ANNUAL
      REPORT TO SHAREHOLDERS
              FOR
      THE YEAR ENDED
              DECEMBER
      31, 2007
              
              
              
              
              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                                                                                                                        1





Selected
Consolidated Financial
Information                                                                                                 2





Corporate
Information                                                                                                                          
4





Shareholder
Information                                                                                                                        5





Management's
Discussion and Analysis of Financial


Condition
and Results of
Operations                                                                                                             6





Index to
Consolidated Financial
Statements                                                                                                   21


























A
Message from the President








Dear
Fellow Shareholders:





As we
enter 2008, we continue to be very frustrated with the stagnant Michigan economy
and its impact on our operations.  However, we are grateful that the
flat interest rate yield curve that appeared in 2004, and subsequently persisted
for an unprecedented length of time, finally started to normalize in late 2007,
as short term rates began to decline.  Short term rates have continued
to decline in 2008 due to aggressive actions by the Federal Reserve Board of
Governors.  During 2006 and 2007 the impact on the Bank of both the
flat yield curve and the stagnant economy was dramatic in terms of increased
cost of funds reducing net interest margin, minimal new business opportunities
and increased loan delinquencies and losses.  Before the yield curve
began to normalize, the Bank’s average cost of funds had more than
doubled.  At the same time, interest rates on new loans remained very
close to historic lows.





The
normalization of the interest rate yield curve to a more traditional, positive,
slope is favorably impacting the Bank’s net interest margin.  However,
the ongoing weakness of the Michigan economy and the very weak housing market
still frustrate new business development efforts and make it unlikely we will to
continue to experience high loan delinquency levels in 2008.  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, 2007, 2006, 2005 and 2004 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 31,2007
            
            
            
            2006
            
            
            
            2005(In
      thousands)Selected
      Balance Sheet Data:Total
      assets
            
            $
            115,028
            
            
            $
            114,543
            
            
            $
            105,121Loans,
      net
            
            
            100,150
            
            
            
            100,653
            
            
            
            91,143Securities
      available for sale, at fair value
            
            
            1,924
            
            
            
            2,088
            
            
            
            2,275Federal
      Home Loan Bank stock
            
            
            1,589
            
            
            
            1,589
            
            
            
            1,725Deposits
            
            
            79,405
            
            
            
            82,701
            
            
            
            64,895Federal
      Home Loan Bank advances
            
            
            26,400
            
            
            
            21,400
            
            
            
            32,000Other
      borrowings
            
            
            700
            
            
            
            700
            
            
            
            1,000Equity
            
            
            7,154
            
            
            
            8,599
            
            
            
            6,414












For
      the year ended December 31,2007
            
            
            2006
            
            
            2005(In
      thousands)Selected
      Operations Data:Total
      interest
      income
            
            $
            6,888
            
            
            $
            6,516
            
            
            $
            5,211Total
      interest
      expense
            
            
            4,377
            
            
            
            3,938
            
            
            
            2,298Net interest
      income
            
            
            2,511
            
            
            
            2,578
            
            
            
            2,913Provision
      for loan
      losses
            
            
            258
            
            
            
            162
            
            
            
            102Net interest income
      after provision for loan losses
            
            
            2,253
            
            
            
            2,416
            
            
            
            2,811Fees
      and service
      charges
            
            
            389
            
            
            
            396
            
            
            
            338Gain
      on sales of
      loans
            
            
            22
            
            
            
            40
            
            
            
            64Gain
      (loss) on sale of repossessed assets
            
            
            49
            
            
            
            (57
            )
            
            
            (67
            )Other
      non-interest
      income
            
            
            31
            
            
            
            49
            
            
            
            64Total non-interest
      income
            
            
            491
            
            
            
            428
            
            
            
            399Total
      non-interest
      expense
            
            
            3,653
            
            
            
            3,469
            
            
            
            3,450Income
      (loss) before
      taxes
            
            
            (909
            )
            
            
            (625
            )
            
            
            (240
            )Income
      tax expense (benefit)
            
            
            437
            
            
            
            (209
            )
            
            
            (88
            )Net income
      (loss)
            
            $
            (1,346
            )
            
            $
            (416
            )
            
            $
            (152
            )













2










For
      the year ended December 31,2007
            
            
            2006
            
            
            2005Selected Financial
      Ratios and Other Data:Performance
      ratios:Return on assets (ratio of net
      income to average total assets)
            
            
            (1.20
            )%
            
            
            (0.39
            )%
            
            
            (0.16
            )%Return on equity (ratio of net
      income to average equity)
            
            
            (19.99
            )%
            
            
            (5.34
            )%
            
            
            (2.30
            )%Interest
      rate spread informationAverage during
    period
            
            
            2.38
            %
            
            
            2.56
            %
            
            
            3.19
            %Net interest margin(1)
            
            
            2.45
            %
            
            
            2.58
            %
            
            
            3.49
            %Non-interest income to operating
      revenue
            
            
            19.57
            %
            
            
            16.31
            %
            
            
            13.70
            %Operating expense to average
      total assets
            
            
            3.25
            %
            
            
            3.26
            %
            
            
            3.67
            %Average interest-earning assets
      to average interest-bearing liabilities
            
            
            101.42
            %
            
            
            101.89
            %
            
            
            101.86
            %Efficiency ratio(2)
            
            
            121.68
            %
            
            
            115.40
            %
            
            
            104.17
            %Asset
      quality ratios:Non-performing assets to total
      assets at end of period
            
            
            2.56
            %
            
            
            1.65
            %
            
            
            0.74
            %Non-performing loans to total
      loans
            
            
            2.02
            %
            
            
            1.07
            %
            
            
            0.09
            %Allowance for loan losses to
      non-performing loans
            
            
            25.02
            %
            
            
            48.91
            %
            
            
            602.53
            %Allowance for loan losses to
      loans receivable, net
            
            
            0.51
            %
            
            
            0.53
            %
            
            
            0.52
            %Net charge-offs to average loans
      outstanding
            
            
            0.30
            %
            
            
            0.10
            %
            
            
            0.05
            %Capital
      Ratios:Equity to total assets at end of
      period
            
            
            6.23
            %
            
            
            7.51
            %
            
            
            6.10
            %Average equity to average
      assets
            
            
            5.99
            %
            
            
            7.22
            %
            
            
            6.88
            %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


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, 2007, our principal assets, on an unconsolidated basis, were all of the
outstanding shares of common stock of MainStreet Savings Bank, FSB and $100,000
in cash, and we had a $700,000 loan from a commercial bank.  In
addition, our employee stock ownership plan has a $256,000 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 three 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
      Chizek and Company LLC
              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 20, 2008, at 7:00 p.m. local time.
            
            Annual
      And Other Reports
              
              A
      copy of our Annual Report on Form 10-KSB for the year ended December
      31, 2007, 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 Dividends
            High
            Low
            DividendsFiscal
      2007First
      Quarter
            $11.00
            $9.65
            NoneSecond
      Quarter
            $10.00
            $9.25
            NoneThird
      Quarter
            $ 9.40
            $9.01
            NoneFourth
      Quarter
            $ 9.25
            $5.55
            NoneHigh
            Low
            DividendsFiscal
      2006First
      Quarter
            N/A
            N/A
            N/ASecond
      Quarter
            N/A
            N/A
            N/AThird
      Quarter
            N/A
            N/A
            N/AFourth
      Quarter
            $11.00
            $10.00
            None




Our stock
offering closed on December 22, 2006 at a price of $10.00 per share, so pricing
information is available from that date forward. Except for the original
issuance price of $10.00 per share, 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 14,
2008 was $6.20.




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 14, 2008 there were 756,068 shares of MainStreet Financial
      Corporation common stock outstanding (including unallocated ESOP shares)
      and there were approximately 111  holders of
record.
              
              Stockholders
      and General Inquiries
                
                MainStreet
      Financial Corporation files an annual report on Form 10-KSB and three
      quarterly reports on Form 10-QSB (or, effective in 2008, 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.
            
            Stock
      Listing
              
              MainStreet
      Financial Corporation common stock is traded on the OTC Bulletin Board
      under the symbol "MSFN.OB."
              
              
              
              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 2007
and 2006, 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 2007, which has reduced our capital.  Our net loss
of $1,345,543 for the year ended December 31, 2007 includes tax expense
of $436,585 to establish a valuation allowance at year-end to reduce our
net deferred tax asset to zero.  The remainder of the net loss for
2007 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.




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.




On March
18, 2008, the OTS asked the Bank to enter into a supervisory agreement to
address the OTS’s concerns regarding the financial condition of the
Bank.  Among other things, the supervisory agreement would require 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 (4) continue to abide by the
limits in the February 5, 2008 “troubled condition” letter.  The Bank
is discussing the provisions of the proposed supervisory agreement with its
counsel and the OTS, and it expects that it will enter into a supervisory
agreement with the OTS early in the second quarter.




General




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 and
investment 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 in
southwest Michigan in 2007 and 2006, and higher interest rates generally, 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.




Our net
interest income may be affected by market interest rate
changes.  Increases in loan rates generally reduce loan
demand.  In addition, a portion of our loan portfolio is tied to the
prime rate and adjusts immediately when this rate adjusts.  Increases
in short-term interest rates in 2007 and 2006 as a result of increases in the
Federal Funds rate by the Board of Governors of the Federal Reserve System,
without a corresponding increase in long-term interest rates, resulted in an
increase in interest expense and reduction in net interest
income.  Short-term interest rates declined slightly in the last two
quarters of 2007, stabilizing net interest income.  Prior to the third
quarter of 2007, our cost of funds increased faster than our yield on loans and
investments, due to the longer-term nature of our interest-earning assets and
the flat yield curve.  As a result, our net interest margin
decreased.






6






We have
implemented strategies to reduce this negative impact on our net interest margin
and earnings; however they have not been sufficient to achieve
profitability.  A majority of our fixed-rate one- to four-family
residential mortgages in portfolio are five- to seven-year balloon loans with up
to 30-year amortization schedules.  As a result, approximately 13% of
our residential mortgage loan portfolio matures or reprices
annually.  We only originate fixed-rate residential mortgages for sale
under commitments to purchase in place prior to the origination of the
mortgages.  Prior to 2006, we increased our emphasis on construction
or development, consumer and commercial lending as well, because these loans
generally have shorter terms and higher interest rates than mortgage
loans.  However, loans for land development and speculative
construction have been reduced in 2007 and 2006 due to the depressed real estate
market in southwest Michigan.  To the extent we increase our
investment in construction or development, consumer and commercial loans, which
are considered to entail greater credit risks than one- to four-family
residential loans, our provision for loan losses may increase, which will cause
a reduction in our income.




