##### 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, 2008
 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
(State or other jurisdiction of incorporation or organization)
    
    38-2062816
(I.R.S. Employer Identification No.)130 SOUTH CEDAR STREET, MANISTIQUE, MI
(Address of principal executive offices)
    
    49854
(Zip Code)
   þ o
  Large accelerated filer oAccelerated filer oNon-accelerated filer o(Do not check if a smaller reporting company)Smaller reporting company þ  o þ




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##### 



Page No.PART I. FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsCondensed
Consolidated Balance Sheets 
June 30, 2008 (Unaudited), December 31, 2007 and
June 30, 2007 (Unaudited)
    
    
    1Condensed Consolidated Statements of Operations  Three and Six
Months Ended June 30, 2008 (Unaudited) and
June 30, 2007 (Unaudited)
    
    
    2Condensed Consolidated Statements of Changes in Shareholders
Equity  Three and Six Months Ended June 30, 2008
(Unaudited) and June 30, 2007 (Unaudited)
    
    
    3Condensed Consolidated Statements of Cash Flows 
Six Months Ended June 30, 2008 (Unaudited) and
June 30, 2007 (Unaudited)
    
    
    4Notes to Condensed Consolidated Financial
Statements (Unaudited)
    
    
    5Item 2.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    15Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 4.
    
    Controls and Procedures
    
    
    31PART II. OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    32Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    32Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    33SIGNATURES
    
    
    34EX-31.1EX-31.2EX-32.1EX-32.2




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##### Table of Contents



FINANCIAL INFORMATION
 
 FINANCIAL STATEMENTS
 
 
 June 30,
    
    
    December 31,
    
    
    June 30,2008
    
    
    2007
    
    
    2007(unaudited)
    
    
    
    
    
    
    (unaudited)ASSETSCash and due from banks
    
    $
    7,115
    
    
    $
    6,196
    
    
    $
    7,518Federal funds sold
    
    
    19,274
    
    
    
    166
    
    
    
    3,489Cash and cash equivalents
    
    
    26,389
    
    
    
    6,362
    
    
    
    11,007Interest-bearing deposits in other financial institutions
    
    
    387
    
    
    
    1,810
    
    
    
    3,687Securities available for sale
    
    
    23,230
    
    
    
    21,597
    
    
    
    24,086Federal Home Loan Bank stock
    
    
    3,794
    
    
    
    3,794
    
    
    
    3,794Loans:Commercial
    
    
    292,645
    
    
    
    288,839
    
    
    
    274,783Mortgage
    
    
    65,869
    
    
    
    62,703
    
    
    
    60,575Installment
    
    
    3,608
    
    
    
    3,537
    
    
    
    3,538Total Loans
    
    
    362,122
    
    
    
    355,079
    
    
    
    338,896Allowance for loan losses
    
    
    (3,585
    )
    
    
    (4,146
    )
    
    
    (4,920
    )Net loans
    
    
    358,537
    
    
    
    350,933
    
    
    
    333,976Premises and equipment
    
    
    11,377
    
    
    
    11,609
    
    
    
    12,471Other real estate held for sale
    
    
    3,395
    
    
    
    1,226
    
    
    
    77Other assets
    
    
    10,218
    
    
    
    11,549
    
    
    
    4,221TOTAL ASSETS
    
    $
    437,327
    
    
    
    408,880
    
    
    $
    393,319LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Non-interest-bearing deposits
    
    $
    27,741
    
    
    $
    25,557
    
    
    $
    28,811Interest-bearing deposits:NOW, money market, checking
    
    
    78,703
    
    
    
    81,160
    
    
    
    73,994Savings
    
    
    15,171
    
    
    
    12,485
    
    
    
    12,422CDs<$100,000
    
    
    78,678
    
    
    
    80,607
    
    
    
    96,546CDs>$100,000
    
    
    28,252
    
    
    
    22,355
    
    
    
    24,879Brokered
    
    
    128,431
    
    
    
    98,663
    
    
    
    84,594Total deposits
    
    
    356,976
    
    
    
    320,827
    
    
    
    321,246BorrowingsFederal funds purchased
    
    
    
    
    
    
    7,710
    
    
    
    Short-term
    
    
    
    
    
    
    1,959
    
    
    
    Long-term
    
    
    36,280
    
    
    
    36,280
    
    
    
    38,307Total borrowings
    
    
    36,280
    
    
    
    45,949
    
    
    
    38,307Other liabilities
    
    
    3,096
    
    
    
    2,783
    
    
    
    3,281Total liabilities
    
    
    396,352
    
    
    
    369,559
    
    
    
    362,834Shareholders equity:Preferred stock  No par value:Authorized 500,000 shares, no shares outstandingCommon stock and additional paid in capital  No par valueAuthorized  18,000,000 sharesIssued and outstanding  3,419,736; 3,428,695; and
and 3,428,695 shares, respectively
    
    
    42,773
    
    
    
    42,843
    
    
    
    42,780Accumulated deficit
    
    
    (1,672
    )
    
    
    (3,582
    )
    
    
    (12,162
    )Accumulated other comprehensive income (loss)
    
    
    (126
    )
    
    
    60
    
    
    
    (133
    )Total shareholders equity
    
    
    40,975
    
    
    
    39,321
    
    
    
    30,485TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    437,327
    
    
    $
    408,880
    
    
    $
    393,319
  1.




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Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007INTEREST INCOME:Interest and fees on loans:Taxable
    
    $
    5,604
    
    
    $
    6,448
    
    
    $
    11,704
    
    
    $
    12,681Tax-exempt
    
    
    102
    
    
    
    143
    
    
    
    210
    
    
    
    314Interest on securities:Taxable
    
    
    271
    
    
    
    293
    
    
    
    537
    
    
    
    594Tax-exempt
    
    
    2
    
    
    
    
    
    
    
    3
    
    
    
    Other interest
    
    
    81
    
    
    
    166
    
    
    
    170
    
    
    
    366Total interest income
    
    
    6,060
    
    
    
    7,050
    
    
    
    12,624
    
    
    
    13,955INTEREST EXPENSE:Deposits
    
    
    2,551
    
    
    
    3,267
    
    
    
    5,616
    
    
    
    6,489Borrowings
    
    
    391
    
    
    
    514
    
    
    
    845
    
    
    
    1,019Total interest expense
    
    
    2,942
    
    
    
    3,781
    
    
    
    6,461
    
    
    
    7,508Net interest income
    
    
    3,118
    
    
    
    3,269
    
    
    
    6,163
    
    
    
    6,447Provision for loan losses
    
    
    750
    
    
    
    
    
    
    
    750
    
    
    
    Net interest income after provision for loan
losses
    
    
    2,368
    
    
    
    3,269
    
    
    
    5,413
    
    
    
    6,447OTHER INCOME:Service fees
    
    
    194
    
    
    
    185
    
    
    
    368
    
    
    
    346Net security gains
    
    
    
    
    
    
    
    
    
    
    65
    
    
    
    Net gains on sale of secondary market loans
    
    
    49
    
    
    
    91
    
    
    
    97
    
    
    
    199Proceeds from lawsuit settlements
    
    
    3,475
    
    
    
    
    
    
    
    3,475
    
    
    
    470Other
    
    
    29
    
    
    
    66
    
    
    
    52
    
    
    
    240Total other income
    
    
    3,747
    
    
    
    342
    
    
    
    4,057
    
    
    
    1,255OTHER EXPENSE:Salaries and employee benefits
    
    
    2,075
    
    
    
    1,672
    
    
    
    3,882
    
    
    
    3,410Occupancy
    
    
    348
    
    
    
    327
    
    
    
    703
    
    
    
    661Furniture and equipment
    
    
    190
    
    
    
    166
    
    
    
    368
    
    
    
    323Data processing
    
    
    216
    
    
    
    210
    
    
    
    437
    
    
    
    381Professional service fees
    
    
    79
    
    
    
    174
    
    
    
    232
    
    
    
    325Loan and deposit
    
    
    144
    
    
    
    79
    
    
    
    254
    
    
    
    151Telephone
    
    
    39
    
    
    
    59
    
    
    
    84
    
    
    
