Monarch Community Bancorp 10Q 2014 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2014or

☐ 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:☒ 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☒ 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☒

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

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practical date: At October 31, 2014, there were 8,962,416 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, 2014 and December 31, 2013	3

	Condensed Consolidated Statements of Income and Comprehensive Income – Three and Nine Months Ended September 30, 2014 and 2013	4

	Condensed Consolidated Statements of Cash Flows – Nine Months Ended September 30, 2014 and 2013	6

	Notes to Condensed Consolidated Financial Statements	7- 29

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations		29-37

Item 3 – Quantitative and Qualitative Disclosures about Market Risk		37

Item 4– Controls and Procedures		37

PART II – OTHER INFORMATION

Item 1 – Legal Proceedings		38

Item 1A – Risk Factors		38

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds		38

Item 3 – Defaults Upon Senior Securities		38

Item 4 – [Reserved]		38

Item 5 – Other Information		38

Item 6 – Exhibits		38

SIGNATURES		39

CERTIFICATIONS		41-43

PART I—FINANCIAL INFORMATION

Item 1. CONDENSED FINANCIAL STATEMENTS

Condensed Consolidated Balance Sheets	(Unaudited)
	September 30,			December 31,
	2014			2013
	(Dollars in thousands,
	except per share data)
Assets
Cash and due from banks	$	10,389		$	9,218
Federal Home Loan Bank overnight time and other interest bearing deposits		5,747			6,173
Total cash and cash equivalents		16,136			15,391
Securities - Available for sale		10,968			18,947
Certificates of Deposit		1,736			1,736
Other securities		3,370			3,370
Loans held for sale		1,062			415
Loans, net		132,299			118,530
Foreclosed assets, net		580			1,068
Premises and equipment		3,628			3,880
Other assets		7,103			7,630
Total assets	$	176,882		$	170,967

Liabilities and Stockholders’ Equity
Liabilities
Deposits:
Non-interest bearing	$	20,224		$	18,606
Interest bearing		124,163			130,949
Total deposits		144,387			149,555
Federal Home Loan Bank advances		11,000			—
Accrued expenses and other liabilities		1,507			1,691
Total liabilities		156,894			151,246

Stockholders’ Equity
Preferred stock-$.01 par value, 5,000,000 shares authorized, and no shares issued and outstanding as of June 30, 2014 and December 31, 2013		—			—
Common stock - $0.05 par value, 20,000,000 shares authorized, 8,962,416 shares issued and outstanding at September 30, 2014 and 8,660,147 shares issued and outstanding as of December 31, 2013, respectively, adjusted for 1:5 split.		448			433
Additional paid-in capital		40,188			39,344
Accumulated deficit		(19,543	)		(19,630	)
Accumulated other comprehensive income (loss)		28			(152	)
Unearned stock compensation		(1,133	)		(274	)
Total stockholders’ equity		19,988			19,721
Total liabilities and stockholders’ equity	$	176,882		$	170,967

See accompanying notes to condensed consolidated financial statements.

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,
	2014		2013			2014			2013
	(Dollars in thousands, except per share data)
Interest Income
Loans, including fees	$	1,777	$	1,742		$	5,236		$	5,334
Investment securities		114		81			396			245
Federal funds sold and overnight deposits		2		13			9			43
Total interest income		1,893		1,836			5,641			5,622
Interest Expense
Deposits		123		220			407			782
Federal Home Loan Bank advances		19		63			30			208
Total interest expense		142		283			437			990
Net Interest Income		1,751		1,553			5,204			4,632
Provision for Loan Losses		—		50			(90	)		437
Net Interest Income After Provision for Loan Losses		1,751		1,503			5,294			4,195
Non-interest Income
Fees and service charges		396		401			1,187			1,228
Loan servicing fees		114		113			339			322
Net gain on sale of loans		333		410			855			1,624
Net gain on sale of securities		23		—			23			3
Other income		8		104			100			356
Total non-interest income		874		1,028			2,504			3,533
Non-interest Expense
Salaries and employee benefits		1,378		1,608			3,914			4,754
Occupancy and equipment		267		302			835			881
Data processing		242		207			742			687
Mortgage banking		93		100			271			337
Professional services		167		175			510			596
Amortization of core deposit intangible		—		36			—			106
NOW account processing		44		46			135			148
ATM/Debit card processing		46		60			138			176
Foreclosed property expense		59		119			131			323
Other general and administrative		307		525			1,035			1,481
Total non-interest expense		2,603		3,178			7,711			9,489
Income (Loss) - Before income taxes		22		(647	)		87			(1,761	)
Income Taxes		—		—			—			38
Net Income (Loss)	$	22	$	(647	)	$	87		$	(1,799	)
Dividends and amortization of discount on preferred stock	$	—	$	107		$	—		$	311
Net Income (Loss) available to common stock	$	22	$	(754	)	$	87		$	(2,110	)
Comprehensive Income (Loss)
Net Income (Loss)	$	22	$	(647	)	$	87		$	(1,799	)
Change in unrealized gain (loss) on securities, net of tax	$	10	$	(45	)	$	180		$	(173	)
Reclassification adjustments for securities’ gain realized in net income, net of taxes	$	15	$	—		$	15		$	2
Comprehensive Income (Loss)	$	47	$	(692	)	$	282		$	(1,970	)
Earnings(Loss) Per Share (adjusted for 1:5 stock split)
Basic	$	0.00	$	(1.87	)	$	0.01		$	(5.24	)
Diluted	$	0.00	$	(1.87	)	$	0.01		$	(5.24	)

See accompanying notes to condensed consolidated financial statements.

Condensed Consolidated Statements of Changes in Stockholders' Equity (Unaudited)

	Preferred Stock Number of Shares		Amount		Common Stock Number of Shares		Amount		Additional Paid in Capital		Accumulated deficit			Accumulated Other Comprehensive Income (Loss)			Unearned Compensation			Total
Balance - January 1, 2014		—		—		8,660,147	$	433	$	39,344	$	(19,630	)	$	(152	)	$	(274	)	$	19,721
Issuance of 302,269 shares of common stock at $2.84/share awarded in connection with Restricted Stock plan.						302,269		15		844								(859	)		—
Net Income												87									87
Other comprehensive loss		—		—		—		—		—		—			180			—			180
Balance - September 30, 2014		—		—		8,962,416		448		40,188		(19,543	)		28			(1,133	)		19,988
See Notes to Consolidated Financial Statements.

