10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

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

For the quarterly period ended June 30, 2013

OR

o     TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from <> to <>

Commission file number: 0-20167

MACKINAC FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)

MICHIGAN	38-2062816
(State or other jurisdiction of	(I.R.S. Employer Identification No.)
incorporation or organization)
130 SOUTH CEDAR STREET, MANISTIQUE, MI	49854
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code:  (888) 343-8147

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 periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

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 x  No o

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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

Large Accelerated Filer o	Accelerated Filer o
Non-accelerated Filer o	Smaller reporting company x

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

As of June 30, 2013, there were outstanding 5,554,459 shares of the registrant’s common stock, no par value.

MACKINAC FINANCIAL CORPORATION

INDEX

		Page No.
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets - June 30, 2013 (Unaudited), December 31, 2012 and June 30, 2012 (Unaudited)	1
	Condensed Consolidated Statements of Operations — Three and Six Months Ended June 30, 2013 (Unaudited) and June 30, 2012 (Unaudited)	2
	Condensed Consolidated Statements of Comprehensive Income — Three and Six Months Ended June 30, 2013 (Unaudited) and June 30, 2012 (Unaudited)	3
	Condensed Consolidated Statements of Changes in Shareholders’ Equity — Three and Six Months Ended June 30, 2013 (Unaudited) and June 30, 2012 (Unaudited)	3
	Condensed Consolidated Statements of Cash Flows - Six Months Ended June 30, 2013 (Unaudited) and June 30, 2012 (Unaudited)	4
	Notes to Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	41
Item 4.	Controls and Procedures	41
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	45
Item 6.	Exhibits and Reports on Form 8-K	45
SIGNATURES		46

MACKINAC FINANCIAL CORPORATION

PART I.   FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)

	June 30,			December 31,			June 30,
	2013			2012			2012
	(Unaudited)						(Unaudited)
ASSETS
Cash and due from banks	$	26,216		$	26,958		$	33,248
Federal funds sold	3			3			—
Cash and cash equivalents	26,219			26,961			33,248
Interest-bearing deposits in other financial institutions	10			10			10
Securities available for sale	47,307			43,799			39,054
Federal Home Loan Bank stock	3,060			3,060			3,060
Loans:
Commercial	343,561			342,841			319,398
Mortgage	98,559			95,413			90,260
Consumer	13,435			10,923			9,795
Total Loans	455,555			449,177			419,453
Allowance for loan losses	(5,177		)	(5,218		)	(5,083		)
Net loans	450,378			443,959			414,370
Premises and equipment	10,536			10,633			10,134
Other real estate held for sale	2,481			3,212			3,518
Deferred Tax Asset	8,367			9,131			10,271
Other assets	5,143			5,215			10,701
TOTAL ASSETS	$	553,501		$	545,980		$	524,366
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest bearing deposits	$	64,736		$	67,652		$	59,872
NOW, money market, interest checking	146,203			155,465			143,795
Savings	12,229			13,829			14,248
CDs<$100,000	134,767			135,550			140,018
CDs>$100,000	25,091			24,355			25,975
Brokered	64,881			37,706			41,473
Total deposits	447,907			434,557			425,381
Borrowings	35,925			35,925			35,997
Other liabilities	3,149			3,050			2,636
Total liabilities	486,981			473,532			464,014
SHAREHOLDERS’ EQUITY:
Preferred stock - No par value:
Authorized - 500,000 shares	4,000			11,000			11,000
Issued and outstanding - 4,000, 11,000 and 11,000 respectively
Common stock and additional paid in capital - No par value
Authorized - 18,000,000 shares
Issued and outstanding - 5,554,459, 5,559,859 and 3,419,736 respectively	53,934			53,797			43,525
Retained earnings	8,156			6,727			5,131
Accumulated other comprehensive income	430			924			696
Total shareholders’ equity	66,520			72,448			60,352
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	553,501		$	545,980		$	524,366

See accompanying notes to condensed consolidated financial statements.

1

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except per Share Data)

	Three Months Ended					Six Months Ended
	June 30,					June 30,
	2013		2012			2013		2012
	(Unaudited)					(Unaudited)
INTEREST INCOME:
Interest and fees on loans:
Taxable	$	6,014	$	5,873		$	11,903	$	11,453
Tax-exempt	28		30			55		62
Interest on securities:
Taxable	241		238			481		502
Tax-exempt	6		7			13		14
Other interest income	32		30			63		55
Total interest income	6,321		6,178			12,515		12,086
INTEREST EXPENSE:
Deposits	886		992			1,763		1,975
Borrowings	166		167			327		329
Total interest expense	1,052		1,159			2,090		2,304
Net interest income	5,269		5,019			10,425		9,782
Provision for loan losses	100		150			475		645
Net interest income after provision for loan losses	5,169		4,869			9,950		9,137
OTHER INCOME:
Deposit service fees	175		189			337		383
Income from secondary market loans sold	279		226			578		524
SBA/USDA loan sale gains	554		620			663		620
Mortgage servicing income	182		115			285		200
Other	61		155			146		184
Total other income	1,251		1,305			2,009		1,911
OTHER EXPENSE:
Salaries and employee benefits	2,375		2,003			4,681		3,978
Occupancy	363		335			745		680
Furniture and equipment	255		219			525		447
Data processing	268		258			533		486
Professional service fees	320		310			545		490
Loan and deposit	45		338			118		479
Writedowns and losses on other real estate held for sale	87		174			89		185
FDIC insurance assessment	95		159			200		318
Telephone	63		57			145		112
Advertising	111		98			215		196
Other	541		256			1,038		670
Total other expenses	4,523		4,207			8,834		8,041
Income before provision for income taxes	1,897		1,967			3,125		3,007
Provision for (benefit of) income taxes	637		(2,335		)	1,052		(1,986		)
NET INCOME	1,260		4,302			2,073		4,993
Preferred dividend and accretion of discount	63		161			200		354
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS	$	1,197	$	4,141		$	1,873	$	4,639
INCOME PER COMMON SHARE*:
Basic	$	.22	$	.97		$	.34	$	1.09
Diluted	$	.22	$	.94		$	.34	$	1.05

*Earnings per share data for 2012 restated for common stock issuance

See accompanying notes to condensed consolidated financial statements.

2

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS COMPREHENSIVE INCOME

(Dollars in Thousands)

(Unaudited)

	Three Months Ended						Six Months Ended
	June 30,			June 30,			June 30,			June 30,
	2013			2012			2013			2012
Net income	$	1,260		$	4,302		$	2,073		$	4,993
Net change in net unrealized gains on securities available for sale:
Unrealized gains (losses) arising during the period	(832		)	139			(763		)	562
Less: reclassification adjustment for gains(losses) included in net income	15			—			15			—
Net securities gain (loss) during the period	(817		)	139			(748		)	562
Tax effect	277			(47		)	254			(191		)
Net of tax	(540		)	92			(494		)	371
Comprehensive income	$	720		$	4,394		$	1,579		$	5,364

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in Thousands)

(Unaudited)

	Three Months Ended									Three Months Ended
	June 30,									June 30,
	2013									2012
				Common			Total					Common			Total
	Preferred			Shareholders’			Shareholders’			Preferred		Shareholders’			Shareholders’
	Stock			Equity			Equity			Stock		Equity			Equity
Balance, beginning of period	$	11,000		$	62,039		$	73,039		$	10,976	$	45,119		$	56,095
Net income for period	—			1,260			1,260			—		4,302			4,302
Net unrealized gain (loss) on securities available for sale	—			(540		)	(540		)	—		92			92
Total comprehensive income (loss)	—			720			720			—		4,394			4,394
Stock compensation	—			75			75			—		—			—
Dividend on common stock	—			(222		)	(222		)	—		—			—
Repurchase of common stock	—			(29		)	(29		)	—		—			—
Redemption of Preferred Series A stock	(7,000		)	—			(7,000		)	—		—			—
Dividend on preferred stock	—			(63		)	(63		)	—		(137		)	(137		)
Accretion of preferred stock discount	—			—			—			24		(24		)	—
Balance, end of period	$	4,000		$	62,520		$	66,520		$	11,000	$	49,352		$	60,352

	Six Months Ended									Six Months Ended
	June 30,									June 30,
	2013									2012
				Common			Total					Common			Total
	Preferred			Shareholders’			Shareholders’			Preferred		Shareholders’			Shareholders’
	Stock			Equity			Equity			Stock		Equity			Equity
Balance, beginning of period	$	11,000		$	61,448		$	72,448		$	10,921	$	44,342		$	55,263
Net income (loss) for period	—			2,073			2,073			—		4,993			4,993
Net unrealized gain (loss) on securities available for sale	—			(494		)	(494		)	—		371			371
Total comprehensive income (loss)	—			1,579			1,579			—		5,364			5,364
Stock compensation	—			183			183			—		—			—
Dividend on common stock	—			(444		)	(444		)	—		—			—
Repurchase of common stock	—			(46		)	(46		)	—		—			—
Redemption of Preferred Series A stock	(7,000		)	—			(7,000		)
Dividend on preferred stock	—			(200		)	(200		)	—		(275		)	(275		)
Accretion of preferred stock discount	—			—			—			79		(79		)	—
Balance, end of period	$	4,000		$	62,520		$	66,520		$	11,000	$	49,352		$	60,352

See accompanying notes to condensed consolidated financial statements.

3

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(Unaudited)

	Six Months Ended
	June 30,
	2013			2012
Cash Flows from Operating Activities:
Net income	$	2,073		$	4,993
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization	840			777
Provision for loan losses	475			645
Deferred income taxes	1,052			(1,986		)
Gain on sales/calls of securities	(15		)	—
(Gain) on sale of secondary market loans	(458		)	(198		)
Origination of loans held for sale in secondary market	(32,597		)	(28,942		)
Proceeds from loans held for sale in secondary market	33,055			29,140
(Gain) loss on sale of premises, equipment, and other real estate held for sale	(25		)	11
Writedown of other real estate held for sale	114			174
Stock compensation	183			—
Change in other assets	72			(5,546		)
Change in other liabilities	99			374
Net cash provided by (used in) operating activities	4,868			(558		)
Cash Flows from Investing Activities:
Net increase in loans	(7,600		)	(19,755		)
Purchase of securities available for sale	(4,974		)	(6,293		)
Proceeds from maturities, sales, calls or paydowns of securities available for sale	476			6,368
Capital expenditures	(501		)	(1,044		)
Proceeds from sale of premises, equipment, and other real estate	1,329			143
Net cash (used in) investing activities	(11,270		)	(20,581		)
Cash Flows from Financing Activities:
Net increase in deposits	13,350			20,592
Repurchase of common stock	(46		)	—
Dividend on common stock	(444		)	—
Redemption of Preferred Series A	(7,000		)	—
Dividend on preferred stock	(200		)	(275		)
Net cash provided by financing activities	5,660			20,317
Net (decrease) in cash and cash equivalents	(742		)	(822		)
Cash and cash equivalents at beginning of period	26,961			34,070
Cash and cash equivalents at end of period	$	26,219		$	33,248
Supplemental Cash Flow Information:
Cash paid during the year for:
Interest	$	1,651		$	2,304
Income taxes	99			50
Noncash Investing and Financing Activities:
Transfers of Foreclosures from Loans to Other Real Estate Held for Sale (net of adjustments made through the allowance for loan losses)	687			685

4

 MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The unaudited condensed consolidated financial statements of Mackinac Financial Corporation (the “Corporation”) have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the six-month period ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.  The unaudited consolidated financial statements and footnotes thereto should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2012.

In order to properly reflect some categories of other income and other expenses, reclassifications of expense and income items have been made to prior period numbers.  The “net” other income and other expenses was not changed due to these reclassifications.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of deferred tax assets, mortgage servicing rights and other real estate held for sale.

Allowance for Loan Losses

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

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

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

5

 MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Stock Compensation Plans

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

On May 22, 2012, the Corporation’s shareholders approved the Mackinac Financial Corporation 2012 Incentive Compensation Plan, under which current and prospective employees, non-employee directors and consultants may be awarded incentive stock options, non-statutory stock options, shares of restricted stock units (“RSUs”), or stock appreciation rights.  The aggregate number of shares of the Corporation’s common stock issuable under the plan is 757,848.

On August 31, 2012, the Corporation granted 148,500 RSUs to certain members of management and all outside directors at the market value of the stock, which was $7.91.  The RSUs were awarded at no cost to the employee and vest ratably over a four-year period.  Compensation cost to be recognized over the four-year vesting period is $1.175 million.  As of June 30, 2013, none of the RSUs were vested and unrecognized compensation expense was $.975 million.

2.     EARNINGS PER SHARE

Diluted earnings per share, which reflects the potential dilution that could occur if outstanding stock options were exercised and stock awards were fully vested and resulted in the issuance of common stock that then shared in our earnings, is computed by dividing net income by the weighted average number of common shares outstanding and common stock equivalents, after giving effect for dilutive shares issued.

The following shows the computation of basic and diluted earnings per share for the three and six months ended June 30, 2013 and 2012 (dollars in thousands, except per share data):

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
(Numerator):
Net income	$	1,260	$	4,302	$	2,073	$	4,993
Preferred stock dividends and accretion of discount	63		161		200		354
Net income available to common shareholders	$	1,197	$	4,141	$	1,873	$	4,639
(Denominator):
Weighted average shares outstanding - basic	5,556,133		3,419,736		5,557,842		3,419,736
Dilutive effect of common stock warrants	—		120,172		—		112,904
Weighted average shares outstanding - diluted	5,556,133		3,539,908		5,557,842		3,532,640
Income per common share*:
Basic	$	.22	$	.97	$	.34	$	1.09
Diluted	$	.22	$	.94	$	.34	$	1.05

*Earnings per share data for 2012 restated for common stock issuance

6

 MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

3.INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities available for sale as of June 30, 2013, December 31, 2012 and June 30, 2012 are as follows (dollars in thousands):

			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
June 30, 2013
US Agencies - MBS	$	7,491	$	354	$	—		$	7,845
US Agencies	15,172		74		(341		)	14,905
Corporate Bonds	18,557		161		(45		)	18,673
Obligations of states and political subdivisions	5,435		450		(1		)	5,884
Total securities available for sale	$	46,655	$	1,039	$	(387	)	$	47,307
December 31, 2012
US Agencies - MBS	$	7,962	$	412	$	—		$	8,374
US Agencies	10,267		137		—			10,404
Corporate Bonds	18,763		237		(23		)	18,977
Obligations of states and political subdivisions	5,407		637		—			6,044
Total securities available for sale	$	42,399	$	1,423	$	(23	)	$	43,799
June 30, 2012
US Agencies - MBS	$	9,667	$	412	$	—		$	10,079
US Agencies	10,338		155		—			10,493
Corporate Bonds	12,519		70		(17		)	12,572
Obligations of states and political subdivisions	5,474		438		(2		)	5,910
Total securities available for sale	$	37,998	$	1,075	$	(19	)	$	39,054

When gross unrealized losses exist within the portfolio, the Corporation considers them temporary in nature and related to interest rate fluctuations.  The Corporation has both the ability and the intent to hold the investment securities until their respective maturities and therefore does not anticipate the realization of the temporary losses.

The amortized cost and estimated fair value of investment securities pledged to secure FHLB borrowings and customer relationships were $6.383 million and $6.669 million, respectively, at June 30, 2013.

4.     LOANS

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

	June 30,		December 31,		June 30,
	2013		2012		2012
Commercial real estate	$	243,363	$	244,966	$	211,506
Commercial, financial, and agricultural	84,145		80,646		85,099
One to four family residential real estate	94,254		87,948		84,665
Construction :
Consumer	4,305		7,465		5,595
Commerical	16,053		17,229		22,793
Consumer	13,435		10,923		9,795
Total loans	$	455,555	$	449,177	$	419,453

7

 MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.     LOANS (Continued)

An analysis of the allowance for loan losses for the six months ended June 30, 2013, the year ended December 31, 2012, and the six months ended June 30, 2012 is as follows (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
Balance at beginning of period	$	5,218		$	5,251		$	5,251
Recoveries on loans previously charged off	100			278			219
Loans charged off	(616		)	(1,256		)	(1,032		)
Provision	475			945			645
Balance at end of period	$	5,177		$	5,218		$	5,083

In the first half of 2013, net charge off activity was $.516 million, or .23% of average loans outstanding compared to net charge-offs of $.813 million, or .40% of average loans, in the same period in 2012.   In the first half of 2013, the Corporation recorded a provision for loan loss of $.475 million compared to $.645 million in the first half of 2012.  The Corporation’s allowance for loan loss reserve policy calls for a measurement of the adequacy of the reserve at each quarter end.  This process includes an analysis of the loan portfolio to take into account increases in loans outstanding and portfolio composition, historical loss rates, and specific reserve requirements of nonperforming loans.

A breakdown of the allowance for loan losses and recorded balances in loans at June 30, 2013 is as follows (dollars in thousands):

				Commercial,						One to four
	Commercial			financial and			Commercial			family residential			Consumer
	real estate			agricultural			construction			real estate			construction		Consumer			Unallocated			Total
Three Months Ended June 30, 2013
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,964		$	847		$	118		$	990		$	—	$	13		$	105		$	5,037
Charge-offs	(21		)	(4		)	—			(6		)	—		(5		)	—			(36		)
Recoveries	29			30			1			6			—		10			—			76
Provision	(311		)	217			(22		)	(113		)	—		(5		)	334			100
Ending balance ALLR	$	2,661		$	1,090		$	97		$	877		$	—	$	13		$	439		$	5,177
Six Months Ended June 30, 2013
Allowance for loan loss reserve:
Beginning balance ALLR	$	3,267		$	692		$	125		$	980		$	—	$	—		$	154		$	5,218
Charge-offs	(456		)	(76		)	—			(13		)	—		(71		)	—			(616		)
Recoveries	41			33			2			11			—		13			—			100
Provision	(191		)	441			(30		)	(101		)	—		71			285			475
Ending balance ALLR	$	2,661		$	1,090		$	97		$	877		$	—	$	13		$	439		$	5,177
At June 30,2013
Loans:
Ending balance	$	243,363		$	84,145		$	16,053		$	94,254		$	4,305	$	13,435		$	—		$	455,555
Ending balance ALLR	(2,661		)	(1,090		)	(97		)	(877		)	—		(13		)	(439		)	(5,177		)
Net loans	$	240,702		$	83,055		$	15,956		$	93,377		$	4,305	$	13,422		$	(439	)	$	450,378
Ending balance ALLR:
Individually evaluated	$	1,396		$	643		$	8		$	148		$	—	$	13		$	—		$	2,208
Collectively evaluated	1,265			447			89			729			—		—			439			2,969
Total	$	2,661		$	1,090		$	97		$	877		$	—	$	13		$	439		$	5,177
Ending balance Loans:
Individually evaluated	$	14,499		$	6,668		$	917		$	640		$	—	$	22		$	—		$	22,746
Collectively evaluated	228,864			77,477			15,136			93,614			4,305		13,413			—			432,809
Total	$	243,363		$	84,145		$	16,053		$	94,254		$	4,305	$	13,435		$	—		$	455,555

Impaired loans, by definition, are individually evaluated.

8

 MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2012 is as follows (dollars in thousands):

	Commercial			Commercial, financial and			Commercial			One to four family residential			Consumer
	real estate			agricultural			construction			real estate			construction			Consumer			Unallocated			Total
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,823		$	1,079		$	207		$	1,114		$	—		$	—		$	28		5,251
Charge-offs	(729		)	(40		)	(6		)	(399		)	—			(82		)	—			(1,256		)
Recoveries	52			201			—			7			—			18			—			278
Provision	1,121			(548		)	(76		)	258			—			64			126			945
Ending balance ALLR	$	3,267		$	692		$	125		$	980		$	—		$	—		$	154		$	5,218
Loans:
Ending balance	$	244,966		$	80,646		$	17,229		$	87,948		$	7,465		$	10,923		$	—		$	449,177
Ending balance ALLR	(3,267		)	(692		)	(125		)	(980		)	—			—			(154		)	(5,218		)
Net loans	$	241,699		$	79,954		$	17,104		$	86,968		$	7,465		$	10,923		$	(154	)	$	443,959
Ending balance ALLR:
Individually evaluated	$	1,662		$	155		$	10		$	112		$	—		$	—		$	—		$	1,939
Collectively evaluated	1,605			537			115			868			—			—			154			3,279
Total	$	3,267		$	692		$	125		$	980		$	—		$	—		$	154		$	5,218
Ending balance Loans:
Individually evaluated	$	22,910		$	6,070		$	858		$	796		$	—		$	—		$	—		$	30,634
Collectively evaluated	222,056			74,576			16,371			87,152			7,465			10,923			—			418,543
Total	$	244,966		$	80,646		$	17,229		$	87,948		$	7,465		$	10,923		$	—		$	449,177
A breakdown of the allowance for loan losses and recorded balances in loans at June 30, 2012 is as follows (dollars in thousands):
	Commercial			Commercial, financial and			Commercial			One to four family residential			Consumer
	real estate			agricultural			construction			real estate			construction			Consumer			Unallocated			Total
Three Months Ended June 30, 2012
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,785		$	1,126		$	230		$	1,083		$	—		$	—		$	158		$	5,382
Charge-offs	(518		)	(4		)	(6		)	(106		)	5			(7		)	—			(636		)
Recoveries	10			169			—			4			—			4						187
Provision	507			(403		)	(6		)	102			(5		)	3			(48		)	150
Ending balance ALLR	$	2,784		$	888		$	218		$	1,083		$	—		$	—		$	110		$	5,083
Six Months Ended June 30, 2012
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,823		$	1,079		$	207		$	1,114		$	—		$	—		$	28		$	5,251
Charge-offs	(691		)	(24		)	(6		)	(296		)	—			(15		)	—			(1,032		)
Recoveries	18			187			—			5			—			9			—			219
Provision	634			(354		)	17			260			—			6			82			645
Ending balance ALLR	$	2,784		$	888		$	218		$	1,083		$	—		$	—		$	110		$	5,083
At June 30,2012
Loans:
Ending balance	$	211,506		$	85,099		$	22,793		$	84,665		$	5,595		$	9,795		$	—		$	419,453
Ending balance ALLR	(2,784		)	(888		)	(218		)	(1,083		)	—			—			(110		)	(5,083		)
Net loans	$	208,722		$	84,211		$	22,575		$	83,582		$	5,595		$	9,795		$	(110	)	$	414,370
Ending balance ALLR:
Individually evaluated	$	1,000		$	148		$	12		$	36		$	—		$	—		$	—		$	1,196
Collectively evaluated	1,784			740			206			1,047			—			—			110			3,887
Total	$	2,784		$	888		$	218		$	1,083		$	—		$	—		$	110		$	5,083
Ending balance Loans:
Individually evaluated	$	22,119		$	6,150		$	1,534		$	764		$	15		$	—		$	—		$	30,582
Collectively evaluated	189,387			78,949			21,259			83,901			5,580			9,795			—			388,871
Total	$	211,506		$	85,099		$	22,793		$	84,665		$	5,595		$	9,795		$	—		$	419,453

Impaired loans, by definition, are individually evaluated.

9

 MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

As part of the management of the loan portfolio, risk ratings are assigned to all commercial loans.  Through the loan review process, ratings are modified as believed to be appropriate to reflect changes in the credit.  Our ability to manage credit risk depends in large part on our ability to properly identify and manage problem loans.  To do so, we operate a credit risk rating system under which our credit management personnel assign a credit risk rating to each loan at the time of origination and review loans on a regular basis to determine each loan’s credit risk rating on a scale of 1 through 8, with higher scores indicating higher risk.  The credit risk rating structure used is shown below.

In the context of the credit risk rating structure, the term Classified is defined as a problem loan which may or may not be in a nonaccrual status, dependent upon current payment status and collectability.

Excellent (1)

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

Good (2)

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

Average (3)

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

Acceptable (4)

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

Special Mention (5)

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

Substandard (6)

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

Doubtful (7)

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

Charge-off/Loss (8)

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

10

 MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

General Reserves:

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

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

Commercial construction loans in the amount of $3.394 million, $3.468 million and $3.407 million for the periods ended June 30, 2013, December 31, 2012 and June 30, 2012, respectively did not receive a specific risk rating.  These amounts represent loans made for land development and unimproved land purchases.  Below is a breakdown of loans by risk category as of June 30, 2013 (dollars in thousands):

	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp. Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	2,294	$	22,319	$	86,404	$	111,180	$	16,446	$	4,531	$	189	$	—	$	243,363
Commercial, financial and agricultural	4,997		5,253		21,780		46,214		4,176		1,725		—		—		84,145
Commercial construction	—		723		5,119		5,660		755		402		—		3,394		16,053
One to four family residential real estate	—		1,954		2,465		4,565		—		—		—		85,270		94,254
Consumer construction	—		—				—		—		—		—		4,305		4,305
Consumer	—		109		36		470		—		—		—		12,820		13,435
Total loans	$	7,291	$	30,358	$	115,804	$	168,089	$	21,377	$	6,658	$	189	$	105,789	$	455,555

Below is a breakdown of loans by risk category as of December 31, 2012 (dollars in thousands):

	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp. Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	4,807	$	20,491	$	84,164	$	113,379	$	16,754	$	5,189	$	182	$	—	$	244,966
Commercial, financial and agricultural	5,026		3,936		23,821		41,785		4,296		1,782		—		—		80,646
Commercial construction	—		1,038		5,103		5,784		759		1,077		—		3,468		17,229
One-to-four family residential real estate	—		1,969		3,635		4,791		—		646		—		76,907		87,948
Consumer construction	—		—		—		—		—		—		—		7,465		7,465
Consumer	—		359		71		257		—		6		—		10,230		10,923
Total loans	$	9,833	$	27,793	$	116,794	$	165,996	$	21,809	$	8,700	$	182	$	98,070	$	449,177

11

 MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

Below is a breakdown of loans by risk category as of June 30, 2012 (dollars in thousands):

	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp. Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	4,394	$	16,806	$	56,024	$	111,719	$	16,917	$	5,452	$	194	$	—	$	211,506
Commercial, financial and agricultural	4,316		5,827		20,866		47,912		4,468		1,710		—		—		85,099
Commercial construction	205		849		5,582		10,892		766		1,092		—		3,407		22,793
One to four family residential real estate	—		1,987		3,774		5,789		—		790		—		72,325		84,665
Consumer construction	—		—		—		—		—		—		—		5,595		5,595
Consumer	—		—		77		582		—		—		—		9,136		9,795
Total loans	$	8,915	$	25,469	$	86,323	$	176,894	$	22,151	$	9,044	$	194	$	90,463	$	419,453

Impaired Loans

Nonperforming loans are those which are contractually past due 90 days or more as to interest or principal payments, on nonaccrual status, or loans, the terms of which have been renegotiated to provide a reduction or deferral on interest or principal.  There was no interest income recorded during impairment for the three and six months ended June 30, 2013.  Interest income that would have been recognized during these periods was $.059 million and $.117 million, respectively.  For the three and six months ended June 30, 2012, the amounts that would have been recognized were $.037 million and $.174 million, respectively.

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

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

12

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

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

											Three Months Ended				Six Months Ended
					QTD		YTD				Interest Income		Interest Income		Interest Income		Interest Income
	Nonaccrual		Accrual		Average		Average		Related		Recognized		on		Recognized		on
	Basis		Basis		Investment		Investment		Valuation Reserve		During Impairment		Accrual Basis		During Impairment		Accrual Basis
June  30, 2013
With no valuation reserve:
Commercial real estate	$	728	$	—	$	733	$	797	$	—	$	—	$	14	$	—	$	26
Commercial, financial and agricultural	176		—		206		248		—		—		3		—		6
Commercial construction	—		—		—		275		—		—		—		—		3
One to four family residential real estate	94		—		133		165		—		—		3		—		5
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	9		—		2		1		—		—		—		—		—
With a valuation reserve:
Commercial real estate	$	2,329	$	—	$	2,308	$	2,298	$	1,240	$	—	$	30	$	—	$	60
Commercial, financial and agricultural	341		—		267		199		106		—		4		—		6
Commercial construction	—		—		—		—		—		—		—		—		—
One to four family residential real estate	306		—		303		289		126		—		5		—		11
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	—		—		—		—		—		—		—		—		—
Total:
Commercial real estate	$	3,057	$	—	$	3,041	$	3,095	$	1,240	$	—	$	44	$	—	$	86
Commercial, financial and agricultural	517		—		473		447		106		—		7		—		12
Commercial construction	—		—		—		275		—		—		—		—		3
One to four family residential real estate	400		—		436		454		126		—		8		—		16
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	9		—		2		1		—		—		—		—		—
Total	$	3,983	$	—	$	3,952	$	4,272	$	1,472	$	—	$	59	$	—	$	117

									Interest Income		Interest Income
For the Year Ended:	Nonaccrual		Accrual		Average		Related		Recognized		on
December 31, 2012	Basis		Basis		Investment		Valuation Reserve		During Impairment		Accrual Basis
With no valuation reserve:
Commercial real estate	$	132	$	—	$	1,550	$	—	$	—	$	37
Commercial, financial and agricultural	—		—		1,063		—		—		19
Commercial construction	675		—		675		—		—		15
One to four family residential real estate	230		—		1,074		—		—		41
Consumer construction	—		—		16		—		—		1
Consumer	—		—		3		—		—		—
With a valuation reserve:
Commercial real estate	$	2,939	$	—	$	3,173	$	1,315	$	54	$	177
Commercial, financial and agricultural	436		—		504		109		—		17
Commercial construction	—		—		—		—		—		—
One to four family residential real estate	275		—		281		95		—		6
Consumer construction	—		—		—		—		—		—
Consumer	—		—		—		—		—		—
Total:
Commercial real estate	$	3,071	$	—	$	4,723	$	1,315	$	54	$	214
Commercial, financial and agricultural	436		—		1,567		109		—		36
Commercial construction	675		—		675		—		—		15
One to four family residential real estate	505		—		1,355		95		—		47
Consumer construction	—		—		16		—		—		1
Consumer	—		—		3		—		—		—
Total	$	4,687	$	—	$	8,339	$	1,519	$	54	$	313

13

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

											Three Months Ended				Six Months Ended
					QTD		YTD				Interest Income		Interest Income		Interest Income		Interest Income
	Nonaccrual		Accrual		Average		Average		Related		Recognized		on		Recognized		on
	Basis		Basis		Investment		Investment		Valuation Reserve		During Impairment		Accrual Basis		During Impairment		Accrual Basis
June  30, 2012
With no valuation reserve:
Commercial real estate	$	535	$	—	$	655	$	1,138	$	—	$	—	$	9	$	—	$	23
Commercial, financial and agricultural	—		—		780		1,063		—		—		7		—		18
Commercial construction	676		—		338		676		—		—		4		—		4
One to four family residential real estate	543		—		613		874		—		—		9		—		24
Consumer construction	15		—		15		16		—		—		1		—		1
Consumer	—		—		—		—		—		—		—		—		—
With a valuation reserve:
Commercial real estate	$	3,214	$	—	$	3,604	$	3,916	$	708	$	17	$	80	$	37	$	94
Commercial, financial and agricultural	278		—		429		459		84		—		—		—		8
Commercial construction	—		—		—		—		—		—		—		—		—
One to four family residential real estate	114		—		93		114		18		—		2		—		2
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	—		—		—		—		—		—		—		—		—
Total:
Commercial real estate	$	3,749	$	—	$	4,259	$	5,054	$	708	$	17	$	89	$	37	$	117
Commercial, financial and agricultural	278		—		1,209		1,522		84		—		7		—		26
Commercial construction	676		—		338		676		—		—		4		—		4
One to four family residential real estate	657		—		706		988		18		—		11		—		26
Consumer construction	15		—		15		16		—		—		1		—		1
Consumer	—		—		—		—		—		—		—		—		—
Total	$	5,375	$	—	$	6,527	$	8,256	$	810	$	17	$	112	$	37	$	174

A summary of past due loans at June 30, 2013, December 31, 2012 and June 30, 2012 is as follows (dollars in thousands):

