Monarch Community Bancorp (MCBF) 10-Q 2013 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

S	Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended September 30, 2013or
£	Transition report under Section 13 or 15(d) of the Exchange Act
For the transition period from _____________ to _____________

Commission file number: 000-49814

MONARCH COMMUNITY BANCORP, INC.

(Exact name of registrant as specified in its charter)

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

375 North Willowbrook Road, Coldwater, MI 49036

(Address of principal executive offices)

517-278-4566

(Registrant’s telephone number)

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes: S   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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes S   No £

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 S

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

Yes: £   No: S

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practical date: At November 2, 2013, there were 410,147 shares of the issuer’s Common Stock outstanding.

Monarch Community Bancorp, Inc.

Index

PART I - FINANCIAL INFORMATION
Item 1 – Condensed Financial Statements:	3
Condensed Consolidated Balance Sheets – September 30, 2013 and December 31, 2012	3
Condensed Consolidated Statements of Income – Three Months and Nine Months Ended September 30, 2013 and 2012	4
Condensed Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2013 and 2012	5
Notes to Condensed Consolidated Financial Statements	6-32
Item 2 –  Management’s Discussion and Analysis of Financial Condition and Results of Operations	33-40
Item 3 – Quantitative and Qualitative Disclosures about Market Risk	40
Item 4 – Controls and Procedures	41
PART II – OTHER INFORMATION
Item 1 – Legal Proceedings	41
Item 1A – Risk Factors	41
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	41
Item 3 – Defaults Upon Senior Securities	41
Item 4 – [Reserved]	41
Item 5 – Other Information	41
Item 6 – Exhibits	41
SIGNATURES	42
CERTIFICATIONS	44-45

2

PART I—FINANCIAL INFORMATION

Item 1.     CONDENSED FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets

	(Unaudited)
	September 30,			December 31,
	2013			2012
	(Dollars in thousands,
	except per share data)
Assets
Cash and due from banks	$	11,707		$	8,978
Federal Home Loan Bank overnight time and other interest bearing deposits		12,289			19,766
Total cash and cash equivalents		23,996			28,744
Securities - Available for sale		10,375			10,047
Certificates of Deposit		1,984			1,981
Other securities		3,370			3,370
Loans held for sale		479			2,045
Loans, net		115,254			128,000
Foreclosed assets, net		810			1,244
Premises and equipment		3,897			3,980
Core deposit intangible		—			107
Accrued interest receivables and other assets		7,769			10,805
Total assets	$	167,934		$	190,323
Liabilities and Stockholders' Equity
Liabilities
Deposits:
Non-interest bearing	$	19,341		$	17,610
Interest bearing		136,972			151,850
Total deposits		156,313			169,460
Federal Home Loan Bank advances		59			7,059
Accrued expenses and other liabilities		3,370			3,337
Total liabilities		159,742			179,856
Stockholders' Equity
Preferred stock-$.01 par value, 5,000,000 shares authorized, and 6,785 shares, fixed rate cumulative perpetual preferred stock, series A, $1,000 per share liquidation preference, issued and outstanding as of September 30, 2013 and December 31, 2012		6,781			6,773
Common stock - $0.05 par value, 20,000,000 shares authorized, 410,147 shares issued and outstanding at September 30, 2013 and December 31, 2012 (Adjusted for 1:5 reverse stock on May 28, 2013)		20			20
Additional paid-in capital		20,994			20,994
Accumulated deficit		(19,185	)		(17,075	)
Accumulated other comprehensive income		(51	)		122
Unearned stock compensation		(367	)		(367	)
Total stockholders' equity		8,192			10,467
Total liabilities and stockholders' equity	$	167,934		$	190,323

See accompanying notes to condensed consolidated financial statements.

3

Condensed Consolidated Statements of Income (Unaudited)

	Three Months			Three Months			Nine Months			Nine Months
	Ended			Ended			Ended			Ended
	September 30,			September 30,			September 30,			September 30,
	2013			2012			2013			2012
	(Dollars in thousands, except per share data)
Interest Income
Loans, including fees	$	1,742		$	2,003		$	5,334		$	6,294
Investment securities		81			93			245			282
Federal funds sold and overnight deposits		13			5			43			34
Total interest income		1,836			2,101			5,622			6,610
Interest Expense
Deposits		220			370			782			1,184
Federal Home Loan Bank advances		63			125			208			508
Total interest expense		283			495			990			1,692
Net Interest Income		1,553			1,606			4,632			4,918
Provision for Loan Losses		50			5			437			58
Net Interest Income After Provision for Loan Losses		1,503			1,601			4,195			4,860
Non-interest Income
Fees and service charges		401			437			1,228			1,283
Loan servicing fees		113			96			322			303
Net gain on sale of loans		410			477			1,624			1,170
Net gain on sale of securities		—			9			3			9
Other income		104			11			356			269
Total non-interest income		1,028			1,030			3,533			3,034
Non-interest Expense
Salaries and employee benefits		1,608			1,462			4,754			4,131
Occupancy and equipment		302			296			881			816
Data processing		207			224			687			677
Mortgage banking		100			108			337			321
Professional services		175			203			596			626
Amortization of core deposit intangible		36			35			106			106
NOW account processing		46			51			148			146
ATM/Debit card processing		60			79			176			222
Foreclosed property expense		119			213			323			666
Other general and administrative		525			473			1,481			1,371
Total non-interest expense		3,178			3,144			9,489			9,082
Income (Loss) - Before income taxes		(647	)		(513	)		(1,761	)		(1,188	)
Income Taxes		—			—			38			—
Net Loss	$	(647	)	$	(513	)	$	(1,799	)	$	(1,188	)
Dividends and amortization of discount on preferred stock	$	107		$	102		$	311		$	300
Net loss available to common stock	$	(754	)	$	(615	)	$	(2,110	)	$	(1,488	)
Comprehensive Loss
Net Loss	$	(647	)	$	(513	)	$	(1,799	)	$	(1,188	)
Change in unrealized gain (loss) on securities, net of tax	$	(45	)	$	25		$	(173	)	$	57
Less:  reclassification adjustments for securities' gain realized in net income, net of taxes	$	—		$	—		$	2		$	—
Comprehensive Loss	$	(692	)	$	(488	)	$	(1,970	)	$	(1,131	)
Earnings (Loss) Per Share
Basic	$	(1.87	)	$	(1.54	)	$	(5.24	)	$	(3.72	)
Diluted	$	(1.87	)	$	(1.54	)	$	(5.24	)	$	(3.72	)

See accompanying notes to condensed consolidated financial statements.

4

Condensed Consolidated Statements of Cash Flows (Unaudited)

	Nine Months Ended
	September, 30
	2013			2012
	(Dollars in thousands)
Cash Flows From Operating Activities
Net Income (Loss)	$	(1,799	)	$	(1,188	)
Adjustments to reconcile net income (loss) to net cash from operating activities
Depreciation and amortization		801			802
Provision for loan losses		437			58
Write down on foreclosed assets		499			1,203
Gain on sale of foreclosed assets		(44	)		(147	)
Mortgage loans originated for sale		(45,201	)		(34,955	)
Proceeds from sale of mortgage loans		46,767			33,926
Gain on sale of available for sale securities		(3	)		(9	)
Gain on sale of mortgage loans		(1,624	)		(1,170	)
Net change in:
Deferred loan fees		(16	)		(36	)
Accrued interest receivable		59			(20)
Other assets		2,648			1,032
Accrued expenses and other liabilities		(70	)		117
Net cash provided by (used in) operating activities		2,454			(387	)
Cash Flows From Investing Activities
Activity in available for sale securities:
Purchases		(2,980	)		(2,008	)
Proceeds from sale of securities		80			254
Proceeds from maturities of securities		2,258			1,967
Activity in held to maturity securities:
Purchases		(248	)		—
Proceeds from maturities of securities		245			—
Loan originations and principal collections, net		12,247			10,437
Proceeds from sale of foreclosed assets		1,562			3,038
Purchase of premises and equipment		(219	)		(349	)
Net cash provided by investing activities		12,945			13,339
Cash Flows From Financing Activities
Net increase in deposits		(13,147	)		264
Dividends accrued on Preferred Stock		—			(300	)
Repayment of FHLB advances		(7,000	)		(13,000	)
Net cash provided by financing activities		(20,147	)		(13,036	)
Net Increase (Decrease) in Cash and Cash Equivalents		(4,748	)		(84	)
Cash and Cash Equivalents - Beginning		28,744			24,111
Cash and Cash Equivalents- End	$	23,996		$	24,027
Supplemental Cash Flow Information:
Cash paid for:
Interest		922			1,638
Noncash investing activities:
Loans transferred to foreclosed assets		1,583			1,437

See accompanying notes to condensed consolidated financial statements.

