2018
A N N U A L
R E P O R T
130 South Cedar Street, Manistique, MI 49854
Community Focused. Client Driven.
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Corporate InformationCORPORATE HEADQUARTERSMackinac Financial Corporation 130 S. Cedar Street Manistique, MI 49854 (888) 343–8147 INVESTOR RELATIONS Jesse A. Deering EVP/CFO (248) 290–5906 jdeering@bankmbank.comINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMPlante Moran, PLLC Grand Rapids, MichiganSHAREHOLDER INFORMATIONCopies 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’ MEETINGThe 2019 Annual Meeting of the Shareholders of Mackinac Financial Corporation will be held on May 29, 2019 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.TRANSFER AGENTBroadridge 51 Mercedes Way Edgewood, NY 11717 (844) 318–0133STOCK LISTING AND SYMBOLNasdaq Capital Market Symbol: MFNCWEBSITEbankmbank.commBank Regional Office | Marquette, MImBank Headquarters | Manistique, MICorporate Information156745CVR_r1_MB_AR_2019_V20.indd 4-64/17/19 10:58 PM About the Company
Mackinac Financial Corporation is a registered
bank holding company formed under the Bank
Holding Company Act of 1956. The principal
subsidiary company is mBank. Headquartered
in Manistique, MI, mBank has a total of 29 branch
locations throughout Michigan and Northern
Wisconsin and current assets in excess of $1.3
billion. The company’s banking services include
commercial lending, asset-based lending, treasury
management products, services geared 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.
FORM 10K
A copy of the Annual Report that
was filed with the Securities and
Exchange Commission on Form
10-K is available without charge
by writing the Shareholders’
Relations Department, Mackinac
Financial Corporation, 130
South Cedar Street, Manistique,
Michigan, 49854.
MARKET SUMMARY
The Company’s common stock
is traded on the Nasdaq Capital
Market under the symbol MFNC.
About the Company
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Dear Fellow
Shareholders:
Your company had a productive year executing our growth strategy to
increase scale, enhance operating income and strengthen the balance
sheet with core funding sources and capital. We were able to complete
two successful strategic acquisitions resulting in a significant increase
in assets, bank deposits, branch footprint and earnings potential. We
also finalized a common stock offering to raise capital and position
the organization for future expansion. The combination of these
activities resulted in roughly 400 new shareholders and increased
liquidity for Mackinac shares. Additionally, with the increase in our
market capitalization, we hope our anticipated inclusion into the Russell
2000 stock index in mid-2019 will continue to help augment the liquidity
of our common stock.
We continued to increase organic loan and deposit production through
new customer generation in both our legacy and newly acquired markets.
And as always, we actively made contributions of time and financial
resources in all communities in which we have a presence. We believe
the Corporation’s culture, competitive position, foundation for growth
and ability to increase value were significantly enhanced in 2018 and
position us well as we move forward in 2019.
4
Shareholder Letter
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Expanding Our Footprint
We successfully integrated two organizations that aligned with our acquisition strategy. The acquisitions
of First Federal of Northern Michigan in Alpena, MI (“FFNM”) and Lincoln Community Bank in Merrill,
WI (“Lincoln”) added seven new branch locations, approximately $320 million in assets, $230 million in
loan balances and $300 million in core deposits to the Corporation. Our preferred strategic partners are
those that have similar business and client ecologies and overall company culture. They should also
augment our balance sheet both on a micro and macro level in terms of funding structures and loan
mix. Finally, we look for organizations that can add scale to improve overall efficiencies and increase
commerce locations in markets that complement our current footprint. Both companies we acquired
in 2018 fit those characteristics and, as we move forward, those are core traits we will continue to look for
in potential new partners in 2019.
Cultural Consistency &
Community Impact
Our company culture continues to be a key focus and remains strong even as we integrated roughly 80
new team members from the two 2018 acquisitions. Our people always have and always will be the cor-
nerstone of our strength as a community-focused organization. Even at our larger size, we take pride in
providing a positive work environment and the necessary training to develop the skills and knowledge each
employee needs to be successful in their various positions. In turn, they deliver personalized and informed
services to our clients, helping us achieve target financial performance and risk management objectives.
Our commitment to cultivating a strong company culture also translates to serving the communities in
which we operate. The Corporation strongly supports non-profit entities that meet community and civic
needs, including but not limited to: education, human services, animal welfare and health care organiza-
tions. We continuously look for opportunities to provide the financial and personnel resources needed to
help magnify their positive impact throughout all the communities in our footprint.
Shareholder Letter
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Earnings Review
As of December 31, 2018, total assets of the Corporation were $1.32 billion, compared to $985.40 million at
December 31, 2017. Shareholders’ equity at December 31, 2018 totaled $152.07 million, compared to $81.40
million at December 31, 2017. We increased our book value per common share to $14.20. The Corporation’s
capital position remains a source of strength.
As with any acquisition activity, there are non-recurring expenses that are attributed to completing the
transaction and integrating the operations. With both acquisitions, we were able to control transaction
expenses and expeditiously complete the operational integration that included data processing plat-
form conversions and branch rebranding. Even with significant non-recurring transaction-related costs
impacting earnings, the Corporation achieved net income of $8.37 million, or $.94 per share, compared
to 2017 net income of $5.48 million, or $.87 per share. Expenses related to the acquisitions had a collective
after-tax impact of $2.46 million on earnings. The 2017 results include the effects of a $2.02 million non-
cash tax expense related to the revaluation of the company’s Deferred Tax Asset (“DTA”) as a result of the
corporate tax code change in December, 2017 and a small amount of transaction expenses related to FFNM.
Adjusted core income (net of transaction-related expenses) for 2018 was $10.83 million, or $1.22 per share,
compared to 2017 adjusted core income (net of the DTA expense) of $7.54 million, or $1.20 per share.
When comparing the adjusted earnings after taxes and adjusted income before taxes results to those of
past years, we are very pleased with our year-over-year progress and expect that our 2019 results will
further demonstrate the accretive impact of the acquisitions.
Common
Shareholders’ Equity
Common Shareholders’ Equity
Book Value
$73,996
$76,602
$11.81
$12.32
$152,069
$14.20
$81,400
$12.93
$78,609
$12.55
2014
2015
2016
2017
2018
6
Shareholder Letter
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Earnings Per Share
EPS
Adjusted
$1.20
$0.87
$1.22
$0.94
$0.90
$1.05
$0.72
$0.62
$0.30
Adjusted Income
Before Taxes
$13,544
$11,068
$9,867
$7,929
$5,304
2014
2015
2016
2017
2018
2014
2015
2016
2017
2018
Stable & Expanding Margin
Our net interest margin has continued to generally outperform peers at 4.44%. While we receive some
positive impact from the accounting treatment of our properly marked-to-market acquired loan portfolios,
the ability to maintain the strong core margin of 4.21% is mainly attributed to our continued discipline of
market-appropriate loan and deposit pricing, a well-balanced loan portfolio in terms of fixed and variable
rate loans to properly absorb interest rate changes and a strong loan-to-deposit ratio.
Margin Analysis
Per Quarter on a
Year-to-Date Basis
mBank Core Margin
Accretion Margin
mBank Total Margin
mBank Core Margin
4.20%
0.12%
4.19%
0.10%
4.23%
0.13%
4.37%
0.26%
4.44%
0.23%
4.08%
4.09%
4.10%
4.11%
4.21%
YTD
12/31/17
YTD
3/31/18
YTD
6/30/18
YTD
9/30/18
YTD
12/31/18
Shareholder Letter
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Loan Activity &
Geographic Diversity
Total balance sheet loans at December 31, 2018 were $1.04 billion compared to December 31, 2017
balances of $811.08 million. Total loans under management now reside at $1.38 billion, which includes
$338.17 million of service retained loans. We believe that while acquisitions are very beneficial, they
are unpredictable in terms of availability. Our opportunistic and disciplined external approach to
acquisitions is complemented by our ability to consistently organically generate new loan production
from our platform as illustrated by the Loan Production & Growth chart on the next page.
Providing the necessary credit and capital for individuals to grow our in-market businesses and aug-
ment job creation is a key focus of our business model. We continue to use various SBA, USDA and
MEDC loan programs to provide credit enhancements when needed to help support businesses and
increase economic development in our markets. These loans are also a good source of non-interest
income through the sale of various loan guarantees that some of these agencies provide.
We were also pleased with the momentum we gained in our Northern Lower Michigan and Wisconsin
markets from the addition of the FFNM and Lincoln platforms and the lender groups that joined us as
part of those acquisitions in 2018. As illustrated on the following page, the organization has had nearly
$1.3 billion of new loan production over the past five years, with nearly half coming from our Upper
Peninsula operations which remains the main driver of our overall lending activity.
However, through the Corporation’s five transactions and expansion into other markets over the last
four plus years, we have been able to diversify our new production and geographical distribution of
where our loan assets reside, achieving a more favorable macro concentration risk profile in the event
of wide-spread economic downturn.
2018
Loan Totals
by Region
9%
$97,285
19%
$198,513
41%
$420,139
31%
$322,927
Upper Peninsula
Northern Lower
Peninsula
Southeast Michigan
Wisconsin
8
Shareholder Letter
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2018 New Loan
Production
$ in thousands (000)
Upper Peninsula
Northern Lower Peninsula
Southeast Michigan
Wisconsin
Asset-Based Lending
Total
Loan Production
& Growth
Production
Outstandings
$600,935
$618,394
$781,857
$811,078
$109,628
$97,854
$34,660
$30,198
$14,550
$286,890
$1,038,864
$183,403
$234,271
$310,093
$277,556
$286,890
2014
2015
2016
2017
2018
Loan Production by Region
Region
2014
2015
2016
2017
2018
Total
Upper Peninsula
$104,601
$133,737
$163,338
$128,865
$109,628
$640,169
Northern Lower
Peninsula
$40,133
$56,142
$58,896
$50,695
$97,854
$303,720
Southeast Michigan
$38,669
$44,392
$69,081
$68,442
$49,210
$269,794
Wisconsin
Total
–
–
$18,778
$29,554
$30,198
$78,530
$183,403
$234,271
$310,093
$277,556
$286,890
$1,292,213
Shareholder Letter
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Bank Deposit &
Funding Composition
Core deposits are the most stable and lowest cost funding source a bank can garner. We are pleased with
our continued progress in growing core deposits over the past few years, both organically and through
acquisitions, such as with FFNM. The below charts represent the improvements in our overall liability
structure year-over-year, as well as the market dispersion of our bank deposits.
2017
Funding Sources
2018
Funding Sources
Bank Deposits
Brokered CDs
FHLB
7%
$60,000
20%
$175,299
73%
$642,699
Bank Deposits
Brokered CDs
FHLB
5%
$57,060
12%
$136,760
83%
$960,777
Core Deposits
by Region
37%
$353,964
35%
$326,649
23%
$221,005
5%
$45,422
Nothern Lower
Peninsula
Upper Peninsula
Wisconsin
Southeast
Michigan
10
Shareholder Letter
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Credit Quality
Non-performing loans totaled $5.08 million, or .49% of total loans at December 31, 2018 compared to $2.57
million, or .32% of total loans at December 31, 2017. The increase in non-performing loans is mainly the
result of credits acquired in the FFNM transaction, which were properly marked to fair value as part of the
credit due diligence process. These metrics are expected to normalize in 2019 consistent with past transac-
tions. Our overall credit quality metrics remain strong with no systemic issues within our legacy loan book.
We believe that our continued focus on vigilant credit administration and risk management will continue to
serve us well within this elongated credit expansion cycle.
Credit Quality
Nonperforming Loans
Nonperforming
Loans to Total Loans
$6,000
$5,000
$4,000
$3,000
$2,000
$1,000
$0
0.70%
0.60%
0.50%
0.40%
0.30%
0.20%
0.10%
0.00%
2014
2015
2016
2017
2018
Shareholder Letter
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Future Outlook
As we move forward, we believe 2019 will present continued challenges in terms of the growing
incidence of cyber security threats and the required personnel and technical infrastructure needed to
manage and mitigate these risks. Ensuring the continued safe and secure client data and operating plat-
forms for both our in-house data systems as well as customer facing applications, including online and
mobile banking, remains a top priority. We strive daily to limit exposure of reputational damage to our
brand or material financial loss to the Corporation.
Interest rate unpredictability remains and the yield curve continues to flatten tightening spreads on
funding sources in relation to risk based loan yields and fixed rate terms. Focus on new core deposit
procurement remains a key initiative as we look to continue to lessen our utilization of more volatile
wholesale funding, through aggressive marketing and business development initiatives within our retail
branch and treasury management business lines.
Enhanced regulatory oversight and internal monitoring needs in the areas of BSA, mortgage servicing
and enterprise compliance management will only expand in accordance with our increasing scale.
Managing these areas to achieve optimal efficiencies for prudent risk control and a consistent client
experience is a focus this year.
In closing, our entire team at Mackinac Financial Corporation will continue to
be guided by our resolve to further your shareholder interests. We believe that
patient and deliberate market decisions will allow for increased scale through
both organic business growth, and the right strategic acquisitions. In turn, we
expect to continue to yield economics that will drive higher earnings per share,
returns on equity and long-term value. We will remain mindful and proactive in
monitoring all risk and expense areas that may impact the business. Thank you
for your continued support as shareholders and commitment to our plans.
Sincerely,
PAUL D. TOBIAS
Chairman & CEO, Mackinac Financial Corporation
Chairman, mBank
KELLY W. GEORGE
President, Mackinac Financial Corporation
President & CEO, mBank
12
Shareholder Letter
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Financial Highlights
(Dollars in thousands, except per share data)
Selected Financial Condition Data (at end of period):
Assets
Loans
Investment securities
Deposits
Borrowings
Shareholders’ equity
Selected Statements of Income Data:
Net interest income
Income before taxes
Net income
Income per common share - Basic
Income per common share - Diluted
Weighted average shares outstanding
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
Shareholder Letter
As of and for the Year Ending
December 31, 2018 (Unaudited)
As of and for the Year Ending
December 31, 2017 (Unaudited)
$1,318,040
$1,038,864
$116,748
$1,097,537
$ 60,441
$152,069
$47,130
$10,593
$8,367
$0.94
$0.94
8,891,967
8,921,658
4.44%
77.70%
0.71%
6.94%
$1,177,455
$120,478
97.75%
$13.65
$14.20
$11.61
$0.48
10,712,745
$5,183
$8,196
0.50%
0.62%
6.33%
29
288
$985,367
$811,078
$75,897
$817,998
$79,552
$81,400
$ 37,938
$11,018
$5,479
$0.87
$0 .87
6,288,791
6,322,413
4.20%
71.39%
0.55%
6.74%
$995,826
$81,349
96.29%
$15.90
$12.93
$11.72
$0.48
6,294,930
$5,079
$6,126
0.63%
0.62%
7.77%
23
233
13
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Expanding Our Presence
Strengthening Our Communities
Headquartered in Manistique, Michigan, mBank is made up of 29 branches
located throughout the Upper Peninsula, Northern Lower Peninsula and
Southeast regions, as well as locations in Northern Wisconsin.
We’re proud of who we are, where we are and
the business we’re doing. This year, we’ve expand-
ed the reach of our operating system to provide
innovative financial products and services to new
communities. Our lending opportunities, industries
and customers increased significantly through
the acquisition of First Federal of Northern Mich-
igan, adding six branch
locations throughout
Northern Lower Michigan in May and Lincoln Com-
munity Bank expanding our presence further into
Northeastern Wisconsin in October. This added
seven branch locations to our company, enabling
the continued prosperity of our shareholders and
the advancement of our communities.
Through expanding our presence in Michigan
and Wisconsin, we were not only able to provide
exceptional financial products and services to
more businesses and more individuals, but also
serve as a financial resource to more communi-
ties in a philanthropic capacity than ever before.
Through supporting businesses and individu-
als with their banking needs and giving back
to non-profits and civic organizations, mBank
strives to help drive economic development in the
communities we serve.
Community Focused. Client Driven. It’s about
supporting where we work and live. It’s about
empowering our clients to make sound finan-
cial decisions, for the good of their business
and their family. It’s about our commitment to
strengthening our communities.
14
Expanding Our Presence
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Commitment to Community
At mBank it is one of our core philosophies to reinvest in the communities we
serve. We do this through sponsorships, donations, and our dedicated staff who
volunteer hundreds of hours each year. $10,000 was donated to underwrite
three Feeding America Mobile Food Pantry distributions. In November, a $20,000
donation was made to the Beacon House in Marquette, MI, a home away from
home for families receiving critical care at UP Health System. Our culture of
giving back continues through our Community Foundation and many other
charitable efforts made throughout the year. In 2018 mBank reinvested a total of
$340,000 back into our communities.
Commitment to Community
156745BDY_r1_MB_AR_2019_V20.indd 15
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MARQUETTE
NEGAUNEE
ISHPEMING
EAGLE RIVER
FLORENCE
ST. GERMAIN
THREE LAKES
AURORA
ESCANABA
NIAGARA
STEPHENSON
MERRILL
MANISTIQUE
TRAVERSE
CITY
KALEVA
Our
Markets
29 branch locations to
conveniently serve you
156745BDY_r5_MB_AR_2019_V20.indd 16
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SAULT STE. MARIE
NEWBERRY
CHEBOYGAN
ALANSON
GAYLORD
ALPENA
LEWISTON
MIO
BIRMINGHAM
156745BDY_r5_MB_AR_2019_V20.indd 17
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LEFT BLANK INTENTIONALLY
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(cid:95)(cid:95) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FORM 10-K
For the fiscal year ended December 31, 2018
OR
(cid:134) 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:134) No (cid:95)
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:134) No (cid:95)
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:95)
No (cid:134)
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files.) (cid:95)
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:95) No (cid:134)
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:134)
Accelerated filer (cid:95)
Non-accelerated filer (cid:134)
Smaller reporting company (cid:95)
Emerging growth company (cid:134)
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:134)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes (cid:134) No (cid:95)
The aggregate market value of the common stock held by non-affiliates of the Registrant, based on a per share price of $16.58 as of June 30, 2018, was $139.633 million. As
of March 17, 2019, there were outstanding, 10,731,905 shares of the Corporation’s Common Stock (no par value).
