UNITED STATES 
SECURITIES AND EXCHANGE COMMISSION 
Washington, D.C. 20549 
 FORM 10-K
  (Mark One)x
ANNUAL REPORT UNDER
  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended
  December 31, 2006Commission
file number 0-49814MONARCH COMMUNITY BANCORP, INC.(Exact
  name of registrant as specified in its charter)  Maryland

04-3627031(State
  or other jurisdiction of

(I.R.S.
  Employerincorporation
  or organization)

Identification
  No.)375 North Willowbrook Road, Coldwater, Michigan

49036(Address
  of principal executive offices)

(Zip
  Code)  Registrants
  telephone number, including area code:     (517)
  278-4566Securities
  Registered Pursuant to Section 12(b) of the Act:Common Stock, par value $.01 per share registered on NASDAQ
  Capital Market Indicate by check mark if
the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. Yes o   No x. Indicate by check mark if
the registrant is not required to file reports pursuant to Section 13 of
Section 15(d) of the Exchange Act. Yes o   No x. Indicate by check mark
whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90 days.
YES x   NO o Indicate by check mark if
disclosure of delinquent filers in response to Item 405 of Regulation S-K is
not contained herein, and will not be contained, to the best of registrants
knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to this Form
10-K. x Indicate by check mark whether
the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definitions of accelerated filer and large
accelerated filer in Rule 12b-2 of the Exchange Act.
 Large Accelerated Filer o      Accelerated
Filer o
      Non-Accelerated Filer x
 Indicate by check mark
whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act). Yes o   No x. The aggregate market value
of the registrants common stock held by non-affiliates of the registrant,
based on the average bid price market price of such stock as of June 30, 2006,
was approximately $31.1 million based on the asked price as reported on the
NASDAQ Capital Market. (The exclusion from such amount of the market value of
the shares owned by any person shall not be deemed an admission by the issuer
that such person is an affiliate of the issuer.) As of February 2, 2007, the
registrant had 2,533,781 shares of common stock issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE PART III of Form 10-K  Portions
of the
Registrants Proxy Statement for the Annual Meeting of Stockholders to be held
in April 2007. 1    PART I

ITEM 1. Business

General

Monarch
Community Bancorp, Inc. (Company) was incorporated in March 2002 under
Maryland law to hold all of the common stock of Monarch Community Bank
(Monarch or the Bank), formerly known as Branch County Federal Savings and
Loan Association. The Bank converted to a stock savings institution effective
August 29, 2002. In connection with the conversion, the Company sold 2,314,375
shares of its common stock in a subscription offering.

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

Monarch
Community Bank provides a broad range of banking services to its primary market
area of Branch, Calhoun and Hillsdale counties, Michigan. The Bank owns 100%
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 a variety of consumer loans.

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

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

At
December 31, 2006, we had assets of $290.0 million, deposits of $192.6 million
and stockholders equity of $40.0 million.

2

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 79 full-time and 3 part-time employees as of December 31, 2006.
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, 2006, we had
a 19.3% market share of FDIC-insured deposits in Branch County, a 6.3% market
share of FDIC-insured deposits in Calhoun County and a 2.5% 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,
2006, our net loan portfolio totaled $230.2 million, which constituted 79.4% 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.

3

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

December 31,2006

2005

2004

2003

2002(Dollars in thousands)Real
  Estate Loans:One-to-four family

$
140,374

$
139,636

$
141,251

$
93,056

$
100,235Multi-family


7,511


3,534


4,042


485


172Commercial


41,079


34,721


42,746


22,728


17,801Construction or
development


9,529


5,415


8,853


9,451


7,177Total real estate
loans


198,493


183,306


196,892


125,720


125,385Other
  Loans:Consumer loans:Automobile


1,509


2,447


2,631


1,546


2,233Home equity


19,077


16,170


14,234


9,613


11,629Manufactured housing


495


576


784


930


1,274Other


7,083


7,799


6,736


3,795


4,655Total consumer loans


28,164


26,992


24,385


15,884


19,791Commercial Business
Loans


6,205


6,364


5,330


2,695


2,130Total other loans


34,369


33,356


29,715


18,579


21,921Total loans


232,862


216,662


226,607


144,299


147,306Less:Allowance for loan
losses


2,024


2,925


6,420


2,618


1,735Net deferred loan
fees


591


640


808


454


406Loans in process








6


2


2Total loans, net

$
230,247

$
213,097

$
219,373

$
141,225

$
145,1634

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

December 31, 2006

December 31, 2005Amount

Percent

Amount

Percent(Dollars in thousands)Fixed-Rate
  LoansReal
  Estate Loans:One-to-four family

$
87,568


37.6
%
$
79,858


36.9
%Multi-family


5,578


2.4
%

1,906


0.9
%Commercial


21,081


9.1
%

11,946


5.5
%Construction or
development


4,908


2.1
%

3,579


1.7
%Total real estate
loans


119,135


51.2
%

97,289


45.0
%Consumer


20,687


8.9
%

16,940


7.7
%Commercial
  Business


4,544


1.9
%

4,357


2.0
%Total fixed-rate
loans


144,366


62.0
%

118,586


54.7
%Adjustable-Rate
  LoansReal
  Estate Loans:One-to-four family

$
52,805


22.7
%
$
58,615


27.1
%Multi-family


1,932


0.8
%

1,628


0.7
%Commercial


19,999


8.6
%

21,216


9.8
%Construction or
development


4,622


2.0
%

1,836


0.8
%Total real estate
loans


79,358


34.1
%

83,295


38.4
%Consumer


7,477


3.2
%

10,052


4.6
%Commercial
  Business


1,661


0.7
%

4,729


2.3
%Total adjustable-rate
loans


88,496


38.0
%

98,076


45.3
%Total loans


232,862


100.0
%

216,662


100.0
%Less:Allowance for loan
losses


2,024





2,925Net deferred loan
fees


591





640Loans in process








Total Loans, net

$
230,247




$
213,0975

The
following table illustrates the contractual maturity of our loan portfolio at
December 31, 2006. Mortgages which have adjustable or renegotiable interest
rates are shown as maturing in the period during which the contract is due. The
table does not reflect the effects of possible prepayments or enforcement of
due-on-sale clauses.


|                                  |  |                        |  |                               |   |                               |  |                           |   |                     |  |                           |   |        |  |                           |   |        |  |                           |   |         |  |                           |  
|--------------------------------- |  | ---------------------- |  | ----------------------------- | - | ----------------------------- |  | ------------------------- | - | ------------------- |  | ------------------------- | - | ------ |  | ------------------------- | - | ------ |  | ------------------------- | - | ------- |  | ------------------------- | -
|                                  |  |                        |  | Real Estate                   |   |                               |  |                           |   |                     |  |                           |  
|                                  |  |                        |  |                               |   |                               |  |                           |   |                     |  |                           |  
|                                  |  | One-to-Four Family     |  | Multi-family and
  Commercial |   | Construction or
  Development |  | Consumer                  |   | Commercial Business |  | Total                     |  
|                                  |  |                        |  |                               |   |                               |  |                           |   |                     |  |                           |  
|                                  |  | Amount                 |  | Weighted
  Average
  Rate     |   | Amount                        |  | Weighted
  Average
  Rate |   | Amount              |  | Weighted
  Average
  Rate |   | Amount |  | Weighted
  Average
  Rate |   | Amount |  | Weighted
  Average
  Rate |   | Amount  |  | Weighted
  Average
  Rate |  
|                                  |  |                        |  |                               |   |                               |  |                           |   |                     |  |                           |   |        |  |                           |   |        |  |                           |   |         |  |                           |  
|                                  |  |                        | 
|                                  |  | (Dollars in Thousands) | 
|                                  |  |                        | 
|Due to Mature:                    |  |                        |  |                               |   |                               |  |                           |   |                     |  |                           |   |        |  |                           |   |        |  |                           |   |         |  |                           |  
|                                  |  |                        |  |                               |   |                               |  |                           |   |                     |  |                           |   |        |  |                           |   |        |  |                           |   |         |  |                           |  
|One year or less (1)              |  | 3,861                  |  | 7.08                          | % | 3,941                         |  | 7.45                      | % | 6,286               |  | 7.28                      | % | 1,853  |  | 7.39                      | % | 558    |  | 9.46                      | % | 16,499  |  | 7.36                      | %
|After one year through five
years |  | 24,568                 |  | 6.78                          | % | 20,709                        |  | 7.16                      | % | 47                  |  | 7.21                      | % | 13,346 |  | 8.13                      | % | 3,089  |  | 7.68                      | % | 61,759  |  | 7.24                      | %
|After five years                  |  | 111,945                |  | 6.87                          | % | 23,940                        |  | 7.38                      | % | 3,196               |  | 6.47                      | % | 12,965 |  | 7.76                      | % | 2,558  |  | 8.25                      | % | 154,604 |  | 7.04                      | %

(1)
Includes
  demand loans. The
total amount of loans due after December 31, 2007 which have predetermined
interest rates is $130.4 million while the total amount of loans due after such
date which have floating or adjustable rates is $85.5 million. 6   One-to-Four Family
Residential Real Estate Lending.We have focused
our lending efforts primarily on the origination of loans secured by first
mortgages on owner-occupied, one-to-four family residences in our market area.
At December 31, 2006, one-to-four family residential mortgage loans totaled
$140.4 million, or 60.3% of our gross loan portfolio.

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

At December
31, 2006, $15.6 million, or 11.1% of our residential mortgage loans were
classified as sub-prime loans as compared to $16.8 million, or 12.0% at
December 31, 2005. 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 2006, $183,000, or 20.3%, of our total net charge-offs of
$901,000 million were due to sub-prime loans as compared to $276,000, or 8.9%
of our total net charge-offs of $3.1 million for 2005. 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, 2006 and December 31,
2005, we originated $6.8 million and $15.1 million of one-to-four family ARM
loans, respectively, and $46.8 million and $51.5 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.

7

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

Multi-family and
Commercial Real Estate Lending. We offer a variety
of multi-family and commercial real estate loans. These loans are secured
primarily by residential development projects, residential rental properties,
commercial properties, retail establishments, churches and small office
buildings located in our market area. At December 31, 2006, multi-family and
commercial real estate loans totaled $48.6 million or 20.9% of our gross loan
portfolio.

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

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

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

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

Construction and
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, 2006, we had $9.5 million in
construction and land development loans outstanding, representing 4.1% of our
gross loan portfolio.

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

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

8

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

Consumer and Other
Lending. Consumer loans generally have shorter
terms to maturity, which reduces our exposure to changes in interest rates, and
carry higher rates of interest than do one-to-four family residential mortgage
loans. In addition, management believes that offering consumer loan products
helps to expand and create stronger ties to our existing customer base by
increasing the number of customer relationships and providing cross-marketing
opportunities. At December 31, 2006, our consumer loan portfolio totaled $28.2
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. 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 $19.1 million, and comprised 8.2% of our gross
loan portfolio at December 31, 2006. These loans may be originated in amounts,
together with the amount of the existing first mortgage, of up to 100% of the
value of the property securing the loan. The term to maturity on our home
equity lines of credit may be up to 15 years and have fixed and adjustable
interest rates. No principal payments are required on home equity lines of
credit during the loan term. Other consumer loan terms vary according to the
type of collateral, length of contract and creditworthiness of the borrower.

We originate
auto loans and manufactured housing loans on a direct basis. We also had $5.5
million of indirect consumer loans at December 31, 2006 which reflects a
decrease of $0.7 million for the year and no longer engage in indirect consumer
lending because of the additional credit risk it presented.

Auto loans
totaled $1.5 million at December 31, 2006, or 0.6% of our gross loan portfolio.
Auto loans may be written for up to six years and have fixed rates of interest.
Loan to value ratios can be up to 100% of the sales price for new autos and
100% of wholesale value on used cars, based on valuation from official used car
guides.

Manufactured
housing loans totaled $495,000 at December 31, 2006, or 0.2% of our gross loan
portfolio. This amount remains low because manufactured housing loans are
offered only on an exception basis with approval by the Management Loan
Committee.

We originate
direct sub-prime consumer loans, using the same definition as residential
mortgage loans. At December 31, 2006, $663,000, or 2.4%, of our consumer loan
portfolio were sub-prime loans.

Consumer loans
may entail greater risk than do one-to-four family residential mortgage loans,
particularly in the case of consumer loans which are secured by rapidly
depreciable assets, such as automobiles, boats, 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, 2006, commercial business loans comprised $6.2 million, or 2.7%
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. 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, 2006, there was a $10,000 financial standby
letter of credit outstanding.

9

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

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

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

During the
last several years up to 2006, 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 16.7% and 14.0% in 2006
and 2005 respectively. We sell a portion of the conforming, fixed-rate,
one-to-four family residential loans we originate, primarily those with lower
interest rates. We keep the sub-prime residential real estate loans we
originate. We may purchase residential loans and commercial real estate loans
from time to time.

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

10

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

Years
  Ended
  December 31,2006

2005(Dollars
  in thousands)Originations
  by type:Real Estate:One-to-four family

$
53,645

$
66,638Multi-family


4,112


719Commercial


9,174


6,884Construction or
development


16,312


10,716Total real estate
loans


83,243


84,957Consumer
  Loans:Automobile


642


1,454Home Equity


12,603


11,576Mobile Homes


37


19Other


1,802


4,194Commercial business


6,169


5,822Total loans
originated


104,496


108,022Sales and
  Repayments:One-to-four family loans
sold


16,191


26,635Commercial real estate loans
sold


899


4,793Principal repayments


68,310


86,393Total reductions


85,400


117,821Loans
  acquired in acquisition





Increase
  (decrease) in other items, net


1,946


(3,555
)Net increase
(decrease)

$
17,150

$
(6,244
)11

Asset Quality

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

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

12

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

60-89
  Days

December
  31, 2006
  Loans Delinquent For:
  90 Days and Over

Total
  Delinquent LoansNumber

Amount

Percent of
  Loan
  Category

Number

Amount

Percent of
  Loan
  Category

Number

Amount

Percent of
  Loan
  Category(Dollars
  in Thousands)Real EstateOne-to-four family


27

$
1,740


1.24
%

2

$
143


0.10
%

29

$
1,883


1.34
%Multi-family








0.00
%







0.00
%







0.00
%Commercial


3


658


1.60
%







0.00
%

3


658


1.60
%Construction or development


1


32


0.34
%







0.00
%

1


32


0.34
%Total real estate loans


31

$
2,430


1.22
%

2

$
143


0.07
%

33

$
2,573


1.29
%Consumer


13


151


0.54
%

2


15


0.05
%

15


166


0.59
%Commercial Business


1


5


0.08
%







0.00
%

1


5


0.08
%Total


45

$
2,586


1.11
%

4

$
158


0.07
%

49

$
2,744


1.18
%60-89
  Days

December
  31, 2005
  Loans Delinquent For:
  90 Days and Over

Total
  Delinquent LoansNumber

Amount

Percent of
  Loan
  Category

Number

Amount

Percent of
  Loan
  Category

Number

Amount

Percent of
  Loan
  Category(Dollars
  in Thousands)Real EstateOne-to-four family


30

$
1,478


1.06
%

5

$
280


0.20
%

35

$
1,758


1.26
%Multi-family








0.00
%







0.00
%







0.00
%Commercial


2


119


0.34
%







0.00
%

2


119


0.34
%Construction or development








0.00
%







0.00
%







0.00
%Total real estate loans


32

$
1,597


0.87
%

5

$
280


0.15
%

37

$
1,877


1.02
%Consumer


7


78


0.29
%

1


8


0.03
%

8


86


0.32
%Commercial Business


3


453


7.12
%







0.00
%

3


453


7.12
%Total


42

$
2,128


0.98
%

6

$
288


0.13
%

48

$
2,416


1.11
%13

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

December
  31,2006

2005

2004

2003

2002(Dollars
  in Thousands)Non-accruing
  loans:One-to-four family

$
408

$
406

$
1,866

$
908

$
1,372Multi-family











318


Commercial real estate





397


1,708


1,558


211Construction or development








220


645


Consumer


60


8


93


101


55Commercial business








344


89


Total


468


811


4,231


3,619


1,638Accruing
  loans delinquent 90 days or more:One-to-four family














864Multi-family














Commercial real estate














342Construction or development














Consumer











127


111Commercial business














Total











127


1,317Foreclosed
  assets:One-to-four family (1)


1,580


2,239


1,560


2,177


2,022Multi-family














Commercial real estate





480


400





Construction or development














Consumer


100


22


9


47


37Commercial business





70








Total


1,680


2,811


1,969


2,224


2,059Total non-performing assets

$
2,148

$
3,622

$
6,200

$
5,970

$
5,014Total as a percentage of total assets


0.74
%

1.31
%

2.23
%

2.94
%

2.53
%(1)
Includes $895,000, $1.3
  million and $726,000 in real estate in judgment and subject to redemption at
  December 31, 2006, 2005 and 2004, respectively.For the years
ended December 31, 2006, 2005 and 2004, respectively, there was $60,000,
$200,000, and $211,000 of gross interest income which would have been recorded
had non-accruing loans been current in accordance with their original
terms.

