2017
ANNUAL
REPORT
130 South Cedar Street, Manistique, MI 49854
B R I D G I N G C L I E N T S A N D C O M M U N I T I E S
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Annual Report
Annual Report
About
About
the Company
the Company
Mackinac Financial Corporation is a registered bank holding company formed
Mackinac Financial Corporation is a registered bank holding company formed
under the Bank Holding Company Act of 1956. The principal subsidiary company
under the Bank Holding Company Act of 1956. The principal subsidiary company
is mBank. Headquartered in Manistique, MI, mBank has a total of 23 branch
is mBank. Headquartered in Manistique, MI, mBank has a total of 23 branch
locations throughout Michigan and Northern Wisconsin and current assets in
locations throughout Michigan and Northern Wisconsin and current assets in
excess of $981 million. The company’s banking services include commercial
excess of $981 million. The company’s banking services include commercial
lending, asset based lending, treasury management products, services geared
lending, asset based lending, treasury management products, services geared
toward small to mid-sized businesses, and a full array of personal and business
toward small to mid-sized businesses, and a full array of personal and business
deposit products, consumer loans, mobile banking, online banking and bill pay.
deposit products, consumer loans, mobile banking, online banking and bill pay.
MARKET SUMMARY
MARKET SUMMARY
The company’s common stock
The company’s common stock
is traded on the Nasdaq Capital
is traded on the Nasdaq Capital
Market under the symbol MFNC.
Market under the symbol MFNC.
FORM 10-K
FORM 10-K
A copy of the Annual Report that
A copy of the Annual Report that
was filed with the Securities and
was filed with the Securities and
Exchange Commission on Form
Exchange Commission on Form
10-K is available without charge
10-K is available without charge
by writing the Shareholders’
by writing the Shareholders’
Relations Department, Mackinac
Relations Department, Mackinac
Financial Corporation, 130
Financial Corporation, 130
South Cedar Street, Manistique,
South Cedar Street, Manistique,
Michigan, 49854.
Michigan, 49854.
Community Focused. Client Driven.
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Annual Report
Annual Report
Shareholder Letter
Shareholder Letter
DEAR FELLOW SHAREHOLDERS:
DEAR FELLOW SHAREHOLDERS:
Overview +
Overview +
Financial Performance
Financial Performance
We are pleased to report that 2017 earnings outpaced past performance on the strength of our legacy franchise
We are pleased to report that 2017 earnings outpaced past performance on the strength of our legacy franchise
and was augmented by the market expansion achieved by the two Wisconsin based acquisitions completed and
and was augmented by the market expansion achieved by the two Wisconsin based acquisitions completed and
integrated in 2016. As we have discussed in the past, well executed and priced strategic transactions, coupled
integrated in 2016. As we have discussed in the past, well executed and priced strategic transactions, coupled
with organic loan growth, provide the increasing operating scale necessary to achieve greater efficiencies and
with organic loan growth, provide the increasing operating scale necessary to achieve greater efficiencies and
drive higher levels of core earnings.
drive higher levels of core earnings.
We were fortunate to find another complementary and strategic banking partner in 2017. First Federal of
We were fortunate to find another complementary and strategic banking partner in 2017. First Federal of
Northern Michigan in Alpena, Michigan, will further support the long-term objectives of creating sharehold-
Northern Michigan in Alpena, Michigan, will further support the long-term objectives of creating sharehold-
er value through increased scale and geographic diversity. While this transaction will increase the size of our
er value through increased scale and geographic diversity. While this transaction will increase the size of our
operating platform, we will continue to remain focused internally on maintaining efficient day-to-day opera-
operating platform, we will continue to remain focused internally on maintaining efficient day-to-day opera-
tions, well margined loan and deposit production, sound corporate governance and employee development.
tions, well margined loan and deposit production, sound corporate governance and employee development.
These objectives will ensure the engine of the company remains financially healthy and operationally sound.
These objectives will ensure the engine of the company remains financially healthy and operationally sound.
Since we embarked on our acquisition strategy in 2014, we have achieved consistent earnings per share growth
Since we embarked on our acquisition strategy in 2014, we have achieved consistent earnings per share growth
when normalizing income for one-time transaction related expenses or, in the case of 2017, for the impact of
when normalizing income for one-time transaction related expenses or, in the case of 2017, for the impact of
the revaluation of the company’s deferred tax asset due to the corporate tax code change in December (which
the revaluation of the company’s deferred tax asset due to the corporate tax code change in December (which
had similar effects for other banks in our industry). The continued increase in earnings and book value has also
had similar effects for other banks in our industry). The continued increase in earnings and book value has also
been reflected in the market price of our shares. Displaying a similar trend (on an actual basis and as adjusted
been reflected in the market price of our shares. Displaying a similar trend (on an actual basis and as adjusted
for the transaction expenses in 2014 and 2016 and non-cash tax expense resulting from tax reform in 2017)
for the transaction expenses in 2014 and 2016 and non-cash tax expense resulting from tax reform in 2017)
Return on Average Equity demonstrates the positive impact from efficiency and scale that supports the growth
Return on Average Equity demonstrates the positive impact from efficiency and scale that supports the growth
and capital strategy employed by your management team.
and capital strategy employed by your management team.
As illustrated by the Common Shareholders’ Equity chart to the right, we have increased the book value of your
As illustrated by the Common Shareholders’ Equity chart to the right, we have increased the book value of your
investment over time. Between year-end 2013 and year-end 2017 common shareholder equity of the company
investment over time. Between year-end 2013 and year-end 2017 common shareholder equity of the company
has grown from $65.2 million to $81.4 million. On a per share basis, the book value has increased from $11.77
has grown from $65.2 million to $81.4 million. On a per share basis, the book value has increased from $11.77
in 2013 to $12.93 as of the most recent year end. During this period, we have also increased annual dividend
in 2013 to $12.93 as of the most recent year end. During this period, we have also increased annual dividend
payments to our shareholders which equated to $.48 per share for 2017 compared to $.17 per share in 2013.
payments to our shareholders which equated to $.48 per share for 2017 compared to $.17 per share in 2013.
2
2
Community Focused. Client Driven.
Community Focused. Client Driven.
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Shareholder Letter
Annual Report
7.41%
8.34%
5.73%
9.30%
6.74%
9.07%
5.30%
2.57%
2013
2014
2015
2016
2017
Return on
Average Equity
ROAE
Adjusted
$1.20
$0.87
$1.05
$0.72
$1.01
$0.90
$0.62
$0.30
Earnings
Per Share
EPS
Adjusted
2013
2014
2015
2016
2017
Common
Shareholders’
Equity
Common Shareholders’ Equity
Book Value
Community Focused. Client Driven.
$90,000
$80,000
$70,000
$65,249
$73,996
$76,602
$78,609
$81,400
$12.93
$12.32
$12.55
$11.77
$11.81
$60,000
$50,000
$40,000
$30,000
$20,000
$10,000
$-
2013
2014
2015
2016
2017
$13.20
$13.00
$12.80
$12.60
$12.40
$12.20
$12.00
$11.80
$11.60
$11.40
$11.20
$11.00
3
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Shareholder Letter
Shareholder Letter
Business Line
Business Line
Diversification + Progress
Diversification + Progress
Our product mix and business line diversification have allowed us to remain consistent in our loan production
Our product mix and business line diversification have allowed us to remain consistent in our loan production
and to prudently grow our loan portfolio. As illustrated in the 2017 Loans By Region chart to the right, the
and to prudently grow our loan portfolio. As illustrated in the 2017 Loans By Region chart to the right, the
largest concentration of our loan portfolio resides in our Upper Peninsula region with balanced and impactful
largest concentration of our loan portfolio resides in our Upper Peninsula region with balanced and impactful
activity spread throughout the other markets of our footprint. The Northern Michigan and Wisconsin regions
activity spread throughout the other markets of our footprint. The Northern Michigan and Wisconsin regions
have borrowers and industries with very similar characteristics, with our Southeast Michigan presence provid-
have borrowers and industries with very similar characteristics, with our Southeast Michigan presence provid-
ing some different types of lending opportunities such as asset based lending.
ing some different types of lending opportunities such as asset based lending.
Because interest income from performing loans is the company’s largest revenue source, healthy loan activity
Because interest income from performing loans is the company’s largest revenue source, healthy loan activity
is required to maintain financial performance. Since the beginning of 2013, the company has generated more
is required to maintain financial performance. Since the beginning of 2013, the company has generated more
than $1.2 billion in new loans across a wide footprint covering two states. This distribution of funding sources
than $1.2 billion in new loans across a wide footprint covering two states. This distribution of funding sources
has supported the credit need and augmented economic activities and job creation within all our communities.
has supported the credit need and augmented economic activities and job creation within all our communities.
This community impact is a key component of our mission statement and core values.
This community impact is a key component of our mission statement and core values.
2017 was a highly competitive year for good earning assets which impacted overall market loan pricing and
2017 was a highly competitive year for good earning assets which impacted overall market loan pricing and
caused us to pass on some opportunities where pricing and/or structure did not meet our requirements for
caused us to pass on some opportunities where pricing and/or structure did not meet our requirements for
certain credit types. Specifically, from a macro portfolio management standpoint, we slowed the origination of
certain credit types. Specifically, from a macro portfolio management standpoint, we slowed the origination of
non-owner occupied commercial real estate loans to ensure our preferred internal concentration and loan mix
non-owner occupied commercial real estate loans to ensure our preferred internal concentration and loan mix
was maintained. These opportunities could have provided higher levels of balance sheet growth and earnings,
was maintained. These opportunities could have provided higher levels of balance sheet growth and earnings,
but were bypassed given their inherent risk in relation to capital.
but were bypassed given their inherent risk in relation to capital.
We will remain consistent in our loan profitability requirements and origination strategy with regard to as-
We will remain consistent in our loan profitability requirements and origination strategy with regard to as-
set type. We do not stretch for short term gains that put long term stress on our balance sheet through an
set type. We do not stretch for short term gains that put long term stress on our balance sheet through an
unbalanced mix of loans, nor do we increase market risk in the escalating rate environment we are now en-
unbalanced mix of loans, nor do we increase market risk in the escalating rate environment we are now en-
tering. Our primary market is more stable than most but we are not immune from business cycles. In 2018,
tering. Our primary market is more stable than most but we are not immune from business cycles. In 2018,
we believe our markets will continue to provide good quality commercial and retail loan opportunities and
we believe our markets will continue to provide good quality commercial and retail loan opportunities and
we expect new loan production levels consistent with our past performance. We also expect growth from
we expect new loan production levels consistent with our past performance. We also expect growth from
our footprint expansion into the First Federal of Northern Michigan markets.
our footprint expansion into the First Federal of Northern Michigan markets.
4
4
Community Focused. Client Driven.
Community Focused. Client Driven.
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Annual Report
12%
$101,034
2017 Loan
Totals
by Region
25%
$198,648
49%
$396,443
UP
NLP
SEM
WISC
Total: $811,078
14%
$114,953
Loan Production by Region
Region
2013
2014
2015
2016
2017
Total
Upper Peninsula
$124,836
$104,601
$133,737
$163,338
$128,885
$655,397
Northern Lower Peninsula
$48,004
$40,133
$56,142
$58,896
$50,695
$253,870
Southeast Michigan
$41,989
$38,669
$44,392
$69,081
$68,442
$262,553
Wisconsin
Total
–
–
–
$18,778
$29,554
$48,332
$214,829
$183,403
$234,271
$310,093
$277,556
$1,220,152
Loan Production
+ Growth
Production
Outstandings
$600,935
$618,394
$483,832
$781,857
$811,078
$214,829
$183,403
$234,271
$310,093
$277,556
2013
2014
2015
2016
2017
Community Focused. Client Driven.
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Margin Stability +
Funding Sources
Core deposit growth and expanding client relation-
ships are high priority objectives given they are the
most cost-effective source of funding new loans
and supporting our investment portfolio needs. The
Upper Peninsula of Michigan continues to provide
the largest sources of core deposits with the new
Wisconsin markets we entered in 2016 showing
progress and accounting for almost 25% of the total.
We have also worked to employ targeted wholesale
funding strategies in 2017 that support the long-
term structural integrity of our balance sheet in
an increasing rate environment. We proactively
review the mix of fixed and variable rate assets and
their collective durations compared to our deposit
composition to ensure both are maintained allow-
ing for the expected increasing rate environment to
have a positive impact on the company’s earnings.
Core Deposits
by Region
UP
NLP
SEM
WISC
23%
$143,421
9%
$54,987
16%
$103,936
52%
$329,300
Net Interest
Margin + Net
Interest Income
Net Interest Income
Net Interest Margin
$40,000
$35,000
$30,000
$25,000
$20,000
$15,000
$10,000
$5,000
$-
4.30%
4.17%
4.19%
4.19%
4.20%
$21,399
$23,527
$29,120
$33,098
$37,938
2013
2014
2015
2016
2017
4.35%
4.30%
4.25%
4.20%
4.15%
4.10%
6
Community Focused. Client Driven.
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Credit
Oversight
We have a strong, well-seasoned leadership team with very little turnover
ensuring a consistent proactive culture of compliance and underwriting year
after year from both a micro and macro perspective. We have remained vigilant
in our credit philosophy and loan policies to ensure continued prudent loan
structures and not stretch for credits that do not meet our underwriting guide-
lines. The slight increase in problem asset quality metrics is due to the loans
attained from the acquisition activity in 2014 and 2016. These metrics have
normalized through proactive resolution of some underperforming credits and
have resulted in a strong risk profile and well-performing loan book.
$10,000
$9,000
$8,000
$7,000
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$-
2013
2014
2015
2016
2017
Credit Quality
NPAs
NPAs to Total Assets
1.00%
0.90%
0.80%
0.70%
0.60%
0.50%
0.40%
0.30%
0.20%
0.10%
0.00%
Community Focused. Client Driven.
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Shareholder Letter
Annual Report
Cyber + Operational
Cyber + Operational
Risk Monitoring
Risk Monitoring
In addition to the financial drivers of the company, we persist in our attentiveness
In addition to the financial drivers of the company, we persist in our attentiveness to governance and in-
formation protection inclusive of cyber security and regulatory compliance. Cyber security is an area that
to governance and information protection inclusive of cyber security and regulato-
ry compliance. Cyber security is an area that remains of paramount importance in
remains of paramount importance in our company and industry. We will continue to evolve our technological
our company and industry. We will continue to evolve our technological safeguards
safeguards to ensure safety of information and effectiveness of security systems. Further, we will ensure
continuance of sound adherence to all regulatory requirements that will advance as the company exceeds
to ensure safety of information and effectiveness of security systems. Further, we
various size thresholds and benchmarks used to determine reporting standards.
will ensure continuance of sound adherence to all regulatory requirements that
will advance as the company exceeds various size thresholds and benchmarks
In order to fulfill our high expectations in operational efficiency, compliance, safety and soundness and cyber
used to determine reporting standards.
security there has been concerted effort and focus toward the evolution of our employee training and develop-
In order to fulfill our high expectations in operational efficiency, compliance, safety
ment initiatives over the past year. By creating a best-in-class knowledge base within our staff, we will allow
and soundness and cyber security there has been concerted effort and focus to-
the organization and each individual to be successful in achieving high levels of performance. We understand
that maintaining these important oversight initiatives are a collective and people-centric task where man-
ward the evolution of our employee training and development initiatives over the
agement and our team members will achieve success by:
past year. By creating a best-in-class knowledge base within our staff, we will allow
the organization and each individual to be successful in achieving high levels of per-
• Maintaining our commitment to excellence, accuracy and soundness in our daily operations. We are a fi-
formance. We understand that maintaining these important oversight initiatives are
nancial institution responsible for the care and safety of our clients’ financial resources, their private data,
a collective and people-centric task where management and our team members
and our shareholders’ investments. Sound operational practices, specifically when it comes to maintaining
will achieve success by:
proper cyber security protocols, are critical to sustaining the high integrity of our bank, from a reputational
• Maintaining our commitment to excellence, accuracy and soundness in our daily oper-
standpoint to maximizing operating efficiencies and limiting any potential financial losses.
ations. We are a financial institution responsible for the care and safety of our clients’
• Continuing the culture and spirit of constant improvement while embracing technology and new pro-
financial resources, their private data, and our shareholders’ investments. Sound opera-
cesses. As our organization increases in size, we will adapt to changes that accompany the growth. It is
tional practices, specifically when it comes to maintaining proper cyber security protocols,
imperative that we utilize technology and look to adopt new ways of completing tasks to remain efficient
are critical to sustaining the high integrity of our bank, from a reputational standpoint to
in our operations. “That is how we always did it in the past,” is not a winning approach to stay in front of
maximizing operating efficiencies and limiting any potential financial losses.
our competition and ahead of the growth curve in our challenging and ever-changing banking industry.
• Continuing the culture and spirit of constant improvement while embracing technology
and new processes. As our organization increases in size, we will adapt to changes that
accompany the growth. It is imperative that we utilize technology and look to adopt new
ways of completing tasks to remain efficient in our operations. “That is how we always
did it in the past,” is not a winning approach to stay in front of our competition and ahead
of the growth curve in our challenging and ever-changing banking industry.
Strategic Expansion Into the
Northern Lower Peninsula
While we focused on strategic growth during the year, relationships produced the opportunity to partner
with a like-minded and community focused organization in First Federal of Northern Michigan. The trans-
action that was negotiated throughout the second half of 2017 resulted in the early 2018 announcement
of the execution of a definitive agreement to acquire First Federal of Northern Michigan through in an
all-stock merger into a subsidiary of the corporation. The transaction remains subject to various approv-
als as of the time of this writing. The pending transaction will increase mBank’s market position as the
largest bank headquartered in the Upper Peninsula of Michigan with post-transaction assets estimated at
approximately $1.3 billion.
There are numerous compelling merger operating synergies that support the acquisition. We believe the
customer-centric cultures and community bank oriented traditions of our two organizations are very com-
plementary and were the driving impetus for the combination of the two banks. First Federal’s presence in
Alpena and surrounding markets also adds a large low-cost core deposit base to improve our funding mix.
With First Federal’s strong mortgage business and a complementary commercial banking sector to further
client expansion activities we will look to now more aggressively compete in the Northern Lower Peninsula
region. More importantly, we are adding high quality team members in various areas to help better position
the company from an overall governance perspective. As we move well above $1.0 billion in total assets, our
growing employee base will strongly support the company’s organic and external growth initiatives into the
future and safeguard the increases in shareholder value.
Outlook Into 2018
As a management team, we maintain goals and aspirations that help us navigate the changing landscape of
this industry and that we believe will lead to your company’s long-term success. We take responsibility and
ownership of these goals with the belief that they are the best path to building a great organization for all our
stakeholders. The following are some of the key operating initiatives we will strive to achieve in 2018:
• Continue footprint expansion within Northern Michigan and Northern Wisconsin through organic
and acquisition growth opportunities that fit culturally and provide limited execution risk.
8
8
Community Focused. Client Driven.
Community Focused. Client Driven.
Community Focused. Client Driven.
9
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Annual Report
Shareholder Letter
Shareholder Letter
Shareholder Letter
Annual Report
Annual Report
Cyber + Operational
Risk Monitoring
In addition to the financial drivers of the company, we persist in our attentiveness to governance and in-
formation protection inclusive of cyber security and regulatory compliance. Cyber security is an area that
remains of paramount importance in our company and industry. We will continue to evolve our technological
safeguards to ensure safety of information and effectiveness of security systems. Further, we will ensure
continuance of sound adherence to all regulatory requirements that will advance as the company exceeds
various size thresholds and benchmarks used to determine reporting standards.
In order to fulfill our high expectations in operational efficiency, compliance, safety and soundness and cyber
security there has been concerted effort and focus toward the evolution of our employee training and develop-
ment initiatives over the past year. By creating a best-in-class knowledge base within our staff, we will allow
the organization and each individual to be successful in achieving high levels of performance. We understand
that maintaining these important oversight initiatives are a collective and people-centric task where man-
agement and our team members will achieve success by:
• Maintaining our commitment to excellence, accuracy and soundness in our daily operations. We are a fi-
nancial institution responsible for the care and safety of our clients’ financial resources, their private data,
and our shareholders’ investments. Sound operational practices, specifically when it comes to maintaining
proper cyber security protocols, are critical to sustaining the high integrity of our bank, from a reputational
standpoint to maximizing operating efficiencies and limiting any potential financial losses.
• Continuing the culture and spirit of constant improvement while embracing technology and new pro-
cesses. As our organization increases in size, we will adapt to changes that accompany the growth. It is
imperative that we utilize technology and look to adopt new ways of completing tasks to remain efficient
in our operations. “That is how we always did it in the past,” is not a winning approach to stay in front of
our competition and ahead of the growth curve in our challenging and ever-changing banking industry.
Strategic Expansion Into the
Strategic Expansion Into the
Northern Lower Peninsula
Northern Lower Peninsula
While we focused on strategic growth during the year, relationships produced
While we focused on strategic growth during the year, relationships produced the opportunity to partner
with a like-minded and community focused organization in First Federal of Northern Michigan. The trans-
the opportunity to partner with a like-minded and community focused organiza-
tion in First Federal of Northern Michigan. The transaction that was negotiated
action that was negotiated throughout the second half of 2017 resulted in the early 2018 announcement
throughout the second half of 2017 resulted in the early 2018 announcement
of the execution of a definitive agreement to acquire First Federal of Northern Michigan through in an
all-stock merger into a subsidiary of the corporation. The transaction remains subject to various approv-
of the execution of a definitive agreement to acquire First Federal of Northern
Michigan through in an all-stock merger into a subsidiary of the corporation. The
als as of the time of this writing. The pending transaction will increase mBank’s market position as the
transaction remains subject to various approvals as of the time of this writing.
largest bank headquartered in the Upper Peninsula of Michigan with post-transaction assets estimated at
approximately $1.3 billion.
The pending transaction will increase mBank’s market position as the largest
bank headquartered in the Upper Peninsula of Michigan with post-transaction
There are numerous compelling merger operating synergies that support the acquisition. We believe the
assets estimated at approximately $1.3 billion.
customer-centric cultures and community bank oriented traditions of our two organizations are very com-
plementary and were the driving impetus for the combination of the two banks. First Federal’s presence in
There are numerous compelling merger operating synergies that support the
acquisition. We believe the customer-centric cultures and community bank ori-
Alpena and surrounding markets also adds a large low-cost core deposit base to improve our funding mix.
ented traditions of our two organizations are very complementary and were the
With First Federal’s strong mortgage business and a complementary commercial banking sector to further
client expansion activities we will look to now more aggressively compete in the Northern Lower Peninsula
driving impetus for the combination of the two banks. First Federal’s presence
region. More importantly, we are adding high quality team members in various areas to help better position
in Alpena and surrounding markets also adds a large low-cost core deposit base
to improve our funding mix. With First Federal’s strong mortgage business and a
the company from an overall governance perspective. As we move well above $1.0 billion in total assets, our
complementary commercial banking sector to further client expansion activities
growing employee base will strongly support the company’s organic and external growth initiatives into the
future and safeguard the increases in shareholder value.
we will look to now more aggressively compete in the Northern Lower Peninsula
region. More importantly, we are adding high quality team members in various
areas to help better position the company from an overall governance perspective.
As we move well above $1.0 billion in total assets, our growing employee base will
strongly support the company’s organic and external growth initiatives into the
future and safeguard the increases in shareholder value.
Outlook Into 2018
As a management team, we maintain goals and aspirations that help us navigate the changing landscape of
this industry and that we believe will lead to your company’s long-term success. We take responsibility and
ownership of these goals with the belief that they are the best path to building a great organization for all our
stakeholders. The following are some of the key operating initiatives we will strive to achieve in 2018:
• Continue footprint expansion within Northern Michigan and Northern Wisconsin through organic
and acquisition growth opportunities that fit culturally and provide limited execution risk.
8
Community Focused. Client Driven.
Community Focused. Client Driven.
Community Focused. Client Driven.
9
9
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Annual Report
Shareholder Letter
Shareholder Letter
Outlook
Outlook Into 2018
Into 2018
(Cont.)
• Operate the company in a safe and sound manner with adequate capital balancing expected shareholder
As a management team, we maintain goals and aspirations that help us navigate the changing
landscape of this industry and that we believe will lead to your company’s long-term success.
returns with a prudent long-term balance sheet structure while not stretching risk parameters for quick
We take responsibility and ownership of these goals with the belief that they are the best path to
or near-term gains.
building a great organization for all our stakeholders. The following are some of the key operating
• Provide strong support to our local communities, our clients, our employees and our shareholders.
initiatives we will strive to achieve in 2018:
We believe all our constituencies should be rewarded for their strong commitment to our company.
• Continue footprint expansion within Northern Michigan and Northern Wisconsin through organic
• Provide personal and professional growth opportunities for our employees. We accomplish this through
and acquisition growth opportunities that fit culturally and provide limited execution risk.
internal and external training, mentoring and continued education.
• Operate the company in a safe and sound manner with adequate capital balancing expected
• Maintain our facilities to a high standard to ensure we provide our customers a positive, professional
shareholder returns with a prudent long-term balance sheet structure while not stretching risk
banking experience and our employees a healthy and safe work environment in which they can take pride.
parameters for quick or near-term gains.
• Invest in technology to improve productivity, and to maintain cyber security and data confidentiality.
• Provide strong support to our local communities, our clients, our employees and our shareholders.
We view technology as a driver of revenue and client expansion, not just a cost center.
We believe all our constituencies should be rewarded for their strong commitment to our company.
through internal and external training, mentoring and continued education.
• Provide personal and professional growth opportunities for our employees. We accomplish this
As we move into 2018 on the heels of the transaction announcement and continue to progress on our key
operational initiatives from 2017, management and your board of directors looks to best position the orga-
• Maintain our facilities to a high standard to ensure we provide our customers a positive,
nization to achieve shareholder expectations and support the mission and vision that are the cornerstone of
professional banking experience and our employees a healthy and safe work environment in
the company culture. We remain resolute to our commitment of being a community bank that embraces the
which they can take pride.
responsibility and importance of supporting the businesses, civic organizations, municipalities and all the
• Invest in technology to improve productivity, and to maintain cyber security and data confidentiality.
people who live and work in our market areas. We thank you for your continued support and patronage and
look forward to another year of prosperous growth for the company.
We view technology as a driver of revenue and client expansion, not just a cost center.
As we move into 2018 on the heels of the transaction announcement and continue to progress
on our key operational initiatives from 2017, management and your board of directors looks to
best position the organization to achieve shareholder expectations and support the mission and
Sincerely,
vision that are the cornerstone of the company culture. We remain resolute to our commitment
of being a community bank that embraces the responsibility and importance of supporting the
businesses, civic organizations, municipalities and all the people who live and work in our market
areas. We thank you for your continued support and patronage and look forward to another year
Chairman
mBank
of prosperous growth for the company.
