ANNUAL
      REPORT TO SHAREHOLDERS
                      FOR
      THE YEAR ENDED
                      DECEMBER
      31, 2008
                      
                      
                      
                      
                      MAINSTREET
      FINANCIAL CORPORATION
                      629 West State Street, Hastings
      Michigan 49058-1643
                      (269) 945-9561
                      www.mainstreetsavingsbank.com
  
  
  TABLE
OF CONTENTS
 
 
 
 
 
 
 
 A
      Message from the President
                1Selected
      Consolidated Financial Information
                2Corporate
      Information
                4Shareholder
      Information
                5Management's
      Discussion and Analysis of FinancialCondition
      and Results of Operations
                6Index
      to Consolidated Financial Statements
                21
 
 
 
 
 
 
 
  
  A
Message from the President
 
 
 Dear
Fellow Shareholders:
 
 As we
enter 2009, we remain extremely frustrated with the circumstances that confront
us.  The deepening recession and the very weak housing market continue
to severely limit new lending opportunities and have significantly increased
loan delinquencies and defaults.  It appears likely that this
environment will continue through 2009, and possibly beyond.  On a
positive note, short term interest rates continued to decline during 2008 due to
aggressive actions by the Federal Reserve Board of Governors.  This
normalization of the interest rate yield curve to a more traditional, positive,
slope is favorably impacting the Bank’s net interest margin.
 
 The Board
of Directors and Senior Management continue to progressively pursue strategies
to strengthen the Bank.  We remain hopeful that the traditional
strength of the southwest Michigan market will eventually produce an economic
recovery that will reinvigorate our primary market area, stabilize property
values and increase lending opportunities with both new and existing
customers.
 
 We
continue to be proud of the heritage and reputation of our sole subsidiary,
MainStreet Savings Bank.  It is an organization built on providing
very high quality customer service and the financial products and services
expected from a true “community” bank.  We say with pride “It’s How We
Bank Here”.
 
 We
appreciate your patience, understanding and support as we work through these
challenging times.
 
 Sincerely,
 
 /s/ David
L. Hatfield
 
 David L.
Hatfield
 President,
Chief Executive Officer
 and
Director
  1
  SELECTED
CONSOLIDATED FINANCIAL INFORMATION
  
 The
summary information presented below under “Selected Financial Condition Data”
and “Selected Operations Data” for, and as of the end of, each of the years
ended December 31, 2008, 2007 and 2006 is derived from our audited financial
statements.  The following information is only a summary, and you
should read it in conjunction with our audited financial statements and notes
beginning page F-1.
  
 At
      December 31,2008
                  
                  
                  2007
                  
                  
                  2006Selected Balance Sheet
Data:Total
      assets
                  
                  $
                  111,808
                  
                  
                  $
                  115,028
                  
                  
                  $
                  114,543Loans,
      net
                  
                  
                  93,880
                  
                  
                  
                  100,150
                  
                  
                  
                  100,653Securities
      available for sale, at fair value
                  
                  
                  1,585
                  
                  
                  
                  1,924
                  
                  
                  
                  2,088Federal
      Home Loan Bank stock
                  
                  
                  1,785
                  
                  
                  
                  1,589
                  
                  
                  
                  1,589Deposits
                  
                  
                  69,407
                  
                  
                  
                  79,405
                  
                  
                  
                  82,701Federal
      Home Loan Bank advances
                  
                  
                  35,700
                  
                  
                  
                  26,400
                  
                  
                  
                  21,400Other
      borrowings
                  
                  
                  700
                  
                  
                  
                  700
                  
                  
                  
                  700Equity
                  
                  
                  5,202
                  
                  
                  
                  7,154
                  
                  
                  
                  8,599
 
  
 For
      the year ended December 31,2008
                  
                  
                  2007
                  
                  
                  2006(In
      thousands)Selected Operations Data:Total
      interest
      income
                  
                  $
                  6,167
                  
                  
                  $
                  6,888
                  
                  
                  $
                  6,516Total
      interest
      expense
                  
                  
                  3,440
                  
                  
                  
                  4,377
                  
                  
                  
                  3,938Net
      interest
      income
                  
                  
                  2,727
                  
                  
                  
                  2,511
                  
                  
                  
                  2,578Provision
      for loan
      losses
                  
                  
                  930
                  
                  
                  
                  258
                  
                  
                  
                  162Net
      interest income after provision for loan losses
                  
                  
                  1,797
                  
                  
                  
                  2,253
                  
                  
                  
                  2,416Fees
      and service
      charges
                  
                  
                  389
                  
                  
                  
                  389
                  
                  
                  
                  396Loss
      on securities.......................................
                  
                  
                  (282
                  )
                  
                  
                  ---
                  
                  
                  
                  ---Gain
      on sales of
      loans
                  
                  
                  31
                  
                  
                  
                  22
                  
                  
                  
                  40Gain
      (loss) on sale of repossessed assets
                  
                  
                  (37
                  )
                  
                  
                  49
                  
                  
                  
                  (57
                  )Other
      non-interest
      income
                  
                  
                  47
                  
                  
                  
                  31
                  
                  
                  
                  49Total
      non-interest income
                  
                  
                  148
                  
                  
                  
                  491
                  
                  
                  
                  428Total
      non-interest
      expense
                  
                  
                  3,927
                  
                  
                  
                  3,653
                  
                  
                  
                  3,469Income
      (loss) before
      taxes
                  
                  
                  (1,982
                  )
                  
                  
                  (909
                  )
                  
                  
                  (625
                  )Income
      tax expense (benefit)
                  
                  
                  ---
                  
                  
                  
                  437
                  
                  
                  
                  (209
                  )Net
      income
      (loss)
                  
                  $
                  (1,982
                  )
                  
                  $
                  (1,346
                  )
                  
                  $
                  (416
                  )
 
  
 
 2
 
   
 For
      the year ended December 31,2008
                          
                          
                          2007Selected Financial Ratios and Other
      Data:Performance
      ratios:Return
      on assets (ratio of net income to average total assets)
                          
                          
                          (1.87
                          )%
                          
                          
                          (1.20
                          )%Return
      on equity (ratio of net income to average equity)
                          
                          
                          (39.48
                          )%
                          
                          
                          (19.99
                          )%Interest
      rate spread informationAverage
      during period
                          
                          
                          2.58
                          %
                          
                          
                          2.38
                          %Net
      interest margin(1)
                          
                          
                          2.71
                          %
                          
                          
                          2.45
                          %Non-interest
      income to operating revenue
                          
                          
                          5.44
                          %
                          
                          
                          19.57
                          %Operating
      expense to average total assets
                          
                          
                          3.70
                          %
                          
                          
                          3.25
                          %Average
      interest-earning assets to average interest-bearing
      liabilities
                          
                          
                          103.23
                          %
                          
                          
                          101.42
                          %Efficiency
      ratio(2)
                          
                          
                          136.60
                          %
                          
                          
                          121.68
                          %Asset
      quality ratios:Non-performing
      assets to total assets at end of period
                          
                          
                          4.65
                          %
                          
                          
                          2.56
                          %Non-performing
      loans to total loans
                          
                          
                          3.55
                          %
                          
                          
                          2.02
                          %Allowance
      for loan losses to non-performing loans
                          
                          
                          25.75
                          %
                          
                          
                          25.02
                          %Allowance
      for loan losses to loans receivable, net
                          
                          
                          0.91
                          %
                          
                          
                          0.51
                          %Net
      charge-offs to average loans outstanding
                          
                          
                          0.57
                          %
                          
                          
                          0.30
                          %Capital
      Ratios:Equity
      to total assets at end of period
                          
                          
                          4.65
                          %
                          
                          
                          6.23
                          %Average
      equity to average assets
                          
                          
                          4.73
                          %
                          
                          
                          5.99
                          %Other
      data:Number
      of full service offices(3)
                          
                          
                          3
                          
                          
                          
                          3
  ____________________
                  (1)Net
      interest income divided by average interest-earning assets.
                  (2)Total
      non-interest expense as a percentage of net interest income and total
      other non-interest income.
                  
                  (3)One
      of our full-service offices was closed in early 2009.
  3
  MAINSTREET
FINANCIAL CORPORATION
 CORPORATE
INFORMATION
 
 
 MainStreet Financial
Corporation is incorporated under federal law to hold all of the stock of
MainStreet Savings Bank, FSB and is subject to regulation by the OTS as a
savings association holding company.  Our principal business is
operating our wholly owned subsidiary, MainStreet Savings Bank, FSB.At December
31, 2008, our principal assets, on an unconsolidated basis, were all of the
outstanding shares of common stock of MainStreet Savings Bank, FSB and $101,000
in cash, and we had a $700,000 loan from a commercial bank.  In
addition, our employee stock ownership plan has a $227,000 loan from the same
bank.  Our principal executive offices are located at 629 W. State
Street, Hastings, Michigan 49058-1643 and our telephone number is (269)
945-9561.
  MainStreet Savings Bank, FSB
is a federally chartered savings bank with two full service banking
offices.  It is a community oriented institution primarily engaged in
attracting retail deposits from the general public and originating one- to
four-family residential loans in its primary market area, including construction
loans and home equity lines of credit.  MainStreet Savings Bank, FSB
also originates a limited amount of construction or development, consumer and
commercial loans.  The executive offices of MainStreet Savings Bank,
FSB are located at 629 W. State Street, Hastings, Michigan 49058-1643, and its
telephone number is (269) 945-9561.  It also operates branch offices
at 802 Fourth Avenue, Lake Odessa, Michigan and at Felpausch Food Center, 127 S.
Michigan Avenue, Hastings Michigan, and a loan production office at Cornerstone
Building, Suite 2, 407 West Michigan Avenue, Kalamazoo, Michigan.
  Board of Directors
      of
                MainStreet
      Financial Corporation and
                MainStreet
      Savings Bank, FSB
                
                Gordon
      F. Fuhr,  Chairman
                Retired
                David
      L. Hatfield
                President,
      MainStreet Savings Bank, FSB
                Eric
      T. Dreisbach
                Owner and Manager, Dreisbach
      Pontiac-GMC
                Mary
      Lou Hart
                Marketing
      Representative, WBCH radio
                David
      L. Jasperse
                Pharmacist
      and Owner, Bosley Pharmacy
                Carl
      A. Schoessel
                Retired
                James
      R. Toburen
                Senior
      Vice President, MainStreet Savings
                Bank,
      FSB
              
              Executive
      Officers of
                MainStreet
      Financial Corporation and
                MainStreet
      Savings Bank, FSB
                
                David
      L. Hatfield
                President
      and Chief Executive Officer
                James
      R. Toburen
                Senior
      Vice President, Treasurer and Chief
                Financial
      Officer
                Melody
      K. Bowman
                Senior
      Vice President, Real Estate and ConsumerLending
                Sandra
      K. Nichols
                Senior
      Vice President, Operations and InformationTechnology and
      Secretary
                Patricia
      L. Woods
                Senior
      Vice President, Branch and DepositServicing OperationsIndependent Auditors
                
                Crowe
      Horwath, LLP
                55
      Campau Avenue, N.W.
                Suite
      300
                Grand
      Rapids, MI   49503-2642
              
              Special Counsel
                
                Silver, Freedman & Taff, L.L.P.
                3299
      K Street, N.W., Suite 100
                Washington, D.C.  20007
  4
  MAINSTREET
FINANCIAL CORPORATION
 SHAREHOLDER
INFORMATION
  Annual
      Meeting
                  
                  The
      Annual Meeting of Shareholders of MainStreet Financial Corporation will be
      held at our main office located at 629 W. State Street, Hastings, Michigan
      49058-1643, on May 19, 2009, at 7:00 p.m. local time.
                
                
                Annual
      And Other Reports
                  
                  A
      copy of our Annual Report on Form 10-K for the year ended December
      31, 2008, as filed with the Securities and Exchange Commission, may be
      obtained without charge by contacting James R. Toburen, MainStreet
      Financial Corporation, 629 W. State Street, Hastings, Michigan
      49058-1643.
 
 Price
      Range Of Common Stock and DividendsHigh
                      
                      
                      Low
                      
                      DividendsFiscal
      2008First
      Quarter
                      
                      
                      $6.30
                      
                      
                      
                      $5.60
                      
                      NoneSecond
      Quarter
                      
                      
                      $6.20
                      
                      
                      
                      $1.50
                      
                      NoneThird
      Quarter
                      
                      
                      $3.10
                      
                      
                      
                      $2.25
                      
                      NoneFourth
      Quarter
                      
                      
                      $3.10
                      
                      
                      
                      $0.15
                      
                      NoneFiscal
      2007First
      Quarter
                      
                      
                      $11.00
                      
                      
                      
                      $9.65
                      
                      NoneSecond
      Quarter
                      
                      
                      $10.00
                      
                      
                      
                      $9.25
                      
                      NoneThird
      Quarter
                      
                      
                      $9.40
                      
                      
                      
                      $9.01
                      
                      NoneFourth
      Quarter
                      
                      
                      $9.25
                      
                      
                      
                      $5.55
                      
                      None
 
 
 Our
      stock price reflects the high and low bid information for each
      period.  The stock price information set forth in the table
      above was provided by the Yahoo Finance System and is based on OTC
      quotations.  The closing price of our common stock on March 17,
      2009 was $0.31.
                  
                  Our
      board of directors currently does not intend to pay cash dividends on its
      common stock, and no assurances can be given that any dividends will be
      paid in the future.Shares
      Outstanding
                  
                  At
      March 17, 2009 there were 756,068 shares of MainStreet Financial
      Corporation common stock outstanding (including unallocated ESOP shares)
      and there were approximately 110 holders of record.
                
                
                Stock
      Listing
                  
                  MainStreet
      Financial Corporation common stock is traded on the OTC Bulletin Board
      under the symbol "MSFN.OB."Stockholders
      and General Inquiries
                  
                  MainStreet
      Financial Corporation files an annual report on Form 10-K and three
      quarterly reports on Form 10-Q with the Securities and Exchange
      Commission.  Copies of these forms are available by request and
      at www. sec.gov in EDGAR filings.  Requests for these reports,
      as well as inquiries from shareholders, analysts and others seeking
      information about MainStreet Financial Corporation should be directed to
      James R. Toburen, Senior Vice President, at 629 W. State Street, Hastings,
      Michigan 49058-1643, telephone (269) 945-9561.
                
                
                Transfer
      Agent
                  
                  Shareholders
      should direct inquiries concerning their stock, including requests to
      change name, address or ownership or consolidate accounts and reports
      of  lost certificates to our transfer agent at 800-368-5948 or
      write:
                  
                  Registrar
      and Transfer Co.
                  10
      Commerce Drive
                  Cranford,
      NJ  07016
                  (800)
      368-5948
   5
  MANAGEMENT’S
DISCUSSION AND ANALYSIS OF
 FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
  
 Overview
and Recent Regulatory Matters
  In 2008
and 2007, the Company’s earnings were negatively impacted by rising short-term
interest rates, which had increased interest expense through mid-year, the flat
yield curve, which reduced interest margins, and the slower economy in southwest
Michigan, which significantly reduced loan demand and increased loan
delinquencies and associated losses.  We have continued to experience
operating losses in 2008, which reduced our capital.  Our net loss of
$1,982,000 for the year ended December 31, 2008, includes a $930,000 loan loss
provision which recognizes the economic downturn in our market
area.  The remainder of the net loss for 2008 is largely attributable
to the continuing slowdown in the Michigan economy and the flat yield
curve.  This declining economy has caused an increase in our
non-performing assets.
  As a
result of the Bank’s continuing operating losses and declining capital levels,
it became adequately capitalized under prompt corrective action regulations of
the Office of Thrift Supervision (“OTS”) as of June 30, 2008.  We
anticipate that the Bank will continue to experience operating losses in 2009,
which will continue to reduce its capital level.  As a result, the
Bank may become undercapitalized under the OTS prompt corrective action
regulations, which would subject it to additional regulatory limits and
requirements and would require the Company to provide a partial capital
guarantee for the Bank.  The Company may not be able to fulfill such a
requirement.
  Primarily
as a result of the continuing operating losses, our subsidiary, MainStreet
Savings Bank, FSB (the “Bank’) received a letter from the OTS dated February 5,
2008, stating that the Bank is deemed to be in troubled condition, and, as a
result, is subject to specified operating restrictions.  These
operating restrictions provide that: (1) the Bank must limit its quarterly asset
growth to net interest credited on deposit liabilities during the quarter
(unless additional asset growth is permitted by the OTS); (2) the Bank must
obtain prior OTS approval prior to appointing any new director or senior
executive officer; (3) the Bank’s ability to enter into certain severance
agreements or make certain severance payments is limited by 12 C.F.R. § 359; (4)
the Bank must receive OTS approval of any new, renewed or amended arrangements
providing compensation or benefits to its directors and officers; (5) the Bank
must obtain OTS approval of all third-party contracts outside the normal course
of business; and (6) the Bank must provide the OTS with 30-days notice of all
proposed transactions with affiliates.
  Effective
April 4, 2008, the Bank entered into a supervisory agreement to address the
OTS’s concerns regarding the financial condition of the Bank.  Among
other things, the supervisory agreement with the OTS requires the Bank to: (1)
prepare and submit a three-year business plan; (2) revise its liquidity
management policy; (3) enhance compliance training; (4) prepare and submit
quarterly reports on classified assets; and (5) continue to abide by the limits
in the February 5, 2008 “troubled condition” letter.
  The
continuing decline in the Bank’s capital since the execution of the supervisory
agreement could result in the OTS pursuing additional enforcement and regulatory
actions against the Bank and Company.  Unless the Bank is acquired or
receives a significant capital infusion, in 2009, such additional actions could
include placing the Bank in receivership.
  The
principal business of MainStreet Financial Corporation (“Company”) is operating
our wholly owned subsidiary, MainStreet Savings Bank (“Bank”).  The
Bank is a community oriented institution primarily engaged in attracting retail
deposits from the general public and originating one- to four-family residential
loans in its primary market area, including construction loans and home equity
lines of credit.  The Company is in a mutual holding company structure
and 53% of its stock is owned by MainStreet Financial Corporation, MHC
(“MHC”).
 
