##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2010
 OR
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from <> to <>
 Commission file number: 0-20167
 MACKINAC FINANCIAL CORPORATION
  MICHIGAN
    
    38-2062816(State or other jurisdiction of 
incorporation or organization)
    
    (I.R.S. Employer Identification No.)130 SOUTH CEDAR STREET, MANISTIQUE, MI
    
    49854(Address of principal executive offices)
    
    (Zip Code)
   þ o
 o o
  Large Accelerated Filer o
    
    Accelerated Filer o
    
    Non-accelerated Filer o
    
    Smaller reporting company þ(Do not check if a smaller reporting company)
  o þ




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##### 



Page No.PART I. FINANCIAL INFORMATIONItem 1. Financial StatementsCondensed Consolidated Balance Sheets -
June 30, 2010 (Unaudited), December 31, 2009 and
June 30, 2009 (Unaudited)
    
    
    1Condensed Consolidated Statements of Operations  Three and Six
Months Ended June 30, 2010 (Unaudited) and
June 30, 2009 (Unaudited)
    
    
    2Condensed Consolidated Statements of Changes in Shareholders
Equity  Three and Six Months Ended June 30, 2010
(Unaudited) and June 30, 2009 (Unaudited)
    
    
    3Condensed Consolidated Statements of Cash Flows -
Six Months Ended June 30, 2010 (Unaudited) and
June 30, 2009 (Unaudited)
    
    
    4Notes to Condensed Consolidated Financial
Statements (Unaudited)
    
    
    5Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    18Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    30Item 4. Controls and Procedures
    
    
    33PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    34Item 6. Exhibits and Reports on Form 8-K
    
    
    34SIGNATURES
    
    
    35EX-31.1EX-31.2EX-32.1EX-32.2




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##### Table of Contents



FINANCIAL INFORMATION
 
 FINANCIAL STATEMENTS
 
 
 June 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009(Unaudited)
    
    
    
    
    
    
    (Unaudited)ASSETSCash and due from banks
    
    $
    39,165
    
    
    $
    18,433
    
    
    $
    12,189Federal funds sold
    
    
    12,000
    
    
    
    27,000
    
    
    
    Cash and cash equivalents
    
    
    51,165
    
    
    
    45,433
    
    
    
    12,189Interest-bearing deposits in other financial institutions
    
    
    678
    
    
    
    678
    
    
    
    618Securities available for sale
    
    
    34,942
    
    
    
    46,513
    
    
    
    95,620Federal Home Loan Bank stock
    
    
    3,794
    
    
    
    3,794
    
    
    
    3,794Loans:Commercial
    
    
    302,228
    
    
    
    305,670
    
    
    
    296,392Mortgage
    
    
    78,428
    
    
    
    74,350
    
    
    
    71,777Consumer
    
    
    4,183
    
    
    
    4,290
    
    
    
    3,835Total Loans
    
    
    384,839
    
    
    
    384,310
    
    
    
    372,004Allowance for loan losses
    
    
    (6,371
    )
    
    
    (5,225
    )
    
    
    (4,119
    )Net loans
    
    
    378,468
    
    
    
    379,085
    
    
    
    367,885Premises and equipment
    
    
    10,085
    
    
    
    10,165
    
    
    
    11,064Other real estate held for sale
    
    
    5,676
    
    
    
    5,804
    
    
    
    4,950Other assets
    
    
    15,966
    
    
    
    23,905
    
    
    
    10,184TOTAL ASSETS
    
    $
    500,774
    
    
    $
    515,377
    
    
    $
    506,304LIABILITIES AND SHAREHOLDERS EQUITYLIABILITIES:Deposits:Noninterest bearing deposits
    
    $
    41,434
    
    
    $
    35,878
    
    
    $
    33,368NOW, money market, checking
    
    
    118,909
    
    
    
    95,790
    
    
    
    75,974Savings
    
    
    20,110
    
    
    
    18,207
    
    
    
    21,411CDs<$100,000
    
    
    90,573
    
    
    
    59,953
    
    
    
    72,139CDs>$100,000
    
    
    23,652
    
    
    
    36,385
    
    
    
    25,455Brokered
    
    
    111,106
    
    
    
    175,176
    
    
    
    184,805Total deposits
    
    
    405,784
    
    
    
    421,389
    
    
    
    413,152Borrowings:Federal Home Loan Bank
    
    
    35,000
    
    
    
    35,000
    
    
    
    35,000Other
    
    
    1,140
    
    
    
    1,140
    
    
    
    1,210Total borrowings
    
    
    36,140
    
    
    
    36,140
    
    
    
    36,210Other liabilities
    
    
    2,619
    
    
    
    2,549
    
    
    
    3,003Total liabilities
    
    
    444,543
    
    
    
    460,078
    
    
    
    452,365Shareholders equity:Preferred stock  No par value:Authorized 500,000 shares, 11,000 shares issued and outstanding
    
    
    10,610
    
    
    
    10,514
    
    
    
    10,418Common stock and additional paid in capital  No par valueAuthorized - 18,000,000 sharesIssued and outstanding  3,419,736 shares
    
    
    43,509
    
    
    
    43,493
    
    
    
    43,468Retained earnings (accumulated deficit)
    
    
    1,236
    
    
    
    199
    
    
    
    (1,158
    )Accumulated other comprehensive income
    
    
    876
    
    
    
    1,093
    
    
    
    1,211Total shareholders equity
    
    
    56,231
    
    
    
    55,299
    
    
    
    53,939TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    500,774
    
    
    $
    515,377
    
    
    $
    506,304
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Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2010
    
    
    2009
    
    
    2010
    
    
    2009(Unaudited)
    
    
    (Unaudited)INTEREST INCOME:Interest and fees on loans:Taxable
    
    $
    5,227
    
    
    $
    5,104
    
    
    $
    10,418
    
    
    $
    10,106Tax-exempt
    
    
    47
    
    
    
    84
    
    
    
    99
    
    
    
    174Interest on securities:Taxable
    
    
    356
    
    
    
    673
    
    
    
    753
    
    
    
    1,132Tax-exempt
    
    
    7
    
    
    
    3
    
    
    
    14
    
    
    
    4Other interest income
    
    
    37
    
    
    
    14
    
    
    
    77
    
    
    
    16Total interest income
    
    
    5,674
    
    
    
    5,878
    
    
    
    11,361
    
    
    
    11,432INTEREST EXPENSE:Deposits
    
    
    1,439
    
    
    
    1,566
    
    
    
    2,896
    
    
    
    3,344Borrowings
    
    
    212
    
    
    
    261
    
    
    
    420
    
    
    
    542Total interest expense
    
    
    1,651
    
    
    
    1,827
    
    
    
    3,316
    
    
    
    3,886Net interest income
    
    
    4,023
    
    
    
    4,051
    
    
    
    8,045
    
    
    
    7,546Provision for loan losses
    
    
    2,800
    
    
    
    150
    
    
    
    3,700
    
    
    
    700Net interest income after provision for loan losses
    
    
    1,223
    
    
    
    3,901
    
    
    
    4,345
    
    
    
    6,846OTHER INCOME:Service fees
    
    
    252
    
    
    
    271
    
    
    
    474
    
    
    
    514Net security gains
    
    
    
    
    
    
    
    
    
    
    215
    
    
    
    Net gains on sale of loans
    
    
    309
    
    
    
    84
    
    
    
    625
    
    
    
    142Other
    
    
    32
    
    
    
    84
    
    
    
    86
    
    
    
    174Total other income
    
    
    593
    
    
    
    439
    
    
    
    1,400
    
    
    
    830OTHER EXPENSE:Salaries and employee benefits
    
    
    1,781
    
    
    
    1,561
    
    
    
    3,501
    
    
    
    3,158Occupancy
    
    
    345
    
    
    
    355
    
    
    
    690
    
    
    
    733Furniture and equipment
    
    
    197
    
    
    
    222
    
    
    
    391
    
    
    
    411Data processing
    
    
    205
    
    
    
    224
    
    
    
    394
    
    
    
    444Professional service fees
    
    
    161
    
    
    
    144
    
    
    
    334
    
    
    
    297Loan and deposit
    
    
    218
    
    
    
    172
    
    
    
    466
    
    
    
    308Writedown of other real estate owned
    
    
    1,800
    
    
    
    
    
    
    
    1,947
    
    
    
    FDIC insurance assessment
    
    
    221
    
    
    
    340
    
    
    
    443
    
    
    
    465Telephone
    
    
    45
    
    
    
    46
    
    
    
    92
    
    
    
    89Advertising
    
    
    72
    
    
    
    80
    
    
    
    144
    
    
    
    158Other
    
    
    285
    
    
    
    326
    
    
    
    557
    
    
    
    646Total other expense
    
    
    5,330
    
    
    
    3,470
    
    
    
    8,959
    
    
    
    6,709Income (loss) before provision for income taxes
    
    
    (3,514
    )
    
    
    870
    
    
    
    (3,214
    )
    
    
    967Provision for (benefit of) income taxes
    
    
    (1,212
    )
    
    
    271
    
    
    
    (4,623
    )
    
    
    278NET INCOME (LOSS)
    
    
    (2,302
    )
    
    
    599
    
    
    
    1,409
    
    
    
    689Preferred dividend and accretion of discount
    
    
    186
    
    
    
    138
    
    
    
    371
    
    
    
    138NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS
    
    $
    (2,488
    )
    
    $
    461
    
    
    $
    1,038
    
    
    $
    551INCOME (LOSS) PER COMMON SHARE:Basic
    
    $
    (0.73
    )
    
    $
    .13
    
    
    $
    .30
    
    
    $
    .16Diluted
    
    $
    (0.73
    )
    
    $
    .13
    
    
    $
    .30
    
    
    $
    .16
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Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2010
    
    
    2009
    
    
    2010
    
    
    2009Balance, beginning of period
    
    $
    58,722
    
    
    $
    41,864
    
    
    $
    55,299
    
    
    $
    41,551Net income (loss) for period
    
    
    (2,302
    )
    
    
    599
    
    
    
    1,409
    
    
    
    689Net unrealized gain (loss) on securities available for sale
    
    
    (58
    )
    
    
    561
    
    
    
    (217
    )
    
    
    766Total comprehensive income (loss)
    
    
    (2,360
    )
    
    
    1,160
    
    
    
    1,192
    
    
    
    1,455Dividend on preferred stock and accretion of discount
    
    
    (186
    )
    
    
    (138
    )
    
    
    (371
    )
    
    
    (138
    )Stock option compensation
    
    
    7
    
    
    
    17
    
    
    
    15
    
    
    
    35Issuance of preferred stock
    
    
    
    
    
    
    10,382
    
    
    
    
    
    
    
    10,382Issuance of common stock warrants
    
    
    
    
    
    
    618
    
    
    
    
    
    
    