KELLY W. GEORGE
PAUL D. TOBIAS
President
Mackinac Financial
Corporation
Chairman + CEO
Mackinac Financial
Corporation
President + CEO
mBank
Sincerely,
PAUL D. TOBIAS
Chairman + CEO
Mackinac Financial
Corporation
Chairman
mBank
KELLY W. GEORGE
President
Mackinac Financial
Corporation
President + CEO
mBank
10
10
Community Focused. Client Driven.
Community Focused. Client Driven.
153065BDY_r2_MB_AR2018_Concepts_V22 2.indd 10
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Shareholder Letter
Annual Report
Financial Highlights
(Dollars in thousands, except per share data)
Selected Financial Condition Data (at end of period):
As of and for the Year Ending
December 31, 2017 (Unaudited)
As of and for the Year Ending
December 31, 2016 (Unaudited)
Assets
Loans
Investment securities
Deposits
Borrowings
Shareholders’ equity
Selected Statements of Income Data:
Net interest income
Income before taxes
Net income
Income per common share - Basic
Income per common share - Diluted
Weighted average shares outstanding
Weighted average shares outstanding - Diluted
Selected Financial Ratios and Other Data:
PERFORMANCE RATIOS:
Net interest margin
Efficiency ratio
Return on average assets
Return on average equity
Average total assets
Average total shareholders’ equity
Average loans to average deposits ratio
COMMON SHARE DATA AT END OF PERIOD:
Market price per common share
Book value per common share
Tangible book value per share
Dividends paid per share, annualized
Common shares outstanding
OTHER DATA AT END OF PERIOD:
Allowance for loan losses
Non-performing assets
Allowance for loan losses to total loans
Non-performing assets to total assets
Texas ratio
Number of:
Branch locations
FTE Employees
$985,367
$811,078
$75,897
$817,998
$79,552
$81,400
$37,938
$11,018
$5,479
$.87
$.87
6,288,791
6,322,413
4.20%
71.39%
.55%
6.74%
$995,826
$81,349
96.29%
$15.90
$12.93
$11.72
$.480
6,294,930
$5,079
$6,126
.63%
.62%
7.77%
23
233
$983,520
$781,857
$86,273
$823,512
$67,579
$78,609
$33,098
$6,766
$4,483
$.72
$.72
6,236,067
6,268,703
4.19%
79.69%
.52%
5.73%
$865,573
$78,300
98.14%
$13.47
$12.55
$11.29
$.400
6,263,371
$5,020
$8,906
.64%
.91%
11.76%
23
222
Community Focused. Client Driven.
11
153065BDY_r1_MB_AR2018_Concepts_V22 2.indd 11
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Annual Report
Annual Report
Our Communities
Our Communities
Community Involvement + Volunteering
Annual Report
Our Communities
Our Communities
Where Culture, Nature and Commerce can all Flourish
Where Culture, Nature and Commerce can all Flourish
mBank, headquartered in Manistique, Michigan, has several
mBank, headquartered in Manistique, Michigan, has several other Michigan
branches located in the Upper Peninsula, Northern Lower Peninsula, and
other Michigan branches located in the Upper Peninsula,
Southeast regions, as well as locations in Northern Wisconsin.
Northern Lower Peninsula, and Southeast regions, as well
as locations in Northern Wisconsin.
All our markets share a similar sense of small town community living and values centered in a beautiful outdoor
mecca with an abundance of fresh water, forests, hills and trails. Several of our regions have been celebrated
All our markets share a similar sense of
and awarded on their excellence for where to raise a family, where to start a business, or go on vacation.
small town community living and values
centered in a beautiful outdoor mecca with
While the beauty of the outdoors certainly is a focal point of our regions, the allure and comforts of city living
an abundance of fresh water, forests, hills
can still be found with abundant shopping, dining, and culture.
and trails. Several of our regions have been
Several outstanding higher education institutions are located right in the cities in which our branches oper-
celebrated and awarded on their excellence
ate including Northern Michigan University (Marquette), Lake Superior State University (Sault Ste. Marie),
for where to raise a family, where to start
Bay College (Escanaba), and Northwestern Michigan College (Traverse City).
a business, or go on vacation.
Several outstanding higher education
institutions are located right in the cities
in which our branches operate including
Northern Michigan University (Marquette),
Lake Superior State University (Sault Ste.
Marie), Bay College (Escanaba), and North-
western Michigan College (Traverse City).
comforts of city living can still be found
with abundant shopping, dining, and culture.
While the beauty of the outdoors certainly is
a focal point of our regions, the allure and
Manistique East Breakwater Lighthouse
Manistique East Breakwater Lighthouse
Soo Locks, Sault Ste. Marie
Soo Locks, Sault Ste. Marie
Shain Park, Birmingham
Shain Park, Birmingham
12
[ 12 ]
Duncan L Clinch Marina, Traverse City
Duncan L Clinch Marina, Traverse City
Marquette
Community Focused. Client Driven.
[ 13 ]
153065BDY_r2_MB_AR2018_Concepts_V22 2.indd 12
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Community
Involvement +
Volunteering
mBank makes investments of time and
money in areas that meet community
needs, including but not limited to: edu-
cation, literacy, human services, animal
welfare and healthcare organizations.
“There are numerous highly valuable or-
ganizations throughout our markets that
have a positive impact on the local resi-
dents,” said mBank President and CEO
Kelly George. “If our involvement can
magnify that impact, we believe it is our
financial responsibility to help in those ef-
forts when we can, and we are happy to do
so along with the many volunteer hours
from our dedicated local staff.”
Eagle River
American Cancer Society
Bay Cliff
Annual Report
Our Communities
Community Involvement + Volunteering
Community Involvement + Volunteering
Annual Report
Annual Report
Our Communities
Where Culture, Nature and Commerce can all Flourish
mBank, headquartered in Manistique, Michigan, has several other Michigan
branches located in the Upper Peninsula, Northern Lower Peninsula, and
Southeast regions, as well as locations in Northern Wisconsin.
All our markets share a similar sense of small town community living and values centered in a beautiful outdoor
mecca with an abundance of fresh water, forests, hills and trails. Several of our regions have been celebrated
and awarded on their excellence for where to raise a family, where to start a business, or go on vacation.
While the beauty of the outdoors certainly is a focal point of our regions, the allure and comforts of city living
can still be found with abundant shopping, dining, and culture.
Several outstanding higher education institutions are located right in the cities in which our branches oper-
ate including Northern Michigan University (Marquette), Lake Superior State University (Sault Ste. Marie),
Bay College (Escanaba), and Northwestern Michigan College (Traverse City).
Manistique East Breakwater Lighthouse
Soo Locks, Sault Ste. Marie
Shain Park, Birmingham
Duncan L Clinch Marina, Traverse City
[ 12 ]
Community
Community
Involvement +
Involvement +
Volunteering
Volunteering
mBank makes investments of time and
mBank makes investments of time and
money in areas that meet community
money in areas that meet community
needs, including but not limited to: edu-
needs, including but not limited to: edu-
cation, literacy, human services, animal
cation, literacy, human services, animal
welfare and healthcare organizations.
welfare and healthcare organizations.
“There are numerous highly valuable or-
“There are numerous highly valuable
ganizations throughout our markets that
organizations throughout our markets
that have a positive impact on the local
have a positive impact on the local resi-
residents,” said mBank President
dents,” said mBank President and CEO
Kelly George. “If our involvement can
& CEO Kelly George. “If our involvement
can magnify that impact, we believe it
magnify that impact, we believe it is our
is our financial responsibility to help in
financial responsibility to help in those ef-
forts when we can, and we are happy to do
those efforts when we can, and we are
happy to do so along with the many volun-
so along with the many volunteer hours
from our dedicated local staff.”
teer hours from our dedicated local staff.”
American Cancer Society
Bay Cliff
American Cancer Society
Bay Cliff
Eagle River
Eagle River
Marquette
Marquette
Community Focused. Client Driven.
Community Focused. Client Driven.
13
[ 13 ]
153065BDY_r2_MB_AR2018_Concepts_V22 2.indd 13
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Annual Report
Branch Locations
Branch Locations
MICHIGAN – Upper Peninsula
WISCONSIN
ESCANABA
2224 N. Lincoln Road
Escanaba, MI 49829
(906) 233–9443
ISHPEMING – Downtown
100 S. Main Street
Ishpeming, MI 49849
(906) 485–6333
MARQUETTE – Washington
857 W. Washington Street
Marquette, MI 49855
(906) 226–5000
MARQUETTE – McClellan
175 S. McClellan Avenue
Marquette, MI 49855
(906) 228–3933
ISHPEMING – Jubilee Foods
900 US 41 West
Ishpeming, MI 49849
(906) 486-9595
NEGAUNEE – Super One Foods
440 US 41 East
Negaunee, MI 49866
(906) 475-0120
ISHPEMING – West
US 41 West & 170 N. Daisy Street
Ishpeming, MI 49849
(906) 485–5717
NEWBERRY
414 Newberry Avenue
Newberry, MI 49868
(906) 293–5165
MANISTIQUE (Headquarters)
130 S. Cedar Street
Manistique, MI 49854
(906) 341–8401
SAULT STE. MARIE
138 Ridge Street
Sault Ste. Marie, MI 49783
(906) 635–3992
MANISTIQUE – Jack’s Fresh Market
735 E. Lakeshore Drive
Manistique, MI 49854
(906) 341-7190
STEPHENSON
S216 Menominee Street
Stephenson, MI 49887
(906) 753–2225
MICHIGAN – Lower Peninsula
AURORA
W563 County Road N.
Niagara, WI 54151
(715) 589–4381
EAGLE RIVER
400 E. Wall Street
Eagle River, WI 54521
(715) 479–4406
FLORENCE
845 Central Avenue
Florence, WI 54121
(715) 528–5670
NIAGARA
900 Roosevelt Road
Niagara, WI 54151
(715) 251–3113
ST. GERMAIN
240 Hwy 70 East
St. Germain, WI 54558
(715) 479–5201
THREE LAKES
1811 Superior Street
Three Lakes, WI 54562
(715) 546–2413
BIRMINGHAM
260 E. Brown Street, Suite 300
Birmingham, MI 48009
(248) 290–5900
KALEVA
14429 Wuoksi Avenue
Kaleva, MI 49645
(231) 362–3223
TRAVERSE CITY – N. Country
3530 N. Country Drive
Traverse City, MI 49684
(231) 929–5600
GAYLORD
1955 S. Otsego Avenue
Gaylord, MI 49735
(989) 732–3750
TRAVERSE CITY – Cass
309 Cass Street, Suite 100
Traverse City, MI 49684
(231) 941–6320
14
Community Focused. Client Driven.
153065BDY_r1_MB_AR2018_Concepts_V22 2.indd 14
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Branch Locations
Annual Report
MARQUETTE
NEGAUNEE
NEWBERRY
ISHPEMING
SAULT STE. MARIE
MANISTIQUE
EAGLE RIVER
FLORENCE
ESCANABA
ST. GERMAIN
THREE LAKES
AURORA
NIAGARA
STEPHENSON
GAYLORD
TRAVERSE CITY
KALEVA
BIRMINGHAM
Community Focused. Client Driven.
15
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LEFT BLANK INTENTIONALLY
153065BDY_r1_MB_AR2018_Concepts_V22 2.indd 16
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(cid:2)(cid:2) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
OR
(cid:3) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-20167
MACKINAC FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
MICHIGAN
(State or other jurisdiction of
incorporation or organization)
38-2062816
(I.R.S. Employer
Identification No.)
130 South Cedar Street
Manistique, Michigan 49854
(888) 343-8147
(Address, including Zip Code, and telephone number,
including area code, of registrant’s principal executive offices)
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Common Stock, no par value
Securities registered pursuant to Section 12(g) of the Act: None
Name of Each Exchange on Which Registered
The NASDAQ Stock Market, LLC
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes (cid:3) No (cid:2)
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes (cid:3) No (cid:2)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes (cid:2)
No (cid:3)
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted
and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to
submit and post such files.) (cid:2)
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be
contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to
this Form 10-K. Yes (cid:2) No (cid:3)
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth
company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange
Act.
Large accelerated filer (cid:3)
Accelerated filer (cid:3)
Non-accelerated filer (cid:3)
(Do not check if a smaller
Reporting company)
Smaller reporting company (cid:2)
Emerging growth company (cid:3)
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial
accounting standards provided pursuant to Section 13(a) of the Exchange Act. (cid:3)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes (cid:3) No (cid:2)
The aggregate market value of the common stock held by non-affiliates of the Registrant, based on a per share price of $13.99 as of June 30, 2017, was $56.785 million. As
of March 12, 2018, there were outstanding, 6,310,564 shares of the Corporation’s Common Stock (no par value).
Documents Incorporated by Reference:
Portions of the Corporation’s Proxy Statement for the 2018 Annual Meeting of Shareholders are incorporated by reference into Part III of this Report.
TABLE OF CONTENTS
PART I
Item 1. Business
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of
Equity Securities
Item 6. Selected Financial Data
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 10. Directors, Executive Officers, and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters
Item 13. Certain Relationships, Related Transactions and Director Independence
Item 14. Principal Accountant Fees and Services
PART IV
Item 15. Exhibits and Financial Statement Schedules
2
2
12
12
13
13
14
14
16
17
36
39
79
79
79
80
80
80
80
81
81
82
82
1
Item 1.
Business
PART I
Mackinac Financial Corporation (the “Corporation”) was incorporated under the laws of the state of Michigan on
December 16, 1974. The Corporation changed its name from “First Manistique Corporation” to “North Country
Financial Corporation” on April 14, 1998. On December 16, 2004, the Corporation changed its name from North
Country Financial Corporation to Mackinac Financial Corporation. The Corporation is headquartered and located in
Manistique, Michigan. The mailing address of the Corporation is P.O. Box 369, 130 South Cedar Street, Manistique,
Michigan 49854.
In December of 2004, the Corporation was recapitalized with the net proceeds, approximately $26.2 million, from the
issuance of $30 million of common stock in a private placement. Commensurate with this recapitalization, the
Corporation changed its name from North Country Financial Corporation to Mackinac Financial Corporation, and its
subsidiary bank adopted the “mBank” identity early in 2005.
On December 5, 2014, the Corporation completed its acquisition of Peninsula Financial Corporation (“PFC”) and its
wholly owned subsidiary, The Peninsula Bank. PFC had six branch offices and $126 million in assets as of the
acquisition date. The results of operations due to the merger have been included in the Corporation’s results since the
acquisition date. The merger was effected by a combination of cash payments and the issuance of shares of the
Corporation’s common stock to PFC shareholders. Each share of PFC’s 288,000 shares of common stock was converted
into the right to receive, at the shareholder’s election and subject to certain limitations (i) approximately 3.64 shares of
the Corporation’s common stock, with cash paid in lieu of fractional shares, or (ii) cash at $46.13 per share of common
stock. The conversion of PFC’s shares resulted in the issuance of 695,361 shares of the Corporation’s common stock
and payment of $4.484 million in cash to the former PFC shareholders.
On April 29, 2016, the Corporation completed its acquisition of The First National Bank of Eagle River (“Eagle River.”)
Eagle River had three branch offices and approximately $125 million in assets as of the acquisition date. The results of
operations due to the merger have been included in the Corporation’s results since the acquisition date. The merger was
effected by a cash payment of $12.5 million.
On August 31, 2016, the Corporation completed its acquisition of Niagara Bancorporation (“Niagara”) and its wholly
owned subsidiary, First National Bank of Niagara. Niagara had four branch offices and approximately $67 million in
assets. The results of operations due to the merger have been included in the Corporation’s results since the acquisition
date. The merger was effected by a cash payment of $7.325 million.
The Corporation owns all of the outstanding stock of its banking subsidiary, mBank (the “Bank”). The Bank currently
has 12 branch offices located in the Upper Peninsula of Michigan, 4 branch offices located in Michigan’s Lower
Peninsula, one branch in Southeast Michigan, and 6 branches in Wisconsin. The Bank maintains offices in the Michigan
counties of: Chippewa, Grand Traverse, Luce, Manistee, Marquette, Menominee, Oakland, Otsego, and Schoolcraft.
The Bank maintains offices in the Wisconsin counties of: Florence, Marinette, Oneida and Vilas. The Bank provides
drive-in convenience at 19 branch locations and has 26 automated teller machines. The Bank has no foreign offices.
The Corporation also owns three non-bank subsidiaries: First Manistique Agency, presently inactive; First Rural
Relending Company, a relending company for nonprofit organizations; and North Country Capital Trust, a statutory
business trust which was formed solely for the issuance of trust preferred securities (none of which remain outstanding).
The Bank represents the principal asset of the Corporation. The Bank has one wholly owned subsidiary, mBank Title
Insurance Agency, LLC, which provided title insurance services until 2014 and is currently inactive. The Corporation
and the Bank are engaged in a single industry segment, commercial banking, broadly defined to include commercial and
retail banking activities, along with other permitted activities closely related to banking.
Operations
The principal business of the Corporation is the general commercial banking business, conducted through the Bank’s
provision of a full range of loan and deposit products. These banking services include customary retail and commercial
banking services, including checking and savings accounts, time deposits, interest bearing transaction accounts, safe
deposit facilities, real estate mortgage lending, commercial lending, commercial and governmental lease financing, and
2
direct and indirect consumer financing. Funds for the Bank’s operations are also provided by brokered deposits and
through borrowings from the Federal Home Loan Bank (“FHLB”) system, proceeds from the sale of loans and
mortgage-backed and other securities, funds from repayment of outstanding loans and earnings from operations.
Earnings depend primarily upon the difference between (i) revenues from loans, investments, and other interest-bearing
assets and (ii) expenses incurred in payment of interest on deposit accounts and borrowings, an adequate allowance for
loan losses, and general operating expenses.
Competition
Banking is a highly competitive business. The Bank competes for loans and deposits with other banks, savings and loan
associations, credit unions, mortgage bankers, and investment firms in the scope and type of services offered, pricing of
loans, interest rates paid on deposits, and number and location of branches, among other things. The Bank also faces
competition for investors’ funds from mutual funds, marketable equity securities, and corporate and government
securities.
The Bank competes for loans principally through interest rates and loan fees, the range and quality of the services it
provides and the locations of its branches. In addition, the Bank actively solicits deposit-related clients and competes for
deposits by offering depositors a variety of savings accounts, checking accounts, and other services.
Employees
As of December 31, 2017, the Corporation and its subsidiaries employed, in the aggregate, 221 employees. The
Corporation provides its employees with comprehensive medical and dental benefit plans, a life insurance plan, and a
401(k) plan. None of the Corporation’s employees are covered by a collective bargaining agreement with the
Corporation. Management believes its relationship with its employees to be good.
Business
The Bank makes mortgage, commercial, and installment loans to customers throughout Michigan and Northeastern
Wisconsin. Fees may be charged for these services. The Bank’s most prominent concentration in the loan portfolio
relates to commercial loans to entities within real estate — operators of nonresidential buildings industry. This
concentration represented $119.025 million, or 20.77%, of the commercial loan portfolio at December 31, 2017. The
Bank also supports the service industry, with its hospitality and related businesses, as well as gas stations and
convenience stores, forestry, restaurants, farming, fishing, and many other activities important to growth in the regions
we service. The economy of the Bank’s market areas is affected by summer and winter tourism activities.
The Bank has become a premier SBA/USDA lender in our regions. Many of these SBA/USDA guaranteed loans are
sold at a premium on the secondary market, with the Bank retaining the servicing. The Bank does not sell the loan
guarantees on every credit, rather only those where acceptable market rates are above par.
The Bank also offers various consumer loan products including installment, mortgages and home equity loans. In
addition to making consumer portfolio loans, the Bank engages in the business of making residential mortgage loans for
sale to the secondary market.
On December 5, 2014, upon the consummation of the merger of PFC with and into the Corporation, the Corporation
consolidated Peninsula Bank with the Bank. The acquisition nearly doubled the bank’s presence in the Upper Peninsula
to 13 total branches and increased the total number of branches in Michigan from 11 to 17.
On April 29, 2016, the Corporation consummated the merger of Eagle River into the Bank. On August 31, 2016, upon
consummation of the purchase of all outstanding stock of Niagara Bancorporation, Inc., the Corporation consolidated
First National Bank of Niagara with the Bank. These acquisitions increased the Bank’s presence to 23 branches.
On January 16, 2018, the Corporation executed a merger agreement with First Federal of Northern Michigan Bancorp,
Inc. in Alpena, Michigan (“FFNM”), the consummation of which requires regulatory and shareholder approval. As of
December 31, 2017, FFNM had approximately $320 million in assets and $283 million in deposits, primarily core in
nature. The Corporation expects to consummate the merger in the second quarter of 2018.
3
The Bank’s primary source for lending, investments, and other general business purposes is deposits. The Bank offers a
wide range of interest bearing and non-interest bearing accounts, including commercial and retail checking accounts,
negotiable order of withdrawal (“NOW”) accounts, money market accounts with limited transactions, individual
retirement accounts, regular interest-bearing statement savings accounts, certificates of deposit with a range of maturity
date options, and accessibility to a customer’s deposit relationship through online banking. The sources of deposits are
residents, businesses and employees of businesses within the Bank’s market areas, obtained through the personal
solicitation of the Bank’s officers and directors, direct mail solicitation and limited advertisements published in the local
media. The Bank also utilizes the wholesale deposit market for any shortfalls in loan funding. No material portions of
the Bank’s deposits have been received from a single person, industry, group, or geographical location.
The Bank is a member of the FHLB of Indianapolis (“FHLB”). The FHLB provides an additional source of liquidity
and long-term funds. Membership in the FHLB has provided access to attractive rate advances, as well as advantageous
lending programs. The Community Investment Program makes advances to be used for funding community-oriented
mortgage lending, and the Affordable Housing Program grants advances to fund lending for long-term low and moderate
income owner occupied and affordable rental housing at subsidized interest rates.
The Bank has secondary borrowing lines of credit available to respond to deposit fluctuations and temporary loan
demands. The unsecured lines totaled $64.0 million at December 31, 2017, with additional amounts available if
collateralized.
As of December 31, 2017, the Bank had no material risks relative to foreign sources. See the “Interest Rate Risk” and
“Foreign Exchange Risk” sections in Management’s Discussion and Analysis of Financial Condition and Results of
Operations under Item 7 below, for details on the Corporation’s foreign account activity.
Compliance with federal, state, and local statutes and/or ordinances relating to the protection of the environment is not
expected to have a material effect upon the Bank’s capital expenditures, earnings, or competitive position.
Supervision and Regulation
As a registered bank holding company, the Corporation is subject to regulation and examination by the Board of
Governors of the Federal Reserve System (the “Federal Reserve Board”) under the Bank Holding Company Act, as
amended (the “BHCA”). The Bank is subject to regulation and examination by the Michigan Department of Insurance
and Financial Services (the “DIFS”) and the Federal Deposit Insurance Corporation (the “FDIC”).
Under the BHCA, the Corporation is subject to periodic examination by the Federal Reserve Board, and is required to
file with the Federal Reserve Board periodic reports of its operations and such additional information as the Federal
Reserve Board may require. In accordance with Federal Reserve Board policy, the Corporation is expected to act as a
source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the
Corporation might not do so absent such policy. In addition, there are numerous federal and state laws and regulations
which regulate the activities of the Corporation, the Bank and the non-bank subsidiaries, including requirements and
limitations relating to capital and reserve requirements, permissible investments and lines of business, transactions with
affiliates, loan limits, mergers and acquisitions, issuances of securities, dividend payments, inter-affiliate liabilities,
extensions of credit and branch banking.
Federal banking regulatory agencies have established risk-based capital guidelines for banks and bank holding
companies that are designed to make regulatory capital requirements more sensitive to differences in risk profiles among
banks and bank holding companies. The resulting capital ratios represent qualifying capital as a percentage of total risk-
weighted assets and off-balance sheet items. The guidelines are minimums, and the federal regulators have noted that
banks and bank holding companies contemplating expansion programs should not allow expansion to diminish their
capital ratios and should maintain all ratios well in excess of the minimums. The current ratios have recently been
significantly adjusted as discussed under “Basel III” below.
The Federal Deposit Insurance Corporation Improvement Act contains “prompt corrective action” provisions pursuant to
which banks are to be classified into one of five categories based upon capital adequacy, ranging from “well capitalized”
to “critically undercapitalized” and which require (subject to certain exceptions) the appropriate federal banking agency
to take prompt corrective action with respect to an institution which becomes “significantly undercapitalized” or
“critically undercapitalized”. The FDIC also, after an opportunity for a hearing, has authority to downgrade an
institution from “well capitalized” to “adequately capitalized” or to subject an “adequately capitalized” or
4
“undercapitalized” institution to the supervisory actions applicable to the next lower category, for supervisory concerns.
Information pertaining to the Corporation’s and the Bank’s capital is contained in “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” in Item 7 below, as well as in Note 16 to the Corporation’s
Consolidated Financial Statements in Item 8 below.
Current federal law provides that adequately capitalized and managed bank holding companies from any state may
acquire banks and bank holding companies located in any other state, subject to certain conditions.
In 1999, Congress enacted the Gramm-Leach-Bliley Act (“GLBA”), which eliminated certain barriers to and restrictions
on affiliations between banks and securities firms, insurance companies and other financial service organizations.
Among other things, GLBA repealed certain Glass-Steagall Act restrictions on affiliations between banks and securities
firms, and amended the BHCA to permit bank holding companies that qualify as “financial holding companies” to
engage in a broad list of “financial activities,” and any non-financial activity that the Federal Reserve Board, in
consultation with the Secretary of the Treasury, determines is “complementary” to a financial activity and poses no
substantial risk to the safety and soundness of depository institutions or the financial system. GLBA treats lending,
insurance underwriting, insurance company portfolio investment, financial advisory, securities underwriting, dealing and
market-making, and merchant banking activities as financial in nature for this purpose.
Under GLBA, a bank holding company may become certified as a financial holding company by filing a notice with the
Federal Reserve Board, together with a certification that the bank holding company meets certain criteria, including
capital, management, and Community Reinvestment Act requirements. The Corporation is not currently required to
qualify as a financial holding company.
Privacy Restrictions
GLBA, in addition to the previously described changes in permissible non-banking activities permitted to banks, bank
holding companies and financial holding companies, also requires financial institutions in the U.S. to provide certain
privacy disclosures to customers and consumers, to comply with certain restrictions on sharing and usage of personally
identifiable information, and to implement and maintain commercially reasonable customer information safeguarding
standards. The Corporation believes that it complies with all provisions of GLBA and all implementing regulations, and
the Bank has developed appropriate policies and procedures to meet its responsibilities in connection with the privacy
provisions of GLBA.
The USA PATRIOT Act
In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept
and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”). The USA PATRIOT Act is designed to deny terrorists
and criminals the ability to obtain access to the United States financial system, and has significant implications for
depository institutions, brokers, dealers and other businesses involved in the transfer of money. The USA PATRIOT
Act mandates financial services companies to implement additional policies and procedures with respect to, or additional
measures designed to address, any or all of the following matters, among others: money laundering, terrorist financing,
identifying and reporting suspicious activities and currency transactions, and currency crimes.
