ITEM 1. Business
General
Monarch Community Bancorp, Inc. (“Company”) was incorporated in March 2002 under Maryland law to hold all of the common stock of Monarch Community Bank (“Monarch” or the “Bank”), formerly known as Branch County Federal Savings and Loan Association. The Bank converted to a stock savings institution effective August 29, 2002. In connection with the conversion, the Company sold 2,314,375 shares of its common stock in a subscription offering.
On April 15, 2004, the Company completed its acquisition of MSB Financial, Inc., parent company of Marshall Savings Bank. Accordingly, MSB Financial was merged with and into Monarch Community Bancorp, Inc. On June 7, 2004, Marshall Savings Bank was merged with and into Monarch Community Bank. The Company issued a total of 310,951 shares of its common stock and paid cash of $19.7 million to former MSB Financial stockholders. The cash paid in the transaction came from the Company’s existing liquidity. The acquisition was accounted for using the purchase method of accounting, and accordingly, the purchase price was allocated to the assets purchased and the liabilities assumed based upon the estimated fair values at the date of acquisition. The purchase accounting fair value adjustments are being amortized under various methods and over the lives of the corresponding assets and liabilities. Goodwill recorded for the acquisition amounted to $9.6 million and is not amortized but evaluated for impairment at least annually. A core deposit intangible of $2.1 million was recorded as part of the acquisition and is being amortized on an accelerated basis over a period of 9.5 years.
Monarch Community Bank provides a broad range of banking services to its primary market area of Branch, Calhoun and Hillsdale counties, Michigan. The Bank owns 100% ownership of First Insurance Agency. First Insurance Agency is a licensed insurance agency established to allow for the receipt of fees on insurance services provided to the Bank’s customers. The Bank also owns a 24.98% interest in a limited partnership formed to construct and operate multi-family housing units. Community Services Group, Inc. with assets totaling $996,000 as of April 30, 2006 was dissolved with no gain or loss on the dissolution.
On June 3, 2006, the Company completed the conversion of the Bank from a federally chartered stock savings institution to a Michigan state chartered commercial bank. As a result of the conversion, the Company became a federal bank holding company regulated by the Board of Governors of the Federal Reserve. The Bank will be regulated by the Michigan Office of Financial and Insurance Services (“OFIS”) and the Federal Deposit Insurance Corporation (“FDIC”). Prior to the conversion, both the Company and the Bank had been regulated by the federal Office of Thrift Supervision. The Bank’s deposits continue to be insured to the maximum extent allowed by the Federal Deposit Insurance Corporation (“FDIC”). The Bank has a website at http://www.monarchcb.com. References in this Form 10-K to “we”, “us”, and “our” refer to the Company and/or the Bank as the context requires. Our common stock trades on The NASDAQ Capital Market under the symbol “MCBF.”
Our principal business consists of attracting retail deposits from the general public and investing those funds primarily in permanent loans secured by first mortgages on owner-occupied, one-to-four family residences, loans secured by commercial and multi-family real estate, commercial business loans and construction loans secured primarily by residential real estate. We also originate home equity loans and a variety of consumer loans. Our originations of consumer loans has steadily declined over the last five years.
Our revenues are derived principally from interest on loans, investment securities and overnight deposits, as well as from sales of loans and fees and charges on deposit accounts.
We offer a variety of deposit accounts having a wide range of interest rates and terms, which generally include passbook and statement savings accounts, money market deposit accounts, interest bearing and non-interest bearing checking accounts and certificates of deposit with varied terms ranging from six months to 60 months. We solicit deposits in our market area and utilize brokered deposits.
At December 31, 2007, we had assets of $279.2 million, including net loans of $224.8, deposits of $177.9 million and stockholders’ equity of $39.1 million.
Forward-Looking Statements
This document, including information incorporated by reference, future filings by Monarch Community Bancorp on Form 10-Q and Form 8-K and future oral and written statements by Monarch Community Bancorp and its management may contain forward-looking statements which are based on assumptions and describe future plans, strategies and expectations of Monarch Community Bancorp and Monarch. These forward-looking statements are generally identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar words. Our ability to predict results or the actual effect of future plans or strategies is uncertain and we disclaim any obligation to update or revise any forward-looking statements based on the occurrence of future events, the receipt of new information or otherwise. Factors which could have a material adverse effect on our operations include, but are not limited to, changes in interest rates, changes in the relative difference between short and long-term interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, including levels of non-performing assets, demand for loan products, deposit flows, competition, demand for financial services in our market area, our operating costs and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and you should not rely too much on these statements.
Employees
The Bank employs 80 full-time and 5 part-time employees as of December 31, 2007. The holding company does not have any employees.
Market Area
Headquartered in Coldwater, Michigan, our geographic market area for loans and deposits is principally Branch, Calhoun and Hillsdale counties. As of June 30, 2007, we had an 18.6% market share of FDIC-insured deposits in Branch County, a 5.7% market share of FDIC-insured deposits in Calhoun County and a 3.0% market share of FDIC-insured deposits in Hillsdale County, ranking us third, seventh and sixth, respectively, in those counties among all insured depository institutions.
The local economy is based primarily on manufacturing and agriculture. Most of the job growth, particularly in Hillsdale County, has been in automobile products-related manufacturing. Median household income and per capita income for our primary market are below statewide averages, reflecting the rural economy and limited economic growth opportunities.
Lending Activities
General. At December 31, 2007, our net loan portfolio totaled $224.8 million, which constituted 80.5% of our total assets.
Our mortgage loans carry either a fixed or an adjustable rate of interest. Mortgage loans are generally long-term and amortize on a monthly basis with principal and interest due each month. Mortgage loans up to $300,000 may be approved by certain loan officers and loans up to $500,000 may be approved by the President, within individual lending limits set by the Board of Directors. Loans up to $1.5 million may be approved by the Management Loan Committee which is comprised of several senior managers. Loans over $1.5 million must be approved by the Board of Directors’ Loan Committee. Applications for loans that would be considered sub-prime cannot be approved by individual loan officers and must be presented to the Management Loan Committee for review and approval. Our legal lending limit is summarized in the Loans to One Borrower paragraph of the Regulation and Supervision section of this document.
Loan Portfolio Composition. The following table presents information concerning the composition of our loan portfolio as of the dates indicated.
The following table shows the composition of our loan portfolio by fixed and adjustable-rate at the dates indicated.
The following table illustrates the contractual maturity of our loan portfolio at December 31, 2007. Mortgages which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. The table does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.
The total amount of loans due after December 31, 2008 which have predetermined interest rates is $141.9 million while the total amount of loans due after such date which have floating or adjustable rates is $69.3 million.
One-to-Four Family Residential Real Estate Lending. We have focused our lending efforts primarily on the origination of loans secured by first mortgages on owner-occupied, one-to-four family residences in our market area. At December 31, 2007, one-to-four family residential mortgage loans totaled $126.8 million, or 55.8% of our gross loan portfolio.
We have originated sub-prime residential mortgage loans since 1985. However in more recent years we have moved away from this type of lending due to the higher risk associated with it. Our definition of sub-prime lending is substantially similar to regulatory guidelines. We review a borrower’s credit score, debt-to-income ratio and the loan-to-value ratio of the collateral in determining whether a loan is sub-prime. We utilize a loan risk grading system for all one-to-four family residential loans. The risk grading system provides that all loans with a credit score of less than 660 shall be considered for potential sub-prime classification. For a loan with a credit score between 600 and 660, loan-to-value ratio, debt-to-income ratio and the borrower’s history with the Bank will determine whether or not the loan is classified as sub-prime.
At December 31, 2007, $14.6 million, or 11.6% of our residential mortgage loans were classified as sub-prime loans as compared to $15.6 million, or 11.1% at December 31, 2006. The decrease was primarily due to management’s efforts to reduce these types of loans in our portfolio. We charge higher interest rates on our sub-prime residential mortgage loans to attempt to compensate for the increased risk in these loans. Sub-prime lending entails a higher risk of delinquency, foreclosure and ultimate loss than residential loans made to more creditworthy borrowers. Delinquencies, foreclosure and losses generally increase during economic slowdowns or recessions as experienced in recent history. During 2007, $284,000, or 23.7%, of our total net charge-offs of $1.2 million were due to sub-prime loans as compared to $183,000, or 20.3% of our total net charge-offs of $901,000 for 2006. See “Asset Quality.”
We generally underwrite our one-to-four family loans based on the applicant’s employment and credit history and the appraised value of the subject property. Presently, we lend up to 103% of the lesser of the appraised value or purchase price for one-to-four family residential loans. For loans with a loan-to-value ratio in excess of 89%, we generally require private mortgage insurance to reduce our credit exposure below 80%. Properties secured by one-to-four family loans are appraised by licensed appraisers. We obtain title insurance and require our borrowers to obtain hazard insurance and flood insurance, if necessary, in an amount not less than the value of the property improvements.
We currently originate one-to-four family mortgage loans on either a fixed rate or adjustable rate basis, as consumer demand dictates. Our pricing strategy for mortgage loans includes setting interest rates that are competitive with secondary market requirements and other local financial institutions, and consistent with our asset/liability strategies. Our pricing for sub-prime loans is higher, as we attempt to offset the increased risks and costs involved in dealing with a greater percentage of delinquencies and foreclosures.
Adjustable-rate mortgages, or ARM loans, are offered with either a one-year, three-year, five-year or seven-year term to the initial repricing date. After the initial period, the interest rate for each ARM loan adjusts annually for the remaining term of the loan. During the years ended December 31, 2007 and December 31, 2006, we originated $1.8 million and $6.8 million of one-to-four family ARM loans, respectively, and $40.0 million and $46.8 million of one-to-four family fixed-rate mortgage loans, respectively.
Fixed-rate loans secured by one-to-four family residences have contractual maturities of up to 30 years, and are generally fully amortizing, with payments due monthly. These loans normally remain outstanding, however, for a substantially shorter period of time because of refinancing and other prepayments. A significant change in the current level of interest rates could alter the average life of a residential loan in our portfolio considerably. Our one-to-four family loans are generally not assumable, do not contain prepayment penalties and do not permit negative amortization of principal. Most are written using secondary market underwriting guidelines, although we retain in our portfolio those loans which do not qualify for sale in the secondary market. Our real estate loans generally contain a “due on sale” clause allowing us to declare the unpaid principal balance due and payable upon the sale of the security property.
Our one-to-four family residential ARM loans are fully amortizing loans with contractual maturities of up to 30 years, with payments due monthly. Our ARM loans generally provide for a maximum 2% annual adjustment and 6% lifetime adjustment to the initial rate. As a consequence of using caps, the interest rates on these loans may not be as rate sensitive as is our cost of funds.
In order to remain competitive in our market area, we may originate ARM loans at initial rates below the fully indexed rate, although that has not been a strategy in recent years.
ARM loans generally pose different credit risks than fixed-rate loans, primarily because as interest rates rise, the borrower’s payment rises, increasing the potential for default. In past periods of rising interest rates, we have not experienced difficulty with the payment history for these loans. See “- Asset Quality - Non-performing Assets and Classified Assets.”
Multi-family and Commercial Real Estate Lending. We offer a variety of multi-family and commercial real estate loans. These loans are secured primarily by residential rental properties, commercial properties, retail establishments, churches and small office buildings located in our market area. At December 31, 2007, multi-family and commercial real estate loans totaled $62.3 million or 27.4% of our gross loan portfolio.
Our loans secured by multi-family and commercial real estate are originated with either a fixed or variable interest rate. The interest rate on variable-rate loans is based on the Wall Street Journal prime rate plus or minus a margin, generally determined through negotiation with the borrower. Loan-to-value ratios on our multi-family and commercial real estate loans typically do not exceed 80% of the appraised value of the property securing the loan. These loans which are typically balloon loans, in general require monthly payments, may not be fully amortizing and have maximum maturities of 25 years.
Loans secured by multi-family and commercial real estate are underwritten based on the income producing potential of the property and the financial strength of the borrower. We generally require personal guarantees of the principals of the borrower in addition to the security property as collateral for these loans. When legally permitted, we require an assignment of rents or leases in order to be assured that the cash flow from the project will be used to repay the debt. Appraisals on properties securing multi-family and commercial real estate loans are generally performed by independent state licensed fee appraisers approved by the Board of Directors. See “- Loan Originations, Purchases, Sales and Repayments.”
We do not generally maintain an insurance escrow account for loans secured by multi-family and commercial real estate, although we may maintain a tax escrow account for these loans. In order to monitor the adequacy of cash flows on income-producing properties, the borrower is requested or required to provide periodic financial information.
Loans secured by multi-family and commercial real estate properties are generally larger and involve a greater degree of credit risk than one-to-four family residential mortgage loans. These loans typically involve large balances to single borrowers or groups of related borrowers. Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation or management of the properties, repayment may be subject to adverse conditions in the real estate market or the economy. If the cash flow from the project is reduced, or if leases are not obtained or renewed, the borrower’s ability to repay the loan may be impaired. See “- Asset Quality - Non-performing Loans.”
Construction and Land Development Lending. We make construction loans to builders and to individuals for the construction of their residences as well as to businesses and individuals for commercial real estate construction projects. At December 31, 2007, we had $6.4 million in construction and land development loans outstanding, representing 2.8% of our gross loan portfolio.
Construction and land development loans are obtained through continued business with builders who have previously borrowed from us, from walk-in customers and through referrals from realtors and other customers. The application process includes submission of plans, specifications and costs of the project to be constructed. These items are used as a basis to determine the appraised value of the subject property. Loans are based on the lesser of current appraised value and/or the cost of construction, including the land and the building. We generally conduct regular inspections of the construction project being financed. During the construction phase, the borrower generally pays interest only on a monthly basis. Loan-to-value ratios on our construction and development loans typically do not exceed 80% of the appraised value of the project on an as completed basis, although the Board of Directors has made limited exceptions to this policy where special circumstances exist.
