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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-KSB  þ
    ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934  For the fiscal year ended December 31, 2004 OR  o
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934  For the transition period from ______to ______  Commission file number 0-49814. MONARCH COMMUNITY BANCORP, INC.  Maryland
(State or other jurisdiction of
incorporation or organization)
    
    04-3627031
(I.R.S. Employer
Identification No.)
 375 North Willowbrook Road, Coldwater, Michigan
(Address of principal executive offices)
    
    49036
(Zip Code)
 Issuers telephone number, including area code: (517) 278-4566 Securities Registered Pursuant to Section 12(b) of the Act:None Securities Registered Pursuant to Section 12(g) of the Act:Common Stock, par value $.01 per share
(Title of Class) Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Exchange Act during the past twelve months (or for such shorter period
that the issuer was required to file such reports), and (2) has been subject to such requirements
for the past 90 days. YES þ NO o Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B
contained in this form, and no disclosure will be contained, to the best of issuers knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. o The issuer had $17.2 million in revenues for the year ended December
31, 2004. As of February 16, 2005, there were issued and outstanding 2,709,220 shares of the issuers
common stock. The aggregate market value of the common stock held by non-affiliates of the issuer,
computed by reference to the closing price of such stock as of February 15, 2005, was approximately
$32.9 million. (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.) DOCUMENTS INCORPORATED BY REFERENCE PART III of Form 10-KSB  Portions of the Proxy Statement for the Annual Meeting of Stockholders to
be held in April 2005.




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TABLE OF CONTENTS  PART IITEM 1. BusinessITEM 2. Description of PropertyITEM 3. Legal ProceedingsITEM 4. Submission of Matters to a Vote of Security HoldersPART IIITEM 5. Market for the Companys Common Equity and Related Stockholders MattersITEM 6. Managements Discussion and Analysis of Financial Condition and Results of OperationsITEM 7. Financial StatementsITEM 8. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureITEM 8A. Controls and ProceduresPART IIIITEM 9. Directors and Executive Officers of the RegistrantITEM 10. Executive CompensationITEM 11. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder MattersITEM 12. Certain Relationships and Related TransactionsITEM 13. ExhibitsITEM 14. Principal Accountant Fees and ServicesSIGNATURESIndex to ExhibitsForm of Stock Option AgreementRegistrant's Conflict of Interest and Ethics PolicySubsidiaries of the RegistrantConsent of Plante & Moran PLLCRule 13a-14(a) Certification of the Company's President and Chief Executive OfficerRule 13a-14(a) Certification of the Company's Chief Financial OfficerSection 1350 Certification    Table of Contents  
 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 Corporation 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 Corporation 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 Corporation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% of Community Services
Group, Inc., which invests in other entities, including 100% ownership of First Insurance Agency, a
minority ownership in a limited liability company that operates a title insurance agency, and a
minority ownership in a limited liability company that reinsures private mortgage insurance. 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 is a federally chartered and insured stock savings institution with seven full
service offices and one drive-through only office. The Banks deposits are insured to the maximum
extent allowed by the Federal Deposit Insurance Corporation (FDIC). The Bank is examined and
regulated by the Office of Thrift Supervision (OTS), its primary federal regulator. The Bank has
a website at http://www.monarchcb.com. References in this Form 10-KSB to we, us, and our
refer to the Company and/or the Bank as the context requires. Our common stock trades on The NASDAQ
SmallCap 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, 2004, we had total assets of $275.4 million, deposits of $167.7 million and
stockholders equity of $39.4 million.




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Forward-Looking Statements This document, including information incorporated by reference, future filings by Monarch
Community Bancorp on Form 10-QSB and Form 8-K and future oral and written statements by Monarch
Community Bancorp and its management may contain forward-looking statements which are based on
assumptions and describe future plans, strategies and expectations of Monarch Community Bancorp and
Monarch. These forward-looking statements are generally identified by use of the words believe,
expect, intend, anticipate, estimate, project, or similar words. Our ability to predict
results or the actual effect of future plans or strategies is uncertain and we disclaim any
obligation to update or revise any forward-looking statements based on the occurrence of future
events, the receipt of new information or otherwise. Factors which could have a material adverse
effect on our operations include, but are not limited to, changes in interest rates, changes in the
relative difference between short and long-term interest rates, general economic conditions,
legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including
policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan
or investment portfolios, including levels of non-performing assets, demand for loan products,
deposit flows, competition, demand for financial services in our market area, our operating costs
and accounting principles and guidelines. These risks and uncertainties should be considered in
evaluating forward-looking statements and you should not rely too much on these statements. Market Area Headquartered in Coldwater, Michigan, our geographic market area for loans and deposits is
principally Branch, Calhoun and Hillsdale counties. As of June 30, 2004, we had a 18.2% market
share of FDIC-insured deposits in Branch County, a 7.8% market share of FDIC-insured deposits in
Calhoun County and a 2.9% market share of FDIC-insured deposits in Hillsdale County, ranking us
third, fifth and sixth, respectively, in those counties among all insured depository institutions.
We have expanded our lending activities to Jackson County; however, we do not expect this expansion
to significantly affect the composition of our loan portfolio. 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.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. At December 31, 2004, our net loan portfolio totaled $219.3 million, which constituted 79.6%
of our total assets. 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 Executive Loan Committee which is
comprised of several senior managers. Loans over $1.5 million must be approved by the Board of
Directors Loan Committee. During 2002, an Officer Loan Committee was formed to further manage the
risk on new loans. Applications for loans that would be considered sub-prime cannot be approved by
individual loan officers and must be presented to the Officer Loan Committee for review and
approval. At December 31, 2004, the maximum amount which we could have loaned to any one borrower
and the borrowers related entities was $4.4 million. At that date we had 14 loan relationships in
excess of $1.0 million.




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Loan Portfolio Composition.The following table presents information concerning the
composition of our loan portfolio in dollar amounts and in percentages (before deductions for loans
in process, deferred fees and discounts and allowances for losses) as of the dates indicated. December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(Dollars in thousands)Real Estate Loans:One-to four-family
    
    $
    141,251
    
    
    $
    93,056
    
    
    $
    100,235
    
    
    $
    95,445
    
    
    $
    96,707Multi-family
    
    
    4,042
    
    
    
    485
    
    
    
    172
    
    
    
    245
    
    
    
    259Commercial
    
    
    42,746
    
    
    
    22,728
    
    
    
    17,801
    
    
    
    14,898
    
    
    
    14,040Construction or development
    
    
    8,853
    
    
    
    9,451
    
    
    
    7,177
    
    
    
    6,785
    
    
    
    5,684Total real estate loans
    
    
    196,892
    
    
    
    125,720
    
    
    
    125,385
    
    
    
    117,373
    
    
    
    116,690Other loans:Consumer loans:Automobile
    
    
    2,631
    
    
    
    1,546
    
    
    
    2,233
    
    
    
    3,287
    
    
    
    4,002Home equity
    
    
    14,234
    
    
    
    9,613
    
    
    
    11,629
    
    
    
    14,084
    
    
    
    14,827Manufactured housing
    
    
    784
    
    
    
    930
    
    
    
    1,274
    
    
    
    1,557
    
    
    
    1,902Other
    
    
    6,645
    
    
    
    3,795
    
    
    
    4,655
    
    
    
    1,800
    
    
    
    1,109Total consumer loans
    
    
    24,294
    
    
    
    15,884
    
    
    
    19,791
    
    
    
    20,728
    
    
    
    21,840Commercial Business Loans
    
    
    5,330
    
    
    
    2,695
    
    
    
    2,130
    
    
    
    1,884
    
    
    
    1,339Total other loans
    
    
    29,624
    
    
    
    18,579
    
    
    
    21,921
    
    
    
    22,612
    
    
    
    23,179Total Loans
    
    
    226,516
    
    
    
    144,299
    
    
    
    147,306
    
    
    
    139,985
    
    
    
    139,869Less:Allowance for loan losses
    
    
    6,385
    
    
    
    2,618
    
    
    
    1,735
    
    
    
    1,683
    
    
    
    857Net deferred loan fees
    
    
    808
    
    
    
    454
    
    
    
    406
    
    
    
    563
    
    
    
    718Loans in process
    
    
    6
    
    
    
    2
    
    
    
    2
    
    
    
    18
    
    
    
    97Total Loans, net
    
    $
    219,317
    
    
    $
    141,225
    
    
    $
    145,163
    
    
    $
    137,721
    
    
    $
    138,197




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The following table shows the composition of our loan portfolio by fixed- and adjustable-rate at
the dates indicated. December 31, 2004
    
    
    December 31, 2003Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Fixed-Rate LoansReal Estate Loans:One-to four-family
    
    
    78,937
    
    
    
    34.8
    %
    
    $
    67,158
    
    
    
    46.5
    %Multi-family
    
    
    1,669
    
    
    
    0.7
    
    
    
    168
    
    
    
    0.1Commercial
    
    
    13,284
    
    
    
    5.9
    
    
    
    15,381
    
    
    
    10.7Construction or development
    
    
    5,886
    
    
    
    2.6
    
    
    
    8,374
    
    
    
    5.8Total real estate loans
    
    
    99,776
    
    
    
    44.0
    
    
    
    91,081
    
    
    
    63.1Consumer
    
    
    14,836
    
    
    
    6.5
    
    
    
    14,653
    
    
    
    10.2Commercial business
    
    
    2,104
    
    
    
    0.9
    
    
    
    1,478
    
    
    
    1.0Total fixed-rate loans
    
    
    116,716
    
    
    
    51.5
    
    
    
    107,212
    
    
    
    74.3Adjustable-rate loansReal Estate Loans:One-to four-family
    
    
    62,314
    
    
    
    27.5
    
    
    
    25,897
    
    
    
    18.0Multi-family
    
    
    2,373
    
    
    
    1.0
    
    
    
    317
    
    
    
    0.2Commercial
    
    
    29,462
    
    
    
    13.0
    
    
    
    7,347
    
    
    
    5.1Construction or development
    
    
    2,967
    
    
    
    1.3
    
    
    
    1,077
    
    
    
    0.7Total real estate loans
    
    
    97,116
    
    
    
    42.9
    
    
    
    34,638
    
    
    
    24.1Consumer
    
    
    9,458
    
    
    
    4.2
    
    
    
    1,232
    
    
    
    0.9Commercial business
    
    
    3,226
    
    
    
    1.4
    
    
    
    1,217
    
    
    
    0.8Total adjustable-rate loans
    
    
    109,800
    
    
    
    48.5
    
    
    
    37,087
    
    
    
    25.8Total Loans
    
    
    226,516
    
    
    
    100.0
    %
    
    
    144,299
    
    
    
    100.0
    %Less:Allowance for loan losses
    
    
    6,385
    
    
    
    
    
    
    
    2,618Net deferred loan fees
    
    
    808
    
    
    
    
    
    
    
    454Loans in process
    
    
    6
    
    
    
    
    
    
    
    2Total Loans, net
    
    $
    219,317
    
    
    
    
    
    
    $
    141,225




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The following table illustrates the contractual maturity of our loan portfolio at December 31,
2004. 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 EstateMulti-family and
    
    
    Construction orOne-to-Four Family
    
    
    Commercial
    
    
    Development
    
    
    Consumer
    
    
    Commercial Business
    
    
    TotalWeighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    Average
    
    
    
    
    
    
    AverageAmount
    
    
    Rate
    
    
    Amount
    
    
    Rate
    
    
    Amount
    
    
    Rate
    
    
    Amount
    
    
    Rate
    
    
    Amount
    
    
    Rate
    
    
    Amount
    
    
    Rate(Dollars in Thousands)Due to Mature:One year or less (1)
    
    
    9,407
    
    
    
    5.65
    %
    
    
    1,862
    
    
    
    6.03
    %
    
    
    6,753
    
    
    
    5.63
    %
    
    
    1,849
    
    
    
    8.42
    %
    
    
    1929
    
    
    
    6.65
    %
    
    
    21,800
    
    
    
    6.00
    %After one year
through five years
    
    
    10,790
    
    
    
    6.67
    %
    
    
    9,479
    
    
    
    7.03
    %
    
    
    334
    
    
    
    4.79
    %
    
    
    9,615
    
    
    
    7.77
    %
    
    
    2449
    
    
    
    6.60
    %
    
    
    32,667
    
    
    
    7.07
    %After five years
    
    
    121,054
    
    
    
    6.56
    %
    
    
    35,447
    
    
    
    6.10
    %
    
    
    1,766
    
    
    
    6.39
    %
    
    
    12,830
    
    
    
    6.54
    %
    
    
    952
    
    
    
    6.83
    %
    
    
    172,049
    
    
    
    6.46
    %
   (1)
    
    Includes demand loans. The total amount of loans due after December 31, 2005 which have predetermined interest rates
is $99.1 million while the total amount of loans due after such date which have floating or
adjustable rates is $105.2 million.




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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, 2004, one- to
four-family residential mortgage loans totaled $141.3 million, or 62.4% 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, 2004, $20.7 million, or 14.7% of our residential mortgage loans were
classified as sub-prime loans as compared to $20.0 million, or 19.7% at December 31, 2003. The
decrease in percentage was due to the impact of the loans acquired from MSB Financial as well as a
decline in originations of these types of loans. 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
2004, $104,000, or 6.4%, of our total net charge-offs of $1.6 million were due to sub-prime loans
as compared to $240,000, or 62.5% for 2003. 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 102% 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 85%, 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- 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, 2004 and December 31, 2003, we originated $19.6 million and $15.1 million of one- to
four-family ARM loans, respectively, and $61.3 million and $79.7 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




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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. 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, golf courses, commercial properties, retail
establishments, churches and small office buildings located in our market area. At December 31,
2004, multi-family and commercial real estate loans totaled $46.8 million or 20.7% 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 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 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, 2004, we had $8.9 million in
construction and development loans outstanding, representing 3.9% of our gross loan portfolio.




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Construction and 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. 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,
2004, our consumer loan portfolio totaled $24.2 million, or 10.7% of our gross loan portfolio. We
offer a variety of secured consumer loans, including home equity loans and lines of credit, auto
loans, boat and recreational vehicle 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 $14.2 million, and comprised 6.3% of our gross loan
portfolio at December 31, 2004. 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, boat and recreational vehicle loans and manufactured housing loans on
a direct basis and boat and recreational vehicle loans on an indirect basis beginning in 2001. We
generally buy indirect loans on a rate basis, paying the dealer a cash payment for loans with an
interest rate in excess of the rate we require. This premium is expensed as the dealer is paid. Any
prepayments within 180 days of the loan date are charged back to the dealer, with no dealer reserve
or other guarantee of payment if the dealer stops doing business with us. We underwrite indirect loans using the Fair-Isaacs credit scoring system, a widely used credit
evaluation system. We generally do not approve indirect loans which would be considered subprime
in accordance with our loan grading system. We had $4.2 million of indirect consumer loans at
December 31, 2004. We intend to continue indirect consumer lending. Auto loans totaled $2.6 million at December 31, 2004, or 1.2% of our gross loan portfolio.
Auto




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##### Table of Contents



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 $784,000 at December 31, 2004, or .3% of our gross loan
portfolio. This amount is down significantly over the last three years, due to a change in our loan
policy regarding these types of loans. Manufactured housing loans are currently offered only on an
exception basis with approval by the Officer Loan Committee. We originate direct sub-prime consumer loans, using the same definition as residential
mortgage loans. At December 31, 2004, $2.3 million, or 9.5%, 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, manufactured housing and recreational vehicles. 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, 2004, commercial business loans comprised $5.3
million, or 2.4% 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, 2004, there was $97,000 of standby letters of
credit outstanding. Our commercial business lending policy includes credit file documentation and analysis of the
borrowers background, capacity to repay the loan, the adequacy of the borrowers capital and
collateral as well as an evaluation of other conditions affecting the borrower. Analysis of the
borrowers past, present and future cash flows is also an important aspect of our credit analysis.
Based on this underwriting information we assign a risk rating which assists management in
evaluating the quality of the loan portfolio. We generally obtain personal guarantees on our
commercial business loans. Nonetheless, these loans are believed to carry higher credit risk than
more traditional single family loans. Unlike residential mortgage loans, commercial business loans are typically made on the basis
of the borrowers ability to make repayment from the cash flow of the borrowers business. As a
result, the availability of funds for the repayment of commercial business loans is substantially
dependent on the success of the business itself (which, in turn, is often dependent in part upon
general economic conditions). Our commercial business loans are usually, but not always, secured by
business assets. However, the collateral securing the loans may depreciate over time, may be
difficult to appraise and may fluctuate in value based on the success of the business. Loan Originations, Purchases, Sales and Repayments. We originate loans through referrals from
real estate brokers and builders and other customers, our marketing efforts, and our existing and
walk-in customers. 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 2004, 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




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adjustable-rate loans. This trend began to reverse in 2004 as we originated more adjustable
rate loans as a percentage of our total originations than in past years. 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. During the
past few years, we, like many other financial institutions, have experienced significant
prepayments on loans due to the low interest rate environment prevailing in the United States. 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.




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##### Table of Contents



The following table shows the loan origination, sale and repayment activities of Monarch for the
periods indicated. Years EndedDecember 31,2004
    
    
    2003(Dollars in thousands)Originations by type:Real Estate:One-to-four family
    
    
    80,961
    
    
    
    94,757Multi-family
    
    
    845
    
    
    
    318Commercial
    
    
    16,854
    
    
    
    10,038Construction or development
    
    
    14,917
    
    
    
    13,194Total real estate loans
    
    
    113,577
    
    
    
    118,307Consumer Loans:Automobile
    
    
    1,469
    
    
    
    725Home Equity
    
    
    10,348
    
    
    
    6,043Mobile Homes
    
    
    23
    
    
    
    59Other
    
    
    4,580
    
    
    
    1,869Commercial business
    
    
    3,666
    
    
    
    2,056Total loans originated
    
    
    133,663
    
    
    
    129,059Sales and Repayments:One-to-four family loans sold
    
    
    29,808
    
    
    
    59,783Principal repayments
    
    
    95,431
    
    
    
    72,283Total reductions
    
    
    125,239
    
    
    
    132,066Loans acquired in acquisition
    
    
    73,793
    
    
    
    Increase (decrease) in other items, net
    
    
    4,125
    
    
    
    931Net increase (decrease)
    
    $
    78,092
    
    
    $
    (3,938
    )
 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 update is
returned, the senior collector determines if the borrower exhibits an ability to repay,
and, if so, brings the file to the Delinquency Committee for a decision whether to forbear
collection action to allow the borrower to demonstrate the ability to make timely payments
and/or
establish an acceptable repayment plan to bring the loan current. If the borrower makes
timely payments for a period of at least six months but does not appear to have the ability
to bring the loan current, the file is given to a loan officer to obtain a new loan
application from the borrower for the purpose of rewriting the loan in accordance with
established loan policy. If the financial




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##### Table of Contents



information update is not returned, or if the
senior collector determines that the borrower no longer has the ability to repay the loan,
or the Delinquency Committee declines to forbear collection activity, then when the loan
becomes 60 days delinquent, the file is reviewed by the Delinquency Committee and the
foreclosure process is begun by the sending of a notice of intent to foreclose. If during a
period of forbearance the borrower fails to make timely payments, the Delinquency Committee
reviews the loan and the foreclosure process commences unless extenuating circumstances
exist. The notice of intent to foreclose allows the borrower up to 30 days to bring the
account current. During this 30 day period, the collector may accept a written repayment
plan from the borrower which would bring the account current within the next 90 days. All
loans over 90 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 President and our staff attorney 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.




