mac

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~March~~June 3130, 2021

☐

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from <> to <>

Commission file number: 0-20167

MACKINAC FINANCIAL CORPORATION

(Exact name of registrant as specified in its charter)


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


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

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

Securities registered pursuant to Section 12(b) of the Act:


Title of each class:	Trading Symbol	Name of each exchange on which registered:
Commmon Stock, No par value	MFNC	The NASDAQ Stock Market, LLC

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

Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ⌧ No ☐

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

Large Accelerated Filer ☐

Accelerated Filer ☒

Non-accelerated Filer ☐

Smaller reporting company ☒

Emerging growth company ☐

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

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

Yes ☐ No ☒

As of ~~May~~August 1211, 2021, there were outstanding 10,550,393 shares of the registrant’s common stock, no par value.

Table of Contents

MACKINAC FINANCIAL CORPORATION

INDEX


		Page No.

PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets – ~~March~~June 3130, 2021 (Unaudited), December 31, 2020	1

	Condensed Consolidated Statements of Operations — Three and Six Months Ended ~~March~~June 3130, 2021 (Unaudited) and ~~March~~June 3130, 2020 (Unaudited)	2

	Condensed Consolidated Statements of Comprehensive Income — Three and Six Months Ended ~~March~~June 3130, 2021 (Unaudited) and ~~March~~June 30, 2020 (Unaudited)	3

	Condensed Consolidated Statements of Changes in Shareholders’ Equity — Three and Six Months Ended ~~March~~June 3130, 2021 (Unaudited) and ~~March~~June 3130, 2020 (Unaudited)	4

	Condensed Consolidated Statements of Cash Flows – ~~Three~~Six Months Ended ~~March~~June 3130, 2021 (Unaudited) and ~~March~~June 3130, 2020 (Unaudited)	6

	Notes to Condensed Consolidated Financial Statements (Unaudited)	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	4142

Item 4.	Controls and Procedures	45

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	46

Item 1A.	Risk Factors	46

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	46



SIGNATURES		48

Table of Contents

MACKINAC FINANCIAL CORPORATION

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)


	~~March~~June 3130,		December 31,
	2021		2020
	(Unaudited)

ASSETS

Cash and due from banks	$	~~239~~341,~~831~~436	$	218,901
Federal funds sold		310,~~661~~041		76
Cash and cash equivalents		~~243~~351,~~492~~477		218,977

Interest-bearing deposits in other financial institutions		2,427		2,917
Securities available for sale		~~109~~101,~~414~~955		111,836
Federal Home Loan Bank stock		4,~~924~~473		4,924

Loans:
Commercial		~~818~~738,~~584~~429		819,907
Mortgage		~~226~~221,~~780~~388		238,705
Consumer		18,~~392~~238		18,980
Total Loans		1978,~~063,756~~055		1,077,592
Allowance for loan losses		(5,~~842~~651)		(5,816)
Net loans		1972,~~057,914~~404		1,071,776

Premises and equipment		2524,~~010~~533		25,518
Other real estate held for sale		1,~~692~~343		1,752
Deferred tax asset		2,~~492~~496		3,303
Deposit based intangibles		4,~~200~~031		4,368
Goodwill		19,574		19,574
Other assets		3734,~~109~~239		36,785

TOTAL ASSETS	$	1,~~508~~518,~~248~~952	$	1,501,730

LIABILITIES AND SHAREHOLDERS’ EQUITY

LIABILITIES:
Deposits:
Noninterest bearing deposits	$	~~443~~459,~~956~~716	$	414,804
NOW, money market, interest checking		~~478~~501,~~181~~251		450,556
Savings		~~137~~141,~~134~~729		130,755
CDs<$250,000		~~190~~178,~~320~~723		202,266
CDs>$250,000		1012,~~337~~384		15,224
Brokered		13,351		45,171
Total deposits		1,~~273~~307,~~279~~154		1,258,776

Federal funds purchased		—		—
Borrowings		28,441		63,479
Borrowings		53,459		63,479
Other liabilities		11,438		11,611
Other liabilities		11,334		11,611
Total liabilities		1,347,033		1,333,866
Total liabilities		1,338,072		1,333,866

SHAREHOLDERS’ EQUITY:
Common stock and additional paid in capital - No par value Authorized - 18,000,000 shares Issued and outstanding - 10,550,393 and 10,500,758 respectively		127,~~397~~624		127,164
Retained earnings		4143,~~721~~189		39,318
Accumulated other comprehensive income
Unrealized gains on available for sale securities		1,~~641~~689		1,965
Minimum pension liability		(583)		(583)
Total shareholders’ equity		~~170~~171,~~176~~919		167,864

TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	1,~~508~~518,~~248~~952	$	1,501,730

Table of Contents

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands, Except per Share Data)

(Unaudited)


	Three Months Ended				Six Months Ended
	~~March~~June 3130,				June 30,
	2021		2020		2021		2020
INTEREST INCOME:
Interest and fees on loans:
Taxable	$	1413,~~121~~414	$	1415,~~613~~549	$	27,535	$	30,162
Tax-exempt		20		7455		40		129
Interest on securities:
Taxable		~~525~~503		~~621~~560		1,028		1,181
Tax-exempt		~~142~~132		87152		274		239
Other interest income		84120		~~270~~125		204		395
Total interest income		14,~~892~~189		1516,~~665~~441		29,081		32,106

INTEREST EXPENSE:
Deposits		~~889~~723		1,~~927~~707		1,612		3,634
Borrowings		~~225~~200		~~341~~276		425		617
Total interest expense		~~1,114~~923		21,~~268~~983		2,037		4,251

Net interest income		13,~~778~~266		1314,~~397~~458		27,044		27,855
Provision for loan losses		50		100		100		200
Net interest income after provision for loan losses		13,~~728~~216		1314,~~297~~358		26,944		27,655

OTHER INCOME:
Deposit service fees		~~257~~265		~~403~~237		522		640
Income from mortgage loans sold on the secondary market		~~1,302~~982		~~538~~1,512		2,284		2,050
SBA/USDA loan sale gains		~~433~~869		~~710~~274		1,302		984
Net mortgage servicing fees		~~241~~154		~~189~~204		395		393
Realized security gains		36—		—		36		—
Other		~~129~~154		97140		283		237
Total other income		2,~~398~~424		12,~~937~~367		4,822		4,304

OTHER EXPENSE:
Salaries and employee benefits		6,~~824~~306		67,~~051~~009		13,130		13,060
Occupancy		1,~~183~~092		1,~~124~~008		2,275		2,132
Furniture and equipment		~~842~~818		~~802~~804		1,660		1,606
Data processing		~~770~~707		~~825~~852		1,477		1,677
Advertising		~~113~~176		~~212~~312		289		524
Professional service fees		~~498~~515		~~498~~574		1,013		1,072
Loan origination expenses and deposit and card related fees		~~450~~419		~~381~~406		869		787
Writedowns and (gains) losses on other real estate held for sale		(52)		3
Writedowns and losses on other real estate held for sale		84		31		32		34
FDIC insurance assessment		~~140~~150		~~150~~165		290		315
Communications		~~241~~259		~~213~~224		500		437
Other		839		1,113
Transaction related expenses		495		—		495		—
Total other expenses		11,848		11,372
Other		891		967		1,730		2,080

Total other expenses		11,912		12,352		23,760		23,724
Income before provision for income taxes		4,278		3,862

Provision for income taxes		398		811
Income before provision for income taxes		3,728		4,373		8,006		8,235

Provision for income taxes		783		919		1,181		1,730
NET INCOME	$	3,880	$	3,051


NET INCOME	$	2,945	$	3,454	$	6,825	$	6,505
INCOME PER COMMON SHARE:

Basic	$	0.37	$	0.28
INCOME PER COMMON SHARE:
Diluted	$	0.37	$	0.28
Basic	$	0.28	$	0.33	$	0.65	$	0.61
Diluted	$	0.28	$	0.33	$	0.65	$	0.61

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MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS COMPREHENSIVE INCOME

(Dollars in Thousands)

(Unaudited)


	Three Months Ended				Six Months Ended
	~~March~~June 3130,				June 30,
	2021		2020		2021		2020
Net income	$	32,~~880~~945	$	3,~~051~~454	$	6,825	$	6,505
Other comprehensive income
Change in securities available for sale:
Unrealized gains arising during the period		(375)		(1,106)
Unrealized gains (losses) arising during the period		61		2,415		(349)		1,309
Reclassification adjustment for securities gains included in net income		(36)		—
Tax effect		(13)		(507)		73		(275)
Tax effect		87		232
Net change in unrealized gains on available for sale securities		48		1,908		(276)		1,034
Net change in unrealized gains on available for sale securities		(324)		(874)


Total comprehensive income	$	2,993	$	5,362	$	6,549	$	7,539
Total comprehensive income	$	3,556	$	2,177

Table of Contents

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in Thousands)

(Unaudited)


	~~Three~~Six Months Ended
	~~March~~June 3130,
	2021
		Common				Accumulated
	Shares of	Stock and				Other
	Common	Additional		Retained		Comprehensive
	Stock	Paid in Capital		Earnings		Income (loss)		Total

Balance, beginning of period	10,500,758	$	127,164	$	39,318	$	1,382	$	167,864

Net income for period	—		—		36,~~880~~825		—		36,~~880~~825
Other comprehensive income
Net unrealized gain on securities available for sale	—		—		—		(~~324~~276)		(~~324~~276)
Total comprehensive income	—		—		36,~~880~~825		(~~324~~276)		36,~~556~~549
Stock compensation	—		~~233~~460		—		—		~~233~~460
Issuance of common stock:
Restricted stock award vesting	49,635		—		—		—		—
Repurchase of common stock	—		—		—		—		—
Dividend on common stock	—		—		(2,954)		—		(2,954)
Dividend on common stock	—		—		(1,477)		—		(1,477)

Balance, end of period	10,550,393	$	127,~~397~~624	$	4143,~~721~~189	$	1,~~058~~106	$	~~170~~171,~~176~~919


	Six Months Ended
	June 30,
	2020
		Common				Accumulated
	Shares of	Stock and				Other
	Common	Additional		Retained		Comprehensive
	Stock	Paid in Capital		Earnings		Income (Loss)		Total

Balance, beginning of period	10,748,712	$	129,564	$	31,740	$	615	$	161,919

Net income for period	—		—		6,505		—		6,505
Other comprehensive income
Net unrealized gain on securities available for sale	—		—		—		1,034		1,034
Total comprehensive income	—		—		6,505		1,034		7,539
Stock compensation	—		378		—		—		378
Issuance of common stock:
Restricted stock award vesting	25,521		—		—		—		—
Repurchase of common stock	(240,644)		(2,729)		—		—		(2,729)
Dividend on common stock	—		—		(2,950)		—		(2,950)

Balance, end of period	10,533,589	$	127,213	$	35,295	$	1,649	$	164,157

Table of Contents

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Dollars in Thousands)

(Unaudited)

Three Months Ended

June 30,

2021

Common

Accumulated

Shares of

Stock and

Other

Common

Additional

Retained

Comprehensive

Stock

Paid in Capital

Earnings

Income

Total

Balance, beginning of period

10,550,393

127,397

41,721

1,058

170,176

Net income for period

—

2,945

—

2,945

Other comprehensive income

Net unrealized gain on securities available for sale

—

Total comprehensive income

—

2,945

2,993

Stock compensation

—

227

—

227

Dividend on common stock

—

(1,477)