Because of the uncertainties inherent in estimating construction and development costs and the market for the project upon completion, it is relatively difficult to evaluate accurately the total loan funds required to complete a project, the related loan-to-value ratios and the likelihood of ultimate success of the project. These loans also involve many of the same risks discussed above regarding multi-family and commercial real estate loans and tend to be more sensitive to general economic conditions than many other types of loans.
Consumer and Other Lending. Consumer loans generally have shorter terms to maturity, which reduces our exposure to changes in interest rates, and carry higher rates of interest than do one-to-four family residential mortgage loans. In addition, management believes that offering consumer loan products helps to expand and create stronger ties to our existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities. At December 31, 2007, our consumer loan portfolio totaled $27.4 million, or 12.1% of our gross loan portfolio. We offer a variety of secured consumer loans, including home equity loans and lines of credit, auto loans, manufactured housing loans and loans secured by savings deposits, however the majority of new originations are home equity loans and lines of credit. We also offer a limited amount of unsecured loans including home improvement loans. We originate our consumer loans in our market area.
Our home equity lines of credit totaled $20.4 million, and comprised 9.0% of our gross loan portfolio at December 31, 2007. These loans may be originated in amounts, together with the amount of the existing first mortgage, of up to 100% of the value of the property securing the loan. The term to maturity on our home equity lines of credit ranges from 3 to 5 years for fixed rate loans and 1 to 15 for variable rate loans. No principal payments are required on home equity lines of credit during the loan term. Other consumer loan terms vary according to the type of collateral, length of contract and creditworthiness of the borrower.
Consumer loans may entail greater risk than do one-to-four family residential mortgage loans, particularly in the case of consumer loans which are secured by rapidly depreciable assets, such as automobiles, boats, and manufactured housing. In these cases, any repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. As a result, consumer loan collections are dependent on the borrower’s continuing financial stability and, thus, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.
Commercial Business Lending. At December 31, 2007, commercial business loans comprised $4.2 million, or 1.8% of our gross loan portfolio. Most of our commercial business loans have been extended to finance local businesses and include short term loans to finance machinery and equipment purchases, inventory and accounts receivable. Commercial business loans also involve the extension of revolving credit for a combination of equipment acquisitions and working capital needs.
The terms of loans extended on the security of machinery and equipment are based on the projected useful life of the machinery and equipment, generally not to exceed seven years. Operating lines of credit generally are available to borrowers for up to 12 months, and may be renewed by Monarch. We issue a few standby letters of credit which are offered at competitive rates and terms and are generally issued on a secured basis. At December 31, 2007, there was a $16,000 financial standby letter of credit outstanding.
Our commercial business lending policy includes credit file documentation and analysis of the borrower’s background, capacity to repay the loan, the adequacy of the borrower’s capital and collateral as well as an evaluation of other conditions affecting the borrower. Analysis of the borrower’s past, present and future cash flows is also an important aspect of our credit analysis. Based on this underwriting information
we assign a risk rating which assists management in evaluating the quality of the loan portfolio. We generally obtain personal guarantees on our commercial business loans. Nonetheless, these loans are believed to carry higher credit risk than more traditional single family loans.
Unlike residential mortgage loans, commercial business loans are typically made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself (which, in turn, is often dependent in part upon general economic conditions). Our commercial business loans are usually, but not always, secured by business assets. However, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business.
Loan Originations, Purchases, Sales and Repayments. We originate loans through referrals from real estate brokers and builders and other customers, our marketing efforts, and our existing and walk-in customers. While we originate adjustable-rate and fixed-rate loans, our ability to originate loans is dependent upon customer demand for loans in our market area. Demand is affected by local competition and the interest rate environment.
During the last several years up to 2007, due to low market interest rates, our dollar volume of fixed-rate, one-to-four family loans has substantially exceeded the dollar volume of the same type of adjustable-rate loans. Adjustable-rate loan originations as a percentage of total originations were 14.8% and 16.7% in 2007 and 2006 respectively. We sell a significant portion of the conforming, fixed-rate, one-to-four family residential loans we originate, primarily those with lower interest rates. We keep the sub-prime residential real estate loans we originate. We may purchase residential loans and commercial real estate loans from time to time.
In periods of economic uncertainty, the ability of financial institutions, including us, to originate or purchase large dollar volumes of real estate loans may be substantially reduced or restricted, with a resultant decrease in income.
The following table shows the loan origination, sale and repayment activities of Monarch for the periods indicated.
Asset Quality
When a borrower fails to make a payment on a residential mortgage loan on or before the due date, a late notice is mailed 10 to 15 days after the due date. All delinquent accounts are reviewed by a collector, who attempts to cure the delinquency by contacting the borrower once the loan is 30 days past due. Additionally, each week the collections department gives each loan officer a list of his or her loans that are 30 days past due. The loan officer attempts to contact the borrower to determine the reason for the delinquency and to urge the borrower to bring the loan current. Once the loan becomes 45 days delinquent, a letter is sent to the borrower requesting the borrower to bring the loan current, or, if that is not possible, to fill out and return a financial information update form. If the form is returned, the senior collector determines if the borrower exhibits an ability to repay, and, if so, brings the file to the Delinquency Committee for a decision whether to forbear collection action to allow the borrower to demonstrate the ability to make timely payments and/or establish an acceptable repayment plan to bring the loan current. If the borrower makes timely payments for a period of at least six months but does not appear to have the ability to bring the loan current, the file is given to a loan officer to obtain a new loan application from the borrower for the purpose of rewriting the loan in accordance with established loan policy. If the financial information update is not returned, or if the senior collector determines that the borrower no longer has the ability to repay the loan, or the Delinquency Committee declines to forbear collection activity, then when the loan becomes 60 days delinquent, the file is reviewed by the Delinquency Committee and the foreclosure process is begun by the sending of a notice of intent to foreclose. If during a period of forbearance the borrower fails to make timely payments, the Delinquency Committee reviews the loan and the foreclosure process commences unless extenuating circumstances exist. The notice of intent to foreclose allows the borrower up to 30 days to bring the account current. All loans over 60 days delinquent are handled by the senior collections officer until the delinquency is resolved or foreclosure occurs.
For consumer loans a similar collection process is followed. Follow-up contacts are generally on an accelerated basis compared to the mortgage loan procedure due to the nature of the collateral. Commercial loan collections are handled by our Delinquency Committee in conjunction with our Collection Department and the appropriate loan officer. The nature of these loans dictates that collection procedures are adjusted to suit each situation.
Delinquent Loans. The following tables set forth our loan delinquencies (60 days past due and over) by type, number, amount and percentage of type at the dates indicated:
Non-performing Assets. The table below sets forth the amounts and categories of the Bank’s non-performing assets. Loans are placed on non-accrual status when the loan is seriously delinquent and there is serious doubt that the Bank will collect all interest owing. Generally, all loans past due at least 90 days are placed on non-accrual status. For all years presented, the Bank had no troubled debt restructurings that involved forgiving a portion of interest or principal on any loans or making loans at a rate materially less than that of market rates. Foreclosed assets include assets acquired in settlement of loans.
For the years ended December 31, 2007, 2006 and 2005, respectively, there was $89,000, $60,000, and $200,000 of gross interest income which would have been recorded had non-accruing loans been current in accordance with their original terms.
Classified Assets. Federal regulations provide for the classification of loans, foreclosed and repossessed assets and other assets, such as debt and equity securities considered by the FDIC and OFIS to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added
characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted.
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances for loan losses in an amount deemed prudent by management and approved by the board of directors. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the FDIC and OFIS, which may order the establishment of additional general or specific loss allowances.
In accordance with our classification of assets policy, we regularly review the problem assets in our portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of management’s review of our assets, at December 31, 2007, we had classified $2.8 million of our assets as substandard, none as doubtful and none as loss. The total amount classified as substandard represented 7.3% of the Bank’s equity capital and 1.0% of the Bank’s assets at December 31, 2007. The allowance for loan losses at December 31, 2007 includes $368,000 related to substandard loans. At December 31, 2007, $2.4 million and $0 of substandard and doubtful assets, respectively, have been included in the table of non-performing assets. See “- Asset Quality - Delinquent Loans.”
Provision for Loan Losses. We recorded a provision for loan losses totaling $971,000 million for the year ended December 31, 2007 compared to $0 recorded for the year ended December 31, 2006. The provision for loan losses is charged to income to establish the allowance for loan losses to cover all known and inherent losses in the loan portfolio that are both probable and reasonable to estimate based on the factors discussed below under “Allowance for Loan Losses.” See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Comparison of Operating Results for the Years Ended December 31, 2007 and 2006 - Provision for Loan Losses” for a discussion of the reasons for the change in our loan loss provision.
Allowance for Loan Losses. The allowance is based on regular, quarterly assessments of the estimated losses inherent in the loan portfolio. Our methodology for assessing the appropriateness of the allowance consists of several key elements, which include the formula allowance and specific allowances for identified problem loans and portfolio segments. In addition, the allowance incorporates the results of measuring impaired loans as provided in SFAS No. 114, “Accounting by Creditors for Impairment of a Loan” and SFAS No. 118, “Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.” These accounting standards prescribe the measurement methods, income recognition and disclosures related to impaired loans.
The formula allowance is calculated by applying loss factors to outstanding loans based on the internal risk evaluation of these loans or pools of loans. Changes in risk evaluations of both performing and nonperforming loans affect the amount of the formula allowance. Loss factors are based both on our historical loss experience as well as on significant factors that, in management’s judgment, affect the collectibility of the portfolio as of the evaluation date.
The appropriateness of the allowance is reviewed by management based upon our evaluation of then-existing economic and business conditions affecting our key lending areas and other conditions, such as credit quality trends (including trends in delinquencies, nonperforming loans and foreclosed assets expected to result from existing conditions), collateral values, loan volumes and concentrations, specific industry conditions within portfolio segments and recent loss experience in particular segments of the portfolio that existed as of the balance sheet date and the impact that such conditions were believed to have had on the collectibility of the loan.
Senior management reviews these conditions quarterly. To the extent that any of these conditions is evidenced by a specifically identifiable problem credit or portfolio segment as of the evaluation date, management’s estimate of the effect of this condition may be reflected as a specific allowance applicable to this credit or portfolio segment.
The allowance for loan losses is based on estimates of losses inherent in the loan portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology as described permits adjustments to any loss factor used in the computation of the formula allowance in the event that, in management’s judgment, significant factors which affect the collectibility of the portfolio as of the evaluation date are not reflected in the loss factors. By assessing the estimated losses inherent in the loan portfolio on a quarterly basis, we are able to adjust specific and inherent loss estimates based upon any more recent information that has become available.
Assessing the adequacy of the allowance for loan losses is inherently subjective as it requires making material estimates, including the net realizable value of collateral expected to be received on impaired loans that may be susceptible to significant change. In the opinion of management, the allowance, when taken as a whole, covers all known and inherent losses in the loan portfolio that are both probable and reasonable to estimate.
The following table summarizes activity in the allowance for loan losses for the years ending (000s omitted):
The distribution of our allowance for losses on loans at the dates indicated is summarized as follows:
Investment Activities
Commercial banks have the authority to invest in various types of liquid assets, including United States Treasury obligations and securities of various federal agencies, including callable securities, certain certificates of deposit of insured banks and savings institutions, certain bankers’ acceptances, repurchase agreements and federal funds. Subject to various restrictions, state chartered commercial banks may also invest their assets in investment grade commercial paper and corporate debt securities and mutual funds whose assets conform to the investments that a state chartered commercial banks is otherwise authorized to make directly.
The President/CEO has the basic responsibility for the management of our investment portfolio, under the guidance of the asset and liability management committee. The President/CEO considers various factors when making decisions, including the marketability, maturity and tax consequences of the proposed investment. The maturity structure of investments will be affected by various market conditions, including the current and anticipated slope of the yield curve, the level of interest rates, the trend of new deposit inflows, and the anticipated demand for funds via deposit withdrawals and loan originations and purchases.
The general objectives of our investment portfolio are to provide liquidity when loan demand is high, to assist in maintaining earnings when loan demand is low and to maximize earnings while satisfactorily managing risk, including credit risk, reinvestment risk, liquidity risk and interest rate risk. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Asset and Liability Management and Market Risk.”
Our investment portfolio consists of U.S. government agency securities, municipal bonds and overnight deposits. This provides us with flexibility and liquidity. We also have a limited amount of mortgage-backed securities. See Note 3 of the Notes to Consolidated Financial Statements.
The following table sets forth the composition of our securities portfolio at the dates indicated (dollars in thousands):
The maturities of the investment securities portfolio, excluding FHLB stock, as of December 31, 2007 are indicated in the following table:
Sources of Funds
General. Our sources of funds are deposits, borrowings, receipt of principal and interest on loans, interest earned on or maturation of investment securities and overnight funds and funds provided from operations.
Deposits. We offer a variety of deposit accounts to both consumers and businesses having a wide range of interest rates and terms. Our deposits consist of passbook and statement savings accounts, money market deposit accounts, NOW and demand accounts and certificates of deposit. We solicit deposits in our market area and have accepted and continue to utilize brokered deposits. At December 31, 2007, we had $34.2 million of brokered deposits. In our experience brokered deposits are an attractive and stable source of funds and are necessary to supplement our local market deposit gathering. However, brokered deposits may be less stable than local deposits if deposit brokers or investors lose confidence in us or find more attractive rates at other financial institutions. We primarily rely on competitive pricing policies, marketing and customer service to attract and retain these deposits.