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##### Table of Contents



Delinquent Loans.The following tables set forth our loan delinquencies by type,
number, amount and percentage of type at the dates indicated: December 31, 2004Loans Delinquent For:60-89 Days
    
    
    90 Days and Over
    
    
    Total Delinquent LoansPercent of
    
    
    
    
    
    
    
    
    
    
    Percent of
    
    
    
    
    
    
    
    
    
    
    Percent ofLoan
    
    
    
    
    
    
    
    
    
    
    Loan
    
    
    
    
    
    
    
    
    
    
    LoanNumber
    
    
    Amount
    
    
    Category
    
    
    Number
    
    
    Amount
    
    
    Category
    
    
    Number
    
    
    Amount
    
    
    Category(Dollars in Thousands)Real EstateOne-to four-family
    
    
    37
    
    
    
    2,020
    
    
    
    1.43
    %
    
    
    39
    
    
    
    1,866
    
    
    
    1.32
    %
    
    
    76
    
    
    
    3,886
    
    
    
    2.75
    %Multi-family
    
    
    
    
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    
    
    
    
    0.00
    %Commercial
    
    
    1
    
    
    
    14
    
    
    
    0.03
    %
    
    
    6
    
    
    
    1,563
    
    
    
    3.66
    %
    
    
    7
    
    
    
    1,577
    
    
    
    3.69
    %Construction or development
    
    
    1
    
    
    
    189
    
    
    
    2.13
    %
    
    
    1
    
    
    
    220
    
    
    
    2.49
    %
    
    
    2
    
    
    
    409
    
    
    
    4.62
    %Total real estate loans
    
    
    39
    
    
    
    2,223
    
    
    
    1.13
    %
    
    
    46
    
    
    
    3,649
    
    
    
    1.85
    %
    
    
    85
    
    
    
    5,872
    
    
    
    2.98
    %Consumer
    
    
    13
    
    
    
    162
    
    
    
    0.67
    %
    
    
    6
    
    
    
    93
    
    
    
    0.38
    %
    
    
    19
    
    
    
    255
    
    
    
    1.05
    %Commercial Business
    
    
    2
    
    
    
    137
    
    
    
    2.57
    %
    
    
    3
    
    
    
    344
    
    
    
    6.45
    %
    
    
    5
    
    
    
    481
    
    
    
    9.02
    %Total
    
    
    54
    
    
    $
    2,522
    
    
    
    1.11
    %
    
    
    55
    
    
    $
    4,086
    
    
    
    1.80
    %
    
    
    109
    
    
    
    6,608
    
    
    
    2.92
    %
 December 31, 2003Loans Delinquent For:60-89 Days
    
    
    90 Days and Over
    
    
    Total Delinquent LoansPercent of
    
    
    
    
    
    
    
    
    
    
    Percent of
    
    
    
    
    
    
    
    
    
    
    Percent ofLoan
    
    
    
    
    
    
    
    
    
    
    Loan
    
    
    
    
    
    
    
    
    
    
    LoanNumber
    
    
    Amount
    
    
    Category
    
    
    Number
    
    
    Amount
    
    
    Category
    
    
    Number
    
    
    Amount
    
    
    Category(Dollars in Thousands)Real EstateOne-to four-family
    
    
    16
    
    
    
    884
    
    
    
    0.95
    %
    
    
    10
    
    
    
    768
    
    
    
    0.83
    %
    
    
    26
    
    
    
    1,652
    
    
    
    1.78
    %Multi-family
    
    
    
    
    
    
    
    
    
    
    0.00
    %
    
    
    1
    
    
    
    317
    
    
    
    65.36
    %
    
    
    1
    
    
    
    317
    
    
    
    65.36
    %Commercial
    
    
    2
    
    
    
    819
    
    
    
    3.60
    %
    
    
    5
    
    
    
    1,558
    
    
    
    6.85
    %
    
    
    7
    
    
    
    2,377
    
    
    
    10.46
    %Construction or development
    
    
    
    
    
    
    
    
    
    
    0.00
    %
    
    
    1
    
    
    
    645
    
    
    
    6.82
    %
    
    
    1
    
    
    
    645
    
    
    
    6.82
    %Total real estate loans
    
    
    18
    
    
    
    1,703
    
    
    
    1.35
    %
    
    
    17
    
    
    
    3,288
    
    
    
    2.62
    %
    
    
    35
    
    
    
    4,991
    
    
    
    3.97
    %Consumer
    
    
    10
    
    
    
    62
    
    
    
    0.39
    %
    
    
    10
    
    
    
    228
    
    
    
    1.44
    %
    
    
    20
    
    
    
    290
    
    
    
    1.83
    %Commercial Business
    
    
    2
    
    
    
    107
    
    
    
    3.97
    %
    
    
    2
    
    
    
    89
    
    
    
    3.30
    %
    
    
    4
    
    
    
    196
    
    
    
    7.27
    %Total
    
    
    30
    
    
    $
    1,872
    
    
    
    1.30
    %
    
    
    29
    
    
    $
    3,605
    
    
    
    2.50
    %
    
    
    59
    
    
    
    5,477
    
    
    
    3.80
    %




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##### Table of Contents



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 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(Dollars in Thousands)Non-accruing loans:One-to four family
    
    $
    1,866
    
    
    $
    908
    
    
    $
    1,372
    
    
    $
    
    
    
    $
    Multi-family
    
    
    
    
    
    
    318
    
    
    
    
    
    
    
    
    
    
    
    Commercial real estate
    
    
    1,708
    
    
    
    1,558
    
    
    
    211
    
    
    
    
    
    
    
    Construction or development
    
    
    220
    
    
    
    645
    
    
    
    
    
    
    
    
    
    
    
    Consumer
    
    
    93
    
    
    
    101
    
    
    
    55
    
    
    
    
    
    
    
    Commercial business
    
    
    344
    
    
    
    89
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    4,231
    
    
    
    3,619
    
    
    
    1,638
    
    
    
    
    
    
    
    Accruing loans delinquent 90 days or more:One-to four family
    
    
    
    
    
    
    
    
    
    
    864
    
    
    
    2,251
    
    
    
    2,248Multi-family
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Commercial real estate
    
    
    
    
    
    
    
    
    
    
    342
    
    
    
    161
    
    
    
    142Construction or development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    257
    
    
    
    Consumer
    
    
    
    
    
    
    127
    
    
    
    111
    
    
    
    306
    
    
    
    290Commercial business
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    17Total
    
    
    
    
    
    
    127
    
    
    
    1,317
    
    
    
    2,975
    
    
    
    2,697Foreclosed assets:One-to four family (1)
    
    
    1,560
    
    
    
    2,177
    
    
    
    2,022
    
    
    
    2,437
    
    
    
    1,304Multi-family
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Commercial real estate
    
    
    400
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Construction or development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Consumer
    
    
    9
    
    
    
    47
    
    
    
    37
    
    
    
    136
    
    
    
    13Commercial business
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    1,969
    
    
    
    2,224
    
    
    
    2,059
    
    
    
    2,573
    
    
    
    1,317Total non-performing assets
    
    $
    6,200
    
    
    $
    5,970
    
    
    $
    5,014
    
    
    $
    5,548
    
    
    $
    4,014Total as a percentage of total assets
    
    
    2.23
    %
    
    
    2.94
    %
    
    
    2.53
    %
    
    
    3.29
    %
    
    
    2.45
    %
   (1)
    
    Includes $726,000 and $1.1 million in real estate in judgment and
subject to redemption at December 31, 2004 and 2003, respectively. For the years ended December 31, 2004 and 2003, respectively, there
was $211,000 and $166,000 of gross interest income which would have been recorded had
non-accruing loans been current in accordance with their original terms.




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##### Table of Contents



Other Loans of Concern.In addition to the non-performing assets set forth in the
table above, as of December 31, 2004, there were also the following loan relationships
totaling an aggregate of $7.3 million with respect to which known information about the
possible credit problems of the borrowers has caused management to have doubts as to the
ability of the borrowers to comply with present loan repayment terms and which may result
in the future inclusion of these loans in the non-performing asset categories. These loans
have been considered in managements determination of the adequacy of our allowance for
loan losses and are included in the commercial category in the table. Our largest loan relationship originated via a series of loans in 2002, 2003 and 2004
and totals $4.2 million. The largest loan within this relationship was originated in 2004,
totals $3.0 million and is secured by a 52 acre island in northern Michigan. The borrower
has experienced recent financial difficulties and at December 31, 2004 the loan was more
than 30 days delinquent. Early in 2005, the Bank entered into a forbearance agreement with
the borrower whereby the borrower is required to make interest only payments for six months
during which time the borrower is attempting to liquidate all properties securing loans
within this relationship. See Managements Discussion and Analysis of Financial Condition
and Results of Operations-Provision for Loan Loss for further discussion of this lending
relationship. The second loan relationship is a commercial real estate loan with a balance of $597,000 at
December 31, 2004. This loan is secured by a golf course in southwest Michigan and is current as of
December 31, 2004. The third loan relationship is a series of commercial real estate loans totaling $753,000,
originated in 1996 for the purpose of developing residential building lots in southwest Michigan.
There was very little sales activity during 2004 and all loans associated with this relationship
are delinquent as of December 31, 2004. Included in non-performing assets is $571,000 of this
relationship. The fourth loan relationship totals $1.3 million at December 31, 2004 for the development of
residential building lots in southwest Michigan. At December 31, 2004 this relationship is current. The fifth loan relationship is a loan on residential rental real estate totaling
$75,000 at December 31, 2004. This loan was current at December 31, 2004. The sixth loan relationship totals $160,000 and is secured by a commercial building.
The business housed in this building is not operational and all loans are more than 30 days
delinquent as of December 31, 2004. The seventh loan relationship is a series of commercial business and real estate loans
totaling $206,000. These loans are secured by a commercial building and inventory related
to a retail operation. All loans were greater than 60 days delinquent as of December 31,
2004. 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 OTS 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




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##### Table of Contents



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 OTS and the FDIC, which may order the establishment
of additional general or specific loss allowances. In connection with the filing of our periodic reports with the OTS and 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,
2004, we had classified $12.8 million of our assets as substandard, $721,000 as doubtful
and none as loss. The total amount classified represented 36.5% of the Banks equity
capital and 4.7% of the Banks assets at December 31, 2004. The allowance for loan losses
at December 31, 2004 includes $3.9 million related to substandard and doubtful loans. At
December 31, 2004, $3.4 million and $721,000 of substandard and doubtful assets,
respectively, have been included in the table of non-performing assets. See - Asset
Quality  Delinquent Loans.




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##### Table of Contents



Provision for Loan Losses. We recorded a provision for loan losses of $4.9 million for
the year ended December 31, 2004 compared to $1.3 million for the year ended December 31,
2003. 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, 2004 and 2003  Provision for Loan Losses for a discussion of the reasons for
the increased provision in 2004. Allowance for Loan Losses. The allowance is based on regular, quarterly assessments of
the estimated losses inherent in the loan portfolio. Our methodology for assessing the
appropriateness of the allowance consists of several key elements, which include the
formula allowance and specific allowances for identified problem loans and portfolio
segments. In addition, the allowance incorporates the results of measuring impaired loans
as provided in SFAS No. 114, Accounting by Creditors for Impairment of a Loan and SFAS
No. 118, Accounting by Creditors for Impairment of a Loan  Income Recognition and
Disclosures. These accounting standards prescribe the measurement methods, income
recognition and disclosures related to impaired loans. The formula allowance is calculated by applying loss factors to outstanding loans
based on the internal risk evaluation of these loans or pools of loans. Changes in risk
evaluations of both performing and nonperforming loans affect the amount of the formula
allowance. Loss factors are based both on our historical loss experience as well as on
significant factors that, in managements judgment, affect the collectibility of the
portfolio as of the evaluation date. The appropriateness of the allowance is reviewed by management based upon our
evaluation of then-existing economic and business conditions affecting our key lending
areas and other conditions, such as credit quality trends (including trends in
delinquencies, nonperforming loans and foreclosed assets expected to result from existing
conditions), collateral values, loan volumes and concentrations, specific industry
conditions within portfolio segments and recent loss experience in particular segments of
the portfolio that existed as of the balance sheet date and the impact that such conditions
were believed to have had on the collectibility of the loan. Senior management reviews
these conditions quarterly. To the extent that any of these conditions is evidenced by a
specifically identifiable problem credit or portfolio segment as of the evaluation date,
managements estimate of the effect of this condition may be reflected as a specific
allowance applicable to this credit or portfolio segment. The allowance for loan losses is based on estimates of losses inherent in the loan
portfolio. Actual losses can vary significantly from the estimated amounts. Our methodology
as described permits adjustments to any loss factor used in the computation of the formula
allowance in the event that, in managements judgment, significant factors which affect the
collectibility of the portfolio as of the evaluation date are not reflected in the loss
factors. By assessing the estimated losses inherent in the loan portfolio on a quarterly
basis, we are able to adjust specific and inherent loss estimates based upon any more
recent information that has become available.




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##### Table of Contents



Assessing the adequacy of the allowance for loan losses is inherently subjective as it
requires making material estimates, including the net realizable value of collateral expected to be
received on impaired loans that may be susceptible to significant change. In the opinion of
management, the allowance, when taken as a whole, covers all known and inherent losses in the loan
portfolio that are both probable and reasonable to estimate. The following table summarizes
activity in the allowance for loan losses for the years ending (000s omitted): December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Balance at beginning of year
    
    $
    2,618
    
    
    $
    1,735
    
    
    $
    1,683
    
    
    $
    857
    
    
    $
    705Charge-offs:One-to four family
    
    
    375
    
    
    
    436
    
    
    
    415
    
    
    
    116
    
    
    
    60Multi-family
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Commercial real estate
    
    
    1,306
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    Construction or development
    
    
    
    
    
    
    15
    
    
    
    
    
    
    
    
    
    
    
    Consumer
    
    
    118
    
    
    
    122
    
    
    
    152
    
    
    
    206
    
    
    
    55Commercial business
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    1,799
    
    
    
    573
    
    
    
    568
    
    
    
    322
    
    
    
    115Recoveries:One-to four family
    
    
    105
    
    
    
    157
    
    
    
    135
    
    
    
    72
    
    
    
    5Multi-family
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Commercial real estate
    
    
    28
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Construction or development
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Consumer
    
    
    45
    
    
    
    32
    
    
    
    88
    
    
    
    37
    
    
    
    17Commercial business
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    178
    
    
    
    189
    
    
    
    223
    
    
    
    109
    
    
    
    22Net charge-offs
    
    
    1,621
    
    
    
    384
    
    
    
    345
    
    
    
    213
    
    
    
    93Allowance acquired in acquisition
    
    
    513
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Additions charged to operations
    
    
    4,875
    
    
    
    1,267
    
    
    
    397
    
    
    
    1,039
    
    
    
    245Balance at end of year
    
    $
    6,385
    
    
    $
    2,618
    
    
    $
    1,735
    
    
    $
    1,683
    
    
    $
    857Ratio of net charge-offs during the year to average loans
outstanding during the year
    
    
    0.82
    %
    
    
    0.26
    %
    
    
    0.24
    %
    
    
    0.15
    %
    
    
    0.07
    %Allowance as a percentage of non-performing loans
    
    
    150.91
    %
    
    
    69.89
    %
    
    
    58.71
    %
    
    
    56.57
    %
    
    
    31.78
    %Allowance as a percentage of total loans (end of year)
    
    
    2.82
    %
    
    
    1.81
    %
    
    
    1.18
    %
    
    
    1.22
    %
    
    
    0.62
    %




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##### Table of Contents



The distribution of our allowance for losses on loans at the dates indicated is summarized as
follows: December 31,2004
    
    
    2003
    
    
    2002Amount of
    
    
    Percentage
    
    
    Amount of
    
    
    Percentage
    
    
    Amount of
    
    
    PercentageLoan Loss
    
    
    of
    
    
    Loan Loss
    
    
    of
    
    
    Loan Loss
    
    
    ofAllowance
    
    
    Loans
    
    
    Allowance
    
    
    Loans
    
    
    Allowance
    
    
    LoansOne-to four-family
    
    $
    1,516
    
    
    
    62.4
    %
    
    $
    624
    
    
    
    64.5
    %
    
    $
    805
    
    
    
    68.0
    %Multi-family and non-residential
real estate
    
    
    4,513
    
    
    
    20.6
    %
    
    
    1,239
    
    
    
    16.1
    %
    
    
    686
    
    
    
    12.2
    %Construction or development
    
    
    27
    
    
    
    3.9
    %
    
    
    507
    
    
    
    6.5
    %
    
    
    33
    
    
    
    4.9
    %Consumer
    
    
    261
    
    
    
    10.7
    %
    
    
    173
    
    
    
    11.0
    %
    
    
    201
    
    
    
    13.4
    %Commercial business
    
    
    68
    
    
    
    2.4
    %
    
    
    75
    
    
    
    1.9
    %
    
    
    10
    
    
    
    1.5
    %Total
    
    $
    6,385
    
    
    
    100.0
    %
    
    $
    2,618
    
    
    
    100.0
    %
    
    $
    1,735
    
    
    
    100.0
    %
 2001
    
    
    2000Amount of
    
    
    Percentage
    
    
    Amount of
    
    
    PercentageLoan Loss
    
    
    of
    
    
    Loan Loss
    
    
    ofAllowance
    
    
    Loans
    
    
    Allowance
    
    
    LoansOne-to four-family
    
    $
    821
    
    
    
    68.2
    %
    
    $
    415
    
    
    
    69.1
    %Multi-family and non-residential
real estate
    
    
    10
    
    
    
    10.8
    %
    
    
    7
    
    
    
    10.2
    %Construction or development
    
    
    27
    
    
    
    4.8
    %
    
    
    12
    
    
    
    4.1
    %Consumer
    
    
    302
    
    
    
    14.8
    %
    
    
    148
    
    
    
    15.7
    %Commercial business
    
    
    523
    
    
    
    1.4
    %
    
    
    275
    
    
    
    0.9
    %$
    1,683
    
    
    
    100.0
    %
    
    $
    857
    
    
    
    100.0
    %
 Investment Activities Federally chartered savings institutions have the authority to invest in various types of
liquid assets, including United States Treasury obligations, securities of various federal
agencies, including callable agency 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




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##### Table of Contents



Liability Management and Market Risk. Our investment portfolio consists of U.S. Treasury, 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 is complete 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 began 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.




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##### Table of Contents



The following table sets forth the composition of our securities portfolio at the dates
indicated. December 31, 2004
    
    
    December 31, 2003Percent of
    
    
    
    
    
    
    
    
    
    
    Percent ofFair
    
    
    Total
    
    
    
    
    
    
    Fair
    
    
    TotalAmortized
    
    
    Market
    
    
    Fair Market
    
    
    Amortized
    
    
    Market
    
    
    Fair MarketCost
    
    
    Value
    
    
    Value
    
    
    Cost
    
    
    Value
    
    
    Value(Dollars in Thousands)Available-for-sale securities:U.S. Treasury obligations
    
    $
    
    
    
    $
    
    
    
    
    0.0
    %
    
    $
    5,177
    
    
    $
    5,230
    
    
    
    26.2
    %U.S. government agency obligations
    
    
    3,984
    
    
    
    3,989
    
    
    
    47.9
    %
    
    
    9,616
    
    
    
    9,653
    
    
    
    48.4
    %Mortgage-backed securities
    
    
    1,677
    
    
    
    1,675
    
    
    
    20.1
    %
    
    
    1,046
    
    
    
    1,034
    
    
    
    5.2
    %Obligations of states and
political subdivisions
    
    
    2,394
    
    
    
    2,393
    
    
    
    28.7
    %
    
    
    3,697
    
    
    
    3,731
    
    
    
    18.7
    %Total available-for-sale securities
    
    $
    8,055
    
    
    $
    8,057
    
    
    
    96.8
    %
    
    $
    19,536
    
    
    $
    19,648
    
    
    
    98.5
    %Held-to-maturity securities:Municipal security
    
    $
    267
    
    
    $
    268
    
    
    
    3.2
    %
    
    $
    286
    
    
    $
    302
    
    
    
    1.5
    %Total investment securities
    
    $
    8,322
    
    
    $
    8,325
    
    
    
    100.0
    %
    
    $
    19,822
    
    
    $
    19,950
    
    
    
    100.0
    %
 December 31, 2002Percent ofFair
    
    
    TotalAmortized
    
    
    Market
    
    
    Fair MarketCost
    
    
    Value
    
    
    ValueAvailable-for-sale securities:U.S. Treasury obligations
    
    $
    3,310
    
    
    
    3,338
    
    
    
    19.1
    %U.S. government agency obligations
    
    
    10,246
    
    
    
    10,312
    
    
    
    59.2
    %Mortgage-backed securities
    
    
    
    
    
    
    
    
    
    
    0.0
    %Obligations of states and
political subdivisions
    
    
    3,505
    
    
    
    3,510
    
    
    
    20.1
    %Total available-for-sale securities
    
    $
    17,061
    
    
    $
    17,160
    
    
    
    98.4
    %Held-to-maturity securities:Municipal security
    
    $
    274
    
    
    
    275
    
    
    
    1.6
    %Total investment securities
    
    $
    17,335
    
    
    $
    17,435
    
    
    
    100.0
    %




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##### Table of Contents



The maturities of the investment securities portfolio, excluding FHLB stock, as of December 31,
2004 are indicated in the following table. Less than 1 year
    
    
    1 to 5 years
    
    
    5 to 10 years
    
    
    Over 10 years
    
    
    Total SecuritiesWgt
    
    
    
    
    
    
    Wgt
    
    
    
    
    
    
    Wgt
    
    
    
    
    
    
    Wgt
    
    
    
    
    
    
    WgtAmortized
    
    
    Ave
    
    
    Amortized
    
    
    Ave
    
    
    Amortized
    
    
    Ave
    
    
    Amortized
    
    
    Ave
    
    
    Amortized
    
    
    AveCost
    
    
    Yield
    
    
    Cost
    
    
    Yield
    
    
    Cost
    
    
    Yield
    
    
    Cost
    
    
    Yield
    
    
    Cost
    
    
    Yield(Dollars in Thousands)Available-for-sale securities:U.S. Treasury obligations
    
    $
    
    
    
    
    0.00
    %
    
    $
    
    
    
    
    0.00
    %
    
    $
    
    
    
    
    0.00
    %
    
    $
    
    
    
    
    0.00
    %
    
    $
    
    
    
    $
    0U.S. government agency obligations
    
    
    
    
    
    
    0.00
    %
    
    
    3,984
    
    
    
    3.75
    %
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    0.00
    %
    
    
    3,984
    
    
    
    3.75
    %Mortgage-backed securities
    
    
    
    
    
    
    0.00
    %
    
    
    706
    
    
    
    3.50
    %
    
    
    972
    
    
    
    4.42
    %
    
    
    
    
    
    
    0.00
    %
    
    
    1,678
    
    
    
    4.04
    %Obligations of states and
political subdivisions
    
    
    1,548
    
    
    
    2.99
    %
    
    
    845
    
    
    
    3.09
    %
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    0.00
    %
    
    
    2,393
    
    
    
    3.02
    %Total available-for-sale securities
    
    
    1,548
    
    
    
    2.99
    %
    
    
    5,535
    
    
    
    3.62
    %
    
    
    972
    
    
    
    4.42
    %
    
    
    
    
    
    
    0.00
    %
    
    
    8,055
    
    
    
    3.59
    %Held-to-maturity securities:Municipal security
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    0.00
    %
    
    
    267
    
    
    
    6.55
    %
    
    
    267
    
    
    
    6.55
    %Total investment securities
    
    $
    1,548
    
    
    
    2.50
    %
    
    $
    5,535
    
    
    
    2.42
    %
    
    $
    972
    
    
    
    3.57
    %
    
    $
    267
    
    
    
    6.55
    %
    
    $
    8,322
    
    
    
    2.56
    %
 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, 2004, we had $18.8 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.




