UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549  Form 10-Q  xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  For the quarterly period ended September 30, 2010  OR  [  ]TRANSITIONREPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ________ to _______  Commission File Number 0-25752  FNBH BANCORP, INC. (Exact name of registrant as specified in its charter)   MICHIGAN
     
     38-2869722(State or other jurisdiction of incorporation or organization)
     
     (I.R.S. Employer Identification No.)
  101 East Grand River, Howell, Michigan 48843 (Address of principal executive offices) (Zip Code)  Registrants telephone number, including area code: (517) 546-3150  Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                            YesxNo ̈  Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                     Yes ̈No ̈  Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. Large accelerated filer ̈Accelerated filer ̈Non-accelerated filer ̈Smaller reporting companyx  Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).               Yes ̈Nox  Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date: 3,165,392 shares of the Corporations Common Stock (no par value) were outstanding as of October 31, 2010.


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TABLE OF CONTENTS   PageNumberPart I.   Financial Information (unaudited)Item 1.
     Financial Statements:Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009
     1Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009
     2Consolidated Statements of Shareholders Equity and Comprehensive Income for the nine months ended September 30, 2010 and 2009
     3Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009
     4Notes to Consolidated Financial Statements
     5Item 2.
     Managements Discussion and Analysis of Financial Condition and Results of Operations
     11Item 3.
     Quantitative and Qualitative Disclosures about Market Risk
     26Item 4.
     Controls and Procedures
     26Part II.  Other InformationItem 1A.
     Risk Factors
     26Item 2.
     Unregistered Sales of Equity Securities and Use of Proceeds
     27Item 6.
     Exhibits
     27Signatures
     28


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Important Note About Forward-Looking Statements  This report includes certain forward-looking statements that are not statements of historical fact, such as (but not limited to) statements that include terms such as "will," "may," "should," "believe," "expect," "forecast," "anticipate," "estimate," "project," "intend," "likely," "optimistic" and "plan."  These may be statements about the Corporation's future or projected financial and operating results, plans, projections, objectives, expectations, and intentions, including (but not limited to) statements about the possibility of further regulatory oversight or enforcement action, measures of future economic performance, and forecasts of credit losses or other asset quality trends.  These forward-looking statements express the current viewpoints of the Corporation's management, but by their nature are subject to significant inherent risks and uncertainties.  A number of important factors could cause actual results to differ materially from those referenced in the forward-looking statements.  Those factors include the economic environment, the pace of any recovery in local real estate markets and the Michigan economy in general, the actions of federal regulatory authorities, the failure of assumptions underlying the establishment of and provision made to the allowance for loan losses, competition, products and pricing in business areas in which the Corporation operates, prevailing interest rates, changes in government regulations and policies affecting financial service companies, credit quality and credit risk management, acquisitions, and integration of acquired businesses.  Important factors also include the Corporations ability to raise additional capital and the nature and scope of any additional regulatory oversight or enforcement actions that may be taken by the agencies that regulate the Corporation and its subsidiary bank.  This list of potential factors is not intended to be all-inclusive.  See the risk factors disclosed in Part I  Item A of the Corporation's Annual Report on Form 10-K for the year ended December 31, 2009, as updated by any new or modified risk factors disclosed in Part II  Item 1A of any subsequently filed Quarterly Report on Form 10-Q, for additional known risks the Corporation's management believes could materially affect the results described by forward-looking statements in this report. In addition, the Corporation's results of operations, cash flows, financial position, and prospects could also be materially and adversely affected by additional factors that are not presently known to management, that management currently consider to be immaterial, or that develop after the date of this report.  No assurance can be given that the Corporation's future results will meet expectations. While the Corporation believes the forward-looking statements in this report are reasonable, you should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. The Corporation does not undertake, and expressly disclaims, any obligation to update or alter any statements, whether as a result of new information, future events, or otherwise, except as required by applicable law.


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PART I - FINANCIAL INFORMATION Item 1. Financial Statements **** FNBH Bancorp, Inc.
Consolidated Balance Sheets (Unaudited) September 30,
     
     
     
     December 31,Assets
     
     2010
     
     
     
     2009Cash and due from banks
     $
     38,491,991
     
     
     $
     36,942,636Short term investments
     
     196,119
     
     
     
     101,029Total cash and cash equivalents
     
     38,688,110
     
     
     
     37,043,665Investment securities:Investment securities available for sale, at fair value
     
     22,768,673
     
     
     
     22,705,612FHLBI and FRB stock, at cost
     
     994,950
     
     
     
     994,950Total investment securities
     
     23,763,623
     
     
     
     23,700,562Loans held for investment:Commercial
     
     207,013,589
     
     
     
     235,937,243Consumer
     
     17,498,122
     
     
     
     18,777,849Real estate mortgage
     
     16,931,812
     
     
     
     19,330,658Total loans held for investment
     
     241,443,523
     
     
     
     274,045,750Less allowance for loan losses
     
     (13,015,102
     )
     
     
     (18,665,173
     )Net loans held for investment
     
     228,428,421
     
     
     
     255,380,577Premises and equipment, net
     
     7,793,641
     
     
     
     8,091,463Other real estate owned, held for sale
     
     7,419,480
     
     
     
     3,777,119Facilities held for sale, net
     
     60,453
     
     
     
     60,453Accrued interest and other assets
     
     2,627,596
     
     
     
     4,336,526Total assets
     $
     308,781,324
     
     
     $
     332,390,365Liabilities and Shareholders' EquityLiabilitiesDeposits:Demand (non-interest bearing)
     $
     64,441,400
     
     
     $
     65,643,739NOW
     
     49,798,992
     
     
     
     50,642,881Savings and money market
     
     68,015,049
     
     
     
     72,297,919Time deposits
     
     108,849,275
     
     
     
     121,200,201Brokered certificates of deposit
     
     3,354,121
     
     
     
     5,410,951Total deposits
     
     294,458,837
     
     
     
     315,195,691Other borrowings
     
     -
     
     
     
     413,970Accrued interest, taxes, and other liabilities
     
     2,011,647
     
     
     
     2,404,440Total liabilities
     
     296,470,484
     
     
     
     318,014,101Shareholders' EquityPreferred stock, no par value.  Authorized 30,000 shares; no shares issued and outstanding
     
     -
     
     
     
     -Common stock, no par value. Authorized 7,000,000 shares at September 30, 2010 and December 31, 2009; 3,165,392 shares issued and outstanding at September 30, 2010 and 3,149,850 shares issued and outstanding at December 31, 2009
     
     6,931,360
     
     
     
     6,738,128Retained earnings
     
     4,423,812
     
     
     
     6,641,060Deferred directors' compensation
     
     708,371
     
     
     
     885,919Accumulated other comprehensive income
     
     247,297
     
     
     
     111,157Total shareholders' equity
     
     12,310,840
     
     
     
     14,376,264Total liabilities and shareholders' equity
     $
     308,781,324
     
     
     $
     332,390,365See notes to consolidated financial statements.
  1


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FNBH Bancorp, Inc. Consolidated Statements of Operations (Unaudited) Three months ended
September 30
     
     
     
     Nine months ended
September 302010
     
     
     
     2009
     
     
     
     2010
     
     
     
     2009Interest and dividend income:Interest and fees on loans
     $
     3,220,073
     
     
     $
     3,939,604
     
     
     $
     9,956,366
     
     
     $
     12,393,430Interest and dividends on investment securities:U.S. Treasury, agency securities and CMOs
     
     183,903
     
     
     
     257,366
     
     
     
     590,264
     
     
     
     973,671Obligations of states and political subdivisions
     
     68,063
     
     
     
     97,989
     
     
     
     211,021
     
     
     
     365,467Other securities
     
     3,555
     
     
     
     7,703
     
     
     
     14,364
     
     
     
     23,864Interest on certificates of deposit
     
     -
     
     
     
     46,539
     
     
     
     -
     
     
     
     146,543Interest on short term investments
     
     92
     
     
     
     141
     
     
     
     324
     
     
     
     14,397Total interest and dividend income
     
     3,475,686
     
     
     
     4,349,342
     
     
     
     10,772,339
     
     
     
     13,917,372Interest expense:Interest on deposits
     
     614,012
     
     
     
     1,095,866
     
     
     
     1,981,698
     
     
     
     3,686,125Interest on other borrowings
     
     -
     
     
     
     7,712
     
     
     
     1,174
     
     
     
     57,686Total interest expense
     
     614,012
     
     
     
     1,103,578
     
     
     
     1,982,872
     
     
     
     3,743,811Net interest income
     
     2,861,674
     
     
     
     3,245,764
     
     
     
     8,789,467
     
     
     
     10,173,561Provision for loan losses
     
     1,200,000
     
     
     
     1,750,000
     
     
     
     3,600,000
     
     
     
     14,646,853Net interest income (deficiency) after provision for loan losses
     
     1,661,674
     
     
     
     1,495,764
     
     
     
     5,189,467
     
     
     
     (4,473,292
     )Noninterest income:Service charges and other fee income
     
     728,172
     
     
     
     845,391
     
     
     
     2,283,066
     
     
     
     2,386,409Trust income
     
     57,274
     
     
     
     90,966
     
     
     
     186,664
     
     
     
     258,832Gain on available for sale securities
     
     -
     
     
     
     15,605
     
     
     
     -
     
     
     
     92,109Other
     
     2,496
     
     
     
     2,500
     
     
     
     2,361
     
     
     
     4,618Total noninterest income
     
     787,942
     
     
     
     954,462
     
     
     
     2,472,091
     
     
     
     2,741,968Noninterest expense:Salaries and employee benefits
     
     1,223,452
     
     
     
     1,591,165
     
     
     
     3,929,357
     
     
     
     5,018,516Net occupancy expense
     
     279,557
     
     
     
     264,991
     
     
     
     819,478
     
     
     
     851,959Equipment expense
     
     79,447
     
     
     
     93,154
     
     
     
     253,180
     
     
     
     289,350Professional and service fees
     
     454,647
     
     
     
     532,233
     
     
     
     1,282,352
     
     
     
     1,571,441Printing and supplies
     
     33,290
     
     
     
     44,314
     
     
     
     107,068
     
     
     
     139,219Computer service fees
     
     109,301
     
     
     
     112,012
     
     
     
     343,066
     
     
     
     337,823Amortization expense
     
     64,422
     
     
     
     66,584
     
     
     
     194,750
     
     
     
     201,081Director fees
     
     15,375
     
     
     
     14,400
     
     
     
     48,450
     
     
     
     58,442FDIC assessment fees
     
     358,099
     
     
     
     510,398
     
     
     
     1,074,953
     
     
     
     1,290,293Insurance expense
     
     182,743
     
     
     
     151,727
     
     
     
     526,765
     
     
     
     358,320Loan collection and foreclosed property expenses
     
     139,120
     
     
     
     475,760
     
     
     
     570,500
     
     
     
     759,119Net loss on sale/writedown of OREO and repossessions
     
     81,687
     
     
     
     (131,662
     )
     
     
     254,450
     
     
     
     462,867Other
     
     179,594
     
     
     
     156,355
     
     
     
     544,570
     
     
     
     600,843Total noninterest expense
     
     3,200,734
     
     
     
     3,881,431
     
     
     
     9,948,939
     
     
     
     11,939,273Loss before federal income taxes
     
     (751,118
     )
     
     
     (1,431,205
     )
     
     
     (2,287,381
     )
     
     
     (13,670,597
     )Federal income tax expense (benefit)
     
     (69,359
     )
     
     
     -
     
     
     
     (70,133
     )
     
     
     467,486Net loss
     $
     (681,759
     )
     
     $
     (1,431,205
     )
     
     $
     (2,217,248
     )
     
     $
     (14,138,083
     )Per share statistics:Basic and Diluted EPS
     $
     (0.21
     )
     
     $
     (0.45
     )
     
     $
     (0.69
     )
     
     $
     (4.47
     )Dividends
     $
     -
     
     
     $
     -
     
     
     $
     -
     
     
     $
     -Basic average shares outstanding
     
     3,193,565
     
     
     
     3,175,252
     
     
     
     3,191,644
     
     
     
     3,164,347Diluted average shares outstanding
     
     3,193,565
     
     
     
     3,175,252
     
     
     
     3,191,644
     
     
     
     3,164,347See notes to consolidated financial statements
  2


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FNBH BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity and Comprehensive Income For the Nine Months Ended September 30, 2010 and 2009(Unaudited) Common Stock
     
     
     
     Retained Earnings
     
     
     
     Deferred Directors' Compensation
     
     
     
     Accumulated Other Comprehensive Income (Loss)
     
     
     
     TotalBalances at December 31, 2008
     $
     6,583,158
     
     
     $
     19,643,976
     
     
     $
     902,333
     
     
     $
     395,635
     
     
     $
     27,525,102Cumulative effect of change in accounting principle, adoption of ASC Topic 320, net of tax
     
     
     
     
     
     692,967
     
     
     
     
     
     
     
     (692,967
     )
     
     
     -Earned portion of long term incentive plan
     
     67,090
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     67,090Issued 2,267 shares for employee stock purchase plan
     
     4,149
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     4,149Issued 18,910 shares for current directors' fees
     
     42,559
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     42,559Issued 823 shares for deferred directors' fees
     
     16,414
     
     
     
     
     
     
     
     (16,414
     )
     
     
     
     
     
     
     -Comprehensive loss:Net loss
     
     
     
     
     
     (14,138,083
     )
     
     
     
     
     
     
     
     
     
     
     (14,138,083
     )Change in unrealized gain on investment securities available for sale, net of tax effect
     
     
     
     
     
     
     
     
     
     
     
     
     
     615,993
     
     
     