—

(1,477)

Balance, end of period

10,550,393

127,624

43,189

1,106

171,919


	Three Months Ended
	March 31,
	2020
		Common				Accumulated
	Shares of	Stock and				Other
	Common	Additional		Retained		Comprehensive
	Stock	Paid in Capital		Earnings		Income		Total

Balance, beginning of period	10,748,712	$	129,564	$	31,740	$	615	$	161,919

Net income for period	—		—		3,051		—		3,051
Other comprehensive income
Net unrealized gain on securities available for sale	—		—		—		(874)		(874)
Total comprehensive income	—		—		3,051		(874)		2,177
Stock compensation	—		168		—		—		168
Issuance of common stock:
Restricted stock award vesting	25,521		—		—		—		—
Repurchase of common stock	(240,644)		(2,729)		—		—		(2,729)
Dividend on common stock	—		—		(1,475)		—		(1,475)

Balance, end of period	10,533,589	$	127,003	$	33,316	$	(259)	$	160,060


	Three Months Ended
	June 30,
	2020
		Common				Accumulated
	Shares of	Stock and				Other
	Common	Additional		Retained		Comprehensive
	Stock	Paid in Capital		Earnings		Income		Total

Balance, beginning of period	10,533,589	$	127,003	$	33,316	$	(259)	$	160,060

Net income for period	—		—		3,454		—		3,454
Other comprehensive income
Net unrealized gain on securities available for sale	—		—		—		1,908		1,908
Total comprehensive income	—		—		3,454		1,908		5,362
Stock compensation	—		210		—		—		210
Dividend on common stock	—		—		(1,475)		—		(1,475)

Balance, end of period	10,533,589	$	127,213	$	35,295	$	1,649	$	164,157

Table of Contents

MACKINAC FINANCIAL CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in Thousands)

(Unaudited)


	~~Three~~Six Months Ended
	~~March~~June 3130,
	2021		2020
Cash Flows from Operating Activities:
Net income	$	36,~~880~~825	$	36,~~051~~505
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		~~812~~1,311		~~687~~1,407
Provision for loan losses		50100		~~100~~200
Deferred tax expense, net		~~179~~1,330		~~456~~866
Gain on sale of loans sold in the secondary market		(12,~~168~~021)		(~~447~~1,744)
Origination of loans held for sale in the secondary market		(3566,~~131~~069)		(1886,~~997~~389)
Proceeds from sale of loans in the secondary market		3667,~~597~~986		1687,~~900~~517
(Gain) on sale other real estate held for sale and fixed assets		(52)		—
Loss on sale other real estate held for sale and fixed assets		235		—
Writedown of other real estate held for sale		—83		330
Stock compensation		~~233~~460		~~168~~378
Change in other assets		~~(339)~~2,434		~~2,090~~(319)
Change in other liabilities		(~~277~~173)		~~(667)~~601
Net cash provided by operating activities		412,~~784~~501		39,~~344~~052

Cash Flows from Investing Activities:
Net increase in loans		13,962		17,200
Net decrease (increase) in loans		98,776		(94,217)
Net decrease in interest bearing deposits in other financial institutions		490		12,~~470~~464
Purchase of securities available for sale		(4,338)		(1719,~~873~~224)
Proceeds from maturities, sales, calls or paydowns of securities available for sale		613,~~279~~720		919,~~988~~733
Capital expenditures		(233)		(1,584)
Redemption of FHLBI stock		451		—
Proceeds from sale of other real estate, premises and fixed assets		565		67
Capital expenditures		(463)		(3,344)
Net cash used in investing activities		16,725		9,268
Proceeds from sale of other real estate, premises and fixed assets		977		332
Net cash provided by (used in) investing activities		109,613		(94,256)

Cash Flows from Financing Activities:
Net increase in deposits		1448,~~503~~378		19151,~~704~~875
Net activity on line of credit		—		3,000
Net decrease in fed funds purchased		—		(6,225)
Net decrease in fed funds purchased		—		16,565
New term debt issuance		—		100,281
New term debt issuance		—		10,000
Principal payments on borrowings		(35,038)		(50,366)
Principal payments on borrowings		(10,020)		(10,431)
Repurchase of common stock		—		(2,729)
Dividend on common stock		(12,~~477~~954)		(12,~~475~~950)
Net cash provided by financing activities		310,~~006~~386		34189,~~634~~886

Net increase in cash and cash equivalents		24132,~~515~~500		47104,~~246~~682
Cash and cash equivalents at beginning of period		218,977		49,826

Cash and cash equivalents at end of period	$	~~243~~351,~~492~~477	$	97154,~~072~~508

Supplemental Cash Flow Information:
Cash paid during the year for:
Cash paid during the six months for:
Interest	$	12,~~356~~333	$	24,~~242~~361
Income taxes		—		—

Noncash Investing and Financing Activities:
Transfers of Foreclosures from Loans to Other Real Estate Held for Sale		~~448~~600		~~155~~333
Transfers of Other Real Estate Held for Sale to Fixed Assets		—		—

Table of Contents

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 and six month period ended ~~March~~June 3130, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021. 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, 2020.

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 unchanged by these reclassifications.

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

Acquired Loans

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

In recording the fair values of acquired impaired loans at acquisition date, management calculates a non-accretable difference (the credit component of the purchased loans) and an accretable difference (the yield component of the purchased loans).

Over the life of the acquired loans, management continues to estimate cash flows expected to be collected. We evaluate at each balance sheet date whether it is probable that we will be unable to collect all cash flows expected at acquisition and if so, recognize a provision for loan loss in our consolidated statement of operations. For any significant increases in cash flows expected to be collected, we adjust the amount of the accretable yield recognized on a prospective basis over the pool’s remaining life.

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

Table of Contents

Allowance for Loan Losses

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

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

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

Stock Compensation Plans

On May 22, 2012, the Corporation’s shareholders approved the Mackinac Financial Corporation 2012 Incentive Compensation Plan, under which current and prospective employees, non-employee directors and consultants may be awarded incentive stock options, non-statutory stock options, shares of restricted stock awards (“RSAs”), stock grants, or stock appreciation rights. The aggregate number of shares of the Corporation’s common stock issuable under the plan is 575,000. At ~~March~~June 3130, 2021 there were 6,560 shares available for issuance under this plan. Awards are made to executive officers at the discretion of the compensation committee of the board of directors. Awards are made to certain other senior officers at the discretion of the Corporation’s management. Compensation cost equal to the fair value of the award is recognized over the vesting period.

2.	RECENT ACCOUNTING PRONOUNCEMENTS

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

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

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

ASU 2016-13 also amends the impairment model for available-for-sale debt securities and requires entities to determine whether all or a portion of the unrealized loss on an available-for-sale debt security is a credit loss. Management may not use the length of time a security has been in an unrealized loss position as a factor in concluding whether a credit loss exists, as is currently permitted. In addition, an entity will recognize an allowance for credit losses on available-for-sale

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debt securities as a contra-account to the amortized cost basis rather than as a direct reduction of the amortized cost basis of the investment, as is currently required. As a result, entities will recognize improvements to credit losses on available-for-sale debt securities immediately in earnings rather than as interest income over time under current practice.

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

Upon adoption of ASU 2016-13, a cumulative-effect adjustment to retained earnings will be recorded as of the beginning of the first reporting period in which the guidance is effective. The Corporation is currently evaluating the provisions of ASU 2016-13 to determine the potential impact on the Corporation's consolidated financial condition and results of operations. The Corporation has formed a cross-functional implementation team consisting of individuals from finance, credit and information systems. A project plan and timeline has been developed and the implementation team meets regularly to assess the project status to ensure adherence to the timeline. The implementation team has also been working with a software vendor to assist in implementing required changes to credit loss estimation models and proceses, and is finalizing the historical data collected to be utilized in the credit loss models. The Corporation expects to recognize a cumulative effect adjustment to the opening balance of retained earnings as of the beginning of the first reporting period in which ASU 2016-13 is effective. The Corporation has not yet determined the magnitude of any such one-time adjustment or the potential impact of ASU 2016-13 on its condensed consolidated financial statements. In October 2019 the Financial Accounting Standards Board (FASB) voted to defer the effective date of ASU 2016-13 to fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, for smaller reporting companies (as defined by the Securities Exchange Commission).

3.	EARNINGS PER SHARE

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

The following shows the computation of basic and diluted earnings per share for the three and six months ended ~~March~~June 3130, 2021 and 2020 (dollars in thousands, except per share data):


	Three Months Ended ~~March~~June 3130,				Six Months Ended June 30,
	2021		2020		2021		2020

(Numerator):
Net income	$	32,~~880~~945	$	3,~~051~~454	$	6,825	$	6,505

(Denominator):
Weighted average shares outstanding		10,~~522~~550,~~899~~393		10,~~717~~533,~~967~~589		10,536,722		10,625,778
Effect of restricted stock awards		—67,029		~~96,824~~—		45,875		—
Diluted weighted average shares outstanding		10,~~522~~617,~~899~~422		10,~~814~~533,~~791~~589		10,582,597		10,625,778
Income per common share:
Basic	$	0.3728	$	0.2833	$	0.65	$	0.61
Diluted	$	0.3728	$	0.2833	$	0.65	$	0.61

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4.	INVESTMENT SECURITIES

At ~~March~~June 3130, 2021, the Corporation had an investment security portfolio totaling $~~109~~101.~~414~~955 million, a decrease of $29.~~422~~881 million from the December 31, 2020 balance of $111.836 million. The amortized cost and estimated fair value of investment securities available for sale as of ~~March~~June 3130, 2021 and December 31, 2020 are as follows (dollars in thousands):


			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Fair Value

March 31, 2021
June 30, 2021

US Treasury	$	1,~~067~~064	$	32	$	—	$	1,~~070~~066
Corporate		29,~~042~~006		~~304~~497		(~~222~~63)		29,~~124~~440
US Agencies		6,~~486~~492		7846		—		6,~~564~~538
US Agencies - MBS		3027,~~389~~924		~~906~~789		(32)		3128,~~292~~711
Obligations of states and political subdivisions		4035,~~353~~331		~~1,061~~903		(5034)		4136,~~364~~200

Total securities available for sale	$	~~107~~99,~~337~~817	$	2,~~352~~237	$	(~~275~~99)	$	~~109~~101,~~414~~955

December 31, 2020

US Treasury	$	—	$	—	$	—	$	—
Corporate		27,815		247		(19)		28,043
US Agencies		6,480		109		—		6,589
US Agencies - MBS		33,372		914		(6)		34,280
Obligations of states and political subdivisions		41,682		1,242		—		42,924

Total securities available for sale	$	109,349	$	2,512	$	(25)	$	111,836

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The following table presents the amortized cost and estimated fair value of investment securities by contractual maturity as of ~~March~~June 3130, 2021 and December 31, 2020 (dollars in thousands):


