(cid:2)
(cid:2)
(cid:2)(cid:2)(cid:2)2008(cid:2)
(cid:2)(cid:2)(cid:2)(cid:2)(cid:2)(cid:2)(cid:3)(cid:4)(cid:4)(cid:5)(cid:3)(cid:6)(cid:2)(cid:7)(cid:8)(cid:9)(cid:10)(cid:7)(cid:11)
Table of Contents
To Our Shareholders ..............................................................................................................................1
Selected Financial Highlights ................................................................................................................6
Five-Year Comparisons .........................................................................................................................7
Quarterly Financial Summary ................................................................................................................9
Report of Independent Registered Public Accounting Firm ................................................................10
Consolidated Balance Sheets ...............................................................................................................11
Consolidated Statements of Operations ...............................................................................................12
Consolidated Statements of Changes in Shareholders’ Equity ............................................................13
Consolidated Statements of Cash Flows ..............................................................................................14
Notes to Consolidated Financial Statements ........................................................................................15
Selected Financial Data ........................................................................................................................39
Summary Quarterly Financial Information ..........................................................................................40
Market Information ..............................................................................................................................42
Shareholder Return Performance Graph ..............................................................................................43
Forward-Looking Statements ...............................................................................................................44
Management’s Discussion and Analysis of Financial
Condition and Results of Operations ................................................................................................45
Directors and Officers ..........................................................................................................................65
Branch Locations .................................................................................................................................66
______________________________________________________________________________________
BUSINESS OF THE CORPORATION
Mackinac Financial Corporation is a registered bank holding company formed under the Bank Holding Company
Act of 1956 with assets in excess of $450 million and whose common stock is traded on the NASDAQ stock market
as “MFNC.” The principal subsidiary of the Corporation is mBank. Headquartered in Manistique, Michigan,
mBank has 13 branch locations; nine in the Upper Peninsula, three in the Northern Lower Peninsula and one in
Oakland County, Michigan. The newest branch, located in Escanaba, opened on March 24, 2009. The Company’s
banking services include commercial lending and treasury management products and services geared toward small
to mid-sized businesses, as well as a full array of personal and business deposit products and consumer loans.
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 1,345 shareholders of record as of March 30, 2008.
To Our Shareholders
March 31, 2009
Dear Shareholders:
This letter will provide you with a review of the performance of Mackinac Financial Corporation through the end of 2008
and our thoughts about business strategy as we move through 2009. We continue to focus on areas impacting our business
which we can control. We are concentrating on managing credit risk, growing our book value per share and on increasing
our core deposits. As you will see from the information below, we are having success in those efforts.
The chart below is a recap of various balances and book value per share as of the end of the last three years (dollars in
thousands, except per share data):
2008
As of December 31,
2007
2008/2007
Increase (Decrease)
2007/2006
Increase (Decrease)
2006
Dollars
Percentage
Dollars
Percentage
Loans
Assets
Deposits
Borrowings
Shareholders' equity
Book vaue per share
$
370,280
451,431
371,097
36,210
41,552
12.15
$
355,079
408,880
320,827
45,949
39,321
11.47
$
322,581
382,791
312,421
38,307
28,790
8.40
$
15,201
42,551
50,270
(9,739)
2,231
.68
%
4.28
10.41
15.67
(21.20)
5.67
5.93
$
32,498
26,089
8,406
7,642
10,531
3.07
%
10.07
6.82
2.69
19.95
36.58
36.55
2008 Year-in-Review
Loan growth of $15.201 million
Credit quality still relatively strong with nonperforming assets to total assets of 1.57%
(cid:2)
(cid:2)
(cid:2) Gain on sale of loans of $.120 million
(cid:2) Net interest margin at 3.23% for the year
(cid:2) Net income of $1.872 million, or $.55 per common share
(cid:2)
Book value at 2008 year-end of $12.15 per share
2008 Earnings Recap
Mackinac Financial Corporation reported net income of $1.872 million, or $.55 per share, for the year ended December 31,
2008, compared to a net income of $10.163 million, or $2.96 per share, for 2007.
The 2008 results include the positive effect, $3.475 of a lawsuit settlement and the negative effect, $.425 million, of a
severance agreement.
1
To Our Shareholders
The results for 2007 include the recognition of a $7.500 million deferred tax benefit for NOL and tax credit carry-forwards
and $.470 million of proceeds from the settlement of a lawsuit against the Corporation’s former accountants. Excluding
these items in both years would have resulted in a net loss of $.141 million, or less than $.01 loss per share, in 2008 versus
$2.353 million or $.69 per share in 2007.
Our operations have been impacted in the past two years by the significant and rapid decline in general interest rates which
impacted interest earned on loans well ahead of interest paid on deposits and borrowings. This margin compression
affected most banks and we acted to minimize the effects as quickly as possible. Additionally, in late summer 2008, we
implemented a program of interest rate floors for new and renewing loans.
Credit Quality
Nonperforming assets at the end of 2008 totaled $7.076 million, or 1.57%, of assets compared to $5.234 million, or 1.28%
of assets at 2007 year-end. Increases in 2008 were due to several large credits in Southeast Michigan. The increase in
nonperforming assets, $2.269 million, in 2007 was due primarily to commercial credits that were originated prior to the
recapitalization and existing management. An important aspect in the management of our loan portfolio is a program of
continual credit monitoring which results in early detection of problem credits. We follow this detection process with a
program that aggressively seeks an early resolution of problem loans to minimize principal loss and the expenses of
problem credits.
Loan Growth/Production
Loan growth in 2008 occurred despite a challenging and tough Michigan economic climate. Each year we continue to
evaluate and adjust underwriting standards to keep pace with the moving risk profile of the bank and corresponding
Michigan economic climate. This focus has enabled the organization to maintain a low and manageable level of problem
assets in relation to many peer and competing banks. These processes for managing our loan portfolio’s growth and overall
risk have provided the foundation for loans growing $15.201 million in 2008, despite high levels of loan pay-downs and
runoff totaling $51.224 million. A good portion of loan runoff in 2008 was due to our discipline in qualifying renewal
loans relative to pricing and risk. New loans originated for the year were $61.597 million. The majority of the loan growth
was centered in the real estate secured commercial, high net worth, and 1-4 family loan portfolios. We have purposely
avoided the subprime lending opportunities in these sectors.
Loan production in our three geographical regions is shown below.
(dollars in thousands)
For the Year Ending December 31,
REGION
Upper Peninsula
Northern Lower Peninsula
Southeast Michigan
2008
2007
2006
37,040
14,183
10,374
$
40,876
22,448
50,404
$
37,115
25,929
72,139
TOTAL
$
61,597
$
113,728
$
135,183
We have generated loan growth in all regions and we will continue to evaluate growth potential in markets where we can
grow loans with good credit quality and acceptable loan pricing enhanced by fee income.
In 2008, mBank was awarded “Michigan Business Development Lender of the Year” by the United States Small Business
Administration. SBA programs not only significantly augment noninterest income, but also positively impact the bank
balance sheet by freeing up liquidity and capital requirements to be allocated to continue earning asset generation, in
addition to transferring all or part of the risk off the bank’s balance sheet.
2
To Our Shareholders
Deposit Growth
Core deposits, which we define as demand deposits, interest bearing checking accounts, money market savings accounts
and certificates of deposit under $100,000 started to grow in mid 2005. 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
newspaper ads for our local markets.
Shown below is the mix of our deposits for the three most recent years.
2008
Mix
2007
Mix
2006
Mix
2008/2007
2007/2006
As of December 31,
Percent Change
DEPOSIT MIX
CORE DEPOSITS
Transactional accounts:
Noninterest bearing
NOW, money market, checking
Savings
Total transactional accounts
Certficates of deposit <$100,000
Total core deposits
NONCORE DEPOSITS
Certificates of deposit >$100,000
Brokered CDs
Total noncore deposits
$
30,099
70,584
20,730
121,413
73,752
195,165
25,044
150,888
175,932
8.11
19.02
5.59
32.72
19.87
52.59
6.75
40.66
47.41
%
$
25,557
81,160
12,485
119,202
80,607
199,809
22,355
98,663
121,018
7.97
25.30
3.89
37.15
25.12
62.28
6.97
30.75
37.72
%
$
23,471
73,188
13,365
110,024
89,585
199,609
23,645
89,167
112,812
%
7.51
23.43
4.28
35.22
28.67
63.89
7.57
28.54
36.11
TOTAL DEPOSITS
$
371,097
100.00
%
$
320,827
100.00
%
$
312,421
100.00
%
%
17.77
(13.03)
66.04
1.85
(8.50)
(2.32)
12.03
52.93
45.38
15.67
%
8.89
10.89
(6.58)
8.34
(10.02)
0.10
(5.46)
10.65
7.27
2.69
%
In the past several years, the Bank has introduced several initiatives to provide customers with simple, flexible, and
convenient banking services to assist them in meeting all their financial needs. We updated our electronic banking products
for both consumers and businesses, rolled out and implemented a comprehensive treasury management program, and
provided remote deposit capture machines or courier services to business customers in order to help garner transactional
account deposits. Additionally, we began an extensive officer calling effort to focus our relationship officers on generating
core deposit relationships with existing and new customers. While total deposits did not grow in 2008, due primarily to our
unwillingness to match high rates on CDs in our local markets, we increased the proportion of transactional account
balances, which are our lowest cost sources of funds.
Noninterest Expense
Controlling noninterest expense is a distinct challenge for a strategy based upon growth. We accept this challenge and
recognize that certain operational costs will increase in future periods. During 2008, our operating costs were negatively
impacted by costs associated with nonperforming assets and a $.425 million severance agreement. We have been
successful in controlling most areas of noninterest expense and will continue to focus on becoming more efficient.
3
To Our Shareholders
The chart below illustrates the breakdown of noninterest expense as a percent of average assets.
The chart below illustrates the impact of controlling expenses and the net interest margin has on our efficiency ratio.
Efficiency Ratio
e
g
a
t
n
e
c
r
e
P
100.00%
95.00%
90.00%
85.00%
80.00%
75.00%
70.00%
2006
2007
Year ended
2008
4
To Our Shareholders
Capital/Shareholders’ Equity
The Bank and Corporation were both well capitalized as of the end of 2008. On a consolidated basis, equity totaled
$41.552 million at 2008 year end compared to $39.321 million at the end of 2007. Book value per share amounted to
$12.15 compared to $11.47 a year earlier.
Looking Forward
In 2009, we are faced with the challenges of an economy in turmoil and low expectations for the economy to improve in the
near term. We recognize the problems that arise during economic downturns and have taken the steps within our company
in order to weather the storm. We will continue to price our loans at profitable levels, decrease costs where we can without
compromising services, and are working diligently to limit losses from our problem assets. In times like these, a strong
capital base is essential. We are currently well capitalized with Tier 1 capital at 8.01% and total risk based capital of
10.38%. This level of capital, however, does not allow for any significant asset growth, given another lean year for
earnings growth with continued margin pressure and the possibility of additional loan issues as the economy continues to
falter.
With the uncertainties noted above, the Corporation made the decision to apply for capital under the Capital Purchase
Program, as part of the Troubled Asset Relief Program, commonly referred to as TARP. We have received preliminary
approval from the United States Treasury Department.
The Corporation is, and will remain, dedicated to the primary strategic objective of enhancing franchise and shareholder
value by building a strong banking franchise in our local markets. We invite you to contact one of our knowledgeable
relationship officers to discuss how mBank’s broad array of products and services can fit your corporate and personal
needs.
We thank you for your support during this difficult economic period and we welcome your comments and questions.
Sincerely,
Paul D. Tobias
Chairman and CEO
Mackinac Financial Corporation
Kelly W. George
President and CEO
mBank
5
Selected Financial Highlights
(Dollars in Thousands, Except Per Share Data)
Selected Financial Condition Data (at end of period) :
Assets
Loans
Investment securities
Deposits
Borrowings
Shareholders' equity
Selected Statements of Income Data:
Net interest income
Income before taxes
Net income
Income per common share - Basic
Income per common share - Diluted
Weighted average shares outstanding
Selected Financial Ratios and Other Data:
Performance Ratios:
Net interest margin
Efficiency ratio
Return on average assets
Return on average equity
Average total assets
Average total shareholders' equity
Average loans to average deposits ratio
Common Share Data at end of period:
Market price per common share
Book value per common share
Common shares outstanding
Other Data at end of period:
Allowance for loan losses
Non-performing assets
Allowance for loan losses to total loans
Non-performing assets to total assets
Number of:
Branch locations
FTE Employees
For The Years Ended December 31,
2008
(Unaudited)
2007
(Unaudited)
$
451,431
370,280
47,490
371,097
36,210
41,552
$
408,880
355,079
21,597
320,827
45,949
39,321
$
12,864
2,659
1,872
.55
.55
3,422,012
$
13,417
2,923
10,163
2.96
2.96
3,428,695
%
3.23
85.51
.44
4.61
%
3.60
79.46
2.59
31.05
$
425,343
40,630
105.61
%
$
392,313
32,731
104.94
%
$
$
4.40
12.15
3,419,736
$
$
8.98
11.47
3,428,695
$
$
4,277
7,076
1.16
1.57
$
$
4,146
5,234
%
1.17
1.28 %
%
%
12
100
12
100
The above summary should be read in connection with the related consolidated financial statements and notes included
elsewhere in this report.
6
Five-Year Comparisons
ASSETS
Total assets on a consolidated basis
increased by 10.4% during 2008 to
$451.4 million.
EARNING ASSETS
Earning assets increased 10.4% during
2008 to $422.1 million.
LOANS
Total loans increased 4.3% during
2008 to $370.3 million
7
Five-Year Comparisons (Continued)
SOURCE OF FUNDS
Source of funds increased by 11.0% to
$407.3 million.
SHAREHOLDERS’ EQUITY
During 2008, shareholders’ equity
increased by $2.2 million, or 5.7% to
$41.6 million.
NET INCOME (LOSS)
Net income for 2008 was $1.9 million,
as compared to net income of $10.2
million in 2007.
