FNBH BANCORP INC - FORM 10-Q

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EX-32.2 - EXHIBIT 32.2 - FNBH BANCORP INC	v232034_ex32-2.htm
EX-31.2 - EXHIBIT 31.2 - FNBH BANCORP INC	v232034_ex31-2.htm
EX-32.1 - EXHIBIT 32.1 - FNBH BANCORP INC	v232034_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - FNBH BANCORP INC	v232034_ex31-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011

¨ TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________ to _______

Commission File Number 0-25752

FNBH BANCORP, INC.

(Exact name of registrant as specified in its charter)

MICHIGAN		38-2869722
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

101 East Grand River, Howell, Michigan 48843

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (517) 546-3150

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 3,171,523 shares of the Corporation’s Common Stock (no par value) were outstanding as of July 31, 2011.

TABLE OF CONTENTS

		Page
		Number
Part I Financial Information (unaudited)
Item 1.	Financial Statements:
	Consolidated Balance Sheets as of June 30, 2011 and December 31, 2010	1
	Consolidated Statements of Operations for the three and six months ended June 30, 2011 and 2010	2
	Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the six months ended June 30, 2011 and 2010	3
	Consolidated Statements of Cash Flows for the six months ended June 30, 2011 and 2010	4
	Notes to Interim Consolidated Financial Statements	5

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	32
Item 4.	Controls and Procedures	32

Part II. Other Information
Item 1A	Risk Factors	32
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	32
Item 6.	Exhibits	33

Signatures		34

Discussions and statements in this report that are not statements of historical fact, including, without limitation, statements that include terms such as “will,” “may,” “should,” “believe,” “expect,” “forecast,” “anticipate,” “estimate,” “project,” “intend,” “likely,” “optimistic” and “plan,” and statements about future or projected financial and operating results, plans, projections, objectives, expectations, and intentions and other statements that are not historical facts, are forward-looking statements. Forward-looking statements include, but are not limited to, descriptions of plans and objectives for future operations, products or services; projections of our future revenue, earnings or other measures of economic performance; forecasts of credit losses and other asset quality trends; predictions as to our Bank’s ability to achieve or maintain certain regulatory capital standards; our expectation that we will have or be able to maintain sufficient cash to meet expected obligations during 2011; and descriptions of steps we may take to improve our capital position. These forward-looking statements express our current expectations, forecasts of future events, or long-term goals and, by their nature, are subject to assumptions, risks, and uncertainties. Although we believe that the expectations, forecasts, and goals reflected in these forward-looking statements are reasonable, actual results could differ materially for a variety of reasons, including, among others:

our ability to successfully raise new equity capital and/or our ability to implement our capital restoration and recovery plan;

our ability to continue as a going concern in light of the uncertainty regarding the extent and timing of possible future regulatory enforcement action against the Bank;

the failure of assumptions underlying the establishment of and provisions made to our allowance for loan losses;

the timing and pace of an economic recovery in Michigan and the United States in general, including regional and local real estate markets;

the ability of our Bank to attain and maintain certain regulatory capital standards;

limitations on our ability to access and rely on wholesale funding sources;

the continued services of our management team, particularly as we work through our asset quality issues and the implementation of our capital restoration plan; and

implementation of the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act or other new legislation, which may have significant effects on us and the financial services industry

This list provides examples of factors that could affect the results described by forward-looking statements contained in this report, but the list is not intended to be all inclusive. The risk factors disclosed in Part I – Item A of our Annual Report on Form 10-K for the year ended December 31, 2010, as updated by any new or modified risk factors disclosed in Part II – Item 1A of any subsequently filed Quarterly Report on Form 10-Q, include all known risk our management believes could materially affect the results described by forward-looking statements in this report. However, those risks may not be the only risks we face. Our results of operations, cash flows, financial position, and prospects could also be materially and adversely affected by additional factors that are not presently known to us, that we currently consider to be immaterial, or that develop after the date of this report. We cannot assure you that our future results will meet expectations. While we believe the forward-looking statements in this report are reasonable, you should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. We do not undertake, and expressly disclaim, any obligation to update or alter any statements, whether as a result of new information, future events, or otherwise, except as required by applicable law.

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

FNBH Bancorp, Inc.

Consolidated Balance Sheets (Unaudited)

	June 30,			December 31,
	2011			2010
Assets
Cash and due from banks	$	27,691,632		$	40,376,267
Short term investments		196,524			196,159
Total cash and cash equivalents		27,888,156			40,572,426

Investment securities:
Investment securities available for sale, at fair value		41,033,144			27,269,670
FHLBI and FRB stock, at cost		779,050			901,350
Total investment securities		41,812,194			28,171,020

Loans held for investment:
Commercial		193,045,176			203,025,518
Consumer		15,482,141			16,641,544
Real estate mortgage		15,293,950			16,271,284
Total loans held for investment		223,821,267			235,938,346
Less allowance for loan losses		(12,650,158	)		(13,970,170	)
Net loans held for investment		211,171,109			221,968,176
Premises and equipment, net		7,675,905			7,692,185
Other real estate owned, held for sale		2,967,340			4,294,212
Accrued interest and other assets		2,014,250			2,642,511
Total assets	$	293,528,954		$	305,340,530

Liabilities and Shareholders' Equity
Liabilities
Deposits:
Demand (non-interest bearing)	$	77,400,567		$	62,294,189
NOW		28,571,521			52,018,941
Savings and money market		76,191,484			75,226,475
Time deposits		95,597,089			100,382,011
Brokered certificates of deposit		3,367,454			3,358,573
Total deposits		281,128,115			293,280,189
Accrued interest, taxes, and other liabilities		1,998,358			1,926,543
Total liabilities		283,126,473			295,206,732

Shareholders' Equity
Preferred stock, no par value. Authorized 30,000 shares; no shares issued and outstanding		-			-
Common stock, no par value. Authorized 7,000,000 shares at June 30, 2011 and December 31, 2010; 3,171,523 shares issued and outstanding at June 30, 2011 and 3,165,392 shares issued and outstanding at December 31, 2010		7,072,759			6,935,140
Retained earnings		2,601,778			2,747,615
Deferred directors' compensation		577,111			708,372
Accumulated other comprehensive income (loss)		150,833			(257,329	)
Total shareholders' equity		10,402,481			10,133,798
Total liabilities and shareholders' equity	$	293,528,954		$	305,340,530

See notes to interim consolidated financial statements (unaudited)

FNBH Bancorp, Inc.

Consolidated Statements of Operations (Unaudited)

	Three months ended June 30						Six months ended June 30
	2011			2010			2011			2010
Interest and dividend income:
Interest and fees on loans	$	2,939,342		$	3,291,285		$	5,903,588		$	6,736,293
Interest and dividends on investment securities:
U.S. Treasury, agency securities and CMOs		275,452			195,740			468,897			406,361
Obligations of states and political subdivisions		67,544			69,681			131,308			142,958
Other securities		6,611			6,016			12,326			10,809
Interest on short term investments		499			143			822			232
Total interest and dividend income		3,289,448			3,562,865			6,516,941			7,296,653
Interest expense:
Interest on deposits		399,554			658,872			850,557			1,367,686
Interest on other borrowings		-			-			-			1,174
Total interest expense		399,554			658,872			850,557			1,368,860
Net interest income		2,889,894			2,903,993			5,666,384			5,927,793
Provision for loan losses		800,002			1,200,000			1,600,000			2,400,000
Net interest income after provision for loan losses		2,089,892			1,703,993			4,066,384			3,527,793
Noninterest income:
Service charges and other fee income		672,076			780,621			1,299,082			1,554,894
Trust income		49,515			57,819			103,026			129,390
Other		559			(1,582	)		31,961			(135	)
Total noninterest income		722,150			836,858			1,434,069			1,684,149
Noninterest expense:
Salaries and employee benefits		1,170,236			1,306,658			2,382,426			2,705,905
Net occupancy expense		209,140			255,547			480,113			539,921
Equipment expense		101,456			83,583			180,378			173,733
Professional and service fees		402,485			437,324			753,037			827,705
Loan collection and foreclosed property expenses		111,322			164,955			263,846			431,380
Computer service fees		109,242			116,664			221,883			233,765
Computer software amortization expense		59,354			64,284			119,306			130,328
FDIC assessment fees		258,319			360,493			583,486			716,854
Insurance		135,876			182,744			283,316			344,022
Printing and supplies		50,786			38,981			80,419			73,778
Director fees		19,938			16,125			39,125			33,075
Net loss on sale/writedown of OREO and repossessions		16,513			141,513			41,668			172,763
Other		168,156			226,783			294,989			364,976
Total noninterest expense		2,812,823			3,395,654			5,723,992			6,748,205
Loss before federal income taxes		(781	)		(854,803	)		(223,539	)		(1,536,263	)
Federal income tax expense (benefit)		(77,702	)		60,542			(77,702	)		(774	)
Net income (loss)	$	76,921		$	(915,345	)	$	(145,837	)	$	(1,535,489	)
Per share statistics:
Basic and Diluted EPS	$	0.02		$	(0.29	)	$	(0.05	)	$	(0.48	)
Basic and diluted average shares outstanding		3,197,837			3,191,928			3,197,729			3,190,668

See notes to interim consolidated financial statements (unaudited)

FNBH BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Shareholders' Equity and Comprehensive Income

For the Six Months Ended June 30, 2011 and 2010 (Unaudited)

	Common Stock		Retained Earnings			Deferred Directors' Compensation			Accumulated Other Comprehensive Income (Loss)			Total
Balances at January 1, 2010	$	6,738,128	$	6,641,060		$	885,919		$	111,157		$	14,376,264
Earned portion of long term incentive plan		8,544											8,544
Issued 3,715 shares for employee stock purchase plan		1,620											1,620
Issued 8,088 shares for deferred directors' fees		177,547					(177,547	)					-
Comprehensive loss:
Net loss				(1,535,489	)								(1,535,489	)
Change in unrealized gain on investment securities available for sale, net of tax effect										1,502			1,502
Total comprehensive loss													(1,533,987	)
Balances at June 30, 2010	$	6,925,839	$	5,105,571		$	708,372		$	112,659		$	12,852,441

Balances at January 1, 2011	$	6,935,140	$	2,747,615		$	708,372		$	(257,329	)	$	10,133,798
Earned portion of long term incentive plan		6,358											6,358
Issued 6,131 shares for deferred directors' fees		131,261					(131,261	)					-
Comprehensive income:
Net loss				(145,837	)								(145,837	)
Change in unrealized gain on investment securities available for sale, net of tax effect										408,162			408,162
Total comprehensive income													262,325
Balances at June 30, 2011	$	7,072,759	$	2,601,778		$	577,111		$	150,833		$	10,402,481

See notes to interim consolidated financial statements (unaudited)

FNBH BANCORP, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Unaudited)

	Six months ended June 30
	2011			2010
Cash flows from operating activities:
Net loss	$	(145,837	)	$	(1,535,489	)
Adjustments to reconcile net loss to net cash provided by operating activites:
Provision for loan losses		1,600,000			2,400,000
Depreciation and amortization		344,849			379,587
Deferred income tax (benefit) expense		(77,702	)		(774	)
Net amortization on investment securities		166,321			4,560
Earned portion of long term incentive plan		6,358			8,544
Loss on the disposal of fixed assets		1,574			-
Loss on the sale of other real estate owned, held for sale		43,218			188,737
Decrease in accrued interest income and other assets		507,381			1,571,903
Decrease in accrued interest, taxes, and other liabilities		71,815			(193,698	)
Net cash provided by operating activities		2,517,977			2,823,370
Cash flows from investing activities:
Purchases of available for sale securities		(16,085,664	)		-
Proceeds from maturities and calls of available for sale securities		250,000			390,000
Proceeds from mortgage-backed securities paydowns-available for sale		2,391,733			2,116,234
Proceeds from repurchse of FHLB stock		122,300			-
Net decrease in loans		9,093,367			13,394,419
Proceeds from sale of other real estate owned, held for sale		1,387,354			841,062
Capital expenditures		(209,263	)		(64,348	)
Net cash provided by (used in) investing activities		(3,050,173	)		16,677,367
Cash flows from financing activities:
Net decrease in deposits		(12,152,074	)		(25,684,575	)
Payments on FHLBI note		-			(413,970	)
Shares issued for employee stock purchase plan		-			1,620
Net cash used in financing activities		(12,152,074	)		(26,096,925	)
Net decrease in cash and cash equivalents		(12,684,270	)		(6,596,188	)
Cash and cash equivalents at beginning of year		40,572,426			37,043,665
Cash and cash equivalents at end of period	$	27,888,156		$	30,447,477
Supplemental disclosures:
Interest paid	$	892,648		$	1,440,914
Net federal income taxes refunded		-			1,693,691
Loans transferred to other real estate		103,700			3,788,742
Loans charged off		3,457,518			7,929,340

See notes to interim consolidated financial statements (unaudited)

Notes to Consolidated Financial Statements (unaudited)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, these financial statements do not include all of the information and footnotes required by US GAAP for complete financial statements. In the opinion of management of FNBH Bancorp, Inc. (the Corporation), all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation were included. The results of operations for the three and six month periods ended June 30, 2011 are not necessarily indicative of the results to be expected for the year ending December 31, 2011. For further information, refer to the consolidated financial statements and footnotes thereto included in the 2010 Annual Report contained in the Corporation’s report on Form 10-K filing. Certain reclassifications have been made to prior period financial statements to conform to the current period presentation.

The consolidated financial statements included in this Form 10-Q have been prepared assuming our wholly-owned subsidiary bank, First National Bank in Howell (the Bank), continues to operate in the normal course of business for the foreseeable future, and do not include any adjustments to recorded assets or liabilities should we be unable to continue as a going concern.