Recently,
the rates on Federal Home Loan Bank advances have decreased, making the cost of
these borrowings lower than the cost of wholesale deposits.  As a
result, we increased our Federal Home Loan Bank advances during the last two
quarters of 2007, rather than renew higher rate wholesale deposits in an effort
to reduce our interest expense.




Our
results of operations also are affected by our provision for loan
losses.  The allowance for loan losses has decreased to $508,000 at
December 31, 2007 from $538,000 at December 31, 2006.  The decrease is
the result of a provision for loan losses during the year ended December 31,
2007 of $258,000 and recoveries of $56,000, less charge offs of
$344,000.  The provision during the year ended December 31, 2006 was
$162,000.  The gross charge-offs of $344,000 for the year ended
December 31, 2007 compared to $127,000 for the year ended December 31, 2006 and
included $94,000 of prior years’ interest on two land development loans, two
residential construction loans to developers and three residential mortgage
loans that were moved to non-accrual status during 2007.  The balance
was attributable to incurred losses relating to twenty consumer loans, five
residential mortgage loans, two residential construction loans to developers and
one commercial line of credit based on management’s assessment of the
liquidation value of the collateral securing these loans.  Although
the allowance declined by $30,000 from December 31, 2006 to December 31, 2007,
management believes the allowance at December 31, 2007 is adequate given the
collateralization of delinquent and non-performing loans.







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 publicaly 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.




Evolution
of Business Strategy




Our
business strategy is dedicated to serving the needs of our customers and local
market.  We strive to be one of the primary financial institutions in
Barry County, which is reflected in our ranking as a leading residential
mortgage originator in Hastings and one of the top five originators in Barry
County.  We also have the second largest deposit market share among
banks and savings institutions in Barry County.  We offer a broad
range of products and services while stressing personalized and efficient
customer service and convenient access to these products and
services.  We intend to continue to operate as a commercial and
consumer lender.  We have structured operations around knowledgeable
and well-trained employees.  We attempt to differentiate ourselves
from our competitors by providing a higher level of customer
service.






7






Following
our mutual holding company reorganization, our board of directors and senior
management attempted to implement a strategic plan to increase our net interest
margin, improve overall earnings and achieve better operational
efficiencies.  This strategy involved:




·
            continuing
      to provide quality personal service to our
  customers;




·
            growing
      and diversifying our loan
portfolio;




·
            reducing
      our reliance on wholesale and brokered deposits and increasing our level
      of core deposits, including business
accounts;




·
            attempting
      to maintain a high level of asset quality and low interest rate
      risk.




·
            expanding
      our banking operations by hiring additional residential loan originators
      for the Caledonia, Kalamazoo and Middleville, Michigan markets and a
      commercial loan officer;




·
            increasing
      marketing efforts, particularly to reach out to underserved constituencies
      in our market area;




·
            selectively
      emphasizing products and services to provide diversification of revenue
      sources and to capture our customer’s full relationship through
      cross-selling our loan and deposit products and services to existing
      customers;




·
            attempting
      to decrease operating expenses;




·
            seeking
      out alternative sources for residential loan sales and wholesale deposits;
      and




·
            borrowing
      from the Federal Home Loan Bank for interest rate risk management
      purposes.




This
strategic plan has been implemented over the last four years.  A
critical element of this strategy was the completion of our stock offering on
December 22, 2006.  We sold a total of 355,352 shares of common stock
to investors at $10.00 per share in a subscription and community offering,
including the purchase of 28,428 shares by our employee stock ownership
plan.   After the payment of offering related expenses, we had
$2,897,000 in net proceeds, 50% of which was contributed to MainStreet Savings
Bank, FSB, and $1,300,000 was used to make a payment on our bank
loan.  The shares sold in the offering represented 47% of our
outstanding shares of common stock.  The remaining 400,716 shares of
our common stock are owned by MainStreet Financial Corporation, MHC, a federal
mutual holding company.





We have
achieved some of the other goals of this strategy but the anticipated increase
in earnings has been more than offset by the impact of the flattening interest
rate yield curve on our cost of funds.  In addition, we continued
initiatives to improve our net interest margin and attract core
deposits.   Current efforts to continue to grow the loan
portfolio are being frustrated by the interest rate environment, the weak
economy in southwest Michigan and the growing competitiveness of the local
market.  Our ability to grow is now limited by regulatory constraints
imposed by the OTS.  During 2007, we were able to reduce our reliance
on wholesale and brokered deposits because of access to lower cost Federal Home
Loan Bank advances.





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






8






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,” requires 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.




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.




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






9






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, MainStreet Savings Bank, FSB 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 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.






10






December
      31, 2007Change
      in
              Interest
              Rates
      in
            
            Net
      Portfolio Value
            
            NPVBasis
      Points
            
            Amount
            
            $
      Change
            
            %
      Change
            
            Ratio
      %(Dollars
      in thousands)+300
      bp
            
            5,810
            
            -2,490
            
            -30%
            
            5.17%+200
      bp
            
            6,828
            
            -1,472
            
            -18%
            
            6.00%+100
      bp
            
            7,682
            
            -618
            
            -7%
            
            6.67%0
      bp
            
            8,300
            
            ---
            
            ---
            
            7.13%-100
      bp
            
            8,683
            
            383
            
            +5%
            
            7.40%-200
      bp
            
            8,888
            
            588
            
            +7%
            
            7.53%





Certain
assumptions are used to assess the interest rate risk of MainStreet Savings
Bank, FSB.  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 2007 financial
information.  Although management finds the assumptions used to be
reasonable, the interest rate sensitivity of MainStreet Savings Bank, FSB’s
assets and liabilities and the estimated effects of changes in interest rates on
MainStreet Savings Bank, FSB’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, 2007 and December 31, 2006




General.  Total assets
increased by $485,000, or 0.4%, to $115.0 million at December 31, 2007, from
$114.5 million at December 31, 2006.  The increase was primarily the
result of a $1.4 million increase in cash and cash equivalents and a $450,000
increase in other real estate owned, which was offset, in part, by decreases of
$164,000 in investment securities, $503,000 in loans, $126,000 in premises and
equipment, $163,000 in intangible assets and $218,000 in other
assets.  The increase in total assets was funded by a $5.0 million
increase in Federal Home Loan Bank borrowings, which was offset by a $3.3
million decrease in deposits.




Cash and
Securities.  Our cash and securities portfolio increased $1.2
million or 19.7% to $7.1 million at December 31, 2007, compared to $5.9 million
at December 31, 2006.  Cash and securities were 6.2% and 5.2% of total
assets at December 31, 2007, and December 31, 2006,
respectively.  Consistent with our current liquidity strategy to
maintain higher levels of available funds to meet expenses and commitments, our
entire securities portfolio is designated as available for sale, and we have
substantially all of our securities investments in shorter-term
instruments.  See “-Liquidity and Commitments.”




11


Loans.  Our
loan portfolio decreased $503,000, or 0.50%, from $100.7 million at December 31,
2006, to $100.2 million at December 31, 2007.  This decrease consisted
of a 0.18% increase in one- to four-family residential mortgages, a 0.37%
decrease in commercial real estate and business loans, a 1.02% increase in
consumer loans, a 7.87% decrease in home equity lines of credit and a 44.35%
decrease in construction and development loans.  The slower economy in
southwest Michigan has significantly reduced loan
demand.  Additionally, new competitors in our primary market are
pursuing new lending opportunities with aggressive pricing.




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, 2007, was $508,000, or 0.51% of net
loans, compared to $538,000, or 0.53% of net loans, at December 31,
2006.  The following table is an analysis of the activity in the
allowance for loan losses for the periods shown.




Twelve
      Months
              Ended December 312007
            
            
            2006Balance
      at beginning of period
            
            $
            538,000
            
            
            $
            476,000Provision
      charged to income
            
            
            258,000
            
            
            
            162,000Recoveries
            
            
            56,000
            
            
            
            27,000Charge-offs
            
            
            (344,000
            )
            
            
            (127,000
            )Balance
      at end of period
            
            $
            508,000
            
            
            $
            538,000







Nonperforming
loans increased during 2007 by $900,000, or 81.8%, from $1.1 million at December
31, 2006, to $2.0 million at December 31, 2007, primarily as a result of the
continued declining economy in Michigan.  Our overall nonperforming
loans to total loans ratio increased from 1.07% at December 31, 2006, to
2.02% at December 31, 2007.   At December 31, 2007, we had 18
nonperforming loans as follows:




·
            Two
      large commercial relationships – The first is a $371,000 loan for the
      development of residential lots, for which the borrower has received a
      purchase offer that would not result in a material loss to the
      Bank.  The second is a $411,000 land development loan for the
      development of residential lots, which is in foreclosure
      proceedings.  The Bank has received an offer on this property,
      which would not result in a material loss to the Bank.   We
      believe the value of the collateral for these land development loans
      currently exceeds the outstanding
balances.




·
            Five
      commercial loans – Four loans to a landscaping company totaling $143,000
      secured by commercial vehicles and a $13,000 unsecured
    loan.






12








·
            Ten
      one- to four-family mortgage loans totaling $1,089,000, including a
      $421,000 loan on one residence.  These loans are not under
      collateralized with respect to the outstanding balances.  The
      Bank expects no material loss related to these
  loans.




·
            One
      unsecured consumer loan totaling
$5,000.




Our
troubled debt restructurings increased from $326,000 at December 31, 2006, to
$901,000 at December 31, 2007.  These restructurings involved eight
loans secured by owner-occupied residences, which were in foreclosure
proceedings. We believe the value of the collateral securing five of these loans
currently exceeds the outstanding balances, and the other three loans have been
written down to our estimate of the current realizable value of the collateral
securing the loans.




