UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

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

Commission file number 000-23550

Fentura Financial, Inc.

(Exact name of registrant as specified in its charter)

Michigan		38-2806518
(State or other jurisdiction of incorporation or organization)		(IRS Employee Identification No.)

(Address of Principal Executive Offices)

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

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

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

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: October 21, 2010

Class — Common Stock                Shares Outstanding — 2,291,121

 

 

Fentura Financial Inc.
Index to Form 10-Q

		Page
Part I — Financial Information			3
Item 1 — Consolidated Financial Statements (Unaudited)			3-24
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations			25-37
Item 3 — Quantitative and Qualitative Disclosures about Market Risk			37-39
Item 4T — Controls and Procedures			39
Part II — Other Information			40
Item 1 — Legal Proceedings			40
Item 1A — Risk Factors			40
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds			40
Item 3 — Defaults Upon Senior Securities			40
Item 4 —Reserved			40
Item 5 — Other Information			40
Item 6 — Exhibits			40
Signatures			41
Exhibit Index			42
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I — FINANCIAL INFORMATION

FENTURA FINANCIAL, INC.
CONSOLIDATED BALANCE SHEETS
(000s omitted except share and per share data)

		September 30,
		2010				Dec 31,
		(unaudited)				2009
ASSETS
Cash and due from banks		$	14,787			$	18,459
Federal funds sold			39,700				23,650
Total cash & cash equivalents			54,487				42,109
Securities-available for sale			54,786				43,608
Securities-held to maturity, (fair value of $4,540 at September 30, 2010 and $5,493 at December 31, 2009)			4,471				5,456
Total securities			59,257				49,064
Loans held for sale			1,877				831
Loans:
Commercial			228,731				252,764
Real estate loans — construction			15,439				26,295
Real estate loans — mortgage			23,719				28,058
Consumer loans			42,806				48,313
Total loans			310,695				355,430
Less: Allowance for loan losses			(15,037	)			(10,726	)
Net loans			295,658				344,704
Bank owned life insurance			7,070				7,221
Bank premises and equipment			15,254				15,914
Federal Home Loan Bank stock			1,900				1,900
Accrued interest receivable			1,582				1,813
Other real estate owned			9,003				7,967
Assets of discontinued operations			0				37,919
Other assets			3,290				12,637
Total assets		$	449,378			$	522,079
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Non-interest bearing deposits		$	68,361			$	64,530
Interest bearing deposits			340,882				376,245
Total deposits			409,243				440,775
Short term borrowings			116				164
Federal Home Loan Bank advances			5,954				7,981
Subordinated debentures			14,000				14,000
Liabilities of discontinued operations			0				35,217
Accrued taxes, interest and other liabilities			3,993				3,410
Total liabilities			433,306				501,547
Shareholders’ equity
Common stock — no par value 2,289,912 shares issued (2,248,553 at December 31, 2009)			43,002				42,913
Retained deficit			(27,257	)			(21,657	)
Accumulated other comprehensive income (loss)			327				(724	)
Total shareholders’ equity			16,072				20,532
Total liabilities and shareholders’ equity		$	449,378			$	522,079

See notes to consolidated financial statements.

FENTURA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(000s omitted except share and per share data)

		Three Months Ended								Nine Months Ended
		September 30								September 30
		2010				2009				2010				2009
Interest income
Interest and fees on loans		$	5,030			$	5,936			$	15,536			$	18,399
Interest and dividends on securities:
Taxable			340				404				929				1,213
Tax-exempt			54				135				282				418
Interest on federal funds sold			12				1				27				1
Total interest income			5,436				6,476				16,774				20,031
Interest expense
Deposits			1,451				2,277				4,862				7,503
Borrowings			203				227				598				829
Total interest expense			1,654				2,504				5,460				8,332
Net interest income			3,782				3,972				11,314				11,699
Provision for loan losses			2,905				1,940				8,314				11,306
Net interest income after provision for loan losses			877				2,032				3,000				393
Non-interest income
Service charges on deposit accounts			378				519				1,255				1,435
Gain on sale of mortgage loans			214				100				442				612
Trust and investment services income			376				458				1,103				1,285
Gain on sale of securities			0				0				75				12
Other than temporary loss
Total impairment			(359	)			0				(359	)			0
Loss recognized in other comprehensive income			52				0				52				0
Net impairment loss recognized in earnings			(307	)			0				(307	)			0
Loss on equity investment			0				0				0				(1,560	)
Other income and fees			522				403				1,520				1,461
Total non-interest income			1,183				1,480				4,088				3,245
Non-interest expense
Salaries and employee benefits			2,013				2,129				6,191				6,752
Occupancy			430				428				1,310				1,378
Furniture and equipment			395				385				1,152				1,212
Loan and collection			542				984				1,532				2,302
Advertising and promotional			25				39				98				126
Other operating expenses			1,242				1,015				3,301				3,458
Total non-interest expense			4,647				4,980				13,584				15,428
Loss from continuing operations before income tax			(2,587	)			(1,468	)			(6,496	)			(11,590	)
Federal income tax/(benefit)			(250	)			(332	)			(524	)			5,028
Net loss from continuing operations		$	(2,337	)		$	(1,136	)		$	(5,972	)		$	(16,618	)
Net income/(loss) from discontinued operations, net of tax			0				289				372				(1,253	)
Net loss		$	(2,337	)		$	(847	)		$	(5,600	)		$	(17,871	)
Loss per share from continuing operations
Basic and diluted		$	(1.03	)		$	(0.51	)		$	(2.64	)		$	(7.56	)
Income/(loss) per share from discontinued operations
Basic and diluted		$	0.00			$	0.13			$	0.17			$	(0.57	)
Net loss per share
Basic and diluted		$	(1.03	)		$	(0.38	)		$	(2.47	)		$	(8.13	)
Cash Dividends declared		$	0.00			$	0.00			$	0.00			$	0.00

See notes to consolidated financial statements.

