MACKINAC FINANCIAL CORP /MI/ - FORM 10-K - EX-13

Attached files

file	filename
10-K - FORM 10-K - MACKINAC FINANCIAL CORP /MI/	k50242e10vk.htm
EX-21 - EX-21 - MACKINAC FINANCIAL CORP /MI/	k50242exv21.htm
EX-32.1 - EX-32.1 - MACKINAC FINANCIAL CORP /MI/	k50242exv32w1.htm
EX-99.1 - EX-99.1 - MACKINAC FINANCIAL CORP /MI/	k50242exv99w1.htm
EX-99.2 - EX-99.2 - MACKINAC FINANCIAL CORP /MI/	k50242exv99w2.htm
EX-32.2 - EX-32.2 - MACKINAC FINANCIAL CORP /MI/	k50242exv32w2.htm
EX-23.1 - EX-23.1 - MACKINAC FINANCIAL CORP /MI/	k50242exv23w1.htm
EX-31 - EX-31 - MACKINAC FINANCIAL CORP /MI/	k50242exv31.htm

Exhibit 13

Table of Contents


To Our Shareholders			1
Five-Year Overview			5
Regional Review			7
Selected Financial Highlights			13
Quarterly Financial Summary			14
Report of Independent Registered Public Accounting Firm			15
Consolidated Balance Sheets			16
Consolidated Statements of Operations			17
Consolidated Statements of Changes in Shareholders’ Equity			18
Consolidated Statements of Cash Flows			19
Notes to Consolidated Financial Statements			20
Selected Financial Data			48
Summary Quarterly Financial Information			49
Market Information			51
Shareholder Return Performance Graph			52
Forward-Looking Statements			53
Management’s Discussion and Analysis of Financial Condition and Results of Operations			54
Directors and Officers			76

BUSINESS OF THE CORPORATION

Mackinac Financial Corporation is a registered bank holding company formed under the Bank Holding Company Act of 1956 with assets in excess of $475 million and whose common stock is traded on the NASDAQ stock market as “MFNC.” The principal subsidiary of the Corporation is mBank. Headquartered in Manistique, Michigan, mBank has 11 branch locations; seven in the Upper Peninsula, three in the Northern Lower Peninsula and one in Oakland County, Michigan. The Company’s banking services include commercial lending and treasury management products and services geared toward small to mid-sized businesses, as well as a full array of personal and business deposit products and consumer loans.

FORM 10-K

A copy of the Annual Report to the Securities and Exchange Commission on Form 10-K is available without charge by writing the Shareholders’ Relations Department, Mackinac Financial Corporation, 130 South Cedar Street, Manistique, Michigan, 49854.

MARKET SUMMARY

The Corporation’s common stock is traded on the Nasdaq Capital Market under the symbol MFNC. The Corporation had 1,216 shareholders of record as of March 30, 2011.

To Our Shareholders

March 31, 2011

Dear Shareholders:

This letter will provide you with an update of the 2010 results of operations for Mackinac Financial Corporation (“MFNC”), the progress we are making in reducing nonperforming assets and the relative success we’ve had in other areas of the Corporation to build franchise value in this trying and difficult economic environment.

Following are several areas that we believe improved franchise value during 2010 and are indicative of increased earnings potential for future periods:

	•		We grew core bank deposits by $80 million. This reduced our reliance on wholesale deposits by $115.4 million, reducing balance sheet risk. We experienced core deposit growth in all of our markets, with $40 million in Northern Lower Michigan, $11 million in Southeast Michigan and $29 million in the Upper Peninsula. Most of our 2010 deposit growth occurred in low cost transactional accounts which grew by $44 million.

	•		We continued to experience good loan demand with approximately $114 million of new loan production, which included $37 million of mortgage loans sold in the secondary market. At 2010 year-end, the Corporation’s loans stood at $383.086 million, a slight decrease from the 2009 year-end balances of $384.310 million. Our total outstanding loans declined by $1.2 million after reductions for loan sales, (both SBA/USDA and secondary market) amortization and payoffs, some associated with the elimination of problem assets. We continue to be highly successful in producing well priced high quality loans in the Upper Peninsula with 2010 loan production of $81 million. Loan production totaled $22 million in Northern Lower Michigan and $11 million in Southeast Michigan where the market have been hit the hardest by the recession.

	•		In 2010 we had continued success in the origination and sales of SBA/USDA loans with total fee income of $.9 million in 2010 compared to $.5 million in fee income during 2009. We continue to be a state leader in these programs.

	•		One of our initiatives for 2010 was the expansion of our consumer lending program by hiring several key mortgage loan producers and the centralization of our consumer lending processing. This was successful, with secondary market fee income of $.5 million in 2010 compared to $.3 million in 2009 and an increase in total consumer loan production from $39 million in 2009 to $60 million in 2010. We also have retained the servicing of approximately $27 million of mortgage loans which provides future refinancing opportunities and is a source of core deposits.

	•		We improved our net interest margin from 3.74% in the fourth quarter of 2009 to 3.88% in 2010’s fourth quarter. Given our current funding structure, we expect to see this improve throughout 2011 as well.

	•		We had an overall reduction in nonperforming assets from $21.0 million at the end of 2009 to $16.1 million at the end of 2010. As noted above, the resolution of problem assets during 2010 impacted our earnings but we divested these problem loans and OREO properties so that we could eliminate holding costs and forego the opportunity cost that impacts longer-term shareholder value creation.

To Our Shareholders

2010 Earnings Recap

In 2010, our operating results were disappointing, as we reported an after tax loss of $1.160 million, or $.34 per share. This loss occurred as a result of credit related charges that included a $6.500 million loan loss provision, $2.753 million in OREO charges and other related costs associated with problem assets such as legal services and OREO carrying costs.


Earnings Analysis
	2010			2009		2008

Income before tax and preferred dividends, as reported:	$	(3,917	)	$	3,536	$	2,659

Credit related costs:
Loan loss provision		6,500			3,700		2,300
OREO write-downs/gains and losses		2,753			208		(80	)
Noncore income:
Security gains		215			1,471		64
Gain on sale of branch offices		—			1,208		—


“Adjusted” income before taxes and preferred dividends (Excluding items, noted above)	$	5,121		$	4,765	$	4,815

As you will note from the chart above, which is not a GAAP measure, the company’s “core earnings” run rate outside of credit related charges and other one-time items has improved as the result of lowered funding costs from the significant growth in our core deposit base, control of non-interest expenses, and increases in non-interest income from our SBA/USDA lending programs

Loan Growth/Production

As stated previously we continue to experience good loan demand as demonstrated with approximately $114 million in new loan production during 2010, including $37 million of mortgage loans sold in the secondary market. Our loan balances actually declined slightly from year-end 2009 balances. The table below details the 2010 activity.


Loan balances as of December 31, 2009	$	384,310

Production, excluding secondary market mortgage loans		77,093
SBA loan sales		(12,571	)
Loans transferred to OREO		(5,373	)
Loans charged off, net of recoveries		(5,112	)
Normal amortization/paydowns and payoffs		(55,261	)


Loan balances as of December 31, 2010	$	383,086

Loan production, excluding secondary market mortgage loans of $37 million, in our three geographical regions is shown below.


	For the Year Ending December 31,
(dollars in thousands)	2010		2009		2008
REGION
Upper Peninsula	$	55,475	$	43,777	$	37,040
Northern Lower Peninsula		10,972		35,027		14,183
Southeast Michigan		10,646		9,318		10,374


TOTAL	$	77,093	$	88,122	$	61,597

We have generated loan growth in all regions and we will continue to evaluate growth potential in markets where we can grow loans with good credit quality and acceptable loan pricing enhanced by fee income.

To Our Shareholders

Government Guaranteed Lending Programs


	SBA Loans Originated
	For the Year Ended December 31,
	2010						2009						2008
	# Loans		SBA Amount		Premium		# Loans		SBA Amount		Premium		# Loans		SBA Amount		Premium
UP		13	$	8,733	$	609		32	$	6,797	$	373		2	$	386	$	18
NLP		8		3,838		258		10		5,829		125		6		1,009		5
SEM		—		—		—		—		—		—		3		572		3

Total		21	$	12,571	$	867		42	$	12,626	$	498		11	$	1,967	$	26

The Corporation has made a concentrated effort to become a premier SBA/USDA lender throughout the State of Michigan and separate ourselves from our local competition in terms of the adjudication of these types of loans to minimize credit risk and increase noninterest income through the sale of the guaranteed portion of the loans for a premium. As you will note from the chart shown below, we have had success due to the strong competencies of our lenders and credit personnel. In addition to the level of SBA production generated, the Corporation recorded $.868 million in fees for 2010, for a total of $1.680 million over the last four years. The Corporation does not sell all the loan guarantees from every credit, only those where acceptable market rates are paid above par that warrant recognizing the income now, and where the Corporation feels that the reinvestment of the monies paid can be lent out again in sufficient time to exceed the lost interest income from the loan sold.

We are pleased with the progress we have made here; first in terms to the benefit of the Corporation, but also for the many local businesses in these markets that through these programs are provided the capital to grow their organization to help rebuild the economic base of the State.

Core Deposit Growth

One of our primary objectives during 2010 was to decrease our reliance on wholesale funding.

Shown below is the mix of our deposits for the three most recent years.


	DEPOSIT MIX
	As of December 31,															Percent Change
	2010		Mix			2009		Mix			2008		Mix			2010/2009			2009/2008
CORE DEPOSITS
Transactional accounts:
Noninterest bearing	$	41,264		10.67	%	$	35,878		8.51	%	$	30,099		8.11	%		15.01	%		19.20	%
NOW, money market, checking		134,703		34.83			95,790		22.73			70,584		19.02			40.62			35.71
Savings		17,670		4.57			18,207		4.32			20,730		5.59			(2.95	)		(12.17	)

Total transactional accounts		193,637		50.07			149,875		35.56			121,413		32.72			29.20			23.44
Certificates of deposit <$100,000		96,977		25.07			59,953		14.23			73,752		19.87			61.76			(18.71	)

*Total core deposits*		290,614		75.14			209,828		49.79			195,165		52.59			38.50			7.51


NONCORE DEPOSITS
Certificates of deposit >$100,000		22,698		5.87			36,385		8.63			25,044		6.75			(37.62	)		45.28
Brokered CDs		73,467		18.99			175,176		41.58			150,888		40.66			(58.06	)		16.10

*Total noncore deposits*		96,165		24.86			211,561		50.21			175,932		47.41			(54.55	)		20.25


TOTAL DEPOSITS	$	386,779		100.00	%	$	421,389		100.00	%	$	371,097		100.00	%		(8.21	)%		13.55	%

As shown in the table above, core deposits grew by more than $80 million in 2010, 38.5%.

Noninterest Expense

Controlling noninterest expense is a distinct challenge for a strategy based upon growth. We accept this challenge and recognize that certain operational costs will increase in future periods; however, we will continue to use a cost benefit analysis to evaluate any major initiatives. In 2010, our operating costs were negatively impacted by costs associated with nonperforming assets, which we expect to reduce in 2011. We have been successful in controlling most other areas of noninterest expense and will continue to focus on becoming more efficient.

To Our Shareholders

Capital/Shareholders’ Equity

At the end of 2010, the Corporation and the Bank had strong capital positions. The Corporation had a Tier 1 ratio of 9.25% and total risk based capital of 12.62%. The Bank’s Tier 1 capital ratio stood at 8.09% with a total risk based capital ratio of 11.18%. Common equity of MFNC totaled $43.176 million with book value per share at $12.63. We believe that our franchise is undervalued with a year-end market value of $4.58 per share, which is 36% of book value.

Building Franchise Value

As mentioned earlier, with this letter are various charts and graphs which track the performance of the company through the last five years in terms of key shareholder metrics and operating performance levels. Over this period the Corporation has increased its common stock book value of stock from $7.75 per share at December 31, 2005 to $12.63 at 2010 year end, an increase of $4.88 per share, or 63%. During this five year period, we significantly increased total assets, loans, and core deposits which provides the foundation that will lead to future increases in common shareholders’ equity. Following this letter is an overview which provides a snapshot of the three distinctively different regions of our franchise, (Upper Peninsula “UP”, Northern Lower Peninsula, and Southeast Michigan).

Looking Forward

In 2011, we will again focus on increased franchise value with one of our key initiatives being the reduction in nonperforming assets. Another objective is to continue our core deposit growth momentum within all of our markets. We expect to have continued success in new loan production with increased fee contribution from both secondary market mortgage loans and SBA/USDA loan sales.

While nonperforming assets are currently below peer levels, we still face challenges in accomplishing our goal for further reduction given the current Michigan economy. Our 2011 Operating Plan calls for aggressive disposition of these nonearning assets in order to minimize carrying costs.

The Corporation is, and will remain dedicated to the primary strategic objective of enhancing franchise and shareholder value by building a strong banking franchise in our local markets and serving the communities that provide the business opportunities for the company to prosper.

We sincerely thank you for your continued support during these difficult times and we will work diligently and prudently to provide improved shareholder results in the years to come.

Sincerely,



Paul D. Tobias		Kelly W. George
Chairman and CEO		President and CEO
Mackinac Financial Corporation		mBank

Five Year Overview

Five Year Overview

Regional Review — Upper Peninsula

BRANCH LOCATIONS


ESCANABA	NEWBERRY	MANISTIQUE — LAKESHORE
Located in Menards	414 Newberry Avenue	Located in Jack’s Supervalu
3300 Ludington Street	Newberry, MI 49868	Manistique, MI 49854
Escanaba, MI 49829	(906) 293-5165	(906) 341-7190
(906) 233-9443	Manager: Michael A. Slaght	Manager: Magan L. MacArthur
Manager: Debbie L. Peterson

MANISTIQUE 130 South Cedar Street Manistique, MI 49854 (906) 341-2413 Manager: Magan L. MacArthur	SAULT STE. MARIE 138 Ridge Street Sault Ste. Marie, MI 49783 (906) 635-3992 Manager: David R. Thomas

MARQUETTE 300 North McClellan Marquette, MI 49855 (906) 226-5000 Manager: Teresa M. Same	STEPHENSON S216 Menominee Street Stephenson, MI 49887 (906) 753-2225 Manager: Barbara A. Parrett

BALANCE SHEET HIGHLIGHTS


	At December 31, 2010				2010 Activity
(dollars in thousands)	Loans		Deposits		Loan Production		Core Deposit Growth
Escanaba	$	5,772	$	4,747	$	9,087	$	3,192
Manistique		64,131		34,024		19,222		2,334
Marquette		72,251		40,423		35,773		11,967
Newberry		15,441		35,368		3,929		123
Sault Ste. Marie		42,249		22,104		10,665		6,337
Stephenson		7,383		30,809		2,112		4,584


TOTAL UPPER PENINSULA	$	207,227	$	167,475	$	80,788	$	28,537

* Includes production of mortgage loans sold on the secondary market.

CONTRIBUTION TO OTHER INCOME


	Secondary Market				SBA/USDA
(dollars in thousands)	Production/Sold		Gains/Fee Income		Production/Sold		Gains/Fee Income
Escanaba	$	4,852	$	62	$	197	$	18
Manistique		1,717		30		5,278		310
Marquette		15,317		207		2,547		221
Newberry		1,323		26		582		47
Sault Ste. Marie		1,589		25		129		13
Stephenson		516		9		—		—


TOTAL UPPER PENINSULA	$	25,314	$	359	$	8,733	$	609

Regional Review — Upper Peninsula

Excluding the branch sales, which were predominantly transactional accounts, total deposits grew $44.8 million in the five year period, with transactional deposits comprising roughly $39.4 million of that growth.

Core deposits are defined as demand deposits, interest bearing checking accounts, money markets, savings and CDs less than $100,000.

Total loan production over the five year period amounted to $214.3 million.

Nonperforming assets in the Upper Peninsula totaled $3.504 million at the end of 2010, which included $.682 million of OREO and $2.822 million of nonperforming loans. Nonperforming loans as a percent of total loans was 1.36%.

Regional Review — Northern Lower Peninsula

Andrew P. Sabatine, Regional President — NLP

BRANCH LOCATIONS


GAYLORD 1955 South Otsego Avenue Gaylord, MI 49735 (989) 732-3750 Manager: Joni L. Freel		KALEVA 14429 Wuoksi Avenue Kaleva, MI (231)362-3223 Manager: Barb J. Miller

TRAVERSE CITY 3530 North Country Drive Traverse City, MI 49684 (231) 929-5600 Manager: Andrea Pease

BALANCE SHEET HIGHLIGHTS


	At December 31, 2010				2010 Activity
(dollars in thousands)	Loans		Deposits		Loan Production*		Core Deposit Growth
Gaylord	$	38,428	$	43,391	$	12,770	$	13,387
Kaleva		498		14,137		466		3,180
Traverse City		49,280		51,545		9,100		23,875


TOTAL NORTHERN LOWER PENINSULA	$	88,206	$	109,073	$	22,336	$	40,442


*		*Includes production of mortgage loans sold on the secondary market.*

CONTRIBUTION TO OTHER INCOME


	Secondary Market				SBA/USDA
(dollars in thousands)	Production/Sold		Gains/Fee Income		Production/Sold		Gains/Fee Income
Gaylord	$	8,777	$	135	$	1,886	$	158
Kaleva		72		2		—		—
Traverse City		2,515		43		1,952		100


TOTAL NORTHERN LOWER PENINSULA	$	11,364	$	180	$	3,838	$	258

Regional Review — Northern Lower Peninsula

Total deposit growth amounted to $71.5 million over the five year period, largely in transactional accounts.

Core deposits are defined as demand deposits, interest bearing checking accounts, money markets, savings and CDs less than $100,000.

Total loan production over the five year period amounted to $108.6 million.

Nonperforming assets in the Northern Lower Peninsula totaled $7.964 million at the end of 2010, which included $1.668 million of OREO and $6.296 million of nonperforming loans. Nonperforming loans as a percent of total loans was 7.14%

Regional Review — Southeast Michigan

Jesse A. Deering, First VP/Southeast Michigan Executive


*BRANCH LOCATION* BIRMINGHAM 260 East Brown Street, Suite 300 Birmingham, MI 48009 (248) 290-5900 Manager: Elena Dritsas

BALANCE SHEET HIGHLIGHTS


	At December 31, 2010				2010 Activity
(dollars in thousands)	Loans		Deposits		Loan Production		Core Deposit Growth
Birmingham	$	87,653	$	36,763	$	10,646	$	11,807

Southeast Michigan had no contribution to other income for the year ended 2010 due in part to a lack of a secondary market mortgage loan producer and management’s focus on overall credit issues in order to reduce levels of nonperforming assets.