2. Financial Condition and Management’s Plan

In light of the Bank’s continued losses, insufficient capital position at June 30, 2011 and noncompliance with a regulatory capital directive stipulated under a Consent Order (as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations”), management believes that it is reasonable to anticipate continued and elevated regulatory oversight of the Bank. In addition, any continued weaknesses in the Michigan economy and local real estate market will likely continue to negatively impact the Bank’s near-term performance and profitability. In response to these difficult market conditions and regulatory standing, management has embarked on various initiatives to mitigate the impact of the economic and regulatory challenges facing the Bank. However, even if successful, implementation of all components of management’s plan is not expected to produce profitable results in 2011 and may not be successful in maintaining the Bank or the Corporation as a going concern. Management’s recovery plan is detailed in Note 2 of the consolidated financial statements included in the 2010 Annual Report within the Corporation’s Form 10-K filing.

Integral to management’s plan is the restoration of the Bank’s capital to a level sufficient to comply with the Office of the Comptroller of the Currency’s (“OCC”) capital directive and provide sufficient capital resources and liquidity to meet commitments and business needs. To date, the Bank has not raised the capital necessary to satisfy requirements of the Consent Order. Management and the Board of Directors continue to work to try to raise the additional equity believed necessary to sufficiently recapitalize the Bank. Management and the Board of Directors are committed to pursuing all potential alternatives and sources of capital to restore the Bank’s capital levels. Such alternatives include raising capital from existing shareholders, individuals, institutional capital market investors and private equity funds and the identification of suitors for a sale or merger transaction. See also the “Capital” section within “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Form 10-Q.

The Company makes no assurances that its plan or related efforts will improve the Bank’s financial condition and further deterioration of the Bank’s capital position is possible. The current economic environment in southeast Michigan and local real estate market conditions will continue to impose significant challenges on the Bank and are expected to adversely impact financial results. Any further declines in the Bank’s capital levels may likely result in more regulatory oversight or enforcement action by either the OCC or the Federal Deposit Insurance Corporation (the “FDIC”).

3. Investment Securities

Investment securities available for sale consist of the following:

	June 30, 2011
			Unrealized
	Amortized Cost		Gains		Losses			Fair Value
Obligations of state and political subdivisions	$	6,060,573	$	128,498	$	(30,349	)	$	6,158,722
U.S. agency securities		5,990,000		63,344		-			6,053,344
Mortgage-backed/CMO securities		28,705,236		428,324		(498,882	)		28,634,678
Preferred stock securities (1)		48,800		137,600		-			186,400
Total securities	$	40,804,609	$	757,766	$	(529,231	)	$	41,033,144

	December 31, 2010
			Unrealized
	Amortized Cost		Gains		Losses			Fair Value
Obligations of state and political subdivisions	$	6,309,076	$	94,982	$	(117,722	)	$	6,286,336
Mortgage-backed/CMO securities		21,169,123		206,063		(439,412	)		20,935,774
Preferred stock securities (1)		48,800		9,560		(10,800	)		47,560
Total securities	$	27,526,999	$	310,605	$	(567,934	)	$	27,269,670

(1) Represents preferred stock issued by Freddie Mac and Fannie Mae.

Investment securities are reviewed quarterly for possible other-than-temporary impairment (OTTI) based on guidance included in ASC Topic 320, Investments – Debt and Equity Instruments. This guidance requires an entity to assess whether it intends to sell, or it is more likely than not that it will be required to sell a security in an unrealized loss position before the recovery of the security’s amortized cost basis. If either of these criteria is met, the entire difference between the amortized cost and fair value is recognized in earnings. For securities that do not meet the aforementioned criteria, the amount of impairment recognized in earnings is limited to the amount related to credit losses, while impairment related to other factors is recognized in other comprehensive income.

Management’s review of the securities portfolio for the existence of OTTI considers various qualitative and quantitative factors regarding each investment category, including if the securities were U.S. Government issued, the credit rating on the securities, credit outlook, payment status and financial condition, the length of time the security has been in a loss position, the size of the loss position and other meaningful information. Based on management’s review, no impairment charges were required to be recognized during the six months ended June 30, 2011.

With respect to the Corporation’s non-government agency CMO security, the only security in a continuous loss position for 12 months or more at June 30, 2011 and December 31, 2010, management’s OTTI review also includes a quarterly cash flow analysis completed with the assistance of a third party specialist. The analysis considers assumptions regarding voluntary prepayment speed, default rate, and loss severity using the CMO’s original yield as the discount rate. At June 30, 2011, the estimated fair value of the CMO, based on a combination of Level 2 and Level 3 inputs, including a market participant discount rate, indicated that the related cash flows continue to support the amortized cost of the security and no additional other-than-temporary impairment had been incurred.

The following is a summary of the gross unrealized losses and fair value of securities by length of time that individual securities have been in a continuous loss position:

	June 30, 2011
	Less than 12 months					12 months or more					Total
	Unrealized losses			Fair value		Unrealized losses			Fair value		Unrealized losses			Fair value
Obligations of state and political subdivisions	$	(30,349	)	$	1,323,666	$	-		$	-	$	(30,349	)	$	1,323,666
Mortgage-backed/CMO securities	$	(19,409	)	$	2,952,742	$	(479,473	)	$	2,308,138	$	(498,882	)	$	5,260,880
Total available for sale	$	(49,758	)	$	4,276,408	$	(479,473	)	$	2,308,138	$	(529,231	)	$	6,584,546

	December 31, 2010
	Less than 12 months					12 months or more					Total
	Unrealized losses			Fair value		Unrealized losses			Fair value		Unrealized losses			Fair value
Obligations of state and political subdivisions	$	(117,722	)	$	2,692,003	$	-		$	-	$	(117,722	)	$	2,692,003
Mortgage-backed/CMO securities		(59,401	)		6,955,344		(380,011	)		2,591,514		(439,412	)		9,546,858
Preferred stock securities		(10,800	)		22,400		-			-		(10,800	)		22,400
Total available for sale	$	(187,923	)	$	9,669,747	$	(380,011	)	$	2,591,514	$	(567,934	)	$	12,261,261

The following is a summary of the amortized cost and approximate fair value of investment securities by contractual maturity at June 30, 2011 and December 31, 2010. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	June 30, 2011				December 31, 2010
	Amortized Cost		Approximate Fair Value		Amortized Cost		Approximate Fair Value
Due in one year or less	$	-	$	-	$	-	$	-
Due after one year through five years		5,453,496		5,537,571		715,954		735,290
Due after five years through ten years		3,653,765		3,741,769		2,646,610		2,701,070
Due after ten years		2,992,111		3,119,126		2,995,312		2,897,536
		12,099,372		12,398,466		6,357,876		6,333,896
Mortgage-backed/CMO securities		28,705,237		28,634,678		21,169,123		20,935,774
Totals	$	40,804,609	$	41,033,144	$	27,526,999	$	27,269,670

Investment securities, with an amortized cost of approximately $32,063,000 at June 30, 2011 were pledged to secure public deposits and for other purposes required or permitted by law, including approximately $21,398,000 of securities pledged as collateral at the Federal Home Loan Bank of Indianapolis (FHLBI) to support potential liquidity needs of the Bank. At December 31, 2010, the amortized cost of pledged investment securities totaled $16,847,000 of which $6,557,000 was designated as collateral for borrowings at the FHLBI for contingent liquidity needs of the Bank.

The Bank owns stock in both the Federal Home Loan Bank of Indianapolis (FHLBI) and the Federal Reserve Bank (FRB), both of which are recorded at cost. The Bank is required to hold stock in the FHLBI equal to 5% of the institution’s borrowing capacity with the FHLBI. The Bank’s investment in FHLBI stock amounted to $734,800 at June 30, 2011 and $857,100 at December 31, 2010, respectively. The Bank’s investment in FRB stock, which totaled $44,250 at June 30, 2011 and December 31, 2010, is a requirement for the Bank’s membership in the Federal Reserve System. These investments can only be resold to, or redeemed by, the issuer.

4. Loans

Portfolio loans consist of the following:

	June 30, 2011			December 31, 2010
Commerical	$	13,916,202		$	16,195,595
Commercial real estate:
Construction, land development, and other land		18,584,557			19,641,905
Owner occupied		60,907,798			63,315,056
Nonowner occupied		88,684,743			91,690,983
Consumer real estate:
Commercial purpose		10,356,320			11,343,509
Mortgage - Residential		15,661,160			16,772,150
Home equity and home equity lines of credit		10,579,819			11,397,448
Consumer and Other		5,325,963			5,783,631
Subtotal		224,016,562			236,140,277
Unearned income		(195,295	)		(201,931	)
Total Loans	$	223,821,267		$	235,938,346

Included in the consumer real estate loans above are residential first mortgages reported as “real estate mortgages” on the consolidated balance sheet. In addition, a portion of these consumer real estate loans include commercial purpose loans where the borrower has pledged a 1-4 family residential property as collateral. Loans also include the reclassification of demand deposit overdrafts, which amounted to $151,000 at June 30, 2011 and $85,000 at December 31, 2010, respectively.

Loans serviced for others, including commercial participations sold, are not reported as assets of the Bank and approximated $4.4 million at June 30, 2011 and $4.2 million at December 31, 2010.

5. Allowance for Loan Losses and Credit Quality of Loans

The Corporation separates its loan portfolio into segments to perform the calculation and analysis of the allowance for loan losses. The four segments analyzed are Commercial, Commercial Real Estate, Consumer Real Estate, and Consumer and Other. The Commercial segment includes loans to finance commercial and industrial businesses that are not secured by real estate. The Commercial Real Estate segment includes: i) construction real estate loans to finance construction and land development and/or loans secured by vacant land and ii) commercial real estate loans secured by non-farm, non-residential real estate which are further classified as either owner occupied or non-owner occupied based on the underlying collateral type. The Consumer Real Estate segment includes (commercial and non-commercial purpose) loans that are secured by 1 – 4 family residential real estate properties, including first mortgages on residential properties and home equity loans and lines of credit that are secured by first or second liens on residential properties. The Consumer and Other segment includes all loans not included in any other segment. These are primarily loans to consumers for household, family, and other personal expenditures, such as autos, boats, and recreational vehicles.

Activity in the allowance for loan losses by portfolio segment is a follows:

	For the Six Months Ended June 30, 2011
				Commercial			Consumer			Consumer
	Commercial			Real Estate			Real Estate			and Other			Total
Allowance for loan losses:
Beginning balance	$	1,049,233		$	10,555,428		$	2,212,618		$	152,891		$	13,970,170
Charge offs		(224,929	)		(2,096,599	)		(1,035,864	)		(100,126	)		(3,457,518	)
Recoveries		122,558			226,684			118,133			70,131			537,506
Provision		(131,499	)		488,868			1,221,413			21,218			1,600,000
Ending balance	$	815,363		$	9,174,381		$	2,516,300		$	144,114		$	12,650,158

	For the Six Months Ended June 30, 2010
				Commercial			Consumer			Consumer
	Commercial			Real Estate			Real Estate			and Other			Total
Allowance for loan losses:
Beginning balance	$	965,255		$	15,554,706		$	1,915,944		$	229,268		$	18,665,173
Charge offs		(413,161	)		(6,675,681	)		(685,531	)		(154,967	)		(7,929,340	)
Recoveries		40,956			560,666			13,474			106,402			721,498
Provision		658,529			1,088,645			625,342			27,484			2,400,000
Ending balance	$	1,251,579		$	10,528,336		$	1,869,229		$	208,187		$	13,857,331

The following table presents the balance in allowance for loan losses and loan balances by portfolio segment based on impairment method:

	June 30, 2011
			Commercial		Consumer		Consumer
	Commercial		Real Estate		Real Estate		and Other		Total
Allowance for loan losses:
Individually evaluated for impairment	$	436,000	$	4,678,000	$	879,000	$	-	$	5,993,000
Collectively evaluated for impairment		379,363		4,496,381		1,637,300		144,114		6,657,158
Total allowance for loan losses	$	815,363	$	9,174,381	$	2,516,300	$	144,114	$	12,650,158

Loan balances:
Individually evaluated for impairment	$	1,028,067	$	25,618,141	$	2,838,370	$	-	$	29,484,578
Collectively evaluated for impairment		12,888,135		142,558,957		33,758,929		5,325,963		194,531,984
Total loans	$	13,916,202	$	168,177,098	$	36,597,299	$	5,325,963	$	224,016,562

	December 31, 2010
			Commercial		Consumer		Consumer
	Commercial		Real Estate		Real Estate		and other		Total
Allowance for loan losses:
Individually evaluated for impairment	$	462,000	$	5,776,000	$	297,000	$	-	$	6,535,000
Collectively evaluated for impairment		587,233		4,779,428		1,915,618		152,891		7,435,170
Total allowance for loan losses	$	1,049,233	$	10,555,428	$	2,212,618	$	152,891	$	13,970,170

Loan balances:
Individually evaluated for impairment	$	1,379,512	$	27,427,229	$	1,396,122	$	403,632	$	30,606,495
Collectively evaluated for impairment		14,816,083		147,220,715		38,116,985		5,379,999		205,533,782
Total Loans	$	16,195,595	$	174,647,944	$	39,513,107	$	5,783,631	$	236,140,277

Management’s on-going monitoring of the credit quality of the portfolio relies on an extensive credit risk monitoring process that considers several factors including: current economic conditions affecting the Bank’s customers, the payment performance of individual loans and pools of homogenous loans, portfolio seasoning, changes in collateral values, and detailed reviews of specific relationships.

Our internal loan grading system assigns a risk grade to all commercial loans. This grading system is similar to those employed by banking regulators. Grades 1 through 5 are considered “pass” credits and grades 6 through 9 are considered “watch” credits and are subject to greater scrutiny. Those loans graded 7 and higher are considered substandard and are evaluated for impairment if reported as nonaccrual and are greater than $250,000 or part of an aggregate relationship exceeding $250,000. All commercial loans are graded at inception and reviewed, and if appropriate, re-graded at various intervals thereafter. Additionally, our commercial loan portfolio and assigned risk grades are periodically subjected to review by external loan reviewers and banking regulators. Certain of the key factors considered in assigning loan grades, include: cash flows, operating performance, financial condition, collateral, industry condition, management, and the strength, liquidity and willingness of guarantors’ support.