Our loan
delinquencies increased during the year, to $4.5 million, or 4.5% of total
loans, at December 31, 2007, compared to $1.8 million or 1.7% of total loans at
December 31, 2006.  The increase in loan delinquencies during 2007
was  primarily the result of more difficult economic conditions in our
market area and borrowers’ difficulty in making increased payments due to upward
rate adjustments and higher energy costs.  We expect these trends to
continue in 2008.  These delinquencies include the two large
commercial relationships described above in the list of non-performing
loans.




On
December 31, 2007, the Bank was monitoring other loans of concern classified as
Substandard loans on the Bank’s monthly delinquency report.  These
loans consisted of one loan for $218,000, secured by a single family home, which
the borrower has requested to deed to the Bank; five loans totaling $284,000,
secured by first mortgages on single family homes that are in the process of
foreclosure; two first mortgages totaling $219,000;  one second
mortgage for $30,000, secured by single family homes; and four consumer loans
totaling $13,000.  All these 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:
(1) five commercial loans to a landscaping company that are secured by vehicles
and equipment and total $178,000; and (2) four loans to a real estate developer,
which are secured by twelve non-owner occupied, one- to four-family unit
apartments and attached condominiums and total $730,000.




The Bank
also is monitoring three construction loans on single family homes, which are
current and total $745,000.  Construction has been completed, but
there are disputes between the borrowers and the contractors.  One
borrower has a lawsuit pending by a sub-contractor, another borrower has
disputed a draw made to the contractor and all three properties have liens
placed on the properties by subcontractors.




As our
local economic conditions continue to decline, we anticipate that increases in
delinquencies and net charge-offs will occur in 2008.




Deposits.  Total
deposits decreased by $3.3 million, or 4.0%, to $79.4 million at December 31,
2007, from $82.7 million at December 31, 2006.  During 2007, demand
deposits decreased $1.0 million and savings and money market accounts decreased
$1.4 million.  The $2.4 million decrease in transaction and savings
accounts is primarily attributable to our customers reducing their bank account
levels for spending needs and the increased competition for deposits in our
market.  The amount of time deposits or certificates at the end of
2007 was $674,000 less than at the end of 2006.  During the latter
part of 2007, we decided not to renew $4.0 million in maturing wholesale
certificates of deposit, and instead obtained $3.0 million in lower-rate Federal
Home Loan Bank advances.




Borrowings.  Federal
Home Loan Bank advances increased $5.0 million, or 23.4%, to $26.4 million at
December 31, 2007 from $21.4 million at December 31, 2006.  We
increased Federal Home Loan Bank borrowings to replace higher cost wholesale
certificates of deposit, which we chose not to renew.




13


At
December 31, 2007, 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, 2007 was
8.2%.   Our recent operating losses have been a violation of a
financial covenant of the loan and an event of default; however the lender
provided a letter agreeing to forbear from enforcing that covenant during each
year.




Our
continuing operating losses are a violation of the financial covenant on
earnings.  In 2007, the increases we have experienced in non-accrual loans
and other real estate owned triggered a violation of two other loan covenants,
which also are events of default.  At December 31, 2007, the combined
total of non-accrual loans and other real estate owned of $2.9 million was 43.9%
of our Tier 1 capital and 2.9% of total loans, which exceeds the maximum levels
of 20.0% of Tier 1 capital and 1.5% of total loans in the loan
covenants.  All of these loan covenants grant a six-month period in
which to cure any violation.  On March 31, 2008, our lender provided
us with a letter indicating that it will refrain and forbear from taking any
action to enforce its remedies with respect to these covenants through December
31, 2008, so long as we otherwise remain in compliance with the loan documents
and forbearance letter for the loan and the lender's other loan to our employee
stock ownership plan.




Equity  Total
equity decreased $1.4 million, or 16.3%, to $7.2 million at December 31, 2007,
from $8.6 million at December 31, 2006.  The decrease in equity was
primarily due to a net loss of $1,346,000 for the year and a final payment made
in 2007 of $115,000 for costs related to the public stock offering completed
during December 2006.  The 2007 net loss includes tax expense of
$436,585 to establish a valuation allowance to reduce our net deferred tax asset
at December 31, 2007 to zero.   This valuation allowance did not
affect our regulatory capital, because net deferred tax assets not supported by
taxes paid and recoverable are not included in regulatory capital.




14




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, 2007 and
2006.  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.




Year
      ended December 31,2007
            
            
            2006Average
              Outstanding
              Balance
            
            
            Interest
      Earned/
              Paid
            
            
            Yield/
              Rate
            
            
            Average
              Outstanding
      Balance
            
            
            Interest
      Earned/
              Paid
            
            
            Yield/
              Rate(Dollars
      in thousands)Interest-Earning
      Assets:Loans
      receivable(1)
            
            $
            94,867
            
            
            $
            6,490
            
            
            
            6.84
            %
            
            $
            95,415
            
            
            $
            6,293
            
            
            
            6.60
            %Deposits
      at other institutions
            
            
            4,133
            
            
            
            207
            
            
            
            5.00
            
            
            
            514
            
            
            
            25
            
            
            
            4.86Mortgage-backed
      securities
            
            
            2,012
            
            
            
            118
            
            
            
            5.87
            
            
            
            2,179
            
            
            
            117
            
            
            
            5.39Federal
      Home Loan Bank stock
            
            
            1,589
            
            
            
            73
            
            
            
            4.62
            
            
            
            1,694
            
            
            
            81
            
            
            
            4.78Total interest-earning
      assets(1)
            
            
            102,601
            
            
            
            6,888
            
            
            
            6.71
            
            
            
            99,802
            
            
            
            6,516
            
            
            
            6.53Interest-Bearing
      Liabilities:Savings
      deposits
            
            
            7,857
            
            
            
            36
            
            
            
            0.46
            
            
            
            8,655
            
            
            
            40
            
            
            
            0.46Demand
      and NOW deposits
            
            
            10,474
            
            
            
            159
            
            
            
            1.52
            
            
            
            11,149
            
            
            
            127
            
            
            
            1.14Certificate
      accounts
            
            
            59,401
            
            
            
            2,925
            
            
            
            4.92
            
            
            
            49,192
            
            
            
            2,161
            
            
            
            4.39Federal
      Home Loan Bank advances
            
            
            22,730
            
            
            
            1,200
            
            
            
            5.28
            
            
            
            27,146
            
            
            
            1,454
            
            
            
            5.36Bank
      loan
            
            
            700
            
            
            
            57
            
            
            
            8.10
            
            
            
            1,800
            
            
            
            156
            
            
            
            8.63Total interest-bearing
      liabilities
            
            
            101,162
            
            
            
            4,377
            
            
            
            4.33
            
            
            
            97,950
            
            
            
            3,938
            
            
            
            4.02Net
      interest income
            
            
            
            
            
            $
            2,511
            
            
            
            
            
            
            
            
            
            
            $
            2,578Net
      interest rate spread
            
            
            
            
            
            
            
            
            
            
            2.38
            %
            
            
            
            
            
            
            
            
            
            
            2.51
            %Net
      earning assets
            
            $
            1,439
            
            
            
            
            
            
            
            
            
            
            $
            1,852Net
      interest margin
            
            
            
            
            
            
            
            
            
            
            2.45
            %
            
            
            
            
            
            
            
            
            
            
            2.58
            %Average
      interest-earning assets
              to
      average interest-bearing
              liabilities
            
            
            101.42
            %
            
            
            
            
            
            
            
            
            
            
            101.89
            %


____________________


(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,
                2007
      vs. 2006
              
              
              Year
      ended December 31,
                2006
      vs. 2005Increase
                (decrease)
      due to
              
              
              Total
                increase
              
              
              Increase
                (decrease
      due to
              
              
              Total
                increaseVolume
              
              
              Rate
              
              
              (decrease)
              
              
              Volume
              
              
              Rate
              
              
              (decrease)Interest-earning
      assets:Loans
      receivable
              
              $
              (36
              )
              
              $
              233
              
              
              $
              197
              
              
              $
              1,070
              
              
              $
              195
              
              
              $
              1,265Deposits
      at other institutions
              
              
              181
              
              
              
              1
              
              
              
              182
              
              
              
              18
              
              
              
              (10
              )
              
              
              8Mortgage-backed
      securities
              
              
              (13
              )
              
              
              14
              
              
              
              1
              
              
              
              (12
              )
              
              
              29
              
              
              
              17Investment
      securities
              
              
              ---
              
              
              
              ---
              
              
              
              ---
              
              
              
              (2
              )
              
              
              ---
              
              
              
              (2
              )Federal  Home
      Loan Bank stock
              
              
              (5
              )
              
              
              (3
              )
              
              
              (8
              )
              
              
              10
              
              
              
              8
              
              
              
              18Total
      interest-earning assets
              
              
              127
              
              
              
              245
              
              
              
              372
              
              
              
              1,084
              
              
              
              222
              
              
              
              1,306Interest-bearing
      liabilities:Savings
      deposits
              
              
              (4
              )
              
              
              ---
              
              
              
              (4
              )
              
              
              (5
              )
              
              
              1
              
              
              
              (4
              )Demand
      and NOW deposits
              
              
              (8
              )
              
              
              40
              
              
              
              32
              
              
              
              (19
              )
              
              
              10
              
              
              
              (9
              )Certificate
      accounts
              
              
              483
              
              
              
              281
              
              
              
              764
              
              
              
              657
              
              
              
              576
              
              
              
              1,233Federal
      Home Loan Bank advances
              
              
              (233
              )
              
              
              (21
              )
              
              
              (254
              )
              
              
              (1
              )
              
              
              299
              
              
              
              298Bank
      loan
              
              
              (90
              )
              
              
              (9
              )
              
              
              (99
              )
              
              
              99
              
              
              
              23
              
              
              
              122Total
      interest-bearing liabilities
              
              $
              148
              
              
              $
              291
              
              
              
              439
              
              
              $
              731
              
              
              $
              909
              
              
              
              1,640Net
      interest income
              
              
              
              
              
              
              
              
              
              $
              (67
              )
              
              
              
              
              
              
              
              
              
              $
              (334
              )





Comparison
of Operating Results for the Years Ended December 31, 2007 and December 31,
2006.




