10-K 1 mfnc-20181231x10k.htm 10-K mfnc_Current_Folio_10K

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 


 

FORM 10-K

 

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

 

For the fiscal year ended December 31, 2018

 

OR

 

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

incorporation or organization)

 

Identification No.)

 

130 South Cedar Street

Manistique, Michigan  49854

(888) 343-8147

(Address, including Zip Code, and telephone number,

including area code, of registrant’s principal executive offices)

 

 

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

 

Title of Each Class

    

Name of Each Exchange on Which Registered

Common Stock, no par value

 

The NASDAQ Stock Market, LLC

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes ☐   No ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ☐  No ☒

 

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 period 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.)  ☒

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K.  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 the 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 Exchange Act).  Yes ☐   No ☒

 

The aggregate market value of the common stock held by non-affiliates of the Registrant, based on a per share price of $16.58 as of June 30, 2018, was $139.633 million.  As of March 17, 2019, there were outstanding, 10,731,905 shares of the Corporation’s Common Stock (no par value).

 

Documents Incorporated by Reference:

 

 

Portions of the Corporation’s Proxy Statement for the 2019 Annual Meeting of Shareholders are incorporated by reference into Part III of this Report.

 

 

 


 

TABLE OF CONTENTS

 

PART I 

2

 

 

 

Item 1.

Business

2

 

Item 1A.

Risk Factors

14

 

Item 1B.

Unresolved Staff Comments

20

 

Item 2.

Properties

20

 

Item 3.

Legal Proceedings

21

 

Item 4.

Mine Safety Disclosures

21

 

 

PART II 

22

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

22

 

Item 6.

Selected Financial Data

24

 

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

25

 

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

40

 

Item 8.

Financial Statements and Supplementary Data

44

 

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

85

 

Item 9A.

Controls and Procedures

85

 

Item 9B.

Other Information

85

 

 

PART III 

86

 

 

 

Item 10.

Directors, Executive Officers, and Corporate Governance

86

 

Item 11.

Executive Compensation

86

 

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

86

 

Item 13.

Certain Relationships, Related Transactions and Director Independence

87

 

Item 14.

Principal Accountant Fees and Services

87

 

 

PART IV 

87

 

 

 

Item 15.

Exhibits and Financial Statement Schedules

87

 

 

 

 

i


 

PART I

 

Item 1.Business

 

Mackinac Financial Corporation (the “Corporation”, or “Mackinac”) is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, (the “BHCA”) that was incorporated under the laws of the state of Michigan on December 16, 1974.  The Corporation changed its name from “First Manistique Corporation” to “North Country Financial Corporation” on April 14, 1998.  On December 16, 2004, the Corporation changed its name from North Country Financial Corporation to Mackinac Financial Corporation.  The Corporation is headquartered and located in Manistique, Michigan.  The mailing address of the Corporation is P.O. Box 369, 130 South Cedar Street, Manistique, Michigan 49854.

 

In December of 2004, the Corporation was recapitalized with the net proceeds, approximately $26.2 million, from the issuance of $30 million of common stock in a private placement.  Commensurate with this recapitalization, the Corporation changed its name from North Country Financial Corporation to Mackinac Financial Corporation, and its subsidiary bank adopted the “mBank” identity early in 2005.

 

On December 5, 2014, the Corporation completed its acquisition of Peninsula Financial Corporation (“PFC”) and its wholly owned subsidiary, The Peninsula Bank.  PFC had six branch offices and $126 million in assets as of the acquisition date.  The results of operations due to the merger have been included in the Corporation’s results since the acquisition date.  The merger was effected by a combination of cash payments and the issuance of shares of the Corporation’s common stock to PFC shareholders.  Each share of PFC’s 288,000 shares of common stock was converted into the right to receive, at the shareholder’s election and subject to certain limitations (i) approximately 3.64 shares of the Corporation’s common stock, with cash paid in lieu of fractional shares, or (ii) cash at $46.13 per share of common stock.  The conversion of PFC’s shares resulted in the issuance of 695,361 shares of the Corporation’s common stock and payment of $4.484 million in cash to the former PFC shareholders.

 

On April 29, 2016, the Corporation completed its acquisition of The First National Bank of Eagle River (“Eagle River.”)  Eagle River had three branch offices and approximately $125 million in assets as of the acquisition date.  The results of operations due to the merger have been included in the Corporation’s results since the acquisition date.  The merger was effected by a cash payment of $12.5 million.

 

On August 31, 2016, the Corporation completed its acquisition of Niagara Bancorporation (“Niagara”) and its wholly owned subsidiary, First National Bank of Niagara.  Niagara had four branch offices and approximately $67 million in assets. The results of operations due to the merger have been included in the Corporation’s results since the acquisition date.  The merger was effected by a cash payment of $7.325 million.

 

On May 18, 2018, the Corporation completed its acquisition of First Federal of Northern Michigan Bancorp, Inc. (“FFNM”).  FFNM had seven branch offices, one of which was consolidated into an existing mBank branch office shortly after consummation of the transaction.  FFNM had approximately $318 million in assets.  The results of operations due to the merger have been included in the Corporation’s results since the acquisition date.  The merger was effected by the issuance of 2,146,378 new shares, approximating $34.1 million.

 

On October 1, 2018, the Corporation completed its acquisition of Lincoln Community Bank (“Lincoln”).  Lincoln had two branch offices, one of which was subsequently closed at the end of 2018.  Lincoln had approximately $60 million in assets. The results of operations due to the merger have been included in the Corporation’s results since the acquisition date.  The merger was effected by a cash payment of $8.5 million.

 

The Corporation owns all of the outstanding stock of its banking subsidiary, mBank (the “Bank”).  The Bank currently has 11 branch offices located in the Upper Peninsula of Michigan, 10 branch offices located in Michigan’s Lower Peninsula, one branch in Southeast Michigan, and 7 branches in Wisconsin.  The Bank maintains offices in the Michigan counties of: Alpena, Cheboygan, Chippewa, Emmet,Grand Traverse, Luce, Manistee, Marquette, Menominee, Montmorency, Oakland, Oscoda, Otsego, and Schoolcraft.  The Bank maintains offices in the Wisconsin counties of: Florence, Lincoln, Marinette, Oneida and Vilas.  The Bank provides drive-in convenience at 29 branch locations and has 31 automated teller machines.  The Bank has no foreign offices.

 

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The Corporation also owns three non-bank subsidiaries: First Manistique Agency, presently inactive; First Rural Relending Company, a relending company for nonprofit organizations; and North Country Capital Trust, a statutory business trust which was formed solely for the issuance of trust preferred securities (none of which remain outstanding).  The Bank represents the principal asset of the Corporation.  The Bank has one wholly owned subsidiary, mBank Title Insurance Agency, LLC, which provided title insurance services until 2014 and is currently inactive.  The Corporation and the Bank are engaged in a single industry segment, commercial banking, broadly defined to include commercial and retail banking activities, along with other permitted activities closely related to banking.

 

Operations

 

The principal business of the Corporation is the general commercial banking business, conducted through the Bank’s provision of a full range of loan and deposit products.  These banking services include customary retail and commercial banking services, including checking and savings accounts, time deposits, interest bearing transaction accounts, safe deposit facilities, real estate mortgage lending, commercial lending, commercial and governmental lease financing, and direct and indirect consumer financing.  Funds for the Bank’s operations are also provided by brokered deposits and through borrowings from the Federal Home Loan Bank (“FHLB”) system, proceeds from the sale of loans and mortgage-backed and other securities, funds from repayment of outstanding loans and earnings from operations.  Earnings depend primarily upon the difference between (i) revenues from loans, investments, and other interest-bearing assets and (ii) expenses incurred in payment of interest on deposit accounts and borrowings, an adequate allowance for loan losses, and general operating expenses.