    117Advertising
    
    
    60
    
    
    
    91
    
    
    
    120
    
    
    
    183Other
    
    
    320
    
    
    
    287
    
    
    
    582
    
    
    
    570Total other expense
    
    
    3,471
    
    
    
    3,065
    
    
    
    6,662
    
    
    
    6,121Income before income taxes
    
    
    2,644
    
    
    
    546
    
    
    
    2,808
    
    
    
    1,581Provision for (benefit of) income taxes
    
    
    875
    
    
    
    
    
    
    
    900
    
    
    
    NET INCOME
    
    $
    1,769
    
    
    $
    546
    
    
    $
    1,908
    
    
    $
    1,581INCOME PER COMMON SHARE:Basic
    
    $
    .52
    
    
    $
    .16
    
    
    $
    .56
    
    
    $
    .46Diluted
    
    $
    .52
    
    
    $
    .16
    
    
    $
    .56
    
    
    $
    .46




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Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Balance, beginning of period
    
    $
    39,633
    
    
    $
    29,932
    
    
    $
    39,321
    
    
    $
    28,790Net income for period
    
    
    1,769
    
    
    
    546
    
    
    
    1,908
    
    
    
    1,581Stock option compensation
    
    
    21
    
    
    
    30
    
    
    
    42
    
    
    
    60Net unrealized gain (loss) on securities available for sale
    
    
    (338
    )
    
    
    (23
    )
    
    
    (186
    )
    
    
    54Total comprehensive income
    
    
    1,452
    
    
    
    553
    
    
    
    1,764
    
    
    
    1,695Repurchase of common stock  oddlot shares
    
    
    (110
    )
    
    
    
    
    
    
    (110
    )
    
    
    Balance, end of period
    
    $
    40,975
    
    
    $
    30,485
    
    
    $
    40,975
    
    
    $
    30,485




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Six Months EndedJune 30,2008
    
    
    2007Cash Flows from Operating Activities:Net income
    
    $
    1,908
    
    
    $
    1,581Adjustments to reconcile net income to
net cash provided by operating activities:Depreciation and amortization
    
    
    607
    
    
    
    344Provision for (benefit of) deferred taxes
    
    
    900
    
    
    
    Provision for loan losses
    
    
    750
    
    
    
    (Gain) on sales/calls of securities available for sale
    
    
    (65
    )
    
    
    (Gain) on sale of premises, equipment and other real estate
    
    
    (5
    )
    
    
    (13
    )Writedown of other real estate
    
    
    201
    
    
    
    Stock option compensation
    
    
    42
    
    
    
    60Change in other assets
    
    
    283
    
    
    
    348Change in other liabilities
    
    
    313
    
    
    
    8Net cash (used in) provided by operating activities
    
    
    4,934
    
    
    
    2,328Cash Flows from Investing Activities:Net (increase) decrease in loans
    
    
    (10,792
    )
    
    
    (16,470
    )Net
(increase) decrease in interest-bearing deposits in other financial institutions
    
    
    1,423
    
    
    
    (2,831
    )Purchase of securities available for sale
    
    
    (24,481
    )
    
    
    (13,564
    )Proceeds from sales, maturities or calls of securities available for sale
    
    
    22,766
    
    
    
    22,440Capital expenditures
    
    
    (266
    )
    
    
    (744
    )Proceeds from sale of premises, equipment, and other real estate
    
    
    73
    
    
    
    317Net cash (used in) provided by investing activities
    
    
    (11,277
    )
    
    
    (10,852
    )Cash Flows from Financing Activities:Net increase in deposits
    
    
    36,149
    
    
    
    8,825Net increase (decrease) in federal funds purchased
    
    
    (7,710
    )
    
    
    Net increase (decrease) in line of credit
    
    
    (1,959
    )
    
    
    Net (decrease) repurchase of common stock  oddlot shares
    
    
    (110
    )
    
    
    Net cash (used in) provided by financing activities
    
    
    26,370
    
    
    
    8,825Net increase in cash and cash equivalents
    
    
    20,027
    
    
    
    301Cash and cash equivalents at beginning of period
    
    
    6,362
    
    
    
    10,706Cash and cash equivalents at end of period
    
    $
    26,389
    
    
    $
    11,007Supplemental Cash Flow Information:Cash paid during the year for:Interest
    
    $
    5,086
    
    
    $
    5,771Income taxes
    
    
    
    
    
    
    Noncash Investing and Financing Activities:Transfers of foreclosures from loans to other real estate held for sale
(net of adjustments made through the allowance for loan losses)
    
    $
    2,237
    
    
    $
    69




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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,
2008 are not necessarily indicative of the results that may be expected for the year ending
December 31, 2008. 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, 2007.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 were not changed due to these classifications.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 continues to maintain 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 possible 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 collectibility 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 collectibility.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.Stock Option PlansThe Corporation sponsors three stock option plans. One plan was approved in 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
 5.




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##### Table of Contents



1.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)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. Options under all of the plans are
granted at the discretion of a committee of the Corporations Board of Directors. 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.The Corporation adopted SFAS No. 123 (Revised) Share Based Payments in the first quarter of
2006. This statement supersedes APB Opinion No. 25 Accounting for Stock Issued to Employees
and its related implementation guidance. Under Opinion No. 25, issuing stock options to
employees generally resulted in recognition of no compensation cost. This adoption resulted in
the recognition of after tax compensation expense in the amount of $42,000 for the six months
ended June 30, 2008, and $60,000 for the same period in 2007. The expense recorded recognizes
the current period vesting of options outstanding. The per share impact of this accounting
change was $.01 and $.02 in the first half of 2008 and 2007, respectively.2.
    
    RECENT ACCOUNTING PRONOUNCEMENTSFASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income TaxesIn July 2006, the Financial Accounting Standards Board (FASB) issued this interpretation to
clarify the accounting for uncertainty in tax positions. FIN 48 requires, among other matters,
that the Corporation recognize in its financial statements the impact of a tax position, if that
position is more likely than not of being sustained on an audit, based on the technical merits
of the position. The provisions of FIN 48 were effective as of the beginning of the
Corporations 2007 fiscal year and required any cumulative effect of the change in accounting
principle to be recorded as an adjustment to opening retained earnings. The Corporation did not
record an adjustment to retained earnings upon adoption of FIN 48. In future periods, The
Corporation will, in accordance with FIN 48, evaluate its tax positions to determine whether or
not an adjustment to deferred tax balances and related valuation accounts is warranted.SFAS No. 157, Fair Value MeasurementsSFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally
accepted accounting principles (GAAP), and expands disclosures about fair value measurements.
This statement is to be applied in concert with other accounting pronouncements which require or
allow fair value measurements. This statement does not require any new fair value adjustments.SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS
No. 159)SFAS No. 159 permits an entity to measure certain financial assets and financial
liabilities at fair value. The Statements objective is to improve financial reporting by
allowing entities to mitigate volatility in reported earnings caused by the measurement of
related assets and liabilities using different attributes, without having to apply complex hedge
accounting provisions. Under SFAS No. 159, entities that elect the fair value option will
report unrealized gains and losses in earnings at each subsequent reporting date. The fair
value option may be elected on an instrument-by-instrument basis, with a few exceptions, as long
as it is applied to the instrument in its entirety. The fair value option election is
irrevocable, unless a new election date occurs. The new Statement establishes presentation and
disclosure requirements to help financial statement users understand the effect of the entitys
election on its earnings but does not eliminate disclosure requirements of other accounting
standards. Assets and liabilities that are measured at fair value must be displayed on the face
of the balance sheet.SFAS No. 157 and No. 159 were effective January 1, 2008. The adoption of SFAS No. 157 and No.
159 by the Corporation did not have any material impact on the consolidated financial
statements.
 6.




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##### Table of Contents



2.
    
