<PAGE>

                                                                      EXHIBIT 13

                           [MACKINAC FINANCIAL LOGO]

                               Mackinac Financial

                              2005 ANNUAL REPORT
<PAGE>
                                                                               .
                                                                               .
                                                                               .



TABLE OF CONTENTS

<TABLE>
<S>                                                                           <C>
To Our Shareholders.......................................................     1

Selected Financial Highlights.............................................     5

Five-Year Comparisons.....................................................     6

Quarterly Financial Summary...............................................     8

Report of Independent Registered Public Accounting Firm...................    10

Consolidated Balance Sheets...............................................    12

Consolidated Statements of Operations.....................................    13

Consolidated Statements of Changes in Shareholders' Equity................    14

Consolidated Statements of Cash Flows.....................................    15

Notes to Consolidated Financial Statements................................    17

Selected Financial Data...................................................    48

Summary Quarterly Financial Information...................................    49

Market Information........................................................    50

Forward-Looking Statements................................................    51

Management's Discussion and Analysis of Financial
   Condition and Results of Operations....................................    52

General Information ......................................................    74

Branch Locations .........................................................    75
</TABLE>

<PAGE>


TO OUR SHAREHOLDERS

                            (MACKINAC FINANCIAL LOGO)

March 30, 2006

Dear Shareholders,

This letter will provide additional insight into the performance of Mackinac
Financial Corporation for 2005. We will attempt to provide information that will
allow you to analyze where we have fallen short and where we have succeeded in
the execution of our strategic plan so that you can make informed judgments
about our prospects.

Our strategy is to deploy relationship bankers with "big bank" lending skills in
Oakland County, Michigan and other growing banking markets. In all of our
markets we will compete with excellent loan structuring skills so that we can
outperform the community banks and stay below the desired loan size profile of
the larger regional banks. We will also seek to maximize the productivity and
efficiency of our branch system to deliver the maximum amount of deposits at the
lowest funding cost possible to compliment loan growth.

2005 Year-in-Review

While 2005 was a year of solid accomplishments, as you know, we fell short of
our business plan. In retrospect, our recapitalization due diligence was flawed
for several reasons, which are noted below:

     -    We overestimated fee income by extrapolating retail account fees that
          in fact were associated with non-competitive products that were
          leaving the bank. We also underestimated the impact of the loss of
          revenue associated with branches that had recently been sold.

     -    We underestimated the costs associated with rehabilitating the Bank's
          image, such as signage and marketing literature/disclosures to convey
          a new brand campaign to new and existing customers.

     -    Costs associated with a necessary bank-wide computer conversion
          exceeded budgeted amounts due to unanticipated hardware write-downs
          and personnel/consultant costs.

     -    It took longer than expected to mesh credit cultures and build loan
          volume in Oakland County.

We started 2005 with loan balances that were $26.2 million lower than what we
expected. This was due to several factors, a late closing of our
recapitalization transaction, a $15 million sale of nonperforming loans in
December of 2004, excessive loan runoff and very little loan production during
the fourth quarter of 2004.

The chart below shows key assets, liabilities and our book value compared to our
original plan.

                               PLAN VERSUS ACTUAL

(dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                           As of December 31, 2004          As of December 31, 2005
                       ----------------------------------------------------------------
                         PLAN      ACTUAL    VARIANCE     PLAN      ACTUAL     VARIANCE
                       --------   --------   --------   --------   --------   ---------
<S>                    <C>        <C>        <C>        <C>        <C>        <C>
Loans                  $230,003   $203,832   $(26,171)  $320,987   $239,771   $ (81,216)
Assets                  319,775    339,497     19,722    408,789    298,722    (110,067)
Deposits                249,188    215,650    (33,538)   313,393    232,632     (80,761)
FHLB borrowings          35,689     83,555     47,866     59,004     35,000     (24,004)
Shareholders' equity     31,075     34,730      3,655     32,518     26,588      (5,930)
Book Value per share       9.06      10.13       1.07       9.48       7.76       (1.72)
</TABLE>



                                        1

<PAGE>

As we began 2005, it simply took us longer than expected to get our loan process
in Oakland County to gel and we realized that we needed some additional loan
talent in our Traverse City and Gaylord markets in Northern Michigan. The chart
below shows new loan production, exclusive of renewals to existing customers, by
market, by quarter.

                               NEW LOAN PRODUCTION

(dollars in thousands)

<TABLE>
<CAPTION>
                            First     Second    Third     Fourth     2005       2005
                           Quarter   Quarter   Quarter   Quarter    Actual      Plan
                           -------   -------   -------   -------   --------   --------
<S>                        <C>       <C>       <C>       <C>       <C>        <C>
REGION
Upper Peninsula             $6,861   $ 9,099   $ 9,090   $19,263   $ 44,313   $ 22,500
Northern Lower Peninsula       686    12,449     9,698    13,786     36,619     30,000
Oakland County               1,100    12,480    10,434    12,813     36,827     60,000
                            ------   -------   -------   -------   --------   --------
   TOTAL                    $8,647   $34,028   $29,222   $45,862   $117,759   $112,500
                            ======   =======   =======   =======   ========   ========
</TABLE>

As you can see, production has picked up in all markets. In Oakland County our
backlog continues to be very strong. Our commercial loan staffing by market and
employment data is shown below.

                            COMMERCIAL LENDING STAFF

<TABLE>
<CAPTION>
                                                        Number
                                                         of          Total          2005       2005 Year End
                                                       Lenders   Compensation   Originations    Outstandings
                                                       -------   ------------   ------------   -------------
                                                                                   (dollars in thousands)
<S>                                                    <C>       <C>            <C>            <C>
REGION
Upper Peninsula - Senior commercial lenders               1
                - Other commercial lenders                3        $381,000        $35,811        $30,082

Northern Lower Peninsula - Senior commercial lenders      1
                         - Other commercial lender        1        $283,000        $35,066        $32,118

Oakland County - Senior commercial lenders                1
               - Other commercial lenders                 2        $384,000        $35,471        $22,385
</TABLE>

We will continue to add loan staffing in markets where we can grow loans with
good credit quality and acceptable loan pricing with fee income. That being
said, our staffing model for 2006 calls for one or two additional commercial
lenders assuming our strong loan growth continues.

We are also pleased with the change in the mix of our loan portfolio. The
commercial loan runoff, totaling $46.8 million in 2005 that has negatively
impacted our growth projection, has improved our loan portfolio mix and quality.
The loans paid off in 2005 included $13.5 million of hotel loans and $6.1
million of gaming related loans. In addition we sold $2.2 million of
nonperforming loans in December of 2005. We also had a $1.1million payoff of a
classified credit. This payoff was achieved after we declined to renew the loan
on requested terms and indicated our intention to sell the loan. The agent bank
then decided to repurchase. We have been very proactive in taking the necessary
steps to improve the quality of our portfolio and are pleased with the results.

Loan quality has continued to improve. Nonperforming loans have decreased from
$4.307 million at December 31, 2004 to $114,000 on December 31, 2005.
Measurement ratios pertaining to credit quality are well below peer group
averages in all categories. The allowance for loan losses, at $6.1 million,
amounts to 2.55% of loans outstanding and over 5000% of nonperforming loans.
Late in 2005, we charged down our last piece of ORE in December by $200,000
after a sale transaction failed to close. We believe that we can sell this
remaining property without further loss.

Core deposits, which we define as demand deposits, interest bearing checking
accounts, money market savings accounts, and certificates of deposits that are
generated by our branch system, have started to grow in mid 2005. To accomplish
this turnaround took more time and money than we expected. Our marketing budget
for 2005 was $100,000, while actual marketing expenditures totaled $814,000. The
damage to the branch system in 2003 and 2004 was considerable. The reputation of
the institution was poor, account closings were extensive and funding costs were
increasing. Early in the year we realized that we needed a thorough makeover to
stem the damage. We renamed the bank, changed all of our signs, altered every
deposit product to bring about market place competitiveness and developed new
collateral material and


                                        2

<PAGE>

newspaper ads for our local markets. The results have been good. Changes in
dollars and number of accounts lost and added are shown below by quarter.

                            DEPOSIT ACCOUNT ACTIVITY

(dollars in thousands)

<TABLE>
<CAPTION>
                            1st       2nd       3rd       4th
                          Quarter   Quarter   Quarter   Quarter
                          -------   -------   -------   -------
<S>                       <C>       <C>       <C>       <C>
Deposit balance, change   $(2,282)   $6,034    $6,230   $19,364
Accounts opened               272       880       956     1,428
Accounts closed               461       748       603       867
                          -------    ------    ------   -------
   Net change                (189)      132       353       561
</TABLE>

The employee morale in our branch system is very strong and we will enter 2006
with positive momentum and competitive products. We are pleased by the trend but
need to continue to build low cost deposits. Most of our branches are about half
of the size in terms of core deposits that they were at their peak. Our goal is
to lower the operating and funding costs per core deposit dollar in each of our
branches by increasing deposits per employee and by lowering the cost of our
deposit mix. As shown above, core deposits have grown by $31.6 million since the
introduction of our new deposit products and rebranding early in 2005. We are
also counting on our branch in Oakland County Michigan that opened January 10,
2006 to help us bring in corporate operating deposit accounts. Marketing
expenditures for 2006 will be significantly lower and should average less than
$20,000 per month.

The other significant enabler for 2006 on the deposit side is the result of
improved competitiveness and efficiency that will follow our very successful
systems conversion to the Fiserv platform. This conversion was not in our
original plan. However, once we realized the necessity of a new platform we
completed the project on time and on budget on November 7, 2005. We took a one
time charge for conversion expenses of $815,000 in 2005. The Fiserv product line
provides us with world class competitive products, including cash management
capabilities for our corporate accounts. In addition, we expect annual cost
savings beginning in 2006 of approximately $500,000. This savings combines a
reduction in our charges for information technology and elimination of the
majority of our branch courier expense.

In 2005 we prepaid $48.6 million worth of FHLB advances and incurred a $4.320
million prepayment penalty. This action was in our original plan but we had
anticipated that it would occur in 2004, at closing. Our original assumption was
that we would prepay the $40 million of advances and incur a $ 6.8 million
penalty. During 2005 we modified that plan as interest rates increased, and
increased the amount to be paid off and realized a reduced penalty. We do not
anticipate further prepayments of these advances.

The prepayment of the expensive FHLB fixed rate advances coupled with an asset
sensitivity position on our balance sheet allowed our net interest margin to
exceed our plan in 2005. We had planned for a 3.10% NIM and our actual year to
date margin for 2005 amounted to 3.64%. This positive rate variance somewhat
offset our lower than expected balance sheet growth.

We missed our budget in fee income. During our planning of the recapitalization
program, we assumed a continuation of deposit fee levels from historical
standards. This proved to be a poor assumption because a majority of the fees
included in noninterest income were associated with non-competitive deposit
products. We had an account type that was generating high fees. Unfortunately,
when we began managing the bank, we realized that we were rapidly losing
customers due to deposit pricing. We subsequently decided to revamp our deposit
products and take a consumer oriented low fee approach to banking. This resulted
in noninterest income for 2005 of $1.111 million versus a plan of $2.048
million. The silver lining is that we are retaining existing accounts and adding
new ones which will generate additional fee opportunities in 2006 and beyond. In
2006, we will also be building fees in the consumer mortgage area and have
initiatives in the commercial mortgage and capital markets areas that we expect
to improve our performance.

Non-interest expenses are high for a bank our size, as a result of our Oakland
County initiative, and will remain relatively high until we grow our balance
sheet. During 2005 and in early 2006 we eliminated several executive positions
and reduced branch and other support staff, which will reduce personnel costs:
$1.057 million in 2006 and $1.147 million in 2007 and beyond. Our additions have
been, and will be focused on revenue production with few exceptions.


                                        3
<PAGE>

Our team is an excellent one. Our key personnel and their responsibilities
follow:

PAUL TOBIAS - Chairman and CEO of the bank and holding company. Overall
responsibility for return on equity, equity allocation and direction of the
bank. Member of the loan committee, asset liability committee and Chairman of
the management committee. Active in customer relationship development in Oakland
County.

ELIOT STARK - EVP and CFO of the bank and holding company. Responsible for asset
liability strategy and overseeing technology strategy. Chairman of the asset
liability committee, and member of the management committee. Active in customer
relationship development in Oakland County.

KELLY GEORGE - President and Chief Loan Officer. Responsible for the day to day
management of the bank, regulatory oversight, and oversees all lending functions
of the bank. Chairman of the loan committee and a member of the asset liability
committee and the management committee. Responsible for customer relationship
development in Northern Michigan.

DAVE CRIMMINS - SVP/Commercial Lender. Responsible for implementing our business
plan in Oakland County. Member of the loan committee, asset liability committee
and the management committee. Responsible for customer relationship development
in Oakland County.

ERNIE KRUEGER - SVP and Controller of the bank and holding company. Responsible
for the day to day management of the bank's finances and shares responsibility
for asset liability strategy. Is responsible for all SEC and bank regulatory
reporting. Vice Chairman of the asset liability committee and member of the
management committee.

ANN STEPP - VP Branch Administration/Operations. Responsible for day to day
management of our branch system. Member of the asset liability committee and the
management committee. Responsible for branch relationship development.

In keeping with our strategy we have made a significant investment in Oakland
County. That investment is summarized below. This table shows the annualized
personnel and occupancy costs for our Oakland County office. Clearly, we are not
yet breaking even in Oakland County but we are on our way towards proving that
the investments will produce excellent return on equity given our anticipated
rate of growth.

                          INVESTMENT IN OAKLAND COUNTY

<TABLE>
<CAPTION>
            Annualized
               Costs
            ----------
<S>         <C>
Salaries     $895,000
Benefits      224,000
Occupancy     240,000
</TABLE>

While 2005 presented us with a few surprises, I believe that we have met them
head on and have remained focused upon our business plan and disciplined in our
spending decisions and in our credit decision making process. Our investments
have positioned us for a profitable 2006. We are very conscious of the
importance for mBank and MFNC to achieve profitability and demonstrate that we
are on track to achieve a strong ROA and ROE performance in 2007 and beyond.

Sincerely,

/s/ Paul D. Tobias
Paul D. Tobias
Chairman and CEO


                                        4

<PAGE>

SELECTED FINANCIAL HIGHLIGHTS

(Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                        For The Years Ended December 31,
                                                        --------------------------------
                                                               2005          2004
                                                        --------------   ---------------
<S>                                                     <C>              <C>
SELECTED FINANCIAL CONDITION DATA (AT END OF PERIOD):
Total assets                                                $  298,722   $  339,497
Total loans                                                    239,771      203,832
Total deposits                                                 232,632      215,650
Borrowings                                                      36,417       85,039
Total shareholders' equity                                      26,588       34,730

SELECTED STATEMENTS OF INCOME:
Net interest income                                         $    9,780   $    8,238
Loss before taxes                                               (7,364)      (1,448)
Net loss                                                        (7,364)      (1,595)
Loss per common share - Basic                                    (2.15)       (3.23)
Loss per common share - Diluted                                  (2.15)       (3.23)

SELECTED FINANCIAL RATIOS AND OTHER:
PERFORMANCE RATIOS:
Net interest margin                                               3.64%        2.57%
Efficiency ratio                                                160.43       103.05
Return on average assets                                         (2.58)        (.44)
Return on average equity                                        (25.63)      (18.64)

Average total assets                                        $  285,896   $  365,024
Average total shareholders' equity                          $   28,732   $    8,555
Average loans to average deposits ratio                          98.17%       97.40%

COMMON SHARE (AT END OF PERIOD):
Market price per common share                               $     9.10   $    17.97
Book value per common share                                 $     7.76   $    10.13
Common shares outstanding                                    3,428,695    3,428,695
Weighted average shares outstanding                          3,428,695      494,305

OTHER (AT END OF PERIOD):
Allowance for loan losses                                   $    6,108   $    6,966
Non-performing assets                                       $    1,059   $    6,037
Allowance for loan losses to total loans                          2.55%        3.42%
Non-performing assets to total assets                              .35%        1.78%
Number of:
   Branch locations                                                 12           12
</TABLE>

The above summary should be read in connection with the related consolidated
financial statements and notes included elsewhere in this report.

          See accompanying notes to consolidated financial statements.


                                        5

<PAGE>

FIVE-YEAR COMPARISONS

                                     ASSETS
                             (DOLLARS IN MILLIONS)

                               (PERFORMANCE GRAPH)

<TABLE>
<CAPTION>
YEAR   DOLLARS
----   -------
<S>    <C>
2001    636.6
2002    565.3
2003    422.5
2004    339.5
2005    298.7
</TABLE>

ASSETS

Total assets on a consolidated basis decreased by 12.0% during 2005 to $298.7
million.

                                   SECURITIES
                              (DOLLARS IN MILLIONS)

                               (PERFORMANCE GRAPH)

<TABLE>
<CAPTION>
YEAR   DOLLARS
----   -------
<S>    <C>
2001     61.9
2002     68.0
2003     84.8
2004     57.1
2005     34.2
</TABLE>

SECURITIES

The portfolio of securities decreased during 2005 by 40.1% to $34.2 million.

                                      LOANS
                              (DOLLARS IN MILLIONS)

                               (PERFORMANCE GRAPH)

<TABLE>
<CAPTION>
YEAR   DOLLARS
----   -------
<S>    <C>
2001    504.4
2002    435.0
2003    297.8
2004    203.8
2005    239.8
</TABLE>

LOANS

Total loans increased 17.6% to $239.8 million in 2005.


                                        6

<PAGE>

FIVE-YEAR COMPARISONS(CONTINUED)

                                    DEPOSITS
                              (DOLLARS IN MILLIONS)

                               (PERFORMANCE GRAPH)

<TABLE>
<CAPTION>
YEAR   DOLLARS
----   -------
<S>    <C>
2001    482.5
2002    437.5
2003    305.8
2004    215.7
2005    232.6
</TABLE>

DEPOSITS

Total deposits increased by 7.9% to $232.6 million.

                              SHAREHOLDERS' EQUITY
                              (DOLLARS IN MILLIONS)

                               (PERFORMANCE GRAPH)

<TABLE>
<CAPTION>
YEAR   DOLLARS
----   -------
<S>    <C>
2001     47.9
2002     20.5
2003     10.7
2004     34.7
2005     26.6
</TABLE>

SHAREHOLDERS' EQUITY

During 2005, shareholders' equity decreased by $8.1 million, or 23.4% to $26.6
million.

                                NET INCOME (LOSS)
                              (DOLLARS IN MILLIONS)

                               (PERFORMANCE GRAPH)

<TABLE>
<CAPTION>
YEAR   DOLLARS
----   -------
<S>    <C>
2001      5.8
2002    -26.7
2003     -9.6
2004     -1.6
2005     -7.4
</TABLE>

NET INCOME (LOSS)

The net loss for 2005 was $7.4 million, as compared to $1.6 million for 2004.


                                        7


<PAGE>

                         MACKINAC FINANCIAL CORPORATION

                           QUARTERLY FINANCIAL SUMMARY

*    (Dollars in thousands, except per share data)

<TABLE>
<CAPTION>
                                                     Average     Return on Average
                     Average   Average   Average  Shareholders'  -----------------  Net Interest  Efficiency  Net Income  Book Value
Quarter Ended        Assets     Loans   Deposits      Equity     Assets   Equity       Margin       Ratio      Per Share   Per Share
-------------       --------  --------  --------  -------------  ------   ------    ------------  ----------  ----------  ----------
<S>                 <C>       <C>       <C>       <C>            <C>      <C>       <C>           <C>         <C>         <C>
December 31, 2005   $288,619  $224,386  $219,967     $27,288     (1.41)%  (14.95)%      3.96%       128.37%     $(0.30)     $ 7.76
September 30, 2005   280,506   209,795   211,197      28,112     (0.73)    (7.39)       3.79        112.11       (0.15)       8.14
June 30, 2005        277,754   197,545   206,875      28,879     (0.83)    (8.01)       3.67        119.07       (0.17)       8.32
March 31, 2005       296,856   199,703   209,035      30,692     (7.16)   (69.25)       3.21        300.96       (1.53)       8.42
December 31, 2004    327,543   218,962   211,685       8,455      2.95    114.17        2.48         71.83        8.25       10.13
September 30, 2004   346,078   226,951   236,418       6,096     (0.87)   (49.53)       2.25        120.66       (2.17)      18.44
June 30, 2004        372,246   244,515   260,031       7,628     (1.72)   (84.13)       2.28        146.88       (4.56)      16.77
March 31, 2004       412,808   289,027   283,190       9,522     (1.62)   (70.22)       2.04        163.37       (4.75)      26.70
December 31, 2003    439,426   309,851   306,848      11,266     (2.23)   (86.77)       1.70        181.17       (7.02)      30.49
</TABLE>

*    Historical per share data has been adjusted for the 20:1 reverse stock
     split distributed in December 2004.

                                  TOTAL LOANS
                             (Dollars in Thousands)

                              (PERFORMANCE GRAPH)

<TABLE>
<CAPTION>
At period end   Dollars
-------------   -------
<S>             <C>
     12/31/03   297,846
      3/31/04   255,021
      6/30/04   233,032
      9/30/04   221,595
     12/31/04   203,832
      3/31/05   194,831
      6/30/05   204,503
      9/30/05   218,462
     12/31/05   239,771
</TABLE>

                                 TOTAL DEPOSITS
                             (Dollars in Thousands)

                              (PERFORMANCE GRAPH)

<TABLE>
<CAPTION>
At period end   Dollars
-------------   -------
<S>             <C>
     12/31/03   305,794
      3/31/04   287,072
      6/30/04   235,646
      9/30/04   223,110
     12/31/04   215,650
      3/31/05   205,239
      6/30/05   207,814
      9/30/05   213,268
     12/31/05   232,632
</TABLE>

                              NONPERFORMING ASSETS
                             (Dollars in Thousands)

                              (PERFORMANCE GRAPH)

<TABLE>
<CAPTION>
At period end   Dollars
-------------   -------
<S>             <C>
     12/31/03   50,438
      3/31/04   22,942
      6/30/04   16,819
      9/30/04   11,655
     12/31/04    6,037
      3/31/05    3,787
      6/30/05    3,273
      9/30/05    3,905
     12/31/05    1,059
</TABLE>


                                       8

<PAGE>

BUSINESS OF THE CORPORATION

Mackinac Financial Corporation is a registered bank holding company formed under
the Bank Holding Company Act of 1956, as amended. The principal assets of the
Corporation are its ownership of all of the outstanding capital stock of mBank,
North Country Capital Trust, First Rural Relending Company, and First Manistique
Agency. mBank, headquartered in Manistique, Michigan, provides a full range of
commercial and retail banking services to customers in Michigan. mBank owns
mBank Mortgage Company, LLC, mBank Employee Services Company, LLC, and NCB Real
Estate Company. mBank Mortgage Company, LLC is engaged in the business of
mortgage lending and brokering. mBank Employee Services Company, LLC provides
employees to mBank. NCB Real Estate Company owns several properties used by the
Bank. North Country Capital Trust was formed solely for the issuance of trust
preferred securities. First Rural Relending Company is a rural lending
corporation. First Manistique Agency has limited activity and was formed for the
selling of insurance.

FORM 10-K

A COPY OF THE ANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION ON FORM
10-K IS AVAILABLE WITHOUT CHARGE BY WRITING THE SHAREHOLDERS' RELATIONS
DEPARTMENT, MACKINAC FINANCIAL CORPORATION, 130 SOUTH CEDAR STREET, MANISTIQUE,
MICHIGAN, 49854.

MARKET SUMMARY

The Corporation's common stock is traded on the Nasdaq Small Cap Market under
the symbol MFNC. The Corporation had 1,825 shareholders of record as of March
24, 2006.


                                       9

<PAGE>

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
                             TO THE SHAREHOLDERS OF
                         MACKINAC FINANCIAL CORPORATION
                              MANISTIQUE, MICHIGAN


                                       10

<PAGE>
[PLANTE & MORAN LOGO]                                       PLANTE & MORAN, PLLC
                                                                       Suite 500
                                                            2601 Cambridge Court
                                                          Auburn Hills, MI 48326
                                                               Tel: 248.375.7100
                                                               Fax: 248.375.7101
                                                                 plantemoran.com


            REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

Mackinac Financial Corporation

Manistique, Michigan

We have audited the accompanying consolidated balance sheet of Mackinac
Financial Corporation and Subsidiaries as of December 31, 2005 and December 31,
2004 and the related consolidated statements of income, stockholders' equity,
and cash flows for each year in the three year period ended December 31, 2005.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Mackinac Financial
Corporation and Subsidiaries as of December 31, 2005 and December 31, 2004 and
the consolidated results of its operations and its cash flows for each year in
the three year period ended December 31, 2005, in conformity with U.S. generally
accepted accounting principles.

