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MFNC > SEC Filings for MFNC > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for MACKINAC FINANCIAL CORP /MI/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for MACKINAC FINANCIAL CORP /MI/


14-Nov-2012

Quarterly Report


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

FORWARD LOOKING STATEMENTS

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

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

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

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

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

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

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

          The ability of borrowers to repay loans;

          The effects on liquidity of unusual decreases in deposits;

          Changes in consumer spending, borrowing, and saving habits;

          Technological changes;

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

          Difficulties in hiring and retaining qualified management and banking
personnel;

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

          The effect of compliance with legislation or regulatory changes;

          The effect of changes in accounting policies and practices;

          The costs and effects of existing and future litigation and of

adverse outcomes in such litigation; and

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

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

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


Table of Contents

FINANCIAL OVERVIEW

The Corporation recorded third quarter 2012 net income available to common shareholders of $.897 million or $.19 per share compared to net income of $.707 million, or $.21 per share for the third quarter of 2011. Income for the nine months ended September 30, 2012 totaled $5.536 million, or $1.44 per share, compared to $1.566 million and $.46 per share in the 2010 nine month period. Operating results for the nine month period in 2012 included a valuation adjustment to the deferred tax asset of $3.000 million.

Weighted average shares outstanding totaled 4,722,029 for the third quarter and 3,857,002 for the nine months ended September 30, 2012. Weighted average shares were constant in 2011 at 3,419,736. The common stock warrants outstanding, of 379,310 shares, were dilutive, at approximately $.01 per share, for the 2012 third quarter and $.05 per share for the nine month period, as the market value of our stock remained above the $4.35 strike price. Dilution of the warrant shares in 2011 was approximately $.01 per share for both reported periods.

The net interest margin for the third quarter of 2012 increased to $4.930 million, or 4.10%, compared to $4.709 million, of 4.14% in the third quarter of 2011. The nine month margin in 2012 was $14.712 million, or 4.19% compared to $13.028 million, or 3.95%.

Total assets of the Corporation at September 30, 2012 were $551.117 million, up by $52.519 million, or 10.53% from the $498.598 million in total assets reported at September 30, 2011 and up by $52.806 million, or 10.60%, from total assets of $498.311 million at year-end 2011. The loan portfolio increased $32.712 million, or 8.15%, from December 31, 2011 balances of $401.246 million. Deposits totaled $439.363 million at September 30, 2012, an increase of $34.574 million from the $404.789 million at December 31, 2011.

FINANCIAL CONDITION

Cash and Cash Equivalents

Cash and cash equivalents increased $13.335 million during the first nine months of 2012. See further discussion of the change in cash and cash equivalents in the Liquidity section.

Investment Securities

Securities available for sale increased $3.749 million from December 31, 2011 to September 30, 2012, with the balance on September 30, 2012, totaling $42.476 million. The Corporation purchased $11.031 million of investments during the 2012 first nine months mainly to replace maturities and paydowns of investments. Investment securities are utilized in an effort to manage interest rate risk and liquidity. As of September 30, 2012, investment securities with an estimated fair value of $7.786 million were pledged.

Loans

Through the first nine months of 2012, loan balances increased by $32.712 million, or 8.15%, from December 31, 2011 balances of $401.246 million. During the first nine months of 2012, the Bank had total loan production of $145 million, which included $46 million of secondary market loan production. This loan production, however, was offset by loan principal runoff, paydowns and amortization, and also SBA/USDA loan sales of $11.540 million, and nonperforming loans transferred to other real estate owned ("OREO") amounting to $1.013 million.

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


Table of Contents

Following is a summary of the loan portfolio at September 30, 2012, December 31, 2011 and September 30, 2011 (dollars in thousands):

                             September 30,    Percent of     December 31,    Percent of     September 30,    Percent of
                                 2012           Total            2011          Total            2011           Total
Commercial real estate      $       224,061        51.63 %  $      199,201        49.64 %  $       195,079        49.78 %
Commercial, financial,
and agricultural                     84,073        19.37            92,269        23.00             84,285        21.51
One to four family
residential real estate              86,643        19.97            77,332        19.27             78,759        20.10
Construction:
Consumer                              6,803         1.57             5,774         1.44              6,268         1.60
Commercial                           21,757         5.01            19,745         4.92             19,771         5.04
Consumer                             10,621         2.45             6,925         1.73              7,741         1.97
Total loans                 $       433,958       100.00 %  $      401,246       100.00 %  $       391,903       100.00 %

Following is a table showing the significant industry types in the commercial loan portfolio as of September 30, 2012, December 31, 2011 and September 30, 2011 (dollars in thousands):

                                   September 30, 2012                            December 31, 2011                            September 30, 2011
                         Outstanding     Percent of    Percent of      Outstanding     Percent of   Percent of      Outstanding     Percent of    Percent of
                           Balance         Loans        Capital          Balance         Loans       Capital          Balance         Loans        Capital