    RECENT ACCOUNTING PRONOUNCEMENTS (Continued)The Corporation has reviewed other recent accounting pronouncements by the Financial Accounting
Standards Board (FASB), in addition to those noted above and determined that there is no current
impact of these accounting pronouncements in the consolidated financial statements of the
Corporation.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 either period.The following shows the computation of basic and diluted earnings per share for the three and
six months ended June 30, 2008 and 2007 (dollars in thousands, except per share data):
 Three Months Ended
    
    
    
    
    
    Weighted Average
    
    
    IncomeJune 30,
    
    Net Income
    
    
    Number of Shares
    
    
    Per Share2008Income per share  Basic and diluted
    
    $
    1,769
    
    
    
    3,419,933
    
    
    $
    .522007Income per share  Basic and diluted
    
    $
    546
    
    
    
    3,428,695
    
    
    $
    .16Six Months EndedJune 30,2008Income per share  Basic and diluted
    
    $
    1,908
    
    
    
    3,424,314
    
    
    $
    .562007Income per share  Basic and diluted
    
    $
    1,581
    
    
    
    3,428,695
    
    
    $
    .46
 4.
    
    INVESTMENT SECURITIESThe amortized cost and estimated fair value of investment securities available for sale as of
June 30, 2008, December 31, 2007 and June 30, 2007 are as follows (dollars in thousands):
 June 30, 2008
    
    
    December 31, 2007
    
    
    June 30, 2007Amortized
    
    
    Estimated
    
    
    Amortized
    
    
    Estimated
    
    
    Amortized
    
    
    EstimatedCost
    
    
    Fair Value
    
    
    Cost
    
    
    Fair Value
    
    
    Cost
    
    
    Fair ValueUS Agencies  MBS
    
    $
    22,696
    
    
    $
    22,623
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    US Agencies
    
    
    
    
    
    
    
    
    
    
    20,982
    
    
    
    20,969
    
    
    
    23,708
    
    
    
    23,517Obligations of states and political
subdivisions
    
    
    550
    
    
    
    607
    
    
    
    556
    
    
    
    628
    
    
    
    511
    
    
    
    569Total securities available for sale
    
    $
    23,246
    
    
    $
    23,230
    
    
    $
    21,538
    
    
    $
    21,597
    
    
    $
    24,219
    
    
    $
    24,086
 The amortized cost and estimated fair value of investment securities pledged to secure FHLB
borrowings and customer relationships were $21.321 million and $21.260 million, respectively, at
June 30, 2008.
 7.




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##### Table of Contents



5.
    
    LOANSThe composition of loans at June 30, 2008, December 31, 2007 and June 30, 2007 is as follows
(dollars in thousands):
 June 30,
    
    
    December 31,
    
    
    June 30,2008
    
    
    2007
    
    
    2007Commercial real estate
    
    $
    186,108
    
    
    $
    171,695
    
    
    $
    161,823Commercial, financial, and agricultural
    
    
    77,473
    
    
    
    78,192
    
    
    
    76,390One to four family residential real
estate
    
    
    60,882
    
    
    
    57,613
    
    
    
    55,090Construction:Commercial
    
    
    29,064
    
    
    
    38,952
    
    
    
    36,570Consumer
    
    
    4,987
    
    
    
    5,090
    
    
    
    5,485Consumer
    
    
    3,608
    
    
    
    3,537
    
    
    
    3,538Total loans
    
    $
    362,122
    
    
    $
    355,079
    
    
    $
    338,896
 LOANS  Allowance for loan lossesAn analysis of the allowance for loan losses for the six months ended June 30, 2008, the year
ended December 31, 2007, and the six months ended June 30, 2007 is as follows: (dollars in thousands):
 June 30,
    
    
    December 31,
    
    
    June 30,2008
    
    
    2007
    
    
    2007Balance at beginning of period
    
    $
    4,146
    
    
    $
    5,006
    
    
    $
    5,006Recoveries on loans
    
    
    9
    
    
    
    50
    
    
    
    25Loans charged off
    
    
    (1,320
    )
    
    
    (1,310
    )
    
    
    (111
    )Provision for loan losses
    
    
    750
    
    
    
    400
    
    
    
    Balance at end of period
    
    $
    3,585
    
    
    $
    4,146
    
    
    $
    4,920
 In the first half of 2008, net charge off activity was $1.311 million, or .36% of average loans
outstanding compared to net charge-offs of $86,000, or .03% of average loans, in the first half
of 2007. In the first half of 2008, the Corporation recorded a provision for loan loss in the
amount of $750,000, 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. The interest income recorded and that
which would have been recorded had nonaccrual and renegotiated loans been current or not
troubled was not material to the consolidated financial statements for the six months ended June
30, 2008 and 2007.
 8.




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##### Table of Contents



5.
    
    LOANS (Continued)Information regarding impaired loans as of June 30, 2008, December 31, 2007 and June 30, 2007 is
as follows (dollars in thousands):
 Valuation ReserveJune 30,
    
    
    December 31,
    
    
    June 30,
    
    
    June 30,
    
    
    December 31,
    
    
    June 30,2008
    
    
    2007
    
    
    2007
    
    
    2008
    
    
    2007
    
    
    2007Balances, at period endImpaired loans with specific valuation reserve
    
    $
    4,052
    
    
    $
    3,639
    
    
    $
    3,559
    
    
    $
    946
    
    
    $
    1,320
    
    
    $
    968Impaired loans with no specific valuation
reserve
    
    
    561
    
    
    
    369
    
    
    
    1,490
    
    
    
    
    
    
    
    
    
    
    
    Total impaired loans
    
    $
    4,613
    
    
    $
    4,008
    
    
    $
    5,049
    
    
    $
    946
    
    
    $
    1,320
    
    
    $
    968Impaired loans on nonaccrual basis
    
    $
    4,613
    
    
    $
    3,298
    
    
    $
    4,758
    
    
    $
    946
    
    
    $
    1,219
    
    
    $
    968Impaired loans on accrual basis
    
    
    
    
    
    
    710
    
    
    
    291
    
    
    
    
    
    
    
    101
    
    
    
    Total impaired loans
    
    $
    4,613
    
    
    $
    4,008
    
    
    $
    5,049
    
    
    $
    946
    
    
    $
    1,320
    
    
    $
    968Average investment in impaired loans
    
    $
    4,779
    
    
    $
    4,135
    
    
    $
    4,113Interest income recognized during impairment
    
    
    46
    
    
    
    129
    
    
    
    15Interest income that would have been recognized
on an accrual basis
    
    
    225
    
    
    
    391
    
    
    
    198Cash-basis interest income recognized
    
    
    46
    
    
    
    84
    
    
    
    10
 The average investment in impaired loans was approximately $4.779 million for the six-months
ended June 30, 2008, $4.135 million for the year ended December 31, 2007, and $4.113 million for
the six months ended June 30, 2007, respectively. Nonperforming assets are discussed in more
detail under Managements Discussion and Analysis.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 30,2008
    
    
    2007
    
    
    2007Loans outstanding beginning of period
    
    $
    1,720
    
    
    $
    1,621
    
    
    $
    1,621New loans
    
    
    
    
    
    
    
    
    
    
    Net activity on revolving lines of
credit
    
    
    479
    
    
    
    556
    
    
    
    Repayment
    
    
    (41
    )
    
    
    (457
    )
    
    
    (16
    )Change in related party interest
    
    
    2,733
    
    
    
    
    
    
    
    Loans outstanding end of period
    
    $
    4,891
    
    
    $
    1,720
    
    
    $
    1,605
 There were no loans to related-parties classified substandard at June 30, 2008, December 31,
2007 or June 30, 2007, respectively.
 9.




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6.
    
    SHORT-TERM BORROWINGSShort-term borrowings consist of the following at June 30, 2008, December 31, 2007, and June 30,
2007 (dollars in thousands):
 June 30,
    
    
    December 31,
    
    
    June 30,2008
    
    
    2007
    
    
    2007Fed funds purchased
    
    $
    
    
    
    $
    7,710
    
    
    $
    Advance outstanding on line of credit with a correspondent bank, interest payable
at the prime rate, 5.00% as of June 30, 2008, maturing November 30, 2008
    
    
    
    
    
    
    1,959
    
    
    
    1,959$
    
    
    
    $
    9,669
    
    
    $
    1,959
 7.
    