General.  We incurred a net loss for the year ended December 31, 2007,
of $1,346,000, compared to a net loss of $416,000 for the year ended December
31, 2006, primarily due to the general interest rate environment, economic
difficulties in southwest Michigan and tax expense of $437,000 to establish a
valuation allowance for our deferred tax asset.  In 2007, our net
interest income decreased by $67,000 or 2.60%, which was primarily attributable
to placing eleven one- to four-family residential loans and four commercial
loans on non-accrual status.  Our provision for loan losses increased
in 2007 by $96,000, and our pension and other overhead expenses increased by
$183,000 for the year, primarily attributable to a $45,000 increase in
regulatory assessments and a $124,000 increase in professional
services.  Most significantly, our federal income tax expense
increased $646,000 in 2007 due to the establishment of a valuation allowance for
our deferred tax asset.  Our non-interest income increased in 2007 by
$63,000, primarily attributable to gains on the sale of repossessed
assets.  In addition, we sold fewer loans during 2007 because we were
unable to originate loans in our market at rates that would be attractive to
purchasers in the secondary market.  As a result, our gain on sale of
loans was lower in 2007 than in 2006.  Under our current business plan
we expect to experience net losses at least through the end of
2008.




16


Interest
Income.  Interest income increased by $371,000 or 5.7%, to $6.9
million for 2007 from $6.5 million for 2006.  The primary reason for
the increase in interest income was increased market rates on new or repricing
loans.  During 2007, interest on loans was reduced by $67,000 as a
result of placing 15 loans on non-accrual status.  These non-accrual
loans were comprised of nine residential loans totaling $1.3 million, two
speculative construction loans on one-to-four family residential properties
totaling $251,000, one land development loan totaling $411,000 and three
unsecured commercial lines of credit of $88,000.




The weighted average yield on loans
increased 3.6% from 6.60% for the year ended December 31, 2006, to 6.84% for the
year ended December 31, 2007.  The increase was the result of new
loans originated at higher interest rates than generally in our portfolio,
existing adjustable interest rate loans re-pricing to higher interest rates and
maturing loans being rewritten at higher interest rates.  In the last
six months of the year the yield curve began to normalize as short-term rates
declined.  This is not expected to significantly impact interest
income.  No assurance can be given that the normalization of the yield
curve will continue or that a flat yield curve will not return.




Total
average interest-earning assets increased $2.8 million from December 31, 2006,
to December 31, 2007, due to increased loan demand, and the weighted average
yield on interest-earning assets increased 18 basis points from 6.53% to 6.71%
during the same period.




Interest
Expense.  Interest expense increased $439,000, or 11.1%, to
$4.4 million for 2007 from $3.9 million for 2006.  The increase was a
result of an increase in the average balance of deposits and an increase in the
average rate paid on both deposits and Federal Home Loan Bank advances due to
the rising interest rate environment and our reliance on wholesale and brokered
deposits.  In addition, we paid $57,000 and $24,000 respectively, in
interest on a bank line of credit and ESOP loan during 2007, as compared to
$156,000 and $0 in 2006.  Our weighted average cost of
interest-bearing liabilities was 4.33% for 2007 compared to 4.02% for
2006.  In addition, our average volume of interest-bearing liabilities
increased by $3.2 million, or 3.29%, primarily due to increased certificate
accounts.




Interest
paid on deposits increased $800,000 or 35.8% to $3.1 million for the year ended
December 31, 2007 from $2.3 million for the year ended December 31,
2006.  This reflects higher interest rates generally as well as a
relative decrease in lower cost demand and savings accounts and an increase in
higher cost wholesale and brokered deposits during the first three quarters of
2007.  Deposits in our local market have been inadequate to meet loan
demand.




Interest
expense on Federal Home Loan Bank advances decreased $254,000, or 17.5%, to $1.2
million for the year months ended December 31, 2007, from $1.5 million for the
year ended December 31, 2006.  The decrease resulted from a decrease
in the average balance of outstanding advances and decreased rates on the
repricing of our advances. The average balance of outstanding Federal Home Loan
Bank advances was $22.7 million for the year ended December 31, 2007, and $27.2
million for the year ended December 31, 2006.  The weighted average
rate of Federal Home Loan Bank advances decreased from 5.36% in the 2006 period
to 5.28% in the 2007 period.




During
the first three quarters of 2007, we increased wholesale and brokered deposits
in order to repay higher cost Federal Home Loan Bank advances.  During
the fourth quarter, as the cost of those advances decreased, we began to
increase advances and not renew wholesale and brokered deposits.  We
will continue to monitor the relative costs of wholesale and brokered deposits
and Federal Home Loan Bank advances in order to manage our interest expense in
2008.   During the last two quarters of 2007, 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.




17


Net Interest
Income.  Net interest income before provision for loan losses
decreased by $67,000, or 3.9% for the year ended December 31, 2007, to $2.5
million compared to $2.6 million for the year ended December 31,
2006.  The decrease in net interest income in 2007 was due to interest
expense increasing more rapidly than interest income, as well as placing 15
loans in non-accrual status.  Our net interest margin was 2.45% for
the year ended December 31, 2007, compared to 2.58% for the year ended December
31, 2006.




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 $258,000 and $162,000
were made during the year ended December 31, 2007 and December 31, 2006,
respectively.  The increase in the provision for loan losses was due
primarily to increased delinquencies and net charge-offs during 2007 compared to
2006.  During the year ended December 31, 2007, net charge-offs were
$287,000 compared to $100,000 for the same period in 2006.  The ratio
of non-performing loans to total loans increased from 1.07% at December 31, 2006
to 2.02% at December 31, 2007.  Non-performing loans at December 31,
2007, consisted of $1,089,000 in residential mortgage loans, $5,000 in consumer
loans and $938,000 in commercial loans.  The increase in the level of
non-performing loans during the year ended December 31, 2007, is a result of the
general 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 increased $63,000 or 14.7% to
$491,000 for the year ended December 31, 2007, compared to $428,000 for the same
period in 2006.  The increase in non-interest income during 2007 was
primarily due to the gain on sale of repossessed property of $50,000 for 2007,
compared to a net loss on sale of repossessed property of $57,000 for
2006.  We may not experience continued gains on repossessed assets due
to the weak real estate market in Michigan.  The increase in
non-interest income also includes a $7,000 decrease in fees and service charges
during the year due to lower ATM fees, an $18,000 lower gain on the sale of
loans during the year and an $19,000 decrease in other non-interest-income
reflecting primarily decreases in fee income.




Non-Interest
Expense.  Non-interest expense increased $183,000 or 5.3%, from
$3.5 million for the year ended December 31, 2006 to $3.7 million for the year
ended December 31, 2007.  Increases in expenses of $45,000 for
regulatory assessments, $16,000 for data processing services, $25,000 in
salaries and employee benefits and $124,000 in professional services were offset
by decreases of $25,000 in premises and equipment, $8,000 in intangibles
amortization from a branch acquisition in 1998, and $17,000 in advertising
costs.  The increase in salaries and employee benefits is primarily
the result of a $98,000 reduction of salaries and wages, which was offset by a
$67,000 increase in employee benefit expenses for the earned ESOP shares
and a $57,000 reduction in the amount of deferred loan origination fees and
costs.  The increase in professional services is primarily due to increases
in legal and audit fees related to the on-going costs related to being a public
company.




Income Tax
Benefit.  During 2007 it was determined that our deferred tax
asset may not be realized in future years due to recent and continuing operating
losses.  A valuation allowance of $437,000 was created for the
deferred tax asset, which also resulted in a federal income tax expense for the
year ended December 31, 2007.  Should operations become profitable in
future years, the deferred tax asset will be recorded at its expected realizable
value.  As a result of the creation of the valuation allowance, we
incurred a tax expense of $437,000 or 48.1%, of our net loss before taxes for
the year ended December 31, 2007 as compared to a tax benefit of $209,000 or
33.5% of our net loss before taxes for the year ended December 31,
2006.




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






18






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.




We
completed the closing of our stock offering with the sale of 355,352 shares of
common stock to investors on December 22, 2006, at $10.00 per share in a
subscription and community offering. After paying $656,000 in offering expenses
from the proceeds and paying $1,300,000 on our bank loan, we had $1,597,000
available for our use.





At
December 31, 2007, the Company had $7.1 million in cash and investment
securities generally available for its cash needs, of which only $261,000 was
available to MainStreet Financial Corporation on an unconsolidated
basis.




MainStreet
Savings Bank, FSB’s primary sources of funds are deposits (including wholesale
and brokered 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, MainStreet Savings Bank, FSB
invests excess funds in short-term interest-earning assets, which provide
liquidity to meet lending requirements.  MainStreet Savings Bank, FSB
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.




Liquidity
management is both a daily and long-term function of business
management.  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.  MainStreet Savings Bank, FSB uses its sources of funds
primarily to meet its ongoing commitments, pay maturing deposits, fund deposit
withdrawals and to fund loan commitments.  At December 31, 2007, we
had $5.9 million in outstanding loan commitments, including unused lines of
credit.  Certificates of deposit scheduled to mature in one year or
less at December 31, 2007, totaled $47.6 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 MainStreet Savings Bank,
FSB.  However, if MainStreet Savings Bank, FSB becomes adequately
capitalized, it may not accept or renew brokered and wholesale deposits without
a waiver from the FDIC.  At December 31, 2007, we had $24.4 million in
wholesale or brokered deposits.  In addition, MainStreet Savings Bank,
FSB had the ability at December 31, 2007 to borrow an additional $7.4 million
from the Federal Home Loan Bank of Indianapolis as a funding source to meet
commitments and for liquidity purposes.




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, 2007, we engaged in no off-balance sheet transactions likely
to have a material effect on our financial condition, results of operations or
cash flows.