                                                        /s/ PLANTE & MORAN, PLLC


Auburn Hills, Michigan

March 4, 2006

                                                                     A MEMBER OF
                                                                      [MRI LOGO]
                         A WORLDWIDE ASSOCIATION OF INDEPENDENT ACCOUNTING FIRMS


                                       11
<PAGE>

CONSOLIDATED BALANCE SHEETS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
                           December 31, 2005 and 2004
                  (Dollars in Thousands, Except Per Share Data)

<TABLE>
<CAPTION>
                                                                                2005       2004
                                                                              --------   --------
<S>                                                                           <C>        <C>
                                              ASSETS

Cash and due from banks                                                       $  4,833   $  4,230
Federal funds sold                                                               3,110     39,848
                                                                              --------   --------
   Cash and cash equivalents                                                     7,943     44,078
Interest-bearing deposits in other financial institutions                        1,025     18,535
Securities available for sale                                                   34,210     57,075
Federal Home Loan Bank stock                                                     4,855      4,754
Total loans                                                                    239,771    203,832
   Allowance for loan losses                                                    (6,108)    (6,966)
                                                                              --------   --------
Net loans                                                                      233,663    196,866
Premises and equipment                                                          11,987     10,739
Other real estate held for sale                                                    945      1,730
Other assets                                                                     4,094      5,720
                                                                              --------   --------
TOTAL ASSETS                                                                  $298,722   $339,497
                                                                              ========   ========

                               LIABILITIES AND SHAREHOLDERS' EQUITY

Liabilities:
   Noninterest-bearing deposits                                               $ 19,684   $ 20,956
   Interest-bearing deposits                                                   212,948    194,694
                                                                              --------   --------
   Total deposits                                                              232,632    215,650
   Borowings                                                                    36,417     85,039
   Other liabilities                                                             3,085      4,078
                                                                              --------   --------
      Total liabilities                                                        272,134    304,767
Shareholders' equity:
   Preferred stock - No par value:
      Authorized 500,000 shares, no shares outstanding                              --         --
   Common stock and additional paid in capital - No par value: Authorized -
      18,000,000 shares Issued and outstanding - 3,428,695 shares in 2005
      and 2004                                                                  42,412     42,335
   Accumulated deficit                                                         (15,461)    (8,097)
   Accumulated other comprehensive income (loss)                                  (363)       492
                                                                              --------   --------
      Total shareholders' equity                                                26,588     34,730
                                                                              --------   --------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY                                    $298,722   $339,497
                                                                              ========   ========
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       12

<PAGE>

CONSOLIDATED STATEMENTS OF OPERATIONS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
                  Years Ended December 31, 2005, 2004, and 2003
                  (Dollars in Thousands, Except Per Share Data)

<TABLE>
<CAPTION>
                                                        2005      2004      2003
                                                      -------   -------   -------
<S>                                                   <C>       <C>       <C>
Interest income:
   Interest and fees on loans:
      Taxable                                         $13,862   $14,517   $18,999
      Tax-exempt                                          928     1,180     1,534
   Interest on securities:
      Taxable                                           1,455     2,401     2,277
      Tax-exempt                                          167       171       230
   Other interest income                                  564       584       601
                                                      -------   -------   -------
      Total interest income                            16,976    18,853    23,641
                                                      -------   -------   -------
Interest expense:
   Deposits                                             5,259     5,443     8,695
   Borrowings                                           1,937     4,730     4,832
   Subordinated debentures                                 --       442       488
                                                      -------   -------   -------
      Total interest expense                            7,196    10,615    14,015
                                                      -------   -------   -------
Net interest income                                     9,780     8,238     9,626
                                                      -------   -------   -------
Provision for loan losses                                  --        --        --
Net interest income after provision for loan losses     9,780     8,238     9,626
                                                      -------   -------   -------
Other income:
   Service fees                                           586       982     1,529
   Loan and lease fees                                     21        17        58
   Net security gains                                      95        --       427
   Net gains on sale of loans                              49        39       136
   Gain on sale of branches                                --       205        --
   Gain on settlement of subordinated debentures           --     6,617        --
   Other                                                  360       682     1,081
                                                      -------   -------   -------
      Total other income                                1,111     8,542     3,231
                                                      -------   -------   -------
Other expenses:
   Salaries and employee benefits                       6,090     8,032     5,973
   Occupancy                                            1,053       994     1,387
   Furniture and equipment                                560       887     1,367
   Data processing                                      1,720     1,220     1,517
   Accounting, legal, and consulting fees                 886     1,836     3,145
   Loan and deposit                                       852     1,718     1,992
   Telephone                                              271       382     1,382
   Advertising                                            814       115       182
   Penalty on prepayment of FHLB borrowings             4,320        --        --
   Other                                                1,689     3,044     3,171
                                                      -------   -------   -------
      Total other expenses                             18,255    18,228    20,116
                                                      -------   -------   -------
Loss before provision for income taxes                 (7,364)   (1,448)   (7,259)
Provision for income taxes                                 --       147     2,329
                                                      -------   -------   -------
Net loss                                              $(7,364)  $(1,595)  $(9,588)
                                                      =======   =======   =======
Loss per common share:
   Basic                                              $ (2.15)  $ (3.23)  $(27.32)
                                                      =======   =======   =======
   Diluted                                            $ (2.15)  $ (3.23)  $(27.32)
                                                      =======   =======   =======
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       13

<PAGE>

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
                  Years Ended December 31, 2005, 2004, and 2003
                  (Dollars in Thousands, Except per Share Data)

<TABLE>
<CAPTION>
                                                                        Retained      Accumulated
                                        Shares of     Common Stock      Earnings         Other
                                          Common     and Additional   (Accumulated   Comprehensive
                                          Stock     Paid in Capital     Deficit)     Income (Loss)    Total
                                        ---------   ---------------   ------------   -------------   -------
<S>                                     <C>         <C>               <C>            <C>             <C>
BALANCE, DECEMBER 31, 2002                350,958       $16,175         $  3,086        $1,242       $20,503
Net loss                                                                  (9,588)                     (9,588)
Other comprehensive loss:
   Net unrealized loss on
      securities available for sale                                                       (215)         (215)
                                                                                        ------       -------
Total comprehensive loss                                                                              (9,803)

BALANCE, DECEMBER 31, 2003                350,958        16,175           (6,502)        1,027        10,700
Additional shares issued as a
   result of 1:20 reverse stock split         817
Common stock issuance                   3,076,920        26,160                                       26,160
Net loss                                                                  (1,595)                     (1,595)
Other comprehensive loss:
   Net unrealized loss on
      securities available for sale                                                       (535)         (535)
                                                                                        ------       -------
Total comprehensive loss                                                                              (2,130)

BALANCE, DECEMBER 31, 2004              3,428,695        42,335           (8,097)          492        34,730
Change in minority interest of
   consolidated subsidiary                                   77                                           77
Net loss                                                                  (7,364)                     (7,364)
Other comprehensive loss:
   Net unrealized loss on
      securities available for sale                                                       (855)         (855)
                                        ---------       -------         --------        ------       -------
Total comprehensive loss                                                                              (8,219)
BALANCE, DECEMBER 31, 2005              3,428,695       $42,412         $(15,461)       $ (363)      $26,588
                                        =========       =======         ========        ======       =======
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       14
<PAGE>

CONSOLIDATED STATEMENTS OF CASH FLOWS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
                  Years Ended December 31, 2005, 2004, and 2003
                             (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                               2005       2004       2003
                                                             --------   --------   --------
<S>                                                          <C>        <C>        <C>
Increase (decrease) in cash and cash equivalents:
   Cash flows from operating activities:
   Net loss                                                  $ (7,364)  $ (1,595)  $ (9,588)
                                                             --------   --------   --------
   Adjustments to reconcile net loss to
      net cash provided by (used in) operating activities:
      Provision for impairment of intangible assets                --         --         60
      Provision for impairment of other real estate
         held for sale                                            200        265        400
      Provision for impairment of bank premises
         and equipment                                             --         --        669
      Provision for depreciation and net
         amortization                                             918      1,580      2,546
      Provision (credit) for deferred taxes                        --        147       (543)
      FHLB stock dividend                                        (101)      (210)      (169)
      Net (gains) losses on sale of:
      Securities                                                  (96)        --       (427)
      Premises, equipment, and other real estate
         held for sale                                             51        459        356
      Branches                                                     --       (205)        --
      Change in other assets                                    1,501      4,021      6,881
      Change in other liabilities                                (993)    (2,491)      (475)
                                                             --------   --------   --------
      Total adjustments                                         1,480      3,566      9,298
                                                             --------   --------   --------
   Net cash (used in ) provided by operating activities        (5,884)     1,971       (290)
                                                             --------   --------   --------

Cash flows from investing activities:
   Net (increase) decrease in interest-bearing
      deposits in other financial institutions                 17,510    (12,487)    (4,038)
   Payment for purchases of securities available for sale     (16,009)   (21,910)   (70,680)
   Proceeds from sale of securities available for sale         30,811         --     36,601
   Proceeds from calls and maturities of securities
      available for sale                                        7,218     48,840     15,928
   Net (increase) decrease in loans                           (37,429)    74,265    129,589
   Proceeds from sale of premises, equipment,
      and other real estate held for sale                       1,437      8,732      4,620
   Capital expenditures                                        (2,226)      (150)        --
   Net cash paid for branch sales                                  --    (25,018)        --
   Purchase of minority interest in subsidiary of bank             77         --         --
                                                             --------   --------   --------
Net cash provided by investing activities                       1,389     72,272    112,020
                                                             --------   --------   --------
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       15

<PAGE>

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
                  Years Ended December 31, 2005, 2004, and 2003
                             (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                      2005       2004        2003
                                                    --------   --------   ---------
<S>                                                 <C>        <C>        <C>
Cash flows from financing activities:
   Net decrease in deposits                         $ 16,982   $(64,921)  $(131,700)
   Proceeds from issuance of borrowings                1,651        125          --
   Principal payments on borrowings                  (50,273)   (14,562)       (789)
   Proceeds from issuance of common stock                 --     26,160          --
                                                    --------   --------   ---------
   Net cash used in financing activities             (31,640)   (53,198)   (132,489)
                                                    --------   --------   ---------
Net increase (decrease) in cash and cash
   equivalents                                       (36,135)    21,045     (20,759)
Cash and cash equivalents at beginning of period      44,078     23,033      43,792
                                                    --------   --------   ---------
Cash and cash equivalents at end of period          $  7,943   $ 44,078   $  23,033
                                                    ========   ========   =========

Supplemental cash flow information:
Cash paid during the year for:
   Interest                                         $  7,260   $  8,405   $  14,456
   Income taxes paid or (refunded)                        --         --      (2,137)

Noncash investing and financing activities:
   Transfer of foreclosures from loans to
      other real estate held for sale                    632      4,762       4,340
   Transfer of property from other real estate to
      premises and equipment                            (358)        --          --

Assets and liabilities divested in branch sales:
   Loans                                                  --         11          --
   Premises and equipment                                 --      1,442          --
   Deposits                                               --     26,471          --
</TABLE>

          See accompanying notes to consolidated financial statements.


                                       16

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accounting policies of Mackinac Financial Corporation (the "Corporation")
and Subsidiaries conform to accounting principles generally accepted in the
United States and prevailing practices within the banking industry. Significant
accounting policies are summarized below.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Corporation
and its wholly owned subsidiaries, mBank (the "Bank") and other minor
subsidiaries, after elimination of inter-company transactions and accounts.

CAPITAL

On December 15, 2004, the Corporation consummated a recapitalization through the
issuance of $30 million of common stock in a private placement. The net proceeds
of this offering amounted to $26.2 million. This recapitalization provided the
funding to enable the Corporation to recapitalize the Bank with a $15.5 million
capital infusion. This capital infusion provided the Bank with enough capital to
be deemed a "well capitalized" institution by regulatory standards. The
Corporation used $6.5 million of the proceeds to settle the $12.5 million
liability of the subordinated debentures. The settlement of this liability also
included the accrued interest of approximately $1.2 million. The Corporation
recognized a gain from the settlement of the subordinated debentures of $6.6
million.

NATURE OF OPERATIONS

The Corporation's and the Bank's revenues and assets are derived primarily from
banking activities. The Bank's primary market area is the Upper Peninsula, the
northern portion of the Lower Peninsula of Michigan, and Oakland County in Lower
Michigan. The Bank provides to its customers commercial, real estate,
agricultural, and consumer loans, as well as a variety of traditional deposit
products. A significant portion, approximately 12%, of the Bank's commercial
loan portfolio consists of leases to commercial and governmental entities, which
are secured by various types of equipment. These leases are dispersed
geographically throughout the country. Approximately 1% of the Corporation's
business activity is with Canadian customers and denominated in Canadian
dollars.

While the Corporation's chief decision makers monitor the revenue streams of the
various Corporation products and services, operations are managed and financial
performance is evaluated on a Corporation-wide basis. Accordingly, all of the
Corporation's banking operations are considered by management to be aggregated
in one reportable operating segment.

USE OF ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenue and expenses during the period.
Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change in
the near term relate to the determination of the allowance for loan losses, the
valuation of foreclosed real estate, deferred tax assets, and impairment of
intangible assets.

CASH AND CASH EQUIVALENTS

For purposes of reporting cash flows, cash and cash equivalents include cash on
hand, noninterest-bearing deposits in correspondent banks, and federal funds
sold. Generally, federal funds are purchased and sold for one-day periods.


                                       17
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

SECURITIES

The Corporation's securities are classified and accounted for as securities
available for sale. These securities are stated at fair value. Premiums and
discounts are recognized in interest income using the interest method over the
period to maturity. Unrealized holding gains and losses on securities available
for sale are reported as accumulated other comprehensive income within
shareholders' equity until realized. When it is determined that securities or
other investments are impaired and the impairment is other than temporary, an
impairment loss is recognized in earnings and a new basis in the affected
security is established. Gains and losses on the sale of securities are recorded
on the trade date and determined using the specific-identification method.

FEDERAL HOME LOAN BANK STOCK

As a member of the Federal Home Loan Bank (FHLB) system, the Bank is required to
hold stock in the FHLB based on the anticipated level of borrowings to be
advanced. This stock is recorded at cost, which approximates fair value.
Transfer of the stock is substantially restricted.

INTEREST INCOME AND FEES ON LOANS

Interest on loans is accrued and credited to income based on the principal
amount outstanding. The accrual of interest on loans is discontinued when, in
the opinion of management, there is an indication that the borrower may be
unable to meet payments as they become due. Upon such discontinuance, all unpaid
accrued interest is reversed. Loans are returned to accrual status when all
principal and interest amounts contractually due are brought current and future
payments are reasonably assured. Interest income on impaired and nonaccrual
loans is recorded on the cash basis. Loan-origination fees and allocated costs
of originating loans are deferred and recognized over the term of the loan as an
adjustment to yield in accordance with FASB Statement No. 91.

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses includes specific allowances related to commercial
loans, which have been judged to be impaired. A loan is impaired when, based on
current information, it is probable that the Corporation will not collect all
amounts due in accordance with the contractual terms of the loan agreement.
These specific allowances are based on discounted cash flows of expected future
payments using the loan's initial effective interest rate or the fair value of
the collateral if the loan is collateral dependent.

The Corporation continues to maintain a general allowance for loan losses for
loans not considered impaired. The allowance for loan losses is maintained at a
level which management believes is adequate to provide for possible loan losses.
Management periodically evaluates the adequacy of the allowance using the
Corporation's past loan loss experience, known and inherent risks in the
portfolio, composition of the portfolio, current economic conditions, and other
factors. The allowance does not include the effects of expected losses related
to future events or future changes in economic conditions. This evaluation is
inherently subjective since it requires material estimates that may be
susceptible to significant change. Loans are charged against the allowance for
loan losses when management believes the collectability of the principal is
unlikely. In addition, various regulatory agencies periodically review the
allowance for loan losses. These agencies may require additions to the allowance
for loan losses based on their judgments of collectability.

In management's opinion, the allowance for loan losses is adequate to cover
probable losses relating to specifically identified loans, as well as probable
losses inherent in the balance of the loan portfolio as of the balance sheet
date.


                                       18

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

OTHER REAL ESTATE HELD FOR SALE

Other real estate held for sale consists of assets acquired through, or in lieu
of, foreclosure and other long-lived assets to be disposed of by sale, whether
previously held and used or newly acquired. Other real estate held for sale is
initially recorded at the lower of cost or fair value, less costs to sell,
establishing a new cost basis. Valuations are periodically performed by
management, and the assets' carrying values are adjusted to the lower of cost
basis or fair value less costs to sell. Impairment losses are recognized for any
initial or subsequent write-downs. Net revenue and expenses from operations of
other real estate held for sale are included in other expense.

PREMISES AND EQUIPMENT

Premises and equipment are stated at cost less accumulated depreciation.
Maintenance and repair costs are charged to expense as incurred. Gains or losses
on disposition of premises and equipment are reflected in income. Depreciation
is computed on the straight-line method over the estimated useful lives of the
assets.

INTANGIBLE ASSETS AND GOODWILL

Intangible assets attributable to the value of core deposits and the excess of
purchase price over fair value of net assets (goodwill) acquired are stated at
cost less accumulated amortization. The core deposit premium is amortized on a
straight-line basis over a period of ten years and is subject to an annual
impairment test based on the change in deposit base. Prior to 2002, goodwill was
being amortized over a period of 15 years. During 2002, goodwill (Note 10) was
written off in its entirety.

The Corporation reviews intangible assets for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. The evaluation includes assessing the estimated fair value of
the intangible asset based on market prices for similar assets, where available,
and the present value of the estimated future cash flows associated with the
intangible asset. Adjustments are recorded if it is determined that the benefit
of the intangible asset has decreased.

EARNINGS PER COMMON SHARE

Basic earnings per common share is net income divided by the weighted average
number of common shares outstanding during the period. Diluted earnings per
common share includes the dilutive effect of additional potential common shares
issuable under stock option agreements.

STOCK OPTION PLANS

The Corporation sponsors three stock option plans. One plan was approved during
2000 and applies to officers, employees, and non-employee directors. This plan
was amended as a part of the recently completed stock offering and
recapitalization. The amendment, approved by shareholders, increased the shares
available under this plan by 428,587 shares from the original 25,000 (adjusted
for the 1:20 split), to a total authorized share balance of 453,587. The other
two plans, one for officers and employees and the other for non-employee
directors, were approved in 1997. A total of 30,000 (adjusted for the 1:20
split), were made available for grant under these plans. Options under all of
the plans are granted at the discretion of a committee of the Corporation's
Board of Directors. Options to purchase shares of the Corporation's stock are
granted at a price equal to the market price of the stock at the date of grant.
The committee determines the vesting of the options when they are granted as
established under the plan.


                                       19

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

The fair value of each option granted is estimated on the grant date using the
Black-Scholes methodology. The following assumptions were made in estimating
fair value for options granted for the years ended December 31, 2005, 2004 and
2003. The weighted average fair value of options granted in 2005 as of their
grant date, along with the assumptions used for each grant, is shown below.
Options granted in 2003 were forfeited as a result of the employee's
resignation.

<TABLE>
<CAPTION>
                                             2005       2004      2003
                                           --------   --------   ------
<S>                                        <C>        <C>        <C>
Shares granted                              112,500    257,152    2,500
Weighted average exercise price            $  11.49   $   9.75   $59.00
Dividend yield                                 0.00%      0.00%    0.00%
Weighted average risk-free interest rate       3.96%      3.25%    1.25%
Weighted average expected life (years)          4.0        4.0      7.0
Weighted average volatility                   28.00%     30.00%   29.85%
Weighted average fair value per share      $   3.36   $   2.80   $14.40
</TABLE>

The Corporation accounts for stock options using the intrinsic value method. For
all options granted, the intrinsic value was zero; therefore, no compensation
cost has been recognized for the plans. Had compensation cost been determined on
the basis of fair value, net income and earnings per share would have been
reduced for the years ended December 31 (dollars in thousands, except per share
data) as follows:

<TABLE>
<CAPTION>
                                                 2005        2004       2003
                                              ----------   --------   --------
<S>                                           <C>          <C>        <C>
NET (LOSS):
   As reported                                $   (7,364)  $ (1,595)  $ (9,588)
   Total stock-based compensations expense
      determined under fair value-based
      method                                         (76)        (6)       (36)
                                              ----------   --------   --------
Pro forma                                     $   (7,440)  $ (1,601)  $ (9,624)
                                              ==========   ========   ========

(LOSS) PER SHARE - BASIC:
   As reported                                $    (2.15)  $  (3.23)  $ (27.32)
                                              ==========   ========   ========
   Pro forma                                  $    (2.17)  $  (3.24)  $ (27.42)
                                              ==========   ========   ========

(LOSS) PER SHARE - DILUTED:
   As reported                                $    (2.15)  $  (3.23)  $ (27.32)
                                              ==========   ========   ========
   Pro forma                                  $    (2.17)  $  (3.26)  $ (27.42)
                                              ==========   ========   ========
   Weighted average shares outstanding         3,428,695    494,305    350,958
                                              ==========   ========   ========
</TABLE>


                                       20
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) consists of net income (loss) and other
comprehensive income (loss). Other comprehensive income (loss) includes
unrealized gains and losses on securities available for sale, which are
recognized as a separate component of equity and accumulated other comprehensive
income (loss).

Earnings (loss) per share are based upon the weighted average number of shares
outstanding. The following shows the computation of basic and diluted loss per
share for the years ended December 31 (dollars in thousands, except per share
data):

<TABLE>
<CAPTION>
                                                    Weighted
                                                     Average          Loss
                                     Net Loss   Number of Shares   per Share
                                     --------   ----------------   ---------
<S>                                  <C>        <C>                <C>
2005
Loss per share - Basic and diluted   $(7,364)       3,428,695       $ (2.15)
                                     =======        =========       =======
2004
Loss per share - Basic and diluted   $(1,595)         494,305       $ (3.23)
                                     =======        =========       =======
2003
Loss per share - Basic and diluted   $(9,588)         350,958       $(27.32)
                                     =======        =========       =======
</TABLE>

In the above disclosure the dilutive effect of additional shares outstanding, as
a result of stock options exercisable, was not taken into account since
additional shares outstanding have an antidilutive effect on loss calculated per
share.

INCOME TAXES

Deferred income taxes have been provided under the liability method. Deferred
tax assets and liabilities are determined based upon the difference between the
financial statement and tax bases of assets and liabilities as measured by the
enacted tax rates which will be in effect when these differences are expected to
reverse. Deferred tax expense (credit) is the result of changes in the deferred
tax asset and liability. A valuation allowance is provided against deferred tax
assets when it is more likely than not that some or all of the deferred asset
will not be realized.

OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS

In the ordinary course of business, the Corporation has entered into
off-balance-sheet financial instruments consisting of commitments to extend
credit, commitments under credit card arrangements, commercial letters of
credit, and standby letters of credit.

In November 2002, FASB issued FASB Interpretation No. 45 ("FIN 45"),
"Guarantor's Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others." FIN 45 elaborates on the
existing disclosure requirements for most guarantees, including loan guarantees
such as standby letters of credit and indemnifications. It also clarifies that
at the time a company issues a guarantee, the company must recognize an initial
liability for the fair or market value of the obligations it assumes under that
guarantee and must disclose that information in its interim and annual financial
statements. The provisions related to recognizing a liability at inception of
the guarantee for the fair value of the guarantor's obligations would not apply
to guarantees accounted for as derivatives. The initial


                                       21

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

recognition and measurement provisions apply on a prospective basis to
guarantees issued or modified after December 31, 2002. Adoption of this
interpretation did not have a material effect on the Corporation's financial
statements. See Note 22 for the disclosures currently required under FIN 45.

RECLASSIFICATIONS

Certain amounts in the 2004 and 2003 consolidated financial statements have been
reclassified to conform to the 2005 presentation.

NOTE 2 - RECENT ACCOUNTING PRONOUNCEMENTS

SFAS No. 123 R - In December 2004, the FASB re-issued SFAS No. 123 "Accounting
for Stock-Based Compensation" which becomes effective for interim periods
beginning after December 15, 2005. This Statement supersedes APB Opinion No. 25
"Accounting for Stock Issued to Employees" and its related implementation
guidance. Under Opinion No. 25, issuing stock options to employees generally
resulted in recognition of no compensation cost. This Statement requires
entities to recognize the cost of employee services received in exchange for
these stock options. This Statement applies to all unvested awards outstanding
as of the effective date. The Corporation plans to adopt SFAS No. 123 for the
period beginning after December 15, 2005 and does not expect a material impact
on the Corporation's Consolidated Financial Statements.