	June 30,						December 31,						June 30,
	2013						2012						2012
	30-89 days		90+ days				30-89 days		90+ days				30-89 days		90+ days
	Past Due		Past Due/				Past Due		Past Due/				Past Due		Past Due/
	(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total
Commercial real estate	$	146	$	3,057	$	3,203	$	575	$	3,071	$	3,646	$	—	$	3,749	$	3,749
Commercial, financial and agricultural	92		517		609		71		436		507		—		278		278
Commercial construction	—		—		—		—		675		675		—		676		676
One to four family residential real estate	100		400		500		291		505		796		286		657		943
Consumer construction	—		—		—		—		—		—		—		15		15
Consumer	18		9		27		14		—		14		14		—		14
Total past due loans	$	356	$	3,983	$	4,339	$	951	$	4,687	$	5,638	$	300	$	5,375	$	5,675

14

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

A roll-forward of nonaccrual activity for the three months ended June 30, 2013 (dollars in thousands):

	For the Three Months Ended June  30, 2013
				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction		Consumer			Total
NONACCRUAL
Beginning balance	$	2,963		$	424		$	—	$	446		$	—	$	—		$	3,833
Principal payments	(31		)	(66		)	—		(16		)	—		—			(113		)
Charge-offs	—			—			—		(6		)	—		(4		)	(10		)
Advances	—			—			—		—			—		—			—
Class transfers	—			—			—		—			—		—			—
Transfers to OREO	—			—			—		(38		)	—		—			(38		)
Transfers to accruing	—			—			—		—			—		—			—
Transfers from accruing	126			179			—		14			—		13			332
Other	(1		)	(20		)	—		—			—		—			(21		)
Ending balance	$	3,057		$	517		$	—	$	400		$	—	$	9		$	3,983

A roll-forward of nonaccrual activity for the three months ended June 30, 2012 (dollars in thousands):

	For the Three Months Ended June  30, 2012
				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction		Consumer		Total
NONACCRUAL
Beginning balance	$	1,954		$	1,626		$	—	$	862		$	15	$	—	$	4,457
Principal payments	(646		)	(1,351		)	—		(4		)	—		—		(2,001		)
Charge-offs	(417		)	—			—		(106		)	—		—		(523		)
Advances	—			—			—		—			—		—		—
Class transfers	—			—			—		—			—		—		—
Transfers to OREO	(139		)	—			—		(186		)	—		—		(325		)
Transfers to accruing	—			—			—		—			—		—		—
Transfers from accruing	2,978			—			676		88			—		—		3,742
Other	19			3			—		3			—		—		25
Ending balance	$	3,749		$	278		$	676	$	657		$	15	$	—	$	5,375

A roll-forward of nonaccrual activity for the first six months ended June 30, 2013 (dollars in thousands):

	For the Six Months Ended June 30, 2013
				Commercial,						One to four
	Commercial			Financial and			Commercial			family residential			Consumer
	Real Estate			Agricultural			Construction			real estate			Construction		Consumer			Total
NONACCRUAL
Beginning balance	$	3,071		$	436		$	675		$	505		$	—	$	—		$	4,687
Principal payments	(148		)	(68		)	(100		)	(65		)	—		—			(381		)
Charge-offs	(329		)	(72		)	—			(13		)	—		(4		)	(418		)
Advances	—			—			—			—			—		—			—
Class transfers	—			—			—			—			—		—			—
Transfers to OREO	—			—			(580		)	(107		)	—		—			(687		)
Transfers to accruing	—			—			—			—			—		—			—
Transfers from accruing	443			241			—			76			—		13			773
Other	20			(20		)	5			4			—		—			9
Ending balance	$	3,057		$	517		$	—		$	400		$	—	$	9		$	3,983

15

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

A roll-forward of nonaccrual activity for the first six months ended June 30, 2012 (dollars in thousands):

	For the Six Months Ended June 30, 2012
				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction			Consumer		Total
NONACCRUAL
Beginning balance	$	2,362		$	1,111		$	—	$	1,997		$	20		$	—	$	5,490
Principal payments	(1,012		)	(1,382		)	—		(1,052		)	—			—		(3,446		)
Charge-offs	(463		)	—			—		(293		)	(5		)	—		(761		)
Advances	—			—			—		—			—			—		—
Class transfers	—			—			—		—			—			—		—
Transfers to OREO	(466		)	—			—		(219		)	—			—		(685		)
Transfers to accruing	—			—			—		—			—			—		—
Transfers from accruing	3,288			559			676		220			—			—		4,743
Other	40			(10		)	—		4			—			—		34
Ending balance	$	3,749		$	278		$	676	$	657		$	15		$	—	$	5,375

A roll-forward of nonaccrual activity during the year ended December 31, 2012 (dollars in thousands):

				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction			Consumer			Total
NONACCRUAL
Beginning balance	$	2,362		$	1,111		$	—	$	1,997		$	20		$	—		$	5,490
Principal payments	(1,569		)	(1,385		)	—		(1,068		)	—			—			(4,022		)
Charge-offs	(463		)	—			—		(387		)	(5		)	(3		)	(858		)
Advances	—			—			—		—			—			—			—
Class transfers	—			—			—		—			—			—			—
Transfers to OREO	(675		)	—			—		(662		)	(15		)	—			(1,352		)
Transfers to accruing	—			—			—		—			—			—			—
Transfers from accruing	3,377			716			675		617			—			3			5,388
Other	39			(6		)	—		8			—			—			41
Ending balance	$	3,071		$	436		$	675	$	505		$	—		$	—		$	4,687

Troubled Debt Restructuring

Troubled debt restructurings (“TDR”) are determined on a loan-by-loan basis.  Generally restructurings are related to interest rate reductions, loan term extensions and short term payment forbearance as means to maximize collectability of troubled credits.  If a portion of the TDR loan is uncollectible (including forgiveness of principal), the uncollectible amount will be charged off against the allowance at the time of the restructuring.  In general, a borrower must make at least six consecutive timely payments before the Corporation would consider a return of a restructured loan to accruing status in accordance with FDIC guidelines regarding restoration of credits to accrual status.

The Corporation has, in accordance with generally accepted accounting principles and per recently enacted accounting standard updates, evaluated all loan modifications to determine the fair value impact of the underlying asset.  The carrying amount of the loan is compared to the expected payments to be received, discounted at the loan’s original rate, or for collateral dependent loans, to the fair value of the collateral.

16

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

A summary of troubled debt restructurings for the periods indicated is as follows (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
	Number of	Recorded		Number of	Recorded		Number of	Recorded
	Modifications	Investment		Modifications	Investment		Modifications	Investment
Commercial real estate	—	$	—	3	$	4,614	—	$	—
Commercial, financial and agricultural	—	—		1	1,221		—	—
Commercial construction	—	—		3	860		—	—
One to four family residential real estate	—	—		1	102		—	—
Consumer construction	—	—		—	—		—	—
Consumer	—	—		—	—		—	—
Total troubled debt restructurings	—	$	—	8	$	6,797	—	$	—

A roll-forward of troubled debt restructuring during the three months ended June 30, 2013 (dollars in thousands):

				Commercial,				One to four		Consumer and
	Commercial			Financial and		Commercial		family residential		Consumer
	Real Estate			Agricultural		Construction		real estate		Construction		Total
ACCRUING
Beginning balance	$	3,588		$	2,174	$	858	$	100	$	—	$	6,720
Principal payments	(25		)	—		—		—		—		(25		)
Charge-offs	—			—		—		—		—		—
Advances	—			—		—		—		—		—
New restructured	—			—		—		—		—		—
Transferred out of TDR	—			—		—		—		—		—
Transfers to nonaccrual	—			—		—		—		—		—
Ending Balance	$	3,563		$	2,174	$	858	$	100	$	—	$	6,695
NONACCRUAL
Beginning balance	$	2,169		$	—	$	—	$	106	$	—	$	2,275
Principal payments	—			—		—		—		—		—
Charge-offs	—			—		—		—		—		—
Advances	—			—		—		—		—		—
New restructured	—			—		—		—		—		—
Transfers to foreclosed properties	—			—		—		—		—		—
Transfers from accruing	—			—		—		—		—		—
Ending Balance	$	2,169		$	—	$	—	$	106	$	—	$	2,275
TOTALS
Beginning balance	$	5,757		$	2,174	$	858	$	206	$	—	$	8,995
Principal payments	(25		)	—		—		—		—		(25		)
Charge-offs	—			—		—		—		—		—
Advances	—			—		—		—		—		—
New restructured	—			—		—		—		—		—
Transfers out of TDRs	—			—		—		—		—		—
Tansfers to nonaccrual	—			—		—		—		—		—
Transfers to foreclosed properties	—			—		—		—		—		—
Transfers from accruing	—			—		—		—		—		—
Ending Balance	$	5,732		$	2,174	$	858	$	206	$	—	$	8,970

17

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

A roll-forward of troubled debt restructuring during the three months ended June 30, 2012 (dollars in thousands):

				Commercial,						One to four			Consumer and
	Commercial			Financial and			Commercial			family residential			Consumer
	Real Estate			Agricultural			Construction			real estate			Construction		Total
ACCRUING
Beginning balance	$	3,672		$	1,221		$	859		$	103		$	—	$	5,855
Principal payments	(19		)	—			(1		)	(1		)	—		(21		)
Charge-offs	—			—			—			—			—		—
Advances	—			—			—			—			—		—
New restructured	—			—			—			—			—		—
Transferred out of TDRs	—			—			—			—			—		—
Transfers to nonaccrual	—			—			—			—			—		—
Ending Balance	$	3,653		$	1,221		$	858		$	102		$	—	$	5,834
NONACCRUAL
Beginning balance	$	3,235		$	1,072		$	—		$	293		$	—	$	4,600
Principal payments	(615		)	(1,072		)	—			—			—		(1,687		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	—			—			—			—			—		—
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	—			—			—			—			—		—
Ending Balance	$	2,194		$	—		$	—		$	6		$	—	$	2,200
TOTALS
Beginning balance	$	6,907		$	2,293		$	859		$	396		$	—	$	10,455
Principal payments	(634		)	(1,072		)	(1		)	(1		)	—		(1,708		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	—			—			—			—			—		—
Transfers out of TDRs	—			—			—			—			—		—
Tansfers to nonaccrual	—			—			—			—			—		—
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	—			—			—			—			—		—
Ending Balance	$	5,847		$	1,221		$	858		$	108		$	—	$	8,034

18

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

A roll-forward of troubled debt restructuring during the six months ended June 30, 2013 (dollars in thousands):

				Commercial,				One to four			Consumer and
	Commercial			Financial and		Commercial		family residential			Consumer
	Real Estate			Agricultural		Construction		real estate			Construction		Total
ACCRUING
Beginning balance	$	3,611		$	1,221	$	858	$	102		$	—	$	5,792
Principal payments	(48		)	—		—		(2		)	—		(50		)
Charge-offs	—			—		—		—			—		—
Advances	—			—		—		—			—		—
New restructured	—			953		—		—			—		953
Transferred out of TDRs	—			—		—		—			—		—
Transfers to nonaccrual	—			—		—		—			—		—
Ending Balance	$	3,563		$	2,174	$	858	$	100		$	—	$	6,695
NONACCRUAL
Beginning balance	$	2,162		$	—	$	—	$	102		$	—	$	2,264
Principal payments	—			—		—		—			—		—
Charge-offs	—			—		—		—			—		—
Advances	—			—		—		—			—		—
New restructured	7			—		—		4			—		11
Transfers to foreclosed properties	—			—		—		—			—		—
Transfers from accruing	—			—		—		—			—		—
Ending Balance	$	2,169		$	—	$	—	$	106		$	—	$	2,275
TOTALS
Beginning balance	$	5,773		$	1,221	$	858	$	204		$	—	$	8,056
Principal payments	(48		)	—		—		(2		)	—		(50		)
Charge-offs	—			—		—		—			—		—
Advances	—			—		—		—			—		—
New restructured	7			953		—		4			—		964
Transfers out of TDR	—			—		—		—			—		—
Transfers to nonaccrual	—			—		—		—			—		—
Transfers to foreclosed properties	—			—		—		—			—		—
Transfer from accruing	—			—		—		—			—		—
Ending Balance	$	5,732		$	2,174	$	858	$	206		$	—	$	8,970

19

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

A roll-forward of troubled debt restructuring during the six months ended June 30, 2012 (dollars in thousands):

				Commercial,						One to four			Consumer and
	Commercial			Financial and			Commercial			family residential			Consumer
	Real Estate			Agricultural			Construction			real estate			Construction		Total
ACCRUING
Beginning balance	$	2,400		$	—		$	—		$	103				$	2,503
Principal payments	(19		)	—			(1		)	(1		)	—		(21		)
Charge-offs	—			—			—			—			—		—
Advances	—			—			—			—			—		—
New restructured	3,672			1,221			859			—			—		5,752
Transferred out of TDRs	—			—			—			—			—		—
Transfers to nonaccrual	(2,400		)	—			—			—			—		(2,400		)
Ending Balance	$	3,653		$	1,221		$	858		$	102		$	—	$	5,834
NONACCRUAL
Beginning balance	$	—		$	—		$	—		$	—		$	—	$	—
Principal payments	(615		)	(1,072		)	—			—			—		(1,687		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	835			1,072			—			293			—		2,200
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	2,400			—			—			—			—		2,400
Ending Balance	$	2,194		$	—		$	—		$	6		$	—	$	2,200
TOTALS
Beginning balance	$	2,400		$	—		$	—		$	103		$	—	$	2,503
Principal payments	(634		)	(1,072		)	(1		)	(1		)	—		(1,708		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	4,507			2,293			859			293			—		7,952
Transfers out of TDRs	—			—			—			—			—		—
Transfers to nonaccrual	(2,400		)	—			—			—			—		(2,400		)
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	2,400			—			—			—			—		2,400
Ending Balance	$	5,847		$	1,221		$	858		$	108		$	—	$	8,034

20

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

4.    LOANS (Continued)

A roll-forward of troubled debt restructuring during the year ended December 31, 2012 (dollars in thousands):

				Commercial,					One to four			Consumer and
	Commercial			Financial and		Commercial			family residential			Consumer
	Real Estate			Agricultural		Construction			real estate			Construction		Total
ACCRUING
Beginning balance	$	2,400		$	—	$	—		$	103		$	—	$	2,503
Principal payments	(84		)	—		(2		)	(1		)	—		(87		)
Charge-offs	—			—		—			—			—		—
Advances	—			—		—			—			—		—
New restructured	3,695			1,221		860			—			—		5,776
Transferred out of TDR	—			—		—			—			—		—
Transfers to nonaccrual	(2,400		)	—		—			—			—		(2,400		)
Ending Balance	$	3,611		$	1,221	$	858		$	102		$	—	$	5,792
NONACCRUAL
Beginning balance	$	—		$	—	$	—		$	—		$	—	$	—
Principal payments	(432		)	—		—			—			—		(432		)
Charge-offs	(772		)	—		—			—			—		(772		)
Advances	47			—		—			—			—		47
New restructured	919			—		—			102			—		1,021
Transfers to foreclosed properties	—			—		—			—			—		—
Transfers from accruing	2,400			—		—			—			—		2,400
Ending Balance	$	2,162		$	—	$	—		$	102		$	—	$	2,264
TOTALS
Beginning balance	$	2,400		$	—	$	—		$	103		$	—	$	2,503
Principal payments	(516		)	—		(2		)	(1		)	—		(519		)
Charge-offs	(772		)	—		—			—			—		(772		)
Advances	47			—		—			—			—		47
New restructured	4,614			1,221		860			102			—		6,797
Transfers out of TDRs	—			—		—			—			—		—
Tansfers to nonaccrual	(2,400		)	—		—			—			—		(2,400		)
Transfers to foreclosed properties	—			—		—			—			—		—
Transfers from accruing	2,400			—		—			—			—		2,400
Ending Balance	$	5,773		$	1,221	$	858		$	204		$	—	$	8,056

Insider Loans

The Bank, in the ordinary course of business, grants loans to the Corporation’s executive officers and directors, including their families and firms in which they are principal owners. Activity in such loans is summarized below (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
Loans outstanding, beginning of period	$	11,297		$	8,827		$	8,827
New loans	496			3,911			936
Net activity on revolving lines of credit	(25		)	233			41
Principal payments	(1,298		)	(1,674		)	(419		)
Loans outstanding, end of period	$	10,470		$	11,297		$	9,385

There were no loans to related parties classified substandard as of June 30, 2013, December 31, 2012 or June 30, 2012.  In addition to the outstanding balances above, there were unfunded commitments of $.055 million to related parties at June 30, 2013.

21

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5.     MORTGAGE SERVICING RIGHTS

Mortgage servicing rights (“MSRs”) are recorded when loans are sold in the secondary market with servicing retained.  As of June 30, 2013, the Corporation had obligations to service approximately $120 million of residential first mortgage loans.  The valuation is based upon the net present value of the projected revenues over the expected life of the loans being serviced, as reduced by estimated internal costs to service these loans.  The fair value of the capitalized servicing rights approximates the carrying value.  The key economic assumptions used in determining the fair value of the mortgage servicing rights include an annual constant prepayment speed of 15.90 and a discount rate of 7.50% for June 30, 2013.

The following summarizes mortgage servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
Balance at beginning of period	$	638		$	400		$	400
Additions from loans sold with servicing retained	225			344			170
Amortization	(80		)	(106		)	(45		)
Fair value of MSRs at end of period	$	783		$	638		$	525

6.BORROWINGS

Borrowings consist of the following at June 30, 2013, December 31, 2012 and June 30, 2012 (dollars in thousands):

	June, 30		December 31,		June, 30
	2013		2012		2012
Federal Home Loan Bank fixed rate advances at June 30, 2013 with a weighted average rate of 1.79% maturing in 2014, 2016 and 2018	$	35,000	$	35,000	$	35,000
USDA Rural Development, fixed-rate note payable, maturing August 24, 2024, interest payable at 1%	925		925		997
	$	35,925	$	35,925	$	35,997

The Federal Home Loan Bank borrowings are collateralized at June 30, 2013 by the following:  a collateral agreement on the Corporation’s one to four family residential real estate loans with a book value of approximately $38.844 million; mortgage related and municipal securities with an amortized cost and estimated fair value of $6.233 million and $6.519 million, respectively; and Federal Home Loan Bank stock owned by the Bank totaling $3.060 million.  Prepayment of the advances is subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank of Indianapolis in effect as of June 30, 2013.

The USDA Rural Development borrowing is collateralized by loans totaling $.132 million originated and held by the Corporation’s wholly owned subsidiary, First Rural Relending, and an assignment of a demand deposit account in the amount of $.873million, and guaranteed by the Corporation.

22

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

7.     STOCK COMPENSATION PLANS

A summary of stock option transactions for the six months ended June 30, 2013 and 2012, and the year ended December 31, 2012, is as follows:

	June 30,		December 31,			June 30,
	2013		2012			2012
Outstanding shares at beginning of year	242,152		392,152			392,152
Granted during the period	—		—			—
Exercised during the period	—		—			—
Expired / forfeited during the period	—		(150,000		)	—
Outstanding shares at end of period	242,152		242,152			392,152
Exercisable shares at end of period	126,361		126,361			148,861
Weighted average exercise price per share at end of period	$	9.88	$	9.88		$	10.27
Shares available for grant at end of period	—		—			—

There were no options granted in the first six months of 2013 and 2012.

Following is a summary of the options outstanding and exercisable at June 30, 2013:

					Weighted Average
Exercise		Number		Unvested	Remaining
Price		Outstanding	Exercisable	Options	Contractual Life-Years
$	9.16	2,500	1,000	1,500	2.46
$	9.75	217,152	120,861	96,291	1.46
$	10.65	12,500	2,500	10,000	3.46
$	12.00	10,000	2,000	8,000	2.04
		242,152	126,361	115,791	1.60

The Corporation, in August 2012, granted 148,500 Restricted Stock Units (“RSU’s”) to outside members of the Board of Directors and Management.  These RSU’s were granted at a market value of $7.91 and will vest equally over a four year term.

8.     INCOME TAXES

A valuation allowance is provided against deferred tax assets when it is more likely than not that some or all of the deferred tax asset will not be realized.  The Corporation, as of June 30, 2013 had a net operating loss and tax credit carryforwards for tax purposes of approximately $19.8 million, and $2.1 million, respectively.  The net operating loss carryforwards expire twenty years from the date they originated.  These carryforwards, if not utilized, will begin to expire in the year 2023.  A portion of the NOL, approximately $8.4 million, and all of the credit carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code.  The annual limitation is $1.400 million for the NOL and the equivalent value of tax credits, which is approximately $.477 million.  These limitations for use were established in conjunction with the recapitalization of the Corporation in December 2004.

The Corporation has reported deferred tax assets of $8.367 million at June 30, 2013, which is net a valuation allowance of $3.0 million.  Management evaluated the deferred tax valuation allowance as of June 30, 2013 and determined that no adjustment to the valuation was warranted.  The Corporation will continue to evaluate the future benefits from these carryforwards and at such time as it becomes “more likely than not” that they would be utilized prior to expiration will recognize the additional benefits as an adjustment to the valuation allowance.

23

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

9.  FAIR VALUE MEASUREMENTS

Fair value estimates, methods, and assumptions are set forth below for the Corporation’s financial instruments:

Cash, cash equivalents, and interest-bearing deposits - The carrying values approximate the fair values for these assets.

Securities - Fair values are based on quoted market prices where available.  If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

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

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

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

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

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

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

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

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

24

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

9.  FAIR VALUE MEASUREMENTS (Continued)

The following table presents information for financial instruments at June 30, 2013, December 31, 2012 and June 30, 2012(dollars in thousands):

		June 30, 2013				December 31, 2012				June 30, 2012
	Level in Fair	Carrying		Estimated		Carrying		Estimated		Carrying		Estimated
	Value Hierarchy	Amount		Fair Value		Amount		Fair Value		Amount		Fair Value
Financial assets:
Cash and cash equivalents	Level 1	$	26,219	$	26,219	$	26,961	$	26,961	$	33,248	$	33,248
Interest-bearing deposits	Level 2	10		10		10		10		10		10
Securities available for sale	Level 2	47,307		47,307		43,799		43,799		39,054		39,054
Federal Home Loan Bank stock	Level 2	3,060		3,060		3,060		3,060		3,060		3,060
Net loans	Level 2	450,378		444,638		443,959		439,239		414,370		411,781
Accrued interest receivable	Level 2	1,636		1,636		1,319		1,319		1,303		1,303
Total financial assets		$	528,610	$	522,870	$	519,108	$	514,388	$	491,045	$	488,456
Financial liabilities:
Deposits	Level 2	$	447,907	$	446,438	$	434,557	$	434,227	$	425,381	$	425,149
Borrowings	Level 2	35,925		35,621		35,925		35,729		35,997		35,853
Accrued interest payable	Level 2	229		229		214		214		239		239
Total financial liabilties		$	484,061	$	482,288	$	470,696	$	470,170	$	461,617	$	461,241

Limitations - Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation’s entire holdings of a particular financial instrument.  Because no market exists for a significant portion of the Corporation’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.  Fair value estimates are based on existing on-and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.  Significant assets and liabilities that are not considered financial assets or liabilities include premises and equipment, other assets, and other liabilities.  In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

The following is information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at June 30, 2013, and the valuation techniques used by the Corporation to determine those fair values.

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

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

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

The fair value of all investment securities at June 30, 2013 and June 30, 2012 were based on level 2 inputs.  There are no other assets or liabilities measured on a recurring basis at fair value.  For additional information regarding investment securities, please refer to “Note 3 Investment Securities.”

25

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

9.  FAIR VALUE MEASUREMENTS (Continued)

The Corporation had no Level 3 assets or liabilities on a recurring basis as of June 30, 2013, December 31, 2012 or June 30, 2012.

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

The Corporation also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis.  These assets include loans and other real estate owned.  The Corporation has estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

Assets Measured at Fair Value on a Nonrecurring Basis at June 30, 2013

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended		Six Months Ended
(dollars in thousands)	June 30, 2013		(Level 1)		(Level 2)		(Level 3)		June 30, 2013		June 30, 2013
Assets
Impaired loans	$	3,983	$	—	$	—	$	3,983	$	10	$	418
Other real estate owned	2,481		—		—		2,481		87		89
									$	97	$	507

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2012

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Year Ended
(dollars in thousands)	December 31, 2012		(Level 1)		(Level 2)		(Level 3)		December 31, 2012
Assets
Impaired loans	$	4,687	$	—	$	—	$	4,687	$	1,151
Other real estate owned	3,212		—		—		3,212		489
									$	1,640

Assets Measured at Fair Value on a Nonrecurring Basis at June 30, 2012

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended		Six Months Ended
(dollars in thousands)	June 30, 2012		(Level 1)		(Level 2)		(Level 3)		June 30, 2012		June 30, 2012
Assets
Impaired loans	$	5,375	$	—	$	—	$	5,375	$	624	$	1,012
Other real estate owned	3,518		—		—		3,518		174		185
									$	798	$	1,197

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

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

26

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

10.  SHAREHOLDERS’ EQUITY

Participation in the TARP Capital Purchase Program

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

Amounts recorded for Preferred Stock and Warrant Common Stock were estimated based on an allocation of the total proceeds from the issuance on the relative fair values of both instruments.  Fair value of the Preferred Stock was determined based on assumptions regarding the discount rate (market rate) on the Preferred Stock (estimated 12%).  Fair value of the Warrant Common Stock is based on the value of the underlying Preferred Stock based on an estimate for a three year term.  The allocation of the proceeds received resulted in the recording of a discount on the Preferred Stock and a premium on the Warrant Common Stock.  The discount on the preferred will be accreted on an effective yield basis over a three-year term.  The allocated carrying value of the Preferred Stock and Warrant Common Stock on the date of issuance (based on their relative fair values) was $10.382 million and $.618 million, respectively.  Cumulative dividends on the Preferred Stock are payable at 5% annum for the first five years and at a rate of 9% per annum thereafter on the liquidation preference of $1,000 per share.  The Company is prohibited from paying any dividend with respect to shares of common stock unless all accrued and unpaid dividends are paid in full on the Preferred Stock for all past dividend periods.  The Preferred Stock is non-voting, other than class voting rights on matters that could adversely affect the Preferred Stock.  The Preferred Stock may be redeemed at any time with regulatory approval.  The preferred stock qualifies as Tier 1 Capital for regulatory purposes at the holding company.  The preferred stock was auctioned by the Treasury in 2012 and is now held by various investors.

In the 2013 second quarter, the Corporation redeemed $7.0 million of the $11.0 million outstanding preferred stock at par.

11.  COMMITMENTS, CONTINGENCIES AND CREDIT RISK

Financial Instruments With Off-Balance-Sheet Risk

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

The Corporation’s exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit, is represented by the contractual amount of those instruments.  The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.  These commitments are as follows (dollars in thousands):

	June 30,		December 31,		June 30,
	2013		2012		2012
Commitments to extend credit:
Variable rate	$	37,462	$	39,782	$	41,693
Fixed rate	19,873		18,427		15,452
Standby letters of credit - Variable rate	3,805		2,879		3,378
Credit card commitments - Fixed rate	3,113		3,060		3,226
	$	64,253	$	64,148	$	63,749

27

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11.  COMMITMENTS, CONTINGENCIES AND CREDIT RISK (Continued)

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Corporation evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management’s credit evaluation of the party.  Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

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

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

Legal Proceedings and Contingencies

In the normal course of business, the Corporation is involved in various legal proceedings.  For expanded discussion on the Corporation’s legal proceedings, see Part II, Item 1, “Legal Proceedings” in this report.

Concentration of Credit Risk

The Bank grants commercial, residential, agricultural, and consumer loans throughout Michigan.  The Bank’s most prominent concentration in the loan portfolio relates to commercial real estate loans to operators of nonresidential buildings.  This concentration at June 30, 2013 represents $95.510 million, or 27.80%, compared to $83.539 million, or 26.15%, of the commercial loan portfolio on June 30, 2012.  The remainder of the commercial loan portfolio is diversified in such categories as hospitality and tourism, real estate agents and managers, new car dealers, gaming, petroleum, forestry, agriculture and construction.  Due to the diversity of the Bank’s locations, the ability of debtors of residential and consumer loans to honor their obligations is not tied to any particular economic sector.

28

Forward Looking Statements/Risk Factors

FORWARD LOOKING STATEMENTS

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

RISK FACTORS

Risks Related to our Lending and Credit Activities

·Our business may be adversely affected by conditions in the financial markets and economic conditions generally, as our borrowers’ ability to repay loans and the value of the collateral securing our loans decline.

·Weakness in the markets for residential or commercial real estate, including the secondary residential mortgage loan markets, could reduce our net income and profitability.

·Our allowance for loan losses may be insufficient.

Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of our control, may require an increase in our allowance for loan losses.

Risks Related to Our Operations

·We are subject to interest rate risk.

Our earnings and cash flows are largely dependent upon our net interest income, which is the difference between interest income on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds.  There are many factors which influence interest rates that are beyond our control, including but not limited to general economic conditions and governmental policy, in particular, the policies of the FRB.

·Changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition.

·Our controls and procedures may fail or be circumvented.

·Impairment of deferred income tax assets could require charges to earnings, which could result in an adverse impact on our results of operations.

In assessing the realizability of deferred income tax assets, management considers whether it is more likely than not that some allowance requires management to evaluate all available evidence, both negative and positive.  Positive evidence necessary to overcome the negative evidence includes whether future taxable income in sufficient amounts and character within the carry back and carry forward periods is available under the tax law, including the use of tax planning strategies.  When negative evidence (e.g. cumulative losses in recent years, history of operating loss or tax credit carry forwards expiring unused) exists, more positive evidence than negative evidence will be necessary.  At June 30, 2013, net deferred tax assets are approximately $8.4 million.  If an additional valuation allowance becomes necessary with respect to such balance, it could have a material adverse effect on our business, results of operations and financial condition.

·Our information systems may experience an interruption or breach in security.

29

Risks Related to Legal and Regulatory Compliance

·We operate in a highly regulated environment, which could increase our cost structure or have other negative impacts on our operations.

·The full impact of the recently enacted Dodd-Frank Act is currently unknown given that many of the details and substance of the new laws will be implemented through agency rulemaking.

Among the many requirements if the Dodd-Frank Act for new banking regulations is a requirement for new capital regulations to be adopted within 15 months.  These regulations must be at least as stringent as, and may call for higher levels of capital than, current regulations.

Strategic Risks

·Maintaining or increasing our market share may depend on lowering prices and market acceptance of new products and services.

·Future growth or operating results may require us to raise additional capital but that capital may not be available.

Reputation Risks

·Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of our computer system or otherwise, could severely harm our business.

Liquidity Risks

·We could experience an unexpected inability to obtain needed liquidity.

The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds.  We seek to ensure our funding needs are met by maintaining an appropriate level of liquidity through asset/liability management.

Risks Related to an Investment in Our Common Stock

·Limited trading activity for shares of our common stock may contribute to price volatility.

·Our securities are not an insured deposit.

·You may not receive dividends on your investment in common stock.

Our ability to pay dividends is dependent upon our receipt of dividends from the Bank, which is subject to regulatory restrictions.  Such restrictions, which govern state-chartered banks, generally limit the payment of dividends on bank stock to the bank’s undivided profits after all payments of all necessary expenses, provided that the bank’s surplus equals or exceeds its capital.

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

30

MACKINAC FINANCIAL CORPORATION

ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion will cover results of operations, asset quality, financial position, liquidity, interest rate sensitivity, and capital resources for the periods indicated.  The information included in this discussion is intended to assist readers in their analysis of, and should be read in conjunction with, the consolidated financial statements and related notes and other supplemental information presented elsewhere in this report.  This discussion should be read in conjunction with the consolidated financial statements and footnotes contained in the Corporation’s Annual Report and Form 10-K for the year-ended December 31, 2012.  Throughout this discussion, the term “Bank” refers to mBank, the principal banking subsidiary of the Corporation.