	~~March~~June 3130,				December 31,
	2021				2020
	Amortized		Estimated		Amortized		Estimated
	Cost		Fair Value		Cost		Fair Value
Available -for-sale securities
Under 1 year	$	1417,~~366~~326	$	1417,~~518~~549	$	15,645	$	15,820
After 1 year through 5 years		2118,~~202~~937		2119,~~754~~252		22,554		23,201
After 5 years through 10 years		2721,~~548~~849		2722,~~724~~282		24,965		25,261
After 10 years		13,~~832~~781		14,~~126~~161		12,813		13,274
Subtotal		7671,~~948~~893		7873,~~122~~244		75,977		77,556
US Agencies - MBS		3027,~~389~~924		3128,~~292~~711		33,372		34,280

Total available -for-sale securities	$	~~107~~99,~~337~~817	$	~~109~~101,~~414~~955	$	109,349	$	111,836

The following is information pertaining to securities with gross unrealized losses at ~~March~~June 3130, 2021 and December 31, 2020 (dollars in thousands):


	Less Than Twelve Months						Over Twelve Months						Total
	Number				Gross		Number				Gross		Number				Gross
	of		Fair		Unrealized		of		Fair		Unrealized		of		Fair		Unrealized
March 31, 2021	Securities		Value		Loss		Securities		Value		Loss		Securities		Value		Loss
June 30, 2021	Securities		Value		Loss		Securities		Value		Loss		Securities		Value		Loss
Corporate		83		147,~~753~~870	$	(~~222~~63)		—		—	$	—		83	$	147,~~753~~870	$	(~~222~~63)
US Agencies		—		—		—		—		—		—		—		—		—
US Agencies - MBS		—		—		—		43		~~150~~138		(32)		43		~~150~~138		(32)
Obligations of states and political subdivisions		2		1,~~373~~387		(5034)		—		—		—		2		1,~~373~~387		(5034)
Total		105	$	169,~~126~~257	$	(~~272~~97)		43	$	~~150~~138	$	(32)		148	$	169,~~276~~395	$	(~~275~~99)


	Less Than Twelve Months						Over Twelve Months						Total
	Number				Gross		Number				Gross		Number				Gross
	of		Fair		Unrealized		of		Fair		Unrealized		of		Fair		Unrealized
December 31, 2020	Securities		Value		Loss		Securities		Value		Loss		Securities		Value		Loss
Corporate		4	$	9,293	$	(19)		—	$	—	$	—		4	$	9,293	$	(19)
US Agencies		—		—		—		—		—		—		—		—		—
US Agencies - MBS		4		83		(2)		2		123		(4)		6		206		(6)
Obligations of states and political subdivisions		—		—		—		—		—		—		—		—		—
Total		8	$	9,376	$	(21)		2	$	123	$	(4)		10	$	9,499	$	(25)

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

The amortized cost and estimated fair value of investment securities pledged to secure FHLB borrowings and customer relationships were $2018.~~887~~691 million and $219.~~285~~162 million, respectively, at ~~March~~June 3130, 2021.

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LOANS

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


	~~March~~June 3130,		December 31,
	2021		2020

Commercial real estate	$	~~496~~480,~~257~~477	$	498,450
Commercial, financial, and agricultural		~~273~~209,~~087~~747		273,759
Commercial construction		4948,~~240~~205		47,698
One to four family residential real estate		~~214~~210,~~034~~364		227,044
Consumer		18,~~392~~238		18,980
Consumer construction		1211,~~746~~024		11,661

Total loans	$	1978,~~063,756~~055	$	1,077,592

The Corporation completed the acquisition of Peninsula Financial Corporation (“PFC”) on December 5, 2014, The First National Bank of Eagle River (“Eagle River”) on April 29, 2016, Niagara Bancorporation (“Niagara”) on August 31, 2016, First Federal of Northern Michigan Bancorp (“FFNM”) on May 18, 2018 and Lincoln Community Bank (“Lincoln”) on October 1, 2018. The PFC acquired impaired loans totaled $13.290 million, the Eagle River acquired impaired loans totaled $3.401 million, the Niagara acquired impaired loans totaled $2.105 million, the FFNM acquired impaired loans totaled $5.440 million, and the Lincoln acquired impaired loans totaled $1.901 million.

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


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

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


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

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


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

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


	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	5,440	$	187,302	$	192,742
Nonaccretable difference		(2,100)		—		(2,100)
Expected cash flows		3,340		187,302		190,642
Accretable yield		(700)		(4,498)		(5,198)
Carrying balance at acquisition date	$	2,640	$	182,804	$	185,444

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


	Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total
Loans acquired - contractual payments	$	1,901	$	37,700	$	39,601
Nonaccretable difference		(421)		—		(421)
Expected cash flows		1,480		37,700		39,180
Accretable yield		(140)		(493)		(633)
Carrying balance at acquisition date	$	1,340	$	37,207	$	38,547

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The table below presents a rollforward of the accretable yield on acquired loans for the ~~three~~six months ended ~~March~~June 3130, 2021 (dollars in thousands):


	PFC						Eagle River
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total
Balance, December 31, 2020	$	53	$	—	$	53	$	183	$	—	$	183
Accretion		(212)		—		(212)		—(153)		—		—(153)
Reclassification from nonaccretable difference		29		—		29		—114		—		—114
Balance, March 31, 2021	$	53	$	—	$	53	$	183	$	—	$	183
Balance, June 30, 2021	$	50	$	—	$	50	$	144	$	—	$	144

	Niagara						First Federal Northern Michigan
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total
Balance, December 31, 2020	$	12	$	—	$	12	$	292	$	869	$	1,161
Accretion		—(1)		—		—(1)		(3276)		(~~205~~384)		(~~208~~660)
Reclassification from nonaccretable difference		—1		—		—1		2207		~~(1)~~—		1207
Balance, March 31, 2021	$	12	$	—	$	12	$	291	$	663	$	954
Balance, June 30, 2021	$	12	$	—	$	12	$	223	$	485	$	708

	Lincoln Community Bank						Total
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total
Balance, December 31, 2020	$	85	$	130	$	215	$	625	$	999	$	1,624
Accretion		(1109)		(2650)		(27159)		(6551)		(~~231~~434)		(~~237~~985)
Reclassification from nonaccretable difference		181		—		181		5412		~~(1)~~—		4412
Balance, March 31, 2021	$	85	$	104	$	189	$	624	$	767	$	1,391
Balance, June 30, 2021	$	57	$	80	$	137	$	486	$	565	$	1,051

The table below presents a rollforward of the accretable yield on acquired loans for the ~~three~~six months ended ~~March~~June 3130, 2020 (dollars in thousands):


	PFC						Eagle River
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total

Balance, December 31, 2019	$	105	$	—	$	105	$	209	$	—	$	209
Accretion		(90150)		—		(90150)		(77)		—		(77)
Reclassification from nonaccretable difference		52113		—		52113		58		—		58
Balance, March 31, 2020	$	67	$	—	$	67	$	190	$	—	$	190
Balance, June 30, 2020	$	68	$	—	$	68	$	190	$	—	$	190

	Niagara						First Federal Northern Michigan
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total

Balance, December 31, 2019	$	19	$	—	$	19	$	518	$	1,953	$	2,471
Accretion		(4)		—		(4)		(237)		(~~310~~595)		(~~547~~832)
Reclassification from nonaccretable difference		3		—		3		177		—1		~~177~~178
Balance, March 31, 2020	$	18	$	—	$	18	$	458	$	1,643	$	2,101
Balance, June 30, 2020	$	18	$	—	$	18	$	458	$	1,359	$	1,817

	Lincoln Community Bank						Total
	Acquired		Acquired		Acquired		Acquired		Acquired		Acquired
	Impaired		Non-impaired		Total		Impaired		Non-impaired		Total

Balance, December 31, 2019	$	108	$	264	$	372	$	959	$	2,217	$	3,176
Accretion		(3)		(3873)		(4176)		(~~411~~471)		(~~348~~668)		(~~759~~1,139)
Reclassification from nonaccretable difference		3		—		3		~~293~~354		—1		~~293~~355
Balance, March 31, 2020	$	108	$	226	$	334	$	841	$	1,869	$	2,710
Balance, June 30, 2020	$	108	$	191	$	299	$	842	$	1,550	$	2,392

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Allowance for Loan Losses

An analysis of the allowance for loan losses for the ~~three~~six months ended ~~March~~June 3130, 2021 and ~~March~~June 30, 2020 is as follows (dollars in thousands):


	~~March~~June 3130,		~~March~~June 3130,
	2021		2020

Balance, January 1	$	5,816	$	5,308
Recoveries on loans previously charged off		3145		29139
Loans charged off		(55310)		(~~145~~292)
Provision		50100		~~100~~200

Balance at end of period	$	5,~~842~~651	$	5,~~292~~355

In the first ~~three~~six months of 2021, net charge-offs were $24265,000, compared to net charge-offs of $~~116~~153,000 in the same period in 2020. In the first ~~three~~six months of 2021, the Corporation recorded a provision for loan loss of $50100,000 compared to a $~~100~~200,000 provision for loan losses in the first ~~three~~six months of 2020. 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~~June 3130, 2021 is as follows (dollars in thousands):


			Commercial,				One to four
	Commercial		financial and		Commercial		family residential		Consumer
	real estate		agricultural		construction		real estate		construction		Consumer		Unallocated		Total
Three Months Ended June 30, 2021
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,~~983~~738	$	12,~~734~~076	$	209	$	~~605~~560	$	8	$	56	$	~~272~~245	$	5,~~816~~842
Charge-offs		~~(8)~~—		—(46)		—		(18185)		~~(29)~~—		—(24)		—		(55255)
Recoveries		34		113		—		54		12—		—3		—		3114
Provision		(~~240~~9)		~~331~~(559)		—(2)		~~(32)~~202		17(3)		123		~~(27)~~398		50
Ending balance ALLR	$	2,~~738~~733	$	21,~~076~~474	$	~~209~~207	$	~~560~~581	$	85	$	68	$	~~245~~643	$	5,~~842~~651

Six Months Ended June 30, 2021
Allowance for loan loss reserve:
Beginning balance ALLR	$	2,983	$	1,734	$	209	$	605	$	5	$	8	$	272	$	5,816
Charge-offs		(8)		(46)		—		(203)		—		(53)		—		(310)
Recoveries		7		14		—		9		—		15		—		45
Provision		(249)		(228)		(2)		170		—		38		371		100
Ending balance ALLR	$	2,733	$	1,474	$	207	$	581	$	5	$	8	$	643	$	5,651

At June 30, 2021
Loans:
Ending balance	$	~~496~~480,~~257~~477	$	~~273~~209,~~087~~747	$	4948,~~240~~205	$	~~214~~210,~~034~~364	$	1211,~~746~~024	$	18,~~392~~238	$	—	$	1978,~~063,756~~055
Ending balance ALLR		(2,~~738~~733)		(21,~~076~~474)		(~~209~~207)		(~~560~~581)		(85)		(68)		(~~245~~643)		(5,~~842~~651)
Net loans	$	~~493~~477,~~519~~744	$	~~271~~208,~~011~~273	$	4947,~~031~~998	$	~~213~~209,~~474~~783	$	1211,~~738~~019	$	18,~~386~~230	$	(~~245~~643)	$	1972,~~057,914~~404

Ending balance ALLR:
Individually evaluated	$	~~277~~258	$	~~594~~302	$	—	$	—	$	—	$	—	$	—	$	~~871~~560
Collectively evaluated		2,~~461~~475		1,~~482~~172		~~209~~207		~~560~~581		85		68		~~245~~643		45,~~971~~091
Total	$	2,~~738~~733	$	21,~~076~~474	$	~~209~~207	$	~~560~~581	$	85	$	68	$	~~245~~643	$	5,~~842~~651

Ending balance Loans:
Individually evaluated	$	1,~~975~~957	$	3,~~887~~421	$	~~261~~359	$	—	$	—	$	—	$	—	$	65,~~123~~737
Collectively evaluated		~~493~~477,~~125~~550		~~268~~206,~~972~~198		4847,~~890~~761		~~213~~209,~~231~~667		1211,~~730~~024		18,~~392~~223		—		1970,~~055,340~~423
Acquired with deteriorated credit quality		~~1,157~~970		~~228~~128		8985		~~803~~697		16—		—15		—		21,~~293~~895
Total	$	~~496~~480,~~257~~477	$	~~273~~209,~~087~~747	$	4948,~~240~~205	$	~~214~~210,~~034~~364	$	1211,~~746~~024	$	18,~~392~~238	$	—	$	1978,~~063,756~~055

Impaired loans, by definition, are individually evaluated.