The flow of deposits is influenced significantly by general economic conditions, changes in money market and prevailing interest rates and competition. The variety of deposit accounts we offer has allowed us to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. We have become more susceptible to short-term fluctuations in deposit flows, as customers have become more interest rate conscious. We try to manage the pricing of our deposits in keeping with our asset/liability management, liquidity and profitability objectives, subject to competitive factors. Based on our experience, we believe that our deposits are relatively stable sources of funds. Despite this stability, our ability to attract and maintain these deposits and the rates paid on them has been and will continue to be significantly affected by market conditions.
The following table sets forth our deposit flows during the periods indicated:
The following table sets forth the dollar amount of savings deposits in the various types of deposit programs offered by Monarch at the dates indicated:
The following table indicates the amount of our certificates of deposit by time remaining until maturity as of December 31, 2007:
The following table shows rate and maturity information for our certificates of deposit as of December 31, 2007:
Borrowings. Although deposits are our primary source of funds, we utilize borrowings when they are a less costly source of funds, when we desire additional capacity to fund loan demand or when they meet our asset/liability management goals. Our borrowings historically have consisted of advances from the Federal Home Loan Bank of Indianapolis.
We may obtain advances from the Federal Home Loan Bank of Indianapolis upon the security of certain of our mortgage loans and investment securities. These advances may be made pursuant to several different credit programs, each of which has its own interest rate, range of maturities and call features. At December 31, 2007, we had $59.3 million in Federal Home Loan Bank advances outstanding. See Note 9 of the Notes to Consolidated Financial Statements for information on maturity dates and interest rates related to our Federal Home Loan Bank advances.
The following table sets forth the maximum month-end balance and average balance of Federal Home Loan Bank advances for the periods indicated:
The following table sets forth certain information concerning our borrowings at the dates indicated.
Competition
We face strong competition in originating real estate and other loans and in attracting deposits. Competition comes from a wide array of sources including but not limited to mortgage brokers, savings institutions, other commercial banks, and credit unions including non-local Internet based and telephone-based competition.
Employees
At December 31, 2007, we had a total of 80 employees, including 5 part-time employees. Our employees are not represented by any collective bargaining group. Management considers its employee relations to be good.
Federal and State Taxation
Federal Taxation
General. The Company is subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not a comprehensive description of the tax rules applicable to Monarch Community Bancorp. Our federal income tax returns for the past three years are open to audit by the IRS. In our opinion, any examination of still open returns would not result in a deficiency which could have a material adverse effect on our financial condition. No federal income tax returns are being audited by the IRS at this time.
Method of Accounting. For federal income tax purposes, the Company reports its income and expenses on the accrual method of accounting and uses a fiscal year ending on December 31, for filing its federal income tax return.
Bad Debt Reserves. The Bank is on the experience method to determine its bad debt deduction for tax purposes. The Bank has made a conformity election and charges off bad debts for tax purposes in accordance with regulatory guidelines.
Taxable Distributions and Recapture. Prior to the Small Business Job Protection Act, bad debt reserves created prior to the year ended December 31, 1997, were subject to recapture into taxable income should the Bank fail to meet certain thrift asset and definitional tests. New federal legislation eliminated these thrift related recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should the Bank make certain non-dividend distributions or cease to maintain a bank charter.
Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, called alternative minimum taxable income. The alternative minimum tax is payable to the extent such alternative minimum taxable income is in excess of an exemption amount. Net operating losses can offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. The Bank has not been subject to the alternative minimum tax, nor do we have any such amounts available as credits for carryover.
Corporate Dividends-Received Deduction. Monarch Community Bancorp may eliminate from its income dividends received from the Bank if it elects to file a consolidated return with the Bank. The corporate dividends-received deduction is 100% or 80%, in the case of dividends received from corporations with which a corporate recipient does not file a consolidated tax return, depending on the level of stock ownership of the payor of the dividend. Corporations which own less than 20% of the stock of a corporation distributing a dividend may deduct 70% of dividends received or accrued on their behalf. Monarch Community Bancorp has elected to file a consolidated return with the Bank.
State Taxation
Monarch Community Bancorp and Monarch Community Bank were subject to the Michigan Single Business Tax (SBT) until December 31, 2007 when it was repealed. The Michigan Business Tax (MBT) replaces the SBT and is effective as of January 1, 2008. The MBT is a consolidated tax based on equity of the corporation. Monarch Community Bank does not anticipate a material impact from the change to the MBT. The tax returns of the Bank for the past four years are open to audit by the Michigan taxation authorities. No returns are being audited by the Michigan taxation authority at the current time. Other applicable state taxes include generally applicable sales, use, real property taxes, and personal property taxes.
Regulation and Supervision
General
The growth and earnings performance of the Company and the Bank can be affected not only by management decisions and general economic conditions, but also by the policies of various governmental regulatory authorities including, but not limited to, the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (the “FDIC”), the Michigan Office of Financial and Insurance Services (the “OFIS”), the Internal Revenue Service and state taxing authorities. Financial institutions and their holding companies are extensively regulated under federal and state law. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty.
Federal and state laws and regulations generally applicable to financial institutions, such as the Company and the Bank, regulate, among other things, the scope of business, investments, reserves against deposits, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, mergers, consolidations and dividends. The system of supervision and regulation applicable to the Company and the Bank establishes a comprehensive framework for their respective operations and is intended primarily for the protection of the FDIC’s deposit insurance funds and the depositors, rather than the shareholders, of financial institutions.
The Company’s common stock is registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Therefore, the Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements of the Securities and Exchange Commission under the Exchange Act.
The Company’s common stock held by persons who are affiliates (generally officers, directors and principal stockholders) of the Company may not be resold without registration unless sold in accordance with certain resale restrictions. If the Company meets specified current public information requirements, each affiliate of the Company is able to sell in the public market, without registration, a limited number of shares in any three-month period.
The following references to material statutes and regulations affecting the Company and the Bank are brief summaries and do not purport to be complete, and are qualified in their entirety by reference to such statues and regulations. Any change in applicable law or regulations may have a material effect on the business of the Company and the Bank.
The Company
General. The Company, as the sole shareholder of the Bank, is a bank holding company. As a bank holding company, the Company is required to register with, and is subject to regulation by, the Federal Reserve under the Bank Holding Company Act, as amended (the “BHCA”). In accordance with Federal Reserve policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Company might not do so absent such policy. Under the BHCA, the Company is subject to periodic examination by the Federal Reserve and is required to file periodic reports of its operations and such additional information as the Federal Reserve may require.
Investments and Activities. Under the BHCA, a bank holding company must obtain Federal Reserve approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company. The Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States without regard to geographic restrictions or reciprocity requirements imposed by state law, but subject to certain conditions, including limitations on the aggregate amount of deposits that may be held by the acquiring holding company and all of its insured depository institution affiliates.
The BHCA limits the activities of a bank holding company that has not qualified as a financial holding company to banking and the management of banking organizations, and to certain non-banking activities. These non-banking activities include those activities that the Federal Reserve found, by order or regulation as of the day prior to enactment of the Gramm-Leach-Bliley Act (the “GLB Act”) on November 11, 1999, to be so closely related to banking or managing or controlling banks as to be a proper incident to those activities.
Such non-banking activities include, among other things: operating a mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, nonoperating basis; and providing securities brokerage services for customers.
A bank holding company whose subsidiary depository institutions all are well-capitalized and well-managed and who have Community Reinvestment Act ratings of at least “satisfactory” may elect to become a financial holding company. A financial holding company is permitted to engage in a broader range of activities than are permitted to bank holding companies.
Those expanded activities include any activity which the Federal Reserve (in certain instances in consultation with the Department of the Treasury) determines, by order or regulation, to be financial in nature or incidental to such financial activity, or to be complementary to a financial activity and not to pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. Such expanded activities include, among others: insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability or death, or issuing annuities, and acting as principal, agent, or broker for such purposes; providing financial, investment, or economic advisory services, including advising a mutual fund; and underwriting, dealing in, or making a market in securities.
Federal law also prohibits the acquisition of control of a bank holding company, such as the Company, by a person or a group of persons acting in concert, without prior notice to the Federal Reserve. Control is defined in certain cases as the acquisition of 10% of the outstanding shares of a bank holding company.
Capital Requirements. The Federal Reserve uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guideline levels, a bank holding company may, among other things, be denied approval to acquire or establish additional banks or non-bank businesses.
The Federal Reserve capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: a risk-based requirement expressed as a percentage of total risk-weighted assets, and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least 4% must be Tier I capital (which consists principally of shareholders’ equity). The leverage requirement consists of a minimum ratio of Tier I capital to total assets of 3% for the most highly rated bank holding companies, with minimum requirements of 4% to 5% for all others.
The risk-based and leverage standards presently used by the Federal Reserve are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier I capital less all intangible assets), well above the minimum levels.
The Bank
General. The Bank is a Michigan state-chartered bank, the deposit accounts of which are insured by the FDIC. As a state-chartered non-member bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the OFIS, as the chartering authority for state banks, and the FDIC, as administrator of the deposit insurance fund, and to the statutes and regulations administered by the OFIS and the FDIC governing such matters as capital standards, mergers, establishment of branch offices, subsidiary investments and activities and general investment authority. The Bank is required to file reports with the OFIS and the FDIC concerning its activities and financial condition and is required to obtain
regulatory approvals prior to entering into certain transactions, including mergers with, or acquisitions of, other financial institutions.
Business Activities. The Bank’s activities are governed primarily by Michigan’s Banking Code of 1999 (the “Banking Code”) and the Federal Deposit Insurance Act (“FDI Act”). The FDI Act, among other things, requires that federal banking regulators intervene promptly when a depository institution experiences financial difficulties; mandates the establishment of a risk-based deposit insurance assessment system; and requires imposition of numerous additional safety and soundness operational standards and restrictions. The GLB Act, which amended the FDI Act, among other things, loosens the restrictions on affiliations between entities engaged in certain financial, securities, and insurance activities; imposes restrictions on the disclosure of consumers’ nonpublic personal information; and institutes certain reforms of the Federal Home Loan Bank System.
The federal laws contain provisions affecting numerous aspects of the operation and regulation of federally insured banks and empower the FDIC, among other agencies, to promulgate regulations implementing their provisions.
Branching. State chartered banks have the authority under Michigan law to establish branches throughout Michigan and in any state, the District of Columbia, any U.S. territory or protectorate, and foreign countries, unless the OFIS objects in writing within 30 days after it receives notice of a bank’s intent to establish a branch.
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allows the FDIC and other federal bank regulators to approve applications for mergers of banks across state lines without regard to whether such activity is contrary to state law. However, each state can determine if it will permit out of state banks to acquire only branches of a bank in that state or to establish de novo branches.
Loans to One Borrower. Under Michigan law, a bank’s total loans and extensions of credit and leases to one borrower is limited to 15% of the bank’s capital and surplus, subject to several exceptions. This limit may be increased to 25% of the bank’s capital and surplus upon approval by a 2/3 vote of its board of directors. Certain loans, including loans secured by bonds or other instruments of the United States and fully guaranteed by the United States as to principal and interest, are not subject to the limit just referenced. In addition, certain loans, including loans arising from the discount of nonnegotiable consumer paper which carries a full recourse endorsement or unconditional guaranty of the person transferring the paper, are subject to a higher limit of 30% of capital and surplus. At December 31, 2007, the Bank’s legal lending limit for loans to one borrower was $4.7 million; the Bank’s legal lending limit with approval of two-thirds of the Board of Directors was $7.9 million.
Enforcement. The OFIS and FDIC each have enforcement authority with respect to the Bank. The Commissioner of the OFIS has the authority to issue cease and desist orders to address unsafe and unsound practices and actual or imminent violations of law and to remove from office bank directors and officers who engage in unsafe and unsound banking practices and who violate applicable laws, orders, or rules. The Commissioner of the OFIS also has authority in certain cases to take steps for the appointment of a receiver or conservator of a bank.
The FDIC has similar broad authority, including authority to bring enforcement actions against all “institution-affiliated parties” (including shareholders, directors, officers, employees, attorneys, consultants, appraisers and accountants) who knowingly or recklessly participate in any violation of law or regulation or any breach of fiduciary duty, or other unsafe or unsound practice likely to cause financial loss to, or otherwise have an adverse effect on, an insured institution. Civil penalties under federal law cover a wide range of violations and actions. Criminal penalties for most financial institution crimes include monetary fines and imprisonment. In addition, the FDIC has substantial discretion to impose enforcement action on banks that fail to comply with its regulatory requirements, particularly with respect to capital levels. Possible enforcement actions range from requiring the preparation of a capital plan or imposition of a capital directive, to receivership, conservatorship, or the termination of deposit insurance.
Assessments and Fees. The Bank pays a supervisory fee to the OFIS of not less than $1,000 and not more than 25 cents for each $1,000 of total assets. The fee incurred in 2007 was $26,000. This fee is invoiced prior to July 1 each year and is due no later than August 15. The OFIS imposes additional fees, in addition to those charged for normal supervision, for applications, special evaluations and analyses, and examinations.
Regulatory Capital Requirements. The Bank is required to comply with capital adequacy standards set by the FDIC. The FDIC may establish higher minimum requirements if, for example, a bank has previously received special attention or has a high susceptibility to interest rate risk. Banks with capital ratios below the required minimum are subject to certain administrative actions. More than one capital adequacy standard applies, and all applicable standards must be satisfied for an institution to be considered to be in compliance. There are three basic measures of capital adequacy: a total risk-based capital measure, a Tier 1 risk-based capital ratio; and a leverage ratio.