 

Competition

 

Banking is a highly competitive business.  The Bank competes for loans and deposits with other banks, savings and loan associations, credit unions, mortgage bankers, and investment firms in the scope and type of services offered, pricing of loans, interest rates paid on deposits, and number and location of branches, among other things.  The Bank also faces competition for investors’ funds from mutual funds, marketable equity securities, and corporate and government securities.

 

The Bank competes for loans principally through interest rates and loan fees, the range and quality of the services it provides and the locations of its branches.  In addition, the Bank actively solicits deposit-related clients and competes for deposits by offering depositors a variety of savings accounts, checking accounts, and other services.

 

Employees

 

As of December 31, 2018, the Corporation and its subsidiaries employed, in the aggregate, 294 employees.  The Corporation provides its employees with comprehensive medical and dental benefit plans, a life insurance plan, and a 401(k) plan.  None of the Corporation’s employees are covered by a collective bargaining agreement with the Corporation.  Management believes its relationship with its employees to be good.

 

Business

 

The Bank makes mortgage, commercial, and installment loans to customers throughout Michigan and Northeastern Wisconsin.  Fees may be charged for these services.  The Bank’s most prominent concentration in the loan portfolio relates to commercial loans to entities within real estate — operators of nonresidential buildings industry.  This concentration represented $150.251 million, or 20.95%, of the commercial loan portfolio at December 31, 2018.  The Bank also supports the service industry, with its hospitality and related businesses, as well as gas stations and convenience stores, forestry, restaurants, farming, fishing, and many other activities important to growth in the regions we service.  The economy of the Bank’s market areas is affected by summer and winter tourism activities.

 

The Bank has become a premier SBA/USDA lender in our regions.  Many of these SBA/USDA guaranteed loans are sold at a premium on the secondary market, with the Bank retaining the servicing.  The Bank does not sell the loan guarantees on every credit, rather only those where acceptable market rates are above par.

 

The Bank also offers various consumer loan products including installment, mortgages and home equity loans.  In addition to making consumer portfolio loans, the Bank engages in the business of making residential mortgage loans for sale to the secondary market.

 

3


 

On January 16, 2018, the Corporation executed a merger agreement with First Federal of Northern Michigan Bancorp, Inc. in Alpena, Michigan (“FFNM”).  On May 18, 2018, upon the consummation of the merger, with and into into the Corporation, the Coporation consolidated First Federal of Northern Michigan with the bank.  FFNM had seven branches, one of which was consolidated into an existing mBank branch shortly after consummation of the transaction.

 

On June 7, 2018 the Corporation announced the execution of a definitive agreement to acquire Lincoln Community Bank (“Lincoln”) located in Merrill, Wisconsin.  On October 1, 2018, upon consummation of the definitive agreement, the Corporation consolidated Lincoln into the Bank.  Lincoln operated two branches, one in each of Merrill and Gleason; As part of the acquisition the Gleason branch was subsequently closed at the end of 2018.

 

After the acquisition activity in 2018, the Bank’s presence increased to 29 branches.

 

The Bank’s primary source for lending, investments, and other general business purposes is deposits.  The Bank offers a wide range of interest bearing and non-interest bearing accounts, including commercial and retail checking accounts, negotiable order of withdrawal (“NOW”) accounts, money market accounts with limited transactions, individual retirement accounts, regular interest-bearing statement savings accounts, certificates of deposit with a range of maturity date options, and accessibility to a customer’s deposit relationship through online banking.  The sources of deposits are residents, businesses and employees of businesses within the Bank’s market areas, obtained through the personal solicitation of the Bank’s officers and directors, direct mail solicitation and limited advertisements published in the local media.  The Bank also utilizes the wholesale deposit market for any shortfalls in loan funding.  No material portions of the Bank’s deposits have been received from a single person, industry, group, or geographical location.

 

The Bank is a member of the FHLB of Indianapolis (“FHLB”).  The FHLB provides an additional source of liquidity and long-term funds.  Membership in the FHLB has provided access to attractive rate advances, as well as advantageous lending programs.  The Community Investment Program makes advances to be used for funding community-oriented mortgage lending, and the Affordable Housing Program grants advances to fund lending for long-term low and moderate income owner occupied and affordable rental housing at subsidized interest rates.

 

The Bank has secondary borrowing lines of credit available to respond to deposit fluctuations and temporary loan demands.  The unsecured lines totaled $64.0 million at December 31, 2018, with additional amounts available if collateralized.

 

As of December 31, 2018, the Bank had no material risks relative to foreign sources.  See the “Interest Rate Risk” and “Foreign Exchange Risk” sections in Management’s Discussion and Analysis of Financial Condition and Results of Operations under Item 7A below, for details on the Corporation’s foreign account activity.

 

Compliance with federal, state, and local statutes and/or ordinances relating to the protection of the environment is not expected to have a material effect upon the Bank’s capital expenditures, earnings, or competitive position.

 

Supervision and Regulation

 

As a registered bank holding company, the Corporation is subject to regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) under the BHCA.  The Bank is subject to regulation and examination by the Michigan Department of Insurance and Financial Services (the “DIFS”) and the Federal Deposit Insurance Corporation (the “FDIC”).

 

Under the BHCA, the Corporation is subject to periodic examination by the Federal Reserve Board, and is required to file with the Federal Reserve Board periodic reports of its operations and such additional information as the Federal Reserve Board may require.  In accordance with Federal Reserve Board policy, the Corporation is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where the Corporation might not do so absent such policy.  In addition, there are numerous federal and state laws and regulations which regulate the activities of the Corporation, the Bank and the non-bank subsidiaries, including requirements and limitations relating to capital and reserve requirements, permissible investments and lines of business, transactions with affiliates, loan limits, mergers and acquisitions, issuances of securities, dividend payments, inter-affiliate liabilities, extensions of credit and branch banking.

 

Federal banking regulatory agencies have established risk-based capital guidelines for banks and bank holding companies that are designed to make regulatory capital requirements more sensitive to differences in risk profiles among

4


 

banks and bank holding companies.  The resulting capital ratios represent qualifying capital as a percentage of total risk-weighted assets and off-balance sheet items.  The guidelines are minimums, and the federal regulators have noted that banks and bank holding companies contemplating expansion programs should not allow expansion to diminish their capital ratios and, “should maintain all ratios well in excess” of the minimums.  The current ratios, and pending changes are discussed under Regulatory Capital Requirements below.

 

The Federal Deposit Insurance Corporation Improvement Act contains “prompt corrective action” provisions pursuant to which banks are to be classified into one of five categories based upon capital adequacy, ranging from “well capitalized” to “critically undercapitalized” and which require (subject to certain exceptions) the appropriate federal banking agency to take prompt corrective action with respect to an institution which becomes “significantly undercapitalized” or “critically undercapitalized”.  The FDIC also, after an opportunity for a hearing, has authority to downgrade an institution from “well capitalized” to “adequately capitalized” or to subject an “adequately capitalized” or “undercapitalized” institution to the supervisory actions applicable to the next lower category, for supervisory concerns.  Information pertaining to the Corporation’s and the Bank’s capital is contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7 below, as well as in Note 16 to the Corporation’s Consolidated Financial Statements in Item 8 below.

 

Current federal law provides that adequately capitalized and managed bank holding companies from any state may acquire banks and bank holding companies located in any other state, subject to certain conditions.

 

In 1999, Congress enacted the Gramm-Leach-Bliley Act (“GLBA”), which eliminated certain barriers to and restrictions on affiliations between banks and securities firms, insurance companies and other financial service organizations.  Among other things, GLBA repealed certain Glass-Steagall Act restrictions on affiliations between banks and securities firms, and amended the BHCA to permit bank holding companies that qualify as “financial holding companies” to engage in a broad list of “financial activities,” and any non-financial activity that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines is “complementary” to a financial activity and poses no substantial risk to the safety and soundness of depository institutions or the financial system.  GLBA treats lending, insurance underwriting, insurance company portfolio investment, financial advisory, securities underwriting, dealing and market-making, and merchant banking activities as financial in nature for this purpose.