FINANCIAL OVERVIEW

The Corporation recorded a second quarter 2013 income of $1.197 million or $.22 per share compared to net income available to common shareholders of $4.141 million, or $.97 per share for the second quarter of 2012. The 2012 second quarter results included a $3 million valuation adjustment to deferred tax assets, which equated to $.70 per share.

Weighted average shares totaled 5,557,842 shares for the six month period in 2013 and 5,556,133 shares in the 2013 second quarter compared to 3,419,736 shares for both periods in 2012. The increase in outstanding shares for 2013 reflects the issuance of 2.138 million shares of common stock in August of 2012. Quarterly and six month per share earnings for 2012 have been adjusted for the common stock issuance.

The net interest margin for the second quarter of 2013 increased to $5.269 million, or 4.16%, compared to $5.019 million, of 4.25% in the second quarter of 2012.  The six month margin in 2013 was $10.425 million, or 4.17% compared to $9.782 million, or 4.23%.

Total assets of the Corporation at June 30, 2013 were $553.501 million, up by $29.135 million, or 5.56% from the $524.366 million in total assets reported at June 30, 2012 and up by $7.521 million, or 1.38%, from total assets of $545.980 million at year-end 2012.  The loan portfolio increased $6.378 million, or 1.42%, from December 31, 2012 balances of $449.177 million.  Deposits totaled $447.907 million at June 30, 2013, an increase of $13.350 million from the $434.557 million at December 31, 2012.

FINANCIAL CONDITION

Cash and Cash Equivalents

Cash and cash equivalents decreased $.742 million during the first half of 2013.  See further discussion of the change in cash and cash equivalents in the Liquidity section.

Investment Securities

Securities available for sale increased $3.508 million from December 31, 2012 to June 30, 2013, with the balance on June 30, 2013, totaling $47.307 million.  Investment securities are utilized in an effort to manage interest rate risk and liquidity.  As of June 30, 2013, investment securities with an estimated fair value of $6.669 million were pledged.

Loans

Through the first half of 2013, loan balances increased by $6.378 million, or 1.42%, from December 31, 2012 balances of $449.177 million.  During the first half of 2013, the Bank had total loan production of $80 million, which included $33 million of secondary market loan production.  This loan production, however, was offset by loan principal runoff, paydowns and amortization, and also SBA/USDA loan sales of $4.947 million, and nonperforming loans transferred to other real estate owned (“OREO”) amounting to $.687 million.

Management continues to actively manage the loan portfolio, seeking to identify and resolve problem assets at an early stage.  Management believes a properly positioned loan portfolio provides the most attractive earning asset yield available to the Corporation and, with a diligent loan approval process and exception reporting, management can effectively manage the risk in the loan portfolio.  Management intends to continue loan growth within its

31

markets for mortgage, consumer, and commercial loan products while concentrating on loan quality, industry concentration issues, and competitive pricing.

Following is a summary of the loan portfolio at June 30, 2013, December 31, 2012 and June 30, 2012 (dollars in thousands):

	June 30,		Percent of		December 31,		Percent of		June 30,		Percent of
	2013		Total		2012		Total		2012		Total
Commercial real estate	$	243,363	53.42	%	$	244,966	54.54	%	$	211,506	50.42	%
Commercial, financial, and agricultural	84,145		18.47		80,646		17.95		85,099		20.29
One to four family residential real estate	94,254		20.69		87,948		19.58		84,665		20.19
Construction:
Consumer	4,305		0.95		7,465		1.66		5,595		1.33
Commercial	16,053		3.52		17,229		3.84		22,793		5.43
Consumer	13,435		2.95		10,923		2.43		9,795		2.34
Total loans	$	455,555	100.00	%	$	449,177	100.00	%	$	419,453	100.00	%

Following is a table showing the significant industry types in the commercial loan portfolio as of June 30, 2013, December 31, 2012 and June 30, 2012 (dollars in thousands):

	June 30, 2013						December 31, 2012						June 30, 2012
	Outstanding		Percent of		Percent of		Outstanding		Percent of		Percent of		Outstanding		Percent of		Percent of
	Balance		Loans		Capital		Balance		Loans		Capital		Balance		Loans		Capital
Real estate - operators of nonres bldgs	$	95,510	27.80	%	143.58	%	$	95,151	27.75	%	131.34	%	$	83,539	26.15	%	138.42	%
Hospitality and tourism	42,833		12.47		64.39		40,787		11.90		56.30		36,557		11.45		60.57
Commercial construction	16,053		4.67		24.13		17,229		5.02		23.78		22,793		7.14		37.77
Lessors of residential buildings	13,377		3.89		20.11		12,672		3.70		17.49		13,358		4.18		22.13
Insurance agencies and brokerages	10,205		2.97		15.34		12,128		3.54		16.74		10,490		3.28		17.38
Other	165,583		48.20		248.92		164,874		48.09		227.58		152,661		47.80		252.95
Total Commercial Loans	$	343,561	100.00	%			$	342,841	100.00	%			$	319,398	100.00	%

Management recognizes the additional risk presented by the concentration in certain segments of the portfolio.  On a historical basis, the Corporation’s highest concentration of credit risk was the hospitality and tourism industry.  Management does not consider the current loan concentrations in hospitality and tourism to be problematic, and has no intention of further reducing loans to this industry segment.  Management does not believe that its current portfolio composition has increased exposure related to any specific industry concentration as of June 30, 2013.  The current concentration of real estate related loans represents a broad customer base composed of a high percentage of owner occupied developments.

Our residential real estate portfolio predominantly includes one to four family adjustable rate mortgages that have repricing terms generally from one to three years, construction loans to individuals and bridge financing loans for qualifying customers.  As of June 30, 2013, our residential loan portfolio totaled $94.254 million, or 20.69% of our total outstanding loans.

The Corporation has also extended credit to governmental units, including Native American organizations.  Tax-exempt loans and leases decreased from $4.346 million at the end of December 31, 2012 to $2.012 million at June 30, 2013.  The Corporation has elected to reduce its tax-exempt portfolio, since it provides no current tax benefit, due to tax net operating loss carryforwards.

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

32

Credit Quality

Management analyzes the allowance for loan losses in detail on a monthly basis to determine whether the losses inherent in the portfolio are properly reserved for.  Net charge-offs for the six months ended June 30, 2013 amounted to $.516 million, or .23% of average loans outstanding, compared to $.813 million, or .40% of average loans outstanding, for the same period in 2012.  The current reserve balance is representative of the relevant risk inherent within the Corporation’s loan portfolio.  Additions or reductions to the reserve in future periods will be dependent upon a combination of future loan growth, nonperforming loan balances and charge-off activity.

The table below shows period end balances of nonperforming assets (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
Nonperforming Assets:
Nonaccrual Loans	$	3,983		$	4,687		$	5,375
Loans past due 90 days or more	—			—			—
Restructured loans	—			—			—
Total nonperforming loans	3,983			4,687			5,375
Other real estate owned	2,481			3,212			3,518
Total nonperforming assets	$	6,464		$	7,899		$	8,893
Nonperforming loans as a % of loans	0.87		%	1.04		%	1.28		%
Nonperforming assets as a % of assets	1.17		%	1.45		%	1.70		%
Reserve for Loan Losses:
At period end	$	5,177		$	5,218		$	5,083
As a % of loans	1.14		%	1.16		%	1.21		%
As a % of nonperforming loans	129.98		%	111.33		%	94.57		%
As a % of nonaccrual loans	129.98		%	111.33		%	94.57		%
Texas ratio*	9.02		%	10.17		%	13.59		%

*calculated by taking total nonperforming assets divided by total equity plus reserve for loan losses

Nonperforming assets at $6.464 million have been reduced in 2013 by $1.435 million from the $7.899 million at 2012 year end.  This reduction in nonperforming assets reflects management’s efforts in the aggressive remediation of problem credits and disposition of OREO properties.  The current low level of nonperforming assets is also representative of the overall quality of the Corporation’s loan portfolio.

The following ratios provide additional information relative to the Corporation’s credit quality:

	At Period End				At Period End
	June 30, 2013		December 31, 2012		June 30, 2012
Total loans, at period end	$	455,555	$	449,177	$	419,453
Average loans for the year	$	453,023	$	422,440	$	413,467

	For the Period Ended						For the Period Ended
	Six Months Ended			Twelve Months Ended			Six Months Ended
	June 30, 2013			December 31, 2012			June 30, 2012
Net charge-offs during the period	$	516		$	978		$	813
Net charge-offs to average loans	.23		%	.23		%	.20		%
Net charge-offs to beginning allowance balance	9.89		%	18.63		%	15.48		%

Management continues to address market issues impacting its loan customer base.  In conjunction with the Corporation’s senior lending staff and the bank regulatory examinations, management reviews the Corporation’s loans, related collateral evaluations, and the overall lending process.  The Corporation also utilizes an outside loan review consultant to perform a review of the loan portfolio.  Historically, this independent review has provided findings similar to management as to the overall adequacy of the loan loss reserve and has substantiated the Corporation’s loan rating system.  In 2013, the Corporation will again utilize a consultant for loan review.

33

As of June 30, 2013, the allowance for loan losses represented 1.14% of total loans.  At June 30, 2013, the allowance included specific reserves in the amount of $2.208 million, as compared to $1.939 million at December 31, 2012 and $1.196 million at June 30, 2012.  In management’s opinion, the allowance for loan losses is adequate to cover probable losses related to specifically identified loans, as well as probable losses inherent in the balance of the loan portfolio.

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

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

	Six Months Ended			Year Ended			Six Months Ended
	June 30 2013			December 31, 2012			June 30 2012
Balance at beginning of period	$	3,212		$	3,162		$	3,162
Other real estate transferred from loans due to foreclosure	687			1,352			685
Other real estate sold	(1,329		)	(775		)	(144		)
Writedowns on other real estate held for sale	(114		)	(496		)	(174		)
Gain (loss) on sale of other real estate held for sale	25			(31		)	(11		)
Balance at end of period	$	2,481		$	3,212		$	3,518

During the first half of 2013, the Corporation received real estate in lieu of loan payments of $.687 million.  Other real estate is initially valued at the lower of cost or the fair value less selling costs.  After the initial receipt, management periodically re-evaluates the recorded balances and any additional reductions in the fair value result in a write-down of other real estate.

Deposits

The Corporation had an increase in deposits in the first six months of 2013.  Total deposits increased by $13.350 million, or 3.07%, in the first half of 2013.  The increase in deposits for the first half of 2013 is composed of an increase in noncore deposits of $27.911 million and a decrease in core deposits of $14.561 million.  In recent years, the Corporation has strategically emphasized the growth of core deposits.  This strategic initiative is supported with an individual incentive plan, along with the introduction of several new deposit products and competitive deposit pricing.  The core deposit balances increased primarily in transactional account deposits, our lowest cost of funds.  Most recently, we have experienced some declines in core deposits.  A portion of these decreases can be attributed to individual customer deposit reductions due to various business related needs.  In an effort to stem some runoff from core deposit CDs, management recently increased some offering rates on CD products.

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

The following table represents detail of deposits at the end of the periods indicated (dollars in thousands):

	June 30,				December 31,				June 30,
	2013		% of Total		2012		% of Total		2012		% of Total
Noninterest bearing	$	64,736	14.45	%	$	67,652	15.57	%	$	59,872	14.07	%
NOW, money market, checking	146,203		32.64		155,465		35.78		143,795		33.81
Savings	12,229		2.73		13,829		3.18		14,248		3.35
Certificates of Deposit <$100,000	134,767		30.09		135,550		31.19		140,018		32.92
Total core deposits	357,935		79.91		372,496		85.72		357,933		84.14
Certificates of Deposit >$100,000	25,091		5.60		24,355		5.60		25,975		6.11
Brokered CDs	64,881		14.49		37,706		8.68		41,473		9.75
Total non-core deposits	89,972		20.09		62,061		14.28		67,448		15.86
Total deposits	$	447,907	100.00	%	$	434,557	100.00	%	$	425,381	100.00	%

34

Borrowings

The Corporation also utilizes FHLB borrowings as a source of funding.  At June 30, 2013, this source of funding totaled $35 million and the Corporation secured this funding by pledging loans and investments.  The $35 million of FHLB borrowings has a weighted average maturity of 1.9 years and a weighted average rate of 1.79% at June 30, 2013.  The Corporation also has a USDA Rural Development loan held by its wholly owned subsidiary, First Rural Relending that has a fixed interest rate of 1% and matures in August 2024.

Shareholders’ Equity

Total shareholders’ equity decreased $5.928 million from December 31, 2012 to June 30, 2013.  Contributing to the decrease in shareholders’ equity was the redemption of Preferred Series A stock of $7.000 million, net income available to common shareholders of $1.873 million, a reduction for common stock dividends of $.444 million, increases due to stock compensation of $.183 million, a decrease in the market value of securities of $.494 million and a decrease due to the repurchase of common stock of $.046 million.

RESULTS OF OPERATIONS

Summary

The Corporation reported net income available to common shareholders of $1.873 million, or $.34 per share, in the first half of 2013, compared to $1.639 million or $.39 per share for the first half of 2013, excluding the $3.0 million deferred tax valuation adjustment.  The first half results include a provision for loan losses of $.475 million. Operating results for the same period in 2012 include a provision for loan losses of $.645 million.

Net Interest Income

Net interest income is the Corporation’s primary source of core earnings.  Net interest income represents the difference between the average yield earned on interest earning assets and the average rate paid on interest bearing obligations.  The net interest income is impacted by economic and competitive factors that influence rates, loan demand, and the availability of funding.

Net interest margin on a fully taxable equivalent basis amounted to $5.287 million, 4.17% of average earning assets, in the second quarter of 2013, compared to $5.038 million, and 4.32% of average earning assets, in the second quarter of 2012.  In the first six months of 2013, net interest margin increased to $10.460 million, 4.19% of average earning assets, compared to $9.821 million, 4.25 % of average earning assets, for the same period in 2012.

35

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

	Three Months Ended
																		2013-2012
	Average Balances									Average Rates				Interest				Income/									Rate/
	June 30,						Increase/			June 30,				June 30,				Expense			Volume			Rate			Volume
(dollars in thousands)	2013			2012			(Decrease)			2013		2012		2013		2012		Variance			Variance			Variance			Variance
Loans (1,2,3)	$	456,937		$	422,888		$	34,049		5.32	%	5.63	%	$	6,056	$	5,917	$	139		$	477		$	(329	)	$	(10	)
Taxable securities	47,456			37,306			10,150			2.04		2.57		241		238		3			65			(49		)	(13		)
Nontaxable securities (2)	835			852			(17		)	4.80		4.72		10		11		(1		)	—			(1		)	—
Federal funds sold	3			5,363			(5,360		)	—		.22		—		3		(3		)	(3		)	(3		)	3
Other interest-earning assets	3,070			3,070			—			4.18		3.54		32		27		5			—			5			—
Total earning assets	508,301			469,479			38,822			5.00		5.31		6,339		6,196		143			539			(377		)	(20		)
Reserve for loan losses	(5,180		)	(5,187		)	7
Cash and due from banks	17,927			20,737			(2,810		)
Fixed Assets	10,635			9,933			702
Other Real Estate	3,175			3,483			(308		)
Other assets	13,597			13,236			361
Total assets	$	548,455		$	511,681		$	36,774
NOW and money market deposits	$	116,362		$	115,500		$	862		.25	%	.36	%	$	72	$	102	$	(30	)	$	1		$	(31	)	$	—
Interest checking	36,761			31,042			5,719			.32		.47		29		36		(7		)	7			(12		)	(2		)
Savings deposits	13,085			13,114			(29		)	.09		.09		3		3		—			—			—			—
CDs <$100,000	130,957			139,214			(8,257		)	1.60		1.79		524		620		(96		)	(37		)	(65		)	5
CDs >$100,000	24,610			24,780			(170		)	1.66		1.74		102		107		(5		)	(1		)	(5		)	1
Brokered deposits	53,449			33,744			19,705			1.17		1.47		156		123		33			73			(25		)	(15		)
Borrowings	40,656			35,997			4,659			1.64		1.87		166		167		(1		)	22			(20		)	(3		)
Total interest-bearing liabilities	415,880			393,391			22,489			1.01		1.18		1,052		1,158		(106		)	65			(158		)	(14		)
Demand deposits	64,556			59,264			5,292
Other liabilities	536			3,111			(2,575		)
Shareholders’ equity	67,483			55,915			11,568
Total liabilities and shareholders’ equity	$	548,455		$	511,681		$	36,774
Rate spread										3.99	%	4.13	%
Net interest margin/revenue										4.17	%	4.32	%	$	5,287	$	5,038	$	249		$	474		$	(219	)	$	(6	)

	Six Months Ended
																		2013-2012
	Average Balances									Average Rates				Interest				Income/									Rate/
	June 30,						Increase/			June 30,				June 30,				Expense			Volume			Rate			Volume
(dollars in thousands)	2013			2012			(Decrease)			2013		2012		2013		2012		Variance			Variance			Variance			Variance
Loans (1,2,3)	$	453,023		$	413,467		$	39,556		5.41	%	5.62	%	$	11,986	$	11,547	$	439		$	1,105		$	(577	)	$	(89	)
Taxable securities	47,082			37,144			9,938			2.06		2.72		481		502		(21		)	134			(121		)	(34		)
Nontaxable securities (2)	839			853			(14		)	4.81		4.72		20		20		—			—			—			—
Federal funds sold	3			10,044			(10,041		)	—		.16		—		8		(8		)	(8		)	(8		)	8
Other interest-earning assets	3,070			3,070			—			4.14		3.08		63		47		16			—			16			—
Total earning assets	504,017			464,578			39,439			5.02		5.25		12,550		12,124		426			1,231			(690		)	(115		)
Reserve for loan losses	(5,153		)	(5,214		)	61
Cash and due from banks	18,243			21,477			(3,234		)
Fixed Assets	10,634			9,879			755
Other Real Estate	3,234			3,339			(105		)
Other assets	13,912			13,487			425
Total assets	$	544,887		$	507,546		$	37,341
NOW and money market deposits	$	120,797		$	118,949		$	1,848		.25	%	.37	%	$	150	$	218	$	(68	)	$	3		$	(70	)	$	(1	)
Interest checking	36,418			30,655			5,763			.32		.51		57		78		(21		)	15			(30		)	(6		)
Savings deposits	13,279			13,108			171			.11		.11		7		7		—			—			—			—
CDs <$100,000	131,297			136,815			(5,518		)	1.62		1.79		1,057		1,218		(161		)	(49		)	(114		)	2
CDs >$100,000	24,620			24,451			169			1.66		1.73		203		210		(7		)	1			(8		)	—
Brokered deposits	45,621			33,290			12,331			1.28		1.47		289		244		45			90			(33		)	(12		)
Borrowings	38,679			35,997			2,682			1.70		1.84		327		329		(2		)	25			(24		)	(3		)
Total interest-bearing liabilities	410,711			393,265			17,446			1.03		1.18		2,090		2,304		(214		)	85			(279		)	(20		)
Demand deposits	62,475			55,686			6,789
Other liabilities	1,854			2,929			(1,075		)
Shareholders’ equity	69,847			55,666			14,181
Total liabilities and shareholders’ equity	$	544,887		$	507,546		$	37,341
Rate spread										3.99	%	4.07	%
Net interest margin/revenue										4.19	%	4.25	%	$	10,460	$	9,820	$	640		$	1,146		$	(411	)	$	(95	)

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

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

(3)Interest income on loans includes fees

In the past several years of a low interest rate environment, the Corporation, repriced all of its brokered deposits along with the majority of its bank time deposits.  This repricing of liabilities is the primary reason for the increased interest margin, on a fully taxable equivalent basis in recent reported periods.

During this relatively low interest environment, the Corporation has also repriced a significant portion of its loan portfolio.  Management has been diligent when repricing maturing or new loans in establishing interest rate floors in order to maintain our improved interest rate spread.  The Corporation is anticipating some margin pressure in future periods as we continue to see extremely competitive pricing on new and renewable loans.

36

Provision for Loan Losses

The Corporation records a provision for loan losses when it believes it is necessary to adjust the allowance for loan losses to maintain an adequate level after considering factors such as loan charge-offs and recoveries, changes in identified levels of risk in the loan portfolio, changes in the mix of loans in the portfolio, loan growth, and other economic factors.  During the first half of 2013, the Corporation determined through this analysis that a $.475 million provision for loan loss was required, compared to $.645 million in the first half of 2012.  Impacting the loan loss provision for the six month period in 2013 were net charge-offs of $.516 million.

Other Income

Other income increased by $.098 million for the six months ended June 30, 2013, compared to the six months ended June 30, 2012.  Included in the first half of 2013 is income from secondary market loans of $.578 million and income from SBA/USDA loan sales of $.663 million, compared to $.524 million for secondary market loans and $.620 million from SBA/USDA loan sales in the first half of 2012.

Management continues to evaluate deposit products and services for ways to better serve its customer base and also enhance service fee income through a broad array of products that price services based on income contribution and cost attributes.

The following table details other income for the three and six months ended June 30, 2013 and 2012 (dollars in thousands):

	Three Months Ended									Six Months Ended
	June 30,									June 30,
					Increase/(Decrease)									Increase/(Decrease)
	2013		2012		Dollars			Percent		2013		2012		Dollars			Percent
Deposit service fees	$	175	$	189	$	(14	)	(7.41	)%	$	337	$	383	$	(46	)	(12.01	)%
Income from secondary market loans sold	279		226		53			23.45		578		524		54			10.31
SBA/USDA loan sale gains	554		620		(66		)	(10.65	)	663		620		43			6.94
Mortgage servicing income	182		115		67			58.26		285		200		85			42.50
Other noninterest income	61		155		(94		)	(60.65	)	146		184		(38		)	(20.65	)
Total other income	$	1,251	$	1,305	$	(54	)	(4.14	)%	$	2,009	$	1,911	$	98		5.13	%

Other Expense

For the first half of 2013, the Corporation recorded other expense of $8.834 million compared to $8.041 million in 2012, an increase of $.793 million.  Included in other expense for the first half is an increase in salaries and employee benefits of $.703 million as a result of necessary staffing additions to the loan and deposit operations areas.  The Corporation also had higher occupancy expenses in 2013 due primarily to weather related expenses as a result of the prolonged winter.

37

The following table details other expense for the three and six months ended June 30, 2013 and 2012 (dollars in thousands):

	Three Months Ended									Six Months Ended
	June 30,									June 30,
					Increase/(Decrease)									Increase/(Decrease)
	2013		2012		Dollars			Percentage		2013		2012		Dollars			Percentage
Salaries and employee benefits	$	2,375	$	2,003	$	372		18.57	%	$	4,681	$	3,978	$	703		17.67	%
Occupancy	363		335		28			8.36		745		680		65			9.56
Furniture and equipment	255		219		36			16.44		525		447		78			17.45
Data processing	268		258		10			3.88		533		486		47			9.67
Professional service fees	320		310		10			3.23		545		490		55			11.22
Loan and deposit	45		338		(293		)	(86.69	)	118		479		(361		)	(75.37	)
Writedowns and losses on other real estate held for sale	87		174		(87		)	(50.00	)	89		185		(96		)	(51.89	)
FDIC insurance premiums	95		159		(64		)	(40.25	)	200		318		(118		)	(37.11	)
Telephone	63		57		6			10.53		145		112		33			29.46
Advertising	111		98		13			13.27		215		196		19			9.69
Other	541		256		285			111.33		1,038		670		368			54.93
Total other expense	$	4,523	$	4,207	$	316		7.51	%	$	8,834	$	8,041	$	793		9.86	%

Federal Income Taxes

A valuation allowance is provided against deferred tax assets when it is more likely than not that some or all of the deferred tax asset will not be realized.  The Corporation, as of June 30, 2013 had a net operating loss and tax credit carryforwards for tax purposes of approximately $25.7 million, and $2.1 million, respectively.  The net operating loss carryforwards expire twenty years from the date they originated.  These carryforwards, if not utilized, will begin to expire in the year 2023.  A portion of the NOL, approximately $15.0 million, and all of the credit carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code.  The annual limitation is $1.400 million for the NOL and the equivalent value of tax credits, which is approximately $.476 million.  These limitations for use were established in conjunction with the recapitalization of the Corporation in December 2004.

The Corporation recognized deferred taxes of $1.052 million for the six months ended June 30, 2013 and a deferred tax benefit of $1.986 for the same period in 2012.  The valuation allowance at June 30, 2013 was approximately $3.0 million.  Management evaluated the deferred tax valuation allowance as of June 30, 2013 and determined that no adjustment to the valuation was warranted.  The Corporation will continue to evaluate the future benefits from these carryforwards and at such time as it becomes “more likely than not” that they would be utilized prior to expiration will recognize the additional benefits as an adjustment to the valuation allowance.

38

LIQUIDITY

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

Current balance sheet liquidity consists of $26.226 million in cash and due from balances, negligible fed funds sold, $40.638 million of unpledged investment securities.   Although current liquidity is deemed adequate, management will increase on hand liquidity in the near term by issuing brokered CDs in order to fund anticipated loan growth.

During the first six months of 2013, the Corporation decreased cash and cash equivalents by $.742 million.  As shown on the Corporation’s condensed consolidated statement of cash flows, liquidity was impacted by cash used in investing activities, with a net increase in loans of $7.600 million.  Offsetting the net decrease used by investing activities was cash provided by financing activities, primarily a net increase in deposits of $13.350 million.  The management of bank liquidity for funding of loans and deposit maturities and withdrawals includes monitoring projected loan fundings and scheduled prepayments and deposit maturities within a 30 day period, a 30- to 90- day period and from 90 days until the end of the year.  This funding forecast model is completed weekly.

The Corporation’s primary source of liquidity on a stand-alone basis is dividends from the Bank.  At this time, the Corporation does not have any definitive plans for payments of dividends by the Bank however may consider doing so in future periods.

Liquidity is managed by the Corporation through its Asset and Liability Committee (“ALCO”).  The ALCO Committee meets monthly to discuss asset and liability management in order to address liquidity and funding needs to provide a process to seek the best alternatives for investments of assets, funding costs, and risk management.  The liquidity position of the Bank is managed daily, thus enabling the Bank to adapt its position according to market fluctuations.  Core deposits are important in maintaining a strong liquidity position as they represent a stable and relatively low cost source of funds.  The Bank’s liquidity is best illustrated by the mix in the Bank’s core and noncore funding dependence ratio, which explains the degree of reliance on noncore liabilities to fund long-term assets.

Core deposits are herein defined as demand deposits, NOW (negotiable order withdrawals), money markets, savings and certificates of deposit under $100,000. Noncore funding consists of certificates of deposit greater than $100,000, brokered deposits, and FHLB and Farmers’ Home Administration borrowings.  At June 30, 2013, the Bank’s core deposits in relation to total funding were 73.98% compared to 77.58% at June 30, 2012.  These ratios indicated at June 30, 2013, that the Bank has decreased its reliance on noncore deposits and borrowings to fund the Bank’s long-term assets, namely loans and investments.  The bank believes that by maintaining adequate volumes of short-term investments and implementing competitive pricing strategies on deposits, it can ensure adequate liquidity to support future growth.  The Bank also has correspondent lines of credit available to meet unanticipated short-term liquidity needs.  As of June 30, 2013, the Bank had $28.375 million of unsecured lines available and additional funding sources available if secured.  The bank believes that its liquidity position remains strong to meet both present and future financial obligations and commitments, events or uncertainties that have resulted or are reasonably likely to result in material changes with respect to the Bank’s liquidity.

From a long-term perspective, the Corporation’s operating plan for 2013 includes strategies to increase core deposits in the Corporation’s local markets.  New deposit products and strategic advertising is expected to aid in efforts of management in growing core deposits which will then reduce the dependency on noncore deposits. The Corporation’s operating plan for 2013 calls for augmenting local deposit growth efforts with wholesale CD funding, to the extent necessary.

CAPITAL AND REGULATORY

As a bank holding company, the Corporation is required to maintain certain levels of capital under government regulation.  There are several measurements of regulatory capital and the Corporation is required to meet minimum requirements under each measurement.  The federal banking regulators have also established capital classifications beyond the minimum requirements in order to risk-rate deposit insurance premiums and to provide trigger points for prompt corrective action in the event an institution becomes financially troubled.  As of June 30, 2013, the Corporation and Bank were well capitalized.

39

The following table details sources of capital for the periods indicated (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
Capital Structure
Shareholders’ equity	$	62,520		$	61,448		$	49,352
Preferred stock	4,000			11,000			11,000
Total shareholders’ equity	$	66,520		$	72,448		$	60,352
Total capitalization	$	66,520		$	72,448		$	60,352
Tangible capital	$	66,520		$	71,800		$	60,299
Intangible Assets
Core deposit premium	$	—		$	—		$	—
Other identifiable intangibles	830			688			525
Total intangibles	$	830		$	688		$	525
Regulatory capital
Tier 1 capital:
Shareholders’ equity	$	66,520		$	72,448		$	60,352
Net unrealized (gains) losses on available for sale securities	(430		)	(924		)	(696		)
Less: disallowed deferred tax asset	(6,500		)	(7,100		)	(8,600		)
Less: intangibles	(83		)	(69		)	(53		)
Total Tier 1 capital	$	59,507		$	64,355		$	51,003
Tier 2 Capital:
Allowable reserve for loan losses	$	5,177		$	5,218		$	5,083
Qualifying long-term debt	—			—			—
Total Tier 2 capital	5,177			5,218			5,083
Total capital	$	64,684		$	69,573		$	56,086
Risk-adjusted assets	$	467,090		$	466,039		$	439,256
Capital ratios:
Tier 1 Capital to average assets	11.01		%	11.98		%	10.16		%
Tier 1 Capital to risk weighted assets	12.74		%	13.81		%	11.61		%
Total Capital to risk weighted assets	13.85		%	14.93		%	12.77		%

Regulatory capital is not the same as shareholders’ equity reported in the accompanying condensed consolidated financial statements.  Certain assets cannot be considered assets for regulatory purposes, such as acquisition intangibles and noncurrent deferred tax benefits.

Presented below is a summary of the capital position in comparison to generally applicable regulatory requirements:

	Shareholders’		Tangible		Tier 1		Tier 1		Total
	Equity to		Equity to		Capital to		Capital to		Capital to
	Quarter-end		Quarter-end		Average		Risk-Weighted		Risk-Weighted
	Assets		Assets		Assets		Assets		Assets
Regulatory minumum for capital adequacy purposes	N/A		N/A		4.00	%	4.00	%	8.00	%
Regulatory defined well capitalized guideline	N/A		N/A		5.00	%	6.00	%	10.00	%
The Corporation:
June 30, 2013	12.02	%	12.02	%	11.01	%	12.74	%	13.85	%
June 30, 2012	11.51	%	11.51	%	10.16	%	11.61	%	12.77	%
The Bank:
June 30, 2013	11.18	%	11.18	%	10.15	%	11.74	%	12.84	%
June 30, 2012	10.87	%	10.86	%	9.52	%	10.89	%	12.04	%

40

 MACKINAC FINANCIAL CORPORATION

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

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

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

Loans are the most significant earning asset.  Management offers commercial and real estate loans priced at interest rates which fluctuate with various indices such as the prime rate or rates paid on various government issued securities.  In addition, the Corporation prices the majority of fixed rate loans so it has an opportunity to reprice the loan within 12 to 36 months.

The Corporation has established interest rate floors on approximately $162.355 million of its variable rate commercial loans.  These interest rate floors will result in a “lag” on the repricing of these variable rate loans when and if interest rates increase in future periods.  Approximately $89 million of the “floor rate” loan balances will reprice with a 100 basis point increase on the prime rate, with another $70 million repricing in the next 100 basis point prime rate increase.

The Corporation also has $47.307 million of securities providing for scheduled monthly principal and interest payments as well as unanticipated prepayments of principal.  These cash flows are then reinvested into other earning assets at current market rates.  The Corporation also has federal funds sold to correspondent banks as well as other interest-bearing deposits with correspondent banks.  These funds are generally repriced on a daily basis.