    LONG-TERM BORROWINGSLong-term borrowings consist of the following at June 30, 2008, December 31, 2007 and June 30,
2007 (dollars in thousands):
 June 30,
    
    
    December 31,
    
    
    June 30,2008
    
    
    2007
    
    
    2007Federal Home Loan Bank fixed rate advances at rates ranging from 4.98% to 5.16%
maturing in 2010
    
    $
    15,000
    
    
    $
    15,000
    
    
    $
    15,000Federal Home Loan Bank variable rate advances at rates ranging from 2.73% to 2.80%
maturing in 2011
    
    
    20,000
    
    
    
    20,000
    
    
    
    20,000Farmers Home Administration, fixed-rate note payable, maturing August 24, 2024
interest payable at 1%
    
    
    1,280
    
    
    
    1,280
    
    
    
    1,348$
    36,280
    
    
    $
    36,280
    
    
    $
    36,348
 The Federal Home Loan Bank borrowings are collateralized at June 30, 2008, by the following: a
collateral agreement on the Corporations one to four family residential real estate loans with
a book value of approximately $22.862 million; mortgage related and municipal securities with an
amortized cost and estimated fair value of $20.071 million and $20.010 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, 2008.The U.S.D.A. Rural Development borrowing is collateralized by loans totaling $367,000 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 $1.031 million, and guaranteed by the Corporation.
 10.




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8.
    
    STOCK OPTION PLANSA summary of stock option transactions for the six months ended June 30, 2008 and 2007, and the
year ended December 31, 2007, is as follows:
 June
30, 2008
    
    

December
31, 2007
    
    

June
30, 2007Outstanding shares at beginning of year
    
    
    446,417
    
    
    
    446,417
    
    
    
    446,417Granted during the period
    
    
    
    
    
    
    
    
    
    
    Expired during the period
    
    
    180
    
    
    
    
    
    
    
    Outstanding shares at end of period
    
    
    446,237
    
    
    
    446,417
    
    
    
    446,417Weighted average exercise price per share at end of period
    
    $
    12.14
    
    
    $
    12.29
    
    
    $
    12.29Shares available for grant at end of period
    
    
    18,488
    
    
    
    18,488
    
    
    
    18,488
 There were no options granted in the first six months of 2008 and 2007.Following is a summary of the options outstanding and exercisable at June 30, 2008:
 Exercise
    
    Number
    
    
    Remaining
    
    
    Weighted AveragePrice Range
    
    Outstanding
    
    
    Exercisable
    
    
    Contractual Life-Years
    
    
    Exercise Price$9.16
    
    
    12,500
    
    
    
    5,000
    
    
    
    7.5
    
    
    $
    9.16$9.75
    
    
    257,152
    
    
    
    120,861
    
    
    
    6.5
    
    
    
    9.75$10.65
    
    
    72,500
    
    
    
    14,500
    
    
    
    8.5
    
    
    
    10.65$11.50
    
    
    40,000
    
    
    
    8,000
    
    
    
    7.3
    
    
    
    11.50$12.00
    
    
    60,000
    
    
    
    12,000
    
    
    
    7.0
    
    
    
    12.00$156.00
 $240.00
    
    
    3,545
    
    
    
    3,545
    
    
    
    2.7
    
    
    
    186.75$300.00
 $406.60
    
    
    540
    
    
    
    540
    
    
    
    1.6
    
    
    
    333.33446,237
    
    
    
    164,446
    
    
    
    6.9
    
    
    $
    12.14
 9.
    
    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. At June 30, 2008, the
Corporation evaluated the valuation allowance against the net deferred tax asset which would
require future taxable income in order to be utilized. The Corporation, as of June 30, 2008 had
a net operating loss and tax credit carryforwards for tax purposes of approximately $34.2
million, and $2.1 million, respectively.The Corporation utilized NOL carryforwards to offset taxable income for the first nine months of
2007. In the third quarter of 2007, the Corporation reversed a portion of the valuation
allowance, $7.500 million that pertained to the deferred tax benefit of NOL and tax credit
carryforwards. This valuation adjustment was recorded as a current period income tax benefit.
In 2006, the Corporation recorded a $500,000 tax benefit and
utilized additional NOL carryforwards to offset current taxable income. The recognition of the
deferred tax benefit in 2007 and 2006 was in accordance with generally accepted accounting
principles, and considered among other things, the probability of utilizing the NOL and credit
carryforwards.
 11.




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##### Table of Contents



9.
    
    INCOME TAXES (Continued)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 $22 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, 2004.10.
    
    FAS 157  FAIR VALUE MEASUREMENTSThe following tables present information about the Corporations assets and liabilities measured
at fair value on a recurring basis at June 30, 2008, and the valuation techniques used by the
Corporation to determine those fair values.
 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 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.Disclosures concerning assets and liabilities measured at fair value are as follows (dollars in
thousands):
 Assets and Liabilities Measured at Fair Value on a Recurring Basis at June 30, 2008
 Quoted Prices in Active
    
    Significant Other
    
    SignificantMarkets for Identical
    
    Observable Inputs
    
    Unobservable Inputs
    
    Balance atAssets (Level 1)
    
    (Level 2)
    
    (Level 3)
    
    June 30, 2008AssetsInvestment securities  available for sale
    
    $
    23,162
    
    
    $
    68
    
    
    $
    
    
    
    $
    23,230LiabilitiesNone
 The Corporation had no Level 3 assets or liabilities on a recurring basis as of December 31,
2007 or June 30, 2008.
 12.




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##### Table of Contents



10.
    
    FAS 157  FAIR VALUE MEASUREMENTS (Continued)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 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, 2008
    
    
    (Level 1)
    
    
    (Level 2)
    
    
    (Level 3)
    
    
    June 30, 2008
    
    
    June 30, 2008AssetsImpaired loans accounted
for under FAS 114
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    1,161
    
    
    $
    862
    
    
    $
    862$
    862
    
    
    $
    862
 The Corporation had no investments subject to fair value measurement on a nonrecurring basis.Impaired loans accounted for under FAS 114 categorized as Level 3 assets consist of
non-homogeneous loans that are considered impaired. 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).Other assets, including bank owned life insurance, goodwill, intangible assets and other assets
acquired in business combinations, are also subject to periodic impairment assessments under
other accounting principles generally accepted in the United States of America. These assets
are not considered financial instruments. Effective February 12, 2008, the FASB issued a staff
position, FSP FAS 157-2, which delayed the applicability of FAS 157 to nonfinancial instruments.
Accordingly, these assets have been omitted from the above disclosures.11.
    
    COMMITMENTS, CONTINGENCIES AND CREDIT RISKFinancial Instruments With Off-Balance-Sheet RiskThe 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.
 13.




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##### Table of Contents



11.
    
    COMMITMENTS, CONTINGENCIES AND CREDIT RISK (Continued)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 30,2008
    
    
    2007
    
    
    2007Commitments to extend credit:Variable rate
    
    $
    40,215
    
    
    $
    43,903
    
    
    $
    51,214Fixed rate
    
    
    8,601
    
    
    
    8,055
    
    
    
    8,881Standby letters of credit  Variable rate
    
    
    6,693
    
    
    
    5,930
    
    
    
    5,914Credit card commitments  Fixed rate
    
    
    2,521
    
    
    
    2,414
    
    
    
    2,432$
    58,030
    
    
    $
    60,302
    
    
    $
    68,441
 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.ContingenciesIn 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 RiskThe 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, 2008 represents
$41.8 million, or 15.9%, compared to $41.7 million, or 17.5%, of the commercial loan portfolio
on June 30, 2007. 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.
 14.




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 FORWARD LOOKING STATEMENTS
  
    
    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 interest rate environment which increase or decrease interest rate
margins;
    
    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.
  15.




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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
  16.




