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SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
   FORM 10-KSB (X)
    
    ANNUAL
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934For the fiscal year ended December 31, 2003
 OR (  )
    

TRANSITION
REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934For the transition period from
_______ to _______Commission file number 0-49814.
 MONARCH COMMUNITY BANCORP, INC.  Maryland
    
    04-3627031(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)375 North Willowbrook Road, Coldwater, Michigan
    
    49036(Address of principal executive offices)
    
    (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
[X]   NO [  ] 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. [X] The issuer had $15.0 million in revenues for the year ended
December 31,
2003. As of February 25, 2004, there were issued and outstanding 2,399,550
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 24, 2004, was approximately $37.8
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 2004.




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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 StatementsIndependent Auditors ReportConsolidated Balance SheetConsolidated Statement of IncomeConsolidated Statement of Stockholders EquityConsolidated Statement of Cash FlowsNotes to Consolidated 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 ManagementITEM 12. Certain Relationships and Related TransactionsITEM 13. Exhibits and Reports on Form 8-KITEM 14. Principal Accountant Fees and ServicesSIGNATURESIndex to ExhibitsSeverance Agreement -- William C. KurtzRegistrants Ethics PolicySubsidiaries of the RegistrantConsent of Plante & Moran PPLC302 Certification of Chief Executive Officer302 Certification of Chief Financial Officer906 Certification of CEO & CFO    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. Monarch Community Bank provides a broad range of banking services to
its primary market area of Branch 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 corporation that reinsures credit life and disability
insurance, 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 five 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.monarchcommunitybank.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 and a variety of consumer loans. We also originate loans
secured by commercial and multi-family real estate, commercial business
loans and construction loans secured primarily by residential real
estate. 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, 2003, we had total assets of $203.1 million,
deposits of $107.2 million and stockholders equity of $37.4 million. 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




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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 and Hillsdale Counties. As of
June 30, 2003, we had a 20.0% market share of FDIC-insured deposits in
Branch County, and a 2.9% market share of FDIC-insured deposits in
Hillsdale County, ranking us third and sixth, respectively, in those
counties among all insured depository institutions. We have expanded our
lending activities to Jackson counties and intend to expand to Calhoun
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
agricultural. 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, 2003, our net loan portfolio totaled $141.2 million, which
constituted 69.5% of our total assets. Loans up to $300,000 may be approved by 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 over $500,000 must be
approved by the full board of directors. 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, 2003, the maximum
amount which we could have loaned to any one borrower and the borrowers
related entities was $4.6 million. At that date we had 10 loan
relationships in excess of $1.0 million. Our largest loan relationship was originated in October 2002 with a
commitment totaling $3.0 million. The loan is for the construction of a
hotel in Grand Rapids, Michigan. The construction is in the final stages
and the balance of the loan was $2.5 million at December 31, 2003. Our second largest loan relationship, originated via a series of
loans in 2002 and 2003, totals $2.2 million and is for the construction
of, and investment in, single-family residences in southwest Michigan. Our third largest loan relationship was originated in May 2003 and
is a loan secured by a major franchise motel in northern Indiana. The
loan has a $2.0 million balance at December 31, 2003 and is a 20 year,
adjustable rate mortgage. Our fourth largest loan relationship was originated in October 2001
with a commitment totaling $1.6 million. The loan was to fund the
construction of a commercial building in southwest Michigan that is now
completed and occupied. At December 31, 2003, $918,000 is owing on a 21
year, fixed rate loan




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which is eight payments behind. $645,000 is owing
on a one-year note which matured May 2003. The Bank is discussing a
workout agreement with the borrower. We believe the borrowers revenue
stream is improving and if it continues to improve, we anticipate Small
Business Administration (SBA) will fund a debenture which will payoff the
$645,000 note. We also have six other loan relationships between $1.0 million and
$1.4 million totaling $7.7 million at December 31, 2003. These loan
relationships are with commercial enterprises and their related entities
operating in southern Michigan and northern Indiana and all of the loans are
current and performing in accordance with their terms as of December 31,
2003.




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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, 2003
    
    December 31, 2002Amount
    
    Percent
    
    Amount
    
    PercentReal Estate Loans:One-to four-family
    
    $
    93,056
    
    
    
    64.5
    %
    
    $
    100,234
    
    
    
    68.0
    %Multi-family
    
    
    485
    
    
    
    0.3
    
    
    
    172
    
    
    
    0.1Commercial
    
    
    22,728
    
    
    
    15.8
    
    
    
    17,801
    
    
    
    12.1Construction or development
    
    
    9,451
    
    
    
    6.5
    
    
    
    7,177
    
    
    
    4.9Total real estate loans
    
    
    125,720
    
    
    
    87.1
    
    
    
    125,384
    
    
    
    85.1Other loans:Consumer loans:Automobile
    
    
    1,546
    
    
    
    1.1
    
    
    
    2,233
    
    
    
    1.5Home equity
    
    
    9,613
    
    
    
    6.7
    
    
    
    11,629
    
    
    
    7.9Manufactured housing
    
    
    930
    
    
    
    0.6
    
    
    
    1,274
    
    
    
    0.9Other
    
    
    3,795
    
    
    
    2.6
    
    
    
    4,655
    
    
    
    3.1Total consumer loans
    
    
    15,884
    
    
    
    11.0
    
    
    
    19,791
    
    
    
    13.4Commercial Business Loans
    
    
    2,695
    
    
    
    1.9
    
    
    
    2,130
    
    
    
    1.5Total other loans
    
    
    18,579
    
    
    
    12.9
    
    
    
    21,921
    
    
    
    14.9Total Loans
    
    
    144,299
    
    
    
    100.0
    %
    
    
    147,305
    
    
    
    100.0
    %Less:Allowance for loan losses
    
    
    2,618
    
    
    
    
    
    
    
    1,735Net deferred loan fees
    
    
    454
    
    
    
    
    
    
    
    406Loans in process
    
    
    2
    
    
    
    
    
    
    
    2Total Loans, net
    
    $
    141,225
    
    
    
    
    
    
    $
    145,162




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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, 2003
    
    December 31, 2002Amount
    
    Percent
    
    Amount
    
    PercentFixed-Rate LoansReal Estate Loans:One-to four-family
    
    $
    67,158
    
    
    
    46.5
    %
    
    $
    85,224
    
    
    
    57.9
    %Multi-family
    
    
    168
    
    
    
    0.1
    
    
    
    172
    
    
    
    0.1Commercial
    
    
    15,381
    
    
    
    10.7
    
    
    
    13,903
    
    
    
    9.4Construction or development
    
    
    8,374
    
    
    
    5.8
    
    
    
    6,943
    
    
    
    4.7Total real estate loans
    
    
    91,081
    
    
    
    63.1
    
    
    
    106,242
    
    
    
    72.1Consumer
    
    
    14,653
    
    
    
    10.2
    
    
    
    19,791
    
    
    
    13.4Commercial business
    
    
    1,478
    
    
    
    1.0
    
    
    
    1,427
    
    
    
    1.0Total fixed-rate loans
    
    
    107,212
    
    
    
    74.3
    
    
    
    127,460
    
    
    
    86.5Adjustable-rate loansReal Estate Loans:One-to four-family
    
    
    25,897
    
    
    
    18.0
    
    
    
    15,010
    
    
    
    10.2
    %Multi-family
    
    
    317
    
    
    
    0.2
    
    
    
    
    
    
    
    Commercial
    
    
    7,347
    
    
    
    5.1
    
    
    
    3,898
    
    
    
    2.7Construction or development
    
    
    1,077
    
    
    
    0.7
    
    
    
    234
    
    
    
    0.1Total real estate loans
    
    
    34,638
    
    
    
    24.1
    
    
    
    19,142
    
    
    
    13.0Consumer
    
    
    1,232
    
    
    
    0.9
    
    
    
    
    
    
    
    Commercial business
    
    
    1,217
    
    
    
    0.8
    
    
    
    703
    
    
    
    0.5Total adjustable-rate loans
    
    
    37,087
    
    
    
    25.8
    
    
    
    19,845
    
    
    
    13.5Total Loans
    
    
    144,299
    
    
    
    100.0
    %
    
    
    147,305
    
    
    
    100.0
    %Less:Allowance for loan losses
    
    
    2,618
    
    
    
    
    
    
    
    1,735Net deferred loan fees
    
    
    454
    
    
    
    
    
    
    
    406Loans in process
    
    
    2
    
    
    
    
    
    
    
    2Total Loans, net
    
    $
    141,225
    
    
    
    
    
    
    $
    145,162




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The following table illustrates the contractual maturity of our loan
portfolio at December 31, 2003. 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 or
    
    
    
    
    
    
    
    
    
    CommercialOne-to-Four Family
    
    Commercial
    
    Development
    
    Consumer
    
    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)
    
    $
    4,175
    
    
    
    7.11
    %
    
    $
    1,881
    
    
    
    6.70
    %
    
    $
    8,371
    
    
    
    5.31
    %
    
    $
    2,179
    
    
    
    8.77
    %
    
    $
    1,254
    
    
    
    5.54
    %
    
    $
    17,860
    
    
    
    6.32
    %After one year
through five years
    
    
    3,374
    
    
    
    7.18
    %
    
    $
    8,453
    
    
    
    7.22
    %
    
    
    262
    
    
    
    7.52
    %
    
    
    8,075
    
    
    
    8.55
    %
    
    
    1,265
    
    
    
    5.36
    %
    
    
    21,429
    
    
    
    7.61
    %After five years
    
    
    85,507
    
    
    
    7.11
    %
    
    
    12,879
    
    
    
    6.61
    %
    
    
    818
    
    
    
    8.57
    %
    
    
    5,630
    
    
    
    8.77
    %
    
    
    176
    
    
    
    7.93
    %
    
    
    105,010
    
    
    
    7.15
    %$
    93,056
    
    
    
    
    
    
    $
    23,213
    
    
    
    
    
    
    $
    9,451
    
    
    
    
    
    
    $
    15,884
    
    
    
    
    
    
    $
    2,695
    
    
    
    
    
    
    $
    144,299
   (1)
    
    Includes demand loans. The total amount of loans due after December 31, 2003 which have
predetermined interest rates is $91.9 million while the total amount of loans
due after such date which have floating or adjustable rates is $34.4 million.




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One- to Four-Family Residential Real Estate
Lending.We focus 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, 2003, one- to four-family residential mortgage loans totaled $93.0 million,
or 64.5% 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. Beginning in 2003 we adopted a loan risk grading system for all one- to
four-family residential loans. This risk grading system resulted in a revised
definition of sub-prime 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. The
risk grading system also allows for loans that were originally classified as
sub-prime to be upgraded and removed from sub-prime status if the loan has had
no delinquent payments for a period of two years. The grading system also
requires that non sub-prime loans which had a credit score of 660 or less and
become 60 days delinquent be reclassified to sub-prime. Management periodically
reviews our loan portfolio to determine which loans between the 600 and 660
credit scores should be classified as sub-prime and which currently classified
sub-prime loans can be upgraded because the loan has had no delinquent payments
for the last two years. During 2003 these reviews did not cause a material
increase or decrease in the total number of loans classified as sub-prime. At December 31, 2003, $20.0 million, or 19.7% of our
residential mortgage
loans were classified as sub-prime loans as compared to $18.4 million, or 18.4%
at December 31, 2002. The increase was due to the revised definition discussed
above and our continued origination of sub-prime residential mortgage 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 2003, $240,000, or 62.5%,
of our total net charge-offs of $384,000 were due to sub-prime loans. 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 internal needs. 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, 2003 and December 31, 2002, we originated $15.1 million and $5.5 million of
one- to four-family ARM loans, respectively, and $79.7 million and $74.1
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




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principal. Most are written using
secondary market underwriting guidelines, although we retain in our portfolio
those loans which do not qualify for sale in the secondary market. Our real
estate loans generally contain a due on sale clause allowing us to declare
the unpaid principal balance due and payable upon the sale of the security
property. Our one- to four-family residential ARM loans are fully amortizing loans
with contractual maturities of up to 30 years, with payments due monthly. Our
ARM loans generally provide for a maximum 2% annual adjustment and 6% lifetime
adjustment to the initial rate. As a consequence of using caps, the interest
rates on these loans may not be as rate sensitive as is our cost of funds. In order to remain competitive in our market area, we may originate ARM
loans at initial rates below the fully indexed rate. 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, 2003, multi-family
and commercial real estate loans totaled $23.2 million or 16.1% 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
borrowers 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, 2003, we had $9.5 million in construction and development loans
outstanding, representing 6.5% of our gross loan portfolio. 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




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##### Table of Contents



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, 2003, our consumer loan portfolio totaled $15.9
million, or 11.0% 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 loans, including lines of credit, totaled
$9.6 million,
and comprised 6.7% of our gross loan portfolio at December 31, 2003. 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 loans may be up to 15 years. Home
equity lines of credit have a maximum term to maturity of five years and have
fixed and adjustable interest rates. We began offering home equity lines of
credit with variable interest rates in 2002. 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 and offset by future amounts owed to that 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 $1.8 million of indirect consumer loans at December 31, 2003. We
intend to continue indirect consumer lending. Auto loans totaled $1.5 million at December 31, 2003, or 1.1%
of our gross
loan portfolio. Auto loans may be written for up to six years and have fixed
rates of interest. Loan to value ratios can be up to 100% of the sales price
for new autos and 100% of wholesale value on used cars, based on valuation from
official used car guides. Manufactured housing loans totaled $930,000 at December 31, 2003, or
..6%
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.