The risk-based framework was adopted to assist in the assessment of capital adequacy of financial institutions by, (i) making regulatory capital requirements more sensitive to differences in risk profiles among organizations; (ii) introducing off-balance-sheet items into the assessment of capital adequacy; (iii) reducing the disincentive to holding liquid, low-risk assets; and (iv) achieving greater consistency in evaluation of capital adequacy of major banking organizations throughout the world. The risk-based guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items to different risk categories. An institution’s risk-based capital ratios are calculated by dividing its qualifying capital by its risk-weighted assets.
Qualifying capital consists of two types of capital components: “core capital elements” (or Tier 1 capital) and “supplementary capital elements” (or Tier 2 capital). Tier 1 capital is generally defined as the sum of core capital elements less goodwill and other intangibles. Core capital elements consist of (i) common shareholders’ equity, (ii) noncumulative perpetual preferred stock (subject to certain limitations), and (iii) minority interests in the equity capital accounts of consolidated subsidiaries. Tier 2 capital consists of (i) allowance for loan and lease losses (subject to certain limitations); (ii) perpetual preferred stock which does not qualify as Tier 1 capital (subject to certain conditions); (iii) hybrid capital instruments and mandatory convertible debt securities; (iv) term subordinated debt and intermediate term preferred stock (subject to limitations); and (v) net unrealized holding gains on equity securities.
Under current capital adequacy standards, the Bank must meet a minimum ratio of qualifying total capital to risk-weighted assets of 8%. Of that ratio, at least half, or 4%, must be in the form of Tier 1 capital.
The Bank must also meet a leverage capital requirement. In general, the minimum leverage capital requirement is not less than 3% Tier 1 capital to total assets if the bank has the highest regulatory rating and is not anticipating or experiencing any significant growth. All other banks should have a minimum leverage capital ratio of 100 to 200 basis points higher and thus a minimum leverage capital ratio of not less than 4%.
Prompt Corrective Regulatory Action. The FDIC is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization. Generally, a bank is considered “well capitalized” if its risk-based capital ratio is at least 10%, its Tier 1 risk-based capital ratio is at least 6%, its leverage ratio is at least 5%, and the bank is not subject to any written agreement, order, or directive by the FDIC.
A bank generally is considered “adequately capitalized” if it does not meet each of the standards for well-capitalized institutions, and its risk-based capital ratio is at least 8%, its Tier 1 risk-based capital ratio is at least 4%, and its leverage ratio is at least 4% (or 3% if the institution receives the highest rating under the Uniform Financial Institution Rating System). A bank that has a risk-based capital ratio less than 8%, or a Tier 1 risk-based capital ratio less than 4%, or a leverage ratio less than 4% (3% or less for institutions with the highest rating under the Uniform Financial Institution Rating System) is considered to be “undercapitalized”. A bank that has a risk-based capital ratio less than 6%, or a Tier 1 capital ratio less than 3%, or a leverage ratio less than 3% is considered to be “significantly undercapitalized,” and a bank is considered “critically undercapitalized” if its ratio of tangible equity to total assets is equal to or less than 2%.
Subject to a narrow exception, the FDIC is required to appoint a receiver or conservator for a bank that is “critically undercapitalized.” In addition, a capital restoration plan must be filed with the FDIC within 45 days of the date a bank receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Compliance with the plan must be guaranteed by each company that controls a bank that submits such a plan, up to an amount equal to 5% of the bank’s assets at the time it was notified regarding its deficient capital status. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring
by regulators and restrictions on growth, capital distributions, and expansion. The FDIC could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Deposit Insurance. The Bank’s deposits are insured up to applicable limitations by a deposit insurance fund administered by the FDIC. Following the adoption of the Federal Deposit Insurance Reform Act of 2005, the FDIC has the opportunity, through its rulemaking authority, to better price deposit insurance for risk than was previously authorized. The FDIC adopted regulations effective January 1, 2007 that create a new system of risk-based assessments. Under the regulations there are four risk categories, and each insured institution will be assigned to a risk category based on capital levels and supervisory ratings. Well-capitalized institutions with CAMELS composite ratings of 1 or 2 will be placed in Risk Category I while other institutions will be placed in Risk Categories II, III or IV depending on their capital levels and CAMELS composite ratings. The current assessment rates established by the FDIC provide that the highest rated institutions, those in Risk Category I will pay premiums of between .05% and .07% of deposits and the lowest rated institutions, those in Risk Category IV will pay premiums of .43% of deposits. The assessment rates may be changed by the FDIC as necessary to maintain the insurance fund at the reserve ratio designated by the FDIC, which currently is 1.25% of insured deposits. The FDIC may set the reserve ratio annually at between 1.15% and 1.50% of insured deposits. Deposit insurance assessments will be collected for a quarter at the end of the next quarter. Assessments will be based on deposit balances at the end of the quarter, except for institutions with $1 billion or more in assets and any institution that becomes insured on or after January 1, 2007 which will have their assessment base determined using average daily balances of insured deposits.
Payment of Dividends by the Bank. There are state and federal requirements limiting the amount of dividends which the Bank may pay. Generally, a bank’s payment of cash dividends must be consistent with its capital needs, asset quality, and overall financial condition. Additionally, OFIS and the FDIC have the authority to prohibit the Bank from engaging in any business practice (including the payment of dividends) which they consider to be unsafe or unsound.
Under Michigan law, the payment of dividends is subject to several additional restrictions. The Bank cannot declare or pay a cash dividend or dividend in kind unless the Bank will have a surplus amounting to not less than 20% of its capital after payment of the dividend. The Bank will be required to transfer 10% of net income to surplus until its surplus is equal to its capital before the declaration of any cash dividend or dividend in kind. In addition, the Bank may pay dividends only out of net income then on hand, after deducting its losses and bad debts. These limitations can affect the Bank’s ability to pay dividends.
Loans to Directors, Executive Officers, and Principal Shareholders. Under FDIC regulations, the Bank’s authority to extend credit to executive officers, directors, and principal shareholders is subject to substantially the same restrictions set forth in Federal Reserve Regulation O. Among other things, Regulation O (i) requires that any such loans be made on terms substantially similar to those offered to nonaffiliated individuals, (ii) places limits on the amount of loans the Bank may make to such persons based, in part, on the Bank’s capital position, and (iii) requires that certain approval procedures be followed in connection with such loans.
Certain Transactions With Related Parties. Under Michigan law, the Bank may purchase securities or other property from a director, or from an entity of which the director is an officer, manager, director, owner, employee, or agent, only if such purchase (i) is made in the ordinary course of business, (ii) is on terms not less favorable to the Bank than terms offered by others, and (iii) the purchase is authorized by a majority of the board of directors not interested in the sale. The Bank may also sell securities or other property to its directors, subject to the same restrictions (except in the case of a sale by the Bank, the terms may not be more favorable to the director than those offered to others).
In addition, the Bank is subject to certain restrictions imposed by federal law on extensions of credit to the Company and its non-bank subsidiaries, on investments in the stock or other securities of the Company and its non-bank subsidiaries, and on the acceptance of stock or other securities of the Company or its non-bank subsidiaries as collateral for loans. Various transactions, including contracts, between the Bank and the Company or its non-bank subsidiaries must be on substantially the same terms as would be available to unrelated parties.
Standards for Safety and Soundness. The FDIC has established safety and soundness standards applicable to the Bank regarding such matters as internal controls, loan documentation, credit underwriting, interest-rate risk exposure, asset growth, compensation and other benefits, and asset quality and earnings. If the Bank were to fail to meet these standards, the FDIC could require it to submit a written compliance plan describing the steps the Bank will take to correct the situation and the time within which such steps will be taken. The FDIC has authority to issue orders to secure adherence to the safety and soundness standards.
Reserve Requirement. Under a regulation promulgated by the Federal Reserve, depository institutions, including the Bank, are required to maintain non-interest earning reserves against a stated percentage of their transaction accounts, as follows:
The effect of maintaining the required non-interest earning reserve is to reduce the Bank’s interest-earning assets.
ITEM 1A.
ITEM 1A. Risk Factors
You should consider these risk factors, in addition to the other information in this Form 10-K, before deciding whether to make an investment in our Company’s stock.
Our future profits may be affected by our inability to grow core deposits
We have had difficulty growing our core deposits. Competition in our market for core deposits is intense. Our net income is heavily dependent on net interest income. If we are unable to grow our core deposits, we will be required to obtain higher costing funds to facilitate asset growth. This could cause our future profits to be below peer.
We are making commercial real estate loans outside of our normal market area
In an attempt to grow our commercial real estate loan portfolio we consider it necessary in certain cases to make these loans outside of our normal market area. We have done this because competition for Commercial Real Estate loans in our local markets is intense. Lending outside of our normal market area may cause increased loan losses in the future if we lend in an area that we are not familiar with and that local economy suffers a recession.
We are dependent on the strength of our local economy for our growth and profitability
The success of our business depends on our ability to generate profits and grow our franchise. Our three county market area has a population base of approximately 231,000, and an economy based primarily on manufacturing and agriculture. Our local economy has not grown, and is not projected to grow as rapidly as the national economy. Job losses and unemployment rates in all three counties exceed the state and national averages.
Our loan portfolio possesses increased risk due to our subprime residential lending
Up until a few years ago, a significant portion of our one-to-four family residential loan originations were considered subprime. At December 31, 2007, $14.6 million of our residential mortgage loans were subprime loans. Historically, our foreclosure rates on our residential loan portfolio are higher than peer and we believe this is, to a significant extent, the result of our subprime residential lending and the economy in our market area. Future foreclosures will negatively impact profits because of higher loan loss provisions and expenses related to foreclosed properties.
ITEM 1A. Risk Factors, continued
If we lose our executive officers, it could adversely affect our operations
The successful operation of Monarch Community Bancorp and Monarch Community Bank is greatly dependent on the continued availability of capable executive officers. At present, the only executive officers of both Monarch Community Bancorp and Monarch Community Bank are Donald L. Denney, President and Chief Executive Officer, William C. Kurtz, Executive Vice President and Chief Operations Officer, Andrew Van Doren, Vice President, Secretary and Corporate Counsel, Rebecca S. Crabill, Vice President, Chief Financial Officer and Treasurer. We have entered into an employment agreement with Mr. Denney but not with the other executive officers. We do not have key man insurance on any of our executive officers.
The amount of common stock controlled by insiders, our articles of incorporation and bylaws and state and federal statutory and regulatory provisions could discourage hostile acquisitions of control
Purchases of common stock by directors and officers are for investment purposes and not necessarily for resale. Inside ownership of Monarch Community Bancorp (totaling 273,374 shares as of December 31, 2007) is significant and this inside ownership and provisions in our articles of incorporation and bylaws may have the effect of discouraging attempts to acquire Monarch Community Bancorp, a proxy contest for control of Monarch Community Bancorp, the assumption of control of Monarch Community Bancorp by a holder of a large block of common stock and the removal of Monarch Community Bancorp’s management, all of which certain shareholders might think are in their best interests. These provisions include among other things:
•
the staggered terms of the members of the Board of Directors;
•
an 80% shareholder vote requirement for the approval of any merger or consolidation of Monarch Community Bancorp into any entity that directly or indirectly owns 10% or more of Monarch Community Bancorp voting stock if the transaction is not approved in advance by at least a majority of the disinterested members of Monarch Community Bancorp’s Board of Directors;
•
supermajority shareholder vote requirements for the approval of certain amendments to Monarch Community Bancorp’s articles of incorporation and bylaws;
•
a prohibition of any holder of common stock voting more than 10% of the outstanding common stock;
•
elimination of cumulative voting by shareholders in the election of directors;
•
restrictions on the acquisition of our equity securities;
•
the authorization of five million shares of preferred stock that could be issued without shareholder approval on terms or in circumstances that could deter a future takeover attempt; and
•
the increase in the number of authorized shares and the reclassification of shares without stockholder approval.
In addition, the Maryland business corporation law, the state where Monarch Community Bancorp is incorporated, provides for certain restrictions on acquisition of Monarch Community Bancorp, and federal law contains restrictions on acquisitions of control of bank holding companies such as Monarch Community Bancorp.
The low trading volume in our common stock may make the value of the stock volatile and may make it difficult for shareholders to sell their shares when they desire.
Historically, there have been times when trading volume has been low. During those times the Company’s stock price has encountered some decline. Average daily trading volume for the years ending December 31, 2007 and 2006 were 8,004 and 4,266 shares respectively. The high and low levels of our stock price for each quarter of the last two fiscal years are disclosed in this document. A more detailed history of the Company’s stock price can be found under our stock symbol (MCBF).
ITEM 1B.
ITEM 1B. Unresolved Staff Comments - None
ITEM 2.
ITEM 2. Properties
At December 31, 2007, we had six full service offices. At December 31, 2007, we owned all of our offices and the net book value of our investment in premises and equipment, excluding computer equipment, was $4.6 million. We believe that our current facilities are adequate to meet our present and immediately foreseeable needs.
The following table provides information regarding our office and other facilities:
We utilize a third party service provider to maintain our data base of depositor and borrower customer information.
ITEM 3.
ITEM 3. Legal Proceedings
From time to time we are involved as plaintiff or defendant in various legal actions arising in the normal course of business. We do not anticipate incurring any material liability as a result of any current litigation.
ITEM 4.
ITEM 4. Submission of Matters to a Vote of Security Holders
At the special meeting of stockholders held on October 9, 2007 the proposed going private transaction failed to receive the requisite affirmative vote of its stockholders. Based on the 2,531,373 shares outstanding and entitled to vote on the record date, the affirmative vote of stockholders representing 1,265,687 shares was necessary to approve the proposed transaction. The proposal received the affirmative vote of stockholders representing 1,194,777 of Monarch’s shares.