5

MONARCH COMMUNITY BANCORP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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. The Bank converted to a stock savings institution effective August 29, 2002. In connection with the conversion, the Corporation sold 2,314,375 shares of its common stock in a subscription offering. On May 28, 2013, the Corporation completed a one for five reverse split of its common stock.

Monarch Community Bank is headquartered in Coldwater, Michigan and operates five full service retail offices in Branch, Calhoun and Hillsdale Counties and nine loan production offices in Kalamazoo, Calhoun, Berrien, Ingham, Lenawee, Kent, Livingston and Jackson Counties in Michigan and one in Steuben County, Indiana. The Bank operates five full service offices. The Bank owns 100% of First Insurance Agency. First Insurance Agency is a licensed insurance agency established to allow for the receipt of fees on insurance services provided to the Bank’s customers. The Bank also owns a 24.98% interest in a limited partnership formed to construct and operate multi-family housing units.

BASIS OF PRESENTATION

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

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

The accompanying financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes required by generally accepted accounting principles in annual consolidated financial statements. These condensed consolidated financial statements should be read in conjunction with the Corporation’s Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission.

The results of operations for the nine month period ended September 30, 2013 are not necessarily indicative of the results to be expected for the full year period.

ALLOWANCE FOR LOAN LOSSES

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

To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of this condition may be reflected as a specific allowance applicable to this credit or portfolio segment. The specific components as mentioned, which relate to identifiable problem credits, are loans classified as doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of the loan.

The allowance also consists of general and unallocated components. The general component covers non-classified loans and is based on historical loss experience. Actual losses, which cover an eighteen month historical period, are carried at a weighted average with the most recent nine months weighted 60% and the later weighted 40%. 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. Management estimates probable losses by evaluating quantitative and qualitative factors for each loan portfolio segment, including net charge-off trends, internal risk ratings, changes in internal risk ratings, loss forecasts, collateral values, geographic location, delinquency rates, nonperforming and restructured loans, origination channel, product mix, underwriting practices, industry conditions, and economic trends.

6

As of September 30, 2013 the residential loan historical loss ratios were increased by .08% to 1.39% based on the particular segment. Multi-family real estate loan historical loss ratios were increased by .32% to 1.32%. All other commercial real estate loan historical loss ratios were increased 1.13% to 1.53%. Construction loan historical loss ratios were increased by .12% to .58%, consumer loan historical loss ratios by .50% to .60%, commercial and industrial loan historical loss ratios by .28% to 1.57% and home equity lines of credit historical loss ratios by .03% to 1.34%. As of September 30, 2013, 20% of the allowance for loan loss reserve was attributable to adjustments to the loss factors. Adjustments were made to the loss factors in the third quarter of 2013 largely due to the segmentation of loans classified as special mention and substandard (but not impaired) in several categories of the loan portfolio. 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.

The unallocated component is maintained to cover uncertainties that could affect management’s estimates 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.

RECLASSIFICATIONS

Certain 2012 amounts have been reclassified to conform to the 2013 presentation.

NOTE 2 - SECURITIES

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

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Market Value
September 30, 2013
Available-for-sale securities:
Collateralized Mortgage obligations	$	5,416	$	27	$	(51	)	$	5,392
U.S. government agency obligations		2,004		9		(31	)		1,982
Mortgage-backed securities		470		32					502
Obligations of states and political subdivisions		2,562		—		(63	)		2,499
Total available-for-sale securities	$	10,452	$	68	$	(145	)	$	10,375

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Market Value
December 31, 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

Proceeds from sales of securities available for sale were $80,000 for the nine months ended September 30, 2013 and $254,000 for the nine months ended September 30, 2012. Gross realized gains were $3,301 and gross realized losses were $0 on the sales of investment securities for the nine months ended September 30, 2013 and gross realized gains were $9,459 and gross realized losses were $0 on the sales of investment securities for the nine months ended September 30, 2012.

7

The amortized cost and fair value of securities available for sale at September 30, 2013 by contractual maturity follow (dollars in thousands). The actual maturity may differ from the contractual maturity because issuers may have a right to call or prepay obligations.

	September 30, 2013
	Available for Sale Securities
	Amortized		Fair
	Cost		Value
	(Dollars in Thousands)
Due in one year or less	$	—	$	—
Due from one to five years		2,372		2,364
Due from five to ten years		2,194		2,117
Due after ten years		—		—
Total		4,566		4,481
Mortgage-backed securities		470		502
CMO Securities		5,416		5,392
Total available-for-sale securities	$	10,452	$	10,375

Other-Than Temporary-Impairment

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

Management determined that there were no securities with OTTI at September 30, 2013.

The following table shows the gross unrealized losses and the fair value of the Company’s investments, aggregated by the investment category and length of time that individual securities have been in a continuous unrealized loss position. As of September 30, 2013 11 securities were in a loss position. There were no securities in an unrealized loss position at December 31, 2012.

	Less than 12 Months					12 Months or More				Total
September 30, 2013	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Collateralized Mortgage obligations	$	2,128	$	(51	)	$	—	$	—	$	2,128	$	(51	)
U.S. government agency obligations		967		(31	)		—		—		967		(31	)
Obligations of states and political subdivisions		2,499		(63	)		—		—		2,499		(63	)
Total available-for-sale securities	$	5,594	$	(145	)	$	—	$	—	$	5,594	$	(145	)

8

NOTE 3 - EARNINGS PER SHARE

A reconciliation of the numerators and denominators used in the computation of the basic earnings per share and diluted earnings per share is presented below (000s omitted except per share data). The share numbers reflect a one-for-five reverse stock split effective May 28, 2013.

	Three Months			Three Months			Nine Months			Nine Months
	Ended			Ended			Ended			Ended
	September 30, 2013			September 30, 2012			September 30, 2013			September 30, 2012
Basic earnings per share
Numerator:
Net (Loss)	$	(647	)	$	(513	)	$	(1,799	)	$	(1,188	)
Dividends and amortization of discount on preferred stock		107			102			311			300
Net (Loss) allocated to common stock		(754	)		(615	)		(2,110	)		(1,488	)
Denominator:
Weighted average common shares outstanding		410			410			410			410
Less: Average unallocated ESOP shares		(7	)		(9	)		(7	)		(9	)
Less: Average non-vested RRP shares		—			—			—			—
Weighted average common shares outstanding for basic earnings (loss)  per share		403			401			403			401
Basic earnings (loss) per share		(1.87	)		(1.54	)		(5.24	)		(3.72	)
Diluted earnings per share
Numerator:
Net (Loss) allocated to common stock		(754	)		(615	)		(2,110	)		(1,488	)
Denominator:
Weighted average common shares outstanding for basic earnings per share		403			401			403			401
Add: Dilutive effects of restricted stock, stock options and warrants		—			—			—			—
Weighted average common shares and dilutive potential common shares outstanding		403			401			403			401
Diluted earnings (loss) per share	$	(1.87	)	$	(1.54	)	$	(5.24	)	$	(3.72	)