NOTE 3 - ACQUISITIONS AND DIVESTITURES

During 2004, the Corporation sold the deposits and the premises and equipment of
five branch offices. The total deposits sold amounted to $26,471,000 and the net
book value of premises and equipment was $1,442,000. Other assets and
liabilities divested in these branch sales were immaterial. The Corporation
realized a gain of $205,000 on the sale of these branches.

NOTE 4 - RESTRICTIONS ON CASH AND CASH EQUIVALENTS

Cash and cash equivalents in the amount of $1.642 million were restricted on
December 31, 2005 to meet the reserve requirements of the Federal Reserve
System.

In the normal course of business, the Corporation maintains cash and due from
bank balances with correspondent banks. Balances in these accounts may exceed
the Federal Deposit Insurance Corporation's insured limit of $100,000.
Management believes that these financial institutions have strong credit ratings
and the credit risk related to these deposits is minimal.


                                       22

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 5 - SECURITIES AVAILABLE FOR SALE

The carrying value and estimated fair value of securities available for sale are
as follows (dollars in thousands):

<TABLE>
<CAPTION>
                                                                  Gross        Gross
                                                   Amortized   Unrealized   Unrealized    Estimated
                                                     Cost         Gains       Losses     Fair Value
                                                   ---------   ----------   ----------   ----------
<S>                                                <C>         <C>          <C>          <C>
DECEMBER 31, 2005
US Agencies                                         $30,980       $ --         $626        $30,354
Obligations of states and political subdivisions      3,593        263           --          3,856
                                                    -------       ----         ----        -------
Total securities available for sale                 $34,573       $263         $626        $34,210
                                                    =======       ====         ====        =======
DECEMBER 31, 2004
US Agencies                                         $21,980       $  1         $138        $21,843
Obligations of states and political subdivisions      3,711        318           --          4,029
Corporate securities                                    667         14           --            681
Mortgage-related securities                          30,225        299            2         30,522
                                                    -------       ----         ----        -------
Total securities available for sale                 $56,583       $632         $140        $57,075
                                                    =======       ====         ====        =======
</TABLE>

Following is information pertaining to securities with gross unrealized losses
at December 31, 2005 and 2004 aggregated by investment category and length of
time these individual securities have been in a loss position (dollars in
thousands):

<TABLE>
<CAPTION>
                                      Less Than Twelve Months    Over Twelve Months
                                      -----------------------   --------------------
                                           Gross                  Gross
                                        Unrealized     Fair     Unrealized     Fair
                                          Losses      Value       Losses      Value
                                        ----------   -------    ----------   -------
<S>                                   <C>            <C>        <C>          <C>
DECEMBER 31, 2005
US Agencies                                $269      $17,711       $357      $12,643
                                           ----      -------       ----      -------
Total securities available for sale        $269      $17,711       $357      $12,643
                                           ====      =======       ====      =======
</TABLE>

The gross unrealized losses in the current portfolio are considered temporary in
nature and relate to interest rate fluctuations.

<TABLE>
<S>                                        <C>       <C>            <C>        <C>
DECEMBER 31, 2004
US Agencies                                $138      $19,842        $--        $--
Mortgage-related securities                   2        8,238        $--        $--
                                           ----      -------        ---        ---
Total securities available for sale        $140      $28,080        $--        $--
                                           ====      =======        ===        ===
</TABLE>


                                       23
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 5 - SECURITIES AVAILABLE FOR SALE (CONTINUED)

Following is a summary of the proceeds from sales of securities available for
sale, as well as gross gains and losses for the years ended December 31 (dollars
in thousands):

<TABLE>
<CAPTION>
                                            2005      2004      2003
                                          -------   -------   -------
<S>                                       <C>       <C>       <C>
Proceeds from sales/calls of securities   $35,364   $35,997   $36,601
Gross gains on sales                           96        --       588
Gross losses on sales                           1        --       161
</TABLE>

The carrying value and estimated fair value of securities available for sale at
December 31, 2005, by contractual maturity, are shown below (dollars in
thousands). Contractual maturities may differ from expected maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.

<TABLE>
<CAPTION>
                                         Amortized    Estimated
                                            Cost     Fair Value
                                         ---------   ----------
<S>                                      <C>         <C>
Due in one year or less                   $ 3,555      $ 3,512
Due after one year through five years      27,810       27,239
Due after five years through ten years      1,063        1,193
Due after ten years                         2,145        2,266
                                          -------      -------
Total                                     $34,573      $34,210
                                          =======      =======
</TABLE>

See Note 12 for information on securities pledged to secure borrowings from the
Federal Home Loan Bank.

NOTE 6 - LOANS

The composition of loans at December 31 (dollars in thousands) is as follows:

<TABLE>
<CAPTION>
                                               2005       2004
                                             --------   --------
<S>                                          <C>        <C>
Commercial real estate                       $118,637   $105,619
Commercial, financial, and agricultural        56,686     47,446
One to four family residential real estate     44,660     45,292
Consumer                                        2,285      2,379
Construction                                   17,503      3,096
                                             --------   --------
Total loans                                  $239,771   $203,832
                                             ========   ========
</TABLE>

An analysis of the allowance for loan losses for the years ended December 31
(dollars in thousands) is as follows:

<TABLE>
<CAPTION>
                        2005      2004       2003
                       ------   --------   -------
<S>                    <C>      <C>        <C>
Balance, January 1     $6,966   $ 22,005   $24,908
Recoveries on loans       134        719     4,053
Loans charged off        (992)   (15,758)   (6,956)
                       ------   --------   -------
Balance, December 31   $6,108   $  6,966   $22,005
                       ======   ========   =======
</TABLE>


                                       24

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 6 - LOANS (CONTINUED)

The allowance for loan losses was significantly impacted by loan charge-offs
during 2004. The Corporation sold $39.3 million of loans, primarily
nonperforming, during 2004, which resulted in a previously allocated specific
reserve charge-off of $10.9 million on these loans being recognized as a
charge-off. Late in 2005, the Corporation completed another $2.1 million sale of
nonperforming assets, which resulted in a charge to the reserve of $.4 million.

Nonperforming loans are those which are contractually past due 90 days or more
as to interest or principal payments, on nonaccrual status, or loans, the terms
of which have been renegotiated to provide a reduction or deferral of interest
or principal. The interest income recorded and that which would have been
recorded had nonaccrual and renegotiated loans been current, or not troubled,
was not material to the consolidated financial statements for the year ended
December 31, 2005 and 2004.

IMPAIRED LOANS

A loan is considered impaired, based on current information and events, if it is
probable that the Corporation will be unable to collect the scheduled payments
of principal or interest when due, according to the contractual terms of the
loan agreement.

The following is a summary of impaired loans and their effect on interest income
(dollars in thousands):

<TABLE>
<CAPTION>
                                                         Impaired Loans                              Valuation Reserve
                                           ------------------------------------------   ------------------------------------------
                                           December 31,   December 31,   December 31,   December 31,   December 31,   December 31,
                                               2005           2004           2003           2005           2004           2003
                                           ------------   ------------   ------------   ------------   ------------   ------------
<S>                                        <C>            <C>            <C>            <C>            <C>            <C>
Balances, at period end
   Impaired loans with valuation reserve      $   --         $   608        $39,993          $--           $136          $5,350
   Impaired loans with no valuation
      reserve                                    114           3,699          5,848           --             --              --
                                              ------         -------        -------          ---           ----          ------
      Total impaired loans                    $  114         $ 4,307        $45,841          $--           $136          $5,350
                                              ======         =======        =======          ===           ====          ======

   Impaired loans on nonaccrual basis         $   15         $ 4,307        $38,660          $--           $136          $4,720
   Impaired loans on accrual basis                99              --          7,181           --             --             630
                                              ------         -------        -------          ---           ----          ------
      Total impaired loans                    $  114         $ 4,307        $45,841          $--           $136          $5,350
                                              ======         =======        =======          ===           ====          ======

Average investment in impaired loans          $1,922         $17,036        $46,700
Interest income recognized during
   impairment                                     78           1,053          1,307
Interest  income that would have been
   recognized on an accrual basis                134             803          2,793
Cash-basis interest income recognized             76             863            718
</TABLE>

INSIDER LOANS

The Bank, in the ordinary course of business, grants loans to the Corporation's
executive officers and directors, including their families and firms in which
they are principal owners. Activity in such loans is summarized below (dollars
in thousands):

<TABLE>
<CAPTION>
                                                  2005     2004
                                                 -----   -------
<S>                                              <C>     <C>
Loans outstanding, January 1                     $  63   $ 6,514
New loans                                           56       365
Net activity on revolving lines of credit          578
Repayment                                         (119)     (765)
Decrease related to retired executive officers
   and directors                                    --    (6,051)
                                                 -----   -------
Loans outstanding, December 31                   $ 578   $    63
                                                 =====   =======
</TABLE>


                                       25

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 6 - LOANS (CONTINUED)

No related party loans were classified substandard as of December 31, 2005 and
2004. In addition to the outstanding balances above, there were unused
commitments to related parties of approximately $264,000.


                                       26
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 7 - PREMISES AND EQUIPMENT

Details of premises and equipment at December 31 (dollars in thousands) are as
follows:

<TABLE>
<CAPTION>
                                       2005      2004
                                     -------   -------
<S>                                  <C>       <C>
Land                                 $ 2,121   $ 2,121
Buildings and improvements            11,910    11,624
Furniture, fixtures, and equipment     7,887     8,083
Construction in progress               1,404        --
                                     -------   -------
Total cost basis                      23,322    21,828
Less - Accumulated depreciation       11,335    11,089
                                     -------   -------
Net book value                       $11,987   $10,739
                                     =======   =======
</TABLE>

The construction in progress at the end of 2005 pertains to two branch office
projects which are expected to be completed by May of 2006.

During 2004, the Bank sold the deposits and premises and equipment of five
branch locations. The sales price of the premises and equipment, $1.442 million,
was equal to the net book value at the date of sale, therefore no gain or loss
was recognized.

Depreciation of premises and equipment charged to operating expenses amounted to
$707,000 in 2005, $1,038,000 in 2004, and $1,378,000 in 2003.

NOTE 8 - OTHER REAL ESTATE HELD FOR SALE

An analysis of other real estate held for sale for the years ended December 31
(dollars in thousands) is as follows:

<TABLE>
<CAPTION>
                                                                2005      2004      2003
                                                              -------   -------   -------
<S>                                                           <C>       <C>       <C>
Balance, January 1                                            $ 1,730   $ 4,356   $ 5,409
Other real estate transferred from loans due to foreclosure       632     4,762     4,340
Other real estate transferred to premises and equipment          (358)       --        --
Other real estate sold / written down                          (1,059)   (7,388)   (5,393)
                                                              -------   -------   -------
Balance, December 31                                          $   945   $ 1,730   $ 4,356
                                                              =======   =======   =======
</TABLE>


                                       27

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 9 - INTANGIBLE ASSET

Included in other assets are core deposit premiums acquired through
acquisitions. These core deposit premiums are considered an intangible asset.
The carrying amount of the intangible asset for the years ended December 31
(dollars in thousands) is as follows:

<TABLE>
<CAPTION>
                                 2005                      2004
                       -----------------------   -----------------------
                         Gross                     Gross
                       Carrying    Accumulated   Carrying    Accumulated
                        Amount    Amortization    Amount    Amortization
                       --------   ------------   --------   ------------
<S>                    <C>        <C>            <C>        <C>
Core deposit premium    $3,734       $3,404       $3,734       $3,279
                        ======       ======       ======       ======
</TABLE>

During 2004, the Bank sold five branch offices with deposits of $26.471 million.
Two of the branch offices sold had unamortized core deposit premiums of $304,000
at the time of the sale. The write-off of this core deposit premium reduced the
gain on the sale of these branch locations. Core deposit premium expense
amounted to $125,000, $308,000 and $520,000 for 2005, 2004 and 2003
respectively.

The following table shows the estimated future amortization expense for the
intangible asset. The projections of amortization expense are based on existing
asset balances as of December 31, 2005 (dollars in thousands):

<TABLE>
<S>     <C>
2006    $125
2007      82
2008      78
2009      45
        ----
Total   $330
        ====
</TABLE>

NOTE 10 - GOODWILL

As required by SFAS No. 142, adopted January 1, 2002, the Corporation is
required to perform an annual impairment test on goodwill. The impairment test
is based in large part on a comparison of the fair value of the Corporation's
outstanding stock, with the carrying value of its net assets. During the fourth
quarter of 2002, events occurred which were determined to, more likely than not,
reduce the fair value of the Corporation. Therefore, as required by SFAS No.
142, an additional impairment test was completed. This test resulted in an
identified potential impairment. Based on the size of the identified impairment,
the entire balance of goodwill was written off in 2002.


                                       28

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 11 - DEPOSITS

The distribution of deposits at December 31 (dollars in thousands) is as
follows:

<TABLE>
<CAPTION>
                                                                2005       2004
                                                              --------   --------
<S>                                                           <C>        <C>
Noninterest-bearing demand deposits                           $ 19,684   $ 20,956
Savings, money market, and interest-bearing demand deposits     79,845     72,103
Time deposits                                                  123,147    122,591
Brokered deposits                                                9,956         --
                                                              --------   --------
Total deposits                                                $232,632   $215,650
                                                              ========   ========
</TABLE>

As of December 31, 2005, $1.311 million of deposits are from Canadian customers.
Nonbrokered time deposits of $100,000 or more were $20,033,000 and $16,329,000
at December 31, 2005 and 2004, respectively. Interest expense on nonbrokered
time deposits of $100,000 or more was $597,000, $514,000, and $785,000, for the
years ended December 31, 2005, 2004 and 2003, respectively.

Maturities of time deposits outstanding at December 31, 2005, (dollars in
thousands) are as follows:

<TABLE>
<CAPTION>
<S>          <C>
2006         $ 99,935
2007           15,226
2008            3,957
2009            2,537
2010              730
Thereafter        762
             --------
Total        $123,147
             ========
</TABLE>

Brokered deposits of $9.956 million mature in 2006.


                                       29
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 12 - BORROWINGS

Borrowings consist of the following at December 31 (dollars in thousands):

<TABLE>
<CAPTION>
                                                                       2005      2004
                                                                     -------   -------
<S>                                                                  <C>       <C>
FEDERAL HOME LOAN BANK:
*   Fixed-rate advance at 6.50%, maturing October, 17, 2005          $    --   $   473
*   Fixed-rate advance at 7.06%, maturing May 15, 2006                    --     3,082
*   Convertible - Fixed-rate advance at 5.49%, callable quarterly,
       maturing June 23, 2008                                             --    10,000
*   Convertible - Fixed-rate advance at 5.66%, callable quarterly,
       maturing, October 21, 2009                                         --    10,000
*   Convertible - Fixed-rate advance at 6.22%, callable quarterly,
       maturing February 22, 2010                                         --    10,000
*   Convertible - Fixed-rate advance at 6.50%, callable quarterly,
       maturing June 22, 2010                                             --    10,000
*   Convertible - Fixed-rate advance at 5.99%, callable quarterly,
       maturing June 23, 2010                                             --     5,000
    Convertible - Fixed-rate advance at 4.98%, callable quarterly,
       maturing December 20, 2010                                      5,000     5,000
    Convertible - Fixed-rate advance at 5.16%, callable quarterly,
       maturing December 28, 2010                                     10,000    10,000
    Convertible - Fixed-rate advance at 4.50%, callable quarterly,
       maturing January 10, 2011                                      10,000    10,000
    Convertible - Fixed-rate advance at 4.35%, callable quarterly,
       maturing February 5, 2011                                      10,000    10,000
                                                                     -------   -------
                                                                      35,000    83,555
FARMERS HOME ADMINISTRATION:
    Fixed-rate note payable to Farmers Home Administration,
       maturing August 24, 2024, interest payable at 1%                1,417     1,484
                                                                     -------   -------
Total borrowings                                                     $36,417   $85,039
                                                                     =======   =======
</TABLE>

*    The Corporation prepaid $48.555 million of the Federal Home Loan Bank
     borrowings in the first quarter of 2005. The Corporation incurred a $4.320
     million penalty as a result of this prepayment.


                                       30

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 12 - BORROWINGS (CONTINUED)

The FHLB has the option to convert the above listed convertible - fixed-rate
advances to adjustable rate advances, repricing quarterly at three month LIBOR
Flat, on the original call date and quarterly thereafter.

Maturities of borrowings outstanding at December 31, 2005 (dollars in thousands)
are as follows:

<TABLE>
<S>          <C>
2010         $15,000
2011          20,000
Thereafter     1,417
             -------
Total        $36,417
             =======
</TABLE>

The Federal Home Loan Bank borrowings are collateralized at December 31, 2005 by
the following: a collateral agreement on the Corporation's one-to-four family
residential real estate loans with a book value of approximately $23,332,000;
U.S. government agency securities with an amortized cost and estimated fair
value of $23,412,000 and $22,883,000, respectively; and Federal Home Loan Bank
stock owned by the Bank totaling $4,854,900. Prepayment of the advances is
subject to the provisions and conditions of the credit policy of the Federal
Home Loan Bank of Indianapolis in effect as of December 31, 2005.

The U.S.D.A. Rural Development borrowing is collateralized by loans totaling
$775,000 originated and held by the Corporation's wholly owned subsidiary, First
Rural Relending and an assignment of a demand deposit account in the amount of
$780,000, and guaranteed by the Corporation.

NOTE 13 - INCOME TAXES

The components of the federal income tax provision (credit) for the years ended
December 31 (dollars in thousands) are as follows:

<TABLE>
<CAPTION>
                                              2005       2004     2003
                                            --------   -------   ------
<S>                                         <C>        <C>       <C>
Current tax expense (credit)                 $    --   $   147   $ (111)
Deferred tax (credit)                         (3,503)   (2,257)    (543)
Change in valuation allowance                  3,503     2,257    2,983
                                             -------   -------   ------
Total provision (credit) for income taxes    $    --   $   147   $2,329
                                             =======   =======   ======
</TABLE>


                                       31

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 13 - INCOME TAXES (CONTINUED)

A summary of the source of differences between income taxes at the federal
statutory rate and the provision (credit) for income taxes for the years ended
December 31 (dollars in thousands) is as follows:

<TABLE>
<CAPTION>
                                                    2005      2004      2003
                                                  -------   -------   -------
<S>                                               <C>       <C>       <C>
Tax (credit) at statutory rate                    $(2,504)  $  (492)  $(2,468)
Increase (decrease) in taxes resulting from:
   Tax-exempt interest                               (340)     (415)     (540)
   Intangible asset amortization and impairment        16       105        10
   Change in valuation allowance                    3,503     2,257     2,983
   Minimum tax                                         --        --     1,313
Other                                                (675)   (1,308)    1,031
                                                  -------   -------   -------
Provision (credit) for income taxes               $    --   $   147   $ 2,329
                                                  =======   =======   =======
</TABLE>

Included in the total provision for income taxes are expenses of $-0-, $-0-, and
$145,000 for the years ended December 31, 2005, 2004, and 2003, respectively,
related to security transactions.

Deferred income taxes are provided for the temporary differences between the
financial reporting and tax bases of the Corporation's assets and liabilities.
The major components of net deferred tax assets at December 31 (dollars in
thousands) are as follows:

<TABLE>
<CAPTION>
                                         2005       2004
                                       --------   --------
<S>                                    <C>        <C>
Deferred tax assets:
   Allowance for loan losses           $  2,076   $  2,369
   Deferred compensation                    421        453
   Intangible assets                        458        580
   Other real estate                        231        388
   Alternative Minimum Tax Credit         1,463      1,463
   NOL carryforward                      12,349      8,281
   Depreciation                             233        194
   Tax credit carryovers                    672        672
   Other                                     48         48
                                       --------   --------
      Total deferred tax assets          17,951     14,448
                                       --------   --------
Valuation allowance                    $(17,951)  $(14,448)
                                       --------   --------
Deferred tax liabilities:
      Total deferred tax liabilities         --         --
                                       --------   --------
Net deferred tax asset (liabilty)      $     --   $     --
                                       ========   ========
</TABLE>


                                       32
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 13 - INCOME TAXES (CONTINUED)

A valuation allowance is provided against deferred tax assets when it is more
likely than not that some or all of the deferred tax asset will not be realized.
At December 31, 2005 and 2004, the Corporation established a valuation allowance
against the net deferred tax asset which would require future taxable income in
order to be utilized. The Corporation has a net operating loss carryforward for
tax purposes of approximately $36.3 million, which could only be benefited if
the Corporation returns to profitability. This net operating loss carryforward
will expire in the 2025 tax year.

NOTE 14 - OPERATING LEASES

The Corporation leases space at two branch offices. The leases are classified as
operating leases. The operating lease for our branch office in Birmingham had an
original term of 66 months, however, it can be renewed for an additional five
year period. Future minimum payments, by year and in the aggregate, under the
non-cancelable operating leases with initial or remaining terms in excess of one
year, consisted of the following (dollars in thousands):

   Operating Leases

<TABLE>
<S>               <C>
2006              $212
2007               179
2008               179
2009               179
2010 and beyond    233
                  ----
                  $982
Total             ====
</TABLE>

Rent expense for all operating leases amounted to $91,000 in 2005, $108,000 in
2004, and $232,000 in 2003.

NOTE 15 - RETIREMENT PLAN

The Corporation has established a 401(k) profit sharing plan. Employees who have
completed three months of service and attained the age of 18 are eligible to
participate in the plan. Eligible employees can elect to have a portion, not to
exceed 80%, of their annual compensation paid into the plan. In addition, the
Corporation may make discretionary contributions into the plan. Retirement plan
contributions charged to operations totaled $107,000, $146,000, and $78,000 for
2005, 2004, and 2003, respectively.

NOTE 16 - DEFERRED COMPENSATION PLANS

As an incentive to retain key members of management and directors, the
Corporation established a deferred compensation plan, with benefits based on the
number of years the individuals have served the Corporation. This plan was
discontinued and no longer applies to current officers and directors. A
liability was recorded on a present value basis and discounted using the rates
in effect at the time the deferred compensation agreement was entered into. The
liability may change depending upon changes in long-term interest rates. The
liability at December 31, 2005 and 2004, for vested benefits under this plan was
$1,238,000 and $1,338,000 respectively. The Corporation maintains life insurance
policies on the plan participants. Death benefits received from the life
insurance policies will be used to offset the obligations under the plan. The
cash surrender value of the policies was $1,494,000 and $1,629,000 at December
31, 2005 and 2004, respectively. Deferred compensation expense for the plan was
$120,000, $194,000, and $157,000 for 2005, 2004, and 2003 respectively.

NOTE 17 - SUBORDINATED DEBENTURES

The Corporation owns a Delaware business trust, North Country Capital Trust (the
"Trust"). The Trust exists solely to issue capital securities. Prior to the
adoption of FIN 46, the Corporation consolidated this entity as a result of its
ownership of the outstanding common securities. This entity meets the FIN 46
definition of a VIE, but the Corporation is not the primary beneficiary in the
entity. As such, the Corporation deconsolidated this entity in 2003. The Trust
has issued trust


                                       33

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 17 - SUBORDINATED DEBENTURES (CONTINUED)

preferred securities and invested the net proceeds in subordinated debentures
issued to the Trust by the Corporation. The subordinated debentures were the
sole asset of the Trust.

As part of the recapitalization through the issuance of $30 million in common
stock in a private placement, the subordinated debentures were paid off. This
payoff settlement was negotiated with all of the holders of the subordinated
debentures. The payment for the debentures was in settlement of $12,450,000 in
principal and accrued interest. The total settlement price was $6,500,000 and
resulted in the Corporation recording a gain on the settlement of $6,617,000.

NOTE 18 - CAPITAL

On December 16, 2004, the Corporation consummated a recapitalization through the
issuance of $30 million of common stock in a private placement. The net proceeds
of this offering amounted to $26.2 million. This recapitalization provided the
funding to enable the Corporation to recapitalize the Bank with a $15.5 million
capital infusion. This capital infusion provided the Bank with enough capital to
be deemed a "well capitalized" institution by regulatory standards. The
Corporation used $6.5 million of the proceeds to settle the $12,450,000
liability of the subordinated debentures. The settlement of this liability also
included the accrued interest of approximately $1.2 million. The Corporation
recognized a gain from the settlement of the subordinated debentures of $6.6
million.

NOTE 19 - REGULATORY MATTERS

The Corporation is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory--and possibly additional
discretionary--actions by regulators that, if undertaken, could have a direct
material effect on the Corporation's consolidated financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Corporation must meet specific capital guidelines that involve
quantitative measures of the Corporation's assets, liabilities, and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Corporation's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings, and other
factors.