14

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, 2006, we had classified $3.5 million of our
assets as substandard, none as doubtful and none as loss. The total amount
classified as substandard represented 8.8% of the Banks equity capital and
1.2% of the Banks assets at December 31, 2006. The allowance for loan losses
at December 31, 2006 includes $438,000 related to substandard and doubtful
loans. At December 31, 2006, $2.2 million and $0 of substandard and doubtful
assets, respectively, have been included in the table of non-performing assets.
See - Asset Quality - Delinquent Loans.

Provision for Loan
Losses. We recorded no provision for loan losses
totaling for the year ended December 31, 2006 compared to a $385,000 recovery
for the year ended December 31, 2005. 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, 2006 and 2005 - 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.

15

Allowance for Loan
Losses, continued -Senior management reviews
these conditions monthly. To the extent that any of these conditions is
evidenced by a specifically identifiable problem credit or portfolio segment as
of the evaluation date, managements estimate of the effect of this condition
may be reflected as a specific allowance applicable to this credit or portfolio
segment.

The allowance
for loan losses is based on estimates of losses inherent in the loan portfolio.
Actual losses can vary significantly from the estimated amounts. Our
methodology as described permits adjustments to any loss factor used in the
computation of the formula allowance in the event that, in management's
judgment, significant factors which affect the collectibility of the portfolio
as of the evaluation date are not reflected in the loss factors. By assessing
the estimated losses inherent in the loan portfolio on a quarterly basis, we
are able to adjust specific and inherent loss estimates based upon any more
recent information that has become available.

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

16

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

December 31,2006

2005

2004

2003

2002Balance at
beginning of year

$
2,925

$
6,420

$
2,618

$
1,735

$
1,683Charge-offs:One-to-four family


223


754


375


436


415Multi-family














Commercial real estate


15


1,904


1,306





1Construction or development


340


6





15


Consumer


494


393


181


122


152Commercial business


113


386








Total


1,185


3,443


1,862


573


568Recoveries:One-to-four family


4


78


105


157


135Multi-family














Commercial real estate





1


28





Construction or development














Consumer


275


230


143


32


88Commercial business


5


24








Total


284


333


276


189


223Net
charge-offs


901


3,110


1,586


384


345Allowance
acquired in acquisition








513





Additions
charged to operations








4,875


1,267


397Provision
recovered from operations





(385
)







Balance at
end of year

$
2,024

$
2,925

$
6,420

$
2,618

$
1,735Ratio of net charge-offs during the year to
  average loans outstanding during the year


0.39
%

1.42
%

0.82
%

0.26
%

0.24
%Allowance as a percentage of non-performing
  loans


432.48
%

360.67
%

151.74
%

69.89
%

58.71
%Allowance
as a percentage of total loans
  (end of year)


0.87
%

1.37
%

2.84
%

1.81
%

1.18
%17

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

December 31,2006

2005

2004Amount of
  Loan Loss
  Allowance

Percentage
  of
  Loans

Amount of
  Loan Loss
  Allowance

Percentage
  of
  Loans

Amount of
  Loan Loss
  Allowance

Percentage
  of
  LoansOne-to-four
family

$
783


60.3
%
$
1,378


64.4
%
$
1,516


62.3
%Multi-family and non-residential real
  estate


809


20.8
%

1,091


17.7
%

4,513


20.7
%Construction or development


7


4.1
%

17


2.5
%

27


3.9
%Consumer


302


12.1
%

284


12.5
%

296


10.7
%Commercial
business


123


2.7
%

155


2.9
%

68


2.4
%Total

$
2,024


100.0
%
$
2,925


100.0
%
$
6,420


100.0
%2003

2002Amount of
  Loan Loss
  Allowance

Percentage
  of
  Loans

Amount of
  Loan Loss
  Allowance

Percentage
  of
  LoansOne-to-four
family

$
624


64.5
%
$
805


68.0
%Multi-family and non-residential real
  estate


1,239


16.1
%

686


12.2
%Construction or development


507


6.5
%

33


4.9
%Consumer


173


11.0
%

201


13.4
%Commercial
business


75


1.9
%

10


1.5
%$
2,618


100.0
%
$
1,735


100.0
%Investment Activities

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

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

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

18

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

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

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

December 31, 2006

December 31, 2005Amortized
  Cost

Fair
  Market
  Value

Percent of
  Total
  Fair Market
  Value

Amortized
  Cost

Fair
  Market
  Value

Percent of
  Total
  Fair Market
  ValueAvailable-for-sale securities:U.S. government agency obligations

$
10,730

$
10,626


76.3
%
$
11,961

$
11,773


80.8
%Mortgage-backed securities


1,108


1,082


7.8
%

1,317


1,278


8.8
%Obligations of states and political subdivisions


1,964


1,998


14.3
%

1,293


1,286


8.8
%Total available-for-sale securities

$
13,802

$
13,706


98.4
%
$
14,571

$
14,337


98.4
%Held-to-maturity securities:Municipal security

$
228

$
228


1.6
%
$
247

$
236


1.6
%Total investment securities

$
14,030

$
13,934


100.0
%
$
14,818

$
14,573


100.0
%December 31, 2004Amortized
  Cost

Fair
  Market
  Value

Percent of
  Total
  Fair Market
  ValueAvailable-for-sale securities:U.S. government agency obligations

$
3,984

$
3,989


47.9
%Mortgage-backed securities


1,677


1,675


20.1
%Obligations of states and political subdivisions


2,394


2,393


28.7
%Total available-for-sale securities

$
8,055

$
8,057


96.8
%Held-to-maturity securities:Municipal security

$
267

$
268


3.2
%Total investment securities

$
8,322

$
8,325


100.0
%19

The maturities
of the investment securities portfolio, excluding FHLB stock, as of December 31,
2006 are indicated in the following table.

Less
  than 1 year

1 to 5
  years

5 to 10
  years

Over 10
  years

Total
  SecuritiesAmortized
  Cost

Wgt
  Ave
  Yield

Amortized
  Cost

Wgt
  Ave
  Yield

Amortized
  Cost

Wgt
  Ave
  Yield

Amortized
  Cost

Wgt
  Ave
  Yield

Amortized
  Cost

Wgt
  Ave
  Yield(Dollars
  in Thousands)Available-for-sale securities:U.S. government agency obligations

$
3,494

3.48
%
$
7,236

4.64
%
$


0.00
%
$


0.00
%
$
10,730

4.26
%Mortgage-backed securities




0.00
%

1,108

4.24
%



0.00
%



0.00
%

1,108

4.24
%Obligations of states and political subdivisions




0.00
%

451

4.24
%

1,338

5.78
%

175

5.94
%

1,964

5.44
%Total available-for-sale securities


3,494

3.48
%

8,795

4.57
%

1,338

5.78
%

175

5.94
%

13,802

4.43
%Held-to-maturity securities:Municipal security




0.00
%



0.00
%



0.00
%

228

6.52
%

228

6.52
%Total investment securities

$
3,494

3.48
%
$
8,795

4.57
%
$
1,338

5.78
%
$
403

6.27
%
$
14,030

4.46
%Sources of Funds

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

Deposits.
We offer a variety of deposit accounts to both consumers and businesses having
a wide range of interest rates and terms. Our deposits consist of passbook and
statement savings accounts, money market deposit accounts, NOW and demand
accounts and certificates of deposit. We solicit deposits in our market area
and have accepted and continue to utilize brokered deposits. At December 31,
2006, we had $41.3 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.

20

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

Year Ended
  December 31,2006

2005(Dollars in Thousands)Opening
  balance

$
174,715

$
169,573Deposits
  acquired





Net deposits
  (withdrawals)


12,355


1,631Interest
  credited


5,502


3,511Ending
  balance

$
192,572

$
174,715Net increase

$
17,857

$
5,142Percent
  increase


10.22
%

3.03
%The following
table sets forth the dollar amount of savings deposits in the various types of
deposit programs offered by Monarch at the dates indicated.

Year Ended December 31,2006

2005Amount

Percent
  of Total

Amount

Percent
  of Total(Dollars in Thousands)Transaction and Savings
  Deposits:Non-interest bearing
  accounts

$
15,733


8.2
%
$
14,837


8.5
%Savings accounts


22,822


11.8
%

26,536


15.2
%Checking & NOW accounts


18,583


9.6
%

20,641


11.8
%Money market accounts


22,630


11.8
%

15,767


9.0
%Total transaction and
  savings

$
79,768


41.4
%
$
77,781


44.5
%Certificates:0.00-1.99%


12


0.0
%

332


0.2
%2.00-3.99%


11,535


6.0
%

44,413


25.4
%4.00-5.99%


101,257


52.6
%

51,895


29.7
%6.00-7.99%





0.0
%

294


0.2
%Total certificates


112,804


58.6
%

96,934


55.5
%Total deposits

$
192,572


100.0
%
$
174,715


100.0
%21

The following
table indicates the amount of our certificates of deposit by time remaining
until maturity as of December 31, 2006.

Maturity3 Months
  or less

Over
  3 to 6
  Months

Over
  6 to 12
  Months

Over
  12
  Months

Total(Dollars in Thousands)Certificates of deposit less than $100,000

$
13,460

$
12,388

$
15,871

$
16,990

$
58,709Certificates of deposit of $100,000 or more


10,269


24,088


6,641


13,097


54,095Total
certificates of deposit

$
23,729

$
36,476

$
22,512

$
30,087

$
112,804The following
table shows rate and maturity information for our certificates of deposit as of
December 31, 2006.

Certificate
accounts maturing in quarter ending:

0.00-1.99%

2.00-3.99%

4.00-5.99%

6.00-7.99%

Total

Percent
  of Total(Dollars
  in Thousands)March 31,
2007

$
12

$
2,744

$
20,974

$


$
23,730


21.0
%June 30,
2007





979


35,497





36,476


32.3
%September
30, 2007





689


11,008





11,697


10.4
%December
31, 2007





575


10,243





10,818


9.6
%March 31,
2008





2,294


862





3,156


2.8
%June 30,
2008





1,325


2,903





4,228


3.8
%September
30, 2008





415


3,903





4,318


3.8
%December
31, 2008





1,275


2,449





3,724


3.3
%March 31,
2009





490


735





1,225


1.1
%June 30,
2009





306


214





520


0.5
%September
30, 2009





223


1,148





1,371


1.2
%December
31, 2009





220


3,511





3,731


3.3
%Thereafter








7,810





7,810


6.9
%Total

$
12

$
11,535

$
101,257

$


$
112,804


100.0
%Percent of
total


0.01
%

10.23
%

89.76
%

0.00
%22

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

We may obtain
advances from the Federal Home Loan Bank of Indianapolis upon the security of
certain of our mortgage loans and mortgage-backed securities. These advances
may be made pursuant to several different credit programs, each of which has
its own interest rate, range of maturities and call features. At December 31,
2006, we had $54.5 million in Federal Home Loan Bank advances outstanding. See
Note 10 of the Notes to Consolidated Financial Statements for information on
maturity dates and interest rates related to our Federal Home Loan Bank
advances.

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

December 31,2006

2005(Dollars in Thousands)Maximum Balance:FHLB advances

$
64,592

$
65,787Average Balance:FHLB advances

$
58,107

$
61,842The following
table sets forth certain information concerning our borrowings at the dates
indicated.

December 31,2006

2005(Dollars in Thousands)FHLB advances

$
54,476

$
59,562Weighted average interest
  rate of FHLBFHLB advances


5.47
%

5.36
%Competition

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

Employees

At December
31, 2006, we had a total of 82 employees, including 3 part-time employees. Our
employees are not represented by any collective bargaining group. Management
considers its employee relations to be good.

23

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.

State Taxation

The State of
Michigan imposes a Single Business Tax (SBT), which is an annual value-added
tax imposed on the privilege of doing business in the state. Every person with
business activity in Michigan is subject to the tax. Most organizations exempt
from federal income tax are also exempt from the SBT. The major components of
the SBT base are compensation, depreciation and federal taxable income,
increased by net operating losses, if any, utilized in arriving at federal
taxable income. An investment tax credit is claimed for the acquisition of
qualifying tangible assets physically located in Michigan. The SBT rate for
2006 was 1.9%. The rate is subject to change annually. The SBT will be repealed
12/31/07. A replacement tax for the SBT has not been finalized at this time. 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.

24

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. In 2006,
the Bank converted to a Michigan state-chartered Bank from a federal savings
bank and the Company, as the sole shareholder of the Bank, became 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.

25

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
legislation 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
now 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.

26

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, 2006, 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 $7.8 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. 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.

27

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, set assessment rates
beginning January 1, 2007 and establish a new insurance assessment system.
Under the new 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 new regulations also established
assessment rates beginning January 1, 2007 with the highest rated institutions,
those in Risk Category I, paying premiums of between .05% and .07% of deposits
and the lowest rated institutions, those in Risk Category IV, paying 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. 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.

28

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:


for
  transaction accounts totaling $8.5 million or less, a reserve of 0%; and
for
  transaction accounts in excess of $8.5 million up to and including $45.8
  million, a reserve of 3%; and
for
  transaction accounts totaling in excess of $45.8 million, a reserve
  requirement of $1.119 million plus 10% against that portion of the total
  transaction accounts greater than $45.8 million.The effect of
maintaining the required non-interest earning reserve is to reduce the Banks
interest-earning assets.

29

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 233,000,
and an economy based primarily on manufacturing and agriculture. Our local
economy has not grown, and is not projected to grow as rapidly as the national
economy. Job losses and unemployment rates in all three counties exceed the
state and national averages.

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

Up until a few
years ago, a significant portion of our one-to-four family residential loan
originations were considered subprime. At December 31, 2006, 11.1% 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.

