##### 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 endedSeptember 30, 2008
 OR
 o
    
    TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from<> to<>
 Commission file number: 0-20167
 MACKINAC FINANCIAL CORPORATION
  MICHIGAN
    
    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
  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, 2008 (Unaudited), December 31, 2007 and
September 30, 2007 (Unaudited)
    
    
    1Condensed Consolidated Statements of Operations  Three and Nine
Months Ended September 30, 2008 (Unaudited) and
September 30, 2007 (Unaudited)
    
    
    2Condensed Consolidated Statements of Changes in Shareholders
Equity  Three and Nine Months Ended September 30, 2008
(Unaudited) and September 30, 2007 (Unaudited)
    
    
    3Condensed Consolidated Statements of Cash Flows -
Nine Months Ended September 30, 2008 (Unaudited) and
September 30, 2007 (Unaudited)
    
    
    4Notes to Condensed Consolidated Financial
Statements (Unaudited)
    
    
    5Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 4. Controls and Procedures
    
    
    31PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    32Item 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,(Dollars in thousands)
    
    2008
    
    
    2007
    
    
    2007(unaudited)
    
    
    
    
    
    
    (unaudited)ASSETSCash and due from banks
    
    $
    8,217
    
    
    $
    6,196
    
    
    $
    7,364Federal funds sold
    
    
    4,422
    
    
    
    166
    
    
    
    947Cash and cash equivalents
    
    
    12,639
    
    
    
    6,362
    
    
    
    8,311Interest-bearing deposits in other financial institutions
    
    
    382
    
    
    
    1,810
    
    
    
    6,995Securities available for sale
    
    
    42,781
    
    
    
    21,597
    
    
    
    17,973Federal Home Loan Bank stock
    
    
    3,794
    
    
    
    3,794
    
    
    
    3,794Loans:Commercial
    
    
    290,406
    
    
    
    288,839
    
    
    
    279,670Mortgage
    
    
    67,576
    
    
    
    62,703
    
    
    
    60,972Installment
    
    
    3,539
    
    
    
    3,537
    
    
    
    3,507Total Loans
    
    
    361,521
    
    
    
    355,079
    
    
    
    344,149Allowance for loan losses
    
    
    (3,385
    )
    
    
    (4,146
    )
    
    
    (5,022
    )Net loans
    
    
    358,136
    
    
    
    350,933
    
    
    
    339,127Premises and equipment
    
    
    11,360
    
    
    
    11,609
    
    
    
    12,733Other real estate held for sale
    
    
    1,751
    
    
    
    1,226
    
    
    
    451Other assets
    
    
    10,110
    
    
    
    11,549
    
    
    
    11,829TOTAL ASSETS
    
    $
    440,953
    
    
    $
    408,880
    
    
    $
    401,213LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Non-interest-bearing deposits
    
    $
    34,858
    
    
    $
    25,557
    
    
    $
    28,325Interest-bearing deposits:NOW, Money Market, Checking
    
    
    80,185
    
    
    
    81,160
    
    
    
    87,262Savings
    
    
    18,957
    
    
    
    12,485
    
    
    
    12,831CDs<$100,000
    
    
    74,940
    
    
    
    80,607
    
    
    
    90,220CDs>$100,000
    
    
    30,220
    
    
    
    22,355
    
    
    
    24,432Brokered
    
    
    121,534
    
    
    
    98,663
    
    
    
    78,301Total deposits
    
    
    360,694
    
    
    
    320,827
    
    
    
    321,371Borrowings:Federal funds purchased
    
    
    
    
    
    
    7,710
    
    
    
    Short-term
    
    
    
    
    
    
    1,959
    
    
    
    Long-term
    
    
    36,210
    
    
    
    36,280
    
    
    
    38,239Total borrowings
    
    
    36,210
    
    
    
    45,949
    
    
    
    38,239Other liabilities
    
    
    2,622
    
    
    
    2,783
    
    
    
    2,906Total liabilities
    
    
    399,526
    
    
    
    369,559
    
    
    
    362,516Shareholders equity:Preferred stock  No par value:Authorized 500,000 shares, no shares outstandingCommon stock and additional paid in capital  No par value
Authorized - 18,000,000 sharesIssued and outstanding  3,419,736; 3,428,695;
and 3,428,695 shares, respectively
    
    
    42,794
    
    
    
    42,843
    
    
    
    42,810Accumulated deficit
    
    
    (1,456
    )
    
    
    (3,582
    )
    
    
    (4,107
    )Accumulated other comprehensive income (loss)
    
    
    89
    
    
    
    60
    
    
    
    (6
    )Total shareholders equity
    
    
    41,427
    
    
    
    39,321
    
    
    
    38,697TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    440,953
    
    
    $
    408,880
    
    
    $
    401,213
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Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(unaudited)
    
    
    (unaudited)INTEREST INCOME:Interest and fees on loans:Taxable
    
    $
    5,537
    
    
    $
    6,929
    
    
    $
    17,241
    
    
    $
    19,610Tax-exempt
    
    
    100
    
    
    
    118
    
    
    
    310
    
    
    
    432Interest on securities:Taxable
    
    
    303
    
    
    
    263
    
    
    
    840
    
    
    
    857Tax-exempt
    
    
    1
    
    
    
    
    
    
    
    4
    
    
    
    Other interest income
    
    
    87
    
    
    
    209
    
    
    
    257
    
    
    
    575Total interest income
    
    
    6,028
    
    
    
    7,519
    
    
    
    18,652
    
    
    
    21,474INTEREST EXPENSE:Deposits
    
    
    2,308
    
    
    
    3,443
    
    
    
    7,924
    
    
    
    9,932Borrowings
    
    
    349
    
    
    
    516
    
    
    
    1,194
    
    
    
    1,535Total interest expense
    
    
    2,657
    
    
    
    3,959
    
    
    
    9,118
    
    
    
    11,467Net interest income
    
    
    3,371
    
    
    
    3,560
    
    
    
    9,534
    
    
    
    10,007Provision for loan losses
    
    
    450
    
    
    
    400
    
    
    
    1,200
    
    
    
    400Net interest income after provision for loan
losses
    
    
    2,921
    
    
    
    3,160
    
    
    
    8,334
    
    
    
    9,607OTHER INCOME:Service fees
    
    
    229
    
    
    
    169
    
    
    
    597
    
    
    
    515Net security gains
    
    
    (1
    )
    
    
    
    
    
    
    64
    
    
    
    Net gains on sale of secondary market loans
    
    
    16
    
    
    
    165
    
    
    
    113
    
    
    
    364Proceeds from settlement of lawsuit
    
    
    
    
    
    
    
    
    
    
    3,475
    
    
    
    470Other
    
    
    44
    
    
    
    62
    
    
    
    96
    
    
    
    302Total other income
    
    
    288
    
    
    
    396
    
    
    
    4,345
    
    
    
    1,651OTHER EXPENSE:Salaries and employee benefits
    
    
    1,534
    
    
    
    1,695
    
    
    
    5,416
    
    
    
    5,106Occupancy
    
    
    336
    
    
    
    322
    
    
    
    1,039
    
    
    
    983Furniture and equipment
    
    
    202
    
    
    
    178
    
    
    
    570
    
    
    
    501Data processing
    
    
    212
    
    
    
    196
    
    
    
    649
    
    
    
    577Professional service fees
    
    
    120
    
    
    
    78
    
    
    
    352
    
    
    
    403Loan and deposit
    
    
    176
    
    
    
    63
    
    
    
    430
    
    
    
    214Telephone
    
    
    41
    
    
    
    68
    
    
    
    125
    
    
    
    185Advertising
    
    
    93
    
    
    
    97
    
    
    
    213
    
    
    
    280Other
    
    
    221
    
    
    
    304
    
    
    
    803
    
    
    
    873Total other expenses
    
    
    2,935
    
    
    
    3,001
    
    
    
    9,597
    
    
    
    9,122Income before income taxes
    
    
    274
    
    
    
    555
    
    
    
    3,082
    
    
    
    2,136Provision for (benefit of) income taxes
    
    
    58
    
    
    
    (7,500
    )
    
    
    958
    
    
    
    (7,500
    )NET INCOME
    
    $
    216
    
    
    $
    8,055
    
    
    $
    2,124
    
    
    $
    9,636INCOME PER COMMON SHARE:Basic
    
    $
    .06
    
    
    $
    2.35
    
    
    $
    .62
    
    
    $
    2.81Diluted
    
    $
    .06
    
    
    $
    2.35
    
    
    $
    .62
    
    
    $
    2.81
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Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Balance, beginning of period
    
    $
    40,975
    
    
    $
    30,485
    
    
    $
    39,321
    
    
    $
    28,790Net income for period
    
    
    216
    
    
    
    8,055
    
    
    
    2,124
    
    
    
    9,636Stock option compensation
    
    
    21
    
    
    
    30
    
    
    
    63
    
    
    
    90Net unrealized gain on securities available for sale
    
    
    215
    
    
    
    127
    
    
    
    29
    
    
    
    181Total comprehensive income
    
    
    452
    
    
    
    8,212
    
    
    
    2,216
    
    
    
    9,907Repurchase of common stock - 8,959 oddlot shares
    
    
    
    
    
    
    
    
    
    
    (110
    )
    
    
    Balance, end of period
    
    $
    41,427
    
    
    $
    38,697
    
    
    $
    41,427
    
    
    $
    38,697
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Nine Months EndedSeptember 30,2008
    