     615,993Less reclassification adjustment for realized securities net gain included in net loss
     
     
     
     
     
     
     
     
     
     
     
     
     
     (92,109
     )
     
     
     (92,109
     )Total comprehensive loss
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     (13,614,199
     )Balances at September 30, 2009
     $
     6,713,370
     
     
     $
     6,198,860
     
     
     $
     885,919
     
     
     $
     226,552
     
     
     $
     14,024,701Balances at December 31, 2009
     $
     6,738,128
     
     
     $
     6,641,060
     
     
     $
     885,919
     
     
     $
     111,157
     
     
     $
     14,376,264Earned portion of long term incentive plan
     
     12,324
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     12,324Issued 7,418 shares for employee stock purchase plan
     
     3,360
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     3,360Issued 8,088 shares for deferred directors' fees
     
     177,548
     
     
     
     
     
     
     
     (177,548
     )
     
     
     
     
     
     
     -Comprehensive loss:Net loss
     
     
     
     
     
     (2,217,248
     )
     
     
     
     
     
     
     
     
     
     
     (2,217,248
     )Change in unrealized gain on investment securities available for sale, net of tax effect
     
     
     
     
     
     
     
     
     
     
     
     
     
     136,140
     
     
     
     136,140Total comprehensive loss
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     
     (2,081,108
     )Balances at September 30, 2010
     $
     6,931,360
     
     
     $
     4,423,812
     
     
     $
     708,371
     
     
     $
     247,297
     
     
     $
     12,310,840See notes to consolidated financial statements
  3


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FNBH BANCORP, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows(Unaudited)  Nine months ended
September 302010
     
     
     2009Cash flows from operating activities:Net loss
     $
     (2,217,248
     )
     
     $
     (14,138,083
     )Adjustments to reconcile net loss to net cash provided by operating activites:Provision for loan losses
     
     3,600,000
     
     
     
     14,646,853Depreciation and amortization
     
     563,912
     
     
     
     639,408Deferred income tax (benefit) expense
     
     (70,133
     )
     
     
     467,486Net amortization on investment securities
     
     801
     
     
     
     17,509Earned portion of long term incentive plan
     
     12,324
     
     
     
     67,090Shares issued for current and variable directors' compensation
     
     -
     
     
     
     42,559Loss on disposal of equipment
     
     -
     
     
     
     24,190Gain on sale of available for sale securities
     
     -
     
     
     
     (92,109
     )Loss on the sale of other real estate owned, held for sale
     
     271,287
     
     
     
     480,733Decrease in accrued interest income and other assets
     
     1,519,180
     
     
     
     2,715,443Decrease in accrued interest, taxes, and other liabilities
     
     (392,793
     )
     
     
     (363,728
     )Net cash provided by operating activities
     
     3,287,330
     
     
     
     4,507,351Cash flows from investing activities:Purchases of available for sale securities
     
     (4,369,159
     )
     
     
     -Proceeds from sales of available for sale securities
     
     -
     
     
     
     4,338,701Proceeds from maturities and calls of available for sale securities
     
     890,000
     
     
     
     10,230,000Proceeds from mortgage-backed securities paydowns-available for sale
     
     3,621,570
     
     
     
     3,213,983Maturity of certificates of deposit
     
     -
     
     
     
     687,000Net decrease in loans
     
     17,781,058
     
     
     
     19,031,247Proceeds from sale of other real estate owned, held for sale
     
     1,657,450
     
     
     
     2,406,358Capital expenditures
     
     (76,340
     )
     
     
     (137,809
     )Net cash provided by investing activities
     
     19,504,579
     
     
     
     39,769,480Cash flows from financing activities:Net decrease in deposits
     
     (20,736,854
     )
     
     
     (20,572,897
     )Payments on FHLBI note
     
     (413,970
     )
     
     
     (383,307
     )Proceeds from issuance of short term debt
     
     -
     
     
     
     2,000,000Repayment of short term debt
     
     -
     
     
     
     (2,100,000
     )Maturity of long term debt
     
     -
     
     
     
     (8,000,000
     )Shares issued for employee stock purchase plan
     
     3,360
     
     
     
     4,149Net cash used in financing activities
     
     (21,147,464
     )
     
     
     (29,052,055
     )Net increase in cash and cash equivalents
     
     1,644,445
     
     
     
     15,224,776Cash and cash equivalents at beginning of year
     
     37,043,665
     
     
     
     22,080,018Cash and cash equivalents at end of period
     $
     38,688,110
     
     
     $
     37,304,794Supplemental disclosures:Interest paid
     $
     2,077,993
     
     
     $
     4,021,194Net federal income taxes refunded
     
     (1,693,691
     )
     
     
     (2,119,770
     )Loans transferred to other real estate
     
     5,571,098
     
     
     
     3,175,058Loans charged off
     
     9,250,071
     
     
     
     9,336,152
  4


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Notes to Consolidated Financial Statements(unaudited)  1. Basis of Presentation The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, these financial statements do not include all of the information and footnotes required by US GAAP for complete financial statements.   In the opinion of management of FNBH Bancorp, Inc. (the Corporation), all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation were included.  The results of operations for the nine months ended September 30, 2010 are not necessarily indicative of the results to be expected for the year ending December 31, 2010.  For further information, refer to the consolidated financial statements and footnotes thereto included in the 2009 Annual Report contained in the Corporations report on Form 10-K filing.  Certain reclassifications have been made to prior period financial statements to conform to the current period presentation.  The consolidated financial statements included in this Form 10-Q have been prepared assuming the Bank continues to operate in the normal course of business for the foreseeable future, and do not include any adjustments to recorded assets or liabilities should we be unable to continue as a going concern.  2. Financial Condition and Managements Plan In light of the Banks continued losses, insufficient capital position at September 30, 2010 and noncompliance with a regulatory capital directive stipulated under a Consent Order (as described in Managements Discussion and Analysis of Financial Condition and Results of Operations), management believes that it is reasonable to anticipate continued and elevated regulatory oversight of the Bank.  In addition, any continued weaknesses in the Michigan economy and local real estate market will likely continue to negatively impact the Banks near-term performance and profitability.  In response to these difficult market conditions and regulatory standing, management has embarked on various initiatives to mitigate the impact of the economic and regulatory challenges facing the Bank.  However, even if successful, implementation of all components of managements plan is not expected to produce profitable results in 2010 and may not be successful in maintaining the Bank or the Corporation as a going concern.  Managements plan is detailed in Note 2 of the consolidated financial statements included in the 2009 Annual Report within the Corporations Form 10-K filing.  Integral to managements plan is the restoration of the Banks capital to a level sufficient to comply with the Office of the Comptroller of the Currencys (OCC) capital directive and provide sufficient capital resources and liquidity to meet commitments and business needs.  To date, the Bank has not raised the capital necessary to satisfy requirements of the Consent Order.  Management and the Board of Directors continue to meet with potential investors in an attempt to raise the additional equity believed necessary to sufficiently recapitalize the Bank.  Management and the Board of Directors are committed to pursuing all potential alternatives and sources of capital to restore the Banks capital levels.  Such alternatives include raising capital from existing shareholders, individuals, institutional capital market investors and private equity funds and the identification of suitors for a sale or merger transaction.  See also the Capital section within Managements Discussion and Analysis of Financial Condition and Results of Operations included in this Form 10-Q.  Management makes no assurances that its plan or related efforts will improve the Banks financial condition and further deterioration of the Banks capital position is possible.  The current economic environment in southeast Michigan and local real estate market conditions will continue to impose significant challenges on the Bank and are expected to adversely impact financial results.  Any further declines in the Banks capital levels may likely result in more regulatory oversight or enforcement action by either the OCC or the Federal Deposit Insurance Corporation (the FDIC).
  5


---



3. Investment Securities Investment securities available for sale consist of the following: September 30, 2010
     
     
     
     December 31, 2009Amortized Cost
     
     
     
     Unrealized gross gains
     
     
     
     Unrealized gross losses
     
     
     
     Fair Value
     
     
     
     Amortized Cost
     
     
     
     Unrealized gross gains
     
     
     
     Unrealized gross losses
     
     
     
     Fair ValueObligations of state and political
subdivisions
     $
     6,690,333
     
     
     $
     259,883
     
     
     $
     (4,025
     )
     
     $
     6,946,191
     
     
     $
     7,088,573
     
     
     $
     126,321
     
     
     $
     (59,093
     )
     
     $
     7,155,801U.S. Treasury and agency securities
     
     1,001,020
     
     
     
     6,689
     
     
     
     -
     
     
     
     1,007,709
     
     
     
     1,504,100
     
     
     
     26,547
     
     
     
     (3,178
     )
     
     
     1,527,469Mortgage-backed/CMO securities
     
     14,653,828
     
     
     
     554,048
     
     
     
     (425,463
     )
     
     
     14,782,413
     
     
     
     13,895,720
     
     
     
     606,611
     
     
     
     (566,789
     )
     
     
     13,935,542Preferred stock securities (1)
     
     48,800
     
     
     
     -
     
     
     
     (16,440
     )
     
     
     32,360
     
     
     
     48,800
     
     
     
     38,000
     
     
     
     -
     
     
     
     86,800Total securities
     $
     22,393,981
     
     
     $
     820,620
     
     
     $
     (445,928
     )
     
     $
     22,768,673
     
     
     $
     22,537,193
     
     
     $
     797,479
     
     
     $
     (629,060
     )
     
     $
     22,705,612
  (1)Represents preferred stock issued by Freddie Mac and Fannie Mae.  Investment securities are reviewed quarterly for possible other-than-temporary impairment (OTTI) based on guidance included in ASC Topic 320,Investments  Debt and Equity Instruments.  This guidance requires an entity to assess whether it intends to sell, or it is more likely than not that it will be required to sell a security in an unrealized loss position before the recovery of the securitys amortized cost basis.  If either of these criteria is met, the entire difference between the amortized cost and fair value is recognized in earnings.  For securities that do not meet the aforementioned criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income.  Managements review of the securities portfolio for the existence of OTTI considers various qualitative and quantitative factors regarding each investment category, including if the securities were U.S. Government issued, the credit rating on the securities, credit outlook, payment status and financial condition, the length of time the security has been in a loss position, the size of the loss position and other meaningful information. Based on managements review, no impairment charges were required to be recognized during the nine months ended September 30, 2010.    With respect to the Corporations non-government agency CMO security, management completes a quarterly cash flow analysis of the CMO with the assistance of a third party specialist.  The analysis considers assumptions regarding voluntary prepayment speed, default rate, and loss severity using the CMOs original yield as the discount rate.  At September 30, 2010, the estimated fair value of the CMO, based on a combination of Level 2 and Level 3 inputs, including a market participant discount rate, indicated that the related cash flows continue to support the amortized cost of the security and no other-than-temporary impairment had been incurred.  The CMO security was the only security in a continuous loss position for 12 months or more at September 30, 2010 and December 31, 2009.  The following is a summary of the available for sale portfolios gross unrealized losses and fair value aggregated by investment category and length of time that individual securities have been in a continuous loss position:  September 30, 2010Less than 12 months
     
     
     
     12 months or more
     
     
     
     TotalUnrealized gross
losses
     
     
     
     Fair
value
     
     
     
     Unrealized gross
losses
     
     
     
     Fair
value
     
     
     
     Unrealized gross
losses
     
     
     
     Fair
valueObligations of state and political
subdivisions
     $
     (4,025
     )
     
     $
     197,306
     
     
     $
     -
     
     
     $
     -
     
     
     $
     (4,025
     )
     
     $
     197,306U.S. Treasury and agency securities
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     -Mortgage-backed/CMO securities
     
     -
     
     
     
     -
     
     
     
     (425,463
     )
     
     
     2,625,470
     
     
     
     (425,463
     )
     
     
     2,625,470Preferred stock securities
     
     (16,440
     )
     
     
     32,360
     
     
     
     -
     
     
     
     -
     
     
     
     (16,440
     )
     
     
     32,360Total available for sale
     $
     (20,465
     )
     
     $
     229,666
     
     
     $
     (425,463
     )
     
     $
     2,625,470
     
     
     $
     (445,928
     )
     
     $
     2,855,136
  6


---



December 31, 2009Less than 12 months
     
     
     
     12 months or more
     
     
     
     TotalUnrealized gross
losses
     
     
     
     Fair
value
     
     
     
     Unrealized gross
losses
     
     
     
     Fair
value
     
     
     
     Unrealized gross
losses
     
     
     
     Fair
valueObligations of state and political
subdivisions
     $
     (59,093
     )
     
     $
     2,885,936
     
     
     $
     -
     
     
     $
     -
     
     
     $
     (59,093
     )
     
     $
     2,885,936U.S. Treasury and agency securities
     
     (3,178
     )
     
     
     495,650
     
     
     
     -
     
     
     
     -
     
     
     
     (3,178
     )
     
     
     495,650Mortgage-backed/CMO securities
     
     -
     
     
     
     -
     
     
     
     (566,789
     )
     
     
     2,734,709
     
     
     
     (566,789
     )
     
     
     2,734,709Preferred stock securities
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     -Total available for sale
     $
     (62,271
     )
     
     $
     3,381,586
     
     
     $
     (566,789
     )
     
     $
     2,734,709
     
     
     $
     (629,060
     )
     
     $
     6,116,295
  The following is a summary of the amortized cost and approximate fair value of investment securities by contractual maturity at September 30, 2010 and December 31, 2009. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.  September 30, 2010
     
     
     
     December 31, 2009Amortized
Cost
     
     
     
     Approximate
Fair Value
     
     
     
     Amortized
Cost
     
     
     
