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

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

(Exact name of registrant as specified in its charter)

MICHIGAN		38-2062816
(State or other jurisdiction of		(I.R.S. Employer Identification No.)
incorporation or organization)

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ    No o

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

Large accelerated filer o		Accelerated filer o		Non-accelerated filer   o (Do not check if a smaller reporting company)		Smaller Reporting Company þ

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

Yes o    No þ

As of October 31, 2008, there were outstanding 3,419,736 shares of the registrant’s common stock, no par value.

 

 

MACKINAC FINANCIAL CORPORATION
INDEX

		Page No.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets - September 30, 2008 (Unaudited), December 31, 2007 and September 30, 2007 (Unaudited)			1
Condensed Consolidated Statements of Operations — Three and Nine Months Ended September 30, 2008 (Unaudited) and September 30, 2007 (Unaudited)			2
Condensed Consolidated Statements of Changes in Shareholders’ Equity — Three and Nine Months Ended September 30, 2008 (Unaudited) and September 30, 2007 (Unaudited)			3
Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2008 (Unaudited) and September 30, 2007 (Unaudited)			4
Notes to Condensed Consolidated Financial Statements (Unaudited)			5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			15
Item 3. Quantitative and Qualitative Disclosures About Market Risk			28
Item 4. Controls and Procedures			31
PART II. OTHER INFORMATION
Item 1. Legal Proceedings			32
Item 6. Exhibits and Reports on Form 8-K			33
SIGNATURES			34
EX-31.1
EX-31.2
EX-32.1
EX-32.2

MACKINAC FINANCIAL CORPORATION

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)

		September 30,				December 31,				September 30,
(Dollars in thousands)		2008				2007				2007
		(unaudited)								(unaudited)
ASSETS
Cash and due from banks		$	8,217			$	6,196			$	7,364
Federal funds sold			4,422				166				947
Cash and cash equivalents			12,639				6,362				8,311
Interest-bearing deposits in other financial institutions			382				1,810				6,995
Securities available for sale			42,781				21,597				17,973
Federal Home Loan Bank stock			3,794				3,794				3,794
Loans:
Commercial			290,406				288,839				279,670
Mortgage			67,576				62,703				60,972
Installment			3,539				3,537				3,507
Total Loans			361,521				355,079				344,149
Allowance for loan losses			(3,385	)			(4,146	)			(5,022	)
Net loans			358,136				350,933				339,127
Premises and equipment			11,360				11,609				12,733
Other real estate held for sale			1,751				1,226				451
Other assets			10,110				11,549				11,829
TOTAL ASSETS		$	440,953			$	408,880			$	401,213
LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Non-interest-bearing deposits		$	34,858			$	25,557			$	28,325
Interest-bearing deposits:
NOW, Money Market, Checking			80,185				81,160				87,262
Savings			18,957				12,485				12,831
CDs<$100,000			74,940				80,607				90,220
CDs>$100,000			30,220				22,355				24,432
Brokered			121,534				98,663				78,301
Total deposits			360,694				320,827				321,371
Borrowings:
Federal funds purchased			—				7,710				—
Short-term			—				1,959				—
Long-term			36,210				36,280				38,239
Total borrowings			36,210				45,949				38,239
Other liabilities			2,622				2,783				2,906
Total liabilities			399,526				369,559				362,516
Shareholders’ equity:
Preferred stock — No par value:
Authorized 500,000 shares, no shares outstanding
Common stock and additional paid in capital — No par value Authorized - 18,000,000 shares
Issued and outstanding — 3,419,736; 3,428,695; and 3,428,695 shares, respectively			42,794				42,843				42,810
Accumulated deficit			(1,456	)			(3,582	)			(4,107	)
Accumulated other comprehensive income (loss)			89				60				(6	)
Total shareholders’ equity			41,427				39,321				38,697
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY		$	440,953			$	408,880			$	401,213

See accompanying notes to condensed consolidated financial statements.

