##### 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 September 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
    
    (I.R.S. Employer Identification No.)incorporation or organization)
 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(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 
September 30, 2010 (Unaudited), December 31, 2009 and
September 30, 2009 (Unaudited)
    
    
    1Condensed Consolidated Statements of Operations  Three and Nine
Months Ended September 30, 2010 (Unaudited) and
September 30, 2009 (Unaudited)
    
    
    2Condensed Consolidated Statements of Changes in Shareholders
Equity  Three and Nine Months Ended September 30, 2010
(Unaudited) and September 30, 2009 (Unaudited)
    
    
    3Condensed Consolidated Statements of Cash Flows 
Nine Months Ended September 30, 2010 (Unaudited) and
September 30, 2009 (Unaudited)
    
    
    4Notes to Condensed Consolidated Financial
Statements (Unaudited)
    
    
    5Item 2.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    17Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    29Item 4.
    
    Controls and Procedures
    
    
    32PART II. OTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    33Item 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
 
 
 September 30,
    
    
    December 31,
    
    
    September 30,2010
    
    
    2009
    
    
    2009(Unaudited)
    
    
    
    
    
    
    (Unaudited)ASSETSCash and due from banks
    
    $
    36,561
    
    
    $
    18,433
    
    
    $
    23,249Federal funds sold
    
    
    12,000
    
    
    
    27,000
    
    
    
    Cash and cash equivalents
    
    
    48,561
    
    
    
    45,433
    
    
    
    23,249Interest-bearing deposits in other financial institutions
    
    
    692
    
    
    
    678
    
    
    
    662Securities available for sale
    
    
    37,450
    
    
    
    46,513
    
    
    
    80,203Federal Home Loan Bank stock
    
    
    3,794
    
    
    
    3,794
    
    
    
    3,794Loans:Commercial
    
    
    295,262
    
    
    
    305,670
    
    
    
    306,590Mortgage
    
    
    82,312
    
    
    
    74,350
    
    
    
    73,116Consumer
    
    
    5,153
    
    
    
    4,290
    
    
    
    4,394Total Loans
    
    
    382,727
    
    
    
    384,310
    
    
    
    384,100Allowance for loan losses
    
    
    (5,437
    )
    
    
    (5,225
    )
    
    
    (4,081
    )Net loans
    
    
    377,290
    
    
    
    379,085
    
    
    
    380,019Premises and equipment
    
    
    9,843
    
    
    
    10,165
    
    
    
    10,281Other real estate held for sale
    
    
    5,758
    
    
    
    5,804
    
    
    
    5,821Other assets
    
    
    15,618
    
    
    
    23,905
    
    
    
    9,151TOTAL ASSETS
    
    $
    499,006
    
    
    $
    515,377
    
    
    $
    513,180LIABILITIES AND SHAREHOLDERS EQUITYLIABILITIES:Deposits:Noninterest bearing deposits
    
    $
    44,402
    
    
    $
    35,878
    
    
    $
    33,254NOW, money market, checking
    
    
    127,828
    
    
    
    95,790
    
    
    
    88,843Savings
    
    
    20,265
    
    
    
    18,207
    
    
    
    18,807CDs<$100,000
    
    
    94,560
    
    
    
    59,953
    
    
    
    59,637CDs>$100,000
    
    
    22,809
    
    
    
    36,385
    
    
    
    25,409Brokered
    
    
    94,660
    
    
    
    175,176
    
    
    
    192,631Total deposits
    
    
    404,524
    
    
    
    421,389
    
    
    
    418,581Borrowings:Federal Home Loan Bank
    
    
    35,000
    
    
    
    35,000
    
    
    
    35,000Other
    
    
    1,069
    
    
    
    1,140
    
    
    
    1,140Total borrowings
    
    
    36,069
    
    
    
    36,140
    
    
    
    36,140Other liabilities
    
    
    2,426
    
    
    
    2,549
    
    
    
    2,693Total liabilities
    
    
    443,019
    
    
    
    460,078
    
    
    
    457,414SHAREHOLDERS EQUITY:Preferred stock  No par value:Authorized 500,000 shares, 11,000 shares issued and outstanding
    
    
    10,658
    
    
    
    10,514
    
    
    
    10,466Common stock and additional paid in capital  No par valueAuthorized  18,000,000 sharesIssued and outstanding  3,419,736 shares
    
    
    43,517
    
    
    
    43,493
    
    
    
    43,485Retained earnings
    
    
    1,131
    
    
    
    199
    
    
    
    378Accumulated other comprehensive income
    
    
    681
    
    
    
    1,093
    
    
    
    1,437Total shareholders equity
    
    
    55,987
    
    
    
    55,299
    
    
    
    55,766TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    499,006
    
    
    $
    515,377
    
    
    $
    513,180
  1.




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Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2010
    
    
    2009
    
    
    2010
    
    
    2009(Unaudited)
    
    
    (Unaudited)INTEREST INCOME:Interest and fees on loans:Taxable
    
    $
    5,300
    
    
    $
    5,106
    
    
    $
    15,718
    
    
    $
    15,212Tax-exempt
    
    
    46
    
    
    
    63
    
    
    
    145
    
    
    
    237Interest on securities:Taxable
    
    
    324
    
    
    
    888
    
    
    
    1,077
    
    
    
    2,020Tax-exempt
    
    
    7
    
    
    
    7
    
    
    
    21
    
    
    
    11Other interest income
    
    
    23
    
    
    
    28
    
    
    
    100
    
    
    
    44Total interest income
    
    
    5,700
    
    
    
    6,092
    
    
    
    17,061
    
    
    
    17,524INTEREST EXPENSE:Deposits
    
    
    1,414
    
    
    
    1,550
    
    
    
    4,309
    
    
    
    4,894Borrowings
    
    
    222
    
    
    
    232
    
    
    
    643
    
    
    
    774Total interest expense
    
    
    1,636
    
    
    
    1,782
    
    
    
    4,952
    
    
    
    5,668Net interest income
    
    
    4,064
    
    
    
    4,310
    
    
    
    12,109
    
    
    
    11,856Provision for loan losses
    
    
    1,000
    
    
    
    700
    
    
    
    4,700
    
    
    
    1,400Net interest income after provision for loan losses
    
    
    3,064
    
    
    
    3,610
    
    
    
    7,409
    
    
    
    10,456OTHER INCOME:Service fees
    
    
    264
    
    
    
    235
    
    
    
    737
    
    
    
    750Net security gains
    
    
    (1
    )
    
    
    644
    
    
    
    215
    
    
    
    644Net gains on sale of loans
    
    
    322
    
    
    
    247
    
    
    
    897
    
    
    
    389Other
    
    
    63
    
    
    
    1,292
    
    
    
    199
    
    
    
    1,465Total other income
    
    
    648
    
    
    
    2,418
    
    
    
    2,048
    
    
    
    3,248OTHER EXPENSE:Salaries and employee benefits
    
    
    1,779
    
    
    
    1,603
    
    
    
    5,281
    
    
    
    4,761Occupancy
    
    
    358
    
    
    
    336
    
    
    
    1,048
    
    
    
    1,069Furniture and equipment
    
    
    202
    
    
    
    193
    
    
    
    594
    
    
    
    604Data processing
    
    
    193
    
    
    
    221
    
    
    
    587
    
    
    
    665Professional service fees
    
    
    168
    
    
    
    161
    
    
    
    502
    
    
    
