Table of Contents
To Our Shareholders ..............................................................................................................................1
Five-Year Overview...............................................................................................................................6
Regional Review ....................................................................................................................................8
Selected Financial Highlights ..............................................................................................................14
Quarterly Financial Summary ..............................................................................................................15
Report of Independent Registered Public Accounting Firm ................................................................16
Consolidated Balance Sheets ...............................................................................................................17
Consolidated Statements of Operations ...............................................................................................18
Consolidated Statements of Changes in Shareholders’ Equity ............................................................19
Consolidated Statements of Cash Flows ..............................................................................................20
Notes to Consolidated Financial Statements........................................................................................21
Selected Financial Data........................................................................................................................50
Summary Quarterly Financial Information ..........................................................................................51
Market Information ..............................................................................................................................53
Shareholder Return Performance Graph ..............................................................................................54
Forward-Looking Statements...............................................................................................................55
Management’s Discussion and Analysis of Financial
Condition and Results of Operations ................................................................................................56
Directors and Officers ..........................................................................................................................78
______________________________________________________________________________________
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 $495 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 11 branch locations; seven in the Upper Peninsula, three in the Northern Lower Peninsula and one in
Oakland County, Michigan. The Company’s banking services include commercial lending and treasury
management products and services geared toward small to mid-sized businesses, retail and commercial, title
insurance, 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 Capital Market under the symbol MFNC. The
Corporation had approximately 1,200 shareholders of record as of March 30, 2012.
To Our Shareholders
March 30, 2012
Dear Shareholders:
This letter will provide you with an overview of the 2011 performance of Mackinac Financial Corporation (―MFNC‖), as to
the progress we have made in reducing nonperforming assets and in the reduction of balance sheet risk, along with other
relative accomplishments we’ve had in various business segments of the Corporation to build franchise value. We view
2011 as a positive step forward as we are seeing signs of economic resurgence in all our geographic markets with new
economic activity and borrower financial conditions improving. We believe this will provide opportunities to expand our
franchise through both organic growth and accretive acquisition opportunities for continued earnings momentum that will
lead to increased shareholder value.
The various charts and graphs following this letter track the performance of the company through the last five years in
terms of key shareholder metrics and operating performance levels. In this period of highly challenging economic times
for banks across the country and especially in the State of Michigan, the Corporation has increased its common stock book
value from $7.75 per share at December 31, 2005 to $12.97 at 2011 year end, an increase of $5.22 per share, or 67.35 %.
During this five year period, we have also significantly increased total assets, loans, and core deposits which provides the
foundation that will lead to future increases in common shareholders’ equity. At the end of 2011, the Corporation and the
Bank had strong equity positions. The Corporation had a Tier 1 ratio of 10.08% and total risk based capital of 12.87%.
The Bank’s Tier 1 capital ratio stood at 9.24% with a total risk based capital ratio of 11.90%. Common equity of MFNC
totaled $44.342 million with book value per share at $12.97.
Listed below are some key performance highlights of 2011.
Improved Credit Quality
We had an overall reduction in nonperforming assets from $16.125 million at the end of 2010 to $11.155 million
at the end of 2011 as we continued with our timely and aggressive problem asset remediation plans to strengthen
our balance sheet. Our Texas Ratio at 2011 year-end was reduced to 18.43% and is one of the lowest amongst the
15 largest public banks headquartered in Michigan.
Core Deposit Growth
We grew core bank deposits by $58.111 million while decreasing wholesale deposits by $40.631 million, therefore
reducing overall balance sheet risk. We experienced core deposit growth in all of our markets, with $27 million in
Northern Lower Michigan, $8 million in Southeast Michigan and $23 million in the Upper Peninsula. A good
portion of our 2011 deposit growth occurred in low cost transactional accounts which grew by $24.402 million and
positively impacted our margin.
Margin Improvement
The margin improvement was largely attributed to the growth in core deposits of $58 million which allowed for
the repayment of higher priced wholesale deposits. The cost of funds declined in 2011 to 1.33% from 1.60% in
2010. Rates on earning assets increased from 5.10% in 2010 to 5.22% in 2011, due in large part to our disciplined
loan pricing, which we expect to continue for 2012 to increase the overall margin.
1
To Our Shareholders
Strong Loan Production
We continued to experience loan demand with approximately $173 million of new loan production split between
commercial related credits accounting for $104 million, and consumer/mortgage loans totaling $69 million. Our
total outstanding loans increased by $18.160 million after reductions for loan sales, (SBA/USDA and secondary
market) amortization and payoffs. Most importantly, we continue to be successful in producing well priced high
quality loans in the Upper Peninsula with 2011 loan production of $95 million. In 2011, we began to see
resurgence in loan opportunities in Northern Lower Michigan with production of $48 million and also Southeast
Michigan with production of $30 million.
Growth in Noninterest Income
In 2011 we continued to be a state leader in the origination of sound SBA and USDA guaranteed loans with total
fee income of $1.500 million in 2011 compared to $.868 million in fee income during 2010. Sold guaranteed loans
totaled $19 million in 2011 compared to $12.6 million in 2010.
We generated higher levels secondary market fee income of $700,000 in 2011 compared to $539,000 in 2010. At
2011 year-end, our mortgage loan servicing portfolio totaled $50 million which provides future refinancing/cross
selling opportunities and also provides a stable source of core deposits since many of these clients maintain
various transactional accounts.
Late in 2011, we established mBank Title Insurance Agency, LLC, in conjunction with the Michigan Bankers’
Association. This agency offers title services for both commercial and retail based mortgage transactions in all of
our markets. This initiative provides another enhancement to noninterest income and is moving ahead well.
2011 Earnings Recap
In 2011, we reported net income of $1.452 million, or $.42 per share. This was an increase of $2.612 million, or $.76 per
share from the 2010 loss of $1.160 million, $.34 per share. The Corporation’s primary asset, its subsidiary bank, mBank,
recorded earnings of $2.656 million which was an improvement of $2.573 million from 2010 earnings of $83,000. In
recent years, we have improved our core banking platform to provide more product flexibility and services to our client
base, added top quality revenue drivers in key markets in both commercial and mortgage lending, and consolidated several
operational areas to provide better efficiencies. These efforts have enhanced the operating foundation of the corporation for
increased earnings potential to take full advantage of the improving economic environment. The table below illustrates the
marked improvement in several key performance areas.
2
201120102009Net Interest Margin4.06%3.66%3.59%Efficiency Ratio68.43%72.57%72.24%Credit Quality (Texas Ratio)18.43%26.66%34.77%
To Our Shareholders
Loan Growth/Production
As stated previously, we continue to experience strong loan demand as demonstrated with approximately $173 million in
new loan production during 2011, including $39 million of mortgage loans sold in the secondary market. The table below
details the 2011 activity.
Loan production, including secondary market mortgage loans of $39 million, in our three geographical regions is shown
below.
As you will note from the chart, we started in 2011 to see good loan production in all regions from the slowing economy of
previous years. 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 to maintain and improve our margin.
Government Guaranteed Lending Programs
In recent years, the Corporation has become a premier SBA/USDA lender throughout the State of Michigan which helps
differentiate ourselves from our local competition. As you will note from the chart shown below, we have had success due
to the strong competencies of our lenders and credit personnel. In addition to the level of SBA production generated, the
Corporation recorded $1.500 million in fees for 2011, for a total of $2.866 million over the last three years. The
Corporation does not sell all the loan guarantees from every credit, only those where acceptable market rates are paid above
par that generate an acceptable internal rate of return. We are pleased with our success in this area of lending; first in terms
to the benefit of the Corporation, but also for the many local businesses that through these programs are provided the
capital to grow and help rebuild the economic base of the State.
Community Partnership Lending and Manistique Papers Inc. Bankruptcy / Michigan Economic Development
Corporation
mBank, late in 2011, played an instrumental and lead role in staving off the permanent closure of Manistique Papers, Inc., a
90-year old paper mill located in Manistique, the bank’s headquarters that was being forced into Chapter 7 bankruptcy
liquidation. The mill employs approximately 150 local workers and is the county’s second largest private employer where
the bank is based. A closure would have devastated the local economy and hundreds of direct manufacturing and indirect
ancillary business jobs would have been lost. We worked quickly and diligently with the mill’s prior non-local regional
3
Loan balances as of December 31, 2010383,086$ Total production172,577 Secondary market sales(38,971) SBA loan sales(18,970) Loans transferred to OREO(5,490) Loans charged off, net of recoveries(3,662) Normal amortization/paydowns and payoffs(87,324) Loan balances as of December 31, 2011401,246$ (dollars in thousands)201120102009REGIONUpper Peninsula95,024$ 55,475$ 43,777$ Northern Lower Peninsula48,226 10,972 35,027 Southeast Michigan29,327 10,646 9,318 TOTAL172,577$ 77,093$ 88,122$ For the Year Ending December 31,SBA Loans OriginatedFor the Year Ended December 31,201120102009# LoansSBA AmountPremium# LoansSBA AmountPremium# LoansSBA AmountPremiumUP12 8,620$ 776$ 13 8,733$ 609$ 32 6,797$ 373$ NLP8 9,024 585 8 3,838 258 10 5,829 125 SEM1 1,326 139 - - - - - - Total21 18,970$ 1,500$ 21 12,571$ 867$ 42 12,626$ 498$
To Our Shareholders
bank to purchase the senior secured debt at a discounted value of $6.8M to avert the Chapter 7 liquidation, and to keep the
company functional in its current Chapter 11 process by also providing additional working capital through a new $5.0M
―debtor in possession‖ loan arrangement.
With mBank as the lead, the bank was supported in these transactions through participation by the Michigan Economic
Development Corporation (―MEDC‖) and the Governor’s office, whose support enabled these transactions to be
consummated. Through these joint actions, the Manistique mill reopened less than six weeks after its closure in mid-August
and days away from a complete liquidation in bankruptcy. We are very proud that we were able to boldly provide the
financial support and expertise to a vital member of our local community to save hundreds of jobs and to help rehabilitate
the paper mill, a long standing member of our business community. This is the essence of real community banking;
providing local banking services and financial expertise to foster economic development in order to preserve and create
employment opportunities, keeping our communities vibrant and strong with a good quality of life for all. The company is
hoping for a successful exit from the Chapter 11 Bankruptcy sale in mid-2012 with a new owner in place providing fresh
capital and operating leverage to enable the mill to remain a vital business asset to the economic base of the local
community. mBank hopes to remain a partner with the new ownership group, and complete the full rehabilitation of the
mill.
Core Deposit Growth
In 2011 we continued our growth of core deposits, and further reduced wholesale funding. Shown below is the mix of our
deposits for the three most recent years.
As shown in the table above, core deposits grew by more than $58 million in 2011, or 20.0%.
Noninterest Expense
Controlling noninterest expense is a daily initiative in which we believe we have made satisfactory progress with in terms
of balancing costs to drive more revenue to the Corporation on a cost-benefit basis. In 2011, we reduced our efficiency ratio
to 69.80% from 72.57%, which is a product of our cost control efforts and growth in noninterest income. The Corporation’s
overall non-interest expense base remains slightly below peer at 2.89% of total assets and should continue to move
downward with the improvements in asset quality noted above. In terms of personnel expense, the Corporation continues to
operate at below peer levels as it has for several years at 1.43% as a percentage of total assets compared to peer levels of
1.50%. We have been successful in controlling most other areas of noninterest expense and will continue to focus on
becoming even more efficient.
Looking Forward
In 2012, we will continue with the execution of our core banking plan to further enhance earnings and ensure balance sheet
risk on both sides is prudently managed and controlled. These basic initiatives include further reduction in nonperforming
assets, organic growth in well priced loans and deposits, increased contribution from expansion in noninterest income
sources, along with diligent expense control. In 2012, we look to build on the momentum from the successes in 2011 and
continue to pivot to a more offensive strategy while still maintaining strong risk management systems to keep pace with the
changing risk profile of the company, in order to accelerate growth in shareholder value.
4
As of December 31, Percent Change2011Mix2010Mix2009Mix2011/20102010/2009CORE DEPOSITSTransactional accounts: Noninterest bearing51,273$ 12.67 %41,264$ 10.67 %35,878$ 8.51 %24.26 %15.01 % NOW, money market, checking152,563 37.69 134,703 34.83 95,790 22.73 13.26 40.62 Savings14,203 3.51 17,670 4.57 18,207 4.32 (19.62) (2.95) Total transactional accounts218,039 53.87 193,637 50.07 149,875 35.56 12.60 29.20 Certificates of deposit <$100,000130,685 32.28 96,977 25.07 59,953 14.23 34.76 61.76 Total core deposits348,724 86.15 290,614 75.14 209,828 49.79 20.00 38.50 NONCORE DEPOSITSCertificates of deposit >$100,00023,229 5.74 22,698 5.87 36,385 8.63 2.34 (37.62) Brokered CDs32,836 8.11 73,467 18.99 175,176 41.57 (55.31) (58.06) Total noncore deposits56,065 13.85 96,165 24.86 211,561 50.21 (41.70) (54.55) TOTAL DEPOSITS404,789$ 100.00 %386,779$ 100.00 %421,389$ 100.00 %4.66 %(8.21) %DEPOSIT MIX
To Our Shareholders
With the improving economic environment, we are currently exploring various options to repay our $11.0 million of TARP
preferred stock and the associated common stock warrants. When the decision to participate in the TARP program was
initially made in late 2008, industry professionals viewed the program as an important factor in augmenting capital levels
given the highly troubled economic uncertainty the industry and country as a whole was entering into. Over this time
period, remaining bank participants that still carry TARP such as ours, continue to trade at a much deeper discount to book
value than those that have exited TARP.
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 and serving the communities that provide the business
opportunities for the company to prosper.
We graciously thank you for your continued support as a shareholder, and many who are clients as well, we thank you for
your steadfast trust in being a customer of the corporation.
Sincerely,
Paul D. Tobias
Chairman and CEO
Mackinac Financial Corporation
Kelly W. George
President and CEO
mBank
5
Five Year Overview
6
Five Year Overview
7
Regional Review – Upper Peninsula
BRANCH LOCATIONS
ESCANABA
Located in Menards
3300 Ludington Street
Escanaba, MI 49829
(906) 233-9443
Manager: Debbie L. Peterson
MANISTIQUE
130 South Cedar Street
Manistique, MI 49854
(906) 341-2413
Manager: Magan L. MacArthur
MARQUETTE
300 North McClellan
Marquette, MI 49855
(906) 226-5000
Manager: Teresa M. Same
NEWBERRY
414 Newberry Avenue
Newberry, MI 49868
(906) 293-5165
Manager: Michael A. Slaght
SAULT STE. MARIE
138 Ridge Street
Sault Ste. Marie, MI 49783
(906) 635-3992
Manager: David R. Thomas
STEPHENSON
S216 Menominee Street
Stephenson, MI 49887
(906) 753-2225
Manager: Barbara A. Parrett
MANISTIQUE - LAKESHORE
Located in Jack’s Supervalu
Manistique, MI 49854
(906) 341-7190
Manager: Magan L. MacArthur
* Includes production of mortgage loans sold on the secondary market.
8
BALANCE SHEET HIGHLIGHTSAt December 31, 20112011 Activity(dollars in thousands)LoansCore DepositsLoan ProductionCore Deposit GrowthEscanaba8,208$ 5,199$ 6,176$ 570$ Manistique81,861 35,327 32,491 6,636 Marquette76,604 43,933 42,905 6,598 Newberry15,355 33,925 3,458 (419) Sault Ste. Marie34,401 22,566 7,435 1,912 Stephenson9,058 36,567 2,559 8,136 TOTAL UPPER PENINSULA225,487$ 177,517$ 95,024$ 23,433$ CONTRIBUTION TO OTHER INCOMESecondary MarketSBA/USDA(dollars in thousands)Production/SoldGains/Fee IncomeProduction/SoldGains/Fee IncomeEscanaba2,915$ 51$ 142$ 13$ Manistique4,627 74 4,103 312 Marquette20,238 306 3,923 412 Newberry717 15 - - Sault Ste. Marie1,083 19 145 14 Stephenson1,171 19 307 25 TOTAL UPPER PENINSULA30,751$ 484$ 8,620$ 776$
Regional Review – Upper Peninsula
Excluding the branch sales, which were predominantly transactional accounts, total deposits grew $56.9 million in the five
year period, with transactional deposits comprising roughly $29.4 million of that growth.
Core deposits are defined as demand deposits, interest bearing checking accounts, money markets, savings and CDs less
than $100,000.
Total loan production over the five year period amounted to $272.2 million.
Nonperforming assets in the Upper Peninsula totaled $2.927 million at the end of 2011, which included $.446 million of
OREO and $2.481 million of nonperforming loans. Nonperforming loans as a percent of total loans was 1.10%.
9
Regional Review – Northern Lower Peninsula
Andrew P. Sabatine, Regional President – NLP
BRANCH LOCATIONS
GAYLORD
1955 South Otsego Avenue
Gaylord, MI 49735
(989) 732-3750
Manager: Joni L. Freel
TRAVERSE CITY
3530 North Country Drive
Traverse City, MI 49684
(231) 929-5600
KALEVA
14429 Wuoksi Avenue
Kaleva, MI
(231)362-3223
Manager: Barb J. Miller
* Includes production of mortgage loans sold on the secondary market.
10
BALANCE SHEET HIGHLIGHTSAt December 31, 20112011 Activity(dollars in thousands)LoansCore DepositsLoan Production*Core Deposit GrowthGaylord37,669$ 53,802$ 8,835$ 13,434$ Kaleva533 14,100 141 745 Traverse City51,569 61,889 39,250 12,895 TOTAL NORTHERN LOWER PENINSULA89,771$ 129,791$ 48,226$ 27,074$ CONTRIBUTION TO OTHER INCOMESecondary MarketSBA/USDA(dollars in thousands)Production/SoldGains/Fee IncomeProduction/SoldGains/Fee IncomeGaylord3,679$ 60$ 555$ 42$ Kaleva- - - - Traverse City4,541 72 8,469 543 TOTAL NORTHERN LOWER PENINSULA8,220$ 132$ 9,024$ 585$
Regional Review – Northern Lower Peninsula
Total core deposit growth amounted to $95.6 million over the five year period, largely in transactional accounts.
Core deposits are defined as demand deposits, interest bearing checking accounts, money markets, savings and CDs less
than $100,000.
Total loan production over the five year period amounted to $130.9 million.
Nonperforming assets in the Northern Lower Peninsula totaled $5.442 million at the end of 2011, which included $.746
million of OREO and $4.696 million of nonperforming loans. Nonperforming loans as a percent of total loans was 5.23%.