     Approximate Fair ValueDue in one year or less
     $
     1,001,020
     
     
     $
     1,007,709
     
     
     $
     1,395,800
     
     
     $
     1,428,773Due after one year through five years
     
     716,887
     
     
     
     752,651
     
     
     
     225,000
     
     
     
     239,281Due after five years through ten years
     
     2,403,277
     
     
     
     2,541,174
     
     
     
     1,800,094
     
     
     
     1,843,489Due after ten years
     
     3,618,969
     
     
     
     3,684,726
     
     
     
     5,220,579
     
     
     
     5,258,5277,740,153
     
     
     
     7,986,260
     
     
     
     8,641,473
     
     
     
     8,770,070Mortgage-backed/CMO securities
     
     14,653,828
     
     
     
     14,782,413
     
     
     
     13,895,720
     
     
     
     13,935,542Totals
     $
     22,393,981
     
     
     $
     22,768,673
     
     
     $
     22,537,193
     
     
     $
     22,705,612
  Investment securities, with an amortized cost of approximately $14,754,000 at September 30, 2010 and $12,241,000 at December 31, 2009 were pledged to secure public deposits and for other purposes required or permitted by law.  At September 30, 2010, $4,368,000 of these securities are pledged as collateral at the Federal Home Loan Bank of Indianapolis to support potential liquidity needs of the Bank.  The Bank owns stock in both the Federal Home Loan Bank of Indianapolis (FHLBI) and the Federal Reserve Bank (FRB), both of which are recorded at cost. The Bank is required to hold stock in the FHLBI equal to 5% of the institutions borrowing capacity with the FHLBI. The Banks investment in FHLBI stock amounted to $950,700 at September 30, 2010 and December 31, 2009. The Banks investment in FRB stock, which totaled $44,250 at September 30, 2010 and December 31, 2009, is a requirement for the Banks membership in the Federal Reserve System. These investments can only be resold to, or redeemed by, the issuer.  4. Allowance for Loan Losses Managements assessment of the allowance for loan losses is based on an evaluation of the loan portfolio, recent loss experience, current economic conditions, and other pertinent factors.  Loans on nonaccrual status and those past due more than 90 days amounted to $28,947,000 at September 30, 2010, $43,724,000 at December 31, 2009, and $45,958,000 at September 30, 2009.  (See Managements Discussion and Analysis of Financial Condition and Results of Operations).  5. Fair Value Measurements The Corporation measures fair values based on ASC Topic 820,Fair Value Measurements and Disclosures.  ASC Topic 820 defines fair value and establishes a consistent framework for measuring and expands disclosure requirements for fair value measurements.  Fair value represents the estimated price that would be received from selling an asset or paid to transfer a liability, otherwise known as an exit price.  The three levels of inputs that may be used to measure fair value are as follows:  Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.  Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or
  7


---



other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means.  Level 3: Significant unobservable inputs that reflect a reporting entitys own assumptions about the assumptions that market participants would use in pricing an asset or liability.  The following is a description of the Corporations valuation methodologies used to measure and disclose the fair values of its financial assets and liabilities on a recurring or nonrecurring basis:  Securities available for sale.  Securities available for sale are recorded at fair value on a recurring basis.  Fair value measurement is based on quoted prices, if available.  If quoted prices are not available, fair values are measured using independent pricing models.  Level 2 securities include U.S. government and agency securities, other U.S. government and agency mortgage-backed securities, municipal bonds and preferred stock securities.  Level 3 securities include private collateralized mortgage obligations.  Fair value of assets measured on a recurring basis are as follows: Fair Value Measurements at September 30, 2010Quoted Prices in Active Markets for Identical Assets
     
     
     
     Significant Other Observable Inputs
     
     
     
     Significant Unobservable InputsTotal
     
     
     
     (Level 1)
     
     
     
     (Level 2)
     
     
     
     (Level 3)Obligations of state and political subdivisions
     $
     6,946,191
     
     
     $
     -
     
     
     $
     6,946,191
     
     
     $
     -U.S. Treasury and agency securities
     
     1,007,709
     
     
     
     -
     
     
     
     1,007,709
     
     
     
     -Mortgage-backed/CMO securities
     
     14,782,413
     
     
     
     -
     
     
     
     12,156,943
     
     
     
     2,625,470Preferred stock securities
     
     32,360
     
     
     
     -
     
     
     
     32,360
     
     
     
     -Total investment securities available for sale
     $
     22,768,673
     
     
     $
     -
     
     
     $
     20,143,203
     
     
     $
     2,625,470
  Fair Value Measurements at December 31, 2009Quoted Prices in Active Markets for Identical Assets
     
     
     
     Significant Other Observable Inputs
     
     
     
     Significant Unobservable InputsTotal
     
     
     
     (Level 1)
     
     
     
     (Level 2)
     
     
     
     (Level 3)Obligations of state and political subdivisions
     $
     7,155,801
     
     
     $
     -
     
     
     $
     7,155,801
     
     
     $
     -U.S. Treasury and agency securities
     
     1,527,469
     
     
     
     -
     
     
     
     1,527,469
     
     
     
     -Mortgage-backed/CMO securities
     
     13,935,542
     
     
     
     
     
     
     
     11,200,833
     
     
     
     2,734,709Preferred stock securities
     
     86,800
     
     
     
     -
     
     
     
     86,800
     
     
     
     -Total investment securities available for sale
     $
     22,705,612
     
     
     $
     -
     
     
     $
     19,970,903
     
     
     $
     2,734,709
  The reconciliation of the beginning and ending balances of the asset classified by the Corporation within Level 3 of the valuation hierarchy for the nine months ended September 30, 2010 is as follows: Fair Value Measurements Using Significant Unobservable Inputs(Level 3)Fair value of CMO, beginning of period(1)
     $
     2,734,709Total gains (losses) realized/unrealized:Included in earnings(2)
     
     -Included in other comprehensive income(2)
     
     141,326Purchases, issuances, and other settlements
     
     (250,565
     )Transfers into Level 3(3)
     
     -Fair value of CMO, September 30, 2010
     $
     2,625,470Total amount of losses for the period included in earnings
attributable to the change in unrealized losses relating to
assets still held at September 30, 2010
     $
     -
  8


---



(1)Non-agency CMO classified as available for sale is valued using internal valuation models and pricing information from third parties. (2)Realized gain (losses), including unrealized losses deemed other-than-temporary, are reported in noninterest income.  Unrealized gains (losses) are reported in accumulated other comprehensive income (loss). (3)Transfers in or out are based on the carrying amount of the security at the beginning of the period.  The following is a description of the Corporations valuation methodologies used to measure and disclose the fair values of its financial assets and liabilities on a non-recurring basis:  Loans.  The Corporation does not record loans at fair value on a recurring basis.  However, from time to time, the Corporation records nonrecurring fair value adjustments to collateral dependent loans to reflect partial write-downs or specific reserves that are based on the observable market price or current appraised value of the collateral.  These loans are reported in the nonrecurring table below at initial recognition of impairment and on an ongoing basis until recovery or charge off.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Corporation records the impaired loan as nonrecurring Level 2.  When a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Corporation records the impaired loan as nonrecurring Level 3.  Other real estate owned.Real estate acquired through foreclosure or deed-in-lieu is adjusted to fair value less costs to sell upon transfer of the loan to other real estate owned, usually based on an appraisal of the property.  Subsequently, other real estate owned is carried at the lower of carrying value or fair value. A valuation based on a current appraisal or by a brokers opinion is considered a Level 2 fair value.   If management determines the fair value of the property is further impaired below the appraised value and there is no observable market price, the Corporation records the property as nonrecurring Level 3.  Fair value on a non-recurring basis is as follows: Fair Value Measurements at September 30, 2010Quoted Prices in Active Markets for Identical Assets
     
     
     
     Significant Other Observable Inputs
     
     
     Significant Unobservable InputsTotal
     
     
     
     (Level 1)
     
     
     
     (Level 2)
     
     
     (Level 3)Impaired loans (1)
     $
     17,999,736
     
     
     $
     -
     
     
     $
     -
     
     $
     17,999,736Other real estate owned
     
     7,419,480
     
     
     
     -
     
     
     
     -
     
     
     7,419,480
  Fair Value Measurements at December 31, 2009Quoted Prices in Active Markets for Identical Assets
     
     
     Significant Other Observable Inputs
     
     
     Significant Unobservable InputsTotal
     
     
     
     (Level 1)
     
     
     (Level 2)
     
     
     (Level 3)Impaired loans (1)
     $
     34,009,626
     
     
     $
     -
     
     $
     -
     
     $
     34,009,626Other real estate owned
     
     3,777,119
     
     
     
     -
     
     
     -
     
     
     3,777,119
  (1)Represents carrying value and related write-downs and specific reserves pertaining to collateral dependent loans for which adjustments are based on the appraised value of the collateral or by other unobservable inputs.  6.  Fair Value of Financial Instruments Fair value disclosures require fair‐value information about financial instruments for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair‐value estimates cannot be substantiated by comparison to independent markets and, in many cases, cannot be realized in immediate settlement of the instrument.  Fair‐value methods and assumptions for the Corporations financial instruments are as follows:  Cash and cash equivalents The carrying amounts reported in the consolidated balance sheet for cash and short term investments reasonably approximate those assets fair values.  Investment securities Fair values for investment securities are determined as discussed above.
  9


---



FHLBI and FRB stock The carrying amounts reported in the consolidated balance sheet for FHLBI and FRB stock reasonably approximate those assets fair values.  Loans For variable‐rate loans that reprice frequently, fair values are generally based on carrying values, adjusted for credit risk. The fair value of fixed‐rate loans is estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.  Accrued interest income The carrying amount of accrued interest income is a reasonable estimate of fair value.  Deposit liabilities The fair value of deposits with no stated maturity, such as demand deposit, NOW, savings, and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is estimated using rates currently offered for wholesale funds with similar remaining maturities.  Other borrowings The fair value of other borrowings is estimated based on quoted market prices.  Accrued interest payable The carrying amount of accrued interest payable is a reasonable estimate of fair value.  Off‐balance‐sheet instruments The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed‐rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of commitments to extend credit, including letters of credit, is estimated to approximate their aggregate book balance and is not considered material and therefore not included in the following table.  The estimated fair values of the Corporations financial instruments are as follows: September 30, 2010
     
     
     
     December 31, 2009Carrying
Value
     
     
     
     Fair
Value
     
     
     
     Carrying
Value
     
     
     
     Fair
ValueFinancial assets:Cash and cash equivalents
     $
     38,688,000
     
     
     $
     38,688,000
     
     
     $
     37,044,000
     
     
     $
     37,044,000Obligations of state and political subdivisions
     
     6,946,000
     
     
     
     6,946,000
     
     
     
     7,156,000
     
     
     
     7,156,000U.S. Treasury and agency securities
     
     1,008,000
     
     
     
     1,008,000
     
     
     
     1,527,000
     
     
     
     1,527,000Mortgage-backed/CMO securities
     
     14,783,000
     
     
     
     14,783,000
     
     
     
     13,936,000
     
     
     
     13,936,000Preferred stock securities
     
     32,000
     
     
     
     32,000
     
     
     
     87,000
     
     
     
     87,000FHLBI and FRB stock
     
     995,000
     
     
     
     995,000
     
     
     
     995,000
     
     
     
     995,000Loans, net
     
     228,428,000
     
     
     
     228,525,000
     
     
     
     255,381,000
     
     
     
     254,923,000Accrued interest income
     
     878,000
     
     
     
     878,000
     
     
     
     1,008,000
     
     
     
     1,008,000Financial liabilities:Deposits:Demand
     $
     64,441,000
     
     
     $
     64,441,000
     
     
     $
     65,644,000
     
     
     $
     65,644,000NOW
     
     49,799,000
     
     
     
     49,799,000
     
     
     
     50,643,000
     
     
     
     50,643,000Savings and money market accounts
     
     68,015,000
     
     
     
     68,015,000
     
     
     
     72,298,000
     
     
     
     72,298,000Time deposits
     
     108,849,000
     
     
     
     109,678,000
     
     
     
     121,200,000
     
     
     
     121,011,000Brokered certificates
     
     3,354,000
     
     
     
     3,476,000
     
     
     
     5,411,000
     
     
     
     5,516,000Other borrowings
     
     -
     
     
     
     -
     
     
     
     414,000
     
     
     
     414,000Accrued interest expense
     
     264,000
     
     
     
     264,000
     
     
     
     359,000
     
     
     
     359,000
  Limitations Fair‐value estimates are made at a specific point in time based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discounts that could result from offering for sale at one time the Corporations entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Corporations financial instruments, fair‐value estimates are based on judgments regarding future loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment, and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.  7. Net Income (Loss) per Common Share Basic earnings per common share is based on the weighted average number of common shares and participating securities outstanding during the period.  Diluted earnings per share are the same as basic earnings per share because any additional potential common shares issuable are included in the basic earnings per share calculation.  The Corporation follows guidance included in ASC Topic 260,Earnings Per Share, related to determining whether instruments granted in a share-based payment transaction are participating securities.  This guidance requires that unvested stock
  10


---



awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid (referred to as participating securities), be included in the number of shares outstanding for both basic and diluted earnings per share calculations.  Our unvested restricted stock under the Long-Term Incentive Plan is considered a participating security.  In the event of a net loss, the participating securities are excluded from the calculation of both basic and diluted earnings per share.  Due to our net loss for the nine months ended September 30, 2010 and 2009, the unvested restricted shares were not included in determining both basic and diluted earnings per share for the respective periods.  The following table presents basic and diluted earnings per share: Third Quarter
     
     
     
     Year-to-Date2010
     
     
     
     2009
     
     
     