A description of the general characteristics of each risk grade follows:

RATING 1 (Minimal) - Loans in this category are generally to persons or entities of unquestioned financial strength, a highly liquid financial position, with collateral that is liquid and well margined. These borrowers have performed without question on past obligations, and the Bank expects their performance to continue. Internally generated cash flow covers current maturities on long-term debt by a substantial margin.

RATING 2 (Modest) – These loans generally to persons or entities with strong financial condition and above-average liquidity who have previously satisfactorily handled their obligations with the Bank. Collateral securing the Bank’s debt is margined in accordance with policy guidelines. Internally-generated cash flow covers current maturities on long-term debt more than adequately.

RATING 3 (Average) – These are loans generally with average cash flow and ratios compared to peers. Usually RMA comparisons show where companies fall in the performance spectrum. Companies have consistent performance for 3 or more years.

RATING 4 (Acceptable) – These are loans generally to persons or entities with an average financial condition, adequate collateral margins, adequate cash flow to service long-term debt, and net worth comprised mainly of fixed assets are included in this category. These entities are minimally profitable now, with projections indicating continued profitability into the foreseeable future. Overall, these loans are basically sound.

RATING 5 (Acceptable – Monitor) - These loans are characterized by borrowers who have marginal cash flow, marginal profitability, or have experienced an unprofitable year and a declining financial condition. The borrower has in the past satisfactorily handled debts with the Bank, but in recent months has either been late, delinquent in making payments, or made sporadic payments. While the Bank continues to be adequately secured, margins have decreased or are decreasing, despite the borrower’s continued satisfactory condition. Other characteristics of borrowers in this class include inadequate credit information or weakness of financial statement and repayment capacity, but with collateral that appears to limit exposure. This classification includes loans to established borrowers that are reasonably margined by collateral, but where near term potential for improvement in financial capacity appears limited.

RATING 6 (Special Mention - OAEM) - Loans in this class generally have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. These potential weaknesses may result in a deterioration of the repayment of the loan and increase the credit risk. Special mention assets are not adversely classified and do not expose the Bank to sufficient risk to warrant adverse classification. Special mention credits may include a borrower that pays the Bank on a timely basis (occasional 30 day delinquent) and may be experiencing temporary cash flow deficiencies.

RATING 7 (Substandard) - These loans are generally inadequately protected by the current sound worth and paying capacity of the borrower or of the collateral pledged, if any. Loans so classified must have a well-defined weakness, or weaknesses, that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual loans. Substandard credits may include a borrower that pays consistently past due, has significant cash flow shortages and may have a collateral shortfall that requires a specific reserve.

RATING 8 (Doubtful) - This risk rating class has all of the weaknesses inherent in the substandard rating but with the added characteristic that the weaknesses make collection in full or liquidation, on the basis of currently known existing facts, condition, and values, highly questionable and improbable. These are poor quality loans in which neither the collateral, if any, nor the financial condition of the borrower presently ensure collectability in full within a reasonable period of time; in fact, there is permanent impairment in the collateral securing the Bank’s loan. These loans are in a work-out status, must be non-accrual status and have a defined work-out strategy.

This is a transitional risk rating class while collateral value and other factors are assessed. Loans will remain in this class for the assessment period, but in no event for more than 1 year. If there is no improvement in the Bank’s position during that time, or if collateral value is determined sooner, a charge-off will be taken to best reflect known asset collateral value.

RATING 9 (Loss) - Loans in this risk rating have a portion of the loan that is deemed to be uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification means the asset has absolutely no recovery or salvage value. The Bank will take the loss in the period in which the related loan becomes uncollectible.

The assessment of compensating factors may result in a rating plus or minus one grade from those listed above. These factors include, but are not limited to collateral, guarantors, environmental conditions, history, plan/projection reasonableness, quality of information, and payment delinquency.

The internal loan grading system is applied to our consumer loan portfolio upon certain triggering events (e.g., delinquency, bankruptcy, restructuring, etc.). The primary risk element for these residential real estate and consumer loans is the timeliness of borrowers’ scheduled payments. We rely primarily on our internal reporting system to monitor past due loans and have internal policies and procedures to pursue collection and protect our collateral interests in order to mitigate losses.

Our monitoring of credit quality is further denoted by classification of loans as nonperforming, which reflects loans where the accrual of interest has been discontinued, loans whose terms have been renegotiated to less than market rates due to a serious weakening of the borrower’s financial condition, and loans that are past due 90 days or more and still accruing interest.

The following table summarizes credit risk grades and nonperforming loans by class of loans at June 30, 2011.

			Commerical Real Estate						Consumer Real Estate
			Construction,										Home equity
			Land										and Home
			Development,		Owner		Non Owner		Commercial		Mortgage -		equity Lines of		Consumer
Risk Grade	Commercial		Other Land		Occupied		Occupied		Purpose		Residential		Credit		and Other
Not Rated	$	-	$	90,464	$	53,384	$	-	$	-	$	13,207,483	$	10,257,321	$	4,272,981
1		716,945		-		-		-		-		-		-		-
2		252,877		-		536,286		-		-		-		-		-
3		2,021,238		1,195,010		3,597,918		1,027,508		443,968		-		-		510,084
4		3,976,514		1,248,688		13,712,865		24,499,757		1,886,754		-		-		148,789
5		3,302,330		5,530,884		27,596,190		41,085,507		3,759,055		-		-		151,332
6		1,305,292		1,976,762		5,257,256		10,246,558		1,611,067		-		-		-
7		2,341,006		8,542,749		10,153,899		11,825,413		2,655,476		2,453,677		322,498		242,777
Total	$	13,916,202	$	18,584,557	$	60,907,798	$	88,684,743	$	10,356,320	$	15,661,160	$	10,579,819	$	5,325,963

Performing	$	12,446,075	$	8,811,787	$	54,058,690	$	79,001,454	$	6,899,817	$	14,351,653	$	10,353,505	$	5,279,718
Nonperforming		1,470,127		9,772,770		6,849,108		9,683,289		3,456,503		1,309,507		226,314		46,245
Total	$	13,916,202	$	18,584,557	$	60,907,798	$	88,684,743	$	10,356,320	$	15,661,160	$	10,579,819	$	5,325,963

The following table summarizes credit risk grades and nonperforming loans by class of loans at December 31, 2010.

			Commerical Real Estate						Consumer Real Estate
			Construction,										Home equity
			Land										and Home
			Development,		Owner		Non Owner		Commercial		Mortgage -		equity Lines of		Consumer
Risk Grade	Commercial		Other Land		Occupied		Occupied		Purpose		Residential		Credit		and Other
Not Rated	$	-	$	90,962	$	59,510	$	-	$	-	$	13,922,193	$	11,100,433	$	4,429,637
1		915,371		-		-		-		-		-		-		-
2		508,717		-		-		-		-		-		-		-
3		2,515,293		1,470,334		2,135,613		843,228		353,935		-		-		662,640
4		3,098,230		1,173,686		14,786,199		22,255,054		1,999,213		-		-		282,613
5		4,627,881		5,317,013		30,193,755		41,308,900		3,511,445		-		-		161,696
6		1,837,269		1,865,608		6,790,306		14,083,914		2,284,589		-		-		-
7		2,692,834		9,724,302		9,349,673		13,199,887		3,194,327		2,849,957		297,015		247,045
Total	$	16,195,595	$	19,641,905	$	63,315,056	$	91,690,983	$	11,343,509	$	16,772,150	$	11,397,448	$	5,783,631

Performing	$	13,897,127	$	10,994,656	$	57,069,363	$	82,662,548	$	8,743,005	$	14,965,365	$	11,209,677	$	5,740,341
Nonperforming		2,298,468		8,647,249		6,245,693		9,028,435		2,600,504		1,806,785		187,771		43,290
Total	$	16,195,595	$	19,641,905	$	63,315,056	$	91,690,983	$	11,343,509	$	16,772,150	$	11,397,448	$	5,783,631

Loans are considered past due when contractually required principal or interest has not been received. The amount classified as past due is the entire principal balance outstanding of the loan, not just the amount of payments that are past due.

An aging analysis of past due loans segregated by class of loans as of June 30, 2011 follows:

													Loans 90+
	Loans Past Due								Loans not		Total		days Past Due
	30-59 days		60-89 days		90+ days		Total		Past Due		Loans		and Accruing
Commercial	$	27,310	$	278,187	$	6,066	$	311,563	$	13,604,639	$	13,916,202	$	-
Commercial real estate:
Construction, land development, and other land		142,902		-		5,161,185		5,304,087		13,280,470		18,584,557		-
Owner occupied		186,240		408,628		1,843,746		2,438,614		58,469,184		60,907,798		-
Nonowner occupied		265,108		128,333		2,122,356		2,515,797		86,168,946		88,684,743		-
Consumer real estate:
Commercial purpose		180,182		-		394,960		575,142		9,781,178		10,356,320		-
Mortgage - Residential		-		738,126		72,793		810,919		14,850,241		15,661,160		-
Home equity and home equity lines of credit		218,766		35,210		-		253,976		10,325,843		10,579,819		-
Consumer and Other		48,138		8,173		1,241		57,552		5,268,411		5,325,963		-
Total	$	1,068,646	$	1,596,657	$	9,602,347	$	12,267,650	$	211,748,912	$	224,016,562	$	-

An aging analysis of past due loans segregated by class of loans as of December 31, 2010 follows:

													Loans 90+
	Loans Past Due								Loans not		Total		days Past Due
	30-59 days		60-89 days		90+ days		Total		Past Due		Loans		and Accruing
Commercial	$	572,949	$	-	$	530,616	$	1,103,565	$	15,092,030	$	16,195,595	$	-
Commercial real estate:
Construction, land development, and other land		-		-		6,091,118		6,091,118		13,550,787		19,641,905		-
Owner occupied		181,565		-		2,672,341		2,853,906		60,461,150		63,315,056		-
Nonowner occupied		-		-		2,032,497		2,032,497		89,658,486		91,690,983		-
Consumer real estate:
Commercial purpose		-		-		1,244,601		1,244,601		10,098,908		11,343,509
Mortgage - Residential		-		179,271		533,216		712,487		16,059,663		16,772,150
Home equity and home equity lines of credit		256,360		104,330		-		360,690		11,036,758		11,397,448		-
Consumer and Other		41,014		13,117		1,631		55,762		5,727,869		5,783,631		-
Total	$	1,051,888	$	296,718	$	13,106,020	$	14,454,626	$	221,685,651	$	236,140,277	$	-

Loans are placed on nonaccrual when, in the opinion of management, the collection of additional interest is doubtful. Loans are generally placed on nonaccrual upon becoming ninety days past due. However, loans may be placed on nonaccrual regardless of whether or not they are past due. All cash received on nonaccrual loans is applied to the principal balance. Loans are considered for return to accrual status on an individual basis when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following is a summary of the recorded investment in nonaccrual loans, by class of loan:

	June 30,		December 31,
	2011		2010
Commercial	$	1,470,127	$	2,298,468
Commercial real estate:
Construction, land development, and other land		9,772,770		8,647,249
Owner occupied		6,849,108		6,245,693
Nonowner occupied		9,683,289		9,028,435
Consumer real estate:
Commercial purpose		3,456,503		2,600,504
Mortgage - Residential		1,309,507		1,806,785
Home equity and home equity lines of credit		226,314		187,771
Consumer and Other		46,245		43,290
Total	$	32,813,863	$	30,858,195

The Bank had $11,739,000 and $12,519,000 of troubled-debt restructured (“TDRs”) loans at June 30, 2011 and December 31, 2010, of which $11,275,000 and $7,053,000 are included in nonaccrual loans, respectively.

For loans deemed to be impaired due to an expectation that all contractual payments will probably not be received, impairment is measured by comparing the Bank’s recorded investment in the loan to the present value of expected cash flows at the loan’s effective interest rate, the fair value of the collateral, or the loan’s observable market price.