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##### Table of Contents



We originate direct sub-prime consumer loans, using the same definition
as
residential mortgage loans. At December 31, 2003, $3.3 million, or 20.1%, 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, 2003, commercial
business
loans comprised $2.7 million, or 1.9% 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
issued on a secured basis. At December 31, 2003, there were no 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. 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, due to low market interest rates, our dollar volume of
fixed-rate, one- to four-family loans has substantially exceeded the dollar
volume of the same type of adjustable-rate loans. 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.
We are currently seeking outlets for some of the sub-prime residential loans we
originate. 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 31,2003
    
    2002Originations by type:Real Estate:One-to-four family
    
    $
    94,757
    
    
    $
    79,658Multi-family
    
    
    318
    
    
    
    Commercial
    
    
    10,038
    
    
    
    8,916Construction or development
    
    
    13,194
    
    
    
    4,142Total real estate loans
    
    
    118,307
    
    
    
    92,716Consumer Loans:Automobile
    
    
    725
    
    
    
    1,046Home Equity
    
    
    6,043
    
    
    
    6,544Mobile Homes
    
    
    59
    
    
    
    94Other
    
    
    1,869
    
    
    
    3,183Commercial business
    
    
    2,056
    
    
    
    871Total loans originated
    
    
    129,059
    
    
    
    104,454Sales and Repayments:One-to-four family loans sold
    
    
    59,783
    
    
    
    35,547Principal repayments
    
    
    72,282
    
    
    
    61,577Total reductions
    
    
    132,065
    
    
    
    97,124Increase (decrease) in other items, net
    
    
    931
    
    
    
    (121
    )Net increase (decrease) in loans, net
    
    $
    (3,937
    )
    
    $
    7,451
 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 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




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##### Table of Contents



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. The nature 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, 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
    %
 December 31, 2002Loans 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
    
    
    71
    
    
    $
    4,137
    
    
    
    4.13
    %
    
    
    33
    
    
    $
    1,913
    
    
    
    1.91
    %
    
    
    104
    
    
    $
    6,050
    
    
    
    6.03
    %Multi-family
    
    
    
    
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    
    
    
    
    0.00
    %Commercial
    
    
    4
    
    
    
    326
    
    
    
    1.83
    %
    
    
    4
    
    
    
    553
    
    
    
    3.11
    %
    
    
    8
    
    
    
    879
    
    
    
    4.94
    %Construction or development
    
    
    
    
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    
    
    
    
    0.00
    %Total real estate loans
    
    
    75
    
    
    
    4,463
    
    
    
    3.56
    %
    
    
    37
    
    
    
    2,466
    
    
    
    1.97
    %
    
    
    112
    
    
    
    6,929
    
    
    
    5.53
    %Consumer
    
    
    19
    
    
    
    224
    
    
    
    1.13
    %
    
    
    8
    
    
    
    122
    
    
    
    0.62
    %
    
    
    27
    
    
    
    346
    
    
    
    1.75
    %Commercial Business
    
    
    
    
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    
    
    
    
    0.00
    %Total
    
    
    94
    
    
    $
    4,687
    
    
    
    3.18
    %
    
    
    45
    
    
    $
    2,588
    
    
    
    1.76
    %
    
    
    139
    
    
    $
    7,275
    
    
    
    4.94
    %




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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 delinquent at least 90 days unless it
is in the process of foreclosure. 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 31,2003
    
    2002(Dollars in Thousands)Non-accruing loans:One-to four family
    
    $
    908
    
    
    $
    1,372Multi-family
    
    
    318
    
    
    
    Commercial real estate
    
    
    1,558
    
    
    
    211Construction or development
    
    
    645
    
    
    
    Consumer
    
    
    101
    
    
    
    55Commercial business
    
    
    89
    
    
    
    Total
    
    
    3,619
    
    
    
    1,638Accruing loans delinquent 90 days or more:One-to four family
    
    
    
    
    
    
    864Multi-family
    
    
    
    
    
    
    Commercial real estate
    
    
    
    
    
    
    342Construction or development
    
    
    
    
    
    
    Consumer
    
    
    127
    
    
    
    111Commercial business
    
    
    
    
    
    
    Total
    
    
    127
    
    
    
    1,317Foreclosed and repossessed assets:One-to four family (1)
    
    
    2,177
    
    
    
    2,022Multi-family
    
    
    
    
    
    
    Commercial real estate
    
    
    
    
    
    
    Construction or development
    
    
    
    
    
    
    Consumer
    
    
    47
    
    
    
    37Commercial business
    
    
    
    
    
    
    Total
    
    
    2,224
    
    
    
    2,059Total non-performing assets
    
    $
    5,970
    
    
    $
    5,014Total as a percentage of total assets
    
    
    2.94
    %
    
    
    2.53
    %
   (1)
    
    Includes $1.1 million in real estate in judgment and subject to redemption at both December 31, 2003 and
2002. For the years ended December 31, 2003 and 2002, respectively, there
was $166,000 and $37,000 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, 2003, there were also four
loan relationships totaling an aggregate of $3.0 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 on page 22. The first loan relationship is a commercial real estate loan with a
balance of $780,000 at December 31, 2003. This loan is secured by a golf course
in southwest Michigan and is current as of December 31, 2003. The second loan relationship is a series of commercial real estate loans
totaling $853,000, originated in 1996 for the purpose of developing residential
building lots in southwest Michigan. At December 31, 2003, 63% of the lots were
sold. We have personal guarantees from the borrowers for 98% of the loan
amount. At December 31, 2003 all the loans associated with this relationship
are current. The third loan relationship is a series of four loans to one borrower
totaling $1.2 million at December 31, 2003 for the development of residential
building lots in southwest Michigan. At December 31, 2003 all the loans
associated with this relationship are current. The fourth loan relationship is a loan on residential rental real
estate totaling $113,000 at December 31, 2003. This loan was delinquent
30 days at December 31, 2003. 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 Office of
Thrift Supervision to be of lesser quality, as substandard, doubtful
or loss. An asset is considered substandard if it is inadequately
protected by the current net worth and paying capacity of the obligor or
of the collateral pledged, if any. Substandard assets include those
characterized by the distinct possibility that the insured institution
will sustain some loss if the deficiencies are not corrected. Assets
classified as doubtful have all of the weaknesses inherent in those
classified substandard, with the added characteristic that the
weaknesses present make collection or liquidation in full, on the basis
of currently existing facts, conditions, and values, highly questionable
and improbable. Assets classified as loss are those considered
uncollectible and of such little value that their continuance as assets
without the establishment of a specific loss reserve is not warranted. When an insured institution classifies problem assets as either
substandard or doubtful, it may establish general allowances for loan
losses in an amount deemed prudent by management and approved by the
board of directors. General allowances represent loss allowances which
have been established to recognize the inherent risk associated with
lending activities, but which, unlike specific allowances, have not been
allocated to particular problem assets. When an insured institution
classifies problem assets as loss, it is required either to establish a
specific allowance for losses equal to 100% of that portion of the asset
so classified or to charge off such amount. An institutions
determination as to the classification of its assets and the amount of
its valuation allowances is subject to review by the Office of Thrift
Supervision 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
Office of Thrift Supervision 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, 2003, we had classified $6.3 million of our
assets as substandard, $2.1 million as doubtful and none as loss. The
total amount classified represented 29.6% of the Banks equity capital
and 4.3% of the Banks assets at December 31, 2003. The allowance for
loan losses at December 31, 2003 includes $645,000 and $1.1 million
related to substandard and doubtful loans, respectively. At December 31,
2003, $3.4 million and $2.1 million 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 $1.3 million for the year ended December 31, 2003 compared to $397,000
for the year ended December 31, 2002. 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, 2003 and 2002 - Provision for
Loan Losses for a discussion of the reasons for the increased provision
in 2003. 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



At December 31, 2003, our allowance for loan losses was
$2.6 million or
1.81% of the total loan portfolio and approximately 69.9% of total
non-performing loans. Assessing the adequacy of the allowance for loan losses
is inherently subjective as it requires making material estimates, including
the amount and timing of future cash flows 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: December 31,2003
    
    2002Balance at beginning of year
    
    $
    1,735
    
    
    $
    1,683Charge-offs:One-to four family
    
    
    435
    
    
    
    415Multi-family
    
    
    
    
    
    
    Commercial real estate
    
    
    
    
    
    
    1Construction or development
    
    
    15
    
    
    
    Consumer
    
    
    121
    
    
    
    152Commercial business
    
    
    
    
    
    
    Total
    
    
    571
    
    
    
    568Recoveries:One-to four family
    
    
    156
    
    
    
    135Multi-family
    
    
    
    
    
    
    Commercial real estate
    
    
    
    
    
    
    Construction or development
    
    
    
    
    
    
    Consumer
    
    
    32
    
    
    
    88Commercial business
    
    
    
    
    
    
    Total
    
    
    188
    
    
    
    223Net charge-offs
    
    
    383
    
    
    
    345Additions charged to operations
    
    
    1,266
    
    
    
    397Balance at end of year
    
    $
    2,618
    
    
    $
    1,735Ratio of net charge-offs during the year to average loans
outstanding during the year
    
    
    0.26
    %
    
    
    0.24
    %Allowance as a percentage of non-performing loans
    
    
    69.89
    %
    
    
    58.71
    %Allowance as a percentage of total loans (end of year)
    
    
    1.81
    %
    
    
    1.18
    %




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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 31,2003
    
    2002Amount of
    
    Loan
    
    Percentage
    
    Amount of
    
    Loan
    
    PercentageLoan Loss
    
    Amounts by
    
    of
    
    Loan Loss
    
    Amounts by
    
    ofAllowance
    
    Category (1)
    
    Allowance
    
    Allowance
    
    Category (1)
    
    AllowanceOne-to four-family (2)
    
    $
    624
    
    
    $
    94,138
    
    
    
    23.8
    %
    
    $
    805
    
    
    $
    101,370
    
    
    
    46.4
    %Multi-family and non-residential
real estate
    
    
    1,239
    
    
    
    23,213
    
    
    
    47.3
    %
    
    
    686
    
    
    
    17,973
    
    
    
    39.5
    %Construction or development
    
    
    507
    
    
    
    9,451
    
    
    
    19.4
    %
    
    
    33
    
    
    
    7,177
    
    
    
    1.9
    %Consumer
    
    
    173
    
    
    
    15,884
    
    
    
    6.6
    %
    
    
    201
    
    
    
    19,791
    
    
    
    11.6
    %Commercial business
    
    
    75
    
    
    
    2,695
    
    
    
    2.9
    %
    
    
    10
    
    
    
    2,130
    
    
    
    0.6
    %$
    2,618
    
    
    $
    145,381
    
    
    
    100.0
    %
    
    $
    1,735
    
    
    $
    148,441
    
    
    
    100.0
    %
 (1) Loan categories are based on the type of
loan as opposed to the underlying
collateral, which is the basis for other loan tables presented in this
document. (2) One-to four-family loan amounts include
real estate in judgment and subject
to redemption of $1.1 million at both December 31, 2003 and 2002. 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 has the basic responsibility for the management of our
investment portfolio, under the guidance of the asset and liability management
committee. The President considers various factors when making decisions,
including the marketability, maturity and tax consequences of the proposed
investment. The maturity structure of investments will be affected by various
market conditions, including the current and anticipated slope of the yield
curve, the level of interest rates, the trend of new deposit inflows, and the
anticipated demand for funds via deposit withdrawals and loan originations and
purchases. The general objectives of our investment portfolio are to provide
liquidity when loan demand is high, to assist in maintaining earnings when loan
demand is low and to maximize earnings while satisfactorily managing risk,
including credit risk, reinvestment risk, liquidity risk and interest rate
risk. See Managements Discussion and Analysis of Financial Condition and
Results of Operations  Asset and Liability Management and Market Risk. Our investment portfolio consists of U.S. 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 2 and 3 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, 2003. 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 on 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




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##### Table of Contents



recorded amount of the investment to zero. See Note
3 of
the Notes to Consolidated Financial Statements for additional information
regarding our limited partnership investment. The following table sets forth the composition of our securities
portfolio
at the dates indicated. 2003
    
    
    
    
    
    
    
    
    
    2002Percent 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
    
    $
    5,177
    
    
    $
    5,230
    
    
    
    26.2
    %
    
    $
    3,310
    
    
    
    3,338
    
    
    
    19.1
    %U.S. government agency obligations
    
    
    10,662
    
    
    
    10,687
    
    
    
    53.6
    %
    
    
    10,246
    
    
    
    10,312
    
    
    
    59.2
    %Obligations of states and
political subdivisions
    
    
    3,697
    
    
    
    3,731
    
    
    
    18.7
    %
    
    
    3,505
    
    
    
    3,510
    
    
    
    20.1
    %Total available-for-sale securities
    
    $
    19,536
    
    
    $
    19,648
    
    
    
    98.5
    %
    
    $
    17,061
    
    
    $
    17,160
    
    
    
    98.4
    %Held-to-maturity securities:Municipal security
    
    $
    286
    
    
    $
    302
    
    
    
    1.5
    %
    
    $
    274
    
    
    
    275
    
    
    
    1.6
    %Total investment securities
    
    $
    19,822
    
    
    $
    19,950
    
    
    
    100.0
    %
    
    $
    17,335
    
    
    $
    17,435
    
    
    
    100.0
    %
 The maturities of the investment securities portfolio, excluding FHLB
stock, as of December 31, 2003 are indicated in the following table. Less than 1 year
    
    1 to 5 years
    
    5 to 10 years
    
    Over 10 years
    
    Total SecuritiesWeighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    WeightedAmortized
    
    Average
    
    Amortized
    
    Average
    
    Amortized
    
    Average
    
    Amortized
    
    Average
    
    Amortized
    
    AverageCost
    
    Yield
    
    Cost
    
    Yield
    
    Cost
    
    Yield
    
    Cost
    
    Yield
    
    Cost
    
    Yield(Dollars in Thousands)Available-for-sale securities:U.S. treasury obligations
    
    $
    
    
    
    
    0.00
    %
    
    $
    5,177
    
    
    
    2.21
    %
    
    $
    
    
    
    
    0.00
    %
    
    $
    
    
    
    
    0.00
    %
    
    $
    5,177
    
    
    $
    0U.S. government agency obligations
    
    
    4,552
    
    
    
    2.46
    %
    
    
    5,065
    
    
    
    2.34
    %
    
    
    1,045
    
    
    
    3.57
    %
    
    
    
    
    
    
    0.00
    %
    
    
    10,662
    
    
    
    2.51
    %Obligations of states and
political subdivisions
    
    
    1,269
    
    
    
    2.68
    %
    
    
    2,428
    
    
    
    3.00
    %
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    0.00
    %
    
    
    3,697
    
    
    
    2.90
    %Total available-for-sale securities
    
    
    5,821
    
    
    
    2.50
    %
    
    
    12,670
    
    
    
    2.42
    %
    
    
    1,045
    
    
    
    3.57
    %
    
    
    
    
    
    
    0.00
    %
    
    
    19,536
    
    
    
    2.50
    %Held-to-maturity securities:Municipal security
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    0.00
    %
    
    
    
    
    
    
    0.00
    %
    
    
    286
    
    
    
    6.55
    %
    
    
    286
    
    
    
    6.55
    %Total investment securities
    
    $
    5,821
    
    
    
    2.50
    %
    
    $
    12,670
    
    
    
    2.42
    %
    
    $
    1,045
    
    
    
    3.57
    %
    
    $
    286
    
    
    
    6.55
    %
    
    $
    19,822
    
    
    
    2.56
    %




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##### Table of Contents



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, 2003 we had $25.3 million of brokered deposits. In
our experience brokered deposits are an attractive and stable source of funds
which may be less costly than local deposits or borrowings. However, brokered
deposits may be less stable than local deposits if deposit brokers or investors
lose confidence in us or find more attractive rates at other financial
institutions. We primarily rely on competitive pricing policies, marketing and
customer service to attract and retain these deposits. The flow of deposits is influenced significantly by general economic
conditions, changes in money market and prevailing interest rates and
competition. The variety of deposit accounts we offer has allowed us to be
competitive in obtaining funds and to respond with flexibility to changes in
consumer demand. We have become more susceptible to short-term fluctuations in
deposit flows, as customers have become more interest rate conscious. We try to
manage the pricing of our deposits in keeping with our asset/liability
management, liquidity and profitability objectives, subject to competitive
factors. Based on our experience, we believe that our deposits are relatively
stable sources of funds. Despite this stability, our ability to attract and
maintain these deposits and the rates paid on them has been and will continue
to be significantly affected by market conditions. The following table sets forth our deposit flows during the periods
indicated. Year EndedDecember 31,2003
    
    2002(Dollars in Thousands)Opening balance
    
    $
    106,744
    
    
    $
    105,698Net deposits (withdrawals)
    
    
    (2,385
    )
    