The Corporation has $223.168 million of transactional accounts, of which $64.736 million consists of noninterest bearing demand deposit balances.  Transaction account balances have increased significantly in the last year due in part to the Corporation’s focus on these low costs accounts by developing new attractive products and increased sales efforts to municipalities, schools and businesses.  These transactional account balances provide additional repricing flexibility in changing interest rate environments since they have no scheduled maturities and interest rates can be reset at any time.

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

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

Exposure to interest rate risk is reviewed on a regular basis.  Interest rate risk is the potential of economic losses due to future interest rate changes.  These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values.  The objective is to measure the effect of interest rate changes on net interest income and to structure the composition of the balance sheet to minimize interest rate risk and at the same time maximize income.  Management realizes certain risks are inherent and that the goal is to identify and minimize the risks.  Tools used by management include maturity and repricing analysis and interest rate sensitivity analysis.  The Bank has monthly asset/liability meetings with an outside consultant to review its current position and strategize about future opportunities on risks relative to pricing and positioning of assets and liabilities.

41

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

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

The following is the Corporation’s opportunities at June 30, 2013 (dollars in thousands):

	1-90		91 - 365			>1-5			Over 5
	Days		Days			Years			Years		Total
Interest-earning assets:
Loans	$	285,798	$	12,022		$	53,924		$	103,811	$	455,555
Securities	—		5,167			27,370			14,770		47,307
Other (1)	13		—			—			3,060		3,073
Total interest-earning assets	285,811		17,189			81,294			121,641		505,935
Interest-bearing obligations:
NOW, money market, savings, interest checking	158,432		—			—			—		158,432
Time deposits	27,821		51,974			79,959			104		159,858
Brokered CDs	12,175		2,239			50,467			—		64,881
Borrowings	—		—			35,000			925		35,925
Total interest-bearing obligations	198,428		54,213			165,426			1,029		419,096
Gap	$	87,383	$	(37,024	)	$	(84,132	)	$	120,612	$	86,839
Cumulative gap	$	87,383	$	50,359		$	(33,773	)	$	86,839

(1)Includes Federal Home Loan Bank Stock

The above analysis indicates that at June 30, 2013, the Corporation had a cumulative asset sensitivity gap position of $50.359 million within the one-year time frame.  The Corporation’s cumulative asset sensitive gap suggests that if market interest rates continue to decline in the next twelve months, the Corporation may experience a decrease in net interest income.  A limitation of the traditional gap analysis is that it does not consider the timing or magnitude of non-contractual repricing or expected prepayments.  In addition, the gap analysis treats savings, NOW, and money market accounts as repricing within 90 days, while experience suggests that these categories of deposits are actually comparatively resistant to rate sensitivity.

At December 31, 2012, the Corporation had a cumulative liability sensitivity gap position of $44.838 million within the one-year time frame.

The borrowings in the gap analysis include $35.000 million of FHLB advances that have a weighted average maturity of 1.9 years and a weighted average rate of 1.79%.

The Corporation’s primary market risk exposure is interest rate risk and, to a lesser extent, liquidity risk and foreign exchange risk.  The Corporation has no market risk sensitive instruments held for trading purposes.  The Corporation has limited agricultural-related loan assets and therefore has minimal significant exposure to changes in commodity prices.  Any impact that changes in foreign exchange rates and commodity prices would have on interest rates are assumed to be insignificant.

42

Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control interest rate risk and the quantitative level of exposure.  The Corporation’s interest rate risk management process seeks to ensure that appropriate policies, procedures, management information systems, and internal controls are in place to maintain interest rate risk at prudent levels with consistency and continuity.  In evaluating the quantitative level of interest rate risk, the Corporation assesses the existing and potential future effects of changes in interest rates on its financial condition, including capital adequacy, earnings, liquidity, and asset quality.

In addition to changes in interest rates, the level of future net interest income is also dependent on a number of variables, including: the growth, composition and levels of loans, deposits, and other earning assets and interest-bearing obligations, and economic and competitive conditions; potential changes in lending, investing, and deposit strategies; customer preferences; and other factors.

FOREIGN EXCHANGE RISK

In addition to managing interest rate risk, management also actively manages risk associated with foreign exchange.  The Corporation provides foreign exchange services, makes loans to, and accepts deposits from, Canadian customers primarily at its banking offices in Sault Ste. Marie, Michigan.  To protect against foreign exchange risk, the Corporation monitors the volume of Canadian deposits it takes in and then invests these Canadian funds in Canadian commercial loans and securities.  Management believes the exposure to short-term foreign exchange risk is minimal and at an acceptable level for the Corporation.

OFF-BALANCE-SHEET RISK

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

Commitments to extend credit and standby letters of credit are not recorded as an asset or liability by the Corporation until the instrument is exercised.

IMPACT OF INFLATION AND CHANGING PRICES

The accompanying condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and results of operations in historical dollars without considering the change in the relative purchasing power of money over time due to inflation.  The impact of inflation is reflected in the increased cost of the Corporation’s operations.  Nearly all the assets and liabilities of the Corporation are financial, unlike industrial or commercial companies.  As a result, the Corporation’s performance is directly impacted by changes in interest rates, which are indirectly influenced by inflationary expectations.  The Corporation’s ability to match the interest sensitivity of its financial assets to the interest sensitivity of its financial liabilities tends to minimize the effect of changes in interest rates on the Corporation’s performance.  Changes in interest rates do not necessarily move to the same extent as changes in the price of goods and services.

43

MACKINAC FINANCIAL CORPORATION

PART II.  OTHER INFORMATION

As of June 30, 2013, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934.  Our management, which includes our principal executive officer and our principal financial officer, does not expect that our disclosure controls and procedures will prevent all errors and all fraud.

A control system, no matter how well conceived and operated, can provide only reasonable, but not absolute, assurance that the objectives of the control system are met.  Further, the design of a control system must reflect the fact that there are resource constraints; additionally, the benefits of controls must be considered relative to their costs.  Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Corporation have been detected.  These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake.  Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls.  The design of any system of controls is also based, in part, upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.  Over time, controls may become inadequate due to changes in conditions; also the degree of compliance with policies or procedures may deteriorate.  Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.  Our principal executive officer and principal accounting officer have concluded, based on our evaluation of our disclosure controls and procedures, that our disclosure controls and procedures, as defined, under Rule 13a-15 of the Securities Exchange Act of 1934 are effective as of June 30, 2013.

Changes in Internal Control Over Financial Reporting

There were no changes in the Corporation’s internal control over financial reporting that occurred during the quarter ended June 30, 2013 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

44

Item 1.  Legal Proceedings

The Corporation and its subsidiaries are subject to routine litigation incidental to the business of banking.

Item 6.  Exhibits and Reports on Form 8-K

(a)Exhibits:

Exhibit 31.1	Rule 13a-14(a) Certification of Chief Executive Officer.
Exhibit 31.2	Rule 13a-14(a) Certification of Chief Financial Officer.
Exhibit 32.1	Section 1350 Certification of Chief Executive Officer.
Exhibit 32.2	Section 1350 Certification of Chief Financial Officer.
101.INS	XBRL Instance Document.
101.SCH	XBRL Taxonomy Extension Schema Document.
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB	XBRL Taxonomy Extension Labels Linkbase Document.
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document.

45

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.

	MACKINAC FINANCIAL CORPORATION
	(Registrant)
Date:      August 14, 2013	By:	/s/ Paul D. Tobias
		PAUL D. TOBIAS,
		CHAIRMAN AND CHIEF EXECUTIVE OFFICER
		(principal executive officer)
	By:	/s/ Ernie R. Krueger
		ERNIE R. KRUEGER
		EVP/CHIEF FINANCIAL OFFICER
		(principal financial and accounting officer)

46

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Paul D. Tobias, Chairman and Chief Executive Officer of Mackinac Financial Corporation certify that:

1.I have reviewed this report on Form 10-Q of Mackinac Financial Corporation (the “registrant”);

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements and other financial information included in this report fairly present, in all material respects, the financial condition, results of operations, and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:

(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:      August 14, 2013	/s/ Paul D. Tobias
	Paul D. Tobias
	Chairman and Chief Executive Officer
	(principal executive officer)

1

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Ernie R. Krueger, Executive Vice President/Chief Financial Officer of Mackinac Financial Corporation, certify that:

1.I have reviewed this report on Form 10-Q of Mackinac Financial Corporation (the “registrant”);

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:

(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:      August 14, 2013	/s/ Ernie R. Krueger
	Ernie R. Krueger
	Executive Vice President/Chief Financial Officer
	(principal financial officer)

1

EX-32.1

Exhibit 32.1

CERTIFICATION PERSUANT TO

18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C § 1350, and accompanies the quarterly report on Form 10-Q for the quarter ended June 30, 2013, (the “Form 10-Q”) of Mackinac Financial Corporation (the “Issuer”).

I, Paul D. Tobias, Chairman and Chief Executive Officer of the Issuer, certify that:

(1)The Form 10-Q fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and

(2)The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operation of the Issuer.

/s/ Paul D. Tobias

Paul D. Tobias

Chairman and Chief Executive Officer

(chief executive officer)

Date:      August 14, 2013

1

EX-32.2

Exhibit 32.2

CERTIFICATION PERSUANT TO

18 U.S.C. SECTION 1350

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

This certification is provided pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C § 1350, and accompanies the quarterly report on Form 10-Q for the quarter ended June 30, 2013, (the “Form 10-Q”) of Mackinac Financial Corporation (the “Issuer”).

I, Ernie R. Krueger, Executive Vice President of the Issuer, certify that:

(1)The Form 10-Q fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)); and

(2)The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operation of the Issuer.

/s/ Ernie R. Krueger

Executive Vice President and Chief Financial Officer

(principal financial officer)

Date:      August 14, 2013

1

XML

SHAREHOLDERS' EQUITY

6 Months Ended

Jun. 30, 2013

SHAREHOLDERS' EQUITY

SHAREHOLDERS' EQUITY

10.  SHAREHOLDERS’ EQUITY

Participation in the TARP Capital Purchase Program

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

Amounts recorded for Preferred Stock and Warrant Common Stock were estimated based on an allocation of the total proceeds from the issuance on the relative fair values of both instruments.  Fair value of the Preferred Stock was determined based on assumptions regarding the discount rate (market rate) on the Preferred Stock (estimated 12%).  Fair value of the Warrant Common Stock is based on the value of the underlying Preferred Stock based on an estimate for a three year term.  The allocation of the proceeds received resulted in the recording of a discount on the Preferred Stock and a premium on the Warrant Common Stock.  The discount on the preferred will be accreted on an effective yield basis over a three-year term.  The allocated carrying value of the Preferred Stock and Warrant Common Stock on the date of issuance (based on their relative fair values) was $10.382 million and $.618 million, respectively.  Cumulative dividends on the Preferred Stock are payable at 5% annum for the first five years and at a rate of 9% per annum thereafter on the liquidation preference of $1,000 per share.  The Company is prohibited from paying any dividend with respect to shares of common stock unless all accrued and unpaid dividends are paid in full on the Preferred Stock for all past dividend periods.  The Preferred Stock is non-voting, other than class voting rights on matters that could adversely affect the Preferred Stock.  The Preferred Stock may be redeemed at any time with regulatory approval.  The preferred stock qualifies as Tier 1 Capital for regulatory purposes at the holding company.  The preferred stock was auctioned by the Treasury in 2012 and is now held by various investors.

In the 2013 second quarter, the Corporation redeemed $7.0 million of the $11.0 million outstanding preferred stock at par.

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CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (USD $) In Thousands, except Per Share data, unless otherwise specified	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012
Interest and fees on loans:
Taxable	$ 6,014	$ 5,873	$ 11,903	$ 11,453
Tax-exempt	28	30	55	62
Interest on securities:
Taxable	241	238	481	502
Tax-exempt	6	7	13	14
Other interest income	32	30	63	55
Total interest income	6,321	6,178	12,515	12,086
INTEREST EXPENSE:
Deposits	886	992	1,763	1,975
Borrowings	166	167	327	329
Total interest expense	1,052	1,159	2,090	2,304
Net interest income	5,269	5,019	10,425	9,782
Provision for loan losses	100	150	475	645
Net interest income after provision for loan losses	5,169	4,869	9,950	9,137
OTHER INCOME:
Deposit service fees	175	189	337	383
Income from secondary market loans sold	279	226	578	524
SBA/USDA loan sale gains	554	620	663	620
Mortgage servicing income	182	115	285	200
Other	61	155	146	184
Total other income	1,251	1,305	2,009	1,911
OTHER EXPENSE:
Salaries and employee benefits	2,375	2,003	4,681	3,978
Occupancy	363	335	745	680
Furniture and equipment	255	219	525	447
Data processing	268	258	533	486
Professional service fees	320	310	545	490
Loan and deposit	45	338	118	479
Writedowns and losses on other real estate held for sale	87	174	89	185
FDIC insurance assessment	95	159	200	318
Telephone	63	57	145	112
Advertising	111	98	215	196
Other	541	256	1,038	670
Total other expenses	4,523	4,207	8,834	8,041
Income before provision for income taxes	1,897	1,967	3,125	3,007
Provision for (benefit of) income taxes	637	(2,335)	1,052	(1,986)
NET INCOME	1,260	4,302	2,073	4,993
Preferred dividend and accretion of discount	63	161	200	354
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS	$ 1,197	$ 4,141	$ 1,873	$ 4,639
INCOME PER COMMON SHARE:
Basic (in dollars per share)	$ 0.22	$ 0.97	$ 0.34	$ 1.09
Diluted (in dollars per share)	$ 0.22	$ 0.94	$ 0.34	$ 1.05

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INVESTMENT SECURITIES

6 Months Ended

Jun. 30, 2013

INVESTMENT SECURITIES

INVESTMENT SECURITIES

3. INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities available for sale as of June 30, 2013, December 31, 2012 and June 30, 2012 are as follows (dollars in thousands):

			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
June 30, 2013
US Agencies - MBS	$	7,491	$	354	$	—		$	7,845
US Agencies	15,172		74		(341		)	14,905
Corporate Bonds	18,557		161		(45		)	18,673
Obligations of states and political subdivisions	5,435		450		(1		)	5,884
Total securities available for sale	$	46,655	$	1,039	$	(387	)	$	47,307
December 31, 2012
US Agencies - MBS	$	7,962	$	412	$	—		$	8,374
US Agencies	10,267		137		—			10,404
Corporate Bonds	18,763		237		(23		)	18,977
Obligations of states and political subdivisions	5,407		637		—			6,044
Total securities available for sale	$	42,399	$	1,423	$	(23	)	$	43,799
June 30, 2012
US Agencies - MBS	$	9,667	$	412	$	—		$	10,079
US Agencies	10,338		155		—			10,493
Corporate Bonds	12,519		70		(17		)	12,572
Obligations of states and political subdivisions	5,474		438		(2		)	5,910
Total securities available for sale	$	37,998	$	1,075	$	(19	)	$	39,054

When gross unrealized losses exist within the portfolio, the Corporation considers them temporary in nature and related to interest rate fluctuations.  The Corporation has both the ability and the intent to hold the investment securities until their respective maturities and therefore does not anticipate the realization of the temporary losses.

The amortized cost and estimated fair value of investment securities pledged to secure FHLB borrowings and customer relationships were $6.383 million and $6.669 million, respectively, at June 30, 2013.

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BORROWINGS (Tables)

6 Months Ended

Jun. 30, 2013

BORROWINGS

Schedule of borrowings

Borrowings consist of the following at June 30, 2013, December 31, 2012 and June 30, 2012 (dollars in thousands):

	June, 30		December 31,		June, 30
	2013		2012		2012
Federal Home Loan Bank fixed rate advances at June 30, 2013 with a weighted average rate of 1.79% maturing in 2014, 2016 and 2018	$	35,000	$	35,000	$	35,000
USDA Rural Development, fixed-rate note payable, maturing August 24, 2024, interest payable at 1%	925		925		997
	$	35,925	$	35,925	$	35,997

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COMMITMENTS, CONTINGENCIES AND CREDIT RISK

6 Months Ended

Jun. 30, 2013

COMMITMENTS, CONTINGENCIES AND CREDIT RISK

COMMITMENTS, CONTINGENCIES AND CREDIT RISK

11.  COMMITMENTS, CONTINGENCIES AND CREDIT RISK

Financial Instruments With Off-Balance-Sheet Risk

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

The Corporation’s exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit, is represented by the contractual amount of those instruments.  The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.  These commitments are as follows (dollars in thousands):

	June 30,		December 31,		June 30,
	2013		2012		2012
Commitments to extend credit:
Variable rate	$	37,462	$	39,782	$	41,693
Fixed rate	19,873		18,427		15,452
Standby letters of credit - Variable rate	3,805		2,879		3,378
Credit card commitments - Fixed rate	3,113		3,060		3,226
	$	64,253	$	64,148	$	63,749

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Corporation evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, if deemed necessary by the Corporation upon extension of credit, is based on management’s credit evaluation of the party.  Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.

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

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

Legal Proceedings and Contingencies

In the normal course of business, the Corporation is involved in various legal proceedings.  For expanded discussion on the Corporation’s legal proceedings, see Part II, Item 1, “Legal Proceedings” in this report.

Concentration of Credit Risk

The Bank grants commercial, residential, agricultural, and consumer loans throughout Michigan.  The Bank’s most prominent concentration in the loan portfolio relates to commercial real estate loans to operators of nonresidential buildings.  This concentration at June 30, 2013 represents $95.510 million, or 27.80%, compared to $83.539 million, or 26.15%, of the commercial loan portfolio on June 30, 2012.  The remainder of the commercial loan portfolio is diversified in such categories as hospitality and tourism, real estate agents and managers, new car dealers, gaming, petroleum, forestry, agriculture and construction.  Due to the diversity of the Bank’s locations, the ability of debtors of residential and consumer loans to honor their obligations is not tied to any particular economic sector.

Forward Looking Statements/Risk Factors

FORWARD LOOKING STATEMENTS

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

RISK FACTORS

Risks Related to our Lending and Credit Activities

· Our business may be adversely affected by conditions in the financial markets and economic conditions generally, as our borrowers’ ability to repay loans and the value of the collateral securing our loans decline.

· Weakness in the markets for residential or commercial real estate, including the secondary residential mortgage loan markets, could reduce our net income and profitability.

· Our allowance for loan losses may be insufficient.

Continuing deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of our control, may require an increase in our allowance for loan losses.

Risks Related to Our Operations

· We are subject to interest rate risk.

Our earnings and cash flows are largely dependent upon our net interest income, which is the difference between interest income on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds.  There are many factors which influence interest rates that are beyond our control, including but not limited to general economic conditions and governmental policy, in particular, the policies of the FRB.

· Changes in our accounting policies or in accounting standards could materially affect how we report our financial results and condition.

· Our controls and procedures may fail or be circumvented.

· Impairment of deferred income tax assets could require charges to earnings, which could result in an adverse impact on our results of operations.

In assessing the realizability of deferred income tax assets, management considers whether it is more likely than not that some allowance requires management to evaluate all available evidence, both negative and positive.  Positive evidence necessary to overcome the negative evidence includes whether future taxable income in sufficient amounts and character within the carry back and carry forward periods is available under the tax law, including the use of tax planning strategies.  When negative evidence (e.g. cumulative losses in recent years, history of operating loss or tax credit carry forwards expiring unused) exists, more positive evidence than negative evidence will be necessary.  At June 30, 2013, net deferred tax assets are approximately $8.4 million.  If an additional valuation allowance becomes necessary with respect to such balance, it could have a material adverse effect on our business, results of operations and financial condition.

· Our information systems may experience an interruption or breach in security.

Risks Related to Legal and Regulatory Compliance

· We operate in a highly regulated environment, which could increase our cost structure or have other negative impacts on our operations.

· The full impact of the recently enacted Dodd-Frank Act is currently unknown given that many of the details and substance of the new laws will be implemented through agency rulemaking.

Among the many requirements if the Dodd-Frank Act for new banking regulations is a requirement for new capital regulations to be adopted within 15 months.  These regulations must be at least as stringent as, and may call for higher levels of capital than, current regulations.

Strategic Risks

· Maintaining or increasing our market share may depend on lowering prices and market acceptance of new products and services.

· Future growth or operating results may require us to raise additional capital but that capital may not be available.

Reputation Risks

· Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of our computer system or otherwise, could severely harm our business.

Liquidity Risks

· We could experience an unexpected inability to obtain needed liquidity.

The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds.  We seek to ensure our funding needs are met by maintaining an appropriate level of liquidity through asset/liability management.

Risks Related to an Investment in Our Common Stock

· Limited trading activity for shares of our common stock may contribute to price volatility.

· Our securities are not an insured deposit.

· You may not receive dividends on your investment in common stock.

Our ability to pay dividends is dependent upon our receipt of dividends from the Bank, which is subject to regulatory restrictions.  Such restrictions, which govern state-chartered banks, generally limit the payment of dividends on bank stock to the bank’s undivided profits after all payments of all necessary expenses, provided that the bank’s surplus equals or exceeds its capital.

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

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FAIR VALUE MEASUREMENTS (Details 3) (Nonrecurring, USD $) In Thousands, unless otherwise specified	3 Months Ended		6 Months Ended		12 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012
Fair value
Total Losses	$ 97	$ 798	$ 507	$ 1,197	$ 1,640
Impaired loans
Fair value
Total Losses	10	624	418	1,012	1,151
Other real estate owned
Fair value
Total Losses	$ 87	$ 174	$ 89	$ 185	$ 489

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LOANS (Details 8) (USD $) In Thousands, unless otherwise specified	3 Months Ended		6 Months Ended		12 Months Ended	3 Months Ended		6 Months Ended		12 Months Ended	3 Months Ended	6 Months Ended		12 Months Ended		3 Months Ended		6 Months Ended		12 Months Ended	3 Months Ended		6 Months Ended		12 Months Ended	3 Months Ended	6 Months Ended		12 Months Ended		3 Months Ended	6 Months Ended		12 Months Ended		6 Months Ended		12 Months Ended			3 Months Ended	6 Months Ended	3 Months Ended	6 Months Ended	12 Months Ended			3 Months Ended	6 Months Ended	12 Months Ended			3 Months Ended	6 Months Ended		12 Months Ended		3 Months Ended	6 Months Ended		12 Months Ended		3 Months Ended	6 Months Ended		12 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012	Jun. 30, 2013 ACCRUING	Jun. 30, 2012 ACCRUING	Jun. 30, 2013 ACCRUING	Jun. 30, 2012 ACCRUING	Dec. 31, 2012 ACCRUING	Jun. 30, 2012 NONACCRUAL	Jun. 30, 2013 NONACCRUAL	Jun. 30, 2012 NONACCRUAL	Dec. 31, 2012 NONACCRUAL	Mar. 31, 2013 NONACCRUAL	Jun. 30, 2013 Commercial real estate	Jun. 30, 2012 Commercial real estate	Jun. 30, 2013 Commercial real estate	Jun. 30, 2012 Commercial real estate	Dec. 31, 2012 Commercial real estate	Jun. 30, 2013 Commercial real estate ACCRUING	Jun. 30, 2012 Commercial real estate ACCRUING	Jun. 30, 2013 Commercial real estate ACCRUING	Jun. 30, 2012 Commercial real estate ACCRUING	Dec. 31, 2012 Commercial real estate ACCRUING	Jun. 30, 2012 Commercial real estate NONACCRUAL	Jun. 30, 2013 Commercial real estate NONACCRUAL	Jun. 30, 2012 Commercial real estate NONACCRUAL	Dec. 31, 2012 Commercial real estate NONACCRUAL	Mar. 31, 2013 Commercial real estate NONACCRUAL	Jun. 30, 2012 Commercial, financial, and agricultural	Jun. 30, 2013 Commercial, financial, and agricultural	Jun. 30, 2012 Commercial, financial, and agricultural	Dec. 31, 2012 Commercial, financial, and agricultural	Mar. 31, 2013 Commercial, financial, and agricultural	Jun. 30, 2013 Commercial, financial, and agricultural ACCRUING	Jun. 30, 2012 Commercial, financial, and agricultural ACCRUING	Dec. 31, 2012 Commercial, financial, and agricultural ACCRUING	Mar. 31, 2013 Commercial, financial, and agricultural ACCRUING	Mar. 31, 2012 Commercial, financial, and agricultural ACCRUING	Jun. 30, 2012 Commercial, financial, and agricultural NONACCRUAL	Jun. 30, 2012 Commercial, financial, and agricultural NONACCRUAL	Jun. 30, 2012 Commercial construction	Jun. 30, 2012 Commercial construction	Dec. 31, 2012 Commercial construction	Jun. 30, 2013 Commercial construction	Mar. 31, 2013 Commercial construction	Jun. 30, 2012 Commercial construction ACCRUING	Jun. 30, 2012 Commercial construction ACCRUING	Dec. 31, 2012 Commercial construction ACCRUING	Jun. 30, 2013 Commercial construction ACCRUING	Mar. 31, 2013 Commercial construction ACCRUING	Jun. 30, 2012 One to four family residential real estate	Jun. 30, 2013 One to four family residential real estate	Jun. 30, 2012 One to four family residential real estate	Dec. 31, 2012 One to four family residential real estate	Mar. 31, 2013 One to four family residential real estate	Jun. 30, 2012 One to four family residential real estate ACCRUING	Jun. 30, 2013 One to four family residential real estate ACCRUING	Jun. 30, 2012 One to four family residential real estate ACCRUING	Dec. 31, 2012 One to four family residential real estate ACCRUING	Mar. 31, 2013 One to four family residential real estate ACCRUING	Jun. 30, 2012 One to four family residential real estate NONACCRUAL	Jun. 30, 2013 One to four family residential real estate NONACCRUAL	Jun. 30, 2012 One to four family residential real estate NONACCRUAL	Dec. 31, 2012 One to four family residential real estate NONACCRUAL	Mar. 31, 2013 One to four family residential real estate NONACCRUAL
Changes in troubled debt restructuring
Beginning balance	$ 8,995	$ 10,455	$ 8,056	$ 2,503	$ 2,503	$ 6,720	$ 5,855	$ 5,792	$ 2,503	$ 2,503	$ 4,600	$ 2,264			$ 2,275	$ 5,757	$ 6,907	$ 5,773	$ 2,400	$ 2,400	$ 3,588	$ 3,672	$ 3,611	$ 2,400	$ 2,400	$ 3,235	$ 2,162			$ 2,169	$ 2,293	$ 1,221			$ 2,174	$ 1,221			$ 2,174	$ 1,221	$ 1,072		$ 859			$ 858	$ 858	$ 859			$ 858	$ 858	$ 396	$ 204	$ 103	$ 103	$ 206	$ 103	$ 102	$ 103	$ 103	$ 100	$ 293	$ 102			$ 106
Principal payments	(25)	(1,708)	(50)	(1,708)	(519)	(25)	(21)	(50)	(21)	(87)	(1,687)		(1,687)	(432)		(25)	(634)	(48)	(634)	(516)	(25)	(19)	(48)	(19)	(84)	(615)		(615)	(432)		(1,072)		(1,072)								(1,072)	(1,072)	(1)	(1)	(2)			(1)	(1)	(2)			(1)	(2)	(1)	(1)		(1)	(2)	(1)	(1)
Charge-offs		(526)		(526)	(772)						(526)		(526)	(772)			(426)		(426)	(772)						(426)		(426)	(772)																								(100)		(100)								(100)		(100)
Advances					47									47						47									47
New restructured			964	7,952	6,797			953	5,752	5,776		11	2,200	1,021				7	4,507	4,614				3,672	3,695		7	835	919			953	2,293	1,221		953	1,221	1,221				1,072		859	860				859	860				4	293	102								4	293	102
Transfers to nonaccrual				(2,400)	(2,400)				(2,400)	(2,400)									(2,400)	(2,400)				(2,400)	(2,400)
Transfers to foreclosed properties		(187)		(187)							(187)		(187)																																								(187)		(187)								(187)		(187)
Transfer from accruing				2,400	2,400								2,400	2,400					2,400	2,400								2,400	2,400
Ending balance	$ 8,970	$ 8,034	$ 8,970	$ 8,034	$ 8,056	$ 6,695	$ 5,834	$ 6,695	$ 5,834	$ 5,792	$ 2,200	$ 2,275	$ 2,200	$ 2,264	$ 2,275	$ 5,732	$ 5,847	$ 5,732	$ 5,847	$ 5,773	$ 3,563	$ 3,653	$ 3,563	$ 3,653	$ 3,611	$ 2,194	$ 2,169	$ 2,194	$ 2,162	$ 2,169	$ 1,221	$ 2,174	$ 1,221	$ 1,221	$ 2,174	$ 2,174	$ 1,221	$ 1,221	$ 2,174	$ 1,221			$ 858	$ 858	$ 858	$ 858	$ 858	$ 858	$ 858	$ 858	$ 858	$ 858	$ 108	$ 206	$ 108	$ 204	$ 206	$ 102	$ 100	$ 102	$ 102	$ 100	$ 6	$ 106	$ 6	$ 102	$ 106

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COMMITMENTS, CONTINGENCIES AND CREDIT RISK (Tables)

6 Months Ended

Jun. 30, 2013

COMMITMENTS, CONTINGENCIES AND CREDIT RISK

Schedule of commitments

These commitments are as follows (dollars in thousands):

	June 30,		December 31,		June 30,
	2013		2012		2012
Commitments to extend credit:
Variable rate	$	37,462	$	39,782	$	41,693
Fixed rate	19,873		18,427		15,452
Standby letters of credit - Variable rate	3,805		2,879		3,378
Credit card commitments - Fixed rate	3,113		3,060		3,226
	$	64,253	$	64,148	$	63,749

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FAIR VALUE MEASUREMENTS (Tables)

6 Months Ended

Jun. 30, 2013

FAIR VALUE MEASUREMENTS

Schedule presenting information for financial instruments

The following table presents information for financial instruments at June 30, 2013, December 31, 2012 and June 30, 2012(dollars in thousands):

		June 30, 2013				December 31, 2012				June 30, 2012
	Level in Fair	Carrying		Estimated		Carrying		Estimated		Carrying		Estimated
	Value Hierarchy	Amount		Fair Value		Amount		Fair Value		Amount		Fair Value
Financial assets:
Cash and cash equivalents	Level 1	$	26,219	$	26,219	$	26,961	$	26,961	$	33,248	$	33,248
Interest-bearing deposits	Level 2	10		10		10		10		10		10
Securities available for sale	Level 2	47,307		47,307		43,799		43,799		39,054		39,054
Federal Home Loan Bank stock	Level 2	3,060		3,060		3,060		3,060		3,060		3,060
Net loans	Level 2	450,378		444,638		443,959		439,239		414,370		411,781
Accrued interest receivable	Level 2	1,636		1,636		1,319		1,319		1,303		1,303
Total financial assets		$	528,610	$	522,870	$	519,108	$	514,388	$	491,045	$	488,456
Financial liabilities:
Deposits	Level 2	$	447,907	$	446,438	$	434,557	$	434,227	$	425,381	$	425,149
Borrowings	Level 2	35,925		35,621		35,925		35,729		35,997		35,853
Accrued interest payable	Level 2	229		229		214		214		239		239
Total financial liabilties		$	484,061	$	482,288	$	470,696	$	470,170	$	461,617	$	461,241

Schedule of fair values of assets using Level 3 inputs

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended		Six Months Ended
(dollars in thousands)	June 30, 2013		(Level 1)		(Level 2)		(Level 3)		June 30, 2013		June 30, 2013
Assets
Impaired loans	$	3,983	$	—	$	—	$	3,983	$	10	$	418
Other real estate owned	2,481		—		—		2,481		87		89
									$	97	$	507

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Year Ended
(dollars in thousands)	December 31, 2012		(Level 1)		(Level 2)		(Level 3)		December 31, 2012
Assets
Impaired loans	$	4,687	$	—	$	—	$	4,687	$	1,151
Other real estate owned	3,212		—		—		3,212		489
									$	1,640

