MBT FINANCIAL CORP - FORM 10-Q

Attached files

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EX-32.1 - EXHIBIT 32.1 - MBT FINANCIAL CORP	v385174_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - MBT FINANCIAL CORP	v385174_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - MBT FINANCIAL CORP	v385174_ex31-1.htm
EX-32.2 - EXHIBIT 32.2 - MBT FINANCIAL CORP	v385174_ex32-2.htm
EXCEL - IDEA: XBRL DOCUMENT - MBT FINANCIAL CORP	Financial_Report.xls

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2014

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 000-30973

MBT FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

Michigan

38-3516922

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

102 E. Front Street

Monroe, Michigan 48161

(Address of principal executive offices)

(Zip Code)

(734) 241-3431

(Registrant’s telephone number, including area code)

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 þ 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 to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ 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 accelerated filer” in Rule 12b-2 of the Exchange Act (check one).

Large accelerated filer ¨	Accelerated Filer ¨
Non-accelerated filer ¨	Smaller reporting company þ

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

As of August 13, 2014, there were 22,691,623 shares of the Company’s Common Stock outstanding.

Part I Financial Information

Item 1. Financial Statements

MBT FINANCIAL CORP.

CONSOLIDATED BALANCE SHEETS

	June 30, 2014
Dollars in thousands	(Unaudited)			December 31, 2013
ASSETS
Cash and Cash Equivalents
Cash and due from banks
Non-interest bearing	$	13,041		$	15,448
Interest bearing		13,675			62,350
Total cash and cash equivalents		26,716			77,798

Securities - Held to Maturity		33,378			34,846
Securities - Available for Sale		436,000			394,956
Federal Home Loan Bank stock - at cost		10,605			10,605

Loans held for sale		1,219			668

Loans		598,584			597,590
Allowance for Loan Losses		(15,001	)		(16,209	)
Loans - Net		583,583			581,381

Accrued interest receivable and other assets		30,537			34,094
Other Real Estate Owned		7,911			9,628
Bank Owned Life Insurance		51,114			50,493
Premises and Equipment - Net		28,768			28,213
Total assets	$	1,209,831		$	1,222,682

LIABILITIES
Deposits:
Non-interest bearing	$	194,946		$	215,844
Interest-bearing		854,843			853,874
Total deposits		1,049,789			1,069,718

Federal Home Loan Bank advances		-			12,000
Repurchase agreements		15,000			15,000
Interest payable and other liabilities		16,248			15,356
Total liabilities		1,081,037			1,112,074

STOCKHOLDERS' EQUITY
Common stock (no par value; 50,000,000 shares authorized, 22,690,142 and 20,605,493 shares issued and outstanding)		22,859			14,671
Retained earnings		110,271			106,817
Unearned compensation		(17	)		(7	)
Accumulated other comprehensive loss		(4,319	)		(10,873	)
Total stockholders' equity		128,794			110,608
Total liabilities and stockholders' equity	$	1,209,831		$	1,222,682

The accompanying notes to consolidated financial statements are an integral part of these statements.

-2-

MBT FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME - UNAUDITED

	Three Months Ended June 30,						Six Months Ended June 30,
Dollars in thousands, except per share data	2014			2013			2014			2013
Interest Income
Interest and fees on loans	$	7,021		$	7,599		$	14,100		$	15,501
Interest on investment securities-
Tax-exempt		297			310			604			633
Taxable		2,200			1,795			4,318			3,562
Interest on balances due from banks		22			37			54			106
Total interest income		9,540			9,741			19,076			19,802

Interest Expense
Interest on deposits		801			1,115			1,656			2,328
Interest on borrowed funds		187			537			373			1,341
Total interest expense		988			1,652			2,029			3,669

Net Interest Income		8,552			8,089			17,047			16,133
Provision For Loan Losses		100			400			200			1,900

Net Interest Income After
Provision For Loan Losses		8,452			7,689			16,847			14,233

Other Income
Income from wealth management services		1,168			1,081			2,302			2,178
Service charges and other fees		968			1,058			1,900			2,100
Debit card income		542			530			1,031			1,008
Net gain on sales of securities available for sale		219			154			276			164
Net gain (loss) on sales of Other Real Estate Owned		(342	)		(747	)		(330	)		(707	)
Origination fees on mortgage loans sold		88			184			150			473
Bank owned life insurance income		351			364			705			754
Rent income on Other Real Estate Owned		130			147			265			292
Other		460			471			949			1,008
Total other income		3,584			3,242			7,248			7,270

Other Expenses
Salaries and employee benefits		5,804			5,214			11,532			10,537
Occupancy expense		670			722			1,414			1,409
Equipment expense		662			674			1,279			1,374
Marketing expense		212			205			415			368
Professional fees		521			550			939			1,051
Other Real Estate Owned expenses		361			293			700			667
FDIC Deposit Insurance Assessment		620			694			1,260			1,383
Bonding and other insurance expense		255			266			519			535
Telephone expense		104			130			247			243
Other		582			687			1,185			1,326
Total other expenses		9,791			9,435			19,490			18,893

Income Before Income Taxes		2,245			1,496			4,605			2,610
Income Tax Expense		558			-			1,151			-
Net Income	$	1,687		$	1,496		$	3,454		$	2,610

Other Comprehensive Income (Loss) - Net of Tax
Unrealized gains (losses) on securities		3,443			(8,354	)		7,002			(8,900	)
Reclassification adjustment for gains included in net income		(144	)		(102	)		(182	)		(108	)
Postretirement benefit liability		27			30			(266	)		61
Total Other Comprehensive Income (Loss) - Net of Tax		3,326			(8,426	)		6,554			(8,947	)

Comprehensive Income (Loss)	$	5,013		$	(6,930	)	$	10,008		$	(6,337	)

Basic Earnings Per Common Share	$	0.08		$	0.08		$	0.16		$	0.15

Diluted Earnings Per Common Share	$	0.08		$	0.08		$	0.16		$	0.15

Common Stock Dividends Declared Per Share	$	-		$	-		$	-		$	-

The accompanying notes to consolidated financial statements are an integral part of these statements.

-3-

MBT FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY - UNAUDITED

									Accumulated
									Other
	Common			Retained		Unearned			Comprehensive
Dollars in thousands	Stock			Earnings		Compensation			Income (Loss)			Total
Balance - January 1, 2014	$	14,671		$	106,817	$	(7	)	$	(10,873	)	$	110,608

Issuance of Common Stock
SOSARs exercised (7,287 shares)		1			-		-			-			1
Restricted stock awards (6,000 shares)		29			-		(29	)		-			-
Other stock issued (2,071,362 shares)		8,814			-		-			-			8,814
Stock Offering Expense		(754	)		-		-			-			(754	)

Equity Compensation		98			-		19			-			117

Net income		-			3,454		-			-			3,454
Other comprehensive income - net of tax		-			-		-			6,554			6,554

Balance - June 30, 2014	$	22,859		$	110,271	$	(17	)	$	(4,319	)	$	128,794

									Accumulated
									Other
	Common			Retained		Unearned			Comprehensive
Dollars in thousands	Stock			Earnings		Compensation			Income (Loss)			Total
Balance - January 1, 2013	$	2,397		$	81,280	$	(27	)	$	(76	)	$	83,574

Issuance of Common Stock
SOSARs exercised (674 shares)		4			-		-			-			4
Other stock issued (513,045 shares)		1,785			-		-			-			1,785
Stock Offering Expense		(18	)		-		-			-			(18	)

Equity Compensation		55			-		12			-			67

Net income		-			2,610		-			-			2,610
Other comprehensive loss - net of tax		-			-		-			(8,947	)		(8,947	)

Balance - June 30, 2013	$	4,223		$	83,890	$	(15	)	$	(9,023	)	$	79,075

The accompanying notes to consolidated financial statements are an integral part of these statements.

-4-

MBT FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

	Six Months Ended June 30,
Dollars in thousands	2014			2013
Cash Flows from Operating Activities
Net Income	$	3,454		$	2,610
Adjustments to reconcile net income to net cash from operating activities
Provision for loan losses		200			1,900
Depreciation		827			965
Deferred income tax benefit		1,102			-
Net amortization of investment premium and discount		483			978
Writedowns of Other Real Estate Owned		163			909
Net increase in interest payable and other liabilities		489			1,702
Net increase in interest receivable and other assets		(741	)		(943	)
Equity based compensation expense		118			139
Net gain on sale/settlement of securities		(276	)		(164	)
Increase in cash surrender value of life insurance		(621	)		(669	)
Net cash provided by operating activities	$	5,198		$	7,427

Cash Flows from Investing Activities
Proceeds from maturities and redemptions of investment securities held to maturity	$	6,058		$	10,132
Proceeds from maturities and redemptions of investment securities available for sale		10,407			56,804
Proceeds from sales of investment securities available for sale		55,998			32,920
Net (increase) decrease in loans		(5,300	)		7,741
Proceeds from sales of other real estate owned		3,696			5,250
Proceeds from sales of other assets		25			64
Purchase of investment securities held to maturity		(4,590	)		(8,065	)
Purchase of investment securities available for sale		(97,323	)		(87,498	)
Purchase of bank premises and equipment		(1,382	)		(464	)
Net cash provided by (used for) investing activities	$	(32,411	)	$	16,884

Cash Flows from Financing Activities
Net decrease in deposits	$	(19,929	)	$	(7,970	)
Repayment of long term debt		-			(135	)
Repayment of Federal Home Loan Bank borrowings		(12,000	)		(95,000	)
Proceeds from issuance of common stock		8,060			1,771
Net cash used for financing activities	$	(23,869	)	$	(101,334	)

Net Decrease in Cash and Cash Equivalents	$	(51,082	)	$	(77,023	)

Cash and Cash Equivalents at Beginning of Period		77,798			112,507
Cash and Cash Equivalents at End of Period	$	26,716		$	35,484

Supplemental Cash Flow Information
Cash paid for interest	$	2,046		$	3,817
Cash paid for federal income taxes	$	49		$	-

Supplemental Schedule of Non Cash Investing Activities
Transfer of loans to other real estate owned	$	2,305		$	3,117
Transfer of loans to other assets	$	42		$	79

The accompanying notes to consolidated financial statements are an integral part of these statements.

-5-

MBT FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES

The unaudited consolidated financial statements include the accounts of MBT Financial Corp. (the “Company”) and its subsidiary, Monroe Bank & Trust (the “Bank”). The Bank includes the accounts of its wholly owned subsidiary, MB&T Financial Services, Inc. The Bank operates seventeen branches in Monroe County, Michigan, seven branches in Wayne County, Michigan, and a loan and wealth management office in Lenawee County. The Bank’s primary source of revenue is from providing loans to customers, who are predominantly small and middle-market businesses and middle-income individuals. The Company’s sole business segment is community banking.