Regional Review — Southeast Michigan

Total deposit growth amounted to $33.8 million over the five year period, almost solely in transactional accounts.

Core deposits are defined as demand deposits, interest bearing checking accounts, money markets, savings and CDs less than $100,000.

Total loan production over the five year period amounted to $152.9 million.

Nonperforming assets in Southeast Michigan totaled $4.657 million at the end of 2010, which included $3.212 million of OREO and $1.445 million of nonperforming loans. Nonperforming loans as a percent of total loans was 1.65%.

Selected Financial Highlights

(Dollars in Thousands, Except Per Share Data)


	For The Years Ended December 31,
(Dollars in thousands, except per share data)	2010			2009
	(Unaudited)			(Unaudited)
Selected Financial Condition Data *(at end of period)*:
Assets	$	478,696		$	515,377
Loans		383,086			384,310
Investment securities		33,860			46,513
Deposits		386,779			421,389
Borrowings		36,069			36,140
Common shareholders’ equity		43,176			44,785
Total shareholders’ equity		53,882			55,299

Selected Statements of Income Data:
Net interest income	$	16,385		$	16,287
Income before taxes and preferred dividend		(3,918	)		3,536
Net income		(1,160	)		1,907
Income per common share — Basic		(.34	)		.56
Income per common share — Diluted		(.34	)		.56
Weighted average shares outstanding		3,419,736			3,419,736

Selected Financial Ratios and Other Data:
*Performance Ratios:*
Net interest margin		3.66	%		3.59	%
Efficiency ratio		72.57			72.24
Return on average assets		(.23	)		.39
Return on average common equity		(2.64	)		4.42
Return on average total equity		(2.06	)		3.77

Average total assets	$	502,993		$	493,652
Average common shareholders’ equity		43,981			43,169
Average total shareholders’ equity		56,171			50,531
Average loans to average deposits ratio		94.36	%		92.99	%

*Common Share Data at end of period:*
Market price per common share	$	4.58		$	4.64
Book value per common share	$	12.63		$	13.10
Common shares outstanding		3,419,736			3,419,736

*Other Data at end of period:*
Allowance for loan losses	$	6,613		$	5,225
Non-performing assets	$	16,125		$	21,041
Allowance for loan losses to total loans		1.73	%		1.36	%
Non-performing assets to total assets		3.37	%		4.08	%
Texas ratio		26.66	%		34.77	%

Number of:
Branch locations		11			10
FTE Employees		110			100

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

Quarterly Financial Summary

MACKINAC FINANCIAL CORPORATION

(Unaudited)


							Average
	Average		Average		Average		Shareholders’		Return on Average						Net Interest			Efficiency			Net Income			Book Value
Quarter Ended	Assets		Loans		Deposits		Equity		Assets			Equity			Margin			Ratio			Per Share			Per Share
December 31, 2010	$	488,320	$	385,296	$	393,266	$	55,015		(1.70)	%		(15.09)	%		3.88	%		65.05	%	$	(.61	)	$	12.63
September 30, 2010		512,335		385,268		416,847		56,668		(.08	)		(.73	)		3.69			75.98			(.03	)		13.26
June 30, 2010		502,942		382,169		405,449		57,889		(1.98	)		(17.24	)		3.56			76.04			(.73	)		13.34
March 31, 2010		508,495		384,640		413,897		55,109		2.81			25.95			3.51			78.12			1.03			14.08
December 31, 2009		514,102		386,203		418,280		55,665		(.14	)		(1.28	)		3.74			71.03			(.05	)		13.10
September 30, 2009		513,687		370,310		419,102		54,594		1.19			11.16			3.66			70.09			.45			13.25
June 30, 2009		491,205		371,609		401,510		49,855		0.38			3.71			3.58			76.55			.13			12.73
March 31, 2009		454,740		370,943		372,669		41,813		.08			0.87			3.35			82.36			.03			12.24
December 31, 2008		441,583		366,077		358,213		41,516		(.23	)		(2.42	)		3.20			80.30			(.07	)		12.15

Report of Independent Registered Public Accounting Firm

Report of Independent Registered Public Accounting Firm

Board of Directors
Mackinac Financial Corporation, Inc.

We have audited the consolidated statement of financial condition of Mackinac Financial Corporation, Inc. as of December 31, 2010 and 2009 and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for each year in the three-year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Mackinac Financial Corporation, Inc. as of December 31, 2010 and 2009 and the consolidated results of their operations and their cash flows for each year in the three-year period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.



Grand Rapids, Michigan March 30, 2011

Consolidated Balance Sheets

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
December 31, 2010 and 2009
(Dollars in Thousands)


	December 31,			December 31,
	2010			2009
ASSETS

Cash and due from banks	$	22,719		$	18,433
Federal funds sold		12,000			27,000

Cash and cash equivalents		34,719			45,433

Interest-bearing deposits in other financial institutions		713			678
Securities available for sale		33,860			46,513
Federal Home Loan Bank stock		3,423			3,794

Loans:
Commercial		297,047			305,670
Mortgage		80,756			74,350
Installment		5,283			4,290

Total Loans		383,086			384,310
Allowance for loan losses		(6,613	)		(5,225	)

Net loans		376,473			379,085

Premises and equipment		9,660			10,165
Other real estate held for sale		5,562			5,804
Other assets		14,286			23,905


TOTAL ASSETS	$	478,696		$	515,377


LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Non-interest-bearing deposits	$	41,264		$	35,878
Interest-bearing deposits:
NOW, Money Market, Checking		134,703			95,790
Savings		17,670			18,207
CDs<$100,000		96,977			59,953
CDs>$100,000		22,698			36,385
Brokered		73,467			175,176

Total deposits		386,779			421,389

Borrowings:
Federal Home Loan Bank		35,000			35,000
Other		1,069			1,140

Total borrowings		36,069			36,140
Other liabilities		1,966			2,549

Total liabilities		424,814			460,078

Shareholders’ equity:
Preferred stock — No par value:
Authorized 500,000 shares, 11,000 shares issued and outstanding		10,706			10,514
Common stock and additional paid in capital — No par value
Authorized — 18,000,000 shares
Issued and outstanding — 3,419,736 shares		43,525			43,493
Retained earnings (accumulated deficit)		(961	)		199
Accumulated other comprehensive income		612			1,093


Total shareholders’ equity		53,882			55,299


TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	478,696		$	515,377

See accompanying notes to consolidated financial statements.

Consolidated Statements of Operations

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
Years Ended December 31, 2010, 2009, and 2008
(Dollars in Thousands, Except Per Share Data)


	For The Years Ended December 31,
	2010			2009		2008
INTEREST INCOME:
Interest and fees on loans:
Taxable	$	21,091		$	20,521	$	22,555
Tax-exempt		188			292		404
Interest on securities:
Taxable		1,406			2,783		1,293
Tax-exempt		28			19		5
Other interest income		127			93		305

Total interest income		22,840			23,708		24,562


INTEREST EXPENSE:
Deposits		5,607			6,431		10,115
Borrowings		848			990		1,583

Total interest expense		6,455			7,421		11,698


Net interest income		16,385			16,287		12,864
Provision for loan losses		6,500			3,700		2,300

Net interest income after provision for loan losses		9,885			12,587		10,564


OTHER INCOME:
Service fees		990			1,023		838
Net security gains		215			1,471		64
Income from loans sold		1,407			830		120
Proceeds from settlement of lawsuits		—			—		3,475
Gain on sales of branch offices		—			1,208		—
Other		183			219		156

Total other income		2,795			4,751		4,653


OTHER EXPENSES:
Salaries and employee benefits		6,918			6,583		6,886
Occupancy		1,313			1,385		1,374
Furniture and equipment		806			805		771
Data processing		740			862		844
Professional service fees		627			603		508
Loan and deposit		910			725		488
ORE writedowns and (gains) losses on sale		2,753			208		(80	)
FDIC insurance premiums		957			839		81
Other		1,574			1,792		1,686

Total other expenses		16,598			13,802		12,558


Income before provision for (benefit of) income taxes		(3,918	)		3,536		2,659
Provision for (benefit of) income taxes		(3,500	)		1,120		787

NET INCOME (LOSS)	$	(418	)	$	2,416	$	1,872


Preferred dividend and accretion of discount		742			509		—


NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS	$	(1,160	)	$	1,907	$	1,872


INCOME (LOSS) PER COMMON SHARE
Basic	$	(.34	)	$	.56	$	.55

Diluted	$	(.34	)	$	.56	$	.55

See accompanying notes to consolidated financial statements.

Consolidated Statements of Changes in Shareholders’ Equity

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
Years Ended December 31, 2010, 2009, and 2008
(Dollars in Thousands)


												Accumulated
	Shares of			Preferred		Common Stock			Retained			Other
	Common			Stock		and Additional			Earnings			Comprehensive
	Stock			Series A		Paid in Capital			(Accumulated Deficit)			Income			Total
Balance, January 1, 2008		3,428,695		$	—	$	42,843		$	(3,582	)	$	60		$	39,321

Purchase of oddlot shares		(8,959	)		—		(110	)		—			—			(110	)
Net income		—			—		—			1,872			—			1,872
Other comprehensive income:
Net unrealized loss on securities available for sale		—			—		—			—			385			385
Other		—			—		—			2			—			2

Total comprehensive income																2,259

Stock option compensation		—			—		82			—			—			82


Balance, December 31, 2008		3,419,736			—		42,815			(1,708	)		445			41,552

Net income					—		—			2,416			—			2,416
Other comprehensive income:
Net unrealized income on securities available for sale		—			—		—			—			648			648

Total comprehensive income																3,064

Stock option compensation		—			—		60			—			—			60
Dividend on preferred stock		—			—		—			(377	)		—			(377	)
Issuance of preferred stock, 11,000 shares		—			10,382		—			—			—			10,382
Issuance of common stock warrants		—			—		618			—			—			618
Accretion of preferred stock discount		—			132		—			(132	)		—			—


Balance, December 31, 2009		3,419,736			10,514		43,493			199			1,093			55,299

Net income (loss)		—			—		—			(418	)		—			(418	)
Other comprehensive income:
Net unrealized income on securities available for sale		—			—		—			—			(481	)		(481	)

Total comprehensive income (loss)																(899	)

Stock option compensation		—			—		32			—						32
Dividend on preferred stock		—			—		—			(550	)		—			(550	)
Accretion of preferred stock discount		—			192		—			(192	)		—			—


Balance, December 31, 2010		3,419,736		$	10,706	$	43,525		$	(961	)	$	612		$	53,882

See accompanying notes to consolidated financial statements.

Consolidated Statements of Cash Flows

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES
Years Ended December 31, 2010, 2009, and 2008
(Dollars in Thousands)


	2010			2009			2008
Cash Flows from Operating Activities:
Net income (loss)	$	(418	)	$	2,416		$	1,872
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		1,643			2,027			1,355
Provision for loan losses		6,500			3,700			2,300
Provision for (benefit of) income taxes		(3,500	)		1,120			787
(Gain) loss on sales/calls of securities available for sale		(215	)		(1,471	)		(64	)
(Gain) loss on sale of secondary market loans		(445	)		(224	)		(107	)
Origination of secondary market loans held for sale		(36,678	)		(21,722	)		(9,985	)
Proceeds from secondary market loans held for sale		37,217			22,039			10,126
(Gain) on sales of branch offices		—			(1,208	)		—
(Gain) loss on sale of premises, equipment, and other real estate		48			23			(77	)
Writedown of other real estate		2,703			187			964
Stock option compensation		32			60			82
Change in other assets		13,174			(15,626	)		333
Change in other liabilities		(583	)		(22	)		(210	)

Net cash (used in) provided by operating activities		19,478			(8,701	)		7,376


Cash Flows from Investing Activities:
Net (increase) in loans		(9,355	)		(21,218	)		(21,173	)
Net (increase) decrease in interest-bearing deposits in other financial institutions		(35	)		(96	)		1,228
Purchase of securities available for sale		(5,000	)		(50,113	)		(50,813	)
Proceeds from maturities, sales, calls or paydowns of securities available for sale		16,788			52,742			25,373
Capital expenditures		(606	)		(679	)		(618	)
Proceeds from sale of premises, equipment, and other real estate		2,876			581			1,956
Redemption of FHLB stock		371			—			—
Net cash paid in connection with branch sales		—			(28,578	)		—

Net cash provided by (used in) investing activities		5,039			(47,361	)		(44,047	)


Cash Flows from Financing Activities:
Net increase (decrease) in deposits		(34,610	)		80,760			50,270
Issuance of Series A Preferred Stock and common stock warrants		—			11,000			—
Dividend on preferred stock		(550	)		(307	)		—
Net (decrease) in federal funds purchased		—			—			(7,710	)
Net (decrease) in lines of credit		—			—			(1,959	)
Repurchase of common stock-oddlot shares		—			—			(110	)
Principal payments on borrowings		(71	)		(70	)		(70	)

Net cash provided by (used in) financing activities		(35,231	)		91,383			40,421


Net increase (decrease) in cash and cash equivalents		(10,714	)		35,321			3,750
Cash and cash equivalents at beginning of period		45,433			10,112			6,362


Cash and cash equivalents at end of period	$	34,719		$	45,433		$	10,112


Supplemental Cash Flow Information:
Cash paid during the year for:
Interest	$	6,548		$	7,584		$	11,961
Income taxes		75			90			70

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)		5,373			4,879			2,849

Assets and Liabilities Divested in Branch Sales:
Loans		—			31			—
Premises and equipment		—			651			—
Deposits		—			29,260			—

See accompanying notes to consolidated financial statements.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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

Principles of Consolidation

The consolidated financial statements include the accounts of the Corporation and its wholly owned subsidiaries, mBank (the “Bank”) and other minor subsidiaries, after elimination of intercompany transactions and accounts.

Nature of Operations

The Corporation’s and the Bank’s revenues and assets are derived primarily from banking activities. The Bank’s primary market area is the Upper Peninsula, the northern portion of the Lower Peninsula of Michigan, and Oakland County in Lower Michigan. The Bank provides to its customers commercial, real estate, agricultural, and consumer loans, as well as a variety of traditional deposit products. A portion, approximately 2.1%, of the Bank’s commercial loan portfolio consists of leases to commercial and governmental entities, which are secured by various types of equipment. These leases are dispersed geographically throughout the country. Less than 1.0% of the Corporation’s business activity is with Canadian customers and denominated in Canadian dollars.

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

Use of Estimates in Preparation of Financial Statements

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

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

Cash and Cash Equivalents

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

Securities

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

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Federal Home Loan Bank Stock

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

Interest Income and Fees on Loans

Interest income on loans is reported on the level-yield method and includes amortization of deferred loan fees and costs over the loan term. Net loan commitment fees or costs for commitment periods greater than one year are deferred and amortized into fee income or other expense on a straight-line basis over the commitment period. The accrual of interest on loans is discontinued when, in the opinion of management, it is probable that the borrower may be unable to meet payments as they become due. 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.

Allowance for Loan Losses

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

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

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

Other Real Estate Held for Sale

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

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Premises and Equipment

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

Stock Option Plans

The Corporation sponsors three stock option plans. One plan was approved during 2000 and applies to officers, employees, and nonemployee directors. This plan was amended as a part of the December 2004 stock offering and recapitalization. The amendment, approved by shareholders, increased the shares available under this plan by 428,587 shares from the original 25,000 (adjusted for the 1:20 reverse stock split), to a total authorized share balance of 453,587. The other two plans, one for officers and employees and the other for nonemployee directors, were approved in 1997. A total of 30,000 shares (adjusted for the 1:20 split), were made available for grant under these plans. Options under all of the plans are granted at the discretion of a committee of the Corporation’s Board of Directors. Options to purchase shares of the Corporation’s stock were granted at a price equal to the market price of the stock at the date of grant. The committee determined the vesting of the options when they were granted as established under the plan. All of the option plans have expired.

Comprehensive Income (Loss)

Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) is composed of unrealized gains and losses on securities available for sale, net of tax.

Earnings per Common Share

Earnings per share are based upon the weighted average number of shares outstanding. The issuance of shares as a result of stock options and common stock warrants issued under the TARP Capital Purchase Program did not have a dilutive effect on earnings for the year ended December 31, 2010 and 2009.

The following shows the computation of basic and diluted earnings per share for the year ended December 31, 2010 and 2009 (dollars in thousands, except per share data):


	Year Ended December 31,
	2010			2009
Net income (loss)	$	(418	)	$	2,416
Preferred stock dividends		742			509

Net income (loss) available to common shareholders	$	(1,160	)	$	1,907


Weighted average shares outstanding		3,419,736			3,419,736
Effect of dilutive stock options and common stock warrants outstanding		60,161			—

Diluted weighted average shares outstanding		3,479,897			3,419,736

Income (loss) per common share:
Basic	$	(.34	)	$	.56
Diluted	$	(.34	)	$	.56

The effect of dilutive common stock warrants is not taken into account when calculating the loss per share in 2010, since it would be anti-dilutive.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

Income Taxes

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

Off-Balance-Sheet Financial Instruments

In the ordinary course of business, the Corporation has entered into off-balance-sheet financial instruments consisting of commitments to extend credit, commitments under credit card arrangements, commercial letters of credit, and standby letters of credit. 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 January 2010, the FASB issued ASU No. 2010-06 “Fair Value Measurements and Disclosures (Topic 820) — Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends the fair value disclosure guidance. The amendments include new disclosures and changes to clarify existing disclosure requirements. ASU 2010-06 was effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements of Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The impact of ASU 2010-06 on the Company’s disclosures is reflected in Note 18 of the consolidated financial statements.

In July 2010, FASB issued ASU No. 2010-20 “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”. The standard requires the Company to expand disclosures about the credit quality of our loans and the related reserves against them. The additional disclosures will include details on our past due loans and credit quality indicators. For public entities, ASU 2010-20 disclosures of period-end balances are effective for interim and annual reporting periods ending on or after December 15, 2010 and are included in Note 4 of the financial statements. Disclosures related to activity that occurs during the reporting period are required for interim and annual reporting periods beginning on or after December 15, 2010. The Company will adopt the disclosures related to the activity that occurs during the reporting period beginning with our March 31, 2011 consolidated financial statements.