 

Under GLBA, a bank holding company may become certified as a financial holding company by filing a notice with the Federal Reserve Board, together with a certification that the bank holding company meets certain criteria, including capital, management, and Community Reinvestment Act requirements.  The Corporation is not currently required to qualify as a financial holding company.

 

Privacy Restrictions

 

GLBA, in addition to the previously described changes in permissible non-banking activities permitted to banks, bank holding companies and financial holding companies, also requires financial institutions in the U.S. to provide certain privacy disclosures to customers and consumers, to comply with certain restrictions on sharing and usage of personally identifiable information, and to implement and maintain commercially reasonable customer information safeguarding standards.  The Corporation believes that it complies with all provisions of GLBA and all implementing regulations, and the Bank has developed appropriate policies and procedures to meet its responsibilities in connection with the privacy provisions of GLBA.

 

The USA PATRIOT Act

 

In 2001, Congress enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”).  The USA PATRIOT Act is designed to deny terrorists and criminals the ability to obtain access to the United States financial system, and has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money.  The USA PATRIOT Act mandates financial services companies to implement additional policies and procedures with respect to, or additional measures designed to address, any or all of the following matters, among others: money laundering, terrorist financing, identifying and reporting suspicious activities and currency transactions, and currency crimes.

 

5


 

Sarbanes-Oxley Act

 

On July 30, 2002, President Bush signed into law The Sarbanes-Oxley Act of 2002.  This legislation addresses accounting oversight and corporate governance matters, including:

 

·

The creation of a five-member oversight board that will set standards for accountants and have investigative and disciplinary powers;

·

The prohibition of accounting firms from providing various types of consulting services to public clients and requiring accounting firms to rotate partners among public client assignments every five years;

·

Increased penalties for financial crimes;

·

Expanded disclosure of corporate operations and internal controls and certification of financial statements;

·

Enhanced controls on, and reporting of, insider training; and

·

Prohibition on lending to officers and directors of public companies, although the Bank may continue to make these loans within the constraints of existing banking regulations.

 

Among other provisions, Section 302(a) of the Sarbanes-Oxley Act requires that our Chief Executive Officer and Chief Financial Officer certify that our quarterly and annual reports do not contain any untrue statement or omission of a material fact.  Specific requirements of the certifications include having these officers confirm that they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our disclosure controls and procedures; they have made certain disclosures to our auditors and Audit Committee about our internal controls; and they have included information in our quarterly and annual reports about their evaluation and whether there have been significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to their evaluation.

 

In addition, Section 404 of the Sarbanes-Oxley Act and the SEC’s rules and regulations thereunder require our management to evaluate, with the participation of our principal executive and principal financial officers, the effectiveness, as of the end of each fiscal year, of our internal control over financial reporting.  Our management must then provide a report of management on our internal over financial reporting that contains, among other things, a statement of their responsibility for establishing and maintaining adequate internal control over financial reporting, and a statement identifying the framework they used to evaluate the effectiveness of our internal control over financial reporting.

 

Dodd-Frank Wall Street Reform and Consumer Protection Act

 

On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) into law.  The Dodd-Frank Act resulted in sweeping changes in the regulation of financial institutions aimed at strengthening safety and soundness for the financial services sector.  A summary of certain provisions of the Dodd-Frank Act is set forth below:

 

·

Increased Capital Standards and Enhanced Supervision.

 

The federal banking agencies are required to establish minimum leverage and risk-based capital requirements for banks and bank holding companies.  These new standards are described below.  The Dodd-Frank Act also increased regulatory oversight, supervision and examination of banks, bank holding companies and their respective subsidiaries by the appropriate regulatory agency.

 

·

Federal Deposit Insurance.

 

The Dodd-Frank Act made permanent the $250,000 deposit insurance limit for insured deposits and provided unlimited federal deposit insurance on noninterest bearing transaction accounts at all insured depository institutions through December 31, 2012.  Subsequent to 2012, these amounts reverted from unlimited insurance to $250,000 coverage per separately insured depositor.  The Dodd-Frank Act also changed the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible equity, eliminated the ceiling on the size of the Deposit Insurance Fund (the “DIF”) and increased the floor on the size of the DIF.

 

6


 

·

The Consumer Financial Protection Bureau (“CFPB”).

 

The Dodd-Frank Act centralized responsibility for consumer financial protection by creating a new agency, the CFPB, responsible for implementing, examining and, for large financial institutions of $10 billion or more in total assets, enforcing compliance with federal consumer financial laws.  Because we have under $10 billion in total assets, however, the Federal Deposit Insurance Corporation will still continue to examine us at the federal level for compliance with such laws.

 

·

Interest on Demand Deposit Accounts.

 

The Dodd-Frank Act repealed the prohibition on the payment of interest on demand deposit accounts effective July 21, 2011, thereby permitting depository institutions to now pay interest on business checking and other accounts.

 

·

Mortgage Reform.

 

The Dodd-Frank Act provided for mortgage reform addressing a customer’s ability to repay, restricted variable-rate lending by requiring the ability to repay to be determined for variable rate loans by using the maximum rate that will apply during the first five years of a variable-rate loan term, and made more loans subject to requirements for higher-cost loans, new disclosures and certain other restrictions.

 

·

Interstate Branching.

 

The Dodd-Frank Act allows banks to engage in de novo interstate branching, a practice that was previously significantly limited.

 

·

Interchange Fee Limitations.

 

The Dodd-Frank Act gave the Federal Reserve Board the authority to establish rules regarding interchange fees charged for electronic debit transactions by a payment card issuer that, together with its affiliates, has assets of $10 billion or more and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.  The Federal Reserve Board has rules under this provision that limit the swipe fees that a debit card issuer can charge a merchant for a transaction to the sum of 21 cents and five basis points times the value of the transaction, plus up to one cent for fraud prevention costs.  While we are not directly subject to such regulations since our total assets do not exceed $10 billion, these regulations may impact our ability to compete with larger institutions who are subject to the restrictions.

 

The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States and requires the CFPB and other federal agencies to implement many new and significant rules and regulations in addition to those discussed above.  The CFPB has issued significant new regulations that impact consumer mortgage lending and servicing.  Those regulations became effective in January 2014.  In addition, the CFPB issued new regulations that changed the disclosure requirements and forms used under the Truth in Lending Act and Real Estate Settlement and Procedures Act effective October 3, 2015.  Compliance with these new laws and regulations and other regulations under consideration by the CFPB will likely result in additional costs, which could be significant and could adversely impact our results of operations, financial condition or liquidity.

 

The Economic Growth, Regulator Relief and Consumer Protection Act of 2018

 

On May 24, 2018, the Economic Growth, Regulatory and Consumer Protection Act of 2018             (the “EGRRCPA) was enacted, which repeals or modifies certain provisions of the Dodd-Frank Act and eases regulations on all but the largest banks.  The EGRRCPA’s highlights include, among other things: (i) creating a new category of “qualified mortgages” presumed to satisfy ability-to-repay requirements for loans that meet certain criteria and are held in portfolio by banks with less than $10 billion in assets from the ability-to-repay requirements for certain qualified residential mortgage loans held in portfolio; (ii) not require appraisals for certain transactions valued at less than $400,000 in rural areas; (iii) exempt banks that originate fewert than 500 open-end and 500 closed-end mortgages from

7


 

the Home Mortgage Disclosure Act’s expanded data disclosures; (iv) clarify that, subject to various conditions, reciprocal deposits of another depository institution obtained using a deposit placement network for purposes of obtaining maximum deposit insurane would not be considered brokered deposits subject to the FDIC’s brokered-deposit regulations; and (v) simplify capital calculations by requiring regulators to establish for institutions under $10 billion in assets a community bank leverage ratio (tangible equity to average consolidated assets) at a percentage not less than 8% and not greater than 10% that such institutions may elect to replace the general applicable risk-based capital requirements for determining well-capitalized status.