11
Regional Review – Southeast Michigan
Jesse A. Deering, SVP/Southeast Michigan Executive
BRANCH LOCATION
BIRMINGHAM
260 East Brown Street, Suite 300
Birmingham, MI 48009
(248) 290-5900
Manager: Elena Dritsas
12
CONTRIBUTION TO OTHER INCOMESecondary MarketSBA/USDA(dollars in thousands)Production/SoldGains/Fee IncomeProduction/SoldGains/Fee IncomeBirmingham-$ -$ 1,327$ 138$ BALANCE SHEET HIGHLIGHTSAt December 31, 20112011 Activity(dollars in thousands)LoansCore DepositsLoan ProductionCore Deposit GrowthBirmingham85,988$ 41,416$ 29,327$ 7,603$
Regional Review – Southeast Michigan
Total core deposit growth amounted to $35.2 million over the five year period, almost solely in transactional accounts.
Core deposits are defined as demand deposits, interest bearing checking accounts, money markets, savings and CDs less
than $100,000.
Total loan production over the five year period amounted to $110.1 million.
Nonperforming assets in Southeast Michigan totaled $2.786 million at the end of 2011, which included $1.970 million of
OREO and $.816 million of nonperforming loans. Nonperforming loans as a percent of total loans was 3.24%.
13
Selected Financial Highlights
(Dollars in Thousands, Except Per Share Data)
The above summary should be read in connection with the related consolidated financial statements and notes included
elsewhere in this report.
14
(Dollars in thousands, except per share data)20112010(Unaudited)(Unaudited)Selected Financial Condition Data (at end of period):Assets498,311$ 478,696$ Loans401,246 383,086 Investment securities38,727 33,860 Deposits404,789 386,779 Borrowings35,997 36,069 Common shareholders' equity44,342 43,176 Total shareholders' equity55,263 53,882 Selected Statements of Income Data:Net interest income17,929$ 16,385$ Income (Loss) before taxes and preferred dividend3,316 (3,918) Net income1,452 1,160 Income (Loss) per common share - Basic.42 (.34) Income (Loss) per common share - Diluted.41 (.34) Weighted average shares outstanding3,419,736 3,419,736 Weighted average shares outstanding - Diluted3,500,204 3,479,897 Selected Financial Ratios and Other Data:Performance Ratios: Net interest margin4.06 %3.66 %Efficiency ratio68.43 72.57 Return on average assets.30 (.23) Return on average common equity3.30 (2.64) Return on average total equity2.66 (2.06) Average total assets489,539$ 502,993$ Average common shareholders' equity43,940 43,981 Average total shareholders' equity54,561 56,171 Average loans to average deposits ratio98.05 %94.36 %Common Share Data (at end of period):Market price per common share5.42$ 4.58$ Book value per common share12.97$ 12.63$ Common shares outstanding3,419,736 3,419,736 Other Data (at end of period):Allowance for loan losses5,251$ 6,613$ Non-performing assets11,155$ 16,125$ Allowance for loan losses to total loans1.31 %1.73 %Non-performing assets to total assets2.24 %3.37 %Texas ratio18.43 %26.66 %Number of: Branch locations11 11 FTE Employees116 110 For The Years Ended December 31,
Quarterly Financial Summary
___________________________________________________________________________________________________
15
AverageAverageAverageAverage Shareholders'Net InterestEfficiencyNet IncomeBook ValueQuarter EndedAssetsLoansDepositsEquityAssetsEquityMarginRatioPer SharePer ShareDecember 31, 2011487,304$ 396,197$ 390,940$ 55,219$ (.09)%(1.02) %4.38 %67.51 %(.03)$ 12.97$ September 30, 2011497,333 397,665 403,957 54,998 .43 3.85 3.95 67.39 .20 13.05 June 30, 2011494,481 378,250 404,549 54,138 .36 3.21 3.85 67.84 .17 12.86 March 31, 2011478,861 380,066 386,743 53,870 .221.92 3.92 75.73 .07 12.67 December 31, 2010488,320 385,296 393,266 55,015 (1.70)(15.09) 3.88 65.05 (.61) 12.63 September 30, 2010512,335 385,268 416,847 56,668 (.08) (.73) 3.69 75.98 (.03) 13.26 June 30, 2010502,942 382,169 405,449 57,889 (1.98) (17.24) 3.56 76.04 (.73) 13.34 March 31, 2010508,495 384,640 413,897 55,109 2.8125.95 3.51 78.12 1.03 14.08 December 31, 2009514,102 386,203 418,280 55,665 (.14) (1.28) 3.74 71.03 (.05) 13.10 Return on Average$4,276 $4,141 $4,178 $4,709 $4,901 3.88%3.92%3.85%3.95%4.38%3.50%3.60%3.70%3.80%3.90%4.00%4.10%4.20%4.30%4.40%4.50% 2,400 2,900 3,400 3,900 4,400 4,900 5,400December-10March-11June-11September-11December-11PercentageDollars (in thousands)Quarter EndedNET INTEREST MARGIN - 50,000 100,000 150,000 200,000 250,000December-10March-11June-11September-11December-11Dollars (in thousands)At Month EndTRANSACTIONAL ACCOUNT DEPOSITSMoney MarketsNOWDemandSavings - 50,000 100,000 150,000 200,000 250,000 300,000 350,000 400,000December-10March-11June-11September-11December-11Dollars (in thousands)At Month EndLOAN PORTFOLIO BALANCESCommercialMortgageLeasesInstallment
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, 2011 and 2010 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, 2011. 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, 2011 and 2010 and the
consolidated results of their operations and their cash flows for each year in the three-year period ended December 31,
2011, in conformity with accounting principles generally accepted in the United States of America.
Grand Rapids, Michigan
March 30, 2012
16
Consolidated Balance Sheets
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
December 31, 2011 and 2010
(Dollars in Thousands)
_____________________________________________________________________________________________
See accompanying notes to consolidated financial statements.
17
December 31,December 31,20112010ASSETSCash and due from banks20,071$ 22,719$ Federal funds sold13,999 12,000 Cash and cash equivalents34,070 34,719 Interest-bearing deposits in other financial institutions10 713 Securities available for sale38,727 33,860 Federal Home Loan Bank stock3,060 3,423 Loans: Commercial311,215 297,047 Mortgage83,106 80,756 Installment6,925 5,283 Total Loans401,246 383,086 Allowance for loan losses(5,251) (6,613) Net loans395,995 376,473 Premises and equipment9,627 9,660 Other real estate held for sale3,162 5,562 Deferred tax asset8,427 9,028 Other assets5,233 5,258 TOTAL ASSETS498,311$ 478,696$ LIABILITIES AND SHAREHOLDERS' EQUITYLiabilities: Non-interest-bearing deposits51,273$ 41,264$ Interest-bearing deposits: NOW, Money Market, Checking152,563 134,703 Savings14,203 17,670 CDs<$100,000130,685 96,977 CDs>$100,00023,229 22,698 Brokered32,836 73,467 Total deposits404,789 386,779 Borrowings35,997 36,069 Other liabilities2,262 1,966 Total liabilities443,048 424,814 Shareholders' equity: Preferred stock - No par value: Authorized 500,000 shares, 11,000 shares issued and outstanding10,921 10,706 Common stock and additional paid in capital - No par value Authorized - 18,000,000 shares Issued and outstanding - 3,419,736 shares43,525 43,525 Retained earnings (deficit)492 (961) Accumulated other comprehensive income 325 612 Total shareholders' equity55,263 53,882 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY498,311$ 478,696$
Consolidated Statements of Operations
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
Years Ended December 31, 2011, 2010, and 2009
(Dollars in Thousands, Except Per Share Data)
___________________________________________________________________________________________________
See accompanying notes to consolidated financial statements.
18
201120102009INTEREST INCOME: Interest and fees on loans: Taxable21,627$ 21,091$ 20,521$ Tax-exempt147 188 292 Interest on securities: Taxable1,162 1,406 2,783 Tax-exempt28 28 19 Other interest income108 127 93 Total interest income23,072 22,840 23,708 INTEREST EXPENSE: Deposits4,530 5,607 6,431 Borrowings613 848 990 Total interest expense5,143 6,455 7,421 Net interest income17,929 16,385 16,287 Provision for loan losses2,300 6,500 3,700 Net interest income after provision for loan losses15,629 9,885 12,587 OTHER INCOME: Deposit service fees832 990 1,023 Net security gains (losses)(1) 215 1,471 Income from loans sold2,200 1,407 830 Mortgage servicing rights400 - - Other225 183 1,427 Total other income3,656 2,795 4,751 OTHER EXPENSES: Salaries and employee benefits7,275 6,918 6,583 Occupancy1,376 1,313 1,385 Furniture and equipment827 806 805 Data processing761 740 862 Professional service fees756 627 603 Loan and deposit1,137 910 792 Writedowns and losses on other real estate held for sale1,137 2,753 208 FDIC Insurance Assessment849 957 839 Telephone215 193 187 Advertising351 297 322 Other1,285 1,084 1,216 Total other expenses15,969 16,598 13,802 Income (loss) before provision for (benefit of) income taxes3,316 (3,918) 3,536 Provision for (benefit of) income taxes1,098 (3,500) 1,120 NET INCOME(LOSS)2,218$ (418)$ 2,416$ Preferred dividend and accretion of discount766 742 509 NET INCOME(LOSS) AVAILABLE TO COMMON SHAREHOLDERS1,452$ (1,160)$ 1,907$ INCOME(LOSS) PER COMMON SHARE Basic.42$ (.34)$ .56$ Diluted.41$ (.34)$ .56$ For The Years Ended December 31,
Consolidated Statements of Changes in Shareholders’ Equity
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
Years Ended December 31, 2011, 2010, and 2009
(Dollars in Thousands)
_____________________________________________________________________________________________
See accompanying notes to consolidated financial statements.
19
AccumulatedShares ofPreferred Common StockRetainedOtherCommonStockand AdditionalEarningsComprehensiveStockSeries APaid in Capital(Accumulated Deficit)IncomeTotalBalance, January 1, 20093,419,736 -$ 42,815$ (1,708)$ 445$ 41,552$ Net income- - - 2,416 - 2,416 Other comprehensive income: Net unrealized income on securities available for sale- - - - 648 648 Total comprehensive income3,064 Stock option compensation- - 60 - - 60 Dividend on preferred stock- - - (377) - (377) Accretion of preferred stock discount- 132 - (132) - - Issuance of preferred stock, 11,000 shares- 10,382 - - - 10,382 Issuance of common stock warrants- - 618 - - 618 Balance, December 31, 20093,419,736 10,514 43,493 199 1,093 55,299 Net (loss)- - - (418) - (418) Other comprehensive income (loss): Net unrealized income on securities available for sale- - - - (481) (481) Total comprehensive income (loss)(899) Stock option compensation- - 32 - - 32 Dividend on preferred stock- - - (550) - (550) Accretion of preferred stock discount- 192 - (192) - - Balance, December 31, 20103,419,736 10,706 43,525 (961) 612 53,882 Net income - - - 2,218 - 2,218 Other comprehensive income (loss): Net unrealized income on securities available for sale- - - - (287) (287) Total comprehensive income (loss)1,931 Dividend on preferred stock- - - (551) - (551) Accretion of preferred stock discount- 215 - (215) - - Other- - - 1 - 1 Balance, December 31, 20113,419,736 10,921$ 43,525$ 492$ 325$ 55,263$
Consolidated Statements of Cash Flows
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
Years Ended December 31, 2011, 2010, and 2009
(Dollars in Thousands)
__________________________________________________________________________________________
See accompanying notes to consolidated financial statements.
20
201120102009Cash Flows from Operating Activities: Net income (loss)2,218$ (418)$ 2,416$ Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization1,419 1,643 2,027 Provision for loan losses2,300 6,500 3,700 Provision for (benefit of) income taxes1,098 (3,500) 1,120 (Gain) loss on sales/calls of securities available for sale(1) (215) (1,471) (Gain) loss on sale of secondary market loans(477) (445) (224) Origination of secondary market loans held for sale(38,971) (36,678) (21,722) Proceeds from secondary market loans held for sale33,048 37,217 22,039 Mortgage servicing rights(400) - - (Gain) on sales of branch offices- - (1,208) Loss on sale of premises, equipment, and other real estate held for sale282 48 23 Writedown of other real estate held for sale855 2,703 187 Stock option compensation- 32 60 Change in other assets211 13,174 (15,626) Change in other liabilities 296 (583) (22) Net cash (used in) provided by operating activities1,878 19,478 (8,701) Cash Flows from Investing Activities: Net (increase) in loans(19,749) (9,355) (21,218) Net (increase) decrease in interest-bearing deposits in other financial institutions703 (35) (96) Purchase of securities available for sale(21,260) (5,000) (50,113) Proceeds from maturities, sales, calls or paydowns of securities available for sale15,607 16,788 52,742 Capital expenditures(1,034) (606) (679) Proceeds from sale of premises, equipment, and other real estate5,456 2,876 581 Redemption of FHLB stock363 371 - Net cash paid in connection with branch sales- - (28,578) Net cash provided by (used in) investing activities(19,914) 5,039 (47,361) Cash Flows from Financing Activities: Net increase (decrease) in deposits18,010 (34,610) 80,760 Issuance of Series A Preferred Stock and common stock warrants- - 11,000 Dividend on preferred stock(551) (550) (307) Principal payments on borrowings(72) (71) (70) Net cash provided by (used in) financing activities17,387 (35,231) 91,383 Net increase (decrease) in cash and cash equivalents(649) (10,714) 35,321 Cash and cash equivalents at beginning of period34,719 45,433 10,112 Cash and cash equivalents at end of period34,070$ 34,719$ 45,433$ Supplemental Cash Flow Information:Cash paid during the year for: Interest4,664$ 6,548$ 7,584$ Income taxes75 75 90 Noncash Investing and Financing Activities:Transfers of Foreclosures from Loans to Other Real Estate Held for Sale (net of adjustments made through the allowance for loan losses)4,194 5,373 4,879 Assets and Liabilities Divested in Branch Sales: Loans- - 31 Premises and equipment- - 651 Deposits- - 29,260
Notes to the 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 1.7%, 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. Less than 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 mortgage servicing rights.
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.
21
Notes to the 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 income on loans is reported on the level-yield method and includes amortization of deferred loan fees and costs
over the loan term. Net loan commitment fees or costs for commitment periods greater than one year are deferred and
amortized into fee income or other expense on a straight-line basis over the commitment period. 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 as well as when required by regulatory provisions. 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.
Mortgage Servicing Rights
Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial
assets. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to,
and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are
evaluated for impairment based on the fair value of the rights compared to amortized cost. Impairment is determined by
using prices for similar assets with similar characteristics, such as interest rates and terms. Fair value is determined by
using prices for similar assets with similar characteristics, when available, or based on discounted cash flows using market-
based assumptions. Impairment is recognized through a valuation allowance for an individual stratum, to the extent that
fair value is less than the capitalized amount for the stratum.
Allowance for Loan Losses
The allowance for loan losses includes specific allowances related to commercial loans which have been judged to be
impaired. A loan is impaired when, based on current information, it is probable that the Corporation will not collect all
amounts due in accordance with the contractual terms of the loan agreement. These specific allowances are based on
discounted cash flows of expected future payments using the loan’s initial effective interest rate or the fair value of the
collateral if the loan is collateral dependent.
The Corporation also has a general allowance for loan losses for loans not considered impaired. The allowance for loan
losses is maintained at a level which management believes is adequate to provide for probable loan losses. Management
periodically evaluates the adequacy of the allowance using the Corporation’s past loan loss experience, known and inherent
risks in the portfolio, composition of the portfolio, current economic conditions, and other factors. The allowance does not
include the effects of expected losses related to future events or future changes in economic conditions. This evaluation is
inherently subjective since it requires material estimates that may be susceptible to significant change. Loans are charged
against the allowance for loan losses when management believes the collectability of the principal is unlikely. In addition,
various regulatory agencies periodically review the allowance for loan losses. These agencies may require additions to the
allowance for loan losses based on their judgments of collectability.
In management’s opinion, the allowance for loan losses is adequate to cover probable losses relating to specifically
identified loans, as well as probable losses inherent in the balance of the loan portfolio as of the balance sheet date.
22
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Other Real Estate Held for Sale
Other real estate held for sale consists of assets acquired through, or in lieu of, foreclosure and other long-lived assets to be
disposed of by sale, whether previously held and used or newly acquired. Other real estate held for sale is initially
recorded at the lower of cost or fair value, less costs to sell, establishing a new cost basis. Valuations are periodically
performed by management, and the assets’ carrying values are adjusted to the lower of cost basis or fair value less costs to
sell. Impairment losses are recognized for any initial or subsequent write-downs. Net revenue and expenses from
operations of other real estate held for sale are included in other expense.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Maintenance and repair costs are charged to
expense as incurred. Gains or losses on disposition of premises and equipment are reflected in income. Depreciation is
computed on the straight-line method over the estimated useful lives of the assets.
Stock Option Plans
The Corporation sponsors three stock option plans. One plan was approved during 2000 and applies to officers, employees,
and nonemployee directors. This plan was amended as a part of the December 2004 stock offering and recapitalization.
The amendment, approved by shareholders, increased the shares available under this plan by 428,587 shares from the
original 25,000 (adjusted for the 1:20 reverse stock split), to a total authorized share balance of 453,587. The other two
plans, one for officers and employees and the other for nonemployee directors, were approved in 1997. A total of 30,000
shares (adjusted for the 1:20 split), were made available for grant under these plans. Options under all of the plans are
granted at the discretion of a committee of the Corporation’s Board of Directors. Options to purchase shares of the
Corporation’s stock were granted at a price equal to the market price of the stock at the date of grant. The committee
determined the vesting of the options when they were granted as established under the plan. No new options may be issued
under the plans.
Comprehensive Income (Loss)
Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive
income (loss) is composed of unrealized gains and losses on securities available for sale, net of tax.
Earnings per Common Share
Earnings per share are based upon the weighted average number of shares outstanding. The issuance of shares as a result of
stock options and common stock warrants issued under the TARP Capital Purchase Program had minimal dilutive effect,
$.01 per share, on earnings for the year ended December 31, 2011, and no dilutive effect on earnings for the years ended
December 31, 2010 and 2009.
23
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following shows the computation of basic and diluted earnings per share for the year ended December 31, 2011 and
2010 (dollars in thousands, except per share data):
The effect of dilutive common stock warrants is not taken into account when calculating the loss per share in 2010, since it
would be anti-dilutive.
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 (benefit) is the result
of changes in the deferred tax asset and liability. A valuation allowance is provided against deferred tax assets when it is
more likely than not that some or all of the deferred asset will not be realized.
Off-Balance-Sheet Financial Instruments
In the ordinary course of business, the Corporation has entered into off-balance-sheet financial instruments consisting of
commitments to extend credit, commitments under credit card arrangements, commercial letters of credit, and standby
letters of credit. For letters of credit, the Corporation recognizes a liability for the fair market value of the obligations it
assumes under that guarantee.