19






A summary of our off-balance sheet
commitments to extend credit at December 31, 2007, is as follows:




Off-balance sheet loan
      commitments:Commitments
      to make loans
            
            $
            161,000Undisbursed
      portion of loans closed
            
            
            419,000Unused
      lines of credit
            
            
            5,323,000Total loan
      commitments
            
            $
            5,903,000





Capital





MainStreet
Savings Bank, FSB is subject to minimum capital requirements imposed by the
OTS.  Based on its capital levels at December 31, 2007, MainStreet
Savings Bank, FSB exceeded these requirements as of that date and continues to
exceed them as of the date of this report.  Our policy is for
MainStreet Savings Bank, FSB to maintain a “well-capitalized” status under the
capital categories of the OTS.  However, with the anticipated
continuation of operating losses in 2008, the Bank’s risk-based capital ratio
may decrease to below 10.0%, and MainStreet Savings Bank, FSB would be
considered adequately capitalized.  The OTS may initiate additional
enforcement actions against the Bank if it becomes adequately
capitalized.  Failure to maintain well-capitalized status also is an
event of default under our bank loan and our forbearance letter for that
loan.  If that occurs, we will ask the bank to agree, in writing, to
forbear from acting on that event of default during 2008.  No
assurance can be given that the bank will agree to provide this
forbearance.  Furthermore, if the Bank becomes adequately capitalized,
it may not accept or renew brokered and wholesale deposits without a waiver from
the FDIC.  We have begun to sell some of our residential mortgage
loans in order to improve our capital ratios and retain well-capitalized
status.  As reflected below, MainStreet Savings Bank, FSB exceeded the
minimum capital ratios to be considered well-capitalized by the OTS based on its
capital levels at December 31, 2007.




The
capital raised in our stock offering increased our regulatory capital levels and
ratios.  However, our continuing operating losses are reducing our
capital levels and ratios.  In addition, 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.  However, this charge did not affect
our regulatory capital, because net deferred tax assets not supported by taxes
paid and recoverable are not included in regulatory capital.




Actual
            
            Required
      for
              Well-Capitalized
      Status
            
            ExcessAmount
            
            Percent
      of
              Assets(1)
            
            Amount
            
            Percent
      of
              Assets(1)
            
            Amount
            
            Percent
      of
              Assets(1)(Dollars
      in thousands)Tier
      1 leverage (core) capital ratio
            $6,696
            
            5.9%
            
            $5,704
            
            5.0%
            
            $992
            
            0.87%Tier
      1 risk-based capital ratio
            6,696
            
            9.7%
            
            4,241
            
            6.0%
            
            2,455
            
            2.15%Total
      risk-based capital ratio
            7,204
            
            10.2%
            
            7,069
            
            10.0%
            
            135
            
            0.12%


____________________


(1)
            Ratio
      is a percent of adjusted total assets of $114.1 million for the Tier 1
      leverage capital ratio and a percent of risk-weighted assets of $70.7
      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.






20






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.




Recent
Accounting Pronouncements




The
Financial Accounting Standard Board (“FASB”) recently issued the following
accounting standards related to the financial services industry:




In
February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
Financial Instruments - an amendment for FASB Statements No. 133 and
140.”  SFAS No. 155 amends FASB Statements No. 133, “Accounting for
Derivative Instruments and Hedging Activities,” and No. 140, “Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities.”  SFAS No. 155 resolves issues addressed in Statement No.
133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial
Interests in Securitized Financial Assets.”  The Statement is
effective for all financial instruments acquired or issued after the beginning
of an entity’s first fiscal year that begins after September 15,
2006.  The adoption of SFAS No. 155 in 2007 did not have a material
impact on our financial position or results of operation.




In March
2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
Assets - an amendment of FASB Statement No. 140.”  SFAS No. 156 amends
FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities,” with respect to the accounting for
separately recognized servicing assets and servicing
liabilities.  Statement No. 156 is effective as of the beginning of an
entity’s first fiscal year that begins after September 15, 2006.  The
adoption of SFAS No. 156 in 2007 did not have a material impact on our financial
position or results of operations.




In June
2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in
Income Taxes – an Interpretation of FASB Statement No. 109 (FIN 48), which
clarifies the accounting for uncertainty in income taxes recognized in a
company's financial statements in accordance with SFAS 109, Accounting for
Income Taxes. FIN 48 prescribes a recognition and measurement threshold for a
tax position taken or expected to be taken in a tax return. FIN 48 also provides
guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure, and transition. FIN 48 is effective for fiscal
years beginning after December 15, 2006.  Adopting FIN 48 on January
1, 2007 did not have any impact on our financial position nor on the results of
our operations for 2007.




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.  In February 2008, the FASB issued Staff Position (FSP)
157-2,Effective Date of FASB
Statement No. 157.This FSP delays the effective date of FAS
157 for all nonfinancial assets and nonfinancial liabilities, except those that
are recognized or disclosed at fair value on a recurring basis (at least
annually) to fiscal years beginning after November 15, 2008, and interim periods
within those fiscal years.  The Company has not completed its
evaluation of the impact of the adoption of this standard.






21






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.

































22







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.







23


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, 2007 and 2006, 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, 2007 and 2006, 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 Chizek and Company
LLC
 Grand
Rapids, Michigan
 March 31,
2008
 
  F-1
  MAINSTREET
FINANCIAL CORPORATION
 CONSOLIDATED
BALANCE SHEETS
 December
31, 2007 and 2006
 
 
 2007
              
              
              2006ASSETSCash
      and due from financial institutions
              
              $
              1,995,698
              
              
              $
              2,407,813Interest-bearing
      deposits
              
              
              3,175,605
              
              
              
              1,432,452Cash
      and cash equivalents
              
              
              5,171,303
              
              
              
              3,840,265Securities
      available for sale
              
              
              1,924,413
              
              
              
              2,088,393Loans,
      net of allowance of $508,364 and $537,667
              
              
              100,149,716
              
              
              
              100,653,114Federal
      Home Loan Bank (FHLB) stock
              
              
              1,589,000
              
              
              
              1,589,000Accrued
      interest receivable
              
              
              605,241
              
              
              
              734,899Premises
      and equipment, net
              
              
              3,557,518
              
              
              
              3,684,203Intangible
      assets
              
              
              856,035
              
              
              
              1,018,942Other
      real estate owned
              
              
              910,846
              
              
              
              452,531Other
      assets
              
              
              264,076
              
              
              
              482,060$
              115,028,148
              
              
              $
              114,543,407LIABILITIES
      AND SHAREHOLDERS’ EQUITYLiabilitiesDepositsNoninterest-bearing
              
              $
              5,278,694
              
              
              $
              6,510,671Interest-bearing
              
              
              74,126,373
              
              
              
              76,190,62279,405,067
              
              
              
              82,701,293FHLB
      advances
              
              
              26,400,000
              
              
              
              21,400,000Note
      payable
              
              
              700,000
              
              
              
              700,000ESOP
      note payable
              
              
              255,852
              
              
              
              284,280Accrued
      interest payable
              
              
              189,015
              
              
              
              131,411Advance
      payments by borrowers for taxes and insurance
              
              
              100,412
              
              
              
              55,894Deferred
      compensation liability
              
              
              506,737
              
              
              
              487,688Accrued
      expenses and other liabilities
              
              
              316,796
              
              
              
              183,899Total
      liabilities
              
              
              107,873,879
              
              
              
              105,944,465Commitments
      and contingenciesShareholders’
      equityCommon
      stock - $.01 par value, 9,000,000 shares
                authorized,
      756,068 shares issued and
                outstanding
      at December 31, 2007 and 2006
              
              
              7,561
              
              
              
              7,561Additional
      paid in capital
              
              
              2,821,602
              
              
              
              2,939,677Unearned
      ESOP
              
              
              (247,856
              )
              
              
              (284,280
              )Retained
      earnings
              
              
              4,603,116
              
              
              
              5,948,659Accumulated
      other comprehensive income (loss)
                (net
      of tax of $0 in 2007 and $6,530 in 2006)
              
              
              (30,154
              )
              
              
              (12,675
              )$
              7,154,269
              
              
              $
              8,598,942$
              115,028,148
              
              
              $
              114,543,407
  See
accompanying notes to consolidated financial statements.
  F-2
  MAINSTREET
FINANCIAL CORPORATION
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 Years
ended December 31, 2007 and 2006
 
 
 2007
              
              
              2006Interest
      incomeLoans,
      including related fees
              
              $
              6,489,711
              
              
              $
              6,292,892Taxable
      securities
              
              
              191,517
              
              
              
              198,755Other
              
              
              206,622
              
              
              
              24,8076,887,850
              
              
              
              6,516,454Interest
      expenseDeposits
              
              
              3,120,113
              
              
              
              2,327,872FHLB
      advances
              
              
              1,200,238
              
              
              
              1,454,419Other
              
              
              56,670
              
              
              
              155,8744,377,021
              
              
              
              3,938,165Net
      interest income
              
              
              2,510,829
              
              
              
              2,578,289Provision
      for loan losses
              
              
              258,000
              
              
              
              162,000Net interest income after
      provision for loan
      losses
              
              
              2,252,829
              
              
              
              2,416,289Noninterest
      incomeFees
      and service charges
              
              
              389,210
              
              
              
              396,115Gain
      on sale of loans
              
              
              21,786
              
              
              
              40,138Gain
      (loss) on sale of repossessed assets
              
              
              49,526
              
              
              
              (57,212
              )Other
              
              
              30,791
              
              
              
              49,457491,313
              
              
              
              428,498Noninterest
      expensesSalaries
      and employee benefits
              
              
              1,731,050
              
              
              
              1,705,670Premises
      and equipment, net
              
              
              559,732
              
              
              
              584,534Administrative
      and general expenses
              
              
              530,635
              
              
              
              508,293Data
      processing through service bureau
              
              
              255,410
              
              
              
              239,755Amortization
      of intangible assets
              
              
              162,907
              
              
              
              170,443Regulatory
      assessments
              
              
              89,418
              
              
              
              44,571Professional
      services
              
              
              244,165
              
              
              
              120,099Advertising
      and public relations
              
              
              79,783
              
              
              
              96,7063,653,100
              
              
              
              3,470,071Loss
      before income taxes
              
              
              (908,958
              )
              
              
              (625,284
              )Federal
      income tax expense (benefit)
              
              
              436,585
              
              
              
              (209,162
              )Net
      loss
              
              $
              (1,345,543
              )
              
              $
              (416,122
              )Basic
      and diluted earnings (loss) per share
              
              $
              (1.84
              )
              
              $
              (21.21
              )
  See
accompanying notes to consolidated financial
statements.
  F-3
  MAINSTREET
FINANCIAL CORPORATION
 CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
 Years
ended December 31, 2007 and 2006
 