For: 1,194,777 Against: 210,626 Abstain/Broker Non Votes: 5,264
PART II
ITEM 5.
ITEM 5. Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock commenced trading on August 29, 2002 on the NASDAQ Market under the symbol “MCBF.” The table below shows the high and low sales prices of the common stock for the periods indicated, as reported on the NASDAQ Capital Market. For the years ended December 31, 2007 and 2006, the Company paid dividends of $0.29 and $0.24 per share, respectively.
As of February 29, 2008, there were 2,277,155 shares of the Company’s common stock issued and outstanding and approximately 701 holders of record. The holders of record do include banks and brokers who act as nominees, each of whom may represent more than one stockholder.
The following graph compares the cumulative total stockholder return on the Company’s common stock (MCBF), with cumulative return for the Russell 3000 Index and the SNL Financial LC, $250-$500 million bank and thrift indexes over the same period, assuming the investment of $100 on January 1, 2003, and reinvestment of all dividends.
ITEM 5. Market for the Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities, continued
ISSUER PURCHASES OF EQUITY SECURITIES
Our board of directors approved the repurchase by us of up to an aggregate of 253,000 shares of our common stock pursuant to the Program. The expiration date of this Program is October 22, 2008. Unless terminated earlier by resolution of our board of directors, the Program will expire on the earlier of such expiration date or when we have repurchased all shares authorized for repurchase under the Program.
ITEM 6.
ITEM 6. Selected Financial Data
SELECTED FINANCIAL AND OTHER DATA
The summary information presented below under “Selected Financial Condition Data” and “Selected Operations Data” for, and as of the end of, each of the years ended December 31 is derived from our audited financial statements. The following information is only a summary and you should read it in conjunction with our consolidated financial statements, including notes thereto, included elsewhere in this document:
ITEM 6. Selected Financial Data, continued
ITEM 7.
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
The following discussion is intended to assist in understanding the financial condition and results of operations of Monarch. The discussion and analysis does not include any comments relating to Monarch Community Bancorp since Monarch Community Bancorp has no significant operations. The information contained in this section should be read in conjunction with the consolidated financial statements.
Monarch’s results of operations depend primarily on its net interest income, which is the difference between interest income earned on loans, investments, and overnight deposits, and interest expense incurred on deposits and borrowings. Monarch’s results of operations also are significantly affected by the level of its gains from sales of mortgage loans.
Critical Accounting Policies
Other than described in Note 1 to the Consolidated Financial Statements, management does not believe the use of estimates and management judgment is likely to present a material risk to the financial statements. In cases where estimates or management judgment are required, internal controls and processes are established to provide assurance that such estimates and management judgments are materially correct to the best of management’s knowledge.
Management Strategy
Our strategy is to operate as an independent retail oriented financial institution dedicated to serving the needs of customers in our market area. We are committed to providing a broad range of products and services to meet the needs of our consumer and small business customers. As part of this commitment, we expect to continue our origination of higher credit quality residential and commercial real estate loans to borrowers in our market area and commercial real estate loans to borrowers outside our current market area.
Our focus in 2008 is to lower our cost of funds through core deposit growth by maintaining a high level of customer service and continued development of our sales culture with secondary emphasis on growth in commercial lending and non-interest income, and continued improvement of credit quality. We are dedicating resources to these initiatives that management believes will lead to a higher level of profitability, shareholder value and overall success. Management believes focusing on these areas in 2008 will serve the Company well into the future.
Changes in Financial Condition from December 31, 2006 to December 31, 2007
General. Monarch’s total assets decreased $10.8 million, or 3.7%, to $279.2 million at December 31, 2007 compared to $290.0 million at December 31, 2006. The most significant decrease was in loans which decreased $5.5 million.
Loans. Monarch’s net loan portfolio decreased $5.5 million, or 2.4%, from $230.2 million at December 31, 2006 to $224.8 million at December 31, 2007. Gross loans decreased $5.7 million, or 2.4%, from $232.9 million at December 31, 2006 to $227.2 million at December 31, 2007. The reduction in the loan portfolio was the result of management’s strategy to sell or broker a significant portion of new originations of one-to-four family loans in 2007 (see “Noninterest Income” below). One-to-four family loans decreased $13.6 million as a result of this strategy. The sale of $1.5 million of troubled loans during 2007 also contributed to the reduction in net loans. The Bank experienced decreases in the level of multifamily real estate, construction and commercial business loans because of reduced originations of these types of loans due mainly to economic conditions in our markets. Commercial real estate loans increased $15.6 million as Management continued to emphasize growth in this part of the loan portfolio. Management expects future growth in the loan portfolio to come from increased originations of commercial real estate and commercial business loans.
Securities. The Bank’s security portfolio decreased $2.6 million, or 18.7%, to $11.3 million at December 31, 2007 from $13.9 million at December 31, 2006. Securities were 4.0% of total assets at December 31, 2007 as compared to 4.8% at December 31, 2006. Due to the Bank’s dependence on borrowed funds and brokered CDs, Management did not consider growth in the investment portfolio to be prudent in 2007. Management purchases securities to maintain sufficient liquidity and to provide yield to offset declines in the loan portfolio when they occur.
Liabilities. Monarch’s deposits decreased $14.7 million, or 7.6%, to $177.9 million at December 31, 2007 compared to $192.6 million at December 31, 2006. This decrease was primarily in certificates of deposit (CDs) which decreased $11.8 million. Brokered CDs decreased from $41.3 million at December 31, 2006 to $34.1 million at December 31, 2007. The Bank has attempted to reduce its reliance on brokered and large, out of area CDs, although the success of this strategy is
dependent on growing core deposits. Savings account balances decreased $3.4 million as we experience movement out of these types of accounts into higher yielding deposit account types which was reflected in our money market accounts increasing $3.4 million. Non-interest bearing deposit accounts decreased $2.1 million. This decrease is seen as a normal balance fluctuation. The Bank expects its non-interest bearing deposits to increase in the future as a result of strategies to attract more small business depositors.
Federal Home Loan Bank advances increased $4.8 million, or 8.9%, to $59.3 million at December 31, 2007 from $54.5 million at December 31, 2006. We replaced maturing advances and increased our outstanding advances because the interest rates available on these borrowings were lower than the market interest rates for brokered CDs. For several years our strategy has been to replace borrowed funds and brokered Cds with lower costing core deposits. Our lack of growth in core deposits has made this difficult.
Equity. Total equity amounted to $39.1 million at December 31, 2007 and $40.0 million at December 31, 2006, or 14.0% and 13.8%, respectively, of total assets at both dates. The decrease in equity resulted from the repurchase during 2007 of 209,000 shares of Company stock at a total cost of $2.5 million and dividends payments of $723,000. Net income for 2007 of $1.7 million helped offset the equity reductions. Management expects to continue to repurchase the Company’s stock in 2008.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table presents for the periods indicated the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. No tax equivalent adjustments were made. All average balances are average daily balances.
(1)
Calculated net of deferred loan fees, loan discounts and loans in process. Nonaccrual loans are included in the average outstanding balance.
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.
Comparison of Results of Operations for the Years Ended December 31, 2007, 2006, and 2005
General. Monarch reported net income of $1.7 million for the year ended December 31, 2007 compared to net income of $1.5 million for the year ended December 31, 2006 and net income of $1.4 million in 2005. The reasons for the change in net income for the years are discussed below.
Net Interest Income. Net interest income before provision for loan losses decreased to $8.3 million for 2007 compared to $8.7 million in 2006 and 2005. Our net interest margin has decreased from 3.56% in 2005 to 3.42% in 2006 and to 3.27% in 2007. This is the result of our cost on interest-bearing liabilities increasing more rapidly (2.84% in 2005 to 3.85% in 2007) than yields on interest-earning assets (6.25% in 2005 to 6.90% in 2007). Our cost on interest bearing liabilities has increased partly due to our inability to grow lower costing core deposits and our reliance on money market accounts, brokered CDs and FHLB borrowings.
Interest Income. Total interest income in 2007 increased $258,000 primarily from increased interest income on loans. This followed a $2.1 million increase in 2006 compared to 2005 again due to increased interest income on loans. The increase in 2006 compared to 2005 was the result of an increase in average loans outstanding of $10 million as well as an increase in average yields on loans. The modest increase in loan interest income in 2007 compared to 2006 was due to minimal growth in average loans outstanding and average yields.
Interest Expense. Total interest expense increased $615,000 in 2007 compared to 2006. This followed an increase of $2.0 million in 2006 compared to 2005. The increase in 2007 was primarily the result of higher interest cost for money market accounts and CDs. The increase from 2005 to 2006 was the result of increased cost for money market accounts, CDs and FHLB advances. The Bank has seen its cost of funds increase because of increased market rates for CDs and further competition for money market deposits which has also resulted in higher rates being paid.
Provision for Loan Losses. The Bank recorded a provision for loan losses of $971,000 for the year ended December 31, 2007 whereas no provision for loan losses was recorded for 2006 and a recovery of provisions totaling $385,000 was recorded for the year ended December 31, 2005.
The increased provision for 2007 was necessitated by net charge-offs of $1.2 million in 2007 and increased loan delinquencies at December 31, 2007 as compared to December 31, 2006. Nonperforming assets increased slightly to .81% of assets at December 31, 2007 compared to .74% at December 31, 2006. These levels are significantly lower than the three years prior to 2006 (see “Selected Financial and Other Data”). The Bank did not record a provision in 2006 despite net charge-offs of $901,000 as Management believed its Allowance for Loan Losses to be adequate. The recovery of provisions in 2005 was possible due to the Bank receiving payoffs on two loan relationships totaling $1.5 million for which the Bank had previously provided loan loss allowances of $535,000.
Maintaining asset quality remains a priority and while Management believes our new loan originations over the last three years are of higher quality than those originated previously, more losses can be expected due to the economic conditions statewide and in the markets we operate in and provisions for loan losses in 2008 could approach the level of 2007. See “Loans” discussion above.
Non-interest Income. Non-interest income increased to $3.9 million for the year ended December 31, 2007 compared to $3.1 million for 2006 and $3.4 million for the year ended December 31, 2005. This represented an increase of 26% in 2007 compared to 2006 which decreased 8% compared to 2005.
Fees and service charges were $2.5 million for 2007, $2.2 million for 2006 and $2.0 million for 2005. Income from the Bounce Protection program has increased from $1.1 million in 2005 to $1.4 million in 2007 due to increased customer usage, an increase in the per transaction fee which took effect in 2006 and to a decrease in 2007 in the charge from the third party service provider of the program. Future increases in this source of income are dependent on the bank increasing the number of checking account customers. Management does not expect significant increases in Bounce Protection income from its existing customer base. Income from brokering residential mortgage loans was $166,000 in 2007 compared to $0 in 2005. During 2006, the Bank developed new mortgage banking relationships with four brokerage companies. These relationships generated $64,000 in income in 2006. Management does not expect brokered loan income to continue at the 2007 level in 2008 nor does it expect brokered loan income to be a significant source of income in the future. Loan fees have declined from $234,000 in 2005 to $107,000 in 2007 due to competitive pressures as well as lower originations of construction and consumer loans.
Gain on sale of loans increased $306,000 in 2007 to $668,000 from $362,000 in 2006. Beginning in 2007, our strategy has been to sell as many of the residential mortgage originations as possible to manage the Bank’s interest rate risk, credit risk and liquidity. Thus our gains increased in spite of lower residential loan originations in 2007 compared to 2006 and 2005. This is a continuing strategy although management does not expect 2008 sales to be as high as 2007 due to changes occurring in the secondary mortgage market. Gains in 2007 represented a $106,000 increase over gains in 2005.
Net gain on sale of premises and equipment was $49,000 in 2007 compared to $0 in 2006 as the Company closed and disposed of one of its branch locations in Coldwater. Net gain on sale of premises and equipment was $39,000 in 2005 which was primarily the result of the sale of the Jonesville branch location.
Other income increased $187,000 (from $138,000 in 2006 to $325,000 in 2007) after decreasing $164,000 in 2006 compared to 2005. This is due to a net gain of $139,000 on sales of foreclosed properties in 2007 compared to a net loss of $67,000 in 2006. In 2005, the Bank experienced a net gain on sale of foreclosed properties of $54,000. These fluctuations were created by the Bank selling more foreclosed properties in 2006 as compared to either 2007 or 2005. The Bank does occasionally experience a gain on sale of foreclosed property, as it has become increasingly more conservative in valuing these properties upon acquisition. Management expects 2008 to be similar to 2007 in terms of foreclosure activity and thus potential gains or losses on subsequent sales of the foreclosed properties. The relatively soft real estate market may lead to longer holding periods as well as larger losses on disposal as compared to recent years.
Non-interest Expense. Non-interest expenses have decreased since 2005 by 14%. We have sought to reduce certain expenses and slow the growth of other operating expenses in an attempt to improve our profitability. Management is confident that the actions taken to control expenses will not affect the Company’s ability to fulfill its obligations to its customers and shareholders.
Salaries and employee benefit expense has declined over the last three years due to a 10% staff reduction and modifications to certain employee benefit programs. The Company changed its employee health insurance program, reducing the expense from $634,000 in 2005 to cut its 401(k) match from 50% to 25%, savings $31,000 and amended the ESOP plan to extend vesting thus saving $100,000. Most of these changes occurred in late 2006 and are expected to stabilize salaries and employee benefit costs in the future. Recruiting and retaining qualified staff is a priority of Management.
