10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

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

For the quarterly period ended March 31, 2017

OR

☐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  ☒     No  ☐

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

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

Large Accelerated Filer  ☐	Accelerated Filer  ☐
Non-accelerated Filer     ☐  (Do not check if a smaller reporting company)	Smaller reporting company  ☒ Emerging growth company  ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes  ☐     No  ☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.☐

As of May 10, 2017, there were outstanding 6,294,930 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 – March 31, 2017 (Unaudited), December 31, 2016	1
	Condensed Consolidated Statements of Operations — Three Months Ended March 31, 2017 (Unaudited) and March 31, 2016 (Unaudited)	2
	Condensed Consolidated Statements of Comprehensive Income — Three Months Ended March 31, 2017 (Unaudited) and March 31, 2016 (Unaudited)	3
	Condensed Consolidated Statements of Changes in Shareholders’ Equity — Three Months Ended March 31, 2017 (Unaudited) and March 31, 2016 (Unaudited)	4
	Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 2017 (Unaudited) and March 31, 2016 (Unaudited)	5
	Notes to Condensed Consolidated Financial Statements (Unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	37
Item 4.	Controls and Procedures	40
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	41
Item 6.	Exhibits and Reports on Form 8-K	41
SIGNATURES		42

MACKINAC FINANCIAL CORPORATION

PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)

	March 31,		December 31,
	2017		2016
	(Unaudited)
ASSETS
Cash and due from banks	$	41,166	$	44,620
Federal funds sold		3		2,135
Cash and cash equivalents		41,169		46,755
Interest-bearing deposits in other financial institutions		13,448		14,047
Securities available for sale		83,882		86,273
Federal Home Loan Bank stock		2,719		2,911
Loans:
Commercial		552,483		543,573
Mortgage		215,042		218,171
Consumer		19,021		20,113
Total Loans		786,546		781,857
Allowance for loan losses		(5,146)		(5,020)
Net loans		781,400		776,837
Premises and equipment		15,970		15,891
Other real estate held for sale		4,466		4,782
Deferred tax asset		7,651		8,760
Deposit based intangibles		2,110		2,172
Goodwill		5,694		5,694
Other assets		18,126		19,398
TOTAL ASSETS	$	976,635	$	983,520
LIABILITIES AND SHAREHOLDERS’ EQUITY
LIABILITIES:
Deposits:
Noninterest bearing deposits	$	147,106	$	164,179
NOW, money market, interest checking		283,314		286,622
Savings		61,171		58,315
CDs<$250,000		141,569		141,629
CDs>$250,000		8,802		8,489
Brokered		179,858		164,278
Total deposits		821,820		823,512
Federal funds purchased		3,000		6,000
Borrowings		66,279		67,579
Other liabilities		5,527		7,820
Total liabilities		896,626		904,911
SHAREHOLDERS’ EQUITY:
Common stock and additional paid in capital - No par value Authorized - 18,000,000 shares Issued and outstanding - 6,294,930 and 6,270,034 respectively		61,683		61,583
Retained earnings		18,176		17,206
Accumulated other comprehensive income (loss)
Unrealized (losses) gains on available for sale securities		228		(102)
Minimum pension liability		(78)		(78)
Total shareholders’ equity		80,009		78,609
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	976,635	$	983,520

1

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except per Share Data)

	Three Months Ended
	March 31,
	2017		2016
	(Unaudited)
INTEREST INCOME:
Interest and fees on loans:
Taxable	$	9,957	$	7,960
Tax-exempt		33		2
Interest on securities:
Taxable		399		262
Tax-exempt		79		31
Other interest income		128		55
Total interest income		10,596		8,310
INTEREST EXPENSE:
Deposits		959		769
Borrowings		471		253
Total interest expense		1,430		1,022
Net interest income		9,166		7,288
Provision for loan losses		150		—
Net interest income after provision for loan losses		9,016		7,288
OTHER INCOME:
Deposit service fees		272		216
Income from mortgage loans sold on the secondary market		298		267
SBA/USDA loan sale gains		60		—
Net mortgage servicing (amortization) income		(8)		(54)
Net realized security gains		—		97
Other		154		101
Total other income		776		627
OTHER EXPENSE:
Salaries and employee benefits		3,797		3,387
Occupancy		785		640
Furniture and equipment		481		383
Data processing		461		345
Advertising		123		156
Professional service fees		321		241
Loan origination expenses and deposit and card related fees		179		127
Writedowns and losses on other real estate held for sale		12		16
FDIC insurance assessment		157		108
Telephone		157		112
Transaction related expenses		—		106
Other		704		577
Total other expenses		7,177		6,198
Income before provision for income taxes		2,615		1,717
Provision for  income taxes		889		585
NET INCOME	$	1,726	$	1,132
INCOME PER COMMON SHARE:
Basic	$	.28	$	.18
Diluted	$	.28	$	.18

2

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS COMPREHENSIVE INCOME

(Dollars in Thousands)

(Unaudited)

	Three Months Ended
	March 31,
	2017		2016
Net income	$	1,726	$	1,132
Other comprehensive income
Change in securities available for sale:
Unrealized gains arising during the period		500		424
Reclassification adjustment for securities gains included in net income		—		(97)
Tax effect		(170)		(110)
Net change in unrealized gains on available for sale securities		330		217
Total comprehensive income	$	2,056	$	1,349

3

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in Thousands)

(Unaudited)

	Three Months Ended
	March 31,
	2017
		Common				Accumulated
	Shares of	Stock and				Other
	Common	Additional		Retained		Comprehensive
	Stock	Paid in Capital		Earnings		Income (loss)		Total
Balance, beginning of period	6,263,371	$	61,583	$	17,206	$	(180)	$	78,609
Net income for period	—		—		1,726		—		1,726
Other comprehensive income
Net unrealized gain on securities available for sale	—		—		—		330		330
Actuarial loss on defined benefit pension obligation	—		—		—		—		—
Total comprehensive income	—		—		1,726		330		2,056
Stock compensation	—		100		—		—		100
Issuance of common stock:
Restricted stock award vesting	31,559		—		—		—		—
Dividend on common stock	—		—		(756)		—		(756)
Balance, end of period	6,294,930	$	61,683	$	18,176	$	150	$	80,009

	Three Months Ended
	March 31,
	2016
		Common				Accumulated
	Shares of	Stock and				Other
	Common	Additional		Retained		Comprehensive
	Stock	Paid in Capital		Earnings		Income (Loss)		Total
Balance, beginning of period	6,217,620	$	61,133	$	15,221	$	248	$	76,602
Net income for period	—		—		1,132		—		1,132
Other comprehensive income
Net unrealized gain on securities available for sale	—		—		—		217		217
Actuarial loss on defined benefit pension obligation	—		—		—		—		—
Total comprehensive income	—		—		1,132		217		1,349
Stock compensation	—		150		—		—		150
Issuance of common stock:
Restricted stock award vesting	22,626		—		—		—		—
Repurchase of common stock	(9,000)		(99)		—		—		(99)
Dividend on common stock	—		—		(607)		—		(607)
Balance, end of period	6,231,246	$	61,184	$	15,746	$	465	$	77,395

4

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(Unaudited)

	Three Months Ended
	March 31,
	2017		2016
Cash Flows from Operating Activities:
Net income	$	1,726	$	1,132
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		572		395
Provision for loan losses		150		—
Deferred tax expense		889		585
Gain on sales/calls of securities		—		(97)
Gain on sale of loans sold in the secondary market		(298)		(228)
Origination of loans held for sale in the secondary market		(15,026)		(13,802)
Proceeds from sale of loans in the secondary market		15,324		14,030
(Gain) loss on sale of premises, equipment, and other real estate held for sale		(4)		16
Writedown of other real estate held for sale		16		—
Stock compensation		100		150
Change in other assets		1,334		(513)
Change in other liabilities		(2,293)		(485)
Net cash provided by operating activities		2,490		1,183
Cash Flows from Investing Activities:
Net increase in loans		(5,099)		(946)
Net decrease in interest bearing deposits in other financial institutions		599		100
Purchase of securities available for sale		—		(5,225)
Proceeds from maturities, sales, calls or paydowns of securities available for sale		2,776		5,238
Redemption of FHLBI stock		192		—
Capital expenditures		(536)		(337)
Proceeds from life insurance		—		99
Proceeds from sale of premises, equipment, and other real estate		740		247
Net cash used in investing activities		(1,328)		(824)
Cash Flows from Financing Activities:
Net decrease in deposits		(1,692)		(17,345)
Net activity on line of credit		(750)		800
(Decrease) increase in fed funds purchased		(3,000)		10,000
Principal payments on borrowings		(550)		(100)
Repurchase of common stock		—		(99)
Dividend on common stock		(756)		(607)
Net cash used in financing activities		(6,748)		(7,351)
Net decrease in cash and cash equivalents		(5,586)		(6,992)
Cash and cash equivalents at beginning of period		46,755		25,008
Cash and cash equivalents at end of period	$	41,169	$	18,016
Supplemental Cash Flow Information:
Cash paid during the year for:
Interest	$	1,411	$	1,013
Income taxes		—		50
Noncash Investing and Financing Activities:
Transfers of Foreclosures from Loans to Other Real Estate Held for Sale		576		623

5

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 three month period ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.  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, 2016.

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, the valuation of investment securities, the valuation of foreclosed real estate, deferred tax assets, mortgage servicing rights, and the assessment of goodwill for impairment.

Acquired Loans

Loans acquired with evidence of credit deterioration since inception and for which it is probable that all contractual payments will not be received are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”).  These loans are recorded at fair value at the time of acquisition, with no carryover of the related allowance for loan losses.  Fair value of acquired loans is determined using a discounted cash flow methodology based on assumptions about the amount and timing of principal and interest payments, principal prepayments and principal defaults and losses, and current market rates.  In recording the fair values of acquired impaired loans at acquisition date, management calculates a non-accretable difference (the credit component of the purchased loans) and an accretable difference (the yield component of the purchased loans).

Over the life of the acquired loans, management continues to estimate cash flows expected to be collected on pools of loans sharing common risk characteristics, which are treated in the aggregate when applying various valuation techniques.  Management evaluates at each balance sheet date whether the present value of our pools of loans determined using the effective interest rates has decreased significantly and if so, recognizes a provision for loan loss in our consolidated statement of income.  For any significant increases in cash flows expected to be collected, we adjust the amount of the accretable yield recognized on a prospective basis over the pool’s remaining life.

Performing acquired loans are accounted for under Financial Accounting Standards Board (“FASB”) Topic 310-20, Receivables – Nonrefundable Fees and Other Costs.  Performance of certain loans may be monitored and based on management’s assessment of the cash flows and other facts available, portions of the accretable difference may be delayed or suspended if management deems appropriate.  The Corporation’s policy for determining when to discontinue accruing interest on performing acquired loans and the subsequent accounting for such loans is essentially the same as the policy for originated loans.

6

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 also has an unallocated allowance for loan losses for loans not considered impaired.  The allowance for loan losses is maintained at a level which management believes is adequate to provide for incurred 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

On May 22, 2012, the Corporation’s shareholders approved the Mackinac Financial Corporation 2012 Incentive Compensation Plan, under which current and prospective employees, non-employee directors and consultants may be awarded incentive stock options, non-statutory stock options, shares of restricted stock awards (“RSAs”), or stock appreciation rights.  The aggregate number of shares of the Corporation’s common stock issuable under the plan is 575,000.  Awards are made to certain other senior officers at the discretion of the Corporation’s management.  Compensation cost equal to the fair value of the award is recognized over the vesting period.

2.RECENT ACCOUNTING PRONOUNCEMENTS

In May 2014, the Financial Accounting Standards Board (FASB) issued guidance on the recognition of revenue from contracts with customers. Revenue recognition will depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The guidance permits two methods of adoption: retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application. The guidance is effective January 1, 2018 and early adoption is permitted only as of January 1, 2017. In this regard, management has completed a preliminary analysis of the impact of implementation.  The key revenue streams affected by implementation would include service charges and mortgage banking income. The new guidance is not expected to have a significant impact on the Corporation’s financial results. Interest income is outside of the scope of the new standard and will not be impacted upon adoption.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”).  ASU 2016-01 amends current guidance by requiring companies to recognize changes in fair value for equity investments that have a readily determinable fair value through net income rather than through other comprehensive income.  Under ASU 2016-01, equity investments that do not have a readily determinable fair value will either be accounted for in the same manner as equity investments that have a readily determinable fair value, with changes in fair value recognized through net income or carried at cost, adjusted for changes in observable prices based on orderly transactions for identical or similar investments issued by the same issuer and further adjusted for impairment, if applicable.  ASU 2016-01 also requires a qualitative assessment of impairment indicators each reporting period.  If this assessment indicates that impairment exists, companies must adjust the investment to fair value and recognize an impairment loss in net income, even if the impairment is determined to be temporary.  ASU 2016-01 is effective for public companies for interim and annual periods beginning after December 15, 2017.   The Corporation’s adoption of ASU 2016-01 is not expected to have a material impact on the Corporation’s consolidated financial condition or results of operations.

7

In February 2016, the FASB issued ASU 2016-02, Leases, which will supersede the current lease requirements in ASC 840.  The ASU requires lessees to recognize an asset with the right of use and related lease liability for all leases, with a limited exception for short-term leases.  Leases will be classified as either finance or operating, with the classification affecting the pattern of expense recognition in the statement of operations.  Currently, leases are classified as either capital or operating, with only capital leases recognized on the balance sheet.  The reporting of lease related expenses in the statements of operations and cash flows will be generally consistent with the current guidance.  The new lease guidance will be effective for the Corporation’s year ending December 31, 2019 and will be applied using modified retrospective transition method to the beginning of the earliest period presented.  The effect of applying the new lease guidance on the financial statements has not yet been determined.

In September 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income.

ASU 2016-13 requires an entity to measure expected credit losses for financial assets over the estimated lifetime of expected credit loss and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The standard includes the following core concepts in determining the expected credit loss.  The estimate must: (a) be based on an asset’s amortized cost (including premiums or discounts, net deferred fees and costs, foreign exchange and fair value hedge accounting adjustments), (b) reflect losses expected over the remaining contractual life of an asset (considering the effect of voluntary prepayments), (c) consider available relevant information about the estimated collectability of cash flows (including information about past events, current conditions, and reasonable and supportable forecasts), and (d) reflect the risk of loss, even when that risk is remote.

ASU 2016-13 also amends the recording of purchased credit-deteriorated assets. Under the new guidance, an allowance will be recognized at acquisition through a gross-up approach whereby an entity will record as the initial amortized cost the sum of (a) the purchase price and (b) an estimate of credit losses as of the date of acquisition. In addition, the guidance also requires immediate recognition in earnings of any subsequent changes, both favorable and unfavorable, in expected cash flows by adjusting this allowance.

ASU 2016-13 also amends the impairment model for available-for-sale debt securities and requires entities to determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. Management may not use the length of time a security has been in an unrealized loss position as a factor in concluding whether a credit loss exists, as is currently permitted. In addition, an entity will recognize an allowance for credit losses on available-for-sale debt securities as a contra-account to the amortized cost basis rather than as a direct reduction of the amortized cost basis of the investment, as is currently required. As a result, entities will recognize improvements to credit losses on available-for-sale debt securities immediately in earnings rather than as interest income over time under current practice.

New disclosures required by ASU 2016-13 include: (a) for financial assets measured at amortized cost, an entity will be required to disclose information about how it developed its allowance, including changes in the factors that influenced management’s estimate of expected credit losses and the reasons for those changes, (b) for financial receivables and net investments in leases measured at amortized cost, an entity will be required to further disaggregate the information it currently discloses about the credit quality of these assets by year or the asset’s origination or vintage for as many as five annual periods, and (c) for available-for-sale debt securities, an entity will be required to provide a roll-forward of the allowance for credit losses and an aging analysis for securities that are past due.

Upon adoption of ASU 2016-13, a cumulative-effect adjustment to retained earnings will be recorded as of the beginning of the first reporting period in which the guidance is effective. ASU 2016-13 is effective for public companies for interim and annual periods beginning after December 15, 2019, with early adoption permitted for annual periods beginning after December 15, 2018. The Corporation is currently evaluating the provisions of ASU 2016-13 to determine the potential impact on the Corporation's consolidated financial condition and results of operations.

3.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

8

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 months ended March 31, 2017 and 2016 (dollars in thousands, except per share data):

	Three Months Ended March 31,
	2017		2016
(Numerator):
Net income	$	1,726	$	1,132
(Denominator):
Weighted average shares outstanding		6,270,034		6,214,083
Effect of dilutive stock options, and vesting of restricted stock awards		10,343		13,902
Diluted weighted average shares outstanding		6,280,377		6,227,985
Income per common share:
Basic	$	.28	$	.18
Diluted	$	.28	$	.18

4.INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities available for sale as of March 31, 2017 and December 31, 2016 are as follows (dollars in thousands):

			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
March 31, 2017
Corporate	$	19,849	$	118	$	(15)	$	19,952
Equity		500		—		—		500
US Agencies		22,991		77		(15)		23,053
US Agencies - MBS		15,903		64		(111)		15,856
Obligations of states and political subdivisions		24,293		405		(177)		24,521
Total securities available for sale	$	83,536	$	664	$	(318)	$	83,882
December 31, 2016
Corporate	$	19,899	$	49	$	(38)	$	19,910
Equity		500		—		—		500
US Agencies		23,991		47		(86)		23,952
US Agencies - MBS		16,980		48		(195)		16,833
Obligations of states and political subdivisions		25,057		447		(426)		25,078
Total securities available for sale	$	86,427	$	591	$	(745)	$	86,273

The Corporation has evaluated gross unrealized losses that exist within the portfolio and considers them temporary in nature.  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 $19.902 million and $19.869 million, respectively, at March 31, 2017.

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5.LOANS

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

	March 31,		December 31,
	2017		2016
Commercial real estate	$	397,192	$	389,420
Commercial, financial, and agricultural		144,673		142,648
Commercial construction		10,618		11,505
One to four family residential real estate		202,654		205,945
Consumer		19,021		20,113
Consumer construction		12,388		12,226
Total loans	$	786,546	$	781,857

The Corporation completed the acquisition of Peninsula Financial Corporation (“PFC”) on December 5, 2014, The First National Bank of Eagle River (“Eagle River”) on April 29, 2016 and Niagara Bancorporation (“Niagara”) on August 31, 2016.    The PFC acquired impaired loans totaled $13.290 million, the Eagle River acquired impaired loans totaled $3.401 million, and the Niagara acquired impaired loans totaled $2.105 million.  In the first three months of 2017, the Corporation had positive resolution of acquired nonperforming loans, which resulted in the recognition of $100,000 of accretable interest.  In the first three months of 2016, the Corporation had positive resolution of one PFC acquired nonperforming loan which resulted in the recognition of approximately $96,000 of accretable interest.

The table below details the outstanding balances of the PFC acquired portfolio and the fair value adjustments at acquisition date (dollars in thousands):

	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	13,290	$	53,849	$	67,139
Nonaccretable difference		(2,234)		—		(2,234)
Expected cash flows		11,056		53,849		64,905
Accretable yield		(744)		(2,100)		(2,844)
Carrying balance at acquisition date	$	10,312	$	51,749	$	62,061

The table below details the outstanding balances of the Eagle River acquired portfolio and the fair value adjustments at acquisition date (dollars in thousands):

	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	3,401	$	80,737	$	84,138
Nonaccretable difference		(1,172)		—		(1,172)
Expected cash flows		2,229		80,737		82,966
Accretable yield		(391)		(1,700)		(2,091)
Carrying balance at acquisition date	$	1,838	$	79,037	$	80,875

The table below details the outstanding balances of the Niagara acquired portfolio and the fair value adjustments at acquisition date (dollars in thousands):

	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	2,105	$	30,555	$	32,660
Nonaccretable difference		(265)		—		(265)
Expected cash flows		1,840		30,555		32,395
Accretable yield		(88)		(600)		(688)
Carrying balance at acquisition date	$	1,752	$	29,955	$	31,707

10

The table below presents a rollforward of the accretable yield on acquired loans for the three months ended March 31, 2017 (dollars in thousands):

	PFC						Eagle River						Niagara
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total		Impaired		Non-impaired		Total
Balance, December 31, 2016	$	282	$	642	$	924	$	236	$	1,221	$	1,457	$	52	$	505	$	557
Accretion		(100)		(175)		(275)		—		(179)		(179)		—		(72)		(72)
Reclassification from nonaccretable difference		57		—		57		—		—		—		(8)		—		(8)
Balance, March 31, 2017	$	239	$	467	$	706	$	236	$	1,042	$	1,278	$	44	$	433	$	477

The table below presents a rollforward of the accretable yield on acquired loans for the three months ended March 31, 2016 (dollars in thousands):

	PFC
	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Balance, December 31, 2015	$	426	$	1,342	$	1,768
Accretion		—		(175)		(175)
Reclassification from nonaccretable difference		(17)		—		(17)
Balance, March 31, 2016	$	409	$	1,167	$	1,576

Allowance for Loan Losses

An analysis of the allowance for loan losses for the three months ended March 31, 2017 and the year ended December 31, 2016 is as follows (dollars in thousands):

	March 31,		March 31,
	2017		2016
Balance, January 1	$	5,020	$	5,004
Recoveries on loans previously charged off		102		56
Loans charged off		(126)		(236)
Provision		150		0
Balance at end of period	$	5,146	$	4,824

In the first three months of 2017, net charge-offs were $24,000, compared to net charge-offs of $.180 million in the same period in 2016.   In the first three  months of 2017, the Corporation recorded a provision for loan loss of $.150 million compared to no provision in the first three months of 2016.  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.

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A breakdown of the allowance for loan losses and recorded balances in loans at March 31, 2017 is as follows (dollars in thousands):

			Commercial,				One to four
	Commercial		financial and		Commercial		family residential		Consumer
	real estate		agricultural		construction		real estate		construction		Consumer		Unallocated		Total
Allowance for loan loss reserve:
Beginning balance ALLR	$	1,345	$	614	$	57	$	296	$	6	$	90	$	2,612	$	5,020
Charge-offs		—		—		—		(49)		—		(77)		—		(126)
Recoveries		34		1		—		61		—		6		—		102
Provision		(19)		35		38		(43)		1		(4)		142		150
Ending balance ALLR	$	1,360	$	650	$	95	$	265	$	7	$	15	$	2,754	$	5,146
Loans:
Ending balance	$	397,192	$	144,673	$	10,618	$	202,654	$	12,388	$	19,021	$	—	$	786,546
Ending balance ALLR		(1,360)		(650)		(95)		(265)		(7)		(15)		(2,754)		(5,146)
Net loans	$	395,832	$	144,023	$	10,523	$	202,389	$	12,381	$	19,006	$	(2,754)	$	781,400
Ending balance ALLR:
Individually evaluated	$	525	$	394	$	38	$	3	$	—	$	5	$	—	$	965
Collectively evaluated		835		256		57		262		7		10		2,754		4,181
Total	$	1,360	$	650	$	95	$	265	$	7	$	15	$	2,754	$	5,146
Ending balance Loans:
Individually evaluated	$	1,564	$	1,464	$	382	$	403	$	—	$	22	$	—	$	3,835
Collectively evaluated		392,409		143,209		8,228		202,196		12,388		18,996		—		777,426
Acquired with deteriorated credit quality		3,219		—		2,008		55		—		3		—		5,285
Total	$	397,192	$	144,673	$	10,618	$	202,654	$	12,388	$	19,021	$	—	$	786,546

Impaired loans, by definition, are individually evaluated.