Reclassifications

Certain amounts in the 2009 and 2008 consolidated financial statements have been reclassified to conform to the 2010 presentation.

NOTE 2 — RESTRICTIONS ON CASH AND CASH EQUIVALENTS

Cash and cash equivalents in the amount of $2.275 million were restricted on December 31, 2010 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.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 3 — SECURITIES AVAILABLE FOR SALE

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


			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
*December 31, 2010*

US Agencies — MBS	$	26,787	$	923	$	—		$	27,710
US Agencies		5,000		—		(27	)		4,973
Obligations of states and political subdivisions		1,146		35		(4	)		1,177


Total securities available for sale	$	32,933	$	958	$	(31	)	$	33,860


December 31, 2009

US Agencies — MBS	$	43,651	$	1,642	$	(55	)	$	45,238
Obligations of states and political subdivisions		1,207		68		—			1,275


Total securities available for sale	$	44,858	$	1,710	$	(55	)	$	46,513

Following is information pertaining to securities with gross unrealized losses at December 31, 2010 and 2009 aggregated by investment category and length of time these individual securities have been in a loss position (dollars in thousands):


	Less Than Twelve Months					Over Twelve Months
	Gross					Gross
	Unrealized			Fair		Unrealized		Fair
	Losses			Value		Losses		Value
*December 31, 2010*

US Agencies — MBS	$	(27	)	$	4,973	$	—	$	—
Obligations of states and political subdivisions		(4	)		325		—		—


Total securities available for sale	$	(31	)	$	5,298	$	—	$	—


December 31, 2009

US Agencies — MBS	$	(55	)	$	3,309	$	—	$	—


Total securities available for sale	$	(55	)	$	3,309	$	—	$	—

There were two securities in an unrealized loss position in 2010 and two in 2009. 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):


	2010			2009			2008
Proceeds from sales and calls	$	8,302		$	44,611		$	12,047
Gross gains on sales		216			1,472			65
Gross (losses) on sales and calls		(1	)		(1	)		(1	)

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 3 — SECURITIES AVAILABLE FOR SALE (CONTINUED)

The carrying value and estimated fair value of securities available for sale at December 31, 2010, by contractual maturity, are shown below (dollars in thousands):


	Amortized		Estimated
	Cost		Fair Value
Due in one year or less	$	6	$	6
Due after one year through five years		5,634		5,617
Due after five years through ten years		506		527
Due after ten years		—		—

Subtotal		6,146		6,150
US Agencies — MBS		26,787		27,710


Total	$	32,933	$	33,860

Contractual maturities may differ from expected maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. See Note 8 for information on securities pledged to secure borrowings from the Federal Home Loan Bank.

NOTE 4 — LOANS

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


	2010		2009
Commercial real estate	$	194,859	$	208,895
Commercial, financial, and agricultural		68,858		72,184
One to four family residential real estate		75,074		67,232
Construction :
Consumer		5,682		7,118
Commerical		33,330		24,591
Consumer		5,283		4,290


Total loans	$	383,086	$	384,310

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


	2010			2009			2008
Balance, January 1	$	5,225		$	4,277		$	4,146
Recoveries on loans previously charged off		374			66			121
Loans charged off		(5,486	)		(2,818	)		(2,290	)
Provision		6,500			3,700			2,300


Balance, December 31	$	6,613		$	5,225		$	4,277

In 2010, net charge off activity was $5.112 million, or 1.33% of average loans outstanding compared to net charge-offs of $2.752 million, or .73% of average loans, in the same period in 2009 and $2.169 million, or .60% of average loans, in 2008. During 2010, a provision of $6.500 million was made to increase the reserve. This provision was made in accordance with the Corporation’s allowance for loan loss reserve policy, which calls for a measurement of the adequacy of the reserve at each quarter end. This process includes an analysis of the loan portfolio to take into account increases in loans outstanding and portfolio composition, historical loss rates, and specific reserve requirements of nonperforming loans.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 4 — LOANS (CONTINUED)

A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2010 is as follows (dollars in thousands):


				Commercial,						One to four
	Commercial			financial and			Commercial			family residential			Consumer
	real estate			agricultural			construction			real estate			construction		Consumer			Unallocated			Total

*Allowance for loan loss reserve:*
Beginning balance ALLR	$	3,284		$	1,135		$	386		$	23		$	—	$	13		$	384		$	5,225
Charge-offs		(2,426	)		(1,804	)		(720	)		(416	)		—		(9	)		(111	)		(5,486	)
Recoveries		18			260			67			—			—		15			14			374
Provision		2,584			1,427			656			2,015			—		(19	)		(163	)		6,500
Unallocated assignment		—			—			—			—			—		—			—			—

Ending balance ALLR	$	3,460		$	1,018		$	389		$	1,622		$	—	$	—		$	124		$	6,613


*Loans:*
Ending balance	$	194,859		$	68,858		$	33,330		$	75,074		$	5,682	$	5,283		$	—		$	383,086
Ending balance ALLR		(3,460	)		(1,018	)		(389	)		(1,622	)		—		—			(124	)		(6,613	)

Net loans	$	191,399		$	67,840		$	32,941		$	73,452		$	5,682	$	5,283		$	(124	)	$	376,473


Ending balance ALLR	$	3,460		$	1,018		$	389		$	1,622		$	—	$	—		$	124		$	6,613
Individually evaluated		1,601			330			39			696			—		—			—			2,666
Collectively evaluated		1,859			688			350			926			—		—			124			3,947

Total	$	3,460		$	1,018		$	389		$	1,622		$	—	$	—		$	124		$	6,613

As part of the management of the loan portfolio, risk ratings are assigned to all commercial loans. Through the loan review process, ratings are modified as believed to be appropriate to reflect changes in the credit. Our ability to manage credit risk depends in large part on our ability to properly identify and manage problem loans. To do so, we operate a credit risk rating system under which our credit management personnel assign a credit risk rating to each loan at the time of origination and review loans on a regular basis to determine each loan’s credit risk rating on a scale of 1 through 8, with higher scores indicating higher risk. The credit risk rating structure used is shown below. In the context of the credit risk rating structure, the term Classified is defined as a problem loan which may or may not be in a nonaccrual status, dependent upon current payment status and collectability.

Excellent (1)

Borrower is not vulnerable to sudden economic or technological changes and is in a non-seasonal business or industry. These loans generally would be characterized by having good experienced management and a strong liquidity position with minimal leverage.

Good (2)

Borrower shows limited vulnerability to sudden economic change with modest seasonal effect. Borrower has “above average” financial statements and an acceptable repayment history with minimal leverage and a profitability that exceeds peers.

Average (3)

Generally, a borrower rated as average may be susceptible to unfavorable changes in the economy and somewhat affected by seasonal factors. Some product lines may be affected by technological change. Borrowers in this category exhibit stable earnings, with a satisfactory payment history.

Acceptable (4)

The loan is an otherwise acceptable credit that warrants a higher level of administration due to various underlying weaknesses. These weaknesses, however, have not and may never deteriorate to the point of a Special Mention rating or Classified status. This rating category may include new businesses not yet having established a firm performance record.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 4 — LOANS (CONTINUED)

Special Mention (5)

The loan is not considered as a Classified status, however may exhibit material weaknesses that, if not corrected, may cause future problems. Borrowers in this category warrant special attention but have not yet reached the point of concern for loss. The borrower may have deteriorated to the point that they would have difficulty refinancing elsewhere. Similarly, purchasers of these businesses would not be eligible for bank financing unless they represent a significantly lessened credit risk.

Substandard (6)

The loan is Classified and exhibits a number of well-defined weaknesses that jeopardize normal repayment. The assets are no longer adequately protected due to declining net worth, lack of earning capacity or insufficient collateral offering the distinct possibility of the loss of a portion of the loan principal. Loans within this category clearly represent troubled and deteriorating credit situations requiring constant supervision and an action plan must be developed and approved by the appropriate officers to mitigate the risk.

Doubtful (7)

Loans in this category exhibit the same weaknesses used to describe the substandard credit; however, the traits are more pronounced. Loans are frozen with collection improbable. Such loans are not yet rated as Charge-off because certain actions may yet occur which would salvage the loan.

Charge-off/Loss (8)

Loans in this category are largely uncollectible and should be charged against the loan loss reserve immediately.

General Reserves:

For loans with a credit risk rating of 5 or better and any loans with a risk rating of 6 or 7 with no specific reserve, reserves are established based on the type of loan collateral, if any, and the assigned credit risk rating. Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogenous loans based on historical loss experience, and consideration of current environmental factors and economic trends, all of which may be susceptible to significant change.

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

Below is a breakdown of loans by risk category as of December 31, 2010 (dollars in thousands):


	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp.Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	4,745	$	16,975	$	44,408	$	109,911	$	3,789	$	10,997	$	3,956	$	78	$	194,859
Commercial, financial and agricultural		3,726		5,275		16,466		39,844		259		2,636		—		652		68,858
Commercial construction		—		579		4,416		22,280		1,921		568		—		3,566		33,330
One-to-four family residential real estate		33		3,589		3,146		4,271		1,464		3,941		—		58,630		75,074
Consumer construction		—		—		—		—		—		—		—		5,682		5,682
Consumer		—		—		34		368		—		—		—		4,881		5,283


Total loans	$	8,504	$	26,418	$	68,470	$	176,674	$	7,433	$	18,142	$	3,956	$	73,489	$	383,086

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 4 — LOANS (CONTINUED)

Impaired Loans

Nonperforming loans are those which are contractually past due 90 days or more as to interest or principal payments, on nonaccrual status, or loans, the terms of which have been renegotiated to provide a reduction or deferral on interest or principal. The interest income recorded during impairment and that which would have been recognized were $.141 million and $.583 million for the year ended December 31, 2010. For the year ended December 31, 2009, the amounts were $.040 million and $.700 million.

The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loans basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

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


									Interest Income		Interest Income
	Nonaccrual		Accrual		Average		Related		Recognized		on
	Basis		Basis		Investment		Valuation Reserve		During Impairment		Accrual Basis
*December 31, 2010*

*With no valuation reserve:*
Commercial real estate	$	960	$	—	$	987	$	—	$	—	$	71
Commercial, financial and agricultural		51		—		13		—		—		1
Commercial construction		458		—		1,186		—		11		33
One to four family residential real estate		362		105		237		—		1		13
Consumer construction		—		—		—		—		—		—
Consumer		—		—		—		—		—		—

*With a valuation reserve:*
Commercial real estate	$	2,562	$	4,537	$	6,531	$	1,258	$	117	$	306
Commercial, financial and agricultural		709		—		1,660		279		—		95
Commercial construction		—		—		—		—		—		21
One to four family residential real estate		767		—		730		230		12		39
Consumer construction		52		—		52		1		—		4
Consumer				—		—		—		—

*Total:*
Commercial real estate	$	3,547	$	4,537	$	7,518	$	1,283	$	117	$	377
Commercial, financial and agricultural		735		—		1,673		254		—		96
Commercial construction		458		—		1,186		—		11		54
One to four family residential real estate		1,129		105		967		230		13		52
Consumer construction		52		—		52		1		—		4
Consumer		—		—		—		—		—		—

Total	$	5,921	$	4,642	$	11,396	$	1,768	$	141	$	583


December 31, 2009

With no valuation reserve:
Commercial real estate	$	1,293	$	869	$	1,954	$	—	$	40	$	133
Commercial, financial and agricultural		397		—		349		—		—		21
Commercial construction		986		—		2,399		—		—		163
One to four family residential real estate		292		—		212		—		—		18
Consumer construction		52		—		10		—		—		—
Consumer		—		—		3		—		—		—

With a valuation reserve:
Commercial real estate	$	6,997	$	—	$	5,187	$	961	$	—	$	349
Commercial, financial and agricultural		2,249		—		173		1,497		—		11
Commercial construction		933		—		72		1		—		2
One to four family residential real estate		1,169		—		90		246		—		3
Consumer construction		—		—		—		—		—		—
Consumer		—		—		—		—		—		—

Total:
Commercial real estate	$	8,290	$	869	$	7,141	$	961	$	40	$	482
Commercial, financial and agricultural		2,646		—		522		1,497		—		32
Commercial construction		1,919		—		2,471		1		—		165
One to four family residential real estate		1,461		—		302		246		—		21
Consumer construction		52		—		10		—		—		—
Consumer		—		—		3		—		—		—

Total	$	14,368	$	869	$	10,449	$	2,705	$	40	$	700

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 4 — LOANS (CONTINUED)

A summary of past due loans at December 31, 2010 is as follows (dollars in thousands):


	2010						2009
	30-89 days		90+ days				30-89 days		90+ days
	Past Due		Past Due/				Past Due		Past Due/
	(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total
Commercial real estate	$	19	$	3,522	$	3,541	$	4,607	$	8,290	$	12,897
Commercial, financial and agricultural		382		760		1,142		492		2,646		3,138
Commercial construction		—		458		510		25		1,971		1,996
One to four family residential real estate		923		1,129		2,052		226		1,461		1,687
Consumer construction		—		52		—		—		—		—
Consumer		20		—		20		68		—		68


Total past due loans	$	1,344	$	5,921	$	7,265	$	5,418	$	14,368	$	19,786

A summary of troubled debt restructurings at December 31 is as follows (dollars in thousands):


	2010				2009
	Number of		Recorded		Number of		Recorded
	Modifications		Investment		Modifications		Investment
Commercial real estate		7	$	4,537		2	$	869
Commercial, financial and agricultural		—		—		—		—
Commercial construction		—		—		—		—
One to four family residential real estate		1		105		—		—
Consumer construction		—		—		—		—
Consumer		—		—		—		—


Total troubled debt restructurings		8	$	4,642		2	$	869

A roll-forward of troubled debt restructuring during the year ended December 31, 2010 (dollars in thousands):


				Commercial,					One to four			Consumer and
	Commercial			Financial and		Commercial			family residential			Consumer
	Real Estate			Agricultural		Construction			real estate			Construction		Total
ACCRUING

Beginning balance	$	869		$	—	$	—		$	—		$	—	$	869

Principal payments		(48	)		—		(2	)		—			—		(50	)
Charge-offs		—			—		(632	)		—			—		(632	)
Advances		—			—		—			—			—		—
New restructured		4,692			—		634			609			—		5,935
Class transfers		—			—		—			—			—		—
Transfers to nonaccrual		(976	)		—		—			(504	)		—		(1,480	)


Ending balance	$	4,537		$	—	$	—		$	105		$	—	$	4,642

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 4 — LOANS (CONTINUED)

A roll-forward of nonaccrual activity during the year ended December 31, 2010 (dollars in thousands):


				Commercial,						One to four
	Commercial			Financial and			Commercial			family residential			Consumer
	Real Estate			Agricultural			Construction			real estate			Construction		Consumer		Total
NONACCRUAL

Beginning balance	$	8,290		$	2,646		$	1,919		$	1,461		$	52	$	—	$	14,368

Principal payments		(5,323	)		(1,095	)		(86	)		(35	)		—		—		(6,539	)
Charge-offs		(2,274	)		(1,539	)		(48	)		(1,311	)		—		—		(5,172	)
Advances		245			—			—			—			—		—		245
Class transfers		—			—			—			—			—		—		—
Transfers to OREO		(4,501	)		(150	)		(1,361	)		(368	)		—		—		(6,380	)
Transfers to accruing		(54	)		(36	)		—			—			—		—		(90	)
Transfers from accruing		6,987			933			24			1,368			—		—		9,312
Other		152			1			10			14			—		—		177


Ending balance	$	3,522		$	760		$	458		$	1,129		$	52	$	—	$	5,921

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):


	2010			2009
Loans outstanding, January 1	$	8,552		$	6,516
New loans		5,243			2,160
Net activity on revolving lines of credit		2,065			1,189
Change in related party interest		—			297
Repayment		(6,328	)		(1,610	)


Loans outstanding, December 31	$	9,532		$	8,552

There were no loans to related-parties classified substandard as of December 31, 2010 and 2009. In addition to the outstanding balances above, there were unfunded commitments of $.351 million to related parties at December 31, 2010.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 5 — PREMISES AND EQUIPMENT

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


	2010		2009
Land	$	1,811	$	1,811
Buildings and improvements		11,925		11,816
Furniture, fixtures, and equipment		4,770		4,346
Construction in progress		12		84

Total cost basis		18,518		18,057
Less — accumulated depreciation		8,858		7,892


Net book value	$	9,660	$	10,165

In August 2009, the Bank sold its Ontonagon and South Range branch offices, with deposits of approximately $29.300 million, premises and equipment with a net book value of $.600 million, and loans totaling approximately $31,000.

Depreciation of premises and equipment charged to operating expenses amounted to $1.098 million in 2010, $1.050 million in 2009, and $1.035 million in 2008.

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):


	2010			2009
Balance, January 1	$	5,804		$	2,189
Other real estate transferred from loans due to foreclosure		5,373			4,879
Reclassification of redemption ORE		—			(475	)
Other real estate sold		(2,862	)		(581	)
OREO writedowns		(2,703	)		(187	)
Loss on ORE		(50	)		(21	)


Balance, December 31	$	5,562		$	5,804

NOTE 7 — DEPOSITS

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


	2010		2009
Noninterest bearing	$	41,264	$	35,878
NOW, money market, checking		134,703		95,790
Savings		17,670		18,207
CDs <$100,000		96,977		59,953
CDs >$100,000		22,698		36,385
Brokered		73,467		175,176


Total deposits	$	386,779	$	421,389

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 7 — DEPOSITS (CONTINUED)

Maturities of non-brokered time deposits outstanding at December 31, 2010, are as follows (dollars in thousands):


2011	$	67,851
2012		34,256
2013		9,248
2014		6,163
2015		1,840
Thereafter		317


Total	$	119,675

Brokered deposits of $70.739 million mature in 2011 and $2.728 million matures thereafter.