FENTURA FINANCIAL, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(UNAUDITED)

		Nine Months Ended
		September 30,
(000s omitted)		2010				2009
Common Stock
Balance, beginning of period		$	42,913			$	42,778
Issuance of shares under
Director stock purchase plan & Dividend reinvestment program (41,359 and 39,449 shares)			89				105
Balance, end of period			43,002				42,883
Retained Deficit
Balance, beginning of period			(21,657	)			(4,677	)
Net loss			(5,600	)			(17,871	)
Balance, end of period			(27,257	)			(22,548	)
Accumulated Other Comprehensive Income (Loss)
Balance, beginning of period			(724	)			(1,977	)
Change in unrealized gain (loss) on securities, net of tax			1,051				1,189
Balance, end of period			327				(788	)
Total shareholders’ equity		$	16,072			$	19,547

See notes to consolidated financial statements.

FENTURA FINANCIAL, INC
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)

		Nine Months Ended
		September 30,
(000s omitted)		2010				2009
OPERATING ACTIVITIES:
Net loss		$	(5,600	)		$	(17,871	)
Adjustments to reconcile net income (loss) to cash
Provided by Operating Activities:
Depreciation and amortization			437				811
Establishment of deferred tax asset valuation allowance			0				5,924
Provision for loan losses			8,314				11,306
Loans originated for sale			(26,921	)			(49,629	)
Proceeds from the sale of loans			26,317				49,497
Gain on sales of loans			(442	)			(612	)
Loss on other real estate owned			104				645
Loss on security impairment			0				200
Loss on equity investment			307				1,360
Gain on sale of securities			(75	)			(12	)
Earnings from bank owned life insurance			(146	)			(59	)
Net (increase) decrease in interest receivable & other assets			9,003				(3,914	)
Net increase (decrease) in interest payable & other liabilities			583				(3,783	)
Net change in discontinued operations operating activities			806				(838	)
Total Adjustments			18,287				10,896
Net cash provided by/(used in) operating activities			12,687				(6,975	)
CASH FLOWS FROM INVESTING ACTIVITES:
Proceeds from maturities of securities — HTM			800				1,183
Proceeds from maturities of securities — AFS			8,705				7,714
Proceeds from calls of securities—HTM			380				0
Proceeds from calls of securities — AFS			5,500				2,000
Proceeds from sales of securities — AFS			7,105				4,000
Proceeds from sales of equity securities			5				0
Purchases of securities — AFS			(30,901	)			(14,560	)
Proceeds from sale of bank subsidiary			1,900				0
Net decrease in loans			36,754				41,379
Proceeds from bank owned life insurance			297				203
Sales of other real estate owned			2,838				1,876
Acquisition of premises and equipment, net			(170	)			(79	)
Net change in discontinued operations investing activities			(548	)			5,557
Net cash provided by investing activities			32,665				49,723
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in deposits			(31,532	)			(498	)
Net decrease in short term borrowings			(48	)			(1,466	)
Repayment of notes payable			0				(1,000	)
Purchase of advances from FHLB			0				55,495
Repayments of advances from FHLB			(2,027	)			(58,221	)
Net proceeds from stock issuance and purchase			89				105
Net change in discontinued operations financing activities			544				(4,275	)
Net cash used in financing activities			(32,974	)			(9,860	)
Net change in cash and cash equivalents		$	12,378			$	32,882
Cash and cash equivalents — Beginning		$	42,109			$	13,626
Cash and cash equivalents — Ending		$	54,487			$	46,064
Less cash and cash equivalents of discontinued operations			0				444
Cash and cash equivalents of continuing operations		$	54,487			$	32,438

FENTURA FINANCIAL, INC
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)

		Nine Months Ended
(000s omitted)		2010				2009
Cash paid for:
Interest		$	5,219			$	8,506
Income taxes		$	0			$	3,981
Non-cash Disclosures:
Transfers from loans to other real estate		$	3,978			$	3,394

FENTURA FINANICIAL, INC
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(000s omitted)		2010				2009				2010				2009
Net loss		$	(2,337	)		$	(847	)		$	(5,600	)		$	(17,871	)
Other comprehensive income (loss), net of tax:
Unrealized holding gains (losses) arising during period			1,114				547				1,977				764
Impairment loss recognized during period			(307	)			0				(307	)			(200	)
Reclassification adjustment for gains included in income			0				12				75				12
Tax effect			(321	)			593				(694	)			613
Other comprehensive income (loss)			486				1,152				1,051				1,189
Comprehensive income (loss)		$	(1,851	)		$	305			$	(4,549	)		$	(16,682	)

FENTURA FINANCIAL, INC.

NOTE 1 — BASIS OF PRESENTATION

The consolidated financial statements at December 31, 2009, September 30, 2009 and September 30, 2010 include Fentura Financial, Inc. (the “Corporation”) and its wholly owned subsidiaries, The State Bank in Fenton, Michigan and West Michigan Community Bank in Hudsonville, Michigan (the “Banks”), as well as West Michigan Mortgage Company, LLC, and the other subsidiaries of the Banks. Intercompany transactions and balances are eliminated in consolidation.