     2010
     
     
     
     2009Weighted average common shares outstanding
     
     3,193,565
     
     
     
     3,175,252
     
     
     
     3,191,644
     
     
     
     3,164,347Weighted average unvested restricted stock outstanding
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     -Weighted average basic and diluted common shares outstanding
     
     3,193,565
     
     
     
     3,175,252
     
     
     
     3,191,644
     
     
     
     3,164,347Net loss available to common shareholders
     $
     (681,759
     )
     
     $
     (1,431,205
     )
     
     $
     (2,217,248
     )
     
     $
     (14,138,083
     )Basic and diluted net loss per share
     $
     (0.21
     )
     
     $
     (0.45
     )
     
     $
     (0.69
     )
     
     $
     (4.47
     )
   8. Long Term Incentive Plan Under the Long Term Incentive Plan (the Plan), the Corporation had the authority to grant stock options and restricted stock as compensation to key employees.  Such authority expired April 22, 2008. The Corporation did not award any stock options under the Plan. The restricted shares have a five-year vesting period. The awards are recorded at fair value on the grant date and are amortized into salary expense over the vesting period.  A summary of the activity under the Plan for the nine months ended September 30, 2010 and 2009 is presented below: 2010
     
     
     
     2009Restricted Stock Awards
     
     Shares
     
     
     
     Weighted-Average
Grant Date
Fair Value
     
     
     
     Shares
     
     
     
     Weighted-Average
Grant Date
Fair ValueOutstanding at January 1,
     
     2,033
     
     
     $
     17.47
     
     
     
     8,327
     
     
     $
     17.90Granted
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     -Vested
     
     (625
     )
     
     
     19.73
     
     
     
     (3,542
     )
     
     
     18.94Forfeited
     
     -
     
     
     
     -
     
     
     
     (554
     )
     
     
     16.36Outstanding at September 30,
     
     1,408
     
     
     $
     16.47
     
     
     
     4,231
     
     
     $
     17.23
  The total fair value of the awards vested during the three months ended September 30, 2010 and 2009 was $3,780 and $8,034, respectively.  Awards vested during the nine months ended September 30, 2010 and 2009 had a total fair value of $12,324 and $67,090, respectively. As of September 30, 2010, there was $23,189 of total unrecognized compensation cost related to nonvested stock awards under the Plan.  That cost is expected to be recognized over a weighted-average period of 2.2 years.  9.  Income Taxes The provision for income taxes represents federal income tax expense calculated using estimated annualized rates on taxable income or loss generated during the respective periods adjusted, as necessary, to avoid recording tax benefits during loss periods in excess of amounts expected to be realized.  Item 2.   Managements Discussion and Analysis of Financial Condition and Results of Operations   The Corporation, a Michigan business corporation, is a one bank holding company which owns all of the outstanding capital stock of First National Bank in Howell (the Bank) and all of the outstanding stock of HB Realty Co., a subsidiary.  The following is a discussion of the Corporations results of operations for the three and nine months ended September 30, 2010 and 2009, and the Corporations financial condition, focusing on its liquidity and capital resources.  During 2009, the level of regulatory enforcement action taken against the Bank by the OCC heightened from a formal agreement entered into on October 16, 2008 to the issuance of a Consent Order (the Consent Order) dated September 24, 2009.   Pursuant to the Consent Order, the Bank was required to achieve and maintain total capital equal to 11% of risk weighted assets and Tier 1 capital equal to at least 8.5% of adjusted total assets by January 22, 2010.  The Bank failed to meet these required minimum ratios by such deadline and is currently out of compliance with these required minimum capital ratios as well as other requirements of the Consent Order.  In light of the Banks continued losses and capital position at September 30, 2010 and the uncertainty regarding the ability to raise additional equity capital, it is reasonable
  11


---



to anticipate that further regulatory oversight or enforcement action may be taken by the OCC.  See also the Capital section of this Managements Discussion and Analysis for further details.  The success of the Corporation depends to a great extent upon the economic conditions in Livingston County and the surrounding area.  The Corporation has in general experienced a slowing economy in Michigan since 2007.  In particular, Michigans current unemployment rate of 13% is the second worst among all states.  Unlike larger banks that are more geographically diversified, we provide banking services to customers primarily in Livingston County.  Our loan portfolio, the ability of the borrowers to repay these loans, and the value of the collateral securing these loans is impacted by local economic conditions.  The continued economic difficulties in Michigan have had and may continue to have adverse consequences as described below in Loans.  Dramatic declines in commercial real estate values in recent years, with elevated levels of foreclosures and unemployment have resulted in and may continue to result in significant write-downs of asset values by us and other financial institutions.  These write-downs have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.  Additionally, capital and credit markets have continued to experience elevated levels of volatility and disruption over the past two years.  This market turmoil and tightening of credit have led to a lack of general consumer confidence and reduction in business activity.  Due to the conditions and events discussed above and elsewhere in this Form 10-Q, there is significant uncertainty regarding the impact of potential future regulatory action against the Bank.  The extent of such regulatory action may threaten the ability of the Bank to continue operating as a going concern.  Notwithstanding the above, the consolidated financial statements included in this Form 10-Q have been prepared assuming the Bank continues to operate in the normal course of business for the foreseeable future, and do not include any adjustments to recorded assets or liabilities should we be unable to continue as a going concern.  As fully described in Note 2, Managements Plan, of the consolidated financial statements included in the 2009 Annual Report within the Corporations Form 10-K filing, management has undertaken various initiatives to address the current challenges facing the Bank.  The successful implementation of the various actions being undertaken by management will be difficult in the current economic environment.  Even if such actions are successfully implemented, such strategy may not be sufficient to increase the Bank's capital levels to satisfactory levels, return the Bank to profitability, or otherwise avoid further regulatory oversight or enforcement action.  Any further declines in the Banks capital levels may result in more severe regulatory oversight or enforcement action by either the OCC or FDIC.  It is against this backdrop that we discuss our financial condition and results of operations for the three and nine months ended September 30, 2010 as compared to earlier periods.  (in thousands except per share data)Earnings
     
     Third Quarter
     
     
     
     Year-to-Date2010
     
     
     
     2009
     
     
     
     2010
     
     
     
     2009Net loss
     $
     (682
     )
     
     $
     (1,431
     )
     
     $
     (2,217
     )
     
     $
     (14,138
     )Basic and diluted net loss per share
     $
     (0.21
     )
     
     $
     (0.45
     )
     
     $
     (0.69
     )
     
     $
     (4.47
     )
  Net loss for the three and nine months ended September 30, 2010 as compared to the same periods last year, was positively affected by lower provision for loan loss, lower interest expense due to lower average deposit balances and lower rates, and lower noninterest expense.  These favorable variances were partially offset by lower interest income on loans due to lower average balances, continued high nonaccrual balances, lower asset yields, and lower noninterest income.  Net loss for the three months ended September 30, 2010 decreased by $749,000 compared to the same period last year.  In the third quarter of 2010, the provision for loan loss decreased by $550,000 and noninterest expense decreased by $681,000.  Partially offsetting these favorable variances were lower net interest income of $384,000 and lower noninterest income of $167,000.  Third quarter 2010 results included a federal income tax benefit of $69,000.  Net loss for the nine months ended September 30, 2010, decreased $11,921,000 compared to the nine months ended September 30, 2009.  Provision for loan loss decreased $11,047,000 and noninterest expense decreased $ 1,990,000.  Partially offsetting these positive variances were decreases in net interest income of $1,384,000 and noninterest income of $270,000.  In addition, income tax expense for the nine months ended September 30, 2010 was lower by $537,000 over the same prior year period.
  12


---



(in thousands)Net Interest Income
     
     Third Quarter
     
     
     
     Year-to-Date2010
     
     
     
     2009
     
     
     
     2010
     
     
     
     2009Interest and dividend income
     $
     3,476
     
     
     $
     4,349
     
     
     $
     10,772
     
     
     $
     13,917Interest expense
     
     614
     
     
     
     1,103
     
     
     
     1,983
     
     
     
     3,744Net Interest Income
     $
     2,862
     
     
     $
     3,246
     
     
     $
     8,789
     
     
     $
     10,173
   The following tables illustrate some of the significant factors contributing to the changes in net interest income (fully tax equivalent basis) for the three and nine months ended September 30:  INTEREST YIELDS AND COSTS September 30, 2010 and 2009 (in thousands) ----------Third Quarter ----------2010
     
     
     2009Average
Balance
     
     
     
     Interest
     
     
     
     Rate
     
     
     Average
Balance
     
     
     
     Interest
     
     
     
     RateAssets:Interest earning assets:Short term investments
     $
     99
     
     
     $
     -
     
     
     
     0.12
     %
     
     $
     94
     
     
     $
     -
     
     
     
     0.11
     %Certificates of deposit
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     3,857
     
     
     
     46.5
     
     
     
     4.79
     %Securities: Taxable
     
     14,024
     
     
     
     187.5
     
     
     
     5.35
     %
     
     
     18,928
     
     
     
     265.1
     
     
     
     5.60
     %Tax-exempt (1)
     
     6,692
     
     
     
     100.0
     
     
     
     5.98
     %
     
     
     9,516
     
     
     
     142.5
     
     
     
     5.99
     %Commercial loans (2)(3)
     
     211,195
     
     
     
     2,780.8
     
     
     
     5.15
     %
     
     
     251,879
     
     
     
     3,383.8
     
     
     
     5.26
     %Consumer loans (2)(3)
     
     17,373
     
     
     
     245.0
     
     
     
     5.60
     %
     
     
     19,854
     
     
     
     295.4
     
     
     
     5.90
     %Mortgage loans (2)(3)
     
     17,513
     
     
     
     204.1
     
     
     
     4.66
     %
     
     
     20,117
     
     
     
     273.3
     
     
     
     5.43
     %Total earning assets and total interest income
     
     266,896
     
     
     
     3,517.4
     
     
     
     5.18
     %
     
     
     324,245
     
     
     
     4,406.6
     
     
     
     5.34
     %Cash and due from banks
     
     38,991
     
     
     
     
     
     
     
     
     
     
     
     49,587All other assets
     
     18,143
     
     
     
     
     
     
     
     
     
     
     
     14,089Allowance for loan losses
     
     (14,047
     )
     
     
     
     
     
     
     
     
     
     
     (20,831
     )Total Assets
     $
     309,983
     
     
     
     
     
     
     
     
     
     
     $
     367,090Liabilities and Shareholders' Equity:Interest bearing liabilities:NOW
     $
     50,311
     
     
     
     15.0
     
     
     
     0.12
     %
     
     $
     49,030
     
     
     
     25.8
     
     
     
     0.21
     %Savings
     
     39,062
     
     
     
     19.6
     
     
     
     0.20
     %
     
     
     43,522
     
     
     
     37.5
     
     
     
     0.34
     %MMDA
     
     32,854
     
     
     
     51.4
     
     
     
     0.62
     %
     
     
     51,393
     
     
     
     122.1
     
     
     
     0.94
     %Time
     
     116,019
     
     
     
     528.0
     
     
     
     1.81
     %
     
     
     145,538
     
     
     
     910.5
     
     
     
     2.48
     %Short term borrowings
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     2
     
     
     
     -
     
     
     
     -FHLBI advances
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     414
     
     
     
     7.7
     
     
     
     7.29
     %Total interest bearing liabilities and total interest expense
     
     238,246
     
     
     
     614.0
     
     
     
     1.02
     %
     
     
     289,899
     
     
     
     1,103.6
     
     
     
     1.51
     %Non-interest bearing deposits
     
     56,632
     
     
     
     
     
     
     
     
     
     
     
     59,305All other liabilities
     
     2,254
     
     
     
     
     
     
     
     
     
     
     
     2,704Shareholders' Equity
     
     12,851
     
     
     
     
     
     
     
     
     
     
     
     15,182Total Liabilities and Shareholders' Equity
     $
     309,983
     
     
     
     
     
     
     
     
     
     
     $
     367,090Interest spread
     
     
     
     
     
     
     
     
     
     4.16
     %
     
     
     
     
     
     
     
     
     
     
     3.83
     %Net interest income-FTE
     
     
     
     
     $
     2,903.4
     
     
     
     
     
     
     
     
     
     
     $
     3,303.0Net interest margin
     
     
     
     
     
     
     
     
     
     4.27
     %
     
     
     
     
     
     
     
     
     
     
     3.99
     %
   (1)Average yields in the above table have been adjusted to a tax-equivalent basis using a 34% tax rate. (2)For purposes of the computation above, average non-accruing loans of $30,542,000 in 2010 and $44,686,000 in 2009 are included in the average daily loan balance. (3)Interest on loans includes origination fees totaling $19,000 in 2010 and $22,000 in 2009.
  13


---



INTEREST YIELDS AND COSTS September 30, 2010 and 2009 (in thousands) ----------Year-to-Date ----------2010
     
     
     2009Average
Balance
     
     
     
     Interest
     
     
     
     Rate
     
     
     Average
Balance
     
     
     
     Interest
     
     
     
     RateAssets:Interest earning assets:Short term investments
     $
     99
     
     
     $
     0.1
     
     
     
     0.10
     %
     
     $
     6,071
     
     
     $
     11.4
     
     
     
     0.25
     %Certificates of deposit
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     4,075
     
     
     
     146.5
     
     
     
     4.81
     %Securities: Taxable
     
     14,977
     
     
     
     604.6
     
     
     
     5.38
     %
     
     
     23,687
     
     
     
     997.5
     
     
     
     5.62
     %Tax-exempt (1)
     
     6,866
     
     
     
     309.7
     
     
     
     6.02
     %
     
     
     11,716
     
     
     