    618Accretion of preferred stock discount
    
    
    48
    
    
    
    36
    
    
    
    96
    
    
    
    36Balance, end of period
    
    $
    56,231
    
    
    $
    53,939
    
    
    $
    56,231
    
    
    $
    53,939
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Six Months EndedJune 30,2010
    
    
    2009Cash Flows From Operating Activities:Net income
    
    $
    1,409
    
    
    $
    689Adjustments to reconcile net income to
net cash provided by (used in) operating activities:Depreciation and amortization
    
    
    802
    
    
    
    1,000Provision for (benefit of) deferred taxes
    
    
    (4,623
    )
    
    
    278Provision for loan losses
    
    
    3,700
    
    
    
    700(Gain) on sales/calls of securities available for sale
    
    
    (215
    )
    
    
    Loss on sales of premises, equipment, and other real estate
    
    
    47
    
    
    
    4Writedown of other real estate
    
    
    1,947
    
    
    
    Stock option compensation
    
    
    15
    
    
    
    35Change in other assets
    
    
    12,673
    
    
    
    (822
    )Change in other liabilities
    
    
    70
    
    
    
    430Net cash provided by operating activities
    
    
    15,825
    
    
    
    2,314Cash Flows From Investing Activities:Net (increase) decrease in loans
    
    
    (6,086
    )
    
    
    (5,383
    )Net (increase) decrease in interest-bearing deposits in other financial institutions
    
    
    
    
    
    
    (36
    )Purchase of securities available for sale
    
    
    
    
    
    
    (50,216
    )Proceeds from sales, maturities or calls of securities available for sale
    
    
    11,277
    
    
    
    2,856Capital expenditures
    
    
    (445
    )
    
    
    (463
    )Proceeds from sale of premises, equipment, and other real estate
    
    
    1,137
    
    
    
    88Net cash provided by (used in) investing activities
    
    
    5,883
    
    
    
    (53,154
    )Cash Flows From Financing Activities:Net increase (decrease) in deposits
    
    
    (15,605
    )
    
    
    42,055Issuance of Preferred Stock Series A Capital
    
    
    
    
    
    
    11,000Dividend on preferred stock and accretion of discount
    
    
    (371
    )
    
    
    (138
    )Net cash provided by (used in) financing activities
    
    
    (15,976
    )
    
    
    52,917Net increase in cash and cash equivalents
    
    
    5,732
    
    
    
    2,077Cash and cash equivalents at beginning of period
    
    
    45,433
    
    
    
    10,112Cash and cash equivalents at end of period
    
    $
    51,165
    
    
    $
    12,189Supplemental Cash Flow Information:Cash paid during the year for:Interest
    
    $
    3,319
    
    
    $
    3,989Income taxes
    
    
    25
    
    
    
    60Noncash Investing and Financing Activities:Transfers of foreclosures from loans to other real estate held for sale
    
    
    3,003
    
    
    
    3,276
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1.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESBasis of PresentationThe unaudited condensed consolidated financial statements of Mackinac Financial Corporation (the
Corporation) have been prepared in accordance with generally accepted accounting principles
for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the six-month period ended June 30,
2010 are not necessarily indicative of the results that may be expected for the year ending
December 31, 2010. The unaudited consolidated financial statements and footnotes thereto should
be read in conjunction with the audited consolidated financial statements and footnotes thereto
included in the Corporations Annual Report on Form 10-K for the year ended December 31, 2009.The preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenue and expenses during the
period. Actual results could differ from those estimates.In order to properly reflect some categories of other income and other expenses,
reclassifications of expense and income items have been made to prior period numbers. The
net other income and other expenses was not changed due to these reclassifications.The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in the near term
relate to the determination of the allowance for loan losses, and the valuation of intangible
assets, deferred tax assets and mortgage servicing rights.Allowance for Loan LossesThe allowance for loan losses includes specific allowances related to commercial loans, which
have been judged to be impaired. A loan is impaired when, based on current information, it is
probable that the Corporation will not collect all amounts due in accordance with the
contractual terms of the loan agreement. These specific allowances are based on discounted
cash flows of expected future payments using the loans initial effective interest rate or the
fair value of the collateral if the loan is collateral dependent.The Corporation also has a general allowance for loan losses for loans not considered impaired.
The allowance for loan losses is maintained at a level which management believes is adequate
to provide for probable loan losses. Management periodically evaluates the adequacy of the
allowance using the Corporations past loan loss experience, known and inherent risks in the
portfolio, composition of the portfolio, current economic conditions, and other factors. The
allowance does not include the effects of expected losses related to future events or future
changes in economic conditions. This evaluation is inherently subjective since it requires
material estimates that may be susceptible to significant change. Loans are charged against
the allowance for loan losses when management believes the collectability of the principal is
unlikely. In addition, various regulatory agencies periodically review the allowance for loan
losses. These agencies may require additions to the allowance for loan losses based on their
judgments of collectability.In managements opinion, the allowance for loan losses is adequate to cover probable losses
relating to specifically identified loans, as well as probable losses inherent in the balance
of the loan portfolio as of the balance sheet date.
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1.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)Stock Option PlansThe Corporation sponsors three stock option plans. One plan was approved during 2000 and
applies to officers, employees, and nonemployee directors. This plan was amended as a part of
the December 2004 stock offering and recapitalization. The amendment, approved by shareholders,
increased the shares available under this plan by 428,587 shares from the original 25,000
(adjusted for the 1:20 reverse stock split), to a total authorized share balance of 453,587.
The other two plans, one for officers and employees and the other for nonemployee directors,
were approved in 1997. A total of 30,000 shares (adjusted for the 1:20 reverse stock split),
were made available for grant under these plans. All three option plans have expired, and
therefore no new shares may be granted. Options to purchase shares of the Corporations stock
are granted at a price equal to the market price of the stock at the date of grant. The
committee determines the vesting of the options when they are granted as established under the
plan.
 2.
    
    RECENT ACCOUNTING PRONOUNCEMENTSIn June 2009, the FASB issued Statements No. 166, Accounting for Transfers of Financial Assets,
(ASC 860-10) and No. 167, Amendments to FASB Interpretation No. 46(R),(ASC 810-10). ASC 860-10
will require more information about transfers of financial assets, including securitization
transactions, and where entities have continuing exposure to the risks related to transferred
financial assets. It eliminates the concept of a qualifying special-purpose entity, changes
the requirements for derecognizing financial assets, and requires additional disclosures. The
adoption of this ASC did not have an impact.ASC 810-10 replaces the quantitative-based risks and rewards calculation for determining which
enterprise, if any, has a controlling financial interest in a variable interest entity with a
qualitative approach focused on identifying which enterprise has the power to direct the
activities of a variable interest entity (VIE) that most significantly impact the entitys
economic performance and (1) the obligation to absorb losses of the entity or (2) the right to
receive benefits from the entity. ASC 860-10 and ASC 810-10 was effective at the start of a
reporting entitys first fiscal year beginning after November 15, 2009, or January 1, 2010, for
a calendar year entity. The adoption of this ASC did not have an impact at the date of
adoption.In July 2010, FASB issued a statement which expands disclosures about credit quality of
financing receivables and allowance for credit losses. The standard will require the
Corporation to expand disclosures about the credit quality of our loans and the related reserves
against them. The extra disclosures will include details on our past due loans, credit quality
indicators and modifications of loans. The Corporation will adopt the standard beginning with
our December 31, 2010 financial statements.
 3.
    
    EARNINGS PER SHAREEarnings per share are based upon the weighted average number of shares outstanding. Additional
shares issued as a result of option exercises would not be dilutive in both the three and six
month period. The issuance of shares as a result of the common stock warrants issued under the
TARP Capital Purchase Program would not have a dilutive effect on earnings for the three month
period in 2010, since they would decrease the loss per share. The common stock warrants would
be slightly dilutive for the six month period ended June 30, 2010. Please refer to the table
below for the dilutive impact.
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##### Table of Contents



3.
    
    EARNINGS PER SHARE (Continued)The following shows the computation of basic and diluted earnings per share for the three and
six months ended June 30, 2010 and 2009 (dollars in thousands, except per share data):
 Three Months Ended June 30,
    
    
    Six Months Ended June 30,2010
    
    
    2009
    
    
    2010
    
    
    2009Net income (loss)
    
    $
    (2,302
    )
    
    $
    599
    
    
    $
    1,409
    
    
    $
    689Preferred stock dividends
    
    
    186
    
    
    
    138
    
    
    
    371
    
    
    
    138Net income (loss) available to common shareholders
    
    $
    (2,488
    )
    
    $
    461
    
    
    $
    1,038
    
    
    $
    551Weighted average shares outstanding
    
    
    3,419,736
    
    
    
    3,419,736
    
    
    
    3,419,736
    
    
    
    3,419,736Effect of dilutive stock options and common stock
warrants outstanding
    
    
    
    
    
    
    
    
    
    
    64,425
    
    
    
    Diluted weighted average shares outstanding
    
    
    3,419,736
    
    
    
    3,419,736
    
    
    
    3,484,161
    
    
    
    3,419,736Earnings per common share:Basic
    
    $
    (0.73
    )
    
    $
    .13
    
    
    $
    .30
    
    
    $
    .16Diluted
    
    $
    (0.73
    )
    
    $
    .13
    
    
    $
    .30
    
    
    $
    .16
 4.
    
    INVESTMENT SECURITIESThe amortized cost and estimated fair value of investment securities available for sale as of
June 30, 2010, December 31, 2009 and June 30, 2009 are as follows (dollars in thousands):
 Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueJune 30, 2010US Agencies  MBS
    
    $
    32,416
    
    
    $
    1,232
    
    
    $
    
    
    
    $
    33,648Obligations of states and political subdivisions
    
    
    1,199
    
    
    
    95
    
    
    
    
    
    
    
    1,294Total securities available for sale
    
    $
    33,615
    
    
    $
    1,327
    
    
    $
    
    
    
    $
    34,942December 31, 2009US Agencies  MBS
    
    $
    43,651
    
    
    $
    1,642
    
    
    $
    (55
    )
    
    $
    45,238Obligations of states and political subdivisions
    
    
    1,207
    
    
    
    68
    
    
    
    
    
    
    
    1,275Total securities available for sale
    
    $
    44,858
    
    
    $
    1,710
    
    
    $
    (55
    )
    
    $
    46,513June 30, 2009US Agencies  MBS
    
    $
    74,390
    
    
    $
    1,596
    
    
    $
    (198
    )
    
    $
    75,788Asset backed  government guaranteed
    
    
    13,936
    
    
    
    349
    
    
    
    
    
    
    
    14,285Obligations of states and political subdivisions
    
    
    1,259
    
    
    
    (21
    )
    
    
    49
    
    
    
    1,287Corporate bonds
    
    
    4,201
    
    
    
    59
    
    
    
    
    
    
    
    4,260Total securities available for sale
    
    $
    93,786
    
    
    $
    1,983
    
    
    $
    (149
    )
    
    $
    95,620
 When gross unrealized losses exist within the portfolio, the Corporation considers them
temporary in nature and related to interest rate fluctuations. The Corporation has both the
ability and the intent to hold the investment securities until their respective maturities and
therefore does not anticipate the realization of the temporary losses.The amortized cost and estimated fair value of investment securities pledged to secure FHLB
borrowings and customer relationships were $15.497 million and $16.459 million, respectively, at
June 30, 2010.
 7




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5.
    