    
    (2,343
    )Interest credited
    
    
    2,881
    
    
    
    3,389Ending balance
    
    $
    107,240
    
    
    $
    106,744Net increase
    
    $
    496
    
    
    $
    1,046Percent increase
    
    
    0.46
    %
    
    
    0.99
    %




---



##### 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. Year Ended December 31,2003
    
    2002Percent
    
    
    
    
    
    PercentAmount
    
    of Total
    
    Amount
    
    of Total(Dollars in Thousands)Transaction and Savings Deposits:Non-interest bearing accounts
    
    $
    4,183
    
    
    
    3.9
    %
    
    $
    3,046
    
    
    
    2.9
    %Savings accounts
    
    
    15,889
    
    
    
    14.8
    %
    
    
    15,274
    
    
    
    14.3
    %NOW accounts
    
    
    9,275
    
    
    
    8.6
    %
    
    
    9,596
    
    
    
    9.0
    %Money market accounts
    
    
    10,909
    
    
    
    10.2
    %
    
    
    9,868
    
    
    
    9.2
    %Total transaction and savings
    
    $
    40,256
    
    
    
    37.5
    %
    
    $
    37,784
    
    
    
    35.4
    %Certificates:0.00-1.99%
    
    
    15,080
    
    
    
    14.1
    %
    
    
    9,019
    
    
    
    8.4
    %2.00-3.99%
    
    
    27,749
    
    
    
    25.9
    %
    
    
    27,616
    
    
    
    25.9
    %4.00-5.99%
    
    
    21,514
    
    
    
    20.1
    %
    
    
    26,908
    
    
    
    25.2
    %6.00-7.99%
    
    
    2,641
    
    
    
    2.5
    %
    
    
    5,417
    
    
    
    5.1
    %Total certificates
    
    
    66,984
    
    
    
    62.5
    %
    
    
    68,960
    
    
    
    64.6
    %Total deposits
    
    $
    107,240
    
    
    
    100.0
    %
    
    $
    106,744
    
    
    
    100.0
    %
 The following table indicates the amount of our certificates of deposit
by
time remaining until maturity as of December 31, 2003. 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
    
    $
    6,643
    
    
    $
    6,001
    
    
    $
    11,202
    
    
    $
    24,006
    
    
    $
    47,852Certificates of deposit of $100,000 or more
    
    
    2,087
    
    
    
    1,572
    
    
    
    5,628
    
    
    
    9,845
    
    
    
    19,132Total certificates of deposit
    
    $
    8,730
    
    
    $
    7,573
    
    
    $
    16,830
    
    
    $
    33,851
    
    
    $
    66,984




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##### Table of Contents



The following table shows rate and maturity
information for our certificates of
deposit as of December 31, 2003. 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, 2004
    
    
    5,606
    
    
    
    592
    
    
    
    2,229
    
    
    
    303
    
    
    
    8,730
    
    
    
    13.0
    %June 30, 2004
    
    
    5,412
    
    
    
    510
    
    
    
    1,453
    
    
    
    198
    
    
    
    7,573
    
    
    
    11.3
    %September 30, 2004
    
    
    2,229
    
    
    
    1,777
    
    
    
    3,695
    
    
    
    100
    
    
    
    7,801
    
    
    
    11.6
    %December 31, 2004
    
    
    1,475
    
    
    
    4,167
    
    
    
    3,114
    
    
    
    373
    
    
    
    9,129
    
    
    
    13.6
    %March 31, 2005
    
    
    96
    
    
    
    4,152
    
    
    
    474
    
    
    
    890
    
    
    
    5,612
    
    
    
    8.4
    %June 30, 2005
    
    
    203
    
    
    
    456
    
    
    
    592
    
    
    
    287
    
    
    
    1,538
    
    
    
    2.3
    %September 30, 2005
    
    
    
    
    
    
    2,166
    
    
    
    4
    
    
    
    231
    
    
    
    2,401
    
    
    
    3.6
    %December 31, 2005
    
    
    59
    
    
    
    6,287
    
    
    
    
    
    
    
    72
    
    
    
    6,418
    
    
    
    9.6
    %March 31, 2006
    
    
    
    
    
    
    3,218
    
    
    
    909
    
    
    
    187
    
    
    
    4,314
    
    
    
    6.4
    %June 30, 2006
    
    
    
    
    
    
    234
    
    
    
    445
    
    
    
    
    
    
    
    679
    
    
    
    1.0
    %September 30, 2006
    
    
    
    
    
    
    393
    
    
    
    1,085
    
    
    
    
    
    
    
    1,478
    
    
    
    2.2
    %December 31, 2006
    
    
    
    
    
    
    279
    
    
    
    478
    
    
    
    
    
    
    
    757
    
    
    
    1.1
    %Thereafter
    
    
    
    
    
    
    3,518
    
    
    
    7,036
    
    
    
    
    
    
    
    10,554
    
    
    
    15.8
    %Total
    
    $
    15,080
    
    
    $
    27,749
    
    
    $
    21,514
    
    
    $
    2,641
    
    
    $
    66,984
    
    
    
    100.0
    %Percent of total
    
    
    22.51
    %
    
    
    41.43
    %
    
    
    32.12
    %
    
    
    3.94
    %




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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, 2003, we had $57.3 million in Federal Home Loan Bank
advances outstanding. See Note 9 of the Notes to Consolidated Financial
Statements for information on maturity dates and interest rates related to our
Federal Home Loan Bank advances. The following table sets forth the maximum month-end balance and average
balance of Federal Home Loan Bank advances for the periods indicated. Year EndedDecember 31,2003
    
    2002(Dollars in Thousands)Maximum Balance:FHLB advances
    
    $
    57,500
    
    
    $
    55,500Average Balance:FHLB advances
    
    $
    57,111
    
    
    $
    51,679
 The following table sets forth certain information concerning our
borrowings at the dates indicated. December 31,2003
    
    2002(Dollars in Thousands)FHLB advances
    
    $
    57,384
    
    
    $
    52,500Weighted average interest rate of FHLB
advances
    
    
    5.51
    %
    
    
    5.72
    %
 Subsidiary and Other Activities As a federally chartered savings bank, we are permitted by Office of
Thrift Supervision regulations to invest up to 2% of our assets, or $3.9
million at December 31, 2003, 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, 2003, the Bank had one active subsidiary, Community
Services Group, Inc., and our total investment in this subsidiary was $816,000
which consisted principally of deposits in Monarch. 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.




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##### Table of Contents



Employees At December 31, 2003, we had a total of 63 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.Prior to the Small Business Job
Protection Act, the
Bank was permitted to establish a reserve for bad debts under the percentage of
taxable income method and to make annual additions to the reserve utilizing
that method. These additions could, within specified formula limits, be
deducted in arriving at taxable income. As a result of the Small Business Job
Protection Act, savings associations of the Banks size may now use the
experience method in computing bad debt deductions beginning with their 1996
Federal tax return. In addition, federal legislation requires the Bank to
recapture, over a six year period, the excess of tax bad debt reserves at
December 31, 1997 over those established as of the base year reserve balance as
of December 31, 1987. The amount of such reserve subject to recapture as of
December 31, 2003 for the Bank was $92,000 and that will be recaptured with the
filing of our 2003 Federal tax return. 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. 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




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##### Table of Contents



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.
Effective January 1, 2002, the SBT rate is 1.9%. Legislation passed in 1999
eliminates the SBT over a 23 year period. The elimination of the SBT will be
accomplished by an annual rate reduction of 0.1 percentage point beginning
January 1, 1999 and on each January 1 after 1999. Barring certain conditions,
the SBT should be fully phased
out as of January 1, 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 Office of Thrift Supervision, 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 Office of Thrift Supervision 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 Office of
Thrift Supervision has
extensive authority over the operations of savings banks. As part of this
authority, the Bank is required to file periodic reports with the Office of
Thrift Supervision and is subject to periodic examinations by the Office of
Thrift Supervision and the FDIC. When these examinations are conducted by the
Office of Thrift Supervision 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 Office of Thrift
Supervision. The Banks Office of Thrift Supervision assessment for the fiscal
year ended December 31, 2003 was $58,924. The Office of Thrift Supervision 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
Office of Thrift Supervision. Except under certain circumstances, public
disclosure of final enforcement actions by the Office of Thrift Supervision is
required. 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 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 Office of Thrift Supervision. 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, 2003, the Banks lending limit under this restriction was $4.6
million. The Bank is in compliance with the loans-to-one-borrower limitation. The Office of Thrift Supervision, 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.




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##### Table of Contents



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
Office of Thrift Supervision 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 Office of Thrift Supervision is also
authorized to impose capital requirements in excess of these standards on
individual banks on a case-by-case basis. The Office of Thrift Supervision 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, 2003, the Bank did
not have any intangible assets. At December 31, 2003, the Bank had tangible capital of
$27.4 million, or
14.2% of adjusted total assets, which is approximately $24.4 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, 2003, the Bank had no intangible assets which were
included in core capital. At December 31, 2003, the Bank had core capital equal to
$27.4 million, or
14.2% of adjusted total assets, which is $19.6 million above the requirement of
4% as in effect on that date. The Office of Thrift Supervision 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 Office of Thrift Supervision 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, 2003, the Bank had $2.6 million of loan and lease loss allowances
which exceeded 1.25% of risk-weighted assets by
$1.1 million.




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##### Table of Contents



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, 2003. 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 Office of Thrift Supervision 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, 2003, the Bank had total risk-based capital of $28.9
million (including $27.4 million in core capital and $1.5 million in qualifying
supplementary capital) and risk-weighted assets of $117.0 million, or total
capital of 24.66% of risk-weighted assets. This amount is $19.5 million above
the 8% requirement in effect on that date. Under the prompt corrective action regulations, the Office of Thrift
Supervision 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 Office of Thrift Supervision 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 Office of Thrift Supervision 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 Office of Thrift Supervision
is authorized to impose the additional restrictions that are applicable to
significantly undercapitalized banks. The Office of Thrift Supervision 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 Office of Thrift Supervision or the FDIC of any of
these measures on Monarch Community Bank may have a substantial adverse effect
on its operations and profitability. Limitations on Dividends and Other Capital
Distributions.Office of Thrift
Supervision 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. Office of Thrift Supervision
regulations generally permit a federal savings bank to pay dividends in any
calendar year equal to net income for that year plus retained earnings for the
preceding two 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 Commitments 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, 2003,
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




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##### Table of Contents



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 Office of Thrift Supervision, 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 Office of
Thrift Supervision. 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 Office of Thrift
Supervision has the discretion to treat subsidiaries of 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
Office of Thrift Supervision. 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
Office of
Thrift Supervision 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 Office of Thrift Supervision 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.




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##### Table of Contents



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, 2003, 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
Office of Thrift Supervision. 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. As a member, the Bank is required to purchase and maintain stock in the
Federal Home Loan Bank of Indianapolis. At December 31, 2003, the Bank had $3.0
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;




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##### Table of Contents




    
    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, 2003, we had five full service offices and one
drive-through only facility. At December 31, 2003, we owned all of our offices.
The net book value of our investment in premises and equipment, excluding
computer equipment, was $4.2 million at December 31, 2003. 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, 2003Owned/
    
    Net Book ValueLocation
    
    County
    
    Leased
    
    (Building)(Dollars in Thousands)Main Office375 North Willowbrook Road
    
    Branch
    
    Owned
    
    $
    2,650Coldwater, Michigan 49036Branch Offices30 West Chicago Street
    
    Branch
    
    Owned
    
    
    101Coldwater, Michigan 49036365 N. Broadway
    
    Branch
    
    Owned
    
    
    58Union City, Michigan 490941 West Carleton Road
    
    Hillsdale
    
    Owned
    
    
    471Hillsdale, Michigan 49242125 West Chicago Street
    
    Hillsdale
    
    Owned
    
    
    83Jonesville, Michigan 49250Other Facilities34 Grand Street (Garage)
    
    Branch
    
    Owned
    
    
    124Coldwater, Michigan 4903624 Grand Street (Drive through)
    
    Branch
    
    Owned
    
    
    35Coldwater, Michiagn 4903687 Marshall Street (Leased to others)
    
    Branch
    
    Owned
    
    
    196Coldwater, Michigan 49036
 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, 2003 was
$32,000.




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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,
2003. 
 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 year ended December 31, 2003, the
Company paid dividends of $.20 per share. The Company did not pay dividends in
2002. Year
    
    Quarter ending
    
    High
    
    Low2002
    
    September 30
    
    $
    11.90
    
    
    $
    10.01December 31
    
    $
    11.98
    
    
    $
    10.252003
    
    March 31
    
    $
    12.25
    
    
    $
    11.10June 30
    
    $
    14.15
    
    
    $
    12.25September 30
    
    $
    15.10
    
    
    $
    13.53December 31
    
    $
    17.21
    
    
    $
    14.86
 As of February 28, 2004, there were 2,399,550 shares of the
Companys
common stock outstanding and approximately 248 holders of record. The holders
of record 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 31,2003
    

    2002
    
    2001
    
    2000
    
    1999(In Thousands)Selected Financial Condition Data:Total Assets
    
    
    203,123
    
    
    $
    197,985
    
    
    $
    168,684
    
    
    $
    164,074
    
    
    $
    148,514Loans receivable, net
    
    
    141,225
    
    
    
    145,162
    
    
    
    137,721
    
    
    
    138,197
    
    
    
    126,414Trading securities at fair value:Mortgage-backed securities
    
    
    
    
    
    
    0
    
    
    
    258
    
    
    
    239
    
    
    
    942Investment securities, at amortized cost
    
    
    19,822
    
    
    
    17,335
    
    
    
    0
    
    
    
    0
    
    
    
    0Fed Funds sold and overnight deposits
    
    
    20,974
    
    
    
    16,063
    
    
    
    12,035
    
    
    
    10,254
    
    
    
    6,814Deposits
    
    
    107,240
    
    
    
    106,744
    
    
    
    105,698
    
    
    
    98,986
    
    
    
    96,089Federal Home Loan Bank Advances
    
    
    57,384
    
    
    
    52,500
    
    
    
    45,500
    
    
    
    49,000
    
    
    
    38,000Equity
    
    
    37,430
    
    
    
    36,949
    
    
    
    15,365
    
    
    
    14,606
    
    
    
    13,270
 2003
    
    2002
    
    2001
    
    2000
    
    1999(In Thousands)Selected Operations Data:Total interest income
    
    $
    12,053
    
    
    $
    12,931
    
    
    $
    14,470
    
    
    $
    13,869
    
    
    $
    12,525Total interest expense
    
    
    6,060
    
    
    
    6,466
    
    
    
    8,117
    
    
    
    7,435
    
    
    
    6,998Net interest income
    
    
    5,993
    
    
    
    6,465
    
    
    
    6,353
    
    
    
    6,434
    
    
    
    5,527Provision for loan losses
    
    
    1,266
    
    
    
    397
    
    
    
    1,039
    
    
    
    245
    
    
    
    180Net interest income after provision for loan losses
    
    
    4,727
    
    
    
    6,068
    
    
    
    5,314
    
    
    
    6,189
    
    
    
    5,347Fees and service charges
    
    
    1,167
    
    
    
    1,154
    
    
    