 

 

Regulatory Capital Framework

 

On July 2, 2013, the Federal Reserve and OCC approved a final rule to establish a new comprehensive regulatory capital framework for all US banking organizations, with an effective date of January 1, 2015.  The Regulatory Capital Framework (“Basel III”) implements several changes to the US regulatory capital framework required by the Dodd-Frank Act.  The new US capital framework imposed higher minimum capital requirements, additional capital buffers above those minimum requirements, a more restrictive definition of capital, and higher risk weights for various enumerated classifications of assets, the combined impact of which effectively results in substantially more demanding capital standards for US banking organizations.

 

The Basel III final rule established a common equity Tier 1 capital (“CET1”) requirement, a Tier 1 capital requirement of 6.0% and an 8.0% total capital requirement.  The new CET1 and minimum Tier 1 capital requirements became effective January 1, 2015.  In addition to these minimum risk-based capital ratios, the Basel III final rule required that all banking organizations maintain a “capital conservation buffer” consisting of CET1 in an amount equal to 2.5% of risk-weighted assets in order to avoid restrictions on their ability to make capital distributions and to pay certain discretionary bonus payments to executive officers.  In order to avoid those restrictions, the capital conservation buffer effectively increased the minimum CET1 capital, Tier 1 capital and total capital ratios for US banking organizations to 7.0%, 8.5% and 10.5%, respectively.  Banking organizations with capital levels that fall within the buffer will be required to limit dividends, shares repurchases or redemptions (unless replaced within the same calendar quarter by capital instruments of equal or higher quality), and discretionary bonus payments.  The capital conservation buffer has phased in, in full beginning January 1, 2019.

 

 

 

 

 

 

 

 

 

 

    

Adequately

    

 

 

Well-Capitalized

 

 

 

Capitalized

 

Well-Capitalized

 

with Buffer, fully

 

 

 

Requirement

 

Requirement

 

phased in 2019

 

Leverage

 

4.0%

 

5.0%

 

5.0%

 

CET1

 

4.5%

 

6.5%

 

7.0%

 

Tier 1

 

6.0%

 

8.0%

 

8.5%

 

Total Capital

 

8.0%

 

10.0%

 

10.5%

 

 

As required by Dodd-Frank, the Basel III final rule requires that capital instruments such as trust preferred securities and cumulative preferred shares be phased out of Tier 1 capital by January 1, 2016, for banking organizations that had $15 billion or more in total consolidated assets as of December 31, 2009 and permanently grandfathers as Tier 1 capital such instruments issued by these smaller entities prior to May 19, 2010 (provided they do not exceed 25% of Tier 1 capital).

 

The Basel III final rule provides banking organizations under $250 billion in total consolidated assets or under $10 billion in foreign exposures with a one-time “opt-out” right to continue excluding Accumulated Other Comprehensive income from CET1 capital.  The election to opt-out must be made on the banking organization’s first Call Report filed after January 1, 2015.  The Corporation has elected to opt-out and continues to exclude Accumulated Other Comprehensive Income from its regulatory capital.

 

The Basel III final rule requires that goodwill and other intangible assets (other than mortgage servicing assets), net of associated deferred tax liabilities, be deducted from CET1 capital.  Additionally, deferred tax assets that arise from net operating loss and tax credit carryforwards, net of associated deferred tax liabilities and valuation allowances, are fully deducted from CET1 capital.  However, deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks, along with mortgage servicing assets and “significant” (defined as greater than

8


 

10% of the issued and outstanding common stock of the unconsolidated financial institution) investments in the common stock of unconsolidated “financial institutions” are partially includible in CET1 capital, subject to deductions defined in the final rule.

 

Notwithstanding the foregoing, the EGRRCPA is expected to simplify capital calculations by requiring regulators to establish for institutions under $10 billion in assets a community bank leverage ratio (tangible equity to average consolidated assets) at a percentage not less than 8% and not greater than 10% that such instituions may elect to replace the general applicable risk-based capital requirements under the Basel III capital rules.  Such institutions that meet the community bank leverage ratio will automatically be deemed to be well-capitalized, although the regulators retain the flexibility to determine that the institution may not qualify for the community bank leverage ratio test based on the institution’s risk profile.  Until the community bank leverage ratio is established by the regulators in accordance with EGRRCPA, the Basel III risk-based and leverage ratios remain in effect.  The effective date and the specific community bank leverage ratio is currently unknown.

 

Information regarding the Corporation and the Bank’s regulatory capital can be found in Note 16 – Regulatory Matters in the financial statements included herein.

 

Monetary Policy

 

The earnings and business of the Corporation and the Bank depends on interest rate differentials.  In general, the difference between the interest rates paid by the Bank to obtain its deposits and other borrowings, and the interest rates received by the Bank on loans extended to its customers and on securities held in the Bank’s portfolio, comprises the major portion of the Bank’s earnings.  These rates are highly sensitive to many factors that are beyond the control of the Bank, and accordingly, its earnings and growth will be subject to the influence of economic conditions, generally, both domestic and foreign, including inflation, recession, unemployment, and the monetary policies of the Federal Reserve Board.  The Federal Reserve Board implements national monetary policies designed to curb inflation, combat recession, and promote growth through, among other means, its open-market dealings in US government securities, by adjusting the required level of reserves for financial institutions subject to reserve requirements, through adjustments to the discount rate applicable to borrowings by banks that are members of the Federal Reserve System, and by adjusting the Federal Funds Rate, the rate charged in the interbank market for purchase of excess reserve balances.  In addition, legislative and economic factors can be expected to have an ongoing impact on the competitive environment within the financial services industry.  The nature and timing of any future changes in such policies and their impact on the Bank cannot be predicted with certainty.

 

Selected Statistical Information

 

I.Distribution of Assets, Obligations, and Shareholders’ Equity; Interest Rates and Interest Differential

 

The key components of net interest income, the daily average balance sheet for each year — including the components of earning assets and supporting obligations — the related interest income on a fully tax equivalent basis and interest expense, as well as the average rates earned and paid on these assets and obligations is contained under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Item 7 below.

 

An analysis of the changes in net interest income from period-to-period and the relative effect of the changes in interest income and expense due to changes in the average balances of earning assets and interest-bearing obligations and changes in interest rates is contained under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under Item 7 below.

 

9


 

II.Investment Portfolio

 

A.Investment Portfolio Composition

 

The following table presents the carrying value of investment securities available for sale as of December 31 of the years set forth below (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

    

2016

 

Corporate

 

 

20,064

 

 

24,891

 

 

20,410

 

US Agencies

 

 

15,970

 

 

16,846

 

 

23,952

 

US Agencies - MBS

 

 

32,840

 

 

12,716

 

 

16,833

 

State and political subdivisions

 

 

47,874

 

 

21,444

 

 

25,078

 

Total

 

$

116,748

 

$

75,897

 

$

86,273

 

 

B.Relative Maturities and Weighted Average Interest Rates

 

The following table presents the maturity schedule of securities held and the weighted average yield of those securities, as of December 31, 2018 (fully taxable equivalent, dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

In one

    

After one,

    

After five, 

    

 

    

 

    

Weighted 

 

 

 

year

 

but within

 

but within

 

Over

 

 

 

Average

 

 

 

or less

 

five years

 

ten years

 

ten years

 

Total

 

Yield (1)

 

US Agencies

 

 

754

 

 

15,216

 

 

 —

 

 

 —

 

 

15,970

 

1.93%

 

US Agencies - MBS

 

 

81

 

 

29,104

 

 

3,655

 

 

 —

 

 

32,840

 

3.00%

 

Corporate

 

 

5,861

 

 

10,185

 

 

3,518

 

 

500

 

 

20,064

 

2.92%

 

State and political subdivisions

 

 

6,969

 

 

28,981

 

 

9,566

 

 

2,358

 

 

47,874

 

3.47%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

13,665

 

$

83,486

 

$

16,739

 

$

2,858

 

$

116,748

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average yield (1)

 

 

2.50%

 

 

2.79%

 

 

3.77%

 

 

3.47%

 

 

2.91%

 

 

 


(1)

Weighted average yield includes the effect of tax-equivalent adjustments using a 21% tax rate.