A breakdown of the allowance for loan losses and recorded balances in loans at March 31, 2016 is as follows (dollars in thousands):

			Commercial,				One to four
	Commercial		financial and		Commercial		family residential		Consumer
	real estate		agricultural		construction		real estate		construction		Consumer		Unallocated		Total
Allowance for loan loss reserve:
Beginning balance ALLR	$	1,611	$	645	$	79	$	274	$	7	$	64	$	2,324	$	5,004
Charge-offs		—		(185)		—		(39)		—		(12)		—		(236)
Recoveries		7		31		7		1		—		10		—		56
Provision		(3)		89		(12)		21		—		(22)		(73)		—
Ending balance ALLR	$	1,615	$	580	$	74	$	257	$	7	$	40	$	2,251	$	4,824
Loans:
Ending balance	$	317,081	$	124,005	$	14,489	$	135,641	$	11,959	$	15,450	$	—	$	618,625
Ending balance ALLR		(1,615)		(580)		(74)		(257)		(7)		(40)		(2,251)		(4,824)
Net loans	$	315,466	$	123,425	$	14,415	$	135,384	$	11,952	$	15,410	$	(2,251)	$	613,801
Ending balance ALLR:
Individually evaluated	$	533	$	185	$	—	$	45	$	—	$	31	$	—	$	794
Collectively evaluated		1,082		395		74		212		7		9		2,251		4,030
Total	$	1,615	$	580	$	74	$	257	$	7	$	40	$	2,251	$	4,824
Ending balance Loans:
Individually evaluated	$	2,001	$	392	$	—	$	750	$	—	$	36	$	—	$	3,179
Collectively evaluated		310,709		123,436		14,489		132,242		11,957		15,413		—		608,246
Acquired with deteriorated credit quality		4,371		177		—		2,649		2		1		—		7,200
Total	$	317,081	$	124,005	$	14,489	$	135,641	$	11,959	$	15,450	$	—	$	618,625

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.

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Strong (1)

Borrower is not vulnerable to sudden economic or technological changes.  They have “strong” balance sheets and are within an industry that is very typical for our markets or type of lending culture.  Borrowers also have “strong” financial and cash flow performance and excellent collateral (low loan to value or readily available to liquidate collateral) in conjunction with an impeccable repayment history.

Good (2)

Borrower shows limited vulnerability to sudden economic change.  These borrowers have “above average” financial and cash flow performance and a very good repayment history.  The balance sheet of the company is also very good as compared to peer and the company is in an industry that is familiar to our markets or our type of lending.  The collateral securing the deal is also very good in terms of its type, loan to value, and other relevant characteristics.

Average (3)

Borrower is typically a well-seasoned business, however may be susceptible to unfavorable changes in the economy, and could be somewhat affected by seasonal factors.  The borrowers within this category exhibit financial and cash flow performance that appear “average” to “slightly above average” when compared to peer standards and they show an adequate payment history.  Collateral securing this type of credit is good, exhibiting above average loan to values, and other relevant characteristics.

Acceptable/Acceptable Watch (4)

A borrower within this category exhibits financial and cash flow performance that appear adequate and satisfactory when compared to peer standards and they show a satisfactory payment history.  The collateral securing the request is within supervisory limits and overall is acceptable.  Borrowers rated acceptable could also be newer businesses that are typically susceptible to unfavorable changes in the economy, and more than likely could be affected by seasonal factors.

Special Mention (5)

The borrower may have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date.  Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.  Examples of this type of credit include a start-up company fully based on projections, a documentation issue that needs to be corrected or a general market condition that the borrower is working through to get corrected.

Substandard (6)

Substandard loans are classified assets exhibiting a number of well-defined weaknesses that jeopardize normal repayment.  The assets are no longer adequately protected due to declining net worth, lack of earning capacity, or insufficient collateral offering the distinct possibility of the loss of a portion of the loan principal.  Loans classified as substandard clearly represent troubled and deteriorating credit situations requiring constant supervision.

Doubtful (7)

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

Charge-off/Loss (8)

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

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General Reserves:

For loans with a credit risk rating of 5 or better and any loans with a risk rating of 6 or 7 not considered impaired, reserves are established based on the type of loan collateral, if any, and the assigned credit risk rating. 

Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogenous loans based on historical loss experience, and consideration of current environmental factors and economic trends, all of which may be susceptible to significant change.

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

Below is a breakdown of loans by risk category as of March 31, 2017 (dollars in thousands):

							(4)
	(1)		(2)		(3)		Acceptable/		(5)		(6)		(7)		Rating
	Strong		Good		Average		Acceptable Watch		Special Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	3,309	$	24,533	$	149,448	$	204,557	$	10,582	$	4,763	$	—	$	—	$	397,192
Commercial, financial and agricultural		10,616		13,463		48,226		68,018		2,463		1,887		—		—		144,673
Commercial construction		—		875		3,163		1,961		756		382		—		3,481		10,618
One-to-four family residential real estate		825		1,367		3,190		7,128		2,798		4,165		—		183,181		202,654
Consumer construction		28		—		—		—		—		16		—		12,344		12,388
Consumer		15		—		14		39		12		59		—		18,882		19,021
Total loans	$	14,793	$	40,238	$	204,041	$	281,703	$	16,611	$	11,272	$	—	$	217,888	$	786,546

Below is a breakdown of loans by risk category as of December 31, 2016 (dollars in thousands):

							(4)
	(1)		(2)		(3)		Acceptable/		(5)		(6)		(7)		Rating
	Strong		Good		Average		Acceptable Watch		Special Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	3,021	$	23,940	$	140,618	$	216,518	$		$	5,323	$	—	$	—	$	389,420
Commercial, financial and agricultural		10,421		13,434		49,434		67,582				1,777		—		—		142,648
Commercial construction		—		900		3,146		2,660				385		—		4,414		11,505
One-to-four family residential real estate		740		1,373		3,412		9,585				5,493		—		185,342		205,945
Consumer construction		28		—		—		—		—		17		—		12,181		12,226
Consumer		20		—		15		55				103		—		19,920		20,113
Total loans	$	14,230	$	39,647	$	196,625	$	296,400	$	—	$	13,098	$	—	$	221,857	$	781,857

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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. 

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):

							QTD				Interest Income
	Nonaccrual			Nonaccrual	Accrual		Average		Related		on
	Recorded Balance			Unpaid Balance	Basis		Investment		Valuation Reserve		Accrual Basis
March 31, 2017
With no valuation reserve:
Commercial real estate	$	1,391	$	1,834	$	2,097	$	4,086	$	—	$	121
Commercial, financial and agricultural		9		9		—		9		—		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,253		1,607		1,903		3,981		—		104
Consumer construction		16		21		55		73		—		1
Consumer		15		19		3		52		—		—
With a valuation reserve:
Commercial real estate	$	301	$	310	$	—	$	302	$	50	$	—
Commercial, financial and agricultural		335		335		—		327		261		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		386		387		—		235		27		—
Consumer construction		—		—		—		—		—		—
Consumer		24		24		—		12		11		—
Total:
Commercial real estate	$	1,692	$	2,144	$	2,097	$	4,388	$	50	$	121
Commercial, financial and agricultural		344		344		—		336		261		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,639		1,994		1,903		4,216		27		104
Consumer construction		16		21		55		73		—		1
Consumer		39		43		3		64		11		—
Total	$	3,730	$	4,546	$	4,058	$	9,077	$	349	$	226
December 31, 2016
With no valuation reserve:
Commercial real estate	$	1,426	$	1,891	$	3,234	$	5,318	$	—	$	232
Commercial, financial and agricultural		11		11		—		116		—		3
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,623		2,198		2,792		4,500		—		196
Consumer construction		17		22		57		36		—		4
Consumer		82		86		4		127		—		2
With a valuation reserve:
Commercial real estate	$	306	$	328	$	—	$	103	$	50	$	—
Commercial, financial and agricultural		326		357		—		109		231		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		333		333		—		171		94		—
Consumer construction		—		—		—		—		—		—
Consumer		0		0		—		5		5		—
Total:
Commercial real estate	$	1,732	$	2,219	$	3,234	$	5,421	$	50	$	232
Commercial, financial and agricultural		337		368		—		225		231		3
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,956		2,531		2,792		4,671		94		196
Consumer construction		17		22		57		36		—		4
Consumer		82		86		4		132		5		2
Total	$	4,124	$	5,226	$	6,087	$	10,485	$	380	$	437

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A summary of past due loans at March 31, 2017 and December 31, 2016 is as follows (dollars in thousands):

	March 31,						December 31,
	2017						2016
	30-89 days		90+ days				30-89 days		90+ days
	Past Due		Past Due/				Past Due		Past Due/
	(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total
Commercial real estate	$	822	$	1,692	$	2,514	$	942	$	1,732	$	2,674
Commercial, financial and agricultural		150		344		494		186		337		523
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		2,206		1,639		3,845		2,113		1,956		4,069
Consumer construction		52		16		68		—		17		17
Consumer		71		39		110		133		82		215
Total past due loans	$	3,301	$	3,730	$	7,031	$	3,374	$	4,124	$	7,498

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.

There were no troubled debt restructurings that occurred during the three months ended March 31, 2017 or March 31, 2016.

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):

	Three Months Ended		Three Months Ended
	March 31,		March 31,
	2017		2016
Loans outstanding, January 1	$	9,195	$	6,887
New loans		—		—
Net activity on revolving lines of credit		500		510
Repayment		(313)		(2,034)
Loans outstanding at end of period	$	9,382	$	5,363

There were no loans to related parties classified substandard as of March 31 2017 or March 31, 2016.  In addition to the outstanding balances above, there were unfunded commitments of $91,000 to related parties at March 31, 2017.

6.GOODWILL AND OTHER INTANGIBLE ASSETS

During the fourth quarter of 2014, the Corporation recorded $3.805 million of goodwill and $1.206 million of deposit based intangible assets associated with the acquisition of PFC.  During 2016, the Corporation recorded $1.839 million of goodwill and $.993 million of deposit based intangible assets associated with the acquisition of Eagle River.  Also in 2016, the Corporation recorded $50,000 of goodwill and $.300 million of deposit based intangible assets associated with the acquisition of Niagara.

16

The deposit based intangible is reported net of accumulated amortization at $2.110 million at March 31, 2017.  Amortization expense in the first three months of 2017 is $62,000.  Amortization expense for the next five years is expected to be at $.250 million per year.

7.SERVICING RIGHTS

Mortgage Loans

Mortgage servicing rights (“MSRs”) are recorded when loans are sold in the secondary market with servicing retained.  As of March 31, 2017, the Corporation had obligations to service approximately $215.730 million of residential first mortgage loans.  The valuation of MSRs is based upon the net present value of the projected revenues over the expected life of the loans being serviced, as reduced by estimated internal costs to service these loans.  The fair value of the capitalized servicing rights approximates the carrying value. On a quarterly basis, management evaluates the MSRs for impairment. The key economic assumptions used in determining the fair value of the MSRs include an annual constant prepayment speed of 10.74% and a discount rate of 9.59% for March 31, 2017. In 2016, management decided to no longer retain the servicing on mortgage loans sold.

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

	Three Months Ended		Three Months Ended
	March 31,		March 31,
	2017		2016
Balance at beginning of period	$	1,573	$	1,965
Additions from loans sold with servicing retained		—		—
Acquired MSRs		—		—
Amortization		(141)		(196)
Balance at end of period	$	1,432	$	1,769
Balance of loan servicing portfolio	$	215,730	$	219,080
Mortgage servicing rights as % of portfolio		.66%		.81%

Commercial Loans

The Corporation also retains the servicing on certain commercial loans that have been sold.  These loans were originated and underwritten under the SBA and USDA government guarantee programs, in which the guaranteed portion of the loan was sold to a third party with servicing retained.  The balance of these sold loans with servicing retained at March 31 2017 and March 31, 2016 was approximately $55.000 million and $49.500 million, respectively. The Corporation valued these servicing rights at $.132 million as of March 31, 2017 and at $.162 million as of March 31, 2016.  This valuation was established in consideration of the discounted cash flow of net expected servicing income over the life of the loans.

8.BORROWINGS

Borrowings consist of the following at March 31, 2017 and December 31, 2016 (dollars in thousands):

	March 31,		December 31,
	2017		2016
Federal Home Loan Bank fixed rate advances	$	45,000	$	45,000
Correspondent bank line of credit		—		750
Correspondent bank term note		20,649		21,199
USDA Rural Development note		630		630
	$	66,279	$	67,579

The Federal Home Loan Bank borrowings bear a weighted average of 2.10% and mature in 2017, 2018, 2019 and 2020. They are collateralized at March 31, 2017 by the following:  a collateral agreement on the Corporation’s one to four

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family residential real estate loans with a book value of approximately  $42.506 million; mortgage related and municipal securities with an amortized cost and estimated fair value of  $12.000 million and  $11.991 million, respectively; and Federal Home Loan Bank stock owned by the Bank totaling $2.719 million.  Prepayment of the advances is subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank of Indianapolis and the Federal Home Loan Bank of Chicago in effect as of March 31, 2017.

The Corporation currently has one banking borrowing relationship.  The relationship consists of a $5.0 million revolving line of credit and a term note. The line of credit bears interest at a rate of LIBOR plus 2.75% and has an initial term that expires on April 30, 2018.  The term note bears the same interest and matures on April 30, 2019 and requires quarterly principal payments of $.550 million beginning March 31, 2017.  This relationship is secured by all of the outstanding mBank stock.  

The USDA Rural Development borrowing bears an interest rate of 1.00% and matures in August, 2024. It is collateralized by loans totaling $.108 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 $.593 million, and guaranteed by the Corporation.

9.DEFINED BENEFIT PENSION PLAN

The Corporation acquired the Peninsula Financial Corporation noncontributory defined benefit pension plan in 2014.  Effective December 31, 2005, the plan was amended to freeze participation in the plan; therefore, no additional employees are eligible to become participants in the plan.  The benefits are based on years of service and the employee’s compensation at the time of retirement.  The Plan was amended effective December 31, 2010, to freeze benefit accrual for all participants.  Expected contributions to the Plan in 2017 are $19,000.

The anticipated distributions over the next five years and through December 31, 2026 are detailed in the table below (dollars in thousands):

2017	$	128
2018		125
2019		122
2020		121
2021		120
2022-2026		723
Total	$	1,339

At March 31, 2017, the plan’s assets had a fair value of $2.049 million and the Corporation had a net unfunded liability of $1.138 million.  The accumulated benefit obligation at March 31, 2017 was $3.187 million.  At March 31, 2016, the plan’s assets had a fair value of $2.033 million and the Corporation had a net unfunded liability of $1.147 million.  The accumulated benefit obligation at March 31, 2016 was $3.180 million.

Assumptions in the actuarial valuation are:

	2017	2016
Weighted average discount rate	3.78%	3.99%
Rate of increase in future compensation levels	N/A	N/A
Expected long-term rate of return on plan assets	8.00%	8.00%

The expected long-term rate of return on plan assets reflects management’s expectations of long-term average rates of return on funds invested to provide for benefits included in the projected benefit obligation.  The expected return is based on the outlook for inflation, fixed income returns and equity returns, while also considering historical returns, asset allocation and investment strategy.  The discount rate assumption is based on investment yields available on AA rated long-term corporate bonds.

The primary investment objective is to maximize growth of the pension plan assets to meet the projected obligations to the beneficiaries over a long period of time, and to do so in a manner that is consistent with the Corporation’s risk

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tolerance.  The intention of the plan sponsor is to invest the plan assets in mutual funds with the following asset allocation; which was in place at both March 31, 2017 and December 31, 2016.

	Target	Actual
	Allocation	Allocation
Equity securities	50% to 70%	60%
Fixed income securities	30% to 50%	40%

10.STOCK COMPENSATION PLANS

Restricted Stock Awards

The Corporation’s restricted stock awards require certain service-based or performance requirements and have a vesting period of four years.  Compensation expense is recognized on a straight-line basis over the vesting period.  Shares are subject to certain restrictions and risk of forfeiture by the participants.

The Corporation has historically granted RSAs to members of the Board of Directors and management. Awards granted are set to vest equally over their award terms and are issued at no cost to the recipient.  The table below summarizes each of the grant awards:

Date of Award	Units Granted	Market Value at grant date	Vesting Term
March, 2014	52,774	12.95	4 years
March, 2015	37,730	11.15	4 years
May, 2015	3,000	10.77	Immediate
February, 2016	35,733	9.91	4 years
February, 2017	28,427	13.39	4 years

On August 31, 2013, 2014, 2015 and 2016, the Corporation issued 37,125 shares of its common stock for vested RSAs, in each year. In March 2015, the Corporation issued 13,194 shares of its common stock for vested RSAs. In May 2015, the Corporation granted 3,000 shares, which were immediately vested and issued.  In March 2016, the Corporation issued 22,626 shares of its common stock for vested RSAs. In the first quarter of 2017, the Corporation issued 31,559 shares of its common stock for vested RSAs.

A summary of changes in our nonvested shares for the period follows:

		Weighted Average
	Number	Grant Date
	Outstanding	Fair Value
Nonvested balance at January 1, 2017	90,417	$	11.19
Granted during the quarter	28,427		13.39
Vested during the quarter	(31,559)		11.55
Nonvested balance at March 31, 2017	87,285	$	11.78

11.INCOME TAXES

The Corporation has reported deferred tax assets of $7.651 million at March 31, 2017. 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 March 31, 2017 had a net operating loss and tax credit carryforwards for tax purposes of approximately $9.1 million, and $2.2 million, respectively.  The Corporation evaluated the future benefits from these carryforwards as of March 31, 2017 and determined that it was “more likely than not” that they would be utilized prior to expiration.  The net operating loss carryforwards expire twenty years from the date they originated.  These carryforwards, if not utilized, will begin to expire in the year 2023.  A portion of the NOL and credit carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code.  The annual limitation is $1.404 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 will continue to evaluate the future benefits from these carryforwards in order to determine if any adjustment to the deferred tax asset is warranted.

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The Corporation recognized a federal income tax expense of approximately $.889 million for the three months ended March 31, 2017 and $.585 million for the three months ended March 31, 2016. 

12.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.

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The following table presents information for financial instruments at March 31, 2017 and December 31, 2016 (dollars in thousands):

		March 31, 2017				December 31, 2016
	Level in Fair	Carrying		Estimated		Carrying		Estimated
	Value Hierarchy	Amount		Fair Value		Amount		Fair Value
Financial assets:
Cash and cash equivalents	Level 1	$	41,169	$	41,169	$	46,755	$	46,755
Interest-bearing deposits	Level 2		13,448		13,448		14,047		14,047
Securities available for sale	Level 2		82,232		82,232		84,623		84,623
Securities available for sale	Level 3		1,650		1,650		1,650		1,650
Federal Home Loan Bank stock	Level 2		2,719		2,719		2,911		2,911
Net loans	Level 3		781,400		780,377		776,837		778,377
Accrued interest receivable	Level 3		2,026		2,026		2,016		2,016
Total financial assets		$	924,644	$	923,621	$	928,839	$	930,379
Financial liabilities:
Deposits	Level 2	$	821,820	$	814,259	$	823,512	$	815,960
Borrowings	Level 2		66,279		66,853		67,579		68,293
Accrued interest payable	Level 3		287		287		267		267
Total financial liabilities		$	888,386	$	881,399	$	891,358	$	884,520

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 March 31, 2017, 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 March 31, 2017 and December 31, 2016 were based on level 2 and level 3 inputs.  There are no other assets or liabilities measured on a recurring basis at fair value.  For additional information regarding investment securities, please refer to “Note 4 Investment Securities.”

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The table below shows investment securities measured at fair value on a recurring basis (dollars in thousands):

			Quoted Prices		Significant		Significant		Total (Gains)
			in Active Markets		Other Observable		Unobservable		Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended
(dollars in thousands)	March 31,  2017		(Level 1)		(Level 2)		(Level 3)		March 31, 2017
Assets
Corporate	$	19,952	$	—	$	19,952	$	—	$	—
Equity		500		—		—		500		—
US Agencies		23,053		—		23,053		—		—
US Agencies - MBS		15,856		—		14,706		1,150		—
Obligations of state and political subdivisions		24,521		—		24,521		—		—
	$	83,882							$	—

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Twelve months ended
(dollars in thousands)	December 31, 2016		(Level 1)		(Level 2)		(Level 3)		December 31, 2016
Assets
Corporate	$	19,910	$	—	$	19,910	$	—	$	—
Equity		500		—		—		500		—
US Agencies		23,952		—		23,952		—		—
US Agencies - MBS		16,833		—		15,683		1,150		—
Obligations of state and political subdivisions		25,078		—		25,078		—		—
	$	86,273							$	—

The Corporation had no Level 3 assets or liabilities measured at fair value on a recurring basis as of March 31, 2017, or December 31, 2016 other than as described above.

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 certain impaired 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 March 31, 2017

			Quoted Prices		Significant		Significant		Total (Gains)
			in Active Markets		Other Observable		Unobservable		Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended
(dollars in thousands)	March 31, 2017		(Level 1)		(Level 2)		(Level 3)		March 31, 2017
Assets
Impaired loans	$	7,788	$	—	$	—	$	7,788	$	37
Other real estate owned		4,466		—		—		4,466		12
									$	49

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Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2016

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Twelve months ended
(dollars in thousands)	December 31, 2016		(Level 1)		(Level 2)		(Level 3)		December 31, 2016
Assets
Impaired loans	$	9,856	$	—	$	—	$	9,856	$	643
Other real estate held for sale		4,782		—		—		4,782		202
									$	845

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).

13.SHAREHOLDERS’ EQUITY

The Corporation currently has a share repurchase program.  The program is conducted under authorizations by the Board of Directors.  The Corporation repurchased 14,000 shares in 2016, 102,455 shares in 2015, 13,700 shares in 2014 and 55,594 shares in 2013.  The share repurchases were conducted under Board authorizations made and publically announced of $.600 million on February 27, 2013, $.600 million on December 17, 2013 and an additional $.750 million on April 28, 2015.  None of these authorizations has an expiration date.  As of March 31, 2017, $26,000 of the total authorization was available for future purchases.