Impaired loans and related allowance allocations by class of loans at June 30, 2011 were as follows:

	Recorded		Unpaid Principal		Related		Average
	Investment		Balance		Allowance		Balance
With no related allowance recorded:
Commercial	$	256,267	$	286,059	$	-	$	259,611
Commercial real estate:
Construction, land development, and other land		1,583,732		1,750,578		-		1,597,740
Owner occupied		1,474,524		1,854,865		-		1,607,881
Non owner occupied		901,980		963,987		-		912,402
Consumer real estate:
Commercial purpose		541,698		637,070		-		610,851
Mortgage - Residential		-		-		-		-
Home equity and home equity lines of credit		-		-		-		-
Consumer and Other		-		-		-		-
		4,758,201		5,492,559		-		4,988,485
With an allowance recorded:
Commercial		771,800		822,499		436,000		784,161
Commercial real estate:
Construction, land development, and other land		7,463,795		11,343,228		1,392,000		7,513,569
Owner occupied		4,296,620		5,235,722		831,000		4,810,096
Non owner occupied		9,897,490		11,439,771		2,455,000		10,389,258
Consumer real estate:
Commercial purpose		2,296,672		2,470,215		879,000		2,310,422
Mortgage - Residential		-		-		-		-
Home equity and home equity lines of credit		-		-		-		-
Consumer and Other		-		-		-		-
		24,726,377		31,311,435		5,993,000		25,807,506
Total:
Commercial		1,028,067		1,108,558		436,000		1,043,772
Commercial real estate:
Construction, land development, and other land		9,047,527		13,093,806		1,392,000		9,111,309
Owner occupied		5,771,144		7,090,587		831,000		6,417,977
Non owner occupied		10,799,470		12,403,758		2,455,000		11,301,660
Consumer real estate:
Commercial purpose		2,838,370		3,107,285		879,000		2,921,273
Mortgage - Residential		-		-		-		-
Home equity and home equity lines of credit		-		-		-		-
Consumer and Other		-		-		-		-
Total	$	29,484,578	$	36,803,994	$	5,993,000	$	30,795,991

Impaired loans and related allowance allocations by class of loans at December 31, 2010 were as follows:

	Recorded		Unpaid Principal		Related		Average
	Investment		Balance		Allowance		Balance
With no related allowance recorded:
Commercial	$	551,143	$	580,023	$	-	$	693,352
Commercial real estate:
Construction, land development, and other land		1,487,350		4,417,929		-		2,376,456
Owner occupied		3,217,843		3,438,668		-		1,740,262
Non owner occupied		1,671,186		1,698,476		-		2,377,437
Consumer real estate:
Commercial purpose		704,837		794,233		-		140,967
Mortgage - Residential		-		-		-		-
Home equity and home equity lines of credit		-		-		-		-
Consumer and Other		-		-		-		-
		7,632,359		10,929,329		-		7,328,474
With an allowance recorded:
Commercial		828,369		861,986		462,000		1,065,747
Commercial real estate:
Construction, land development, and other land		6,706,756		8,262,532		1,085,000		9,269,626
Owner occupied		4,606,999		5,070,441		1,394,000		4,954,620
Non owner occupied		9,737,095		10,473,268		3,297,000		7,838,019
Consumer real estate:
Commercial purpose		1,094,917		1,100,483		297,000		218,983
Mortgage - Residential		-		-		-		-
Home equity and home equity lines of credit		-		-		-		-
Consumer and Other		-		-		-		-
		22,974,136		25,768,710		6,535,000		23,346,995
Total:
Commercial		1,379,512		1,442,009		462,000		1,759,099
Commercial real estate:
Construction, land development, and other land		8,194,106		12,680,461		1,085,000		11,646,082
Owner occupied		7,824,842		8,509,109		1,394,000		6,694,882
Non owner occupied		11,408,281		12,171,744		3,297,000		10,215,456
Consumer real estate:
Commercial purpose		1,799,754		1,894,716		297,000		359,950
Mortgage - Residential		-		-		-		-
Home equity and home equity lines of credit		-		-		-		-
Consumer and Other		-		-		-		-
Total	$	30,606,495	$	36,698,039	$	6,535,000	$	30,675,469

6. Fair Value Measurements

The Corporation measures fair values based on ASC Topic 820, Fair Value Measurements and Disclosures. ASC Topic 820 defines fair value and establishes a consistent framework for measuring and expands disclosure requirements for fair value measurements. Fair value represents the estimated price that would be received from selling an asset or paid to transfer a liability, otherwise known as an “exit price”. The three levels of inputs that may be used to measure fair value are as follows:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be derived from or corroborated by observable market data by correlation or other means.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The following is a description of the Corporation’s valuation methodologies used to measure and disclose the fair values of its financial assets and liabilities on a recurring basis:

Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based on quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models. Level 2 securities include U.S. government and agency securities, other U.S. government and agency mortgage-backed securities, municipal bonds and preferred stock securities. Level 3 securities include private collateralized mortgage obligations.

Fair value of assets measured on a recurring basis:

	Fair Value Measurements at June 30, 2011
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Obligations of state and political subdivisions	$	6,158,722	$	-	$	6,158,722	$	-
U.S. agency securities		6,053,344		-		6,053,344		-
Mortgage-backed/CMO securities		28,634,678		-		26,326,540		2,308,138
Preferred stock securities		186,400		-		186,400		-
Total investment securities available for sale	$	41,033,144	$	-	$	38,725,006	$	2,308,138

	Fair Value Measurements at December 31, 2010
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Obligations of state and political subdivisions	$	6,286,336	$	-	$	6,286,336	$	-
Mortgage-backed/CMO securities		20,935,774		-		18,344,260		2,591,514
Preferred stock securities		47,560		-		47,560		-
Total investment securities available for sale	$	27,269,670	$	-	$	24,678,156	$	2,591,514

The reconciliation of the beginning and ending balances of the asset classified by the Corporation within Level 3 of the valuation hierarchy for the six months ended June 30, 2011 is as follows:

	Fair Value Measurements Using Significant Unobservable Inputs
	(Level 3)
Fair value of CMO, beginning of period(1)	$	2,591,514
Total gains (losses) realized/unrealized:
Included in earnings(2)		-
Included in other comprehensive income(2)		(99,462	)
Purchases, issuances, and other settlements		(183,914	)
Transfers into Level 3(3)		-
Fair value of CMO, June 30, 2011	$	2,308,138

Total amount of losses for the period included in earnings attributable to the change in unrealized losses relating to assets still held at June 30, 2011	$	-

(1)

Non-agency CMO classified as available for sale is valued using internal valuation models and pricing information from third parties.

(2)

Realized gain (losses), including unrealized losses deemed other-than-temporary, are reported in noninterest income. Unrealized gains (losses) are reported in accumulated other comprehensive income (loss).

(3)

Transfers in or out are based on the carrying amount of the security at the beginning of the period.

The following is a description of the Corporation’s valuation methodologies used to measure and disclose the fair values of its financial assets and liabilities on a nonrecurring basis:

Loans. The Corporation does not record loans at fair value on a recurring basis. However, from time to time, the Corporation records nonrecurring fair value adjustments to collateral dependent loans to reflect partial write-downs or specific reserves that are based on the observable market price or current appraised value of the collateral. These loans are reported in the nonrecurring table below at initial recognition of impairment and on an ongoing basis until recovery or charge off. When the fair value of the collateral is based on an observable market price or a current appraised value, the Corporation records the impaired loan as nonrecurring Level 2. When a current appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Corporation records the impaired loan as nonrecurring Level 3.

Other real estate owned. Real estate acquired through foreclosure or deed-in-lieu is adjusted to fair value less costs to sell upon transfer of the loan to other real estate owned, usually based on an appraisal of the property. Subsequently, other real estate owned is carried at the lower of carrying value or fair value. A valuation based on a current appraisal or by a broker’s opinion is considered a Level 2 fair value. If management determines the fair value of the property is further impaired below the appraised value and there is no observable market price, the Corporation records the property as nonrecurring Level 3.

Fair value on a nonrecurring basis is as follows:

	Fair Value Measurements at June 30, 2011
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Impaired loans (1)	$	23,491,578	$	-	$	-	$	23,491,578
Other real estate owned		2,967,339		-		-		2,967,339

	Fair Value Measurements at December 31, 2010
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Impaired loans (1)	$	24,071,495	$	-	$	-	$	24,071,495
Other real estate owned		4,294,212		-		-		4,294,212

(1)	Represents carrying value and related write-downs and specific reserves pertaining to collateral dependent loans for which adjustments are based on the appraised value of the collateral or by other unobservable inputs.

7. Fair Value of Financial Instruments

Fair value disclosures require fair-value information about financial instruments for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair-value estimates cannot be substantiated by comparison to independent markets and, in many cases, cannot be realized in immediate settlement of the instrument.

Fair-value methods and assumptions for the Corporation’s financial instruments are as follows:

Cash and cash equivalents – The carrying amounts reported in the consolidated balance sheet for cash and short term investments reasonably approximate those assets’ fair values.

Investment securities – Fair values for investment securities are determined as discussed above.

FHLBI and FRB stock – It is not practicable to determine the fair value of the FHLB and FRB stock due to restrictions placed on transferability.

Loans – For variable-rate loans that reprice frequently, fair values are generally based on carrying values, adjusted for credit risk. The fair value of fixed-rate loans is estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Accrued interest income – The carrying amount of accrued interest income is a reasonable estimate of fair value.

Deposit liabilities – The fair value of deposits with no stated maturity, such as demand deposit, NOW, savings, and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is estimated using rates currently offered for wholesale funds with similar remaining maturities.

Accrued interest expense – The carrying amount of accrued interest payable is a reasonable estimate of fair value.

Off-balance-sheet instruments – The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of commitments to extend credit, including letters of credit, is estimated to approximate their aggregate book balance and is not considered material and therefore not included in the following table.

The estimated fair values of the Corporation’s financial instruments are as follows:

	June 30, 2011				December 31, 2010
	Carrying Value		Fair Value		Carrying Value		Fair Value
Financial assets:
Cash and cash equivalents	$	27,888,000	$	27,888,000	$	40,572,000	$	40,572,000
Investments and mortgage-backed securities		41,033,000		41,033,000		27,270,000		27,270,000
FHLBI and FRB stock		779,000	NA			901,000	NA
Loans, net		223,821,000		224,458,000		221,968,000		222,025,000
Accrued interest income		803,000		803,000		834,000		834,000
Financial liabilities:
Deposits
Demand	$	77,401,000	$	77,401,000	$	62,294,000	$	62,294,000
NOW		28,572,000		28,176,000		52,019,000		52,089,000
Savings and money market accounts		76,191,000		75,547,000		75,226,000		75,276,000
Time deposits		95,597,000		96,559,000		100,382,000		100,647,000
Brokered certificates		3,367,000		3,482,000		3,359,000		3,463,000
Accrued interest expense		162,000		162,000		204,000		204,000

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 discounts 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 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.

8. Net Income (Loss) per Common Share

Basic earnings per common share is based on the weighted average number of common shares and participating securities outstanding during the period. Diluted earnings per share are the same as basic earnings per share because any additional potential common shares issuable are included in the basic earnings per share calculation. The Corporation follows guidance included in ASC Topic 260, Earnings Per Share, related to determining whether instruments granted in a share-based payment transaction are participating securities. This guidance requires that unvested stock awards which contain non-forfeitable rights to dividends or dividend equivalents, whether paid or unpaid (referred to as “participating securities”), be included in the number of shares outstanding for both basic and diluted earnings per share calculations. Our unvested restricted stock under the Long-Term Incentive Plan is considered a participating security. In the event of a net loss, the participating securities are excluded from the calculation of both basic and diluted earnings per share, as the impact would be anti-dilutive.

The following table presents basic and diluted earnings per share:

	Second Quarter					Year-to-Date
	2011		2010			2011			2010
Weighted average common shares outstanding		3,197,837		3,191,928			3,197,729			3,190,668
Weighted average unvested restricted stock outstanding		-		-			-			-
Weighted average basic and diluted common shares outstanding		3,197,837		3,191,928			3,197,729			3,190,668

Net income (loss) available to common shareholders	$	76,921	$	(915,345	)	$	(145,837	)	$	(1,535,489	)
Basic and diluted net income (loss) per share	$	0.02	$	(0.29	)	$	(0.05	)	$	(0.48	)

9. Long Term Incentive Plan

Under the Long Term Incentive Plan (the “Plan”), the Corporation had the authority to grant stock options and restricted stock as compensation to key employees. Such authority expired April 22, 2008. The Corporation did not award any stock options under the Plan. The restricted shares granted under the Plan have a five-year vesting period. The awards were recorded at fair value on the grant date and are amortized into salary expense over the vesting period.

A summary of the activity under the Plan for the six months ended June 30, 2011 and 2010 is presented below:

	2011					2010
				Weighted-					Weighted-
				Average					Average
				Grant Date					Grant Date
Restricted Stock Awards	Shares			Fair Value		Shares			Fair Value
Outstanding at January 1,		1,210		$	16.03		2,033		$	17.47
Granted		-			-		-			-
Vested		(348	)		18.26		(428	)		19.99
Forfeited		-			-		-			-
Outstanding at June 30,		862		$	15.14		1,605		$	16.80

The total fair value of the awards vested during the three months ended June 30, 2011 and 2010 was $2,578 and $3,780, respectively. Awards vested during the six months ended June 30, 2011 and 2010 had a total fair value of $6,358 and $8,544, respectively. As of June 30, 2011, there was $13,051 of total unrecognized compensation cost related to nonvested stock awards under the Plan. That cost is expected to be recognized over a weighted-average period of 1.41 years.

10. Income Taxes

The provision for income taxes represents federal income tax expense calculated using estimated annualized rates on taxable income or loss generated during the respective periods adjusted, as necessary, to avoid recording tax benefits during loss periods in excess of amounts expected to be realized.

In the second quarter of 2011, the Corporation recorded a federal income tax benefit to reduce its deferred tax valuation allowance established on previously recorded deferred tax assets. The decrease in the recorded valuation allowance resulted from an increase in the deferred tax liability related to appreciation in the available for sale investment portfolio. The Corporation recorded a deferred tax valuation allowance against the tax benefit related to the respective pre-tax losses incurred during the three and six month periods ended June 2011 and 2010 due to the uncertainty of future taxable income necessary to realize the recorded net deferred tax asset.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The Corporation, a Michigan business corporation, is a one bank holding company which owns all of the outstanding capital stock of First National Bank in Howell (the Bank) and all of the outstanding stock of HB Realty Co., a subsidiary. The following is a discussion of the Corporation’s results of operations for the three and six months ended June 30, 2011 and 2010, and the Corporation’s financial condition, focusing on its liquidity and capital resources.

Since June 30, 2009 the Bank has been undercapitalized by regulatory standards. Effective September 24, 2009, the Bank has been subject to the terms of a Consent Order agreement with the Office of the Comptroller of the Currency (“OCC”). Pursuant to the Consent Order, the Bank was required to achieve and maintain total capital equal to 11% of risk weighted assets and Tier 1 capital equal to at least 8.5% of adjusted total assets by January 22, 2010. To date, the Bank has failed to meet these required minimum ratios and is currently out of compliance with these required minimum capital ratios as well as other requirements of the Consent Order. In light of the Bank’s noncompliance with the Consent Order, continued losses, deficient capital position and the uncertainty regarding the ability to raise additional equity capital, management believes it is reasonable to anticipate that further regulatory oversight or enforcement action may be taken by the OCC. See also the “Capital” section of this Management’s Discussion and Analysis for further details.