On March 17, 2009, The Corporation entered into an agreement to sell all of the stock of one of its bank subsidiaries, Davison State Bank, to a private, non-affiliated, investor group. The Corporation recorded an estimated loss on the sale of Davison State Bank of $700,000 in the first quarter of 2009. As a result of the amended sales agreement, the estimated loss of $700,000 was reversed in the first quarter of 2010. On April 30, 2010, the sale of Davison State Bank closed and the assets and liabilities were transferred to the investor group. As a result of the timing of the sale, discontinued operations reflect four months of income on the income statement for the nine month period.

Financial statements are presented with discontinued operations separately presented on the balance sheet and income statement. The presentations have been updated for December 31, 2009 and September 30, 2009 to reflect the discontinued operations results.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information

NOTE 1 — BASIS OF PRESENTATION (continued)

and the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation’s annual report on Form 10-K for the year ended December 31, 2009.

Reclassifications

Some items in the prior year financial statements were reclassified to conform to the current presentation. For the nine month period end September 2009, a $700,000 impairment charge on discontinued operations was reclassified in the prior year presentation from non-interest expense of continuing operations to discontinued operations. This reclassification reduced the loss from continuing operations by $700,000, net of tax, and had no impact on net income.

Securities

Securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income, net of tax.

Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities, where prepayments are anticipated. Gains and losses on sales are based on the amortized cost of the security sold.

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.

In determining OTTI management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

NOTE 1 — BASIS OF PRESENTATION (continued)

Allowance for Loan Losses

The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.

A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated 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. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Loans for which the terms have been modified and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and are classified as impaired. Troubled debt restructurings are measured at the present value of estimated future cash flows using the loans effective rate at inception.

Other Real Estate Owned and Foreclosed Assets: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed.

Income Taxes

Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance reduces deferred tax assets to the amount expected to be realized.

The Corporation recognizes interest and/or penalties related to income tax matters in income tax expense.

There were no unrecognized tax benefits at September 30, 2010 or December 31, 2009, and the Corporation does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months.

Dividend Restriction

Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Banks to the Corporation or by the Corporation to shareholders. West Michigan Community Bank and The State Bank have been restricted from dividend payments due to the signing of Consent Orders with the Federal Deposit Insurance Corporation (FDIC).

On October 27, 2010, management received a notice from The Federal Reserve which defined restrictions being placed upon the Holding Company. The restrictions include the declaration or payment of any dividends, the receipt of dividends from subsidiary Banks and the repayment of any principal or interest on subordinated debentures or Trust Preferred securities.

NOTE 1 — BASIS OF PRESENTATION (continued)

Stock Option Plans

The Nonemployee Director Stock Option Plan provides for granting options to nonemployee directors to purchase the Corporation’s common stock. The purchase price of the shares is the fair market value at the date of the grant, and there is a three-year vesting period before options may be exercised. Options to acquire no more than 8,131 shares of stock may be granted under the Plan in any calendar year and options to acquire not more than 73,967 shares in the aggregate may be outstanding at any one time. No options were granted in 2010 or 2009.

The Employee Stock Option Plan grants options to eligible employees to purchase the Corporation’s common stock at or above, the fair market value of the stock at the date of the grant. Awards granted under this plan are limited to an aggregate of 86,936 shares. The administrator of the plan is a committee of directors. The administrator has the power to determine the number of options to be granted, the exercise price of the options and other terms of the options, subject to consistency with the terms of the Plan.

The following table summarizes stock option activity:

		Number of				Weighted
		Options				Average Price
Options outstanding at December 31, 2009			20,297			$	29.55
Options granted 2010			0			$	0.00
Options forfeited 2010			(3,542	)		$	25.04
Options outstanding and exercisable at September 30, 2010			16,755			$	30.51

Going Concern

As a result of the Corporation’s net losses and non-compliance with the capital requirements of the Consent Orders, our auditors added a paragraph to their opinion on the Corporation’s December 31, 2009 consolidated financial statements, expressing substantial doubt about the Corporation’s ability to continue as a going concern. In 2010, the Banks achieved compliance with substantially all areas of the Consent Orders, except for the capital requirements. Strategies to improve profitability and to meet the capital requirements of the Consent Orders, discussed in Note 10, include shrinking the balance sheets, reducing costs, and selling subsidiary banks. The sale of Davison State Bank, which closed on April, 30, 2010, recovered $2.8 million, of which a portion was reinvested in The State Bank. On April 27, 2010, an agreement was signed to sell West Michigan Community Bank. See Note 11 for details regarding the definitive agreement to sell West Michigan Community Bank.

These financial statements do not include any adjustments that might be necessary if the Corporation is unable to continue as a going concern.

NOTE 2 — ADOPTION OF NEW ACCOUNTING STANDARDS

New Accounting Pronouncements:

In June 2009, the FASB amended previous guidance relating to transfers of financial assets and eliminates the concept of a qualifying special purpose entity. This guidance must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. This guidance must be applied to transfers occurring on or after the effective date. Additionally, on and after the effective date, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes. Therefore, formerly qualifying special-purpose entities should be evaluated for

NOTE 2 — ADOPTION OF NEW ACCOUNTING STANDARDS (continued)

consolidation by reporting entities on and after the effective date in accordance with the applicable consolidation guidance. The disclosure provisions were also amended and apply to transfers that occurred both before and after the effective date of this guidance. The effect of adopting this new guidance was not material to the Corporation.

In June 2009, the FASB amended guidance for consolidation of variable interest entity guidance by replacing the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. Additional disclosures about an enterprise’s involvement in variable interest entities are also required. This guidance is effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Early adoption is prohibited. The effect of adopting this new guidance was not material to the Corporation.