14.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):

	March 31,		December 31,
	2017		2016
Commitments to extend credit:
Variable rate	$	60,204	$	59,496
Fixed rate		27,407		28,737
Standby letters of credit - Variable rate		7,926		8,252
Credit card commitments - Fixed rate		5,677		5,533
	$	101,214	$	102,018

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.

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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 March 31, 2017 represents $114.650 million, or  20.75%, compared to  $121.861 million, or 22.42%, of the commercial loan portfolio on December 31, 2016.  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.

15.  BUSINESS COMBINATIONS

The First National Bank of Eagle River

The Corporation completed its acquisition of The First National Bank of Eagle River (“Eagle River”) in April 2016.  Eagle River had three branch offices and approximately $125 million in assets as of April 29, 2016, including total loans of $84 million and total deposits of $105 million. The results of operations due to the merger have been included in the Corporation’s results since the acquisition date.  The merger was effected by a cash payment of $12.500 million. The Corporation recorded a $.933 million core deposit intangible asset and $1.839 million of goodwill in conjunction with the acquisition. Goodwill was recorded due to the synergies and economies of scale expected from combining operations of the Corporation with Eagle River.

Niagara Bancorporation

The Corporation completed its acquisition of Niagara Bancorporation, Inc. (“Niagara”) in August 2016.  Niagara had four branch offices and approximately $67 million in assets as of August 31, 2016 including total loans of $33 million and total deposits of $59 million. The results of operations due to the merger have been included in the Corporation’s results since the acquisition date. The merger was effected by a cash payment of $7.325 million. The corporation recorded a $.300 million core deposit intangible asset and $50,000 of goodwill in conjunction with the acquisition. Goodwill was recorded due to the synergies and economies of scale expected from combining operations of the Corporation with Niagara.

Forward Looking Statements/Risk Factors

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:

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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.

· As a community banking organization, the Corporation’s success depends upon local and regional economic conditions and has different lending risks than larger banks.

We manage our credit exposure through careful monitoring of loan applicants and loan concentrations in particular industries and through loan approval and review procedures.  We have established an evaluation process designed to determine the adequacy of our allowance for loan losses.  While this evaluation process uses historical and other objective information, the classification of loans and the establishment of loan losses is estimated based on experience, judgment and expectations regarding borrowers and economic conditions, as well as regulator judgments.  We can make no assurance that our loan loss reserves will be sufficient to absorb future loan losses or prevent a material adverse effect on our business, profitability or financial condition.

· 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.

· We may not realize the expected benefits of our recent acquisitions of The First National Bank of Eagle River and Niagara Bancorporation, Inc.

· 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 March 31, 2017, net deferred tax assets were approximately $7.651 million.  If a 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.

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· Our information systems may experience an interruption of 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.

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.

MACKINAC FINANCIAL CORPORATION

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

The following discussion covers 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, the related notes, and other supplemental information presented elsewhere in this report.  It should be noted that there are non-GAAP disclosures presented within this discussion to further assist readers in their analysis of the financial condition of the

26

Corporation.  These disclosures are specifically noted where present.  This discussion should also 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, 2016.  Throughout this discussion and elsewhere in this report, the term “Bank” refers to mBank, the principal banking subsidiary of the Corporation.

FINANCIAL OVERVIEW

The Corporation recorded first quarter 2017 net income of $1.726 million, or $.28 per share, compared to net income available to common shareholders of $1.132 million, or $.18 per share for the first quarter of 2016.

Weighted average shares for the three month period in 2017 totaled 6,270,034, compared to 6,214,083 shares in the same period of 2016. 

The net interest margin for the first quarter of 2017 was $9.166 million, or 4.19%, compared to $7.288 million, or 4.33% in the first quarter of 2016. 

Total assets of the Corporation at March 31, 2017 were $976.635 million, down by $6.885 million, or 0.70%, from the $983.520 million in total assets reported at year-end 2016.

FINANCIAL CONDITION

Cash and Cash Equivalents

Cash and cash equivalents decreased $5.586 million during the first three months of 2017, when compared to 2016 year end.  See further discussion of the change in cash and cash equivalents in the Liquidity section.

Investment Securities

Securities available for sale decreased $2.391 million from December 31, 2016 to March 31, 2017, with the balance on March 31, 2017 totaling $83.882 million.  Investment securities are utilized in an effort to manage interest rate risk and liquidity.  As of March 31, 2017, investment securities with an estimated fair value of $19.869 million were pledged against borrowings at the FHLB and certain customer relationships.

Loans

Through the first three months of 2017, loan balances increased by $4.689 million from December 31, 2016 balances of $781.857 million.  During the first three months of 2017, the Bank had total loan production of $52.6 million, which included $15.0 million of secondary market loan production.  This loan production, however, was offset by loan amortization and pay-offs.

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 markets for mortgage, consumer, and commercial loan products while concentrating on loan quality, industry concentration issues, and competitive pricing. The Corporation is highly competitive in structuring loans to meet borrowing needs and satisfy strong underwriting requirements.

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Following is a summary of the loan portfolio at March 31, 2017 and December 31, 2016 (dollars in thousands):

	March 31,		Percent of	December 31,		Percent of
	2017		Total	2016		Total
Commercial real estate	$	397,192	50.50%	$	389,420	49.81%
Commercial, financial, and agricultural		144,673	18.39		142,648	18.24
One to four family residential real estate		202,654	25.77		205,945	26.34
Consumer construction		12,388	1.57		12,226	1.56
Commercial construction		10,618	1.35		11,505	1.47
Consumer		19,021	2.42		20,113	2.57
Total loans	$	786,546	100.00%	$	781,857	100.00%

Following is a table showing the significant industry types in the commercial loan portfolio as of March 31, 2017 and December 31, 2016 (dollars in thousands):

	March 31, 2017				December 31, 2016
	Outstanding		Percent of	Percent of	Outstanding		Percent of	Percent of
	Balance		Loans	Capital	Balance		Loans	Capital
Real estate - operators of nonresidential buildings		114,650	20.75%	143.30%		121,861	22.42%	155.02%
Hospitality and tourism		69,568	12.59	86.95		68,025	12.51	86.54
Lessors of residential buildings		30,118	5.45	37.64		27,590	5.08	35.10
Gasoline stations and convenience stores		20,187	3.65	25.23		20,509	3.77	26.09
Logging		16,096	2.91	20.12		19,903	3.66	25.32
Commercial construction		10,618	1.92	13.27		11,505	2.12	14.64
Other		291,246	52.73	364.02		274,180	50.44	348.79
Total Commercial Loans	$	552,483	100.00%		$	543,573	100.00%

Management recognizes the additional risk presented by the concentration in certain segments of the portfolio.  Management does not believe that its current portfolio composition has increased exposure related to any specific industry concentration as of March 31, 2017.  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 March 31, 2017, our residential loan portfolio totaled $215.042 million, or 27.34% of our total outstanding loans.

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

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Credit Quality

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

	March 31,		December 31,
	2017		2016
Nonperforming Assets:
Nonaccrual loans	$	3,691	$	3,959
Loans past due 90 days or more		—		—
Restructured loans		39		165
Total nonperforming loans		3,730		4,124
Other real estate owned		4,466		4,782
Total nonperforming assets	$	8,196	$	8,906
Nonperforming loans as a % of loans		0.47%		0.53%
Nonperforming assets as a % of assets		0.84%		0.91%
Reserve for Loan Losses:
At period end	$	5,146	$	5,020
As a % of outstanding loans		.65%		.64%
As a % of nonperforming loans		137.96%		121.73%
As a % of nonaccrual loans		139.42%		126.80%
Texas Ratio		10.60%		11.76%

The following ratios provide additional information relative to the Corporation’s credit quality (dollars in thousands):

	At Period End
	March 31, 2017		December 31, 2016
Total loans, at period end	$	786,546		781,857
Average loans for the period	$	782,477	$	703,047
	For the Period Ended
	Three Months Ended		Twelve Months Ended
	March 31, 2017		December 31, 2016
Net charge-offs during the period	$	24		584
Net charge-offs to average loans, annualized	.01%		.08%

Management continues to address market issues impacting its loan customer base.  In conjunction with the Corporation’s senior lending staff and bank regulatory examinations, management reviews the Corporation’s loans, related collateral evaluations, and the overall lending process.  The Corporation also utilizes an outside loan consultant to perform a review of the loan portfolio.  The opinion of this consultant upon completion of the 2016 independent review provided findings similar to management with respect to credit quality.  In 2017, the Corporation will continue to utilize a consultant for loan review.

As of March 31, 2017, the allowance for loan losses represented .65% of total loans.  At March 31, 2017, the allowance included specific reserves in the amount of $.965 million, as compared to specific reserves of $.958 million at December 31, 2016.  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. Purchased impaired credits do not have an effect on the allowance for loan losses, in accordance with ASC 310-30.

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.

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

	Three Months Ended		Year Ended
	March 31, 2017		December 31, 2016
Balance at beginning of period	$	4,782	$	2,324
Other real estate acquired, net of purchase accounting		—		1,205
Other real estate transferred from loans due to foreclosure		576		3,292
Proceeds from sale of other real estate		(740)		(1,640)
Transfer to premise and equipment		—		(197)
Writedowns on other real estate held for sale		(148)		(212)
Gain (loss) on other real estate held for sale		(4)		10
Balance at end of period	$	4,466	$	4,782

During the first three months of 2017, the Corporation received real estate in lieu of loan payments of $.576 million.  In determining the carrying value of other real estate held for sale, the Corporation generally starts with a third party appraisal of the underlying collateral and then deducts estimated selling costs to arrive at a net asset value. After the initial receipt, management periodically re-evaluates the recorded balances and records any additional reductions in the fair value as a write-down of other real estate held for sale.

Deposits

The Corporation had an decrease in deposits in the first three months of 2017.  Total deposits decreased by $1.692 million, or 0.20%, in the first three months of 2017.  The decrease in deposits for the first three months of 2017 is composed of an decrease in core deposits of $17.585 million and an increase in noncore deposits of $15.893 million.  In recent years, the Corporation has strategically emphasized the growth of core deposits with the introduction of several new deposit products and competitive deposit pricing.    Management also utilizes brokered deposits as a funding source, which provides flexibility in managing interest rate risk for fixed rate longer term loan fundings.

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

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

	March 31,			December 31,
	2017		% of Total	2016		% of Total
Noninterest bearing	$	147,106	17.90%	$	164,179	19.94%
NOW, money market, checking		283,314	34.47		286,622	34.80
Savings		61,171	7.44		58,315	7.08
Certificates of Deposit <$250,000		141,569	17.23		141,629	17.20
Total core deposits		633,160	77.04		650,745	79.02
Certificates of Deposit >$250,000		8,802	1.07		8,489	1.03
Brokered CDs		179,858	21.89		164,278	19.95
Total non-core deposits		188,660	22.96		172,767	20.98
Total deposits	$	821,820	100.00%	$	823,512	100.00%

Borrowings

The Corporation also utilizes FHLB borrowings as a source of funding.  At March 31, 2017, this source of funding totaled $45 million and the Corporation secured this funding by pledging loans and investments.  The $45 million of

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FHLB borrowings has a weighted average maturity of 1.62 years and a weighted average rate of 2.10% at March 31, 2017.  The Corporation also has a USDA Rural Development loan held by its wholly owned subsidiary, First Rural Relending, that has an outstanding balance of $.630 million, with a fixed interest rate of 1% that matures in August 2024.

The Corporation currently has one correspondent banking borrowing relationship.  The relationship consists of a $5.0 million revolving line of credit and a term note. The line of credit bears interest at a rate of LIBOR plus 2.75% and has an initial term that expires on April 30, 2018.  The term note had a balance of $20.649 million at March 31, 2017 and bears the same interest as the line of credit. The term note matures on April 30, 2019 and requires quarterly principal payments of $.550 million beginning March 31, 2017.  This relationship is secured by all of the outstanding mBank stock.  

Shareholders’ Equity

Total shareholders’ equity increased $1.400 million from December 31, 2016 to March 31, 2017.  Contributing to the increase in shareholders’ equity was net income available to common shareholders of $1.726 million, a reduction for cash dividends on common stock of $.756 million,  an increase due to stock compensation of $100,000, and an increase in the market value of securities of $.330 million.

RESULTS OF OPERATIONS

Summary

The Corporation reported net income available to common shareholders of $1.726 million, or $.28 per share, in the first three months of 2016, compared to $1.132 million, or $.18 per share, for the first three months of 2016.

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 $9.223 million, 4.21% of average earning assets, in the first three months of 2017, compared to $7.306 million, and 4.34% of average earning assets, in the first three months of 2017. 

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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
													2017-2016
	Average Balances						Average Rates		Interest				Income/						Rate/
	March 31,				Increase/		March 31,		March 31,				Expense		Volume		Rate		Volume
(dollars in thousands)	2017		2016		(Decrease)		2017	2016	2017		2016		Variance		Variance		Variance		Variance
Loans (1,2,3)	$	782,477	$	615,684	$	166,793	5.19%	5.20%	$	10,007	$	7,965	$	2,042	$	2,140	$	(25)	$	(73)
Taxable securities		70,954		50,965		19,989	2.28	2.07		399		262		137		102		27		8
Nontaxable securities (2)		14,923		2,466		12,457	3.26	7.34		120		45		75		225		(25)		(125)
Federal funds sold		2,899		1169		1,730	.42	0.34		3		1		2		1		—		1
Other interest-earning assets		16,615		7,224		9,391	3.05	3.01		125		54		71		70		1		—
Total earning assets		887,868		677,508		210,360	4.87	4.94		10,654		8,327		2,327		2,538		(22)		(189)
Reserve for loan losses		(5,018)		(4,937)		(81)
Cash and due from banks		43,374		27,416		15,958
Fixed Assets		15,945		12,500		3,445
Other Real Estate		4,326		2,747		1,579
Other assets		33,995		21,854		12,141
Total assets	$	980,490	$	737,088	$	243,402
NOW and money market deposits	$	221,154	$	161,785	$	59,369	.33	.34	$	179	$	137	$	42	$	50	$	(5)	$	(3)
Interest checking		67,604		47,662		19,942	.15	.17		25		20		5		8		(2)		(1)
Savings deposits		58,938		31,084		27,854	.07	.12		10		9		1		8		(4)		(3)
Certificates of deposit		147,283		131,700		15,583	.85	0.97		309		319		(10)		37		(40)		(7)
Brokered deposits		173,166		112,140		61,026	1.02	1.01		437		283		154		153		2		(1)
Borrowings		70,194		52,157		18,037	2.72	1.95		471		253		218		87		99		32
Total interest-bearing liabilities		738,339		536,528		201,811	.79	.77		1,431		1,021		410		343		50		17
Demand deposits		157,164		119,992		37,172
Other liabilities		5,694		3,284		2,410
Shareholders’ equity		79,293		77,284		2,009
Total liabilities and shareholders’ equity	$	980,490	$	737,088	$	243,402
Rate spread							4.08%	4.17%
Net interest margin/revenue							4.21%	4.34%	$	9,223	$	7,306	$	1,917	$	2,195	$	(72)	$	(206)

(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 equivalent basis, using a 34% tax rate.

(3) Interest income on loans includes fees.

In 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.

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 three months of 2017, the Corporation recorded a loan loss provision of $.150 million, compared to no provision in the first three months of 2016.  There were net charge-offs of $24,000 in the first three months of 2017, compared to net charge-offs of $.180 million for the same period in 2016.

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Other Income

Other income was $.776 million in the first three months of 2017, compared to $.627 million in the same period in 2016.  The increases year over year was largely a result of increased SBA/USDA loan sale gains and increased secondary market mortgage income, as well as additional deposit service fees garnered.

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 months ended March 31, 2017 and 2016 (dollars in thousands):

	Three Months Ended
	March 31,
					Increase/(Decrease)
	2017		2016		Dollars		Percent
Deposit service fees	$	272	$	216	$	56	25.93%
Income from loans sold in the secondary market		298		267		31	11.61
SBA/USDA loan sale gains		60		—		60	N/A
Net mortgage servicing (amortization) income		(8)		(54)		46	(85.19)
Net realized security gains		—		97		(97)	N/A
Other noninterest income		154		101		53	52.48
Total other income	$	776	$	627	$	149	23.76%

Other Expense

For the first three months of 2017, the Corporation recorded other expenses of $7.177 million, compared to $6.198 million in 2016, an increase of $.979 million.  The 2017 increase from the first three months of 2016 was largely attributable to the increased employee base from the two recent acquisitions and customary operating expenses necessary to ensure our platform infrastructure keeps pace with our growing asset base and the associated regulatory and risk management needs.

The following table details other expense for the three months ended March 31, 2017 and 2016 (dollars in thousands):

	Three Months Ended
	March 31,
					Increase/(Decrease)
	2017		2016		Dollars		Percentage
Salaries and employee benefits	$	3,797	$	3,387	$	410	12.11%
Occupancy		785		640		145	22.66
Furniture and equipment		481		383		98	25.59
Data processing		461		345		116	33.62
Advertising		123		156		(33)	(21.15)
Professional service fees		321		241		80	33.20
Loan origination expenses and deposit and card related fees		179		127		52	40.94
Writedowns and losses on other real estate held for sale		12		16		(4)	(25.00)
FDIC insurance assessment		157		108		49	45.37
Telephone		157		112		45	40.18
Transaction related expenses		—		106		(106)	N/A
Other		704		577		127	22.01
Total other expense	$	7,177	$	6,198	$	979	15.80%

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Federal Income Taxes

The Corporation recognized a federal income tax expense for the three months ended March 31, 2017 of $.889 million, compared to $.585 million a year earlier.

The Corporation has reported deferred tax assets of $7.651 million at March 31, 2017.  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 March 31, 2017 had a net operating loss and tax credit carryforwards for tax purposes of approximately $9.1 million and $2.2 million, respectively.  The Corporation evaluated the future benefits from these carryforwards as of March 31, 2017 and determined it was “more likely than not” that they would be utilized prior to expiration.  The net operating loss carryforwards expire twenty years from the date they originated.  These carryforwards, if not utilized, will begin to expire in the year 2023.  A portion of the NOL and 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 $1.404 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 will continue to evaluate the future benefits from these carryforwards in order to determine if any adjustment to the deferred tax asset is warranted.

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 $41.169 million in cash and cash equivalents and $64.013 million of unpledged investment securities.   Although current liquidity is deemed adequate, management has the ability to increase on hand liquidity by acquiring brokered CDs in order to fund any anticipated loan growth.

During the first three months of 2017, the Corporation decreased cash and cash equivalents by $5.586 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. During the first quarter of 2017, the Bank paid a dividend to the Corporation of $3.0 million. Bank capital after the payment of this dividend remained strong and above the “well capitalized” regulatory level. The Corporation also has a line of credit with a correspondent bank with current availability of $5.000 million.  The Corporation’s current plan for dividends from the Bank are dependent upon the profitability of the Bank, growth of assets at the Bank and the level of capital needed to stay “adequately capitalized.” The Corporation will continue to explore alternative opportunities for longer term sources of liquidity and permanent equity to support projected asset growth.

Liquidity is managed by the Corporation through its Asset and Liability Committee (“ALCO”).  The ALCO Committee meets regularly to discuss asset and liability management in order to address liquidity and funding needs to provide a process to seek the best alternatives for investments of assets, funding costs, and risk management.  The liquidity position of the Bank is managed daily, thus enabling the Bank to adapt its position according to market fluctuations.  Core deposits are important in maintaining a strong liquidity position as they represent a stable and relatively low cost source of funds.  The Bank’s liquidity is best illustrated by the mix in the Bank’s core and 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 $250,000. Noncore funding consists of certificates of deposit greater than $250,000, brokered deposits, and FHLB and Farmers’ Home Administration borrowings.  At March 31, 2017, the Bank’s core deposits in relation to total funding were 71.05% compared to 72.54% at December 31, 2016.  These ratios indicate that at March 31, 2017, that the Bank had slightly increased 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

34

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 March 31, 2017, the Bank had $43.000 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 strategy is to increase core deposits in the Corporation’s local markets.  Management continually evaluates deposit products offered in order to remain competitive in its goal of increasing core deposits. The Corporation also has the ability to augment local deposit growth efforts with wholesale CD funding.

CAPITAL AND REGULATORY

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

Quantitative measures established by regulation to ensure capital adequacy require the Corporation to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets.  Management has determined that, as of March 31, 2017, the Corporation is adequately capitalized.

Effective January 1, 2015, the Corporation became subject to new capital requirements due to the Basel III regulation, including:

· A new minimum ratio of Common Equity Tier I Capital to risk-weighted assets of 4.5%;

· An increase in the minimum required amount of Additional Tier 1 Capital to 6% of risk-weighted assets;

· A continuation of the current minimum required amount of Total Capital (Tier 1 plus Tier 2) of 8% of risk-weighted assets; and

· A minimum leverage ratio of Tier I Capital to total assets equal to 4% in all circumstances.

In order to be “well-capitalized” under the current guidelines, a depository institution must maintain a Common Equity Tier 1 Capital ratio of 6.5% or more; an Additional Tier 1 Capital ratio of 8% or more; a Total Capital ratio of 10% or more; and a leverage ratio of 5% or more.

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The Corporation’s and the Bank’s actual capital and ratios compared to generally applicable regulatory requirements as of March 31, 2017 are as follows (dollars in thousands):

	Actual				Adequacy Purposes					Well-Capitalized
	Amount		Ratio		Amount			Ratio		Amount			Ratio
Total capital to risk weighted assets:
Consolidated	$	71,503	9.2%	>	$	62,202	>	8.0%	>	$	77,752	>	10.0%
mBank	$	90,806	11.7%	>	$	62,162	>	8.0%	>	$	77,703	>	10.0%
Tier 1 capital to risk weighted assets:
Consolidated	$	66,357	8.5%	>	$	46,651	>	6.0%	>	$	62,202	>	8.0%
mBank	$	85,701	11.0%	>	$	46,622	>	6.0%	>	$	62,162	>	8.0%
Common equity Tier 1 capital to risk weighted assets
Consolidated	$	66,357	8.5%	>	$	34,988	>	4.5%	>	$	50,539	>	6.5%
mBank	$	85,701	11.0%	>	$	34,966	>	4.5%	>	$	50,507	>	6.5%
Tier 1 capital to average assets:
Consolidated	$	66,357	6.9%	>	$	38,680	>	4.0%	>	$	48,349	>	5.0%
mBank	$	85,701	8.9%	>	$	38,651	>	4.0%	>	$	48,314	>	5.0%

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.

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

As of March 31, 2017, the Corporation had established interest rate floors on approximately $146.206 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 $127.303 million of the “floor rate” loan balances will reprice with a 100 basis point increase on the prime rate, with another $20.478 million repricing in the next 100 basis point prime rate increase.

The Corporation also has $83.882 million of securities providing for scheduled monthly principal and interest payments as well as unanticipated prepayments of principal as of March 31, 2017.  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 offers deposit products with a variety of terms ranging from deposits whose interest rates can change on a weekly basis to certificates of deposit with repricing terms of up to five years.  Longer term deposits generally include penalty provisions for early withdrawal.