    458Loan and deposit
    
    
    218
    
    
    
    162
    
    
    
    683
    
    
    
    470Writedown of other real estate owned
    
    
    1
    
    
    
    36
    
    
    
    1,948
    
    
    
    36FDIC insurance assessment
    
    
    222
    
    
    
    203
    
    
    
    665
    
    
    
    668Telephone
    
    
    53
    
    
    
    50
    
    
    
    145
    
    
    
    139Advertising
    
    
    77
    
    
    
    80
    
    
    
    220
    
    
    
    238Other
    
    
    330
    
    
    
    398
    
    
    
    887
    
    
    
    1,044Total other expense
    
    
    3,601
    
    
    
    3,443
    
    
    
    12,560
    
    
    
    10,152Income (loss) before provision for income taxes
    
    
    111
    
    
    
    2,585
    
    
    
    (3,103
    )
    
    
    3,552Provision for (benefit of) income taxes
    
    
    30
    
    
    
    864
    
    
    
    (4,593
    )
    
    
    1,142NET INCOME (LOSS)
    
    
    81
    
    
    
    1,721
    
    
    
    1,490
    
    
    
    2,410Preferred dividend and accretion of discount
    
    
    185
    
    
    
    185
    
    
    
    556
    
    
    
    323NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS
    
    $
    (104
    )
    
    $
    1,536
    
    
    $
    934
    
    
    $
    2,087INCOME (LOSS) PER COMMON SHARE:Basic
    
    $
    (.03
    )
    
    $
    .45
    
    
    $
    .27
    
    
    $
    .61Diluted
    
    $
    (.03
    )
    
    $
    .45
    
    
    $
    .27
    
    
    $
    .61
  2.




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Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2010
    
    
    2009
    
    
    2010
    
    
    2009Balance, beginning of period
    
    $
    56,231
    
    
    $
    53,939
    
    
    $
    55,299
    
    
    $
    41,551Net income (loss) for period
    
    
    81
    
    
    
    1,721
    
    
    
    1,490
    
    
    
    2,410Net unrealized gain (loss) on
securities available for sale
    
    
    (195
    )
    
    
    226
    
    
    
    (412
    )
    
    
    992Total comprehensive income (loss)
    
    
    (114
    )
    
    
    1,947
    
    
    
    1,078
    
    
    
    3,402Dividend on preferred stock
    
    
    (185
    )
    
    
    (185
    )
    
    
    (556
    )
    
    
    (323
    )Stock option compensation
    
    
    7
    
    
    
    17
    
    
    
    22
    
    
    
    52Issuance of preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,382Issuance of common stock warrants
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    618Accretion of preferred stock discount
    
    
    48
    
    
    
    48
    
    
    
    144
    
    
    
    84Balance, end of period
    
    $
    55,987
    
    
    $
    55,766
    
    
    $
    55,987
    
    
    $
    55,766
  3.




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Nine Months EndedSeptember 30,2010
    
    
    2009Cash Flows From Operating Activities:Net income
    
    $
    1,490
    
    
    $
    2,410Adjustments to reconcile net income to
net cash provided by (used in) operating activities:Depreciation and amortization
    
    
    1,238
    
    
    
    1,494Provision for (benefit of) deferred taxes
    
    
    (4,593
    )
    
    
    1,052Provision for loan losses
    
    
    4,700
    
    
    
    1,400(Gain) on sales/calls of securities available for sale
    
    
    (215
    )
    
    
    (644
    )Loss on sales of premises, equipment, and other real estate
    
    
    51
    
    
    
    17Writedown of other real estate
    
    
    1,948
    
    
    
    36Stock option compensation
    
    
    22
    
    
    
    52Change in other assets
    
    
    13,092
    
    
    
    (686
    )Change in other liabilities
    
    
    (123
    )
    
    
    121Net cash provided by operating activities
    
    
    17,610
    
    
    
    5,252Cash Flows From Investing Activities:Net (increase) decrease in loans
    
    
    (7,509
    )
    
    
    (19,212
    )Net (increase) decrease in interest-bearing deposits in other financial institutions
    
    
    (14
    )
    
    
    (80
    )Purchase of securities available for sale
    
    
    (5,000
    )
    
    
    (50,113
    )Proceeds from sales, maturities or calls of securities available for sale
    
    
    13,372
    
    
    
    18,976Capital expenditures
    
    
    (502
    )
    
    
    (540
    )Proceeds from sale of premises, equipment, and other real estate
    
    
    2,663
    
    
    
    81Net cash paid in connection with branch sales
    
    
    
    
    
    
    (28,578
    )Net cash provided by (used in) investing activities
    
    
    3,010
    
    
    
    (79,466
    )Cash Flows From Financing Activities:Net increase (decrease) in deposits
    
    
    (16,865
    )
    
    
    76,744Issuance of Preferred Stock Series A Capital
    
    
    
    
    
    
    11,000Dividend on preferred stock and accretion of discount
    
    
    (556
    )
    
    
    (323
    )Principal payments on borrowings
    
    
    (71
    )
    
    
    (70
    )Net cash provided by (used in) financing activities
    
    
    (17,492
    )
    
    
    87,351Net increase in cash and cash equivalents
    
    
    3,128
    
    
    
    13,137Cash and cash equivalents at beginning of period
    
    
    45,433
    
    
    
    10,112Cash and cash equivalents at end of period
    
    $
    48,561
    
    
    $
    23,249Supplemental Cash Flow Information:Cash paid during the period for:Interest
    
    $
    4,988
    
    
    $
    5,836Income taxes
    
    
    25
    
    
    
    90Noncash 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)
    
    
    4,604
    
    
    
    4,205
  4.




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##### Table of Contents



1.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Basis of Presentation
 The 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 nine-month period ended
September 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 deferred tax
assets and mortgage servicing rights.
 Allowance for Loan Losses
 The 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.
 5.




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##### Table of Contents



1.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 Stock Option Plans
 The 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 PRONOUNCEMENTS
 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 SHARE
 Earnings per share are based upon the weighted average number of shares outstanding. 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 ended
September 30, 2010, since they would decrease the loss per share. The common stock warrants
would be slightly dilutive for the nine month period ended September 30, 2010. Please refer to
the table below for the dilutive impact.
 The following shows the computation of basic and diluted earnings per share for the three and
nine months ended September 30, 2010 and 2009 (dollars in thousands, except per share data):
 Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2010
    
    
    2009
    
    
    2010
    
    
    2009Net income (loss)
    
    $
    81
    
    
    $
    1,721
    
    
    $
    1,490
    
    
    $
    2,410Preferred stock dividends
    
    
    185
    
    
    
    185
    
    
    
    556
    
    
    
    323Net income (loss) available to common shareholders
    
    $
    (104
    )
    
    $
    1,536
    
    
    $
    934
    
    
    $
    2,087Weighted average shares outstanding
    
    
    3,419,736
    
    
    
    3,419,736
    
    
    
    3,419,736
    
    
    
    3,419,736Effect of dilutive stock options and common stock warrants outstanding
    
    
    
    
    
    
    
    
    
    
    68,734
    
    
    
    Diluted weighted average shares outstanding
    
    
    3,419,736
    
    
    
    3,419,736
    
    
    
    3,488,470
    
    
    
    3,419,736Earnings per common share:Basic
    
    $
    (.03
    )
    
    $
    .45
    
    
    $
    .27
    
    
    $
    .61Diluted
    
    $
    (.03
    )
    
    $
    .45
    
    
    $
    .27
    
    
    $
    .61
 6.