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
  June 30,
    
    
    Percent of
    
    
    December 31,
    
    
    Percent of
    
    
    June 30,
    
    
    Percent of2008
    
    
    Total
    
    
    2007
    
    
    Total
    
    
    2007
    
    
    TotalCommercial real estate
    
    $
    186,108
    
    
    
    51.39
    %
    
    $
    171,695
    
    
    
    48.35
    %
    
    $
    161,823
    
    
    
    47.75
    %Commercial, financial, and agricultural
    
    
    77,473
    
    
    
    21.39
    
    
    
    78,192
    
    
    
    22.02
    
    
    
    76,390
    
    
    
    22.54One to four family residential real estate
    
    
    60,882
    
    
    
    16.81
    
    
    
    57,613
    
    
    
    16.23
    
    
    
    55,090
    
    
    
    16.26Consumer
    
    
    3,608
    
    
    
    1.00
    
    
    
    3,537
    
    
    
    1.00
    
    
    
    3,538
    
    
    
    1.04ConstructionCommercial
    
    
    29,064
    
    
    
    8.03
    
    
    
    38,952
    
    
    
    10.97
    
    
    
    36,570
    
    
    
    10.79Consumer
    
    
    4,987
    
    
    
    1.38
    
    
    
    5,090
    
    
    
    1.43
    
    
    
    5,485
    
    
    
    1.62Total loans
    
    $
    362,122
    
    
    
    100.00
    %
    
    $
    355,079
    
    
    
    100.00
    %
    
    $
    338,896
    
    
    
    100.00
    %
  June 30, 2008
    
    
    December 31, 2007
    
    
    June 30, 2007Percent 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
    
    
    EquityR/E  oper. of nonresidential bldgs.
    
    $
    41,778
    
    
    
    15.85
    %
    
    
    101.96
    %
    
    $
    41,597
    
    
    
    14.40
    %
    
    
    105.79
    %
    
    $
    41,662
    
    
    
    17.49
    %
    
    
    136.66
    %Hospitality and tourism
    
    
    35,053
    
    
    
    13.30
    
    
    
    85.55
    
    
    
    37,604
    
    
    
    13.02
    
    
    
    95.63
    
    
    
    37,286
    
    
    
    15.65
    
    
    
    122.31Real estate agents and managers
    
    
    27,495
    
    
    
    10.43
    
    
    
    67.10
    
    
    
    29,571
    
    
    
    10.24
    
    
    
    75.20
    
    
    
    31,937
    
    
    
    13.41
    
    
    
    104.76Commercial construction
    
    
    10,716
    
    
    
    4.07
    
    
    
    26.15
    
    
    
    38,952
    
    
    
    13.49
    
    
    
    99.06
    
    
    
    10,270
    
    
    
    4.31
    
    
    
    33.69Other
    
    
    148,539
    
    
    
    56.35
    
    
    
    362.51
    
    
    
    141,115
    
    
    
    48.85
    
    
    
    358.88
    
    
    
    117,058
    
    
    
    49.14
    
    
    
    383.99Total Commercial Loans
    
    $
    263,581
    
    
    
    100.00
    %
    
    
    
    
    
    $
    288,839
    
    
    
    100.00
    %
    
    
    
    
    
    $
    238,213
    
    
    
    100.00
    %
  Credit Quality
  17.




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
  June 30,
    
    
    December 31,
    
    
    June 30,2008
    
    
    2007
    
    
    2007Nonperforming Assets:Nonaccrual Loans
    
    $
    4,613
    
    
    $
    3,298
    
    
    $
    4,758Loans past due 90 days or more
    
    
    
    
    
    
    710
    
    
    
    291Total nonperforming loans
    
    
    4,613
    
    
    
    4,008
    
    
    
    5,049Other real estate owned
    
    
    3,395
    
    
    
    1,226
    
    
    
    77Total nonperforming assets
    
    $
    8,008
    
    
    $
    5,234
    
    
    $
    5,126Nonperforming loans as a % of loans
    
    
    1.27
    %
    
    
    1.13
    %
    
    
    1.49
    %Nonperforming assets as a % of assets
    
    
    1.83
    %
    
    
    1.28
    %
    
    
    1.30
    %Reserve for Loan Losses:At period end
    
    $
    3,585
    
    
    $
    4,146
    
    
    $
    4,920As a % of loans
    
    
    .99
    %
    
    
    1.17
    %
    
    
    1.45
    %As a % of nonperforming loans
    
    
    77.72
    %
    
    
    103.44
    %
    
    
    97.45
    %As a % of nonaccrual loans
    
    
    77.72
    %
    
    
    125.71
    %
    
    
    103.41
    %
  June 30,
    
    
    December 31,
    
    
    June 30,2008
    
    
    2007
    
    
    2007Total loans, at period end
    
    $
    362,122
    
    
    $
    355,079
    
    
    $
    338,896Average loans for the year
    
    
    360,176
    
    
    
    333,415
    
    
    
    321,414Allowance for loan losses
    
    
    3,585
    
    
    
    4,146
    
    
    
    4,920Allowance to total loans at period end
    
    
    .99
    %
    
    
    1.17
    %
    
    
    1.45
    %Net charge-offs during the period
    
    $
    1,311
    
    
    $
    1,260
    
    
    $
    86Net charge-offs to average loans
    
    
    .36
    %
    
    
    .38
    %
    
    
    .03
    %Net charge-offs to beginning allowance balance
    
    
    31.62
    %
    
    
    25.17
    %
    
    
    1.72
    %
  18.




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
  Estimated
    
    
    
    
    
    
    
    
    
    
    EstimatedLiquidation
    
    
    (Deficiency)
    
    
    Reserve
    
    
    Net Surplus/Collateral Type
    
    Balance
    
    
    Value
    
    
    Surplus
    
    
    Allocation
    
    
    (Exposure)(a)
    
    
    (b)
    
    
    (c ) = (b)-(a)
    
    
    (d)
    
    
    (e) = (c )+(d)Nonaccrual LoansLand Development
    
    $
    2,754
    
    
    $
    2,134
    
    
    $
    (620
    )
    
    $
    620
    
    
    $
    Land Development / Condo
    
    
    1,042
    
    
    
    1,080
    
    
    
    38
    
    
    
    300
    
    
    
    338Cabins / Land
    
    
    414
    
    
    
    414
    
    
    
    
    
    
    
    
    
    
    
    1-4 Family
    
    
    203
    
    
    
    197
    
    
    
    (6
    )
    
    
    6
    
    
    
    Non-Farm/Non-Residential
    
    
    117
    
    
    
    97
    
    
    
    (20
    )
    
    
    20
    
    
    
    Business Equipment
    
    
    50
    
    
    
    50
    
    
    
    
    
    
    
    
    
    
    
    Land
    
    
    34
    
    
    
    88
    
    
    
    54
    
    
    
    
    
    
    
    54Total nonaccrual loans
    
    
    4,614
    
    
    
    4,060
    
    
    
    (554
    )
    
    
    946
    
    
    
    392Other Real EstateConv 5+ Resdential
    
    
    1,746
    
    
    
    1,225
    
    
    
    (521
    )
    
    
    521
    
    
    
    Land Development
    
    
    511
    
    
    
    511
    
    
    
    
    
    
    
    
    
    
    
    Motel / Hotel
    
    
    387
    
    
    
    387
    
    
    
    
    
    
    
    
    
    
    
    Cabins / Land
    
    
    260
    
    
    
    260
    
    
    
    
    
    
    
    
    
    
    
    1-4 Family
    
    
    217
    
    
    
    198
    
    
    
    (19
    )
    
    
    19
    
    
    
    Equipment Storage Building
    
    
    150
    
    
    
    150
    
    
    
    
    
    
    
    
    
    
    
    Downtown Store Frontage / 2 / 1-4 Family
    
    
    77
    
    
    
    77
    
    
    
    
    
    
    
    
    
    
    
    Non-Farm/Non-Residential
    
    
    46
    
    
    
    46
    
    
    
    
    
    
    
    
    
    
    
    Total other real estate owned
    
    
    3,394
    
    
    
    2,854
    
    
    
    (540
    )
    
    
    540
    
    
    
    Total Nonperforming Assets
    
    $
    8,008
    
    
    $
    6,914
    
    
    $
    (1,094
    )
    
    $
    1,486
    
    
    $
    392
   June 30,
    
    
    December 31,
    
    
    June 30,2008
    
    
    2007
    
    
    2007Commercial, financial and agricultural loans
    
    $
    3,276
    
    
    $
    3,808
    
    
    $
    4,261One to four family residential real estate loans
    
    
    27
    
    
    
    22
    
    
    
    60Consumer loans
    
    
    15
    
    
    
    20
    
    
    
    Unallocated and general reserves
    
    
    267
    
    
    
    296
    
    
    
    599Totals
    
    $
    3,585
    
    
    $
    4,146
    
    
    $
    4,920
  19.




