Loss (Continued)

	Twelve Months Ended December 31, 2011
	Average Recorded Investment		Interest Income
With no related allowance recorded:
Commercial	$	428	$	—
Commercial Real Estate:
Commercial Real Estate—Mulit-family		—		—
Commercial Real Estate—other		13,625		131
Consumer:
Consumer—Helocs and other		—		—
Residential:
Residential—prime		82		—
Residential—subprime		—		—
With an allowance recorded:
Commercial		—		—
Commercial Real Estate:
Commercial Real Estate—Multi-family		454		32
Commercial Real Estate—other		6,967		229
Consumer:
Consumer—Helocs and others		—		—
Residential:
Residential—prime		151		—
Residential—subprime		—		—
Total
Commercial	$	21,474	$	392
Consumer	$	—	$	—
Residental	$	233	$	—

31

Note 5—Loans And Allowance For Loan Loss (Continued)

Payments received on loans in nonaccrual status are typically applied to reduce the recorded investment in the asset. While an loan is in nonaccrual status, some or all of the cash interest payments received may be treated as interest income on a cash basis as long as the remaining recorded investment in the asset (i.e., after charge-off of identified losses, if any) is deemed to be fully collectible. As of December 31, 2012 and 2011 the Corporation had not recognized any interest income on a cash basis. The following presents by class, the recorded investment in loans on non-accrual status as of December 31, 2012 and 2011 (000s omitted):

Financing Receivables on Nonaccrual Status

	December 31, 2012
Commercial	$	316
Commercial real estate:
Commercial Real Estate—mulit-family		—
Commercial Real Estate—other		5,008
Consumer:
Consumer—Helocs and other		9
Residential:
Residential—prime		2,108
Residential—subprime		329
Construction
Construction—prime		—
Construction—subprime		—
Total	$	7,770

Financing Receivables on Nonaccrual Status

	December 31, 2011
Commercial	$	1,521
Commercial real estate:
Commercial Real Estate—mulit-family		—
Commercial Real Estate—other		6,278
Consumer:
Consumer—Helocs and other		—
Residential:
Residential—prime		786
Residential—subprime		180
Construction
Construction—prime		—
Construction—subprime		—
Total	$	8,765

32

Note 5—Loans And Allowance For Loan Loss (Continued)

Loans in which the Bank elects to grant a concession, providing terms more favorable than those prevalent in the market (e.g., rate, amortization term), and are formally restructured due to the weakening credit status of a borrower are reported as trouble debt restructure (TDR). All other modifications in which the new terms are at current market conditions and are granted to clients due to competitive pressures because of the customer’s favorable past and current performance and credit risk do not constitute a TDR loan.

In order to maximize the collection of loan balances, we evaluate troubled loans on a case-by-case basis to determine if a loan modification would be appropriate. We pursue loan modifications when there is a reasonable chance that an appropriate modification would allow our client to continue servicing the debt. For loans secured by either commercial or residential real estate, if the client demonstrates a loss of income such that the client cannot reasonably support even a modified loan, we may pursue foreclosure, short sales and/or deed-in-lieu arrangements. For all troubled loans, we review a number of factors, including cash flows, loan structures, collateral values, and guarantees. Based on our review of these factors and our assessment of overall risk, we evaluate the benefits of renegotiating the terms of the loans so that they have a higher likelihood of continuing to perform. To date, we have restructured loans in a variety of ways to help our clients service their debt and to mitigate the potential for additional losses. The primary restructuring methods being offered to our clients are reductions in interest rates and extensions in terms. Loans that, after being restructured, remain in compliance with their modified terms and whose modified interest rate yielded a market rate at the time the loan was restructured, are reviewed annually and may be reclassified as non-TDR, provided they conform with the prevailing regulatory criteria. As of December 31, 2012 there have been no loans in which the TDR designation has been removed.

33

Note 5—Loans And Allowance For Loan Loss (Continued)

The following table represents the modifications completed during the twelve months ended December��31, 2012 and 2011 (000s omitted):

			Modifications
			December 31, 2012
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Commercial		1	$	50	$	50
Commercial real estate:
Commercial Real Estate—mulit-family		—		—		—
Commercial Real Estate—other		—		—		—
Consumer:
Consumer—Helocs and other		—		—		—
Residential:
Residential—prime		7		1,010		1,022
Residential—subprime		3		134		146
Construction
Construction—prime		—		—		—
Construction—subprime		—		—		—
Total		11	$	1,194	$	1,218