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##### Table of Contents



4.
    
    INVESTMENT SECURITIES
 The amortized cost and estimated fair value of investment securities available for sale as of
September 30, 2010, December 31, 2009 and September 30, 2009 are as follows (dollars in
thousands):
 Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Fair ValueSeptember 30, 2010US Agencies
    
    $
    5,000
    
    
    $
    5
    
    
    $
    
    
    
    $
    5,005US Agencies  MBS
    
    
    30,272
    
    
    
    982
    
    
    
    
    
    
    
    31,254Obligations of states and political subdivisions
    
    
    1,147
    
    
    
    48
    
    
    
    (4
    )
    
    
    1,191Total securities available for sale
    
    $
    36,419
    
    
    $
    1,035
    
    
    $
    (4
    )
    
    $
    37,450December 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
    )
    
    $
    46,513September 30, 2009US Agencies  MBS
    
    $
    72,623
    
    
    $
    2,007
    
    
    $
    (67
    )
    
    $
    74,563Obligations of states and political subdivisions
    
    
    1,207
    
    
    
    74
    
    
    
    
    
    
    
    1,281Corporate bonds
    
    
    4,198
    
    
    
    161
    
    
    
    
    
    
    
    4,359Total securities available for sale
    
    $
    78,028
    
    
    $
    2,242
    
    
    $
    (67
    )
    
    $
    80,203
 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 $13.688 million and $14.286 million, respectively, at
September 30, 2010.
 5.
    
    LOANS
 The composition of loans at September 30, 2010, December 31, 2009 and September 30, 2009 is as
follows (dollars in thousands):
 September 30,
    
    
    December 31,
    
    
    September 30,2010
    
    
    2009
    
    
    2009Commercial real estate
    
    $
    199,892
    
    
    $
    208,895
    
    
    $
    211,994Commercial, financial, and agricultural
    
    
    69,652
    
    
    
    72,184
    
    
    
    70,520One to four family residential real estate
    
    
    74,829
    
    
    
    67,232
    
    
    
    66,700Construction:Commercial
    
    
    25,718
    
    
    
    24,591
    
    
    
    24,076Consumer
    
    
    7,483
    
    
    
    7,118
    
    
    
    6,416Consumer
    
    
    5,153
    
    
    
    4,290
    
    
    
    4,394Total loans
    
    $
    382,727
    
    
    $
    384,310
    
    
    $
    384,100
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5.
    
    LOANS (Continued)
 LOANS  Allowance for loan losses
  September 30,
    
    
    December 31,
    
    
    September 30,2010
    
    
    2009
    
    
    2009Balance at beginning of period
    
    $
    5,225
    
    
    $
    4,277
    
    
    $
    4,277Recoveries on loans
    
    
    89
    
    
    
    66
    
    
    
    50Loans charged off
    
    
    (4,577
    )
    
    
    (2,818
    )
    
    
    (1,646
    )Provision for loan losses
    
    
    4,700
    
    
    
    3,700
    
    
    
    1,400Balance at end of period
    
    $
    5,437
    
    
    $
    5,225
    
    
    $
    4,081
 In the first nine months of 2010, net charge off activity was $4.488 million, or 1.17% of
average loans outstanding compared to net charge offs of $1.596 million, or .43% of average
loans, in the first nine months of 2009. In the first nine months of 2010, the Corporation
recorded a provision for loan loss in the amount of $4.700 million compared to $1.400 million in
the first nine months 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.Information regarding impaired loans as of September 30, 2010, December 31, 2009 and September
30, 2009 is as follows (dollars in thousands):
 Valuation ReserveSeptember 30,
    
    
    December 31,
    
    
    September 30,
    
    
    September 30,
    
    
    December 31,
    
    
    September 30,2010
    
    
    2009
    
    
    2009
    
    
    2010
    
    
    2009
    
    
    2009Balances, at period endImpaired loans with specific valuation reserve
    
    $
    6,038
    
    
    $
    11,348
    
    
    $
    6,561
    
    
    $
    1,256
    
    
    $
    2,705
    
    
    $
    1,341Impaired loans with no specific valuation reserve
    
    
    5,209
    
    
    
    3,889
    
    
    
    4,967
    
    
    
    
    
    
    
    
    
    
    
    Total impaired loans
    
    $
    11,247
    
    
    $
    15,237
    
    
    $
    11,528
    
    
    $
    1,256
    
    
    $
    2,705
    
    
    $
    1,341Impaired loans on nonaccrual basis
    
    $
    4,447
    
    
    $
    14,368
    
    
    $
    10,655
    
    
    $
    161
    
    
    $
    2,705
    
    
    $
    1,341Impaired loans on accrual basis
    
    
    6,800
    
    
    
    869
    
    
    
    873
    
    
    
    1,095
    
    
    
    
    
    
    
    Total impaired loans
    
    $
    11,247
    
    
    $
    15,237
    
    
    $
    11,528
    
    
    $
    1,256
    
    
    $
    2,705
    
    
    $
    1,341
 Nine Months
    
    Twelve Months
    
    Nine MonthsEnded
    
    Ended
    
    EndedSeptember 30,
    
    December 31,
    
    September 30,2010
    
    2009
    
    2009Average investment in impaired loans
    
    $
    11,479
    
    
    $
    10,449
    
    
    $
    9,809Interest income recognized during period
    
    
    7
    
    
    
    40
    
    
    
    32Interest income that would have been recognized
on an accrual basis
    
    
    467
    
    
    
    700
    
    
    
    508Cash-basis interest income recognized
    
    
    
    
    
    
    
    
    
    
    
 Additional discussion on impaired loans is presented in the Managements Discussion and
Analysis section of this report.
 8.




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5.
    
    LOANS (Continued)LOANS  Related partiesmBank, the Corporations principal subsidiary (the 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):
 September 30,
    
    
    December 31,
    
    
    September 30,2010
    
    
    2009
    
    
    2009Loans outstanding beginning of period
    
    $
    8,552
    
    
    $
    6,516
    
    
    $
    6,516New loans
    
    
    2,665
    
    
    
    2,160
    
    
    
    2,160Net activity on revolving lines of credit
    
    
    2,055
    
    
    
    1,189
    
    
    
    812Repayment
    
    
    (3,857
    )
    
    
    (1,610
    )
    
    
    (1,205
    )Change in related party interest
    
    
    
    
    
    
    297
    
    
    
    297Loans outstanding end of period
    
    $
    9,415
    
    
    $
    8,552
    
    
    $
    8,580
 There were no loans to related parties classified substandard at September 30, 2010, December
31, 2009 or September 30, 2009. In addition to the outstanding balances above, there were
unused commitments of $.395 million to related parties at September 30, 2010.
 6.
    
    BORROWINGS
 Borrowings consist of the following at September 30, 2010, December
31, 2009 and September 30, 2009 (dollars in thousands):
 September 30,
    
    
    December 31,
    
    
    September 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 .455% to .548%
maturing in January and February 2011
    
    
    20,000
    
    
    
    20,000
    
    
    
    20,000USDA Rural Development, fixed-rate note payable, maturing
August 24, 2024, interest payable at 1%
    
    
    1,069
    
    
    
    1,140
    
    
    
    1,140$
    36,069
    
    
    $
    36,140
    
    
    $
    36,140
 The Federal Home Loan Bank borrowings are collateralized at September 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 $33.571 million; mortgage related and municipal securities
with an amortized cost and estimated fair value of $13.105 million and $13.703 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 September 30, 2010.The USDA Rural Development borrowing is collateralized by loans totaling $.260 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 $.914 million, and guaranteed by the
Corporation.
 9.