Sarbanes-Oxley Act
On July 30, 2002, President Bush signed into law The Sarbanes-Oxley Act of 2002. This legislation addresses
accounting oversight and corporate governance matters, including:
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(cid:2)
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(cid:2)
(cid:2)
The creation of a five-member oversight board that will set standards for accountants and have
investigative and disciplinary powers;
The prohibition of accounting firms from providing various types of consulting services to public
clients and requiring accounting firms to rotate partners among public client assignments every five
years;
Increased penalties for financial crimes;
Expanded disclosure of corporate operations and internal controls and certification of financial
statements;
Enhanced controls on, and reporting of, insider training; and
5
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Prohibition on lending to officers and directors of public companies, although the Bank may continue
to make these loans within the constraints of existing banking regulations.
Among other provisions, Section 302(a) of the Sarbanes-Oxley Act requires that our Chief Executive Officer and Chief
Financial Officer certify that our quarterly and annual reports do not contain any untrue statement or omission of a
material fact. Specific requirements of the certifications include having these officers confirm that they are responsible
for establishing, maintaining and regularly evaluating the effectiveness of our disclosure controls and procedures; they
have made certain disclosures to our auditors and Audit Committee about our internal controls; and they have included
information in our quarterly and annual reports about their evaluation and whether there have been significant changes in
our internal controls or in other factors that could significantly affect internal controls subsequent to their evaluation.
In addition, Section 404 of the Sarbanes-Oxley Act and the SEC’s rules and regulations thereunder require our
management to evaluate, with the participation of our principal executive and principal financial officers, the
effectiveness, as of the end of each fiscal year, of our internal control over financial reporting. Our management must
then provide a report of management on our internal over financial reporting that contains, among other things, a
statement of their responsibility for establishing and maintaining adequate internal control over financial reporting, and a
statement identifying the framework they used to evaluate the effectiveness of our internal control over financial
reporting.
Dodd-Frank Wall Street Reform and Consumer Protection Act
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
(the “Dodd-Frank Act”) into law. The Dodd-Frank Act resulted in sweeping changes in the regulation of financial
institutions aimed at strengthening safety and soundness for the financial services sector. A summary of certain
provisions of the Dodd-Frank Act is set forth below:
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Increased Capital Standards and Enhanced Supervision.
The federal banking agencies are required to establish minimum leverage and risk-based capital
requirements for banks and bank holding companies. These new standards are described below. The
Dodd-Frank Act also increased regulatory oversight, supervision and examination of banks, bank
holding companies and their respective subsidiaries by the appropriate regulatory agency.
Federal Deposit Insurance.
The Dodd-Frank Act made permanent the $250,000 deposit insurance limit for insured deposits and
provided unlimited federal deposit insurance on noninterest bearing transaction accounts at all insured
depository institutions through December 31, 2012. Subsequent to 2012, these amounts reverted from
unlimited insurance to $250,000 coverage per separately insured depositor. The Dodd-Frank Act also
changed the assessment base for federal deposit insurance from the amount of insured deposits to
consolidated assets less tangible equity, eliminated the ceiling on the size of the Deposit Insurance
Fund (the “DIF”) and increased the floor on the size of the DIF.
The Consumer Financial Protection Bureau (“CFPB”).
The Dodd-Frank Act centralized responsibility for consumer financial protection by creating a new
agency, the CFPB, responsible for implementing, examining and, for large financial institutions of $10
billion or more in total assets, enforcing compliance with federal consumer financial laws. Because
we have under $10 billion in total assets, however, the Federal Deposit Insurance Corporation will still
continue to examine us at the federal level for compliance with such laws.
Interest on Demand Deposit Accounts.
The Dodd-Frank Act repealed the prohibition on the payment of interest on demand deposit accounts
effective July 21, 2011, thereby permitting depository institutions to now pay interest on business
checking and other accounts.
6
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(cid:2)
(cid:2)
Mortgage Reform.
The Dodd-Frank Act provided for mortgage reform addressing a customer’s ability to repay, restricted
variable-rate lending by requiring the ability to repay to be determined for variable rate loans by using
the maximum rate that will apply during the first five years of a variable-rate loan term, and made
more loans subject to requirements for higher-cost loans, new disclosures and certain other restrictions.
Interstate Branching.
The Dodd-Frank Act allows banks to engage in de novo interstate branching, a practice that was
previously significantly limited.
Interchange Fee Limitations.
The Dodd-Frank Act gave the Federal Reserve Board the authority to establish rules regarding
interchange fees charged for electronic debit transactions by a payment card issuer that, together with
its affiliates, has assets of $10 billion or more and to enforce a new statutory requirement that such fees
be reasonable and proportional to the actual cost of a transaction to the issuer. The Federal Reserve
Board has rules under this provision that limit the swipe fees that a debit card issuer can charge a
merchant for a transaction to the sum of 21 cents and five basis points times the value of the
transaction, plus up to one cent for fraud prevention costs. While we are not directly subject to such
regulations since our total assets do not exceed $10 billion, these regulations may impact our ability to
compete with larger institutions who are subject to the restrictions.
The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the
United States and requires the CFPB and other federal agencies to implement many new and
significant rules and regulations in addition to those discussed above. The CFPB has issued significant
new regulations that impact consumer mortgage lending and servicing. Those regulations became
effective in January 2014. In addition, the CFPB issued new regulations that changed the disclosure
requirements and forms used under the Truth in Lending Act and Real Estate Settlement and
Procedures Act effective October 3, 2015. Compliance with these new laws and regulations and other
regulations under consideration by the CFPB will likely result in additional costs, which could be
significant and could adversely impact our results of operations, financial condition or liquidity.
Basel III
On July 2, 2013, the Federal Reserve and OCC approved a final rule to establish a new comprehensive regulatory capital
framework for all US banking organizations, with an effective date of January 1, 2015. The Regulatory Capital
Framework (“Basel III”) implements several changes to the US regulatory capital framework required by the Dodd-
Frank Act. The new US capital framework imposed higher minimum capital requirements, additional capital buffers
above those minimum requirements, a more restrictive definition of capital, and higher risk weights for various
enumerated classifications of assets, the combined impact of which effectively results in substantially more demanding
capital standards for US banking organizations.
The Basel III final rule established a common equity Tier 1 capital (“CET1”) requirement, a Tier 1 capital requirement
of 6.0% and an 8.0% total capital requirement. The new CET1 and minimum Tier 1 capital requirements became
effective January 1, 2015. In addition to these minimum risk-based capital ratios, the Basel III final rule required that all
banking organizations maintain a “capital conservation buffer” consisting of CET1 in an amount equal to 2.5% of risk-
weighted assets in order to avoid restrictions on their ability to make capital distributions and to pay certain discretionary
bonus payments to executive officers. In order to avoid those restrictions, the capital conservation buffer effectively
increased the minimum CET1 capital, Tier 1 capital and total capital ratios for US banking organizations to 7.0%, 8.5%
and 10.5%, respectively. Banking organizations with capital levels that fall within the buffer will be required to limit
dividends, shares repurchases or redemptions (unless replaced within the same calendar quarter by capital instruments of
7
equal or higher quality), and discretionary bonus payments. The capital conservation buffer is phased in over a 5-year
period, beginning January 1, 2016.
Leverage
CET1
Tier 1
Total Capital
Adequately
Capitalized
Requirement
4.0%
4.5%
6.0%
8.0%
Requirement
Well-Capitalized
Well-Capitalized with Buffer, fully
phased in 2019
5.0%
7.0%
8.5%
10.5%
5.0%
6.5%
8.0%
10.0%
As required by Dodd-Frank, the Basel III final rule requires that capital instruments such as trust preferred securities and
cumulative preferred shares be phased out of Tier 1 capital by January 1, 2016, for banking organizations that had $15
billion or more in total consolidated assets as of December 31, 2009 and permanently grandfathers as Tier 1 capital such
instruments issued by these smaller entities prior to May 19, 2010 (provided they do not exceed 25% of Tier 1 capital).
The Basel III final rule provides banking organizations under $250 billion in total consolidated assets or under $10
billion in foreign exposures with a one-time “opt-out” right to continue excluding Accumulated Other Comprehensive
income from CET1 capital. The election to opt-out must be made on the banking organization’s first Call Report filed
after January 1, 2015. The Corporation has elected to opt-out and continues to exclude Accumulated Other
Comprehensive Income from its regulatory capital.
The Basel III final rule requires that goodwill and other intangible assets (other than mortgage servicing assets), net of
associated deferred tax liabilities, be deducted from CET1 capital. Additionally, deferred tax assets that arise from net
operating loss and tax credit carryforwards, net of associated deferred tax liabilities and valuation allowances, are fully
deducted from CET1 capital. However, deferred tax assets arising from temporary differences that could not be realized
through net operating loss carrybacks, along with mortgage servicing assets and “significant” (defined as greater than
10% of the issued and outstanding common stock of the unconsolidated financial institution) investments in the common
stock of unconsolidated “financial institutions” are partially includible in CET1 capital, subject to deductions defined in
the final rule.
Information regarding the Corporation and the Bank’s regulatory capital can be found in Note 16 – Regulatory Matters
in the financial statements included herein.
Monetary Policy
The earnings and business of the Corporation and the Bank depends on interest rate differentials. In general, the
difference between the interest rates paid by the Bank to obtain its deposits and other borrowings, and the interest rates
received by the Bank on loans extended to its customers and on securities held in the Bank’s portfolio, comprises the
major portion of the Bank’s earnings. These rates are highly sensitive to many factors that are beyond the control of the
Bank, and accordingly, its earnings and growth will be subject to the influence of economic conditions, generally, both
domestic and foreign, including inflation, recession, unemployment, and the monetary policies of the Federal Reserve
Board. The Federal Reserve Board implements national monetary policies designed to curb inflation, combat recession,
and promote growth through, among other means, its open-market dealings in US government securities, by adjusting
the required level of reserves for financial institutions subject to reserve requirements, through adjustments to the
discount rate applicable to borrowings by banks that are members of the Federal Reserve System, and by adjusting the
Federal Funds Rate, the rate charged in the interbank market for purchase of excess reserve balances. In addition,
legislative and economic factors can be expected to have an ongoing impact on the competitive environment within the
financial services industry. The nature and timing of any future changes in such policies and their impact on the Bank
cannot be predicted with certainty.
8
Selected Statistical Information
I.
Distribution of Assets, Obligations, and Shareholders’ Equity; Interest Rates and Interest Differential
The key components of net interest income, the daily average balance sheet for each year — including the components
of earning assets and supporting obligations — the related interest income on a fully tax equivalent basis and interest
expense, as well as the average rates earned and paid on these assets and obligations is contained under the caption
“Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Item 7 below.
An analysis of the changes in net interest income from period-to-period and the relative effect of the changes in interest
income and expense due to changes in the average balances of earning assets and interest-bearing obligations and
changes in interest rates is contained under the caption “Management’s Discussion and Analysis of Financial Condition
and Results of Operations” under Item 7 below.
II.
Investment Portfolio
A.
Investment Portfolio Composition
The following table presents the carrying value of investment securities available for sale as of December 31 of the years
set forth below (dollars in thousands):
2017
2016
2015
US Treasuries
Corporate
Equity
US Agencies
US Agencies - MBS
State and political subdivisions
Total
$
— $
— $
—
12,646
19,910
—
500
27,377
23,952
3,759
16,833
9,946
25,078
$ 75,897 $ 86,273 $ 53,728
24,391
500
16,846
12,716
21,444
B.
Relative Maturities and Weighted Average Interest Rates
The following table presents the maturity schedule of securities held and the weighted average yield of those securities,
as of December 31, 2017 (fully taxable equivalent, dollars in thousands):
US Treasuries
US Agencies
US Agencies - MBS
Corporate
Equity
State and political
subdivisions
In one
year
or less
After one, After five,
but within but within
ten years
five years
Over
ten years
Total
$
— $
— $
2,299
2,342
5,250
—
14,547
1,219
17,626
—
— $
—
2,968
1,515
—
— $
—
6,187
—
500
—
16,846
12,716
24,391
500
Weighted
Average
Yield (1)
—
1.81%
2.22%
2.73%
4.61%
1,713
8,492
9,469
1,770
21,444
3.35%
Total
$ 11,604 $ 41,884 $ 13,952 $ 8,457 $ 75,897
Weighted average yield (1)
1.97%
2.29%
3.81%
4.07%
2.63%
(1) Weighted average yield includes the effect of tax-equivalent adjustments using a 21% tax rate.
9
III.
Loan Portfolio
A.
Type of Loans
The following table sets forth the major categories of loans outstanding for each category at December 31 (dollars in
thousands):
Commercial real estate
Commercial, financial and agricultural
One to four family residential real estate
Construction
Consumer
2016
2017
2015
$ 406,742 $ 389,420 $ 312,805 $ 315,387 $ 268,809
122,140
79,655
103,768
140,502
17,799
27,100
13,801
15,847
101,895
139,553
25,715
18,385
156,951
209,890
20,061
17,434
142,648
205,945
23,731
20,113
2014
2013
Total
$ 811,078 $ 781,857 $ 618,394 $ 600,935 $ 483,832
B.
Maturities and Sensitivities of Loans to Changes in Interest Rates
The following table presents the remaining maturity of total loans outstanding for the categories shown at December 31,
2017, based on scheduled principal repayments (dollars in thousands):
Commercial,
Financial,
and
1-4 Family
Commercial
Residential
Real Estate Agricultural Real Estate Consumer Construction
Total
In one year or less:
Variable interest rates
Fixed interest rates
After one year but within five years:
Variable interest rates
Fixed interest rates
After five years:
Variable interest rates
Fixed interest rates
$ 24,191 $ 46,614 $
761 $
22 $
37,068
8,849
6,813
1,994
661 $ 72,249
65,274
10,550
26,377
28,122
8,921
16,795
144,805
24,023
1,317
2,331
3,841
166
185,261
71,437
78,147
212,837
23,424
52,348
2,981
30,507
42
11,728
1,638
3,205
106,232
310,625
Total
$ 406,742 $ 156,951 $ 209,890 $ 17,434 $ 20,061 $ 811,078
C.
Risk Elements
The following table presents a summary of nonperforming assets and problem loans as of December 31 (dollars in
thousands):
2017
2016
2015
2014
2013
Nonaccrual loans
$ 2,388 $ 3,959 $ 2,353 $ 3,939 $ 1,406
Interest income recorded during period for nonaccrual loans
—
437
795
—
—
Accruing loans past due 90 days or more
—
—
32
—
—
Restructured loans on nonaccrual not included above
180
165
154
3,105
614
10
IV.
Summary of Loan Loss Experience
A.
Analysis of the Allowance for Loan Losses
Changes in the allowance for loan losses arise from loans charged off, recoveries on loans previously charged off by
loan category, and additions to the allowance for loan losses through provisions charged to expense. Factors which
influence management’s judgment in determining the provision for loan losses include establishing specified loss
allowances for selected loans (including large loans, nonaccrual loans, and problem and delinquent loans) and
consideration of historical loss information and local economic conditions.
The following table presents information relative to the allowance for loan losses for the years ended December 31,
(dollars in thousands):
2017
2016
2015
2014
2013
Balance of allowance for loan losses at
beginning of period
$
5,020 $
5,004 $
5,140 $
4,661 $
5,218
Loans charged off:
Commercial
One to four family residential real
estate
Consumer
Total loans charged off
Recoveries of loans previously charged
off:
Commercial
One to four family residential real
estate
Consumer
Total recoveries
Net loans charged off
Provisions charged to expense
419
155
229
803
119
67
51
237
566
625
477
133
113
723
102
5
32
139
584
600
1,801
142
87
2,030
662
2
26
690
682
2,171
290
74
1,046
141
120
2,432
259
22
44
325
150
26
24
200
1,340
1,204
721
1,200
2,232
1,675
Balance at end of period
$
5,079 $
5,020 $
5,004 $
5,140 $
4,661
Average loans outstanding
795,532
703,047
602,904
509,749
462,500
Ratio of net charge-offs to average loans
.07%
.08%
.22%
.14%
.48%
11
B.
Allocation of Allowance for Loan Losses
The allocation of the allowance for loan losses for the years ended December 31, is shown on the following table. The
percentages shown represent the percent of each loan category to total loans (dollars in thousands):
2017
2016
2015
2014
2013
Amount %
Amount %
Amount %
Amount %
Amount %
Commercial real estate
$ 1,650 50.15% $ 1,345 49.81% $ 1,611 50.58% $ 2,813 52.48% $ 1,849 55.56%
Commercial, financial, and
agricultural
576
19.35
614
18.25
645
19.75 1,539
16.96 1,378
16.46
Commercial construction
54
1.14
57
1.47
79
2.48
142
2.71
80
1-4 family residential real estate
160
25.88
296
26.34
274
22.72
285
23.22
516
Consumer construction
6
1.33
6
1.56
7
1.91
6
1.57
25
Consumer
10
2.15
90
2.57
64
2.56
13
3.06
148
Unallocated general reserves
2,623
— 2,612
— 2,324
—
342
—
665
2.25
21.45
1.43
2.85
—
Total
$ 5,079 100.00% $ 5,020 100.00% $ 5,004 100.00% $ 5,140 100.00% $ 4,661 100.00%
V.
Deposits
Deposit information is contained in Note 7 to the Corporation’s Consolidated Financial Statements in Item 8 of this
Form 10-K below.
VI.
Return on Equity and Assets
See Item 6 of this Form 10-K, “Selected Financial Data”
VII.
Financial Instruments with Off-Balance Sheet Risk
Information relative to commitments, contingencies, and credit risk are discussed in Note 19 to the Corporation’s
Consolidated Financial Statements contained in Item 8 of this Form 10-K.
Item 1B. Unresolved Staff Comments
None.
Item 2.
Properties
The Corporation’s headquarters are located at 130 South Cedar Street, Manistique, Michigan 49854. The headquarters
location is owned by the Corporation and not subject to any mortgage.
12
All of the branch locations are designed for use and operation as a bank, are well maintained, and are suitable for current
operations. Of the 23 branch locations, 16 are owned and 7 are leased. The Corporation has additional office space to
house administrative operational support. Below is a comprehensive listing of our branch locations:
Aurora
Birmingham
W563 County Road N
260 E. Brown Street,
Aurora, WI
Birmingham, MI
Owned
Leased
Suite 300
Eagle River, WI
400 E. Wall Street
Escanaba, MI
2224 N. Lincoln Road
Florence, WI
845 Central Ave
1955 S. Otsego Avenue Gaylord, MI
Eagle River
Escanaba
Florence
Gaylord
Ishpeming - Downtown 100 S. Main Street
Ishpeming - Jubilee
Ishpeming - West
900 US 41 West
US West & 170 N.
Ishpeming, MI
Ishpeming, MI
Ishpeming, MI
Daisy Street
Kaleva
Manistique
Manistique - Jack’s
Marquette
Kaleva, MI
14429 Wuoksi Avenue
130 South Cedar Street
Manistique, MI
735 E. Lakeshore Drive Manistique, MI
Marquette, MI
857 W. Washington
Street
Marquette - McClellan 175 S. McClellan
Marquette, MI
Avenue
Negaunee
Newberry
Niagara
Sault Ste. Marie
Stephenson
St. Germain
Three Lakes
Traverse City- Cass St 309 Cass Street
Traverse City
440 US 41 East
414 Newberry Avenue
900 Roosevelt Road
138 Ridge Street
S216 Menominee Street Stephenson, MI
St. Germain, WI
240 HWY 70 East
Three Lakes, WI
1811 Superior Street
Traverse City, MI
Traverse City, MI
Negaunee, MI
Newberry, MI
Niagara, WI
Sault Ste. Marie, MI
3530 North Country
Owned
Owned
Owned
Owned
Owned
Leased
Owned
Owned
Owned
Leased
Leased
Owned
Leased
Owned
Owned
Owned
Owned
Owned
Owned
Leased
Owned
Item 3.
Legal Proceedings
Drive
There are 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.
Item 4. Mine Safety Disclosures
Not applicable.
13
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of
Equity Securities
PART II
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, 2016
through December 31, 2017, as reported by NASDAQ.
2017
High
Low
Close
Dividends declared per share
Book value
2016
High
Low
Close
Dividends declared per share
For the Quarter Ended
March 31 June 30 September 30 December 31
$ 13.88 $ 13.99 $
13.63
13.72
0.120
12.71
13.92
13.99
0.120
12.92
15.52 $
15.01
15.38
0.120
13.13
16.10
15.89
15.90
0.120
12.93
$ 11.69 $ 11.97 $
9.90
10.25
0.100
10.00
11.01
0.100
11.98 $
10.64
11.49
0.100
14.07
11.00
13.47
0.100
The Corporation had approximately 1600 shareholders of record as of March 8, 2018. A substantially greater number of
holders are beneficial owners whose shares are held of record by banks, brokers and other nominees.
Dividends
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. In 2017, the Bank paid dividends to the Corporation totaling $7.0 million.
Issuer Purchases of Equity Securities
The Corporation currently has a share repurchase program. The program is conducted under authorizations from time to
time by the Board of Directors. Shares repurchased to date are covered by Board authorizations made and publically
announced for $600,000 on February 27, 2013, an additional $600,000 on December 17, 2013, and an additional
$750,000 on April 28, 2015. None of these authorizations has an expiration date. The Corporation purchased 14,000
shares for $.150 million in 2016, 102,455 shares for $1.122 million in 2015, 13,700 shares of its common stock for $.143
million in 2014, and $.509 million in 2013. There were no repurchases made during 2017. As of December 31, 2017
the Corporation had $25,000 remaining of the previously authorized buyback amount.
For information regarding securities authorized for issuance under equity compensation plans, see Item 12 of this
Form 10-K.
14
Performance Graph
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, 2017. The following information is based on an
investment of $100, on December 31, 2012 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.
15
Item 6.
Selected Financial Data
SELECTED FINANCIAL DATA
(Unaudited)
(Dollars in Thousands, Except Per Share Data)
Year Ended December 31,
2017
2016
2015
2014
2013
SELECTED FINANCIAL CONDITION DATA:
Total assets
Loans
Securities
Deposits
Borrowings
Common shareholders’ equity
Total shareholders’ equity
SELECTED OPERATIONS DATA:
Interest income
Interest expense
Net interest income
Provision for loan losses
Net security gains
Other income
Other expenses
Income before income taxes
Provision (credit) for income taxes
Net income
Preferred dividend and accretion of discount
Net income available to common shareholders
PER SHARE DATA:
Earnings — Basic
Earnings — Diluted
Cash dividends declared
Book value
Tangible book value
Market value - closing price at year end
FINANCIAL RATIOS:
Return on average common equity
Return on average total equity
Return on average assets
Dividend payout ratio
Average equity to average assets
Net interest margin
ASSET QUALITY RATIOS:
Nonperforming loans to total loans
Nonperforming assets to total assets
Allowance for loan losses to total loans
Allowance for loan losses to nonperforming loans
Net charge-offs to average loans
Texas ratio
$ 985,367 $ 983,520 $ 739,269 $ 743,785 $ 572,800
483,832
618,394
53,728
44,388
466,299
610,323
37,852
45,754
65,249
76,602
65,249
76,602
811,078
75,897
817,998
79,552
81,400
81,400
781,857
86,273
823,512
67,579
78,609
78,609
600,935
65,832
606,973
49,846
73,996
73,996
$ 44,376 $ 37,983 $ 33,513 $ 27,669 $ 25,523
4,124
21,399
1,675
73
3,865
(18,128)
5,534
(403)
5,937
308
5,629
4,393
29,120
1,204
455
3,434
(23,876)
7,929
2,333
5,596
—
4,483 $ 5,596 $ 1,700 $
6,438
37,938
625
231
3,810
(30,336)
11,018
5,539
5,479
—
4,885
33,098
600
150
4,003
(29,885)
6,766
2,283
4,483
—
4,142
23,527
1,200
54
3,058
(22,610)
2,829
1,129
1,700
—
$ 5,479 $
$
0.87 $
0.87
0.48
12.93
11.72
15.90
0.72 $
0.72
0.40
12.55
11.29
13.47
0.90 $
0.89
0.35
12.32
11.54
11.49
0.30 $
0.30
0.225
11.81
11.01
11.85
1.01
1.00
0.17
11.77
11.77
9.90
6.74%
6.74
0.55
55.17
8.17
4.20
5.73%
5.73
0.52
55.56
9.05
4.19
7.41%
7.41
0.76
41.67
10.23
4.30
2.57%
2.57
0.28
75.00
10.94
4.19
9.07%
8.26
1.01
16.83
12.28
4.17
.32%
0.62
0.64
197.78
0.07
7.77
.53%
0.91
0.64
121.73
0.08
11.76
.41%
0.66
0.81
197.09
0.22
6.34
.66%
0.93
0.86
130.49
0.14
9.37
.42%
0.58
0.96
230.29
0.48
5.59
16
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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:
Risk Factors
Risks Related to our Lending and Credit Activities
(cid:2)
(cid:2)
(cid:2)
Our business may be adversely affected by conditions in the financial markets and economic
conditions generally, as our borrowers’ ability to repay loans and the value of the collateral securing
our loans decline.
Weakness in the markets for residential or commercial real estate, including the secondary residential
mortgage loan markets, could reduce our net income and profitability.
As a community banking organization, the Corporation’s success depends upon local and regional
economic conditions and has different lending risks than larger banks.
We manage our credit exposure through careful monitoring of loan applicants and loan concentrations
in particular industries and through loan approval and review procedures. We have established an
evaluation process designed to determine the adequacy of our allowance for loan losses. While this
evaluation process uses historical and other objective information, the classification of loans and the
establishment of loan losses is an estimate based on experience, judgment and expectations regarding
borrowers and economic conditions, as well as regulator judgments. We can make no assurance that
our loan loss reserves will be sufficient to absorb future loan losses or prevent a material adverse effect
on our business, profitability or financial condition.
(cid:2)
Our allowance for loan losses may be insufficient.
Continuing deterioration in economic conditions affecting borrowers, new information regarding
existing loans, identification of additional problem loans, and other factors, both within and outside of
our control, may require an increase in our allowance for loan losses.
Risks Related to Our Operations
(cid:2)
(cid:2)
We are subject to interest rate risk.
Our earnings and cash flows are largely dependent upon our net interest income, which is the
difference between interest income on interest-earning assets such as loans and securities and interest
expense paid on interest-bearing liabilities such as deposits and borrowed funds. There are many
factors which influence interest rates that are beyond our control, including but not limited to general
economic conditions and governmental policy, and in particular, the policies of the FRB.
Changes in our accounting policies or in accounting standards could materially affect how we report
our financial results and condition.
17
(cid:2)
(cid:2)
(cid:2)
We may not realize the expected benefits of our recent acquisitions of The First National Bank of
Eagle River and the First National Bank of Niagara, or our recently announced proposed merger with
First Federal of Northern Michigan.
Our controls and procedures may fail or be circumvented.
Impairment of deferred income tax assets could require charges to earnings, which could result in an
adverse impact on our results of operations.