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##### Table of Contents



The following table sets forth our deposit flows during the periods indicated. Year EndedDecember 31,2004
    
    
    2003(Dollars in Thousands)Opening balance
    
    $
    107,240
    
    
    $
    106,744Deposits acquired
    
    $
    70,216
    
    
    $
    Net deposits (withdrawals)
    
    
    (12,683
    )
    
    
    (2,385
    )Interest credited
    
    
    2,960
    
    
    
    2,881Ending balance
    
    $
    167,733
    
    
    $
    107,240Net increase
    
    $
    60,493
    
    
    $
    496Percent increase
    
    
    56.41
    %
    
    
    0.46
    %




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##### Table of Contents



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. 2004
    
    
    2003Percent
    
    
    
    
    
    
    PercentAmount
    
    
    of Total
    
    
    Amount
    
    
    of Total(Dollars in Thousands)Transaction and Savings Deposits:Non-interest bearing accounts
    
    $
    5,198
    
    
    
    3.1
    %
    
    $
    4,183
    
    
    
    3.9
    %Savings accounts
    
    
    29,177
    
    
    
    17.4
    %
    
    
    15,889
    
    
    
    14.8
    %Checking & NOW accounts
    
    
    27,843
    
    
    
    16.6
    %
    
    
    9,275
    
    
    
    8.6
    %Money market accounts
    
    
    19,114
    
    
    
    11.4
    %
    
    
    10,909
    
    
    
    10.2
    %Total transaction and savings
    
    $
    81,332
    
    
    
    48.5
    %
    
    $
    40,256
    
    
    
    37.5
    %Certificates:0.00-1.99%
    
    
    18,658
    
    
    
    11.1
    %
    
    
    15,080
    
    
    
    14.1
    %2.00-3.99%
    
    
    49,714
    
    
    
    29.6
    %
    
    
    27,749
    
    
    
    25.9
    %4.00-5.99%
    
    
    15,836
    
    
    
    9.4
    %
    
    
    21,514
    
    
    
    20.1
    %6.00-7.99%
    
    
    2,193
    
    
    
    1.3
    %
    
    
    2,641
    
    
    
    2.5
    %Total certificates
    
    
    86,401
    
    
    
    51.5
    %
    
    
    66,984
    
    
    
    62.5
    %Total deposits
    
    $
    167,733
    
    
    
    100.0
    %
    
    $
    107,240
    
    
    
    100.0
    %
 The following table indicates the amount of our certificates of deposit by
time remaining until maturity as of December 31, 2004. MaturityOver
    
    
    Over
    
    
    Over3 Months
    
    
    3 to 6
    
    
    6 to 12
    
    
    12or less
    
    
    Months
    
    
    Months
    
    
    Months
    
    
    Total(Dollars in Thousands)Certificates of deposit less than $100,000
    
    $
    14,440
    
    
    $
    13,366
    
    
    $
    16,102
    
    
    $
    24,649
    
    
    $
    68,557Certificates of deposit of $100,000 or more
    
    
    3,179
    
    
    
    2,332
    
    
    
    6,752
    
    
    
    5,581
    
    
    
    17,844Total certificates of deposit
    
    $
    17,619
    
    
    $
    15,698
    
    
    $
    22,854
    
    
    $
    30,230
    
    
    $
    86,401




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##### Table of Contents



The following table shows rate and maturity information for our certificates of deposit as of
December 31, 2004. 0.00-
    
    
    2.00-
    
    
    4.00-
    
    
    6.00-
    
    
    
    
    
    
    Percent1.99%
    
    
    3.99%
    
    
    5.99%
    
    
    7.99%
    
    
    Total
    
    
    of Total(Dollars in Thousands)Certificate accounts
maturing in quarter ending:March 31, 2005
    
    
    8,059
    
    
    
    8,066
    
    
    
    892
    
    
    
    888
    
    
    
    17,905
    
    
    
    20.7
    %June 30, 2005
    
    
    8,083
    
    
    
    6,266
    
    
    
    885
    
    
    
    462
    
    
    
    15,696
    
    
    
    18.2
    %September 30, 2005
    
    
    2,015
    
    
    
    4,341
    
    
    
    207
    
    
    
    330
    
    
    
    6,893
    
    
    
    8.0
    %December 31, 2005
    
    
    137
    
    
    
    15,299
    
    
    
    9
    
    
    
    228
    
    
    
    15,673
    
    
    
    18.1
    %March 31, 2006
    
    
    178
    
    
    
    5,628
    
    
    
    1,318
    
    
    
    285
    
    
    
    7,409
    
    
    
    8.6
    %June 30, 2006
    
    
    103
    
    
    
    1,053
    
    
    
    1,320
    
    
    
    
    
    
    
    2,476
    
    
    
    2.9
    %September 30, 2006
    
    
    43
    
    
    
    674
    
    
    
    1,389
    
    
    
    
    
    
    
    2,106
    
    
    
    2.4
    %December 31, 2006
    
    
    
    
    
    
    655
    
    
    
    652
    
    
    
    
    
    
    
    1,307
    
    
    
    1.5
    %March 31, 2007
    
    
    16
    
    
    
    517
    
    
    
    3,126
    
    
    
    
    
    
    
    3,659
    
    
    
    4.2
    %June 30, 2007
    
    
    
    
    
    
    462
    
    
    
    2,624
    
    
    
    
    
    
    
    3,086
    
    
    
    3.6
    %September 30, 2007
    
    
    
    
    
    
    387
    
    
    
    1,808
    
    
    
    
    
    
    
    2,195
    
    
    
    2.5
    %December 31, 2007
    
    
    
    
    
    
    544
    
    
    
    1,432
    
    
    
    
    
    
    
    1,976
    
    
    
    2.3
    %Thereafter
    
    
    24
    
    
    
    5,822
    
    
    
    174
    
    
    
    
    
    
    
    6,020
    
    
    
    7.0
    %Total
    
    $
    18,658
    
    
    $
    49,714
    
    
    $
    15,836
    
    
    $
    2,193
    
    
    $
    86,401
    
    
    
    100.0
    %Percent of total
    
    
    21.59
    %
    
    
    57.54
    %
    
    
    18.33
    %
    
    
    2.54
    %




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##### Table of Contents



Borrowings.Although deposits are our primary source of funds, we utilize borrowings when they
are a less costly source of funds and can be invested at a positive interest rate spread, 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, 2004, we had $66.0 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. Year EndedDecember 31,2004
    
    
    2003(Dollars in Thousands)Maximum Balance:FHLB advances
    
    $
    66,253
    
    
    $
    57,500Average Balance:FHLB advances
    
    $
    62,643
    
    
    $
    57,111
 The following table sets forth certain information concerning our
borrowings at the dates indicated. December 31,2004
    
    
    2003(Dollars in Thousands)FHLB advances
    
    $
    65,955
    
    
    $
    57,384Weighted average interest rate of FHLB advances
FHLB advances
    
    
    5.36
    %
    
    
    5.51
    %
 Subsidiary and Other Activities As a federally chartered savings bank, we are permitted by OTS regulations to invest up to 2%
of our assets, or $5.6 million at December 31, 2004, in the stock of, or unsecured loans to,

service corporation subsidiaries. We may invest an additional 1% of our assets in service
corporations where such additional funds are used for inner-city or community development purposes. At December 31, 2004, the Bank had one active subsidiary, Community Services Group, Inc., and
our total investment in this subsidiary was $975,000 which consisted principally of deposits in
Monarch.




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##### Table of Contents



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 other savings
institutions, commercial banks, credit unions and mortgage bankers, including non-local Internet
based and telephone-based competition. Other savings institutions, commercial banks, credit unions
and finance companies, including non-local Internet based entities, also provide vigorous
competition in consumer lending. Employees At December 31, 2004, we had a total of 96 employees, including one part-time employee. Our
employees are not represented by any collective bargaining group. Management considers its employee
relations to be good. Federal and State Taxation Federal Taxation General.The Company is subject to federal income taxation in the same general manner as other
corporations, with some exceptions discussed below. The following discussion of federal taxation is
intended only to summarize certain pertinent federal income tax matters and is not a comprehensive
description of the tax rules applicable to Monarch Community Bancorp. Our federal income tax
returns for the past three years are open to audit by the IRS. In our opinion, any examination of
still open returns would not result in a deficiency which could have a material adverse effect on
our financial condition. No 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 thrift/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.




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##### Table of Contents



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 2004 was 1.9%. The rate is subject to change
annually and is expected to decrease through 2021. 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 and real property taxes. Regulation and Supervision General.Monarch Community Bank is a federally chartered savings bank, the deposits of which
are federally insured and backed by the full faith and credit of the United States Government.
Accordingly, the Bank is subject to broad federal regulation, primarily by the OTS, and oversight
extending to all its operations. The Bank is a member of the Federal Home Loan Bank of Indianapolis
and is subject to certain limited regulation by the Board of Governors of the Federal Reserve
System (Federal Reserve Board). As the holding company of the Bank, Monarch Community Bancorp is
also subject to federal regulation by the OTS and oversight which is designed to protect subsidiary
savings associations, like the Bank. The deposits of the Bank are insured by the FDIC. The Bank is
a member of the Savings Association Insurance Fund or the SAIF, which together with the Bank
Insurance Fund or the BIF are the two deposit insurance funds administered by the FDIC. As a
result, the FDIC has certain regulatory and examination authority over the Bank. Certain of these regulatory requirements and restrictions are discussed below or elsewhere in
this document. Federal Regulation of Savings Banks.The OTS has extensive authority over the operations of
savings banks. As part of this authority, the Bank is required to file periodic reports with the
OTS and is subject to periodic examinations by the OTS and the FDIC. When these examinations are
conducted by the OTS and the FDIC, the examiners may require the Bank to provide for higher general
or specific loan loss reserves. All savings associations are subject to a semi-annual assessment,
based upon the associations total assets, to fund the operations of the OTS. The Banks Office of
Thrift Supervision assessment for the fiscal year ended December 31, 2004 was $72,161. The OTS also has extensive enforcement authority over all federal savings banks and their
holding companies, including the Bank and Monarch Community Bancorp. This enforcement authority
includes, among other things, the ability to assess civil money penalties, to issue
cease-and-desist or removal orders and to initiate injunctive actions. In general, these
enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound
practices. Other actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS. Except under certain circumstances, public
disclosure of final enforcement actions by the OTS is required. Based on an examination completed in 2004 by the OTS, the Bank was fined $4,550 for violations
of the Federal Flood Protection Act. This Act requires Banks to require borrowers on real estate
loans obtain flood insurance where the property is located in a designated flood zone in
participating communities. The Bank failed to do so in 13 instances and thus incurred the fine. The investment, lending and branching authority of the Bank is prescribed by federal laws and
it is prohibited from engaging in any activities not permitted by these laws. For instance, no
savings bank




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##### Table of Contents



may invest in non-investment grade corporate debt securities. In addition, the permissible
level of investment by federal savings banks in loans secured by non-residential real property may
not exceed 400% of total capital, except with approval of the OTS. Federal savings banks are also
generally authorized to branch nationwide. The Banks general permissible lending limit for loans-to-one-borrower is equal to the greater
of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain
readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital
and surplus). At December 31, 2004, the Banks lending limit under this restriction was $4.5
million. The Bank is in compliance with the loans-to-one-borrower limitation. The OTS, as well as the other federal banking agencies, has adopted guidelines establishing
safety and soundness standards on matters like loan underwriting and documentation, asset quality,
earnings standards, internal controls and audit systems, interest rate risk exposure and
compensation and other employee benefits. Any institution which fails to comply with these
standards must submit a compliance plan. Insurance of Accounts and Regulation by the FDIC.The Bank is a member of the SAIF, which is
administered by the FDIC. Deposits are insured up to applicable limits by the FDIC and the
insurance is backed by the full faith and credit of the United States Government. As insurer, the
FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require
reporting by FDIC-insured institutions. It also may prohibit any FDIC-insured institution from
engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the
SAIF or the BIF. The FDIC also has the authority to initiate enforcement actions against savings
banks, after giving the Office of Thrift Supervision an opportunity to take action, and may
terminate the deposit insurance if it determines that the bank has engaged in unsafe or unsound
practices or is in an unsafe or unsound condition. The FDICs deposit insurance premiums are assessed through a risk-based system under which all
insured depository institutions are placed into one of nine categories and assessed insurance
premiums based upon their level of capital and supervisory evaluation. The current assessment rates
range from zero to 0.27% per $100 of assessable deposits. Under the system, institutions classified
as well capitalized (i.e., a core capital ratio of at least 5%, a ratio of Tier 1 or core capital
to risk-weighted assets (Tier 1 risk-based capital) of at least 6% and a risk-based capital ratio
of at least 10%) and considered healthy pay the lowest premium while institutions that are less
than adequately capitalized (i.e., core and Tier 1 risk-based capital ratios of less than 4% or a
risk-based capital ratio of less than 8%) and considered of substantial supervisory concern pay the
highest premium. Risk classification of all insured institutions is made by the FDIC for each
semi-annual assessment period. FDIC-insured institutions are subject to assessments to repay obligations issued by a
federally chartered corporation to provide financing for resolving the thrift crisis in the 1980s.
Currently, the rate established by the FDIC for this purpose is 1.68 basis points per dollar of
SAIF deposits and BIF deposits. Regulatory Capital Requirements.Federally insured savings banks, such as the Bank, are
required to maintain a minimum level of regulatory capital. The OTS has established capital
standards, including a tangible capital requirement, a leverage ratio (or core capital) requirement
and a risk-based capital requirement applicable to such savings banks. These capital requirements
must be generally as stringent as the comparable capital requirements for national banks. The OTS
is also authorized to impose capital requirements in excess of these standards on individual banks
on a case-by-case basis. The OTS capital regulations require tangible capital of at least 1.5% of adjusted total assets
(as defined by regulation). Tangible capital generally includes common stockholders equity and
retained income, and certain noncumulative perpetual preferred stock and related income. In
addition, all intangible assets, other than a limited amount of purchased mortgage servicing
rights, must be deducted from tangible capital for calculating compliance with the requirement. At
December 31, 2004, the Bank has intangible assets of $11.4 million.




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##### Table of Contents



At December 31, 2004, the Bank had tangible capital of $23.7 million, or 9.06% of adjusted
total assets, which is approximately $19.8 million above the minimum requirement of 1.5% of
adjusted total assets in effect on that date. As a result of the prompt corrective action provisions discussed below, a savings bank must
maintain a core capital ratio of at least 4% to be considered adequately capitalized unless its
supervisory condition allows it to maintain a 3% ratio. Core capital generally consists of tangible
capital plus certain intangible assets, including a limited amount of purchased credit card
receivables. At December 31, 2004, the Bank had no intangible assets which were included in core
capital. At December 31, 2004, the Bank had core capital equal to $23.7 million, or 9.06% of adjusted
total assets, which is $13.2 million above the requirement of 4% as in effect on that date. The OTS risk-based requirement requires savings banks to have total capital of at least 8% of
risk-weighted assets. Total capital consists of core capital, as defined above and supplementary
capital. Supplementary capital consists of certain permanent and maturing capital instruments that
do not qualify as core capital and loan and lease loss allowances up to a maximum of 1.25% of
risk-weighted assets. Supplementary capital may be used to satisfy the risk-based requirement only
to the extent of core capital. The OTS is also authorized to require a savings bank to maintain an
additional amount of total capital to account for concentration of credit risk and the risk of
non-traditional activities. At December 31, 2004, the Bank had $6.4 million of loan and lease loss
allowances which exceeded 1.25% of risk-weighted assets by $4.6 million. Certain exclusions from capital and assets are required to be made for the purpose of
calculating total capital. Such exclusions consist of equity investments (as defined by regulation)
and reciprocal holdings of qualifying capital instruments. The Bank had no exclusions from capital
and assets at December 31, 2004. In determining the amount of risk-weighted assets, all assets, including certain off-balance
sheet items, will be multiplied by a risk weight, ranging from 0% to 100%, based on the risk
inherent in the type of asset. For example, the OTS has assigned a risk weight of 50% for prudently
underwritten permanent one- to four-family first lien mortgage loans not more than 90 days
delinquent and having a loan-to-value ratio of not more than 90% at origination unless insured to
such ratio by an insurer approved by Fannie Mae or Freddie Mac. On December 31, 2004, the Bank had total risk-based capital of $25.5 million (including $23.7
million in core capital and $1.8 million in qualifying supplementary capital) and risk-weighted
assets of $187.0 million, or total capital of 13.6% of risk-weighted assets. This amount is $10.5
million above the 8% requirement in effect on that date. Under the prompt corrective action regulations, the OTS and the FDIC are authorized, and under
certain circumstances required, to take certain actions against savings banks that fail to meet
their capital requirements. The OTS is generally required to take action to restrict the activities
of an undercapitalized bank (generally defined to be one with less than a 4% core capital ratio,
a 4% Tier 1 risked-based capital ratio or an 8% risk-based capital ratio). Any undercapitalized
bank must submit a capital restoration plan and until the plan is approved by the OTS may not
increase its assets, acquire another bank, establish a branch or engage in any new activities, and
generally may not make capital distributions. The OTS is authorized to impose the additional
restrictions that are applicable to significantly undercapitalized banks. The OTS is also generally authorized to reclassify a bank into a lower capital category and
impose the restrictions applicable to such category if the association is engaged in unsafe or
unsound practices or is in an unsafe or unsound condition. The imposition by the OTS or the FDIC of any of these measures on Monarch Community Bank may
have a substantial adverse effect on its operations and profitability.