Repossessed property expense has decreased since 2005. This is attributed to better management of properties during the holding period, better sales efforts that have led to shorter holding periods and decreased impairment write-downs due to better valuation techniques at the time of foreclosure.
For the year ended December 31, 2007 we did experience an increase in professional services expense of $150,000 due to the costs incurred in the Company’s attempt at going private. These costs in 2007 offset decreases the Company has experienced since 2005 in auditing expense, loan related legal fees and supervisory expenses. The Bank’s supervisory expense has been reduced because of a charter conversion in 2006 which changed the Bank’s primary regulator. We expect professional services expenses to return to 2006 levels in 2008 but the Company’s need to continue to comply with provisions of Sarbanes-Oxley will likely increase professional services expense in 2009 and beyond.
Amortization expense of intangible assets has decreased consistent with the aging of the Core Deposit Intangible established upon the acquisition of MSB Financial in 2004. As indicated in Note 2 to the Company’s financial statements, this expense will continually decline over the remaining life of the related asset.
Other general and administrative expense has decreased from $1.3 million in 2005 to $1.2 million in 2006 to $973,000 in 2007. As mentioned earlier, cost control has been a strategic priority since 2005 and this is reflected in reductions in many of the expense included in Other General and Administrative.
Federal Income Taxes. Our effective tax rate for purposes of the tax provision was 24.3% in 2007 compared to 26% in 2006 and 2005. The difference between the effective tax rates and the federal corporate income tax rate of 34% is attributable to the low income housing credits available to the Bank from the investment in the limited partnership as well as fluctuation of permanent book and tax differences such as non-taxable income and non-deductible expenses.
Liquidity and Commitments
We are required to maintain appropriate levels of liquid assets under FDIC regulations. Appropriate levels are determined by our Board of Directors and Management and are included in our asset liability management policy. Liquidity may increase or decrease depending upon the availability of funds and comparative yields on investments in relation to the return on loans. We have maintained liquidity at levels above those believed to be adequate to meet the requirements of normal operations, including new loan funding and potential deposit outflows. At December 31, 2007, our liquidity ratio, which is our liquid assets as a percentage of total deposits less certificates of deposit maturing in more than one year and plus borrowings maturing in one year or less, was 8.4%. This level of liquidity is lower than that maintained last year but management is confident they will be able to effectively address the Bank’s liquidity needs while facilitating increased profitability.
Monarch’s liquidity, represented by cash and cash equivalents, is a product of our operating, investing and financing activities. Monarch’s primary sources of funds are deposits, amortization, prepayments and maturities of outstanding loans, overnight deposits and funds provided from operations. While scheduled payments from the amortization of loans and overnight deposits are relatively predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. Monarch also generates cash through borrowings. Monarch utilizes Federal Home Loan Bank advances to leverage its capital base and provide funds for its lending and investment activities, and to enhance its interest rate risk management.
Liquidity management is both a daily and long-term function of business management. Excess liquidity is generally invested in overnight deposits, including fed funds, and short-term treasury and governmental agency securities. On a longer term basis, Monarch maintains a strategy of investing in various investments and lending products. Monarch uses its sources of funds primarily to meet its ongoing commitments, to pay maturing certificates of deposit and savings withdrawals and to fund loan commitments. Certificates of deposit scheduled to mature in one year or less at December 31, 2007, totaled $63.9 million. Based on historical experience, management believes that a significant portion of these certificates of deposit can be retained by continuing to pay competitive interest rates.
If necessary, additional funding sources include additional deposits (including core deposits), brokered deposits, and Federal Home Loan Bank advances. Management is committed to increasing our core deposit balances but we have had difficulty doing so and core deposit growth may not be a significant source of liquidity in the future. Based on current collateral levels, at December 31, 2007, Monarch could borrow an additional $20.9 million from the Federal Home Loan Bank at prevailing interest rates. We anticipate we will continue to have sufficient funds, through deposits and borrowings, to meet our current commitments. For the year ended December 31, 2007, Monarch had a net decrease in cash and cash equivalents of $1.5 million as compared to a net decrease of $989,000 million for the year ended December 31, 2006.
The Company’s primary sources of funds during 2007 were operations of $3.9 million, excess of repayments over new funding of loans of $3.0 million and net proceeds from Federal Home Loan Bank advances of $4.9 million. The primary uses of funds in 2007 were a decrease in deposits of $14.6 million and repurchases of the Company’s stock of $2.5 million.
The Company’s primary sources of funds during 2006 were operations of $4.1 million, a net increase in deposits totaling $17.6 million and proceeds from the sale of foreclosed assets totaling $3.2 million. The primary uses of funds in 2006 were excess of new loan funding over repayments of $19.3 million, net repayments of Federal Home Loan Bank advances of $5.1 million and repurchases of the Company’s stock of $2.1 million.
Off-Balance Sheet Arrangements
At December 31, 2007, the total unused commercial and consumer lines of credit were $20.3 million and there were outstanding commitments under letters of credit of $16,000. At December 31, 2006, the total unused commercial and consumer lines of credit were $19.3 million and there were outstanding commitments under letters of credit of $10,000. The Company has no arrangements with any other entities that have or are reasonably likely to have a material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Contractual Obligations
The Company has certain obligations and commitments to make future payments under contracts. At December 31, 2007, the aggregate contractual obligations and commitments are:
Long-term obligations also include the liability under the Company’s Director Deferred Compensation Plans. See Note 14 in the Notes to Consolidated Financial Statements for additional information on the plans.
Capital
Consistent with its goals to operate a sound and profitable financial organization, Monarch actively seeks to maintain a “well capitalized” institution in accordance with regulatory standards. Note 12 to the Financial Statements details the capital position of the Bank as well as the capital levels necessary to remain well capitalized. At December 31, 2007 the equity to assets ratio of the Company was 14% which Management and the Board of Directors feels is more than adequate. During 2007, the Company repurchased 209,000 shares of its common stock in open market purchases. The Company intends to repurchase up to an additional 10% of its outstanding shares during 2008. Management and the Board of Directors anticipate the Company and the Bank will continue to have adequate capital levels upon completion of the 2008 repurchase program.
Impact of Inflation
The consolidated financial statements presented herein have been prepared in accordance with generally accepted accounting principles. These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.
Our primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates, however, do not necessarily move in the same direction or with the same magnitude as the price of goods and services, since such prices are affected by inflation. In a period of rapidly rising interest rates, the liquidity and maturity structures of our assets and liabilities are critical to the maintenance of acceptable performance levels.
The principal effect of inflation, as distinct from levels of interest rates, on earnings is in the area of non-interest expense. Such expense items as employee compensation, employee benefits and occupancy and equipment costs may be subject to increases as a result of inflation. An additional effect of inflation is the possible increase in the dollar value of the collateral securing loans that we have made. We are unable to determine the extent, if any, to which properties securing our loans have appreciated in dollar value due to inflation.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Asset and Liability Management and Market Risk
Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in interest rates and comply with applicable regulations, we monitor our interest rate risk. In monitoring interest rate risk, we continually analyze and manage assets and liabilities based on their payment streams and interest rates, the timing of their maturities, and their sensitivity to actual or potential changes in market interest rates.
The Board of Directors sets and recommends the asset and liability policies of the Bank which are implemented by the asset and liability management committee. The asset and liability management committee is comprised of members of our senior management. The purpose of the asset and liability management committee is to communicate, coordinate and control asset/liability management consistent with our business plan and board approved policies. The asset and liability management committee establishes and monitors the volume and mix of assets and funding sources taking into account relative costs and spreads, interest rate sensitivity and liquidity needs.
The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, growth, risk and profitability goals. The asset and liability management committee generally meets on a quarterly basis to review, among other things, economic conditions and interest rate outlook, current and projected liquidity needs and capital position, anticipated changes in the volume and mix of assets and liabilities and interest rate risk exposure limits versus current projections. The Chief Financial Officer is responsible for reviewing and reporting on the effects of the policy implementation and strategies to the Board of Directors, each quarter.
In order to manage our assets and liabilities and achieve the desired liquidity, credit quality, interest rate risk, profitability and capital targets, we have focused our strategies on:
•
originating shorter-term commercial real estate loans for retention in our portfolio;
•
selling a significant portion of the long-term, fixed rate residential mortgage loans we make;
•
managing our deposits to establish stable deposit relationships with an emphasis on core, non-certificate deposits, supplementing these with brokered deposits, as appropriate; and
•
maintaining longer-term borrowings at fixed interest rates to offset the negative impact of longer-term fixed rate loans in our loan portfolio. Future borrowings are expected to be short-term to reduce the average maturity of our borrowings.
At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the asset and liability management committee may determine to increase Monarch’s interest rate risk position somewhat in order to maintain the net interest margin. In addition, in an effort to manage our interest rate risk and liquidity, in 2007 and 2006 we sold $28.7 million and $16.2 million, respectively, of fixed-rate, one-to-four family mortgage loans in the secondary market. We expect to continue to sell a significant portion of our originated long term, fixed-rate, one-to-four family loans but may retain some portion of our 15 year and shorter, fixed-rate loans.
Monarch uses an internally generated model that uses scenario analysis to evaluate the IRR exposure of the Bank by estimating the sensitivity of the Bank’s portfolios of assets, liabilities, and off-balance sheet contracts to changes in market interest rates. The information presented in the following table presents the expected change in Monarch’s net portfolio value at December 31, 2007 that would occur upon an immediate change in interest rates.
(1)
Assumes an instantaneous uniform change in interest rates at all maturities.
Based on the data from the model, management believes that the Bank’s IRR level remains minimal.
As with any method of measuring interest rate risk, certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable rate mortgage loans, have features which restrict changes in interest rates on a short-term basis and over the life of the asset. Further, if interest rates change, expected rates of prepayments on loans and early withdrawals from certificates could deviate significantly from those assumed in calculating the table.
The Bank, like other financial institutions, is affected by changes in market interest rates. Our net interest margin can change, either positively or negatively, as the result of increases or decreases in market interest rates. Some factors affecting net interest margin are outside of our control; market interest rates are but one factor affecting the Bank’s net interest margin. However, management has the ability, through its asset/liability management and pricing policies to affect the Bank’s net interest margin notwithstanding the level of market interest rates. The preceding table indicates the Bank’s net portfolio value will decrease in an increasing interest rate scenario and increase in a decreasing interest rate scenario. Management believes that its net interest margin will behave similarly.
If rising interest rates stifle loan demand or create additional competitive pressures in attracting and retaining deposits, the Bank’s desire for growth in total assets may cause management to alter its strategy that could negatively impact the net interest margin. The timing and magnitude of interest rate changes, as well as the sector affected (short-term vs. long-term) will have an impact on the Bank’s net interest margin.
The following table provides information about the Company’s financial instruments that are sensitive to changes to interest rates as of December 31, 2007. The Company had no derivative instruments, or trading portfolio as of that date. The expected maturity date values for loans receivable, mortgage-backed securities and investment securities were calculated without adjusting the contractual maturity dates for expectations of repayments. Expected maturity date values for non-maturity, interest bearing deposits were based on the opportunity for repricing.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data
Monarch Community Bancorp, Inc. and Subsidiaries
Consolidated Financial Report
December 31, 2007
Monarch Community Bancorp, Inc. and Subsidiaries
Plante & Moran, PLLC
Bridgewater Place
Suit 600
333 Bridge St. N.W
Grand Rapids, MI 49504
Tel: 616.774.8221
Fax: 616.774.0702
plantemoran.com
Report of Independent Registered Public Accounting Firm
To the Board of Directors
Monarch Community Bancorp, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheet of Monarch Community Bancorp, Inc. and Subsidiaries as of December 31, 2007 and 2006, and the related consolidated statements of income, stockholders’ equity, and cash flows for each year in the three-year period ended December 31, 2007. These consolidated financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Monarch Community Bancorp, Inc. and Subsidiaries as of December 31, 2007 and 2006, and the consolidated results of their operations and their cash flows for each year in the three-year period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America.
Grand Rapids, Michigan
March 3, 2008
Monarch Community Bancorp, Inc. and Subsidiaries
Consolidated Balance Sheet
(000s omitted, except per share data)
See Notes to Consolidated Financial Statements.
Monarch Community Bancorp, Inc. and Subsidiaries
Consolidated Statement of Income
(000s omitted, except per share data)
See Notes to Consolidated Financial Statements.
Monarch Community Bancorp, Inc. and Subsidiaries
Consolidated Statement of Stockholders’ Equity
(000s omitted, except per share data)
See Notes to Consolidated Financial Statements.
Monarch Community Bancorp, Inc. and Subsidiaries
Consolidated Statement of Cash Flows
(000s omitted)
See Notes to Consolidated Financial Statements.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 1 - Summary of Significant Accounting Policies
Organization - Monarch Community Bancorp, Inc. (the Corporation) was incorporated in 2002 under Maryland law to hold all of the common stock of Monarch Community Bank (the Bank), formerly known as Branch County Federal Savings and Loan Association.
Monarch Community Bank provides a broad range of banking services to its primary market area of Branch, Calhoun and Hillsdale counties in Michigan. The Bank operates six full service offices. The Bank owns 100% of First Insurance Agency. The Bank also owns a 24.98% interest in a limited partnership formed to construct and operate multi-family housing units.
Community Services Group, Inc. with assets totaling $996,000 has been dissolved as of April 30, 2006 with all assets being transferred to Monarch Community Bank resulting in no gain or loss on the dissolution.
On June 3, 2006 the Corporation completed the conversion of the Bank from a federally chartered stock savings institution to a Michigan state chartered commercial bank. As a result of the conversion, the Corporation became a federal bank holding company regulated by the Board of Governors of the Federal Reserve and the Bank became regulated by the State of Michigan Office of Financial and Insurance Services (“OFIS”) and the Federal Deposit Insurance Corporation (“FDIC”). Prior to the conversion, both the Corporation and the Bank had been regulated by the Office of Thrift Supervision.