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in Thousands, Except per Share Data)
(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
		(unaudited)								(unaudited)
INTEREST INCOME:
Interest and fees on loans:
Taxable		$	5,537			$	6,929			$	17,241			$	19,610
Tax-exempt			100				118				310				432
Interest on securities:
Taxable			303				263				840				857
Tax-exempt			1				—				4				—
Other interest income			87				209				257				575
Total interest income			6,028				7,519				18,652				21,474
INTEREST EXPENSE:
Deposits			2,308				3,443				7,924				9,932
Borrowings			349				516				1,194				1,535
Total interest expense			2,657				3,959				9,118				11,467
Net interest income			3,371				3,560				9,534				10,007
Provision for loan losses			450				400				1,200				400
Net interest income after provision for loan losses			2,921				3,160				8,334				9,607
OTHER INCOME:
Service fees			229				169				597				515
Net security gains			(1	)			—				64				—
Net gains on sale of secondary market loans			16				165				113				364
Proceeds from settlement of lawsuit			—				—				3,475				470
Other			44				62				96				302
Total other income			288				396				4,345				1,651
OTHER EXPENSE:
Salaries and employee benefits			1,534				1,695				5,416				5,106
Occupancy			336				322				1,039				983
Furniture and equipment			202				178				570				501
Data processing			212				196				649				577
Professional service fees			120				78				352				403
Loan and deposit			176				63				430				214
Telephone			41				68				125				185
Advertising			93				97				213				280
Other			221				304				803				873
Total other expenses			2,935				3,001				9,597				9,122
Income before income taxes			274				555				3,082				2,136
Provision for (benefit of) income taxes			58				(7,500	)			958				(7,500	)
NET INCOME		$	216			$	8,055			$	2,124			$	9,636
INCOME PER COMMON SHARE:
Basic		$	.06			$	2.35			$	.62			$	2.81
Diluted		$	.06			$	2.35			$	.62			$	2.81

See accompanying notes to condensed consolidated financial statements.

MACKINAC FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Dollars in Thousands)
(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2008				2007				2008				2007
Balance, beginning of period		$	40,975			$	30,485			$	39,321			$	28,790
Net income for period			216				8,055				2,124				9,636
Stock option compensation			21				30				63				90
Net unrealized gain on securities available for sale			215				127				29				181
Total comprehensive income			452				8,212				2,216				9,907
Repurchase of common stock - 8,959 oddlot shares			—				—				(110	)			—
Balance, end of period		$	41,427			$	38,697			$	41,427			$	38,697

See accompanying notes to condensed consolidated financial statements.

MACKINAC FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
(Unaudited)

		Nine Months Ended
		September 30,
		2008				2007
Cash Flows From Operating Activities:
Net income		$	2,124			$	9,636
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization			917				547
Provision for loan losses			1,200				400
Provision for deferred income taxes			—				(7,500	)
(Gain) on sales/calls of securities available for sale			(64	)			—
(Gain) on sales of premises, equipment, and other real estate			(35	)			(12	)
Writedown of other real estate			936				40
Stock option compensation			63				90
Change in other assets			396				221
Change in other liabilities			797				(368	)
Net cash provided by operating activities			6,334				3,054
Cash Flows From Investing Activities:
Net (increase) in loans			(11,144	)			(22,435	)
Net (increase) decrease in interest-bearing deposits in other financial institutions			1,428				(6,139	)
Purchase of securities available for sale			(45,699	)			(18,558	)
Proceeds from maturities, calls or paydowns of securities available for sale			24,542				33,715
Capital expenditures			(519	)			(1,231	)
Proceeds from sale of premises, equipment, and other real estate			1,317				317
Net cash (used in) investing activities			(30,075	)			(14,331	)
Cash Flows From Financing Activities:
Net increase in deposits			39,867				8,950
Net increase (decrease) in federal funds purchased			(7,710	)			—
Net increase (decrease) in lines of credit			(1,959	)			—
Principal payments on borrowings			(70	)			(68	)
Net (decrease) in repurchase of common stock — oddlot shares			(110	)
Net cash provided by financing activities			30,018				8,882
Net increase (decrease) in cash and cash equivalents			6,277				(2,395	)
Cash and cash equivalents at beginning of period			6,362				10,706
Cash and cash equivalents at end of period		$	12,639			$	8,311
Supplemental Cash Flow Information:
Cash paid during the year for:
Interest		$	7,872			$	9,735
Income taxes			44				—
Noncash Investing and Financing Activities:
Transfers of foreclosures from loans to other real estate held for sale (net of adjustments made through the allowance for loan losses)			1,804				443