	Number of Contracts		Recorded Investment
Troubled Debt Restructurings That Subsequently Defaulted
Commercial		—	$	—
Commercial real estate:
Commercial Real Estate—mulit-family		1		450
Commercial Real Estate—other		1		2,534
Consumer:
Consumer—Helocs and other		6		69
Residential:
Residential—prime		7		1,684
Residential—subprime		15		784
Construction
Construction—prime		—		—
Construction—subprime		—		—
		30	$	5,521

34

Note 5—Loans And Allowance For Loan Loss (Continued)

			Modifications
			December 31, 2011
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Commercial		1	$	241	$	215
Commercial real estate:
Commercial Real Estate—mulit-family		—		—		—
Commercial Real Estate—other		4		2,982		2,835
Consumer:
Consumer—Helocs and other		2		81		78
Residential:
Residential—prime		19		1,606		1,596
Residential—subprime		9		470		472
Construction
Construction—prime		—		—		—
Construction—subprime		—		—		—
Total		35	$	5,380	$	5,196

	Number of Contracts		Recorded Investment
Troubled Debt Restructurings That Subsequently Defaulted
Commercial		6	$	1,413
Commercial real estate:
Commercial Real Estate—mulit-family		1		187
Commercial Real Estate—other		16		5,692
Consumer:
Consumer—Helocs and other		6		243
Residential:
Residential—prime		15		1,938
Residential—subprime		3		261
Construction
Construction—prime		1		239
Construction—subprime		—		—
		48	$	9,973

35

Note 5—Loans And Allowance For Loan Loss (Continued)

All TDR loans are considered impaired. When individually evaluating loans for impairment, we may measure impairment using (1) the present value of expected future cash flows discounted at the loan’s effective interest rate (i.e., the contractual interest rate adjusted for any net deferred loan fees or costs, premium, or discount existing at the origination or acquisition of the loan), (2) the loan’s observable market price, or (3) the fair value of the collateral. If the present value of expected future cash flows discounted at the loan’s effective interest rate is used as the means of measuring impairment the change in the present value attributable to the passage time is recognized as bad-debt expense. As previously mentioned all impaired loans are also classified as nonaccrual loans unless they are deemed to be impaired solely due to their status as a troubled debt restructure and, 1) the borrower is not past due or, 2) there is verifiable adequate cash flow to support the restructured debt service or, 3) there is an adequate collateral valuation supporting the restructured loan. Nonaccruing TDR loans that demonstrate a history of repayment performance in accordance with their modified terms are reclassified to accruing restructured status, typically after six months of repayment performance and are supported by a current credit evaluation of the borrower’s financial condition and expectations for repayment under the revised terms. At December 31, 2012, $15.1 million of loans restructured were accruing compared to $15.8 million at December 31, 2011. Of the troubled debt restructured balances as of December 31, 2012 $13.9 million were paying in accordance with modified terms compares to $15.7 million which were paying in accordance with modified terms at December 31, 2011.

36

Note 5—Loans and Allowance for Loan Loss (Continued)

Analysis related to the allowance for credit losses as of December 31, 2012 and 2011 is as follows (0000s omitted):

				As of
				DECEMBER 31, 2012
	Commercial			Comercial Real Estate Other			Multi Family		Consumer			Residential - Prime			Residential - Subprime			Construction			Total
ALLOWANCE FOR CREDIT LOSSES:
Beginning Balance	$	45		$	1,262		$	45	$	259		$	2,280		$	664		$	101		$	4,656
Charge-Offs		(22	)		(579	)		—		(345	)		(925	)		(195	)		(6	)		(2,072	)
Recoveries		7			1,241			1		221			20			3			—			1,493
Provision		(18	)		(1,187	)		35		95			69			49			(85	)		(1,042	)
Ending Balance		12			737			81		230			1,444			521			10			3,035
Ending Balance: individually evaluated for impairment		—			64			71		—			318			—			—			453
Ending Balance: collectively evaluated for impairment	$	12		$	673		$	10	$	230		$	1,126		$	521		$	10		$	2,582

				As of
				DECEMBER 31, 2011
	Commercial			Comercial Real Estate Other			Multi Family			Consumer			Residential - Prime			Residential - Subprime			Construction			Total
ALLOWANCE FOR CREDIT LOSSES:
Beginning Balance	$	180		$	1,610		$	473		$	503		$	3,496		$	458		$	130		$	6,850
Charge-Offs		(81	)		(590	)		(286	)		(441	)		(1,606	)		(510	)		(3	)		(3,517	)
Recoveries		35			235			4			196			79			41			—			590
Provision		(89	)		7			(146	)		1			311			675			(26	)		733
Ending Balance		45			1,262			45			259			2,280			664			101			4,656
Ending Balance: individually evaluated for impairment		—			480			35			—			81			—			—			596
Ending Balance: collectively evaluated for impairment	$	45		$	782		$	10		$	259		$	2,199		$	664		$	101		$	4,060