    
    2007Cash Flows From Operating Activities:Net income
    
    $
    2,124
    
    
    $
    9,636Adjustments to reconcile net income to
net cash provided by (used in) operating activities:Depreciation and amortization
    
    
    917
    
    
    
    547Provision for loan losses
    
    
    1,200
    
    
    
    400Provision for deferred income taxes
    
    
    
    
    
    
    (7,500
    )(Gain) on sales/calls of securities available for sale
    
    
    (64
    )
    
    
    (Gain) on sales of premises, equipment, and other real estate
    
    
    (35
    )
    
    
    (12
    )Writedown of other real estate
    
    
    936
    
    
    
    40Stock option compensation
    
    
    63
    
    
    
    90Change in other assets
    
    
    396
    
    
    
    221Change in other liabilities
    
    
    797
    
    
    
    (368
    )Net cash provided by operating activities
    
    
    6,334
    
    
    
    3,054Cash Flows From Investing Activities:Net (increase) in loans
    
    
    (11,144
    )
    
    
    (22,435
    )Net (increase) decrease in interest-bearing deposits in other financial
institutions
    
    
    1,428
    
    
    
    (6,139
    )Purchase of securities available for sale
    
    
    (45,699
    )
    
    
    (18,558
    )Proceeds from maturities, calls or paydowns of securities available for sale
    
    
    24,542
    
    
    
    33,715Capital expenditures
    
    
    (519
    )
    
    
    (1,231
    )Proceeds from sale of premises, equipment, and other real estate
    
    
    1,317
    
    
    
    317Net cash (used in) investing activities
    
    
    (30,075
    )
    
    
    (14,331
    )Cash Flows From Financing Activities:Net increase in deposits
    
    
    39,867
    
    
    
    8,950Net increase (decrease) in federal funds purchased
    
    
    (7,710
    )
    
    
    Net increase (decrease) in lines of credit
    
    
    (1,959
    )
    
    
    Principal payments on borrowings
    
    
    (70
    )
    
    
    (68
    )Net (decrease) in repurchase of common stock  oddlot shares
    
    
    (110
    )Net cash provided by financing activities
    
    
    30,018
    
    
    
    8,882Net increase (decrease) in cash and cash equivalents
    
    
    6,277
    
    
    
    (2,395
    )Cash and cash equivalents at beginning of period
    
    
    6,362
    
    
    
    10,706Cash and cash equivalents at end of period
    
    $
    12,639
    
    
    $
    8,311Supplemental Cash Flow Information:Cash paid during the year for:Interest
    
    $
    7,872
    
    
    $
    9,735Income taxes
    
    
    44
    
    
    
    Noncash Investing and Financing Activities:Transfers of foreclosures from loans to other real estate held for sale
(net of adjustments made through the allowance for loan losses)
    
    
    1,804
    
    
    
    443
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1.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESBasis of PresentationThe unaudited condensed consolidated financial statements of Mackinac Financial Corporation (the
Corporation) have been prepared in accordance with generally accepted accounting principles
for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements. In the opinion of
management, all adjustments (consisting of normal recurring accruals) considered necessary for a
fair presentation have been included. Operating results for the nine month period ended
September 30, 2008 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2008. The unaudited consolidated financial statements and footnotes
thereto should be read in conjunction with the audited consolidated financial statements and
footnotes thereto included in the Corporations Annual Report on Form 10-K for the year ended
December 31, 2007.The preparation of financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements, and the reported amounts of revenue and expenses during the
period. Actual results could differ from those estimates.In order to properly reflect some categories of other income and other expenses,
reclassifications of expense and income items have been made to prior period numbers. The
net other income and other expenses were not changed due to these classifications.Allowance for Loan LossesThe allowance for loan losses includes specific allowances related to commercial loans, which
have been judged to be impaired. A loan is impaired when, based on current information, it is
probable that the Corporation will not collect all amounts due in accordance with the
contractual terms of the loan agreement. These specific allowances are based on discounted
cash flows of expected future payments using the loans initial effective interest rate or the
fair value of the collateral if the loan is collateral dependent.The Corporation continues to maintain a general allowance for loan losses for loans not
considered impaired. The allowance for loan losses is maintained at a level which management
believes is adequate to provide for possible loan losses. Management periodically evaluates
the adequacy of the allowance using the Corporations past loan loss experience, known and
inherent risks in the portfolio, composition of the portfolio, current economic conditions, and
other factors. The allowance does not include the effects of expected losses related to future
events or future changes in economic conditions. This evaluation is inherently subjective
since it requires material estimates that may be susceptible to significant change. Loans are
charged against the allowance for loan losses when management believes the 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.Stock Option PlansThe Corporation sponsors three stock option plans. One plan was approved in 2000 and applies to
officers, employees, and nonemployee directors. This plan was amended as a part of the December
2004 stock offering and recapitalization. The amendment, approved by shareholders, increased
the shares available under this plan by 428,587 shares from the original 25,000 (adjusted for
the 1:20 reverse stock split), to a total authorized share balance of 453,587. The other two
plans, one for officers and employees and the other for nonemployee directors, were approved in
1997. A total of 30,000 shares (adjusted for the 1:20 reverse stock split), were
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##### Table of Contents



1.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)made available for grant under these plans. These two 1997 plans expired early in 2007.
Options under all of the plans are granted at the discretion of a committee of the Corporations
Board of Directors. Options to purchase shares of the Corporations stock are granted at a
price equal to the market price of the stock at the date of grant. The committee determines the
vesting of the options when they are granted as established under the plan.The Corporation adopted SFAS No. 123 (Revised) Share Based Payments in the first quarter of
2006. This statement supersedes APB Opinion No. 25 Accounting for Stock Issued to Employees
and its related implementation guidance. Under Opinion No. 25, issuing stock options to
employees generally resulted in recognition of no compensation cost. This adoption resulted in
the recognition of before tax compensation expense in the amount of $63,000 for the nine months
ended September 30, 2008, and $90,000 for the same period in 2007. The expense recorded
recognizes the current period vesting of options outstanding. The per share impact of this
accounting change was $.02 and $.03 in the first nine months of 2008 and 2007, respectively.2.
    
    RECENT ACCOUNTING PRONOUNCEMENTFASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income TaxesIn July 2006, the Financial Accounting Standards Board (FASB) issued this interpretation to
clarify the accounting for uncertainty in tax positions. FIN 48 requires, among other matters,
that the Corporation recognize in its financial statements the impact of a tax position, if that
position is more likely than not of being sustained on an audit, based on the technical merits
of the position. The provisions of FIN 48 were effective as of the beginning of the
Corporations 2007 fiscal year and required any cumulative effect of the change in accounting
principle to be recorded as an adjustment to opening retained earnings. The Corporation did not
record an adjustment to retained earnings upon adoption of FIN 48. In future periods, The
Corporation will, in accordance with FIN 48, evaluate its tax positions to determine whether or
not an adjustment to deferred tax balances and related valuation accounts is warranted.SFAS No. 157, Fair Value MeasurementsSFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally
accepted accounting principles (GAAP), and expands disclosures about fair value measurements.
This statement is to be applied in concert with other accounting pronouncements which require or
allow fair value measurements. This statement does not require any new fair value adjustments.SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159)SFAS No. 159 permits an entity to measure certain financial assets and financial
liabilities at fair value. The Statements objective is to improve financial reporting by
allowing entities to mitigate volatility in reported earnings caused by the measurement of
related assets and liabilities using different attributes, without having to apply complex hedge
accounting provisions. Under SFAS No. 159, entities that elect the fair value option will
report unrealized gains and losses in earnings at each subsequent reporting date. The fair
value option may be elected on an instrument-by-instrument basis, with a few exceptions, as long
as it is applied to the instrument in its entirety. The fair value option election is
irrevocable, unless a new election date occurs. The new Statement establishes presentation and
disclosure requirements to help financial statement users understand the effect of the entitys
election on its earnings but does not eliminate disclosure requirements of other accounting
standards. Assets and liabilities that are measured at fair value must be displayed on the face
of the balance sheet.SFAS No. 157 and No. 159 were effective January 1, 2008. The adoption of SFAS No. 157 and No.
159 by the Corporation did not have any material impact on the consolidated financial
statements.
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##### Table of Contents



2.
    
    RECENT ACCOUNTING PRONOUNCEMENTS (Continued)The Corporation has reviewed other recent accounting pronouncements by the Financial Accounting
Standards Board (FASB), in addition to those noted above and determined that there is no current
impact of these accounting pronouncements in the consolidated financial statements of the
Corporation.3.
    
    EARNINGS PER SHAREEarnings per share are based upon the weighted average number of shares outstanding.Additional shares issued as a result of option exercises would not be dilutive in either period.The following shows the computation of basic and diluted earnings per share for the three and
nine months ended September 30, 2008 and 2007 (dollars in thousands, except per share data):
 Three Months Ended
    
    
    
    
    
    Weighted Average
    
    
    IncomeSeptember 30,
    
    Net Income
    
    
    Number of Shares
    
    
    Per Share2008Income per share  Basic
and diluted
    
    $
    216
    
    
    
    3,419,736
    
    
    $
    .062007Income per share  Basic
and diluted
    
    $
    8,055
    
    
    
    3,428,695
    
    
    $
    2.35
 Nine Months EndedSeptember 30,2008Income per share  Basic
and diluted
    
    $
    2,124
    
    
    
    3,422,777
    
    
    $
    .622007Income per share  Basic
and diluted
    
    $
    9,636
    
    
    
    3,428,695
    
    
    $
    2.81
 4.
    
