Edgar Filing: MACKINAC FINANCIAL CORP /MI/

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Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2012

¨	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 incorporation or organization)		(I.R.S. Employer Identification No.)

130 SOUTH CEDAR STREET, MANISTIQUE, MI		49854
(Address of principal executive offices)		(Zip Code)

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

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

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

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

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

As of April 30, 2012, there were outstanding 3,419,736 shares of the registrant’s common stock, no par value.

MACKINAC FINANCIAL CORPORATION

INDEX


PART I. FINANCIAL INFORMATION		Page No.
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets - March 31, 2012 (Unaudited), December 31, 2011 and March 31, 2011 (Unaudited)	1
	Condensed Consolidated Statements of Operations - Three Months Ended March 31, 2012 (Unaudited) and March 31, 2011 (Unaudited)	2
	Condensed Consolidated Statements of Comprehensive Income - Three Months Ended March 31, 2012 (Unaudited) and March 31, 2011 (Unaudited)	3
	Condensed Consolidated Statements of Changes in Shareholders’ Equity – Three Months Ended March 31, 2012 (Unaudited) and March 31, 2011 (Unaudited)	3
	Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 2012 (Unaudited) and March 31, 2011 (Unaudited)	4
	Notes to Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
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, 2012			December 31, 2011			March 31, 2011
	(Unaudited)						(Unaudited)
ASSETS
Cash and due from banks	$	16,912		$	20,071		$	41,715
Federal funds sold		14,000			13,999			12,000

Cash and cash equivalents		30,912			34,070			53,715
Interest-bearing deposits in other financial institutions		10			10			734
Securities available for sale		36,788			38,727			37,543
Federal Home Loan Bank stock		3,060			3,060			3,423
Loans:
Commercial		318,810			311,215			287,760
Mortgage		81,953			83,106			81,404
Consumer		13,639			6,925			5,445

Total Loans		414,402			401,246			374,609
Allowance for loan losses		(5,382	)		(5,251	)		(6,184	)

Net loans		409,020			395,995			368,425
Premises and equipment		9,774			9,627			9,715
Other real estate held for sale		3,494			3,162			5,081
Deferred tax asset		7,958			8,427			8,773
Other assets		5,480			5,233			5,381

TOTAL ASSETS	$	506,496		$	498,311		$	492,790


LIABILITIES AND SHAREHOLDERS’ EQUITY

LIABILITIES:
Deposits:
Noninterest bearing deposits	$	52,470		$	51,273		$	39,269
NOW, money market, interest checking		151,614			152,563			154,420
Savings		13,601			14,203			17,691
CDs<$100,000		137,501			130,685			104,258
CDs>$100,000		24,066			23,229			21,803
Brokered		32,836			32,836			63,342

Total deposits		412,088			404,789			400,783
Borrowings:
Federal Home Loan Bank		35,000			35,000			35,000
Other		997			997			1,069

Total borrowings		35,997			35,997			36,069
Other liabilities		2,316			2,262			1,841

Total liabilities		450,401			443,048			438,693

SHAREHOLDERS’ EQUITY:
Preferred stock—No par value:
Authorized 500,000 shares, 11,000 shares issued and outstanding		10,976			10,921			10,757
Common stock and additional paid in capital—No par value
Authorized—18,000,000 shares
Issued and outstanding—3,419,736 shares		43,525			43,525			43,525
Retained earnings (deficit)		990			492			(705	)
Accumulated other comprehensive income		604			325			520

Total shareholders’ equity		56,095			55,263			54,097

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	506,496		$	498,311		$	492,790

See accompanying notes to condensed consolidated financial statements.

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except per Share Data)


	Three Months Ended March 31,
	2012		2011
	(Unaudited)
INTEREST INCOME:
Interest and fees on loans:
Taxable	$	5,580	$	5,136
Tax-exempt		32		42
Interest on securities:
Taxable		264		282
Tax-exempt		7		7
Other interest income		25		33

Total interest income		5,908		5,500


INTEREST EXPENSE:
Deposits		983		1,219
Borrowings		162		140

Total interest expense		1,145		1,359

Net interest income		4,763		4,141
Provision for loan losses		495		—

Net interest income after provision for loan losses		4,268		4,141


OTHER INCOME:
Deposit service fees		194		217
Income from secondary market loans sold		298		78
SBA/USDA loan sale gains		—		236
Mortgage servicing income		85		—
Other		29		46

Total other income		606		577


OTHER EXPENSE:
Salaries and employee benefits		1,975		1,824
Occupancy		345		365
Furniture and equipment		228		194
Data processing		228		176
Professional service fees		180		153
Loan and deposit		141		179
Writedowns and losses on other real estate held for sale		11		467
FDIC insurance assessment		159		285
Telephone		55		51
Advertising		98		88
Other		414		277

Total other expenses		3,834		4,059

Income before provision for income taxes		1,040		659
Provision for income taxes		349		214

NET INCOME		691		445

Preferred dividend and accretion of discount		193		189

NET INCOME AVAILABLE TO COMMON SHAREHOLDERS	$	498	$	256

INCOME PER COMMON SHARE:
Basic	$	.15	$	.07

Diluted	$	.14	$	.07

See accompanying notes to condensed consolidated financial statements.

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS COMPREHENSIVE INCOME

(Dollars in Thousands)

(Unaudited)


	Three Months Ended March 31,
	2012			2011
Net income	$	691		$	445
Net change in net unrealied gains and losses on securities available for sale:
Unrealized gains (losses) arising during the period		423			(139	)
Less: reclassification adjustment for gains included in net income		—			—

Net securities gain (loss) during the period		423			(139	)
Tax effect		(144	)		47

Net of tax		279			(92	)

Comprehensive income	$	970		$	353

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in Thousands)

(Unaudited)


	Three Months Ended
	March 31,
	2012								2011
			Common			Total					Common			Total
	Preferred		Shareholders’			Shareholders’			Preferred		Shareholders’			Shareholders’
	Stock		Equity			Equity			Stock		Equity			Equity
Balance, beginning of period	$	10,921	$	44,342		$	55,263		$	10,706	$	43,176		$	53,882
Net income for period		—		691			691			—		445			445
Net unrealized gain (loss) on securities available for sale		—		279			279			—		(92	)		(92	)

Total comprehensive income (loss)		—		970			970			—		353			353
Dividend on preferred stock		—		(138	)		(138	)		—		(138	)		(138	)
Stock option compensation		—		—			—			—		—			—
Accretion of preferred stock discount		55		(55	)		—			51		(51	)		—
Rounding		—					—								—

Balance, end of period	$	10,976	$	45,119		$	56,095		$	10,757	$	43,340		$	54,097

See accompanying notes to condensed consolidated financial statements.

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(Unaudited)


	Three Months Ended March 31,
	2012			2011
Cash Flows from Operating Activities:
Net income	$	691		$	445
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		395			398
Provision for loan losses		495			—
Provision for income taxes		349			214
(Gain) loss on sale of secondary market loans		(198	)		(42	)
Origination of secondary market loans held for sale		(14,526	)		(4,926	)
Proceeds from secondary market loans held for sale		14,788			5,005
(Gain) loss on sale of premises, equipment, and other real estate held for sale		11			15
Writedown of other real estate held for sale		—			452
Change in other assets		(302	)		(86	)
Change in other liabilities		54			(125	)

Net cash provided by operating activities		1,757			1,350


Cash Flows from Investing Activities:
Net (increase) decrease in loans		(13,967	)		7,213
Net increase in interest-bearing deposits in other financial institutions		—			(21	)
Purchase of securities available for sale		(1,107	)		(8,088	)
Proceeds from maturities, sales, calls or paydowns of securities available for sale		3,395			4,194
Capital expenditures		(413	)		(330	)
Proceeds from sale of premises, equipment, and other real estate		16			812

Net cash provided by (used in) investing activities		(12,076	)		3,780


Cash Flows from Financing Activities:
Net increase in deposits		7,299			14,004
Dividend on preferred stock		(138	)		(138	)

Net cash provided by financing activities		7,161			13,866

Net increase (decrease) in cash and cash equivalents		(3,158	)		18,996
Cash and cash equivalents at beginning of period		34,070			34,719

Cash and cash equivalents at end of period	$	30,912		$	53,715


Supplemental Cash Flow Information:
Cash paid during the year for:
Interest	$	1,145		$	1,315
Income taxes		25			25

Noncash Investing and Financing Activities:
Transfers of Foreclosures from Loans to Other Real Estate Held for Sale		359			798

See accompanying notes to condensed consolidated financial statements.

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, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. 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, 2011.

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

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

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

Allowance for Loan Losses

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

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

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

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Stock Option Plans

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

2. RECENT ACCOUNTING PRONOUNCEMENTS

In May 2011, the FASB issued ASU No. 2011-04 “Fair Value Measurement (Topic 820)—Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” ASU 2011-04 changes the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. Consequently, the amendments in this update result in common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards. ASU 2011-04 is effective prospectively during interim and annual periods beginning on or after December 15, 2011. The Company has assessed the impact of ASU 2011-04 on its fair value disclosures and found no material impact on its fair value disclosures.

In May 2011, the FASB issued ASU No. 2011-03, Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. The ASU is intended to improve financial reporting of repurchase agreements (“repos”) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The amendments to the Codification in this ASU are intended to improve the accounting for these transactions by removing them from the assessment of effective control the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets. The guidance in the ASU is effective for the first interim or annual period beginning on or after December 15, 2011. The provisions of this guidance did not have a significant impact on the Corporation’s consolidated financial condition, results of operation or liquidity.

In June 2011, the FASB issued ASU No. 2011-05 “Comprehensive Income (Topic 220)—Presentation of Comprehensive Income.” ASU 2011-05 requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income along with a total for other comprehensive income, and a total amount for comprehensive income. Retrospective application of the standard is required. In December 2011, the FASB issued Accounting Standards Update (ASU) No. 2011-12: “Comprehensive Income (Topic 220)—Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income” in ASU No. 2011-05, to defer the effective date for the part of ASU No. 2011-05 that would require adjustments of items out of accumulated other income to be presented on the components of both net income and other comprehensive income in financial statements. The Company has included the consolidated statements of comprehensive income beginning this interim period. There was no impact on the consolidated statements of operations or balance sheets based on the adoption of this standard.