    1,227
    
    
    
    1,234
    
    
    
    1,148Gains on sales of loans, mortgage-backed securities
and investment securities
    
    
    1,671
    
    
    
    998
    
    
    
    1,170
    
    
    
    234
    
    
    
    317Other non-interest income
    
    
    87
    
    
    
    7
    
    
    
    85
    
    
    
    65
    
    
    
    217Total non-interest income
    
    
    2,925
    
    
    
    2,159
    
    
    
    2,482
    
    
    
    1,533
    
    
    
    1,682Total non-interest expense
    
    
    6,737
    
    
    
    6,798
    
    
    
    6,738
    
    
    
    5,636
    
    
    
    5,365Income before taxes
    
    
    915
    
    
    
    1,429
    
    
    
    1,058
    
    
    
    2,086
    
    
    
    1,664Income tax provision
    
    
    251
    
    
    
    415
    
    
    
    299
    
    
    
    749
    
    
    
    530Net income
    
    $
    664
    
    
    $
    1,014
    
    
    $
    759
    
    
    $
    1,337
    
    
    $
    1,134




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##### Table of Contents



December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999Selected Financial Ratios and Other Data:Performance Ratios:Return on assets (ratio of net income to average total assets)
    
    
    0.32
    %
    
    
    0.54
    %
    
    
    0.44
    %
    
    
    0.87
    %
    
    
    0.76
    %Return on Equity (ratio of net income to average equity)
    
    
    1.80
    %
    
    
    4.08
    %
    
    
    5.05
    %
    
    
    9.62
    %
    
    
    9.60
    %Interest rate spread information:Average during period
    
    
    2.69
    %
    
    
    3.58
    %
    
    
    3.69
    %
    
    
    4.20
    %
    
    
    3.57
    %Net interest margin(1)
    
    
    3.11
    %
    
    
    3.85
    %
    
    
    3.89
    %
    
    
    4.44
    %
    
    
    4.01
    %Ratio of operating expense to average total assets
    
    
    3.22
    %
    
    
    3.72
    %
    
    
    3.87
    %
    
    
    3.65
    %
    
    
    3.58
    %Ratio of average interest-earning assets to average
interest-bearing liabilities
    
    
    1.13
    
    
    
    1.07
    
    
    
    1.04
    
    
    
    1.03
    
    
    
    1.02Efficiency ratio(2)
    
    
    74.14
    %
    
    
    75.10
    %
    
    
    74.10
    %
    
    
    69.80
    %
    
    
    73.80
    %Asset Quality Ratios:Non-performing assets to total assets at end of period
    
    
    2.92
    %
    
    
    2.53
    %
    
    
    3.29
    %
    
    
    2.45
    %
    
    
    1.67
    %Non-performing loans to total loans
    
    
    2.60
    %
    
    
    2.04
    %
    
    
    2.16
    %
    
    
    1.95
    %
    
    
    1.39
    %Allowance for loan losses to non-performing loans
    
    
    69.89
    %
    
    
    58.70
    %
    
    
    56.57
    %
    
    
    31.78
    %
    
    
    40.30
    %Allowance for loan losses to loans receivable, net
    
    
    1.81
    %
    
    
    1.18
    %
    
    
    1.20
    %
    
    
    0.62
    %
    
    
    0.56
    %Capital ratios:Equity to total assets at end of period
    
    
    18.43
    %
    
    
    18.67
    %
    
    
    9.11
    %
    
    
    8.90
    %
    
    
    8.93
    %Other data:Number of full-service offices
    
    
    5
    
    
    
    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




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##### Table of Contents



controls and processes are
established to provide assurance that such estimates and management judgments
are materially correct to the best of managements knowledge. Allowance for Loan Losses.Accounting for loan
classifications, accrual
status, and determination of the allowance for loan losses is based on
regulatory guidance. This guidance includes, but is not limited to, generally
accepted accounting principles, the uniform retail credit classification and
account management policy issued by the Federal Financial Institutions
Examination Council, and the joint policy statement on the allowance for loan
losses methodologies issued by the Federal Financial Institutions Examination
Council. 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, and other subjective factors. 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 both higher credit quality and
sub-prime residential real estate loans to borrowers in our market area. On September 2, 2003 the Company entered into an Agreement and Plan
of
Merger with MSB Financial, Inc., parent company of Marshall Savings Bank
pursuant to which MSB Financial will merge with and into Monarch Community
Bancorp. Within a short time of that merger it is expected that Marshall
Savings Bank will merge with and into Monarch Community Bank. Additional
information regarding this proposed purchase can be found in the current Report
on Form 8-K filed by the Company on September 5, 2003 and the S-4 filed by the
Company on November 21, 2003. We expect to consummate the acquisition of MSB Financial during the 2nd
quarter of 2004 which will expand our market area to Calhoun County. This
expanded market area will allow us to increase our originations of one-to
four-family residential loans as well as commercial real estate and business
loans. When the acquisition is complete our sub-prime loans will likely exceed
current Board policy limitations. In an effort to reduce our level of sub-prime
loans and to comply with our own policies we will originate less sub-prime
loans or sell those that we originate. This may reduce our earnings if we are
not able to originate prime loans at a volume sufficient to offset the
decreased originations of sub-prime loans. 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 couple of 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 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.




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##### Table of Contents

'

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 2003 and 2002 we sold $59.8 million and $35.6 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 fixed-rate, one-to four-family loans. The Office of Thrift Supervision provides Monarch with the information
presented in the following table. It presents the expected change in Monarchs
net portfolio value at September 30, 2003 that would occur upon an immediate
change in interest rates based on Office of Thrift Supervision 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
    
    
    31,419
    
    
    
    -209
    
    
    
    -1
    %
    
    
    15.73
    %
    
    +63 bp+ 200 bp
    
    
    32,161
    
    
    
    533
    
    
    
    2
    %
    
    
    15.81
    %
    
    +70 bp+ 100 bp
    
    
    32,124
    
    
    
    497
    
    
    
    2
    %
    
    
    15.55
    %
    
    +44 bp0 bp
    
    
    31,628
    
    
    
    
    
    
    
    
    
    
    
    15.11
    %- 100 bp
    
    
    30,515
    
    
    
    -1113
    
    
    
    -4
    %
    
    
    14.42
    %
    
    -68 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 Office of Thrift Supervision 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.




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##### Table of Contents



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. Changes in Financial Condition from December 31, 2003 to December 31, 2002 General.Monarchs total assets increased by
$5.1 million or 2.6% to
$203.0 million at December 31, 2003 compared to $198.0 million at December 31,
2002. The increase was due to an increase in cash and cash equivalents of $7.1
million or 35.3%. Management anticipated increasing interest rates during 2003
and as a result borrowed $5.0 million early in 2003 to fund loan growth. This
rate increase did not materialize and much of the Banks one  to four-family
loan originations were sold in the secondary market. Loans.Monarchs net loan portfolio decreased by
$3.9 million, or 2.7%
from $145.2 million at December 31, 2002 to $141.2 million at December 31,
2003. One-to four-family loans decreased by $7.2 million as Monarch continued
to experience significant levels of refinancing activity in 2003 as a result of
the historically low interest rates. We originated $94.8 million of residential
mortgage loans and sold $59.8 million of these loans in 2003. Consumer loans
declined significantly, from $19.8 million at December 31, 2002 to $15.9
million at December 31, 2003, or 19.7%. Borrowers have the ability during
periods of low interest rates to consolidate equity debt into first mortgages
and they continued to do so in 2003. Also, the Bank has de-emphasized
automobile lending because of the competitive nature of that market as
exemplified by financing incentives offered by automobile manufacturers.
Commercial real estate increased from $17.8 million to $22.7 million, or 27.7%
during 2003 as we continued our efforts to grow our commercial loan portfolio.
We are attempting to expand our capabilities with regards to commercial real
estate and business lending. We plan to expand our staff in the area of credit
administration as well as improve our policies and procedures. The acquisition
of MSB Financial will provide 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
regards to soliciting new business. Securities.The Banks security portfolio increased to
$19.6 million at
December 31, 2003 from $17.1 million at December 31, 2002, or 14.5%. Securities
were 9.7% of total assets at December 31, 2003 as compared to 8.6% at December
31, 2002. Management purchases securities to maintain sufficient liquidity and
to provide yield to offset declines in the loan portfolio. Liabilities.Monarchs deposits increased $496,000 to
$107.2 million at
December 31, 2003 compared to $106.7 million at December 31, 2002. Transaction
and savings accounts increased $2.5 million which offset a decline in
certificates of deposit (CDs) of $2.0 million. Total deposits were as high as
$116.8 million early in 2003 but management reduced the interest rate paid on
new and renewing CDs late in 2003 to reduce these balances as part of the
asset/liability




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##### Table of Contents



management process. Federal Home Loan Bank advances
increased
$4.9 million to $57.4 million at December 31, 2003 from $52.5 million at
December 31, 2002. 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 had a negative impact on the
Banks net interest margin in 2003. We expect this strategy to help improve net
interest margin as interest rates rise in the future. Equity. Total equity amounted to $37.4 million at
December 31, 2003 and
$36.9 million at December 31, 2002, or 18.4% and 18.7%, respectively, of total
assets at both dates. The increase in equity over the period was due to
profitable operations during 2003 exceeding dividends paid during the year.




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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 31,2003
    
    2002Average
    
    Interest
    
    
    
    
    
    Average
    
    InterestOutstanding
    
    Earned/
    
    Yield/
    
    Outstanding
    
    Earned/
    
    Yield/Balance
    
    Paid
    
    Rate
    
    Balance
    
    Paid
    
    Rate(dollars in thousands)Fed Funds and overnight deposits
    
    $
    23,745
    
    
    $
    253
    
    
    
    1.07
    %
    
    $
    17,376
    
    
    $
    285
    
    
    
    1.64
    %Investment securities
    
    
    18,063
    
    
    
    457
    
    
    
    2.53
    
    
    
    2,614
    
    
    
    80
    
    
    
    3.06Other securities
    
    
    2,915
    
    
    
    148
    
    
    
    5.08
    
    
    
    2,627
    
    
    
    158
    
    
    
    6.01Loans receivable (1)
    
    
    147,896
    
    
    
    11,195
    
    
    
    7.57
    
    
    
    145,487
    
    
    
    12,408
    
    
    
    8.53Total earning assets
    
    
    192,619
    
    
    
    12,053
    
    
    
    6.26
    
    
    
    168,104
    
    
    
    12,931
    
    
    
    7.69Demand and NOW Accounts
    
    
    14,082
    
    
    
    79
    
    
    
    0.56
    
    
    
    12,717
    
    
    
    146
    
    
    
    1.15Money market accounts
    
    
    10,241
    
    
    
    135
    
    
    
    1.32
    
    
    
    11,065
    
    
    
    194
    
    
    
    1.75Savings accounts
    
    
    15,996
    
    
    
    137
    
    
    
    0.86
    
    
    
    16,945
    
    
    
    222
    
    
    
    1.31Certificates of deposit
    
    
    72,286
    
    
    
    2,513
    
    
    
    3.48
    
    
    
    64,925
    
    
    
    2,763
    
    
    
    4.26Federal Home Loan Bank Advances
    
    
    57,111
    
    
    
    3,196
    
    
    
    5.60
    
    
    
    51,679
    
    
    
    3,141
    
    
    
    6.08Total interest bearing liabilities
    
    $
    169,716
    
    
    
    6,060
    
    
    
    3.57
    
    
    $
    157,331
    
    
    
    6,466
    
    
    
    4.11Net interest income
    
    
    
    
    
    $
    5,993
    
    
    
    
    
    
    
    
    
    
    $
    6,465Net interest spread
    
    
    
    
    
    
    
    
    
    
    2.69
    
    
    
    
    
    
    
    
    
    
    
    3.58Net interest margin
    
    
    
    
    
    
    
    
    
    
    3.11
    %
    
    
    
    
    
    
    
    
    
    
    3.85
    %Average interest-earning assets to
average interest-bearing liabilities
    
    
    
    
    
    
    1.13
    X
    
    
    
    
    
    
    
    
    
    
    1.07
    X
   (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 31,2003 vs. 2002
    
    2002 vs. 2001Increase (Decrease) Due to
    
    Total
    
    Increase (Decrease) Due to
    
    TotalIncrease
    

    
    
    IncreaseRate
    
    Volume
    
    Mix
    
    Decrease
    
    Rate
    
    Volume
    
    Mix
    
    Decrease(in thousands)
    
    
    
    
    
    
    
    
    
    (in thousands)Interest Earning AssetsFed funds and overnight deposits
    
    ($
    100
    )
    
    $
    104
    
    
    ($
    36
    )
    
    ($
    32
    )
    
    ($
    373
    )
    
    ($
    67
    )
    
    $
    36
    
    
    ($
    404
    )Trading assets
    
    $
    0
    
    
    $
    0
    
    
    $
    0
    
    
    $
    0
    
    
    ($
    2
    )
    
    ($
    10
    )
    
    $
    1
    
    
    ($
    11
    )Investment securities
    
    
    (14
    )
    
    $
    473
    
    
    ($
    82
    )
    
    
    377
    
    
    
    (18
    )
    
    
    158
    
    
    
    (94
    )
    
    $
    46Other securities
    
    
    (25
    )
    
    $
    17
    
    
    ($
    2
    )
    
    
    (10
    )
    
    
    (34
    )
    
    
    9
    
    
    
    (2
    )
    
    ($
    27
    )Loans receivable
    
    
    (1395
    )
    
    $
    205
    
    
    ($
    23
    )
    
    
    (1213
    )
    
    
    (1549
    )
    
    
    458
    
    
    
    (52
    )
    
    ($
    1,143
    )Total interest-earning assets
    
    ($
    1,534
    )
    
    $
    799
    
    
    ($
    143
    )
    
    ($
    878
    )
    
    ($
    1,976
    )
    
    $
    548
    
    
    ($
    111
    )
    
    ($
    1,539
    )Interest-bearing liabilitiesDemand and NOW Accounts
    
    
    (75
    )
    
    $
    16
    
    
    ($
    8
    )
    
    ($
    67
    )
    
    ($
    69
    )
    
    $
    23
    
    
    ($
    8
    )
    
    ($
    54
    )Money market accounts
    
    
    (48
    )
    
    ($
    14
    )
    
    $
    3
    
    
    ($
    59
    )
    
    
    (136
    )
    
    
    108
    
    
    
    (53
    )
    
    ($
    81
    )Savings accounts
    
    
    (77
    )
    
    ($
    12
    )
    
    $
    4
    
    
    ($
    85
    )
    
    
    (178
    )
    
    
    61
    
    
    
    (30
    )
    
    ($
    147
    )Certificates of deposit
    
    
    (506
    )
    
    $
    313
    
    
    ($
    57
    )
    
    ($
    250
    )
    
    
    (1003
    )
    
    
    (511
    )
    
    
    123
    
    
    ($
    1,391
    )Federal Home Loan Bank Advances
    
    
    (249
    )
    
    $
    330
    
    
    ($
    26
    )
    
    $
    55
    
    
    
    (147
    )
    
    
    177
    
    
    
    (8
    )
    
    $
    22Total interest bearing liabilities
    
    ($
    955
    )
    