The accounting and reporting policies of the Bank conform to practice within the banking industry and are in accordance with accounting principles generally accepted in the United States. Preparation of financial statements in conformity with generally accepted accounting principles requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near term are the determination of the allowance for loan losses, the valuation of other real estate owned, and the fair value of investment securities.

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, such information reflects all adjustments (consisting of normal recurring adjustments), which are, in the opinion of Management, necessary for fair statement of results for the interim periods.

The significant accounting policies are as follows:

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and its subsidiary. All material intercompany transactions and balances have been eliminated.

COMPREHENSIVE INCOME

Accounting principles generally require that revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, however, such as unrealized gains and losses on securities available for sale and amounts recognized related to postretirement benefit plans (gains and losses, prior service costs, and transition assets or obligations), are reported as a direct adjustment to the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income.

BUSINESS SEGMENTS

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

-6-

FAIR VALUE

The Company measures or monitors many of its assets and liabilities on a fair value basis. Fair value is used on a recurring basis for assets and liabilities that are elected to be accounted for under The Fair Value Option as well as for certain assets and liabilities in which fair value is the primary basis of accounting. Examples of these include derivative instruments and available for sale securities. Additionally, fair value is used on a non-recurring basis to evaluate assets or liabilities for impairment or for disclosure purposes. Examples of these non-recurring uses of fair value include certain loans held for sale accounted for on a lower of cost or market basis. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions when estimating fair value.

When determining the fair value measurements for assets and liabilities required or permitted to be recorded at and/or marked to fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. When possible, the Company looks to active and observable markets to price identical assets or liabilities. When identical assets and liabilities are not traded in active markets, the Company looks to market observable data for similar assets or liabilities. Nevertheless, certain assets and liabilities are not actively traded in observable markets and the Company must use alternative valuation techniques to derive a fair value measurement.

ACCOUNTING PRONOUNCEMENTS

No recent accounting pronouncements are expected to have a significant impact on the Company’s financial statements.

2. EARNINGS PER SHARE

The calculations of earnings per common share are as follows:

	For the three months ended June 30,				For the six months ended June 30,
	2014		2013		2014		2013
Basic
Net income	$	1,687,000	$	1,496,000	$	3,454,000	$	2,610,000
Average common shares outstanding		22,205,086		17,906,085		21,515,737		17,712,310
Earnings per common share - basic	$	0.08	$	0.08	$	0.16	$	0.15

Diluted
Net income	$	1,687,000	$	1,496,000	$	3,454,000	$	2,610,000
Average common shares outstanding		22,205,086		17,906,085		21,515,737		17,712,310
Equity compensation		293,150		260,135		289,428		246,259
Average common shares outstanding - diluted		22,498,236		18,166,220		21,805,165		17,958,569
Earnings per common share - diluted	$	0.08	$	0.08	$	0.16	$	0.15

3. STOCK BASED COMPENSATION

Stock Options - The following table summarizes the options that had been granted to certain key executives in accordance with the Long-Term Incentive Compensation Plan that was approved by shareholders at the Annual Meeting of Shareholders on April 6, 2000.

			Weighted Average
	Shares		Exercise Price
Options Outstanding, January 1, 2014		283,900	$	18.41
Granted		-		-
Exercised		-		-
Forfeited		1,500		15.33
Expired		77,000		16.69
Options Outstanding, June 30, 2014		205,400	$	19.08
Options Exercisable, June 30, 2014		205,400	$	19.08

-7-

Stock Only Stock Appreciation Rights (SOSARs) - On March 7, 2014, 110,000 Stock Only Stock Appreciation Rights (SOSARs) were awarded to certain executives in accordance with the MBT 2008 Stock Incentive Plan that was approved by shareholders on May 1, 2008. The SOSARs have a term of ten years and vest in three equal annual installments beginning on December 31, 2014. The fair value of $2.98 for the SOSARs was estimated at the date of the grant, using the Black-Scholes option pricing model, with the following assumptions: expected option lives of 7 years, expected volatility of 60.11%, a risk free interest rate of 2.27% and dividend yield of 0.00%.

SOSARs granted under the plan are structured as fixed grants with the exercise price equal to the market value of the underlying stock on the date of the grant.

The following table summarizes the SOSARs that have been granted:

			Weighted Average
	Shares		Exercise Price
SOSARs Outstanding, January 1, 2014		472,271	$	3.23
Granted		110,000		4.90
Exercised		18,998		2.15
Forfeited		5,834		4.91
SOSARs Outstanding, June 30, 2014		557,439	$	3.58
SOSARs Exercisable, June 30, 2014		352,062	$	3.53

The exercise of a SOSAR results in the issuance of a number of shares of common stock of the Company based on the appreciation of the market price of the stock over the exercise price of the SOSAR. The market value of the Company’s common stock on June 30, 2014 was $5.47. The value of the exercisable SOSARs as of June 30, 2014 was $683,000, and exercise of those SOSARs on that date would have resulted in the issuance of 124,863 shares of common stock.

Restricted Stock Unit Awards – On March 7, 2014, performance restricted stock units were awarded to certain key executive officers in accordance with the MBT 2008 Stock Incentive Plan that was approved by shareholders on May 1, 2008. Each Restricted Stock Unit (RSU) is equivalent to one share of MBT Financial Corp. common stock. Stock will be issued to the participants following a two year performance period that ends on December 31, 2015. Up to 50% of the aggregate RSUs granted may be earned in each year of the performance period subject to satisfying weighted performance thresholds. Earned RSUs vest on December 31, 2016.

The total expense for equity based compensation was $79,000 in the second quarter of 2014 and $72,000 in the second quarter of 2013. The total expense for equity based compensation was $146,000 in the first six months of 2014 and $145,000 in the first six months of 2013.

4. LOANS

The Bank makes commercial, consumer, and mortgage loans primarily to customers in Monroe County, Michigan, southern and western Wayne County, Michigan, and surrounding areas. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent on the automotive, manufacturing, and real estate development economic sectors.

-8-

Loans consist of the following (000s omitted):

	June 30,		December 31,
	2014		2013
Residential real estate loans	$	222,449	$	228,024
Commercial and Construction real estate loans		280,824		280,579
Agriculture and agricultural real estate loans		17,207		14,997
Commercial and industrial loans		62,963		59,440
Loans to individuals for household, family, and other personal expenditures		15,141		14,550
Total loans, gross	$	598,584	$	597,590
Less: Allowance for loan losses		15,001		16,209
	$	583,583	$	581,381

Loans are placed in a nonaccrual status when, in the opinion of Management, the collection of additional interest is doubtful. All loan relationships over $250,000 that are classified by Management as nonperforming as well as selected performing accounts and all renegotiated loans are reviewed for impairment each quarter. Allowances for loans determined to be impaired are included in the allowance for loan losses. All cash received on nonaccrual loans is applied to the principal balance. Nonperforming assets consist of nonaccrual loans, loans 90 days or more past due, restructured loans, nonaccrual investment securities, and other real estate owned. Other real estate owned includes real estate that has been acquired in full or partial satisfaction of loan obligations or upon foreclosure and real estate that the bank has purchased but no longer intends to use for bank premises.

The following table summarizes nonperforming assets (000’s omitted):

	June 30,			December 31,
	2014			2013
Nonaccrual loans	$	19,048		$	23,710
Loans 90 days past due and accruing		4			46
Restructured loans		29,658			32,450
Total nonperforming loans	$	48,710		$	56,206

Other real estate owned		7,911			9,628
Other assets		22			10
Nonperforming investment securities		3,403			3,259
Total nonperforming assets	$	60,046		$	69,103

Nonperforming assets to total assets		4.96	%		5.65	%
Allowance for loan losses to nonperforming loans		30.80	%		28.84	%

5. ALLOWANCE FOR LOAN LOSSES

The Company separates its loan portfolio into segments to perform the calculation and analysis of the allowance for loan losses. The six segments analyzed are Agriculture and Agricultural Real Estate, Commercial, Commercial Real Estate, Construction Real Estate, Residential Real Estate, and Consumer and Other. The Agriculture and Agricultural Real Estate segment includes all loans to finance agricultural production and all loans secured by agricultural real estate. This segment does not include loans to finance agriculture that are secured by residential real estate, which are included in the Residential Real Estate segment. The Commercial segment includes loans to finance commercial and industrial businesses that are not secured by real estate. The Commercial Real Estate segment includes loans secured by non-farm, non-residential real estate. The Construction Real Estate segment includes loans to finance construction and land development. This includes residential and commercial construction and land development. The Residential Real Estate segment includes all loans, other than construction loans, that are secured by single family and multi family residential real estate 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.

-9-

Activity in the allowance for loan losses during the three and six months ended June 30, 2014 was as follows (000s omitted):

	Agriculture and Agricultural Real Estate		Commercial			Commercial Real Estate			Construction Real Estate			Residential Real Estate			Consumer and Other			Total

Allowance for loan losses: For the three months ended June 30, 2014
Beginning Balance	$	205	$	1,780		$	7,460		$	1,430		$	4,478		$	805		$	16,158
Charge-offs		-		(440	)		(1,103	)		-			(79	)		(40	)		(1,662	)
Recoveries		5		56			211			20			73			40			405
Provision		4		(108	)		967			(303	)		(192	)		(268	)		100
Ending balance	$	214	$	1,288		$	7,535		$	1,147		$	4,280		$	537		$	15,001

Allowance for loan losses: For the six months ended June 30, 2013
Beginning Balance	$	171	$	1,989		$	7,030		$	1,397		$	4,606		$	1,016		$	16,209
Charge-offs		-		(626	)		(1,211	)		(210	)		(211	)		(78	)		(2,336	)
Recoveries		5		89			276			254			238			66			928
Provision		38		(164	)		1,440			(294	)		(353	)		(467	)		200
Ending balance	$	214	$	1,288		$	7,535		$	1,147		$	4,280		$	537		$	15,001

Allowance for loan losses as of June 30, 2014
Ending balance individually evaluated for impairment	$	36	$	511		$	2,234		$	900		$	1,713		$	243		$	5,637
Ending balance collectively evaluated for impairment		178		777			5,301			247			2,567			294			9,364
Ending balance	$	214	$	1,288		$	7,535		$	1,147		$	4,280		$	537		$	15,001