Quantitative measures established by regulation to ensure capital adequacy
require the Corporation to maintain minimum amounts and ratios (set forth in the
table below) of total and Tier I capital to risk-weighted assets and of Tier I
capital to average assets. Management has determined that, as of December 31,
2005, the Corporation is well capitalized.

To be categorized as well capitalized the Bank must maintain minimum total
risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the
table. In addition, federal banking regulators have established capital
classifications beyond the minimum requirements in order to risk-rate deposit
insurance premiums and to provide trigger points for prompt corrective action.
Although the Bank is well capitalized as of December 31, 2005, it is operating
under an informal agreement which requires a minimum Tier 1 Capital ratio of 8%.


                                       34

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 19 - REGULATORY MATTERS (CONTINUED)

The Corporation's and the Bank's actual and required capital amounts and ratios
as of December 31 (dollars in thousands) are as follows:

<TABLE>
<CAPTION>
                                                                                               To Be Well
                                                                                            Capitalized Under
                                                                For Capital                 Prompt Corrective
                                           Actual            Adequacy Purposes              Action Provisions
                                      ---------------   ---------------------------   ----------------------------
                                       Amount   Ratio       Amount          Ratio         Amount          Ratio
                                      -------   -----   --------------   ----------   --------------   -----------
<S>                                   <C>       <C>     <C>              <C>          <C>              <C>
2005
Total capital (to risk-
   weighted assets):
      Consolidated                    $29,806   11.8%   > or = $20,153   > or = 8.0%        N/A
      mBank                           $28,484   11.4%   > or = $20,076   > or = 8.0%  > or = $25,095   > or = 10.0%

Tier 1 capital (to risk-
   weighted assets):
      Consolidated                    $26,622   10.6%   > or = $10,075   > or = 4.0%        N/A
      mBank                           $25,309   10.1%   > or = $10,033   > or = 4.0%  > or = $15,050   > or =  6.0%

Tier 1 capital (to average assets):
      Consolidated                    $26,622    9.2%   > or = $11,537   > or = 4.0%        N/A
      mBank                           $25,309    8.8%   > or = $11,504   > or = 4.0%  > or = $14,380   > or =  5.0%

2004
Total capital (to risk-
   weighted assets):
      Consolidated                    $36,779   16.0%   > or = $18,348   > or = 8.0%        N/A
      mBank                           $34,855   15.2%   > or = $18,303   > or = 8.0%  > or = $22,879   > or = 10.0%

Tier 1 capital (to risk-
   weighted assets):
      Consolidated                    $33,861   14.8%   > or = $ 9,174   > or = 4.0%        N/A
      mBank                           $31,943   14.0%   > or = $ 9,151   > or = 4.0%  > or = $13,727   > or =  6.0%

Tier 1 capital (to average assets):
      Consolidated                    $33,861   10.7%   > or = $13,045   > or = 4.0%        N/A
      mBank                           $31,943    9.8%   > or = $13,081   > or = 4.0%  > or = $16,351   > or =  5.0%
</TABLE>

The Bank is restricted, by banking regulations, from making dividend
distributions above prescribed amounts. At December 31, 2005, the Bank was not
authorized to pay dividends to the Corporation without prior regulatory approval
because of a negative retained earnings balance due to cumulative losses and as
a restriction of the regulatory informal agreement.


                                       35
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

HISTORY

In October 2001, the Bank was notified by the FDIC that it was a "troubled
institution" within the meaning of FDIC regulations. As a troubled institution,
the Bank is required to notify the FDIC 30 days prior to the addition or
replacement of a Board member and the employment or changes in responsibilities
of a senior executive officer.

In September 2002, a regularly-scheduled safety and soundness examination of the
Bank was conducted by its principal regulators, the Michigan Office of Financial
and Insurance Services ("OFIS"), and the FDIC. During the course of that
examination, the FDIC, the OFIS, and the Federal Reserve Bank of Chicago ("FRB")
requested that the Corporation and the Bank take certain actions, including
suspending the payment of dividends and conserving the liquidity of the
Corporation.

In response to the concerns expressed by the regulators, the Board of Directors
of the Corporation and the Bank adopted resolutions providing for prior
regulatory approval of the declaration or payment of any dividend by the
Corporation or the Bank, and suspension of interest payments by the Corporation
in connection with its trust preferred securities. The agreements relating to
the trust preferred securities allow for the suspension of payments for up to 20
quarters. Therefore, the suspension of the interest payments did not violate the
agreement.

Following the completion of the regularly-scheduled safety and soundness
examination of the Bank by the FDIC and the OFIS in November 2002, and the
Bank's receipt of the related Report of Examination ("Report"), the FDIC and the
OFIS, with the consent of the Bank, on March 26, 2003, entered a formal order
(the "Order") under Federal and State banking laws. The Order became effective
on April 5, 2003, and was to remain in effect until modified or terminated by
action of the FDIC and the OFIS. The Order identified deficiencies in the Bank's
policies and procedures for safe and sound operation, including its directorate
and management personnel and practices, credit underwriting, credit
administration, and policies regarding asset/liability management, liquidity,
funds management and investments, and its compliance with all applicable laws
and regulations, including Regulations O and U of the Board of Governors of the
Federal Reserve System (the "Board"), the FDIC Rules and Regulations, and the
Michigan Banking Code of 1999. The Order also required the Bank to maintain
specified capital ratios during the life of the Order.

The Order required the Bank and its directors to take specific steps, within
time periods specified in the Order, to address the operational deficiencies,
including certain violations of law and regulations, identified by the FDIC and
the OFIS in the Order and the Report.

Significant progress was made by the Corporation in addressing all of the
deficiencies of the Order. The most significant event, which occurred in
mid-December 2004, was the consummation of a $30 million stock offering through
a private placement that resulted in net proceeds of $26.2 million. This
recapitalization allowed the Corporation to inject $15.5 million of capital into
the Bank which satisfied all of the capital requirements of the Order.

On February 8, 2005, the Order was formally removed; however, the Bank entered
into an informal agreement which requires the Bank to maintain a Tier 1 Capital
ratio of at least 8%. The Bank is also required to have regulatory approval
before paying dividends.

NOTE 20 - STOCK OPTION PLANS

The Corporation sponsors three stock option plans. All historical information
presented below has been adjusted to reflect the 1 for 20 reverse stock split
which occurred on December 16, 2004. One plan was approved during 2000 and
applies to officers, employees, and non-employee directors. A total of 25,000
shares were made available for grant under this plan. This plan was amended as a
part of the recapitalization to provide for additional authorized shares equal
to 12.50% of all outstanding shares subsequent to the recapitalization, which
amounted to 428,587 shares. The other two plans, one for officers and employees
and the other for non-employee directors, were approved in 1997. A total of
30,000 shares were made available for grant under these plans. Options under all
of the plans are granted at the discretion of a committee of the Corporation's
Board of Directors. Options to purchase shares of the Corporation's stock are
granted at a price equal to


                                       36

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 20 - STOCK OPTION PLANS (CONTINUED)

the market price of the stock at the date of grant. The committee determines the
vesting of the options when they are granted as established under the plan.

A summary of stock option transactions for the years ended December 31 is as
follows:

<TABLE>
<CAPTION>
                                                   Number of Shares
                                            ------------------------------
                                              2005       2004       2003
                                            --------   --------   --------
<S>                                         <C>        <C>        <C>
Outstanding shares at beginning of year      282,999     27,483     38,616
Granted during the year                      112,500    257,152      2,500
Expired / forfeited during the year          (20,082)    (1,636)   (13,633)
                                            --------   --------   --------
Outstanding shares at end of year            375,417    282,999     27,483
                                            ========   ========   ========
Weighted average exercise price per share
   at end of year                           $  14.15   $  34.55   $ 278.80
                                            ========   ========   ========
Shares available for grant at end of year     89,488    189,532     17,912
                                            ========   ========   ========
</TABLE>

As part of the recapitalization of the Corporation, options were granted to two
new senior executives of the Corporation and Bank. These options, totaling
257,152 shares, were granted at an exercise price of $9.75 per share or market
value. The market value was based upon the offering price of the common stock in
the private placement.

Options in 2003 were granted at $59.00 per share (as adjusted for the 1 for 20
reverse stock split). These same options expired in 2003 as a result of the
grantee's resignation. Under these plans, options expire ten years after the
date of grant.

Following is a summary of the options outstanding and exercisable at December
31, 2005:

<TABLE>
<CAPTION>
                                                  Weighted
                                                  Average     Weighted
                              Number             Remaining     Average
     Exercise       -------------------------   Contractual   Exercise
   Price Range      Outstanding   Exercisable    Life-Years     Price
   -----------      -----------   -----------   -----------   --------
<S>                 <C>           <C>           <C>           <C>
       $9.16           12,500         2,500         10.0      $  9.16
       $9.75          257,152       120,861         10.6         9.75
      $11.50           40,000         8,000          9.8        11.50
      $12.00           60,000        12,000          9.5        12.00
$156.00 - $240.00       3,545         3,545          5.3       186.75
$300.00 - $400.00       2,220         2,220          3.6       382.16
                      -------       -------          ---      -------
                      375,417       149,126          9.1      $ 14.15
                      =======       =======          ===      =======
</TABLE>


                                       37

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 21 - OTHER COMPREHENSIVE INCOME (LOSS)

Other comprehensive income (loss) components and related taxes for the years
ended December 31 (dollars in thousands) were as follows:

<TABLE>
<CAPTION>
                                            2005    2004    2003
                                           -----   -----   -----
<S>                                        <C>     <C>     <C>
   Unrealized holding gains (losses) on
      available for sale securities        $(855)  $(535)  $ 212
   Less reclassification adjustments for
      gains later recognized in income        --      --     427
                                           -----   -----   -----
   Net unrealized (losses)                  (855)   (535)   (215)
   Tax effect                                 --      --      --
                                           -----   -----   -----
Other comprehensive (loss)                 $(855)  $(535)  $(215)
                                           =====   =====   =====
</TABLE>

NOTE 22 - COMMITMENTS, CONTINGENCIES, AND CREDIT RISK

FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

The Corporation is a party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Those instruments involve, to varying degrees, elements of
credit risk in excess of the amount recognized in the consolidated balance
sheets.

The Corporation's exposure to credit loss, in the event of nonperformance by the
other party to the financial instrument for commitments to extend credit and
standby letters of credit, is represented by the contractual amount of those
instruments. The Corporation uses the same credit policies in making commitments
and conditional obligations as it does for on-balance-sheet instruments. These
commitments at December 31 (dollars in thousands) are as follows:

<TABLE>
<CAPTION>
                                              2005      2004
                                            -------   -------
<S>                                         <C>       <C>
Commitments to extend credit:
   Fixed rate                               $ 2,118   $   638
   Variable rate                             31,557    10,889
Standby letters of credit - Variable rate    10,493    17,970
Credit card commitments - Fixed rate          3,135     2,995
                                            -------   -------
                                            $47,303   $32,492
                                            =======   =======
</TABLE>

Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Corporation evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Corporation upon extension of credit, is based on
management's credit evaluation of the party. Collateral held varies, but may
include accounts receivable, inventory, property, plant and equipment, and
income-producing commercial properties.

Standby letters of credit are irrevocable commitments issued by the Corporation
to guarantee the performance of a customer to a third party. Those guarantees
are primarily issued to support public and private borrowing arrangements. The
credit


                                       38
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 22 - COMMITMENTS, CONTINGENCIES, AND CREDIT RISK (CONTINUED)

risk involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. The commitments are
structured to allow for 100% collateralization on all standby letters of credit.

Credit card commitments are commitments on credit cards issued by the
Corporation's subsidiary and serviced by other companies. These commitments are
unsecured.

CONTINGENCIES

In the normal course of business the Corporation is involved in various legal
proceedings. For expanded discussion on the Corporation's legal proceedings, see
Note 25.

CONCENTRATION OF CREDIT RISK

The Bank grants commercial, residential, agricultural, and consumer loans
throughout Michigan. The Bank's most prominent concentration in the loan
portfolio relates to commercial loans to entities within the hospitality and
tourism industry. This concentration at December 31, 2005 represents $37.7
million, or 21.5%, compared to $52.7 million, or 34.4%, of the commercial loan
portfolio on December 31, 2004. The remainder of the commercial loan portfolio
is diversified in such categories as gaming, petroleum, forestry, and
agriculture. Due to the diversity of the Bank's locations, the ability of
debtors of residential and consumer loans to honor their obligations is not tied
to any particular economic sector.

NOTE 23 - FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value estimates, methods, and assumptions are set forth below for the
Corporation's financial instruments:

CASH, CASH EQUIVALENTS, AND INTEREST-BEARING DEPOSITS - The carrying values
approximate the fair values for these assets.

SECURITIES - Fair values are based on quoted market prices where available. If a
quoted market price is not available, fair value is estimated using quoted
market prices for similar securities.

FEDERAL HOME LOAN BANK STOCK - Federal Home Loan Bank stock is carried at cost,
which is its redeemable value and approximates its fair value, since the market
for this stock is limited.

LOANS - Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as commercial, residential
mortgage, and other consumer. The fair value of loans is calculated by
discounting scheduled cash flows using discount rates reflecting the credit and
interest rate risk inherent in the loan.

The methodology in determining fair value of nonaccrual loans is to average them
into the blended interest rate at 0% interest. This has the effect of decreasing
the carrying amount below the risk-free rate amount and, therefore, discounts
the estimated fair value.

Impaired loans are measured at the estimated fair value of the expected future
cash flows at the loan's effective interest rate or the fair value of the
collateral for loans which are collateral dependent. Therefore, the carrying
values of impaired loans approximate the estimated fair values for these assets.

DEPOSITS - The fair value of deposits with no stated maturity, such as
noninterest-bearing demand deposits and savings, is equal to the amount payable
on demand at the reporting date. The fair value of time deposits is based on the
discounted value of contractual cash flows applying interest rates currently
being offered on similar time deposits.

BORROWINGS - Rates currently available for debt with similar terms and remaining
maturities are used to estimate the fair value of existing debt. The fair value
of borrowed funds due on demand is the amount payable at the reporting date.

ACCRUED INTEREST - The carrying amount of accrued interest approximates fair
value.


                                       39

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 23 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)

OFF-BALANCE-SHEET INSTRUMENTS - The fair value of commitments is estimated using
the fees currently charged to enter into similar agreements, taking into account
the remaining terms of the agreements, the current interest rates, and the
present creditworthiness of the counterparties. Since the differences in the
current fees and those reflected to the off-balance-sheet instruments at
year-end are immaterial, no amounts for fair value are presented.

The following table presents information for financial instruments at December
31 (dollars in thousands):

<TABLE>
<CAPTION>
                                              2005                    2004
                                     ---------------------   ---------------------
                                     Carrying    Estimated   Carrying    Estimated
                                      Amount    Fair Value    Amount    Fair Value
                                     --------   ----------   --------   ----------
<S>                                  <C>        <C>          <C>        <C>
Financial assets:
   Cash and cash equivalents         $  7,943    $  7,943    $ 44,078    $ 44,078
   Interest-bearing deposits            1,025       1,025      18,535      18,535
   Securities available for sale       34,210      34,210      57,075      57,075
   Federal Home Loan Bank stock         4,855       4,855       4,754       4,754
   Net loans                          233,663     231,279     196,866     199,551
   Accrued interest receivable          1,590       1,590       1,909       1,909
                                     --------    --------    --------    --------
Total financial assets               $283,286    $280,902    $323,217    $325,902
                                     ========    ========    ========    ========
Financial liabilities:
   Deposits                          $232,632    $232,175    $215,650    $215,835
   Borrowings                          36,417      35,225      85,039      89,142
   Accrued interest payable               730         730         794         794
   Directors deferred compensation      1,238       1,238       1,338       1,338
                                     --------    --------    --------    --------
Total financial liabilities          $271,017    $269,368    $302,821    $307,109
                                     ========    ========    ========    ========
</TABLE>

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 discount 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 expected 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. Fair value estimates
are based on existing on- and off-balance-sheet financial instruments without
attempting to estimate the value of anticipated future business and the value of
assets and liabilities that are not considered financial instruments.
Significant assets and liabilities that are not considered financial assets or
liabilities include premises and equipment, other assets, and other liabilities.
In addition, the tax ramifications related to the realization of the unrealized
gains and losses can have a significant effect on fair value estimates and have
not been considered in the estimates.


                                       40

<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 24 - PARENT COMPANY ONLY FINANCIAL STATEMENTS

                                 BALANCE SHEETS
                           December 31, 2005 and 2004
                             (Dollars in Thousands)

<TABLE>
<CAPTION>
                                               2005      2004
                                             -------   -------
<S>                                          <C>       <C>
                  ASSETS

Cash and cash equivalents                    $ 1,173   $ 2,313
Investment in subsidiaries                    25,409    33,288
Other assets                                      53        26
                                             -------   -------
TOTAL ASSETS                                 $26,635   $35,627
                                             =======   =======
   LIABILITIES AND SHAREHOLDERS' EQUITY

Liabilities                                  $    47   $   897
Shareholders' equity                          26,588    34,730
                                             -------   -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY   $26,635   $35,627
                                             =======   =======
</TABLE>


                                       41
<PAGE>

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 24 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)

                            STATEMENTS OF OPERATIONS
                  Years Ended December 31, 2005, 2004, and 2003
                             (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                     2005      2004      2003
                                                   -------   -------   -------
<S>                                                <C>       <C>       <C>
Income:
   Security gains                                  $    --   $    --   $   102
   Gain on settlement of subordinated debentures        --     6,617        --
   Other                                                34        13        17
                                                   -------   -------   -------
      Total income                                      34     6,630       119
                                                   -------   -------   -------

Expenses:
   Salaries and benefits                               120     1,568        66
   Interest                                             --       458       504
   Accounting, legal and consulting fees               302     1,031       746
   Other                                               196       183       126
                                                   -------   -------   -------
      Total expenses                                   618     3,240     1,442
                                                   -------   -------   -------
Income (loss) before credit for income
   taxes and equity in undistributed net
   income (loss) of subsidiaries                      (584)    3,390    (1,323)
Credit for income taxes                                 --        --        --
                                                   -------   -------   -------
Income before equity in undistributed
   net income (loss) of subsidiaries                  (584)    3,390    (1,323)
Equity in undistributed net (loss) of
   subsidiaries                                     (6,780)   (4,985)   (8,265)
                                                   -------   -------   -------
Net (loss)                                         $(7,364)  $(1,595)  $(9,588)
                                                   =======   =======   =======
</TABLE>


                                       42

<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 24 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)

                            STATEMENTS OF CASH FLOWS
                  Years Ended December 31, 2005, 2004, and 2003
                             (Dollars in Thousands)

<TABLE>
<CAPTION>
                                                               2005      2004       2003
                                                             -------   --------   -------
<S>                                                          <C>       <C>        <C>
Increase (decrease) in cash and cash equivalents:
   Cash flows from operating activities:
      Net (loss)                                             $(7,364)  $ (1,595)  $(9,588)
                                                             -------   --------   -------
      Adjustments to reconcile net (loss) to net
         cash provided by operating activities:
         Provision for depreciation and amortization              --         26        28
         Net gain on settlement of subordinated debentures        --     (6,617)       --
         Equity in undistributed net loss of subsidiaries      6,780      4,985     8,265
         Change in other assets                                  (27)        59       486
         Change in other liabilities                            (850)       872       518
                                                             -------   --------   -------
            Total adjustments                                  5,903       (675)    9,297
                                                             -------   --------   -------
   Net cash (used in) operating activities                    (1,461)    (2,270)     (291)
                                                             -------   --------   -------

   Cash flows from financing activities:
      Proceeds from issuance of common stock                      --     26,160        --
      Payment in settlement of subordinated debentures            --     (6,500)       --
      Investments in subsidiaries                                321    (15,500)       --
      Dividends paid                                              --         --        --
                                                             -------   --------   -------
   Net cash provided by financing activities                     321      4,160        --
                                                             -------   --------   -------
Net increase (decrease) in cash and cash equivalents          (1,140)     1,890      (291)
Cash and cash equivalents at beginning of period               2,313        423       714
                                                             -------   --------   -------
Cash and cash equivalents at end of period                   $ 1,173   $  2,313   $   423
                                                             =======   ========   =======
</TABLE>

NOTE 25 - LEGAL PROCEEDINGS

The Corporation and its subsidiaries are subject to routine litigation
incidental to the business of banking.  In addition, the Corporation or the Bank
is subject to an informal agreement with regulatory authorities and the
litigation described below.  Information regarding the informal agreement is
contained in "Management's Discussion and Analysis of Financial Condition and
Results of Operations" under the caption "History" in this report, and is
incorporated here by reference.  The litigation that is not routine and
incidental to the business of banking is described below.

Shareholder's Derivative Litigation

Damon Trust v. Bittner, et al.

In an action styled Virginia M. Damon Trust v. North Country Financial
Corporation, Nominal Defendant, and Dennis Bittner, Bernard A. Bouschor, Ronald
G. Ford, Sherry L. Littlejohn, Stanley J. Gerou II, John D. Lindroth, Stephen
Madigan, Spencer Shunk, Michael Hendrickson, Glen Tolksdorf, and Wesley Hoffman,
filed in the U.S. District Court for the Western District of Michigan on July 1,
2003, a shareholder of the Corporation has brought a shareholder's derivative
action under Section 27 of the Exchange Act against the Corporation and certain
of its current and former directors and senior executive officers.  The
Complaint, which demands a jury trial, is brought on behalf of the Corporation
against the individual defendants.  It alleges that the individual defendants
have caused loss and damage to the Corporation through breaches of their
fiduciary duties of oversight and supervision by failing i) adequately to
safeguard the assets of the Corporation, (ii) to ensure that adequate
administrative, operating, and internal controls were in place and implemented,
(iii) to ensure that the Corporation was operated in accordance with
legally-prescribed procedures, and (iv) to oversee the audit process to ensure
that the Corporation's assets were properly accounted for and preserved.  The
Complaint further alleges that the individual defendants violated Section 14(a)
of the Exchange Act by making materially false and misleading statements in the
proxy statement mailed to shareholders in connection with the annual meeting of
the Corporation held May 29, 2000, and the adoption by the shareholders at that
meeting of the Corporation's 2000 Stock Incentive Plan.  The Complaint also
alleges that Mr. Ford and Ms. Littlejohn, through a series of compensation
arrangements, stock options, and employment agreements obtained by them through
improper means resulting from the offices they held with the Corporation,
received excessive compensation, to the injury of the Corporation.  Among other
things, the Complaint is based upon allegations of material misstatements or
omissions in filings made by the Corporation with the SEC, and deficiencies in
the Corporation's policies and procedures for safe and sound operation,
including its directorate and management personnel and practices, credit
underwriting, credit administration, and policies regarding asset/liability
management, liquidity, funds management, and investments, and its compliance
with all applicable laws and regulations, including Regulations O and U of the
Board, FDIC Rules and Regulations, and the Michigan Banking Code of 1999.  The
Complaint seeks (i) rescission of the approval of the 2000 Stock Incentive Plan
and return of all stock and options granted under the Plan, (ii) a declaration
that the individual defendants breached their fiduciary duty to the Corporation,
(iii) an order to the individual defendants to account to the Corporation for
all losses and/or damages by reason of the acts and omissions alleged, (iv) an
order to each of the individual defendants to remit to the Corporation all
salaries and other compensation received for periods during which they breached
their fiduciary duties, (v) compensatory damages in favor of the Corporation,
(vi) injunctive relief, and (vii) interest, costs, and attorney's and expert's
fees.

By letter dated September 17, 2003, and expressly without prejudice to the
argument that any such written demand is not required, plaintiff's counsel
purported to make a written demand that the Corporation pursue a number of
indicated putative claims against: (1) present and former officers and directors
of the Corporation who also are the individual defendants in the Damon action,
and (2) the certified public accounting firm of Wipfli, Ullrich, Bertelson, LLP.

On September 18, 2003, the Corporation filed a motion to dismiss the Damon
action because plaintiff did not satisfy the mandatory precondition, under
Section 493a of the Michigan Business Corporation Act ("MBCA"), M.C.L.Section
450.1493a, for filing a shareholder derivative action that the shareholder must
first have submitted a written demand that the Corporation pursue in its own
right the claims asserted by the

                                       43

<PAGE>
NOTE 25 - LEGAL PROCEEDINGS (CONTINUED)

shareholder (the plaintiff here).  Certain of the individual defendants in the
Damon action filed their own motion to dismiss on November 25, 2003, in which
motion the other individual defendants later joined. The plaintiff filed an
Opposition to both motions to dismiss on January 9, 2004, and on January 30,
2004, the defendants filed reply briefs in support of their motions to dismiss.