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7.
    
    STOCK OPTION PLANS
 A summary of stock option transactions for the nine months ended September 30, 2010 and 2009,
and the year ended December 31, 2009, is as follows:
 September 30,
    
    
    December 31,
    
    
    September 30,2010
    
    
    2009
    
    
    2009Outstanding shares at beginning of year
    
    
    411,057
    
    
    
    446,237
    
    
    
    446,237Granted during the period
    
    
    
    
    
    
    
    
    
    
    Expired during the period
    
    
    (16,985
    )
    
    
    (35,180
    )
    
    
    (35,180
    )Outstanding shares at end of period
    
    
    394,072
    
    
    
    411,057
    
    
    
    411,057Weighted average exercise price per share at end of period
    
    $
    10.98
    
    
    $
    12.03
    
    
    $
    12.03Shares available for grant at end of period
    
    
    0
    
    
    
    24,780
    
    
    
    24,780
 There were no options granted in the first nine months of 2010 and 2009.Following is a summary of the options outstanding and exercisable at September 30, 2010:
 Exercise
    
    
    Number
    
    
    Remaining
    
    
    Weighted AveragePrice
    
    
    Outstanding
    
    
    Exercisable
    
    
    Contractual Life-Years
    
    
    Exercise Price$
    9.16
    
    
    
    5,000
    
    
    
    2,000
    
    
    
    5.2
    
    
    $
    9.16$
    9.75
    
    
    
    257,152
    
    
    
    120,861
    
    
    
    4.2
    
    
    $
    9.75$
    10.65
    
    
    
    50,000
    
    
    
    10,000
    
    
    
    6.2
    
    
    $
    10.65$
    11.50
    
    
    
    40,000
    
    
    
    8,000
    
    
    
    5.0
    
    
    $
    11.50$
    12.00
    
    
    
    40,000
    
    
    
    8,000
    
    
    
    4.7
    
    
    $
    12.00$
    156.00
    
    
    
    1,920
    
    
    
    1,920
    
    
    
    1.1
    
    
    $
    156.00394,072
    
    
    
    150,781
    
    
    
    4.6
    
    
    $
    10.98
 8.
    
    INCOME TAXES
 A 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 $3.5 million deferred
tax benefit related to the utilization of the NOL carryforward. The Corporation, as of
September 30, 2010 had a net operating loss and tax credit carryforwards for tax purposes of
approximately $29.5 million, and $2.1 million, respectively. As of September 30, 2010 the
Corporation had total net deferred tax assets of $12.3 million, with a related valuation
allowance of approximately $2.0 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
additional impairment of this net deferred tax asset.
 10.




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9.
    
    FAIR VALUE MEASUREMENTS
 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, 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 September 30, 2010 and
December 31, 2009 (dollars in thousands):
 September 30, 2010
    
    
    December 31, 2009Carrying
    
    
    Estimated
    
    
    Carrying
    
    
    EstimatedAmount
    
    
    Fair Value
    
    
    Amount
    
    
    Fair ValueFinancial assets:Cash and cash equivalents
    
    $
    48,561
    
    
    $
    48,561
    
    
    $
    45,433
    
    
    $
    45,433Interest bearing deposits
    
    
    692
    
    
    
    692
    
    
    
    678
    
    
    
    678Securities available for sale
    
    
    37,450
    
    
    
    37,450
    
    
    
    46,513
    
    
    
    46,513Federal Home Loan Bank stock
    
    
    3,794
    
    
    
    3,794
    
    
    
    3,794
    
    
    
    3,794Net loans
    
    
    377,290
    
    
    
    378,190
    
    
    
    379,085
    
    
    
    382,352Accrued interest receivable
    
    
    1,175
    
    
    
    1,175
    
    
    
    1,413
    
    
    
    1,413Total financial assets
    
    $
    468,962
    
    
    $
    469,862
    
    
    $
    476,916
    
    
    $
    480,183Financial liabilities:Deposits
    
    $
    404,524
    
    
    $
    405,621
    
    
    $
    421,389
    
    
    $
    421,124Borrowings
    
    
    36,069
    
    
    
    36,177
    
    
    
    36,140
    
    
    
    36,447Accrued interest payable
    
    
    289
    
    
    
    289
    
    
    
    325
    
    
    
    325Total financial liabilties
    
    $
    440,882
    
    
    $
    442,087
    
    
    $
    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.
 11.




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##### Table of Contents



9.
    
    FAIR VALUE MEASUREMENTS (Continued)
 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.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:
 12.




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9.
    
    FAIR VALUE MEASUREMENTS (Continued)
 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 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 September 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 September 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 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
    
    
    Nine Months Ended(dollars in thousands)
    
    September 30, 2010
    
    
    (Level 1)
    
    
    (Level 2)
    
    
    (Level 3)
    
    
    September 30, 2010
    
    
    September 30, 2010AssetsImpaired loans
    
    $
    7,290
    
    
    $
    
    
    
    $
    
    
    
    $
    7,290
    
    
    $
    629
    
    
    $
    1,609Other real estate
owned
    
    
    5,758
    
    
    
    
    
    
    
    
    
    
    
    5,758
    
    
    
    7
    
    
    
    2,001$
    636
    
    
    $
    3,610
 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.
 13.




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9.
    
    FAIR VALUE MEASUREMENTS (Continued)
 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).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 TARP Capital Purchase Program (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 the Corporations annual 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
 14.




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10.
    
    SHAREHOLDERS EQUITY (Continued)
 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.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.A portion of this capital, $4.000 million, was used to maintain a strong capital position of the
Bank. In addition, the remaining 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):
 September 30,
    
    
    December 31,
    
    
    September 30,2010
    
    
    2009
    
    
    2009Commitments to extend credit:Variable rate
    
    $
    24,293
    
    
    $
    24,839
    
    
    $
    37,533Fixed rate
    
    
    16,891
    
    
    
    6,039
    
    
    
    8,653Standby letters of credit  Variable rate
    
    
    1,363
    
    
    
    1,279
    
    
    
    1,231Credit card commitments  Fixed rate
    
    
    2,801
    
    
    
    2,714
    
    
    
    2,638$
    45,348
    
    
    $
    34,871
    
    
    $
    50,055
 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.
 15.




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##### Table of Contents



11.
    
    COMMITMENTS, CONTINGENCIES AND CREDIT RISK (Continued)
 Credit card commitments are commitments on credit cards issued by the Corporations subsidiary
and serviced by other companies. These commitments are unsecured.
 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 September 30, 2010
represents $52.2 million, or 17.68%, compared to $47.0 million, or 15.33%, of the commercial
loan portfolio on September 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.
 16.




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTSOF 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 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; and
    
    An increase in the Corporations FDIC insurance premiums, or the collection of special
assessments by the FDIC.
  17.




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS
(Continued)
  FINANCIAL OVERVIEW
     FINANCIAL CONDITION
 Cash and Cash Equivalents
  Investment Securities
  Loans
  18.