NOTE 4 - FAIR VALUE MEASUREMENTS

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

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

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

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

9

The following table presents information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at September 30, 2013, and December 31, 2012, and the valuation techniques used by the Corporation to determine those fair values. Investment securities with fair value determined by Level 2 inputs include mortgage backed securities, collateralized mortgage obligations, 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 September 30, 2013
Assets:
Investment Securities
Collateralized Mortgage obligations	$	—	$	5,392	$	—	$	5,392
U.S. government agency obligations		—		1,982		—		1,982
Mortgage-backed securities		—		502		—		502
Obligations of states and political subdivisions		—		2,499		—		2,499
	$	—	$	10,375	$	—	$	10,375

	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:
Investment Securities
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

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 2013 and 2012 to the impaired loans were recorded as additional allocations to the allowance for loan and lease losses. Adjustments in 2013 and 2012 to foreclosed assets were recorded as additional allocations to the allowance for loan and lease losses. The following table presents the Corporation’s assets at fair value on a nonrecurring basis as of September 30, 2013 and December 31, 2012 (000s omitted):

	Assets Measured at Fair Value on  a Nonrecurring Basis
	Balance at September 30, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired Loans accounted for under FASB ASC 310		10,645		—		—		10,645
Foreclosed Assets		810		—		—		810

	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 accounted for under FASB ASC 310		13,347		—		—		13,347
Foreclosed Assets		1,244		—		—		1,244

10

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. Management reviews the impaired loans no less than quarterly for potential additional impairment and when there is little prospect of collecting principal or interest, loans or portions thereof may be charged off to the allowance for loan losses. Losses are recognized in the period a debt becomes uncollectible. The recognition of a loss does not mean that the loan has no recovery or salvage value, but rather it is not practical or desirable to defer writing off the loan even though a partial recovery may occur in the future. During the nine months ended September 30, 2013 the Corporation charged off $31,000 of impaired loans to the allowance for loan losses. The change in fair value of impaired loans is accounted for in the allowance for loan losses (see Note 6).

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. As of September 30, 2013 the Corporation held 810,000 in foreclosed assets owned as a result of foreclosure or the acceptance of a deed in lieu and $1.2 million in foreclosed assets as of December 31, 2012. No assets were redeemed by borrowers in 2012 or in the first nine months of 2013.

Fair Value of Financial Instruments

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

The fair value of all financial instruments not discussed below (cash and cash equivalents, federal funds sold, Federal Home Loan Bank stock, accrued interest receivable, federal funds purchased and interest payable) are estimated to be equal to their carrying amounts as of September 30, 2013 and December 31, 2012. 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 flow analyses using current market rates applied to the estimated life. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

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.

11

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

	September 30, 2013
	Carrying Amount		Level 1		Level 2		Level 3		Total Estimated Fair Value
Assets:
Cash and cash equivalents	$	23,996	$	23,996	$	—	$	—	$	23,996
Certificates of Deposit		1,984		—		1,984		—		1,984
Securities - Available for sale		10,375		—		10,375		—		10,375
Other securities		3,370		—		3,370		—		3,370
Loans and loans held for sale, net		115,733		—		—		120,135		120,135
Liabilities:
Deposits		156,313		—		157,116				157,116
Federal Home Loan Bank advances	$	59	$	—	$	60			$	60

	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
Certificates of Deposit		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

12

NOTE 5 - LOANS

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

	September 30, 2013					December 31, 2012
	Amount		Percent			Amount		Percent
	(Dollars in thousands)
Real Estate Loans:
One-to-four family	$	61,101		51.57		$	69,043		52.60
Multi-family		2,100		1.77			1,183		0.90
Commercial		43,085		36.37			43,952		35.03
Construction or development		2,490		2.10			3,446		1.08
Total real estate loans		108,776		91.81			117,624		89.61
Other loans:
Consumer loans:
Home equity		6,454		5.45			8,058		6.14
Other		1,556		1.31			1,885		1.43
Total consumer loans		8,010		6.76			9,943		7.57
Commercial Business Loans		1,691		1.43			3,709		2.82
Total other loans		9,701		8.19			13,652		10.39
Total Loans		118,477		100.00	%		131,276		100.00	%
Allowance for loan losses		2,994					3,035
Less: Net deferred loan fees		229					241
Total Loans, net	$	115,254				$	128,000

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. 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.

13

An age analysis of past due loans including nonaccrual loans, segregated by class of loans, as of September 30, 2013 and December 31, 2012 are as follows:

September 30, 2013	30-59 Days Past Due		60-89 Days Past Due		Loans 90 Days or More Past Due		Total Past due Loans		Current Loans		Total Loans
Commercial	$	—	$	—	$	273	$	273	$	1,418	$	1,691
Commercial Real Estate:
Multi-family		450		—		—		450		1,650		2,100
Commercial Real Estate - other		414		—		277		691		42,394		43,085
Consumer:
Consumer - Helocs and other		128		—		24		152		7,858		8,010
Residential:
Residential - prime		1,074		653		468		2,195		45,588		47,783
Residential - subprime		397		427		7		831		12,487		13,318
Construction:
Construction - prime		—		—		—		—		2,490		2,490
Construction - subprime		—		—		—		—		—		—
Total	$	2,463	$	1,080	$	1,049	$	4,592	$	113,885	$	118,477

December 31, 2012	30-59 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		—		—		1,560		1,560		42,392		43,952
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		98		—		—		98		2,880		2,978
Construction - subprime		—		—		—		—		468		468
Total	$	2,624	$	862	$	2,006	$	5,492	$	125,784	$	131,276

14

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

Risk Rating Scores by definition:

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

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

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.

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.

15

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

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

· Deteriorating liquidity.

· Serious management problems.

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

· Likelihood of bankruptcy.

· Inability to access other funding sources.

· Reliance on secondary source of repayment.

· Interest non-accrual may be warranted.

· Collateral provided is of little or no value.

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

· Repayment may require litigation.

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

· Normal operations are severely diminished or have ceased.

· Seriously impaired cash flow.

· Secondary source of repayment is inadequate.

· Survivability as a “going concern” is impossible.

· Placement on interest non-accrual

· Collection process has begun.

· Bankruptcy petition has been filed.

· Judgments have been filed.

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

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.

16

The following table represents the risk category of loans by class based on the analysis performed as of September 30, 2013 and December 31, 2012 (in thousands):

				September 30, 2013
Credit Rating			Commercial		Commercial Real Estate Multi-family		Commercial Real Estate Other
0		$	—	$	28	$	312
1-2			—		—		493
3			236		778		7,060
4			1,042		844		22,999
5			50		—		8,787
6			363		450		3,434
7			—		—		—
	Total	$	1,691	$	2,100	$	43,085

					December 31, 2012
			Commercial		Commercial Real Estate Multi-family		Commercial Real Estate Other
0		$	—	$	31	$	314
1-2			—		—		6
3			521		—		2,890
4			2,610		601		24,564
5			163		101		2,135
6			415		450		14,043
7			—		—		—
	Total	$	3,709	$	1,183	$	43,952

17

For consumer residential real estate, and consumer loans, 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 September 30, 2013 and December 31, 2012.

	September 30, 2013
	Residential - Prime		Residential - Subprime
Grade
Pass	$	46,744	$	12,990
Substandard		1,039		328
Total	$	47,783	$	13,318
			Consumer - Helocs and other
Performing			$	7,903
Nonperforming				107
Total			$	8,010
			Construction
Performing			$	2,490
Nonperforming				—
Total			$	2,490

	December 31, 2012
	Residential - Prime		Residential - Subprime
Grade
Pass	$	54,026	$	14,107
Substandard		645		265
Total	$	54,671	$	14,372
			Consumer - Helocs and other
Performing			$	9,832
Nonperforming				111
Total			$	9,943
			Construction
Performing			$	3,428
Nonperforming				18
Total			$	3,446

18

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2013 and December 31, 2012 (in thousands).