     527.9
     
     
     
     6.01
     %Commercial loans (2)(3)
     
     220,933
     
     
     
     8,573.4
     
     
     
     5.12
     %
     
     
     262,181
     
     
     
     10,617.1
     
     
     
     5.34
     %Consumer loans (2)(3)
     
     17,775
     
     
     
     757.3
     
     
     
     5.70
     %
     
     
     20,649
     
     
     
     936.3
     
     
     
     6.06
     %Mortgage loans (2)(3)
     
     18,293
     
     
     
     660.6
     
     
     
     4.82
     %
     
     
     20,596
     
     
     
     883.3
     
     
     
     5.72
     %Total earning assets and total interest income
     
     278,943
     
     
     
     10,905.7
     
     
     
     5.17
     %
     
     
     348,975
     
     
     
     14,120.0
     
     
     
     5.35
     %Cash and due from banks
     
     31,804
     
     
     
     
     
     
     
     
     
     
     
     25,765All other assets
     
     17,993
     
     
     
     
     
     
     
     
     
     
     
     16,523Allowance for loan losses
     
     (15,931
     )
     
     
     
     
     
     
     
     
     
     
     (16,044
     )Total Assets
     $
     312,809
     
     
     
     
     
     
     
     
     
     
     $
     375,219Liabilities and Shareholders' Equity:Interest bearing liabilities:NOW
     $
     49,070
     
     
     
     64.0
     
     
     
     0.17
     %
     
     $
     46,331
     
     
     
     62.9
     
     
     
     0.18
     %Savings
     
     39,108
     
     
     
     57.1
     
     
     
     0.20
     %
     
     
     41,343
     
     
     
     87.3
     
     
     
     0.28
     %MMDA
     
     32,471
     
     
     
     157.7
     
     
     
     0.65
     %
     
     
     53,104
     
     
     
     386.8
     
     
     
     0.97
     %Time
     
     119,669
     
     
     
     1,702.9
     
     
     
     1.90
     %
     
     
     151,754
     
     
     
     3,149.1
     
     
     
     2.77
     %Short term borrowings
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     148
     
     
     
     1.9
     
     
     
     1.66
     %FHLBI advances
     
     21
     
     
     
     1.2
     
     
     
     7.29
     %
     
     
     1,371
     
     
     
     55.8
     
     
     
     5.37
     %Total interest bearing liabilities and total interest expense
     
     240,339
     
     
     
     1,982.9
     
     
     
     1.10
     %
     
     
     294,051
     
     
     
     3,743.8
     
     
     
     1.70
     %Non-interest bearing deposits
     
     56,475
     
     
     
     
     
     
     
     
     
     
     
     55,143All other liabilities
     
     2,322
     
     
     
     
     
     
     
     
     
     
     
     2,661Shareholders' Equity
     
     13,673
     
     
     
     
     
     
     
     
     
     
     
     23,364Total Liabilities and Shareholders' Equity
     $
     312,809
     
     
     
     
     
     
     
     
     
     
     $
     375,219Interest spread
     
     
     
     
     
     
     
     
     
     4.07
     %
     
     
     
     
     
     
     
     
     
     
     3.65
     %Net interest income-FTE
     
     
     
     
     $
     8,922.8
     
     
     
     
     
     
     
     
     
     
     $
     10,376.2Net interest margin
     
     
     
     
     
     
     
     
     
     4.22
     %
     
     
     
     
     
     
     
     
     
     
     3.92
     %
   (1)Average yields in the above table have been adjusted to a tax-equivalent basis using a 34% tax rate. (2)For purposes of the computation above, average non-accruing loans of $35,746,000 in 2010 and $40,118,000 in 2009 are included in the average daily loan balance. (3)Interest on loans includes origination fees totaling $61,000 in 2010 and $77,000 in 2009.  Interest Earning Assets/Interest Income On a tax equivalent basis, interest income decreased $889,000 (20.2%) in the third quarter of 2010 compared to the third quarter of 2009.  This is due to a decrease in average earning assets of $57,349,000 (17.7%) combined with a decrease in the yield on average earning assets of 16 basis points.  The average balance of certificates of deposit decreased by $3,857,000 in the third quarter of 2010 compared to the third quarter of 2009 due to sale of the certificate of deposit portfolio in the fourth quarter of 2009.  The average balance of securities decreased $7,728,000 (27.2%) in the third quarter of 2010 as compared with the same period in 2009.  This decrease was due to $14,817,000 of securities being called, matured, sold or paid down from July 2009 through September 2010, including $8,566,000 in the third quarter of 2009 and $2,005,000 in third quarter of 2010.  The decrease in average security balances was partially offset by the purchase of $4,369,000 of securities during the third quarter of 2010.  The yield on average security balances decreased 18 basis points in the third quarter of 2010 compared to 2009.  Loan average balances decreased $45,769,000 (15.7%) combined with a 16 basis point decrease in yield in the third quarter of 2010 compared to the same period last year. Commercial loans have continued to decrease due to charge offs, transfers to other real estate, receipt of scheduled payments and decreased loan origination activities.  It is expected that
  14


---



continued efforts to manage the Banks regulatory capital levels (i.e., shrinking the Banks size) will further decrease net interest income in future periods.  For the first nine months of the year, tax equivalent interest income decreased $3,214,000 (22.8%). Short-term investments, certificates of deposit and securities interest income decreased by $769,000 (45.7%) due primarily to a decrease in security income of $611,000.  Security average balances decreased $13,560,000 (38.3%) combined with a decrease in the average yield of 17 basis points. Loan interest income decreased $2,445,000 (19.7%) due to lower average balances of $46,425,000 (15.3%) combined with the average yield decreasing 27 basis points.  The largest decline in terms of average balances was in commercial loans, the majority of our loan portfolio, which decreased $41,248,000 (15.7%); combined with a decrease in yield of 22 basis points in the first nine months of 2010 compared to 2009.  Average balances decreased primarily due to charge offs, loans transferred to other real estate, receipt of scheduled payments and decreased loan origination activities.  The renewal of maturing loans in the current lower rate environment has exerted downward pressure on average loan portfolio yields.  Loan yields in 2010 continue to be negatively impacted by continued high average balances of nonperforming loans.  Management expects the average balance of nonperforming loans to continue to remain high in 2010, adversely impacting net interest income.  Moreover, competitive pressures as well as the weakened local economy have had, and are expected to continue to have, a negative impact on commercial balances and yields.  Interest Bearing Liabilities/Interest Expense Interest expense on deposits for the third quarter of 2010 decreased $482,000 (44.0%) compared to the third quarter of 2009.  This was the result of lower cost of funds due to lower interest rates paid on deposits of 48 basis points combined with lower average deposit balances of $51,237,000 (17.7%).  Interest expense on deposits for the first nine months of 2010 decreased $1,704,000 (46.2%) compared to 2009. This was a result of a decrease in the average interest rate paid on deposits of 59 basis points along with lower average balances of $52,214,000 (17.8%) in 2010 compared to 2009.  Borrowed funds average balance decreased $416,000 (100.0%) in the third quarter of 2010 compared to the third quarter of 2009. At September 30, 2010, the Bank had no outstanding borrowed funds.  Liquidity Liquidity risk is the risk of the Corporation being unable to meet current and future financial obligations in a timely manner. Liquidity is managed to ensure stable, reliable and cost-effective sources of funds to satisfy demand for credit, deposit withdrawals and investment opportunities. The Corporation relies primarily on a large, stable core deposit base to manage liquidity risk.  Additionally, the Corporation has access to certain wholesale funding sources (as discussed below) to manage unexpected liquidity needs.  The Corporation identifies, measures and monitors its liquidity profile. The profile is evaluated daily, weekly and monthly by analyzing the composition of all funding sources, reviewing projected liquidity commitments and identifying sources and uses of funds. A contingency funding plan is also prepared that details the potential erosion of funds in the event of systemic financial market crisis or institution-specific stress. In addition, the overall management of the Corporations liquidity position is integrated into retail deposit pricing policies to ensure a stable core deposit base.  Asset liquidity for financial institutions typically consists of cash and cash equivalents, certificates of deposit and investment securities available for sale. These categories totaled $61.5 million at September 30, 2010 or about 19.9% of total assets. This compares to $59.7 million or about 18.0% of total assets at year end 2009.  Liquidity is important for financial institutions because of their need to meet loan funding commitments and depositor withdrawal requests. Liquidity can vary significantly on a daily basis based on customer activity.  Of the Corporations available liquidity at September 30, 2010, investment securities with a fair value of approximately $15,323,000 were pledged to secure public deposits, to provide FHLBI borrowing capacity and for other purposes as required or permitted by law.  Deposits are the principal source of funds for the Bank.  Management monitors rates at other financial institutions in the area to ascertain that its rates are competitive in the market.  Management also attempts to offer a wide variety of products to meet the needs of its customers.  The makeup of the Banks Large Certificates, which are generally considered to be more volatile and sensitive to changes in rates, consist principally of local depositors known to the Bank. The Bank had Large Certificates totaling approximately $42,000,000 at September 30, 2010 and $46,000,000 at December 31, 2009.  The Bank had $3.4 million of brokered deposits at September 30, 2010.  Due to the Banks capital classification as undercapitalized at September 30, 2010, these brokered deposits may not be renewed or additional brokered deposits issued without prior approval of the Federal Deposit Insurance Corporation (FDIC).  See Capital section of this Managements Discussion and Analysis for further details.
  15


---



It is Bank managements intention to handle unexpected liquidity needs through its cash and cash equivalents, FHLBI borrowings, or Federal Reserve discount borrowings. The Bank had a $12,400,000 line of credit available at the FHLBI for which the Bank has pledged agency securities and certain commercial and consumer loans secured by residential real estate.  As of September 30, 2010, the Bank had no borrowings against the line. The Bank also had a $32,000,000 line of credit available at the Federal Reserve for which the Bank has pledged certain commercial loans as collateral.  At September 30, 2010, no borrowings were outstanding against the line.  Although the Bank has established these lines of credit, because of its undercapitalized status, any borrowing requests are subject to review (i.e., for purpose and repayment ability) by the FHLBI and Federal Reserve.  Consequently, full borrowing availability under these existing lines may be restricted at the lenders discretion.  In addition, due to the Banks capital position, FHLBI borrowings must be repaid within 14 to 30 days and Federal Reserve discount borrowings are currently limited to overnight advances.  If necessary, the Bank could also satisfy unexpected liquidity needs through repurchase agreements which would allow it to borrow from a broker, pledging investment securities as collateral.  Interest Rate Risk Interest rate risk is the potential for economic losses due to future rate changes and can be reflected as a loss of future net interest income and/or a loss of current market values. The Corporations Asset/Liability Management Committees (ALCO) objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Tools used by management include the standard GAP report which reflects the repricing schedule for various asset and liability categories and an interest rate shock simulation report. The Bank has no market risk sensitive instruments held for trading purposes. However, the Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers including commitments to extend credit and letters of credit. A commitment or letter of credit is not recorded as an asset until the instrument is exercised.  The table below shows the scheduled maturity and repricing of the Corporations interest sensitive assets and liabilities as of September 30, 2010: (in thousands)0-3
     
     
     
     4-12
     
     
     
     1-5
     
     
     
     5+Interest Rate Sensitivity
     
     Months
     
     
     
     Months
     
     
     
     Years
     
     
     
     Years
     
     
     
     TotalAssets:Loans
     $
     94,386
     
     
     $
     65,818
     
     
     $
     79,810
     
     
     $
     1,430
     
     
     $
     241,444Securities
     
     2,292
     
     
     
     2,748
     
     
     
     11,707
     
     
     
     7,017
     
     
     
     23,764Short term investments
     
     196
     
     
     
     -
     
     
     
     -
     
     
     
     -
     
     
     
     196Total rate sensitive assets
     $
     96,874
     
     
     $
     68,566
     
     
     $
     91,517
     
     
     $
     8,447
     
     
     $
     265,404Liabilities:NOW, Savings & MMDA
     $
     29,536
     
     
     $
     -
     
     
     $
     -
     
     
     $
     88,278
     
     
     $
     117,814Time deposits
     
     36,072
     
     
     
     54,039
     
     
     
     22,066
     
     
     
     26
     
     
     
     112,203Total rate sensitive liabilities
     $
     65,608
     
     
     $
     54,039
     
     
     $
     22,066
     
     
     $
     88,304
     
     
     $
     230,017Rate sensitivity GAP and ratios:GAP for period
     $
     31,266
     
     
     $
     14,527
     
     
     $
     69,451
     
     
     $
     (79,857
     )Cumulative gap
     
     31,266
     
     
     
     45,793
     
     
     
     115,244
     
     
     
     35,387Cumulative rate sensitive ratio
     
     1.48
     
     
     
     1.38
     
     
     
     1.81
     
     
     
     1.15December 31, 2009 rate sensitive ratio
     
     1.62
     
     
     
     1.51
     
     
     
     1.78
     
     
     
     1.19
   The preceding table sets forth the time periods in which earning assets and interest bearing liabilities will mature or may re-price in accordance with their contractual terms. The entire balance of savings including MMDA and NOW are not categorized as 0-3 months, although they are variable rate products.  Some of these balances are core deposits and are not considered rate sensitive.  Allocations are made to time periods based on the Banks historical experience and managements analysis of industry trends.  In the GAP table above, the short term (one year and less) cumulative interest rate sensitivity is 138% asset sensitive as of September 30, 2010.  Because of the Banks asset sensitive position, if market interest rates increase, this positive GAP position indicates that the interest margin would be positively affected. However, GAP analysis is limited and may not provide an accurate
  16