Documents Incorporated by Reference:
Portions of the Corporation’s Proxy Statement for the 2019 Annual Meeting of Shareholders are incorporated by reference into Part III of this Report.
TABLE OF CONTENTS
PART I
Item 1. Business
Item 1A. Risk Factors
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
14
20
20
21
21
22
22
24
25
40
44
85
85
85
86
86
86
86
87
87
87
87
1
Item 1.
Business
PART I
Mackinac Financial Corporation (the “Corporation”, or “Mackinac”) is a bank holding company registered under the
Bank Holding Company Act of 1956, as amended, (the “BHCA”) that 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.
On May 18, 2018, the Corporation completed its acquisition of First Federal of Northern Michigan Bancorp, Inc.
(“FFNM”). FFNM had seven branch offices, one of which was consolidated into an existing mBank branch office
shortly after consummation of the transaction. FFNM had approximately $318 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 the issuance of 2,146,378 new shares, approximating $34.1 million.
On October 1, 2018, the Corporation completed its acquisition of Lincoln Community Bank (“Lincoln”). Lincoln had
two branch offices, one of which was subsequently closed at the end of 2018. Lincoln had approximately $60 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 $8.5 million.
The Corporation owns all of the outstanding stock of its banking subsidiary, mBank (the “Bank”). The Bank currently
has 11 branch offices located in the Upper Peninsula of Michigan, 10 branch offices located in Michigan’s Lower
Peninsula, one branch in Southeast Michigan, and 7 branches in Wisconsin. The Bank maintains offices in the Michigan
counties of: Alpena, Cheboygan, Chippewa, Emmet,Grand Traverse, Luce, Manistee, Marquette, Menominee,
Montmorency, Oakland, Oscoda, Otsego, and Schoolcraft. The Bank maintains offices in the Wisconsin counties of:
Florence, Lincoln, Marinette, Oneida and Vilas. The Bank provides drive-in convenience at 29 branch locations and has
31 automated teller machines. The Bank has no foreign offices.
2
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
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, 2018, the Corporation and its subsidiaries employed, in the aggregate, 294 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 $150.251 million, or 20.95%, of the commercial loan portfolio at December 31, 2018. 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.
3
On January 16, 2018, the Corporation executed a merger agreement with First Federal of Northern Michigan Bancorp,
Inc. in Alpena, Michigan (“FFNM”). On May 18, 2018, upon the consummation of the merger, with and into into the
Corporation, the Coporation consolidated First Federal of Northern Michigan with the bank. FFNM had seven branches,
one of which was consolidated into an existing mBank branch shortly after consummation of the transaction.
On June 7, 2018 the Corporation announced the execution of a definitive agreement to acquire Lincoln Community
Bank (“Lincoln”) located in Merrill, Wisconsin. On October 1, 2018, upon consummation of the definitive agreement,
the Corporation consolidated Lincoln into the Bank. Lincoln operated two branches, one in each of Merrill and Gleason;
As part of the acquisition the Gleason branch was subsequently closed at the end of 2018.
After the acquisition activity in 2018, the Bank’s presence increased to 29 branches.
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, 2018, with additional amounts available if
collateralized.
As of December 31, 2018, 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 7A 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 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
4
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, and pending changes
are discussed under Regulatory Capital Requirements 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
“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.
5
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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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
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.
6
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The Consumer Financial Protection Bureau (“CFPB”).
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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.
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.
The Economic Growth, Regulator Relief and Consumer Protection Act of 2018
On May 24, 2018, the Economic Growth, Regulatory and Consumer Protection Act of 2018
(the “EGRRCPA) was enacted, which repeals or modifies certain provisions of the Dodd-Frank Act
and eases regulations on all but the largest banks. The EGRRCPA’s highlights include, among other
things: (i) creating a new category of “qualified mortgages” presumed to satisfy ability-to-repay
requirements for loans that meet certain criteria and are held in portfolio by banks with less than $10
billion in assets from the ability-to-repay requirements for certain qualified residential mortgage loans
held in portfolio; (ii) not require appraisals for certain transactions valued at less than $400,000 in rural
areas; (iii) exempt banks that originate fewert than 500 open-end and 500 closed-end mortgages from
7
the Home Mortgage Disclosure Act’s expanded data disclosures; (iv) clarify that, subject to various
conditions, reciprocal deposits of another depository institution obtained using a deposit placement
network for purposes of obtaining maximum deposit insurane would not be considered brokered
deposits subject to the FDIC’s brokered-deposit regulations; and (v) simplify capital calculations by
requiring regulators to establish for institutions under $10 billion in assets a community bank leverage
ratio (tangible equity to average consolidated assets) at a percentage not less than 8% and not greater
than 10% that such institutions may elect to replace the general applicable risk-based capital
requirements for determining well-capitalized status.
Regulatory Capital Framework
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
equal or higher quality), and discretionary bonus payments. The capital conservation buffer has phased in, in full
beginning January 1, 2019.
Leverage
CET1
Tier 1
Total Capital
Adequately
Well-Capitalized
Capitalized Well-Capitalized with Buffer, fully
Requirement
4.0%
4.5%
6.0%
8.0%
phased in 2019
5.0%
7.0%
8.5%
10.5%
Requirement
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
8
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.
Notwithstanding the foregoing, the EGRRCPA is expected to simplify capital calculations by requiring regulators to
establish for institutions under $10 billion in assets a community bank leverage ratio (tangible equity to average
consolidated assets) at a percentage not less than 8% and not greater than 10% that such instituions may elect to replace
the general applicable risk-based capital requirements under the Basel III capital rules. Such institutions that meet the
community bank leverage ratio will automatically be deemed to be well-capitalized, although the regulators retain the
flexibility to determine that the institution may not qualify for the community bank leverage ratio test based on the
institution’s risk profile. Until the community bank leverage ratio is established by the regulators in accordance with
EGRRCPA, the Basel III risk-based and leverage ratios remain in effect. The effective date and the specific community
bank leverage ratio is currently unknown.
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.
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.
9
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):
Corporate
US Agencies
US Agencies - MBS
State and political subdivisions
Total
2018
20,064
15,970
32,840
47,874
$ 116,748
2017
24,891
16,846
12,716
21,444
$ 75,897
2016
20,410
23,952
16,833
25,078
$ 86,273
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, 2018 (fully taxable equivalent, dollars in thousands):
US Agencies
US Agencies - MBS
Corporate
State and political
subdivisions
In one
year
or less
754
81
5,861
After one, After five,
but within
but within
ten years
five years
—
15,216
3,655
29,104
3,518
10,185
Over
ten years
—
—
500
Weighted
Average
Yield (1)
1.93%
3.00%
2.92%
Total
15,970
32,840
20,064
6,969
28,981
9,566
2,358
47,874
3.47%
Total
$ 13,665
$ 83,486
$ 16,739
$ 2,858
$ 116,748
Weighted average yield (1)
2.50%
2.79%
3.77% 3.47%
2.91%
(1) Weighted average yield includes the effect of tax-equivalent adjustments using a 21% tax rate.
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
2018
$ 496,207
191,060
286,908
44,318
20,371
2017
$ 406,742
156,951
209,890
20,061
17,434
2016
$ 389,420
142,648
205,945
23,731
20,113
2015
$ 312,805
122,140
140,502
27,100
15,847
2014
$ 315,387
101,895
139,553
25,715
18,385
Total
$ 1,038,864
$ 811,078
$ 781,857
$ 618,394
$ 600,935
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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,
2018, 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
$ 57,306
31,733
$ 52,436
16,713
$
1,540
9,039
$
21
1,062
$
1,986
12,589
$ 113,289
71,136
59,765
280,322
34,110
72,129
6,734
23,908
2,272
13,779
3,800
11,229
106,681
401,367
43,621
23,460
5,344
10,328
188,106
57,581
1,360
1,877
8,264
6,450
246,695
99,696
Total
$ 496,207
$ 191,060
$ 286,908
$ 20,371
$ 44,318
$ 1,038,864
C.
Risk Elements
The following table presents a summary of nonperforming assets and problem loans as of December 31 (dollars in
thousands):
2018
2017
2016
2015
2014
Nonaccrual loans
$ 5,054
$ 2,388
$ 3,959
$ 2,353
$ 3,939
Interest income recorded during period for nonaccrual loans
Accruing loans past due 90 days or more
Restructured loans on nonaccrual not included above
IV.
Summary of Loan Loss Experience
A.
Analysis of the Allowance for Loan Losses
—
23
—
—
—
437
—
795
32
—
—
180
165
154
3,105
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.
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The following table presents information relative to the allowance for loan losses for the years ended December 31,
(dollars in thousands):
2018
2017
2016
2015
2014
Balance of allowance for loan losses at
beginning of period
$
5,079
$
5,020
$
5,004
$
5,140
$
4,661
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
330
230
156
716
221
64
35
320
396
500
419
155
229
803
121
65
51
237
566
625
477
133
113
723
102
5
32
139
584
600
1,801
142
87
2,030
662
2
26
690
1,340
1,204
682
290
74
1,046
259
22
44
325
721
1,200
Balance at end of period
$
5,183
$
5,079
$
5,020
$
5,004
$
5,140
Average loans outstanding
941,221
795,532
703,047
602,904
509,749
Ratio of net charge-offs to average loans
.04%
.07%
.08%
.22%
.14%
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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):
2018
2017
2016
2015
2014
Amount
%
Amount
%
Amount
%
Amount
%
Amount
%
Commercial real estate
$ 1,682
47.76% $ 1,650
50.15% $ 1,345
49.81% $ 1,611
50.58% $ 2,813
52.48%
Commercial, financial, and
agricultural
Commercial construction
648
101
18.39
576
19.35
614
18.25
645
19.75
1,539
16.96
2.87
54
1.14
57
1.47
79
2.48
142
2.71
1-4 family residential real estate
199
27.62
160
25.88
296
26.34
274
22.72
285
23.22
Consumer construction
Consumer
6
8
1.40
1.96
6
10
1.33
2.15
6
90
1.56
2.57
7
64
1.91
2.56
6
13
1.57
3.06
Unallocated general reserves
2,539
— 2,623
— 2,612
— 2,324
—
342
—
Total
$ 5,183 100.00% $ 5,079 100.00% $ 5,020 100.00% $ 5,004 100.00% $ 5,140 100.00%
The unallocated balance of the allowance for loan losses represents general reserves not attributed directly to one
segment or class of loans, rather, represents additional reserves management believes is warranted based on local and
broader economic trends. These reserves are subjective in nature and based on qualitative factors impacting the overall
loan portfolio.
V.
Deposits
CDs <$100,000
CDs >$100,000
Three months
or less
Three to Six to twelve Over twelve
six months
months
months
Total
23,623
9,368
15,369
6,959
36,571
22,172
83,370
41,541
158,933
80,040
Total time deposits
$
32,991
$ 22,328 $ 58,743
$ 124,911
$ 238,973
Additional 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.
Available Information
Our Internet address is www.bankmbank.com. We will make available free of charge in the investor relations section of
our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and
13
amendments to those reports as soon as reasonably practicable after such materials are electronically filed with (or
furnished to) the SEC. Information contained on our website is not incorporated by reference into this Annual Report on
Form 10-K. In addition, the SEC maintains an Internet site, www.sec.gov, that includes filings of and information about
issuers that file electronically with the SEC.
Item 1A. Risk Factors
Our business, prospects, financial condition, or operating results could be materially adversely affected by any of the
risks and uncertainties set forth below, as well as in any amendments or updates reflected in subsequent filings with the
SEC. In assessing these risks, you should also refer to the other information contained in this Annual Report on Form
10-K, including our consolidated financial statements and related notes.
RISK FACTORS
Investing in our securities involves risk. You should carefully consider the specific risks set forth in “Risk Factors” in
this Annual Report on Form 10-K. These risks are not the only risks we face. Additional risks not presently known to
us, or that we currently view as immaterial, may also impair our business, if any of the risks described herein or any
additional risks actually occur, our business, financial condition, results of operations and cash flows could be materially
and adversely affected.
Mackinac’s net interest income could be negatively affected by interest rate adjustments by the Federal Reserve, as
well as by competition in its primary market area.
As a financial institution, Mackinac’s earnings are significantly dependent upon its net interest income, which is the
difference between the interest income that is earned on interest-earning assets, such as investment securities and loans,
and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any
change in general market interest rates, including changes resulting from changes in the Federal Reserve’s fiscal and
monetary policies, affects it more than non-financial institutions and can have a significant effect on net interest income
and total income. Mackinac’s assets and liabilities may react differently to changes in overall market rates or conditions
because there may be mismatches between the repricing or maturity characteristics of the assets and liabilities. As a
result, an increase or decrease in market interest rates could have material adverse effects on net interest margin and
results of operations.
If the allowance for loan losses is not sufficient to cover actual loan losses, Mackinac’s earnings could decrease.
Mackinac’s success depends to a significant extent upon the quality of its assets, particularly loans. In originating loans,
there is a substantial likelihood that credit losses will be experienced. The risk of loss will vary with, among other things,
general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan
and, in the case of a collateralized loan, the quality of the collateral for the loan.
Mackinac’s loan customers may not repay their loans according to the terms of these loans, and the collateral securing
the payment of these loans may be insufficient to assure repayment. As a result, Mackinac may experience significant
loan losses, which could have a material adverse effect on operating results. Management makes various assumptions
and judgments about the collectability of the loan portfolio, including the creditworthiness of borrowers and the value of
the real estate and other assets serving as collateral for the repayment of many of Mackinac’s loans. An allowance for
loan losses is maintained in an attempt to cover any loan losses that may occur. In determining the size of the allowance,
management relies on an analysis of the loan portfolio based on historical loss experience, volume and types of loans,
trends in classification, volume and trends in delinquencies and non-accruals, national and local economic conditions
and other pertinent information. The determination of the size of the allowance could be understated due to deviations in
one or more of these factors.
If assumptions are wrong, the current allowance may not be sufficient to cover future loan losses, and adjustments may
be necessary to allow for different economic conditions or adverse developments in Mackinac’s loan portfolio. Material
additions to the allowance would materially decrease net income.
In addition, federal and state regulators periodically review the allowance for loan losses and may require Mackinac to
increase its provision for loan losses or recognize further loan charge-offs, based on judgments different than those of
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management. Any increase in the allowance for loan losses or loan charge-offs as required by these regulatory agencies
could have a negative effect on Mackinac’s operating results.
Mackinac may need to raise additional capital in the future, but that capital may not be available when it is needed.
Mackinac is required by federal and state regulatory authorities to maintain adequate levels of capital to support its
operations. Management may at some point in the future need to raise additional capital to support its business as a result
of losses. Its ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time,
which are outside the control of management, and on Mackinac’s financial performance. Accordingly, Mackinac cannot
assure you of its ability to raise additional capital if needed on terms acceptable to management. If additional capital
cannot be raised when needed, Mackinac’s ability to further expand its operations through internal growth and to operate
its business could be materially impaired.
If Mackinac is unable to increase its share of deposits in the markets that its bank operates within, it may accept out-
of-market and brokered deposits, the costs of which may be higher than expected.
Mackinac’s management can offer no assurance that it will be able to maintain or increase Mackinac’s market share of
deposits in its highly competitive service areas. If unable to do so, it may be forced to accept increased amounts of out-
of-market or brokered deposits. As of December 31, 2018, Mackinac had approximately $136.760 million in out of
market brokered deposits, which represented approximately 12.46% of total deposits. At times, the cost of out-of-market
and brokered deposits exceeds the cost of deposits in the local market. In addition, the cost of out-of-market and
brokered deposits can be volatile, and if Mackinac is unable to access these markets, or if its costs related to out of
market and brokered deposits increase, its liquidity and ability to support demand for loans could be adversely affected.
Volatility and disruptions in global capital and credit markets may adversely impact Mackinac’s business, financial
condition and results of operations.
Even though Mackinac operates in a distinct geographic region in the U.S., it is impacted by global capital and credit
markets, which are sometimes subject to periods of extreme volatility and disruption. Disruptions, uncertainty or
volatility in the capital and credit markets may limit Mackinac’s ability to access capital and manage liquidity, which
may adversely affect Mackinac’s business, financial condition and results of operations. Further, Mackinac’s customers
may be adversely impacted by such conditions, which could have a negative impact on Mackinac’s business, financial
condition and results of operations.
Mackinac is subject to extensive regulation that could limit or restrict its activities.
Mackinac operates in a highly regulated industry and is subject to examination, supervision and comprehensive
regulation by various federal and state agencies. Compliance with these regulations is costly and restricts certain
activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged,
interest rates paid on deposits and locations of offices. Mackinac is also subject to capitalization guidelines established
by its regulators, which require it to maintain adequate capital to support its growth.
Mackinac’s business also is subject to laws, rules and regulations regarding the disclosure of non-public information
about its customers to non-affiliated third parties. Internet operations are not currently subject to direct regulation by any
government agency in the United States beyond regulations applicable to businesses generally. A number of legislative
and regulatory proposals currently under consideration by federal, state and local governmental organizations may lead
to laws or regulations concerning various aspects of Mackinac’s business on the Internet, including: user privacy,
taxation, content, access charges, liability for third-party activities and jurisdiction. The adoption of new laws or a
change in the application of existing laws may decrease the use of the Internet, increase costs or otherwise adversely
affect Mackinac’s business.