    LOANSThe composition of loans at June 30, 2010, December 31, 2009 and June 30, 2009 is as follows
(dollars in thousands):
 June 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009Commercial real estate
    
    $
    208,596
    
    
    $
    208,895
    
    
    $
    196,895Commercial, financial, and agricultural
    
    
    66,413
    
    
    
    72,184
    
    
    
    73,372One to four family residential real
estate
    
    
    71,613
    
    
    
    67,232
    
    
    
    65,564Construction:Commercial
    
    
    27,219
    
    
    
    24,591
    
    
    
    26,125Consumer
    
    
    6,815
    
    
    
    7,118
    
    
    
    6,213Consumer
    
    
    4,183
    
    
    
    4,290
    
    
    
    3,835Total loans
    
    $
    384,839
    
    
    $
    384,310
    
    
    $
    372,004
 LOANS  Allowance for loan losses
 An analysis of the allowance for loan losses for the six months ended June 30, 2010, the year
ended December
31, 2009, and the six months ended June 30, 2009 is as follows (dollars in thousands):
 June 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009Balance at beginning of period
    
    $
    5,225
    
    
    $
    4,277
    
    
    $
    4,277Recoveries on loans
    
    
    33
    
    
    
    66
    
    
    
    45Loans charged off
    
    
    (2,587
    )
    
    
    (2,818
    )
    
    
    (903
    )Provision for loan losses
    
    
    3,700
    
    
    
    3,700
    
    
    
    700Balance at end of period
    
    $
    6,371
    
    
    $
    5,225
    
    
    $
    4,119
 In the first half of 2010, net charge off activity was $2.554 million, or .67% of average loans
outstanding compared to net charge offs of $.858 million, or .23% of average loans, in the first
half of 2009. In the first half of 2010, the Corporation recorded a provision for loan loss in
the amount of $3.700 million compared to $.700 million in the first half of 2009, which is
discussed in more detail under Managements Discussion and Analysis.LOANS  Impaired loansNonperforming loans are those which are contractually past due 90 days or more as to interest or
principal payments, on nonaccrual status, or loans, the terms of which have been renegotiated to
provide a reduction or deferral on interest or principal.
 8




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5.
    
    LOANS (Continued)Information regarding impaired loans as of June 30, 2010, December 31, 2009 and June 30, 2009 is
as follows (dollars in thousands):
 Valuation ReserveJune 30,
    
    
    December 31,
    
    
    June 30,
    
    
    June 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009
    
    
    2010
    
    
    2009
    
    
    2009Balances, at period endImpaired loans with specific valuation reserve
    
    $
    4,841
    
    
    $
    11,348
    
    
    $
    7,708
    
    
    $
    2,023
    
    
    $
    2,705
    
    
    $
    1,556Impaired loans with no specific valuation
reserve
    
    
    6,202
    
    
    
    3,889
    
    
    
    2,167
    
    
    
    
    
    
    
    
    
    
    
    Total impaired loans
    
    $
    11,043
    
    
    $
    15,237
    
    
    $
    9,875
    
    
    $
    2,023
    
    
    $
    2,705
    
    
    $
    1,556Impaired loans on nonaccrual basis
    
    $
    10,174
    
    
    $
    14,368
    
    
    $
    9,277
    
    
    $
    2,023
    
    
    $
    2,705
    
    
    $
    1,556Impaired loans on accrual basis
    
    
    869
    
    
    
    869
    
    
    
    598
    
    
    
    
    
    
    
    
    
    
    
    Total impaired loans
    
    $
    11,043
    
    
    $
    15,237
    
    
    $
    9,875
    
    
    $
    2,023
    
    
    $
    2,705
    
    
    $
    1,556
 Six Months
    
    
    Twelve Months
    
    
    Six MonthsEnded
    
    
    Ended
    
    
    EndedJune 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009Average investment in impaired loans
    
    $
    11,717
    
    
    $
    10,449
    
    
    $
    9,452Interest income recognized during period
    
    
    7
    
    
    
    40
    
    
    
    11Interest income that would have been
recognized on an accrual basis
    
    
    328
    
    
    
    700
    
    
    
    338Cash-basis interest income recognized
    
    
    
    
    
    
    
    
    
    
    11
 Additional discussion on impaired loans is presented in the Managements Discussion and
Analysis section of this report.LOANS  Related partiesThe Bank, in the ordinary course of business, grants loans to the Corporations executive
officers and directors, including their families and firms in which they are principal owners.Activity in such loans is summarized below (dollars in thousands):
 June 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009Loans outstanding beginning of period
    
    $
    8,552
    
    
    $
    6,516
    
    
    $
    6,516New loans
    
    
    1,267
    
    
    
    2,160
    
    
    
    900Net activity on revolving lines of credit
    
    
    2,068
    
    
    
    1,189
    
    
    
    398Repayment
    
    
    (2,267
    )
    
    
    (1,610
    )
    
    
    (205
    )Change in related party interest
    
    
    
    
    
    
    297
    
    
    
    Loans outstanding end of period
    
    $
    9,620
    
    
    $
    8,552
    
    
    $
    7,609
 There were no loans to related parties classified substandard at June 30, 2010, December 31,
2009 or June 30, 2009, respectively. In addition to the outstanding balances above, there were
unused commitments of $.405 million to related parties at June 30, 2010.
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6.
    
    BORROWINGSBorrowings consist of the following at June 30, 2010, December 31,
2009 and June 30, 2009 (dollars in thousands):
 June 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009Federal Home Loan Bank fixed rate advances at rates ranging from 4.98% to 5.16%
maturing in December 2010
    
    $
    15,000
    
    
    $
    15,000
    
    
    $
    15,000Federal Home Loan Bank variable rate advances at rates ranging from .314% to .367%
maturing in January and February 2011
    
    
    20,000
    
    
    
    20,000
    
    
    
    20,000Farmers Home Administration, fixed-rate
note payable, maturing August 24, 2024
interest payable at 1%
    
    
    1,140
    
    
    
    1,140
    
    
    
    1,210$
    36,140
    
    
    $
    36,140
    
    
    $
    36,210
 The Federal Home Loan Bank borrowings are collateralized at June 30, 2010 by the following: a
collateral agreement on the Corporations one to four family residential real estate loans with
a book value of approximately $30.551 million; mortgage related and municipal securities with an
amortized cost and estimated fair value of $14.997 million and $15.742 million, respectively;
and Federal Home Loan Bank stock owned by the Bank totaling $3.794 million. Prepayment of the
remaining advances is subject to the provisions and conditions of the credit policy of the
Federal Home Loan Bank of Indianapolis in effect as of June 30, 2010.The U.S.D.A. Rural Development borrowing is collateralized by loans totaling $.263 million
originated and held by the Corporations wholly owned subsidiary, First Rural Relending, and an
assignment of a demand deposit account in the amount of $.991 million, and guaranteed by the
Corporation.
 7.
    
    STOCK OPTION PLANSA summary of stock option transactions for the six months ended June 30, 2010 and 2009, and the
year ended December 31, 2009, is as follows:
 June 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009Outstanding shares at beginning of year
    
    
    411,057
    
    
    
    446,237
    
    
    
    446,237Granted during the period
    
    
    
    
    
    
    
    
    
    
    Expired during the period
    
    
    (1,485
    )
    
    
    (35,180
    )
    
    
    (35,180
    )Outstanding shares at end of period
    
    
    409,572
    
    
    
    411,057
    
    
    
    411,057Weighted average exercise price per share
at end of period
    
    $
    11.15
    
    
    $
    12.03
    
    
    $
    12.03Shares available for grant at end of period
    
    
    
    
    
    
    24,780
    
    
    
    24,780
 There were no options granted in the first six months of 2010 and 2009.
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7.
    
    STOCK OPTION PLANS (Continued)Following is a summary of the options outstanding and exercisable at June 30, 2010:
 Exercise
    
    Number
    
    
    Remaining
    
    
    Weighted AveragePrice Range
    
    Outstanding
    
    
    Exercisable
    
    
    Contractual Life-Years
    
    
    Exercise Price$9.16
    
    
    12,500
    
    
    
    5,000
    
    
    
    5.5
    
    
    $
    9.16$9.75
    
    
    257,152
    
    
    
    120,861
    
    
    
    4.5
    
    
    
    9.75$10.65
    
    
    57,500
    
    
    
    11,500
    
    
    
    6.5
    
    
    
    10.65$11.50
    
    
    40,000
    
    
    
    8,000
    
    
    
    5.3
    
    
    
    11.50$12.00
    
    
    40,000
    
    
    
    8,000
    
    
    
    5.0
    
    
    
    12.00$156.00 - $185.00
    
    
    2,420
    
    
    
    2,420
    
    
    
    1.1
    
    
    
    161.99409,572
    
    
    
    155,781
    
    
    
    4.9
    
    
    $
    11.15
 8.
    
    INCOME TAXESA valuation allowance is provided against deferred tax assets when it is more likely than not
that some or all of the deferred tax asset will not be realized. During the first quarter of
2010, the Corporation evaluated the valuation allowance against the net deferred tax asset which
would require future taxable income in order to be
utilized and recorded a $3.500 million deferred tax benefit related to the utilization of the
NOL carryforward. The Corporation, as of June 30, 2010 had a net operating loss and tax credit
carryforwards for tax purposes of approximately $28.0 million, and $2.1 million, respectively.
As of June 30, 2010 the Corporation had total net deferred tax assets of $10.0 million, with a
related valuation allowance of approximately $3.0 million.The Corporation recorded the future benefits from these carryforwards at such time as it became
more likely than not that they would be utilized prior to expiration. Please refer to further
discussion on income taxes contained in Managements Discussion and Analysis. The net
operating loss carryforwards expire twenty years from the date they originated. These
carryforwards, if not utilized, will begin to expire in the year 2023. A portion of the NOL,
approximately $18.0 million, and all of the credit carryforwards are subject to the limitations
for utilization as set forth in Section 382 of the Internal Revenue Code. The annual limitation
is $1.4 million for the NOL and the equivalent value of tax credits, which is approximately
$.477 million. These limitations for use were established in conjunction with the
recapitalization of the Corporation in December, 2004.Subsequent to June 30, 2010, in deference to the loss recorded in the 2010 second quarter, an
analysis of the deferred tax asset was performed in order to determine if there was any
impairment relative to ultimate utilization during the carryforward period. As a part of this
analysis, management reviewed projected levels of taxable income and assessed the probability of
attaining these projected levels. Based upon this analysis, it was determined that there was no
impairment of this deferred tax asset.
 9.
    