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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, 2012 and 2011 (dollars in thousands, except per share data):


	Three Months Ended March 31,
	2012		2011
(Numerator):
Net income	$	691	$	445
Preferred stock dividends and accretion of discount		193		189

Net income available to common shareholders	$	498	$	256

(Denominator):
Weighted average shares outstanding—basic		3,419,736		3,419,736
Dilutive effect of stock options		—		—
Dilutive effect of common stock warrants		105,217		90,074
Weighted average shares outstanding—diluted		3,524,953		3,509,810
Income per common share:
Basic	$	.15	$	.07
Diluted	$	.14	$	.07

4. INVESTMENT SECURITIES

The amortized cost and estimated fair value of investment securities available for sale as of March 31, 2012, December 31, 2011 and March 31, 2011 are as follows (dollars in thousands):


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
*March 31, 2012*

US Agencies—MBS	$	10,664	$	360	$	—		$	11,024
US Agencies		10,373		156		—			10,529
Corporate Bonds		9,371		87		(3	)		9,455
Obligations of states and political subdivisions		5,464		318		(2	)		5,780

Total securities available for sale	$	35,872	$	921	$	(5	)	$	36,788

*December 31, 2011*

US Agencies—MBS	$	14,065	$	387	$	(34	)	$	14,418
US Agencies		10,407		168		—			10,575
Corporate Bonds		8,314		—		(136	)		8,178
Obligations of states and political subdivisions		5,448		110		(2	)		5,556

Total securities available for sale	$	38,234	$	665	$	(172	)	$	38,727

*March 31, 2011*

US Agencies—MBS	$	22,528	$	739	$	—		$	23,267
US Agencies		7,742		11		—			7,753
Corporate Bonds		5,338		2		—			5,340
Obligations of states and political subdivisions		1,146		41		(4	)		1,183

Total securities available for sale	$	36,754	$	793	$	(4	)	$	37,543

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

The amortized cost and estimated fair value of investment securities pledged to secure FHLB borrowings and customer relationships were $11.799 million and $12.208 million, respectively, at March 31, 2012.

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5. LOANS

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


	March 31,		December 31,		March 31,
	2012		2011		2011
Commercial real estate	$	203,676	$	199,201	$	200,649
Commercial, financial, and agricultural		93,018		92,269		63,673
One to four family residential real estate		81,953		77,332		75,663
Construction :
Consumer		5,115		5,774		5,741
Commerical		22,116		19,745		23,438
Consumer		8,524		6,925		5,445

Total loans	$	414,402	$	401,246	$	374,609

An analysis of the allowance for loan losses for the three months ended March 31, 2012, the year ended December 31, 2011, and the three months ended March 31, 2011 is as follows (dollars in thousands):


	March 31,			December 31,			March 31,
	2012			2011			2011
Balance at beginning of period	$	5,251		$	6,613		$	6,613
Recoveries on loans previously charged off		32			138			9
Loans charged off		(396	)		(3,800	)		(438	)
Provision		495			2,300			—

Balance at end of period	$	5,382		$	5,251		$	6,184

In the first quarter of 2012, net charge off activity was $.364 million, or .09% of average loans outstanding compared to net charge-offs of $.429 million, or .11% of average loans, in the same period in 2011. In the first quarter of 2011, the Corporation recorded no provision for loan loss compared to $.495 million in the first quarter of 2012. The Corporation’s allowance for loan loss reserve policy calls for a measurement of the adequacy of the reserve at each quarter end. This process includes an analysis of the loan portfolio to take into account increases in loans outstanding and portfolio composition, historical loss rates, and specific reserve requirements of nonperforming loans.

A breakdown of the allowance for loan losses and recorded balances in loans at March 31, 2012 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	$	2,823		$	1,079		$	207		$	1,114		$	—		$	—		$	28		$	5,251
Charge-offs		(173	)		(20	)		—			(190	)		(5	)		(8	)		—			(396	)
Recoveries		8			18			—			1			—			5			—			32
Provision		127			49			23			158			5			3			130			495

Ending balance ALLR	$	2,785		$	1,126		$	230		$	1,083		$	—		$	—		$	158		$	5,382

*Loans:*
Ending balance	$	203,676		$	94,156		$	22,116		$	81,953		$	5,115		$	7,386		$	—		$	414,402
Ending balance ALLR		(2,785	)		(1,126	)		(230	)		(1,083	)		—			—			(158	)		(5,382	)

Net loans	$	200,891		$	93,030		$	21,886		$	80,870		$	5,115		$	7,386		$	(158	)	$	409,020

*Ending balance ALLR:*
Individually evaluated		969			374			13			28			—			—			—			1,384
Collectively evaluated		1,816			752			217			1,055			—			—			158			3,998

Total	$	2,785		$	1,126		$	230		$	1,083		$	—		$	—		$	158		$	5,382

*Ending balance Loans:*
Individually evaluated	$	22,804		$	12,886		$	—		$	859		$	1,172		$	—		$	—		$	37,721
Collectively evaluated		180,872			80,132			22,116			81,094			3,943			8,524			—			376,681

Total	$	203,676		$	93,018		$	22,116		$	81,953		$	5,115		$	8,524		$	—		$	414,402

Impaired loans, by definition, are individually evaluated.

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5. LOANS (Continued)

A breakdown of the allowance for loan losses and recorded balances in loans at December 31, 2011 is as follows (dollars in thousands):


				Commercial,						One to four
	Commercial			financial and			Commercial			family residential			Consumer
	real estate			agricultural			construction			real estate			construction		Consumer			Unallocated			Total
*Allowance for loan loss reserve:*
Beginning balance ALLR	$	3,460		$	1,018		$	389		$	1,622		$	—	$	—		$	124			6,613
Charge-offs		(2,267	)		(579	)		(412	)		(490	)		—		(52	)		—			(3,800	)
Recoveries		32			21			75			1			—		9			—			138
Provision		1,598			619			155			(19	)		—		43			(96	)		2,300
Unallocated assignment		—			—			—			—			—		—			—			—

Ending balance ALLR	$	2,823		$	1,079		$	207		$	1,114		$	—	$	—		$	28		$	5,251

*Loans:*
Ending balance	$	199,201		$	92,269		$	19,745		$	77,332		$	5,774	$	6,925		$	—		$	401,246
Ending balance ALLR		(2,823	)		(1,079	)		(207	)		(1,114	)		—		—			(28	)		(5,251	)

Net loans	$	196,378		$	91,190		$	19,538		$	76,218		$	5,774	$	6,925		$	(28	)	$	395,995

*Ending balance ALLR:*
Individually evaluated		926			160			—			114			—		—			—			1,200
Collectively evaluated		1,897			919			207			1,000			—		—			28			4,051

Total	$	2,823		$	1,079		$	207		$	1,114		$	—	$	—		$	28		$	5,251

*Ending balance Loans:*
Individually evaluated	$	13,628		$	1,707		$	—		$	1,930		$	—	$	—		$	—		$	17,265
Collectively evaluated		185,573			90,562			19,745			75,402			5,774		6,925			—			383,981

Total	$	199,201		$	92,269		$	19,745		$	77,332		$	5,774	$	6,925		$	—		$	401,246

A breakdown of the allowance for loan losses and recorded balances in loans at March 31, 2011 is as follows (dollars in thousands):


				Commercial,						One to four
	Commercial			financial and			Commercial			family residential			Consumer
	real estate			agricultural			construction			real estate			construction		Consumer			Unallocated			Total
*Allowance for loan loss reserve:*
Beginning balance ALLR	$	3,460		$	1,018		$	389		$	1,622		$	—	$	—		$	124		$	6,613
Charge-offs		(215	)		(25	)		—			(190	)		—		(8	)		—			(438	)
Recoveries		3			1			—			—			—		5			—			9
Provision		(242	)		(13	)		(128	)		356			—		3			24			—
Unallocated assignment		—			—			—			—			—		—			—			—

Ending balance ALLR	$	3,006		$	981		$	261		$	1,788		$	—	$	—		$	148		$	6,184

*Loans:*
Ending balance	$	200,649		$	63,673		$	23,438		$	75,663		$	5,741	$	5,445		$	—		$	374,609
Ending balance ALLR		(3,006	)		(981	)		(261	)		(1,788	)		—		—			(148	)		(6,184	)

Net loans	$	197,643		$	62,692		$	23,177		$	73,875		$	5,741	$	5,445		$	(148	)	$	368,425

*Ending balance ALLR:*
Individually evaluated	$	1,144		$	361		$	39		$	845		$	—	$	—		$	—		$	2,389
Collectively evaluated		1,862			620			222			943			—		—			148			3,795

Total	$	3,006		$	981		$	261		$	1,788		$	—	$	—		$	148		$	6,184

*Ending balance Loans:*
Individually evaluated	$	17,568		$	2,604		$	2,409		$	4,951		$	—	$	—		$	—		$	27,532
Collectively evaluated		183,081			61,069			21,029			70,712			5,741		5,445			—			347,077

Total	$	200,649		$	63,673		$	23,438		$	75,663		$	5,741	$	5,445		$	—		$	374,609

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5. LOANS (Continued)

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

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

Excellent (1)

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

Good (2)

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

Average (3)

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

Acceptable (4)

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

Special Mention (5)

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

Substandard (6)

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

Doubtful (7)

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

Charge-off/Loss (8)

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

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5. LOANS (Continued)

General Reserves:

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

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

Commercial construction loans in the amount of $3.503 million, $3.694 million and $3.536 million for the periods ended March 31, 2012, December 31, 2011 and March 31, 2011, respectively did not receive a specific risk rating. These amounts represent loans made for land development and unimproved land purchases. Below is a breakdown of loans by risk category as of March 31, 2012 (dollars in thousands):