8
Quarterly Financial Information
MACKINAC FINANCIAL CORPORATION
QUARTERLY FINANCIAL SUMMARY
Quarter Ended
December 31, 2008
September 30, 2008
June 30, 2008
March 31, 2008
December 31, 2007
September 30, 2007
June 30, 2007
March 31, 2007
December 31, 2006
Average
Assets
Average
Loans
Average
Deposits
$
441,583
423,702
418,246
417,682
406,308
400,105
382,065
380,403
366,566
$
366,077
358,844
362,574
357,778
350,050
340,391
324,721
318,072
301,508
$
358,213
341,377
332,725
336,016
324,194
327,293
309,469
309,619
294,755
Average
Shareholders'
Equity
$
41,516
41,097
40,399
39,491
38,973
32,184
30,412
29,254
28,646
Return on Average
Assets
Equity
Net Interest
Margin
Efficiency
Ratio
%
(.23) % (2.42)
2.08
.20
17.62
1.70
1.42
.13
5.36
.51
99.30
7.99
7.20
.57
14.35
1.10
4.68
.37
3.20
3.39
3.19
3.13
3.55
3.71
3.60
3.55
3.44
% 80.30
79.12
88.45
95.34
78.02
74.71
83.18
82.39
94.60
%
Net Income Book Value
Per Share
Per Share
$
12.15
$
(.07)
12.11
.06
11.98
.52
11.56
.04
11.47
.15
11.29
2.35
8.89
.16
8.73
.30
8.40
.10
LOAN PORTFOLIO BALANCES
TRANSACTIONAL ACCOUNT DEPOSITS
400,000
350,000
300,000
250,000
200,000
150,000
100,000
50,000
-
)
s
d
n
a
s
u
o
h
t
n
i
(
s
r
a
l
l
o
D
140,000
120,000
100,000
80,000
60,000
40,000
20,000
-
)
s
d
n
a
s
u
o
h
t
n
i
(
s
r
a
l
l
o
D
December-07
March-08
June-08
September-08
December-08
December-07
March-08
June-08
September-08 December-08
At Month End
Commercial
Mortgage
Leases
Installment
At Month End
Money Markets
NOW
Demand
Savings
NET INTEREST MARGIN
3.55%
3,600
3,400
3,200
$3,410
)
s
d
n
a
s
u
o
h
t
n
i
(
s
r
a
l
l
o
D
3,000
2,800
2,600
2,400
$3,371
3.39%
$3,330
$3,118
3.19%
3.20%
$3,045
3.13%
3.60%
3.50%
3.40%
3.30%
3.20%
3.10%
3.00%
2.90%
P
e
r
c
e
n
t
a
g
e
December-07
Ma rch-08
June-08
September-08
December-08
Quarter Ended
9
Report of Independent Registered Public Accounting Firm
Report of Independent Registered Public Accounting Firm
Board of Directors
Mackinac Financial Corporation, Inc.
We have audited the consolidated statement of financial condition of Mackinac Financial Corporation,
Inc. as of December 31, 2008 and 2007 and the related consolidated statements of income, changes
in stockholders’ equity, and cash flows for each year in the three-year period ended December 31,
2008. These consolidated financial statements are the responsibility of the Company’s management.
Our responsibility is to express an opinion on these consolidated financial statements based on our
audits.
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. The
Company is not required to have, nor were we engaged to perform, an audit of its internal control
over financial reporting. Our audits included consideration of internal control over financial reporting
as a basis for designing audit procedures that are appropriate in the circumstances, but not for the
purpose of expressing an opinion on the effectiveness of the Company’s internal control over
financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial statements, 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 consolidated financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Mackinac Financial Corporation, Inc. as of December
31, 2008 and 2007 and the consolidated results of their operations and their cash flows for each year
in the three-year period ended December 31, 2008, in conformity with accounting principles
generally accepted in the United States of America.
Auburn Hills, Michigan
March 20, 2009
10
Consolidated Balance Sheets
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
December 31, 2008 and 2007
(Dollars in Thousands)
_____________________________________________________________________________________________
AS S ETS
Cas h and due from banks
Federal funds s old
Cas h and cas h equivalents
Interes t bearing depos its in other financial ins titutions
Securities available for s ale
Federal Home Loan Bank s tock
Loans :
Commercial
M ortgage
Ins tallment
Total loans
A llowance for loan los s es
Net loans
Premis es and equipment
Other real es tate held for s ale
Other as s ets
2008
2007
$
10,112
-
10,112
$
6,196
166
6,362
582
47,490
3,794
296,088
70,447
3,745
370,280
(4,277)
366,003
11,189
2,189
10,072
1,810
21,597
3,794
288,839
62,703
3,537
355,079
(4,146)
350,933
11,609
1,226
11,549
TOTAL AS S ETS
$
451,431
$
408,880
LIABILITIES AND S HAREHOLDERS ' EQUITY
LIA BILITIES:
Depos its :
Noninteres t bearing depos its
NOW , money market, checking
Savings
CDs <$100,000
CDs >$100,000
Brokered
Total depos its
Borrowings :
Federal funds purchas ed
Short-term
Long-term
Total borrowings
Other liabilities
Total liabilities
SHA REHOLDERS' EQUITY
Preferred s tock - no par value:
A uthorized 500,000 s hares , no s hares outs tanding
Common s tock and additional paid in capital - no par value
A uthorized - 18,000,000 s hares
Is s ued and outs tanding - 3,419,736 and 3,428,695, res pectively
A ccumulated deficit
A ccumulated other comprehens ive income
Total s hareholders ' equity
$
30,099
70,584
20,730
73,752
25,044
150,888
371,097
$
25,557
81,160
12,485
80,607
22,355
98,663
320,827
-
-
36,210
36,210
2,572
409,879
7,710
1,959
36,280
45,949
2,783
369,559
-
-
42,815
(1,708)
445
41,552
42,843
(3,582)
60
39,321
TOTAL LIABILITIES AND S HAREHOLDERS ' EQUITY
$
451,431
$
408,880
See accompanying notes to consolidated financial statements.
11
Consolidated Statements of Operations
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
Years Ended December 31, 2008, 2007, and 2006
(Dollars in Thousands, Except Per Share Data)
_________________________________________________________________________________________
For The Years Ended December 31,
2007
2006
2008
INTEREST INCOME:
Interest and fees on loans:
Taxable
Tax-exempt
Interest on securities:
Taxable
Tax-exempt
Other interest income
Total interest income
INTEREST EXPENSE:
Deposits
Borrowings
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
NONINTEREST INCOME:
Service fees
Net security gains
Net gains on sale of secondary market loans
Proceeds from settlement of lawsuit
Other
Total noninterest income
NONINTEREST EXPENSE:
Salaries and employee benefits
Occupancy
Furniture and equipment
Data processing
Professional service fees
Loan and deposit
Telephone
Advertising
Other
Total noninterest expense
Income before provision for income taxes
Provision for (benefit of) income taxes
NET INCOME
INCOME PER COMMON SHARE:
Basic
Diluted
$
22,555
404
$
26,340
533
$
21,239
753
1,293
5
305
24,562
10,115
1,583
11,698
12,864
2,300
10,564
838
64
120
3,475
156
4,653
6,886
1,374
771
844
508
569
170
305
1,131
12,558
1,100
-
722
28,695
13,224
2,054
15,278
13,417
400
13,017
688
(1)
498
470
351
2,006
6,757
1,272
678
785
532
285
228
370
1,193
12,100
1,186
87
787
24,052
10,575
1,884
12,459
11,593
(861)
12,454
547
(1)
197
-
240
983
6,132
1,264
631
691
1,425
392
210
346
1,130
12,221
2,659
787
1,872
$
2,923
(7,240)
10,163
$
1,216
(500)
1,716
$
$
$
.55
.55
$
$
2.96
2.96
$
$
.50
.50
See accompanying notes to consolidated financial statements.
12
Consolidated Statements of Changes in Shareholders’ Equity
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
Years Ended December 31, 2008, 2007, and 2006
(Dollars in Thousands)
_____________________________________________________________________________________________
Shares of
Common
Stock
Common Stock
and Additional
Paid in Capital
Accumulated
Deficit
Accumulated
Other
Comprehensive
Income (Loss)
Total
Balance, January 1, 2006
3,428,695
$
42,412
$
(15,461)
$
(363)
$
26,588
Net income
Other comprehensive income:
Net unrealized loss on
securities available for sale
Total comprehensive income
Stock option compensation
-
-
-
-
-
310
1,716
-
1,716
-
-
176
-
176
1,892
310
Balance, December 31, 2006
3,428,695
42,722
(13,745)
(187)
28,790
Net income
Other comprehensive income:
Net unrealized income on
securities available for sale
Total comprehensive income
Stock option compensation
-
-
-
Balance, December 31, 2007
3,428,695
Purchase of oddlot shares
Net income
Other comprehensive income:
Net unrealized income on
securities available for sale
Other
Total comprehensive income
Stock option compensation
(8,959)
-
-
-
-
-
-
121
42,843
(110)
-
-
-
82
10,163
-
10,163
-
-
(3,582)
-
1,872
-
2
-
247
-
60
-
-
385
-
-
247
10,410
121
39,321
(110)
1,872
385
2
2,259
82
Balance, December 31, 2008
3,419,736
$
42,815
$
(1,708)
$
445
$
41,552
See accompanying notes to consolidated financial statements.
13
Consolidated Statements of Cash Flows
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
Years Ended December 31, 2008, 2007, and 2006
(Dollars in Thousands)
_____________________________________________________________________________________________
Cash Flows from Operating Activities:
Net income
Adjustments to reconcile net income to net net cash
provided by (used in) operating activities:
Depreciation and amortization
Provision for loan losses
Provision for (benefit of) deferred income taxes
(Gain) loss on sales/calls of securities available for sale
(Gain) on sale of premises, equipment, branch and other real estate
Writedown of other real estate
Stock option compensation
Change in other assets
Change in other liabilities
Net cash provided by operating activities
Cash Flows from Investing Activities:
Net (increase) in loans
Net (increase) decrease in interest-bearing deposits in other financial institutions
Purchase of securities available for sale
Proceeds from maturities, sales, calls or paydowns of securities available for sale
FHLB repurchase of stock
Capital expenditures
Proceeds from sale of premises, equipment, and other real estate
Net cash paid in connection with branch sales
Net cash (used in) investing activities
Cash Flows from Financing Activities:
Net increase in deposits
Net increase (decrease) in federal funds purchased
Net increase (decrease) in lines of credit
Repurchase of common stock-oddlot shares
Principal payments on borrowings
Net cash provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
2008
2007
2006
$
1,872
$
10,163
$
1,716
1,355
2,300
787
(64)
(77)
964
82
367
(210)
7,376
(21,173)
1,228
(50,813)
25,373
-
(618)
1,956
-
(44,047)
50,270
(7,710)
(1,959)
(110)
(70)
40,421
3,750
6,362
942
400
(7,240)
1
(17)
40
121
12
(491)
3,931
(35,043)
(954)
(25,556)
37,215
-
(1,516)
323
(8,042)
(33,573)
17,656
7,710
-
-
(68)
25,298
(4,344)
10,706
1,052
(861)
(500)
1
(60)
-
310
(143)
188
1,703
(83,074)
169
(5,000)
6,579
1,061
(1,367)
1,013
-
(80,619)
79,789
-
1,959
-
(69)
81,679
2,763
7,943
Cash and cash equivalents at end of period
$
10,112
$
6,362
$
10,706
Supplemental Cash Flow Information:
Cash paid during the year for:
Interest
Income taxes
Noncash Investing and Financing Activities:
Transfers of Foreclosures from Loans to Other Real Estate Held for Sale
Assets and Liabilities Divested in Branch Sales:
Loans
Premises and equipment
Deposits
$
11,961
70
$
13,609
-
$
12,270
-
2,849
1,218
-
-
-
27
1,181
9,250
23
-
-
-
See accompanying notes to consolidated financial statements.
14
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 intercompany transactions and accounts.
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 portion, approximately 3.0%, 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 1.0% 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 investment securities, 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.
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.
15
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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, it is probable 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 a 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, when they 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.
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.
16
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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
Intangible assets attributable to the value of core deposits 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.
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.
Stock Option Plans
The Corporation sponsors three stock option plans. One plan was approved during 2000 and applies to officers, employees,
and nonemployee directors. This plan was amended as a part of the December 2004 stock offering and recapitalization.
The amendment, approved by shareholders, increased the shares available under this plan by 428,587 shares from the
original 25,000 (adjusted for the 1:20 reverse stock split), to a total authorized share balance of 453,587. The other two
plans, one for officers and employees and the other for nonemployee directors, were approved in 1997. A total of 30,000
(adjusted for the 1:20 split), were made available for grant under these plans. These two 1997 plans expired early in 2007.
Options under all of the plans are granted at the discretion of a committee of the Corporation’s Board of Directors. Options
to purchase shares of the Corporation’s stock are granted at a price equal to the market price of the stock at the date of
grant. The committee determines the vesting of the options when they are granted as established under the plan.
The Corporation adopted SFAS No. 123 (Revised) “Share Based Payments” in the first quarter of 2006. This statement
supersedes APB Opinion No. 25, “Accounting for Stock Issue to Employees” and its related implementation guidance.
Under Opinion No. 25, issuing stock options to employees generally resulted in recognition of no compensation cost. This
adoption resulted in the recognition of before tax compensation expense in the amount of $82,000 for 2008, $121,000 for
2007, and $310,000 in 2006. The expense recorded recognizes the current period vesting of options outstanding. The per
share impact of this accounting change was $.02 for 2008. In 2007 and 2006, the per share impact was $.04 and $.08,
respectively.
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 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
17
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 1- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Earnings per share are based upon the weighted average number of shares outstanding. The following shows the
computation of basic and diluted income per share for the years ended December 31 (dollars in thousands, except per share
data):
2008
Income per share - basic and diluted
2007
Income per share - basic and diluted
2006
Income per share - basic and diluted
Net Income
Weighted
Average
Number of Shares
Income
per Share
$
1,872
3,422,012
$
.55
$
10,163
3,428,695
$
2.96
$
1,716
3,428,695
$
.50
In the above disclosure the dilutive effect of additional shares outstanding, as a result of stock options exercisable, was not
taken into account since the additional shares issued as a result of vested options under the Company’s option plans would
not have a dilutive effect on the earnings 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. In 2008, the Corporation recorded a current tax
provision of $.787 million. The Corporation recorded a $.260 million current tax provision in the fourth quarter of 2007. In
the third quarter of 2007, the Corporation reversed a portion of the valuation allowance that pertained to the deferred tax
benefit of NOL and tax credit carryforwards. This valuation adjustment, $7.500 million, was recorded as a current period
income tax benefit. In 2006, the Corporation recorded a $.500 million tax benefit and utilized additional NOL carryforward
benefits to offset current taxable income. The recognition of the deferred tax benefit in 2007 and 2006 was in accordance
with generally accepted accounting principles, and considered, among other things, the probability of utilizing the NOL and
credit carryforwards. Further discussion on the NOL carryforward and future benefits is presented in the “Management’s
Discussion and Analysis” section of this report.
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. For letters of credit, the Corporation recognizes a liability for the fair market value of the obligations it
assumes under that guarantee.
Reclassifications
Certain amounts in the 2007 and 2006 consolidated financial statements have been reclassified to conform to the 2008
presentation.
18
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 2 – RESTRICTIONS ON CASH AND CASH EQUIVALENTS
Cash and cash equivalents in the amount of $1.400 million were restricted on December 31, 2008 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 $250,000, which was
increased from $100,000 under certain provisions of the Troubled Asset Relief Program (“TARP”) and will revert back to
$100,000 at 2009 year end.
Management believes that these financial institutions have strong credit ratings and the credit risk related to these deposits
is minimal.