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
   Three Months Ended
    
    
    Year Ended
    
    
    Three Months EndedJune 30, 2008
    
    
    December 31, 2007
    
    
    June 30, 2007Balance at beginning of period
    
    $
    1,226
    
    
    $
    26
    
    
    $
    26Other real estate transferred from loans due to foreclosure
    
    
    2,439
    
    
    
    1,218
    
    
    
    69Other real estate sold/written down
    
    
    (270
    )
    
    
    (18
    )
    
    
    (18
    )Balance at end of period
    
    $
    3,395
    
    
    $
    1,226
    
    
    $
    77
  Deposits
   June 30,
    
    
    
    
    
    
    December 31,
    
    
    
    
    
    
    June 30,2008
    
    
    % of Total
    
    
    2007
    
    
    % of Total
    
    
    2007
    
    
    % of TotalNon-interest-bearing
    
    $
    27,741
    
    
    
    7.77
    %
    
    $
    25,557
    
    
    
    7.97
    %
    
    $
    28,811
    
    
    
    8.97
    %NOW, money market, checking
    
    
    78,703
    
    
    
    22.05
    
    
    
    81,160
    
    
    
    25.30
    
    
    
    73,994
    
    
    
    23.03Savings
    
    
    15,171
    
    
    
    4.25
    
    
    
    12,485
    
    
    
    3.89
    
    
    
    12,422
    
    
    
    3.87Certificates of Deposit <$100,000
    
    
    78,678
    
    
    
    22.04
    
    
    
    80,607
    
    
    
    25.12
    
    
    
    96,546
    
    
    
    30.05Total core deposits
    
    
    200,293
    
    
    
    56.11
    
    
    
    199,809
    
    
    
    62.28
    
    
    
    211,773
    
    
    
    65.92Certificates of Deposit >$100,000
    
    
    28,252
    
    
    
    7.91
    
    
    
    22,355
    
    
    
    6.97
    
    
    
    24,879
    
    
    
    7.75Brokered CDs
    
    
    128,431
    
    
    
    35.98
    
    
    
    98,663
    
    
    
    30.75
    
    
    
    84,594
    
    
    
    26.33Total non-core deposits
    
    
    156,683
    
    
    
    43.89
    
    
    
    121,018
    
    
    
    37.72
    
    
    
    109,473
    
    
    
    34.08Total deposits
    
    $
    356,976
    
    
    
    100.00
    %
    
    $
    320,827
    
    
    
    100.00
    %
    
    $
    321,246
    
    
    
    100.00
    %
 20.




---



##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
 Borrowings
  Shareholders Equity
  RESULTS OF OPERATIONS
 Summary
   Net Interest Income
     21.




---



##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
  Three Months Ended2008-2007Average Balances
    
    
    Average Rates
    
    
    Interest
    
    
    Income/
    
    
    
    
    
    
    
    
    
    
    Rate/June 30,
    
    
    Increase/
    
    
    June 30,
    
    
    June 30,
    
    
    Expense
    
    
    Volume
    
    
    Rate
    
    
    Volume(dollars in thousands)
    
    2008
    
    
    2007
    
    
    (Decrease)
    
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007
    
    
    Variance
    
    
    Variance
    
    
    Variance
    
    
    VarianceLoans (1,2,3)
    
    $
    362,574
    
    
    $
    324,721
    
    
    $
    37,853
    
    
    
    6.39
    %
    
    
    8.23
    %
    
    $
    5,759
    
    
    $
    6,664
    
    
    $
    (905
    )
    
    $
    775
    
    
    $
    (1,489
    )
    
    
    (191
    )Taxable securities
    
    
    23,960
    
    
    
    25,971
    
    
    
    (2,011
    )
    
    
    4.58
    
    
    
    4.53
    
    
    
    273
    
    
    
    293
    
    
    
    (20
    )
    
    
    (23
    )
    
    
    4
    
    
    
    (1
    )Nontaxable securities (2)
    
    
    69
    
    
    
    
    
    
    
    69
    
    
    
    5.83
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1Federal funds sold
    
    
    1,923
    
    
    
    7,756
    
    
    
    (5,833
    )
    
    
    2.09
    
    
    
    5.27
    
    
    
    10
    
    
    
    102
    
    
    
    (92
    )
    
    
    (77
    )
    
    
    (61
    )
    
    
    46Other interest-earning assets
    
    
    4,183
    
    
    
    5,934
    
    
    
    (1,751
    )
    
    
    6.73
    
    
    
    4.33
    
    
    
    70
    
    
    
    64
    
    
    
    6
    
    
    
    (19
    )
    
    
    36
    
    
    
    (11
    )Total earning assets
    
    
    392,709
    
    
    
    364,382
    
    
    
    28,327
    
    
    
    6.26
    
    
    
    7.84
    
    
    
    6,113
    
    
    
    7,123
    
    
    
    (1,010
    )
    
    
    656
    
    
    
    (1,510
    )
    
    
    (156
    )Reserve for loan losses
    
    
    (3,886
    )
    
    
    (4,972
    )
    
    
    1,086Cash and due from banks
    
    
    6,053
    
    
    
    5,976
    
    
    
    77Intangible assets
    
    
    94
    
    
    
    172
    
    
    
    (78
    )Other assets
    
    
    23,276
    
    
    
    16,507
    
    
    
    6,769Total assets
    
    $
    418,246
    
    
    $
    382,065
    
    
    $
    36,181NOW and money market deposits
    
    $
    80,379
    
    
    $
    72,371
    
    
    $
    8,008
    
    
    
    1.53
    
    
    
    3.49
    
    
    
    306
    
    
    
    629
    
    
    
    (323
    )
    
    
    69
    
    
    
    (352
    )
    
    
    (40)Savings deposits
    
    
    13,310
    
    
    
    13,288
    
    
    
    22
    
    
    
    .94
    
    
    
    1.63
    
    
    
    31
    
    
    
    54
    
    
    
    (23
    )
    
    
    
    
    
    
    (23
    )
    
    
    CDs <$100,000
    
    
    81,746
    
    
    
    96,442
    
    
    
    (14,696
    )
    
    
    4.25
    
    
    
    5.00
    
    
    
    863
    
    
    
    1,202
    
    
    
    (339
    )
    
    
    (183
    )
    
    
    (181
    )
    
    
    25CDs >$100,000
    
    
    26,773
    
    
    
    24,350
    
    
    
    2,423
    
    
    
    3.97
    
    
    
    5.02
    
    
    
    264
    
    
    
    305
    
    
    
    (41
    )
    
    
    30
    
    
    
    (64
    )
    
    
    (7
    )Brokered deposits
    
    
    104,187
    
    
    
    79,301
    
    
    
    24,886
    
    
    
    4.20
    
    
    
    5.45
    
    
    
    1,087
    
    
    
    1,077
    
    
    
    10
    
    
    
    337
    
    
    
    (247
    )
    
    
    (80)Borrowings
    
    
    42,430
    
    
    
    39,209
    
    
    
    3,221
    
    
    
    3.71
    
    
    
    5.25
    
    
    
    391
    
    
    
    513
    
    
    
    (122
    )
    
    
    41
    
    
    
    (150
    )
    
    
    (13)Total interest-bearing liabilities
    
    
    348,825
    
    
    
    324,961
    
    
    
    23,864
    
    
    
    3.39
    
    
    
    4.67
    
    
    
    2,942
    
    
    
    3,780
    
    
    
    (838
    )
    
    
    294
    
    
    
    (1,017
    )
    
    
    (115)Demand deposits
    
    
    26,331
    
    
    
    23,717
    
    
    
    2,614Other liabilities
    
    
    2,691
    
    
    
    2,975
    
    
    
    (284
    )Shareholders equity
    
    
    40,399
    
    
    