(1)

(2)

(3)

(4)

(5)

(6)

(7)

Rating

Excellent

Good

Average

Acceptable

Sp. Mention

Substandard

Doubtful

Unassigned

Total

Commercial real estate

3,906

16,755

50,487

109,881

16,533

5,282

832

—

203,676

Commercial, financial and agricultural

4,691

8,697

19,205

44,845

12,289

3,291

—

93,018

Commercial construction

207

690

6,353

10,180

767

416

—

3,503

22,116

One to four family residential real estate

—

2,000

3,731

6,705

—

993

—

68,524

81,953

Consumer construction

—

5,115

Consumer

—

657

—

7,770

8,524

Total loans

8,804

28,142

79,873

172,268

29,589

9,982

832

84,912

414,402

Below is a breakdown of loans by risk category as of December 31, 2011 (dollars in thousands):


	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp. Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	3,083	$	16,946	$	47,154	$	118,259	$	5,198	$	7,642	$	919	$	—	$	199,201
Commercial, financial and agricultural		4,416		7,875		17,738		60,498		201		1,541		—		—		92,269
Commercial construction		209		552		4,542		10,415		313		20		—		3,694		19,745
One-to-four family residential real estate		—		—		3,359		5,910		2,023		—		—		66,040		77,332
Consumer construction		—		—		—		—		—		—		—		5,774		5,774
Consumer		—		—		105		599		—		—		—		6,221		6,925

Total loans	$	7,708	$	25,373	$	72,898	$	195,681	$	7,735	$	9,203	$	919	$	81,729	$	401,246

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5. LOANS (Continued)

Below is a breakdown of loans by risk category as of March 31, 2011 (dollars in thousands):


	(1)		(2)		(3)		(4)		(5)		(6)		(7)		Rating
	Excellent		Good		Average		Acceptable		Sp. Mention		Substandard		Doubtful		Unassigned		Total
Commercial real estate	$	6,418	$	16,899	$	42,970	$	116,110	$	6,490	$	9,049	$	2,582	$	131	$	200,649
Commercial, financial and agricultural		3,373		3,722		15,524		37,455		230		2,534		—		835		63,673
Commercial construction		186		563		5,000		11,400		2,237		516		—		3,536		23,438
One to four family residential real estate		33		3,584		3,118		4,256		1,454		3,786		—		59,432		75,663
Consumer construction		—		—		—		—		—		—		—		5,741		5,741
Consumer		—		—		92		475		—		—		—		4,878		5,445

Total loans	$	10,010	$	24,768	$	66,704	$	169,696	$	10,411	$	15,885	$	2,582	$	74,553	$	374,609

Impaired Loans

Nonperforming loans are those which are contractually past due 90 days or more as to interest or principal payments, on nonaccrual status, or loans, the terms of which have been renegotiated to provide a reduction or deferral on interest or principal. The interest income recorded during impairment and that which would have been recognized were $.020 million and $.062 million for the three months ended March 31, 2012. For the three months ended March 31, 2011, the amounts were $.057 million and $.127 million.

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

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

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5. LOANS (Continued)

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


	Nonaccrual Basis		Accrual Basis		Average Investment		Related Valuation Reserve		Interest Income Recognized During Impairment		Interest Income on Accrual Basis
March 31, 2012

With no valuation reserve:
Commercial real estate	$	1,861	$	—	$	1,038	$	—	$	—	$	14
Commercial, financial and agricultural		1,397		—		13		—		—		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		854		—		1,117		—		—		15
Consumer construction		15		—		19		—		—		—
Consumer		—		—		—		—		—		—

With a valuation reserve:
Commercial real estate	$	93	$	2,400	$	3,585	$	671	$	20	$	14
Commercial, financial and agricultural		229		—		1,358		229		—		19
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		8		—		8		8		—		—
Consumer construction		—		—		—		—		—		—
Consumer		—		—		—		—		—		—

Total:
Commercial real estate	$	1,954	$	2,400	$	4,623	$	671	$	20	$	28
Commercial, financial and agricultural		1,626		—		1,371		229		—		19
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		862		—		1,125		8		—		15
Consumer construction		15		—		19		—		—		—
Consumer		—		—		—		—		—		—

Total	$	4,457	$	2,400	$	7,138	$	908	$	20	$	62

December 31, 2011

With no valuation reserve:
Commercial real estate	$	1,313	$	—	$	2,519	$	—	$	66	$	116
Commercial, financial and agricultural		16		—		542		—		29		35
Commercial construction		—		—		176		—		—		11
One to four family residential real estate		608		—		1,727		—		—		99
Consumer construction		—		—		4		—		—		—
Consumer		—		—		2		—		—		—

With a valuation reserve:
Commercial real estate	$	1,049	$	2,400	$	807	$	700	$	20	$	31
Commercial, financial and agricultural		1,095		—		282		173		—		14
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		1,389		103		1,121		150		3		56
Consumer construction		20		—		9		4		—		1
Consumer		—		—		—		—		—		—

Total:
Commercial real estate	$	2,362	$	2,400	$	3,326	$	700	$	86	$	147
Commercial, financial and agricultural		1,111		—		824		173		29		49
Commercial construction		—		—		176		—		—		11
One to four family residential real estate		1,997		103		2,848		150		3		155
Consumer construction		20		—		13		4		—		1
Consumer		—		—		2		—		—		—

Total	$	5,490	$	2,503	$	7,189	$	1,027	$	118	$	363

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5. LOANS (Continued)


									Interest Income		Interest Income
	Nonaccrual		Accrual		Average		Related		Recognized		on
	Basis		Basis		Investment		Valuation Reserve		During Impairment		Accrual Basis
March 31, 2011

With no valuation reserve:
Commercial real estate	$	876	$	—	$	5,602	$	—	$	24	$	30
Commercial, financial and agricultural		52		—		63		—		—		1
Commercial construction		458		—		458		—		—		8
One to four family residential real estate		942		105		785		—		—		11
Consumer construction		—		—		13		—		—		—
Consumer		—		—		—		—		—		—

With a valuation reserve:
Commercial real estate	$	3,181	$	—	$	1,156	$	770	$	33	$	22
Commercial, financial and agricultural		1,069		—		971		332		—		20
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		3,281		—		1,633		753		—		35
Consumer construction		—		—		—		—		—		—
Consumer		—		—		—		—		—		—

Total:
Commercial real estate	$	4,057	$	—	$	6,758	$	770	$	57	$	52
Commercial, financial and agricultural		1,121		—		1,034		332		—		21
Commercial construction		458		—		458		—		—		8
One to four family residential real estate		4,223		105		2,418		753		—		46
Consumer construction		—		—		13		—		—		—
Consumer		—		—		—		—		—		—

Total	$	9,859	$	105	$	10,681	$	1,855	$	57	$	127

A summary of past due loans at March 31, 2012, December 31, 2011 and March 31, 2011 is as follows (dollars in thousands):


	March 31,						December 31,						March 31,
	2012						2011						2011
	30-89 days		90+ days				30-89 days		90+ days				30-89 days		90+ days
	Past Due		Past Due/				Past Due		Past Due/				Past Due		Past Due/
	(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total		(accruing)		Nonaccrual		Total
Commercial real estate	$	784	$	1,954	$	2,738	$	15	$	2,362	$	2,377	$	649	$	4,057	$	4,706
Commercial, financial and agricultural		20		1,626		1,646		137		1,111		1,248		1,137		1,121		2,258
Commercial construction		706		—		706		—		20		20		58		458		516
One to four family residential real estate		124		862		986		188		1,997		2,185		600		4,223		4,823
Consumer construction		—		15		15		—		—		—		—		—		—
Consumer		16		—		16		14		—		14		2		—		2

Total past due loans	$	1,650	$	4,457	$	6,107	$	354	$	5,490	$	5,844	$	2,446	$	9,859	$	12,305

A roll-forward of nonaccrual activity for the first three months ended March 31, 2012 (dollars in thousands):


	For the Three Months Ended March 31, 2012
				Commercial,					One to four
	Commercial			Financial and			Commercial		family residential			Consumer
	Real Estate			Agricultural			Construction		real estate			Construction			Consumer		Total
NONACCRUAL

Beginning balance	$	2,362		$	1,111		$	—	$	1,997		$	20		$	—	$	5,490

Principal payments		(366	)		(31	)		—		(1,048	)		(5	)		—		(1,450	)
Charge-offs		(46	)		—			—		(187	)		—			—		(233	)
Advances		—			—			—		—			—			—		—
Class transfers		—			—			—		—			—			—		—
Transfers to OREO		(327	)		—			—		(33	)		—			—		(360	)
Transfers to accruing		—			—			—		—			—			—		—
Transfers from accruing		310			559			—		132			—			—		1,001
Other		21			(13	)		—		1			—			—		9

Ending balance	$	1,954		$	1,626		$	—	$	862		$	15		$	—	$	4,457

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5. LOANS (Continued)

A roll-forward of nonaccrual activity during the year ended December 31, 2011 (dollars in thousands):


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

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

Principal payments		(1,458	)		(767	)		(14	)		(47	)		—			—			(2,286	)
Charge-offs		(1,950	)		(557	)		(62	)		(601	)		—			(27	)		(3,197	)
Advances		—			—			—			—			—			—			—
Class transfers		—			—			—			—			—			—			—
Transfers to OREO		(1,203	)		(262	)		(382	)		(1,948	)		(53	)		—			(3,848	)
Transfers to accruing		(892	)		—			—			—			—			—			(892	)
Transfers from accruing		4,301			1,938			—			3,273			20			27			9,559
Other		42			(1	)		—			191			1			—			233

Ending balance	$	2,362		$	1,111		$	—		$	1,997		$	20		$	—		$	5,490

A roll-forward of nonaccrual activity for the first three months ended March 31, 2011 (dollars in thousands):


	For the Three Months Ended March 31, 2011
	Commercial Real Estate			Commercial, Financial and Agricultural			Commercial Construction		One to four family residential real estate			Consumer Construction			Consumer		Total
NONACCRUAL

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

Principal payments		(458	)		(5	)		—		(15	)		—			—		(478	)
Charge-offs		(203	)		(25	)		—		(28	)		—			—		(256	)
Advances		—			—			—		—			—			—		—
Class transfers		—			—			—		—			—			—		—
Transfers to OREO		(643	)		—			—		(101	)		(53	)		—		(797	)
Transfers to accruing		(892	)		—			—		—			—			—		(892	)
Transfers from accruing		2,724			389			—		3,237			—			—		6,350
Other		7			2			—		1			1			—		11

Ending balance	$	4,057		$	1,121		$	458	$	4,223		$	—		$	—	$	9,859

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.