37

Note 5—Loans and Allowance for Loan Loss (Continued)

	December 31, 2012
	Commercial		Comercial Real Estate Other		Multi Family		Consumer		Residential - Prime		Residential - Subprime		Construction		Total
FINANCING RECEIVABLES:
Ending Balance	$	3,709	$	45,982	$	1,183	$	9,943	$	54,671	$	14,372	$	1,416	$	131,276
Ending Balance: individually evaluated for impairment		365		11,132		450		—		1,852		—		—		13,799
Ending Balance: collectively evaluated for impairment	$	3,344	$	34,850	$	733	$	9,943	$	52,819	$	14,372	$	1,416	$	117,477

	December 31, 2011
	Commercial		Comercial Real Estate Other		Multi Family		Consumer		Residential - Prime		Residential - Subprime		Construction		Total
FINANCING RECEIVABLES:
Ending Balance	$	5,212	$	54,308	$	765	$	13,015	$	63,309	$	15,191	$	1,639	$	153,439
Ending Balance: individually evaluated for impairment		404		14,665		454		—		203		—		—		15,726
Ending Balance: collectively evaluated for impairment	$	4,808	$	39,643	$	311	$	13,015	$	63,106	$	15,191	$	1,639	$	137,713

38

Note 5—Loans and Allowance for Loan Loss (Continued)

The Corporation’s charge-off policy (which meets regulatory minimums) has not required any revisions since the second quarter of 2010. Losses on unsecured consumer loans are recognized at or before 120 days past due. Secured consumer loans, including residential real estate, are typically charged-off between 120 and 180 days past due, depending on the collateral type, in compliance with the FFIEC guidelines. Specific loan reserves are established based on credit and or collateral risks on an individual loan basis. When the probability for full repayment of a loan is unlikely the Bank will initiate a full charge-off or a partial write down of a loan based upon the status of the loan. Impaired loans or portions thereof are charged-off when deemed uncollectible. Loans that have been partially charged-off remain on nonperforming status, regardless of collateral value, until specific borrower performance criteria are met. Total impaired loans were $22.3 million as of December 31, 2012 and $23.8 million as of December 31, 2011. Partial charge-offs associated with the impaired loans totaled $729,000 as of December 31, 2012 and $447,000 as of December 31, 2011.

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 $170,130,000 and $168,863,000 at December 31, 2012 and 2011, respectively.

The fair value of mortgage servicing rights approximates $1,362,000 and $1,727,000 at December 31, 2012 and 2011, respectively. The fair value in 2012 was determined by discounting estimated net future cash flows from mortgage servicing activities using a 7.75% discount rate and estimated prepayment speeds of 9.8 to 36.9 based on current Freddie Mac experience. In 2011 the discount rate of 7.75% and estimated prepayment speeds of 6.2 to 28.6 were used. The impairment valuation allowance is $0 as of December 31, 2012 and 2011. There has been no activity in the impairment valuation allowance during the years ended December 31, 2012 and 2011.

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

	December 31,
	2012			2011
Mortgage servicing rights—Beginning	$	962		$	1,066
Mortgage servicing rights capitalized		528			321
Mortgage servicing rights scheduled amortization and direct writedown for loan payoffs		(442	)		(425	)
Mortgage servicing rights—Ending	$	1,048		$	962

39

Note 7—Foreclosed Assets

Foreclosed assets, which include real estate owned and real estate in judgment and subject to redemption, 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 performed annually 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. The valuations consist of obtaining a broker price opinion or a new appraisal depending on the value of the asset. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets. Assets held as real estate in judgment may be subject to redemption for a period of six to twelve months depending on the collateral, following the foreclosure sale. Assets may be redeemed by the borrower for the foreclosure sale price, accrued interest and foreclosure costs. Any asset redeemed would be treated as a paid off loan.

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

	December 31,
	2012		2011
Real estate owned	$	810	$	2,519
Real estate in judgment and subject to redemption		434		1,914
Total	$	1,244	$	4,433

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

	December 31,
	2012			2011
Net (gain) on sales of real estate	$	(68	)	$	(300	)
Operating expenses		820			745
Total	$	752		$	445

40

Note 7—Foreclosed Assets (Continued)

The following table summarizes the activity associated with other real estate owned (000s omitted):

	2012			2011
Balance at beginning of year	$	2,519		$	1,542
Properties transferred into OREO		2,093			5,444
Valuation impairments recorded		(944	)		(1,295	)
Proceeds from Sale of Properties		(2,926	)		(2,872	)
(Gain) or Loss on sale of properties		(68	)		(300	)
	$	810		$	2,519

Note 8—Premises and Equipment

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

	December 31,				Depreciable
	2012		2011		Life (in Years)
Land		566		566
Buildings and improvements		5,840		5,824		3-40
Furniture, fixtures and equipment		3,482		3,105		3-15
Total bank premises and equipment		9,888		9,495
Less accumulated depreciation and amortization		5,908		5,491
Net carrying amount		3,980		4,004

Depreciation expense was approximately $419,000 and $400,000, in 2012 and 2011, respectively.