Real estate -
operators of nonres
bldgs                   $      88,505         26.82 %      121.33 %   $      75,391         24.22 %     135.53 %   $      62,567         20.92 %      112.78 %
Hospitality and
tourism                        36,950         11.20         50.65            33,306         10.70        59.87            33,867         11.32         61.04
Commercial
construction                   21,757          6.60         29.83            19,745          6.34        35.50            19,771          6.61         35.64
Real estate agents
and managers                   12,336          3.74         16.91            10,617          3.41        19.09            12,781          4.27         23.04
Lessors of
nonresidential
buildings                      12,326          3.74         16.90            16,499          5.30        29.66            16,433          5.49         29.62
Other                         158,017         47.90        326.30           155,657         50.02       279.83           153,716         51.39        277.07

Total Commercial
Loans                   $     329,891        100.00 %                 $     311,215        100.00 %                $     299,135        100.00 %

Management recognizes the additional risk presented by the concentration in certain segments of the portfolio. On a historical basis, the Corporation's highest concentration of credit risk was the hospitality and tourism industry. Management does not consider the current loan concentrations in hospitality and tourism to be problematic, and has no intention of further reducing loans to this industry segment. Management does not believe that its current portfolio composition has increased exposure related to any specific industry concentration as of September 30, 2012. The current concentration of real estate related loans represents a broad customer base composed of a high percentage of owner occupied developments.

Our residential real estate portfolio predominantly includes one to four family adjustable rate mortgages that have repricing terms generally from one to three years, construction loans to individuals and bridge financing loans for qualifying customers. As of September 30, 2012, our residential loan portfolio totaled $86.643 million, or 19.97% of our total outstanding loans. Management has been conservative in its consumer lending policies and has not engaged in lending activities such as subprime loans or making loans in excess of appraised value. The majority of its residential real estate portfolio is composed of credit extended based upon appraised values not to exceed 80% to 90%.

The Corporation has also extended credit to governmental units, including Native American organizations. Tax-exempt loans and leases decreased from $1.991 million at the end of December 31, 2011 to $1.689 million at September 30, 2012. The Corporation has elected to reduce its tax-exempt portfolio, since it provides no current tax benefit, due to tax net operating loss carryforwards.

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


Table of Contents

Credit Quality

Management analyzes the allowance for loan losses in detail on a monthly basis to determine whether the losses inherent in the portfolio are properly reserved for. Net charge-offs for the nine months ended September 30, 2012 amounted to $.860 million, or .28% annualized, of average loans outstanding, compared to $1.775 million, or .62% annualized, of average loans outstanding, for the same period in 2011. The current reserve balance is representative of the relevant risk inherent within the Corporation's loan portfolio. Additions or reductions to the reserve in future periods will be dependent upon a combination of future loan growth, nonperforming loan balances and charge-off activity.

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

                                          September 30,      December 31,      September 30,
                                              2012               2011              2011
Nonperforming Assets:
Nonaccrual Loans                         $         3,122    $        5,490    $         5,954
Loans past due 90 days or more                         -                 -                  -
Restructured loans                                 2,168             2,503              3,719
Total nonperforming loans                          5,290             7,993              9,673
Other real estate owned                            3,511             3,162              5,212
Total nonperforming assets               $         8,801    $       11,155    $        14,885
Nonperforming loans as a % of loans                 1.22 %            1.99 %             2.47 %
Nonperforming assets as a % of assets               1.60 %            2.24 %             2.99 %
Reserve for Loan Losses:
At period end                            $         5,186    $        5,251    $         5,838
As a % of loans                                     1.20 %            1.35 %             1.49 %
As a % of nonperforming loans                      98.03 %           65.69 %            60.35 %
As a % of nonaccrual loans                        166.11 %           95.65 %            98.05 %
Texas ratio*                                       11.26 %           18.43 %            24.28 %


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

Nonperforming assets at $8.801 million have been reduced in 2012 by $2.354 million from the $11.155 million at 2011 year end. This reduction in nonperforming assets reflects management's efforts in the aggressive remediation of problem credits and disposition of OREO properties.

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

                                                             At Period End
                                    September 30, 2012      December 31, 2011      September30, 2011

Total loans, at period end         $            433,958    $           401,246    $           391,903
Average loans for the year         $            417,159    $           388,115    $           385,391




                                                             For the Period Ended
                                      Nine Months Ended       Twelve Months Ended       Nine Months Ended
                                     September 30, 2012        December 31, 2011       September 30, 2011

Net charge-offs during the
period                               $               860     $               3,662     $             1,775
Net charge-offs to average
loans, annualized                                    .28 %                     .94 %                   .62 %
Net charge-offs to beginning
allowance balance                                  16.38 %                   55.38 %                 26.84 %

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


Table of Contents

As of September 30, 2012, the allowance for loan losses represented 1.20% of total loans. At September 30, 2012, the allowance included specific reserves in the amount of $1.631 million, as compared to $1.200 million at December 31, 2011 and $1.992 million at September 30, 2011. In management's opinion, the allowance for loan losses is adequate to cover probable losses related to specifically identified loans, as well as probable losses inherent in the balance of the loan portfolio.