    INVESTMENT SECURITIESThe amortized cost and estimated fair value of investment securities available for sale as of
September 30, 2008, December 31, 2007 and September 30, 2007 are as follows (dollars in
thousands):
 September 30, 2008
    
    
    December 31, 2007
    
    
    September 30, 2007Amortized
    
    
    Estimated
    
    
    Amortized
    
    
    Estimated
    
    
    Amortized
    
    
    EstimatedCost
    
    
    Fair Value
    
    
    Cost
    
    
    Fair Value
    
    
    Cost
    
    
    Fair ValueUS Agencies  MBS
    
    $
    42,147
    
    
    $
    42,234
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    US Agencies
    
    
    
    
    
    
    
    
    
    
    20,982
    
    
    
    20,969
    
    
    
    17,494
    
    
    
    17,428Obligations of states and political subdivisions
    
    
    499
    
    
    
    547
    
    
    
    556
    
    
    
    628
    
    
    
    485
    
    
    
    545Total securities available for sale
    
    $
    42,646
    
    
    $
    42,781
    
    
    $
    21,538
    
    
    $
    21,597
    
    
    $
    17,979
    
    
    $
    17,973
 The amortized cost and estimated fair value of investment securities pledged to secure FHLB
borrowings and customer relationships were $19.243 million and $19.276 million, respectively,
at September 30, 2008.
 7




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5.
    
    LOANSThe composition of loans at September 30, 2008, December 31, 2007 and September 30, 2007 is as
follows (dollars in thousands):
 September 30,
    
    
    December 31,
    
    
    September 30,2008
    
    
    2007
    
    
    2007Commercial real estate
    
    $
    184,423
    
    
    $
    171,695
    
    
    $
    161,032Commercial, financial, and agricultural
    
    
    75,610
    
    
    
    78,192
    
    
    
    78,822One to four family residential real estate
    
    
    62,895
    
    
    
    57,613
    
    
    
    54,962Construction:Commercial
    
    
    30,373
    
    
    
    38,952
    
    
    
    39,816Consumer
    
    
    4,681
    
    
    
    5,090
    
    
    
    6,010Consumer
    
    
    3,539
    
    
    
    3,537
    
    
    
    3,507Total loans
    
    $
    361,521
    
    
    $
    355,079
    
    
    $
    344,149
 LOANS  Allowance for loan lossesAn analysis of the allowance for loan losses for the nine months ended September 30, 2008, the
year ended December
31, 2007, and the nine months ended September 30, 2007 is as follows: (dollars in thousands):
 September 30,
    
    
    December 31,
    
    
    September 30,2008
    
    
    2007
    
    
    2007Balance at beginning of period
    
    $
    4,146
    
    
    $
    5,006
    
    
    $
    5,006Recoveries on loans
    
    
    117
    
    
    
    50
    
    
    
    39Loans charged off
    
    
    (2,078
    )
    
    
    (1,310
    )
    
    
    (423
    )Provision
    
    
    1,200
    
    
    
    400
    
    
    
    400Balance at end of period
    
    $
    3,385
    
    
    $
    4,146
    
    
    $
    5,022
 In the first nine months of 2008, net charge off activity was $1.961 million, or .55% of
average loans outstanding compared to net charge-offs of $.384 million, or .12% of average
loans, in the first nine months of 2007. In the first nine months of 2008, the Corporation
recorded a provision for loan loss in the amount of $1.2 million, which is discussed in more
detail under Managements Discussion and Analysis.LOANS  Impaired loansNonperforming loans are those which are contractually past due 90 days or more as to interest
or principal payments, on nonaccrual status, or loans, the terms of which have been
renegotiated to provide a reduction or deferral on interest or principal. The interest income
recorded and that which would have been recorded had nonaccrual and renegotiated loans been
current or not troubled was not material to the consolidated financial statements for the nine
months ended September 30, 2008 and 2007.
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##### Table of Contents



5.
    
    LOANS (Continued)Information regarding impaired loans as of September 30, 2008, December 31, 2007 and September
30, 2007 is as follows (dollars in thousands):
 Valuation ReserveSeptember 30,
    
    
    December 31,
    
    
    September 30,
    
    
    September 30,
    
    
    December 31,
    
    
    September 30,2008
    
    
    2007
    
    
    2007
    
    
    2008
    
    
    2007
    
    
    2007(Unaudited)
    
    
    
    
    
    
    (Unaudited)Balances, at period endImpaired loans with specific valuation reserve
    
    $
    3,913
    
    
    $
    3,639
    
    
    $
    2,889
    
    
    $
    951
    
    
    $
    1,320
    
    
    $
    835Impaired loans with no specific valuation
reserve
    
    
    736
    
    
    
    369
    
    
    
    283
    
    
    
    
    
    
    
    
    
    
    
    Total impaired loans
    
    $
    4,649
    
    
    $
    4,008
    
    
    $
    3,172
    
    
    $
    951
    
    
    $
    1,320
    
    
    $
    835Impaired loans on nonaccrual basis
    
    $
    4,649
    
    
    $
    3,298
    
    
    $
    3,136
    
    
    $
    951
    
    
    $
    1,219
    
    
    $
    835Impaired loans on accrual basis
    
    
    
    
    
    
    710
    
    
    
    36
    
    
    
    
    
    
    
    101
    
    
    
    Total impaired loans
    
    $
    4,649
    
    
    $
    4,008
    
    
    $
    3,172
    
    
    $
    951
    
    
    $
    1,320
    
    
    $
    835Average investment in impaired loans
    
    $
    4,732
    
    
    $
    4,135
    
    
    $
    4,018Interest income recognized during impairment
    
    
    50
    
    
    
    129
    
    
    
    71Interest income that would have been recognized
on an accrual basis
    
    
    263
    
    
    
    391
    
    
    
    288Cash-basis interest income recognized
    
    
    50
    
    
    
    84
    
    
    
    65
 The average investment in impaired loans was approximately $4.732 million for the nine months
ended September 30, 2008, $4.135 million for the year ended December 31, 2007, and $4.018
million for the nine months ended September 30, 2007, respectively. Additional discussion on
impaired loans is presented in the Managements Discussion and Analysis section of this
report.LOANS  Related partiesThe Bank, in the ordinary course of business, grants loans to the Corporations executive
officers and directors, including their families and firms in which they are principal owners.Activity in such loans is summarized below (dollars in thousands):
 September 30,
    
    
    December 31,
    
    
    September 30,2008
    
    
    2007
    
    
    2007Loans outstanding beginning of period
    
    $
    1,720
    
    
    $
    1,621
    
    
    $
    1,621New loans
    
    
    115
    
    
    
    
    
    
    
    Net activity on revolving lines of credit
    
    
    2,109
    
    
    
    556
    
    
    
    Repayment
    
    
    (647
    )
    
    
    (457
    )
    
    
    (449
    )Change in related party interest
    
    
    3,758
    
    
    
    
    
    
    
    Loans outstanding end of period
    
    $
    7,055
    
    
    $
    1,720
    
    
    $
    1,172
 There were no loans to related-parties classified substandard at September 30, 2008, December
31, 2007 or September 30, 2007, respectively. In addition to the outstanding balances above,
there were unused commitments of $3.6 million to related parties at September 30, 2008.
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6.
    
    SHORT-TERM BORROWINGSShort-term borrowings consist of the following at September 30, 2008, December 31, 2007, and
September 30, 2007 (dollars in thousands):
 September 30,
    
    
    December 31,
    
    
    September 30,2008
    
    
    2007
    
    
    2007Fed funds purchased
    
    $
    
    
    
    $
    7,710
    
    
    $
    Advance outstanding on line of credit with a correspondent bank, interest payable
at the prime rate, 5.00% as of September 30, 2008, maturing November 30, 2008
    
    
    
    
    
    
    1,959
    
    
    
    $
    
    
    
    $
    9,669
    
    
    $
    
 7.
    
    LONG-TERM BORROWINGSLong-term borrowings consist of the following at September 30, 2008, December 31, 2007 and
September 30, 2007 (dollars in thousands):
 September 30,
    
    
    December 31,
    
    
    September 30,2008
    
    
    2007
    
    
    2007Federal Home Loan Bank fixed rate advances at rates ranging from 4.98% to 5.16%
maturing in 2010
    
    $
    15,000
    
    
    $
    15,000
    
    
    $
    15,000Federal Home Loan Bank variable rate advances at rates of 2.81% maturing in 2011
    
    
    20,000
    
    
    
    20,000
    
    
    
    20,000Advance outstanding on line of credit with a correspondent bank, interest payable
at the prime rate, 5.00% as of September 30, 2008, maturing November 30, 2008
    
    
    
    
    
    
    
    
    
    
    1,959Farmers Home Administration, fixed-rate note payable, maturing August 24, 2024
interest payable at 1%
    
    
    1,210
    
    
    
    1,280
    
    
    
    1,280$
    36,210
    
    
    $
    36,280
    
    
    $
    38,239
 The Federal Home Loan Bank borrowings are collateralized at September 30, 2008 by the following:
a collateral agreement on the Corporations one to four family residential real estate loans
with a book value of approximately $25.251 million; mortgage related and municipal securities
with an amortized cost and estimated fair value of $18.693 million and $18.726 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, 2008.The U.S.D.A. Rural Development borrowing is collateralized by loans totaling $352,000 originated
and held by the Corporations wholly owned subsidiary, First Rural Relending, and an assignment
of a demand deposit account in the amount of $.964 million, and guaranteed by the Corporation.
 10




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8.
    