On March 22, 2004, the Court issued an Opinion and Order granting in part and
denying in part the motions to dismiss in the Damon case.  The Court dismissed
the Section 14(a) claim against all of the defendants as barred by the statute
of limitations and, as further grounds, dismissed that claim as to those who
were not directors at the time of the mailing of the proxy statement.  The Court
has permitted the plaintiff to proceed with its breach of fiduciary duty claims
against the Directors on the grounds that the plaintiff cured its procedural
failings by subsequently transmitting a demand letter as required by Section 493
of the MBCA. On April 19, 2004, the Court entered an Order Granting Stipulation
to Grant Plaintiff Leave to File Amended Complaint and to Grant Related Relief
to All Parties. On May 14, 2004, the plaintiff filed an Amended Complaint and,
thereafter, all Defendants timely filed Answers to the Amended Complaint. In its
Answer, the Corporation averred that the plaintiff's claims are asserted for and
on behalf of the Corporation, that the plaintiff does not assert any claims
against the Corporation and, therefore, the Corporation properly should be
realigned as a plaintiff in the action.

During the above described proceedings, on November 11, 2003, the Corporation
filed a motion, as permitted by section 495 of the MBCA, M.C.L.Sectioin
450.1495, requesting the Court to appoint a disinterested person to conduct a
reasonable investigation of the claims made by the plaintiff and to make a good
faith determination whether the maintenance of the derivative action is in the
best interests of the Corporation.  After additional written submissions to the
Court by the defendants and the plaintiff concerning the issues presented by
this motion, and after several conferences with the Court, on May 20, 2004, the
Court entered an Order adopting the parties' written stipulations concerning the
appointment of a disinterested person and the manner of conducting the
investigation of the claims made by the plaintiff and making recommendations as
to whether the maintenance of the derivative action is in the best interests of
the Corporation.

On July 14, 2004, the Court convened a settlement conference among counsel for
all parties and counsel for the individual defendants' insurer. Although a
settlement was not achieved, at the direction of the Court, the parties'
respective counsel agreed to continue settlement discussions.

By Order of the Court dated November 2, 2004, the report of the disinterested
person was timely filed with the Corporation on October 23, 2004, and the action
was stayed until November 22, 2004.  On December 22, 2004, the plaintiff filed a
motion with the Court seeking a scheduling conference among the Court and the
parties.  The Court granted the plaintiff's motion on January 10, 2005.  On
January 13, 2005, the parties to the action and the individual defendants'
insurer entered into an agreement regarding limited disclosure of the report of
the disinterested person to the insurer and counsel for the parties on the terms
and conditions set forth in the agreement.  Also on January 13, 2005, a
scheduling conference was held with the Court, and was adjourned to February 14,
2005.

On February 9, 2005, the parties filed a joint status report with the Court.  A
further status conference was held on February 14, 2005.  At that time, the
Court entered a Stipulated Protective Order regarding limited dissemination of
the report of the disinterested person.  Also on February 14, in a separate
Order, the Court required the parties to complete their respective review of the
report and communicate among themselves regarding their positions.  Absent a
negotiated resolution, the Corporation was given the opportunity until March 21,
2005, to file an appropriate motion to dismiss.  On March 21, 2005, consistent
with the determinations of the disinterested person in his report, the
Corporation filed with the Court a motion to dismiss (i) all the breach of
fiduciary duty claims against defendants Bittner, Bouschor, Gerou, Lindroth,
Madigan, Shunk, Hendrickson, and Tolksdorf, (ii) the breach of fiduciary duty
claims against defendant Hoffman, except for one claim identified by the
disinterested person in his report, and (iii) the excess compensation claims
against defendants Ford and Littlejohn.  The plaintiff  opposed the motion to
dismiss.

In an Order dated September 6, 2005, the Court stayed the proceedings in this
case against defendant Littlejohn, in light of her filing for personal
bankruptcy under Chapter 7 of the Bankruptcy Code in the U.S. Bankruptcy Court
for the Western District of Michigan on August 9, 2005.

                                       44

<PAGE>
NOTE 25 - LEGAL PROCEEDINGS (CONTINUED)

In an Opinion and Order, each dated September 7, 2005, the Court granted the
Corporation's motion and dismissed with prejudice (i) all the breach of
fiduciary duty claims against defendants Bittner, Bouschor, Gerou, Lindroth,
Madigan, Shunk, Hendrickson, and Tolksdorf, (ii) the breach of fiduciary duty
claims against defendant Hoffman, except for one claim identified by the
disinterested person in his report, and (iii) the excess compensation claims
against defendants Ford and Littlejohn.  The Court directed that the case
proceed with the claim against defendant Hoffman with respect to his involvement
in defendant Ford's December 21, 2001 employment agreement, and with respect to
the breach of fiduciary duty claims against defendants Ford and Littlejohn,
subject to the stay regarding proceedings against defendant Littlejohn.

A Case Management Order was entered by the Court on September 16, 2005.  The
Court also scheduled a mediation among the parties, the Corporation, and its
insurer for November 15, 2005.

On October 21, 2005, without the required permission of the Court, the plaintiff
filed a Third Amended Complaint which (A) deleted (i) substantive allegations
previously asserted against defendants Bittner, Boushcor, Gerou, Lindroth,
Madigan, Shunk, Hendrickson, and Tolksdorf, (ii) the claim brought under Section
14 of the Exchange Act, (iii) allegations that the defendants engaged in acts to
"artificially inflate the price" of the Corporation's stock, and (iv) the
previous allegations quantifying damages to the Corporation at $40 million
(instead alleging "million of dollars" in damages), and (B) otherwise appears to
have been drafted to comport with the Court's Opinion and Order dated September
7, 2005.  The Third Amended Complaint continues to include allegations against
defendant Littlejohn, notwithstanding the Court's September 6, 2005 Order
staying the case against her because of her personal bankruptcy filing.  Before
the defendants responded to the Third Amended Complaint, the Court entered an
Order on October 31, 2005, striking the Third Amended Complaint because the
required permission of the Court was not obtained for its filing.  The Court's
Order affords plaintiff seven days in which to submit a stipulated order for
filing of the Third Amended Complaint, or the filing of a motion to permit its
filing.  Plaintiff subsequently filed a motion for leave to file a Third Amended
Complaint, and the Court has taken the motion under advisement after conducting
a hearing on the motion on December 6, 2005.

The mediation scheduled by the Court among the parties, the Corporation, and its
insurer was held on November 15, 2005.  No settlement was reached.  A
continuation of the mediation has been scheduled for April 26, 2006 by the
parties, which are conducting discovery in preparation for the mediation.

On November 22, 2005, the U.S. Bankruptcy Court for the Western District of
Michigan entered an Order granting the plaintiff's motion to lift the automatic
stay under 11 U.S.C. Section 362 and to permit plaintiff to continue the Damon
action against defendant Littlejohn, to the extent that plaintiff limits its
recovery to insurance proceeds.  On December 14, 2005, the Bankruptcy Court
entered an order discharging defendant Littlejohn as a debtor in bankruptcy.

On March 3, 2006, the Court amended the Case Management Order to extend the
discovery and motion cutoff deadlines in the Damon case.

Prosecution of this case is the responsibility of the plaintiff and its counsel.
The Corporation's role will be to monitor the case and to respond to discovery
requests from the parties.  Any settlement or judgment ultimately obtained by
plaintiff in this action, net of fees and expenses of counsel for plaintiff,
will inure to the benefit of the Corporation.

If a settlement is not reached as a result of the mediation, the Corporation
will incur additional legal fees and expenses in monitoring the plaintiff's
prosecution of the case on behalf of the Corporation and in responding to the
parties' requests for discovery directed to it.  At this time the Corporation
cannot accurately estimate the amount of any such future legal fees and
expenses.

Damon Trust v. Wipfli

On August 27, 2004, a second shareholder's derivative action, styled Virginia M.
Damon Trust v. Wipfli Ullrich Bertelson, LLP, and North Country Financial
Corporation, Nominal Defendant, was filed in the Michigan Circuit Court for
Grand Traverse County by the same shareholder which brought the derivative

                                       45

<PAGE>
NOTE 25 - LEGAL PROCEEDINGS (CONTINUED)

action discussed above.  The complaint, which demands a jury trial, is brought
on behalf of the Corporation against Wipfli Ullrich Bertelson, LLP ("Wipfli")
under the Michigan Accountant Liability statute, M.C.L. 600.2962.  It alleges
that Wipfli damaged the Corporation by (i) failing to conduct and oversee, with
the due care and competence required of professional accountants, the annual
audit of the Corporation's financial statements for its fiscal years ending
December 31, 2000 and December 31, 2001, (ii) failing to provide, with requisite
due care and competence, the internal audit, regulatory compliance, and
financial reporting services Wipfli had agreed to provide the Corporation after
August 28, 2002, when Wipfli resigned as its auditors to undertake such
consulting services, (iii) failing to exercise due care and competence required
to ensure that the Corporation's financial statements conformed to applicable
regulatory accounting principles ("RAP") and generally accepted accounting
principles ("GAAP"), (iv) failing to make full disclosure that the Corporation's
administrative, operating, and internal controls were inadequate to prevent loss
and damage to its assets, and (v) failing to conduct a diligent and careful
"review" of the Corporation's quarterly financial statements during its fiscal
years 2000 and 2001 and the first and second quarters of 2002.

The complaint further alleges that Wipfli undertook in writing (i) to provide
professional services, including auditing services, accounting services for
preparation of audited financial statements, advice regarding financial
statement disclosure, and preparation of annual reports for regulators,
including  the annual report required by section 36 of the Federal Deposit
Insurance Act, and (ii) to ensure that the Corporation had sufficient systems in
place to determine whether it was in compliance with RAP and other regulations
of the FDIC and the OFIS.  The complaint alleges that Wipfli (i) failed to
conduct its audits of the Corporation's financial statements in accordance with
generally accepted auditing standards ("GAAS"), (ii) negligently represented
that the Corporation's audited annual financial statements for the year ended
December 31, 2000 were fairly presented in all material respects, (iii)
negligently conducted reviews of the Corporation's quarterly financial
statements for the interim quarters of 2000, 2001 and 2002, and (iv) negligently
audited the Corporation's financial statements for the fiscal years 2000 and
2001 by failing to obtain or review sufficient documentation failing to limit
the scope of the audit in light of such failure to obtain or review sufficient
documentation, failing to verify the accuracy of information obtained from the
Corporation for the audit, failing to limit the scope of the audit in light of
such failure to verify the accuracy of the information obtained from the
Corporation, and substantially underestimating the Corporation's liabilities and
misrepresenting its solvency.

The complaint also alleges that Wipfli is a party responsible for the
Corporation's liability in any securities fraud action arising out of a material
overstatement of its financial results.  The complaint claims contribution and
indemnification from Wipfli on behalf of the Corporation under the Private
Securities Litigation Reform Act of 1995 for any liability it may incur in any
such securities fraud action.

On October 12, 2004, Wipfli removed the second shareholder's derivative action
to the U.S. District Court for the Western District of Michigan.  By stipulation
between the respective counsel for the Corporation and the plaintiff, the
Corporation was initially granted until December 10, 2004, to file its first
response to the Complaint, which period was extended by a Stipulated Order until
January, 2005.

On January 10, 2005, the Corporation filed its Answer to the Complaint in the
second shareholder's derivative action.  Also on that date, a joint status
report was filed with the Court by all parties.  A scheduling conference was
held with the Court on January 13, 2005.  On that date, the Court entered a
Preliminary Case Management Order, affording the Corporation the opportunity
until February 3, 2005, to make a motion to realign the Corporation in, or to
dismiss, the litigation.

On February 3, 2005, the Corporation filed a Motion to realign the Corporation
as the plaintiff, and to dismiss the Virginia M. Damon Trust as a party, in the
second shareholder's derivative action.  The plaintiff, Virginia M. Damon Trust,
filed a brief opposing the Corporation's motion.  Oral argument on the
Corporation's motion was held before the Court on March 7, 2005.  The Court took
the matter under advisement.

In an Order dated September 29, 2005, the Court realigned the Corporation as the
plaintiff and made the Corporation exclusively responsible for prosecuting all
further aspects of the case, including any

                                       46
<PAGE>
NOTE 25 - LEGAL PROCEEDINGS (CONTINUED)

settlement.  In the same Order, the Court stated that the Virginia M. Damon
Trust would remain as a nominal plaintiff in the case, entitled to notice.

A Case Management Order was entered by the Court on January 27, 2006.  The Court
also scheduled a mediation among the parties for June, 2006.  The parties have
jointly retained a facilitator to conduct a non-binding mediation on June 20 and
21, 2006.  Pursuant to the Court's order, the parties intend to exchange
documents and expert reports prior to that mediation.

Litigation of the types involved in the actions described above can be complex,
time-consuming, and often protracted.  The Corporation has incurred substantial
expense for legal and other professional fees as a result of these actions.  The
Corporation anticipates that it will incur additional such expenses in
connection with the two actions described above.  The Corporation does not
believe that legal costs associated with the Damon action noted above will be
material for 2006. The amount of the costs to be incurred for 2006 pertaining to
the Wipfli action is unknown; however, the Corporation believes it will not be
in excess of $200,000.

                                       47

<PAGE>

SELECTED FINANCIAL DATA

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

                             SELECTED FINANCIAL DATA
                                   (Unaudited)
                  (Dollars in Thousands, Except Per Share Data)

<TABLE>
<CAPTION>
                                                              Years Ended December 31,
                                              ----------------------------------------------------
                                                2005       2004       2003       2002       2001
                                              --------   --------   --------   --------   --------
<S>                                           <C>        <C>        <C>        <C>        <C>
SELECTED FINANCIAL CONDITION DATA:
   Total assets                               $298,722   $339,497   $422,539   $565,306   $636,629
   Loans                                       239,771    203,832    297,846    435,043    504,412
   Securities                                   34,210     57,075     84,774     67,955     61,885
   Deposits                                    232,632    215,650    305,794    437,494    482,524
   Borrowings                                   36,417     85,039     87,026     87,815     88,549
   Total equity                                 26,588     34,730     10,700     20,503     47,889

SELECTED OPERATIONS DATA:
   Interest income                            $ 16,976   $ 18,853   $ 23,641   $ 35,969   $ 50,475
   Interest expense                             (7,196)    10,615    (14,015)   (18,089)   (26,842)
                                              --------   --------   --------   --------   --------
      Net interest income                        9,780      8,238      9,626     17,880     23,633
   Provision for loan losses                        --         --         --    (26,658)    (3,200)
   Net security gains                               95         --        427        746      1,073
   Other income                                  1,016      8,542      2,804      4,512      9,363
   Impairment loss on intangibles                   --         --        (60)    (3,647)        --
   Other expenses                              (18,255)   (18,228)   (20,056)   (23,416)   (24,307)
                                              --------   --------   --------   --------   --------
      Income (loss) before income taxes         (7,364)    (1,448)    (7,259)   (30,583)     6,562
   Provision (credit) for income taxes              --        147      2,329     (3,870)       788
                                              --------   --------   --------   --------   --------

      Net income (loss)                       $ (7,364)  $ (1,595)  $ (9,588)  $(26,713)  $  5,774
                                              ========   ========   ========   ========   ========

PER SHARE DATA:
   Earnings (loss) - Basic                    $  (2.15)  $  (3.23)  $ (27.32)  $ (76.11)  $  16.40
   Earnings (loss) - Diluted                     (2.15)     (3.23)    (27.32)    (76.11)     16.40
   Cash dividends declared                          --         --         --       5.00       6.00
   Book value                                     7.76      10.13      30.40      58.40     136.40
   Market value - closing price at year end       9.10      17.97      35.00      48.40     147.84

FINANCIAL RATIOS:
   Return on average equity                     (25.63)%   (18.64)%   (59.15)%   (61.07)%    12.48%
   Return on average assets                      (2.58)      (.44)     (1.96)     (4.31)       .89
   Dividend payout ratio                           N/A        N/A        N/A         NM      36.48
   Average equity to average assets              10.05       2.34       3.32       7.05       7.10
</TABLE>


                                       48

<PAGE>

SUMMARY QUARTERLY FINANCIAL INFORMATION

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

                     SUMMARY QUARTERLY FINANCIAL INFORMATION
                                   (Unaudited)
                  (Dollars in Thousands, Except per Share Data)

<TABLE>
<CAPTION>
                                                         THREE MONTHS ENDED
                                          -----------------------------------------------
                                          MARCH 31   JUNE 30   SEPTEMBER 30   DECEMBER 31
                                          --------   -------   ------------   -----------
<S>                                       <C>        <C>       <C>            <C>
2005
SELECTED OPERATIONS DATA:
   Interest income                         $ 3,988   $ 4,017      $4,270        $ 4,701
   Interest expense                          1,783     1,629       1,763          2,021
                                           -------   -------      ------        -------
      Net interest income                    2,205     2,388       2,507            680
   Other income                                184       370         254            303
   Other expenses                            7,630     3,335       3,279          4,011
                                           -------   -------      ------        -------
      Income (loss) before income taxes     (5,241)     (577)       (518)        (1,028)
   Provision for income taxes                   --        --          --             --
                                           -------   -------      ------        -------
      Net income (loss)                    $(5,241)  $  (577)     $ (518)       $(1,028)
                                           =======   =======      ======        =======

PER SHARE DATA:
   Earnings (loss) - Basic                 $ (1.53)  $  (.17)     $ (.15)       $  (.30)
   Earnings (loss) - Diluted                 (1.53)     (.17)       (.15)          (.30)

2004
SELECTED OPERATIONS DATA:
   Interest income                         $ 4,976   $ 5,153      $4,408        $ 4,316
   Interest expense                          2,965     2,686       2,548          2,416
                                           -------   -------      ------        -------
      Net interest income                    2,011     2,467       1,860          1,900
   Other income                                663        63         867          6,949
   Other expenses                            4,341     4,130       3,488          6,269
                                           -------   -------      ------        -------
      Income (loss) before income taxes     (1,667)   (1,600)       (761)         2,580
   Provision for income taxes                   --        --          --            147
                                           -------   -------      ------        -------
      Net income (loss)                    $(1,667)  $(1,600)     $ (761)       $ 2,433
                                           =======   =======      ======        =======

PER SHARE DATA:
   Earnings (loss) - Basic                 $ (4.75)  $ (4.56)     $(2.17)       $  8.25
   Earnings (loss) - Diluted                 (4.75)    (4.56)      (2.17)          8.25
</TABLE>


                                       49
<PAGE>

MARKET INFORMATION

                 MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

                               MARKET INFORMATION
                                   (Unaudited)

During 2001, the Corporation's stock began trading on the NASDAQ Small Cap
Market; effective on August 31, 2001, the Corporation changed its trading symbol
from "NCUF" to "NCFC." As part of the recapitalization, the Corporation changed
its name from North Country Financial Corporation to Mackinac Financial
Corporation and changed its trading symbol from "NCFC" to "MFNC".

The following table sets forth the range of high and low bid prices of the
Corporation's common stock from January 1, 2003 through December 31, 2005, as
reported by NASDAQ. Quotations for the NASDAQ Small Cap Market reflect
inter-dealer prices, without retail mark-up, markdown, or commission, and may
not reflect actual transactions. All historical stock prices have been adjusted
for the 1 for 20 reverse stock split.

<TABLE>
<CAPTION>
                      THREE MONTHS ENDED
       -----------------------------------------------
       MARCH 31   JUNE 30   SEPTEMBER 30   DECEMBER 31
       --------   -------   ------------   -----------
<S>    <C>        <C>       <C>            <C>
2005
High    $19.26     $18.25      $15.25         $10.75
 Low     17.50      11.78       10.99           9.05
2004
High    $44.60     $52.80      $41.00         $21.80
 Low     31.00      28.00       14.40           7.00
</TABLE>

The Corporation had 1,825 shareholders of record as of March 24, 2006.


                                       50

<PAGE>

FORWARD-LOOKING STATEMENTS

This report contains certain forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. The Corporation intends such
forward-looking statements to be covered by the safe harbor provisions for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995 and is including this statement for purposes of these safe harbor
provisions. Forward-looking statements which are based on certain assumptions
and describe future plans, strategies, or expectations of the Corporation, are
generally identifiable by use of the words "believe", "expect", "intend",
"anticipate", "estimate", "project", or similar expressions. The Corporation's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors that could cause actual results to differ from the
results in forward-looking statements include, but are not limited to:

     -    Impact of continued operating losses;

     -    Asset growth of the Corporation may be constrained in order to
          maintain regulatory defined "well capitalized" equity to asset ratios;

     -    The highly regulated environment in which the Corporation operates
          could adversely affect its ability to carry out its strategic plan due
          to restrictions on new products, funding opportunities or new market
          entrances;

     -    General economic conditions, either nationally or in the state(s) in
          which the Corporation does business;

     -    Legislation or regulatory changes which affect the business in which
          the Corporation is engaged;

     -    Changes in the interest rate environment which increase or decrease
          interest rate margins;

     -    Changes in securities markets with respect to the market value of
          financial assets and the level of volatility in certain markets such
          as foreign exchange;

     -    Significant increases in competition in the banking and financial
          services industry resulting from industry consolidation, regulatory
          changes and other factors, as well as action taken by particular
          competitors;

     -    The ability of borrowers to repay loans;

     -    The effects on liquidity of unusual decreases in deposits;

     -    Changes in consumer spending, borrowing, and saving habits;

     -    Technological changes;

     -    Acquisitions and unanticipated occurrences which delay or reduce the
          expected benefits of acquisitions;

     -    Difficulties in hiring and retaining qualified management and banking
          personnel;

     -    The Corporation's ability to increase market share and control
          expenses;

     -    The effect of compliance with legislation or regulatory changes;

     -    The effect of changes in accounting policies and practices;

     -    The costs and effects of existing and future litigation and of adverse
          outcomes in such litigation.

These risks and uncertainties should be considered in evaluating forward-looking
statements. Further information concerning the Corporation and its business,
including additional factors that could materially affect the Corporation's
financial results, is included in the Corporation's filings with the Securities
and Exchange Commission. All forward-looking statements contained in this report
are based upon information presently available and the Corporation assumes no
obligation to update any forward-looking statements.


                                       51

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion will cover results of operations, asset quality,
financial position, liquidity, interest rate sensitivity, and capital resources
for the years 2003 through 2005. The information included in this discussion is
intended to assist readers in their analysis of, and should be read in
conjunction with, the consolidated financial statements and related notes and
other supplemental information presented elsewhere in this report. Throughout
this discussion, the term "Bank" refers to mBank, the principal banking
subsidiary of the Corporation.

HISTORY

The Corporation, in the past several years, has experienced significant
operating losses and a continued deterioration of its financial condition. In
March 2003, the Bank entered into a formal Cease and Desist Order (the "Order")
under Federal and State banking laws. As a result of this Order, the Bank
initiated significant management and operational changes along with balance
sheet strategies to comply with the Order. The Bank experienced substantial
adverse publicity as a result of the public notice of this Order and from the
reported financial condition of the Bank. This negative publicity resulted in
substantial deposit runoff. In 2003, its external auditors issued a qualified
opinion concerning the Corporation's ability to continue as a going concern. The
Bank also incurred an inordinate amount of legal and accounting fees, along with
consulting costs during 2003 in its attempt to address the financial and
operational deficiencies which led to the issuance of the Order.

On December 16, 2004, the Corporation consummated a recapitalization plan
through the issuance of $30 million of its common stock in a private placement
which resulted in net proceeds of $26.2 million. The Corporation utilized a
portion of these proceeds, $15.5 million, to infuse capital into the Bank. The
Corporation, as a part of the recapitalization, also reached a settlement for a
$6.5 million payment to retire its $12.5 million of subordinated debentures.
Recapitalization occurred as the culmination of the following historical
progression of events. Early in 2005, the Order was terminated and replaced with
an informal agreement. The Order and informal agreement are discussed in more
detail in the Consolidated Notes to the Financial Statements and later in
Management's Discussion.

EXECUTIVE OVERVIEW

The purpose of this section is to provide a brief overview of the 2005 results
of operations. Additional detail of the balance sheet and Statement of
Operations is provided in Management Discussion following this summary.

The Corporation reported a net loss of $7.364 million, or $2.15 per share, for
the year ended December 31, 2005, compared to a net loss of $1.595 million, or
$3.23 per share for 2004. Weighted average shares outstanding amounted to
3,248,695 in 2005 and 494,305 in 2004.

The 2005 loss of $7.364 million includes a number of significant one-time
charges. Included are $4.320 million of penalties incurred to prepay $48.555
million of FHLB borrowings, $.815 million of costs associated with conversion of
the Corporation's data processing system, approximately $.500 million of
marketing expense to launch the new "mBank" name along with a new line of
products and services, and lastly a $.200 million write-down of other real
estate property.