Condensed Consolidated Statements of Cash Flows (Unaudited)	Nine Months Ended
	September, 30
	2014			2013
	(Dollars in thousands)
Cash Flows From Operating Activities
Net Income (Loss)	$	87		$	(1,799	)
Adjustments to reconcile net income (loss) to net cash from operating activities
Depreciation and amortization		652			801
Provision for loan losses		(90	)		437
Restricted stock expense		28			—
Write down on foreclosed assets		143			499
(Gain) loss on sale of foreclosed assets		(122	)		(44	)
Mortgage loans originated for sale		(21,482	)		(45,201	)
Proceeds from sale of mortgage loans		20,833			46,767
Gain on sale of available for sale securities		(23	)		(3	)
Gain on sale of mortgage loans		(855	)		(1,624	)
Net change in:
Deferred loan fees		(26	)		(16	)
Accrued interest receivable		21			59
Other assets		157			2,648
Accrued expenses and other liabilities		74			(70	)
Net cash (used in) provided by operating activities		(603	)		2,454
Cash Flows From Investing Activities
Activity in available for sale securities:
Purchases		(521	)		(2,980	)
Proceeds from sale of securities		7,482			80
Proceeds from maturities of securities		1,237			2,258
Net change in Certificates of Deposit:
Purchases of certificates of deposit		(248	)		(248	)
Proceeds from maturities of certificates of deposit		248			245
Loan originations and principal collections, net		(13,565	)		12,247
Proceeds from sale of foreclosed assets		935			1,562
Purchase of premises and equipment		(52	)		(219	)
Net cash (used in) provided by investing activities		(4,484	)		12,945
Cash Flows From Financing Activities
Net increase in deposits		(5,168	)		(13,147	)
Repayment of FHLB advances		(6,000	)		(7,000	)
Proceeds from FHLB advances		17,000			—
Net cash provided by (used in) financing activities		5,832			(20,147	)
Net Increase (Decrease) in Cash and Cash Equivalents		745			(4,748	)
Cash and Cash Equivalents - Beginning		15,391			28,744
Cash and Cash Equivalents - End	$	16,136		$	23,996
Supplemental Cash Flow Information:
Cash paid for:
Interest		423			922
Noncash investing activities:
Loans transferred to foreclosed assets		545			1,583

See accompanying notes to condensed consolidated financial statements.

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 November 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.

On November 15, 2013, the Corporation completed its offering of 8,250,000 shares of its common stock. The shares were issued at a purchase price of $2.00 per share, for aggregate consideration of $16.5 million. The closing of the offering occurred simultaneously with the closing of the series of transactions between the Corporation and the Department of Treasury pursuant to which the Department of Treasury received 2,272,601 shares of the Corporation’s common stock in exchange the 6,785 shares of Preferred Stock and the Warrants it held, and accrued dividends and interest on the preferred stock totaling $1,491,951. The transactions with Treasury resulted in the preferred stock and other obligations being settled at a discount, which was credited to paid-in-capital. The shares issued to the Treasury were sold as part of the offering, resulting in $4,545,202 of the offering proceeds being paid to the Department of Treasury. The net cash proceeds of the offering to the Corporation were approximately $10.5 million (net of the Treasury shares sold and total costs of $1.4 million).

Monarch Community Bank is headquartered in Coldwater, Michigan and operates five full service retail offices in Branch, Calhoun and Hillsdale Counties and seven loan production offices in Calhoun, Ingham, Lenawee, Kent, Livingston and Jackson Counties in Michigan and one in Steuben County, Indiana. 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, 2013 filed with the Securities and Exchange Commission.

The results of operations for the nine month period ended September 30, 2014 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. Weighted average historical losses are used in this analysis, which are based on actual losses over the prior eighteen month, with the most recent nine months weighted 60% and the latter nine months 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.

As of September 30, 2014 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 by .92% to 1.32%. Construction loan historical loss ratios were increased by .50% to .64%, 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, 2014, 23.9% of the allowance for loan loss reserve was attributable to adjustments to the loss factors. By assessing the estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.

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.

STOCK-BASED COMPENSATION

OnAugust19,2014,theboardofdirectorsapprovedastockcompensationplan(“2014Plan”)intendedtoattractandretainservices of employees, officers, and directors. The2014Plan authorizes up to860,000 shares orstock optionstobe issued to employees and directors. In August 2014, 302,269sharesofrestricted stockwereissued toemployees. Underthe plan, the awards vest20%per year forfive yearsand will vestimmediatelyuponany changein control. The total fair value ofthe awards approximated$859,000 Compensation expense applicableto theRRP amountedto approximately $28,000 forthe thirdquarter ended September 30, 2014.At September30,2014,there wasapproximately $831,000ofunrecognized compensation expense relatedto the unvested portionofthe awarded shares.

RECENT ACCOUNTING PRONOUNCEMENTS

FASB ASC 310 –In January 2014, the FASB issued an update (ASU No. 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure) impacting FASB ASC 310-40. The amendments in this update clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the property in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. The amendments also require disclosure of (1) the amount of foreclosed residential real estate property held by the creditor (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure. The new authoritative guidance will be effective for reporting periods after January 1, 2015.

RECLASSIFICATIONS

Certain 2013 amounts have been reclassified to conform to the 2014 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, 2014
Available-for-sale securities:
Collateralized Mortgage obligations	$	1,706	$	12	$	—		$	1,718
U.S. government agency obligations		3,613		7		(25	)		3,595
Mortgage-backed securities		1,774		40		—			1,814
Obligations of states and political subdivisions		3,832		25		(16	)		3,841
Total available-for-sale securities	$	10,925	$	84	$	(41	)	$	10,968

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Market Value

December 31, 2013
Available-for-sale securities:
Collateralized Mortgage obligations	$	6,925	$	—	$	(141	)	$	6,784
U.S. government agency obligations		5,129		11		(49	)		5,091
Mortgage-backed securities		3,287		30		(10	)		3,307
Obligations of states and political subdivisions		3,836		—		(71	)		3,765
Total available-for-sale securities	$	19,177	$	41	$	(271	)	$	18,947

There were $7.5 million in proceeds from the sale of investment securities for the nine months ended September 30, 2014 compared to $80,000 in proceeds from the sale of investment securities for the same period ended September 30, 2013. Gross realized gains were $23,000 and $3,000 on the sales of investment securities for the nine months ended September 30, 2014 and September 30, 2013, respectively.

The amortized cost and fair value of securities available for sale at September 30, 2014 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, 2014
	Available for Sale Securities
	Amortized		Fair
	Cost		Value
	(Dollars in Thousands)

Due in one year or less	$	—	$	—
Due from one to five years		5,663		5,627
Due from five to ten years		1,782		1,809
Due after ten years		—		—
Total		7,445		7,436
Mortgage-backed securities		1,774		1,814
CMO Securities		1,706		1,718
Total available-for-sale securities	$	10,925	$	10,968

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, 2014.