NOTE 8 — BORROWINGS

Federal Home Loan Bank borrowings consist of the following at December 31 (dollars in thousands):


	2010		2009
Federal Home Loan Bank fixed rate advances at rates ranging from .61% to 2.10% maturing in 2011 and 2014	$	15,000	$	15,000
Federal Home Loan Bank variable rate advances at rates ranging from .306% to .309% maturing in 2011		20,000		20,000
Farmers Home Administration, fixed-rate note payable, maturing August 24, 2024 interest payable at 1%		1,069		1,140


	$	36,069	$	36,140

The Federal Home Loan Bank borrowings are collateralized at December 31, 2010 by the following: a collateral agreement on the Corporation’s one to four family residential real estate loans with a book value of approximately $34.577 million; mortgage related and municipal securities with an amortized cost and estimated fair value of $13.286 million and $13.919 million, respectively; and Federal Home Loan Bank stock owned by the Bank totaling $3.423 million. Prepayment of the advances is subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank of Indianapolis in effect as of December 31, 2010. The $20.0 million FHLB advances which matured early in 2011 were refinanced into longer term fixed rate maturities.

The U.S.D.A. Rural Development borrowing is collateralized by loans totaling $.256 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 $.920 million, and guaranteed by the Corporation.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 8 — BORROWINGS (CONTINUED)

Maturities of borrowings outstanding at December 31, 2010 are as follows (dollars in thousands):


2011	$	25,072
2012		72
2013		73
2014		10,074
2015		74
Thereafter		704


Total	$	36,069

NOTE 9 — INCOME TAXES

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


	2010			2009		2008
Current tax expense (benefit)	$	—		$	—	$	—
Change in valuation allowance		(2,136	)		—		—
Deferred tax expense (benefit)		(1,364	)		1,120		787


Total provision (credit) for income taxes	$	(3,500	)	$	1,120	$	787

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):


	2010			2009			2008
Tax expense at statutory rate	$	(1,332	)	$	1,202		$	904
Increase (decrease) in taxes resulting from:
Tax-exempt interest		(73	)		(106	)		(137	)
Change in valuation allowance		(2,136	)		—			—
Other		41			24			20


Provision for (benefit of) income taxes, as reported	$	(3,500	)	$	1,120		$	787

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 9 — INCOME TAXES(CONTINUED)

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


	2010			2009
Deferred tax assets:
NOL carryforward	$	9,342		$	9,520
Allowance for loan losses		2,248			1,776
Alternative Minimum Tax Credit		1,463			1,463
OREO Tax basis > book basis		1,081			80
Tax credit carryovers		672			672
Deferred compensation		247			273
Stock option compensation		204			196
Depreciation		118			72
Intangible assets		95			112
Other		11			49


Total deferred tax assets		15,481			14,213


Valuation allowance	$	(6,010	)	$	(8,146	)


Deferred tax liabilities:
FHLB stock dividend		(128	)		(128	)
Unrealized gain (loss) on securities		(315	)		(563	)
Other		—			(95	)


Total deferred tax liabilities		(443	)		(786	)


Net deferred tax asset	$	9,028		$	5,281

A valuation allowance is provided against deferred tax assets when it is more likely than not that some or all of the deferred tax asset will not be realized. At March 31, 2010 Management evaluated the valuation allowance. An analysis of the deferred tax asset was made to determine the utilization of those tax benefits based upon projected future taxable income. At that time, based upon management’s determination and in accordance with the generally accepted accounting principles, that it was “more likely than not” that a portion of these benefits would be utilized, a $3.500 million valuation adjustment was made as a credit to income tax expense. Among the criteria that management considered in evaluating the deferred tax asset was taxable income for the three most recent taxable years ending December 31, 2009 which totaled $8.2 million. This taxable income allowed the Corporation to utilize NOL carryforwards.

Management assessed the valuation allowance for the second and third quarters of 2010 and determined that no additional adjustment was deemed appropriate. At December 31, 2010, based upon further analysis, and in recognition of the current period operating loss before taxes, management determined that an adjustment to the valuation was appropriate and increased the valuation allowance by $1.364 million with an increase to current tax expense. The Corporation, as of December 31, 2010 had a net operating loss and tax credit carryforwards for tax purposes of approximately $27.5 million, and $2.1 million, respectively.

The Corporation will continue to evaluate the future benefits from these carryforwards and at such time as it became “more likely than not” that they would be utilized prior to expiration will recognize the additional benefits as an adjustment to the valuation allowance. The net operating loss carryforwards expire twenty years from the date they originated. These carryforwards, if not utilized, will begin to expire in the year 2023. A portion of the NOL, approximately $17.0 million, and all of the credit carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code. The annual limitation is $1.400 million for the NOL and the equivalent value of tax credits, which is approximately $.477 million. These limitations for use were established in conjunction with the recapitalization of the Corporation in December 2004.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 10 — OPERATING LEASES

The Corporation currently maintains three operating leases for branch office locations. The first operating lease, for our location in Birmingham, was originated in September 2005 and had an original term of 66 months with an option to renew for an additional five year period. It is anticipated that the original term of this will be extended for an additional three year term.

The second operating lease, for our location in Escanaba, was executed in December 2008, the terms of which began in April 2009. The original term of this lease is three years and will automatically renew and extend for four additional consecutive terms of two years each, but either party may elect to terminate by providing notice of such election to the other party at least 120 days prior to the end of the then-current term. The additional terms call for a lease adjustment based on the Consumer Price Index at time of renewal.

The third operating lease, for our new location in Manistique, was executed in April 2010, the terms of which began at that time. The original term of this lease is three years and will automatically renew and extend for four additional consecutive terms of two years each.

Future minimum payments, by year and in the aggregate, under the initial terms of the operating lease agreements, consist of the following (dollars in thousands):


2011	$	90
2012		25
2013		4


Total	$	119

Rent expense for all operating leases amounted to $270,000 in 2010, $207,000 in 2009, and $195,000 in 2008.

NOTE 11 — 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 $110,000, $120,000, and $90,000 in 2010, 2009, and 2008, respectively.

NOTE 12 — DEFERRED COMPENSATION PLAN

As an incentive to retain key members of management and directors, the Corporation established a deferred compensation plan, with benefits based on the number of years the individuals have served the Corporation. This plan was discontinued and no longer applies to current officers and directors. A liability was recorded on a present value basis and discounted using the rates in effect at the time the deferred compensation agreement was entered into. The liability may change depending upon changes in long-term interest rates. The liability at December 31, 2010 and 2009, for vested benefits under this plan, was $.725 million and $.815 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 $1.559 million and $1.464 million at December 31, 2010 and 2009, respectively. Deferred compensation expense for the plan was $43,000, $72,000, and $84,000 for 2010, 2009, and 2008, respectively.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 13 — 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, 2010, the Corporation is well capitalized.

To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. In addition, federal banking regulators have established capital classifications beyond the minimum requirements in order to risk-rate deposit insurance premiums and to provide trigger points for prompt corrective action.

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


													To Be Well
													Capitalized Under
							For Capital						Prompt Corrective
	Actual						Adequacy Purposes						Action Provisions
	Amount		Ratio				Amount		Ratio				Amount		Ratio
2010
Total capital to risk weighted assets:
Consolidated	$	49,132		12.6	%	≥	$	31,157		≥ 8.0	%			N/A
mBank	$	43,477		11.2	%	≥	$	31,118		≥ 8.0	%	≥	$	38,897		10.0	%
Tier 1 capital to risk weighted assets:
Consolidated	$	44,242		11.4	%	≥	$	15,579		≥ 4.0	%			N/A
mBank	$	38,594		9.9	%	≥	$	15,559		≥ 4.0	%	≥	$	23,338		6.0	%
Tier 1 capital to average assets:
Consolidated	$	44,242		9.3	%	≥	$	19,130		≥ 4.0	%			N/A
mBank	$	38,594		8.1	%	≥	$	19,092		≥ 4.0	%	≥	$	23,865		5.0	%
2009
Total capital to risk weighted assets:
Consolidated	$	54,587		13.2	%	≥	$	33,155		≥ 8.0	%			N/A
mBank	$	47,630		11.5	%	≥	$	33,166		≥ 8.0	%	≥	$	41,458		10.0	%
Tier 1 capital to risk weighted assets:
Consolidated	$	49,406		11.9	%	≥	$	16,578		≥ 4.0	%			N/A
mBank	$	42,446		10.2	%	≥	$	16,583		≥ 4.0	%	≥	$	24,875		6.0	%
Tier 1 capital to average assets:
Consolidated	$	49,406		9.8	%	≥	$	20,272		≥ 4.0	%			N/A
mBank	$	42,446		8.4	%	≥	$	20,261		≥ 4.0	%	≥	$	25,326		5.0	%

At December 31, 2010, the Bank was not authorized to pay dividends to the Corporation without prior regulatory approval because of a negative retained earnings balance due to cumulative losses.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 14 — STOCK OPTION PLANS

The Corporation sponsors three stock option plans. All historical information presented below has been adjusted to reflect the 1 for 20 reverse stock split which occurred on December 16, 2004. One plan was approved during 2000 and applies to officers, employees, and non-employee directors. A total of 25,000 shares were made available for grant under this plan. This plan was amended as a part of the recapitalization to provide for additional authorized shares equal to 12.50% of all outstanding shares subsequent to the recapitalization, which amounted to 428,587 shares. This plan expired on February 15, 2010. The other two plans, one for officers and employees and the other for non-employee directors, were approved in 1997 and expired in 2007. A total of 30,000 shares were made available for grant under these plans. Options under all of the plans are granted at the discretion of a committee of the Corporation’s Board of Directors. Options to purchase shares of the Corporation’s stock are granted at a price equal to the market price of the stock at the date of grant. The committee determines the vesting of the options when they are granted as established under the plan.

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


	2010			2009
Outstanding shares at beginning of year		411,057			446,237
Granted during the year		—			—
Exercised during the year		—			—
Expired / forfeited during the year		(16,985	)		(35,180	)

Outstanding shares at end of year		394,072			411,057

Exercisable shares at end of year		150,781			157,266

Weighted average exercise price per share
at end of year	$	10.98		$	12.03

Shares available for grant at end of year		0			24,780

There were no options granted in 2010 and in 2009.

Following is a summary of the options outstanding and exercisable at December 31, 2010:


							Weighted
							Average
							Remaining
Exercise	Number of Shares						Contractual
Price	Outstanding		Exercisable		Unvested Options		Life-Years
$9.16		5,000		2,000		3,000		4.96
$9.75		257,152		120,861		136,291		3.96
$10.65		50,000		10,000		40,000		5.96
$11.50		40,000		8,000		32,000		4.75
$12.00		40,000		8,000		32,000		4.46
$156.00		1,920		1,920		—		.83

		394,072		150,781		243,291		4.34

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 14 — STOCK OPTION PLANS (CONTINUED)

Options issued since the Corporation’s recapitalization in December of 2004 call for 20% immediate vesting upon issue and subsequent vesting to occur over a two to five year period, based upon the market value appreciation of the underlying Corporation’s stock. Compensation related to these options is expensed based upon the vesting period without consideration given to market value appreciation. There are no future compensation expenses related to existing option programs.

NOTE 15 — OTHER COMPREHENSIVE INCOME (LOSS)

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


	2010			2009		2008
Unrealized holding gains (losses) on available for sale securities	$	(513	)	$	2,451	$	681
Less reclassification adjustments for gains (losses) later recognized in income		215			1,471		64

Net unrealized gains (losses)		(728	)		980		617
Tax effect		(247	)		331		232

Other comprehensive income (loss)	$	(481	)	$	649	$	385

NOTE 16 — SHAREHOLDERS’ EQUITY

Participation in the TARP Capital Purchase Program

On April 24, 2009, the Corporation entered into and closed a Letter Agreement, including the Securities Purchase Agreement-Standard Terms (collectively, the “Securities Purchase Agreement”), related to the CPP. Pursuant to the Securities Purchase Agreement, the Corporation issued and sold to the Treasury (i) 11,000 shares of the Corporation’s Series A Preferred Shares, and (ii) a 10-year Warrant to purchase 379,310 shares of the Corporation’s Common Shares, at an exercise price of $4.35 per share (subject to certain anti-dilution and other adjustments), for aggregate proceeds of $11.000 million in cash.

As a result of the CPP transaction, the Corporation is required to take certain actions, for so long as the Treasury holds any securities acquired from the Corporation pursuant to the CPP (excluding any period in which the Treasury holds only the Warrant to purchase Common Shares of the Corporation) (the “CPP Period”), to ensure that its executive compensation and benefit plans with respect to Senior Executive Officers (as defined in the relevant agreements) comply with Section 111(b) of Emergency Economic Stabilization Act of 2008 (“EESA”), as implemented by any guidance or regulations issued under Section 111(b) of EESA, and not adopt any benefit plans with respect to, or which cover, the Corporation’s Senior Executive Officers that do not comply with EESA, as amended by the American Recovery and Reinvestment Act of 2009 (the “ARRA”), which was passed by Congress and signed by the President on February 17, 2009. The applicable executive compensation standards generally remain in effect during the CPP Period and apply to the Corporation’s Senior Executive Officers (which for purposes of the ARRA and the CPP agreements, includes the Corporation’s Chief Executive Officer, its Chief Financial Officer, and the next three most highly-compensated executive officers, even though the Corporation’s senior executive officers consist of a smaller group of executives for purposes of the other compensation disclosures in this proxy statement).

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 16 — SHAREHOLDERS’ EQUITY (CONTINUED)

Amounts recorded for Preferred Stock and Warrant Common Stock were estimated based on an allocation of the total proceeds from the issuance on the relative fair values of both instruments. Fair value of the Preferred Stock was determined based on assumptions regarding the discount rate (market rate) on the Preferred Stock (estimated 12%). Fair value of the Warrant Common Stock is based on the value of the underlying Preferred Stock based on an estimate for a three year term. The allocation of the proceeds received resulted in the recording of a discount on the Preferred Stock and a premium on the Warrant Common Stock. The discount on the preferred will be accreted on an effective yield basis over a three-year term. The allocated carrying value of the Preferred Stock and Warrant Common Stock on the date of issuance (based on their relative fair values) was $10.382 million and $.618 million, respectively. Cumulative dividends on the Preferred Stock are payable at 5% annum for the first five years and at a rate of 9% per annum thereafter on the liquidation preference of $1,000 per share. The Company is prohibited from paying any dividend with respect to shares of common stock unless all accrued and unpaid dividends are paid in full on the Preferred Stock for all past dividend periods. The Preferred Stock is non-voting, other than class voting rights on matters that could adversely affect the Preferred Stock. The Preferred Stock may be redeemed at any time with regulatory approval. The Treasury may also transfer the Preferred Stock to a third party at any time. The preferred stock qualifies as Tier 1 Capital for regulatory purposes at the holding company.

The Corporation has the right to redeem the Series A Preferred Shares at any time after consulting with its primary regulator, in which case the executive compensation standards would no longer apply to the Corporation.

The Corporation is considering whether or not to participate in the U.S. Treasury’s Small Business Lending Fund program (“SBLF”). The Corporation has applied for funding under the SBLF, but has not yet received approval, nor has the Corporation determined if it will participate if approved. This SBLF program would allow the Corporation to pay off the TARP preferred and also requires an injection of capital into the Bank which is dependent upon the amount of the total SBLF funding less the $11 million of TARP preferred.

NOTE 17 — 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):


	2010		2009
Commitments to extend credit:
Variable rate	$	18,092	$	24,839
Fixed rate		13,034		6,039
Standby letters of credit — Variable rate		2,192		1,279
Credit card commitments — Fixed rate		2,737		2,714


	$	36,055	$	34,871

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

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 17 — COMMITMENTS, CONTINGENCIES, AND CREDIT RISK (CONTINUED)

creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management’s credit evaluation of the party. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Corporation to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The commitments are structured to allow for 100% collateralization on all standby letters of credit.

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

Contingencies

In the normal course of business the Corporation is involved in various legal proceedings.

Concentration of Credit Risk

The Bank grants commercial, residential, agricultural, and consumer loans throughout Michigan. The Bank’s most prominent concentration in the loan portfolio relates to commercial real estate loans to operators of nonresidential buildings. This concentration at December 31, 2010 represents $58.114 million, or 19.56%, compared to $48.689 million, or 15.93%, of the commercial loan portfolio on December 31, 2009. The remainder of the commercial loan portfolio is diversified in such categories as hospitality and tourism, real estate agents and managers, new car dealers, gaming, petroleum, forestry, agriculture, and construction. Due to the diversity of the Bank’s locations, the ability of debtors of residential and consumer loans to honor their obligations is not tied to any particular economic sector.

NOTE 18 — 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.

Federal Home Loan Bank stock — Federal Home Loan Bank stock is carried at cost, which is its redeemable value and approximates its fair value, since the market for this stock is limited.

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

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

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

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 18 — FAIR VALUE (CONTINUED)

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

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

Accrued interest - The carrying amount of accrued interest approximates fair value.

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

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


	Fair Value Measurements
	2010				2009
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Financial assets:
Cash and cash equivalents	$	34,719	$	34,719	$	45,433	$	45,433
Interest-bearing deposits		713		713		678		678
Securities available for sale		33,860		33,860		46,513		46,513
Federal Home Loan Bank stock		3,423		3,423		3,794		3,794
Net loans		376,473		376,713		379,085		382,352
Accrued interest receivable		1,155		1,155		1,413		1,413


Total financial assets	$	450,343	$	450,583	$	476,916	$	480,183


Financial liabilities:
Deposits	$	386,779	$	387,885	$	421,389	$	421,124
Borrowings		36,069		36,234		36,140		36,447
Accrued interest payable		232		232		325		325


Total financial liabilities	$	423,080	$	424,351	$	457,854	$	457,896

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.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 18 — FAIR VALUE (CONTINUED)

The following is information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at December 31, 2010, and the valuation techniques used by the Corporation to determine those fair values.

Level 1: In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that the Corporation has the ability to access.

Level 2: Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3: Level 3 inputs are unobservable inputs, including inputs available in situations where there is little, if any, market activity for the related asset or liability.

The fair value of all investment securities at December 31, 2010 and December 31, 2009 were based on level 2 inputs. There are no other assets or liabilities measured on a recurring basis at fair value. For additional information regarding investment securities, please refer to “Note 3 — Investment Securities.”

The Corporation had no Level 3 assets or liabilities on a recurring basis as of December 31, 2010 or December 31, 2009.

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.