The success of the Corporation depends to a great extent upon the economic conditions in Livingston County and the surrounding area. The Corporation has in general experienced a slowing economy in Michigan since 2007. In particular, Michigan’s unemployment rate at June 2011, although improved from 2010 levels, remains above the national average and among the worst for all states. Unlike larger banks that are more geographically diversified, we provide banking services to customers primarily in Livingston County. Our loan portfolio, the ability of the borrowers to repay these loans, and the value of the collateral securing these loans is impacted by local economic conditions. The continued economic difficulties in Michigan have had and may continue to have adverse consequences as described below in “Loans and Asset Quality”.

Dramatic declines in commercial real estate values in recent years, with elevated levels of foreclosures and unemployment have resulted in and may continue to result in significant write-downs of asset values by us and other financial institutions. These write-downs have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Additionally, capital and credit markets have continued to experience elevated levels of volatility and disruption in recent years. This market turmoil and tightening of credit have led to a lack of general consumer confidence and reduction in business activity.

Due to the conditions and events discussed above and elsewhere in this Form 10-Q, there is significant uncertainty regarding the impact of potential future regulatory action against the Bank. The extent of such regulatory action may threaten the Bank’s ability to continue operating as a going concern. Notwithstanding the above, the consolidated financial statements included in this Form 10-Q have been prepared assuming the Bank continues to operate in the normal course of business for the foreseeable future, and do not include any adjustments to recorded assets or liabilities should we be unable to continue as a going concern.

As fully described in Note 2, “Regulatory Matters and Going Concern”, of the consolidated financial statements included in the 2010 Annual Report within the Corporation’s Form 10-K filing, management has undertaken various initiatives identified in its recovery plan to address the current challenges facing the Bank. The successful implementation of the various actions being undertaken by management will be difficult in the current economic environment. Even if such actions are successfully implemented, such strategy may not be sufficient to increase the Bank's capital levels to satisfactory levels, return the Bank to profitability, or otherwise avoid further regulatory oversight or enforcement action. Any further declines in the Bank’s capital levels may result in more severe regulatory oversight or enforcement action by either the OCC or FDIC, including the possibility of regulatory receivership.

It is against this backdrop that we discuss our financial condition and results of operations for the three and six months ended June 30, 2011 as compared to earlier periods.

	(in thousands except per share data)
Earnings	Second Quarter					Year-to-Date
	2011		2010			2011			2010
Net income (loss)	$	77	$	(915	)	$	(146	)	$	(1,535	)
Basic and diluted net income (loss) per share	$	0.02	$	(0.29	)	$	(0.05	)	$	(0.48	)

Net income (loss) for the three and six months ended June 30, 2011 compared to the same periods last year was positively affected by lower provision for loan losses, lower interest expense due to lower average deposit balances and lower rates, and lower noninterest expense. These favorable variances were partially offset by lower interest income on loans due to lower average balances, continued high nonaccrual balances, lower loan yields, and lower noninterest income.

Net income for the three months ended June 30, 2011 increased by $992,000 compared to the same period last year. In the second quarter of 2011, the provision for loan losses decreased by $400,000 and noninterest expense decreased by $583,000 due to lower salaries and employee benefits, FDIC assessment fees, loan collection and foreclosed property expenses, and a decrease in other real estate losses. Federal income tax benefit increased by $138,000. Partially offsetting these favorable variances, noninterest income decreased by $115,000.

Net loss for the six months ended June 30, 2011, decreased $1,390,000 compared to the six months ended June 30, 2010. Provision for loan losses decreased $800,000 and noninterest expense decreased $1,024,000 due to lower salaries and employee benefits, FDIC assessment fees, loan collection and foreclosed property expenses, and lower losses related to other real estate properties. Federal income tax benefit increased by $77,000. Partially offsetting these favorable variances, net interest income and noninterest income decreased by $261,000 and $250,000, respectively.

	(in thousands)
Net Interest Income	Second Quarter				Year-to-Date
	2011		2010		2011		2010
Interest and dividend income	$	3,290	$	3,563	$	6,517	$	7,297
Interest expense		400		659		851		1,369
Net Interest Income	$	2,890	$	2,904	$	5,666	$	5,928

The following tables show an analysis of net interest margin for the three and six months ended June 30:

INTEREST YIELDS AND COSTS

(in thousands)

	For the three months ended June 30,
	2011								2010
	Average								Average
	Balance			Interest		Rate			Balance			Interest		Rate
Assets:
Interest earning assets:
Short term investments	$	196		$	0.1		0.27	%	$	97		$	-		0.12	%
Securities: Taxable		36,335			282.1		3.11	%		14,923			201.8		5.41	%
Tax-exempt (1)		6,060			97.3		6.42	%		6,822			102.3		6.00	%
Commercial loans (2)(3)		197,764			2,573.1		5.15	%		220,682			2,835.3		5.08	%
Consumer loans (2)(3)		15,657			207.3		5.31	%		17,624			251.2		5.72	%
Mortgage loans (2)(3)		15,514			168.4		4.34	%		18,376			217.8		4.74	%
Total earning assets and total interest income		271,526			3,328.3		4.86	%		278,524			3,608.4		5.14	%
Cash and due from banks		21,753								29,240
All other assets		13,192								18,045
Allowance for loan losses		(13,601	)							(15,723	)
Total Assets	$	292,870							$	310,086
Liabilities and Shareholders' Equity:
Interest bearing liabilities:
NOW	$	28,617		$	1.7		0.02	%	$	47,625		$	23.1		0.19	%
Savings		42,090			9.9		0.09	%		39,438			18.6		0.19	%
MMDA		33,542			50.6		0.60	%		30,197			46.9		0.62	%
Time		99,822			337.4		0.01			120,299			570.3		1.90	%
Total interest bearing liabilities and total interest expense		204,071			399.6		0.79	%		237,559			658.9		1.11	%
Non-interest bearing deposits		76,368								56,338
All other liabilities		2,093								2,368
Shareholders' Equity		10,338								13,821
Total Liabilities and Shareholders' Equity	$	292,870							$	310,086
Interest spread							4.07	%							4.03	%
Net interest income-FTE				$	2,928.7							$	2,949.5
Net interest margin							4.27	%							4.19	%

(1)

Average yields in the above table have been adjusted to a tax-equivalent basis using a 34% tax rate.

(2)

For purposes of the computation above, average non-accruing loans of $30,260,000 in 2011 and $36,153,000 in 2010 are included in the average daily loan balance.

(3)

Interest on loans includes origination fees totaling $19,000 in 2011 and $27,000 in 2010.

INTEREST YIELDS AND COSTS

(in thousands)

	For the six months ended June 30,
	2011								2010
	Average								Average
	Balance			Interest		Rate			Balance			Interest		Rate
Assets:
Interest earning assets:
Short term investments	$	196		$	0.3		0.36	%	$	99		$	-		0.08	%
Securities: Taxable		30,844			481.2		3.12	%		15,462			417.2		5.40	%
Tax-exempt (1)		6,181			191.7		6.20	%		6,954			210.2		6.03	%
Commercial loans (2)(3)		199,735			5,152.8		5.13	%		225,883			5,792.1		5.10	%
Consumer loans (2)(3)		15,908			426.6		5.41	%		17,980			512.3		5.75	%
Mortgage loans (2)(3)		15,780			342.8		4.34	%		18,689			456.5		4.89	%
Total earning assets and total interest income		268,644			6,595.4		4.89	%		285,067			7,388.3		5.16	%
Cash and due from banks		28,733								28,151
All other assets		13,504								17,916
Allowance for loan losses		(13,849	)							(16,889	)
Total Assets	$	297,032							$	314,245
Liabilities and Shareholders' Equity:
Interest bearing liabilities:
NOW	$	29,021		$	4.2		0.03	%	$	48,440		$	49.0		0.20	%
Savings		41,129			22.8		0.11	%		39,130			37.5		0.19	%
MMDA		35,196			109.1		0.63	%		32,276			106.3		0.66	%
Time		101,676			714.5		1.42	%		121,525			1,174.9		1.95	%
FHLBI advances		-			-		-			32			1.2		7.29	%
Total interest bearing liabilities and total interest expense		207,022			850.6		0.83	%		241,403			1,368.9		1.14	%
Non-interest bearing deposits		77,638								56,395
All other liabilities		2,110								2,356
Shareholders' Equity		10,262								14,091
Total Liabilities and Shareholders' Equity	$	297,032							$	314,245
Interest spread							4.06	%							4.02	%
Net interest income-FTE				$	5,744.8							$	6,019.4
Net interest margin							4.25	%							4.20	%

(1)

Average yields in the above table have been adjusted to a tax-equivalent basis using a 34% tax rate.

(2)

For purposes of the computation above, average non-accruing loans of $30,539,000 in 2011 and $38,348,000 in 2010 are included in the average daily loan balance.

(3)

Interest on loans includes origination fees totaling $46,000 in 2011 and $42,000 in 2010.

Interest Earning Assets/Interest Income

On a tax equivalent basis, interest income decreased $280,000 (7.8%) in the second quarter of 2011 compared to the second quarter of 2010. This was due to a decrease in average earning assets of $6,998,000 (2.5%) combined with a decrease in the yield on average earning assets of 28 basis points.

The average balance of securities increased $20,650,000 (95.0%) in the second quarter of 2011 compared to the same period in 2010. This increase was due to $32,424,000 of investment security purchases made from September 2010 through March 2011 as the Bank gradually invested its excess on-balance liquidity into interest earning assets. The yield on average security balances decreased 201 basis points in the second quarter of 2011 compared to 2010. Second quarter 2011 investment yields were impacted by the sales of higher yielding securities in December 2010 and the comparatively lower yields of new securities acquired in the current rate environment.

Loan average balances decreased $27,748,000 (10.8%) in the second quarter of 2011 compared to the same period last year while the yield remained the same. The largest decline in terms of average balances was in commercial loans, the majority of our loan portfolio, which decreased $22,918,000 (10.4%) in the second quarter of 2011 compared to 2010, while the yield increased 7 basis points. Commercial loans have continued to decrease due to receipt of scheduled payments, charge offs and decreased loan origination activities. It is expected that continued efforts to manage the Bank’s regulatory capital levels (i.e., shrinking the Bank’s size) will further decrease both average loan balances and net interest income in future periods. In addition, the renewal of maturing loans in the current lower rate environment has exerted downward pressure on average loan portfolio yields.

Loan yields in 2011 continue to be negatively impacted by the elevated level of nonperforming loans. Management expects the average balance of nonperforming loans to continue to remain high in 2011, adversely impacting net interest income. Moreover, competitive pressures as well as the weakened local economy have had, and are expected to continue to have, a negative impact on commercial balances and yields. For the first six months of the year, tax equivalent interest income decreased $793,000 (10.7%) from 2010. This was due to a decrease in average earning assets of $16,423,000 (5.8%) combined with a decrease in the yield on average earning assets of 27 basis points.

Securities interest income increased $46,000 and resulted from a $14,609,000 (65.2%) increase in average securities balances, partially offset by a 196 basis point decrease in yield attributable to the comparatively lower yields on securities purchased in the current rate environment, as discussed above. Loan interest income decreased $839,000 (12.4%) due to lower average balances of $31,130,000 (11.9%) combined with a decrease in the average yield of 3 basis points.

The largest decline in terms of average balances was in commercial loans, which decreased $26,148,000 (11.6%). Average balances decreased primarily due to charge-offs, receipt of scheduled payments and decreased loan origination activities. Partially offsetting the impact of lower average balances was an increase in yield of 3 basis points in the first six months of 2011 compared to 2010. The renewal of maturing loans in the current lower rate environment has exerted downward pressure on average loan portfolio yields.

Interest Bearing Liabilities/Interest Expense

Interest expense on deposits for the second quarter of 2011 decreased $259,000 (39.4%) compared to the second quarter of 2010. This was the result of lower interest rates paid on deposits of 32 basis points combined with lower average deposit balances of $33,488,000 (14.1%).

Interest expense on deposits for the first six months of 2011 decreased $517,000 (37.8%) compared to 2010. This resulted from a decrease in the average interest rate paid on deposits of 31 basis points and lower average balances of $34,349,000 (14.2%) in 2011 compared to 2010.

The Bank had no outstanding borrowed funds at June 30, 2011 and 2010, respectively.

Liquidity

Liquidity is managed to ensure stable, reliable and cost-effective sources of funds to satisfy demand for credit, deposit withdrawals and investment opportunities. Liquidity risk is the risk of the Corporation being unable to meet current and future financial obligations in a timely manner. To manage liquidity risk the Corporation relies primarily on a large, stable core deposit base and excess on-balance sheet cash positions. Additionally, the Corporation has access to certain wholesale funding sources (as discussed below) to manage unexpected liquidity needs.

The Corporation identifies, measures and monitors its liquidity profile. The profile is evaluated daily, weekly and monthly by analyzing the composition of all funding sources, reviewing projected liquidity commitments and identifying sources and uses of funds. A contingency funding plan is also prepared that details the potential erosion of funds in the event of systemic financial market crisis or institution-specific stress. In addition, the overall management of the Corporation’s liquidity position is integrated into retail deposit pricing policies to ensure a stable core deposit base.

Asset liquidity for financial institutions typically consists of cash and cash equivalents, certificates of deposit and investment securities available for sale. These categories totaled $68.9 million at June 30, 2011 or about 23.5% of total assets. This compares to $67.8 million or about 22.2% of total assets at year end 2010. Liquidity is important for financial institutions because of the need to meet loan funding commitments and depositor withdrawal requests. Liquidity can vary significantly on a daily basis based on customer activity.

Of the Corporation’s liquid assets at June 30, 2011, investment securities with a fair value of approximately $32,544,000 were pledged to secure borrowing availability on a line of credit from the Federal Home Loan Bank of Indianapolis, public deposits and for other purposes as required or permitted by law.

