Macatawa Bank (MCBC) is a $185M market cap plain vanilla regional bank based in Holland, Michigan (in Western Michigan near Grand Rapids). It has poor asset quality and trades at a very high valuation compared to some of its Michigan peers. I believe the regulators will force them to take a large charge for bad loans in Q2/08, which could send the stock down 50% or more, where it would trade in line with its peers.

I would encourage you to look at two of Macatawa’s peers, both of whom have gotten killed in the last year: cross town rival Mercantile Bancorp (MCBC) and Citizens Republic (CRBC), based further east in the Detroit suburb of Flint. Asset quality at all three banks is bad, but MCBC’s is actually the worst. See the table below for a brief comparison of the three:

Recent results across the banking universe have demonstrated pretty conclusively that construction loans are very high risk. MCBC has roughly $1.8B in total loans, of which $334M is construction ($334M). This portfolio has been responsible for much of MCBC’s current bad loans. I believe this will continue to worsen and ultimately cause Macatawa to report a large loss in Q2/08 (the regulators will probably force them to build reserves). The current consensus is $0.06, with a $0.04 to $0.08 range, so I do not think a loss is really baked into the stock, even though some of the sell-side analysts I have spoken with would not be surprised.

I believe this loss plus a potential cut in the dividend (CRBC just cut its dividend to zero) will spark a large decline in the stock, closer to 50% of tangible book, implying downside of over 50%.

MCBC’s Q1/08 results were a joke. They reported $0.14 of EPS, beating the $0.02 consensus. Bad loans increased by 5% (from a very high base) to $84M. Net charge-offs (which is the amount of bad loans that a bank writes off; please note that from an accounting perspective this does not impact earnings and only reduces a banks loan loss reserves, which is a contra-asset on the balance sheet (it reduces gross loans)) were $4.2M (0.95% of total loans) while loan loss provisions (which is what hits earnings and increases loan loss reserves) were only $2.7M. In this environment, for a bank to report provisions less than charge-offs while the amount of bad loans is increasing is unacceptable. (What are the regulators thinking?!) If we adjust the provision to match charge-offs (and exclude a non-core derivates gain of $0.8M), EPS would have been $0.05 per share. You could argue that the provisions should be much high than charge-offs given that loan loss reserves of $32M are only a fraction of their $84M in bad loans. I believe they will have to come to terms with this in 2Q/08. I would not be surprised to see a provision of nearly $10M, which would lead to a loss of roughly $0.20 per share.

To conclude, Macatawa is a plain vanilla bank based in recessionary Michigan trading at 1.1 times tangible book and 20 times forward consensus earnings, putting it at a substantial premium to some of its direct peers with similar profiles. I believe a reported loss for the upcoming quarter plus a potential cut in the dividend will spark a large decline in the price. The stock was difficult to short for several months, but it has eased up recently.

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