The Corporation, at March 31, 2012, had loans totaling $2.400 million for which repayment terms were modified to the extent that they were deemed to be “restructured” loans. The $2.400 million is comprised of 1 loan. This loan was modified to allow the suspension of principal payments for “over a 12-month period”. This suspension of

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5.	LOANS (Continued)

principal payments on this loan with a 30-year amortization does not result in a significant change to the net present value of total principal and interest payments over the term of the note. This loan is deemed collateral dependent, and as such an evaluation of the underlying collateral and ability for repayment based upon cash flows was done. This evaluation resulted in an estimate of expected loss of principal. As of March 31, 2012, the Corporation established a $.671 million specific reserve on this loan.

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


	March 31, 2012				December 31, 2011				March 31, 2011
	Number of Modifications		Recorded Investment		Number of Modifications		Recorded Investment		Number of Modifications		Recorded Investment
Commercial real estate		1	$	2,400		1	$	2,400		—	$	—
Commercial, financial and agricultural		—		—		—		—		—		—
Commercial construction		—		—		—		—		—		—
One to four family residential real estate		—		—		1		103		1		105
Consumer construction		—		—		—		—		—		—
Consumer		—		—		—		—		—		—

Total troubled debt restructurings		1	$	2,400		2	$	2,503		1	$	105

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

Commercial
Real Estate

Commercial,
Financial and
Agricultural

Commercial
Construction

One to four
family residential
real estate

Consumer and
Consumer
Construction

Total

ACCRUING

Beginning balance

2,400

—

103

—

2,503

Principal payments

—

Charge-offs

—

Advances

—

New restructured

—

Transfers to performing status

—

(103

)

—

(103

)

Transfers to nonaccrual

—

Ending balance

2,400

—

2,400

A roll-forward of troubled debt restructuring during the year ended December 31, 2011 (dollars in thousands):


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

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

Principal payments		—			—		—		(2	)		—		(2	)
Charge-offs		—			—		—		—			—		—
Advances		—			—		—		—			—		—
New restructured		2,400			—		—		—			—		2,400
Transfers to performing		(582	)		—		—		—			—		(582	)
Transfers to nonaccrual		(3,955	)		—		—		—			—		(3,955	)

Ending balance	$	2,400		$	—	$	—	$	103		$	—	$	2,503

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

5. LOANS (Continued)

A roll-forward of troubled debt restructuring during the year ended March 31, 2011 (dollars in thousands):


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

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

Principal payments		—			—		—		—		—		—
Charge-offs		—			—		—		—		—		—
Advances		—			—		—		—		—		—
New restructured		—			—		—		—		—		—
Transfers to performing		(582	)		—		—		—		—		(582	)
Transfers to nonaccrual		(3,955	)		—		—		—		—		(3,955	)

Ending balance	$	—		$	—	$	—	$	105	$	—	$	105

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):


	March 31, 2012			December 31, 2011			March 31, 2011
Loans outstanding, beginning of period	$	8,827		$	9,532		$	9,532
New loans		770			933			705
Net activity on revolving lines of credit		(31	)		69			124
Repayment		(200	)		(1,707	)		(1,216	)

Loans outstanding, end of period	$	9,366		$	8,827		$	9,145

There were no loans to related parties classified substandard as of March 31, 2012, December 31, 2011 or March 31, 2011. In addition to the outstanding balances above, there were unfunded commitments of $.316 million to related parties at March 31, 2012.

6.	MORTGAGE SERVICING RIGHTS

Mortgage servicing rights (“MSRs”) are recorded when loans are sold in the secondary market with servicing retained. As of March 31, 2012, the Corporation had obligations to service approximately $58 million of residential first mortgage loans. The valuation is based upon the net present value of the projected revenues over the expected life of the loans being serviced, as reduced by estimated internal costs to service these loans. The fair value of the capitalized servicing rights approximates the carrying value. The key economic assumptions used in determining the fair value of the mortgage servicing rights include an annual constant prepayment speed of 15.90 and a discount rate of 7.50% for March 31, 2012.

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


	March 31, 2012			December 31, 2011
Balance at beginning of period	$	400		$	—
Additions from loans sold with servicing retained		70			415
Changes in valuation		—			—
Loan payments and payoffs		(20	)		(15	)

Fair value of MSRs at end of period	$	450		$	400

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Sidehead (Continued)

7.	BORROWINGS

Borrowings consist of the following at March 31, 2012, December 31, 2011 and March 31, 2011 (dollars in thousands):


	March 31,		December 31,		March 31,
	2012		2011		2011
Federal Home Loan Bank fixed rate advances at March 31, 2012 with a weighted average rate of 1.82% maturing in 2013, 2014 and 2016	$	35,000	$	35,000	$	35,000
USDA Rural Development, fixed-rate note payable, maturing
August 24, 2024, interest payable at 1%		997		997		1,069

	$	35,997	$	35,997	$	36,069

The Federal Home Loan Bank borrowings are collateralized at March 31, 2012 by the following: a collateral agreement on the Corporation’s one to four family residential real estate loans with a book value of approximately $43.641 million; mortgage related and municipal securities with an amortized cost and estimated fair value of $11.959 million and $11.547 million, respectively; and Federal Home Loan Bank stock owned by the Bank totaling $3.060 million. Prepayment of the advances is subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank of Indianapolis in effect as of March 31, 2012.

The USDA Rural Development borrowing is collateralized by loans totaling $.158 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 $.997 million, and guaranteed by the Corporation.

8.	STOCK OPTION PLANS

A summary of stock option transactions for the three months ended March 31, 2012 and 2011, and the year ended December 31, 2011, is as follows:


	March 31,		December 31,			March 31,
	2012		2011			2011
Outstanding shares at beginning of year		392,152		394,072			394,072
Granted during the period		—		—			—
Exercised during the period		—		—			—
Expired / forfeited during the period		—		(1,920	)		—

Outstanding shares at end of period		392,152		392,152			394,072

Exercisable shares at end of period		148,861		148,861			150,781

Weighted average exercise price per share at end of period	$	10.27	$	10.27		$	10.98

Shares available for grant at end of period		—		—			—

There were no options granted in the first three months of 2012 and 2011.

Following is a summary of the options outstanding and exercisable at March 31, 2012:


							Weighted Average
Exercise	Number				Unvested		Remaining
Price	Outstanding		Exercisable		Options		Contractual Life-Years
$9.16		5,000		2,000		3,000		3.71
$9.75		257,152		120,861		136,291		2.63
$10.65		50,000		10,000		40,000		4.71
$11.50		40,000		8,000		32,000		3.46
$12.00		40,000		8,000		32,000		3.21

		392,152		148,861		243,291		3.05

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

9.	INCOME TAXES

A valuation allowance is provided against deferred tax assets when it is more likely than not that some or all of the deferred tax asset will not be realized. The Corporation, as of March 31, 2012 had a net operating loss and tax credit carryforwards for tax purposes of approximately $26.0 million, and $2.1 million, respectively. The net operating loss carryforwards expire twenty years from the date they originated. These carryforwards, if not utilized, will begin to expire in the year 2023. A portion of the NOL, approximately $15.6 million, and all of the credit carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code. The annual limitation is $1.400 million for the NOL and the equivalent value of tax credits, which is approximately $.477 million. These limitations for use were established in conjunction with the recapitalization of the Corporation in December 2004.

The Corporation recognized deferred taxes of approximately $.349 million and $.214 million for the quarter ended March 31, 2012 and 2011, respectively. The valuation allowance at March 31, 2012 was $6.010 million. Management evaluated the deferred tax valuation allowance as of March 31, 2012 and determined that no adjustment to the valuation was warranted. The Corporation will continue to evaluate the future benefits from these carryforwards and at such time as it becomes “more likely than not” that they would be utilized prior to expiration will recognize the additional benefits as an adjustment to the valuation allowance.

10.

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.

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

10. FAIR VALUE MEASUREMENTS (Continued)

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, 2012, December 31, 2011 and March 31, 2011(dollars in thousands):


		March 31, 2012				December 31, 2011				March 31, 2011
	Level in Fair	Carrying		Estimated		Carrying		Estimated		Carrying		Estimated
	Value Hierarchy	Amount		Fair Value		Amount		Fair Value		Amount		Fair Value
Financial assets:
Cash and cash equivalents	Level 1	$	30,912	$	30,912	$	34,070	$	34,070	$	53,715	$	53,715
Interest-bearing deposits	Level 2		10		10		10		10		734		734
Securities available for sale	Level 2		36,788		36,788		38,727		38,727		37,543		37,543
Federal Home Loan Bank stock	Level 2		3,060		3,060		3,060		3,060		3,423		3,423
Net loans	Level 2		409,020		406,919		395,995		394,463		368,425		368,436
Accrued interest receivable	Level 2		1,425		1,425		1,261		1,261		1,401		1,401

Total financial assets		$	481,215	$	479,114	$	473,123	$	471,591	$	465,241	$	465,252

Financial liabilities:
Deposits	Level 2	$	412,088	$	412,119	$	404,789	$	404,821	$	400,783	$	402,311
Borrowings	Level 2		35,996		35,648		35,997		35,634		36,069		35,658
Accrued interest payable	Level 2		234		234		202		202		276		276

Total financial liabilties		$	448,318	$	448,001	$	440,988	$	440,657	$	437,128	$	438,245

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 December 31, 2011, 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, 2012 and March 31, 2011 were based on level 2 inputs. There are no other assets or liabilities measured on a recurring basis at fair value. For additional information regarding investment securities, please refer to “Note 4 Investment Securities.”