Total assets of the corporation at December 31, 2005 were $298.722 million, a
decrease of 12.01% from total assets of $339.497 million reported at December
31, 2004. The balance sheet totals at December 31, 2005 reflect the liquidation
of short term investments to fund the prepayment of the FHLB borrowings.

During 2005 the Corporation increased loans by $35.939 million from 2004
year-end balances of $203.832 million, a 17.6% increase. This growth in loans
occurred despite unusually high payoffs of existing portfolio loans, which
totaled $46.8 million, along with normal principal reductions or amortization of
$23.3 million. Total loan production in 2005 amounted to $117.759 million.

The Bank's asset quality continued to improve in 2005. Nonperforming loans, as a
percent of loans, amounted to .05% at 2005 year-end, compared to 2.11% at
December 31, 2004, and 15.47% at 2003 year-end. Nonperforming assets at December
31, 2005 were $1.059 million, .35% of total assets, compared to $6.037 million,
or 1.78% of total assets at the end of 2004.

Total deposits grew from $215.650 million at December 31, 2004 to $232.632
million at December 31, 2005, an increase of 7.87%. The increase includes the
growth in core deposits of the Bank in the amount of $21.436 million, a 14.0%
increase


                                       52

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

from 2004 year-end balances of $153.094 million, and the addition of $9.956
million in brokered deposits in December 2005.

Shareholders' equity totaled $26.588 million at December 31, 2005 compared to
$34.730 million at the end of 2004, a decrease of $8.142 million. This decrease
reflects the consolidated loss of $7.364 million and also the reduction in
equity due to the decrease in the market value of held-for-sale investments,
which amounted to $.855 million. The book value per share at December 31, 2005
amounted to $7.76 compared to $10.13 at the end of 2004.

ASSET QUALITY

During 2004 and 2003 results of operations were significantly impacted by high
levels of nonperforming assets. The Corporation also incurred additional costs
for legal and collection efforts as a result of the high level of nonperforming
assets. Finally, management had to redirect its efforts to address nonperforming
assets in 2003 and 2004, which impacted the ability to generate new loan growth.

The table below shows balances of nonperforming assets for the three years ended
December 31 (dollars in thousands):

<TABLE>
<CAPTION>
                                             2005       2004      2003
                                          ---------   -------   -------
<S>                                       <C>         <C>       <C>
NONPERFORMING ASSETS:
Nonaccrual loans                          $      15   $ 4,307   $38,660
Accruing loans past due 90 days or more          99        --       241
Restructured loans                               --        --     7,181
                                          ---------   -------   -------
   Total nonperforming loans                    114     4,307    46,082
Other real estate owned                         945     1,730     4,356
                                          ---------   -------   -------
Total nonperforming assets                $   1,059   $ 6,037   $50,438
                                          =========   =======   =======
Nonperforming loans as a % of loans             .05%     2.11%    15.47%
                                          ---------   -------   -------
Nonperforming assets as a % of assets           .35%     1.78%    11.94%
                                          ---------   -------   -------
RESERVE FOR LOAN LOSSES:
At period end                             $   6,108   $ 6,966   $22,005
                                          ---------   -------   -------
As a % of loans                                2.55%     3.42%     7.39%
                                          ---------   -------   -------
As a % of nonperforming loans              5,357.89%   161.74%    47.75%
                                          ---------   -------   -------
As a % of nonaccrual loans                   N/M   %   161.74%    56.92%
                                          =========   =======   =======
</TABLE>

The following table details the impact of nonperforming loans on interest income
for the three years ended December 31 (dollars in thousands):

Impact of Nonperforming Loans on Interest Income

<TABLE>
<CAPTION>
                                    2005    2004     2003
                                    ----   ------   ------
<S>                                 <C>    <C>      <C>
Interest income that would have
   been recorded at original rate   $134   $  803   $2,793
                                    ----   ------   ------
Interest income that was
   actually recorded                  78    1,053    1,307
                                    ----   ------   ------
Net interest lost (gained)          $ 56     (250)   1,486
                                    ====   ======   ======
</TABLE>

As shown in the above table, the Corporation has been successful in the
reduction of nonperforming assets from $50.438 million at the end of 2003, to
$1.059 million at the end of 2005.

FINANCIAL POSITION

LOANS

In 2005, the Corporation increased loan balances by $35.939 million, or 17.6%,
from 2004 year-end loan balances of $203.832 million. This loan growth in 2005
reversed the decline the Corporation registered in recent years. The declines


                                       53
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

experienced in 2003 and 2004 were largely due to strategic management decisions
to sell problem loans and reduce loan concentration through non-renewal of
out-of-market loans in hospitality, tourism and gaming. The loan growth in 2005
was accomplished despite unusually high loan payoffs of existing portfolio loans
of $46.8 million and was aided by the addition of one senior commercial lender
late in 2004 and the addition of three more commercial lenders during 2005. The
Corporation emphasizes high quality commercial based lending with the majority
of loans carrying variable interest rates which adjust up or down with the prime
interest rate or other national indices.

Loans represented 80.27% of total assets at the end of 2005 compared to 60.04%
at the end of 2004. The loan to deposit ratio increased from 94.52% at December
31, 2004, to 103.07% at December 31, 2005. The loan to deposit ratio is higher
than a peer average of approximately 90% due in part to the Bank's utilization
of Federal Home Loan Bank long-term borrowings as a funding source.

Following is a summary of the Corporation's loan balances at December 31
(dollars in thousands):

<TABLE>
<CAPTION>
                                                                                  Percent Change
                                                                              ---------------------
                                               2005       2004       2003     2005/2004   2004/2003
                                             --------   --------   --------   ---------   ---------
<S>                                          <C>        <C>        <C>        <C>         <C>
Commercial real estate                       $118,637   $105,619   $161,976     12.33%     (34.79)%
Commercial, financial, and agricultural        56,686     47,446     80,988     19.47      (41.42)
One to four family residential real estate     44,660     45,292     51,120     (1.40)     (11.40)
Consumer                                        2,285      2,379      3,195     (3.95)     (25.54)
Construction                                   17,503      3,096        567    465.34      446.03
                                             --------   --------   --------    ------      ------
   Total                                     $239,771   $203,832   $297,846     17.63%     (31.56)%
                                             ========   ========   ========    ======      ======
</TABLE>

The above table more clearly illustrates the reduction of the commercial loan
portfolio in 2004, followed by a resurgence of growth in 2005. This growth in
loans for 2005 was accomplished through a concentrated effort to return the
Corporation to profitability by adding high quality commercial loans generated
by a highly skilled commercial lending staff supported with an extensive credit
review and underwriting process.

Management has strengthened its lending staff and established a central loan
underwriting, documentation, and approval process which will allow the
Corporation to again become an active participant in serving the commercial loan
needs of its local markets. The Corporation continues to feel that a properly
positioned loan portfolio is the most attractive earning asset available and is
the key to returning the Corporation to profitability. The Corporation, with its
commercial lending expertise, is highly competitive in structuring loans to meet
borrowing needs and meet strong underwriting requirements in order to maintain
credit quality.

Following is a table showing the significant industry types in the commercial
loan portfolio as of December 31 (dollars in thousands):

<TABLE>
<CAPTION>
                                        2005                          2004                          2003
                            ---------------------------   ---------------------------   ----------------------------
                                        % of      % of                % of      % of                % of      % of
                             Balance    Loans   Capital    Balance    Loans   Capital    Balance    Loans    Capital
                            --------   ------   -------   --------   ------   -------   --------   ------   --------
<S>                         <C>        <C>      <C>       <C>        <C>      <C>       <C>        <C>      <C>
Hospitality and Tourism     $ 37,681    21.49%  141.72%   $ 52,659    34.40%  151.62%   $ 76,131    31.33%    711.50%
Gaming                         7,553     4.31    28.41      14,310     9.35    41.20      22,317     9.19     208.57
Petroleum                      6,508     3.71    24.48       7,718     5.04    22.22       8,770     3.61      81.96
Forestry                       5,370     3.06    20.20       2,245     1.47     6.46       1,911      .79      17.86
Other                        118,211    67.43   444.60      76,133    49.74   219.21     133,835    55.08   1,250.79
                            --------   ------   ------    --------   ------   ------    --------   ------   --------
   Total Commercial Loans   $175,323   100.00%            $153,065   100.00%            $242,964   100.00%
                            ========   ======             ========   ======             ========   ======
</TABLE>

Management has recognized the additional risk presented by the concentration in
certain segments of the portfolio, particularly hospitality and gaming. The
corporation completed two loan sales in 2004 totaling $40 million of primarily
nonperforming loans. These loan sales included $14.2 million of hospitality and
tourism loans, which when sold, reduced the Bank's concentration for this
industry segment. The Bank is currently under a regulatory agreement to limit
the concentration of hospitality and tourism loans to less than 180% of equity.
Management does not consider the current loan


                                       54

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

concentrations in hospitality and gaming to be problematic, and has no intention
of further reducing loans to this industry segment, other than to comply with
existing regulatory guidelines.

The Corporation has also extended credit to governmental units, including Native
American organizations. Tax-exempt loans and leases decreased from $16.8 million
at the end of 2004 to $13.1 million at 2005 year-end. The Corporation has
elected to reduce its tax-exempt portfolio, since it currently receives no tax
benefit, due to tax net operating loss carryforwards.

Due to the seasonal nature of many of the Corporation's commercial loan
customers, loan payment terms were historically structured around the customer's
business cycle. The lending staff evaluates the collectability of the past due
loans based on documented collateral values and payment history. The Corporation
discontinues the accrual of interest on loans when, in the opinion of
management, there is an indication that the borrower may be unable to meet the
payments as they become due. Upon such discontinuance, all unpaid accrued
interest is reversed. Loans are returned to accrual status when all principal
and interest amounts contractually due are brought current and future payments
are reasonably assured.

ALLOWANCE FOR LOAN LOSSES

Management analyzes the allowance for loan losses on a monthly basis to
determine whether the losses inherent in the portfolio are properly reserved
for. In conjunction with the Corporation's senior lending staff and the bank
regulatory examinations, management intensified the review of the Corporation's
loans, related collateral evaluations, and the overall lending process during
2003 and 2004. The Corporation utilizes a loan review consultant to perform a
review of the loan portfolio. The opinion of this consultant, upon completion of
the independent review in 2005, provided findings similar to management on the
overall adequacy of the reserve. The Corporation will utilize this same
consultant for loan review during 2006.

As a result of these changes in the Corporation's monitoring of delinquent
credits and more rigorous collection efforts, management believes that credit
problems will be identified and resolved earlier, at which time there may be
more opportunities for favorable resolution.

The Corporation's credit quality history is demonstrated in the following table
(dollars in thousands):

<TABLE>
<CAPTION>
                                                      2005        2004        2003
                                                    --------    --------    --------
<S>                                                 <C>         <C>         <C>
Total loans, at period end                          $239,771    $203,832    $297,846
                                                    --------    --------    --------
Average loans for the year                          $207,928    $244,730    $361,144
                                                    --------    --------    --------
Allowance for loan losses                           $  6,108    $  6,966    $ 22,005
                                                    --------    --------    --------
Allowance to total loans at end of year                 2.55%       3.42%       7.38%
                                                    --------    --------    --------
Net charge-offs during the year                     $    858    $ 15,039    $  2,903
                                                    --------    --------    --------
Net charge-offs to average loans                         .41%       6.15%        .80%
                                                    --------    --------    --------
Net charge-offs to beginning allowance balance         12.32%      68.34%      11.65%
                                                    --------    --------    --------
Nonaccrual loans at end of year                     $     15    $  4,307    $ 38,660
Loans past due 90 days or more                            99          --         241
Restructured loans                                        --          --       7,181
   Total nonperforming loans                        $    114    $  4,307    $ 46,082
                                                    ========    ========    ========
Nonperforming loans to total loans at end of year        .05%       2.11%      15.47%
                                                    --------    --------    --------
</TABLE>

Nonaccrual loans have decreased $4.292 million from December 31, 2004 to
December 31, 2005, while loans 90 days or more past due and still accruing have
increased $99,000. In 2004, the Bank sold $40.0 million of primarily
nonperforming loans of which $22.9 were in a nonaccrual status. Late in 2005 the
Bank sold $2.1 million of nonperforming assets which included $1.0 million of
nonaccrual loans. There was no gain or loss on these sales of loans since the
sale proceeds were equal to the net carrying value of the loans sold.


                                       55

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The computation of the required allowance for loan losses as of any point in
time is one of the critical accounting estimates made by management in the
financial statements. As such, factors used to establish the allowance could
change significantly from the assumptions made and impact future earnings
positively or negatively. The future of the national and local economies and the
resulting impact on borrowers' ability to repay their loans and the value of
collateral are examples of areas where assumptions must be made for individual
loans, as well as the overall portfolio.

The Corporation's computation of the allowance for loan losses follows the
Interagency Policy Statement on Allowance for Loan and Lease Losses
Methodologies and Documentation for Banks and Savings Associations issued by the
Federal Financial Institutions Examination Council (FFIEC) in July 2001. The
computation of the allowance for loan losses considers prevailing local and
national economic conditions as well as past and present underwriting practices.

ALLOWANCE FOR LOAN AND LEASE LOSSES - THREE YEAR SUMMARY (dollars in thousands):

<TABLE>
<CAPTION>
                                                           2005       2004       2003
                                                         --------   --------   --------
<S>                                                      <C>        <C>        <C>
Balance at beginning of period                           $  6,966   $ 22,005   $ 24,908
Loans charged off:
   Commercial, Financial &
      Agricultural                                            448     10,187      5,068
   One-to-four family residential real estate                 493      3,118      1,683
   Consumer                                                    51      2,453        205
                                                         --------   --------   --------
      Total loans charged off                                 992     15,758      6,956
                                                         --------   --------   --------
Recoveries of loans previously charged off:
   Commercial, Financial &
      Agricultural                                            102        312      2,926
   One-to-four family residential real estate                  23        148        931
   Consumer                                                     9        259        196
                                                         --------   --------   --------
      Total recoveries of loans previously charged off        134        719      4,053
                                                         --------   --------   --------
         Net loans charged off                                858     15,039      2,903
                                                         --------   --------   --------
Provision charged to expense                                   --         --         --
Balance at end of period                                 $  6,108   $  6,966   $ 22,005
                                                         ========   ========   ========
Reserve as a percent of loans                                2.55%      3.42%      7.39%
                                                         --------   --------   --------
Net loans charged off as a percent of average loans           .41%      6.15%       .80%
                                                         --------   --------   --------
Loans outstanding at period end                          $239,771   $203,832   $297,846
                                                         --------   --------   --------
Average loans outstanding during period                  $207,928   $244,730   $361,144
                                                         --------   --------   --------
</TABLE>

As part of the management of the loan portfolio, risk ratings are assigned to
all commercial loans. Through the loan review process ratings are modified as
believed to be appropriate to reflect changes in the credit. Using a historical
average loss by loan type as a base, each loan graded as higher risk is assigned
a specific percentage. Within the commercial loan portfolio, the historical loss
rates are used for specific industries such as hospitality, gaming, petroleum,
and forestry. The residential real estate and consumer loan portfolios are
assigned a loss percentage as a homogenous group. If, however, on an individual
loan the projected loss based on collateral value and payment histories are in
excess of the computed allowance, the allocation is increased for the higher
anticipated loss. These computations provide the basis for the allowance for
loan losses as recorded by the Corporation.


                                       56
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Following is a table showing the specific loan allocation of the allowance for
loan losses at December 31, 2005 (dollars in thousands):

<TABLE>
<S>                                                <C>
Commercial, financial and agricultural loans       $1,492
One to four family residential real estate loans       17
Consumer loans                                         --
Unallocated and general reserves                    4,599
                                                   ------
Total                                              $6,108
                                                   ======
</TABLE>

At the end of 2005, the allowance for loan losses represented 2.55% of total
loans. In management's opinion, the allowance for loan losses is adequate to
cover probable losses related to specifically identified loans, as well as
probable losses inherent in the balance of the loan portfolio

As part of the process of resolving problem credits, the Corporation may acquire
ownership of real estate collateral which secured such credits. The Corporation
carries this collateral in other real estate on the balance sheet.

The following table represents the activity in other real estate (dollars in
thousands):

<TABLE>
<S>                                                           <C>
Balance at January 1, 2004                                    $ 4,356
Other real estate transferred from loans                        4,762
Other real estate sold / written down                          (7,388)
                                                              -------
Balance at December 31, 2004                                    1,730
Other real estate transferred from loans due to foreclosure       632
Other real estate transferred to premises and equipment          (358)
Other real estate sold / written down                          (1,059)
                                                              -------
Balance at December 31, 2005                                  $   945
                                                              =======
</TABLE>

Other real estate is initially valued at the lower of cost or the fair value
less selling costs. After the initial receipt, management periodically
re-evaluates the recorded balance and any additional reductions in the fair
value result in a write-down of other real estate.

SECURITIES

During 2005, the securities portfolio continued to be an important component of
the Corporation's strategy to diversify its asset base and increase liquidity.
Securities decreased $22.865 million in 2005, from $57.075 million at December
31, 2004 to $34.210 million at December 31, 2005.


                                       57

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The carrying value of the Corporation's securities is as follows at December 31
(dollars in thousands):

<TABLE>
<CAPTION>
                                                     2005      2004
                                                   -------   -------
<S>                                                <C>       <C>
US Agencies                                        $30,354   $21,843
Obligations of states and political subdivisions     3,856     4,029
Corporate securities                                    --       681
Mortgage-related securities                             --    30,522
                                                   -------   -------
Total securities                                   $34,210   $57,075
                                                   =======   =======
Securities as a percent of year end assets           11.45%    16.81%
                                                   =======   =======
</TABLE>

The Corporation's policy is to purchase securities of high credit quality,
consistent with its asset/liability management strategies. During the year,
securities were purchased and others matured or were called as steps in the
process of managing the interest-rate-risk profile of the portfolio. In 2005,
the Corporation utilized the excess liquidity provided by held-for-sale
securities to fund loan growth. A net gain of $95,000 on the sale of securities
was recognized in 2005. There were no security gains or losses in 2004. A net
gain of approximately $427,000 was recognized during the year 2003 with the
proceeds from the sale of securities used to purchase new securities and
increase liquidity. The Corporation classifies all securities as available for
sale, in order to maintain adequate liquidity and to maximize its ability to
react to changing market conditions.

DEPOSITS

Total deposits at December 31, 2005, were $232.632 million compared to $215.650
million at the end of 2004. The table below shows the deposit mix for the
periods indicated (dollars in thousands):

<TABLE>
<CAPTION>
                                      2005       Mix      2004       Mix      2003       Mix
                                    --------   ------   --------   ------   --------   ------
<S>                                 <C>        <C>      <C>        <C>      <C>        <C>
Demand deposit accounts             $ 19,684     8.46%  $ 20,956     9.72%  $ 26,179     8.56%
NOW and money market                  64,566    27.75     53,468    24.79     71,101    23.25
Savings and IRAs                      22,555     9.70     25,570    11.86     29,453     9.63
Certificates of Deposit <$100,000     67,725    29.11     53,100    24.62     63,296    20.70
                                    --------   ------   --------   ------   --------   ------
   Total core deposits               174,530    75.02    153,094    70.99    190,029    62.14
Certificates of Deposit >$100,000     12,335     5.30     10,726     4.97     11,396     3.73
Internet CD                           35,811    15.39     51,830    24.03     74,405    24.33
Brokered CDs                           9,956     4.28         --       --     29,964     9.80
                                    --------   ------   --------   ------   --------   ------
   Total non-core deposits            58,102    24.98     62,556    29.01    115,765    37.86
                                    --------   ------   --------   ------   --------   ------
   Total deposits                   $232,632   100.00%  $215,650   100.00%  $305,794   100.00%
                                    ========   ======   ========   ======   ========   ======
</TABLE>

During 2004, the Corporation experienced deposit runoff primarily due to the
financial condition of the Bank. The Corporation also closed five branch
locations and sold the deposits of five branch locations during 2004. Deposits
sold amounted to $26.5 million. To offset this deposit runoff, the Corporation
increased its reliance on Internet certificates of deposit. In 2005, this trend
in deposit runoff was reversed through an extensive marketing campaign
introducing a new, more competitive product line, along with the new branding
from North Country Bank and Trust to mBank. As of December 31, 2005, non-core
deposits amounted to 24.98% of total deposits, a decline from 29.01% at 2004
year-end and 37.86% at the end of 2003. The Bank had $9.956 million in brokered
deposits at December 21, 2005, 4.28% of total deposits. Non-core funding through
Internet time deposits and brokered CDs has a negative effect on the
Corporation's net interest margin, as non-core out-of-market deposits carry
higher interest costs.

Management continues to monitor existing deposit products in order to stay
competitive, both as to terms and pricing. It is the intent of management to be
aggressive in its markets to grow core deposits with an emphasis placed on
transactional accounts.


                                       58

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

BORROWINGS

The Corporation historically used alternative funding sources to provide
long-term, stable sources of funds. The current borrowings carry fixed interest
rates and stated maturities ranging through 2011. Fixed rate borrowings totaling
$35 million are callable quarterly at the option of the FHLB and can also be
converted to variable rates, at the option of the FHLB, should rates rise above
certain index levels. These borrowings are secured by a blanket collateral
agreement on the Bank's residential mortgage loans and specific assignment of
securities, loans and cash.

SHAREHOLDERS' EQUITY

Changes in shareholders' equity are discussed in detail in the "Capital and
Regulatory" section of this report.

RESULTS OF OPERATIONS

SUMMARY

The Corporation incurred a loss of $7.364 million in 2005, compared to a loss of
$1.595 million and $9.588 million in 2004 and 2003, respectively. The loss in
2005 includes a number of significant one-time charges, including a $4.320
million FHLB prepayment penalty, $.815 million data processing conversion
charges, $.55 million of marketing expense to launch the new mBank name and new
product line, and $.200 million write-down of other real estate property. The
reduction in the pretax loss of $8.0 million in 2004, compared to 2003, is
primarily a result of a gain of $6.6 million on the settlement of the
subordinated debentures and a decrease in noninterest expense of $1.9 million.
Basic earnings per share was a loss of $2.15 in 2005, compared to a loss of
$3.23 in 2004 and a loss of $27.32 in 2003. The per share data reflects the
issuance of shares and a 1 for 20 reverse stock split that occurred as a result
of the recapitalization, in December 2004.


                                       59
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table details changes in earnings and earnings per share for the
three years ended December 31 (dollars in thousands, except for per share data):

<TABLE>
<CAPTION>
                                                                                             Change
                                                         Income/Expense      --------------------------------------
                                                  -------------------------       2005/2004           2004/2003
                                                    2005     2004     2003   ------------------  ------------------
                                                  Dollars  Dollars  Dollars  Dollars  Per Share  Dollars  Per Share
                                                  -------  -------  -------  -------  ---------  -------  ---------
<S>                                               <C>      <C>      <C>      <C>      <C>        <C>      <C>
Net Income, prior period                              N/A      N/A      N/A  $    --   $   --    $(9,588)  $(27.32)
Interest Income                                   $16,976  $18,853  $23,641   (1,877)    (.55)    (4,788)    (9.69)
Interest Expense                                    7,196   10,615   14,015   (3,419)   (1.00)    (3,400)    (6.88)
                                                  -------  -------  -------  -------   ------    -------   -------
   Net Interest Income                              9,780    8,238    9,626    1,542      .45     (1,388)    (2.81)
Provision for Loan Losses                              --       --       --       --       --         --        --
                                                  -------  -------  -------  -------   ------    -------   -------
Net interest income (loss) after provision          9,780    8,238    9,626    1,542      .45     (1,388)    (2.81)
Noninterest Income:
   Service fees                                       586      982    1,529     (396)    (.12)      (547)    (1.11)
   Loan and lease fees                                 21       17       58        4       --        (41)     (.08)
   Net security gains                                  95       --      427       95      .03       (427)     (.86)
   Gain on sales of loans                              49       39      136       10       --        (97)     (.20)
   Gain on sales of branches                           --      205       --     (205)    (.06)       205       .41
   Gain on settlement of subordinated debentures       --    6,617       --   (6,617)   (1.93)     6,617     13.39
   Other                                              360      682    1,081     (322)    (.09)      (399)     (.81)
                                                  -------  -------  -------  -------   ------    -------   -------
      Total noninterest income                      1,111    8,542    3,231   (7,431)   (2.17)     5,311     10.75
                                                  -------  -------  -------  -------   ------    -------   -------
Noninterest Expense:
   Salaries and employee benefits                   6,090    8,032    5,973   (1,942)    (.57)     2,059      4.17
   Occupancy                                        1,053      994    1,387       59      .02       (393)     (.80)
   Furniture and equipment                            560      887    1,367     (327)    (.10)      (480)     (.97)
   Data processing                                  1,720    1,220    1,517      500      .15       (297)     (.60)
   Accounting, legal, and consulting fees             886    1,836    3,145     (950)    (.28)    (1,309)    (2.65)
   Loan and deposit                                   852    1,718    1,992     (866)    (.25)      (274)     (.55)
   Telephone                                          271      382    1,382     (111)    (.03)    (1,000)    (2.02)
   Advertising                                        814      115      182      699      .20        (67)     (.31)
   Penalty on prepayment of FHLB borrowings         4,320       --       --    4,320     1.26
   Other                                            1,689    3,044    3,171   (1,355)    (.39)      (127)     (.62)
                                                  -------  -------  -------  -------   ------    -------   -------
      Total noninterest expense                    18,255   18,228   20,116       27      .01     (1,888)    (3.82)
                                                  -------  -------  -------  -------   ------    -------   -------
Income (loss) before provision for income taxes    (7,364)  (1,448)  (7,259)  (5,916)   (1.72)     5,811     11.76
Provision (credit) for income taxes                    --      147    2,329     (147)    (.04)    (2,182)     4.42
                                                  -------  -------  -------  -------   ------    -------   -------
Change due to increase in outstanding shares          N/A      N/A      N/A              (.47)       N/A      7.91
Net Change                                         (7,364)  (1,595)  (9,588)  (5,769)   (2.15)     7,993     24.09
                                                  -------  -------  -------  -------   ------    -------   -------
Net Income (loss), current period                 $(7,364) $(1,595) $(9,588) $(5,769)  $(2.15)   $(1,595)  $ (3.23)
                                                  =======  =======  =======  =======   ======    =======   =======
</TABLE>

Net interest income is the Corporation's primary source of core earnings. Net
interest income increased $1.542 million to $9.780 million, in 2005. In 2004,
net interest income decreased $1.388 million, from $9.626 million in 2003,
largely a result of a significant decrease in earning assets.