 
 Common
                Stock
              
              
              Additional
                Paid-in
                Capital
              
              
              Retained
                Earnings
              
              
              Unearned
                ESOP
                Shares
              
              
              Accumulated
                Other
                Comprehensive
                Loss
              
              
              Total
                Shareholder’s
                EquityBalance
      – January 1, 2006
              
              $
              10
              
              
              $
              49,990
              
              
              $
              6,375,781
              
              
              $
              -
              
              
              $
              (12,148
              )
              
              $
              6,413,633Dividends
      paid
              
              
              -
              
              
              
              -
              
              
              
              (11,000
              )
              
              
              -
              
              
              
              -
              
              
              
              (11,000
              )Net
      loss
              
              
              -
              
              
              
              -
              
              
              
              (416,122
              )
              
              
              -
              
              
              
              -
              
              
              
              (416,122
              )Change
      in net unrealized gain/loss onsecurities
      available for sale, net of tax
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (527
              )
              
              
              (527
              )Comprehensive
      loss
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (416,649
              )Unearned
      ESOP Shares
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (284,280
              )
              
              
              -
              
              
              
              (284,280
              )Sale
      of 355,352 common shares in the initialpublic
      offering
              
              
              3,554
              
              
              
              2,893,684
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              2,897,238Issuance
      of 399,716 common shares toMainStreet
      Financial corporation, MHC
              
              
              3,997
              
              
              
              (3,997
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Balance
      – December 31, 2006
              
              
              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
              )
              
              $
              7,154,269
 
 See
accompanying notes to consolidated financial
statements.
  F-4
  MAINSTREET
FINANCIAL CORPORATION
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 Years
ended December 31, 2007 and 2006
 
 
 2007
              
              
              2006Cash
      flows from operating activitiesNet
      income (loss)
              
              $
              (1,345,543
              )
              
              $
              (416,122
              )Adjustments
      to reconcile net income (loss) tonet
      cash from operating activitiesDepreciation
              
              
              246,897
              
              
              
              279,952Amortization,
      net of accretionSecurities
              
              
              3,816
              
              
              
              4,391Loans
              
              
              (5,123
              )
              
              
              18,699Intangible
      assets
              
              
              162,907
              
              
              
              170,443Provision
      for loan losses
              
              
              258,000
              
              
              
              162,000Loans
      originated for sale
              
              
              (1,724,640
              )
              
              
              (2,992,715
              )Proceeds
      from sales of loans originated for sale
              
              
              1,746,426
              
              
              
              3,032,853Gain
      on sale of loans
              
              
              (21,786
              )
              
              
              (40,138
              )ESOP
      expense
              
              
              33,342
              
              
              
              -(Gain)
      loss on sale of other real estate owned
              
              
              (49,526
              )
              
              
              57,212Change
      in assets and liabilitiesChange
      in deferred fees and discounts
              
              
              29,391
              
              
              
              (8,483
              )Accrued
      interest receivable
              
              
              129,658
              
              
              
              (241,588
              )Other
      assets
              
              
              221,707
              
              
              
              (118,472
              )Accrued
      interest payable
              
              
              57,604
              
              
              
              118,140Other
      liabilities
              
              
              141,690
              
              
              
              (38,954
              )Net
      cash from (used for) operating activities
              
              
              (115,178
              )
              
              
              (12,782
              )Cash
      flows from investing activitiesActivity
      in available-for-sale securities:Principal
      repayments, maturities, and calls
              
              
              149,215
              
              
              
              181,609Redemption
      of FHLB stock
              
              
              -
              
              
              
              136,000Loan
      originations and payments, net
              
              
              (752,147
              )
              
              
              (10,071,800
              )Sales
      of other real estate owned
              
              
              609,007
              
              
              
              150,565Purchases
      of premises and equipment, net
              
              
              (120,212
              )
              
              
              6,146Net
      cash used for investing activities
              
              
              (114,137
              )
              
              
              (9,597,480
              )
  (Continued)
 F-5
  MAINSTREET
FINANCIAL CORPORATION
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 Years
ended December 31, 2007 and 2006
 
 
 2007
              
              
              2006Cash
      flows from financing activitiesNet
      change in deposits
              
              $
              (3,296,226
              )
              
              $
              17,806,466Proceeds
      from Federal Home Loan Bank advances
              
              
              35,300,000
              
              
              
              49,778,000Repayment
      of Federal Home Loan Bank advances
              
              
              (30,300,000
              )
              
              
              (60,378,000
              )Payments
      on ESOP loan
              
              
              (28,428
              )
              
              
              -Dividends
      paid
              
              
              -
              
              
              
              (11,000
              )Public
      offering costs
              
              
              (114,993
              )
              
              
              -Draws
      on note payable
              
              
              -
              
              
              
              1,000,000Payments
      on note payable
              
              
              -
              
              
              
              (1,300,000
              )Net
      proceeds from sale of stock
              
              
              -
              
              
              
              2,897,238Net
      cash from (used for) financing activities
              
              
              1,560,353
              
              
              
              9,792,704Net
      change in cash and cash equivalents
              
              
              1,331,038
              
              
              
              182,442Cash
      and cash equivalents at beginning of year
              
              
              3,840,265
              
              
              
              3,657,823Cash
      and cash equivalents at end of year
              
              $
              5,171,303
              
              
              $
              3,840,265Supplemental
      disclosures of cash flow informationCash
      paid during the year forInterest
              
              $
              4,319,417
              
              
              $
              3,820,025Taxes
              
              
              -
              
              
              
              -Supplemental
      disclosures of noncash activitiesTransfer
      of loans to other real estate
              
              $
              1,017,795
              
              
              $
              356,234
  See
accompanying notes to consolidated financial statements.
 F-6
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 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 carrying value of intangible assets 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, 2007 and 2006
 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.
  (Continued)
  F-8
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE 1 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
 
 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.
 
 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.
 
 Foreclosed
Assets:  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.
  (Continued)
  F-9
  MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE 1 - SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES (Continued)
 
 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.
 
 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 affect 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, 2007 and 2006
 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.  No shares were earned by participants in
2006.  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 729,554 shares for 2007 and 19,618 for 2006.  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, 2007 or 2006 that will have a material effect on the
financial statements.
 
 Dividend
Restrictions:  Banking regulations require maintaining certain
capital levels and may limit the dividends paid by the bank to the holding
company or by the holding company to shareholders.
  (Continued)
  F-11
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 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 But
Not Yet Effective 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.  The Company has not completed its evaluation of the impact of
the adoption of this standard.
 
 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, 2007 and 2006
 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:
 
 Fair
                Value
              
              
              Gross
                Unrealized
                Gains
              
              
              Gross
                Unrealized
                Losses2007Mortgage-backed
      securities
              
              $
              886,048
              
              
              $
              7,187
              
              
              $
              13,690Mutual
      fund investment
              
              
              1,038,365
              
              
              
              -
              
              
              
              23,651$
              1,924,413
              
              
              $
              7,187
              
              
              $
              37,3412006Mortgage-backed
      securities
              
              $
              1,098,355
              
              
              $
              6,772
              
              
              $
              6,517Mutual
      fund investment
              
              
              990,038
              
              
              
              -
              
              
              
              19,460$
              2,088,393
              
              
              $
              6,772
              
              
              $
              25,977
 
 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 2007 or 2006.
 
 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
                Value
              
              
              Unrealized
                Loss
              
              
              Fair
                Value
              
              
              Unrealized
                Loss
              
              
              Fair
                Value
              
              
              Unrealized
                Loss2007Mortgage-backed
              
              $
              -
              
              
              $
              -
              
              
              $
              399,927
              
              
              $
              (13,690
              )
              
              $
              399,930
              
              
              $
              (13,690
              )Mutual
      fund
              
              
              -
              
              
              
              -
              
              
              
              1,038,365
              
              
              
              (23,651
              )
              
              
              1,038,365
              
              
              
              (23,651
              )$
              -
              
              
              $
              -
              
              
              $
              1,438,292
              
              
              $
              (37,341
              )
              
              $
              1,438,292
              
              
              $
              (37,341
              )2006Mortgage-backed
              
              $
              -
              
              
              $
              -
              
              
              $
              501,427
              
              
              $
              (6,517
              )
              
              $
              501,427
              
              
              $
              (6,517
              )Mutual
      fund
              
              
              -
              
              
              
              -
              
              
              
              990,039
              
              
              
              (19,460
              )
              
              
              990,039
              
              
              
              (19,460
              )$
              -
              
              
              $
              -
              
              
              $
              1,491,466
              
              
              $
              (25,977
              )
              
              $
              1,491,466
              
              
              $
              (25,977
              )
 
 No loss
has been recognized into income because management has the intent and ability to
hold these securities for the foreseeable future.  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.  Management expects the mutual fund unrealized loss to
decrease as short term interest rates continue to decline and the market for
mortgage related securities stabilizes.
  (Continued)
 
 F-13
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE
3 – LOANS
 
 Loans at
year end are summarized as follows:
 
 2007
              
              
              2006Real
      estate loans secured by:One-to-four-family
      residential properties
              
              $
              74,463,818
              
              
              $
              74,327,622Home
      Equity
              
              
              5,476,501
              
              
              
              5,944,061Construction
      and development projects
              
              
              2,054,384
              
              
              
              3,691,469Commercial
      real estate and business loans
              
              
              12,868,148
              
              
              
              12,916,405Consumer
      loans
              
              
              6,172,793
              
              
              
              6,110,612Less:Loans
      in process
              
              
              (418,938
              )
              
              
              (1,816,495
              )Deferred
      (fees) and costs, net
              
              
              41,374
              
              
              
              17,107Allowance
      for loan losses
              
              
              (508,364
              )
              
              
              (537,667
              )Loans,
      net
              
              $
              100,149,716
              
              
              $
              100,653,114
 
 Loans
serviced for others are not included in the accompanying consolidated balance
sheets.  The unpaid principal balance of such loans was approximately
$3,919,000 and $2,987,000 at December 31, 2007 and 2006.
 