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended		Six Months Ended
(dollars in thousands)	June 30, 2012		(Level 1)		(Level 2)		(Level 3)		June 30, 2012		June 30, 2012
Assets
Impaired loans	$	5,375	$	—	$	—	$	5,375	$	624	$	1,012
Other real estate owned	3,518		—		—		3,518		174		185
									$	798	$	1,197

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FAIR VALUE MEASUREMENTS (Details) (USD $) In Thousands, unless otherwise specified	3 Months Ended
	Jun. 30, 2013	Dec. 31, 2012	Jun. 30, 2012
FAIR VALUE MEASUREMENTS
Blended interest rate for determining fair value of nonaccrual loans (as a percent)	0.00%
Financial assets:
Interest-bearing deposits	$ 10	$ 10	$ 10
Securities available for sale	47,307	43,799	39,054
Carrying Amount
Financial assets:
Total financial assets	528,610	519,108	491,045
Financial liabilities:
Total financial liabilities	484,061	470,696	461,617
Estimated Fair Value
Financial assets:
Total financial assets	522,870	514,388	488,456
Financial liabilities:
Total financial liabilities	482,288	470,170	461,241
Level 1 | Carrying Amount
Financial assets:
Cash and cash equivalents	26,219	26,961	33,248
Level 1 | Estimated Fair Value
Financial assets:
Cash and cash equivalents	26,219	26,961	33,248
Level 2 | Carrying Amount
Financial assets:
Interest-bearing deposits	10	10	10
Securities available for sale	47,307	43,799	39,054
Federal Home Loan Bank stock	3,060	3,060	3,060
Net loans	450,378	443,959	414,370
Accrued interest receivable	1,636	1,319	1,303
Financial liabilities:
Deposits	447,907	434,557	425,381
Borrowings	35,925	35,925	35,997
Accrued interest payable	229	214	239
Level 2 | Estimated Fair Value
Financial assets:
Interest-bearing deposits	10	10	10
Securities available for sale	47,307	43,799	39,054
Federal Home Loan Bank stock	3,060	3,060	3,060
Net loans	444,638	439,239	411,781
Accrued interest receivable	1,636	1,319	1,303
Financial liabilities:
Deposits	446,438	434,227	425,149
Borrowings	35,621	35,729	35,853
Accrued interest payable	$ 229	$ 214	$ 239

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LOANS (Details 4) (USD $) In Thousands, unless otherwise specified	3 Months Ended		6 Months Ended		12 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012
Impaired Loans
Number of days past due to be considered as nonperforming loans			90 days
Average investment
Total	$ 3,952	$ 6,527	$ 4,272	$ 8,256	$ 8,339
Related Valuation Reserve	1,472	810	1,472	810	1,519
Interest Income Recognized During Impairment
Total		17		37	54
Interest Income on Accrual Basis
Total	59	37	117	174	313
Nonaccrual Basis
Recorded investment
Total	3,983	5,375	3,983	5,375	4,687
Commercial real estate
Average investment
With no valuation reserve	733	655	797	1,138	1,550
With a valuation reserve	2,308	3,604	2,298	3,916	3,173
Total	3,041	4,259	3,095	5,054	4,723
Related Valuation Reserve	1,240	708	1,240	708	1,315
Interest Income Recognized During Impairment
With a valuation reserve		17		37	54
Total		17		37	54
Interest Income on Accrual Basis
With no valuation reserve	14	9	26	23	37
With a valuation reserve	30	80	60	94	177
Total	44	89	86	117	214
Commercial real estate | Nonaccrual Basis
Recorded investment
With no valuation reserve	728	535	728	535	132
With a valuation reserve	2,329	3,214	2,329	3,214	2,939
Total	3,057	3,749	3,057	3,749	3,071
Commercial, financial, and agricultural
Average investment
With no valuation reserve	206	780	248	1,063	1,063
With a valuation reserve	267	429	199	459	504
Total	473	1,209	447	1,522	1,567
Related Valuation Reserve	106	84	106	84	109
Interest Income on Accrual Basis
With no valuation reserve	3	7	6	18	19
With a valuation reserve	4		6	8	17
Total	7	7	12	26	36
Commercial, financial, and agricultural | Nonaccrual Basis
Recorded investment
With no valuation reserve	176		176
With a valuation reserve	341	278	341	278	436
Total	517	278	517	278	436
Commercial construction
Average investment
With no valuation reserve		338	275	676	675
Total		338	275	676	675
Interest Income on Accrual Basis
With no valuation reserve		4	3	4	15
Total		4	3	4	15
Commercial construction | Nonaccrual Basis
Recorded investment
With no valuation reserve		676		676	675
Total		676		676	675
One to four family residential real estate
Average investment
With no valuation reserve	133	613	165	874	1,074
With a valuation reserve	303	93	289	114	281
Total	436	706	454	988	1,355
Related Valuation Reserve	126	18	126	18	95
Interest Income on Accrual Basis
With no valuation reserve	3	9	5	24	41
With a valuation reserve	5	2	11	2	6
Total	8	11	16	26	47
One to four family residential real estate | Nonaccrual Basis
Recorded investment
With no valuation reserve	94	543	94	543	230
With a valuation reserve	306	114	306	114	275
Total	400	657	400	657	505
Consumer construction
Average investment
With no valuation reserve		15		16	16
Total		15		16	16
Interest Income on Accrual Basis
With no valuation reserve		1		1	1
Total		1		1	1
Consumer construction | Nonaccrual Basis
Recorded investment
With no valuation reserve		15		15
Total		15		15
Consumer
Average investment
With no valuation reserve	2		1		3
Total	2		1		3
Consumer | Nonaccrual Basis
Recorded investment
With no valuation reserve	9		9
Total	$ 9		$ 9

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MORTGAGE SERVICING RIGHTS (Details) (USD $)	6 Months Ended		12 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012
MORTGAGE SERVICING RIGHTS
Residential first mortgage loans the Corporation has obligations to service	$ 120,000,000
Annual constant prepayment speed (as a percent)	15.90%
Discount rate (as a percent)	7.50%
Changes in mortgage servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances
Balance at beginning of period	638,000	400,000	400,000
Additions from loans sold with servicing retained	225,000	170,000	344,000
Amortization	(80,000)	(45,000)	(106,000)
Fair value of MSRs at end of period	$ 783,000	$ 525,000	$ 638,000

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SHAREHOLDERS' EQUITY (Details) (TARP Capital Purchase Program, USD $)	0 Months Ended	6 Months Ended
	Apr. 24, 2009	Jun. 30, 2013
Participation in the TARP Capital Purchase Program
Allocated carrying value of Preferred Stock		$ 11,000,000
Preferred stock redeemed		7,000,000
Preferred Stock | Series A
Participation in the TARP Capital Purchase Program
Estimated discount rate to determine the fair value of stock (as a percent)	12.00%
Term used to determine fair value	3 years
Allocated carrying value of Preferred Stock	10,382,000
Annual rate of cumulative dividends on Preferred Stock for the first five years (as a percent)		5.00%
Annual rate of cumulative dividends on Preferred Stock after the first five years (as a percent)		9.00%
Liquidation preference (in dollars per share)		$ 1,000
Warrant
Participation in the TARP Capital Purchase Program
Term used to determine fair value	3 years
Allocated carrying value of Warrant Common Stock	618,000
Securities Purchase Agreement
Participation in the TARP Capital Purchase Program
Proceeds from issuance of Series A Preferred Shares and common stock warrants	$ 11,000,000
Securities Purchase Agreement | Preferred Stock | Series A
Participation in the TARP Capital Purchase Program
Shares issued	11,000
Securities Purchase Agreement | Warrant
Participation in the TARP Capital Purchase Program
Number of shares that can be purchased	379,310
Exercise price of warrants (in dollars per share)	$ 4.35

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LOANS (Details) (USD $) In Thousands, unless otherwise specified	3 Months Ended		6 Months Ended		12 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012
Loans
Total loans	$ 455,555	$ 419,453	$ 455,555	$ 419,453	$ 449,177
Changes in the allowance for loan losses
Balance at beginning of period	5,037	5,382	5,218	5,251	5,251
Recoveries on loans previously charged off	76	187	100	219	278
Loans charged off	(36)	(636)	(616)	(1,032)	(1,256)
Provision	100	150	475	645	945
Balance at end of period	5,177	5,083	5,177	5,083	5,218
Net charge off activity			516	813
Net charge off activity as percentage of average loans outstanding			0.23%	0.40%
Commercial real estate
Loans
Total loans	243,363	211,506	243,363	211,506	244,966
Changes in the allowance for loan losses
Balance at beginning of period	2,964	2,785	3,267	2,823	2,823
Recoveries on loans previously charged off	29	10	41	18	52
Loans charged off	(21)	(518)	(456)	(691)	(729)
Provision	(311)	507	(191)	634	1,121
Balance at end of period	2,661	2,784	2,661	2,784	3,267
Commercial, financial, and agricultural
Loans
Total loans	84,145	85,099	84,145	85,099	80,646
Changes in the allowance for loan losses
Balance at beginning of period	847	1,126	692	1,079	1,079
Recoveries on loans previously charged off	30	169	33	187	201
Loans charged off	(4)	(4)	(76)	(24)	(40)
Provision	217	(403)	441	(354)	(548)
Balance at end of period	1,090	888	1,090	888	692
One to four family residential real estate
Loans
Total loans	94,254	84,665	94,254	84,665	87,948
Changes in the allowance for loan losses
Balance at beginning of period	990	1,083	980	1,114	1,114
Recoveries on loans previously charged off	6	4	11	5	7
Loans charged off	(6)	(106)	(13)	(296)	(399)
Provision	(113)	102	(101)	260	258
Balance at end of period	877	1,083	877	1,083	980
Consumer construction
Loans
Total loans	4,305	5,595	4,305	5,595	7,465
Changes in the allowance for loan losses
Loans charged off		5
Provision		(5)
Commercial construction
Loans
Total loans	16,053	22,793	16,053	22,793	17,229
Changes in the allowance for loan losses
Balance at beginning of period	118	230	125	207	207
Recoveries on loans previously charged off	1		2
Loans charged off		(6)		(6)	(6)
Provision	(22)	(6)	(30)	17	(76)
Balance at end of period	97	218	97	218	125
Consumer
Loans
Total loans	13,435	9,795	13,435	9,795	10,923
Changes in the allowance for loan losses
Balance at beginning of period	13
Recoveries on loans previously charged off	10	4	13	9	18
Loans charged off	(5)	(7)	(71)	(15)	(82)
Provision	(5)	3	71	6	64
Balance at end of period	$ 13		$ 13

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STOCK COMPENSATION PLANS (Details 2) (USD $)	6 Months Ended
	Jun. 30, 2013
Stock option plans
Number of Shares, Outstanding	242,152
Number of Shares, Exercisable	126,361
Number of Shares, Unvested Options	115,791
Weighted Average Remaining Contractual Life-Years	1 year 7 months 6 days
Exercise price, one
Stock option plans
Exercise Price (in dollars per share)	$ 9.16
Number of Shares, Outstanding	2,500
Number of Shares, Exercisable	1,000
Number of Shares, Unvested Options	1,500
Weighted Average Remaining Contractual Life-Years	2 years 5 months 16 days
Exercise price, two
Stock option plans
Exercise Price (in dollars per share)	$ 9.75
Number of Shares, Outstanding	217,152
Number of Shares, Exercisable	120,861
Number of Shares, Unvested Options	96,291
Weighted Average Remaining Contractual Life-Years	1 year 5 months 16 days
Exercise price, three
Stock option plans
Exercise Price (in dollars per share)	$ 10.65
Number of Shares, Outstanding	12,500
Number of Shares, Exercisable	2,500
Number of Shares, Unvested Options	10,000
Weighted Average Remaining Contractual Life-Years	3 years 5 months 16 days
Exercise price, four
Stock option plans
Exercise Price (in dollars per share)	$ 12.00
Number of Shares, Outstanding	10,000
Number of Shares, Exercisable	2,000
Number of Shares, Unvested Options	8,000
Weighted Average Remaining Contractual Life-Years	2 years 14 days

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STOCK COMPENSATION PLANS (Tables)

6 Months Ended

Jun. 30, 2013

STOCK COMPENSATION PLANS

Summary of stock option transactions

	June 30,		December 31,			June 30,
	2013		2012			2012
Outstanding shares at beginning of year	242,152		392,152			392,152
Granted during the period	—		—			—
Exercised during the period	—		—			—
Expired / forfeited during the period	—		(150,000		)	—
Outstanding shares at end of period	242,152		242,152			392,152
Exercisable shares at end of period	126,361		126,361			148,861
Weighted average exercise price per share at end of period	$	9.88	$	9.88		$	10.27
Shares available for grant at end of period	—		—			—

Summary of the options outstanding and exercisable

Following is a summary of the options outstanding and exercisable at June 30, 2013:

					Weighted Average
Exercise		Number		Unvested	Remaining
Price		Outstanding	Exercisable	Options	Contractual Life-Years
$	9.16	2,500	1,000	1,500	2.46
$	9.75	217,152	120,861	96,291	1.46
$	10.65	12,500	2,500	10,000	3.46
$	12.00	10,000	2,000	8,000	2.04
		242,152	126,361	115,791	1.60

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CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (USD $) In Thousands, unless otherwise specified	Total	Preferred Stock	Common Shareholders' Equity	Comprehensive Income (Loss)
Balance, beginning of period at Dec. 31, 2011	$ 55,263	$ 10,921	$ 44,342
Increase (Decrease) in Shareholders' Equity
Net income (loss) for period	4,993		4,993	4,993
Net unrealized gain (loss) on securities available for sale	371		371	371
Total comprehensive income (loss)	5,364		5,364	5,364
Dividend on preferred stock	(275)		(275)
Accretion of preferred stock discount		79	(79)
Balance, end of period at Jun. 30, 2012	60,352	11,000	49,352
Balance, beginning of period at Mar. 31, 2012	56,095	10,976	45,119
Increase (Decrease) in Shareholders' Equity
Net income (loss) for period	4,302		4,302	4,302
Net unrealized gain (loss) on securities available for sale	92		92	92
Total comprehensive income (loss)	4,394		4,394	4,394
Dividend on preferred stock	(137)		(137)
Accretion of preferred stock discount		24	(24)
Balance, end of period at Jun. 30, 2012	60,352	11,000	49,352
Balance, beginning of period at Dec. 31, 2012	72,448	11,000	61,448
Increase (Decrease) in Shareholders' Equity
Net income (loss) for period	2,073		2,073	2,073
Net unrealized gain (loss) on securities available for sale	(494)		(494)	(494)
Total comprehensive income (loss)	1,579		1,579	1,579
Stock compensation	183		183
Dividend on common stock	(444)		(444)
Repurchase of common stock	(46)		(46)
Redemption of Preferred Series A stock	(7,000)	(7,000)
Dividend on preferred stock	(200)		(200)
Balance, end of period at Jun. 30, 2013	66,520	4,000	62,520
Balance, beginning of period at Mar. 31, 2013	73,039	11,000	62,039
Increase (Decrease) in Shareholders' Equity
Net income (loss) for period	1,260		1,260	1,260
Net unrealized gain (loss) on securities available for sale	(540)		(540)	(540)
Total comprehensive income (loss)	720		720	720
Stock compensation	75		75
Dividend on common stock	(222)		(222)
Repurchase of common stock	(29)		(29)
Redemption of Preferred Series A stock	(7,000)	(7,000)
Dividend on preferred stock	(63)		(63)
Balance, end of period at Jun. 30, 2013	$ 66,520	$ 4,000	$ 62,520

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SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

6 Months Ended

Jun. 30, 2013

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The unaudited condensed consolidated financial statements of Mackinac Financial Corporation (the “Corporation”) have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the six-month period ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.  The unaudited consolidated financial statements and footnotes thereto should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2012.

In order to properly reflect some categories of other income and other expenses, reclassifications of expense and income items have been made to prior period numbers.  The “net” other income and other expenses was not changed due to these reclassifications.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of deferred tax assets, mortgage servicing rights and other real estate held for sale.

Allowance for Loan Losses

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

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

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

Stock Compensation Plans

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

On May 22, 2012, the Corporation’s shareholders approved the Mackinac Financial Corporation 2012 Incentive Compensation Plan, under which current and prospective employees, non-employee directors and consultants may be awarded incentive stock options, non-statutory stock options, shares of restricted stock units (“RSUs”), or stock appreciation rights.  The aggregate number of shares of the Corporation’s common stock issuable under the plan is 757,848.

On August 31, 2012, the Corporation granted 148,500 RSUs to certain members of management and all outside directors at the market value of the stock, which was $7.91.  The RSUs were awarded at no cost to the employee and vest ratably over a four-year period.  Compensation cost to be recognized over the four-year vesting period is $1.175 million.  As of June 30, 2013, none of the RSUs were vested and unrecognized compensation expense was $.975 million.

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LOANS

6 Months Ended

Jun. 30, 2013

LOANS

LOANS

4.     LOANS

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

	June 30,		December 31,		June 30,
	2013		2012		2012
Commercial real estate	$	243,363	$	244,966	$	211,506
Commercial, financial, and agricultural	84,145		80,646		85,099
One to four family residential real estate	94,254		87,948		84,665
Construction :
Consumer	4,305		7,465		5,595
Commerical	16,053		17,229		22,793
Consumer	13,435		10,923		9,795
Total loans	$	455,555	$	449,177	$	419,453

An analysis of the allowance for loan losses for the six months ended June 30, 2013, the year ended December 31, 2012, and the six months ended June 30, 2012 is as follows (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
Balance at beginning of period	$	5,218		$	5,251		$	5,251
Recoveries on loans previously charged off	100			278			219
Loans charged off	(616		)	(1,256		)	(1,032		)
Provision	475			945			645
Balance at end of period	$	5,177		$	5,218		$	5,083

In the first half of 2013, net charge off activity was $.516 million, or .23% of average loans outstanding compared to net charge-offs of $.813 million, or .40% of average loans, in the same period in 2012.   In the first half of 2013, the Corporation recorded a provision for loan loss of $.475 million compared to $.645 million in the first half of 2012.  The Corporation’s allowance for loan loss reserve policy calls for a measurement of the adequacy of the reserve at each quarter end.  This process includes an analysis of the loan portfolio to take into account increases in loans outstanding and portfolio composition, historical loss rates, and specific reserve requirements of nonperforming loans.

A breakdown of the allowance for loan losses and recorded balances in loans at June 30, 2013 is as follows (dollars in thousands):

				Commercial,						One to four
	Commercial			financial and			Commercial			family residential			Consumer
	real estate			agricultural			construction			real estate			construction		Consumer			Unallocated			Total
Three Months Ended June 30, 2013
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,964		$	847		$	118		$	990		$	—	$	13		$	105		$	5,037
Charge-offs	(21		)	(4		)	—			(6		)	—		(5		)	—			(36		)
Recoveries	29			30			1			6			—		10			—			76
Provision	(311		)	217			(22		)	(113		)	—		(5		)	334			100
Ending balance ALLR	$	2,661		$	1,090		$	97		$	877		$	—	$	13		$	439		$	5,177
Six Months Ended June 30, 2013
Allowance for loan loss reserve:
Beginning balance ALLR	$	3,267		$	692		$	125		$	980		$	—	$	—		$	154		$	5,218
Charge-offs	(456		)	(76		)	—			(13		)	—		(71		)	—			(616		)
Recoveries	41			33			2			11			—		13			—			100
Provision	(191		)	441			(30		)	(101		)	—		71			285			475
Ending balance ALLR	$	2,661		$	1,090		$	97		$	877		$	—	$	13		$	439		$	5,177
At June 30,2013
Loans:
Ending balance	$	243,363		$	84,145		$	16,053		$	94,254		$	4,305	$	13,435		$	—		$	455,555
Ending balance ALLR	(2,661		)	(1,090		)	(97		)	(877		)	—		(13		)	(439		)	(5,177		)
Net loans	$	240,702		$	83,055		$	15,956		$	93,377		$	4,305	$	13,422		$	(439	)	$	450,378
Ending balance ALLR:
Individually evaluated	$	1,396		$	643		$	8		$	148		$	—	$	13		$	—		$	2,208
Collectively evaluated	1,265			447			89			729			—		—			439			2,969
Total	$	2,661		$	1,090		$	97		$	877		$	—	$	13		$	439		$	5,177
Ending balance Loans:
Individually evaluated	$	14,499		$	6,668		$	917		$	640		$	—	$	22		$	—		$	22,746
Collectively evaluated	228,864			77,477			15,136			93,614			4,305		13,413			—			432,809
Total	$	243,363		$	84,145		$	16,053		$	94,254		$	4,305	$	13,435		$	—		$	455,555

Impaired loans, by definition, are individually evaluated.

A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2012 is as follows (dollars in thousands):

	Commercial			Commercial, financial and			Commercial			One to four family residential			Consumer
	real estate			agricultural			construction			real estate			construction			Consumer			Unallocated			Total
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,823		$	1,079		$	207		$	1,114		$	—		$	—		$	28		5,251
Charge-offs	(729		)	(40		)	(6		)	(399		)	—			(82		)	—			(1,256		)
Recoveries	52			201			—			7			—			18			—			278
Provision	1,121			(548		)	(76		)	258			—			64			126			945
Ending balance ALLR	$	3,267		$	692		$	125		$	980		$	—		$	—		$	154		$	5,218
Loans:
Ending balance	$	244,966		$	80,646		$	17,229		$	87,948		$	7,465		$	10,923		$	—		$	449,177
Ending balance ALLR	(3,267		)	(692		)	(125		)	(980		)	—			—			(154		)	(5,218		)
Net loans	$	241,699		$	79,954		$	17,104		$	86,968		$	7,465		$	10,923		$	(154	)	$	443,959
Ending balance ALLR:
Individually evaluated	$	1,662		$	155		$	10		$	112		$	—		$	—		$	—		$	1,939
Collectively evaluated	1,605			537			115			868			—			—			154			3,279
Total	$	3,267		$	692		$	125		$	980		$	—		$	—		$	154		$	5,218
Ending balance Loans:
Individually evaluated	$	22,910		$	6,070		$	858		$	796		$	—		$	—		$	—		$	30,634
Collectively evaluated	222,056			74,576			16,371			87,152			7,465			10,923			—			418,543
Total	$	244,966		$	80,646		$	17,229		$	87,948		$	7,465		$	10,923		$	—		$	449,177
A breakdown of the allowance for loan losses and recorded balances in loans at June 30, 2012 is as follows (dollars in thousands):
	Commercial			Commercial, financial and			Commercial			One to four family residential			Consumer
	real estate			agricultural			construction			real estate			construction			Consumer			Unallocated			Total
Three Months Ended June 30, 2012
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,785		$	1,126		$	230		$	1,083		$	—		$	—		$	158		$	5,382
Charge-offs	(518		)	(4		)	(6		)	(106		)	5			(7		)	—			(636		)
Recoveries	10			169			—			4			—			4						187
Provision	507			(403		)	(6		)	102			(5		)	3			(48		)	150
Ending balance ALLR	$	2,784		$	888		$	218		$	1,083		$	—		$	—		$	110		$	5,083
Six Months Ended June 30, 2012
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,823		$	1,079		$	207		$	1,114		$	—		$	—		$	28		$	5,251
Charge-offs	(691		)	(24		)	(6		)	(296		)	—			(15		)	—			(1,032		)
Recoveries	18			187			—			5			—			9			—			219
Provision	634			(354		)	17			260			—			6			82			645
Ending balance ALLR	$	2,784		$	888		$	218		$	1,083		$	—		$	—		$	110		$	5,083
At June 30,2012
Loans:
Ending balance	$	211,506		$	85,099		$	22,793		$	84,665		$	5,595		$	9,795		$	—		$	419,453
Ending balance ALLR	(2,784		)	(888		)	(218		)	(1,083		)	—			—			(110		)	(5,083		)
Net loans	$	208,722		$	84,211		$	22,575		$	83,582		$	5,595		$	9,795		$	(110	)	$	414,370
Ending balance ALLR:
Individually evaluated	$	1,000		$	148		$	12		$	36		$	—		$	—		$	—		$	1,196
Collectively evaluated	1,784			740			206			1,047			—			—			110			3,887
Total	$	2,784		$	888		$	218		$	1,083		$	—		$	—		$	110		$	5,083
Ending balance Loans:
Individually evaluated	$	22,119		$	6,150		$	1,534		$	764		$	15		$	—		$	—		$	30,582
Collectively evaluated	189,387			78,949			21,259			83,901			5,580			9,795			—			388,871
Total	$	211,506		$	85,099		$	22,793		$	84,665		$	5,595		$	9,795		$	—		$	419,453

Impaired loans, by definition, are individually evaluated.

As part of the management of the loan portfolio, risk ratings are assigned to all commercial loans.  Through the loan review process, ratings are modified as believed to be appropriate to reflect changes in the credit.  Our ability to manage credit risk depends in large part on our ability to properly identify and manage problem loans.  To do so, we operate a credit risk rating system under which our credit management personnel assign a credit risk rating to each loan at the time of origination and review loans on a regular basis to determine each loan’s credit risk rating on a scale of 1 through 8, with higher scores indicating higher risk.  The credit risk rating structure used is shown below.

In the context of the credit risk rating structure, the term Classified is defined as a problem loan which may or may not be in a nonaccrual status, dependent upon current payment status and collectability.

Excellent (1)

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

Good (2)

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

Average (3)

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

Acceptable (4)

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

Special Mention (5)

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

Substandard (6)

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

Doubtful (7)

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

Charge-off/Loss (8)

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

General Reserves:

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

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

Commercial construction loans in the amount of $3.394 million, $3.468 million and $3.407 million for the periods ended June 30, 2013, December 31, 2012 and June 30, 2012, respectively did not receive a specific risk rating.  These amounts represent loans made for land development and unimproved land purchases.  Below is a breakdown of loans by risk category as of June 30, 2013 (dollars in thousands):

	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp. Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	2,294	$	22,319	$	86,404	$	111,180	$	16,446	$	4,531	$	189	$	—	$	243,363
Commercial, financial and agricultural	4,997		5,253		21,780		46,214		4,176		1,725		—		—		84,145
Commercial construction	—		723		5,119		5,660		755		402		—		3,394		16,053
One to four family residential real estate	—		1,954		2,465		4,565		—		—		—		85,270		94,254
Consumer construction	—		—				—		—		—		—		4,305		4,305
Consumer	—		109		36		470		—		—		—		12,820		13,435
Total loans	$	7,291	$	30,358	$	115,804	$	168,089	$	21,377	$	6,658	$	189	$	105,789	$	455,555

Below is a breakdown of loans by risk category as of December 31, 2012 (dollars in thousands):

	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp. Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	4,807	$	20,491	$	84,164	$	113,379	$	16,754	$	5,189	$	182	$	—	$	244,966
Commercial, financial and agricultural	5,026		3,936		23,821		41,785		4,296		1,782		—		—		80,646
Commercial construction	—		1,038		5,103		5,784		759		1,077		—		3,468		17,229
One-to-four family residential real estate	—		1,969		3,635		4,791		—		646		—		76,907		87,948
Consumer construction	—		—		—		—		—		—		—		7,465		7,465
Consumer	—		359		71		257		—		6		—		10,230		10,923
Total loans	$	9,833	$	27,793	$	116,794	$	165,996	$	21,809	$	8,700	$	182	$	98,070	$	449,177

Below is a breakdown of loans by risk category as of June 30, 2012 (dollars in thousands):

	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp. Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	4,394	$	16,806	$	56,024	$	111,719	$	16,917	$	5,452	$	194	$	—	$	211,506
Commercial, financial and agricultural	4,316		5,827		20,866		47,912		4,468		1,710		—		—		85,099
Commercial construction	205		849		5,582		10,892		766		1,092		—		3,407		22,793
One to four family residential real estate	—		1,987		3,774		5,789		—		790		—		72,325		84,665
Consumer construction	—		—		—		—		—		—		—		5,595		5,595
Consumer	—		—		77		582		—		—		—		9,136		9,795
Total loans	$	8,915	$	25,469	$	86,323	$	176,894	$	22,151	$	9,044	$	194	$	90,463	$	419,453

Impaired Loans

Nonperforming loans are those which are contractually past due 90 days or more as to interest or principal payments, on nonaccrual status, or loans, the terms of which have been renegotiated to provide a reduction or deferral on interest or principal.  There was no interest income recorded during impairment for the three and six months ended June 30, 2013.  Interest income that would have been recognized during these periods was $.059 million and $.117 million, respectively.  For the three and six months ended June 30, 2012, the amounts that would have been recognized were $.037 million and $.174 million, respectively.