The following table shows the gross unrealized losses and the fair value of the Corporation’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, 2014, 11 securities were in a loss position. There were 21 securities in an unrealized loss position at December 31, 2013.

	Less than 12 Months					12 Months or More					Total
September 30, 2014	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Collateralized Mortgage obligations	$	—	$	—		$	—	$	—		$	—	$	—
Mortgage-backed securities		—		—			—		—			—		—
U.S. government agency obligations		1,513		(3	)		976		(22	)		2,489		(25	)
Obligations of states and political subdivisions		1,112		(2	)		1,431		(14	)		2,543		(16	)
Total available-for-sale securities	$	2,625	$	(5	)	$	2,407	$	(36	)	$	5,032	$	(41	)

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, 2014			September 30, 2013			September 30, 2014			September 30, 2013
Basic earnings (loss) per share
Numerator:
Net income (loss)	$	22		$	(647	)	$	87		$	(1,799	)
Dividends and amortization of discount on preferred stock		—			107			—			311
Net Income (Loss) allocated to common stock		22			(754	)		87			(2,110	)

Denominator:
Weighted average common shares outstanding		8,801			410			8,708			410
Less: Average unallocated ESOP shares		(6	)		(7	)		(6	)		(7	)
Less: Average non-vested RRP shares		(141	)		—			(48	)		—
Weighted average common shares outstanding for basic earnings (loss) per share		8,654			403			8,654			403
Basic earnings (loss) per share		0.00			(1.87	)		0.01			(5.24	)

Diluted earnings (loss) per share
Numerator:
Net Income (Loss) allocated to common stock		22			(754	)		87			(2,110	)

Denominator:
Weighted average common shares outstanding for basic earnings per share		8,654			403			8,654			403
Add: Dilutive effects of restricted stock, stock options and warrants		—			—			—			—
Weighted average common shares and dilutive potential common shares outstanding		8,654			403			8,654			403
Diluted earnings (loss) per share	$	0.00		$	(1.87	)	$	0.01		$	(5.24	)

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.

The following table presents information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at September 30, 2014, and December 31, 2013, 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, 2014
Assets:
Investment Securities
Collateralized Mortgage obligations	$	—	$	1,718	$	—	$	1,718
U.S. government agency obligations		—		3,595		—		3,595
Mortgage-backed securities		—		1,814		—		1,814
Obligations of states and political subdivisions		—		3,841		—		3,841
	$	—	$	10,968	$	—	$	10,968

	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, 2013
Assets:
Investment Securities
Collateralized Mortgage obligations	$	—	$	6,784	$	—	$	6,784
U.S. government agency obligations		—		5,091		—		5,091
Mortgage-backed securities		—		3,307		—		3,307
Obligations of states and political subdivisions		—		3,765		—		3,765
	$	—	$	18,947	$	—	$	18,947

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 2014 and 2013 to the impaired loans were recorded as additional allocations to the allowance for loan and lease losses. Adjustments in 2014 and 2013 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, 2014 and December 31, 2013 (000s omitted):

Assets Measured at Fair Value on a Nonrecurring Basis
	Balance at September 30, 2014		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		10,176		—		—		10,176
Foreclosed Assets		580		—		—		580

Assets Measured at Fair Value on a Nonrecurring Basis
	Balance at December 31, 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		10,097		—		—		10,097
Foreclosed Assets		1,068		—		—		1,068

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.

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, 2014 the Corporation held $580,000 in foreclosed assets owned as a result of foreclosure or the acceptance of a deed in lieu and $1.1 million in foreclosed assets as of December 31, 2013. No assets were redeemed by borrowers in 2013 or in the first six months of 2014. One commercial property was redeemed in the third quarter of 2014 in the amount of $112,000.

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, 2014 and December 31, 2013. 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.

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

	September 30, 2014
	Carrying Amount		Level 1		Level 2		Level 3		Total Estimated Fair Value
Assets:
Cash and cash equivalents	$	16,136	$	16,136		—		—	$	16,136
Certifcates of Deposit		1,736		—		1,736		—		1,736
Securities - Available for sale		10,968		—		10,968		—		10,968
Other securities		3,370		—		3,370		—		3,370
Loans and loans held for sale, net		133,361		—		—		137,956		137,956

Liabilities:
Deposits		144,387		—		144,739		—		144,739
Federal Home Loan Bank advances		11,000		—		10,943		—		10,943

		December 31, 2013
		Carrying Amount		Level 1	Level 2	Level 3		Total Estimated Fair Value
Assets:
Cash and cash equivalents	$	15,391	$	15,391	—	—	$	15,391
Certificates of Deposit		1,736		—	1,736	—		1,736
Securities - Available for sale		18,947		—	18,947	—		18,947
Other securities		3,370		—	3,370	—		3,370
Loans and loans held for sale, net		118,945		—	—	123,427		123,427

Liabilities:
Deposits		149,555		—	150,205	—		150,205
Federal Home Loan Bank advances		—		—	—	—		—

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, 2014					December 31, 2013
	Amount		Percent			Amount		Percent
	(Dollars in thousands)
Real Estate Loans:
One-to-four family	$	61,372		45.47		$	60,585		49.89
Multi-family		6,751		5.00			2,345		1.93
Commercial		53,999		40.01			47,245		38.90
Construction or development		4,102		3.04			2,332		1.92
Total real estate loans		126,224		93.53			112,507		92.64
Other loans:
Consumer loans:
Helocs and other		6,835		5.07			7,533		6.20
Commercial Business Loans		1,904		1.41			1,411		1.16
Total other loans		8,739		6.48			8,944		7.36
Total Loans		134,963		100.00	%		121,451		100.00	%

Allowance for loan losses		2,388					2,672
Less: Net deferred loan fees		276					249
Total Loans, net	$	132,299				$	118,530

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.

An age analysis of past due loans including nonaccrual loans, segregated by class of loans, as of September 30, 2014 and December 31, 2013 are as follows:

September 30, 2014	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	$	14	$	25	$	40	$	79	$	1,825	$	1,904
Commercial Real Estate:
Multi-family		—		—		—		—		6,751		6,751
Commercial Real Estate - other		99		70		—		169		53,830		53,999
Consumer:
Consumer - Helocs and other		9		21		18		48		6,787		6,835
Residential:
Residential - prime		1,184		235		78		1,497		48,020		49,517
Residential - subprime		855		116		162		1,133		10,722		11,855
Construction:
Construction - prime		—		—		—		—		4,102		4,102
Construction - subprime		—		—		—		—		—		—
Total	$	2,161	$	467	$	298	$	2,926	$	132,037	$	134,963

December 31, 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	$	—	$	—	$	—	$	—	$	1,411	$	1,411
Commercial Real Estate:
Multi-family		—		—		—		—		2,345		2,345
Commercial Real Estate - other		306		—		112		418		46,827		47,245
Consumer:
Consumer - Helocs and other		44		52		—		96		7,437		7,533
Residential:
Residential - prime		934		336		440		1,710		45,816		47,526
Residential - subprime		410		107		221		738		12,321		13,059
Construction:
Construction - prime		—		—		—		—		2,332		2,332
Construction - subprime		—		—		—		—		—		—
Total	$	1,694	$	495	$	773	$	2,962	$	118,489	$	121,451

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:

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

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

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

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.