September 30, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial	$	273	$	350	$	—
Commercial Real Estate:
Commercial Real Estate - Multi-family		—		—		—
Commercial Real Estate - other		4,015		6,104		—
Consumer:
Consumer - Helocs and other		—		—		—
Residential:
Residential - prime		—		—		—
Residential - subprime		—		—		—
Construction:
Construction - prime		—		—		—
Construction - subprime		—		—		—
With an allowance recorded:
Commercial		49		49		—
Commercial Real Estate:
Commercial Real Estate - Multi-family		450		464		63
Commercial Real Estate - other		4,175		4,175		35
Consumer:
Consumer - Helocs and others		—		—		—
Residential:
Residential - prime		1,576		1,614		195
Residential - subprime		—		—		—
Construction:
Construction - prime		446		446		45
Construction - subprime		—		—		—
Total
Commercial	$	9,408	$	11,588	$	143
Consumer	$	—	$	—	$	—
Residential	$	1,576	$	1,614	$	195

19

December 31, 2012
	Recorded Investment		Unpaid Principal Balance		Related Allowance
With no related allowance recorded:
Commercial	$	315	$	382	$	—
Commercial Real Estate:
Commercial Real Estate - Multi-family		—		—		—
Commercial Real Estate - other		10,724		16,429		—
Consumer:
Consumer - Helocs and others		—		—		—
Residential:
Residential - prime		62		78		—
Residential - subprime		—		—		—
Construction:
Construction - prime		—		—		—
Construction - subprime		—		—		—
With an allowance recorded:
Commercial		50		50		5
Commercial Real Estate:
Commercial Real Estate - Multi-family		450		464		71
Commercial Real Estate - other		107		107		25
Consumer:
Consumer - Helocs and others		—		—		—
Residential:
Residential - prime		1,790		1,820		313
Residential - subprime		—		—		—
Construction:
Construction - prime		301		301		38
Construction - subprime		—		—		—
Total
Commercial	$	11,947	$	17,733	$	139
Consumer	$	—	$	—	$	—
Residential	$	1,852	$	1,898	$	313

20

The following table presents loans individually evaluated for impairment by class of loans for the three months ended September 30, 2013 and September 30, 2012 (in thousands).

	Three Months Ended September 30, 2013				Three Months Ended September 30, 2012
	Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income
With no related allowance recorded:
Commercial	$	358	$	—	$	386	$	—
Commercial Real Estate:
Commercial Real Estate - Multi-family		—		—		—		—
Commercial Real Estate - other		6,114		60		14,762		60
Consumer:
Consumer - Helocs and other		—		—		—		—
Residential:
Residential - prime		—		—		—		—
Residential - subprime		—		—		—		—
With an allowance recorded:
Commercial		49		1		53		1
Commercial Real Estate:
Commercial Real Estate - Multi-family		464		6		464		6
Commercial Real Estate - other		4,183		42		1,826		—
Consumer:
Consumer - Helocs and others		—		—		—		—
Residential:
Residential - prime		1,619		19		1,903		5
Residential - subprime		—		—		—		—
Construction:
Construction - prime		448		5		306		3
Construction - subprime		—		—		—		—
Total
Commercial	$	11,616	$	114	$	17,797	$	70
Consumer	$	—	$	—	$	—	$	—
Residential	$	1,619	$	19	$	1,903	$	5

21

The following table presents loans individually evaluated for impairment by class of loans for the nine months ended September 30, 2013 and September 30, 2012 (in thousands).

	Nine Months Ended September 30, 2013				Nine Months Ended September 30, 2012
	Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income
With no related allowance recorded:
Commercial	$	371	$	—	$	390	$	—
Commercial Real Estate:
Commercial Real Estate - Multi-family		—		—		—		—
Commercial Real Estate - other		6,138		179		14,754		179
Consumer:
Consumer - Helocs and other		—		—		—		—
Residential:
Residential - prime		—		—		—		—
Residential - subprime		—		—		—		—
With an allowance recorded:
Commercial		49		2		54		2
Commercial Real Estate:
Commercial Real Estate - Multi-family		464		17		465		17
Commercial Real Estate - other		4,208		126		1,828		—
Consumer:
Consumer - Helocs and others		—		—		—		—
Residential:
Residential - prime		1,648		57		1,869		17
Residential - subprime		—		—		—		—
Construction:
Construction - prime		452		15		310		9
Construction - subprime		—		—		—		—
Total
Commercial	$	11,682	$	339	$	17,801	$	207
Consumer	$	—	$	—	$	—	$	—
Residential	$	1,648	$	57	$	1,869	$	17

22

Payments received on loans in nonaccrual status are typically applied to reduce the recorded investment in the asset. While a 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. The following presents, by class, the recorded investment in loans and leases on non-accrual status as of September 30, 2013 and December 31, 2012.

Loans on Nonaccrual Status
	September 30, 2013
Commercial	$	273
Commercial real estate:
Commercial Real Estate - multi-family		—
Commercial Real Estate - other		276
Consumer:
Consumer - Helocs and other		24
Residential:
Residential - prime		1,121
Residential - subprime		603
Construction
Construction - prime		—
Construction - subprime		—
Total	$	2,297

Loans on Nonaccrual Status
	December 31, 2012
Commercial	$	316
Commercial real estate:
Commercial Real Estate - multi-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

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 troubled 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 and because of the customer’s favorable past and current performance and credit risk do not constitute a TDR loan and are not monitored.

23

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 September 30, 2013 there have been no loans in which the TDR designation has been removed.

24

The following table represents the modifications completed during the three months ended September 30, 2013 and 2012.

	Modifications
	Three Months Ended September 30, 2013
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Commercial		—		—		—
Commercial real estate:
Commercial Real Estate - multi-family		—		—		—
Commercial Real Estate - other		—		—		—
Consumer:
Consumer - Heloc and other		—		—		—
Residential:
Residential - prime		—		—		—
Residential - subprime		—		—		—
Construction
Construction - prime		—		—		—
Construction - subprime		—		—		—
Total		—	$	—	$	—

	Modifications
	Three Months Ended September 30, 2012
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Commercial		—		—		—
Commercial real estate:
Commercial Real Estate - multi-family		—		—		—
Commercial Real Estate - other		—		—		—
Consumer:
Consumer - Heloc and other		—		—		—
Residential:
Residential - prime		—		—		—
Residential - subprime		—		—		—
Construction
Construction - prime		1		158		157
Construction - subprime		1		44		46
Total		2	$	202	$	203

25

The following table represents the modifications completed during the nine months ended September 30, 2013 and 2012.

	Modifications
	Nine Months Ended September 30, 2013
	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Commercial		—		—		—
Commercial real estate:
Commercial Real Estate - multi-family		—		—		—
Commercial Real Estate - other		1		212		212
Consumer:
Consumer - Heloc and other		—		—		—
Residential:
Residential - prime		6		861		860
Residential - subprime		5		217		217
Construction
Construction - prime		—		—		—
Construction - subprime		—		—		—
Total		12	$	1,290	$	1,289

	Modifications
	Nine Months Ended September 30, 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 - multi-family		—		—		—
Commercial Real Estate - other		—		—		—
Consumer:
Consumer - Heloc and other		—		—		—
Residential:
Residential - prime		6		862		865
Residential - subprime		—		—		—
Construction
Construction - prime		1		158		157
Construction - subprime		1		44		46
Total		9	$	1,114	$	1,118

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Troubled debt restructured loans which had payment defaults during the three months ended September 30, 2013 and 2012, segregated by class, are shown in the table below. Default occurs when a loan is 90 days or more past due or has been transferred to nonaccrual.