Recent Developments
In June 2011, the FASB issued ASU No. 2011-05 ―Presentation of Comprehensive Income.‖ This standard requires an
entity to present the total of comprehensive income, the components of net income, and the components of other
comprehensive income either in a single continuous statement of comprehensive income or in two separate but continuous
statements. This standard eliminates the option to present the components of other comprehensive income as part of the
statement of equity. This standard is effective for fiscal years and interim periods with those years beginning after
December 15, 2011. The implementation of this standard will only change the presentation of comprehensive income; it
will not have an impact on the Corporation’s financial position or results of operations. In December 2011, the FASB
issued ASU No. 2011-12. This standard defers the requirement to present reclassification adjustments for each component
of other comprehensive income in both net income and other comprehensive income on the face of the financial statements.
In May 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective
Control for Repurchase Agreements. The ASU is intended to improve financial reporting of repurchase agreements
(―repos‖) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before
their maturity. The amendments to the Codification in this ASU are intended to improve the accounting for these
transactions by removing them from the assessment of effective control the criterion requiring the transferor to have the
ability to repurchase or redeem the financial assets. The guidance in the ASU is effective for the first interim or annual
24
201120102009Net income (loss)2,218$ (418)$ 2,416$ Preferred stock dividends and accretion of discount766 742 509 Net income (loss) available to common shareholders1,452$ (1,160)$ 1,907$ Weighted average shares outstanding3,419,736 3,419,736 3,419,736 Effect of dilutive stock options and common stock warrants outstanding80,468 60,161 - Diluted weighted average shares outstanding3,500,204 3,479,897 3,419,736 Income (loss) per common share: Basic.42$ (.34)$ .56$ Diluted.41$ (.34)$ .56$ Year Ended December 31,
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
period beginning on or after December 15, 2011. The provisions of this guidance did not have a significant impact on the
Corporation’s consolidated financial condition, results of operation or liquidity.
The FASB has issued ASU No. 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair
Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. This ASU represents the converged guidance
of the FASB and the IASB (the Boards) on fair value measurement. The collective efforts of the Boards and their staffs,
reflected in ASU No. 2011-04, have resulted in common requirements for measuring fair value and for disclosing
information about fair value measurements, including a consistent meaning of the term ―fair value.‖ The Boards have
concluded the common requirements will result in greater comparability of fair value measurements presented and
disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs. The amendments to the Codification
in this ASU are to be applied prospectively. For public entities, the amendments are effective during interim and annual
periods beginning after December 15, 2011. The impact of adoption of this ASU did not have a significant impact on the
Corporation’s consolidated financial condition, results of operation or liquidity.
Reclassifications
Certain amounts in the 2010 and 2009 consolidated financial statements have been reclassified to conform to the 2011
presentation.
NOTE 2 – RESTRICTIONS ON CASH AND CASH EQUIVALENTS
Cash and cash equivalents in the amount of $3.748 million were restricted on December 31, 2011 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 $250,000.
Management believes that these financial institutions have strong credit ratings and the credit risk related to these deposits
is minimal.
NOTE 3 – SECURITIES AVAILABLE FOR SALE
The carrying value and estimated fair value of securities available for sale are as follows (dollars in thousands):
25
AmortizedUnrealizedUnrealizedEstimatedCostGainsLossesFair ValueDecember 31, 2011US Agencies - MBS11,111$ 387$ -$ 11,498$ US Agencies10,407 168 - 10,575 Corporate 8,314 - (136) 8,178 Obligations of states and political subdivisions5,448 110 (2) 5,556 Other asset backed2,954 - (34) 2,920 Total securities available for sale38,234$ 665$ (172)$ 38,727$ December 31, 2010US Agencies - MBS26,787$ 923$ -$ 27,710$ US Agencies 5,000 - (27) 4,973 Obligations of states and political subdivisions1,146 35 (4) 1,177 Total securities available for sale32,933$ 958$ (31)$ 33,860$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 3 – SECURITIES AVAILABLE FOR SALE (CONTINUED)
At December 31, 2011 and 2010, the mortgage backed securities portfolio was $11.498 million (29.69%) and $27.710
million (81.84%), respectively, of the securities portfolio. At December 31, 2011, the entire mortgage backed securities
portfolio consisted of securities issued and guaranteed by either the Federal National Mortgage Association (FNMA) or the
Federal Home Loan Mortgage Corporation (FHLMC); United States government-sponsored agencies. Other asset backed
securities are collateralized with government guaranteed student loans.
Following is information pertaining to securities with gross unrealized losses at December 31, 2011 and 2010 aggregated
by investment category and length of time these individual securities have been in a loss position (dollars in thousands):
There were three securities in an unrealized loss position in 2011 and two in 2010. The gross unrealized losses in the
current portfolio are considered temporary in nature and related to interest rate fluctuations. The Corporation has both the
ability and intent to hold the investment securities until their respective maturities and therefore does not anticipate the
realization of the temporary losses.
Following is a summary of the proceeds from sales and calls of securities available for sale, as well as gross gains and
losses for the years ended December 31 (dollars in thousands):
The carrying value and estimated fair value of securities available for sale at December 31, 2011, by contractual maturity,
are shown below (dollars in thousands):
Contractual maturities may differ from expected maturities because issuers may have the right to call or prepay obligations
with or without call or prepayment penalties. See Note 9 for information on securities pledged to secure borrowings from
the Federal Home Loan Bank.
26
GrossGrossUnrealizedFairUnrealizedFairLossesValueLossesValueDecember 31, 2011US Agencies - MBS-$ 2,920$ -$ -$ Obligations of states and political subdivisions- - (2) 250 Corporate(136) 8,178 - - Total securities available for sale(136)$ 11,098$ (2)$ 250$ December 31, 2010US Agencies - MBS(27)$ 4,973$ - - Obligations of states and political subdivisions(4) 325 - - Total securities available for sale(31)$ 5,298$ -$ -$ Less Than Twelve MonthsOver Twelve Months201120102009Proceeds from sales and calls76$ 8,302$ 44,611$ Gross gains on sales- 216 1,472 Gross (losses) on sales and calls(1) (1) (1) AmortizedEstimatedCostFair ValueDue in one year or less2,580$ 2,550$ Due after one year through five years17,193 17,294 Due after five years through ten years10 10 Due after ten years4,386 4,455 Subtotal24,169 24,309 US Agencies - MBS14,065 14,418 Total38,234$ 38,727$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 4 - LOANS
The composition of loans at December 31 is as follows (dollars in thousands):
An analysis of the allowance for loan losses for the years ended December 31 is as follows (dollars in thousands):
In 2011, net charge off activity was $3.662 million, or .94% of average loans outstanding compared to net charge-offs of
$5.112 million, or 1.33% of average loans, in the same period in 2010 and $2.752 million, or .73% of average loans, in
2009. During 2011, a provision of $2.300 million was made to increase the reserve. This provision was made in
accordance with the Corporation’s allowance for loan loss reserve policy, which calls for a measurement of the adequacy of
the reserve at each quarter end. This process includes an analysis of the loan portfolio to take into account increases in
loans outstanding and portfolio composition, historical loss rates, and specific reserve requirements of nonperforming
loans.
A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2011 is as follows (dollars in
thousands):
27
20112010Commercial real estate199,201$ 194,859$ Commercial, financial, and agricultural92,269 68,858 One to four family residential real estate77,332 75,074 Construction : Consumer5,774 5,682 Commerical19,745 33,330 Consumer6,925 5,283 Total loans401,246$ 383,086$ 201120102009Balance, January 16,613$ 5,225$ 4,277$ Recoveries on loans previously charged off138 374 66 Loans charged off(3,800) (5,486) (2,818) Provision2,300 6,500 3,700 Balance, December 315,251$ 6,613$ 5,225$ Commercial,One to fourCommercialfinancial andCommercialfamily residentialConsumerreal estateagriculturalconstructionreal estateconstructionConsumerUnallocatedTotalAllowance for loan loss reserve:Beginning balance ALLR3,460$ 1,018$ 389$ 1,622$ -$ -$ 124$ 6,613$ Charge-offs(2,267) (579) (412) (490) - (52) - (3,800) Recoveries32 21 75 1 - 9 - 138 Provision1,598 619 155 (19) - 43 (96) 2,300 Ending balance ALLR2,823$ 1,079$ 207$ 1,114$ -$ -$ 28$ 5,251$ Loans:Ending balance199,201$ 92,269$ 19,745$ 77,332$ 5,774$ 6,925$ -$ 401,246$ Ending balance ALLR(2,823) (1,079) (207) (1,114) - - (28) (5,251) Net loans196,378$ 91,190$ 19,538$ 76,218$ 5,774$ 6,925$ (28)$ 395,995$ Ending balance ALLR:Individually evaluated926$ 160$ -$ 114$ -$ -$ -$ 1,200$ Collectively evaluated1,897 919 207 1,000 - - 28 4,051 Total2,823$ 1,079$ 207$ 1,114$ -$ -$ 28$ 5,251$ Ending balance Loans:Individually evaluated13,628$ 1,707$ -$ 1,930$ -$ -$ -$ 17,265$ Collectively evaluated185,573 90,562 19,745 75,402 5,774 6,925 - 383,981 Total199,201$ 92,269$ 19,745$ 77,332$ 5,774$ 6,925$ -$ 401,246$ Impaired loans, by definition, are individually evaluated.
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 4 – LOANS (CONTINUED)
A breakdown of the allowance for loan losses, the activity for the period, and recorded balances in loans for the year ended
December 31, 2010 is as follows (dollars in thousands):
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. Our ability to manage credit risk
depends in large part on our ability to properly identify and manage problem loans. To do so, we operate a credit risk rating
system under which our credit management personnel assign a credit risk rating to each loan at the time of origination and
review loans on a regular basis to determine each loan’s credit risk rating on a scale of 1 through 8, with higher scores
indicating higher risk. The credit risk rating structure used is shown below.
In the context of the credit risk rating structure, the term Classified is defined as a problem loan which may or may not be
in a nonaccrual status, dependent upon current payment status and collectability.
Excellent (1)
Borrower is not vulnerable to sudden economic or technological changes and is in a non-seasonal business or industry.
These loans generally would be characterized by having good experienced management and a strong liquidity position with
minimal leverage.
Good (2)
Borrower shows limited vulnerability to sudden economic change with modest seasonal effect. Borrower has ―above
average‖ financial statements and an acceptable repayment history with minimal leverage and a profitability that exceeds
peers.
Average (3)
Generally, a borrower rated as average may be susceptible to unfavorable changes in the economy and somewhat affected
by seasonal factors. Some product lines may be affected by technological change. Borrowers in this category exhibit stable
earnings, with a satisfactory payment history.
Acceptable (4)
The loan is an otherwise acceptable credit that warrants a higher level of administration due to various underlying
weaknesses. These weaknesses, however, have not and may never deteriorate to the point of a Special Mention rating or
Classified status. This rating category may include new businesses not yet having established a firm performance record.
28
Commercial,One to fourCommercialfinancial andCommercialfamily residentialConsumerreal estateagriculturalconstructionreal estateconstructionConsumerUnallocatedTotalAllowance for loan loss reserve:Beginning balance ALLR3,284$ 1,135$ 386$ 23$ -$ 13$ 384$ 5,225$ Charge-offs(2,426) (1,804) (720) (416) - (9) (111) (5,486) Recoveries18 260 67 - - 15 14 374 Provision2,584 1,427 656 2,015 - (19) (163) 6,500 Ending balance ALLR3,460$ 1,018$ 389$ 1,622$ -$ -$ 124$ 6,613$ Loans:Ending balance194,859$ 68,858$ 33,330$ 75,074$ 5,682$ 5,283$ -$ 383,086$ Ending balance ALLR(3,460) (1,018) (389) (1,622) - - (124) (6,613) Net loans191,399$ 67,840$ 32,941$ 73,452$ 5,682$ 5,283$ (124)$ 376,473$ Ending balance ALLR:Individually evaluated1,601$ 330$ 39$ 696$ -$ -$ -$ 2,666$ Collectively evaluated1,859 688 350 926 - - 124 3,947 Total3,460$ 1,018$ 389$ 1,622$ -$ -$ 124$ 6,613$ Ending balance Loans:Individually evaluated18,610$ 2,696$ 2,437$ 5,238$ -$ -$ -$ 28,981$ Collectively evaluated176,249 66,162 30,893 69,836 5,682 5,283 - 354,105 Total194,859$ 68,858$ 33,330$ 75,074$ 5,682$ 5,283$ -$ 383,086$ Impaired loans, by definition, are individually evaluated.
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 4 – LOANS (CONTINUED)
Special Mention (5)
The loan is not considered as a Classified status, however may exhibit material weaknesses that, if not corrected, may cause
future problems. Borrowers in this category warrant special attention but have not yet reached the point of concern for loss.
The borrower may have deteriorated to the point that they would have difficulty refinancing elsewhere. Similarly,
purchasers of these businesses would not be eligible for bank financing unless they represent a significantly lessened credit
risk.
Substandard (6)
The loan is Classified and exhibits a number of well-defined weaknesses that jeopardize normal repayment. The assets are
no longer adequately protected due to declining net worth, lack of earning capacity or insufficient collateral offering the
distinct possibility of the loss of a portion of the loan principal. Loans within this category clearly represent troubled and
deteriorating credit situations requiring constant supervision and an action plan must be developed and approved by the
appropriate officers to mitigate the risk.
Doubtful (7)
Loans in this category exhibit the same weaknesses used to describe the substandard credit; however, the traits are more
pronounced. Loans are frozen with collection improbable. Such loans are not yet rated as Charge-off because certain
actions may yet occur which would salvage the loan.
Charge-off/Loss (8)
Loans in this category are largely uncollectible and should be charged against the loan loss reserve immediately.
General Reserves:
For loans with a credit risk rating of 5 or better and any loans with a risk rating of 6 or 7 with no specific reserve, reserves
are established based on the type of loan collateral, if any, and the assigned credit risk rating. Determination of the
allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future
cash flows on impaired loans, estimated losses on pools of homogenous loans based on historical loss experience, and
consideration of current environmental factors and economic trends, all of which may be susceptible to significant change.
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. In 2011 and 2010, commercial
construction loans of $3.694 million and $3.566 million, respectively, did not receive a specific risk rating. These amounts
represent loans made for land development and unimproved land purchases.
Below is a breakdown of loans by risk category as of December 31, 2011 (dollars in thousands):
29
(1)(2)(3)(4)(5)(6)(7)RatingExcellentGoodAverageAcceptableSp. MentionSubstandardDoubtfulUnassignedTotalCommercial real estate3,083$ 16,946$ 47,154$ 118,259$ 5,198$ 7,642$ 919$ -$ 199,201$ Commercial, financial and agricultural4,416 7,875 17,738 60,498 201 1,541 - - 92,269 Commercial construction209 552 4,542 10,415 313 20 - 3,694 19,745 One-to-four family residential real estate- - 3,359 5,910 2,023 - - 66,040 77,332 Consumer construction- - - - - - - 5,774 5,774 Consumer- - 105 599 - - - 6,221 6,925 Total loans7,708$ 25,373$ 72,898$ 195,681$ 7,735$ 9,203$ 919$ 81,729$ 401,246$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 4 – LOANS (CONTINUED)
Below is a breakdown of loans by risk category as of December 31, 2010 (dollars in thousands)
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 during impairment and that which would have been recognized were $.118 million
and $.363 million for the year ended December 31, 2011. For the year ended December 31, 2010, the amounts were $.141
million and $.583 million.
The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet
payment obligations as they become due, as well as when required by regulatory provisions. When interest accrual is
discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash
payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest
amounts contractually due are brought current and future payments are reasonably assured.
Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable
to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled
principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an
individual loans basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that
the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value
of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied
to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a
cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
30
(1)(2)(3)(4)(5)(6)(7)RatingExcellentGoodAverageAcceptableSp. MentionSubstandardDoubtfulUnassignedTotalCommercial real estate4,745$ 16,975$ 44,408$ 109,989$ 3,789$ 10,997$ 3,956$ -$ 194,859$ Commercial, financial and agricultural3,726 5,275 16,466 40,496 259 2,636 - - 68,858 Commercial construction- 579 4,416 22,280 1,921 568 - 3,566 33,330 One-to-four family residential real estate33 3,589 3,146 4,271 1,464 3,941 - 58,630 75,074 Consumer construction- - - - - - - 5,682 5,682 Consumer- - 34 368 - - - 4,881 5,283 Total loans8,504$ 26,418$ 68,470$ 177,404$ 7,433$ 18,142$ 3,956$ 72,759$ 383,086$
Notes to the 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):
31
Interest IncomeInterest IncomeNonaccrualAccrualAverageRelatedRecognizedonBasisBasisInvestmentValuation ReserveDuring ImpairmentAccrual BasisDecember 31, 2011With no valuation reserve: Commercial real estate1,313$ -$ 2,519$ -$ 66$ 116$ Commercial, financial and agricultural16 - 542 - 29 35 Commercial construction- - 176 - - 11 One to four family residential real estate608 - 1,727 - - 99 Consumer construction- - 4 - - - Consumer- - 2 - - - With a valuation reserve: Commercial real estate1,049$ 2,400$ 807$ 700$ 20$ 31$ Commercial, financial and agricultural1,095 - 282 173 - 14 Commercial construction- - - - - - One to four family residential real estate1,389 103 1,121 150 3 56 Consumer construction20 - 9 4 - 1 Consumer- - - - - - Total: Commercial real estate2,362$ 2,400$ 3,326$ 700$ 86$ 147$ Commercial, financial and agricultural1,111 - 824 173 29 49 Commercial construction- - 176 - - 11 One to four family residential real estate1,997 103 2,848 150 3 155 Consumer construction20 - 13 4 - 1 Consumer- - 2 - - - Total5,490$ 2,503$ 7,189$ 1,027$ 118$ 363$ December 31, 2010With no valuation reserve: Commercial real estate960$ -$ 987$ -$ -$ 71$ Commercial, financial and agricultural51 - 13 - - 1 Commercial construction458 - 1,186 - 11 33 One to four family residential real estate362 105 237 - 1 13 Consumer construction- - - - - - Consumer- - - - - - With a valuation reserve: Commercial real estate2,562$ 4,537$ 6,531$ 1,258$ 117$ 306$ Commercial, financial and agricultural709 - 1,660 279 - 95 Commercial construction- - - - - 21 One to four family residential real estate767 - 730 230 12 39 Consumer construction52 - 52 1 - 4 Consumer- - - - - - Total: Commercial real estate3,522$ 4,537$ 7,518$ 1,258$ 117$ 377$ Commercial, financial and agricultural760 - 1,673 279 - 96 Commercial construction458 - 1,186 - 11 54 One to four family residential real estate1,129 105 967 230 13 52 Consumer construction52 - 52 1 - 4 Consumer- - - - - - Total5,921$ 4,642$ 11,396$ 1,768$ 141$ 583$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 4 – LOANS (CONTINUED)
A summary of past due loans at December 31, 2011 is as follows (dollars in thousands):
A roll-forward of nonaccrual activity during the year ended December 31, 2011 (dollars in thousands):
A roll-forward of nonaccrual activity during the year ended December 31, 2010 (dollars in thousands):
32
2011201030-89 days90+ days30-89 days90+ daysPast DuePast Due/Past DuePast Due/(accruing)NonaccrualTotal(accruing)NonaccrualTotalCommercial real estate15$ 2,362$ 2,377$ 19$ 3,522$ 3,541$ Commercial, financial and agricultural137 1,111 1,248 382 760 1,142 Commercial construction- 20 20 - 458 458 One to four family residential real estate188 1,997 2,185 923 1,129 2,052 Consumer construction- - - - 52 52 Consumer14 - 14 20 - 20 Total past due loans354$ 5,490$ 5,844$ 1,344$ 5,921$ 7,265$ Commercial,One to fourCommercialFinancial andCommercialfamily residentialConsumerReal EstateAgriculturalConstructionreal estateConstructionConsumerTotalNONACCRUALBeginning balance3,522$ 760$ 458$ 1,129$ 52$ -$ 5,921$ Principal payments(1,458) (767) (14) (47) - - (2,286) Charge-offs(1,950) (557) (62) (601) - (27) (3,197) Advances- - - - - - - Class transfers- - - - - - - Transfers to OREO(1,203) (262) (382) (1,948) (53) - (3,848) Transfers to accruing(892) - - - - - (892) Transfers from accruing4,301 1,938 - 3,273 20 27 9,559 Other42 (1) - 191 1 - 233 Ending balance2,362$ 1,111$ -$ 1,997$ 20$ -$ 5,490$ Commercial,One to fourCommercialFinancial andCommercialfamily residentialConsumerReal EstateAgriculturalConstructionreal estateConstructionConsumerTotalNONACCRUALBeginning balance8,290$ 2,646$ 1,919$ 1,461$ 52$ -$ 14,368$ Principal payments(5,323) (1,095) (86) (35) - - (6,539) Charge-offs(2,274) (1,539) (48) (1,311) - - (5,172) Advances245 - - - - - 245 Class transfers- - - - - - - Transfers to OREO(4,501) (150) (1,361) (368) - - (6,380) Transfers to accruing(54) (36) - - - - (90) Transfers from accruing6,987 933 24 1,368 - - 9,312 Other152 1 10 14 - - 177 Ending balance3,522$ 760$ 458$ 1,129$ 52$ -$ 5,921$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 4 – LOANS (CONTINUED)
Troubled Debt Restructuring
Troubled debt restructurings (―TDR‖) are determined on a loan-by-loan basis. Generally restructurings are related to
interest rate reductions, loan term extensions and short term payment forbearance as means to maximize collectability of
troubled credits. If a portion of the TDR loan is uncollectible (including forgiveness of principal), the uncollectible amount
will be charged off against the allowance at the time of the restructuring. In general, a borrower must make at least six
consecutive timely payments before the Corporation would consider a return of a restructured loan to accruing status in
accordance with FDIC guidelines regarding restoration of credits to accrual status.
The Corporation has, in accordance with generally accepted accounting principles and per recently enacted accounting
standard updates, evaluated all loan modifications to determine the fair value impact of the underlying asset. The carrying
amount of the loan is compared to the expected payments to be received, discounted at the loan’s original rate, or for
collateral dependent loans, to the fair value of the collateral.
The Corporation, at December 31, 2011, had loans totaling $2.503 million for which repayment terms were modified to the
extent that they were deemed to be ―restructured‖ loans. The $2.503 million is comprised of 2 loans, the largest of which
had a December 31, 2011 balance of $2.400 million. This loan was modified to allow the suspension of principal payments
for ―over a 12-month period‖. This suspension of principal payments on this loan with a 30-year amortization does not
result in a significant change to the net present value of total principal and interest payments over the term of the note. This
loan is deemed collateral dependent, and as such an evaluation of the underlying collateral and ability for repayment based
upon cash flows was done. This evaluation resulted in an estimate of expected loss of principal. As of December 31, 2011,
the Corporation established a $.650 million specific reserve on this loan.
A summary of troubled debt restructurings at December 31 is as follows (dollars in thousands):
A roll-forward of troubled debt restructuring during the year ended December 31, 2011 (dollars in thousands):
33
20112010Number ofRecordedNumber ofRecordedModificationsInvestmentModificationsInvestmentCommercial real estate1 2,400$ 7 4,537$ Commercial, financial and agricultural- - - - Commercial construction- - - - One to four family residential real estate1 103 1 105 Consumer construction- - - - Consumer- - - - Total troubled debt restructurings2 2,503$ 8 4,642$ Commercial,One to fourConsumer andCommercialFinancial andCommercialfamily residentialConsumerReal EstateAgriculturalConstructionreal estateConstructionTotalACCRUINGBeginning balance4,537$ -$ -$ 105$ -$ 4,642$ Principal payments- - - (2) - (2) Charge-offs- - - - - - Advances- - - - - - New restructured2,400 - - - - 2,400 Transfers to performing(582) - - - - (582) Transfers to nonaccrual(3,955) - - - - (3,955) Ending balance2,400$ -$ -$ 103$ -$ 2,503$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 4 – LOANS (CONTINUED)
A roll-forward of troubled debt restructuring during the year ended December 31, 2010 (dollars in thousands):
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):
There were no loans to related-parties classified substandard as of December 31, 2011 and 2010. In addition to the
outstanding balances above, there were unfunded commitments of $.318 million to related parties at December 31, 2011.
NOTE 5 – PREMISES AND EQUIPMENT
Details of premises and equipment at December 31 are as follows (dollars in thousands):
Depreciation of premises and equipment charged to operating expenses amounted to $1.067 million in 2011, $1.098 million
in 2010, and $1.050 million in 2009.
34
Commercial,One to fourConsumer andCommercialFinancial andCommercialfamily residentialConsumerReal EstateAgriculturalConstructionreal estateConstructionTotalACCRUINGBeginning balance869$ -$ -$ -$ -$ 869$ Principal payments(48) - (2) - - (50) Charge-offs- - (632) - - (632) Advances- - - - - - New restructured4,692 - 634 609 - 5,935 Class transfers- - - - - - Transfers to nonaccrual(976) - - (504) - (1,480) Ending balance4,537$ -$ -$ 105$ -$ 4,642$ 20112010Loans outstanding, January 19,532$ 8,552$ New loans933 5,243 Net activity on revolving lines of credit69 2,065 Repayment(1,707) (6,328) Loans outstanding, December 318,827$ 9,532$ 20112010Land1,811$ 1,811$ Buildings and improvements12,141 11,925 Furniture, fixtures, and equipment4,933 4,770 Construction in progress196 12 Total cost basis19,081 18,518 Less - accumulated depreciation 9,454 8,858 Net book value9,627$ 9,660$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
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):
NOTE 7 – DEPOSITS
The distribution of deposits at December 31 is as follows (dollars in thousands):
Maturities of non-brokered time deposits outstanding at December 31, 2011 are as follows (dollars in thousands):
Maturities of brokered deposits outstanding at December 31, 2011 are as follows (dollars in thousands):
35
20112010Balance, January 15,562$ 5,804$ Other real estate transferred from loans due to foreclosure4,194 5,373 Other real estate sold(5,457) (2,862) Writedowns of other real estate held for sale(855) (2,703) Loss on other real estate held for sale(282) (50) Balance, December 313,162$ 5,562$ 20112010Noninterest bearing51,273$ 41,264$ NOW, money market, checking152,563 134,703 Savings14,203 17,670 CDs <$100,000130,685 96,977 CDs >$100,00023,229 22,698 Brokered32,836 73,467 Total deposits404,789$ 386,779$ 201278,937$ 201349,132 201410,332 201513,227 20162,038 Thereafter248 Total153,914$ 2012-$ 2013- 20147,844 201510,540 201612,506 Thereafter1,946 Total32,836$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 8 – MORTGAGE SERVICING RIGHTS
Mortgage servicing rights (―MSRs‖) are recorded when loans are sold in the secondary market with servicing retained. As
of December 31, 2011, the Corporation had obligations to service approximately $50 million of residential first mortgage
loans. The valuation is based upon the net present value of the projected revenues over the expected life of the loans being
serviced, as reduced by estimated internal costs to service these loans. The fair value of the capitalized servicing rights
approximates the carrying value. The key economic assumptions used in determining the fair value of the mortgage
servicing rights include an annual constant prepayment speed of 15.90 and a discount rate of 7.50% for December 31, 2011.
The following summarizes mortgage servicing rights capitalized and amortized, along with the aggregate activity in related
valuation allowances (dollars in thousands):
NOTE 9 – BORROWINGS
Federal Home Loan Bank borrowings consist of the following at December 31 (dollars in thousands):
The Federal Home Loan Bank borrowings are collateralized at December 31, 2011 by the following: a collateral agreement
on the Corporation’s one to four family residential real estate loans with a book value of approximately $37.416 million;
mortgage related and municipal securities with an amortized cost and estimated fair value of $19.793 million and $20.883
million, respectively; and Federal Home Loan Bank stock owned by the Bank totaling $3.060 million. Prepayment of the
advances is subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank of Indianapolis in
effect as of December 31, 2011.
The U.S.D.A. Rural Development borrowing is collateralized by loans totaling $.160 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 $.935 million, and guaranteed by the Corporation.
Maturities and principal payments of borrowings outstanding at December 31, 2011 are as follows (dollars in thousands):
36
December 31,2011Balance at beginning of period-$ Additions from loans sold with servicing retained415 Changes in valuation- Loan payments and payoffs(15) Fair value of MSRs at end of period400$ 20112010Federal Home Loan Bank fixed rate advances at rates ranging from 1.30% to 2.45%35,000$ -$ maturing in 2013, 2014 and 2016Federal Home Loan Bank fixed rate advances at rates ranging from .61% to 2.10 maturing in 2011 and 2014- 15,000 Federal Home Loan Bank variable rate advances at rates ranging from .306% to .309% maturing in 2011- 20,000 Farmers Home Administration, fixed-rate note payable, maturing August 24, 2024 interest payable at 1%997 1,069 35,997$ 36,069$ 201272$ 201310,073 201410,074 201574 201615,075 Thereafter629 Total35,997$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 10 – INCOME TAXES
The components of the federal income tax provision (credit) for the years ended December 31 are as follows (dollars in
thousands):
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):
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):
37
201120102009Current tax expense (benefit)314$ -$ -$ Change in valuation allowance- (2,136) - Deferred tax expense (benefit)784 (1,364) 1,120 Total provision (credit) for income taxes1,098$ (3,500)$ 1,120$ 201120102009Tax expense at statutory rate1,127$ (1,332)$ 1,202$ Increase (decrease) in taxes resulting from: Tax-exempt interest(59) (73) (106) Change in valuation allowance- (2,136) - Other30 41 24 Provision for (benefit of) income taxes, as reported1,098$ (3,500)$ 1,120$ 20112010Deferred tax assets: NOL carryforward9,073$ 9,342$ Allowance for loan losses1,785 2,248 Alternative Minimum Tax Credit1,463 1,463 OREO Tax basis > book basis1,050 1,081 Tax credit carryovers672 672 Deferred compensation217 247 Stock option compensation172 204 Depreciation225 118 Intangible assets77 95 Other110 11 Total deferred tax assets14,844 15,481 Valuation allowance(6,010)$ (6,010)$ Deferred tax liabilities: FHLB stock dividend(103) (128) Unrealized gain on securities(168) (315) Mortgage servicing rights(136) - Total deferred tax liabilities(407) (443) Net deferred tax asset 8,427$ 9,028$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 10 – INCOME TAXES (CONTINUED)
A valuation allowance is provided against deferred tax assets when it is more likely than not that some or all of the deferred
tax asset will not be realized. The Corporation, as of December 31, 2011 had a net operating loss and tax credit
carryforwards for tax purposes of approximately $26.7 million, and $2.1 million, respectively. The Corporation will
continue to evaluate the future benefits from these carryforwards and at such time as it becomes ―more likely than not‖ that
they would be utilized prior to expiration will recognize the additional benefits as an adjustment to the valuation allowance.
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 $15.6 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.
NOTE 11 – OPERATING LEASES
The Corporation currently maintains three 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 original term of this was extended during 2011 for an additional three year term.
The second operating lease, for our location in Escanaba, was executed in December 2008, the terms of which began 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, but either party may elect to terminate by providing notice of such election to the
other party at least 120 days prior to the end of the then-current term. The additional terms call for a lease adjustment based
on the Consumer Price Index at time of renewal. The Corporation signed an extension on this lease through September
2012. The Corporation is currently in the process of building a new banking facility in Escanaba to replace its current
leased location.
The third operating lease, for a second location in Manistique, was executed in April 2010, the terms of which began at that
time. 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):
Rent expense for all operating leases amounted to $260,000 in 2011, $270,000 in 2010, and $207,000 in 2009.
NOTE 12 – 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 $125,000, $110,000, and $120,000 in 2011,
2010, and 2009, respectively.
38
2012228$ 2013190 201447 Total465$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 13 – DEFERRED COMPENSATION PLAN
Prior to the recapitalization in 2004, 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,
2011 and 2010, for vested benefits under this plan, was $.638 million and $.725 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 $1.626 million and $1.559 million at December 31, 2011 and
2010, respectively. Deferred compensation expense for the plan was $35,000, $43,000, and $72,000 for 2011, 2010, and
2009, respectively.
NOTE 14 – REGULATORY MATTERS
The Corporation is subject to various regulatory capital requirements administered by the federal banking agencies. Failure
to meet minimum capital requirements can initiate certain mandatory—and possibly additional discretionary—actions by
regulators that, if undertaken, could have a direct material effect on the Corporation’s consolidated financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation must meet
specific capital guidelines that involve quantitative measures of the Corporation’s assets, liabilities, and certain off-balance-
sheet items as calculated under regulatory accounting practices. The Corporation’s capital amounts and classification are
also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum
amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to
average assets. Management has determined that, as of December 31, 2011, 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.
39
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 14 – REGULATORY MATTERS (CONTINUED)
The Corporation’s and the Bank’s actual and required capital amounts and ratios as of December 31 are as follows (dollars
in thousands):
At December 31, 2011, 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.
NOTE 15 – 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. This plan expired on February
15, 2010. The other two plans, one for officers and employees and the other for non-employee directors, were approved in
1997 and expired in 2007. A total of 30,000 shares were made available for grant under these plans. Options under all of
the plans were granted at the discretion of a committee of the Corporation’s Board of Directors. Options to purchase shares
of the Corporation’s stock were granted at a price equal to the market price of the stock at the date of grant. The committee
determined the vesting of the options when they were granted as established under the plan.
40
ActualAdequacy PurposesAction ProvisionsAmountRatioAmountRatioAmountRatio2011Total capital to risk weighted assets: Consolidated56,304$ 12.9%>33,314$ > 8.0%N/AN/A mBank49,551$ 11.9%>33,309$ > 8.0%>41,637$ 10.0%Tier 1 capital to risk weighted assets: Consolidated48,398$ 11.6%>16,657$ > 4.0%N/AN/A mBank44,346$ 10.7%>16,655$ > 4.0%>20,818$ 6.0%Tier 1 capital to average assets: Consolidated44,398$ 10.1%>19,205$ > 4.0%N/AN/A mBank44,364$ 9.2%>19,196$ > 4.0%>23,995$ 5.0%2010Total capital to risk weighted assets: Consolidated49,132$ 12.6%>31,157$ > 8.0%N/AN/A mBank43,477$ 11.2%>31,118$ > 8.0%>38,897$ 10.0%Tier 1 capital to risk weighted assets: Consolidated44,242$ 11.4%>15,579$ > 4.0%N/AN/A mBank38,594$ 9.9%>15,559$ > 4.0%>23,338$ 6.0%Tier 1 capital to average assets: Consolidated44,242$ 9.3%>19,130$ > 4.0%N/AN/A mBank38,594$ 8.1%>19,092$ > 4.0%>23,865$ 5.0%
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 15 – STOCK OPTION PLANS (CONTINUED)
A summary of stock option transactions for the years ended December 31 is as follows:
There were no options granted in 2011 and in 2010.
Following is a summary of the options outstanding and exercisable at December 31, 2011:
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 was expensed based upon the vesting period without
consideration given to market value appreciation. There are no future compensation expenses related to existing option
programs.
41
20112010Outstanding shares at beginning of year394,072 411,057 Granted during the year- - Exercised during the year- - Expired / forfeited during the year(1,920) (16,985) Outstanding shares at end of year392,152 394,072 Exercisable shares at end of year148,861150,781 Weighted average exercise price per share at end of year10.27$ 10.98$ Shares available for grant at end of year-$ -$ WeightedAverageRemainingExercise ContractualPriceOutstandingExercisableUnvested OptionsLife-Years9.16$ 5,000 2,000 3,000 4.96 9.75$ 257,152 120,861 136,291 3.96 10.65$ 50,000 10,000 40,000 5.96 11.50$ 40,000 8,000 32,000 4.75 12.00$ 40,000 8,000 32,000 4.46 392,152 148,861 243,291 3.35 Number of Shares
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 16 – OTHER COMPREHENSIVE INCOME (LOSS)
Other comprehensive income (loss) components and related taxes for the years ended December 31 are as follows (dollars
in thousands):
NOTE 17 – SHAREHOLDERS’ EQUITY
Participation in the TARP Capital Purchase Program
On April 24, 2009, the Corporation entered into and closed a Letter Agreement, including the Securities Purchase
Agreement-Standard Terms (collectively, the ―Securities Purchase Agreement‖), related to the CPP. Pursuant to the
Securities Purchase Agreement, the Corporation issued and sold to the Treasury (i) 11,000 shares of the Corporation’s
Series A Preferred Shares, and (ii) a 10-year Warrant to purchase 379,310 shares of the Corporation’s Common Shares, at
an exercise price of $4.35 per share (subject to certain anti-dilution and other adjustments), for aggregate proceeds of
$11.000 million in cash.