Newly Issued But Not Yet Effective Accounting Guidance

In July 2010, the FASB issued an Accounting Standards Update, “Receivables: Disclosure About the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The objective of this ASU is for an entity to provide disclosures that facilitate financial statement users’ evaluation of the nature of credit risk inherent in the entity’s portfolio of financing receivables, how that risk is analyzed and assessed in arriving at the allowance for credit losses, and the changes and reasons for those changes in the allowance for credit losses. An entity should provide disclosure on a disaggregated basis on two defined levels: (1) portfolio segment; and (2) class of financing receivable. The update makes changes to existing disclosure requirements and includes additional disclosure requirements about financing receivables, including credit quality indicators of financing receivables at the end of the reporting period by class of financing receivables, the aging of past due financing receivables at the end of the reporting period by class of financing receivables and their effect on the allowance for credit losses. The Corporation expects the adoption on December 31, 2010 to be disclosure-related only and to have no impact on its results of operations.

NOTE 3 — SECURITIES

Securities are as follows:

						Gross				Gross
(000s omitted)		Amortized				Unrealized				Unrealized
Available for Sale		Cost				Gains				Losses				Fair Value
September 30, 2010
U.S. Government & federal agency		$	11,210			$	34			$	0			$	11,244
State and municipal			898				8				0				906
Mortgage-backed residential			8,678				326				0				9,004
Collateralized mortgage obligations			31,844				509				(427	)			31,926
Equity securities			1,658				54				(6	)			1,706
		$	54,288			$	931			$	(433	)		$	54,786

December 31, 2009
U.S. Government & federal agency		$	6,543			$	38			$	(67	)		$	6,514
State and municipal			7,034				102				(41	)			7,095
Mortgage-backed residential			13,482				298				0				13,780
Collateralized mortgage obligations			15,369				199				(878	)			14,690
Equity securities			1,971				21				(463	)			1,529
		$	44,399			$	658			$	(1,449	)		$	43,608

NOTE 3 — SECURITIES (continued)

Gross

Gross

(000s omitted)

Amortized

Unrecognized

Unrecognized

Held to Maturity

Cost

Gains

Losses

Fair Value

September 30, 2010

State and municipal

$

4,471

$

69

$

0

$

4,540

December 31, 2009
State and municipal		$	5,455			$	55			$	(18	)		$	5,492
Mortgage-backed residential			1				0				0				1
		$	5,456			$	55			$	(18	)		$	5,493

The amortized cost and fair value of the securities portfolio are shown by expected maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Contractual maturities of securities at September 30, 2010 were as follows:

		Available for Sale
		Amortized				Fair
(000s omitted)		Cost				Value
Due in one year or less		$	12,108			$	12,150
Due from one to five years			0				0
Due from five to ten years			0				0
Mortgage-backed securities			8,678				9,004
Collateralized mortgage obligations			31,844				31,926
Equity securities			1,658				1,706
		$	54,288			$	54,786

		Held to Maturity
		Amortized				Fair
(000s omitted)		Cost				Value
Due in one year or less		$	2,792			$	2,805
Due from one to five years			1,679				1,735
Due from five to ten years			0				0
Due after ten years			0				0
		$	4,471			$	4,540

At September 30, 2010, there were 2 private label CMO securities, with holdings totaling $4,079,000, which exceeded 10% of shareholders’ equity. At September 30, 2009, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders equity.

Sales of available for sale securities were as follows:

(000s omitted)		2010				2009
Proceeds		$	7,110			$	4,000
Gross gains			90				12
Gross losses			(15	)			0

Securities with unrealized losses at September 30, 2010 and December 31, 2009, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position are as follows:

NOTE 3 — SECURITIES (continued)

		Less than 12 Months								12 Months or More								Total
2010		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(000s omitted)		Value				Loss				Value				Loss				Value				Loss
Collateralized mortgage obligations		$	5,483			$	(45	)		$	4,584			$	(382	)		$	10,067			$	(427	)
Equity securities			0				0				2				(6	)			2				(6	)
Total temporarily impaired		$	5,583			$	(45	)		$	4,586			$	(388	)		$	10,119			$	(433	)

		Less than 12 months								12 months or more								Total
2009		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(000s omitted)		Value				Loss				Value				Loss				Value				Loss
US Gov’t & federal agencies		$	3,475			$	(67	)		$	0			$	0			$	3,475			$	(67	)
State & municipal			497				(18	)			659				(41	)			1,156				(59	)
Collateralized Mortgage Obligations			0				0				4,872				(878	)			4,872				(878	)
Equity securities			0				0				1,009				(463	)			1,009				(463	)
Total temporarily impaired		$	3,972			$	(85	)		$	6,540			$	(1,382	)		$	10,512			$	(1,467	)

Other-Than-Temporary-Impairment

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. In evaluating OTTI, management considers the factors presented in Note 1.

As of September 30, 2010, the Corporation’s security portfolio consisted of 101 securities, 8 of which were in an unrealized loss position. All unrealized losses are related to the Corporation’s collateralized mortgage obligations (CMOs) and equity securities, as discussed below.

Losses recognized in earnings on securities totaled $288,000 for the year ended December 31, 2009 and $307,000 of additional OTTI losses were recognized through earnings during the period ending September 30, 2010.

Collateralized Mortgage Obligations (CMOs)

The Corporation’s unrealized losses related primarily to its investment in collateralized mortgage obligation securities. The decline in fair value is primarily attributable to temporary illiquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual securities. These six investments have an amortized cost of $10,484,000 and a net unrealized loss of $427,000. Three of these securities were issued by the U.S. government sponsored agency Ginnie Mae and hold an AAA rating by a major rating agency.