    FAIR VALUE MEASUREMENTSIn June 2009, the FASB issued authoritative guidance to improve the information a reporting
entity provides in its financial statements about transfers of financial assets, including the
effect of a transfer on an entitys financial position, financial performance and cash flows and
the transferors continuing involvement in the transferred assets. The guidance eliminates the
concept of a qualifying special-purpose entity and changes the guidance for evaluation for
consolidation. This guidance became effective January 1, 2010 and did not have significant
impact on the Corporations financial position, results of operations or cash flows.In 2010, the FASB issued authoritative guidance expanding disclosures related to fair value
measurements including (i) the amounts of significant transfers of assets or liabilities between
Levels 1 and 2 of the fair value hierarchy and the reasons for the transfers, (ii) the reasons
for transfers of assets or liabilities in or out of Level 3 of the fair value hierarchy, with
significant transfers disclosed separately, (iii) the policy for determining when transfers
between levels of the fair value hierarchy are recognized and (iv) for recurring fair value
measurements of assets and liabilities in Level 3 of the fair value hierarchy, a gross
presentation of information about purchases,
 11




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9. FAIR VALUE MEASUREMENTS
 sales, issuances and settlements. The new guidance further clarifies that (i) fair value
measurement disclosures should be provided for each class of assets and liabilities (rather than
major category), which would generally be a subset of assets or liabilities within a line item in
the statement of financial position and (ii) disclosures should be provided about the valuation
techniques and inputs used to measure fair value for both recurring and nonrecurring fair value
measurements for each class of assets and liabilities included in Levels 2 and 3 of the fair
value hierarchy. The disclosures related to the gross presentation of purchases, sales issuances
and settlements of assets and liabilities included in Level 3 of the fair value hierarchy will be
required beginning January 1, 2011. The remaining disclosure requirements and clarifications
made by the new guidance became effective on January 1, 2010.
 The following table presents information for financial instruments at June 30, 2010 and December
31, 2009 (dollars in thousands):
 June 30, 2010
    
    
    December 31, 2009Carrying
    
    
    Estimated
    
    
    Carrying
    
    
    EstimatedAmount
    
    
    Fair Value
    
    
    Amount
    
    
    Fair ValueFinancial assets:Cash and cash equivalents
    
    $
    51,165
    
    
    $
    51,165
    
    
    $
    45,433
    
    
    $
    45,433Interest bearing deposits
    
    
    678
    
    
    
    678
    
    
    
    678
    
    
    
    678Securities available for sale
    
    
    34,942
    
    
    
    34,942
    
    
    
    46,513
    
    
    
    46,513Federal Home Loan Bank stock
    
    
    3,794
    
    
    
    3,794
    
    
    
    3,794
    
    
    
    3,794Net loans
    
    
    378,468
    
    
    
    378,883
    
    
    
    379,085
    
    
    
    382,352Accrued interest receivable
    
    
    1,343
    
    
    
    1,343
    
    
    
    1,413
    
    
    
    1,413Total financial assets
    
    $
    470,390
    
    
    $
    470,805
    
    
    $
    476,916
    
    
    $
    480,183Financial liabilities:Deposits
    
    $
    405,784
    
    
    $
    405,941
    
    
    $
    421,389
    
    
    $
    421,124Borrowings
    
    
    36,140
    
    
    
    36,291
    
    
    
    36,140
    
    
    
    36,447Accrued interest payable
    
    
    322
    
    
    
    322
    
    
    
    325
    
    
    
    325Total financial liabilities
    
    $
    442,246
    
    
    $
    442,554
    
    
    $
    457,854
    
    
    $
    457,896
 Fair value estimates, methods, and assumptions are set forth below for the Corporations
financial instruments:
 Cash, cash equivalents, and interest-bearing deposits- The carrying values approximate the fair
values for these assets.
 Securities- Fair values are based on quoted market prices where available. If a quoted market
price is not available, fair value is estimated using quoted market prices for similar
securities.
 Federal Home Loan Bank stock- Federal Home Loan Bank stock is carried at cost, which
is its redeemable value and approximates its fair value, since the market for this stock is
limited.
 Loans- Fair values are estimated for portfolios of loans with similar financial characteristics.
Loans are segregated by type such as commercial, residential mortgage, and other consumer. The
fair value of loans is calculated by discounting scheduled cash flows using discount rates
reflecting the credit and interest rate risk inherent in the loan.
 The methodology in determining fair value of nonaccrual loans is to average them into the blended
interest rate at 0% interest. This has the effect of decreasing the carrying amount below the
risk-free rate amount and, therefore, discounts the estimated fair value.
 12




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9. FAIR VALUE MEASUREMENTS
 Impaired loans are measured at the estimated fair value of the expected future cash flows at the
loans effective interest rate or the fair value of the collateral for loans which are collateral
dependent. Therefore, the carrying values of impaired loans approximate the estimated fair
values for these assets.
 Deposits- The fair value of deposits with no stated maturity, such as noninterest-bearing demand
deposits and savings, is equal to the amount payable on demand at the reporting date. The fair
value of time deposits is based on the discounted value of contractual cash flows applying
interest rates currently being offered on similar time deposits.
 Borrowings- Rates currently available for debt with similar terms and remaining maturities are
used to estimate the fair value of existing debt. The fair value of borrowed funds due on demand
is the amount payable at the reporting date.Accrued interest- The carrying amount of accrued interest approximates fair value.
 Off-balance-sheet instruments- The fair value of commitments is estimated using the fees
currently charged to enter into similar agreements, taking into account the remaining terms of
the agreements, the current interest rates, and the present creditworthiness of the
counterparties. Since the differences in the current fees and those reflected to the
off-balance-sheet instruments at year-end are immaterial, no amounts for fair value are
presented.
 Limitations-The authoritative accounting guidance for fair value measurements defines fair
value as the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants. A fair value measurement assumes that the
transaction to sell the asset or transfer the liability occurs in the principal market for the
asset or liability or, in the absence of a principal market, the most advantageous market for the
asset or liability. The price in the principal (or most advantageous) market used to measure the
fair value of the asset or liability shall not be adjusted for transaction costs. An orderly
transaction is a transaction that assumes exposure to the market for a period prior to the
measurement date to allow for marketing activities that are usual and customary for transactions
involving such assets and liabilities; it is not a forced transaction. Market participants are
buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii)
able to transact and (iv) willing to transact.
 The authoritative accounting guidance requires the use of valuation techniques that are
consistent with the market approach, the income approach and/or the cost approach. The market
approach uses prices and other relevant information generated by market transactions involving
identical or comparable assets and liabilities. The income approach uses valuation techniques to
convert future amounts, such as cash flows or earnings, to a single present amount on a
discounted basis. The cost approach is based on the amount that currently would be required to
replace the service capacity of an asset (replacement costs). Valuation techniques should be
consistently applied. Inputs to valuation techniques refer to the assumptions that market
participants would use in pricing the asset or liability. Inputs may be observable, meaning
those that reflect the assumptions market participants would use in pricing the asset or
liability developed based on market data obtained from independent sources, or unobservable,
meaning those that reflect the reporting entitys own assumptions about the assumptions market
participants would use in pricing the asset or liability developed based on the best information
available in the circumstances. In that regard, the authoritative guidance establishes a fair
value hierarchy for valuation inputs that gives the highest priority to quoted prices in active
markets for identical assets or liabilities and the lowest priority to unobservable outputs. The
fair value hierarchy is as follows:
 Level 1:
    
    In general, fair values determined by Level 1 inputs use quoted prices in active
markets for identical assets or liabilities that the Corporation has the ability to access.
 Level 2:
    
    Fair values determined by Level 2 inputs use other inputs that are observable,
either directly or indirectly. These Level 2 inputs include quoted prices for similar
assets and liabilities in active markets, and other inputs such as interest rates and
yield curves that are observable at commonly quoted intervals. Level 2 investments
consist primarily of obligations of U.S. government
 13




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9. FAIR VALUE MEASUREMENTS
 sponsored enterprises and agencies, obligations of state and municipal subdivisions,
corporate bonds and mortgage backed securities.
 Level 3:
    
    Level 3 inputs are unobservable inputs, including inputs available in situations
where there is little, if any, market activity for the related asset or liability.
 In instances where inputs used to measure fair value fall into different levels in the above fair
value hierarchy, fair value measurements in their entirety are categorized based on the lowest
level input that is significant to the valuation. The Corporations assessment of the
significance of particular inputs to these fair value measurements requires judgment and
considers factors specific to each asset or liability.
 The fair value of all investment securities at December 31, 2009 and June 30, 2010 were based on
level 2 inputs. There are no other assets or liabilities measured on a recurring basis at fair
value. For additional information regarding investment securities, please refer to Note 4 
Investment Securities.
 The Corporation had no Level 3 assets or liabilities on a recurring basis as of December 31, 2009
or June 30, 2010.
 The Corporation also has assets that under certain conditions are subject to measurement at fair
value on a non-recurring basis. These assets include held to maturity investments, other real
estate and loans. The Corporation has estimated the fair values of these assets using Level 3
inputs, specifically discounted cash flow projections.
 Assets Measured at Fair Value on a Nonrecurring Basis
 Quoted Prices
    
    
    Significant
    
    
    Significantin Active Markets
    
    
    Other Observable
    
    
    Unobservable
    
    
    Total Losses forBalance at
    
    
    for Identical Assets
    
    
    Inputs
    
    
    Inputs
    
    
    Three Months Ended
    
    
    Six Months Ended(dollars in thousands)
    
    June 30, 2010
    
    
    (Level 1)
    
    
    (Level 2)
    
    
    (Level 3)
    
    
    June 30, 2010
    
    
    June 30, 2010AssetsImpaired loans
    
    $
    7,959
    
    
    $
    
    
    
    $
    
    
    
    $
    7,959
    
    
    $
    894
    
    
    $
    980Other real estate owned
    
    
    5,676
    
    
    
    
    
    
    
    
    
    
    
    5,676
    
    
    
    1,845
    
    
    
    1,994$
    2,739
    
    
    $
    2,974
 Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2009
 Quoted Prices
    
    
    Significant
    
    
    Significantin Active Markets
    
    
    Other Observable
    
    
    Unobservable
    
    
    Total Losses forBalance at
    
    
    for Identical Assets
    
    
    Inputs
    
    
    Inputs
    
    
    Year Ended(dollars in thousands)
    
    December 31, 2009
    
    
    (Level 1)
    
    
    (Level 2)
    
    
    (Level 3)
    