As a result of the CPP transaction, the Corporation is required to take certain actions, for so long as the Treasury holds any
securities acquired from the Corporation pursuant to the CPP (excluding any period in which the Treasury holds only the
Warrant to purchase Common Shares of the Corporation) (the ―CPP Period‖), to ensure that its executive compensation and
benefit plans with respect to Senior Executive Officers (as defined in the relevant agreements) comply with Section 111(b)
of Emergency Economic Stabilization Act of 2008 (―EESA‖), as implemented by any guidance or regulations issued under
Section 111(b) of EESA, and not adopt any benefit plans with respect to, or which cover, the Corporation’s Senior
Executive Officers that do not comply with EESA, as amended by the American Recovery and Reinvestment Act of 2009
(the ―ARRA‖), which was passed by Congress and signed by the President on February 17, 2009. The applicable executive
compensation standards generally remain in effect during the CPP Period and apply to the Corporation’s Senior Executive
Officers (which for purposes of the ARRA and the CPP agreements, includes the Corporation’s Chief Executive Officer, its
Chief Financial Officer, and the next three most highly-compensated executive officers, even though the Corporation’s
senior executive officers consist of a smaller group of executives for purposes of the other compensation disclosures in this
proxy statement).
Amounts recorded for Preferred Stock and Warrant Common Stock were estimated based on an allocation of the total
proceeds from the issuance on the relative fair values of both instruments. Fair value of the Preferred Stock was determined
based on assumptions regarding the discount rate (market rate) on the Preferred Stock (estimated 12%). Fair value of the
Warrant Common Stock is based on the value of the underlying Preferred Stock based on an estimate for a three year term.
The allocation of the proceeds received resulted in the recording of a discount on the Preferred Stock and a premium on the
Warrant Common Stock. The discount on the preferred will be accreted on an effective yield basis over a three-year term.
The allocated carrying value of the Preferred Stock and Warrant Common Stock on the date of issuance (based on their
relative fair values) was $10.382 million and $.618 million, respectively. Cumulative dividends on the Preferred Stock are
payable at 5% annum for the first five years and at a rate of 9% per annum thereafter on the liquidation preference of
$1,000 per share. The Company is prohibited from paying any dividend with respect to shares of common stock unless all
accrued and unpaid dividends are paid in full on the Preferred Stock for all past dividend periods. The Preferred Stock is
non-voting, other than class voting rights on matters that could adversely affect the Preferred Stock. The Preferred Stock
may be redeemed at any time with regulatory approval. The Treasury may also transfer the Preferred Stock to a third party
at any time. The preferred stock qualifies as Tier 1 Capital for regulatory purposes at the holding company.
42
201120102009Unrealized holding gains (losses) on available for sale securities(435)$ (513)$ 2,451$ Less reclassification adjustments for gains (losses) later recognized in income(1) 215 1,471 Net unrealized gains (losses)(434) (728) 980 Tax effect(147) (247) 332 Other comprehensive income (loss)(287)$ (481)$ 648$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 17 – SHAREHOLDERS’ EQUITY (CONTINUED)
The Corporation has the right to redeem the Series A Preferred Shares at any time after consulting with its primary
regulator, in which case the executive compensation standards would no longer apply to the Corporation.
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 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.
Legal Proceedings and Contingencies
At December 31, 2011, there were no pending material legal proceedings to which the Corporation is a party or to which
any of its property was subject, except for proceedings which arise in the ordinary course of business. In the opinion of
management, pending legal proceedings will not have a material effect on the consolidated financial position or results of
operations of the Corporation.
43
20112010Commitments to extend credit: Variable rate28,495$ 18,092$ Fixed rate15,453 13,034 Standby letters of credit - Variable rate3,523 2,192 Credit card commitments - Fixed rate3,019 2,737 50,490$ 36,055$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 18 - COMMITMENTS, CONTINGENCIES, AND CREDIT RISK (CONTINUED)
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, 2011 represents $75.391 million, or 24.22%, compared to $58.114 million,
or 19.56%, of the commercial loan portfolio on December 31, 2010. 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
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 and other inputs such as interest rates and yield curves
that are observable at commonly quoted intervals.
Federal Home Loan Bank stock – Federal Home Loan Bank stock is carried at cost, which is its redeemable value and
approximates its fair value, since the market for this stock is limited.
Loans - Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type
such as commercial, residential mortgage, and other consumer. The fair value of loans is calculated by discounting
scheduled cash flows using discount rates reflecting the credit and interest rate risk inherent in the loan.
The methodology in determining fair value of nonaccrual loans is to average them into the blended interest rate at 0%
interest. This has the effect of decreasing the carrying amount below the risk-free rate amount and, therefore, discounts the
estimated fair value.
Impaired loans are measured at the estimated fair value of the expected future cash flows at the loan’s effective interest rate
or the fair value of the collateral for loans which are collateral dependent. Therefore, the carrying values of impaired loans
approximate the estimated fair values for these assets.
Deposits - The fair value of deposits with no stated maturity, such as noninterest-bearing demand deposits and savings, is
equal to the amount payable on demand at the reporting date. The fair value of time deposits is based on the discounted
value of contractual cash flows applying interest rates currently being offered on similar time deposits.
Borrowings - Rates currently available for debt with similar terms and remaining maturities are used to estimate the fair
value of existing debt. The fair value of borrowed funds due on demand is the amount payable at the reporting date.
Accrued interest - The carrying amount of accrued interest approximates fair value.
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.
44
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 19 - FAIR VALUE (CONTINUED)
The following table presents information for financial instruments at December 31 (dollars in thousands):
Limitations - Fair value estimates are made at a specific point in time based on relevant market information and
information about the financial instrument. These estimates do not reflect any premium or discount that could result from
offering for sale at one time the Corporation’s entire holdings of a particular financial instrument. Because no market exists
for a significant portion of the Corporation’s financial instruments, fair value estimates are based on judgments regarding
future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other
factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value
estimates are based on existing on-and off-balance-sheet financial instruments without attempting to estimate the value of
anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant
assets and liabilities that are not considered financial assets or liabilities include premises and equipment, other assets, and
other liabilities. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a
significant effect on fair value estimates and have not been considered in the estimates.
The following is information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at
December 31, 2011 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.
45
Fair Value MeasurementsCarryingEstimatedCarryingEstimatedAmountFair ValueAmountFair ValueFinancial assets: Cash and cash equivalents34,070$ 34,070$ 34,719$ 34,719$ Interest-bearing deposits10 10 713 713 Securities available for sale38,727 38,727 33,860 33,860 Federal Home Loan Bank stock3,060 3,060 3,423 3,423 Net loans395,995 394,463 376,473 376,713 Accrued interest receivable1,261 1,261 1,155 1,155 Total financial assets473,123$ 471,591$ 450,343$ 450,583$ Financial liabilities: Deposits404,789$ 404,821$ 386,779$ 387,885$ Borrowings35,997 35,634 36,069 36,234 Accrued interest payable202 202 232 232 Total financial liabilities440,988$ 440,657$ 423,080$ 424,351$ 20102011
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 19 - FAIR VALUE (CONTINUED)
The fair value of all investment securities at December 31, 2011 and December 31, 2010 were based on level 2 inputs.
There are no other assets or liabilities measured on a recurring basis at fair value. For additional information regarding
investment securities, please refer to ―Note 3 – Investment Securities.‖
The Corporation had no Level 3 assets or liabilities on a recurring basis as of December 31, 2011 or December 31, 2010.
In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value
measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The
Corporation’s assessment of the significance of particular inputs to these fair value measurements requires judgment and
considers factors specific to each asset or liability.
The Corporation also has assets that under certain conditions are subject to measurement at fair value on a non-recurring
basis. These assets include loans and other real estate held for sale. The Corporation has estimated the fair values of these
assets using Level 3 inputs, specifically discounted cash flow projections.
The Corporation had no investments subject to fair value measurement on a nonrecurring basis.
Impaired loans 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).
46
(dollars in thousands)Quoted PricesSignificantSignificantin Active MarketsOther ObservableUnobservableTotal Losses forBalance atfor Identical AssetsInputsInputsYear EndedDecember 31, 2011(Level 1)(Level 2)(Level 3)December 31, 2011AssetsImpaired loans7,993$ -$ -$ 7,993$ 3,200$ Other real estate held for sale3,162 - - 3,162 1,137 4,337$ Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2011(dollars in thousands)Quoted PricesSignificantSignificantin Active MarketsOther ObservableUnobservableTotal Losses forBalance atfor Identical AssetsInputsInputsYear EndedDecember 31, 2010(Level 1)(Level 2)(Level 3)December 31, 2010AssetsImpaired Loans10,563$ -$ -$ 10,563$ 1,666$ Other real estate held for sale5,562 - - 5,562 2,753 4,419$ Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2010
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 20 - PARENT COMPANY ONLY FINANCIAL STATEMENTS
BALANCE SHEETS
December 31, 2011 and 2010
(Dollars in Thousands)
47
ASSETS20112010Cash and cash equivalents4,301$ 5,353$ Investment in subsidiaries51,381 49,016 Other assets245 275 TOTAL ASSETS55,927$ 54,644$ LIABILITIES AND SHAREHOLDERS' EQUITYOther liabilities664$ 762$ Shareholders' equity: Preferred stock - no par value: Authorized 500,000 shares, 11,000 shares issued and outstanding10,921 10,706 Common stock and additional paid in capital - no par value Authorized 18,000,000 shares Issued and outstanding - 3,419,73643,525 43,525 Accumulated earnings (deficit)492 (961) Accumulated other comprehensive income325 612 Total shareholders' equity55,263 53,882 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY55,927$ 54,644$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 20 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF OPERATIONS
Years Ended December 31, 2011, 2010, and 2009
(Dollars in Thousands)
48
201120102009INCOME: Interest income3$ 11$ 8$ Total income3 11 8 EXPENSES: Salaries and benefits180 218 250 Professional service fees245 136 196 Other223 147 227 Total expenses648 501 673 Income (loss) before income taxes and equity in undistributed net income (loss) of subsidiaries(645) (490) (665) Provision for (benefit of) income taxes(211) - (226) (Loss) before equity in undistributed net income (loss) of subsidiaries(434) (490) (439) Equity in undistributed net income of subsidiaries2,652 72 2,855 Net income (loss)2,218 (418) 2,416 Preferred dividend and accretion of discount766 742 509 NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS1,452$ (1,160)$ 1,907$
Notes to the Consolidated Financial Statements
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 20 - PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2011, 2010, and 2009
(Dollars in Thousands)
49
201120102009Cash Flows from Operating Activities: Net income (loss)2,218$ (418)$ 2,416$ Adjustments to reconcile net income to net cash provided by operating activities: Equity in undistributed net (income) loss of subsidiaries(2,652) (72) (2,855) Increase in capital from stock option compensation- 32 60 Change in other assets29 31 (348) Change in other liabilities(97) (149) 32 Net cash (used in) operating activities(502) (576) (695) Cash Flows from Financing Activities: Proceeds from issuance of Series A Preferred Stock and common stock warrants- - 11,000 Dividend on preferred stock(551) (550) (307) Payments from subsidiaries- - 69 Investments in subsidiaries- (1,000) (3,000) Net cash (used in) provided by financing activities(551) (1,550) 7,762 Net increase (decrease) in cash and cash equivalents(1,053) (2,126) 7,067 Cash and cash equivalents at beginning of period5,354 7,480 413 Cash and cash equivalents at end of period4,301$ 5,354$ 7,480$
Selected Financial Data
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
SELECTED FINANCIAL DATA
(Unaudited)
(Dollars in Thousands, Except Per Share Data)
50
20112010200920082007SELECTED FINANCIAL CONDITION DATA: Total assets498,311$ 478,696$ 515,377$ 451,431$ 408,880$ Loans401,246 383,086 384,310 370,280 355,079 Securities38,727 33,860 46,513 47,490 21,597 Deposits404,789 386,779 421,389 371,097 320,827 Borrowings35,997 36,069 36,140 36,210 45,949 Common shareholders' equity44,342 43,176 44,785 41,552 39,321 Total shareholders' equity55,263 53,882 55,299 41,552 39,321 SELECTED OPERATIONS DATA: Interest income23,072$ 22,840$ 23,708$ 24,562$ 28,695$ Interest expense5,143 6,455 7,421 11,698 (15,278) Net interest income17,929 16,385 16,287 12,864 13,417 Provision for loan losses2,300 6,500 3,700 2,300 400 Net security gains (losses)(1) 215 1,471 64 (1) Other income3,657 2,580 3,280 4,589 2,007 Other expenses(15,969) (16,598) (13,802) (12,558) (12,100) Income (loss) before income taxes3,316 (3,918) 3,536 2,659 2,923 Provision (credit) for income taxes1,098 (3,500) 1,120 787 (7,240) Net income (loss)2,218 (418) 2,416 1,872 10,163 Preferred dividend and accretion of discount766 742 509 - - Net income available to common shareholders1,452$ (1,160)$ 1,907$ 1,872$ 10,163$ PER SHARE DATA: Earnings (loss) - Basic.42$ (.34)$ .56$ .55$ 2.96$ Earnings (loss) - Diluted.41 (.34) .56 .55 2.96 Cash dividends declared- - - - - Book value12.97 12.63 13.10 12.15 11.47 Market value - closing price at year end5.42 4.58 4.64 4.40 8.98 FINANCIAL RATIOS: Return on average common equity3.30 %(2.64) %4.42 %4.61 %31.05 % Return on average total equity2.66 (2.06) 3.77 4.61 31.05 Return on average assets.30 (.23) .39 .442.59 Dividend payout ratioN/AN/AN/AN/AN/A Average equity to average assets 11.15 11.17 10.24 9.55 8.34 Efficiency ratio69.56 72.57 72.24 85.51 79.46 Net interest margin4.06 3.66 3.59 3.23 3.60 Years Ended December 31
Summary Quarterly Financial Information
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
SUMMARY QUARTERLY FINANCIAL INFORMATION
(Unaudited)
(Dollars in Thousands, Except per Share Data)
51
12/319/306/303/3112/319/306/303/31BALANCE SHEETTotal loans401,246$ 391,903$ 394,812$ 374,609$ 383,086$ 382,727$ 384,839$ 377,311$ Allowance for loan losses(5,251) (5,838) (6,155) (6,184) (6,613) (5,437) (6,371) (4,737) Total loans, net395,995 386,065 388,657 368,425 376,473 377,290 378,468 372,574 Intangible assets- - - - - - - - Total assets498,311 498,598 492,373 492,790 478,696 499,006 500,774 502,427 Core deposits348,724 346,843 329,958 315,638 290,614 287,055 271,026 236,227 Noncore deposits (1)56,065 58,215 69,709 85,145 96,165 117,469 134,758 168,985 Total deposits404,789 405,058 399,667 400,783 386,779 404,524 405,784 405,212 Total borrowings35,997 35,997 36,069 36,069 36,069 36,069 36,140 36,140 Total shareholders' equity55,263 55,479 54,784 54,097 53,882 55,987 56,231 58,722 Total shares outstanding3,419,736 3,419,736 3,419,736 3,419,736 3,419,736 3,419,736 3,419,736 3,419,736 AVERAGE BALANCE SHEETTotal loans396,197$ 397,665$ 378,250$ 380,066$ 385,296$ 385,268$ 382,169$ 384,640$ Allowance for loan losses(5,251) (6,070) (6,371) (6,687) (5,816) (6,094) (5,159) (5,073) Total loans, net390,946 391,595 371,879 373,379 379,480 379,174 377,010 379,567 Intangible assets- - - - - - - - Total assets487,304 497,333 494,481 478,861 488,320 512,335 502,942 508,495 Core deposits347,700 342,294 322,119 298,241 286,807 285,697 255,023 221,284 Noncore deposits (1)43,241 61,663 82,430 88,502 106,459 131,150 150,426 192,613 Total deposits390,941 403,957 404,549 386,743 393,266 416,847 405,449 413,897 Total borrowings38,117 36,045 36,069 36,609 36,069 36,115 36,140 36,140 Total shareholders' equity55,219 54,998 54,138 53,870 55,015 56,668 57,889 55,109 ASSET QUALITY RATIOSNonperforming loans/total loans1.99 %2.47 %2.39 %2.47 %2.76 %2.94 %2.87 %2.62 %Nonperforming assets/total assets2.24 2.99 2.89 2.99 3.37 3.41 3.34 3.51 Allowance for loan losses/total loans1.18 1.49 1.56 1.49 1.73 1.42 1.66 1.26 Allowance for loan losses/nonperforming loans65.69 60.35 65.19 60.35 62.61 48.34 57.69 47.87 Net charge-offs/average loans.48 .18 .17 .11 .16 .50 .31 .36 Texas Ratio (2)18.43 24.2823.3824.2826.6627.6826.7127.76CAPITAL ADEQUACY RATIOSTier 1 leverage ratio10.08 %9.73 %9.50 %9.70 %9.25 %9.22 %9.38 %9.85 %Tier 1 capital to risk weighted assets11.62 11.65 11.40 11.69 11.36 11.73 11.65 12.48 Total capital to risk weighted assets12.87 12.97 12.66 12.94 12.62 12.98 12.91 13.69 Average equity/average assets11.33 11.06 10.95 11.25 11.27 11.06 11.51 10.84 Tangible equity/tangible assets11.33 11.06 10.95 11.25 11.27 11.06 11.51 10.84 (1) Noncore deposits include brokered deposits and CDs greater than $100,000(2) Texas Ratio: Nonperforming Assets Divided by Total Equity plus Allowance for Loan Losses2011FOR THE QUARTER ENDEDFOR THE QUARTER ENDED2010
Summary Quarterly Financial Information
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
SUMMARY QUARTERLY FINANCIAL INFORMATION
(Unaudited)
(Dollars in Thousands, Except per Share Data)
52
12/319/306/303/3112/319/306/303/31INCOME STATEMENTNet interest income4,901$ 4,709$ 4,178$ 4,141$ 4,276$ 4,064$ 4,023$ 4,022$ Provision for loan losses1,300 400 600 - 1,800 1,000 2,800 900 Net interest income after provision3,601 4,309 3,578 4,141 2,476 3,064 1,223 3,122 Total noninterest income725 1,006 1,348 577 747 648 593 807 Total noninterest expense4,221 3,960 3,729 4,059 4,037 3,601 5,330 3,629 Income before taxes105 1,355 1,197 659 (814) 111 (3,514) 300 Provision for income taxes27 455 402 214 1,093 30 (1,212) (3,411) Net income78 900 795 445 (1,907) 81 (2,302) 3,711 Preferred dividend and accretion of discount192 193 192 189 185 185 186 185 Net income available to common shareholders(114)$ 707$ 603$ 256$ (2,092)$ (104)$ (2,488)$ 3,526$ PER SHARE DATAEarnings (loss) - basic(.03)$ .21$ .18$ .07$ (.61)$ (.03)$ (.73)$ 1.03$ Earnings (loss) - diluted(.03) .20 .17 .07 (.61) (.03) (.73) 1.03 Book value 12.97 13.05 12.86 12.67 12.63 13.26 13.34 14.08 Market value5.42 5.46 6.00 6.02 4.58 5.10 6.50 4.72 PROFITABILITY RATIOSReturn on average assets(.09) %.56 %.49 %.22 %(1.70) %(.08) %(1.98) %2.81 %Return on average common equity(1.02) 6.35 5.58 2.35 (18.76) (.91) (21.28) (30.77) Return on average total equity(.82) 5.10 4.47 1.93 (15.09) (.73) (17.24) 25.95 Net interest margin4.38 4.14 3.79 3.92 3.88 3.69 3.56 3.51 Efficiency ratio69.04 67.39 67.84 75.73 65.05 75.98 76.04 78.12 Average loans/average deposits101.34 96.96 96.19 98.27 97.97 92.42 94.26 92.93 FOR THE QUARTER ENDED 2011FOR THE QUARTER ENDED 2010
Market Information
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
MARKET INFORMATION
(Unaudited)
The Corporation’s common stock is traded on the NASDAQ Capital Market under the symbol MFNC. The following table
sets forth the range of high and low trading prices of the Corporation’s common stock from January 1, 2010 through
December 31, 2011, as reported by NASDAQ.