NOTE 3 – SECURITIES AVAILABLE FOR SALE
The carrying value and estimated fair value of securities available for sale are as follows (dollars in thousands):
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Estimated
Fair Value
December 31, 2008
US Agencies - MBS
Obligations of states and political subdivisions
$
46,316
498
$
632
51
$
(7)
-
$
46,941
549
Total securities available for sale
$
46,814
$
683
$
(7)
$
47,490
December 31, 2007
US Agencies
Obligations of states and political subdivisions
$
20,982
556
$
25
72
$
(38)
-
$
20,969
628
Total securities available for sale
$
21,538
$
97
$
(38)
$
21,597
Following is information pertaining to securities with gross unrealized losses at December 31, 2008 and 2007 aggregated
by investment category and length of time these individual securities have been in a loss position (dollars in thousands):
Less Than Twelve Months
Gross
Unrealized
Losses
Fair
Value
Over Twelve Months
Gross
Unrealized
Losses
Fair
Value
December 31, 2008
US Agencies - MBS
$
(7)
$
5,106
$
-
$
-
Total securities available for sale
$
(7)
$
5,106
$
-
$
-
December 31, 2007
US Agencies
$
(7)
$
6,978
$
(31)
$
8,969
Total securities available for sale
$
(7)
$
6,978
$
(31)
$
8,969
19
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 3 – SECURITIES AVAILABLE FOR SALE (CONTINUED)
The gross unrealized losses in the current portfolio are considered temporary in nature and related to interest rate
fluctuations. The Corporation has both the ability and intent to hold the investment securities until their respective
maturities and therefore does not anticipate the realization of the temporary losses.
Following is a summary of the proceeds from sales and calls of securities available for sale, as well as gross gains and
losses for the years ended December 31 (dollars in thousands):
Proceeds from sales and calls
Gross gains on sales
Gross (losses) on sales and calls
2008
2007
2006
$
12,047
65
(1)
$
6,579
-
(1)
$
3,010
-
(1)
The carrying value and estimated fair value of securities available for sale at December 31, 2008, by contractual maturity,
are shown below (dollars in thousands):
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Total
Amortized
Cost
5
$
26
467
46,316
$
46,814
Estimated
Fair Value
$
$
5
26
517
46,942
47,490
Contractual maturities may differ from expected maturities because issuers may have the right to call or prepay obligations
with or without call or prepayment penalties. See Note 10 for information on securities pledged to secure borrowings from
the Federal Home Loan Bank.
20
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 4 - LOANS
The composition of loans at December 31 is as follows (dollars in thousands):
Commercial real estate
Commercial, financial, and agricultural
One to four family residential real estate
Construction :
Consumer
Commerical
Consumer
2008
2007
$
185,241
79,734
65,595
$
171,695
78,192
57,613
4,852
31,113
3,745
5,090
38,952
3,537
Total loans
$
370,280
$
355,079
An analysis of the allowance for loan losses for the years ended December 31 is as follows (dollars in thousands):
2008
2007
2006
Balance, January 1
Recoveries on loans previously charged off
Loans charged off
Provision
$
4,146
121
(2,290)
2,300
$
5,006
50
(1,310)
400
$
6,108
91
(332)
(861)
Balance, December 31
$
4,277
$
4,146
$
5,006
In 2008, net charge off activity was $2.169 million, or .60% of average loans outstanding compared to net charge-offs of
$1.260 million, or .38% of average loans, in the same period in 2007 and $.241 million, or .08% of average loans, in 2006.
During 2008, a provision of $2.300 million was made to increase the reserve. This provision was made in accordance with
the Corporation’s allowance for loan loss reserve policy, which calls for a measurement of the adequacy of the reserve at
each quarter end. This process includes an analysis of the loan portfolio to take into account increases in loans outstanding
and portfolio composition, historical loss rates, and specific reserve requirements of nonperforming loans. During the third
quarter of 2007, a provision of $.400 million was made to increase the reserve. In the first quarter of 2006, the Corporation
reduced the allowance for loan losses by recording a negative provision amounting to $.600 million In the fourth quarter of
2006, a reduction of $.261 million was made to the reserve due to the resolution of a problem loan with an excess specific
reserve. These reductions in the reserve were made in recognition of the improved credit quality existent in the loan
portfolio and are discussed in more detail under “Management’s Discussion and Analysis.”
Impaired Loans
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 on interest or
principal. The interest income recorded, and that which would have been recorded had nonaccrual and renegotiated loans
been current or not troubled, was not material to the consolidated financial statements for the years ended December 31,
2008 and 2007.
A loan is considered impaired, based on current information and events, if it is probable that the Bank will be unable to
collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement.
21
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 4 – LOANS (CONTINUED)
The following is a summary of impaired loans and their effect on interest income (dollars in thousands):
Impaired Loans
December 31,
2007
2008
2006
2008
Valuation Reserve
December 31,
2007
2006
Balances, at period end
Impaired loans with valuation reserve
Impaired loans with no valuation reserve
$
3,730
1,157
$
3,639
369
$
1,804
1,136
$
994
-
$
1,320
-
Total impaired loans
$
4,887
$
4,008
$
2,940
$
994
$
1,320
Impaired loans on nonaccrual basis (1)
Impaired loans on accrual basis
$
4,887
-
$
3,298
710
$
2,900
40
$
994
-
$
1,219
101
Total impaired loans
$
4,887
$
4,008
$
2,940
$
994
$
1,320
$
$
$
$
493
-
493
493
-
493
Average investment in impaired loans
Interest income recognized during impairment
Interest income that would have been
recognized on an accrual basis
Cash-basis interest income recognized
$
4,834
60
$
4,135
129
$
1,192
7
377
60
391
84
114
5
(1) In addition to the valuation reserves on impaired loans as of December 31, 2007, the Bank had an SBA loan guarantee of $.435 million,
which relates to a hotel/motel loan included with nonaccrual loans.
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):
Loans outstanding, January 1
New loans
Net activity on revolving lines of credit
Change in related party interest
Repayment
2008
2007
$
1,720
372
2,378
2,733
(687)
$
1,621
-
556
-
(457)
Loans outstanding, December 31
$
6,516
$
1,720
There were no loans to related-parties classified substandard as of December 31, 2008 and 2007. In addition to the
outstanding balances above, there were unused commitments of $.924 million to related parties at December 31, 2008.
22
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 5 – PREMISES AND EQUIPMENT
Details of premises and equipment at December 31 are as follows (dollars in thousands):
Land
Buildings and improvements
Furniture, fixtures, and equipment
Construction in progress
Total cost basis
Less - accumulated depreciation
2008
2007
$
2,042
12,545
4,261
70
18,918
7,729
$
2,042
12,258
3,783
224
18,307
6,698
Net book value
$
11,189
$
11,609
The construction in progress at the end of 2008 pertains to ATM installation at a branch location, improvements to an
existing branch location, and costs associated with the establishment of a new branch location.
In October 2007, the Bank sold its Ripley branch office, with deposits of approximately $9.3 million, premises and
equipment with a net book value of $1.2 million, and loans totaling $27,000.
Depreciation of premises and equipment charged to operating expenses amounted to $1.035 million in 2008, $.891 million
in 2007, and $.890 million in 2006.
NOTE 6 – OTHER REAL ESTATE HELD FOR SALE
An analysis of other real estate held for sale for the years ended December 31 is as follows (dollars in thousands):
Balance, January 1
Other real estate transferred from loans due to foreclosure
Other real estate sold / written down
Balance, December 31
2008
2007
$
$
1,226
2,849
(1,886)
$
26
1,218
(18)
2,189
$
1,226
NOTE 7 – INTANGIBLE ASSET
Included in other assets are core deposit premiums acquired through acquisitions. These core deposit premiums are
considered an intangible asset. As of December 31, 2008, the remaining balance of core deposit intangibles was $45,000.
Core deposit premium expense amounted to $78,000 in 2008, $82,000 in 2007, $125,000 in 2006. The remaining balance
of $45,000 will be amortized in 2009.
23
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 8 – DEPOSITS
The distribution of deposits at December 31 is as follows (dollars in thousands):
Noninterest bearing
NOW, money market, checking
Savings
CDs <$100,000
CDs >$100,000
Brokered
Total deposits
2008
2007
$
30,099
70,584
20,730
73,752
25,044
150,888
$
25,557
81,160
12,485
80,607
22,355
98,663
$
371,097
$
320,827
Maturities of non-brokered time deposits outstanding at December 31, 2008, are as follows (dollars in thousands):
2009
2010
2011
2012
2013
Thereafter
Total
$
85,296
8,239
2,976
1,223
291
771
$
98,796
Brokered deposits of $150.888 million mature in 2009.
NOTE 9 – SHORT-TERM BORROWINGS
Short-term borrowings consist of the following at December 31 (dollars in thousands):
2008
2007
Fed funds purchased with a weighted average rate of 4.18%
$
-
$
7,710
Advance outstanding on line of credit with a correspondent bank, interest payable
at the prime rate, 7.25% as of December 31, 2007, matured November 30, 2008
-
1,959
$
-
$
9,669
In the second quarter of 2006, the Corporation established a $6 million line of credit with a correspondent bank. This line
of credit, which is priced at the prime rate, was utilized by the Corporation to infuse capital into the Bank in order to
support the regulatory required 8% Tier 1 Capital and provide cash for holding company operations. This line of credit was
secured by all of the shares of the Bank, matured November 30, 2008 and was subsequently closed.
24
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 10 – LONG-TERM BORROWINGS
Long-term borrowings consist of the following at December 31 (dollars in thousands):
Federal Home Loan Bank fixed rate advances at rates ranging from 4.98% to 5.16%
maturing in 2010
Federal Home Loan Bank variable rate advances at rates ranging from 2.88% to 4.54%
maturing in 2011
Farmers Home Administration, fixed-rate note payable, maturing August 24, 2024
interest payable at 1%
2008
2007
$
15,000
$
15,000
20,000
20,000
1,210
1,280
$
36,210
$
36,280
The Federal Home Loan Bank borrowings are collateralized at December 31, 2008 by the following: a collateral agreement
on the Corporation’s one to four family residential real estate loans with a book value of approximately $26.972 million;
mortgage related and municipal securities with an amortized cost and estimated fair value of $19.107 million and $18.870
million, respectively; and Federal Home Loan Bank stock owned by the Bank totaling $3.794 million. Prepayment of the
remaining advances is subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank of
Indianapolis in effect as of December 31, 2008.
The $35.000 million FHLB borrowings are comprised of both fixed and variable rate borrowings as shown in the above
table. The FHLB has the option to convert the $15.000 million of fixed rate advances to adjustable rate advances, repricing
quarterly at three month LIBOR flat, on the original call date and thereafter.
The U.S.D.A. Rural Development borrowing is collateralized by loans totaling $.334 million originated and held by the
Corporation’s wholly owned subsidiary, First Rural Relending and an assignment of a demand deposit account in the
amount of $.981 million, and guaranteed by the Corporation.
Maturities of long-term borrowings outstanding at December 31, 2008 are as follows (dollars in thousands):
2009
2010
2011
2012
2013
Thereafter
Total
$
70
15,071
20,072
72
73
852
$
36,210
25
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 11 – INCOME TAXES
The components of the federal income tax provision (credit) for the years ended December 31 are as follows (dollars in
thousands):
Current tax expense (credit)
Change in valuation allowance
Deferred tax expense
2008
2007
2006
-
$
-
787
$
15
(7,255)
-
$
-
(500)
-
Total provision (credit) for income taxes
$
787
$
(7,240)
$
(500)
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 is as follows (dollars in thousands):
Tax expense (benefit) at statutory rate
Increase (decrease) in taxes resulting from:
Tax-exempt interest
Change in valuation allowance
Other
2008
2007
2006
$
904
$
993
$
413
(137)
-
20
(181)
(8,136)
84
(252)
(288)
(373)
Provision for (benefit of) income taxes
$
787
$
(7,240)
$
(500)
26
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 11 – INCOME TAXES (CONTINUED)
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 are as follows (dollars
in thousands):
Deferred tax assets:
Allowance for loan losses
Deferred compensation
Intangible assets
Alternative Minimum Tax Credit
NOL carryforward
Depreciation
Tax credit carryovers
Other
Total deferred tax assets
Valuation allowance
Deferred tax liabilities:
2008
2007
$
1,454
310
129
1,463
10,924
131
672
215
15,298
$
1,410
350
289
1,463
11,623
65
672
405
16,277
$
(8,146)
$
(8,146)
Total deferred tax liabilities
(418)
(376)
Net deferred tax asset (liabilty)
$
6,734
$
7,755
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, 2008 and 2007, the Corporation evaluated the valuation allowance against
the net deferred tax asset which would require future taxable income in order to be utilized. The Corporation, as of
December 31, 2008 had a net operating loss and tax credit carryforwards for tax purposes of approximately $32.128
million, and $2.136 million, respectively.
The Corporation utilized NOL carryforwards to offset taxable income for the first nine months of 2007. In the third quarter
of 2007, the Corporation reversed a portion of the valuation allowance, $7.500 million that pertained to the deferred tax
benefit of NOL and tax credit carryforwards. This valuation adjustment was recorded as a current period income tax
benefit. In 2006, the Corporation recorded a $.500 million tax benefit and utilized additional NOL carryforwards to offset
current taxable income. The recognition of the deferred tax benefit in 2007 and 2006 was in accordance with generally
accepted accounting principles, and considered among other things, the probability of utilizing the NOL and credit
carryforwards.
The Corporation recorded the future benefits from these carryforwards at such time as it became “more likely than not” that
they would be utilized prior to expiration. Please refer to further discussion on income taxes contained in “Management’s
Discussion and Analysis.” The net operating loss carryforwards expire twenty years from the date they originated. These
carryforwards, if not utilized, will begin to expire in the year 2023. A portion of the NOL, approximately $22 million, and
all of the credit carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue
Code. The annual limitation is $1.400 million for the NOL and the equivalent value of tax credits, which is approximately
$.477 million. These limitations for use were established in conjunction with the recapitalization of the Corporation in
December 2004.
27
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 12 – OPERATING LEASES
The Corporation currently maintains two operating leases for branch office locations. The first operating lease, for our
location in Birmingham, was originated in September 2005 and had an original term of 66 months with an option to renew
for an additional five year period.
The second operating lease, for our new location in Escanaba, was executed in December 2008, the terms of which are
scheduled to begin in April 2009. The original term of this lease is three years and will automatically renew and extend for
four additional consecutive terms of two years each.
Future minimum payments, by year and in the aggregate, under the initial terms of the operating lease agreements, consist
of the following (dollars in thousands):
2009
2010
2011
2012
Total
$
199
206
91
10
$
506
Rent expense for all operating leases amounted to $195,000 in 2008, $141,000 in 2007, and $182,000 in 2006.
NOTE 13 – 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 $90,000, $112,000, and $70,000 in 2008, 2007,
and 2006, respectively.
NOTE 14 – DEFERRED COMPENSATION PLAN
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, 2008 and 2007, for vested benefits under
this plan, was $.912 million and $1.028 million respectively. These benefits were originally contracted to be paid over a
ten to fifteen-year period. The final payment is scheduled to occur in 2023. The deferred compensation plan is unfunded;
however, the Bank maintains life insurance policies on the majority of the plan participants. The cash surrender value of
the policies was $1.384 million and $1.332 million at December 31, 2008 and 2007, respectively. Deferred compensation
expense for the plan was $84,000, $90,000, and $85,000 for 2008, 2007, and 2006 respectively.
NOTE 15 – 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-
28
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 15 – REGULATORY MATTERS (CONTINUED)
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 1 capital to risk-weighted assets and of Tier 1 capital to
average assets. Management has determined that, as of December 31, 2008, 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.