In the first ~~three~~six months of 2021, the Corporation booked a provision for loan losses of $50100,000 ~~as a result of changes in environmental factors~~.

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A breakdown of the allowance for loan losses and recorded balances in loans at ~~March~~June 3130, 2020 is as follows (dollars in thousands):


			Commercial,				One to four
	Commercial		financial and		Commercial		family residential		Consumer
	real estate		agricultural		construction		real estate		construction		Consumer		Unallocated		Total
Three Months Ended June 30, 2020
Allowance for loan loss reserve:
Beginning balance ALLR	$	1,818	$	1,633	$	98	$	427	$	10	$	10	$	1,296	$	5,292
Charge-offs		—		(121)		—		(10)		—		(16)		—		(147)
Recoveries		85		—		1		1		—		23		—		110
Provision		(65)		347		21		(18)		—		(8)		(177)		100
Ending balance ALLR	$	1,838	$	1,859	$	120	$	400	$	10	$	9	$	1,119	$	5,355

Six Months Ended June 30, 2020
Allowance for loan loss reserve:
Beginning balance ALLR	$	1,189	$	1,197	$	71	$	148	$	11	$	13	$	2,679	$	5,308
Charge-offs		—		(66187)		—		(2232)		(8)		(4965)		—		(~~145~~292)
Recoveries		691		—		—1		1011		—		1336		—		29139
Provision		~~623~~558		~~502~~849		2748		~~291~~273		7		3325		(1,~~383~~560)		~~100~~200
Ending balance ALLR	$	1,~~818~~838	$	1,~~633~~859	$	98120	$	~~427~~400	$	10	$	109	$	1,~~296~~119	$	5,~~292~~355

At June 30, 2020
Loans:
Ending balance	$	~~522~~507,~~659~~530	$	~~207~~332,~~727~~279	$	2938,~~971~~712	$	~~244~~235,~~059~~467	$	1920,~~386~~057	$	2019,~~375~~745	$	—	$	1,~~044~~153,~~177~~790
Ending balance ALLR		(1,~~818~~838)		(1,~~633~~859)		(98120)		(~~427~~400)		(10)		(109)		(1,~~296~~119)		(5,~~292~~355)
Net loans	$	~~520~~505,~~841~~692	$	~~206~~330,~~094~~420	$	2938,~~873~~592	$	~~243~~235,~~632~~067	$	1920,~~376~~047	$	2019,~~365~~736	$	(1,~~296~~119)	$	1,~~038~~148,~~885~~435

Ending balance ALLR:
Individually evaluated	$	~~913~~914	$	~~476~~527	$	—	$	—	$	—	$	—	$	—	$	1,~~389~~441
Collectively evaluated		~~905~~924		1,~~157~~332		98120		~~427~~400		10		109		1,~~296~~119		3,~~903~~914
Total	$	1,~~818~~838	$	1,~~633~~859	$	98120	$	~~427~~400	$	10	$	109	$	1,~~296~~119	$	5,~~292~~355

Ending balance Loans:
Individually evaluated	$	2,~~278~~436	$	1,~~454~~589	$	—	$	—	$	—	$	—	$	—	$	34,~~732~~025
Collectively evaluated		~~518~~503,~~642~~233		~~203~~330,~~857~~433		2938,~~604~~531		~~243~~234,~~251~~576		1920,~~386~~057		2019,~~374~~723		—		1,~~035~~146,~~114~~553
Acquired with deteriorated credit quality		1,~~739~~861		~~2,416~~257		~~367~~181		~~808~~891		—		122		—		53,~~331~~212
Total	$	~~522~~507,~~659~~530	$	~~207~~332,~~727~~279	$	2938,~~971~~712	$	~~244~~235,~~059~~467	$	1920,~~386~~057	$	2019,~~375~~745	$	—	$	1,~~044~~153,~~177~~790

As part of the management of the loan portfolio, risk ratings are assigned to all commercial loans. Through the loan review process, ratings are modified as believed to be appropriate to reflect changes in the credit. Our ability to manage credit risk depends in large part on our ability to properly identify and manage problem loans.

To do so, we operate a credit risk rating system under which our credit management personnel assign a credit risk rating to each loan at the time of origination and review loans on a regular basis to determine each loan’s credit risk rating on a scale of 1 through 8, with higher scores indicating higher risk. The credit risk rating structure used is shown below.

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

Strong (1)

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

Good (2)

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

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Average (3)

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

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Acceptable (4)

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

Acceptable Watch (44)

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

Substandard (6)

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

Doubtful (7)

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

Charge-off/Loss (8)

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

General Reserves:

For loans with a credit risk rating of 44 or better and any loans with a risk rating of 6 or 7 not considered impaired, reserves are established based on the type of loan collateral, if any, and the assigned credit risk rating.

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

Using a historical average loss by loan type as a base, each loan graded as higher risk is assigned a specific percentage. The residential real estate and consumer loan portfolios are assigned a loss percentage as a homogenous group. If, however, on an individual loan the projected loss based on collateral value and payment histories is 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.

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Below is a breakdown of loans by risk category as of ~~March~~June 3130, 2021 (dollars in thousands):


	(1)		(2)		(3)		(4)		(44)		(6)		(7)		Rating
	Strong		Good		Average		Acceptable		Acceptable Watch		Substandard		Doubtful		Unassigned		Total

Commercial real estate	$	79,~~621~~378	$	109,~~114~~386	$	~~225~~216,~~610~~690	$	~~246~~236,~~287~~767	$	24,~~632~~308	$	3,~~993~~948	$	—	$	—	$	~~496~~480,~~257~~477
Commercial, financial and agricultural		~~120~~66,~~509~~446		129,~~715~~341		4838,~~855~~192		8691,~~331~~672		~~597~~580		43,~~080~~516		—		—		~~273~~209,~~087~~747
Commercial construction		—		3736		20,~~465~~550		1615,~~530~~868		~~488~~482		~~381~~378		—		1110,~~339~~891		4948,~~240~~205
One-to-four family residential real estate		—		~~2,120~~607		4,~~698~~783		1619,~~766~~124		~~365~~361		1,~~605~~607		—		~~188~~183,~~480~~882		~~214~~210,~~034~~364
Consumer construction		—		—		—		—		—		—		—		1211,~~746~~024		1211,~~746~~024
Consumer		—		6049		~~114~~100		1,~~234~~548		—		5130		—		16,~~933~~511		18,~~392~~238

Total loans	$	~~128~~75,~~130~~824	$	2519,~~046~~419	$	~~299~~280,~~742~~315	$	~~367~~364,~~148~~979	$	45,~~082~~731	$	109,~~110~~479	$	—	$	~~229~~222,~~498~~308	$	1978,~~063,756~~055

At ~~March~~June 3130, 2021, $~~109~~55.~~733~~384 million of Paycheck Protection Program (“PPP”) loans are included with a risk rating of “1” in the Commercial, financial and agricultural category.

Below is a breakdown of loans by risk category as of December 31, 2020 (dollars in thousands):


	(1)		(2)		(3)		(4)		(44)		(6)		(7)		Rating
	Strong		Good		Average		Acceptable		Acceptable Watch		Substandard		Doubtful		Unassigned		Total

Commercial real estate	$	7,425	$	10,521	$	223,875	$	249,159	$	3,352	$	4,118	$	—	$	—	$	498,450
Commercial, financial and agricultural		116,107		6,760		51,150		94,743		656		4,343		—		—		273,759
Commercial construction		—		40		19,063		16,671		600		385		—		10,939		47,698
One-to-four family residential real estate		—		3,139		5,614		18,864		369		1,814		—		197,244		227,044
Consumer construction		—		—		—		—		—		—		—		11,661		11,661
Consumer		—		79		128		1,141		—		67		—		17,565		18,980

Total loans	$	123,532	$	20,539	$	299,830	$	380,578	$	4,977	$	10,727	$	—	$	237,409	$	1,077,592

Impaired Loans

Impaired loans are those which are contractually past due 90 days or more as to interest or principal payments, on nonaccrual status, or loans, the terms of which have been renegotiated to provide a reduction or deferral on interest or principal.

Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan 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.

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


	Impaired Loans		Impaired Loans		Total		Unpaid		Related
	with No Related		with Related		Impaired		Principal		Allowance for
	Allowance		Allowance		Loans		Balance		Loan Losses
March 31, 2021
June 30, 2021

Commercial real estate	$	12,~~587~~159	$	~~1,545~~768	$	32,~~132~~927	$	54,~~343~~776	$	~~277~~258
Commercial, financial and agricultural		2,~~885~~023		1,~~230~~526		43,~~115~~549		43,~~247~~658		~~594~~302
Commercial construction		~~350~~444		—		~~350~~444		~~480~~578		—
One to four family residential real estate		~~803~~697		—		~~803~~697		21,~~057~~903		—
Consumer construction		—		—		—		—		—
Consumer		1615		—		1615		1715		—
Total	$	5,~~641~~338	$	2,~~775~~294	$	87,~~416~~632	$	1210,~~144~~930	$	~~871~~560

December 31, 2020
Commercial real estate	$	1,251	$	2,309	$	3,560	$	5,786	$	476
Commercial, financial and agricultural		2,423		1,445		3,868		3,946		679
Commercial construction		537		—		537		678		—
One to four family residential real estate		869		—		869		1,993		—
Consumer construction		—		—		—		—		—
Consumer		16		—		16		19		—
Total	$	5,096	$	3,754	$	8,850	$	12,422	$	1,155


	Individually Evaluated Impaired Loans
	~~March~~June 3130, 2021				December 31, 2020
	Average		Interest Income		Average		Interest Income
	Balance for		Recognized for		Balance for		Recognized for
	the Period		the Period		the Period		the Period
Commercial real estate	$	5,~~671~~022	$	62111	$	6,860	$	270
Commercial, financial and agricultural		~~883~~944		47		1,204		13
Commercial construction		~~117~~168		69		541		27
One to four family residential real estate		2,~~571~~237		3158		3,064		135
Consumer construction		—		—		—		—
Consumer		2822		—1		37		1
Total	$	98,~~270~~393	$	~~103~~186	$	11,706	$	446

A summary of past due loans at ~~March~~June 3130, 2021 and December 31, 2020 is as follows (dollars in thousands):


	~~March~~June 3130,								December 31,
	2021								2020
	30-89 days		90+ days						30-89 days		90+ days
	Past Due		Past Due						Past Due		Past Due
	(accruing)		(accruing)		Nonaccrual		Total		(accruing)		(accruing)		Nonaccrual		Total

Commercial real estate	$	—147	$	—	$	1,~~446~~530	$	1,~~446~~677	$	24	$	—	$	1,481	$	1,505
Commercial, financial and agricultural		—33		—		~~384~~359		~~384~~392		42		—		478		520
Commercial construction		—		—		6159		6159		—		—		79		79
One to four family residential real estate		~~1,230~~742		—6		32,~~100~~964		43,~~330~~712		1,925				3,371		5,296
Consumer construction		—		—		—		—		—		—		—		—
Consumer		5144		—		3315		8459		78		—		49		127

Total past due loans	$	~~1,281~~966	$	—6	$	54,~~024~~927	$	65,~~305~~899	$	2,069	$	—	$	5,458	$	7,527

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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 a 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. More recent regulatory guidelines and accounting standards indicate that loan modifications or forbearances related to the COVID-19 pandemic will generally not be considered TDRs.