41

Note 8—Premises and Equipment (Continued)

Rent expense for 2012 and 2011 was $114,100 and $28,275, respectively. Rent commitments under noncancelable operating leases are as follows (000s omitted):

Year Ending
December 31
2013	$	124
2014		47
2015		11
Total	$	182

Note 9—Deposits

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

	December 31,
	2012		2011
Balances by account type:
Demand and NOW accounts	$	26,008	$	24,477
Money market		34,851		34,951
Passbook and statement savings		23,719		20,612
Total transactional accounts		84,578		80,040
Certificates of deposit:
$100,000 and over		30,395		33,023
Under $100,000		36,877		41,439
Total certificates of deposit		67,272		74,462
Total	$	151,850	$	154,502

42

Note 9—Deposits (Continued)

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

	December 31, 2012
	Less than $100,000		$100,000 & greater
Less than one year	$	23,844	$	16,785
One to two years		7,672		5,753
Two to three years		3,142		5,545
Three to four years		1,285		1,630
Four to five years		934		682
Total	$	36,877	$	30,395

Note 10—Federal Home Loan Bank Advances and Fed Funds Purchased

The Bank has Federal Home Loan Bank advances of $7,059,000 and $20,175,000 at December 31, 2012 and 2011, respectively, which mature through 2013. At December 31, 2012, the interest rates on fixed rate advances ranged from 3.96% to 5.64%. At December 31, 2011, the interest rates on fixed rate advances ranged from 3.96% to 5.98%.

At December 31, 2012 and 2011, the Bank had no floating rate advances. The weighted average interest rate of all advances was 4.10% and 4.74% at December 31, 2012 and 2011, respectively.

The Bank has provided a pledge of all of the Bank’s eligible residential mortgage loans and certain securities as collateral for all FHLB debt. The amount of the residential loans including home equity lines of credit totaled $43.1 million and $52.1 million as of December 31, 2012 and 2011, respectively.

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

Year Ending
December 31
2013	$	7,059
2014		—
2015		—
Total	$	7,059

43

Note 11—Income Taxes

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

	December 31,
	2012			2011
Current expense (benefit)	$	—		$	(217	)
Deferred expense (benefit)		161			(721	)
Valuation allowance		(161	)		1,039
Total tax expense	$	—		$	101

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,
	2012			2011
Statutory federal tax rate		34.00	%		34.00	%
Increase (decrease) resulting from:
Nondeductible expenses		-1.72	%		-3.90	%
Tax exempt income		21.33	%		-23.90	%
Valuation allowance		-45.57	%		-49.30	%
Other		-8.04	%		3.00	%
Reported tax expense		0.00	%		-40.10	%

44

Note 11—Income Taxes (Continued)

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

	December 31,
	2012			2011
Deferred tax assets:
Provision for loan losses	$	—		$	464
Net deferred loan fees		82			98
Deferred compensation		296			305
General business tax credit carryforward		1,671			1,480
Depreciation		383			521
Net NOL Carryforward		5,694			4,501
Other Real Estate		293			760
Other		690			1,145
Total deferred tax assets		9,109			9,274
Deferred tax liabilities:
Provision for loan losses	$	9		$	—
Mortgage servicing rights		352			317
Original issue discount		36			45
Net purchase premiums		351			464
Unrealized gain on available for sale securities		63			40
Other		150			90
Total deferred tax liabilities		952			956
Valuation allowance		(8,157	)		(8,318	)
Net deferred tax asset	$	—		$	—

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. The general business credits of $1,671,000 expire between 2027 and 2033.

The Corporation has invested in a partnership involved in a low cost housing project for which tax credits are generated. The project is operating as a multi-family housing community. The partnership is eligible and qualifies for the 70% present value low income housing tax credit in accordance with the Section 42 of the Internal Revenue Code as enacted by the Tax Reform Act of 1986 on qualified low income units. The Corporation’s share of tax credits generated by the investee partnership approximated $191,000 in 2012 and $191,000 in 2011.