In particular, Congress and other regulators have increased their focus on the regulation of the financial services industry
in recent years. While recent changes in the executive branch may mitigate this impact, the effects on Mackinac of recent
legislation and regulatory actions cannot reliably be fully determined at this time. Moreover, as some of the legislation
and regulatory actions previously implemented in response to the recent financial crisis expire, the impact of the
conclusion of these programs on the financial sector and on the economic recovery is unknown. Any delay in the
economic recovery or a worsening of current financial market conditions could adversely affect Mackinac. Mackinac
15
can neither predict when or whether future regulatory or legislative reforms will be enacted nor what their contents will
be. The impact of any future legislation or regulatory actions on Mackinac’s businesses or operations cannot be
determined at this time, and such impact may adversely affect Mackinac.
The laws and regulations applicable to the banking industry could change at any time, and management cannot predict
the effects of these changes on Mackinac’s business and profitability. Additionally, Mackinac cannot predict the effect
of any legislation that may be passed at the state or federal level in response to the recent deterioration of the subprime,
mortgage, credit and liquidity markets. Because government regulation greatly affects the business and financial results
of all commercial banks and bank holding companies, the cost of compliance could adversely affect Mackinac’s ability
to operate profitably.
Mackinac’s financial condition and results of operations are reported in accordance with accounting principles generally
accepted in the United States (“GAAP”). While not impacting economic results, future changes in accounting principles
issued by the Financial Accounting Standards Board could impact Mackinac’s earnings as reported under GAAP. As a
public company, Mackinac is also subject to the corporate governance standards set forth in the Sarbanes-Oxley Act of
2002, as well as applicable rules and regulations promulgated by the SEC. Complying with these standards, rules and
regulations has and continues to impose administrative costs and burdens on the company.
Additionally, political conditions could impact Mackinac’s earnings. Acts or threats of war or terrorism, as well as
actions taken by the United States or other governments in response to such acts or threats, could impact the business
and economic conditions in which it operates.
Mackinac may make or be required to make further increases in its provision for loan losses and to charge off
additional loans in the future, which could adversely affect the results of operations.
As a result of changes in balances and composition of Mackinac’s loan portfolio, changes in economic and market
conditions that occur from time to time and other factors specific to a borrower’s circumstances, the level of non-
performing assets will fluctuate. Increased non-performing assets, credit losses or the provision for loan losses would
materially adversely affect Mackinac’s financial condition and results of operations.
Mackinac’s adjustable-rate loans may expose it to increased default risks.
While adjustable-rate loans better offset the adverse effects of an increase in interest rates as compared to fixed-rate
loans, the increased payments required of adjustable-rate loan borrowers upon an interest rate adjustment in a rising
interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying
property may also be adversely affected in a rising interest rate environment. In addition, although adjustable-rate loans
help make Mackinac’s asset base more responsive to changes in interest rates, the extent of this interest sensitivity is
limited by the annual and lifetime interest rate adjustment limits.
Changing interest rates may decrease Mackinac’s earnings and asset values.
Management is unable to accurately predict future market interest rates, which are affected by many factors, including,
but not limited to, inflation, recession, changes in employment levels, changes in the money supply and domestic and
international disorder and instability in domestic and foreign financial markets. Changes in the interest rate environment
may reduce Mackinac’s profits. Net interest income is a significant component of its net income and consists of the
difference, or spread, between interest income generated on interest-earning assets and interest expense incurred on
interest-bearing liabilities. Net interest spreads are affected by the difference between the maturities and repricing
characteristics of interest-earning assets and interest-bearing liabilities. Although certain interest-earning assets and
interest-bearing liabilities may have similar maturities or periods in which they reprice, they may react in different
degrees to changes in market interest rates. In addition, residential mortgage loan origination volumes are affected by
market interest rates on loans; rising interest rates generally are associated with a lower volume of loan originations,
while falling interest rates are usually associated with higher loan originations. Mackinac’s ability to generate gains on
sales of mortgage loans is significantly dependent on the level of originations. Cash flows are affected by changes in
market interest rates. Generally, in rising interest rate environments, loan prepayment rates are likely to decline, and in
falling interest rate environments, loan prepayment rates are likely to increase. A majority of Mackinac’s commercial,
commercial real estate and multi-family residential real estate loans are adjustable rate loans and an increase in the
general level of interest rates may adversely affect the ability of some borrowers to pay the interest on and principal of
16
their obligations, especially borrowers with loans that have adjustable rates of interest. Changes in interest rates,
prepayment speeds and other factors may also cause the value of loans held for sale to change. Accordingly, changes in
levels of market interest rates could materially and adversely affect Mackinac’s net interest spread, loan volume, asset
quality, value of loans held for sale and cash flows, as well as the market value of its securities portfolio and overall
profitability.
Mackinac faces strong competition from other financial institutions, financial services companies and other
organizations offering services similar to those offered by it, which could result in Mackinac not being able to sustain
or grow its loan and deposit businesses.
Mackinac conducts its business operations primarily in the State of Michigan, and more recently, Northeastern
Wisconsin. Increased competition within these markets may result in reduced loan originations and deposits. Ultimately,
Mackinac may not be able to compete successfully against current and future competitors. Many competitors offer the
types of loans and banking services that it offers. These competitors include other savings associations, community
banks, regional banks and money center banks. Mackinac also faces competition from many other types of financial
institutions, including finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and
other financial intermediaries. Mackinac’s competitors with greater resources may have a marketplace advantage
enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns.
Additionally, financial intermediaries not subject to bank regulatory restrictions and banks and other financial
institutions with larger capitalization have larger lending limits and are thereby able to serve the credit needs of larger
clients. These institutions, particularly to the extent they are more diversified than Mackinac is, may be able to offer the
same loan products and services that Mackinac offers at more competitive rates and prices. If Mackinac is unable to
attract and retain banking clients, it may be unable to sustain current loan and deposit levels or increase its loan and
deposit levels, and its business, financial condition and future prospects may be negatively affected.
Our business could be adversely affected due to risks related to our recent acquisitions and the subsequent integration
of the acquired businesses.
In recent years, we have closed several acquisitions of varying significance, and expect to consider future acquisitions
from time to time. We cannot be certain that we will be able to identify, consummate and successfully integrate
acquisitions, and no assurance can be given with respect to the timing, likelihood or business effect of any possible
transaction. Transactions that we consummate would involve risks and uncertainties to us, including mispricing the
inherent value of the acquired entity, as well as potential difficulties integrating people, systems and customers and
realizing synergies.
The risks associated with our recent acquisitions any future acquisitions include, but are not limited to:
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(cid:120)
(cid:120)
(cid:120)
We may experience inconsistencies in standards, controls, procedures and policies that adversely affect
our ability to maintain relationships with clients, customers, depositors and employees;
We could be subject to liabilities that could be material or become subject to litigation or regulatory
risks as a result of the acquisition;
Management’s attention may be diverted from other business initiatives; and
Unanticipated restructuring and other integration costs may be incurred.
Any future acquisitions could involve these and additional risks. Our ability to pursue additional strategic transactions
may also be limited by any significant decrease our stock price, which would adversely affect the attractiveness of our
currency to potential targets, or by our ability to raise additional equity or debt capital to fund future acquisitions. Any of
these risks, whether with respect to the current or any future acquisitions, could have a material adverse effect on our
business and results of operations.
17
Mackinac may be required to transition from the use of the LIBOR interest rate index in the future.
A portion of the loans in Mackinac’s portfolio are indexed to LIBOR to calculate the loan interest rate. The continued
availability of the LIBOR index is not guaranteed after 2021. It is impossible to predict whether and to what extent banks
will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR
may be enacted. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR.
The implementation of a substitute index or indices for the calculation of interest rates under our loan agreements with
our borrowers may incur significant expenses in effecting the transition, may result in reduced loan balances if
borrowers do not accept the substitute index or indices, and may result in disputes or litigation with customers over the
appropriateness or comparability to LIBOR of the substitute index or indices, each of which could have an adverse effect
on Mackinac’s results of operations.
Mackinac’s ability to use net operating loss carryovers to reduce future tax payments may be limited or restricted.
As of December 31, 2018, Mackinac had net operating loss (“NOL”) carryforwards of approximately $12.5 million.
Mackinac is generally able to carry NOLs forward to reduce taxable income in future years. However, its ability to
utilize its NOL carryforwards is subject to the rules of Section 382 of the Code. Section 382 of the Code generally
restricts the use of NOL carryforwards after an “ownership change.” An ownership change occurs if, among other
things, the shareholders (or specified groups of shareholders) who own or have owned, directly or indirectly, 5% or more
of a corporation’s common shares, or are otherwise treated as 5% shareholders under Section 382 of the Code and the
Treasury regulations promulgated thereunder, increase their aggregate percentage ownership of that corporation’s shares
by more than fifty (50) percentage points over the lowest percentage of the shares owned by these shareholders over a
three (3)-year rolling period. In the event of an ownership change, Section 382 of the Code imposes an annual limitation
on the amount of taxable income a corporation may offset with its pre-ownership change NOL carry forwards. This
annual limitation is generally equal to the value of the corporation’s shares immediately before the ownership change
multiplied by the long-term tax-exempt rate in effect for the month in which the ownership change occurs. Any unused
annual limitation may be carried over to later years until the applicable expiration date for the respective NOL
carryforwards.
As of December 31, 2018, Mackinac had tax credit carryforwards of approximately $1.7 million. Mackinac is generally
able to carry tax credits forward to reduce taxes in future years. However, Mackinac’s ability to utilize the tax credit
carryforwards is subject to the rules of Section 383 of the Code. Section 383 of the Code imposes a comparable and
related set of rules for limiting the use of capital loss and tax credit carry-forwards in the event of an ownership change.
Management cannot ensure that Mackinac’s ability to use its NOL carryforwards to offset taxable income or its tax
credit carryforwards to offset tax will not become limited in the future. As a result, Mackinac could pay taxes earlier and
in larger amounts than would be the case if its NOL and tax credit carryforwards were available to reduce its federal
income taxes without restriction.
Mackinac may not be able to utilize technology to efficiently and effectively develop, market, and deliver new products
and services to its customers.
The financial services industry experiences rapid technological change with regular introductions of new technology-
driven products and services. The efficient and effective utilization of technology enables financial institutions to better
serve customers and to reduce costs. Mackinac’s future success depends, in part, upon its ability to address the needs of
its customers by using technology to market and deliver products and services that will satisfy customer demands, meet
regulatory requirements, and create additional efficiencies in its operations. Mackinac may not be able to effectively
develop new technology-driven products and services or be successful in marketing or supporting these products and
services to its customers, which could have a material adverse impact on its financial condition and results of operations.
Operational difficulties, failure of technology infrastructure or information security incidents could adversely affect
Mackinac’s business and operations.
Mackinac is exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of
fraud or theft by employees or outsiders, failure of its controls and procedures and unauthorized transactions by
employees or operational errors, including clerical or recordkeeping errors or those resulting from computer or
telecommunications systems malfunctions. Given the high volume of transactions Mackinac processes, certain errors
18
may be repeated or compounded before they are identified and resolved. In particular, Mackinac’s operations rely on the
secure processing, storage and transmission of confidential and other information on its technology systems and
networks. Any failure, interruption or breach in security of these systems could result in failures or disruptions in its
customer relationship management, general ledger, deposit, loan and other systems.
Mackinac also faces the risk of operational disruption, failure or capacity constraints due to its dependency on third party
vendors for components of its business infrastructure, including its core data processing systems which are largely
outsourced. While Mackinac has selected these third party vendors carefully, it does not control their operations. As
such, any failure on the part of these business partners to perform their various responsibilities could also adversely
affect Mackinac’s business and operations.
Mackinac may also be subject to disruptions of its operating systems arising from events that are wholly or partially
beyond its control, which may include, for example, computer viruses, cyberattacks, spikes in transaction volume and/or
customer activity, electrical or telecommunications outages, or natural disasters. Although Mackinac has programs in
place related to business continuity, disaster recovery and information security to maintain the confidentiality, integrity,
and availability of its systems, business applications and customer information, such disruptions may give rise to
interruptions in service to customers and loss or liability to Mackinac.
The occurrence of any failure or interruption in Mackinac’s operations or information systems, or any security breach,
could cause reputational damage, jeopardize the confidentiality of customer information, result in a loss of customer
business, subject Mackinac to regulatory intervention or expose it to civil litigation and financial loss or liability, any of
which could have a material adverse effect on Mackinac.
Changes in customer behavior may adversely impact Mackinac’s business, financial condition and results of
operations.
Mackinac uses a variety of methods to anticipate customer behavior as a part of its strategic planning and to meet certain
regulatory requirements. Individual, economic, political, industry-specific conditions and other factors outside of its
control, such as fuel prices, energy costs, real estate values or other factors that affect customer income levels, could
alter predicted customer borrowing, repayment, investment and deposit practices. Such a change in these practices could
materially adversely affect Mackinac’s ability to anticipate business needs and meet regulatory requirements.
Further, difficult economic conditions may negatively affect consumer confidence levels. A decrease in consumer
confidence levels would likely aggravate the adverse effects of these difficult market conditions on Mackinac, its
customers and others in the financial institutions industry.
Mackinac’s ability to maintain and expand customer relationships may differ from expectations.
The financial services industry is very competitive. Mackinac not only vies for business opportunities with new
customers, but also competes to maintain and expand the relationships it has with its existing customers. While
Mackinac believes that it can continue to grow many of these relationships, Mackinac will continue to experience
pressures to maintain these relationships as its competitors attempt to capture its customers. Failure to create new
customer relationships and to maintain and expand existing customer relationships to the extent anticipated may
adversely impact Mackinac’s earnings.
The trading price of Mackinac’s common stock may be subject to significant fluctuations and volatility.
The market price of Mackinac’s common stock could be subject to significant fluctuations due to, among other things:
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(cid:120)
(cid:120)
(cid:120)
variations in quarterly or annual results of operations;
changes in dividends per share;
deterioration in asset quality, including declining real estate values;
changes in interest rates;
19
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital
commitments by or involving Mackinac or its competitors;
regulatory actions, including changes to regulatory capital levels, the components of regulatory capital
and how regulatory capital is calculated;
new regulations that limit or significantly change Mackinac’s ability to continue to offer products or
services;
volatility of stock market prices and volumes;
issuance of additional shares of common stock or other debt or equity securities;
changes in market valuations of similar companies;
changes in securities analysts’ estimates of financial performance or recommendations;
perceptions in the marketplace regarding the financial services industry, Mackinac and/or its
competitors; and/or
the occurrence of any one or more of the risk factors described above.
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.
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.
20
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 29 branch locations, 24 are owned and 5 are leased. The Corporation has additional office space to
house administrative operational support. Below is a comprehensive listing of our branch locations:
Alanson
Alpena
Alpena – Ripley
Aurora
Birmingham
Cheboygan
Eagle River
Escanaba
Florence
Gaylord
Ishpeming - Downtown
Ishpeming - West
Kaleva
Lewiston
Manistique
Manistique - Jack’s
Marquette
Marquette - McClellan
Merrill
Mio
Negaunee
Newberry
Niagara
Sault Ste. Marie
Stephenson
St. Germain
Three Lakes
Traverse City- Cass St
Traverse City
Kaleva, MI
Lewiston, MI
Alanson, MI
Alpena, MI
Alpena, MI
Aurora, WI
Birmingham, MI
Cheboygan, MI
Eagle River, WI
Escanaba, MI
Florence, WI
Gaylord, MI
Ishpeming, MI
Ishpeming, MI
6232 River Street
100 S. Second Avenue
468 N. Ripley Blvd
W563 County Road N
260 E. Brown Street,
Suite 300
350 Main Street
400 E. Wall Street
2224 N. Lincoln Road
845 Central Ave
1955 S. Otsego Avenue
100 S. Main Street
US West & 170 N.
Daisy Street
14429 Wuoksi Avenue
2885 S. County Road
489
130 South Cedar Street
Manistique, MI
735 E. Lakeshore Drive Manistique, MI
Marquette, MI
857 W. Washington
Street
175 S. McClellan
Avenue
1400 East Main Street
308 N. Morenci Street
440 US 41 East
414 Newberry Avenue
900 Roosevelt Road
138 Ridge Street
S216 Menominee Street
240 HWY 70 East
1811 Superior Street
309 Cass Street
3530 North Country
Drive
Merrill, WI
Mio, MI
Negaunee, MI
Newberry, MI
Niagara, WI
Sault Ste. Marie, MI
Stephenson, MI
St. Germain, WI
Three Lakes, WI
Traverse City, MI
Traverse City, MI
Marquette, MI
Owned
Owned
Owned
Owned
Leased
Owned
Owned
Owned
Owned
Owned
Owned
Owned
Owned
Owned
Owned
Leased
Leased
Owned
Owned
Owned
Leased
Owned
Owned
Owned
Owned
Owned
Owned
Leased
Owned
Item 3.
Legal Proceedings
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.
21
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, 2017
through December 31, 2018, as reported by NASDAQ.
2018
High
Low
Close
Dividends declared per share
Book value
2017
High
Low
Close
Dividends declared per share
Book value
For the Quarter Ended
March 31
June 30
September 30 December 31
$ 16.68 $ 17.25 $
15.43
16.25
0.120
12.96
14.75
16.58
0.120
13.90
$ 13.88 $ 13.99 $
13.63
13.72
0.120
12.71
13.92
13.99
0.120
12.92
$
$
17.58
15.80
16.20
0.120
13.94
15.52
15.01
15.50
0.120
13.13
16.45
12.60
13.65
0.120
14.20
16.10
15.89
15.90
0.120
12.93
The Corporation had approximately 1,600 shareholders of record as of March 15, 2019. 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 2018, the Bank paid dividends to the Corporation totaling $2.0 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 2018. As of December 31, 2018
the Corporation had approximaely $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.