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

There were no TDRs that occurred during the ~~three~~six months ended ~~March~~June 3130, 2021 and 3 TDRs during the ~~three~~six months ended ~~March~~June 3130, 2020. The balance of these restructured loans pre-modification was $.504 million. Post-modification balances as of June 30. 2020 were $.476 million. The three TDRs are not COVID-19 related.

Insider Loans

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


	~~Three~~Six Months Ended		~~Three~~Six Months Ended
	~~March~~June 3130,		~~March~~June 3130,
	2021		2020
Loans outstanding, January 1	$	11,778	$	12,196
New loans		~~500~~—		—
Net activity on revolving lines of credit		~~(18)~~1,464		(354)
Repayment		(69)		(100)
Change in status of insiders		(9,869)		—
Loans outstanding at end of period	$	12,191	$	11,742
Repayment		(15)		(100)
Loans outstanding at end of period	$	3,358	$	11,742

There were no loans to related parties classified as substandard as of ~~March~~June 3130, 2021 or ~~March~~June 3130, 2020. In addition to the outstanding balances above, there were no unfunded commitments to related parties at ~~March~~June 3130, 2021.

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6.	GOODWILL AND OTHER INTANGIBLE ASSETS

The Corporation through the acquisition of Peninsula in 2014, Eagle River and Niagara in 2016, and FFNM and Lincoln in 2018, has recorded goodwill and core deposit intangibles as presented below (dollars in thousands):


	Deposit Based		Amortization Expense
	Intangible		for the		Future Annual
	~~March~~June 3130, 2021		period end		Amortization
	Balance		~~March~~June 3130, 2021		Expense
Peninsula	$	~~443~~413	$	3060	$	121
Eagle River		~~505~~480		2549		99
Niagara		~~163~~155		815		30
FFNM		2,~~074~~002		72145		290
Lincoln		~~1,015~~981		3468		135
Total	$	4,~~200~~031	$	~~169~~337	$	675


	Deposit Based
	Intangible		2020
	December 31, 2020		Amortization
	Balance		Expense
Peninsula	$	473	$	121
Eagle River		529		99
Niagara		170		30
FFNM		2,147		290
Lincoln		1,049		135
Total	$	4,368	$	675

The deposit based intangible asset is reported net of accumulated amortization at $4.~~200~~031 million at ~~March~~June 3130, 2021. Amortization expense in the first ~~three~~six months of 2021 is $.~~169~~337 million. Amortization expense for the next five years is expected to be at $.675 million per year.

The Corporation, in accordance with GAAP, evaluates goodwill annually for impairment.

7.	SERVICING RIGHTS

Mortgage Loans

Mortgage servicing rights (“MSRs”) are recorded when loans are sold in the secondary market with servicing retained. As of ~~March~~June 3130, 2021, the Corporation had obligations to service approximately $~~191~~179.~~363~~491 million of residential first mortgage loans. The valuation of MSRs is based upon the net present value of the projected revenues over the expected life of the loans being serviced, as reduced by estimated internal costs to service these loans. On a quarterly basis, management evaluates the MSRs for impairment. The key economic assumptions used in determining the fair value of the MSRs include an annual constant prepayment speed of 19.01% and a discount rate of 7.75% as of ~~March~~June 3130, 2021.

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The following table summarizes MSRs capitalized and amortized (dollars in thousands) for the ~~three~~six month periods ending ~~March~~June 3130, 2021 and ~~March~~June 3130, 2020:


	~~March~~June 3130,		~~March~~June 3130,
	2021		2020
Balance at beginning of period	$	1,359	$	1,499
Additions from loans sold with servicing retained		75		—
Amortization		(7)		(70)
Amortization		(38)		(35)

Balance at end of period	$	1,~~396~~352	$	1,~~464~~429
Balance of loan servicing portfolio	$	~~191~~179,~~363~~491	$	~~246~~232,~~370~~345
Mortgage servicing rights as % of portfolio		.7375%		.5962%
Fair value of servicing rights		1,436		21,~~159~~746

Commercial Loans

The Corporation periodically retains the servicing on certain commercial loans that have been sold. These loans were originated and underwritten under the SBA and USDA government guarantee programs, in which the guaranteed portion of the loan was sold to a third party with servicing retained. The balance of these sold loans with servicing retained at ~~March~~June 3130, 2021 was approximately $5357 million. The Corporation valued these servicing rights at $125,000 as of ~~March~~June 3130, 2021 and at $4235,000 as of ~~March~~June 3130, 2020. This valuation was established in consideration of the discounted cash flow of net expected servicing income over the life of the loans.

8.	BORROWINGS

Borrowings consist of the following at ~~March~~June 3130, 2021 and December 31, 2020 (dollars in thousands):


	~~March~~June 3130,		December 31,
	2021		2020
Federal Home Loan Bank fixed rate advances	$	5328,~~135~~117	$	63,155
USDA Rural Development note		324		324
	$	5328,~~459~~441	$	63,479

The Federal Home Loan Bank borrowings bear a weighted average rate of 1.6447% and mature at various dates through 2026. They are collateralized at ~~March~~June 3130, 2021 by the following: a collateral agreement on the Corporation’s one to four family residential real estate loans with a book value of approximately $6663.~~740~~235 million; mortgage related and municipal securities with an amortized cost and estimated fair value of $2018.~~318~~691 million and $2019.~~887~~162 million, respectively; and Federal Home Loan Bank stock owned by the Bank totaling $4.~~924~~473 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~~June 3130, 2021.

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act), created the Paycheck Protection Program to support lending to small businesses that have been affected by the disruption caused by COVID-19. The Federal Reserve created the Paycheck Protection Program Lending Facility (PPPLF) to offer a source of liquidity to the financial institution lenders who lend to small businesses through the Small Business Administration’s (SBA) Paycheck Protection Program. The PPPLF bears an interest rate of 0.35% and is collateralized by the PPP loans pledged. There were no PPP loans pledged as of ~~March~~June 3130, 2021 as the PPPLF was repaid during the third quarter of 2020.

The Corporation currently has one correspondent banking borrowing relationship. As of ~~March~~June 3130, 2021 the relationship consisted of a $15.0 million revolving line of credit, which had no balance. The line of credit bears an interest rate of LIBOR plus 2.00%, with a floor rate of 3.00% and a ceiling of 22%. The line of credit expires April 30, 2022. LIBOR at ~~March~~June 3130, 2021 was 0.2015%. This relationship is secured by all of the outstanding mBank stock.

The USDA Rural Development borrowing bears an interest rate of 1.00% and matures in August, 2024. It is collateralized by an assignment of a demand deposit account held by the Corporation’s wholly owned subsidiary, First Rural Relending, in the amount of $.389 million, and guaranteed by the Corporation.

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9.	DEFINED BENEFIT PENSION PLAN

The Corporation acquired the Peninsula Financial Corporation noncontributory defined benefit pension plan in 2014. Effective December 31, 2005, the plan was amended to freeze participation in the plan; therefore, no additional employees are eligible to become participants in the plan. The benefits are based on years of service and the employee’s compensation at the time of retirement. The Plan was amended effective December 31, 2010, to freeze benefit accrual for all participants. Expected contributions to the Plan in 2021 are $57,000.

The anticipated distributions over the next five years and through December 31, 2030 are detailed in the table below (dollars in thousands):


2021	$	133
2022		140
2023		144
2024		142
2025		157
2026-2030		901
Total	$	1,617

The Corporation receives a valuation of the Plan annually. As such, at ~~March~~June 3130, 2021, the plan’s assets had a fair value of $2.264 million and the Corporation had a net unfunded liability of $1.370 million. The accumulated benefit obligation at ~~March~~June 3130, 2021 was $3.634 million.

Assumptions in the actuarial valuation are:


	2021	2020
Weighted average discount rate	2.45%	2.45%
Rate of increase in future compensation levels	N/A	N/A
Expected long-term rate of return on plan assets	2.00%	2.00%

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

The primary investment objective is to maximize growth of the pension plan assets to meet the projected obligations to the beneficiaries over a long period of time, and to do so in a manner that is consistent with the Corporation’s risk tolerance. The intention of the plan sponsor is to invest the plan assets in mutual funds with the following asset allocation; which was in place at both ~~March~~June 3130, 2021 and December 31, 2020.


	Target	Actual
	Allocation	Allocation
Equity securities	50% to 70%	36%
Fixed income securities	30% to 50%	64%

10.

STOCK COMPENSATION PLANS

Restricted Stock Awards

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

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


		Market Value at
Date of Award	Units Granted	grant date	Vesting Term
February, 2017	28,427	13.39	4 years
February, 2018	18,643	16.30	4 years
April, 2018	8,000	16.00	Immediate
February, 2019	27,790	15.70	4 years
October, 2019	8,000	15.40	Immediate
February, 2020	132,000	15.46	4 years
October, 2020	8,000	9.46	Immediate
January, 2021	64,000	13.43	4 years

In the first ~~three~~six months of 2021, the Corporation issued 49,635 shares of its common stock for vested RSAs. In the first ~~three~~six months of 2020, the Corporation issued 25,521 shares of its common stock for vested RSAs.

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


		Weighted Average
	Number	Grant Date
	Outstanding	Fair Value
Nonvested balance at January 1, 2021	170,153	$	14.90
Granted during the period	~~170~~64,~~153~~000		1413.9043
Forfeited during the period	64,000		13.43
Vested during the period	(49,635)		12.91
Nonvested balance at March 31, 2021	184,518	$	14.94
Nonvested balance at June 30, 2021	184,518	$	14.94

11.

INCOME TAXES

The Corporation has reported deferred tax assets of $2.~~492~~496 million at ~~March~~June 3130, 2021.

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~~June 3130, 2021 had a net operating loss carryforwards for tax purposes of approximately $8.0 million. The carryforwards, if not utilized, will begin to expire in the year 2023. A portion of the NOL and credit carryforwards are subject to the limitations for utilization as set forth in Section 382 of the Internal Revenue Code. The annual limitation is $2.0 million for the NOL and the equivalent value of tax credits, which is approximately $.420 million. These limitations for use were established in conjunction with the recapitalization of the Corporation in December 2004. The Corporation will continue to evaluate the future benefits from these carryforwards in order to determine if any adjustment to the deferred tax asset is warranted.