 Our
results of operations depend primarily on our net interest
income.  Net interest income is the difference between the interest
income we earn on our interest-earning assets, consisting primarily of loans,
investments and mortgage-backed securities, and the interest we pay on our
interest-bearing liabilities, consisting of savings and checking accounts, money
market accounts, time deposits and borrowings.  Our results of
operations also are affected by our provision for loan losses, non-interest
income and non-interest expense.  As a result of the slower economy,
declining household net worth
   6
   and an
overall decline in consumer and business activity, loan originations have
decreased.  Non-interest income consists primarily of service charges
on deposit accounts, transaction fees and commissions from investment
services.  Non-interest expense consists primarily of salaries and
employee benefits, occupancy, equipment and data processing, advertising and
other costs.  Our results of operations also may be affected
significantly by general and local economic and competitive conditions, changes
in market interest rates, governmental policies and actions of regulatory
authorities.
 
 During
2008, the Company’s earnings continued to be negatively impacted by decreased
interest income, due to a lower volume of loan originations and the slower
economy in southwest Michigan.  The economic environment significantly
reduced loan demand and increased loan delinquencies and associated losses,
particularly due to decreased property values.  We experienced a
$1,982,000 loss during 2008, which reduced our capital.  This
continuing weak economy has caused a $950,000 increase in other real estate
owned during the year ended December 31, 2208.  During 2008,
$1,608,000 in delinquent real estate loans were converted to other real estate
owned, as compared to only $1,018,000 during 2007.  We experienced a
$37,000 loss on the sale of repossessed properties 2008, compared to a $50,000
gain during 2007.
 
 The
allowance for loan losses has increased to $858,000 at December 31, 2008 from
$508,000 at December 31, 2007.  The increase during the year is the
result of a $930,000 provision for loan losses and recoveries of $18,000 less
charge-offs of $598,000.  These charge offs include a $36,000 loss
attributable to the sale of property by a borrower, which was security for a
delinquent land development loan.  Additionally, there were $362,000
in write downs experienced on eight other real estate properties, either held in
redemption or real estate owned, which are currently listed or in the process of
being listed for sale by the bank.  Charge offs totaling $80,000 on 14
consumer loans, eight of which were unsecured and six secured by collateral are
in the process of being repossessed, a $13,000 charge off on a commercial loan
secured by a vehicle, an $18,000 charge off of a second mortgage where the value
was not enough to satisfy both liens and an $89,000 charge off of a mortgage
that was later deemed unsecured due to a lien
imperfection.  Management believes the allowance at December 31, 2008
is adequate given the collateralization of delinquent and non-performing
loans.
 
 Difficult
market conditions and economic trends have adversely affected our industry and
our business.
 
 Dramatic
declines in the housing market, with decreasing home prices and increasing
delinquencies and foreclosures, have negatively impacted the credit performance
of mortgage and construction loans and resulted in significant writedowns of
assets by many financial institutions.  General downward economic
trends, reduced availability of commercial credit and increasing unemployment
have negatively impacted the credit performance of commercial and consumer
credit, resulting in additional writedowns.  Concerns over the
stability of the financial markets and the economy have resulted in decreased
lending by financial institutions to their customers and to each
other.  This market turmoil and tightening of credit has led to
increased commercial and consumer deficiencies, lack of customer confidence,
increased market volatility and widespread reduction in general business
activity.  Southwestern Michigan has experienced the adverse impact of
these economic trends more significantly than most of the country for over three
years.  Financial institutions have experienced decreased access to
deposits or borrowings.  Our access to Federal Home Loan Bank advances
has decreased in recent months as the required collateral level has
increased.
 
 The
resulting economic pressure on consumers and businesses and the lack of
confidence in the financial markets has adversely affected our business,
financial condition, results of operations and stock price.
 
 Our
ability to assess the creditworthiness of customers and to estimate the losses
inherent in our credit exposure is made more difficult and complex under these
difficult market and economic conditions.  We also expect to face
increased regulation and government oversight as a result of these downward
trends.  This increased government action may increase our costs and
limit our ability to pursue certain business opportunities.  We also
may be required to pay even higher FDIC premiums than the recently increased
level, because financial institution failures resulting from the depressed
market conditions have and may continue to deplete the insurance fund of the
FDIC and reduce the FDIC’s ratio of reserves to insured deposits.
 
 We do not
expect these difficult conditions to likely improve in the near
future.  A worsening of these conditions would likely exacerbate the
adverse effects of these difficult market and economic conditions on us, our
customers and the other financial institutions in our market.  We
expect to experience continued increases in foreclosures, delinquencies and
   7
   customer
bankruptcies, as well as more restricted access to funds, all of which will
result in our continued operating losses and declining capital.
 
 Recent
legislative and regulatory initiatives to address these difficult market and
economic conditions may not stabilize the U.S. banking system.
 
 The
recently enacted Emergency Economic Stabilization Act of 2008 (“EESA”)
authorizes the Treasury Department to purchase from financial institutions and
their holding companies up to $700 billion in mortgage loans, mortgage-related
securities and certain other financial instruments, including debt and equity
securities issued by financial institutions and their holding companies in a
troubled asset relief program (”TARP”).  The purpose of TARP was to
restore confidence and stability to the U.S. banking system and to encourage
financial institutions to increase their lending to customers and to each
other.  The Treasury Department has allocated $250 billion towards the
TARP Capital Purchase Program (“CPP”).  Under the CPP, Treasury will
purchase debt or equity securities from participating
institutions.  The TARP also will include direct purchases or
guarantees of troubled asset of financial institutions.
 
 EESA also
increased FDIC deposit insurance on most accounts from $100,000 to
$250,000.  This increase is in place until the end of 2009 and is not
covered by deposit insurance premiums paid by the banking
industry.  In addition, the FDIC has implemented two temporary
programs to provide deposit insurance for the full amount of most non-interest
bearing transaction accounts through the end of 2009 and to guarantee certain
unsecured debt of financial institutions and their holding companies through
June 2012.  Financial institutions were allowed to opt out of these
two programs.
 
 We opted
out of the guarantee of unsecured debt.  We are participating in the
program that provides unlimited deposit insurance coverage through December 31,
2009, for noninterest bearing savings accounts.   Under that
program we pay a 10 basis point fee (annualized) on the balance of each covered
account in excess of $250,000, while this extra deposit insurance is in
place.  At December 31, 2008 we had $263,000 in such accounts in
excess of $250,000.
 
 Our
deposit insurance premiums during the year ended December 31, 2008 were
$179,000, compared to $30,000 for the prior year.  This increase
reflects the higher premiums charged all institutions generally and charged to
institutions with regulatory issues or declining financial
condition.  These premiums will increase in 2009 due to recent strains
on the FDIC deposit insurance fund.
 
 The FDIC
has issued new deposit premium levels for 2009 to include higher regulatory
payments plus a special assessment during the second quarter of 2009, which will
range from 10 to 20 basis points (depending on whether the FDIC is given broader
borrowing authority).  These increases also include higher premiums
based on an institution’s level of brokered deposits and FHLB advances, which
may apply to the Bank.  These premiums are expected to increase by
approximately 175% during 2009.
 
 
 Forward-Looking
Statements
 
 This
report contains certain ‘forward-looking statements’ that may be identified by
the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,”
or “estimated.”  Our financial condition, results of operations and
business are subject to various factors that could cause actual results to
differ materially from these estimates.  These factors include, but
are not limited to, general and local economic conditions, changes in interest
rates (particularly the relationship of short-term rates to long-term rates),
deposit flows, demand for mortgage, consumer and other loans, real estate
values, local levels of unemployment and underemployment, competition, changes
in accounting principles, policies or guidelines, changes in legislation or
regulation, and other economic, competitive, governmental, regulatory and
technological factors affecting our operations, pricing, products and
services.  Our ability to predict results or the actual effect of
future plans or strategies is uncertain.   We do not undertake,
and specifically disclaim, any obligation to publicly revise any forward-looking
statements to reflect events or circumstances after the date of such statements
or to reflect the occurrence of anticipated or unanticipated
events.
   8
  
 Critical Accounting
Policies
  We have
established certain accounting and financial reporting policies to govern the
application of accounting principles generally accepted in the United States of
America in the preparation of our financial statements.  Our
significant accounting policies are described in the Notes to Consolidated
Financial Statements.  Certain accounting policies involve significant
judgments and assumptions by management which have a material impact on the
carrying value of certain assets and liabilities.  The judgments and
assumptions used by management are based on historical experience and other
factors that are believed to be reasonable under the
circumstances.  Because of the nature of the judgments and assumptions
made by management, actual results could differ from the judgments and estimates
adopted by management, which could have a material impact on the carrying values
of assets and liabilities and the results of our operations.  We
believe the following accounting policies applied by us represent critical
accounting policies.
  Allowance for Loan
Losses.We
believe the allowance for loan losses is a critical accounting policy that
requires the most significant judgments and estimates used in the preparation of
our consolidated financial statements.  The allowance for loan losses
represents management’s estimate of loan losses in the loan
portfolio.  Calculation of the allowance for loan losses represents a
critical accounting estimate due to the significant judgment, assumptions and
estimates related to the amount and timing of estimated losses, consideration of
current and historical trends and the amount and timing of cash flows related to
impaired loans.
  Management
believes that the allowance for loan losses is maintained at a level that
represents our best estimate of losses in the loan portfolio.  While
management uses available information to recognize losses on loans, future
additions to the allowance for loan losses may be necessary based on changes in
economic and other conditions.  In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
our allowance for loan losses.  These agencies may require us to
recognize additions to the allowance for loan losses based on their judgments
about information available to them at the time of their
examination.
  Management
evaluates current information and events regarding a borrower’s ability to repay
its obligations and considers a loan to be impaired when the ultimate
collectibility of amounts due, according to the contractual terms of the loan
agreement, is in doubt.  If the loan is collateral-dependent, the fair
value of the collateral is used to determine the amount of
impairment.  Impairment losses are included in the allowance for loan
losses through a charge to the provision for losses on loans.
  Subsequent
recoveries are credited to the allowance for loan losses.  Cash
receipts for accruing loans are applied to principal and interest under the
contractual terms of the loan agreement.  Cash receipts on impaired
loans for which the accrual of interest has been discontinued are applied first
to principal and then to interest income.
  Income Taxes.SFAS
No.  109, “Accounting for Income Taxes,” require the asset and
liability approach for financial accounting and reporting for deferred income
taxes.  We use the asset and liability method of accounting for
deferred income taxes and provide deferred income taxes for all significant
income tax temporary differences.  During 2007 we concluded, based on
higher than expected operating losses and a difficult operating environment,
that a valuation allowance should be established to reduce our net deferred tax
asset at December 31, 2007 to zero.  This non-cash charge increased
our net loss for the year ended December 31, 2007 by $437,000 and decreased
shareholders’ equity but does not affect our regulatory capital, because net
deferred tax assets not supported by taxes paid and recoverable are not included
in regulatory capital.  During 2008 no provision was made for income
taxes as we continued to incur operating losses.
  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 rates change over time.  Like other financial
institutions, our results of operations 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.
   9
    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 doing so, we analyze and manage assets and
liabilities based on their interest rates and payment streams, timing of
maturities, repricing opportunities, and sensitivity to actual or potential
changes in market interest rates.
  To manage
the potential for adverse effects of material and prolonged increases in
interest rates on our results of operations, we adopted asset and liability
management policies to understand, measure, monitor, and control the
risk.  These policies are designed to allow us to implement strategies
to minimize the effects of interest rate changes to net income and capital
position by properly matching the maturities and repricing terms of our
interest-earning assets and interest-bearing liabilities.  These
policies are adopted by our board of directors and are implemented by our asset
and liability management committee, which is comprised of senior
management.  The asset and liability management committee establishes
guidelines for and monitors the volume and mix of assets and funding sources,
taking into account relative costs and spreads, interest rate sensitivity and
liquidity requirements.  The objectives are to manage assets and
funding sources to produce results that limit negative changes in net income and
capital while supporting liquidity, capital adequacy, growth, risk and
profitability goals.  Senior managers oversee the process on a daily
basis.  The asset and liability management committee meets regularly
to review, among other things, economic conditions and interest rate outlook,
current and projected needs and capital position, anticipated changes in the
volume and mix of assets and liabilities, interest rate risk exposure, liquidity
position and net portfolio present value.  The committee also
recommends strategy changes, as appropriate, based on its review.  The
committee is responsible for reviewing and reporting the effects of the policy
implementations and strategies to the board of directors on a quarterly
basis.
  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:
  ·
              continuing
      to limit the percentage of long-term fixed-rate loans within our
      portfolio;
  ·
              originating
      a mix of variable-rate and shorter term fixed-rate
  loans;
  ·
              originating
      prime-based home equity lines of
credit;
  ·
              continuing
      the origination of one- to four-family residential construction loans to
      prospective owners and developers;
  ·
              continuing
      the origination of consumer loans;
  ·
              continuing
      the origination of commercial
loans;
  ·
              managing
      deposit relationships for stability and a lower cost of funds position;
      and
  ·
              using
      Federal Home Loan Bank advances to align maturities and repricing terms of
      funding sources with loans.
  The asset
and liability management committee regularly reviews interest rate risk by
forecasting the impact of alternative interest rate environments on net income
and the market value of portfolio equity.  Market value of portfolio
equity is a measurement of the value of the balance sheet at a fixed point in
time.  It is summarized as the fair value of assets less the fair
value of liabilities.  The committee reviews computations of the value
of capital at current interest rates and alternative interest
rates.  The variance in the net portfolio value between current
interest rate computations and alternative rate computations represents the
potential impact on capital if rates were to change.
  As
illustrated in the table below, which is based on the most recent information
available from the OTS, the Bank would benefit from a decrease in market rates
of interest.  Our net portfolio value, or NPV, would be negatively
impacted by an increase in interest rates.  An increase in rates would
negatively impact our NPV as a result of deposit accounts and
   10
   Federal
Home Loan Bank borrowings repricing more rapidly than loans and securities due
to the fixed rate nature of a large portion of our loan and security
portfolios.  As rates rise, the market value of fixed rate assets
declines due to both the rate increases and slowing prepayments.
  