22
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, 2018. The following information is based on an
investment of $100, on December 31, 2013 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.
g
23
Item 6.
Selected Financial Data
SELECTED FINANCIAL DATA
(Unaudited)
(Dollars in Thousands, Except Per Share Data)
Year Ended December 31,
2016
2017
2015
$ 985,367
811,078
75,897
817,998
79,552
81,400
81,400
$ 983,520
781,857
86,273
823,512
67,579
78,609
78,609
$ 739,269
618,394
53,728
610,323
45,754
76,602
76,602
$ 44,376
6,438
37,938
625
231
3,810
30,336
11,018
5,539
5,479
5,479
$
$ 37,983
4,885
33,098
600
150
4,003
29,885
6,766
2,283
4,483
4,483
$
$ 33,513
4,393
29,120
1,204
455
3,434
23,876
7,929
2,333
5,596
5,596
$
$
0.87
0.87
0.48
12.93
11.72
15.90
6.74%
6.74
0.55
55.17
8.17
4.20
.32%
0.62
0.64
197.78
0.07
7.77
$
0.72
0.72
0.40
12.55
11.29
13.47
5.73%
5.73
0.52
55.56
9.05
4.19
.53%
0.91
0.64
121.73
0.08
11.76
$
0.90
0.89
0.35
12.32
11.54
11.49
7.41%
7.41
0.76
41.67
10.23
4.30
.41%
0.66
0.81
197.09
0.22
6.34
2014
$ 743,785
600,935
65,832
606,973
49,846
73,996
73,996
$ 27,669
4,142
23,527
1,200
54
3,058
22,610
2,829
1,129
1,700
1,700
$
$
0.30
0.30
0.225
11.81
11.01
11.85
2.57%
2.57
0.28
75.00
10.94
4.19
.66%
0.93
0.86
130.49
0.14
9.37
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 for income taxes
Net income
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
2018
$ 1,318,040
1,038,864
116,748
1,097,537
60,441
152,069
152,069
$
$
$
55,377
8,247
47,130
500
—
4,263
40,300
10,593
2,226
8,367
8,367
0.94
0.94
0.48
14.20
11.61
13.65
6.94%
6.94
0.71
51.06
10.23
4.44
.49%
0.62
0.50
102.09
0.04
6.33
24
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:
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
(cid:120)
changes in business, economic or political conditions;
changes in interest rates or interest rate volatility;
our ability to manage our balance sheet size and capital levels;
disruptions or failures of our information technology systems or those of our third party service providers;
cyber security threats, system disruptions and other potential security breaches or incidents;
customer demand for financial products and services;
our ability to continue to compete effectively and respond to aggressive competition within our industry;
our ability to participate in consolidation opportunities in our industry, to complete consolidation transactions
and to realize synergies or implement integration plans;
our ability to manage our significant risk exposures effectively;
the occurrence of risks associated with our advisory services;
our ability to manage credit risk with customers and counterparties;
changes in government regulation, including interpretations, or actions by our regulators, including those that
may result from the implementation and enforcement of regulatory reform legislation;
adverse developments in any investigations, disciplinary actions or litigation; and
other factors detailed from time to time in our filings with the SEC.
Overview
The following discussion and analysis presents the more significant factors affecting the Corporation’s financial
condition as of December 31, 2018 and 2017 and the results of operations for 2017 and 2018. This discussion also
covers asset quality, liquidity, interest rate sensitivity, and capital resources for the years 2017 and 2018. 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 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. The acquisition of FFNM added approximately $318 million in assets, $192
million in loan balances and $254 million in deposits. The acquisition of Lincoln added approximately $60 million in
assets, $40 million in loan balances and $52 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 2018 results of operations and financial condition. A
more detailed analysis of the results of operations and financial condition follows this summary.
25
The Corporation reported net income of $8.367 million, or $.94 per share, for the year ended December 31, 2018,
compared to $5.479 million, or $.87 per share, in 2017. The 2018 results include expenses related to the the acquisitions
of FFNM and Lincoln, which had a collective after-tax impact of $2.461 million on earnings. 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.
Total assets of the Corporation at December 31, 2018, were $1.318 billion, an increase of $332.673 million, or 33.76%,
from total assets of $985.367 million reported at December 31, 2017.
At December 31, 2018, the Corporation’s total loans stood at $1.039 billion, an increase of $227.786 million, or 28.08%,
from 2017 year-end balances of $811.078 million. Total loan production in 2018 amounted to $286.890 million, which
included $57.118 million of secondary market mortgage loans sold. The Corporation also sold $9.245 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 $5.077 million, or .49%, of total loans at December 31, 2018 compared to $2.568 million,
or .32% of total loans at December 31, 2017. Nonperforming assets at December 31, 2018, were $8.196 million, .62%
of total assets, compared to $6.126 million, or .62% of total assets, at December 31, 2017.
Total deposits increased from $817.998 million at December 31, 2017 to $1.098 billion at December 31, 2018, an
increase of 34.17%. The increase in deposits in 2018 was comprised of a decrease in noncore deposits of $35.857
million and an increase in core deposits of $315.396 million, $306.928 million of which was attributable to our 2018
acquisitions. In 2018, the Corporation utilized wholesale deposits in order to better manage interest rate risk in funding
fixed rate loans.
Shareholders’ equity totaled $152.069 million at December 31, 2018, compared to $81.400 million at the end of 2017, an
increase of $70.669 million. This change reflects the net income available to common shareholders of $8.367 million,
other comprehensive loss of $.171 million, an increase related to stock compensation expense of $.533 million, and
dividends declared on common stock of $4.612 million. Also contributing to the increase was the equity garnered in the
acquisition of FFNM of $34.101 million and the capital raise of $32.451 million. The book value per common share at
December 31, 2018, amounted to $14.20 compared to $12.93 at the end of 2017.
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)
2018
2017
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
Net income
Earnings per common share
Basic
Diluted
Return on average assets
Return on average equity
26
$ 47,367
(237)
$ 38,140
(202)
47,130
500
4,263
40,300
10,593
2,226
37,938
625
4,041
30,336
11,018
5,539
$ 8,367
$ 5,479
$
$
0.94
0.94
$
$
0.87
0.87
.71%
6.94
.55%
6.74
Summary
The Corporation reported net income available to common shareholders of $8.367 million in 2018, compared to $5.479
million in 2017. The 2018 results include expenses related to the acquisitions of FFNM and Lincoln, which had a
collective after-tax impact of $2.461 million on earnings. 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.
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 91.71% of total revenue in
2018. The Corporation’s 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 $9.227 million from $38.140 million in 2017 to $47.400
million in 2018. There were four 25 basis point rate increases to the federal funds rate in 2018. The Corporation
experienced an increase of 29 basis points in the overall rates on earning assets from 4.95% in 2017 to 5.24% in 2018.
Interest bearing funding sources increased by 12 basis points, from .86% in 2017 to .98% in 2018. The combination of
these effective rate changes resulted in an increase in the taxable equivalent net interest margin from 4.23% in 2017 to
4.46% in 2018.
The following table details sources of net interest income for the two years ended December 31 (dollars in thousands):
Interest Income
Loans, taxable
Loans, tax-exempt
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
Net interest income
Average Rates
Earning assets
Interest-bearing funds
Interest rate spread
2018
Mix
2017
Mix
$ 51,407
123
2,408
338
1,101
55,377
92.83% $ 41,770
95
1,606
298
607
100.00% 44,376
0.22
4.35
0.61
1.99
1,039
73
2,516
2,864
1,755
8,247
12.60
0.89
30.51
34.73
21.28
100.00%
817
42
1,403
2,099
2,077
6,438
94.13%
0.21
3.62
0.67
1.37
100.00%
12.69%
0.65
21.79
32.60
32.26
100.00%
$ 47,130
$ 37,938
5.22%
0.98
4.24
4.92%
0.86
4.06
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 92% of the Corporation’s interest revenue. The
Corporation’s loan portfolio has approximately $466.665 million of variable rate loans that predominantly reprice with
changes in the prime rate and $572.199 million of fixed rate loans. A portion of the variable rate loans, 29%, or
$133.520 million, have interest rate floors. The majority of these loans have surpassed their interest rate floors and now
reprice with each increase in the prime rate.
27
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.
Taxable equivalent adjustments are the result of increasing income from tax-free loans and investments by an amount
equal to the taxes that would be paid if the income were fully taxable based on a 21% federal tax rate, thus making tax-
exempt yields comparable to taxable asset yields.
(dollars in thousands)
ASSETS:
Loans (1,2,3)
Taxable securities
Nontaxable securities (2)
Other interest-earning assets
Total earning assets
Reserve for loan losses
Cash and due from banks
Fixed assets
Other real estate owned
Other assets
Year Ended December 31,
2018
Average
Balance
Interest
Average
Rate
Average
Balance
$ 51,563
2,408
575
1,101
55,647
$
941,221
86,189
14,678
18,929
1,061,017
(5,530)
56,500
19,421
2,407
43,640
116,438
2.79
3.92
5.82
5.24
5.48% $ 795,532
69,589
14,412
21,607
901,140
(5,044)
46,779
16,426
4,092
32,433
94,686
2017
Interest
$ 41,913
1,606
452
607
44,578
Average
Rate
5.27%
2.31
3.14
2.81
4.95
TOTAL AVERAGE ASSETS
$ 1,177,455
$ 995,826
LIABILITIES AND SHAREHOLDERS’ EQUITY:
NOW and Money Markets
Interest checking
Savings deposits
Certificates of deposit
Brokered deposits
Borrowings
Total interest-bearing liabilities
Demand deposits
Other liabilities
Shareholders’ equity
$
230,751
84,238
90,758
191,543
158,554
85,648
841,492
207,021
8,464
120,478
335,963
$
908
131
73
2,515
2,865
1,755
8,247
0.16
0.08
1.31
1.81
2.05
0.98
0.39% $ 205,443
67,647
60,473
151,401
184,043
82,830
751,837
157,194
5,446
81,349
243,989
$
717
100
42
1,402
2,099
2,078
6,438
0.35%
0.15
0.07
0.93
1.14
2.51
0.86
TOTAL AVERAGE LIABILITIES AND
SHAREHOLDERS’ EQUITY
$ 1,177,455
$ 995,826
Rate spread
Net interest margin/revenue, tax equivalent basis
$ 47,400
4.26
4.46%
$ 38,140
4.09
4.23%
(1) For purposes of these computations, non-accruing loans are included in the daily average loan amounts outstanding.
(2) The amount of interest income on nontaxable securities and loans has been adjusted to a tax equivalent basis, using
a 21% tax rate for 2018 and 34% for 2017.
(3) Interest income on loans includes loan fees.
28
The following table presents the dollar amount, in thousands, of changes in taxable equivalent interest income and
interest expense for major components of interest-earning assets and interest-bearing obligations. It distinguishes
between changes related to higher or lower outstanding balances and changes due to the levels and fluctuations in
interest rates. For each category of interest-earning assets and interest-bearing obligations, information is provided for
changes attributable to (i) changes in volume (i.e. changes in volume multiplied by prior period rate) and (ii) changes in
rate (i.e. changes in rate multiplied by prior period volume). For purposes of this table, changes attributable to both rate
and volume are shown as a separate variance.
Interest earning assets:
Loans
Taxable securities
Nontaxable securities
Other interest earning assets
Total interest earning assets
Interest bearing obligations:
NOW and money market deposits
Interest checking
Savings deposits
Certificates of deposit
Brokered deposits
Borrowings
Year ended December 31,
2018 vs. 2017
Increase (Decrease)
Due to
Volume
Rate
Volume
and Rate
Total
Increase
(Decrease)
$ 7,676
383
8
(34)
$ 8,033
$ 1,669
338
113
563
$ 2,683
$ 306
81
2
(36)
$ 353
$ 9,651
802
123
493
$ 11,069
$
88
25
21
372
(291)
71
$
91
5
7
586
1,227
(381)
$
12
1
3
155
(170)
(13)
$
191
31
31
1,113
766
(323)
Total interest bearing obligations
$
286
$ 1,535
$
(12) $ 1,809
Net interest income, tax equivalent basis
$ 9,260
Provision for Loan Losses
The Corporation records a provision for loan losses when it believes it is necessary to adjust the allowance for loan
losses to maintain an adequate level after considering factors such as loan charge-offs and recoveries, changes in
identified levels of risk in the loan portfolio, changes in the mix of loans in the portfolio, loan growth, and other
economic factors. During 2018, the Corporation recorded a provision for loan loss of $.500 million, compared to a
provision of $.625 million in 2017. There was no provision for loan losses for acquired loans as there was no further
deterioration of acquired loans since acquisition.
Noninterest Income
Noninterest income was $4.263 million and $4.041 million in 2018 and 2017, 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 2018, revenues from these two business lines totaled $1.950 million compared to $2.240 million in 2017.
Deposit related income totaled $1.441 million in 2018 compared to $1.056 million in 2017. 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.
29
The following table details noninterest income for the two 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
2018
$
481
960
1,019
270
661
197
675
4,263
—
$ 4,263
2017
$
372
684
1,130
243
867
(31)
545
3,810
231
$ 4,041
2018-2017%
29.30%
40.35
(9.82)
11.11
(23.76)
735.48
23.85
11.89
—
5.49%
Noninterest Expense
Noninterest expense was $40.300 million in 2018 compared to $30.336 million in 2017. In 2018, the Corporation
incurred $2.951 million of costs related to the acquisition of FFNM and Lincoln, compared to no transaction costs in
2017. Salaries and benefits, at $20.064 million, increased by $4.574 million, or 29.53%, from the 2017 expenses of
$15.490 million. 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.
Management will continue to review all areas of noninterest expense in order to evaluate where opportunities may exist
which could reduce expenses without compromising service to customers.
The following table details noninterest expense for the two 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
2018
$ 20,064
3,640
2,548
2,503
629
184
762
1,575
1,166
182
700
726
905
2,951
3,340
$ 40,300
2017
$ 15,490
3,104
2,209
2,037
600
200
734
1,534
1,335
388
731
604
711
50
2,143
$ 30,336
% Increase
(Decrease)
2018-2017
29.53%
17.27
15.35
22.88
4.83
(8.00)
3.81
2.67
(12.66)
(53.09)
(4.24)
20.20
27.29
NM
55.86
32.85%
The Corporation recognized a federal income tax expense of approximately $2.226 million for the year ended
December 31, 2018 and $5.539 million for the year ended December 31, 2017. 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.
30
The Corporation has reported deferred tax assets of $5.763 million at December 31, 2018. 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, 2018, had a net operating loss and tax credit carryforwards for tax
purposes of approximately $12.5 million, and $1.7 million, respectively. As a result of the repeal of the corporate
alternative minimum tax in the Tax Cuts and Jobs Act, any outstanding alternative minimum tax credits are believed to
be utilized or refundable as of December 31, 2018. Therefore, the $1.6 million of alternative minimum tax credits, was
reclassified to a current tax receivable included in other assets during the year. The Corporation evaluated the future
benefits from these carryforwards as of December 31, 2018 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 $2.0 million for the NOL and the equivalent value of tax credits, which is approximately $.420
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.
The table below details the major components of the Corporation’s net deferred tax assets (dollars in thousands):
2018
2017
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
$ 2,634
1,078
$ 1,580
948
— 1,463
119
235
242
240
79
19
785
63
168
140
307
221
92
99
2,206
808
Total deferred tax assets
7,753
5,773
Deferred tax liabilities:
Core deposit premium
FHLB stock dividend
Depreciation
Mortgage servicing rights
Other
Total deferred tax liabilities
Net deferred tax asset
(1,256)
(73)
(101)
61
(621)
(1,990)
(404)
(56)
(79)
(240)
(24)
(803)
$ 5,763
$ 4,970
31
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
Total
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
December 31,
2018
2017
Balance
Mix
Balance
Mix
$
241,556
480,248
225,236
947,040
13,737
136,760
150,497
60,441
7,993
152,069
18.33% $ 148,079
341,406
142,159
631,644
11,055
175,299
186,354
79,552
6,417
81,400
36.44
17.09
71.85
1.04
10.39
11.42
4.59
0.61
11.54
15.03%
34.65
14.43
64.10
1.12
17.80
18.92
8.07
0.65
8.26
$ 1,318,040
100.00% $ 985,367
100.00%
$ 1,033,681
116,748
6
4,924
13,452
64,151
85,078
78.43% $ 805,999
75,897
6
3,112
13,374
37,420
49,559
8.86
0.00
0.37
1.02
4.87
6.44
81.80%
7.70
0.00
0.32
1.36
3.80
5.02
$ 1,318,040
100.00% $ 985,367
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 increased $40.851 million in 2018, from $75.897 million at December 31, 2017 to
$116.748 million at December 31, 2018. The majority of this increase was a result of acquisition activity.
The carrying value of the Corporation’s securities at December 31 (dollars in thousands) is as follows:
US Agencies
US Agencies - MBS
Corporate
Obligations of states and political subdivisions
Total securities
2018
$ 15,970
32,840
20,064
47,874
2017
$ 16,846
12,716
24,891
21,444
$ 116,748
$ 75,897
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, 2018, investment securities with an
estimated fair market value of $24.908 million were pledged as collateral for FHLB borrowings and certain customer
relationships.
32
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 69% of total loans outstanding at December 31, 2018.