 

III.Loan Portfolio

 

A.Type of Loans

 

The following table sets forth the major categories of loans outstanding for each category at December 31 (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

    

2016

    

2015

    

2014

 

Commercial real estate

 

$

496,207

 

$

406,742

 

$

389,420

 

$

312,805

 

$

315,387

 

Commercial, financial and agricultural

 

 

191,060

 

 

156,951

 

 

142,648

 

 

122,140

 

 

101,895

 

One to four family residential real estate

 

 

286,908

 

 

209,890

 

 

205,945

 

 

140,502

 

 

139,553

 

Construction

 

 

44,318

 

 

20,061

 

 

23,731

 

 

27,100

 

 

25,715

 

Consumer

 

 

20,371

 

 

17,434

 

 

20,113

 

 

15,847

 

 

18,385

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

1,038,864

 

$

811,078

 

$

781,857

 

$

618,394

 

$

600,935

 

 

10


 

B.Maturities and Sensitivities of Loans to Changes in Interest Rates

 

The following table presents the remaining maturity of total loans outstanding for the categories shown at December 31, 2018, based on scheduled principal repayments (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

    

    

Commercial,

    

    

    

    

    

    

    

    

 

 

 

 

 

Financial,

 

1-4 Family

 

 

 

 

 

 

 

 

 

Commercial

 

 and

 

Residential

 

 

 

 

 

 

 

 

 

Real Estate

 

Agricultural

 

Real Estate

 

Consumer

 

Construction

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

In one year or less:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable interest rates

 

$

57,306

 

$

52,436

 

$

1,540

 

$

21

 

$

1,986

 

$

113,289

 

Fixed interest rates

 

 

31,733

 

 

16,713

 

 

9,039

 

 

1,062

 

 

12,589

 

 

71,136

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

After one year but within five years:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable interest rates

 

 

59,765

 

 

34,110

 

 

6,734

 

 

2,272

 

 

3,800

 

 

106,681

 

Fixed interest rates

 

 

280,322

 

 

72,129

 

 

23,908

 

 

13,779

 

 

11,229

 

 

401,367

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

After five years:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Variable interest rates

 

 

43,621

 

 

5,344

 

 

188,106

 

 

1,360

 

 

8,264

 

 

246,695

 

Fixed interest rates

 

 

23,460

 

 

10,328

 

 

57,581

 

 

1,877

 

 

6,450

 

 

99,696

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

496,207

 

$

191,060

 

$

286,908

 

$

20,371

 

$

44,318

 

$

1,038,864

 

 

C.Risk Elements

 

The following table presents a summary of nonperforming assets and problem loans as of December 31 (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

    

2016

    

2015

    

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nonaccrual loans

 

$

5,054

 

$

2,388

 

$

3,959

 

$

2,353

 

$

3,939

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest income recorded during period for nonaccrual loans

 

 

 —

 

 

 —

 

 

437

 

 

795

 

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing loans past due 90 days or more

 

 

23

 

 

 —

 

 

 —

 

 

32

 

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restructured loans on nonaccrual not included above

 

 

 —

 

 

180

 

 

165

 

 

154

 

 

3,105

 

 

IV.Summary of Loan Loss Experience

 

A.Analysis of the Allowance for Loan Losses

 

Changes in the allowance for loan losses arise from loans charged off, recoveries on loans previously charged off by loan category, and additions to the allowance for loan losses through provisions charged to expense.  Factors which influence management’s judgment in determining the provision for loan losses include establishing specified loss allowances for selected loans (including large loans, nonaccrual loans, and problem and delinquent loans) and consideration of historical loss information and local economic conditions.

 

11


 

The following table presents information relative to the allowance for loan losses for the years ended December 31, (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

2018

    

2017

    

2016

    

2015

    

2014

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance of allowance for loan losses at beginning of period

 

$

5,079

 

$

5,020

 

$

5,004

 

$

5,140

 

$

4,661

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loans charged off:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

330

 

 

419

 

 

477

 

 

1,801

 

 

682

 

One to four family residential real estate

 

 

230

 

 

155

 

 

133

 

 

142

 

 

290

 

Consumer

 

 

156

 

 

229

 

 

113

 

 

87

 

 

74

 

Total loans charged off

 

 

716

 

 

803

 

 

723

 

 

2,030

 

 

1,046

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Recoveries of loans previously charged off:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

221

 

 

121

 

 

102

 

 

662

 

 

259

 

One to four family residential real estate

 

 

64

 

 

65

 

 

 5

 

 

 2

 

 

22

 

Consumer

 

 

35

 

 

51

 

 

32

 

 

26

 

 

44

 

Total recoveries

 

 

320

 

 

237

 

 

139

 

 

690

 

 

325

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loans charged off

 

 

396

 

 

566

 

 

584

 

 

1,340

 

 

721

 

Provisions charged to expense

 

 

500

 

 

625

 

 

600

 

 

1,204

 

 

1,200

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at end of period

 

$

5,183

 

$

5,079

 

$

5,020

 

$

5,004

 

$

5,140

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average loans outstanding

 

 

941,221

 

 

795,532

 

 

703,047

 

 

602,904

 

 

509,749

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratio of net charge-offs to average loans

 

 

.04%

 

 

.07%

 

 

.08%

 

 

.22%

 

 

.14%

 

 

12


 

B.Allocation of Allowance for Loan Losses

 

The allocation of the allowance for loan losses for the years ended December 31, is shown on the following table.  The percentages shown represent the percent of each loan category to total loans (dollars in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2018

 

2017

 

2016

 

2015

 

2014

 

 

  

Amount

  

%

  

Amount

  

%

  

Amount

  

%

  

Amount

  

%

  

Amount

  

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

$

1,682

 

47.76%

 

$

1,650

 

50.15%

 

$

1,345

 

49.81%

 

$

1,611

 

50.58%

 

$

2,813

 

52.48%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial, financial, and agricultural

 

 

648

 

18.39

 

 

576

 

19.35

 

 

614

 

18.25

 

 

645

 

19.75

 

 

1,539

 

16.96

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial construction

 

 

101

 

2.87

 

 

54

 

1.14

 

 

57

 

1.47

 

 

79

 

2.48

 

 

142

 

2.71

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1-4 family residential real estate

 

 

199

 

27.62

 

 

160

 

25.88

 

 

296

 

26.34

 

 

274

 

22.72

 

 

285

 

23.22

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer construction

 

 

 6

 

1.40

 

 

 6

 

1.33

 

 

 6

 

1.56

 

 

 7

 

1.91

 

 

 6

 

1.57

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

 

 8

 

1.96

 

 

10

 

2.15

 

 

90

 

2.57

 

 

64

 

2.56

 

 

13

 

3.06

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unallocated general reserves

 

 

2,539

 

 —

 

 

2,623

 

 —

 

 

2,612

 

 —

 

 

2,324

 

 —

 

 

342

 

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

5,183

 

100.00%

 

$

5,079

 

100.00%

 

$

5,020

 

100.00%

 

$

5,004

 

100.00%

 

$

5,140

 

100.00%

 

 

The unallocated balance of the allowance for loan losses represents general reserves not attributed directly to one

segment or class of loans, rather, represents additional reserves management believes is warranted based on local and

broader economic trends.  These reserves are subjective in nature and based on qualitative factors impacting the overall

loan portfolio.