    STOCK OPTION PLANSA summary of stock option transactions for the nine months ended September 30, 2008 and 2007,
and the year ended December 31, 2007, is as follows: (Historical stock option information has
been adjusted for the 1:20 reverse stock split which occurred in December 2004).
 September 30,
    
    
    December 31,
    
    
    September 30,2008
    
    
    2007
    
    
    2007Outstanding shares at beginning of year
    
    
    446,417
    
    
    
    446,417
    
    
    
    446,417Granted during the period
    
    
    
    
    
    
    
    
    
    
    Expired during the period
    
    
    180
    
    
    
    
    
    
    
    Outstanding shares at end of period
    
    
    446,237
    
    
    
    446,417
    
    
    
    446,417Weighted average exercise price per share at end of period
    
    $
    12.14
    
    
    $
    12.29
    
    
    $
    12.29Shares available for grant at end of period
    
    
    18,488
    
    
    
    18,488
    
    
    
    18,488
 There were no options granted in the first nine months of 2008 and 2007.Following is a summary of the options outstanding and exercisable at September 30, 2008:
 Weighted AverageExercise
    
    Number
    
    
    Remaining
    
    
    Weighted AveragePrice Range
    
    Outstanding
    
    
    Exercisable
    
    
    Contractual Life-Years
    
    
    Exercise Price$9.16
    
    
    12,500
    
    
    
    5,000
    
    
    
    7.21
    
    
    $
    9.16$9.75
    
    
    257,152
    
    
    
    120,861
    
    
    
    6.21
    
    
    
    9.75$10.65
    
    
    72,500
    
    
    
    14,500
    
    
    
    8.21
    
    
    
    10.65$11.50
    
    
    40,000
    
    
    
    8,000
    
    
    
    7.00
    
    
    
    11.50$12.00
    
    
    60,000
    
    
    
    12,000
    
    
    
    6.71
    
    
    
    12.00$156.00 - $240.00
    
    
    3,545
    
    
    
    3,545
    
    
    
    2.48
    
    
    
    186.75$300.00 - $406.60
    
    
    540
    
    
    
    540
    
    
    
    1.21
    
    
    
    333.33446,237
    
    
    
    164,446
    
    
    
    6.66
    
    
    $
    12.14
 9.
    
    INCOME TAXESA valuation allowance is provided against deferred tax assets when it is more likely than not
that some or all of the deferred tax asset will not be realized. At September 30, 2008, the
Corporation evaluated the valuation allowance against the net deferred tax asset which would
require future taxable income in order to be utilized. The Corporation, as of September 30,
2008 had a net operating loss and tax credit carryforwards for tax purposes of approximately
$34.1 million, and $2.1 million, respectively.The Corporation utilized NOL carryforwards to offset taxable income for the first nine months of
2007. In the third quarter of 2007, the Corporation reversed a portion of the valuation
allowance, $7.500 million that pertained to the deferred tax benefit of NOL and tax credit
carryforwards. This valuation adjustment was recorded as a current period income tax benefit.
In 2006, the Corporation recorded a $500,000 tax benefit and utilized additional NOL
carryforwards to offset current taxable income. The recognition of the deferred tax benefit in
2007 and 2006 was in accordance with generally accepted accounting principles, and considered
among other things, the probability of utilizing the NOL and credit carryforwards.
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9.
    
    INCOME TAXES (Continued)The Corporation recorded the future benefits from these carryforwards at such time as it became
more likely than not that they would be utilized prior to expiration. Please refer to further
discussion on income taxes contained in Managements Discussion and Analysis. The net
operating loss carryforwards expire twenty years from the date they originated. These
carryforwards, if not utilized, will begin to expire in the year 2023. A portion of the NOL,
approximately $22 million, and all of the credit carryforwards are subject to the limitations
for utilization as set forth in Section 382 of the Internal Revenue Code. The annual limitation
is $1.4 million for the NOL and the equivalent value of tax credits, which is approximately
$.477 million. These limitations for use were established in conjunction with the
recapitalization of the Corporation in December, 2004.10.
    
    FAS 157  FAIR VALUE MEASUREMENTSThe following tables present information about the Corporations assets and liabilities measured
at fair value on a recurring basis at September 30, 2008, and the valuation techniques used by
the Corporation to determine those fair values.
 Level 1:
    
    In general, fair values determined by Level 1 inputs use quoted prices in active
markets for identical assets or liabilities that the Corporation has the ability to access.Level 2:
    
    Fair values determined by Level 2 inputs use other inputs that are observable,
either directly or indirectly. These Level 2 inputs include quoted prices for similar
assets and liabilities in active markets, and other inputs such as interest rates and yield
curves that are observable at commonly quoted intervals.Level 3:
    
    Level 3 inputs are unobservable inputs, including inputs available in situations
where there is little, if any, market activity for the related asset or liability.
 In instances where inputs used to measure fair value fall into different levels in the above
fair value hierarchy, fair value measurements in their entirety are categorized based on the
lowest level input that is significant to the valuation. The Corporations assessment of the
significance of particular inputs to these fair value measurements requires judgment and
considers factors specific to each asset or liability.Disclosures concerning assets and liabilities measured at fair value are as follows (dollars in
thousands):
 Assets and Liabilities Measured at Fair Value on a Recurring Basis at September 30, 2008
 Quoted Prices in Active
    
    
    Significant Other
    
    
    SignificantMarkets for Identical
    
    
    Observable Inputs
    
    
    Unobservable Inputs
    
    
    Balance atAssets (Level 1)
    
    
    (Level 2)
    
    
    (Level 3)
    
    
    September 30, 2008AssetsInvestment
securities -
available for sale
    
    $
    42,713
    
    
    $
    68
    
    
    $
    
    
    
    $
    42,781LiabilitiesNone
 The Corporation had no Level 3 assets or liabilities on a recurring basis as of December 31,
2007 or September 30, 2008.
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10.
    
    FAS 157  FAIR VALUE MEASUREMENTS (Continued)The Corporation also has assets that under certain conditions are subject to measurement at fair
value on a non-recurring basis. These assets include held to maturity investments and loans.
The Corporation has estimated the fair values of these assets using Level 3 inputs, specifically
discounted cash flow projections.
 Assets Measured at Fair Value on a Nonrecurring Basis
 Quoted Prices
    
    
    Significant
    
    
    Significantin Active Markets
    
    
    Other Observable
    
    
    Unobservable
    
    
    Total Losses forBalance at
    
    
    for Identical Assets
    
    
    Inputs
    
    
    Inputs
    
    
    Three Months Ended
    
    
    Nine Months Ended(dollars in thousands)
    
    September 30, 2008
    
    
    (Level 1)
    
    
    (Level 2)
    
    
    (Level 3)
    
    
    September 30, 2008
    
    
    September 30, 2008AssetsImpaired loans
accounted
for under FAS 114
    
    
    
    
    
    $
    
    
    
    $
    
    
    
    $
    640
    
    
    $
    
    
    
    $
    862$
    
    
    
    $
    862
 The Corporation had no investments subject to fair value measurement on a nonrecurring basis.Impaired loans accounted for under FAS 114 categorized as Level 3 assets consist of
non-homogeneous loans that are considered impaired. The Corporation estimates the fair value of
the loans based on the present value of expected future cash flows using managements best
estimate of key assumptions. These assumptions include future payment ability, timing of
payment streams, and estimated realizable values of available collateral (typically based on
outside appraisals).Other assets, including bank owned life insurance, goodwill, intangible assets and other assets
acquired in business combinations, are also subject to periodic impairment assessments under
other accounting principles generally accepted in the United States of America. These assets
are not considered financial instruments. Effective February 12, 2008, the FASB issued a staff
position, FSP FAS 157-2, which delayed the applicability of FAS 157 to nonfinancial instruments.
Accordingly, these assets have been omitted from the above disclosures.In October 2008, the FASB issued FSP 157-3, Determining the Fair Value of a Financial Asset When
the Market for That Asset Is Not Active.FSP 157-3 provides clarification of the application of
FASB 157 in an inactive market. FSP 157-3 is effective for the Corporations interim financial
statements as of September 30, 2008. This change had no impact on the Corporations disclosure
on fair value measurements.11.
    
    COMMITMENTS, CONTINGENCIES AND CREDIT RISKFinancial Instruments With Off-Balance-Sheet RiskThe Corporation is a party to financial instruments with off-balance-sheet risk in the normal
course of business to meet the financing needs of its customers. These financial instruments
include commitments to extend credit and standby letters of credit. Those instruments involve,
to varying degrees, elements of credit risk in excess of the amount recognized in the
consolidated balance sheets.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.
 13




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11.
    