Loans as of June 30, 2014
Ending balance individually evaluated for impairment	$	947	$	1,870		$	27,281		$	3,221		$	14,438		$	556		$	48,313
Ending balance collectively evaluated for impairment		16,260		61,093			238,694			11,628			208,011			14,585			550,271
Ending balance	$	17,207	$	62,963		$	265,975		$	14,849		$	222,449		$	15,141		$	598,584

-10-

Activity in the allowance for loan losses during the three and six months ended June 30, 2013 was as follows (000s omitted):

	Agriculture and Agricultural Real Estate		Commercial			Commercial Real Estate			Construction Real Estate			Residential Real Estate			Consumer and Other			Total

Allowance for loan losses: For the three months ended June 30, 2013
Beginning Balance	$	70	$	2,153		$	7,908		$	2,469		$	5,108		$	191		$	17,899
Charge-offs		-		(199	)		(1,056	)		(19	)		(383	)		(16	)		(1,673	)
Recoveries		-		27			226			14			239			63			569
Provision		39		461			478			(575	)		(177	)		174			400
Ending balance	$	109	$	2,442		$	7,556		$	1,889		$	4,787		$	412		$	17,195

Allowance for loan losses: For the six months ended June 30, 2013
Beginning Balance	$	76	$	2,224		$	7,551		$	2,401		$	4,715		$	332		$	17,299
Charge-offs		-		(402	)		(1,868	)		(37	)		(816	)		(137	)		(3,260	)
Recoveries		-		263			290			288			319			96			1,256
Provision		33		357			1,583			(763	)		569			121			1,900
Ending balance	$	109	$	2,442		$	7,556		$	1,889		$	4,787		$	412		$	17,195

Allowance for loan losses as of June 30, 2013
Ending balance individually evaluated for impairment	$	-	$	1,237		$	2,648		$	1,434		$	2,005		$	108		$	7,432
Ending balance collectively evaluated for impairment		109		1,205			4,908			455			2,782			304			9,763
Ending balance	$	109	$	2,442		$	7,556		$	1,889		$	4,787		$	412		$	17,195


Loans as of June 30, 2013
Ending balance individually evaluated for impairment	$	423	$	5,735		$	39,176		$	6,671		$	15,826		$	362		$	68,193
Ending balance collectively evaluated for impairment		14,421		66,342			229,600			9,959			211,893			14,963			547,178
Ending balance	$	14,844	$	72,077		$	268,776		$	16,630		$	227,719		$	15,325		$	615,371

Each period the provision for loan losses in the income statement results from the combination of an estimate by Management of loan losses that occurred during the current period and the ongoing adjustment of prior estimates of losses occurring in prior periods.

The provision for loan losses increases the allowance for loan losses, a valuation account which appears on the consolidated balance sheets. As the specific customer and amount of a loan loss is confirmed by gathering additional information, taking collateral in full or partial settlement of the loan, bankruptcy of the borrower, etc., the loan is charged off, reducing the allowance for loan losses. If, subsequent to a charge off, the Bank is able to collect additional amounts from the customer or sell collateral worth more than earlier estimated, a recovery is recorded.

To serve as a basis for making this provision, the Bank maintains 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 homogeneous loans, portfolio seasoning, changes in collateral values, and detailed reviews of specific loan relationships.

The Company utilizes an internal loan grading system to assign a risk grade to all commercial loans, all renegotiated loans, and each commercial credit relationship. Grades 1 through 4 are considered “pass” credits and grades 5 and 6 are considered “watch” credits and are subject to greater scrutiny. Loans with grades 7, 8, and 9 and considered “doubtful” or “loss” and have generally been charged off. A description of the general characteristics of each grade is as follows:

-11-

•

Grade 1 – Excellent – Loans secured by marketable collateral, with adequate margin, or supported by strong financial statements, including substantial levels of tangible net worth. Probability of serious financial deterioration is unlikely. Possess a sound repayment source and a secondary source. This classification will also include individual loans backed by liquid personal assets, established history and unquestionable character. High liquidity, minimum risk, strong ratios, and low handling costs are common to these loans.

•

Grade 2 – Above Average – Loans that exhibit less than average risk and clearly demonstrate debt service coverage that is consistently above average as well as a strong capital base. These loans may have some deficiency or vulnerability, but with offsetting features and are considered to be fully collectable.

•

Grade 3 – Satisfactory – Loans that have an acceptable amount of risk but may exhibit vulnerability to deterioration if adverse circumstances are encountered. These loans should demonstrate adequate debt service coverage and adequate levels of capital support but warrant periodic monitoring to ensure that weaknesses do not materialize or advance.

•

Grade 4 – Pass – Loans that are considered “pass credits” and typically demonstrate adequate debt service coverage. The level of risk is considered acceptable but these loans warrant ongoing monitoring to ensure that adverse trends or other credit deficiencies have not materialized or advanced. The level of risk is considered acceptable so long as the loan is given adequate and ongoing management supervision.

•

Grade 5 – Watch – Loans that possess some credit deficiency or potential weakness that deserves close attention. The primary source of loan repayment is sufficient but may be considered inadequate by the Bank’s standards.

•

Grade 6 – Substandard – Loans that exhibit one or more of the following characteristics: (1) a defined credit weakness, financial deterioration is underway, and uncertainty about the likelihood that the loan will be paid from the primary source of repayment; (2) inadequately protected by the current net worth and paying capacity of the obligor; (3) reliance on secondary source of repayment such as collateral liquidation or guarantees; (4) distinct possibility the Bank will sustain loss if deficiencies are not corrected; (5) unusual courses of action are needed to maintain a high probability of repayment; (6) insufficient cash flow to repay principal but continuing to pay interest; (7) the Bank is subordinated or unsecured due to flaws in documentation; (8) loans are restructured or are on nonaccrual status due to concessions to the borrower when compared to normal loan terms; (9) the Bank is contemplating foreclosure or legal action due to the apparent deterioration in the loan; or (10) there is deterioration in the market conditions and the borrower is highly vulnerable to these conditions.

•

Grade 7 – Doubtful – Loans that exhibit one or more of the following characteristics: (1) loans with all the weaknesses of Substandard loans and collection or liquidation is not probable to result in payment in full; (2) the primary source of repayment is gone and there is considerable doubt as to the quality of the secondary source of repayment; or (3) the possibility of loss is high, but certain important pending factors may strengthen the loan and loss classification is deferred.

•

Grades 8 & 9 - Loss – Loans are considered uncollectible and of such little value that continuing to carry them on the Bank’s financial statements is not feasible.

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.

-12-

The portfolio segments in each credit risk grade as of June 30, 2014 are as follows (000s omitted):

Credit Quality Indicators as of June 30, 2014

Credit Risk by Internally Assigned Grade

	Agriculture and Agricultural Real Estate		Commercial		Commercial Real Estate		Construction Real Estate		Residential Real Estate		Consumer and Other		Total
Not Rated	$	132	$	3,026	$	-	$	5,445	$	136,800	$	10,452	$	155,855
1		-		3,199		-		-		-		366		3,565
2		280		305		882		-		138		-		1,605
3		186		4,413		13,295		84		897		-		18,875
4		14,603		42,421		175,288		4,886		48,156		3,474		288,828
5		968		7,138		40,393		2,475		15,016		201		66,191
6		1,038		2,461		36,117		1,959		21,442		648		63,665
7		-		-		-		-		-		-		-
8		-		-		-		-		-		-		-
9		-		-		-		-		-		-		-
Total	$	17,207	$	62,963	$	265,975	$	14,849	$	222,449	$	15,141	$	598,584

Performing	$	16,176	$	61,114	$	240,175	$	11,518	$	206,591	$	14,300	$	549,874
Nonperforming		1,031		1,849		25,800		3,331		15,858		841		48,710
Total	$	17,207	$	62,963	$	265,975	$	14,849	$	222,449	$	15,141	$	598,584

The portfolio segments in each credit risk grade as of December 31, 2013 are as follows (000s omitted):

Credit Quality Indicators as of December 31, 2013

Credit Risk by Internally Assigned Grade

	Agriculture and Agricultural Real Estate		Commercial		Commercial Real Estate		Construction Real Estate		Residential Real Estate		Consumer and Other		Total
Not Rated	$	144	$	2,151	$	-	$	3,643	$	141,102	$	9,656	$	156,696
1		-		4,054		-		-		-		194		4,248
2		31		153		931		-		142		-		1,257
3		788		4,000		10,755		99		1,040		-		16,682
4		12,304		34,130		172,592		4,825		53,047		3,743		280,641
5		838		11,594		41,914		2,525		9,005		251		66,127
6		892		3,358		39,720		3,575		23,688		706		71,939
7		-		-		-		-		-		-		-
8		-		-		-		-		-		-		-
9		-		-		-		-		-		-		-
Total	$	14,997	$	59,440	$	265,912	$	14,667	$	228,024	$	14,550	$	597,590

Performing	$	14,428	$	56,941	$	235,531	$	9,732	$	211,149	$	13,603	$	541,384
Nonperforming		569		2,499		30,381		4,935		16,875		947		56,206
Total	$	14,997	$	59,440	$	265,912	$	14,667	$	228,024	$	14,550	$	597,590

Loans are considered past due when contractually required payment of interest or principal 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. The following is a summary of past due loans as of June 30, 2014 and December 31, 2013 (000s omitted):

-13-

June 30, 2014	30-59 Days Past Due		60-89 Days Past Due		>90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment >90 Days Past Due and Accruing

Agriculture and Agricultural Real Estate	$	106	$	-	$	84	$	190	$	17,017	$	17,207	$	-
Commercial		123		48		53		224		62,739		62,963		4
Commercial Real Estate		4,027		1,484		1,928		7,439		258,536		265,975		-
Construction Real Estate		83		-		150		233		14,616		14,849		-
Residential Real Estate		2,012		516		1,036		3,564		218,885		222,449		-
Consumer and Other		69		12		74		155		14,986		15,141		-
Total	$	6,420	$	2,060	$	3,325	$	11,805	$	586,779	$	598,584	$	4

December 31, 2013	30-59 Days Past Due		60-89 Days Past Due		>90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment >90 Days Past Due and Accruing

Agriculture and Agricultural Real Estate	$	210	$	-	$	171	$	381	$	14,616	$	14,997	$	-
Commercial		87		93		210		390		59,050		59,440		46
Commercial Real Estate		1,640		535		3,506		5,681		260,231		265,912		-
Construction Real Estate		90		265		1,177		1,532		13,135		14,667		-
Residential Real Estate		2,612		803		2,342		5,757		222,267		228,024		-
Consumer and Other		150		52		153		355		14,195		14,550		-
Total	$	4,789	$	1,748	$	7,559	$	14,096	$	583,494	$	597,590	$	46

Loans are placed on non-accrual status when, in the opinion of Management, the collection of additional interest is doubtful. Loans are automatically placed on non-accrual status upon becoming ninety days past due, however, loans may be placed on non-accrual status regardless of whether or not they are past due. All cash received on non-accrual 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 non-accrual loans as of June 30, 2014 and December 31, 2013 (000s omitted):

	June 30, 2014		December 31, 2013
Agriculture and Agricultural Real Estate	$	84	$	172
Commercial		508		1,035
Commercial Real Estate		10,544		13,289
Construction Real Estate		712		2,009
Residential Real Estate		6,915		6,865
Consumer and Other		285		340
Total	$	19,048	$	23,710

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 discounted at the loan’s effective interest rate, the fair value of the collateral, or the loan’s observable market price.