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##### Table of Contents



Limitations on Dividends and Other Capital Distributions.OTS regulations impose various
restrictions on savings banks with respect to their ability to make distributions of capital, which
include dividends, stock redemptions or repurchases, cash-out mergers and other transactions
charged to the capital account. OTS regulations generally permit a federal savings bank to pay
dividends in any calendar year equal to the sum of net profits the preceding three years. Monarch
Community Bank is in compliance with this requirement. Liquidity.All savings banks, including Monarch Community Bank, are required to maintain a
sufficient level of liquid assets to ensure their safe and sound operation. For a discussion of
what Monarch Community Bank includes in liquid assets, see Managements Discussion and Analysis of
Financial Condition and Results of Operations included in this Annual Report. Qualified Thrift Lender Test.All savings banks, including Monarch Community Bank, are
required to meet a qualified thrift lender (QTL) test to avoid certain restrictions on their
operations. This test requires a savings bank to have at least 65% of its portfolio assets in
qualified thrift investments on a monthly average for nine out of every 12 months on a rolling
basis. As an alternative, the savings association may maintain 60% of its assets in those assets
specified in Section 7701(a)(19) of the Internal Revenue Code of 1986, as amended. Under either
test, such assets primarily consist of residential housing related loans and investments. At
December 31, 2004, Monarch Community Bank met the test and has always met the test since its
inception. Any savings bank that fails to meet the QTL test must convert to a national bank charter,
unless it requalifies as a QTL and thereafter remains a QTL. If a savings bank does not requalify
and converts to a national bank charter, it must remain SAIF-insured until the FDIC permits it to
transfer to the BIF. If the savings bank has not yet requalified or converted to a national bank,
its new investments and activities are limited to those permissible for both a savings bank and a
national bank. It is limited to national bank branching rights and it is subject to national bank
limits for payment of dividends. If the savings bank has not requalified or converted to a national
bank within three years after the failure, it must divest all investments and cease all activities
not permissible for a national bank. If any savings bank that fails the QTL test is controlled by a
holding company, then within one year after the failure, the holding company must register as a
bank holding company and become subject to all restrictions on bank holding companies. See -
Holding Company Regulation. Community Reinvestment Act.Under the Community Reinvestment Act (CRA), every FDIC insured
institution has a continuing and affirmative obligation consistent with safe and sound banking
practices to help meet the credit needs of its entire community, including low and moderate income
neighborhoods. The CRA does not establish specific lending requirements or programs for financial
institutions nor does it limit an institutions discretion to develop the types of products and
services that it believes are best suited to its particular community. The CRA requires the OTS, in
connection with the examination of Monarch Community Bank, to assess the institutions record of
meeting the credit needs of its community and to take such record into account in its evaluation of
certain applications, such as a merger or the establishment of a branch, by Monarch Community Bank.
An unsatisfactory rating may be used as the basis for the denial of an application by the OTS. Due to the heightened attention being given to the CRA in recent years, Monarch Community Bank
may be required to devote additional funds for investment and lending in its local community. The
Bank was examined for CRA compliance in 2001 and received a rating of satisfactory. Transactions with Affiliates.Generally, transactions between a savings bank or its
subsidiaries and its affiliates are required to be on terms as favorable to the bank as
transactions with non-affiliates. In addition, certain of these transactions, such as loans to an
affiliate, are restricted to a percentage of the banks capital and must be secured by eligible
collateral. Affiliates of the Bank include Monarch Community Bancorp and any company which is under
common control with the Bank. In addition, a savings bank may not lend to any affiliate engaged in
activities not permissible for a bank holding company or acquire the securities of most affiliates.
The OTS has the discretion to treat subsidiaries of




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##### Table of Contents



savings banks as affiliates on a case by case basis. Certain transactions with directors, officers or controlling persons are also subject to
restrictions under statutes and regulations enforced by the OTS. These statutes and regulations
also impose restrictions on loans to such persons and their related interests. Among other things,
such loans must be made on terms substantially the same as for loans to unaffiliated individuals. Holding Company Regulation.Pursuant to regulations of the OTS and the terms of Monarch
Community Bancorps Maryland charter, the purpose and powers of Monarch Community Bancorp are to
pursue any or all of the lawful objectives of a savings and loan holding company and to exercise
any of the powers accorded to a savings and loan holding company. If the Bank fails the qualified thrift lender test, Monarch Community Bancorp must obtain the
approval of the OTS prior to continuing after such failure, directly or through other subsidiaries,
any business activity other than those approved for multiple savings and loan holding companies or
their subsidiaries. In addition, within one year of such failure, (unless the Bank requalifies
under the test) Monarch Community Bancorp must register as, and will become subject to, the
restrictions applicable to bank holding companies. The activities authorized for a bank holding
company are more limited than are the activities authorized for a unitary or multiple savings and
loan holding company. See  - Qualified Thrift Lender Test. Federal Securities Law.The common stock of Monarch Community Bancorp is registered with the
Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended (the
Exchange Act). Monarch Community Bancorp is subject to the information, proxy solicitation,
insider trading restrictions and other requirements of the Securities and Exchange Commission under
the Exchange Act. Monarch Community Bancorp common stock held by persons who are affiliates (generally officers,
directors and principal stockholders) of Monarch Community Bancorp may not be resold without
registration unless sold in accordance with certain resale restrictions. If Monarch Community
Bancorp meets specified current public information requirements, each affiliate of Monarch
Community Bancorp is able to sell in the public market, without registration, a limited number of
shares in any three-month period. Federal Reserve System.The Federal Reserve Board requires all depository institutions to
maintain noninterest bearing reserves at specified levels against their transaction accounts
(primarily checking, NOW and Super NOW checking accounts). At December 31, 2004, the Bank was in
compliance with these reserve requirements. The balances maintained to meet the reserve
requirements imposed by the Federal Reserve Board may be used to satisfy liquidity requirements
that may be imposed by the OTS. See - Liquidity. Savings banks are authorized to borrow from the Federal Reserve Bank discount window, but
Federal Reserve Board regulations require institutions to exhaust other reasonable alternative
sources of funds, including Federal Home Loan Bank borrowings, before borrowing from the Federal
Reserve Bank. Federal Home Loan Bank System.Monarch Community Bank is a member of the Federal Home Loan
Bank of Indianapolis, which is one of 12 regional Federal Home Loan Banks that administer the home
financing credit function of savings banks. Each Federal Home Loan Bank serves as a reserve or
central bank for its members within its assigned region. It is funded primarily from proceeds
derived from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes
loans to members (i.e., advances) in accordance with policies and procedures, established by the
board of directors of the Federal Home Loan Bank, which are subject to the oversight of the Federal
Housing Finance Board. All advances from the Federal Home Loan Bank are required to be fully
secured by sufficient collateral as determined by the Federal Home Loan Bank. In addition, all
long-term advances are required to provide funds for residential home financing.




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##### Table of Contents



As a member, the Bank is required to purchase and maintain stock in the Federal Home Loan Bank
of Indianapolis. At December 31, 2004, the Bank had $4.7 million in Federal Home Loan Bank stock,
which was in compliance with this requirement. Sarbanes-Oxley Act.On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of
2002 (the SOA). The stated goals of the SOA are to increase corporate responsibility, to provide
for enhanced penalties for accounting and auditing improprieties at publicly traded companies and
to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to
the securities laws. The SOA is the most far-reaching U.S. securities legislation enacted in some time. The SOA
generally applies to all companies, both U.S. and non-U.S., that file or are required to file
periodic reports with the Securities and Exchange Commission under the Exchange Act. Given the
extensive role of the Securities and Exchange Commission in implementing rules relating to many of
the SOAs new requirements, the final scope of many of these requirements remains to be determined. The SOA includes very specific additional disclosure requirements and new corporate governance
rules, requires the Securities and Exchange Commission and securities exchanges to adopt extensive
additional disclosure, corporate governance and other related rules and mandates further studies of
certain issues by the Securities and Exchange Commission and the Comptroller General. The SOA
represents significant federal involvement in matters traditionally left to state regulatory
systems, such as the regulation of the accounting profession, and to state corporate law, such as
the relationship between a board of directors and management and between a board of directors and
its committees. The SOA addresses, among other matters:  
    audit committees;
    certification of financial statements by the chief executive officer and
the chief financial officer;
    the forfeiture of bonuses or other incentive-based compensation and
profits from the sale of an issuers securities by directors and senior
officers in the twelve month period following initial publication of any
financial statements that later require restatement;
    a prohibition on insider trading during pension plan black out periods;
    disclosure of off-balance sheet transactions;
    expedited filing requirements for Form 4s;
    disclosure of a code of ethics and filing a Form 8-K for a change or
waiver of such code;
    real time filing of periodic reports;
    the formation of a public accounting oversight board
    auditor independence
    various increased criminal penalties for violations of securities laws. The SOA contains provisions which became effective upon enactment on July 30, 2002 and
provisions which became effective from within 30 days to one year from enactment. The
Securities and Exchange Commission has been delegated the task of enacting rules to
implement various of the provisions with respect to, among other matters, disclosure in
periodic filings pursuant to the Exchange Act.




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##### Table of Contents



ITEM 2. Description of Property At December 31, 2004, we had seven full service offices and one drive-through only facility.
At December 31, 2004, we owned all of our offices and the net book value of our investment in
premises and equipment, excluding computer equipment, was $6.3 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: December 31, 2004Owned/
    
    
    Net Book ValueLocation
    
    County
    
    
    Leased
    
    
    (Building)(Dollars in Thousands)Main Office375 North Willowbrook Road
    
    Branch
    
    Owned
    
    $
    2,531Coldwater, Michigan 49036Branch Offices30 West Chicago Street
    
    Branch
    
    Owned
    
    
    96Coldwater, Michigan 49036365 N. Broadway
    
    Branch
    
    Owned
    
    
    55Union City, Michigan 490941 West Carleton Road
    
    Hillsdale
    
    Owned
    
    
    439Hillsdale, Michigan 49242125 West Chicago Street
    
    Hillsdale
    
    Owned
    
    
    81Jonesville, Michigan 4925015975 West Michigan Avenue
    
    Calhoun
    
    Owned
    
    
    749Marshall, Michigan 49068107 North Park
    
    Calhoun
    
    Owned
    
    
    577Marshall, Michigan 49068Other Facilities34 Grand Street (Garage)
    
    Branch
    
    Owned
    
    
    119Coldwater, Michigan 4903624 Grand Street (Drive through)
    
    Branch
    
    Owned
    
    
    31Coldwater, Michiagn 4903687 Marshall Street (Leased to others)
    
    Branch
    
    Owned
    
    
    180Coldwater, Michigan 49036801 West Michigan (vacant branch office)
    
    Calhoun
    
    Owned
    
    
    177Marshall, Michigan 49068119 Grand Street (Leased to others)
    
    Calhoun
    
    Owned
    
    
    136Marshall, Michigan 49068
 The branch office located at 125 West Chicago Street, Jonesville, Michigan was closed
effective February 4, 2005. We utilize a third party service provider to maintain our data base of depositor and borrower
customer information. The net book value of the data processing and computer equipment utilized by
us at December 31, 2004 was $179,000.




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##### Table of Contents



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 matter was submitted to a vote of security holders, through the solicitation of proxies or
otherwise, during the quarter ended December 31, 2004. 
 PART II 
 ITEM 5. Market for the Companys Common Equity and Related Stockholders Matters The Companys common stock commenced trading on August 29, 2002 on the NASDAQ SmallCap 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 SmallCap Stock Market. For the years ended
December 31, 2004 and 2003, the Company paid dividends of $.20 per share. Year
    
    Quarter ending
    
    
    High
    
    
    Low2003
    
    March 31
    
    $
    12.25
    
    
    $
    11.10June 30
    
    $
    14.15
    
    
    $
    12.25September 30
    
    $
    15.10
    
    
    $
    13.53December 31
    
    $
    17.21
    
    
    $
    14.862004
    
    March 31
    
    $
    16.35
    
    
    $
    15.59June 30
    
    $
    15.95
    
    
    $
    13.00September 30
    
    $
    14.45
    
    
    $
    13.26December 31
    
    $
    14.23
    
    
    $
    12.60
 As of February 25, 2005, there were 2,709,220 shares of the Companys
common stock outstanding and approximately 659 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.




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##### Table of Contents



ITEM 6. Managements Discussion and Analysis of Financial Condition and Results of
Operations MONARCH SELECTED FINANCIAL AND OTHER DATA The summary information presented below under Selected Financial Condition
Data and Selected Operating 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 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(In Thousands)Selected Financial Condition Data:Total Assets
    
    
    275,448
    
    
    
    203,123
    
    
    $
    197,985
    
    
    $
    168,684
    
    
    $
    164,074Loans receivable, net
    
    
    219,317
    
    
    
    141,225
    
    
    
    145,162
    
    
    
    137,721
    
    
    
    138,197Trading securities at fair value:Mortgage-backed securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    258
    
    
    
    239Investment securities, at carrying value
    
    
    8,324
    
    
    
    19,934
    
    
    
    17,434
    
    
    
    0
    
    
    
    0Fed Funds sold and overnight deposits
    
    
    6,120
    
    
    
    20,974
    
    
    
    16,063
    
    
    
    12,035
    
    
    
    10,254Deposits
    
    
    167,733
    
    
    
    107,240
    
    
    
    106,744
    
    
    
    105,698
    
    
    
    98,986Federal Home Loan Bank Advances
    
    
    65,955
    
    
    
    57,384
    
    
    
    52,500
    
    
    
    45,500
    
    
    
    49,000Equity
    
    
    39,419
    
    
    
    37,430
    
    
    
    36,949
    
    
    
    15,365
    
    
    
    14,606
 2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(In Thousands)Selected Operations Data:Total interest income
    
    $
    13,818
    
    
    $
    12,053
    
    
    $
    12,931
    
    
    $
    14,470
    
    
    $
    13,869Total interest expense
    
    
    6,173
    
    
    
    6,060
    
    
    
    6,466
    
    
    
    8,117
    
    
    
    7,435Net interest income
    
    
    7,645
    
    
    
    5,993
    
    
    
    6,465
    
    
    
    6,353
    
    
    
    6,434Provision for loan losses
    
    
    4,875
    
    
    
    1,266
    
    
    
    397
    
    
    
    1,039
    
    
    
    245Net interest income after provision for loan losses
    
    
    2,770
    
    
    
    4,727
    
    
    
    6,068
    
    
    
    5,314
    
    
    
    6,189Fees and service charges
    
    
    2,333
    
    
    
    1,167
    
    
    
    1,154
    
    
    
    1,227
    
    
    
    1,234Gains on sales of loans, mortgage-backed securities
and investment securities
    
    
    805
    
    
    
    1,672
    
    
    
    998
    
    
    
    1,170
    
    
    
    234Other non-interest income
    
    
    287
    
    
    
    86
    
    
    
    7
    
    
    
    85
    
    
    
    65Total non-interest income
    
    
    3,425
    
    
    
    2,925
    
    
    
    2,159
    
    
    
    2,482
    
    
    
    1,533Total non-interest expense
    
    
    9,978
    
    
    
    6,737
    
    
    
    6,798
    
    
    
    6,738
    
    
    
    5,636Income before taxes
    
    
    (3,783
    )
    
    
    915
    
    
    
    1,429
    
    
    
    1,058
    
    
    
    2,086Income tax provision
    
    
    (1,272
    )
    
    
    251
    
    
    
    415
    
    
    
    299
    
    
    
    749Net income (loss)
    
    $
    (2,511
    )
    
    $
    664
    
    
    $
    1,014
    
    
    $
    759
    
    
    $
    1,337




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##### Table of Contents



December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000Selected Financial Ratios and Other Data:Performance Ratios:Return on assets (ratio of net income to average total assets)
    
    
    -0.97
    %
    
    
    0.32
    %
    
    
    0.54
    %
    
    
    0.44
    %
    
    
    0.87
    %Return on Equity (ratio of net income to average equity)
    
    
    -6.53
    %
    
    
    1.80
    %
    
    
    4.08
    %
    
    
    5.05
    %
    
    
    9.62
    %Interest rate spread information:Average during period
    
    
    3.15
    %
    
    
    2.69
    %
    
    
    3.58
    %
    
    
    3.69
    %
    
    
    4.20
    %Net interest margin
    
    
    3.33
    %
    
    
    3.11
    %
    
    
    3.85
    %
    
    
    3.89
    %
    
    
    4.44
    %Ratio of operating expense to average total assets
    
    
    3.85
    %
    
    
    3.22
    %
    
    
    3.72
    %
    
    
    3.87
    %
    
    
    3.65
    %Ratio of average interest-earning assets to average
interest-bearing liabilities
    
    
    1.07
    
    
    
    1.13
    
    
    
    1.07
    
    
    
    1.04
    
    
    
    1.03Efficiency ratio
    
    
    88.18
    %
    
    
    74.14
    %
    
    
    75.10
    %
    
    
    74.10
    %
    
    
    69.80
    %Asset Quality Ratios:Non-performing assets to total assets at end of period
    
    
    2.23
    %
    
    
    2.94
    %
    
    
    2.53
    %
    
    
    3.29
    %
    
    
    2.45
    %Non-performing loans to total loans
    
    
    1.87
    %
    
    
    2.60
    %
    
    
    2.04
    %
    
    
    2.16
    %
    
    
    1.95
    %Allowance for loan losses to non-performing loans
    
    
    150.91
    %
    
    
    69.89
    %
    
    
    58.70
    %
    
    
    56.57
    %
    
    
    31.78
    %Allowance for loan losses to loans receivable, net
    
    
    2.82
    %
    
    
    1.81
    %
    
    
    1.18
    %
    
    
    1.20
    %
    
    
    0.62
    %Capital ratios:Equity to total assets at end of period
    
    
    14.31
    %
    
    
    18.43
    %
    
    
    18.67
    %
    
    
    9.11
    %
    
    
    8.90
    %Other data:Number of full-service offices
    
    
    7
    
    
    
    5
    
    
    
    5
    
    
    
    5
    
    
    
    5
   (1)
    
    Net interest income divided by average-earning assets.(2)
    
    Total noninterest expenses, excluding real estate owned and
repossessed property expense, as a percentage of net interest
income and total noninterest income. 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




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##### Table of Contents



provide assurance that such estimates and management judgments are materially correct to the best
of managements knowledge. Allowance for Loan Losses.Accounting for loan classifications, accrual status, and
determination of the allowance for loan losses is based on regulatory guidance. This guidance
includes, but is not limited to, generally accepted accounting principles, the uniform retail
credit classification and account management policy issued by the Federal Financial Institutions
Examination Council, the joint policy statement on the allowance for loan losses methodologies
issued by the Federal Financial Institutions Examination Council and guidance issued by the
Securities and Exchange Commission. Accordingly, the allowance for loan losses includes a reserve
calculation based on an evaluation of loans determined to be impaired, risk ratings, historical
losses, loans past due, collateral values and cost of disposal and other subjective factors. 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 while decreasing the amount of
sub-prime lending we do. Our focus in 2005 will be growth of core deposits, growth in commercial lending with an
emphasis on increasing the credit quality of our loan portfolio and staff training and education.
We are dedicating resources to these initiatives that current management believes were not
adequately provided for in the past. Management believes focusing on these areas in 2005 will begin
a turnaround that will serve the Company well into the future. We intend to capitalize on the
acquisition of MSB Financial, Inc. by further expanding our lending activities in Calhoun County. 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. We have
employed a strategy of fixed rate long-term borrowing to guard against rising interest rates. As
interest rates have declined over the last several years this strategy has resulted in declining
net interest income. 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




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##### Table of Contents



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, lower yielding, fixed
rate residential mortgage loans we make;
    managing our deposits to establish stable deposit relationships with an
emphasis on core, non-certificate deposits, supplementing these with
brokered deposits, as appropriate; and
    maintaining longer-term borrowings at fixed interest rates to offset the
negative impact of longer-term fixed rate loans in our loan portfolio.
Future borrowings are expected to be short-term to reduce the average
maturity of our borrowings. At times, depending on the level of general interest rates, the relationship between long- and
short-term interest rates, market conditions and competitive factors, the asset and liability
management committee may determine to increase Monarchs interest rate risk position somewhat in
order to maintain the net interest margin. In addition, in an effort to manage our interest rate
risk and liquidity, in 2004 and 2003 we sold $29.8 million and $59.8 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
also intend to retain some portion of our 15 year and shorter, fixed-rate loans.




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##### Table of Contents



The OTS provides Monarch with the information presented in the following table. It
presents the expected change in Monarchs net portfolio value at September 30, 2004 that would
occur upon an immediate change in interest rates based on OTS assumptions, but without giving
effect to any steps that management might take to counteract that change. Change in Interest RatesBasis Points (bp)
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net Portfolio Value as %(Rate Shock in Rates) (1)
    
    Net Portfolio Value
    
    
    of Present Value of Assets$ Amount
    
    
    $ Change
    
    
    % Change
    
    
    NPV Ratio
    
    
    Change+ 300 bp
    
    
    37,910
    
    
    
    -675
    
    
    
    -2
    %
    
    
    14.03
    %
    
    + 29 bp+ 200 bp
    
    
    39,234
    
    
    
    649
    
    
    
    2
    %
    
    
    14.28
    %
    
    + 54 bp+100 bp
    
    
    39,356
    
    
    
    771
    
    
    
    2
    %
    
    
    14.15
    %
    
    + 41 bp0 bp
    
    
    38,585
    
    
    
    
    
    
    
    
    
    
    
    13.74
    %-100 bp
    
    
    36,590
    
    
    
    -1995
    
    
    
    -5
    %
    
    
    12.95
    %
    
    - 79 bp-200 bp
    
    
    n/m
    (2)
    
    
    n/m
    (2)
    
    
    n/m
    (2)
    
    
    n/m
    (2)
    
    
    n/m
    (2)-300 bp
    
    
    n/m
    (2)
    
    
    n/m
    (2)
    
    
    n/m
    (2)
    
    
    n/m
    (2)
    
    
    n/m
    (2)
   (1)
    
    Assumes an instantaneous uniform change in interest rates at all maturities.(2)
    
    Not meaningful because some market rates would compute to a rate less than 0. The OTS uses certain assumptions in assessing the interest rate risk of
savings institutions. These assumptions relate to interest rates, loan prepayment rates, deposit
decay rates, and the market values of certain assets under differing interest rate scenarios, among
others. 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 increase in a moderately increasing
interest rate scenario (up to +200 bp) and management believes that its net interest margin will
behave similarly. Management believes its asset/liability strategies have positioned the Bank for
increasing interest rates to have a positive impact on its net interest margin. This may not hold
true 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 even in an
increasing rate environment. While the Bank has seen its net interest margin decline during this
period of low interest rates, many of its borrowers lack the ability or willingness to refinance at
the levels experienced by other financial institutions. The timing and magnitude of interest rate
changes, as well as the sector affected (short-term vs. long-term) will have an impact on the
Banks net interest margin.