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

The successful
operation of Monarch Community Bancorp and Monarch Community Bank is greatly
dependent on the continued availability of capable executive officers. At
present, the only executive officers of both Monarch Community Bancorp and
Monarch Community Bank are Donald L. Denney, President and Chief Executive
Officer, William C. Kurtz, Senior Vice President and Chief Operations Officer,
Andrew Van Doren, Vice President, Secretary and Corporate Counsel, Ralph
Micalizzi, Vice President, Chief Financial Officer and Treasurer, Eric Cook,
Vice President and Vicki Bassage, Assistant Secretary. 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
335,757 shares as of December 31, 2006) 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:

30

ITEM 1A. Risk Factors, continued


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, 2006 and 2005 were 4,266 and 1,658
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. Unresolved Staff Comments - None

31

ITEM 2. Properties

At December
31, 2006, we had six full service offices and one drive-through only facility.
At December 31, 2006, we owned all of our offices and the net book value of our
investment in premises and equipment, excluding computer equipment, was $5.3
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:

Location

County

Owned/
  LeasedMain Office375 North
  Willowbrook Road

Branch

OwnedColdwater,
  Michigan 49036Branch
  Offices30 West
  Chicago Street

Branch

OwnedColdwater,
  Michigan 49036365 N.
  Broadway

Branch

OwnedUnion City,
  Michigan 490941 West
  Carleton Road

Hillsdale

OwnedHillsdale,
  Michigan 4924215975 West
  Michigan Avenue

Calhoun

OwnedMarshall,
  Michigan 49068107 North
  Park

Calhoun

OwnedMarshall,
  Michigan 49068Other
  Facilities34 Grand
  Street (Garage)

Branch

OwnedColdwater,
  Michigan 4903624 Grand
  Street (Drive through)

Branch

OwnedColdwater,
  Michigan 4903687 Marshall
  Street (Leased to others)

Branch

OwnedColdwater,
  Michigan 49036119 Grand
  Street (Vacant)

Calhoun

OwnedMarshall,
  Michigan 49068We utilize a
third party service provider to maintain our data base of depositor and
borrower customer information.

32

ITEM 3. Legal Proceedings

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

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

No matters
were submitted to a vote of Monarchs stockholders, through the solicitation of
proxies or otherwise, during the fourth quarter of the 2006 fiscal year.

PART II

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

The Companys
common stock commenced trading on August 29, 2002 on the NASDAQ Market under
the symbol MCBF. The table below shows the high and low sales prices of the
common stock for the periods indicated, as reported on the NASDAQ Capital
Market. For the years ended December 31, 2006 and 2005, the Company paid
dividends of $0.24 and $0.21 per share, respectively.

Year

Quarter
  ending

High

Low2005

March 31

$
14.33

$
12.00June 30

$
14.33

$
11.00September 30

$
13.75

$
12.00December 31

$
12.59

$
10.502006

March 31

$
12.80

$
11.02June 30

$
13.00

$
11.07September 30

$
12.63

$
10.90December 31

$
11.25

$
10.03As of February
2, 2007, there were 2,533,781 shares of the Companys common stock issued and
outstanding and approximately 560 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.

33

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

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 August 30, 2002, and reinvestment of all
dividends.

(LINE GRAPH)

Period EndingIndex

08/30/02

12/31/02

12/31/03

12/31/04

12/31/05

12/31/06Monarch
  Community Bancorp


100.00


97.09


139.91


114.49


101.24


93.31Russell 3000


100.00


96.67


126.70


141.83


150.51


174.17SNL
  $250M-$500M Bank Index


100.00


108.80


157.21


178.43


189.44


197.93SNL
  $250M-$500M Thrift Index


100.00


106.64


150.95


165.80


152.89


172.79Source: SNL Financial, LC, Charlottesville, VA 
© 2007

34

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:

December
  31,2006

2005

2004

2003

2002(In
  Thousands)Selected Financial
  Condition Data:Total
Assets

$
289,987

$
277,068

$
275,448

$
203,123

$
197,985Loans
receivable, net


230,247


213,097


219,373


141,225


145,162Investment
securities, at carrying value


13,934


14,584


8,324


19,934


17,434Fed Funds sold
and overnight deposits


7,864


6,988


6,120


20,974


16,063Deposits


192,572


174,715


169,573


107,240


106,744Federal Home
Loan Bank Advances


54,476


59,562


65,955


57,384


52,500Equity


39,986


40,576


39,419


37,430


36,949December 31,2006

2005

2004

2003

2002(In Thousands)Selected Operations Data:Total interest
income

$
17,287

$
15,231

$
13,818

$
12,053

$
12,931Total interest
expense


8,607


6,567


6,173


6,060


6,466Net interest
income


8,680


8,664


7,645


5,993


6,465Provision for
loan losses





(385
)

4,875


1,266


397Net interest
income after provision for loan losses


8,680


9,049


2,770


4,727


6,068Fees and
service charges


2,642


2,496


2,333


1,167


1,154Gains on sales
of loans, mortgage-backed securities and investment
  securities


342


562


805


1,672


998Other
non-interest income


138


341


287


86


7Total
non-interest income


3,122


3,399


3,425


2,925


2,159Total
non-interest expense


9,710


10,503


9,978


6,737


6,798Income before
taxes


2,092


1,945


(3,783
)

915


1,429Income tax
provision


544


505


(1,272
)

251


415Net income
(loss)

$
1,548

$
1,440

$
(2,511
)
$
664

$
1,01435

ITEM 6. Selected Financial Data, continued

December
  31,2006

2005

2004

2003

2002Selected Financial Ratios
  and Other Data:Performance Ratios:Return on
assets (ratio of net income to average total assets)


0.54
%

0.52
%

-0.97
%

0.32
%

0.54
%Return on
Equity (ratio of net income to average equity)


3.85
%

3.59
%

-6.53
%

1.80
%

4.08
%Interest rate
spread information:Average during
period


3.26
%

3.41
%

3.15
%

2.69
%

3.58
%Net interest
margin


3.42
%

3.56
%

3.33
%

3.11
%

3.85
%Ratio of
operating expense to average total assets


3.41
%

3.80
%

3.85
%

3.22
%

3.72
%Ratio of
average interest-earning assets to average interest-bearing
  liabilities


1.05


1.05


1.07


1.13


1.07Efficiency
ratio


80.44
%

85.39
%

88.18
%

74.14
%

75.10
%Asset Quality Ratios:Non-performing
assets to total assets at end of period


0.74
%

1.31
%

2.23
%

2.94
%

2.53
%Non-performing
loans to total loans


0.20
%

0.37
%

1.87
%

2.60
%

2.04
%Allowance for
loan losses to non-performing loans


432.48
%

360.67
%

151.74
%

69.89
%

58.70
%Allowance for
loan losses to loans receivable, net


0.88
%

1.37
%

2.84
%

1.81
%

1.18
%Capital ratios:Equity to
total assets at end of period


13.79
%

14.64
%

14.31
%

18.43
%

18.67
%Other data:Number of
full-service offices


6


6


7


5


5ITEM 7. Managements Discussion and Analysis
of Financial Condition and Results of Operations

General

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

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

Critical Accounting Policies

As described under
Regulation and Supervision, the financial services industry is highly
regulated. Other than described below, management does not believe the use of
estimates and management judgment is likely to present a material risk to the
financial statements. In cases where estimates or management judgment are
required, internal controls and processes are established to provide assurance
that such estimates and management judgments are materially correct to the best
of managements knowledge.

36

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

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

Management Strategy

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

Our focus in
2007 will be growth in commercial lending and non-interest income, maintaining
a high level of customer service, growth of core deposits, continued
improvement of credit quality, and continued development of our sales culture.
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 2007 will serve the Company well
into the future. We intend to continue to capitalize on the 2004 acquisition of
MSB Financial, Inc. with further expansion of our lending activities in Calhoun
County.

Changes in Financial Condition from December
31, 2005 to December 31, 2006

General. Monarchs
total assets increased $12.9 million, or 4.7%, to $290.0 million at December
31, 2006 compared to $277.1 million at December 31, 2005. Increases in loans in
2006 were offset by decreases in cash, investments, foreclosed assets, premises
and equipment and other assets.

Loans. Monarchs net
loan portfolio increased $17.1 million, or 8.0%, from $213.1 million at
December 31, 2005 to $230.2 million at December 31, 2006. Gross loans increased
$16.2 million, or 7.5%, from $216.7 million at December 31, 2005 to $232.9
million at December 31, 2006.

The increases
in loan balances were due to new loan production exceeding repayments and
payoffs on existing loans. Total loan originations decreased 3.2% from $108.0
million in 2005 to $104.5 million in 2006. One-to-four family originations have
declined as new loan production has declined along with the mortgage market.
Commercial real estate, multi-family, home equity, and construction/land
development loans increased in 2006 as lenders had more time to focus on new
loan origination as a result of the success they had in 2005 improving overall
Bank credit quality. Management expects future growth in the loan portfolio to
come from increased originations of commercial real estate and business loans
as well as expanded geographic outreach facilitated by the 2004 acquisition.

Securities. The
Banks security portfolio decreased $0.7 million, or 4.8%, to $13.9 million at
December 31, 2006 from $14.6 million at December 31, 2005. Securities were 4.8%
of total assets at December 31, 2006 as compared to 5.3% at December 31, 2005.
During 2006, securities were purchased primarily to replace investments with
relatively low yields when compared to the current market. Management purchases
securities to maintain sufficient liquidity and to provide yield to offset
declines in the loan portfolio when they occur.

37

Liabilities.
Monarchs deposits increased $17.9 million, or 10.2%, to $192.6 million at
December 31, 2006 compared to $174.7 million at December 31, 2005. This
increase was primarily in certificates of deposit (CDs) as the Bank increased
its reliance on brokered CDs to maintain sufficient liquidity and to fund
repayment of borrowings. Brokered CDs increased from $28.6 million at December
31, 2005 to $41.3 million at December 31, 2006. The Bank did experience a $0.9
million increase in non-interest bearing deposit accounts and a $6.8 million
increase in money market accounts. Most of the increase in money market
accounts came from our Investors Money Market Account which offers a high
interest rate compared to our competition. The Bank did not experience deposit
increases in other areas and continues to compete for core deposits.

Federal Home
Loan Bank advances decreased $5.1 million, or 8.6%, to $59.6 million at
December 31, 2005 from $54.5 million at December 31, 2006. The decrease was
primarily due to repayment of outstanding advances and the replacement of these
advances with brokered deposits. In an effort to manage our interest rate risk,
Monarch is decreasing its dependency on Federal Home Loan Bank advances and
intends to replace these funds with core deposits, brokered deposits, and in
some cases if necessary, lower yielding advances in an environment where it
appears that interest rates are expected to fall. The interest rates paid on
advances is high relative to current market rates, and reducing our dependency
on them should help improve net interest margin as long as interest rates
continue to fall.

Equity. Total equity
amounted to $40.0 million at December 31, 2006 and $40.6 million at December
31, 2005, or 13.8% and 14.6%, respectively, of total assets at both dates. The
decrease in equity over the period was due primarily to 2006 net income of $1.5
million offset by the repurchase of $2.1 million in common stock and the
payment of $630,000 in dividends.

38

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

The following
table presents for the periods indicated the total dollar amount of interest
income from average interest-earning assets and the resultant yields, as well
as the interest expense on average interest-bearing liabilities, expressed both
in dollars and rates. No tax equivalent adjustments were made. All average
balances are average daily balances.

Year
  Ended December 31,2006

2005Average
  Outstanding
  Balance

Interest
  Earned/
  Paid

Yield/
  Rate

Average
  Outstanding
  Balance

Interest
  Earned/
  Paid

Yield/
  Rate(dollars
  in thousands)Fed Funds and overnight
deposits

$
6,444

$
380


5.90
%
$
6,834

$
269


3.94
%Investment securities


13,796


574


4.16


13,494


500


3.71Other securities


4,582


226


4.93


4,753


204


4.29Loans receivable (1)


228,652


16,107


7.04


218,632


14,258


6.52Total earning
assets

$
253,474

$
17,287


6.82

$
243,713

$
15,231


6.25Demand and NOW
accounts

$
34,222

$
70


0.20

$
33,811

$
78


0.23Money market accounts


19,318


617


3.19


16,731


211


1.26Savings accounts


25,223


105


0.42


28,535


119


0.42Certificates of
deposit


105,185


4,626


4.40


90,397


2,929


3.24Federal Home Loan Bank
advances


58,107


3,189


5.49


61,842


3,230


5.22Total interest
bearing liabilities

$
242,055


8,607


3.56

$
231,316


6,567


2.84Net interest
income




$
8,680







$
8,664Net interest spread








3.26
%







3.41
%Net interest margin








3.42
%







3.56
%2004Average
  Outstanding
  Balance

Interest
  Earned/
  Paid

Yield/
  RateFed Funds and overnight
deposits

$
9,349

$
123


1.32
%Investment securities


17,643


442


2.51Other securities


4,093


179


4.37Loans receivable (1)


198,336


13,074


6.59Total earning
assets

$
229,421

$
13,818


6.02Demand and NOW
accounts

$
28,880

$
94


0.33Money market accounts


15,815


176


1.11Savings accounts


24,215


117


0.48Certificates of
deposit


83,478


2,323


2.78Federal Home Loan Bank
advances


62,643


3,463


5.53Total interest
bearing liabilities

$
215,031


6,173


2.87Net interest
income




$
7,645Net interest spread








3.15
%Net interest margin








3.33
%(1)
Calculated net of deferred
  loan fees, loan discounts and loans in process. Nonaccrual loans are included
  in the average outstanding balance.39

Rate/Volume Analysis

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

Year
  Ended December 31,
  2006 vs. 2005

Year
  Ended December 31,
  2005 vs. 2004Increase
  (Decrease) Due to

Total

Increase
  (Decrease) Due to

TotalIncrease



IncreaseRate

Volume

Mix

(Decrease)

Rate

Volume

Mix

(Decrease)(in
  thousands)Interest-earning
assetsFed funds and
overnight deposits

$
134

$
(15
)
$
(8
)
$
111

$
245

$
(33
)
$
(36
)
$
146Investment
securities


61


11


1


73


212


(104
)

(50
)

58Other
securities


30


(7
)




23


(3
)

29


(2
)

24Loans
receivable


1,144


654


51


1,849


(140
)

1,338


(14
)

1,184Total
interest-earning assets

$
1,369

$
643

$
44

$
2,056

$
314

$
1,230

$
(102
)
$
1,412Interest-bearing
liabilitiesDemand and NOW
accounts

$
(9
)
$
1

$


$
(8
)
$
(27
)
$
16

$
(5
)
$
(16
)Money market
accounts


323


33


50


406


23


10


3


36Savings
accounts





(14
)




(14
)

(16
)

21


(3
)

2Certificates
of deposit


1,047


479


171


1,697


382


193


32


607Federal Home
Loan Bank advances


164


(195
)

(10
)

(41
)

(191
)

(44
)

2


(233
)Total
interest-bearing liabilities

$
1,525

$
304

$
211

$
2,040

$
171

$
195

$
30

$
396Net interest
income










$
16










$
1,01640

Rate/Volume Analysis, continued

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

December 31,2006

2005Weighted
  average yield on:Fed Funds and
overnight deposits


4.71
%

3.75
%Investment
securities


4.46
%

3.87
%Federal Home
Loan Bank stock


5.00
%

4.75
%Loans:One-to-four
family


6.86
%

6.62
%Multi-family
and nonresidential real estate


7.29
%

7.08
%Construction
or development


7.01
%

5.86
%Total real
estate loans


6.97
%

6.69
%Other
loans:Consumer
loans


7.91
%

7.62
%Commercial
business loans


8.07
%

7.76
%Total
Loans


7.12
%

6.85
%Combined weighted average yield
on interest
  earning assets


6.87
%

6.54
%Weighted average rate paid
on:Demand and NOW
accounts


0.21
%

0.27
%Money market
accounts


3.73
%

2.36
%Savings
deposits


0.42
%

0.41
%Certificates
of deposit


4.78
%

3.95
%Federal Home
Loan Bank advances


5.47
%

5.36
%Combined weighted average rate
paid on
  interest-bearing liabilities


3.87
%

3.24
%Spread


3.00
%

3.30
%Comparison of Results of Operations for the
Years Ended December 31, 2006, 2005, and 2004

General. Monarch
reported net income of $1.5 million for the year ended December 31, 2006
compared to net income of $1.4 million for the year ended December 31, 2005 and
a net loss of $2.5 million in 2004. The increase in earnings in 2006 was
primarily due to a $0.8 million decrease in total non-interest expense offset
by a $0.3 million decrease in non-interest income and zero loss provision in
2006 whereas a $0.4 million recovery of loan loss provision was recorded in
2005.