    COMMITMENTS, CONTINGENCIES AND CREDIT RISK (Continued)These commitments are as follows (dollars in thousands):
 September 30,
    
    
    December 31,
    
    
    September 30,2008
    
    
    2007
    
    
    2007Commitments to extend credit:Variable rate
    
    $
    40,133
    
    
    $
    43,903
    
    
    $
    50,728Fixed rate
    
    
    2,752
    
    
    
    8,055
    
    
    
    10,075Standby letters of credit  Variable rate
    
    
    6,308
    
    
    
    5,930
    
    
    
    5,957Credit card commitments  Fixed rate
    
    
    2,457
    
    
    
    2,414
    
    
    
    2,388$
    51,650
    
    
    $
    60,302
    
    
    $
    69,148
 Commitments to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally have fixed
expiration dates or other termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without being drawn upon, the total commitment amounts do
not necessarily represent future cash requirements. The Corporation evaluates each customers
creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Corporation upon extension of credit, is based on managements credit
evaluation of the party. Collateral held varies but may include accounts receivable; inventory;
property, plant, and equipment; and income-producing commercial properties.Standby letters of credit are conditional commitments issued by the Corporation to guarantee the
performance of a customer to a third party. Those guarantees are primarily issued to support
public and private borrowing arrangements. The credit risk involved in issuing letters of
credit is essentially the same as that involved in extending loan facilities to customers. The
commitments are structured to allow for 100% collateralization on all standby letters of credit.Credit card commitments are commitments on credit cards issued by the Corporations subsidiary
and serviced by other companies. These commitments are unsecured.ContingenciesIn the normal course of business, the Corporation is involved in various legal proceedings. For
expanded discussion on the Corporations legal proceedings, see Part II, Item 1, Legal
Proceedings in this report.Concentration of Credit RiskThe Bank grants commercial, residential, agricultural, and consumer loans throughout Michigan.
The Banks most prominent concentration in the loan portfolio relates to commercial real estate
loans to operators of nonresidential buildings. This concentration at September 30, 2008
represents $41.5 million, or 14.29%, compared to $43.4 million, or 15.53%, of the commercial
loan portfolio on September 30, 2007. The remainder of the commercial loan portfolio is
diversified in such categories as hospitality and tourism, real estate agents and managers, new
car dealers, gaming, petroleum, forestry, agriculture and construction. Due to the diversity of
the Banks locations, the ability of debtors of residential and consumer loans to honor their
obligations is not tied to any particular economic sector.12.
    
    RECENT DEVELOPMENTSThe Corporation has applied for capital under the Troubled Asset Relief Program (TARP) to
strengthen its capital position. For further discussion regarding this, please refer to the
Capital and Regulatory portion of Managements Discussion and Analysis.
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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
 FORWARD-LOOKING STATEMENTS
  
    
    The highly regulated environment in which the Corporation operates could adversely
affect its ability to carry out its strategic plan due to restrictions on new products,
funding opportunities, or new market entrances;
    
    General economic conditions, either nationally or in the state(s) in which the
Corporation does business;
    
    Legislation or regulatory changes which affect the business in which the Corporation is
engaged;
    
    Changes in the interest rate environment which increase or decrease interest rate
margins;
    
    Changes in securities markets with respect to the market value of financial assets and
the level of volatility in certain markets such as foreign exchange;
    
    Significant increases in competition in the banking and financial services industry
resulting from industry consolidation, regulatory changes, and other factors, as well as
action taken by particular competitors;
    
    The ability of borrowers to repay loans;
    
    The effects on liquidity of unusual decreases in deposits;
    
    Changes in consumer spending, borrowing, and saving habits;
    
    Technological changes;
    
    Acquisitions and unanticipated occurrences which delay or reduce the expected benefits
of acquisitions;
    
    Difficulties in hiring and retaining qualified management and banking personnel;
    
    The Corporations ability to increase market share and control expenses;
    
    The effect of compliance with legislation or regulatory changes;
    
    The effect of changes in accounting policies and practices;
    
    The costs and effects of existing and future litigation and of adverse outcomes in such
litigation.
  15




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
  FINANCIAL OVERVIEW
   FINANCIAL CONDITION
 Cash and Cash Equivalents
  Investment Securities
   Loans
  16




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MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
  September 30,
    
    
    Percent of
    
    
    December 31,
    
    
    Percent of
    
    
    September 30,
    
    
    Percent of2008
    
    
    Total
    
    
    2007
    
    
    Total
    
    
    2007
    
    
    TotalCommercial real estate
    
    $
    184,423
    
    
    
    51.01
    %
    
    $
    171,695
    
    
    
    48.35
    %
    
    $
    161,032
    
    
    
    46.79
    %Commercial, financial, and
agricultural
    
    
    75,610
    
    
    
    20.91
    
    
    
    78,192
    
    
    
    22.02
    
    
    
    78,822
    
    
    
    22.90One to four family residential real
estate
    
    
    62,895
    
    
    
    17.40
    
    
    
    57,613
    
    
    
    16.23
    
    
    
    54,962
    
    
    
    15.97Consumer
    
    
    3,539
    
    
    
    .98
    
    
    
    3,537
    
    
    
    1.00
    
    
    
    3,507
    
    
    
    1.02Construction:Commercial
    
    
    30,373
    
    
    
    8.40
    
    
    
    38,952
    
    
    
    10.97
    
    
    
    39,816
    
    
    
    11.57Consumer
    
    
    4,681
    
    
    
    1.30
    
    
    
    5,090
    
    
    
    1.43
    
    
    
    6,010
    
    
    
    1.75Total loans
    
    $
    361,521
    
    
    
    100.00
    %
    
    $
    355,079
    
    
    
    100.00
    %
    
    $
    344,149
    
    
    
    100.00
    %
  September 30, 2008
    
    
    December 31, 2007
    
    
    September 30, 2007Percent of
    
    
    Percent of
    
    
    
    
    
    
    Percent of
    
    
    Percent of
    
    
    
    
    
    
    Percent of
    
    
    Percent ofOutstanding
    
    
    Commercial
    
    
    Shareholders
    
    
    Outstanding
    
    
    Commercial
    
    
    Shareholders
    
    
    Outstanding
    
    
    Commercial
    
    
    ShareholdersBalance
    
    
    Loans
    
    
    Equity
    
    
    Balance
    
    
    Loans
    
    
    Equity
    
    
    Balance
    
    
    Loans
    
    
    EquityR/E  oper of nonresidential bldgs.
    
    $
    41,486
    
    
    
    14.29
    %
    
    
    100.14
    %
    
    $
    41,597
    
    
    
    14.40
    %
    
    
    105.79
    %
    
    $
    43,422
    
    
    
    15.53
    %
    
    
    112.21
    %Hospitality and tourism
    
    
    35,287
    
    
    
    12.15
    
    
    
    85.18
    
    
    
    37,604
    
    
    
    13.02
    
    
    
    95.63
    
    
    
    37,479
    
    
    
    13.40
    
    
    
    96.85Real estate agents & managers
    
    
    29,277
    
    
    
    10.08
    
    
    
    70.67
    
    
    
    29,571
    
    
    
    10.24
    
    
    
    75.20
    
    
    
    25,662
    
    
    
    9.18
    
    
    
    66.32Commercial construction
    
    
    30,373
    
    
    
    10.46
    
    
    
    73.32
    
    
    
    38,952
    
    
    
    13.49
    
    
    
    99.06
    
    
    
    39,816
    
    
    
    14.24
    
    
    
    102.89Other
    
    
    153,983
    
    
    
    53.02
    
    
    
    371.70
    
    
    
    141,115
    
    
    
    48.85
    
    
    
    358.88
    
    
    
    133,291
    
    
    
    47.65
    
    
    
    344.45Total Commercial Loans
    
    $
    290,406
    
    
    
    100.00
    %
    
    
    
    
    
    $
    288,839
    
    
    
    100.00
    %
    
    
    
    
    
    $
    279,670
    
    
    
    100.00
    %
  Credit Quality
  17




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
  September 30,
    
    
    December 31,
    
    
    September 30,2008
    
    
    2007
    
    
    2007Nonperforming Assets :Nonaccrual loans
    
    $
    4,649
    
    
    $
    3,298
    
    
    $
    3,136Loans past due 90 days or more
    
    
    
    
    
    
    710
    
    
    
    36Total nonperforming loans
    
    
    4,649
    
    
    
    4,008
    
    
    
    3,172Other real estate owned
    
    
    1,751
    
    
    
    1,226
    
    
    
    451Total nonperforming assets
    
    $
    6,400
    
    
    $
    5,234
    
    
    $
    3,623Nonperforming loans as a % of
loans
    
    
    1.29
    %
    
    
    1.13
    %
    
    
    .92
    %Nonperforming assets as a %
of assets
    
    
    1.45
    %
    
    
    1.28
    %
    
    
    .90
    %Reserve for Loan Losses:At period end
    
    $
    3,385
    
    
    $
    4,146
    
    
    $
    5,022As a % of loans
    
    
    .94
    %
    
    
    1.24
    %
    
    
    1.46
    %As a % of nonperforming loans
    
    
    72.81
    %
    
    
    103.44
    %
    
    
    158.32
    %As a % of nonaccrual loans
    
    
    72.81
    %
    
    
    125.71
    %
    
    
    160.14
    %
  September 30,
    
    
    December 31,
    
    
    September 30,2007
    
    
    2007
    
    
    2007Total loans, at period end
    
    $
    361,521
    
    
    $
    355,079
    
    
    $
    344,149Average loans for the year
    
    
    359,729
    
    
    
    333,415
    
    
    
    327,810Allowance for loan losses
    
    
    3,385
    
    
    
    4,146
    
    
    