  December
      31, 2008Change
      in
                  Interest
                  Rates
      in
                
                Net
      Portfolio Value
                
                NPVBasis
      Points
                
                Amount
                
                $
      Change
                
                %
      Change
                
                Ratio
      %(Dollars
      in thousands)+300
      bp
                
                4,707
                
                -1,421
                
                -23%
                
                4.24%+200
      bp
                
                5,399
                
                -728
                
                -12%
                
                4.82%+100
      bp
                
                5,878
                
                -249
                
                -4%
                
                5.21%0
      bp
                
                6,127
                
                ---
                
                ---
                
                5.40%-100
      bp
                
                5,995
                
                -132
                
                -2%
                
                5.28%
 
 Certain
assumptions are used to assess the interest rate risk of the
Bank.  These assumptions relate to interest rates, loan prepayment
rates, deposit decay rates and the market values of certain assets and
liabilities.  The assumptions used for loan repayment rates and
deposit decay rates were obtained from the OTS based on December 2008 financial
information.  Although management finds the assumptions used to be
reasonable, the interest rate sensitivity of the Bank’s assets and liabilities
and the estimated effects of changes in interest rates on the Bank’s net
interest income and market value of portfolio equity indicated in the above
table could vary substantially if different assumptions were used or actual
experience differs from such assumptions.
  Despite
our efforts to reduce the inherent interest rate risk in our portfolio, the
flattening of the yield curve has reduced our net interest margin, eliminating
our ability to generate net profits.
  Comparison
of Financial Condition at December 31, 2008 and December 31, 2007
  General.  Total
assets decreased by $3.2 million, or 2.8%, to $111.8 million at December 31,
2008, from $115.0 million at December 31, 2007.  A significant reason
for this decrease was a sale of $3.8 million in residential real estate loans
during the first quarter of 2008, in order to maintain the Bank’s then
well-capitalized status and to comply with the growth limits in the OTS
supervisory directive and supervisory agreement.  These sold loans had
balloon notes with an average remaining term of less than five years and
contained terms typical of current offerings and portfolio
averages.  Our cash and securities increased $2.4 million during
2008.  Our loan portfolio decreased $6.3 million after the loan sale
due to delinquent loans converting to other real estate owned, decreased demand
for loans and the retention of the proceeds of loan repayments for liquidity
purposes, rather than for loan originations.
  Cash and Securities. Cash and
cash equivalents increased by $2.8 million during the period, to $7.9 million at
December 31, 2008. Our current liquidity strategy is to maintain higher levels
of available funds to meet expenses and commitments. Our securities
portfolio decreased by $340,000 during the year, which primarily was a result of
a $282,000 other-than-temporary impairment adjustment on a mutual fund
investment.  That portfolio is designated as available for sale and we
have substantially all of our securities investments in shorter-term
instruments.  Cash and securities were 8.5% and 6.2% of total assets
at December 31, 2008, and December 31, 2007, respectively.  See
also “Liquidity” and Off-Balance Sheet Commitments.”
  Loans.  Our loan
portfolio decreased $6.3 million or 6.3 %, from $100.2 million at December 31,
2007 to $93.9 million at December 31, 2008.  In March 2008, we sold
$3.8 million in residential loans in order to comply with the OTS growth limit
and to maintain the Bank’s then well-capitalized status.  The slower
economy in southwest Michigan has significantly reduced loan demand,
particularly for residential purchase mortgage, construction and development
   11
   loans.  That
slower economy also has resulted in increased foreclosures described
below.  Additionally, new competitors in our primary market are
pursuing new lending opportunities with aggressive pricing.   The
decrease in our loan portfolio consisted of a 6.23% decrease in one- to
four-family residential mortgages (including the $3.8 million in loans sold), a
10.92% decrease in commercial real estate and business loans, a 10.99% decrease
in consumer loans, a 21.13% increase in home equity lines of credit (half of
which was attributable to one loan of $550,000 secured by a first mortgage) and
a 5.31% increase in construction and development loans.
  Other Real Estate
Owned.  Other real estate owned (“OREO”) increased by $950,000
or 104.28% from $911,000 at December 31, 2007 to $1.9 million at December 31,
2008.  During 2008, $1.6 million in delinquent real estate loans were
converted to other real estate owned, as compared to only $1.0 million during
2007.  This increase in 2008 reflects foreclosures or properties
deeded in lieu of foreclosure on twelve single family homes with loan balances
totaling $1.6 million.  Our other real estate owned currently consists
of 19 one-to four- family homes with balances of $1.9 million.  This
increase reflects the continued deteriorating economic conditions in
Michigan.
  Allowance for Loan
Losses.  The allowance for loan losses is maintained to cover
losses that are probable and can be estimated on the date of the evaluation in
accordance with U.S. generally accepted accounting principles.  It is
our estimate of probable incurred credit losses in our loan
portfolio.
  Our
methodology for analyzing the allowance for loan losses consists of specific and
general components.  We stratify the loan portfolio into homogeneous
groups of loans that possess similar loss-potential characteristics and apply an
appropriate loss ratio to the homogeneous pools of loans to estimate the
probable losses in the loan portfolio.  The amount of loan losses in
our consumer portfolio is estimated by using historical loss ratios for major
loan collateral types adjusted for current factors.  We use historical
peer group averages for commercial loans, due to the less-seasoned nature of
this portion of our loan portfolio.  The historical loss experience is
generally defined as an average percentage of net loan losses to loans
outstanding.  A separate valuation of known losses for individual
classified large-balance, non-homogeneous loans is also conducted in accordance
with Statement of Financial Accounting Standards (“SFAS”) No.
114.  The allowance for loan losses on individually analyzed loans
includes commercial business loans and one- to four-family and commercial real
estate loans, where management has concerns about the borrower’s ability to
repay.  Loss estimates include the difference between the current fair
value of the collateral and the loan amount due.
  Our
allowance for loan losses at December 31, 2008, was $858,000, or 0.91% of net
loans, compared to $508,000, or 0.51% of net loans, at December 31,
2007.  The following table is an analysis of the activity in the
allowance for loan losses for the periods shown.
  Twelve
      Months
                    Ended December 312008
                  
                  
                  2007Balance
      at beginning of period
                  
                  $
                  508,000
                  
                  
                  $
                  538,000Provision
      charged to income
                  
                  
                  930,000
                  
                  
                  
                  258,000Recoveries
                  
                  
                  18,000
                  
                  
                  
                  56,000Charge-offs
                  
                  
                  (598,000
                  )
                  
                  
                  (344,000
                  )Balance
      at end of period
                  
                  $
                  858,000
                  
                  
                  $
                  508,000
 
  Nonperforming
loans increased during 2008 by $1.3 million, or 65.0%, from $2.0 million at
December 31, 2007, to $3.3 million at December 31, 2008, primarily as a result
of the continued declining economy in Michigan.  Our overall
nonperforming loans to total loans ratio increased from 2.02% at
December 31, 2007, to 3.55% at December 31, 2008.   At
December 31, 2008, we had 26 nonperforming loans as follows:
  ●
                      Two
      large commercial relationships – A $412,000 loan for the development of
      residential lots, which is in non-accrual status and in the process of
      foreclosure.  We believe the value of the collateral for this
      land development loan currently exceeds the outstanding
      balance.  The other is a $523,000 land development loan
      currently past maturity on which we are working with the borrower
      regarding
renewal.
   12
   ●
                  Nine
      commercial loans - One participation loan secured by multi unit housing
      for $217,000 that is in non-accrual status.  Three loans to a
      landscaping company totaling $63,000 (borrower is making scheduled
      payments but has not been able to cure the arrearage) secured by vehicles
      and equipment.  A $127,000 loan on commercial real estate; two
      construction spec loans totaling $293,000; two commercial totaling $64,000
      secured by corporate assets and real estate.  The Bank believes these
      loans to be adequately collateralized with respect to the outstanding
      balances and the Bank expects no material loss related to these
      loans.●
                  Twelve
      one-to-four-family mortgage loans totaling $1,503,000.  Eleven
      of these loans totaling $1,368,000 are in non-accrual status and are in
      various stages of foreclosure.  Eight of the twelve loans
      totaling $912,000 are believed to be adequately collateralized with
      respect to the outstanding balances and the Bank expects no material loss
      related to these loans. Four of the loans totaling $591,000 have
      insufficient collateral values on which the bank expects to incur a
      loss.  Loan loss reserve dollars have been allocated to these
      loans in anticipation of these losses.  Three of these loans
      totaling $491,000 are to the same borrower and these properties are in the
      process of being deeded to the Bank in lieu of a foreclosure
      action.●
                  Two
      vacant land loans to the same borrower totaling $133,000, where the
      borrower has filed bankruptcy and the bank is waiting for release of stay
      by the bankruptcy trustee to complete a deed to the Bank in lieu of a
      foreclosure action.●
                  One
      consumer loan totaling
$7,000.
  The
Bank has purchased participation interests in two loans to a commercial real
estate development company, both of which are now classified troubled debt
restructures.  One loan in the amount of $476,000 is for the
development of residential lots in a now partially completed condominium
project.  The lead bank has provided construction financing for all of
the homes in the project.  The second loan of $153,000 is secured by a
commercial building.  The lead lender, with our concurrence, has
reduced the interest rate of these loans, as they did on all of this borrower’s
loans held in their own portfolio, in order to reduce the required payments to a
level that can be supported by the borrower’s current cash flow.  No
loss is expected on these loans.
  Our loan
delinquencies increased during the year to $4.7 million, or 5.0% of total loans,
at December 31, 2008, compared to $4.5 million, or 4.5% of total loans, at
December 31, 2007.  The increase in loan delinquencies during 2008 was
primarily the result of the current market conditions in our market
area.
  On
December 31, 2008, the Bank was monitoring other loans of concern classified as
substandard or doubtful on the Bank’s monthly delinquency
report.  These loans consisted of commercial loans that include: three
loans totaling $408,000 secured by one- to four- family first mortgages; a
$25,000 second mortgage secured by one- to four- family real estate; two loans
totaling $78,000 secured by commercial real estate; and a $205,000 line of
credit for land development.   Residential loans that include:
two loans totaling $232,000 secured by one- to four- family real estate; three
second mortgage HELOC loans totaling $129,000; and two loans for vacant land
with a total of $134,000.  Consumer loans include: six secured loans
totaling $25,000; three unsecured loans totaling $14,000.  All loans
are being actively monitored and collection efforts are continuing.
  Past
due loans classified as special mention that are being monitored by the Bank’s
loan review committee include two loans to a real estate developer that are
secured by a single family real estate development and a second mortgage HELOC
on the developer’s primary residence that totals $313,000, two loans that
include a first and a second mortgage secured by a single family home totaling
$214,000, and a $71,000 first mortgage loan secured by a one- to four- family
residential property.
  With
our market area continuing to experience sluggish economic conditions, we
anticipate high levels of delinquencies and net charge-offs will continue during
the remainder of 2009.
   13
    Deposits.Total
deposits decreased by $10.0 million, or 12.6%, to $69.4 million at December 31,
2008, from $79.4 million at December 31, 2007.  This decrease is
primarily the result of not renewing $18.4 million in wholesale deposits during
the year, as we shifted to FHLB advances and were precluded from accepting these
deposits when we became adequately capitalized in June 2008.  We have
not experienced a material decrease in retail deposits in our local
market.
  During
the year, demand deposits increased $76,000 and savings and money market
accounts increased $2.8 million.  The amount of time deposits or
certificates at December 31, 2008 was $12.9 million less than at the end of
2007, primarily due to the decision of our customers holding cash in more liquid
accounts and our decision to not renew wholesale deposits.
  Borrowings.Federal Home Loan Bank
advances increased $9.3 million, or 35.2%, to $35.7 million at December 31,
2008, from $26.4 million at December 31, 2007.  We increased Federal
Home Loan Bank borrowings to replace higher cost wholesale certificates of
deposit, which we chose not to renew.  At December 31, 2008, we had
the ability to borrow an additional $725,000 from the Federal Home Loan
Bank.
  At December 31, 2008, we had $700,000
outstanding on our loan from another bank, which is secured by 100% of the
outstanding common stock of the Bank.  The interest rate on this loan
at December 31, 2008 was7.15%.  Our operating losses and
level of non-accrual loans and other real estate owned have been a violation of
financial covenants of the loan and an event of default.  OnFebruary 6,
2009, the lender provided a
letter agreeing to forbear from enforcing those covenantsthrough June 30, 2009so long as we otherwise remain in
compliance with the loan documents and forbearance letter for this loan and the
lender’s other loan to our employee stock ownership plan.  AtDecember 31, 2008 we were not in compliance with
these requirements.Failure to maintain well-capitalized status is a
default under our bank loan and the 2008 forbearance letters for previous events
of default under that loan.  We will ask the lending bank for
additional forbearance if the Bank does not return to well-capitalized status by
June 30, 2009.  However, that forbearance may not be
granted.
  Equity.Total
equity decreased $1.9 million, or 26.8%, to $5.2 million at December 31, 2008, from $7.1
million at December 31, 2007.  The decrease in equity was primarily
due to a net loss of $1.9 million for the year.  On August 8, 2008 the
Bank lost well-capitalized status under prompt corrective action regulations of
the OTS and became adequately capitalized.  The change in status was
effective June 30, 2008.  See “Capital.”
   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.  Also presented is the weighted
average yield on interest-earning assets, rates paid on interest-bearing
liabilities and the resultant spread at December 31, 2008 and
2007.  Income and yields on tax-exempt obligations have not been
computed on a tax equivalent basis.  All average balances are daily
average balances.  Non-accruing loans have been included in the table
as loans carrying a zero yield.
  
  14
 
 
  Year
      ended December 31,2008
                  
                  
                  2007Average
      Outstanding
                    Balance
                  
                  
                  Interest
      Earned/
                    Paid
                  
                  
                  Yield/
                    Rate
                  
                  
                  Average
      Outstanding Balance
                  
                  
                  Interest
      Earned/
                    Paid
                  
                  
                  Yield/
                    Rate(Dollars
      in thousands)Interest-Earning
      Assets:Loans
      receivable(1)
                  
                  $
                  94,397
                  
                  
                  $
                  5,943
                  
                  
                  
                  6.30
                  %
                  
                  $
                  94,867
                  
                  
                  $
                  6,490
                  
                  
                  
                  6.84
                  %Deposits
      at other institutions
                  
                  
                  2,908
                  
                  
                  
                  57
                  
                  
                  
                  1.96
                  
                  
                  
                  4,133
                  
                  
                  
                  207
                  
                  
                  
                  5.00Mortgage-backed
      securities
                  
                  
                  1,820
                  
                  
                  
                  86
                  
                  
                  
                  4.73
                  
                  
                  
                  2,012
                  
                  
                  
                  118
                  
                  
                  
                  5.87Federal
      Home Loan Bank stock
                  
                  
                  1,640
                  
                  
                  
                  81
                  
                  
                  
                  4.94
                  
                  
                  
                  1,589
                  
                  
                  
                  73
                  
                  
                  
                  4.62Total
      interest-earning assets(1)
                  
                  
                  100,397
                  
                  
                  
                  6,167
                  
                  
                  
                  6.12
                  
                  
                  
                  102,601
                  
                  
                  
                  6,888
                  
                  
                  
                  6.71Interest-Bearing
      Liabilities:Savings
      deposits
                  
                  
                  7,462
                  
                  
                  
                  34
                  
                  
                  
                  0.46
                  
                  
                  
                  7,857
                  
                  
                  
                  36
                  
                  
                  
                  0.46Demand
      and NOW deposits
                  
                  
                  11,671
                  
                  
                  
                  208
                  
                  
                  
                  1.78
                  
                  
                  
                  10,474
                  
                  
                  
                  159
                  
                  
                  
                  1.52Certificate
      accounts
                  
                  
                  46,159
                  
                  
                  
                  2,022
                  
                  
                  
                  4.38
                  
                  
                  
                  59,401
                  
                  
                  
                  2,925
                  
                  
                  
                  4.92Federal
      Home Loan Bank advances
                  
                  
                  31,264
                  
                  
                  
                  1,129
                  
                  
                  
                  3.61
                  
                  
                  
                  22,730
                  
                  
                  
                  1,200
                  
                  
                  
                  5.28Bank
      loan
                  
                  
                  700
                  
                  
                  
                  47
                  
                  
                  
                  6.71
                  
                  
                  
                  700
                  
                  
                  
                  57
                  
                  
                  
                  8.10Total
      interest-bearing liabilities
                  
                  
                  97,256
                  
                  
                  
                  3,440
                  
                  
                  
                  3.54
                  
                  
                  
                  101,162
                  
                  
                  
                  4,377
                  
                  
                  
                  4.33Net
      interest income
                  
                  
                  
                  
                  
                  $
                  2,727
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  2,511Net
      interest rate spread
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2.58
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2.38
                  %Net
      earning assets
                  
                  $
                  3,141
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  $
                  1,439Net
      interest margin
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2.71
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  2.45
                  %Average
      interest-earning assets
                    to
      average interest-bearing
                    liabilities
                  
                  
                  103.23
                  %
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  101.42
                  %
 ____________________
 (1)         Calculated
net of deferred loan fees, loan discounts and loans in process.
 