Basis of Presentation and Consolidation - The consolidated financial statements include the accounts of Monarch Community Bancorp, Inc., Monarch Community Bank, and First Insurance Agency, Inc. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates - The accounting and reporting policies of the Corporation and its subsidiaries conform to accounting principles generally accepted in the United States of America. Management is required to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates and assumptions. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, identification and valuation of impaired loans, valuation of the mortgage servicing asset, valuation of intangible assets and the valuation of the other real estate.
Significant Group Concentrations of Credit Risk - Most of the Corporation’s activities are with customers located within its primary market areas in Michigan. Note 3 summarizes the types of securities the Corporation invests in. Note 4 summarizes the types of lending that the Corporation engages in. The Corporation has a significant concentration of loans secured by residential real estate located in Branch, Calhoun and Hillsdale counties.
Cash and Cash Equivalents - For the purpose of the consolidated statement of cash flows, cash and cash equivalents include cash and balances due from banks, interest-bearing deposits and overnight time deposits with the Federal Home Loan Bank and fed funds sold. The Bank is required to maintain average balances on hand or with the Federal Reserve Bank. At December 31, 2007 and 2006, these reserve balances amounted to approximately $477,000 and $606,000, respectively.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 1 - Summary of Significant Accounting Policies (Continued)
Securities - Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity or trading including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses, net of deferred income taxes, excluded from earnings and reported in other comprehensive income.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held-to-maturity securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Loans Held for Sale - Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized in a valuation allowance by charges to income.
Loans - The Corporation grants mortgage, commercial and consumer loans to customers. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans.
The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Allowance for Loan Losses - The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 1 - Summary of Significant Accounting Policies (Continued)
The allowance consists of specific, general and unallocated components. The specific components relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower that the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. The unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.
Large groups of homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential loans for impairment disclosures.
Servicing - Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into noninterest expense in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost.
Impairment is determined by stratifying rights by predominant characteristics, such as interest rates and terms. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that fair value is less than the capitalized amount for the stratum.
Credit Related Financial Instruments - In the ordinary course of business, the Corporation has entered into commitments to extend credit, including commitments under commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 1 - Summary of Significant Accounting Policies (Continued)
Foreclosed Assets - Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of the foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated selling expenses, which consist primarily of commissions that will be paid to an independent real estate agent upon sale of the property. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.
Premises and Equipment - Land is carried at cost. Buildings and equipment are carried at cost, less accumulated depreciation computed on the straight-line method over the estimated useful lives of the assets.
Goodwill and Other Intangible Assets - Goodwill represents the excess of the cost of an acquisition over the fair value of net identifiable tangible and intangible assets acquired. Under the provisions of SFAS 142, goodwill is no longer amortized into the income statement over an estimated life, but rather is tested at least annually for impairment. Impairment of goodwill is evaluated by reporting unit and is based on a comparison of the recorded balance of goodwill to the applicable market value or discounted cash flows. To the extent that impairment may exist, the current carrying amount is reduced by the estimated shortfall.
Intangible assets which have finite lives are amortized over their estimated useful lives and are subject to impairment testing.
Income Taxes - Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the various temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.
Comprehensive Income - Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income.
The components of other comprehensive income and related tax effects are as follows (000s omitted):
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 1 - Summary of Significant Accounting Policies (Continued)
Earnings (Loss) Per Common Share - Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustments to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate to outstanding stock options and Recognition and Retention Plan shares, and are determined using the treasury stock method.
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):
At December 31, 2007, stock options not considered in computing diluted loss per share because they were antidilutive totaled 174,757 and non-vested RRP shares not considered in computing diluted earnings per share because they were antidilutive totaled 24,817. At December 31, 2006, there were 191,547 antidilutive stock options and 42,706 non-vested RRP shares. At December 31, 2005, there were 185,487 antidilutive stock options and 55,633 non-vested RRP shares.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 1 - Summary of Significant Accounting Policies (Continued)
Employee Stock Ownership Plan (ESOP) - Compensation expense is recognized as ESOP shares are committed to be released. Allocated and committed to be released ESOP shares are considered outstanding for earnings per share calculation based on debt service payments. Dividends declared on allocated ESOP shares are charged to retained earnings. Dividends declared on unallocated ESOP shares are used for debt service. The Corporation has committed to make contributions to the ESOP sufficient to service the debt to the extent not paid through dividends. The value of unearned shares to be allocated to ESOP participants for future services not yet performed is reflected as a reduction of stockholders’ equity.
Stock Based Compensation - SFAS No. 123(R) requires all companies to measure the cost for stock options provided to employees in return for employee service. The cost is measured at the fair value of the options granted and recognized over the employee service period, which is usually the vesting period for the options. As amended, this statement became effective for the Corporation’s fiscal year beginning January 1, 2006. The effect on the Corporation’s net income will depend on the level of future option grants and the calculation of the fair value of the options granted, as well as the vesting periods provided.
The Corporation adopted the modified prospective method as required by SFAS 123(R) which requires companies to expense the fair value of new stock option awards as well as the fair value of all unvested options outstanding at December 31, 2005 over the vesting period. No compensation costs were recognized in 2005. Options granted in 2006 and 2007 under the fair value method had an exercise price equal to the market price of the underlying common stock at the date of the grant. Had compensation cost for stock options granted in 2005 been measured using the fair value method, the Corporation’s net income and basic and diluted earnings per share would have been the pro forma amounts indicated below (000s omitted except per share data):
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 1 - Summary of Significant Accounting Policies (Continued)
Stock Based Compensation, continued - Under APB Opinion No. 25, because the exercise price of the Corporation’s stock option grants equal the market price of the underlying stock on the date of the grant, no compensation cost was recognized prior to January 1, 2006. Compensation expense in the pro forma disclosures is not indicative of future amounts, as options vest over several years and additional grants are generally made each year.
Recent Accounting Pronouncements
FASB No. 157 and FASB No. 159 - Fair Value Measurement and The Fair Value Option for Financial Assets and Financial Liabilities - SFAS No. 157 clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. It applies under other accounting pronouncements that require or permit fair value measurements and does not require any new fair value measurements. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 157 and SFAS No. 159 are effective for fiscal years beginning after November 15, 2007. The Corporation did not early adopt and does not anticipate the adoption of these statements to have a significant effect on the consolidated financial statements.
FASB Interpretation No. 48 - Accounting for Uncertainty in Income Taxes - In July 2006, the Financial Accounting Standards Board (FASB) issued this interpretation to clarify the accounting for uncertainty in tax positions. FIN 48 requires, among other matters, that the Corporation recognizes in its consolidated financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 became effective as of the beginning of the Corporation’s 2007 fiscal year, with any cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The adoption of this statement did not have a significant effect on the consolidated financial statements.
Supplemental Cash Flow Information (000s omitted)
Reclassifications - Certain prior year amounts have been reclassified to conform with current year presentation.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 2 - Goodwill and Intangible Assets
Acquired intangible assets at year end were as follows:
Aggregate amortization expense was $230,000, $291,000 and $369,000 for 2007, 2006, and 2005 respectively.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 3 - Securities
The amortized cost and fair value of securities, with gross unrealized gains and losses, follows (000s omitted):
The amortized cost and estimated market values of securities at December 31, 2007, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers will have the right to call or prepay obligations with or without call or prepayment penalties (000s omitted):
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 3 - Securities (Continued)
For the years ended December 31, 2007, 2006 and 2005, proceeds from sales of securities available for sale amounted to $4,428,000, $2,543,000, and $0, respectively. Gross realized gains amounted to $2,000, $0, and $0, respectively. Gross realized losses amounted to $19,000, $20,000, and $0, respectively. The tax benefit (provision) applicable to these net realized gains and losses amounted to $4,250, $5,000, and $0, respectively.
Information pertaining to securities with gross unrealized losses at December 31, 2007 and 2006, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
Management evaluates securities for other-than-temporary impairment on a periodic basis as economic or market concerns warrant such evaluation. Consideration is given to the length of time the security has been in a loss position, the financial condition and near-term prospects of the issuer and the intent and ability of the Corporation to retain its investment in the issuer to allow for recovery of fair value.
Other securities, consisting primarily of restricted Federal Home Loan Bank stock, are recorded at cost, which approximates market value. As of December 31, 2007 Monarch Community Bank had $8.6 million in pledged securities as collateral for Federal Home Loan Bank Advances. There were no pledged securities at December 31, 2006.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 4 - Loans
A summary of the balances of loans follows (000s omitted):
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 4 - Loans (Continued)
The following is an analysis of the allowance for loan losses (000s omitted):
The following is a summary of information pertaining to impaired loans (000s omitted):
There are no impaired loans without a valuation allowance as of December 31, 2007 and 2006. The following is a summary of our average investment in impaired loans (000s omitted):
Interest income recognized on impaired loans was not significant for the years ended December 31, 2007, 2006, and 2005. No additional funds are committed to be advanced in connection with impaired loans.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 5 - Servicing
Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage loans serviced for others were $178,449,000 and $176,566,000 at December 31, 2007 and 2006, respectively.
The fair value of mortgage servicing rights approximates $1,769,000 and $1,636,000 at December 31, 2007 and 2006, respectively. The fair value was determined by discounting estimated net future cash flows from mortgage servicing activities using an 8.20% discount rate and estimated prepayment speeds of 8.1 to 10.9 based on current Freddie Mac experience. The impairment valuation allowance is $0 as of December 31, 2007, 2006, and 2005. There has been no activity in the impairment valuation allowance during the years ended December 31, 2007, 2006, and 2005.
The following summarizes mortgage servicing rights capitalized and amortized (000s omitted):
Note 6 - Foreclosed Assets
Foreclosed assets consisted of the following (000s omitted):
Expenses applicable to foreclosed and repossessed assets include the following (000s omitted):
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 7 - Premises and Equipment
A summary of the cost and accumulated depreciation of premises and equipment follows (000s omitted):
Depreciation expense totaled $483,000, $528,000, and $561,000 in 2007, 2006, and 2005, respectively.
Note 8 - Deposits
The following is a summary of interest bearing deposit accounts (000s omitted):
Generally, deposit amounts in excess of $100,000 are not federally insured.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 8 - Deposits (Continued)
The remaining maturities of certificates of deposit outstanding are as follows (000s omitted):
Note 9 - Federal Home Loan Bank Advances
The Bank has Federal Home Loan Bank advances of $59,330,000 and $54,476,000 at December 31, 2007 and 2006, respectively, which mature through 2013. At December 31, 2007, the interest rates on fixed rate advances ranged from 4.02% to 6.21%. At December 31, 2006 the interest rates on fixed rate advances ranged from 4.70% to 6.56%.
At December 31, 2007, the Bank had no floating rate advances. The Bank had two floating rate advances totaling $3,500,000 with a weighted average interest rate of 5.32% as of December 31, 2006. The weighted average interest rate of all advances was 5.10% and 5.47% at December 31, 2007 and 2006, respectively.
At December 31, 2007, the Bank had two putable advances totaling $10,000,000 with a weighted average interest rate of 3.68%. One advance can be put on January 28, 2008 and another on May 12, 2008. At December 31, 2006, the Bank had one putable advance of $5,000,000 with an interest rate of 3.34%.
The Bank has provided a pledge of all of the Bank’s eligible residential mortgage loans and certain securities as collateral for all FHLB debt. The amount of the mortgage loans totaled $117,643,000 and $122,433,000 as of December 31, 2007 and 2006, respectively.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 9 - Federal Home Loan Bank Advances (continued)
The contractual maturities of advances are as follows (000s omitted):
Note 10 - Income Taxes
Allocation of income taxes between current and deferred portions is as follows (000s omitted):
The reasons for the differences between the statutory federal income tax rate and the effective tax rates are summarized as follows:
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 10 - Income Taxes (Continued)
The components of the net deferred tax asset are as follows (000s omitted):
The Corporation has qualified under a provision of the Internal Revenue Code which permits it to deduct from taxable income a provision for bad debts in excess of such provision charged to income in the consolidated financial statements. Accordingly, retained earnings at December 31, 2007 and 2006 include approximately $1,592,000 for which no provision for federal income taxes has been made. Unrecognized deferred taxes on this amount are approximately $541,000. If, in the future, this portion of retained earnings is used for any purpose other than to absorb bad debt losses, federal income taxes would be imposed at the then applicable rates. The general business credits of $328,000 expire between 2024 and 2027.
The Corporation has recorded an estimate of the tax credit through December 31, 2007. The Corporation’s share of tax credits generated by the investee partnership approximated $191,000, in 2007, 2006, and 2005.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 11 - Off-Balance Sheet Activities
Credit Related Financial Instruments - The Corporation is a party to credit related financial instruments with off-balance sheet risk in the normal course of business to meet the financing need of its customer. These financial instruments include commitments to extend credit, and unfunded commitments under lines of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
The Corporation’s exposure to credit loss is represented by the contractual amount of these commitments. The Corporation follows the same credit policies in making commitments as it does for on-balance sheet instruments.
The following financial instruments were outstanding whose contract amounts represent credit risk (000s omitted):
The above commitments include fixed rate and variable rate loan commitments and lines of credit with interest rates ranging between 5.25% and 11.50% at December 31, 2007, and 5.875% and 12.25% at December 31, 2006.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Corporation, is based on management’s credit evaluation of the customer.
Unfunded commitments under commercial lines of credit and revolving credit lines are commitments for possible future extensions of credit to existing customers. These lines of credit are collateralized and usually do not contain a specified maturity date and may be drawn upon to the total extent to which the Corporation is committed.