In addition, the portfolio contains three private label securities with an amortized cost of $5,000,000. The ratings held on the private label securities are AA, A- and CCC. The underlying collateral of these CMOs is comprised largely of 1-4 family residences, with geographic concentrations in California, Florida and Virginia. The higher rated securities are supported by mortgages classified as alt-a, while the CCC rated security is supported by Prime classified mortgages. In each of these securities, the Corporation lies in the senior tranche and receives payments before other tranches. For private label securities, management completes an analysis to review the recent performance of the mortgage pools underlying the instruments.

The Corporation has been closely monitoring the performance of the CMO portfolio. In 2009, there were several CMOs that were downgraded in the market. Management continues to review historical and projected payment streams, delinquency ratios, geographic distribution, ratings, projected future cash

NOTE 3 — SECURITIES (continued)

flows and general market conditions. Management uses multiple assumptions to project the expected future cash flows of the private label CMOs, which include prepayment speeds, projected default rates and loss severity rates. The cash flows are then discounted using the effective rate on the securities determined at acquisition. Recent historical experience is the base for determining the cash flow assumptions and is adjusted when appropriate after considering characteristics of the underlying loans collateralizing the private label CMO security. As a result of its review, in the fourth quarter of 2009, the Corporation recognized a $79,000 other-than-temporary impairment as a result of incurred credit losses which was reflected in the income statement. As part of the September 30, 2010 analysis, management’s review indicated $9,500 of additional credit related OTTI on this security. The security with the credit loss is the Corporation’s sole CCC rated security and has a remaining amortized cost of $589,000 at September 30, 2010. The remaining unrealized loss of $84,000 on this security has been reflected in accumulated other comprehensive loss.

Equity securities

The Corporation also holds investments in equity securities which gross unrealized losses of $6,000 at September 30, 2010. There are two equity securities which comprise the gross unrealized loss. They are moderate to actively traded stocks and therefore have active market valuation data. Management continues to watch these securities and their respective valuations. The equity securities portfolio has an amortized cost of $1,658,000 and a fair value of $1,706,000. The majority of the equity securities are investments in Michigan bank holding companies. On a quarterly basis, management reviews the Corporation’s investment in these equity securities. Management reviews current market prices on publicly traded equity securities and compares the current price to the book price. Any difference is adjusted as a temporary valuation difference, unless other resources provide other information. Equity securities that are not publicly traded receive a multi-faceted review utilizing call report data. Management reviews such performance indicators as earnings, ROE, ROA, non-performing assets, brokered deposits and capital ratios. Management draws conclusions from this information, as well as any published information or trading activity received from the individual institutions, to assist in determining if any unrealized loss is other than temporary impairment. As a result of the September 30, 2010 review, OTTI totaling $298,000 was recognized during the quarter on the Corporation’s equity securities in bank holding companies. The impairment was recognized as a result of the length of time these securities have been at an unrealized loss position.

The table below represents a roll forward of the credit losses recognized in earnings for the period ended September 30, 2010.

(000s omitted)
Beginning Balance, January 1, 2010		$	288
Increases to the amount related to the credit loss for which other-than-temporary was previously recognized			307
Ending balance, September 30, 2010		$	595

NOTE 4 — LOANS AND ALLOWANCE FOR LOAN LOSSES

Major categories of loans are as follows:

(000s omitted)		September 30, 2010				December 31, 2009
Commercial		$	77,281			$	81,425
Real estate — commercial			151,450				171,339
Real estate — construction			15,439				26,295
Real estate — mortgage			23,719				28,058
Consumer			42,806				48,313
			310,695				355,430
Less allowance for loan losses			15,037				10,726
		$	295,658			$	344,704

NOTE 4 — LOANS AND ALLOWANCE FOR LOAN LOSSES (continued)

The Corporation has originated primarily residential and commercial real estate loans, commercial, construction and installment loans. The Corporation estimates that the majority of their loan portfolio is based in Genesee, Oakland and Livingston counties within southeast Michigan; in Kent and Ottawa counties in west Michigan, with the remainder of the portfolio distributed throughout Michigan. The ability of the Corporation’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in these areas.

Activity in the allowance for loan losses, for the nine month periods ended September 30, 2010 and September 30, 2009 is as follows:

(000s omitted)		September 30, 2010				September 30, 2009
Balance, January 1,		$	10,726			$	10,455
Provision for loan losses			8,314				11,306
Loans charged off			(4,863	)			(7,524	)
Loan recoveries			860				248
Balance, end of period		$	15,037			$	14,485

Activity in the allowance for loan losses, for the three month periods ended September 30, 2010 and September 30, 2009 is as follows:

(000s omitted)		September 30, 2010				September 30, 2009
Balance, July 1,		$	14,227			$	13,970
Provision for loan losses			2,905				1,940
Loans charged off			(2,216	)			(1,567	)
Loan recoveries			121				142
Balance, end of period		$	15,037			$	14,485

Loan impairment is measured by valuing the underlying collateral or by estimating the expected future cash flows and discounting them at the respective effective interest rate.

The recorded investment in these loans is as follows:

(000s omitted)		September 30, 2010				December 31, 2009
Period end loans not requiring allocation		$	12,998			$	15,874
Period end loans requiring allocation			30,154				23,059
		$	43,152			$	38,933
Amount of the allowance for loan losses allocated		$	9,229			$	5,683

Nonaccrual loans and loans past due 90 days still on accrual were as follows:

(000s omitted)		September 30, 2010				December 31, 2009
Loans past due over 90 days still on accrual		$	0			$	319
Troubled debt restructurings		$	3,225			$	3,822
Nonaccrual loans		$	15,410			$	16,507

Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

NOTE 5— FAIR VALUE

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values.