Net interest income increased $1.542 million in 2005, despite a significant
decline in average earning assets. This increase was attributable to the
increase in yield on earning assets, due to lower balances on nonaccural loans
and repricing of commercial loans as the prime rate increased.

There was no provision for loan losses in 2005, 2004, or 2003.

Noninterest income decreased $7.431 million in 2005, which was due primarily
from the $6.617 gain on settlement of subordinated debentures included with
noninterest income in 2004. Noninterest expenses in general increased for 2005,
however; salaries, commissions, and benefits decreased by $1.942 million in
2005, due primarily from contractual payouts in December as result of the change
of control from the recapitalization.

NET INTEREST INCOME

Net interest income represents the difference between the average yield earned
on interest-earning assets and the average rate paid on interest-bearing
obligations. The net interest income is impacted by economic and competitive
factors that influence rates, loan demand, and the availability of funding.


                                       60

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Because the Corporation has a significant portion of its commercial loans at
rates that adjust with changes to the prime rate, these rate changes have a
significant impact on the Corporation's interest income.

In 2005, the Corporation's net interest margin was 3.64%, an increase of 107
basis points from the 2004 net interest margin of 2.57%. This increase in
margin, despite a decline of $78.585 million in average earning asset balances
was attributed primarily to higher interest rates and lower balances of
nonperforming loans. The prime rate increased from 5.25% in December 2004 to
7.25% at 2005 year-end. During 2005, a majority of the Corporation's commercial
loans repriced upward with each prime rate change. This asset sensitivity proved
to benefit the Corporation in 2005, and will continue to favorably impact the
Corporation in the near term, as rates are expected to increase from their
current level. The Bank is also well positioned in an asset sensitive position
to benefit from expected rate increases in early 2005.

The following table details sources of net interest income for the three years
ended December 31, 2005 (dollars in thousands):

Sources of Net Interest Income

<TABLE>
<CAPTION>
                                       2005      Mix      2004     Mix      2003     Mix
                                     -------   ------   -------   -----   -------   -----
<S>                                  <C>       <C>      <C>       <C>     <C>       <C>
Interest Income
   Loans                             $15,268    87.05%  $16,303   83.40%  $21,323   86.86%
   Funds sold                            311     1.77       210    1.07       312    1.27
   Taxable securities                  1,708     9.74     2,776   14.20     2,566   10.45
   Nontaxable securities                 253     1.44       259    1.33       348    1.42
                                     -------   ------   -------   -----   -------   -----
      Total earning assets           $17,540   100.00%  $19,548   100.0%  $24,549   100.0%
                                     -------   ------   -------   -----   -------   -----
Interest Expense
   NOW and money market deposits     $ 1,132    15.73%  $   870    8.20%  $ 1,433   10.23%
   Savings deposits                      190     2.64       187    1.76       208    1.48
   Time deposits                       3,937    54.71     4,386   41.32     7,053   50.32
   Borrowings                          1,937    26.92     4,730   44.56     4,832   34.48
   Subordinated debentures                --       --       442    4.16       489    3.49
                                     -------   ------   -------   -----   -------   -----
      Total interest-bearing funds   $ 7,196   100.00%  $10,615   100.0%  $14,015   100.0%
                                     -------   ------   -------   -----   -------   -----
Net interest income-
   taxable equivalent basis          $10,344            $ 8,933           $10,534
                                     =======            =======           =======
Average Rates
   Earning assets                       6.87%              5.63%             5.25%
                                     -------            -------           -------
   Interest-bearing funds               3.10               3.33              3.15
                                     -------            -------           -------
   Net yield on earning assets          3.64               2.57              2.25
                                     =======            =======           =======
</TABLE>

While a majority of the Corporation's loan portfolio, approximately 68%, is
repriced with each prime rate change due to floating rate loans, interest paid
on similar rate changes does not impact the pricing of interest-bearing
liabilities to nearly the same degree. The mix of time deposits reflects the
Corporation's need to utilize the brokered and Internet certificate of deposit
markets for loan funding when core deposits did not provide adequate sources.

The corporation's historical reliance on out-of-market non-core funding from
Internet and brokered deposits along with the FHLB borrowings, have had a
negative effect on net interest margin due to the relative high costs of this
funding. The Corporation has placed a high priority on gathering in-market core
deposits in order to reduce funding costs and expects less reliance on non-core
funding in future periods. The future impact of FHLB borrowings will be somewhat
mitigated as a result of the prepayment of $45 million of these borrowings early
in 2005.

One final factor that negatively impacted the Corporation's net interest margin
in 2004 and 2003, was the high level of nonaccrual loans. The average balance of
nonaccrual loans was $1.9 million in 2005, $16.4 million in 2004, and $36.4
million in 2003. The reduction in nonperforming loans in the last two years has
been a significant contributing factor to the Corporation's improved net
interest margin.


                                       61

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table presents the amount of interest income from average
interest-earning assets and the yields earned on those assets, as well as the
interest expense on average interest-bearing obligations and the rates paid on
those obligations. All average balances are daily average balances.

<TABLE>
<CAPTION>
                                                           2005                         2004                         2003
                                               ---------------------------  ---------------------------  ---------------------------
                                                Average            Average   Average            Average   Average            Average
                                                Volume   Interest    Rate    Volume   Interest    Rate    Volume   Interest   Rate
                                               --------  --------  -------  --------  --------  -------  --------  --------  -------
<S>                                            <C>       <C>       <C>      <C>       <C>       <C>      <C>       <C>       <C>
(dollars in thousands)
ASSETS:
Loans  (1,2,3)                                 $207,928   $16,196   7.79%   $244,730   $16,303   6.66%   $361,144   $21,323   5.90%
Taxable securities                               40,254     1,455   3.62      66,847     2,401   3.59      64,400     2,277   3.54
Nontaxable securities (2)                         3,654       253   6.92       3,729       259   6.95       3,997       348   8.71
Federal Funds sold                               10,321       311   3.01      16,415       210   1.28      27,991       312   1.11
Other interest-earning assets                     6,702       253   3.77      15,723       375   2.39      10,279       289   2.81
                                               --------   -------   ----    --------   -------   ----    --------   -------   ----
   Total earning assets                         268,859    18,468   6.87     347,444    19,548   5.63     467,811    24,549   5.25
                                               --------   -------   ----    --------   -------   ----    --------   -------   ----
Reserve for loan losses                          (6,724)                     (13,762)                     (22,970)
Cash and due from banks                           5,399                        5,667                        9,722
Fixed assets                                     10,852                       12,373                       13,249
Other assets                                      7,510                       13,302                       15,297
                                               --------                     --------                     --------
                                                 17,037                       17,580                       15,298
                                               --------                     --------                     --------
   TOTAL ASSETS                                $285,896                     $365,024                     $483,109
                                               ========                     ========                     ========
LIABILITIES AND SHAREHOLDER' EQUITY:
NOW and money market deposits                  $ 56,644   $ 1,132   2.00%   $ 61,299   $   869   1.42%   $ 94,829   $ 1,434   1.51%
Savings deposits                                 17,505       190   1.09      19,631       187    .95      39,297       208    .53
Time deposits                                   117,204     3,937   3.36     148,251     4,386   2.96     210,993     7,053   3.34
Borrowings                                       40,651     1,937   4.76      86,109     4,731   5.49      87,496     4,832   5.52
Subordinated debentures                              --        --     --      11,518       442   3.84      12,450       488   3.93
                                               --------   -------   ----    --------   -------   ----    --------   -------   ----
   Total interest-bearing liabilities           232,004     7,196   3.10     326,808    10,615   3.25     445,065    14,015   3.15
                                               --------   -------   ----    --------   -------   ----    --------   -------   ----
Demand deposits                                  20,444                       22,076                       32,150
Other liabilities                                 4,716                        7,585                        3,206
Shareholders' equity                             28,732                        8,555                       16,210
                                               --------                     --------                     --------
                                                 53,892                       38,216                       51,566
                                               --------                     --------                     --------
   TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY  $285,896                     $365,024                     $483,109
                                               ========                     ========                     ========
Rate spread                                                         3.77%                        2.38%                        2.10%
                                                          -------   ----               -------   ----               -------   ----
Net interest margin/revenue                               $11,272   3.64%              $ 8,933   2.57%              $10,534   2.25%
                                                          =======   ====               =======   ====               =======   ====
</TABLE>

(1)  For purposes of these computations, non-accruing loans are included in the
     daily average loan amounts outstanding.

(2)  The amount of interest income on nontaxable securities and loans has been
     adjusted to a tax equivalent basis, using a 34% tax rate.

(3)  Interest income on loans includes loan fees.


                                       62
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table presents the dollar amount, in thousands, of changes in
interest income and interest expense for major components of interest-earning
assets and interest-bearing obligations. It distinguishes between changes
related to higher or lower outstanding balances and changes due to the levels
and fluctuations in interest rates. For each category of interest-earning assets
and interest-bearing obligations, information is provided for changes
attributable to (i) changes in volume (i.e. changes in volume multiplied by old
rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume).
For purposes of this table, changes attributable to both rate and volume are
shown as a separate variance.

<TABLE>
<CAPTION>
                                                                        Years ended December 31,
                                        ---------------------------------------------------------------------------------------
                                                       2005 vs. 2004                                2004 vs. 2003
                                        ------------------------------------------   ------------------------------------------
                                          Increase (Decrease) Due to                   Increase (Decrease) Due to
                                        -----------------------------                -----------------------------
                                                                          Total                                         Total
                                                              Rate       Increase                          Rate       Increase
                                         Volume    Rate    and Volume   (Decrease)    Volume    Rate    and Volume   (Decrease)
                                        -------   ------   ----------   ----------   -------   ------   ----------   ----------
<S>                                     <C>       <C>      <C>          <C>          <C>       <C>      <C>          <C>
Interest earning assets:
Loans                                   $(2,452)  $2,760     $(415)      $  (107)    $(6,874)  $2,735    $  (882)     $(5,021)
Taxable securities                         (955)      15        (6)         (946)        (66)     196         (6)         124
Nontaxable securities                        (5)      (1)       --            (6)        (23)     (70)         5          (88)
Federal funds sold                          (78)     285      (106)          101        (129)      46        (19)        (102)
Other interest earning assets              (215)     219      (125)         (121)        491     (150)      (255)          86
                                        -------   ------     -----       -------     -------   ------    -------      -------
   Total interest earning assets        $(3,705)  $3,278     $(652)      $(1,079)    $(6,601)  $2,757    $(1,157)     $(5,001)
                                        =======   ======     =====       =======     =======   ======    =======      =======
Interest bearing obligations
NOW and money market deposits           $   (66)  $  356     $ (27)      $   263     $  (507)  $  (90)   $    32      $  (565)
Savings deposits                            (20)      26        (3)            3        (104)     166        (83)         (21)
Time deposits                              (919)     594      (124)         (449)     (2,097)    (809)       241       (2,665)
Borrowings                               (2,498)    (628)      332        (2,794)        (77)     (25)        --         (102)
Subordinated debentures                    (442)    (442)      442          (442)        (37)     (11)         1          (47)
                                        -------   ------     -----       -------     -------   ------    -------      -------
   Total interest bearing obligations   $(3,945)  $  (94)    $ 620       $(3,419)    $(2,822)  $ (769)   $   191      $(3,400)
                                        =======   ======     =====       =======     =======   ======    =======      =======
Net interest income                                                      $ 2,340                                      $(1,601)
                                                                         =======                                      =======
</TABLE>

As discussed in the "Deposits" section, the Corporation has developed new
deposit products for its local markets to raise funds to be used to replace the
higher rate out-of-market certificates. This, coupled with the decrease in the
level of nonperforming assets and increased lending in its local markets, is
anticipated to increase the net interest margin. The Bank will also benefit from
additional rate increases due to its existing asset sensitive position, provided
that it is successful with generation of in-market deposit growth to fund new
loan production.

PROVISION FOR LOAN LOSSES

The Corporation records a provision for loan losses when it believes it is
necessary to adjust the allowance for loan losses to maintain an adequate level
after considering factors such as loan charge-offs and recoveries, changes in
identified levels of risk in the loan portfolio, changes in the mix of loans in
the portfolio, loan growth, and other economic factors. There was no provision
for loan losses for the years ended December 31, 2005, 2004 and 2003.

NONINTEREST INCOME

Noninterest income was $1.111 million, $8.542 million, and $3.231 million in
2005, 2004, and 2003, respectively. The principal recurring sources of
noninterest income are fees for services related to deposit and loan accounts.
In 2004, the Corporation realized a $6.6 million gain from the settlement of the
subordinated debentures as a part of the recapitalization. Gains of $205,000
from branch sales and $258,000 from the sale of a limited partnership also
benefited noninterest income in 2004.


                                       63

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table details noninterest income for the three years ended
December 31 (dollars in thousands):

<TABLE>
<CAPTION>
                                                                           % Increase (Decrease)
                                                                           ---------------------
                                                 2005     2004     2003    2005-2004   2004-2003
                                                ------   ------   ------   ---------   ---------
<S>                                             <C>      <C>      <C>      <C>         <C>
Service fees                                    $  586   $  982   $1,529    (40.33)%    (35.78)%
Loan and lease fees                                 21       17       58     23.53      (70.69)
Net gains on sale of loans                          49       39      136     25.64      (71.32)
Gain on sale of branches                            --      205       --   (100.00)     100.00
Gain on settlement of subordinated debentures       --    6,617       --   (100.00)     100.00
Other                                              360      682    1,081    (47.21)     (36.91)
                                                ------   ------   ------   -------     -------
   Subtotal                                      1,016    8,542    2,804    (88.11)     204.64
                                                ------   ------   ------   -------     -------
Net security gains                                  95       --      427    100.00     (100.00)
                                                ------   ------   ------   -------     -------
   Total noninterest income                     $1,111   $8,542   $3,231    (86.99)%    164.38%
                                                ======   ======   ======   =======     =======
</TABLE>

Service fees on customer accounts have continued to decline over the three year
period of 2003 through 2005, due to significant declines in transactional
deposit balances. In 2005, the Corporation introduced new deposit products which
deemphasized fees in order to attract new accounts, which was another reason for
the decrease in fee income for 2005. Service fees as a percentage of average
noninterest-bearing deposits for the year ended December 31, 2005, was 2.87%,
compared to 4.45% and 4.76% for 2004 and 2003, respectively. Management
continually reviews the pricing on its deposit products in relation to
competition and alternative sources of funds. Management expects to continue to
fairly price its fees for services rendered. The Corporation also intends to
expand its noninterest revenue from other sources such as secondary mortgage
fees. In 2005, the Corporation added three mortgage originators and expects a
higher noninterest income contribution from the area in 2006.

NONINTEREST EXPENSE

Noninterest expense was $18.255 million in 2005, compared to $18.228 million and
$20.116 million in 2004 and 2003, respectively.

In 2005, the Corporation made considerable progress in reducing its normal
noninterest expense in most areas, however; incurred significant one-time
charges, which included the $4.3 million FHLB prepayment penalty, $.5 million of
advertising expenses incurred to promote the new mBank identity, new deposit
products, full system conversion costs of $.8 million, and the $.2 million
write-down of an other real estate property. Management believes that 2005 was a
year of transition and anticipates reductions in operating expense in 2006.
These reductions, along with continued asset growth will bring the relationship
of operating expenses to total assets closer to peer averages.

Noninterest expense in 2004 and 2003 was comparatively impacted, due to the
combined sales and closings of ten branch office locations. The Corporation was
also successful in 2004 in significantly reducing accounting, legal, and
consulting fees due to management efforts for reliance on external
professionals.


                                       64

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following table details noninterest expense for the three years ended
December 31 (dollars in thousands):

NONINTEREST EXPENSE

<TABLE>
<CAPTION>
                                                                          % Increase (Decrease)
                                                                          ---------------------
                                              2005      2004      2003    2005-2004   2004-2003
                                            -------   -------   -------   ---------   ---------
<S>                                         <C>       <C>       <C>       <C>         <C>
Salaries and employee benefits              $ 6,090   $ 8,032   $ 5,973    (24.18)%     34.47%
Occupancy                                     1,053       994     1,387      5.94      (28.33)
Furniture and equipment                         560       887     1,367    (36.87)     (35.11)
Data processing                               1,720     1,220     1,517     40.98      (19.58)
Accounting, legal and consulting fees           886     1,836     3,145    (51.74)     (41.62)
Loan and deposit                                852     1,718     1,992    (50.41)     (13.76)
Telephone                                       271       382     1,382    (29.06)     (72.36)
Impairment of acquisition intangibles            --        --        60        --     (100.00)
ORE writedowns/impairment                       200       265       400    (24.53)     (33.75)
Loss (Gain) on sale of prop & equip & ORE        51       459       362    (88.89)      26.80
Advertising                                     814       115       182    607.83      (36.81)
Amortization of intangibles                     125       308       460    (59.42)     (33.04)
Penalty on prepayment of FHLB borrowings      4,320        --        --    100.00          --
Other operating expenses                      1,313     2,012     1,889    (34.74)       6.51
                                            -------   -------   -------    ------     -------
   Total noninterest expense                $18,255   $18,228   $20,116       .15%      (9.39)%
                                            =======   =======   =======    ======     =======
</TABLE>

FEDERAL INCOME TAXES

The Corporation recorded no income tax expense in 2005 compared to an income tax
provision of $147,000 in 2004 and $2.3 million in 2003. The differences in each
year between the tax provision or benefit and the federal corporate income tax
rate of 34% are primarily due to permanent and temporary differences between
book and taxable income. The loss generated for tax purposes in 2005 will be
carried over to future tax years. The 2005, 2004 and 2003 tax benefits were
reduced by valuation allowances against the net deferred tax assets. A valuation
allowance is provided against deferred tax assets when it is more likely than
not that some or all of the deferred tax assets will not be realized. The $2.3
million provision in 2003 was recorded to write off all remaining deferred tax
benefits of the Corporation. The provision of $147,000 in 2004 was to recognize
further limitations of the 2003 NOL carryback due to alternative minimum tax. As
of December 31, 2005, the Corporation had an NOL carryforward of approximately
$36.5 million along with various credit carryforwards of $2.1 million. This NOL
and credit carryforward benefit is dependent upon the future profitability of
the Corporation; therefore no future benefit has been recorded.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

In general, the Corporation attempts to manage interest rate risk by investing
in a variety of assets which afford it an opportunity to reprice assets and
increase interest income at a rate equal to or greater than the interest expense
associated with repricing liabilities.

Interest rate risk is the exposure of the Corporation to adverse movements in
interest rates. The Corporation derives its income primarily from the excess of
interest collected on its interest-earning assets over the interest paid on its
interest-bearing obligations. The rates of interest the Corporation earns on its
assets and owes on its obligations generally are established contractually for a
period of time. Since market interest rates change over time, the Corporation is
exposed to lower profitability if it cannot adapt to interest rate changes.
Accepting interest rate risk can be an important source of profitability and
shareholder value; however, excess levels of interest rate risk could pose a
significant threat to the Corporation's earnings and capital base. Accordingly,
effective risk management that maintains interest rate risk at prudent levels is
essential to the Corporation's safety and soundness.

Loans are the most significant earning asset. Management offers commercial and
real estate loans priced at interest rates which fluctuate with various indices,
such as the prime rate or rates paid on various government issued securities.
When


                                       65
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

loans are made with longer-term fixed rates, the Corporation attempts to match
these balances with sources of funding with similar maturities in order to
mitigate interest rate risk. In addition, the Corporation prices loans so it has
an opportunity to reprice the loan within 12 to 36 months.

The Bank has $34.210 million of securities, with a weighted average maturity of
34 months. The investment portfolio is intended to provide a source of liquidity
to the Corporation with limited interest rate risk. The Corporation also has
investments in federal funds sold to correspondent banks, as well as other
interest bearing deposits with correspondent banks. These funds are generally
repriced on a daily basis.

The Corporation offers deposit products with a variety of terms ranging from
deposits whose interest rates can change on a weekly basis to certificates of
deposit with repricing terms of up to five years. Longer-term deposits generally
include penalty provisions for early withdrawal.

Beyond general efforts to shorten the loan pricing periods and extend deposit
maturities, management can manage interest rate risk by the maturity periods of
securities purchased, selling securities available for sale, and borrowing funds
with targeted maturity periods, among other strategies. Also, the rate of
interest rate changes can impact the actions taken, since the speed of change
affects borrowers and depositors differently.

Exposure to interest rate risk is reviewed on a regular basis. Interest rate
risk is the potential of economic losses due to future interest rate changes.
These economic losses can be reflected as a loss of future net interest income
and/or a loss of current fair market values. The objective is to measure the
effect of interest rate changes on net interest income and to structure the
composition of the balance sheet to minimize interest rate risk and, at the same
time, maximize income.

Management realizes certain risks are inherent and that the goal is to identify
and minimize the risks. Tools used by management include maturity and repricing
analysis and interest rate sensitivity analysis. The Bank has monthly asset/
liability meetings with an outside consultant to review its current position and
strategize about future opportunities on risks relative to pricing and
positioning of assets and liabilities.

The difference between repricing assets and liabilities for a specific period is
referred to as the GAP. An excess of repricable assets over liabilities is
referred to as a positive gap. An excess of repricable liabilities over assets
is referred to as a negative gap. The cumulative gap is the summation of the gap
for all periods to the end of the period for which the cumulative gap is being
measured.

Assets and liabilities scheduled to reprice are reported in the following
timeframes. Those instruments with a variable interest rate tied to an index and
considered immediately repricable are reported in the 1 to 90 day timeframe. The
estimates of principal amortization and prepayments are assigned to the
following time frames.


                                       66

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following is the Corporation's repricing opportunities at December 31, 2005
(dollars in thousands):

<TABLE>
<CAPTION>
                                          1-90      91-365      >1-5     Over 5
                                          Days       Days      Years     Years      Total
                                        --------   --------   -------   -------   --------
<S>                                     <C>        <C>        <C>       <C>       <C>
Interest-earning assets:
   Loans                                $169,322   $  6,601   $44,117   $19,731   $239,771
   Securities                                 70      3,442    27,239     3,459     34,210
   Other                                   8,990         --        --        --      8,990
                                        --------   --------   -------   -------   --------
   Total interest-earning assets         178,382     10,043    71,356    23,190    282,971
                                        --------   --------   -------   -------   --------
Interest-bearing obligations:
   Savings deposits                       79,845         --        --        --     79,845
   Time deposits                          14,005     95,886    22,450       762    133,103
   Borrowings                                 --         --    15,000    21,417     36,417
                                        --------   --------   -------   -------   --------
   Total interest-bearing obligations     93,850     95,886    37,450    22,179    249,365
                                        --------   --------   -------   -------   --------
GAP                                     $ 84,532   $(85,843)  $33,906   $ 1,011   $ 33,606
                                        ========   ========   =======   =======   ========
Cumulative GAP                          $ 84,532   $ (1,311)  $32,595   $33,606
                                        ========   ========   =======   =======
</TABLE>

The above analysis indicates that at December 31, 2005, the Corporation had a
cumulative liability sensitivity GAP position of $1.311 million within the
one-year timeframe. The Corporation's cumulative liability sensitive GAP
suggests that if market interest rates continue to increase in the next twelve
months, the Corporation has the potential to earn less net interest income.
Conversely, if market interest rates increase in the next twelve months, the
above GAP position suggests the Corporation's net interest income would
decrease.