Deposits are the principal source of funds for the Bank. Management monitors rates at other financial institutions in the area to ascertain that its rates are competitive in the market. Management also attempts to offer a wide variety of products to meet the needs of its customers. The makeup of the Bank’s “Large Certificates”, which are generally considered to be more volatile and sensitive to changes in rates, consist principally of local depositors known to the Bank. The Bank had Large Certificates totaling approximately $36,000,000 at June 30, 2011 and $35,000,000 at December 31, 2010. The Bank had $3.4 million of brokered deposits at June 30, 2011. Due to the Bank’s capital classification as “undercapitalized” at June 30, 2011, these brokered deposits may not be renewed or additional brokered deposits issued without prior approval of the Federal Deposit Insurance Corporation (“FDIC”). See “Capital” section of this Management’s Discussion and Analysis for further details.

It is Bank management’s intention to handle unexpected liquidity needs through its cash and cash equivalents, FHLBI borrowings, or Federal Reserve discount borrowings. At June 30, 2011, the Bank had a $27,000,000 line of credit available at the FHLBI for which the Bank has pledged investment securities and certain commercial and consumer loans secured by residential real estate as collateral. The Bank also had a $17,000,000 line of credit available at the Federal Reserve for which the Bank has pledged certain commercial loans as collateral. At June 30, 2011, the Bank had no borrowings outstanding against these lines of credit.

Although the Bank has established these lines of credit, because of its undercapitalized status, any borrowing requests are subject to review (i.e., for purpose and repayment ability) and approval by the FHLBI and Federal Reserve. Consequently, full borrowing availability under these existing lines may be restricted at the lender’s discretion and terms may be limited or restricted.

If necessary, the Bank could also satisfy unexpected liquidity needs through repurchase agreements which would allow it to borrow from a broker, pledging investment securities as collateral.

Interest Rate Risk

Interest rate risk is the potential for economic losses due to future rate changes and can be reflected as a loss of future net interest income and/or a loss of current market values. The Corporation’s Asset/Liability Management Committee’s (ALCO) objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income. Tools used by management include the standard GAP report which reflects the repricing schedule for various asset and liability categories and an interest rate shock simulation report. The Bank has no market risk sensitive instruments held for trading purposes. However, the Bank is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers including commitments to extend credit and letters of credit. A commitment or letter of credit is not recorded as an asset until the instrument is exercised.

The table below shows the scheduled maturity and repricing of the Corporation’s interest sensitive assets and liabilities as of June 30, 2011:

	(in thousands)
	0-3		4-12		1-5		5+
Interest Rate Sensitivity	Months		Months		Years		Years			Total
Assets:
Loans	$	93,672	$	50,818	$	78,224	$	1,107		$	223,821
Securities		4,940		11,070		20,377		5,425			41,812
Short term investments		197		-		-		-			197
Total rate sensitive assets	$	98,809	$	61,888	$	98,601	$	6,532		$	265,830
Liabilities:
NOW, Savings & MMDA	$	33,802	$	-	$	-	$	70,961		$	104,763
Time deposits		22,320		45,388		31,230		26			98,964
Total rate sensitive liabilities	$	56,122	$	45,388	$	31,230	$	70,987		$	203,727
Rate sensitivity GAP and ratios:
GAP for period	$	42,687	$	16,500	$	67,371	$	(64,455	)
Cumulative gap		42,687		59,187		126,558		62,103

Cumulative rate sensitive ratio		1.76		1.58		1.95		1.30
December 31, 2010 rate sensitive ratio		1.55		1.50		1.83		1.14

The preceding table sets forth the time periods in which earning assets and interest bearing liabilities will mature or may re-price in accordance with their contractual terms. The entire balance of savings including MMDA and NOW are not categorized as 0-3 months, although they are variable rate products. Some of these balances are core deposits and are not considered rate sensitive. Allocations are made to time periods based on the Bank’s historical experience and management’s analysis of industry trends.

In the GAP table above, the short term (one year and less) cumulative interest rate sensitivity is 158% asset sensitive as of June 30, 2011.

Because of the Bank’s asset sensitive position, if market interest rates increase, this positive GAP position indicates that the interest margin would be positively affected. However, GAP analysis is limited and may not provide an accurate indication of the impact of general interest rate movements on the net interest margin since repricing of various categories of assets and liabilities is subject to the Bank’s needs, competitive pressures, and the needs of the Bank’s customers. In addition, various assets and liabilities indicated as repricing within the same period may in fact reprice at different times within the period and at different rate indices. Due to these inherent limitations in the GAP analysis, the Corporation also utilizes simulation modeling, which measures the impact of upward and downward movements of interest rates on interest margin. This modeling indicates that a 100 basis point gradual decrease in interest rates would decrease net interest income by approximately 1.10% in the first year, while a 200 basis point increase in interest rates would increase net interest income by approximately 2.00% in the first year. This is influenced by the assumptions regarding how quickly and to what extent liabilities will reprice with an increase in interest rates.

Loans

	Second Quarter				Year-to-Date
Provision for Loan Losses	2011		2010		2011		2010
Total	$	800	$	1,200	$	1,600	$	2,400

The provision for loan losses for the second quarter of 2011 was $800,000 compared to $1,200,000 for the second quarter of 2010. A provision of $1,600,000 was recorded for the six months ended June 30, 2011 compared to a provision of $2,400,000 during the same period of 2010. The reduction in provision expense was primarily associated with reduced charge offs, a decrease in nonperforming loans, stabilizing real estate values on problem credits and continued shrinkage in the overall loan portfolio relative to the conditions faced by the Bank one year ago.

Loan charge offs totaled $2,129,000 for the second quarter 2011 compared to $1,329,000 and $3,283,000 for the quarters ended March 31, 2011 and June 30, 2010, respectively. Loan charge offs totaled $3,458,000 for the six months ended June 30, 2011 compared to $7,930,000 during the same period in 2010. The charge offs for each period have largely been driven by declines in the value of real estate securing our loans. In recent quarters, however, the velocity of the value decline has been slowing, thereby translating into a decline in charge offs. Loans transferred to other real estate during the quarter ended June 30, 2011 totaled $104,000 compared to $0 and $1,078,000 transferred to ORE during the quarters ended March 31, 2011 and June 30, 2010, respectively.

In recent quarters we have experienced a decline in the pace of commercial loans migrating to lower loan risk grades, which receive higher allocations in our allowance for loan loss analysis. We have also experienced an improvement in the quality of some credits resulting in improved loan grades and lower reserve allocations. Management considered these factors in conjunction with its quarterly analysis of the loan portfolio to identify and quantify the level of credit risk to estimate losses to determine the recorded provision expense of $1,600,000 for the six months of 2011 and the level of the allowance for loan losses of $12,650,000 at June 30, 2011.

Loans and Asset Quality

The following table shows the balance and percentage composition of loans as of:

	(in thousands)
	June 30, 2011						December 31, 2010
Secured by real estate:	Balances			Percent			Balances			Percent
Residential first mortgage	$	23,496			10.5	%	$	24,546			10.4	%
Residential home equity/other junior liens		13,101			5.8	%		14,967			6.4	%
Construction, land development and other land loans		18,585			8.3	%		19,641			8.3	%
Multifamily residential properties		2,328			1.0	%		2,364			1.0	%
Owner-occupied nonfarm, nonresidential properties		60,908			27.2	%		63,315			26.8	%
Other nonfarm, nonresidential properties		86,356			38.6	%		89,327			37.8	%
Commercial		13,916			6.2	%		16,196			6.9	%
Consumer		4,283			1.9	%		4,499			1.9	%
Other		1,043			0.5	%		1,285			0.5	%
Total gross loans		224,016			100.0	%		236,140			100.0	%
Net unearned fees		(195	)					(202	)
Total loans	$	223,821					$	235,938

At June 30, 2011, total loans decreased $12,124,000 (5.1%) from December 31, 2010. During the six months of 2011, construction, land development and other land loans decreased $1,056,000 (5.4%), loans secured by nonresidential properties (owner occupied and nonowner occupied) decreased $5,378,000 (3.5%), commercial loans decreased $2,280,000 (14.1%), and loans secured by consumer real estate decreased $2,916,000 (7.4%).

In general, the decrease in all portfolio segments was primarily attributable to the receipt of scheduled payments which has served to reduce the Bank’s asset size and facilitate some improvement in our regulatory capital ratios, while reducing concentrations in higher stress real estate secured loans. In addition, charge offs totaling $3,458,000, taken primarily on impaired loans with previously established specific reserves, contributed to the $12,124,000 decrease in loans. These factors, coupled with limited demand for new loans by credit worthy borrowers, have curbed net portfolio growth.

The future size of the loan portfolio is dependent on a number of economic, competitive, and regulatory factors faced by the Bank. In light of the economic and regulatory challenges currently impacting the Bank, we anticipate continued and managed shrinkage of the loan portfolio in subsequent quarters of 2011. Further declines in loans, restrictions on the Bank’s ability to make new loans or competition that leads to lower relative pricing on new loans could adversely impact our operating results.

Nonperforming assets consist of loans accounted for on a nonaccrual basis, loans contractually past due 90 days or more as to interest or principal payments (but not included in nonaccrual loans), and other real estate which has been acquired primarily through foreclosure and is actively managed through the time of disposition to minimize loss.

The aggregate amount of nonperforming loans and other nonperforming assets are presented below:

	(in thousands)
	June 30,			December 31,			June 30,
	2011			2010			2010
Nonaccrual loans	$	32,814		$	30,858		$	33,125
90 days or more past due and still accruing		-			-			202
Total nonperforming loans		32,814			30,858			33,327
Other real estate owned		2,967			4,294			6,536
Total nonperforming assets	$	35,781		$	35,152		$	39,863

Nonperforming loans as a percent of total loans		14.66	%		13.08	%		13.35	%
Allowance for loan losses as a percent of nonperforming loans		38.55	%		45.27	%		41.58	%
Nonperforming assets as a percent of total loans and other real estate		15.78	%		14.63	%		15.56	%

Nonperforming loans at June 30, 2011 increased $1,956,000 from December 31, 2010 and decreased $311,000 from $33,125,000 reported at June 30, 2010. The decrease from June 30, 2010 results from the combination of charge offs recorded on collateral dependent loans, the upgrade of certain loans now demonstrating both improved cash flows and established payment history following the culmination of successful work-outs and/or restructurings, the migration of loans to other real estate owned, and continued payments received from borrowers, which in aggregate, exceeded newly identified nonperforming loans. The net increase of $1,956,000 in nonperforming loans from December 31, 2010 resulted primarily from the transfer of 6 commercial real estate loan relationships totaling approximately $6,950,000 to nonaccrual status based on management’s assessment of projected cash flow weaknesses and known collateral shortfalls. At June 30, 2011, all but one of these loans totaling $321,000 continues to be current on their scheduled payments. Management continues to focus on reducing the level of nonperforming assets and making improvements in asset quality.

As of June 30, 2011, approximately $21,500,000 (65.5%) of nonperforming loans are making scheduled payments on their loans. Management closely monitors each of these loans to identify opportunities where workout efforts or restructuring may improve borrowers’ credit risk profiles to facilitate a return to accrual status for credits with sustained repayment histories. All nonperforming loans are reviewed regularly for collectability and uncollectible balances are promptly charged off.

Management regularly evaluates the condition of problem credits and when reduced cash flows coupled with collateral shortfalls are evident, the loans are placed on nonaccrual. In addition, loans are generally placed on nonaccrual when principal or interest is past due ninety days or more. If management believes there is significant risk of not collecting full principal and interest, we may elect to place the loan on nonaccrual even if the borrower is current. Based on the existing level of problem loans, we anticipate that other real estate owned may increase as the Bank manages through the problem loan portfolio and borrowers continue to face financial difficulties and tight credit markets.

At June 30, 2011, impaired loans totaled approximately $29,485,000, which included specifically identified loans in nonaccrual status, other than homogeneous smaller commercial, residential, and consumer loans, and $9,244,000 of commercial troubled debt restructurings. Specific reserves assigned to impaired loans at June 30, 2011 aggregated to $5,993,000. Impaired loans without specific reserve allocations totaled $4,758,000, indicating that the loans are well collateralized at this time.

Total troubled debt restructured loans totaled $11,739,000 at June 30, 2011, of which $11,275,000 were included in nonaccrual loans and $2,158, 000 were nonperforming commercial real estate restructurings.

Allowance for Loan Losses

The allowance for loan losses at June 30, 2011 was $12,650,000, a decrease of $1,320,000 from December 31, 2010. The allowance for loan losses represented 5.65% and 5.92% of gross loans at June 30, 2011 and December 31, 2010 and provided a coverage ratio to nonperforming loans of 38.6% and 45.3% at each respective period-end.

Management estimates the required allowance balance based on past loan loss experience, the nature and volume of the portfolio segments and concentrations, information about specific borrower situations, estimated collateral values, economic conditions and trends, and other factors. Allocations of the allowance are made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. Management continually analyzes portfolio risk to refine the process of effective risk identification and measurement for determination of what it believes is an adequate allowance for loan losses. When all of these factors were considered, management determined that the $1,600,000 provision for the six months of 2011 and the $12,650,000 allowance as of June 30, 2011 were appropriate.

Given the significant portion of our loans that are secured by real estate, our portfolio continues to be sensitive to the weakened economic conditions in Southeast Michigan and the Bank’s market area, and is especially impacted by depressed real estate values. In response, each quarter our portfolio management practices continue to analyze and quantify risk within all segments of our portfolio to ensure effective problem loan identification procedures. Our practice is to obtain updated appraisals on criticized loans secured by real estate and apply appropriate discounting practices based on perceived declines in market value.