  15
  Rate/Volume
Analysis
  The
following schedule presents the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities.  It distinguishes between the changes
related to outstanding balances and that due to the changes in interest
rates.  For each category of interest-earning assets and
interest-bearing liabilities, information is provided on changes attributable to
(i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii)
changes in rate (i.e., changes in rate multiplied by old volume).  For
purposes of this table, changes attributable to both rate and volume, which
cannot be segregated, have been allocated proportionately to the change due to
volume and the change due to rate.
  Year
      ended December 31,
              
              Year
      ended December 31,2008
      vs. 2007
              
              2007
      vs. 2006Increase
              
              Total
              
              Increase
              
              Total(decrease)
      due to
              
              increase
              
              (decrease
      due to
              
              increaseVolume
              
              Rate
              
              (decrease)
              
              Volume
              
              Rate
              
              (decrease)Interest-earning
      assets:Loans
      receivable
              $(32)
              
              $(515)
              
              $(547)
              
              $
      (36)
              
              $233
              
              $197Deposits
      at other institutions
              (49)
              
              (101)
              
              (150)
              
              181
              
              1
              
              182Mortgage-backed
      securities
              (11)
              
              (21)
              
              (32)
              
              (13)
              
              14
              
              1Federal  Home
      Loan Bank stock
              2
              
              6
              
              8
              
              (5)
              
              (3)
              
              (8)Total
      interest-earning assets
              (90)
              
              (631)
              
              (721)
              
              127
              
              245
              
              372Interest-bearing
      liabilities:Savings
      deposits
              (2)
              
              ---
              
              (2)
              
              (4)
              
              ---
              
              (4)Demand
      and NOW deposits
              19
              
              30
              
              49
              
              (8)
              
              40
              
              32Certificate
      accounts
              (604)
              
              (299)
              
              (903)
              
              483
              
              281
              
              764Federal
      Home Loan Bank advances
              373
              
              (444)
              
              (71)
              
              (233)
              
              (21)
              
              (254)Bank
      loan
              ---
              
              (10)
              
              (10)
              
              (90)
              
              (9)
              
              (99)Total
      interest-bearing liabilities
              $(214)
              
              $(723)
              
              (937)
              
              $148
              
              $291
              
              439Net
      interest income
              
              
              
              
              $216
              
              
              
              
              
              $(67)
 
 
 Comparison
of Operating Results for the Years Ended December 31, 2008 and December 31,
2007.
  General.  The net loss for the year ended December 31, 2008, was $2.0
million as compared to a net loss of $1.3 million in 2007.  The net
loss for 2008 reflects a $200,000 increase in net interest income primarily
attributable to declining interest rates for deposits and Federal Home Bank
advances.  Our provision for loan losses increased $672,000 for the
year.  Regulatory assessments increased $177,000, salaries and
employee benefits increased $38,000, administrative services increased $67,000
and professional services increased $65,000 during 2008.  These
increases were offset by a $61,000 decrease in premises and equipment
expense.  Non-interest income decreased during the year by
$343,000.  The decrease is primarily attributable to a $282,000
impairment of a mortgage-backed mutual fund that was determined to be other than
temporarily impaired and a $37,000 loss on the sale of repossessed
property.
  Interest
Income.  Interest income decreased by $721,000, or 10.5%, to
$6.2 million for the year ended December 31, 2008, from $6.9 million in
2007.   The decrease in interest income is primarily related to the
decrease in the weighted average yield of the residential loan portfolio during
the year, as well as the decrease in loan portfolio balances.
  The
weighted average yield on loans decreased to 6.30% for the year ended December
31, 2008, from 6.84% for the year ended December 31, 2007.   The
decrease was primarily the result of prime rate based adjustable rate loans,
home equity loans and commercial loans re-pricing to lower rates as the prime
rate decreased from 7.25% to 3.25% as
   16
    the
result of Federal Reserve rate cuts.  Interest rates on other types of
loans have remained relatively stable.  We anticipate this trend to
continue for the short term.
  Total
average interest-earning assets decreased $1.8 million from December 31, 2007,
to December 31, 2008, due to decreased loan demand. The weighted average yield
on interest-earning assets decreased 59 basis points from 6.71% to 6.12% during
the same period.
  Interest
Expense.   Interest expense decreased $937,000, or 21.3%,
to $3.4 million for the year ended December 31, 2008, from $4.4 million for the
year ended December 31, 2007.  The decrease was a result of a decrease
in the average balance of deposits and a decrease in the average rate paid on
both deposits and Federal Home Loan Bank advances as a result of the lower
interest rate environment and our decreased reliance on wholesale and brokered
deposits.  We paid $47,000 and $57,000 in interest, respectively, on
our bank line of credit during the quarter ended December 31, 2008 and December
31, 2007.   The average cost of interest-bearing liabilities decreased
from 4.3% for the year ended December 31, 2007 to 3.5% for the year ended
December 31, 2008.
  Interest
paid on deposits decreased $856,000, or 34.2%, to $2.3 million for the year
ended December 31, 2008 from $3.1 million for the year ended December 31,
2007.   This reflects our shift from wholesale and brokered
deposits to Federal Home Loan Bank advances, lower interest rates generally as
well as a relative increase in lower cost demand accounts.
  Interest
expense on Federal Home Loan Bank advances decreased $72,000 or 6.0%, to $1.1
million for the year ended December 31, 2008, from $1.2 million for the year
ended December 31, 2007.   This decrease resulted from decreasing
rates on the repricing of our advances and an increase in the average balance of
outstanding Federal Home Loan Bank advances of $8.5 million for the year ended
December 31, 2008, from $22.7 million for the year ended December 31,
2007.
  During
2008, we decreased wholesale and brokered deposits as a result of losing
well-capitalized status and the  lower cost of Federal Home Loan Bank
advances.   During 2008, short-term interest rates decreased
slightly, which produced a positively sloped yield curve.  The
decrease in short-term interest rates has had a favorable impact on our interest
expense.  If this trend continues we will see further reductions in
our interest expense and an improved net interest margin.  No
assurance can be given that this will occur.
  Net Interest
Income.   Net interest income before provision for loan
losses increased by $216,000, or 8.6% for the year ended December 31, 2008, to
$2.7 million compared to $2.5 million for the year ended December 31,
2007.  The increase in net interest income in 2008 was due to interest
expense decreasing more rapidly than interest income. Our net interest margin
was 2.54% for the year ended December 31, 2008, compared to 2.45% for the year
ended December 31, 2007.
  Provision for
Loan Losses.   We establish the provision for loan losses,
which is charged to operations, at a level management believes will adjust the
allowance for loan losses to reflect probable incurred credit losses in the loan
portfolio.  In evaluating the level of the allowance for loan losses,
management considers the types of loans and the amount of loans in the loan
portfolio, historical loss experience, adverse situations that may affect the
borrower's ability to repay, estimated value of any underlying collateral and
prevailing economic conditions.
  Based on
management’s evaluation of these factors, provisions of $930,000 and $258,000
were made during the year ended December 31, 2008 and December 31, 2007,
respectively.  The increase in the provision for loan losses was due
primarily to increased delinquencies and net charge-offs during 2008 compared to
2007.  During the year ended December 31, 2008, net charge-offs were
$580,000 compared to $288,000 for the same period in 2007.  The ratio
of non-performing loans to total loans increased from 2.02% at December 31,
2007, to 3.55% at December 31, 2008.  Non-performing loans at December
31, 2008, consisted of $1.6 million in residential mortgage loans, $7,000 in
consumer loans and $1.7 million in commercial loans.  The increase in
the level of non-performing loans during the year
   17
    ended
December 31, 2008, is a result of the continuing decline in the southwest
Michigan economy and such national factors as increased fuel cost and the higher
cost of consumer credit.
  Non-interest
Income.   Non-interest income decreased $343,000 or 69.9%
to $148,000 for the year ended December 31, 2008, compared to $491,000 for the
same period in 2007.  The decrease in non-interest income during the
2008 period was primarily due to the $282,000 impairment of a mortgage-backed
mutual fund and a $37,000 loss on a repossessed property compared to a $50,000
gain on the sale of properties in 2007.
  Non-Interest
Expense.   Non-interest expense increased $275,000, or
7.6%, from $3.6 million for the year period ended December 31, 2007 to $3.9
million for the year ended December 31, 2008.  Increases in expenses
of $177,000 for regulatory assessments, $38,000 for salaries and employee
benefits, $67,000 for administrative services and $65,000 for professional
services were offset by decreases of $61,000 for premises and equipment, $9,000
in advertising costs and $5,000 for the amortization of
intangibles.  The increase in regulatory assessments is primarily due
to an increase in the general assessment rate from 2007.
  Income Tax
Benefit.  During 2007, management concluded, based on higher
than expected operating losses and a difficult operating environment, that a
valuation allowance should be established to reduce the net deferred tax asset
at December 31, 2007 to zero.  This valuation allowance increased the
net loss for the year ended December 31, 2007 and decreased shareholders’ equity
but did not affect regulatory capital.  As a result of the
establishment of the valuation allowance, no tax benefit has been recorded in
the income statement at December 31, 2008.
  Liquidity
and Commitments
  We are
required to have enough cash and investments that qualify as liquid assets in
order to maintain sufficient liquidity to ensure safe and sound
operations.  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 believed to be adequate to meet the requirements of normal operations,
including potential deposit outflows.  Cash flow projections are
regularly reviewed and updated to assure that adequate liquidity is
maintained.  The consolidated statements of cash flows included in our
consolidated financial statements and notes beginning on page F-1 detail cash
flows from operating, investing and financing activities.
  Liquidity
management is both a daily and long-term function of the management of the
Company and the Bank.  Excess liquidity is generally invested in
short-term investments, such as overnight deposits and federal
funds.  On a longer term basis, we maintain a strategy of investing in
various lending products and investment securities, including mortgage-backed
securities.  The Bank uses its sources of funds primarily to meet its
ongoing commitments, pay maturing deposits, fund deposit withdrawals and to fund
loan commitments.  The Bank has adopted the new liquidity management
policy required in its supervisory agreement with the
OTS.
  The
Bank’s primary sources of funds are deposits, amortization, prepayments and
maturities of outstanding loans and mortgage-backed securities, maturities of
investment securities and other short-term investments and funds provided by
operations.  While scheduled payments from the amortization of loans
and maturing short-term investments are relatively predictable sources of funds,
deposit flows and loan prepayments are greatly influenced by general interest
rates, economic conditions and competition.  In addition, the Bank
invests excess funds in short-term interest-earning assets, which provide
liquidity to meet lending requirements.  The Bank also generates cash
through borrowings, primarily from Federal Home Loan Bank advances, to leverage
its capital base, provide funds for its lending and investment activities and
enhance its interest rate risk management.
  We
maintain cash and investments that qualify as liquid assets to maintain
liquidity to ensure safe and sound operation and meet demands for funds
(particularly withdrawals of deposits).  At December 31, 2008,
the Bank had $9.5 million in cash and investment securities on a
consolidated basis available for sale generally available for its cash needs, of
which $8.6 million was available to the Bank on an unconsolidated
basis.  The Company has $170,000 which is adequate to meet its needs for
the foreseeable future.
   18
    The
Bank’s liquidity position at December 31, 2008 was $8.7 million compared to $7.1
million at December 31, 2007.  This increase reflects the
proceeds from the sale of $3.8 million of residential loans and new Federal Home
Loan Bank advances of $9.3 million. For liquidity management purposes we can
generate funds from additional borrowings, deposit gathering activities and loan
sales.  At December 31, 2008, we had $7.4 million in outstanding loan
commitments, including unused lines of credit.  Certificates of
deposit scheduled to mature in one year or less at December 31, 2008, totaled
$37.6 million.  It is management’s policy to maintain deposit rates
that are competitive with other local financial institutions.  Based
on this management strategy, we believe that a majority of maturing deposits
will remain with the Bank.  However, because the Bank has become
adequately capitalized, it may not accept or renew brokered deposits without
regulatory approval. See “Capital.” At December 31, 2008, we had $6.4 million in
wholesale or brokered deposits, which is an $18.0 million, or 73.6%, decrease
from the level at December 31, 2007.   At December 31, 2008, the
Bank had the ability to borrow an additional $725,000 in Federal Home Loan Bank
advances.  Because of the Bank’s limited ability to borrow from the
Federal Home Loan Bank and the inability to currently utilize brokered deposits
the Bank has, and anticipates continuing to, obtained deposits in the national
market to meet funding needs.  The interest rates the Bank has paid to
obtain national market deposits have generally ranged from being equivalent to
the rate offered in the local market to 0.5% above the local rate The Bank is
also maintaining higher levels of liquidity to provide added flexibility due to
its’ limited sources for liquidity.
  Local
deposit flows have been stable over the last twelve months.  Local savings
flows do not appear to have been materially impacted by local economic
conditions although a continuation of higher unemployment levels and decreased
economic activity could result in decreased personal and business savings.
Interest rates on deposits offered in the local market have been above average
in relation to national averages due to the competitiveness of the local
market. .  In the event we experience unexpected withdrawals of
deposits or are unable to renew the majority of our maturing certificates of
deposit at acceptable rates, we could have difficulty funding our ongoing
operations.
 
 Off-Balance
Sheet Activities
 
 In the
normal course of operations, we engage in a variety of financial transactions
that are not recorded in our financial statements.  These transactions
involve varying degrees of off-balance sheet credit, interest rate and liquidity
risks.  These transactions are used primarily to manage customers’
requests for funding and take the form of loan commitments and lines of
credit.  For the year ended December 31, 2008, we engaged in no
off-balance sheet transactions likely to have a material effect on our financial
condition, results of operations or cash flows.
  A summary
of our off-balance sheet commitments to extend credit at December 31, 2008, is
as follows:
  Off-balance sheet loan
      commitments:Commitments
      to make loans
                        
                        $
                        965,000Undisbursed
      portion of loans closed
                        
                        
                        903,000Unused
      lines of
      credit
                        
                        
                        5,549,000Total
      loan
      commitments
                        
                        $
                        7,417,000
 
 
  19
  Capital
 
 The Bank
is subject to minimum capital requirements imposed by the OTS.  Based
on its capital levels at December 31, 2008, the Bank exceeded these requirements
as of that date. Effective June 30, 2008, as a result of the $78,000
write-down of our mortgage-backed securities mutual fund investment and
continued operating losses, the Bank’s risk based capital fell to below 10%, and
it lost well-capitalized status.  As reflected below, the Bank met the
minimum capital ratios to be considered adequately-capitalized by the OTS based
on its capital levels at December 31, 2008.  As a result of our
operating losses, we do not expect to return to well-capitalized and there can
be no assurance that we will continue to meet the adequately-capitalized
standards.
  The Bank
is currently under a supervisory directive and supervisory agreement from the
OTS.  Because the Bank’s capital level has fallen below
well-capitalized status, the OTS may initiate additional enforcement action
against the Bank.  See “- Overview and Recent Regulatory Matters”.
 Failure to maintain well-capitalized status is also a default under our
bank loan.  We have received forbearance letters from our
lender for this and other events of default under that loan. This
forbearance is in place through June 30, 2009.  The lending bank may not
grant additional forbearance beyond June 30, 2009.  Because the Bank
has fallen below well-capitalized status, it may not accept or renew brokered
deposits without regulatory approval from the FDIC, which has been applied
for.  There can be no assurances when, or if, this FDIC approval will
be received.
  Actual
              
              Required
      for
                Adequately-Capitalized
                Status
              
              ExcessAmount
              
              Percent
      of
                Assets(1)
              
              Amount
              
              Percent
      of
                Assets(1)
              
              Amount
              
              Percent
      of
                Assets1)(Dollars
      in thousands)Tier
      1 leverage (core) capital ratio
              $5,014
              
              4.5%
              
              $4,440
              
              4.0%
              
              $   
      574
              
              0.5%Tier
      1 risk-based capital ratio
              5,014
              
              7.1
              
              2,815
              
              4.0
              
              2,199
              
              2.0Total
      risk-based capital ratio
              5,872
              
              8.4
              
              5,629
              
              8.0
              
              243
              
              0.3
 ____________________
 (1)
              Ratio
      is a percent of adjusted total assets of $110.9 million for the Tier 1
      leverage capital ratio and a percent of risk-weighted assets of $70.3
      million for the Tier 1 and total risk-based capital
  ratios.
  Impact
of Inflation
  The
consolidated financial statements presented herein have been prepared in
accordance with accounting principles generally accepted in the United States of
America.  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 these prices are affected by
inflation.  In a period of rapidly rising interest rates, the
liquidity and maturity structures of our assets and liabilities are critical to
the maintenance of acceptable performance levels.
  The
principal effect of inflation, as distinct from levels of interest rates, on
earnings is in the area of non-interest expense.  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.
  