 

V.Deposits

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months

 

Three to

 

Six to twelve

 

Over twelve

 

 

 

 

 

    

or less

    

six months

 

months

    

months

 

    

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

CDs <$100,000

 

 

23,623

 

 

15,369

 

 

36,571

 

 

83,370

 

 

 

158,933

 

CDs >$100,000

 

 

9,368

 

 

6,959

 

 

22,172

 

 

41,541

 

 

 

80,040

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total  time deposits

 

$

32,991

 

$

22,328

 

$

58,743

 

$

124,911

 

 

$

238,973

 

 

Additional deposit information is contained in Note 7 to the Corporation’s Consolidated Financial Statements in Item 8 of this Form 10-K below.

 

VI.Return on Equity and Assets

 

See Item 6 of this Form 10-K, “Selected Financial Data”

 

VII.Financial Instruments with Off-Balance Sheet Risk

 

Information relative to commitments, contingencies, and credit risk are discussed in Note 19 to the Corporation’s Consolidated Financial Statements contained in Item 8 of this Form 10-K.

 

Available Information

 

Our Internet address is www.bankmbank.com. We will make available free of charge in the investor relations section of our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and

13


 

amendments to those reports as soon as reasonably practicable after such materials are electronically filed with (or furnished to) the SEC. Information contained on our website is not incorporated by reference into this Annual Report on Form 10-K. In addition, the SEC maintains an Internet site, www.sec.gov, that includes filings of and information about issuers that file electronically with the SEC.

 

Item 1A.    Risk Factors

Our business, prospects, financial condition, or operating results could be materially adversely affected by any of the risks and uncertainties set forth below, as well as in any amendments or updates reflected in subsequent filings with the SEC.  In assessing these risks, you should also refer to the other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and related notes.

RISK FACTORS

Investing in our securities involves risk. You should carefully consider the specific risks set forth in “Risk Factors” in this Annual Report on Form 10-K.  These risks are not the only risks we face. Additional risks not presently known to us, or that we currently view as immaterial, may also impair our business, if any of the risks described herein or any additional risks actually occur, our business, financial condition, results of operations and cash flows could be materially and adversely affected.

Mackinac’s net interest income could be negatively affected by interest rate adjustments by the Federal Reserve, as well as by competition in its primary market area.

As a financial institution, Mackinac’s earnings are significantly dependent upon its net interest income, which is the difference between the interest income that is earned on interest-earning assets, such as investment securities and loans, and the interest expense that we pay on interest-bearing liabilities, such as deposits and borrowings. Therefore, any change in general market interest rates, including changes resulting from changes in the Federal Reserve’s fiscal and monetary policies, affects it more than non-financial institutions and can have a significant effect on net interest income and total income. Mackinac’s assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of the assets and liabilities. As a result, an increase or decrease in market interest rates could have material adverse effects on net interest margin and results of operations.

If the allowance for loan losses is not sufficient to cover actual loan losses, Mackinac’s earnings could decrease.

Mackinac’s success depends to a significant extent upon the quality of its assets, particularly loans. In originating loans, there is a substantial likelihood that credit losses will be experienced. The risk of loss will vary with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the quality of the collateral for the loan.

Mackinac’s loan customers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. As a result, Mackinac may experience significant loan losses, which could have a material adverse effect on operating results. Management makes various assumptions and judgments about the collectability of the loan portfolio, including the creditworthiness of borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of Mackinac’s loans. An allowance for loan losses is maintained in an attempt to cover any loan losses that may occur. In determining the size of the allowance, management relies on an analysis of the loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume and trends in delinquencies and non-accruals, national and local economic conditions and other pertinent information. The determination of the size of the allowance could be understated due to deviations in one or more of these factors.

If assumptions are wrong, the current allowance may not be sufficient to cover future loan losses, and adjustments may be necessary to allow for different economic conditions or adverse developments in Mackinac’s loan portfolio. Material additions to the allowance would materially decrease net income.

In addition, federal and state regulators periodically review the allowance for loan losses and may require Mackinac to increase its provision for loan losses or recognize further loan charge-offs, based on judgments different than those of

14


 

management. Any increase in the allowance for loan losses or loan charge-offs as required by these regulatory agencies could have a negative effect on Mackinac’s operating results.

Mackinac may need to raise additional capital in the future, but that capital may not be available when it is needed.

Mackinac is required by federal and state regulatory authorities to maintain adequate levels of capital to support its operations. Management may at some point in the future need to raise additional capital to support its business as a result of losses. Its ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside the control of management, and on Mackinac’s financial performance. Accordingly, Mackinac cannot assure you of its ability to raise additional capital if needed on terms acceptable to management. If additional capital cannot be raised when needed, Mackinac’s ability to further expand its operations through internal growth and to operate its business could be materially impaired.

If Mackinac is unable to increase its share of deposits in the markets that its bank operates within, it may accept out-of-market and brokered deposits, the costs of which may be higher than expected.

Mackinac’s management can offer no assurance that it will be able to maintain or increase Mackinac’s market share of deposits in its highly competitive service areas. If unable to do so, it may be forced to accept increased amounts of out-of-market or brokered deposits. As of December 31, 2018, Mackinac had approximately $136.760 million in out of market brokered deposits, which represented approximately 12.46% of total deposits. At times, the cost of out-of-market and brokered deposits exceeds the cost of deposits in the local market. In addition, the cost of out-of-market and brokered deposits can be volatile, and if Mackinac is unable to access these markets, or if its costs related to out of market and brokered deposits increase, its liquidity and ability to support demand for loans could be adversely affected.

Volatility and disruptions in global capital and credit markets may adversely impact Mackinac’s business, financial condition and results of operations.

Even though Mackinac operates in a distinct geographic region in the U.S., it is impacted by global capital and credit markets, which are sometimes subject to periods of extreme volatility and disruption. Disruptions, uncertainty or volatility in the capital and credit markets may limit Mackinac’s ability to access capital and manage liquidity, which may adversely affect Mackinac’s business, financial condition and results of operations. Further, Mackinac’s customers may be adversely impacted by such conditions, which could have a negative impact on Mackinac’s business, financial condition and results of operations.

Mackinac is subject to extensive regulation that could limit or restrict its activities.

Mackinac operates in a highly regulated industry and is subject to examination, supervision and comprehensive regulation by various federal and state agencies. Compliance with these regulations is costly and restricts certain activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. Mackinac is also subject to capitalization guidelines established by its regulators, which require it to maintain adequate capital to support its growth.

Mackinac’s business also is subject to laws, rules and regulations regarding the disclosure of non-public information about its customers to non-affiliated third parties. Internet operations are not currently subject to direct regulation by any government agency in the United States beyond regulations applicable to businesses generally. A number of legislative and regulatory proposals currently under consideration by federal, state and local governmental organizations may lead to laws or regulations concerning various aspects of Mackinac’s business on the Internet, including: user privacy, taxation, content, access charges, liability for third-party activities and jurisdiction. The adoption of new laws or a change in the application of existing laws may decrease the use of the Internet, increase costs or otherwise adversely affect Mackinac’s business.

In particular, Congress and other regulators have increased their focus on the regulation of the financial services industry in recent years. While recent changes in the executive branch may mitigate this impact, the effects on Mackinac of recent legislation and regulatory actions cannot reliably be fully determined at this time. Moreover, as some of the legislation and regulatory actions previously implemented in response to the recent financial crisis expire, the impact of the conclusion of these programs on the financial sector and on the economic recovery is unknown. Any delay in the economic recovery or a worsening of current financial market conditions could adversely affect Mackinac. Mackinac

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can neither predict when or whether future regulatory or legislative reforms will be enacted nor what their contents will be. The impact of any future legislation or regulatory actions on Mackinac’s businesses or operations cannot be determined at this time, and such impact may adversely affect Mackinac.