45

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 needs of its customers. 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,
	2012		2011
Commitments to grant loans	$	3,726	$	2,464
Unfunded commitments under lines of credit		8,583		11,116
Unfunded commitments under letters of credit		—		—

The above commitments include fixed rate and variable rate loan commitments and lines of credit with interest rates ranging between 2.00% and 14.50% at December 31, 2011 and 2012.

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.

46

Note 13—Regulatory Matters

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The Bank’s regulatory capital ratios as of December 31, 2012 were as follows: Tier 1 leverage ratio 5.95%, Tier 1 risk-based capital ratio 9.24%; and total risk-based capital, 10.49%.

47

Note 13—Regulatory Matters (Continued)

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

	December 31,
	2012			2011
Equity per consolidated Bank balance sheet	$	11,766		$	11,798
Less: intangible and disallowed assets		(226	)		(319	)
Tier 1 Capital		11,540			11,479
Plus: Allowance for loan losses **		1,574			1,780
Total Capital	$	13,114		$	13,259

** Limited to 1.25% of risk weighted assets

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.

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

	Actual					To Comply With Minimum Capital Requirements					To be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2012
Total Capital
(to Risk-Weighted Assets)		13,114		10.49	%		9,997		8.00	%		12,496		10.00	%
Tier 1 Capital
(to Risk-Weighted Assets)		11,540		9.24	%		4,998		4.00	%		7,498		6.00	%
Tier 1 Capital
(to Average Assets)		11,540		5.95	%		9,697		5.00	%		9,697		5.00	%
As of December 31, 2011
Total Capital
(to Risk-Weighted Assets)	$	13,259		9.50	%	$	11,161		8.00	%	$	13,952		10.00	%
Tier 1 Capital
(to Risk-Weighted Assets)	$	11,479		8.23	%	$	5,581		4.00	%	$	8,371		6.00	%
Tier 1 Capital
(to Average Assets)	$	11,479		5.27	%	$	10,900		5.00	%	$	10,900		5.00	%

48

Note 14—Restrictions on Dividends, Loans and Advances

Banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Corporation. The primary source of liquidity for the Corporation is from dividends paid by the Bank. On September 21, 2010, the Corporation entered into a Written Agreement with the Federal Reserve Bank of Chicago (the “FRB”). Among other things, the Written Agreement requires that the Corporation obtain the approval of the FRB prior to paying a dividend. In addition, all accrued and unpaid dividends on the Corporation’s Series A, $.01 par value $1,000 liquidation preference, fixed rate cumulative perpetual preferred stock (Preferred Stock) must be declared and the payment set aside for the benefit of the holders of Preferred Stock before any dividend may be declared or paid on our common stock.

The total amount of dividends which may be paid at any date is generally limited to the retained earnings of the Bank. However, dividends paid by the Bank would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum standards. At December 31, 2012, the Bank had no retained earnings available for the payment of dividends. Accordingly, the Corporation’s entire investment in the Bank was restricted at December 31, 2012.

Loans or advances made by the Bank to the Corporation are generally limited to 10 percent of the Bank’s capital stock and surplus. Accordingly, at December 31, 2012, Bank funds available for loans or advances to the Corporation amounted to $1,176,500.

Note 15—Shareholders’ Equity

On February 6, 2009 the Corporation issued 6,785 shares of Preferred Stock and warrants to purchase 260,962 shares of our common stock at an exercise price of $3.90 per share (Warrants), to the U.S. Department of Treasury in return for $6.8 million under the Capital Purchase Program (CPP). Of the proceeds, $6,729,000 was allocated to the Preferred Stock and $56,000 was allocated to the Warrants based on the relative fair value of each. The $56,000 discount on the Preferred Stock is being accreted using an effective yield method over five years. The Preferred Stock and Warrants qualify as Tier 1 capital.

The Preferred Stock pays cumulative quarterly cash dividends at a rate of 5% per year on the $1,000 liquidation preference through February 15, 2014 and at a rate of 9% per year thereafter. We accrue dividends based on the rates, liquidation preference and time since last quarterly dividend payment. All accrued and unpaid dividends on the Preferred Stock must be declared and the payment set aside for the benefit of the holders of Preferred Stock before any dividend may be declared or paid on our common stock.

Holders of shares of the Preferred Stock have no right to exchange or convert such shares into any other security of the Corporation and have no right to require the redemption or repurchase of the Preferred Stock. The Preferred Stock does not have any sinking fund. The Preferred Stock is non-voting, other than class voting rights on certain matters that could adversely affect the Preferred Stock.

49

Note 15—Shareholders’ Equity (Continued)

The Corporation may redeem the Preferred Stock for the liquidation preference plus accrued and unpaid dividends at anytime. Any such redemption is subject to U.S. Treasury’s prior consultation with the Federal Reserve Board. In April 2010, the Corporation announced the suspension of the dividend on the Preferred Stock in order to preserve capital. At December 31, 2012, $1,142,000 in dividends and interest have been accrued but not paid.