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS
(Continued)
   September 30,
    
    
    Percent of
    
    
    December 31,
    
    
    Percent of
    
    
    September 30,
    
    
    Percent of2010
    
    
    Total
    
    
    2009
    
    
    Total
    
    
    2009
    
    
    TotalCommercial real estate
    
    $
    199,892
    
    
    
    52.23
    %
    
    $
    208,895
    
    
    
    54.36
    %
    
    $
    211,994
    
    
    
    55.19
    %Commercial, financial, and agricultural
    
    
    69,652
    
    
    
    18.20
    
    
    
    72,184
    
    
    
    18.78
    
    
    
    70,520
    
    
    
    18.36One to four family residential real estate
    
    
    74,829
    
    
    
    19.55
    
    
    
    67,232
    
    
    
    17.49
    
    
    
    66,700
    
    
    
    17.37Consumer
    
    
    5,153
    
    
    
    1.35
    
    
    
    4,290
    
    
    
    1.12
    
    
    
    4,394
    
    
    
    1.14Construction:Commercial
    
    
    25,718
    
    
    
    6.72
    
    
    
    24,591
    
    
    
    6.40
    
    
    
    24,076
    
    
    
    6.27Consumer
    
    
    7,483
    
    
    
    1.95
    
    
    
    7,118
    
    
    
    1.85
    
    
    
    6,416
    
    
    
    1.67Total loans
    
    $
    382,727
    
    
    
    100.00
    %
    
    $
    384,310
    
    
    
    100.00
    %
    
    $
    384,100
    
    
    
    100.00
    %
  September 30, 2010
    
    
    December 31, 2009
    
    
    September 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
    
    $
    52,192
    
    
    
    17.68
    %
    
    
    93.22
    %
    
    $
    48,689
    
    
    
    15.93
    %
    
    
    88.05
    %
    
    $
    47,007
    
    
    
    15.33
    %
    
    
    84.29
    %Hospitality and tourism
    
    
    39,998
    
    
    
    13.55
    
    
    
    71.44
    
    
    
    45,315
    
    
    
    14.82
    
    
    
    81.95
    
    
    
    45,867
    
    
    
    14.96
    
    
    
    82.25Commercial construction
    
    
    25,718
    
    
    
    8.71
    
    
    
    45.94
    
    
    
    24,591
    
    
    
    8.04
    
    
    
    44.47
    
    
    
    24,076
    
    
    
    7.85
    
    
    
    43.17Real estate agents and managers
    
    
    19,675
    
    
    
    6.66
    
    
    
    35.14
    
    
    
    24,242
    
    
    
    7.93
    
    
    
    43.84
    
    
    
    23,996
    
    
    
    7.83
    
    
    
    43.03Other
    
    
    157,679
    
    
    
    53.40
    
    
    
    281.64
    
    
    
    162,833
    
    
    
    53.28
    
    
    
    294.46
    
    
    
    165,644
    
    
    
    54.03
    
    
    
    297.03Total Commercial Loans
    
    $
    295,262
    
    
    
    100.00
    %
    
    
    
    
    
    $
    305,670
    
    
    
    100.00
    %
    
    
    
    
    
    $
    306,590
    
    
    
    100.00
    %
   Credit Quality
  19.




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS
(Continued)
    September 30,
    
    
    December 31,
    
    
    September 30,2010
    
    
    2009
    
    
    2009Nonperforming Assets:Nonaccural Loans
    
    $
    4,447
    
    
    $
    14,368
    
    
    $
    10,625Loans past due 90 days or more
    
    
    
    
    
    
    
    
    
    
    Restructured loans
    
    
    6,800
    
    
    
    869
    
    
    
    873Total nonperforming loans
    
    
    11,247
    
    
    
    15,237
    
    
    
    11,528Other real estate owned
    
    
    5,758
    
    
    
    5,804
    
    
    
    5,821Total nonperforming assets
    
    $
    17,005
    
    
    $
    21,041
    
    
    $
    17,349Nonperforming loans as a % of loans
    
    
    2.94
    %
    
    
    3.96
    %
    
    
    3.00
    %Nonperforming loans as a % of assets
    
    
    3.41
    %
    
    
    4.08
    %
    
    
    3.38
    %Reserve for Loan Losses:At period end
    
    $
    5,437
    
    
    $
    5,225
    
    
    $
    4,081As a % of loans
    
    
    1.42
    %
    
    
    1.36
    %
    
    
    1.06
    %As a % of nonperforming loans
    
    
    48.34
    %
    
    
    34.29
    %
    
    
    35.40
    %As a % of nonaccural loans
    
    
    122.26
    %
    
    
    36.37
    %
    
    
    38.30
    %Texas rate*
    
    
    27.68
    %
    
    
    34.77
    %
    
    
    28.99
    %
 
 *
    
    calculated by taking total nonperforming assets divided
by total equity plus reserve for loan losses   At Period EndSeptember 30, 2010
    
    
    December 31, 2009
    
    
    September 30, 2009Total loans, at period end
    
    $
    382,727
    
    
    $
    384,310
    
    
    $
    384,100Average loans for the year
    
    
    384,028
    
    
    
    374,796
    
    
    
    370,952
 For the Period EndedNine Months Ended
    
    
    Twelve Months Ended
    
    
    Nine Months EndedSeptember 30, 2010
    
    
    December 31, 2009
    
    
    September 30, 2009Net charge-offs during the period
    
    $
    4,488
    
    
    $
    2,752
    
    
    $
    1,596Net charge-offs to average loans
    
    
    1.17
    %
    
    
    .73
    %
    
    
    .43
    %Net charge-offs to beginning allowance balance
    
    
    85.89
    %
    
    
    64.34
    %
    
    
    37.32
    %
 20.




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTSOF OPERATIONS
(Continued)
   September 30,
    
    
    December 31,
    
    
    September 30,2010
    
    
    2009
    
    
    2009Commercial, financial and agricultural loans
    
    $
    4,509
    
    
    $
    4,805
    
    
    $
    3,564One to four family residential real estate loans
    
    
    98
    
    
    
    23
    
    
    
    47Consumer loans
    
    
    2
    
    
    
    13
    
    
    
    9Unallocated and general reserves
    
    
    828
    
    
    
    384
    
    
    
    461Totals
    
    $
    5,437
    
    
    $
    5,225
    
    
    $
    4,081
    Nine Months Ended
    
    
    Year EndedSeptember 30, 2010
    
    
    December 31, 2009
    
    
    September 30, 2009Balance at beginning of period
    
    $
    5,804
    
    
    $
    2,189
    
    
    $
    2,189Other real estate transferred from loans due to foreclosure
    
    
    4,604
    
    
    
    4,879
    
    
    
    4,205Reclassification of redemption OREO
    
    
    
    
    
    
    (475
    )
    
    
    (475
    )Other real estate sold/written down
    
    
    (4,597
    )
    
    
    (789
    )
    
    
    (82
    )Loss on sale of other real estate
    
    
    (53
    )
    
    
    
    
    
    
    (16
    )Balance at end of period
    
    $
    5,758
    
    
    $
    5,804
    
    
    $
    5,821
  Deposits
  21.