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

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

                                           Nine Months Ended         Year Ended          Nine Months Ended
                                           September 30 2012      December 31, 2011     September 30, 2011

Balance at beginning of period            $             3,162    $             5,562    $             5,562
Other real estate transferred from
loans due to foreclosure                                1,013                  4,194                  4,129
Other real estate sold                                   (178 )               (5,457 )               (3,751 )
Writedowns on other real estate held
for sale                                                 (474 )                 (855 )                 (550 )
Loss on sale of other real estate held
for sale                                                  (12 )                 (282 )                 (178 )

Balance at end of period                  $             3,511    $             3,162    $             5,212

During the first nine months of 2012, the Corporation received real estate in lieu of loan payments of $1.013 million. Other real estate is initially valued at the lower of cost or the fair value less selling costs. After the initial receipt, management periodically re-evaluates the recorded balances and any additional reductions in the fair value result in a write-down of other real estate.

Deposits

The Corporation had an increase in deposits in the first nine months of 2012. Total deposits increased by $34.574 million, or 8.54%, in the first nine months of 2012. The increase in deposits for the first nine months of 2012 is composed of an increase in noncore deposits of $10.798 million and an increase in core deposits of $23.776 million. In 2012, the rate of growth on core deposits slowed from that experienced in recent years. The Corporation, as part of an overall strategy to increase interest margins, reduced rates on some of its deposits to be more in line with competitors. This has resulted in slower core deposit growth and some migration of deposit dollars to short-term certificates of deposit. Management will continue to monitor deposit flows and adjust rates when it is deemed necessary to maintain or increase core deposits.

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

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

                        September 30,                   December 31,                   September 30,
                            2012         % of Total         2011        % of Total         2011         % of Total

Noninterest bearing    $        62,306        14.18 %  $       51,273        12.67 %  $        53,736        13.27 %
NOW, money market,
checking                       152,286        34.66           152,563        37.69            157,596        38.92
Savings                         15,783         3.59            14,203         3.51             15,618         3.86
Certificates of
Deposit <$100,000              142,125        32.35           130,685        32.28            119,893        29.60
Total core deposits            372,500        84.78           348,724        86.15            346,843        85.63

Certificates of
Deposit >$100,000               25,390         5.78            23,229         5.74             24,138         5.96
Brokered CDs                    41,473         9.44            32,836         8.11             34,077         8.41
Total non-core
deposits                        66,863        15.22            56,065        13.85             58,215        14.37

Total deposits         $       439,363       100.00 %  $      404,789       100.00 %  $       405,058       100.00 %


Table of Contents

Borrowings

The Corporation also utilizes FHLB borrowings as a source of funding. At September 30, 2012, this source of funding totaled $35 million and the Corporation secured this funding by pledging loans and investments. The $35 million of FHLB borrowings has a weighted average maturity of 2.28 years and a weighted average rate of 1.82% at September 30, 2012. The Corporation also has a USDA Rural Development loan held by its wholly owned subsidiary, First Rural Relending that has a fixed interest rate of 1% and matures in August 2024.

Shareholders' Equity

Total shareholders' equity increased $17.682 million from December 31, 2011 to September 30, 2012. The major reason for the increase in shareholders' equity was the common stock rights offering and a private placement, in which the Corporation issued 2,140,178 shares of its common stock and received net proceeds of $11.506 million. Also contributing to the increase was net income of $5.536 million, an increase in the market value of securities of $.545 million, the accretion of the discount on preferred stock of $.079 million, and stock option compensation of $.016 million.

RESULTS OF OPERATIONS

Summary

The Corporation reported net income available to common shareholders of $5.536 million, or $1.44 per share, in the first nine months of 2012, compared to $1.566 million or $.46 per share for the first nine months of 2011. Fully diluted earnings per share amounted to $1.39 per share for the 2012 nine-month period and $.45per share in 2011. The warrants outstanding were more dilutive in 2012 due to the increased market value of our common stock. The first nine month results include a valuation adjustment to the deferred tax asset of $3 million, a provision for loan losses of $.795 million and OREO writedowns and losses of $.450 million. Operating results for the same period in 2011 include a $1.000 million provision for loan losses, and $.728 million of OREO writedowns and losses.

Net Interest Income

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

Net interest margin on a fully taxable equivalent basis amounted to $4.934 million, 4.10% of average earning assets, in the third quarter of 2012, compared to $4.732 million, and 4.18% of average earning assets, in the third quarter of 2011. In the first nine months of 2012, net interest margin increased to $14.722 million, 4.19% of average earning assets, compared to $13.103 million, 3.78 % of average earning assets, for the same period in 2011. Margin improvement in 2012 was primarily due to a reduction in funding costs between periods.


Table of Contents

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

                                                                               Three Months Ended
                                                                                                                            2012-2011
                                  Average Balances               Average Rates           Interest         Income/                               Rate/
. . .
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