    $
    633
    
    
    ($
    84
    )
    
    ($
    406
    )
    
    ($
    1,533
    )
    
    ($
    142
    )
    
    $
    24
    
    
    ($
    1,651
    )Net interest income
    
    
    
    
    
    
    
    
    
    
    
    
    
    ($
    472
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    112




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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 31,2003
    
    2002Weighted average yield on:Fed Funds and overnight deposits
    
    
    0.95
    %
    
    
    1.12
    %Investment securities
    
    
    2.56
    %
    
    
    2.58
    %Federal Home Loan Bank stock
    
    
    5.02
    %
    
    
    5.75
    %Loans:One- to four-family
    
    
    7.11
    %
    
    
    7.94
    %Multi-family
    
    
    6.56
    %
    
    
    9.51
    %Commercial real estate
    
    
    6.85
    %
    
    
    7.44
    %Construction or development
    
    
    5.65
    %
    
    
    6.60
    %Total real estate loans
    
    
    6.95
    %
    
    
    7.79
    %Other loans:Consumer loans
    
    
    8.66
    %
    
    
    9.37
    %Commercial business loans
    
    
    5.61
    %
    
    
    6.65
    %Total Loans
    
    
    7.11
    %
    
    
    7.99
    %Combined weighted average yield
on interest earning assets
    
    
    5.91
    %
    
    
    6.89
    %Weighted average rate paid on:Demand and NOW accounts
    
    
    0.51
    %
    
    
    0.87
    %Money market accounts
    
    
    1.35
    %
    
    
    1.75
    %Savings deposits
    
    
    0.43
    %
    
    
    1.26
    %Certificates of deposit
    
    
    3.39
    %
    
    
    3.80
    %Federal Home Loan Bank advances
    
    
    5.51
    %
    
    
    5.72
    %Combined weighted average rate paid
on interest-bearing liabilities
    
    
    3.47
    %
    
    
    3.83
    %Spread
    
    
    2.44
    %
    
    
    3.06
    %
 Comparison of Results of Operations for the
Years Ended December 31, 2003 and 2002 General. Monarch reported net income of $664,000 and
$1.0 million,
respectively, for the years ended December 31, 2003 and 2002. The decrease was
primarily the result of the decrease in net interest income and an increased
provision for loan losses. Net Interest Income.Net interest income before provision for loan
losses
decreased 7.3% to $6.0 million for 2003 compared to $6.4 million in 2002. Our
interest income decreased by $878,000 while our interest expense decreased by
$406,000. Our net interest margin continued to decline from 3.85% in 2002 to
3.11% in 2003 as our yield on earning assets has declined more rapidly than our
cost of funds. Interest Income.Interest income decreased $878,000 during the
year ended
December 31, 2003 primarily due to a decline in yields on all interest-earning
assets as a result of lower market interest rates. Although a significant
portion of the Banks loan portfolio is fixed rate, substantial refinancing
activity during the past three years has reduced the yield on
the portfolio. Management believes it will be difficult to increase interest
income in 2004 without an increase in market




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##### Table of Contents



interest rates which would
increase the yield on our adjustable rate loans as well as decrease the
likelihood of refinances of existing fixed rate loans to lower rates. Interest Expense.Partially offsetting the decrease in interest
income was
a decrease in interest expense of $406,000. Interest on deposits decreased by
$461,000 in 2003 from 2002, due primarily to a decline in the rate paid on all
deposit accounts. Interest on Federal Home Loan Bank advances increased $55,000
in 2003 from 2002 due to an increase in borrowings. 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
$1.3 million
for the year ended December 31, 2003 compared to $397,000 for the year ended
December 31, 2002. The Banks net charge-offs were $383,000 in 2003 compared to
$345,000 for 2002. During the past two 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 is related to sub-prime loans we feel we have
implemented controls which will limit losses on sub-prime loans in the future.
Beginning in 2003 we became more aggressive in foreclosing on delinquent one-to
four-family loans and the result has been increased charge-offs as well as
decreased delinquencies. The increased provision for 2003 was due to the
charge-offs we have experienced and increases in our non-performing commercial
loans. Noninterest Income.Noninterest income was $2.9 million and
$2.2 million
for the years ended December 31, 2003 and 2002, respectively. This was
primarily the result of increased gains from the sale of mortgage loans from
$1.0 million in 2002 to $1.7 million in 2003. We expect the sales of loans to
be significantly down in 2004 as well as the gains resulting from such sales.
Other income increased $86,000 primarily due to income from our subsidiary
increasing $56,000. We do not expect this income to repeat in 2004. Losses on
sales of real estate owned were $40,000 in 2003 another result of our high
level of foreclosures in 2003. Management believes it can increase fee income
in 2004 by offering new products and services ancillary to its deposit and
lending products and by increasing fees for products and services it currently
provides at below market fees. Noninterest Expenses.Noninterest expenses increased $61,000 for
the year
ended December 31, 2003 compared to the year ended December 31, 2002.
Compensation and benefits increased $120,000. Compensation expense decreased
$72,000 due to reduction in staff and management expects to experience further
staff reductions due primarily to attrition. This decrease was offset by an
increase in retirement costs of $200,000 which includes ESOP, 401(k), pension
plan and restricted stock plan costs. Occupancy and equipment decreased $42,000
largely due to less depreciation expense as certain equipment became fully
depreciated during 2002. Other general and administrative expenses decreased
$96,000 during 2003 as we were better able to manage certain of our operating
expenses. Professional services increased $113,000 due to additional legal,
stock exchange fees, stock transfer fees and related costs of being a public
company for all of 2003 compared to a portion of 2002. We expect to continue
this trend of increased spending for professional fees primarily due to
compliance with Sarbanes-Oxley. Income Taxes.Monarch recorded income tax expense for the year
ended
December 31, 2003 of $251,000 on income before tax of $915,000 for an effective
tax rate of 27.4%. In 2002, we recorded an income tax expense of $415,000 on
income before tax of $1,429,000 for an effective tax rate of 29.0%. 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
Office of Thrift Supervision 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. During 2003 we
maintained excess liquidity in anticipation of our pending purchase of MSB
Financial, Inc. At December 31, 2003, 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 37.2%. 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




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##### Table of Contents



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, 2003, totaled $33.2 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. Deposits can be obtained in the local market
area and from out of market sources; however, this may require Monarch to offer
interest rates higher than those of the competition. Based on current
collateral levels, at December 31, 2003 Monarch could borrow an additional $4.4
million from the Federal Home Loan Bank at prevailing interest rates. This
capacity has decreased during the year consistent with the decrease in the
Banks one- to four-family portfolio balance. 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, 2003, Monarch had a net increase in
cash
and cash equivalents of $7.1 million as compared to $3.9 million for the year
ended December 31, 2002. Monarchs primary sources of funds during the year were the proceeds
of a
FHLB advance of $5.0 million, the sale of foreclosed assets of $2.7 million and
operating activities including the sale of mortgage loans which provided $2.8
million. The primary use of funds was the continued investing activities which
used $3.0 million during 2003. Off-Balance Sheet Arrangements At December 31, 2003, the total unused commercial and consumer lines
of
credit were $8.9 million. As of December 31, 2003; there were no outstanding
letters of credit. The Company has no arrangements with any other entities that
have or are reasonably likely to have a material affect 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 8 & 9 in the Notes to Consolidated Financial Statements for
a schedule of maturities of our certificates of deposit and advances. 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, 2003,
Monarch exceeded all capital requirements of the Office of Thrift Supervision.
Monarchs regulatory capital ratios at that date were as follows: tangible
capital 14.2%; leverage capital, 14.2%; and total risk-based capital, 24.7%.
The regulatory capital requirements to be considered well capitalized are 3.0%,
5.0% and 10.0%, respectively. The acquisition of MSB Financial will cause
capital levels to decline but Monarch expects to remain well capitalized. In
2004 management does not anticipate seeking additional capital nor does it
anticipate reducing capital any further such as from buybacks of the Companys
stock.




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##### Table of Contents



Impact of Inflation The consolidated financial statements presented herein have been prepared
in accordance with generally accepted accounting principles. These principles
require the measurement of financial position and operating results in terms of
historical dollars, without considering changes in the relative purchasing
power of money over time due to inflation. Our primary assets and liabilities are monetary in nature. As a result,
interest rates have a more significant impact on our performance than the
effects of general levels of inflation. Interest rates, however, do not
necessarily move in the same direction or with the same magnitude as the price
of goods and services, since such prices are affected by inflation. In a period
of rapidly rising interest rates, the liquidity and 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, 2003




---



##### 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
    
    
    8-38




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##### Table of Contents



(PLANTE & MORAN LOGO)
    
    Plante & Moran, PLLC
Suite 500
2601 Cambridge Court
Auburn Hills, MI 48320
Tel: 248 375 7100
Fax: 248 375 7101
plantemoran.com
 
 Independent Auditors Report 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, 2003 and 2002, and
the related consolidated statements of income, stockholders equity, and cash
flows for each year in the three-year period ended December 31, 2003. 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 auditing standards generally
accepted in the United States of America. 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, 2003 and
2002, and the consolidated results of their operations and their cash flows for
each year in the three-year period ended December 31, 2003, in conformity with
accounting principles generally accepted in the United States of America. (PLANTE & MORAN, PLLC)
 Auburn Hills, Michigan February 5, 2004 (MRI LOGO)




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries 
 Consolidated Balance Sheet(000s omitted, except per share data) December 312003
    
    2002AssetsCash and due from banks
    
    $
    6,357
    
    
    $
    4,144Federal Home Loan Bank overnight time and
other interest bearing deposits
    
    
    20,974
    
    
    
    16,063Total cash and cash equivalents
    
    
    27,331
    
    
    
    20,207Securities - Available for sale (Note 2)
    
    
    19,648
    
    
    
    17,160Securities - Held to maturity (Note 2)
    
    
    286
    
    
    
    274Other securities (Note 2)
    
    
    3,029
    
    
    
    2,807Real estate
investment - Limited partnership,
at equity (Note 3)
    
    
    1,415
    
    
    
    1,554Loans held for sale
    
    
    421
    
    
    
    1,527Loans, net (Notes 4 and 15)
    
    
    141,225
    
    
    
    145,162Accrued interest receivable
    
    
    1,041
    
    
    
    1,275Foreclosed assets, net (Note 6)
    
    
    2,177
    
    
    
    2,022Premises and equipment (Note 7)
    
    
    4,168
    
    
    
    4,569Deferred income taxes (Note 10)
    
    
    882
    
    
    
    556Other assets (Note 5)
    
    
    1,500
    
    
    
    872Total assets
    
    $
    203,123
    
    
    $
    197,985Liabilities and Stockholders EquityLiabilitiesDeposits (Notes 8 and 15):Noninterest-bearing
    
    $
    4,183
    
    
    $
    3,046Interest-bearing
    
    
    103,057
    
    
    
    103,698Total deposits
    
    
    107,240
    
    
    
    106,744Federal Home Loan Bank advances (Note 9)
    
    
    57,384
    
    
    
    52,500Accrued expenses and other liabilities
    
    
    1,069
    
    
    
    1,792Total liabilities
    
    
    165,693
    
    
    
    161,036Commitments and Contingencies(Note 11)
    
    
    
    
    
    
    Stockholders Equity(Note 12)Common stock
- $0.01 par value
authorized - 20,000,000 shares
issued and outstanding - 2,399,550 shares at December 31, 2003 and
2,314,375 shares at December 31, 2002
    
    
    24
    
    
    
    23Additional paid-in capital
    
    
    23,352
    
    
    
    22,149Retained
earnings - Substantially restricted
    
    
    16,567
    
    
    
    16,379Accumulated other comprehensive income
    
    
    75
    
    
    
    64Unearned compensation (Note 17 and 18)
    
    
    (2,588
    )
    
    
    (1,666
    )Total stockholders equity
    
    
    37,430
    
    
    
    36,949Total liabilities and stockholders equity
    
    $
    203,123
    
    
    $
    197,985
 See Notes to Consolidated
Financial Statements. 4




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries 
 Consolidated Statement of Income(000s omitted) Year Ended December 312003
    
    2002
    
    2001Interest IncomeLoans, including fees
    
    $
    11,195
    
    
    $
    12,408
    
    
    $
    13,551Investment securities
    
    
    605
    
    
    
    238
    
    
    
    230Federal funds sold and overnight deposits
    
    
    253
    
    
    
    285
    
    
    
    689Total interest income
    
    
    12,053
    
    
    
    12,931
    
    
    
    14,470Interest ExpenseDeposits (Note 8)
    
    
    2,864
    
    
    
    3,325
    
    
    
    4,997Federal Home Loan Bank advances
    
    
    3,196
    
    
    
    3,141
    
    
    
    3,120Total interest expense
    
    
    6,060
    
    
    
    6,466
    
    
    
    8,117Net Interest Income
    
    
    5,993
    
    
    
    6,465
    
    
    
    6,353Provision for Loan Losses(Note 4)
    
    
    1,266
    
    
    
    397
    
    
    
    1,039Net Interest Income After Provision for Loan Losses
    
    
    4,727
    
    
    
    6,068
    
    
    
    5,314Noninterest IncomeFees and service charges
    
    
    954
    
    
    
    955
    
    
    
    1,059Loan servicing fees
    
    
    213
    
    
    
    199
    
    
    
    182Net gain on sale of loans
    
    
    1,672
    
    
    
    1,000
    
    
    
    1,166Net gain (loss) on trading activities
    
    
    (1
    )
    
    
    (2
    )
    
    
    5Net gain (loss) on sale of premises and equipment
    
    
    
    
    
    
    (35
    )
    
    
    (4
    )Net gain (loss) on sale of foreclosed property
    
    
    (40
    )
    
    
    1
    
    
    
    (1
    )Other income
    
    
    127
    
    
    
    41
    
    
    
    75Total noninterest income
    
    
    2,925
    
    
    
    2,159
    
    
    
    2,482Noninterest ExpensesSalaries and employee benefits (Note 14, 17 and 18)
    
    
    3,662
    
    
    
    3,542
    
    
    
    3,277Occupancy and equipment
    
    
    724
    
    
    
    782
    
    
    
    836Data processing
    
    
    359
    
    
    
    370
    
    
    
    535Mortgage banking
    
    
    353
    
    
    
    365
    
    
    
    369NOW account expense
    
    
    141
    
    
    
    162
    
    
    
    172Professional services
    
    
    409
    
    
    
    296
    
    
    
    222Office supplies and forms
    
    
    118
    
    
    
    182
    
    
    
    212Advertising
    
    
    83
    
    
    
    115
    
    
    
    127Other general and administrative
    
    
    888
    
    
    
    984
    
    
    
    988Total noninterest expense
    
    
    6,737
    
    
    
    6,798
    
    
    
    6,738Income- Before income taxes
    
    
    915
    
    
    
    1,429
    
    
    
    1,058Income Taxes(Note 10)
    
    
    251
    
    
    
    415
    
    
    