Beyond general efforts to shorten the loan pricing periods and extend deposit maturities, management can manage interest rate risk by managing 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 interest rate risks are inherent in the business of banking 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 regular 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.

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.

37

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 repricing opportunities at March 31, 2017 (dollars in thousands):

	1-90		91-365		>1-5		Over 5
	Days		Days		Years		Years		Total
Interest-earning assets:
Loans	$	297,383		161,526		323,761		3,876	$	786,546
Securities		6,336		5,034		50,023		22,489		83,882
Other (1)		5,843		2,919		7,161		247		16,170
Total interest-earning assets		309,562		169,479		380,945		26,612		886,598
Interest-bearing obligations:
NOW, money market, savings and interest checking		344,485		—		—		—		344,485
Time deposits		28,390		71,643		47,942		2,396		150,371
Brokered CDs		39,583		115,698		24,577		—		179,858
Borrowings and fed funds purchased		3,550		21,726		43,759		244		69,279
Total interest-bearing obligations		416,008		209,067		116,278		2,640		743,993
Gap	$	(106,446)	$	(39,588)	$	264,667	$	23,972	$	142,605
Cumulative gap	$	(106,446)	$	(146,034)	$	118,633	$	142,605

(1) Includes Federal Home Loan Bank Stock.

The above analysis indicates that at March 31, 2017, the Corporation had a cumulative liability sensitivity gap position of $146.034 million within the one-year time frame.  The Corporation’s cumulative liability sensitive gap suggests that if market interest rates were to increase in the next twelve months, the Corporation has the potential to earn less net interest income.  This is because more liabilities would reprice at higher rates than assets.  Conversely, if market interest rates decrease in the next twelve months, the above gap position suggests the Corporation’s net interest income would increase.  A limitation of the traditional gap analysis is that it does not consider the timing or magnitude of non-contractual repricing or 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, 2016, the Corporation had a cumulative liability sensitivity gap position of $115.670 million within the one-year time frame.

The borrowings in the gap analysis include $45.000 million of FHLB advances that have a weighted average maturity of 1.62 years and a weighted average rate of 2.10%.

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

Evaluating the exposure to changes in interest rates includes assessing both the adequacy of the process used to control interest rate risk and the quantitative level of exposure.  The Corporation’s interest rate risk management process seeks to ensure that appropriate policies, procedures, management information systems, and internal controls are in place to maintain interest rate risk at prudent levels with consistency and continuity.  In evaluating the quantitative level of

38

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.

39

MACKINAC FINANCIAL CORPORATION

ITEM 4  CONTROLS AND PROCEDURES

As of March 31, 2017, 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 March 31, 2017.

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 March 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

40

MACKINAC FINANCIAL CORPORATION

PART II.  OTHER INFORMATION

Item 1.  Legal Proceedings

The Corporation and its subsidiaries are subject to routine litigation incidental to the business of banking. Although the results of litigation and claims cannot be predicted, management believes there are no legal proceedings, the outcome of which, if determined adversely to the Corporation, would individually or in the aggregate be reasonably expected to have a material adverse effect on the Corporation’s result of operations.

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

The Corporation currently has a share repurchase program.  The program is conducted under authorizations from time to time by the Board of Directors.  The shares reported in the table below are covered by Board authorizations made and publically announced for $600,000 on February 27, 2013, an additional $600,000 on December 17, 2013 and an additional $750,000 on April 28, 2015.  None of these authorizations has an expiration date. As presented below, there were no purchases during the first quarter of 2017.

Issuer purchase of Equity Securities

				Total number of
				shares purchased	Maximum
				as part of a	dollars
				publically	yet to
	Total number of	Average price		announced	be used for
Period of purchases	shares purchased	paid per share		plan or program	stock purchases
January 1, 2017 to January 31, 2017	—	$	—	—	$	25,335
February 1, 2017 to February 28, 2017	—	$	—	—		25,335
March 1, 2017 to March 31, 2017	—	$	—	—		25,335
Total First Quarter 2017	—	$	—	—

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.

41

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:     May 15, 2017	By:	/s/ Paul D. Tobias
		PAUL D. TOBIAS,
		CHAIRMAN AND CHIEF EXECUTIVE OFFICER
		(principal executive officer)
	By:	/s/ Jesse A. Deering
		JESSE A. DEERING
		EVP/CHIEF FINANCIAL OFFICER
		(principal financial and accounting officer)

42

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:     May 15, 2017	/s/ Paul D. Tobias
	Paul D. Tobias
	Chairman and Chief Executive Officer
	(principal executive officer)

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Jesse A. Deering, 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.

ay
Date:     May 15, 2017	/s/ Jesse A. Deering
	Jesse A. Deering
	Executive Vice President/Chief Financial Officer
	(principal financial officer)

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 March  31, 2017, (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.

aya

/s/ Paul D. Tobias

Paul D. Tobias

Chairman and Chief Executive Officer

(chief executive officer)

Date:     May 15, 2017

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 March 31, 2017, (the “Form 10-Q”) of Mackinac Financial Corporation (the “Issuer”).

I, Jesse A. Deering, 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.

Ma

/s/ Jesse A. Deering

Executive Vice President and Chief Financial Officer

(principal financial officer)

Date:     May 15, 2017

XML

Document and Entity Information - shares	3 Months Ended
	Mar. 31, 2017	May 10, 2017
Document and Entity Information
Entity Registrant Name	MACKINAC FINANCIAL CORP /MI/
Entity Central Index Key	0000036506
Document Type	10-Q
Document Period End Date	Mar. 31, 2017
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		6,294,930
Document Fiscal Year Focus	2017
Document Fiscal Period Focus	Q1

XML

CONSOLIDATED BALANCE SHEETS - USD ($) $ in Thousands	Mar. 31, 2017	Dec. 31, 2016
ASSETS
Cash and due from banks	$ 41,166	$ 44,620
Federal funds sold	3	2,135
Cash and cash equivalents	41,169	46,755
Interest-bearing deposits in other financial institutions	13,448	14,047
Securities available for sale	83,882	86,273
Federal Home Loan Bank stock	2,719	2,911
Loans:
Commercial	552,483	543,573
Mortgage	215,042	218,171
Consumer	19,021	20,113
Total Loans	786,546	781,857
Allowance for loan losses	(5,146)	(5,020)
Net loans	781,400	776,837
Premises and equipment	15,970	15,891
Other real estate held for sale	4,466	4,782
Deferred tax asset	7,651	8,760
Deposit based intangibles	2,110	2,172
Goodwill	5,694	5,694
Other assets	18,126	19,398
TOTAL ASSETS	976,635	983,520
Deposits:
Noninterest bearing deposits	147,106	164,179
NOW, money market, interest checking	283,314	286,622
Savings	61,171	58,315
CDs less than $250,000	141,569	141,629
CDs more than $250,000	8,802	8,489
Brokered	179,858	164,278
Total deposits	821,820	823,512
Federal funds purchased	3,000	6,000
Borrowings	66,279	67,579
Other liabilities	5,527	7,820
Total liabilities	896,626	904,911
SHAREHOLDERS' EQUITY:
Common stock and additional paid in capital - No par value Authorized - 18,000,000 shares Issued and outstanding - 6,294,930 and 6,270,034 respectively	61,683	61,583
Retained earnings	18,176	17,206
Accumulated other comprehensive income (loss)
Unrealized (losses) gains on available for sale securities	228	(102)
Minimum pension liability	(78)	(78)
Total shareholders' equity	80,009	78,609
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY	$ 976,635	$ 983,520

XML

CONSOLIDATED BALANCE SHEETS (Parenthetical) - $ / shares	Mar. 31, 2017	Dec. 31, 2016
CONSOLIDATED BALANCE SHEETS
Common stock, par value	$ 0	$ 0
Common stock, Authorized shares	18,000,000	18,000,000
Common stock, Shares issued	6,294,930	6,270,034
Common stock, Shares outstanding	6,294,930	6,270,034

XML

CONSOLIDATED STATEMENTS OF OPERATIONS - USD ($) $ in Thousands	3 Months Ended
	Mar. 31, 2017	Mar. 31, 2016
Interest and fees on loans:
Taxable	$ 9,957	$ 7,960
Tax-exempt	33	2
Interest on securities:
Taxable	399	262
Tax-exempt	79	31
Other interest income	128	55
Total interest income	10,596	8,310
INTEREST EXPENSE:
Deposits	959	769
Borrowings	471	253
Total interest expense	1,430	1,022
Net interest income	9,166	7,288
Provision for loan losses	150	0
Net interest income after provision for loan losses	9,016	7,288
OTHER INCOME:
Deposit service fees	272	216
Income from mortgage loans sold on the secondary market	298	267
SBA/USDA loan sale gains	60
Net mortgage servicing (amortization) income	(8)	(54)
Net realized security gains		97
Other	154	101
Total other income	776	627
OTHER EXPENSE:
Salaries and employee benefits	3,797	3,387
Occupancy	785	640
Furniture and equipment	481	383
Data processing	461	345
Advertising	123	156
Professional service fees	321	241
Loan origination expenses and deposit and card related fees	179	127
Writedowns and losses on other real estate held for sale	12	16
FDIC insurance assessment	157	108
Telephone	157	112
Transaction related expenses		106
Other	704	577
Total other expenses	7,177	6,198
Income before provision for income taxes	2,615	1,717
Provision for income taxes	889	585
NET INCOME	$ 1,726	$ 1,132
INCOME PER COMMON SHARE:
Basic (in dollars per share)	$ 0.28	$ 0.18
Diluted (in dollars per share)	$ 0.28	$ 0.18

XML

CONSOLIDATED STATEMENTS COMPREHENSIVE INCOME - USD ($) $ in Thousands	3 Months Ended
	Mar. 31, 2017	Mar. 31, 2016
CONSOLIDATED STATEMENTS COMPREHENSIVE INCOME
Net income	$ 1,726	$ 1,132
Other comprehensive income
Unrealized gains arising during the period	500	424
Reclassification adjustment for securities gains included in net income		(97)
Tax effect	(170)	(110)
Net change in unrealized gains on available for sale securities	330	217
Total comprehensive income	$ 2,056	$ 1,349

XML

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY - USD ($) $ in Thousands	Shares of Common Stock	Common Stock and Additional Paid in Capital	Retained Earnings (Accumulated Deficit)	Accumulated Other Comprehensive Income (Loss)	Total
Balance, beginning of period at Dec. 31, 2015		$ 61,133	$ 15,221	$ 248	$ 76,602
Balance (in shares) at Dec. 31, 2015	6,217,620
Increase (Decrease) in Shareholders' Equity
Net income for period			1,132		1,132
Other comprehensive income (loss):
Net unrealized gain on securities available for sale				217	217
Total comprehensive income			1,132	217	1,349
Stock compensation		150			150
Restricted stock award vesting (in shares)	22,626
Repurchase of common stock		(99)			(99)
Repurchase of common stock (in shares)	(9,000)
Dividend on common stock			(607)		(607)
Balance, end of period at Mar. 31, 2016		61,184	15,746	465	77,395
Balance (in shares) at Mar. 31, 2016	6,231,246
Balance, beginning of period at Dec. 31, 2015		61,133	15,221	248	76,602
Balance (in shares) at Dec. 31, 2015	6,217,620
Other comprehensive income (loss):
Repurchase of common stock (in shares)	(14,000)
Balance, end of period at Dec. 31, 2016		61,583	17,206	(180)	78,609
Balance (in shares) at Dec. 31, 2016	6,263,371
Increase (Decrease) in Shareholders' Equity
Net income for period			1,726		1,726
Other comprehensive income (loss):
Net unrealized gain on securities available for sale				330	330
Total comprehensive income			1,726	330	2,056
Stock compensation		100			100
Restricted stock award vesting (in shares)	31,559
Dividend on common stock			(756)		(756)
Balance, end of period at Mar. 31, 2017		$ 61,683	$ 18,176	$ 150	$ 80,009
Balance (in shares) at Mar. 31, 2017	6,294,930

XML

CONSOLIDATED STATEMENTS OF CASH FLOWS - USD ($) $ in Thousands	3 Months Ended
	Mar. 31, 2017	Mar. 31, 2016
Cash Flows from Operating Activities:
Net income	$ 1,726	$ 1,132
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	572	395
Provision for loan losses	150	0
Deferred tax expense	889	585
Gain on sales/calls of securities		(97)
Gain on sale of loans sold in the secondary market	(298)	(228)
Origination of loans held for sale in secondary market	(15,026)	(13,802)
Proceeds from sale of loans in the secondary market	15,324	14,030
(Gain) loss on sale of premises, equipment, and other real estate held for sale	(4)	16
Writedown of other real estate held for sale	16
Stock compensation	100	150
Change in other assets	1,334	(513)
Change in other liabilities	(2,293)	(485)
Net cash provided by operating activities	2,490	1,183
Cash Flows from Investing Activities:
Net increase in loans	(5,099)	(946)
Net decrease in interest bearing deposits in other financial institutions	599	100
Purchase of securities available for sale		(5,225)
Proceeds from maturities, sales, calls or paydowns of securities available for sale	2,776	5,238
Redemption of FHLB stock	192
Capital expenditures	(536)	(337)
Proceeds from life insurance		99
Proceeds from sale of premises, equipment, and other real estate	740	247
Net cash used in investing activities	(1,328)	(824)
Cash Flows from Financing Activities:
Net decrease in deposits	(1,692)	(17,345)
Net activity on lines of credit	(750)	800
(Decrease) increase in fed funds purchased	(3,000)	10,000
Principal payments on borrowings	(550)	(100)
Repurchase of common stock		(99)
Dividend on common stock	(756)	(607)
Net cash used in financing activities	(6,748)	(7,351)
Net (decrease) in cash and cash equivalents	(5,586)	(6,992)
Cash and cash equivalents at beginning of period	46,755	25,008
Cash and cash equivalents at end of period	41,169	18,016
Cash paid during the year for:
Interest	1,411	1,013
Income taxes		50
Noncash Investing and Financing Activities:
Transfers of Foreclosures from Loans to Other Real Estate Held for Sale	$ 576	$ 623

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SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

3 Months Ended

Mar. 31, 2017

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 three month period ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.  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, 2016.

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, the valuation of investment securities, the valuation of foreclosed real estate, deferred tax assets, mortgage servicing rights, and the assessment of goodwill for impairment.

Acquired Loans

Loans acquired with evidence of credit deterioration since inception and for which it is probable that all contractual payments will not be received are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”).  These loans are recorded at fair value at the time of acquisition, with no carryover of the related allowance for loan losses.  Fair value of acquired loans is determined using a discounted cash flow methodology based on assumptions about the amount and timing of principal and interest payments, principal prepayments and principal defaults and losses, and current market rates.  In recording the fair values of acquired impaired loans at acquisition date, management calculates a non-accretable difference (the credit component of the purchased loans) and an accretable difference (the yield component of the purchased loans).

Over the life of the acquired loans, management continues to estimate cash flows expected to be collected on pools of loans sharing common risk characteristics, which are treated in the aggregate when applying various valuation techniques.  Management evaluates at each balance sheet date whether the present value of our pools of loans determined using the effective interest rates has decreased significantly and if so, recognizes a provision for loan loss in our consolidated statement of income.  For any significant increases in cash flows expected to be collected, we adjust the amount of the accretable yield recognized on a prospective basis over the pool’s remaining life.

Performing acquired loans are accounted for under Financial Accounting Standards Board (“FASB”) Topic 310-20, Receivables – Nonrefundable Fees and Other Costs.  Performance of certain loans may be monitored and based on management’s assessment of the cash flows and other facts available, portions of the accretable difference may be delayed or suspended if management deems appropriate.  The Corporation’s policy for determining when to discontinue accruing interest on performing acquired loans and the subsequent accounting for such loans is essentially the same as the policy for originated loans.

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 also has an unallocated allowance for loan losses for loans not considered impaired.  The allowance for loan losses is maintained at a level which management believes is adequate to provide for incurred 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

On May 22, 2012, the Corporation’s shareholders approved the Mackinac Financial Corporation 2012 Incentive Compensation Plan, under which current and prospective employees, non-employee directors and consultants may be awarded incentive stock options, non-statutory stock options, shares of restricted stock awards (“RSAs”), or stock appreciation rights.  The aggregate number of shares of the Corporation’s common stock issuable under the plan is 575,000.  Awards are made to certain other senior officers at the discretion of the Corporation’s management.  Compensation cost equal to the fair value of the award is recognized over the vesting period.

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RECENT ACCOUNTING PRONOUNCEMENTS

3 Months Ended

Mar. 31, 2017

RECENT ACCOUNTING PRONOUNCEMENTS

RECENT ACCOUNTING PRONOUNCEMENTS

2.RECENT ACCOUNTING PRONOUNCEMENTS

In May 2014, the Financial Accounting Standards Board (FASB) issued guidance on the recognition of revenue from contracts with customers. Revenue recognition will depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also requires disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The guidance permits two methods of adoption: retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application. The guidance is effective January 1, 2018 and early adoption is permitted only as of January 1, 2017. In this regard, management has completed a preliminary analysis of the impact of implementation.  The key revenue streams affected by implementation would include service charges and mortgage banking income. The new guidance is not expected to have a significant impact on the Corporation’s financial results. Interest income is outside of the scope of the new standard and will not be impacted upon adoption.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”).  ASU 2016-01 amends current guidance by requiring companies to recognize changes in fair value for equity investments that have a readily determinable fair value through net income rather than through other comprehensive income.  Under ASU 2016-01, equity investments that do not have a readily determinable fair value will either be accounted for in the same manner as equity investments that have a readily determinable fair value, with changes in fair value recognized through net income or carried at cost, adjusted for changes in observable prices based on orderly transactions for identical or similar investments issued by the same issuer and further adjusted for impairment, if applicable.  ASU 2016-01 also requires a qualitative assessment of impairment indicators each reporting period.  If this assessment indicates that impairment exists, companies must adjust the investment to fair value and recognize an impairment loss in net income, even if the impairment is determined to be temporary.  ASU 2016-01 is effective for public companies for interim and annual periods beginning after December 15, 2017.   The Corporation’s adoption of ASU 2016-01 is not expected to have a material impact on the Corporation’s consolidated financial condition or results of operations.

In February 2016, the FASB issued ASU 2016-02, Leases, which will supersede the current lease requirements in ASC 840.  The ASU requires lessees to recognize an asset with the right of use and related lease liability for all leases, with a limited exception for short-term leases.  Leases will be classified as either finance or operating, with the classification affecting the pattern of expense recognition in the statement of operations.  Currently, leases are classified as either capital or operating, with only capital leases recognized on the balance sheet.  The reporting of lease related expenses in the statements of operations and cash flows will be generally consistent with the current guidance.  The new lease guidance will be effective for the Corporation’s year ending December 31, 2019 and will be applied using modified retrospective transition method to the beginning of the earliest period presented.  The effect of applying the new lease guidance on the financial statements has not yet been determined.

In September 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income.

ASU 2016-13 requires an entity to measure expected credit losses for financial assets over the estimated lifetime of expected credit loss and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The standard includes the following core concepts in determining the expected credit loss.  The estimate must: (a) be based on an asset’s amortized cost (including premiums or discounts, net deferred fees and costs, foreign exchange and fair value hedge accounting adjustments), (b) reflect losses expected over the remaining contractual life of an asset (considering the effect of voluntary prepayments), (c) consider available relevant information about the estimated collectability of cash flows (including information about past events, current conditions, and reasonable and supportable forecasts), and (d) reflect the risk of loss, even when that risk is remote.

ASU 2016-13 also amends the recording of purchased credit-deteriorated assets. Under the new guidance, an allowance will be recognized at acquisition through a gross-up approach whereby an entity will record as the initial amortized cost the sum of (a) the purchase price and (b) an estimate of credit losses as of the date of acquisition. In addition, the guidance also requires immediate recognition in earnings of any subsequent changes, both favorable and unfavorable, in expected cash flows by adjusting this allowance.

ASU 2016-13 also amends the impairment model for available-for-sale debt securities and requires entities to determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. Management may not use the length of time a security has been in an unrealized loss position as a factor in concluding whether a credit loss exists, as is currently permitted. In addition, an entity will recognize an allowance for credit losses on available-for-sale debt securities as a contra-account to the amortized cost basis rather than as a direct reduction of the amortized cost basis of the investment, as is currently required. As a result, entities will recognize improvements to credit losses on available-for-sale debt securities immediately in earnings rather than as interest income over time under current practice.

New disclosures required by ASU 2016-13 include: (a) for financial assets measured at amortized cost, an entity will be required to disclose information about how it developed its allowance, including changes in the factors that influenced management’s estimate of expected credit losses and the reasons for those changes, (b) for financial receivables and net investments in leases measured at amortized cost, an entity will be required to further disaggregate the information it currently discloses about the credit quality of these assets by year or the asset’s origination or vintage for as many as five annual periods, and (c) for available-for-sale debt securities, an entity will be required to provide a roll-forward of the allowance for credit losses and an aging analysis for securities that are past due.

Upon adoption of ASU 2016-13, a cumulative-effect adjustment to retained earnings will be recorded as of the beginning of the first reporting period in which the guidance is effective. ASU 2016-13 is effective for public companies for interim and annual periods beginning after December 15, 2019, with early adoption permitted for annual periods beginning after December 15, 2018. The Corporation is currently evaluating the provisions of ASU 2016-13 to determine the potential impact on the Corporation's consolidated financial condition and results of operations.

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EARNINGS PER SHARE

3 Months Ended

Mar. 31, 2017

EARNINGS PER SHARE

EARNINGS PER SHARE

3.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 months ended March 31, 2017 and 2016 (dollars in thousands, except per share data):

	Three Months Ended March 31,
	2017		2016
(Numerator):
Net income	$	1,726	$	1,132
(Denominator):
Weighted average shares outstanding		6,270,034		6,214,083
Effect of dilutive stock options, and vesting of restricted stock awards		10,343		13,902
Diluted weighted average shares outstanding		6,280,377		6,227,985
Income per common share:
Basic	$	.28	$	.18
Diluted	$	.28	$	.18

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INVESTMENT SECURITIES

3 Months Ended

Mar. 31, 2017

INVESTMENT SECURITIES

INVESTMENT SECURITIES

4.INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities available for sale as of March 31, 2017 and December 31, 2016 are as follows (dollars in thousands):

			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
March 31, 2017
Corporate	$	19,849	$	118	$	(15)	$	19,952
Equity		500		—		—		500
US Agencies		22,991		77		(15)		23,053
US Agencies - MBS		15,903		64		(111)		15,856
Obligations of states and political subdivisions		24,293		405		(177)		24,521
Total securities available for sale	$	83,536	$	664	$	(318)	$	83,882
December 31, 2016
Corporate	$	19,899	$	49	$	(38)	$	19,910
Equity		500		—		—		500
US Agencies		23,991		47		(86)		23,952
US Agencies - MBS		16,980		48		(195)		16,833
Obligations of states and political subdivisions		25,057		447		(426)		25,078
Total securities available for sale	$	86,427	$	591	$	(745)	$	86,273

The Corporation has evaluated gross unrealized losses that exist within the portfolio and considers them temporary in nature.  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 $19.902 million and $19.869 million, respectively, at March 31, 2017.