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 nine month period ended September 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. 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, 2007.
		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 were not changed due to these classifications.
		Allowance for Loan Losses
		The allowance for loan losses includes specific allowances related to commercial loans, which have been judged to be impaired. A loan is impaired when, based on current information, it is probable that the Corporation will not collect all amounts due in accordance with the contractual terms of the loan agreement. These specific allowances are based on discounted cash flows of expected future payments using the loan’s initial effective interest rate or the fair value of the collateral if the loan is collateral dependent.
		The Corporation continues to maintain a general allowance for loan losses for loans not considered impaired. The allowance for loan losses is maintained at a level which management believes is adequate to provide for possible loan losses. Management periodically evaluates the adequacy of the allowance using the Corporation’s past loan loss experience, known and inherent risks in the portfolio, composition of the portfolio, current economic conditions, and other factors. The allowance does not include the effects of expected losses related to future events or future changes in economic conditions. This evaluation is inherently subjective since it requires material estimates that may be susceptible to significant change. Loans are charged against the allowance for loan losses when management believes the collectability of the principal is unlikely. In addition, various regulatory agencies periodically review the allowance for loan losses. These agencies may require additions to the allowance for loan losses based on their judgments of collectability.
		In management’s opinion, the allowance for loan losses is adequate to cover probable losses relating to specifically identified loans, as well as probable losses inherent in the balance of the loan portfolio as of the balance sheet date.
		Stock Option Plans
		The Corporation sponsors three stock option plans. One plan was approved in 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 reverse stock split), were

MACKINAC FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.		SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
		made available for grant under these plans. These two 1997 plans expired early in 2007. 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 are granted at a price equal to the market price of the stock at the date of grant. The committee determines the vesting of the options when they are granted as established under the plan.
		The Corporation adopted SFAS No. 123 (Revised) “Share Based Payments” in the first quarter of 2006. This statement supersedes APB Opinion No. 25 “Accounting for Stock Issued to Employees” and its related implementation guidance. Under Opinion No. 25, issuing stock options to employees generally resulted in recognition of no compensation cost. This adoption resulted in the recognition of before tax compensation expense in the amount of $63,000 for the nine months ended September 30, 2008, and $90,000 for the same period in 2007. The expense recorded recognizes the current period vesting of options outstanding. The per share impact of this accounting change was $.02 and $.03 in the first nine months of 2008 and 2007, respectively.
2.		RECENT ACCOUNTING PRONOUNCEMENT
		FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes
		In July 2006, the Financial Accounting Standards Board (FASB) issued this interpretation to clarify the accounting for uncertainty in tax positions. FIN 48 requires, among other matters, that the Corporation recognize in its financial statements the impact of a tax position, if that position is more likely than not of being sustained on an audit, based on the technical merits of the position. The provisions of FIN 48 were effective as of the beginning of the Corporation’s 2007 fiscal year and required any cumulative effect of the change in accounting principle to be recorded as an adjustment to opening retained earnings. The Corporation did not record an adjustment to retained earnings upon adoption of FIN 48. In future periods, The Corporation will, in accordance with FIN 48, evaluate its tax positions to determine whether or not an adjustment to deferred tax balances and related valuation accounts is warranted.
		SFAS No. 157, Fair Value Measurements
		SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This statement is to be applied in concert with other accounting pronouncements which require or allow fair value measurements. This statement does not require any new fair value adjustments.
		SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (SFAS No. 159)
		SFAS No. 159 permits an entity to measure certain financial assets and financial liabilities at fair value. The Statement’s objective is to improve financial reporting by allowing entities to mitigate volatility in reported earnings caused by the measurement of related assets and liabilities using different attributes, without having to apply complex hedge accounting provisions. Under SFAS No. 159, entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date. The fair value option may be elected on an instrument-by-instrument basis, with a few exceptions, as long as it is applied to the instrument in its entirety. The fair value option election is irrevocable, unless a new election date occurs. The new Statement establishes presentation and disclosure requirements to help financial statement users understand the effect of the entity’s election on its earnings but does not eliminate disclosure requirements of other accounting standards. Assets and liabilities that are measured at fair value must be displayed on the face of the balance sheet.
		SFAS No. 157 and No. 159 were effective January 1, 2008. The adoption of SFAS No. 157 and No. 159 by the Corporation did not have any material impact on the consolidated financial statements.