The Warrants are immediately exercisable for 260,962 shares of the Corporation’s common stock at an initial exercise price of $3.90 per common share. The Warrants are transferrable and may be exercised at any time on or before February 6, 2019.

Note 16—Retirement Plans

The Bank participates in the Pentegra Defined Benefit Plan for Financial Institutions the (“Pentegra DB Plan”), a tax-qualified defined-benefit pension plan. The Pentegra DB Plan’s Employer Identification Number is 13-5645888 and the Plan Number is 333. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes and as a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra DB Plan. Effective April 1, 2004 employees’ benefits under the plan were frozen. The plan is administered by the trustees of the Financial Institutions Retirement Fund. During 2012 and 2011, the Corporation recognized expense for this plan of $97,000 and $93,000, respectively.

The Pentegra DB Plan is a single plan under Internal Revenue Code Section 413(c) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan contributions made by a participating employer may be used to provide benefits to participants of other participating employers.

Total contributions made to the Pentegra DB Plan, as reported on Form 5500, equal $299,729,365 and $203,582,159 for the plan years ending June 30, 2012 and June 30, 2011, respectively. The Bank’s contributions to the Pentegra DB Plan are not more than 5% of the total contributions to the Pentegra DB Plan. The Bank was requested to provide additional funding of $1.2 million in 2010; however the minimum required contribution for the 2011-2012 plan year was $83,000. The Corporation has approximately $1.1 million included in other assets for this prefunding balance. The excess funding remains within the plan and the Corporation may elect to utilize the prefunding balance for future required contributions.

50

Note 16—Retirement Plans (Continued)

The following contributions were paid by the Bank during the fiscal years ending December 31 (000s omitted):

	2012				2011
Date Paid	Amount		Date Paid		Amount
1/3/2012	$	32			$	—
10/17/2012		19				—
12/27/2012		67				—
Total	$	118		Total	$	—

The Corporation has a Defined Contribution Retirement plan for all eligible employees. The Corporation’s matching contribution agreement of any portion of an employee’s salary was discontinued in 2010. During 2012 and 2011, the Corporation recognized expense for this plan of $0.

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 higher of the Corporation’s return on average equity or 5.0%. The value of benefits accrued to participants was $426,000 and $430,000 at December 31, 2012 and 2011, respectively. The expense for the plan, including the increase due to the annual earnings credit was $22,000 and $21,000 for 2012 and 2011, respectively.

The Corporation has a liability for the directors’ deferred compensation plan. 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 3.84% as of December 31, 2012. The present value of benefits accrued to participants (also included as part of the other liabilities section of the balance sheet) is $445,000 and $468,000 at December 31, 2012 and 2011, respectively.

Note 17—Related Party Transactions

Extensions of credit to principal officers, directors and their affiliates totaled $2,518,000 and $2,633,000 for the years ending December 31, 2011 and 2012, respectively. During the year ending December 31, 2012, total principal additions were $68,000 and total principal payments were $183,000, and during the year ending December 31, 2011, total principal additions were $19,000 and total principal payments were $254,000. Deposits from related parties and their affiliates held by the Bank at December 31, 2012 and 2011 amounted to $908,000 and $924,000 respectively.

51

Note 18—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. FASB ASC 820-10-50 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation.

The fair value of all financial instruments not discussed below (cash and cash equivalents, federal funds sold, Federal Home Loan Bank stock, accrued interest receivable, federal funds purchased and interest payable) are estimated to be equal to their carrying amounts as of December 31, 2012 and December 31, 2011. The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments:

Securities—Fair values for securities, excluding Federal Home Loan Bank stock, are based on quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

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

Loans Receivable—For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flows analyses, using 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.

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

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

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

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

52

Note 18—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, 2012
	Carrying Amount		Level 1		Level 2		Level 3		Total Estimated Fair Value
Assets:
Cash and cash equivalents	$	28,744	$	28,744	$	—	$	—	$	28,744
Securities—Held to maturity		1,981		—		1,981		—		1,981
Securities—Available for sale		10,047		—		10,047		—		10,047
Other securities		3,370		—		3,370		—		3,370
Loans and loans held for sale, net		130,045		—		—		134,944		134,944
Liabilities:
Deposits		169,460		—		171,129				171,129
Federal Home Loan Bank advances	$	7,059	$	—	$	7,194			$	7,194