-14-

The following is a summary of impaired loans as of June 30, 2014 and 2013 (000s omitted):

June 30, 2014	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment for the Three Months Ended		Interest Income Recognized in the Three Months Ended		Average Recorded Investment for the Six Months Ended		Interest Income Recognized in the Six Months Ended

With no related allowance recorded:
Agriculture and Agricultural Real Estate	$	259	$	259	$	-	$	259	$	2	$	259	$	3
Commercial		736		920		-		873		17		921		26
Commercial Real Estate		13,191		16,785		-		13,717		230		14,807		388
Construction Real Estate		550		1,790		-		925		13		972		18
Residential Real Estate		6,896		7,796		-		7,350		84		7,426		168
Consumer and Other		54		57		-		55		1		57		2

With an allowance recorded:
Agriculture and Agricultural Real Estate		688		687		36		701		9		707		19
Commercial		1,134		1,214		511		1,162		16		1,176		31
Commercial Real Estate		14,090		15,366		2,234		14,712		163		14,749		323
Construction Real Estate		2,671		2,699		900		2,775		29		2,865		60
Residential Real Estate		7,542		7,882		1,713		7,801		87		7,648		158
Consumer and Other		502		499		243		503		5		507		11

Total:
Agriculture and Agricultural Real Estate	$	947	$	946	$	36	$	960	$	11	$	966	$	22
Commercial		1,870		2,134		511		2,035		33		2,097		57
Commercial Real Estate		27,281		32,151		2,234		28,429		393		29,556		711
Construction Real Estate		3,221		4,489		900		3,700		42		3,837		78
Residential Real Estate		14,438		15,678		1,713		15,151		171		15,074		326
Consumer and Other		556		556		243		558		6		564		13

	Recorded Investment as of December 31, 2013		Unpaid Principal Balance as of December 31, 2013		Related Allowance as of December 31, 2013		Average Recorded Investment for the Three Months Ended June 30, 2013		Interest Income Recognized in the Three Months Ended June 30, 2013		Average Recorded Investment for the Six Months Ended June 30, 2013		Interest Income Recognized in the Six Months Ended June 30, 2013

With no related allowance recorded:
Agriculture and Agricultural Real Estate	$	-	$	-	$	-	$	423	$	12	$	423	$	23
Commercial		869		966		-		788		9		807		16
Commercial Real Estate		19,567		23,005		-		18,556		167		18,798		359
Construction Real Estate		1,165		2,408		-		2,104		12		2,109		47
Residential Real Estate		7,929		9,035		-		6,856		84		6,991		168
Consumer and Other		33		36		-		1		-		1		-

With an allowance recorded:
Agriculture and Agricultural Real Estate		398		397		1		-		-		-		-
Commercial		1,540		1,627		1,031		4,900		54		4,882		116
Commercial Real Estate		16,025		20,032		2,697		23,510		253		23,646		490
Construction Real Estate		3,615		4,236		1,194		5,103		68		5,187		122
Residential Real Estate		8,745		9,194		1,809		9,459		87		9,646		185
Consumer and Other		585		581		265		359		5		364		11

Total:
Agriculture and Agricultural Real Estate	$	398	$	397	$	1	$	423	$	12	$	423	$	23
Commercial		2,409		2,593		1,031		5,688		63		5,689		132
Commercial Real Estate		35,592		43,037		2,697		42,066		420		42,444		849
Construction Real Estate		4,780		6,644		1,194		7,207		80		7,296		169
Residential Real Estate		16,674		18,229		1,809		16,315		171		16,637		353
Consumer and Other		618		617		265		360		5		365		11

The Bank may agree to modify the terms of a loan in order to improve the Bank’s ability to collect amounts due. These modifications may include reduction of the interest rate, extension of the loan term, or in some cases, reduction of the principal balance. Modifications that are performed due to the debtor’s financial difficulties are considered Troubled Debt Restructurings (“TDRs”).

Loans that have been classified as TDRs during the three and six month periods ended June 30, 2014 and June 30, 2013 are as follows (000s omitted from dollar amounts):

-15-

	Three months ended						Six months ended
	June 30, 2014						June 30, 2014
	Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance		Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance
Agriculture and Agricultural Real Estate		-	$	-	$	-		1	$	314	$	314
Commercial		4		295		91		4		295		91
Commercial Real Estate		2		301		140		4		1,247		1,059
Construction Real Estate		-		-		-		-		-		-
Residential Real Estate		7		579		556		10		844		779
Consumer and Other		-		-		-		-		-		-
Total		13	$	1,175	$	787		19	$	2,700	$	2,243

	Three months ended						Six months ended
	June 30, 2013						June 30, 2013
	Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance		Number of Contracts		Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance
Agriculture and Agricultural Real Estate		-	$	-	$	-		-	$	-	$	-
Commercial		4		181		139		7		354		311
Commercial Real Estate		4		586		575		7		2,047		1,988
Construction Real Estate		-		-		-		-		-		-
Residential Real Estate		5		460		297		16		1,446		1,155
Consumer and Other		2		17		13		4		266		25
Total		15	$	1,244	$	1,024		34	$	4,113	$	3,479

The Bank considers TDRs that become past due under the modified terms as defaulted. There were no loans that became TDRs during the three and six month periods ended June 30, 2014 and June 30, 2013 that subsequently defaulted during the three month periods ended June 30, 2014 and June 30, 2013, respectively.

The Company has allocated $4,679,000 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings at June 30, 2014. In addition, there are no commitments to lend additional amounts to borrowers that are classified as troubled debt restructurings as of June 30, 2014 and June 30, 2013.

6. INVESTMENT SECURITIES

The following is a summary of the Bank’s investment securities portfolio as of June 30, 2014 and December 31, 2013 (000’s omitted):

	Held to Maturity
	June 30, 2014
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Market
	Cost		Gains		Losses			Value
Obligations of States and Political Subdivisions	$	32,878	$	999	$	(157	)	$	33,720
Corporate Debt Securities		500		-		-			500
	$	33,378	$	999	$	(157	)	$	34,220

-16-

	Available for Sale
	June 30, 2014
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Market
	Cost		Gains		Losses			Value
Obligations of U.S. Government Agencies	$	338,541	$	2,732	$	(4,170	)	$	337,103
Mortgage Backed Securities issued by U.S. Government Agencies		67,802		454		(671	)		67,585
Obligations of States and Political Subdivisions		14,795		436		(64	)		15,167
Trust Preferred CDO Securities		9,363		-		(3,396	)		5,967
Corporate Debt Securities		7,971		85		(3	)		8,053
Equity Securities		2,044		81		-			2,125
	$	440,516	$	3,788	$	(8,304	)	$	436,000

	Held to Maturity
	December 31, 2013
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Market
	Cost		Gains		Losses			Value
Obligations of States and Political Subdivisions	$	34,346	$	557	$	(364	)	$	34,539
Corporate Debt Securities		500		-		-			500
	$	34,846	$	557	$	(364	)	$	35,039

	Available for Sale
	December 31, 2013
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Market
	Cost		Gains		Losses			Value
Obligations of U.S. Government Agencies	$	277,383	$	1,147	$	(11,817	)	$	266,713
Mortgage Backed Securities issued by U.S. Government Agencies		97,168		995		(1,637	)		96,526
Obligations of States and Political Subdivisions		15,197		289		(123	)		15,363
Trust Preferred CDO Securities		9,509		-		(3,758	)		5,751
Corporate Debt Securities		7,967		104		-			8,071
Equity Securities		2,584		43		(95	)		2,532
	$	409,808	$	2,578	$	(17,430	)	$	394,956

The amortized cost and estimated market values of securities by contractual maturity as of June 30, 2014 are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

-17-

	Held to Maturity				Available for Sale
			Estimated				Estimated
	Amortized		Market		Amortized		Market
	Cost		Value		Cost		Value
Contractual maturity in
1 year or less	$	5,497	$	5,537	$	7,578	$	7,623
After 1 year through five years		13,551		13,847		63,094		62,910
After 5 years through 10 years		11,400		11,691		272,897		272,306
After 10 years		2,930		3,145		27,101		23,451
Total		33,378		34,220		370,670		366,290
Mortgage Backed Securities		-		-		67,802		67,585
Securities with no stated maturity		-		-		2,044		2,125
Total	$	33,378	$	34,220	$	440,516	$	436,000

The investment securities portfolio is evaluated for impairment throughout the year. Impairment is recorded against individual securities, unless the decrease in fair value is attributable to interest rates or the lack of an active market, and Management determines that the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before a recovery of their amortized costs bases, which may be maturity. The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses (in thousands), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2014 and December 31, 2013.

June 30, 2014

	Less than 12 months				12 months or longer				Total
	Aggregate Fair Value		Gross Unrealized Losses		Aggregate Fair Value		Gross Unrealized Losses		Aggregate Fair Value		Gross Unrealized Losses
Obligations of United States Government Agencies	$	33,990	$	134	$	161,737	$	4,036	$	195,727	$	4,170
Mortgage Backed Securities issued by U.S. Government Agencies		10,360		50		36,636		621		46,996		671
Obligations of States and Political Subdivisions		3,682		73		4,824		148		8,506		221
Trust Preferred CDO Securities		-		-		5,967		3,396		5,967		3,396
Corporate Debt Securities		2,000		3		-		-		2,000		3
	$	50,032	$	260	$	209,164	$	8,201	$	259,196	$	8,461

December 31, 2013

	Less than 12 months				12 months or longer				Total
	Aggregate Fair Value		Gross Unrealized Losses		Aggregate Fair Value		Gross Unrealized Losses		Aggregate Fair Value		Gross Unrealized Losses
Obligations of United States Government Agencies	$	234,264	$	10,828	$	13,614	$	989	$	247,878	$	11,817
Mortgage Backed Securities issued by U.S. Government Agencies		49,202		1,005		14,544		632		63,746		1,637
Obligations of States and Political Subdivisions		10,384		321		3,113		166		13,497		487
Trust Preferred CDO Securities		-		-		5,751		3,758		5,751		3,758
Equity Securities		-		-		445		95		445		95
	$	293,850	$	12,154	$	37,467	$	5,640	$	331,317	$	17,794

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The amount of investment securities issued by government agencies, states, and political subdivisions with unrealized losses and the amount of unrealized losses on those investment securities are primarily the result of market interest rates and not the result of the credit quality of the issuers of the securities. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other than temporarily impaired at June 30, 2014. As of June 30, 2014 and December 31, 2013, there were 106 and 175 securities in an unrealized loss position, respectively.