---



indication of the impact of general interest rate movements on the net interest margin since repricing of various categories of assets and liabilities is subject to the Banks needs, competitive pressures, and the needs of the Banks customers. In addition, various assets and liabilities indicated as repricing within the same period may in fact reprice at different times within the period and at different rate indices.  Due to these inherent limitations in the GAP analysis, the Corporation also utilizes simulation modeling, which measures the impact of upward and downward movements of interest rates on interest margin.  This modeling indicates that a 100 basis point gradual increase in interest rates would decrease net interest income by approximately 2.24% in the first year, while a 200 basis point increase in interest rates would decrease net interest income by approximately 2.98% in the first year. This is influenced by the assumptions regarding how quickly and to what extent liabilities will reprice with an increase in interest rates.  Loans (in thousands)Third Quarter
     
     
     
     Year-to-DateProvision for Loan Losses
     
     2010
     
     
     
     
     2009
     
     
     
     2010
     
     
     
     
     2009Total
     $
     1,200
     
     
     
     $
     1,750
     
     
     $
     3,600
     
     
     
     $
     14,647
  The Corporation recorded a provision of $1,200,000 in the third quarter of 2010 compared to $1,750,000 in the same period of 2009.  A provision of $3,600,000 was recorded for the nine months ended September 30, 2010 compared to a provision of $14,647,000 during the same period of 2009.  Each quarter management performs a detailed analysis of the loan portfolio to appropriately identify and quantify the credit risk to estimate losses inherent in the portfolio.   The evaluation considers identified problem loans, loss experience, current and future economic factors and other risk considerations impacting the portfolio at large to determine the required reserve level.  Given the significant portion of loans that are secured by real estate, our portfolio has been directly impacted by the economic downturn and deterioration of real estate values.  Quarterly, management performs a detailed review of the portfolio to insure that loans are appropriately risk rated and collateral is realistically valued.  Our practices for analysis and quantification of risk within various segments of our portfolio have improved the effectiveness of our problem loan identification procedures. Updated appraisals are obtained on criticized loans secured by real estate and appropriate discounting practices are applied based on perceived declines in market value.  Although updated appraisals received during the quarter indicated that property values for collateral on our impaired loans continue to be depressed, appraisals did not reflect the magnitude of decline in value relative to that experienced in prior quarters.  At present, the weak Michigan economy and historically high unemployment levels continue to delay signs of economic recovery in our market area.  Consequently, we have continued to allocate reserves for these risks and uncertainties, resulting in reserves well above normal levels.  At September 30, 2010, managements analysis determined that a reserve of $13,015,000 was required resulting in provision for loan loss expense of $1,200,000 and $3,600,000 for the three and nine month periods ended September 30, 2010, respectively.  Nonperforming loans at September 30, 2010 decreased $14,777,000 to $28,947,000 from the December 31, 2009 balance of $43,724,000, and decreased $17,011,000 from the September 30, 2009 balance of $45,958,000.  Nonperforming loans as a percentage of total loans were 11.99% at September 30, 2010 compared to 15.95% at December 31, 2009, and 16.17% at September 30, 2009.  The decrease in nonperforming loans during the first nine months of 2010 resulted from the combination of loans transferred to other real estate, charge offs, loans returned to accrual status and continued payments received on nonperforming loans, which in aggregate, exceeded newly identified nonperforming loans.  During the quarter ended September 30, 2010, total loan charge offs and transfers to other real estate amounted to $2,404,000 and $1,782,000, respectively.  Current quarter charge offs reflected losses primarily on commercial collateral dependent loans where specific reserves were partially or fully allocated in prior quarters.  Loan charge offs and transfers to other real estate totaled $3,283,000 and $1,079,000 during the quarter ended June 30, 2010, $4,646,000 and $2,710,000 during the quarter ended March 31, 2010 and $3,117,000 and $1,394,000 during the quarter ended September 30, 2009, respectively.  For the nine month periods, total charge offs and transfers to other real estate amounted to $10,333,000 and $5,571,000 through September 30, 2010 and $9,663,000 and $3,175,000 through September 30, 2009, respectively.  The following table reflects the composition of the commercial and consumer loans in the Consolidated Financial Statements.  Included in the residential first mortgage totals below are the real estate mortgage loans and other loans to customers who pledge their homes as collateral for their borrowings.  A portion of the loans listed in residential first mortgages represent commercial loans where the borrower has pledged his/her residence as collateral.  In the majority of the loans to commercial customers, the Bank is relying on the borrowers cash flow to service the loans.
  17


---



The following table shows the balance and percentage composition of loans as of: (in thousands)September 30, 2010
     
     
     December 31, 2009Secured by real estate:
     
     Balances
     
     
     Percent
     
     
     Balances
     
     
     
     PercentResidential first mortgage
     $
     25,490
     
     
     10.5
     %
     
     $
     29,719
     
     
     
     10.9
     %Residential home equity/other junior liens
     
     15,662
     
     
     6.5
     %
     
     
     17,606
     
     
     
     6.4
     %Construction, land development and other land loans
     
     21,459
     
     
     8.9
     %
     
     
     29,119
     
     
     
     10.6
     %Multifamily residential properties
     
     2,391
     
     
     1.0
     %
     
     
     2,556
     
     
     
     0.9
     %Owner-occupied nonfarm, nonresidential properties
     
     62,554
     
     
     25.9
     %
     
     
     66,078
     
     
     
     24.1
     %Other nonfarm, nonresidential properties
     
     92,768
     
     
     38.4
     %
     
     
     101,730
     
     
     
     37.1
     %Commercial
     
     15,100
     
     
     6.2
     %
     
     
     20,015
     
     
     
     7.3
     %Consumer
     
     4,809
     
     
     2.0
     %
     
     
     5,793
     
     
     
     2.1
     %Other
     
     1,418
     
     
     0.6
     %
     
     
     1,674
     
     
     
     0.6
     %Total gross loans
     
     241,651
     
     
     100.0
     %
     
     
     274,290
     
     
     
     100.0
     %Net unearned fees
     
     (207
     )
     
     
     
     
     
     (244
     )Total loans
     $
     241,444
     
     
     
     
     
     $
     274,046
  At September 30, 2010, loans secured by 1-4 family residential construction and other construction, land development and other land loans decreased a total of $7,660,000 (26.3%), loans secured by nonresidential properties (owner-occupied and other nonfarm properties) decreased $12,486,000 (7.4%), and commercial loans decreased $4,915,000 (24.6%) from December 31, 2009.  This is due primarily to charge offs, loans transferred to other real estate and the intentional run-off of such loans to reduce exposure within this segment of the loan portfolio.  The Corporations exposure to real estate secured loans continues as economic conditions and real estate values continue to be depressed.  If the economy continues to weaken and/or real estate values decline further, nonperforming loans may increase in subsequent quarters.  Due to the uncertainty of future current economic conditions and the decline in real estate values, the provision for loan losses for the balance of 2010 may continue to be impacted by the Banks concentration in real estate secured loans.  While we have considered these factors when determining the level of reserves, it is difficult to accurately predict future economic events, especially in the current environment.  Loans also include demand deposit overdrafts, which amounted to $96,000 and $128,000 at September 30, 2010 and December 31, 2009, respectively.  Nonperforming assets consist of loans accounted for on a nonaccrual basis, loans contractually past due 90 days or more as to interest or principal payments (but not included in nonaccrual loans), and other real estate which has been acquired primarily through foreclosure and is actively managed through the time of disposition to minimize loss.  Based on the existing level of problem loans, we anticipate that other real estate owned may increase as the Bank manages through the problem loan portfolio and borrowers continue to face financial difficulties and tight credit markets.  The aggregate amount of nonperforming loans and other nonperforming assets are presented below:  (in thousands)Nonperforming Assets
     
     September 30,
     
     
     
     December 31,
     
     
     
     September 30,2010
     
     
     
     2009
     
     
     
     2009Nonaccrual Loans
     $
     28,872
     
     
     $
     43,724
     
     
     $
     45,52890 days or more past due and still accruing
     
     75
     
     
     
     -
     
     
     
     430Total nonperforming loans
     
     28,947
     
     
     
     43,724
     
     
     
     45,958Other real estate owned
     
     7,419
     
     
     
     3,777
     
     
     
     2,966Total nonperforming assets
     $
     36,366
     
     
     $
     47,501
     
     
     $
     48,924Nonperforming loans as a percent of  total loans
     
     11.99
     %
     
     
     15.95
     %
     
     
     16.17
     %Allowance for loan losses as a percent of nonperforming loans
     
     45
     %
     
     
     43
     %
     
     
     42
     %Nonperforming assets as a percent of total loans
and other real estate owned
     
     14.61
     %
     
     
     17.10
     %
     
     
     17.03
     %
  18


---



The following table shows nonperforming loans by type of loan collateral and percentage composition of nonperforming loans as of: (in thousands)September 30,
     
     
     
     December 31,
     
     
     September 30,2010
     
     
     
     2009
     
     
     2009Nonperforming Loans
     
     Balance
     
     
     
     Percent
     
     
     
     Balance
     
     
     
     Percent
     
     
     
     Balance
     
     
     
     PercentSecured by real estate:Residential first mortgage
     $
     2,282
     
     
     
     7.9
     %
     
     $
     4,503
     
     
     
     10.3
     %
     
     $
     4,849
     
     
     
     10.6
     %Residential home equity/other junior liens
     
     770
     
     
     
     2.7
     %
     
     
     1,043
     
     
     
     2.4
     %
     
     
     1,060
     
     
     
     2.3
     %1-4 family construction loans
     
     1,792
     
     
     
     6.2
     %
     
     
     4,099
     
     
     
     9.4
     %
     
     
     5,201
     
     
     
     11.3
     %Other construction, land development and other land loans
     
     8,525
     
     
     
     29.4
     %
     
     
     11,638
     
     
     
     26.6
     %
     
     
     10,264
     
     
     
     22.3
     %Multifamily residential properties
     
     858
     
     
     
     3.0
     %
     
     
     997
     
     
     
     2.3
     %
     
     
     1,102
     
     
     
     2.4
     %Owner-occupied nonfarm, nonresidential properties
     
     7,781
     
     
     
     26.9
     %
     
     
     7,795
     
     
     
     17.8
     %
     
     
     8,009
     
     
     
     17.4
     %Other nonfarm, nonresidential properties
     
     4,680
     
     
     
     16.2
     %
     
     
     11,010
     
     
     
     25.2
     %
     
     
     12,246
     
     
     
     26.6
     %Commercial
     
     2,123
     
     
     
     7.3
     %
     
     
     2,586
     
     
     
     5.9
     %
     
     
     3,156
     
     
     
     6.9
     %Consumer
     
     10
     
     
     
     0.0
     %
     
     
     53
     
     
     
     0.1
     %
     
     
     71
     
     
     
     0.2
     %Other
     
     126
     
     
     
     0.4
     %
     
     
     -
     
     
     
     0.0
     %
     
     
     -
     
     
     
     0.0
     %Total nonperforming loans
     $
     28,947
     
     
     
     100.0
     %
     
     $
     43,724
     
     
     
     100.0
     %
     
     $
     45,958
     
     
     
     100.0
     %
  Management continually evaluates the condition of problem credits and when reduced cash flows coupled with collateral shortfalls are evident, the loans are placed on nonaccrual.  In addition, loans are generally placed on nonaccrual when principal or interest is past due ninety days or more.  If management believes there is significant risk of not collecting full principal and interest, we may elect to place the loan on nonaccrual even if the borrower is current.  Loans categorized as 90 days past due and still accruing are well secured and in the process of collection.  As of September 30, 2010, approximately $13,825,000 (47.8%) of nonperforming loans are making scheduled payments on their loans.  In addition, the level of nonperforming loans has decreased four consecutive quarters dating from September 30, 2009 to September 30, 2010.  The decrease results from the combination of charge offs recorded on collateral dependent loans, loans returned to accrual status pursuant to successful workout strategies and/or restructuring and continued payments received on nonperforming loans, which in aggregate, exceeded newly identified nonperforming loans.  Nonperforming loans are reviewed regularly for collectibility and uncollectible balances are promptly charged off.  At September 30, 2010, impaired loans totaled approximately $23,049,000 representing specifically identified loans in nonaccrual status, other than homogeneous smaller commercial, residential, and consumer loans, and included $6,652,000 of commercial troubled debt restructurings.  Specific reserves assigned to impaired loans at September 30, 2010 aggregated to $5,049,000 and impaired loans without specific reserve allocations totaled $5,923,000, indicating that the loans are well collateralized at this time.  Total troubled debt restructured loans at September 30, 2010 approximated $11,035,000.  Of those not included in impaired commercial loans noted above, $2,120,000 were accruing interest and in compliance with modified terms and $2,263,000, comprised principally of smaller commercial, consumer and residential mortgage loans with individual balances less than $250,000, remained in nonaccrual status at September 30, 2010.
  19


---



The following table summarizes the changes in the allowance for loan losses and reserve for unfunded credit commitments for the nine months of 2010 and 2009:  (in thousands)Components:
     
     2010
     
     
     
     2009Allowance for loan lossesBalance, beginning of year
     $
     18,665
     
     
     $
     14,122Loans charged off:Secured by real estate:Residential first mortgage
     
     619
     
     
     
     972Residential home equity/junior liens
     
     312
     
     
     
     1,1521-4 family residential construction loans
     
     1,592
     
     
     
     1,509Other construction and land development and other land loans
     
     2,368
     
     
     
     1,348Multifamily residential properties
     
     -
     
     
     
     62Owner-occupied nonfarm, nonresidential properties
     
     1,468
     
     
     
     206Other nonfarm, nonresidential properties
     
     3,331
     
     
     