	Modifications That Subsequently Defaulted
	Three Months Ended September 30, 2013
	Number of Contracts		Recorded Investment
Troubled Debt Restructurings That Subsequently Defaulted
Commercial		—		—
Commercial real estate:
Commercial Real Estate - multi-family		—		—
Commercial Real Estate - other		—		—
Consumer:
Consumer - Heloc and other		—		—
Residential:
Residential - prime		—		—
Residential - subprime		—		—
Construction
Construction - prime		—		—
Construction - subprime		—		—
		—	$	—

	Modifications That Subsequently Defaulted
	Three Months Ended September 30, 2012
	Number of Contracts			Recorded Investment
Troubled Debt Restructurings That Subsequently Defaulted
Commercial		—		—
Commercial real estate:
Commercial Real Estate - multi-family		—		—
Commercial Real Estate - other		1		2,534
Consumer:
Consumer - Heloc and other		3		54
Residential:
Residential - prime		2		143
Residential - subprime		8		350
Construction
Construction - prime		—		—
Construction - subprime		—		—
		14	$	3,081

27

Troubled debt restructured loans which had payment defaults during the nine months ended September 30, 2013 and 2012, segregated by class, are shown in the table below.

	Modifications That Subsequently Defaulted
	Nine Months Ended September 30, 2013
	Number of Contracts		Recorded Investment
Troubled Debt Restructurings That Subsequently Defaulted
Commercial		—		—
Commercial real estate:
Commercial Real Estate - multi-family		—		—
Commercial Real Estate - other		1		212
Consumer:
Consumer - Heloc and other		—		—
Residential:
Residential - prime		—		—
Residential - subprime		—		—
Construction
Construction - prime		—		—
Construction - subprime		—		—
		1	$	212

	Modifications That Subsequently Defaulted
	Nine Months Ended September 30, 2012
	Number of Contracts		Recorded Investment
Troubled Debt Restructurings That Subsequently Defaulted
Commercial		—		—
Commercial real estate:
Commercial Real Estate - multi-family		—		—
Commercial Real Estate - other		1		2,534
Consumer:
Consumer - Heloc and other		4		56
Residential:
Residential - prime		4		241
Residential - subprime		8		350
Construction
Construction - prime		—		—
Construction - subprime		—		—
		17	$	3,181

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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. We do not have any outstanding commitments to borrowers with loans classified as TDR loans.

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NOTE 6 - ALLOWANCE FOR LOAN LOSSES

Analysis related to the allowance for credit losses (in thousands) for the three months ended September 30, 2013 and 2012 is as follows:

For the Three Months Ended September 30, 2013
	Commercial			Commercial Real Estate Other			Multi Family		Consumer			Residential - Prime			Residential - Subprime			Construction		Total
ALLOWANCE FOR CREDIT LOSSES:
Beginning Balance	$	9		$	599		$	76	$	189		$	1,357		$	463		$	51	$	2,744
Charge-Offs		—			—			—		(56	)		(105	)		(149	)		—		(310	)
Recoveries		3			466			—		36			1			4			—		510
Provision		(3	)		(501	)		8		73			143			312			18		50
Ending Balance		9			564			84		242			1,396			630			69		2,994
Ending Balance: individually evaluated for impairment		—			35			63		—			195			—			45		338
Ending Balance: collectively evaluated for impairment	$	9		$	529		$	21	$	242		$	1,201		$	630		$	24	$	2,656

For the Three Months Ended September 30, 2012
	Commercial			Commercial Real Estate Other			Multi Family			Consumer			Residential - Prime			Residential - Subprime			Construction			Total
ALLOWANCE FOR CREDIT LOSSES:
Beginning Balance	$	17		$	933		$	128		$	223		$	1,670		$	707		$	88		$	3,766
Charge-Offs		—			(48	)		—			(76	)		(101	)		(48	)		—			(273	)
Recoveries		3			12			1			50			1			—			—			67
Provision		(1	)		67			(45	)		(30	)		104			(87	)		(3	)		5
Ending Balance		19			964			84			167			1,674			572			85			3,565
Ending Balance: individually evaluated for impairment		—			130			49			—			406			—			35			620
Ending Balance: collectively evaluated for impairment	$	19		$	834		$	35		$	167		$	1,268		$	572		$	50		$	2,945

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Analysis related to the allowance for credit losses (in thousands) for the nine months ended September 30, 2013 and 2012 is as follows:

For the Nine Months Ended September. 30, 2013
	Commercial			Commercial Real Estate Other			Multi Family		Consumer			Residential - Prime			Residential - Subprime			Construction		Total
ALLOWANCE FOR CREDIT LOSSES:
Beginning Balance	$	12		$	695		$	81	$	230		$	1,444		$	521		$	52	$	3,035
Charge-Offs		—			(121	)		—		(273	)		(513	)		(272	)		—		(1,179	)
Recoveries		5			496			1		148			43			8			—		701
Provision		(8	)		(506	)		2		137			422			373			17		437
Ending Balance		9			564			84		242			1,396			630			69		2,994
Ending Balance: individually evaluated for impairment		—			35			63		—			195			—			45		338
Ending Balance: collectively evaluated for impairment	$	9		$	529		$	21	$	242		$	1,201		$	630		$	24	$	2,656

For the Nine Months Ended September 30, 2012
	Commercial			Commercial 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		—			(256	)		—		(213	)		(756	)		(170	)		—			(1,395	)
Recoveries		6			39			1		177			20			3			—			246
Provision		(32	)		(81	)		38		(56	)		130			75			(16	)		58
Ending Balance		19			964			84		167			1,674			572			85			3,565
Ending Balance: individually evaluated for impairment		—			130			49		—			406			—			35			620
Ending Balance: collectively evaluated for impairment	$	19		$	834		$	35	$	167		$	1,268		$	572		$	50		$	2,945

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The allowance for loan losses was $3.0 million at September 30, 2013 representing 2.6% of total loans, compared to $3.0 million at December 31, 2012 or 2.4% of total loans. The allowance for loan losses to non-performing loans ratio was 130.4% at September 30, 2013 compared to 39.1% at December 31, 2012. At September 30, 2013 we believe that our allowance appropriately considers incurred losses in our loan portfolio.

Analysis related to the allowance for financing receivables (in thousands) for the nine months ended September 30, 2013 and December 31, 2012 is as follows:

As of
September 30, 2013
	Commercial		Commercial Real Estate Other		Multi Family		Consumer		Residential - Prime		Residential - Subprime		Construction		Total
LOANS
Ending Balance	$	1,691	$	43,085	$	2,100	$	8,010	$	47,783	$	13,318	$	2,490	$	118,477
Ending Balance: individually evaluated for impairment		322		8,190		450		—		1,576		—		446		10,984
Ending Balance: collectively evaluated for impairment	$	1,369	$	34,895	$	1,650	$	8,010	$	46,207	$	13,318	$	2,044	$	107,493

As of
December 31, 2012
	Commercial		Commercial Real Estate Other		Multi Family		Consumer		Residential - Prime		Residential - Subprime		Construction		Total
LOANS
Ending Balance	$	3,709	$	43,952	$	1,183	$	9,943	$	54,671	$	14,372	$	3,446	$	131,276
Ending Balance: individually evaluated for impairment		365		10,831		450		—		1,852		—		301		13,799
Ending Balance: collectively evaluated for impairment	$	3,344	$	33,121	$	733	$	9,943	$	52,819	$	14,372	$	3,145	$	117,477

The Corporation’s charge-off policy which meets regulatory minimums has not required any revisions during the third quarter of 2013. 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.

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

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

FORWARD-LOOKING STATEMENTS

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

Factors which could have a material adverse effect on our operations include, but are not limited to, changes in interest rates, changes in the relative difference between short and long-term interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, including levels of non-performing assets, demand for loan products, deposit flows, competition, demand for financial services in our market area, our operating costs and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and you should not place undue influence on these statements.