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##### Table of Contents



Changes in Financial Condition from December 31, 2004 to December 31, 2003 General.Monarchs total assets increased by $72.3 million or 35.6% to $275.4 million at
December 31, 2004 compared to $203.0 million at December 31, 2003. Assets increased $106 million
due to the acquisition of MSB Financial, Inc. This increase offset decreases in cash and cash
equivalents, securities and other assets. Loans.Monarchs net loan portfolio increased by $78.0 million, or 55.3% from $141.2 million
at December 31, 2003 to $219.3 million at December 31, 2004. Loans increased $73.8 million due to
the acquisition of MSB Financial, Inc. One-to-four-family loans increased $48.1 million. $40.8
million of this increase was due to the acquisition and $8.1 million was due to new loan
originations. The Bank originated more ARM mortgages during 2004 and also retained a larger
percentage of its fixed rate originations than in past years. These fixed rate loans were mainly 15
year mortgages. Commercial real estate loans increased $20.0 million to $42.7 million at December
31, 2004. $15.9 million of this increase was due to the acquisition and $4.1 million was due to
increased loan production. Multifamily loans increased $3.6 million primarily due to the
acquisition. Commercial business loans increased $2.6 million. $1.6 million was due to the
acquisition and $1.0 million from increased loan production. During 2004, we continued our efforts
to grow our commercial loan portfolio. We have expanded our capabilities with regards to commercial
real estate and business lending with increases in staff in the area of credit administration and
loan origination as well as improved lending policies and procedures. The acquisition of MSB
Financial has provided an expanded market for commercial business lending. The increasing and
strengthening of our staff will allow current business development officers the opportunity to
increase their activities with regard to soliciting new business. Consumer loans acquired from MSB
Financial were $10.1 million but consumer loans only increased $8.4 million from December 31, 2003
to December 31, 2004. This reflects the Banks lack of emphasis on consumer lending, particularly
automobile lending because management does not believe the Bank can adequately compete with captive
automobile finance companies. Securities.The Banks security portfolio decreased to $8.0 million at December 31, 2004 from
$19.6 million at December 31, 2003, or 59.1%. Securities were 2.9% of total assets at December 31,
2004 as compared to 9.7% at December 31, 2003. During 2004, securities were sold to replace cash
utilized for the acquisition and to fund deposit declines. Management purchases securities to
maintain sufficient liquidity and to provide yield to offset declines in the loan portfolio. Liabilities.Monarchs deposits increased $60.5 million to $167.7 million at December 31, 2004
compared to $107.2 million at December 31, 2003. The acquisition provided $70.2 million so actual
deposits declined by $9.7 million. This decline was primarily in certificates of deposit (CDs).
Management has attempted to reduce the Banks reliance on brokered CDs and they declined from $25.3
at December 31, 2003 to $18.8 million at December 31, 2004. This is a function of the interest
rates the Bank is willing to pay on these deposits. Unfortunately, the Bank did not experience
deposit increases in other areas to offset this decline. Management does not believe the deposit
decline is the result of any negative customer reaction to the acquisition and deposit balances at
the former Marshall Savings Bank branches have been stable. The Bank has made a commitment to core
deposit growth in 2005 and recognizes a lower cost of funds is critical to future profitability.
Federal Home Loan Bank advances increased $8.6 million to $66.0 million at December 31, 2004 from
$57.4 million at December 31, 2003. The increase was primarily the result of advances assumed in
the acquisition. In an effort to manage our interest rate risk, Monarch has utilized longer term
(in excess of five year maturities) fixed rate Federal Home Loan Bank advances to extend the
overall maturity of our liabilities. While the interest rates paid on these advances is high
relative to current market rates, the longer-term advances allow the Bank to better match the term
of these advances against anticipated maturities of loans in an attempt to reduce future interest
rate risk. This strategy has had a negative impact on the Banks net interest margin for the past
few years and 2004 is no exception. We expect this strategy to help improve net interest margin as
interest rates rise in the future.




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##### Table of Contents



Equity. Total equity amounted to $39.4 million at December 31, 2004 and $37.4 million at
December 31, 2003, or 14.3% and 18.4%, respectively, of total assets at both dates. The increase in
equity over the period was due the issuance of common stock in connection with the acquisition
offsetting the net loss for 2004.




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##### Table of Contents



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 31,2004
    
    
    2003Average
    
    
    Interest
    
    
    
    
    
    
    Average
    
    
    InterestOutstanding
    
    
    Earned/
    
    
    Yield/
    
    
    Outstanding
    
    
    Earned/
    
    
    Yield/Balance
    
    
    Paid
    
    
    Rate
    
    
    Balance
    
    
    Paid
    
    
    Rate(dollars in thousands)Fed Funds and overnight deposits
    
    $
    9,349
    
    
    $
    123
    
    
    
    1.32
    %
    
    $
    23,745
    
    
    $
    253
    
    
    
    1.07
    %Investment securities
    
    
    17,643
    
    
    
    442
    
    
    
    2.51
    
    
    
    18,063
    
    
    
    457

    
    
    
    2.53Other securities
    
    
    4,093
    
    
    
    179
    
    
    
    4.37
    
    
    
    2,915
    
    
    
    148
    
    
    
    5.08Loans receivable (1)
    
    
    198,336
    
    
    
    13,074
    
    
    
    6.59
    
    
    
    147,896
    
    
    
    11,195
    
    
    
    7.57Total earning assets
    
    $
    229,421
    
    
    $
    13,818
    
    
    
    6.02
    
    
    $
    192,619
    
    
    $
    12,053
    
    
    
    6.26Demand and NOW Accounts
    
    $
    28,880
    
    
    $
    94
    
    
    
    0.33
    
    
    $
    14,082
    
    
    $
    79
    
    
    
    0.56Money market accounts
    
    
    15,815
    
    
    
    176
    
    
    
    1.11
    
    
    
    10,241
    
    
    
    135
    
    
    
    1.32Savings accounts
    
    
    24,215
    
    
    
    117
    
    
    
    0.48
    
    
    
    15,996
    
    
    
    137
    
    
    
    0.86Certificates of deposit
    
    
    83,478
    
    
    
    2,323
    
    
    
    2.78
    
    
    
    72,286
    
    
    
    2,513
    
    
    
    3.48Federal Home Loan Bank Advances
    
    
    62,643
    
    
    
    3,463
    
    
    
    5.53
    
    
    
    57,111
    
    
    
    3,196
    
    
    
    5.60Total interest bearing liabilities
    
    $
    215,031
    
    
    
    6,173
    
    
    
    2.87
    
    
    $
    169,716
    
    
    
    6,060
    
    
    
    3.57Net interest income
    
    
    
    
    
    $
    7,645
    
    
    
    
    
    
    
    
    
    
    $
    5,993Net interest spread
    
    
    
    
    
    
    
    
    
    
    3.15
    %
    
    
    
    
    
    
    
    
    
    
    2.69
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    3.33
    %
    
    
    
    
    
    
    
    
    
    
    3.11
    %
 2002Average
    
    
    InterestOutstanding
    
    
    Earned/
    
    
    Yield/Balance
    
    
    Paid
    
    
    RateFed Funds and overnight deposits
    
    $
    17,376
    
    
    $
    285
    
    
    
    1.64
    %Investment securities
    
    
    2,614
    
    
    
    80
    
    
    
    3.06Other securities
    
    
    2,627
    
    
    
    158
    
    
    
    6.01Loans receivable (1)
    
    
    145,487
    
    
    
    12,408
    
    
    
    8.53Total earning assets
    
    $
    168,104
    
    
    $
    12,931
    
    
    
    7.69Demand and NOW Accounts
    
    $
    12,717
    
    
    $
    146
    
    
    
    1.15Money market accounts
    
    
    11,065
    
    
    
    194
    
    
    
    1.75Savings accounts
    
    
    16,945
    
    
    
    222
    
    
    
    1.31Certificates of deposit
    
    
    64,925
    
    
    
    2,763
    
    
    
    4.26Federal Home Loan Bank Advances
    
    
    51,679
    
    
    
    3,141
    
    
    
    6.08Total interest bearing liabilities
    
    $
    157,331
    
    
    
    6,466
    
    
    
    4.11Net interest income
    
    
    
    
    
    $
    6,465Net interest spread
    
    
    
    
    
    
    
    
    
    
    3.58
    %Net interest margin
    
    
    
    
    
    
    
    
    
    
    3.85
    %
   (1)
    Calculated net of deferred loan fees, loan discounts and loans in
process. Nonaccrual loans are included in the average outstanding
balance.




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##### Table of Contents



Rate/Volume Analysis The following table presents the dollar amount of changes in interest income and interest
expense for major components of interest-earning assets and interest-bearing liabilities. For each
category of interest-earning assets and interest-bearing liabilities, information is provided on
changes attributable to (1) changes in volume, which are changes in volume multiplied by the old
rate, and (2) changes in rate, which are changes in rate multiplied by the old volume. Changes
attributable to both rate and volume are shown as mixed. Year Ended December 31,
    
    
    Year Ended December 31,2004 vs. 2003
    
    
    2003 vs. 2002Total
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    TotalIncrease (Decrease) Due to
    
    
    Increase
    
    
    Increase (Decrease) Due to
    
    
    IncreaseRate
    
    
    Volume
    
    
    Mix
    
    
    (Decrease)
    
    
    Rate
    
    
    Volume
    
    
    Mix
    
    
    (Decrease)(in thousands)Interest earning AssetsFed funds and overnight deposits
    
    $
    59

    
    
    ($
    153
    )
    
    ($
    36
    )
    
    ($
    130
    )
    
    ($
    100
    )
    
    $
    104
    
    
    ($
    36
    )
    
    ($
    32
    )Investment securities
    
    
    (4
    )
    
    ($
    11
    )
    
    $
    0
    
    
    
    (15
    )
    
    
    (14
    )
    
    $
    473
    
    
    ($
    82
    )
    
    
    377Other securities
    
    
    (21
    )
    
    $
    60
    
    
    ($
    2
    )
    
    
    31
    
    
    
    (25
    )
    
    $
    17
    
    
    ($
    2
    )
    
    
    (10
    )Loans receivable
    
    
    (1446
    )
    
    $
    3,818
    
    
    ($
    493
    )
    
    
    1879
    
    
    
    (1395
    )
    
    $
    205
    
    
    ($
    23
    )
    
    
    (1213
    )Total interest-earning assets
    
    ($
    1,412
    )
    
    $
    799
    
    
    ($
    531
    )
    
    $
    1,765
    
    
    ($
    1,534
    )
    
    $
    799
    
    
    ($
    143
    )
    
    ($
    878
    )Interest-bearing liabilitiesDemand and NOW Accounts
    
    
    (33
    )
    
    $
    83
    
    
    ($
    35
    )
    
    $
    15
    
    
    
    (75
    )
    
    $
    16
    
    
    ($
    8
    )
    
    ($
    67
    )Money market accounts
    
    
    (21
    )
    
    $
    73
    
    
    $
    3
    
    
    $
    41
    
    
    
    (48
    )
    
    ($
    14
    )
    
    $
    3
    
    
    ($
    59
    )Savings accounts
    
    
    (60
    )
    
    $
    70
    
    
    ($
    31
    )
    
    ($
    20
    )
    
    
    (77
    )
    
    ($
    12
    )
    
    $
    4
    
    
    ($
    85
    )Certificates of deposit
    
    
    (501
    )
    
    $
    389
    
    
    ($
    78
    )
    
    ($
    190
    )
    
    
    (506
    )
    
    $
    313
    
    
    ($
    57
    )
    
    ($
    250
    )Federal Home Loan Bank Advances
    
    
    (39
    )
    
    $
    310
    
    
    ($
    4
    )
    
    $
    267
    
    
    
    (249
    )
    
    $
    330
    
    
    ($
    26
    )
    
    $
    55Total interest bearing liabilities
    
    ($
    654
    )
    
    $
    633
    
    
    ($
    144
    )
    
    $
    113
    
    
    ($
    955
    )
    
    $
    633
    
    
    ($
    84
    )
    
    ($
    406
    )Net interest income
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    1,652
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    ($
    472
    )




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##### Table of Contents



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. At December 31,2004
    
    
    2003Weighted average yield on:Fed Funds and overnight deposits
    
    
    1.85
    %
    
    
    0.95
    %Investment securities
    
    
    3.53
    %
    
    
    2.56
    %Federal Home Loan Bank stock
    
    
    4.25
    %
    
    
    5.02
    %Loans:One- to four-family
    
    
    6.51
    %
    
    
    7.11
    %Multi-family
    
    
    5.90
    %
    
    
    6.56
    %Commercial real estate
    
    
    6.33
    %
    
    
    6.85
    %Construction or development
    
    
    5.75
    %
    
    
    5.65
    %Total real estate loans
    
    
    6.42
    %
    
    
    6.95
    %Other loans:Consumer loans
    
    
    7.17
    %
    
    
    8.66
    %Commercial business loans
    
    
    6.66
    %
    
    
    5.61
    %Total Loans
    
    
    6.51
    %
    
    
    7.11
    %Combined weighted average yield
on interest earning assets
    
    
    6.25
    %
    
    
    5.91
    %Weighted average rate paid on:Demand and NOW accounts
    
    
    0.25
    %
    
    
    0.51
    %Money market accounts
    
    
    0.96
    %
    
    
    1.35
    %Savings deposits
    
    
    0.51
    %
    
    
    0.43
    %Certificates of deposit
    
    
    3.05
    %
    
    
    3.39
    %Federal Home Loan Bank advances
    
    
    5.36
    %
    
    
    5.51
    %Combined weighted average rate paid
on interest-bearing liabilities
    
    
    2.82
    %
    
    
    2.91
    %Spread
    
    
    3.43
    %
    
    
    3.00
    %
 Comparison of Results of Operations for the Years Ended December 31, 2004 and 2003 General. Monarch reported a net loss of $2.5 million for the year ended December 31, 2004
compared to net income of $664,000 for the year ended December 31, 2003. The decrease in earnings
was primarily the result of increased provision for loan losses. Net Interest Income.Net interest income before provision for loan losses increased 27.6% to
$7.6 million for 2004 compared to $6.0 million in 2003. Our interest income increased by $1.8
million and our interest expense increased $113,000. These increases were the result of increased
earning assets and costing liabilities from the acquisition of MSB Financial, Inc. Our net interest
margin increased from 3.11% in 2003 to 3.33% in 2004. This increase was primarily the result of
acquired deposits reducing our cost of funds.




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##### Table of Contents



Interest Income.Interest income increased $1.8 million during the year ended December 31,
2004, primarily due to increased earning assets from the acquisition. The average yield on earning
assets declined due to the lower yielding loans acquired as well as increased origination of
adjustable rate loans which yield less than fixed rate loans. Management believes the increased
weighting of adjustable rate loans in the loan portfolio will help increase interest income in the
future as market interest rates rise. Interest Expense.Interest on deposits decreased by $154,000 in 2004 from 2003, due primarily
to a decline in the rate paid on all deposit accounts. Deposits acquired from MSB Financial were
significantly lower costing than our existing deposit balances. Interest on Federal Home Loan Bank
advances increased $267,000 in 2004 from 2003 due to the borrowings assumed in the acquisition. The
rates on the advances are fixed and have not declined as has the rate paid on our deposits. Provision for Loan Losses.The provision for loan losses was $4.9 million for the year ended
December 31, 2004 compared to $1.3 million for the year ended December 31, 2003. The Banks net
charge-offs were $1.6 million in 2004 compared to $383,000 for 2003. The increased provision for
2004 was due to the charge-offs we have experienced, increases in our non-performing loans and
management identifying certain commercial loans as watch credits and the resulting impact on the
determination of the adequacy of the allowance for loan losses. During 2004, the Bank charged off
$1.2 million of a $1.6 million loan relationship secured by a commercial building in southwest
Michigan. The relationship included two loans which were made to fund the construction of a
commercial building in southwest Michigan that was completed in 2003. Both loans were placed into
non-accrual status as of June 30, 2003. In June 2004, the Bank foreclosed on the property in an
attempt to satisfy the debt. The foreclosure was subject to redemption rights by the borrower which
will expire in June 2005. The borrower has contested the expiration of redemption rights and the
Bank has not taken possession of the property. The property is recorded in Real Estate Owned at
December 31, 2004. Also, late in 2004, management became aware of financial stress being
experienced by two related borrowers whose indebtedness to the Bank totals $5.2 million. Due to the
deteriorating financial strength of the borrowers management deemed it prudent and necessary to
establish loss allowances totaling $2.3 million resulting from these two relationships. Also,
management has determined that within the loan portfolio acquired from MSB Financial, Inc. there is
indication that future losses may exceed those experienced by Marshall Savings Bank prior to the
acquisition. During the past three years we have experienced higher than historical charge-offs on
one-to four-family and consumer loans. While a larger portion of our charge-offs has been related
to sub-prime loans, in 2004, we began to realize the benefits of controls implemented with regard
to sub-prime loans. During 2004, we 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. Noninterest Income.Noninterest income was $3.4 million and $2.9 million for the years ended
December 31, 2004 and 2003, respectively. The increase was primarily the result of increased fees
and service charges on deposit accounts. Fees and service charges on deposit accounts have
increased significantly due to the number of savings and checking accounts acquired. Also, during
2004 the Bank began an overdraft protection program which is expected to further increase fees in
the future. The increased fees helped offset a decline in gains from sale of loans which decreased
to $865,000 compared to $1.7 million for the year ended December 31, 2003 as mortgage banking
activities declined significantly in 2004 compared to the same period in 2003. Management believes
this trend will continue into 2005. Losses on sales of investment securities were $60,000 for 2004
whereas the Company had no significant securities activity in the past. These losses were the
result of a strategy to increase the yield on the investment portfolio by selling securities that
carried below market coupon rates and re-investing in securities at market rates. Other income
increased $201,000, primarily due to income from our investment services activity of $72,000. We
started offering investment services during 2004 as MSB Financial had previously offered the
service and we expect our income from offering these services to increase in 2005. Earnings on
Company owned life insurance also helped increase Other Income by $57,000. The life insurance
policies which produced the income were acquired as part of the acquisition. Net gains on
sales of foreclosed properties amounted to $16,000 during 2004 compared to a net loss of $40,000
during 2003.




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##### Table of Contents



Noninterest Expenses.Noninterest expenses increased $3.2 million for the year ended December
31, 2004 compared to the year ended December 31, 2003. The increase is primarily due to the cost of
the operations acquired. In addition, the Company incurred costs related to the termination of its
former CEO. Severance costs were $487,000 and legal fees in connection with the severance were
$47,000. The Company does not anticipate any additional expense in connection with this matter. We
also incurred an additional $50,000 in costs related to a data processing conversion necessitated
by the acquisition. Professional services increased $223,000 due to additional costs related to
being a public company, employee recruitment, employee benefit administration, legal assistance in
connection with problem loans and the CEO termination mentioned above. We expect to continue
increased spending for professional fees as well as additional costs related to staffing due to
compliance with Sarbanes-Oxley, specifically Section 404 compliance. Amortization of Core Deposit
Intangible amounted to $329,000 for 2004 compared to $0 in 2003. The 2004 amortization was for the
period since the acquisition date of April 15, 2004. We expect the expense to be higher in 2005
because amortization will be for the full year. Income Taxes.Monarch recorded an income tax recovery for the year ended December 31, 2004 of
$1.3 million which represented an effective tax rate of 33.6% of income before tax. This recovery
was recorded in anticipation of carrying back a net operating loss incurred in 2004 to prior years
and receiving refunds from the IRS. In 2003, we recorded an income tax expense of $251,000 on
income before tax of $915,000 for an effective tax rate of 27.4%. 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 OTS 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, 2004, 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 9.4%. This level of liquidity is significantly lower than the
Company has maintained in previous years and management feels it is adequate 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, 2004,
totaled $56.1 million. Based on historical experience, management believes that a significant
portion of these certificates of deposit can be retained by continuing to pay competitive interest
rates. If necessary, additional funding sources include additional deposits and Federal Home Loan
Bank advances. Management is committed to increase 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,




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##### Table of Contents



2004, Monarch could borrow an additional $19.2 million from the Federal Home Loan Bank
at prevailing interest rates. This capacity has increased during the year consistent with the
increase in the Banks one- to four-family portfolio balance as a result of the acquisition. 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, 2004, Monarch had a net decrease in cash and cash equivalents
of $11.7 million as compared to an increase of $7.1 million for the year ended December 31, 2003. Monarchs primary sources of funds during the year were the net effect of securities
transactions of $11.2 million and operating activities including the sale of mortgage loans which
provided $7.9 million. The primary use of funds was the acquisition of MSB Financial, Inc. which
used $13.1 million, a decrease in deposits of $9.7 million and loan originations, net of
collections of $11.2 million. Off-Balance Sheet Arrangements At December 31, 2004, the total unused commercial and consumer lines of credit were $18.7
million. As of December 31, 2004 there were outstanding commitments under letters of credit of
$97,000. The Company has no arrangements with any other entities that have or are reasonably likely
to have a material effect on financial condition, changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital resources. Contractual Obligations The long-term debt obligations consist of certificates of deposit and fixed rate advances from
the Federal Home Loan Bank. Payments of the advances include monthly interest payments and
principal payments that are due upon maturity. See Notes 9 & 10 in the Notes to Consolidated
Financial Statements for a schedule of maturities of our certificates of deposit and advances. Long-term obligations also include the liability under the Corporation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, 2004, Monarch exceeded all capital requirements of the OTS. Monarchs
regulatory capital ratios at that date were as follows: tangible capital 9.06%; leverage capital,
9.06%; and total risk-based capital, 13.62%. These levels are significantly lower than at December
31, 2003 due to the acquisition of MSB Financial and the net loss for the year ended December 31,
2004. The regulatory capital requirements to be considered well capitalized are 3.0%, 5.0% and
10.0%, respectively. In 2005 management does not anticipate seeking additional capital as it
considers the capital levels to be adequate and expects a return to profitable operations. 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.