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.

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.

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.

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.

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

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

Fraudulently overstated assets and/or earnings.

Collateral has marginal or no value.

Debtor cannot be located.

The following table represents the risk category of loans by class based on the analysis performed as of September 30, 2014 and December 31, 2013 (in thousands):

					September 30, 2014
Credit Rating			Commercial		Commercial Real Estate Multi-family		Commercial Real Estate Other
	0		$	—	$	25	$	303
	1-2			—		—		422
	3			455		2,958		18,565
	4			809		3,321		26,728
	5			492		—		4,896
	6			148		447		3,085
	7			—		—		—
		Total	$	1,904	$	6,751	$	53,999

				December 31, 2013
		Commercial		Commercial Real Estate Multi-family		Commercial Real Estate Other
0		$	—	$	27	$	309
1-2			—		—		472
3			312		835		14,252
4			1,011		1,033		20,408
5			—		—		8,677
6			88		450		3,127
7			—		—		—
	Total	$	1,411	$	2,345	$	47,245

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, 2014 and December 31, 2013.

	September 30, 2014
	Residential - Prime		Residential - Subprime

Grade
Pass	$	49,245	$	11,654
Substandard		272		201
Total	$	49,517	$	11,855

				Consumer - Helocs and other
Performing			$	6,739
Nonperforming				96
Total			$	6,835

				Construction
Performing			$	4,102
Nonperforming				—
Total			$	4,102

	December 31, 2013
	Residential - Prime		Residential - Subprime

Grade
Pass	$	46,860	$	12,775
Substandard		666		284
Total	$	47,526	$	13,059

				Consumer - Helocs and other
Performing			$	7,431
Nonperforming				102
Total			$	7,533

				Construction
Performing			$	2,332
Nonperforming				—
Total			$	2,332

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2014 and December 31, 2013 (in thousands).

September 30, 2014
	Recorded Investment		Unpaid Principal Balance		Related Allowance

With no related allowance recorded:
Commercial	$	66	$	66	$	—
Commercial Real Estate:

Commercial Real Estate - Mulit-family		—		—		—
Commercial Real Estate - other		7,683		9,745		—
Consumer:
Consumer - Helocs and other		—		—		—
Residential:
Residential - prime		1,140		1,183		—
Residential - subprime		—		—		—
Construction:
Construction - prime		—		—		—
Construction - subprime		—		—		—

With an allowance recorded:
Commercial		47		47		23
Commercial Real Estate:

Commercial Real Estate - Multi-family		448		462		64
Commercial Real Estate - other

Consumer:		—		—		—
Consumer - Helocs and others		—		—		—
Residential:
Residential - prime		370		370		172
Residential - subprime		—		—		—
Construction:
Construction - prime		422		422		33
Construction - subprime		—		—		—

Total
Commercial	$	8,666	$	10,742	$	120
Consumer	$	—	$	—	$	—
Residental	$	1,510	$	1,553	$	172

December 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance

With no related allowance recorded:
Commercial	$	—	$	—	$	—
Commercial Real Estate:
Commercial Real Estate - Mulit-family		—		—		—
Commercial Real Estate - other		3,802		5,817		—
Consumer:
Consumer - Helocs and others		—		—		—
Residential:
Residential - prime		—		—		—
Residential - subprime		—		—		—
Construction:
Construction - prime		—		—		—
Construction - subprime		—		—		—

With an allowance recorded:
Commercial		48		48		22
Commercial Real Estate:
Commercial Real Estate - Multi-family		450		463		63
Commercial Real Estate - other		4,150		4,150		35
Consumer:
Consumer - Helocs and others		—		—		—
Residential:
Residential - prime		1,554		1,596		182
Residential - subprime		—		—		—
Construction:
Construction - prime		440		440		45
Construction - subprime		—		—		—
Total
Commercial	$	8,890	$	10,918	$	165
Consumer	$	—	$	—	$	—
Residental	$	1,554	$	1,596	$	182

The following table presents loans individually evaluated for impairment by class of loans for the three months ended September 30, 2014 and September 30, 2013 (in thousands).

	Three Months Ended September 30, 2014				Three Months Ended September 30, 2013
	Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income
With no related allowance recorded:
Commercial	$	66	$	—	$	358	$	—
Commercial Real Estate:

Commercial Real Estate - Mulit-family		—		—		—		—
Commercial Real Estate - other		9,765		100		6,114		60
Consumer:
Consumer - Helocs and other		—		—		—		—
Residential:
Residential - prime		1,187		12		—		—
Residential - subprime		—		—		—		—

With an allowance recorded:
Commercial		47		1		49		1
Commercial Real Estate:

Commercial Real Estate - Multi-family		462		8		464		6
Commercial Real Estate - other		—		—		4,183		42
Consumer:
Consumer - Helocs and others		—		—		—		—
Residential:
Residential - prime		370		6		1,619		19
Residential - subprime		—		—		—		—
Construction:
Construction - prime		424		5		448		5
Construction - subprime		—		—		—		—
Total
Commercial	$	10,764	$	114	$	11,616	$	114
Consumer	$	—	$	—	$	—	$	—
Residental	$	1,557	$	18	$	1,619	$	19

The following table presents loans individually evaluated for impairment by class of loans for the nine months ended September 30, 2014 and September 30, 2013 (in thousands).

	Nine Months Ended September 30, 2014				Nine Months Ended September 30, 2013
	Average Recorded Investment		Interest Income		Average Recorded Investment		Interest Income
With no related allowance recorded:
Commercial	$	68	$	—	$	371	$	—
Commercial Real Estate:

Commercial Real Estate - Mulit-family		—		—		—		—
Commercial Real Estate - other		9,819		298		6,138		179
Consumer:
Consumer - Helocs and other		—		—		—		—
Residential:
Residential - prime		1,200		36		—		—
Residential - subprime		—		—		—		—

With an allowance recorded:
Commercial		47		2		49		2
Commercial Real Estate:

Commercial Real Estate - Multi-family		463		24		464		17
Commercial Real Estate - other		—		—		4,208		126
Consumer:
Consumer - Helocs and others		—		—		—		—
Residential:
Residential - prime		371		18		1,648		57
Residential - subprime		—		—		—		—
Construction:
Construction - prime		430		14		452		15
Construction - subprime		—		—		—		—
Total
Commercial	$	10,827	$	338	$	11,682	$	339
Consumer	$	—	$	—	$	—	$	—
Residental	$	1,571	$	54	$	1,648	$	57

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, 2014 and December 31, 2013.