CRITICAL ACCOUNTING POLICIES

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

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

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

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

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OVERVIEW

Following Monarch Community Bank’s Safety and Soundness examination which was completed in early 2010, the Board of Directors of Monarch Community Bank stipulated to the terms of a formal enforcement action (“Consent Order”) with Federal Deposit Insurance Corporation (“FDIC”) and the Office of Financial and Insurance Regulation for the State of Michigan (“OFIR”). The Consent Order, which was effective May 6, 2010, contains specific actions needed to address certain findings from their examination and to address our current financial condition. Following Monarch Community Bank’s most recent Safety and Soundness examination, there were no changes to the existing formal enforcement action (“Consent Order”).

Since stipulating to the terms of the Consent Order, we have complied with all of the required actions, with the exception of fully raising our capital levels to the required levels. As of September 30, 2013, we have successfully raised $16.5 million in investor funds, which are being held in escrow, pending the completion of all documentation associated with the Corporation’s retirement, at a negotiated 55% discount, of the $6,785 million of U.S. Department of Treasury Tarp obligations and the closing of the financing, which is expected to be completed prior to December 1, 2013.

Management continues to focus on the improvement of credit quality at the Bank, and has completed four comprehensive external loan reviews over the last twenty four months, with no recommendations for additional loan loss provisions or charge-offs, and no identification of material weaknesses in the credit approval or administration processes. Likewise, the Bank retained the services of Rehmann Consulting to conduct the Bank’s internal audit function, a task which had previously been performed by a Bank employee. Since retaining Rehmann, the firm has performed three comprehensive internal audits, in compliance with Sarbanes Oxley, and has found no material weaknesses in the Bank’s policies and procedures.

In addition to the enhanced loan review and audit functions, the Bank has continued to focus on the reduction of problem loans. As a result, the Bank’s total non-performing assets have declined from $9.0 million at December 31, 2012 to $3.1 million at September 30, 2013. This constitutes a 66% drop in non-performing assets over a nine month period.

While continuing the focus on the reduction in problem loans, the Bank has also pursued the development of additional sources of fee income. Since January of 2011, the Bank has opened nine loan production offices throughout Michigan and Indiana, three of which now house commercial lenders. The establishment of these offices provides a geographic dispersion of risk, and places us in markets with demographics that support our growth plans.

Improved growth and profitability will be derived from the following ongoing initiatives:

1. The reduction in non-performing assets and classified loans. As demonstrated in the aforementioned data, non-performing assets have declined significantly over the past nine months. Our intent is to continue our disciplined, aggressive approach to further reducing non-performing and classified loans.

2. An expense reduction initiative that will reduce annual non-interest expenses by approximately $1.3 million on an ongoing basis.

3. Organic growth, focusing on commercial lending, residential mortgage lending in existing markets and the expansion of our wealth management revenue in late 2011. We established a new relationship with Investment Professionals, Inc., (IPI) replacing our previous relationship with Prudential. IPI will provide compliance, sales, research and clearing support for investment advisors that will be employed by the Bank and will provide investment services under the name of Monarch Investment Services. This will provide for enhanced branding of the Monarch name and increased fee income potential from investment services.

4. De novo LPO’s, opened in markets across the state and across state lines that have strong demographic features. The offices are opened with at least two residential mortgage originators. This can be followed by the addition of a commercial lender and, where appropriate, a Monarch Investment Services Advisor.

5. A continued exploration of acquisition opportunities, where markets and synergies combine for the potential of enhanced shareholder value.

34

FINANCIAL CONDITION

Summary

Our total assets decreased by $22.4 million, or 11.8%, to $167.9 million at September 30, 2013 compared to $190.3 million at December 31, 2012. Loans, excluding loans held for sale, totaled $115.3 million at September 30, 2013, down 10.0% from $128.0 million at December 31, 2012.

Securities

Securities increased to $10.4 million at September 30, 2013 compared to $10.0 million at December 31, 2012.The increase was attributable to purchases of $2.9 million in taxable municipal investments and U.S agency securities, purchased to offset maturities and paydowns totaling $2.3 million. The yield on investment securities has decreased to 2.10% during the nine months ended September 30, 2013 from 2.21% for the same period a year ago. Management has continued to maintain a diversified securities portfolio, which includes obligations of U.S. government-sponsored agencies, securities issued by states and political subdivisions and mortgage-backed securities. Management regularly evaluates asset/liability management needs and attempts to maintain a portfolio structure that provides sufficient liquidity and cash flow.

Loans

The Bank’s net loan portfolio decreased by $12.7 million, or 10.0%, from $128.0 million at December 31, 2012 to $115.3 million at September 30, 2013. The following table presents information concerning the composition of our loan portfolio in dollar amounts and in percentages as of the dates indicated:

	September 30, 2013					December 31, 2012
	Amount		Percent			Amount		Percent
	(Dollars in thousands)
Real Estate Loans:
One-to-four family	$	61,101		51.57		$	69,043		52.60
Multi-family		2,100		1.77			1,183		0.90
Commercial		43,085		36.37			43,952		35.03
Construction or development		2,490		2.10			3,446		1.08
Total real estate loans		108,776		91.81			117,624		89.61
Other loans:
Consumer loans:
Home equity		6,454		5.45			8,058		6.14
Other		1,556		1.31			1,885		1.43
Total consumer loans		8,010		6.76			9,943		7.57
Commercial Business Loans		1,691		1.43			3,709		2.82
Total other loans		9,701		8.19			13,652		10.39
Total Loans		118,477		100.00	%		131,276		100.00	%
Allowance for loan losses		2,994					3,035
Less: Net deferred loan fees		229					241
Total Loans, net	$	115,254				$	128,000

One-to-four family loans decreased $7.9 million from year end 2012 as a result of the Bank’s continued strategy to sell a greater portion of new one-to-four family loan originations. Commercial real estate loans including multi-family loans and construction or development loans decreased $906,000 or 1.86%.

The allowance for loan losses was relatively unchanged at $3.0 million for the period ended September 30, 2013 when compared to December 31, 2012. A net recovery was recognized in the third quarter of 2013 of $200,000 compared to net charge off activity of $206,000 for the same period a year ago. The net recovery was attributable to the recovery of approximately $453,000 on the sale of a loan, which had previously been written down. Net charge offs for the third quarter of 2013 and year to date consisted of primarily one-to-four family residential mortgages. See “Provision for Loan Losses” below for further explanation regarding charge-offs and non-performing loans.The current level of the allowance for loan losses is the result of management’s assessment of the risks within the portfolio based on the information revealed in credit monitoring processes.

35

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

Deposits

Total deposits decreased $13.1 million, or 7.8%, from $169.5 million at December 31, 2012 to $156.3 million at September 30, 2013. The decline in deposits included decreases of $14.6 million in certificates of deposits and $2.1 million in money market accounts offset by increases in demand deposits, saving accounts and interest bearing checking of $3.6 million.

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

Federal Home Loan Bank Advances

Total Federal Home Loan Bank (FHLB) advances decreased to $.1 million as of September 30, 2013. Management is attempting to reduce its reliance on borrowed funds through the growth of low cost core deposits. Should this strategy not succeed, management anticipates the need for future borrowings to fund loan growth. See “Net Interest Income” below, and also see “Liquidity” later in this report regarding available borrowings.