     2,643Commerical
     
     452
     
     
     
     1,409Consumer
     
     191
     
     
     
     362Total charge offs
     
     10,333
     
     
     
     9,663Recoveries to loans previously charged off:Secured by real estate:Residential first mortgage
     
     7
     
     
     
     1Residential home equity/junior liens
     
     13
     
     
     
     301-4 family residential construction loans
     
     89
     
     
     
     113Other construction and land development and other land loans
     
     188
     
     
     
     -Other nonfarm, nonresidential properties
     
     570
     
     
     
     8Commerical
     
     75
     
     
     
     72Consumer
     
     141
     
     
     
     103Total recoveries
     
     1,083
     
     
     
     327Net loans charged off
     
     9,250
     
     
     
     9,336Additions to allowance charged to operations
     
     3,600
     
     
     
     14,663Balance, end of quarter
     
     13,015
     
     
     
     19,449Reserve for unfunded credit commitmentsBalance, beginning of year
     
     300
     
     
     
     316Additions to reserve charged to operations
     
     -
     
     
     
     (16
     )Balance, end of quarter
     
     300
     
     
     
     300Total allowance for loan losses and reserve forunfunded credit commitments
     $
     13,315
     
     
     $
     19,749Ratios:Net loans charged off (annualized) to average loans outstanding
     
     4.80
     %
     
     
     4.10
     %Allowance for loan losses to loans outstanding
     
     5.39
     %
     
     
     6.84
     %
   Management estimates the required allowance balance using past loan loss experience, the nature and volume of the portfolio segments and concentrations, information about specific borrower situations, estimated collateral values, economic conditions and trends, and other factors. Allocations of the allowance are made for specific loans, but the entire allowance is available for any loan that, in managements judgment, should be charged off.  Management continually analyzes portfolio risk to refine the process of effective risk identification and measurement for determination of the required allowance balance.  When all of these factors were considered, management determined that the $3,600,000 provision for the first nine months of 2010 and the $13,015,000 allowance as of September 30, 2010 were appropriate.
  20


---



(in thousands)Third Quarter
     
     
     
     Year-to-DateNoninterest Income
     
     2010
     
     
     
     
     2009
     
     
     
     2010
     
     
     
     
     2009Total
     $
     788
     
     
     
     $
     954
     
     
     $
     2,472
     
     
     
     $
     2,742
   Noninterest income, which includes service charges and other fee income, trust income, and other miscellaneous income, decreased by $166,000 (17.4%) during the third quarter of 2010 compared to the same quarter in 2009.  Service charges and other fee income decreased $117,000 (13.9%) during the third quarter of 2010 compared to the third quarter of 2009 primarily due to lower returned check fees, service charges on deposits, service charges on sold mortgages, commercial loan late fees, commercial loan service charges, consumer loan late fees, ATM foreign fees  and mortgage application fees. These unfavorable variances were partially offset by higher network income.  Trust income decreased $34,000 (37.0%) in the third quarter of 2010 compared to the same period last year primarily due to a decrease in total assets under management, a greater percentage of investments in fixed income products and less nonrecurring consulting income.  Gain on available for sale securities of $16,000 in the third quarter of 2009 resulted from the sale of twelve municipal securities.  For the nine months ended September 30, 2010, noninterest income decreased $270,000 (9.8%) compared to same prior year period. The decrease resulted from lower service charges and other fees of $103,000 and a decrease in trust income of $72,000, each attributable to the respective factors identified above.  In addition, 2009 noninterest income benefited from a net gain on sale of securities of $92,000.   These unfavorable variances were partially offset by higher network income.   (in thousands)Third Quarter
     
     
     
     Year-to-DateNoninterest Expense
     
     2010
     
     
     
     
     2009
     
     
     
     2010
     
     
     
     
     2009Total
     $
     3,201
     
     
     
     $
     3,881
     
     
     $
     9,949
     
     
     
     $
     11,939
     Noninterest expense decreased $680,000 (17.5%) in the third quarter of 2010 compared to the same quarter in 2009.  Salaries and employee benefits decreased $368,000 (23.1%) in the third quarter of 2010 compared to the same quarter of 2009.  The decrease in compensation related expenses resulted from lower staffing levels in 2010 and modifications to employee health insurance plan coverage.  Specifically, total savings included $202,000 in salaries and wages, $18,000 in FICA taxes and $15,000 in group medical insurance. In addition, the Corporation discontinued its retirement plan contributions 2010 resulting in a third quarter savings of $73,000 over the same prior year period.  Occupancy expense increased $15,000 (5.5%) in the third quarter of 2010 compared to the same quarter of 2009 primarily due to increases of $21,000 in repairs and maintenance, $5,000 in utilities and $3,000 in building services, partially offset by a decrease of $16,000 in depreciation expense. Repairs and maintenance increased due to higher exterior maintenance costs incurred in 2010 compared to 2009. Utilities are higher due to the warmer summer weather in 2010 compared to 2009. Building services were higher due to increase in lawn maintenance costs in 2010. Depreciation expense is lower due to Main Office building renovations becoming fully depreciated.  Equipment expense decreased $14,000 (14.7%) in the third quarter of 2010 compared to the same quarter in 2009  due to lower equipment maintenance of $6,000 and lower depreciation expense of $8,000 as a result of equipment at the Operations Center becoming fully depreciated.  Professional and service fees decreased $78,000 (14.6%) in the third quarter of 2010 compared to the same quarter in 2009.  Over the respective three month periods, legal fees decreased $50,000 primarily due to a decrease in the volume of nonperforming loans and less corporate legal assistance required by the Bank.  In addition, audit and accounting fees decreased $19,000 due to a lower 2010 engagement fee and other audit fee adjustments related to the impact of the Dodd-Frank Legislation on smaller public companies.  FDIC assessment fees decreased $152,000 (29.8%) in the third quarter of 2010 compared to the same quarter in 2009 due to lower deposit balances in 2010 compared to 2009 and a premium adjustment of $104,000 recorded in the third quarter of 2009.  The impact of these factors was partially offset by higher assessment rates imposed on the Bank beginning in the second quarter of 2009 and continuing during 2010.
  21


---



Insurance expense increased $31,000 (20.4%) in the third quarter of 2010 compared to the same quarter in 2009 reflecting the Banks regulatory and financial risk profile and the timing of the Corporations insurance renewal period.  The elevated premium expense continues to reflect an increase in the known and perceived risk, overall instability and economic uncertainty of the community banking industry.  Printing and supplies decreased $11,000 (24.9%) in the third quarter of 2010 compared to the same quarter in 2009 due to the timing of purchases.  Loan collection and foreclosed property expense decreased $337,000 (70.8%) in the third quarter of 2010 compared to 2009 primarily due to a decrease in the number of newly identified problem loans and an accelerated recognition of property tax expense on ORE properties in 2009.  This favorable decrease was partially offset by increased appraisal and ORE holding costs related to the existing problem loan portfolio and increased number of ORE properties in the third quarter of 2010 compared to the same prior year period.  For the three months ended September 30, 2010, net loss on sale/write down of OREO and repossessions totaled $82,000 and included $105,000 of valuation write downs on ORE properties and $23,000 of gains on sales of ORE properties and repossessed assets.  Other expenses increased $23,000 (14.9%) in the third quarter 2010 compared to the same quarter in 2009 primarily due to higher telephone expense and the completion of a use tax audit which identified use tax due on certain prior year purchases.  These unfavorable variances were offset by lower postage, back office losses and education.  For the first nine months of 2010, noninterest expense decreased $1,991,000 (16.7%) compared to 2009.  Salaries and employee benefits decreased $1,089,000 (21.7%) in 2010 compared to 2009. Of the decrease, $636,000 related to lower salaries and wages, $43,000 to lower FICA taxes, $9,000 to lower group life insurance and $46,000 to lower group medical insurance resulting from lower staffing levels in 2010, modifications to employee health insurance plan coverage, and severance benefits awarded to former employees during the first nine months of 2009.  Other decreases include a $23,000 reduction in employee benefits. In addition, the Corporation discontinued its retirement  contribution effective January 1, 2010, which resulted in a savings of $233,000 over the same prior year period.  Occupancy expense decreased $32,000 (3.8%) in 2010 compared to 2009 primarily due to decreases of $27,000 in building services and $42,000 in depreciation expense. Building services decreased due to lower snow removal costs in 2010 compared to 2009 and the closing of a branch facility in May 2009.  Depreciation expense is lower due to Main Office building renovations becoming fully depreciated in 2009.  These favorable decreases were partially offset by $17,000 of higher repairs and maintenance expense incurred for upkeep of branch facilities and $18,000 of higher utility costs related to warmer summer weather in 2010.  Equipment expense decreased $36,000 (12.5%) in 2010 compared to 2009 primarily due to lower depreciation expense as a result of equipment at the branches and the Operations Center becoming fully depreciated in 2009.  Professional and service fees decreased $289,000 (18.4%) in 2010 compared to 2009.  Legal fees decreased $136,000 as the volume of nonperforming loans trended lower and as the nature and amount of corporate legal fees related to regulatory issues and recapitalization efforts decreased in the first nine months of 2010 compared to same prior year period.   Consulting fees decreased $98,000 due to lower correspondent bank fees in 2010 and nonrecurring recruiting fees for certain new hires incurred in the same nine month period of 2009.  Audit and accounting fees decreased $47,000 primarily due to additional billings incurred in 2009 related to the 2008 audit and tax engagement as well as fee reductions related to the 2010 engagement. In addition, fees incurred by the Bank to provide cash management (sweep) services to customers decreased by $16,000 as underlying customer account balances declined over the respective nine month periods.  These decreases were partially offset by $28,000 of higher network fees in the first nine months of 2010 due to a large credit recognized in the first half of 2009 for switching vendors.  FDIC assessment fees decreased $215,000 (16.7%) in 2010 compared to 2009 primarily due to the one-time special assessment fee incurred in June 2009 of $172,000 as well as lower deposit levels during the first nine months of 2010 compared to 2009.  The favorable impact of these factors was partially offset by higher assessment rates imposed on the Bank during 2010.  Insurance expense increased $168,000 (47.0%) in 2010 compared to 2009 reflecting the Banks regulatory and financial risk profile and the timing of the Corporations insurance renewal period.  In addition, the elevated premium expense continues to reflect the known and perceived risk, overall instability and economic uncertainty of the community banking industry.  Printing and supplies decreased $32,000 (23.1%) in 2010 compared to 2009 due to the timing of purchases and tighter expense management.
  22


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Director fees decreased $10,000 (17.1%) in 2010 compared to 2009 due to fewer directors and reductions in director compensation.  Loan collection and foreclosed property expense decreased $189,000 (24.8%) in 2010 compared to 2009.  The decrease resulted primarily from fewer loan collection expenses incurred on problem loans as the velocity of newly identified problem loans has slowed in 2010.  This favorable decrease was partially offset by increased appraisal and ORE related expenses associated with continued management of the problem loan portfolio and an increase in number of ORE properties over the same prior year period. Despite the net decrease, these costs are expected to remain relatively high in the near term future as the Bank works through its elevated levels of other real estate holdings.  For the nine months ended September 30, 2010, net loss on sale/write down of OREO and repossessions was $254,000 and included $318,000 of valuation write downs on ORE properties and net gains of $64,000 on sales of ORE properties and repossessed assets.  Other expenses decreased $56,000 (9.4%) in 2010 compared to 2009 primarily due to lower expenses incurred for postage, advertising, meals and entertainment, business development, education and losses on fixed asset disposals during 2009  These favorable variances were offset by elevated losses on bad checks and higher use tax expense and telephone expense in 2010 compared to 2009.  (in thousands)Third Quarter
     
     
     
     Year-to-DateIncome Tax Expense (Benefit)
     
     2010
     
     
     
     
     2009
     
     
     
     2010
     
     
     
     
     2009Total
     $
     (69
     )
     
     
     $
     -
     
     
     $
     (70
     )
     
     
     $
     467
   In the third quarter of 2010, the Corporation recorded a federal income tax benefit to reduce its deferred tax valuation allowance established on previously recorded deferred tax assets.  The tax benefit resulted from adjustment of the deferred tax liability related to appreciation in the Corporations available for sale investment portfolio.    The Corporation also recorded a deferred tax valuation allowance on the tax benefit related to the loss recognized during the three and nine month periods ended September 30, 2010 and 2009 due to the uncertainty of future taxable income necessary to fully realize the recorded net deferred tax asset.  Capital The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can result in the initiation of certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct, material effect on the Corporations financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices.  The Corporations and the Banks capital classification are also subject to qualitative judgments by regulators with regard to components, risk weightings, and other factors.  The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required that the federal regulatory agencies adopt regulations defining five capital tiers for banks:  Total
Risk-Based
Capital Ratio
     Tier 1
Risk-Based
Capital Ratio
     Leverage RatioWell capitalized
     10% or above
     6% or above
     5% or aboveAdequately capitalized
     8% or above
     4% or above
     4% or aboveUndercapitalized
     Less than 8%
     Less than 4%
     Less than 4%Significantly undercapitalized
     Less than 6%
     Less than 3%
     Less than 3%Critically undercapitalized
     -
     -
     A ratio of tangible equity to total assets of 2% or less
  Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier 1 capital (as defined) to average assets (as defined).
  23


---



The Corporations and the Banks actual capital amounts and ratios are presented as of September 30, 2010 and December 31, 2009 in the following table:  Actual
     
     
     Minimum for
Capital Adequacy Purposes
     
     
     To be Well Capitalized
Under Prompt Corrective
Action ProvisionAs of September 30, 2010
     
     
     Amount
     
     
     