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LOANS

3 Months Ended

Mar. 31, 2017

LOANS

LOANS

5.LOANS

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

	March 31,		December 31,
	2017		2016
Commercial real estate	$	397,192	$	389,420
Commercial, financial, and agricultural		144,673		142,648
Commercial construction		10,618		11,505
One to four family residential real estate		202,654		205,945
Consumer		19,021		20,113
Consumer construction		12,388		12,226
Total loans	$	786,546	$	781,857

The Corporation completed the acquisition of Peninsula Financial Corporation (“PFC”) on December 5, 2014, The First National Bank of Eagle River (“Eagle River”) on April 29, 2016 and Niagara Bancorporation (“Niagara”) on August 31, 2016.    The PFC acquired impaired loans totaled $13.290 million, the Eagle River acquired impaired loans totaled $3.401 million, and the Niagara acquired impaired loans totaled $2.105 million.  In the first three months of 2017, the Corporation had positive resolution of acquired nonperforming loans, which resulted in the recognition of $100,000 of accretable interest.  In the first three months of 2016, the Corporation had positive resolution of one PFC acquired nonperforming loan which resulted in the recognition of approximately $96,000 of accretable interest.

The table below details the outstanding balances of the PFC acquired portfolio and the fair value adjustments at acquisition date (dollars in thousands):

	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	13,290	$	53,849	$	67,139
Nonaccretable difference		(2,234)		—		(2,234)
Expected cash flows		11,056		53,849		64,905
Accretable yield		(744)		(2,100)		(2,844)
Carrying balance at acquisition date	$	10,312	$	51,749	$	62,061

The table below details the outstanding balances of the Eagle River acquired portfolio and the fair value adjustments at acquisition date (dollars in thousands):

	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	3,401	$	80,737	$	84,138
Nonaccretable difference		(1,172)		—		(1,172)
Expected cash flows		2,229		80,737		82,966
Accretable yield		(391)		(1,700)		(2,091)
Carrying balance at acquisition date	$	1,838	$	79,037	$	80,875

The table below details the outstanding balances of the Niagara acquired portfolio and the fair value adjustments at acquisition date (dollars in thousands):

	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	2,105	$	30,555	$	32,660
Nonaccretable difference		(265)		—		(265)
Expected cash flows		1,840		30,555		32,395
Accretable yield		(88)		(600)		(688)
Carrying balance at acquisition date	$	1,752	$	29,955	$	31,707

The table below presents a rollforward of the accretable yield on acquired loans for the three months ended March 31, 2017 (dollars in thousands):

	PFC						Eagle River						Niagara
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total		Impaired		Non-impaired		Total
Balance, December 31, 2016	$	282	$	642	$	924	$	236	$	1,221	$	1,457	$	52	$	505	$	557
Accretion		(100)		(175)		(275)		—		(179)		(179)		—		(72)		(72)
Reclassification from nonaccretable difference		57		—		57		—		—		—		(8)		—		(8)
Balance, March 31, 2017	$	239	$	467	$	706	$	236	$	1,042	$	1,278	$	44	$	433	$	477

The table below presents a rollforward of the accretable yield on acquired loans for the three months ended March 31, 2016 (dollars in thousands):

	PFC
	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Balance, December 31, 2015	$	426	$	1,342	$	1,768
Accretion		—		(175)		(175)
Reclassification from nonaccretable difference		(17)		—		(17)
Balance, March 31, 2016	$	409	$	1,167	$	1,576

Allowance for Loan Losses

An analysis of the allowance for loan losses for the three months ended March 31, 2017 and the year ended December 31, 2016 is as follows (dollars in thousands):

	March 31,		March 31,
	2017		2016
Balance, January 1	$	5,020	$	5,004
Recoveries on loans previously charged off		102		56
Loans charged off		(126)		(236)
Provision		150		0
Balance at end of period	$	5,146	$	4,824

In the first three months of 2017, net charge-offs were $24,000, compared to net charge-offs of $.180 million in the same period in 2016.   In the first three  months of 2017, the Corporation recorded a provision for loan loss of $.150 million compared to no provision in the first three months of 2016.  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 March 31, 2017 is as follows (dollars in thousands):

			Commercial,				One to four
	Commercial		financial and		Commercial		family residential		Consumer
	real estate		agricultural		construction		real estate		construction		Consumer		Unallocated		Total
Allowance for loan loss reserve:
Beginning balance ALLR	$	1,345	$	614	$	57	$	296	$	6	$	90	$	2,612	$	5,020
Charge-offs		—		—		—		(49)		—		(77)		—		(126)
Recoveries		34		1		—		61		—		6		—		102
Provision		(19)		35		38		(43)		1		(4)		142		150
Ending balance ALLR	$	1,360	$	650	$	95	$	265	$	7	$	15	$	2,754	$	5,146
Loans:
Ending balance	$	397,192	$	144,673	$	10,618	$	202,654	$	12,388	$	19,021	$	—	$	786,546
Ending balance ALLR		(1,360)		(650)		(95)		(265)		(7)		(15)		(2,754)		(5,146)
Net loans	$	395,832	$	144,023	$	10,523	$	202,389	$	12,381	$	19,006	$	(2,754)	$	781,400
Ending balance ALLR:
Individually evaluated	$	525	$	394	$	38	$	3	$	—	$	5	$	—	$	965
Collectively evaluated		835		256		57		262		7		10		2,754		4,181
Total	$	1,360	$	650	$	95	$	265	$	7	$	15	$	2,754	$	5,146
Ending balance Loans:
Individually evaluated	$	1,564	$	1,464	$	382	$	403	$	—	$	22	$	—	$	3,835
Collectively evaluated		392,409		143,209		8,228		202,196		12,388		18,996		—		777,426
Acquired with deteriorated credit quality		3,219		—		2,008		55		—		3		—		5,285
Total	$	397,192	$	144,673	$	10,618	$	202,654	$	12,388	$	19,021	$	—	$	786,546

Impaired loans, by definition, are individually evaluated.

A breakdown of the allowance for loan losses and recorded balances in loans at March 31, 2016 is as follows (dollars in thousands):

			Commercial,				One to four
	Commercial		financial and		Commercial		family residential		Consumer
	real estate		agricultural		construction		real estate		construction		Consumer		Unallocated		Total
Allowance for loan loss reserve:
Beginning balance ALLR	$	1,611	$	645	$	79	$	274	$	7	$	64	$	2,324	$	5,004
Charge-offs		—		(185)		—		(39)		—		(12)		—		(236)
Recoveries		7		31		7		1		—		10		—		56
Provision		(3)		89		(12)		21		—		(22)		(73)		—
Ending balance ALLR	$	1,615	$	580	$	74	$	257	$	7	$	40	$	2,251	$	4,824
Loans:
Ending balance	$	317,081	$	124,005	$	14,489	$	135,641	$	11,959	$	15,450	$	—	$	618,625
Ending balance ALLR		(1,615)		(580)		(74)		(257)		(7)		(40)		(2,251)		(4,824)
Net loans	$	315,466	$	123,425	$	14,415	$	135,384	$	11,952	$	15,410	$	(2,251)	$	613,801
Ending balance ALLR:
Individually evaluated	$	533	$	185	$	—	$	45	$	—	$	31	$	—	$	794
Collectively evaluated		1,082		395		74		212		7		9		2,251		4,030
Total	$	1,615	$	580	$	74	$	257	$	7	$	40	$	2,251	$	4,824
Ending balance Loans:
Individually evaluated	$	2,001	$	392	$	—	$	750	$	—	$	36	$	—	$	3,179
Collectively evaluated		310,709		123,436		14,489		132,242		11,957		15,413		—		608,246
Acquired with deteriorated credit quality		4,371		177		—		2,649		2		1		—		7,200
Total	$	317,081	$	124,005	$	14,489	$	135,641	$	11,959	$	15,450	$	—	$	618,625

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.

Strong (1)

Borrower is not vulnerable to sudden economic or technological changes.  They have “strong” balance sheets and are within an industry that is very typical for our markets or type of lending culture.  Borrowers also have “strong” financial and cash flow performance and excellent collateral (low loan to value or readily available to liquidate collateral) in conjunction with an impeccable repayment history.

Good (2)

Borrower shows limited vulnerability to sudden economic change.  These borrowers have “above average” financial and cash flow performance and a very good repayment history.  The balance sheet of the company is also very good as compared to peer and the company is in an industry that is familiar to our markets or our type of lending.  The collateral securing the deal is also very good in terms of its type, loan to value, and other relevant characteristics.

Average (3)

Borrower is typically a well-seasoned business, however may be susceptible to unfavorable changes in the economy, and could be somewhat affected by seasonal factors.  The borrowers within this category exhibit financial and cash flow performance that appear “average” to “slightly above average” when compared to peer standards and they show an adequate payment history.  Collateral securing this type of credit is good, exhibiting above average loan to values, and other relevant characteristics.

Acceptable/Acceptable Watch (4)

A borrower within this category exhibits financial and cash flow performance that appear adequate and satisfactory when compared to peer standards and they show a satisfactory payment history.  The collateral securing the request is within supervisory limits and overall is acceptable.  Borrowers rated acceptable could also be newer businesses that are typically susceptible to unfavorable changes in the economy, and more than likely could be affected by seasonal factors.

Special Mention (5)

The borrower may have potential weaknesses that deserve management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or in the institution’s credit position at some future date.  Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.  Examples of this type of credit include a start-up company fully based on projections, a documentation issue that needs to be corrected or a general market condition that the borrower is working through to get corrected.

Substandard (6)

Substandard loans are classified assets exhibiting a number of well-defined weaknesses that jeopardize normal repayment.  The assets are no longer adequately protected due to declining net worth, lack of earning capacity, or insufficient collateral offering the distinct possibility of the loss of a portion of the loan principal.  Loans classified as substandard clearly represent troubled and deteriorating credit situations requiring constant supervision.

Doubtful (7)

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

Charge-off/Loss (8)

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

General Reserves:

For loans with a credit risk rating of 5 or better and any loans with a risk rating of 6 or 7 not considered impaired, reserves are established based on the type of loan collateral, if any, and the assigned credit risk rating. 

Determination of the allowance is inherently subjective as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on pools of homogenous loans based on historical loss experience, and consideration of current environmental factors and economic trends, all of which may be susceptible to significant change.

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

Below is a breakdown of loans by risk category as of March 31, 2017 (dollars in thousands):

							(4)
	(1)		(2)		(3)		Acceptable/		(5)		(6)		(7)		Rating
	Strong		Good		Average		Acceptable Watch		Special Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	3,309	$	24,533	$	149,448	$	204,557	$	10,582	$	4,763	$	—	$	—	$	397,192
Commercial, financial and agricultural		10,616		13,463		48,226		68,018		2,463		1,887		—		—		144,673
Commercial construction		—		875		3,163		1,961		756		382		—		3,481		10,618
One-to-four family residential real estate		825		1,367		3,190		7,128		2,798		4,165		—		183,181		202,654
Consumer construction		28		—		—		—		—		16		—		12,344		12,388
Consumer		15		—		14		39		12		59		—		18,882		19,021
Total loans	$	14,793	$	40,238	$	204,041	$	281,703	$	16,611	$	11,272	$	—	$	217,888	$	786,546

Below is a breakdown of loans by risk category as of December 31, 2016 (dollars in thousands):

							(4)
	(1)		(2)		(3)		Acceptable/		(5)		(6)		(7)		Rating
	Strong		Good		Average		Acceptable Watch		Special Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	3,021	$	23,940	$	140,618	$	216,518	$		$	5,323	$	—	$	—	$	389,420
Commercial, financial and agricultural		10,421		13,434		49,434		67,582				1,777		—		—		142,648
Commercial construction		—		900		3,146		2,660				385		—		4,414		11,505
One-to-four family residential real estate		740		1,373		3,412		9,585				5,493		—		185,342		205,945
Consumer construction		28		—		—		—		—		17		—		12,181		12,226
Consumer		20		—		15		55				103		—		19,920		20,113
Total loans	$	14,230	$	39,647	$	196,625	$	296,400	$	—	$	13,098	$	—	$	221,857	$	781,857

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. 

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):

							QTD				Interest Income
	Nonaccrual			Nonaccrual	Accrual		Average		Related		on
	Recorded Balance			Unpaid Balance	Basis		Investment		Valuation Reserve		Accrual Basis
March 31, 2017
With no valuation reserve:
Commercial real estate	$	1,391	$	1,834	$	2,097	$	4,086	$	—	$	121
Commercial, financial and agricultural		9		9		—		9		—		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,253		1,607		1,903		3,981		—		104
Consumer construction		16		21		55		73		—		1
Consumer		15		19		3		52		—		—
With a valuation reserve:
Commercial real estate	$	301	$	310	$	—	$	302	$	50	$	—
Commercial, financial and agricultural		335		335		—		327		261		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		386		387		—		235		27		—
Consumer construction		—		—		—		—		—		—
Consumer		24		24		—		12		11		—
Total:
Commercial real estate	$	1,692	$	2,144	$	2,097	$	4,388	$	50	$	121
Commercial, financial and agricultural		344		344		—		336		261		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,639		1,994		1,903		4,216		27		104
Consumer construction		16		21		55		73		—		1
Consumer		39		43		3		64		11		—
Total	$	3,730	$	4,546	$	4,058	$	9,077	$	349	$	226
December 31, 2016
With no valuation reserve:
Commercial real estate	$	1,426	$	1,891	$	3,234	$	5,318	$	—	$	232
Commercial, financial and agricultural		11		11		—		116		—		3
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,623		2,198		2,792		4,500		—		196
Consumer construction		17		22		57		36		—		4
Consumer		82		86		4		127		—		2
With a valuation reserve:
Commercial real estate	$	306	$	328	$	—	$	103	$	50	$	—
Commercial, financial and agricultural		326		357		—		109		231		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		333		333		—		171		94		—
Consumer construction		—		—		—		—		—		—
Consumer		0		0		—		5		5		—
Total:
Commercial real estate	$	1,732	$	2,219	$	3,234	$	5,421	$	50	$	232
Commercial, financial and agricultural		337		368		—		225		231		3
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,956		2,531		2,792		4,671		94		196
Consumer construction		17		22		57		36		—		4
Consumer		82		86		4		132		5		2
Total	$	4,124	$	5,226	$	6,087	$	10,485	$	380	$	437

A summary of past due loans at March 31, 2017 and December 31, 2016 is as follows (dollars in thousands):

	March 31,						December 31,
	2017						2016
	30-89 days		90+ days				30-89 days		90+ days
	Past Due		Past Due/				Past Due		Past Due/
	(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total
Commercial real estate	$	822	$	1,692	$	2,514	$	942	$	1,732	$	2,674
Commercial, financial and agricultural		150		344		494		186		337		523
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		2,206		1,639		3,845		2,113		1,956		4,069
Consumer construction		52		16		68		—		17		17
Consumer		71		39		110		133		82		215
Total past due loans	$	3,301	$	3,730	$	7,031	$	3,374	$	4,124	$	7,498

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.

There were no troubled debt restructurings that occurred during the three months ended March 31, 2017 or March 31, 2016.

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):

	Three Months Ended		Three Months Ended
	March 31,		March 31,
	2017		2016
Loans outstanding, January 1	$	9,195	$	6,887
New loans		—		—
Net activity on revolving lines of credit		500		510
Repayment		(313)		(2,034)
Loans outstanding at end of period	$	9,382	$	5,363

There were no loans to related parties classified substandard as of March 31 2017 or March 31, 2016.  In addition to the outstanding balances above, there were unfunded commitments of $91,000 to related parties at March 31, 2017.

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GOODWILL AND OTHER INTANGIBLE ASSETS

3 Months Ended

Mar. 31, 2017

GOODWILL AND OTHER INTANGIBLE ASSETS

GOODWILL AND OTHER INTANGIBLE ASSETS

6.GOODWILL AND OTHER INTANGIBLE ASSETS

During the fourth quarter of 2014, the Corporation recorded $3.805 million of goodwill and $1.206 million of deposit based intangible assets associated with the acquisition of PFC.  During 2016, the Corporation recorded $1.839 million of goodwill and $.993 million of deposit based intangible assets associated with the acquisition of Eagle River.  Also in 2016, the Corporation recorded $50,000 of goodwill and $.300 million of deposit based intangible assets associated with the acquisition of Niagara.

The deposit based intangible is reported net of accumulated amortization at $2.110 million at March 31, 2017.  Amortization expense in the first three months of 2017 is $62,000.  Amortization expense for the next five years is expected to be at $.250 million per year.

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SERVICING RIGHTS

3 Months Ended

Mar. 31, 2017

SERVICING RIGHTS

SERVICING RIGHTS

7.SERVICING RIGHTS

Mortgage Loans

Mortgage servicing rights (“MSRs”) are recorded when loans are sold in the secondary market with servicing retained.  As of March 31, 2017, the Corporation had obligations to service approximately $215.730 million of residential first mortgage loans.  The valuation of MSRs is based upon the net present value of the projected revenues over the expected life of the loans being serviced, as reduced by estimated internal costs to service these loans.  The fair value of the capitalized servicing rights approximates the carrying value. On a quarterly basis, management evaluates the MSRs for impairment. The key economic assumptions used in determining the fair value of the MSRs include an annual constant prepayment speed of 10.74% and a discount rate of 9.59% for March 31, 2017. In 2016, management decided to no longer retain the servicing on mortgage loans sold.

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

	Three Months Ended		Three Months Ended
	March 31,		March 31,
	2017		2016
Balance at beginning of period	$	1,573	$	1,965
Additions from loans sold with servicing retained		—		—
Acquired MSRs		—		—
Amortization		(141)		(196)
Balance at end of period	$	1,432	$	1,769
Balance of loan servicing portfolio	$	215,730	$	219,080
Mortgage servicing rights as % of portfolio		.66%		.81%

Commercial Loans

The Corporation also retains the servicing on certain commercial loans that have been sold.  These loans were originated and underwritten under the SBA and USDA government guarantee programs, in which the guaranteed portion of the loan was sold to a third party with servicing retained.  The balance of these sold loans with servicing retained at March 31 2017 and March 31, 2016 was approximately $55.000 million and $49.500 million, respectively. The Corporation valued these servicing rights at $.132 million as of March 31, 2017 and at $.162 million as of March 31, 2016.  This valuation was established in consideration of the discounted cash flow of net expected servicing income over the life of the loans.

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BORROWINGS

3 Months Ended

Mar. 31, 2017

BORROWINGS

BORROWINGS

8.BORROWINGS

Borrowings consist of the following at March 31, 2017 and December 31, 2016 (dollars in thousands):

	March 31,		December 31,
	2017		2016
Federal Home Loan Bank fixed rate advances	$	45,000	$	45,000
Correspondent bank line of credit		—		750
Correspondent bank term note		20,649		21,199
USDA Rural Development note		630		630
	$	66,279	$	67,579

The Federal Home Loan Bank borrowings bear a weighted average of 2.10% and mature in 2017, 2018, 2019 and 2020. They are collateralized at March 31, 2017 by the following:  a collateral agreement on the Corporation’s one to four family residential real estate loans with a book value of approximately $42.506 million; mortgage related and municipal securities with an amortized cost and estimated fair value of $12.000 million and $11.991 million, respectively; and Federal Home Loan Bank stock owned by the Bank totaling $2.719 million.  Prepayment of the advances is subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank of Indianapolis and the Federal Home Loan Bank of Chicago in effect as of March 31, 2017.

The Corporation currently has one banking borrowing relationship.  The relationship consists of a $5.0 million revolving line of credit and a term note. The line of credit bears interest at a rate of LIBOR plus 2.75% and has an initial term that expires on April 30, 2018.  The term note bears the same interest and matures on April 30, 2019 and requires quarterly principal payments of $.550 million beginning March 31, 2017.  This relationship is secured by all of the outstanding mBank stock.  

The USDA Rural Development borrowing bears an interest rate of 1.00% and matures in August, 2024. It is collateralized by loans totaling $.108 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 $.593 million, and guaranteed by the Corporation.

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DEFINED BENEFIT PENSION PLAN

3 Months Ended

Mar. 31, 2017

DEFINED BENEFIT PENSION PLAN

DEFINED BENEFIT PENSION PLAN

9.DEFINED BENEFIT PENSION PLAN

The Corporation acquired the Peninsula Financial Corporation noncontributory defined benefit pension plan in 2014.  Effective December 31, 2005, the plan was amended to freeze participation in the plan; therefore, no additional employees are eligible to become participants in the plan.  The benefits are based on years of service and the employee’s compensation at the time of retirement.  The Plan was amended effective December 31, 2010, to freeze benefit accrual for all participants.  Expected contributions to the Plan in 2017 are $19,000.  

The anticipated distributions over the next five years and through December 31, 2026 are detailed in the table below (dollars in thousands):

2017	$	128
2018		125
2019		122
2020		121
2021		120
2022-2026		723
Total	$	1,339

At March 31, 2017, the plan’s assets had a fair value of $2.049 million and the Corporation had a net unfunded liability of $1.138 million.  The accumulated benefit obligation at March 31, 2017 was $3.187 million.  At March 31, 2016, the plan’s assets had a fair value of $2.033 million and the Corporation had a net unfunded liability of $1.147 million.  The accumulated benefit obligation at March 31, 2016 was $3.180 million.

Assumptions in the actuarial valuation are:

	2017	2016
Weighted average discount rate	3.78%	3.99%
Rate of increase in future compensation levels	N/A	N/A
Expected long-term rate of return on plan assets	8.00%	8.00%

The expected long-term rate of return on plan assets reflects management’s expectations of long-term average rates of return on funds invested to provide for benefits included in the projected benefit obligation.  The expected return is based on the outlook for inflation, fixed income returns and equity returns, while also considering historical returns, asset allocation and investment strategy.  The discount rate assumption is based on investment yields available on AA rated long-term corporate bonds.

The primary investment objective is to maximize growth of the pension plan assets to meet the projected obligations to the beneficiaries over a long period of time, and to do so in a manner that is consistent with the Corporation’s risk tolerance.  The intention of the plan sponsor is to invest the plan assets in mutual funds with the following asset allocation; which was in place at both March 31, 2017 and December 31, 2016.

	Target	Actual
	Allocation	Allocation
Equity securities	50% to 70%	60%
Fixed income securities	30% to 50%	40%

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STOCK COMPENSATION PLANS

3 Months Ended

Mar. 31, 2017

STOCK COMPENSATION PLANS

STOCK COMPENSATION PLANS

10.STOCK COMPENSATION PLANS

Restricted Stock Awards

The Corporation’s restricted stock awards require certain service-based or performance requirements and have a vesting period of four years.  Compensation expense is recognized on a straight-line basis over the vesting period.  Shares are subject to certain restrictions and risk of forfeiture by the participants.