    5,022Allowance to total loans at period end
    
    
    .94
    %
    
    
    1.17
    %
    
    
    1.46
    %Net charge-offs during the period
    
    $
    1,961
    
    
    $
    1,260
    
    
    $
    384Net charge-offs to average loans
    
    
    .55
    %
    
    
    .38
    %
    
    
    .12
    %Net charge-offs to beginning
allowance balance
    
    
    47.30
    %
    
    
    25.17
    %
    
    
    7.67
    %
  18




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
  Estimated
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    EstimatedLiquidation
    
    
    (Deficiency)
    
    
    SBA
    
    
    Reserve
    
    
    Net Surplus/Collateral Type
    
    Balance
    
    
    Value
    
    
    Surplus
    
    
    Guarantee
    
    
    Allocation
    
    
    (Exposure)(a)
    
    
    (b)
    
    
    ( c) = (b) - (a)
    
    
    (d)
    
    
    (e)
    
    
    (f) = (c ) + (d) + (e)Nonaccrual LoansLand Development
    
    $
    2,754
    
    
    $
    2,134
    
    
    $
    (620
    )
    
    $
    
    
    
    $
    620
    
    
    $
    Land Development/Condo
    
    
    1,038
    
    
    
    700
    
    
    
    (338
    )
    
    
    
    
    
    
    350
    
    
    
    12Cabins / Land
    
    
    410
    
    
    
    410
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Non-Farm/Non-Residential
    
    
    229
    
    
    
    234
    
    
    
    5
    
    
    
    116
    
    
    
    
    
    
    
    121Land
    
    
    107
    
    
    
    149
    
    
    
    42
    
    
    
    
    
    
    
    13
    
    
    
    551-4 Family
    
    
    85
    
    
    
    84
    
    
    
    (1
    )
    
    
    
    
    
    
    2
    
    
    
    1Business Equipment
    
    
    26
    
    
    
    10
    
    
    
    (16
    )
    
    
    
    
    
    
    16
    
    
    
    Total nonaccrual loans
    
    
    4,649
    
    
    
    3,721
    
    
    
    (928
    )
    
    
    116
    
    
    
    1,001
    
    
    
    189Other Real EstateLand Development
    
    
    511
    
    
    
    511
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1-4 Family
    
    
    403
    
    
    
    377
    
    
    
    (26
    )
    
    
    
    
    
    
    25
    
    
    
    (1
    )Motel/Hotel
    
    
    337
    
    
    
    337
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cabins/Land
    
    
    260
    
    
    
    240
    
    
    
    (20
    )
    
    
    
    
    
    
    
    
    
    
    (20
    )Non-Farm/Non-Residential
    
    
    163
    
    
    
    142
    
    
    
    (21
    )
    
    
    
    
    
    
    20
    
    
    
    (1
    )Downtown Store Frontage / 2 / 1-4 Family
    
    
    77
    
    
    
    77
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total other real estate owned
    
    
    1,751
    
    
    
    1,684
    
    
    
    (67
    )
    
    
    
    
    
    
    45
    
    
    
    (22
    )Total nonperforming assets
    
    $
    6,400
    
    
    $
    5,405
    
    
    $
    (995
    )
    
    $
    116
    
    
    $
    1,046
    
    
    $
    167
   September 30,
    
    
    December 31,
    
    
    September 30,2008
    
    
    2007
    
    
    2007Commercial, financial and agricultural loans
    
    $
    2,974
    
    
    $
    3,808
    
    
    $
    4,803One to four family residential real estate loans
    
    
    53
    
    
    
    22
    
    
    
    31Consumer loans
    
    
    9
    
    
    
    20
    
    
    
    Unallocated and general reserves
    
    
    349
    
    
    
    296
    
    
    
    188Totals
    
    $
    3,385
    
    
    $
    4,146
    
    
    $
    5,022
  19




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
  Nine Months Ended
    
    
    Year Ended
    
    
    Nine Months EndedSeptember 30, 2008
    
    
    December 31, 2007
    
    
    September 30, 2007Balance at beginning of period
    
    $
    1,226
    
    
    $
    26
    
    
    $
    26Other real estate transferred from loans due to foreclosure
    
    
    2,745
    
    
    
    1,218
    
    
    
    443Other real estate sold/written down
    
    
    (2,220
    )
    
    
    (18
    )
    
    
    (18
    )Balance at end of period
    
    $
    1,751
    
    
    $
    1,226
    
    
    $
    451
  Deposits
   September 30,
    
    
    
    
    
    
    December 31,
    
    
    
    
    
    
    September 30,2008
    
    
    % of Total
    
    
    2007
    
    
    % of Total
    
    
    2007
    
    
    % of TotalNon-interest-bearing
    
    $
    34,858
    
    
    
    9.66
    %
    
    $
    25,557
    
    
    
    7.97
    %
    
    $
    28,325
    
    
    
    8.81
    %NOW, money market,
checking
    
    
    80,185
    
    
    
    22.23
    
    
    
    81,160
    
    
    
    25.30
    
    
    
    87,262
    
    
    
    27.15Savings
    
    
    18,957
    
    
    
    5.26
    
    
    
    12,485
    
    
    
    3.89
    
    
    
    12,831
    
    
    
    3.99Certificates of Deposit
<$100,000
    
    
    74,940
    
    
    
    20.78
    
    
    
    80,607
    
    
    
    25.12
    
    
    
    90,220
    
    
    
    28.07Total core deposits
    
    
    208,940
    
    
    
    57.93
    
    
    
    199,809
    
    
    
    62.28
    
    
    
    218,638
    
    
    
    68.02Certificates of Deposit
>$100,000
    
    
    30,220
    
    
    
    8.38
    
    
    
    22,355
    
    
    
    6.97
    
    
    
    24,432
    
    
    
    7.61Brokered CDs
    
    
    121,534
    
    
    
    33.69
    
    
    
    98,663
    
    
    
    30.75
    
    
    
    78,301
    
    
    
    24.37Total non-core deposits
    
    
    151,754
    
    
    
    42.07
    
    
    
    121,018
    
    
    
    37.72
    
    
    
    102,733
    
    
    
    31.98Total deposits
    
    $
    360,694
    
    
    
    100.00
    %
    
    $
    320,827
    
    
    
    100.00
    %
    
    $
    321,371
    
    
    
    100.00
    %
 Borrowings
  Shareholders Equity
  20




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##### Table of Contents



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




---



##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
   Three Months Ended2008-2007Average Balances
    
    
    Average Rates
    
    
    Interest
    
    
    Income/
    
    
    
    
    
    
    
    
    
    
    Rate/September 30,
    
    
    Increase/
    
    
    September 30,
    
    
    September 30,
    
    
    Expense
    
    
    Volume
    
    
    Rate
    
    
    Volume(dollars in thousands)
    
    2008
    
    
    2007
    
    
    (Decrease)
    
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007
    
    
    Variance
    
    
    Variance
    
    
    Variance
    
    
    VarianceLoans (1,2,3)
    
    $
    358,844
    
    
    $
    340,391
    
    
    $
    18,453
    
    
    
    6.31
    %
    
    
    8.28
    %
    
    $
    5,689
    
    
    $
    7,107
    
    
    $
    (1,418
    )
    
    $
    384
    
    
    $
    (1,691
    )
    
    
    (111
    )Taxable securities
    
    
    24,647
    
    
    
    22,979
    
    
    
    1,668
    
    
    
    4.89
    
    
    
    4.54
    
    
    
    303
    
    
    
    263
    
    
    
    40
    
    
    
    19
    
    
    
    20
    
    
    
    1Nontaxable securities
    
    
    68
    
    
    
    
    
    
    
    68
    
    
    
    11.70
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    2Federal funds sold
    
    
    7,944
    
    
    
    9,339
    
    
    
    (1,395
    )
    
    
    2.00
    
    
    
    5.14
    
    
    
    40
    
    
    
    121
    
    
    
    (81
    )
    
    
    (18
    )
    
    
    (74
    )
    
    
    11Other interest-earning assets
    
    
    4,178
    
    
    
    7,838
    
    
    
    (3,660
    )
    
    
    4.48
    
    
    
    4.45
    
    
    
    47
    
    
    
    88
    
    
    
    (41
    )
    
    
    (41
    )
    
    
    
    
    
    
    Total earning assets
    
    
    395,681
    
    
    
    380,547
    
    
    
    15,134
    
    
    
    6.11
    
    
    
    7.90
    
    
    
    6,081
    
    
    
    7,579
    
    
    
    (1,498
    )
    
    
    344
    
    
    
    (1,745
    )
    
    
    (97
    )Reserve for loan losses
    
    
    (3,500
    )
    
    
    (4,839
    )
    
    
    1,339Cash and due from banks
    
    
    7,443
    
    
    
    7,110
    
    
    
    333Intangible assets
    
    
    74
    
    
    
    152
    
    
    
    (78
    )Other assets
    
    
    24,004
    
    
    
    17,135
    
    
    
    6,869Total assets
    
    $
    423,702
    
    
    $
    400,105
    
    
    $
    23,597NOW and money market deposits
    
    $
    78,645
    
    
    $
    83,186
    
    
    $
    (4,541
    )
    
    
    1.55
    
    
    
    3.60
    
    
    
    307
    
    
    
    755
    
    
    
    (448
    )
    
    
    (41
    )
    
    
    (428
    )
    
    
    21Interest checking
    
    
    2,087
    
    
    
    
    
    
    
    2,087
    
    
    
    3.05
    
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    
    
    
    
    16Savings deposits
    
    
    17,453
    
    
    
    12,900
    
    
    
    4,553
    
    
    