    
    December 31, 2009AssetsImpaired loans
    
    $
    13,621
    
    
    $
    
    
    
    $
    
    
    
    $
    13,621
    
    
    $
    1,300Other real estate owned
    
    
    5,804
    
    
    
    
    
    
    
    
    
    
    
    5,804
    
    
    
    399$
    1,699
 The Corporation had no investments subject to fair value measurement on a nonrecurring basis.
 Certain financial assets and financial liabilities are measured at fair value on a nonrecurring
basis, that is, the instruments are not measured at fair value on an ongoing basis but are
subject to fair value adjustments in certain circumstances (for example, when there is evidence
of impairment).
 14




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##### Table of Contents



9. FAIR VALUE MEASUREMENTS
 Impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are
considered impaired. Impaired loans are reported at the fair value of the underlying collateral
if repayment is expected solely from the collateral. The Corporation estimates the fair value
of the loans based on the present value of expected future cash flows using managements best
estimate of key assumptions. These assumptions include future payment ability, timing of
payment streams, and estimated realizable values of available collateral (typically based on
outside appraisals). For purposes of valuing other real estate owned, the Corporation relies
upon third party appraisals and reduces this appraised value by anticipated liquidation costs.
 10. SHAREHOLDERS EQUITY
 Participation in the TARP Capital Purchase Program
 On April 24, 2009, the Corporation entered into and closed a Letter Agreement, including the
Securities Purchase Agreement-Standard Terms (collectively, the Securities Purchase
Agreement), related to the CPP. Pursuant to the Securities Purchase Agreement, the Corporation
issued and sold to the Treasury (i) 11,000 shares of the Corporations Series A Preferred
Shares, and (ii) the Warrant to purchase 379,310 shares of the Corporations Common Shares, at an exercise price of $4.35 per share (subject to certain
anti-dilution and other adjustments), for an aggregate purchase price of $11.000 million in
cash. The Warrant has a ten-year term.
 As a result of the CPP transaction, the Corporation is required to take certain actions, for so
long as the Treasury holds any securities acquired from the Corporation pursuant to the CPP
(excluding any period in which the Treasury holds only the Warrant to purchase Common Shares of
the Corporation) (the CPP Period), to ensure that its executive compensation and benefit plans
with respect to Senior Executive Officers (as defined in the relevant agreements) comply with
Section 111(b) of Emergency Economic Stabilization Act of 2008 (EESA), as implemented by any
guidance or regulations issued under Section 111(b) of EESA, and not adopt any benefit
plans with respect to, or which cover, the Corporations Senior Executive Officers that do not
comply with EESA, as amended by the American Recovery and Reinvestment Act of 2009 (the ARRA),
which was passed by Congress and signed by the President on February 17, 2009. The applicable
executive compensation standards generally remain in effect during the CPP Period and apply to
the Corporations Senior Executive Officers (which for purposes of the ARRA and the CPP
agreements, includes the Corporations Chief Executive Officer, its Chief Financial Officer, and
the next three most highly-compensated executive officers, even though the Corporations senior
executive officers consist of a smaller group of executives for purposes of the other
compensation disclosures in this proxy statement).
 Amounts recorded for Preferred Stock and Warrant Common Stock were estimated based on an
allocation of the total proceeds from the issuance on the relative fair values of both
instruments. Fair value of the Preferred Stock was determined based on assumptions regarding
the discount rate (market rate) on the Preferred Stock (estimated 12%). Fair value of the
Warrant Common Stock is based on the value of the underlying Preferred Stock based on an
estimate for a three year term. The allocation of the proceeds received resulted in the
recording of a discount on the Preferred Stock and a premium on the Warrant Common Stock. The
discount on the preferred will be accreted on an effective yield basis over a three-year term.
The allocated carrying value of the Preferred Stock and Warrant Common Stock on the date of
issuance (based on their relative fair values) was $10.382 million and $.618 million,
respectively. Cumulative dividends on the Preferred Stock are payable at 5% annum for the first
five years and at a rate of 9% per annum thereafter on the liquidation preference of $1,000 per
share. The Company is prohibited from paying any dividend with respect to shares of common
stock unless all accrued and unpaid dividends are paid in full on the Preferred Stock for all
past dividend periods. The Preferred Stock is non-voting, other than class voting rights on
matters that could adversely affect the Preferred Stock. The Preferred Stock may be redeemed at
any time with regulatory approval. The Treasury may also transfer the Preferred Stock to a
third party at any time. The preferred stock qualifies as Tier 1 Capital for regulatory
purposes at the holding company.
 15




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##### Table of Contents



10. SHAREHOLDERS EQUITY
 The Corporation has the right to redeem the Series A Preferred Shares at any time after
consulting with its primary regulator, in which case the executive compensation standards would
no longer apply to the Corporation.
 This capital will be used to increase the strong capital position of the Bank. The Bank will
use the capital to grow loans. In addition, the capital will allow the Corporation to consider
acquisitions of deposit franchisees that would enhance our funding mix.
 11. COMMITMENTS, CONTINGENCIES AND CREDIT RISK
 Financial Instruments With Off-Balance-Sheet Risk
 The Corporation is a party to financial instruments with off-balance-sheet risk in the normal
course of business to meet the financing needs of its customers. These financial instruments
include commitments to extend credit and standby letters of credit. Those instruments involve,
to varying degrees, elements of credit risk in excess of the amount recognized in the
consolidated balance sheets.
 The Corporations exposure to credit loss, in the event of nonperformance by the other party to
the financial instrument for commitments to extend credit and standby letters of credit, is
represented by the contractual amount of those instruments. The Corporation uses the same
credit policies in making commitments and conditional obligations as it does for
on-balance-sheet instruments. These commitments are as follows (dollars in thousands):
 June 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009Commitments to extend credit:Variable rate
    
    $
    22,702
    
    
    $
    24,839
    
    
    $
    31,337Fixed rate
    
    
    9,423
    
    
    
    6,039
    
    
    
    7,005Standby letters of credit  Variable rate
    
    
    1,470
    
    
    
    1,279
    
    
    
    1,742Credit card commitments  Fixed rate
    
    
    2,694
    
    
    
    2,714
    
    
    
    2,528$
    36,289
    
    
    $
    34,871
    
    
    $
    42,612
 Commitments to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. The Corporation evaluates each customers
creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Corporation upon extension of credit, is based on managements credit
evaluation of the party. Collateral held varies, but may include accounts receivable,
inventory, property, plant and equipment, and income-producing commercial properties.
 Standby letters of credit are conditional commitments issued by the Corporation to guarantee the
performance of a customer to a third party. Those guarantees are primarily issued to support
public and private borrowing arrangements. The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loan facilities to customers. The
commitments are structured to allow for 100% collateralization on all standby letters of credit.
 Credit card commitments are commitments on credit cards issued by the Corporations subsidiary
and serviced by other companies. These commitments are unsecured.
 16




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##### Table of Contents



11. COMMITMENTS, CONTINGENCIES AND CREDIT RISK
 Contingencies
 In the normal course of business, the Corporation is involved in various legal proceedings. For
expanded discussion on the Corporations legal proceedings, see Part II, Item 1, Legal
Proceedings in this report.
 Concentration of Credit Risk
 The Bank grants commercial, residential, agricultural, and consumer loans throughout Michigan.
The Banks most prominent concentration in the loan portfolio relates to commercial real estate
loans to operators of nonresidential buildings. This concentration at June 30, 2010 represents
$50.000 million, or 16.54%, compared to $44.087 million, or 14.87%, of the commercial loan
portfolio on June 30, 2009. The remainder of the commercial loan portfolio is diversified in
such categories as hospitality and tourism, real estate agents and managers, new car dealers,
gaming, petroleum, forestry, agriculture and construction. Due to the diversity of the Banks
locations, the ability of debtors of residential and consumer loans to honor their obligations
is not tied to any particular economic sector. Additional discussion regarding the
concentration of credit risk is presented in the Managements Discussion and Analysis section
of this report.
 17




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 FORWARD LOOKING STATEMENTSThis report contains certain forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as
amended. The Corporation intends such forward-looking statements to be covered by the safe harbor
provisions for forward-looking statements contained in the Private Securities Litigation Reform Act
of 1995 and is including this statement for purposes of these safe harbor provisions.
Forward-looking statements which are based on certain assumptions and describe future plans,
strategies, or expectations of the Corporation, are generally identifiable by use of the words
believe, expect, intend, anticipate, estimate, project, or similar expressions. The
Corporations ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors that could cause actual results to differ from the results in
forward-looking statements include, but are not limited to:
 
    
    The highly regulated environment in which the Corporation operates could adversely
affect its ability to carry out its strategic plan due to restrictions on new products,
funding opportunities or new market entrances;
    
    General economic conditions, either nationally or in the state(s) in which the
Corporation does business;
    
    Legislation or regulatory changes which affect the business in which the Corporation is
engaged;
    
    Changes in the level and volatility of interest rates which may negatively affect the
Corporations interest margin;
    
    Changes in securities markets with respect to the market value of financial assets and
the level of volatility in certain markets such as foreign exchange;
    
    Significant increases in competition in the banking and financial services industry
resulting from industry consolidation, regulatory changes and other factors, as well as
action taken by particular competitors;
    
    The ability of borrowers to repay loans;
    
    The effects on liquidity of unusual decreases in deposits;
    
    Changes in consumer spending, borrowing, and saving habits;
    
    Technological changes;
    
    Acquisitions and unanticipated occurrences which delay or reduce the expected benefits
of acquisitions;
    
    Difficulties in hiring and retaining qualified management and banking personnel;
    
    The Corporations ability to increase market share and control expenses;
    
    The effect of compliance with legislation or regulatory changes;
    
    The effect of changes in accounting policies and practices;
    
    The costs and effects of existing and future litigation and of adverse outcomes in such
litigation;
    
    An increase in the Corporations FDIC insurance premiums, or the collection of special
assessments by the FDIC.
 These risks and uncertainties should be considered in evaluating forward-looking statements.
Further information concerning the Corporation and its business, including additional factors that
could materially affect the Corporations financial results, is included in the Corporations
filings with the Securities and Exchange Commission. All forward-looking statements contained in
this report are based upon information presently available and the Corporation assumes no
obligation to update any forward-looking statements.
 18




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
  FINANCIAL OVERVIEW
     FINANCIAL CONDITION
 Cash and Cash Equivalents
  Investment Securities
  Loans
  19




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
   June 30,
    
    
    Percent of
    
    
    December 31,
    
    
    Percent of
    
    
    June 30,
    
    
    Percent of2010
    
    
    Total
    
    
    2009
    
    
    Total
    
    
    2009
    
    
    TotalCommercial real estate
    
    $
    208,596
    
    
    
    54.20
    %
    
    $
    208,895
    
    
    