Financing Receivables on Nonaccrual Status

	September 30, 2014
Commercial	$	66
Commercial real estate:
Commercial Real Estate - mulit-family		—
Commercial Real Estate - other		70
Consumer:
Consumer - Helocs and other		22
Residential:
Residential - prime		859
Residential - subprime		707
Construction
Construction - prime		—
Construction - subprime		—
Total	$	1,724

Financing Receivables on Nonaccrual Status
	December 31, 2013
Commercial	$	—
Commercial real estate:
Commercial Real Estate - mulit-family		—
Commercial Real Estate - other		112
Consumer:
Consumer - Helocs and other		—
Residential:
Residential - prime		748
Residential - subprime		494
Construction
Construction - prime		—
Construction - subprime		—
Total	$	1,354

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.

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, 2014 there have been no loans in which the TDR designation has been removed. The following table represents the modifications completed during the three months ended September 30, 2014 and 2013.

	Modifications
	Three Months Ended September 30, 2014

	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		1		66		66
Construction
Construction - prime		—		—		—
Construction - subprime		—		—		—
Total		1	$	66	$	66

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

—

The following table represents the modifications completed during the nine months ended September 30, 2014 and 2013.

	Modifications
	Nine Months Ended September 30, 2014

	Number of Contracts		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Troubled Debt Restructurings
Commercial		—	$	—	$	—
Commercial real estate:
Commercial Real Estate - mulit-family		—		—		—
Commercial Real Estate - other		—		—		—
Consumer:		—
Consumer - Heloc and other		—		—		—
Residential:
Residential - prime		1		156		156
Residential - subprime		1		66		66
Construction
Construction - prime		—		—		—
Construction - subprime		—		—		—
Total		2	$	222	$	222

	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 - mulit-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

There were no troubled debt restructured loans which had payment defaults during the three months ended September 30, 2014 and 2013. There were no troubles debt restructured loans which had payment defaults during the nine months ended September 30, 2014, compared to loans in the amount of $212,000 as of September 30, 2013. Default occurs when a loan is 90 days or more past due or has been transferred to nonaccrual.

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.

NOTE 6 - ALLOWANCE FOR LOAN LOSSES

Analysis related to the allowance for credit losses (in thousands) for the three months ended September 30, 2014 and 2013 is as follows:

For the Three Months Ended September 30, 2014

	Commercial			Commercial Real Estate Other			Multi Family		Consumer			Residential - Prime			Residential - Subprime			Construction			Total


ALLOWANCE FOR CREDIT LOSSES:
Beginning Balance	$	110		$	568		$	93	$	206		$	955		$	512		$	66		$	2,510
Charge-Offs		(1	)		(10	)		—		(63	)		(56	)		(69	)		—			(199	)
Recoveries		9			21			—		46			—			1			—			77
Provision		(14	)		(48	)		7		9			(37	)		87			(4	)		—
Ending Balance		104			531			100		198			862			531			62			2,388

Ending Balance: individually evaluated for impairment		23			—			64		—			172			—			33			292

Ending Balance: collectively evaluated for impairment	$	81		$	531		$	36	$	198		$	690		$	531		$	29		$	2,096

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

Analysis related to the allowance for credit losses (in thousands) for the nine months ended September 30, 2014 and 2013 is as follows:

For the Nine Months Ended September 30, 2014

	Commercial			Commercial Real Estate Other			Multi Family		Consumer			Residential - Prime			Residential - Subprime			Construction		Total

ALLOWANCE FOR CREDIT LOSSES:
Beginning Balance	$	56		$	521		$	77	$	249		$	1,132		$	577		$	60	$	2,672
Charge-Offs		(1	)		(11	)		—		(261	)		(105	)		(133	)		—		(511	)
Recoveries		11			124			1		167			13			1			—		317
Provision		38			(103	)		22		43			(178	)		86			2		(90	)
Ending Balance		104			531			100		198			862			531			62		2,388

Ending Balance: individually evaluated for impairment		23			—			64		—			172			—			33		292


Ending Balance: collectively evaluated for impairment	$	81		$	531		$	36	$	198		$	690		$	531		$	29	$	2,096

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

The allowance for loan losses was $2.4 million at September 30, 2014 representing 1.77% of total loans, compared to $2.7 million at December 31, 2013 or 2.20% of total loans. The allowance for loan losses to non-performing loans ratio was 139% at September 30, 2014 compared to 197% at December 31, 2013. At September 30, 2014 we believe that our allowance appropriately considers incurred losses in our loan portfolio.

Analysis related to the allowance for loan receivables (in thousands) for the nine months ended September 30, 2014 and December 31, 2013 is as follows:

As of
September 30, 2014
	Commercial		Commercial Real Estate Other		Multi Family		Consumer		Residential - Prime		Residential - Subprime		Construction		Total

LOAN RECEIVABLES:

Ending Balance	$	1,904	$	53,999	$	6,751	$	6,835	$	49,517	$	11,855	$	4,102	$	134,963

Ending Balance: individually evaluated for impairment		113		7,683		448		—		1,510		—		422		10,176

Ending Balance: collectively evaluated for impairment	$	1,791	$	46,316	$	6,303	$	6,835	$	48,007	$	11,855	$	3,680	$	124,787

As of
December 31, 2013
	Commercial		Commercial Real Estate Other		Multi Family		Consumer		Residential - Prime		Residential - Subprime		Construction		Total

LOAN RECEIVABLES:

Ending Balance	$	1,411	$	47,245	$	2,345	$	7,533	$	47,526	$	13,059	$	2,332	$	121,451

Ending Balance: individually evaluated for impairment		48		7,952		450		—		1,554		—		440		10,444

Ending Balance: collectively evaluated for impairment	$	1,363	$	39,293	$	1,895	$	7,533	$	45,972	$	13,059	$	1,892	$	111,007

The Corporation’s charge-off policy which meets regulatory minimums has not required any revisions during the third quarter of 2014. 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.

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.

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, contained specific actions needed to address certain findings from their examination and to address our financial condition. The Consent Order was terminated by the FDIC by order dated July 9, 2014.