The Trust Preferred CDO Securities consist of three pooled trust Preferred Collateralized Debt Obligations (CDOs). These CDOs are debt securities issued by special purpose entities that own trust preferred stock issued by banks and insurance companies. The trust preferred stock owned by the special purpose entities is the collateral that backs the debt securities we own. The three pooled CDOs that we own have each been in an unrealized loss position for more than 12 months. These securities have final maturity dates of 2033, 2035, and 2037. The main reasons for the impairment are the overall decline in market values for financial industry securities and the lack of an active market for these types of securities in particular.

To determine whether or not the impairment is other-than-temporary, the Company utilizes a third party valuation service to conduct a fair value analysis of each individual security. The other-than-temporary-impairment analysis of each of the CDO securities owned by the Company is conducted by projecting the expected cash flows from the security, discounting the cash flows to determine the present value of the cash flows, and comparing the present value to the amortized cost to determine if there is impairment. The cash flow projection for each security is developed using estimated prepayment speeds, estimated rates at which payments will be deferred, estimated rates at which issuers will default, and the severity of the losses on the securities which default. Prepayment estimates are negatively impacted by the lack of an active market for issuers to refinance their trust preferred securities; however, prepayment of trust preferred securities is expected to increase due to recent restrictions on the treatment of trust preferred debt as regulatory capital.

The size and creditworthiness of each institution in the CDO pool are the most significant pieces of evidence in estimating prepayment speeds. Deferral and default rates are the key drivers of the cash flow projections for each of the securities. Deferral of interest payments is allowed for up to five years, and estimates of deferral rates are determined by examining the current deferral status of the issuers, the current financial condition of the issuers, and the historical deferral levels of the issuers in each CDO pool. Key evidence examined includes whether or not an issuer has received TARP funding, the most recent credit ratings from outside services, stock price information, capitalization, asset quality, profitability, and liquidity. The most significant evidence in estimating deferrals is the comparison of key financial ratios to industry benchmarks. Near term (next 12 months) deferral rates are estimated for each security by analyzing the credit characteristics of each individual issuer in the pool. When an issuer is expected to defer interest payments, the analysis assumes that the deferral will continue for the entire five year period allowed and then, depending on the individual credit characteristics of that issuer, begin performing or move to default. Longer term annual default rates for each CDO are estimated using the credit analysis of each individual issuer compared to industry benchmarks to modify the historical default rates of financial companies. Finally, loss severity is estimated using analytical research provided by Standard and Poor’s and Moody’s, which supports the assumption that a small percentage of defaulted trust preferred securities recover without loss. The projected cash flows are discounted using the contractual rate of each security.

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In the Other-Than-Temporary-Impairment (OTTI) analysis of our CDO securities as of December 31, 2009, it was expected that there would be cash flow disruptions on two of the CDOs we own. These credit losses were recorded through a charge to earnings in 2009. In subsequent analyses in 2010, 2011, 2012, 2013, and 2014 the expectation of a disruption of cash flows diminished on both of these CDO securities, with one of the securities no longer expected to experience a disruption of cash flow. The present value of the expected cash flows is at least as great as the amortized costs bases following the charges to earnings recorded in 2009, therefore no additional charges to earnings have been recorded.

7. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value, as defined in ASC Topic 820, is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for market activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Fair value is used on a recurring basis for Available for Sale Securities. Additionally, fair value is used on a non-recurring basis to evaluate assets or liabilities for impairment or for disclosure purposes. Examples of these non-recurring uses of fair value include certain loans held for sale accounted for on a lower of cost or market basis. Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions when estimating fair value.

The Company applied the following fair value hierarchy:

Level 1 – Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. The Company’s mutual fund investments where quoted prices are available in an active market generally are classified within Level 1 of the fair value hierarchy.

Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. The Company’s borrowed funds and investments in U.S. government agency securities, government sponsored mortgage backed securities, corporate debt securities, and obligations of states and political subdivisions are generally classified in Level 2 of the fair value hierarchy. Fair values for these instruments are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows.

Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Private equity investments and trust preferred collateralized debt obligations are classified within Level 3 of the fair value hierarchy. Fair values are initially valued based on transaction price and are adjusted to reflect exit values.

The following tables present information about the Company’s financial assets and liabilities measured at fair value on a recurring basis at June 30, 2014 and December 31, 2013, and the valuation techniques used by the Company to determine those fair values.

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									Total
	Carrying								Estimated
June 30, 2014	Value		Level 1		Level 2		Level 3		Fair Value
Financial Assets:
Cash and due from banks	$	26,716	$	26,716	$	-	$	-	$	26,716
Securities - Held to Maturity
Obligations of States and Political Subdivisions		32,878		-		33,720		-		33,720
Corporate Debt Securities		500		-		500		-		500

Securities - Available for Sale
Obligations of U.S. Government Agencies		337,103		-		337,103		-		337,103
MBS issued by U.S. Government Agencies		67,585		-		67,585		-		67,585
Obligations of States and Political Subdivisions		15,167		-		15,167		-		15,167
Trust Preferred CDO Securities		5,967		-		-		5,967		5,967
Corporate Debt Securities		8,053		-		8,053		-		8,053
Other Securities		2,125		2,125		-		-		2,125

Federal Home Loan Bank Stock		10,605		-		10,605		-		10,605
Loans Held for Sale		1,219		-		-		1,219		1,219
Loans, net		583,583		-		-		593,407		593,407
Accrued Interest Receivable		3,851		-		-		3,851		3,851

Financial Liabilities:
Noninterest Bearing Deposits		194,946		194,946		-		-		194,946
Interest Bearings Deposits		854,843		-		857,321		-		857,321
Borrowed funds
FHLB Advances		-		-		-		-		-
Repurchase Agreements		15,000		-		16,144		-		16,144
Accrued Interest Payable		162		-		-		162		162

									Total
	Carrying								Estimated
December 31, 2013	Value		Level 1		Level 2		Level 3		Fair Value
Financial Assets:
Cash and due from banks	$	77,798	$	77,798	$	-	$	-	$	77,798
Securities - Held to Maturity
Obligations of States and Political Subdivisions		34,346		-		34,539		-		34,539
Corporate Debt Securities		500		-		500		-		500

Securities - Available for Sale
Obligations of U.S. Government Agencies		266,713		-		266,713		-		266,713
MBS issued by U.S. Government Agencies		96,526		-		96,526		-		96,526
Obligations of States and Political Subdivisions		15,363		-		15,363		-		15,363
Trust Preferred CDO Securities		5,751		-		-		5,751		5,751
Corporate Debt Securities		8,071		-		8,071		-		8,071
Other Securities		2,532		2,087		445		-		2,532

Federal Home Loan Bank Stock		10,605		-		10,605		-		10,605
Loans Held for Sale		668		-		-		668		668
Loans, net		581,381		-		-		591,471		591,471
Accrued Interest Receivable		3,502		-		-		3,502		3,502

Financial Liabilities:
Noninterest Bearing Deposits		215,844		215,844		-		-		215,844
Interest Bearings Deposits		853,874		-		857,149		-		857,149
Borrowed funds
FHLB Advances		12,000		-		12,000		-		12,000
Repurchase Agreements		15,000		-		16,352		-		16,352
Accrued Interest Payable		179		-		-		179		179

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In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset.

The changes in Level 3 assets measured at fair value on a recurring basis were (000’s omitted):

Investment Securities - Available for Sale	2014			2013
Balance at January 1	$	5,751		$	5,406
Total realized and unrealized gains (losses) included in income		(21	)		(8	)
Total unrealized gains (losses) included in other comprehensive income		362			117
Net purchases, sales, calls and maturities		(125	)		-
Net transfers in/out of Level 3		-			-
Balance at June 30	$	5,967		$	5,515

The Company did not have any sales or purchases of Level 3 available for sale securities during the period.

Both observable and unobservable inputs may be used to determine the fair value of positions classified as Level 3 assets. As a result, the unrealized gains and losses for these assets presented in the tables above may include changes in fair value that were attributable to both observable and unobservable inputs.

The Company owns pooled Trust Preferred Securities (“TRUPs”) with a fair value of $5,967,000 as of June 30, 2014. Trading of these types of securities has increased recently but is primarily conducted on a distress sale or forced liquidation basis. As a result, the Company measures the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

The Company also has assets that under certain conditions are subject to measurement at fair value on a nonrecurring basis. These assets include loans and Other Real Estate Owned. The Company estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

Assets measured at fair value on a nonrecurring basis are as follows (000’s omitted):

	Balance at June 30, 2014		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired loans	$	48,313	$	-	$	-	$	48,313
Other Real Estate Owned	$	7,911	$	-	$	-	$	7,911

	Balance at December 31, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired loans	$	60,471	$	-	$	-	$	60,471
Other Real Estate Owned	$	9,628	$	-	$	-	$	9,628

Impaired loans categorized as Level 3 assets consist of non-homogenous loans that are considered impaired. The Company estimates the fair value of the loans based on the present value of expected future cash flows using management’s best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals). Other Real Estate Owned (OREO) consists of property received in full or partial satisfaction of a receivable. The Company utilizes independent appraisals to estimate the fair value of OREO properties.

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9. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of condition.

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for its other lending activities.