In assessing the realizability of deferred income tax assets, management considers whether it is more
likely than not that some valuation allowance is necessary, which requires management to evaluate all
available evidence, both negative and positive. Positive evidence necessary to overcome the negative
evidence includes whether future taxable income in sufficient amounts and character within the carry
back and carry forward periods is available under the tax law, including the use of tax planning
strategies. When negative evidence (e.g. cumulative losses in recent years, history of operating loss or
tax credit carry forwards expiring unused) exists, more positive evidence than negative evidence will
be necessary. At December 31, 2017, net deferred tax assets are approximately $4.970 million. If a
valuation allowance becomes necessary with respect to such balance, it could have a material adverse
effect on our business, results of operations and financial condition.
(cid:2)
Our information systems may experience an interruption of breach in security.
Risks Related to Legal and Regulatory Compliance
(cid:2)
We operate in a highly regulated environment, which could increase our cost structure or have other
negative impacts on our operations.
Strategic Risks
(cid:2)
(cid:2)
Reputation Risks
(cid:2)
Liquidity Risks
Maintaining or increasing our market share may depend on lowering prices and market acceptance of
new products and services.
Future growth or operating results may require us to raise additional capital but that capital may not
be available.
Unauthorized disclosure of sensitive of confidential client or customer information, whether through a
breach of our computer system or otherwise, could severely harm our business.
(cid:2)
We could experience an unexpected inability to obtain needed liquidity.
The ability of a financial institution to meet its current financial obligations is a function of its balance
sheet structure, its ability to liquidate assets and its access to alternative sources of funds. We seek to
ensure our funding needs are met by maintaining an appropriate level of liquidity through
asset/liability management.
Risks Related to an Investment in Our Common Stock
(cid:2)
(cid:2)
Limited trading activity for shares of our common stock may contribute to price volatility.
Our securities are not an insured deposit.
18
(cid:2)
You may not receive dividends on your investment in common stock.
Our ability to pay dividends is dependent upon our receipt of dividends from the Bank, which is
subject to regulatory restrictions. Such restrictions, which govern state-chartered banks, generally
limit the payment of dividends on bank stock to the bank’s undivided profits after all payments of all
necessary expenses, provided that the bank’s surplus amounts to at least 20% of its capital after
payment of the dividend.
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.
Overview
The following discussion and analysis presents the more significant factors affecting the Corporation’s financial
condition as of December 31, 2017 and 2016 and the results of operations for 2015 through 2017. This discussion also
covers asset quality, liquidity, interest rate sensitivity, and capital resources for the years 2016 and 2017. 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.
The acquisition of Eagle River in April 2016 added approximately $125 million in assets, $81 million in loan balances
and $105 million in deposits to the Corporation. The acquisition of Niagara added $67 million in assets, $32 million in
loan balances and $59 million in deposits.
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 2017 results of operations and financial condition. A
more detailed analysis of the results of operations and financial condition follows this summary.
The Corporation reported net income of $5.479 million, or $.87 per share, for the year ended December 31, 2017,
compared to $4.483 million, or $.72 per share, in 2016, and net income of $5.596 million, or $.90 per share, for 2015.
The 2017 results include the effects of the $2.025 million non-cash tax related expense related to the revaluation of the
Corporations deferred tax asset (“DTA”) as a result of the corporate tax code change announced in December 2017. The
2016 results include costs related to the acquisitions of Eagle River and Niagara in the amount of $3.101 million. The
2015 results include one-time charges related to regulatory audit costs incurred in connection with our approval as an
SBA preferred lender and the transfer of our asset based lending subsidiary assets to mBank, which included a
prepayment penalty on its line of credit.
Total assets of the Corporation at December 31, 2017, were $985.367 million, an increase of $1.847 million, or 0.19%,
from total assets of $983.520 million reported at December 31, 2016.
At December 31, 2017, the Corporation’s total loans stood at $811.078 million, an increase of $29.221 million, or
3.74%, from 2016 year-end balances of $781.857 million. Total loan production in 2017 amounted to $277.556 million,
which included $65.711 million of secondary market mortgage loans sold. The Corporation also sold $7.689 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 $2.568 million, or .32%, of total loans at December 31, 2017 compared to $4.124 million,
or .53% of total loans at December 31, 2016. Nonperforming assets at December 31, 2017, were $6.126 million, .62%
of total assets, compared to $8.906 million or .91% of total assets at December 31, 2016.
19
Total deposits decreased from $823.512 million at December 31, 2016 to $817.998 million at December 31, 2017, a
decrease of 0.67%. The decrease in deposits in 2017 was comprised of an increase in wholesale deposits of $13.587
million and an decrease in core deposits of $19.101 million. In 2017, the Corporation utilized wholesale deposits in
order to better manage interest rate risk in funding fixed rate loans.
Shareholders’ equity totaled $81.400 million at December 31, 2017, compared to $78.609 million at the end of 2016, an
increase of $2.791 million. This change reflects the net income available to common shareholders of $5.479 million,
other comprehensive loss of $64,000, an increase related to stock compensation expense of $.398 million, and dividends
declared on common stock of $3.022 million. The book value per common share at December 31, 2017, amounted to
$12.93 compared to $12.55 at the end of 2016.
For a description of our significant accounting policies, see Note 1 to the financial statements included herein.
RESULTS OF OPERATIONS
(dollars in thousands, except per share data)
2017
2016
2015
Taxable-equivalent net interest income
Taxable-equivalent adjustment
Net interest income, per income statement
Provision for loan losses
Other income
Other expense
Income before provision for income taxes
Provision for income taxes
$ 38,140 $ 33,244 $ 29,210
(90)
(202)
(146)
37,938
625
4,041
30,336
33,098
600
4,153
29,885
29,120
1,204
3,889
23,876
11,018
5,539
6,766
2,283
7,929
2,333
Net income
$ 5,479 $ 4,483 $ 5,596
Earnings per common share
Basic
Diluted
Return on average assets
Return on average equity
Summary
$
$
0.87 $
0.87 $
0.72 $ 0.90
0.72 $ 0.89
.55%
6.74
.52%
5.73
.76%
7.41
The Corporation reported net income available to common shareholders of $5.479 million in 2017, compared to $4.483
million in 2016 and $5.596 million in 2015. The 2017 results include the effects of the $2.025 million non-cash tax
related expense related to the revaluation of the Corporation’s DTA as a result of the corporate tax code change
announced in December 2017. The 2016 results include costs related to the acquisition of Eagle River and Niagara in the
amount of $3.101 million.
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 92% of total revenue in
2017. 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 $4.896 million from $33.244 million in 2016 to $38.140
million in 2017. There were three 25 basis point rate increases to the federal funds rate in 2017. The Corporation
experienced an increase of 12 basis points in the overall rates on earning assets from 4.83% in 2016 to 4.95% in 2017.
Interest bearing funding sources increased by 10 basis points, from .76% in 2016 to .86% in 2017. The combination of
20
these effective rate changes resulted in an increase in the taxable equivalent net interest margin from 4.21% in 2016 to
4.23% in 2017.
The following table details sources of net interest income for the three years ended December 31 (dollars in thousands):
2017
Mix
2016
Mix
2015
Mix
Interest Income
Loans
Funds sold
Taxable securities
Nontaxable securities
Other interest-earning assets
Total earning assets
Interest Expense
NOW, money markets, checking
Savings
Certificates of deposit
Brokered deposits
Borrowings
Total interest-bearing funds
$ 41,770
95
1,606
298
607
0.21
3.62
0.67
1.37
44,376 100.00%
94.13% $ 36,078
64
1,322
220
299
0.03
3.48
0.55
0.79
37,983 100.00%
95.15% $ 32,047
1
1,095
162
208
95.63%
—
3.27
0.48
0.62
33,513 100.00%
12.69%
817
0.65
42
21.79
1,403
32.60
2,099
2,077
32.26
6,438 100.00%
14.96%
731
0.84
41
25.71
1,256
26.49
1,294
1,563
32.00
4,885 100.00%
13.27%
583
0.70
31
37.04
1,627
22.99
1,010
1,142
26.00
4,393 100.00%
Net interest income
$ 37,938
$ 33,098
$ 29,120
Average Rates
Earning assets
Interest-bearing funds
Interest rate spread
4.92%
0.86
4.06
4.81%
0.76
4.05
4.95%
0.80
4.15
For purposes of this presentation, non-taxable interest income has not been restated on a tax-equivalent basis.
As shown in the table above, income on loans provides more than 94% of the Corporation’s interest revenue. The
Corporation’s loan portfolio has approximately $363.742 million of variable rate loans that predominantly reprice with
changes in the prime rate and $447.336 million of fixed rate loans. A portion of the variable rate loans, 37%, or
$139.623 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 $121.977
million of these loans with floors, while the majority of 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 rate sensitivity of earning assets and interest
bearing liabilities to minimize the risk of movements in interest rates.
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.
21
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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 2017, the Corporation recorded a provision for loan loss of $.625 million, compared to a
provision of $.600 million in 2016 and $1.204 million in 2015. There was no provision for loan losses for acquired
loans as a result of acquisition fair value adjustments.
Noninterest Income
Noninterest income was $4.041 million, $4.153 million, and $3.889 million in 2017, 2016, and 2015, respectively. The
principal recurring sources of noninterest income are the gains and fees on the sale of SBA/USDA guaranteed loans and
secondary market loans. In 2017, revenues from these two business lines totaled $2.240 million compared to $2.472
million in 2016 and $1.681 million in 2015.
Deposit related income totaled $1.056 million in 2017 compared to $.995 million in 2016 and $.836 million in 2015.
Management continues to evaluate deposit products and services for ways to better serve its customer base and also
enhance service fee income through a broad array of products that price services based on income contribution and cost
attributes.
The following table details noninterest income for the three years ended December 31 (dollars in thousands):
Deposit service charges
NSF Fees
Gain on sale of secondary market
loans
Secondary market fees generated
SBA Fees
Mortgage servicing rights
(amortization) income
Other
Subtotal
Net security gains
Total noninterest income
2017
$ 372 $
684
2016
2015
348 $
647
2017-2016% 2016-2015
74.00%
1.73
6.90%
5.72
200
636
1,130
243
867
1,340
235
897
873
198
610
(31)
545
3,810
231
547
370
3,434
455
$ 4,041 $ 4,153 $ 3,889
(40)
576
4,003
150
(15.67)
2.98
(3.34)
(22.50)
(5.21)
(4.82)
54.00
-2.70%
53.49
18.69
47.05
(107.31)
55.68
16.57
(67.03)
6.79%
Noninterest Expense
Noninterest expense was $30.336 million in 2017, compared to $29.885 million and $23.876 million in 2016 and 2015,
respectively. In 2016, the Corporation incurred $3.101 million of costs related to the acquisition of Eagle River and
Niagara. Salaries and benefits, at $15.490 million, increased by $.865 million, or 5.91%, from the 2016 expenses of
$14.625 million and compared to $12.449 million in 2015. The increased salaries and benefits expense was largely a
result of an increased number of staff as a result of the acquisitions, as well as customary annual increases to legacy
employees. In 2015, the increase in noninterest expense totaled $1.266 million, or 5.60%.
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.
24
The following table details noninterest expense for the three years ended December 31 (dollars in thousands):
Salaries and benefits
Occupancy
Furniture and equipment
Data processing
Professional service fees:
Accounting
Legal
Consulting and other
Total professional service fees
Loan origination expenses and deposit and card related fees
Writedowns and losses on OREO held for sale
FDIC insurance assessment
Telephone
Advertising
Transaction related expenses
Other operating expenses
Total noninterest expense
Federal Income Taxes
Current Federal Tax Provision
2017
2016
% Increase (Decrease)
2017-2016 2016-2015
2015
$ 15,490 $ 14,625 $ 12,449 5.91% 17.48%
10.56
12.77
17.31
2,680
1,749
1,620
2,424
1,551
1,381
15.82
26.30
25.74
3,104
2,209
2,037
600
200
734
1,534
1,335
388
731
604
711
50
2,143
(6.32)
(55.40)
0.58
(7.95)
15.18
(39.16)
(3.56)
16.04
22.29
100.00
(2.10)
$ 30,336 $ 29,885 $ 23,876 1.51% 25.17%
44.58
222.58
6.07
31.22
21.36
92.08
49.80
14.39
14.68
— (100.00)
9.49
415
62
692
1,169
1,100
202
488
528
620
3,101
2,003
443
139
688
1,270
955
332
506
455
507
2,046
The Corporation recognized a federal income tax expense of approximately $5.539 million for the year ended
December 31, 2017 and $2.283 million for the year ended December 31, 2016. A large portion of this, $2.025 million
was related to the revaluation of the Corporation’s deferred tax asset as a result of the corporate tax code change
announced in December 2017.
The Corporation has reported deferred tax assets of $4.970 million at December 31, 2017. 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, 2017, had a net operating loss and tax credit carryforwards for tax
purposes of approximately $7.5 million, and $1.7 million, respectively. The Corporation evaluated the future benefits
from these carryforwards as of December 31, 2017 and determined that it was “more likely than not” that they would be
utilized prior to expiration. 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 and credit
carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code. The
annual limitation is $1.537 million for the NOL and the equivalent value of tax credits, which is approximately $.476
million. These limitations for use were established in conjunction with the recapitalization of the Corporation in
December 2004. The Corporation will continue to evaluate the future benefits from these carryforwards in order to
determine if any adjustment to the deferred tax asset is warranted.
25
The table below details the major components of the Corporation’s net deferred tax assets (dollars in thousands):
Deferred tax assets:
NOL carryforward
Allowance for loan losses
Alternative Minimum Tax Credit
OREO
Tax credit carryovers
Deferred compensation
Pension liability
Stock compensation
Unrealized loss on securities
Purchase accounting adjustments
Other
Total deferred tax assets
Deferred tax liabilities:
Core deposit premium
FHLB stock dividend
Depreciation
Mortgage servicing rights
Other
Total deferred tax liabilities
Net deferred tax asset
2017
2016
$ 1,580 $ 3,080
1,413
1,944
142
235
443
387
116
52
1,791
805
948
1,463
119
235
242
240
79
19
785
63
5,773
10,408
(404)
(56)
(79)
(240)
(24)
(803)
(739)
(91)
(208)
(583)
(27)
(1,648)
$ 4,970 $ 8,760
26
FINANCIAL POSITION
The table below illustrates the relative composition of various liability funding sources and asset make-up.
(dollars in thousands)
Sources of funds:
Deposits:
Non-interest bearing transactional
deposits
Interest-bearing transactional deposits
CD’s <$250,000
Total core deposit funding
CD’s >$250,000
Brokered deposits
Total noncore deposit funding
FHLB and other borrowings
Other liabilities
Shareholders’ equity
2017
December 31,
2016
2015
Balance
Mix
Balance
Mix
Balance
Mix
$ 148,079 15.03% $ 164,179 16.69% $ 122,775 16.61%
31.61
14.32
62.54
3.62
16.40
20.02
6.19
0.89
10.36
344,937
141,629
650,745
8,489
164,278
172,767
73,579
7,820
78,609
233,666
105,859
462,300
26,757
121,266
148,023
45,754
6,590
76,602
341,406
142,159
631,644
11,055
175,299
186,354
79,552
6,417
81,400
34.65
14.43
64.10
1.12
17.80
18.91
8.07
0.65
8.26
35.07
14.40
66.16
0.86
16.71
17.57
7.48
0.80
7.99
Total
$ 985,367 100.00% $ 983,520 100.00% $ 739,269 100.00%
Uses of Funds:
Net Loans
Securities available for sale
Federal funds sold
Federal Home Loan Bank Stock
Interest-bearing deposits
Cash and due from banks
Other assets
Total
Securities
$ 805,999 81.80% $ 776,837 78.99% $ 613,390 82.29%
7.27
—
0.29
0.69
3.38
5.40
86,273
2,135
2,911
14,047
44,620
56,697
53,728
3
2,169
5,089
25,005
39,885
75,897
6
3,112
13,374
37,420
49,559
8.77
0.22
0.30
1.43
4.54
5.75
7.70
0.00
0.32
1.36
3.80
5.02
$ 985,367 100.00% $ 983,520 100.00% $ 739,269 100.00%
The securities portfolio is an important component of the Corporation’s asset composition to provide diversity in its asset
base and provide liquidity. Securities decreased $10.376 million in 2017, from $86.273 million at December 31, 2016 to
$75.897 million at December 31, 2017.
The carrying value of the Corporation’s securities at December 31 (dollars in thousands) is as follows:
US Agencies
US Agencies - MBS
Corporate
Equity
Obligations of states and political subdivisions
Total securities
2017
2016
$ 16,846 $ 23,952
16,833
19,910
500
25,078
12,716
24,391
500
21,444
$ 75,897 $ 86,273
The Corporation’s policy is to purchase securities of high credit quality, consistent with its asset/liability management
strategies. 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, 2017, investment securities with an
estimated fair market value of $4.584 million were pledged as collateral for FHLB borrowings and certain customer
relationships.
27
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 71% of total loans outstanding at December 31, 2017.
The Corporation continued to experience strong loan demand in 2017 with approximately $277.556 million of new
organic loan production, including $65.711 million of mortgage loans sold in the secondary market. At 2017 year-end,
the Corporation’s loans stood at $811.078 million, an increase from the 2016 year-end balances of $781.857 million.
The production of loans was distributed among the regions, with the Upper Peninsula at $128.885 million, $50.695
million in the Northern Lower Peninsula, $45.512 million in Southeast Michigan and $52.464 million in Wisconsin.
The 2016 acquisitions of Eagle River and Niagara added loans of $112.582 million to our consolidated loan portfolio.
These acquired loans did not result in any significant concentration risk.
Management believes a properly positioned loan portfolio provides the most attractive earning asset yield available to
the Corporation and, with the current 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 2016 and 2017 (dollars in thousands):
Loan balances as of December 31, 2015
Total production
Total loans acquired
Secondary market sales
SBA loan sales
Loans transferred to OREO
Loans charged off, net of recoveries
Normal amortization/paydowns and payoffs
Loan balances as of December 31, 2016
Total production
Total loans acquired
Secondary market sales
SBA loan sales
Loans transferred to OREO
Loans charged off, net of recoveries
Normal amortization/paydowns and payoffs
$ 618,394
301,893
112,582
(81,693)
(7,202)
(3,292)
(584)
(158,241)
$ 781,857
277,556
—
(65,711)
(7,689)
(2,147)
(566)
(172,222)
Loan balances as of December 31, 2017
$ 811,078
28
Following is a table that illustrates the balance changes in the loan portfolio from 2015 through 2017 year-end (dollars in
thousands):
Commercial real estate
Commercial, financial, and
agricultural
One-to-four family residential real
estate
Construction:
Consumer
Commercial
Consumer
Total
2017
2016
2015
Percent Change
2017-2016 2016-2015
$ 406,742 $ 389,420 $ 312,805 4.45% 24.49%
156,951
142,648
122,140
10.03
16.79
209,890
205,945
140,502
1.92
46.58
10,818
9,243
17,434
12,226
11,505
20,113
11,770
15,330
15,847
(11.52)
(19.66)
(13.32)
3.87
(24.95)
26.92
$ 811,078 $ 781,857 $ 618,394 3.74% 26.43%
Our commercial real estate loan portfolio predominantly relates to owner occupied real estate, and our loans are
generally secured by a first mortgage lien. 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):
2017
2016
Balance
% of
Loans
% of
Capital
Balance
% of
Loans
% of
Capital
Real estate - operators of
nonres bldgs
Hospitality and tourism
Lessors of residential
buildings
Gasoline stations and
convenience stores
Logging
Commercial construction
Other
$ 119,025 20.77%
13.13
75,228
146.22 $ 121,861 22.42%
12.51
68,025
92.42
155.02
86.54
33,032
5.77
40.58
27,590
5.08
35.10
21,176
17,554
9,243
297,678
3.70
3.06
1.61
51.96
26.01
21.57
11.36
365.70
20,509
19,903
11,505
274,180
3.77
3.66
2.12
50.44
26.09
25.32
14.64
348.79
Total commercial loans $ 572,936 100.00%
$ 543,573 100.00%
Management recognizes the additional risk presented by the concentration in certain segments of the portfolio.
Management does not believe that its current portfolio composition has increased exposure related to any specific
industry concentration as of 2017 year-end.
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, 2017, our residential loan portfolio totaled $220.708 million, or 27.21%, of
our total outstanding loans.
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
29
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.
The Corporation has, in accordance with generally accepted accounting principles 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, 2017, had performing loans of $5.215 million and $.180 million of nonperforming
loans for which repayment terms were modified to the extent that they were deemed to be “restructured” loans. The total
restructured loans of $5.395 million is comprised of 27 performing loans, the largest of which had a December 31, 2017
balance of $1.104 million and three nonperforming loans.
Credit Quality
The table below shows balances of nonperforming assets for the years ended December 31 (dollars in thousands):
Nonperforming Assets:
Nonaccrual loans
Loans past due 90 days or more
Restructured loans on nonaccrual
Total nonperforming loans
Other real estate owned
Total nonperforming assets
Nonperforming loans as a % of loans
Nonperforming assets as a % of assets
Reserve for Loan Losses:
At period end
As a % of outstanding loans
As a % of nonperforming loans
As a % of nonaccrual loans
Texas Ratio
December 31, December 31,
2017
2016
$
$
2,388 $
—
180
2,568
3,558
6,126 $
0.32%
0.62%
3,959
—
165
4,124
4,782
8,906
0.53%
0.91%
$
5,079 $
.64%
197.78%
212.69%
7.77%
5,020
.64%
121.73%
126.80%
11.76%
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 2017 independent review provided
findings similar to management with respect to credit quality. The Corporation will again utilize a consultant for loan
review in 2018.
30
The following table details the impact of nonperforming loans on interest income for the three years ended December 31
(dollars in thousands):
Interest income that would have been recorded at original rate
Interest income that was actually recorded
$ 113 $ 640 $ 1,125
795
437
—
Net interest lost
$ 113 $ 203 $ 330
2017
2016
2015
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 2017 amounted to $.566 million, or .07% of average loans
outstanding, compared to $.584 million, or .08% of loans outstanding in 2016. The current reserve balance is
representative of the relevant risk inherent within the Corporation’s loan portfolio. The balance of the allowance for
loan losses does not contemplate acquisition fair value adjustments, as detailed in Note 4 – “Loans.” 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 two year history of relevant information on the Corporation’s credit quality is displayed in the following table (dollars
in thousands):
Allowance for Loan Losses
2017
2016
Balance at beginning of period
Loans charged off:
Commercial
One-to-four family residential real estate
Consumer
Total loans charged off
Recoveries of loans previously charged off:
Commercial
One-to-four family residential real estate
Consumer
Total recoveries of loans previously charged off
Net loans charged off
Provision for loan losses
$
5,020 $
5,004
419
155
229
803
121
65
51
237
566
625
477
133
113
723
102
5
32
139
584
600
Balance at end of period
$
5,079 $
5,020
Total loans, period end
Average loans for the year
Allowance to total loans at end of year
Net charge-offs to average loans
Net charge-offs to beginning allowance balance
$ 811,078 $
795,532
0.63%
0.07
11.27
781,857
703,047
0.64%
0.08
11.67
*The above does not include information regarding the quality of acquired impaired loans.
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 allowance for loan losses consists of specific and general components. Our internal risk system is used to identify
loans that meet the criteria for being “impaired” as defined in the accounting guidance. The specific component relates
31
to loans that are individually classified as impaired and where expected cash flows are less than carrying value. The
general component covers non-impaired loans and is based on historical loss experience adjusted for qualitative factors.
These qualitative factors include: (1) changes in the nature, volume and terms of loans, (2) changes in lending personnel,
(3) changes in the quality of the loan review function, (4) changes in nature and volume of past-due, nonaccrual and/or
classified loans, (5) changes in concentration of credit risk, (6) changes in economic and industry conditions, (7) changes
in legal and regulatory requirements, (8) unemployment and inflation statistics, and (9) underlying collateral values.
At the end of 2017, the allowance for loan losses represented .63% 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. This position is further illustrated by the ratio of the allowance as a
percent of nonperforming loans, which stood at 197.78% at December 31, 2017.
The Corporation completed the acquisition of PFC on December 5, 2014, Eagle River on April 29, 2016 and Niagara on
August 31, 2016. The PFC acquired impaired loans totaled $13.290 million, the Eagle River acquired impaired loans
totaled $3.401 million, and the Niagara acquired impaired loans totaled $2.105 million. In 2017, the Corporation had
positive resolution of acquired nonperforming loans, which resulted in recognition of approximately $.550 million. In
2016, the Corporation had positive resolution of acquired nonperforming loans, which resulted in the recognition of
approximately $96,000 of accretable interest. In 2015, the Corporation had positive resolution of acquired
nonperforming loans, which resulted in the recognition of approximately $.578 million of the accretable interest.
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.
The following table represents the activity in other real estate held for sale (dollars in thousands):
Balance at December 31, 2015
Other real estate transferred from loans due to foreclosure
Other real estate acquired, net of purchase accounting
Proceeds from sale of other real estate
Transfer to premise and equipment
Writedowns on other real estate held for sales
Gain on other real estate held for sale
$
2,324
3,292
1,205
(1,640)
(197)
(212)
10
Balance at December 31, 2016
$
4,782
Other real estate transferred from loans due to foreclosure
Other real estate acquired, net of purchase accounting
Proceeds from sale of other real estate
Transfer to premise and equipment
Writedowns on other real estate held for sales
Gain (loss) on other real estate held for sale
2,147
—
(2,782)
—
(508)
(81)
Balance at December 31, 2017
$
3,558
During 2017, the Corporation received real estate in lieu of loan payments of $2.147 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.
32
Deposits
Total deposits at December 31, 2017 were $817.998 million, a decrease of $5.514 million, or .67%, from December 31,
2016 deposits of $823.512 million. The table below shows the deposit mix for the periods indicated (dollars in
thousands):
2017
Mix
2016
Mix
CORE:
Non-interest-bearing
NOW, money market, checking
Savings
Certificates of Deposit <$250,000
Total core deposits
NONCORE:
Certificates of Deposit >$250,000
Brokered CDs
Total non-core deposits
$ 148,079 18.10% $ 164,179 19.94%
34.80
7.08
17.20
79.02
286,622
58,315
141,629
650,745
280,309
61,097
142,159
631,644
34.27
7.47
17.38
77.22
11,055
175,299
186,354
1.35
21.43
22.78
8,489
164,278
172,767
1.03
19.95
20.98
Total deposits
$ 817,998 100.00% $ 823,512 100.00%
The decrease in deposits, is composed of an increase in noncore deposits of $13.587 million, and a decrease in core
deposits of $19.101 million. Management has increased its efforts to grow core deposits in recent years by introducing
several new deposit products. As shown in the table above, core deposits represent approximately 77% of total
deposits. The Corporation will continue to seek core deposit growth in its funding sources, but will also supplement this
funding with strategic utilization of wholesale brokered deposits to help manage interest rate risk.
Management continues to monitor existing deposit products in order to stay competitive, both as to terms and pricing.