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##### Table of Contents



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 maturities 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 noninterest expense. Such expense items as employee compensation, employee benefits
and occupancy and equipment costs may be subject to increases as a result of inflation. An
additional effect of inflation is the possible increase in the dollar value of the collateral
securing loans that we have made. We are unable to determine the extent, if any, to which
properties securing our loans have appreciated in dollar value due to inflation.




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##### Table of Contents



ITEM 7. Financial Statements Monarch Community Bancorp, Inc. and Subsidiaries   Consolidated Financial Report December 31, 2004




---



##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  ContentsReport Letter
    
    
    3Consolidated Financial StatementsBalance Sheet
    
    
    4Statement of Income
    
    
    5Statement of Changes in Stockholders Equity
    
    
    6Statement of Cash Flows
    
    
    7Notes to Consolidated Financial Statements
    
    
    8-43




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##### Table of Contents



(PLANTE MORAN LOGO)
    
    Plante & Moran, PLLC
Suite 500 
2601 Cambridge Court 
Auburn Hills, MI 48326 
Tel: 248.375.7100 
Fax: 248.375.7101 
plantemoran.com
 Report of Independent Registered Public Accounting Firm To the Board of Directors
Monarch Community Bancorp, Inc. and Subsidiaries We have audited the accompanying consolidated balance sheet of Monarch Community Bancorp, Inc. and
Subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income,
stockholders equity, and cash flows for each year in the three-year period ended December 31,
2004. 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, 2004 and 2003, and the consolidated results of their operations and
their cash flows for each year in the three-year period ended December 31, 2004, in conformity with
accounting principles generally accepted in the United States of America. -s- PLANTE MORAN, PLLC Auburn Hills, Michigan March 7 , 2005




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries 
 Consolidated Balance
Sheet
 (000s omitted, except per
share data)
 December 312004
    
    
    2003AssetsCash and due from banks
    
    $
    9,529
    
    
    $
    6,357Federal Home Loan Bank overnight time and
other interest bearing deposits
    
    
    6,120
    
    
    
    20,974Total cash and cash equivalents
    
    
    15,649
    
    
    
    27,331Securities - Available for sale (Note 3)
    
    
    8,057
    
    
    
    19,648Securities - Held to maturity (Note 3)
    
    
    267
    
    
    
    286Other securities (Note 3)
    
    
    4,720
    
    
    
    3,029Real estate
investment - Limited partnership,
at equity (Note 4)
    
    
    1,278
    
    
    
    1,415Loans held for sale
    
    
    361
    
    
    
    421Loans, net (Notes 5 and 17)
    
    
    219,317
    
    
    
    141,225Accrued interest and late charges receivable
    
    
    1,138
    
    
    
    1,041Foreclosed assets, net (Note 7)
    
    
    1,960
    
    
    
    2,177Premises and equipment (Note 8)
    
    
    6,444
    
    
    
    4,168Deferred income taxes (Note 11)
    
    
    612
    
    
    
    882Goodwill (Note 2 )
    
    
    9,606
    
    
    
    Core deposit (Note 2 )
    
    
    1,752
    
    
    
    Other assets (Note 6 and 11)
    
    
    4,287
    
    
    
    1,500Total assets
    
    $
    275,448
    
    

    $
    203,123Liabilities and Stockholders EquityLiabilitiesDeposits (Notes 9 and 17):Noninterest-bearing
    
    $
    5,198
    
    
    $
    4,183Interest-bearing
    
    
    162,535
    
    
    
    103,057Total deposits
    
    
    167,733
    
    
    
    107,240Federal Home Loan Bank advances (Note 10)
    
    
    65,955
    
    
    
    57,384Accrued expenses and other liabilities
    
    
    2,341
    
    
    
    1,069Total liabilities
    
    
    236,029
    
    
    
    165,693Commitments and Contingencies(Note 12)
    
    
    
    
    
    
    Stockholders Equity(Note 13 and 14)Common stock
- $0.01 par value
authorized - 20,000,000 shares
issued and outstanding - 2,709,220 shares at December 31, 2004 and
2,399,550 shares at December 31, 2003
    
    
    27
    
    
    
    24Additional paid-in capital
    
    
    28,059
    
    
    
    23,352Retained
earnings - Substantially restricted
    
    
    13,529
    
    
    
    16,567Accumulated other comprehensive income
    
    
    2
    
    
    
    75Unearned compensation (Note 18 and 19)
    
    
    (2,198
    )
    
    
    (2,588
    )Total stockholders equity
    
    
    39,419
    
    
    
    37,430Total liabilities and stockholders equity
    
    $
    275,448
    
    
    $
    203,123
 See Notes to Consolidated                              4
Financial Statements.




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries 
 Consolidated Statement
of Income
 (000s omitted, except
per share data)
 Year Ended December 312004
    
    
    2003
    
    
    2002Interest IncomeLoans, including fees
    
    $
    13,074
    
    
    $
    11,195
    
    
    $
    12,408Investment securities
    
    
    621
    
    
    
    605
    
    
    
    238Federal funds sold and overnight deposits
    
    
    123
    
    
    
    253
    
    
    
    285Total interest income
    
    
    13,818
    
    
    
    12,053
    
    
    
    12,931Interest ExpenseDeposits (Note 9)
    
    
    2,710
    
    
    
    2,864
    
    
    
    3,325Federal Home Loan Bank advances
    
    
    3,463
    
    
    
    3,196
    
    
    
    3,141Total interest expense
    
    
    6,173
    
    
    
    6,060
    
    
    
    6,466Net Interest Income
    
    
    7,645
    
    
    
    5,993
    
    
    
    6,465Provision for Loan Losses(Note 5)
    
    
    4,875
    
    
    
    1,266
    
    
    
    397Net Interest Income After Provision for Loan Losses
    
    
    2,770
    
    
    
    4,727
    
    
    
    6,068Noninterest IncomeFees and service charges
    
    
    1,933
    
    
    
    954
    
    
    
    955Loan servicing fees
    
    
    400
    
    
    
    213
    
    
    
    199Net gain on sale of loans
    
    
    865
    
    
    
    1,672
    
    
    
    1,000Net gain (loss) on sale of investment securities
    
    
    (60
    )
    
    
    
    
    
    
    Other income
    
    
    287
    
    
    
    86
    
    
    
    5Total noninterest income
    
    
    3,425
    
    
    
    2,925
    
    
    
    2,159Noninterest ExpensesSalaries and employee benefits (Note 15, 18 and 19)
    
    
    5,084
    
    
    
    3,662
    
    
    
    3,542Occupancy and equipment
    
    
    1,060
    
    
    
    724
    
    
    
    782Data processing
    
    
    622
    
    
    
    359
    
    
    
    370Mortgage banking
    
    
    385
    
    
    
    353
    
    
    
    365Professional services
    
    
    632
    
    
    
    409
    
    
    
    296Amortization of intangible assets (Note 2)
    
    
    329
    
    
    
    
    
    
    
    NOW account processing
    
    
    179
    
    
    
    141
    
    
    
    162ATM/Debit card processing
    
    
    219
    
    
    
    76
    
    
    
    71Foreclosed property expense
    
    
    216
    
    
    
    126
    
    
    
    210Other general and administrative
    
    
    1,252
    
    
    
    887
    
    
    
    1,000Total noninterest expense
    
    
    9,978
    
    
    
    6,737
    
    
    
    6,798Income (Loss)- Before income taxes
    
    
    (3,783
    )
    
    
    915
    
    
    
    1,429Income Taxes(Note 11)
    
    
    (1,272
    )
    
    
    251
    
    
    
    415Net Income (Loss)
    
    $
    (2,511
    )
    
    $
    664
    
    
    $
    1,014Earnings (Loss) Per Share (Note 1)Basic
    
    $
    (1.05
    )
    
    $
    0.31
    
    
    
    n/aDiluted
    
    $
    (1.05
    )
    
    $
    0.31
    
    
    
    n/a
 See Notes to Consolidated                              5
Financial Statements.




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries 
 Consolidated Statement
of Stockholders Equity
 (000s omitted, except
per share data)
 Common Stock
    
    
    
    
    
    
    
    
    
    
    AccumulatedAdditional
    
    
    
    
    
    
    OtherNumber of
    
    
    
    
    
    
    Paid in
    
    
    Retained
    
    
    Comprehensive
    
    
    UnearnedShares
    
    
    Amount
    
    
    Capital
    
    
    Earnings
    
    
    Income
    
    
    Compensation
    
    
    TotalBalance- January 1, 2002
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    $
    15,365
    
    
    $
    
    
    
    $
    
    
    
    $
    15,365Issuance of common stock in
connection with the Banks
conversion from mutual to
stock-owned holding company
    
    
    2,314
    
    
    
    23
    
    
    
    22,124
    
    
    
    
    
    
    
    
    
    
    
    (1,852
    )
    
    
    20,295Allocation of ESOP shares (Note 18)
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    
    
    
    
    
    
    
    
    186
    
    
    
    211Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,014
    
    
    
    
    
    
    
    
    
    
    
    1,014Change in unrealized gain on
securities available-for-sale
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    64
    
    
    
    
    
    
    
    64Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,078Balance- December 31, 2002
    
    
    2,314
    
    
    
    23
    
    
    
    22,149
    
    
    
    16,379
    
    
    
    64
    
    
    
    (1,666
    )
    
    
    36,949Issuance of 88,875 shares of
common stock at $13/share awarded
in connection with Restricted
Stock Plan, net of forfeitures of
3,700 shares
    
    
    85
    
    
    
    1
    
    
    
    1,106
    
    
    
    
    
    
    
    
    
    
    
    (1,107
    )
    
    
    Allocation of ESOP shares (Note 18)
    
    
    
    
    
    
    
    
    
    
    97
    
    
    
    
    
    
    
    
    
    
    
    185
    
    
    
    282Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    664
    
    
    
    
    
    
    
    
    
    
    
    664Change in unrealized gain on
securities available-for-sale,
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    11Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    675Dividends paid ($0.20/share)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (476
    )
    
    
    
    
    
    
    
    
    
    
    (476
    )Balance- December 31, 2003
    
    
    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 17,040 of 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
    )
    
    $
    39,419
 See Notes to Consolidated                              6
Financial Statements.




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries 
 Consolidated Statement
of Cash Flows
 (000s omitted)
 Year Ended December 312004
    
    
    2003
    
    
    2002Cash Flows From Operating ActivitiesNet income (Loss)
    
    $
    (2,511
    )
    
    $
    664
    
    
    $
    1,014Adjustments to reconcile net income to net cash from operating
activitiesDepreciation and amortization
    
    
    1,448
    
    
    
    1,139
    
    
    
    821Provision for loan loss
    
    
    4,875
    
    
    
    1,266
    
    
    
    397(Gain) loss on sale of foreclosed assets
    
    
    (16
    )
    
    
    40
    
    
    
    (1
    )Deferred income taxes
    
    
    599
    
    
    
    (329
    )
    
    
    (105
    )Mortgage loans originated for sale
    
    
    (29,553
    )
    
    
    (59,447
    )
    
    
    (37,074
    )Proceeds from sale of mortgage loans
    
    
    30,670
    
    
    
    62,225
    
    
    
    36,547Gain on sale of mortgage loans
    
    
    (865
    )
    
    
    (1,672
    )
    
    
    (1,000
    )(Gain) loss on sale of available for sale securities
    
    
    60

    
    
    
    
    
    
    
    (Gain) loss on sale of premises and equipment
    
    
    
    
    
    
    
    
    
    
    35Earned stock compensation
    
    
    525
    
    
    
    282
    
    
    
    211Net change in:Trading assets
    
    
    
    
    
    
    
    
    
    
    258Change in deferred loan fees
    
    
    (333
    )
    
    
    (41
    )
    
    
    (141
    )Accrued interest receivable
    
    
    229
    
    
    
    234
    
    
    
    (74
    )Other assets
    
    
    4,844
    
    
    
    (842
    )
    
    
    (707
    )Accrued expenses and other liabilities
    
    
    (2,025
    )
    
    
    (723
    )
    
    
    (329
    )Net cash provided by (used in) operating activities
    
    
    7,947
    
    
    
    2,796
    
    
    
    (148
    )Cash Flows From Investing ActivitiesActivity in available-for-sale securities:Purchases
    
    
    (8,545
    )
    
    
    (7,635
    )
    
    
    (17,110
    )Proceeds from sale of securities
    
    
    16,946
    
    
    
    
    
    
    
    Proceeds from maturities of securities
    
    
    2,823
    
    
    
    4,798
    
    
    
    Activity in held-to-maturity securities:Purchases
    
    
    (21
    )
    
    
    (291
    )
    
    
    Proceeds from maturities of securities
    
    
    19
    
    
    
    279
    
    
    
    93Activity in other securities:Purchase of other securities
    
    
    (189
    )
    
    
    (222
    )
    
    
    (255
    )Loan originations and principal collections, net
    
    
    (11,254
    )
    
    
    (132
    )
    
    
    (9,633
    )Proceeds from sale of foreclosed assets
    
    
    3,819
    
    
    
    2,649
    
    
    
    2,745Proceeds on sale of premises and equipment
    
    
    
    
    
    
    
    
    
    
    17Purchase of premises and equipment
    
    
    (373
    )
    
    
    (22
    )
    
    
    (155
    )Loan to employee ESOP plan
    
    
    
    
    
    
    
    
    
    
    (1,852
    )Acquisition, net of cash acquired (Note 2)
    
    
    (13,192
    )
    
    
    
    
    
    
    Net cash used in investing activities
    
    
    (9,967
    )
    
    
    (576
    )
    
    
    (26,150
    )Cash Flows From Financing ActivitiesNet increase (decrease) in deposits
    
    
    (9,723
    )
    
    
    496
    
    
    
    1,046Proceeds from issuance of common stock
    
    
    
    
    
    
    
    
    
    
    22,147Repurchase of Common Stock
    
    
    (11
    )
    
    
    
    
    
    
    Dividends paid
    
    
    (527
    )
    
    
    (476
    )Proceeds from FHLB advances
    
    
    4,000
    
    
    
    5,000
    
    
    
    14,000Repayment of FHLB advances
    
    
    (3,401
    )
    
    
    (116
    )
    
    
    (7,000
    )Net cash provided by financing activities
    
    
    (9,662
    )
    
    
    4,904
    
    
    
    30,193Net Increase (Decrease) in Cash and Cash Equivalents
    
    
    (11,682
    )
    
    
    7,124
    
    
    
    3,895Cash and Cash Equivalents- Beginning
    
    
    27,331
    
    
    
    20,207
    
    
    
    16,312Cash and
Cash Equivalents -End
    
    $
    15,649
    
    
    $
    27,331
    
    
    $
    20,207
 See Notes to Consolidated                              7
Financial Statements.




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries 
 Notes to Consolidated
Financial Statements
 December 31, 2004, 2003
and 2002
 Note 1  Summary of Significant Accounting Policies Organization- Monarch Community Bancorp, Inc. (the Corporation) was incorporated in
2002 under Maryland law to hold all of the common stock of Monarch Community Bank (the
Bank), formerly known as Branch County Federal Savings and Loan Association. Prior to
August 29, 2002, the Bank was a federally charted 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 seven
full service offices and one drive-through only office. The Bank owns 100 percent of
Community Services Group, Inc., which invests in other entities, including 100 percent
ownership of First Insurance Agency, a minority ownership in a limited liability
company that operates a title insurance company, and a minority ownership in a limited
liability company that re-insures private mortgage insurance services provided to the
Banks customers. The Bank also owns a 25% interest in a limited partnership formed to
construct and operate multi-family housing units. Basis of Presentation and Consolidation- The consolidated financial statements include
the accounts of Monarch Community Bancorp, Inc., Monarch Community Bank, and Community
Services Group, 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 real estate limited partnership investment. Significant Group Concentrations of Credit Risk- Most of the Corporations activities
are with customers located within Michigan. Notes 3 discusses the types of securities
the Corporation invests in. Note 4 discusses the Corporations investment in an
unconsolidated partnership. Note 5 discusses the types of lending that the Corporation
engages in. The Corporation has a significant concentration of loans secured by
residential real estate located in Branch, Calhoun and Hillsdale counties. Cash and Cash Equivalents- For the purpose of the consolidated statement of cash
flows, cash and cash equivalents include cash and balances due from banks,
interest-bearing deposits and overnight time deposits with the Federal Home Loan Bank
and fed funds sold. 8




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries 
 Notes to Consolidated
Financial Statements
 December 31, 2004, 2003
and 2002
 Note 1  Summary of Significant Accounting Policies (Continued) Securities- Debt securities that management has the positive intent and ability
to hold to maturity are classified as held to maturity and recorded at amortized
cost. Securities not classified as held to maturity or trading including equity
securities with readily determinable fair values, are classified as available for sale and recorded at fair value,
with unrealized gains and losses, net of deferred income taxes, excluded from earnings
and reported in other comprehensive income. Purchase premiums and discounts are recognized in interest income using the interest
method over the terms of the securities. Declines in the fair value of held-to-maturity
securities below their cost that are deemed to be other than temporary are reflected in
earnings as realized losses. In estimating other-then-temporary impairment losses,
management considers (1) the length of time and the extent to which the fair value has
been less than cost, (2) the financial condition and near-term prospects of the issuer,
and (3) the intent and ability of the Corporation to retain its investment in the
issuer for a period of time sufficient to allow for any anticipated recovery in fair
value. Gains and losses on the sale of securities are recorded on the trade date and
are determined using the specific identification method. Loans Held for Sale- Loans originated and intended for sale in the secondary market
are carried at the lower of cost or estimated fair value in the aggregate. Net
unrealized losses, if any, are recognized in a valuation allowance by charges to
income. Loans The Corporation grants mortgage, commercial and consumer loans to
customers. Loans that management has the intent and ability to hold for the foreseeable
future or until maturity or pay-off are reported at their outstanding unpaid principal
balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees
or costs on originated loans. The accrual of interest on loans is discontinued at the time the loan is 90 days
delinquent unless the credit is well-secured and in process of collection. In all
cases, loans are placed on nonaccrual or charged-off at an earlier date if collection
of principal or interest is considered doubtful. All interest accrued but not collected for loans that are placed on nonaccrual or
charged off is reversed against interest income. The interest on these loans is
accounted for on the cash-basis or cost-recovery method, until qualifying for return to
accrual. Loans are returned to accrual status when all the principal and interest
amounts contractually due are brought current and future payments are reasonably
assured. Allowance for Loan Losses- The allowance for loan losses is established as losses are
estimated to have occurred through a provision for loan losses charged to earnings.
Loan losses are charged against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are
credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is
based upon managements periodic review of the collectibility of the loans in light of
historical experience, the nature and volume of the loan portfolio, adverse situations
that may affect the borrowers ability to repay, estimated value of any underlying
collateral and prevailing 9




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 1 - Summary of Significant Accounting Policies (Continued) 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 relates to loans that are classified as either doubtful, substandard or
special mention. For such loans that are also classified as impaired, an allowance is
established when the discounted cash flows (or collateral value or observable market
price) of the impaired loan is lower that the carrying value of that loan. The general
component covers non-classified loans and is based on historical loss experience
adjusted for qualitative factors. The unallocated component is maintained to cover
uncertainties that could affect managements estimate of probable losses. The
unallocated component of the allowance reflects the margin of imprecision inherent in
the underlying assumptions used in the methodologies for estimating specific and
general losses in the portfolio. A loan is considered impaired when, based on current information and events, it is
probable that the Corporation will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by management in determining impairment include payment
status, collateral value, and the probability of collecting scheduled principal and
interest payments when due. Loans that experience insignificant payment delays and
payment shortfalls generally are not classified as impaired. Management determines the
significance of payment delays and payment shortfalls on a case-by-case basis, taking
into consideration all of the circumstances surrounding the loan and the borrower,
including length of the delay, the reasons for the delay, the borrowers prior payment
record, and the amount of the shortfall in relation to the principal and interest owed.
Impairment is measured on a loan by loan basis for commercial and construction loans by
either the present value of expected future cash flows discounted at the loans
effective interest rate, the loans obtainable market price, or the fair value of the
collateral if the loan is collateral dependent. Large groups of homogeneous loans are collectively evaluated for impairment.
Accordingly, the Corporation does not separately identify individual consumer and
residential loans for impairment disclosures. Servicing- Servicing assets are recognized as separate assets when rights are acquired
through purchase or through sale of financial assets. Capitalized servicing rights are
reported in other assets and are amortized into noninterest expense in proportion to,
and over the period of, the estimated future net servicing income of the underlying
financial assets. Servicing assets are evaluated for impairment based upon the fair
value of the rights as compared to amortized cost. Impairment is determined by
stratifying rights by predominant characteristics, such as interest rates and terms.
Fair value is determined using prices for similar assets with similar characteristics,
when available, or based upon discounted cash flows using market-based assumptions.
Impairment is recognized through a valuation allowance for an individual stratum, to
the extent that fair value is less than the capitalized amount for the stratum. Credit Related Financial Instruments- In the ordinary course of business, the
Corporation has entered into commitments to extend credit, including commitments under
commercial 10