The Corporation recognized a federal income tax expense of approximately $1.~~398~~181 million for the ~~three~~six months ended ~~March~~June 3130, 2021 and $1.~~811~~730 million for the ~~three~~six months ended ~~March~~June 3130, 2020.

12.

FAIR VALUE MEASUREMENTS

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

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

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

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

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

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

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

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

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

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

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

The following table presents information for financial instruments at ~~March~~June 3130, 2021 and December 31, 2020 (dollars in thousands):


		~~March~~June 3130, 2021				December 31, 2020
	Level in Fair	Carrying		Estimated		Carrying		Estimated
	Value Hierarchy	Amount		Fair Value		Amount		Fair Value

Financial assets:
Cash and cash equivalents	Level 1	$	~~243~~351,~~492~~477	$	~~243~~351,~~492~~477	$	218,977	$	218,977
Interest-bearing deposits	Level 2		2,427		2,427		2,917		2,917
Securities available for sale	Level 2		~~108~~100,~~083~~686		~~108~~100,~~083~~686		110,505		110,505
Securities available for sale	Level 3		1,~~331~~269		1,~~331~~269		1,331		1,331
Federal Home Loan Bank stock	Level 2		4,~~924~~473		4,~~924~~473		4,924		4,924
Net loans	Level 3		1972,~~057,914~~404		1969,~~061,119~~195		1,071,776		1,072,770
Accrued interest receivable	Level 3		43,~~176~~635		43,~~176~~635		4,310		4,310

Total financial assets		$	1,~~422~~436,~~347~~371	$	1,~~425~~433,~~552~~162	$	1,414,740	$	1,415,734

Financial liabilities:
Deposits	Level 2	$	1,~~273~~307,~~279~~154	$	1,~~288~~329,~~686~~943	$	1,258,776	$	1,262,930
Borrowings	Level 2		5328,~~459~~441		5227,~~427~~605		63,479		61,975
Accrued interest payable	Level 3		~~211~~157		~~211~~157		453		453

Total financial liabilities		$	1,~~326~~335,~~949~~752	$	1,~~341~~357,~~324~~705	$	1,322,708	$	1,325,358

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

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~~financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of~~ significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on-and off-balance-sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial assets or liabilities include premises and equipment, other assets, and other liabilities. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

The following is information about the Corporation’s assets and liabilities measured at fair value on a recurring basis at ~~March~~June 3130, 2021, 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~~June 3130, 2021 and December 31, 2020 were based on level 2 and level 3 inputs. There are no other assets or liabilities measured on a recurring basis at fair value. For additional information regarding investment securities, please refer to “Note 4 - Investment Securities.”

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


			Quoted Prices		Significant		Significant		Total (Gains)		Total (Gains)
			in Active Markets		Other Observable		Unobservable		Losses for		Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Three Months Ended		Six Months Ended
(dollars in thousands)	~~March~~June 3130, 2021		(Level 1)		(Level 2)		(Level 3)		~~March~~June 3130, 2021		June 30, 2021
Assets

Corporate	$	29,~~124~~440	$	—	$	28,~~624~~940	$	500	$	—	$	—
US Treasury		1,~~070~~066		—		1,~~070~~066		—		—		—
US Agencies		6,~~564~~538		—		6,~~564~~538		—		—		—
US Agencies - MBS		3128,~~292~~711		—		3128,~~292~~711		—		—		—
Obligations of state and political subdivisions		4136,~~364~~200		—		4035,~~533~~431		~~831~~769		2—		—
	$	~~109~~101,~~414~~955							$	2—		—


			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total (Gains) Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Twelve Months Ended
(dollars in thousands)	December 31, 2020		(Level 1)		(Level 2)		(Level 3)		December 31, 2020
Assets

Corporate	$	28,043	$	—	$	27,543	$	500	$	—
US Agencies		6,589		—		6,589		—		—
US Agencies - MBS		34,280		—		34,280		—		—
Obligations of state and political subdivisions		42,924		—		42,093		831		2
	$	111,836							$	2

The Corporation had no Level 3 assets or liabilities measured at fair value on a recurring basis as of ~~March~~June 3130, 2021, or December 31, 2020 other than as described above.

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

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

Assets Measured at Fair Value on a Nonrecurring Basis at ~~March~~June 3130, 2021

Quoted Prices

Significant

Total (Gains)

in Active Markets

Other Observable

Unobservable

Losses for

Balance at

for Identical Assets

Inputs

Three Months Ended

Six Months Ended

(dollars in thousands)

~~March~~June 3130, 2021

(Level 1)

(Level 2)

(Level 3)

~~March~~June 3130, 2021

June 30, 2021

Assets

Impaired loans

87,~~416~~632

—

87,~~416~~632

—

Other real estate owned

1,~~692~~343

—

1,~~692~~343

~~(52)~~84

Assets Measured at Fair Value on a Nonrecurring Basis at December 31, 2020


			Quoted Prices		Significant		Significant
			in Active Markets		Other Observable		Unobservable		Total (Gains) Losses for
	Balance at		for Identical Assets		Inputs		Inputs		Year Ended
(dollars in thousands)	December 31, 2020		(Level 1)		(Level 2)		(Level 3)		December 31, 2020
Assets

Impaired loans	$	8,850	$	—	$	—	$	8,850	$	186
Other real estate held for sale		1,752		—		—		1,752		(22)
									$	164

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

13.

SHAREHOLDERS’ EQUITY

The Corporation currently has one active share repurchase program and one repurchase program that has since expired. All share repurchase programs are conducted under authorizations by the Board of Directors. Under the now expired program, the Corporation repurchased 1,661 shares in 2020, 14,000 shares in 2016, 102,455 shares in 2015, 13,700 shares in 2014 and 55,594 shares in 2013. The share repurchases were conducted under Board authorizations made and publicly announced of $.600 million on February 27, 2013, $.600 million on December 17, 2013 and an additional $.750 million on April 28, 2015.

On August 28, 2019, the Corporation, under the authorization of the Board of Directors announced a new common stock repurchase program. Under the Repurchase Program, the Company is authorized to repurchase up to approximately 5% of the Company’s outstanding common stock, and has no expiration date. During 2020, the Corporation repurchased 283,779 shares under this plan. The Corporation has formally paused any repurchase activity, with no repurchases made during 2021.

14.COMMITMENTS, CONTINGENCIES AND CREDIT RISK

Financial Instruments With Off-Balance-Sheet Risk

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

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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~~June 3130,		December 31,
	2021		2020
Commitments to extend credit:
Variable rate	$	~~121~~108,~~102~~865	$	114,458
Fixed rate		5349,~~659~~881		58,175
Standby letters of credit - Variable rate		87,~~003~~896		8,781
Credit card commitments - Fixed rate		7,~~569~~798		7,136

	$	~~190~~174,~~333~~440	$	188,550

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 an 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 and Northeastern Wisconsin. 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~~June 3130, 2021 represents $~~137~~130.~~356~~222 million, or 1617.7864%, compared to $138.992 million, or 16.95%, of the commercial loan portfolio on December 31, 2020. The remainder of the commercial loan portfolio is diversified in such categories as hospitality and tourism, real estate agents and managers, new car dealers, gas stations and convenience stores, petroleum, forestry, agriculture and construction. Due to the diversity of the Bank’s locations, the ability of debtors of residential and consumer loans to honor their obligations is not tied to any particular economic sector.

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NOTE 15 – ~~SUBSEQUENT~~BUSINESS ~~EVENT~~COMBINATION

On April 12, 2021, the Corporation announced that it entered into an Agreement and Plan of Merger (“the Merger Agreement”) with Nicolet Bankshares, Inc. (“Nicolet”). Pursuant to the terms of the agreement, the Corporation’s shareholders will receive 0.22 shares of Nicolet common stock and $4.64 in cash for each share of the Corporation common stock with total consideration to consist of approximately 80% stock and 20% cash. Further pursuant to the Agreement, the Corporation’s wholly owned subsidiary, mBank, will merge with and into Nicolet National Bank, which will be the surviving bank, with all bank branches operating under the Nicolet National Bank brand. ~~Consummation~~On ofJuly ~~the~~15, ~~merger~~2021, ~~is subject to~~ the ~~approval~~Corporation’s ~~of the~~ shareholders ofapproved the ~~Corporation~~Merger. ~~and~~As ~~Nicolet,~~all necessary regulatory ~~agency~~and shareholder approvals have been received, ~~and~~the ~~customary~~consummation ~~closing~~of ~~conditions~~this ~~contained~~transaction inwill ~~the~~occur ~~Merger~~on ~~Agreement~~September 3, 2021.

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MACKINAC FINANCIAL CORPORATION

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

Forward Looking Statements/Risk Factors

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

RISK FACTORS

Risks Related to our Lending and Credit Activities

●

The outbreak of the COVID-19 pandemic, including the severity, magnitude, duration and businesses’ and governments’ responses thereto, may have a negative impact on the Corportion’s operations and personnel, as well as on activity and demand across the customers it serves.

●

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

●

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

●

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

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

●

Our allowance for loan losses may be insufficient.

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

Risks Related to Our Operations

●

We are subject to interest rate risk.

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

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●

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

●

We may not realize the expected benefits of our acquisitions of First Federal of Northern Michigan or Lincoln Community Bank.

●

Our controls and procedures may fail or be circumvented.

●

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

In assessing the realizability of deferred income tax assets, management considers whether it is more likely than not that some allowance requires management to evaluate all available evidence, both negative and positive. Positive evidence necessary to overcome the negative evidence includes whether future taxable income in sufficient amounts and character within the carry back and carry forward periods is available under the tax law, including the use of tax planning strategies. When negative evidence (e.g. cumulative losses, history of operating loss or tax credit carry forwards expiring unused) exists, more positive evidence than negative evidence will be necessary. At ~~March~~June 3130, 2021, net deferred tax assets were approximately $2.~~492~~496 million. If a valuation allowance becomes necessary with respect to such balance, it could have a material adverse effect on our business, results of operations and financial condition.

●

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

Risks Related to Legal and Regulatory Compliance

●

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

Strategic Risks

●

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

●

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

Reputation Risks

●

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

Liquidity Risks

●

We could experience an unexpected inability to obtain needed liquidity.

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

Risks Related to an Investment in Our Common Stock

●

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

●

Our securities are not an insured deposit.

●

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

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

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

The following discussion covers results of operations, asset quality, financial position, liquidity, interest rate sensitivity, and capital resources for the periods indicated. The information included in this discussion is intended to assist readers in their analysis of, and should be read in conjunction with, the consolidated financial statements, the related notes, and other supplemental information presented elsewhere in this report. It should be noted that there may be non-GAAP disclosures presented within this discussion to further assist readers in their analysis of the financial condition of the Corporation. This discussion should also be read in conjunction with the consolidated financial statements and footnotes contained in the Corporation’s Annual Report and Form 10-K for the year-ended December 31, 2020. Throughout this discussion and elsewhere in this report, the term “Bank” refers to mBank, the principal banking subsidiary of the Corporation.

FINANCIAL OVERVIEW

The Corporation recorded ~~first~~second quarter 2021 net income of $32.~~880~~945 million, or $.3728 per share, compared to net income of $3.~~051~~454 million, or $.2833 per share, for the ~~first~~second quarter of 2020.