This focus on deposits has become especially important with changing client banking habits and demographics, as well
as customer desire for more electronic and mobile based banking products and services. 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 2017 year end, this source of funding totaled
$60.0 million and the Corporation secured this funding by pledging loans and investments. The $60.0 million of FHLB
borrowings had a weighted average maturity of 2.13 years, with a weighted average rate of 1.66% at December 31,
2017.
The Corporation currently has one correspondent banking borrowing relationship. The relationship consists of a non-
revolving line of credit and a term note. The line of credit bears interest at a rate of LIBOR plus 2.75%, and has an
initial term that expires on April 30, 2018. LIBOR was 1.69% at December 31, 2017. The term note had a balance of
$18.999 million at December 31, 2017 bears the same interest as the line of credit, and matures on April 30, 2019 and
requires quarterly principal payments of $550,000 which began March 31, 2017. The relationship is secured by all of
the outstanding mBank stock.
Shareholders’ Equity
Changes in shareholders’ equity are discussed in detail in the “Capital and Regulatory” section of this report.
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 making payments on existing borrowing
commitments. The Bank’s principal sources of liquidity are core deposits and loan and investment payments and
33
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 2017, the Corporation decreased cash and cash equivalents by $9.329 million. As shown on the Corporation’s
consolidated statement of cash flows, liquidity was primarily impacted by cash used in investing activities and cash used
in financing activities. The net change in investing activities included a net increase in loans of $33.600 million and a
net decrease in securities available for sale of $10.376 million. The Corporation also had a net decrease in cash through
investment activities partially due to a decrease in deposit liabilities of $5.514 million. This decrease in deposits was
composed of an increase in non-core deposits of $13.587 million combined with a decrease in core deposits of $19.101
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 provides added liquidity during periods of market turmoil and overall liquidity concerns
in the financial markets. As of December 31, 2017, $71.313 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 2018, the Corporation will fund anticipated loan production with a combination of core-
deposit growth and noncore funding, primarily brokered CDs to the extent the level of brokered CDs remains within our
conservative policy limitations.
The Corporation’s primary source of liquidity on a stand-alone basis is dividends from the Bank. In 2017, the Bank paid
a $7.0 million dividend to the Corporation. Bank capital, after payment of this dividend, remained strong and above the
“well capitalized” level for regulatory purposes. The Corporation has a $5.0 million line of credit with a correspondent
bank, which also serves as a source of liquidity. As of December 31, 2017, $5.0 million was available to the
Corporation under this line. The Corporation’s current plan for dividends from the Bank are dependent upon the
profitability of the Bank, growth of assets at the Bank and the level of capital needed to stay “adequately capitalized”.
The Corporation will continue to explore 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 (the “ALCO” Committee). The
ALCO Committee meets regularly 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 $250,000. Non-core funding consists of certificates of deposit greater than $250,000,
brokered deposits, and FHLB and other borrowings. At December 31, 2017, the Bank’s core deposits in relation to total
funding were 70.37% compared to 72.54% in 2016. These ratios indicated at December 31, 2017, that the Bank had
slightly increased 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, 2017, the
Bank had $64 million of unsecured overnight borrowing lines available and additional amounts 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 strategy is to increase core deposits in the Corporation’s local markets.
The Corporation also has the ability to augment local deposit growth with wholesale CD funding.
34
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, 2017, the aggregate contractual obligations
and commitments are (dollars in thousands):
Less than 1 Year 1 to 3 Years 4 to 5 Years
After 5
Years
Total
Payments Due by Period
Contractual Obligations
Total deposits
Federal Home Loan Bank borrowings
Other borrowings
Directors’ deferred compensation
Annual rental / purchase commitments under
noncancelable leases / contracts
$
747,738 $ 55,916 $ 12,545 $ 1,799 $ 817,998
60,000
25,000
19,552
165
1,443
350
25,000
16,964
434
10,000
2,277
226
—
146
433
854
1,390
1,015
3,124
6,383
TOTAL
$
761,095 $ 99,704 $ 39,075 $ 5,502 $ 905,376
Other Commitments
Letters of credit
Commitments to extend credit
Credit card commitments
$
7,753 $
109,655
5,788
— $
—
—
— $
—
—
— $
—
—
7,753
109,655
5,788
TOTAL
$
123,196 $
— $
— $
— $ 123,196
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.
The Corporation and Bank capital is 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 based on the amount of the
asset, net of any valuation allowance and deferred tax liabilities. The amount included is phased in through 2018. See
“Business — Supervision and Regulation” and “— Basel III for additional information regarding regulatory capital, as
well as Note 16 to the Corporation’s Consolidated Financial Statements in Item 8 of this Form 10-K below.
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.
35
Item 7A. 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 Corporation’s 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, 2017 the Bank had $75.897 million of securities, with a weighted average maturity of 53.52 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 cash to correspondent banks as investments in federal funds. The Corporation also
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.
36
The following are the Corporation’s repricing opportunities at December 31, 2017 (dollars in thousands):
Interest-earning assets:
Loans
Securities
Other (1)
1-90
Days
91-365
Days
>1-5
Years
Over 5
Years
Total
$ 288,033
6,261
9,333
182,275
9,942
3,308
331,896
40,496
3,604
8,874 $ 811,078
75,897
16,492
19,198
247
Total interest-earning assets
303,627
195,525
375,996
28,319
903,467
Interest-bearing obligations:
NOW, money market, savings and interest
checking
Time deposits
Brokered CDs
Borrowings
341,406
31,295
73,854
10,077
—
59,161
93,943
2,514
—
60,959
7,502
58,962
—
1,799
—
7,999
341,406
153,214
175,299
79,552
Total interest-bearing obligations
456,632
155,618
127,423
9,798
749,471
Gap
$ (153,005) $
39,907 $ 248,573 $ 18,521 $ 153,996
Cumulative gap
$ (153,005) $ (113,098) $ 135,475 $ 153,996
(1) includes Federal Home Loan Bank stock
The above analysis indicates that at December 31, 2017, the Corporation had a cumulative liability sensitivity gap
position of $113.098 million within the one-year timeframe. The Corporation’s cumulative liability sensitive gap
suggests that if market interest rates were to increase in the next twelve months, the Corporation has the potential to earn
less net interest income since more liabilities would reprice at higher rates than assets. Conversely, if market interest
rates decrease in the next twelve months, the above gap position suggests the Corporation’s net interest income would
increase. A limitation of the traditional gap analysis is that it does not consider the timing or magnitude of non-
contractual repricing or unexpected prepayments. In addition, the gap analysis treats savings, NOW and money market
accounts as repricing within 90 days, while experience suggests that these categories of deposits are actually
comparatively resistant to rate sensitivity.
At December 31, 2017, the Corporation had $363.742 million of variable rate loans that reprice primarily with the prime
rate index. Approximately $139.623 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, $121.977 million of
these floor-rate loans would reprice with a 100 basis point prime rate increase, with the majority of the remainder
repricing with an additional 100 basis point prime rate increase.
At December 31, 2016, the Corporation had a cumulative liability sensitive gap position of $115.670 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
37
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, other earning assets and interest-bearing obligations, and economic and
competitive conditions; potential changes in lending, investing, and deposit strategies; customer preferences; and other
factors.
The table below measures current maturity levels of interest-earning assets and interest-bearing obligations, along with
average stated rates and estimated fair values at December 31, 2017 (dollars in thousands). Nonaccrual loans of $2.568
million are included in the table at an average interest rate of 0.00% and a maturity greater than five years.
Principal/Notional Amount Maturing/Repricing In:
2018
2019
2020
2021
2022
Thereafter
Total
Fair Value
12/31/2017
$
9,363 $ 12,571 $ 18,187 $ 14,036 $ 3,281 $ 18,459 $ 75,897 $ 75,897
1.99
76,722
4.56
363,742
5.09
9,523
2.29
2.37
47,938
4.58
—
—
1,439
1.92
2.08
77,960
4.62
—
—
1,965
2.16
2.43
90,007
4.29
—
—
200
2.30
2.51
83,215
4.79
—
—
—
—
3.84
71,494
4.16
—
—
247
2.50
447,336
437,694
363,742
360,032
13,374
13,374
$ 459,350 $ 61,948 $ 98,112 $ 104,243 $ 86,496 $ 90,200 $ 900,349 $ 886,997
4.88%
4.07%
4.10%
4.04%
4.70%
4.09%
4.14%
Rate Sensitive Assets
Fixed interest rate securities
Average interest rate
Fixed interest rate loans
Average interest rate
Variable interest rate loans
Average interest rate
Other assets
Average interest rate
Total rate sensitive assets
Average interest rate
Rate Sensitive Liabilities
Interest-bearing savings, NOW, MMAs, checking $ 341,406 $
Average interest rate
Time deposits
Average interest rate
Variable interest rate borrowings
Average interest rate
Fixed interest rate borrowings
Average interest rate
0.29
258,253
1.12
10,077
1.11
2,200
4.44
— $
—
37,620
1.21
15,077
1.77
16,799
4.44
— $
—
18,296
1.37
10,078
1.59
—
—
— $
—
8,644
1.65
25,079
1.84
—
—
— $
—
3,901
1.49
80
1.00
—
—
316,719
328,513
— $ 341,406 $ 341,406
—
1,799
0.26
162
1.00
—
—
60,553
18,999
60,317
18,925
Total rate sensitive liabilities
$ 611,936 $ 69,496 $ 28,374 $ 33,723 $ 3,981 $ 1,961 $ 749,471 $ 737,367
Average interest rate
0.67%
2.11%
1.45%
1.79%
1.48%
0.32%
0.89%
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 to its Canadian customers primarily at its banking office in Sault Ste.
Marie, Michigan. Management believes the exposure to short-term foreign exchange risk is minimal and at an
acceptable level for the Corporation.
Off-Balance-Sheet Risk
Derivative financial instruments include futures, forwards, interest rate swaps, option contracts and other financial
instruments with similar characteristics. In 2017, the Corporation did not enter into futures, forwards, swaps or options.
However, the Corporation is party to financial instruments with off-balance-sheet risk in the normal course of business
to meet the financing needs of its customers. These financial instruments include commitments to extend credit and
standby letters of credit and involve to varying degrees, elements of credit and interest rate risk in excess of the amount
recognized in the consolidated balance sheets. Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration
dates and may require collateral from the borrower if deemed necessary by the Corporation. Standby letters of credit are
conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party up to a
stipulated amount and with specified terms and conditions.
Commitments to extend credit and standby letters of credit are not recorded as an asset or liability by the Corporation
until the instrument is exercised. See Note 19 to the consolidated financial statements for additional information.
38
Item 8.
Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors of Mackinac Financial Corporation
Opinion on the Financial Statements
We have audited the accompanying balance sheets of Mackinac Financial Corporation (the “Corporation”) as of
December 31, 2017 and 2016, and the related statements of operations, comprehensive income, stockholders' equity, and
cash flows for each of the years in the three-year period ended December 31, 2017, and the related notes (collectively
referred to as the “financial statements”). In our opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of the Corporation as of December 31, 2017 and 2016, and the results of its
operations and its cash flows for each of the years in the three-year period ended December 31, 2017, in conformity with
accounting principles generally accepted in the United States of America.
Basis for Opinion
The Corporation's management is responsible for these financial statements. Our responsibility is to express an opinion
on the Corporation’s financial statements based on our audits. We are a public accounting firm registered with the Public
Corporation Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to
the Corporation in accordance with the U.S. federal securities laws and the applicable rules and regulations of the
Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial statements are free of material
misstatement, whether due to error or fraud. The Corporation is not required to have, nor were we engaged to perform,
an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding
of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the
Corporation's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements,
whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included
examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also
included evaluating the accounting principles used and significant estimates made by management, as well as evaluating
the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/Plante & Moran, PLLC
We have served as the Corporation’s auditor since 2002.
Auburn Hills, Michigan
March 13, 2018
39
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2017 and 2016
(Dollars in Thousands)
ASSETS
Cash and due from banks
Federal funds sold
Cash and cash equivalents
Interest-bearing deposits in other financial institutions
Securities available for sale
Federal Home Loan Bank stock
Loans:
Commercial
Mortgage
Consumer
Total Loans
Allowance for loan losses
Net loans
Premises and equipment
Other real estate held for sale
Deferred tax asset
Deposit based intangibles
Goodwill
Other assets
TOTAL ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest bearing deposits
NOW, money market, interest checking
Savings
CDs<$250,000
CDs>$250,000
Brokered
Total deposits
Federal funds purchased
Borrowings
Other liabilities
Total liabilities
SHAREHOLDERS’ EQUITY:
Common stock and additional paid in capital - No par value Authorized - 18,000,000 shares Issued and
outstanding - 6,294,930 and 6,263,371 respectively
Retained earnings
Accumulated other comprehensive income (loss)
Unrealized (losses) on available for sale securities
Minimum pension liability
Total shareholders’ equity
December 31, December 31,
2017
2016
$
$
37,420
6
37,426
13,374
75,897
3,112
572,936
220,708
17,434
811,078
(5,079)
805,999
16,290
3,558
4,970
1,922
5,694
17,125
44,620
2,135
46,755
14,047
86,273
2,911
543,573
218,171
20,113
781,857
(5,020)
776,837
15,891
4,782
8,760
2,172
5,694
19,398
$
985,367
$
983,520
$
$
148,079
280,309
61,097
142,159
11,055
175,299
817,998
—
79,552
6,417
903,967
61,981
19,711
(71)
(221)
81,400
164,179
286,622
58,315
141,629
8,489
164,278
823,512
6,000
67,579
7,820
904,911
61,583
17,206
(102)
(78)
78,609
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
985,367
$
983,520
See accompanying notes to consolidated financial statements.
40
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2017, 2016, and 2015
(Dollars in Thousands, Except Per Share Data)
INTEREST INCOME:
Interest and fees on loans:
Taxable
Tax-exempt
Interest on securities:
Taxable
Tax-exempt
Other interest income
Total interest income
INTEREST EXPENSE:
Deposits
Borrowings
Total interest expense
Net interest income
Provision for loan losses
Net interest income after provision for loan losses
OTHER INCOME:
Deposit service fees
Income from mortgage loans sold on the secondary market
SBA/USDA loan sale gains
Net mortgage servicing (amortization) income
Net realized security gains
Other
Total other income
OTHER EXPENSE:
Salaries and employee benefits
Occupancy
Furniture and equipment
Data processing
Advertising
Professional service fees
Loan origination expenses and deposit and card related fees
Writedowns and losses on other real estate held for sale
FDIC insurance assessment
Telephone
Transaction related expenses
Other
Total other expenses
Income before provision for income taxes
Provision for income taxes
NET INCOME
INCOME PER COMMON SHARE:
Basic
Diluted
For the Year Ended December 31,
2015
2016
2017
$
41,770
95
$
36,078
64
$
32,034
13
1,606
298
607
44,376
4,361
2,077
6,438
37,938
625
37,313
1,056
1,373
867
(31)
231
545
4,041
15,490
3,104
2,209
2,037
711
1,534
1,335
388
731
604
50
2,143
30,336
11,018
5,539
1,322
220
299
37,983
3,322
1,563
4,885
33,098
600
32,498
995
1,575
897
(40)
150
576
4,153
14,625
2,680
1,749
1,620
620
1,169
1,100
202
488
528
3,101
2,003
29,885
6,766
2,283
1,095
162
209
33,513
3,251
1,142
4,393
29,120
1,204
27,916
836
1,071
610
547
455
370
3,889
12,449
2,424
1,551
1,381
507
1,270
955
332
506
455
—
2,046
23,876
7,929
2,333
$
5,479
$
4,483
$
5,596
$
$
.87
.87
$
$
.72
.72
$
$
.90
.89
See accompanying notes to consolidated financial statements.
41
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2017, 2016, and 2015
(Dollars in Thousands)
Net income
Other comprehensive income
Change in securities available for sale:
Unrealized (losses) gains arising during the period
Reclassification adjustment for securities gains included in net income
Tax effect
Net change in unrealized gains on available for sale securities
Defined benefit pension plan:
Net unrealized actuarial loss on defined benefit pension obligation
Tax effect
Changes from defined benefit pension plan
Other comprehensive (loss), net of tax
December 31,
2016
2017
5,479 $ 4,483 $
$
2015
5,596
295
(231)
(22)
42
(161)
55
(106)
(64)
(455)
(150)
206
(399)
(44)
15
(29)
(428)
(24)
(455)
214
(265)
—
—
—
(265)
Total comprehensive income
$
5,415 $
4,055 $
5,331
See accompanying notes to consolidated financial statements.
42
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years Ended December 31, 2017, 2016, and 2015
(Dollars in Thousands)
Shares of
Common
Stock
Common Stock
and Additional
Paid in Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Total
Balance, January 1, 2015
6,266,756 $
61,679 $
11,804 $
513 $
73,996
Net income
Other comprehensive income (loss):
Net change in unrealized gain on securities available
for sale
Total comprehensive income
Stock compensation
Restricted stock award vesting
Repurchase of common stock
Dividend on common stock
—
—
—
53,319
(102,455)
—
—
5,596
—
5,596
—
—
576
—
(1,122)
—
—
—
—
(2,179)
(265)
(265)
—
—
—
—
(265)
5,331
576
—
(1,122)
(2,179)
Balance, December 31, 2015
6,217,620 $
61,133 $
15,221 $
248 $
76,602
Net income
Other comprehensive income (loss):
Net change in unrealized gain on securities available
for sale
Actuarial loss on defined benefit pension obligation
Total comprehensive income
Stock compensation
Restricted stock award vesting
Repurchase of common stock
Dividend on common stock
—
—
—
—
59,751
(14,000)
—
—
4,483
—
4,483
—
—
600
—
(150)
—
—
—
—
—
—
(2,498)
(399)
(29)
(428)
—
—
—
—
(399)
(29)
4,055
600
—
(150)
(2,498)
Balance, December 31, 2016
6,263,371 $
61,583 $
17,206 $
(180) $
78,609
Net income
Other comprehensive income (loss):
Net change in unrealized gain on securities available
for sale
Actuarial loss on defined benefit pension obligation
Total comprehensive income
Stock compensation
Restricted stock award vesting
Repurchase of common stock
Reclassification of certain deferred tax effects
Dividend on common stock
—
—
—
—
31,559
—
—
—
—
5,479
—
5,479
—
—
398
—
—
—
—
—
—
—
—
—
48
(3,022)
42
(106)
(64)
(48)
42
(106)
5,415
398
—
—
—
(3,022)
Balance, December 31, 2017
6,294,930 $
61,981 $
19,711 $
(292) $
81,400
See accompanying notes to consolidated financial statements.
43
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS CASH FLOWS
Years Ended December 31, 2017, 2016, and 2015
(Dollars in Thousands)
Cash Flows from Operating Activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization
Provision for loan losses
Deferred tax expense
Net realized security gains
(Gain) on sale of loans sold in the secondary market
Origination of loans held for sale in secondary market
Proceeds from sale of loans in the secondary market
Loss (gain) on sale other real estate held for sale
Writedown of other real estate held for sale
Stock compensation
Change in other assets
Change in other liabilities
Net cash provided by operating activities
Cash Flows from Investing Activities:
Net increase in loans
Net decrease in interest-bearing deposits in other financial institutions
Purchase of securities available for sale
Proceeds from maturities, sales, calls or paydowns of securities available for sale
Capital expenditures
Proceeds from life insurance
Purchase additional FHLB Stock
Net cash used in Eagle acquisition and reimbursement of contract termination fee
Net cash received in Niagara acquisition
Proceeds from sale of premises, equipment, and other real estate
Redemption of FHLB stock
Net cash (used in) investing activities
Cash Flows from Financing Activities:
Net (decrease) increase in deposits
Net activity on line of credit
(Decrease) increase in fed funds purchased
Repurchase of common stock
Dividend on common stock
Proceeds from FHLB borrowing
Proceeds from term borrowing
Principal payments on borrowings
Net cash (used in) provided by financing activities
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents at beginning of period
Cash and cash equivalents at end of period
Supplemental Cash Flow Information:
Cash paid during the year for:
Interest
Income taxes
Business Combinations
Fair value of tangible assets acquired (noncash)
Goodwill and identifiable intangible assets acquired
Liabilities assumed
For the year ended December 31,
2015
2016
2017
$
5,479
$
4,483
$
5,596
2,426
625
4,954
(231)
(1,130)
(65,711)
66,841
81
307
398
2,523
(818)
15,744
(33,600)
673
(5,999)
16,011
(2,377)
—
(531)
—
—
2,983
330
(22,510)
(5,514)
(750)
(6,000)
—
(3,022)
25,000
—
(12,277)
(2,563)
(9,329)
46,755
37,426
6,383
1,100
1,921
600
1,798
(150)
(1,575)
(81,693)
83,268
(10)
212
600
(10,282)
1,205
377
(56,237)
3,015
(16,105)
26,689
(2,137)
301
—
(1,900)
2,453
1,608
15
(42,298)
49,491
(8,801)
6,000
(150)
(2,498)
—
19,800
(174)
63,668
21,747
25,008
46,755
4,792
1,100
$
$
—
—
—
$ 188,537
2,845
175,209
$
$
$
1,670
1,204
2,333
(455)
(873)
(53,229)
54,102
65
295
576
8,188
(6,380)
13,092
(19,321)
708
(23,894)
35,091
(1,341)
263
—
—
—
1,702
804
(5,988)
3,350
(3,367)
—
(1,122)
(2,179)
—
—
(725)
(4,043)
3,061
21,947
25,008
4,423
150
—
—
—
$
$
$
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)
$
2,147
$
3,292
$
1,376
See accompanying notes to consolidated financial statements.
44
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, Northeastern Wisconsin
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. 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, mortgage servicing rights, and the assessment of goodwill for impairment.
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.
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.
45
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.
Acquired Loans
Loans acquired with evidence of credit deterioration since inception and for which it is probable that all contractual
payments will not be received are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with
Deteriorated Credit Quality (“ASC 310-30”). These loans are recorded at fair value at the time of acquisition, with no
carryover of the related allowance for loan losses. Fair value of acquired loans is determined based on the present value
of amounts expected to be received, which incorporates assumptions about the amount and timing of principal and
interest payments, principal prepayments and principal defaults and losses, collateral values, and current market rates.
In recording the fair values of acquired impaired loans at acquisition date, management calculates a non-accretable
difference (the credit component of the purchased loans) and an accretable difference (the yield component of the
purchased loans).
Over the life of the acquired loans, management continues to estimate cash flows expected to be collected. We evaluate
at each balance sheet date whether it is probable that we will be unable to collect all cash flows expected at acquisition
and if so, recognize a provision for loan loss in our consolidated statement of operations. For any significant increases in
cash flows expected to be collected, we adjust the amount of the accretable yield recognized on a prospective basis over
the pool’s remaining life.
Performing acquired loans are accounted for under ASC Topic 310-20, Receivables – Nonrefundable Fees and Other
Costs. Performance of certain loans may be monitored and based on management’s assessment of the cash flows and
other facts available, portions of the accretable difference may be delayed or suspended if management deems
appropriate. The Corporation’s policy for determining when to discontinue accruing interest on performing acquired
loans and the subsequent accounting for such loans is essentially the same as the policy for originated loans.
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 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 an unallocated 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,
46
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.
Troubled Debt Restructuring
Troubled debt restructuring of loans is undertaken to improve the likelihood that the loan will be repaid in full under the
modified terms in accordance with a reasonable repayment schedule. All modified loans are evaluated to determine
whether the loans should be reported as a Troubled Debt Restructure (TDR). A loan is a TDR when the Corporation, for
economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower by
modifying or renewing a loan that the Corporation would not otherwise consider. To make this determination, the
Corporation must determine whether (a) the borrower is experiencing financial difficulties and (b) the Corporation
granted the borrower a concession. This determination requires consideration of all of the facts and circumstances
surrounding the modification. An overall general decline in the economy or some deterioration in a borrower’s financial
condition does not automatically mean the borrower is experiencing financial difficulties.
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 fair value, less costs to sell, establishing a new cost basis. Valuations are periodically performed by
management or a third party, 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.
Goodwill and Other Intangible Assets
The excess of the cost of acquired entities over the fair value of identifiable assets acquired less liabilities assumed is
recorded as goodwill. In accordance with ASC 350, amortization of goodwill and indefinite-lived assets is not recorded.
However, the recoverability of goodwill is annually tested for impairment. The Corporation’s core deposit intangible is
currently being amortized over its estimated useful life of ten years.
Stock Compensation Plans
On May 22, 2012, the Corporation’s shareholders approved the Mackinac Financial Corporation 2012 Incentive
Compensation Plan, under which current and prospective employees, non-employee directors and consultants may be
awarded incentive stock options, non-statutory stock options, shares of restricted stock awards (“RSAs”), or stock
appreciation rights. The aggregate number of shares of the Corporation’s common stock issuable under the plan is
575,000. Awards are made to certain other senior officers at the discretion of the Corporation's management.
Compensation cost equal to the fair value of the award is recognized over the vesting period.
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, and
47
unrecognized actuarial gains and losses in the defined benefit pension plan, arising during the period. These gains and
losses for the period are shown as a component of other comprehensive income. The accumulated gains and losses are
reported as a component of equity, net of any tax effect. At December 31, 2017, the balance in accumulated other
comprehensive income consisted of unrealized losses on available for sales securities of $71,000 and actuarial losses on
the defined benefit pension obligation of $.185 million. At December 31, 2016, the balance in accumulated other
comprehensive income consisted of unrealized losses on available for sale securities of $.102 million and actuarial losses
on the defined benefit pension obligation of $78,000.
The Corporation early adopted ASU No. 2018-02, “Income Statement- Reporting Comprehensive Income (Topic 220):
Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” (ASU 2018-02) in the fourth
quarter 2017. ASU 2018-02, issued in February 2018, provides for the reclassification of the effect of remeasuring
deferred tax balances related to items within accumulated other comprehensive income (AOCI) to retained earnings
resulting from the Tax Cuts and Jobs Act of 2017. As a result, the Corporation reclassified $12,000 from AOCI to
retained earnings.
Earnings per Common Share
Diluted earnings per share, which reflects the potential dilution that could occur if outstanding stock options and
warrants were exercised and stock awards were fully vested and resulted in the issuance of common stock that then
shared in our earnings, is computed by dividing net income by the weighted average number of common shares
outstanding and common stock equivalents, after giving effect for dilutive shares issued.