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

10. FAIR VALUE MEASUREMENTS (Continued)

The Corporation had no Level 3 assets or liabilities on a recurring basis as of March 31, 2012, December 31, 2011 or March 31, 2011.

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

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

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

(dollars in thousands)

Quoted Prices

Significant

in Active Markets

Other Observable

Unobservable

Total Losses for

Balance at

for Identical Assets

Inputs

Three Months Ended

March 31, 2012

(Level 1)

(Level 2)

(Level 3)

March 31, 2012

Assets

Impaired loans

6,857

—

6,857

388

Other real estate owned

3,494

—

3,494

399


Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2011

(dollars in thousands)			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Year Ended
	December 31, 2011		(Level 1)		(Level 2)		(Level 3)		December 31, 2011
Assets

Impaired loans	$	7,993	$	—	$	—	$	7,993	$	3,200
Other real estate owned		3,162		—		—		3,162		1,137

									$	4,337


Assets Measured at Fair Value on a Nonrecurring Basis at March 31, 2011

(dollars in thousands)			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Year Ended
	March 31, 2011		(Level 1)		(Level 2)		(Level 3)		March 31, 2011
Assets

Impaired loans	$	9,964	$	—	$	—	$	9,964	$	426
Other real estate owned		5,081		—		—		5,081		467

									$	893

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

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

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

11.

SHAREHOLDERS’ EQUITY

Participation in the TARP Capital Purchase Program

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

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

Officers (which for purposes of the ARRA and the CPP agreements, includes the Corporation’s Chief Executive Officer, its Chief Financial Officer, and the next three most highly-compensated executive officers, even though the Corporation’s senior executive officers consist of a smaller group of executives for purposes of the other compensation disclosures in the Corporation’s annual proxy statement).

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

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

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

12.

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,		March 31,
	2012		2011		2011
Commitments to extend credit:
Variable rate	$	29,088	$	28,495	$	27,814
Fixed rate		15,636		15,453		11,325
Standby letters of credit—Variable rate		4,427		3,523		2,137
Credit card commitments—Fixed rate		3,137		3,019		2,991

	$	52,288	$	50,490	$	44,267

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, 2012 represents $78.769 million, or 24.71%, compared to $58.132 million, or 20.20%, of the commercial loan portfolio on March 31, 2011. 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.

MACKINAC FINANCIAL CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

13.

COMMON STOCK RIGHTS OFFERING/MATERIAL DEFINITIVE AGREEMENT

On March 27, 2012 the Corporation entered into a Securities Purchase Agreement (“the SPA”) with Steinhardt Capital Investors, LLLP (“SCI”). Pursuant to the SPA SCI has agreed to purchase, upon completion of the rights offering, between $5,000,000 and $11,000,000 of the Corporation’s securities (the “SCI Investment”). The specific types and amounts of the Corporation’s securities to be purchased by SCI depends on (i) the outcome of the rights offering and (ii) SCI receiving approval from the Board of Governors of the Federal Reserve System to hold more than 9.9% of the total number of shares of the Corporation’s common stock, no par value per share (each a “Common Share” and, collectively, the “Common Shares”), then issued and outstanding (“the Federal Reserve Approval”).

If SCI receives the Federal Reserve Approval by completion of the rights offering, then SCI has agreed to purchase, for no more than an aggregate of $11,000,000:

(1)

Such number of Common Shares (at a purchase price of $5.75 per Common Share) which will include some or all of the Common Shares not purchased by the Corporation’s shareholders in the rights offering, that SCI can purchase without SCI owning more than 19.9% of the Corporation’s Common Shares then issued and outstanding (the “Approval Common Shares”); and

(2)

An 8.0% senior promissory note in a principal amount to be determined based on the amount of proceeds derived from the rights offering and the sale to SCI of the Approval Common Shares.

If SCI does not receive the Federal Reserve Approval by completion of the right offering, then SCI has agreed to purchase, for no more than an aggregate of $11,000,000:

(1)

Such number of Common Shares (at a purchase price of $5.75 per Common Share) which will include some or all of the Common Shares not purchased by the Corporation’s shareholders in the rights offering, that SCI can purchase without SCI owning more than 9.9% of the Corporation’s Common Shares then issued and outstanding (the “No Approval Common Shares”); and

(2)

A number of shares of the Company’s Mandatorily Convertible Cumulative Participating Series B Preferred Stock to be designated by the Company at a later date (the “Series B Preferred”), such number to be determined by dividing the amount of the investment that SCI could not make in Approval Common Shares (due to the absence of the Federal Reserve Approval) by a Series B Preferred per share price of $1,000; and

(3)

A senior promissory note in a principal amount to be determined based on the amounts of proceeds derived from the rights offering and the sale to SCI of the No Approval Common Shares and the Series B Preferred.

The proceeds from the sale of securities derived from the SCI Investment and the rights offering would be used exclusively to repurchase the Corporation’s outstanding TARP Securities that were issued by the Corporation to the U.S. Department of the Treasury under the Troubled Asset Relief Capital Purchase Program. In the event of Federal Reserve Approval, the aggregate maximum number of Common Shares that may be sold to SCI, if no current shareholder exercises its subscription rights or over-subscription rights in the rights offering, is 728,498. If Federal Reserve Approval does not occur, the aggregate maximum number of Common Shares that may be sold to SCI, if no current shareholder exercises its subscription rights or over-subscription rights in the rights offering is 268,095.

The Corporation announced that it intends to conduct a $7 million rights offering in conjunction with the SPA. The Corporation has filed a preliminary prospectus with the Securities and Exchange Commission (the “SEC”) with respect to the rights offering. The record date for the rights offering is April 6, 2012.

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS

13.

COMMON STOCK RIGHTS OFFERING/MATERIAL DEFINITIVE AGREEMENT (Continued)

The following table sets forth the Corporation’s actual (see Column A) and pro forma capitalization as of December 31, 2011 after completion of various levels of the SCI Investment and the rights offering, as if the noted level of the SCI Investment and the rights offering and the exercise of all such rights to purchase the underlying Common Shares had been completed on that date. The Corporation’s pro forma capitalization gives effect to (i) the exercise by the current shareholders of 100% of their basic subscription privileges or over-subscription privileges with SCI purchasing the maximum amount of Common Shares it is able to purchase without exceeding the 19.9% threshold (see Column B), (ii) the exercise by the current shareholders of none of their basic subscription privilege or over-subscription privilege, with SCI purchasing the maximum amount of Common Shares it is able to purchase without exceeding the 9.9% threshold (see Column C) and (iii) the exercise by the current shareholders of none of their basic subscription privileges or over-subscription privileges, with SCI purchasing the maximum amount of Common Shares it is able to purchase without exceeding the 19.9% threshold (see Column D).


				100% Current			No Current			No Current
				Shareholder			Shareholder			Shareholder
				Subscription Rights			Subscription Rights			Subscription Rights
				Exercised and			Exercised and			Exercised and
	Actual			Maximum SCI			Maximum SCI			Maximum SCI
	(as of 12-31-2011)			Purchase up to 19.9%			Purchase up to 9.9%			Purchase up to 19.9%
	(A)			(B)			(C )			(D)
Capital Structure
Common shareholders’ equity	$	44,342		$	55,454		$	44,054		$	46,704
Preferred stock		10,921			—			9,450			6,800

Total shareholders’ equity	$	55,263		$	55,454		$	53,504		$	53,504

Total capitalization	$	55,263		$	55,454		$	53,504		$	53,504

Tangible capital	$	55,263		$	55,454		$	53,504		$	53,504

Intangible assets
Subsidiaries:
Core deposit premium	$	—		$	—		$	—		$	—
Other identifiable intangibles—MSRs		400			400			400			400

Total intangibles	$	400		$	400		$	400		$	400

Risk-Based Capital
Tier 1 Capital
Total shareholders’ equity	$	55,263		$	55,454		$	53,504		$	53,504
Net unrealized (gains) losses on available for sale securities		(325	)		(325	)		(325	)		(325	)
Less: disallowed deferred tax asset		(6,500	)		(6,500	)		(6,500	)		(6,500	)
Less: intangibles		(40	)		(40	)		(40	)		(40	)

Total Tier 1 Capital	$	48,398		$	48,589		$	46,639		$	46,639

Tier 2 Capital
Allowable reserve for loan losses (limited to 1.25% of risk-weighted assets)	$	5,206		$	5,206		$	5,206		$	5,206
Qualifying long-term debt		—			—			—			—
Total Tier 2 Capital		5,206			5,206			5,206			5,206

Total risk-based capital	$	53,604		$	53,795		$	51,845		$	51,845

Risk-weighted assets	$	416,423		$	416,423		$	416,423		$	416,423

Capital Ratios:
Tier 1 Capital to average assets		10.08	%		10.12	%		9.71	%		9.71	%
Tier 1 Capital to risk-weighted assets		11.62	%		11.67	%		11.20	%		11.20	%
Total Capital to risk-weighted assets		12.87	%		12.92	%		12.45	%		12.45	%
Average Assetes (4th quarter)	$	486,672		$	486,672		$	486,672		$	486,672

Total Tier 1 Average Assets (excluding Deferred Tax Asset)	$	480,172		$	480,172		$	480,172		$	480,172

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS

FORWARD LOOKING STATEMENTS

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

•

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

•

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

•

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

•

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

•

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

•

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

•

The ability of borrowers to repay loans;

•

The effects on liquidity of unusual decreases in deposits;

•

Changes in consumer spending, borrowing, and saving habits;

•

Technological changes;

•

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

•

Difficulties in hiring and retaining qualified management and banking personnel;

•

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

•

The effect of compliance with legislation or regulatory changes;

•

The effect of changes in accounting policies and practices;

•

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

•

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

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

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS (Continued)

The following discussion will cover results of operations, asset quality, financial position, liquidity, interest rate sensitivity, and capital resources for the periods indicated. The information included in this discussion is intended to assist readers in their analysis of, and should be read in conjunction with, the consolidated financial statements and related notes and other supplemental information presented elsewhere in this report. This discussion should be read in conjunction with the consolidated financial statements and footnotes contained in the Corporation’s Annual Report and Form 10-K for the year-ended December 31, 2011. Throughout this discussion, the term “Bank” refers to mBank, the principal banking subsidiary of the Corporation.