Weighted average shares outstanding for the ~~three~~six month period in 2021 totaled 10,~~522~~536,~~899~~722, compared to 10,~~717~~625,~~967~~778 shares in the same period of 2020.

The net interest income and net interest margin for the ~~first~~second quarter of 2021 was $13.~~778~~266 million, or 4.5256%, compared to $1314.~~397~~458 million, or 4.6051%, for the ~~first~~second quarter of 2020. Net interest income in the ~~first~~second quarter of 2021 was positively impacted by the recognition of $21.~~152~~167 million of fees generated by participation in the PPP loan program.

Total assets of the Corporation at ~~March~~June 3130, 2021 were $1.~~508~~519 billion, up by $617.~~518~~222 million, or 1.4315%, from the $1.502 billion in total assets reported at year-end 2020. A large portion of this increase is a result of participation in the Paycheck Protection Program, of which we have current loan balances of $~~109~~55.~~733~~384 million.

As of the end of the ~~first~~second quarter of 2021, the Corporation had experienced no material adverse systemic issues or material deterioration in its loan portfolio ~~prior~~due to the COVID-19 pandemic. At the onset of COVID-19, the Corporation began to actively work to identify potential heightened industry and consumer exposure within the portfolio based on its footprint. The Corporation does expect that COVID-19 will unavoidably impact many of its customer’s businesses and will be prepared to assist these customers with appropriate relief using the regulatory guidance provided, particularly for industries experiencing negative environmental factors and risk trends. The Corporation will continue to refine these measures and continually assess its financial reporting and loan loss reserves as the Corporation and its customers work through the pandemic crisis in the upcoming quarters.

FINANCIAL CONDITION

Cash and Cash Equivalents

Cash and cash equivalents increased $24132.~~515~~500 million during the first ~~three~~six months of 2021, compared to 2020 year end. See further discussion of the change in cash and cash equivalents in the Liquidity section of this Quarterly Report on Form 10-Q.

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Investment Securities

Securities available for sale decreased $29.~~422~~881 million from December 31, 2020 to ~~March~~June 3130, 2021, with the balance on ~~March~~June 3130, 2021 totaling $~~109~~101.~~414~~955 million. Investment securities are increased or decreased as appropriate as a result of managing interest rate risk and liquidity. As of ~~March~~June 3130, 2021, investment securities with an estimated fair value of $2319.~~172~~162 million were pledged against borrowings at the FHLB and certain customer relationships.

Loans

Through the first ~~three~~six months of 2021, loan balances decreased by $1399.~~836~~537 million from December 31, 2020 balances of $1.078 billion. During the first ~~three~~six months of 2021, the Bank had total loan production of $79161.~~837~~225 million, exclusive of PPP loans, which included $3567.~~131~~986 million of secondary market loan production. This loan production, however, was ~~partially~~ offset by loan amortization and payoffs. When including the PPP loans, total production was $~~133~~218.~~564~~897 million, which includes $5357.~~727~~672 million of PPP loans.

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

Following is a summary of the loan portfolio at ~~March~~June 3130, 2021 and December 31, 2020 (dollars in thousands):


	~~March~~June 3130,		Percent of	December 31,		Percent of
	2021		Total	2020		Total

Commercial real estate	$	~~496~~480,~~257~~477	4649.6512%	$	498,450	46.25%
Commercial, financial, and agricultural		~~273~~209,~~087~~747	2521.6745		273,759	25.40
Commercial construction		4948,~~240~~205	4.6393		47,698	4.43
One to four family residential real estate		~~214~~210,~~034~~364	2021.1251		227,044	21.07
Consumer		18,~~392~~238	1.7386		18,980	1.76
Consumer construction		1211,~~746~~024	1.2013		11,661	1.08
Total loans	$	1978,~~063,756~~055	100.00%	$	1,077,592	100.00%

Following is a table showing the significant industry types in the commercial loan portfolio as of ~~March~~June 3130, 2021 and December 31, 2020 (dollars in thousands).


	~~March~~June 3130, 2021				December 31, 2020
	Outstanding		Percent of	Percent of	Outstanding		Percent of	Percent of
	Balance		Loans	Capital	Balance		Loans	Capital

Real estate - operators of nonresidential buildings		~~137~~130,~~356~~222	1617.7864%	8075.7175%		138,992	16.95%	82.80%
Hospitality and tourism		~~105~~100,~~077~~162	1213.8456	6158.7526		100,237	12.23	59.71
Lessors of residential buildings		5153,~~288~~016	67.2718	30.1484		52,035	6.35	31.00
Gasoline stations and convenience stores		2726,~~562~~583	3.3760	1615.2046		29,046	3.54	17.30
Logging		1617,~~756~~408	2.0536	910.8513		18,651	2.27	11.11
Commercial construction		4948,~~240~~205	6.0253	28.9304		47,698	5.82	28.41
Other		~~431~~362,~~305~~833	5249.6713	~~253~~211.4505		433,248	52.84	258.09
Total Commercial Loans	$	~~818~~738,~~584~~429	100.00%		$	819,907	100.00%

Management recognizes that additional risks presented by concentration in certain segments of the portfolio. Management does not believe that its current portfolio composition has increased such risk related to any specific industry concentration as of ~~March~~June 3130, 2021. The current concentration of commercial real estate-related loans represents a broad customer base composed of a high percentage of owner-occupied developments. The company will slow, and has slowed, growth and origination of certain industry concentrations where internal limits have been reached.

Our residential real estate portfolio predominantly includes one to four family adjustable rate mortgages that have repricing terms generally from one to three years, construction loans to individuals and bridge financing loans for qualifying customers. As of June 30, 2021, our residential loan portfolio totaled $221.388 million, or 22.64%, of our total outstanding loans.

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qualifying customers. As of March 31, 2021, our residential loan portfolio totaled $226.780 million, or 21.32%, of our total outstanding loans.

Due to the seasonal nature of many of the Corporation’s commercial loan customers, our loan payment terms provide flexibility by structuring payments to coincide with our customers’ business cycles. The lending staff evaluates the collectability of 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.

Credit Quality

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


	~~March~~June 3130,		December 31,
	2021		2020

Nonperforming Assets:
Nonaccrual loans	$	54,~~024~~927	$	5,458
Loans past due 90 days or more		—6		—
Restructured loans on nonaccrual		—		—
Total nonperforming loans		54,~~024~~933		5,458
Other real estate owned		1,~~692~~343		1,752
Total nonperforming assets	$	6,~~716~~276	$	7,210
Nonperforming loans as a % of loans		.4750%		.51%
Nonperforming assets as a % of assets		.4541%		.48%
Reserve for Loan Losses:
At period end	$	5,~~842~~651	$	5,816
As a % of outstanding loans		.5558%		.54%
As a % of nonperforming loans		~~116~~114.2856%		106.56%
As a % of nonaccrual loans		~~116~~114.2869%		106.56%
Texas Ratio		4.4107%		4.82%

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


	At Period End
	~~March~~June 3130, 2021		December 31, 2020

Total loans, at period end	$	1978,~~063,756~~055		1,077,592
Average loans for the period	$	1,~~078~~051,~~022~~518	$	1,117,132

	For the Period Ended
	~~Three~~Six Months Ended		Twelve Months Ended
	~~March~~June 3130, 2021		December 31, 2020

Net charge-offs during the period	$	24265		492
Net charge-offs to average loans, annualized	.0105%		.04%

Management seeks to address market issues, if any, impacting its loan customer base. In conjunction with the Corporation’s senior lending staff and bank regulatory examinations, management reviews the Corporation’s loans, related collateral evaluations, and the overall lending process. The Corporation also utilizes an outside loan consultant to perform a review of the loan portfolio. The opinion of this consultant upon completion of the 2020 independent review provided findings similar to management’s findings with respect to credit quality.

During the first six months of 2021, the Corporation recorded a provision for loan losses of $100,000. The Corporation is not yet subject to the requirements of CECL and management will actively refine the provision and loan reserves as client impact and broader economic data from the pandemic become more clear.

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~~During~~COVID-19 ~~the~~loan ~~first~~modifications ~~three~~resided ~~months~~at ofapproximately ~~2021, the Corporation recorded a provision for loan losses of~~ $~~50,000~~2. ~~The~~1 ~~Corporation~~million, isor ~~not~~.22% ~~yet subject to the requirements~~ of ~~CECL~~total ~~and~~loans ~~management~~with ~~will~~no ~~actively~~commercial ~~refine~~loans ~~the~~remaining ~~provision~~in ~~and~~total ~~loan~~payment ~~reserves~~deferral asat ~~client~~June ~~impact~~30, ~~and~~2021. ~~broader~~This ~~economic~~is ~~data~~compared ~~from~~to ~~the~~peak ~~pandemic~~levels ~~become~~of ~~more~~$201 ~~clear~~million in the second quarter ~~and~~of ~~beyond~~2020.

~~COVID-19~~As ~~loan~~of ~~modifications~~June ~~resided~~30, at2021, ~~approximately~~the ~~$5.6~~allowance ~~million,~~for orloan losses represented .5958% of total loans. At ~~with~~June no30, ~~commercial~~2021, ~~loans~~the ~~remaining~~allowance included specific reserves in ~~total~~the ~~payment~~amount ~~deferral~~of $.560 million, as compared to specific reserves of $1.155 million at ~~March~~December 31, ~~2021~~2020. In ~~This~~management’s opinion, the allowance for loan losses is ~~compared~~adequate to ~~peak~~cover ~~leves~~probable oflosses ~~$201~~related ~~million~~to specifically identified loans, as well as probable losses inherent in the ~~second~~balance ~~quarter~~ of ~~2020~~the loan portfolio. Purchased impaired credits do not have an effect on the allowance for loan losses, unless they experience further deterioration subsequent to acquisition, in accordance with ASC 310-30.

As of March 31, 2021, the allowance for loan losses represented .55% of total loans. The total coverage ratio (equivalent to ALLL plus remaining purchase accounting credit marks to total loans less PPP balances) is .95%. At March 31, 2021, the allowance included specific reserves in the amount of $.871 million, as compared to specific reserves of $1.155 million at December 31, 2020. In management’s opinion, the allowance for loan losses is adequate to cover probable losses related to specifically identified loans, as well as probable losses inherent in the balance of the loan portfolio. Purchased impaired credits do not have an effect on the allowance for loan losses, unless they experience further deterioration subsequent to acquisition, in accordance with ASC 310-30.

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

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


	~~Three~~Six Months Ended		Year Ended
	~~March~~June 3130, 2021		December 31, 2020

Balance at beginning of period	$	1,752	$	2,194
Other real estate transferred from loans due to foreclosure		~~448~~600		874
Proceeds from sale of other real estate		(~~560~~977)		(1,338)
Writedowns on other real estate held for sale		—(83)		(65)
Gain on other real estate held for sale		5251		87

Balance at end of period	$	1,~~692~~343	$	1,752

During the first ~~three~~six months of 2021, the Corporation received real estate in lieu of loan payments of $.~~448~~600 million. In determining the carrying value of other real estate held for sale, the Corporation generally starts with a third party appraisal of the underlying collateral and then deducts estimated selling costs to arrive at a net asset value. After the initial receipt, management periodically re-evaluates the recorded balances and records any additional reductions in the fair value as a write-down of other real estate held for sale.