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

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

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

											Three Months Ended				Six Months Ended
					QTD		YTD				Interest Income		Interest Income		Interest Income		Interest Income
	Nonaccrual		Accrual		Average		Average		Related		Recognized		on		Recognized		on
	Basis		Basis		Investment		Investment		Valuation Reserve		During Impairment		Accrual Basis		During Impairment		Accrual Basis
June  30, 2013
With no valuation reserve:
Commercial real estate	$	728	$	—	$	733	$	797	$	—	$	—	$	14	$	—	$	26
Commercial, financial and agricultural	176		—		206		248		—		—		3		—		6
Commercial construction	—		—		—		275		—		—		—		—		3
One to four family residential real estate	94		—		133		165		—		—		3		—		5
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	9		—		2		1		—		—		—		—		—
With a valuation reserve:
Commercial real estate	$	2,329	$	—	$	2,308	$	2,298	$	1,240	$	—	$	30	$	—	$	60
Commercial, financial and agricultural	341		—		267		199		106		—		4		—		6
Commercial construction	—		—		—		—		—		—		—		—		—
One to four family residential real estate	306		—		303		289		126		—		5		—		11
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	—		—		—		—		—		—		—		—		—
Total:
Commercial real estate	$	3,057	$	—	$	3,041	$	3,095	$	1,240	$	—	$	44	$	—	$	86
Commercial, financial and agricultural	517		—		473		447		106		—		7		—		12
Commercial construction	—		—		—		275		—		—		—		—		3
One to four family residential real estate	400		—		436		454		126		—		8		—		16
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	9		—		2		1		—		—		—		—		—
Total	$	3,983	$	—	$	3,952	$	4,272	$	1,472	$	—	$	59	$	—	$	117

									Interest Income		Interest Income
For the Year Ended:	Nonaccrual		Accrual		Average		Related		Recognized		on
December 31, 2012	Basis		Basis		Investment		Valuation Reserve		During Impairment		Accrual Basis
With no valuation reserve:
Commercial real estate	$	132	$	—	$	1,550	$	—	$	—	$	37
Commercial, financial and agricultural	—		—		1,063		—		—		19
Commercial construction	675		—		675		—		—		15
One to four family residential real estate	230		—		1,074		—		—		41
Consumer construction	—		—		16		—		—		1
Consumer	—		—		3		—		—		—
With a valuation reserve:
Commercial real estate	$	2,939	$	—	$	3,173	$	1,315	$	54	$	177
Commercial, financial and agricultural	436		—		504		109		—		17
Commercial construction	—		—		—		—		—		—
One to four family residential real estate	275		—		281		95		—		6
Consumer construction	—		—		—		—		—		—
Consumer	—		—		—		—		—		—
Total:
Commercial real estate	$	3,071	$	—	$	4,723	$	1,315	$	54	$	214
Commercial, financial and agricultural	436		—		1,567		109		—		36
Commercial construction	675		—		675		—		—		15
One to four family residential real estate	505		—		1,355		95		—		47
Consumer construction	—		—		16		—		—		1
Consumer	—		—		3		—		—		—
Total	$	4,687	$	—	$	8,339	$	1,519	$	54	$	313

											Three Months Ended				Six Months Ended
					QTD		YTD				Interest Income		Interest Income		Interest Income		Interest Income
	Nonaccrual		Accrual		Average		Average		Related		Recognized		on		Recognized		on
	Basis		Basis		Investment		Investment		Valuation Reserve		During Impairment		Accrual Basis		During Impairment		Accrual Basis
June  30, 2012
With no valuation reserve:
Commercial real estate	$	535	$	—	$	655	$	1,138	$	—	$	—	$	9	$	—	$	23
Commercial, financial and agricultural	—		—		780		1,063		—		—		7		—		18
Commercial construction	676		—		338		676		—		—		4		—		4
One to four family residential real estate	543		—		613		874		—		—		9		—		24
Consumer construction	15		—		15		16		—		—		1		—		1
Consumer	—		—		—		—		—		—		—		—		—
With a valuation reserve:
Commercial real estate	$	3,214	$	—	$	3,604	$	3,916	$	708	$	17	$	80	$	37	$	94
Commercial, financial and agricultural	278		—		429		459		84		—		—		—		8
Commercial construction	—		—		—		—		—		—		—		—		—
One to four family residential real estate	114		—		93		114		18		—		2		—		2
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	—		—		—		—		—		—		—		—		—
Total:
Commercial real estate	$	3,749	$	—	$	4,259	$	5,054	$	708	$	17	$	89	$	37	$	117
Commercial, financial and agricultural	278		—		1,209		1,522		84		—		7		—		26
Commercial construction	676		—		338		676		—		—		4		—		4
One to four family residential real estate	657		—		706		988		18		—		11		—		26
Consumer construction	15		—		15		16		—		—		1		—		1
Consumer	—		—		—		—		—		—		—		—		—
Total	$	5,375	$	—	$	6,527	$	8,256	$	810	$	17	$	112	$	37	$	174

A summary of past due loans at June 30, 2013, December 31, 2012 and June 30, 2012 is as follows (dollars in thousands):

	June 30,						December 31,						June 30,
	2013						2012						2012
	30-89 days		90+ days				30-89 days		90+ days				30-89 days		90+ days
	Past Due		Past Due/				Past Due		Past Due/				Past Due		Past Due/
	(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total
Commercial real estate	$	146	$	3,057	$	3,203	$	575	$	3,071	$	3,646	$	—	$	3,749	$	3,749
Commercial, financial and agricultural	92		517		609		71		436		507		—		278		278
Commercial construction	—		—		—		—		675		675		—		676		676
One to four family residential real estate	100		400		500		291		505		796		286		657		943
Consumer construction	—		—		—		—		—		—		—		15		15
Consumer	18		9		27		14		—		14		14		—		14
Total past due loans	$	356	$	3,983	$	4,339	$	951	$	4,687	$	5,638	$	300	$	5,375	$	5,675

A roll-forward of nonaccrual activity for the three months ended June 30, 2013 (dollars in thousands):

	For the Three Months Ended June  30, 2013
				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction		Consumer			Total
NONACCRUAL
Beginning balance	$	2,963		$	424		$	—	$	446		$	—	$	—		$	3,833
Principal payments	(31		)	(66		)	—		(16		)	—		—			(113		)
Charge-offs	—			—			—		(6		)	—		(4		)	(10		)
Advances	—			—			—		—			—		—			—
Class transfers	—			—			—		—			—		—			—
Transfers to OREO	—			—			—		(38		)	—		—			(38		)
Transfers to accruing	—			—			—		—			—		—			—
Transfers from accruing	126			179			—		14			—		13			332
Other	(1		)	(20		)	—		—			—		—			(21		)
Ending balance	$	3,057		$	517		$	—	$	400		$	—	$	9		$	3,983

A roll-forward of nonaccrual activity for the three months ended June 30, 2012 (dollars in thousands):

	For the Three Months Ended June  30, 2012
				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction		Consumer		Total
NONACCRUAL
Beginning balance	$	1,954		$	1,626		$	—	$	862		$	15	$	—	$	4,457
Principal payments	(646		)	(1,351		)	—		(4		)	—		—		(2,001		)
Charge-offs	(417		)	—			—		(106		)	—		—		(523		)
Advances	—			—			—		—			—		—		—
Class transfers	—			—			—		—			—		—		—
Transfers to OREO	(139		)	—			—		(186		)	—		—		(325		)
Transfers to accruing	—			—			—		—			—		—		—
Transfers from accruing	2,978			—			676		88			—		—		3,742
Other	19			3			—		3			—		—		25
Ending balance	$	3,749		$	278		$	676	$	657		$	15	$	—	$	5,375

A roll-forward of nonaccrual activity for the first six months ended June 30, 2013 (dollars in thousands):

	For the Six Months Ended June 30, 2013
				Commercial,						One to four
	Commercial			Financial and			Commercial			family residential			Consumer
	Real Estate			Agricultural			Construction			real estate			Construction		Consumer			Total
NONACCRUAL
Beginning balance	$	3,071		$	436		$	675		$	505		$	—	$	—		$	4,687
Principal payments	(148		)	(68		)	(100		)	(65		)	—		—			(381		)
Charge-offs	(329		)	(72		)	—			(13		)	—		(4		)	(418		)
Advances	—			—			—			—			—		—			—
Class transfers	—			—			—			—			—		—			—
Transfers to OREO	—			—			(580		)	(107		)	—		—			(687		)
Transfers to accruing	—			—			—			—			—		—			—
Transfers from accruing	443			241			—			76			—		13			773
Other	20			(20		)	5			4			—		—			9
Ending balance	$	3,057		$	517		$	—		$	400		$	—	$	9		$	3,983

A roll-forward of nonaccrual activity for the first six months ended June 30, 2012 (dollars in thousands):

	For the Six Months Ended June 30, 2012
				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction			Consumer		Total
NONACCRUAL
Beginning balance	$	2,362		$	1,111		$	—	$	1,997		$	20		$	—	$	5,490
Principal payments	(1,012		)	(1,382		)	—		(1,052		)	—			—		(3,446		)
Charge-offs	(463		)	—			—		(293		)	(5		)	—		(761		)
Advances	—			—			—		—			—			—		—
Class transfers	—			—			—		—			—			—		—
Transfers to OREO	(466		)	—			—		(219		)	—			—		(685		)
Transfers to accruing	—			—			—		—			—			—		—
Transfers from accruing	3,288			559			676		220			—			—		4,743
Other	40			(10		)	—		4			—			—		34
Ending balance	$	3,749		$	278		$	676	$	657		$	15		$	—	$	5,375

A roll-forward of nonaccrual activity during the year ended December 31, 2012 (dollars in thousands):

				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction			Consumer			Total
NONACCRUAL
Beginning balance	$	2,362		$	1,111		$	—	$	1,997		$	20		$	—		$	5,490
Principal payments	(1,569		)	(1,385		)	—		(1,068		)	—			—			(4,022		)
Charge-offs	(463		)	—			—		(387		)	(5		)	(3		)	(858		)
Advances	—			—			—		—			—			—			—
Class transfers	—			—			—		—			—			—			—
Transfers to OREO	(675		)	—			—		(662		)	(15		)	—			(1,352		)
Transfers to accruing	—			—			—		—			—			—			—
Transfers from accruing	3,377			716			675		617			—			3			5,388
Other	39			(6		)	—		8			—			—			41
Ending balance	$	3,071		$	436		$	675	$	505		$	—		$	—		$	4,687

Troubled Debt Restructuring

Troubled debt restructurings (“TDR”) are determined on a loan-by-loan basis.  Generally restructurings are related to interest rate reductions, loan term extensions and short term payment forbearance as means to maximize collectability of troubled credits.  If a portion of the TDR loan is uncollectible (including forgiveness of principal), the uncollectible amount will be charged off against the allowance at the time of the restructuring.  In general, a borrower must make at least six consecutive timely payments before the Corporation would consider a return of a restructured loan to accruing status in accordance with FDIC guidelines regarding restoration of credits to accrual status.

The Corporation has, in accordance with generally accepted accounting principles and per recently enacted accounting standard updates, evaluated all loan modifications to determine the fair value impact of the underlying asset.  The carrying amount of the loan is compared to the expected payments to be received, discounted at the loan’s original rate, or for collateral dependent loans, to the fair value of the collateral.

A summary of troubled debt restructurings for the periods indicated is as follows (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
	Number of	Recorded		Number of	Recorded		Number of	Recorded
	Modifications	Investment		Modifications	Investment		Modifications	Investment
Commercial real estate	—	$	—	3	$	4,614	—	$	—
Commercial, financial and agricultural	—	—		1	1,221		—	—
Commercial construction	—	—		3	860		—	—
One to four family residential real estate	—	—		1	102		—	—
Consumer construction	—	—		—	—		—	—
Consumer	—	—		—	—		—	—
Total troubled debt restructurings	—	$	—	8	$	6,797	—	$	—

A roll-forward of troubled debt restructuring during the three months ended June 30, 2013 (dollars in thousands):

				Commercial,				One to four		Consumer and
	Commercial			Financial and		Commercial		family residential		Consumer
	Real Estate			Agricultural		Construction		real estate		Construction		Total
ACCRUING
Beginning balance	$	3,588		$	2,174	$	858	$	100	$	—	$	6,720
Principal payments	(25		)	—		—		—		—		(25		)
Charge-offs	—			—		—		—		—		—
Advances	—			—		—		—		—		—
New restructured	—			—		—		—		—		—
Transferred out of TDR	—			—		—		—		—		—
Transfers to nonaccrual	—			—		—		—		—		—
Ending Balance	$	3,563		$	2,174	$	858	$	100	$	—	$	6,695
NONACCRUAL
Beginning balance	$	2,169		$	—	$	—	$	106	$	—	$	2,275
Principal payments	—			—		—		—		—		—
Charge-offs	—			—		—		—		—		—
Advances	—			—		—		—		—		—
New restructured	—			—		—		—		—		—
Transfers to foreclosed properties	—			—		—		—		—		—
Transfers from accruing	—			—		—		—		—		—
Ending Balance	$	2,169		$	—	$	—	$	106	$	—	$	2,275
TOTALS
Beginning balance	$	5,757		$	2,174	$	858	$	206	$	—	$	8,995
Principal payments	(25		)	—		—		—		—		(25		)
Charge-offs	—			—		—		—		—		—
Advances	—			—		—		—		—		—
New restructured	—			—		—		—		—		—
Transfers out of TDRs	—			—		—		—		—		—
Tansfers to nonaccrual	—			—		—		—		—		—
Transfers to foreclosed properties	—			—		—		—		—		—
Transfers from accruing	—			—		—		—		—		—
Ending Balance	$	5,732		$	2,174	$	858	$	206	$	—	$	8,970

A roll-forward of troubled debt restructuring during the three months ended June 30, 2012 (dollars in thousands):

				Commercial,						One to four			Consumer and
	Commercial			Financial and			Commercial			family residential			Consumer
	Real Estate			Agricultural			Construction			real estate			Construction		Total
ACCRUING
Beginning balance	$	3,672		$	1,221		$	859		$	103		$	—	$	5,855
Principal payments	(19		)	—			(1		)	(1		)	—		(21		)
Charge-offs	—			—			—			—			—		—
Advances	—			—			—			—			—		—
New restructured	—			—			—			—			—		—
Transferred out of TDRs	—			—			—			—			—		—
Transfers to nonaccrual	—			—			—			—			—		—
Ending Balance	$	3,653		$	1,221		$	858		$	102		$	—	$	5,834
NONACCRUAL
Beginning balance	$	3,235		$	1,072		$	—		$	293		$	—	$	4,600
Principal payments	(615		)	(1,072		)	—			—			—		(1,687		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	—			—			—			—			—		—
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	—			—			—			—			—		—
Ending Balance	$	2,194		$	—		$	—		$	6		$	—	$	2,200
TOTALS
Beginning balance	$	6,907		$	2,293		$	859		$	396		$	—	$	10,455
Principal payments	(634		)	(1,072		)	(1		)	(1		)	—		(1,708		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	—			—			—			—			—		—
Transfers out of TDRs	—			—			—			—			—		—
Tansfers to nonaccrual	—			—			—			—			—		—
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	—			—			—			—			—		—
Ending Balance	$	5,847		$	1,221		$	858		$	108		$	—	$	8,034

A roll-forward of troubled debt restructuring during the six months ended June 30, 2013 (dollars in thousands):

				Commercial,				One to four			Consumer and
	Commercial			Financial and		Commercial		family residential			Consumer
	Real Estate			Agricultural		Construction		real estate			Construction		Total
ACCRUING
Beginning balance	$	3,611		$	1,221	$	858	$	102		$	—	$	5,792
Principal payments	(48		)	—		—		(2		)	—		(50		)
Charge-offs	—			—		—		—			—		—
Advances	—			—		—		—			—		—
New restructured	—			953		—		—			—		953
Transferred out of TDRs	—			—		—		—			—		—
Transfers to nonaccrual	—			—		—		—			—		—
Ending Balance	$	3,563		$	2,174	$	858	$	100		$	—	$	6,695
NONACCRUAL
Beginning balance	$	2,162		$	—	$	—	$	102		$	—	$	2,264
Principal payments	—			—		—		—			—		—
Charge-offs	—			—		—		—			—		—
Advances	—			—		—		—			—		—
New restructured	7			—		—		4			—		11
Transfers to foreclosed properties	—			—		—		—			—		—
Transfers from accruing	—			—		—		—			—		—
Ending Balance	$	2,169		$	—	$	—	$	106		$	—	$	2,275
TOTALS
Beginning balance	$	5,773		$	1,221	$	858	$	204		$	—	$	8,056
Principal payments	(48		)	—		—		(2		)	—		(50		)
Charge-offs	—			—		—		—			—		—
Advances	—			—		—		—			—		—
New restructured	7			953		—		4			—		964
Transfers out of TDR	—			—		—		—			—		—
Transfers to nonaccrual	—			—		—		—			—		—
Transfers to foreclosed properties	—			—		—		—			—		—
Transfer from accruing	—			—		—		—			—		—
Ending Balance	$	5,732		$	2,174	$	858	$	206		$	—	$	8,970

A roll-forward of troubled debt restructuring during the six months ended June 30, 2012 (dollars in thousands):

				Commercial,						One to four			Consumer and
	Commercial			Financial and			Commercial			family residential			Consumer
	Real Estate			Agricultural			Construction			real estate			Construction		Total
ACCRUING
Beginning balance	$	2,400		$	—		$	—		$	103				$	2,503
Principal payments	(19		)	—			(1		)	(1		)	—		(21		)
Charge-offs	—			—			—			—			—		—
Advances	—			—			—			—			—		—
New restructured	3,672			1,221			859			—			—		5,752
Transferred out of TDRs	—			—			—			—			—		—
Transfers to nonaccrual	(2,400		)	—			—			—			—		(2,400		)
Ending Balance	$	3,653		$	1,221		$	858		$	102		$	—	$	5,834
NONACCRUAL
Beginning balance	$	—		$	—		$	—		$	—		$	—	$	—
Principal payments	(615		)	(1,072		)	—			—			—		(1,687		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	835			1,072			—			293			—		2,200
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	2,400			—			—			—			—		2,400
Ending Balance	$	2,194		$	—		$	—		$	6		$	—	$	2,200
TOTALS
Beginning balance	$	2,400		$	—		$	—		$	103		$	—	$	2,503
Principal payments	(634		)	(1,072		)	(1		)	(1		)	—		(1,708		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	4,507			2,293			859			293			—		7,952
Transfers out of TDRs	—			—			—			—			—		—
Transfers to nonaccrual	(2,400		)	—			—			—			—		(2,400		)
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	2,400			—			—			—			—		2,400
Ending Balance	$	5,847		$	1,221		$	858		$	108		$	—	$	8,034

A roll-forward of troubled debt restructuring during the year ended December 31, 2012 (dollars in thousands):

				Commercial,					One to four			Consumer and
	Commercial			Financial and		Commercial			family residential			Consumer
	Real Estate			Agricultural		Construction			real estate			Construction		Total
ACCRUING
Beginning balance	$	2,400		$	—	$	—		$	103		$	—	$	2,503
Principal payments	(84		)	—		(2		)	(1		)	—		(87		)
Charge-offs	—			—		—			—			—		—
Advances	—			—		—			—			—		—
New restructured	3,695			1,221		860			—			—		5,776
Transferred out of TDR	—			—		—			—			—		—
Transfers to nonaccrual	(2,400		)	—		—			—			—		(2,400		)
Ending Balance	$	3,611		$	1,221	$	858		$	102		$	—	$	5,792
NONACCRUAL
Beginning balance	$	—		$	—	$	—		$	—		$	—	$	—
Principal payments	(432		)	—		—			—			—		(432		)
Charge-offs	(772		)	—		—			—			—		(772		)
Advances	47			—		—			—			—		47
New restructured	919			—		—			102			—		1,021
Transfers to foreclosed properties	—			—		—			—			—		—
Transfers from accruing	2,400			—		—			—			—		2,400
Ending Balance	$	2,162		$	—	$	—		$	102		$	—	$	2,264
TOTALS
Beginning balance	$	2,400		$	—	$	—		$	103		$	—	$	2,503
Principal payments	(516		)	—		(2		)	(1		)	—		(519		)
Charge-offs	(772		)	—		—			—			—		(772		)
Advances	47			—		—			—			—		47
New restructured	4,614			1,221		860			102			—		6,797
Transfers out of TDRs	—			—		—			—			—		—
Tansfers to nonaccrual	(2,400		)	—		—			—			—		(2,400		)
Transfers to foreclosed properties	—			—		—			—			—		—
Transfers from accruing	2,400			—		—			—			—		2,400
Ending Balance	$	5,773		$	1,221	$	858		$	204		$	—	$	8,056

Insider Loans

The Bank, in the ordinary course of business, grants loans to the Corporation’s executive officers and directors, including their families and firms in which they are principal owners. Activity in such loans is summarized below (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
Loans outstanding, beginning of period	$	11,297		$	8,827		$	8,827
New loans	496			3,911			936
Net activity on revolving lines of credit	(25		)	233			41
Principal payments	(1,298		)	(1,674		)	(419		)
Loans outstanding, end of period	$	10,470		$	11,297		$	9,385

There were no loans to related parties classified substandard as of June 30, 2013, December 31, 2012 or June 30, 2012.  In addition to the outstanding balances above, there were unfunded commitments of $.055 million to related parties at June 30, 2013.

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EARNINGS PER SHARE

6 Months Ended

Jun. 30, 2013

EARNINGS PER SHARE

EARNINGS PER SHARE

2.     EARNINGS PER SHARE

Diluted earnings per share, which reflects the potential dilution that could occur if outstanding stock options were exercised and stock awards were fully vested and resulted in the issuance of common stock that then shared in our earnings, is computed by dividing net income by the weighted average number of common shares outstanding and common stock equivalents, after giving effect for dilutive shares issued.

The following shows the computation of basic and diluted earnings per share for the three and six months ended June 30, 2013 and 2012 (dollars in thousands, except per share data):

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
(Numerator):
Net income	$	1,260	$	4,302	$	2,073	$	4,993
Preferred stock dividends and accretion of discount	63		161		200		354
Net income available to common shareholders	$	1,197	$	4,141	$	1,873	$	4,639
(Denominator):
Weighted average shares outstanding - basic	5,556,133		3,419,736		5,557,842		3,419,736
Dilutive effect of common stock warrants	—		120,172		—		112,904
Weighted average shares outstanding - diluted	5,556,133		3,539,908		5,557,842		3,532,640
Income per common share*:
Basic	$	.22	$	.97	$	.34	$	1.09
Diluted	$	.22	$	.94	$	.34	$	1.05

*Earnings per share data for 2012 restated for common stock issuance

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BORROWINGS (Details) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2013	Dec. 31, 2012	Jun. 30, 2012
BORROWINGS
Borrowings	$ 35,925	$ 35,925	$ 35,997
Federal Home Loan Bank fixed rate advances at June 30, 2013 with a weighted average rate of 1.79% maturing in 2014, 2016 and 2018
BORROWINGS
Borrowings	35,000	35,000	35,000
Interest rate on note (as a percent)	1.79%
Federal Home Loan Bank fixed rate advances at June 30, 2013 with a weighted average rate of 1.79% maturing in 2014, 2016 and 2018 | Mortgage related and municipal securities
BORROWINGS
Securities pledged as collateral, amortized cost	6,233
Securities pledged as collateral, fair value	6,519
Federal Home Loan Bank fixed rate advances at June 30, 2013 with a weighted average rate of 1.79% maturing in 2014, 2016 and 2018 | Federal Home Loan Bank stock
BORROWINGS
Stock owned and pledged as collateral	3,060
Federal Home Loan Bank fixed rate advances at June 30, 2013 with a weighted average rate of 1.79% maturing in 2014, 2016 and 2018 | One to four family residential real estate
BORROWINGS
Loans pledged as collateral	38,844
USDA Rural Development, fixed-rate note payable, maturing August 24, 2024, interest payable at 1%
BORROWINGS
Borrowings	925	925	997
Interest rate on note (as a percent)	1.00%
USDA Rural Development, fixed-rate note payable, maturing August 24, 2024, interest payable at 1% | First Rural Relending
BORROWINGS
Loans pledged as collateral	132
Demand deposit account pledged as collateral	$ 873

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SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Details) (USD $) In Thousands, except Share data, unless otherwise specified		1 Months Ended	12 Months Ended		12 Months Ended			0 Months Ended	6 Months Ended
	Jun. 30, 2013 item	Aug. 31, 2012 RSUs	Dec. 31, 2004 Plan approved in 2000	Jun. 30, 2013 Plan approved in 2000 item	Dec. 31, 2004 Plans approved in 1997	Jun. 30, 2013 Plans approved in 1997 item	May 22, 2012 2012 Incentive Compensation Plan	Aug. 31, 2012 2012 Incentive Compensation Plan RSUs	Jun. 30, 2013 2012 Incentive Compensation Plan RSUs
Stock Compensation Plans
Number of stock option plans	3			1		2
Increase in number of shares authorized			428,587
Shares authorized prior to amendment			25,000
Reverse stock split, conversion ratio			0.05		0.05
Total authorized share balance			453,587		30,000		757,848
Number of RSUs granted (in shares)		148,500						148,500
Purchase price (in dollars per share)								$ 7.91
Cost to the employee								$ 0
Vesting period								4 years
Recognition period of compensation cost to be recognized								4 years
Compensation cost to be recognized, net of income tax								$ 1,175	$ 975
Number of RSUs vested (in shares)									0

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LOANS (Details 2) (USD $) In Thousands, unless otherwise specified	3 Months Ended		6 Months Ended		12 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012
Allowance for loan loss reserve:
Balance at beginning of period	$ 5,037	$ 5,382	$ 5,218	$ 5,251	$ 5,251
Charge-offs	(36)	(636)	(616)	(1,032)	(1,256)
Recoveries	76	187	100	219	278
Provision	100	150	475	645	945
Balance at end of period	5,177	5,083	5,177	5,083	5,218
Loans:
Ending balance	455,555	419,453	455,555	419,453	449,177
Ending balance ALLR	(5,177)	(5,083)	(5,177)	(5,083)	(5,218)
Net loans	450,378	414,370	450,378	414,370	443,959
Ending balance ALLR:
Individually evaluated	2,208	1,196	2,208	1,196	1,939
Collectively evaluated	2,969	3,887	2,969	3,887	3,279
Total	5,177	5,083	5,177	5,083	5,218
Ending balance Loans:
Individually evaluated	22,746	30,582	22,746	30,582	30,634
Collectively evaluated	432,809	388,871	432,809	388,871	418,543
Total Loans	455,555	419,453	455,555	419,453	449,177
Commercial real estate
Allowance for loan loss reserve:
Balance at beginning of period	2,964	2,785	3,267	2,823	2,823
Charge-offs	(21)	(518)	(456)	(691)	(729)
Recoveries	29	10	41	18	52
Provision	(311)	507	(191)	634	1,121
Balance at end of period	2,661	2,784	2,661	2,784	3,267
Loans:
Ending balance	243,363	211,506	243,363	211,506	244,966
Ending balance ALLR	(2,661)	(2,784)	(2,661)	(2,784)	(3,267)
Net loans	240,702	208,722	240,702	208,722	241,699
Ending balance ALLR:
Individually evaluated	1,396	1,000	1,396	1,000	1,662
Collectively evaluated	1,265	1,784	1,265	1,784	1,605
Total	2,661	2,784	2,661	2,784	3,267
Ending balance Loans:
Individually evaluated	14,499	22,119	14,499	22,119	22,910
Collectively evaluated	228,864	189,387	228,864	189,387	222,056
Total Loans	243,363	211,506	243,363	211,506	244,966
Commercial, financial, and agricultural
Allowance for loan loss reserve:
Balance at beginning of period	847	1,126	692	1,079	1,079
Charge-offs	(4)	(4)	(76)	(24)	(40)
Recoveries	30	169	33	187	201
Provision	217	(403)	441	(354)	(548)
Balance at end of period	1,090	888	1,090	888	692
Loans:
Ending balance	84,145	85,099	84,145	85,099	80,646
Ending balance ALLR	(1,090)	(888)	(1,090)	(888)	(692)
Net loans	83,055	84,211	83,055	84,211	79,954
Ending balance ALLR:
Individually evaluated	643	148	643	148	155
Collectively evaluated	447	740	447	740	537
Total	1,090	888	1,090	888	692
Ending balance Loans:
Individually evaluated	6,668	6,150	6,668	6,150	6,070
Collectively evaluated	77,477	78,949	77,477	78,949	74,576
Total Loans	84,145	85,099	84,145	85,099	80,646
Commercial construction
Allowance for loan loss reserve:
Balance at beginning of period	118	230	125	207	207
Charge-offs		(6)		(6)	(6)
Recoveries	1		2
Provision	(22)	(6)	(30)	17	(76)
Balance at end of period	97	218	97	218	125
Loans:
Ending balance	16,053	22,793	16,053	22,793	17,229
Ending balance ALLR	(97)	(218)	(97)	(218)	(125)
Net loans	15,956	22,575	15,956	22,575	17,104
Ending balance ALLR:
Individually evaluated	8	12	8	12	10
Collectively evaluated	89	206	89	206	115
Total	97	218	97	218	125
Ending balance Loans:
Individually evaluated	917	1,534	917	1,534	858
Collectively evaluated	15,136	21,259	15,136	21,259	16,371
Total Loans	16,053	22,793	16,053	22,793	17,229
One to four family residential real estate
Allowance for loan loss reserve:
Balance at beginning of period	990	1,083	980	1,114	1,114
Charge-offs	(6)	(106)	(13)	(296)	(399)
Recoveries	6	4	11	5	7
Provision	(113)	102	(101)	260	258
Balance at end of period	877	1,083	877	1,083	980
Loans:
Ending balance	94,254	84,665	94,254	84,665	87,948
Ending balance ALLR	(877)	(1,083)	(877)	(1,083)	(980)
Net loans	93,377	83,582	93,377	83,582	86,968
Ending balance ALLR:
Individually evaluated	148	36	148	36	112
Collectively evaluated	729	1,047	729	1,047	868
Total	877	1,083	877	1,083	980
Ending balance Loans:
Individually evaluated	640	764	640	764	796
Collectively evaluated	93,614	83,901	93,614	83,901	87,152
Total Loans	94,254	84,665	94,254	84,665	87,948
Consumer construction
Allowance for loan loss reserve:
Charge-offs		5
Provision		(5)
Loans:
Ending balance	4,305	5,595	4,305	5,595	7,465
Net loans	4,305	5,595	4,305	5,595	7,465
Ending balance Loans:
Individually evaluated		15		15
Collectively evaluated	4,305	5,580	4,305	5,580	7,465
Total Loans	4,305	5,595	4,305	5,595	7,465
Consumer
Allowance for loan loss reserve:
Balance at beginning of period	13
Charge-offs	(5)	(7)	(71)	(15)	(82)
Recoveries	10	4	13	9	18
Provision	(5)	3	71	6	64
Balance at end of period	13		13
Loans:
Ending balance	13,435	9,795	13,435	9,795	10,923
Ending balance ALLR	(13)		(13)
Net loans	13,422	9,795	13,422	9,795	10,923
Ending balance ALLR:
Individually evaluated	13		13
Total	13		13
Ending balance Loans:
Individually evaluated	22		22
Collectively evaluated	13,413	9,795	13,413	9,795	10,923
Total Loans	13,435	9,795	13,435	9,795	10,923
Unallocated
Allowance for loan loss reserve:
Balance at beginning of period	105	158	154	28	28
Provision	334	(48)	285	82	126
Balance at end of period	439	110	439	110	154
Loans:
Ending balance ALLR	(439)	(110)	(439)	(110)	(154)
Net loans	(439)	(110)	(439)	(110)	(154)
Ending balance ALLR:
Collectively evaluated	439	110	439	110	154
Total	$ 439	$ 110	$ 439	$ 110	$ 154

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LOANS (Details 7) (USD $) In Thousands, unless otherwise specified	12 Months Ended
	Dec. 31, 2012 item	Jun. 30, 2013 item
Troubled Debt Restructuring
Minimum number of consecutive timely payments before the Corporation would consider return of a restructured loan to accruing status		6
Number of Modifications	8
Recorded Investment	$ 6,797
Commercial real estate
Troubled Debt Restructuring
Number of Modifications	3
Recorded Investment	4,614
Commercial, financial, and agricultural
Troubled Debt Restructuring
Number of Modifications	1
Recorded Investment	1,221
Commercial construction
Troubled Debt Restructuring
Number of Modifications	3
Recorded Investment	860
One to four family residential real estate
Troubled Debt Restructuring
Number of Modifications	1
Recorded Investment	$ 102

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COMMITMENTS, CONTINGENCIES AND CREDIT RISK (Details) (USD $) In Thousands, unless otherwise specified	6 Months Ended
	Jun. 30, 2013	Dec. 31, 2012	Jun. 30, 2012
Financial Instruments with Off-Balance-Sheet Risk
Commitments	$ 64,253	$ 64,148	$ 63,749
Commitments to extend credit
Financial Instruments with Off-Balance-Sheet Risk
Commitments, variable rate	37,462	39,782	41,693
Commitments, fixed rate	19,873	18,427	15,452
Standby letters of credit
Financial Instruments with Off-Balance-Sheet Risk
Commitments, variable rate	3,805	2,879	3,378
Percentage collateralization on financial instruments allowed under commitments	100.00%
Credit card commitments
Financial Instruments with Off-Balance-Sheet Risk
Commitments, fixed rate	$ 3,113	$ 3,060	$ 3,226

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INCOME TAXES (Details) (USD $)	6 Months Ended
	Jun. 30, 2013	Dec. 31, 2012	Jun. 30, 2012
INCOME TAXES
Net operating loss (NOL) carryforwards	$ 19,800,000
Tax credit carryforwards	2,100,000
Expiration period from date of origination for net operating loss carryforwards	20 years
Portion of the NOL subject to limitations for utilization	8,400,000
Annual limitation for usage of NOL	1,400,000
Annual limitation for usage of tax credits	477,000
Deferred tax assets, net of valuation allowance	8,367,000	9,131,000	10,271,000
Valuation allowance	3,000,000
Adjustment warranted to the valuation	$ 0

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CONDENSED CONSOLIDATED BALANCE SHEETS (Parenthetical) (USD $)	Jun. 30, 2013	Dec. 31, 2012	Jun. 30, 2012
CONDENSED CONSOLIDATED BALANCE SHEETS
Preferred stock, par value	$ 0	$ 0	$ 0
Preferred stock, Authorized shares	500,000	500,000	500,000
Preferred stock, shares issued	4,000	11,000	11,000
Preferred stock, shares outstanding	4,000	11,000	11,000
Common stock, par value	$ 0	$ 0	$ 0
Common stock and additional paid in capital, authorized shares	18,000,000	18,000,000	18,000,000
Common stock and additional paid in capital, shares issued	5,554,459	5,559,859	3,419,736
Common stock and additional paid in capital, shares outstanding	5,554,459	5,559,859	3,419,736

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STOCK COMPENSATION PLANS

6 Months Ended

Jun. 30, 2013

STOCK COMPENSATION PLANS

STOCK COMPENSATION PLANS

7.     STOCK COMPENSATION PLANS

A summary of stock option transactions for the six months ended June 30, 2013 and 2012, and the year ended December 31, 2012, is as follows:

	June 30,		December 31,			June 30,
	2013		2012			2012
Outstanding shares at beginning of year	242,152		392,152			392,152
Granted during the period	—		—			—
Exercised during the period	—		—			—
Expired / forfeited during the period	—		(150,000		)	—
Outstanding shares at end of period	242,152		242,152			392,152
Exercisable shares at end of period	126,361		126,361			148,861
Weighted average exercise price per share at end of period	$	9.88	$	9.88		$	10.27
Shares available for grant at end of period	—		—			—

There were no options granted in the first six months of 2013 and 2012.