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
   September 30,
    
    
    
    
    
    
    December 31,
    
    
    
    

    
    
    September 30,2010
    
    
    % of Total
    
    
    2009
    
    
    % of Total
    
    
    2009
    
    
    % of TotalNon-interest-bearing
    
    $
    44,402
    
    
    
    10.98
    %
    
    $
    35,878
    
    
    
    8.51
    %
    
    $
    33,254
    
    
    
    7.94
    %NOW, money market,
checking
    
    
    127,828
    
    
    
    31.60
    
    
    
    95,790
    
    
    
    22.74
    
    
    
    88,843
    
    
    
    21.23Savings
    
    
    20,265
    
    
    
    5.01
    
    
    
    18,207
    
    
    
    4.32
    
    
    
    18,807
    
    
    
    4.49Certificates of Deposit
<$100,000
    
    
    94,560
    
    
    
    23.37
    
    
    
    59,953
    
    
    
    14.23
    
    
    
    59,637
    
    
    
    14.25Total core deposits
    
    
    287,055
    
    
    
    70.96
    
    
    
    209,828
    
    
    
    49.80
    
    
    
    200,541
    
    
    
    47.91Certificates of Deposit
>$100,000
    
    
    22,809
    
    
    
    5.64
    
    
    
    36,385
    
    
    
    8.63
    
    
    
    25,409
    
    
    
    6.07Brokered CDs
    
    
    94,660
    
    
    
    23.40
    
    
    
    175,176
    
    
    
    41.57
    
    
    
    192,631
    
    
    
    46.02Total non-core deposits
    
    
    117,469
    
    
    
    29.04
    
    
    
    211,561
    
    
    
    50.20
    
    
    
    218,040
    
    
    
    52.09Total deposits
    
    $
    404,524
    
    
    
    100.00
    %
    
    $
    421,389
    
    
    
    100.00
    %
    
    $
    418,581
    
    
    
    100.00
    %
 Borrowings
  Shareholders Equity
  RESULTS OF OPERATIONS
 Summary
   Net Interest Income
  22.




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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/September 30,
    
    
    Increase/
    
    
    September 30,
    
    
    September 30,
    
    
    Expense
    
    
    Volume
    
    
    Rate
    
    
    Volume(dollars in thousands)
    
    2010
    
    
    2009
    
    
    (Decrease)
    
    
    2010
    
    
    2009
    
    
    2010
    
    
    2009
    
    
    Variance
    
    
    Variance
    
    
    Variance
    
    
    VarianceLoans (1,2,3)
    
    $
    385,268
    
    
    $
    370,310
    
    
    $
    14,958
    
    
    
    5.53
    %
    
    
    5.57
    %
    
    $
    5,369
    
    
    $
    5,201
    
    
    $
    168
    
    
    $
    210
    
    
    $
    (40
    )
    
    $
    (2
    )Taxable securities
    
    
    33,989
    
    
    
    91,837
    
    
    
    (57,848
    )
    
    
    3.78
    
    
    
    3.84
    
    
    
    324
    
    
    
    888
    
    
    
    (564
    )
    
    
    (559
    )
    
    
    (13
    )
    
    
    8Nontaxable
securities (2)
    
    
    859
    
    
    
    1,226
    
    
    
    (367
    )
    
    
    5.08
    
    
    
    3.56
    
    
    
    11
    
    
    
    11
    
    
    
    
    
    
    
    (3
    )
    
    
    5
    
    
    
    (2
    )Federal funds sold
    
    
    12,000
    
    
    
    
    
    
    
    12,000
    
    
    
    .26
    
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    8Other
interest-earning
assets
    
    
    4,472
    
    
    
    4,434
    
    
    
    38
    
    
    
    1.33
    
    
    
    2.51
    
    
    
    15
    
    
    
    28
    
    
    
    (13
    )
    
    
    
    
    
    
    (13
    )
    
    
    Total earning
assets
    
    
    436,588
    
    
    
    467,807
    
    
    
    (31,219
    )
    
    
    5.20
    
    
    
    5.20
    
    
    
    5,727
    
    
    
    6,128
    
    
    
    (401
    )
    
    
    (352
    )
    
    
    (61
    )
    
    
    12Reserve for loan
losses
    
    
    (6,094
    )
    
    
    (4,231
    )
    
    
    (1,863
    )Cash and due from
banks
    
    
    49,943
    
    
    
    24,233
    
    
    
    25,710Intangible assets
    
    
    
    
    
    
    1
    
    
    
    (1
    )Other assets
    
    
    31,898
    
    
    
    25,877
    
    
    
    6,021Total assets
    
    $
    512,335
    
    
    $
    513,687
    
    
    $
    (1,352
    )NOW and money
market deposits
    
    $
    105,634
    
    
    $
    73,236
    
    
    $
    32,398
    
    
    
    .91
    %
    
    
    .96
    %
    
    $
    241
    
    
    $
    177
    
    
    $
    64
    
    
    $
    78
    
    
    $
    (10
    )
    
    $
    (4
    )Interest checking
    
    
    20,252
    
    
    
    8,853
    
    
    
    11,399
    
    
    
    1.39
    
    
    
    1.88
    
    
    
    71
    
    
    
    42
    
    
    
    29
    
    
    
    54
    
    
    
    (11
    )
    
    
    (14
    )Savings deposits
    
    
    20,557
    
    
    
    21,273
    
    
    
    (716
    )
    
    
    .44
    
    
    
    .73
    
    
    
    23
    
    
    
    39
    
    
    
    (16
    )
    
    
    (1
    )
    
    
    (15
    )
    
    
    CDs <$100,000
    
    
    93,265
    
    
    
    66,291
    
    
    
    26,974
    
    
    
    2.05
    
    
    
    2.61
    
    
    
    481
    
    
    
    436
    
    
    
    45
    
    
    
    177
    
    
    
    (94
    )
    
    
    (38
    )CDs >$100,000
    
    
    23,376
    
    
    
    25,777
    
    
    
    (2,401
    )
    
    
    1.68
    
    
    
    2.31
    
    
    
    99
    
    
    
    150
    
    
    
    (51
    )
    
    
    (14
    )
    
    
    (41
    )
    
    
    4Brokered deposits
    
    
    107,774
    
    
    
    191,471
    
    
    
    (83,697
    )
    
    
    1.84
    
    
    
    1.46
    
    
    
    499
    
    
    
    706
    
    
    
    (207
    )
    
    
    (309
    )
    
    
    181
    
    
    
    (79
    )Borrowings
    
    
    36,115
    
    
    
    36,194
    
    
    
    (79
    )
    
    
    2.44
    
    
    
    2.54
    
    
    
    222
    
    
    
    232
    
    
    
    (10
    )
    
    
    (1
    )
    
    
    (10
    )
    
    
    1Total
interest-bearing
liabilities
    
    
    406,973
    
    
    
    423,095
    
    
    
    (16,122
    )
    
    
    1.59
    
    
    
    1.67
    
    
    
    1,636
    
    
    
    1,782
    
    
    
    (146
    )
    
    
    (16
    )
    
    
    
    
    
    
    (130
    )Demand deposits
    
    
    45,989
    
    
    
    32,201
    
    
    
    13,788Other liabilities
    
    
    2,705
    
    
    
    3,797
    
    
    
    (1,092
    )Shareholders equity
    
    
    56,668
    
    
    
    54,594
    
    
    
    2,074Total liabilities
and shareholders
equity
    
    $
    512,335
    
    
    $
    513,687
    
    
    $
    (1,352
    )Rate spread
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.61
    %
    
    
    3.53
    %Net interest
margin/revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.72
    %
    
    
    3.69
    %
    
    $
    4,091
    
    
    $
    4,346
    
    
    $
    (255
    )
    
    $
    (336
    )
    
    $
    (61
    )
    
    $
    142
 
 (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 Nine Months Ended2010-2009Average Balances
    