    299Net Income
    
    $
    664
    
    
    $
    1,014
    
    
    $
    759Earnings Per Share (Note 1)Basic
    
    $
    0.29
    
    
    
    n/a
    
    
    
    n/aDiluted
    
    $
    0.28
    
    
    
    n/a
    
    
    
    n/a
 See Notes to Consolidated
Financial Statements. 5




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries 
 Consolidated Statement of Stockholders Equity(000s omitted) Common Stock
    
    
    
    
    
    
    
    
    
    AccumulatedNumber
    
    
    
    
    
    Additional
    
    
    
    
    
    Otherof
    
    
    
    
    
    Paid in
    
    Retained
    
    Comprehensive
    
    UnearnedShares
    
    Amount
    
    Capital
    
    Earnings
    
    Income
    
    Compensation
    
    TotalBalance- January 1, 2001
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    $
    14,606
    
    
    $
    
    
    
    $
    
    
    
    $
    14,606Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    759
    
    
    
    
    
    
    
    
    
    
    
    759Balance- December 31, 2001
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    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 17)
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    
    
    
    
    
    
    
    
    186
    
    
    
    211Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,014
    
    
    
    
    
    
    
    
    
    
    
    1,014Change in unrealized gain on
securities available-for-sale,
net of tax of $33
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    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 17)
    
    
    
    
    
    
    
    
    
    
    97
    
    
    
    
    
    
    
    
    
    
    
    185
    
    
    
    282Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    664
    
    
    
    
    
    
    
    
    
    
    
    664Change in unrealized gain on
securities available-for-sale,
net of tax of $5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    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
    )
    
    $
    37,430
 See Notes to Consolidated
Financial Statements. 6




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries 
 Consolidated Statement of Cash Flows(000s omitted) Year Ended December 312003
    
    2002
    
    2001Cash Flows From Operating ActivitiesNet income
    
    $
    664
    
    
    $
    1,014
    
    
    $
    759Adjustments to reconcile net income to net cash from
operating activities:Depreciation
    
    
    423
    
    
    
    462
    
    
    
    482Provision for loan loss
    
    
    1,266
    
    
    
    397
    
    
    
    1,039Amortization
    
    
    716
    
    
    
    359
    
    
    
    369(Gain) loss on sale of foreclosed assets
    
    
    40
    
    
    
    (1
    )
    
    
    1Deferred income taxes
    
    
    (329
    )
    
    
    (105
    )
    
    
    (280
    )Mortgage loans originated for sale
    
    
    (59,447
    )
    
    
    (37,074
    )
    
    
    (46,568
    )Proceeds from sale of mortgage loans
    
    
    62,225
    
    
    
    36,547
    
    
    
    48,117Gain on sale of mortgage loans
    
    
    (1,672
    )
    
    
    (1,000
    )
    
    
    (1,166
    )(Gain) loss on sale of premises and equipment
    
    
    
    
    
    
    35
    
    
    
    4Allocation of ESOP shares
    
    
    282
    
    
    
    211
    
    
    
    Net change in:Trading assets
    
    
    
    
    
    
    258
    
    
    
    (19
    )Real estate investment
    
    
    139
    
    
    
    
    
    
    
    Change in deferred loan fees
    
    
    (41
    )
    
    
    (141
    )
    
    
    (155
    )Accrued interest receivable
    
    
    234
    
    
    
    (74
    )
    
    
    (189
    )Other assets
    
    
    (981
    )
    
    
    (707
    )
    
    
    (248
    )Accrued expenses and other liabilities
    
    
    (723
    )
    
    
    (329
    )
    
    
    640Net cash provided by (used in) operating activities
    
    
    2,796
    
    
    
    (148
    )
    
    
    2,786Cash Flows From Investing ActivitiesActivity in available-for-sale securities:Purchases
    
    
    (7,635
    )
    
    
    (17,110
    )
    
    
    Proceeds from maturities of securities
    
    
    4,798
    
    
    
    
    
    
    
    Activity in held-to-maturity securities:Purchases
    
    
    (291
    )
    
    
    
    
    
    
    Proceeds from maturities of securities
    
    
    279
    
    
    
    93
    
    
    
    106Activity in other securities:Purchase of other securities
    
    
    (222
    )
    
    
    (255
    )
    
    
    (81
    )Purchase of real estate investment  Limited partnership
    
    
    
    
    
    
    
    
    
    
    (1,500
    )Loan originations and principal collections, net
    
    
    (132
    )
    
    
    (9,633
    )
    
    
    (2,644
    )Proceeds from sale of foreclosed assets
    
    
    2,649
    
    
    
    2,745
    
    
    
    1,109Proceeds on sale of premises and equipment
    
    
    
    
    
    
    17
    
    
    
    Purchase of premises and equipment
    
    
    (22
    )
    
    
    (155
    )
    
    
    (237
    )Loan to employee ESOP plan
    
    
    
    
    
    
    (1,852
    )
    
    
    Net cash used in investing activities
    
    
    (576
    )
    
    
    (26,150
    )
    
    
    (3,247
    )Cash Flows From Financing ActivitiesNet increase in deposits
    
    
    496
    
    
    
    1,046
    
    
    
    6,711Proceeds from issuance of common stock
    
    
    
    
    
    
    22,147
    
    
    
    Dividends paid
    
    
    
    
    
    
    
    
    
    
    (476
    )Proceeds from FHLB advances
    
    
    5,000
    
    
    
    14,000
    
    
    
    1,500Repayment of FHLB advances
    
    
    (116
    )
    
    
    (7,000
    )
    
    
    (5,000
    )Net cash provided by financing activities
    
    
    4,904
    
    
    
    30,193
    
    
    
    3,211Net Increase in Cash and Cash Equivalents
    
    
    7,124
    
    
    
    3,895
    
    
    
    2,750Cash and Cash Equivalents- Beginning
    
    
    20,207
    
    
    
    16,312
    
    
    
    13,562Cash and
Cash Equivalents -End
    
    $
    27,331
    
    
    $
    20,207
    
    
    $
    16,312
 See Notes to Consolidated
Financial Statements. 7




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries 
 Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 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 and Hillsdale counties in Michigan.
The Bank operates five 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 re-insures credit life and disability insurance, 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 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 2 discusses the types of securities the Corporation invests in.
Note 3 discusses the Corporations investment in an unconsolidated
partnership. Note 4 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 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 StatementsDecember 31, 2003, 2002 and 2001 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. Gains and losses on the sale of securities are
recorded on the trade date and are determined using the specific
identification method.Loans Held for Sale- Loans originated and intended for sale in the
secondary market are carried at the lower of cost or estimated fair
value in the aggregate. Net unrealized losses, if any, are recognized
in a valuation allowance by charges to income.Loans -The Corporation grants mortgage, commercial and consumer
loans to customers. Loans that management has the intent and ability
to hold for the foreseeable future or until maturity or pay-off are
reported at their outstanding unpaid principal balances adjusted for
charge-offs, the allowance for loan losses, and any deferred fees or
costs on originated loans.The accrual of interest on loans is discontinued at the time the loan
is 90 days delinquent unless the credit is well-secured and in
process of collection. In all cases, loans are placed on nonaccrual
or charged-off at an earlier date if collection of principal or
interest is considered doubtful.All interest accrued but not collected for loans that are placed
on nonaccrual or charged off is reversed against interest income. The
interest on these loans is accounted for on the cash-basis or
cost-recovery method, until qualifying for return to accrual. Loans
are returned to accrual status when all the principal and interest
amounts contractually due are brought current and future payments are
reasonably assured.Allowance for Loan Losses- The allowance for loan losses is
established as losses are estimated to have occurred through a
provision for loan losses charged to earnings. Loan losses are
charged against the allowance when management believes the
uncollectibility of a loan balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance.The allowance for loan losses is evaluated on a regular basis by
management and is based upon managements periodic review of the
collectibility of the loans in light of historical
experience, the nature and volume of the loan portfolio, adverse
situations that may affect the borrowers ability to repay, estimated
value of any underlying collateral and prevailing economic
conditions. This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as more
information becomes available. 9




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 1  Summary of Significant Accounting Policies (Continued)  The allowance consists of specific, general and unallocated
components. The specific components relates to loans that are
classified as either doubtful, substandard or special mention. For
such loans that are also classified as impaired, an allowance is
established when the discounted cash flows (or collateral value or
observable market price) of the impaired loan is lower that the
carrying value of that loan. The general component covers
non-classified loans and is based on historical loss experience
adjusted for qualitative factors. The unallocated component is
maintained to cover uncertainties that could affect managements
estimate of probable losses. The unallocated component of the
allowance reflects the margin of imprecision inherent in the
underlying assumptions used in the methodologies for estimating
specific and general losses in the portfolio.A loan is considered impaired when, based on current information and
events, it is probable that the Corporation will be unable to collect
the scheduled payments of principal or interest when due according to
the contractual terms of the loan agreement. Factors considered by
management in determining impairment include payment status,
collateral value, and the probability of collecting scheduled
principal and interest payments when due. Loans that experience
insignificant payment delays and payment shortfalls generally are not
classified as impaired. Management determines the significance of
payment delays and payment shortfalls on a case-by-case basis, taking
into consideration all of the circumstances surrounding the loan and
the borrower, including length of the delay, the reasons for the
delay, the borrowers prior payment record, and the amount of the
shortfall in relation to the principal and interest owed. Impairment
is measured on a loan by loan basis for commercial and construction
loans by either the present value of expected future cash flows
discounted at the loans effective interest rate, the loans
obtainable market price, or the fair value of the collateral if the
loan is collateral dependent.Large groups of homogeneous loans are collectively evaluated for
impairment. Accordingly, the Corporation does not separately identify
individual consumer and residential loans for impairment disclosures.Servicing- Servicing assets are recognized as separate assets when
rights are acquired through purchase or through sale of financial
assets. Capitalized servicing rights are reported in other assets and
are amortized into noninterest expense in proportion to, and over the
period of, the estimated future net servicing income of the underlying
financial assets. Servicing assets are evaluated for impairment based
upon the fair value of the rights as compared to amortized cost.
Impairment is determined by stratifying rights by predominant
characteristics, such as interest rates and terms. Fair value is
determined using prices for similar assets with similar
characteristics, when available, or based upon discounted cash flows
using market-based assumptions. Impairment is recognized through a
valuation allowance for an individual stratum, to the extent that fair
value is less than the capitalized amount for the stratum.Credit Related Financial Instruments- In the ordinary course of
business, the Corporation has entered into commitments to extend
credit, including commitments under commercial
letters of credit and standby letters of credit. Such financial
instruments are recorded when they are funded. 10




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 1 - Summary of Significant Accounting Policies (Continued)  Foreclosed Assets- Assets acquired through, or in lieu of, loan
foreclosure are held for sale and are initially recorded at fair
value at the date of the foreclosure, establishing a new cost basis.
Subsequent to foreclosure, valuations are periodically performed by
management and the assets are carried at the lower of carrying amount
or fair value less estimated selling expenses, which consist
primarily of commissions that will be paid to an independent real
estate agent upon sale of the property. Revenue and expenses from
operations and changes in the valuation allowance are included in net
expenses from foreclosed assets.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.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. Although certain changes in assets and liabilities, such as
unrealized gains and losses on available-for-sale securities, are
reported as a separate component of the equity section of the balance
sheet, such items, along with net income, are components of
comprehensive income.The components of other comprehensive income and related tax effects
are as follows (000s omitted): 2003
    
    2002
    
    2001Net Unrealized gain (loss) on
available-for-sale securities
    
    $
    112
    
    
    $
    99
    
    
    $
    Tax Effect
    
    
    (37
    )
    
    
    (35
    )
    
    
    Net-of-tax amount
    
    $
    75
    
    
    $
    64
    
    
    $
    
  Earnings Per Common Share- Basic earnings per share represents
income available to common stockholders divided by the
weighted-average number of common share 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 solely to outstanding stock
options, 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. Earnings per share
data does not apply to the periods prior to the conversion, since the
Bank was a mutual savings bank with no stock outstanding. 11




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 1 - Summary of Significant Accounting Policies (Continued)  Earnings per share have been computed based on the following (000s
omitted): 2003Net Income
    
    $
    664Average number of common shares
outstanding
    
    
    2,314Effect of dilutive options and unvested restricted stock
    
    
    24Average number of common shares
outstanding used to calculate diluted
earnings per common share
    
    
    2,338
  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- In December 2002, the FASB issued SFAS No.
148, Accounting for Stock-Based Compensation-Transition and
Disclosure  an Amendment of FASB Statement No. 123. This statement
amends SFAS No. 123, Accounting for Stock-Based Compensation, to
provide alternative methods of transition for a voluntary change to
the fair value method of accounting for stock-based employee
compensation. In addition, this statement amends the disclosure
requirements of SFAS No. 123 to require more prominent disclosures
about the method of accounting for stock-based employee compensation
and the effect of the method used on reported results in both annual
and interim financial statements. This statement is effective for
financial statements for fiscal years ending after December 15, 2002.
As permitted by SFAS No. 148, the Bancorp will continue to apply the
provisions of APB Opinion No. 25, Accounting for Stock-Based
Compensation, for all employee stock opinion grants and has elected
to disclose pro forma net income and earnings per share amounts as if
the fair-value based method has been applied in measuring
compensation costs. In addition, the Bancorp is awaiting further
guidance and clarity that may result from current FASB and
International Accounting Standards Board (IASB) stock compensation
projects and will continue to evaluate any developments concerning
mandated, as opposed to optional, fair-value based expense
recognition. 12




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 1 - Summary of Significant Accounting Policies (Continued)  The Bancorps as reported and the pro forma information for the years
ended December 31: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 weighted average fair value of options granted was $1.83 per
option 2003. The fair value of each option grant is estimated on the
date of grant using the Black-Scholes option-pricing model with the
following assumptions used for grants in 2003: expected option lives
of five years; expected volatility of 4.0% and risk-free interest rate
of 3.0%. There were no stock options issued prior to 2003. 2003(Dollars in thousands, except per share data)As reported net income available to common shareholders
    
    $
    664less: additional stock-based compensation determined
under the fair value method, net of tax
    
    
    33$
    631As reported earnings per share
    
    $
    0.29Proforma earnings per share
    
    $
    0.27As reported earnings per diluted share
    
    $
    0.28Proforma earnings per diluted share
    
    $
    0.27
  Supplemental Cash Flow Information (000s omitted) December 31,2003
    
    2002
    
    2001Cash paid for:Interest
    
    $
    6,069
    
    
    $
    6,487
    
    
    $
    8,182Income taxes
    
    
    635
    
    
    
    583
    
    
    
    809Noncash investing activities -Loans transferred to real estate owned
    
    
    2,844
    
    
    
    1,936
    
    
    
    2,243
 13




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 2  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 Value2003Available-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
    
    
    $
    
    
    
    $
    3022002Available-for-sale securities:U.S. treasury obligations
    
    $
    3,310
    
    
    $
    28
    
    
    $
    
    
    
    $
    3,338U.S. government agency obligations
    
    
    10,246
    
    
    
    66
    
    
    
    
    
    
    
    10,312Obligations of states and
political subdivisions
    
    
    3,505
    
    
    
    5
    
    
    
    
    
    
    
    3,510Total available-for-sale securities
    
    $
    17,061
    
    
    $
    99
    
    
    $
    
    
    