FINANCIAL OVERVIEW

The Corporation recorded a first quarter 2012 net income available to common shareholders of $.498 million or $.15 per share compared to net income of $.256 million, or $.07 per share for the first quarter of 2011. Operating results for the first quarter of 2012 included a provision of loan losses of $.495 million compared to no provision for the same period of 2011. OREO writedowns were negligible in the first quarter of 2012, compared to $.467 million for the first quarter of 2011.

Weighted average shares outstanding totaled 3,419,736 for both periods. The common stock warrants outstanding of 379,310 shares were slightly dilutive, at approximately $.01 per share, for the 2012 first quarter, as the market value of our stock remained above the $4.35 strike price.

The net interest margin for the first quarter of 2012 increased to $4.763 million, or 4.17%, compared to $4.141 million, of 3.92% in the first quarter of 2011.

Total assets of the Corporation at March 31, 2012 were $506.496 million, up by $13.706 million, or 2.78% from the $492.790 million in total assets reported at March 31, 2011 and up by $8.185 million, or 1.64%, from total assets of $498.311 million at year-end 2011. The loan portfolio increased $13.156 million in the first quarter of 2012, from December 31, 2011 balances of $401.246 million. Deposits totaled $412.088 million at March 31, 2012, an increase of $7.299 million from the $404.789 million at December 31, 2011.

FINANCIAL CONDITION

Cash and Cash Equivalents

Cash and cash equivalents decreased $3.158 million during the first quarter of 2012. See further discussion of the change in cash and cash equivalents in the Liquidity section.

Investment Securities

Securities available for sale decreased $1.939 million, or 5.01%, from December 31, 2011 to March 31, 2012, with the balance on March 31, 2012, totaling $36.788 million. The Corporation purchased $1.107 million of investments during the 2012 first quarter as deposit growth exceeded loan funding demand. Investment securities are utilized in an effort to manage interest rate risk and liquidity. As of March 31, 2012, investment securities with an estimated fair value of $12.208 million were pledged.

Loans

Through the first quarter of 2012, loan balances increased by $13.156 million, or 3.28%, from December 31, 2011 balances of $401.246 million. During the first three months of 2012, the Bank had total loan production of $42.445 million, which included $14.526 million of secondary market loan production. This loan production, however, was offset by loan principal runoff, paydowns and amortization, totaling $5.884 million, and nonperforming loans transferred other real estate owned to OREO amounting to $.359 million.

Management continues to actively manage the loan portfolio, seeking to identify and resolve problem assets at an early stage. Management believes a properly positioned loan portfolio provides the most attractive earning asset yield available to the Corporation and, with a diligent loan approval process and exception reporting, management can effectively manage the risk in the loan portfolio. Management intends to continue loan growth within its markets for mortgage, consumer, and commercial loan products while concentrating on loan quality, industry concentration issues, and competitive pricing.

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS (Continued)

Following is a summary of the loan portfolio at March 31, 2012, December 31, 2011 and March 31, 2011 (dollars in thousands):


	March 31,		Percent of			December 31,		Percent of			March 31,		Percent of
	2012		Total			2011		Total			2011		Total
Commercial real estate	$	203,676		49.15	%	$	199,201		49.64	%	$	200,649		53.56	%
Commercial, financial, and agricultural		93,018		22.45			92,269		23.00			63,673		17.00
One to four family residential real estate		81,953		19.78			77,332		19.27			75,663		20.20
Construction:
Consumer		5,115		1.23			5,774		1.44			5,741		1.53
Commercial		22,116		5.34			19,745		4.92			23,438		6.26
Consumer		8,524		2.06			6,925		1.73			5,445		1.45

Total loans	$	414,402		100.00	%	$	401,246		100.00	%	$	374,609		100.00	%

Following is a table showing the significant industry types in the commercial loan portfolio as of March 31, 2012, December 31, 2011 and March 31, 2011 (dollars in thousands):


	March 31, 2012								December 31, 2011								March 31, 2011
	Outstanding		Percent of			Percent of			Outstanding		Percent of			Percent of			Outstanding		Percent of			Percent of
	Balance		Loans			Capital			Balance		Loans			Capital			Balance		Loans			Capital
Real estate—operators of nonres bldgs	$	78,769		24.71	%		140.42	%	$	75,391		24.22	%		135.53	%	$	58,132		20.20	%		107.46	%
Hospitality and tourism		33,452		10.49			59.63			33,306		10.70			59.87			35,016		12.17			64.73
Commercial construction		22,116		6.95			39.43			19,745		6.34			35.50			23,438		8.14			43.33
Lessors of nonresidential buildings		15,460		4.85			27.56			16,499		5.30			29.66			17,091		5.94			31.59
Real estate agents and managers		13,296		4.17			23.70			10,617		3.41			19.09			15,518		5.39			28.69
Other		155,717		48.84			277.60			155,657		50.02			279.83			138,565		48.15			256.14

Total Commercial Loans	$	318,810		100.00	%				$	311,215		100.00	%				$	287,760		100.00	%

Management recognizes the additional risk presented by the concentration in certain segments of the portfolio. On a historical basis, the Corporation’s highest concentration of credit risk was the hospitality and tourism industry. Management does not consider the current loan concentrations in hospitality and tourism to be problematic, and has no intention of further reducing loans to this industry segment. Management does not believe that its current portfolio composition has increased exposure related to any specific industry concentration as of March 31, 2012. 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, 2012, our residential loan portfolio totaled $81.953 million, or 19.78% of our total outstanding loans.

The Corporation has also extended credit to governmental units, including Native American organizations. Tax-exempt loans and leases decreased from $1.991 million at the end of December 31, 2011 to $1.852 million at March 31, 2012. The Corporation has elected to reduce its tax-exempt portfolio, since it provides no current tax benefit, due to tax net operating loss carryforwards.

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

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS (Continued)

Credit Quality

Management analyzes the allowance for loan losses in detail on a monthly basis to determine whether the losses inherent in the portfolio are properly reserved for. Net charge-offs for the three months ended March 31, 2012 amounted to $.364 million, or .09% of average loans outstanding, compared to $.429 million, or .11% of average loans outstanding, for the same period in 2011. The current reserve balance is representative of the relevant risk inherent within the Corporation’s loan portfolio. Additions or reductions to the reserve in future periods will be dependent upon a combination of future loan growth, nonperforming loan balances and charge-off activity.

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


	March 31,			December 31,			March 31,
	2012			2011			2011
Nonperforming Assets:
Nonaccrual Loans	$	4,457		$	5,490		$	9,859
Loans past due 90 days or more		—			—			—
Restructured loans		2,400			2,503			105

Total nonperforming loans		6,857			7,993			9,964
Other real estate owned		3,494			3,162			5,081

Total nonperforming assets	$	10,351		$	11,155		$	15,045

Nonperforming loans as a % of loans		1.65	%		1.99	%		2.66	%

Nonperforming assets as a % of assets		2.04	%		2.24	%		3.05	%

Reserve for Loan Losses:
At period end	$	5,382		$	5,251		$	6,184

As a % of loans		1.30	%		1.35	%		1.65	%

As a % of nonperforming loans		78.49	%		65.69	%		62.06	%

As a % of nonaccrual loans		120.75	%		95.65	%		62.72	%

Texas ratio*		16.84	%		18.43	%		24.96	%

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

Nonperforming assets at $10.351 million have been reduced in 2012 by $.804 million from the $11.155 million at 2011 year end. This reduction in nonperforming assets reflects management’s efforts in the aggressive remediation of problem credits and disposition of OREO properties.

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


	At Period End
	March 31, 2012			December 31, 2011			March 31, 2011
Total loans, at period end	$	414,402		$	401,246		$	374,609

Average loans for the year	$	404,048		$	388,115		$	380,066


	For the Period Ended
	Three Months Ended			Twelve Months Ended			Three Months Ended
	March 31, 2012			December 31, 2011			March 31, 2011
Net charge-offs during the period	$	364		$	3,662		$	429

Net charge-offs to average loans		.09	%		.94	%		.11	%

Net charge-offs to beginning allowance balance		6.93	%		55.38	%		6.49	%

Management continues to address market issues impacting its loan customer base. In conjunction with the Corporation’s senior lending staff and the bank regulatory examinations, management reviews the Corporation’s loans, related collateral evaluations, and the overall lending process. The Corporation also utilizes an outside loan review consultant to perform a review of the loan portfolio. Historically, this independent review has provided findings similar to management as to the overall adequacy of the loan loss reserve and has substantiated the Corporation’s loan rating system. In 2012, the Corporation will again utilize a consultant for loan review.

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS (Continued)

As of March 31, 2012, the allowance for loan losses represented 1.30% of total loans. At March 31, 2012, the allowance included specific reserves in the amount of $1.384 million, as compared to $1.200 million at December 31, 2011 and $2.389 million at March 31, 2011. In management’s opinion, the allowance for loan losses is adequate to cover probable losses related to specifically identified loans, as well as probable losses inherent in the balance of the loan portfolio.