    30,412
    
    
    
    9,987Total liabilities and shareholders equity
    
    $
    418,246
    
    
    $
    382,065
    
    
    $
    36,181Rate spread
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2.87
    %
    
    
    3.17
    %Net interest margin/revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.25
    %
    
    
    3.68
    %
    
    $
    3,171
    
    
    $
    3,343
    
    
    $
    (172
    )
    
    $
    362
    
    
    $
    (493
    )
    
    $
    (41
    )
 
 (1)
    
    For purposes of these computations, nonaccruing loans are included in the
daily average loan amounts outstanding.(2)
    
    Interest income on loans includes loan
fees.(3)
    
    Interest income on loans includes fees Six Months Ended2008-2007Average Balances
    
    
    Average Rates
    
    
    Interest
    
    
    Income/
    
    
    
    
    
    
    
    
    
    
    Rate/June 30,
    
    
    Increase/
    
    
    June 30,
    
    
    June 30,
    
    
    Expense
    
    
    Volume
    
    
    Rate
    
    
    Volume(dollars in thousands)
    
    2008
    
    
    2007
    
    
    (Decrease)
    
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007
    
    
    Variance
    
    
    Variance
    
    
    Variance
    
    
    VarianceLoans (1,23)
    
    $
    360,176
    
    
    $
    321,415
    
    
    $
    38,761
    
    
    
    6.71
    %
    
    
    8.15
    %
    
    $
    12,022
    
    
    $
    13,157
    
    
    $
    (1,135
    )
    
    $
    1,591
    
    
    $
    (2,465
    )
    
    
    (261
    )Taxable securities
    
    
    23,930
    
    
    
    27,703
    
    
    
    (3,773
    )
    
    
    4.51
    
    
    
    4.32
    
    
    
    537
    
    
    
    594
    
    
    
    (57
    )
    
    
    (81
    )
    
    
    26
    
    
    
    (2
    )Nontaxable securities
    
    
    70
    
    
    
    
    
    
    
    70
    
    
    
    11.49
    
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    4Federal funds sold
    
    
    3,641
    
    
    
    9,103
    
    
    
    (5,462
    )
    
    
    2.93
    
    
    
    5.32
    
    
    
    53
    
    
    
    240
    
    
    
    (187
    )
    
    
    (144
    )
    
    
    (108
    )
    
    
    65Other interest-earning assets
    
    
    4,436
    
    
    
    5,450
    
    
    
    (1,014
    )
    
    
    5.30
    
    
    
    4.66
    
    
    
    117
    
    
    
    126
    
    
    
    (9
    )
    
    
    (24
    )
    
    
    17
    
    
    
    (2
    )Total earning assets
    
    
    392,253
    
    
    
    363,671
    
    
    
    28,582
    
    
    
    6.53
    
    
    
    7.74
    
    
    
    12,733
    
    
    
    14,117
    
    
    
    (1,384
    )
    
    
    1,342
    
    
    
    (2,530
    )
    
    
    (196
    )Reserve for loan losses
    
    
    (3,982
    )
    
    
    (4,985
    )
    
    
    1,003Cash and due from banks
    
    
    6,127
    
    
    
    5,911
    
    
    
    216Intangible assets
    
    
    104
    
    
    
    183
    
    
    
    (79
    )Other assets
    
    
    23,462
    
    
    
    16,459
    
    
    
    7,003Total assets
    
    $
    417,964
    
    
    $
    381,239
    
    
    $
    36,725NOW and money market deposits
    
    $
    81,107
    
    
    $
    72,282
    
    
    $
    8,825
    
    
    
    1.85
    
    
    
    3.48
    
    
    
    748
    
    
    
    1,249
    
    
    
    (501
    )
    
    
    153
    
    
    
    (586
    )
    
    
    (68
    )Savings deposits
    
    
    12,668
    
    
    
    13,284
    
    
    
    (616
    )
    
    
    0.89
    
    
    
    1.64
    
    
    
    56
    
    
    
    108
    
    
    
    (52
    )
    
    
    (5
    )
    
    
    (50
    )
    
    
    3CDs <$100,000
    
    
    82,146
    
    
    
    94,243
    
    
    
    (12,097
    )
    
    
    4.44
    
    
    
    4.95
    
    
    
    1,813
    
    
    
    2,312
    
    
    
    (499
    )
    
    
    (254
    )
    
    
    (283
    )
    
    
    38CDs >$100,000
    
    
    24,962
    
    
    
    24,117
    
    
    
    845
    
    
    
    4.25
    
    
    
    4.98
    
    
    
    527
    
    
    
    596
    
    
    
    (69
    )
    
    
    21
    
    
    
    (88
    )
    
    
    (2
    )Brokered deposits
    
    
    107,105
    
    
    
    82,022
    
    
    
    25,083
    
    
    
    4.64
    
    
    
    5.47
    
    
    
    2,471
    
    
    
    2,225
    
    
    
    246
    
    
    
    682
    
    
    
    (339
    )
    
    
    (97
    )Borrowings
    
    
    40,906
    
    
    
    38,795
    
    
    
    2,111
    
    
    
    4.15
    
    
    
    5.29
    
    
    
    845
    
    
    
    1,018
    
    
    
    (173
    )
    
    
    56
    
    
    
    (219
    )
    
    
    (10
    )Total interest-bearing liabilities
    
    
    348,894
    
    
    
    324,743
    
    
    
    24,151
    
    
    
    3.72
    
    
    
    4.66
    
    
    
    6,460
    
    
    
    7,508
    
    
    
    (1,048
    )
    
    
    653
    
    
    
    (1,565
    )
    
    
    (136
    )Demand deposits
    
    
    26,383
    
    
    
    23,596
    
    
    
    2,787Other liabilities
    
    
    2,742
    
    
    
    3,064
    
    
    
    (322
    )Shareholders equity
    
    
    39,945
    
    
    
    29,836
    
    
    
    10,109Total liabilities and shareholders equity
    
    $
    417,964
    
    
    $
    381,239
    
    
    $
    36,725Rate spread
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2.81
    %
    
    
    3.08
    %Net interest margin/revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.22
    %
    
    
    3.57
    %
    
    $
    6,273
    
    
    $
    6,609
    
    
    $
    (336
    )
    
    $
    689
    
    
    $
    (965
    )
    
    $
    (60
    )
 
 (1)
    
    For purposes of these computations, nonaccruing loans are included in the
daily average loan amounts outstanding.(2)
    
    Interest income on loans includes loan
fees.(3)
    
    Interest income includes fees on loans  22.




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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)2008
    
    
    2007
    
    
    2008-2007
    
    
    2008
    
    
    2007
    
    
    2008-2007Service fees
    
    $
    194
    
    
    $
    185
    
    
    
    4.86
    
    
    $
    368
    
    
    $
    346
    
    
    
    6.36Net gains on sale of secondary
market loans
    
    
    49
    
    
    
    91
    
    
    
    (46.15
    )
    
    
    97
    
    
    
    199
    
    
    
    (51.26
    )Proceeds from lawsuit settlements
    
    
    3,475
    
    
    
    
    
    
    
    100.00
    
    
    
    3,475
    
    
    
    470
    
    
    
    639.36Other noninterest income
    
    
    29
    
    
    
    66
    
    
    
    (56.06
    )
    
    
    52
    
    
    
    240
    
    
    
    (78.33
    )Subtotal
    
    
    3,747
    
    
    
    342
    
    
    
    995.61
    
    
    
    3,992
    
    
    
    1,255
    
    
    
    218.09Net security gain (loss)
    
    
    
    
    
    
    
    
    
    
    0.00
    
    
    
    65
    
    
    
    
    
    
    
    100.00Total other income
    
    $
    3,747
    
    
    $
    342
    
    
    
    995.61
    
    
    $
    4,057
    
    
    $
    1,255
    
    
    
    223.27
 Other Expenses
  23.




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)
     Three Months Ended
    
    
    % Increase
    
    
    Six Months Ended
    
    
    % IncreaseJune 30,
    
    
    (Decrease)
    