The Corporation had approximately 1,200 shareholders of record as of March 30, 2012.
The holders of the Corporation’s common stock are entitled to dividends when, and if declared by the Board of Directors of
the Corporation, out of funds legally available for that purpose. In determining dividends, the Board of Directors considers
the earnings, capital requirements and financial condition of the Corporation and its subsidiary bank, along with other
relevant factors. The Corporation’s principal source of funds for cash dividends is the dividends paid by the Bank. The
ability of the Corporation and the Bank to pay dividends is subject to regulatory restrictions and requirements. The Bank
currently has a negative retained earnings position which precludes payment of dividends. The Bank, in order to pay
dividends, would need to eliminate the negative retained earnings position and have regulatory approval. There were no
dividends declared or paid in 2009, 2010 and 2011. There were no sales of unregistered securities in 2011, nor were there
any repurchases of the Corporation’s common stock in 2011.
53
2011March 31June 30September 30December 31High6.52$ 6.20$ 7.01$ 5.94$ Low4.58 4.85 4.96 4.63 Close6.02 6.00 5.46 5.42 Book value12.67 12.86 13.05 12.97 2010High5.20$ 7.39$ 6.95$ 5.28$ Low4.09 4.51 4.74 3.95 Close4.72 6.50 5.10 4.58 Book value14.08 13.34 13.26 12.63 For the Quarter Ended
Shareholder Return Performance Graph
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
Shown 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 Index and the NASDAQ
Composite Index for the five-year period ended December 31, 2011. The following information is based on an investment
of $100, on December 31, 2006 in the Corporation’s common stock, the NASDAQ Bank Index, and the NASDAQ
Composite Index, with dividends reinvested.
This graph and other information contained in this section shall not be deemed to be ―soliciting‖ material 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.
54
COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*Among Mackinac Financial Corporation, the NASDAQ Composite Index, and the NASDAQ Bank Index$0$20$40$60$80$100$12012/0612/0712/0812/0912/1012/11Mackinac Financial CorporationNASDAQ CompositeNASDAQ Bank*$100 invested on 12/31/06 in stock or index, including reinvestment of dividends.Fiscal year ending December 31.
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:
The highly regulated environment in which the Corporation operates could adversely affect its ability to carry out
its strategic plan due to restrictions on new products, funding opportunities or new market entrances;
General economic conditions, either nationally or in the state(s) in which the Corporation does business;
Legislation or regulatory changes which affect the business in which the Corporation is engaged;
Changes in the level and volatility of interest rates which may negatively affect the Corporation’s interest margin;
Changes in securities markets with respect to the market value of financial assets and the level of volatility in
certain markets such as foreign exchange;
Significant increases in competition in the banking and financial services industry resulting from industry
consolidation, regulatory changes and other factors, as well as action taken by particular competitors;
The ability of borrowers to repay loans;
The effects on liquidity of unusual decreases in deposits;
Changes in consumer spending, borrowing, and saving habits;
Technological changes;
Acquisitions and unanticipated occurrences which delay or reduce the expected benefits of acquisitions;
Difficulties in hiring and retaining qualified management and banking personnel;
The Corporation’s ability to increase market share and control expenses;
The effect of compliance with legislation or regulatory changes;
The effect of changes in accounting policies and practices;
The costs and effects of existing and future litigation and of adverse outcomes in such litigation; and
An increase in the Corporation’s FDIC insurance premiums, or the collection of special assessments by the FDIC.
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.
55
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
OVERVIEW
The following discussion and analysis presents the more significant factors affecting the Corporation’s financial condition
as of December 31, 2011 and 2010 and the results of operations for 2009 through 2011. This discussion also covers asset
quality, liquidity, interest rate sensitivity, and capital resources for the years 2010 and 2011. 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.
Taxable equivalent adjustments are the result of increasing income from tax-free loans and investments by an amount equal
to the taxes that would be paid if the income were fully taxable based on a 34% federal tax rate, thus making tax-exempt
yields comparable to taxable asset yields.
Dollar amounts in tables are stated in thousands, except for per share data.
EXECUTIVE SUMMARY
The purpose of this section is to provide a brief summary of the 2011 results of operations and financial condition. A more
detailed analysis of the results of operations and financial condition follows this summary.
The Corporation reported a profit available to common shareholders in 2011 of $1.452 million, or $.42 per share, compared
to a loss of $1.160 million, $.34 per share, in 2010 and net income in 2009 of $1.907 million, $.56 per share.
Total assets of the Corporation at December 31, 2011, were $498.311 million, an increase of $19.615 million, or 4.10%
from total assets of $478.696 million reported at December 31, 2010. In 2011, the Corporation showed increased balances
in both investments and loans, which were funded primarily with Bank core deposit growth.
At December 31, 2011, the Corporation’s loans stood at $401.246 million, an increase of $18.160 million, or 4.74%, from
2010 year-end balances of $383.086 million. Total loan production in 2011 amounted to $172.577 million, which included
$38.971 million of secondary market mortgage loans sold. The Corporation also sold $18.970 million of SBA/USDA
guaranteed loans. Loan balances were also impacted by normal amortization and paydowns, some of which related to
payoffs on participation loans.
Nonperforming loans totaled $7.993 million, or 1.99% of total loans at December 31, 2011. Nonperforming assets at
December 31, 2011, were $11.155 million, 2.24% of total assets, compared to $16.125 million or 3.37% of total assets at
December 31, 2010.
Total deposits increased from $386.779 million at December 31, 2010, to $404.789 million at December 31, 2011, an
increase of 4.66%. The increase in deposits in 2011 was comprised of a decrease in wholesale deposits of $40.100 million
and an increase in core deposits of $58.110 million.
Shareholders’ equity totaled $55.263 million at December 31, 2011, compared to $53.882 million at the end of 2010, an
increase of $1.381 million. This increase reflects the consolidated net income of $1.452 million, the after tax decrease in
the market value of available-for-sale investments, which amounted to $.287 million and the increase from the accretion of
the discount on preferred stock of $.215 million. The book value per common share at December 31, 2011, amounted to
$12.97 compared to $12.63 at the end of 2010.
56
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
RESULTS OF OPERATIONS
Summary
The Corporation reported net income available to common shareholders of $1.452 million in 2011, compared to a net loss
of $1.160 million in 2010 and net income of $1.907 million in 2009. The 2011 results include significantly reduced credit
related expenses and a decreased loan loss provision. The loan loss provision in 2011 was $2.300 million, with write-
downs and losses on other real estate held for sale of $1.137 million. Also included in 2011 results are income of $1.500
million from SBA/USDA loan sales and the initial valuation of mortgage servicing rights of $.400 million. The 2010
results reflected elevated costs associated with nonperforming assets, including loan loss provisions of $6.500 million and
write-downs and losses on other real estate held for sale of $2.753 million. The 2009 results include $1.208 million of
gains related to branch office sales and $1.471 million of security gains.
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 funding sources.
Net interest revenue is the Corporation’s principal source of revenue, representing 83% of total revenue in 2011. The net
interest income is impacted by economic and competitive factors that influence rates, loan demand, and the availability of
funding.
Net interest income on a taxable equivalent basis increased $1.523 million from $16.496 million in 2010 to $18.019
million, in 2011. In 2011, interest rates were stable with the prime rate at 3.25% for the entire year. The Corporation
experienced a modest increase, 12 basis points, in the overall rates on earnings assets from 5.12% in 2010 to 5.24% in
2011. Interest bearing funding sources declined, by 27 basis points, from 1.60% in 2010 to 1.33% in 2011. The
combination of these rate changes resulted in an improved net interest margin from 3.68% in 2010 to 4.08% in 2011. In
2010, the Corporation realized an increase of $.098 million in net interest income. A portion of this increase was attributed
to higher levels of investment securities which were funded by lower cost wholesale funding sources.
57
For the Years Ended December 31,(dollars in thousands, except per share data)201120102009Taxable-equivalent net interest income18,019$ 16,496$ 16,446$ Taxable-equivalent adjustment90 111 159 Net interest income17,929 16,385 16,287 Provision for loan losses2,300 6,500 3,700 Other income3,656 2,795 4,571 Other expense15,969 16,598 13,802 Income before provision for income taxes3,316 (3,918) 3,536 Provision for (benefit of) income taxes1,098 (3,500) 1,120 Net income (loss)2,218$ (418)$ 2,416$ Preferred dividend expense766 742 509 Net income (loss) available to common shareholders1,452$ (1,160)$ 1,907$ Earnings (loss) per common share Basic.42$ (.34)$ .56$ Diluted.41$ (.34)$ .56$ Return on average assets.30 %(.23) %.39 %Return on average common equity3.30 (2.64) 4.42 Return on average equity2.66 (2.06) 3.77
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
In 2010, the Corporation benefited from low interest rates prevalent on wholesale deposit instruments. During 2010,
interest rates in the wholesale environment were significantly more attractive than rates offered by competitors in local
markets. In addition to the benefits derived from lower rates or wholesale deposit instruments a number of new or rewritten
loans were structured with interest rate floors that locked in a near term favorable interest rate spread.
The following table details sources of net interest income for the three years ended December 31 (dollars in thousands):
As shown in the table above, income on loans provides more than 90% of the Corporation’s interest revenue. The
Corporation’s loan portfolio has approximately 69% of variable rate loans that predominantly reprice with changes in the
prime rate and 31% of fixed rate loans. A majority of the variable rate loans, 69%, or $191 million, have interest rate
floors. These loans will not reprice until the prime rate increases to the extent necessary to surpass the interest rate floor. A
prime rate increase of 100 basis points or more will reprice $98 million of these loans with floors, while the remainder will
reprice with an additional 100 basis point increase in the prime rate.
The majority of interest bearing liabilities do not reprice automatically with changes in interest rates, which provides
flexibility to manage interest income. Management monitors the interest sensitivity of earning assets and interest bearing
liabilities to minimize the risk of movements in interest rates.
58
2011Mix2010Mix2009MixInterest Income Loans21,774$ 94.37 %21,279$ 93.17 %20,813$ 87.80 % Funds sold21 .09 58 .25 - - Taxable securities1,162 5.04 1,406 6.16 2,783 11.74 Nontaxable securities28 .12 28 .12 19 .08 Other interest-earning assets87 .38 69 .30 93 .39 Total earning assets23,072 100.00 %22,840 100.00 %23,708 100.00 %Interest Expense NOW, money markets, checking1,002 19.48 %1,218 18.87 %809 10.90 % Savings36 0.70 97 1.50 142 1.91 CDs <$100,0002,064 40.13 1,756 27.20 1,857 25.02 CDs >$100,000383 7.45 449 6.96 633 8.53 Brokered deposits1,045 20.32 2,087 32.34 2,990 40.30 Borrowings613 11.92 848 13.14 990 13.34 Total interest-bearing funds5,143 100.00 %6,455 100.00 %7,421 100.00 %Net interest income17,929$ 16,385$ 16,287$ Average Rates Earning assets5.22 %5.10 %5.22 % Interest-bearing funds1.33 1.60 1.82 Interest rate spread3.89 3.50 3.40
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The following table presents the amount of taxable equivalent 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.
(1)
(2)
(3)
For purposes of these computations, non-accruing loans are included in the daily average loan amounts outstanding.
The amount of interest income on nontaxable securities and loans has been adjusted to a tax equivalent basis, using a 34% tax rate.
Interest income on loans includes loan fees.
59
(dollars in thousands)AverageAverage AverageAverage AverageAverage BalanceInterestRateBalanceInterestRateBalanceInterestRateASSETS:Loans (1,2,3)388,115$ 21,850$ 5.63 %384,347$ 21,376$ 5.56 %374,796$ 20,964$ 5.59 %Taxable securities36,155 1,162 3.21 35,475 1,406 3.96 74,005 2,782 3.76 Nontaxable securities (2)850 42 4.94 853 42 4.92 571 28 4.90 Federal Funds sold13,102 21 .16 22,934 58 .25 74 - - Other interest-earning assets3,504 87 2.48 4,448 69 1.55 4,415 93 2.11 Total earning assets441,726 23,162 5.24 448,057 22,951 5.12 453,861 23,867 5.26 Reserve for loan losses(6,027) (5,539) (4,337) Cash and due from banks25,622 29,291 19,397 Fixed assets9,630 10,002 10,839 Other real estate owned4,581 6,196 3,374 Other assets14,007 14,986 10,518 47,813 54,936 39,791 TOTAL ASSETS489,539$ 502,993$ 493,652$ LIABILITIES AND SHAREHOLDERS' EQUITY:NOW and Money Markets124,575$ 762$ .61 %99,411$ 943$ .95 %73,003$ 665$ .91 %Interest checking26,962 240 .89 18,987 275 1.45 7,735 143 1.85 Savings deposits16,242 36 .22 19,503 97 .50 20,179 142 .70 CDs <$100,000112,464 2,064 1.84 84,841 1,756 2.07 67,356 1,858 2.76 CDs >$100,00022,909 383 1.67 26,273 449 1.71 26,906 633 2.35 Brokered deposits45,906 1,045 2.28 118,615 2,087 1.76 176,017 2,990 1.70 Borrowings36,579 613 1.68 36,116 848 2.35 36,338 990 2.72 Total interest-bearing liabilities385,637 5,143 1.33 %403,746 6,455 1.60 407,534 7,421 1.82 Demand deposits46,773 39,704 31,864 Other liabilities2,568 3,372 3,723 Shareholders' equity54,561 56,171 50,531 103,902 99,247 86,118 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY489,539$ 502,993$ 493,652$ Rate spread3.91 3.52 %3.44 %Net interest margin/revenue, tax equivalent basis18,019$ 4.08 %16,496$ 3.68 %16,446$ 3.62 %200920102011Years ended December 31,
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The following table presents the dollar amount, in thousands, of changes in taxable equivalent 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 prior period rate) and (ii) changes in rate (i.e. changes in rate multiplied by prior
period volume). For purposes of this table, changes attributable to both rate and volume are shown as a separate variance.
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
2011, the Corporation recorded a provision for loan loss of $2.300 million, compared to a provision of $6.500 million in
2010 and $3.700 million in 2009.
Noninterest Income
Noninterest income was $3.656 million, $2.795 million, and $4.751 million in 2011, 2010, and 2009, respectively. The
principal recurring sources of noninterest income are the gains on the sale of SBA/USDA guaranteed loans and secondary
market loans. In 2011, revenues from these two business lines totaled $2.300 million compared to $1.407 million in 2010
and $.830 million in 2009. In 2010, the Corporation expanded its efforts to generate increased income from secondary
market loans by adding additional staff and centralizing processing activities. In 2010, the Bank initiated the new business
of retaining the servicing rights on mortgage loans sold to the secondary market. This line of business attained profitability
during 2011, and as such, a valuation of the future revenue stream was recognized as income and booked as an asset at the
Bank. In 2011, income from servicing mortgages amounted to $.400 million. Late in 2011, the bank also established its
own title insurance agency which offers title services for both commercial and retail based mortgage transactions. Income
from this line of business was minimal in 2011, but is expected to provide increased revenues in 2012 and beyond.
Deposit related income totaled $.832 million in 2011 compared to $.990 million in 2010 and $1.023 million in 2009. The
current regulatory environment may limit the Corporation’s ability to grow these revenue sources. In 2009, the Corporation
recorded a gain on the sale of two branch offices, $1.208 million, and a gain on security sales of $1.471 million.
60
TotalTotalVolumeIncreaseVolumeIncreaseVolumeRateand Rate(Decrease)VolumeRateand Rate(Decrease)Interest earning assets:Loans210$ 262$ 2$ 474$ 534$ (119)$ (3)$ 412$ Taxable securities27 (266) (5) (244) (1,448) 151 (79) (1,376) Nontaxable securities- - - - 13 - 1 14 Federal funds sold(25) (21) 9 (37) 58 - - 58 Other interest earning assets(15) 41 (8) 18 1 (25) - (24) Total interest earning assets197$ 16$ (2)$ 211$ (842)$ 7$ (81)$ (916)$ Interest bearing obligations:NOW and money market deposits239$ (335)$ (85)$ (181)$ 241$ 27$ 10$ 278$ Interest checking116 (106) (45) (35) 208 (31) (45) 132 Savings deposits(16) (54) 9 (61) (5) (41) 1 (45) CDs <$100,000573 (199) (66) 308 482 (464) (120) (102) CDs >$100,000(57) (10) 1 (66) (15) (173) 4 (184) Brokered deposits(1,278) 612 (376) (1,042) (975) 107 (35) (903) Borrowings11 (243) (3) (235) (6) (137) 1 (142) Total interest bearing obligations(412)$ (335)$ (565)$ (1,312)$ (70)$ (712)$ (184)$ (966)$ Net interest income, tax equivalent basis1,523$ 50$ Increase (Decrease)Years ended December 31,2010 vs. 2009Increase (Decrease)Due to2011 vs. 2010Due to
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):
Noninterest Expense
Noninterest expense was $15.969 million in 2011, compared to $16.598 million and $13.802 million in 2010 and 2009,
respectively. In 2011, the decrease in noninterest expense totaled $.629 million, or 3.79%. The largest decrease in
noninterest expense for 2011 occurred in write-downs and losses on the sale of other real estate, which decreased from
$2.753 million in 2010 to $1.137 million in 2011. Salaries and benefits, at $7.275 million, increased by $.357 million,
5.16%, from the 2010 expenses of $6.918 million and compared to $6.583 million in 2009. Professional service fees
increased in 2011 largely due to increased costs associated with the compliance issues of regulatory reform. These
increased costs are expected to continue for future periods.
Management will continue to review all areas of noninterest expense in order to evaluate where opportunities may exist
which could reduce expenses without compromising service to customers.