Following is a summary of the options outstanding and exercisable at June 30, 2013:

					Weighted Average
Exercise		Number		Unvested	Remaining
Price		Outstanding	Exercisable	Options	Contractual Life-Years
$	9.16	2,500	1,000	1,500	2.46
$	9.75	217,152	120,861	96,291	1.46
$	10.65	12,500	2,500	10,000	3.46
$	12.00	10,000	2,000	8,000	2.04
		242,152	126,361	115,791	1.60

The Corporation, in August 2012, granted 148,500 Restricted Stock Units (“RSU’s”) to outside members of the Board of Directors and Management.  These RSU’s were granted at a market value of $7.91 and will vest equally over a four year term.

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CONDENSED CONSOLIDATED STATEMENTS COMPREHENSIVE INCOME (USD $) In Thousands, unless otherwise specified	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012
CONDENSED CONSOLIDATED STATEMENTS COMPREHENSIVE INCOME
Net income	$ 1,260	$ 4,302	$ 2,073	$ 4,993
Net change in net unrealized gains on securities available for sale:
Unrealized gains (losses) arising during the period	(832)	139	(763)	562
Less: reclassification adjustment for gains (losses) included in net income	15		15
Net securities gain (loss) during the period	(817)	139	(748)	562
Tax effect	277	(47)	254	(191)
Net of tax	(540)	92	(494)	371
Total comprehensive income (loss)	$ 720	$ 4,394	$ 1,579	$ 5,364

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CONDENSED CONSOLIDATED BALANCE SHEETS (USD $) In Thousands, unless otherwise specified	Jun. 30, 2013	Dec. 31, 2012	Jun. 30, 2012
ASSETS
Cash and due from banks	$ 26,216	$ 26,958	$ 33,248
Federal funds sold	3	3
Cash and cash equivalents	26,219	26,961	33,248
Interest-bearing deposits in other financial institutions	10	10	10
Securities available for sale	47,307	43,799	39,054
Federal Home Loan Bank stock	3,060	3,060	3,060
Loans:
Commercial	343,561	342,841	319,398
Mortgage	98,559	95,413	90,260
Consumer	13,435	10,923	9,795
Total Loans	455,555	449,177	419,453
Allowance for loan losses	(5,177)	(5,218)	(5,083)
Net loans	450,378	443,959	414,370
Premises and equipment	10,536	10,633	10,134
Other real estate held for sale	2,481	3,212	3,518
Deferred Tax Asset	8,367	9,131	10,271
Other assets	5,143	5,215	10,701
TOTAL ASSETS	553,501	545,980	524,366
Deposits:
Noninterest bearing deposits	64,736	67,652	59,872
NOW, money market, interest checking	146,203	155,465	143,795
Savings	12,229	13,829	14,248
CDs less than $100,000	134,767	135,550	140,018
CDs more than $100,000	25,091	24,355	25,975
Brokered	64,881	37,706	41,473
Total deposits	447,907	434,557	425,381
Borrowings	35,925	35,925	35,997
Other liabilities	3,149	3,050	2,636
Total liabilities	486,981	473,532	464,014
SHAREHOLDERS' EQUITY:
Preferred stock - No par value: Authorized - 500,000 shares Issued and outstanding - 4,000, 11,000 and 11,000 respectively	4,000	11,000	11,000
Common stock and additional paid in capital - No par value Authorized - 18,000,000 shares Issued and outstanding - 5,554,459, 5,559,859 and 3,419,736 respectively	53,934	53,797	43,525
Retained earnings	8,156	6,727	5,131
Accumulated other comprehensive income	430	924	696
Total shareholders' equity	66,520	72,448	60,352
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$ 553,501	$ 545,980	$ 524,366

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COMMITMENTS, CONTINGENCIES AND CREDIT RISK (Details 2) (USD $) In Thousands, unless otherwise specified				6 Months Ended
	Jun. 30, 2013	Dec. 31, 2012	Jun. 30, 2012	Jun. 30, 2013 Bank Commercial real estate loans Commercial loan portfolio Credit risk concentration	Jun. 30, 2012 Bank Commercial real estate loans Commercial loan portfolio Credit risk concentration
Concentration of Credit Risk
Loan portfolio	$ 450,378	$ 443,959	$ 414,370	$ 95,510	$ 83,539
Percentage of concentration risk under a specified benchmark				27.80%	26.15%

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EARNINGS PER SHARE (Details) (USD $) In Thousands, except Per Share data, unless otherwise specified	3 Months Ended		6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012
(Numerator):
Net income	$ 1,260	$ 4,302	$ 2,073	$ 4,993
Preferred dividend and accretion of discount	63	161	200	354
NET INCOME AVAILABLE TO COMMON SHAREHOLDERS	$ 1,197	$ 4,141	$ 1,873	$ 4,639
(Denominator):
Weighted average shares outstanding - basic	5,556,133	3,419,736	5,557,842	3,419,736
Dilutive effect of common stock warrants (in shares)		120,172		112,904
Weighted average shares outstanding - diluted	5,556,133	3,539,908	5,557,842	3,532,640
Income per common share:
Basic (in dollars per share)	$ 0.22	$ 0.97	$ 0.34	$ 1.09
Diluted (in dollars per share)	$ 0.22	$ 0.94	$ 0.34	$ 1.05

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MORTGAGE SERVICING RIGHTS (Tables)

6 Months Ended

Jun. 30, 2013

MORTGAGE SERVICING RIGHTS

Summary of mortgage servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances

The following summarizes mortgage servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
Balance at beginning of period	$	638		$	400		$	400
Additions from loans sold with servicing retained	225			344			170
Amortization	(80		)	(106		)	(45		)
Fair value of MSRs at end of period	$	783		$	638		$	525

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STOCK COMPENSATION PLANS (Details 3) (Restricted Stock Units, USD $)	1 Months Ended
	Aug. 31, 2012
Restricted Stock Units
Stock Compensation Plans
Number of RSUs granted (in shares)	148,500
Market value of granted stock (in dollars per unit)	$ 7.91
Vesting term of restricted stock units	4 years

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LOANS (Details 9) (Bank, USD $) In Thousands, unless otherwise specified	6 Months Ended		12 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012
Bank
Activity in insider loans granted to the entity's executive officers and directors, including their families and firms
Loans outstanding, beginning of period	$ 11,297	$ 8,827	$ 8,827
New loans	496	936	3,911
Net activity on revolving lines of credit	(25)	41	233
Principal payments	(1,298)	(419)	(1,674)
Loans outstanding, end of period	10,470	9,385	11,297
Loans to related-parties classified substandard	0	0	0
Unfunded commitments	$ 55

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LOANS (Details 5) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2013	Mar. 31, 2013	Dec. 31, 2012	Jun. 30, 2012	Mar. 31, 2012	Dec. 31, 2011
Past due loans
30-89 days Past Due (accruing)	$ 356		$ 951	$ 300
90+ days Past Due/Nonaccrual	3,983	3,833	4,687	5,375	4,457	5,490
Total	4,339		5,638	5,675
Commercial real estate
Past due loans
30-89 days Past Due (accruing)	146		575
90+ days Past Due/Nonaccrual	3,057	2,963	3,071	3,749	1,954	2,362
Total	3,203		3,646	3,749
Commercial, financial, and agricultural
Past due loans
30-89 days Past Due (accruing)	92		71
90+ days Past Due/Nonaccrual	517	424	436	278	1,626	1,111
Total	609		507	278
Commercial construction
Past due loans
90+ days Past Due/Nonaccrual			675	676
Total			675	676
One to four family residential real estate
Past due loans
30-89 days Past Due (accruing)	100		291	286
90+ days Past Due/Nonaccrual	400	446	505	657	862	1,997
Total	500		796	943
Consumer construction
Past due loans
90+ days Past Due/Nonaccrual				15	15	20
Total				15
Consumer
Past due loans
30-89 days Past Due (accruing)	18		14	14
90+ days Past Due/Nonaccrual	9
Total	$ 27		$ 14	$ 14

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LOANS (Details 6) (USD $) In Thousands, unless otherwise specified	3 Months Ended		6 Months Ended		12 Months Ended	3 Months Ended		6 Months Ended		12 Months Ended	3 Months Ended		6 Months Ended		12 Months Ended	3 Months Ended	6 Months Ended		12 Months Ended	3 Months Ended		6 Months Ended		12 Months Ended	6 Months Ended	12 Months Ended		3 Months Ended	6 Months Ended	12 Months Ended
	Jun. 30, 2013	Jun. 30, 2012	Jun. 30, 2013	Jun. 30, 2012	Dec. 31, 2012	Jun. 30, 2013 Commercial real estate	Jun. 30, 2012 Commercial real estate	Jun. 30, 2013 Commercial real estate	Jun. 30, 2012 Commercial real estate	Dec. 31, 2012 Commercial real estate	Jun. 30, 2013 Commercial, financial, and agricultural	Jun. 30, 2012 Commercial, financial, and agricultural	Jun. 30, 2013 Commercial, financial, and agricultural	Jun. 30, 2012 Commercial, financial, and agricultural	Dec. 31, 2012 Commercial, financial, and agricultural	Jun. 30, 2012 Commercial construction	Jun. 30, 2013 Commercial construction	Jun. 30, 2012 Commercial construction	Dec. 31, 2012 Commercial construction	Jun. 30, 2013 One to four family residential real estate	Jun. 30, 2012 One to four family residential real estate	Jun. 30, 2013 One to four family residential real estate	Jun. 30, 2012 One to four family residential real estate	Dec. 31, 2012 One to four family residential real estate	Jun. 30, 2012 Consumer construction	Dec. 31, 2012 Consumer construction	Mar. 31, 2012 Consumer construction	Jun. 30, 2013 Consumer	Jun. 30, 2013 Consumer	Dec. 31, 2012 Consumer
Roll-forward of nonaccrual activity
Beginning balance	$ 3,833	$ 4,457	$ 4,687	$ 5,490	$ 5,490	$ 2,963	$ 1,954	$ 3,071	$ 2,362	$ 2,362	$ 424	$ 1,626	$ 436	$ 1,111	$ 1,111		$ 675			$ 446	$ 862	$ 505	$ 1,997	$ 1,997	$ 20	$ 20	$ 15
Principal payments	(113)	(2,001)	(381)	(3,446)	(4,022)	(31)	(646)	(148)	(1,012)	(1,569)	(66)	(1,351)	(68)	(1,382)	(1,385)		(100)			(16)	(4)	(65)	(1,052)	(1,068)
Charge-offs	(10)	(523)	(418)	(761)	(858)		(417)	(329)	(463)	(463)			(72)							(6)	(106)	(13)	(293)	(387)	(5)	(5)		(4)	(4)	(3)
Transfers to OREO	(38)	(325)	(687)	(685)	(1,352)		(139)		(466)	(675)							(580)			(38)	(186)	(107)	(219)	(662)		(15)
Transfers from accruing	332	3,742	773	4,743	5,388	126	2,978	443	3,288	3,377	179		241	559	716	676		676	675	14	88	76	220	617				13	13	3
Other	(21)	25	9	34	41	(1)	19	20	40	39	(20)	3	(20)	(10)	(6)		5				3	4	4	8
Ending balance	$ 3,983	$ 5,375	$ 3,983	$ 5,375	$ 4,687	$ 3,057	$ 3,749	$ 3,057	$ 3,749	$ 3,071	$ 517	$ 278	$ 517	$ 278	$ 436	$ 676		$ 676	$ 675	$ 400	$ 657	$ 400	$ 657	$ 505	$ 15		$ 15	$ 9	$ 9

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BORROWINGS

6 Months Ended

Jun. 30, 2013

BORROWINGS

BORROWINGS

6. BORROWINGS

Borrowings consist of the following at June 30, 2013, December 31, 2012 and June 30, 2012 (dollars in thousands):

	June, 30		December 31,		June, 30
	2013		2012		2012
Federal Home Loan Bank fixed rate advances at June 30, 2013 with a weighted average rate of 1.79% maturing in 2014, 2016 and 2018	$	35,000	$	35,000	$	35,000
USDA Rural Development, fixed-rate note payable, maturing August 24, 2024, interest payable at 1%	925		925		997
	$	35,925	$	35,925	$	35,997

The Federal Home Loan Bank borrowings are collateralized at June 30, 2013 by the following:  a collateral agreement on the Corporation’s one to four family residential real estate loans with a book value of approximately $38.844 million; mortgage related and municipal securities with an amortized cost and estimated fair value of $6.233 million and $6.519 million, respectively; and Federal Home Loan Bank stock owned by the Bank totaling $3.060 million.  Prepayment of the advances is subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank of Indianapolis in effect as of June 30, 2013.

The USDA Rural Development borrowing is collateralized by loans totaling $.132 million originated and held by the Corporation’s wholly owned subsidiary, First Rural Relending, and an assignment of a demand deposit account in the amount of $.873million, and guaranteed by the Corporation.

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INVESTMENT SECURITIES (Details) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2013	Dec. 31, 2012	Jun. 30, 2012
INVESTMENT SECURITIES
Amortized Cost	$ 46,655	$ 42,399	$ 37,998
Gross Unrealized Gains	1,039	1,423	1,075
Gross Unrealized Losses	(387)	(23)	(19)
Estimated Fair Value	47,307	43,799	39,054
US Agencies - MBS
INVESTMENT SECURITIES
Amortized Cost	7,491	7,962	9,667
Gross Unrealized Gains	354	412	412
Estimated Fair Value	7,845	8,374	10,079
US Agencies
INVESTMENT SECURITIES
Amortized Cost	15,172	10,267	10,338
Gross Unrealized Gains	74	137	155
Gross Unrealized Losses	(341)
Estimated Fair Value	14,905	10,404	10,493
Corporate Bonds
INVESTMENT SECURITIES
Amortized Cost	18,557	18,763	12,519
Gross Unrealized Gains	161	237	70
Gross Unrealized Losses	(45)	(23)	(17)
Estimated Fair Value	18,673	18,977	12,572
Obligations of states and political subdivisions
INVESTMENT SECURITIES
Amortized Cost	5,435	5,407	5,474
Gross Unrealized Gains	450	637	438
Gross Unrealized Losses	(1)		(2)
Estimated Fair Value	5,884	6,044	5,910
FHLB borrowings and customer relationships
INVESTMENT SECURITIES
Amortized Cost	6,383
Estimated Fair Value	$ 6,669

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STOCK COMPENSATION PLANS (Details) (USD $)	12 Months Ended
	Dec. 31, 2012	Jun. 30, 2013	Jun. 30, 2012
Stock option transactions
Outstanding shares at beginning of year	392,152	242,152	392,152
Expired / forfeited during the period (in shares)	(150,000)
Outstanding shares at end of period	242,152	242,152	392,152
Exercisable shares at end of period	126,361	126,361	148,861
Weighted average exercise price per share at end of period (in dollars per share)	$ 9.88	$ 9.88	$ 10.27

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FAIR VALUE MEASUREMENTS

6 Months Ended

Jun. 30, 2013

FAIR VALUE MEASUREMENTS

FAIR VALUE MEASUREMENTS

9.  FAIR VALUE MEASUREMENTS

Fair value estimates, methods, and assumptions are set forth below for the Corporation’s financial instruments:

Cash, cash equivalents, and interest-bearing deposits - The carrying values approximate the fair values for these assets.

Securities - Fair values are based on quoted market prices where available.  If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

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

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

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

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

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

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

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

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

The following table presents information for financial instruments at June 30, 2013, December 31, 2012 and June 30, 2012(dollars in thousands):

		June 30, 2013				December 31, 2012				June 30, 2012
	Level in Fair	Carrying		Estimated		Carrying		Estimated		Carrying		Estimated
	Value Hierarchy	Amount		Fair Value		Amount		Fair Value		Amount		Fair Value
Financial assets:
Cash and cash equivalents	Level 1	$	26,219	$	26,219	$	26,961	$	26,961	$	33,248	$	33,248
Interest-bearing deposits	Level 2	10		10		10		10		10		10
Securities available for sale	Level 2	47,307		47,307		43,799		43,799		39,054		39,054
Federal Home Loan Bank stock	Level 2	3,060		3,060		3,060		3,060		3,060		3,060
Net loans	Level 2	450,378		444,638		443,959		439,239		414,370		411,781
Accrued interest receivable	Level 2	1,636		1,636		1,319		1,319		1,303		1,303
Total financial assets		$	528,610	$	522,870	$	519,108	$	514,388	$	491,045	$	488,456
Financial liabilities:
Deposits	Level 2	$	447,907	$	446,438	$	434,557	$	434,227	$	425,381	$	425,149
Borrowings	Level 2	35,925		35,621		35,925		35,729		35,997		35,853
Accrued interest payable	Level 2	229		229		214		214		239		239
Total financial liabilties		$	484,061	$	482,288	$	470,696	$	470,170	$	461,617	$	461,241

Limitations- Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instrument.  These estimates do not reflect any premium or discount that could result from offering for sale at one time the Corporation’s entire holdings of a particular financial instrument.  Because no market exists for a significant portion of the Corporation’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors.  These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.  Fair value estimates are based on existing on-and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments.  Significant assets and liabilities that are not considered financial assets or liabilities include premises and equipment, other assets, and other liabilities.  In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

The following is information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at June 30, 2013, and the valuation techniques used by the Corporation to determine those fair values.

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

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

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

The fair value of all investment securities at June 30, 2013 and June 30, 2012 were based on level 2 inputs.  There are no other assets or liabilities measured on a recurring basis at fair value.  For additional information regarding investment securities, please refer to “Note 3 Investment Securities.”

The Corporation had no Level 3 assets or liabilities on a recurring basis as of June 30, 2013, December 31, 2012 or June 30, 2012.

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

The Corporation also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis.  These assets include loans and other real estate owned.  The Corporation has estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

Assets Measured at Fair Value on a Nonrecurring Basis at June 30, 2013

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended		Six Months Ended
(dollars in thousands)	June 30, 2013		(Level 1)		(Level 2)		(Level 3)		June 30, 2013		June 30, 2013
Assets
Impaired loans	$	3,983	$	—	$	—	$	3,983	$	10	$	418
Other real estate owned	2,481		—		—		2,481		87		89
									$	97	$	507

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2012

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Year Ended
(dollars in thousands)	December 31, 2012		(Level 1)		(Level 2)		(Level 3)		December 31, 2012
Assets
Impaired loans	$	4,687	$	—	$	—	$	4,687	$	1,151
Other real estate owned	3,212		—		—		3,212		489
									$	1,640

Assets Measured at Fair Value on a Nonrecurring Basis at June 30, 2012

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended		Six Months Ended
(dollars in thousands)	June 30, 2012		(Level 1)		(Level 2)		(Level 3)		June 30, 2012		June 30, 2012
Assets
Impaired loans	$	5,375	$	—	$	—	$	5,375	$	624	$	1,012
Other real estate owned	3,518		—		—		3,518		174		185
									$	798	$	1,197

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

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

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MORTGAGE SERVICING RIGHTS

6 Months Ended

Jun. 30, 2013

MORTGAGE SERVICING RIGHTS

MORTGAGE SERVICING RIGHTS

5.     MORTGAGE SERVICING RIGHTS

Mortgage servicing rights (“MSRs”) are recorded when loans are sold in the secondary market with servicing retained.  As of June 30, 2013, the Corporation had obligations to service approximately $120 million of residential first mortgage loans.  The valuation is based upon the net present value of the projected revenues over the expected life of the loans being serviced, as reduced by estimated internal costs to service these loans.  The fair value of the capitalized servicing rights approximates the carrying value.  The key economic assumptions used in determining the fair value of the mortgage servicing rights include an annual constant prepayment speed of 15.90 and a discount rate of 7.50% for June 30, 2013.

The following summarizes mortgage servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
Balance at beginning of period	$	638		$	400		$	400
Additions from loans sold with servicing retained	225			344			170
Amortization	(80		)	(106		)	(45		)
Fair value of MSRs at end of period	$	783		$	638		$	525

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (USD $) In Thousands, unless otherwise specified	6 Months Ended
	Jun. 30, 2013	Jun. 30, 2012
Cash Flows from Operating Activities:
Net income	$ 2,073	$ 4,993
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization	840	777
Provision for loan losses	475	645
Deferred income taxes	1,052	(1,986)
Gain on sales/calls of securities	(15)
(Gain) on sale of secondary market loans	(458)	(198)
Origination of loans held for sale in secondary market	(32,597)	(28,942)
Proceeds from loans held for sale in secondary market	33,055	29,140
(Gain) loss on sale of premises, equipment, and other real estate held for sale	(25)	11
Writedown of other real estate held for sale	114	174
Stock compensation	183
Change in other assets	72	(5,546)
Change in other liabilities	99	374
Net cash provided by (used in) operating activities	4,868	(558)
Cash Flows from Investing Activities:
Net increase in loans	(7,600)	(19,755)
Purchase of securities available for sale	(4,974)	(6,293)
Proceeds from maturities, sales, calls or paydowns of securities available for sale	476	6,368
Capital expenditures	(501)	(1,044)
Proceeds from sale of premises, equipment, and other real estate	1,329	143
Net cash (used in) investing activities	(11,270)	(20,581)
Cash Flows from Financing Activities:
Net increase in deposits	13,350	20,592
Repurchase of common stock	(46)
Dividend on common stock	(444)
Redemption of Preferred Series A	(7,000)
Dividend on preferred stock	(200)	(275)
Net cash provided by financing activities	5,660	20,317
Net (decrease) in cash and cash equivalents	(742)	(822)
Cash and cash equivalents at beginning of period	26,961	34,070
Cash and cash equivalents at end of period	26,219	33,248
Cash paid during the year for:
Interest	1,651	2,304
Income taxes	99	50
Noncash Investing and Financing Activities:
Transfers of Foreclosures from Loans to Other Real Estate Held for Sale (net of adjustments made through the allowance for loan losses)	$ 687	$ 685

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FAIR VALUE MEASUREMENTS (Details 2) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2013	Dec. 31, 2012	Jun. 30, 2012
Fair value measurements
Other real estate owned	$ 2,481	$ 3,212	$ 3,518
Nonrecurring
Fair value measurements
Investments	0
Nonrecurring | Total
Fair value measurements
Impaired loans	3,983	4,687	5,375
Other real estate owned	2,481	3,212	3,518
Nonrecurring | Significant Unobservable Inputs (Level 3)
Fair value measurements
Impaired loans	3,983	4,687	5,375
Other real estate owned	2,481	3,212	3,518
Recurring | Significant Unobservable Inputs (Level 3)
Fair value measurements
Assets	0	0	0
Liabilities	$ 0	$ 0	$ 0

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LOANS (Details 3) (USD $) In Thousands, unless otherwise specified	Jun. 30, 2013	Dec. 31, 2012	Jun. 30, 2012
Breakdown of loans by risk category
Total loans	$ 455,555	$ 449,177	$ 419,453
Minimum
Breakdown of loans by risk category
Credit risk rating for which reserves are established if no specific reserves made	6
Maximum
Breakdown of loans by risk category
Credit risk rating for which general reserves are established	5
Credit risk rating for which reserves are established if no specific reserves made	7
Commercial real estate
Breakdown of loans by risk category
Total loans	243,363	244,966	211,506
Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	84,145	80,646	85,099
Commercial construction
Breakdown of loans by risk category
Total loans	16,053	17,229	22,793
One to four family residential real estate
Breakdown of loans by risk category
Total loans	94,254	87,948	84,665
Consumer construction
Breakdown of loans by risk category
Total loans	4,305	7,465	5,595
Consumer
Breakdown of loans by risk category
Total loans	13,435	10,923	9,795
Excellent (1)
Breakdown of loans by risk category
Total loans	7,291	9,833	8,915
Excellent (1) | Commercial real estate
Breakdown of loans by risk category
Total loans	2,294	4,807	4,394
Excellent (1) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	4,997	5,026	4,316
Excellent (1) | Commercial construction
Breakdown of loans by risk category
Total loans			205
Good (2)
Breakdown of loans by risk category
Total loans	30,358	27,793	25,469
Good (2) | Commercial real estate
Breakdown of loans by risk category
Total loans	22,319	20,491	16,806
Good (2) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	5,253	3,936	5,827
Good (2) | Commercial construction
Breakdown of loans by risk category
Total loans	723	1,038	849
Good (2) | One to four family residential real estate
Breakdown of loans by risk category
Total loans	1,954	1,969	1,987
Good (2) | Consumer
Breakdown of loans by risk category
Total loans	109	359
Average (3)
Breakdown of loans by risk category
Total loans	115,804	116,794	86,323
Average (3) | Commercial real estate
Breakdown of loans by risk category
Total loans	86,404	84,164	56,024
Average (3) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	21,780	23,821	20,866
Average (3) | Commercial construction
Breakdown of loans by risk category
Total loans	5,119	5,103	5,582
Average (3) | One to four family residential real estate
Breakdown of loans by risk category
Total loans	2,465	3,635	3,774
Average (3) | Consumer
Breakdown of loans by risk category
Total loans	36	71	77
Acceptable (4)
Breakdown of loans by risk category
Total loans	168,809	165,996	176,894
Acceptable (4) | Commercial real estate
Breakdown of loans by risk category
Total loans	111,180	113,379	111,719
Acceptable (4) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	46,214	41,785	47,912
Acceptable (4) | Commercial construction
Breakdown of loans by risk category
Total loans	5,660	5,784	10,892
Acceptable (4) | One to four family residential real estate
Breakdown of loans by risk category
Total loans	4,565	4,791	5,789
Acceptable (4) | Consumer
Breakdown of loans by risk category
Total loans	470	257	582
Special Mention (5)
Breakdown of loans by risk category
Total loans	21,377	21,809	22,151
Special Mention (5) | Commercial real estate
Breakdown of loans by risk category
Total loans	16,446	16,754	16,917
Special Mention (5) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	4,176	4,296	4,468
Special Mention (5) | Commercial construction
Breakdown of loans by risk category
Total loans	755	759	766
Substandard (6)
Breakdown of loans by risk category
Total loans	6,658	8,700	9,044
Substandard (6) | Commercial real estate
Breakdown of loans by risk category
Total loans	4,531	5,189	5,452
Substandard (6) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	1,725	1,782	1,710
Substandard (6) | Commercial construction
Breakdown of loans by risk category
Total loans	402	1,077	1,092
Substandard (6) | One to four family residential real estate
Breakdown of loans by risk category
Total loans		646	790
Substandard (6) | Consumer
Breakdown of loans by risk category
Total loans		6
Doubtful (7)
Breakdown of loans by risk category
Total loans	189	182	194
Doubtful (7) | Commercial real estate
Breakdown of loans by risk category
Total loans	189	182	194
Rating Unassigned
Breakdown of loans by risk category
Total loans	105,789	98,070	90,463
Rating Unassigned | Commercial construction
Breakdown of loans by risk category
Total loans	3,394	3,468	3,407
Rating Unassigned | One to four family residential real estate
Breakdown of loans by risk category
Total loans	85,270	76,907	72,325
Rating Unassigned | Consumer construction
Breakdown of loans by risk category
Total loans	4,305	7,465	5,595
Rating Unassigned | Consumer
Breakdown of loans by risk category
Total loans	$ 12,820	$ 10,230	$ 9,136

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SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Policies)

6 Months Ended

Jun. 30, 2013

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

Basis of Presentation

The unaudited condensed consolidated financial statements of Mackinac Financial Corporation (the “Corporation”) have been prepared in accordance with generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Operating results for the six-month period ended June 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.  The unaudited consolidated financial statements and footnotes thereto should be read in conjunction with the audited consolidated financial statements and footnotes thereto included in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2012.

In order to properly reflect some categories of other income and other expenses, reclassifications of expense and income items have been made to prior period numbers.  The “net” other income and other expenses was not changed due to these reclassifications.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period.  Actual results could differ from those estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, and the valuation of deferred tax assets, mortgage servicing rights and other real estate held for sale.

Allowance for Loan Losses

Allowance for Loan Losses

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

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

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

Stock Compensation Plans

Stock Compensation Plans

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

On May 22, 2012, the Corporation’s shareholders approved the Mackinac Financial Corporation 2012 Incentive Compensation Plan, under which current and prospective employees, non-employee directors and consultants may be awarded incentive stock options, non-statutory stock options, shares of restricted stock units (“RSUs”), or stock appreciation rights.  The aggregate number of shares of the Corporation’s common stock issuable under the plan is 757,848.

On August 31, 2012, the Corporation granted 148,500 RSUs to certain members of management and all outside directors at the market value of the stock, which was $7.91.  The RSUs were awarded at no cost to the employee and vest ratably over a four-year period.  Compensation cost to be recognized over the four-year vesting period is $1.175 million.  As of June 30, 2013, none of the RSUs were vested and unrecognized compensation expense was $.975 million.

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INCOME TAXES

6 Months Ended

Jun. 30, 2013

INCOME TAXES

INCOME TAXES

8.     INCOME TAXES

A valuation allowance is provided against deferred tax assets when it is more likely than not that some or all of the deferred tax asset will not be realized.  The Corporation, as of June 30, 2013 had a net operating loss and tax credit carryforwards for tax purposes of approximately $19.8 million, and $2.1 million, respectively.  The net operating loss carryforwards expire twenty years from the date they originated.  These carryforwards, if not utilized, will begin to expire in the year 2023.  A portion of the NOL, approximately $8.4 million, and all of the credit carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code.  The annual limitation is $1.400 million for the NOL and the equivalent value of tax credits, which is approximately $.477 million.  These limitations for use were established in conjunction with the recapitalization of the Corporation in December 2004.

The Corporation has reported deferred tax assets of $8.367 million at June 30, 2013, which is net a valuation allowance of $3.0 million.  Management evaluated the deferred tax valuation allowance as of June 30, 2013 and determined that no adjustment to the valuation was warranted.  The Corporation will continue to evaluate the future benefits from these carryforwards and at such time as it becomes “more likely than not” that they would be utilized prior to expiration will recognize the additional benefits as an adjustment to the valuation allowance.