Net Interest Income.
Net interest income before provision for loan losses increased 0.2% to $8.68
million for 2006 compared to $8.66 million in 2005. Total interest income
increased $2.06 million primarily from a $1.85 million increase in interest
income on loans and a $0.21 million increase in total interest income on
federal funds sold, overnight deposits and investment securities. The increase
in interest expense is summarized in the Interest Expense paragraph below.

41

Net Interest Income, continued -
Our net interest margin decreased from 3.56% in 2005 to 3.42% in 2006 due to
yields on interest-bearing liabilities increasing more rapidly (2.84% in 2005
to 3.56% in 2006) than yields on interest-earning assets (6.25% in 2005 to
6.82% in 2006). Our net interest margin increased from 3.33% in 2004 to 3.56%
in 2005 because yields on interest-earning assets increased (6.02% in 2004 to
6.25% in 2005) and yields on interest-bearing liabilities (2.87% in 2004 to
2.84% in 2005) slightly decreased.

Interest Income.Interest
income increased $2.06 million during the year ended December 31, 2006. The key
factors contributing to this growth were a $15.2 million increase in loans
secured by real estate, a $2.9 million increase in home equity loans and lines
of credit, and a rising interest rate environment that did not level off until
the third quarter of 2006. The average yield on earning assets increased as a
result of these factors as well as much higher yields on Fed funds, overnight
deposits and investment securities. Please also note that the Bank had an
adjustment correcting the calculation of net deferred fees (which increased
interest income in the fourth quarter of 2006 by approximately $103,000) most
of which corrected net deferred fees on certain loans originated in the last
five years.

Interest
income increased $1.4 million in 2005 primarily as a result of a $2.0 million
increase in home equity loans and lines of credit, a $6.3 million increase in
investment securities, and a rising interest rate environment that lasted
throughout 2005. The average yield on earning assets increased as a result of
these factors as well as much higher yields on Fed funds, overnight deposits
and investment securities.

Interest Expense.Total
interest expense increased $2.04 million in 2006. This was primarily due to a
$2.08 million increase in our cost of funds for deposits (where brokered
deposits increased $12.7 million in 2006) which was partially offset by a
$41,000 decrease in our cost of funds resulting from net repayments of Federal
Home Loan Bank advances totaling $5.1 million. The overall yield on advances
increased from 5.36% in 2005 to 5.47% in 2006 but is expected to decline in
subsequent years as these advances are projected to be replaced (should they be
needed) with deposits and/or advances having a lower cost.

Total interest
expense increased $394,000 in 2005. This was primarily due to a $627,000
increase in our cost of funds for deposits which was partially offset by a
$233,000 decrease in our cost of funds resulting from net repayments of Federal
Home Loan Bank advances totaling $6.2 million.

Provision for Loan Losses.The
Bank recorded no provision for loan losses for the year ended December 31, 2006
compared to a recovery of provisions totaling $385,000 for the year ended
December 31, 2005. This was because of improved asset quality, a lower level of
non-performing assets, and a lower level of charge-offs compared to previous
years. The Bank will consider provisions in future periods if there are changes
in asset quality or other trends noted above.

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.

The Banks net
charge-offs were $0.9 million in 2006 compared to $3.1 million for 2005. The
decreased charge-offs in 2006 are primarily the result of aggressive collection
efforts since 2004, improved credit quality of our loan portfolio that led to a
lower level non-performing assets, and a lower level of delinquencies.
Maintaining asset quality remains a priority of management. See Loans
discussion above.

The Banks net
charge-offs were $3.1 million in 2005 compared to $1.6 million for 2004. The
increased charge-offs in 2005 (provided for in 2004) are primarily the result
of losses incurred on the sale of problem loans completed during the second
quarter of 2005 as well as the Bank continuing to aggressively deal with problem
loans. During the past several years we have continued to be aggressive in
foreclosing on delinquent one-to-four family loans in an attempt to improve the
credit quality of our loan portfolio and the result has been higher than
historical charge-offs, as well as decreased delinquencies on this type of
loans.

42

Non-interest Income.
Non-interest income was $3.1 million and $3.4 million for the years ended
December 31, 2006 and 2005, respectively (a decrease of 8.8%). Fees and service
charges on deposit accounts increased $161,000 as the Bank increased its level
of bounce protection on customer direct deposit accounts (effective May 1,
2006) and its non-sufficient funds fee from $25 to $29 per transaction
(effective September 1, 2006) both of which led to an increase of $113,000 in
NSF fees. Other factors contributing to the increase in fees and service
charges were a $41,000 increase in loan related fees (as the Bank developed new
mortgage banking relationships with four brokerage companies in June 2006 which
led to $64,000 in new fee income) as well as a $8,000 increase in fees for
certificates of deposit early withdrawal penalties and a $14,000 increase in
ATM/Debit Card income.

Gain on sale
of loans decreased $200,000 to $362,000 from $562,000 a year ago as mortgage
banking activities continue to decline due to lower than expected volume of
originations (137 for 2006 compared to 208 for 2005)partly resulting from interest rates that were higher than
they were last year. Other income decreased $203,000 (from $341,000 in 2005 to
$138,000 in 2006) primarily due to a $15,000 decrease in rental income (from
$49,000 in 2005 to $34,000 in 2006), a $120,000 increase in net losses on the
sale of real estate owned (from a $53,000 net gain in 2005 compared to a $67,000
net loss in 2006), a $25,000 decrease in investment services income (from
$58,000 in 2005 to $33,000 in 2006), and a $39,000 decrease (to $0 in 2006) in
net gains on sales of fixed assets (including the Jonesville branch in 2005).
In 2005, the Bank was receiving rental income related to a foreclosed property
that was subsequently sold. The Bank also had a $20,000 loss on the sale of
securities as management replaced two agency securities and one municipal
security with tax-free municipal securities earning higher interest rates in
anticipation of what management expects to be falling interest rates in 2007.

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

Non-interest Expense.Non-interest
expense was $9.7 million and $10.5 million for the years ended December 31,
2006 and 2005, respectively, a decrease of 7.6%. Salaries and employee benefits
decreased $136,000 primarily due to a $68,000 decrease in total employee
salaries and wages (including payroll taxes), and a $206,000 decrease in health
insurance expense resulting primarily from revision to the Banks medical
coverage plans for calendar year 2006 offset by $85,000 in stock option
expenses (as the Bank implemented SFAS No. 123(R) in 2006), a $20,000 increase
in pension fund expense, and a $14,000 increase in restricted stock expense.
Occupancy and equipment expense decreased $61,000 primarily due to lower
depreciation expense. Professional services expense decreased $161,000 due to a
$35,000 reduction in legal expense, a $50,000 reduction in audit and accounting
expense, and a $46,000 reduction in regulatory examination costs. Other
decreases in professional fees were not individually significant.

Expense
control and revenue enhancement continue to be challenges for management as
efforts continue on improving efficiency. In September 2006, management (with
approval from the Board of Directors) decided to downsize certain departments
in order to position the Company for improved financial results. This resulted
in a reduction of 11 full-time equivalent employees (FTEs) in the fourth
quarter of 2006. Management also decided to reduce employee benefits in October
2006 that include reducing the employer match in the Companys 401(k) plan by 50%
(an estimated $38,000 annual savings) and extending the time the Company
allocates ESOP shares to employees from 5 years to 10 years (estimated to be a
$93,000 annual savings for 2007). As strategic planning for 2007 continues,
ways to enhance revenue and improve expense control continued to be pursued.
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.

Repossessed
property expenses decreased $175,000 for the year ended December 31, 2006
compared to the same period in 2005. Management recorded $121,000 in
write-downs of foreclosed properties for 2006 compared to $318,000 in 2005. The
Bank also had a $22,000 increase in foreclosed property operating expenses for
the same period. Amortization of core deposit intangible decreased $78,000 and
amortization of mortgage servicing rights (mortgage banking expense) decreased
$56,000 (consistent with the decline in refinancing) for the year ended December
31, 2006.

43

Other general
and administrative expenses decreased $142,000 for year ended December 31, 2006
as compared to the same period for 2005 primarily due to a $41,000 decrease in
office supplies and printing expenses, a $50,000 decrease in expenses related
to indirect lending (as the Bank exited this type of lending), a $45,000
decrease in telephone expense, and a $45,000 decrease in employee education and
business travel expense offset by a $69,000 increase in advertising and
promotion expense used for professional services for an extensive marketing
campaign. All other increases in non-interest expense were not significant.

Non-interest
expense increased $525,000 for the year ended December 31, 2005 compared to the
year ended December 31, 2004. Repossessed property expense increased to
$521,000 in 2005 from $216,000 in 2004 as a result of the Bank taking $318,000
in write-downs based on recent assessments of the appraised value of
repossessions. Data processing expense increased to $689,000 in 2005 from
$622,000 in 2004 as we continue to stay current with advancing technology which
involved a $32,000 increase in service bureau expense, a $27,000 increase in
licenses and software expense data processing expense and a $10,000 increase in
other related expense most of which were data processing maintenance expenses.
Amortization of core deposit intangible amounted to $369,000 for 2005 compared
to $329,000 in 2004. We expect the expense to be approximately $290,000 in 2007
and will carefully monitor whether additional amortization is needed.
Amortization of mortgage servicing rights amounted to $438,000 for 2005
compared to $385,000 in 2004. We expect the expense for 2006 to be higher than
in 2005 as our portfolio continues to grow. All other increases in non-interest
expense were not significant.

Federal Income Taxes.
Monarch recorded an income tax expense for the year ended December 31, 2006 of
$544,000 on income before tax of $2.1 million which represented an effective
tax rate of 26.0% of income before tax. In 2005, we recorded an income tax
expense of $505,000 which also represented an effective tax rate of 26.0% of
income before tax. 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.
Liquidity may increase or decrease depending upon the availability of funds and
comparative yields on investments in relation to the return on loans.
Historically, we have maintained liquid assets at levels above those believed
to be adequate to meet the requirements of normal operations, including
potential deposit outflows. At December 31, 2006, our liquidity ratio, which is
our liquid assets as a percentage of net withdrawable savings deposits with a
maturity of one year or less and current borrowings, was 10.1%. 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 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, 2006, totaled $82.7 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.

44

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 and is willing to offer
interest rates higher than those of the competition. Based on current
collateral levels, at December 31, 2006, Monarch could borrow an additional
$22.8 million from the Federal Home Loan Bank at prevailing interest rates.
This borrowing capacity can be increased in the future if Monarch pledges
additional collateral, such as securities, to the Federal Home Loan Bank.
Monarch anticipates that it will continue to have sufficient funds, through
deposits and borrowings, to meet its current commitments. For the year ended
December 31, 2006, Monarch had a net decrease in cash and cash equivalents of
$989,000 as compared to a net increase of $637,000 million for the year ended
December 31, 2005.

The Banks
primary sources of funds during 2006 were net income of $1.5 million, a net
increase in deposits totaling $17.6 million, proceeds from Federal Home Loan
Bank advances totaling $27.0 million, proceeds from the sale of foreclosed
assets totaling $3.2 million and proceeds from the sales and maturities of
securities totaling $5.5 million. The primary uses of funds in 2006 were for
purchases of investments totaling $4.8 million, repayments of Federal Home Loan
Bank advances totaling $32.0 million, and net loan originations and principal
collections totaling $19.3 million.

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

Off-Balance Sheet Arrangements

At December 31, 2006, the total
unused commercial and consumer lines of credit were $19.3 million. As of
December 31, 2006, there were outstanding commitments under letters of credit
of $10,000. At December 31, 2005, the total unused commercial and consumer
lines of credit were $19.8 million. As of December 31, 2005 there were
outstanding commitments under letters of credit of $64,000. The Company has no
arrangements with any other entities that have or are reasonably likely to have
a material effect on financial condition, changes in financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures or
capital resources.

45

Contractual Obligations

The Company
has certain obligations and commitments to make future payments under
contracts.  At December 31, 2006, the
aggregate contractual obligations and commitments are:

Payments Due by PeriodTotal

Less than
  1 year

1-3
  years

3-5
  years

After
  5 years(Dollars in Thousands)Certificates
  of deposit

$
112,804

$
82,717

$
22,277

$
7,810

$
FHLB
  advances


54,476


13,646


20,313


7,342


13,175Total

$
167,280

$
96,363

$
42,590

$
15,152

$
13,175Amount of commitment expiration per periodTotal

Less than
  1 year

1-3 
  years

3-5
  years

After
  5 years(Dollars in Thousands )Commitments
  to grant loans

$
1,648

$
1,648

$


$


$
Unfunded
  commitments under HELOCs


17,687


1,088


4,111


4,445


8,043Unfunded
  commitments under Commercial LOCs


1,627


1,233


389


5


Letters of
  credit


10


10








Total

$
20,972

$
3,979

$
4,500

$
4,450

$
8,043Long-term
obligations also include the liability under the Companys Director Deferred
Compensation Plans. See Note 15 in the Notes to Consolidated Financial
Statements for additional information on the plans.

Capital

Consistent
with its goals to operate a sound and profitable financial organization,
Monarch actively seeks to maintain a well capitalized institution in
accordance with regulatory standards. As of December 31, 2006, Monarch exceeded
all capital requirements of the FDIC. Monarchs regulatory capital ratios at
that date were as follows: Tier 1 leverage capital 9.97%; Tier 1 risk-based
capital 13.46%; and total risk-based capital, 14.44%. The regulatory capital
requirements to be considered well capitalized are 5.0%, 6.0% and 10.0%,
respectively. In 2007, management does not anticipate seeking additional
capital. On January 24, 2006, management issued a press release announcing an
intention to repurchase 270,000 of its outstanding shares in the open market in
block trades or privately negotiated transactions. The repurchase program was
effective January 30, 2006 and 177,300 shares were repurchased.

On February
15, 2007, the Board of Directors voted unanimously to approve a reverse merger
transaction which would reduce the number of total shareholders below 300. The
merger is expected to be completed in the fourth quarter of 2007 subject to
regulatory, SEC and shareholder approval. As a result, if the reverse merger is
completed, the Company intends to terminate the registration of its stock with
the SEC and cause the stock to cease to be traded on the Nasdaq Capital Market.
Additional information regarding the reverse merger is summarized in Note 20 
Subsequent Event in the audited consolidated financial report for 2006.

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.

46

Impact of Inflation, continued

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. 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 monthly basis to
review, among other things, economic conditions and interest rate outlook,
current and projected liquidity needs and capital position, anticipated changes
in the volume and mix of assets and liabilities and interest rate risk exposure
limits versus current projections. The Chief Financial Officer is responsible
for reviewing and reporting on the effects of the policy implementation and
strategies to the Board of Directors, at least quarterly.