The laws and regulations applicable to the banking industry could change at any time, and management cannot predict the effects of these changes on Mackinac’s business and profitability. Additionally, Mackinac cannot predict the effect of any legislation that may be passed at the state or federal level in response to the recent deterioration of the subprime, mortgage, credit and liquidity markets. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, the cost of compliance could adversely affect Mackinac’s ability to operate profitably.

Mackinac’s financial condition and results of operations are reported in accordance with accounting principles generally accepted in the United States (“GAAP”). While not impacting economic results, future changes in accounting principles issued by the Financial Accounting Standards Board could impact Mackinac’s earnings as reported under GAAP. As a public company, Mackinac is also subject to the corporate governance standards set forth in the Sarbanes-Oxley Act of 2002, as well as applicable rules and regulations promulgated by the SEC. Complying with these standards, rules and regulations has and continues to impose administrative costs and burdens on the company.

Additionally, political conditions could impact Mackinac’s earnings. Acts or threats of war or terrorism, as well as actions taken by the United States or other governments in response to such acts or threats, could impact the business and economic conditions in which it operates.

Mackinac may make or be required to make further increases in its provision for loan losses and to charge off additional loans in the future, which could adversely affect the results of operations.

As a result of changes in balances and composition of Mackinac’s loan portfolio, changes in economic and market conditions that occur from time to time and other factors specific to a borrower’s circumstances, the level of non-performing assets will fluctuate. Increased non-performing assets, credit losses or the provision for loan losses would materially adversely affect Mackinac’s financial condition and results of operations.

Mackinac’s adjustable-rate loans may expose it to increased default risks.

While adjustable-rate loans better offset the adverse effects of an increase in interest rates as compared to fixed-rate loans, the increased payments required of adjustable-rate loan borrowers upon an interest rate adjustment in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying property may also be adversely affected in a rising interest rate environment. In addition, although adjustable-rate loans help make Mackinac’s asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.

Changing interest rates may decrease Mackinac’s earnings and asset values.

Management is unable to accurately predict future market interest rates, which are affected by many factors, including, but not limited to, inflation, recession, changes in employment levels, changes in the money supply and domestic and international disorder and instability in domestic and foreign financial markets. Changes in the interest rate environment may reduce Mackinac’s profits. Net interest income is a significant component of its net income and consists of the difference, or spread, between interest income generated on interest-earning assets and interest expense incurred on interest-bearing liabilities. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities. Although certain interest-earning assets and interest-bearing liabilities may have similar maturities or periods in which they reprice, they may react in different degrees to changes in market interest rates. In addition, residential mortgage loan origination volumes are affected by market interest rates on loans; rising interest rates generally are associated with a lower volume of loan originations, while falling interest rates are usually associated with higher loan originations. Mackinac’s ability to generate gains on sales of mortgage loans is significantly dependent on the level of originations. Cash flows are affected by changes in market interest rates. Generally, in rising interest rate environments, loan prepayment rates are likely to decline, and in falling interest rate environments, loan prepayment rates are likely to increase. A majority of Mackinac’s commercial, commercial real estate and multi-family residential real estate loans are adjustable rate loans and an increase in the general level of interest rates may adversely affect the ability of some borrowers to pay the interest on and principal of

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their obligations, especially borrowers with loans that have adjustable rates of interest. Changes in interest rates, prepayment speeds and other factors may also cause the value of loans held for sale to change. Accordingly, changes in levels of market interest rates could materially and adversely affect Mackinac’s net interest spread, loan volume, asset quality, value of loans held for sale and cash flows, as well as the market value of its securities portfolio and overall profitability.

Mackinac faces strong competition from other financial institutions, financial services companies and other organizations offering services similar to those offered by it, which could result in Mackinac not being able to sustain or grow its loan and deposit businesses.

Mackinac conducts its business operations primarily in the State of Michigan, and more recently, Northeastern Wisconsin. Increased competition within these markets may result in reduced loan originations and deposits. Ultimately, Mackinac may not be able to compete successfully against current and future competitors. Many competitors offer the types of loans and banking services that it offers. These competitors include other savings associations, community banks, regional banks and money center banks. Mackinac also faces competition from many other types of financial institutions, including finance companies, brokerage firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. Mackinac’s competitors with greater resources may have a marketplace advantage enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns.

Additionally, financial intermediaries not subject to bank regulatory restrictions and banks and other financial institutions with larger capitalization have larger lending limits and are thereby able to serve the credit needs of larger clients. These institutions, particularly to the extent they are more diversified than Mackinac is, may be able to offer the same loan products and services that Mackinac offers at more competitive rates and prices. If Mackinac is unable to attract and retain banking clients, it may be unable to sustain current loan and deposit levels or increase its loan and deposit levels, and its business, financial condition and future prospects may be negatively affected.

Our business could be adversely affected due to risks related to our recent acquisitions and the subsequent integration of the acquired businesses.

In recent years, we have closed several acquisitions of varying significance, and expect to consider future acquisitions from time to time. We cannot be certain that we will be able to identify, consummate and successfully integrate acquisitions, and no assurance can be given with respect to the timing, likelihood or business effect of any possible transaction. Transactions that we consummate would involve risks and uncertainties to us, including mispricing the inherent value of the acquired entity, as well as potential difficulties integrating people, systems and customers and realizing synergies.

The risks associated with our recent acquisitions any future acquisitions include, but are not limited to:

·

We may experience inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, customers, depositors and employees;

·

We could be subject to liabilities that could be material or become subject to litigation or regulatory risks as a result of the acquisition;

·

Management’s attention may be diverted from other business initiatives; and

·

Unanticipated restructuring and other integration costs may be incurred.

Any future acquisitions could involve these and additional risks. Our ability to pursue additional strategic transactions may also be limited by any significant decrease our stock price, which would adversely affect the attractiveness of our currency to potential targets, or by our ability to raise additional equity or debt capital to fund future acquisitions. Any of these risks, whether with respect to the current or any future acquisitions, could have a material adverse effect on our business and results of operations.

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Mackinac may be required to transition from the use of the LIBOR interest rate index in the future. 

A portion of the loans in Mackinac’s portfolio are indexed to LIBOR to calculate the loan interest rate. The continued availability of the LIBOR index is not guaranteed after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR or whether any additional reforms to LIBOR may be enacted. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR. The implementation of a substitute index or indices for the calculation of interest rates under our loan agreements with our borrowers may incur significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices, and may result in disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute index or indices, each of which could have an adverse effect on Mackinac’s results of operations.

Mackinac’s ability to use net operating loss carryovers to reduce future tax payments may be limited or restricted.

As of December 31, 2018, Mackinac had net operating loss (“NOL”) carryforwards of approximately $12.5 million. Mackinac is generally able to carry NOLs forward to reduce taxable income in future years. However, its ability to utilize its NOL carryforwards is subject to the rules of Section 382 of the Code. Section 382 of the Code generally restricts the use of NOL carryforwards after an “ownership change.” An ownership change occurs if, among other things, the shareholders (or specified groups of shareholders) who own or have owned, directly or indirectly, 5% or more of a corporation’s common shares, or are otherwise treated as 5% shareholders under Section 382 of the Code and the Treasury regulations promulgated thereunder, increase their aggregate percentage ownership of that corporation’s shares by more than fifty (50) percentage points over the lowest percentage of the shares owned by these shareholders over a three (3)-year rolling period. In the event of an ownership change, Section 382 of the Code imposes an annual limitation on the amount of taxable income a corporation may offset with its pre-ownership change NOL carry forwards. This annual limitation is generally equal to the value of the corporation’s shares immediately before the ownership change multiplied by the long-term tax-exempt rate in effect for the month in which the ownership change occurs. Any unused annual limitation may be carried over to later years until the applicable expiration date for the respective NOL carryforwards.