Collateral Requirements - To reduce credit risk related to the use of credit related financial instruments, the Corporation might deem it necessary to obtain collateral. The amount and nature of the collateral obtained is based on the Corporation’s credit evaluation of the customer. Collateral held varies but may include cash, securities, accounts receivable, inventory, property, plant, and equipment and real estate.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 12- Regulatory Matters
The Bank is subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios, which are shown in the table below. Management believes, as of December 31, 2007 and 2006, that the Bank has met all of the capital adequacy requirements to which they are subject.
As of December 31, 2007, the most recent notification from the FDIC categorized the Bank as well capitalized, under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s capital category.
A reconciliation of the Bank’s equity to major categories of capital is as follows (000s omitted):
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 12 - Regulatory Matters (Continued)
Regulatory capital balances and ratios are as follows (000s omitted):
Note 13 - Restrictions on Dividends, Loans and Advances
Banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Corporation.
The amount of total dividends which may be paid at any date is generally limited to the retained earnings of the Bank. However, dividends paid by the Bank would be prohibited if the effect thereof would cause the Bank’s capital to be reduced below applicable minimum standards. At December 31, 2007, the Bank’s retained earnings available for the payment of dividends, without approval from the regulators, totaled $6,781,000. Accordingly, $31,528,000 of the Corporation’s investment in the Bank was restricted at December 31, 2007.
Loans or advances made by the Bank to the Corporation are generally limited to 10 percent of the Bank’s capital stock and surplus. Accordingly, at December 31, 2007, Bank funds available for loans or advances to the Corporation amounted to $3,148,000.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 14 - Retirement Plans
The Corporation is part of a non-contributory, multi-employer defined benefit pension plan covering substantially all employees. Effective April 1, 2004 employees’ benefits under the plan were frozen. The plan is administered by the trustees of the Financial Institutions Retirement Fund. Because it is a multi-employer plan, there is no separate valuation of plan benefits or segregation of plan assets specifically for the Corporation. During 2007, 2006 and 2005, the Corporation recognized expense for this plan of $205,000, $246,000, and $226,000, respectively.
The Corporation has a Defined Contribution Retirement plan for all eligible employees. The Corporation has a matching contribution agreement to match 25% of the first 6% of an employee’s salary (reduced from a 50% match effective October 1, 2006). During 2007, 2006 and 2005, the Corporation recognized expense for this plan of $32,000, $63,000, and $64,000, respectively.
The Corporation has a nonqualified deferred-compensation plan (included as part of the other liabilities section of the consolidated balance sheet) to provide retirement benefits to the Directors, at their option, in lieu of annual directors’ fees and meeting fees. Undistributed benefits are increased by an annual earnings rate which is based on the higher of the Company’s return on average equity or 5.0%. The value of benefits accrued to participants was $420,000 and $410,000 at December 31, 2007 and 2006, respectively. The expense for the plan, including the increase due to the annual earnings credit was $19,000, $20,000, and $20,000, for 2007, 2006, and 2005, respectively.
The Corporation has a liability for the directors’ deferred compensation plan. This plan does not allow for future deferrals and all benefits are being paid out to participants over a 180 month term. Undistributed benefits are increased by an annual earnings rate based on an index which was 5.81% as of December 31, 2007. The present value of benefits accrued to participants (also included as part of the other liabilities section of the balance sheet) is $598,000 and $634,000 at December 31, 2007 and 2006, respectively.
Note 15 - Related Party Transactions
Extensions of credit to principal officers, directors and their affiliates totaled $518,000 and $882,000 for the years ending December 31, 2007 and 2006, respectively. During the year ending December 31, 2007, total principal additions were $261,000 and total principal payments were $625,000, and during the year ending December 31, 2006, total principal additions were $105,000 and total principal payments were $254,000. Deposits from related parties and their affiliates held by the Bank at December 31, 2007 and 2006 amounted to $744,000 and $890,000 respectively.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 16 - Fair Value of Financial Instruments
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Corporation’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Corporation.
The following methods and assumptions were used by the Corporation in estimating fair value disclosures for financial instruments:
Cash and Cash Equivalents - The carrying amounts of cash and short-term instruments approximate fair values. The carrying amounts of interest-bearing deposits maturing within ninety days approximate their fair values. Fair values of other interest-bearing deposits are estimated using discounted cash flow analyses based on current rates for similar types of deposits.
Securities - Fair values for securities, excluding Federal Home Loan Bank stock, are based on quoted market prices. The carrying value of Federal Home Loan Bank stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank.
Mortgage Loans Held for Sale - Fair values of mortgage loans held for sale are based on commitments on hand from investors or prevailing market prices.
Loans Receivable - For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flows analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
Deposit Liabilities - The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 16 - Fair Value of Financial Instruments (Continued)
Federal Home Loan Bank Advances - The fair values of the Corporation’s Federal Home Loan Bank advances are estimated using discounted cash flow analyses based on the Corporation’s current incremental borrowing rates for similar types of borrowing arrangements.
Accrued Interest - The carrying amounts of accrued interest approximate fair value.
The estimated fair values, and related carrying or notional amounts, of the Corporation’s financial instruments are as follows (000s omitted):
Note 17 - Employee Stock Ownership Plan (ESOP)
As part of the conversion (Note 1), the Corporation implemented an employee stock ownership plan (ESOP) covering substantially all employees. The Corporation provided a loan to the ESOP, which was used to purchase 185,150 shares of the Corporation’s outstanding stock at $10 per share. In December 2006, the Board of Directors approved an amendment to the ESOP plan revising the vesting, allocation and loan repayment guidelines of the plan. As a result of the amendment, the loan bears interest equal to 4.75% and will be repaid over a period of fifteen years ending on December 31, 2016. Dividends on the allocated shares are distributed to participants and the dividends on the unallocated shares are used to pay debt service.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 17 - Employee Stock Ownership Plan (ESOP) (Continued)
The scheduled maturities of the loan are as follows (000’s omitted):
The Corporation has committed to make contributions to the ESOP sufficient to support debt service of the loan. The ESOP shares initially were pledged as collateral for its debt. As the debt is repaid, shares are released from collateral and allocated to active participants. The shares pledged as collateral are included in unearned compensation in the equity section of the balance sheet. As shares are released they become outstanding for earnings per share computations.
The ESOP shares as of December 31 were as follows (000s omitted except shares):
Total compensation expense applicable to the ESOP amounted to approximately $108,000, $214,000, and $234,000 for the years ended December 31, 2007, 2006, and 2005, respectively.
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 18 - Stock Compensation Plans
The Corporation has a Recognition and Retention Plan (RRP) which authorizes up to 92,575 shares to be issued to employees and directors. 92,275 shares of restricted stock have been issued to employees and directors since 2003. Under the plan, the shares vest 20% per year for five years. Shares forfeited total 3,326 in 2007 and 3,399 in 2006. No shares of restricted stock were issued in 2007 and 3,884 shares of restricted stock were issued to certain employees and directors during 2006. During 2007, 17,589 shares vested and are no longer restricted for a total of 67,458 vested shares as of December 31, 2007. During 2006, 16,811 shares vested and are no longer restricted for a total of 49,869 vested shares as of December 31, 2006. Compensation expense applicable to the RRP amounted to $229,000, $230,000 and $215,000 for the years ended December 31, 2007, 2006 and 2005 respectively.
The Company’s Employee Stock Option Plan (the Plan), which is stockholder approved, permits the grant of stock options to its employees for up to 231,438 shares of common stock. The Company believes that such awards better align the interests of its employees with those of its stockholders. Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of grant; those option awards generally vest based on five years of continuous service and have ten year contractual terms.
The fair value of each option award is estimated on the date of grant using a Black Scholes option valuation model that uses the weighted average assumptions noted in the following table. Expected volatilities are based on the Company’s stock price and dividend history. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.
The fair value of each option granted in 2007 was $2.05. The fair value of each option granted in 2006 was $2.41. There were no options granted in 2005. As of December 31, 2007, there was $27,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted average period of 2.6 years. The fair value is estimated on the date of the grant using with the following weighted average assumptions:
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 18 - Stock Compensation Plans (continued)
A summary of changes of the status of the Corporation’s stock option plan is presented below (000s omitted except per share data):
A summary of changes in exercisable stock options December 31, 2007 and 2006 is as follows:
A summary of outstanding and exercisable stock options at December 31, 2007 is as follows:
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 19 - Condensed Financial Statements of Parent Company
The following represents the condensed financial statements of Monarch Community Bancorp, Inc. (“Parent”) only. The Parent-only financial information should be read in conjunction with the Corporation’s consolidated financial statements.
Condensed Balance Sheet (000s omitted)
Condensed Income Statement (000s omitted)
Monarch Community Bancorp, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
(000s omitted, except per share data)
Note 19 - Condensed Financial Statements of Parent Company (Continued)
Condensed Statement of Cash Flows (000s omitted)
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain income and expense and per share data on a quarterly basis for the three-month periods indicated:
ITEM 9.
ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None
ITEM 9A
ITEM 9A (T). Controls and Procedures
An evaluation of the Registrant’s disclosure controls and procedures (as defined in Section 13(a)-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”) as of December 31, 2007 was carried out under the supervision and with the participation of the Registrant’s Chief Executive Officer, Chief Financial Officer and several other members of the Registrant’s senior management. The Registrant’s Chief Executive Officer and Chief Financial Officer concluded that the Registrant’s disclosure controls and procedures as currently in effect are effective in ensuring that the information required to be disclosed by the Registrant in the reports it files or submits under the Exchange Act is (i) accumulated and communicated to the Registrant’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the Security and Exchange Commission’s rules and forms. There have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the quarter ended December 31, 2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
The Registrant intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Registrant’s business. While the Registrant believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Registrant to modify its disclosure controls and procedures.
Monarch Community Bancorp, Inc. and Subsidiaries Management’s Report on Internal Control Over Financial Reporting
The management of Monarch Community Bancorp, Inc. and Subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting. Monarch Community Bancorp, Inc. and Subsidiaries internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of its financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective, provide only reasonable assurance with respect to financial statement preparation and presentation.
Management of Monarch Community Bancorp, Inc. and Subsidiaries assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework. Based on our assessment we believe that, as of December 31, 2007, the Company’s internal control over financial reporting is effective based on those criteria.
Dated: March 28, 2008
Donald L. Denney
President and Chief Executive Officer
Rebecca S. Crabill
Vice President and Chief Financial Officer
This annual report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the company to provide only management’s report in this annual report.
ITEM 9B.
ITEM 9B. Other Information - Not Applicable
PART III
ITEM 10.
ITEM 10. Directors, Executive Officers and Corporate Governance
Information required by this Item 10 is incorporated herein by reference from the definitive proxy statement for the annual meeting of shareholders, to be held in April 2008, under the captions “Election of Directors”, ”The Audit Committee”, ”Audit Committee Financial Expert”, ”Compliance with Section 16”, “Code of Ethics”, and “Role and Composition of the Board of Directors”, a copy of which will be filed not later than 120 days after the close of the fiscal year.
ITEM 11.
ITEM 11. Executive Compensation
Information concerning executive compensation is incorporated herein by reference from the definitive proxy statement for the annual meeting of shareholders, to be held in April 2008, under the captions “Compensation Discussion and Analysis”, “Compensation Committee Report”, and “Compensation Committee Interlocks and Insider Participation”, a copy of which will be filed not later than 120 days after the close of the fiscal year.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
Information concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the definitive proxy statement for the annual meeting of shareholders, to be held in April 2008, under the captions “Security Ownership of Shareholder Holding 5% or More” and “Security Ownership of Directors, Nominees for Directors, Most Highly Compensated Executive Officers and All Directors and Officers as a Group”, a copy of which will be filed not later than 120 days after the close of the fiscal year.
Equity Compensation Plan Information
The following table summarizes our equity compensation plans as of December 31, 2007:
Number of securities
to be issued upon
Weighted-average
Number of securities
exercise of
exercise price of
remaining available for
outstanding options
outstanding options
future issuance under
Plan Category
warrants and rights
warrants and rights
equity compensation plans
Equity compensation plans approved by security holders (1)
174,757
13.21
56,681
Equity compensation plans not approved by security holders
-
-
-
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions, and Director Independence
Information concerning certain relationships and related transactions is incorporated herein by reference from the definitive proxy statement for the annual meeting of stockholders, to be held in April 2008, under the captions “Transactions with Certain Related Persons” and “Role and Composition of the Board of Directors”, a copy of which will be filed not later than 120 days after the close of the fiscal year.
ITEM 14.
ITEM 14. Principal Accountant Fees and Services
Information concerning principal accountant fees and services is incorporated herein by reference from the definitive proxy statement for the annual meeting of stockholders, to be held in April 2008, under the caption “Item 2. Ratification of Auditors”, a copy of which will be filed not later than 120 days after the close of the fiscal year.
PART IV
ITEM 15.
ITEM 15. Exhibits and Financial Statement Schedules
Documents Filed As Part Of This Annual Report on Form 10-K
1.
Financial Statement - See the Financial Statements included in Item 8.
2.
Financial Statement Schedules - Financial statement schedules are omitted for the reason that they are not required or are not applicable, or the required information is included in the financial statements.
3.
Exhibits - The exhibits filed as part of this Annual Report on Form 10-K are identified in the Exhibit Index, which Exhibit Index specifically identifies those exhibits that describe or evidence all management contracts and compensation plans or arrangements required to be filed as exhibits to this report. Such Exhibit Index is incorporated herein by reference.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Company and in the capacities and on the date indicated.
Exhibit Index