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


originating shorter-term consumer loans,
  commercial construction and commercial permanent real estate loans for
  retention in our portfolio;
selling a
  significant portion of the long-term, fixed rate residential mortgage loans
  we make;
managing our deposits to establish stable
  deposit relationships with an emphasis on core, non-certificate deposits,
  supplementing these with brokered deposits, as appropriate; and
maintaining longer-term borrowings at
  fixed interest rates to offset the negative impact of longer-term fixed rate
  loans in our loan portfolio. Future borrowings are expected to be short-term
  to reduce the average maturity of our borrowings.47

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 2006 and 2005 we sold $16.2 million and $25.4 million,
respectively, of fixed-rate, one-to-four family mortgage loans in the secondary
market. We expect to continue to sell a significant portion of our originated
long term, fixed-rate, one-to-four family loans but may retain some portion of
our 15 year and shorter, fixed-rate loans.

Monarch uses
an internally generated model that uses scenario analysis to evaluate the IRR
exposure of the Bank by estimating the sensitivity of the Banks portfolios of
assets, liabilities, and off-balance sheet contracts to changes in market
interest rates. The information presented in the following table presents the
expected change in Monarchs net portfolio value at December 31, 2006 that
would occur upon an immediate change in interest rates.

Change in
  Interest Rates
  Basis Points (bp) 
  (Rate Shock in Rates) (1)

Net
  Portfolio Value

Net
  Portfolio Value as %
  of Present Value of Assets$ Amount

$ Change

% Change

NPV Ratio

Change+ 300 bp



33,457


-10,386


-24
%

12.20
%

-278 bp+ 200 bp



36,468


-7,375


-17
%

13.03
%

- 195 bp+100 bp



40,776


-3,067


-7
%

14.22
%

-76 bp0 bp



43,843








14.98
%-100 bp



44,628


+785


+2
%

15.05
%

+ 7 bp-200 bp



44,474


+631


+1
%

14.85
%

- 13 bp(1)
Assumes an instantaneous
  uniform change in interest rates at all maturities.Data from the
model indicates 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.


48

The following
table provides information about the Companys financial instruments that are
sensitive to changes to interest rates as of December 31, 2006.  The Company had no derivative instruments,
or trading portfolio as of that date. The expected maturity date values for loans
receivable, mortgage-backed securities and investment securities were
calculated without adjusting the contractual maturity dates for expectations of
repayments. Expected maturity date values for non-maturity, interest bearing
deposits were based on the opportunity for repricing.

Principal
  Amount Maturing In:2007

2008

2009

2010

2011

2012
  and
  beyond

Total

Fair
  Value
  12/31/2006Rate-sensitive
assetsFed
  funds and overnight deposits

$
7,864

$


$


$


$


$


$
7,864

$
7,864Average
  interest rate


5.00
%Securities

$
3,494

$
3,449

$
2,990

$
404

$
1,952

$
1,741

$
14,030

$
13,934Average
  interest rate


3.48
%

4.32
%

4.47
%

4.09
%

5.26
%

5.89
%Gross
  loans

$
16,951

$
7,152

$
13,026

$
15,652

$
25,928

$
154,153

$
232,862

$
232,512Average
  interest rate


7.16
%

7.41
%

7.22
%

6.87
%

7.43
%

7.06
%Rate-sensitive liabilitiesSavings
  & interest-bearing demand
  deposits

$
64,035

$


$


$


$


$


$
64,035

$
64,035Average
  interest rate


1.34
%Certificates
  of deposit

$
82,720

$
15,425

$
6,849

$
3,009

$
4,801

$


$
112,804

$
112,660Average
  interest rate


4.85
%

4.37
%

4.62
%

4.66
%

5.13
%FHLB
  advances

$
13,646

$
20,153

$
160

$
6,167

$
1,175

$
13,175

$
54,476

$
54,403Average
  interest rate


5.79
%

5.67
%

5.64
%

6.19
%

5.40
%

4.49
%49

ITEM 8. Financial Statements and Supplementary Data


Monarch Community Bancorp, Inc.
  and SubsidiariesConsolidated Financial Report
  December 31, 200650

Monarch
  Community Bancorp, Inc. and SubsidiariesContentsReport Letter
52Consolidated Financial StatementsBalance Sheet
53Statement of Operations
54Statement of Stockholders
  Equity
55Statement of Cash Flows
56Notes to Consolidated
  Financial Statements
57-9251

Monarch
  Community Bancorp, Inc. and SubsidiariesReport 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, 2006 and 2005, and the related consolidated statements of
operations, stockholders equity, and cash flows for each year in the
three-year period ended December 31, 2006. These consolidated financial
statements are the responsibility of the Corporations management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

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

In our opinion, the consolidated financial
statements referred to above present fairly, in all material respects, the
consolidated financial position of Monarch Community Bancorp, Inc. and
Subsidiaries as of December 31, 2006 and 2005, and the consolidated results of
their operations and their cash flows for each year in the three-year period
ended December 31, 2006, in conformity with accounting principles generally
accepted in the United States of America.

-s- Plante & Morse, PLLC

Grand
Rapids, Michigan
February 15, 2007

52

Monarch
  Community Bancorp, Inc. and SubsidiariesConsolidated Balance Sheet(000s omitted, except per share data)December 312006

2005AssetsCash and due
from banks

$
7,433

$
9,298Federal Home
Loan Bank overnight time and
  other interest bearing deposits


7,864


6,988Total cash
and cash equivalents


15,297


16,286Securities -
Available for sale (Note 3)


13,706


14,337Securities -
Held to maturity (Note 3)


228


247Other
securities (Note 3)


4,237


4,837Real estate
investment - Limited
  partnership, at equity (Note 4)


979


1,129Loans held for
sale


937


168Loans, net
(Note 5)


230,247


213,097Foreclosed
assets, net (Note 7)


1,680


2,811Premises and
equipment (Note 8)


5,261


5,706Goodwill (Note
2)


9,606


9,606Core deposit
(Note 2)


1,092


1,384Other assets
(Notes 6 and 11)


6,717


7,460Total
assets

$
289,987

$
277,068Liabilities and Stockholders
  EquityLiabilitiesDeposits (Note
9):Noninterest-bearing

$
15,733

$
14,837Interest-bearing


176,839


159,878Total
deposits


192,572


174,715Federal Home
Loan Bank advances (Note 10)


54,476


59,562Accrued
expenses and other liabilities


2,953


2,215Total
liabilities


250,001


236,492Commitments and Contingencies(Note 12)





Stockholders Equity(Notes 13 and
  14)Common stock -
$0.01 par value 20,000,000
  shares authorized, 2,533,781 shares issued and outstanding at December 31,
  2006 and 2,709,596 shares issued and outstanding at December 31, 2005


25


27Additional
paid-in capital


26,191


28,150Retained
earnings


15,319


14,401Accumulated
other comprehensive loss


(63
)

(155
)Unearned
compensation (Notes 18 and 19)


(1,486
)

(1,847
)Total
stockholders equity


39,986


40,576Total
liabilities and stockholders equity

$
289,987

$
277,068See Notes to Consolidated
Financial Statements.

53

Monarch
  Community Bancorp, Inc. and SubsidiariesConsolidated Statement of
  Operations(000s omitted, except per share data)Year Ended December 312006

2005

2004Interest IncomeLoans,
including fees

$
16,107

$
14,258

$
13,074Investment
securities


800


704


621Federal funds
sold and overnight deposits


380


269


123Total
interest income


17,287


15,231


13,818Interest ExpenseDeposits (Note
9)


5,418


3,337


2,710Federal Home
Loan Bank advances


3,189


3,230


3,463Total
interest expense


8,607


6,567


6,173Net Interest Income


8,680


8,664


7,645Provision for Loan Losses (Note 5)





(385
)

4,875Net Interest Income After Provision for Loan Losses


8,680


9,049


2,770Noninterest IncomeFees and
service charges


2,195


2,034


1,933Loan servicing
fees


447


462


400Net gain on
sale of loans


362


562


865Net loss on
sale of investment securities
  (Note 3)


(20
)




(60
)Other
income


138


341


287Total
noninterest income


3,122


3,399


3,425Noninterest ExpenseSalaries and
employee benefits (Note 15,
  18 and 19)


4,967


5,103


5,084Occupancy and
equipment


1,020


1,081


1,060Data
processing


704


689


622Mortgage
banking


382


438


385Professional
services


441


602


632Amortization
of intangible assets (Note 2)


291


369


329NOW account
processing


171


182


179ATM/Debit card
processing


233


221


219Repossessed
property expense (Note 7)


346


521


216Other general
and administrative


1,155


1,297


1,252Total
noninterest expense


9,710


10,503


9,978Income (Loss) - Before income taxes


2,092


1,945


(3,783
)Income Taxes (Note 11)


544


505


(1,272
)Net Income (Loss)

$
1,548

$
1,440

$
(2,511
)Earnings (Loss) Per Share (Note 1)Basic

$
0.63

$
0.57

$
(1.05
)Diluted

$
0.63

$
0.57

$
(1.05
)See Notes to Consolidated Financial
Statements.

54

Monarch Community Bancorp, Inc. and SubsidiariesConsolidated Statement of Stockholders'
  Equity(000s omitted, except per share
data)Common Stock





Accumulated
  
  Other
  Comprehensive
  Income (Loss)Number of
  Shares

Amount

Additional Paid
  in Capital

Retained
  Earnings


Unearned
  Compensation

TotalBalance - January 1, 2004


2,399

$
24

$
23,352

$
16,567

$
75

$
(2,588
)
$
37,430Issuance of 310,951 shares of common stock
  at $14.75/share in connection with acquisition of MSB Financial, Inc. (Note
  2)


311


3


4,583











4,586797 shares repurchased at $14.15/share


(1
)




(11
)










(11
)Issuance of 18,000 shares of common stock
  at $14.26/share awarded in connection with Restricted Stock Plan, net of
  forfeitures of 18,484 shares at $13/share








16








(16
)

Vesting of 17,040 restricted shares

















221


221Allocation of ESOP shares (Note 18)








119








185


304Comprehensive income:Net Loss











(2,511
)







(2,511
)Change in unrealized gain on securities
  available-for-sale,














(73
)




(73
)Total comprehensive income




















(2,584
)Dividends paid ($0.20/share)











(527
)







(527
)Balance - December 31,
  2004


2,709

$
27

$
28,059

$
13,529

$
2

$
(2,198
)
$
39,419Issuance of 4,000 shares of common stock at
  an average price of $11.57/share in connection with Restricted Stock Plan


4





46








(46
)

2,624 shares forfeited at average price of
  $12.27/share


(3
)




(32
)










(32
)Vesting of 16,018 restricted shares

















212


212Allocation of ESOP shares (Note 18)








77








185


262Comprehensive Income:Net Income











1,440








1,440Change in unrealized gain on securities
  available-for-sale,














(157
)




(157
)Total comprehensive income




















1,283Dividends paid ($0.21/share)











(568
)







(568
)Balance - December 31,
  2005


2,710

$
27

$
28,150

$
14,401

$
(155
)
$
(1,847
)
$
40,576Issuance of 3,884 shares of common stock at
  an average price of $12.03/share in connection with Restricted Stock Plan


4





47








(47
)

3,399 shares forfeited at average price of
  $11.42/share


(3
)




(39
)










(39
)Vesting of 16,811 restricted shares

















223


223Allocation of ESOP shares (Note 18)








56








185


241Repurchase of 177,300 shares


(177
)

(2
)

(2,108
)










(2,110
)Stock option expenses








85











85Comprehensive Income:Net Income











1,548








1,548Change in unrealized loss on securities
  available-for-sale,














92





92Total comprehensive income




















1,640Dividends paid ($0.24/share)











(630
)







(630
)Balance - December 31,
  2006


2,534

$
25

$
26,191

$
15,319

$
(63
)
$
(1,486
)
$
39,986See Notes to Consolidated
55Financial Statements.Monarch Community Bancorp, Inc. and
SubsidiariesConsolidated Statement of
  Cash Flows(000s omitted)Year Ended December 312006

2005

2004Cash Flows From Operating
  ActivitiesNet income (loss)

$
1,548

$
1,440

$
(2,511
)Adjustments to reconcile net income (loss)
  to net cash provided by operating activities:Depreciation and amortization


1,271


1,028


1,448Provision for loan loss





(385
)

4,875Stock dividends on other securities





(100
)

(171
)Stock option expense


85





(Gain) loss on sale of foreclosed assets


67


(53
)

(16
)Deferred income taxes


264


323


599Mortgage loans originated for sale


(16,969
)

(25,217
)

(29,553
)Proceeds from sale of mortgage loans


16,563


25,973


30,670Gain on sale of mortgage loans


(362
)

(562
)

(865
)(Gain) loss on sale of available for sale
  securities


20





60(Gain) loss on sale of premises and equipment





(39
)

Earned stock compensation


464


474


525Net change in:Change in deferred loan fees


48


168


(333
)Accrued interest receivable


(164
)

79


229Other assets


337


(2,091
)

4,844Accrued expenses and other liabilities


925


1,714


(2,025
)Net cash provided by operating activities


4,097


2,752


7,776Cash Flows From Investing
  ActivitiesActivity in available-for-sale securities:Purchases


(4,755
)

(8,408
)

(8,545
)Proceeds from sale of securities


2,543





16,946Proceeds from maturities of securities


2,994


1,909


2,823Activity in held-to-maturity securities:Purchases


(7
)

(17
)

(21
)Proceeds from maturities of securities








19Activity in other securities:Purchase of other securities








(18
)Redemption of other securities, at par


600





Loan originations and principal
  collections, net


(19,296
)

2,884


(11,254
)Proceeds from sale of foreclosed assets


3,196


2,810


3,819Proceeds on sale of premises and equipment


30


345


Purchase of premises and equipment


(113
)

(129
)

(373
)Acquisition, net of cash acquired (Note 2)








(13,192
)Net cash used in investing activities


(14,808
)

(606
)

(9,796
)Cash Flows From Financing
  ActivitiesNet increase (decrease) in deposits


17,587


5,316


(9,723
)Repurchases of common stock


(2,149
)

(32
)

(11
)Dividends paid


(630
)

(568
)

(527
)Proceeds from FHLB advances


27,000


4,000


4,000Repayment of FHLB advances


(32,086
)

(10,225
)

(3,401
)Net cash provided by (used in) financing
  activities


9,722


(1,509
)

(9,662
)Net Increase (Decrease) in
  Cash and Cash Equivalents


(989
)

637


(11,682
)Cash and Cash Equivalents- Beginning


16,286


15,649


27,331Cash and Cash Equivalents- End

$
15,297

$
16,286

$
15,649See Notes to Consolidated
56Financial Statements.Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements
  December 31, 2006, 2005 and 2004Note 1 - Summary of Significant
Accounting Policies

Organization - Monarch Community Bancorp, Inc. (the Corporation) was
incorporated
  in 2002 under Maryland law to hold all of the common stock of Monarch
  Community Bank (the Bank), formerly known as Branch County Federal Savings
  and Loan Association. Prior to August 29, 2002, the Bank was a federally
  chartered and insured mutual savings institution, which converted to a stock
  savings institution effective August 29, 2002. In connection with the
  conversion, on August 29, 2002, the Corporation sold 2,314,375 shares of its
  common stock in a subscription offering. Fifty percent of the net proceeds
  from this offering were used to purchase all of the shares of the common
  stock of the Bank.Monarch Community Bank
  provides a broad range of banking services to its primary market area of
  Branch, Calhoun and Hillsdale counties in Michigan. The Bank operates six
  full service offices and one drive-through only office. The Bank owns 100% 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 Corporations investment in an unconsolidated partnership.
  Note 5 summarizes the types of lending that the Corporation engages in. The
  Corporation has a significant concentration of loans secured by residential
  real estate located in Branch, Calhoun and Hillsdale counties.57