 Activity
in the allowance for loan losses is summarized as follows:
  2007
              
              
              2006Balance
      at beginning of period
              
              $
              537,667
              
              
              $
              475,962Provision
      charged to income
              
              
              258,000
              
              
              
              162,000Recoveries
              
              
              56,045
              
              
              
              27,299Charge-offs
              
              
              (343,348
              )
              
              
              (127,594
              )Balance
      at end of period
              
              $
              508,364
              
              
              $
              537,667
 
 Impaired
loans, as defined by SFAS No. 114, Accounting by Creditors for
Impairment of a Loan, were as follows:
 
 2007
              
              
              2006Year-end
      loans with no allocated allowancefor
      loan losses
              
              $
              1,829,000
              
              
              $
              371,000Year-end
      loans with allocated allowancefor
      loan losses
              
              
              420,000
              
              
              
              -Total
              
              $
              2,249,000
              
              
              $
              371,000Amount
      of the allowance allocated
              
              $
              59,000
              
              
              $
              -
  (Continued)
 
 F-14
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE 3 – LOANS(Continued)
 
 Nonperforming
loans were as follows:
 
 2007
              
              
              2006Loans
      past due over 90 days still on accrual
              
              $
              552,778
              
              
              $
              568,594Nonaccrual
      loans
              
              
              1,479,177
              
              
              
              531,000
 
 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 $40,707,000 and $41,224,000 at December 31, 2007 and 2006 were
pledged to secure FHLB advances.
 
 NOTE
4 - PREMISES AND EQUIPMENT
 
 A summary
of premises and equipment at period end is as follows:
 
 2007
              
              
              2006Land
      and improvements
              
              $
              705,822
              
              
              $
              705,822Buildings
              
              
              4,059,138
              
              
              
              4,059,138Furniture
      and equipment
              
              
              2,035,034
              
              
              
              1,920,6136,799,994
              
              
              
              6,685,573Accumulated
      depreciation
              
              
              (3,242,476
              )
              
              
              (3,001,370
              )$
              3,557,518
              
              
              $
              3,684,203
 
 Depreciation
expense was $246,897 and $279,952 for 2007 and 2006.
 
 Operating Leases: The
Company leases certain branch properties under operating leases.  Rent
expense was $54,166 and $49,609 for the calendar years 2007 and
2006.  Firm rent commitments at December 31, 2007, including
consideration of termination options and not including renewal options that
generally are present, were not significant at December 31, 2007.
  (Continued)
 F-15
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE
5 – INTANGIBLE ASSETS
 
 2 0 0 7
              
              
              2 0 0 6Carrying
                Amount
              
              
              Gross
                Accumulated
                Amortization
              
              
              Carrying
                Amount
              
              
              Gross
                Accumulated
                AmortizationAmortized
      intangible assets:Core
      deposit intangible
              
              $
              379,957
              
              
              $
              376,744
              
              
              $
              379,957
              
              
              $
              368,896Other
      unidentified
                intangibles
              
              
              2,327,038
              
              
              
              1,474,215
              
              
              
              2,327,038
              
              
              
              1,319,157$
              2,706,995
              
              
              $
              1,850,959
              
              
              $
              2,706,995
              
              
              $
              1,688,053
 
 Aggregate
amortization expense was $162,907 and $170,443 for the years ended December 31,
2007 and 2006.
 
 Estimated
amortization expense for each of the next five years:
 
 2008
              
              $
              158,2712009
              
              
              155,0592010
              
              
              155,0592011
              
              
              155,0592012
              
              
              155,059
 
 NOTE
6 - DEPOSITS
 
 The
aggregate amount of time deposit accounts (including certificates of deposit)
with a minimum denomination of $100,000 was approximately $44,368,000 and
$46,642,000 at December 31, 2007 and 2006.
 
 Brokered
deposits totaled approximately $24,448,000 and $26,021,000 at December 31, 2007
and 2006.  At December 31, 2007 and December 31, 2006, brokered
deposits had interest rates ranging from 4.65% to 5.35% and 4.50% to 5.50%,
respectively.  In general, deposit amounts greater than $100,000 are
not insured.
  (Continued)
  F-16
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE 6 – DEPOSITS
(Continued)
 
 At
December 31, 2007, the scheduled maturities of certificates of deposits are as
follows:
 
 2008
              
              $
              47,583,1102009
              
              
              7,819,6052010
              
              
              681,4272011
              
              
              390,4192012
              
              
              159,387Thereafter
              
              
              -$
              56,633,948
 
 Interest
expense by deposit type for the period indicated is as follows:
 
 2007
              
              
              2006Savings
              
              $
              36,000
              
              
              $
              40,000Demand/NOW
              
              
              134,000
              
              
              
              127,000Certificates
              
              
              2,950,000
              
              
              
              2,161,000$
              3,120,000
              
              
              $
              2,328,000
 
 NOTE
7 - FEDERAL HOME LOAN BANK ADVANCES
 
 Advances
from the Federal Home Loan Bank at December 31, 2007 and 2006 were:
 
 ---------December
      31, 2007---------
              
              
              ---------December
      31, 2006---------Interest
                Rate
                Ranges
              
              
              Weighted
                Average
                Rate
              
              
              Balance
              
              
              Interest
                Rate
                Ranges
              
              
              Weighted
                Average
                Rate
              
              
              BalanceAdvances
      maturing and payments
                due
      in calendar year:2007
              
              
              
              
              
              
              
              
              
              
              5.22
      to 5.95%
              
              
              
              5.34
              %
              
              $
              12,000,0002008
              
              3.75
      to 5.53%
              
              
              
              4.92
              %
              
              $
              17,000,000
              
              
              5.27
      to 5.53
              
              
              
              5.34
              
              
              
              7,000,0002009
              
              4.08
      to 4.92
              
              
              
              4.68
              
              
              
              7,000,000
              
              
              
              
              
              
              
              
              
              
              -2010
              
              
              4.98
              
              
              
              4.98
              
              
              
              2,400,000
              
              
              
              4.98
              
              
              
              4.98
              
              
              
              2,400,000$
              26,400,000
              
              
              
              
              
              
              
              
              
              
              $
              21,400,000
  All
advances require monthly interest payments and are due, in full, at
maturity.
  (Continued)
  F-17
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE 7 - FEDERAL HOME LOAN BANK
ADVANCES (Continued)
 
 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 $9,400,000 at December 31, 2007 and $11,400,000 at
December 31, 2006.
 
 FHLB
advances are collateralized by specific loans 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.
 
 
 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, 2007 and 2006 were $173,694 and
$172,205, 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, 2007 and 2006 were $19,892 and $24,504, respectively.
 
 The
Company also sponsors a deferred compensation plan that is available to senior
officers and directors.  Plan participants who elect to defer a
portion of their salary receive interest on the amount deferred at prevailing
two-year certificate of deposit interest rates.  Expense related to
the plan was $19,049 and $18,333 for the years ended December 31, 2007 and
2006.
 
 (Continued)
  F-18
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 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 and expense is
recorded.  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 during 2007 were $52,883.  Expense was
$57,797.  In 2006 no contributions were made or expense incurred for
the plan.
 
 Shares
held by the ESOP we as follows:
 
 2007
              
              
              2006Allocated
      to participants
              
              
              3,648
              
              
              
              -Unearned
              
              
              24,780
              
              
              
              28,428Total
      ESOP shares
              
              
              28,428
              
              
              
              28,428Fair
      value of unearned shares
              
              $
              156,114
              
              
              $
              284,280Fair
      value of allocated shares subject to repurchase obligation
              
              $
              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, 2007, the Company was not in compliance with
certain covenants, but the lender has agreed to waive acceleration of loan
collection.
 
 (Continued)
  F-19
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE
10 - FEDERAL INCOME TAXES
 
 The
provision for federal taxes consists of the following:
 
 2007
              
              
              2006Current
              
              $
              -
              
              
              $
              (5,774
              )Deferred
              
              
              (296,111
              )
              
              
              (203,388
              )Change
      in valuation allowance
              
              
              732,696
              
              
              
              -$
              436,585
              
              
              $
              (209,162
              )
 
 The
provision (benefit) for federal income taxes differs from that computed at the
statutory corporate tax rate of 34% as follows:
 
 2007
              
              
              2006Tax
      expense (benefit) at statutory rate
              
              $
              (309,046
              )
              
              $
              (212,597
              )Change
      in valuation allowance
              
              
              732,696
              
              
              
              -Other
              
              
              12,935
              
              
              
              3,435$
              436,585
              
              
              $
              (209,162
              )
 
 The tax
effects of temporary differences that give rise to significant portions of the
deferred tax assets and deferred tax liabilities are as follows:
 
 2007
              
              
              2006Deferred
      tax assetsAcquisition
      intangibles
              
              $
              41,588
              
              
              $
              47,570Allowance
      for loan losses
              
              
              179,712
              
              
              
              189,152Deferred
      compensation
              
              
              172,291
              
              
              
              165,814Net
      operating loss carry-forward
              
              
              489,461
              
              
              
              253,018Unrealized
      loss on securities available for sale
              
              
              -
              
              
              
              6,530Contribution
      carryforward
              
              
              20,671
              
              
              
              14,280Non-accrual
      loan interest
              
              
              55,575
              
              
              
              132Other
              
              
              4,163
              
              
              
              4,267963,461
              
              
              
              680,763Deferred
      tax liabilitiesFHLB
      dividends
              
              
              (49,355
              )
              
              
              (49,661
              )Accumulated
      depreciation
              
              
              (167,099
              )
              
              
              (187,491
              )Deferred
      loan costs
              
              
              (14,311
              )
              
              
              (5,816
              )(230,765
              )
              
              
              (242,968
              )Valuation
      allowance
              
              
              (732,696
              )
              
              
              -Net
      deferred tax asset
              
              $
              -
              
              
              $
              437,795
  (Continued)
 
 F-20
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE 10 - FEDERAL INCOME TAXES
(Continued)
 
 At
year-end 2007, the Company had federal net operating loss carryforwards of
approximately $1,440,000. 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,
2007.
  Retained
earnings at December 31, 2007 and 2006 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, 2007.  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
2004.
 
 NOTE
11 – RELATED PARTY TRANSACTIONS
 
 Loans to
principal officers, directors, and their affiliates during 2007 were as
follows:
 
 Beginning
      balance
              
              $
              1,898,018New
      loans
              
              
              1,539,363Repayments
              
              
              (1,679,400
              )Ending
      balance
              
              $
              1,757,981
 
 Deposits
from principal officers, directors, and their affiliates at year-end 2007 and
2006 were approximately $1,117,000 and $649,000.
 