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LOANS (Tables)

6 Months Ended

Jun. 30, 2013

LOANS

Schedule of composition of loans

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

	June 30,		December 31,		June 30,
	2013		2012		2012
Commercial real estate	$	243,363	$	244,966	$	211,506
Commercial, financial, and agricultural	84,145		80,646		85,099
One to four family residential real estate	94,254		87,948		84,665
Construction :
Consumer	4,305		7,465		5,595
Commerical	16,053		17,229		22,793
Consumer	13,435		10,923		9,795
Total loans	$	455,555	$	449,177	$	419,453

Schedule of the allowance for loan losses

An analysis of the allowance for loan losses for the six months ended June 30, 2013, the year ended December 31, 2012, and the six months ended June 30, 2012 is as follows (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
Balance at beginning of period	$	5,218		$	5,251		$	5,251
Recoveries on loans previously charged off	100			278			219
Loans charged off	(616		)	(1,256		)	(1,032		)
Provision	475			945			645
Balance at end of period	$	5,177		$	5,218		$	5,083

Schedule of breakdown of the allowance for loan losses and recorded balances in loans

A breakdown of the allowance for loan losses and recorded balances in loans at June 30, 2013 is as follows (dollars in thousands):

				Commercial,						One to four
	Commercial			financial and			Commercial			family residential			Consumer
	real estate			agricultural			construction			real estate			construction		Consumer			Unallocated			Total
Three Months Ended June 30, 2013
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,964		$	847		$	118		$	990		$	—	$	13		$	105		$	5,037
Charge-offs	(21		)	(4		)	—			(6		)	—		(5		)	—			(36		)
Recoveries	29			30			1			6			—		10			—			76
Provision	(311		)	217			(22		)	(113		)	—		(5		)	334			100
Ending balance ALLR	$	2,661		$	1,090		$	97		$	877		$	—	$	13		$	439		$	5,177
Six Months Ended June 30, 2013
Allowance for loan loss reserve:
Beginning balance ALLR	$	3,267		$	692		$	125		$	980		$	—	$	—		$	154		$	5,218
Charge-offs	(456		)	(76		)	—			(13		)	—		(71		)	—			(616		)
Recoveries	41			33			2			11			—		13			—			100
Provision	(191		)	441			(30		)	(101		)	—		71			285			475
Ending balance ALLR	$	2,661		$	1,090		$	97		$	877		$	—	$	13		$	439		$	5,177
At June 30,2013
Loans:
Ending balance	$	243,363		$	84,145		$	16,053		$	94,254		$	4,305	$	13,435		$	—		$	455,555
Ending balance ALLR	(2,661		)	(1,090		)	(97		)	(877		)	—		(13		)	(439		)	(5,177		)
Net loans	$	240,702		$	83,055		$	15,956		$	93,377		$	4,305	$	13,422		$	(439	)	$	450,378
Ending balance ALLR:
Individually evaluated	$	1,396		$	643		$	8		$	148		$	—	$	13		$	—		$	2,208
Collectively evaluated	1,265			447			89			729			—		—			439			2,969
Total	$	2,661		$	1,090		$	97		$	877		$	—	$	13		$	439		$	5,177
Ending balance Loans:
Individually evaluated	$	14,499		$	6,668		$	917		$	640		$	—	$	22		$	—		$	22,746
Collectively evaluated	228,864			77,477			15,136			93,614			4,305		13,413			—			432,809
Total	$	243,363		$	84,145		$	16,053		$	94,254		$	4,305	$	13,435		$	—		$	455,555

Impaired loans, by definition, are individually evaluated.

A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2012 is as follows (dollars in thousands):

	Commercial			Commercial, financial and			Commercial			One to four family residential			Consumer
	real estate			agricultural			construction			real estate			construction			Consumer			Unallocated			Total
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,823		$	1,079		$	207		$	1,114		$	—		$	—		$	28		5,251
Charge-offs	(729		)	(40		)	(6		)	(399		)	—			(82		)	—			(1,256		)
Recoveries	52			201			—			7			—			18			—			278
Provision	1,121			(548		)	(76		)	258			—			64			126			945
Ending balance ALLR	$	3,267		$	692		$	125		$	980		$	—		$	—		$	154		$	5,218
Loans:
Ending balance	$	244,966		$	80,646		$	17,229		$	87,948		$	7,465		$	10,923		$	—		$	449,177
Ending balance ALLR	(3,267		)	(692		)	(125		)	(980		)	—			—			(154		)	(5,218		)
Net loans	$	241,699		$	79,954		$	17,104		$	86,968		$	7,465		$	10,923		$	(154	)	$	443,959
Ending balance ALLR:
Individually evaluated	$	1,662		$	155		$	10		$	112		$	—		$	—		$	—		$	1,939
Collectively evaluated	1,605			537			115			868			—			—			154			3,279
Total	$	3,267		$	692		$	125		$	980		$	—		$	—		$	154		$	5,218
Ending balance Loans:
Individually evaluated	$	22,910		$	6,070		$	858		$	796		$	—		$	—		$	—		$	30,634
Collectively evaluated	222,056			74,576			16,371			87,152			7,465			10,923			—			418,543
Total	$	244,966		$	80,646		$	17,229		$	87,948		$	7,465		$	10,923		$	—		$	449,177
A breakdown of the allowance for loan losses and recorded balances in loans at June 30, 2012 is as follows (dollars in thousands):
	Commercial			Commercial, financial and			Commercial			One to four family residential			Consumer
	real estate			agricultural			construction			real estate			construction			Consumer			Unallocated			Total
Three Months Ended June 30, 2012
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,785		$	1,126		$	230		$	1,083		$	—		$	—		$	158		$	5,382
Charge-offs	(518		)	(4		)	(6		)	(106		)	5			(7		)	—			(636		)
Recoveries	10			169			—			4			—			4						187
Provision	507			(403		)	(6		)	102			(5		)	3			(48		)	150
Ending balance ALLR	$	2,784		$	888		$	218		$	1,083		$	—		$	—		$	110		$	5,083
Six Months Ended June 30, 2012
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,823		$	1,079		$	207		$	1,114		$	—		$	—		$	28		$	5,251
Charge-offs	(691		)	(24		)	(6		)	(296		)	—			(15		)	—			(1,032		)
Recoveries	18			187			—			5			—			9			—			219
Provision	634			(354		)	17			260			—			6			82			645
Ending balance ALLR	$	2,784		$	888		$	218		$	1,083		$	—		$	—		$	110		$	5,083
At June 30,2012
Loans:
Ending balance	$	211,506		$	85,099		$	22,793		$	84,665		$	5,595		$	9,795		$	—		$	419,453
Ending balance ALLR	(2,784		)	(888		)	(218		)	(1,083		)	—			—			(110		)	(5,083		)
Net loans	$	208,722		$	84,211		$	22,575		$	83,582		$	5,595		$	9,795		$	(110	)	$	414,370
Ending balance ALLR:
Individually evaluated	$	1,000		$	148		$	12		$	36		$	—		$	—		$	—		$	1,196
Collectively evaluated	1,784			740			206			1,047			—			—			110			3,887
Total	$	2,784		$	888		$	218		$	1,083		$	—		$	—		$	110		$	5,083
Ending balance Loans:
Individually evaluated	$	22,119		$	6,150		$	1,534		$	764		$	15		$	—		$	—		$	30,582
Collectively evaluated	189,387			78,949			21,259			83,901			5,580			9,795			—			388,871
Total	$	211,506		$	85,099		$	22,793		$	84,665		$	5,595		$	9,795		$	—		$	419,453

Schedule of breakdown of loans by risk category

These amounts represent loans made for land development and unimproved land purchases.  Below is a breakdown of loans by risk category as of June 30, 2013 (dollars in thousands):

	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp. Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	2,294	$	22,319	$	86,404	$	111,180	$	16,446	$	4,531	$	189	$	—	$	243,363
Commercial, financial and agricultural	4,997		5,253		21,780		46,214		4,176		1,725		—		—		84,145
Commercial construction	—		723		5,119		5,660		755		402		—		3,394		16,053
One to four family residential real estate	—		1,954		2,465		4,565		—		—		—		85,270		94,254
Consumer construction	—		—				—		—		—		—		4,305		4,305
Consumer	—		109		36		470		—		—		—		12,820		13,435
Total loans	$	7,291	$	30,358	$	115,804	$	168,089	$	21,377	$	6,658	$	189	$	105,789	$	455,555

Below is a breakdown of loans by risk category as of December 31, 2012 (dollars in thousands):

	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp. Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	4,807	$	20,491	$	84,164	$	113,379	$	16,754	$	5,189	$	182	$	—	$	244,966
Commercial, financial and agricultural	5,026		3,936		23,821		41,785		4,296		1,782		—		—		80,646
Commercial construction	—		1,038		5,103		5,784		759		1,077		—		3,468		17,229
One-to-four family residential real estate	—		1,969		3,635		4,791		—		646		—		76,907		87,948
Consumer construction	—		—		—		—		—		—		—		7,465		7,465
Consumer	—		359		71		257		—		6		—		10,230		10,923
Total loans	$	9,833	$	27,793	$	116,794	$	165,996	$	21,809	$	8,700	$	182	$	98,070	$	449,177

Below is a breakdown of loans by risk category as of June 30, 2012 (dollars in thousands):

	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp. Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	4,394	$	16,806	$	56,024	$	111,719	$	16,917	$	5,452	$	194	$	—	$	211,506
Commercial, financial and agricultural	4,316		5,827		20,866		47,912		4,468		1,710		—		—		85,099
Commercial construction	205		849		5,582		10,892		766		1,092		—		3,407		22,793
One to four family residential real estate	—		1,987		3,774		5,789		—		790		—		72,325		84,665
Consumer construction	—		—		—		—		—		—		—		5,595		5,595
Consumer	—		—		77		582		—		—		—		9,136		9,795
Total loans	$	8,915	$	25,469	$	86,323	$	176,894	$	22,151	$	9,044	$	194	$	90,463	$	419,453

Summary of impaired loans and their effect on interest income

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

											Three Months Ended				Six Months Ended
					QTD		YTD				Interest Income		Interest Income		Interest Income		Interest Income
	Nonaccrual		Accrual		Average		Average		Related		Recognized		on		Recognized		on
	Basis		Basis		Investment		Investment		Valuation Reserve		During Impairment		Accrual Basis		During Impairment		Accrual Basis
June  30, 2013
With no valuation reserve:
Commercial real estate	$	728	$	—	$	733	$	797	$	—	$	—	$	14	$	—	$	26
Commercial, financial and agricultural	176		—		206		248		—		—		3		—		6
Commercial construction	—		—		—		275		—		—		—		—		3
One to four family residential real estate	94		—		133		165		—		—		3		—		5
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	9		—		2		1		—		—		—		—		—
With a valuation reserve:
Commercial real estate	$	2,329	$	—	$	2,308	$	2,298	$	1,240	$	—	$	30	$	—	$	60
Commercial, financial and agricultural	341		—		267		199		106		—		4		—		6
Commercial construction	—		—		—		—		—		—		—		—		—
One to four family residential real estate	306		—		303		289		126		—		5		—		11
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	—		—		—		—		—		—		—		—		—
Total:
Commercial real estate	$	3,057	$	—	$	3,041	$	3,095	$	1,240	$	—	$	44	$	—	$	86
Commercial, financial and agricultural	517		—		473		447		106		—		7		—		12
Commercial construction	—		—		—		275		—		—		—		—		3
One to four family residential real estate	400		—		436		454		126		—		8		—		16
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	9		—		2		1		—		—		—		—		—
Total	$	3,983	$	—	$	3,952	$	4,272	$	1,472	$	—	$	59	$	—	$	117

									Interest Income		Interest Income
For the Year Ended:	Nonaccrual		Accrual		Average		Related		Recognized		on
December 31, 2012	Basis		Basis		Investment		Valuation Reserve		During Impairment		Accrual Basis
With no valuation reserve:
Commercial real estate	$	132	$	—	$	1,550	$	—	$	—	$	37
Commercial, financial and agricultural	—		—		1,063		—		—		19
Commercial construction	675		—		675		—		—		15
One to four family residential real estate	230		—		1,074		—		—		41
Consumer construction	—		—		16		—		—		1
Consumer	—		—		3		—		—		—
With a valuation reserve:
Commercial real estate	$	2,939	$	—	$	3,173	$	1,315	$	54	$	177
Commercial, financial and agricultural	436		—		504		109		—		17
Commercial construction	—		—		—		—		—		—
One to four family residential real estate	275		—		281		95		—		6
Consumer construction	—		—		—		—		—		—
Consumer	—		—		—		—		—		—
Total:
Commercial real estate	$	3,071	$	—	$	4,723	$	1,315	$	54	$	214
Commercial, financial and agricultural	436		—		1,567		109		—		36
Commercial construction	675		—		675		—		—		15
One to four family residential real estate	505		—		1,355		95		—		47
Consumer construction	—		—		16		—		—		1
Consumer	—		—		3		—		—		—
Total	$	4,687	$	—	$	8,339	$	1,519	$	54	$	313

											Three Months Ended				Six Months Ended
					QTD		YTD				Interest Income		Interest Income		Interest Income		Interest Income
	Nonaccrual		Accrual		Average		Average		Related		Recognized		on		Recognized		on
	Basis		Basis		Investment		Investment		Valuation Reserve		During Impairment		Accrual Basis		During Impairment		Accrual Basis
June  30, 2012
With no valuation reserve:
Commercial real estate	$	535	$	—	$	655	$	1,138	$	—	$	—	$	9	$	—	$	23
Commercial, financial and agricultural	—		—		780		1,063		—		—		7		—		18
Commercial construction	676		—		338		676		—		—		4		—		4
One to four family residential real estate	543		—		613		874		—		—		9		—		24
Consumer construction	15		—		15		16		—		—		1		—		1
Consumer	—		—		—		—		—		—		—		—		—
With a valuation reserve:
Commercial real estate	$	3,214	$	—	$	3,604	$	3,916	$	708	$	17	$	80	$	37	$	94
Commercial, financial and agricultural	278		—		429		459		84		—		—		—		8
Commercial construction	—		—		—		—		—		—		—		—		—
One to four family residential real estate	114		—		93		114		18		—		2		—		2
Consumer construction	—		—		—		—		—		—		—		—		—
Consumer	—		—		—		—		—		—		—		—		—
Total:
Commercial real estate	$	3,749	$	—	$	4,259	$	5,054	$	708	$	17	$	89	$	37	$	117
Commercial, financial and agricultural	278		—		1,209		1,522		84		—		7		—		26
Commercial construction	676		—		338		676		—		—		4		—		4
One to four family residential real estate	657		—		706		988		18		—		11		—		26
Consumer construction	15		—		15		16		—		—		1		—		1
Consumer	—		—		—		—		—		—		—		—		—
Total	$	5,375	$	—	$	6,527	$	8,256	$	810	$	17	$	112	$	37	$	174

Summary of past due loans

A summary of past due loans at June 30, 2013, December 31, 2012 and June 30, 2012 is as follows (dollars in thousands):

	June 30,						December 31,						June 30,
	2013						2012						2012
	30-89 days		90+ days				30-89 days		90+ days				30-89 days		90+ days
	Past Due		Past Due/				Past Due		Past Due/				Past Due		Past Due/
	(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total
Commercial real estate	$	146	$	3,057	$	3,203	$	575	$	3,071	$	3,646	$	—	$	3,749	$	3,749
Commercial, financial and agricultural	92		517		609		71		436		507		—		278		278
Commercial construction	—		—		—		—		675		675		—		676		676
One to four family residential real estate	100		400		500		291		505		796		286		657		943
Consumer construction	—		—		—		—		—		—		—		15		15
Consumer	18		9		27		14		—		14		14		—		14
Total past due loans	$	356	$	3,983	$	4,339	$	951	$	4,687	$	5,638	$	300	$	5,375	$	5,675

Schedule of roll-forward of nonaccrual activity

A roll-forward of nonaccrual activity for the three months ended June 30, 2013 (dollars in thousands):

	For the Three Months Ended June  30, 2013
				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction		Consumer			Total
NONACCRUAL
Beginning balance	$	2,963		$	424		$	—	$	446		$	—	$	—		$	3,833
Principal payments	(31		)	(66		)	—		(16		)	—		—			(113		)
Charge-offs	—			—			—		(6		)	—		(4		)	(10		)
Advances	—			—			—		—			—		—			—
Class transfers	—			—			—		—			—		—			—
Transfers to OREO	—			—			—		(38		)	—		—			(38		)
Transfers to accruing	—			—			—		—			—		—			—
Transfers from accruing	126			179			—		14			—		13			332
Other	(1		)	(20		)	—		—			—		—			(21		)
Ending balance	$	3,057		$	517		$	—	$	400		$	—	$	9		$	3,983

A roll-forward of nonaccrual activity for the three months ended June 30, 2012 (dollars in thousands):

	For the Three Months Ended June  30, 2012
				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction		Consumer		Total
NONACCRUAL
Beginning balance	$	1,954		$	1,626		$	—	$	862		$	15	$	—	$	4,457
Principal payments	(646		)	(1,351		)	—		(4		)	—		—		(2,001		)
Charge-offs	(417		)	—			—		(106		)	—		—		(523		)
Advances	—			—			—		—			—		—		—
Class transfers	—			—			—		—			—		—		—
Transfers to OREO	(139		)	—			—		(186		)	—		—		(325		)
Transfers to accruing	—			—			—		—			—		—		—
Transfers from accruing	2,978			—			676		88			—		—		3,742
Other	19			3			—		3			—		—		25
Ending balance	$	3,749		$	278		$	676	$	657		$	15	$	—	$	5,375

A roll-forward of nonaccrual activity for the first six months ended June 30, 2013 (dollars in thousands):

	For the Six Months Ended June 30, 2013
				Commercial,						One to four
	Commercial			Financial and			Commercial			family residential			Consumer
	Real Estate			Agricultural			Construction			real estate			Construction		Consumer			Total
NONACCRUAL
Beginning balance	$	3,071		$	436		$	675		$	505		$	—	$	—		$	4,687
Principal payments	(148		)	(68		)	(100		)	(65		)	—		—			(381		)
Charge-offs	(329		)	(72		)	—			(13		)	—		(4		)	(418		)
Advances	—			—			—			—			—		—			—
Class transfers	—			—			—			—			—		—			—
Transfers to OREO	—			—			(580		)	(107		)	—		—			(687		)
Transfers to accruing	—			—			—			—			—		—			—
Transfers from accruing	443			241			—			76			—		13			773
Other	20			(20		)	5			4			—		—			9
Ending balance	$	3,057		$	517		$	—		$	400		$	—	$	9		$	3,983

A roll-forward of nonaccrual activity for the first six months ended June 30, 2012 (dollars in thousands):

	For the Six Months Ended June 30, 2012
				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction			Consumer		Total
NONACCRUAL
Beginning balance	$	2,362		$	1,111		$	—	$	1,997		$	20		$	—	$	5,490
Principal payments	(1,012		)	(1,382		)	—		(1,052		)	—			—		(3,446		)
Charge-offs	(463		)	—			—		(293		)	(5		)	—		(761		)
Advances	—			—			—		—			—			—		—
Class transfers	—			—			—		—			—			—		—
Transfers to OREO	(466		)	—			—		(219		)	—			—		(685		)
Transfers to accruing	—			—			—		—			—			—		—
Transfers from accruing	3,288			559			676		220			—			—		4,743
Other	40			(10		)	—		4			—			—		34
Ending balance	$	3,749		$	278		$	676	$	657		$	15		$	—	$	5,375

A roll-forward of nonaccrual activity during the year ended December 31, 2012 (dollars in thousands):

				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction			Consumer			Total
NONACCRUAL
Beginning balance	$	2,362		$	1,111		$	—	$	1,997		$	20		$	—		$	5,490
Principal payments	(1,569		)	(1,385		)	—		(1,068		)	—			—			(4,022		)
Charge-offs	(463		)	—			—		(387		)	(5		)	(3		)	(858		)
Advances	—			—			—		—			—			—			—
Class transfers	—			—			—		—			—			—			—
Transfers to OREO	(675		)	—			—		(662		)	(15		)	—			(1,352		)
Transfers to accruing	—			—			—		—			—			—			—
Transfers from accruing	3,377			716			675		617			—			3			5,388
Other	39			(6		)	—		8			—			—			41
Ending balance	$	3,071		$	436		$	675	$	505		$	—		$	—		$	4,687

Summary of troubled debt restructurings

A summary of troubled debt restructurings for the periods indicated is as follows (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
	Number of	Recorded		Number of	Recorded		Number of	Recorded
	Modifications	Investment		Modifications	Investment		Modifications	Investment
Commercial real estate	—	$	—	3	$	4,614	—	$	—
Commercial, financial and agricultural	—	—		1	1,221		—	—
Commercial construction	—	—		3	860		—	—
One to four family residential real estate	—	—		1	102		—	—
Consumer construction	—	—		—	—		—	—
Consumer	—	—		—	—		—	—
Total troubled debt restructurings	—	$	—	8	$	6,797	—	$	—

Schedule of roll-forward of troubled debt restructurings

A roll-forward of troubled debt restructuring during the three months ended June 30, 2013 (dollars in thousands):

				Commercial,				One to four		Consumer and
	Commercial			Financial and		Commercial		family residential		Consumer
	Real Estate			Agricultural		Construction		real estate		Construction		Total
ACCRUING
Beginning balance	$	3,588		$	2,174	$	858	$	100	$	—	$	6,720
Principal payments	(25		)	—		—		—		—		(25		)
Charge-offs	—			—		—		—		—		—
Advances	—			—		—		—		—		—
New restructured	—			—		—		—		—		—
Transferred out of TDR	—			—		—		—		—		—
Transfers to nonaccrual	—			—		—		—		—		—
Ending Balance	$	3,563		$	2,174	$	858	$	100	$	—	$	6,695
NONACCRUAL
Beginning balance	$	2,169		$	—	$	—	$	106	$	—	$	2,275
Principal payments	—			—		—		—		—		—
Charge-offs	—			—		—		—		—		—
Advances	—			—		—		—		—		—
New restructured	—			—		—		—		—		—
Transfers to foreclosed properties	—			—		—		—		—		—
Transfers from accruing	—			—		—		—		—		—
Ending Balance	$	2,169		$	—	$	—	$	106	$	—	$	2,275
TOTALS
Beginning balance	$	5,757		$	2,174	$	858	$	206	$	—	$	8,995
Principal payments	(25		)	—		—		—		—		(25		)
Charge-offs	—			—		—		—		—		—
Advances	—			—		—		—		—		—
New restructured	—			—		—		—		—		—
Transfers out of TDRs	—			—		—		—		—		—
Tansfers to nonaccrual	—			—		—		—		—		—
Transfers to foreclosed properties	—			—		—		—		—		—
Transfers from accruing	—			—		—		—		—		—
Ending Balance	$	5,732		$	2,174	$	858	$	206	$	—	$	8,970

A roll-forward of troubled debt restructuring during the three months ended June 30, 2012 (dollars in thousands):

				Commercial,						One to four			Consumer and
	Commercial			Financial and			Commercial			family residential			Consumer
	Real Estate			Agricultural			Construction			real estate			Construction		Total
ACCRUING
Beginning balance	$	3,672		$	1,221		$	859		$	103		$	—	$	5,855
Principal payments	(19		)	—			(1		)	(1		)	—		(21		)
Charge-offs	—			—			—			—			—		—
Advances	—			—			—			—			—		—
New restructured	—			—			—			—			—		—
Transferred out of TDRs	—			—			—			—			—		—
Transfers to nonaccrual	—			—			—			—			—		—
Ending Balance	$	3,653		$	1,221		$	858		$	102		$	—	$	5,834
NONACCRUAL
Beginning balance	$	3,235		$	1,072		$	—		$	293		$	—	$	4,600
Principal payments	(615		)	(1,072		)	—			—			—		(1,687		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	—			—			—			—			—		—
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	—			—			—			—			—		—
Ending Balance	$	2,194		$	—		$	—		$	6		$	—	$	2,200
TOTALS
Beginning balance	$	6,907		$	2,293		$	859		$	396		$	—	$	10,455
Principal payments	(634		)	(1,072		)	(1		)	(1		)	—		(1,708		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	—			—			—			—			—		—
Transfers out of TDRs	—			—			—			—			—		—
Tansfers to nonaccrual	—			—			—			—			—		—
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	—			—			—			—			—		—
Ending Balance	$	5,847		$	1,221		$	858		$	108		$	—	$	8,034

A roll-forward of troubled debt restructuring during the six months ended June 30, 2013 (dollars in thousands):

				Commercial,				One to four			Consumer and
	Commercial			Financial and		Commercial		family residential			Consumer
	Real Estate			Agricultural		Construction		real estate			Construction		Total
ACCRUING
Beginning balance	$	3,611		$	1,221	$	858	$	102		$	—	$	5,792
Principal payments	(48		)	—		—		(2		)	—		(50		)
Charge-offs	—			—		—		—			—		—
Advances	—			—		—		—			—		—
New restructured	—			953		—		—			—		953
Transferred out of TDRs	—			—		—		—			—		—
Transfers to nonaccrual	—			—		—		—			—		—
Ending Balance	$	3,563		$	2,174	$	858	$	100		$	—	$	6,695
NONACCRUAL
Beginning balance	$	2,162		$	—	$	—	$	102		$	—	$	2,264
Principal payments	—			—		—		—			—		—
Charge-offs	—			—		—		—			—		—
Advances	—			—		—		—			—		—
New restructured	7			—		—		4			—		11
Transfers to foreclosed properties	—			—		—		—			—		—
Transfers from accruing	—			—		—		—			—		—
Ending Balance	$	2,169		$	—	$	—	$	106		$	—	$	2,275
TOTALS
Beginning balance	$	5,773		$	1,221	$	858	$	204		$	—	$	8,056
Principal payments	(48		)	—		—		(2		)	—		(50		)
Charge-offs	—			—		—		—			—		—
Advances	—			—		—		—			—		—
New restructured	7			953		—		4			—		964
Transfers out of TDR	—			—		—		—			—		—
Transfers to nonaccrual	—			—		—		—			—		—
Transfers to foreclosed properties	—			—		—		—			—		—
Transfer from accruing	—			—		—		—			—		—
Ending Balance	$	5,732		$	2,174	$	858	$	206		$	—	$	8,970

A roll-forward of troubled debt restructuring during the six months ended June 30, 2012 (dollars in thousands):

				Commercial,						One to four			Consumer and
	Commercial			Financial and			Commercial			family residential			Consumer
	Real Estate			Agricultural			Construction			real estate			Construction		Total
ACCRUING
Beginning balance	$	2,400		$	—		$	—		$	103				$	2,503
Principal payments	(19		)	—			(1		)	(1		)	—		(21		)
Charge-offs	—			—			—			—			—		—
Advances	—			—			—			—			—		—
New restructured	3,672			1,221			859			—			—		5,752
Transferred out of TDRs	—			—			—			—			—		—
Transfers to nonaccrual	(2,400		)	—			—			—			—		(2,400		)
Ending Balance	$	3,653		$	1,221		$	858		$	102		$	—	$	5,834
NONACCRUAL
Beginning balance	$	—		$	—		$	—		$	—		$	—	$	—
Principal payments	(615		)	(1,072		)	—			—			—		(1,687		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	835			1,072			—			293			—		2,200
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	2,400			—			—			—			—		2,400
Ending Balance	$	2,194		$	—		$	—		$	6		$	—	$	2,200
TOTALS
Beginning balance	$	2,400		$	—		$	—		$	103		$	—	$	2,503
Principal payments	(634		)	(1,072		)	(1		)	(1		)	—		(1,708		)
Charge-offs	(426		)	—			—			(100		)	—		(526		)
Advances	—			—			—			—			—		—
New restructured	4,507			2,293			859			293			—		7,952
Transfers out of TDRs	—			—			—			—			—		—
Transfers to nonaccrual	(2,400		)	—			—			—			—		(2,400		)
Transfers to foreclosed properties	—			—			—			(187		)	—		(187		)
Transfers from accruing	2,400			—			—			—			—		2,400
Ending Balance	$	5,847		$	1,221		$	858		$	108		$	—	$	8,034

A roll-forward of troubled debt restructuring during the year ended December 31, 2012 (dollars in thousands):

				Commercial,					One to four			Consumer and
	Commercial			Financial and		Commercial			family residential			Consumer
	Real Estate			Agricultural		Construction			real estate			Construction		Total
ACCRUING
Beginning balance	$	2,400		$	—	$	—		$	103		$	—	$	2,503
Principal payments	(84		)	—		(2		)	(1		)	—		(87		)
Charge-offs	—			—		—			—			—		—
Advances	—			—		—			—			—		—
New restructured	3,695			1,221		860			—			—		5,776
Transferred out of TDR	—			—		—			—			—		—
Transfers to nonaccrual	(2,400		)	—		—			—			—		(2,400		)
Ending Balance	$	3,611		$	1,221	$	858		$	102		$	—	$	5,792
NONACCRUAL
Beginning balance	$	—		$	—	$	—		$	—		$	—	$	—
Principal payments	(432		)	—		—			—			—		(432		)
Charge-offs	(772		)	—		—			—			—		(772		)
Advances	47			—		—			—			—		47
New restructured	919			—		—			102			—		1,021
Transfers to foreclosed properties	—			—		—			—			—		—
Transfers from accruing	2,400			—		—			—			—		2,400
Ending Balance	$	2,162		$	—	$	—		$	102		$	—	$	2,264
TOTALS
Beginning balance	$	2,400		$	—	$	—		$	103		$	—	$	2,503
Principal payments	(516		)	—		(2		)	(1		)	—		(519		)
Charge-offs	(772		)	—		—			—			—		(772		)
Advances	47			—		—			—			—		47
New restructured	4,614			1,221		860			102			—		6,797
Transfers out of TDRs	—			—		—			—			—		—
Tansfers to nonaccrual	(2,400		)	—		—			—			—		(2,400		)
Transfers to foreclosed properties	—			—		—			—			—		—
Transfers from accruing	2,400			—		—			—			—		2,400
Ending Balance	$	5,773		$	1,221	$	858		$	204		$	—	$	8,056

Schedule of activity in insider loans granted to the entity's executive officers and directors, including their families and firms

Activity in such loans is summarized below (dollars in thousands):

	June 30,			December 31,			June 30,
	2013			2012			2012
Loans outstanding, beginning of period	$	11,297		$	8,827		$	8,827
New loans	496			3,911			936
Net activity on revolving lines of credit	(25		)	233			41
Principal payments	(1,298		)	(1,674		)	(419		)
Loans outstanding, end of period	$	10,470		$	11,297		$	9,385

XML

EARNINGS PER SHARE (Tables)

6 Months Ended

Jun. 30, 2013

EARNINGS PER SHARE

Schedule showing the computation of basic and diluted earnings per share

The following shows the computation of basic and diluted earnings per share for the three and six months ended June 30, 2013 and 2012 (dollars in thousands, except per share data):

	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
(Numerator):
Net income	$	1,260	$	4,302	$	2,073	$	4,993
Preferred stock dividends and accretion of discount	63		161		200		354
Net income available to common shareholders	$	1,197	$	4,141	$	1,873	$	4,639
(Denominator):
Weighted average shares outstanding - basic	5,556,133		3,419,736		5,557,842		3,419,736
Dilutive effect of common stock warrants	—		120,172		—		112,904
Weighted average shares outstanding - diluted	5,556,133		3,539,908		5,557,842		3,532,640
Income per common share*:
Basic	$	.22	$	.97	$	.34	$	1.09
Diluted	$	.22	$	.94	$	.34	$	1.05

*Earnings per share data for 2012 restated for common stock issuance

XML

Document and Entity Information	6 Months Ended
	Jun. 30, 2013
Document and Entity Information
Entity Registrant Name	MACKINAC FINANCIAL CORP /MI/
Entity Central Index Key	0000036506
Document Type	10-Q
Document Period End Date	Jun. 30, 2013
Amendment Flag	false
Current Fiscal Year End Date	--12-31
Entity Current Reporting Status	Yes
Entity Filer Category	Smaller Reporting Company
Entity Common Stock, Shares Outstanding	5,554,459
Document Fiscal Year Focus	2013
Document Fiscal Period Focus	Q2

XML

INVESTMENT SECURITIES (Tables)

6 Months Ended

Jun. 30, 2013

INVESTMENT SECURITIES

Schedule of amortized cost and estimated fair value of investment securities available for sale

The amortized cost and estimated fair value of investment securities available for sale as of June 30, 2013, December 31, 2012 and June 30, 2012 are as follows (dollars in thousands):

			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Fair Value
June 30, 2013
US Agencies - MBS	$	7,491	$	354	$	—		$	7,845
US Agencies	15,172		74		(341		)	14,905
Corporate Bonds	18,557		161		(45		)	18,673
Obligations of states and political subdivisions	5,435		450		(1		)	5,884
Total securities available for sale	$	46,655	$	1,039	$	(387	)	$	47,307
December 31, 2012
US Agencies - MBS	$	7,962	$	412	$	—		$	8,374
US Agencies	10,267		137		—			10,404
Corporate Bonds	18,763		237		(23		)	18,977
Obligations of states and political subdivisions	5,407		637		—			6,044
Total securities available for sale	$	42,399	$	1,423	$	(23	)	$	43,799
June 30, 2012
US Agencies - MBS	$	9,667	$	412	$	—		$	10,079
US Agencies	10,338		155		—			10,493
Corporate Bonds	12,519		70		(17		)	12,572
Obligations of states and political subdivisions	5,474		438		(2		)	5,910
Total securities available for sale	$	37,998	$	1,075	$	(19	)	$	39,054