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements
  December 31, 2006, 2005 and 2004Note 1 - Summary of Significant
Accounting Policies (Continued)

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, 2006 and 2005, these reserve balances amounted to approximately
  $606,000 and $649,000, respectively.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.58

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements
  December 31, 2006, 2005 and 2004Note 1 - Summary of Significant
Accounting Policies (Continued)

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.The allowance consists of
  specific, general and unallocated components. The specific components relate
  to loans that are classified as either doubtful, substandard or special
  mention. For such loans that are also classified as impaired, an allowance is
  established when the discounted cash flows (or collateral value or observable
  market price) of the impaired loan is lower that the carrying value of that
  loan. The general component covers non-classified loans and is based on
  historical loss experience adjusted for qualitative factors. The unallocated
  component is maintained to cover uncertainties that could affect managements
  estimate of probable losses. The unallocated component of the allowance
  reflects the margin of imprecision inherent in the underlying assumptions
  used in the methodologies for estimating specific and general losses in the
  portfolio.A loan is considered
  impaired when, based on current information and events, it is probable that
  the Corporation will be unable to collect the scheduled payments of principal
  or interest when due according to the contractual terms of the loan
  agreement. Factors considered by management in determining impairment include
  payment status, collateral value, and the probability of collecting scheduled
  principal and interest payments when due. Loans that experience insignificant
  payment delays and payment shortfalls generally are not classified as
  impaired. Management determines the significance of payment delays and
  payment shortfalls on a case-by-case basis, taking into consideration all of
  the circumstances surrounding the loan and the borrower, including length of
  the delay, the reasons for the delay, the borrowers prior payment record,
  and the amount of the shortfall in relation to the principal and interest
  owed. Impairment is measured on a loan by loan basis for commercial and construction
  loans by either the present value of expected future cash flows discounted at
  the loans effective interest rate, the loans obtainable market price, or
  the fair value of the collateral if the loan is collateral dependent.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.59

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements
  December 31, 2006, 2005 and 2004Note 1 - Summary of Significant
Accounting Policies (Continued)

Impairment is determined
  by stratifying rights by predominant characteristics, such as interest rates
  and terms. Fair value is determined using prices for similar assets with
  similar characteristics, when available, or based upon discounted cash flows
  using market-based assumptions. Impairment is recognized through a valuation
  allowance for an individual stratum, to the extent that fair value is less than
  the capitalized amount for the stratum.Credit Related Financial Instruments - In the ordinary course of
business, the
  Corporation has entered into commitments to extend credit, including
  commitments under commercial letters of credit and standby letters of credit.
  Such financial instruments are recorded when they are funded.Foreclosed Assets - Assets acquired through, or in lieu of, loan
foreclosure are held
  for sale and are initially recorded at fair value at the date of the
  foreclosure, establishing a new cost basis. Subsequent to foreclosure,
  valuations are periodically performed by management and the assets are
  carried at the lower of carrying amount or fair value less estimated selling
  expenses, which consist primarily of commissions that will be paid to an
  independent real estate agent upon sale of the property. Revenue and expenses
  from operations and changes in the valuation allowance are included in net
  expenses from foreclosed assets.Premises and Equipment - Land is carried at cost. Buildings and
  equipment are carried at cost, less accumulated depreciation computed on the
  straight-line method over the estimated useful lives of the assets.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.60

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements
  December 31, 2006, 2005 and 2004Note 1 - Summary of Significant
Accounting Policies (Continued)

The components of other
  comprehensive income and related tax effects are as follows (000s omitted):2006

2005

2004Change in unrealized
  holding gain (loss) on available-for-sale securities

$
118

$
(236
)
$
(170
)Reclassification
  adjustment for losses (gains) realized in income


20





60Net unrealized gains
  (losses)

$
138

$
(236
)
$
(110
)Tax effect


(46
)

79


37Net-of-tax amount

$
92

$
(157
)
$
(73
)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.61

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements
  December 31, 2006, 2005 and 2004Note 1 - Summary of Significant
Accounting Policies (Continued)

A reconciliation of the
  numerators and denominators used in the computation of the basic earnings
  (loss) per share and diluted earnings (loss) per share is presented below
  (000s omitted except per share data):2006

2005

2004Basic earnings (loss) per
  shareNumerator:Net income (loss)

$
1,548

$
1,440

$
(2,511
)Denominator:Weighted average common
shares outstanding


2,626


2,709


2,619Less: Average unallocated
ESOP shares


(111
)

(130
)

(148
)Less: Average non-vested RRP
shares


(49
)

(59
)

(73
)Weighted average common
shares outstanding for basic earnings (loss)
  per share


2,466


2,520


2,398Basic earnings (loss) per
share

$
0.63

$
0.57

$
(1.05
)Diluted earnings (loss)
  per shareNumerator:Net income (loss)

$
1,548

$
1,440

$
(2,511
)Denominator:Weighted average common
shares outstanding for basic earnings (loss)
  per share


2,466


2,520


2,398Add: Dilutive effects of
assumed exercises of stock options








Add: Dilutive effects of
average non-vested RRP shares








Weighted average common
shares and dilutive potential common shares
  outstanding


2,466


2,520


2,398Diluted earnings (loss) per
share

$
0.63

$
0.57

$
(1.05
)At December 31, 2006,
  stock options not considered in computing diluted earnings per share because
  they were antidilutive totaled 191,547 and non-vested RRP shares not
  considered in computing diluted earnings per share because they were
  antidilutive totaled 42,706. At December 31, 2005, there were 185,487
  antidilutive stock options and 55,633 non-vested RRP shares. At December 31,
  2004, there were 192,000 antidilutive stock options and 68,000 non-vested RRP
  shares.62

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements
  December 31, 2006, 2005 and 2004Note 1 - Summary of Significant
Accounting Policies (Continued)

Employee Stock Ownership Plan (ESOP) - Compensation expense is
recognized as
  ESOP shares are committed to be released. Allocated and committed to be
  released ESOP shares are considered outstanding for earnings per share
  calculation based on debt service payments. Other ESOP shares are excluded
  from earnings per share calculation. Dividends declared on allocated ESOP
  shares are charged to retained earnings. Dividends declared on unallocated
  ESOP shares are used for debt service. The Corporation has committed to make
  contributions to the ESOP sufficient to service the debt to the extent not
  paid through dividends. The cost of unearned shares to be allocated to ESOP
  participants for future services not yet performed is reflected as a
  reduction of stockholders equity.Stock Based Compensation  SFAS No. 123(R) requires all public
  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. Total compensation cost related to stock options was $85,000
  in 2006 with no compensation cost recognized in 2005 or 2004. Options granted
  in 2006 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 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):2006

2005

2004As reported net income
(loss)

$
1,548

$
1,440

$
(2,511
)Stock option
expenses


85





Less: additional stock-based
compensation determined under the fair
  value method, net of tax


(85
)

(85
)

(63
)$
1,548

$
1,355

$
(2,574
)As reported earnings (loss)
per share

$
0.63

$
0.57

$
(1.05
)Proforma earnings (loss) per
share

$
0.63

$
0.54

$
(1.07
)As reported earnings (loss)
per diluted share

$
0.63

$
0.57

$
(1.05
)Proforma earnings (loss) per
diluted share

$
0.63

$
0.54

$
(1.07
)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.63

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 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 In
  2006, the FASB issued SFAS No. 157 Fair Value Measurements. This statement
  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. 157 is effective for fiscal years beginning after November 15, 2007. The
  Corporation has not determined the impact the adoption of SFAS No. 157 will
  have on the financial statements.In
  July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty
  in Income Taxes- An Interpretation of SFAS No. 109 (FIN 48) to clarify the
  accounting for uncertainty in tax positions. FIN 48 requires, among other
  matters, that the Corporation recognize in its 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 are 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
  Corporation is currently evaluating the impact of adopting FIN 48 on the
  financial statements.In
  2006, the FASB issued SFAS No. 158 Accounting for Defined Benefit Pension
  and Other Postretirement Plans. This statement requires balance sheet
  recognition of the funded status of a defined benefit plan. It also requires
  that changes in the funded status be recognized through comprehensive income
  and expands disclosures. Additionally, SFAS No. 158 requires employers to
  measure the funded status of a plan as of the date of its year-end balance
  sheet, which is a change from the Corporations present measurement date of December
  31.The
  recognition and disclosures under SFAS No. 158 are required as of the end of
  the fiscal year ending after December 15, 2006 while the new measurement date
  is effective for fiscal years ending after December 15, 2008. The Corporation
  does not expect a material impact of SFAS No. 158 on its financial
  statements.64

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note
1 - Summary of Significant Accounting Policies (Continued)

Supplemental Cash Flow Information (000s omitted)December 31,2006

2005

2004Cash paid (received)
for:Interest

$
8,491

$
6,470

$
6,115Income
taxes

$
(1,122
)
$
(63
)
$
(315
)Noncash investing activities
-Loans
transferred to real estate owned

$
2,097

$
3,608

$
2,221Issuance of
common stock in connection
  with the 2003 Recognition and Retention Plan

$
47

$
46

$
16Issuance of
common stock in connection
  with the acquisition of MSB Financial, Inc.

$


$


$
4,586Reclassifications- Certain prior year amounts have been
  reclassified to conform with current year presentation.Note
2 - Acquisition

On
  April 15, 2004 the Corporation completed its acquisition of MSB Financial,
  Inc., parent company of Marshall Savings Bank. On June 7, 2004 Marshall
  Savings Bank was merged with and into Monarch Community Bank. The acquisition
  was accounted for using the purchase method of accounting, and accordingly,
  the purchase price was allocated to the assets purchased and the liabilities
  assumed based upon the estimated fair values at the date of acquisition.The
  aggregate purchase price was $24,922,000, including $679,000 of acquisition
  costs. The Corporation issued a total of 310,951 shares of its common stock
  and paid $19.7 million in cash
  to former MSB Financial stockholders. The cash paid in the transaction came
  from the Corporations existing liquidity.65

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note
2 - Acquisition (Continued)

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

Cash
  and cash equivalents

$
7,144Other
  securities


1,500Loans,
  net


73,793Premises
  and equipment


2,452Core
  deposits


2,081Goodwill


9,606Other
  assets


9,861Total
  assets acquired


106,437Deposits


70,216Federal
  Home Loan Bank advances


8,002Other
  liabilities


3,297Total
  liabilities assumed


81,515Net
  assets acquired

$
24,922The
  purchase accounting fair value adjustments are being amortized under various
  methods and over lives of the corresponding assets and liabilities. Goodwill
  recorded for the acquisition amounted to $9.6 million.A
  Core Deposit Intangible of $2.1 million was recorded as part of the
  acquisition and is being amortized on an accelerated basis over a period of
  9.5 years. Amortization for the years ended December 31, 2006, 2005 and 2004
  was $291,000, $369,000 and $329,000, respectively. Accumulated amortization
  through December 31, 2006 is $989,000. The estimated amortization expense for
  the next five years is as follows (000s omitted):Year Ending
  December 312007

$
2302008


1812009


1492010


1422011


142Thereafter


248Total

$
1,09266

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 2 - Acquisition (Continued)

The
  following pro forma disclosures, including the effect of the purchase
  accounting adjustments, depict the results of operations as though the merger
  had taken place at the beginning of each period.2004Net
  interest income

$
3,698Noninterest
  income


3,874Total
income


7,572Net
  income (loss)

$
(4,102
)Basic
  earnings per share

$
(1.71
)Diluted
  earnings per share

$
(1.71
)MSB
  Financial was acquired to expand our geographic presence into Calhoun County,
  Michigan. The 2004 operations include the results of operations for MSB
  Financial, Inc. beginning on April 16, 2004.67

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 3 - Securities

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

Gross
  Unrealized
  Gains

Gross
  Unrealized
  Losses

Estimated
  Market
  Value2006Available-for-sale
  securities:U.S.
government agency obligations

$
10,730

$
12

$
(116
)
$
10,626Mortgage-backed securities


1,108





(26
)

1,082Obligations of
states and political
  subdivisions


1,964


39


(5
)

1,998Total
  available-for-sale securities

$
13,802

$
51

$
(147
)
$
13,706Held-to-maturity
  securities:Municipal
security

$
228

$


$


$
2282005Available-for-sale
  securities:U.S.
government agency obligations

$
11,961

$


$
(188
)
$
11,773Mortgage-backed securities


1,317





(39
)

1,278Obligations of
states and political
  subdivisions


1,293





(7
)

1,286Total
  available-for-sale securities

$
14,571

$


$
(234
)
$
14,337Held-to-maturity
  securities:Municipal
security

$
247

$


$
(11
)
$
23668

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 3 - Securities (Continued)

The
  amortized cost and estimated market values of securities at December 31,
  2006, by contractual maturity, are shown below. Expected maturities will
  differ from contractual maturities because issuers will have the right to
  call or prepay obligations with or without call or prepayment penalties (000s
  omitted):Held to Maturity

Available for SaleAmortized
  Cost

Market Value

Amortized
  Cost

Market ValueDue in one year or
less

$


$


$
3,494

$
3,452Due in one through five
years








7,687


7,620Due after five years through
ten years








1,338


1,372Due after ten years


228


228


175


180Total

$
228

$
228


12,694


12,624Mortgage-backed
securities








1,108


1,082Total available-for-sale
securities







$
13,802

$
13,706For the
  years ended December 31, 2006, 2005, and 2004, proceeds from sales of
  securities available for sale amounted to $2,543,000, $0, and $16,946,000,
  respectively. Gross realized gains amounted to $0, $0, and $17,000, respectively.
  Gross realized losses amounted to $20,000, $0, and $77,000, respectively. The
  tax benefit (provision) applicable to these net realized gains and losses
  amounted to $6,000, $0, and $20,000, respectively.69

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 3 - Securities (Continued)

Information
pertaining to securities with gross unrealized losses at December 31, 2006 and
2005, aggregated by investment category and length of time that individual
securities have been in a continuous loss position, follows:

Less than Twelve Months

Twelve Months and Over2006

Gross
  Unrealized
  Losses

Estimated
  Market Value

Gross
  Unrealized
  Losses

Estimated
  Market ValueAvailable-for-sale
securities:U.S.
government agency obligations

$


$


$
116

$
8,370Mortgage-backed securities








26


1,082Obligations
of states and political
  subdivisions








5


446Total available-for-sale
securities

$


$


$
147

$
9,898Held-to-maturity
securities:Municipal
security

$


$


$


$
2005Available-for-sale
securities:U.S.
government agency obligations

$
102

$
8,376

$
86

$
3,397Mortgage-backed securities


39


1,278





Obligations
of states and political
  subdivisions


7


1,286





Total available-for-sale
securities

$
148

$
10,940

$
86

$
3,397Held-to-maturity
securities:Municipal
security

$
11

$
236

$


$
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.

70

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 4 - Real Estate Investment -
Limited Partnership

In
June of 2001, the Corporation acquired a 24.98% interest in a limited
partnership formed to construct and operate multi-family housing units. All
income, expenses and tax credits will be allocated to the Corporation based
upon ownership percentage. The Corporation accounts for the investment in the
limited partnership using the equity method. The Corporation as an investor is
able to exercise influence over operating and financial policies of the
management through provisions of the partnership agreement that require a
majority approval of the limited partners. At such time the project is sold,
the limited partners will receive a share of the net proceeds proportionate to
the limited partners outstanding capital balance. Under the terms of the
limited partnership agreement, the Corporation has made a total capital
contribution of approximately $1,500,000, in cash, and is allocated tax losses
and affordable housing federal income tax credits.