We complied with all of the required actions in the Consent Order, including raising our Tier 1 and Total Risk Based Capital ratios to minimums of 9.0% and 11.0%, respectively. This was accomplished through the successful Private Placement of $16.5 million in common stock of the Corporation, which was completed in the fourth quarter of 2013. Concurrent with the closing of the capital raise, the Corporation also completed a series of transactions between the Corporation and the Department of Treasury pursuant to which the Department of Treasury received 2,272,601 shares of the Corporation’s common stock in exchange for the shares of Preferred Stock and the Warrants it held, and accrued dividends and interest on the Preferred Stock totaling $1,491,951. The transactions with Treasury resulted in the Preferred Stock and other obligations being settled at a discount, which was credited to paid-in-capital. The shares issued to the Treasury were sold as part of the public offering, resulting in $4,545,202 of the offering proceeds being paid to the Department of Treasury. The net cash proceeds of the offering to the Corporation were approximately $10.5 million (net of the Treasury shares sold and total costs of $1.4 million).

In connection with the termination of the Consent Order, the Company agreed among other things to: (i) to adopt a plan for collecting, charging off, selling or otherwise improving the quality of the Bank’s delinquent or substandard credits in order to reduce the Bank’s risk position with respect to these credits; (ii) not to extend additional credit to or for the benefit of borrowers with credits classified as “loss” or otherwise written off; (iii) to adopt a plan for reducing the volume of real estate loans with loan to value ratios in excess of regulatory guidelines; (iv) to adopt a profit plan aimed at improving earnings, with such plan to address the viability of each loan production office, realistic operating budgets and a budget review process for monitoring performance against budget; and (v) maintain Tier 1 capital as a percentage of assets at a minimum of 8.5%.

Credit quality continues to improve at the Bank, which has now completed multiple comprehensive external loan reviews over the last four years, 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, in 2010, 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 multiple comprehensive internal audits, 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 $2.4 million at December 31, 2013 to $2.3 million at September 30, 2014.

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 a number of loan production offices throughout Michigan and Indiana, two of which now house commercial lenders. Residential loan production offices are currently operating in Battle Creek, Jackson, Brighton, and Adrian, Michigan, with an additional office in Angola, Indiana. Commercial loan production offices are now operating in East Lansing and Grand Rapids, Michigan. The establishment of these offices provides a geographic dispersion of risk, and places us in markets with demographics that support our growth plans.

On October 31, 2014, the Corporation entered into an Agreement and Plan of Merger with Chemical Financial Corporation ("Chemical") providing for a business combination of Chemical and the Corporation. The merger agreement was unanimously approved by the board of directors of the Corporation, and will be submitted to a vote of the shareholders of the Corporation for their approval. Subject to the terms and conditions of the merger agreement, Chemical will exchange 0.0982 shares of Chemical common stock for each share of Corporation common stock outstanding. The merger agreement provides that, upon the terms and subject to the conditions set forth in the agreement, the Corporation will be merged with and into Chemical, with Chemical as the surviving corporation. Following completion of the merger, Chemical intends to consolidate the Bank with and into Chemical Bank, Chemical's wholly-owned subsidiary bank, with Chemical Bank as the surviving institution.

Assuming the merger is approved, the Corporation’s shareholders will become shareholders of Chemical. If the merger does not close, the Corporation will continue to improve growth and profitability 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 quarter. Our intent is to continue our disciplined, aggressive approach to further reducing non-performing and classified loans.
	2.	Continued expense reduction throughout the organization.
	3.	Organic growth, focusing on commercial and residential lending in our defined 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 provides compliance, sales, research and clearing support for investment advisors that are employed by the Bank and provide investment services under the name of Monarch Investment Services. This provides for enhanced branding of the Monarch name and increased fee income potential from investment services.
	4.	A continued exploration of acquisition opportunities, where markets and synergies combine for the potential of enhanced shareholder value.

FINANCIAL CONDITION

Summary

Our total assets increased by $5.9 million, or 3.46%, to $176.9 million at September 30, 2014 compared to $171.0 million at December 31, 2013. Loans, excluding loans held for sale, totaled $132.3 million at September 30, 2014, up 11.6% from $118.5 million at December 31, 2013.

Securities

Securities decreased $8.0 million to $11.0 million as of September 30, 2014 compared to $18.9 million at December 31, 2013. The Corporation sold approximately $7.5 million in securities during the third quarter and utilized the funds to repay FHLBI advances. A gain of $23,000 was recognized as a result of the sale. The Corporation also received $400,000 in normal pay downs in the Mortgage Backed Securities and Collateralized Mortgage Obligation portfolios during the third quarter of 2014. The yield on investment securities has decreased to 1.85% during the nine months ended September 30, 2014 from 2.10% 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 increased by $13.8 million, or 11.6%, from $118.5 million at December 31, 2013 to $132.2 million at September 30, 2014. 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, 2014					December 31, 2013
	Amount		Percent			Amount		Percent
	(Dollars in thousands)
Real Estate Loans:
One-to-four family	$	61,372		45.46		$	60,585		49.89
Multi-family		6,751		5.00			2,345		1.93
Commercial		53,999		40.01			47,245		38.90
Construction or development		4,102		3.04			2,332		1.92
Total real estate loans		126,224		93.53			112,507		92.64
Other loans:
Consumer loans:
Helocs and other		6,835		5.06			7,533		6.20
Commercial Business Loans		1,904		1.41			1,411		1.16
Total other loans		8,739		6.48			8,944		7.36
Total Loans		134,963		100.00	%		121,451		100.00	%

Allowance for loan losses		2,388					2,672
Less: Net deferred loan fees		276					249
Total Loans, net	$	132,299				$	118,530

One-to-four family loans increased slightly by $787,000 from year end 2013 as a result of an increase in customer interest in adjustable rate mortgages which the Bank retains rather than sell in the secondary market. The Bank has continued 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 increased $12.9 million or 24.9%.

The allowance for loan losses was $2.4 million at September 30, 2014 compared to $2.67 million at December 31, 2013, a decrease of $284,000. Year to date net charge offs totaled $194,000 compared to $479,000 for the same period a year ago. Net charge offs year to date consisted of primarily residential loans. The Corporation also recognized a reverse provision of $90,000, which was associated with the recovery of a previously charged off commercial real estate loan. See “Provision for Loan Losses” below for further explanation regarding charge-offs and non-performing loans. The current level of the allowance for loan losses is the result of management’s assessment of the risks within the portfolio based on the information revealed in credit monitoring processes.

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

Deposits

Total deposits decreased $5.17 million, or 3.46%, from $149.6 million at December 31, 2013 to $144.4 million at September 30, 2014. The decrease in deposits included decreases of $5.73 million in certificates of deposits, $3.6 million in interest bearing checking, offset by increases of $1.6 million in demand deposits, $1.3 million in money markets accounts and $1.26 million in saving accounts.