 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-21
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 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.  At year-end 2007, the most recent regulatory notification
categorized the Bank as well 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,
      2007Total
      adjusted capital (to risk
                weighted
      assets)
              
              $
              7,204
              
              
              
              10.2
              %
              
              $
              5,655
              
              
              
              8.0
              %
              
              $
              7,069
              
              
              
              10.0
              %Tier
      1 (core) capital (to risk weighted
                assets)
              
              
              6,696
              
              
              
              9.5
              
              
              
              N/A
              
              
              
              N/A
              
              
              
              4,241
              
              
              
              6.0Tier
      1 (core) capital (to adjusted total
                assets)
              
              
              6,696
              
              
              
              5.9
              
              
              
              4,563
              
              
              
              4.0
              
              
              
              5,704
              
              
              
              5.0Tangible
      capital (to adjusted total
                assets)
              
              
              6,696
              
              
              
              5.9
              
              
              
              1,711
              
              
              
              1.5
              
              
              
              N/A
              
              
              
              N/ADecember 31,
      2006Total
      adjusted capital (to risk
                weighted
      assets)
              
              $
              7,883
              
              
              
              11.2
              %
              
              $
              5,617
              
              
              
              8.0
              %
              
              $
              7,022
              
              
              
              10.0
              %Tier
      1 (core) capital (to risk weighted
                assets)
              
              
              7,345
              
              
              
              10.5
              
              
              
              N/A
              
              
              
              N/A
              
              
              
              4,213
              
              
              
              6.0Tier
      1 (core) capital (to adjusted total
                assets)
              
              
              7,345
              
              
              
              6.5
              
              
              
              4,529
              
              
              
              4.0
              
              
              
              5,662
              
              
              
              5.0Tangible
      capital (to adjusted total
                assets)
              
              
              7,345
              
              
              
              6.5
              
              
              
              1,698
              
              
              
              1.5
              
              
              
              N/A
              
              
              
              N/A
 
 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, 2007 and 2006.
  (Continued)
 F-22
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE 12 - CAPITAL REQUIREMENTS
AND REGULATORY MATTERS
(Continued)
 
 The Bank
was notified by its primary regulator 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, the Bank’s primary regulator 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 would require the Bank to prepare and submit an updated
business plan and 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, 2007 and 2006, the Company had the following:
 
 2007
              
              
              2006Commitments
      to make loans
              
              $
              161,000
              
              
              $
              719,000Unused
      lines of credit
              
              
              5,323,000
              
              
              
              5,412,000Loans
      in process
              
              
              419,000
              
              
              
              1,816,000
 
 Fixed
rate loan commitments as of December 31, 2007 and 2006 were $161,000 and
$689,000.  These commitments had interest rates ranging from 6.38% to
7.38% at December 31, 2007 (6.13% to 8.38% at December 31, 2006) and maturities
ranging from four to five years at December 31, 2007 (3 years to 30 years at
December 31, 2006).  Variable rate loan commitments are at market
rates and were $0 and $30,000 at December 31, 2007 and 2006.
 
 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-23
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE
14 – OTHER COMPREHENSIVE INCOME (LOSS)
 
 2007
              
              
              2006Unrealized
      holding gains (losses)
                on
      available for sale securities
              
              $
              (10,949
              )
              
              $
              (800
              )Reclassification
      adjustments for (gains)
                and
      losses later recognized
              
              
              -
              
              
              
              -Net
      unrealized gain (loss)
              
              
              (10,949
              )
              
              
              (800
              )Income
      tax expense (benefit)
              
              
              (6,530
              )
              
              
              273Other
      comprehensive income (loss)
              
              $
              (17,479
              )
              
              $
              (527
              )
 
 
 NOTE
15 - FAIR VALUES OF FINANCIAL INSTRUMENTS
 
 Carrying
amount and estimated fair values of financial instruments (in thousands) were as
follows:
 
 2 0 0 7
              
              
              2 0 0 6Carrying
                Amount
              
              
              Fair
                Value
              
              
              Carrying
                Amount
              
              
              Fair
                ValueFinancial
      assetsCash
      and cash equivalents
              
              $
              5,171
              
              
              $
              5,171
              
              
              $
              3,840
              
              
              $
              3,840Securities
              
              
              1,924
              
              
              
              1,924
              
              
              
              2,088
              
              
              
              2,088Loans,
      net
              
              
              100,150
              
              
              
              99,891
              
              
              
              100,653
              
              
              
              99,712FHLB
      stock
              
              
              1,589
              
              
              
              1,589
              
              
              
              1,589
              
              
              
              1,589Accrued
      interest receivable
              
              
              605
              
              
              
              605
              
              
              
              735
              
              
              
              735Financial
      liabilitiesDeposits
              
              $
              79,405
              
              
              $
              80,091
              
              
              $
              82,701
              
              
              $
              82,593FHLB
      advances
              
              
              26,400
              
              
              
              26,624
              
              
              
              21,400
              
              
              
              21,440Notes
      payable
              
              
              956
              
              
              
              956
              
              
              
              984
              
              
              
              984Accrued
      interest payable
              
              
              189
              
              
              
              189
              
              
              
              131
              
              
              
              131
 
 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, Federal Home Loan Bank stock, accrued interest receivable and
payable, demand deposits, short-term debt, and variable rate loans or deposits
that reprice frequently and fully.  Security fair values are based on
market prices or dealer quotes, and if no such information is available, on the
rate and term of the security and information about the issuer.  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.  The fair value
of off-balance-sheet items is not considered material.
  (Continued)
  F-24
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE
16 – NOTES PAYABLE
 
 On
December 31, 2007 and 2006 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, 2007 and 2006, the Company was not in compliance with certain of
these covenants, yet the lender has agreed not to accelerate collection of the
loan.
 
 In
accordance with generally accepted accounting principles, the financial
statements also include the ESOP note payable which represents an obligation of
the Company’s Employee Stock Ownership Plan but is guaranteed by the
Company.  See Note 9 for additional information regarding this
obligation.
 
 NOTE
17 – CONDENSED FINANCIAL STATEMENTS (PARENT COMPANY ONLY)
 
 Following
are condensed parent company only financial statements:
 
 CONDENSED
BALANCE SHEETS
 
 2007
              
              
              2006ASSETSCash
      and cash equivalents
              
              $
              260,709
              
              
              $
              723,461Investment
      in Bank subsidiary
              
              
              7,778,032
              
              
              
              8,839,846Other
      assets
              
              
              71,380
              
              
              
              69,265Total
      assets
              
              $
              8,110,121
              
              
              $
              9,632,572LIABILITIES
      AND SHAREHOLDERS’ EQUITYNote
      payable
              
              $
              700,000
              
              
              $
              700,000ESOP
      note payable
              
              
              255,852
              
              
              
              284,280Other
      liabilities
              
              
              -
              
              
              
              49,350Total
      liabilities
              
              
              955,852
              
              
              
              1,033,630Shareholders’
      equity
              
              
              7,154,269
              
              
              
              8,598,942Total
      liabilities and shareholders’ equity
              
              $
              8,110,121
              
              
              $
              9,632,572
  (Continued)
 
 F-25
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE
17 – CONDENSED FINANCIAL STATEMENTS (PARENT COMPANY ONLY)
 (Continued)
 
 CONDENSED
STATEMENTS OF INCOME
 
 2007
              
              
              2006IncomeInterest
      income
              
              $
              6,325
              
              
              $
              8,510ExpenseInterest
      expense
              
              
              56,670
              
              
              
              155,874Other
      expense
              
              
              85,561
              
              
              
              15,429Total
      expense
              
              
              142,231
              
              
              
              171,303Loss
      before income tax and equity inundistributed
      net loss of subsidiaries
              
              
              (135,906
              )
              
              
              (162,793
              )Equity
      in undistributed net loss of subsidiary
              
              
              (1,140,372
              )
              
              
              (307,536
              )Loss
      before income tax benefit (expense)
              
              
              (1,276,278
              )
              
              
              (470,329
              )Income
      tax benefit (expense)
              
              
              (69,265
              )
              
              
              54,207Net
      loss
              
              $
              (1,345,543
              )
              
              $
              (416,122
              )
 
 (Continued)
 
 F-26
   MAINSTREET
FINANCIAL CORPORATION
 NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
 December
31, 2007 and 2006
 NOTE
17 – CONDENSED FINANCIAL STATEMENTS (PARENT COMPANY ONLY)
 (Continued)
 
 CONDENSED
STATEMENTS OF CASH FLOWS
 
 2007
              
              
              2006Cash
      flows from operating activitiesNet
      income (loss)
              
              $
              (1,345,543
              )
              
              $
              (416,122
              )Adjustments
      to reconcile net income to net cashprovided
      by (used in) operating activities:Equity
      in loss of subsidiary
              
              
              1,140,372
              
              
              
              307,536(Increase)
      decrease in other assets
              
              
              (2,115
              )
              
              
              (54,206
              )Increase
      (decrease) in other liabilities
              
              
              (49,350
              )
              
              
              30,625Net
      cash used for operating activities
              
              
              (256,636
              )
              
              
              (132,167
              )Cash
      flows from investing activitiesInvestment
      in subsidiary
              
              
              (62,695
              )
              
              
              (1,819,998
              )Net
      cash used for investing activities
              
              
              (62,695
              )
              
              
              (1,819,998
              )Cash
      flows from financing activitiesProceeds
      from stock offering
              
              
              -
              
              
              
              2,897,238Public
      offering costs
              
              
              (114,993
              )
              
              
              -Draws
      on note payable
              
              
              -
              
              
              
              1,000,000Payments
      on note payable
              
              
              (28,428
              )
              
              
              (1,300,000
              )Cash
      dividends paid
              
              
              -
              
              
              
              (11,000
              )Net
      cash from financing activities
              
              
              (143,421
              )
              
              
              2,586,238Net
      change in cash and cash equivalents
              
              
              (462,752
              )
              
              
              634,073Cash
      and cash equivalents at beginning of year
              
              
              723,461
              
              
              
              89,388Cash
      and cash equivalents at end of year
              
              $
              260,709
              
              
              $
              723,461
    F-27