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 18 — FAIR VALUE (CONTINUED)

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 owned. The Corporation has estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2010


			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Year Ended
(dollars in thousands)	December 31, 2010		(Level 1)		(Level 2)		(Level 3)		December 31, 2010
Assets

Impaired loans	$	10,563	$	—	$	—	$	10,563	$	1,666
Other real estate owned		5,562		—		—		5,562		2,753


									$	4,419

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2009


			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Year Ended
(dollars in thousands)	December 31, 2009		(Level 1)		(Level 2)		(Level 3)		December 31, 2009
Assets

Impaired Loans	$	15,237	$	—	$	—	$	15,237	$	1,300
Other real estate owned		5,804		—		—		5,804		399

									$	1,699

The Corporation had no investments subject to fair value measurement on a nonrecurring basis.

Impaired loans categorized as Level 3 assets consist of non-homogeneous loans that are considered impaired. The Corporation estimates the fair value of the loans based on the present value of expected future cash flows using management’s best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals).

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 19 — PARENT COMPANY ONLY FINANCIAL STATEMENTS

BALANCE SHEETS
December 31, 2010 and 2009
(Dollars in Thousands)


	2010			2009
ASSETS

Cash and cash equivalents	$	5,353		$	7,480
Investment in subsidiaries		49,016			48,575
Other assets		275			156


TOTAL ASSETS	$	54,644		$	56,211


LIABILITIES AND SHAREHOLDERS’ EQUITY

Other liabilities	$	762		$	912
Shareholders’ equity:
Preferred stock — no par value:
Authorized 500,000 shares, 11,000 shares issued and outstanding		10,706			10,514
Common stock and additional paid in capital — no par value
Authorized 18,000,000 shares
Issued and outstanding - 3,419,736		43,525			43,493
Accumulated earnings (deficit)		(961	)		199
Accumulated other comprehensive income		612			1,093


Total shareholders’ equity		53,882			55,299


TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	54,644		$	56,211

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 19 — PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)

STATEMENTS OF OPERATIONS
Years Ended December 31, 2010, 2009, and 2008
(Dollars in Thousands)


	2010			2009			2008
INCOME:
Proceeds from settlement of lawsuits	$	—		$	—		$	3,475
Other		11			8			9


Total income		11			8			3,484


EXPENSES:
Salaries and benefits		218			250			265
Interest		—			—			51
Professional service fees		136			196			55
Other		147			227			141


Total expenses		501			673			512


Income (loss) before income taxes and equity in undistributed net income (loss) of subsidiaries		(490	)		(665	)		2,972


Provision for (benefit of) income taxes		—			(226	)		1,005


Income (loss) before equity in undistributed net income (loss) of subsidiaries		(490	)		(439	)		1,967

Equity in undistributed net income (loss) of subsidiaries		72			2,855			(95	)


Net income (loss)		(418	)		2,416			1,872

Preferred dividend and accretion of discount		742			509			—


NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS	$	(1,160	)	$	1,907		$	1,872

Notes to the Consolidated Financial Statements

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

NOTE 19 — PARENT COMPANY ONLY FINANCIAL STATEMENTS (CONTINUED)

STATEMENTS OF CASH FLOWS
Years Ended December 31, 2010, 2009, and 2008
(Dollars in Thousands)


	2010			2009			2008
Cash Flows from Operating Activities:
Net income	$	(418	)	$	2,416		$	1,872
Adjustments to reconcile net income to net cash provided by operating activities:
Equity in undistributed net (income) loss of subsidiaries		(72	)		(2,855	)		95
Increase in capital from stock option compensation		32			60			82
Change in other assets		31			(348	)		49
Change in other liabilities		(149	)		32			765

Net cash (used in) provided by operating activities		(576	)		(695	)		2,863


Cash Flows from Financing Activities:
Proceeds from issuance of Series A Preferred Stock and common stock warrants		—			11,000			—
Dividend on preferred stock		(550	)		(307	)		—
Net increase (decrease) in lines of credit		—			—			(1,959	)
Purchase of common stock — oddlot shares		—			—			(110	)
Payments from subsidiaries		—			69			—
Investments in subsidiaries		(1,000	)		(3,000	)		(500	)

Net cash (used) provided by financing activities		(1,550	)		7,762			(2,569	)


Net increase (decrease) in cash and cash equivalents		(2,126	)		7,067			294
Cash and cash equivalents at beginning of period		7,480			413			119


Cash and cash equivalents at end of period	$	5,354		$	7,480		$	413

Selected Financial Data

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

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


	Years Ended December 31
	2010			2009			2008			2007			2006
*SELECTED FINANCIAL CONDITION DATA:*
Total assets	$	478,696		$	515,377		$	451,431		$	408,880		$	382,791
Loans		383,086			384,310			370,280			355,079			322,581
Securities		33,860			46,513			47,490			21,597			32,769
Deposits		386,779			421,389			371,097			320,827			312,421
Borrowings		36,069			36,140			36,210			45,949			38,307
Common shareholders’ equity		43,176			44,785			41,552			39,321			28,790
Total shareholders’ equity		53,882			55,299			41,552			39,321			28,790

*SELECTED OPERATIONS DATA:*
Interest income	$	22,840		$	23,708		$	24,562		$	28,695		$	24,052
Interest expense		6,455			7,421			11,698			(15,278	)		(12,459	)

Net interest income		16,385			16,287			12,864			13,417			11,593
Provision for loan losses		6,500			3,700			2,300			400			(861	)
Net security gains (losses)		215			1,471			64			(1	)		(1	)
Other income		2,580			3,280			4,589			2,007			984
Other expenses		(16,598	)		(13,802	)		(12,558	)		(12,100	)		(12,221	)

Income (loss) before income taxes		(3,918	)		3,536			2,659			2,923			1,216
Provision (credit) for income taxes		(3,500	)		1,120			787			(7,240	)		(500	)

Net income (loss)		(418	)		2,416			1,872			10,163			1,716
Preferred dividend and accretion of discount		742			509			—			—			—

Net income available to common shareholders	$	(1,160	)	$	1,907		$	1,872		$	10,163		$	1,716


*PER SHARE DATA:*
Earnings (loss) — Basic	$	(.34	)	$	.56		$	.55		$	2.96		$	.50
Earnings (loss) — Diluted		(.34	)		.56			.55			2.96			.50
Cash dividends declared		—			—			—			—			—
Book value		12.63			13.10			12.15			11.47			8.40
Market value — closing price at year end		4.58			4.64			4.40			8.98			11.50

*FINANCIAL RATIOS:*
Return on average common equity		(2.64	)%		4.42	%		4.61	%		31.05	%		6.19	%
Return on average total equity		(2.06	)		3.77			4.61			31.05			6.19
Return on average assets		(.23	)		.39			.44			2.59			.49
Dividend payout ratio		N/A			N/A			N/A			N/A			N/A
Average equity to average assets		11.17			10.24			9.55			8.34			7.97
Efficiency ratio		72.57			72.24			85.51			79.46			93.95
Net interest margin		3.66			3.59			3.23			3.60			3.51

Summary Quarterly Financial Information

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

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


	FOR THE QUARTER ENDED												FOR THE QUARTER ENDED
	2010												2009
	12/31			9/30			6/30			3/31			12/31			9/30			6/30			3/31
BALANCE SHEET

Total loans	$	383,086		$	382,727		$	384,839		$	377,311		$	384,310		$	384,100		$	372,004		$	370,776
Allowance for loan losses		(6,613	)		(5,437	)		(6,371	)		(4,737	)		(5,225	)		(4,081	)		(4,119	)		(4,793	)
Total loans, net		376,473			377,290			378,468			372,574			379,085			380,019			367,885			365,983
Intangible assets		—			—			—			—			—			—			6			26
Total assets		478,696			499,006			500,774			502,427			515,377			513,180			506,304			466,375
Core deposits		290,614			287,055			271,026			236,227			209,828			200,541			202,892			196,860
Noncore deposits ⁽¹⁾		96,165			117,469			134,758			168,985			211,561			218,040			210,260			188,897
Total deposits		386,779			404,524			405,784			405,212			421,389			418,581			413,152			385,757
Total borrowings		36,069			36,069			36,140			36,140			36,140			36,140			36,210			36,210
Total shareholders’ equity		53,882			55,987			56,231			58,722			55,299			55,766			53,939			41,864
Total shares outstanding		3,419,736			3,419,736			3,419,736			3,419,736			3,419,736			3,419,736			3,419,736			3,419,736

AVERAGE BALANCE SHEET

Total loans	$	385,296		$	385,268		$	382,169		$	384,640		$	386,203		$	370,310		$	371,609		$	370,943
Allowance for loan losses		(5,816	)		(6,094	)		(5,159	)		(5,073	)		(3,872	)		(4,231	)		(4,847	)		(4,405	)
Total loans, net		379,480			379,174			377,010			379,567			382,331			366,079			366,762			366,538
Intangible assets		—			—			—			—			—			1			16			35
Total assets		488,320			512,335			502,942			508,495			514,102			513,687			491,205			454,740
Core deposits		286,807			285,697			255,023			221,284			204,972			201,854			198,631			194,962
Noncore deposits ⁽¹⁾		106,459			131,150			150,426			192,613			213,308			217,248			202,879			177,707
Total deposits		393,266			416,847			405,449			413,897			418,280			419,102			401,510			372,669
Total borrowings		36,069			36,115			36,140			36,140			36,140			36,194			36,376			36,648
Total shareholders’ equity		55,015			56,668			57,889			55,109			55,665			54,594			49,855			41,813

ASSET QUALITY RATIOS

Nonperforming loans/total loans		2.76	%		2.94	%		2.87	%		2.62	%		3.96	%		3.00	%		2.66	%		3.52	%
Nonperforming assets/total assets		3.37			3.41			3.34			3.51			4.08			3.38			2.93			3.27
Allowance for loan losses/total loans		1.73			1.42			1.66			1.26			1.36			1.06			1.11			1.29
Allowance for loan losses/nonperforming loans		62.61			48.34			57.69			47.87			34.29			35.40			41.71			36.72
Net charge-offs/average loans		.16			.50			.31			.36			.30			.20			.22			.01
Texas Ratio ⁽²⁾		26.66			27.68			26.71			27.76			34.76			28.99			25.53			32.69

CAPITAL ADEQUACY RATIOS

Tier 1 leverage ratio		9.25	%		9.22	%		9.38	%		9.85	%		9.75	%		9.74	%		9.65	%		7.86	%
Tier 1 capital to risk weighted assets		11.36			11.73			11.65			12.48			11.92			12.18			11.94			9.31
Total capital to risk weighted assets		12.62			12.98			12.91			13.69			13.17			13.19			13.00			10.56
Average equity/average assets		11.27			11.06			11.51			10.84			10.83			10.63			10.15			9.19
Tangible equity/tangible assets		11.27			11.06			11.51			10.84			10.83			10.87			10.65			8.97


⁽¹⁾		Noncore deposits include brokered deposits and CDs greater than $100,000

⁽²⁾		Texas Ratio: Nonperforming Assets Divided by Total Equity plus Allowance for Loan Losses

Summary Quarterly Financial Information

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

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


	FOR THE QUARTER ENDED 2010												FOR THE QUARTER ENDED 2009
	12/31			9/30			6/30			3/31			12/31			9/30			6/30			3/31
INCOME STATEMENT

Net interest income	$	4,276		$	4,064		$	4,023		$	4,022		$	4,431		$	4,310		$	4,051		$	3,495
Provision for loan losses		1,800			1,000			2,800			900			2,300			700			150			550
Net interest income after provision		2,476			3,064			1,223			3,122			2,131			3,610			3,901			2,945
Total noninterest income		747			648			593			807			1,503			2,418			439			391
Total noninterest expense		4,037			3,601			5,330			3,629			3,650			3,443			3,470			3,239
Income before taxes		(814	)		111			(3,514	)		300			(16	)		2,585			870			97
Provision for income taxes		1,093			30			(1,212	)		(3,411	)		(22	)		864			271			7

Net income		(1,907	)		81			(2,302	)		3,711			6			1,721			599			90
Preferred dividend and accretion of discount		185			185			186			185			186			185			138			—
Net income available to common shareholders	$	(2,092	)	$	(104	)	$	(2,488	)	$	3,526		$	(180	)	$	1,536		$	461		$	90


PER SHARE DATA

Earnings per share — basic	$	(.61	)	$	(.03	)	$	(.73	)	$	1.03		$	(.05	)	$	.45		$	.13		$	.03
Earnings per share — diluted		(.61	)		(.03	)		(.73	)		1.03			(.05	)		.45			.13			.03
Book value per share		12.63			13.26			13.34			14.08			13.10			13.25			12.73			12.24
Market value per share		4.58			5.10			6.50			4.72			4.64			4.10			4.50			4.00

PROFITABILITY RATIOS

Return on average assets		(1.70	)%		(.08	)%		(1.98)	%		2.81	%		(.14)	%		1.19	%		.38	%		.08	%
Return on average common equity		(18.76	)		(.91	)		(21.28	)		(30.77	)		(1.59	)		13.72			4.33			.87
Return on average total equity		(15.09	)		(0.73	)		(17.24	)		25.95			(1.28	)		11.16			3.71			.87
Net interest margin		3.88			3.69			3.56			3.51			3.74			3.66			3.58			3.35
Efficiency ratio		65.05			75.98			76.04			78.12			71.03			70.09			76.55			82.36
Average loans/average deposits		97.97			92.42			94.26			92.93			92.33			88.36			92.55			99.54

Market Information

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

MARKET INFORMATION
(Unaudited)

The Corporation’s common stock is traded on the NASDAQ Capital Market under the symbol MFNC. The following table sets forth the range of high and low trading prices of the Corporation’s common stock from January 1, 2009 through December 31, 2010, as reported by NASDAQ.


	For the Quarter Ended
	March 31		June 30		September 30		December 31
2010
High	$	5.20	$	7.39	$	6.95	$	5.28
Low		4.09		4.51		4.74		3.95
Close		4.72		6.50		5.10		4.58
Book value, at quarter end		14.08		13.34		13.26		12.63

2009
High	$	4.72	$	4.50	$	6.37	$	5.85
Low		2.45		3.76		4.00		4.00
Close		4.00		4.50		4.10		4.64
Book value, at quarter end		12.24		12.73		13.25		13.10

The Corporation had 1,216 shareholders of record as of March 30, 2011.

The holders of the Corporation’s common stock are entitled to dividends when, and if declared by the Board of Directors of the Corporation, out of funds legally available for that purpose. In determining dividends, the Board of Directors considers the earnings, capital requirements and financial condition of the Corporation and its subsidiary bank, along with other relevant factors. The Corporation’s principal source of funds for cash dividends is the dividends paid by the Bank. The ability of the Corporation and the Bank to pay dividends is subject to regulatory restrictions and requirements. The Bank currently has a negative retained earnings position which precludes payment of dividends. The Bank, in order to pay dividends, would need to eliminate the negative retained earnings position and have regulatory approval. There were no dividends declared or paid in 2008, 2009 and 2010. There were no sales of unregistered securities in 2010, nor were there any repurchases of the Corporation’s common stock in 2010.

Shareholder Return Performance Graph

MACKINAC FINANCIAL CORPORATION AND SUBSIDIARIES

Set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on the Corporation’s common stock with that of the cumulative total return on the NASDAQ Bank Index and the NASDAQ Composite Index for the five-year period ended December 31, 2010. The following information is based on an investment of $100, on December 31, 2005 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.

Forward Looking Statements

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

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

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

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

	•		Changes in the level and volatility of interest rates which may negatively affect the Corporation’s interest margin;

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

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

	•		The ability of borrowers to repay loans;

	•		The effects on liquidity of unusual decreases in deposits;

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

	•		Technological changes;

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

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

	•		The Corporation’s ability to increase market share and control expenses;

	•		The effect of compliance with legislation or regulatory changes;

	•		The effect of changes in accounting policies and practices;

	•		The costs and effects of existing and future litigation and of adverse outcomes in such litigation; and

	•		An increase in the Corporation’s FDIC insurance premiums, or the collection of special assessments by the FDIC.

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

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

OVERVIEW

The following discussion and analysis presents the more significant factors affecting the Corporation’s financial condition as of December 31, 2010 and 2009 and the results of operations for 2008 through 2010. This discussion also covers asset quality, liquidity, interest rate sensitivity, and capital resources for the years 2009 and 2010. The information included in this discussion is intended to assist readers in their analysis of, and should be read in conjunction with, the consolidated financial statements and related notes and other supplemental information presented elsewhere in this report. Throughout this discussion, the term “Bank” refers to mBank, the principal banking subsidiary of the Corporation.

Taxable equivalent adjustments are the result of increasing income from tax-free loans and investments by an amount equal to the taxes that would be paid if the income were fully taxable based on a 34% federal tax rate, thus making tax-exempt yields comparable to taxable asset yields.

Dollar amounts in tables are stated in thousands, except for per share data.

EXECUTIVE SUMMARY

The purpose of this section is to provide a brief summary of the 2010 results of operations and financial condition. A more detailed analysis of the results of operations and financial condition follows this summary.

The Corporation reported a loss available to common shareholders in 2010 of $1.160 million, or $.34 per share, compared to net income of $1.907 million, $.56 per share, in 2009 and net income in 2008 of $1.872 million, $.55 per share.

Total assets of the Corporation at December 31, 2010, were $478.696 million, a decrease of $36.681 million, or 7.12% from total assets of $515.377 million reported at December 31, 2009. In 2010, the Corporation reduced excess liquidity and reliance on wholesale funding.

At December 31, 2010, the Corporation’s loans stood at $383.086 million, a decrease of $1.224 million, or .32%, from 2009 year-end balances of $384.310 million. Loan balances were impacted by normal amortization and paydowns. A good portion of these payoffs pertained to loan relationships that no longer met our pricing or credit standards. Total loan production in 2010 amounted to $113.8 million, which included $36.7 million of secondary market mortgage loans. The Corporation also sold $12.6 million of SBA/USDA guaranteed loans.

Nonperforming loans totaled $10.563 million, or 2.76% of total loans at December 31, 2010. Nonperforming assets at December 31, 2010, were $16.125 million, 3.37% of total assets, compared to $21.041 million or 4.08% of total assets at December 31, 2009.

Total deposits decreased from $421.389 million at December 31, 2009, to $386.779 million at December 31, 2010, a decrease of 8.21%. The decrease in deposits in 2010 was comprised of a decrease in wholesale deposits of $115.396 million and an increase in core deposits of $80.786 million.