The Corporation’s and the Bank’s actual and required capital amounts and ratios as of December 31 are as follows (dollars
in thousands):
Actual
Amount
Ratio
For Capital
Adequacy Purposes
Amount
Ratio
$
$
39,138
39,428
10.4%
10.4%
>
>
$
$
30,158
30,202
> 8.0%
> 8.0%
$
$
34,861
35,192
$
$
34,861
35,192
9.3%
9.3%
8.0%
8.1%
>
>
>
>
$
$
15,079
15,101
> 4.0%
> 4.0%
$
$
17,407
17,393
> 4.0%
> 4.0%
To Be W ell
Capitalized Under
Prompt Corrective
Action Provisions
Ratio
Amount
N/A
N/A
N/A
>
>
>
>
10.0%
>
6.0%
>
5.0%
$
$
36,293
38,048
10.1%
10.6%
>
>
$
$
28,673
28,629
> 8.0%
> 8.0%
N/A
35,786
$
>
>
10.0%
$
$
32,147
33,950
$
$
32,147
33,950
9.0%
9.5%
8.1%
8.5%
>
>
>
>
$
$
14,336
14,315
> 4.0%
> 4.0%
$
$
15,967
15,951
> 4.0%
> 4.0%
N/A
21,472
$
N/A
19,938
$
>
>
>
>
6.0%
5.0%
2008
Total capital (to ris k-
weighted as sets ):
Cons olidated
mBank
Tier 1 capital (to ris k-
weighted as sets ):
Cons olidated
mBank
Tier 1 capital (to average as s ets):
Cons olidated
mBank
2007
Total capital (to ris k-
weighted as s ets):
Cons olidated
mBank
Tier 1 capital (to ris k-
weighted as s ets):
Cons olidated
mBank
Tier 1 capital (to average as sets ):
Cons olidated
mBank
At December 31, 2008, 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.
29
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 16 – 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
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:
Outstanding shares at beginning of year
Granted during the year
Expired / forfeited during the year
2008
2007
446,417
-
(180)
446,417
-
-
Outstanding shares at end of year
446,237
446,417
Exercisable shares at end of year
164,446
164,626
Weighted average exercise price per share
at end of year
$
12.14
$
12.29
Shares available for grant at end of year
18,488
18,488
There were no options granted in 2008 and in 2007.
Following is a summary of the options outstanding and exercisable at December 31, 2008:
Exercise
Price Range
$9.16
$9.75
$10.65
$11.50
$12.00
$156.00 - $240.00
$300.00 - $400.00
Number of Shares
Outstanding
Exercisable
12,500
257,152
72,500
40,000
60,000
3,545
540
446,237
5,000
120,861
14,500
8,000
12,000
3,545
540
164,446
30
Weighted
Average
Remaining
Contractual
Life-Years
7.0
6.0
8.0
6.8
6.5
2.3
1.0
6.4
Weighted
Average
Exercise
Price
$
9.16
9.75
10.65
11.50
12.00
186.75
180.00
$
12.14
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 16 – STOCK OPTION PLANS (CONTINUED)
Options issued since the Corporation’s recapitalization in December of 2004 call for 20% immediate vesting upon issue and
subsequent vesting to occur over a two to five year period, based upon the market value appreciation of the underlying
Corporation’s stock. Compensation related to these options is expensed based upon the vesting period without
consideration given to market value appreciation. Future compensation for all outstanding options is projected to total
$61,000 in 2009, $29,000 in 2010, and none thereafter.
NOTE 17 – OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes for the years ended December 31 are as follows (dollars
in thousands):
Unrealized holding gains on
available for sale securities
Less reclassification adjustments for gains (losses)
later recognized in income
Net unrealized gains
Tax effect
2008
2007
2006
$
551
$
248
$
177
64
615
230
(1)
247
-
(1)
176
-
Other comprehensive income
$
385
$
247
$
176
NOTE 18 - 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 are as follows (dollars in thousands):
Commitments to extend credit:
Variable rate
Fixed rate
Standby letters of credit - Variable rate
Credit card commitments - Fixed rate
2008
2007
$
40,036
4,487
1,838
2,438
$
43,903
8,055
5,930
2,414
$
48,799
$
60,302
31
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 18 - COMMITMENTS, CONTINGENCIES, AND CREDIT RISK (CONTINUED)
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition
established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. The Corporation evaluates each customer’s
creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon
extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include
accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.
Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer
to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit
risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
The commitments are structured to allow for 100% collateralization on all standby letters of credit.
Credit card commitments are commitments on credit cards issued by the Corporation’s subsidiary and serviced by other
companies. These commitments are unsecured.
Contingencies
In the normal course of business the Corporation is involved in various legal proceedings.
Concentration of Credit Risk
The Bank grants commercial, residential, agricultural, and consumer loans throughout Michigan. The Bank’s most
prominent concentration in the loan portfolio relates to commercial real estate loans to operators of nonresidential
buildings. This concentration at December 31, 2008 represents $41.299 million, or 13.95%, compared to $41.597 million,
or 14.40%, of the commercial loan portfolio on December 31, 2007. The remainder of the commercial loan portfolio is
diversified in such categories as hospitality and tourism, real estate agents and managers, new car dealers, gaming,
petroleum, forestry, agriculture, and construction. Due to the diversity of the Bank’s locations, the ability of debtors of
residential and consumer loans to honor their obligations is not tied to any particular economic sector.
NOTE 19 - 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.
32
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Impaired loans are measured at the estimated fair value of the expected future cash flows at the loan’s effective interest rate
or the fair value of the collateral for loans which are collateral dependent. Therefore, the carrying values of impaired loans
approximate the estimated fair values for these assets.
Deposits - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits and savings, is
equal to the amount payable on demand at the reporting date. The fair value of time deposits is based on the discounted
value of contractual cash flows applying interest rates currently being offered on similar time deposits.
Borrowings - Rates currently available for debt with similar terms and remaining maturities are used to estimate the fair
value of existing debt. The fair value of borrowed funds due on demand is the amount payable at the reporting date.
Accrued interest - The carrying amount of accrued interest approximates fair value.
Off-balance-sheet instruments - The fair value of commitments is estimated using the fees currently charged to enter into
similar agreements, taking into account the remaining terms of the agreements, the current interest rates, and the present
creditworthiness of the counterparties. Since the differences in the current fees and those reflected to the off-balance-sheet
instruments at year-end are immaterial, no amounts for fair value are presented.
The following table presents information for financial instruments at December 31 (dollars in thousands):
Financial assets:
Cash and cash equivalents
Interest-bearing deposits
Securities available for sale
Federal Home Loan Bank stock
Net loans
Cash surrender value - life insurance
Accrued interest receivable
2008
2007
Carrying
Amount
Estimated
Fair Value
Carrying
Amount
Estimated
Fair Value
$
10,112
582
47,490
3,794
366,003
1,397
1,457
$
10,112
582
47,490
3,794
372,080
1,397
1,457
$
6,362
1,810
21,597
3,794
350,933
1,332
1,806
$
6,362
1,810
21,597
3,794
350,512
1,332
1,806
Total financial assets
$
430,835
$
436,912
$
387,634
$
387,213
Financial liabilities:
Deposits
Borrowings
Directors deferred compensation
Accrued interest payable
$
371,097
36,210
912
488
$
371,434
36,846
912
488
$
320,827
45,949
1,028
751
$
319,213
46,111
1,028
751
Total financial liabilities
$
408,707
$
409,680
$
368,555
$
367,103
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
33
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
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.
The following tables present information about the Corporation’s assets and liabilities measured at fair value on a recurring
basis at December 31, 2008, and the valuation techniques used by the Corporation to determine those fair values.
Level 1:
liabilities that the Corporation has the ability to access.
In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or
Level 2: Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly.
These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as
interest rates and yield curves that are observable at commonly quoted intervals.
Level 3: Level 3 inputs are unobservable inputs, including inputs available in situations where there is little, if any,
market activity for the related asset or liability.
In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value
measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The
Corporation’s assessment of the significance of particular inputs to these fair value measurements requires judgment and
considers factors specific to each asset or liability.
Disclosures concerning assets and liabilities measured at fair value are as follows (dollars in thousands):
Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2008
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
Significant Other
Observable Inputs
(Level 2)
Significant
Unobservable Inputs
(Level 3)
Balance at
December 31, 2008
$
47,422
$
68
$
-
$
47,490
Assets
Investment securities - available for sale
Liabilities
None
The Corporation had no Level 3 assets or liabilities on a recurring basis as of December 31, 2008.
The Corporation also has assets that under certain conditions are subject to measurement at fair value on a non-recurring
basis. These assets include held to maturity investments and loans. The Corporation has estimated the fair values of these
assets using Level 3 inputs, specifically discounted cash flow projections.
34
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 19 - FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2008
(dollars in thousands)
Assets
Impaired loans accounted
for under FAS 114
Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
Significant
Other Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Total Losses for
Year Ended
December 31, 2008
$
-
$
-
$
1,030
$
862
$
862
The Corporation had no investments subject to fair value measurement on a nonrecurring basis.
Impaired loans accounted for under FAS 114 categorized as Level 3 assets consist of non-homogeneous loans that are
considered impaired. The Corporation estimates the fair value of the loans based on the present value of expected future
cash flows using management’s best estimate of key assumptions. These assumptions include future payment ability,
timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals).
Other assets, including bank owned life insurance, goodwill, intangible assets and other assets acquired in business
combinations, are also subject to periodic impairment assessments under other accounting principles generally accepted in
the United States of America. These assets are not considered financial instruments. Effective February 12, 2008, the
FASB issued a staff position, FSP FAS 157-2, which delayed the applicability of FAS 157 to nonfinancial instruments.
Accordingly, these assets have been omitted from the above disclosures.
In October 2008, the FASB issued FSP 157-3, Determining the Fair Value of a Financial Asset When the Market for That
Asset Is Not Active. FSP 157-3 provides clarification of the application of FASB 157 in an inactive market. FSP 157-3 is
effective for the Corporation’s interim financial statements as of December 31, 2008. This change had no impact on the
Corporation’s disclosure on fair value measurements.
35
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 20 - PARENT COMPANY ONLY FINANCIAL STATEMENTS
BALANCE SHEETS
December 31, 2008 and 2007
(Dollars in Thousands)
ASSETS
Cash and cash equivalents
Investment in subsidiaries
Other assets
2008
2007
$
413
41,990
29
$
119
41,198
78
TOTAL ASSETS
$
42,432
$
41,395
LIABILITIES AND SHAREHOLDERS' EQUITY
Borrowings
Other liabilities
Shareholders' equity
-
$
880
41,552
$
1,959
115
39,321
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$
42,432
$
41,395
36
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 20 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF OPERATIONS
Years Ended December 31, 2008, 2007, and 2006
(Dollars in Thousands)
2008
2007
2006
$
3,484
$
482
$
INCOME:
Other
Total income
EXPENSES:
Salaries and benefits
Interest
Professional service fees
Other
Total expenses
Income (loss) before income
taxes and equity in undistributed net
income (loss) of subsidiaries
Provision for (benefit of) income taxes
Income (loss) before equity in undistributed
net income (loss) of subsidiaries
Equity in undistributed net income (loss) of
subsidiaries
3,484
265
51
55
141
512
2,972
1,005
39
39
489
68
728
137
1,422
482
300
160
96
127
683
(201)
(50)
(1,383)
-
1,967
(151)
(1,383)
(95)
10,314
3,099
NET INCOME
$
1,872
$
10,163
$
1,716
37
Notes to Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 20 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2008, 2007, and 2006
(Dollars in Thousands)
Cash Flows from Operating Activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in undistributed net (income) loss of subsidiaries
Increase in capital from stock option compensation
Change in other assets
Change in other liabilities
Net cash (used in) operating activities
Cash Flows from Financing Activities:
Net increase (decrease) in lines of credit
Purchase of common stock - oddlot shares
Investments in subsidiaries
Net cash (used) provided by financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
2008
2007
2006
$
1,872
$
10,163
$
1,716
95
82
49
765
2,863
(1,959)
(110)
(500)
(2,569)
294
119
(10,314)
121
(15)
(59)
(104)
-
-
-
-
(104)
223
(3,099)
310
(11)
125
(959)
1,959
-
(1,950)
9
(950)
1,173
Cash and cash equivalents at end of period
$
413
$
119
$
223
NOTE 21 – SUBSEQUENT EVENTS
Mackinac Financial Corporation filed an application with the Federal Deposit Insurance Corporation (“FDIC”) on
November 4, 2008, for participation in the Capital Purchase Program (“CPP”) under the Troubled Asset Relief Program
(“TARP”). The FDIC responded and recommended approval for our participation and forwarded our application to the
Department of the Treasury (“Treasury”). We received preliminary approval from the Treasury on January 30, 2009 for
our maximum requested participation amount of $11.000 million.
Under the CPP, the Corporation will issue previously authorized preferred stock with a 5.00% annual dividend rate to
the Treasury. The Corporation will also, as a required part of this transaction, issue 379,093 common stock warrants
with an exercise price of $4.35 per share. The preferred stock and common stock warrants will be issued on the
expected closing date in May 2009.
The Corporation intends to utilize the proceeds, $11.000 million, to support future growth of the Corporation by
generating new loan growth through its principal subsidiary, mBank.