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 1 - Summary of Significant Accounting Policies (Continued) 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. Banking 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. 11




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 1 - Summary of Significant Accounting Policies (Continued) The components of other comprehensive income and related tax effects are as follows
(000s omitted): 2004
    
    
    2003
    
    
    2002Unrealized holding gain (loss) on
available-for-sale securities
    
    $
    (170
    )
    
    $
    16
    
    
    $
    99Reclassification adjustment for losses
(gains) realized in income
    
    
    60
    
    
    
    
    
    
    
    Net unrealized gains (losses)
    
    $
    (110
    )
    
    $
    16
    
    
    $
    99Tax Effect
    
    
    37
    
    
    
    (5
    )
    
    
    (35
    )Net-of-tax amount
    
    $
    (73
    )
    
    $
    11
    
    
    $
    64
 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. Earnings per share data from August 29, 2002 (the date of conversion) to December 31,
2002 is not meaningful due to the shortness of the period and, accordingly, has not
been presented. 12




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 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): 2004
    
    
    2003Basic earnings (loss) per shareNumerator:Net income (loss)
    
    $
    (2,511
    )
    
    $
    664Denominator:Weighted average common shares outstanding
    
    
    2,619
    
    
    
    2,373Less: Average unallocated ESOP shares
    
    
    (148
    )
    
    
    (167
    )Less: Average non-vested RRP shares
    
    
    (73
    )
    
    
    (59
    )Weighted average common shares outstanding
for basic earnings (loss) per share
    
    
    2,398
    
    
    
    2,147Basic earnings (loss) per share
    
    $
    (1.05
    )
    
    $
    0.31Diluted earnings (loss) per shareNumerator:Net income (loss)
    
    $
    (2,511
    )
    
    $
    664Denominator:Weighted average common shares outstanding
for basic earnings (loss) per share
    
    
    2,398
    
    
    
    2,147Add:
Dilutive effects of assumed exercises of stock options
    
    
    
    
    
    
    8Add: Dilutive effects of average non-vested RRP shares
    
    
    
    
    
    
    16Weighted average common shares and dilutive
potential common shares outstanding
    
    
    2,398
    
    
    
    2,171Diluted earnings (loss) per share
    
    $
    (1.05
    )
    
    $
    0.31
 At December 31, 2004, stock options not considered in computing diluted loss per share
because they were antidilutive totaled 192,000 and non-vested RRP shares not considered
in computing diluted earnings per share because they were antidilutive totaled 68,000.
At December 31, 2003, there were no antidilutive stock options or non-vested RRP
shares. 13




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 1 - Summary of Significant Accounting Policies (Continued) Employee Stock Ownership Plan (ESOP)- Compensation expense is recognized as
ESOP shares are committed to be
released. Allocated and committed to be released ESOP shares are considered outstanding
for earnings per share calculation based on debt service payments. 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 value
of unearned shares to be allocated to ESOP participants for future services not yet
performed is reflected as a reduction of stockholders equity. Stock Based Compensation The Corporation accounts for stock option plans using the
intrinsic value method. No compensation cost related to stock options was recognized
during 2004 or 2003, as all options granted had an exercise price equal to or greater
than 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): 2004
    
    
    2003As reported net income (loss)
    
    
    (2,511
    )
    
    $
    664less: additional stock-based compensation determined
under the fair value method, net of tax
    
    
    63
    
    
    
    59$
    (2,574
    )
    
    $
    605As reported earnings (loss) per share
    
    $
    (1.05
    )
    
    $
    0.31Proforma earnings (loss) per share
    
    $
    (1.07
    )
    
    $
    0.28As reported earnings (loss) per diluted share
    
    $
    (1.05
    )
    
    $
    0.31Proforma earnings (loss) per diluted share
    
    $
    (1.07
    )
    
    $
    0.28
 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. The fair value of each option granted in 2004 and 2003 is $2.93 and $2.69,
respectively. The fair value is estimated on the date of the grant using the Black
Scholes option pricing model with the following weighted average assumptions: 2004
    
    
    2003Dividend yield
    
    
    1.4
    %
    
    
    1.4
    %Expected life
    
    7 years
    
    7 yearsExpected volatility
    
    
    17.5
    %
    
    
    17.2
    %Risk-free interest rate
    
    
    3.0
    %
    
    
    3.0
    %
 14




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 1 - Summary of Significant Accounting Policies (Continued) Recent Accounting Pronouncement In December 2004, the FASB re-issued SFAS
No. 123 Accounting for Stock-Based Compensation which becomes effective for periods
beginning after June 15, 2005. This Statement supersedes APB Opinion No. 25 Accounting
for Stock Issued to Employees and its related implementation guidance. Under Opinion
No. 25, issuing stock options to employees generally resulted in recognition of no
compensation cost. This statement requires entities to recognize the cost of employee
services received in exchange for these stock options. The Corporation is evaluating
the transition provisions allowed by SFAS No. 123. The financial statement impact is
not expected to be materially different from that shown in the existing proforma
disclosure required under the original SFAS No. 123. Supplemental Cash Flow Information (000s omitted) December 31,2004
    
    
    2003
    
    
    2002Cash paid (received) for:Interest
    
    $
    6,115
    
    
    $
    6,069
    
    
    $
    6,487Income taxes
    
    
    (315
    )
    
    
    635
    
    
    
    583Noncash investing activities -Loans transferred to real estate owned
    
    
    2,221
    
    
    
    2,844
    
    
    
    1,936Issuance of common stock in connection with
the 2003 Recognition and Retention
Plan
    
    
    16
    
    
    
    1,107
    
    
    
    Issuance of common stock in connection with
the acquisition of MSB Financial, Inc.
    
    
    4,586
    
    
    
    
    
    
    
    
 Reclassification 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. 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 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. 15




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 2 - Acquisition (Continued) 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 cash of
$19.7 million to former MSB Financial stockholders. The cash paid in the transaction
came from the Corporations existing liquidity. 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
    
    $
    24,922
 16




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 2  Acquisition (Continued) 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. 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 year ended December 31, 2004 was $
329,000 and accumulated amortization thru December 31, 2004 is $329,000. The estimated
amortization expense for the next five years ended December 31 is as follows (000s
omitted): 2005
    
    $
    3692006
    
    
    2912007
    
    
    2302008
    
    
    1812009
    
    
    150Thereafter
    
    
    531Total
    
    $
    1,752
 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. 2004
    
    
    2003Net interest income
    
    $
    3,698
    
    
    $
    8,399Noninterest income
    
    
    3,874
    
    
    
    5,406Total income
    
    
    7,572
    
    
    
    13,805Net income (loss)
    
    $
    (4,102
    )
    
    $
    1,781Basic earnings per share
    
    $
    (1.71
    )
    
    $
    0.74Diluted earnings per share
    
    $
    (1.71
    )
    
    $
    0.74
 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. 17




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 3 - Securities The amortized cost and fair value of securities, with gross unrealized gains and
losses, follows (000s omitted): Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Market Value2004Available-for-sale securities:U.S. government agency obligations
    
    
    3,984
    
    
    
    5
    
    
    
    
    
    
    
    3,989Mortgage-backed securities
    
    
    1,677
    
    
    
    6
    
    
    
    (8
    )
    
    
    1,675Obligations of states and
political subdivisions
    
    
    2,394
    
    
    
    1
    
    
    
    (2
    )
    
    
    2,393Total available-for-sale securities
    
    $
    8,055
    
    
    $
    12
    
    
    $
    (10
    )
    
    $
    8,057Held-to-maturity securities:Municipal security
    
    $
    267
    
    
    $
    1
    
    
    $
    
    
    
    $
    2682003Available-for-sale securities:U.S. treasury obligations
    
    $
    5,177
    
    
    $
    53
    
    
    $
    
    
    
    $
    5,230U.S. government agency obligations
    
    
    9,616
    
    
    
    63
    
    
    
    (26
    )
    
    
    9,653Mortgage-backed securities
    
    
    1,046
    
    
    
    
    
    
    
    (12
    )
    
    
    1,034Obligations of states and
political subdivisions
    
    
    3,697
    
    
    
    34
    
    
    
    
    
    
    
    3,731Total available-for-sale securities
    
    $
    19,536
    
    
    $
    150
    
    
    $
    (38
    )
    
    $
    19,648Held-to-maturity securities:Municipal security
    
    $
    286
    
    
    $
    16
    
    
    $
    
    
    
    $
    302
 18




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 3 - Securities (Continued) The amortized cost and estimated market values of securities at December 31, 2004, 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
    
    
    
    
    
    
    AmortizedCost
    
    
    Market Value
    
    
    Cost
    
    
    Market ValueDue in one year or less
    
    $
    
    
    
    $
    
    
    
    $
    1,548
    
    
    $
    1,550Due in one through five years
    
    
    
    
    
    
    
    
    
    
    4,830
    
    
    
    4,832Due after five years through ten years
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Due after ten years
    
    
    267
    
    
    
    268
    
    
    
    
    
    
    
    Total
    
    $
    267
    
    
    $
    268
    
    
    
    6,378
    
    
    
    6,382Mortgage-backed securities
    
    
    
    
    
    
    
    
    
    
    1,677
    
    
    
    1,675Total available-for-sale securities
    
    
    
    
    
    
    
    
    
    $
    8,055
    
    
    $
    8,057
 For the years ended December 31, 2004, 2003 and 2002, proceeds from sales of securities
available for sale amounted to $16,946,000, $0 and $0 , respectively. Gross realized
gains amounted to $17,000, $0 and $0, respectively. Gross realized losses amounted to
$77,000, $0 and $0 , respectively. The tax benefit (provision) applicable to these net
realized gains and losses amounted to $20,000, $0 and 0, respectively. 19




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 3 - Securities (Continued) Information pertaining to securities with gross unrealized losses at December 31, 2004
and 2003, aggregated by investment category and length of time that individual
securities have been in a continuous loss position, follows: Less than Twelve Months
    
    
    Over Twelve MonthsGross
    
    
    
    
    
    
    GrossUnrealized
    
    
    Estimated
    
    
    Unrealized
    
    
    EstimatedLosses
    
    
    Market Value
    
    
    Losses
    
    
    Market Value2004Available-for-sale securities:Mortgage-backed securities
    
    $
    
    
    
    $
    
    
    
    $
    8
    
    
    $
    698Obligations of states and
political subdivisions
    
    
    2
    
    
    
    419
    
    
    
    
    
    
    
    Total available-for-sale securities
    
    $
    2
    
    
    $
    419
    
    
    $
    8
    
    
    $
    6982003Available-for-sale securities:U.S. government agency obligations
    
    $
    26
    
    
    $
    983
    
    
    $
    
    
    
    $
    Mortgage-backed securities
    
    
    12
    
    
    
    1,034
    
    
    
    
    
    
    
    Total available-for-sale securities
    
    $
    38
    
    
    $
    2,017
    
    
    $
    
    
    
    $
    
 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. Note 4 - Real Estate Investment - Limited Partnership In June of 2001, the Corporation acquired a 24.98 percent 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. 20




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 4 - Real Estate Investment - Limited Partnership (Continued) Condensed financial information for the investee partnership is summarized as follows
(000s omitted): September 30,
    
    
    December 31,2004
    
    
    2003Balance Sheet:Cash
    
    $
    5
    
    
    $
    28Prepaid expenses
    
    
    71
    
    
    
    18Accounts receivable
    
    
    20
    
    
    
    Note receivable
    
    
    
    
    
    
    500Loan to affiliates
    
    
    18
    
    
    
    22Amortizable costs
    
    
    48
    
    
    
    Property and equipment
    
    
    9,084
    
    
    
    9,266Total assets
    
    $
    9,246
    
    
    $
    9,834Accounts payable
    
    $
    
    
    
    $
    9Accrued liabilities
    
    
    315
    
    
    
    76Due to developer and affiliates
    
    
    700
    
    
    
    989Loans payable to
    
    
    Monarch Community Bank
    
    
    1,384
    
    
    
    1,384Loans payable to others
    
    
    6,791
    
    
    
    6,240Partners equity
    
    
    56
    
    
    
    1,136Total liabilities and partners equity
    
    $
    9,246
    
    
    $
    9,834Operations -Net income (loss)
    
    $
    (434
    )
    
    $
    (470
    )
 Financial Information for the investee partnership as of December 31, 2004 is not yet available.
The Corporation has recorded an estimate of the tax credit through December 31, 2004. The
Corporations share of tax credits generated by the investee partnership approximated $185,000,
$175,000 and $37,000 in 2004, 2003, 2002, respectively. 21




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 5 - Loans A summary of the balances of loans follows (000s omitted): December 31,2004
    
    
    2003Mortgage loans on real estate:One-to-four family
    
    $
    141,251
    
    
    $
    93,056Multi-family
    
    
    4,042
    
    
    
    485Commercial
    
    
    42,746
    
    
    
    22,728Construction or development
    
    
    8,853
    
    
    
    9,451Total real estate loans
    
    
    196,892
    
    
    
    125,720Consumer loans:Automobile
    
    
    2,631
    
    
    
    1,546Home equity
    
    
    14,234
    
    
    
    9,613Manufactured housing
    
    
    784
    
    
    
    930Other
    
    
    6,645
    
    
    
    3,795Total consumer loans
    
    
    24,294
    
    
    
    15,884Commercial business loans
    
    
    5,330
    
    
    
    2,695Subtotal
    
    
    226,516
    
    
    
    144,299Less: Allowance for loan losses
    
    
    6,385
    
    
    
    2,618Net deferred loan fees
    
    
    808
    
    
    
    454Loans in process
    
    
    6
    
    
    
    2Loans, net
    
    $
    219,317
    
    
    $
    141,225
 22




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 5 - Loans (Continued) An analysis of the allowance for loan losses follows (000s omitted): December 31,2004
    
    
    2003
    
    
    2002Balance - Beginning
    
    
    2,618
    
    
    $
    1,735
    
    
    $
    1,683Allowance acquired in acquisition
    
    
    513
    
    
    $
    
    
    
    $
    Provision for loan losses
    
    
    4,875
    
    
    
    1,266
    
    
    
    397Loans charged-off
    
    
    (1,799
    )
    
    
    (571
    )
    
    
    (568
    )Recoveries of loans previously charged off
    
    
    178
    
    
    
    188
    
    
    
    223Balance - Ending
    
    $
    6,385
    
    
    $
    2,618
    
    
    $
    1,735
 The following is a summary of information pertaining to impaired loans (000s omitted): December 31,2004
    
    
    2003Impaired loans with a valuation allowance
    
    $
    10,205
    
    
    $
    1,771Valuation allowance related to impaired loans
    
    $
    3,727
    
    
    $
    886Total non-accrual loans
    
    $
    4,231
    
    
    $
    3,619Total loans past-due ninety days or more and still accruing
    
    $
    
    
    
    $
    127
 There are no impaired loans without a valuation allowance as of December 31, 2004 and
2003 (000s omitted). December 31,2004
    
    
    2003
    
    
    2002Average investment in impaired loans
    
    $
    4,905
    
    
    $
    1,777
    
    
    $
    213
 Interest income recognized on impaired loans was not significant for the years ended
December 31, 2004, 2003, and 2002. No additional funds are committed to be advanced in
connection with impaired loans. 23




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##### Table of Contents



Monarch Community Bancorp, Inc. and SubsidiariesNotes to Consolidated Financial StatementsDecember 31, 2004, 2003 and 2002
 Note 6 - Servicing Loans serviced for others are not included in the accompanying consolidated balance
sheets. The unpaid principal balances of mortgage loans serviced for others were
$188,915,000 and $92,836,000 at December 31, 2004 and 2003, respectively. The fair value of mortgage servicing rights approximates $1,586,000 and $1,005,000 at
December 31, 2004 and 2003, respectively. The fair value was determined by discounting
estimated net future cash flows from mortgage servicing activities using an 8.25
percent discount rate and estimated prepayment speeds of 7.9 to 32.9 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, 2004, 2003, and 2002. There has been no activity in the impairment valuation
allowance during the years ended December 31, 2004, 2003, and 2002. The following summarizes mortgage servicing rights capitalized and amortized (000s
omitted): December 31,2004
    
    
    2003
    
    
    2002Mortgage servicing rights - Beginning
    
    $
    667
    
    
    $
    428
    
    
    $
    432Mortgage servicing rights acquired in acquisition
    
    $
    940
    
    
    $
    
    
    
    
    Mortgage servicing rights capitalized
    
    
    316
    
    
    
    592
    
    
    
    361Mortgage servicing rights - direct writedown for
loan payoffs
    
    
    (117
    )
    
    
    (311
    )
    
    
    (312
    )Mortgage servicing rights scheduled amortization
    
    
    (267
    )
    
    
    (42
    )
    
    
    (53
    )Mortgage servicing rights - Ending
    
    $
    1,539
    
    
    $
    667
    
    
    $
    428
 24




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 7  Foreclosed Assets Foreclosed assets consisted of the following (000s omitted): December 31,2004
    
    
    2003Real estate owned
    
    $
    1,234
    
    
    $
    1,095Real estate in judgment and
subject to redemption
    
    
    726
    
    
    
    1,082Total
    
    $
    1,960
    
    
    $
    2,177
 Expenses applicable to foreclosed assets include the following (000s omitted): December 31,2004
    
    
    2003
    
    
    2002Net loss (gain) on sales of real estate
    
    $
    (16
    )
    
    $
    40
    
    
    $
    (1
    )Operating expenses
    
    
    205
    
    
    
    114
    
    
    
    203Total
    
    $
    189
    
    
    $
    154
    
    
    $
    202
 25




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 8  Premises and Equipment A summary of the cost and accumulated depreciation of premises and equipment follows
(000s omitted): December 31,
    
    
    DepreciableLife2004
    
    
    2003
    
    
    (in Years)Land
    
    $
    646
    
    
    $
    646Buildings and improvements
    
    
    6,233
    
    
    
    4,524
    
    
    30-40Furniture, fixtures and equipment
    
    
    4,083
    
    
    
    2,994
    
    
    5-7Total bank premises and equipment
    
    
    10,962
    
    
    
    8,164Less accumulated depreciation
and amortization
    
    
    4,518
    
    
    
    3,996Net carrying amount
    
    $
    6,444
    
    
    $
    4,168
 26




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 9  Deposits The following is a summary of interest bearing deposit accounts (000s omitted): December 31,2004
    
    
    2003Balances by account type:Demand and NOW accounts
    
    $
    27,843
    
    
    $
    9,275Money market
    
    
    19,114
    
    
    
    10,909Passbook and statement savings
    
    
    29,177
    
    
    
    15,889Total transactional accounts
    
    
    76,134
    
    
    
    36,073Certificates of deposit:$100,000 and over
    
    
    17,844
    
    
    
    19,132Under $100,000
    
    
    68,557
    
    
    
    47,852Total certificates of deposit
    
    
    86,401
    
    
    
    66,984Total
    
    $
    162,535
    
    
    $
    103,057
 Generally, deposit amounts in excess of $100,000 are not federally insured. 27




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 9  Deposits (Continued) The remaining maturities of certificates of deposit outstanding are as follows (000s
omitted): December 31,2004Year
    

Less
than $100,000
    
    

$100,000
& greaterLess than one year
    
    $
    43,908
    
    
    $
    12,263One to two years
    
    
    11,298
    
    
    
    1,999Two to three years
    
    
    8,446
    
    
    
    2,472Three to four years
    
    
    3,364
    
    
    
    800Four to five years
    
    
    1,541
    
    
    
    310Total
    
    $
    68,557
    
    
    $
    17,844
 The following is a summary of interest expense by deposit account type (000s omitted): December 31,2004
    
    
    2003
    
    
    2002Demand and NOW accounts
    
    $
    94
    
    
    $
    79
    
    
    $
    146Money market
    
    
    176
    
    
    
    135
    
    
    
    194Passbook and statement savings
    
    
    117
    
    
    
    137
    
    
    
    222Certificates of deposit
    
    
    2,323
    
    
    
    2,513
    
    
    
    2,763Total deposit interest expense
    
    $
    2,710
    
    
    $
    2,864
    
    
    $
    3,325
 Note 10  Federal Home Loan Bank Advances The Bank has Federal Home Loan Bank advances of $65,955,000 and $57,384,000 at
December 31, 2004 and 2003, respectively, which mature through 2013. At December 31,
2004 and 2003, the interest rates on fixed rate advances ranged from 3.34 percent to
6.73 percent and from 3.34 percent to 6.62 percent, respectively. At December 31, 2004
the Bank had one floating rate advance of $3,000,000. The interest rate on that
advance was 2.54% at December 31, 2004. The Bank had no floating rate advances at
December 31, 2003. The weighted average interest rate of all advances was 5.36 percent
and 5.51 percent at December 31, 2004 and 2003, respectively. 28




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 10  Federal Home Loan Bank Advances (Continued) 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 $122,539,000 as of December 31, 2004. The contractual maturities of advances are as follows (000s omitted): December 31,2004Less than one year
    
    $
    9,393One to two years
    
    
    8,585Two to three years
    
    
    6,146Three to four years
    
    
    20,153Four to five years
    
    
    160Thereafter
    
    
    21,518Total
    
    $
    65,955
 29




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 11  Income Taxes Allocation of income taxes between current and deferred portions is as follows (000s
omitted): December 31,2004
    