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

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


	Three Months Ended			Year Ended			Three Months Ended
	March 31, 2012			December 31, 2011			March 31, 2011
Balance at beginning of period	$	3,162		$	5,562		$	5,562
Other real estate transferred from loans due to foreclosure		359			4,194			798
Other real estate sold		(16	)		(5,457	)		(812	)
Writedowns on other real estate held for sale		—			(855	)		(452	)
Loss on sale of other real estate held for sale		(11	)		(282	)		(15	)

Balance at end of period	$	3,494		$	3,162		$	5,081

During the first quarter of 2012, the Corporation received real estate in lieu of loan payments of $.359 million. Other real estate is initially valued at the lower of cost or the fair value less selling costs. After the initial receipt, management periodically re-evaluates the recorded balances and any additional reductions in the fair value result in a write-down of other real estate.

Deposits

The Corporation had an increase in deposits in the first quarter of 2012. Total deposits increased by $7.299 million, or 1.80%, in the first quarter of 2012. The increase in deposits for the first quarter of 2012 is composed of an increase in noncore deposits of $.837 million and an increase in core deposits of $6.462 million. In 2012, the Corporation continued to strategically emphasize the growth of core deposits. This strategic initiative was supported with an individual incentive plan, along with the introduction of several new deposit products and competitive deposit pricing. The core deposit balance increases are primarily in transactional account deposits, our lowest cost of funds.

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

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


	March 31,					December 31,					March 31,
	2012		% of Total			2011		% of Total			2011		% of Total
Noninterest bearing	$	52,470		12.73	%	$	51,273		12.67	%	$	39,269		9.80	%
NOW, money market, checking		151,614		36.80			152,563		37.69			154,420		38.54
Savings		13,601		3.30			14,203		3.51			17,691		4.41
Certificates of Deposit <$100,000		137,501		33.37			130,685		32.28			104,258		26.01

Total core deposits		355,186		86.19			348,724		86.15			315,638		78.76
Certificates of Deposit >$100,000		24,066		5.84			23,229		5.74			21,803		5.44
Brokered CDs		32,836		7.97			32,836		8.11			63,342		15.80

Total non-core deposits		56,902		13.81			56,065		13.85			85,145		21.25

Total deposits	$	412,088		100.00	%	$	404,789		100.00	%	$	400,783		100.00	%

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS (Continued)

Borrowings

The Corporation also utilizes FHLB borrowings as a source of funding. At March 31, 2012, this source of funding totaled $35 million and the Corporation secured this funding by pledging loans and investments. The $35 million of FHLB borrowings has a weighted average maturity of 2.8 years and a weighted average rate of 1.82% at March 31, 2012. The Corporation also has a USDA Rural Development loan held by its wholly owned subsidiary, First Rural Relending that has a fixed interest rate of 1% and matures in August 2024.

Shareholders’ Equity

Total shareholders’ equity increased $.832 million from December 31, 2011 to March 31, 2012. Contributing to the increase in shareholders’ equity was net income of $.498 million, an increase in the market value of securities of $.279 million and the accretion of the discount on preferred stock of $.055 million.

RESULTS OF OPERATIONS

Summary

The Corporation reported net income available to common shareholders of $.498 million, or $.15 per share, in the first quarter of 2012, compared to $.256 million or $.07 per share for the first quarter of 2011. The first quarter results include a provision for loan losses of $.495 million and negligible OREO writedowns and losses. Operating results for the same period in 2011 include no provision for loan losses, and $.467 million of OREO writedowns and losses.

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 $4.767 million, 4.17% of average earning assets, in the first quarter of 2012, compared to $4.166 million, and 3.94% of average earning assets, in the first quarter of 2011. Margin improvement in 2012 was primarily due to a reduction in funding costs between periods.

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS (Continued)

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
																				2011-2010
	Average Balances									Average Rates						Interest				Income/									Rate/
	March 31,						Increase/			March 31,						March 31,				Expense			Volume			Rate			Volume
(dollars in thousands)	2012			2011			(Decrease)			2012			2011			2012		2011		Variance			Variance			Variance			Variance
Loans (1,2,3)	$	404,048		$	380,066		$	23,982			5.59	%		5.55	%	$	5,612	$	5,199	$	413		$	331		$	36		$	46
Taxable securities		36,983			32,271			4,712			2.87			3.54			264		282		(18	)		42			(54	)		(6	)
Nontaxable securities (2)		854			855			(1	)		5.18			5.22			11		11		—			—			—			—
Federal funds sold		14,725			11,611			3,114			.14			.24			5		7		(2	)		2			(3	)		(1	)
Other interest-earning assets		3,070			4,140			(1,070	)		2.62			2.55			20		26		(6	)		(7	)		1			—

Total earning assets		459,680			428,943			30,737			5.17			5.22			5,912		5,525		387			367			(19	)		39

Reserve for loan losses		(5,241	)		(6,687	)		1,446
Cash and due from banks		22,217			27,254			(5,037	)
Fixed Assets		9,825			9,684			141
Other Real Estate		3,194			4,921			(1,727	)
Other assets		13,737			14,746			(1,009	)

Total assets	$	503,412		$	478,861		$	24,551

NOW and money market deposits	$	122,398		$	120,034		$	2,364			.38	%		.79	%	$	117	$	234	$	(117	)	$	5		$	(121	)	$	(1	)
Interest checking		30,269			23,829			6,440			.56			1.17			42		69		(27	)		19			(37	)		(9	)
Savings deposits		13,102			17,741			(4,639	)		.12			.27			4		12		(8	)		(3	)		(7	)		2
CDs <$100,000		134,416			96,735			37,681			1.79			1.90			596		453		143			178			(27	)		(7	)
CDs >$100,000		24,122			22,122			2,000			1.70			1.74			102		95		7			9			(2	)		—
Brokered deposits		32,836			66,380			(33,544	)		1.49			2.18			122		356		(234	)		(181	)		(112	)		59
Borrowings		35,997			36,069			(72	)		1.81			1.57			162		140		22			—			21			1

Total interest-bearing liabilities		393,140			382,910			10,230			1.17			1.44			1,145		1,359		(214	)		27			(285	)		45
Demand deposits		52,107			39,902			12,205
Other liabilities		2,747			2,179			568
Shareholders’ equity		55,418			53,870			1,548

Total liabilities and shareholders’ equity	$	503,412		$	478,861		$	24,551

Rate spread											4.00	%		3.78	%

Net interest margin/revenue											4.17	%		3.94	%	$	4,767	$	4,166	$	601		$	340		$	266		$	(6	)

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

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

We are now into the third year of a low interest rate environment. The Corporation, during this period, repriced all of its brokered deposits along with the majority of its bank time deposits. This repricing of liabilities is the primary reason for the increased interest margin, on a fully taxable equivalent basis, from 3.94% in the first quarter of 2011 to 4.17% in the first quarter of 2012.

During this relatively low interest environment, the Corporation has also repriced a significant portion of its loan portfolio. Management has been diligent when repricing maturing or new loans in establishing interest rate floors in order to maintain our improved interest rate spread.

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 quarter of 2012, the Corporation determined through this analysis that a $.495 million provision for loan loss was required, compared to none required in the first quarter of 2011. Impacting the loan loss provision for the first quarter of 2012 were net charge-offs of $.364 million.

Other Income

Other income increased by $.029 million for the three months ended March 31, 2012, compared to the three months ended March 31, 2011. In the first quarter of 2012, revenue due to 1-4 family loans produced and sold in the secondary market, amounted to $.298 million compared to $.078 million a year ago. We expect to continue to benefit from secondary market activity in future periods. While we recorded no SBA fees in the first quarter of 2012, we anticipate this activity to significantly increase as the year progresses. Service fees and other noninterest income decreased slightly between periods largely because of lower NSF fees, which we believe will continue due to customers being more diligent in managing their accounts.

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.

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS (Continued)

The following table details other income for the three months ended March 31, 2012 and 2011 (dollars in thousands):


	Three Months Ended
	March 31,
					Increase/(Decrease)
	2012		2011		Dollars			Percent
Deposit service fees	$	194	$	217	$	(23	)		(10.60	)%
Income from secondary market loans sold		298		78		220			282.05
SBA/USDA loan sale gains		—		236		(236	)		(100.00	)
Mortgage servicing income		85		—		85			100.00
Other noninterest income		29		46		(17	)		(36.96	)

Total other income	$	606	$	577	$	29			5.03	%

Other Expense

Other expenses decreased $.225 million for the quarter ended March 31, 2012, compared to the same period in 2011. The most significant decline in other expense was in writedowns and losses on OREO. During the first quarter of 2012, the Corporation recorded negligible write-downs and net losses on OREO properties, compared to $.467 million for the same period in 2011. Salaries and employee benefits increased primarily due to increased benefit costs between periods. Management continually reviews all areas of other expense for cost reduction opportunities that will not impact service quality and employee morale.

The following table details other expense for the three months ended March 31, 2012 and 2011 (dollars in thousands):


	Three Months Ended
	March 31,
					Increase/(Decrease)
	2012		2011		Dollars			Percentage
Salaries and employee benefits	$	1,975	$	1,824	$	151			8.28	%
Occupancy		345		365		(20	)		(5.48	)
Furniture and equipment		228		194		34			17.53
Data processing		228		176		52			29.55
Professional service fees		180		153		27			17.65
Loan and deposit		141		179		(38	)		(21.23	)
Writedowns and losses on other real estate held for sale		11		467		(456	)		(97.64	)
FDIC insurance premiums		159		285		(126	)		(44.21	)
Telephone		55		51		4			7.84
Advertising		98		88		10			11.36
Other		414		277		137			49.46

Total other expense	$	3,834	$	4,059	$	(225	)		(5.54	)%

Federal Income Taxes

Current Federal Tax Provision

The Corporation recorded a first quarter provision for income taxes of $.349 million, compared to $.214 million in the first quarter of 2011.

In the first quarter of 2012, management evaluated the deferred tax benefits associated with the net operating loss and tax credit carryforwards based upon the Corporation’s foreseen ability to utilize the benefits of these carryforwards prior to their expiration. As a part of this analysis, management considered, among other things, current asset levels and projected loan and deposit growth, current interest rate spreads and projected net interest income levels, and other income and expense, along with management’s ability to control expenses and the potential for increasing contributions of noninterest income. Management also considered the impact of nonperforming assets and future period charge-off activity relative to projected provisions. Based upon the analysis of projected taxable income and the probability of achieving these projected taxable income levels, no adjustment to the valuation allowance was deemed necessary.