38
Selected Financial Data
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
SELECTED FINANCIAL DATA
(Unaudited)
(Dollars in Thousands, Except Per Share Data)
Years Ended December 31
SELECTED FINANCIAL CONDITION DATA:
Total assets
Loans
Securities
Deposits
Borrowings
Total equity
2008
2007
2006
2005
2004
$
451,431
370,280
47,490
371,097
36,210
41,552
$
408,880
355,079
21,597
320,827
45,949
39,321
$
382,791
322,581
32,769
312,421
38,307
28,790
$
298,722
239,771
34,210
232,632
36,417
26,588
$
339,497
203,832
57,075
215,650
85,039
34,730
SELECTED OPERATIONS DATA:
Interest income
Interest expense
Net interest income
Provision for loan losses
Net security gains (losses)
Other income
Other expenses
Income (loss) before income taxes
Provision (credit) for income taxes
$
24,562
11,698
12,864
2,300
64
4,589
(12,558)
2,659
787
$
28,695
(15,278)
13,417
400
(1)
2,007
(12,100)
2,923
(7,240)
$
24,052
(12,459)
11,593
(861)
(1)
984
(12,221)
1,216
(500)
$
16,976
(7,196)
9,780
-
95
1,016
(18,255)
(7,364)
-
$
18,853
(10,615)
8,238
-
-
8,542
(18,228)
(1,448)
147
Net income (loss)
$
1,872
$
10,163
$
1,716
$
(7,364)
$
(1,595)
PER SHARE DATA:
Earnings (loss) - Basic
Earnings (loss) - Diluted
Cash dividends declared
Book value
Market value - closing price at year end
FINANCIAL RATIOS:
Return on average equity
Return on average assets
Dividend payout ratio
Average equity to average assets
Efficiency ratio
Net interest margin
$
.55
.55
-
12.15
4.40
$
2.96
2.96
-
11.47
8.98
$
.50
.50
-
8.40
11.50
$
(2.15)
(2.15)
-
7.75
9.10
$
(3.23)
(3.23)
-
10.13
17.97
%
4.61
.44
N/A
9.55
85.51
3.23
%
31.05
2.59
N/A
8.34
79.46
3.60
%
6.19
.49
N/A
7.97
93.95
3.51
(25.63)
(2.58)
N/A
10.05
160.43
3.64
%
%
(18.64)
(.44)
N/A
2.34
103.05
2.57
39
Summary Quarterly Financial Information
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
SUMMARY QUARTERLY FINANCIAL INFORMATION
(Unaudited)
(Dollars in Thousands, Except per Share Data)
BALANCE SHEET
Total loans
Allowance for loan losses
Total loans, net
Intangible assets
Total assets
Core deposits
Noncore deposits (1)
Total deposits
Total borrowings
Total shareholders' equity
Total shares outstanding
AVERAGE BALANCE SHEET
Total loans
Allowance for loan losses
Total loans, net
Intangible assets
Total assets
Core deposits
Noncore deposits (1)
Total deposits
Total borrowings
Total shareholders' equity
ASSET QUALITY RATIOS
Nonperforming loans/total loans
Nonperforming assets/total assets
Allowance for loan losses/total loans
Allowance for loan losses/nonperforming loa
Net charge-offs/average loans
CAPITAL ADEQUACY RATIOS
Tier 1 leverage ratio
Tier 1 capital to risk weighted assets
Total capital to risk weighted assets
Average equity/average assets
Tangible equity/tangible assets
FOR THE QUARTER ENDED
2008
FOR THE QUARTER ENDED
2007
12/31
9/30
6/30
3/31
12/31
9/30
6/30
3/31
$
370,280
(4,277)
366,003
46
451,431
195,165
175,932
371,097
36,210
41,552
3,419,736
$
361,521
(3,385)
358,136
65
440,953
208,940
151,754
360,694
36,210
41,427
3,419,736
$
362,122
(3,585)
358,537
85
437,327
200,293
156,683
356,976
36,280
40,975
3,419,736
$
360,056
(3,924)
356,132
104
417,175
203,445
122,602
326,047
48,849
39,633
3,428,695
$
355,079
(4,146)
350,933
124
408,880
199,809
121,018
320,827
45,949
39,321
3,428,695
$
344,149
(5,022)
339,127
143
401,213
218,638
102,733
321,371
38,239
38,697
3,428,695
$
338,896
(4,920)
333,976
163
393,319
211,773
109,473
321,246
38,307
30,485
3,428,695
$
318,421
(4,975)
313,446
182
375,644
201,529
102,883
304,412
38,307
29,932
3,428,695
$
366,077
(3,530)
362,547
55
441,583
201,159
157,054
358,213
37,969
41,516
$
358,844
(3,500)
355,344
75
423,702
208,460
132,917
341,377
37,245
41,097
$
362,574
(3,886)
358,688
94
418,246
201,765
130,960
332,725
42,430
40,399
$
357,778
(4,079)
353,699
113
417,682
202,841
133,175
336,016
39,382
39,491
$
350,050
(4,719)
345,331
133
406,308
208,043
116,151
324,194
39,876
38,973
$
340,391
(4,839)
335,552
152
400,105
217,500
109,793
327,293
38,325
32,184
$
324,721
(4,972)
319,749
172
382,065
205,818
103,651
309,469
39,209
30,412
$
318,072
(4,999)
313,073
194
380,403
200,965
108,654
309,619
38,376
29,254
1.32 %
1.57
1.16
87.52
.01
%
8.01
9.25
10.38
9.40
9.20
1.29 %
1.45
.94
72.81
.18
%
8.31
9.40
10.31
9.70
9.38
1.27 %
1.83
.99
77.22
.30
8.56 %
9.48
10.45
9.66
9.35
.94 %
1.08
1.09
116.06
.06
7.85 %
8.84
9.92
9.45
9.48
%
%
1.13
1.28
1.17
103.42
.25
8.05
8.97
10.13
9.59
9.59
%
%
.92
.90
1.46
158.32
.09
8.03
9.03
10.28
8.04
9.61
%
%
1.49
1.30
1.45
97.45
.02
7.97
8.85
10.10
7.96
7.71
%
%
1.53
1.33
1.56
102.32
.01
7.85
9.16
10.41
7.69
7.92
(1) Noncore deposits include brokered deposits and CDs greater than $100,000
40
Summary Quarterly Financial Information
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
_____________________________________________________________________________________________
SUMMARY QUARTERLY FINANCIAL INFORMATION
(Unaudited)
(Dollars in Thousands, Except per Share Data)
FOR THE QUARTER ENDED 2008
FOR THE QUARTER ENDED 2007
12/31
9/30
6/30
3/31
12/31
9/30
6/30
3/31
INCOME STATEMENT
Net interest income
Provision for loan losses
Net interest income after provision
Total noninterest income
Total noninterest expense
Income before taxes
Provision for income taxes
$
3,330
$
3,371
$
3,118
$
3,045
$
3,410
$
3,560
$
3,269
$
3,178
1,100
2,230
308
2,961
(423)
(171)
450
2,921
288
2,935
274
58
750
2,368
3,747
3,471
2,644
875
-
3,045
310
3,191
164
25
-
3,410
355
2,978
787
260
400
3,160
396
3,001
555
(7,500)
-
3,269
342
3,065
546
-
-
3,178
913
3,056
1,035
-
Net income
$
(252)
$
216
$
1,769
$
139
$
527
$
8,055
$
546
$
1,035
PER SHARE DATA
Earnings per share - basic
Earnings per share - diluted
Book value per share
Market value per share
PROFITABILITY RATIOS
Return on average assets
Return on average equity
Net interest margin
Efficiency ratio
Average loans/average deposits
$
(.07)
$
.06
$
.52
$
.04
$
.15
$
2.35
$
.16
$
.30
(.07)
12.15
4.40
.06
12.11
5.26
.52
11.98
7.00
.04
11.56
8.50
.15
11.47
8.98
2.35
11.29
8.75
.16
8.89
9.45
.30
8.73
9.26
(.23)
%
.20
%
1.70
%
.13
%
.51
%
7.99
%
.57
%
1.10
%
(2.42)
3.20
80.30
102.20
2.08
3.39
79.12
105.12
17.62
3.19
88.45
108.97
1.42
3.13
95.34
106.48
5.36
3.55
78.02
107.98
99.30
3.71
74.71
104.00
7.20
3.60
83.18
104.93
14.35
3.55
82.39
102.73
41
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,
2007 through December 31, 2008, 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.
2008
High
Low
Close
Book value, at quarter end
March 31
$
9.24
7.55
8.50
11.56
June 30
$
8.50
7.00
7.00
11.98
September 30
8.00
$
3.00
5.26
12.11
December 31
5.95
$
3.75
4.40
12.15
For the Quarter Ended
2007
High
Low
Close
Book value, at quarter end
$
11.50
9.25
9.26
8.73
$
10.02
9.00
9.45
8.89
$
9.70
7.75
8.75
11.29
$
9.70
7.65
8.98
11.47
The Corporation had 1,345 shareholders of record as of March 30, 2009.
42
Shareholder Return Performance Graph
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
SHAREHOLDER RETURN PERFORMANCE GRAPH
Set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on the
Corporation’s common stock with that of the cumulative total return on the NASDAQ Bank Stocks Index and the
NASDAQ Market Index for the five-year period ended December 31, 2008. The following information is based on an
investment of $100, on December 31, 2003 in the Corporation’s common stock, the NASDAQ Bank Stocks Index, and the
NASDAQ Market Index, with dividends reinvested. From August 31, 2001 to December 15, 2004, the Corporation’s
common stock traded on the NASDAQ Small Cap Market under the symbol “NCFC.” Effective with the recapitalization
and the 20:1 reverse stock split on December 16, 2004, the Corporation’s stock began trading on the NASDAQ Small Cap
Market under the symbol “MFNC”.
This graph and other information furnished in the section titled “Performance Graph” under this Part II, Item 5 of this Form
10-K shall not be deemed to be “soliciting” materials or to be “filed” with the Securities and Exchange Commission or
subject to Regulation 14A or 14C, or to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended.
43
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:
(cid:2)
(cid:2)
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;
(cid:2) General economic conditions, either nationally or in the state(s) in which the Corporation does business;
(cid:2)
Legislation or regulatory changes which affect the business in which the Corporation is engaged;
(cid:2)
Changes in the interest rate environment which increase or decrease interest rate margins;
(cid:2)
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;
(cid:2)
(cid:2)
(cid:2)
(cid:2)
(cid:2) Acquisitions and unanticipated occurrences which delay or reduce the expected benefits of acquisitions;
(cid:2) Difficulties in hiring and retaining qualified management and banking personnel;
(cid:2)
(cid:2)
(cid:2)
(cid:2)
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.
44
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The following discussion will cover results of operations for 2006 through 2008 and asset quality, financial position,
liquidity, interest rate sensitivity, and capital resources for the years 2007 and 2008. 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.
EXECUTIVE OVERVIEW
The purpose of this section is to provide a brief overview of the 2008 results of operations. Additional detail of the balance
sheet and Statement of Operations follows this summary.
The Corporation reported net income of $1.872 million, or $.55 per share for the year ended December 31, 2008, compared
to net income of $10.163 million, or $2.96 per share for 2007. Weighted average shares outstanding amounted to
3,422,012 in 2008 and 3,428,695 in 2007.
The 2008 results include the positive effect, $3.475 million of a lawsuit settlement and the negative effect from a $.425
million severance agreement. The results for 2007 include the recognition of a $7.500 million deferred tax benefit for NOL
and tax credit carryforwards and $.470 million of proceeds from the settlement of a lawsuit against the Corporation’s
former accountants.
Excluding these items in both years would have resulted in net loss of $.141 million, or less than $.01 per share, in 2008
versus $2.353 million, or $.69 per share, in 2007.
Total assets of the Corporation at December 31, 2008, were $451.431 million, an increase of $42.551 million, or 10.41%
from total assets of $408.880 million reported at December 31, 2007.
At December 31, 2008, the Corporation’s loans stood at $370.280 million, an increase of $15.201 million, or 4.28%, from
2007 year-end balances of $355.079 million. Total loan originations in 2008 amounted to $61.597 million, while we
experienced significant reductions from loan amortization and principal payoffs of $51.224 million. A good portion of
these payoffs pertained to loan relationships that no longer met our pricing or credit standards.
Asset quality remains relatively strong. Nonperforming loans totaled $4.887 million, or 1.32% of total loans at December
31, 2008. Nonperforming assets at December 31, 2008, were $7.076 million, 1.57% of total assets, compared to $5.234
million or 1.28% of total assets at December 31, 2007.
Total deposits grew from $320.827 million at December 31, 2007, to $371.097 million at December 31, 2008, an increase
of 15.67%.
Shareholders’ equity totaled $41.552 million at December 31, 2008, compared to $39.321 million at the end of 2007, an
increase of $2.231 million. This increase reflects consolidated net income of $1.872 million, the capital contribution
impact of stock options and also the increase in equity due to the increase in the market value of available-for-sale
investments, which amounted to $.385 million. The book value per share at December 31, 2008, amounted to $12.15
compared to $11.47 at the end of 2007.
45
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
FINANCIAL POSITION
Loans
In 2008, the Corporation increased loan balances by $15.201 million, or 4.28%, from 2007 year-end loan balances of
$355.079 million. The loan growth in 2008 compares to loan growth in 2007 of $32.498 million, or 10.07% from 2006
year-end loan balances of $322.581 million. The loan growth in 2008 and 2007 was accomplished despite high loan
payoffs of existing portfolio loans of $51.2 million in 2008 and $37.8 million in 2007.
Management continues to actively manage the loan portfolio, seeking to identify and resolve problem assets at an early
stage. Management believes a properly positioned loan portfolio provides the most attractive earning asset yield available
to the Corporation and, with changes to the loan approval process and exception reporting, management can effectively
manage the risk in the loan portfolio. Management intends to continue loan growth within its markets for mortgage,
consumer, and commercial loan products while concentrating on loan quality, industry concentration issues, and
competitive pricing.
Loans represented 82.0% of total assets at the end of 2008 compared to 86.8% at the end of 2007. The loan to deposit ratio,
at 99.8%, is higher than a peer average of approximately 89.4% 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):
2008
2007
2006
2008-2007
2007-2006
Percent Change
Commercial real estate
Commercial, financial, and agricultural
One-to-four family residential real estate
Construction
Consumer
$
185,241
79,734
65,595
35,965
3,745
$
171,695
78,192
57,613
44,042
3,537
$
154,332
71,385
58,014
36,009
2,841
7.89 % 11.25 %
1.97
13.85
(18.34)
5.88
9.54
(.69)
22.31
24.50
Total
$
370,280
$
355,079
$
322,581
4.28 % 10.07 %
The above table more clearly illustrates the growth of the loan portfolio from 2006 through 2008 year end. The
Corporation continues to feel that a properly positioned loan portfolio is the most attractive earning asset available. The
Corporation is highly competitive in structuring loans to meet borrowing needs and meet strong underwriting requirements.
Looking forward, based upon the current economic outlook for the Michigan economy, management believes there will be
limited opportunity for loan growth in the near term. The Corporation will continue to use a demanding pricing model for
all new credit opportunities and existing loan renewals.
Following is a table showing the significant industry types in the commercial loan portfolio as of December 31 (dollars in
thousands):
Real estate - operators of nonres bldgs
Hospitality and tourism
Real estate agents and managers
Other
Balance
$
41,299
35,086
29,292
190,411
2008
% of
Loans
% of
Capital
Balance
2007
% of
Loans
% of
Capital
Balance
2006
% of
Loans
% of
Capital
%
13.95
11.85
9.89
64.31
%
99.39
84.44
70.50
458.25
$
41,597
37,604
29,571
180,067
%
14.40
13.02
10.24
62.34
%
105.79
95.63
75.20
457.94
$
44,308
30,826
25,071
125,512
%
19.63
13.66
11.11
55.60
%
153.90
107.07
87.08
435.96
Total
$
296,088
100.00
%
$
288,839
100.00
%
$
225,717
100.00
%
Management recognizes the additional risk presented by the concentration in certain segments of the portfolio. On a
historical basis, the Corporation’s highest concentration of credit risk was the hospitality and tourism industry.
46
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Management does not consider the current loan concentrations in hospitality and tourism to be problematic, and has no
intention of further reducing loans to this industry segment. Management does not believe that its current portfolio
composition has increased exposure related to any specific industry concentration as of 2008 year-end. The current
concentration of real estate related loans represents a broad customer base composed of a high percentage of owner-
occupied developments.
The Corporation has also extended credit to governmental units, including Native American organizations. Tax-exempt
loans and leases decreased from $6.622 million at the end of 2007 to $5.589 million at 2008 year-end. The Corporation has
elected to reduce its tax-exempt portfolio, since it provides no current 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 provide flexibility
by structuring payments to coincide with 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.