    
    Average Rates
    
    
    Interest
    
    
    Income/
    
    
    
    
    
    
    
    
    
    
    Rate/September 30,
    
    
    Increase/
    
    
    September 30,
    
    
    September 30,
    
    
    Expense
    
    
    Volume
    
    
    Rate
    
    
    Volume(dollars in thousands)
    
    2010
    
    
    2009
    
    
    (Decrease)
    
    
    2010
    
    
    2009
    
    
    2010
    
    
    2009
    
    
    Variance
    
    
    Variance
    
    
    Variance
    
    
    VarianceLoans (1,2,3)
    
    $
    384,028
    
    
    $
    370,952
    
    
    $
    13,076
    
    
    
    5.55
    %
    
    
    5.61
    %
    
    $
    15,938
    
    
    $
    15,570
    
    
    $
    368
    
    
    $
    549
    
    
    $
    (175
    )
    
    $
    (6
    )Taxable securities
    
    
    35,546
    
    
    
    72,214
    
    
    
    (36,668
    )
    
    
    4.05
    
    
    
    3.74
    
    
    
    1,077
    
    
    
    2,020
    
    
    
    (943
    )
    
    
    (1,026
    )
    
    
    168
    
    
    
    (85
    )Nontaxable securities (2)
    
    
    849
    
    
    
    838
    
    
    
    11
    
    
    
    5.04
    
    
    
    2.70
    
    
    
    32
    
    
    
    17
    
    
    
    15
    
    
    
    
    
    
    
    15
    
    
    
    Federal funds sold
    
    
    26,619
    
    
    
    
    
    
    
    26,619
    
    
    
    .25
    
    
    
    
    
    
    
    50
    
    
    
    
    
    
    
    50
    
    
    
    
    
    
    
    
    
    
    
    50Other interest-earning assets
    
    
    4,477
    
    
    
    4,400
    
    
    
    77
    
    
    
    1.49
    
    
    
    1.34
    
    
    
    50
    
    
    
    44
    
    
    
    6
    
    
    
    1
    
    
    
    5
    
    
    
    Total earning assets
    
    
    451,519
    
    
    
    448,404
    
    
    
    3,115
    
    
    
    5.08
    
    
    
    5.26
    
    
    
    17,147
    
    
    
    17,651
    
    
    
    (504
    )
    
    
    (476
    )
    
    
    13
    
    
    
    (41
    )Reserve for loan losses
    
    
    (5,446
    )
    
    
    (4,494
    )
    
    
    (952
    )Cash and due from banks
    
    
    30,714
    
    
    
    18,469
    
    
    
    12,245Intangible assets
    
    
    
    
    
    
    17
    
    
    
    (17
    )Other assets
    
    
    31,151
    
    
    
    24,364
    
    
    
    6,787Total assets
    
    $
    507,938
    
    
    $
    486,760
    
    
    $
    21,178NOW and money market deposits
    
    $
    96,866
    
    
    $
    70,214
    
    
    $
    26,652
    
    
    
    1.00
    %
    
    
    .85
    %
    
    $
    722
    
    
    $
    448
    
    
    $
    274
    
    
    $
    170
    
    
    $
    75
    
    
    $
    30Interest checking
    
    
    17,880
    
    
    
    6,380
    
    
    
    11,500
    
    
    
    1.56
    
    
    
    1.93
    
    
    
    209
    
    
    
    92
    
    
    
    117
    
    
    
    166
    
    
    
    (17
    )
    
    
    (32
    )Savings deposits
    
    
    19,676
    
    
    
    20,791
    
    
    
    (1,115
    )
    
    
    .56
    
    
    
    .73
    
    
    
    83
    
    
    
    113
    
    
    
    (30
    )
    
    
    (6
    )
    
    
    (25
    )
    
    
    1CDs <$100,000
    
    
    80,997
    
    
    
    69,838
    
    
    
    11,159
    
    
    
    2.11
    
    
    
    2.87
    
    
    
    1,277
    
    
    
    1,497
    
    
    
    (220
    )
    
    
    239
    
    
    
    (396
    )
    
    
    (63
    )CDs >$100,000
    
    
    27,494
    
    
    
    25,823
    
    
    
    1,671
    
    
    
    1.69
    
    
    
    2.48
    
    
    
    348
    
    
    
    479
    
    
    
    (131
    )
    
    
    31
    
    
    
    (152
    )
    
    
    (10
    )Brokered deposits
    
    
    130,344
    
    
    
    173,600
    
    
    
    (43,256
    )
    
    
    1.71
    
    
    
    1.74
    
    
    
    1,671
    
    
    
    2,265
    
    
    
    (594
    )
    
    
    (564
    )
    
    
    (39
    )
    
    
    9Borrowings
    
    
    36,132
    
    
    
    36,404
    
    
    
    (272
    )
    
    
    2.38
    
    
    
    2.84
    
    
    
    642
    
    
    
    774
    
    
    
    (132
    )
    
    
    (6
    )
    
    
    (127
    )
    
    
    1Total interest-bearing liabilities
    
    
    409,389
    
    
    
    403,050
    
    
    
    6,339
    
    
    
    1.62
    
    
    
    1.88
    
    
    
    4,952
    
    
    
    5,668
    
    
    
    (716
    )
    
    
    30
    
    
    
    (682
    )
    
    
    (64
    )Demand deposits
    
    
    38,818
    
    
    
    31,285
    
    
    
    7,533Other liabilities
    
    
    3,170
    
    
    
    3,624
    
    
    
    (454
    )Shareholders equity
    
    
    56,561
    
    
    
    48,801
    
    
    
    7,760Total liabilities and
shareholders equity
    
    $
    507,938
    
    
    $
    486,760
    
    
    $
    21,178Rate spread
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.46
    %
    
    
    3.38
    %Net interest margin/revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.61
    %
    
    
    3.57
    %
    
    $
    12,195
    
    
    $
    11,983
    
    
    $
    212
    
    
    $
    (506
    )
    
    $
    695
    
    
    $
    23
 
 (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)
    
    Interest income on loans includes fees 23.




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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
    
    
    Nine Months Ended
    
    
    % IncreaseSeptember 30,
    
    
    (Decrease)
    
    
    September 30,
    
    
    (Decrease)2010
    
    
    2009
    
    
    2010-2009
    
    
    2010
    
    
    2009
    
    
    2010-2009Service fees
    
    $
    264
    
    
    $
    235
    
    
    
    12.34
    
    
    $
    737
    
    
    $
    750
    
    
    
    (1.73
    )Net gains on sale of loans
    
    
    322
    
    
    
    247
    
    
    
    30.36
    
    
    
    897
    
    
    
    389
    
    
    
    130.59Net gain on sale of branches
    
    
    
    
    
    
    1,208
    
    
    
    (100.00
    )
    
    
    
    
    
    
    1,208
    
    
    
    (100.00
    )Other noninterest income
    
    
    63
    
    
    
    84
    
    
    
    (25.00
    )
    
    
    199
    
    
    
    257
    
    
    
    (22.57
    )Subtotal
    
    
    649
    
    
    
    1,774
    
    
    
    (63.42
    )
    
    
    1,833
    
    
    
    2,604
    
    
    
    (29.61
    )Net security gain (loss)
    
    
    (1
    )
    
    
    644
    
    
    
    (100.16
    )
    
    
    215
    
    
    
    644
    
    
    
    (66.61
    )Total noninterest income
    
    $
    648
    
    
    $
    2,418
    
    
    
    (73.20
    )
    
    $
    2,048
    
    
    $
    3,248
    
    
    
    (36.95
    )
 24.