The Corporation has historically granted RSAs to members of the Board of Directors and management. Awards granted are set to vest equally over their award terms and are issued at no cost to the recipient.  The table below summarizes each of the grant awards:

Date of Award	Units Granted	Market Value at grant date	Vesting Term
March, 2014	52,774	12.95	4 years
March, 2015	37,730	11.15	4 years
May, 2015	3,000	10.77	Immediate
February, 2016	35,733	9.91	4 years
February, 2017	28,427	13.39	4 years

On August 31, 2013, 2014, 2015 and 2016, the Corporation issued 37,125 shares of its common stock for vested RSAs, in each year. In March 2015, the Corporation issued 13,194 shares of its common stock for vested RSAs. In May 2015, the Corporation granted 3,000 shares, which were immediately vested and issued.  In March 2016, the Corporation issued 22,626 shares of its common stock for vested RSAs. In the first quarter of 2017, the Corporation issued 31,559 shares of its common stock for vested RSAs.

A summary of changes in our nonvested shares for the period follows:

		Weighted Average
	Number	Grant Date
	Outstanding	Fair Value
Nonvested balance at January 1, 2017	90,417	$	11.19
Granted during the quarter	28,427		13.39
Vested during the quarter	(31,559)		11.55
Nonvested balance at March 31, 2017	87,285	$	11.78

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INCOME TAXES

3 Months Ended

Mar. 31, 2017

INCOME TAXES

INCOME TAXES

11.INCOME TAXES

The Corporation has reported deferred tax assets of $7.651 million at March 31, 2017. 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 March 31, 2017 had a net operating loss and tax credit carryforwards for tax purposes of approximately $9.1 million, and $2.2 million, respectively.  The Corporation evaluated the future benefits from these carryforwards as of March 31, 2017 and determined that it was “more likely than not” that they would be utilized prior to expiration.  The net operating loss carryforwards expire twenty years from the date they originated.  These carryforwards, if not utilized, will begin to expire in the year 2023.  A portion of the NOL and credit carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code.  The annual limitation is $1.404 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 will continue to evaluate the future benefits from these carryforwards in order to determine if any adjustment to the deferred tax asset is warranted.

The Corporation recognized a federal income tax expense of approximately $.889 million for the three months ended March 31, 2017 and $.585 million for the three months ended March 31, 2016. 

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FAIR VALUE MEASUREMENTS

3 Months Ended

Mar. 31, 2017

FAIR VALUE MEASUREMENTS

FAIR VALUE MEASUREMENTS

12.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 March 31, 2017 and December 31, 2016 (dollars in thousands):

		March 31, 2017				December 31, 2016
	Level in Fair	Carrying		Estimated		Carrying		Estimated
	Value Hierarchy	Amount		Fair Value		Amount		Fair Value
Financial assets:
Cash and cash equivalents	Level 1	$	41,169	$	41,169	$	46,755	$	46,755
Interest-bearing deposits	Level 2		13,448		13,448		14,047		14,047
Securities available for sale	Level 2		82,232		82,232		84,623		84,623
Securities available for sale	Level 3		1,650		1,650		1,650		1,650
Federal Home Loan Bank stock	Level 2		2,719		2,719		2,911		2,911
Net loans	Level 3		781,400		780,377		776,837		778,377
Accrued interest receivable	Level 3		2,026		2,026		2,016		2,016
Total financial assets		$	924,644	$	923,621	$	928,839	$	930,379
Financial liabilities:
Deposits	Level 2	$	821,820	$	814,259	$	823,512	$	815,960
Borrowings	Level 2		66,279		66,853		67,579		68,293
Accrued interest payable	Level 3		287		287		267		267
Total financial liabilities		$	888,386	$	881,399	$	891,358	$	884,520

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 March 31, 2017, 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 March 31, 2017 and December 31, 2016 were based on level 2 and level 3 inputs.  There are no other assets or liabilities measured on a recurring basis at fair value.  For additional information regarding investment securities, please refer to “Note 4 Investment Securities.”

The table below shows investment securities measured at fair value on a recurring basis (dollars in thousands):

			Quoted Prices		Significant		Significant		Total (Gains)
			in Active Markets		Other Observable		Unobservable		Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended
(dollars in thousands)	March 31,  2017		(Level 1)		(Level 2)		(Level 3)		March 31, 2017
Assets
Corporate	$	19,952	$	—	$	19,952	$	—	$	—
Equity		500		—		—		500		—
US Agencies		23,053		—		23,053		—		—
US Agencies - MBS		15,856		—		14,706		1,150		—
Obligations of state and political subdivisions		24,521		—		24,521		—		—
	$	83,882							$	—

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Twelve months ended
(dollars in thousands)	December 31, 2016		(Level 1)		(Level 2)		(Level 3)		December 31, 2016
Assets
Corporate	$	19,910	$	—	$	19,910	$	—	$	—
Equity		500		—		—		500		—
US Agencies		23,952		—		23,952		—		—
US Agencies - MBS		16,833		—		15,683		1,150		—
Obligations of state and political subdivisions		25,078		—		25,078		—		—
	$	86,273							$	—

The Corporation had no Level 3 assets or liabilities measured at fair value on a recurring basis as of March 31, 2017, or December 31, 2016 other than as described above.

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 certain impaired 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 March 31, 2017

			Quoted Prices		Significant		Significant		Total (Gains)
			in Active Markets		Other Observable		Unobservable		Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended
(dollars in thousands)	March 31, 2017		(Level 1)		(Level 2)		(Level 3)		March 31, 2017
Assets
Impaired loans	$	7,788	$	—	$	—	$	7,788	$	37
Other real estate owned		4,466		—		—		4,466		12
									$	49

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2016

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Twelve months ended
(dollars in thousands)	December 31, 2016		(Level 1)		(Level 2)		(Level 3)		December 31, 2016
Assets
Impaired loans	$	9,856	$	—	$	—	$	9,856	$	643
Other real estate held for sale		4,782		—		—		4,782		202
									$	845

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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SHAREHOLDERS' EQUITY

3 Months Ended

Mar. 31, 2017

SHAREHOLDERS' EQUITY

SHAREHOLDERS' EQUITY

13.SHAREHOLDERS’ EQUITY

The Corporation currently has a share repurchase program.  The program is conducted under authorizations by the Board of Directors.  The Corporation repurchased 14,000 shares in 2016, 102,455 shares in 2015, 13,700 shares in 2014 and 55,594 shares in 2013.  The share repurchases were conducted under Board authorizations made and publically announced of $.600 million on February 27, 2013, $.600 million on December 17, 2013 and an additional $.750 million on April 28, 2015.  None of these authorizations has an expiration date.  As of March 31, 2017, $26,000 of the total authorization was available for future purchases.

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COMMITMENTS, CONTINGENCIES, AND CREDIT RISK

3 Months Ended

Mar. 31, 2017

COMMITMENTS, CONTINGENCIES, AND CREDIT RISK

COMMITMENTS, CONTINGENCIES, AND CREDIT RISK

14.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):

	March 31,		December 31,
	2017		2016
Commitments to extend credit:
Variable rate	$	60,204	$	59,496
Fixed rate		27,407		28,737
Standby letters of credit - Variable rate		7,926		8,252
Credit card commitments - Fixed rate		5,677		5,533
	$	101,214	$	102,018

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 March 31, 2017 represents $114.650 million, or 20.75%, compared to $121.861 million, or 22.42%, of the commercial loan portfolio on December 31, 2016.  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.

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BUSINESS COMBINATIONS

3 Months Ended

Mar. 31, 2017

BUSINESS COMBINATIONS

BUSINESS COMBINATIONS

15.  BUSINESS COMBINATIONS

The First National Bank of Eagle River

The Corporation completed its acquisition of The First National Bank of Eagle River (“Eagle River”) in April 2016.  Eagle River had three branch offices and approximately $125 million in assets as of April 29, 2016, including total loans of $84 million and total deposits of $105 million. The results of operations due to the merger have been included in the Corporation’s results since the acquisition date.  The merger was effected by a cash payment of $12.500 million. The Corporation recorded a $.933 million core deposit intangible asset and $1.839 million of goodwill in conjunction with the acquisition. Goodwill was recorded due to the synergies and economies of scale expected from combining operations of the Corporation with Eagle River.

Niagara Bancorporation

The Corporation completed its acquisition of Niagara Bancorporation, Inc. (“Niagara”) in August 2016.  Niagara had four branch offices and approximately $67 million in assets as of August 31, 2016 including total loans of $33 million and total deposits of $59 million. The results of operations due to the merger have been included in the Corporation’s results since the acquisition date. The merger was effected by a cash payment of $7.325 million. The corporation recorded a $.300 million core deposit intangible asset and $50,000 of goodwill in conjunction with the acquisition. Goodwill was recorded due to the synergies and economies of scale expected from combining operations of the Corporation with Niagara.

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SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Policies)

3 Months Ended

Mar. 31, 2017

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 three month period ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.  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, 2016.

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, the valuation of investment securities, the valuation of foreclosed real estate, deferred tax assets, mortgage servicing rights, and the assessment of goodwill for impairment.

Acquired Loans

Acquired Loans

Loans acquired with evidence of credit deterioration since inception and for which it is probable that all contractual payments will not be received are accounted for under ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”).  These loans are recorded at fair value at the time of acquisition, with no carryover of the related allowance for loan losses.  Fair value of acquired loans is determined using a discounted cash flow methodology based on assumptions about the amount and timing of principal and interest payments, principal prepayments and principal defaults and losses, and current market rates.  In recording the fair values of acquired impaired loans at acquisition date, management calculates a non-accretable difference (the credit component of the purchased loans) and an accretable difference (the yield component of the purchased loans).

Over the life of the acquired loans, management continues to estimate cash flows expected to be collected on pools of loans sharing common risk characteristics, which are treated in the aggregate when applying various valuation techniques.  Management evaluates at each balance sheet date whether the present value of our pools of loans determined using the effective interest rates has decreased significantly and if so, recognizes a provision for loan loss in our consolidated statement of income.  For any significant increases in cash flows expected to be collected, we adjust the amount of the accretable yield recognized on a prospective basis over the pool’s remaining life.

Performing acquired loans are accounted for under Financial Accounting Standards Board (“FASB”) Topic 310-20, Receivables – Nonrefundable Fees and Other Costs.  Performance of certain loans may be monitored and based on management’s assessment of the cash flows and other facts available, portions of the accretable difference may be delayed or suspended if management deems appropriate.  The Corporation’s policy for determining when to discontinue accruing interest on performing acquired loans and the subsequent accounting for such loans is essentially the same as the policy for originated loans.

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 also has an unallocated allowance for loan losses for loans not considered impaired.  The allowance for loan losses is maintained at a level which management believes is adequate to provide for incurred 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

On May 22, 2012, the Corporation’s shareholders approved the Mackinac Financial Corporation 2012 Incentive Compensation Plan, under which current and prospective employees, non-employee directors and consultants may be awarded incentive stock options, non-statutory stock options, shares of restricted stock awards (“RSAs”), or stock appreciation rights.  The aggregate number of shares of the Corporation’s common stock issuable under the plan is 575,000.  Awards are made to certain other senior officers at the discretion of the Corporation’s management.  Compensation cost equal to the fair value of the award is recognized over the vesting period.

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EARNINGS PER SHARE (Tables)

3 Months Ended

Mar. 31, 2017

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 months ended March 31, 2017 and 2016 (dollars in thousands, except per share data):

	Three Months Ended March 31,
	2017		2016
(Numerator):
Net income	$	1,726	$	1,132
(Denominator):
Weighted average shares outstanding		6,270,034		6,214,083
Effect of dilutive stock options, and vesting of restricted stock awards		10,343		13,902
Diluted weighted average shares outstanding		6,280,377		6,227,985
Income per common share:
Basic	$	.28	$	.18
Diluted	$	.28	$	.18

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INVESTMENT SECURITIES (Tables)

3 Months Ended

Mar. 31, 2017

INVESTMENT SECURITIES

Schedule of carrying value and estimated fair value of securities available for sale

The amortized cost and estimated fair value of investment securities available for sale as of March 31, 2017 and December 31, 2016 are as follows (dollars in thousands):

			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value
March 31, 2017
Corporate	$	19,849	$	118	$	(15)	$	19,952
Equity		500		—		—		500
US Agencies		22,991		77		(15)		23,053
US Agencies - MBS		15,903		64		(111)		15,856
Obligations of states and political subdivisions		24,293		405		(177)		24,521
Total securities available for sale	$	83,536	$	664	$	(318)	$	83,882
December 31, 2016
Corporate	$	19,899	$	49	$	(38)	$	19,910
Equity		500		—		—		500
US Agencies		23,991		47		(86)		23,952
US Agencies - MBS		16,980		48		(195)		16,833
Obligations of states and political subdivisions		25,057		447		(426)		25,078
Total securities available for sale	$	86,427	$	591	$	(745)	$	86,273

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LOANS (Tables)

3 Months Ended

Mar. 31, 2017

Schedule of composition of loans

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

	March 31,		December 31,
	2017		2016
Commercial real estate	$	397,192	$	389,420
Commercial, financial, and agricultural		144,673		142,648
Commercial construction		10,618		11,505
One to four family residential real estate		202,654		205,945
Consumer		19,021		20,113
Consumer construction		12,388		12,226
Total loans	$	786,546	$	781,857

Schedule of the accretable yield by acquisition

The table below presents a rollforward of the accretable yield on acquired loans for the three months ended March 31, 2017 (dollars in thousands):

	PFC						Eagle River						Niagara
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total		Impaired		Non-impaired		Total
Balance, December 31, 2016	$	282	$	642	$	924	$	236	$	1,221	$	1,457	$	52	$	505	$	557
Accretion		(100)		(175)		(275)		—		(179)		(179)		—		(72)		(72)
Reclassification from nonaccretable difference		57		—		57		—		—		—		(8)		—		(8)
Balance, March 31, 2017	$	239	$	467	$	706	$	236	$	1,042	$	1,278	$	44	$	433	$	477

The table below presents a rollforward of the accretable yield on acquired loans for the three months ended March 31, 2016 (dollars in thousands):

	PFC
	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Balance, December 31, 2015	$	426	$	1,342	$	1,768
Accretion		—		(175)		(175)
Reclassification from nonaccretable difference		(17)		—		(17)
Balance, March 31, 2016	$	409	$	1,167	$	1,576

Schedule of the allowance for loan losses

An analysis of the allowance for loan losses for the three months ended March 31, 2017 and the year ended December 31, 2016 is as follows (dollars in thousands):

	March 31,		March 31,
	2017		2016
Balance, January 1	$	5,020	$	5,004
Recoveries on loans previously charged off		102		56
Loans charged off		(126)		(236)
Provision		150		0
Balance at end of period	$	5,146	$	4,824

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 March 31, 2017 is as follows (dollars in thousands):

			Commercial,				One to four
	Commercial		financial and		Commercial		family residential		Consumer
	real estate		agricultural		construction		real estate		construction		Consumer		Unallocated		Total
Allowance for loan loss reserve:
Beginning balance ALLR	$	1,345	$	614	$	57	$	296	$	6	$	90	$	2,612	$	5,020
Charge-offs		—		—		—		(49)		—		(77)		—		(126)
Recoveries		34		1		—		61		—		6		—		102
Provision		(19)		35		38		(43)		1		(4)		142		150
Ending balance ALLR	$	1,360	$	650	$	95	$	265	$	7	$	15	$	2,754	$	5,146
Loans:
Ending balance	$	397,192	$	144,673	$	10,618	$	202,654	$	12,388	$	19,021	$	—	$	786,546
Ending balance ALLR		(1,360)		(650)		(95)		(265)		(7)		(15)		(2,754)		(5,146)
Net loans	$	395,832	$	144,023	$	10,523	$	202,389	$	12,381	$	19,006	$	(2,754)	$	781,400
Ending balance ALLR:
Individually evaluated	$	525	$	394	$	38	$	3	$	—	$	5	$	—	$	965
Collectively evaluated		835		256		57		262		7		10		2,754		4,181
Total	$	1,360	$	650	$	95	$	265	$	7	$	15	$	2,754	$	5,146
Ending balance Loans:
Individually evaluated	$	1,564	$	1,464	$	382	$	403	$	—	$	22	$	—	$	3,835
Collectively evaluated		392,409		143,209		8,228		202,196		12,388		18,996		—		777,426
Acquired with deteriorated credit quality		3,219		—		2,008		55		—		3		—		5,285
Total	$	397,192	$	144,673	$	10,618	$	202,654	$	12,388	$	19,021	$	—	$	786,546

Impaired loans, by definition, are individually evaluated.

A breakdown of the allowance for loan losses and recorded balances in loans at March 31, 2016 is as follows (dollars in thousands):

			Commercial,				One to four
	Commercial		financial and		Commercial		family residential		Consumer
	real estate		agricultural		construction		real estate		construction		Consumer		Unallocated		Total
Allowance for loan loss reserve:
Beginning balance ALLR	$	1,611	$	645	$	79	$	274	$	7	$	64	$	2,324	$	5,004
Charge-offs		—		(185)		—		(39)		—		(12)		—		(236)
Recoveries		7		31		7		1		—		10		—		56
Provision		(3)		89		(12)		21		—		(22)		(73)		—
Ending balance ALLR	$	1,615	$	580	$	74	$	257	$	7	$	40	$	2,251	$	4,824
Loans:
Ending balance	$	317,081	$	124,005	$	14,489	$	135,641	$	11,959	$	15,450	$	—	$	618,625
Ending balance ALLR		(1,615)		(580)		(74)		(257)		(7)		(40)		(2,251)		(4,824)
Net loans	$	315,466	$	123,425	$	14,415	$	135,384	$	11,952	$	15,410	$	(2,251)	$	613,801
Ending balance ALLR:
Individually evaluated	$	533	$	185	$	—	$	45	$	—	$	31	$	—	$	794
Collectively evaluated		1,082		395		74		212		7		9		2,251		4,030
Total	$	1,615	$	580	$	74	$	257	$	7	$	40	$	2,251	$	4,824
Ending balance Loans:
Individually evaluated	$	2,001	$	392	$	—	$	750	$	—	$	36	$	—	$	3,179
Collectively evaluated		310,709		123,436		14,489		132,242		11,957		15,413		—		608,246
Acquired with deteriorated credit quality		4,371		177		—		2,649		2		1		—		7,200
Total	$	317,081	$	124,005	$	14,489	$	135,641	$	11,959	$	15,450	$	—	$	618,625

Schedule of breakdown of loans by risk category

Below is a breakdown of loans by risk category as of March 31, 2017 (dollars in thousands):

							(4)
	(1)		(2)		(3)		Acceptable/		(5)		(6)		(7)		Rating
	Strong		Good		Average		Acceptable Watch		Special Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	3,309	$	24,533	$	149,448	$	204,557	$	10,582	$	4,763	$	—	$	—	$	397,192
Commercial, financial and agricultural		10,616		13,463		48,226		68,018		2,463		1,887		—		—		144,673
Commercial construction		—		875		3,163		1,961		756		382		—		3,481		10,618
One-to-four family residential real estate		825		1,367		3,190		7,128		2,798		4,165		—		183,181		202,654
Consumer construction		28		—		—		—		—		16		—		12,344		12,388
Consumer		15		—		14		39		12		59		—		18,882		19,021
Total loans	$	14,793	$	40,238	$	204,041	$	281,703	$	16,611	$	11,272	$	—	$	217,888	$	786,546

Below is a breakdown of loans by risk category as of December 31, 2016 (dollars in thousands):

							(4)
	(1)		(2)		(3)		Acceptable/		(5)		(6)		(7)		Rating
	Strong		Good		Average		Acceptable Watch		Special Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	3,021	$	23,940	$	140,618	$	216,518	$		$	5,323	$	—	$	—	$	389,420
Commercial, financial and agricultural		10,421		13,434		49,434		67,582				1,777		—		—		142,648
Commercial construction		—		900		3,146		2,660				385		—		4,414		11,505
One-to-four family residential real estate		740		1,373		3,412		9,585				5,493		—		185,342		205,945
Consumer construction		28		—		—		—		—		17		—		12,181		12,226
Consumer		20		—		15		55				103		—		19,920		20,113
Total loans	$	14,230	$	39,647	$	196,625	$	296,400	$	—	$	13,098	$	—	$	221,857	$	781,857

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):

							QTD				Interest Income
	Nonaccrual			Nonaccrual	Accrual		Average		Related		on
	Recorded Balance			Unpaid Balance	Basis		Investment		Valuation Reserve		Accrual Basis
March 31, 2017
With no valuation reserve:
Commercial real estate	$	1,391	$	1,834	$	2,097	$	4,086	$	—	$	121
Commercial, financial and agricultural		9		9		—		9		—		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,253		1,607		1,903		3,981		—		104
Consumer construction		16		21		55		73		—		1
Consumer		15		19		3		52		—		—
With a valuation reserve:
Commercial real estate	$	301	$	310	$	—	$	302	$	50	$	—
Commercial, financial and agricultural		335		335		—		327		261		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		386		387		—		235		27		—
Consumer construction		—		—		—		—		—		—
Consumer		24		24		—		12		11		—
Total:
Commercial real estate	$	1,692	$	2,144	$	2,097	$	4,388	$	50	$	121
Commercial, financial and agricultural		344		344		—		336		261		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,639		1,994		1,903		4,216		27		104
Consumer construction		16		21		55		73		—		1
Consumer		39		43		3		64		11		—
Total	$	3,730	$	4,546	$	4,058	$	9,077	$	349	$	226
December 31, 2016
With no valuation reserve:
Commercial real estate	$	1,426	$	1,891	$	3,234	$	5,318	$	—	$	232
Commercial, financial and agricultural		11		11		—		116		—		3
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,623		2,198		2,792		4,500		—		196
Consumer construction		17		22		57		36		—		4
Consumer		82		86		4		127		—		2
With a valuation reserve:
Commercial real estate	$	306	$	328	$	—	$	103	$	50	$	—
Commercial, financial and agricultural		326		357		—		109		231		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		333		333		—		171		94		—
Consumer construction		—		—		—		—		—		—
Consumer		0		0		—		5		5		—
Total:
Commercial real estate	$	1,732	$	2,219	$	3,234	$	5,421	$	50	$	232
Commercial, financial and agricultural		337		368		—		225		231		3
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,956		2,531		2,792		4,671		94		196
Consumer construction		17		22		57		36		—		4
Consumer		82		86		4		132		5		2
Total	$	4,124	$	5,226	$	6,087	$	10,485	$	380	$	437

Summary of past due loans

A summary of past due loans at March 31, 2017 and December 31, 2016 is as follows (dollars in thousands):