    54.36
    %
    
    $
    196,895
    
    
    
    52.93
    %Commercial, financial, and agricultural
    
    
    66,413
    
    
    
    17.26
    
    
    
    72,184
    
    
    
    18.78
    
    
    
    73,372
    
    
    
    19.72One to four family residential real estate
    
    
    71,613
    
    
    
    18.61
    
    
    
    67,232
    
    
    
    17.49
    
    
    
    65,564
    
    
    
    17.63Consumer
    
    
    4,183
    
    
    
    1.09
    
    
    
    4,290
    
    
    
    1.12
    
    
    
    3,835
    
    
    
    1.03Construction:Commercial
    
    
    27,219
    
    
    
    7.07
    
    
    
    24,591
    
    
    
    6.40
    
    
    
    26,125
    
    
    
    7.02Consumer
    
    
    6,815
    
    
    
    1.77
    
    
    
    7,118
    
    
    
    1.85
    
    
    
    6,213
    
    
    
    1.67Total loans
    
    $
    384,839
    
    
    
    100.00
    %
    
    $
    384,310
    
    
    
    100.00
    %
    
    $
    372,004
    
    
    
    100.00
    %
  June 30, 2010
    
    
    December 31, 2009
    
    
    June 30, 2009Percent of
    
    
    Percent of
    
    
    
    
    
    
    Percent of
    
    
    Percent of
    
    
    
    
    
    
    Percent of
    
    
    Percent ofOutstanding
    
    
    Commerical
    
    
    Shareholders
    
    
    Outstanding
    
    
    Commercial
    
    
    Shareholders
    
    
    Outstanding
    
    
    Commerical
    
    
    ShareholdersBalance
    
    
    Loans
    
    
    Equity
    
    
    Balance
    
    
    Loans
    
    
    Equity
    
    
    Balance
    
    
    Loans
    
    
    EquityReal estate  operators of nonres bldgs
    
    $
    50,000
    
    
    
    16.54
    %
    
    
    88.92
    %
    
    $
    48,689
    
    
    
    15.93
    %
    
    
    88.05
    %
    
    $
    44,087
    
    
    
    14.87
    %
    
    
    81.74
    %Hospitality and tourism
    
    
    43,883
    
    
    
    14.52
    
    
    
    78.04
    
    
    
    45,315
    
    
    
    14.82
    
    
    
    81.95
    
    
    
    35,033
    
    
    
    11.82
    
    
    
    64.95Commercial construction
    
    
    27,219
    
    
    
    9.01
    
    
    
    48.41
    
    
    
    24,591
    
    
    
    8.04
    
    
    
    44.47
    
    
    
    26,125
    
    
    
    8.81
    
    
    
    48.43Real estate agents and managers
    
    
    20,727
    
    
    
    6.86
    
    
    
    36.86
    
    
    
    24,242
    
    
    
    7.93
    
    
    
    43.84
    
    
    
    24,614
    
    
    
    8.30
    
    
    
    45.63Other
    
    
    160,399
    
    
    
    53.07
    
    
    
    285.25
    
    
    
    162,833
    
    
    
    53.28
    
    
    
    294.46
    
    
    
    166,533
    
    
    
    56.20
    
    
    
    308.74Total Commercial Loans
    
    $
    302,228
    
    
    
    100.00
    %
    
    
    
    
    
    $
    305,670
    
    
    
    100.00
    %
    
    
    
    
    
    $
    296,392
    
    
    
    100.00
    %
   Credit Quality
  20




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
    June 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009Nonperforming Assets:Nonaccrual Loans
    
    $
    10,174
    
    
    $
    14,368
    
    
    $
    9,283Loans past due 90 days or more
    
    
    
    
    
    
    
    
    
    
    Restructured loans
    
    
    869
    
    
    
    869
    
    
    
    592Total nonperforming loans
    
    
    11,043
    
    
    
    15,237
    
    
    
    9,875Other real estate owned
    
    
    5,676
    
    
    
    5,804
    
    
    
    4,950Total nonperforming assets
    
    $
    16,719
    
    
    $
    21,041
    
    
    $
    14,825Nonperforming loans as a % of loans
    
    
    2.87
    %
    
    
    3.96
    %
    
    
    2.65
    %Nonperforming assets as a % of assets
    
    
    3.34
    %
    
    
    4.08
    %
    
    
    2.93
    %Reserve for Loan Losses:At period end
    
    $
    6,371
    
    
    $
    5,225
    
    
    $
    4,119As a % of loans
    
    
    1.66
    %
    
    
    1.36
    %
    
    
    1.11
    %As a % of nonperforming loans
    
    
    57.69
    %
    
    
    34.29
    %
    
    
    41.71
    %As a % of nonaccrual loans
    
    
    62.62
    %
    
    
    36.37
    %
    
    
    44.37
    %Texas ratio*
    
    
    26.71
    %
    
    
    34.77
    %
    
    
    25.54
    %
 
 *
    
    calculated by taking total nonperforming assets divided by total equity plus reserve for loan losses  At Period EndJune 30, 2010
    
    
    December 31, 2009
    
    
    June 30, 2009Total loans, at period end
    
    $
    384,839
    
    
    $
    384,310
    
    
    $
    372,004Average loans for the year
    
    
    383,398
    
    
    
    374,796
    
    
    
    371,278
 For the Period EndedSix Months Ended
    
    
    Twelve Months Ended
    
    
    Six Months EndedJune 30, 2010
    
    
    December 31, 2009
    
    
    June 30, 2009Net charge-offs during the period
    
    $
    2,554
    
    
    $
    2,752
    
    
    $
    858Net charge-offs to average loans
    
    
    .67
    %
    
    
    .73
    %
    
    
    .23
    %Net charge-offs to beginning allowance balance
    
    
    48.88
    %
    
    
    64.34
    %
    
    
    20.06
    %
  21




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
  June 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009Commercial, financial and agricultural loans
    
    $
    5,616
    
    
    $
    4,805
    
    
    $
    3,769One to four family residential real estate loans
    
    
    100
    
    
    
    23
    
    
    
    5Consumer loans
    
    
    16
    
    
    
    13
    
    
    
    5Unallocated and general reserves
    
    
    639
    
    
    
    384
    
    
    
    340Totals
    
    $
    6,371
    
    
    $
    5,225
    
    
    $
    4,119
    Six Months Ended
    
    
    Year Ended
    
    
    Six Months EndedJune 30, 2010
    
    
    December 31, 2009
    
    
    June 30, 2009Balance at beginning of period
    
    $
    5,804
    
    
    $
    2,189
    
    
    $
    2,189Other real estate transferred from loans due to foreclosure
    
    
    3,003
    
    
    
    4,879
    
    
    
    3,276Reclassification of redemption OREO
    
    
    
    
    
    
    (475
    )
    
    
    (475
    )Other real estate sold/written down
    
    
    (3,084
    )
    
    
    (789
    )
    
    
    (37
    )Loss on sale of other real estate
    
    
    (47
    )
    
    
    
    
    
    
    (3
    )Balance at end of period
    
    $
    5,676
    
    
    $
    5,804
    
    
    $
    4,950
  Deposits
   22




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Continued)
  June 30,
    
    
    
    
    
    
    December 31,
    
    
    
    
    
    
    June 30,2010
    
    
    % of Total
    
    
    2009
    
    
    % of Total
    
    
    2009
    
    
    % of TotalNon-interest-bearing
    
    $
    41,434
    
    
    
    10.21
    %
    
    $
    35,878
    
    
    
    8.51
    %
    
    $
    33,368
    
    
    
    8.08
    %NOW, money market, checking
    
    
    118,909
    
    
    
    29.30
    
    
    
    95,790
    
    
    
    22.73
    
    
    
    75,974
    
    
    
    18.39Savings
    
    
    20,110
    
    
    
    4.96
    
    
    
    18,207
    
    
    
    4.32
    
    
    
    21,411
    
    
    
    5.18Certificates of Deposit <$100,000
    
    
    90,573
    
    
    
    22.32
    
    
    
    59,953
    
    
    
    14.23
    
    
    
    72,139
    
    
    
    17.46Total core deposits
    
    
    271,026
    
    
    
    66.79
    
    
    
    209,828
    
    
    
    49.79
    
    
    
    202,892
    
    
    
    49.11Certificates of Deposit >$100,000
    
    
    23,652
    
    
    
    5.83
    
    
    
    36,385
    
    
    
    8.63
    
    
    
    25,455
    
    
    
    6.16Brokered CDs
    
    
    111,106
    
    
    
    27.38
    
    
    
    175,176
    
    
    
    41.57
    
    
    
    184,805
    
    
    
    44.73Total non-core deposits
    
    
    134,758
    
    
    
    33.21
    
    
    
    211,561
    
    
    
    50.21
    
    
    
    210,260
    
    
    
    50.88Total deposits
    
    $
    405,784
    
    
    
    100.00
    %
    
    $
    421,389
    
    
    
    100.00
    %
    
    $
    413,152
    
    
    
    100.00
    %
 Borrowings
  Shareholders Equity
  RESULTS OF OPERATIONS
 Summary
   Net Interest Income
   23




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
   Three Months Ended2010-2009Average Balances
    
    
    Average Rates
    
    
    Interest
    
    
    Income/
    
    
    
    
    
    
    
    
    
    
    Rate/June 30,
    
    
    Increase/
    
    
    June 30,
    
    
    June 30,
    
    
    Expense
    
    
    Volume
    
    
    Rate
    
    
    Volume(dollars in thousands)
    
    2010
    
    
    2009
    
    
    (Decrease)
    
    
    2010
    
    
    2009
    
    
    2010
    
    
    2009
    
    
    Variance
    
    
    Variance
    
    
    Variance
    
    
    VarianceLoans (1,2,3)
    
    $
    382,169
    
    
    $
    371,609
    
    
    $
    10,560
    
    
    
    5.56
    %
    
    
    5.65
    %
    
    $
    5,298
    
    
    $
    5,231
    
    
    $
    67
    
    
    $
    149
    
    
    $
    (79
    )
    
    $
    (3
    )Taxable securities
    
    
    35,291
    
    
    
    76,092
    
    
    
    (40,801
    )
    
    
    4.05
    
    
    
    3.56
    
    
    
    356
    
    
    
    675
    
    
    
    (319
    )
    
    
    (362
    )
    
    
    93
    
    
    
    (50
    )Nontaxable securities (2)
    
    
    845
    
    
    
    1,939
    
    
    
    (1,094
    )
    
    
    5.22
    
    
    
    .41
    
    
    
    11
    
    
    
    2
    
    
    
    9
    
    
    
    (1
    )
    
    
    23
    
    
    
    (13
    )Federal funds sold
    
    
    30,308
    
    
    
    
    
    
    
    30,308
    
    
    
    .25
    
    
    
    
    
    
    
    19
    
    
    