    
    June 30,
    
    
    (Decrease)2008
    
    
    2007
    
    
    2008-2007
    
    
    2008
    
    
    2007
    
    
    2008-2007Salaries and employee benefits
    
    $
    2,075
    
    
    $
    1,672
    
    
    
    24.10
    
    
    $
    3,882
    
    
    $
    3,410
    
    
    
    13.84Occupancy
    
    
    348
    
    
    
    327
    
    
    
    6.42
    
    
    
    703
    
    
    
    661
    
    
    
    6.35Furniture and equipment
    
    
    190
    
    
    
    166
    
    
    
    14.46
    
    
    
    368
    
    
    
    323
    
    
    
    13.93Data processing
    
    
    216
    
    
    
    210
    
    
    
    2.86
    
    
    
    437
    
    
    
    381
    
    
    
    14.70Professional service fees
    
    
    79
    
    
    
    174
    
    
    
    (54.60
    )
    
    
    232
    
    
    
    325
    
    
    
    (28.62
    )Loan and deposit
    
    
    144
    
    
    
    79
    
    
    
    82.28
    
    
    
    254
    
    
    
    151
    
    
    
    68.21Telephone
    
    
    39
    
    
    
    59
    
    
    
    (33.90
    )
    
    
    84
    
    
    
    117
    
    
    
    (28.21
    )Advertising
    
    
    60
    
    
    
    91
    
    
    
    (34.07
    )
    
    
    120
    
    
    
    183
    
    
    
    (34.43
    )Other
    
    
    320
    
    
    
    287
    
    
    
    11.50
    
    
    
    582
    
    
    
    570
    
    
    
    2.11Total noninterest expense
    
    $
    3,471
    
    
    $
    3,065
    
    
    
    13.25
    
    
    $
    6,662
    
    
    $
    6,121
    
    
    
    8.84
 Federal Income Taxes
 Current Federal Tax Provision
  Deferred Tax Benefit
  24.




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS (Continued)
  LIQUIDITY
       25.




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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 30,2008
    
    
    2007
    
    
    2007Capital StructureShareholders equity
    
    $
    40,975
    
    
    $
    39,321
    
    
    $
    30,485Total capitalization
    
    $
    40,975
    
    
    $
    39,321
    
    
    $
    30,485Tangible capital
    
    $
    40,890
    
    
    $
    39,197
    
    
    $
    30,323Intangible AssetsCore deposit premium
    
    $
    85
    
    
    $
    124
    
    
    $
    162Other identifiable intangibles
    
    
    
    
    
    
    
    
    
    
    Total intangibles
    
    $
    85
    
    
    $
    124
    
    
    $
    162Regulatory capitalTier 1 capital:Shareholders equity
    
    $
    40,975
    
    
    $
    39,321
    
    
    $
    30,485Net unrealized (gains) losses on
available for sale securities
    
    
    126
    
    
    
    (60
    )
    
    
    133Less: disallowed deferred tax asset
    
    
    (5,731
    )
    
    
    (6,990
    )
    
    
    Less: intangibles
    
    
    (85
    )
    
    
    (124
    )
    
    
    (162
    )Total Tier 1 capital
    
    $
    35,285
    
    
    $
    32,147
    
    
    $
    30,456Tier 2 Capital:Allowable reserve for loan losses
    
    $
    3,585
    
    
    $
    4,146
    
    
    $
    4,309Qualifying long-term debt
    
    
    
    
    
    
    
    
    
    
    Total Tier 2 capital
    
    
    3,585
    
    
    
    4,146
    
    
    
    4,309Total capital
    
    $
    38,870
    
    
    $
    36,293
    
    
    $
    34,765Risk-adjusted assets
    
    $
    372,139
    
    
    $
    358,410
    
    
    $
    344,120Capital ratios:Tier 1 Capital to average assets
    
    
    8.56
    %
    
    
    8.05
    %
    
    
    7.97
    %Tier 1 Capital to risk weighted assets
    
    
    9.48
    %
    
    
    8.97
    %
    
    
    8.85
    %Total Capital to risk weighted assets
    
    
    10.45
    %
    
    
    10.13
    %
    
    
    10.10
    %
  26.




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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, 2008
    
    
    9.37
    %
    
    
    9.35
    %
    
    
    8.56
    %
    
    
    9.48
    %
    
    
    10.45
    %June 30, 2007
    
    
    7.75
    %
    
    
    7.71
    %
    
    
    7.97
    %
    
    
    8.85
    %
    
    
    10.10
    %The Bank:June 30, 2008
    
    
    9.27
    %
    
    
    9.26
    %
    
    
    8.26
    %
    
    
    9.13
    %
    
    
    10.08
    %June 30, 2007
    
    
    8.13
    %
    
    
    8.09
    %
    
    
    8.37
    %
    
    
    9.30
    %
    
    
    10.56
    %
 27.




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##### Table of Contents



QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 INTEREST RATE RISK
          28.




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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
    
    $
    249,817
    
    
    $
    9,441
    
    
    $
    28,927
    
    
    $
    73,937
    
    
    $
    362,122Securities
    
    
    
    
    
    
    5
    
    
    
    22,650
    
    
    
    575
    
    
    
    23,230Other (1)
    
    
    19,661
    
    
    
    
    
    
    
    
    
    
    
    3,794
    
    
    
    23,455Total interest-earning assets
    
    
    269,478
    
    
    
    9,446
    
    
    
    51,577
    
    
    
    78,306
    
    
    
    408,807Interest-bearing obligations:NOW, money market, savings, interest checking
    
    
    93,874
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    93,874Time deposits
    
    
    35,749
    
    
    
    57,653
    
    
    
    12,624
    
    
    
    904
    
    
    
    106,930Brokered deposits
    
    
    71,905
    
    
    
    56,526
    
    
    
    
    
    
    
    
    
    
    
    128,431Borrowings
    
    
    20,000
    
    
    
    
    
    
    
    15,000
    
    
    
    1,280
    
    
    
    36,280Total interest-bearing obligations
    
    
    221,528
    
    
    
    114,179
    
    
    
    27,624
    
    
    
    2,184
    
    
    
    365,515Gap
    
    $
    47,950
    
    
    $
    (104,733
    )
    
    $
    23,953
    
    
    $
    76,122
    
    
    $
    43,292Cumulative gap
    
    $
    47,950
    
    
    $
    (56,783
    )
    
    $
    (32,830
    )
    
    $
    43,292
 
 (1)
    
    Includes Federal Home Loan Bank Stock      29.




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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
  30.




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##### Table of Contents



CONTROLS AND PROCEDURES
   31.




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##### Table of Contents

5

OTHER INFORMATION
 
 Item 1. Legal Proceedings
  Shareholders Derivative Litigation
 Damon Trust v. Bittner, et al.
  Damon Trust v. Wipfli
  
 Item 4. Submission of Matters to a Vote of Security Holders
  Director
    
    For
    
    WithheldDennis B. Bittner
    
    
    2,455,097
    
    
    
    38,071Joseph D. Garea
    
    
    2,480,127
    
    
    
    13,041Kelly W. George
    
    
    2,480,076
    
    
    
    13,092L. Brooks Patterson
    
    
    2,453,692
    
    
    
    39,476
 32.




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##### Table of Contents



OTHER INFORMATION
 
 Item 6. Exhibits and Reports on Form 8-K
  Exhibit 3.1
    
    Articles of Incorporation, as amended, incorporated herein by
reference to exhibit 3.1 of the Corporations Quarterly
Report on Form 10-Q for the quarter ended September 30, 1999.Exhibit 3.2
    
    Amended and Restated Bylaws, incorporated herein by reference
to exhibit 3.1 of the Corporations Quarterly Report on Form
10-Q for the quarter ended September 30, 2001.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.
 33.




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##### Table of Contents



MACKINAC FINANCIAL CORPORATION(Registrant)Date: August 14, 2008
    By:
    /s/ Paul D. TobiasPAUL D. TOBIAS,CHAIRMAN AND CHIEF EXECUTIVE OFFICER
(principal executive officer)By:
    /s/ Ernie R. KruegerERNIE R. KRUEGER,EVP / CHIEF FINANCIAL OFFICER
(principal accounting officer) 34.