Shareholders’ equity totaled $53.882 million at December 31, 2010, compared to $55.299 million at the end of 2009, a decrease of $1.417 million. This decrease reflects the consolidated net loss of $1.160 million, the $32,000 capital contribution impact of stock options, the decrease in the market value of available-for-sale investments, which amounted to $.481 million and the decrease from the accretion of the discount on preferred stock of $.192 million. The book value per common share at December 31, 2010, amounted to $12.63 compared to $13.10 at the end of 2009.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

RESULTS OF OPERATIONS


	For the Years Ended December 31,
(dollars in thousands, except per share data)	2010			2009			2008
Taxable-equivalent net interest income	$	16,496		$	16,446		$	13,074
Taxable-equivalent adjustment		111			159			210


Net interest income		16,385			16,287			12,864
Provision for loan losses		6,500			3,700			2,300
Other income		2,795			4,751			4,653
Other expense		16,598			13,802			12,558


Income before provision for income taxes		(3,918	)		3,536			2,659
Provision for (benefit of) income taxes		(3,500	)		1,120			787


Net income (loss)	$	(418	)	$	2,416		$	1,872
Preferred dividend expense		742			509			—


Net income (loss) available to common shareholders	$	(1,160	)	$	1,907		$	1,872


Earnings (loss) per common share
Basic	$	(.34	)	$	.56		$	.55
Diluted	$	(.34	)	$	.56		$	.55

Return on average assets		(.23	)%		.39	%		.44	%

Summary

The Corporation reported a net loss available to common shareholders of $1.160 million in 2010, compared to net income of $1.907 million in 2009 and a net income of $1.872 million in 2008. The 2010 results include elevated costs associated with nonperforming assets, including loan loss provisions of $6.500 million and OREO write-downs and gains/losses of $2.753 million. Also included in the 2010 results are security gains of $.215 million. The 2009 results include $1.208 million of gains related to branch office sales and $1.471 million of security gains. The 2008 operating results include the positive effect, $3.475 million of a lawsuit settlement, and the negative effect, $.425 million of a severance agreement.

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 89% of total revenue in 2010. The net interest income is impacted by economic and competitive factors that influence rates, loan demand, and the availability of funding.

Net interest income on a taxable equivalent basis increased $.098 million from $16.287 in 2009 to $16.385 million, in 2010. Attributing to the overall decrease in net interest income was a reduction in investment securities which were sold late in 2009 in order to reduce excess liquidity and lower market interest rate risk. The proceeds from these sales were used to repay maturing wholesale deposits. In 2010, interest rates were somewhat stable with the prime rate at 3.25% for the entire year. The Corporation experienced a modest reduction, 14 basis points, in the overall rates on earnings assets from 5.26% in 2009 to 5.12% in 2010. Interest bearing funding sources also declined, by 22 basis points, from 1.82% in 2009 to 1.60% in 2010. The combination of these rate reductions resulted in an improved net interest margin from 3.62% in 2009 to 3.68% in 2010.

In 2009, the Corporation realized an increase of $3.423 million in net interest income. A portion of this increase was attributed to higher levels of investment securities which were funded by lower cost wholesale funding sources. In 2009, the Corporation benefited from low interest rates prevalent on wholesale deposit instruments. The interest rates in the

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

wholesale environment were significantly more attractive than offering rates by competitors in local markets. In addition to the benefits derived from lower rates or wholesale deposit instruments a number of new or rewritten loans were structured with interest rate floors that locked in a near term favorable interest rate spread.

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


	2010			Mix			2009			Mix			2008			Mix
Interest Income
Loans	$	21,279			93.17	%	$	20,813			87.79	%	$	22,959			93.48	%
Funds sold		58			.25			—			—			96			.39
Taxable securities		1,406			6.16			2,783			11.74			1,293			5.26
Nontaxable securities		28			.12			19			.08			5			.02
Other interest-earning assets		69			.30			93			.39			209			.85

Total earning assets		22,840			100.00	%		23,708			100.00	%		24,562			100.00	%

Interest Expense
NOW, money markets, checking		1,218			18.87	%		809			10.90	%		1,284			10.98	%
Savings		97			1.50			142			1.91			193			1.65
CDs <$100,000		1,756			27.20			1,857			25.02			3,181			27.19
CDs >$100,000		449			6.96			633			8.53			1,037			8.86
Brokered deposits		2,087			32.33			2,990			40.30			4,420			37.79
Borrowings		848			13.14			990			13.34			1,583			13.53

Total interest-bearing funds		6,455			100.00	%		7,421			100.00	%		11,698			100.00	%


Net interest income	$	16,385					$	16,287					$	12,864


Average Rates
Earning assets		5.10	%					5.22	%					6.16	%

Interest-bearing funds		1.60						1.82						3.32

Interest rate spread		3.50						3.40						2.84

As shown in the table above, income on loans provides more than 90% of the Corporation’s interest revenue. The Corporation’s loan portfolio has approximately 71% of variable rate loans that predominantly reprice with changes in the prime rate and 29% of fixed rate loans. A majority of the variable rate loans, 60%, or $160 million, have interest rate floors. These loans will not reprice until the prime rate increases to the extent necessary to surpass the interest rate floor. A prime rate increase of 100 basis points or more will reprice $66 million of these loans with floors, while the remainder will reprice with a 200 basis point increase in the prime rate.

The majority of interest bearing liabilities do not reprice automatically with changes in interest rates, which provides flexibility to manage interest income. Management monitors the interest sensitivity of earning assets and interest bearing liabilities to minimize the risk of movements in interest rates.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

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


	Years ended December 31,
	2010								2009								2008
	Average					Average			Average					Average			Average					Average
(dollars in thousands)	Balance			Interest		Rate			Balance			Interest		Rate			Balance			Interest		Rate
ASSETS:
Loans (1,2,3)	$	384,347		$	21,376		5.56	%	$	374,796		$	20,964		5.59	%	$	361,324		$	23,166		6.41	%
Taxable securities		35,475			1,406		3.96			74,005			2,782		3.76			28,766			1,293		4.49
Nontaxable securities (2)		853			42		4.92			571			28		4.90			69			8		11.59
Federal Funds sold		22,934			58		.25			74			—		—			4,101			96		2.34
Other interest-earning assets		4,448			69		1.55			4,415			93		2.11			4,318			209		4.84

Total earning assets		448,057			22,951		5.12			453,861			23,867		5.26			398,578			24,772		6.22

Reserve for loan losses		(5,539	)							(4,337	)							(3,747	)
Cash and due from banks		29,291								19,397								6,901
Fixed assets		10,002								10,839								11,453
Other real estate owned		6,196								3,374								1,048
Other assets		14,986								10,518								11,110

		54,936								39,791								26,765


TOTAL ASSETS	$	502,993							$	493,652							$	425,343


LIABILITIES AND SHAREHOLDERS’ EQUITY:
NOW and Money Markets	$	99,411		$	943		.95	%	$	73,003		$	665		0.91	%	$	77,997		$	1,245		1.60	%
Interest checking		18,987			275		1.45			7,735			143		1.85			1,501			39		2.60
Savings deposits		19,503			97		.50			20,179			142		0.70			15,963			193		1.21
CDs <$100,000		84,841			1,756		2.07			67,356			1,858		2.76			78,755			3,181		4.04
CDs >$100,000		26,273			449		1.71			26,906			633		2.35			27,079			1,037		3.83
Brokered deposits		118,615			2,087		1.76			176,017			2,990		1.70			111,482			4,420		3.96
Borrowings		36,116			848		2.35			36,338			990		2.72			39,248			1,583		4.03

Total interest-bearing liabilities		403,746			6,455		1.60	%		407,534			7,421		1.82			352,025			11,698		3.32

Demand deposits		39,704								31,864								29,348
Other liabilities		3,372								3,723								3,340
Shareholders’ equity		56,171								50,531								40,630

		99,247								86,118								73,318


TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	502,993							$	493,652							$	425,343


Rate spread							3.52								3.44	%							2.90	%

Net interest margin/revenue, tax equivalent basis				$	16,496		3.68	%				$	16,446		3.62	%				$	13,074		3.28	%


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

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

⁽³⁾		Interest income on loans includes loan fees.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

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


	Years ended December 31,
	2010 vs. 2009												2009 vs. 2008
	Increase (Decrease)												Increase (Decrease)
	Due to												Due to
										Total												Total
							Volume			Increase									Volume			Increase
	Volume			Rate			and Rate			(Decrease)			Volume			Rate			and Rate			(Decrease)
Interest earning assets:
Loans	$	534		$	(119	)	$	(3	)	$	412		$	863		$	(2,955	)	$	(110	)	$	(2,202	)
Taxable securities		(1,448	)		151			(79	)		(1,376	)		2,033			(212	)		(332	)		1,489
Nontaxable securities		13			—			1			14			58			(5	)		(33	)		20
Federal funds sold		58			—			—			58			(94	)		(96	)		94			(96	)
Other interest earning assets		1			(25	)		—			(24	)		5			(118	)		(3	)		(116	)


Total interest earning assets	$	(842	)	$	7		$	(81	)	$	(916	)	$	2,865		$	(3,386	)	$	(384	)	$	(905	)


Interest bearing obligations
NOW and money market deposits	$	241		$	27		$	10		$	278		$	(80	)	$	(535	)	$	35		$	(580	)
Interest checking		208			(31	)		(45	)		132			162			(11	)		(47	)		104
Savings deposits		(5	)		(41	)		1			(45	)		51			(81	)		(21	)		(51	)
CDs <$100,000		482			(464	)		(120	)		(102	)		(460	)		(1,010	)		147			(1,323	)
CDs >$100,000		(15	)		(173	)		4			(184	)		(7	)		(400	)		3			(404	)
Brokered deposits		(975	)		107			(35	)		(903	)		2,559			(2,526	)		(1,463	)		(1,430	)
Borrowings		(6	)		(137	)		1			(142	)		(117	)		(514	)		38			(593	)


Total interest bearing obligations	$	(70	)	$	(712	)	$	(184	)	$	(966	)	$	2,108		$	(5,077	)	$	(1,308	)	$	(4,277	)


Net interest income, tax equivalent basis										$	50											$	3,372

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 2010, the Corporation recorded a provision for loan loss of $6.500 million, compared to a provision of $3.700 million in 2009. The higher provision for 2010 was due in large part to an elevated level of charge-offs which totaled $5.112 million, or 1.33% of average loans compared to $2.752 million or .73% on average loans in 2009.

Noninterest Income

Noninterest income was $2.795 million, $4.751 million, and $4.653 million in 2010, 2009, and 2008, respectively. The principal recurring sources of noninterest income are the gains on the sale of secondary market loans and fees for services related to deposit and loan accounts. In 2010, the Corporation expanded its efforts to generate increased income from secondary market loans by adding additional staff and centralizing processing activities. In 2009, the Corporation recorded a gain on the sale of two branch offices, $1.208 million, and a gain on security sales of $1.471 million.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

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


							% Increase (Decrease)
	2010		2009		2008		2010-2009			2009-2008
Deposit service charges	$	128	$	116	$	101		10.34	%		14.85	%
NSF Fees		862		907		737		(4.96	)		23.07
Gain on sale of secondary market loans		445		224		107		98.66			109.35
Secondary market fees generated		94		93		34		1.08			173.53
SBA Fees		868		513		12		69.20			4,175.00
Proceeds from settlement of lawsuits		—		—		3,475		—			(100.00	)
Gain on sale of branch offices		—		1,208		—		(100.00	)		100.00
Other		183		219		123		(16.44	)		78.05

Subtotal		2,580		3,280		4,589		(21.34	)		(28.52	)

Net security gains		215		1,471		64		(85.38	)		2,198.44


Total noninterest income	$	2,795	$	4,751	$	4,653		(41.17)	%		2.11	%

Total revenues from the loan sale activities amounted to $1.407 million in 2010, $.830 million in 2009 and $.153 million in 2008. The Corporation anticipates increased revenues from these activities in future periods. As stated, we increased our capacity for secondary market activities with several key staff additions. We are also increasing our SBA and USDA lending activities as these types of government sponsored programs become more advantageous to borrowers. Deposit related income totaled $.990 million in 2010 compared to $1.023 million in 2009 and $.838 million in 2008. The current regulatory environment may limit the Corporation’s ability to grow these revenue sources.

Noninterest Expense

Noninterest expense was $16.598 million in 2010, compared to $13.802 million and $12.558 million in 2009 and 2008, respectively. In 2010, the increase in noninterest expense totaled $2.796 million, or 20.26%. The largest increase in noninterest expense for 2010 occurred in OREO write-downs and gains/losses on the sale of OREO, which increased from $.208 million in 2009 to $2.753 million in 2010. In 2008 the Corporation had net gains of $80,000 on the sale of OREO. Management expects that costs associated with carrying nonperforming loans will continue to be above historical norms. Salaries and benefits, at $6.918 million, increased by $.335 million, 5.09%, from the 2009 expenses of $6.583 million and compared to $6.886 million in 2008. The other most significant loan and deposit expense increase was in FDIC insurance assessment premiums which totaled $.839 million in 2009 and increased to $.957 million in 2010. FDIC insurance costs are also expected to increase in future periods based upon the need to replenish the deposit insurance fund for charges due to increased bank failures.

Management will continue to review all areas of noninterest expense in order to evaluate where opportunities may exist which could reduce expenses without compromising service to customers.

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


								% Increase (Decrease)
	2010		2009		2008			2010 - 2009			2009 - 2008
Salaries and benefits	$	6,918	$	6,583	$	6,886			5.09	%		(4.40	)%
Occupancy		1,313		1,385		1,374			(5.20	)		.80
Furniture and equipment		806		805		771			0.12			4.41
Data processing		740		862		844			(14.15	)		2.13
Professional service fees:
Accounting		269		261		254			3.07			2.76
Legal		98		95		41			3.16			131.71
Consulting and other		260		247		213			5.26			15.96

Total professional service fees		627		603		508			3.98			18.70
Loan and deposit		910		746		488			21.98			52.87
OREO writedowns and (gains) losses on sale		2,753		208		(80	)		1,223.56			(360.00	)
FDIC insurance premiums		957		839		81			14.06			935.80
Telephone		193		187		170			3.21			10.00
Advertising		297		322		305			(7.76	)		5.57
Amortization of intangibles		—		46		78			(100.00	)		(41.03	)
Other operating expenses		1,084		1,216		1,133			(10.86	)		7.33

Total noninterest expense	$	16,598	$	13,802	$	12,558			20.26	%		9.91	%

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Federal Income Taxes

A deferred tax asset is recognized for temporary differences that will result in deductible amounts in future years and contain tax carryforwards including past net operating losses and tax credits. For example, a temporary difference is created between the reported amount and the tax basis of a liability for estimated expenses if, for tax purposes, those estimated expenses are not deductible until a future year. Settlement of that liability will result in tax deductions in future years, and a deferred tax asset is recognized based on the weight of available evidence. All available evidence, both positive and negative, is considered to determine whether, based on the weight of that evidence, a valuation allowance is needed for some portion or all of a deferred tax asset. Judgment must be used in considering the relative impact of negative and positive evidence. The weight given to the potential effect of negative and positive evidence should be commensurate with the extent to which it can be objectively verified. The more negative evidence that exists, (a) the more positive evidence is necessary and (b) the more difficult it is to support a conclusion that a valuation allowance is not needed. A valuation allowance is provided against deferred tax assets when it is more likely than not that some or all of the deferred tax assets will not be realized.

Current Federal Tax Provision

The Corporation recorded a current period federal tax benefit of $3.500 million in 2010, compared to a $1.120 million provision in the same period a year earlier. In the first quarter of 2010, management evaluated the deferred tax assets associated with the net operating loss and tax credit carryforwards based upon the Corporation’s foreseen ability to utilize the benefits of these carryforwards prior to their expiration. At that time, the Corporation had net deferred tax assets of approximately $13.4 million and a valuation allowance of $8.1 million against these assets. As a part of this analysis, management considered, among other things, current asset levels and projected loan and deposit growth, current interest rate spreads and projected net interest income levels, and noninterest income and expense, along with management’s ability to control expenses and the potential for increasing contributions of noninterest income. Management also considered the impact of nonperforming assets and future period charge-off activity relative to projected provisions. Based upon the analysis of projected taxable income and the probability of achieving these projected taxable income levels, the Corporation reduced the valuation allowance on its deferred tax assets by $3.500 million. Among the criteria that management considered in evaluating the deferred tax asset was taxable income for the three most recent taxable years ending December 31, 2009 which totaled $8.2 million. This taxable income allowed the Corporation to utilize NOL carryforwards. At 2010 year end, management, in recognition of the net operating loss before taxes of $3.918 million and based upon additional analysis of deferred tax balances and future taxable income projections, made the determination to increase the valuation allowance by approximately $1.364 million, resulting in a net decrease in the valuation allowance of $2.136 million for the year.

Deferred Tax Benefit — Historical Commentary

The Corporation recognized a federal deferred tax benefit of $7.500 million in the third quarter of 2007. The recognition of this deferred tax benefit relates to the generally accepted accounting principles applicable to the probability of utilizing the NOL and tax credit carryforwards of the Corporation. The Corporation, based upon current profitability trends largely supported by expansion of the net interest margin and controlled expenses, determined that a portion, $7.500 million, of the NOL carryforward was probable. The $7.500 million recognition was based upon assumptions of a sustained level of taxable income within the NOL carryforward period and took into account Section 382, annual limitations. This tax benefit was recorded by reducing the valuation allowance that was recorded against the deferred tax assets of the Corporation. In 2006, the Corporation recognized a portion of this benefit, $.500 million, based upon the then current probabilities.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

The table below details the Corporation’s deferred tax assets and liabilities (dollars in thousands):


	2010			2009
Deferred tax assets:
NOL carryforward	$	9,342		$	9,520
Allowance for loan losses		2,248			1,776
Alternative Minimum Tax Credit		1,463			1,463
OREO Tax basis > book basis		1,081			80
Tax credit carryovers		672			672
Deferred compensation		247			273
Stock option compensation		204			196
Depreciation		118			72
Intangible assets		95			112
Other		11			49


Total deferred tax assets		15,481			14,213


Valuation allowance	$	(6,010	)	$	(8,146	)


Deferred tax liabilities:
FHLB stock dividend		(128	)		(128	)
Unrealized gain (loss) on securities		(315	)		(563	)
Other		—			(95	)


Total deferred tax liabilities		(443	)		(786	)


Net deferred tax asset	$	9,028		$	5,281

As shown in the table above, the NOL and tax credit carryforwards comprise the majority of the deferred tax asset, which is reduced by the $6.010 million valuation adjustment.