Financial instruments whose contractual amounts represent off-balance sheet credit risk were as follows (000s omitted):

	Contractual Amount
	June 30,		December 31,
	2014		2013
Commitments to extend credit:
Unused portion of commercial lines of credit	$	58,278	$	68,159
Unused portion of credit card lines of credit		3,342		3,255
Unused portion of home equity lines of credit		17,464		16,769
Standby letters of credit and financial guarantees written		3,577		3,667
All other off-balance sheet commitments		-		-

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Most commercial lines of credit are secured by real estate mortgages or other collateral, and generally have fixed expiration dates or other termination clauses. Since the lines of credit may expire without being drawn upon, the total committed amounts do not necessarily represent future cash requirements. Credit card lines of credit have various established expiration dates, but are fundable on demand. Home equity lines of credit are secured by real estate mortgages, a majority of which have ten year expiration dates, but are fundable on demand. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of the collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on Management’s credit evaluation of the counterparty.

Standby letters of credit written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and other business transactions.

10. subsequent events

Subsequent to the end of the second quarter of 2014, the Bank recovered $716,000 from the sale of a credit relationship that had been charged off in a previous year. This recovery was recorded in the third quarter as an increase in the Allowance for Loan Losses. Management will evaluate the overall adequacy of the allowance for loan loss in the third quarter and determine if there is any impact to the Statement of Operations.

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In addition, the Bank’s federal and state regulators are requiring the Bank to continue to reduce its classified assets and Management is focusing on reducing the ratio of classified assets to total capital. As of June 30, 2014, the Company owned three CDO securities, with a total amortized cost of $9,363,000. These securities are included in the Company’s financial statements at their estimated fair value of $5,967,000, with the difference of $3,396,000 included in the Accumulated Other Comprehensive Loss component of capital. Between July 28, 2014 and August 6, 2014, the Bank received offers to purchase the three CDOs for a total of $6,785,000. These offers resulted in a loss of $2,578,000 on the sale. However, the total capital as of June 30, 2014 reflected an unrealized loss of $3,396,000 on the aforementioned CDOs, and completing the sale resulted in a decrease of $9,363,000 in classified assets and an increase of $818,000 in total capital. The results of the transactions are consistent with the objective to reduce the ratio of classified assets to total capital, and Management sold the CDOs beginning on July 28, 2014.

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

Introduction

MBT Financial Corp. (the “Company”) is a bank holding company with one subsidiary, Monroe Bank & Trust (“the Bank”). The Bank is a commercial bank with a wholly owned subsidiary, MB&T Financial Services. MB&T Financial Services is an insurance agency which sells insurance policies to the Bank. The Bank operates 17 branch offices in Monroe County, Michigan and 7 branch offices in Wayne County, Michigan, and a loan and wealth management office in Lenawee County, Michigan. The Bank’s primary source of income is interest income on its loans and investments and its primary expense is interest expense on its deposits and borrowings. The discussion and analysis should be read in conjunction with the accompanying consolidated statements and footnotes.

Executive Overview

The Bank is operated as a community bank, primarily providing loan, deposit, and wealth management products and services to the people, businesses, and communities in its market area. In addition to our commitment to our mission of serving the needs of our local communities, we are focused on improving asset quality, increasing net interest income, and improving non-interest income and expenses.

The net profit of $1,687,000 for the quarter ended June 30, 2014 was an increase of $191,000 or 12.8% compared to the second quarter of 2013. The increase was the result of improved net interest income and non-interest income, and a lower provision for loan losses. These improvements exceeded the increases in non-interest expense and federal income tax expense. This quarter marked the twelfth consecutive quarterly profit following significant losses caused by the severe economic downturn that impacted the regional and national economies beginning in 2006.

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The national economic recovery is gaining momentum, and the recovery in southeast Michigan is steadily improving. Local unemployment rates improved significantly since 2011, and while they are now comparable to the state and national averages, they remain above the historical norms. Commercial and residential development property values are improving, but remain below pre-recession levels. Our total classified assets, which include internal watch list loans, other real estate owned, and our portfolio of pooled trust preferred CDOs, improved significantly during 2013 and this trend of improvement continued into 2014. Classified assets went down $7.4 million, or 8.4% during the second quarter of 2014, and decreased $34.8 million or 30.1% compared to a year ago. Net charge offs increased slightly from $1.1 million in the second quarter of 2013 to $1.2 million in the second quarter of 2014, but this was due to a $1.0 million charge off on one credit in 2014. The amount of this charge off was previously identified and our allowance included a specific allocation for it, so no additional provision was required. As a result, our Allowance for Loan and Lease Losses (ALLL) remains adequate even though it decreased from $16.2 million to $15.0 million this quarter. We recorded a provision expense of only $100,000, a reduction of $300,000, or 75.0% compared to the second quarter of 2013. The loan portfolio held for investment increased during the quarter, and the ALLL as a percent of loans decreased from 2.73% to 2.50%. We will continue to assess the adequacy of our ALLL each quarter, and adjust it as necessary by debiting or crediting the provision expense.

Net Interest Income increased $463,000, or 5.7% compared to the second quarter of 2013 even though the average earning assets decreased $21.1 million because the net interest margin increased from 2.92% to 3.15%. The decrease in the average earning assets was due to the use of short term investments to pay off maturing borrowings in the second quarter of 2013. The cost of those borrowings was higher than the yield on the assets used to retire the borrowings, and this caused the net interest margin to increase. The provision for loan losses decreased $300,000 compared to the second quarter of 2013 as the low level of net loan losses and the improving quality of the loan portfolio enabled us to maintain our ALLL with a small provision. Non-interest income for the quarter increased $342,000, primarily due to an increase in the gains on securities transactions and a decrease in the losses on Other Real Estate Owned transactions. Non-interest expenses increased $356,000, as salaries and employee benefits expenses increased due to an increase in the accrual for the officer incentive plan. We expect non-interest expenses to remain at the current level throughout 2014.

Critical Accounting Policies

The Company’s Allowance for Loan Losses, Fair Value of Investment Securities, and Other Real Estate Owned are “critical accounting estimates” because they are estimates that are based on assumptions that are highly uncertain, and if different assumptions were used or if any of the assumptions used were to change, there could be a material impact on the presentation of the Company’s financial condition. These assumptions include, but are not limited to, collateral values, the effect of economic conditions on the financial condition of the borrowers, the Company, and the issuers of investment securities, market interest rates, and projected earnings for the Company.

To determine the Allowance for Loan Losses, the Company estimates losses on all loans that are not classified as non accrual or renegotiated by applying historical loss rates, adjusted for current conditions, to those loans. In addition, all non accrual loan relationships over $250,000 that are classified by Management as nonperforming as well as selected performing accounts and all renegotiated loans are individually tested for impairment. Any amount of monetary impairment is included in the Allowance for Loan Losses.

To determine the fair value of investment securities, the Company utilizes quoted prices in active markets for identical assets, quoted prices for similar assets in active markets, or discounted cash flow calculations for investments where there is little, if any, market activity for the asset.

To determine the fair value of Other Real Estate Owned, the Company utilizes independent appraisals to estimate the fair value of the property.

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Financial Condition

The pace of the economic recovery has increased over the last year, with local unemployment and property values steadily improving in 2014. Management is focusing our efforts on improving asset quality, increasing net interest income, and improving non-interest income and expenses.

With respect to asset quality, our nonperforming assets (“NPAs”) decreased 12.3% during the quarter, from $68.4 million to $60.0 million, and total classified assets decreased 8.4% from $88.4 million to $81.0 million. Loan delinquencies decreased from 2.9% to 2.1% during the quarter, which is significantly better than the 4.0% total reported one year ago. Over the last twelve months, NPAs decreased $18.8 million, or 23.9%, with nonperforming loans decreasing 24.2% from $64.3 million to $48.7 million, and Other Real Estate Owned (“OREO”) decreasing 30.8% from $11.5 million to $7.9 million. Total classified assets, which include internally classified watch list loans, other real estate, and our portfolio of pooled trust preferred collateralized debt obligation securities, decreased $34.8 million, or 30.1%. The Company’s Allowance for Loan and Lease Losses (“ALLL”) decreased $2.2 million over the last four quarters due to a decrease in the size of the portfolio and an improvement in the quality of the assets in the loan portfolio. The ALLL is now 2.50% of loans, down from 2.79% at June 30, 2013. The ALLL is 30.80% of nonperforming loans (“NPLs”), compared to 28.84% at year end and 26.76% at June 30, 2013. In light of current economic conditions, we believe that this level of ALLL adequately estimates the potential losses in the loan portfolio.

Since December 31, 2013, total loans held for investment increased 0.2% as new loan activity in the second quarter of 2014 was strong enough to cover payments received and other reductions in the quarter and to offset the $5.8 million decrease experienced in the first quarter of 2014. The new loan production in the second quarter consumed a considerable portion of our pipeline of loans in process, but we continue to expect new loan production to exceed run off, resulting in an increase in loans outstanding.

Since December 31, 2013, deposits decreased $19.9 million, or 1.9% due to normal seasonal fluctuations in local deposit activity. In addition to this reduction in deposit funding, we reduced our non-deposit funding by paying off $12.0 million of Federal Home Loan Bank borrowings. The decrease in liability funding was partially offset by an increase of $18.2 million in capital, and as a result our total assets decreased $12.9 million, or 1.1%. The Company expects deposit funding to gradually increase later in the year due to the normal seasonal fluctuations. The increase in total capital during the first half of 2014 was due to the profit of $3.5 million, issuance of common stock of $8.2 million, and an increase of $6.5 million in the accumulated other comprehensive income (AOCI). AOCI increased mainly due to an increase in the value of our securities available for sale. The increase in capital and the decrease in total assets caused the capital to assets ratio to increase from 9.05% at December 31, 2013 to 10.65% at June 30, 2014.

Results of Operations – Second Quarter 2014 vs. Second Quarter 2013

Net Interest Income - A comparison of the income statements for the three months ended June 30, 2014 and 2013 shows an increase of $463,000, or 5.7%, in Net Interest Income. Interest income on loans decreased $0.6 million or 7.6% as the average loans outstanding decreased $19.6 million and the average yield on loans decreased from 4.93% to 4.71%. The interest income on investments, fed funds sold, and interest bearing balances due from banks increased $377,000 even though the average amount of investments, fed funds sold, and interest bearing balances due from banks decreased $1.5 million as the yield increased from 1.69% to 1.99%. The yield on investments increased because the Company was maintaining a very high liquidity position in 2013 by keeping a large amount of funds in low yielding short term investments and deposits in the Federal Reserve Bank. This large cash position was being maintained in the first quarter of 2013 in anticipation of paying off maturing debt in the second quarter of 2013. A continued low overall level of interest rates and the maturity of some high cost borrowings helped reduce the funding costs. The interest expense on deposits decreased $314,000 or 28.2% even though the average deposits increased $14.5 million because the average cost of deposits decreased from 0.43% to 0.30%. The cost of borrowed funds decreased $350,000 as the average amount of borrowed funds decreased $52.7 million.