In the past, we 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. Because the Bank’s regulatory capital ratios were less than the levels necessary to be considered “well capitalized” while the Consent Order was in effect, it could 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. With the Consent Order terminated, the rate limitations and prior approval requirements have ceased.

Federal Home Loan Bank Advances

Total Federal Home Loan Bank (FHLB) advances increased to $11.0 million as of September 30, 2014. While additional borrowings were utilized during the quarter, funds from the sale of securities were used to repay outstanding advances of $6.0 million. Management continues to evaluate all sources of funding to meet the liquidity and growth needs of the bank. 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 $20.0 million at September 30, 2014 compared to $19.72 million at December 31, 2013. This represents 11.31% and 11.53% of total assets at September 30, 2014 and December 31, 2013, respectively. Increases in equity for the nine months ended September 30, 2014 included net earnings of $87,000 and $180,000 in changes in unrealized losses on available for sale securities. During the third quarter ending September 30, 2014, the Corporation issued 820,000 shares of restricted stock to employees of the Corporation. The stock awarded vests over a five year period ending in 2019.

RESULTS OF OPERATIONS

Net Interest Income

Net interest income before any provision for loan losses increased $198,000 for the quarter ended September 30, 2014 compared to the same period in 2013.

The net interest margin for the third quarter of 2014 increased 31 basis points to 4.04% compared to 3.73% for the same period in 2013. The improvement in the margin is largely due to a decrease in certificates of deposits, the repricing of the remaining portfolio and a reduction in wholesale funding costs as management continues to actively monitor its deposit base and borrowing. The net interest margin for the nine months ended September 30, 2014 increased 51 basis points to 4.07% compared to 3.56% for the same period in 2013.

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

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,							Nine Months Ended September 30,
	2014							2013
	Average		Interest					Average		Interest
	Outstanding		Earned/		Yield/			Outstanding		Earned/		Yield/
	Balance		Paid		Rate			Balance		Paid		Rate
	(dollars in thousands)
Fed Funds and overnight deposits	$	17,031	$	9		0.07	%	$	34,280	$	43		0.17	%
Investment securities		20,529		284		1.85			10,165		160		2.10
Other securities		3,307		112		4.53			5,393		85		2.11
Loans receivable		129,415		5,236		5.41			123,768		5,334		5.76
Total earning assets	$	170,282	$	5,641		4.43		$	173,606	$	5,622		4.33

Demand and NOW Accounts	$	50,288	$	6		0.02		$	47,358	$	6		0.02
Money market accounts		32,983		26		0.11			34,590		28		0.11
Savings accounts		25,988		10		0.05			24,247		9		0.05
Certificates of deposit		43,177		365		1.13			60,053		739		1.65
Federal Home Loan Bank Advances		7,165		31		0.58			6,684		208		4.16
Total interest bearing liabilities	$	159,601		438		0.37		$	172,932		990		0.77
Net interest income			$	5,203						$	4,632
Net interest spread						4.06	%						3.56	%
Net interest margin						4.07	%						3.56	%

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,
	2014 vs. 2013
										Total
	Increase (Decrease) Due to									Increase
	Rate			Volume			Mix			(Decrease)
	(in thousands)
Interest-earning assets
Fed funds and overnight deposits		(33	)		(29	)		28			(34	)
Investment securities		(26	)		218			(68	)		124
Other securities		131			(44	)		(60	)		27
Loans receivable		(435	)		324			13			(98	)
Total interest-earning assets		(363	)		469			(87	)		19

Interest-bearing liabilities
Demand and NOW accounts		(0	)		0			(0	)		0
Money market accounts		(1	)		(2	)		1			(2	)
Savings accounts		0			1			(0	)		1
Certificates of deposit		(309	)		(278	)		213			(374	)
Federal Home Loan Bank advances		(239	)		20			42			(177	)
Total interest-bearing liabilities		(549	)		(259	)		256			(552	)
Net interest income											571

Provision for Loan Losses

No provision was recorded for the third quarter ending September 30, 2014 compared to a provision of $50,000 recorded in the same period a year ago.

The Corporation recorded net charge offs of $122,000 during the third quarter of 2014 compared to a net recovery of $200,000 for the same period in 2013. The Corporation continues to monitor real estate dependent loans and focus on asset quality. Watch list credits totaling $8.0 million as of September 30, 2014 as compared to $11.8 million as of December 31, 2013 were positively impacted due to the upgrade of a large commercial real estate relationship during the third quarter of 2014. Non-performing loans totaled $1.7 million as of September 30, 2014, increasing from $1.4 million at December 31, 2013. The increase in non-performing loans is a result of a slight increase in residential loans being placed on nonaccrual status due to the borrower becoming 90 days delinquent. Net charge offs for the nine months ended September 30, 2014 were $194,000 compared to $479,000 for the same period in 2013. The Bank recorded a reverse provision $90,000 in the nine months ended September 2014 compared to $437,000 for the same period a year ago.

Nonperforming assets, including the amount of real estate in judgment and foreclosed and repossessed properties, decreased from $2.4 million at the end of 2013 to $2.3 million as of September 30, 2014. The following table presents non-performing assets and certain asset quality ratios at September 30, 2014 and December 31, 2013.

	September 30, 2014			December 31, 2013
				(In thousands)
Non-performing loans	$	1,724		$	1,354
Real estate in judgement		119			523
Foreclosed and repossessed assets		461			545
Total non-performing assets	$	2,304		$	2,422

Non-performing loans to total loans		1.28	%		1.11	%
Non-performing assets to total assets		1.30	%		1.42	%
Allowance for loan losses to non-performing loans		138.54	%		197.40	%
Allowance for loan losses to total loans receivable		1.77	%		2.20	%

Non-interest Income

Non-interest income for the quarter ended September 30, 2014 decreased $154,000 to $874,000 from $1.03 million when compared to the same period a year ago. The decrease in non-interest income was mainly attributable to a decrease in gain on the sale of loans and other income.

Gain on sale of loans decreased $77,000, to $333,000 for the quarter ended September 30, 2014 from $410,000 for the same period a year ago. The decrease was a result of the slow-down in residential lending as rates rose in the second half of 2013 and remained higher during the first nine months of 2014 than rates were during the first half of 2013.

Other income decreased $96,000 during the third quarter ending September 30, 2014 compared to the same period a year ago. This decrease was largely due increased losses on the sale of real estate owned and lower levels of income recognized with the adjustment for derivative activity associated with commitments to sell loans into the secondary market.