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. Securities classified as available for sale are generally reported at fair value utilizing Level 2 inputs where the Corporation obtains fair value measurements from an independent pricing service which uses matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows and the bonds’ terms and conditions, among other things. The fair value of the Corporation’s equity securities, which primarily consists of the common stock in other Michigan bank holding companies, is based on the prices of recent stock trades, if available and is considered Level 2 because these stocks are not actively traded in public markets. If there are no available recent trades for the Corporation’s bank holding company equity holdings an analysis is performed which compares trading multiples of book value of publicly traded peer banks and the Corporation’s holdings are marked to a similar value based on their reported book value (Level 2 inputs).

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing and asset or liability.

The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs). The remaining fair values of securities (Level 3 inputs) are based on the reporting entity’s own assumptions and basic knowledge of market conditions and individual investment performance.

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Other Real Estate Owned: Non-recurring adjustments to certain commercial and residential real estate properties classified as other real estate owned are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.

NOTE 5— FAIR VALUE (continued)

Assets Measured on a Recurring Basis

Assets measured at fair value on a recurring basis are summarized below:

		Fair Value Measurements Using
						Quoted Prices in
						Active Markets for				Significant Other				Significant
						Identical Assets				Observable Inputs				Unobservable Inputs
(000s omitted)		Total				(Level 1)				(Level 2)				(Level 3)
September 30, 2010
Available for sale securities
US Government and federal agency		$	11,244			$	0			$	11,244			$	0
State and municipal			906				0				906				0
Mortgage-backed residential			9,004				0				9,004				0
Collateralized mortgage obligations			31,926				0				31,926				0
Equity securities			1,706				12				1,694				0
		$	54,786			$	12			$	54,774			$	0

		Fair Value Measurements Using
						Quoted Prices in
						Active Markets for				Significant Other				Significant
						Identical Assets				Observable Inputs				Unobservable Inputs
(000s omitted)		Total				(Level 1)				(Level 2)				(Level 3)
December 31, 2009
Available for sale securities
US Government and federal agency		$	6,514			$	0			$	6,514			$	0
State and municipal			7,095				0				7,095				0
Mortgage-backed residential			13,780				0				13,780				0
Collateralized mortgage obligations			14,690				0				14,690				0
Equity securities			1,529				18				1,511				0
		$	43,608			$	18			$	43,590			$	0

The table below presents a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2009. The Corporation did not hold any Level 3 assets during 2010.

NOTE 5— FAIR VALUE (continued)

		Fair Value Measurements Using Significant
		Unobservable Inputs
		(Level 3)
(000s omitted)		Asset				Liability				Total
Beginning balance, Jan. 1, 2009		$	1,229			$	0			$	1,229
Total gains or losses (realized / unrealized)
Included in earnings			7								7
Loss on security impairment			(208	)			0				(208	)
Included in other comprehensive income			357				0				357
Purchases, issuances, and settlements
Transfers in and / or out of Level 3			(1,385	)			0				(1,385	)
Ending balance, September 30, 2009		$	0			$	0			$	0

Assets Measured on a Non-Recurring Basis

Assets measured at fair value on a non-recurring basis are summarized below:

						Quoted Prices
						in Active Markets
						for Identical				Significant Other				Significant
						Assets				Observable Inputs				Unobservable Inputs
(000s omitted)		Total				(Level 1)				(Level 2)				(Level 3)
At September 30, 2010
Impaired loans		$	20,925			$	0			$	0			$	20,925
Other real estate owned			1,401				0				0				1,401
At December 31, 2009
Impaired loans		$	17,376			$	0			$	0			$	17,376
Other real estate owned			1,274				0				0				1,274

The following represent impairment charges recognized during the period:

At September 30, 2010, impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a principal amount of $30,154,000 with a valuation allowance of $9,229,000 resulting in an additional provision for loan losses of $1,930,000 for the three month period, and $4,740,000 for the nine month period, ending September 30, 2010. This is compared to December 31, 2009 when the principal amount of impaired loans was $23,059,000 with a valuation allowance of $5,683,000.

Other real estate owned which is measured at the lower of carrying value or fair value less costs to sell, had a net carrying amount of $9,003,000, of which $1,401,000 was at fair value at September 30, 2010, resulting from write-downs totaling $144,000 for the three month period and $295,000 for the nine month period. At December 31, 2009, other real estate owned had a net carrying amount of $7,967,000, of which $1,274,000 was at fair value.

NOTE 5— FAIR VALUE (continued)

Carrying amount and estimated fair value of financial instruments, not previously presented were as follows:

		September 30, 2010								December 31, 2009
(000s omitted)		Carrying Amount				Fair Value				Carrying Amount				Fair Value
Assets:
Cash and cash equivalents		$	54,487			$	54,487			$	42,109			$	42,109
Securities — held to maturity			4,471				4,540				5,456				5,493
FHLB stock			1,900				n/a				1,900				n/a
Loans held for sale			1,877				1,880				831				831
Loans (including impaired loans)			295,658				270,583				344,704				326,422
Accrued interest receivable			1,582				1,582				1,813				1,813
Liabilities:
Deposits		$	409,243			$	403,614			$	440,775			$	441,827
Short-term borrowings			116				116				164				164
FHLB advances			5,954				6,311				7,981				8,488
Subordinated debentures			14,000				12,644				14,000				12,656
Accrued interest payable			1,132				1,132				892				892

The following methods and assumptions were used by the Corporation in estimating its fair value disclosures for financial instruments:

Cash and cash equivalents

The carrying amounts reported in the balance sheet for cash and short-term instruments approximate their fair values.