Although updated appraisals received during more recent quarters indicated that property values for collateral on our impaired loans continue to be depressed, the appraisals did not reflect the extent of value erosion relative to that experienced in prior quarters. However, at present, the weak Michigan economy and historically high unemployment levels continue to delay signs of economic recovery in our market area. Consequently, we have continued to allocate reserves for these risks and uncertainties, resulting in reserves well above normal levels.

If the economy continues to weaken and/or real estate values decline further, nonperforming loans may increase in subsequent quarters. Due to the uncertainty of future economic conditions and the decline in real estate values, the provision for loan losses for the balance of 2011 may continue to be impacted by the Bank’s concentration in real estate secured loans. While we have considered these factors when determining the level of reserves, it is difficult to accurately predict future economic events, especially in the current environment.

The allowance consists of specific and general components. The specific component relates to loans that are classified as nonaccrual or renegotiated. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan are lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience, adjusted for qualitative factors used to reflect changes in the portfolio’s collectability not captured by historical loss data.

The methodology for measuring the appropriate level of allowance and related provision for loan losses relies on several key elements, which include specific allowances for loans considered impaired, general allowances for non-impaired commercial loans based on our internal loan grading system, and general allocations based on historical trends for homogeneous loan groups with similar risk characteristics.

The general allowance allocated to non-impaired commercial loans was based on the internal risk grade of such loans and their assigned portfolio segment, as primarily determined based on underlying collateral; and, if real estate secured, the type of real estate. Each risk grade within a portfolio is assigned a loss allocation factor. The higher a risk grade, the greater the assigned loss allocation percentage. Accordingly, changes in the risk grades of loans affect the amount of the allowance allocation.

Our loss factors are determined based on our actual loss history by loan grade and adjusted for significant qualitative factors that, in management’s judgment, affect the collectability of the portfolio at the analysis date. We use a rolling 24 month charge off history as the base for our computation which is weighted to give emphasis to more recent quarters.

Groups of homogeneous noncommercial loans, such as residential real estate loans, home equity and home equity lines of credit, and consumer loans receive allowance allocations based on loan type, primarily determined based on historical loss experience rather than by risk grade. These allocations are adjusted for consideration of general economic and business conditions, credit quality and delinquency trends, collateral values, and recent loss experience for these similar pools of loans.

Although management evaluates the adequacy of the allowance for loan losses based on information known at a given point in time, as facts and circumstances change, the provision and resulting allowance may also change. While we believe that our allowance for loan loss analysis has identified all probable losses inherent in the portfolio at June 30, 2011, there can be no assurance that all losses have been identified or that the amount of the allowance is sufficient.

	(in thousands)
	Second Quarter				Year-to-Date
Noninterest Income	2011		2010		2011		2010
Total	$	722	$	837	$	1,434	$	1,684

Noninterest income which includes service charges and other fee income, trust income, gain (loss) on available for sale securities, gain on sale of loans, and other miscellaneous income, decreased by $115,000 (13.7%) in the second quarter of 2011 compared to the same quarter of 2010.

Service charges and other fee income decreased $109,000 (13.9%) in the second quarter of 2011 compared to the second quarter of 2010 primarily due to lower nonsufficient fund fees resulting from the impact of new regulation on overdraft protection effective August 2010, lower commercial and consumer loan late fees, lower service charges on business checking accounts, and lower merchant discount fees. These unfavorable variances were partially offset by higher ATM network income.

Trust income decreased $8,000 (14.4%) in the second quarter of 2011 compared to the second quarter of 2010. This was due to market value fluctuations (as fees are market value based), change in composition of investments, and fewer accounts.

For the six months ended June 30, 2011, noninterest income decreased $250,000 (14.8%) compared to the same prior year period. The decrease resulted from lower service charges of $256,000 and a decrease in trust income of $26,000, each attributable to the respective factors identified above. These unfavorable variances were partially offset by gains on sale of SBA loans of $31,000 in the first quarter of 2011.

	(in thousands)
	Second Quarter				Year-to-Date
Noninterest Expense	2011		2010		2011		2010
Total	$	2,813	$	3,396	$	5,724	$	6,748

Noninterest expense decreased $583,000 (17.2%) in the second quarter of 2011 compared to the same quarter in 2010.

The decrease is due to reductions in salaries and benefits, occupancy expense, FDIC assessment fees, professional fees, loan and collection expenses, loss on sale of ORE, NSF check and other losses and insurance expense. Due to the challenging economic environment, management continues to be focused on initiatives to reduce and contain noninterest expense.

The most significant component of noninterest expense is salaries and employee benefits. In the second quarter of 2011, salaries and employee benefits decreased $136,000 (10.4%) from the second quarter of 2010. This was primarily due to decreases in salaries of $87,000 (8.0%), contracted payroll of $56,000 (86.6%), and FICA taxes of $6,000 (7.6%). The decrease in salary and wage expense resulted from leaner staffing levels and a vacant management position relative to the same period in 2010. Contract payroll expense was lower due to reduced commercial loan workout staffing levels as a result of a reduction in the number of newly identified, higher stress, problem credits relative to the Bank’s experience in the same prior year period.

Occupancy expense decreased $46,000 (18.2%) in the second quarter of 2011 compared to the same quarter of 2010 primarily due to lower depreciation and building services expense. Building services expense decreased due to a change in the Bank’s cleaning services vendor and from lower exterior maintenance costs incurred for lawn maintenance services during the current quarter relative to same quarter of 2010.

Equipment expense increased $18,000 (21.4%) in the second quarter of 2011 compared to the same quarter of 2010 due to higher costs incurred for vehicle maintenance and equipment rental expense. During the second quarter of 2011 the Bank’s courier vehicle required extensive repairs related to transmission work and collision repair. Higher equipment rental expense resulted from rental of certain components of a new phone system which was installed in 2010.

Professional and service fees decreased $35,000 (8.0%) in the second quarter of 2011 compared to the same quarter in 2010. The decrease in legal fees correlates with the reduction in the number of newly identified problem credits and fewer foreclosure actions initiated relative to the Bank’s experience in the same prior year period. Audit and accounting fees decreased from the comparable prior year period due to fee adjustments related to financial reform legislation and reduced audit scopes for which fee adjustments were not recognized until late 2010. Partially offsetting these favorable expense reductions, other fees increased over the same prior year period due to consulting fees related to the Company’s recapitalization efforts, SBA loan program, and the timing of a benefit plan audit.

Computer service fees decreased $7,000 (6.4%) in the second quarter of 2011 compared to the same quarter of 2010. This decrease was primarily due to a decrease in cost for trust department software in 2011 compared to 2010.

FDIC assessment fees decreased $102,000 (28.3%) in the second quarter of 2011 compared to the same quarter of 2010 in part due to a decrease in the Bank’s size (i.e., net assets) and the FDIC’s reconfiguration of the assessment system for deposit insurance premiums which became effective April 1, 2011.

As a FDIC insured institution, we are required to pay deposit insurance premium assessments to the FDIC. Under the FDIC’s former risk-based assessment system for deposit insurance premiums, all insured depository institutions were placed into one of four categories and assessed insurance premiums based primarily on their level of capital and supervisory evaluations. Deposit insurance assessments ranged from 0.07% to 0.78% of average domestic deposits, depending on an institution’s risk classification and other factors.

Effective beginning April 1, 2011, banks are charged FDIC insurance premiums based on net assets (defined as the quarter to date average daily total assets less the quarter to date average daily Tier 1 capital) rather than based on average domestic deposits. Initial base assessment rates vary from 0.05% to 0.35% of net assets and may be adjusted between negative 0.025% and positive .010% for an unsecured debt adjustment and a brokered deposit adjustment. Assuming that we remain in the same risk category, we expect that this new FDIC assessment system will continue to result in reduced deposit insurance premiums relative to 2010 levels.

Insurance expense decreased $47,000 (25.6%) in the second quarter of 2011 compared to the same quarter of 2010. The decrease is a result of favorable policy renewals and rewrites completed in the first quarter of 2011.

Printing and supplies increased $12,000 (30.3%) in the second quarter of 2011 compared to the same quarter of 2010 due to the timing of purchases.

Loan collection and foreclosed property expenses primarily include collection costs related to nonperforming and delinquent loans, including costs incurred to protect the Bank’s interest in collateral securing problem loans prior to taking title to the property, and carrying costs related to other real estate. Total expense decreased $54,000 (32.5%) in the second quarter of 2011 compared to the same quarter of 2010. The decrease in 2011 is primarily due to fewer new problem loans in 2011 and a decrease in the level of other real estate owned during the quarter relative to the comparable quarter of 2010.

For the three months ended June 30, 2011, net loss on the sale/write-down of ORE totaled $17,000 and included $32,000 of valuation write-downs on ORE properties and $15,000 of net gains recorded on sales of ORE properties and repossessed assets.

Other expense decreased $59,000 (25.9%) in the second quarter of 2011 compared to the same quarter of 2010 primarily due to elevated losses on fraudulent checks incurred during June 2010 and reduced marketing expenses in 2011. These favorable variances were partially offset by higher expense for business development and postage.

For the first six months of 2011, noninterest expense decreased $1,024,000 (15.2%) compared to 2010.

The most significant component of noninterest expense is salaries and employee benefits. In the first half of 2011, salaries and employee benefits decreased $323,000 (12.0%) from the same period in 2010. This was primarily due to decreases in salaries of $256,000 (11.3%), contract payroll of $85,000 (79.3%), and FICA taxes of $19,000 (11.5%). These decreases were partially offset by an increase of $36,000 (39.5%) in group medical insurance. These decreases were the result of leaner staffing levels in 2011 compared to 2010 as well as not yet filling an upper management position that was vacated in the second half of 2010. Contract payroll expense was lower due to reduced loan workout staffing levels as a result of a reduction in newly identified, higher stress, problem credits relative to the same prior year period. Group medical insurance increased due to a greater number of employees electing to participate in the Bank’s medical insurance plan in 2011 compared to 2010 and the general, continued increase in medical insurance costs.

Occupancy expense decreased $60,000 (11.1%) in the first half of 2011 due to lower building services expense, property taxes and depreciation. Building services expense decreased due to selection of a new interior cleaning services vendor and lower exterior maintenance costs for lawn care services compared to same period of 2010. Lower property tax expense in 2011 reflects general decreases in the assessed and taxable values of the Bank’s facilities relative to 2010. Depreciation expense has decreased as certain of the Bank’s main office renovation projects have become fully depreciated.

Equipment expense increased $7,000 (3.8%) in the first half of 2011 compared to the same six months of 2010 due to the higher costs for vehicle maintenance and equipment rental expense identified above. These were partially offset by lower equipment maintenance and depreciation expense.

Professional and service fees decreased $75,000 (9.0%) in the first half of 2011 compared to the same period of 2010. Expense reductions primarily related to lower legal, auditing, and accounting fees resulting from factors explained above. These expense decreases were partially offset by increased other fees, also explained above.

Computer service fees decreased $12,000 (5.1%) in the first half of 2011 compared to the same period of 2010. This decrease was due to a decrease in cost for trust department software in 2011 compared to 2010 as well as reductions in charges from other vendors.

FDIC assessment fees decreased $133,000 (18.6%) in the first half of 2011 compared to the same period of 2010 in part due to a decrease in the Bank’s size (i.e., net assets) and the FDIC’s reconfiguration of the assessment system for deposit insurance premiums which became effective April 1, 2011, as explained above.

Insurance expense decreased $61,000 (17.6%) in the first half of 2011 compared to the same period of 2010. The decrease is a result of favorable policy renewals and rewrites with different and existing carriers completed in the first quarter of 2011.

Printing and supplies increased $7,000 (9.0%) in the first half of 2011 compared to the same period of 2010 due to the timing of purchases.

Director fees increased $6,000 (18.3%) in the first half of 2011 compared to the same period of 2010 due to the timing of scheduled meetings and the addition of a new director to the Bank’s Compliance Committee in late 2010.

Loan collection and foreclosed property expenses primarily includes collection costs related to nonperforming and delinquent loans and other real estate. Total expense decreased $168,000 (38.8%) in the first half of 2011 compared to the same period of 2010. The decrease relates to the identification of fewer new problem loans and a decrease in the level of other real estate owned by the Bank in 2011 relative to the same period in 2010.

For the six months ended June 30, 2011, net loss on the sale/write-down of ORE totaled $42,000 and included $50,000 of valuation write-downs on ORE properties and $8,000 of net gains recorded on sales of ORE properties and repossessed assets.

Other expense decreased $70,000 (19.2%) in the first half of 2011 compared to the same period of 2010 primarily due to elevated fraudulent checks losses incurred in June 2010, reduced marketing expenses in 2011, and the timing of community contributions made to date in 2011. These favorable variances were partially offset by higher expense for business development, postage, and continuing employee education and training costs.

	(in thousands)
	Second Quarter					Year-to-Date
Income Tax Expense (Benefit)	2011			2010		2011			2010
Total	$	(78	)	$	61	$	(78	)	$	(1	)

In the second quarter of 2010, the Corporation recorded a federal income tax benefit to reduce its deferred tax valuation allowance established on previously recorded deferred tax assets. The tax benefit resulted from adjustment of the deferred tax liability related to appreciation in the Corporation’s available for sale investment portfolio. The Corporation also recorded a deferred tax valuation allowance on the tax benefit related to the pre-tax loss recognized during the six month periods ended June 30, 2011 and 2010 due to the uncertainty of future taxable income necessary to fully realize the recorded net deferred tax asset.