  20
  
  MAINSTREET
FINANCIAL CORPORATION
  INDEX TO
CONSOLIDATED FINANCIAL STATEMENTS
 PageReports
      of Independent Registered Public Accounting Firm
                          F-1Consolidated
      Balance
      Sheets
                          F-2Consolidated
      Statements of
      Operations
                          F-3Consolidated
      Statements of Changes in Shareholder’s Equity
                          F-4Consolidated
      Statements of Cash
      Flows
                          F-5Notes
      to Consolidated Financial
      Statements
                          F-7
 
 All
schedules are omitted because the required information is not applicable or is
included in the Consolidated Financial Statements and related
Notes.
  
 
  21
   
 
 
 
 
 
 
 REPORT OF
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 
 
 Board of
Directors
 MainStreet
Financial Corporation
 Hastings,
Michigan
 
 
 We have
audited the accompanying consolidated balance sheets of MainStreet Financial
Corporation as of December 31, 2008 and 2007, and the related consolidated
statements of operations, changes in shareholders’ equity and cash flows for
each of the years then ended. These financial statements are the responsibility
of the Corporation’s management. Our responsibility is to express an opinion on
these financial statements based on our audits.
 
 We conducted our audits in accordance
with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  The Company is not required to have, nor were we
engaged to perform, an audit of its internal control over financial
reporting.  Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting.  Accordingly, we express no such opinion.  An
audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the 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 financial position of MainStreet Financial
Corporation as of December 31, 2008 and 2007, and the results of its operations
and its cash flows for the years then ended, in conformity with U.S. generally
accepted accounting principles.
 
 
 Crowe Horwath LLP
 Grand
Rapids, Michigan
 March
31, 2009
  F-1
  MAINSTREET
FINANCIAL CORPORATION
 CONSOLIDATED
BALANCE SHEETS
 December
31, 2008 and 2007
 
 
 2008
                
                
                2007ASSETSCash
      and due from financial institutions
                
                $
                2,336,048
                
                
                $
                1,995,698Interest-bearing
      deposits
                
                
                5,587,338
                
                
                
                3,175,605Cash
      and cash equivalents
                
                
                7,923,386
                
                
                
                5,171,303Securities
      available for sale
                
                
                1,584,990
                
                
                
                1,924,413Loans,
      net of allowance of $858,370 and $508,364
                
                
                93,879,925
                
                
                
                100,149,716Federal
      Home Loan Bank (FHLB) stock
                
                
                1,785,000
                
                
                
                1,589,000Accrued
      interest receivable
                
                
                550,079
                
                
                
                605,241Premises
      and equipment, net
                
                
                3,389,961
                
                
                
                3,557,518Intangible
      assets
                
                
                697,764
                
                
                
                856,035Other
      real estate owned
                
                
                1,861,048
                
                
                
                910,846Other
      assets
                
                
                135,961
                
                
                
                264,076$
                111,808,114
                
                
                $
                115,028,148LIABILITIES
      AND SHAREHOLDERS’ EQUITYLiabilitiesDepositsNoninterest-bearing
                
                $
                4,742,394
                
                
                $
                5,278,694Interest-bearing
                
                
                64,664,994
                
                
                
                74,126,37369,407,388
                
                
                
                79,405,067FHLB
      advances
                
                
                35,700,000
                
                
                
                26,400,000Note
      payable
                
                
                700,000
                
                
                
                700,000ESOP
      note payable
                
                
                227,424
                
                
                
                255,852Accrued
      interest payable
                
                
                64,329
                
                
                
                189,015Advance
      payments by borrowers for taxes and insurance
                
                
                137,073
                
                
                
                100,412Deferred
      compensation liability
                
                
                -
                
                
                
                506,737Accrued
      expenses and other liabilities
                
                
                369,853
                
                
                
                316,796Total
      liabilities
                
                
                106,606,067
                
                
                
                107,873,879Commitments
      and contingenciesShareholders’
      equityCommon
      stock - $.01 par value, 9,000,000 sharesauthorized,
      756,068 shares issued andoutstanding
      at December 31, 2008 and 2007
                
                
                7,561
                
                
                
                7,561Additional
      paid in capital
                
                
                2,799,766
                
                
                
                2,821,602Unearned
      ESOP
                
                
                (213,738
                )
                
                
                (247,856
                )Retained
      earnings
                
                
                2,620,794
                
                
                
                4,603,116Accumulated
      other comprehensive income (loss)
                
                
                (12,336
                )
                
                
                (30,154
                )5,202,047
                
                
                
                7,154,269$
                111,808,114
                
                
                $
                115,028,148
 
  See
accompanying notes to consolidated financial statements.
 
 F-2
  MAINSTREET
FINANCIAL CORPORATION
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 Years
ended December 31, 2008 and 2007
 
 
 2008
                
                
                2007Interest
      incomeLoans,
      including related fees
                
                $
                5,943,235
                
                
                $
                6,489,711Taxable
      securities
                
                
                166,895
                
                
                
                191,517Other
                
                
                56,981
                
                
                
                206,6226,167,111
                
                
                
                6,887,850Interest
      expenseDeposits
                
                
                2,264,580
                
                
                
                3,120,113FHLB
      advances
                
                
                1,128,623
                
                
                
                1,200,238Other
                
                
                46,844
                
                
                
                56,6703,440,047
                
                
                
                4,377,021Net
      interest income
                
                
                2,727,064
                
                
                
                2,510,829Provision
      for loan losses
                
                
                929,901
                
                
                
                258,000Net interest income after
      provision for loan
      losses
                
                
                1,797,163
                
                
                
                2,252,829Noninterest
      incomeFees
      and service charges
                
                
                388,791
                
                
                
                389,210Loss
      on securities
                
                
                (281,544
                )
                
                
                -Gain
      (loss) on sale of loans
                
                
                31,112
                
                
                
                21,786Gain
      (loss) on sale of repossessed assets
                
                
                (36,954
                )
                
                
                49,526Other
                
                
                46,947
                
                
                
                30,791148,352
                
                
                
                491,313Noninterest
      expensesSalaries
      and employee benefits
                
                
                1,768,549
                
                
                
                1,731,050Premises
      and equipment, net
                
                
                498,999
                
                
                
                559,732Administrative
      and general expenses
                
                
                598,739
                
                
                
                530,635Data
      processing through service bureau
                
                
                256,726
                
                
                
                255,410Amortization
      of intangible assets
                
                
                158,271
                
                
                
                162,907Regulatory
      assessments
                
                
                266,251
                
                
                
                89,418Professional
      services
                
                
                309,340
                
                
                
                244,165Advertising
      and public relations
                
                
                70,962
                
                
                
                79,7833,927,837
                
                
                
                3,653,100Loss
      before income taxes
                
                
                (1,982,322
                )
                
                
                (908,958
                )Federal
      income tax expense (benefit)
                
                
                -
                
                
                
                436,585Net
      loss
                
                $
                (1,982,322
                )
                
                $
                (1,345,543
                )Basic
      and diluted earnings (loss) per share
                
                $
                (2.70
                )
                
                $
                (1.84
                )
 
  See
accompanying notes to consolidated financial statements.
 
 F-3
  MAINSTREET
FINANCIAL CORPORATION
 CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
 Years
ended December 31, 2008 and 2007
 
 
 AccumulatedAdditional
                
                
                
                
                
                Unearned
                
                
                Other
                
                
                TotalCommon
                
                
                Paid-in
                
                
                Retained
                
                
                ESOP
                
                
                Comprehensive
                
                
                Shareholder’sStock
                
                
                Capital
                
                
                Earnings
                
                
                Shares
                
                
                Loss
                
                
                EquityBalance
      – January 1, 2007
                
                $
                7,561
                
                
                $
                2,939,677
                
                
                $
                5,948,659
                
                
                $
                (284,280
                )
                
                $
                (12,675
                )
                
                $
                8,598,942Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                (1,345,543
                )
                
                
                -
                
                
                
                -
                
                
                
                (1,345,543
                )Change
      in net unrealized gain/loss onsecurities
      available for sale, net of tax
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (17,479
                )
                
                
                (17,479
                )Comprehensive
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,363,022
                )Public
      offering costs
                
                
                -
                
                
                
                (114,993
                )
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (114,993
                )Earned
      ESOP Shares
                
                
                -
                
                
                
                (3,082
                )
                
                
                -
                
                
                
                36,424
                
                
                
                -
                
                
                
                33,342Balance
      – December 31, 2007
                
                
                7,561
                
                
                
                2,821,602
                
                
                
                4,603,116
                
                
                
                (247,856
                )
                
                
                (30,154
                )
                
                
                7,154,269Net
      loss
                
                
                -
                
                
                
                -
                
                
                
                (1,982,322
                )
                
                
                -
                
                
                
                -
                
                
                
                (1,982,322
                )Change
      in net unrealized gain/loss onsecurities
      available for sale, net of tax
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                17,818
                
                
                
                17,818Comprehensive
      loss
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                -
                
                
                
                (1,964,504
                )Earned
      ESOP Shares
                
                
                -
                
                
                
                (21,836
                )
                
                
                -
                
                
                
                34,118
                
                
                
                -
                
                
                
                12,282Balance
      – December 31, 2008
                
                $
                7,561
                
                
                $
                2,799,766
                
                
                $
                2,620,794
                
                
                $
                (213,738
                )
                
                $
                (12,336
                )
                
                $
                5,202,047
 
 
 
 
  See
accompanying notes to consolidated financial statements.
 
 F-4
  MAINSTREET
FINANCIAL CORPORATION
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 Years
ended December 31, 2008 and 2007
 
 
 2008
                
                
                2007Cash
      flows from operating activitiesNet
      income (loss)
                
                $
                (1,982,322
                )
                
                $
                (1,345,543
                )Adjustments
      to reconcile net income (loss) tonet
      cash from operating activitiesDepreciation
                
                
                179,028
                
                
                
                246,897Amortization,
      net of accretionSecurities
                
                
                3,006
                
                
                
                3,816Loans
                
                
                977
                
                
                
                (5,123
                )Intangible
      assets
                
                
                158,271
                
                
                
                162,907Provision
      for loan losses
                
                
                929,901
                
                
                
                258,000Loans
      originated for sale
                
                
                (3,130,290
                )
                
                
                (1,724,640
                )Proceeds
      from sales of loans originated for sale
                
                
                3,161,402
                
                
                
                1,746,426Other
      – than – temporary impairment of securities
                
                
                281,544
                
                
                
                -Gain
      on sale of loans
                
                
                (31,112
                )
                
                
                (21,786
                )ESOP
      expense
                
                
                12,282
                
                
                
                33,342(Gain)
      loss on sale of other real estate owned
                
                
                36,954
                
                
                
                (49,526
                )Change
      in assets and liabilitiesChange
      in deferred fees and discounts
                
                
                21,929
                
                
                
                29,391Accrued
      interest receivable
                
                
                55,162
                
                
                
                129,658Other
      assets
                
                
                128,116
                
                
                
                221,709Accrued
      interest payable
                
                
                (124,686
                )
                
                
                57,604Other
      liabilities
                
                
                (453,680
                )
                
                
                141,690Net
      cash from (used for) operating activities
                
                
                (753,518
                )
                
                
                (115,178
                )Cash
      flows from investing activitiesActivity
      in available-for-sale securities:Principal
      repayments, maturities, and calls
                
                
                72,690
                
                
                
                149,215Purchases
      of FHLB stock
                
                
                (196,000
                )
                
                
                -Loan
      originations and payments, net
                
                
                233,250
                
                
                
                (752,147
                )Loans
      sold from portfolio
                
                
                3,874,571
                
                
                
                -Sales
      of other real estate owned
                
                
                258,668
                
                
                
                609,007Purchases
      of premises and equipment, net
                
                
                (11,471
                )
                
                
                (120,212
                )Net
      cash used for investing activities
                
                
                4,231,708
                
                
                
                (114,137
                )
 
  (Continued)
 
 F-5
  MAINSTREET
FINANCIAL CORPORATION
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 Years
ended December 31, 2008 and 2007
 
 
 2008
                
                
                2007Cash
      flows from financing activitiesNet
      change in deposits
                
                $
                (9,997,679
                )
                
                $
                (3,296,226
                )Proceeds
      from Federal Home Loan Bank advances
                
                
                46,780,000
                
                
                
                35,300,000Repayment
      of Federal Home Loan Bank advances
                
                
                (37,480,000
                )
                
                
                (30,300,000
                )Payments
      on ESOP loan
                
                
                (28,428
                )
                
                
                (28,428
                )Public
      offering costs
                
                
                -
                
                
                
                (114,993
                )Net
      cash from (used for) financing activities
                
                
                (726,107
                )
                
                
                1,560,353Net
      change in cash and cash equivalents
                
                
                2,752,083
                
                
                
                1,331,038Cash
      and cash equivalents at beginning of year
                
                
                5,171,303
                
                
                
                3,840,265Cash
      and cash equivalents at end of year
                
                $
                7,923,386
                
                
                $
                5,171,303Supplemental
      disclosures of cash flow informationCash
      paid during the year forInterest
                
                $
                3,564,733
                
                
                $
                4,319,417Supplemental
      disclosures of noncash activitiesTransfer
      of loans to other real estate
                
                $
                1,245,824
                
                
                $
                1,017,795
 
  See
accompanying notes to consolidated financial statements.
 
 F-6
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 Principles of
Consolidation:  The consolidated financial statements include
the accounts of MainStreet Financial Corporation, its wholly owned subsidiary
MainStreet Savings Bank, FSB (the Bank) and the Bank’s wholly owned
subsidiaries, HSL Services, Inc., an investment services corporation and
MainStreet Financial Services, Inc., an investment and insurance corporation,
collectively referred to as “the Company.”  The financial statements
do not include the accounts of MainStreet Financial Corporation’s parent
company, MainStreet Financial Corporation, MHC, which owns 53% of the Company’s
common stock.  Intercompany transactions and balances are eliminated
in consolidation.
 
 The
Company provides financial services through its offices in Barry and Ionia
counties of Michigan.  Its primary deposit products are checking,
savings, and term certificate accounts, and its primary lending products are
residential mortgage, commercial, and installment
loans.  Substantially all loans are secured by specific items of
collateral including business assets, consumer assets and real
estate.  Commercial loans are expected to be repaid from cash flows
from operations of businesses.  Real estate loans are secured by both
residential and commercial real estate.  There are no significant
concentrations of loans to any one industry or customer.  However, the
customers’ ability to repay their loans is dependent on the real estate and
general economic conditions in the area.  Other financial instruments
which potentially represent concentrations of credit risk include deposit
accounts in other financial institutions.
 
 In
December 2006, the Company completed a minority stock
offering.  MainStreet Financial Corporation, MHC, retained majority
ownership of the Company.  The offering raised external capital of
$3,554,000, before expenses, through the sale of 47% of the Company’s
stock.   Capital raising costs were deferred and deducted from
the proceeds of the shares sold in the offering.
 
 Use of
Estimates:  To prepare financial statements in conformity with
U.S. generally accepted accounting principles, management makes estimates and
assumptions based on available information.  These estimates and
assumptions affect the amounts reported in the financial statements and the
disclosures provided, and future results could differ.  The allowance
for loan losses, fair values of financial instruments, deferred tax asset
valuation and the carrying values of intangible assets and other real estate
owned are particularly subject to change.
 