	March 31,						December 31,
	2017						2016
	30-89 days		90+ days				30-89 days		90+ days
	Past Due		Past Due/				Past Due		Past Due/
	(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total
Commercial real estate	$	822	$	1,692	$	2,514	$	942	$	1,732	$	2,674
Commercial, financial and agricultural		150		344		494		186		337		523
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		2,206		1,639		3,845		2,113		1,956		4,069
Consumer construction		52		16		68		—		17		17
Consumer		71		39		110		133		82		215
Total past due loans	$	3,301	$	3,730	$	7,031	$	3,374	$	4,124	$	7,498

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

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):

	Three Months Ended		Three Months Ended
	March 31,		March 31,
	2017		2016
Loans outstanding, January 1	$	9,195	$	6,887
New loans		—		—
Net activity on revolving lines of credit		500		510
Repayment		(313)		(2,034)
Loans outstanding at end of period	$	9,382	$	5,363

PFC

Schedule of acquired portfolio at acquisition date

	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	13,290	$	53,849	$	67,139
Nonaccretable difference		(2,234)		—		(2,234)
Expected cash flows		11,056		53,849		64,905
Accretable yield		(744)		(2,100)		(2,844)
Carrying balance at acquisition date	$	10,312	$	51,749	$	62,061

Eagle River

Schedule of acquired portfolio at acquisition date

The table below details the outstanding balances of the Eagle River acquired portfolio and the fair value adjustments at acquisition date (dollars in thousands):

	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	3,401	$	80,737	$	84,138
Nonaccretable difference		(1,172)		—		(1,172)
Expected cash flows		2,229		80,737		82,966
Accretable yield		(391)		(1,700)		(2,091)
Carrying balance at acquisition date	$	1,838	$	79,037	$	80,875

Niagara Bancorporation

Schedule of acquired portfolio at acquisition date

	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	2,105	$	30,555	$	32,660
Nonaccretable difference		(265)		—		(265)
Expected cash flows		1,840		30,555		32,395
Accretable yield		(88)		(600)		(688)
Carrying balance at acquisition date	$	1,752	$	29,955	$	31,707

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SERVICING RIGHTS (Tables)

3 Months Ended

Mar. 31, 2017

SERVICING RIGHTS

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

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

	Three Months Ended		Three Months Ended
	March 31,		March 31,
	2017		2016
Balance at beginning of period	$	1,573	$	1,965
Additions from loans sold with servicing retained		—		—
Acquired MSRs		—		—
Amortization		(141)		(196)
Balance at end of period	$	1,432	$	1,769
Balance of loan servicing portfolio	$	215,730	$	219,080
Mortgage servicing rights as % of portfolio		.66%		.81%

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BORROWINGS (Tables)

3 Months Ended

Mar. 31, 2017

BORROWINGS

Schedule of borrowings

Borrowings consist of the following at March 31, 2017 and December 31, 2016 (dollars in thousands):

	March 31,		December 31,
	2017		2016
Federal Home Loan Bank fixed rate advances	$	45,000	$	45,000
Correspondent bank line of credit		—		750
Correspondent bank term note		20,649		21,199
USDA Rural Development note		630		630
	$	66,279	$	67,579

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DEFINED BENEFIT PENSION PLAN (Tables)

3 Months Ended

Mar. 31, 2017

DEFINED BENEFIT PENSION PLAN

Schedule of anticipated distributions over the next five years

The anticipated distributions over the next five years and through December 31, 2026 are detailed in the table below (dollars in thousands):

2017	$	128
2018		125
2019		122
2020		121
2021		120
2022-2026		723
Total	$	1,339

Schedule of assumptions in the actuarial valuation

	2017	2016
Weighted average discount rate	3.78%	3.99%
Rate of increase in future compensation levels	N/A	N/A
Expected long-term rate of return on plan assets	8.00%	8.00%

Schedule of asset allocation

	Target	Actual
	Allocation	Allocation
Equity securities	50% to 70%	60%
Fixed income securities	30% to 50%	40%

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STOCK COMPENSATION PLANS (Tables)

3 Months Ended

Mar. 31, 2017

STOCK COMPENSATION PLANS

Summary of restricted stock units awards granted

Date of Award	Units Granted	Market Value at grant date	Vesting Term
March, 2014	52,774	12.95	4 years
March, 2015	37,730	11.15	4 years
May, 2015	3,000	10.77	Immediate
February, 2016	35,733	9.91	4 years
February, 2017	28,427	13.39	4 years

Summary of changes in nonvested shares

		Weighted Average
	Number	Grant Date
	Outstanding	Fair Value
Nonvested balance at January 1, 2017	90,417	$	11.19
Granted during the quarter	28,427		13.39
Vested during the quarter	(31,559)		11.55
Nonvested balance at March 31, 2017	87,285	$	11.78

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FAIR VALUE MEASUREMENTS (Tables)

3 Months Ended

Mar. 31, 2017

FAIR VALUE MEASUREMENTS

Schedule presenting information for financial instruments

The following table presents information for financial instruments at March 31, 2017 and December 31, 2016 (dollars in thousands):

		March 31, 2017				December 31, 2016
	Level in Fair	Carrying		Estimated		Carrying		Estimated
	Value Hierarchy	Amount		Fair Value		Amount		Fair Value
Financial assets:
Cash and cash equivalents	Level 1	$	41,169	$	41,169	$	46,755	$	46,755
Interest-bearing deposits	Level 2		13,448		13,448		14,047		14,047
Securities available for sale	Level 2		82,232		82,232		84,623		84,623
Securities available for sale	Level 3		1,650		1,650		1,650		1,650
Federal Home Loan Bank stock	Level 2		2,719		2,719		2,911		2,911
Net loans	Level 3		781,400		780,377		776,837		778,377
Accrued interest receivable	Level 3		2,026		2,026		2,016		2,016
Total financial assets		$	924,644	$	923,621	$	928,839	$	930,379
Financial liabilities:
Deposits	Level 2	$	821,820	$	814,259	$	823,512	$	815,960
Borrowings	Level 2		66,279		66,853		67,579		68,293
Accrued interest payable	Level 3		287		287		267		267
Total financial liabilities		$	888,386	$	881,399	$	891,358	$	884,520

Schedule of investment securities measured at fair value on a recurring basis

The table below shows investment securities measured at fair value on a recurring basis (dollars in thousands):

			Quoted Prices		Significant		Significant		Total (Gains)
			in Active Markets		Other Observable		Unobservable		Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended
(dollars in thousands)	March 31,  2017		(Level 1)		(Level 2)		(Level 3)		March 31, 2017
Assets
Corporate	$	19,952	$	—	$	19,952	$	—	$	—
Equity		500		—		—		500		—
US Agencies		23,053		—		23,053		—		—
US Agencies - MBS		15,856		—		14,706		1,150		—
Obligations of state and political subdivisions		24,521		—		24,521		—		—
	$	83,882							$	—

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Twelve months ended
(dollars in thousands)	December 31, 2016		(Level 1)		(Level 2)		(Level 3)		December 31, 2016
Assets
Corporate	$	19,910	$	—	$	19,910	$	—	$	—
Equity		500		—		—		500		—
US Agencies		23,952		—		23,952		—		—
US Agencies - MBS		16,833		—		15,683		1,150		—
Obligations of state and political subdivisions		25,078		—		25,078		—		—
	$	86,273							$	—

Schedule of assets measured at fair value on a non-recurring basis

Assets Measured at Fair Value on a Nonrecurring Basis at March 31, 2017

			Quoted Prices		Significant		Significant		Total (Gains)
			in Active Markets		Other Observable		Unobservable		Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended
(dollars in thousands)	March 31, 2017		(Level 1)		(Level 2)		(Level 3)		March 31, 2017
Assets
Impaired loans	$	7,788	$	—	$	—	$	7,788	$	37
Other real estate owned		4,466		—		—		4,466		12
									$	49

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2016

			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Twelve months ended
(dollars in thousands)	December 31, 2016		(Level 1)		(Level 2)		(Level 3)		December 31, 2016
Assets
Impaired loans	$	9,856	$	—	$	—	$	9,856	$	643
Other real estate held for sale		4,782		—		—		4,782		202
									$	845

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COMMITMENTS, CONTINGENCIES, AND CREDIT RISK (Tables)

3 Months Ended

Mar. 31, 2017

COMMITMENTS, CONTINGENCIES, AND CREDIT RISK

Schedule of commitments

These commitments are as follows (dollars in thousands):

	March 31,		December 31,
	2017		2016
Commitments to extend credit:
Variable rate	$	60,204	$	59,496
Fixed rate		27,407		28,737
Standby letters of credit - Variable rate		7,926		8,252
Credit card commitments - Fixed rate		5,677		5,533
	$	101,214	$	102,018

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SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Details)	May 22, 2012 shares
2012 Incentive Compensation Plan
Stock Compensation Plans
Total authorized share balance	575,000

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EARNINGS PER SHARE (Details) - USD ($) $ / shares in Units, $ in Thousands	3 Months Ended
	Mar. 31, 2017	Mar. 31, 2016
(Numerator):
Net income	$ 1,726	$ 1,132
(Denominator):
Weighted average shares outstanding	6,270,034	6,214,083
Effect of dilutive stock options, and vesting of restricted stock awards	10,343	13,902
Diluted weighted average shares outstanding	6,280,377	6,227,985
Income per common share:
Basic (in dollars per share)	$ 0.28	$ 0.18
Diluted (in dollars per share)	$ 0.28	$ 0.18

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INVESTMENT SECURITIES (Details) - USD ($) $ in Thousands	Mar. 31, 2017	Dec. 31, 2016
SECURITIES AVAILABLE FOR SALE
Amortized Cost	$ 83,536	$ 86,427
Gross Unrealized Gains	664	591
Gross Unrealized Losses	(318)	(745)
Estimated Fair Value	83,882	86,273
Corporate
SECURITIES AVAILABLE FOR SALE
Amortized Cost	19,849	19,899
Gross Unrealized Gains	118	49
Gross Unrealized Losses	(15)	(38)
Estimated Fair Value	19,952	19,910
Equity
SECURITIES AVAILABLE FOR SALE
Amortized Cost	500	500
Estimated Fair Value	500	500
US Agencies
SECURITIES AVAILABLE FOR SALE
Amortized Cost	22,991	23,991
Gross Unrealized Gains	77	47
Gross Unrealized Losses	(15)	(86)
Estimated Fair Value	23,053	23,952
US Agencies - MBS
SECURITIES AVAILABLE FOR SALE
Amortized Cost	15,903	16,980
Gross Unrealized Gains	64	48
Gross Unrealized Losses	(111)	(195)
Estimated Fair Value	15,856	16,833
Obligations of states and political subdivisions
SECURITIES AVAILABLE FOR SALE
Amortized Cost	24,293	25,057
Gross Unrealized Gains	405	447
Gross Unrealized Losses	(177)	(426)
Estimated Fair Value	24,521	$ 25,078
FHLB borrowings and customer relationships
SECURITIES AVAILABLE FOR SALE
Amortized Cost	19,902
Estimated Fair Value	$ 19,869

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LOANS (Details) - USD ($)	3 Months Ended
	Mar. 31, 2017	Mar. 31, 2016	Dec. 31, 2016
Loans
Total loans	$ 786,546,000	$ 618,625,000	$ 781,857,000
Changes in the allowance for loan losses
Net charge off activity		180,000
PFC
Acquired portfolio
Loans acquired - contractual payments	67,139,000
Nonaccretable difference	(2,234,000)
Expected cash flows	64,905,000
Accretable yield	(2,844,000)
Carrying balance at acquisition date	62,061,000
Balance at the beginning of period	924,000	1,768,000
Accretion	(275,000)	(175,000)
Reclassification from nonaccretable difference	57,000	(17,000)
Balance at the end of period	706,000	1,576,000
Eagle River
Acquired portfolio
Loans acquired - contractual payments	84,138,000
Nonaccretable difference	(1,172,000)
Expected cash flows	82,966,000
Accretable yield	(2,091,000)
Carrying balance at acquisition date	80,875,000
Balance at the beginning of period	1,457,000
Accretion	(179,000)
Balance at the end of period	1,278,000
Niagara Bancorporation
Acquired portfolio
Loans acquired - contractual payments	32,660,000
Nonaccretable difference	(265,000)
Expected cash flows	32,395,000
Accretable yield	(688,000)
Carrying balance at acquisition date	31,707,000
Balance at the beginning of period	557,000
Accretion	(72,000)
Reclassification from nonaccretable difference	(8,000)
Balance at the end of period	477,000
Commercial real estate
Loans
Total loans	397,192,000	317,081,000	389,420,000
Commercial, financial, and agricultural
Loans
Total loans	144,673,000	124,005,000	142,648,000
Commercial construction
Loans
Total loans	10,618,000	14,489,000	11,505,000
One to four family residential real estate
Loans
Total loans	202,654,000	135,641,000	205,945,000
Consumer
Loans
Total loans	19,021,000	15,450,000	20,113,000
Consumer construction
Loans
Total loans	12,388,000	11,959,000	$ 12,226,000
Acquired impaired
Acquired portfolio
Accretion	(100,000)	(96,000)
Acquired impaired | PFC
Acquired portfolio
Loans acquired - contractual payments	13,290,000
Nonaccretable difference	(2,234,000)
Expected cash flows	11,056,000
Accretable yield	(744,000)
Carrying balance at acquisition date	10,312,000
Balance at the beginning of period	282,000	426,000
Accretion	(100,000)
Reclassification from nonaccretable difference	57,000	(17,000)
Balance at the end of period	239,000	409,000
Acquired impaired | Eagle River
Acquired portfolio
Loans acquired - contractual payments	3,401,000
Nonaccretable difference	(1,172,000)
Expected cash flows	2,229,000
Accretable yield	(391,000)
Carrying balance at acquisition date	1,838,000
Balance at the beginning of period	236,000
Balance at the end of period	236,000
Acquired impaired | Niagara Bancorporation
Acquired portfolio
Loans acquired - contractual payments	2,105,000
Nonaccretable difference	(265,000)
Expected cash flows	1,840,000
Accretable yield	(88,000)
Carrying balance at acquisition date	1,752,000
Balance at the beginning of period	52,000
Reclassification from nonaccretable difference	(8,000)
Balance at the end of period	44,000
Acquired Non-impaired | PFC
Acquired portfolio
Loans acquired - contractual payments	53,849,000
Expected cash flows	53,849,000
Accretable yield	(2,100,000)
Carrying balance at acquisition date	51,749,000
Balance at the beginning of period	642,000	1,342,000
Accretion	(175,000)	(175,000)
Balance at the end of period	467,000	$ 1,167,000
Acquired Non-impaired | Eagle River
Acquired portfolio
Loans acquired - contractual payments	80,737,000
Expected cash flows	80,737,000
Accretable yield	(1,700,000)
Carrying balance at acquisition date	79,037,000
Balance at the beginning of period	1,221,000
Accretion	(179,000)
Balance at the end of period	1,042,000
Acquired Non-impaired | Niagara Bancorporation
Acquired portfolio
Loans acquired - contractual payments	30,555,000
Expected cash flows	30,555,000
Accretable yield	(600,000)
Carrying balance at acquisition date	29,955,000
Balance at the beginning of period	505,000
Accretion	(72,000)
Balance at the end of period	$ 433,000

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LOANS - ALLOWANCE (Details) - USD ($) $ in Thousands	3 Months Ended
	Mar. 31, 2017	Mar. 31, 2016	Mar. 31, 2017	Dec. 31, 2016	Mar. 31, 2016
Allowance for loan loss reserve:
Balance at beginning of period	$ 5,020	$ 5,004
Charge-offs	(126)	(236)
Recoveries	102	56
Provision	150	0
Balance at end of period	5,146	4,824
Loans:
Ending balance			$ 786,546	$ 781,857	$ 618,625
Ending balance ALLR	(5,020)	(5,004)	(5,146)	(5,020)	(4,824)
Net loans			781,400	776,837	613,801
Ending balance ALLR:
Individually evaluated			965		794
Collectively evaluated			4,181		4,030
Total	5,020	5,004	5,146	5,020	4,824
Ending balance Loans:
Individually evaluated			3,835		3,179
Collectively evaluated			777,426		608,246
Acquired with deteriorated credit quality			5,285		7,200
Total Loans			786,546	781,857	618,625
Commercial real estate
Allowance for loan loss reserve:
Balance at beginning of period	1,345	1,611
Recoveries	34	7
Provision	(19)	(3)
Balance at end of period	1,360	1,615
Loans:
Ending balance			397,192	389,420	317,081
Ending balance ALLR	(1,345)	(1,611)	(1,360)	(1,345)	(1,615)
Net loans			395,832		315,466
Ending balance ALLR:
Individually evaluated			525		533
Collectively evaluated			835		1,082
Total	1,345	1,611	1,360	1,345	1,615
Ending balance Loans:
Individually evaluated			1,564		2,001
Collectively evaluated			392,409		310,709
Acquired with deteriorated credit quality			3,219		4,371
Total Loans			397,192	389,420	317,081
Commercial, financial, and agricultural
Allowance for loan loss reserve:
Balance at beginning of period	614	645
Charge-offs		(185)
Recoveries	1	31
Provision	35	89
Balance at end of period	650	580
Loans:
Ending balance			144,673	142,648	124,005
Ending balance ALLR	(614)	(645)	(650)	(614)	(580)
Net loans			144,023		123,425
Ending balance ALLR:
Individually evaluated			394		185
Collectively evaluated			256		395
Total	614	645	650	614	580
Ending balance Loans:
Individually evaluated			1,464		392
Collectively evaluated			143,209		123,436
Acquired with deteriorated credit quality					177
Total Loans			144,673	142,648	124,005
Commercial construction
Allowance for loan loss reserve:
Balance at beginning of period	57	79
Recoveries		7
Provision	38	(12)
Balance at end of period	95	74
Loans:
Ending balance			10,618	11,505	14,489
Ending balance ALLR	(57)	(79)	(95)	(57)	(74)
Net loans			10,523		14,415
Ending balance ALLR:
Individually evaluated			38
Collectively evaluated			57		74
Total	57	79	95	57	74
Ending balance Loans:
Individually evaluated			382
Collectively evaluated			8,228		14,489
Acquired with deteriorated credit quality			2,008
Total Loans			10,618	11,505	14,489
One to four family residential real estate
Allowance for loan loss reserve:
Balance at beginning of period	296	274
Charge-offs	(49)	(39)
Recoveries	61	1
Provision	(43)	21
Balance at end of period	265	257
Loans:
Ending balance			202,654	205,945	135,641
Ending balance ALLR	(296)	(274)	(265)	(296)	(257)
Net loans			202,389		135,384
Ending balance ALLR:
Individually evaluated			3		45
Collectively evaluated			262		212
Total	296	274	265	296	257
Ending balance Loans:
Individually evaluated			403		750
Collectively evaluated			202,196		132,242
Acquired with deteriorated credit quality			55		2,649
Total Loans			202,654	205,945	135,641
Consumer construction
Allowance for loan loss reserve:
Balance at beginning of period	6	7
Provision	1
Balance at end of period	7	7
Loans:
Ending balance			12,388	12,226	11,959
Ending balance ALLR	(6)	(7)	(7)	(6)	(7)
Net loans			12,381		11,952
Ending balance ALLR:
Collectively evaluated			7		7
Total	6	7	7	6	7
Ending balance Loans:
Collectively evaluated			12,388		11,957
Acquired with deteriorated credit quality					2
Total Loans			12,388	12,226	11,959
Consumer
Allowance for loan loss reserve:
Balance at beginning of period	90	64
Charge-offs	(77)	(12)
Recoveries	6	10
Provision	(4)	(22)
Balance at end of period	15	40
Loans:
Ending balance			19,021	20,113	15,450
Ending balance ALLR	(90)	(64)	(15)	(90)	(40)
Net loans			19,006		15,410
Ending balance ALLR:
Individually evaluated			5		31
Collectively evaluated			10		9
Total	90	64	15	90	40
Ending balance Loans:
Individually evaluated			22		36
Collectively evaluated			18,996		15,413
Acquired with deteriorated credit quality			3		1
Total Loans			19,021	20,113	15,450
Unallocated
Allowance for loan loss reserve:
Balance at beginning of period	2,612	2,324
Provision	142	(73)
Balance at end of period	2,754	2,251
Loans:
Ending balance ALLR	(2,612)	(2,324)	(2,754)	(2,612)	(2,251)
Net loans			(2,754)		(2,251)
Ending balance ALLR:
Collectively evaluated			2,754		2,251
Total	$ 2,612	$ 2,324	$ 2,754	$ 2,612	$ 2,251

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LOANS - LOANS BY RISK CATEGORY (Details) $ in Thousands	Mar. 31, 2017 USD ($) item	Dec. 31, 2016 USD ($)	Mar. 31, 2016 USD ($)
Breakdown of loans by risk category
Total loans	$ 786,546	$ 781,857	$ 618,625
Minimum
Breakdown of loans by risk category
Credit risk rating for which reserves are established if no specific reserves made | item	6
Maximum
Breakdown of loans by risk category
Credit risk rating for which general reserves are established | item	5
Credit risk rating for which reserves are established if no specific reserves made | item	7
Commercial real estate
Breakdown of loans by risk category
Total loans	$ 397,192	389,420	317,081
Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	144,673	142,648	124,005
Commercial construction
Breakdown of loans by risk category
Total loans	10,618	11,505	14,489
One to four family residential real estate
Breakdown of loans by risk category
Total loans	202,654	205,945	135,641
Consumer construction
Breakdown of loans by risk category
Total loans	12,388	12,226	11,959
Consumer
Breakdown of loans by risk category
Total loans	19,021	20,113	$ 15,450
Strong (1)
Breakdown of loans by risk category
Total loans	14,793	14,230
Strong (1) | Commercial real estate
Breakdown of loans by risk category
Total loans	3,309	3,021
Strong (1) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	10,616	10,421
Strong (1) | One to four family residential real estate
Breakdown of loans by risk category
Total loans	825	740
Strong (1) | Consumer construction
Breakdown of loans by risk category
Total loans	28	28
Strong (1) | Consumer
Breakdown of loans by risk category
Total loans	15	20
Good (2)
Breakdown of loans by risk category
Total loans	40,238	39,647
Good (2) | Commercial real estate
Breakdown of loans by risk category
Total loans	24,533	23,940
Good (2) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	13,463	13,434
Good (2) | Commercial construction
Breakdown of loans by risk category
Total loans	875	900
Good (2) | One to four family residential real estate
Breakdown of loans by risk category
Total loans	1,367	1,373
Average (3)
Breakdown of loans by risk category
Total loans	204,041	196,625
Average (3) | Commercial real estate
Breakdown of loans by risk category
Total loans	149,448	140,618
Average (3) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	48,226	49,434
Average (3) | Commercial construction
Breakdown of loans by risk category
Total loans	3,163	3,146
Average (3) | One to four family residential real estate
Breakdown of loans by risk category
Total loans	3,190	3,412
Average (3) | Consumer
Breakdown of loans by risk category
Total loans	14	15
Acceptable/Acceptable Watch (4)
Breakdown of loans by risk category
Total loans	281,703	296,400
Acceptable/Acceptable Watch (4) | Commercial real estate
Breakdown of loans by risk category
Total loans	204,557	216,518
Acceptable/Acceptable Watch (4) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	68,018	67,582
Acceptable/Acceptable Watch (4) | Commercial construction
Breakdown of loans by risk category
Total loans	1,961	2,660
Acceptable/Acceptable Watch (4) | One to four family residential real estate
Breakdown of loans by risk category
Total loans	7,128	9,585
Acceptable/Acceptable Watch (4) | Consumer
Breakdown of loans by risk category
Total loans	39	55
Special Mention (5)
Breakdown of loans by risk category
Total loans	16,611
Special Mention (5) | Commercial real estate
Breakdown of loans by risk category
Total loans	10,582
Special Mention (5) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	2,463
Special Mention (5) | Commercial construction
Breakdown of loans by risk category
Total loans	756
Special Mention (5) | One to four family residential real estate
Breakdown of loans by risk category
Total loans	2,798
Special Mention (5) | Consumer
Breakdown of loans by risk category
Total loans	12
Substandard (6)
Breakdown of loans by risk category
Total loans	11,272	13,098
Substandard (6) | Commercial real estate
Breakdown of loans by risk category
Total loans	4,763	5,323
Substandard (6) | Commercial, financial, and agricultural
Breakdown of loans by risk category
Total loans	1,887	1,777
Substandard (6) | Commercial construction
Breakdown of loans by risk category
Total loans	382	385
Substandard (6) | One to four family residential real estate
Breakdown of loans by risk category
Total loans	4,165	5,493
Substandard (6) | Consumer construction
Breakdown of loans by risk category
Total loans	16	17
Substandard (6) | Consumer
Breakdown of loans by risk category
Total loans	59	103
Rating Unassigned
Breakdown of loans by risk category
Total loans	217,888	221,857
Rating Unassigned | Commercial construction
Breakdown of loans by risk category
Total loans	3,481	4,414
Rating Unassigned | One to four family residential real estate
Breakdown of loans by risk category
Total loans	183,181	185,342
Rating Unassigned | Consumer construction
Breakdown of loans by risk category
Total loans	12,344	12,181
Rating Unassigned | Consumer
Breakdown of loans by risk category
Total loans	$ 18,882	$ 19,920