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Provision for Loan Losses - The Provision for Loan Losses decreased from $400,000 in the second quarter of 2013 to $100,000 in the second quarter of 2014. Net charge offs were $1,257,000 during the second quarter of 2014, compared to $1,104,000 in the second quarter of 2013, however, $1.0 million of the second quarter of 2014 charge off amount was for one credit relationship which previously had a specific allocation in the ALLL. Each quarter, the Company conducts a review and analysis of its ALLL to determine its adequacy. This analysis involves specific allocations for impaired credits and a general allocation for losses expected based on historical experience adjusted for current conditions. Due to a decrease in the size of the portfolio, an improvement in portfolio risk indicators, and a decrease in the historical loss percentages, the amount of provision required to maintain an adequate ALLL in the second quarter of 2014 decreased 75.0% compared to the amount required in the second quarter of 2013. The ALLL is 2.50% of loans as of June 30, 2014, and, in light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in our loan portfolio.

Other Income – Non interest income increased $342,000, or 10.5% compared to the second quarter of 2013 due to an increase in gains on securities transactions and a decrease in losses on other real estate owned. Excluding securities and OREO activity, non-interest income decreased $128,000, or 3.3%. Wealth management income increased $87,000 or 8.0% due to an increase in the market value of assets managed. Service charges and other fees decreased $90,000, or 8.5% due to a decrease in the amount of checking account overdraft activity. Origination fees on mortgage loans sold decreased $96,000, or 52.2% as market interest rates increased sharply near the end of the second quarter of 2013, significantly decreasing mortgage refinance activity since then.

Other Expenses – Total non-interest expenses increased $356,000, or 3.8% compared to the second quarter of 2013. Salaries and Employee Benefits increased $590,000, or 11.3%, due to an increase of $262,000 in the officers’ incentive plan accrual, and increase of $201,000 in salaries and wages, and an increase of $53,000 in benefits. The incentive plan accrual increased because the awards under the plan are based on the earnings performance of the company, which is currently higher than last year. Salaries increased due to a small increase in the number of employees and annual merit increases. Occupancy expense decreased $52,000 due to lower repairs and maintenance. Also, rent expense is lower in 2014 due to the relocation of our mortgage operations from leased space to a property that we purchased and renovated in downtown Monroe. FDIC insurance assessments decreased $74,000 due to a decrease in the assessment base that resulted from reducing our use of borrowed funds.

As a result of the above activity, the Profit Before Income Taxes in the second quarter of 2014 was $2,245,000, an increase of $749,000 compared to the pre-tax profit of $1,496,000 in the second quarter of 2013. In the second quarter of 2013, the Company was maintaining a valuation allowance against its deferred tax asset, and accordingly, did not record a federal income tax expense. If we did not have the valuation allowance we would have incurred a federal income tax expense of $297,000, for an effective tax rate of 19.9% in the second quarter of 2013. The valuation allowance was eliminated in the third quarter of 2013, and the Company recorded a federal income tax expense of $558,000 in the second quarter of 2014, reflecting an effective tax rate of 24.9%. The Net profit for the second quarter of 2014 was $1,687,000, an increase of 12.8% compared to the net profit of $1,496,000 in the second quarter of 2013.

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Results of Operations – Six Months Ended June 30, 2014 vs. Six Months Ended June 30, 2013

Net Interest Income - A comparison of the income statements for the six months ended June 30, 2014 and 2013 shows an increase of $914,000, or 5.7%, in Net Interest Income. Interest income on loans decreased $1.4 million or 9.0% as the average loans outstanding decreased $22.5 million and the average yield on loans decreased from 5.04% to 4.76%. The interest income on investments, fed funds sold, and interest bearing balances due from banks increased $675,000 even though the average amount of investments, fed funds sold, and interest bearing balances due from banks decreased $26.5 million as the yield increased from 1.63% to 1.98%. The yield on investments increased because the Company was maintaining a very high liquidity position in 2013 by keeping a large amount of funds in low yielding short term investments and deposits in the Federal Reserve Bank. This large cash position was being maintained through most of the first six months of 2013 in anticipation of paying off maturing debt near the end of the second quarter of 2013. A continued low overall level of interest rates and the maturity of some high cost borrowings helped reduce the funding costs. The interest expense on deposits decreased $672,000 or 28.9% even though the average deposits increased $11.6 million because the average cost of deposits decreased from 0.45% to 0.31%. The cost of borrowed funds decreased $968,000 as the average amount of borrowed funds decreased $73.8 million.

Provision for Loan Losses - The Provision for Loan Losses decreased from $1.9 million in the first six months of 2013 to $200,000 in the first six months of 2014. Net charge offs were $1.4 million during the first six months of 2014, compared to $2.0 million in the first six months of 2013. Each quarter, the Company conducts a review and analysis of its ALLL to determine its adequacy. This analysis involves specific allocations for impaired credits and a general allocation for losses expected based on historical experience adjusted for current conditions. Due to a decrease in the size of the portfolio, an improvement in portfolio risk indicators, and a decrease in the historical loss percentages, the amount of provision required to maintain an adequate ALLL in the first six months of 2014 decreased 89.5% compared to the amount required in the first six months of 2013. The ALLL is 2.50% of loans as of June 30, 2014, and, in light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in our loan portfolio.

Other Income – Non interest income decreased $22,000, or 0.3% compared to the first six months of 2013. Wealth management income increased $124,000 or 5.7% due to an increase in the market value of assets managed. Service charges and other fees decreased $200,000, or 9.5% due to a decrease in the amount of checking account overdraft activity. Debit card income increased $23,000 or 2.3% due as debit card usage continued to increase. Securities gains increased $112,000 or 68.3% primarily due to the sale of an equity investment that no longer served its strategic purpose. Losses on other real estate owned decreased $377,000 or 53.3% as real estate values in southeast Michigan continued to improve. Origination fees on mortgage loans sold decreased $323,000, or 68.3% as a sharp increase in market interest rates near the end of the second quarter of 2013 significantly decreased mortgage refinance activity.

Other Expenses – Total non-interest expenses increased $597,000, or 3.2% compared to the first six months of 2013. Salaries and Employee Benefits increased $995,000, or 9.4%, as salaries increased due to an increase in the number of employees, annual merit increases, and an increase in the accrual for the officer incentive program. Equipment expense decreased $95,000 due to lower depreciation expense. Marketing expense increased $47,000 due to higher advertising and sales promotion expenses in an effort to grow our lending and wealth management business. Professional fees decreased $112,000, or 10.7%, mostly due to lower credit related legal expenses. FDIC insurance assessments decreased $123,000 due to a decrease in the assessment base that resulted from reducing our use of borrowed funds. Other non-interest expense decreased $141,000 or 10.6% primarily due to lower collection related expenses.

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As a result of the above activity, the Profit Before Income Taxes in the first six months of 2014 was $4,605,000, an increase of $1,995,000 compared to the pre-tax profit of $2,610,000 in the first six months of 2013. In the first six months of 2013, the Company was maintaining a valuation allowance against its deferred tax asset, and accordingly, did not record a federal income tax expense. If we did not have the valuation allowance we would have incurred a federal income tax expense of $452,000, for an effective tax rate of 17.3% in the first six months of 2013. The valuation allowance was eliminated in the third quarter of 2013, and the Company recorded a federal income tax expense of $1,151,000 in the first six months of 2014, reflecting an effective tax rate of 25.0%. The Net profit for the first six months of 2014 was $3,454,000, an increase of 32.3% compared to the net profit of $2,610,000 in the first six months of 2013.

Cash Flows

Cash flows provided by operating activities decreased $2.2 million compared to the first six months of 2013 as the increase in net income was due to improvements in noncash items, primarily the $1.7 million decrease in the provision for loan losses. In the first six months of 2013, investing activities provided $16.9 million in cash as sales and maturities of investment securities exceeded purchases by $4.3 million and loans decreased $7.7 million. In the first six months of 2014, cash used to purchase investment securities exceeded cash provided by sales and maturities of investment securities by $29.5 million and loan growth used an additional $5.3 million of our cash, and total cash used for investing activities was $32.4 million. This use of cash for investing activities contributed to the improvement in interest income for the company. The amount of cash used for financing activities in the first six months of 2014 was $23.9 million as the decrease in deposits and the repayment of maturing Federal Home Loan Bank borrowings exceeded the $8.1 million of capital raised from the issuance of common stock. The cash used for financing was $101.3 million in the first six months of 2013, mainly to fund the repayment of $95.0 million of Federal Home Loan Bank debt and the decrease of $8.0 million in deposits. In the first six months of 2014, the use of beginning cash and cash provided by operations for investment in loans and securities and to reduce financing, contributed to the improvement in net interest income by decreasing the amount of cash and cash equivalents by $51.1 million. In the first six months of 2013, the beginning cash, cash provided by operations, and cash provided by investing activities was used to reduce financing. This resulted in a reduction in interest expense by decreasing the amount of interest bearing borrowed funds.

Liquidity and Capital

The Company believes it has sufficient liquidity to fund its lending activity and allow for fluctuations in deposit levels. Internal sources of liquidity include the maturities of loans and securities in the ordinary course of business as well as our available for sale securities portfolio. External sources of liquidity include a line of credit with the Federal Home Loan Bank of Indianapolis, the Federal funds line that has been established with our correspondent bank, and Repurchase Agreements with money center banks that allow us to pledge securities as collateral for borrowings. As of June 30, 2014, the Bank was not utilizing any of its authorized limit of $255 million with the Federal Home Loan Bank of Indianapolis, or its $20 million overdraft line of credit with the Federal Home Loan Bank of Indianapolis, or of its $25 million of federal funds line with a correspondent bank. The Company periodically draws on its overdraft and fed funds lines to ensure that funding will be available if needed.

The Company’s Funds Management Policy includes guidelines for desired amounts of liquidity and capital. The Funds Management Policy also includes contingency plans for liquidity and capital that specify actions to take if liquidity and capital ratios fall below the levels contained in the policy. Throughout the first six months of 2014 the Company was in compliance with its Funds Management Policy regarding liquidity and capital.

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Total stockholders’ equity of the Company was $128.8 million at June 30, 2014 and $110.6 million at December 31, 2013. Common stock increased $8.2 million due to the issuance of stock in a private placement and a rights offering, retained earnings increased $3.5 million due to the year to date profit, and the Accumulated Other Comprehensive Loss (AOCL) decreased $6.6 million due to improvement in the value of our securities that are classified as Available For Sale. Total equity increased $18.2 million and total assets decreased $12.9 million, so the ratio of equity to assets increased from 9.05% at December 31, 2013 to 10.65% at June 30, 2014.