MACKINAC FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

2.		RECENT ACCOUNTING PRONOUNCEMENTS (Continued)
		The Corporation has reviewed other recent accounting pronouncements by the Financial Accounting Standards Board (FASB), in addition to those noted above and determined that there is no current impact of these accounting pronouncements in the consolidated financial statements of the Corporation.
3.		EARNINGS PER SHARE
		Earnings per share are based upon the weighted average number of shares outstanding.
		Additional shares issued as a result of option exercises would not be dilutive in either period.
		The following shows the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2008 and 2007 (dollars in thousands, except per share data):

Three Months Ended						Weighted Average				Income
September 30,		Net Income				Number of Shares				Per Share
2008
Income per share — Basic and diluted		$	216				3,419,736			$	.06
2007
Income per share — Basic and diluted		$	8,055				3,428,695			$	2.35

Nine Months Ended
September 30,
2008
Income per share — Basic and diluted		$	2,124				3,422,777			$	.62
2007
Income per share — Basic and diluted		$	9,636				3,428,695			$	2.81

4.		INVESTMENT SECURITIES
		The amortized cost and estimated fair value of investment securities available for sale as of September 30, 2008, December 31, 2007 and September 30, 2007 are as follows (dollars in thousands):

		September 30, 2008								December 31, 2007								September 30, 2007
		Amortized				Estimated				Amortized				Estimated				Amortized				Estimated
		Cost				Fair Value				Cost				Fair Value				Cost				Fair Value
US Agencies — MBS		$	42,147			$	42,234			$	—			$	—			$	—			$	—
US Agencies			—				—				20,982				20,969				17,494				17,428
Obligations of states and political subdivisions			499				547				556				628				485				545
Total securities available for sale		$	42,646			$	42,781			$	21,538			$	21,597			$	17,979			$	17,973

The amortized cost and estimated fair value of investment securities pledged to secure FHLB borrowings and customer relationships were $19.243 million and $19.276 million, respectively, at September 30, 2008.

MACKINAC FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

5.		LOANS
		The composition of loans at September 30, 2008, December 31, 2007 and September 30, 2007 is as follows (dollars in thousands):

		September 30,				December 31,				September 30,
		2008				2007				2007
Commercial real estate		$	184,423			$	171,695			$	161,032
Commercial, financial, and agricultural			75,610				78,192				78,822
One to four family residential real estate			62,895				57,613				54,962
Construction:
Commercial			30,373				38,952				39,816
Consumer			4,681				5,090				6,010
Consumer			3,539				3,537				3,507
Total loans		$	361,521			$	355,079			$	344,149

		LOANS — Allowance for loan losses
		An analysis of the allowance for loan losses for the nine months ended September 30, 2008, the year ended December 31, 2007, and the nine months ended September 30, 2007 is as follows: (dollars in thousands):

		September 30,				December 31,				September 30,
		2008				2007				2007
Balance at beginning of period		$	4,146			$	5,006			$	5,006
Recoveries on loans			117				50				39
Loans charged off			(2,078	)			(1,310	)			(423	)
Provision			1,200				400				400
Balance at end of period		$	3,385			$	4,146			$	5,022

		In the first nine months of 2008, net charge off activity was $1.961 million, or .55% of average loans outstanding compared to net charge-offs of $.384 million, or .12% of average loans, in the first nine months of 2007. In the first nine months of 2008, the Corporation recorded a provision for loan loss in the amount of $1.2 million, which is discussed in more detail under “Management’s Discussion and Analysis.”
		LOANS — 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 and that which would have been recorded had nonaccrual and renegotiated loans been current or not troubled was not material to the consolidated financial statements for the nine months ended September 30, 2008 and 2007.

MACKINAC FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

5.		LOANS (Continued)
		Information regarding impaired loans as of September 30, 2008, December 31, 2007 and September 30, 2007 is as follows (dollars in thousands):

														Valuation Reserve
		September 30,				December 31,				September 30,				September 30,				December 31,				September 30,
		2008				2007				2007				2008				2007				2007
		(Unaudited)								(Unaudited)
Balances, at period end
Impaired loans with specific valuation reserve		$	3,913			$	3,639			$	2,889			$	951			$	1,320			$	835
Impaired loans with no specific valuation reserve			736				369				283				—				—				—
Total impaired loans		$	4,649			$	4,008			$	3,172			$	951			$	1,320			$	835
Impaired loans on nonaccrual basis		$	4,649			$	3,298			$	3,136			$	951			$	1,219			$	835
Impaired loans on accrual basis			—				710				36				—				101				—
Total impaired loans		$	4,649			$	4,008			$	3,172			$	951			$	1,320			$	835
Average investment in impaired loans		$	4,732			$	4,135			$	4,018
Interest income recognized during impairment			50				129				71
Interest income that would have been recognized on an accrual basis			263				391				288
Cash-basis interest income recognized			50				84				65