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LOANS - IMPAIRED LOANS AND EFFECT ON INTEREST INCOME (Details) - USD ($) $ in Thousands	3 Months Ended	12 Months Ended
	Mar. 31, 2017	Dec. 31, 2016
Impaired Loans
Number of days past due to be considered as nonperforming loans	90 days
Recorded investment
Total	$ 349
Average investment
Total	9,077	$ 10,485
Related Valuation Reserve		380
Interest Income on Accrual Basis
Total	226	437
Accrual Basis
Recorded investment
Total	4,058	6,087
Non Accrual Recorded Balance
Recorded investment
Total	3,730	4,124
Non Accrual Unpaid Balance
Recorded investment
Total	4,546	5,226
Commercial real estate
Recorded investment
With a valuation reserve	50
Total	50
Average investment
With no valuation reserve	4,086	5,318
With a valuation reserve	302	103
Total	4,388	5,421
Related Valuation Reserve		50
Interest Income on Accrual Basis
With no valuation reserve	121	232
Total	121	232
Commercial real estate | Accrual Basis
Recorded investment
With no valuation reserve	2,097	3,234
Total	2,097	3,234
Commercial real estate | Non Accrual Recorded Balance
Recorded investment
With no valuation reserve	1,391	1,426
With a valuation reserve	301	306
Total	1,692	1,732
Commercial real estate | Non Accrual Unpaid Balance
Recorded investment
With no valuation reserve	1,834	1,891
With a valuation reserve	310	328
Total	2,144	2,219
Commercial, financial, and agricultural
Recorded investment
With a valuation reserve	261
Total	261
Average investment
With no valuation reserve	9	116
With a valuation reserve	327	109
Total	336	225
Related Valuation Reserve		231
Interest Income on Accrual Basis
With no valuation reserve		3
Total		3
Commercial, financial, and agricultural | Non Accrual Recorded Balance
Recorded investment
With no valuation reserve	9	11
With a valuation reserve	335	326
Total	344	337
Commercial, financial, and agricultural | Non Accrual Unpaid Balance
Recorded investment
With no valuation reserve	9	11
With a valuation reserve	335	357
Total	344	368
One to four family residential real estate
Recorded investment
With a valuation reserve	27
Total	27
Average investment
With no valuation reserve	3,981	4,500
With a valuation reserve	235	171
Total	4,216	4,671
Related Valuation Reserve		94
Interest Income on Accrual Basis
With no valuation reserve	104	196
Total	104	196
One to four family residential real estate | Accrual Basis
Recorded investment
With no valuation reserve	1,903	2,792
Total	1,903	2,792
One to four family residential real estate | Non Accrual Recorded Balance
Recorded investment
With no valuation reserve	1,253	1,623
With a valuation reserve	386	333
Total	1,639	1,956
One to four family residential real estate | Non Accrual Unpaid Balance
Recorded investment
With no valuation reserve	1,607	2,198
With a valuation reserve	387	333
Total	1,994	2,531
Consumer construction
Average investment
With no valuation reserve	73	36
Total	73	36
Interest Income on Accrual Basis
With no valuation reserve	1	4
Total	1	4
Consumer construction | Accrual Basis
Recorded investment
With no valuation reserve	55	57
Total	55	57
Consumer construction | Non Accrual Recorded Balance
Recorded investment
With no valuation reserve	16	17
Total	16	17
Consumer construction | Non Accrual Unpaid Balance
Recorded investment
With no valuation reserve	21	22
Total	21	22
Consumer
Recorded investment
With a valuation reserve	11
Total	11
Average investment
With no valuation reserve	52	127
With a valuation reserve	12	5
Total	64	132
Related Valuation Reserve		5
Interest Income on Accrual Basis
With no valuation reserve		2
Total		2
Consumer | Accrual Basis
Recorded investment
With no valuation reserve	3	4
Total	3	4
Consumer | Non Accrual Recorded Balance
Recorded investment
With no valuation reserve	15	82
With a valuation reserve	24	0
Total	39	82
Consumer | Non Accrual Unpaid Balance
Recorded investment
With no valuation reserve	19	86
With a valuation reserve	24	0
Total	$ 43	$ 86

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LOANS - PAST DUE (Details) - USD ($) $ in Thousands	Mar. 31, 2017	Dec. 31, 2016
Past due loans
30-89 days Past Due (accruing)	$ 3,301	$ 3,374
90+ days Past Due/Nonaccrual	3,730	4,124
Total	7,031	7,498
Commercial real estate
Past due loans
30-89 days Past Due (accruing)	822	942
90+ days Past Due/Nonaccrual	1,692	1,732
Total	2,514	2,674
Commercial, financial, and agricultural
Past due loans
30-89 days Past Due (accruing)	150	186
90+ days Past Due/Nonaccrual	344	337
Total	494	523
One to four family residential real estate
Past due loans
30-89 days Past Due (accruing)	2,206	2,113
90+ days Past Due/Nonaccrual	1,639	1,956
Total	3,845	4,069
Consumer construction
Past due loans
30-89 days Past Due (accruing)	52
90+ days Past Due/Nonaccrual	16	17
Total	68	17
Consumer
Past due loans
30-89 days Past Due (accruing)	71	133
90+ days Past Due/Nonaccrual	39	82
Total	$ 110	$ 215

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LOANS - INSIDER LOANS (Details) - USD ($)	3 Months Ended
	Mar. 31, 2017	Mar. 31, 2016	Mar. 31, 2017
Activity in insider loans granted to the entity's executive officers and directors, including their families and firms
Loans outstanding, beginning of period	$ 9,195,000	$ 6,887,000
Net activity on revolving lines of credit	500,000	510,000
Repayment	(313,000)	(2,034,000)
Loans outstanding, end of period	9,382,000	5,363,000
Loans outstanding	9,195,000	6,887,000	$ 9,382,000
Bank
Activity in insider loans granted to the entity's executive officers and directors, including their families and firms
Unfunded commitments			91,000
Bank | Substandard (6)
Activity in insider loans granted to the entity's executive officers and directors, including their families and firms
Loans outstanding, end of period	0	0
Loans outstanding	$ 0	$ 0	$ 0

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GOODWILL AND OTHER INTANGIBLE ASSETS (Details) - USD ($)	3 Months Ended
	Mar. 31, 2017	Dec. 31, 2016	Aug. 31, 2016	Apr. 30, 2016	Dec. 31, 2014
Goodwill	$ 5,694,000	$ 5,694,000
Deposit based intangible assets	2,110,000	2,172,000
Amortization of Intangible Assets	62,000
Amortization expense year one	250,000
Amortization expense year two	250,000
Amortization expense year three	250,000
Amortization expense year four	250,000
Amortization expense year five	$ 250,000
PFC
Goodwill					$ 3,805,000
Deposit based intangible assets					$ 1,206,000
Eagle River
Goodwill		1,839,000		$ 1,839,000
Deposit based intangible assets		993,000
Niagara Bancorporation
Goodwill		50,000	$ 50,000
Deposit based intangible assets		$ 300,000

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SERVICING RIGHTS (Details) - USD ($) $ in Thousands	3 Months Ended
	Mar. 31, 2017	Mar. 31, 2016
Commercial loans
Commercial Loans
Commercial Loans	$ 55,000	$ 49,500
Servicing rights	$ 132	162
Mortgage loans
Mortgage Loans
Annual constant prepayment speed (as a percent)	10.74%
Discount rate (as a percent)	9.59%
Changes in mortgage servicing rights capitalized and amortized, along with the aggregate activity in related valuation allowances
Balance at beginning of period	$ 1,573	1,965
Amortization	(141)	(196)
Balance at end of period	1,432	1,769
Balance of loan servicing portfolio	$ 215,730	$ 219,080
Mortgage servicing rights as % of portfolio	0.66%	0.81%

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BORROWINGS (Details) $ in Thousands	3 Months Ended
	Mar. 31, 2017 USD ($) item	Dec. 31, 2016 USD ($)
BORROWINGS
Borrowings	$ 66,279	$ 67,579
Federal Home Loan Bank Borrowing Weighted Average Interest Rate	2.10%
Federal Home Loan Bank borrowings
BORROWINGS
Borrowings	$ 45,000	45,000
Federal Home Loan Bank borrowings | Mortgage related and municipal securities
BORROWINGS
Securities pledged as collateral, amortized cost	12,000
Securities pledged as collateral, fair value	11,991
Federal Home Loan Bank borrowings | FHLB stock
BORROWINGS
Stock owned and pledged as collateral	2,719
Federal Home Loan Bank borrowings | One to four family residential real estate
BORROWINGS
Loans pledged as collateral	$ 42,506
Correspondent bank line of credit
BORROWINGS
Borrowings		750
Number of banking borrowing relationships | item	1
Variable rate (as a percent)	2.75%
Correspondent bank term note
BORROWINGS
Borrowings	$ 20,649	21,199
Quarterly principal payment	550
USDA Rural Development note
BORROWINGS
Borrowings	$ 630	$ 630
Interest rate on note (as a percent)	1.00%
USDA Rural Development note | First Rural Relending
BORROWINGS
Loans pledged as collateral	$ 108
Demand deposit account pledged as collateral	593
Revolving Credit Facility
BORROWINGS
Line of Credit	$ 5,000

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DEFINED BENEFIT PENSION PLAN (Details)	3 Months Ended
	Mar. 31, 2017 USD ($) item	Mar. 31, 2016 USD ($)
Defined Benefit Pension Plan
Expected contributions to the plan	$ 19,000
Number of years over which anticipated pension distributions disclosed | item	5
Anticipated distributions from the plan
2017	$ 128
2018	125
2019	122
2020	121
2021	120
2022-2026	723
Total	1,339
Peninsula Financial Corporation noncontributory defined benefit pension plan
Change in plan assets
Fair value of plan assets	2,049,000	$ 2,033,000
Accrued pension expense, included with other assets or liabilities	1,138,000	1,147,000
Accumulated benefit obligation	$ 3,187,000	$ 3,180,000
Assumptions in the actuarial valuation
Weighted average discount rate	3.78%	3.99%
Expected long-term rate of return on plan assets	8.00%	8.00%
Peninsula Financial Corporation noncontributory defined benefit pension plan | Equity securities
Plan assets
Target Allocation, minimum	50.00%
Target Allocation, maximum	70.00%
Peninsula Financial Corporation noncontributory defined benefit pension plan | Equity securities | Plan
Plan assets
Actual Allocation	60.00%
Peninsula Financial Corporation noncontributory defined benefit pension plan | Fixed income securities
Plan assets
Target Allocation, minimum	30.00%
Target Allocation, maximum	50.00%
Peninsula Financial Corporation noncontributory defined benefit pension plan | Fixed income securities | Plan
Plan assets
Actual Allocation	40.00%

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STOCK COMPENSATION PLANS (Details) - $ / shares					1 Months Ended						3 Months Ended
	Aug. 31, 2016	Aug. 31, 2015	Aug. 31, 2014	Aug. 31, 2013	Feb. 28, 2017	Mar. 31, 2016	Feb. 29, 2016	May 31, 2015	Mar. 31, 2015	Mar. 31, 2014	Mar. 31, 2017
Summary of nonvested shares
Nonvested beginning balance (in shares)											90,417
Granted during the period (in shares)											28,427
Vested during the period (in shares)											(31,559)
Nonvested ending balance (in shares)											87,285
Weighted Average Grant Date Fair Value
Nonvested beginning balance (in dollars per share)											$ 11.19
Granted during the period (in dollars per share)											13.39
Vested during the period (in dollars per share)											11.55
Nonvested ending balance (in dollars per share)											$ 11.78
RSUs
Stock Compensation Plans
Market value at grant date (in dollars per share)					$ 13.39		$ 9.91	$ 10.77	$ 11.15	$ 12.95
Stock issued for vested restricted stocks	37,125	37,125	37,125	37,125		22,626		3,000	13,194		31,559
Vesting period					4 years		4 years		4 years	4 years	4 years
Summary of nonvested shares
Granted during the period (in shares)					28,427		35,733	3,000	37,730	52,774

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INCOME TAXES (Details) - USD ($) $ in Thousands	3 Months Ended
	Mar. 31, 2017	Mar. 31, 2016	Dec. 31, 2016
INCOME TAXES
Deferred tax assets, net of valuation allowance	$ 7,651		$ 8,760
Net operating loss (NOL) carryforwards	9,100
Tax credit carryforwards	$ 2,200
Expiration period from date of origination for net operating loss carryforwards	20 years
Annual limitation for usage of NOL	$ 1,404
Annual limitation for usage of tax credits	476
Deferred tax expense (benefit)	$ 889	$ 585

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FAIR VALUE MEASUREMENTS (Details) - USD ($) $ in Thousands	3 Months Ended
	Mar. 31, 2017	Dec. 31, 2016
Fair Value Measurements
Blended interest rate for determining fair value of nonaccrual loans (as a percent)	0.00%
Fair value of commitments	$ 0
Financial assets:
Interest-bearing deposits	13,448	$ 14,047
Securities available for sale	83,882	86,273
Carrying Amount
Financial assets:
Total financial assets	924,644	928,839
Financial liabilities:
Total financial liabilities	888,386	891,358
Estimated Fair Value
Financial assets:
Total financial assets	923,621	930,379
Financial liabilities:
Total financial liabilities	881,399	884,520
Level 1 | Carrying Amount
Financial assets:
Cash and cash equivalents	41,169	46,755
Level 1 | Estimated Fair Value
Financial assets:
Cash and cash equivalents	41,169	46,755
Level 2 | Carrying Amount
Financial assets:
Interest-bearing deposits	13,448	14,047
Securities available for sale	82,232	84,623
Federal Home Loan Bank stock	2,719	2,911
Financial liabilities:
Deposits	821,820	823,512
Borrowings	66,279	67,579
Level 2 | Estimated Fair Value
Financial assets:
Interest-bearing deposits	13,448	14,047
Securities available for sale	82,232	84,623
Federal Home Loan Bank stock	2,719	2,911
Financial liabilities:
Deposits	814,259	815,960
Borrowings	66,853	68,293
Significant Unobservable Inputs (Level 3) | Carrying Amount
Financial assets:
Securities available for sale	1,650	1,650
Net loans	781,400	776,837
Accrued interest receivable	2,026	2,016
Financial liabilities:
Accrued interest payable	287	267
Significant Unobservable Inputs (Level 3) | Estimated Fair Value
Financial assets:
Securities available for sale	1,650	1,650
Net loans	780,377	778,377
Accrued interest receivable	2,026	2,016
Financial liabilities:
Accrued interest payable	$ 287	$ 267

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FAIR VALUE MEASUREMENTS - OTHER ASSETS AND OTHER LIABILITIES (Details) - Recurring - USD ($) $ in Thousands	Mar. 31, 2017	Dec. 31, 2016
Fair value measurements
Other assets	$ 0	$ 0
Other liabilities	0	0
Significant Unobservable Inputs (Level 3)
Fair value measurements
Assets	0	0
Liabilities	$ 0	$ 0

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FAIR VALUE MEASUREMENTS - RECURRING (Details) - USD ($) $ in Thousands	Mar. 31, 2017	Dec. 31, 2016
Available-for-sale Securities	$ 83,882	$ 86,273
Corporate
Available-for-sale Securities	19,952	19,910
Equity
Available-for-sale Securities	500	500
US Agencies
Available-for-sale Securities	23,053	23,952
US Agencies - MBS
Available-for-sale Securities	15,856	16,833
Obligations of states and political subdivisions
Available-for-sale Securities	24,521	25,078
Recurring
Available-for-sale Securities	83,882	86,273
Recurring | Corporate
Available-for-sale Securities	19,952	19,910
Recurring | Equity
Available-for-sale Securities	500	500
Recurring | US Agencies
Available-for-sale Securities	23,053	23,952
Recurring | US Agencies - MBS
Available-for-sale Securities	15,856	16,833
Recurring | Obligations of states and political subdivisions
Available-for-sale Securities	24,521	25,078
Level 2 | Recurring | Corporate
Available-for-sale Securities	19,952	19,910
Level 2 | Recurring | US Agencies
Available-for-sale Securities	23,053	23,952
Level 2 | Recurring | US Agencies - MBS
Available-for-sale Securities	14,706	15,683
Level 2 | Recurring | Obligations of states and political subdivisions
Available-for-sale Securities	24,521	25,078
Significant Unobservable Inputs (Level 3) | Recurring | Equity
Available-for-sale Securities	500	500
Significant Unobservable Inputs (Level 3) | Recurring | US Agencies - MBS
Available-for-sale Securities	$ 1,150	$ 1,150

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FAIR VALUE MEASUREMENTS - NONRECURRING BASIS (Details) - USD ($) $ in Thousands	3 Months Ended	12 Months Ended
	Mar. 31, 2017	Dec. 31, 2016
Fair value
Impaired loans	$ 349
Other real estate owned	4,466	$ 4,782
Nonrecurring
Fair value
Total Losses	49	845
Nonrecurring | Impaired loans
Fair value
Impaired loans	7,788	9,856
Total Losses	37	643
Nonrecurring | Other real estate owned
Fair value
Other real estate owned	4,466	4,782
Total Losses	12	202
Nonrecurring | Significant Unobservable Inputs (Level 3) | Impaired loans
Fair value
Impaired loans	7,788	9,856
Nonrecurring | Significant Unobservable Inputs (Level 3) | Other real estate owned
Fair value
Other real estate owned	$ 4,466	$ 4,782

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SHAREHOLDERS' EQUITY (Details) - USD ($)	3 Months Ended	12 Months Ended
	Mar. 31, 2016	Dec. 31, 2016	Dec. 31, 2015	Dec. 31, 2014	Dec. 31, 2013	Mar. 31, 2017	Apr. 28, 2015	Dec. 17, 2013	Feb. 27, 2013
Participation in the TARP Capital Purchase Program
Number of shares authorized to be repurchased						$ 26,000		$ 600,000	$ 600,000
Number of additional shares authorized to be repurchased							$ 750,000
Shares of Common Stock
Participation in the TARP Capital Purchase Program
Number of shares repurchased	9,000	14,000	102,455	13,700	55,594

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COMMITMENTS, CONTINGENCIES, AND CREDIT RISK (Details) - USD ($) $ in Thousands	3 Months Ended
	Mar. 31, 2017	Dec. 31, 2016
Financial Instruments with Off-Balance-Sheet Risk
Commitments	$ 101,214	$ 102,018
Commitments to extend credit
Financial Instruments with Off-Balance-Sheet Risk
Commitments, variable rate	60,204	59,496
Commitments, fixed rate	27,407	28,737
Standby letters of credit
Financial Instruments with Off-Balance-Sheet Risk
Commitments, variable rate	$ 7,926	8,252
Percentage collateralization on financial instruments allowed under commitments	100.00%
Credit card commitments
Financial Instruments with Off-Balance-Sheet Risk
Commitments, fixed rate	$ 5,677	$ 5,533

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COMMITMENTS, CONTINGENCIES, AND CREDIT RISK - CREDIT RISK (Details) - USD ($) $ in Thousands	3 Months Ended	12 Months Ended
	Mar. 31, 2017	Dec. 31, 2016	Mar. 31, 2016
Concentration of Credit Risk
Loan portfolio	$ 781,400	$ 776,837	$ 613,801
Commercial real estate
Concentration of Credit Risk
Loan portfolio	395,832		$ 315,466
Bank | Commercial real estate | Commercial loan portfolio | Credit risk concentration
Concentration of Credit Risk
Loan portfolio	$ 114,650	$ 121,861
Percentage of concentration risk under a specified benchmark	20.75%	22.42%

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BUSINESS COMBINATIONS (Details)	1 Months Ended
	Aug. 31, 2016 USD ($) item	Apr. 30, 2016 USD ($)	Apr. 29, 2016 USD ($) item	Mar. 31, 2017 USD ($)	Dec. 31, 2016 USD ($)
Business Acquisition [Line Items]
Assets				$ 976,635,000	$ 983,520,000
Goodwill				$ 5,694,000	5,694,000
Eagle River
Business Acquisition [Line Items]
Number of banking offices | item			3
Assets			$ 125,000,000
Total loans		$ 84,000,000
Total deposits		105,000,000
Deposit based intangible		933,000
Total purchase price		12,500,000
Goodwill		$ 1,839,000			1,839,000
Niagara Bancorporation
Business Acquisition [Line Items]
Number of banking offices | item	4
Assets	$ 67,000,000
Total loans	33,000,000
Total deposits	59,000,000
Deposit based intangible	300,000
Purchase price of acquisition	7,325,000
Goodwill	$ 50,000				$ 50,000