Deposits

The Corporation had an increase in deposits in the first ~~three~~six months of 2021. Total deposits increased by $1448.~~503~~378 million, or 113.5284%, in the first ~~three~~six months of 2021. The increase in deposits for the first ~~three~~six months of 2021 is composed of a increase in core deposits of $5183.~~210~~038 million and a decrease in noncore deposits of $3634.~~707~~660 million. Management utilizes brokered deposits as a funding source, which provides flexibility in managing interest rate risk for fixed rate longer term loan fundings.

Management continues to monitor existing deposit products in order to stay competitive, both as to terms and pricing, which will remain important as we move through the current rate cycle to protect our margin. This focus on deposits has become especially important with changing client banking habits and demographics, as well as customer desire for more electronic and mobile based banking products and services, particularly in light of the pandemic. It is the intent of management to focus on growing core deposit levels, as the comparatively inexpensive core deposits, in relation to wholesale deposit sources, will continue to prove valuable as rates continue to increase.

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


	~~March~~June 3130,			December 31,
	2021		% of Total	2020		% of Total

Noninterest bearing	$	~~443~~459,~~956~~716	3435.8617%	$	414,804	32.94%
NOW, money market, checking		~~478~~501,~~181~~251	3738.5635		450,556	35.79
Savings		~~137~~141,~~134~~729	10.7784		130,755	10.39
Certificates of Deposit <$250,000		~~190~~178,~~320~~723	1413.9567		202,266	16.07
Total core deposits		1,~~249~~281,~~591~~419	98.1403		1,198,381	95.20

Certificates of Deposit >$250,000		1012,~~337~~384	.8195		15,224	1.21
Brokered CDs		13,351	1.0502		45,171	3.59
Total non-core deposits		2325,~~688~~735	1.8697		60,395	4.80

Total deposits	$	1,~~273~~307,~~279~~154	100.00%	$	1,258,776	100.00%

Borrowings

The Corporation also utilizes FHLB borrowings as a source of funding. At ~~March~~June 3130, 2021, this source of funding totaled $5328 million and the Corporation secured this funding by pledging loans and investments. The $5328 million of FHLB borrowings have a weighted average maturity of 13.9933 years and a weighted average interest rate of 1.6447% at ~~March~~June 3130, 2021. The Corporation also has a USDA Rural Development loan held by its wholly owned subsidiary, First Rural Relending, that has an outstanding balance of $.324 million, with a fixed interest rate of 1% that matures in August 2024.

Shareholders’ Equity

Total shareholders’ equity increased $24.~~312~~055 million from December 31, 2020 to ~~March~~June 3130, 2021. Contributing to the change in shareholders’ equity was net income of $36.~~880~~825 million, offset by a reduction for cash dividends on common stock of $12.~~477~~954 million, an increase due to stock compensation of $.~~233~~460 million, and an decrease in the market value of securities of $.~~324~~276 million.

RESULTS OF OPERATIONS

Summary

The Corporation recorded first ~~three~~six months of 2021 net income of $36.~~880~~825 million, or $.3765 per share, compared to net income of $36.~~051~~505 million, or $.2861 per share, for the first ~~three~~six months of 2020.

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. Net

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~~Net~~interest ~~Interest~~income ~~Income~~is impacted by economic and competitive factors that influence rates, loan demand, and the availability of funding.

Net interest income isand ~~the~~net ~~Corporation’s~~interest ~~primary~~margin ~~source~~on ofa ~~core~~fully ~~earnings~~taxable equivalent basis amounted to $27. ~~Net~~206 ~~interest~~million ~~income~~and ~~represents~~4.57% ~~the~~of ~~difference~~average ~~between~~earning assets, respectively, in the ~~average~~first ~~yield~~six ~~earned~~months onof ~~interest~~2021, ~~earning~~compared ~~assets~~to $28.112 million and ~~the~~4.59% of average ~~rate~~earning ~~paid~~assets, onrespectively, ~~interest~~in ~~bearing~~the ~~obligations~~first six months of 2020. ~~Net~~Included in the net interest income for the first six months of 2021 is ~~impacted~~$3.319 bymillion ~~economic~~of ~~and~~fee ~~competitive~~recognition ~~factors~~on ~~that~~the ~~influence~~PPP ~~rates,~~loans. The ~~loan~~$3.319 ~~demand,~~million ~~and~~of fee recognition included $.749 million to offset direct origination costs involved in the ~~availability~~program, as well as $2.570 million of ~~funding~~accretion of the remaining deferred fees.

Net interest income and net interest margin on a fully taxable equivalent basis amounted to $13.862 million and 4.55% of average earning assets, respectively, in the first three months of 2021, compared to $13.481 million and 4.63% of average earning assets, respectively, in the first three months of 2020. Included in the net interest income for the first three months of 2021 is $2.782 million of fee recognition on the PPP loans. The $2.782 million of fee recognition included $.826 million to offset direct origination costs involved in the program, as well as $.296 million of accretion of the remaining deferred fees.

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~~Six Months Ended
													2021-2020
	Average Balances						Average Rates		Interest				Income/						Rate/
	~~March~~June 3130,				Increase/		~~March~~June 3130,		~~March~~June 3130,				Expense		Volume		Rate		Volume
(dollars in thousands)	2021		2020		(Decrease)		2021	2020	2021		2020		Variance		Variance		Variance		Variance

Loans (1,2,3)	$	1,078,022	$	1,047,144	$	30,878	5.35%	5.66%	$	14,225	$	14,749	$	(524)	$	431	$	(809)	$	(146)
Taxable securities		86,502		93,577		(7,075)	2.28	2.66		487		620		(133)		(46)		(88)		1
Nontaxable securities (2)		22,704		14,917		7,787	3.22	2.99		180		111		69		57		8		4
Federal funds sold		40,558		1,044		39,514	.10	1.54		10		4		6		150		(4)		(140)
Other interest-earning assets		7,449		14,869		(7,420)	4.03	7.17		74		265		(191)		(131)		(115)		55
Total earning assets		1,235,235		1,171,551		63,684	4.92	5.41		14,976		15,749		(773)		461		(1,008)		(226)
Reserve for loan losses		(5,660)		(5,269)		(391)
Cash and due from banks		197,014		66,967		130,047
Fixed Assets		25,350		24,171		1,179
Other Real Estate		1,666		2,180		(514)
Other assets		58,891		61,534		(2,643)
Total assets	$	1,512,496	$	1,321,134	$	191,362

NOW and money market deposits	$	360,824	$	284,315	$	76,509	.20	0.42	$	179	$	296	$	(117)	$	79	$	(153)	$	(43)
Loans (1,2,3)	$	1,051,518	$	1,097,382	$	(45,864)	5.31%	5.59%	$	27,664	$	30,484	$	(2,820)	$	(1,271)		(1,529)		(20)
Interest checking		107,323		93,922		13,401	.02	0.07		6		17		(11)		2		(12)		(1)
Taxable securities		85,524		89,996		(4,472)	2.42	2.50		1,028		1,181		(153)		(55)		(32)		(66)
Savings deposits		132,404		110,351		22,053	.19	0.87		61		238		(177)		47		(185)		(39)
Nontaxable securities (2)		21,632		19,522		2,110	3.24	3.12		348		303		45		33		12		—
Certificates of deposit		207,635		242,882		(35,247)	.99	1.82		508		1,101		(593)		(158)		(498)		63
Federal funds sold		35,552		9,835		25,717	.10	.18		18		9		9		23		(4)		(10)
Brokered deposits		44,287		60,059		(15,772)	1.24	1.84		135		275		(140)		(72)		(90)		22
Other interest-earning assets		7,208		14,061		(6,853)	5.18	5.52		185		386		(201)		(188)		(24)		11
Borrowings		54,799		72,911		(18,112)	1.67	1.88		225		341		(116)		(84)		(39)		7
Total earning assets		1,201,434		1,230,796		(29,362)	4.91	5.28		29,243		32,363		(3,120)		(1,458)		(1,577)		(85)
Total interest-bearing liabilities		907,272		864,440		42,832	.49	1.06		1,114		2,268		(1,154)		(186)		(977)		9
Reserve for loan losses		(5,750)		(5,287)		(463)
Demand deposits		426,890		284,677		142,213
Cash and due from banks		236,573		96,700		139,873
Other liabilities		9,311		9,356		(45)
Fixed Assets		25,069		24,719		350
Shareholders’ equity		169,023		162,661		6,362
Other Real Estate		1,654		2,221		(567)
Total liabilities and shareholders’ equity	$	1,512,496	$	1,321,134	$	191,362
Other assets		58,205		61,932		(3,727)
Rate spread							4.42%	4.35%
Total assets	$	1,517,185	$	1,411,081	$	106,104
Net interest margin/revenue							4.55%	4.63%	$	13,862	$	13,481	$	381	$	647	$	(31)	$	(235)

NOW and money market deposits	$	370,775	$	284,440	$	86,335	.21	.30	$	379	$	426	$	(47)	$	129		(134)		(42)
Interest checking		109,969		95,965		14,004	.02	.05		12		25		(13)		4		(14)		(3)
Savings deposits		136,135		114,299		21,836	.18	.62		123		352		(229)		67		(248)		(48)
Certificates of deposit		202,145		241,298		(39,153)	.92	1.76		924		2,116		(1,192)		(342)		(1,007)		157
Brokered deposits		28,734		92,287		(63,553)	1.22	1.56		174		715		(541)		(491)		(154)		104
Borrowings		51,771		95,308		(43,537)	1.66	1.30		425		617		(192)		(281)		167		(78)
Total interest-bearing liabilities		899,529		923,597		(24,068)	.46	.93		2,037		4,251		(2,214)		(914)		(1,390)		90
Demand deposits		439,089		315,863		123,226
Other liabilities		8,350		9,065		(715)
Shareholders’ equity		170,217		162,556		7,661
Total liabilities and shareholders’ equity	$	1,517,185	$	1,411,081	$	106,104
Rate spread							4.45%	4.35%
Net interest margin/revenue							4.57%	4.59%	$	27,206	$	28,112	$	(906)	$	(544)	$	(187)	$	(175)

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	Three Months Ended
													2021-2020
	Average Balances						Average Rates		Interest				Income/						Rate/
	June 30,				Increase/		June 30,		June 30,				Expense		Volume		Rate		Volume
(dollars in thousands)	2021		2020		(Decrease)		2021	2020	2021		2020		Variance		Variance		Variance		Variance

Loans (1,2,3)	$	1,025,306	$	1,147,620	$	(122,314)	5.27%	5.48%	$	13,477	$	15,635	$	(2,158)	$	(1,672)	$	(602)	$	116
Taxable securities		84,558		90,991		(6,433)	2.39	2.62		504		560		(56)		(42)		(51)		37
Nontaxable securities (2)		20,571		19,521		1,050	3.26	3.96		167		192		(25)		10		(34)		(1)
Federal funds sold		30,601		18,627		11,974	.10	0.10		8		5		3		3		—		—
Other interest-earning assets		6,970		13,253		(6,283)	6.39	3.67		111		121		(10)		(58)		90		(42)
Total earning assets		1,168,006		1,290,012		(122,006)	4.90	5.16

Filing Compare · MACKINAC FINANCIAL CORP /MI/