The following shows the computation of basic and diluted earnings per share for the years ended December 31, 2017,
2016 and 2015 (dollars in thousands, except per share data):
Year Ended December 31,
2016
2015
2017
(Numerator):
Net income
(Denominator):
Weighted average shares outstanding
Effect of dilutive stock options, and vesting of restricted stock awards
Diluted weighted average shares outstanding
Income per common share:
Basic
Diluted
Income Taxes
$
5,479 $
4,483 $
5,596
6,288,791
33,622
6,322,413
6,236,067
32,636
6,268,703
6,241,921
31,400
6,273,321
$
$
.87 $
.87 $
.72 $
.72 $
.90
.89
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 May 2014, the Financial Accounting Standards Board (FASB) issued guidance on the recognition of revenue from
contracts with customers. Revenue recognition will depict the transfer of promised goods or services to customers in an
amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
The guidance also requires disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows
48
arising from contracts with customers. The guidance permits two methods of adoption: retrospectively to each prior
reporting period presented or retrospectively with the cumulative effect of initially applying the guidance recognized at
the date of initial application. The guidance is effective January 1, 2018. The key revenue streams impacted include
service charges and mortgage banking income. The Corporation will adopt the guidance using a modified retrospective
approach in the first quarter of 2018. The revenue streams with in the scope of the guidance are less than 5% of total
revenues, and the total amount of these fees reflected in the net income of the Corporation is not expected to
significantly change.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and
Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). ASU 2016-01 amends current guidance
by requiring companies to recognize changes in fair value for equity investments that have a readily determinable fair
value through net income rather than through other comprehensive income. Under ASU 2016-01, equity investments
that do not have a readily determinable fair value will either be accounted for the same as equity investments that have a
readily determinable fair value, with changes in fair value recognized through net income or carried at cost, adjusted for
changes in observable prices based on orderly transactions for identical or similar investments issued by the same issuer
and further adjusted for impairment, if applicable. ASU 2016-01 also requires a qualitative assessment of impairment
indicators each reporting period. If this assessment indicates that impairment exists, companies must adjust the
investment to fair value and recognize an impairment loss in net income, even if the impairment is determined to be
temporary. ASU 2016-01 is effective for public companies for interim and annual periods beginning after December 15,
2017. As of December 31, 2017 the Corporation had $.500 million of available for sale equity securities. The
Corporation recorded no impact upon adoption of ASU 2016-01 in January 2018. Any further changes to the fair value
of equity securities will be recorded in net income.
In February 2016, the FASB issued ASU 2016-02, Leases, which will supersede the current lease requirements in ASC
840. The ASU requires lessees to recognize an asset with right of use and related lease liability for all leases, with a
limited exception for short-term leases. Leases will be classified as either finance or operating, with the classification
affecting the pattern of expense recognition in the statement of operations. Currently, leases are classified as either
capital or operating, with only capital leases recognized on the balance sheet. The reporting of lease related expenses in
the statements of operations and cash flows will be generally consistent with the current guidance. The new lease
guidance will be effective for the Corporation’s year ending December 31, 2019 and will be applied using modified
retrospective transition method to the beginning of the earliest period presented. The Corporation currently has no
capital leases, but does maintain seven operating leases for branch locations that will be impacted by the implementation
of this guidance. The effect of applying the new lease guidance on the financial statements has not yet been determined.
In September, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of
Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 changes how entities will measure credit losses
for most financial assets and certain other instruments that are not measured at fair value through net income.
ASU 2016-13 requires an entity to measure expected credit losses for financial assets over the estimated lifetime of
expected credit loss and record an allowance that, when deducted from the amortized cost basis of the financial asset,
presents the net amount expected to be collected on the financial asset. The standard includes the following core
concepts in determining the expected credit loss. The estimate must: (a) be based on an asset’s amortized cost (including
premiums or discounts, net deferred fees and costs, foreign exchange and fair value hedge accounting adjustments), (b)
reflect losses expected over the remaining contractual life of an asset (considering the effect of voluntary prepayments),
(c) consider available relevant information about the estimated collectability of cash flows (including information about
past events, current conditions, and reasonable and supportable forecasts), and (d) reflect the risk of loss, even when that
risk is remote.
ASU 2016-13 also amends the recording of purchased credit-deteriorated assets. Under the new guidance, an allowance
will be recognized at acquisition through a gross-up approach whereby an entity will record as the initial amortized cost
the sum of (a) the purchase price and (b) an estimate of credit losses as of the date of acquisition. In addition, the
guidance also requires immediate recognition in earnings of any subsequent changes, both favorable and unfavorable, in
expected cash flows by adjusting this allowance.
ASU 2016-13 also amends the impairment model for available-for-sale debt securities and requires entities to determine
whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. Management may not
use the length of time a security has been in an unrealized loss position as a factor in concluding whether a credit loss
49
exists, as is currently permitted. In addition, an entity will recognize an allowance for credit losses on available-for-sale
debt securities as a contra-account to the amortized cost basis rather than as a direct reduction of the amortized cost basis
of the investment, as is currently required. As a result, entities will recognize improvements to credit losses on available-
for-sale debt securities immediately in earnings rather than as interest income over time under current practice.
New disclosures required by ASU 2016-13 include: (a) for financial assets measured at amortized cost, an entity will be
required to disclose information about how it developed its allowance, including changes in the factors that influenced
management’s estimate of expected credit losses and the reasons for those changes, (b) for financial receivables and net
investments in leases measured at amortized cost, an entity will be required to further disaggregate the information it
currently discloses about the credit quality of these assets by year or the asset’s origination or vintage for as many as five
annual periods, and (c) for available-for-sale debt securities, an entity will be required to provide a roll-forward of the
allowance for credit losses and an aging analysis for securities that are past due.
Upon adoption of ASU 2016-13, a cumulative-effect adjustment to retained earnings will be recorded as of the
beginning of the first reporting period in which the guidance is effective. ASU 2016-13 is effective for public companies
for interim and annual periods beginning after December 15, 2019, with early adoption permitted for annual periods
beginning after December 15, 2018. The Corporation is currently evaluating the provisions of ASU 2016-13 to
determine the potential impact on the Corporation's consolidated financial condition and results of operations.
In May 2017, the FASB issued ADU 2017-09, Compensation – Stock Compensation (Topic 718). ASU 2017-09 applies
to entities that change the terms or conditions of a share-based payment award to provide clarity and reduce diversity in
practice as well as cost and complexity when applying the guidance in Topic 718 to the modification to the terms and
conditions of a share-based payment award. The updated guidance is effective for interim and annual reporting periods
beginning after December 15, 2017. The Corporation has determined the new guidance will not have a material impact
on its consolidated financial statements.
Reclassifications
Certain amounts in the 2016 consolidated financial statements have been reclassified to conform to the 2017
presentation.
NOTE 2 — RESTRICTIONS ON CASH AND CASH EQUIVALENTS
Cash and cash equivalents in the amount of $15.131 million were restricted on December 31, 2017 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.
50
NOTE 3 — SECURITIES AVAILABLE FOR SALE
The carrying value and estimated fair value of securities available for sale are as follows (dollars in thousands):
December 31, 2017
Amortized Unrealized Unrealized Estimated
Fair Value
Cost
Losses
Gains
Corporate
Equity
US Agencies
US Agencies - MBS
Obligations of states and political subdivisions
500
16,935
12,830
21,370
$ 24,352 $
82 $
—
10
42
307
(43) $ 24,391
500
—
16,846
(99)
12,716
(156)
21,444
(233)
Total securities available for sale
$ 75,987 $
441 $
(531) $ 75,897
December 31, 2016
Corporate
Equity
US Agencies
US Agencies - MBS
Obligations of states and political subdivisions
$ 19,899 $
500
23,991
16,980
25,057
49 $
—
47
48
447
(38) $ 19,910
500
—
23,952
(86)
16,833
(195)
25,078
(426)
Total securities available for sale
$ 86,427 $
591 $
(745) $ 86,273
Following is information pertaining to securities with gross unrealized losses at December 31, 2017 and 2016 aggregated
by investment category and length of time these individual securities have been in a loss position (dollars in thousands):
December 31, 2017
Losses
Less Than Twelve Months Over Twelve Months
Gross
Unrealized
Fair
Value
Gross
Unrealized
Losses
Fair
Value
Corporate
Equity
US Agencies
US Agencies - MBS
Obligations of states and political subdivisions
$
(43) $ 14,204 $
—
(87)
(67)
(99)
—
14,799
4,400
10,245
— $
—
(12)
(89)
(134)
—
—
745
5,218
1,589
Total securities available for sale
$
(296) $ 43,648 $
(235) $ 7,552
December 31, 2016
Corporate
Equity
US Agencies
US Agencies - MBS
Obligations of states and political subdivisions
(38)
—
(86)
(192)
(426)
12,085
—
19,153
11,589
13,328
—
—
—
(3)
—
—
—
—
932
—
Total securities available for sale
$
(742) $ 56,155 $
(3) $
932
There were 105 securities in an unrealized loss position in 2017 and 118 in 2016. 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.
51
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):
2017
2016
2015
Proceeds from sales and calls
Gross gains on sales and calls
Gross (losses) on sales and calls
$ 11,651 $ 19,719 $ 25,628
455
—
253
(22)
190
(40)
The carrying value and estimated fair value of securities available for sale at December 31, 2017, by contractual
maturity, are shown below (dollars in thousands):
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Subtotal
US Agencies - MBS
Total
Amortized Estimated
Fair Value
Cost
$ 8,908 $ 9,262
40,665
10,984
2,270
63,181
12,716
37,544
13,780
2,925
63,157
12,830
$ 75,987 $ 75,897
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. Securities with a market value of $2.460 million are pledged as
collateral to the Federal Home Loan Bank and $2.124 million are pledged to certain customer relationships. See Note 10
for information on securities pledged to secure borrowings from the Federal Home Loan Bank.
NOTE 4 — LOANS
The composition of loans at December 31 is as follows (dollars in thousands):
Commercial real estate
Commercial, financial, and agricultural
Commercial construction
One to four family residential real estate
Consumer
Consumer construction
Total loans
2017
2016
$ 406,742 $ 389,420
142,648
156,951
11,505
9,243
205,945
209,890
20,113
17,434
12,226
10,818
$ 811,078 $ 781,857
The Corporation completed the acquisition of Peninsula Financial Corporation, (“PFC”), on December 5, 2014, The First
National Bank of Eagle River (“Eagle River”) on April 29, 2016 and Niagara Bancorporation (“Niagara”) on August 31,
2016. The PFC acquired impaired loans totaled $13.290 million, the Eagle River acquired impaired loans totaled $3.401
million, and the Niagara acquired impaired loans totaled $2.105 million. In 2017, The Corporation had positive
resolution of acquired nonperforming loans, which resulted in the recognition of approximately $.550 million of
accretable interest. In 2016, the Corporation had positive resolution of acquired nonperforming loans, which resulted in
the recognition of approximately $96,000 of accretable interest. In 2015, the Corporation had positive resolution of
acquired nonperforming loans, which resulted in the recognition of approximately $.578 million of the accretable
interest.
52
The table below details the outstanding balances of the PFC acquired portfolio and the acquisition fair value adjustments
at acquisition date (dollars in thousands):
Loans acquired - contractual payments
Nonaccretable difference
Expected cash flows
Accretable yield
Carrying balance at acquisition date
Acquired Acquired
Acquired
Impaired Non-impaired
Total
$ 13,290 $
(2,234)
11,056
(744)
$ 10,312 $
53,849 $ 67,139
(2,234)
—
64,905
53,849
(2,100)
(2,844)
51,749 $ 62,061
The table below details the outstanding balances of the Eagle River acquired portfolio and the acquisition fair value
adjustments at acquisition date (dollars in thousands):
Loans acquired - contractual payments
Nonaccretable difference
Expected cash flows
Accretable yield
Carrying balance at acquisition date
Acquired Acquired
Acquired
Impaired Non-impaired
Total
$ 3,401 $
(1,172)
2,229
(391)
$ 1,838 $
80,737 $ 84,138
(1,172)
—
82,966
80,737
(1,700)
(2,091)
79,037 $ 80,875
The table below details the outstanding balances of the Niagara acquired portfolio and the acquisition fair value
adjustments at acquisition date (dollars in thousands):
Loans acquired - contractual payments
Nonaccretable difference
Expected cash flows
Accretable yield
Carrying balance at acquisition date
Acquired Acquired
Acquired
Impaired Non-impaired
Total
$ 2,105 $
(265)
1,840
(88)
$ 1,752 $
—
30,555
(600)
30,555 $ 32,660
(265)
32,395
(688)
29,955 $ 31,707
The table below presents a rollforward of the accretable yield on acquired loans for year ended December 31, 2017
(dollars in thousands):
Acquired Acquired
Impaired Non-impaired
PFC
Eagle River
Acquired Acquired Acquired
Niagara
Acquired Acquired Acquired
Total
Impaired Non-impaired
Total
Impaired Non-impaired
Acquired
Total
Balance, December 31, 2016
Acquisitions
Accretion
Reclassification from nonaccretable
difference
Balance, December 31, 2017
$
282 $
—
(460)
642 $
—
(642)
924
—
(1,102)
$
236 $
—
(70)
1,221 $ 1,457
—
(688)
—
(618)
$
52 $
—
(20)
505 $
—
(224)
557
—
(244)
327
149 $
$
— $
327
149
52
218 $
$
—
603 $
52
821
$
6
38 $
—
281 $
6
319
The table below presents a rollforward of the accretable yield on acquired loans for year ended December 31, 2016
(dollars in thousands):
PFC
Acquired
Acquired
Impaired Non-impaired Total
Acquired Acquired
Eagle River
Acquired
Acquired Acquired
Niagara
Acquired
Acquired
Impaired Non-impaired Total
Impaired Non-impaired Total
Balance, December 31, 2015
Acquisition
Accretion
Reclassification from nonaccretable
difference
Balance, December 31, 2016
$
426 $
—
(50)
1,342 $ 1,768
—
(750)
—
(700)
$
— $
— $
391
(46)
1,700
(479)
$
—
2,091
(525)
— $
88
—
— $
600
(95)
—
688
(95)
(94)
282 $
$
—
642 $
(94)
924
(109)
236 $
$
—
(109)
1,221 $ 1,457
$
(36)
52 $
—
505 $
(36)
557
53
A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2017 is as follows (dollars
in thousands):
Allowance for loan loss reserve:
Beginning balance ALLR
Charge-offs
Recoveries
Provision
Ending balance ALLR
Loans:
Ending balance
Ending balance ALLR
Net loans
Ending balance ALLR:
Individually evaluated
Collectively evaluated
Total
Commercial,
One to four
Commercial
financial and Commercial
real estate agricultural construction
family residential Consumer
real estate
construction Consumer Unallocated
Total
$
$
1,345 $
(155)
80
380
1,650 $
614 $
(264)
39
187
576 $
57 $
—
2
(5)
54 $
296 $
(155)
65
(46)
160 $
6 $
—
—
—
6 $
90 $
(229)
51
98
10 $
2,612 $
—
—
11
2,623 $
5,020
(803)
237
625
5,079
$
$
406,742 $
(1,650)
405,092 $
156,951 $
(576)
156,375 $
9,243 $
(54)
9,189 $
209,890 $
(160)
209,730 $
10,818 $ 17,434 $
(6)
(10)
10,812 $ 17,424 $
— $ 811,078
(2,623)
(5,079)
(2,623) $ 805,999
$
$
168 $
1,482
1,650 $
166 $
410
576 $
— $
54
54 $
— $
160
160 $
— $
6
6 $
— $
10
10 $
— $
2,623
2,623 $
334
4,745
5,079
Ending balance Loans:
Individually evaluated
Collectively evaluated
Acquired with deteriorated credit quality
Total
$
$
516 $
404,835
1,391
406,742 $
166 $
156,785
—
156,951 $
— $
9,243
—
9,243 $
— $
— $
— $
208,269
1,621
209,890 $
10,801
17
17,413
21
10,818 $ 17,434 $
— $
682
—
807,346
3,050
—
— $ 811,078
Impaired loans, by definition, are individually evaluated.
A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2016 is as follows (dollars
in thousands):
Allowance for loan loss reserve:
Beginning balance ALLR
Charge-offs
Recoveries
Provision
Ending balance ALLR
Loans:
Ending balance
Ending balance ALLR
Net loans
Ending balance ALLR:
Individually evaluated
Collectively evaluated
Total
Ending balance Loans:
Individually evaluated
Collectively evaluated
Acquired with deteriorated credit quality
Total
Commercial,
One to four
Commercial
financial and Commercial
real estate agricultural construction
family residential Consumer
real estate
construction Consumer Unallocated
Total
$
$
1,611 $
(245)
54
(75)
1,345 $
645 $
(232)
41
160
614 $
79 $
—
7
(29)
57 $
274 $
(133)
5
150
296 $
7 $
—
—
(1)
6 $
64 $
(113)
32
107
90 $
2,324 $
—
—
288
2,612 $
5,004
(723)
139
600
5,020
$ 389,420 $ 142,648 $
(1,345)
(614)
$ 388,075 $ 142,034 $
11,505 $
(57)
11,448 $
205,945 $
(296)
205,649 $
12,226 $ 20,113 $
— $ 781,857
(5,020)
12,220 $ 20,023 $ (2,612) $ 776,837
(2,612)
(90)
(6)
$
$
70 $
1,275
1,345 $
251 $
363
614 $
— $
57
57 $
— $
296
296 $
— $
6
6 $
— $
90
90 $
— $
2,612
2,612 $
321
4,699
5,020
$
345 $
325 $
— $
— $
— $
— $
385,841
3,234
142,323
—
$ 389,420 $ 142,648 $
11,505
—
11,505 $
203,153
2,792
205,945 $
12,169
57
20,109
4
12,226 $ 20,113 $
670
— $
775,100
—
—
6,087
— $ 781,857
Impaired loans, by definition, are individually evaluated.
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.
54
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.
Strong (1)
Borrower is not vulnerable to sudden economic or technological changes. They have “strong” balance sheets and are
within an industry that is very typical for our markets or type of lending culture. Borrowers also have “strong” financial
and cash flow performance and excellent collateral (low loan to value or readily available to liquidate collateral) in
conjunction with an impeccable repayment history.
Good (2)
Borrower shows limited vulnerability to sudden economic change. These borrowers have “above average” financial and
cash flow performance and a very good repayment history. The balance sheet of the company is also very good as
compared to peer and the company is in an industry that is familiar to our markets or our type of lending. The collateral
securing the deal is also very good in terms of its type, loan to value, etc.
Average (3)
Borrower is typically a well-seasoned business, however may be susceptible to unfavorable changes in the economy, and
could be somewhat affected by seasonal factors. The borrowers within this category exhibit financial and cash flow
performance that appear “average” to “slightly above average” when compared to peer standards and they show an
adequate payment history. Collateral securing this type of credit is good, exhibiting above average loan to values, etc.
Acceptable (4)
A borrower within this category exhibits financial and cash flow performance that appear adequate and satisfactory
when compared to peer standards and they show a satisfactory payment history. The collateral securing the request is
within supervisory limits and overall is acceptable. Borrowers rated acceptable could also be newer businesses that are
typically susceptible to unfavorable changes in the economy, and more than likely could be affected by seasonal factors.
Acceptable Watch (44)
The borrower may have potential weaknesses that deserve management’s close attention. If left uncorrected, these
potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit
position at some future date. Acceptable watch assets are not adversely classified and do not expose an institution to
sufficient risk to warrant adverse classification. Examples of this type of credit include a start-up company fully based
on projections, a documentation issue that needs to be corrected or a general market condition that the borrower is
working through to get corrected.
Substandard (6)
Substandard loans are classified assets exhibiting 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 classified as
substandard clearly represent troubled and deteriorating credit situations requiring constant supervision.
Doubtful (7)
Loans in this category exhibit the same, if not more pronounced weaknesses used to describe the substandard credit.
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.
55
General Reserves:
For loans with a credit risk rating of 44 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.
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.
Commercial construction loans in the amount of $3.854 million and $4.414 million at December 31, 2017, and 2016,
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, 2017 (dollars in thousands):
Commercial real estate
Commercial, financial and
agricultural
Commercial construction
One-to-four family
residential real estate
Consumer construction
Consumer
(1)
(2)
(3)
(4)
(44)
(6)
(7)
Rating
Strong
Good
Average Acceptable Acceptable Watch Substandard Doubtful Unassigned Total
$ 2,775 $ 23,929 $ 159,385 $ 207,921 $
8,700 $
4,032 $
— $
— $ 406,742
11,528
—
8,980
308
53,448
2,749
77,964
1,310
—
—
—
1,377
—
—
2,575
—
—
5,449
—
28
3,658
648
1,212
—
5
1,373
374
3,515
14
96
—
—
—
3,854
156,951
9,243
—
—
—
195,762
10,804
17,305
209,890
10,818
17,434
Total loans
$ 14,303 $ 34,594 $ 218,157 $ 292,672 $
14,223 $
9,404 $
— $ 227,725 $ 811,078
Below is a breakdown of loans by risk category as of December 31, 2016 (dollars in thousands)
(1)
(2)
(3)
Strong
Good
Average
(4)
(6)
Acceptable Acceptable Watch Substandard Doubtful Unassigned Total
Rating
(44)
(7)
Commercial real estate
Commercial, financial and
agricultural
Commercial construction
One-to-four family
residential real estate
Consumer construction
Consumer
$ 3,021 $ 23,940 $ 140,618 $ 205,710 $
10,808 $
5,323 $
— $
— $ 389,420
10,421
—
13,434
900
49,434
3,146
65,097
1,877
740
28
20
1,373
—
—
3,412
—
15
6,927
—
42
2,485
783
2,658
—
13
1,777
385
5,493
17
103
—
—
—
4,414
142,648
11,505
—
—
—
185,342
12,181
19,920
205,945
12,226
20,113
Total loans
$ 14,230 $ 39,647 $ 196,625 $ 279,653 $
16,747 $
13,098 $
— $ 221,857 $ 781,857
Impaired Loans
Impaired 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.
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
56
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.
The following is a summary of impaired loans and their effect on interest income (dollars in thousands):
with No Related
Impaired Loans Impaired Loans
with Related
Allowance
Allowance
Total
Impaired
Loans
Unpaid
Principal
Balance
Related
Allowance for
Loan Losses
December 31, 2017
Commercial real estate
Commercial, financial and agricultural
Commercial construction
One to four family residential real estate
Consumer construction
Consumer
Total
December 31, 2016
Commercial real estate
Commercial, financial and agricultural
Commercial construction
One to four family residential real estate
Consumer construction
Consumer
Total
Commercial real estate
Commercial, financial and agricultural
Commercial construction
One to four family residential real estate
Consumer construction
Consumer
Total
$
$
$
$
$
$
1,511
—
—
1,621
17
21
3,170
3,234
—
—
2,792
57
4
6,087
$
$
$
$
2017
516
166
—
—
—
—
682
345
325
—
—
—
—
670
$
$
$
$
2,027
166
—
1,621
17
21
3,852
3,579
325
—
2,792
57
4
6,757
$
$
$
$
3,326
326
—
2,315
66
21
6,054
4,700
400
—
3,794
80
28
9,002
$
$
$
$
Individually Evaluated Impaired Loans
168
166
—
—
—
—
334
70
251
—
—
—
—
321
Average
Balance for
the Period
Interest Income Average
Recognized for
the Period
Balance for Recognized for
the Period
the Period
Interest Income
Balance for Recognized for
the Period
the Period
2016
Interest Income Average
2015
2,784
246
—
2,057
37
13
5,137
$
$
141
1
3
134
—
2
281
$
$
3,848
200
—
3,794
40
14
7,896
$
$
178
4
—
182
4
2
370
$
$
2,656
628
—
2,120
—
—
5,404
$
$
232
9
—
129
—
—
370
A summary of past due loans at December 31, is as follows (dollars in thousands):
2017
2016
30-89 days
Past Due 90+ days
(accruing) Past Due Nonaccrual Total
30-89 days
Past Due 90+ days
(accruing) Past Due Nonaccrual
Total
Commercial real estate
Commercial, financial and
agricultural
Commercial construction
One to four family residential real
estate
Consumer construction
Consumer
$
460 $
— $
866 $ 1,326 $
942 $
— $
1,732 $ 2,674
16
73
3,424
—
72
—
—
—
—
—
338
14
354
87
1,350
—
—
4,774
—
72
186
—
2,113
—
133
—
—
—
—
—
337
—
523
—
1,956
17
82
4,069
17
215
Total past due loans
$
4,045 $
— $
2,568 $ 6,613 $
3,374 $
— $
4,124 $ 7,498
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
57
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.
There were no troubled debt restructurings that occurred during the years ended December 31 2017, and December 31,
2016.
Insider Loans
The Bank, in the ordinary course of business, grants loans to the Corporation’s executive officers and directors,
including their families and firms in which they are principal owners. Activity in such loans is summarized below
(dollars in thousands):
Loans outstanding, January 1
New loans
Net activity on revolving lines of credit
Repayment
Loans outstanding at end of period
2017
2016
$ 9,195 $ 6,887
2,510
2,018
2,119
237
(2,321)
(1,413)
$ 10,037 $ 9,195
There were no loans to related-parties classified substandard as of December 31, 2017 and 2016. In addition to the
outstanding balances above, there were unfunded commitments of $.605 million to related parties at December 31, 2017.
NOTE 5 — PREMISES AND EQUIPMENT
Details of premises and equipment at December 31 are as follows (dollars in thousands):
Land
Buildings and improvements
Furniture, fixtures, and equipment
Construction in progress
Total cost basis
Less - accumulated depreciation
Net book value
2017
2016
$ 2,998 $ 2,566
18,001
9,142
310
30,019
14,128
18,473
11,178
—
32,649
16,359
$ 16,290 $ 15,891
Depreciation of premises and equipment charged to operating expenses amounted to $1.978 million in 2017, $1.617
million in 2016, and $1.457 million in 2015.
NOTE 6 — OTHER REAL ESTATE HELD FOR SALE
An analysis of other real estate held for sale for the years ended December 31 is as follows (dollars in thousands):
Balance, January 1
Other real estate transferred from loans due to foreclosure
Other real estate acquired
Proceeds from other real estate sold
Transfer to premise and equipment
Writedowns of other real estate held for sale
Gain (loss) on sale of other real estate held for sale
Total other real estate held for sale
58
2017
2016
$ 4,782 $ 2,324
3,292
1,205
(1,640)
(197)
(212)
10
2,147
—
(2,983)
—
(307)
(81)
$ 3,558 $ 4,782
Foreclosed residential real estate property of $.894 million is included in other real estate as of December 31, 2017. The
recorded investment in consumer mortgage loans secured by residential real estate property that are in the process of
foreclosure according to local requirements of the applicable jurisdictions was $13,000 as of December 31, 2017.
NOTE 7 — DEPOSITS
The distribution of deposits at December 31 is as follows (dollars in thousands):
Noninterest bearing deposits
NOW, money market, interest checking
Savings
CDs <$250,000
CDs >$250,000
Brokered
Total deposits
2017
2016
$ 148,079 $ 164,179
286,622
58,315
141,629
8,489
164,278
280,309
61,097
142,159
11,055
175,299
$ 817,998 $ 823,512
Maturities of non-brokered time deposits outstanding at December 31, 2017 are as follows (dollars in thousands):
2018
2019
2020
2021
2022
Thereafter
Total
$ 90,456
30,118
18,296
8,644
3,901
1,799
$ 153,214
NOTE 8 — GOODWILL AND OTHER INTANGIBLE ASSETS
During the fourth quarter of 2014, the Corporation recorded $3.805 million of goodwill and $1.206 million of deposit
based intangible assets associated with the acquisition of Peninsula. During 2016, the Corporation recorded $1.839
million of goodwill and $.993 million of deposit based intangible assets associated with the acquisition of Eagle River.