The following table details noninterest expense for the three years ended December 31 (dollars in thousands):
Federal Income Taxes
A deferred tax asset is recognized for temporary differences that will result in deductible amounts in future years and
contain tax carryforwards including past net operating losses and tax credits. For example, a temporary difference is
created between the reported amount and the tax basis of a liability for estimated expenses if, for tax purposes, those
estimated expenses are not deductible until a future year. Settlement of that liability will result in tax deductions in future
years, and a deferred tax asset is recognized based on the weight of available evidence. All available evidence, both
positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is
61
% Increase (Decrease)2011201020092011 - 20102010 - 2009Salaries and benefits7,275$ 6,918$ 6,583$ 5.16 %5.09 %Occupancy1,376 1,313 1,385 4.80 (5.20) Furniture and equipment827 806 805 2.61 .12 Data processing761 740 862 2.84 (14.15) Professional service fees: Accounting260 269 261 (3.35) 3.07 Legal207 98 95 111.22 3.16 Consulting and other289 260 247 11.15 5.26 Total professional service fees756 627 603 20.57 3.98 Loan and deposit1,137 910 746 24.95 21.98 OREO writedowns and (gains) losses on sale1,137 2,753 208 (58.70) 1,223.56 FDIC insurance premiums849 957 839 (11.29) 14.06 Telephone215 193 187 11.40 3.21 Advertising351 297 322 18.18 (7.76) Other operating expenses1,285 1,084 1,262 18.54 (14.10) Total noninterest expense15,969$ 16,598$ 13,802$ (3.79) %20.26 %2011201020092011-20102010-2009Deposit service charges123$ 128$ 116$ (3.91) %10.34 %NSF Fees709 862 907 (17.75) (4.96) Gain on sale of secondary market loans477 445 224 7.19 98.66 Secondary market fees generated223 94 93 137.23 1.08 SBA Fees1,500 868 513 72.81 69.20 Mortgage servicing rights400 - - - - Gain on sale of branch offices- - 1,208 - 100.00 Other 225 183 219 22.95 (16.44) Subtotal3,657 2,580 3,280 41.74 (21.34) Net security gains (1) 215 1,471 (100.47) (85.38) Total noninterest income3,656$ 2,795$ 4,751$ 30.81 %(41.17) %% Increase (Decrease)
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
needed for some portion or all of a deferred tax asset. Judgment must be used in considering the relative impact of negative
and positive evidence. The weight given to the potential effect of negative and positive evidence should be commensurate
with the extent to which it can be objectively verified. The more negative evidence that exists, (a) the more positive
evidence is necessary and (b) the more difficult it is to support a conclusion that a valuation allowance is not needed.
A valuation allowance is provided against deferred tax assets when it is more likely than not that some or all of the deferred
tax assets will not be realized. The Corporation, as of December 31, 2011, had net operating loss (―NOL‖) and tax credit
carryforwards of approximately $26.7 million and $2.7 million, respectively.
Current Federal Tax Provision
In 2011, the Corporation recorded a provision for income taxes of $1.098 million, compared to a $3.500 million tax benefit
in 2010 and a $.787 million provision in 2009. In 2011, the Corporation evaluated the valuation allowance against the
deferred tax asset balances and determined expectations for the utilization of the NOL and tax credit carryforwards. In
making this determination the Corporation reviewed current year core earnings and forecasts of future earnings. The
probability of attaining the forecasted earnings was also evaluated based upon the current economic environment both
nationally and in local markets. The Corporation will re-evaluate this deferred tax asset and the related valuation in 2012 to
determine the likelihood of realization of all the remaining unbooked benefit.
Deferred Tax Benefit – Historical Commentary
The Corporation recorded a current period federal tax benefit of $3.500 million in 2010, compared to a $1.120 million
provision in the same period a year earlier. In the first quarter of 2010, management evaluated the deferred tax assets
associated with the net operating loss and tax credit carryforwards based upon the Corporation’s foreseen ability to utilize
the benefits of these carryforwards prior to their expiration. At that time, the Corporation had net deferred tax assets of
approximately $13.4 million and a valuation allowance of $8.1 million against these assets. As a part of this analysis,
management considered, among other things, current asset levels and projected loan and deposit growth, current interest
rate spreads and projected net interest income levels, and noninterest income and expense, along with management’s ability
to control expenses and the potential for increasing contributions of noninterest income. Management also considered the
impact of nonperforming assets and future period charge-off activity relative to projected provisions. Based upon the
analysis of projected taxable income and the probability of achieving these projected taxable income levels, the Corporation
reduced the valuation allowance on its deferred tax assets by $3.500 million. Among the criteria that management
considered in evaluating the deferred tax asset was taxable income for the three most recent taxable years ending December
31, 2009 which totaled $8.2 million. This taxable income allowed the Corporation to utilize NOL carryforwards. At 2010
year end, management, in recognition of the net operating loss before taxes of $3.918 million and based upon additional
analysis of deferred tax balances and future taxable income projections, made the determination to increase the valuation
allowance by approximately $1.364 million, resulting in a net decrease in the valuation allowance of $2.136 million for the
year.
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 a portion, $7.500 million, of the
NOL carryforward was probable. The $7.500 million recognition was based upon assumptions of a sustained level of
taxable income within the NOL carryforward period and took into account Section 382, annual limitations. 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.
62
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The table below details the Corporation’s deferred tax assets and liabilities (dollars in thousands):
As shown in the table above, the NOL and tax credit carryforwards comprise the majority of the deferred tax asset, which is
reduced by the $6.010 million valuation adjustment.
As of December 31, 2011, the Corporation had an NOL carryforward of approximately $26.7 million along with various
credit carryforwards of $2.1 million. This NOL and credit carryforward benefit is dependent upon the future profitability of
the Corporation. A portion of the NOL, approximately $15.6 million, and all of the tax credit carryforwards are also
subject to the use limitations of Section 382 of the Internal Revenue Code since they originated prior to the December 2004
recapitalization of the Corporation. These carryforwards, if not utilized, will begin to expire in the year 2023. The annual
limitation is $1.4 million for the NOL carryforwards and the equivalent value of tax credits, which is approximately $.477
million.
The Corporation will continue to 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.
Management believes that the Corporation will ultimately utilize all of the NOL carryforwards and a portion of the tax
credit carryforwards. The valuation allowance, which stands at $6.0 million as of December 31, 2011 is a conservative
measurement of the uncertainty related to the current economy and level of profitability the Corporation will attain in the
near term.
63
20112010Deferred tax assets: NOL carryforward9,073$ 9,342$ Allowance for loan losses1,785 2,248 Alternative Minimum Tax Credit1,463 1,463 OREO Tax basis > book basis1,050 1,081 Tax credit carryovers672 672 Deferred compensation217 247 Stock option compensation204 204 Depreciation225 118 Intangible assets77 95 Other78 11 Total deferred tax assets14,844 15,481 Valuation allowance(6,010)$ (6,010)$ Deferred tax liabilities: FHLB stock dividend(103) (128) Unrealized gain (loss) on securities(168) (315) Other(136) - Total deferred tax liabilities(407) (443) Net deferred tax asset8,427$ 9,028$
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
FINANCIAL POSITION
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 $4.867 million in 2011, from $33.860 million at December 31, 2010 to
$38.727 million at December 31, 2011.
The carrying value of the Corporation’s securities is as follows at December 31 (dollars in thousands):
The Corporation’s policy is to purchase securities of high credit quality, consistent with its asset/liability management
strategies. The majority of the bank’s current investments, $24.993 million or 65%, 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, 2011, investment
securities with an estimated fair market value of $19.020 million were pledged.
64
December 31,(dollars in thousands)201120102009Sources of funds:BalanceMixBalanceMixBalanceMixDeposits: Non-interest bearing transactional deposits51,273$ 10.29 %41,264$ 8.62 %35,878$ 6.96 % Interest-bearing transactional depopsits166,766 33.47 152,373 31.83 113,997 22.12 CD's <$100,000130,685 26.23 96,977 20.26 59,953 11.63 Total core deposit funding348,724 69.98 290,614 60.71 209,828 40.71 CD's >$100,00023,229 4.66 22,698 4.74 36,385 7.06 Brokered deposits32,836 6.59 73,467 15.35 175,176 33.99 Total noncore deposit funding56,065 11.25 96,165 20.09 211,561 41.05 FHLB and other borrowings35,997 7.22 36,069 7.53 36,140 7.01 Other liabilities2,262 .45 1,966 .41 2,549 .49 Shareholders' equity55,263 11.09 53,882 11.27 55,299 10.74 Total498,311$ 100.00 %478,696$ 100.00 %515,377$ 100.00 %Uses of Funds:Net Loans395,995$ 79.46 %376,473$ 78.64 %379,085$ 73.55 %Securities available for sale38,727 7.77 33,860 7.07 46,513 9.03 Federal funds sold13,999 2.81 12,000 2.51 27,000 5.24 Federal Home Loan Bank Stock3,060 .61 3,423 .72 3,794 .74 Interest-bearing deposits10 .00 713 .15 678 .13 Cash and due from banks20,071 4.03 22,719 4.75 18,433 3.58 Other assets26,449 5.31 29,508 6.16 39,874 7.74 Total498,311$ 100.00 %478,696$ 100.00 %515,377$ 100.00 %20112010US Agencies - MBS14,418$ 27,710$ US Agencies10,575 4,973 Corporate8,178 - Obligations of states and political subdivisions5,556 1,177 Total securities38,727$ 33,860$
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Loans
The Bank is a full service lender and offers a variety of loan products in all of its markets. The majority of its loans are
commercial, which represents approximately 78% of total loans outstanding at December 31, 2011.
The Corporation continued to experience strong loan demand in 2011 with approximately $172.577 million of new loan
production, including $38.971 million of mortgage loans sold in the secondary market. At 2011 year-end, the
Corporation’s loans stood at $401.246 million, an increase from the 2010 year-end balances of $383.086 million. In 2011,
the secondary mortgage loans that were produced and sold totaled $38.971 million while the SBA/USDA loan sales
amounted to $18.970 million. The production of loans was distributed among the regions, with the Upper Peninsula at
$95.024 million, $48.226 million in the Northern Lower Peninsula and $29.327 million in Southeast Michigan where the
market has been hit the hardest by the recession.
Management believes a properly positioned loan portfolio provides the most attractive earning asset yield available to the
Corporation and, with changes to the loan approval process and exception reporting, management can effectively manage
the risk in the loan portfolio. Management intends to continue loan growth within its markets for mortgage, consumer, and
commercial loan products while concentrating on loan quality, industry concentration issues, and competitive pricing. The
Corporation is highly competitive in structuring loans to meet borrowing needs and satisfy strong underwriting
requirements.
The following table details the loan activity for 2010 and 2011 (dollars in thousands):
Following is a table that illustrates the balance changes in the loan portfolio from 2009 through 2011 year end (dollars in
thousands):
65
Loan balances as of December 31, 2009384,310$ Total production113,770 Secondary market sales(36,677) SBA loan sales(12,571) Loans transferred to OREO(5,373) Loans charge off, net of recoveries(5,112) Normal amortization/paydowns and payoffs(55,261) Loan balances as of December 31, 2010383,086 Total production172,577 Secondary market sales(38,971) SBA loan sales(18,790) Loans transferred to OREO(4,193) Loans charge off, net of recoveries(3,662) Normal amortization/paydowns and payoffs(88,621) Loan balances as of December 31, 2011401,426$ 2011201020092011-20102010-2009Commercial real estate199,201$ 194,859$ 208,895$ 2.23 % (6.72)%Commercial, financial, and agricultural92,269 68,858 72,184 34.00 (4.61)One-to-four family residential real estate77,332 75,074 67,232 3.01 11.66 Construction: Consumer5,774 5,682 7,118 1.62 (20.17) Commercial19,745 33,330 24,591 (40.76) 35.54 Consumer6,925 5,283 4,290 31.08 23.15 Total401,246$ 383,086$ 384,310$ 4.74 % (.32)%Percent Change
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
Our commercial real estate loan portfolio predominantly relates to owner occupied real estate, and our loans are generally
secured by a first mortgage lien. Commercial real estate market conditions continued to be under stress in 2011, and we
expect this trend to continue. These conditions may negatively affect our commercial real estate loan portfolio in future
periods. We make commercial loans for many purposes, including: working capital lines, which are generally renewable
annually and supported by business assets, personal guarantees and additional collateral. Commercial business lending is
generally considered to involve a higher degree of risk than traditional consumer bank lending.
Following is a table showing the composition of loans by significant industry types in the commercial loan portfolio as of
December 31 (dollars in thousands):
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.
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 2011 year-end. The current
concentration of real estate related loans represents a broad customer base composed of a high percentage of owner-
occupied developments.
Our residential real estate portfolio predominantly includes one-to-four family adjustable rate mortgages that have repricing
terms generally from one to three years, construction loans to individuals and bridge financing loans for qualifying
customers. As of December 31, 2011, our residential loan portfolio totaled $83.106 million, or 21.46% of our total
outstanding loans.
The Corporation has also extended credit to governmental units, including Native American organizations. Tax-exempt
loans and leases decreased from $2.471 million at the end of 2010 to $1.991 million at 2011 year-end. The Corporation has
elected to refrain from making tax-exempt loans, since they provide no current tax benefit, due to tax net operating loss
carryforwards.
Due to the seasonal nature of many of the Corporation’s commercial loan customers, loan payment terms provide flexibility
by structuring payments to coincide with the customer’s business cycle. The lending staff evaluates the collectability of the
past due loans based on documented collateral values and payment history. The Corporation discontinues the accrual of
interest on loans when, in the opinion of management, there is an indication that the borrower may be unable to meet the
payments as they become due. Upon such discontinuance, all unpaid accrued interest is reversed. Loans are returned to
accrual status when all principal and interest amounts contractually due are brought current and future payments are
reasonably assured.
Troubled debt restructurings (―TDR‖) are determined on a loan-by-loan basis. Generally restructurings are related to
interest rate reductions, loan term extensions and short term payment forbearance as means to maximize collectability of
troubled credits. If a portion of the TDR loan is uncollectible (including forgiveness of principal), the uncollectible amount
will be charged off against the allowance at the time of the restructuring. In general, a borrower must make at least six
consecutive timely payments before the Corporation would consider a return of a restructured loan to accruing status in
accordance with FDIC guidelines regarding restoration of credits to accrual status.
66
% of% of% of% of% of% ofBalanceLoansCapitalBalanceLoansCapitalBalanceLoansCapitalReal estate - operators of nonres bldgs75,391$ 24.22 %135.53 %58,114$ 19.56 %107.85 %48,689$ 15.93 %88.05 Hospitality and tourism33,306 10.70 59.87 37,737 12.70 70.04 45,315 14.82 81.95 Commercial construction19,745 6.34 35.50 33,330 11.22 61.86 24,591 8.04 44.47 Lessors of residential buildings16,499 5.30 29.66 16,598 5.59 30.80 12,619 4.13 22.82 Real estate agents and managers10,617 3.41 19.09 15,857 5.34 29.43 24,242 7.93 43.84 Other155,657 50.02 279.83 135,411 45.60 251.31 150,214 49.14 271.64 Total commercial loans311,215$ 100.00 %297,047$ 100.00 %305,670$ 100.00 %201120102009
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The Corporation has, in accordance with generally accepted accounting principles and per recently enacted accounting
standard updates, evaluated all loan modifications to determine the fair value impact of the underlying asset. The carrying
amount of the loan is compared to the expected payments to be received, discounted at the loan’s original rate, or for
collateral dependent loans, to the fair value of the collateral.
The Corporation, at December 31, 2011, had loans totaling $2.503 million for which repayment terms were modified to the
extent that they were deemed to be ―restructured‖ loans. The $2.503 million is comprised of 2 loans, the largest of which
had a December 31, 2011 balance of $2.400 million. This loan was modified to allow the suspension of principal payments
for ―over a 12-month period‖. This suspension of principal payments on this loan with a 30-year amortization does not
result in a significant change to the net present value of total principal and interest payments over the term of the note. This
loan is deemed collateral dependent, and as such an evaluation of the underlying collateral and ability for repayment based
upon cash flows was done. This evaluation resulted in an estimate of expected loss of principal. As of December 31, 2011,
the Corporation established a $.650 million specific reserve on this loan.
Credit Quality
The table below shows balances of nonperforming assets for the three years ended December 31 (dollars in thousands):
Management continues to address market issues impacting its loan customer base. In conjunction with the Corporation’s
senior lending staff and the bank regulatory examinations, management reviews the Corporation’s loans, related collateral
evaluations, and the overall lending process. The Corporation also utilizes a loan review consultant to perform a review of
the loan portfolio. The opinion of this consultant upon completion of the 2011 independent review provided findings
similar to management on the overall adequacy of the reserve. The Corporation will again utilize a consultant for loan
review in 2012.
The following table details the impact of nonperforming loans on interest income for the three years ended December 31
(dollars in thousands):
67
December 31,December 31,December 31,201120102009(Unaudited)(Audited)(Audited)Nonperforming Assets :Nonaccrual loans5,490$ 5,921$ 14,368$ Loans past due 90 days or more- - - Restructured loans2,503 4,642 869 Total nonperforming loans7,993 10,563 15,237 Other real estate owned3,162 5,562 5,804 Total nonperforming assets11,155$ 16,125$ 21,041$ Nonperforming loans as a % of loans1.99 %2.76 %3.96 Nonperforming assets as a % of assets2.24 %3.37 %4.05 Reserve for Loan Losses:At period end5,251$ 6,613$ 5,225$ As a % of average loans1.35 %1.72 %1.36 As a % of nonperforming loans65.69 %62.61 %34.29 As a % of nonaccrual loans95.65 %111.69 %36.67 Texas Ratio18.43 %26.66 %34.77 Charge-off Information (year to date): Average loans388,115$ 384,347$ 374,796$ Net charge-offs3,662$ 5,112$ 2,752$ Charge-offs as a % of average loans.94 %1.33 %.73 201120102009Interest income that would have been recorded at original rate363$ 583$ 700$ Interest income that was actually recorded118 141 40 Net interest lost245$ 442$ 660$
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
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 2011 amounted to $3.662 million, or .94% of average loans
outstanding, compared to $5.112 million, or 1.33% of loans outstanding in 2010. In 2010, $2.342 million of the charge-offs
resulted from three credit relationships in Southeast Michigan. 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.
A three year history of the Corporation’s credit quality is displayed in the following table (dollars in thousands):
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.
At the end of 2011, the allowance for loan losses represented 1.31% 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 held for sale on the balance sheet.