		The average investment in impaired loans was approximately $4.732 million for the nine months ended September 30, 2008, $4.135 million for the year ended December 31, 2007, and $4.018 million for the nine months ended September 30, 2007, respectively. Additional discussion on impaired loans is presented in the “Management’s Discussion and Analysis” section of this report.
		LOANS — Related parties
		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):

		September 30,				December 31,				September 30,
		2008				2007				2007
Loans outstanding beginning of period		$	1,720			$	1,621			$	1,621
New loans			115				—				—
Net activity on revolving lines of credit			2,109				556				—
Repayment			(647	)			(457	)			(449	)
Change in related party interest			3,758				—				—
Loans outstanding end of period		$	7,055			$	1,720			$	1,172

There were no loans to related-parties classified substandard at September 30, 2008, December 31, 2007 or September 30, 2007, respectively. In addition to the outstanding balances above, there were unused commitments of $3.6 million to related parties at September 30, 2008.

MACKINAC FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

6.		SHORT-TERM BORROWINGS
		Short-term borrowings consist of the following at September 30, 2008, December 31, 2007, and September 30, 2007 (dollars in thousands):

		September 30,				December 31,				September 30,
		2008				2007				2007
Fed funds purchased		$	—			$	7,710			$	—
Advance outstanding on line of credit with a correspondent bank, interest payable at the prime rate, 5.00% as of September 30, 2008, maturing November 30, 2008			—				1,959				—
		$	—			$	9,669			$	—

7.		LONG-TERM BORROWINGS
		Long-term borrowings consist of the following at September 30, 2008, December 31, 2007 and September 30, 2007 (dollars in thousands):

		September 30,				December 31,				September 30,
		2008				2007				2007
Federal Home Loan Bank fixed rate advances at rates ranging from 4.98% to 5.16% maturing in 2010		$	15,000			$	15,000			$	15,000
Federal Home Loan Bank variable rate advances at rates of 2.81% maturing in 2011			20,000				20,000				20,000
Advance outstanding on line of credit with a correspondent bank, interest payable at the prime rate, 5.00% as of September 30, 2008, maturing November 30, 2008			—				—				1,959
Farmers Home Administration, fixed-rate note payable, maturing August 24, 2024 interest payable at 1%			1,210				1,280				1,280
		$	36,210			$	36,280			$	38,239

		The Federal Home Loan Bank borrowings are collateralized at September 30, 2008 by the following: a collateral agreement on the Corporation’s one to four family residential real estate loans with a book value of approximately $25.251 million; mortgage related and municipal securities with an amortized cost and estimated fair value of $18.693 million and $18.726 million, respectively; and Federal Home Loan Bank stock owned by the Bank totaling $3.794 million. Prepayment of the remaining advances is subject to the provisions and conditions of the credit policy of the Federal Home Loan Bank of Indianapolis in effect as of September 30, 2008.
		The U.S.D.A. Rural Development borrowing is collateralized by loans totaling $352,000 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 $.964 million, and guaranteed by the Corporation.

MACKINAC FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

8.		STOCK OPTION PLANS
		A summary of stock option transactions for the nine months ended September 30, 2008 and 2007, and the year ended December 31, 2007, is as follows: (Historical stock option information has been adjusted for the 1:20 reverse stock split which occurred in December 2004).

		September 30,				December 31,				September 30,
		2008				2007				2007
Outstanding shares at beginning of year			446,417				446,417				446,417
Granted during the period			—				—				—
Expired during the period			180				—				—
Outstanding shares at end of period			446,237				446,417				446,417
Weighted average exercise price per share at end of period		$	12.14			$	12.29			$	12.29
Shares available for grant at end of period			18,488				18,488				18,488

		There were no options granted in the first nine months of 2008 and 2007.
		Following is a summary of the options outstanding and exercisable at September 30, 2008:

										Weighted Average
Exercise		Number								Remaining				Weighted Average
Price Range		Outstanding				Exercisable				Contractual Life-Years				Exercise Price
$9.16			12,500				5,000				7.21			$	9.16
$9.75			257,152				120,861				6.21				9.75
$10.65			72,500				14,500				8.21				10.65
$11.50			40,000				8,000				7.00				11.50
$12.00			60,000				12,000				6.71				12.00
$156.00 - $240.00			3,545				3,545				2.48				186.75
$300.00 - $406.60			540				540				1.21				333.33
			446,237				164,446				6.66			$	12.14

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. At September 30, 2008, the Corporation evaluated the valuation allowance against the net deferred tax asset which would require future taxable income in order to be utilized. The Corporation, as of September 30, 2008 had a net operating loss and tax credit carryforwards for tax purposes of approximately $34.1 million, and $2.1 million, respectively.
		The Corporation utilized NOL carryforwards to offset taxable income for the first nine months of 2007. In the third quarter of 2007, the Corporation reversed a portion of the valuation allowance, $7.500 million that pertained to the deferred tax benefit of NOL and tax credit carryforwards. This valuation adjustment was recorded as a current period income tax benefit. In 2006, the Corporation recorded a $500,000 tax benefit and utilized additional NOL carryforwards to offset current taxable income. The recognition of the deferred tax benefit in 2007 and 2006 was in accordance with generally accepted accounting principles, and considered among other things, the probability of utilizing the NOL and credit carryforwards.

MACKINAC FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

9.		INCOME TAXES (Continued)
		The Corporation recorded the future benefits from these carryforwards at such time as it became “more likely than not” that they would be utilized prior to expiration. Please refer to further discussion on income taxes contained in “Management’s Discussion and Analysis.” 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 $22 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 $1.4 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.
10.		FAS 157 — FAIR VALUE MEASUREMENTS
		The following tables present information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at September 30, 2008, 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.

		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.
		Disclosures concerning assets and liabilities measured at fair value are as follows (dollars in thousands):

Assets and Liabilities Measured at Fair Value on a Recurring Basis at September 30, 2008

Quoted Prices in Active

Significant Other

Significant

Markets for Identical

Observable Inputs

Unobservable Inputs

Balance at

Assets (Level 1)

(Level 2)

(Level 3)

September 30, 2008

Assets

Investment securities - available for sale

$

42,713

$

68

$

—

$

42,781

Liabilities

None

The Corporation had no Level 3 assets or liabilities on a recurring basis as of December 31, 2007 or September 30, 2008.

MACKINAC FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

10.		FAS 157 — FAIR VALUE MEASUREMENTS (Continued)
		The Corporation also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets include held to maturity investments and loans. The Corporation has estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

Quoted Prices

Significant

Significant

in Active Markets

Other Observable

Unobservable

Total Losses for

Balance at

for Identical Assets

Inputs

Inputs

Three Months Ended

Nine Months Ended

(dollars in thousands)

September 30, 2008

(Level 1)

(Level 2)

(Level 3)

September 30, 2008

September 30, 2008

Assets

Impaired loans accounted for under FAS 114

$

—

$

—

$

640

$

—

$

862

$

—

$

862

		The Corporation had no investments subject to fair value measurement on a nonrecurring basis.
		Impaired loans accounted for under FAS 114 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).
		Other assets, including bank owned life insurance, goodwill, intangible assets and other assets acquired in business combinations, are also subject to periodic impairment assessments under other accounting principles generally accepted in the United States of America. These assets are not considered financial instruments. Effective February 12, 2008, the FASB issued a staff position, FSP FAS 157-2, which delayed the applicability of FAS 157 to nonfinancial instruments. Accordingly, these assets have been omitted from the above disclosures.
		In October 2008, the FASB issued FSP 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. FSP 157-3 provides clarification of the application of FASB 157 in an inactive market. FSP 157-3 is effective for the Corporation’s interim financial statements as of September 30, 2008. This change had no impact on the Corporation’s disclosure on fair value measurements.
11.		COMMITMENTS, CONTINGENCIES AND CREDIT RISK
		Financial Instruments With Off-Balance-Sheet Risk
		The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the consolidated balance sheets.
		The Corporation’s exposure to credit loss, in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit, is represented by the contractual amount of those instruments. The Corporation uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