Equity

Total equity was $8.2 million at September 30, 2013 compared to $10.5 million at December 31, 2012. This represents 4.88% and 5.50% of total assets at September 30, 2013 and December 31, 2012, respectively. Decreases in equity for the nine months ended September 30, 2013 included net losses of $1.8 million and $311,000 in accrued dividend payments and accrued interest on dividend payments on the Preferred Stock. The annual 5% dividend on the Preferred Stock with the amortization of the discount will reduce net income (or increase the net loss) applicable to common stock by approximately $350,000 annually. Effective February 2010, the Corporation deferred regularly scheduled dividend payments on the $6.7 million in par outstanding on its Series A fixed rate, cumulative perpetual preferred stock (aggregate liquidation preference of $6.8 million) which was issued to the U.S. Treasury in February 2009. At September 30, 2013 the dividend and interest payable to the Treasury Department totaled $1.4 million. The suspension of dividend payments is permissible under the terms of the TARP Capital Purchase Program, but the dividend is a cumulative dividend and failure to pay dividends for six dividend periods would trigger board of director appointment rights for the holder of the Series A Preferred Stock, (see further discussion under “Capital Resources”).

RESULTS OF OPERATIONS

Net Interest Income

Net interest income before any provision for loan losses decreased $53,000 for the quarter ended September 30, 2013 compared to the same period in 2012.

The net interest margin for the third quarter of 2012 increased 31 basis points to 3.73% compared to 3.42% for the same period in 2012. The improvement in the margin is largely due to reduction in wholesale funding as management continues to actively monitor its deposit base and borrowing. The Bank has focused on repaying Federal Home Loan Bank Advances and allowing Brokered Certificates of Deposit to mature. The net interest margin for the nine months ended September 30, 2013 increased 16 basis points to 3.56% compared to 3.40% for the same period in 2012.

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

36

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.

	Nine Months Ended September 30, 2013							Nine Months Ended September 30, 2012
	Average		Interest					Average		Interest
	Outstanding		Earned/		Yield/			Outstanding		Earned/		Yield/
	Balance		Paid		Rate			Balance		Paid		Rate
	(dollars in thousands)
Fed Funds and overnight deposits	$	34,280	$	43		0.17	%	$	26,506	$	34		0.17	%
Investment securities		10,165		160		2.10			12,718		211		2.21
Other securities		5,393		85		2.11			5,309		71		1.78
Loans receivable		123,768		5,334		5.76			148,343		6,294		5.65
Total earning assets	$	173,606	$	5,622		4.33			192,876		6,610		4.57
Demand and NOW Accounts		47,358		6		0.02			47,550		6		0.02
Money market accounts		34,590		28		0.11			35,726		87		0.32
Savings accounts		24,247		9		0.05			22,573		13		0.08
Certificates of deposit		60,053		739		1.65			74,608		1,078		1.92
Federal Home Loan Bank Advances		6,684		208		4.16			15,039		508		4.50
Total interest bearing liabilities	$	172,932	$	990		0.77		$	195,496	$	1,692		1.15
Net interest income			$	4,632						$	4,918
Net interest spread						3.56	%						3.41	%
Net interest margin						3.56	%						3.40	%

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.

	Nine Months Ended September 30, 2013 vs. 2012
										Total
	Increase (Decrease) Due to									Increase
	Rate			Volume			Mix			(Decrease)
	(in thousands)
Interest-earning assets
Fed funds and overnight deposits	$	(1	)	$	13			(3	)		9
Investment securities	$	(13	)	$	(64	)		26			(51	)
Other securities	$	17		$	—			(3	)		14
Loans receivable	$	163		$	(1,389	)		266			(960	)
Total interest-earning assets	$	166		$	(1,440	)	$	286		$	(988	)
Interest-bearing liabilities
Demand and NOW accounts	$	—		$	—			—			—
Money market accounts	$	(77	)	$	(4	)		22			(59	)
Savings accounts	$	(6	)	$	1			1			(4	)
Certificates of deposit	$	(209	)	$	(280	)		150			(339	)
Federal Home Loan Bank advances	$	(51	)	$	(376	)		127			(300	)
Total interest-bearing liabilities	$	(343	)	$	(659	)	$	300		$	(702	)
Net interest income										$	(286	)

37

Provision for Loan Losses

The provision for loan losses was $50,000 in the third quarter of 2013 compared to $5,000 for the third quarter of 2012.   The Corporation was able to book lower provisions in both third quarters of 2013 and 2012 due to the availability of excess, unallocated reserves.  In the third quarter of 2013 the excess in unallocated reserves was due to the recovery associated with the sale of a loan recognized by the Corporation in September 2013.  In the third quarter of 2012 the excess in unallocated reserves became available because of a drop in historical loss ratios.  The drop in historical ratios reflects the migration by the bank from a rolling eight quarter calculation of historical loss ratios to a rolling six quarter calculation. TheCompanyrecorded net recovery of $200,000 during the third quarter of 2013 compared to a net charge off of $206,000 for the same period in 2012.  The Corporation continues to monitor real estate dependent loans and focus on asset quality.  Non-performing loans totaled $2.3 million as of September 30, 2013, decreasing from $7.8 million at December 31, 2012.Net charge offs for the nine months ended September 30, 2013 were $480,000 compared to $1.1 million for the same period in 2012.  The provision for loan losses was $437,000 in the nine months ended September 2013 compared to $58,000 for the same period a year ago.  

Nonperforming assets including the amount of real estate in judgment and foreclosed and repossessed properties, decreased from $9.0 million at the end of 2012 to $3.1 million as of September 30, 2013.The following table presents non-performing assets and certain asset quality ratios at September 30, 2013 and December 31, 2012.

	September 30, 2013			December 31, 2012
				(In thousands)
Non-performing loans	$	2,297		$	7,770
Real estate in judgement		643			434
Foreclosed and repossessed assets		167			810
Total non-performing assets	$	3,107		$	9,014
Non-performing loans to net loans		1.99	%		6.07	%
Non-performing assets to total assets		1.85	%		4.74	%
Allowance for loan losses to non-performing loans		130.40	%		39.10	%
Allowance for loan losses to net loans receivable		2.60	%		2.37	%

Non-interest Income

Non-interest income for the quarter ended September 30, 2013 remained relatively unchanged at $1.0 million compared to the same period a year ago. While non-interest income remained relatively unchanged, other income increased $93,000 offset by a decrease in gain on the sale of loans of $67,000 and fees and service charges of $36,000.

Other income increased $93,000 during the third quarter ending September 30, 2013 largely due to the Company recognizing a gain on the sale of foreclosed assets of $19,000 compared to a loss of $28,000 when compared to the same period a year ago. The increase in other income was also attributable to the income adjustment based the valuation of interest rate lock-in commitments agreements, forward loan sales commitments and closed loan inventory of $42,000 compared to $0 for the same period a year ago. Net gain on sale of loans decreased $67,000 for the quarter ended September 30, 2013 from $477,000 to $410,000 compared to the same period a year ago. The decrease is largely due to the slow in one-to-four family residential mortgage refinancing activity as rates increased during in the third quarter.

Fees and Service charges decreased $36,000 for the quarter ended September 30, 2013 compared to the same period a year ago primarily due to an decrease in income associated fees from the overdraft protection program which decreased $36,000 as of September 30, 2013 to $219,000 from $255,000 for the same period a year ago. Management expects income from this program to be less in 2013 than in 2012 due to the regulatory changes that became effective August 15, 2010 with the amendment to Regulation E and the need for customers to “opt in” to the Overdraft Program.

Other income increased $10,000 for the three months ended September 30, 2013 compared to a year ago.

Non-interest income for the nine months ended September 30, 2013 increased $500,000, or 16.45%, from $3.0 million to $3.5 million compared to the same period a year ago. This is mainly attributable to an increase in gain on sale of loans.

Net gain on sale of loans increased $454,000 for the nine months ended September 30, 2013 from $1.2 million to $1.6 million compared to the same period a year ago. Fees and Service charges decreased $55,000 for the nine months ended September 30, 2013 compared to the same period a year ago primarily due to an decrease in fees from the overdraft protection program. Other income increased $87,000 which was largely attributable to the income adjustment associated with the valuation income adjustment based the valuation of interest rate lock-in commitments agreements, forward loan sales commitments and closed loan inventory of $159,000 compared to $0 for the same period a year ago. The decrease in gain on sale of foreclosed assets of $88,000 for the period offset the increase in other income associated with the valuation of commitments on residential loan activity. All other income increased $13,000 for the nine months ended September 30, 2013 compared to a year ago.