Federal bank regulatory agencies have set capital adequacy standards for Total Risk Based Capital, Tier 1 Risk Based Capital, and Leverage Capital. These standards require banks to maintain Leverage and Tier 1 ratios of at least 4% and a Total Capital ratio of at least 8% to be adequately capitalized. The regulatory agencies consider a bank to be well capitalized if its Total Risk Based Capital is at least 10% of Risk Weighted Assets, Tier 1 Capital is at least 6% of Risk Weighted Assets, and the Leverage Capital Ratio is at least 5%.

The following table summarizes the capital ratios of the Company and the Bank:

	Actual					Minimum to Qualify as Well Capitalized
	Amount		Ratio			Amount		Ratio
As of June 30, 2014:
Total Capital to Risk-Weighted Assets
Consolidated	$	123,428		15.77	%	$	78,249		10	%
Monroe Bank & Trust		121,811		15.57	%		78,220		10	%
Tier 1 Capital to Risk-Weighted Assets
Consolidated		113,542		14.51	%		46,949		6	%
Monroe Bank & Trust		111,929		14.31	%		46,932		6	%
Tier 1 Capital to Average Assets
Consolidated		113,542		9.38	%		60,499		5	%
Monroe Bank & Trust		111,929		9.26	%		60,452		5	%

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	Actual					Minimum to Qualify as Well Capitalized
	Amount		Ratio			Amount		Ratio
As of December 31, 2013:
Total Capital to Risk-Weighted Assets
Consolidated	$	110,414		14.55	%	$	75,899		10	%
Monroe Bank & Trust		108,818		14.36	%		75,760		10	%
Tier 1 Capital to Risk-Weighted Assets
Consolidated		100,839		13.29	%		45,540		6	%
Monroe Bank & Trust		99,242		13.10	%		45,456		6	%
Tier 1 Capital to Average Assets
Consolidated		100,839		8.61	%		58,593		5	%
Monroe Bank & Trust		99,242		8.48	%		58,522		5	%

On July 12, 2010, the Bank entered into a Consent Order with its state and federal regulators. While the Bank was under the Consent Order, it was classified as “adequately capitalized” even though its ratios met the “well capitalized” guidelines. The Consent Order required the Bank to raise its Tier 1 Leverage ratio to 9% and its Total Risk Based Capital Ratio to 12%. As of June 30, 2014, the Bank is in compliance with the capital ratio requirements of the Consent Order. The Consent Order was terminated by the regulators effective June 30, 2014 and the Bank is now considered “well capitalized”.

Although the Consent Order has been terminated, the Bank continues to be subject to certain informal regulatory requirements and restrictions, including, among other things, requirements to maintain a Tier 1 leverage ratio of at least 9%, continue to reduce classified and delinquent assets, continually monitor its progress, and submit quarterly progress reports to the regulators. The Bank must also request prior approval from its state and federal regulators before paying dividends.

Market risk for the Bank, as is typical for most banks, consists mainly of interest rate risk and market price risk. The Bank’s earnings and the economic value of its equity are exposed to interest rate risk and market price risk, and monitoring this risk is the responsibility of the Asset/Liability Management Committee (ALCO) of the Bank. The Bank’s market risk is monitored monthly and it has not changed significantly since year-end 2013.

Internal Revenue Service Audit

Since the fourth quarter of 2010, the Internal Revenue Service (IRS) has been conducting an audit of our tax returns for the 2004, 2005, 2007, 2008, 2009, and 2010 tax years. The IRS is nearing completion of the audit and has proposed adjustments to our taxable income, mainly challenging our treatment of interest on non accrual loans, OREO valuations, OREO carrying costs, and loan charge-offs. Although our loan charge-offs were in compliance with state and federal bank regulatory agency guidelines, the IRS examining agent conducting the audit has called into question the deductibility of certain charge-offs for income tax purposes based on the facts and circumstances of a loan at the time of the charge-off and certain differences between tax and financial accounting for charge-offs. We believe that the charge-off deductions were proper when taken, and our belief is supported by confirmation of our charge off methodology by our federal and state banking regulators.

According to ASC 740, Accounting for Uncertainty in Income Taxes, an entity is required to evaluate the validity of uncertain tax positions and determine if the relevant taxing authority would conclude that it is more likely than not (greater than fifty percent) that the position taken will be sustained, based upon technical merits, upon examination. We have reviewed our tax positions and have concluded that it is appropriate to record a liability for potential reimbursement to the IRS.

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Since the audit began in 2010, the Company has incurred over $200,000 of professional fees expenses with its accountants and lawyers for assistance in resolution. In order to resolve the audit without incurring significant additional expenses, the Company offered a settlement proposal to the IRS in the third quarter of 2012. The Company’s proposal resulted in a current tax liability of $2.0 million. The Company has concluded that its offer to settle of $2.0 million is the best estimate of potential liability at this time. The Company expects the audit to be resolved without incurring significant additional tax or professional fees expenses.

Although the timing of the resolution and/or closure of the audit remains highly uncertain, the Company believes it is reasonably possible that the IRS will conclude this audit within the current year. Adjustments could be necessary in future periods to the estimated potential federal income tax payable noted above based on issues raised by the IRS. Management will re-evaluate the estimate quarterly based on current, relevant facts.

Forward-Looking Statements

Certain statements contained herein are not based on historical facts and are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements which are based on various assumptions (some of which are beyond the Company's control), may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "estimate," "anticipate," "continue," or similar terms or variations on those terms, or the negative of these terms. Actual results could differ materially from those set forth in forward-looking statements, due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, changes in the financial and securities markets, including changes with respect to the market value of our financial assets, the availability of and costs associated with sources of liquidity, and the ability of the Company to resolve or dispose of problem loans.

The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The Bank faces market risk to the extent that the fair values of its financial instruments are affected by changes in interest rates. The Bank does not face market risk due to changes in foreign currency exchange rates, commodity prices, or equity prices. The asset and liability management process of the Bank seeks to monitor and manage the amount of interest rate risk. This is accomplished by analyzing the differences in repricing opportunities for assets and liabilities, by simulating operating results under varying interest rate scenarios, and by estimating the change in the net present value of the Bank’s assets and liabilities due to interest rate changes.

Each month, the Asset and Liability Committee (ALCO), which includes the senior management of the Bank, estimates the effect of interest rate changes on the projected net interest income of the Bank. The sensitivity of the Bank’s net interest income to changes in interest rates is measured by using a computer based simulation model to estimate the impact on earnings of both gradual and sudden increases or decreases of 100, 200, 300, and 400 basis points in the interest rates. The net interest income projections are compared to a base case projection, which assumes no changes in interest rates.

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The Bank’s ALCO has established limits in the acceptable amount of interest rate risk, as measured by the change in the Bank’s projected net interest income, in its policy. Throughout the first six months of 2014, the Bank’s interest rate risk has remained within its policy limits.

The ALCO also monitors interest rate risk by estimating the effect of changes in interest rates on the economic value of the Bank’s equity each month. The economic value of the Bank’s equity is first determined by subtracting the fair value of the Bank’s liabilities from the fair value of the Bank’s assets. The Bank estimates the interest rate risk by calculating the effect of market interest rate changes on that economic value of its equity. For this analysis, the Bank assumes immediate parallel shifts of plus or minus 100, 200, and 300 basis points in interest rates. The discount rates used to determine the present values of the loans and deposits, as well as the prepayment rates for the loans, are based on Management’s expectations of the effect of the rate changes on the market for loans and deposits. In addition, each quarter, the Bank conducts additional analyses that utilize other rate scenarios, such as larger shifts in rates and changes in the shape of the yield curve, to assess the Bank’s exposure to interest rate risk in stress scenarios.

The Bank’s interest rate risk, as measured by the net interest income and economic value of equity simulations, has not changed significantly from December 31, 2013.

Item 4. Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of June 30, 2014, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of June 30, 2014, in alerting them in a timely manner to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings.

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ended June 30, 2014, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II Other Information

Item 1. Legal Proceedings

MBT Financial Corp. and its subsidiaries are not a party to, nor is any of their property the subject of any material legal proceedings other than ordinary routine litigation incidental to their respective businesses, nor are any such proceedings known to be contemplated by governmental authorities.

Item 1A. Risk Factors

Not applicable for smaller reporting companies.

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

None.

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Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

No matters to be reported.

Item 6. Exhibits

3.1

Articles of Incorporation of MBT Financial Corp. Previously filed as Exhibit 3.1 to MBT Financial Corp.’s Form 10-Q for its quarter ended June 30, 2011.

3.2

Amended and Restated Bylaws of MBT Financial Corp. Previously filed as Exhibit 3.2 to MBT Financial Corp.’s Form 10-Q for its quarter ended March 31, 2008.

31.1

Certification by Chief Executive Officer required by Securities and Exchange Commission Rule 13a-14.

31.2

Certification by Chief Financial Officer required by Securities and Exchange Commission Rule 13a-14.

32.1

Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS

XBRL Instance Document ⁽¹⁾

101.SCH

XBRL Taxonomy Extension Schema Document ⁽¹⁾

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document⁽¹⁾

101.DEF

XBRL Taxonomy Extension Definition Linkbase Document ⁽¹⁾

101.LAB

XBRL Taxonomy Extension Label Linkbase Document ⁽¹⁾

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document ⁽¹⁾

(1)

Pursuant to Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed to be “filed” for purposes of Section 18 of the Securities Exchange Act of 1934 (the Exchange Act”), or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act of 1933 or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.

-34-

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	MBT Financial Corp.
	(Registrant)

August 13, 2014	By	/s/ H. Douglas Chaffin
Date	H. Douglas Chaffin
	President &
	Chief Executive Officer

August 13, 2014	By	/s/ John L. Skibski
Date	John L. Skibski
	Executive Vice President and Chief Financial Officer

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Exhibit Index

Exhibit Number		Description of Exhibits
31.1		Certification by Chief Executive Officer required by Securities and Exchange Commission Rule 13a-14.
31.2		Certification by Chief Financial Officer required by Securities and Exchange Commission Rule 13a-14.
32.1		Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS		XBRL Instance Document⁽¹⁾
101.SCH		XBRL Taxonomy Extension Schema Document⁽¹⁾
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document⁽¹⁾
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document⁽¹⁾
101.LAB		XBRL Taxonomy Extension Label Linkbase Document⁽¹⁾
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document⁽¹⁾

(1)

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