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

The
Corporation has recorded an estimate of the tax credit through December 31,
2006. The Corporations share of tax credits generated by the investee
partnership approximated $191,000, in 2006, 2005, and 2004.

71

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 5 - Loans

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

December 31,2006

2005Mortgage loans on real
estate:One-to-four
family

$
140,374

$
139,636Multi-family


7,511


3,534Commercial


41,079


34,721Construction or land development


9,529


5,415Total real
estate loans


198,493


183,306Consumer loans:Automobile


1,509


2,447Home
equity


19,077


16,170Manufactured housing


495


576Other


7,083


7,799Total
consumer loans


28,164


26,992Commercial business
loans


6,205


6,364Subtotal


232,862


216,662Less: Allowance for loan
losses


2,024


2,925Net
deferred loan fees


591


640Loans, net

$
230,247

$
213,09772

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 5 - Loans (Continued)
The
following is an analysis of the allowance for loan losses:

December 31,2006

2005

2004Balance -
Beginning

$
2,925

$
6,420

$
2,618Allowance acquired in
acquisition







$
513Provision for loan
losses





(385
)

4,875Loans charged-off


(1,185
)

(3,443
)

(1,862
)Recoveries of loans
previously charged off


284


333


276Balance - Ending

$
2,024

$
2,925

$
6,420The following is a summary of information
pertaining to impaired loans (000s omitted):

December 31,2006

2005Impaired loans with a
valuation allowance

$
1,668

$
2,570Valuation allowance related
to impaired
  loans

$
342

$
670Total non-accrual
loans

$
468

$
811Total loans past-due ninety
days or more
  and still accruing

$


$
There
are no impaired loans without a valuation allowance as of December 31, 2006 and
2005. The following is a summary of our average investment in impaired loans
(000s omitted):

December 31,2006

2005

2004Average
  investment in impaired loans

$
2,709

$
4,177

$
4,905Interest
income recognized on impaired loans was not significant for the years ended December
31, 2006, 2005, and 2004. No additional funds are committed to be advanced in
connection with impaired loans.
73

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements
  December 31, 2006, 2005 and 2004Note 6 - Servicing
Loans
serviced for others are not included in the accompanying consolidated balance
sheets. The unpaid principal balances of mortgage loans serviced for others
were $176,566,000 and $184,370,000 at December 31, 2006 and 2005, respectively.

The
fair value of mortgage servicing rights approximates $1,636,000 and $1,522,000
at December 31, 2006 and 2005, respectively. The fair value was determined by
discounting estimated net future cash flows from mortgage servicing activities
using an 8.50% discount rate and estimated prepayment speeds of 8.8 to 11.6
based on current Freddie Mac experience as well as Freddie Mac projections of
slower prepayment speeds due to rising interest rates. The impairment valuation
allowance is $0 as of December 31, 2006, 2005, and 2004. There has been no
activity in the impairment valuation allowance during the years ended December
31, 2006, 2005, and 2004.

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

December 31,2006

2005

2004Mortgage servicing rights -
Beginning

$
1,358

$
1,539

$
667Mortgage servicing rights
acquired in
  acquisition








940Mortgage servicing rights
capitalized


153


257


316Mortgage servicing rights
scheduled amortization and direct writedown for
loan payoffs


(382
)

(438
)

(384
)Mortgage servicing rights -
Ending

$
1,129

$
1,358

$
1,539
74

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 7 - Foreclosed and
Repossessed Assets
Foreclosed
assets consisted of the following (000s omitted):

December 31,2006

2005Real estate owned

$
785

$
1,462Real estate in judgment and
subject to
  redemption


895


1,349Total

$
1,680

$
2,811Expenses
applicable to foreclosed and repossessed assets include the following (000s
omitted):

December 31,2006

2005

2004Net loss (gain) on sales of
real estate

$
67

$
(53
)
$
(16
)Operating expenses


346


521


216Total

$
413

$
468

$
200
75

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 8 - Premises and Equipment
A
summary of the cost and accumulated depreciation of premises and equipment
follows (000s omitted):

December 31,

Depreciable
  Life(in Years)2006

2005Land

$
598

$
598Buildings and
improvements


5,921


5,890


7-40Furniture, fixtures and
equipment


2,701


2,803


2-7Total bank
premises and equipment


9,220


9,291Less accumulated
depreciation and
  amortization


3,959


3,585Net
carrying amount

$
5,261

$
5,706Depreciation
expense totaled $528,000, $561,000, and $549,000 in 2006, 2005, and 2004,
respectively.
76

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 9 - Deposits

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

December 31,2006

2005Balances by account type:Demand and NOW
accounts

$
18,583

$
20,641Money market


22,630


15,767Passbook and statement
savings


22,822


26,536Total transactional
accounts


64,035


62,944Certificates of deposit:$100,000 and over


54,095


35,949Under $100,000


58,709


60,985Total certificates of
deposit


112,804


96,934Total

$
176,839

$
159,878Generally, deposit amounts
in excess of $100,000 are not federally insured.

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

December 31, 2006Less than
  $100,000

$100,000 &
  greaterLess than one year

$
41,716

$
41,001One to two years


6,860


8,568Two to three years


4,174


2,675Three to four years


2,503


506Four to five years


3,456


1,345Total

$
58,709

$
54,095


77

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 9 - Deposits (Continued)


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

December 31,2006

2005

2004Demand and NOW accounts

$
70

$
78

$
94Money market


617


211


176Passbook and statement
  savings


105


120


117Certificates of deposit


4,626


2,928


2,323Total deposit interest
expense

$
5,418

$
3,337

$
2,710
Note 10 - Federal Home Loan Bank
Advances
The Bank has Federal Home
Loan Bank advances of $54,476,000 and $59,562,000 at December 31, 2006 and
2005, respectively, which mature through 2013. At December 31, 2006, the
interest rates on fixed rate advances ranged from 4.70% to 6.56%. At December
31, 2005, the interest rates on fixed rate advances ranged from 3.43% to 6.73%.

At December 31, 2006, the
Bank had two floating rate advances totaling $3,500,000 with a weighted average
interest rate of 5.32%. The Bank had one floating rate advance of $3,000,000
with an interest rate of 4.29% as of December 31, 2005. The weighted average
interest rate of all advances was 5.47% and 5.36% at December 31, 2006 and
2005, respectively.

At December 31, 2006, the
Bank had one putable advance totaling $5,000,000 with an interest rate of
3.34%. The advance can be put on January 28, 2008. At December 31, 2005, the
Bank had three putable advances totaling $7,000,000 with a weighted average
interest rate of 3.62%.

The Bank has provided a
blanket pledge of all of the Banks eligible residential mortgage loans as
collateral for all FHLB debt. The amount of these mortgage loans totaled
$122,433,000 and $103,588,000 as of December 31, 2006 and 2005, respectively.

78

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 10 - Federal Home Loan Bank
Advances (Continued)

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

December 31,
  2006Less than one year

$
13,646One to two years


20,153Two to three years


160Three to four years


6,167Four to five years


1,175Thereafter


13,175Total

$
54,476
Note 11 - Income Taxes

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

December 31,2006

2005

2004Current expense (recovery)

$
280

$
182

$
(1,871
)Deferred expense
  (recovery)


264


323


599Total tax expense
(recovery)

$
544

$
505

$
(1,272
)


79

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 11 - Income Taxes (Continued)


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

Percent of Pretax Income (Loss)
  December 31,2006

2005

2004Statutory federal tax rate


34.00
%

34.00
%

34.00
%Increase (decrease)
  resulting from:Nondeductible
expenses


1.30
%

0.20
%

0.30
%Tax exempt income


-2.73
%

-1.90
%

-1.10
%Low income housing
credit


-4.18
%

-9.80
%

-4.00
%Other


-2.39
%

3.50
%

4.40
%Reported tax expense
(recovery)


26.00
%

26.00
%

33.60
%

80

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 11 - Income Taxes (Continued)

The components of the net
  deferred tax asset are as follows (000s omitted):December
  31,2006

2005Deferred tax assets:Provision for loan losses

$
224

$
530Net deferred loan fees


201


217Deferred compensation


355


365Employee benefits


30


23Net operating loss carryforward





209Unrealized loss on available for sale securities


33


79General business tax credit carryforward


653


557Other


87


227Total deferred tax assets


1,583


2,207Deferred tax liabilities:Mortgage servicing rights


356


429Original issue discount


105


120Net purchase premiums


885


1,090Stock dividends


143


167Other


36


33Total deferred tax liabilities


1,525


1,839Net deferred tax asset

$
58

$
368The 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, 2006 and 2005 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
  $653,000 expire between 2022 and 2025.81

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 12 - Off-Balance Sheet Activities

Credit Related Financial
Instruments- The Corporation is a party to credit related financial
instruments with off-balance sheet risk in the normal course of business to
meet the financing need of its customer. These financial instruments include
commitments to extend credit, and unfunded commitments under lines of credit.
Such commitments involve, to varying degrees, elements of credit and interest
rate risk in excess of the amount recognized in the consolidated balance
sheets.The Corporations exposure
  to credit loss is represented by the contractual amount of these commitments.
  The Corporation follows the same credit policies in making commitments as it
  does for on-balance sheet instruments.The following financial
  instruments were outstanding whose contract amounts represent credit risk
  (000s omitted):Contract
  AmountDecember
  31,2006

2005Commitments to grant loans

$
1,648

$
12,854Unfunded commitments under
  lines of credit

$
19,314

$
19,838Unfunded commitments under
  letters of credit

$
10

$
64The above commitments
  include fixed rate and variable rate loan commitments and lines of credit
  with interest rates ranging between 5.875% and 12.25% at December 31, 2006,
  and 4.75% and 12.25% at December 31, 2005.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.82

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 13 - Regulatory Matters

The Bank is subject to
  various regulatory capital requirements administered by federal banking
  agencies. Failure to meet minimum capital requirements can initiate certain
  mandatory and discretionary actions by regulators that could have a direct
  material effect on the Banks financial statements. Under capital adequacy
  guidelines and the regulatory framework for prompt corrective action, the
  Bank must meet specific capital guidelines that involve quantitative measures
  of the Banks assets, liabilities, and certain off-balance sheet items as
  calculated under regulatory accounting practices.Quantitative measures
  established by regulation to ensure capital adequacy require the Bank to
  maintain minimum amounts and ratios, which are shown in the table below.
  Management believes, as of December 31, 2006 and 2005, that the Bank has met
  all of the capital adequacy requirements to which they are subject.As of December 31, 2006,
  the most recent notification from the FDIC categorized the Bank as well
  capitalized, under the regulatory framework for prompt corrective action. To
  be categorized as well capitalized, minimum capital amounts and ratios must
  be maintained as shown in the following tables. There are no conditions or
  events since that notification that management believes have changed the
  Banks capital category.A reconciliation of the
  Banks equity to major categories of capital is as follows (000s omitted):December
  31,2006


2005Equity per consolidated
  balance sheet

$
39,262

$
37,420Less: intangible and
  disallowed assets


(11,393
)

(11,448
)Tangible and leverage
  capital


27,869


25,972Plus: Allowance for loan
  losses **


2,024


2,280Risk based capital

$
29,893

$
28,252**     Limited to 1.25% of risk
weighted assets

83

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 13 - Regulatory Matters (Continued)

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

To Comply With
  Minimum Capital
  Requirements

To be Well Capitalized
  Under Prompt
  Corrective Action
  ProvisionsAmount

Ratio

Amount

Ratio

Amount

RatioAs of
December 31, 2006:Total
Capital 
  (to Risk-Weighted Assets)

$
29,893


14.44
%
$
16,562


8.00
%
$
20,702


10.00
%Tier 1
Capital 
  (to Risk-Weighted Assets)

$
27,869


13.46
%
$
8,281


4.00
%
$
12,421


6.00
%Tier 1
Capital 
  (to Average Assets)

$
27,869


9.97
%
$
13,977


5.00
%
$
13,977


5.00
%As of
December 31, 2005:Total
Capital 
  (to Risk-Weighted Assets)

$
28,252


15.54
%
$
14,544


8.00
%
$
18,180


10.00
%Tier 1
Capital 
  (to Risk-Weighted Assets)

$
25,972


14.29
%
$
7,272


4.00
%
$
10,908


6.00
%Tier 1
Capital 
  (to Average Assets)

$
25,972


9.90
%
$
13,111


5.00
%
$
13,111


5.00
%Note 14 - Restrictions on Dividends, Loans and Advances

Banking regulations place
  certain restrictions on dividends paid and loans or advances made by the Bank
  to the Corporation.The 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, 2006, the Banks retained
  earnings available for the payment of dividends, without approval from the
  regulators, totaled $6,268,000. Accordingly, $32,994,000 of the Corporations
  investment in the Bank was restricted at December 31, 2006.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, 2006, Bank funds
  available for loans or advances to the Corporation amounted to $3,139,000.84

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 15 - Retirement Plans

The Corporation is part of
  a non-contributory, multi-employer defined benefit pension plan covering
  substantially all employees. Effective April 1, 2004 employees benefits
  under the plan were frozen. The plan is administered by the trustees of the
  Financial Institutions Retirement Fund. Because it is a multi-employer plan,
  there is no separate valuation of plan benefits or segregation of plan assets
  specifically for the Corporation. During 2006, 2005, and 2004, the
  Corporation recognized pension expense for this plan of $246,000, $226,000,
  and $246,000, 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 2006, 2005, and 2004, the Corporation recognized pension
  expense for this plan of $63,000, $64,000, and $64,000, respectively.Through 2004, the Bank
  maintained 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
  $410,000 and $402,000 at December 31, 2006 and 2005, respectively. The
  expense for the plan, including the increase due to the annual earnings
  credit was $20,000, $20,000, and $59,000, for 2006, 2005, and 2004,
  respectively.Upon acquisition, the
  Corporation assumed the liability for the directors deferred compensation
  plan of MSB Financial, Inc. This plan does not allow for future deferrals and
  all benefits are being paid out to participants over a 180 month term.
  Undistributed benefits are increased by an annual earnings rate based on an
  index which was 5.62% as of December 31, 2006. The present value of benefits
  accrued to participants (also included as part of the other liabilities
  section of the balance sheet) is $634,000 and $669,000 at December 31, 2006
  and 2005, respectively.Note 16 - Related Party Transactions

In the ordinary course of
  business, the Bank granted loans to principal officers and directors and their
  affiliates totaling $300,000 and $449,000 for the years ending December 31,
  2006 and 2005, respectively. During the year ended December 31, 2006, total
  principal additions were $105,000 and total principal payments were $254,000,
  and during the year ending December 31, 2005, total principal additions were
  $125,000 and total principal payments were $868,000. Deposits from related
  parties and their affiliates held by the Bank at December 31, 2006 and 2005
  amounted to $890,000 and $917,000 respectively.85

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 17 - Fair Value of Financial
Instruments
The
fair value of a financial instrument is the current amount that would be
exchanged between willing parties, other than in a forced liquidation. Fair
value is best determined based upon quoted market prices. However, in many
instances, there are no quoted market prices for the Corporations various
financial instruments. In cases where quoted market prices are not available,
fair values are based on estimates using present value or other valuation
techniques. Those techniques are significantly affected by the assumptions
used, including the discount rate and estimates of future cash flows.
Accordingly, the fair value estimates may not be realized in an immediate
settlement of the instrument. SFAS 107 excludes certain financial instruments
and all nonfinancial instruments from its disclosure requirements. Accordingly,
the aggregate fair value amounts presented may not necessarily represent the
underlying fair value of the Corporation.