As of December 31, 2010, the Corporation had an NOL carryforward of approximately $27.5 million along with various credit carryforwards of $2.1 million. This NOL and credit carryforward benefit is dependent upon the future profitability of the Corporation. A portion of the NOL, approximately $17.0 million, and all of the tax credit carryforwards are also subject to the use limitations of Section 382 of the Internal Revenue Code since they originated prior to the December 2004 recapitalization of the Corporation. These carryforwards, if not utilized, will begin to expire in the year 2023. The annual limitation is $1.4 million for the NOL carryforwards and the equivalent value of tax credits, which is approximately $.477 million.

The Corporation will continue to evaluate the utilization of the NOL and credit carryforwards in subsequent periods to determine if any further adjustment to the valuation allowance is necessary. The determination criteria for recognition of deferred tax benefits will include the assumption of future period taxable income based upon the projected profitability of the Corporation.

Management believes that the Corporation will ultimately utilize all of the NOL carryforwards and a portion of the tax credit carryforwards. The valuation allowance, which stands at $6.0 million as of December 31, 2010 is a conservative measurement of the uncertainty related to the current economy and level of profitability the Corporation will attain in the near term.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

FINANCIAL POSITION


	December 31,
(dollars in thousands)	2010					2009					2008
Sources of funds:	Balance		Mix			Balance		Mix			Balance		Mix

Deposits:
Non-interest bearing transactional deposits	$	41,264		8.62	%	$	35,878		6.96	%	$	30,099		6.67	%
Interest-bearing transactional depopsits		152,373		31.83			113,997		22.12			91,314		20.23
CD’s <$100,000		96,977		20.26			59,953		11.63			73,752		16.34

Total core deposit funding		290,614		60.71			209,828		40.71			195,165		43.23

CD’s >$100,000		22,698		4.74			36,385		7.06			25,044		5.55
Brokered deposits		73,467		15.35			175,176		33.99			150,888		33.42

Total noncore deposit funding		96,165		20.09			211,561		41.05			175,932		38.97

FHLB and other borrowings		36,069		7.53			36,140		7.01			36,210		8.02
Other liabilities		1,966		.41			2,549		.49			2,572		.57
Shareholders’ equity		53,882		11.26			55,299		10.74			41,552		9.21


Total	$	478,696		100.00	%	$	515,377		100.00	%	$	451,431		99.57	%


Uses of Funds:
Net Loans	$	376,473		78.64	%	$	379,085		73.54	%	$	366,003		81.08	%
Securities available for sale		33,860		7.07			46,513		9.03			47,490		10.52
Federal funds sold		12,000		2.51			27,000		5.24			—		—
Federal Home Loan Bank Stock		3,423		.72			3,794		.74			3,794		.84
Interest-bearing deposits		713		.15			678		.13			582		.13
Cash and due from banks		22,719		4.75			18,433		3.58			10,112		2.24
Other assets		29,508		6.16			39,874		7.74			23,450		5.19


Total	$	478,696		100.00	%	$	515,377		100.00	%	$	451,431		100.00	%

Securities

The securities portfolio is an important component of the Corporation’s asset composition to provide diversity in its asset base and provide liquidity. Securities decreased $12.653 million in 2010, from $46.513 million at December 31, 2009 to $33.860 million at December 31, 2010. This decrease in 2010 was largely attributable to paydowns on mortgage backed securities. The Corporation also sold $5 million of investments early in 2010 to reduce excess liquidity. In 2009, a net gain of $1.471 million was recorded in connection with the sale of approximately $45 million of investments. These investments were purchased early in 2009 as a short-term “leveraging” program in the deployment of a portion of the proceeds from the issuance of preferred stock in conjunction with the Corporation’s participation in TARP. This “leveraging” program to increase investment securities was intended to offset the relatively high cost of the preferred stock. Management, along with the concurrence of the Board of Directors, deleveraged this position late in 2009.

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


	2010		2009
US Agencies — MBS	$	27,710	$	45,238
US Agencies		4,973		—
Obligations of states and political subdivisions		1,177		1,275


Total securities	$	33,860	$	46,513

The Corporation’s policy is to purchase securities of high credit quality, consistent with its asset/liability management strategies. The majority of the bank’s current investments, $32.683 million or 97%, are highly marketable investments guaranteed by the U.S. government. The Corporation classifies all securities as available for sale, in order to maintain adequate liquidity and to maximize its ability to react to changing market conditions. At December 31, 2010, investment securities with an estimated fair market value of $14.462 million were pledged.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Loans

The Bank is a full service lender and offers a variety of loan products in all of its markets. The majority of its loans are commercial, which represents approximately 78% of total loans outstanding at December 31, 2010.

The Corporation continued to experience strong loan demand in 2010 with approximately $114 million of new loan production, including $37 million of mortgage loans sold in the secondary market. At 2010 year-end, the Corporation’s loans stood at $383.086 million, a slight decrease from the 2009 year-end balances of $384.310 million. The total outstanding loans declined by $1.2 million after reductions for loans sales, (both SBA/USDA and secondary market) amortization and payoffs, some associated with the elimination of problem assets. In 2010, the secondary mortgage loans that were produced and sold totaled $36.7 million while the SBA/USDA loan sales amounted to $12.6 million. The production of loans was distributed among the regions, with the Upper Peninsula at $81 million, $22 million in the Northern Lower Peninsula and $11 million in Southeast Michigan where the market has been hit the hardest by the recession.

Management believes a properly positioned loan portfolio provides the most attractive earning asset yield available to the Corporation and, with changes to the loan approval process and exception reporting, management can effectively manage the risk in the loan portfolio. Management intends to continue loan growth within its markets for mortgage, consumer, and commercial loan products while concentrating on loan quality, industry concentration issues, and competitive pricing. The Corporation is highly competitive in structuring loans to meet borrowing needs and satisfy strong underwriting requirements.

Following is a table that illustrates the balance changes in the loan portfolio from 2008 through 2010 year end (dollars in thousands):


							Percent Change
	2010		2009		2008		2010-2009			2009-2008
Commercial real estate	$	194,859	$	208,895	$	185,241		(6.72)	%		12.77	%
Commercial, financial, and agricultural		68,858		72,184		79,734		(4.61	)		(9.47	)
One-to-four family residential real estate		75,074		67,232		65,595		11.66			2.50
Construction
Consumer		5,682		7,118		4,852		(20.17	)		46.70
Commercial		33,330		24,591		31,113		35.54			(20.96	)
Consumer		5,283		4,290		3,745		23.15			14.55


Total	$	383,086	$	384,310	$	370,280		(0.32)	%		3.79	%

Our commercial real estate loan portfolio predominantly relates to owner occupied real estate, and our loans are generally secured by a first mortgage lien. Commercial real estate market conditions continued to be under stress in 2010, and we expect this trend to continue. These conditions may negatively affect our commercial real estate loan portfolio in future periods. We make commercial loans for many purposes, including: working capital lines, which are generally renewable annually and supported by business assets, personal guarantees and additional collateral. Commercial business lending is generally considered to involve a higher degree of risk than traditional consumer bank lending.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

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):


	2010								2009								2008
			% of			% of					% of			% of					% of			% of
	Balance		Loans			Capital			Balance		Loans			Capital			Balance		Loans			Capital
Real estate — operators of nonres bldgs	$	58,114		19.56	%		107.85	%	$	48,689		15.93	%		88.05	%	$	41,299		13.95	%		99.39	%
Hospitality and tourism		37,737		12.70			70.04			45,315		14.82			81.95			35,086		11.85			84.44
Commercial construction		33,330		11.22			61.86			24,591		8.04			44.47			31,113		10.51			74.88
Operators of nonresidential buildings		16,598		5.59			30.80			12,619		4.13			22.82			13,352		4.51			32.13
Real estate agents and managers		15,857		5.34			29.43			24,242		7.93			43.84			29,292		9.89			70.50
Other		135,411		45.59			251.31			150,214		49.15			271.64			145,946		49.29			351.24

Total commercial loans	$	297,047		100.00	%				$	305,670		100.00	%				$	296,088		100.00	%

Management recognizes the additional risk presented by the concentration in certain segments of the portfolio. On a historical basis, the Corporation’s highest concentration of credit risk was the hospitality and tourism industry. Management does not consider the current loan concentrations in hospitality and tourism to be problematic, and has no intention of further reducing loans to this industry segment. Management does not believe that its current portfolio composition has increased exposure related to any specific industry concentration as of 2010 year-end. The current concentration of real estate related loans represents a broad customer base composed of a high percentage of owner-occupied developments.

Our residential real estate portfolio predominantly includes one-to-four family adjustable rate mortgages that have repricing terms generally from one to three years, construction loans to individuals and bridge financing loans for qualifying customers. As of December 31, 2010, our residential loan portfolio totaled $80.756 million, or 21.08% of our total outstanding loans.

The Corporation has also extended credit to governmental units, including Native American organizations. Tax-exempt loans and leases decreased from $3.184 million at the end of 2009 to $2.471 million at 2010 year-end. The Corporation has elected to reduce its tax-exempt portfolio, since it provides no current tax benefit, due to tax net operating loss carryforwards.

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

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Credit Quality

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


	2010			2009			2008
Nonperforming Assets:
Nonaccrual loans	$	5,921		$	14,368		$	4,887
Accruing loans past due 90 days or more		—			—			—
Restructured Loans		4,642			869			—

Total nonperforming loans		10,563			15,237			4,887
Other real estate owned		5,562			5,804			2,189

Total nonperforming assets	$	16,125		$	21,041		$	7,076

Nonperforming loans as a % of loans		2.76	%		3.96	%		1.32	%

Nonperforming assets as a % of assets		3.37	%		4.08	%		1.57	%

Reserve for Loan Losses:
At period end	$	6,613		$	5,225		$	4,277

As a % of loans		1.73	%		1.36	%		1.16	%

As a % of nonperforming loans		62.61	%		34.29	%		87.52	%

As a % of nonaccrual loans		111.69	%		36.37	%		87.52	%

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 2010 independent review provided findings similar to management on the overall adequacy of the reserve. The Corporation will again utilize a consultant for loan review in 2011.

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


	2010		2009		2008
Interest income that would have been recorded at original rate	$	583	$	700	$	377
Interest income that was actually recorded		141		40		60


Net interest lost	$	442	$	660	$	317

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 2010 amounted to $5.112 million, or 1.33% of average loans outstanding, compared to $2.752 million, or .73% of loans outstanding in 2009. In 2010, $2.342 million of the charge-offs resulted from three credit relationships in Southeast Michigan. The current reserve balance is representative of the relevant risk inherent within the Corporation’s loan portfolio. Additions or reductions to the reserve in future periods will be dependent upon a combination of future loan growth, nonperforming loan balances and charge-off activity.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

A three year history of the Corporation’s credit quality is displayed in the following table (dollars in thousands):


Allowance for Loan Losses	2010			2009			2008
Balance at beginning of period	$	5,225		$	4,277		$	4,146
Loans charged off:
Commercial, financial & agricultural		5,027			2,465			2,062
One-to-four family residential real estate		410			282			157
Consumer		48			71			71

Total loans charged off		5,485			2,818			2,290

Recoveries of loans previously charged off:
Commercial, financial & agricultural		346			38			114
One-to-four family residential real estate		11			16			—
Consumer		16			12			7

Total recoveries of loans previously charged off		373			66			121
Net loans charged off		5,112			2,752			2,169

Provision for loan losses		6,500			3,700			2,300


Balance at end of period	$	6,613		$	5,225		$	4,277


Total loans, period end	$	383,086		$	384,310		$	370,280
Average loans for the year		384,347			374,796			361,324
Allowance to total loans at end of year		1.73	%		1.36	%		1.16	%
Net charge-offs to average loans		1.33			.73			.60
Net charge-offs to beginning allowance balance		97.84			64.34			52.32

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

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

At the end of 2010, the allowance for loan losses represented 1.73% of total loans. In management’s opinion, the allowance for loan losses is adequate to cover probable losses related to specifically identified loans, as well as probable losses inherent in the balance of the loan portfolio.

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

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

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


Balance at January 1, 2009	$	2,189
Other real estate transferred from loans due to foreclosure		4,879
Reclassification of redemption ORE		(475	)
Other real estate transferred to premises and equipment		—
Other real estate sold		(581	)
OREO writedowns		(187	)
Loss on OREO		(21	)


Balance at December 31, 2009		5,804
Other real estate transferred from loans due to foreclosure		5,373
Reclassification of redemption ORE		—
Other real estate transferred to premises and equipment		—
Other real estate sold		(2,862	)
OREO writedowns		(2,703	)
Loss on OREO		(50	)


Balance at December 31, 2010	$	5,562

During 2010, the Corporation received real estate in lieu of loan payments of $5.373 million. In determining the carrying value of other real estate, 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.

Deposits

Total deposits at December 31, 2010 were $386.779 million, a decrease of $34.610 million, or 8.21% from December 31, 2009 deposits of $421.389 million. The table below shows the deposit mix for the periods indicated (dollars in thousands):


	2010		Mix			2009		Mix			2008		Mix
Non-interest-bearing	$	41,264		10.67	%	$	35,878		8.51	%	$	30,099		8.11	%
NOW, money market, checking		134,703		34.83			95,790		22.73			70,584		19.02
Savings		17,670		4.57			18,207		4.32			20,730		5.59
Certificates of Deposit <$100,000		96,977		25.07			59,953		14.23			73,752		19.87

Total core deposits		290,614		75.14			209,828		49.79			195,165		52.59


Certificates of Deposit >$100,000		22,698		5.87			36,385		8.64			25,044		6.75
Brokered CDs		73,467		18.99			175,176		41.57			150,888		40.66

Total non-core deposits		96,165		24.86			211,561		50.21			175,932		47.41


Total deposits	$	386,779		100.00	%	$	421,389		100.00	%	$	371,097		100.00	%

The decrease in deposits, as illustrated above, is composed of a decrease in noncore deposits of $115.396 million, while core deposits increased by $80.786 million.

Historically the Corporation’s loan growth outpaced core deposit growth, which resulted in more reliance on brokered deposits as a source of funding. Management has increased its efforts to grow core deposits in recent years by introducing several new deposit products and implementing a bank-wide deposit incentive program. In 2010, the Corporation grew core deposits by $81 million with most of this growth occurring in lower cost transactional deposits.

During 2009, the increase in wholesale brokered deposits were in part utilized to enhance balance sheet liquidity and to fund the acquisition of investments purchased in the TARP leveraging program discussed earlier in this management discussion. At the end of 2009, the Corporation initiated the sale of approximately $39 million of its investment portfolio

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

to deleverage the balance sheet. Proceeds from the sale of these investments were used to pay off matured brokered deposits. In August 2009, the Bank sold two branch offices with core deposits of approximately $29 million. This strategic decision was in conjunction the bank’s overall strategy to tighten its existing geographical footprint and concentrate its resources in the commercial hubs of the Upper Peninsula.

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

Borrowings

The Corporation also utilizes FHLB borrowings as a source of funding. At 2010 year end, this source of funding totaled $35 million, of which $20 million matured early in 2011 and was refinanced into longer term FHLB borrowings. Subsequent to the refinancing, the $25 million of FHLB borrowings had a weighted average maturity of 3.5 years.

Shareholders’ Equity

Changes in shareholders’ equity are discussed in detail in the “Capital and Regulatory” section of this report.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

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

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

Loans are the most significant earning asset. Management offers commercial and real estate loans priced at interest rates which fluctuate with various indices, such as the prime rate or rates paid on various government issued securities. When loans are made with longer-term fixed rates, the Corporation attempts to match these balances with sources of funding with similar maturities in order to mitigate interest rate risk. In addition, the Corporation prices loans so it has an opportunity to reprice the loan within 12 to 36 months.

At December 31, 2010 the Bank had $33.860 million of securities, with a weighted average maturity of 15.8 months. The investment portfolio is intended to provide a source of liquidity to the Corporation with limited interest rate risk. The Corporation may also elect to sell monies as investments in federal funds sold to correspondent banks, and has other interest bearing deposits with correspondent banks. These funds are generally repriced on a daily basis.

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

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

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

Management realizes certain risks are inherent and that the goal is to identify and minimize the risks. Tools used by management include maturity and repricing analysis and interest rate sensitivity analysis. The Bank has monthly asset/ liability (“ALCO”) meetings, whose membership includes senior management, board representation and third party investment consultants. During these monthly meetings, we review the current ALCO position and strategize about future opportunities on risks relative to pricing and positioning of assets and liabilities.

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

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

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

The following is the Corporation’s repricing opportunities at December 31, 2010 (dollars in thousands):


	1-90		91-365			>1-5			Over 5
	Days		Days			Years			Years		Total
Interest-earning assets:
Loans	$	276,547	$	7,157		$	25,210		$	74,172	$	383,086
Securities		970		17,318			14,706			866		33,860
Other ⁽¹⁾		12,713		—			—			3,423		16,136


Total interest-earning assets		290,230		24,475			39,916			78,461		433,082


Interest-bearing obligations:
NOW, money market, savings and interest checking		152,373		—			—			—		152,373
Time deposits		26,845		41,006			51,507			317		119,675
Brokered CDs		10,125		60,614			—			2,728		73,467
Borrowings		20,000		5,000			10,000			1,069		36,069


Total interest-bearing obligations		209,343		106,620			61,507			4,114		381,584


Gap	$	80,887	$	(82,145	)	$	(21,591	)	$	74,347	$	51,498


Cumulative gap	$	80,887	$	(1,258	)	$	(22,849	)	$	51,498


⁽¹⁾		includes Federal Home Loan Bank stock

The above analysis indicates that at December 31, 2010, the Corporation had a cumulative liability sensitivity gap position of $1.258 million within the one-year timeframe. The Corporation’s cumulative liability sensitive gap suggests that if market interest rates were to increase in the next twelve months, the Corporation has the potential to earn less net interest income since more liabilities would reprice at higher rates than assets. Conversely, if market interest rates decrease in the next twelve months, the above gap position suggests the Corporation’s net interest income would increase. A limitation of the traditional gap analysis is that it does not consider the timing or magnitude of non-contractual repricing or unexpected prepayments. In addition, the gap analysis treats savings, NOW and money market accounts as repricing within 90 days, while experience suggests that these categories of deposits are actually comparatively resistant to rate sensitivity.