 Statement of Cash
Flows:  Cash and cash equivalents include cash, deposits with
other financial institutions under 90 days, and federal funds
sold.  Net cash flows are reported for customer loan and deposit
transactions.
 
 Interest-bearing Deposits in
Other Financial Institutions:  Interest-bearing deposits in
other financial institutions mature within one year and are carried at
cost.
  (Continued)
 
 F-7
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE 1 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
 
 Securities:  Securities
are classified as available for sale because they might be sold before
maturity.  These securities are carried at fair value, with unrealized
holding gains and losses reported in other comprehensive income, net of
tax.
 
 Interest
income includes amortization of purchase premium or
discount.  Premiums and discounts on securities are amortized on the
level-yield method without anticipating prepayments, except for mortgage backed
securities where prepayments are anticipated.
 
 Gains and
losses on sales are recorded on the trade date and determined using the specific
identification method.
 
 Declines
in the fair value of securities below their cost that are other than temporary
are reflected as realized losses.  In estimating other-than-temporary
losses, management considers the length of time and extent that fair value has
been less than cost, the financial condition and near term prospects of the
issuer, and the Company’s ability and intent to hold the security for a period
sufficient to allow for any anticipated recovery in fair value.
 
 Loans Held for
Sale:  Mortgage loans originated and intended for sale in the
secondary market are carried at the lower of aggregate cost or market, as
determined by outstanding commitments from investors.  Net unrealized
losses, if any, are recorded as a valuation allowance and charged to
earnings.  Mortgage loans held for sale are generally sold with
servicing rights released.  Gains and losses on sales of mortgage
loans are based on the difference between the selling price and the carrying
value of the related loan sold.
 
 Loans:  Loans
are reported at the principal balance outstanding, net of unearned interest,
deferred loan fees and costs, and an allowance for loan losses.  Loans
held for sale are reported at the lower of cost or market, on an aggregate
basis.
 
 Interest
income is reported on the interest method and includes amortization of net
deferred loan fees and costs over the loan term.  Interest income is
not reported when full loan repayment is in doubt, typically when the loan is
impaired or payments are significantly past due.  Past due status is
based on the contractual terms of the loan.  In all cases, loans are
placed on nonaccrual or charged-off at an earlier date if collection of
principal or interest is considered doubtful.  Interest income on
mortgage, installment and commercial loans is discontinued at the time the loan
is 90 days past due unless the loan is well secured and in the process of
collection.  All interest accrued but not received for loans placed on
nonaccrual is reversed against interest income.  Interest received on
such 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.
  (Continued)
 
 F-8
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE 1 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
 
 Allowance for Loan
Losses:  The allowance for loan losses is a valuation allowance
for probable incurred credit losses.  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.  Management estimates the allowance balance required using
past loan loss experience, the nature and volume of the portfolio, information
about specific borrower situations and estimated collateral values, economic
conditions, and other factors.
 
 Allocations
of the allowance may be made for specific loans, but the entire allowance is
available for any loan that, in management’s judgment, should be charged
off.
 
 The
allowance consists of specific and general components.  The specific
component relates to loans that are individually classified as impaired or loans
otherwise classified as substandard or doubtful.  The general
component covers non-classified loans and is based on historical loss experience
adjusted for current factors.
 
 A loan is
impaired when full payment under the loan terms is not
expected.  Impairment is evaluated in total for smaller balance loans
of similar nature such as residential mortgage and consumer loans, and on an
individual loan basis for other loans.  If a loan is impaired, a
portion of the allowance is allocated so that the loan is reported net, at the
present value of estimated future cash flows using the loan’s existing rate or
at the fair value of collateral if repayment is expected solely from the
collateral.
 
 Transfers of Financial
Assets:  Transfers of financial assets are accounted for as
sales, when control over the assets has been relinquished.  Control
over transferred assets is deemed to be surrendered when the assets have been
isolated from the Company, the transferee obtains the right (free of conditions
that constrain it from taking advantage of that right) to pledge or exchange the
transferred assets, and the Company does not maintain effective control over the
transferred assets through an agreement to repurchase them before their
maturity.
 
 Other Real Estate
Owned:  Assets acquired through or instead of loan foreclosure
are initially recorded at fair value, defined as estimated sales value less
costs to sell, when acquired, establishing a new cost basis.  If fair
value declines, a valuation allowance is recorded through
expense.  Costs after acquisition are expensed.
 
 Premises and
Equipment:  Premises and equipment are stated at cost less
accumulated depreciation.  Depreciation is computed using the
straight-line method over the estimated useful lives of the related
assets.  Buildings and related components are depreciated using the
straight- line method with useful lives ranging from 10 to 39
years.  Furniture, fixtures and equipment are depreciated using the
straight-line method with useful lives ranging from five to ten
years.
 
  (Continued)
 
 F-9
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE 1 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
 
 Intangible
Assets:  Intangible assets, allocated core deposit value and
unidentified intangibles related to a branch purchase were recorded at fair
value at acquisition and are amortized to expense over their estimated useful
lives.  Core deposit amortization is being recognized using an
accelerated method over 10 years and unidentified intangibles are being
amortized using a straight line method over 15 years.  These assets
are reviewed for impairment when events indicate carrying value may not be
recoverable.
 
 Long-Term
Assets:  Premises and equipment and intangible assets are
reviewed for impairment when events indicate their carrying amounts may not be
recoverable from undiscounted future cash flows.  If impaired, the
assets are recorded at fair value.
 
 Income
Taxes:  Income tax expense is the total of the current year
income tax due or refundable and the change in deferred tax assets and
liabilities.  Deferred tax assets and liabilities are the expected
future tax amounts for the temporary differences between carrying amounts and
tax bases of assets and liabilities, computed using enacted tax
rates.  A valuation allowance, if needed, reduces deferred tax assets
to the amount expected to be realized.
 
 The
Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income
Taxes (“FIN 48”), as of January 1, 2007.A tax position is
recognized as a benefit only if it is "more likely than not" that the tax
position would be sustained in a tax examination, with a tax examination being
presumed to occur.  The amount recognized is the largest amount of tax
benefit that is greater than 50% likely of being realized on
examination.  For tax positions not meeting the "more likely than not"
test, no tax benefit is recorded.  The adoption had no effect on the
Company’s financial statements.  The Company recognizes interest
and/or penalties related to income tax matters, if any, in income tax
expense.
 
 Employee
Benefits:  The Company provides retirement benefits for
eligible full-time employees through contributions to the Financial Institutions
Retirement Fund (FIRF), a qualified multiple-employer defined benefit pension
fund.  The Company’s policy is to fund pension costs
accrued.  Pension expense is based on required contributions to that
plan.  The Company also sponsors a 401(k) plan and provides matching
contributions for a portion of employee 401(k) plan deferrals.  401(k) plan expense is the amount the
Company has committed to contribute to match employee contributions for the
year.
  (Continued)
 
 F-10
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE 1 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
 
 Off-Balance Sheet Financial
Instruments:  Financial instruments include off-balance sheet
credit instruments, such as commitments to make loans and standby letters of
credit, issued to meet customer financing needs.  The face amount for
these items represents the exposure to loss, before considering customer
collateral or ability to repay.  Such financial instruments are
recorded when they are funded.
 
 Comprehensive
Income:  Comprehensive income consists of net income and other
comprehensive income.  Other comprehensive income includes unrealized
gains and losses on securities available for sale which is also recognized as a
separate component of equity.
 
 Employee Stock Ownership
Plan (ESOP):  In conjunction with the 2006 stock offering, the
Company formed an ESOP which borrowed $284,280 from a financial institution and
acquired 28,428 shares of the Company’s stock.  The cost of shares
issued to the ESOP, but not yet allocated to participants, is shown as a
reduction of shareholders’ equity.  Compensation expense is based on
the market price of shares as they are committed to be released to participant
accounts.  Dividends on allocated ESOP shares reduce retained
earnings; dividends on unearned ESOP shares reduce debt and accrued
interest.
 
 Earnings Per
Share:  Basic earnings per share is net income divided by the
weighted average number of common shares outstanding during the periods which
was 734,410 shares for 2008 and 729,554 for 2007.  ESOP shares are
considered outstanding for this calculation unless unearned.  There
are currently no potentially dilutive common shares issuable under stock options
or other programs.  Earnings and dividends per share are restated for
all stock splits and dividends through the date of issue of the financial
statements.
 
  Federal Home Loan Bank
(FHLB) Stock:  The Bank is a member of the FHLB
system.  Members are required to own a certain amount of stock based
on the level of borrowings and other factors, and may invest in additional
amounts.  FHLB stock is carried at cost, classified as a restricted
security, and periodically evaluated for impairment based on ultimate recovery
of par value.  Both cash and stock dividends are reported as
income.
 
 Loss
Contingencies:  Loss contingencies, including claims and legal
actions arising in the ordinary course of business, are recorded as liabilities
when the likelihood of loss is probable and an amount or range of loss can be
reasonably estimated.  Management does not believe there are such
matters at December 31, 2008 or 2007 that will have a material effect on the
financial statements.
 
 Dividend
Restrictions: The Company cannot pay dividends for the foreseeable future
due to its capital levels and other factors.   See Note
12.
  (Continued)
 
 F-11
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE 1 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
 
 Fair Value of Financial
Instruments:  Fair values of financial instruments are
estimated using relevant market information and other assumptions, as more fully
disclosed in a separate note.  Fair value estimates involve
uncertainties and matters of significant judgment regarding interest rates,
credit risk, prepayments, and other factors, especially in the absence of broad
markets for particular items.  Changes in assumptions or in market
conditions could significantly affect the estimates.
  Operating
Segments:  While the chief decision-makers monitor the revenue
streams of the various products and services, operations are managed and
financial performance is evaluated on a Company-wide
basis.  Accordingly, all of the financial service operations are
considered by management to be aggregated in one reportable operating
segment.
 
 Reclassifications:  Some
items in the prior year financial statements were reclassified to conform to the
current presentation.
 
 Effect of Newly Issued
Accounting Standards:
 In
September 2006, the FASB issued Statement No. 157, Fair Value
Measurements.  This Statement defines fair value, establishes a
framework for measuring fair value and expands disclosures about fair value
measurements.  This Statement establishes a fair value hierarchy about
the assumptions used to measure fair value and clarifies assumptions about risk
and the effect of a restriction on the sale or use of an asset.  The
standard is effective for fiscal years beginning after November 15,
2007.  As a result of adopting this standard, the Company added
additional disclosures to the Notes to the financial statements.
 
 In
February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities.  The standard provides
companies with an option to report selected financial assets and liabilities at
fair value and establishes presentation and disclosure requirements designed to
facilitate comparisons between companies that choose different measurement
attributes for similar types of assets and liabilities.  The new
standard is effective for the Company on January 1, 2008.  The Company
did not elect the fair value option for any financial assets or financial
liabilities as of January 1, 2008.
 
  (Continued)
 
 F-12
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
2 – SECURITIES
 
 The fair
value of available for sale securities and the related gross unrealized gains
and losses recognized in accumulated other comprehensive income (loss) were as
follows:
 
 Gross
                    
                    
                    GrossFair
                    
                    
                    Unrealized
                    
                    
                    UnrealizedValue
                    
                    
                    Gains
                    
                    
                    Losses2008Mortgage-backed
      securities
                    
                    $
                    760,735
                    
                    
                    $
                    4,619
                    
                    
                    $
                    16,955Mutual
      fund investment
                    
                    
                    824,255
                    
                    
                    
                    -
                    
                    
                    
                    -$
                    1,584,990
                    
                    
                    $
                    4,619
                    
                    
                    $
                    16,9552007Mortgage-backed
      securities
                    
                    $
                    886,048
                    
                    
                    $
                    7,187
                    
                    
                    $
                    13,690Mutual
      fund investment
                    
                    
                    1,038,365
                    
                    
                    
                    -
                    
                    
                    
                    23,651$
                    1,924,413
                    
                    
                    $
                    7,187
                    
                    
                    $
                    37,341
 
 Mortgage-backed
securities are issued by U.S. Government-sponsored entities.  The
mutual fund invests primarily in short-term adjustable rate mortgage-backed
securities.
 
 There
were no sales of securities or mutual fund shares in 2008 or 2007.
 
  Securities
with unrealized losses, aggregated by investment category and length of time
that individual securities have been in a continuous unrealized loss position,
are as follows:
 
 Less than 12 Months
                      
                      
                      12 Months or More
                      
                      
                      TotalFair
                      
                      
                      Unrealized
                      
                      
                      Fair
                      
                      
                      Unrealized
                      
                      
                      Fair
                      
                      
                      UnrealizedValue
                      
                      
                      Loss
                      
                      
                      Value
                      
                      
                      Loss
                      
                      
                      Value
                      
                      
                      Loss2008Mortgage-backed
                      
                      $
                      252,546
                      
                      
                      $
                      (1,550
                      )
                      
                      $
                      355,804
                      
                      
                      $
                      (15,405
                      )
                      
                      $
                      608,350
                      
                      
                      $
                      (16,955
                      )2007Mortgage-backed
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      399,927
                      
                      
                      $
                      (13,690
                      )
                      
                      $
                      399,927
                      
                      
                      $
                      (13,690
                      )Mutual fund
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      1,038,365
                      
                      
                      
                      (23,651
                      )
                      
                      
                      1,038,365
                      
                      
                      
                      (23,651
                      )$
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      1,438,292
                      
                      
                      $
                      (37,341
                      )
                      
                      $
                      1,438,292
                      
                      
                      $
                      (37,341
                      )
 
 During
2008, management determined its mutual fund investment was
other-than-temporarily impaired.  As a result, management recognized
impairment losses of $281,544 during 2008.
 
 For
mortgage-backed securities a loss has been recognized into income because
management has the intent and ability to hold these securities for the
foreseeable future.
 
  (Continued)
 
 F-13
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE 2 – SECURITIES
(Continued)
 
 The
decline in the fair value of the mortgage-backed securities is expected to
recover as these securities approach their maturity date or as interest rates
change.
 Mortgage-backed
securities with a carrying value of approximately $773,000 at December 31, 2008
were pledged to secure FHLB advances.
 
 NOTE
3 – LOANS
 
 Loans at
year end are summarized as follows:
 
 2008
                      
                      
                      2007Real
      estate loans secured by:One-to-four-family
      residential properties
                      
                      $
                      69,823,086
                      
                      
                      $
                      74,463,818Home
      Equity
                      
                      
                      6,633,707
                      
                      
                      
                      5,476,501Construction
      and development projects
                      
                      
                      2,163,404
                      
                      
                      
                      2,054,384Commercial
      real estate and business loans
                      
                      
                      11,462,447
                      
                      
                      
                      12,868,148Consumer
      loans
                      
                      
                      5,494,396
                      
                      
                      
                      6,172,793Less:Loans
      in process
                      
                      
                      (903,026
                      )
                      
                      
                      (418,938
                      )Deferred
      (fees) and costs, net
                      
                      
                      64,281
                      
                      
                      
                      41,374Allowance
      for loan losses
                      
                      
                      (858,370
                      )
                      
                      
                      (508,364
                      )Loans,
      net
                      
                      $
                      93,879,925
                      
                      
                      $
                      100,149,716
 
 Loans
serviced for others are not included in the accompanying consolidated balance
sheets.  The unpaid principal balance of such loans was approximately
$7,274,000 and $3,919,000 at December 31, 2008 and 2007.
 