Credit Quality
The table below shows balances of nonperforming assets for the three years ended December 31 (dollars in thousands):
Nonperforming Assets:
Nonaccrual loans
Accruing loans past due 90 days or more
Total nonperforming loans
Other real estate owned
Total nonperforming assets
Nonperforming loans as a % of loans
Nonperforming assets as a % of assets
Reserve for Loan Losses:
At period end
As a % of loans
As a % of nonperforming loans
As a % of nonaccrual loans
2008
2007
2006
$
$
$
$
$
4,887
-
4,887
2,189
7,076
1.32
1.57
$
4,277
1.16
87.52
87.52
%
%
%
%
%
2,899
40
2,939
26
2,965
3,298
710
4,008
1,226
5,234
1.13
1.28
$
$
% .91 %
% .77 %
$
4,146
1.17
103.44
125.71
%
%
%
$
5,006
1.55
170.33
172.68
%
%
%
Management continues to address market issues impacting its loan customer base. In conjunction with the Corporation’s
senior lending staff and the bank regulatory examinations, management reviews the Corporation’s loans, related collateral
evaluations, and the overall lending process. The Corporation also utilizes a loan review consultant to perform a review of
the loan portfolio. The opinion of this consultant upon completion of the 2008 independent review provided findings
similar to management on the overall adequacy of the reserve. The Corporation will utilize this same consultant for loan
review in 2009.
47
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The following table details the impact of nonperforming loans on interest income for the three years ended December 31
(dollars in thousands):
Interest income that would have
been recorded at original rate
Interest income that was
actually recorded
2008
2007
2006
$
377
$
391
$
114
60
129
7
Net interest lost
$
317
$
262
$
107
The following table will provide additional information with respect to our nonperforming assets as of December 31, 2008
(dollars in thousands):
Collateral Type
Nonaccrual Loans
Land development
Non-farm / non-residential
Cabins / land
Conv 5+ residential properties
Land
1-4 family
Business equipment
Total nonaccrual loans
Other Real Estate
Land development / condo
Land development
1-4 family
Non-farm / non-residential
Downtown store frontage / 2 / 1-4 family
Total other real estate owned
Estimated
Liquidation
Value
(b)
Balance
(a)
(Deficiency)/
Surplus
( c) = (b) - (a)
Reserve
Allocation
(d)
Estimated
Net Surplus/
(Exposure)
(e) = ( c) + (d)
$
2,755
1,210
422
296
105
85
14
4,887
$
2,134
1,094
422
72
182
81
-
3,985
$
(621)
(116)
-
(224)
77
(4)
(14)
(902)
$
620
150
-
220
-
4
-
994
$
(1)
34
-
(4)
77
-
(14)
92
1,061
510
378
163
77
2,189
750
511
370
121
77
1,829
(311)
1
(8)
(42)
-
(360)
350
-
20
40
-
410
39
1
12
(2)
-
50
TOTAL NONPERFORMING ASSETS
$
7,076
$
5,814
$
(1,262)
$
1,404
$
142
The schedule above shows the detail of nonperforming assets categorized by type of loan/collateral. In determining
estimated liquidation value, management considered existing appraisals, the date of the appraisals, and current market
conditions, along with related selling costs. Personal guarantees are also in place for various nonperforming assets, which
will also help mitigate losses.
Allowance for Loan Losses
Management analyzes the allowance for loan losses on a quarterly basis to determine whether the losses inherent in the
portfolio are properly reserved for. Net charge-offs in 2008 amounted to $2.169 million, or .60% of average loans
outstanding, compared to $1.260 million, or .38% of loans outstanding in 2007. The 2008 charge-offs reflect the
writedown of four commercial loans, totaling $.994 million, which were reserved for in prior periods. The current reserve
balance is representative of the relevant risk inherent within the Corporation’s loan portfolio. Additions or reductions to the
reserve in future periods will be dependent upon a combination of future loan growth, nonperforming loan balances and
charge-off activity.
48
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
A three year history of the Corporation’s credit quality is demonstrated in the following table (dollars in thousands):
Allowance for Loan Losses
2008
2007
2006
$
4,146
$
5,006
$
6,108
Balance at beginning of period
Loans charged off:
Commercial, financial &
agricultural
One-to-four family residential real estate
Consumer
Total loans charged off
Recoveries of loans previously charged off:
Commercial, financial & agicultural
One-to-four family residential real estate
Consumer
Total recoveries of loans previously charged off
Net loans charged off
Provision for loan losses
2,062
157
71
2,290
114
-
7
121
2,169
2,300
1,148
89
73
1,310
15
-
35
50
1,260
400
199
88
45
332
53
13
25
91
241
(861)
$
$
5,006
322,581
278,953
1.55
.08
3.95
%
Balance at end of period
$
4,277
$
4,146
Total loans, period end
Average loans for the year
Allowance to total loans at end of year
Net charge-offs to average loans
Net charge-offs to beginning allowance balance
370,280
361,324
1.16
.60
52.32
%
$
355,079
333,415
1.17
.38
25.17
%
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.
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.
49
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, 2008 (dollars in
thousands):
Commercial, financial and agricultural loans
One-to-four family residential real estate loans
Consumer loans
Unallocated and general reserves
Total
$
3,819
27
40
391
$
4,277
At the end of 2008, the allowance for loan losses represented 1.16% 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):
Balance at January 1, 2007
Other real estate transferred from loans due to foreclosure
Other real estate transferred to premises and equipment
Other real estate sold / written down
Balance at December 31, 2007
Other real estate transferred from loans due to foreclosure
Other real estate transferred to premises and equipment
Other real estate sold / written down
$
26
1,218
-
(18)
1,226
2,849
-
(1,886)
Balance at December 31, 2008
$
2,189
During 2008, the Corporation received real estate in lieu of loan payments of $2.849 million. 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
The securities portfolio is an important component of the Corporation’s asset composition to provide diversity in its asset
base and provide liquidity. Securities increased $25.893 million in 2008, from $21.597 million at December 31, 2007 to
$47.490 million at December 31, 2008.
The carrying value of the Corporation’s securities is as follows at December 31 (dollars in thousands):
US Agencies - MBS
US Agencies
Obligations of states and political subdivisions
Total securities
2008
2007
$
46,941
-
549
-
$
20,969
628
$
47,490
$
21,597
50
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The Corporation’s policy is to purchase securities of high credit quality, consistent with its asset/liability management
strategies. A net gain of $64,000 on the sale of securities was recognized in 2008. The Corporation recorded $1,000 of net
losses related to securities transactions in 2007 and 2006.
In the second half of 2008, investment securities were increased in order to address overall market liquidity concerns. This
increase provided the Bank with significant short-term liquidity. All of the bank’s current investments are highly
marketable investments guaranteed by the U.S. government. 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. At December 31,
2008, investment securities with an estimated fair market value of $20.182 million were pledged.
Deposits
Total deposits at December 31, 2008 were $370.197 million, an increase of $50.270 million, or 15.67% from December 31,
2007 deposits of $320.827 million. The table below shows the deposit mix for the periods indicated (dollars in thousands):
2008
Mix
2007
Mix
2006
Mix
Non-interest-bearing
NOW, money market, checking
Savings
Certificates of Deposit <$100,000
Total core deposits
Certificates of Deposit >$100,000
Brokered CDs
Total non-core deposits
$
30,099
70,584
20,730
73,752
195,165
25,044
150,888
175,932
8.11
19.02
5.59
19.87
52.59
6.75
40.66
47.41
%
$
25,557
81,160
12,485
80,607
199,809
22,355
98,663
121,018
%
7.97
25.30
3.89
25.12
62.28
6.97
30.75
37.72
$
23,471
73,188
13,365
89,585
199,609
23,645
89,167
112,812
%
7.51
23.43
4.28
28.67
63.89
7.57
28.54
36.11
Total deposits
$
371,097
100.00
%
$
320,827
100.00
%
$
312,421
100.00
%
The increase in deposits, as illustrated above, is composed of an increase in wholesale brokered deposits of $52.225 million
and a decrease in bank deposits of $1.955 million. The additional wholesale brokered deposits were in part utilized to
enhance balance sheet liquidity, as rates on these deposits were priced lower than in-market deposits.
Although the Corporation has been successful in growing core deposits, the high level of funding required by loan growth
has resulted in increased reliance upon brokered deposits. As of December 31, 2008, non-core deposits amounted to
47.41% of total deposits, an increase from 37.72% at 2007 year-end. A portion, approximately $25.000 million, of the
increase in brokered deposits was used to augment liquidity through the purchase of investment securities. The Bank had
$150.888 million in brokered deposits at December 31, 2008, 40.66% of total deposits. Non-core funding has a negative
effect on the Corporation’s net interest margin, as non-core out-of-market deposits carry higher interest costs.
In 2007, the Corporation increased its reliance on non-core funding due in part to the sale of a branch office in the
northwest part of the Upper Peninsula of Michigan with $9.3 million of deposits. The sale of this branch office was in
accordance with the overall strategy of the Corporation to focus on markets with higher growth potential.
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.
Borrowings
The Corporation historically used alternative funding sources to provide long-term, stable sources of funds. Current
borrowings total $35.000 million with stated maturities ranging through 2011. Borrowings at year end include $20.000
million with adjustable rates that reprice quarterly based upon the three month LIBOR. The FHLB has the option to
convert the remaining $15.000 million fixed-rate advances to adjustable rate advances on the original call date and
quarterly thereafter.
51
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
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 reported income of $1.872 million in 2008, compared to net income of $10.163 million in 2007 and a net
income of $1.716 million in 2006. As previously mentioned, the 2008 operating results include the positive effect, $3.475
million of a lawsuit settlement, and the negative effect, $.425 million of a severance agreement. The 2007 results of
operations include the $7.500 million recognition of a deferred tax benefit pertaining to NOL and tax credit carryforwards.
Also included in the 2007 results is $.470 million from the settlement of the lawsuit against the Corporation’s former
accountants. The 2006 operations include a $.600 million negative provision recorded in the first quarter, in recognition of
improved credit quality, a $.261 million negative provision recorded in the fourth quarter to recognize a specific reserve
reduction on a loan payoff, and a $.500 million deferred tax benefit recorded in the third quarter. The deferred tax benefit
was recorded in accordance with generally accepted accounting principles for recognition of a portion of the benefits to be
derived from NOL carry-forwards. The 2006 results also include $.310 million of stock option expense required under
accounting rules for stock compensation plans, which were effective beginning in 2006, as well as $.550 million of
expenses incurred to pursue legal action against the Corporation’s former accountants.
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):
Interest Income
Interest Expense
Net Interest Income
Provision for loan losses
Net interest income after provision
Noninterest Income:
Service fees
Net gains on sale of secondary market loans
Proceeds from settlement of lawsuit
Other
Total noninterest income
Noninterest Expense:
Salaries and employee benefits
Occupancy
Furniture and equipment
Data processing
Professional services:
Accounting
Legal
Consulting and other
Loan and deposit
Telephone
Advertising
Other
Total noninterest expense
Income (loss) before provision for income taxes
Provision (credit) for income taxes
Net Change
2008
Dollars
Income/Expense
2007
Dollars
2006
Dollars
Change
2008-2007
2007-2006
Dollars
Per Share
Dollars
Per Share
$
24,562
11,698
12,864
2,300
10,564
$
28,695
15,278
13,417
400
13,017
$
24,052
12,459
11,593
(861)
12,454
$
(4,133)
(3,580)
(553)
1,900
(2,453)
838
120
3,475
220
4,653
6,886
1,374
771
844
254
41
213
569
170
305
1,131
12,558
2,659
787
1,872
688
498
470
350
2,006
6,757
1,272
678
785
308
42
182
285
228
370
1,193
12,100
2,923
(7,240)
10,163
547
197
-
239
983
6,132
1,264
631
691
273
927
225
392
210
346
1,130
12,221
1,216
(500)
1,716
150
(378)
3,005
(130)
2,647
129
102
93
59
(54)
(1)
31
284
(58)
(65)
(62)
458
(264)
8,027
(8,291)
(1.21)
(1.05)
(.16)
.56
(.72)
.04
(.11)
.88
(.04)
.77
.04
.03
.03
.02
(.02)
-
.01
.08
(.02)
(.02)
(.02)
.13
(.08)
2.34
(2.42)
$
4,643
2,819
1,824
1,261
563
$
1.35
.82
.53
.37
.16
141
301
470
111
1,023
625
8
47
94
35
(885)
(43)
(107)
18
24
63
(121)
1,707
(6,740)
8,447
.04
.09
.14
.03
.30
.18
-
.01
.03
.01
(.26)
(.01)
(.03)
.01
.01
.02
(.03)
.49
(1.97)
2.46
Net Income (loss), current period
$
1,872
$
10,163
$
1,716
$
(8,291)
$
(2.42)
$
8,447
$
2.46
52
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Net Interest Income
Net interest income is the Corporation’s primary source of core earnings. 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.
Net interest income decreased $.553 million to $12.864 million, in 2008. The decrease in net interest income for 2008 was
primarily the result of prime rate reductions that have translated into lower yields on the Corporation’s earning assets,
specifically variable rate commercial loans and short-term investments which reprice immediately. Offering rates on
brokered certificates of deposit are influenced by other factors, such as overall market liquidity. During most of 2008, rates
on brokered deposits were high due to overall liquidity issues prevalent in the financial markets. In recent months, rates on
brokered deposits have decreased significantly. Throughout 2008, as interest rates continued to decline and economic
conditions deteriorated, management evaluated new and existing credit relationships to ensure proper pricing. Floors were
established on the majority of new loans and renewals to mitigate interest rate risk going forward.
In 2007, net interest income increased $1.824 million, from $11.593 million in 2006. The increase in net interest income
for 2007 was primarily the result of the successful expansion of the Corporation’s loan portfolio. The Corporation also
benefited from increasing interest rates during this same period since a large portion of the Bank’s loan portfolio repriced
immediately with each increase in the prime rate while the liability repricing lagged.
The Corporation’s net interest margin, on a fully taxable equivalent basis, was 3.28% in 2008 compared to 3.68% in 2007.
During 2008, the prime rate decreased from 7.25% to 3.25%, which created significant margin pressure since a majority of
the commercial loan portfolio repriced downward with each prime rate change, and the majority of the bank’s funding
sources had significant lag time in repricing. We experienced additional margin pressure due to our brokered deposits,
which did not reprice in line with prime rate reduction, due to the overall market liquidity crisis. Management remains
diligent in its efforts to reduce margin pressure in this decreasing rate environment.
The following table details sources of net interest income for the three years ended December 31, 2008 (dollars in
thousands):
Interest Income
Loans
Funds sold
Taxable securities
Nontaxable securities
Other interest-earning assets
Total earning assets
Interest Expense
NOW, money markets, checking
Savings
CDs <$100,000
CDs >$100,000
Brokered deposits
Borrowings
Total interest-bearing funds
2008
Mix
2007
Mix
2006
Mix
$
22,959
96
1,293
5
209
24,562
1,284
193
3,181
1,037
4,420
1,583
11,698
93.47
.39
5.27
.02
.85
100.00
10.98
1.66
27.19
8.86
37.78
13.53
100.00
%
%
%
%
$
26,873
391
1,100
-
331
28,695
2,668
199
4,490
1,183
4,684
2,054
15,278
93.65
1.36
3.83
-
1.16
100.00
17.46
1.30
29.39
7.74
30.66
13.45
100.00
%
%
%
%
$
21,992
554
1,186
87
233
24,052
2,263
210
3,595
846
3,661
1,884
12,459
91.44
2.30
4.93
.36
.97
100.00
18.16
1.69
28.85
6.79
29.39
15.12
100.00
%
%
%
%
Net interest income
$
12,864
$
13,417
$
11,593
Average Rates
Earning assets
Interest-bearing funds
Interest rate spread
%
6.16
3.32
2.84
%
7.71
4.62
3.09
%
7.28
4.21
3.07
53
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
While a majority of the Corporation’s loan portfolio, approximately 65%, 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 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 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 reduce the risk associated with non-core funding.