The
following methods and assumptions were used by the Corporation in estimating
fair value disclosures for financial instruments:

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

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

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

Loans Receivable - For
variable-rate loans that reprice frequently and with no significant change in
credit risk, fair values are based on carrying values. Fair values for other
loans are estimated using discounted cash flows analyses, using interest rates currently
being offered for loans with similar terms to borrowers of similar credit
quality. Fair values for non-performing loans are estimated using discounted
cash flow analyses or underlying collateral values, where applicable.

Deposit Liabilities - The fair values
disclosed for demand deposits (e.g., interest and non-interest checking,
passbook savings, and certain types of money market accounts) are, by
definition, equal to the amount payable on demand at the reporting date (i.e.,
their carrying amounts). The carrying amounts of variable-rate, fixed term
money market accounts and certificates of deposit approximate their fair values
at the reporting date. Fair values for fixed-rate certificates of deposit are
estimated using a discounted cash flow calculation that applies interest rates
currently being offered on certificates to a schedule of aggregated expected
monthly maturities on time deposits.

Federal Home Loan Bank Advances - The fair values
of the Corporations Federal Home Loan Bank advances are estimated using
discounted cash flow analyses based on the Corporations current incremental
borrowing rates for similar types of borrowing arrangements.

Accrued Interest -
The carrying amounts of accrued interest approximate fair value.
86

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 17 - Fair Value of Financial
Instruments (Continued)
The
estimated fair values, and related carrying or notional amounts, of the
Corporations financial instruments are as follows (000s omitted):

December 31,2006

2005Carrying
  Amount

Fair Value

Carrying
  Amount

Fair ValueAssets:Cash and cash
equivalents

$
15,297

$
15,297

$
16,286

$
16,286Securities -
Held to maturity


228


228


247


236Securities -
Available for sale


13,706


13,706


14,337


14,337Other
securities


4,237


4,237


4,837


4,837Loans held for
sale


937


952


168


169Net
loans


230,247


229,897


213,097


215,220Accrued
interest and late charges
  receivable


1,381


1,381


1,217


1,217Liabilities:Federal Home
Loan Bank advances


54,476


54,403


59,562


59,953Deposits


192,572


192,428


174,715


174,888Accrued
interest payable


546


546


430


430
Note 18 - Employee Stock Ownership
Plan (ESOP)
As
part of the conversion (Note 1), the Corporation implemented an employee stock
ownership plan (ESOP) covering substantially all employees. The Corporation
provided a loan to the ESOP, which was used to purchase 185,150 shares of the
Corporations outstanding stock at $10 per share. 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.
87

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 18 - Employee Stock Ownership
Plan (ESOP) (Continued)
The
scheduled maturities of the loan are as follows (000s omitted):

Year Ending 
  December 312007

$
812008


852009


892010


942011


98Thereafter


567Total

$
1,014The
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):

2006

2005Allocated shares


74,060


55,545Shares released for
allocation


18,515


18,515Shares distributed


(18,785
)

(11,284
)Unreleased shares


92,575


111,090Total ESOP
shares


166,365


173,866Fair value of unallocated
shares

$
1,133

$
1,465Total
compensation expense applicable to the ESOP amounted to approximately $214,000,
$234,000, and $266,000 for the years ended December 31, 2006, 2005, and 2004,
respectively.
88

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 19 - Stock Compensation Plans
The
Corporation has a Recognition and Retention Plan (RRP) under which 88,875
shares of restricted stock were issued to employees and directors during 2003.
Under the plan, the shares vest 20% per year for five years. Shares forfeited
total 3,399 in 2006 and 2,624 in 2005. During 2006, 3,884 shares of restricted
stock were issued to certain employees and directors. During 2005, 4,000 shares
of restricted stock were issued to employees. During 2006, 16,811 shares vested
and are no longer restricted for a total of 49,869 vested shares as of December
31, 2006. During 2005, 16,018 shares vested and are no longer restricted for a
total of 33,058 shares as of December 31, 2005. Compensation expense applicable
to the RRP amounted to $230,000 and $215,000 for the years ended December 31,
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 Entity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 2006 was $2.41. There were no options
granted in 2005. The fair value of each option granted in 2004 is $2.93. As of
December 31, 2006, there was $147,000 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
2.7 years. The fair value is estimated on the date of the grant using with the
following weighted average assumptions:

2006

2004Dividend
  yield

1.6%

1.4%Expected
  life

5 years

7 yearsExpected
  volatility

23.0%

17.5%Risk-free
  interest rate

3.02%-4.80%

3.02%-3.58%
89

Monarch Community Bancorp, Inc. and SubsidiariesNotes to
  Consolidated Financial StatementsDecember 31, 2006, 2005 and 2004Note 19  Stock Compensation Plans
(Continued)
A
summary of the status of the Corporations stock option plan is presented below
(000s omitted except per share data):

2006

2005Shares

Weighted
  Average
  Exercise
  Price

Shares

Weighted
  Average
  Exercise
  PriceOutstanding
  at beginning of year


185

$
13.22


192

$
13.21Granted


12


11.11





Exercised











Forfeited/expired


5


13.00


7


13.00Outstanding
  at end of year


192

$
13.09


185

$
13.22Exercisable
  at year-end


101

$
13.15


65

$
13.12The
weighted average remaining contractual life of the outstanding options is 7.1
years at December 31, 2006.

A
summary changes in exercisable stock options December 31, 2006 and 2005 is as
follows:

2006


2005Beginning
  of year


65


30Newly
  vested


36


35Exercised





End
  of year


101


65
Note 20  Subsequent Event
On
February 15, 2007, the Board of Directors voted unanimously to approve a
reverse merger transaction which would reduce the number of total shareholders
below 300. Based on the number of shareholders as of December 31, 2006, the
Company plans to repurchase approximately 60,000 shares. Based on the current
share price of the Corporation and the estimated costs of the transaction, the
estimated capital outlay to repurchase shares is approximately $800,000. The
estimated expenses related to the reverse merger will approximate $200,000 for
a total estimated aggregate cash outlay of $1.0 million. The agreement calls
for shareholders of record with less than 1,000 shares to be paid $13.50 per
share which is based on the fair market value of the common stock as of
February 15, 2007 and is expected to be completed in the fourth quarter of 2007
subject to regulatory, SEC, and shareholder approval.
90

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 21 - Condensed Financial
Statements of Parent Company
The
following represents the condensed financial statements of Monarch Community
Bancorp, Inc. (Parent) only. The Parent-only financial information should be
read in conjunction with the Corporations consolidated financial statements.

Condensed Balance Sheets (000s
omitted)

December 31,

December 31,2006

2005AssetsCash

$
523

$
2,614Investments


313


667Investment in
Monarch Community Bank


39,262


37,420Other
assets


167


157Total
assets

$
40,265

$
40,858Liabilities
  and Stockholders EquityAccrued
expenses

$
279

$
282Stockholders equity


39,986


40,576Total
liabilities and stockholders equity

$
40,265

$
40,858Condensed Statements of Income (000s omitted)

December 31,

December 31,2006

2005Income
  - Interest on investments

$
83

$
84Operating
  expense


204


170Loss
  before equity in undistributed net income of subsidiary


(121
)

(86
)Equity
  in undistributed net income of subsidiary


1,669


1,526Net
  income

$
1,548

$
1,440
91

Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial Statements 
  December 31, 2006, 2005 and 2004Note 21 - Condensed Financial Statements of
Parent Company (Continued)
Condensed Statements of Cash Flows (000s
omitted)

December
  31,

December
  31,2006

2005Cash flows
  from operating activities:Net
income

$
1,548

$
1,440Adjustments to
reconcile net income to net
  cash provided by operating activities:Amortization


2


7Allocation of
ESOP and RRP


464


474(Increase)
decrease in other assets


(10
)

1,230Decrease in
accrued expenses


(3
)

(24
)Undistributed
net income of subsidiary


(1,669
)

(1,526
)Net cash
provided by operating activities


332


1,601Cash flows
  from investing activities:Purchase of
securities


(83
)

Proceeds from
sales and maturities of
  securities


439


606Net cash
provided by investing activities


356


606Cash flows
  from financing activities:Repurchase of
common stock


(2,149
)

(32
)Dividends
paid


(630
)

(568
)Net cash used
in financing activities


(2,779
)

(600
)Net increase
  (decrease) in cash


(2,091
)

1,607Cash at beginning
  of year


2,614


1,007Cash at end
  of year

$
523

$
2,614
92

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

Year Ended December 31, 20061st Qtr

2nd Qtr

3rd Qtr

4th Qtr(Dollars in thousands, except
  per share data)Interest
  income

$
4,032

$
4,234

$
4,415

$
4,606Interest
  expense


1,916


2,049


2,255


2,387Net
  interest income


2,116


2,185


2,160


2,219Provision
  for loan losses











Net
  interest income after provision for loan losses


2,116


2,185


2,160


2,219Noninterest
  income


752


803


743


824Noninterest
  expense


2,463


2,542


2,438


2,267Income
  before income taxes


405


446


465


776Income
  tax expense


75


130


133


206Net
  Income

$
330

$
316

$
332

$
570Earnings
  per share:Basic

$
0.13

$
0.12

$
0.14

$
0.24Diluted

$
0.13

$
0.12

$
0.14

$
0.24Cash
  dividends declared per share

$
0.06

$
0.06

$
0.06

$
0.06Year Ended December 31, 20051st Qtr

2nd Qtr

3rd Qtr

4th Qtr(Dollars in thousands, except
  per share data)Interest
  income

$
3,766

$
3,763

$
3,818

$
3,884Interest
  expense


1,546


1,596


1,666


1,759Net
  interest income


2,220


2,167


2,152


2,125Provision
  for loan losses


(385
)







Net
  interest income after provision for loan losses


2,605


2,167


2,152


2,125Noninterest
  income


780


844


884


891Noninterest
  expense


2,821


2,540


2,541


2,601Income
  before income taxes


564


471


495


415Income
  tax expense


152


120


129


104Net
  Income

$
412

$
351

$
366

$
311Earnings
  per share:Basic

$
0.16

$
0.13

$
0.14

$
0.14Diluted

$
0.16

$
0.13

$
0.14

$
0.14Cash
  dividends declared per share

$
0.05

$
0.05

$
0.05

$
0.0693

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

ITEM 9A. Controls and Procedures

An evaluation of the Registrants disclosure
controls and procedures (as defined in Section 13(a)-15(e) of the Securities
Exchange Act of 1934 (the Exchange Act) as of December 31, 2006 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, 2006 that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.

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

ITEM 9B. Other Information Not Applicable

PART III

ITEM 10. Directors, 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 2007, 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. 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 2007, 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.

94

ITEM 12. Security Ownership of Certain Beneficial Owners
  and Management and Related Shareholder MattersInformation 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 2007, 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,
2006.

Plan Category

Number of securities
to be issued upon
exercise of
outstanding options
warrants and rights

Weighted-average
exercise price of
outstanding options
warrants and rights

Number of securities
remaining available for
future issuance under
equity compensation plansEquity
  compensation plans approved by security holders (1)

191,547

13.09

39,891Equity
  compensation plans not approved by security holders





(1)
Includes
  2003 Stock Option and Incentive Plan and 2003 Recognition and Retention Plan
  approved at the 2003 Annual Meeting of ShareholdersITEM 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
2007, under the captions Transactions with Certain Related Persons and Role
and Composition of the Board of Directors, a copy of which will be filed not
later than 120 days after the close of the fiscal year.

ITEM 14. Principal Accountant Fees
and Services

Information concerning principal accountant fees
and services is incorporated herein by reference from the definitive proxy
statement for the annual meeting of stockholders, to be held in April 2007,
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.

95

PART IVITEM 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.96

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

MONARCH COMMUNITY BANCORP, INC.Dated: March 26, 2007
By:
/s/Donald L. Denney,
  Presidentand Chief Executive
  OfficerPursuant to the requirements
of the Securities Exchange Act of 1934, this report has been signed below by
the following persons on behalf of the Company and in the capacities and on the
date indicated.

Signature

Title

Date/s/President and Chief
  Executive Officer

March
  26, 2007Donald L. Denney

(Principal
  Executive Officer)/s/

Chairman of the BoardMarch
  26, 2007Stephen M. Ross/s/



March
  26, 2007Vice President and Chief
  Financial OfficerRalph A. Micalizzi, Jr.

(Principal
  Accounting Officer)/s/

Director

March
  26, 2007Harold A. Adamson/s/

Director

March
  26, 2007Lauren L. Bracy/s/

Director

March
  26, 2007James R. Vozar/s/

Director

March
  26, 2007Martin L. Mitchell/s/

Director

March
  26, 2007Gordon L. Welch/s/

Director

March
  26, 2007Craig W. Dally/s/

Director

March
  26, 2007Richard L. Dobbins97

Exhibit
  IndexReference toPrior Filing orExhibit



Exhibit NumberNumber

Document

Attached Hereto3.1

Registrants Articles of
  Incorporation

*3.2

Registrants Bylaws (also
  incorporated by reference from Form 8-K filed on 9/20/06)

*4

Registrants Specimen Stock
  Certificate

*10.1

Employment Agreement
  between Monarch Community Bancorp, Inc and Donald L. Denney (incorporated by
  reference from Form 8-K filed on 9/25/2006)10.2

Management Continuity
  Agreement between Monarch Community Bancorp, Inc. and William C. Kurtz and
  Andrew J. Van Doren (incorporated by reference from Form 8-K filed on
  12/21/2004)10.3

Registrants Employee Stock
  Ownership Plan

*10.4

Registrants 2003 Stock
  Option and Incentive Plan

**10.5

Registrants Recognition
  and Retention Plan

**10.6

Form of Stock Option
  Agreement

***10.7

Management Continuity
  Agreement between Monarch Community Bancorp, Inc. and Ralph A. Micalizzi, Jr.
  (incorporated by reference from Form 10-K filed on 3/21/06)10.8

Form of Restricted Stock
  Agreement (incorporated by reference from Form 10-K filed on 3/21/06)10.9

Management Continuity
  Agreement between Monarch Community Bancorp, Inc. and Eric C. Cook
  (incorporated by reference from Form 8-K filed on 4/26/06)11

Statement re computation of
  per share earnings

See
  Note 1 of theNotesto
  ConsolidatedFinancialStatementscontained
  inthis
  report12

Statements re computation
  of ratios

None13

Annual Report to Security
  Holders

Not
  required14

Registrants Code of
  Conduct

1416

Letter re: change in
  certifying accountant

None18

Letter re: change in
  accounting principles

None21

Subsidiaries of the
  registrant

2122

Published report regarding
  matters submitted to vote of security holders

None23

Consent of Plante &
  Moran, PLLC

2324

Power of Attorney

Not
  required31.1

Rule 13a-14(a)
  Certification of the Companys President and Chief Executive Officer

31.131.2

Rule 13a-14(a)
  Certification of the Companys Chief Financial Officer

31.232

Section 1350 Certification.

32*
Filed on  March 27, 2002 as an exhibit to the
  Registrants Registration Statement on Form SB-2 (File No. 333-85018), and
  incorporated herein by reference.**
Filed on March 19, 2003 as
  part of Registrants Schedule 14A (File No. 000-49814), and incorporated by
  reference***
Incorporated by reference
  from Annual Report on Form 10-KSB for the year ended December 31, 200498