    
    
    
    
    19
    
    
    
    
    
    
    
    
    
    
    
    19Other interest-earning assets
    
    
    4,488
    
    
    
    4,399
    
    
    
    89
    
    
    
    1.61
    
    
    
    1.28
    
    
    
    18
    
    
    
    14
    
    
    
    4
    
    
    
    
    
    
    
    4
    
    
    
    Total earning assets
    
    
    453,101
    
    
    
    454,039
    
    
    
    (938
    )
    
    
    5.05
    
    
    
    5.23
    
    
    
    5,702
    
    
    
    5,922
    
    
    
    (220
    )
    
    
    (214
    )
    
    
    41
    
    
    
    (47
    )Reserve for loan losses
    
    
    (5,159
    )
    
    
    (4,847
    )
    
    
    (312
    )Cash and due from banks
    
    
    22,096
    
    
    
    17,708
    
    
    
    4,388Intangible assets
    
    
    
    
    
    
    16
    
    
    
    (16
    )Other assets
    
    
    32,904
    
    
    
    24,289
    
    
    
    8,615Total assets
    
    $
    502,942
    
    
    $
    491,205
    
    
    $
    11,737NOW and money market deposits
    
    $
    97,069
    
    
    $
    69,098
    
    
    $
    27,971
    
    
    
    1.06
    %
    
    
    .81
    %
    
    $
    257
    
    
    $
    140
    
    
    $
    117
    
    
    $
    57
    
    
    $
    43
    
    
    $
    17Interest checking
    
    
    17,860
    
    
    
    5,884
    
    
    
    11,976
    
    
    
    1.63
    
    
    
    1.91
    
    
    
    72
    
    
    
    28
    
    
    
    44
    
    
    
    57
    
    
    
    (4
    )
    
    
    (9
    )Savings deposits
    
    
    20,070
    
    
    
    21,363
    
    
    
    (1,293
    )
    
    
    .60
    
    
    
    .66
    
    
    
    30
    
    
    
    35
    
    
    
    (5
    )
    
    
    (2
    )
    
    
    (3
    )
    
    
    CDs <$100,000
    
    
    83,241
    
    
    
    71,608
    
    
    
    11,633
    
    
    
    2.10
    
    
    
    2.85
    
    
    
    435
    
    
    
    508
    
    
    
    (73
    )
    
    
    83
    
    
    
    (134
    )
    
    
    (22
    )CDs >$100,000
    
    
    26,101
    
    
    
    25,939
    
    
    
    162
    
    
    
    1.68
    
    
    
    2.35
    
    
    
    109
    
    
    
    152
    
    
    
    (43
    )
    
    
    1
    
    
    
    (44
    )
    
    
    Brokered deposits
    
    
    124,325
    
    
    
    176,940
    
    
    
    (52,615
    )
    
    
    1.73
    
    
    
    1.59
    
    
    
    536
    
    
    
    703
    
    
    
    (167
    )
    
    
    (209
    )
    
    
    60
    
    
    
    (18
    )Borrowings
    
    
    36,140
    
    
    
    36,376
    
    
    
    (236
    )
    
    
    2.35
    
    
    
    2.88
    
    
    
    212
    
    
    
    261
    
    
    
    (49
    )
    
    
    (2
    )
    
    
    (48
    )
    
    
    1Total interest-bearing liabilities
    
    
    404,806
    
    
    
    407,208
    
    
    
    (2,402
    )
    
    
    1.64
    
    
    
    1.80
    
    
    
    1,651
    
    
    
    1,827
    
    
    
    (176
    )
    
    
    (15
    )
    
    
    (130
    )
    
    
    (31
    )Demand deposits
    
    
    36,784
    
    
    
    30,678
    
    
    
    6,106Other liabilities
    
    
    3,463
    
    
    
    3,464
    
    
    
    (1
    )Shareholders equity
    
    
    57,889
    
    
    
    49,855
    
    
    
    8,034Total liabilities and
shareholders equity
    
    $
    502,942
    
    
    $
    491,205
    
    
    $
    11,737Rate spread
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.41
    %
    
    
    3.43
    %Net interest margin/revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.59
    %
    
    
    3.62
    %
    
    $
    4,051
    
    
    $
    4,095
    
    
    $
    (44
    )
    
    $
    (199
    )
    
    $
    171
    
    
    $
    (16
    )
 
 (1)
    
    For purposes of these computations, nonaccruing loans are included in the daily average
loan amounts outstanding.(2)
    
    The amount of interest income on loans and nontaxable securities has been adjusted to a tax
euivalent basis, using a 34% tax rate(3)
    
    Interest income on loans includes fees Six Months Ended2010-2009Average Balances
    
    
    Average Rates
    
    
    Interest
    
    
    Income/
    
    
    
    
    
    
    
    
    
    
    Rate/June 30,
    
    
    Increase/
    
    
    June 30,
    
    
    June 30,
    
    
    Expense
    
    
    Volume
    
    
    Rate
    
    
    Volume(dollars in thousands)
    
    2010
    
    
    2009
    
    
    (Decrease)
    
    
    2010
    
    
    2009
    
    
    2010
    
    
    2009
    
    
    Variance
    
    
    Variance
    
    
    Variance
    
    
    VarianceLoans (1,2,3)
    
    $
    383,398
    
    
    $
    371,278
    
    
    $
    12,120
    
    
    
    5.56
    %
    
    
    5.63
    %
    
    $
    10,579
    
    
    $
    10,370
    
    
    $
    209
    
    
    $
    339
    
    
    $
    (125
    )
    
    $
    (5
    )Taxable securities
    
    
    36,336
    
    
    
    61,906
    
    
    
    (25,570
    )
    
    
    4.17
    
    
    
    3.69
    
    
    
    752
    
    
    
    1,132
    
    
    
    (380
    )
    
    
    (468
    )
    
    
    149
    
    
    
    (61
    )Nontaxable securities (2)
    
    
    844
    
    
    
    975
    
    
    
    (131
    )
    
    
    5.02
    
    
    
    1.24
    
    
    
    21
    
    
    
    6
    
    
    
    15
    
    
    
    (1
    )
    
    
    18
    
    
    
    (2
    )Federal funds sold
    
    
    34,050
    
    
    
    
    
    
    
    34,050
    
    
    
    .25
    
    
    
    
    
    
    
    42
    
    
    
    
    
    
    
    42
    
    
    
    
    
    
    
    
    
    
    
    42Other interest-earning assets
    
    
    4,479
    
    
    
    4,383
    
    
    
    96
    
    
    
    1.58
    
    
    
    .74
    
    
    
    35
    
    
    
    16
    
    
    
    19
    
    
    
    
    
    
    
    18
    
    
    
    1Total earning assets
    
    
    459,107
    
    
    
    438,542
    
    
    
    20,565
    
    
    
    5.02
    
    
    
    5.30
    
    
    
    11,429
    
    
    
    11,524
    
    
    
    (95
    )
    
    
    (130
    )
    
    
    60
    
    
    
    (25
    )Reserve for loan losses
    
    
    (5,116
    )
    
    
    (4,627
    )
    
    
    (489
    )Cash and due from banks
    
    
    20,940
    
    
    
    15,539
    
    
    
    5,401Intangible assets
    
    
    
    
    
    
    26
    
    
    
    (26
    )Other assets
    
    
    30,772
    
    
    
    23,594
    
    
    
    7,178Total assets
    
    $
    505,703
    
    
    $
    473,074
    
    
    $
    32,629NOW and money market deposits
    
    $
    92,410
    
    
    $
    68,677
    
    
    $
    23,733
    
    
    
    1.05
    %
    
    
    .79
    %
    
    $
    481
    
    
    $
    270
    
    
    $
    211
    
    
    $
    93
    
    
    $
    87
    
    
    $
    31Interest checking
    
    
    16,674
    
    
    
    5,124
    
    
    
    11,550
    
    
    
    1.67
    
    
    
    1.97
    
    
    
    138
    
    
    
    50
    
    
    
    88
    
    
    
    113
    
    
    
    (8
    )
    
    
    (17
    )Savings deposits
    
    
    19,229
    
    
    
    20,545
    
    
    
    (1,316
    )
    
    
    .63
    
    
    
    .74
    
    
    
    60
    
    
    
    75
    
    
    
    (15
    )
    
    
    (5
    )
    
    
    (11
    )
    
    
    1CDs <$100,000
    
    
    74,761
    
    
    
    71,642
    
    
    
    3,119
    
    
    
    2.15
    
    
    
    2.99
    
    
    
    797
    
    
    
    1,061
    
    
    
    (264
    )
    
    
    46
    
    
    
    (297
    )
    
    
    (13
    )CDs >$100,000
    
    
    29,587
    
    
    
    25,846
    
    
    
    3,741
    
    
    
    1.70
    
    
    
    2.57
    
    
    
    249
    
    
    
    329
    
    
    
    (80
    )
    
    
    48
    
    
    
    (111
    )
    
    
    (17
    )Brokered deposits
    
    
    141,816
    
    
    
    164,517
    
    
    
    (22,701
    )
    
    
    1.67
    
    
    
    1.91
    
    
    
    1,171
    
    
    
    1,559
    
    
    
    (388
    )
    
    
    (215
    )
    
    
    (201
    )
    
    
    28Borrowings
    
    
    36,140
    
    
    
    36,511
    
    
    
    (371
    )
    
    
    2.34
    
    
    
    2.99
    
    
    
    420
    
    
    
    542
    
    
    
    (122
    )
    
    
    (6
    )
    
    
    (118
    )
    
    
    2Total interest-bearing liabilities
    
    
    410,617
    
    
    
    392,862
    
    
    
    17,755
    
    
    
    1.63
    
    
    
    1.99
    
    
    
    3,316
    
    
    
    3,886
    
    
    
    (570
    )
    
    
    74
    
    
    
    (659
    )
    
    
    15Demand deposits
    
    
    35,173
    
    
    
    30,819
    
    
    
    4,354Other liabilities
    
    
    3,407
    
    
    
    3,537
    
    
    
    (130
    )Shareholders equity
    
    
    56,506
    
    
    
    45,856
    
    
    
    10,650Total liabilities and
shareholders equity
    
    $
    505,703
    
    
    $
    473,074
    
    
    $
    32,629Rate spread
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.39
    %
    
    
    3.31
    %Net interest margin/revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.56
    %
    
    
    3.51
    %
    
    $
    8,113
    
    
    $
    7,638
    
    
    $
    475
    
    
    $
    (204
    )
    
    $
    719
    
    
    $
    (40
    )
 
 (1)
    
    For purposes of these computations, nonaccruing loans are included in the daily average
loan amounts outstanding.(2)
    
    The amount of interest income on loans and nontaxable securities has been adjsuted to a tax
equivalent basis, using a 34% tax rate(3)
    