Securities

Fair values for securities held to maturity are based on similar information previously presented for securities available for sale.

FHLB Stock

It was not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

Loans held for sale

The fair values of these loans are determined in the aggregate on the basis of existing forward commitments or fair values attributable to similar loans.

Loans

For variable rate loans that re-price frequently and with no significant change in credit risk, fair values are based on carrying values. The fair value for other loans is estimated using discounted cash flow analysis. The carrying amount of accrued interest receivable approximates its fair value.

Off-balance-sheet instruments

The fair value of off-balance sheet items is not considered material.

Deposit liabilities

The fair values disclosed for demand deposits are, by definition equal to the amount payable on demand at the reporting date. The carrying amounts for variable rate, fixed term money market accounts and

NOTE 5— FAIR VALUE (continued)

certificates of deposit approximate their fair values at the reporting date. Fair values for fixed certificates of deposit are estimated using discounted cash flow calculation that applies interest rates currently being offered on similar certificates. The carrying amount of accrued interest payable approximates its fair value.

Short-term borrowings

The carrying amounts of federal funds purchased and other short-term borrowings approximate their fair values.

FHLB advances

Rates currently available for FHLB debt with similar terms and remaining maturities are used to estimate the fair value of the existing debt.

Subordinated Debentures

The estimated fair value of the existing subordinated debentures is calculated by comparing a current market rate for the instrument compared to the book rate. The difference between these rates computes the fair value.

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 management’s judgments regarding future expected loss experience, current economic conditions, risk characteristics 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.

NOTE 6 — INCOME TAXES

A valuation allowance related to deferred tax assets is required when it is considered more likely than not that all or part of the benefit related to such assets will not be realized. Management has reviewed the deferred tax position for the Corporation at September 30, 2010 and December 31, 2009. The Corporation’s evaluation of taxable events, losses in recent years and the continuing deterioration of the Michigan economy led management to conclude that it was more likely than not that all or part of the benefit would not be realized. During the second quarter of 2009, the Corporation established a full valuation allowance against our deferred tax assets. The valuation allowance against our deferred tax assets may be reversed to income in future periods to the extent that the related deferred income tax assets are realized or the valuation allowance is otherwise no longer required. Management will continue to monitor our deferred tax assets quarterly for changes affecting their realizability.

Normally, the calculation for the income tax expense (benefit) does not consider the tax effects of changes in other categories of income such as other comprehensive income (“OCI”), which is a component of shareholders’ equity on the balance sheet. However, an exception is warranted when there is a pre-tax loss in continuing operations. When this is the case, pre-tax income from other categories, such as changes in OCI and discontinued operations, are included in the calculation of the tax expense or benefit for the current year. For the first nine months of 2010, this resulted in an income tax benefit recorded to continuing operations.

There were no unrecognized tax benefits at September 30, 2010 or December 31, 2009, and the Corporation does not expect the total amount of unrecognized tax benefits to significantly increase in the next twelve months.

NOTE 7 — EARNINGS PER COMMON SHARE

A reconciliation of the numerators and denominators used in the computation of basic earnings per common share and diluted earnings per common share is presented below. Earnings per common share are presented below for the three and nine months ended September 30, 2010 and 2009:

The factors in the earnings per share computation follow.

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
(000s omitted except share and per share data)		2010				2009				2010				2009
Basic
Net loss		$	(2,337	)		$	(847	)		$	(5,600	)		$	(17,871	)
Weighted average common shares outstanding			2,277,406				2,210,613				2,265,472				2,198,233
Basic loss per common share		$	(1.03	)		$	(0.38	)		$	(2.47	)		$	(8.13	)
Diluted
Net loss		$	(2,337	)		$	(847	)		$	(5,600	)		$	(17,871	)
Weighted average common shares outstanding for basic earnings per common share			2,277,406				2,210,613				2,265,472				2,198,233
Add: Dilutive effects of assumed exercises of stock Options			0				0				0				0
Average shares and dilutive potential common shares			2,277,406				2,210,613				2,265,472				2,198,233
Diluted loss per common share		$	(1.03	)		$	(0.38	)		$	(2.47	)		$	(8.13	)

There were no stock options for the three or nine month period ended September 30, 2010 or September 30, 2009 that were dilutive, as a result of the net loss the period.

NOTE 8 — COMMITMENTS AND CONTINGENCIES

There are various contingent liabilities that are not reflected in the financial statements including claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material effect on the Corporation’s consolidated financial condition or results of operations.

NOTE 9 — DISCONTINUED OPERATIONS

On March 17, 2009, The Corporation entered into an agreement to sell all of the stock of one of its bank subsidiaries, Davison State Bank, to a private, non-affiliated, investor group. The Corporation recorded an estimated loss on the sale of Davison State Bank of $700,000 in the first quarter of 2009. As a result of the amended sales agreement, the estimated loss of $700,000 was reversed in the first quarter of 2010. A condensed balance sheet of held for sale operations is presented below for the period ended and December 31, 2009. As of April 30, 2010, Davison State Bank was sold to an independent financial group. As a result, there is no balance sheet for presentation at September 30, 2010.