	December 31, 2011
	Carrying Amount		Level 1		Level 2		Level 3		Total Estimated Fair Value
Assets:
Cash and cash equivalents	$	24,111	$	24,111	$	—	$	—	$	24,111
Securities—Held to maturity		1,981		—		1,981		—		1,981
Securities—Available for sale		12,536		—		12,536		—		12,536
Other securities		3,370		—		3,370		—		3,370
Loans and loans held for sale, net		149,148		—		—		156,794		156,794
Liabilities:
Deposits		174,185		—		175,720		—		175,720
Federal Home Loan Bank advances	$	20,175	$	—	$	20,566	$	—	$	20,566

53

Note 19—Fair Value Measurements

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

The following table presents information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at December 31, 2012 and December 31, 2011, and the valuation techniques used by the Corporation to determine those fair values (000s omitted). Investment securities with fair value determined by Level 2 inputs include mortgage backed securities, collateralized mortgage obligations, and obligations of states and political subdivisions and U.S Government Agency obligations.

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable  Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at December 31, 2012
Assets:
December 31, 2012
Collateralized Mortgage obligations	$	—	$	6,699	$	—	$	6,699
U.S. government agency obligations		—		2,031		—		2,031
Mortgage-backed securities		—		653		—		653
Obligations of states and political subdivisions		—		664		—		664
	$	—	$	10,047	$	—	$	10,047

	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable  Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Balance at December 31, 2011
Assets:
December 31, 2011
Collateralized Mortgage obligations	$	—	$	7,780	$	—	$	7,780
U.S. government agency obligations		—		3,426		—		3,426
Mortgage-backed securities		—		998		—		998
Obligations of states and political subdivisions		—		332		—		332
	$	—	$	12,536	$	—	$	12,536

54

Note 19—Fair Value Measurements (Continued)

The Corporation also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets include loans and foreclosed assets. These assets are not measured at fair value on an ongoing basis, but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Adjustments in 2012 and 2011 to the impaired loans were recorded as additional allocations to the allowance for loan losses. Adjustments in 2012 to foreclosed assets were recorded as additional allocations to the allowance for loan losses. Adjustments in 2012 on foreclosed assets that were held longer than 90 days following redemption were made to repossessed property expense. The following table presents the Corporation’s assets at fair value on a nonrecurring basis as of December 31, 2012 and December 31, 2011 (000s omitted):

	Assets Measured at Fair Value on a Nonrecurring Basis
	Balance at December 31, 2012		Quoted Prices in Active  Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired Loans	$	13,347	$	—	$	—	$	13,347
Foreclosed Assets	$	1,244	$	—	$	—	$	1,244

	Assets Measured at Fair Value on a Nonrecurring Basis
	Balance at December 31, 2011		Quoted Prices in Active  Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired Loans	$	15,130	$	—	$	—	$	15,130
Foreclosed Assets	$	4,433	$	—	$	—	$	4,433

55

Note 19—Fair Value Measurements (Continued)

The fair value of impaired loans is estimated using either discounted cash flows or collateral value. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. Impaired loans where a specific reserve is established based on the fair value of the collateral require classification in the fair value hierarchy. Impaired loans are categorized as level 3 assets because the values are based on available collateral (typically based on outside appraisals obtained at least annually) and discounted based on internal loan to value limits which typically range from 50% to 80% based on the collateral.

Foreclosed assets, which include real estate owned and real in estate in judgment and subject to redemption, 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 performed annually 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. The valuations consist of obtaining a broker price opinion or a new appraisal depending on the value of the asset. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets. Assets held as real estate in judgment may be subject to redemption for a period of six to twelve months depending on the collateral, following the foreclosure sale. Assets may be redeemed by the borrower for the foreclosure sale price, accrued interest and foreclosure costs. Any asset redeemed would be treated as a paid off loan. As of December 31, 2012 the Corporation held $1.2 million in foreclosed assets owned as a result of foreclosure or the acceptance of a deed in lieu and $4.4 million in foreclosed assets as of December 31, 2011. No assets were redeemed in 2012 or 2011.

56

Note 20—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. In December 2006, the Board of Directors approved an amendment to the ESOP plan revising the vesting, allocation and loan repayment guidelines of the plan. As a result of the amendment, the loan bears interest equal to 4.75% and will be repaid over a period of fifteen years ending on December 31, 2016. 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 (000s omitted):

	Year Ending
	December 31,
2013	$	108
2014		113
2015		118
2016		124
2017		—
Total	$	463

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):

	2012			2011
Allocated shares		138,862			129,605
Shares released for allocation		9,257			9,257
Shares distributed		(67,349	)		(64,144	)
Unreleased shares		37,031			46,288
Total ESOP shares		117,801			121,006
Fair value of unallocated shares	$	29		$	50

Total compensation expense applicable to the ESOP amounted to approximately $10,000, and $12,000 for the years ended December 31, 2012 and 2011, respectively.