    $
    17,160Held-to-maturity securities:Mortgage-backed securities
    
    $
    274
    
    
    $
    1
    
    
    $
    
    
    
    $
    275
 14




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 2 - Securities (Continued)  The amortized cost and estimated market values of securities at
December 31, 2003, 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
    
    $
    
    
    
    $
    
    
    
    $
    5,821
    
    
    $
    5,860Due in one through five years
    
    
    
    
    
    
    
    
    
    
    12,670
    
    
    
    12,755Due after five years through ten years
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Due after ten years
    
    
    286
    
    
    
    302
    
    
    
    
    
    
    
    Total
    
    $
    286
    
    
    $
    302
    
    
    
    18,491
    
    
    
    18,615Mortgage-backed securities
    
    
    
    
    
    
    
    
    
    
    1,045
    
    
    
    1,033Total available-for-sale securities
    
    
    
    
    
    
    
    
    
    $
    19,536
    
    
    $
    19,648
  Other securities, consisting primarily of restricted Federal Home Loan
Bank stock, are recorded at cost, which approximates market value. Note 3 - 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. 15




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 3 - Real Estate Investment - Limited Partnership (Continued)  Condensed financial information for the investee partnership is
summarized as follows (000s omitted): December 31,
    
    December 31,2003
    
    2002Balance Sheet:Cash
    
    $
    28
    
    
    $
    7Prepaid expenses
    
    
    18
    
    
    
    25Accounts receivable
    
    
    
    
    
    
    24Note receivable
    
    
    500
    
    
    
    500Loan to affiliates
    
    
    22
    
    
    
    Property and equipment
    
    
    9,266
    
    
    
    9,517Total assets
    
    $
    9,834
    
    
    $
    10,073Accounts payable
    
    $
    9
    
    
    $
    7Accrued liabilities
    
    
    76
    
    
    
    74Due to developer and affiliates
    
    
    989
    
    
    
    1,084Loans payable to
Monarch Community Bank
    
    
    1,384
    
    
    
    1,500Loans payable to others
    
    
    6,240
    
    
    
    6,475Partners equity
    
    
    1,136
    
    
    
    933Total liabilities and partners equity
    
    $
    9,834
    
    
    $
    10,073Operations -Net income (loss)
    
    $
    (470
    )
    
    $
    (131
    )
 16




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 4 - Loans  A summary of the balances of loans follows (000s omitted): December 31,2003
    
    2002Mortgage loans on real estate:One-to-four family
    
    $
    93,056
    
    
    $
    100,234Multi-family
    
    
    485
    
    
    
    172Commercial
    
    
    22,728
    
    
    
    17,801Construction or development
    
    
    9,451
    
    
    
    7,177Total real estate loans
    
    
    125,720
    
    
    
    125,384Consumer loans:Automobile
    
    
    1,546
    
    
    
    2,233Home equity
    
    
    9,613
    
    
    
    11,629Manufactured housing
    
    
    930
    
    
    
    1,274Other
    
    
    3,795
    
    
    
    4,655Total consumer loans
    
    
    15,884
    
    
    
    19,791Commercial business loans
    
    
    2,695
    
    
    
    2,130Subtotal
    
    
    144,299
    
    
    
    147,305Less: Allowance for loan losses
    
    
    2,618
    
    
    
    1,735Net deferred loan fees
    
    
    454
    
    
    
    406Loans in process
    
    
    2
    
    
    
    2Loans, net
    
    $
    141,225
    
    
    $
    145,162
 17




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 4 - Loans (Continued)  An analysis of the allowance for loan losses follows (000s omitted): December 31,2003
    
    2002
    
    2001Balance - Beginning
    
    $
    1,735
    
    
    $
    1,683
    
    
    $
    857Provision for loan losses
    
    
    1,266
    
    
    
    397
    
    
    
    1,039Loans charged-off
    
    
    (571
    )
    
    
    (568
    )
    
    
    (322
    )Recoveries of loans previously charged off
    
    
    188
    
    
    
    223
    
    
    
    109Balance - Ending
    
    $
    2,618
    
    
    $
    1,735
    
    
    $
    1,683
  The following is a summary of information pertaining to impaired loans
(000s omitted): December 31,2003
    
    2002Impaired loans with a valuation allowance
    
    $
    1,771
    
    
    $
    211Valuation allowance related to impaired loans
    
    $
    886
    
    
    $
    105Total non-accrual loans
    
    $
    3,619
    
    
    $
    1,638Total loans past-due ninety days or more and still accruing
    
    $
    127
    
    
    $
    1,317
  There are no impaired loans without a valuation allowance as of
December 31, 2003 and 2002 (000s omitted). December 31,2003
    
    2002
    
    2001Average investment in impaired loans
    
    $
    1,777
    
    
    $
    213
    
    
    $
    75
  Interest income recognized on impaired loans was not significant for
the years ended December 31, 2003, 2002, and 2001. No additional funds
are committed to be advanced in connection with impaired loans. 18




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 5 - Servicing  Loans serviced for others are not included in the accompanying
consolidated balance sheets. The unpaid principal balances of mortgage
loans serviced for others were $92,836,000, $80,798,000, and
$81,828,000 at December 31, 2003, 2002, and 2001, respectively.The fair value of mortgage servicing rights approximates $1,005,000
and $775,000 at December 31, 2003 and 2002, respectively. The fair
value was determined by discounting estimated net future cash flows
from mortgage servicing activities using an 8.0 percent discount rate
and estimated prepayment speeds 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, 2003, 2002, and 2001. There has
been no activity in the impairment valuation allowance during the
years ended December 31, 2003, 2002, and 2001.The following summarizes mortgage servicing rights capitalized and
amortized (000s omitted): December 31,2003
    
    2002
    
    2001Mortgage servicing rights - Beginning
    
    $
    428
    
    
    $
    432
    
    
    $
    326Mortgage servicing rights capitalized
    
    
    592
    
    
    
    361
    
    
    
    475Mortgage servicing rights - direct writedown for
loan payoffs
    
    
    (311
    )
    
    
    (312
    )
    
    
    (241
    )Mortgage servicing rights scheduled amortization
    
    
    (42
    )
    
    
    (53
    )
    
    
    (128
    )Mortgage servicing rights - Ending
    
    $
    667
    
    
    $
    428
    
    
    $
    432
 19




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 6 - Foreclosed Assets  Foreclosed assets consisted of the following (000s omitted): December 31,2003
    
    2002Real estate owned
    
    $
    1,095
    
    
    $
    886Real estate in judgment and
subject to redemption
    
    
    1,082
    
    
    
    1,136Total
    
    $
    2,177
    
    
    $
    2,022
  Expenses applicable to foreclosed assets include the following (000s
omitted): December 31,2003
    
    2002
    
    2001Net loss (gain) on sales of real estate
    
    $
    40
    
    
    $
    (1
    )
    
    $
    1Operating expenses
    
    
    114
    
    
    
    203
    
    
    
    158Total
    
    $
    154
    
    
    $
    202
    
    
    $
    159
 20




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 7 - Premises and Equipment  A summary of the cost and accumulated depreciation of premises and
equipment follows (000s omitted): December 31,DepreciableLife2003
    
    2002
    
    (in Years)Land
    
    $
    646
    
    
    $
    646Buildings and improvements
    
    
    4,524
    
    
    
    4,517
    
    
    30-40Furniture, fixtures and equipment
    
    
    2,994
    
    
    
    2,981
    
    
    5-7Total bank premises and equipment
    
    
    8,164
    
    
    
    8,144Less accumulated depreciation
and amortization
    
    
    3,996
    
    
    
    3,575Net carrying amount
    
    $
    4,168
    
    
    $
    4,569
 21




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 8 - Deposits  The following is a summary of interest bearing deposit accounts (000s
omitted): December 31,2003
    
    2002Balances by account type:Demand and NOW accounts
    
    $
    9,275
    
    
    $
    9,596Money market
    
    
    10,909
    
    
    
    9,868Passbook and statement savings
    
    
    15,889
    
    
    
    15,274Total transactional accounts
    
    
    36,073
    
    
    
    34,738Certificates of deposit:$100,000 and over
    
    
    19,132
    
    
    
    18,380Under $100,000
    
    
    47,852
    
    
    
    50,580Total certificates of deposit
    
    
    66,984
    
    
    
    68,960Total
    
    $
    103,057
    
    
    $
    103,698
 Generally, deposit amounts in excess of $100,000 are not federally
insured. 22




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 8  Deposits (Continued)  The remaining maturities of certificates of deposit outstanding are
as follows (000s omitted): December 31,2003Less than
    
    Greater thanYear
    
    $100,000
    
    $100,000Less than one year
    
    $
    23,846
    
    
    $
    9,387One to two years
    
    
    10,460
    
    
    
    5,509Two to three years
    
    
    5,828
    
    
    
    1,401Three to four years
    
    
    5,098
    
    
    
    2,035Four to five years
    
    
    2,620
    
    
    
    800Total
    
    $
    47,852
    
    
    $
    19,132
  The following is a summary of interest expense by deposit account type
(000s omitted): December 31,2003
    
    2002
    
    2001Demand and NOW accounts
    
    $
    79
    
    
    $
    146
    
    
    $
    200Money market
    
    
    135
    
    
    
    194
    
    
    
    275Passbook and statement savings
    
    
    137
    
    
    
    222
    
    
    
    369Certificates of deposit
    
    
    2,513
    
    
    
    2,763
    
    
    
    4,153Total deposit interest expense
    
    $
    2,864
    
    
    $
    3,325
    
    
    $
    4,997
 Note 9 - Federal Home Loan Bank Advances  The Corporation has fixed rate Federal Home Loan Bank advances of
$57,384,000 and $52,500,000 at December 31, 2003 and 2002,
respectively, which mature through 2013. At December 31, 2003 and
2002, the interest rates on fixed rate advances ranged from 3.34
percent to 6.62 percent and from 3.43 percent to 6.56 percent,
respectively. At December 31, 2003 and 2002, the weighted average
interest rates were 5.51 percent and 5.72 percent, respectively. The
Bank has no floating rate advances as of December 31, 2003 and 2002. 23




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 9 - Federal Home Loan Bank Advances (Continued)  The Corporation has provided a blanket pledge of all of the
Corporations residential mortgage loans as collateral for fixed
rate debt.The contractual maturities of advances are as follows (000s
omitted): December 31,2003Less than one year
    
    $
    One to two years
    
    
    4,000Two to three years
    
    
    7,000Three to four years
    
    
    6,000Four to five years
    
    
    20,000Thereafter
    
    
    20,384Total
    
    $
    57,384
 24




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 10  Income Taxes  Allocation of income taxes between current and deferred portions is
as follows (000s omitted): December 31,2003
    
    2002
    
    2001Current expense
    
    $
    580
    
    
    $
    520
    
    
    $
    579Deferred expense (recovery)
    
    
    (329
    )
    
    
    (105
    )
    
    
    (280
    )Total tax expense
    
    $
    251
    
    
    $
    415
    
    
    $
    299
  The reasons for the differences between the statutory federal income
tax rate and the effective tax rates are summarized as follows: Percent of Pretax IncomeDecember 31,2003
    
    2002
    
    2001Statutory federal tax rate
    
    
    34.0
    %
    
    
    34.0
    %
    
    
    34.0
    %Increase (decrease) resulting from:Nondeductible expenses
    
    
    8.9
    %
    
    
    2.4
    %
    
    
    0.3
    %Dividend received deduction
    
    
    (5.2
    %)
    
    
    (1.5
    %)
    
    
    (1.3
    %)Tax exempt income
    
    
    (4.8
    %)
    
    
    (0.2
    %)
    
    
    
    %Low income housing credit
    
    
    (8.4
    %)
    
    
    (2.7
    %)
    
    
    
    %Other
    
    
    2.9
    %
    
    
    (3.0
    %)
    
    
    (4.7
    %)Reported tax expense
    
    
    27.4
    %
    
    
    29.0
    %
    
    
    28.3
    %
 25




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 10  Income Taxes (Continued)  The components of the net deferred tax asset are as follows (000s
omitted): December 31,2003
    
    2002Deferred tax assets:Provision for loan losses
    
    $
    823
    
    
    $
    543Net deferred loan fees
    
    
    152
    
    
    
    138Deferred compensation
    
    
    211
    
    
    
    96Accrued employee benefits
    
    
    66
    
    
    
    40Other real estate
    
    
    32
    
    
    
    46Loans held for sale
    
    
    3
    
    
    
    15Other
    
    
    74
    
    
    
    33Total deferred tax assets
    
    
    1,361
    
    
    
    911Deferred tax liabilities:Depreciation
    
    
    26
    
    
    
    52Mortgage servicing rights
    
    
    227
    
    
    
    146Original issue discount
    
    
    102
    
    
    
    122Unrealized gain on available-for-sale securities
    
    
    38
    
    
    
    35Stock dividends
    
    
    50
    
    
    
    Other
    
    
    36
    
    
    
    Total deferred tax liabilities
    
    
    479
    
    
    
    355Net deferred tax asset
    
    $
    882
    
    
    $
    556
 Note 11  Off-Balance Sheet Activities  Credit Related Financial Instruments- The Corporation is a party to
credit related financial instruments with off-balance sheet risk in
the normal course of business to meet the financing need of its
customer. These financial instruments include commitments to extend
credit, and unfunded commitments under lines of credit. Such
commitments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the
consolidated balance sheets.The Corporations exposure to credit loss is represented by the
contractual amount of these commitments. The Corporation follows the
same credit policies in making commitments as it does for on-balance
sheet instruments. 26




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 11  Off-Balance Sheet Activities (Continued)  The following financial instruments were outstanding whose contract
amounts represent credit risk (000s omitted): Contract AmountDecember 31,2003
    
    2002Commitments to grant loans
    
    $
    
    
    
    $
    5,644Unfunded commitments under lines of credit
    
    
    8,892
    
    
    
    6,150
  The above commitments include fixed rate and variable rate loan
commitments and lines of credit with interest rates ranging between
4.00 percent and 8.25 percent at December 31, 2003, 4.25 percent and
9.00 percent at December 31, 2002.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.Employment Agreement- The Corporation has entered into an
employment agreement with its president and chief executive officer.
The agreement has a term of two years, with annual renewals upon
Board approval, that provides for annual base salary in an amount of
not less than $149,000. Also, in the unlikely event of a change of
control of the Corporation, following conversion, the president and
chief executive officer will receive a payment of approximately
$450,000. 27




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 12  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, 2003 and 2002 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, 2003 and 2002, that the Bank has met all of the capital
adequacy requirements to which they are subject.As of December 31, 2003, 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. 28




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 12  Regulatory Matters (Continued)  A reconciliation of the Banks equity to major categories of capital
is as follows (000s omitted): December 31,2003
    
    2002Equity per consolidated balance sheet
    
    $
    28,339
    
    
    $
    27,567Less: deferred tax asset and other
    
    
    (957
    )
    
    
    (612
    )Tangible and leverage capital
    
    
    27,382
    
    
    
    26,955Plus: Allowance for loan losses **
    
    
    1,477
    
    
    
    1,586Risk based capital
    
    $
    28,859
    
    
    $
    28,541
  **
    
    Limited to 1.25 percent of risk weighed assetsRegulatory 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, 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
    %Total risk-based capital
    