The Corporation continued to experience strong loan demand in 2018 with approximately $286.890 million of new
organic loan production, including $57.118 million of mortgage loans sold in the secondary market. At 2018 year-end,
the Corporation’s loans stood at $1.039 billion, an increase from the 2017 year-end balances of $811.078 million. The
production of loans was distributed among the regions, with the Upper Peninsula at $109.628 million, $97.854 million in
the Northern Lower Peninsula, $49.210 million in Southeast Michigan and $30.198 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.
The 2018 acquisitions of FFNM and Lincoln added loans of $223.445 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 2017 and 2018 (dollars in thousands):
Loan balances as of December 31, 2016
$
781,857
Total production
Total loans acquired
Secondary market sales
SBA loan sales
Loans transferred to OREO
Normal amortization/paydowns and payoffs
Loan balances as of December 31, 2017
$
Total production
Total loans acquired
Secondary market sales
SBA loan sales
Loans transferred to OREO
Normal amortization/paydowns and payoffs
277,556
—
(65,711)
(7,689)
(2,147)
(172,788)
811,078
286,890
223,445
(57,118)
(9,245)
(1,878)
(214,308)
Loan balances as of December 31, 2018
$ 1,038,864
33
Following is a table that illustrates the balance changes in the loan portfolio for 2018 and 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
2018
2017
Percent Change
2018-2017
$ 496,207
191,060
286,908
$ 406,742
156,951
209,890
14,553
29,765
20,371
10,818
9,243
17,434
22.00%
21.73
36.69
34.53
222.03
16.85
$ 1,038,864
$ 811,078
28.08%
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):
Real estate - operators of
nonresidential buildings
Hospitality and tourism
Lessors of residential
buildings
Gasoline stations and
convenience stores
Logging
Commercial construction
Other
2018
% of
Loans
Balance
% of
Capital
Balance
2017
% of
Loans
% of
Capital
$ 150,251
77,598
20.95% 98.80
51.03
10.82
$ 119,025
75,228
20.77% 146.22
92.42
13.13
50,204
7.00
33.01
33,032
5.77
40.58
24,189
20,860
29,765
364,165
3.37
2.91
4.15
50.80
15.91
13.72
8.39
250.66
21,176
17,554
9,243
297,678
3.70
3.06
1.61
51.96
26.01
21.57
11.36
365.70
Total commercial loans $ 717,032
100.00%
$ 572,936
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 2018 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, 2018, our residential loan portfolio totaled $301.461 million, or 29.02%, 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
reversed. Loans are returned to accrual status when all principal and interest amounts contractually due are brought
current and future payments are reasonably assured.
34
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, 2018, had performing loans of $4.836 million and $1.145 million of nonperforming
loans for which repayment terms were modified to the extent that they were deemed to be “restructured” loans. The total
performing restructured loans of $4.836 million is comprised of 30 performing loans, the largest of which had a
December 31, 2018 balance of $.903 million and five nonperforming loans.
Credit Quality
The table below shows balances of nonperforming assets for the years ended December 31 (dollars in thousands):
December 31, December 31,
2018
2017
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
$
$
$
$
$
5,054
23
—
5,077
3,119
8,196
0.49%
0.62%
2,388
—
180
2,568
3,558
6,126
0.32%
0.62%
$
5,183
.50%
5,079
.63%
102.09% 197.78%
102.55% 212.69%
7.77%
6.33%
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 2018 independent review provided
findings similar to management with respect to credit quality. The Corporation will again utilize a consultant for loan
review in 2019.
The following table details the impact of nonperforming loans on interest income for the two years ended December 31
(dollars in thousands):
Interest income that would have been recorded at original rate
Interest income that was actually recorded
Net interest lost
2018
2017
$ 194
—
$ 113
—
$ 194
$ 113
35
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 2018 amounted to $.396 million, or .04% of average loans
outstanding, compared to $.566 million, or .07% of loans outstanding in 2017. 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
2018
2017
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
Balance at end of period
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
$
5,079
$
5,020
330
230
156
716
221
64
35
320
396
500
419
155
229
803
121
65
51
237
566
625
$
5,183
$
5,079
$
$ 1,038,864
941,221
0.50%
0.04
7.80
811,078
795,532
0.63%
0.07
11.27
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
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 2018, the allowance for loan losses represented .50% 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 102.09% at December 31, 2018.
36
The Corporation completed the acquisition of Eagle River on April 29, 2016, Niagara on August 31, 2016, First Federal
of Northern Michigan Bancorp Inc. (“FFNM”) on May 18, 2018 and Lincoln Community Bank (“Lincoln”) on October
1 2018. The Eagle River acquired impaired loans totaled $3.401 million, and the Niagara acquired impaired loans
totaled $2.105 million. The FFNM impaired loans totaled $5.440 million and the Lincoln impaired loans totaled $1.901
million. In 2018, the Corporation had positive resolution of acquired nonperforming loans, which resulted in recognition
of accretable interest of approximately $.546 million compared to $.550 million in 2017.
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, 2016
Other real estate transferred from loans due to foreclosure
Proceeds from sale of other real estate
Writedowns on other real estate held for sales
Loss on other real estate held for sale
Balance at December 31, 2017
Other real estate transferred from loans due to foreclosure
Other real estate acquired in business combinations
Proceeds from sale of other real estate
Writedowns on other real estate held for sales
Loss on other real estate held for sale
$
$
4,782
2,147
(2,782)
(508)
(81)
3,558
1,878
263
(2,398)
(125)
(57)
Balance at December 31, 2018
$
3,119
During 2018, the Corporation received real estate in lieu of loan payments of $1.878 million. In determining the
carrying value of other real estate held for sale, the Corporation generally starts with a third party appraisal of the
underlying collateral and then deducts estimated selling costs to arrive at a net asset value. After the initial receipt,
management periodically re-evaluates the recorded balance and records any additional reductions in the fair value as a
write-down of other real estate held for sale.
Deposits
Total deposits at December 31, 2018 were $1.098 billion, an increase of $279.539 million, or 34.17%, from
December 31, 2017 deposits of $817.998 million. The table below shows the deposit mix for the periods indicated
(dollars in thousands):
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
2018
Mix
2017
Mix
$ 241,556
368,890
111,358
225,236
947,040
22.01% $ 148,079
280,309
61,097
142,159
631,644
33.61
10.15
20.52
86.29
18.10%
34.27
7.47
17.38
77.22
13,737
136,760
150,497
1.25
12.46
13.71
11,055
175,299
186,354
1.35
21.43
22.78
Total deposits
$ 1,097,537
100.00% $ 817,998
100.00%
37
The increase in deposits, is composed of a decrease in noncore deposits of $35.857 million, and an increase in core
deposits of $315.396 million, $306.928 which is attributable to acquisition activity. As shown in the table above, core
deposits represent approximately 86% 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 2018 year end, this source of funding totaled
$57.1 million and the Corporation secured this funding by pledging loans and investments. The $57.1 million of FHLB
borrowings had a weighted average maturity of 2.58 years, with a weighted average rate of 1.72% at December 31,
2018.
The Corporation currently has one correspondent banking borrowing relationship. The relationship consists of a $15.0
million revolving line of credit, which had no outstanding balance at December 31, 2018. The line of credit bears
interest at a rate of LIBOR plus 2.00%, with a floor rate of 3.00% and a ceiling of 22%. The line of credit expires on
April 30, 2020. LIBOR was 2.81% at December 31, 2018. The Corporation previously had a term note as part of this
relationship that was paid in full during the second quarter of 2018. 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
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 2018, the Corporation increased cash and cash equivalents by $26.731 million. As shown on the Corporation’s
consolidated statement of cash flows, liquidity was primarily impacted by cash provided by investing activities and cash
used in financing activities. The net change in investing activities included a net increase in loans of $6.148 million and
a net increase in securities available for sale of $61.415 million. The Corporation also had a net decrease in cash through
financing activities partially due to a decrease in deposit liabilities of $27.389 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, 2018, $86.468 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 2019, 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 2018, the Bank paid
a $2.0 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 $15.0 million line of credit with a correspondent
bank, which also serves as a source of liquidity. As of December 31, 2018, $15.0 million was available to the
38
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, 2018, the Bank’s core deposits in relation to total
funding were 81.78% compared to 70.37% in 2017. These ratios indicated at December 31, 2018, that the Bank had
decreased its reliance on non-core deposits and borrowings to fund the Bank’s long-term assets, namely loans and
investments. The Bank believes that by maintaining adequate volumes of short-term investments and implementing
competitive pricing strategies on deposits, it can ensure adequate liquidity to support future growth. The Bank also has
correspondent lines of credit available to meet unanticipated short-term liquidity needs. As of December 31, 2018, 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.
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, 2018, the aggregate contractual obligations
and commitments are (dollars in thousands):
Contractual Obligations
Total deposits
Federal Home Loan Bank borrowings
Other borrowings
Directors’ deferred compensation
Annual rental / purchase commitments under
noncancelable leases / contracts
Less than 1 Year
1 to 3 Years
4 to 5 Years
After 5
Years
Total
Payments Due by Period
$
975,368
16,612
77
316
$ 104,672
37,398
157
868
$ 17,014
131
161
423
$
483
2,919
81
586
$ 1,097,537
57,060
476
2,193
747
1,610
1,000
2,124
5,481
TOTAL
$
993,120
$ 144,705
$ 18,729
$ 6,193
$ 1,162,747
Other Commitments
Letters of credit
Commitments to extend credit
Credit card commitments
$
$
7,208
143,295
5,108
— $
—
—
— $ — $
—
—
—
—
7,208
143,295
5,108
TOTAL
$
155,611
$
— $
— $ — $ 155,611
39
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 “— “Regulatory Capital Requirements” 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.
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, 2018 the Bank had $116.748 million of securities, with a weighted average maturity of 60.29 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.
40
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.
The following are the Corporation’s repricing opportunities at December 31, 2018 (dollars in thousands):
Interest-earning assets:
Loans
Securities
Other (1)
1-90
Days
91-365
Days
>1-5
Years
Over 5
Years
Total
$ 243,557
5,821
5,909
357,958
15,239
2,667
411,689
72,966
9,553
25,660
22,722
247
$ 1,038,864
116,748
18,376
Total interest-earning assets
255,287
375,864
494,208
48,629
1,173,988
Interest-bearing obligations:
NOW, money market, savings and interest
checking
Time deposits
Brokered CDs
Borrowings
480,248
33,598
60,393
10,496
—
83,208
76,367
6,193
—
121,684
—
37,847
—
483
—
3,000
480,248
238,973
136,760
57,536
Total interest-bearing obligations
584,735
165,768
159,531
3,483
913,517
Gap
$ (329,448)
$ 210,096
$ 334,677
$ 45,146
$ 260,471
Cumulative gap
$ (329,448)
$ (119,352)
$ 215,325
$ 260,471
(1) includes Federal Home Loan Bank stock
The above analysis indicates that at December 31, 2018, the Corporation had a cumulative liability sensitivity gap
position of $119.352 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
41
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, 2018, the Corporation had $466.665 million of variable rate loans that reprice primarily with the prime
rate index. Approximately $133.520 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. The majority of these loans have
surpassed their interest rate floors and now reprice with each increase in the prime rate.
At December 31, 2017, the Corporation had a cumulative liability sensitive gap position of $113.098 million within the
one-year time frame.
The Corporation’s primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk and foreign
exchange risk. The Corporation has no market risk sensitive instruments held for trading purposes. The Corporation has
limited agricultural-related loan assets, and therefore, has minimal significant exposure to changes in commodity prices.
Any impact that changes in foreign exchange rates and commodity prices would have on interest rates are assumed to be
insignificant.
Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control
interest rate risk and the quantitative level of exposure. The Corporation’s interest rate risk management process seeks
to ensure that appropriate policies, procedures, management information systems, and internal controls are in place to
maintain interest rate risk at prudent levels with consistency and continuity. In evaluating the quantitative level of
interest rate risk, the Corporation assesses the existing and potential future effects of changes in interest rates on its
financial condition, including capital adequacy, earnings, liquidity, and asset quality. In addition to changes in interest
rates, the level of future net interest income is also dependent on a number of variables, including: the growth,
composition and levels of loans, deposits, 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, 2018 (dollars in thousands). Nonaccrual loans of $5.054
million are included in the table at an average interest rate of 0.00% and a maturity greater than 5 years.
42
Principal/Notional Amount Maturing/Repricing In:
2019
2020
2021
2022
2023
Thereafter
Total
Fair Value
12/31/2018
$ 13,665
2.50
73,218
4.78
466,665
5.69
8,582
3.32
$ 562,130
5.46%
$ 30,251
2.38
73,226
4.67
—
—
6,881
2.15
$ 110,358
3.89%
$ 28,563
2.96
93,092
4.47
—
—
690
2.26
$ 122,345
4.11%
$ 15,959
3.06
94,137
4.78
—
—
1,732
2.38
$ 111,828
4.50%
$
8,712
3.18
138,206
5.14
—
—
250
2.39
$ 147,168
5.02%
$ 19,598
3.73
100,320
5.19
—
—
247
2.11
$ 120,165
4.95%
$ 116,748
$ 116,748
572,199
560,869
466,665
457,425
18,382
18,382
$ 1,173,994
4.97%
$ 1,153,424
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
Average interest rate
Time deposits
Average interest rate
Variable interest rate borrowings
Average interest rate
Fixed interest rate borrowings
Average interest rate
Total rate sensitive liabilities
Average interest rate
Foreign Exchange Risk
$ 480,248
0.31
253,564
1.87
16,290
1.76
2,905
2.75
$ 753,007
0.88%
$
— $
—
81,828
2.02
12,567
1.58
—
-
$ 94,395
1.96%
— $
—
22,844
1.92
25,145
1.84
—
—
$ 47,989
1.88%
— $
—
11,996
1.97
80
1.00
—
—
$ 12,076
1.96%
$
— $
—
5,018
2.20
373
1.50
—
—
5,391
2.15%
$
375,733
— $ 480,248
—
483
1.40
3,081
1.18
—
—
3,564
1.21%
$ 916,422
1.06%
57,536
2,905
$ 480,248
358,675
56,771
2,905
$ 898,599
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 2018, 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.
43
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
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying balance sheets of Mackinac Financial Corporation (the “Company”) as of December
31, 2018 and 2017, the related statements of income, comprehensive income, stockholders' equity, and cash flows for the
years then ended, and the related notes (collectively referred to as the “financial statements”). We also have audited the
Company's internal control over financial reporting as of December 31, 2018, based on criteria established in Internal
Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway
Commission (the “COSO framework”).
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of
the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for the years then
ended, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion,
the Company maintained, in all material respects, effective internal control over financial reporting as of December 31,
2018, based on criteria established in the COSO framework.
Basis for Opinion
The Company's management is responsible for these financial statements, for maintaining effective internal control over
financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the
accompanying “Report on Management’s Assessment of Internal Control Over Financial Reporting.” Our responsibility
is to express an opinion on the Company’s financial statements and an opinion on the Company's internal control over
financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting
Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement,
whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material
respects.
Our audits of the financial statements 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. Our audit of internal control over financial reporting
included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness
exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our
audits also included performing such other procedures as we considered necessary in the circumstances. We believe that
our audits provide a reasonable basis for our opinions.
Definition and Limitations of Internal Control over Financial Reporting
A company's internal control over financial reporting is a process designed 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. A company's internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded
as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles,
and that receipts and expenditures of the company are being made only in accordance with authorizations of management
and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of
44
unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial
statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/Plante & Moran, PLLC
We have served as the Company’s auditor since 2002.
Grand Rapids, Michigan
March 18, 2019
45
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2018 and 2017
(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 - 10,712,745 and 6,294,930 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,
2018
2017
$
$
64,151
6
64,157
13,452
116,748
4,924
717,032
301,461
20,371
1,038,864
(5,183)
1,033,681
22,783
3,119
5,763
5,720
22,024
25,669
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
$
1,318,040
$
985,367
$
$
241,556
368,890
111,358
225,236
13,737
136,760
1,097,537
2,905
57,536
7,993
1,165,971
129,066
23,466
(245)
(218)
152,069
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
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$
1,318,040
$
985,367
See accompanying notes to consolidated financial statements.
46
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2018 and 2017
(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 fees (amortization)
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,
2018
2017
$
$
$
$
51,407
123
2,408
338
1,101
55,377
6,492
1,755
8,247
47,130
500
46,630
1,441
1,289
661
197
—
675
4,263
20,064
3,640
2,548
2,503
905
1,575
1,166
182
700
726
2,951
3,340
40,300
10,593
2,226
8,367
.94
.94
$
$
$
$
41,770
95
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
5,479
.87
.87
See accompanying notes to consolidated financial statements.
47
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years Ended December 31, 2018 and 2017
(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 (losses) gains on available for sale securities
Defined benefit pension plan:
Net unrealized actuarial gain (loss) on defined benefit pension obligation
Tax effect
Changes from defined benefit pension plan
Other comprehensive loss, net of tax
December 31,
2018
2017
$
8,367
$
5,479
(220)
—
46
(174)
9
(6)
3
(171)
295
(231)
(22)
42
(161)
55
(106)
(64)
Total comprehensive income
$
8,196
$
5,415
See accompanying notes to consolidated financial statements.