    
    2003
    
    
    2002Current expense (recovery)
    
    $
    (1,871
    )
    
    $
    590
    
    
    $
    520Deferred expense (recovery)
    
    
    599
    
    
    
    (339
    )
    
    
    (105
    )Total tax expense (recovery)
    
    $
    (1,272
    )
    
    $
    251
    
    
    $
    415
 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 31,2004
    
    
    2003
    
    
    2002Statutory federal tax rate
    
    
    34.0
    %
    
    
    34.0
    %
    
    
    34.0
    %Increase (decrease) resulting from:Nondeductible expenses
    
    
    0.3
    %
    
    
    8.9
    %
    
    
    2.4
    %Dividend received deduction
    
    
    -0.3
    %
    
    
    -5.2
    %
    
    
    -1.5
    %Tax exempt income
    
    
    -1.1
    %
    
    
    -4.8
    %
    
    
    -0.2
    %Low income housing credit
    
    
    -1.2
    %
    
    
    -8.4
    %
    
    
    -2.7
    %Other
    
    
    1.9
    %
    
    
    2.9
    %
    
    
    -3.0
    %Reported tax expense (recovery)
    
    
    33.6
    %
    
    
    27.4
    %
    
    
    29.0
    %
 30




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 11  Income Taxes (Continued) The components of the net deferred tax asset are as follows (000s omitted): December 31,2004
    
    
    2003Deferred tax assets:Provision for loan losses
    
    $
    1,719
    
    
    $
    823Net deferred loan fees
    
    
    273
    
    
    
    152Deferred compensation
    
    
    288
    
    
    
    115Employee benefits
    
    
    52
    
    
    
    74Other
    
    
    53
    
    
    
    197Total deferred tax assets
    
    
    2,385
    
    
    
    1,361Deferred tax liabilities:Depreciation
    
    
    
    
    
    
    26Mortgage servicing rights
    
    
    483
    
    
    
    227Original issue discount
    
    
    111
    
    
    
    102Unrealized gain on available-for-sale securities
    
    
    
    
    
    
    38Net purchase premiums
    
    
    1,030
    
    
    
    Stock dividends
    
    
    133
    
    
    
    50Other
    
    
    16
    
    
    
    36Total deferred tax liabilities
    
    
    1,773
    
    
    
    479Net deferred tax asset
    
    $
    612
    
    
    $
    882
 Note 12  Off-Balance Sheet Activities Credit Related Financial Instruments- The Corporation is a party to credit related
financial instruments with off-balance sheet risk in the normal course of business to
meet the financing 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. 31




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Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 12  Off-Balance Sheet Activities (Continued) The following financial instruments were outstanding whose contract amounts represent
credit risk (000s omitted): Contract AmountDecember 31,2004
    
    
    2003Commitments to grant loans
    
    $
    257
    
    
    $
    Unfunded commitments under lines of credit
    
    
    18,672
    
    
    
    8,892Unfunded commitments under letters of credit
    
    
    97
    
    
    
    
 The above commitments include fixed rate and variable rate loan commitments and lines
of credit with interest rates ranging between 3.875 percent and 12.75 percent at
December 31, 2004, and 4.00 percent and 8.25 percent at December 31, 2003. 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. 32




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 13  Regulatory Matters The Corporation has qualified under a provision of the Internal Revenue Code which
permits it to deduct from taxable income a provision for bad debts in excess of such
provision charged to income in the consolidated financial statements. Accordingly,
retained earnings at December 31, 2004 and 2003 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 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, 2004 and 2003, that the Bank has met all of
the capital adequacy requirements to which they are subject. As of December 31, 2004, the most recent notification from the Office of Thrift
Supervision (OTS) 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. 33




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 13  Regulatory Matters (Continued) A reconciliation of the Banks equity to major categories of capital is as follows
(000s omitted): December 31,2004
    
    
    2003Equity per consolidated balance sheet
    
    $
    35,090
    
    
    $
    28,339Less: intangible assets and deferred tax asset
    
    
    (11,361
    )
    
    
    (957
    )Tangible and leverage capital
    
    
    23,729
    
    
    
    27,382Plus: Allowance for loan losses **
    
    
    1,747
    
    
    
    1,477Risk based capital
    
    $
    25,476
    
    
    $
    28,859
    Regulatory capital balances and ratios are as follows (000s omitted): To be Well CapitalizedFor Capital Adequacy
    
    
    Under Prompt CorrectiveActual
    
    
    Purposes
    
    
    Action ProvisionsAmount
    
    
    Ratio
    
    
    Amount
    
    
    Ratio
    
    
    Amount
    
    
    RatioAs of December 31, 2004:Tangible capital
    
    $
    23,729
    
    
    
    9.06
    %
    
    $
    3,928
    
    
    
    1.50
    %
    
    $
    7,857
    
    
    
    3.00
    %Leverage capital
    
    
    23,729
    
    
    
    9.06
    %
    
    
    10,475
    
    
    
    4.00
    %
    
    
    13,094
    
    
    
    5.00
    %Total risk-based capital
    
    
    25,476
    
    
    
    13.62
    %
    
    
    14,959
    
    
    
    8.00
    %
    
    
    18,699
    
    
    
    10.00
    %As of December 31, 2003:Tangible capital
    
    $
    27,382
    
    
    
    14.16
    %
    
    $
    2,900
    
    
    
    1.50
    %
    
    $
    5,800
    
    
    
    3.00
    %Leverage capital
    
    
    27,382
    
    
    
    14.16
    %
    
    
    7,733
    
    
    
    4.00
    %
    
    
    9,667
    
    
    
    5.00
    %Risk-based capital
    
    
    28,859
    
    
    
    24.66
    %
    
    
    9,361
    
    
    
    8.00
    %
    
    
    11,701
    
    
    
    10.00
    %
 34




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 14  Restrictions on Dividends, Loans and Advances OTS regulations impose limitations upon all capital distributions by the Bank
including cash dividends. The Bank would need to file an application to, and
receive the approval of, the OTS prior to any capital distribution. In the event the
Banks capital falls below its regulatory requirements or the OTS notifies it that
is was in need of more than normal supervision, the Banks ability to make capital
distributions could be further restricted. In addition, the OTS could prohibit a
proposed capital distribution by the Bank, which would otherwise be permitted by the
regulation, if the OTS determines that such distribution would constitute an unsafe
or unsound practice. The total amount of dividends which may be paid by the Bank is
generally limited to the sum of the net profits of the bank for the preceding three
years. Accordingly, all of the Corporations investment in the Bank was restricted
at December 31, 2004. Note 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 2004, 2003 and 2002, the Corporation recognized pension expense
for this plan of $246,000, $242,000, and $192,000, respectively. The Corporation has a Defined Contribution Retirement plan for all eligible employees.
The Corporation has a matching contribution agreement to match 50 percent of the first
6 percent of an employees salary. During 2004, 2003 and 2002, the Corporation
recognized pension expense for this plan of $64,000, $54,000, and $99,000,
respectively. The Corporation has a nonqualified deferred-compensation plan to provide retirement
benefits to the Directors, at their option, in lieu of annual directors fees and
meeting fees. The value of benefits accrued to participants is $394,000 and $338,000
at December 31, 2004 and 2003, respectively. The expense for the plan was $41,000,
$39,600, and $52,000 for 2004, 2003, and 2002, 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. The value
of benefits accrued to participants is $702,000 at December 31, 2004. Note 16  Related Party Transactions In the ordinary course of business, the Bank has granted loans to principal officers
and directors and their affiliates with balances of $1,192,000 and $342,000 at
December 31, 2004 and 2003, respectively. Included in the December 31, 2004 were loans
totaling $177,000 made to principal officers and directors prior to them becoming
principal officers and directors. During the year ended December 31, 2004, total
principal additions were $879,000 and total principal payments were $206,000. Deposits from related parties held by the Bank at December 31, 2004 and 2003 amounted
to $ 713,880 and $1,340,000, respectively. 35




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 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. Real Estate Investment  Limited Partnership, at Equity- Fair value is estimated
using discounted cash flow analysis of the future tax benefit related to the
investment. 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. 36




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 17  Fair Value of Financial Instruments (Continued) 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. 37




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 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 31,2004
    
    
    2003Carrying
    
    
    
    
    
    
    CarryingAmount
    
    
    Fair Value
    
    
    Amount
    
    
    Fair ValueAssets:Cash and cash equivalents
    
    $
    15,649
    
    
    $
    15,649
    
    
    $
    27,331
    
    
    $
    27,331Securities  Held to maturity
    
    
    267
    
    
    
    268
    
    
    
    286
    
    
    
    302Securities  Available for sale
    
    
    8,057
    
    
    
    8,057
    
    
    

    19,648
    
    
    
    19,648Other securities
    
    
    4,720
    
    
    
    4,720
    
    
    
    3,029
    
    
    
    3,029Real estate investment  Limited
partnership, at equity
    
    
    1,278
    
    
    
    1,278
    
    
    
    1,415
    
    
    
    1,415Loans held for sale
    
    
    361
    
    
    
    367
    
    
    
    421
    
    
    
    429Net loans
    
    
    219,317
    
    
    
    221,929
    
    
    
    141,225
    
    
    
    144,755Accrued interest
and late charges
receivable
    
    
    1,138
    
    
    
    1,138
    
    
    
    1,041
    
    
    
    1,041Liabilities:Federal Home Loan Bank
advances
    
    
    65,955
    
    
    
    68,155
    
    
    
    57,384
    
    
    
    59,810Deposits
    
    
    167,733
    
    
    
    168,712
    
    
    
    107,240
    
    
    
    108,142Accrued interest payable
    
    
    333
    
    
    
    333
    
    
    
    275
    
    
    
    275
 Note 18  Employee Stock Ownership Plan (ESOP) As part of the conversion, 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. The loan will be repaid over a period of ten years ending on
December 31, 2011. Dividends on the allocated shares are distributed to participants
and the dividends on the unallocated shares are used to pay debt service. The
Corporation has committed to make contributions to the ESOP sufficient to support debt
service of the loan. The ESOP shares initially were pledged as collateral for its
debt. As the debt is repaid, shares are released from collateral and allocated to
active participants. The shares pledged as collateral are included in unearned
compensation in the equity section of the balance sheet. As shares are released they
become outstanding for earnings per share computations. 38




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Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 18  Employee Stock Ownership Plan (ESOP) (Continued) The ESOP shares as of December 31 were as follows (000s omitted except shares): 2004
    
    
    2003Allocated shares
    
    
    37,030
    
    
    
    18,515Shares released for allocation
    
    
    18,515
    
    
    
    18,515Shares distributed
    
    
    (3,841
    )
    
    
    (1,233
    )Unreleased shares
    
    
    129,605
    
    
    
    148,120Total ESOP shares
    
    
    181,309
    
    
    
    183,917Fair value of unallocated shares
    
    $
    1,876
    
    
    $
    2,665
 Total compensation expense applicable to the ESOP amounted to approximately
$266,000, $258,000 and $211,000 for the years ended December 31, 2004, 2003, and 2002,
respectively. Note 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. Due to employee termination, there were
18,484 shares forfeited during 2004 and 3,700 shares forfeited during 2003. During
2004, 18,000 shares of restricted stock were issued to employees. During 2004, 17,040
shares vested and were thus no longer restricted. Compensation expense applicable to
the RRP amounted to $194,000 and $148,000 for the years ended December 31, 2004 and
2003, respectively. Under the Corporations Employee Stock Option Plan, the Corporation may grant options
to its directors, officers and employees for up to 231,438 shares of common stock. Both
incentive stock options and non-qualified stock options may be granted under the plan.
The exercise price of each option equals the market price of the Corporations stock on
the date of grant and an options maximum term is ten years. 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 is recognized. 39




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 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): 2004
    
    
    2003Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    AverageExercise
    
    
    
    
    
    
    ExerciseShares
    
    
    Price
    
    
    Shares
    
    
    PriceOutstanding at
beginning of year
    
    
    183
    
    
    $
    13.00
    
    
    
    
    
    
    $
    Granted
    
    
    45
    
    
    
    13.90
    
    

    
    197
    
    
    
    13.00Exercised
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Forfeited/expired
    
    
    36
    
    
    
    13.00
    
    
    
    14
    
    
    
    13.00Outstanding at end
of year
    
    
    192
    
    
    $
    13.21
    
    
    
    183
    
    
    $
    13.00Exercisable at year-end
    
    
    30
    
    
    $
    13.00
    
    
    
    
    
    
    
    
 The weighted average remaining contractual life of the outstanding options is 8.6 years
at December 31, 2004. 40




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 20  Condensed Financial Statements of Parent Company The following represents the condensed financial statements of Monarch Community
Bancorp, Inc. (Parent) only. The Parent-only financial information should be read in
conjunction with the Corporations consolidated financial statements. Condensed Balance Sheet (000s omitted) December 31,
    
    
    December 31,2004
    
    
    2003AssetsCash
    
    $
    1,007
    
    
    $
    6,410Investments
    
    
    1,283
    
    
    
    2,288Investment in Monarch Community Bank
    
    
    35,089
    
    
    
    28,332Other assets
    
    
    2,350
    
    
    
    417Total assets
    
    $
    39,729
    
    
    $
    37,447Liabilities and Stockholders EquityAccrued expenses
    
    $
    310
    
    
    $
    17Stockholders equity
    
    
    39,419
    
    
    
    37,430Total liabilities and stockholders equity
    
    $
    39,729
    
    
    $
    37,447
 41




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 20  Condensed Financial Statements of Parent Company (Continued) Condensed Statement of Income (000s omitted) December 31,
    
    
    December 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2002Income  Interest on investments
    
    $
    106
    
    
    $
    120
    
    
    $
    65Dividends from Monarch Community Bank
    
    
    10,000
    
    
    
    
    
    
    
    Operating expense
    
    
    233
    
    
    
    220
    
    
    
    48Income (loss)  Before equity in undistributed
net income of subsidiary
    
    
    9,873
    
    
    
    (100
    )
    
    
    17Equity in undistributed net income
of subsidiary
    
    
    (12,384
    )
    
    
    764
    
    
    
    997Net income (loss)
    
    $
    (2,511
    )
    
    $
    664
    
    
    $
    1,014
 42




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries  Notes to Consolidated Financial Statements
December 31, 2004, 2003 and 2002
 Note 20  Condensed Financial Statements of Parent Company (Continued) Condensed Statements of Cash Flows (000s omitted) December 31,
    
    
    December 31,
    
    
    December 31,2004
    
    
    2003
    
    
    2002Cash flows from operating activities:Net income (loss)
    
    $
    (2,511
    )
    
    $
    664
    
    
    
    1,014Adjustments to reconcile net income to net cash
provided by operating activities:Amortization
    
    
    25
    
    
    
    34
    
    
    
    Allocation of ESOP and RRP
    
    
    525
    
    
    
    282
    
    
    
    211(Increase) decrease in other assets
    
    
    4,001
    
    
    
    (404
    )
    
    
    (13
    )Increase in accrued expenses
    
    
    (133
    )
    
    
    11
    
    
    
    6Undistributed net (income) loss of subsidiary
    
    
    12,384
    
    
    
    (764
    )
    
    
    (997
    )Net cash provided by operating activities
    
    
    14,291
    
    
    
    (177
    )
    
    
    221Cash flows from investing activities:Purchase of subsidiary stock
    
    
    
    
    
    
    
    
    
    
    (11,141
    )Purchase of securities
    
    
    
    
    
    
    (624
    )
    
    
    (1,763
    )Proceeds from maturities of securities
    
    
    964
    
    
    
    75
    
    
    
    Loan to employee ESOP plan
    
    
    
    
    
    
    
    
    
    
    (1,852
    )Acquisition, net of cash
    
    
    (20,120
    )
    
    
    
    
    
    
    Net cash used in investing activities
    
    
    (19,156
    )
    
    
    (549
    )
    
    
    (14,756
    )Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    
    
    
    
    
    
    
    
    22,147Repurchase of common stock
    
    
    (11
    )
    
    
    
    
    
    
    Dividends paid
    
    
    (527
    )
    
    
    (476
    )
    
    
    Net cash used in financing activities
    
    
    (538
    )
    
    
    (476
    )
    
    
    22,147Net increase (decrease) in cash
    
    
    (5,403
    )
    
    
    (1,202
    )
    
    
    7,612Cash at beginning of year
    
    
    6,410
    
    
    
    7,612
    
    
    
    Cash at end of year
    
    $
    1,007
    
    
    $
    6,410
    
    
    $
    7,612
 43




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##### Table of Contents



ITEM 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None 
 ITEM 8A. Controls and Procedures An evaluation of the Registrants disclosure controls and procedures (as defined in Section
13(a)-14(c) of the Exchange Act) as of December 31, 2004 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, EXCEPT AS NOTED BELOW,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, 2004, EXCEPT AS NOTED BELOW,that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting. During the quarter ended September 30, 2004, management determined that controls relating to
the ongoing monitoring of the Banks Commercial Loan portfolio were not sufficient to ensure that a
deterioration of credit quality would be disclosed in a timely manner within the Banks financial
statements. Management has since taken steps to ensure the Commercial Loan portfolio is monitored
properly and that deterioration of credit quality, should it occur, would be properly disclosed in
the financial statement but this condition remains as of December 31, 2004. 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.




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##### Table of Contents



PART III 
 ITEM 9. Directors and Executive Officers of the Registrant Information required by this Item 9 is incorporated herein by reference from the definitive
proxy statement for the annual meeting of shareholders, to be held in April 2005, under the
captions Election of Directors, The Audit Committee, Audit Committee Financial Expert,
Compliance with Section 16, and Code of Ethics, a copy of which will be filed not later than
120 days after the close of the fiscal year. 
 ITEM 10. 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 2005, under
the captions Executive Compensation, Directors Compensation, Deferred Compensation Plan,
Other Compensation Arrangements, a copy of which will be filed not later than 120 days after the
close of the fiscal year.




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##### Table of Contents



ITEM 11. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters Information concerning security ownership of certain beneficial owners and management is
incorporated herein by reference from the definitive proxy statement for the annual meeting of
shareholders, to be held in April 2005, 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, 2004. Number of securitiesto be issued upon
    
    
    Weighted-average
    
    
    Number of securitiesexercise of
    
    
    exercise price of
    
    
    remaining available foroutstanding options
    
    
    outstanding options
    
    
    future issuance underPlan Category
    
    
    warrants and rights
    
    
    warrants and rights
    
    
    equity compensation plansEquity
compensation plans
approved by
security holders
(1)
    
    
    191,457
    
    
    13.21
    
    
    47,865Equity compensation
plans not approved
by security holders
    
    
    
    
    
    
    
    
    
   (1)
    
    Includes 2003 Stock Option and Incentive Plan and 2003 Recognition and Retention Plan
approved at the 2003 Annual Meeting of Shareholders 
 ITEM 12. Certain Relationships and Related Transactions 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 2005, under the caption Transactions with Certain Related Persons, a copy of which will
be filed not later than 120 days after the close of the fiscal year. 
 ITEM 13. Exhibits  (a)
    ExhibitsSee the index to exhibits 
 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 2005, 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.




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Company has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized. MONARCH COMMUNITY BANCORP, INC. Dated: March 18, 2005
    
    By:
    /s/ Donald L. DenneyDonald L. Denney, Presidentand Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Company and in the capacities and on the date
indicated. Signature
    
    Title
    
    Date/s/ Donald L. Denney
    
    President and Chief Executive Officer(Principal Executive Officer)
    
    March 18, 2005Donald L. Denney/s/ Stephen M. Ross
    
    Chairman of the Board
    
    March 18, 2005Stephen M. Ross/s/ William C. Kurtz

William C. Kurtz
    
    Senior Vice President and Chief
Financial Officer(Principal Accounting Officer)
    
    March 18, 2005/s/ Harold A. Adamson
    
    Director
    
    March 18, 2005Harold A. Adamson/s/ Lauren L. Bracy
    
    Director
    
    March 18, 2005Lauren L. Bracy/s/ James R. Vozar
    
    Director
    
    March 18, 2005James R. Vozar/s/ Martin L. Mitchell
    
    Director
    
    March 18, 2005Martin L. Mitchell/s/ Gordon L. Welch
    
    Director
    
    March 18, 2005Gordon L. Welch/s/ Craig W. Dally
    
    Director
    
    March 18, 2005Craig W. Dally/s/ Richard Dobbins
    
    Director
    
    March 18, 2005Richard Dobbins




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Index to Exhibits Reference toPrior Filing orExhibit
    
    
    
    Exhibit NumberNumber
    
    Document
    
    Attached Hereto3.1
    
    Registrants Articles of Incorporation
    
    
    
    *3.2
    
    Registrants Bylaws
    
    
    
    *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 9/23/2004)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
    
    
    
    10.611
    
    Statement re computation of per share earnings
    
    See Note 1 of the
Notes
to Consolidated
Financial
Statements
contained in this report12
    
    Statements re computation of ratios
    
    
    
    None13
    
    Annual Report to Security Holders
    
    
    
    Not required14
    
    Registrants Conflict of Interest and Ethics Policy
    
    
    
    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