At December 31, 2010, the Corporation had $276.547 million of variable rate loans that reprice primarily with the prime rate index. Approximately $160 million of these variable rate loans have interest rate floors. This means that the prime rate will have to increase above the floor rate before these loans will reprice. At year end, $66 million of these floor-rate loans would reprice with a 100 basis point prime rate increase, with $94 million repricing with an additional 100 basis point prime rate increase.

At December 31, 2009, the Corporation had a cumulative liability sensitivity gap position of $17.977 million within the one-year time frame.

The borrowings in the gap analysis include $20 million of FHLB advances that were refinanced early in 2011 into fixed rate advances. Subsequent to this refinancing, the $35 million total of FHLB borrowings then carried a weighted average maturity of 3.5 years.

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

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

maintain interest rate risk at prudent levels with consistency and continuity. In evaluating the quantitative level of interest rate risk, the Corporation assesses the existing and potential future effects of changes in interest rates on its financial condition, including capital adequacy, earnings, liquidity, and asset quality. In addition to changes in interest rates, the level of future net interest income is also dependent on a number of variables, including: the growth, composition and levels of loans, deposits, and other earning assets and interest-bearing obligations, and economic and competitive conditions; potential changes in lending, investing, and deposit strategies; customer preferences; and other factors.

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, 2010 (dollars in thousands). Nonaccrual loans of $5.921 million are included in the table at an average interest rate of 0.00% and a maturity greater than five years.

Principal/Notional Amount Maturing/Repricing In:


																						Fair Value
	2011			2012			2013			2014			2015			Thereafter			Total			12/31/2010
Rate Sensitive Assets
Fixed interest rate securities	$	23,261		$	2,906		$	6,198		$	334		$	295		$	866		$	33,860		$	33,860
Average interest rate		3.85	%		4.49	%		5.55	%		8.07	%		3.13	%		3.98	%		4.25	%

Fixed interest rate loans		36,552			23,566			15,769			14,752			4,736			15,565			110,940			108,441
Average interest rate		6.00			6.68			6.57			5.62			6.33			6.14			6.16

Variable interest rate loans		272,146			—			—			—			—			—			272,146			274,885
Average interest rate		5.08			—			—			—			—			—			5.08

Other assets		12,713			—			—			—			—			3,423			16,136			16,136
Average interest rate		.25			—			—			—			—			2.50			.73


Total rate sensitive assets	$	344,672		$	26,472		$	21,967		$	15,086		$	5,031		$	19,854		$	433,082		$	433,322

Average interest rate		4.90	%		6.44	%		6.28	%		5.67	%		6.14	%		5.42	%		4.88	%


Rate Sensitive Liabilities
Interest-bearing savings,
NOW, MMAs, interest checking	$	152,373		$	—		$	—		$	—		$	—		$	—		$	152,373		$	152,373
Average interest rate		.88	%		—	%		—	%		—	%		—	%		—	%		—	%

Time deposits		138,596			34,256			9,248			6,163			1,840			3,039			193,142			194,248
Average interest rate		1.86			2.06			2.76			3.01			3.14			3.45			2.01

Fixed interest rate borrowings		5,000			—			—			10,000			—			1,069			16,069			16,230
Average interest rate		.61			—			—			2.10			—			1.00			1.56

Variable interest rate borrowings		20,000			—			—			—			—			—			20,000			20,004
Average interest rate		.31			—			—			—			—			—			.31


Total rate sensitive liabilities	$	315,969		$	34,256		$	9,248		$	16,163		$	1,840		$	4,108		$	381,584		$	382,855

Average interest rate		1.27	%		2.06	%		2.76	%		2.45	%		3.14	%		2.81	%		1.42	%

Foreign Exchange Risk

In addition to managing interest rate risk, management also actively manages risk associated with foreign exchange. The Corporation provides foreign exchange services, makes loans to, and accepts deposits from, Canadian customers primarily at its banking office in Sault Ste. Marie. To protect against foreign exchange risk, the Corporation monitors the volume of Canadian deposits it takes in and then invests these Canadian funds in Canadian commercial loans and securities. As of December 31, 2010, the Corporation had excess Canadian liabilities of .106 million, which equated to approximately the same valuation in U.S. dollars. Management believes the exposure to short-term foreign exchange risk is minimal and at an acceptable level for the Corporation. Management intends to limit the Corporation’s foreign exchange risk by acquiring deposit liabilities approximately equal to its Canadian assets.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

Off-Balance-Sheet Risk

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

Commitments to extend credit and standby letters of credit are not recorded as an asset or liability by the Corporation until the instrument is exercised. See Note 17 to the consolidated financial statements for additional information.

LIQUIDITY

Liquidity is defined as the ability to generate cash at a reasonable cost to fulfill lending commitments and support asset growth, while satisfying the withdrawal demands of customers and make payments on existing borrowing commitments. The Bank’s principal sources of liquidity are core deposits and loan and investment payments and prepayments. Providing a secondary source of liquidity is the available for sale investment portfolio. As a final source of liquidity, the Bank can exercise existing credit arrangements.

During 2010, the Corporation decreased cash and cash equivalents by $10.714 million. As shown on the Corporation’s consolidated statement of cash flows, liquidity was primarily impacted by cash provided by operating activities, resulting primarily from a reduction in other assets due to a settlement from the prior year sale of investment securities recorded as a receivable at 2009 year end. The net change in investing activities included a net increase in loans of $9.355 million and a “net” decrease in securities available for sale of $11.788 million. The net increases in assets were offset by a similar decrease in deposit liabilities of $34.610 million. This decrease in deposits was composed of a decrease in non-core deposits of $115.386 million combined with an increase in bank deposits of $80.776 million. The management of bank liquidity for funding of loans and deposit maturities and withdrawals includes monitoring projected loan fundings and scheduled prepayments and deposit maturities within a 30 day period, a 30 to 90 day period and from 90 days until the end of the year. This funding forecast model is completed weekly.

The Bank’s investment portfolio, most of which are guaranteed by the U.S. government, provide added liquidity during periods of market turmoil and overall liquidity concerns in the financial markets. As of December 31, 2010, $19.398 million of the Bank’s investment portfolio was unpledged, which makes them readily available for sale to address any short term liquidity needs.

It is anticipated that during 2011, the Corporation will fund anticipated loan production with a combination of core-deposit growth and noncore funding, primarily brokered CDs.

The Corporation’s primary source of liquidity on a stand-alone basis is dividends from the Bank. The Bank is currently prohibited from paying dividends because of a deficit in retained earnings. The Bank, in order to pay dividends in future periods, will need regulatory approval. The Corporation is currently exploring alternative opportunities for longer term sources of liquidity and permanent equity to support projected asset growth.

Liquidity is managed by the Corporation through its Asset and Liability Committee (“ALCO”). The ALCO Committee meets monthly to discuss asset and liability management in order to address liquidity and funding needs to provide a process to seek the best alternatives for investments of assets, funding costs, and risk management. The liquidity position of the Bank is managed daily, thus enabling the Bank to adapt its position according to market fluctuations. Core deposits are important in maintaining a strong liquidity position as they represent a stable and relatively low cost source of funds. The Bank’s liquidity is best illustrated by the mix in the Bank’s core and non-core funding dependency ratio, which explains the degree of reliance on non-core liabilities to fund long-term assets. Core deposits are herein defined as demand deposits, NOW (negotiable order withdrawals), money markets, savings and certificates of deposit under $100,000. Non-core funding consists of certificates of deposit greater than $100,000, brokered deposits, and FHLB and other borrowings. At December 31, 2010, the Bank’s core deposits in relation to total funding were 68.73% compared to 45.86% in 2009. These ratios indicated at December 31, 2010, that the Bank has decreased its reliance on non-core deposits and borrowings to fund the Bank’s long-term assets, namely loans and investments. The Bank believes that by maintaining adequate volumes of short-term investments and implementing competitive pricing strategies on deposits, it can ensure adequate

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

liquidity to support future growth. The Bank also has correspondent lines of credit available to meet unanticipated short-term liquidity needs. As of December 31, 2010, the Bank had $15.875 million of unsecured lines available and another $2.500 million available if secured. Management believes that its liquidity position remains strong to meet both present and future financial obligations and commitments, events or uncertainties that have resulted or are reasonably likely to result in material changes with respect to the Bank’s liquidity.

From a long-term perspective, the Corporation’s liquidity plan for 2011 includes strategies to increase core deposits in the Corporation’s local markets and will continue to augment local deposit growth efforts with wholesale CD funding, to the extent necessary.

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, 2010, the aggregate contractual obligations and commitments are (dollars in thousands):


	Payments Due by Period
	Less than 1 Year		1 to 3 Years		4 to 5 Years		After 5 Years		Total
Contractual Obligations

Total deposits	$	332,233	$	43,504	$	8,003	$	3,039	$	386,779
Federal Home Loan Bank borrowings		25,000		—		10,000		—		35,000
Preferred stock ⁽¹⁾		—		—		11,000		—		11,000
Other borrowings		—		—		—		1,069		1,069
Directors’ deferred compensation		123		246		216		323		908
Annual rental / purchase commitments under noncancelable leases / contracts		90		29		—		—		119


TOTAL	$	357,446	$	43,779	$	29,219	$	4,431	$	434,875


Other Commitments

Letters of credit	$	2,192	$	—	$	—	$	—	$	2,192
Commitments to extend credit		31,126		—		—		—		31,126
Credit card commitments		2,737		—		—		—		2,737


TOTAL	$	36,055	$	—	$	—	$	—	$	36,055

⁽¹⁾ The Corporation issued preferred stock in April of 2009 as part of its participation in TARP. The initial term of this preferred stock is five years with an interest rate of 5%, which increases to 9% after the initial term. Although there is no contractual obligation to do so, the Corporation intends to repay this obligation within the initial term.

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

CAPITAL AND REGULATORY

As a bank holding company, the Corporation is required to maintain certain levels of capital under government regulation. There are several measurements of regulatory capital, and the Corporation is required to meet minimum requirements under each measurement. The federal banking regulators have also established capital classifications beyond the minimum requirements in order to risk-rate deposit insurance premiums and to provide trigger points for prompt corrective action in the event an institution becomes financially troubled. As of December 31, 2010, the Corporation and the Bank were well capitalized. The Corporation is currently exploring its alternatives for the possible issuance of equity or debt in order to provide a broader base to support future asset growth. During 2010, total capitalization decreased by $1.417 million. Other changes in total capital occurred from recognition of net income and market value decrease of the Corporation’s investment securities. During 2010, risk based capital decreased by $5.455 million, while Tier 1 Capital decreased by $5.164 million.

The decrease in capital was also impacted by the disallowed portion of the Corporation’s deferred tax asset. The portion of the deferred tax asset which is allowed to be included in regulatory capital is only that portion that can be utilized within the next 12-month period. At December 31, 2010, the Corporation did not include any of the deferred tax asset in its Tier 1 or Total Risk Based Capital.

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


	2010			2009			2008
Capital Structure
Common shareholders’ equity	$	43,176		$	44,785		$	41,552
Preferred stock		10,706			10,514			—

Total shareholders’ equity		53,882			55,299			41,552

Total capitalization	$	53,882		$	55,299		$	41,552

Tangible capital	$	53,882		$	55,299		$	41,506


Intangible Assets
Subsidiaries:
Core deposit premium	$	—		$	—		$	46
Other identifiable intangibles		—			—			—

Total intangibles	$	—		$	—		$	46


Risk-Based Capital
Tier 1 capital:
Total shareholders’ equity	$	53,882		$	55,299		$	41,552
Net unrealized (gains) losses on available for sale securities		(612	)		(1,093	)		(445	)
Less: disallowed deferred tax asset		(9,028	)		(4,800	)		(6,200	)
Less: intangibles		—			—			(46	)

Total Tier 1 capital	$	44,242		$	49,406		$	34,861

Tier 2 Capital:
Allowable reserve for loan losses	$	4,890		$	5,181		$	4,277
Qualifying long-term debt		—			—			—

Total Tier 2 capital		4,890			5,181			4,277

Total risk-based capital	$	49,132		$	54,587		$	39,138

Risk-weighted assets	$	389,468		$	414,440		$	376,986

Capital Ratios:
Tier 1 Capital to average assets		9.25	%		9.75	%		8.01	%
Tier 1 Capital to risk-weighted assets		11.36	%		11.92	%		9.25	%
Total Capital to risk-weighted assets		12.62	%		13.17	%		10.38	%

Management’s Discussion and Analysis of
Financial Condition and Results of Operations

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

Presented below is a summary of the Corporation’s and Bank’s capital position in comparison to generally applicable regulatory requirements:


				Tangible			Tier 1			Tier 1			Total
	Equity to			Equity to			Capital to			Capital to			Capital to
	Year-end			Year-end			Average			Risk Weighted			Risk Weighted
	Assets			Assets			Assets			Assets			Assets
Regulatory minimum for capital adequacy purposes		N/A			N/A			4.00	%		4.00	%		8.00	%
Regulatory defined well capitalized guideline		N/A			N/A			5.00	%		6.00	%		10.00	%

The Corporation:

December 31, 2010		11.26	%		11.26	%		9.25	%		11.36	%		12.62	%
December 31, 2009		10.73	%		10.73	%		9.75	%		11.92	%		13.17	%

The Bank:

December 31, 2010		10.22	%		10.22	%		8.09	%		9.92	%		11.18	%
December 31, 2009		9.38	%		9.38	%		8.38	%		10.24	%		11.49	%

The Corporation intends to maintain the Bank’s Tier I Capital at 8% and total capital to risk-weighted assets at a minimum of 10.00% in order to qualify for reduced FDIC deposit based insurance.

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.

Directors and Officers


*DIRECTORS*
*Mackinac Financial Corporation and mBank*
Walter J. Aspatore — Lead Director Chairman Amherst Partners Director Since: 2004		Robert H. Orley Vice President and Secretary Real Estate Interests Group, Inc. Director Since: 2004

Dennis B. Bittner Owner and President Bittner Engineering, Inc. Director Since: 2001		L. Brooks Patterson County Executive Oakland County Director Since: 2006

Joseph D. Garea Managing Partner Hancock Securities Director Since: 2007		Randolph C. Paschke Chairman, Department of Accounting Wayne State University, School of Business Administration Director Since: 2004

Kelly W. George President, Mackinac Financial Corporation President and CEO, mBank Director Since: 2006		Paul D. Tobias Chairman and CEO, Mackinac Financial Corporation Chairman, mBank Director Since: 2004

Robert E. Mahaney Sole Proprietor Veridea Group, LLC Director Since: 2008


*OFFICERS*
*Mackinac Financial Corporation*
Name	Title	Location
Paul D. Tobias	Chairman and Chief Executive Officer	Birmingham
Kelly W. George	President	Manistique
Ernie R. Krueger	EVP — Chief Financial Officer	Manistique


*mBank*
Name	Title	Location
Bernadette C. Beaudre	AVP — Deposit Compliance Officer	Manistique
Shelby J. Bischoff	AVP — Business Development Officer	Marquette
Linda K. Bolda	VP — Human Resources	Manistique
Jesse A. Deering	First VP — SEM Executive	Birmingham
Kevin D. Evans	SVP — Retail Sales Management	Newberry
Jeremy W. Flodin	VP — Sr. Credit Admin/Credit Risk Analyst	Manistique
Laura L. Garvin	VP — Commercial Banking Officer	Birmingham
Kelly W. George	President and CEO	Manistique
Clarice A. Ghiardi	VP — Mortgage/Consumer Banking Officer	Marquette
Robert C. Henry	VP — Commercial Banking Officer	Traverse City
Ernie R. Krueger	EVP — Chief Financial Officer	Manistique
David W. Leslie	VP — Commercial Banking Officer	Birmingham
Boris Martysz	SVP — Marquette Market Executive	Marquette
Tamara R. McDowell	EVP — Chief Credit and Operations Officer	Manistique
Jacquelyn R. Menhennick	SVP — Mortgage and Consumer Lending Manager	Marquette
Kevin J. Negri	VP — Commercial Banking Officer	Marquette
Barbara A. Parrett	AVP — Branch Sales Manager/Retail Banking Officer	Stephenson
Debra L. Peterson	VP — Branch Sales Manager/Mortgage-Consumer Banking Officer	Escanaba
Scott A. Ravet	VP — Commercial Banking Officer	Manistique/Escanaba
Andrew P. Sabatine	Regional President — NLP	Traverse City
Gregory D. Schuetter	First VP — Commercial Lending Manger	Manistique
Joanna B. Slaght	SVP — Compliance/Risk Manager	Manistique
Michael A. Slaght	VP — Branch Sales Manager/Commercial Banking Officer	Newberry
Jennifer A. Stempki	VP — Assistant Controller	Manistique
Ann M. Stepp	SVP — Branch Administration/Inc Program Officer	Gaylord
Daniel L. Stoudt	AVP — Mortgage Loan Officer	Traverse City
David R. Thomas	VP — Commercial Banking Officer	Sault Ste. Marie
Timothy J. Timmer	VP — Commercial Banking Officer	Gaylord
Paul D. Tobias	Chairman	Birmingham
Janet M. Willbee	AVP — Mortgage Loan Officer	Gaylord

Corporate Information


*CORPORATE HEADQUARTERS* Mackinac Financial Corporation 130 South Cedar Street Manistique, Michigan 49854 (888) 343-8147		*TRANSFER AGENT* Registrar and Transfer Company 10 Commerce Drive Cranford, NJ 07016 (800) 368-5948

*INVESTOR RELATIONS* (888) 343-8147		*WEBSITE* www.bankmbank.com

*INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM* Plante and Moran, PLLC Grand Rapids, Michigan		*STOCK LISTING AND SYMBOL* NASDAQ Capital Market Symbol: MFNC

SHAREHOLDER INFORMATION

Copies of the Corporation’s 10-K and 10-Q reports as filed with the Securities and Exchange Commission are available upon request from the Corporation.

ANNUAL SHAREHOLDERS’ MEETING

The 2011 Annual Meeting of the Shareholders of Mackinac Financial Corporation will be held on May 25, 2011.

Visit our website, www.bankmbank.com, for updated news releases, financial reports, SEC filings, corporate governance and other investor information.

MACKINAC FINANCIAL CORP /MI/ - FORM 10-K - EX-13 - March 31, 2011

Attached files

MACKINAC FINANCIAL CORP /MI/ Reports