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS (Continued)

Deferred Tax Benefit

As of March 31, 2012, the Corporation had an NOL carryforward of approximately $26.0 million along with various credit carryforwards of $2.1 million. This NOL and credit carryforward benefit is dependent upon the future profitability of the Corporation. A portion of the NOL, approximately $15.6 million, and all of the tax credit carryforwards are also subject to the use limitations of Section 382 of the Internal Revenue Code since they originated prior to the December 2004 recapitalization of the Corporation. These carryforwards, if not utilized, will begin to expire in the year 2023. The annual limitation is $1.4 million for the NOL carryforwards and the equivalent value of tax credits, which is approximately $.477 million.

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

The Corporation recognized deferred taxes of approximately $.349 million and $.214 million for the quarter ended March 31, 2012 and 2011, respectively. Management believes that the Corporation will ultimately utilize all of the NOL carryforwards and a portion of the tax credit carryforwards. The valuation allowance, which stands at $6.010 million as of March 31, 2012 is a conservative measurement of the uncertainty related to the current economy and level of profitability the Corporation will attain in the near term.

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 $16.912 million in cash and due from balances, $14.000 million in federal funds sold and $24.580 million of unpledged investment securities. The Corporation has also experienced significant deposit inflows during the first three months of 2012. Management anticipates reducing liquidity levels in future periods through payments of maturing brokered deposits and funding loan growth.

During the first quarter of 2012, the Corporation decreased cash and cash equivalents by $3.158 million. As shown on the Corporation’s condensed consolidated statement of cash flows, liquidity was impacted by cash provided by investing activities, with a net decrease in investment securities of $2.288 million and a net increase in loans of $13.967 million. Offsetting the net decrease used by investing activities was cash provided by financing activities, primarily a net increase in deposits of $7.299 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.

It is anticipated that during the remainder of 2012, the Corporation will fund anticipated loan production by reducing current balances of liquidity.

The Corporation’s primary source of liquidity on a stand-alone basis is dividends from the Bank. The Bank is currently prohibited from paying dividends because of a deficit in retained earnings. The Bank, in order to pay dividends in future periods, will need to completely eliminate the negative balance of retained earnings through future profits.

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

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS (Continued)

Core deposits are herein defined as demand deposits, NOW (negotiable order withdrawals), money markets, savings and certificates of deposit under $100,000. Noncore funding consists of certificates of deposit greater than $100,000, brokered deposits, and FHLB and Farmers’ Home Administration borrowings. At March 31, 2012, the Bank’s core deposits in relation to total funding were 79.27% compared to 72.25% at March 31, 2011. These ratios indicated at March 31, 2012, that the Bank has decreased its reliance on noncore deposits and borrowings to fund the Bank’s long-term assets, namely loans and investments. The bank believes that by maintaining adequate volumes of short-term investments and implementing competitive pricing strategies on deposits, it can ensure adequate liquidity to support future growth. The Bank also has correspondent lines of credit available to meet unanticipated short-term liquidity needs. As of March 31, 2012, the Bank had $27.500 million of unsecured lines available and another $1.675 million available if secured. The bank believes that its liquidity position remains strong to meet both present and future financial obligations and commitments, events or uncertainties that have resulted or are reasonably likely to result in material changes with respect to the Bank’s liquidity.

From a long-term perspective, the Corporation’s operating plan for 2012 includes strategies to increase core deposits in the Corporation’s local markets. New deposit products and strategic advertising is expected to aid in efforts of management in growing core deposits which will then reduce the dependency on noncore deposits. The Corporation’s operating plan for 2012 calls for augmenting local deposit growth efforts with wholesale CD funding, to the extent necessary.

CAPITAL AND REGULATORY

As a bank holding company, the Corporation is required to maintain certain levels of capital under government regulation. There are several measurements of regulatory capital and the Corporation is required to meet minimum requirements under each measurement. The federal banking regulators have also established capital classifications beyond the minimum requirements in order to risk-rate deposit insurance premiums and to provide trigger points for prompt corrective action in the event an institution becomes financially troubled. As of March 31, 2012, the Corporation and Bank were well capitalized. During the first quarter of 2012, total capitalization increased by $.832 million.

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


	March 31, 2012			December 31, 2011			March 31, 2011
Capital Structure
Shareholders’ equity	$	45,119		$	44,342		$	43,340
Preferred stock		10,976			10,921			10,757

Total shareholders’ equity	$	56,095		$	55,263		$	54,097

Total capitalization	$	56,095		$	55,263		$	54,097

Tangible capital	$	56,095		$	55,263		$	54,097

Intangible Assets
Core deposit premium	$	—		$	—		$	—
Other identifiable intangibles		450			400			—

Total intangibles	$	450		$	400		$	—

Regulatory capital
Tier 1 capital:
Shareholders’ equity	$	56,095		$	55,263		$	54,097
Net unrealized (gains) losses on available for sale securities		(605	)		(325	)		(520	)
Less: disallowed deferred tax asset		(6,000	)		(6,500	)		(8,000	)
Less: intangibles		(45	)		(40	)		—

Total Tier 1 capital	$	49,445		$	48,398		$	45,577

Tier 2 Capital:
Allowable reserve for loan losses	$	5,352		$	5,206		$	4,891
Qualifying long-term debt		—			—			—

Total Tier 2 capital		5,352			5,206			4,891

Total capital	$	54,797		$	53,604		$	50,468

Risk-adjusted assets	$	428,101		$	416,423		$	393,226

Capital ratios:
Tier 1 Capital to average assets		9.95	%		10.08	%		9.70	%
Tier 1 Capital to risk weighted assets		11.55	%		11.62	%		11.69	%
Total Capital to risk weighted assets		12.80	%		12.87	%		12.94	%

MACKINAC FINANCIAL CORPORATION

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

OF OPERATIONS (Continued)

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

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


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

The Corporation:
March 31, 2012		11.08	%		10.99	%		9.95	%		11.55	%		12.80	%
March 31, 2011		10.98	%		10.98	%		9.70	%		11.69	%		12.94	%

The Bank:
March 31, 2012		10.35	%		10.26	%		9.23	%		10.72	%		11.97	%
March 31, 2011		10.02	%		10.02	%		8.54	%		10.29	%		11.54	%

MACKINAC FINANCIAL CORPORATION

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

INTEREST RATE RISK

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

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

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

The Corporation has established interest rate floors on approximately $187 million, or 63% 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 $99 million of the “floor rate” loan balances will reprice with a 100 basis point increase on the prime rate, with another $87 million repricing in the next 100 basis point prime rate increase.

The Corporation also has $36.788 million of securities providing for scheduled monthly principal and interest payments as well as unanticipated prepayments of principal. These cash flows are then reinvested into other earning assets at current market rates. The Corporation also has federal funds sold to correspondent banks as well as other interest-bearing deposits with correspondent banks. These funds are generally repriced on a daily basis.

The Corporation has $217.685 million of transactional accounts, of which $52.470 million consists of noninterest bearing demand deposit balances. Transaction account balances have increased significantly in the last year due in part to the Corporation’s focus on these low costs accounts by developing new attractive products and increased sales efforts to municipalities, schools and businesses. These transactional account balances provide additional repricing flexibility in changing interest rate environments since they have no scheduled maturities and interest rates can be reset at any time.

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

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

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

MACKINAC FINANCIAL CORPORATION

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)

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

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

The following is the Corporation’s opportunities at March 31, 2012 (dollars in thousands):

1-90
Days

91 - 365
Days

>1-5
Years

Over 5
Years

Total

Interest-earning assets:

Loans

293,662

8,385

36,701

75,654

414,402

Securities

2,815

3,233

23,072

7,668

36,788

Other (1)

14,000

—

3,060

17,060

Total interest-earning assets

310,477

11,618

59,773

86,382

468,250

Interest-bearing obligations:

NOW, money market, savings, interest checking

170,002

—

170,002

Time deposits

23,439

52,032

85,852

242

161,565

Brokered CDs

—

30,890

1,946

32,836

Borrowings

—

35,000

997

35,997

Total interest-bearing obligations

193,441

52,032

151,742

3,185

400,400

Gap

117,036

(40,414

)

(91,969

)

83,197

67,850

Cumulative gap

117,036

76,622

(15,347

)

67,850

(1)	Includes Federal Home Loan Bank Stock

The above analysis indicates that at March 31, 2012, the Corporation had a cumulative asset sensitivity gap position of $76.622 million within the one-year time frame. The Corporation’s cumulative asset sensitive gap suggests that if market interest rates continue to decline in the next twelve months, the Corporation may experience a decrease in net interest income. A limitation of the traditional gap analysis is that it does not consider the timing or magnitude of non-contractual repricing or expected prepayments. In addition, the gap analysis treats savings, NOW, and money market accounts as repricing within 90 days, while experience suggests that these categories of deposits are actually comparatively resistant to rate sensitivity.

At December 31, 2011, the Corporation had a cumulative liability sensitivity gap position of $69.219 million within the one-year time frame.

The borrowings in the gap analysis include $35.000 million of FHLB advances that were refinanced in late 2011. These borrowings now have a weighted average maturity of 2.8 years and a weighted average rate of 1.82%.

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.

MACKINAC FINANCIAL CORPORATION

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (Continued)

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

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

FOREIGN EXCHANGE RISK

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

OFF-BALANCE-SHEET RISK

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

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

IMPACT OF INFLATION AND CHANGING PRICES

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

MACKINAC FINANCIAL CORPORATION

ITEM 4 CONTROLS AND PROCEDURES

As of March 31, 2012, 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, 2012.

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, 2012 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

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.

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.

MACKINAC FINANCIAL CORPORATION

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, 2012	By:	/s/ Paul D. Tobias
		PAUL D. TOBIAS,
		CHAIRMAN AND CHIEF EXECUTIVE OFFICER
		(principal executive officer)