MACKINAC FINANCIAL CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

11.		COMMITMENTS, CONTINGENCIES AND CREDIT RISK (Continued)
		These commitments are as follows (dollars in thousands):

		September 30,				December 31,				September 30,
		2008				2007				2007
Commitments to extend credit:
Variable rate		$	40,133			$	43,903			$	50,728
Fixed rate			2,752				8,055				10,075
Standby letters of credit — Variable rate			6,308				5,930				5,957
Credit card commitments — Fixed rate			2,457				2,414				2,388
		$	51,650			$	60,302			$	69,148

		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.
		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 September 30, 2008 represents $41.5 million, or 14.29%, compared to $43.4 million, or 15.53%, of the commercial loan portfolio on September 30, 2007. 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.
12.		RECENT DEVELOPMENTS
		The Corporation has applied for capital under the Troubled Asset Relief Program (“TARP”) to strengthen its capital position. For further discussion regarding this, please refer to the Capital and Regulatory portion of “Management’s Discussion and Analysis.”

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 interest rate environment which increase or decrease interest rate margins;
	•		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.

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, 2007. Throughout this discussion, the term “Bank” refers to mBank, the principal banking subsidiary of the Corporation.

FINANCIAL OVERVIEW

Year-to-date consolidated net income was $2.124 million through September 30, 2008, or $.62 per share, compared to income of $9.636 million, $2.81 per share, for the same period in 2007. The income for the three months ended September 30, 2008 amounted to $.216 million, or $.06 per share, compared to income of $8.055 million, or $2.35 per share for the same period in 2007. The results of operations for the first nine months of 2008 include the positive effect, $3.475 million, of a lawsuit settlement, the negative effect, $.425 million, of a severance agreement and a $1.200 million loan loss provision. The results of operations for the same period in 2007 include a provision for the benefit of income taxes in the amount of $7.500 million in recognition of a deferred tax benefit, $470,000, of proceeds from the settlement of a lawsuit against the Corporation’s former accountants, and a provision for loan losses of $400,000.

Total assets increased $32.073 million from December 31, 2007 to September 30, 2008. The loan portfolio increased $6.442 million in the first nine months of 2008, from December 31, 2007 balances of $355.079 million. Deposits totaled $360.694 million at September 30, 2008, an increase of $39.867 million from the $320.827 million at December 31, 2007.

FINANCIAL CONDITION

Cash and Cash Equivalents

Cash and cash equivalents increased $6.277 million in 2008. See further discussion of the change in cash and cash equivalents in the Liquidity section.

Investment Securities

Securities available for sale increased $21.184 million, or 98.09%, from December 31, 2007 to September 30, 2008, with the balance on September 30, 2008, totaling $42.781 million. Investment securities are utilized in an effort to manage interest rate risk and liquidity. As of September 30, 2008, investment securities with an estimated fair value of $19.276 million were pledged.

In the third quarter of 2008, investment securities were increased in order to address overall market liquidity concerns. The Bank’s investment portfolio increased from $23.230 million at June 30, 2008 to $42.781 million on September 30, 2008. This increase of $19.557 million provided the Bank with significant short-term liquidity, since $23.505 million of the investments are unpledged. All of the Bank’s current investments are highly marketable investments guaranteed by the U.S. government.

Loans

Through the third quarter of 2008, loan balances increased by $6.442 million, or 1.81%, from December 31, 2007 balances of $355.079 million. During the first nine months of 2008, the Bank had total loan production of $46.539 million. This loan production, some of which has not yet funded, was significantly offset by normal principal runoff and amortization, $24.320 million, and large paydowns and refinancing, which totaled $18.680 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 changes to the 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 September 30, 2008, December 31, 2007 and September 30, 2007 (dollars in thousands):

		September 30,				Percent of				December 31,				Percent of				September 30,				Percent of
		2008				Total				2007				Total				2007				Total
Commercial real estate		$	184,423				51.01	%		$	171,695				48.35	%		$	161,032				46.79	%
Commercial, financial, and agricultural			75,610				20.91				78,192				22.02				78,822				22.90
One to four family residential real estate			62,895				17.40				57,613				16.23				54,962				15.97
Consumer			3,539				.98				3,537				1.00				3,507				1.02
Construction:
Commercial			30,373				8.40				38,952				10.97				39,816				11.57
Consumer			4,681				1.30				5,090				1.43				6,010				1.75
Total loans		$	361,521				100.00	%		$	355,079				100.00	%		$	344,149				100.00	%