Also in 2016, the Corporation recorded $50,000 of goodwill and $.300 million of deposit based intangible assets with the
acquisition of Niagara.
The deposit based intangible is reported net of accumulated amortization at $1.922 million at December 31, 2017,
compared to $2.172 million at December 31, 2016. Amortization expense in 2017 is $.249 million, compared to $.197
million in 2016 and $.121 million in 2015. Amortization expense for the next five years is expected to be at $.250
million per year.
NOTE 9 – SERVICING RIGHTS
Mortgage Loans
Mortgage servicing rights (“MSRs”) are recorded when loans are sold in the secondary market with servicing retained.
As of December 31, 2017, the Corporation had obligations to service $198.524 million of residential first mortgage
loans. The valuation of MSRs 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. On a quarterly basis, management
evaluates the MSRs for impairment. The key economic assumptions used in determining the fair value of the mortgage
servicing rights include an annual constant prepayment speed of 10.57% and a discount rate of 10.17% for December 31,
2017.
In 2016, management decided to no longer retain the servicing on mortgage loans sold.
59
The following summarizes the fair value of the mortgage servicing rights capitalized and amortized. There was no
valuation allowance required (dollars in thousands):
Balance at beginning of period
Acquired MSRs
Amortization
Balance at end of period
Balance of loan servicing portfolio
Mortgage servicing rights as % of portfolio
Commercial Loans
December 31, December 31,
$
2017
1,573 $
—
(540)
2016
1,965
207
(599)
1,033 $
$
1,573
$ 198,524 $ 221,355
.71%
0.52%
The Corporation also retains the servicing on commercial loans that have been sold that were originated and
underwritten under the SBA and USDA government guarantee programs, in which the guaranteed portion of the loan
was sold to a third party with servicing retained. The balance of these sold loans with servicing retained at December
31, 2017 and December 31, 2016 was approximately $44 million and $41 million, respectively. The Corporation valued
these servicing rights at $.110 million as of December 31, 2017 and $.140 million at December 31, 2016. This valuation
was established in consideration of the discounted cash flow of expected servicing income over the life of the loans.
NOTE 10 — BORROWINGS
Borrowings consist of the following at December 31 (dollars in thousands):
Federal Home Loan Bank fixed rate advances
Correspondent bank line of credit
Correspondent bank term note
USDA Rural Development note
2017
2016
$ 60,000 $ 45,000
750
21,199
630
—
18,999
553
$ 79,552 $ 67,579
The Federal Home Loan Bank borrowings bear a weighted average rate of 1.66% and mature in 2018, 2019, and 2021.
They are collateralized at December 31, 2017 by the following: a collateral agreement on the Corporation’s one to four
family residential real estate loans with a book value of approximately $72.552 million; mortgage related and municipal
securities with an amortized cost and estimated fair value of $2.482 million and $2.460 million, respectively; and
Federal Home Loan Bank stock owned by the Bank totaling $3.112 million. Prepayment of the advances is subject to
the provisions and conditions of the credit policies of the Federal Home Loan Bank of Indianapolis and the Federal
Home Loan Bank of Chicago in effect as of December 31, 2017.
The Corporation currently has one correspondent banking borrowing relationship. The relationship consists of a $5.0
million revolving line of credit and a term note. The line of credit bears interest at a rate of LIBOR plus 2.75%, and has
an initial term that expires on April 30, 2018. LIBOR was 1.69% at December 31, 2017. The term note had a balance of
$18.999 million at December 31, 2017 and bears the same interest as the line of credit, and matures on April 30, 2019
and requires quarterly principal payments of $550,000 which began on March 31, 2017. The relationship is secured by
all of the outstanding common stock of mBank.
The USDA Rural Development borrowing bears an interest rate of 1.00% and matures in August, 2024. It is
collateralized by loans totaling $.553 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 $.619 million, and guaranteed by the
Corporation.
60
Maturities and principal payments of borrowings outstanding at December 31, 2017 are as follows (dollars in
thousands):
2018
2019
2020
2021
2022
Thereafter
Total
$ 12,277
31,876
10,078
25,079
80
162
$ 79,552
NOTE 11 — INCOME TAXES
The components of the federal income tax provision (credit) for the years ended December 31 are as follows (dollars in
thousands):
Current tax expense
Change in valuation allowance
Adjustment of deferred taxes due to change in enacted tax rate
Deferred tax expense
2017
$ 585 $
—
2,025
2,929
2015
2016
485 $
—
—
1,798
—
(760)
—
3,093
Provision for income taxes
$ 5,539 $ 2,283 $ 2,333
A summary of the source of differences between income taxes at the federal statutory rate and the provision (credit) for
income taxes for the years ended December 31 is as follows (dollars in thousands):
Tax expense at statutory rate
Increase (decrease) in taxes resulting from:
Tax-exempt interest
Change in valuation allowance
Adjustment of deferred taxes due to change in enacted tax rate
Expiration of deferred tax assets
Nondeductible transaction expenses
Other
2017
$ 3,746 $ 2,301 $ 2,695
2015
2016
(133)
—
2,025
—
17
(116)
(96)
—
—
—
95
(17)
(60)
(760)
—
429
—
29
Provision for income taxes, as reported
$ 5,539 $ 2,283 $ 2,333
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Deferred income taxes are provided for the temporary differences between the financial reporting and tax bases of the
Corporation’s assets and liabilities. The major components of net deferred tax assets at December 31 are as follows
(dollars in thousands):
Deferred tax assets:
NOL carryforward
Allowance for loan losses
Alternative Minimum Tax Credit
OREO
Tax credit carryovers
Deferred compensation
Pension liability
Stock compensation
Unrealized loss on securities
Purchase accounting adjustments
Other
Total deferred tax assets
Deferred tax liabilities:
Core deposit premium
FHLB stock dividend
Depreciation
Mortgage servicing rights
Other
Total deferred tax liabilities
Net deferred tax asset
2017
2016
$ 1,580 $ 3,080
1,413
1,944
142
235
443
387
116
52
1,791
805
948
1,463
119
235
242
240
79
19
785
63
5,773
10,408
(404)
(56)
(79)
(240)
(24)
(803)
(739)
(91)
(208)
(583)
(27)
(1,648)
$ 4,970 $ 8,760
The Corporation has reported net deferred tax assets of $4.970 million at December 31, 2017. The income tax expense
for 2017 was impacted by the adjustment of deferred tax assets and liabilities related to the reduction in the U.S. federal
statutory income tax rate to 21% under the Tax Cuts and Jobs Act, which was enacted on December 22, 2017. As a
result of the new law, and additional expense of $2.025 million was recorded in 2017. 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, 2017 had a net operating loss and tax credit carryforwards for tax
purposes of approximately $7.5 million, and $1.7 million, respectively. The Corporation evaluated the future benefits
from these carryforwards as of December 31, 2017 and determined that it was “more likely than not” that they would be
utilized prior to expiration. 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 and credit
carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code. The
annual limitation is $1.537 million for the NOL and the equivalent value of tax credits, which is approximately $.476
million. These limitations for use were established in conjunction with the recapitalization of the Corporation in
December 2004. The Corporation will continue to evaluate the future benefits from these carryforwards in order to
determine if any adjustment to the deferred tax asset is warranted.
NOTE 12 — OPERATING LEASES
The Corporation currently maintains seven operating leases for office locations. The first operating lease, for the
Corporation's 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, again in 2014 for an additional three year term, and again in 2017 for an additional three year term.
The second 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 expired in 2013, and the third of the four consecutive renewal terms of two
years each is in place.
62
The third operating lease, for a loan production office in Traverse City, was executed in May 2012, the terms of which
began in August 2012. The original term of this lease expired in 2015 and automatically renewed at that time. The lease
was renegotiated in 2016 for a term of 36-months, with two consecutive options to extend the lease for 36 months each.
The fourth operating lease was initiated in December 2013 as the Corporation consolidated its banking offices in
Marquette. The original term of this lease is 15 years with options for two consecutive renewal terms of four years each.
The fifth operating lease, located in Troy, for the asset based lending office, was initiated in December 2013. The
Corporation terminated this lease in early 2018.
With the acquisition of PFC, the Corporation acquired three additional operating leases for office locations. The first,
for an additional location in Marquette, was executed in February 2011 with a term of five years and expired in 2016.
The Corporation opted not to renew this lease, and subsequently closed that office location. The second, for the location
in Negaunee was executed in September 2012 with an initial term of five years, expiring in 2017. This lease was
renewed for one additional term of five years. The final, for a location in Ishpeming was executed in April 2008 for an
initial term of five years. This lease was renewed in May 2013 for an additional five years.
Future minimum payments for base rent, by year and in the aggregate, under the initial terms of the operating lease
agreements, consist of the following (dollars in thousands):
2018
2019
2020
2021
2022
Thereafter
Total
$
772
747
608
503
499
3,124
$ 6,253
Rent expense for all operating leases amounted to $1.109 million in 2017, $1.053 million in 2016, and $.985 million in
2015.
NOTE 13 — RETIREMENT PLAN
The Corporation has established a 401(k) profit sharing plan. Employees who have completed three months of service
and attained the age of 18 are eligible to participate in the plan. Eligible employees can elect to have a portion, not to
exceed 80%, of their annual compensation paid into the plan. In addition, the Corporation may make discretionary
contributions into the plan. Retirement plan contributions charged to operations totaled $340,800, $300,000, and
$288,000 in 2017, 2016, and 2015, respectively.
NOTE 14 — DEFINED BENEFIT PENSION PLAN
The Corporation acquired the Peninsula Financial Corporation noncontributory defined benefit pension plan. Effective
December 31, 2005, the plan was amended to freeze participation in the plan; therefore, no additional employees are
eligible to become participants in the plan. The benefits are based on years of service and the employee’s compensation
at the time of retirement. The Plan was amended effective December 31, 2010, to freeze benefit accrual for all
participants. Expected contributions to the Plan in 2018 are $79,000.
63
The anticipated distributions over the next five years and through December 31, 2017 are detailed in the table below
(dollars in thousands):
2018
2019
2020
2021
2022
2023-2027
Total
$
133
130
126
125
131
796
$ 1,441
The following table sets forth the plan’s funded status and amounts recognized in the Corporation’s balance sheets and
the activity from date of acquisition (dollars in thousands):
Change in benefit obligation:
Benefit obligation, beginning of year
Interest cost
Actuarial loss
Benefits paid
Benefit obligation at end of year
Change in plan assets:
Fair value of plan assets, beginning of year
Actual return on plan assets
Employer contributions
Benefits paid
Fair value of plan assets at end of year
2017
2016
$ 3,187 $ 3,180
187
(44)
(136)
3,187
118
161
(135)
3,331
2,049
259
18
(135)
2,191
2,033
103
49
(136)
2,049
Funded status, included with other liabilities
$ (1,140) $ (1,138)
Net pension costs included in the Corporation’s results of operations was immaterial.
Assumptions in the actuarial valuation were:
Weighted average discount rate
Rate of increase in future compensation levels
Expected long-term rate of return on plan assets
2016
2017
3.33% 3.78%
N/A N/A
8.00% 8.00%
The expected long-term rate of return on plan assets reflects management’s expectations of long-term average rates of
return on funds invested to provide for benefits included in the projected benefit obligation. The expected return is
based on the outlook for inflation, fixed income returns and equity returns, while also considering historical returns,
asset allocation and investment strategy. The discount rate assumption is based on investment yields available on AA
rated long-term corporate bonds.
The primary investment objective is to maximize growth of the pension plan assets to meet the projected obligations to
the beneficiaries over a long period of time, and to do so in a manner that is consistent with the Corporation’s risk
tolerance. The intention of the plan sponsor is to invest the plan assets in mutual funds with the following asset
allocation, which was in place at both December 31, 2017 and December 31, 2016:
Target
Allocation
50% to 70%
30% to 50%
Actual
Allocation
60%
40%
Equity securities
Fixed income securities
64
NOTE 15 — 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, 2017 and 2016, for vested benefits under this plan, was $.113 million and $.179 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 $1.465 million and $1.398 million at
December 31, 2017 and 2016, respectively.
Peninsula Financial Corporation, acquired by the Corporation in December 2014, also had a deferred compensation plan,
which was similar in nature to the Corporation’s discontinued plan. The liability for this plan at December 31, 2017 and
2016, for vested benefits under this plan was $1.038 million and $1.124 million, respectively. The bank owned life
insurance policy as of December 31, 2017 and 2016 had cash surrender values of $1.741 million and $1.722 million,
respectively. This Plan was also discontinued by the Corporation and will not apply to future employees or directors of
the Corporation.
Deferred compensation expense for both plans was $65,000 and $77,000 and $27,000 for 2017, 2016 and 2015
respectively.
NOTE 16 — 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, 2017, the Corporation is well
capitalized.
Effective January 1, 2015, the Corporation was subject to new capital requirements due to the Basel III regulation,
including:
(cid:2) A new minimum ratio of Common Equity Tier I Capital to risk-weighted assets of 4.5%;
(cid:2) An increase in the minimum required amount of Additional Tier 1 Capital to 6% of risk-weighted assets;
(cid:2) A continuation of the current minimum required amount of Total Capital (Tier 1 plus Tier 2) at 8% of risk-
weighted assets; and
(cid:2) A minimum leverage ratio of Tier I Capital to total assets equal to 4% in all circumstances.
In order to be “well-capitalized” under the new guidelines, a depository institution must maintain a Common Equity Tier
1 Capital ratio of 6.5% or more; an Additional Tier 1 Capital ratio of 8% or more; a Total Capital ratio of 10% or more;
and a leverage ratio of 5% or more.
65
The Corporation’s and the Bank’s actual capital and ratios compared to generally applicable regulatory requirements as
of December 31, 2017 are as follows (dollars in thousands):
Total capital to risk weighted assets:
Consolidated
mBank
Tier 1 capital to risk weighted assets:
Consolidated
mBank
Common equity Tier 1 capital to risk weighted assets
Consolidated
mBank
Tier 1 capital to average assets:
Consolidated
mBank
Actual
Amount Ratio
Adequacy Purposes Well-Capitalized
Amount Ratio Amount Ratio
9.3% > $ 64,190 > 8.0% > $ 80,237 10.0%
$ 74,533
$ 93,598 11.7% > $ 64,202 > 8.0% > $ 80,252 10.0%
$ 69,454
8.7% > $ 48,142 > 6.0% > $ 64,190 8.0%
$ 88,560 11.0% > $ 48,151 > 6.0% > $ 64,202 8.0%
$ 69,454
8.7% > $ 36,107 > 4.5% > $ 52,154
$ 88,560 11.0% > $ 36,113 > 4.5% > $ 52,164
6.5%
6.5%
$ 69,454
$ 88,560
7.1% > $ 39,375 > 4.0% > $ 49,219 5.0%
9.0% > $ 39,279 > 4.0% > $ 49,098 5.0%
The Corporation’s and the Bank’s actual capital and ratios compared to generally applicable regulatory requirements as
of December 31, 2016 are as follows (dollars in thousands):
Total capital to risk weighted assets:
Consolidated
mBank
Tier 1 capital to risk weighted assets:
Consolidated
mBank
Common equity Tier 1 capital to risk weighted assets
Consolidated
mBank
Tier 1 capital to average assets:
Consolidated
mBank
NOTE 17 — STOCK COMPENSATION PLANS
Restricted Stock Awards
Adequacy Purposes Well-Capitalized
Amount Ratio Amount Ratio Amount Ratio
Actual
$ 73,811
9.5% > $ 62,503 > 8.0% > $ 78,128 10.0%
$ 92,521 11.9% > $ 62,102 > 8.0% > $ 77,627 10.0%
$ 68,791
8.8% > $ 46,877 > 6.0% > $ 62,503 8.0%
$ 87,542 11.3% > $ 46,576 > 6.0% > $ 62,102 8.0%
$ 68,791
8.8% > $ 35,158 > 4.5% > $ 50,783
$ 87,542 11.3% > $ 34,932 > 4.5% > $ 50,458
6.5%
6.5%
$ 68,791
$ 87,542
7.3% > $ 37,939 > 4.0% > $ 47,242 5.0%
9.2% > $ 37,889 > 4.0% > $ 47,361 5.0%
The Corporation’s restricted stock awards (“RSAs”) require certain service-based or performance requirements and have
a vesting period of four years. Compensation expense is recognized on a straight-line basis over the vesting period.
Shares are subject to certain restrictions and risk of forfeiture by the participants.
66
The Corporation has historically granted RSAs to members of the Board of Directors and management. Awards granted
are set to vest equally over their award terms and are issued at no cost to the recipient. The table below summarizes each
of the grant awards.
Date of Award
August, 2012
March, 2014
March, 2015
May, 2015
February, 2016
February, 2017
Units Granted
148,500
52,774
37,730
3,000
35,733
28,427
Market Value at
grant date
$ 7.91
12.95
11.15
10.77
9.91
13.39
Vesting Term
4 years
4 years
4 years
Immediate
4 years
4 years
On August 31, 2013, 2014, 2015 and 2016, the Corporation issued 37,125 shares of its common stock for vested RSAs,
in each year. In March 2015, the Corporation issued 13,194 shares of its common stock for vested RSAs. In May 2015,
the Corporation granted 3,000 shares, which were immediately vested and issued. In March 2016, the Corporation
issued 22,626 shares of its common stock for vested RSAs. In the first quarter of 2017, the Corporation issued 31,559
shares of its common stock for vested RSAs.
The Corporation recognized annual compensation expense of $.398 million in 2017, $.600 million in 2016 and $.576
million in 2015. Unrecognized compensation expense at the end of 2017 was $.660 million.
A summary of changes in our nonvested awards for the year follows:
Nonvested balance at January 1, 2017
Granted during the period
Vested during the period
Nonvested balance at December 31, 2017
NOTE 18 — SHAREHOLDERS’ EQUITY
Number
Outstanding
Weighted Average
Grant Date
Fair Value
90,417 $
28,427
(31,559)
87,285 $
11.19
13.39
11.55
11.78
The Corporation currently has a share repurchase program. The program is conducted under authorizations by the Board
of Directors. The Corporation repurchased 14,000 shares in 2016, 102,455 shares in 2015, 13,700 shares in 2014 and
55,594 shares in 2013. The share repurchases were conducted under Board authorizations made and publicly announced
of $600,000 on February 27, 2013, $600,000 on December 17, 2013 and an additional $750,000 on April 28, 2015.
None of these authorizations has an expiration date. As of December 31, 2017, $26,000 of the total authorization was
available for future purchases.
NOTE 19 — 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
67
instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it
does for on-balance-sheet instruments. These commitments at December 31 are as follows (dollars in thousands):
Commitments to extend credit:
Variable rate
Fixed rate
Standby letters of credit - Variable rate
Credit card commitments - Fixed rate
2017
2016
$ 72,187 $ 59,496
28,737
37,468
8,252
7,753
5,533
5,788
$ 123,196 $ 102,018
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, 2017, 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.
Concentration of Credit Risk
The Bank grants commercial, residential, agricultural, and consumer loans throughout Michigan and Northeastern
Wisconsin. 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, 2017 represents $119.025 million, or 20.77%,
compared to $121.861 million, or 22.42%, of the commercial loan portfolio on December 31, 2016. The remainder of
the commercial loan portfolio is diversified in such categories as hospitality and tourism, real estate agents and
managers, new car dealers, gas stations and convenience stores, 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 20 — 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.
68
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.
The following table presents information for financial instruments at December 31 (dollars in thousands):
December 31, 2017
December 31, 2016
Level in Fair
Value Hierarchy
Carrying Estimated Carrying Estimated
Fair Value
Fair Value
Amount
Amount
Financial assets:
Cash and cash equivalents
Interest-bearing deposits
Securities available for sale
Securities available for sale
Federal Home Loan Bank stock
Net loans
Accrued interest receivable
Level 1
Level 2
Level 2
Level 3
Level 2
Level 3
Level 3
$ 37,426
13,374
74,397
1,500
3,112
805,999
2,276
37,426 $ 46,755 $ 46,755
14,047
14,047
13,374
84,623
84,623
74,397
1,650
1,650
1,500
2,911
2,911
3,112
778,377
776,837
797,726
2,016
2,016
2,276
Total financial assets
$ 938,084 $ 929,811 $ 928,839 $ 930,379
Financial liabilities:
Deposits
Borrowings
Accrued interest payable
Total financial liabilities
Level 2
Level 2
Level 3
$ 817,998
79,552
322
788,632 $ 823,512 $ 815,960
68,293
67,579
267
267
79,242
322
$ 897,872 $ 868,196 $ 891,358 $ 884,520
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
69
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, 2017 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.
The fair value of all investment securities at December 31, 2017 and 2016 were based on level 2 and level 3 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 table below shows investment securities
measured at fair value on a recurring basis (dollars in thousands):
Quoted Prices
Significant
Significant
(dollars in thousands)
Assets
Corporate
Equity
US Agencies
US Agencies - MBS
Obligations of state and
political subdivisions
Balance at
December 31, 2017
in Active Markets Other Observable Unobservable
for Identical Assets
(Level 1)
Inputs
(Level 3)
Inputs
(Level 2)
Total Losses for
Twelve months ended
December 31, 2017
$
24,391 $
500
16,846
12,716
$
21,444
75,897
— $
—
—
—
24,391 $
—
16,846
12,716
— $
500
—
—
—
20,444
1,000
$
—
—
—
—
—
—
(dollars in thousands)
Assets
Corporate
Equity
US Agencies
US Agencies - MBS
Obligations of state and political
subdivisions
Quoted Prices
Significant
in Active Markets Other Observable Unobservable
for Identical Assets
Significant
Inputs
Inputs
Total Losses for
Twelve months ended
(Level 1)
(Level 2)
(Level 3)
December 31, 2016
Balance at
December
31, 2016
$ 19,910 $
500
23,952
16,833
25,078
$
86,273
— $
—
—
—
19,910 $
—
23,952
15,683
— $
500
—
1,150
—
25,078
—
$
—
—
—
—
—
—
70
The Corporation had no other Level 3 assets or liabilities on a recurring basis as of December 31, 2017.
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 table below shows the activity in level three assets for the years ended, December 31, 2017 and 2016 (dollars in
thousands):
Balance at
Beginning Net Gains (losses)
of Period Realized Unrealized Level 3
Transfers
in (out) of
Purchases
Sales
Balance
at end
of Period
Year Ended December 31, 2017
Equity
US Agencies- MBS
Obligations of state and political subdivisions
$
500 $
1,150
—
—
38
—
$
— $
—
—
— $
—
740
— $
—
260
— $
(1,188)
—
500
—
1,000
Balance at
Beginning Net Gains (losses)
of Period Realized Unrealized Level 3
Transfers
in (out) of
Purchases Sales
Balance
at end
of Period
Year Ended December 31, 2016
Equity
US Agencies- MBS
$
—
—
$
—
—
$
— $
—
—
—
$
500 $ —
—
1,150
$
500
1,150
Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2017
Quoted Prices
Significant
Significant
(dollars in thousands) December 31, 2017
Assets
Balance at
in Active Markets Other Observable Unobservable
for Identical Assets
(Level 1)
Inputs
(Level 2)
Inputs
(Level 3)
Total Losses for
Twelve months ended
December 31, 2017
Impaired loans
Other real estate
held for sale
$
3,852 $
— $
— $
3,852 $
3,558
—
—
3,558
$
141
388
529
71
Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2016
Quoted Prices
Significant
Significant
(dollars in thousands) December 31, 2016
Assets
Balance at
in Active Markets Other Observable Unobservable
for Identical Assets
(Level 1)
Inputs
(Level 3)
Inputs
(Level 2)
Total Losses for
Year Ended
December 31, 2016
Impaired loans
Other real estate
held for sale
$
9,856 $
— $
— $
9,856 $
4,782
—
—
4,782
$
643
202
845
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 or collateral
values 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).
NOTE 21 — BUSINESS COMBINATIONS
The First National Bank of Eagle River
The Corporation completed its acquisition of Eagle River on April 29, 2016. Eagle River had three branch offices and
approximately $125 million in assets of April 29, 2016. The results of operations due to the merger have been included
in the Corporation’s results since the acquisition date. The merger was effected with a cash payment of $12.500 million.
72
The table below highlights the allocation of the purchase price:
Purchase Price:
Eagle River shares outstanding
Price per share/Cash price
Total purchase price
Reimbursement of termination fees
Cash consideration
Net assets acquired:
Cash and cash equivalents
Securities available for sale, net of purchase accounting marks
FRB & FHLB Stock
Total Loans, net of purchase accounting marks
Premises and equipment
Other real estate owned, net of purchase accounting marks
Deposit based intangible
Mortgage servicing rights
Deferred tax asset
Bank owned life insurance
Other assets
Total assets
Non-interest bearing deposits
Interest bearing deposits
Total deposits
FHLB Borrowings
Other liabilities
Total liabilities
Net assets acquired
Goodwill
85,776
145.73
$
$
$
12,500
(1,763)
10,737
$
10,600
23,296
575
80,875
1,931
904
993
120
948
4,132
323
124,697
22,349
82,165
104,514
11,000
285
115,799
8,898
$
1,839
The results of operations for the twelve months ended December 31, 2016, include the operating results of the acquired
assets and assumed liabilities for the 245 days subsequent to the acquisition date. Eagle River’s results of operations
prior to the acquisition date are not included in the Corporation’s consolidated statement of comprehensive income.
In addition to the data processing termination fees of $1.763 million, the Corporation incurred other Eagle River
transaction related expenses of $.954 million, for a total of $2.717 million, or $1.793 million on an after tax basis during
2016. These expenses included professional services such as legal, accounting, employee severance payments and
contractual arrangements for consulting services.
Niagara Bancorporation
The Corporation completed its acquisition of Niagara on August 31, 2016. Niagara had four branch offices and
approximately $67 million in assets as of August 31, 2016. The results of operations due to the merger have been
included in the Corporation’s results since the acquisition date. The merger was effected with a cash payment of $7.325
million.
73
The table below highlights the allocation of the purchase price (dollars in thousands, except per share data):
Purchase Price:
Niagara shares outstanding
Price per share/Cash price
Total purchase price
Net assets acquired:
Cash and cash equivalents
Securities available for sale
FRB & FHLB Stock
Total Loans, net of purchase accounting marks
Premises and equipment
Other real estate owned, net of purchase accounting marks
Deposit based intangible
Mortgage servicing rights
Deferred tax assets
Bank owned life insurance
Other assets
Total assets
Non-interest bearing deposits
Interest bearing deposits
Total deposits
Other liabilities
Total liabilities
Net assets acquired
Goodwill
4,354
$ 1,682.36
$
7,325
$
9,778
21,491
287
31,707
926
301
300
87
397
1,109
302
66,685
5,396
53,788
59,184
226
59,410
7,275
$
50
The results of operations for the twelve months ended December 31, 2016, include the operating results of the acquired
assets and assumed liabilities for the 122 days subsequent to the acquisition date. Niagara’s results of operations prior to
the acquisition date are not included in the Corporation’s consolidated statement of comprehensive income.