NOTE 9 — DISCONTINUED OPERATIONS (continued)

DAVISON STATE BANK
CONDENSED BALANCE SHEET OF DISCONTINUED OPERATIONS
(Unaudited)

		Dec 31, 2009
ASSETS
Cash and cash equivalents		$	2,537
Securities — available for sale			7,082
Securities — held to maturity			405
Loans, net of allowance ($679-2009)			24,396
Other assets			3,499
Total assets		$	37,919
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Non-interest bearing		$	9,012
Interest bearing			26,265
Total deposits			35,277
Accrued taxes, interest and other liabilities			(60	)
Shareholders’ equity			2,702
Total liabilities and shareholders’ equity		$	37,919

DAVISON STATE BANK
CONDENSED STATEMENT OF INCOME OF DISCONTINUED OPERATIONS
(Unaudited)

		Three Months Ended								Nine Months Ended
		September 30								September 30
		2010				2009				2010				2009
Interest income		$	0			$	494			$	607			$	1,556
Interest expense			0				151				116				510
Net interest income			0				343				491				1,046
Provision for loan losses			0				35				(5	)			190
Net interest income after provision for loan losses			0				308				496				856
Non-interest income			0				143				178				405
Non-interest expense			0				418				121				2,095
Income/(loss) before federal income tax			0				33				553				(834	)
Federal income tax expense/(benefit)			0				(256	)			181				419
Net income/(loss)		$	0			$	289			$	372			$	(1,253	)

NOTE 10-REGULATORY MATTERS

The Corporation (on a consolidated basis) and its Bank subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Banks’ financial statements. Under capital adequacy guidelines and regulatory enforcement action, the Corporation (see Note 12) and the Banks must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items are calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

NOTE 10— REGULATORY MATTERS (continued)

Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). As of December 31, 2009 notification from Federal Deposit Insurance Corporation categorized the Banks as adequately capitalized under the regulatory framework for prompt corrective action.

As of December 31, 2009, The State Bank was required by regulatory authorities to maintain certain minimum capital ratios. The State Bank’s required capital ratios were those required in the Consent Order that was effective January 10, 2010 which is discussed later in this note.

In March 2009, West Michigan Community Bank entered into a Consent Order with federal and state banking regulators that contain provisions to foster improvement in West Michigan Community Bank’s earnings, reduce non performing loan levels, and increase capital. The Consent Order requires West Michigan Community Bank to retain a Tier 1 capital to average assets ratio of a minimum of 8.0%. As of September 30, 2010, West Michigan Community Bank has a Tier 1 capital to average assets ratio of 6.7%, as compared to Tier 1 capital to average assets ratio of 6.9% at December 31, 2009. At both September 30, 2010 and December 31, 2009, West Michigan Community Bank was not in compliance with the Consent Order capital requirements.

Effective January 10, 2010, The State Bank entered into a Consent Order with federal and state banking regulators that contain provisions to foster improvement in The State Bank’s earnings, reduce nonperforming loan levels and increase capital. The Consent Order requires The State Bank to maintain a Tier 1 capital to average asset ratio of a minimum of 8.0%. It also requires The State Bank to maintain a total capital to risk weighted asset ratio of 12.0%. At September 30, 2010, The State Bank had a Tier 1 capital to average assets ratio of 6.2% and a total capital to risk-weighted assets ratio of 9.4%. This is compared to ratios at December 31, 2009, of a Tier 1 capital to average assets ratio of 6.2% and a total capital to risk-weighted assets ratio of 8.9%. At September 30, 2010 and at December 31, 2009, The State Bank was not in compliance with the Consent Order capital requirements.

The Consent Orders restrict the Banks from issuing or renewing brokered deposits. The Consent Orders also restrict dividend payments from The State Bank and West Michigan Community Bank to the Corporation. The Corporation, the Boards of Directors and management continue to work on plans to comply with the Consent Orders. While below the compliance level required by the Orders, both Banks maintain capital levels considered adequate by regulatory standards. Non-compliance with Consent Order requirements may cause the Banks to be subject to further enforcement actions by the FDIC.

As illustrated in the table below, at September 30, 2010, the Consolidated Corporation’s total capital to risk weighted assets ratio at 7.4% was below the adequately capitalized requirement of 8.0%. At December 31, 2009, the Consolidated Corporation’s total capital to risk weighted assets ratio of 7.8% was below the minimum requirement of 8.0%.

The Corporation’s principal source of funds for possible shareholder dividend payments is dividends received from the Banks. Regulatory agreements limit the payment of dividends without prior approval of regulatory agencies.

On October 27, 2010, management received a notice from The Federal Reserve which defined restrictions being placed upon the Holding Company. The restrictions include the declaration or payment of any dividends, the receipt of dividends from subsidiary Banks, the repayment of any principal or interest on subordinated debentures or Trust Preferred securities, restrictions on debt, any changes in Executive or Senior Management or change in the role of Senior Management. The written agreement will be effective in November, 2010. In addition, the notice provided an indication for the corporation to “maintain sufficient capital” levels.

NOTE 10—REGULATORY MATTERS (continued)

										For Capital								Regulatory
										Adequacy								Agreement
		Actual								Purposes								Requirements
(000s omitted)		Amount				Ratio				Amount				Ratio				Amount				Ratio
As of September 30, 2010
Total Capital
(to Risk Weighted Assets)
Consolidated		$	25,393				7.4	%		$	27,544				8.0	%		NA				NA
The State Bank			22,632				9.4				19,219				8.0			$	24,023			12.0% (1)
West Michigan Community Bank			10,404				10.1				8,226				8.0			NA				NA
Tier 1 Capital
(to Risk Weighted Assets)
Consolidated			20,956				6.1				13,772				4.0			NA				NA
The State Bank			19,509				8.1				9,609				4.0			NA				NA
West Michigan Community Bank			9,090				8.8				4,113				4.0			NA				NA
Tier 1 Capital
(to Average Assets)
Consolidated			20,956				4.6				18,191				4.0			NA				NA
The State Bank			19,509				6.2				12,634				4.0				25,268			8.0
West Michigan Community Bank			9,090				6.7				5,462				4.0				10,924			8.0