48
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Years Ended December 31, 2018 and 2017
(Dollars in Thousands)
Shares of
Common
Stock
Common Stock
and Additional
Paid in Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Income (Loss)
Total
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
Reclassification of certain deferred tax effects
Dividend on common stock
—
—
—
—
31,559
—
—
—
—
—
398
—
—
—
5,479
—
5,479
—
—
—
—
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
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
Issuance of common stock:
FFNM acquisition
Capital Raise, net of costs of $2.05 million
Dividend on common stock
—
—
—
—
45,630
2,146,378
2,225,807
—
—
—
—
533
—
34,101
32,451
—
8,367
—
8,367
—
—
—
—
—
—
(4,612)
(174)
3
(171)
—
—
—
—
—
(174)
3
8,196
533
—
34,101
32,451
(4,612)
Balance, December 31, 2018
10,712,745
$
129,066
$
23,466
$
(463) $
152,069
See accompanying notes to consolidated financial statements.
49
MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS CASH FLOWS
Years Ended December 31, 2018 and 2017
(Dollars in Thousands)
Cash Flows from Operating Activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
For the year ended December 31,
2018
2017
$
8,367
$
5,479
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
Cash paid for acquisitions and reimbursement of fees, net of cash acquired
Proceeds from sale of premises, equipment, and other real estate
Redemption of FHLB stock
Net cash provided by (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
Proceeds from common stock offering
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
Common stock issued
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)
2,607
500
874
—
(1,019)
(57,118)
58,137
57
125
533
7,531
37
20,631
(6,148)
5,807
(1,989)
63,404
(2,549)
—
—
4,768
2,190
—
65,483
(27,389)
—
2,905
—
(4,612)
—
32,451
(62,738)
(59,383)
26,731
37,426
64,157
8,178
1,600
372,967
20,192
349,464
2,146,378
$
$
$
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
—
—
—
—
1,878
$
2,147
$
$
$
$
See accompanying notes to consolidated financial statements.
50
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 debt 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.
51
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,
52
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
53
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, 2018, the balance in accumulated other
comprehensive income consisted of unrealized losses on available for sales securities of $.245 million and actuarial
losses on the defined benefit pension obligation of $.218 million. At December 31, 2017, the balance in accumulated
other comprehensive income consisted of unrealized losses on available for sale securities of $71,000 and actuarial
losses on the defined benefit pension obligation of $.221 million.
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 $48,000 from AOCI to
retained earnings as of Decemer 31, 2017.
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, 2018 and
2017 (dollars in thousands, except per share data):
(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
Year Ended December 31,
2018
2017
$
8,367
$
5,479
8,891,967
29,691
8,921,658
6,288,791
33,622
6,322,413
$
$
.94
.94
$
$
.87
.87
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
54
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 Corporation adopted the new guidance on January 1, 2018. Management’s analysis
included: identification of all revenue streams included in the financial statements; determination of scope exclusions to
identify “in-scope” revenue streams; determination of size, timing and amount of revenue recognition for in-scope items.
Key revenue streams identified include service charges on deposit accounts, and credit card income. The new guidance
did not have a material impact on the Corporation’s consolidated financial consition or results of operations.
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. The Corporation recorded no impact upon adoption of ASU 2016-01 in January 2018. Also, the fair value of
financial instruments measured at amortized cost is now determined using an exit price notion. Prior to 2018, entrance
pricing was used to determine the fair value of financial instruments measured at amortized cost.
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 expects to recognize
right-of-use assets and lease liabilities of approximately $5.481 million, representing substantially all of its operating
lease commitments. The amount recognized will be impacted by assumptions around renewals and/or extensions.
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
55
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.
Reclassifications
Certain amounts in the 2017 consolidated financial statements have been reclassified to conform to the 2018
presentation.
NOTE 2 — RESTRICTIONS ON CASH AND CASH EQUIVALENTS
Cash and cash equivalents in the amount of $29.252 million were restricted on December 31, 2018 to meet the reserve
requirements of the Federal Reserve System.In the normal course of business, the Corporation maintains cash and due
from bank balances with correspondent banks. Balances in these accounts may exceed the Federal Deposit Insurance
Corporation’s insured limit of $250,000. Management believes that these financial institutions have strong credit ratings
and the credit risk related to these deposits is minimal.
NOTE 3 — SECURITIES AVAILABLE FOR SALE
The carrying value and estimated fair value of securities available for sale are as follows (dollars in thousands):
Amortized Unrealized Unrealized
Gains
Losses
Cost
Estimated
Fair Value
December 31, 2018
Corporate
US Agencies
US Agencies - MBS
Obligations of states and political subdivisions
$
$ 20,198
16,198
32,974
47,828
24
5
124
341
$
(158) $ 20,064
15,970
(233)
32,840
(258)
47,874
(295)
Total securities available for sale
$ 117,198
$
494
$
(944) $ 116,748
December 31, 2017
Corporate
US Agencies
US Agencies - MBS
Obligations of states and political subdivisions
$
$ 24,852
16,935
12,830
21,370
82
10
42
307
$
(43) $ 24,891
16,846
(99)
12,716
(156)
21,444
(233)
Total securities available for sale
$ 75,987
$
441
$
(531) $ 75,897
56
Following is information pertaining to securities with gross unrealized losses at December 31, 2018 and 2017 aggregated
by investment category and length of time these individual securities have been in a loss position (dollars in thousands):
Less Than Twelve Months
Gross
Unrealized
Losses
Fair
Value
Over Twelve Months
Gross
Unrealized
Losses
Fair
Value
December 31, 2018
Corporate
US Agencies
US Agencies - MBS
Obligations of states and political subdivisions
$
(50)
—
(73)
(29)
$ 4,969
504
3,903
5,812
$
(108) $ 11,876
14,439
(233)
6,908
(185)
9,533
(266)
Total securities available for sale
$
(152)
$ 15,188
$
(792) $ 42,756
December 31, 2017
Corporate
US Agencies
US Agencies - MBS
Obligations of states and political subdivisions
(43)
(87)
(67)
(99)
14,204
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
There were 132 securities in an unrealized loss position in 2018 and 105 in 2017. The gross unrealized losses in the
current portfolio are considered temporary in nature and related to interest rate fluctuations. The Corporation has both
the ability and intent to hold the investment securities until their respective maturities and therefore does not anticipate
the realization of the temporary losses.
Following is a summary of the proceeds from sales and calls of securities available for sale, as well as gross gains and
losses for the years ended December 31 (dollars in thousands):
Proceeds from sales and calls
Gross gains on sales and calls
Gross (losses) on sales and calls
2018
2017
$ 48,649
—
—
$ 11,651
253
(22)
The carrying value and estimated fair value of securities available for sale at December 31, 2018, 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
Cost
Estimated
Fair Value
$ 13,728
54,563
13,058
2,875
84,224
32,974
$ 13,583
54,382
13,085
2,858
83,908
32,840
$ 117,198
$ 116,748
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 $24.908 million are pledged
as collateral to the Federal Home Loan Bank and $5.372 million are pledged to certain customer relationships. See Note
10 for information on securities pledged to secure borrowings from the Federal Home Loan Bank.
57
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
2018
2017
$
496,207 $ 406,742
156,951
191,060
9,243
29,765
209,890
286,908
17,434
20,371
10,818
14,553
$
1,038,864 $ 811,078
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, Niagara Bancorporation (“Niagara”) on August 31,
2016, First Federal of Northern Michigan Bancorp, Inc. (“FFNM”) on May 18, 2018, and Lincoln Community Bank
(“Lincoln”) on October 1, 2018. 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. The FFNM
impaired loans totaled $5.440 million and the Lincoln impaired loans totaled $1.901 million. In 2018, the Corporation
had positive resolution of acquired nonperforming loans, which resuled in the recognition of accretable interest of
approximately $.546 million. In 2017, The Corporation had positive resolution of acquired nonperforming loans, which
resulted in the recognition of approximately $.550 million of accretable interest.
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
Impaired
$ 13,290
(2,234)
11,056
(744)
$ 10,312
Acquired
Non-impaired
53,849
$
—
53,849
(2,100)
51,749
$
Acquired
Total
$ 67,139
(2,234)
64,905
(2,844)
$ 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
Impaired
$ 3,401
(1,172)
2,229
(391)
$ 1,838
Acquired
Non-impaired
80,737
$
—
80,737
(1,700)
79,037
$
Acquired
Total
$ 84,138
(1,172)
82,966
(2,091)
$ 80,875
58
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
Impaired
$ 2,105
(265)
1,840
(88)
$ 1,752
Acquired
Non-impaired
30,555
$
—
30,555
(600)
29,955
$
Acquired
Total
$ 32,660
(265)
32,395
(688)
$ 31,707
The table below details the outstanding balances of the FFNM 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
Impaired Non-impaired
$ 187,302
$ 5,440
—
(2,100)
187,302
3,340
(4,498)
(700)
$ 182,804
$ 2,640
Acquired
Total
$ 192,742
(2,100)
190,642
(5,198)
$ 185,444
The table below details the outstanding balances of the Lincoln 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
Impaired
$ 1,901
(546)
1,355
(561)
794
$
Acquired
Non-impaired
37,700
$
—
37,700
(493)
37,207
$
Acquired
Total
$ 39,601
(546)
39,055
(1,054)
$ 38,001
59
The table below presents a rollforward of the accretable yield on acquired loans for year ended December 31, 2018
(dollars in thousands):
Acquired
Impaired
PFC
Acquired
Non-impaired
Acquired
Total
Acquired
Impaired
Eagle River
Acquired
Non-impaired
Acquired
Total
Balance, December 31, 2017
Accretion
Reclassification from nonaccretable difference
Balance, December 31, 2018
Balance, December 31, 2017
Acquisition activity
Accretion
Reclassification from nonaccretable difference
Balance, December 31, 2018
Balance, December 31, 2017
Acquisition activity
Accretion
Reclassification from nonaccretable difference
Balance, December 31, 2018
$
$
$
$
$
$
149
(86)
65
128
$
$
— $
—
—
— $
149
(86)
65
128
Acquired
Impaired
Niagara
Acquired
Non-impaired
Acquired
Total
38
—
(48)
36
26
$
$
281
—
(212)
—
69
$
$
319
—
(260)
36
95
$
$
$
$
218
(22)
17
213
$
$
603
(587)
—
16
$
$
821
(609)
17
229
First Federal Northern Michigan
Acquired
Non-impaired
Acquired
Total
Acquired
Impaired
— $
— $
700
(515)
386
571
$
4,498
(1,052)
—
3,446
Acquired
Impaired
Lincoln Community Bank
Acquired
Non-impaired
Acquired
Total
Acquired
Impaired
Total
Acquired
Non-impaired
— $
— $
— $
561
—
—
561
$
493
(51)
—
442
$
1,054
(51)
—
1,003
$
405
1,261
(671)
504
1,499
$
$
884
4,991
(1,902)
—
3,973
—
5,198
(1,567)
386
4,017
Acquired
Total
1,289
6,252
(2,573)
504
5,472
$
$
$
The table below presents a rollforward of the accretable yield on acquired loans for year ended December 31, 2017
(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, 2016
Accretion
Reclassification from nonaccretable
difference
Balance, December 31, 2017
$
$
282
(460)
327
149
$
$
642
(642)
$
924
(1,102)
—
— $
327
149
$
$
236
(70)
52
218
$
$
1,221
(618)
$ 1,457
(688)
—
603
$
52
821
$
$
52
(20)
6
38
$
$
505
(224)
—
281
$
$
557
(244)
6
319
60
A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2018 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
real estate
financial and Commercial
construction
agricultural
family residential
real estate
Consumer
construction Consumer Unallocated
Total
$
$
$
$
$
$
$
$
1,650
(198)
55
175
1,682
496,207
(1,682)
494,525
486
1,196
1,682
2,148
491,282
2,777
496,207
$
$
$
$
$
$
$
$
576
(132)
164
40
648
191,060
(648)
190,412
340
308
648
577
189,023
1,460
191,060
$
$
$
$
$
$
$
$
54
—
2
45
101
29,765
(101)
29,664
$
$
$
$
— $
101
101
$
— $
29,399
366
29,765
$
160
(230)
64
205
199
286,908
(199)
286,709
$
$
$
$
6
—
—
—
6
$
$
10
(156)
35
119
8
14,553
(6)
14,547
$ 20,371
(8)
$ 20,363
$
$
$
$
2,623
—
—
(84)
2,539
$
$
5,079
(716)
320
500
5,183
— $ 1,038,864
(5,183)
$ 1,033,681
(2,539)
(2,539)
— $
199
199
$
— $
6
6
$
— $
8
8
$
— $
2,539
2,539
$
826
4,357
5,183
— $
— $
— $
285,677
14,336
20,329
— $
—
2,725
1,030,046
1,231
286,908
$
217
14,553
42
$ 20,371
$
—
6,093
— $ 1,038,864
Impaired loans, by definition, are individually evaluated.
A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2017 is as follows (dollars
in thousands):
Commercial,
One to four
Commercial
real estate
financial and Commercial
construction
agricultural
family residential Consumer
real estate
construction Consumer Unallocated
Total
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
$
$
1,345
(155)
80
380
1,650
$
$
614
(264)
39
187
576
$ 406,742
(1,650)
$ 405,092
$ 156,951
(576)
$ 156,375
$
$
168
1,482
1,650
$
$
166
410
576
$
516
404,835
1,391
$ 406,742
$
166
156,785
—
$ 156,951
$
$
$
$
$
$
$
$
57
—
2
(5)
54
9,243
(54)
9,189
$
$
$
$
296
(155)
65
(46)
160
209,890
(160)
209,730
$
$
$
$
6
—
—
—
6
$
$
90
(229)
51
98
10
$
$
2,612
—
—
11
2,623
$
$
5,020
(803)
237
625
5,079
10,818
(6)
10,812
$ 17,434
(10)
$ 17,424
$
— $ 811,078
(5,079)
$ (2,623) $ 805,999
(2,623)
— $
54
54
$
— $
160
160
$
— $
6
6
$
— $
10
10
$
— $
2,623
2,623
$
334
4,745
5,079
— $
— $
— $
— $
9,243
—
9,243
$
208,269
1,621
209,890
10,801
17
10,818
17,413
21
$ 17,434
$
$
— $
682
—
807,346
3,050
—
— $ 811,078
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.
61
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.
62
General Reserves:
For loans with a credit risk rating of 44 or better and any loans with a risk rating of 6 or 7 not considered impaired,
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 $7.585 million and $3.854 million at December 31, 2018, and 2017,
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, 2018 (dollars in thousands):
(1)
(2)
Strong Good Average
(3)
(4)
(44)
(6)
(7)
Rating
Acceptable Acceptable Watch Substandard Doubtful Unassigned
Total
Commercial real estate
Commercial, financial and
agricultural
Commercial construction
One-to-four family
residential real estate
Consumer construction
Consumer
$ 9,564
$ 22,265
$ 189,898
$ 257,627
$
5,993
$
10,860
$ — $
— $
496,207
8,077
734
70
—
19
8,678
706
2,873
—
236
72,466
6,844
6,941
—
625
97,441
12,244
15,711
200
1,156
2,269
829
2,095
50
42
2,129
823
4,757
11
77
—
—
—
7,585
— 254,461
14,292
—
18,216
—
191,060
29,765
286,908
14,553
20,371
Total loans
$ 18,464
$ 34,758
$ 276,774
$ 384,379
$
11,278
$
18,657
$ — $ 294,554
$ 1,038,864
Below is a breakdown of loans by risk category as of December 31, 2017 (dollars in thousands)
(1)
(2)
(3)
(4)
(44)
(6)
(7)
Rating
Strong Good
Average Acceptable Acceptable Watch Substandard Doubtful Unassigned
Total
Commercial real estate
Commercial, financial and
agricultural
Commercial construction
One-to-four family
residential real estate
Consumer construction
Consumer
$ 2,775
$ 23,929
$ 159,385
$ 207,921
$
8,700
$
4,032
$ — $
— $ 406,742
11,528
—
—
—
—
8,980
308
1,377
—
—
53,448
2,749
2,575
—
—
77,964
1,310
5,449
—
28
3,658
648
1,212
—
5
1,373
374
3,515
14
96
—
—
—
—
—
—
3,854
195,762
10,804
17,305
156,951
9,243
209,890
10,818
17,434
Total loans
$ 14,303
$ 34,594
$ 218,157
$ 292,672
$
14,223
$
9,404
$ — $ 227,725
$ 811,078
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
63
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):
December 31, 2018
Commercial real estate
Commercial, financial and agricultural
Commercial construction
One to four family residential real estate
Consumer construction
Consumer
Total
December 31, 2017
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
Impaired Loans
with No Related
Allowance
Impaired Loans
with Related
Allowance
Total
Impaired
Loans
Unpaid
Principal
Balance
Related
Allowance for
Loan Losses
$
$
$
$
2,777
1,460
366
1,231
217
42
6,093
1,511
—
—
1,621
17
21
3,170
$
$
$
$
2,148
577
—
—
—
—
2,725
516
166
—
—
—
—
682
$
$
$
$
4,925
2,037
366
1,231
217
42
8,818
2,027
166
—
1,621
17
21
3,852
$
$
$
$
10,740
2,249
1,132
4,136
—
55
18,312
3,326
326
—
2,315
66
21
6,054
$
$
$
$
486
340
—
—
—
—
826
168
166
—
—
—
—
334
Individually Evaluated Impaired Loans
December 31, 2018
December 31, 2017
Average
Balance for
the Period
Interest Income
Recognized for
the Period
Average
Balance for
the Period
Interest Income
Recognized for
the Period
5,024
374
383
2,879
9
38
8,707
$
$
410
26
13
203
—
4
656
$
$
2,784
246
—
2,057
37
13
5,137
$
$
141
1
3
134
—
2
281
$
$
A summary of past due loans at December 31, is as follows (dollars in thousands):
December 31,
2018
December 31,
2017
30-89 days 90+ days
Past Due
(accruing)
Past Due
(accruing) Nonaccrual
$
Commercial real estate
Commercial, financial and agricultural
Commercial construction
One to four family residential real estate
Consumer construction
Consumer
298
398
112
5,456
—
108
$
— $
—
—
18
—
5
1,700
320
266
2,725
—
43
30-89 days 90+ days
Past Due
(accruing)
Past Due
(accruing) Nonaccrual
$
$
460
16
73
3,424
—
72
— $
—
—
—
—
—
866
338
14
1,350
—
—
Total
$ 1,998
718
378
8,199
—
156
Total
$ 1,326
354
87
4,774
—
72
Total past due loans
$
6,372
$
23
$
5,054
$ 11,449
$
4,045
$
— $
2,568
$ 6,613
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
64
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 new troubled debt restructurings that occurred during the years ended December 31 2018, and December
31, 2017.