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Non-interest Expense

Noninterest expense increased $34,000 for the quarter ended September 30, 2013 compared to the same period a year ago. Salaries and employee benefits increased $146,000. The increase in personnel expense was primarily attributable to the addition of loan originators for new offices opened. Other general and administrative expenses increased$52,000 due to increases in costs for the additional staff such has training, travel and lodging and meals and entertainment associated with business development. Foreclosed property expense decreased $94,000 during the third quarter of 2013 mainly due to the lower level of foreclosed properties maintained by the Bank.Data processing expense decreased $17,000.All other expenses increased $53,000.

Noninterest expense increased $407,000 for the nine months ended September 30, 2013 compared to the same period a year ago. Salaries and employee benefits increased $623,000.Occupancy expense increased $65,000 due to the additional offices opened.Other general and administrative expenses increased $110,000 year over year largely due reasons mentioned previously. Foreclosed property expense decreased $343,000, mainly due to continued efforts to aggressively dispose of properties. All other expenses decreased $48,000.

Federal Income Tax Expense

A $615,000 tax benefit for the nine months of 2013, primarily associated with the $1.8 million net losses before income taxes, was offset by a corresponding increase in the valuation allowance on deferred tax assets. Tax expense of $38,000 was recognized during the second quarter due to a write off of a small deferred tax asset remaining on the Balance sheet which had previously been offset by a tax liability associated with available for sale securities. A significant component of income tax expense is made up of general tax credits generated each year. Our 2009 tax return is under audit; however there were no findings as of September 30, 2013.

LIQUIDITY

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

At September 30, 2013, the Bank was considered “well capitalized” under regulatory guidelines which subject the Bank to restrictions under the FDIC. These restrictions prohibit the Bank from accepting, renewing, or rolling over brokered deposits without a waiver from the FDIC. These guidelines also subject the Bank to restrictions on the interest rates that can be paid on deposits.

Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in short-term investments such as overnight deposits. On a longer-term basis, the Bank maintains a strategy of investing in various investments and lending products. The Bank uses its sources of funds primarily to meet its ongoing commitments, to pay maturing certificates of deposit and savings withdrawals and to fund loan commitments. Certificates of deposit scheduled to mature in one year or less at September 30, 2013 totaled $30.4 million. Management believes that a significant portion of these certificates of deposit will remain with the Bank provided the Bank pays a rate of interest that is competitive both in the local and national markets.

If necessary, additional funding sources include additional local core deposits, certificates of deposit gathered via the internet, Federal Home Loan Bank advances and securities available for sale. At September 30, 2013 and based on current collateral levels, the Bank could borrow an additional $20.9 million from the Federal Home Loan Bank at prevailing interest rates. This borrowing capacity can be increased in the future if the Bank pledges additional collateral to the Federal Home Loan Bank. The Corporation anticipates that it will continue to have sufficient funds, through deposits, and borrowings, to meet its current commitments.

The Bank’s total cash and cash equivalents decreased by $4.7 million during the nine months ended September 30, 2013 compared to a $.1 million decrease for the same period in 2012. The primary sources of cash for the nine months ended September 30, 2013 were $46.8 million in proceeds from the sale of mortgage loans, $2.3 million the sale and maturities of available-for-sale investment securities $12.2 million of principal loan collections in excess of loan originations compared to, $33.9 million in proceeds from the sale of mortgage loans, $10.4 million of principal loan collections in excess of loan originations and $2.0 million in the sale and maturities of available-for-sale investment securities for the nine months ended September 30, 2012.

The primary uses of cash for the nine months ended September 30, 2013 were $45.2 million of mortgage loans originated for sale, $3.0 million in purchases of available for sale securities and a decrease in deposits of $13.1 million and $7.0 million in repayment of FHLB advances compared to $35.0 million of mortgage loans originated for sale, $13.0 million in repayment of FHLB advances and $2.0 million in purchases of available for sale securities.

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

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Contractual Obligations AND OFF BALANCE SHEET ARRANGEMENTS

The Corporation has certain obligations and commitments to make future payments under contracts. At September 30, 2013, the aggregate contractual obligations and commitments are:

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

	Payments Due by Period
			Less than		1-3		3-5		After
	Total		1 year		years		years		5 years
	(Dollars in Thousands)
Certificates of deposit	$	52,652	$	30,430	$	17,054	$	5,168	$	—
FHLB advances		59		59		—		—		—
Total	$	52,711	$	30,489	$	17,054	$	5,168	$	—

	Amount of commitment expiration per period
			Less than		1-3		3-5		After
	Total		1 year		years		years		5 years
	(Dollars in Thousands)
Commitments to grant loans	$	10,125	$	10,125	$	—	$	—	$	—
Unfunded commitments under HELOCs		6,456		827		1,383		1,625		2,621
Unfunded commitments under Construction loans		451		435		16		—		—
Unfunded commitments under Commercial LOCs		122		72		50		—		—
Letters of credit		—		—		—		—		—
Total	$	17,154	$	11,459	$	1,449	$	1,625	$	2,621

CAPITAL RESOURCES

The Bank is subject to various regulatory capital requirement administered by federal and state banking agencies. The Bank’s regulatory capital ratios as of September 30, 2013 were as follows: Tier 1 leverage ratio 5.56%, Tier 1 risk-based capital ratio 9.48%; and total risk-based capital 10.75%.

In May 2010, the Bank agreed with the FDIC to increase the Bank’s Tier 1 risk-based capital ratio to at least 9%, and its total risk-based capital ratio to at least 11.0%. At September 30, 2013, these capital ratio requirements had not been met. The Board of Directors and management remain committed to reaching the capital requirements and continue to evaluate different capital raising alternatives. For additional information, please refer to Note 2 to the Corporation’s financial statements included in it’s Form 10-K for the year ended December 31, 2012 in connection with uncertainty about the Corporation’s ability to continue as a going concern.

ITEM 3.     QUANTITATIVE AND QUALITIVE DISCLOSURES ABOUT MARKET RISK

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

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

40

ITEM 4.     CONTROLS AND PROCEDURES

An evaluation of the Corporation’s disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of September 30, 2013 was carried out under the supervision and with the participation of the Corporation’s Chief Executive Officer, Chief Financial Officer and several other members of the Corporation’s senior management. The Corporation’s Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Corporation in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Corporation’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within time periods specified in the SEC’s rules and forms. There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the quarter ended September 30, 2013, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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

PART II-OTHER INFORMATION

Item 1.  LEGAL PROCEEDINGS

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

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

Not applicable

Item 3.  DEFAULTS UPON SENIOR SECURITIES

Not applicable

Item 4.  [RESERVED]

Item 5.  OTHER INFORMATION

Not applicable

Item 6.  EXHIBITS

See the index to exhibits.

41

SIGNATURES

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

	MONARCH COMMUNITY BANCORP, INC.
Date: November 14, 2013	By:	/s/ Richard J. DeVries
	Richard J. DeVries
	President and Chief Executive Officer
	(Principal Executive Officer)
Date: November 14, 2013	And:	/s/ Rebecca S. Crabill
	Rebecca S. Crabill
	Senior Vice President, Chief Financial Officer
	(Principal Financial Officer)

42

INDEX TO EXHIBITS

Exhibit No.	Description of Exhibit
31.1	Rule 13a-14(a) Certification of the Corporation’s President and Chief Executive Officer.
31.2	Rule 13a-14(a) Certification of the Corporation’s Chief Financial Officer.
32	Section 1350 Certification.

101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

43