Non-interest income for the nine months ended September 30, 2014 decreased $1.03 million, or 29.13%, from $3.53 million to $2.5 million compared to the same period a year ago. This is mainly attributable to a decrease in gain on sale of loans and other income.

Net gain on sale of loans decreased $769,000 for the nine months ended September 30, 2014 from $1.6 million to $855,000 when compared to the same period a year ago for reasons mentioned previously. Other income decreased $256,000 for the nine months ended September 30, 2014 compared to a year ago attributable to a one – time charge of $156,000 due to outstanding past variances associated with Freddie Mac taken in the second quarter and lower levels of income recognized with the adjustment for derivative activity associated with commitments to sell loans into the secondary market as mentioned above. All other non-interest income decreased $4,000.

Non-interest Expense

Non-interest expense decreased $575,000, or 18.09% for the quarter ended September 30, 2014 compared to the same period a year ago. The decrease is primarily due to decreases in compensation and benefits, other general and administrative expenses and foreclosed property expense. Compensation and benefits decreased $230,000 as a result of the reduction in staffing completed early in the fourth quarter of 2013. Other general and administrative expense decreased $218,000 for the quarter ended September 30, 2014 compared to the same period a year ago, largely due to reduction in expenses associated with travel and lodging and office supplies and lower Federal Deposit Insurance Corporation (FDIC) expense. Foreclosed property expense decreased $60,000 for the quarter as a result of decreased maintenance costs associated with the other repossessed properties held by the bank. Amortization of core deposit intangible decreased $36,000 as a result of the conclusion of the amortization of the core deposit intangible. All other non-interest expenses decreased $31,000 as of September 30, 2014 compared to the same period a year ago.

Noninterest expense decreased $1.8 million for the nine months ended September 30, 2014 compared to the same period a year ago. Salaries and employee benefits decreased $840,000. Other general and administrative expenses decreased $446,000 year over year largely due reasons mentioned previously. Foreclosed property expense decreased $192,000, mainly due to continued efforts to aggressively dispose of properties. Amortization of core deposit intangible decreased $106,000 as a result of the conclusion of the amortization of the core deposit intangible. Professional fees decreased $86,000 due to a decrease in fees associated with problem loans. Mortgage banking expense decreased $66,000 due to decrease in one to four family refinance activity. All other expenses decreased $42,000.

Federal Income Tax Expense

For the nine months ended September 30, 2014, we generated pretax income of $87,000. At September 30, 2014 we have a deferred tax asset of $9.2 million, primarily the result of net operating losses and timing differences associated with the deductibility of the allowance for loan losses. Based on our most recent assessment of our ability to utilize the deferred tax asset through generation of taxable income we have determined that we should retain the valuation allowance previously established on the deferred tax asset, reducing the carrying value to zero as of September 30, 2014. For the nine months ended September 30, 2014, we reduced our tax valuation to the extent we would have otherwise recorded tax expense, which was approximately $17,000. There were no other changes in the carrying value of the deferred tax asset during the quarter.

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.

Prior to termination of the Consent Order, under regulatory guidelines which subject the Bank to restrictions under the FDIC the Bank was prohibited from accepting, renewing, or rolling over brokered deposits without a waiver from the FDIC. These guidelines also subjected the Bank to restrictions on the interest rates that could be paid on deposits. These restrictions have been eliminated by the termination of the Consent Order

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, 2014 totaled $24.9 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, 2014 and based on current collateral levels, the Bank could borrow an additional $18.3 million from the Federal Home Loan Bank at prevailing interest rates. This borrowing capacity can be increased in the future if the Bank pledges additional collateral to the Federal Home Loan Bank. The Corporation anticipates that it will continue to have sufficient funds, through deposits, and borrowings, to meet its current commitments.

The Bank’s total cash and cash equivalents increased by $745,000 during the nine months ended September 30, 2014 compared to a $4.7 million decrease for the same period in 2013. The primary sources of cash for the nine months ended September 30, 2014 were $17.0 million in proceeds of FHLBI advances, $20.8 million in proceeds from the sale of mortgage loans, and $7.5 million in proceeds from the sale of available for sale investment securities and $1.2 million in the maturities of available-for-sale investment securities compared to $46.8 million in proceeds from the sale of mortgage loans, $12.2 million of principal loan collections in excess of loan originations and $2.3 million in the maturities of available-for-sale investment securities for the nine months ended September 30, 2013.

The primary uses of cash for the nine months ended September 30, 2014 were $21.5 million of mortgage loans originated for sale, 13.6 million of principal loan originations in excess of collections, $6.0 million in repayment of FHLBI advances and $5.2 million decrease in deposits and $521,000 in purchases of available for sale securities compared to $45.2 million of mortgage loans originated for sale, $13.1 decrease in deposits, $7.0 million in repayment of FHLBI advances and $3.0 million in purchases of available for sale securities.

Contractual Obligations AND OFF BALANCE SHEET ARRANGEMENTS

The Corporation has certain obligations and commitments to make future payments under contracts. At September 30, 2014, 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	$	41,067	$	24,896	$	11,456	$	4,715	$	—
FHLB advances		11,000		7,000		4,000		—		—

Total	$	52,067	$	31,896	$	15,456	$	4,715	$	—

	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	$	4,216	$	4,216	$	—	$	—	$	—
Unfunded commitments under HELOCs		6,075		704		1,219		1,328		2,824
Unfunded commitments under Contruction loans		814		808		6		—		—
Unfunded commitments under
Commercial LOCs		2,261		1,839		155		267		—
Letters of credit		—		—		—		—		—

Total	$	13,366	$	7,567	$	1,380	$	1,595	$	2,824

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, 2014 were as follows: Tier 1 leverage ratio 10.16%, Tier 1 risk-based capital ratio 14.49%; and total risk-based capital 15.75%.

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%. In connection with the termination of the Consent Order the Company agreed the Bank would maintain a Tier 1 risk-based capital ratio of at least 8.5%. At September 30, 2014, these capital ratio requirements have been met.

ITEM 3. QUANTITATIVE AND QUALITIVE DISCLOSURES ABOUT MARKET RISK

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

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

ITEM 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, 2014 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, 2014, 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.

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, 2014	By:	/s/ Richard J. DeVries
		Richard J. DeVries
		President and Chief Executive Officer
		(Principal Executive Officer)

Date: November 14, 2014	And:	/s/ Rebecca S. Crabill
		Rebecca S. Crabill
		Senior Vice President, Chief Financial Officer
		(Principal Financial Officer)

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

Positive
Negative
Uncertain
Constraining
Legalese
Litigous
Readability	H.S. freshman Bad

Monarch Community Bancorp (MCBF) Inactive 10-Q2014 Q3 Quarterly report

Content analysis