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
2018
2017
$ 10,037
660
(245)
(635)
$ 9,195
2,018
237
(1,413)
$ 9,817
$10,037
There were no loans to related-parties classified substandard as of December 31, 2018 and 2017. In addition to the
outstanding balances above, there were unfunded commitments of $.987 million to related parties at December 31, 2018.
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
2018
2017
$ 4,417
23,283
13,428
540
41,668
18,885
$ 2,998
18,473
11,178
—
32,649
16,359
$ 22,783
$ 16,290
Depreciation of premises and equipment charged to operating expenses amounted to $2.432 million in 2018 and $1.978
million in 2017.
65
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 in business combinations
Proceeds from other real estate sold
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
2018
2017
$ 3,558
1,878
263
(2,398)
(125)
(57)
$ 4,782
2,147
—
(2,983)
(307)
(81)
$ 3,119
$ 3,558
Foreclosed residential real estate property of $.596 million is included in other real estate as of December 31, 2018. 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 $.596 as of December 31, 2018.
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
2018
2017
$ 241,556
368,890
111,358
225,236
13,737
136,760
$ 148,079
280,309
61,097
142,159
11,055
175,299
$ 1,097,537
$ 817,998
Maturities of non-brokered time deposits outstanding at December 31, 2018 are as follows (dollars in thousands):
2019
2020
2021
2022
2023
Thereafter
Total
$ 116,806
81,825
22,844
11,996
5,019
483
$ 238,973
66
NOTE 8 — GOODWILL AND OTHER INTANGIBLE ASSETS
The Corporation through the acquisition of Peninsula in 2014, Eagle River and Niagara in 2016, and FFNM and Lincoln
in 2018, has recorded goodwill and core deposit intangibles as presented below (dollars in thousands):
Peninsula
Eagle River
Niagara
FFNM
Lincoln
Total
Peninsula
Eagle River
Niagara
FFNM
Lincoln
Total
Peninsula
Eagle River
Niagara
Total
Goodwill
Balance
Deposit Based
Intangible
Initital Balance
$
$
$
3,805
1,839
50
14,915
1,415
22,024
$
1,206
993
300
2,894
1,353
6,746
Deposit Based
Intangible
2018
Future Annual
December 31, 2018
Amortization
Amortization
Balance
Expense
Expense
$
$
$
714
728
230
2,735
1,313
$
121
99
30
159
41
5,720
$
450
$
121
99
30
290
135
675
Deposit Based
Intangible
2017
December 31, 2017
Amortization
Balance
Expense
$
$
$
835
827
260
1,922
$
120
99
30
249
The deposit based intangible is reported net of accumulated amortization at $5.720 million at December 31, 2018,
compared to $1.922 million at December 31, 2017. Amortization expense in 2018 is $.450 million compared to $.249
million in 2017. Amortization expense for the next five years is expected to be at $.675 million per year.
67
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, 2018, the Corporation had obligations to service $293.771 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 8.87% and a discount rate of 10.40% for December 31,
2018, which resulted in a fair value of $2.898 million. In 2017, the fair value was $1.767 million.
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
Additions from loans sold with servicing retained
Acquired MSRs
Amortization
Balance at end of period
Balance of loan servicing portfolio
Mortgage servicing rights as % of portfolio
Fair value of servicing rights
December 31, December 31,
2018
2017
$
$
1,033
18
539
(446)
1,573
—
—
(540)
$
1,144
$ 293,771
0.34%
2,898
$
$
1,033
$ 198,524
0.52%
1,767
$
Commercial Loans
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, 2018 and December 31, 2017 was approximately $44 million and $44 million, respectively. The Corporation valued
these servicing rights at $80,000 as of December 31, 2018 and $.110 million at December 31, 2017. 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 term note
USDA Rural Development note
2018
$ 57,060
—
476
2017
$ 60,000
18,999
553
$ 57,536
$ 79,552
The Federal Home Loan Bank borrowings bear a weighted average rate of 1.72% and mature in 2019, 2020, 2021, 2023,
and 2026. They are collateralized at December 31, 2018 by the following: a collateral agreement on the Corporation’s
one to four family residential real estate loans with a book value of approximately $64.918 million; mortgage related and
municipal securities with an amortized cost and estimated fair value of $24.919 million and $24.908 million,
respectively; and Federal Home Loan Bank stock owned by the Bank totaling $4.924 million. Prepayment of the
advances is subject to the provisions and conditions of the credit policies of the Federal Home Loan Bank of
Indianapolis in effect as of December 31, 2018.
68
The Corporation currently has one correspondent banking borrowing relationship. The relationship consists of a $15.0
million revolving line of credit, which had no outstanding balance at December 31, 2018. The line of credit bears
interest at a rate of LIBOR plus 2.00%, with a floor rate of 3.00% and a ceiling of 22%. The line of credit expires on
April 30, 2020. LIBOR was 2.81% at December 31, 2018. The Corporation previously had a term note as part of this
relationship that was paid in full during the second quarter of 2018. 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 $.476 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 $.537 million, and guaranteed by the
Corporation.
Maturities and principal payments of borrowings outstanding at December 31, 2018 are as follows (dollars in
thousands):
2019
2020
2021
2022
2023
Thereafter
Total
$16,290
12,567
25,145
80
373
3,081
$57,536
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
Adjustment of deferred taxes due to change in enacted tax rate
Deferred tax expense
Provision for income taxes
2018
$ 1,352
—
874
$
2017
585
2,025
2,929
$ 2,226
$ 5,539
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
Adjustment of deferred taxes due to change in enacted tax rate
Nondeductible transaction expenses
Other
2018
$ 2,225
2017
$ 3,746
(97)
—
138
(40)
(133)
2,025
17
(116)
Provision for income taxes, as reported
$ 2,226
$ 5,539
69
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):
2018
2017
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
$ 2,634
1,078
$ 1,580
948
— 1,463
119
235
242
240
79
19
785
63
168
140
307
221
92
99
2,206
808
Total deferred tax assets
7,753
5,773
Deferred tax liabilities:
Core deposit premium
FHLB stock dividend
Depreciation
Mortgage servicing rights
Other
Total deferred tax liabilities
Net deferred tax asset
(1,256)
(73)
(101)
61
(621)
(1,990)
(404)
(56)
(79)
(240)
(24)
(803)
$ 5,763
$ 4,970
The Corporation has reported net deferred tax assets of $5.763 million at December 31, 2018.
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, 2018 had a net operating loss and tax credit
carryforwards for tax purposes of approximately $12.5 million, and $1.7 million, respectively. As a result of the repeal
of the corporate alternative minimum tax in the Tax Cuts and Jobs Act, any outstanding alternative minimum tax credits
are believed to be utilized or refundable as of December 31, 2018. Therefore, the $1.6 million of alternative minimum
tax credits, was reclassified to a current tax receivable included in other assets during the year. The Corporation
evaluated the future benefits from these carryforwards as of December 31, 2018 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 $2.0 million for the NOL and the equivalent value of tax credits, which is
approximately $.420 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 five operating leases for branch locations in Birmingham, Manistique, Marquette,
Negaunee and Traverse City.
70
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):
2019
2020
2021
2022
2023
Thereafter
Total
$
747
608
503
499
495
2,629
$ 5,481
Rent expense for all operating leases amounted to $1.096 million in 2018 and $1.109 million in 2017.
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 $.400 million and $.341 million
in 2018 and 2017 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 2019 are $22,000.
The anticipated distributions over the next five years and through December 31, 2028 are detailed in the table below
(dollars in thousands):
2019
2020
2021
2022
2023
2024-2028
Total
$
136
132
131
137
143
823
$ 1,502
71
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 (gain) 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
2018
2017
$ 3,331
109
(315)
(134)
2,991
$ 3,187
118
161
(135)
3,331
2,191
(134)
64
(134)
1,987
2,049
259
18
(135)
2,191
Funded status, included with other liabilities
$ (1,004) $ (1,140)
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
2018
2017
4.02% 3.33%
N/A
8.00% 8.00%
N/A
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, 2018 and December 31, 2017:
Equity securities
Fixed income securities
NOTE 15 — DEFERRED COMPENSATION PLAN
Target
Allocation
50% to 70%
30% to 50%
Actual
Allocation
59%
41%
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, 2018 and 2017, for vested benefits under this plan, was $82,000 and $.113 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 $1.443 million and $1.465 million at
December 31, 2018 and 2017, respectively.
72
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, 2018 and
2017, for vested benefits under this plan was $.900 million and $1.038 million, respectively. The bank owned life
insurance policy as of December 31, 2018 and 2017 had cash surrender values of $1.760 million and $1.741 million,
respectively. This Plan was also discontinued by the Corporation and will not apply to future employees or directors of
the Corporation.
First Federal of Northern Michigan, acquired in May 2018 had a deferred compensation plan, which was similar in
nature to the Corporation’s discontinued plan. The liability for this plan at December 31, 2018, for vested benefits under
this plan was $.417 million. The bank owned life insurance policy as of December 31, 2018 had a cash surrender value
of $5.239 million. This Plan was also discontinued by the Corporation and will not apply to future employees or
directors of the Corporation.
Deferred compensation expense for the three plans was $92,000 and $65,000 for 2018 and 2017 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, 2018, the Corporation is well
capitalized.
The Corporation’s and the Bank’s actual capital and ratios compared to generally applicable regulatory requirements as
of December 31, 2018 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
Ratio
Amount
Well-Capitalized
Ratio
Amount
$ 124,207
$ 121,406
12.5% > $ 79,705 > 8.0% >
N/A
12.2% > $ 79,464 > 8.0% > $ 99,329
N/A
10.0%
$ 119,024
$ 116,264
12.0% > $ 59,779 > 6.0% >
N/A
11.7% > $ 59,598 > 6.0% > $ 79,464
N/A
8.0%
$ 119,024
$ 116,264
12.0% > $ 44,834 > 4.5% >
N/A
11.7% > $ 44,698 > 4.5% > $ 64,564
N/A
6.5%
$ 119,024
$ 116,264
9.2% > $ 51,552 > 4.0% >
N/A
9.0% > $ 51,556 > 4.0% > $ 64,445
N/A
5.0%
73
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
NOTE 17 — STOCK COMPENSATION PLANS
Restricted Stock Awards
Actual
Amount
Ratio
Adequacy Purposes
Ratio
Amount
Well-Capitalized
Ratio
Amount
$ 74,533
$ 93,598
N/A
9.3% > $ 64,190 > 8.0% >
11.7% > $ 64,202 > 8.0% > $ 80,252
N/A
10.0%
$ 69,454
$ 88,560
N/A
8.7% > $ 48,142 > 6.0% >
11.0% > $ 48,151 > 6.0% > $ 64,202
N/A
8.0%
$ 69,454
$ 88,560
N/A
8.7% > $ 36,107 > 4.5% >
11.0% > $ 36,113 > 4.5% > $ 52,164
N/A
6.5%
$ 69,454
$ 88,560
N/A
7.1% > $ 39,375 > 4.0% >
9.0% > $ 39,279 > 4.0% > $ 49,098
N/A
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.
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
March, 2015
May, 2015
February, 2016
February, 2017
February, 2018
April, 2018
Units Granted
37,730
3,000
35,733
28,427
18,643
8,000
Market Value at
grant date
11.15
10.77
9.91
13.39
16.30
16.00
Vesting Term
4 years
Immediate
4 years
4 years
4 years
Immediate
On August 31, 2016, the Corporation issued 37,125 shares of its common stock for vested RSAs. 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. In 2018, the Corporation issued 46,666 shares for vested
RSAs.
The Corporation recognized annual compensation expense of $.533 million in 2018 and $.398 million in 2017.
Unrecognized compensation expense at the end of 2018 was $.550 million.
74
A summary of changes in our nonvested awards for the year follows:
Nonvested balance at January 1, 2018
Granted during the period
Forfeited during the period
Vested during the period
Nonvested balance at December 31, 2018
NOTE 18 — SHAREHOLDERS’ EQUITY
Number
Outstanding
87,285
26,643
2,060
(46,666)
69,322
Weighted Average
Grant Date
Fair Value
$
$
11.78
16.21
14.75
12.65
12.79
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, 2018, $25,000 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
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
2018
2017
$
$ 88,862
54,434
7,208
5,107
72,187
37,468
7,753
5,788
$ 155,611
$
123,196
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.
75
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, 2018, 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, 2018 represents $150.251 million, or 20.95%,
compared to $119.025 million, or 20.77%, of the commercial loan portfolio on December 31, 2017. 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.
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 using an exit
notion as of December 31, 2018. As of December 31, 2017 an entrance price was used to measure the fair value of
loans.
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.
76
Off-balance-sheet instruments - The fair value of commitments is estimated using the fees currently charged to enter
into similar agreements, taking into account the remaining terms of the agreements, the current interest rates, and the
present creditworthiness of the counterparties. Since the differences in the current fees and those reflected to the off-
balance-sheet instruments at year-end are immaterial, no amounts for fair value are presented.
The following table presents information for financial instruments at December 31 (dollars in thousands):
Financial assets:
Cash and cash equivalents
Interest-bearing deposits
Securities available for sale
Securities available for sale
Federal Home Loan Bank stock
Net loans
Accrued interest receivable
Level in Fair
Value Hierarchy
Carrying
Amount
Estimated
Fair Value
December 31, 2018
December 31, 2017
Carrying
Amount
Estimated
Fair Value
Level 1
Level 2
Level 2
Level 3
Level 2
Level 3
Level 3
$
64,157
13,452
115,260
1,488
4,924
1,033,681
3,005
$
64,157
13,452
115,260
1,488
4,924
1,013,214
3,005
$ 37,426
13,374
74,397
1,500
3,112
805,999
2,276
$ 37,426
13,374
74,397
1,500
3,112
797,726
2,276
Total financial assets
$ 1,235,967
$ 1,215,500
$ 938,084
$ 929,811
Financial liabilities:
Deposits
Borrowings
Accrued interest payable
Total financial liabilities
Level 2
Level 2
Level 3
$ 1,097,537
57,536
391
$ 1,047,709
56,771
391
$ 817,998
79,552
322
$ 788,632
79,242
322
$ 1,155,464
$ 1,104,871
$ 897,872
$ 868,196
Limitations - Fair value estimates are made at a specific point in time based on relevant market information and
information about the financial instrument. These estimates do not reflect any premium or discount that could result
from offering for sale at one time the Corporation’s entire holdings of a particular financial instrument. Because no
market exists for a significant portion of the Corporation’s financial instruments, fair value estimates are based on
judgments regarding future expected loss experience, current economic conditions, risk characteristics of various
financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters
of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly
affect the estimates. Fair value estimates are based on existing on-and off-balance-sheet financial instruments without
attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not
considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities
include premises and equipment, other assets, and other liabilities. In addition, the tax ramifications related to the
realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been
considered in the estimates.
The following is information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at
December 31, 2018 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.
77
The fair value of all investment securities at December 31, 2018 and 2017 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
US Agencies
US Agencies - MBS
Obligations of state and
political subdivisions
Balance at
December 31, 2018
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, 2018
$
$
$
20,064
15,970
32,840
47,874
116,748
— $
—
—
—
$
19,564
15,970
32,840
46,886
500
—
—
988
$
$
—
—
—
—
—
Quoted Prices
Significant
Significant
(dollars in thousands)
Assets
Balance at
December 31, 2017
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
Corporate
US Agencies
US Agencies - MBS
Obligations of state and political
subdivisions
$
$
$
24,891
16,846
12,716
21,444
75,897
— $
—
—
$
24,391
16,846
12,716
500
—
—
—
20,444
1,000
$
$
—
—
—
—
—
The Corporation had no other Level 3 assets or liabilities on a recurring basis as of December 31, 2018.
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, 2018 and 2017 (dollars in
thousands):
Balance at
Net Gains (losses)
Beginning
of Period Realized Unrealized Level 3
Transfers
in (out) of
Purchases
Sales
Balance
at end
of Period
Year Ended December 31, 2018
Corporate
Obligations of state and political subdivisions
$
500 $ — $
1,000
—
78
— $ — $ — $ — $
—
(12)
—
—
500
988
Balance at
Beginning Net Gains (losses)
of Period Realized Unrealized Level 3 Purchases
Transfers
in (out) of
Sales
Balance
at end
of Period
Year Ended December 31, 2017
Corporate
US Agencies- MBS
Obligations of state and political subdivisions
$
500 $ — $ — $ — $ — $
—
—
— 740
1,150
—
38
—
260
— (1,188)
— $
500
—
— 1,000
Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2018
Quoted Prices
Significant
Significant
(dollars in thousands) December 31, 2018
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, 2018
Impaired loans
Other real estate
held for sale
$
8,818
$
— $
— $
8,818
$
3,119
—
—
3,119
$
198
182
380
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
Year Ended
December 31, 2017
Impaired loans
Other real estate
held for sale
$
3,852
$
— $
— $
3,852
$
3,558
—
—
3,558
$
141
388
529
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
First Federal of Northern Michigan Bancorp, Inc.