    1.41
    
    
    
    1.54
    
    
    
    62
    
    
    
    50
    
    
    
    12
    
    
    
    18
    
    
    
    (4
    )
    
    
    (2
    )CDs <$100,000
    
    
    76,621
    
    
    
    93,223
    
    
    
    (16,602
    )
    
    
    3.75
    
    
    
    4.92
    
    
    
    723
    
    
    
    1,155
    
    
    
    (432
    )
    
    
    (205
    )
    
    
    (272
    )
    
    
    45CDs >$100,000
    
    
    29,905
    
    
    
    24,590
    
    
    
    5,315
    
    
    
    3.61
    
    
    
    5.15
    
    
    
    271
    
    
    
    319
    
    
    
    (48
    )
    
    
    69
    
    
    
    (95
    )
    
    
    (22
    )Brokered deposits
    
    
    103,012
    
    
    
    85,203
    
    
    
    17,809
    
    
    
    3.59
    
    
    
    5.42
    
    
    
    930
    
    
    
    1,164
    
    
    
    (234
    )
    
    
    243
    
    
    
    (392
    )
    
    
    (85
    )Borrowings
    
    
    37,245
    
    
    
    38,325
    
    
    
    (1,080
    )
    
    
    3.73
    
    
    
    5.34
    
    
    
    349
    
    
    
    516
    
    
    
    (167
    )
    
    
    (15
    )
    
    
    (155
    )
    
    
    3Total interest-bearing liabilities
    
    
    344,968
    
    
    
    337,427
    
    
    
    7,541
    
    
    
    3.07
    
    
    
    4.65
    
    
    
    2,658
    
    
    
    3,959
    
    
    
    (1,301
    )
    
    
    69
    
    
    
    (1,346
    )
    
    
    (24
    )Demand deposits
    
    
    33,654
    
    
    
    28,191
    
    
    
    5,463Other liabilities
    
    
    3,983
    
    
    
    2,303
    
    
    
    1,680Shareholders equity
    
    
    41,097
    
    
    
    32,184
    
    
    
    8,913Total liabilities and
shareholders equity
    
    $
    423,702
    
    
    $
    400,105
    
    
    $
    23,597Rate spread
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.04
    %
    
    
    3.25
    %Net interest margin/revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.44
    %
    
    
    3.77
    %
    
    $
    3,423
    
    
    $
    3,620
    
    
    $
    (197
    )
    
    $
    275
    
    
    $
    (399
    )
    
    $
    (73
    )
 
 (1)
    
    For purposes of these computations, nonaccruing loans are included in the daily average loan amounts outstanding.(2)
    
    The amount of interest income on nontaxable securities and loans has been adjusted to a tax equivalent basis, using a 34% tax rate.(3)
    
    Interest income on loans includes loan fees. Nine Months Ended2008-2007Average Balances
    
    
    Average Rates
    
    
    Interest
    
    
    Income/
    
    
    
    
    
    
    
    
    
    
    Rate/September 30,
    
    
    Increase/
    
    
    September 30,
    
    
    September 30,
    
    
    Expense
    
    
    Volume
    
    
    Rate
    
    
    Volume(dollars in thousands)
    
    2008
    
    
    2007
    
    
    (Decrease)
    
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007
    
    
    Variance
    
    
    Variance
    
    
    Variance
    
    
    VarianceLoans (1,2)
    
    $
    359,729
    
    
    $
    327,810
    
    
    $
    31,919
    
    
    
    6.58
    
    
    
    8.26
    %
    
    $
    17,712
    
    
    $
    20,264
    
    
    $
    (2,552
    )
    
    $
    1,975
    
    
    $
    (4,142
    )
    
    
    (385
    )Taxable securities
    
    
    24,171
    
    
    
    26,111
    
    
    
    (1,940
    )
    
    
    4.63
    
    
    
    4.39
    
    
    
    838
    
    
    
    857
    
    
    
    (19
    )
    
    
    (64
    )
    
    
    47
    
    
    
    (2
    )Nontaxable securities
    
    
    69
    
    
    
    
    
    
    
    69
    
    
    
    11.62
    
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    6
    
    
    
    
    
    
    
    
    
    
    
    6Federal funds sold
    
    
    5,086
    
    
    
    9,183
    
    
    
    (4,097
    )
    
    
    2.44
    
    
    
    5.26
    
    
    
    93
    
    
    
    361
    
    
    
    (268
    )
    
    
    (161
    )
    
    
    (193
    )
    
    
    86Other interest-earning assets
    
    
    4,349
    
    
    
    6,254
    
    
    
    (1,905
    )
    
    
    5.07
    
    
    
    4.57
    
    
    
    165
    
    
    
    214
    
    
    
    (49
    )
    
    
    (65
    )
    
    
    23
    
    
    
    (7
    )Total earning assets
    
    
    393,404
    
    
    
    369,358
    
    
    
    24,046
    
    
    
    6.39
    
    
    
    7.85
    
    
    
    18,814
    
    
    
    21,696
    
    
    
    (2,882
    )
    
    
    1,685
    
    
    
    (4,265
    )
    
    
    (302
    )Reserve for loan losses
    
    
    (3,820
    )
    
    
    (4,936
    )
    
    
    1,116Cash and due from banks
    
    
    6,569
    
    
    
    6,315
    
    
    
    254Intangible assets
    
    
    94
    
    
    
    173
    
    
    
    (79
    )Other assets
    
    
    23,644
    
    
    
    16,687
    
    
    
    6,957Total assets
    
    $
    419,891
    
    
    $
    387,597
    
    
    $
    32,294NOW and money market deposits
    
    $
    80,274
    
    
    $
    75,957
    
    
    $
    4,317
    
    
    
    1.75
    
    
    
    3.53
    
    
    
    1,054
    
    
    
    2,005
    
    
    
    (951
    )
    
    
    114
    
    
    
    (1,010
    )
    
    
    (55
    )Interest checking
    
    
    707
    
    
    
    
    
    
    
    707
    
    
    
    3.02
    
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    16
    
    
    
    
    
    
    
    
    
    
    
    16Savings deposits
    
    
    14,275
    
    
    
    13,155
    
    
    
    1,120
    
    
    
    1.10
    
    
    
    1.61
    
    
    
    118
    
    
    
    158
    
    
    
    (40
    )
    
    
    13
    
    
    
    (49
    )
    
    
    (4
    )CDs <$100,000
    
    
    80,291
    
    
    
    93,898
    
    
    
    (13,607
    )
    
    
    4.22
    
    
    
    4.94
    
    
    
    2,537
    
    
    
    3,467
    
    
    
    (930
    )
    
    
    (503
    )
    
    
    (503
    )
    
    
    76CDs >$100,000
    
    
    26,622
    
    
    
    24,276
    
    
    
    2,346
    
    
    
    4.00
    
    
    
    5.04
    
    
    
    798
    
    
    
    915
    
    
    
    (117
    )
    
    
    89
    
    
    
    (188
    )
    
    
    (18
    )Brokered deposits
    
    
    105,730
    
    
    
    83,094
    
    
    
    22,636
    
    
    
    4.30
    
    
    
    5.45
    
    
    
    3,401
    
    
    
    3,387
    
    
    
    14
    
    
    
    924
    
    
    
    (717
    )
    
    
    (193
    )Borrowings
    
    
    39,677
    
    
    
    38,637
    
    
    
    1,040
    
    
    
    4.02
    
    
    
    5.31
    
    
    
    1,194
    
    
    
    1,535
    
    
    
    (341
    )
    
    
    41
    
    
    
    (374
    )
    
    
    (8
    )Total interest-bearing liabilities
    
    
    347,576
    
    
    
    329,017
    
    
    
    18,559
    
    
    
    3.50
    
    
    
    4.66
    
    
    
    9,118
    
    
    
    11,467
    
    
    
    (2,349
    )
    
    
    678
    
    
    
    (2,841
    )
    
    
    (186
    )Demand deposits
    
    
    28,824
    
    
    
    25,144
    
    
    
    3,680Other liabilities
    
    
    3,159
    
    
    
    2,809
    
    
    
    350Shareholders equity
    
    
    40,332
    
    
    
    30,627
    
    
    
    9,705Total liabilities and
shareholders equity
    
    $
    419,891
    
    
    $
    387,597
    
    
    $
    32,294Rate spread
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2.89
    
    
    
    3.19
    %Net interest margin/revenue
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3.29
    
    
    
    3.70
    %
    
    $
    9,696
    
    
    $
    10,229
    
    
    $
    (533
    )
    
    $
    1,007
    
    
    $
    (1,424
    )
    
    $
    (116
    )
 
 (1)
    
    For purposes of these computations, nonaccruing loans are included in the daily average loan amounts outstanding.(2)
    
    The amount of interest income on nontaxable securities and loans has been adjusted to a tax equivalent basis, using a 34% tax rate.(3)
    
    Interest income on loans includes loan fees.  22




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
   Provision for Loan Losses
  Other Income
    Three Months Ended
    
    
    % Increase
    
    
    Nine Months Ended
    
    
    % IncreaseSeptember 30,
    
    
    (Decrease)
    
    
    September 30,
    
    
    (Decrease)2008
    
    
    2007
    
    
    2008-2007
    
    
    2008
    
    
    2007
    
    
    2008-2007Service fees
    
    $
    229
    
    
    $
    169
    
    
    
    35.5
    
    
    $
    597
    
    
    $
    515
    
    
    