 Activity
in the allowance for loan losses is summarized as follows:
  2008
                
                
                2007Balance
      at beginning of period
                
                $
                508,364
                
                
                $
                537,667Provision
      charged to income
                
                
                929,901
                
                
                
                258,000Recoveries
                
                
                18,396
                
                
                
                56,045Charge-offs
                
                
                (598,291
                )
                
                
                (343,348
                )Balance
      at end of period
                
                $
                858,370
                
                
                $
                508,364
 
  (Continued)
 
 F-14
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE 3 – LOANS(Continued)
 
 Impaired
loans, as defined by SFAS No. 114, Accounting by Creditors for
Impairment of a Loan, were as follows:
 
 2008
                    
                    
                    2007Year-end
      loans with no allocated allowancefor
      loan losses
                    
                    $
                    1,394,000
                    
                    
                    $
                    794,000Year-end
      loans with allocated allowancefor
      loan losses
                    
                    
                    729,000
                    
                    
                    
                    420,000Total
                    
                    $
                    2,123,000
                    
                    
                    $
                    1,214,000Amount
      of the allowance allocated
                    
                    $
                    170,000
                    
                    
                    $
                    59,000Average
      of individually impaired loans during year
                    
                    $
                    2,110,000
                    
                    
                    $
                    1,214,000Interest
      income recognized during impairment
                    
                    
                    15,330
                    
                    
                    
                    ---Cash-basis
      interest income recognized
                    
                    
                    6,840
                    
                    
                    
                    ---Nonperforming
      loans were as follows:Loans
      past due over 90 days still on accrual
                    
                    $
                    988,488
                    
                    
                    $
                    552,778Nonaccrual
      loans
                    
                    
                    2,349,974
                    
                    
                    
                    1,479,177
 
 Nonperforming
loans includes both smaller balance homogeneous loans that are collectively
evaluated for impairment and individually classified impaired
loans.
 
 Specific
loans secured by one-to-four-family residences with a carrying value of
approximately $49,755,000 and $40,707,000 at December 31, 2008 and 2007 were
pledged to secure FHLB advances.
 
 
  (Continued)
 
 F-15
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
4 - PREMISES AND EQUIPMENT
 
 A summary
of premises and equipment at period end is as follows:
 
 2008
                
                
                2007Land
      and improvements
                
                $
                712,658
                
                
                $
                705,822Buildings
                
                
                4,059,138
                
                
                
                4,059,138Furniture
      and equipment
                
                
                2,039,669
                
                
                
                2,035,0346,811,465
                
                
                
                6,799,994Accumulated
      depreciation
                
                
                (3,421,504
                )
                
                
                (3,242,476
                )$
                3,389,961
                
                
                $
                3,557,518
 
 Depreciation
expense was $179,028 and $246,897 for 2008 and 2007.
 
 Operating Leases: The
Company leases certain branch properties under operating leases.  Rent
expense was $61,169 and $54,166 for the calendar years 2008 and
2007.  Firm rent commitments at December 31, 2008, including
consideration of termination options and not including renewal options that
generally are present, were not significant at December 31, 2008.
 
 NOTE
5 – INTANGIBLE ASSETS
 
 2008
                
                
                2007Gross
                
                
                
                
                
                GrossCarrying
                
                
                Accumulated
                
                
                Carrying
                
                
                AccumulatedAmount
                
                
                Amortization
                
                
                Amount
                
                
                AmortizationAmortized
      intangible assets:Core
      deposit intangible
                
                $
                -
                
                
                $
                -
                
                
                $
                379,957
                
                
                $
                376,744Other
      unidentifiedintangibles
                
                
                2,327,038
                
                
                
                1,629,273
                
                
                
                2,327,038
                
                
                
                1,474,215$
                2,327,038
                
                
                $
                1,629,273
                
                
                $
                2,706,995
                
                
                $
                1,850,959
 
 The
Company’s core deposit intangible was fully amortized during 2008.
 
 Aggregate
amortization expense was $158,271 and $162,907 for the years ended December 31,
2008 and 2007.
 
 
 
  (Continued)
 
 F-16
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE 5 – INTANGIBLE ASSETS
(Continued)
 
 Estimated
amortization expense for each of the next five years:
 
 2009
                  
                  $
                  155,0592010
                  
                  
                  155,0592011
                  
                  
                  155,0592012
                  
                  
                  155,0592013
                  
                  
                  77,529
 
 NOTE
6 - DEPOSITS
 
  The
aggregate amount of time deposit accounts (including certificates of deposit)
with a minimum denomination of $100,000 was approximately $30,228,000 and
$44,368,000 at December 31, 2008 and 2007.
 
 Brokered
deposits totaled approximately $6,448,000 and $24,448,000 at December 31, 2008
and 2007.  At December 31, 2008 and December 31, 2007, brokered
deposits had interest rates ranging from 3.55% to 5.25% and 4.65% to 5.35%,
respectively.  In general, deposit amounts greater than $250,000 are
not insured.
 
  At
December 31, 2008, the scheduled maturities of certificates of deposits are as
follows:
 
 2009
                  
                  $
                  37,578,9642010
                  
                  
                  4,758,2622011
                  
                  
                  713,8132012
                  
                  
                  251,7792013
                  
                  
                  395,740Thereafter
                  
                  
                  40,690$
                  43,739,248
 
 Interest
expense by deposit type for the period indicated is as follows:
 
 2008
                  
                  
                  2007Savings
                  
                  $
                  34,000
                  
                  
                  $
                  36,000Demand/NOW
                  
                  
                  188,000
                  
                  
                  
                  134,000Certificates
                  
                  
                  2,043,000
                  
                  
                  
                  2,950,000$
                  2,265,000
                  
                  
                  $
                  3,120,000
 
  (Continued)
 
 F-17
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
7 - FEDERAL HOME LOAN BANK ADVANCES
 
 Advances
from the Federal Home Loan Bank at December 31, 2008 and 2007 were:
 
 December
      31, 2008
                    
                    
                    December
      31, 2007Weighted
                    
                    
                    
                    
                    
                    
                    
                    
                    WeightedInterest
      Rate
                    
                    
                    Average
                    
                    
                    
                    
                    
                    Interest
      Rate
                    
                    
                    AverageRanges
                    
                    
                    Rate
                    
                    
                    Balance
                    
                    
                    Ranges
                    
                    
                    Rate
                    
                    
                    BalanceVariable
      rate advances maturingand
      payments due in calendaryear:2008
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    3.75
                    %
                    
                    
                    3.75
                    %
                    
                    $
                    2,000,0002009
                    
                    
                    .65
                    
                    
                    
                    .65
                    %
                    
                    $
                    23,500,000Fixed
      rate advances maturingand
      payments due in calendaryear:2008
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    4.65
      to 5.53
                    %
                    
                    
                    5.07
                    %
                    
                    
                    15,000,0002009
                    
                    2.51
      to 4.92
                    %
                    
                    
                    4.13
                    
                    
                    
                    9,800,000
                    
                    
                    4.08
      to 4.92
                    
                    
                    
                    4.68
                    
                    
                    
                    7,000,0002010
                    
                    
                    4.98
                    %
                    
                    
                    4.98
                    
                    
                    
                    2,400,000
                    
                    
                    
                    4.98
                    
                    
                    
                    4.98
                    
                    
                    
                    2,400,000$
                    35,700,000
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    $
                    26,400,000
 
 All
advances require monthly interest payments and are due, in full, at
maturity.
  
 Certain
FHLB advances have put features that allow the FHLB to change the advance to
variable rate, at its option.  If that option is exercised, the Bank
may repay the advance without penalty.  Advances with such put
features had a balance of $2,400,000 at December 31, 2008 and $9,400,000 at
December 31, 2007.
 
 FHLB
advances are collateralized by specific loans and securities held by the
FHLB.  Prepayment of the advances is subject to the provisions,
conditions and penalties of the credit policy of the Federal Home Loan Bank of
Indianapolis.
 
  (Continued)
 
 F-18
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
8 – EMPLOYEE BENEFITS
 
 Participation
in the Financial Institutions Retirement Fund includes all eligible
employees.  To be eligible, an employee must be at least 21 years old
and work at least 1,000 hours over the prior year.  There is no
separate valuation of plan benefits nor segregation of plan assets specifically
for the Company because the plan is a multiple-employer plan and separate
actuarial valuations are not made with respect to each employer nor are the plan
assets so segregated.
 
 Plan
contributions for the years ended December 31, 2008 and 2007 were $133,886 and
$173,694, respectively.
 
 Upon
withdrawal from the plan, the Company would be required to continue to fund its
share of the plan's unfunded vested benefits, if any.  The Company,
however, has no present intention of withdrawing from the plan.
 
 The
Company also sponsors a 401(k) plan that covers substantially all
employees.  Employees may elect to contribute to the plan from 1% to
15% of their salary subject to statutory limitations.  The Company
makes matching contributions equal to 50% of employee
contributions.  The Company’s contributions for the years ended
December 31, 2008 and 2007 were $29,216 and $19,892, respectively.
 
 The
Company has sponsored a deferred compensation plan that was available to senior
officers and directors.  Plan participants who elect to defer a
portion of their salary received interest on the amount deferred at prevailing
two-year certificate of deposit interest rates.  Expense related to
the plan was $11,118 and $19,049 for the years ended December 31, 2008 and
2007.  The plan was discontinued in 2008 and the related liability of
approximately $518,000 was paid to participants during the year.
 
 
  (Continued)
 
 F-19
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
9 – ESOP PLAN
 
 Employees
participate in an Employee Stock Option Plan (ESOP).  The ESOP
borrowed $284,280 from another financial institution to purchase 28,428 shares
of stock in the initial public offering at $10 per share.  The Company
makes discretionary contributions to the ESOP and may pay dividends on
unallocated shares to the ESOP.  The ESOP uses funds it receives to
repay the loan.  When loan payments are made, ESOP shares are
allocated to participants based on relative compensation. Compensation expense
is based on the fair value of shares earned.  Dividends on allocated
shares increase participant accounts.
 
 Participants
receive the shares at the end of employment.  A participant may
require stock received to be repurchased unless the stock is traded on an
established market.
 
 Contributions
to the ESOP for the years ended December 31, 2008 and 2007 were $49,536 and
$52,883 respectively.  Expense for 2008 and 2007 was $27,619 and
$57,797.
 Shares
held by the ESOP we as follows:
 
 2008
                
                
                2007Allocated
      to participants
                
                
                7,054
                
                
                
                3,648Unearned
                
                
                21,374
                
                
                
                24,780Total
      ESOP shares
                
                
                28,428
                
                
                
                28,428Fair
      value of unearned shares
                
                $
                3,205
                
                
                $
                156,114Fair
      value of allocated shares subject to repurchase obligation
                
                $
                1,059
                
                
                $
                22,982
 
 The ESOP
was funded by a loan from another financial institution, which is guaranteed by
the Company.  The loan has a ten year term and requires annual
principal and interest payments beginning in 2007.  Upon payment,
shares are released for allocation following a formula.  The loan also
requires the Company to comply with certain financial covenants, which, if not
achieved could allow the lender to accelerate collection of the
loan.  As of December 31, 2008, the Company was not in compliance with
certain covenants, but the lender has agreed to waive acceleration of loan
collection.  See Note 16 for further discussion.
 
 
  (Continued)
 
 F-20
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
10 - FEDERAL INCOME TAXES
 
 The
provision for federal taxes consists of the following:
 
 2008
                
                
                2007Current
                
                $
                -
                
                
                $
                -Deferred
                
                
                (682,071
                )
                
                
                (296,111
                )Change in valuation allowance
                
                
                682,071
                
                
                
                732,696$
                -
                
                
                $
                436,585
 
 The
provision (benefit) for federal income taxes differs from that computed at the
statutory corporate tax rate of 34% as follows:
 
 2008
                
                
                2007Tax expense (benefit) at statutory rate
                
                $
                (673,989
                )
                
                $
                (309,046
                )Change in valuation allowance
                
                
                682,071
                
                
                
                732,696Other
                
                
                (8,082
                )
                
                
                12,935$
                -
                
                
                $
                436,585
 
 The tax
effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred tax liabilities are as follows:
 
 2008
                
                
                2007Deferred
      tax assetsAcquisition
      intangibles
                
                $
                34,030
                
                
                $
                41,588Allowance
      for loan losses
                
                
                305,907
                
                
                
                179,712Deferred
      compensation
                
                
                -
                
                
                
                172,291Net
      operating loss carry-forward
                
                
                1,219,608
                
                
                
                489,461Contribution
      carryforward
                
                
                24,422
                
                
                
                20,671Non-accrual
      loan interest
                
                
                66,317
                
                
                
                55,575Other
                
                
                -
                
                
                
                4,1631,650,284
                
                
                
                963,461Deferred
      tax liabilitiesFHLB
      dividends
                
                
                (49,661
                )
                
                
                (49,355
                )Accumulated
      depreciation
                
                
                (163,657
                )
                
                
                (167,099
                )Deferred
      loan costs
                
                
                (22,199
                )
                
                
                (14,311
                )(235,517
                )
                
                
                (230,765
                )Valuation
      allowance
                
                
                (1,414,767
                )
                
                
                (732,696
                )Net
      deferred tax asset
                
                $
                -
                
                
                $
                -
  (Continued)
 
 F-21
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE 10 - FEDERAL INCOME TAXES
(Continued)
 
 At
year-end 2008, the Company had federal net operating loss carryforwards of
approximately $3,590,000. The net operating losses may be carried forward for 20
years and begin expiring in 2021.  Management has determined that a
valuation allowance to reduce deferred tax assets was needed at December 31,
2008.
  
 Retained
earnings at December 31, 2008 and 2007 include approximately $1,882,000 for
which no federal income tax liability has been recorded.  This amount
represents an allocation of income to bad debt deductions for tax purposes
alone.  Reduction of amounts so allocated for purposes other than tax
bad debt losses or adjustments from carryback of net operating losses would
create income for tax purposes only, which would be subject to current
tax.  The unrecorded deferred tax liability on the above amounts was
approximately $640,000.
 
 There
were no unrecognized tax benefits at December 31, 2008.  The Company
does not expect the balance of unrecognized tax benefits to significantly change
in the next twelve months.  The Company is no longer subject to
examination by the Internal Revenue Service for years prior to
2005.
 
 
 NOTE
11 – RELATED PARTY TRANSACTIONS
 
 Loans to
principal officers, directors, and their affiliates during 2008 were as
follows:
 
 Beginning
      balance
                  
                  $
                  1,757,981New
      loans
                  
                  
                  1,243,460Repayments
                  
                  
                  (1,335,039
                  )Ending
      balance
                  
                  $
                  1,666,402
 
 Deposits
from principal officers, directors, and their affiliates at year-end 2008 and
2007 were approximately $1,152,000 and $1,117,000.
 