The Corporation incurred Niagara transaction related expenses of $.384 million, or $.253 million on an after tax basis
during 2016. These expenses included professional services such as legal, accounting, employee severance payments
and contractual arrangements for consulting services.
The following table provides the unaudited pro forma information for the results of operations for the twelve months
ended December 31, 2016 and 2015, as if both the Eagle River acquisition and Niagara acquisition had occurred on
January 1. These adjustments reflect the impact of certain purchase accounting fair value measurements, primarily on
the loan and deposit portfolios of Eagle River and Niagara. In addition, the merger-related costs noted above are
excluded from the 2016 results of operations, for comparative purposes. Further operating cost savings are expected
along with additional business synergies as a result of the merger which are not presented in the pro forma amounts.
These unaudited pro forma results are presented for illustrative purposes only and are not intended to represent or be
indicative of the actual results of operations of the combined banking organization that would have been achieved had
74
the merger occurred at the beginning of the period presented, nor are they intended to represent or be indicative of future
results of the Corporation.
2016
2015
Net interest income
Noninterest income
Noninterest expense
Net income
Net income per diluted share
Fair Value
$ 36,902 $ 32,924
4,865
26,851
7,219
1.15
5,129
30,857
7,375
1.18 $
$
In most instances, determining the fair value of the acquired assets and assumed liabilities required the Corporation to
estimate the cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate
rates of interest. The most significant of those determinations is related to the valuation of acquired loans. For such
loans, the excess cash flows expected at merger over the estimated fair value is recognized as interest income over the
remaining lives of the loans. The difference between contractually required payments at merger and the cash flows
expected to be collected at merger reflects the impact of estimated credit losses, interest rate changes, and other factors,
such as prepayments. In accordance with the applicable accounting guidance for business combinations, there was no
carry-over of the acquired banks’ previously established allowance for loan losses.
Goodwill recognized in these acquisitions was based primarily due to the synergies and economies of scale expected
from combining the operations of the Corporation with Eagle River and Niagara.
NOTE 22 — SUBSEQUENT EVENT
On January 16, 2018, the Corporation announced the signing of a definitive agreement to acquire First Federal of
Northern Michigan Bancorp, Inc in Alpena, Michigan (“FFNM”). FFNM is headquartered in Alpena, Michigan and has
assets in excess of $320 million. The consummation of this transaction is expected to occur in the second quarter of
2018. Completion of the acquisition is subject to regulatory approval in addition to satisfaction of other customary
closing conditions.
75
NOTE 23 — PARENT COMPANY ONLY FINANCIAL STATEMENTS
BALANCE SHEETS
December 31, 2017 and 2016
(Dollars in Thousands)
ASSETS
Cash and cash equivalents
Investment in subsidiaries
Other assets
TOTAL ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
Line of Credit
Other borrowing
Other liabilities
Total liabilities
Shareholders’ equity:
Common stock and additional paid in capital - no par value
Authorized 18,000,000 shares
Issued and outstanding - 6,294,930 and 6,263,371 shares respectively
Retained earnings
Accumulated other comprehensive income
Total shareholders’ equity
2017
2016
$
198 $
97,984
3,263
106
97,407
4,014
$ 101,445 $ 101,527
$
— $
18,999
1,046
20,045
750
21,199
969
22,918
61,981
19,711
(292)
61,583
17,206
(180)
81,400
78,609
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$ 101,445 $ 101,527
76
STATEMENTS OF OPERATIONS
Years Ended December 31, 2017, 2016, and 2015
(Dollars in Thousands)
INCOME:
Interest income
Total income
EXPENSES:
Interest expense on borrowings
Salaries and benefits
Professional service fees
Transaction related expenses
Other
Total expenses
2017
2016
2015
$
— $
2 $
—
$
— $
2 $
—
868
698
279
50
294
707
900
173
443
152
453
876
256
—
184
2,189
2,375
1,769
Loss before income taxes and equity in net income of subsidiaries
(2,189)
(2,373)
(1,769)
Provision for (benefit of) income taxes
(27)
(807)
(602)
Loss before equity in net income of subsidiaries
(2,162)
(1,566)
(1,167)
Equity in net income of subsidiaries
7,641
6,049
6,763
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS
$ 5,479 $ 4,483 $ 5,596
77
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2017, 2016, and 2015
(Dollars in Thousands)
Cash Flows from Operating Activities:
Net income
Adjustments to reconcile net income to net cash provided by operating
activities:
Equity in net (income) of subsidiaries
Increase in capital from stock based compensation
Change in other assets
Change in other liabilities
Net cash provided by (used in) operating activities
Cash Flows from Investing Activities:
Investments in subsidiaries
Net cash paid in acquisitions
Net cash provided by (used in) investing activities
Cash Flows from Financing Activities:
Increase on term borrowing
Principal payments on term borrowings
Net activity on line of credit
Repurchase of common stock
Dividend on common stock
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
2017
2016
2015
$
5,479 $
4,483 $ 5,596
(7,641)
398
751
77
(936)
(6,049)
600
(1,033)
(132)
(2,131)
(6,763)
576
2,903
(4,907)
(2,595)
7,000
—
7,000
11,825
(19,825)
(8,000)
5,839
—
5,839
—
(2,200)
(750)
—
(3,022)
(5,972)
19,799
(100)
(7,800)
(150)
(2,498)
9,251
—
(100)
(550)
(1,122)
(2,179)
(3,951)
92
106
(880)
986
(707)
1,693
Cash and cash equivalents at end of period
$
198 $
106 $
986
78
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
As of the end of the period covered by this report, management of the company, under the supervision and with the
participation of the Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of
the design and operation of the Corporation’s disclosure controls and procedures as defined under Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures were
effective, in ensuring the information relating to the Corporation (and its consolidated subsidiaries) required to be
disclosed by the Corporation in the reports it files or submits under the Exchange Act was recorded, processed,
summarized and reported to the Corporation’s management, including its Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
There were no changes in the Corporation’s internal control over financial reporting that occurred during the quarter
ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Corporation’s
internal control over financial reporting.
Report on Management’s Assessment of Internal Control over Financial Reporting
Mackinac Financial Corporation is responsible for the preparation, integrity, and fair presentation of the consolidated
financial statements included in this Form 10-K. The consolidated financial statements and notes included in this
Form 10-K have been prepared in conformity with generally accepted accounting principles in the United States and
necessarily include some amounts that are based on management’s best estimates and judgments.
We, as management of Mackinac Financial Corporation, are responsible for establishing and maintaining effective
internal control over financial reporting that is designed to produce reliable financial statements in conformity with
generally accepted accounting principles in the United States. The system of internal control over financial reporting as
it relates to the financial statements is evaluated for effectiveness by management and tested for reliability through a
program of internal audits. Actions are taken to correct potential deficiencies as they are identified. Any system of
internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be
circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of
changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of
internal control will provide only reasonable assurance with respect to financial statement preparation.
Management assessed the Corporation’s system of internal control over financial reporting as of December 31, 2017, in
relation to criteria for the effective internal control over financial reporting as described in “Internal Control —
Integrated Framework,” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on
this assessment, management concludes that, as of December 31, 2017, its system of internal control over financial
reporting is effective and meets the criteria of the “Internal Control — Integrated Framework.”
Item 9B. Other Information
None.
79
Item 10. Directors, Executive Officers, and Corporate Governance
Executive Officers of the Registrant
PART III
The executive officers of the Corporation are listed below. The executive officers serve at the pleasure of the Board of
Directors and are appointed by the Board annually. There are no arrangements or understandings between any officer
and any other person pursuant to which the officer was selected.
Name
Age
Position
Paul D. Tobias
67 Chairman and Chief Executive Officer
Kelly W. George
50 President
Jesse A. Deering
38 Executive Vice President/Chief Financial Officer
Additional information for the executive officers of the registrant is included in the Corporation’s Proxy Statement for its
2018 Annual Meeting of Shareholders under the caption “Executive Officers.”
The information set forth under the captions “Information About Directors and Nominees,” “Director Independence,”
“Board of Directors and Committees,” “Indebtedness and Transactions with Management,” and
“Section 16(a) Beneficial Ownership Reporting Compliance” in the Corporation’s definitive Proxy Statement for its
2018 Annual Meeting of Shareholders (the “Proxy Statement”), a copy of which will be filed with the SEC prior to the
meeting date, is incorporated herein by reference.
Item 11. Executive Compensation
Information relating to compensation of the Corporation’s executive officers and directors is contained under the caption
“Compensation of Executive Officers and Directors” in the Corporation’s Proxy Statement and is incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information relating to security ownership of certain beneficial owners and management is contained under the caption
“Beneficial Ownership of Common Stock” in the Corporation’s Proxy Statement is incorporated herein by reference.
80
The following table provides information as of December 31, 2017 with respect to compensation plans (including
individual compensation arrangements) under which equity securities of the Corporation are authorized for issuance. All
such compensation plans were previously approved by security holders.
Plan Category
Equity stock based compensation plans approved by
security holders:
Issued and outstanding:
Restricted stock awards - August 2012
Restricted stock awards - March 2014
Restricted stock awards - March 2015
Restricted stock awards - February 2016
Restricted stock awards - February 2017
Shares available for future issuance
Weighted average
Number of securities to exercise issue price
be issued upon exercise
of outstanding options,
warrants and rights
(a)
of outstanding
options, warrants
and rights
(b)
Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column (a))
(c)
37,125
39,580
37,730
35,733
28,427
—
7.91
12.95
11.15
9.91
13.39
—
—
—
—
—
—
165,299
Total
178,595 $
10.98
165,299
Item 13. Certain Relationships, Related Transactions and Director Independence
Information relating to certain relationships and related transactions is contained under the caption “Indebtedness of and
Transactions with Management” in the Corporation’s Proxy Statement and is incorporated herein by reference.
Additional information is contained under the captions “Information about Directors and Nominees and “Board of
Directors Meetings and Committees.” within the Corporation’s Proxy Statement and is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
Information relating to principal accountant fees and services is contained under the caption “Principal Accountant Fees
and Services” in the Corporation’s Proxy Statement and is incorporated herein by reference.
81
Item 15. Exhibits and Financial Statement Schedules
(commission file number for all incorporated documents: 0-20167)
PART IV
(a)
The following documents are filed as a part of this report.
1.
Consolidated Financial Statements
Part II, Item 8.
(i)
The financial statements of the Corporation included in this Form 10-K are listed in
2.
3.
All of the schedules for which provision is made in the applicable accounting regulations of
the Securities and Exchange Commission are either not required under the related instruction,
the required information is contained elsewhere in the Form 10-K, or the schedules are
inapplicable, and therefore have been omitted.
Exhibits
The exhibits required to be filed as part of this Form 10-K are listed in the attached Exhibit Index.
INDEX TO EXHIBITS
Incorporated by Reference
Form
8-K
File No.
000-20167
Exhibit
Filing Date
2.1 1/19/2016
Filed Herewith
Exhibit
Number
2.1
2.2
2.3
2.4
3.1
3.3
Exhibit Description
Stock Purchase Agreement, dated as of
January 19, 2016, by and between Ellis
Bankshares, Inc. and Mackinac Financial
Corporation
Stock Purchase Agreement, dated as of May
24, 2016, by and among Mackinac Financial
Corporation, the Sellers named therein, and
Niagara Bancorporation, Inc.
Agreement and Plan of Merger, dated as of
January 16, 2018, by and among Mackinac
Financial Corporation and First Federal of
Northern Michigan Bancorp, Inc.
First Amendment to Agreement and Plan of
Merger Dated as of February 8, 2018, by and
among Mackinac Financial Corporation and
First Federal of Northern Michigan Bancorp,
Inc.
Articles of Incorporation and all amendments
(most recent amendment filed December 14,
2004)
Third Amended and Restated Bylaws
adopted March 18, 2014
8-K
000-20167
2.1 5/24/2016
8-K
000-20167
2.1 1/16/2018
8-K
000-20167
2.1 2/13/2018
10-K
000-20167
3.1 3/31/2009
8-K
000-20167
3.1 3/24/2014
82
10.3
10.1
10.2
10.4
10.5
Form of Director and Officer Indemnification
Agreement**
Mackinac Financial Corporation 2012
Incentive Compensation Plan**
Amended and Restated Employment
Agreement, dated as of March 1, 2018, by
and between Mackinac Financial Corporation
and Paul D. Tobias**
Amended and Restated Employment
Agreement, dated as of March 1, 2018, by
and between Mackinac Financial Corporation
and Kelly W. George**
Amended and Restated Employment
Agreement, dated as of March 1, 2018, by
and between Mackinac Financial Corporation
and Jesse A. Deering **
Form of Restricted Stock Unit Award
Agreement under the Mackinac Financial
Corporation 2012 Incentive Compensation
Plan**
Subsidiaries of the Corporation
Consent of Plante & Moran, PLLC
Rule 13(a) — 14(a) Certifications
Section 1350 Chief Executive Officer
Certification
Section 1350 Chief Financial Officer
Certification
101.INS XBRL Instance Document
101.SCH
21
23.1
31
32.1
32.2
10.6
101.CA
L
101.DEF
101.LA
B
101.PRE
XBRL Taxonomy Extension Schema
Document***
XBRL Taxonomy Extension Calculation
Linkbase Document***
XBRL Taxonomy Extension Definition
Linkbase Document***
XBRL Taxonomy Extension Labels Linkbase
Document***
XBRL Taxonomy Extension Presentation
Linkbase Document***
8-K
000-20167
10.1 3/24/2014
DEF14A 000-20167 Annex I 4/25/2012
8-K
000-20167
10.3 8/13/2012
*
*
*
*
*
*
*
*
*
*
*
*
*
*
* Filed herewith.
** Management compensatory plan, contract, or arrangement.
*** As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for the purposes of
Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 or
otherwise subject to liability under those Sections.
83
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Corporation has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, dated March 15, 2018.
SIGNATURES
MACKINAC FINANCIAL CORPORATION
/s/ Paul D. Tobias
Paul D. Tobias
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 15,
2018, by the following persons on behalf of the Corporation and in the capacities indicated. Each director of the
Corporation, whose signature appears below, hereby appoints Paul D. Tobias and Jesse A. Deering, and each of them
severally, as his attorney-in-fact, to sign in his name and on his behalf, as a director of the Corporation, and to file with
the Commission any and all Amendments to this Report on Form 10-K.
Signature
/s/ Paul D. Tobias
Paul D. Tobias — Chairman,
Chief Executive Officer & Director
(principal executive officer)
/s/ Walter J. Aspatore
Walter J. Aspatore - Director
/s/ Robert E. Mahaney
Robert E. Mahaney — Director
/s/ Dennis B. Bittner
Dennis B. Bittner — Director
/s/ Jesse A. Deering
Jesse A. Deering — Executive Vice President/Chief
Financial Officer
(principal financial and accounting officer)
/s/ Joseph D. Garea
Joseph D. Garea — Director
/s/ Robert H. Orley
Robert H. Orley - Director
/s/ L. Brooks Patterson
L. Brooks Patterson — Director
/s/ Kelly W. George
Kelly W. George — President & Director
/s/ Randolph C. Paschke
Randolph C. Paschke — Director
/s/ David R. Steinhardt
David R. Steinhardt — Director
84
Exhibit 21
Subsidiaries of Mackinac Financial Corporation
First Manistique Agency, Inc. - 100% owned
(incorporated as a Michigan corporation)
First Rural Relending Company - 100% owned
(incorporated as a Michigan corporation)
North Country Capital Trust — 100% owned
(organized as a Delaware business trust)
mBank - 100% owned
(incorporated as a Michigan banking corporation)
Mackinac Financial Corporation directly owns the four subsidiaries listed above.
Consent of Independent Registered Public Accounting Firm
We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (no. 333-183199) of
Mackinac Financial Corporation, of our report dated March 13, 2018 on the financial statements of Mackinac Financial
Corporation and Subsidiaries for the year ended December 31, 2017, appearing in this Form 10-K.
Exhibit 23.1
/s/Plante & Moran, PLLC
March 13, 2018
Auburn Hills, Michigan
RULE 13(a) — 14 (a) CERTIFICATIONS
EXHIBIT 31
I, Paul D. Tobias, Chairman and Chief Executive Officer of Mackinac Financial Corporation certify that:
1.
I have reviewed this report on Form 10-K of Mackinac Financial Corporation (the “registrant”);
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements and other financial information included in this report fairly
present, in all material respects, the financial condition, results of operations, and cash flows of the registrant as of,
and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting
to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report
our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred
during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control
over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize
and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in
the registrant’s internal control over financial reporting.
Date: March 15, 2018
/s/ Paul D. Tobias
Paul D. Tobias
Chairman and Chief Executive Officer
(principal executive officer)
I, Jesse A. Deering, Executive Vice President/Chief Financial Officer of Mackinac Financial Corporation, certify that:
1.
I have reviewed this report on Form 10-K of Mackinac Financial Corporation (the “registrant”);
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a
material fact necessary to make the statements made, in light of the circumstances under which such statements were
made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly
present in all material respects the financial condition, results of operations and cash flows of the registrant as of,
and for, the periods presented in this report;
4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial
reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be
designed under our supervision, to ensure that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting
to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally
accepted accounting principles;
(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report
our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period
covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred
during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual
report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control
over financial reporting; and
5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of
directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize
and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in
the registrant’s internal control over financial reporting.
Date: March 15, 2018
/s/ Jesse A. Deering
Jesse A. Deering
Executive Vice President/
Chief Financial Officer
(principal financial officer)
MACKINAC FINANCIAL CORPORATION
CERTIFICATION PERSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
EXHIBIT 32.1
This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C § 1350, and
accompanies the annual report on Form 10-K for the year ended December 31, 2017, (the “Form 10-K”) of Mackinac
Financial Corporation (the “Issuer”).
I, Paul D. Tobias, Chairman and Chief Executive Office of the Issuer, certify that to the best of my knowledge:
(1) The Form 10-K fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the
Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and
(2) The information contained in the Form 10-K fairly presents, in all material respects, the financial condition and
results of operation of the Issuer.
Date: March 15, 2018
/s/ Paul D. Tobias
Paul D. Tobias
Chairman and Chief Executive Officer
(chief executive officer)
MACKINAC FINANCIAL CORPORATION
CERTIFICATION PERSUANT TO
18 U.S.C. SECTION 1350
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
EXHIBIT 32.2
This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C § 1350, and
accompanies the annual report on Form 10-K for the year ended December 31, 2017, (the “Form 10-K”) of Mackinac
Financial Corporation (the “Issuer”).
I, Jesse A. Deering, Executive Vice President/Chief Financial Officer of the Issuer, certify that to the best of my
knowledge:
(1) The Form 10-K fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the
Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and
(2) The information contained in the Form 10-K fairly presents, in all material respects, the financial condition and
results of operation of the Issuer.
Date: March 15, 2018
/s/ Jesse A. Deering
Jesse A. Deering
Executive Vice President/
Chief Financial Officer
(chief financial officer)
Directors + Officers
Directors + Officers
DIRECTORS
OCCUPATION
DATE JOINED
Walter J. Aspatore
Lead Director
Chairman
Methode Electronics, Inc.
Dennis B. Bittner
Joseph D. Garea
Kelly W. George
Robert E. Mahaney
Robert H. Orley
Owner and President
Bittner Engineering, Inc.
Managing Director
Detalus Advisors
President, Mackinac Financial Corporation
President and CEO, mBank
Owner and President
Veridea Group, LLC
Founding Partner
O2 Investments, LLC
Randolph C. Paschke
Executive-in-Residence, Mike Ilitch School of Business
Wayne State University
L. Brooks Patterson
County Executive
Oakland County
David R. Steinhardt
Co-Founder and Board Member
Clarity Capital
Paul D. Tobias
Chairman and CEO, Mackinac Financial Corporation
Chairman, mBank
2004
2001
2007
2006
2008
2004
2004
2006
2012
2004
Annual Report OFFICERS
MACKINAC FINANCIAL CORPORATION
Paul D. Tobias
Chairman
Chief Executive Officer
Kelly W. George
President
Jesse A. Deering
Executive Vice President
Chief Financial Officer
Directors + Officers
LOCATION
Birmingham
Manistique
Birmingham
OFFICERS
MBANK EXECUTIVE MANAGEMENT
LOCATION
Paul D. Tobias
Chairman
Kelly W. George
President
Chief Executive Officer
Jesse A. Deering
Executive Vice President
Chief Financial Officer
Tamara R. McDowell
Executive Vice President
Managing Director Credit Admin/Operations/IT
Joanna B. Slaght
Executive Vice President, Managing Director
of Administration & Regulatory Compliance Risk
Clay V. Peterson
Executive Vice President, Western U.P. & Wisconsin
Market Executive and Managing Director of Retail Banking
Birmingham
Manistique
Birmingham
Manistique
Manistique
Escanaba
Annual Report Directors + Officers
OFFICERS
MBANK SENIOR MANAGEMENT
Sherry Arnold
Senior Vice President – Bank Administration/
Training and Development Manager
Linda Bolda
Senior Vice President – Director of Human Resources
LOCATION
Manistique
Manistique
Jeremy Flodin
Senior Vice President – Senior Credit Administrator/ Risk Analyst
Manistique
Michael Hoar
Edward Lewan
Senior Vice President – Director of Information Technology/
Communications/Facilities Maintenance
President mBank Business Credit
Asset Based Lending Division
Manistique
Birmingham
Boris Martysz
Senior Vice President – Senior Commercial Banking Officer
Marquette
Erin McCormick
Senior Vice President – Branch Administration & Sales Officer
Eagle River
Andrew Sabatine
Regional President – Northern Lower Michigan
Traverse City
Gregory Schuetter
Senior Vice President – Marquette County Executive/
Eastern UP Commercial Lending Manager
Manistique
Jennifer Stempki
Senior Vice President – Controller/ Liquidity Funding Manager
Manistique
ADDITIONAL OFFICERS
CENTRAL DEPARTMENTS
Michael Gallagher
Regional Vice President
Austin Meyers
Assistant Vice President – Credit Manager
DEPARTMENT
Asset Based
Lending
Asset Based
Lending
Julie Bosanic
Vice President – Director of Mortgage Administration
Central Credit
Shannon O’Brien
Assistant Vice President – Sr. Credit Analyst Supervisor/
Assistant Credit Risk Manager
Central Credit
Nicole Tryan
Assistant Vice President – Senior Loan Operations Officer
Central Credit
Bernadette Beaudre
Vice President – Deposit Compliance/BSA Officer
Amy Lee
Assistant Vice President – Training and Development Officer
Ryan Valiquette
Assistant Vice President – Senior Network Administrator
Bethany Cody
Assistant Vice President – Marketing Officer
Compliance/
Administration
Compliance/
Administration
Information
Technology
Marketing
Annual Report ADDITIONAL OFFICERS
UPPER PENINSULA
Ann Deming
Vice President – Mortgage & Consumer Lending Manager
Scott Ravet
Vice President – Commercial Banking Officer
April Stropich
Assistant Vice President – Mortgage Loan Officer
Terry Garceau
Vice President – Retail & Commercial Banking Officer
Richard Demers
Vice President – Commercial Banking Officer
Magan Peterson
Vice President – Mortgage Loan Officer
Ross Anthony
Vice President – Mortgage Loan Officer
Josh Bal
Assistant Vice President – Mortgage Loan Officer
Catherine Bolm
Vice President – Mortgage Loan Officer
Joseph Havican
Vice President – Commercial Banking Officer
Jeremy Hinkson
Assistant Vice President – Commercial Banking Officer
Teresa Same
Vice President – Branch Operations
Angela Buckingham
Assistant Vice President – Branch Manager
Michael Slaght
Vice President – Commercial Banking Officer
Directors + Officers
LOCATION
Escanaba
Escanaba
Escanaba
Ishpeming
Manistique
Manistique
Marquette
Marquette
Marquette
Marquette
Marquette
Marquette
Newberry
Newberry
David Thomas
Vice President – Commercial Banking Officer
Sault Ste. Marie
Barbara Parrett
Vice President – Branch Operations
Stephenson
Annual Report Directors + Officers
ADDITIONAL OFFICERS
SOUTHEAST MICHIGAN
LOCATION
George Demou
Vice President – Senior Commercial Banking Officer
Birmingham
Laura Garvin
Vice President – Senior Commercial Portfolio Manager
Birmingham
Amy Gennaro
Vice President – Senior Commercial Banking Officer
Birmingham
ADDITIONAL OFFICERS
NORTHERN LOWER PENINSULA
Janet Willbee
Vice President – Mortgage Loan Officer
LOCATION
Gaylord
Michael Caruso
Vice President – Senior Commercial Banking Officer
Traverse City
Daniel Galbraith
Assistant Vice President – Branch Manager
John Klingelsmith
Vice President – Mortgage Loan Officer
Traverse City
Traverse City
Daniel Stoudt
Assistant Vice President – Mortgage Loan Officer
Traverse City
ADDITIONAL OFFICERS
WISCONSIN
John Hletko
Assistant Vice President – Mortgage Loan Officer
LOCATION
Eagle River
Jason (Jed) Lechleitner
Assistant Vice President – Commercial Banking Officer
Eagle River
Patrick Nickel
Vice President – Senior Commercial Banking Officer
Eagle River
Eric Wozny
Assistant Vice President – Commercial Banking Officer
Niagara
Catherine Humbaugh
Assistant Vice President – Mortgage Loan Officer
Debbie Vold
Assistant Vice President – Mortgage Loan Officer
St. Germain
Three Lakes
Annual Report LEFT BLANK INTENTIONALLY
Corporate Information
Annual Report
Corporate
Information
CORPORATE HEADQUARTERS
TRANSFER AGENT
SHAREHOLDER INFORMATION
Mackinac Financial Corporation
Broadridge
130 S. Cedar Street
Manistique, MI 49854
(888) 343–8147
51 Mercedes Way
Edgewood, NY 11717
(844) 318–0133
INVESTOR RELATIONS
Jesse A. Deering EVP/CFO
(248) 290–5906
jdeering@bankmbank.com
INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
Plante Moran, PLLC
Auburn Hills, Michigan
STOCK LISTING
AND SYMBOL
NASDAQ Capital Market
Symbol: MFNC
WEBSITE
bankmbank.com
Copies of the company’s 10–K
and 10–Q reports as filed with
the Securities and Exchange
Commission are available upon
request from the Company.
ANNUAL
SHAREHOLDERS’ MEETING
The 2018 Annual Meeting of
the Shareholders of Mackinac
Financial Corporation will be
held on May 30, 2018 at:
Staybridge Suites
855 W. Washington Street
Marquette, MI 49855
Visit our website, bankmbank.com,
for investor relations, updated
news releases, financial reports,
SEC filings, corporate governance
and other investor information.
mBank Headquarters | Manistique, MI
mBank Regional Office | Marquette, MI
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2017
ANNUAL
REPORT
130 South Cedar Street, Manistique, MI 49854
B R I D G I N G C L I E N T S A N D C O M M U N I T I E S
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