    15.9Net gains on sale of loans
    
    
    16
    
    
    
    165
    
    
    
    (90.3
    )
    
    
    113
    
    
    
    364
    
    
    
    (69.0
    )Proceeds from settlement of lawsuit
    
    
    
    
    
    
    
    
    
    
    N/A
    
    
    
    3,475
    
    
    
    470
    
    
    
    639.4Other
    
    
    44
    
    
    
    62
    
    
    
    (29.0
    )
    
    
    96
    
    
    
    302
    
    
    
    (68.2
    )Subtotal
    
    
    289
    
    
    
    396
    
    
    
    (27.0
    )
    
    
    4,281
    
    
    
    1,651
    
    
    
    159.3Net securities gains
    
    
    (1
    )
    
    
    
    
    
    
    N/A
    
    
    
    64
    
    
    
    
    
    
    
    N/ATotal other income
    
    $
    288
    
    
    $
    396
    
    
    
    (27.3
    )
    
    $
    4,345
    
    
    $
    1,651
    
    
    
    163.2
 Other Expenses
  23




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
     Three Months Ended
    
    
    % Increase
    
    
    Nine Months Ended
    
    
    % IncreaseSeptember 30,
    
    
    (Decrease)
    
    
    September 30,
    
    
    (Decrease)2008
    
    
    2007
    
    
    2007-2006%
    
    
    2008
    
    
    2007
    
    
    2007-2006%Salaries and employee
benefits
    
    $
    1,534
    
    
    $
    1,695
    
    
    
    (9.5
    )
    
    $
    5,416
    
    
    $
    5,106
    
    
    
    6.1Occupancy
    
    
    336
    
    
    
    322
    
    
    
    4.3
    
    
    
    1,039
    
    
    
    983
    
    
    
    5.7Furniture and equipment
    
    
    202
    
    
    
    178
    
    
    
    13.5
    
    
    
    570
    
    
    
    501
    
    
    
    13.8Data processing
    
    
    212
    
    
    
    196
    
    
    
    8.2
    
    
    
    649
    
    
    
    577
    
    
    
    12.5Professional service fees
    
    
    120
    
    
    
    78
    
    
    
    53.8
    
    
    
    352
    
    
    
    403
    
    
    
    (12.7
    )Loan and deposit
    
    
    176
    
    
    
    63
    
    
    
    179.4
    
    
    
    430
    
    
    
    214
    
    
    
    100.9Telephone
    
    
    41
    
    
    
    68
    
    
    
    (39.7
    )
    
    
    125
    
    
    
    185
    
    
    
    (32.4
    )Advertising
    
    
    93
    
    
    
    97
    
    
    
    (4.1
    )
    
    
    213
    
    
    
    280
    
    
    
    (23.9
    )Other
    
    
    221
    
    
    
    304
    
    
    
    (27.3
    )
    
    
    803
    
    
    
    873
    
    
    
    (8.0
    )Total other expense
    
    $
    2,935
    
    
    $
    3,001
    
    
    
    (2.2
    )
    
    $
    9,597
    
    
    $
    9,122
    
    
    
    5.2
 Federal Income Taxes
 Current Federal Tax Provision
  Deferred Tax Benefit
  24




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##### Table of Contents



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




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##### Table of Contents



MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Continued)
   CAPITAL AND REGULATORY
    26




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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 30,2008
    
    
    2007
    
    
    2007Capital StructureShareholders equity
    
    $
    41,427
    
    
    $
    39,321
    
    
    $
    38,697Total capitalization
    
    $
    41,427
    
    
    $
    39,321
    
    
    $
    38,697Tangible capital
    
    $
    41,362
    
    
    $
    39,197
    
    
    $
    38,554Intangible AssetsCore deposit premium
    
    $
    65
    
    
    $
    124
    
    
    $
    143Other identifiable intangibles
    
    
    
    
    
    
    
    
    
    
    Total intangibles
    
    $
    65
    
    
    $
    124
    
    
    $
    143Regulatory capitalTier 1 capital:Shareholders equity
    
    $
    41,427
    
    
    $
    39,321
    
    
    $
    38,697Net unrealized (gains) losses on
available for sale securities
    
    
    (89
    )
    
    
    (60
    )
    
    
    6Less: intangibles
    
    
    (65
    )
    
    
    (124
    )
    
    
    (143
    )Less: disallowed deferred tax asset
    
    
    (6,600
    )
    
    
    (6,990
    )
    
    
    (7,000
    )Total Tier 1 capital
    
    $
    34,673
    
    
    $
    32,147
    
    
    $
    31,560Tier 2 Capital:Allowable reserve for loan losses
    
    $
    3,385
    
    
    $
    4,146
    
    
    $
    4,379Qualifying long-term debt
    
    
    
    
    
    
    
    
    
    
    Total Tier 2 capital
    
    
    3,385
    
    
    
    4,146
    
    
    
    4,379Total capital
    
    $
    38,058
    
    
    $
    36,293
    
    
    $
    35,939Risk-adjusted assets
    
    $
    369,011
    
    
    $
    358,410
    
    
    $
    349,678Capital ratios:Tier 1 Capital to average assets
    
    
    8.31
    %
    
    
    8.05
    %
    
    
    8.03Tier 1 Capital to risk weighted
assets
    
    
    9.40
    %
    
    
    8.97
    %
    
    
    9.03Total Capital to risk weighted
assets
    
    
    10.31
    %
    
    
    10.13
    %
    
    
    10.28
   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, 2008
    
    
    9.40
    %
    
    
    9.38
    %
    
    
    8.31
    %
    
    
    9.40
    %
    
    
    10.31
    %September 30, 2007
    
    
    9.65
    %
    
    
    9.61
    %
    
    
    8.03
    %
    
    
    9.03
    %
    
    
    10.28
    %The Bank:September 30, 2008
    
    
    9.31
    %
    
    
    9.30
    %
    
    
    8.26
    %
    
    
    9.32
    %
    
    
    10.22
    %September 30, 2007
    
    
    10.05
    %
    
    
    10.02
    %
    
    
    8.46
    %
    
    
    9.51
    %
    
    
    10.76
    %
 27




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##### Table of Contents



QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 INTEREST RATE RISK
          28




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##### Table of Contents



QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)
  1-90
    
    
    91 - 365
    
    
    >1-5
    
    
    Over 5Days
    
    
    Days
    
    
    Years
    
    
    Years
    
    
    TotalInterest-earning assets:Loans
    
    $
    253,043
    
    
    $
    9,431
    
    
    $
    28,639
    
    
    $
    70,408
    
    
    $
    361,521Securities
    
    
    
    
    
    
    5
    
    
    
    30,809
    
    
    
    11,967
    
    
    
    42,781Other (1)
    
    
    4,804
    
    
    
    
    
    
    
    
    
    
    
    3,794
    
    
    
    8,598Total interest-earning assets
    
    
    257,847
    
    
    
    9,436
    
    
    
    59,448
    
    
    
    86,169
    
    
    
    412,900Interest-bearing obligations:NOW, money markets, savings and
interest checking
    
    
    99,142
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    99,142Time deposits
    
    
    31,939
    
    
    
    59,150
    
    
    
    13,218
    
    
    
    853
    
    
    
    105,160Brokered deposits
    
    
    66,823
    
    
    
    54,711
    
    
    
    
    
    
    
    
    
    
    
    121,534Borrowings
    
    
    20,000
    
    
    
    
    
    
    
    15,000
    
    
    
    1,210
    
    
    
    36,210Total interest-bearing obligations
    
    
    217,904
    
    
    
    113,861
    
    
    
    28,218
    
    
    
    2,063
    
    
    
    362,046Gap
    
    $
    39,943
    
    
    $
    (104,425
    )
    
    $
    31,230
    
    
    $
    84,106
    
    
    $
    50,854Cumulative gap
    
    $
    39,943
    
    
    $
    (64,482
    )
    
    $
    (33,252
    )
    
    $
    50,854
 
 (1)
    
    Includes Federal Home Loan Bank Stock      29




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##### Table of Contents



QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)
 FOREIGN EXCHANGE RISK
  OFF-BALANCE-SHEET RISK
   IMPACT OF INFLATION AND CHANGING PRICES
  30




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##### Table of Contents



CONTROLS AND PROCEDURES
   31




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##### Table of Contents



OTHER INFORMATION
 
 Item 1. Legal Proceedings
  Shareholders Derivative Litigation
 Damon Trust v. Bittner, et al.
  Damon Trust v. Wipfli
  32




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##### Table of Contents



OTHER INFORMATION
  Item 6. Exhibits and Reports on Form 8-K
  Exhibit 3.1
    
    Articles of Incorporation, as amended, incorporated herein by
reference to exhibit 3.1 of the Corporations Quarterly
Report on Form 10-Q for the quarter ended September 30, 1999.Exhibit 3.2
    
    Amended and Restated Bylaws, incorporated herein by reference
to exhibit 3.1 of the Corporations Quarterly Report on Form
10-Q for the quarter ended September 30, 2001.Exhibit 31.1
    
    Rule 13a-14(a) Certification of Chief Executive Officer.Exhibit 31.2
    
    Rule 13a-14(a) Certification of Chief Financial Officer.Exhibit 32.1
    
    Section 1350 Certification of Chief Executive Officer.Exhibit 32.2
    
    Section 1350 Certification of Chief Financial Officer.
 33




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##### Table of Contents



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