 NOTE
12 - CAPITAL REQUIREMENTS AND REGULATORY MATTERS
 
 The Bank
is subject to regulatory capital requirements administered by federal regulatory
agencies.  Capital adequacy guidelines and prompt corrective action
regulations involve quantitative measures of assets, liabilities, and certain
off-balance-sheet items calculated under regulatory accounting
practices.  Capital amounts and classifications are also subject to
qualitative judgments by regulators.  Failure to meet various capital
requirements can initiate regulatory action.
  (Continued)
 
 F-22
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE 12 - CAPITAL REQUIREMENTS
AND REGULATORY MATTERS
(Continued)
 
 The
prompt corrective action regulations provide five classifications, including
well-capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized, and critically undercapitalized, although these terms are not
used to represent overall financial condition.  If adequately
capitalized, regulatory approval is required to accept brokered
deposits.  If undercapitalized, capital distributions are limited, as
is asset growth and expansion, and plans for capital restoration are
required.  See Note 18 for further discussion. At year-end 2008, the
most recent regulatory notification categorized the Bank as adequately
capitalized under the regulatory framework for prompt corrective
action.  There are no conditions or events since that notification
that management believes have changed the institution's category.  The
Bank's actual capital levels (in thousands) and minimum required levels
were:
  
 Actual
                      
                      
                      Minimum
      Required
                        for
      Capital
                        Adequacy Purposes
                      
                      
                      Minimum
      Required
                        To
      Be Well
                        Capitalized
                        Under
      Prompt Corrective
                        Action RegulationsAmount
                      
                      
                      Ratio
                      
                      
                      Amount
                      
                      
                      Ratio
                      
                      
                      Amount
                      
                      
                      RatioDecember 31, 2008Total
      adjusted capital (to riskweighted
      assets)
                      
                      $
                      5,872
                      
                      
                      
                      8.4
                      %
                      
                      $
                      5,629
                      
                      
                      
                      8.0
                      %
                      
                      $
                      7,036
                      
                      
                      
                      10.0
                      %Tier
      1 (core) capital (to risk weightedassets)
                      
                      
                      5,014
                      
                      
                      
                      7.1
                      
                      
                      
                      2,815
                      
                      
                      
                      4.0
                      
                      
                      
                      4,222
                      
                      
                      
                      6.0Tier
      1 (core) capital (to adjusted totalassets)
                      
                      
                      5,014
                      
                      
                      
                      4.5
                      
                      
                      
                      4,440
                      
                      
                      
                      4.0
                      
                      
                      
                      5,549
                      
                      
                      
                      5.0Tangible
      capital (to adjusted totalassets)
                      
                      
                      5,014
                      
                      
                      
                      4.5
                      
                      
                      
                      1,664
                      
                      
                      
                      1.5
                      
                      
                      
                      N/A
                      
                      
                      
                      N/ADecember 31, 2007Total
      adjusted capital (to riskweighted
      assets)
                      
                      $
                      7,204
                      
                      
                      
                      10.2
                      %
                      
                      $
                      5,655
                      
                      
                      
                      8.0
                      %
                      
                      $
                      7,069
                      
                      
                      
                      10.0
                      %Tier
      1 (core) capital (to risk weightedassets)
                      
                      
                      6,696
                      
                      
                      
                      9.5
                      
                      
                      
                      N/A
                      
                      
                      
                      N/A
                      
                      
                      
                      4,241
                      
                      
                      
                      6.0Tier
      1 (core) capital (to adjusted totalassets)
                      
                      
                      6,696
                      
                      
                      
                      5.9
                      
                      
                      
                      4,563
                      
                      
                      
                      4.0
                      
                      
                      
                      5,704
                      
                      
                      
                      5.0
 
 The
Qualified Thrift Lender (QTL) test requires 65% of assets be maintained in
housing-related finance and other specified assets.  If the QTL test
is not met, limits are placed on growth, branching, new investments, FHLB
advances, and dividends, or the institution must convert to a commercial bank
charter.  It is management's opinion that the QTL test was met as of
December 31, 2008 and 2007.
  (Continued)
 
 F-23
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE 12 - CAPITAL REQUIREMENTS
AND REGULATORY MATTERS
(Continued)
 
 The Bank
was notified by the Office of Thrift Supervision (OTS) in February 2008 that it
was deemed to be in “troubled” condition, and, as a result, is subject to
specified operating restrictions which include limitations on asset growth and
prior regulatory of certain compensation agreements proposed transactions with
affiliates.  In March 2008, OTS asked the Bank to enter into a
supervisory agreement to address their concerns regarding the financial
condition of the Bank.  Among other things, the supervisory agreement
limits growth, precludes dividend payments, required the Bank to prepare and
submit an updated business plan and to provide regular reports on classified
assets.
 
 NOTE
13 - COMMITMENTS AND CONTINGENT LIABILITIES
 
 The
Company is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet financing needs of its
customers.  These financial instruments include commitments to make
loans.  The Company's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for commitments to
make loans is represented by the contractual amount and terms of those
instruments.  The Company follows the same credit policy to make such
commitments as is followed for those loans recorded in the financial
statements.
 
 As of
December 31, 2008 and 2007, the Company had the following:
 
 2008
                  
                  
                  2007Commitments
      to make loans
                  
                  $
                  965,000
                  
                  
                  $
                  161,000Unused
      lines of credit
                  
                  
                  5,549,000
                  
                  
                  
                  5,323,000Loans
      in process
                  
                  
                  903,000
                  
                  
                  
                  419,000
 
 Fixed
rate loan commitments as of December 31, 2008 and 2007 were $961,000 and
$161,000.  These commitments had interest rates ranging from 5.38% to
6.50% at December 31, 2008 (6.38% to 7.38% at December 31, 2007) and maturities
of  5 years at December 31, 2008 (four to five years at December 31,
2007).  Variable rate loan commitments are at market rates and were
$4,000 and $0 at December 31, 2008 and 2007.
 
 Since
certain commitments to make loans and fund loans in process expire without being
used, the amount does not necessarily represent future cash
commitments.  Commitment periods are generally for 45
days.  No losses are anticipated as a result of these
transactions.
  
 
  (Continued)
 
 F-24
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
14 – OTHER COMPREHENSIVE INCOME (LOSS)
 
 Other
comprehensive income (loss) components and related tax effect were as
follows:
 
 2008
                  
                  
                  2007Unrealized
      holding gains (losses)on
      available for sale securities
                  
                  $
                  (263,726
                  )
                  
                  $
                  (10,949
                  )Reclassification
      adjustments for (gains)and
      losses later recognized
                  
                  
                  281,544
                  
                  
                  
                  -Net
      unrealized gain (loss)
                  
                  
                  17,818
                  
                  
                  
                  (10,949
                  )Income
      tax expense (benefit)
                  
                  
                  -
                  
                  
                  
                  (6,530
                  )Other
      comprehensive income (loss)
                  
                  $
                  17,818
                  
                  
                  $
                  (17,479
                  )
 
 
 NOTE
15 - FAIR VALUES OF FINANCIAL INSTRUMENTS
 FAIR VALUE
MEASUREMENTS:
 
 Statement 157 establishes a fair value
hierarchy which requires an entity to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value.The standard describes three levels of
inputs that may be used to measure fair value:
 
 Level 1: Quoted prices (unadjusted) for
identical assets or liabilities in active markets that the entity has the
ability to access as of the measurement date.
 
 Level 2: Significant other observable
inputs other than Level 1 prices such as quoted prices for similar assets or
liabilities; quoted prices in markets that are not active; or other inputs that
are observable or can be corroborated by observable market
data.
 
 Level 3: Significant unobservable inputs
that reflect a reporting entity’s own assumptions about the value that market
participants would use in pricing an asset or liability.
 
 The fair values of securities available
for sale are determined by obtaining quoted prices on nationally recognized
securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical
technique widely used in the industry to value debt securities without relying
exclusively on quoted prices for the specific securities but rather by relying
on the securities’ relationship to other benchmark quoted securities (Level 2
inputs).
 
 The fair value of impaired loans with
specific allocations of the allowance for loan losses is generally based on
recent real estate appraisals.  These appraisals may utilize a single
valuation approach or a combination of approaches including comparable sales and
the income approach.  Adjustments are routinely made in the appraisal
process by the appraisers to adjust for differences between the
comparable
 
  (Continued)
 
 F-25
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
15 - FAIR VALUES OF FINANCIAL INSTRUMENTS
 FAIR
VALUE MEASUREMENTS:(Continued)
 
 sales and income data
available.  Such adjustments are typically significant and result in a
Level 3 classification of the inputs for determining fair
value.
 
 Assets and
Liabilities Measured on a Recurring Basis
 
 Assets and liabilities measured at fair
value on a recurring basis are summarized below:
 
 Fair Value Measurements at
      December 31, 2008 UsingDecember
                31,2008
              
              Quoted Prices in Active Markets
      for Identical Assets
                (Level 1)
              
              Significant Other Observable
      Inputs (Level 2)
              
              Significant Unobservable
      Inputs
                (Level
3)Assets:Available for sale
      securities
              $1,585,000
              
              
              
              $1,585,000
 
 Assets and
Liabilities Measured on a Non-Recurring Basis
 
 Assets and liabilities measured at fair
value on a non-recurring basis are summarized below:
 
 Fair Value Measurements at
      December 31, 2008 UsingDecember 31,
      2008
              
              Quoted Prices in Active Markets
      for Identical Assets
                (Level 1)
              
              Significant Other Observable
      Inputs (Level 2)
              
              Significant Unobservable
      Inputs
                (Level
3)Assets:Impaired
    loans
              $729,000
              
              
              
              
              
              $559,000
 
 Impaired
loans, which are measured for impairment using the fair value of collateral for
collateral dependent loans, had a principal balance of $729,000, with a
valuation allowance of $170,000, resulting in additional provision for loan
losses of $111,000.
 
 
  (Continued)
 
 F-26
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
15 - FAIR VALUES OF FINANCIAL INSTRUMENTS
 FAIR
VALUE MEASUREMENTS:(Continued)
 
 Carrying
amount and estimated fair values of financial instruments (in thousands) were as
follows:
 
 2008
                
                
                2007Carrying
                
                
                Fair
                
                
                Carrying
                
                
                FairAmount
                
                
                Value
                
                
                Amount
                
                
                ValueFinancial
      assetsCash
      and cash equivalents
                
                $
                7,923
                
                
                $
                7,923
                
                
                $
                5,171
                
                
                $
                5,171Securities
                
                
                1,585
                
                
                
                1,585
                
                
                
                1,924
                
                
                
                1,924Loans,
      net
                
                
                93,880
                
                
                
                90,894
                
                
                
                100,150
                
                
                
                99,891FHLB
      stock
                
                
                1,785
                
                
                
                N/A
                
                
                
                1,589
                
                
                
                N/AAccrued
      interest receivable
                
                
                550
                
                
                
                550
                
                
                
                605
                
                
                
                605Financial
      liabilitiesDeposits
                
                $
                69,407
                
                
                $
                70,418
                
                
                $
                79,405
                
                
                $
                80,091FHLB
      advances
                
                
                35,700
                
                
                
                35,995
                
                
                
                26,400
                
                
                
                26,624Notes
      payable
                
                
                927
                
                
                
                927
                
                
                
                956
                
                
                
                956Accrued
      interest payable
                
                
                64
                
                
                
                64
                
                
                
                189
                
                
                
                189
 
 The
methods and assumptions used to estimate fair value are described as
follows:
 
 Carrying
amount is the estimated fair value for cash and cash equivalents, interest
bearing deposits, accrued interest receivable and payable, demand deposits,
short-term debt, and variable rate loans or deposits that reprice frequently and
fully.  For fixed rate loans or deposits and for variable rate loans
or deposits with infrequent repricing or repricing limits, fair value is based
on discounted cash flows using current market rates applied to the estimated
life and credit risk.  Fair values for impaired loans are estimated
using discounted cash flow analysis or underlying collateral
values.  Fair value of debt is based on current rates for similar
financing. It was not practicable to estimate the fair value of the FHLB stock
due to restrictions placed on its transferability.   The fair
value of off-balance-sheet items is not considered material.
 
  (Continued)
 
 F-27
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
16 – NOTES PAYABLE
 
 On
December 31, 2008 and 2007, the Company’s balance in its commercial bank line of
credit was $700,000.  This line of credit was obtained in prior
years.  The loan matures on June 15, 2010, requires quarterly interest
payments at a rate of 3% over three-month LIBOR and is secured by a pledge of
the Bank’s common stock.  The loan agreement contains certain
financial covenants which, if not complied with, could allow the lender to
accelerate repayment of the loan.
 
 At
December 31, 2008 and 2007, the Company was not in compliance with certain of
these covenants, yet the lender has agreed not to accelerate collection of the
loan until June 30, 2009 provided there are no further events of
default.
 
 NOTE
17 – CONDENSED FINANCIAL STATEMENTS (PARENT COMPANY ONLY)
 
 Following
are condensed parent company only financial statements:
 
 CONDENSED
BALANCE SHEETS
 
 2008
                
                
                2007ASSETSCash
      and cash equivalents
                
                $
                169,930
                
                
                $
                260,709Investment
      in Bank subsidiary
                
                
                5,927,042
                
                
                
                7,778,032Other
      assets
                
                
                32,499
                
                
                
                71,380Total
      assets
                
                $
                6,129,471
                
                
                $
                8,110,121LIABILITIES
      AND SHAREHOLDERS’ EQUITYNote
      payable
                
                $
                700,000
                
                
                $
                700,000ESOP
      note payable
                
                
                227,424
                
                
                
                255,852Total
      liabilities
                
                
                927,424
                
                
                
                955,852Shareholders’
      equity
                
                
                5,202,047
                
                
                
                7,154,269Total
      liabilities and shareholders’ equity
                
                $
                6,129,471
                
                
                $
                8,110,121
 
  (Continued)
 
 F-28
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
17 – CONDENSED FINANCIAL STATEMENTS (PARENT COMPANY ONLY)
 (Continued)
 
 CONDENSED
STATEMENTS OF INCOME
 
 2008
                
                
                2007IncomeInterest
      income
                
                $
                2,695
                
                
                $
                6,325ExpenseInterest
      expense
                
                
                46,844
                
                
                
                56,670Other
      expense
                
                
                85,511
                
                
                
                85,561Total
      expense
                
                
                132,355
                
                
                
                142,231Loss
      before income tax and equity inundistributed
      net loss of subsidiaries
                
                
                (129,660
                )
                
                
                (135,906
                )Equity
      in undistributed net loss of subsidiary
                
                
                (1,852,662
                )
                
                
                (1,140,372
                )Loss
      before income tax benefit (expense)
                
                
                (1,982,322
                )
                
                
                (1,276,278
                )Income
      tax benefit (expense)
                
                
                -
                
                
                
                (69,265
                )Net
      loss
                
                $
                (1,982,322
                )
                
                $
                (1,345,543
                )
 
 (Continued)
 
 F-29
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
17 – CONDENSED FINANCIAL STATEMENTS (PARENT COMPANY ONLY)
 (Continued)
 
 CONDENSED
STATEMENTS OF CASH FLOWS
 
 2008
                
                
                2007Cash
      flows from operating activitiesNet
      income (loss)
                
                $
                (1,982,322
                )
                
                $
                (1,345,543
                )Adjustments
      to reconcile net income to net cashprovided
      by (used in) operating activities:Equity
      in loss of subsidiary
                
                
                1,852,662
                
                
                
                1,140,372(Increase)
      decrease in other assets
                
                
                38,881
                
                
                
                (2,115
                )Increase
      (decrease) in other liabilities
                
                
                28,428
                
                
                
                (49,350
                )Net
      cash used for operating activities
                
                
                (62,351
                )
                
                
                (256,636
                )Cash
      flows from investing activitiesInvestment
      in subsidiary
                
                
                -
                
                
                
                (62,695
                )Net
      cash used for investing activities
                
                
                -
                
                
                
                (62,695
                )Cash
      flows from financing activitiesPublic
      offering costs
                
                
                -
                
                
                
                (114,993
                )Payments
      on note payable
                
                
                (28,428
                )
                
                
                (28,428
                )Net
      cash from financing activities
                
                
                (28,428
                )
                
                
                (143,421
                )Net
      change in cash and cash equivalents
                
                
                (90,779
                )
                
                
                (462,752
                )Cash
      and cash equivalents at beginning of year
                
                
                260,709
                
                
                
                723,461Cash
      and cash equivalents at end of year
                
                $
                169,930
                
                
                $
                260,709
 
 (Continued)
 
 F-30
 
 MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2008 and 2007
  NOTE
18 – MANAGEMENT’S PLANS REGARDING CONTINUING OPERATIONS
 
 The
Company recorded significant operating losses in 2008 and 2007 resulting
primarily from increased levels of problem loans and substantially higher
provisions for loan losses.  In addition, in 2008 the Company recorded
other-than-temporary losses on a mutual fund investment and incurred higher
regulatory assessments and deposit insurance costs.  These increased
costs more than offset the benefit of their increased net interest
margin.
 
 Management
has undertaken a variety of initiatives to manage overhead costs, improve net
interest income and non interest income and manage loan related
costs.  However, the difficult economic environment is negatively
impacting the Company’s customers’ ability to repay their loans and the value of
the collateral securing their loans.  In addition, it is likely that
regulatory and deposit insurance assessments will continue to increase in 2009
and the Bank’s primarily regulators deal with the environment.
 
 Management
believes the Company has sufficient liquid assets and access to alternative
funding sources to continue to operate normally.  As described in Note
16, the covenant violations affecting the Company’s notes payable have been
waived, thus they are not currently due.  While the waiver is until
June 30, 2009, the lender has historically granted such waivers and management
expects they will continue to work with the Company in the future.
 
 As
described in Note 12, these operating losses resulted in the Bank no longer
being considered well capitalized, as defined by its federal
regulator.  Further, the Company’s primary regulator deemed the Bank
to be in “troubled” condition and required the Bank to enter into a supervisory
agreement in March 2008 which, among other thing, restricts asset growth and
requires ongoing reporting and increased supervision.  At December 31,
2008, the Bank was adequately capitalized and its total risk based capital ratio
of 8.35% only exceeded the adequately capitalized minimum by approximately
$240,000.  Accordingly, if operating losses continue and management is
not able to sufficiently reduce risk weighted assets or raise additional
capital, it is possible that the Bank will become undercapitalized and could,
then become subject to additional regulatory operation restrictions or,
potentially, be ordered to raise capital or undertake other actions that it may
or may not be able to achieve.
 
  F-31