    
    28,859
    
    
    
    24.66
    %
    
    
    9,361
    
    
    
    8.00
    %
    
    
    11,701
    
    
    
    10.00
    %As of December 31, 2002:Tangible capital
    
    $
    26,955
    
    
    
    14.10
    %
    
    $
    2,868
    
    
    
    1.50
    %
    
    $
    5,737
    
    
    
    3.00
    %Leverage capital
    
    
    26,955
    
    
    
    14.10
    %
    
    
    7,651
    
    
    
    4.00
    %
    
    
    9,562
    
    
    
    5.00
    %Risk-based capital
    
    
    28,541
    
    
    
    22.53
    %
    
    
    10,136
    
    
    
    8.00
    %
    
    
    12,670
    
    
    
    10.00
    %
 29




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 13  Restrictions on Dividends, Loans and Advances  OTS regulations impose limitations upon all capital distributions
including cash dividends. The total amount of dividends which may
be paid is generally limited to the sum of the net profits of the
bank for the preceding three years. An application to and the
approval of the OTS is required prior to any capital distribution
if the institution does not meet the criteria for expedited
treatment of applications under OTS regulations. If an
application is not required, the institution must still provide
prior notice to the OTS of the 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 restricted. In addition, the OTS could prohibit a proposed
capital distribution by any institution, which would otherwise be
permitted by the regulation, if the OTS determines that such
distribution would constitute an unsafe or unsound practice. At
December 31, 2003, the Banks retained earnings available for the
payment of dividends totaled $2,520,000. Accordingly, $25,823,000
of the Corporations investment in the Bank was restricted at
December 31, 2003. Note 14  Retirement Plans  The Corporation is part of a non-contributory, multiple-employer
defined benefit pension plan covering substantially all employees.
The plan is administered by the trustees of the Financial
Institutions Retirement Fund. Because it is a multiple-employer
plan, there is no separate valuation of plan benefits or segregation
of plan assets specifically for the Corporation. During 2003, 2002
and 2001, the Corporation recognized pension expense for this plan
of $242,000, $192,000, and $156,000, 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 2003, 2002 and 2001, the Corporation
recognized pension expense for this plan of $54,000, $99,000, and
$96,000, 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 $338,000 and $283,000 at
December 31, 2003 and 2002, respectively. The expense for the plan
was $39,600, $52,000, and $92,000 for 2003, 2002, and 2001,
respectively. Note 15  Related Party Transactions  In the ordinary course of business, the Bank has granted loans to
principal officers and directors and their affiliates amounting to
$346,000 and $672,000 at December 31, 2003 and 2002, respectively.
During the year ended December 31, 2003, total principal additions
were $0 and total principal payments were $326,000.Deposits from related parties held by the Bank at December 31, 2003
and 2002 amounted to $1,340,000 and $1,379,000, respectively. 30




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Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 16  Fair Value of Financial Instruments  The fair value of a financial instrument is the current amount that
would be exchanged between willing parties, other than in a forced
liquidation. Fair value is best determined based upon quoted market
prices. However, in many instances, there are no quoted market
prices for the Corporations various financial instruments. In cases
where quoted market prices are not available, fair values are based
on estimates using present value or other valuation techniques.
Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows.
Accordingly, the fair value estimates may not be realized in an
immediate settlement of the instrument. SFAS 107 excludes certain
financial instruments and all nonfinancial instruments from its
disclosure requirements. Accordingly, the aggregate fair value
amounts presented may not necessarily represent the underlying fair
value of the Corporation.The following methods and assumptions were used by the Corporation
in estimating fair value disclosures for financial instruments:Cash and Cash Equivalents- The carrying amounts of cash and
short-term instruments approximate fair values. The carrying amounts
of interest-bearing deposits maturing within ninety days approximate
their fair values. Fair values of other interest-bearing deposits
are estimated using discounted cash flow analyses based on current
rates for similar types of deposits.Securities- Fair values for securities, excluding Federal Home Loan
Bank stock, are based on quoted market prices. The carrying value of
Federal Home Loan Bank stock approximates fair value based on the
redemption provisions of the Federal Home Loan Bank.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. 31




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 16  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 certain mortgage loans (e.g.,
one-to-four family residential) and other consumer loans are based
on quoted market prices of similar loans sold in conjunction with
securitization transactions, adjusted for differences in loan
characteristics. Fair values for other loans (e.g., commercial real
estate and investment property mortgage loans, commercial and
industrial loans) are estimated using discounted cash flow 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. 32




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Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 16  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 31,2003
    
    2002Carrying Amount
    
    Fair Value
    
    Carrying Amount
    
    Fair ValueAssets:Cash and cash equivalents
    
    $
    27,331
    
    
    $
    27,331
    
    
    $
    20,207
    
    
    $
    20,207Securities - Held to maturity
    
    
    286
    
    
    
    302
    
    
    
    274
    
    
    
    275Securities - Available for sale
    
    
    19,648
    
    
    
    19,648
    
    
    
    17,160
    
    
    
    17,160Other securities
    
    
    3,029
    
    
    
    3,029
    
    
    
    2,807
    
    
    
    2,807Real estate
investment - Limited
partnership, at equity
    
    
    1,415
    
    
    
    1,415
    
    
    
    1,554
    
    
    
    1,554Loans held for sale
    
    
    421
    
    
    
    429
    
    
    
    1,527
    
    
    
    1,570Net loans
    
    
    141,225
    
    
    
    144,755
    
    
    
    145,162
    
    
    
    148,133Accrued interest receivable
    
    
    976,167
    
    
    
    976,167
    
    
    
    1,078,698
    
    
    
    1,078,698Liabilities:Federal Home Loan Bank
advances
    
    
    57,384
    
    
    
    59,810
    
    
    
    52,500
    
    
    
    57,148Deposits
    
    
    107,240
    
    
    
    108,142
    
    
    
    106,744
    
    
    
    108,717Accrued interest payable
    
    
    274,887
    
    
    
    274,887
    
    
    
    284,569
    
    
    
    284,569
 Note 17  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 reported as unallocated common stock held by the
ESOP in the equity section of the balance sheet. As shares are
released they become outstanding for earnings per share
computations. 33




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Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 17  Employee Stock Ownership Plan (ESOP) (Continued)  The ESOP shares as of December 31 were as follows: 2003
    
    2002Allocated shares
    
    
    18,515
    
    
    
    Shares released for allocation
    
    
    18,515
    
    
    
    18,515Shares distributed during the year
    
    
    (1,233
    )
    
    
    Unreleased shares
    
    
    148,120
    
    
    
    166,635Total ESOP shares
    
    
    183,917
    
    
    
    185,150
  Total compensation expense applicable to the ESOP amounted to
approximately $258,000 and $211,000 for the years ended December 31,
2003 and 2002, respectively. Note 18  Stock Compensation Plans  The Corporation has a Recognition and Retention Plan 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. There were 3,700 shares forfeited during 2003 due to
employee termination. No shares vested in 2003. Compensation expense
of $148,000 was recognized under this plan during 2003.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 Bancorps
stock option grants equal the market price of the underlying stock on
the date of the grant, no compensation cost is recognized. 34




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##### Table of Contents



Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 18  Stock Compensation Plans (Continued)  A summary of the status of the Corporations stock option plan is
presented below (shares-000 omitted): 2003WeightedAverageExerciseShares
    
    PriceOutstanding at
beginning of year
    
    
    
    
    
    $
    Granted
    
    
    197
    
    
    
    13.00Exercised
    
    
    
    
    
    
    Forfeited
    
    
    14
    
    
    
    13.00Outstanding at end
of year
    
    
    183
    
    
    $
    13.00Exercisable at year-end
    
    
    
    
    
    
    
 Note 19  Subsequent Events  On September 2, 2003 the Corporation enter into a definitive
agreement to purchase all of the outstanding common shares of MSB
Financial, Inc., holding company for Marshall Savings Bank, FSB of
Marshall, Michigan. Under the terms of the agreement, MSB
shareholders will receive $15.04 per share in cash and the balance in
Monarch Community Bancorp, Inc. common stock for each share of MSB
common stock. The total cost to Monarch for this acquisition is
approximately $19.6 million in cash and $4.9 million in Monarch
common stock. MSB Financials shareholders approved the proposed
purchase at its annual meeting on January 22, 2004. Monarch has filed
an application with the Office of Thrift Supervision (OTS) seeking
approval for the proposed purchase. As of the statement date OTS has
not completed its review of the application. Management anticipates
OTS approval and expects the purchase to be completed late in the
first quarter or early in the second quarter of 2004. 35




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Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 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 31,2003
    
    2002AssetsCash
    
    $
    6,410
    
    
    $
    7,612Investments
    
    
    2,288
    
    
    
    1,763Investment in Monarch Community Bank
    
    
    28,332
    
    
    
    27,567Other assets
    
    
    417
    
    
    
    13Total assets
    
    $
    37,447
    
    
    $
    36,955Liabilities and Stockholders EquityAccrued expenses
    
    $
    17
    
    
    $
    6Stockholders equity
    
    
    37,430
    
    
    
    36,949Total liabilities and stockholders equity
    
    $
    37,447
    
    
    $
    36,955
 36




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Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 20  Condensed Financial Statements of Parent Company (Continued)  Condensed Statement of Income (000s omitted) December 31,
    
    December 31,2003
    
    2002Income - Interest on investments
    
    $
    120
    
    
    $
    65Operating expense
    
    
    220
    
    
    
    48Income
(loss) - Before equity in undistributed
net income of subsidiary
    
    
    (100
    )
    
    
    17Equity in undistributed net income of subsidiary
    
    
    764
    
    
    
    997Net income
    
    $
    664
    
    
    $
    1,014
 37




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Monarch Community Bancorp, Inc. and Subsidiaries Notes to Consolidated Financial StatementsDecember 31, 2003, 2002 and 2001 Note 20  Condensed Financial Statements of Parent Company (Continued)  Condensed Statements of Cash Flows (000s omitted) December 31,
    
    December 31,2003
    
    2002Cash flows from operating activities:Net income
    
    $
    664
    
    
    $
    1,014Adjustments to reconcile net income to net cash
provided by operating activities:Amortization
    
    
    34
    
    
    
    Allocation of ESOP
    
    
    282
    
    
    
    211Increase in other assets
    
    
    (404
    )
    
    
    (13
    )Increase in accrued expenses
    
    
    11
    
    
    
    6Undistributed net income of subsidiary
    
    
    (764
    )
    
    
    (997
    )Net cash provided by operating activities
    
    
    (177
    )
    
    
    221Cash flows from investing activities:Purchase of subsidiary stock
    
    
    
    
    
    
    (11,141
    )Purchase of securities
    
    
    (624
    )
    
    
    (1,763
    )Proceeds from maturities of securities
    
    
    75
    
    
    
    Loan to employee ESOP plan
    
    
    
    
    
    
    (1,852
    )Net cash used in investing activities
    
    
    (549
    )
    
    
    (14,756
    )Cash flows from financing activities:Proceeds from issuance of common stock
    
    
    
    
    
    
    22,147Dividends paid
    
    
    (476
    )
    
    
    Net cash used in financing activities
    
    
    (476
    )
    
    
    22,147Net increase in cash
    
    
    (1,202
    )
    
    
    7,612Cash at beginning of year
    
    
    7,612
    
    
    
    Cash at end of year
    
    $
    6,410
    
    
    $
    7,612
 38




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ITEM 8.
    Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure There has been no Current Report on Form 8-K filed within 24 months prior
to the date of the most recent financial statements reporting a change of
accountants and/or reporting disagreements on any matter of accounting
principle or financial statement disclosure. 
 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, 2003 was
carried out under the supervision and with the participation of the
Registrants Chief Executive Officer, Chief Financial Officer and several other
members of the Registrants senior management. The Registrants Chief Executive
Officer and Chief Financial Officer concluded that the Registrants disclosure
controls and procedures as currently in effect are effective in ensuring that
the information required to be disclosed by the Registrant in the reports it
files or submits under the Exchange Act is (i) accumulated and communicated to
the Registrants management (including the Chief Executive Officer and Chief
Financial Officer) in a timely manner, and (ii) recorded, processed, summarized
and reported within the time periods specified in the Security and Exchange
Commissions rules and forms. There have been no changes in our internal
control over financial reporting (as defined in Rule 13a-15(f) of the Exchange
Act) that occurred during the quarter ended December 31, 2003, that have
materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting. The Registrant intends to continually review and evaluate the design and
effectiveness of its disclosure controls and procedures and to improve its
controls and procedures over time and to correct any deficiencies that it may
discover in the future. The goal is to ensure that senior management has timely
access to all material financial and non-financial information concerning the
Registrants business. While the Registrant believes the present design of its
disclosure controls and procedures is effective to achieve its goal, future
events affecting its business may cause the Registrant to modify its disclosure
controls and procedures.




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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 2004, 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 2004, 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 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 2004,
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, 2003. 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)
    
    
    183,721
    
    
    
    13.00
    
    
    
    55,117Equity 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 2004, 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 and Reports on Form 8-K  (a)
    
    ExhibitsSee the index to exhibits(b)
    
    Reports on Form 8-K (1) On September 5, 2003 the Registrant filed a Current Report on Form 8-K
related to its announcement of its proposed purchase of MSB Financial, Inc.
pursuant to which MSB Financial, Inc. will be merged with and into Registrant. (2) On September 26, 2003 the Registrant filed a current report on Form
8-K related to the execution of an Amended and Restated Agreement and Plan of
Merger to make certain technical revisions to the previously executed Agreement
and Plan of Merger. 
 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 2004, 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, 2004
    
    By:
    
    /s/ John R. SchrollJohn R. Schroll, President andChief 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/ John R. Schroll
John R. Schroll
    
    President and Chief Executive Officer(Principal Executive Officer)
    
    March 18, 2004/s/ Frank M. Tripp
Frank M. Tripp
    
    Chairman of the Board
    
    March 18, 2004/s/ William C. Kurtz
William C. Kurtz
    
    Senior Vice President and Chief
Financial Officer(Principal Accounting Officer)
    
    March 18, 2004/s/ Harold A. Adamson
Harold A. Adamson
    
    Director
    
    March 18, 2004/s/ Lauren L. Bracy
Lauren L. Bracy
    
    Director
    
    March 18, 2004/s/ James R. Vozar
James R. Vozar
    
    Director
    
    March 18, 2004/s/
Stephen M. Ross
Stephen M. Ross
    
    Director
    
    March 18, 2004/s/ Gordon L. Welch
Gordon L. Welch
    
    Director
    
    March 18, 2004/s/ Craig W. Dally
Craig W. Dally
    
    Director
    
    March 18, 2004




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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 Bank and John R.
Schroll
    
    
    *10.2
    
    Severance Agreement between Monarch Community Bank and William C. Kurtz
    
    
    10.210.3
    
    Registrants Employee Stock Ownership Plan
    
    
    *10.4
    
    Registrants 2003 Stock Option and Incentive Plan
    
    
    **10.5
    
    Registrants Recognition and Retention Plan
    
    
    **11
    
    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 by reference**
    
    Filed on March 19, 2003 as part of Registrants Schedule 14A (File No.
000-49814), and incorporated by reference