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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
    
    
    Nine Months Ended
    
    
    % IncreaseSeptember 30,
    
    
    (Decrease)
    
    
    September 30,
    
    
    (Decrease)2010
    
    
    2009
    
    
    2010-2009
    
    
    2010
    
    
    2009
    
    
    2010-2009Salaries and employee benefits
    
    $
    1,779
    
    
    $
    1,603
    
    
    
    10.98
    
    
    $
    5,281
    
    
    $
    4,761
    
    
    
    10.92Occupancy
    
    
    358
    
    
    
    336
    
    
    
    6.55
    
    
    
    1,048
    
    
    
    1,069
    
    
    
    (1.96
    )Furniture and equipment
    
    
    202
    
    
    
    193
    
    
    
    4.66
    
    
    
    594
    
    
    
    604
    
    
    
    (1.66
    )Data processing
    
    
    193
    
    
    
    221
    
    
    
    (12.67
    )
    
    
    587
    
    
    
    665
    
    
    
    (11.73
    )Professional service fees
    
    
    168
    
    
    
    161
    
    
    
    4.35
    
    
    
    502
    
    
    
    458
    
    
    
    9.61Loan and deposit:FDIC insurance premiums
    
    
    222
    
    
    
    203
    
    
    
    9.36
    
    
    
    665
    
    
    
    668
    
    
    
    (0.45
    )Other loan and deposit
    
    
    219
    
    
    
    198
    
    
    
    10.61
    
    
    
    2,631
    
    
    
    506
    
    
    
    419.96Telephone
    
    
    53
    
    
    
    50
    
    
    
    6.00
    
    
    
    145
    
    
    
    139
    
    
    
    4.32Advertising
    
    
    77
    
    
    
    80
    
    
    
    (3.75
    )
    
    
    220
    
    
    
    238
    
    
    
    (7.56
    )Other
    
    
    330
    
    
    
    398
    
    
    
    (17.09
    )
    
    
    887
    
    
    
    1,044
    
    
    
    (15.04
    )Total noninterest expense
    
    $
    3,601
    
    
    $
    3,443
    
    
    
    4.59
    
    
    $
    12,560
    
    
    $
    10,152
    
    
    
    23.72
 Federal Income Taxes
 Current Federal Tax Provision
  Deferred Tax Benefit
  25.




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
   LIQUIDITY
        26.




---



##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
   CAPITAL AND REGULATORY
   September 30,
    
    
    December 31,
    
    
    September 30,2010
    
    
    2009
    
    
    2009Capital StructureShareholders equity
    
    $
    55,987
    
    
    $
    55,299
    
    
    $
    55,766Total capitalization
    
    $
    55,987
    
    
    $
    55,299
    
    
    $
    55,766Tangible capital
    
    $
    55,987
    
    
    $
    55,299
    
    
    $
    55,766Intangible AssetsCore deposit premium
    
    $
    
    
    
    $
    
    
    
    $
    Other identifiable intangibles
    
    
    
    
    
    
    
    
    
    
    Total intangibles
    
    $
    
    
    
    $
    
    
    
    $
    Regulatory capitalTier 1 capital:Shareholders equity
    
    $
    55,987
    
    
    $
    55,299
    
    
    $
    55,766Net unrealized (gains) losses on
available for sale securities
    
    
    (681
    )
    
    
    (1,093
    )
    
    
    (1,437
    )Less: disallowed deferred tax
asset
    
    
    (9,000
    )
    
    
    (4,800
    )
    
    
    (5,000
    )Less: intangibles
    
    
    
    
    
    
    
    
    
    
    Total Tier 1 capital
    
    $
    46,306
    
    
    $
    49,406
    
    
    $
    49,329Tier 2 Capital:Allowable reserve for loan losses
    
    $
    4,941
    
    
    $
    5,181
    
    
    $
    4,081Qualifying long-term debt
    
    
    
    
    
    
    
    
    
    
    Total Tier 2 capital
    
    
    4,941
    
    
    
    5,181
    
    
    
    4,081Total capital
    
    $
    51,247
    
    
    $
    54,587
    
    
    $
    53,410Risk-adjusted assets
    
    $
    39,780
    
    
    $
    414,440
    
    
    $
    404,883Capital ratios:Tier 1 Capital to average assets
    
    
    9.22
    %
    
    
    9.75
    %
    
    
    9.74
    %Tier 1 Capital to risk weighted
assets
    
    
    11.73
    %
    
    
    11.92
    %
    
    
    12.18
    %Total Capital to risk weighted
assets
    
    
    12.98
    %
    
    
    13.17
    %
    
    
    13.19
    %
 27.




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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:September 30, 2010
    
    
    11.22
    %
    
    
    11.22
    %
    
    
    9.22
    %
    
    
    11.73
    %
    
    
    12.98
    %September 30, 2009
    
    
    10.87
    %
    
    
    10.87
    %
    
    
    9.74
    %
    
    
    12.18
    %
    
    
    13.19
    %The Bank:September 30, 2010
    
    
    10.16
    %
    
    
    10.16
    %
    
    
    8.10
    %
    
    
    10.30
    %
    
    
    11.55
    %September 30, 2009
    
    
    9.46
    %
    
    
    9.46
    %
    
    
    8.32
    %
    
    
    10.40
    %
    
    
    11.40
    %
 28.




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##### Table of Contents



QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 INTEREST RATE RISK
          29.




---



##### 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
    
    $
    276,160
    
    
    $
    13,853
    
    
    $
    24,493
    
    
    $
    68,221
    
    
    $
    382,727Securities
    
    
    548
    
    
    
    22,632
    
    
    
    13,734
    
    
    
    536
    
    
    
    37,450Other (1)
    
    
    12,692
    
    
    
    
    
    
    
    
    
    
    
    3,794
    
    
    
    16,486Total interest-earning assets
    
    
    289,400
    
    
    
    36,485
    
    
    
    38,227
    
    
    
    72,551
    
    
    
    436,663Interest-bearing obligations:NOW, money market, savings,
interest checking
    
    
    148,093
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    148,093Time deposits
    
    
    21,169
    
    
    
    54,370
    
    
    
    41,471
    
    
    
    359
    
    
    
    117,369Brokered CDs
    
    
    21,193
    
    
    
    70,739
    
    
    
    
    
    
    
    2,728
    
    
    
    94,660Borrowings
    
    
    35,000
    
    
    
    
    
    
    
    
    
    
    
    1,069
    
    
    
    36,069Total interest-bearing obligations
    
    
    225,455
    
    
    
    125,109
    
    
    
    41,471
    
    
    
    4,156
    
    
    
    396,191Gap
    
    $
    63,945
    
    
    $
    (88,624
    )
    
    $
    (3,244
    )
    
    $
    68,395
    
    
    $
    40,472Cumulative gap
    
    $
    63,945
    
    
    $
    (24,679
    )
    
    $
    (27,923
    )
    
    $
    40,472
 
 (1)
    
    Includes Federal Home Loan Bank Stock     30.




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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
  31.




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##### Table of Contents



CONTROLS AND PROCEDURES
   Changes in Internal Control Over Financial Reporting
  32.




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##### Table of Contents



OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 6. Exhibits and Reports on Form 8-K
 (a)
    
    Exhibits:
 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: November 15, 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) 34.