As of December 31, 2018, Mackinac had tax credit carryforwards of approximately $1.7 million. Mackinac is generally able to carry tax credits forward to reduce taxes in future years. However, Mackinac’s ability to utilize the tax credit carryforwards is subject to the rules of Section 383 of the Code. Section 383 of the Code imposes a comparable and related set of rules for limiting the use of capital loss and tax credit carry-forwards in the event of an ownership change.

Management cannot ensure that Mackinac’s ability to use its NOL carryforwards to offset taxable income or its tax credit carryforwards to offset tax will not become limited in the future. As a result, Mackinac could pay taxes earlier and in larger amounts than would be the case if its NOL and tax credit carryforwards were available to reduce its federal income taxes without restriction.

Mackinac may not be able to utilize technology to efficiently and effectively develop, market, and deliver new products and services to its customers.

The financial services industry experiences rapid technological change with regular introductions of new technology-driven products and services. The efficient and effective utilization of technology enables financial institutions to better serve customers and to reduce costs. Mackinac’s future success depends, in part, upon its ability to address the needs of its customers by using technology to market and deliver products and services that will satisfy customer demands, meet regulatory requirements, and create additional efficiencies in its operations. Mackinac may not be able to effectively develop new technology-driven products and services or be successful in marketing or supporting these products and services to its customers, which could have a material adverse impact on its financial condition and results of operations.

Operational difficulties, failure of technology infrastructure or information security incidents could adversely affect Mackinac’s business and operations.

Mackinac is exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, failure of its controls and procedures and unauthorized transactions by employees or operational errors, including clerical or recordkeeping errors or those resulting from computer or telecommunications systems malfunctions. Given the high volume of transactions Mackinac processes, certain errors

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may be repeated or compounded before they are identified and resolved. In particular, Mackinac’s operations rely on the secure processing, storage and transmission of confidential and other information on its technology systems and networks. Any failure, interruption or breach in security of these systems could result in failures or disruptions in its customer relationship management, general ledger, deposit, loan and other systems.

Mackinac also faces the risk of operational disruption, failure or capacity constraints due to its dependency on third party vendors for components of its business infrastructure, including its core data processing systems which are largely outsourced. While Mackinac has selected these third party vendors carefully, it does not control their operations. As such, any failure on the part of these business partners to perform their various responsibilities could also adversely affect Mackinac’s business and operations.

Mackinac may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control, which may include, for example, computer viruses, cyberattacks, spikes in transaction volume and/or customer activity, electrical or telecommunications outages, or natural disasters. Although Mackinac has programs in place related to business continuity, disaster recovery and information security to maintain the confidentiality, integrity, and availability of its systems, business applications and customer information, such disruptions may give rise to interruptions in service to customers and loss or liability to Mackinac.

The occurrence of any failure or interruption in Mackinac’s operations or information systems, or any security breach, could cause reputational damage, jeopardize the confidentiality of customer information, result in a loss of customer business, subject Mackinac to regulatory intervention or expose it to civil litigation and financial loss or liability, any of which could have a material adverse effect on Mackinac.

Changes in customer behavior may adversely impact Mackinac’s business, financial condition and results of operations.

Mackinac uses a variety of methods to anticipate customer behavior as a part of its strategic planning and to meet certain regulatory requirements. Individual, economic, political, industry-specific conditions and other factors outside of its control, such as fuel prices, energy costs, real estate values or other factors that affect customer income levels, could alter predicted customer borrowing, repayment, investment and deposit practices. Such a change in these practices could materially adversely affect Mackinac’s ability to anticipate business needs and meet regulatory requirements.

Further, difficult economic conditions may negatively affect consumer confidence levels. A decrease in consumer confidence levels would likely aggravate the adverse effects of these difficult market conditions on Mackinac, its customers and others in the financial institutions industry.

Mackinac’s ability to maintain and expand customer relationships may differ from expectations.

The financial services industry is very competitive. Mackinac not only vies for business opportunities with new customers, but also competes to maintain and expand the relationships it has with its existing customers. While Mackinac believes that it can continue to grow many of these relationships, Mackinac will continue to experience pressures to maintain these relationships as its competitors attempt to capture its customers. Failure to create new customer relationships and to maintain and expand existing customer relationships to the extent anticipated may adversely impact Mackinac’s earnings.

The trading price of Mackinac’s common stock may be subject to significant fluctuations and volatility.

The market price of Mackinac’s common stock could be subject to significant fluctuations due to, among other things:

·

variations in quarterly or annual results of operations;

·

changes in dividends per share;

·

deterioration in asset quality, including declining real estate values;

·

changes in interest rates;

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·

significant acquisitions or business combinations, strategic partnerships, joint ventures, or capital commitments by or involving Mackinac or its competitors;

·

regulatory actions, including changes to regulatory capital levels, the components of regulatory capital and how regulatory capital is calculated;

·

new regulations that limit or significantly change Mackinac’s ability to continue to offer products or services;

·

volatility of stock market prices and volumes;

·

issuance of additional shares of common stock or other debt or equity securities;

·

changes in market valuations of similar companies;

·

changes in securities analysts’ estimates of financial performance or recommendations;

·

perceptions in the marketplace regarding the financial services industry, Mackinac and/or its competitors; and/or

·

the occurrence of any one or more of the risk factors described above. 

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.

Item 1B.Unresolved Staff Comments

 

None.

 

Item 2.Properties

 

The Corporation’s headquarters are located at 130 South Cedar Street, Manistique, Michigan 49854.  The headquarters location is owned by the Corporation and not subject to any mortgage.

 

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All of the branch locations are designed for use and operation as a bank, are well maintained, and are suitable for current operations.  Of the 29 branch locations, 24 are owned and 5 are leased.  The Corporation has additional office space to house administrative operational support.  Below is a comprehensive listing of our branch locations:

 

Alanson

    

6232 River Street

    

Alanson, MI

    

Owned

Alpena

 

100 S. Second Avenue

 

Alpena, MI

 

Owned

Alpena – Ripley

 

468 N. Ripley Blvd

 

Alpena, MI

 

Owned

Aurora

 

W563 County Road N

 

Aurora, WI

 

Owned

Birmingham

    

260 E. Brown Street, Suite 300

    

Birmingham, MI

    

Leased

Cheboygan

 

350 Main Street

 

Cheboygan, MI

 

Owned

Eagle River

 

400 E. Wall Street

 

Eagle River, WI

 

Owned

Escanaba

 

2224 N. Lincoln Road

 

Escanaba, MI

 

Owned

Florence

 

845 Central Ave

 

Florence, WI

 

Owned

Gaylord

 

1955 S. Otsego Avenue

 

Gaylord, MI

 

Owned

Ishpeming - Downtown

 

100 S. Main Street

 

Ishpeming, MI

 

Owned

Ishpeming - West

 

US West & 170 N. Daisy Street

 

Ishpeming, MI

 

Owned

Kaleva

 

14429 Wuoksi Avenue

 

Kaleva, MI

 

Owned

Lewiston

 

2885 S. County Road 489

 

Lewiston, MI

 

Owned

Manistique

 

130 South Cedar Street

 

Manistique, MI

 

Owned

Manistique - Jack’s

 

735 E. Lakeshore Drive

 

Manistique, MI

 

Leased

Marquette

 

857 W. Washington Street

 

Marquette, MI

 

Leased

Marquette - McClellan

 

175 S. McClellan Avenue

 

Marquette, MI

 

Owned

Merrill

 

1400 East Main Street

 

Merrill, WI

 

Owned

Mio

 

308 N. Morenci Street

 

Mio, MI

 

Owned

Negaunee

 

440 US 41 East

 

Negaunee, MI

 

Leased

Newberry

 

414 Newberry Avenue

 

Newberry, MI

 

Owned

Niagara

 

900 Roosevelt Road

 

Niagara, WI

 

Owned

Sault Ste. Marie

 

138 Ridge Street

 

Sault Ste. Marie, MI

 

Owned