68
Allowance for Loan Losses201120102009Balance at beginning of period6,613$ 5,225$ 4,277$ Loans charged off: Commercial, financial & agricultural3,2585,0272,465 One-to-four family residential real estate490410282 Consumer524871 Total loans charged off3,800 5,485 2,818 Recoveries of loans previously charged off: Commercial, financial & agricultural12834638 One-to-four family residential real estate1 11 16 Consumer9 16 12 Total recoveries of loans previously charged off138 373 66 Net loans charged off3,662 5,112 2,752 Provision for loan losses2,300 6,500 3,700 Balance at end of period5,251$ 6,613$ 5,225$ Total loans, period end401,246$ 383,086$ 384,310$ Average loans for the year388,115 384,347 374,796 Allowance to total loans at end of year1.31 %1.73 %1.36 %Net charge-offs to average loans.94 1.33 .73 Net charge-offs to beginning allowance balance55.38 97.84 64.34
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The following table represents the activity in other real estate held for sale (dollars in thousands):
During 2011, the Corporation received real estate in lieu of loan payments of $4.194 million. In determining the carrying
value of other real estate held for sale, the Corporation generally starts with a third party appraisal of the underlying
collateral and then deducts estimated selling costs to arrive at a net asset value. After the initial receipt, management
periodically re-evaluates the recorded balance and records any additional reductions in the fair value as a write-down of
other real estate held for sale.
Deposits
Total deposits at December 31, 2011 were $404.789 million, an increase of $18.010 million, or 4.66% from December 31,
2010 deposits of $386.779 million. The table below shows the deposit mix for the periods indicated (dollars in thousands):
The increase in deposits, as illustrated above, is composed of a decrease in noncore deposits of $40.100 million, while core
deposits increased by $58.110 million.
Historically the Corporation’s loan growth outpaced core deposit growth, which resulted in more reliance on brokered
deposits as a source of funding. Management has increased its efforts to grow core deposits in recent years by introducing
several new deposit products and implementing a bank-wide deposit incentive program. Most of the deposit growth in
2011 and 2010 occurred in lower cost transactional deposits.
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 also utilizes FHLB borrowings as a source of funding. At 2011 year end, this source of funding totaled
$35 million and the Corporation secured this funding by pledging loans and investments. The $35 million of FHLB
borrowings had a weighted average maturity of 3.3 years, with a weighted average rate of 1.85% at December 31, 2011.
Shareholders’ Equity
Changes in shareholders’ equity are discussed in detail in the ―Capital and Regulatory‖ section of this report.
69
Balance at January 1, 20105,804$ Other real estate transferred from loans due to foreclosure5,373 Other real estate sold(2,862) Writedowns on other real estate held for sales(2,703) Loss on other real estate held for sale(50) Balance at December 31, 20105,562 Other real estate transferred from loans due to foreclosure4,194 Other real estate sold(5,457) Writedowns on other real estate held for sales(855) Loss on other real estate held for sale(282) Balance at December 31, 20113,162$ 2011Mix2010Mix2009MixNon-interest-bearing51,273$ 12.67 %41,264$ 10.67 %35,878$ 8.51 %NOW, money market, checking152,563 37.69 134,703 34.83 95,790 22.73 Savings14,203 3.51 17,670 4.57 18,207 4.32 Certificates of Deposit <$100,000130,685 32.28 96,977 25.07 59,953 14.23 Total core deposits348,724 86.15 290,614 75.14 209,828 49.79 Certificates of Deposit >$100,00023,229 5.74 22,698 5.87 36,385 8.63 Brokered CDs32,836 8.11 73,467 18.99 175,176 41.57 Total non-core deposits56,065 13.85 96,165 24.86 211,561 50.21 Total deposits404,789$ 100.00 %386,779$ 100.00 %421,389$ 100.00 %
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.
At December 31, 2011 the Bank had $38.727 million of securities, with a weighted average maturity of 41.8 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 (―ALCO‖) meetings, whose membership includes senior management, board representation and third party
investment consultants. During these monthly meetings, we review the current ALCO 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.
70
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The following is the Corporation’s repricing opportunities at December 31, 2011 (dollars in thousands):
The above analysis indicates that at December 31, 2011, the Corporation had a cumulative asset sensitivity gap position of
$69.219 million within the one-year timeframe. The Corporation’s cumulative asset sensitive gap suggests that if market
interest rates were to increase in the next twelve months, the Corporation has the potential to earn more net interest income
since more assets would reprice at higher rates than liabilities. Conversely, if market interest rates decrease in the next
twelve months, the above gap position suggests the Corporation’s net interest income would decrease. A limitation of the
traditional gap analysis is that it does not consider the timing or magnitude of non-contractual repricing or unexpected
prepayments. In addition, the gap analysis treats savings, NOW and money market accounts as repricing within 90 days,
while experience suggests that these categories of deposits are actually comparatively resistant to rate sensitivity.
At December 31, 2011, the Corporation had $276.547 million of variable rate loans that reprice primarily with the prime
rate index. Approximately $191.158 million of these variable rate loans have interest rate floors. This means that the prime
rate will have to increase above the floor rate before these loans will reprice. At year end, $92.493 million of these floor-
rate loans would reprice with a 100 basis point prime rate increase, with $97.608 million repricing with an additional 100
basis point prime rate increase.
At December 31, 2010, the Corporation had a cumulative liability sensitivity gap position of $1.258 million within the one-
year time frame.
The Corporation’s primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk and foreign
exchange risk. The Corporation has no market risk sensitive instruments held for trading purposes. The Corporation has
limited agricultural-related loan assets, and therefore, has minimal significant exposure to changes in commodity prices.
Any impact that changes in foreign exchange rates and commodity prices would have on interest rates are assumed to be
insignificant.
Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control
interest rate risk and the quantitative level of exposure. The Corporation’s interest rate risk management process seeks to
ensure that appropriate policies, procedures, management information systems, and internal controls are in place to
maintain interest rate risk at prudent levels with consistency and continuity. In evaluating the quantitative level of interest
rate risk, the Corporation assesses the existing and potential future effects of changes in interest rates on its financial
condition, including capital adequacy, earnings, liquidity, and asset quality. In addition to changes in interest rates, the
level of future net interest income is also dependent on a number of variables, including: the growth, composition and
levels of loans, deposits, and other earning assets and interest-bearing obligations, and economic and competitive
conditions; potential changes in lending, investing, and deposit strategies; customer preferences; and other factors.
71
1-9091-365>1-5Over 5DaysDaysYearsYearsTotalInterest-earning assets: Loans284,065$ 7,683$ 32,925$ 76,573$ 401,246$ Securities2,626 6,553 22,163 7,385 38,727 Other (1)13,999 - - 3,060 17,059 Total interest-earning assets300,690 14,236 55,088 87,018 457,032 Interest-bearing obligations: NOW, money market, savings and interest checking166,766 - - - 166,766 Time deposits17,768 61,173 74,727 246 153,914 Brokered CDs- - 30,890 1,946 32,836 Borrowings- - 35,000 997 35,997 Total interest-bearing obligations184,534 61,173 140,617 3,189 389,513 Gap116,156$ (46,937)$ (85,529)$ 83,829$ 67,519$ Cumulative gap116,156$ 69,219$ (16,310)$ 67,519$ (1) includes Federal Home Loan Bank stock
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The table below measures current maturity levels of interest-earning assets and interest-bearing obligations, along with
average stated rates and estimated fair values at December 31, 2011 (dollars in thousands). Nonaccrual loans of $5.490
million are included in the table at an average interest rate of 0.00% and a maturity greater than five years.
Foreign Exchange Risk
In addition to managing interest rate risk, management also actively manages risk associated with foreign exchange. The
Corporation provides foreign exchange services, makes loans to, and accepts deposits from, Canadian customers primarily
at its banking office in Sault Ste. Marie. To protect against foreign exchange risk, the Corporation monitors the volume of
Canadian deposits it takes in and then invests these Canadian funds in Canadian commercial loans and securities. As of
December 31, 2011, the Corporation had excess Canadian liabilities of $.106 million, which equated to approximately the
same valuation 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.
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
72
Fair Value20122013201420152016ThereafterTotal12/31/2011 $ 9,180 $ 7,609 $ 5,777 4,824$ 3,952$ $ 7,385 $ 38,727 $ 38,727 4.11 % 1.44 % 1.73 %5.56 %2.88 % 3.47 % 3.16 %19,72112,87718,2425,562 20,326 26,575 103,303 107,803 6.09 6.51 5.68 6.40 5.57 5.93 5.94 297,943 - - - - - 297,943 291,911 5.07 - - - - - 5.07 14,009 - - - - 3,060 17,069 17,069 .15 - - - - 2.50 .57 $ 340,853 $ 20,486 $ 24,019 $ 10,386 $ 24,278 $ 37,020 $ 457,042 $ 455,510 5.51 %4.63%4.73% 6.01 %5.13% 5.16 % 4.98 % $ 166,766 $ - $ - $ - -$ $ - $ 166,766 $ 166,766 .43 % - % - % - %- % - % - %78,94149,131 17,425 24,517 14,544 2,192 186,750 186,782 1.49 1.88 2.39 1.87 1.68 3.45 1.76 - 10,000 10,000 - 15,000 997 35,997 35,634 - 1.22 2.10 - 2 1.00 1.80 $ 245,707 $ 59,131 $ 27,425 $ 24,517 $ 29,544 $ 3,189 $ 389,513 $ 389,182 1.27 %1.77%2.29% 1.87 %1.86% 2.68 % 1.17 %Principal/Notional Amount Maturing/Repricing In:Rate Sensitive AssetsFixed interest rate loans Average interest rateFixed interest rate securities Average interest rate Variable interest rate loans Average interest rate Total rate sensitive assets Average interest rateOther assets Average interest rate NOW, MMAs, interest Rate Sensitive LiabilitiesAverage interest rateInterest-bearing savings, Average interest rateTime depositsAverage interest rate Total rate sensitive liabilities Average interest rateFixed interest rate borrowings
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
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 2011, the Corporation decreased cash and cash equivalents by $.649 million. As shown on the Corporation’s
consolidated statement of cash flows, liquidity was primarily impacted by cash used in investing activities. The net change
in investing activities included a net increase in loans of $19.749 million and a ―net‖ increase in securities available for sale
of $5.653 million. The net increases in assets were offset by a similar increase in deposit liabilities of $18.010 million.
This increase in deposits was composed of a decrease in non-core deposits of $40.100 million combined with an increase in
core deposits of $58.110 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.
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, 2011, $19.707
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 2011, 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 regulatory approval. 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 dependency 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, 2011, the Bank’s core deposits in relation to total funding were 79.29% compared to 68.73% in 2010.
These ratios indicated at December 31, 2011, 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
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, 2011, the Bank had $27.500 million of unsecured lines available and another
$1.675 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 2011 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.
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Management’s Discussion and Analysis of
Financial Condition and Results of Operations
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
As disclosed in the Notes to the Consolidated Financial Statements, the Corporation has certain obligations and
commitments to make future payments under contracts. At December 31, 2011, the aggregate contractual obligations and
commitments are (dollars in thousands):
(1)The Corporation issued preferred stock in April of 2009 as part of its participation in TARP. The initial term of this preferred stock is five
years with an interest rate of 5%, which increases to 9% after the initial term. Although there is no contractual obligation to do so, the
Corporation intends to repay this obligation within the initial term.
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, 2011, 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 2011, total capitalization decreased by $1.381 million. Other
changes in total capital occurred from recognition of net income and market value decrease of the Corporation’s investment
securities. During 2011, risk based capital increased by $4.472 million, while Tier 1 Capital increased by $4.156 million.
The increase in capital was also impacted by the disallowed portion of the Corporation’s deferred tax asset. The portion of
the deferred tax asset which is allowed to be included in regulatory capital is only that portion that can be utilized within the
next 12-month period.
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Contractual ObligationsLess than 1 Year1 to 3 Years4 to 5 YearsAfter 5 YearsTotalTotal deposits296,980$ 66,556$ 39,061$ 2,192$ 404,789$ Federal Home Loan Bank borrowings- 20,000 15,000 - 35,000 Preferred stock (1)- 11,000 - - 11,000 Other borrowings- - - 997 997 Directors' deferred compensation123 238 204 221 786 Annual rental / purchase commitments under noncancelable leases / contracts228 237 - - 465 TOTAL297,331$ 98,031$ 54,265$ 3,410$ 453,037$ Other CommitmentsLetters of credit3,523$ -$ -$ -$ 3,523$ Commitments to extend credit43,948 - - - 43,948 Credit card commitments3,019 - - - 3,019 TOTAL50,490$ -$ -$ -$ 50,490$ Payments Due by Period
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
The following table details sources of capital for the three years ended December 31 (dollars in thousands):
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, which was discussed earlier.
Presented below is a summary of the Corporation’s and Bank’s capital position in comparison to generally applicable
regulatory requirements:
The Corporation intends to maintain the Bank’s Tier I Capital at 8% and total capital to risk-weighted assets at a minimum
of 10.00% in order to qualify for reduced FDIC deposit based insurance.
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201120102009Capital StructureCommon shareholders' equity44,342$ 43,176$ 44,785$ Preferred stock10,921 10,706 10,514 Total shareholders' equity55,263 53,882 55,299 Total capitalization55,263$ 53,882$ 55,299$ Tangible capital55,263$ 53,882$ 55,299$ Intangible AssetsSubsidiaries: Core deposit premium-$ -$ -$ Other identifiable intangibles400 - - Total intangibles400$ -$ -$ Risk-Based CapitalTier 1 capital: Total shareholders' equity55,263$ 53,882$ 55,299$ Net unrealized (gains) losses on available for sale securities(325)(612)(1,093) Less: disallowed deferred tax asset(6,500)(9,028)(4,800) Less: disallowed intangibles(40) - 0 Total Tier 1 capital48,398$ 44,242$ 49,406$ Tier 2 Capital: Allowable reserve for loan losses5,206$ 4,890$ 5,181$ Qualifying long-term debt- - Total Tier 2 capital5,206 4,890 5,181 Total risk-based capital53,604$ 49,132$ 54,587$ Risk-weighted assets416,423$ 389,468$ 414,440$ Capital Ratios: Tier 1 Capital to average assets10.08%9.25%9.75% Tier 1 Capital to risk-weighted assets11.62%11.36%11.92% Total Capital to risk-weighted assets12.87%12.62%13.17%TangibleTier 1Tier 1TotalEquity toEquity to Capital toCapital toCapital to Year-endYear-endAverageRisk WeightedRisk WeightedAssetsAssetsAssetsAssetsAssetsRegulatory minimum for capital adequacy purposesN/AN/A4.00%4.00%8.00%Regulatory defined well capitalized guidelineN/AN/A5.00%6.00%10.00%The Corporation: December 31, 201111.09%11.01%10.08%11.62%12.87% December 31, 201011.26%11.26%9.25%11.36%12.62%The Bank: December 31, 201110.30%10.22%9.24%10.65%11.90% December 31, 201010.22%10.22%8.38%9.92%11.18%
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
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.
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Directors and Officers
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Walter J. Aspatore - Lead DirectorRobert H. OrleyChairman EmeritusFounding PartnerAmherst PartnersO2 Investment Partners, LLCDirector Since: 2004Director Since: 2004Dennis B. BittnerL. Brooks PattersonOwner and PresidentCounty ExecutiveBittner Engineering, Inc.Oakland CountyDirector Since: 2001Director Since: 2006Joseph D. GareaRandolph C. PaschkeManaging PartnerChairman, Department of AccountingHancock SecuritiesWayne State University, School of Business AdministrationDirector Since: 2007Director Since: 2004Kelly W. GeorgePaul D. TobiasPresident, Mackinac Financial CorporationChairman and CEO, Mackinac Financial CorporationPresident and CEO, mBankChairman, mBankDirector Since: 2006Director Since: 2004Robert E. MahaneyPresident and OwnerVeridea Group, LLCDirector Since: 2008DIRECTORSMackinac Financial Corporation and mBank
Directors and Officers
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OFFICERSMackinac Financial CorporationNameTitleLocationPaul D. TobiasChairman and Chief Executive OfficerBirminghamKelly W. GeorgePresidentManistiqueErnie R. KruegerEVP - Chief Financial OfficerManistiquemBankNameTitleLocationBernadette C. BeaudreAVP - Deposit Compliance/BSA OfficerManistiqueShelby J. BischoffAVP - Business Development OfficerMarquetteLinda K. BoldaVP - Human ResourcesManistiqueJesse A. DeeringSVP - SEM ExecutiveBirminghamTrisha L. DemarsAVP - Sr. Deposit Operations SpecialistManistiqueGeorge J. DemouVP - Senior Commercial Banking OfficerBirminghamKevin D. EvansSVP - Retail Sales ManagementNewberryJeremy W. FlodinVP - Sr. Credit Admin/Credit Risk AnalystManistiqueJoni L. FreelAVP - Branch Sales Manager/Treasury Management OfficerGaylordLaura L. GarvinVP - Commercial Portfolio ManagerBirminghamKelly W. GeorgePresident and CEOManistiqueClarice A. GhiardiVP - Regional Retail Banking ManagerMarquetteRobert C. HenryVP - Commercial Banking OfficerTraverse CityMichael J. HoarSVP - IT/CommunicationsManistiqueErnie R. KruegerEVP - Chief Financial OfficerManistiqueDavid W. LeslieFirst VP - Commercial Lending ManagerBirminghamMagan L. MacArthurAVP - Branch Sales Manager/Retail Banking OfficerManistiqueBoris MartyszSVP - Marquette Regional ExecutiveMarquetteTamara R. McDowellEVP - Chief Credit and Operations OfficerManistiqueJacquelyn R. MenhennickSVP - Mortgage and Consumer Lending ManagerMarquetteKevin J. NegriVP - Commercial Banking OfficerMarquetteBarbara A. ParrettAVP - Branch Sales Manager/Retail Banking OfficerStephensonDebra L. PetersonVP - Branch Sales Manager/Mortgage-Consumer Banking OfficerEscanabaScott A. RavetVP - Commercial Banking OfficerManistique/EscanabaAndrew P. SabatineRegional President - NLPTraverse CityGregory D. SchuetterFirst VP - Commercial Lending MangerManistiqueJoanna B. SlaghtSVP - Compliance/Risk ManagerManistiqueMichael A. SlaghtVP - Branch Sales Manager/Commercial Banking OfficerNewberryJennifer A. StempkiVP - ControllerManistiqueAnn M. SteppSVP - Branch Administration/Incentive Program OfficerGaylordDaniel L. StoudtAVP - Mortgage Loan OfficerTraverse CityDavid R. ThomasVP - Commercial Banking OfficerSault Ste. MariePaul D. TobiasChairmanBirminghamNicole A. TryanAVP - Sr. Loan Operations OfficerManistiqueJanet M. WillbeeVP - Mortgage Loan OfficerGaylord
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 Moran, PLLC
Grand Rapids, Michigan
STOCK LISTING AND SYMBOL
NASDAQ Capital 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 2012 Annual Meeting of the Shareholders of Mackinac Financial Corporation will be held on May 22, 2012.
Visit our website, www.bankmbank.com, for updated news releases, financial reports, SEC filings, corporate governance
and other investor information.
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