Recent prime rate reductions have translated into lower yields on the Corporation’s earning assets, specifically variable rate
commercial loans and short-term investments which reprice immediately. Offering rates on brokered certificates of deposit
are influenced by other factors, such as overall market liquidity. Reliance upon wholesale funding and further rate
reductions in the near term will unfavorably impact the net interest margin of the Corporation.
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.
(dollars in thousands)
ASSETS:
Loans (1,2,3)
Taxable securities
Nontaxable securities (2)
Federal Funds sold
Other interest-earning assets
Total earning assets
Reserve for loan losses
Cash and due from banks
Fixed assets
Other assets
Years ended December 31,
2008
Interest
$
23,166
1,293
8
96
209
24,772
Average
Balance
$
361,324
28,766
69
4,101
4,318
398,578
(3,747)
6,901
11,453
12,158
26,765
Average
Rate
Average
Balance
%
6.41
4.49
11.59
2.34
4.84
6.22
$
333,415
25,061
5
7,515
6,358
372,354
(4,881)
6,266
12,276
6,298
19,959
2007
Interest
$
27,146
1,100
-
391
332
28,969
Average
Rate
Average
Balance
%
8.14
4.39
-
5.20
5.22
7.78
$
278,953
32,795
1,658
11,123
5,885
330,414
(5,495)
5,775
12,375
4,858
17,513
2006
Interest
$
22,380
1,186
132
554
233
24,485
Average
Rate
%
8.02
3.62
7.96
4.98
3.96
7.41
TOTAL ASSETS
$
425,343
$
392,313
$
347,927
LIABILITIES AND SHAREHOLDERS' EQUITY:
NOW and Money Markets
Interest checking
Savings deposits
CDs <$100,000
CDs >$100,000
Brokered deposits
Borrowings
Total interest-bearing liabilities
Demand deposits
Other liabilities
Shareholders' equity
$
1,245
39
193
3,181
1,037
4,420
1,583
11,698
$
77,997
1,501
15,963
78,755
27,079
111,482
39,248
352,025
29,348
3,340
40,630
73,318
$
2,669
-
199
4,490
1,183
4,683
2,054
15,278
1.60
2.60
1.21
4.04
3.83
3.90
4.03
3.32
%
%
$
77,942
-
13,013
91,313
23,879
85,703
38,949
330,799
25,860
2,923
32,731
61,514
%
3.42
-
1.53
4.92
4.96
5.46
5.27
4.62
$
70,417
-
14,412
82,445
18,128
72,768
37,422
295,592
21,414
3,177
27,744
52,335
$
2,263
-
210
3,595
846
3,661
1,884
12,459
%
3.21
-
1.46
4.36
4.67
5.03
5.03
4.21
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY
$
425,343
$
392,313
$
347,927
Rate spread
Net interest margin/revenue, tax equivalent basis
$
13,074
3.28
%
$
13,691
3.16
3.68
%
%
$
12,026
3.20
3.64
%
%
(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.
54
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.
2008 vs. 2007
2007 vs. 2006
Years ended December 31,
Increase (Decrease)
Due to
Increase (Decrease)
Due to
Volume
Rate
Volume
and Rate
Total
Increase
(Decrease)
Volume
Rate
Volume
and Rate
Total
Increase
(Decrease)
Interest earning assets:
Loans
Taxable securities
Nontaxable securities
Federal funds sold
Other interest earning assets
$
2,271
163
-
(178)
(107)
$
(5,768)
26
1
(215)
(24)
$
(483)
4
7
98
8
$
(3,980)
193
8
(295)
(123)
$
4,369
(279)
(132)
(180)
19
$
332
253
(132)
25
74
$
65
(60)
132
(8)
6
$
4,766
(86)
(132)
(163)
99
Total interest earning assets
$
2,149
$
(5,980)
$
(366)
$
(4,197)
$
3,797
$
552
$
135
$
4,484
Interest bearing obligations
NOW and money market deposits
Interest checking
Savings deposits
CDs <$100,000
CDs >$100,000
Brokered deposits
Borrowings
$
2
-
45
(617)
159
1,409
16
$
(1,425)
-
(42)
(802)
(269)
(1,285)
(483)
$
(1)
39
(9)
110
(36)
(387)
(4)
$
(1,424)
39
(6)
(1,309)
(146)
(263)
(471)
$
242
-
(20)
387
268
650
77
$
148
-
10
459
52
316
89
$
16
-
(1)
49
17
56
4
$
406
-
(11)
895
337
1,022
170
Total interest bearing obligations
$
1,014
$
(4,306)
$
(288)
$
(3,580)
$
1,604
$
1,074
$
141
$
2,819
Net interest income
$
(617)
$
1,665
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. During
2008, the Corporation recorded a provision for loan loss of $2.300 million. In the third quarter of 2007, the Corporation
recorded a $.400 million provision in order to provide for the potential loss related to a commercial loan. In 2006, a
negative loan loss provision of $.860 million was recorded. This negative provision was recorded due in part to recognize
the overall reduction in loan portfolio risk and also as a direct result of a specific reserve reduction from a payoff of a
problem loan.
Noninterest Income
Noninterest income was $4.653 million, $2.006 million, and $.983 million in 2008, 2007, and 2006, respectively. The
principal recurring sources of noninterest income are fees for services related to deposit and loan accounts. In 2008, the
Corporation recorded the benefit of proceeds received, $3.475 million, from the settlement of a lawsuit. In 2007, the
Corporation recognized $.470 million of income from the settlement of a lawsuit against its former accountants. Service
fees were $.838 million in 2008, while other noninterest income was $.156 million.
Revenue due to loans produced and sold in the secondary market amounted to $.120 million compared to $.498 million a
year ago. Poor overall market conditions, caused by a declining economy and a housing slump, limited any ability to
expand our revenues from secondary mortgage loan activity during 2008. We do anticipate increased fee income in future
periods as the housing market improves and home buyers look to more traditional lenders for their borrowing needs. We
did realize increased income from service fees related to our deposit products. Management initiated several changes in
fees associated with various deposit products, to better align services and costs.
55
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):
Service fees
Net gains on loan s ales
Proceeds from settlement of laws uit
Other
Subtotal
Net security gains
% Increase (Decrease)
2008
2007
2006
2008-2007
2007-2006
$
838
$
688
$
547
21.80
%
25.78
%
120
3,475
156
4,589
64
498
470
351
2,007
(1)
197
-
240
984
(1)
(75.90)
639.36
(55.56)
128.65
N/A
152.79
N/A
46.25
103.96
-
Total noninteres t income
$
4,653
$
2,006
$
983
131.95
%
104.07
%
Noninterest Expense
Noninterest expense was $12.558 million in 2008, compared to $12.100 million and $12.221 million in 2007 and 2006,
respectively. Salaries and employee benefits increased in 2008 by $.129 million to $6.886 million, compared to 2007
expense of $6.757 million. During 2008, the Corporation recorded a $.425 million expense related to a severance payment.
Excluding this item, the Corporation had a reduction in salaries and employee benefits of $.296 million from 2007.
Data processing expense increased from $.785 million in 2007 to $.844 million in 2008, largely as a result of increased
services and volume. Professional fees decreased from $.532 million in 2007 to $.508 million in 2008. This decrease is a
result of the settlement of a longstanding derivative shareholder lawsuit which resulted in $3.475 million in settlement fees
recorded to income, as well as the dismissal of unpaid legal fees totaling $95,000 related to the defense of prior directors of
the Corporation. This dismissal resulted in the reversal of the accrual for these fees.
Telephone expenses of $.170 million are lower than the 2007 level of $.228 million, as a result of the installation of a new
phone system which reduced long distance service costs. Advertising costs also decreased in 2008, as the Corporation
initiated cost controls in this area.
The Corporation saw an increase in loan and deposit expense of $.284 million to $.569 million in 2008 from $.285 million
in 2007. This increase is a result of legal and carrying costs incurred in connection with increased levels of nonperforming
assets. Looking forward, management expects to experience increased loan and deposit costs due to increased FDIC
insurance premiums, as assessment rates are increased, in order to replenish the deposit insurance fund.
Management continuously reviews all areas of noninterest expense in order to evaluate where opportunities may exist
which could reduce expenses without compromising service to customers.
56
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):
Salaries and employee benefits
Occupancy
Furniture and equipment
Data processing
Professional service fees:
Accounting
Legal
Consulting and other
Total professional service fees
Loan and deposit
Telephone
ORE writedowns/impairment
(Gain) loss on sale of premises, equipment
branch and other real estate
Advertising
Amortization of intangibles
Other operating expenses
2008
2007
2006
$
6,886
1,374
771
844
$
6,757
1,272
678
785
$
6,132
1,264
631
691
% Increase (Decrease)
%
2008-2007
1.91
8.02
13.72
7.52
%
2007-2006
10.19
.63
7.45
13.60
254
41
213
508
569
170
-
77
305
78
976
308
42
182
532
285
228
40
(17)
370
82
1,088
273
927
225
1,425
392
210
-
(60)
281
125
1,130
(17.53)
(2.38)
17.03
(4.51)
99.65
(25.44)
12.82
(95.47)
(19.11)
(62.67)
(27.30)
8.57
N/A
N/A
(552.94)
(17.57)
(4.88)
(10.29)
(71.67)
31.67
(34.40)
(3.72)
Total noninterest expense
$
12,558
$
12,100
$
12,221
3.79
%
(.99)
%
Federal Income Taxes
Current Federal Tax Provision
The Corporation recorded a current period federal tax provision of $.787 million in 2008, compared to a $7.240 million
negative provision in the same period a year earlier, in recognition of a federal deferred tax benefit, which is discussed
further below.
Deferred Tax Benefit
The Corporation recognized a federal deferred tax benefit of $7.500 million in the third quarter of 2007. The recognition of
this deferred tax benefit relates to the generally accepted accounting principles applicable to the probability of utilizing the
NOL and tax credit carryforwards of the Corporation. The Corporation, based upon current profitability trends largely
supported by expansion of the net interest margin and controlled expenses, determined that the utilization of the NOL
carryforward was probable. This tax benefit was recorded by reducing the valuation allowance that was recorded against
the deferred tax assets of the Corporation. In 2006, The Corporation recognized a portion of this benefit, $.500 million,
based upon the then current probabilities. The $7.500 million recognition is based upon assumptions of a sustained level of
taxable income within the NOL carryforward period and takes into account Section 382, establishing annual limitations. 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. As of December 31, 2008, the Corporation had an NOL carryforward of approximately
$32.128 million along with various credit carryforwards of $2.136 million. This NOL and credit carryforward benefit is
dependent upon the future profitability of the Corporation. A portion of the NOL, approximately $22.000 million, and all
of the tax credit carryforwards are also subject to the limitations of Section 382 of the Internal Revenue Code since they
originated prior to the December 2004 recapitalization of the Corporation. The Corporation intends to further evaluate the
utilization of the NOL and credit carryforwards in subsequent periods to determine if any further adjustment to the
valuation allowance is necessary. The determination criteria for recognition of deferred tax benefits will include the
assumption of future period taxable income based upon the projected profitability of the Corporation.
57
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
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
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 $47.490 million of securities, with a weighted average maturity of 16 months. The investment portfolio is
intended to provide a source of liquidity to the Corporation with limited interest rate risk. The Corporation may also elect to
sell monies as investments in federal funds sold to correspondent banks, and has 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.
58
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The following is the Corporation’s repricing opportunities at December 31, 2008 (dollars in thousands):
Interest-earning assets:
Loans
Securities
Other (1)
1-90
Days
91-365
Days
>1-5
Years
Over 5
Years
Total
$
257,789
-
582
$
11,061
30,358
$
26,943
16,615
-
-
$
74,487
517
3,794
$
370,280
47,490
4,376
Total interest-earning assets
258,371
41,419
43,558
78,798
422,146
Interest-bearing obligations:
NOW, money market, savings and interest checking
Time deposits
Brokered CDs
Borrowings
91,314
35,759
102,745
20,000
-
49,537
48,143
-
-
12,729
-
15,000
-
771
-
1,210
91,314
98,796
150,888
36,210
Total interest-bearing obligations
249,818
97,680
27,729
1,981
377,208
Gap
Cumulative gap
$
8,553
$
(56,261)
$
15,829
$
76,817
$
44,938
$
8,553
$
(47,708)
$
(31,879)
$
44,938
(1) includes Federal Home Loan Bank stock
The above analysis indicates that at December 31, 2008, the Corporation had a cumulative liability sensitivity GAP position
of $47.708 million within the one-year timeframe. The Corporation’s cumulative liability sensitive GAP suggests that if
market interest rates were to increase in the next twelve months, the Corporation has the potential to earn less net interest
income. Conversely, if market interest rates decrease in the next twelve months, the above GAP position suggests the
Corporation’s net interest income would increase. 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
At December 31, 2007, the Corporation had a cumulative liability sensitivity gap position of $43.774 million within the
one-year time frame.
The borrowings in the gap analysis include $15 million of 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 repricing dates currently
assumed in the analysis.
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
59
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
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. 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.
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, 2008 (dollars in thousands). Nonaccrual loans of $4.887
million are included in the table at an average interest rate of 0.00% and a maturity greater than five years.
Principal/Notional Amount Maturing/Repricing In:
2009
2010
2011
2012
2013
Thereafter
Total
Fair Value
12/31/2008
Rate Sensitive Assets
Fixed interest rate
securities
Average interest rate
$ 30,357
$ 5,112
3.08 % 3.94 % 5.09 %
$ 3,779
$
7,717
5.24
%
Fixed interest rate loans
Average interest rate
39,647
6.88
22,912
7.70
22,315
7.65
16,641
7.53
Variable interest rate loans
Average interest rate
245,193
4.68
-
-
-
-
-
-
Other assets
Average interest rate
582
1.25
-
-
-
-
-
-
7
7.00
6,501
6.88
-
-
-
-
$ 518
$ 47,490
$ 47,490
% 8.02 % 3.74 %
13,067
6.52
121,083
7.23
119,095
4,004
-
249,197
4.61
257,262
3,794
4.75
4,376
4.29
4,376
Total rate sensitive assets
Average interest rate
$ 315,779
4.80 %
$ 28,024
$ 26,094
$ 24,358
$ 6,508
$ 21,383
$ 422,146
$ 428,223
7.01 %
7.28 % 6.80 %
6.88 % 5.02 % 5.00 %
Rate Sensitive Liabilities
Interest-bearing savings,
NOW, MMAs, interest checking
Average interest rate
91,314
-
1.07 % -
-
- % - %
-
-
91,314
91,314
% - % 1.07 %
-
-
Time deposits
Average interest rate
Fixed interest rate
borrowings
Average interest rate
Variable interest rate
borrowings
Average interest rate
Total rate sensitive
liabilities
Average interest rate
Foreign Exchange Risk
236,184
2.91
8,239
3.82
2,976
4.05
1,223
3.99
291
10.72
771
5.97
249,684
2.98
250,021
-
-
15,000
5.10
-
-
-
-
20,000
3.71
-
-
-
-
-
-
-
-
-
-
1,210
1.00
16,210
4.79
16,808
-
-
20,000
3.71
20,038
$ 347,498
2.47 % 4.65 % 4.05 % 3.99 %
$ 23,239
$ 1,223
$ 2,976
$ 291
$ 1,981
$ 377,208
$ 378,181
10.72 % 2.94 % 2.62 %
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, 2008, the Corporation had excess Canadian liabilities of $22,000 (or $26,000 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.