Capital

The Corporation and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can result in the initiation of certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct, material effect on the Corporation’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Corporation’s and the Bank’s capital classification are also subject to qualitative judgments by regulators with regard to components, risk weightings, and other factors.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required that the federal regulatory agencies adopt regulations defining five capital tiers for banks:

	Total	Tier 1
	Risk-Based	Risk-Based
	Capital Ratio	Capital Ratio	Leverage Ratio
Well capitalized	10% or above	6% or above	5% or above
Adequately capitalized	8% or above	4% or above	4% or above
Undercapitalized	Less than 8%	Less than 4%	Less than 4%
Significantly undercapitalized	Less than 6%	Less than 3%	Less than 3%
Critically undercapitalized	-	-	A ratio of tangible equity
			to total assets of 2% or less

Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and Tier 1 capital (as defined) to average assets (as defined).The Corporation’s and the Bank’s actual capital amounts and ratios are presented as of June 30, 2011 and December 31, 2010 in the following table:

						Minimum for					To be Well Capitalized
						Capital Adequacy					Under Prompt Corrective
	Actual					Purposes					Action Provision
As of June 30, 2011	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital (to risk weighted assets)
Bank	$	13,437,000		5.71	%	$	18,810,000		8	%	$	23,512,000		10	%
FNBH Bancorp		13,314,000		5.66	%		18,810,000		8	%		N/A		N/A

Tier 1 Capital (to risk weighted assets)
Bank		10,374,000		4.41	%		9,405,000		4	%		14,107,000		6	%
FNBH Bancorp		10,251,000		4.36	%		9,405,000		4	%		N/A		N/A

Tier 1 Capital (to average assets)
Bank		10,374,000		3.54	%		11,715,000		4	%		14,644,000		5	%
FNBH Bancorp		10,251,000		3.50	%		11,715,000		4	%		N/A		N/A

As of December 31, 2010	Amount		Ratio			Amount		Ratio			Amount		Ratio
Total Capital (to risk weighted assets)
Bank	$	13,632,000		5.58	%	$	19,530,000		8	%	$	24,412,000		10	%
FNBH Bancorp		13,580,000		5.56	%		19,530,000		8	%		N/A		N/A

Tier 1 Capital (to risk weighted assets)
Bank		10,442,000		4.28	%		9,765,000		4	%		14,647,000		6	%
FNBH Bancorp		10,390,000		4.26	%		9,765,000		4	%		N/A		N/A

Tier 1 Capital (to average assets)
Bank		10,442,000		3.50	%		11,919,000		4	%		14,898,000		5	%
FNBH Bancorp		10,390,000		3.49	%		11,919,000		4	%		N/A		N/A

The OCC has established the following minimum capital standards for national banks: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total average assets of 3% for the most highly-rated banks, with minimum requirements of 4% to 5% for all others, and a risk-based capital requirement consisting of a minimum ratio of total capital to total risk-weighted assets of 8%, at least one-half of which must be Tier 1 capital. Tier 1 capital consists principally of shareholders’ equity. These capital requirements are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions.

On September 24, 2009, the Bank consented to the issuance of a Consent Order (the “Consent Order”) with the OCC. Pursuant to the Consent Order, the Bank was required to achieve and maintain total capital equal to 11% of risk weighted assets and Tier 1 capital equal to at least 8.5% of adjusted total assets by January 22, 2010. At June 30, 2011 and through the current date, the Bank’s capital ratios are and continue to be significantly below the increased minimum requirements imposed by the OCC. In addition to these minimum capital requirements, the Consent Order imposes other requirements on the Bank, including the development and pursuit of a strategic plan addressing certain specific factors listed in the Consent Order, improvements to the Bank's liquidity risk management program, improvements to the Bank's loan portfolio management, the reduction of the Bank's concentration in various loan categories, and related matters. Since the time the Consent Order was entered, the Bank has been actively working to address all requirements of the Consent Order. The Bank believes it is in material compliance with all of the requirements of the Consent Order other than the minimum capital requirements described above; however, there may be additional, ongoing actions the Bank is required to take in order to be in full compliance with the Consent Order. While the OCC could take further regulatory enforcement action against the Bank if the OCC believes the Bank is not in compliance with any requirement of the Consent Order, the Bank currently believes that its failure to meet the minimum capital requirements established by the Consent Order is the primary risk factor in determining the likelihood and extent of any further, more severe regulatory enforcement action (such as receivership of the Bank). In light of the Bank’s continued losses and capital position at June 30, 2011, it is reasonable to anticipate further regulatory enforcement action by either the OCC or FDIC, particularly if the Corporation is unsuccessful in raising additional capital.

In addition and as a result of noncompliance with certain terms of the Consent Order, the Bank is categorized as “significantly undercapitalized” for Prompt Corrective Action purposes, as described in Note 2 of the 2010 Annual Report contained in the Corporation’s report on Form 10-K filing. The Prompt Corrective Action provisions impose certain restrictions on institutions that are undercapitalized. The restrictions become increasingly more severe as an institution’s capital category declines from undercapitalized to significantly undercapitalized to critically undercapitalized.

Even if we do not become subject to more stringent regulatory requirements or restrictions, our current capital deficiencies and elevated levels of nonperforming assets may make it very difficult to continue as a going concern. As of June 30, 2011, our nonperforming assets exceed the sum of our capital and allowance for loan losses by over 50%. As described elsewhere in this Form 10-Q, we have established our allowance for loan losses at a level we currently believe, based on the data available to us, is sufficient to absorb expected losses in our loan portfolio. However, this process involves a very significant degree of judgment, is based on numerous different assumptions that are difficult to make and, by its nature, is inherently uncertain. Moreover, the performance of our existing loan portfolio is, in many respects, dependent on external factors such as our borrowers' ability to repay their loan obligations and the value of collateral securing those obligations, which in turn depend on macro and micro economic conditions including the pace of economic recovery in Southeast Michigan. If our loan portfolio performs worse than we currently expect, we may not have sufficient capital to absorb all of the losses, which could render us insolvent.

During 2010 and through the current date, we have worked with financial and legal advisors to pursue various transactions that would provide additional capital to the Bank. We continue to actively pursue these transactions. In connection with these efforts, the Corporation has scheduled a special shareholder meeting to be held on Thursday, September 22, 2011. The purpose of the special meeting is to vote upon a proposal to effect a 1-for-7 reverse stock split of the Corporation's outstanding shares of common stock. The primary purpose of this reverse stock split is to increase the number of the Corporation’s authorized common stock available for future issuance. Please refer to the proxy statement we filed with the Securities and Exchange Commission (SEC) on August 10, 2011 for more details regarding the special meeting, the proposed reverse stock split, and how to vote your shares of common stock.

However, the Corporation’s alternatives for additional capital are somewhat limited. The ongoing liquidity concerns in the broader market and the loss of confidence in financial institutions will likely serve to increase our cost of funding and further limit our access to capital. We may not be able to raise the necessary capital on favorable terms, or at all. An inability to raise capital would likely have a materially adverse effect on our business, financial condition and results of operations. Management’s future plans in response to the Bank’s undercapitalized regulatory classification and the need to raise additional capital pursuant to the Consent Order are described more fully in Note 2 of the 2010 Annual Report contained in the Corporation’s report on Form 10-K filing.

The Corporation’s ability to pay dividends is subject to various regulatory and state law requirements. Due to the Bank’s financial condition, the Bank cannot pay a dividend to the Corporation without the prior approval of the OCC. The Corporation suspended, indefinitely, the payment of dividends in the third quarter of 2008 due to the Bank’s inability to pay dividends to the holding company and insufficient cash at the holding company to pay the dividends.

Pursuant to the results of examinations of the Corporation by the Federal Reserve in January 2011 and November 2009, the Corporation is considered a troubled institution due to the critically deficient condition of its subsidiary Bank. As such, the Federal Reserve has required the Corporation to take action to support the Bank, which principally involves a capital infusion sufficient to satisfy minimum capital ratios imposed on the Bank. In addition, the Corporation must receive prior approval from the Federal Reserve before the payment of dividends, issuance of debt, or redemption of stock. Additional restrictions imposed on the Corporation by the Federal Reserve relate to changes in the composition of board members, the employment of senior executive officers or changes in the responsibilities of senior executive officers, and limitations on indemnification and severance payments.

As a result of the Bank's current inability to pay dividends to the Corporation, the Corporation has an insufficient level of resources and cash flows to meet operational liquidity needs. The Bank is prohibited from paying expenses on behalf of the Corporation. To resolve the Corporation's illiquidity and the deficient capital levels at the Corporation and the Bank, the Corporation's board of directors has provided certain interim funding to the Corporation. Depending on the extent of the future cash needs of the holding company, the timing and success of any capital raise, and the directors' willingness and ability to continue funding holding company expenses (through loans), the Corporation may be required to attempt to borrow funds from other sources to pay its expenses. Such additional borrowings may be at a price and on terms that are unfavorable to the Corporation. The holding company expenses were approximately $62,000 for 2010 and approximately $76,000 for the first six months of 2011.

Critical Accounting Policies

The Corporation maintains critical accounting policies for the valuation of investment securities, the allowance for loan losses, and income taxes. Refer to Notes 1c, 1e and 1k of the December 31, 2010 Consolidated Financial Statements as included in Form 10-K for additional information on critical accounting policies.

Contractual Obligations

The Bank had outstanding irrevocable standby letters of credit, which carry a maximum potential commitment of approximately $92,000 at June 30, 2011 and December 31, 2010, respectively. These letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The majority of these letters of credit are short-term guarantees of one year or less, although some have maturities which extend as long as two years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Bank primarily holds real estate as collateral supporting those commitments for which collateral is deemed necessary. The extent of collateral held on those commitments at June 30, 2011 and December 31, 2010, where there is collateral, was in excess of the committed amount. A letter of credit is not recorded on the balance sheet unless a customer fails to perform.

New Accounting Standards

In April 2011, the FASB has issued ASU 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This ASU provides guidance for creditors when determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring or loan modification constitutes a troubled debt restructuring. The ASU also provides additional disclosure requirements. It is effective for public companies for interim and annual periods beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. Adoption of this standard is not expected to have a material impact on our consolidated financial statements.

In July 2010, FASB issued ASU No. 2010-20, Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. The ASU amends FASB Accounting Standards Codification™ Topic 310, Receivables, to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate, by portfolio segment or class of financing receivable, certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010 and have been added to Note 5.

In January 2010, the FASB issued ASU 2010-06, Improving Disclosures about Fair Value Measurements. This standard requires new disclosures on the amount and reason for transfers in and out of Level 1 and 2 recurring fair value measurements. The standard also requires disclosure of activities (i.e., on a gross basis), including purchases, sales, issuances, and settlements, in the reconciliation of Level 3 fair value recurring measurements. The standard clarifies existing disclosure requirements on levels of disaggregation and disclosures about inputs and valuation techniques. The new disclosures regarding Level 1 and 2 fair value measurements and clarification of existing disclosures are effective for periods beginning after December 15, 2009. The disclosures about the reconciliation of information in Level 3 recurring fair value measurements are required for periods beginning after December 15, 2010. Adoption of this standard did not have a significant impact on our quarterly disclosures.

Recent Legislative Developments

In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law. Uncertainty remains as to the ultimate impact of the new law, which could have a material adverse impact either on the financial services industry as a whole, or on the Corporation’s and Bank’s business, results of operations and financial condition. This new federal law contains a number of provisions that could affect the Corporation and the Bank. For example, the law:

Makes national banks (such as the Bank) and their subsidiaries subject to a number of state laws that were previously preempted by federal laws;

Imposes new restrictions on how mortgage brokers and loan originators may be compensated;

Establishes a new federal consumer protection agency that will have broad authority to develop and implement rules regarding most consumer financial products;

Creates new rules affecting corporate governance and executive compensation at all publicly traded companies (such as the Corporation);

Broadens the base for FDIC insurance assessments and makes other changes to federal deposit insurance, including permanently increasing FDIC deposit insurance coverage to $250,000; and

Allows depository institutions to pay interest on business checking accounts

Many of these provisions are not yet effective and are subject to implementation by various regulatory agencies. As a result, the actual impact this new law will have on the Bank's business is not yet known. However, this law and any other changes to laws applicable to the financial industry may impact the profitability of the Bank's business activities or change certain of its business practices and may expose the Corporation and the Bank to additional costs, including increased compliance costs, and require the investment of significant management attention and resources. As a result, this law may negatively affect the business and future financial performance of the Corporation and the Bank.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There has been no material change in the market risk faced by the Corporation since December 31, 2010. For information regarding our risk factors, refer to the FNBH Bancorp, Inc. Form 10-K for the year ended December 31, 2010.

Item 4. Controls and Procedures

(a)

Evaluation of Disclosure Controls and Procedures.

With the participation of management, the Corporation’s chief executive officer and chief financial officer, after evaluating the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Exchange Act Rules 13a – 15(e) and 15d – 15(e)) for the period ended June 30, 2011, have concluded that, as of such date, the Corporation’s disclosure controls and procedures were effective.

(b)

Changes in Internal Control Over Financial Reporting.

During the quarter ended June 30, 2011 there were no changes in the Corporation’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1A. Risk Factors

There have been no material changes to the risk factors disclosed in Item 1A. Risk Factors of the Corporation's Annual Report on Form 10-K for the year ended December 31, 2010.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

There were no sales or repurchases of stock by the Corporation for the three months ended June 30, 2011.

Item 6. Exhibits

The following exhibits (listed by number corresponding to the Exhibit Table as Item 601 in Regulation S-K) are filed with this report:

31.1

Certificate of the Chief Executive Officer of FNBH Bancorp, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

Certificate of the Chief Financial Officer of FNBH Bancorp, Inc. pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

Certificate of the Chief Executive Officer of FNBH Bancorp, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).

32.2

Certificate of the Chief Financial Officer of FNBH Bancorp, Inc. pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350).

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Quarterly Report on Form 10-Q for the quarter ended June 30, 2011 to be signed on its behalf by the undersigned hereunto duly authorized.

	FNBH BANCORP, INC.

	/s/ Ronald L. Long
	Ronald L. Long
	President and Chief Executive Officer

	/s/ Mark J. Huber
	Mark J. Huber
	Chief Financial Officer

Date: August 15, 2011

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