     Ratio
     
     
     Amount
     
     
     
     Ratio
     
     
     Amount
     
     
     
     RatioTotal Capital (to risk weighted assets)Bank
     
     $
     15,412,000
     
     
     
     6.05
     %
     
     $
     20,380,000
     
     
     
     8
     %
     
     $
     25,475,000
     
     
     
     10
     %FNBH Bancorp
     
     
     15,352,000
     
     
     
     6.05
     %
     
     
     20,313,000
     
     
     
     8
     %
     
     
     N/A
     
     
     
     N/ATier 1 Capital (to risk weighted assets)Bank
     
     
     12,103,000
     
     
     
     4.75
     %
     
     
     10,190,000
     
     
     
     4
     %
     
     
     15,285,000
     
     
     
     6
     %FNBH Bancorp
     
     
     12,053,000
     
     
     
     4.75
     %
     
     
     10,156,000
     
     
     
     4
     %
     
     
     N/A
     
     
     
     N/ATier 1 Capital (to average assets)Bank
     
     
     12,103,000
     
     
     
     3.90
     %
     
     
     12,399,000
     
     
     
     4
     %
     
     
     15,499,000
     
     
     
     5
     %FNBH Bancorp
     
     
     12,053,000
     
     
     
     3.89
     %
     
     
     12,399,000
     
     
     
     4
     %
     
     
     N/A
     
     
     
     N/A
  As of December 31, 2009
     
     
     Amount
     
     
     
     Ratio
     
     
     Amount
     
     
     
     Ratio
     
     
     Amount
     
     
     
     RatioTotal Capital (to risk weighted assets)Bank
     
     $
     17,934,000
     
     
     
     6.46
     %
     
     $
     22,195,000
     
     
     
     8
     %
     
     $
     27,743,000
     
     
     
     10
     %FNBH Bancorp
     
     
     17,924,000
     
     
     
     6.46
     %
     
     
     22,195,000
     
     
     
     8
     %
     
     
     N/A
     
     
     
     N/ATier 1 Capital (to risk weighted assets)Bank
     
     
     14,275,000
     
     
     
     5.15
     %
     
     
     11,097,000
     
     
     
     4
     %
     
     
     16,646,000
     
     
     
     6
     %FNBH Bancorp
     
     
     14,265,000
     
     
     
     5.14
     %
     
     
     11,097,000
     
     
     
     4
     %
     
     
     N/A
     
     
     
     N/ATier 1 Capital (to average assets)Bank
     
     
     14,275,000
     
     
     
     4.25
     %
     
     
     13,435,000
     
     
     
     4
     %
     
     
     16,794,000
     
     
     
     5
     %FNBH Bancorp
     
     
     14,265,000
     
     
     
     4.25
     %
     
     
     13,435,000
     
     
     
     4
     %
     
     
     N/A
     
     
     
     N/A  The OCC has established the following minimum capital standards for national banks: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total average assets of 3% for the most highly-rated banks, with minimum requirements of 4% to 5% for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. Tier 1 capital consists principally of shareholders equity. These capital requirements are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions.  Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions.  On September 24, 2009, the Bank consented to the issuance of a Consent Order (the Consent Order) with the OCC.  Pursuant to the Consent Order, the Bank was required to achieve and maintain total capital equal to 11% of risk weighted assets and Tier 1 capital equal to at least 8.5% of adjusted total assets by January 22, 2010.  The Bank failed to meet these required minimum ratios by such date and is currently out of compliance with these required capital ratios as well as other requirements of the Consent Order.  At September 30, 2010, based on the above minimum capital requirements, the Corporation and its subsidiary Bank are classified as undercapitalized.  Under the terms of the Consent Order with the OCC, referenced above, the Bank submitted to the OCC a capital restoration plan and capital plan (collectively, the Plan).  The OCC has determined that the Plan is not acceptable, principally due to the fact that the OCC is unable to determine that the Plan is realistic and likely to succeed in restoring the Banks capital, based upon the information provided in the Plan.  As noted below, the Bank intends to update the Plan and continue to pursue its capital raising efforts as well as resubmit the Plan to the OCC.  As a result of its failure to submit an acceptable plan to the OCC within the permitted time, for purposes of Prompt Corrective Action (PCA) the Bank is now treated as if it were significantly undercapitalized.  As a result of this classification, for purposes of PCA, the Bank is subject to a number of additional restrictions.  These include, among other things, (1) the requirement that the Bank obtain prior written approval of the OCC before paying any bonus or increase in the compensation of any senior executive officer of the Bank, (2) prohibitions on the acceptance of employee benefit plan deposits, and (3) restrictions on interest rates paid on deposits.
  24


---



As of September 30, 2010, the Banks capital ratios are significantly below the increased minimum requirements imposed by the OCC.  In light of the Banks continued losses and capital position at September 30, 2010, it is reasonable to anticipate further regulatory oversight or enforcement action by the OCC or FDIC.  Based on the Banks current financial condition, asset quality issues, and capital ratios, management estimates that the Bank needs to raise a minimum of approximately $16 million of additional capital to comply with the OCCs capital directive and provide sufficient capital resources and liquidity to meet commitments and business needs.  Management and the Board continue to meet with potential investors in an attempt to raise the additional equity believed necessary to sufficiently recapitalize the Bank.  The size of the institution and other factors are likely to limit our ability to access the public capital markets.  As such, the Corporations alternatives for additional capital are somewhat limited.  The ongoing liquidity concerns in the broader market and the loss of confidence in financial institutions will likely serve to only further increase our cost of funding and further limit our access to capital.  We may not be able to raise the necessary capital on favorable terms, or at all.  An inability to raise capital would likely have a materially adverse effect on our business, financial condition and results of operations.  The Corporations ability to pay dividends is subject to various regulatory and state law requirements. Due to the Banks financial condition, the Bank cannot pay a dividend to the Corporation without the prior approval of the OCC. The Corporation suspended, indefinitely, the payment of dividends in the third quarter of 2008 due to the Banks inability to pay dividends to the holding company and insufficient cash at the holding company to pay the dividends.  Critical Accounting Policies The Corporation maintains critical accounting policies for the allowance for loan losses.  Refer to Notes 1c and 1d of the December 31, 2009 Consolidated Financial Statements as included in Form 10-K for additional information on critical accounting policies.  Contractual Obligations The Bank had outstanding irrevocable standby letters of credit, which carry a maximum potential commitment of approximately $92,000 at September 30, 2010, $200,000 at December 31, 2009 and $198,000 at September 30, 2009.  These letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.  The majority of these letters of credit are short-term guarantees of one year or less, although some have maturities which extend as long as two years.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.  The Bank primarily holds real estate as collateral supporting those commitments for which collateral is deemed necessary.  The extent of collateral held on those commitments at September 30, 2010, December 31, 2009 and September 30, 2009, where there is collateral, was in excess of the committed amount.  A letter of credit is not recorded on the balance sheet unless a customer fails to perform.  New Accounting Standards In July 2010, FASB issued ASU No. 2010-20,Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The ASU amends FASB Accounting Standards Codification Topic 310, Receivables, to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate, by portfolio segment or class of financing receivable, certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010.  In January 2010, the FASB issued ASU 2010-06,Improving Disclosures about Fair Value Measurements. This standard requires new disclosures on the amount and reason for transfers in and out of Level 1 and 2 recurring fair value measurements. The standard also requires disclosure of activities (i.e., on a gross basis), including purchases, sales, issuances, and settlements, in the reconciliation of Level 3 fair value recurring measurements. The standard clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. The new disclosures regarding Level 1 and 2 fair value measurements and clarification of existing disclosures are effective for periods beginning after December 15, 2009. The disclosures about the reconciliation of information in Level 3 recurring fair value measurements are required for periods beginning after December 15, 2010. Upon adoption of the applicable portions of this standard on January 1, 2010, we provided the required disclosures as presented in Note 6.  For those additional disclosures required for fiscal years beginning after December 15, 2010, we anticipate first including those disclosures in our Form 10-Q for the period ending March 31, 2011.  In December 2009, the FASB issued ASU 2009-16,Accounting for Transfers of Financial Assets(formerly Statement No. 166,Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140). This standard amends the guidance on accounting for transfers of financial assets, including securitization transactions, where entities have
  25


---



continued exposure to risks related to transferred financial assets. This standard also expands the disclosure requirements for such transactions. It is effective as of the beginning of the first annual reporting period that begins after November 15, 2009.   The adoption of this standard on January 1, 2010 had no impact on our results of operations or financial position.  Recent Legislative Developments In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law.  Uncertainty remains as to the ultimate impact of the new law, which could have a material adverse impact either on the financial services industry as a whole, or on the Corporations and Banks business, results of operations and financial condition.  This new federal law contains a number of provisions that could affect the Corporation and the Bank.  For example, the law:  ·Makes national banks (such as the Bank) and their subsidiaries subject to a number of state laws that were previously preempted by federal laws;  ·Imposes new restrictions on how mortgage brokers and loan originators may be compensated;  ·Establishes a new federal consumer protection agency that will have broad authority to develop and implement rules regarding most consumer financial products;  ·Creates new rules affecting corporate governance and executive compensation at all publicly traded companies (such as the Corporation);  ·Broadens the base for FDIC insurance assessments and makes other changes to federal deposit insurance, including permanently increasing FDIC deposit insurance coverage to $250,000; and  ·Allows depository institutions to pay interest on business checking accounts  Many of these provisions are not yet effective and are subject to implementation by various regulatory agencies.  As a result, the actual impact this new law will have on the Bank's business is not yet known.  However, this law and any other changes to laws applicable to the financial industry may impact the profitability of the Bank's business activities or change certain of its business practices and may expose the Corporation and the Bank to additional costs, including increased compliance costs, and require the investment of significant management attention and resources.  As a result, this law may negatively affect the business and future financial performance of the Corporation and the Bank.  Item 3.  Quantitative and Qualitative Disclosures About Market Risk  There has been no material change in the market risk faced by the Corporation since December 31, 2009.  For information regarding our risk factors, refer to the FNBH Bancorp, Inc. Form 10-K for the year ended December 31, 2009 and subsequently filed quarterly reports on Form 10-Q.  Item 4.  Controls and Procedures  (a)Evaluation of Disclosure Controls and Procedures. With the participation of management, the Corporations chief executive officer and chief financial officer, after evaluating the effectiveness of the Corporations disclosure controls and procedures (as defined in Exchange Act Rules 13a  15(e) and 15d  15(e)) for the period ended September 30, 2010, have concluded that, as of such date, the Corporations disclosure controls and procedures were effective.  (b)Changes in Internal Control Over Financial Reporting. During the quarter ended September 30, 2010 there were no changes in the Corporations internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.  PART II - OTHER INFORMATION  Item 1A.  Risk Factors  There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors of the Corporation's Annual Report on Form 10-K for the year ended December 31, 2009, except as follows:  The Dodd-Frank Wall Street Reform and Consumer Protection Act may affect the Bank's business, financial condition, and future results of operations and may make it more difficult for the Corporation to raise capital in order to meet the minimum capital levels required by federal bank regulatory authorities and otherwise restore its capital.  In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law.  This new federal law contains a number of provisions that could affect the Corporation and the Bank.  For example, the law:
  26


---



·Makes national banks (such as the Bank) and their subsidiaries subject to a number of state laws that were previously preempted by federal laws;  ·Imposes new restrictions on how mortgage brokers and loan originators may be compensated;  ·Establishes a new federal consumer protection agency that will have broad authority to develop and implement rules regarding most consumer financial products;  ·Creates new rules affecting corporate governance and executive compensation at all publicly traded companies (such as the Corporation); and  ·Broadens the base for FDIC insurance assessments and makes other changes to federal deposit insurance.  Many of these provisions are not yet effective and are subject to implementation by various regulatory agencies.  As a result, the actual impact this new law will have on the Bank's business is not yet known.  However, this law and any other changes to laws applicable to the financial industry may impact the profitability of the Bank's business activities or change certain of its business practices and may expose the Corporation and the Bank to additional costs, including increased compliance costs, and require the investment of significant management attention and resources.  As a result, this law may negatively affect the business and future financial performance of the Corporation and the Bank.  In addition, the restrictions imposed by this new law and the uncertainty regarding the way in which the law will be implemented may negatively affect the Corporation's current efforts to raise additional capital in order to meet minimum federal regulatory standards and to otherwise restore its capital levels.  Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds  All securities sold by the Corporation through the Employee Stock Purchase Plan and the Long-Term Incentive Plan during the quarter ended September 30, 2010 were registered under the Securities Act of 1933.  There were no repurchases of common stock by the Corporation for the three months ended September 30, 2010.  Item 6.  Exhibits  The following exhibits (listed by number corresponding to the Exhibit Table as Item 601 in Regulation S-K) are filed with this report:  31.1        Certificate of the Chief Executive Officer of FNBH Bancorp, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.  31.2        Certificate of the Chief Financial Officer of FNBH Bancorp, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.  32.1        Certificate of the Chief Executive Officer of FNBH Bancorp, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).  32.2        Certificate of the Chief Financial Officer of FNBH Bancorp, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).
  27


---



SIGNATURES  Pursuant to the requirements
of the Securities Exchange Act of 1934, the Registrant has duly caused this
Quarterly Report on Form 10-Q for the quarter ended September 30, 2010 to be signed on its behalf by the undersigned hereunto duly authorized.   FNBH BANCORP, INC./s/ Ronald L.
  Long
  Ronald L. Long
  President and Chief
  Executive Officer/s/ Mark J.
  Huber
  Mark J. Huber
  Chief Financial Officer
   Date:  November 12, 2010
  28


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