The Corporation completed its acquisition of First Federal of Northern Michigan Bancorp, Inc. in May 2018. FFNM had
seven branch offices, one of which was consolidated into an existing mBank branch shortly after consummation of the
transaction. Total assets of FFNM as of May 18, 2018 were $318 million, including total loans of $192 million. Deposits
garnered in the acquisition the majority of which are core deposits, totaled $254 million. The results of operations due to
the merger have been included in the Corporation’s results since the acquisition date. As consideration in the
acquisition, the Corporation issued 2,146,378 new shares, approximating $34.101 million. The Corporation recorded
preliminary deposit based intangibles of $2.894 million and goodwill of $14.915 million. While the Corporation
believes the majority of the business combination and purchase accounting activity is complete, it is expected there will
79
be minor adjustments in the normal course within the allotted GAAP adjustment period. Purchase accounting activity
still being analyzed primarily includes certain tax implications.
The table below highlights the allocation of purchase price for the FFNM acquisition (dollars in thousands, except per
share data):
Purchase Price:
FFNM shares outstanding
Price per share
Total purchase price
Net assets acquired:
Cash and cash equivalents
Securities available for sale
FHLB Stock
Total loans
Premises and equipment
Other real estate owned
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
FHLB borrowings
Deferred tax liability
Other liabilities
Total liabilities
Net assets acquired
Goodwill
3,726,925
9.15
$
$
34,101
$
13,267
96,297
1,748
185,444
5,134
194
2,894
386
2,844
5,170
1,775
315,153
60,616
193,099
253,715
40,722
133
1,397
295,967
19,186
$
14,915
80
Lincoln Community Bank
The Corporation completed its acquisition of Lincoln Community Bank on October 1, 2018. Lincoln had two branch
offices, one of which was subsequently closed in 2018, and total assets of $60 million. 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 $8.500 million.
Purchase Price:
Cash consideration
Net assets acquired:
Cash and cash equivalents
Securities available for sale
Total loans
Premises and equipment
Other real estate owned
Deposit based intangible
Bank owned life insurance
Other assets
Total assets
Non-interest bearing deposits
Interest bearing deposits
Total deposits
Deferred tax liability
Other liabilities
Total liabilities
Net assets acquired
Goodwill
$
8,500
$
10,971
6,947
38,001
1,249
69
1,353
1,653
339
60,582
15,559
37,654
53,213
231
53
53,497
7,085
$
1,415
The following table provides the unaudited pro forma information for the results of operations for the twelve months
ended December 31, 2018 and 2017, as if both the FFNM acquisition and Lincoln acquisition had occurred on January 1.
These adjustments reflec the impact of certain purchase accounting fair value measurements, primarily on the loan and
deposit portfolios of FFNM and Lincoln. In addition, merger-related costs noted above are excluded from the 2017
results of operations, for comparative purposes. Further operating cost savings are expected along with additional
business synergies as a result of the mergers 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 the merger occurred at
the beginning of the period, nor are they intended to represent or be indicative of the future results of the Corporation.
Net interest income
Noninterest income
Noninterest expense
Net income
Net income per diluted share
Fair Value
2018
$ 50,787
5,071
47,529
8,329
0.75
$
2017
$ 49,728
6,366
49,360
6,734
0.80
$
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
81
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 FFNM and Lincoln.
NOTE 23 — PARENT COMPANY ONLY FINANCIAL STATEMENTS
BALANCE SHEETS
December 31, 2018 and 2017
(Dollars in Thousands)
ASSETS
Cash and cash equivalents
Investment in subsidiaries
Other assets
TOTAL ASSETS
LIABILITIES AND SHAREHOLDERS’ EQUITY
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 - 10,712,745 and 6,294,930 shares respectively
Retained earnings
Accumulated other comprehensive income
Total shareholders’ equity
2018
2017
$
2,470
146,516
4,306
$
198
97,984
3,263
$ 153,292
$ 101,445
—
1,223
1,223
18,999
1,046
20,045
129,066
23,466
(463)
61,981
19,711
(292)
152,069
81,400
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY
$ 153,292
$ 101,445
82
STATEMENTS OF OPERATIONS
Years Ended December 31, 2018 and 2017
(Dollars in Thousands)
INCOME:
Interest income
Miscellaneous income
Total income
EXPENSES:
Interest expense on borrowings
Salaries and benefits
Professional service fees
Transaction related expenses
Other
Total expenses
Loss before income taxes and equity in net income of subsidiaries
Provision for (benefit of) income taxes
Loss before equity in net income of subsidiaries
Equity in net income of subsidiaries
$
$
2018
2017
$
$
1
17
18
320
835
242
814
350
—
—
—
868
698
279
50
294
2,561
2,189
(2,543)
(2,189)
(534)
(27)
(2,009)
(2,162)
10,376
7,641
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS
$
8,367
$
5,479
83
STATEMENTS OF CASH FLOWS
Years Ended December 31, 2018 and 2017
(Dollars in Thousands)
Cash Flows from Operating Activities:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
$
8,367
$
5,479
2018
2017
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 from capital raise
Net cash provided by (used in) financing activities
Net increase (decrease) in cash and cash equivalents
Cash and cash equivalents at beginning of period
(10,376)
533
1,043
365
(68)
2,000
(8,500)
(6,500)
—
(18,999)
—
—
(4,612)
32,451
8,840
2,272
198
(7,641)
398
751
77
(936)
7,000
—
7,000
—
(2,200)
(750)
—
(3,022)
—
(5,972)
92
106
Cash and cash equivalents at end of period
$
2,470
$
198
84
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, 2018 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, 2018, 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, 2018, its system of internal control over financial
reporting is effective and meets the criteria of the “Internal Control — Integrated Framework.”
Our independent registered public accounting firm also attested to, and reported on, the Company’s Internal Control over
Financial Reporting. Management’s report and the independent registered public accounting firm’s report are included
in Item 8 of this Annual Report on Form 10-K.
Item 9B. Other Information
None.
85
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
68 Chairman and Chief Executive Officer
Kelly W. George
51
President
Jesse A. Deering
39
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
2019 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
2019 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.
86
The following table provides information as of December 31, 2018 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 - March 2015
Restricted stock awards - February 2016
Restricted stock awards - February 2017
Restricted stock awards - February 2018
Shares available for future issuance
Total
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)
9,432
17,867
23,441
18,993
—
69,733
$
—
—
—
—
—
—
—
—
—
—
244,100
244,100
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.
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.
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.
87
3.
Exhibits
The exhibits required to be filed as part of this Form 10-K are listed in the attached Exhibit Index.
Exhibit
Number
INDEX TO EXHIBITS
Incorporated by Reference
2.1
2.2
2.3
2.4
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.
2.5 Merger Agreement, dated as of May 18,
2018, by and among Mackinac Financial
Corporation and First Federal of Northern
Michigan Bancorp, Inc.
Form
8-K
File No.
000-20167
Exhibit
Filing Date
2.1 1/19/2016
Filed Herewith
8-K
000-20167
2.1 5/24/2016
8-K
000-20167
2.1 1/19/2018
8-K
000-20167
2.1 2/13/2018
8-K
000-20167
99.1 5/18/2018
2.6 Merger Agreement, dated as of October 1,
8-K
000-20167
99.1 10/01/2018
2018, by and among Mackinac Financial
Corporation and Lincoln Community Bank.
Articles of Incorporation and all amendments
(most recent amendment filed December 14,
2004)
Third Amended and Restated Bylaws
adopted March 18, 2014
Form of Director and Officer Indemnification
Agreement**
3.1
3.3
10.1
10.3
10.2 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**
10-K
000-20167
3.1 3/31/2009
8-K
000-20167
3.1 3/24/2014
8-K
000-20167
10.1 3/24/2014
DEF14A 000-20167 Annex I 4/25/2012
10-K
000-20167
10.3 3/15/2018
88
10-K
000-20167
10.4 3/15/2018
10-K
000-20167
10.5 3/15/2018
8-K
000-20167
10.3 8/13/2012
10.4
10.5
10.6
21
23.1
31
32.1
32.2
101.INS
101.SCH
101.CA
L
101.DEF
101.LA
B
101.PRE
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
XBRL Instance Document
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***
*
*
*
*
*
*
*
*
*
*
*
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.
89
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 18, 2019.
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 18,
2019, 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
/s/ Martin Thomson
Martin Thomson — Director
90
DIRECTORSOCCUPATIONDATE JOINEDWalter J. Aspatore Lead DirectorChairman Methode Electronics, Inc.2004Dennis B. BittnerOwner and President Bittner Engineering, Inc.2001Joseph D. GareaManaging Director Detalus Advisors2007Kelly W. GeorgePresident, Mackinac Financial Corporation President and CEO, mBank2006Robert E. MahaneyOwner and President Veridea Group, LLC2008Robert H. OrleyFounding Partner O2 Investments, LLC2004Randolph C. PaschkeExecutive-in-Residence, Mike Ilitch School of Business Wayne State University2004L. Brooks PattersonCounty Executive Oakland County2006David R. SteinhardtCo-Founder and Board Member Clarity Capital 2012Martin A. ThomsonDirector mBank2018Paul D. TobiasChairman and CEO, Mackinac Financial Corporation Chairman, mBank2004Directors + OfficersBoard of Directors156745BDY_r1_MB_AR_2019_V20.indd 194/17/19 9:16 PM OFFICERSMBANK EXECUTIVE MANAGEMENTLOCATIONPaul D. TobiasChairmanBirminghamKelly W. GeorgePresident Chief Executive OfficerManistiqueJesse A. DeeringExecutive Vice President Chief Financial OfficerBirminghamTamara R. McDowellExecutive Vice President – Managing Director of Credit Administration/OperationsManistiqueJoanna B. SlaghtExecutive Vice President – Managing Director of Compliance & Regulatory RiskManistiqueClay V. PetersonExecutive Vice President – Managing Director of Retail Lending and Western UP & Wisconsin Market ExecutiveEscanabaMichael W. MahlerExecutive Vice President – Managing Director of Community Banking & AdministrationAlpenaJake D. MartinExecutive Vice President – Chief Technology OfficerTraverse CityOFFICERSMACKINAC FINANCIAL CORPORATIONLOCATIONPaul D. TobiasChairman Chief Executive OfficerBirminghamKelly W. GeorgePresidentManistiqueJesse A. DeeringExecutive Vice President Chief Financial OfficerBirminghamDirectors + OfficersOfficers156745BDY_r1_MB_AR_2019_V20.indd 204/17/19 9:16 PM OFFICERSMBANK SENIOR MANAGEMENTLOCATIONSherry ArnoldSenior Vice President – Administration and Talent DirectorManistiqueJeremy FlodinSenior Vice President – Senior Credit Administrator/ Risk AnalystManistiqueEdward LewanPresident – mBank Business Credit Asset-Based Lending DivisionBirminghamBoris MartyszSenior Vice President – Commercial Banking Manager and Marquette County ExecutiveMarquetteErin McCormickSenior Vice President – Branch Administration & Sales OfficerEagle RiverAndrew SabatineRegional President – Northern Lower MichiganTraverse CityGregory SchuetterSenior Vice President – Eastern UP/NLP Commercial Banking ManagerManistiqueJennifer StempkiSenior Vice President – Controller/Liquidity Funding ManagerManistiqueJerome W. TraceySenior Vice President – Commercial Banking/ Alpena Market ExecutiveAlpenaDirectors + Officers156745BDY_r1_MB_AR_2019_V20.indd 214/17/19 9:16 PM ADDITIONAL OFFICERSCENTRAL DEPARTMENTSDEPARTMENTMichael GallagherRegional Vice PresidentAsset-Based LendingAustin MyersAssistant Vice President – Credit ManagerAsset-Based LendingBarbara ParrettVice President – Branch OperationsBranch OperationsMelissa ChabotVice President – Branch Operations ManagerBranch Operations Teresa SameVice President – Branch OperationsBranch OperationsJulie BosanicVice President – Director of Mortgage Administration Central CreditShannon O’BrienAssistant Vice President – Senior Credit Analyst Supervisor/ Assistant Credit Risk ManagerCentral CreditNicole TryanAssistant Vice President – Senior Loan Operations OfficerCentral CreditTeresa BeachAssistant Vice President – Loan Compliance OfficerComplianceBernadette BeaudreVice President – Deposit Compliance/BSA OfficerCompliance/ AdministrationTrisha DeMarsAssistant Vice President – Senior Deposit Operations SpecialistDeposit OperationsChristopher PerrymanAssistant Vice President – Assistant ControllerFinanceAmy LeeAssistant Vice President – Human Resources Manager Human ResourcesRyan ValiquetteAssistant Vice President – IT Department Manager/ Senior Network Administrator Information TechnologyBethany CodyAssistant Vice President – Marketing OfficerMarketingElizabeth YoungAssistant Vice President – Marketing OfficerMarketingEileen BudnickVice President – Director of Deposit OperationsOperationsTifanie TrembleVice President – Treasury ManagementTreasury Management Directors + Officers156745BDY_r1_MB_AR_2019_V20.indd 224/17/19 9:16 PM ADDITIONAL OFFICERSUPPER PENINSULALOCATIONAnn DemingVice President – Mortgage & Consumer Lending ManagerEscanabaScott RavetVice President – Commercial Banking OfficerEscanabaApril StropichAssistant Vice President – Mortgage Loan OfficerEscanabaTerry GarceauVice President – Retail & Commercial Banking OfficerIshpemingTia RoddaAssistant Vice President – District ManagerIshpemingRichard DemersVice President – Commercial Banking OfficerManistiqueMagan PetersonVice President – Regional Retail Lending Team LeadManistiqueRoss AnthonyVice President – Regional Retail Lending Team LeadMarquetteJosh BalAssistant Vice President – Mortgage Loan OfficerMarquetteJoseph HavicanVice President – Commercial Banking OfficerMarquetteJeremy HinksonVice President – Commercial Banking OfficerMarquetteKari StockingerAssistant Vice President – Mortgage Loan OfficerMarquetteAngela BuckinghamAssistant Vice President – Branch ManagerNewberryDavid ThomasVice President – Commercial Banking OfficerSault Ste. MarieDirectors + Officers156745BDY_r1_MB_AR_2019_V20.indd 234/17/19 9:16 PM ADDITIONAL OFFICERSNORTHERN LOWER PENINSULALOCATIONThomas HendricksVice President – Commercial Banking OfficerAlpenaAndrew TraceyVice President – Commercial Banking OfficerAlpenaPaulette RoznowskiAssistant Vice President – Mortgage Loan OfficerAlpenaJoAnn DehringAssistant Vice President – District ManagerAlpenaBarbara FoxAssistant Vice President – Mortgage Loan OfficerAlpenaCyril DrierVice President – Commercial Banking OfficerCheboyganDeborah DombroskiAssistant Vice President – Mortgage Loan OfficerCheboyganPenny ShumakerAssistant Vice President – Mortgage Loan OfficerLewistonElaine BunkerAssistant Vice President – District ManagerGaylordJanet WillbeeVice President – Mortgage Loan OfficerGaylordMichael CarusoSenior Vice President - Commercial Banking OfficerTraverse CityJohn KlingelsmithVice President – Mortgage Loan OfficerTraverse CityDaniel StoudtAssistant Vice President – Mortgage Loan OfficerTraverse CityADDITIONAL OFFICERSSOUTHEAST MICHIGANLOCATIONGeorge DemouSenior Vice President – Commercial Banking OfficerBirminghamLaura GarvinSenior Vice President – Commercial Portfolio ManagerBirminghamJody ParadisVice President – Senior Commercial Banking OfficerBirminghamBrian WawsczykVice President – Asset Liability Manager & Senior Risk AnalystBirminghamDirectors + Officers156745BDY_r1_MB_AR_2019_V20.indd 244/17/19 9:16 PM ADDITIONAL OFFICERSWISCONSINLOCATIONChelsea BrandtAssistant Vice President – District ManagerEagle RiverJohn HletkoAssistant Vice President – Mortgage Loan OfficerEagle RiverJed LechleitnerVice President – Commercial Banking OfficerEagle RiverPatrick NickelVice President – Senior Commercial Banking OfficerEagle RiverClyde NelsonSenior Vice President – Business Development OfficerMerrillKurt RustVice President – Senior Commercial Banking OfficerMerrillMatthew AndersonAssistant Vice President – Mortgage Loan OfficerMerrillCatherine HumbaughAssistant Vice President – Mortgage Loan OfficerSt. GermainDirectors + Officers156745BDY_r1_MB_AR_2019_V20.indd 254/17/19 9:16 PM LEFT BLANK INTENTIONALLY
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Corporate InformationCORPORATE HEADQUARTERSMackinac Financial Corporation 130 S. Cedar Street Manistique, MI 49854 (888) 343–8147 INVESTOR RELATIONS Jesse A. Deering EVP/CFO (248) 290–5906 jdeering@bankmbank.comINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMPlante Moran, PLLC Grand Rapids, MichiganSHAREHOLDER INFORMATIONCopies 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’ MEETINGThe 2019 Annual Meeting of the Shareholders of Mackinac Financial Corporation will be held on May 29, 2019 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.TRANSFER AGENTBroadridge 51 Mercedes Way Edgewood, NY 11717 (844) 318–0133STOCK LISTING AND SYMBOLNasdaq Capital Market Symbol: MFNCWEBSITEbankmbank.commBank Regional Office | Marquette, MImBank Headquarters | Manistique, MICorporate Information156745CVR_r1_MB_AR_2019_V20.indd 4-64/17/19 10:58 PM 2018
A N N U A L
R E P O R T
130 South Cedar Street, Manistique, MI 49854
Community Focused. Client Driven.
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