    Interet income on loans includes fees 24




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
   Provision for Loan Losses
  Other Income
    Three Months Ended
    
    
    % Increase
    
    
    Six Months Ended
    
    
    % IncreaseJune 30,
    
    
    (Decrease)
    
    
    June 30,
    
    
    (Decrease)2010
    
    
    2009
    
    
    2010-2009
    
    
    2010
    
    
    2009
    
    
    2010-2009Service fees
    
    $
    252
    
    
    $
    271
    
    
    
    (7.01
    )
    
    $
    474
    
    
    $
    514
    
    
    
    (7.78
    )Net gains on sale of loans
    
    
    309
    
    
    
    84
    
    
    
    267.86
    
    
    
    625
    
    
    
    142
    
    
    
    340.14Other noninterest income
    
    
    32
    
    
    
    84
    
    
    
    (61.90
    )
    
    
    86
    
    
    
    174
    
    
    
    (50.57
    )Subtotal
    
    
    593
    
    
    
    439
    
    
    
    35.08
    
    
    
    1,185
    
    
    
    830
    
    
    
    42.77Net security gain (loss)
    
    
    
    
    
    
    
    
    
    
    N/A
    
    
    
    215
    
    
    
    
    
    
    
    N/ATotal noninterest income
    
    $
    593
    
    
    $
    439
    
    
    
    35.08
    
    
    $
    1,400
    
    
    $
    830
    
    
    
    68.67
 25




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
 Other Expense
   Three Months Ended
    
    
    % Increase
    
    
    Six Months Ended
    
    
    % IncreaseJune 30,
    
    
    (Decrease)
    
    
    June 30,
    
    
    (Decrease)2010
    
    
    2009
    
    
    2010-2009
    
    
    2010
    
    
    2009
    
    
    2010-2009Salaries and employee benefits
    
    $
    1,781
    
    
    $
    1,561
    
    
    
    14.09
    
    
    $
    3,501
    
    
    $
    3,158
    
    
    
    10.86Occupancy
    
    
    345
    
    
    
    355
    
    
    
    (2.82
    )
    
    
    690
    
    
    
    733
    
    
    
    (5.87
    )Furniture and equipment
    
    
    197
    
    
    
    222
    
    
    
    (11.26
    )
    
    
    391
    
    
    
    411
    
    
    
    (4.87
    )Data processing
    
    
    205
    
    
    
    224
    
    
    
    (8.48
    )
    
    
    394
    
    
    
    444
    
    
    
    (11.26
    )Professional service fees
    
    
    161
    
    
    
    144
    
    
    
    11.81
    
    
    
    334
    
    
    
    297
    
    
    
    12.46Loan and deposit:FDIC insurance premiums
    
    
    221
    
    
    
    340
    
    
    
    (35.00
    )
    
    
    443
    
    
    
    465
    
    
    
    (4.73
    )Writedown of other real etstate owned
    
    
    218
    
    
    
    
    
    
    
    N/A
    
    
    
    1,947
    
    
    
    
    
    
    
    N/AOther loan and deposit
    
    
    1,800
    
    
    
    172
    
    
    
    946.51
    
    
    
    466
    
    
    
    308
    
    
    
    51.30Telephone
    
    
    45
    
    
    
    46
    
    
    
    (2.17
    )
    
    
    92
    
    
    
    89
    
    
    
    3.37Advertising
    
    
    72
    
    
    
    80
    
    
    
    (10.00
    )
    
    
    144
    
    
    
    158
    
    
    
    (8.86
    )Other
    
    
    285
    
    
    
    326
    
    
    
    (12.58
    )
    
    
    557
    
    
    
    646
    
    
    
    (13.78
    )Total noninterest expense
    
    $
    5,330
    
    
    $
    3,470
    
    
    
    53.60
    
    
    $
    8,959
    
    
    $
    6,709
    
    
    
    33.54
 Federal Income Taxes
 Current Federal Tax Provision
  Deferred Tax Benefit
  26




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
   LIQUIDITY
        27




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
   CAPITAL AND REGULATORY
   June 30,
    
    
    December 31,
    
    
    June 30,2010
    
    
    2009
    
    
    2009Capital StructureShareholders equity
    
    $
    56,231
    
    
    $
    55,299
    
    
    $
    53,939Total capitalization
    
    $
    56,231
    
    
    $
    55,299
    
    
    $
    53,939Tangible capital
    
    $
    56,231
    
    
    $
    55,299
    
    
    $
    53,932Intangible AssetsCore deposit premium
    
    $
    
    
    
    $
    
    
    
    $
    7Other identifiable intangibles
    
    
    
    
    
    
    
    
    
    
    Total intangibles
    
    $
    
    
    
    $
    
    
    
    $
    7Regulatory capitalTier 1 capital:Shareholders equity
    
    $
    56,231
    
    
    $
    55,299
    
    
    $
    53,939Net unrealized (gains) losses on
available for sale securities
    
    
    (876
    )
    
    
    (1,093
    )
    
    
    (1,211
    )Less: disallowed deferred tax asset
    
    
    (9,200
    )
    
    
    (4,800
    )
    
    
    (6,000
    )Less: intangibles
    
    
    
    
    
    
    
    
    
    
    (7
    )Total Tier 1 capital
    
    $
    46,155
    
    
    $
    49,406
    
    
    $
    46,721Tier 2 Capital:Allowable reserve for loan losses
    
    $
    4,968
    
    
    $
    5,181
    
    
    $
    4,119Qualifying long-term debt
    
    
    
    
    
    
    
    
    
    
    Total Tier 2 capital
    
    
    4,968
    
    
    
    5,181
    
    
    
    4,119Total capital
    
    $
    51,123
    
    
    $
    54,587
    
    
    $
    50,840Risk-adjusted assets
    
    $
    396,037
    
    
    $
    414,440
    
    
    $
    391,160Capital ratios:Tier 1 Capital to average assets
    
    
    9.38
    %
    
    
    9.75
    %
    
    
    9.65
    %Tier 1 Capital to risk weighted assets
    
    
    11.65
    %
    
    
    11.92
    %
    
    
    11.94
    %Total Capital to risk weighted assets
    
    
    12.91
    %
    
    
    13.17
    %
    
    
    13.00
    %
 28




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
   Shareholders
    
    
    Tangible
    
    
    Tier 1
    
    
    Tier 1
    
    
    TotalEquity to
    
    
    Equity to
    
    
    Capital to
    
    
    Capital to
    
    
    Capital toQuarter-end
    
    
    Quarter-end
    
    
    Average
    
    
    Risk-Weighted
    
    
    Risk-WeightedAssets
    
    
    Assets
    
    
    Assets
    
    
    Assets
    
    
    AssetsRegulatory minumum for capital adequacy purposes
    
    
    N/A
    
    
    
    N/A
    
    
    
    4.00
    %
    
    
    4.00
    %
    
    
    8.00
    %Regulatory defined well capitalized guideline
    
    
    N/A
    
    
    
    N/A
    
    
    
    5.00
    %
    
    
    6.00
    %
    
    
    10.00
    %The Corporation:June 30, 2010
    
    
    11.23
    %
    
    
    11.23
    %
    
    
    9.38
    %
    
    
    11.65
    %
    
    
    12.91
    %June 30, 2009
    
    
    10.65
    %
    
    
    10.65
    %
    
    
    9.65
    %
    
    
    11.94
    %
    
    
    13.00
    %The Bank:June 30, 2010
    
    
    9.93
    %
    
    
    9.93
    %
    
    
    7.98
    %
    
    
    9.91
    %
    
    
    11.16
    %June 30, 2009
    
    
    9.17
    %
    
    
    9.17
    %
    
    
    8.12
    %
    
    
    10.03
    %
    
    
    11.07
    %
 29




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##### Table of Contents



QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 INTEREST RATE RISK
          30




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##### Table of Contents



QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)
    1-90
    
    
    91 - 365
    
    
    >1-5
    
    
    Over 5Days
    
    
    Days
    
    
    Years
    
    
    Years
    
    
    TotalInterest-earning assets:Loans
    
    $
    264,178
    
    
    $
    6,360
    
    
    $
    24,677
    
    
    $
    89,624
    
    
    $
    384,839Securities
    
    
    
    
    
    
    19,720
    
    
    
    14,701
    
    
    
    521
    
    
    
    34,942Other (1)
    
    
    12,678
    
    
    
    
    
    
    
    
    
    
    
    3,794
    
    
    
    16,472Total interest-earning assets
    
    
    276,856
    
    
    
    26,080
    
    
    
    39,378
    
    
    
    93,939
    
    
    
    436,253Interest-bearing obligations:NOW, money market, savings, interest checking
    
    
    139,019
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    139,019Time deposits
    
    
    23,369
    
    
    
    53,068
    
    
    
    37,398
    
    
    
    390
    
    
    
    114,225Brokered CDs
    
    
    16,446
    
    
    
    51,716
    
    
    
    40,216
    
    
    
    2,728
    
    
    
    111,106Borrowings
    
    
    20,000
    
    
    
    15,000
    
    
    
    
    
    
    
    1,140
    
    
    
    36,140Total interest-bearing obligations
    
    
    198,834
    
    
    
    119,784
    
    
    
    77,614
    
    
    
    4,258
    
    
    
    400,490Gap
    
    $
    78,022
    
    
    $
    (93,704
    )
    
    $
    (38,236
    )
    
    $
    89,681
    
    
    $
    35,763Cumulative gap
    
    $
    78,022
    
    
    $
    (15,682
    )
    
    $
    (53,918
    )
    
    $
    35,763
 
 (1)
    
    Includes Federal Home Loan Bank Stock     31




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##### Table of Contents



QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)
  FOREIGN EXCHANGE RISK
  OFF-BALANCE-SHEET RISK
   IMPACT OF INFLATION AND CHANGING PRICES
  32




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##### Table of Contents



CONTROLS AND PROCEDURES
   Changes in Internal Control Over Financial Reporting
  33




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##### Table of Contents



OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 6. Exhibits and Reports on Form 8-K
  Exhibit 31.1
    
    Rule 13a-14(a) Certification of Chief Executive Officer.Exhibit 31.2
    
    Rule 13a-14(a) Certification of Chief Financial Officer.Exhibit 32.1
    
    Section 1350 Certification of Chief Executive Officer.Exhibit 32.2
    
    Section 1350 Certification of Chief Financial Officer.
 34




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##### Table of Contents



MACKINAC FINANCIAL CORPORATION
                         (Registrant)Date:      August 16, 2010
    By:
    /s/ Paul D. TobiasPAUL D. TOBIAS,CHAIRMAN AND CHIEF EXECUTIVE OFFICER
(principal executive officer)By:
    /s/ Ernie R. KruegerERNIE R. KRUEGEREVP/CHIEF FINANCIAL OFFICER
(principal financial and accounting officer) 35