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Note 21—Stock Compensation Plans

The Corporation has a Recognition and Retention Plan (RRP) which authorizes up to 92,575 shares to be issued to employees and directors. At December 31, 2012 1,100 shares were available for issuance. Under the plan, the shares vest 20% per year for five years. No shares were issued or forfeited in 2011 or 2012. No shares vested in 2012 and there were a total of 85,653 vested shares as of December 31, 2012 and 5,822 retired shares. Compensation expense applicable to the RRP amounted to $0 and $2,000 for the years ended December 31, 2012 and 2011 respectively.

The Corporation’s Employee Stock Option Plan (the Plan), which is stockholder approved, permits the grant of stock options to its employees for up to 231,438 shares of common stock. The Corporation believes that such awards better align the interests of its employees with those of its stockholders. Option awards are generally granted with an exercise price equal to the market price of the Corporation’s stock at the date of grant; those option awards generally vest based on five years of continuous service and have ten year contractual terms.

The fair value of each option award is estimated on the date of grant using a Black Scholes option valuation model that uses the weighted average assumptions noted in the following table. Expected volatilities are based on the Corporation’s stock price and dividend history. The Corporation uses historical data to estimate option exercise and employee termination within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

There were no options granted in 2012 or 2011.

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

	2012				2011
			Weighted				Weighted
			Average				Average
			Exercise				Exercise
	Shares		Price		Shares		Price
Outstanding at beginning of year		152,837	$	10.67		157,312	$	10.72
Granted		—	$	—		—	$	—
Forfeited/expired		—	$	—		4,475	$	12.59
Outstanding at end of year		152,837	$	10.67		152,837	$	10.67
Exercisable at year-end		152,837	$	10.67		152,837	$	10.67

A summary of outstanding and exercisable stock options at December 31, 2012 is as follows:

Outstanding			Exercisable
Exercise Price Per share	Number Outstanding		Remaining Life (in Months)		Number Exercisable
13.00		93,001		4		93,001
14.00		19,836		21		19,836
3.60		40,000		79		40,000

The aggregate intrinsic value of outstanding options at December 31, 2012 is $0.00 because the exercise price for all options exceeds the current market value.

As of December 31, 2012 there was no unrecognized compensation cost, net of expected forfeitures, related to nonvested options under the Plan. The total fair value of shares vested during the year ended December 31, 2012 and 2011 was $0 and $1,000 respectively.

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Note 22—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)

Monarch Community Bancorp, Inc

Balance Sheet

	December 31, 2012		December 31, 2011
Assets
Cash	$	385	$	570
Investments		81		83
Investment in Monarch Community Bank		11,765		11,798
Other assets		203		25
Total assets	$	12,434	$	12,476
Liabilities and Stockholders’ Equity
Accrued expenses	$	1,967	$	1,334
Stockholders’ equity		10,467		11,142
Total liabilities and stockholders’ equity	$	12,434	$	12,476

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Note 22—Condensed Financial Statements of Parent Company (Continued)

Condensed Income Statement (000s omitted)

Monarch Community Bancorp, Inc

Income Statement

	December 31, 2012			December 31, 2011
Income—Interest on investments	$	3		$	4
Dividends from Monarch Community Bank		—			—
Operating expense		279			194
(Loss)—Before equity in undistributed net (loss) of subsidiary		(276	)		(190	)
Equity in undistributed net (loss) of subsidiary		(77	)		(163	)
Net loss	$	(353	)	$	(353	)

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Note 22—Condensed Financial Statements of Parent Company (Continued)

Condensed Statement of Cash Flows (000s omitted)

	December 31,
	2012			2011
Cash flows from operating activities:
Net income (loss)	$	(353	)	$	(353	)
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Amortization and depreciation		13			9
Allocation of ESOP and RRP		10			35
(Increase) decrease in other assets		—			(2	)
(Increase) decrease in accrued expenses		68			150
Undistributed net (income) loss of subsidiary		77			163
Net cash (used in) provided by operating activities		(185	)		2
Cash flows from investing activities:
Purchase of securities		—			—
Investment in subisidary		—			—
Proceeds from sales and maturities of securities		—			—
Net cash (used in) provided by investing activities		—			—
Cash flows from financing activities:
Issuance of Preferred Stock		—			—
Repurchase of Common Stock		—			—
Dividends paid		—			—
Net cash (used in) provided by financing activities		—			—
Net increase (decrease) in cash		(185	)		2
Cash at beginning of year		570			568
Cash at end of year	$	385		$	570

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