A limitation of the traditional GAP analysis is that it does not consider the
timing or magnitude of non-contractual repricing or unexpected prepayments. In
addition, the GAP analysis treats savings, NOW and money market accounts as
repricing within 90 days, while experience suggests that these categories of
deposits are actually comparatively resistant to rate sensitivity.

The borrowings in the table above and on the next page include FHLB advances as
fixed-rate advances. These advances actually give the FHLB the option to convert
from a fixed-rate advance to an adjustable rate advance with quarterly repricing
at three month LIBOR Flat. The exercise of this conversion feature by the FHLB
would impact the maturity dates currently assumed in the tables. The Bank, in
recognition of the interest rate risk exposure of the FHLB borrowings, prepaid
$48.6 million of the borrowings in the first quarter of 2005. This prepayment
better positions the Corporation to manage future asset growth through a better
matching of asset and liability maturities.

The Corporation's primary market risk exposure is interest rate risk and, to a
lesser extent, liquidity risk and foreign exchange risk. The Corporation has no
market risk sensitive instruments held for trading purposes. The Corporation has
limited agricultural-related loan assets, and therefore, has minimal significant
exposure to changes in commodity prices. Any impact that changes in foreign
exchange rates and commodity prices would have on interest rates are assumed to
be insignificant.

Evaluating the exposure to changes in interest rates includes assessing both the
adequacy of the process used to control interest rate risk and the quantitative
level of exposure. The Corporation's interest rate risk management process seeks
to ensure that appropriate policies, procedures, management information systems,
and internal controls are in place to maintain interest rate risk at prudent
levels with consistency and continuity. In evaluating the quantitative level of
interest rate risk, the Corporation assesses the existing and potential future
effects of changes in interest rates on its financial condition, including
capital adequacy, earnings, liquidity, and asset quality.


                                       67

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The table below measures current maturity levels of interest-earning assets and
interest-bearing obligations, along with average stated rates and estimated fair
values at December 31, 2005 (dollars in thousands). Nonaccrual loans of $15,000
are included in the table at an average interest rate of 0.0% and a maturity
greater than five years.

<TABLE>
<CAPTION>
                                                                                                        Fair Value
                                2006       2007      2008     2009      2010    Thereafter     Total    12/31/2005
                              --------   -------   -------   ------   -------   ----------   --------   ----------
<S>                           <C>        <C>       <C>       <C>      <C>       <C>          <C>        <C>
RATE SENSITIVE ASSETS
Fixed interest rate
   securities                 $  3,512   $18,261   $ 6,853   $2,035   $    89    $ 3,460     $ 34,210    $ 34,210
   Average interest rate          3.49%     3.30%     3.42%    4.10%     5.50%      6.00%        3.67%
Fixed interest rate loans
   Average interest rate         7,643    10,561     7,743    6,469    19,344     19,730       71,490      69,106
                                  8.21      6.43      7.47     6.80      6.98       6.79         7.01
Variable interest rate
   loans                       168,281        --        --       --        --         --      168,281     168,281
   Average interest rate          7.24        --        --       --        --         --         7.24
Other assets                     8,990        --        --       --        --         --        8,990       8,990
   Average interest rate          4.25        --        --       --        --         --         4.25
                              --------   -------   -------   ------   -------    -------     --------    --------
Total rate sensitive assets   $188,426   $28,822   $14,596   $8,504   $19,433    $23,190     $282,971    $280,587
                              ========   =======   =======   ======   =======    =======     ========    ========
Average interest rate             7.07%     4.45%     5.57%    6.15%     6.97%      6.67%        6.66%
                              ========   =======   =======   ======   =======    =======     ========
RATE SENSITIVE LIABILITIES
Interest-bearing savings        79,845        --        --       --        --         --       79,845      79,845
   Average interest rate          2.36%       --%       --%      --%       --%        --%        2.36%
Time deposits                  110,037    15,215     3,840    2,533       720        758      133,103     136,646
   Average interest rate          4.01      4.00      3.81     4.30      4.80       6.61         4.03
Fixed interest rate
   borrowings                       --        --        --       --        --      1,417        1,417         667
   Average interest rate            --        --        --       --        --       1.00         1.00
Variable interest rate
   borrowings                       --        --        --       --    15,000     20,000       35,000      34,558
   Average interest rate            --        --        --       --      5.10       4.43         4.71
                              --------   -------   -------   ------   -------    -------     --------    --------
Total rate sensitive
   liabilities                $189,882   $15,215   $ 3,840   $2,533   $15,720    $22,175     $249,365    $251,716
                              ========   =======   =======   ======   =======    =======     ========    ========
   Average interest rate          3.32%     4.00%     3.81%    4.30%     5.09%      4.29%        3.57%
                              ========   =======   =======   ======   =======    =======     ========
</TABLE>

In addition to changes in interest rates, the level of future net interest
income is also dependent on a number of variables, including: the growth,
composition and levels of loans, deposits, and other earning assets and
interest-bearing obligations, and economic and competitive conditions; potential
changes in lending, investing, and deposit strategies; customer preferences; and
other factors.

FOREIGN EXCHANGE RISK

In addition to managing interest rate risk, management also actively manages
risk associated with foreign exchange. The Corporation provides foreign exchange
services, makes loans to, and accepts deposits from, Canadian customers
primarily at its banking office in Sault Ste. Marie. To protect against foreign
exchange risk, the Corporation monitors the volume of Canadian deposits it takes
in and then invests these Canadian funds in Canadian commercial loans and
securities. As of December 31, 2005, the Corporation had excess Canadian assets
of $.219 million (or $.186 million in U.S. dollars). Management believes the
exposure to short-term foreign exchange risk is minimal and at an acceptable
level for the Corporation. Management intends to limit the Corporation's foreign
exchange risk by acquiring deposit liabilities approximately equal to its
Canadian assets.


                                       68
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OFF-BALANCE-SHEET RISK

Derivative financial instruments include futures, forwards, interest rate swaps,
option contracts and other financial instruments with similar characteristics.
The Corporation currently does not enter into futures, forwards, swaps or
options. However, the Corporation is party to financial instruments with
off-balance-sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit and standby letters of credit and involve to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the consolidated balance sheets. Commitments to extend credit are agreements to
lend to a customer as long as there is no violation of any condition established
in the contract. Commitments generally have fixed expiration dates and may
require collateral from the borrower if deemed necessary by the Corporation.
Standby letters of credit are conditional commitments issued by the Corporation
to guarantee the performance of a customer to a third party up to a stipulated
amount and with specified terms and conditions.

Commitments to extend credit and standby letters of credit are not recorded as
an asset or liability by the Corporation until the instrument is exercised. See
note 22 to the consolidated financial statements for additional information.

LIQUIDITY

The Corporation augments core deposits, as a source of liquidity, with
correspondent lines of credit, brokered deposits, and the use of Internet
deposits. The Corporation also has approximately $11 million of unpledged
securities, which would be available to secure additional borrowings from the
FHLB.

During 2005, the Corporation decreased cash and cash equivalents by $36.135
million. This decrease was attributed to the planned utilization of the funds
received from the 2004 year-end recapitalization to prepay $48.555 million of
the FHLB borrowings. As shown on the Corporation's Statement of Cash Flows,
despite the net loss of $7.364 million, along with the funding needs of loan
growth in 2005, the Corporation was able to adequately manage liquidity needs.

Liquidity is managed by the Corporation through its Asset and Liability
Committee ("ALCO"). The ALCO Committee meets monthly to discuss asset and
liability management in order to address liquidity and funding needs to provide
a process to seek the best alternatives for investments of assets, funding
costs, and risk management.

During 2003 and 2004 the Corporation experienced a steady decline in core
deposits due to the ongoing concerns associated with the Bank and Corporation's
financial condition. The recapitalization late in 2004 allayed these concerns,
however; deposits continued to decline in the first half of 2005. The Bank had
an extensive marketing campaign to introduce its new mBank brand and rolled out
new, more competitive deposit products. This marketing campaign, along with
management's renewed efforts to seek core deposit growth, was successful and
resulted in core deposit growth of $19 million in the second half of 2005. The
Corporation will continue to emphasize in-market deposits to decrease reliance
on non-core funding.

From a long-term perspective, the Corporation's liquidity plan for 2006 includes
strategies to increase core deposits in the Corporation's local markets. The new
deposit products and strategic advertising is expected to aid in efforts of
management in growing core deposits to reduce the dependency on noncore
deposits, while also reducing interest costs. The Corporation's liquidity plan
for 2006 calls for augmenting local deposit growth efforts with Internet and
brokered CD funding, to the extent necessary.


                                       69

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

As disclosed in the Notes to the Consolidated Financial Statements, the
Corporation has certain obligations and commitments to make future payments
under contracts. At December 31, 2005, the aggregate contractual obligations and
commitments are:

<TABLE>
<CAPTION>
                                                          Payments Due by Period
                                            --------------------------------------------------
                                            Less than    1 to 3    4 to 5   After 5
                                              1 Year     Years     Years     Years      Total
                                            ---------   -------   -------   -------   --------
<S>                                         <C>         <C>       <C>       <C>       <C>
Contractual Obligations
Total deposits                               $209,566   $19,055   $ 3,253   $   758   $232,632
Long-term borrowings                               --        --    15,000    21,417     36,417
Directors' deferred compensation                  184       375       273     1,271      2,103
Annual rental / purchase commitments
   under noncancelable leases / contracts         212       358       179       233        982
                                             --------   -------   -------   -------   --------
TOTAL                                        $209,962   $19,788   $18,705   $23,679   $272,134
                                             ========   =======   =======   =======   ========
Other Commitments
Letters of credit                            $ 10,493   $    --   $    --   $    --   $ 10,493
Commitments to extend credit                   33,675        --        --        --     33,675
Credit card commitments                         3,135        --        --        --      3,135
                                             --------   -------   -------   -------   --------
TOTAL                                        $ 47,303   $    --   $    --   $    --   $ 47,303
                                             ========   =======   =======   =======   ========
</TABLE>


                                       70

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAPITAL AND REGULATORY

During 2005, total capitalization decreased by $8.017 million.

The following table details sources of capital for the three years ended
December 31 (dollars in thousands):

<TABLE>
<CAPTION>
                                              2005       2004       2003
                                            --------   --------   --------
<S>                                         <C>        <C>        <C>
CAPITAL STRUCTURE
Long-term debt (1)                          $     --   $     --   $ 12,450
Shareholders' equity                          26,588     34,730     10,700
                                            --------   --------   --------
Total capitalization                        $ 26,588   $ 34,730   $ 23,150
                                            --------   --------   --------
Tangible capital                            $ 26,258   $ 34,275   $ 21,557
                                            --------   --------   --------
INTANGIBLE ASSETS
Subsidiaries:
   Core deposit premium                     $    330   $    455   $  1,067
   Other identifiable intangibles                 --         --        526
                                            --------   --------   --------
Total intangibles                           $    330   $    455   $  1,593
                                            --------   --------   --------
RISK-BASED CAPITAL
Tier 1 capital:
   Shareholders' equity                     $ 26,588   $ 34,730   $ 10,700
   Net unrealized (gains) losses on
      available for sale securities              363       (492)    (1,027)
   Minority interest                              --         78      2,785
   Less: intangibles                            (330)      (455)    (1,593)
                                            --------   --------   --------
      Total Tier 1 capital                  $ 26,621   $ 33,861   $ 10,865
                                            --------   --------   --------
Tier 2 Capital:
   Allowable reserve for loan losses        $  3,184   $  2,918   $  4,016
   Qualifying long-term debt                      --         --      6,749
                                            --------   --------   --------
      Total Tier 2 capital                     3,184      2,918     10,865
                                            --------   --------   --------
      Total risk-based capital              $ 29,805   $ 36,779   $ 21,730
                                            ========   ========   ========
RISK-WEIGHTED ASSETS                        $251,796   $229,355   $303,284
                                            ========   ========   ========
CAPITAL RATIOS:
   Tier 1 Capital to average assets             9.23%     10.68%      2.48%
   Tier 1 Capital to risk-weighted assets      10.57%     14.76%      3.58%
   Total Capital to risk-weighted assets       11.84%     16.04%      7.16%
</TABLE>

*    Total Capital is calculated as the sum of Tier 1 Capital plus the allowable
     Tier 2 Capital, which is the lesser of Tier 1 Capital or Tier 2 Capital.
     In this case, Tier 1 Capital = 10,865 and Tier 2 Capital = 13,750.
     Therefore, Total Capital equals 10,865 + 10,865 = 21,730

**   Tier 1 Leverage is calculated as Tier 1 Capital divided by the average
     total assets for leverage purposes, which in this case is $437,833

(1)  Corporation's subordinated debentures.

As a bank holding company, the Corporation is required to maintain certain
levels of capital under government regulation. There are several measurements of
regulatory capital and the Corporation is required to meet minimum requirements
under each measurement. The federal banking regulators have also established
capital classifications beyond the minimum requirements in order to risk-rate
deposit insurance premiums and to provide trigger points for prompt corrective
action in the event an institution becomes financially troubled. As of December
31, 2005, the Corporation and Bank were well capitalized.

Regulatory capital is not the same as shareholders' equity reported in the
accompanying financial statements. Certain assets cannot be considered assets
for regulatory purposes. The Corporation's acquisition intangibles and a portion
of the deferred tax asset are examples of such assets.


                                       71
<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Presented below is a summary of the Corporation's consolidated capital position
in comparison to generally applicable regulatory requirements:

<TABLE>
<CAPTION>
                                                     Tier 1         Tier 1          Total
                                                   Capital to     Capital to      Capital to
                                                     Average    Risk Weighted   Risk Weighted
                                                     Assets         Assets          Assets
                                                   ----------   -------------   -------------
<S>                                                <C>          <C>             <C>
Regulatory minimum for capital adequacy purposes      4.00%          4.00%           8.00%
Regulatory defined well capitalized guideline         5.00%          6.00%          10.00%

The Corporation:
   December 31, 2005                                  9.23%         10.57%          11.84%
   December 31, 2004                                 10.68%         14.76%          16.04%

The Bank:
   December 31, 2005                                  8.80%         10.09%          11.35%
   December 31, 2004                                  9.89%         13.96%          15.23%
</TABLE>

The Bank is currently under an informal agreement which requires that it
maintain a minimum of 8% Tier 1 Capital. This requirement could constrain the
Bank's future growth to the extent that profits are insufficient to maintain the
8% of Tier 1 Capital relative to growth in assets. The Corporation does however
have unbooked deferred tax benefits which, subject to regulatory limitations,
provide limited additions to Tier 1 equity. The Corporation also has limited
ability to provide a capital infusion to the Bank to support added growth. The
Corporation is in the process of establishing borrowing lines with correspondent
banks, which will provide interim funding to provide funding for any additional
capital infusions necessary to support the Bank's Tier 1 Capital maintenance.

REGULATORY AFFAIRS

In October 2001, the Bank was notified by the FDIC that it was a "troubled
institution" within the meaning of FDIC regulations. As a troubled institution,
the Bank is required to notify the FDIC 30 days prior to the addition or
replacement of a Board member and the employment or changes in responsibilities
of a senior executive officer.

In September 2002, a regularly-scheduled safety and soundness examination of the
Bank was conducted by its principal regulators, the Michigan Office of Financial
and Insurance Services ("OFIS") and the FDIC. During the course of that
examination, the FDIC, the OFIS, and the Federal Reserve Bank of Chicago ("FRB")
requested that the Corporation and the Bank take certain actions, including
suspending the payment of dividends and conserving the liquidity of the
Corporation.

In response to the concerns expressed by the regulators, the Board of Directors
of the Corporation and the Bank adopted resolutions providing for prior
regulatory approval of the declaration or payment of any dividend by the
Corporation or the Bank, and suspension of interest payments by the Corporation
in connection with its trust preferred securities. The agreements relating to
the trust preferred securities allowed for the suspension of payments for up to
20 quarters. As mentioned above, as a part of the recapitalization, a settlement
payment of $6.5 million was made to retire the subordinated debentures.

Following the completion of the 2002 regularly-scheduled safety and soundness
examination of the Bank by the FDIC and the OFIS, and the Bank's receipt of the
related Joint Report of Examination ("Report"), the FDIC and the OFIS, with the
consent of the Bank, on March 26, 2003, entered a formal Cease and Desist Order
(the "Order") under Federal and State banking laws. The Order was reported on
the Corporation's Form 8-K filed on April 9, 2003 and became effective on April
5, 2003. The Order identified deficiencies in the Bank's policies and
procedures, including its directorate and management personnel and practices,
credit underwriting, credit administration, and policies regarding
asset/liability management, liquidity, funds management, and investments, and
its compliance with all applicable laws and regulations, including


                                       72

<PAGE>

MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Regulations O and U of the Board of Governors of the Federal Reserve System (the
"Board"), the FDIC Rules and Regulations, and the Michigan Banking Code of 1999.
The Order also required the Bank to maintain specified capital ratios during the
life of the Order.

The Order required the Bank and its directors to take specific steps, within
time periods specified in the Order, to address the operational deficiencies,
including certain violations of law and regulations, identified by the FDIC and
the OFIS in the Order and the Report. Among other things, the Bank must
establish, and submit to the FDIC and the OFIS for comment, written plans (i) to
reduce the Bank's risk position with respect to certain classified loans
identified in the Report or any subsequent Report of Examination during the life
of the Order, (ii) to reduce identified loan concentrations, (iii) to reduce and
collect delinquent loans, (iv) to eliminate the classified amounts of loans to
directors, executive officers, principal shareholders of the Bank and their
respective related interests, (v) to address the Bank's relationship of volatile
liabilities to temporary investments, rate sensitivity objectives, and
asset/liability management, (vi) setting forth the Bank's strategic plan,
including financial goals and strategies to maintain adequate capital and
liquidity, to reduce problem loans, and to attract and keep qualified
management, (vii) covering the policies and procedures for review and approval
of reimbursement of customer entertainment and business development expenses of
the Bank's directors, officers and employees, (viii) for a realistic budget for
calendar year 2003 and each subsequent year during the life of the Order,
including strategies to improve the Bank's net interest margin, (ix) to reduce
the Bank's portfolio of other real estate owned as a result of foreclosure or
surrender of collateral for loans, and (x) to address procedures for the
directors to monitor, and management to implement, the requirements of the
Order.

Addressing the requirements of the Order, carrying out the objectives of the
strategic plan, and attempting to return the Corporation to profitability
required the strengthening of the executive management team. During 2003, the
Corporation added management with experience in turnaround situations, loan
portfolio, credit and problem loan administration, and financial management
expertise commensurate with the issues the Corporation needed to address.

The Bank adopted new policies for liquidity, investment and asset liability
management. In regards to its lending functions, practices related to credit
underwriting, credit administration and problem loan management were revamped.
Most of the above changes were put in place during the second half of 2003.

The Corporation, through the recapitalization which occurred on December 15,
2004, and the progressive steps noted above, was successful in addressing all
issues of the Order with the exception of loan concentration. The Order was
terminated by regulatory authorities on February 8, 2005. The Corporation is,
however, subject to an informal agreement with the OFIS and FDIC which has the
following financial related action requirements. The Corporation is required to
maintain the Bank's Tier 1 equity at a minimum of 8%. The Bank is also
prohibited from payment of dividends without prior written consent.

IMPACT OF INFLATION AND CHANGING PRICES

The accompanying financial statements have been prepared in accordance with
generally accepted accounting principles, which require the measurement of
financial position and results of operations in historical dollars without
considering the change in the relative purchasing power of money over time due
to inflation. The impact of inflation is reflected in the increased cost of the
Corporation's operations. Nearly all the assets and liabilities of the
Corporation are financial, unlike industrial or commercial companies. As a
result, the Corporation's performance is directly impacted by changes in
interest rates, which are indirectly influenced by inflationary expectations.
The Corporation's ability to match the interest sensitivity of its financial
assets to the interest sensitivity of its financial liabilities tends to
minimize the effect of changes in interest rates on the Corporation's
performance. Changes in interest rates do not necessarily move to the same
extent as changes in the prices of goods and services.


                                       73

<PAGE>

GENERAL INFORMATION

BOARD OF DIRECTORS

WALTER J. ASPATORE
Investment Banker
Amherst Partners
Director Since: 2004

C. JAMES BESS
Vice Chairman
Mackinac Financial Corporation and mBank
Director Since: 2003

DENNIS B. BITTNER
Owner and President
Bittner Engineering, Inc.
Director Since: 2001

ROBERT H. ORLEY
Vice President and Secretary
Real Estate Investment Group, Inc.
Director Since: 2004

RANDOLPH C. PASCHKE
Chairman, Department of Accounting
Wayne State University
School of Business Administration
Director Since: 2004

ELIOT R. STARK
Executive Vice President and
Chief Financial Officer
Mackinac Financial Corporation and mBank
Director Since: 2004

PAUL D. TOBIAS
Chairman and
Chief Executive Officer
Mackinac Financial Corporation and mBank
Director Since: 2004

OFFICERS

MACKINAC FINANCIAL CORPORATION

PAUL D. TOBIAS
Chairman and
Chief Executive Officer

C. JAMES BESS
Vice Chairman

ELIOT R. STARK
Executive Vice President and Chief Financial Officer

ERNIE R. KRUEGER
Senior Vice President and Controller

MBANK

PAUL D. TOBIAS
Chairman and CEO

C. JAMES BESS
Vice Chairman

KELLY W. GEORGE
President and Chief Lending Officer

ELIOT R. STARK
Executive Vice President and Chief Financial Officer

DAVID C. CRIMMINS
Senior Vice President and Commercial Lender

JACK C. FROST
Senior Vice President and Commercial Lender

ERNIE R. KRUEGER
Senior Vice President and Controller

ANDY P. SABATINE
Senior Vice President and Commercial Lender

ANN M. STEPP
Vice President
Branch Administration / Operations

CONTACT INFORMATION

MACKINAC FINANCIAL CORPORATION
130 South Cedar Street
Manistique, MI 49854

SHAREHOLDER INFORMATION
For assistance with questions,
please contact Investor Relations
(800) 200-7032

DIVIDEND REINVESTMENT PLAN AGENT
Registrar and Transfer Company
(800) 368-5948

STOCK TRANSFER AGENT
For questions regarding transfer of
stock, please contact Registrar and
Transfer Company (800) 368-5948


                                       74

<PAGE>

BRANCH LOCATIONS

BIRMINGHAM *
260 East Brown Street
Suite 300
Birmingham, MI 48009
(248) 290-5900
Manager: Surab Deb

GAYLORD
145 North Otsego Avenue
Gaylord, MI 49735
(989) 732-3750
Manager: Nicole Shelters

KALEVA
14429 Wouski Avenue
Kaleva, MI 49645
(231) 362-3223
Manager: Sandy Asiala

MANISTIQUE
130 South Cedar Street
Manistique, MI 49854
(906) 341-8401
Manager: Rose Garvin

MARQUETTE MAIN
300 North McClellan Street
Marquette, MI 49855
(906) 226-5000
Manager: Teresa Same

MARQUETTE PRESQUE ISLE
1400 Presque Isle
Marquette, MI 49855
(906) 228-3640
Manager: Shelby Bischoff

NEWBERRY
414 Newberry Avenue
Newberry, MI 49868
(906) 293-5165
Manager: Mike Slaght

ONTONAGON
601 River Street
Ontonagon, MI 49953
(906) 884-4115
Manger: Sue Preiss

RIPLEY
106 Royce Road
Hancock, MI 49930
(906) 482-1269
Manager: Heidi Gervais

SAULT STE. MARIE
138 Ridge Street
Sault Ste. Marie, MI 49783
(906) 635-3992
Manager: Theresa Zednicek

SOUTH RANGE
47 Trimountain Avenue
South Range, MI 49963
(906) 482-1170
Manager: Sandy Pesola

STEPHENSON
S216 Menominee Street
Stephenson, MI 49887
(906) 753-2225
Manager: Barb Parrett

TRAVERSE CITY
3530 North Country Drive
Traverse City, MI 49684
(231) 929-5253
Manager: Sherry Barnard

*    Opened on January 10, 2006.


                                       75