60
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 18 to the consolidated financial statements for additional information.
LIQUIDITY
Liquidity is defined as the ability to generate cash at a reasonable cost to fulfill lending commitments and support asset
growth, while satisfying the withdrawal demands of customers and make payments on existing borrowing commitments.
The Bank’s principal sources of liquidity are core deposits and loan and investment payments and prepayments. Providing
a secondary source of liquidity is the available for sale investment portfolio. As a final source of liquidity, the Bank can
exercise existing credit arrangements.
During 2008, the Corporation increased cash and cash equivalents by $3.750 million. As shown on the Corporation’s
condensed consolidated statement of cash flows, liquidity was primarily impacted by cash provided by investing activities,
a net increase in loans of $21.173 million and a “net” increase in securities available for sale of $25.440 million. The net
increases in assets were offset by a similar increase in deposit liabilities of $50.270 million. This increase in deposits was
composed of an increase in non-core deposits of $54.914 million combined with a decrease in bank deposits of $4.644
million. The management of bank liquidity for funding of loans and deposit maturities and withdrawals includes
monitoring projected loan fundings and scheduled prepayments and deposit maturities within a 30 day period, a 30 to 90
day period and from 90 days until the end of the year. This funding forecast model is completed weekly.
During 2008, management increased the Bank’s investment portfolio by approximately $25.000 million. The Bank’s
investment portfolio, most of which are guaranteed by the U.S. government, provide added liquidity during periods of
market turmoil and overall liquidity concerns in the financial markets. As of December 31, 2008, $27.308 million of the
Bank’s investment portfolio was unpledged, which makes them readily available for sale to address any short term liquidity
needs.
It is anticipated that during 2009, the Corporation will fund anticipated loan production with a combination of core-deposit
growth and noncore funding, primarily brokered CDs.
The Corporation’s primary source of liquidity on a stand-alone basis is dividends from the Bank. The Bank is currently
prohibited from paying dividends because of a deficit in retained earnings. The Bank, in order to pay dividends in future
periods, will need to restate its capital accounts, which requires the approval of the Office of Financial and Insurance
Services of the State of Michigan. The Corporation is currently exploring alternative opportunities for longer term sources
of liquidity and permanent equity to support projected asset growth.
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. The liquidity position
of the Bank is managed daily, thus enabling the Bank to adapt its position according to market fluctuations. Core deposits
are important in maintaining a strong liquidity position as they represent a stable and relatively low cost source of funds.
The Bank’s liquidity is best illustrated by the mix in the Bank’s core and non-core funding dependence ratio, which
explains the degree of reliance on non-core liabilities to fund long-term assets. Core deposits are herein defined as demand
deposits, NOW (negotiable order withdrawals), money markets, savings and certificates of deposit under $100,000. Non-
core funding consists of certificates of deposit greater than $100,000, brokered deposits, and FHLB and other borrowings.
At December 31, 2008, the Bank’s core deposits in relation to total funding was 47.92% compared to 55.95% in 2007.
These ratios indicated at December 31, 2008, that the Bank has decreased its reliance on non-core deposits and borrowings
to fund the Bank’s long-term assets, namely loans and investments. The Bank believes that by maintaining adequate
volumes of short-term investments and implementing competitive pricing strategies on deposits, it can ensure adequate
61
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
liquidity to support future growth. The Bank also has correspondent lines of credit available to meet unanticipated short-
term liquidity needs. As of December 31, 2008, the Bank had $13.375 million of unsecured lines available and another
$10.185 million available if secured. Management believes that its liquidity position remains strong to meet both present
and future financial obligations and commitments, events or uncertainties that have resulted or are reasonably likely to
result in material changes with respect to the Bank’s liquidity.
From a long-term perspective, the Corporation’s liquidity plan for 2009 includes strategies to increase core deposits in the
Corporation’s local markets and will continue to augment local deposit growth efforts with wholesale CD funding, to the
extent necessary.
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, 2008, the aggregate contractual obligations and
commitments are:
Contractual Obligations
Total deposits
Short-term borrowings
Long-term borrowings
Directors' deferred compensation
Annual rental / purchase commitments
under noncancelable leases / contracts
TOTAL
Other Commitments
Less than 1
Year
$
357,597
-
-
170
Payments Due by Period
4 to 5
Years
1 to 3
Years
After 5
Years
$
11,215
-
35,000
254
$
1,514
-
-
246
$
771
-
1,210
549
Total
$
371,097
-
36,210
1,219
199
297
10
-
506
$
357,966
$
46,766
$
1,770
$
2,530
$
409,032
Letters of credit
Commitments to extend credit
Credit card commitments
$
1,838
44,523
2,438
$
-
-
-
$
-
-
-
$
-
-
-
$
1,838
44,523
2,438
TOTAL
$
48,799
$
-
$
-
$
-
$
48,799
CAPITAL AND REGULATORY
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, 2008, the Corporation and the Bank were well
capitalized. The Corporation is currently exploring its alternatives for the possible issuance of equity or debt in order to
provide a broader base to support future asset growth. During 2008, total capitalization increased by $2.231 million
primarily from an increase in retained earnings from net income earned in the period. During 2008, risk based capital
increased by $2.845 million, while Tier 1 Capital increased by $2.714 million.
On October 3, 2008, congress passed the Emergency Economic Stabilization Act of 2008 (“EESA”), which provides the
U.S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to
U.S. markets. One of the provisions resulting from the EESA is the Treasury Capital Purchase Program (“CPP”), which
provides direct equity investment of perpetual preferred stock by the Treasury in qualified financial institutions. The
program is voluntary and requires an institution to comply with a number of restrictions and provisions including limits on
executive compensation, stock redemptions and declaration of dividends. Applications must be submitted by November
14, 2008, and are subject to approval by the Treasury. The CPP provides for a minimum of 1% of risk weighted assets,
with a maximum investment equal to the lesser of 3% of total risk weighted assets or $25 billion. The perpetual preferred
62
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
stock investment will have a dividend rate of 5% per year, until the fifth anniversary of the Treasury investments, and a
dividend of 9% thereafter. The CPP also requires the Treasury to receive warrants for common stock equal to 15% of the
capital invested by the Treasury.
The Corporation has applied for $11.000 million in capital under this program, and has received preliminary approval by
the U.S. Department of Treasury.
The following table details sources of capital for the three years ended December 31 (dollars in thousands):
Capital Structure
Shareholders' equity
Total capitalization
Tangible capital
Intangible Assets
Subsidiaries:
Core deposit premium
Other identifiable intangibles
Total intangibles
Risk-Based Capital
Tier 1 capital:
Shareholders' equity
Net unrealized (gains) losses on
available for sale securities
Less: disallowed deferred tax asset
Less: intangibles
Total Tier 1 capital
Tier 2 Capital:
Allowable reserve for loan losses
Qualifying long-term debt
Total Tier 2 capital
Total risk-based capital
Risk-weighted assets
Capital Ratios:
Tier 1 Capital to average assets
Tier 1 Capital to risk-weighted assets
Total Capital to risk-weighted assets
2008
2007
2006
$
$
$
41,552
41,552
41,507
$
$
$
39,321
39,321
39,197
$
$
$
28,790
28,790
28,585
$
$
$
46
-
46
124
-
124
205
-
205
$
$
$
$
41,552
$
39,321
$
28,790
(445)
(6,200)
(46)
34,861
$
(60)
(6,990)
(124)
32,147
$
187
-
(205)
28,772
$
$
$
$
4,277
-
4,277
39,138
376,986
$
$
4,146
-
4,146
36,293
358,410
$
$
4,113
-
4,113
32,885
328,133
$
$
8.01%
9.25%
10.38%
8.05%
8.97%
10.13%
7.85%
8.77%
10.02%
Regulatory capital is not the same as shareholders’ equity reported in the accompanying condensed consolidated 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.
63
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Presented below is a summary of the Corporation’s and Bank’s capital position in comparison to generally applicable
regulatory requirements:
Regulatory minimum for capital adequacy purposes
Regulatory defined well capitalized guideline
The Corporation:
December 31, 2008
December 31, 2007
The Bank:
December 31, 2008
December 31, 2007
Equity to
Year-end
Assets
N/A
N/A
Tangible
Equity to
Year-end
Assets
N/A
N/A
9.21%
9.62%
9.20%
9.59%
9.25%
10.04%
9.24%
10.01%
Tier 1
Capital to
Average
Assets
Tier 1
Capital to
Risk Weighted
Assets
Total
Capital to
Risk Weighted
Assets
4.00%
5.00%
8.01%
8.05%
8.09%
8.51%
4.00%
6.00%
9.25%
8.97%
9.32%
9.49%
8.00%
10.00%
10.38%
10.13%
10.44%
10.63%
The Corporation intends to maintain the Bank’s total capital to risk-weighted assets at a minimum of 10.00% in order to
qualify for reduced FDIC deposit based insurance.
TROUBLED ASSET RELIEF PROGRAM
The Corporation will be participating in the Capital Purchase Program (“CPP”) under the Troubled Asset Relief Program
(“TARP”). The Corporation will issue $11.000 million in perpetual preferred stock and 379,092 common stock warrants,
effective with the anticipated close date in May, 2009. Mackinac Financial Corporation believes that participation in the
CPP will provide a stronger base of capital for future growth. Shown below are “Proforma” capital ratios for the
Corporation which shows the effect of the issuance of the $11.000 million preferred stock.
Total capital to risk weighted assets
Tier 1 leverage
Tier 1 capital to risk weighted assets
Historical
December 31, 2008
Proforma
December 31, 2008
10.38%
8.01%
9.25%
13.11%
10.28%
11.99%
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.
64
Directors and Officers
DIRECTORS
Mackinac Financial Corporation and mBank
Walter J. Aspatore
Investment Banker
Amherst Partners
Director Since: 2004
Dennis B. Bittner
Owner and President
Bittner Engineering, Inc.
Director Since: 2001
Joseph D. Garea
Managing Partner
Hancock Securities
Director Since: 2007
Robert H. Orley
Vice President and Secretary
Real Estate Interests Group, Inc.
Director Since: 2004
L. Brooks Patterson
County Executive
Oakland County
Director Since: 2006
Randolph C. Paschke
Chairman, Department of Accounting
Wayne State University, School of Business Administration
Director Since: 2004
Kelly W. George
President, Mackinac Financial Corporation
President and CEO, mBank
Director Since: 2006
Paul D. Tobias
Chairman and CEO, Mackinac Financial Corporation
Chairman, mBank
Director Since: 2004
Robert E. Mahaney
Sole Proprietor
Veridea Group, LLC
Director Since: 2008
OFFICERS
Mackinac Financial Corporation
mBank
Paul D. Tobias
Chairman and Chief Executive Officer
Paul D. Tobias
Chairman
Kelly W. George
President
Kelly W. George
President and Chief Executive Officer
Ernie R. Krueger
Executive Vice President/Chief Financial Officer
Jack C. Frost
Regional President, Upper Peninsula
Andrew P. Sabatine
Regional President, Northern Lower Peninsula
Ernie R. Krueger
Executive Vice President and Chief Financial Officer
Kevin D. Evans
Senior Vice President/Branch Management/Retail Banking/Deposits
Jake D. Martin
Senior Vice President - Information Technology
Tamara R. McDowell
Senior Vice President/Senior Credit/Operations Officer
Ann M. Stepp
Senior Vice President/Branch Administration Officer
65
Branch Locations
UPPER PENINSULA
Regional President - Jack C. Frost
ESCANABA (opened March 2009)
3300 Ludington Street
Escanaba, MI 49829
(906) 233-9443
Manager: Scott A. Ravet
MARQUETTE PRESQUE ISLE
SAULT STE. MARIE
1400 Presque Isle
Marquette, MI 49855
138 Ridge Street
Sault Ste. Marie, MI 49783
(906) 228-3640
Bus. Dev. Officer: Shelby J. Bischoff
(906) 635-3992
Manager: David R. Thomas
MANISTIQUE
130 South Cedar Street
Manistique, MI 49854
(906) 341-8401
Manager: Gregory D. Schuetter
NEWBERRY
414 Newberry Avenue
Newberry, MI 49868
(906) 293-5165
Manager: Michael A. Slaght
MARQUETTE MAIN
300 North McClellan
Marquette, MI 49855
(906) 226-5000
Manager: Teresa M. Same
ONTONAGON
601 River Street
Ontonagon, MI 49953
(906) 884-4115
Manager: Sue A. Preiss
SOUTH RANGE
47 Trimountain Avenue
South Range, MI 49963
(906) 482-1170
Manager: Sandra L. Pesola
STEPHENSON
S216 Menominee Street
Stephenson, MI 49887
(906) 753-2225
Manager: Barbara A. Parrett
NORTHERN LOWER PENINSULA
Regional President - Andrew P. Sabatine
GAYLORD
1955 South Otsego Avenue
Gaylord, MI 49735
(989) 732-3750
Manager: Rosalba Boone
KALEVA
14429 Wuoksi Avenue
Kaleva, MI 49645
(231) 362-3223
Manager: Barb J. Miller
TRAVERSE CITY
3530 North Country Drive
Traverse City, MI 49684
(231) 929-5600
Manager: Andrea M. Pease
SOUTHEAST MICHIGAN
First Vice President – Jesse A. Deering
BIRMINGHAM
260 East Brown Street, Suite 300
Birmingham, MI 48009
(248) 290-5900
Manager: Elena C. Dritsas
66
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Corporate Information
CORPORATE HEADQUARTERS
Mackinac Financial Corporation
130 South Cedar Street
Manistique, Michigan 49854
(888) 343-8147
TRANSFER AGENT
Registrar and Transfer Company
10 Commerce Drive
Cranford, NJ 07016
(800) 368-5948
INVESTOR RELATIONS
(888) 343-8147
WEBSITE
www.bankmbank.com
INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Plante and Moran, PLLC
Auburn Hills, Michigan
STOCK LISTING AND SYMBOL
NASDAQ Small Cap Market
Symbol: MFNC
SHAREHOLDER INFORMATION
Copies of the Corporation’s 10-K and 10-Q reports as filed with the Securities and Exchange Commission are available
upon request from the Corporation.
ANNUAL SHAREHOLDERS’ MEETING
The 2009 Annual Meeting of the Shareholders of Mackinac Financial Corporation will be held on Wednesday May 27,
2009.
Visit our website, www.bankmbank.com, for updated news releases, financial reports, SEC filings, corporate governance
and other investor information.
130 South Cedar Street
Manistique, MI 49854