Clarkston Financial (CKSB) 10QSB Quarterly report (small business)

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

_________________

FORM 10-QSB

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

For the quarterly period ended March 31, 2006

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

For the transition period from _______ to ________

Commission file number:333-63685

CLARKSTON FINANCIAL CORPORATION
(Exact name of small business issuer as specified in its charter)

MICHIGAN
(State of other jurisdiction of
incorporation or organization) 38-3412321
(I.R.S. Employer
Identification No.)

6600 Highland Road, Waterford, MI 48327
(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (248) 922-6940

_________________

Check whether the issuer: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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  X  No     

The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:1,245,722 shares of the Corporation’s Common Stock (no par value) were outstanding as of May 15, 2006.

Transitional Small Business Disclosure Format (check one): Yes     No  X  

INDEX

		Page Number(s)
Part I	Financial Information (unaudited):
	Item 1.
	Condensed Consolidated Financial Statements		3
	Notes to Condensed Consolidated Financial Statements		7
	Item 2.
	Management's Discussion and Analysis of
	Financial Condition and Results of Operations		14
	Item 3.
	Controls & Procedures		24
Part II.	Other Information
	Item 1.
	Legal Proceedings		25
	Item 2.
	Changes in Securities and Use of Proceeds		25
	Item 3.
	Defaults Upon Senior Securities		25
	Item 4.
	Submission of Matters to a Vote of Securities Holders		25
	Item 5.
	Other Information		25
	Item 6.
	Exhibits and Reports on Form 8-K		25
Signatures			26

2

Part I Financial Information (unaudited)

CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
March 31, 2006 (unaudited) and December 31, 2005
(dollars in thousands)

	March 31, 2006		December 31, 2005
	(Unaudited)
ASSETS
Cash and cash equivalents
Total cash and due from banks	$3,848		$3,305
Federal funds sold	2,815		4,785
Total cash and cash equivalents	6,663		8,090
Securities available for sale, at fair value	49,948		48,982
Loans held for sale	294		314
Loans
Total loans	139,319		133,230
Less: Allowance for loan losses	(2,118	)	(1,930	)
Net loans	137,201		131,300
Banking premises and equipment	4,882		3,911
Deferred tax asset	865		851
Interest receivable and other assets	2,034		2,128
Total assets	$201,887		$195,576
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits
Noninterest-bearing	22,491		23,633
Interest-bearing	141,305		137,699
Total deposits	163,796		161,332
Advances from Federal Home Loan Bank of Indianapolis	10,200		10,200
Junior subordinated debentures held by
unconsolidated subsidiary trust	4,000		4,000
Interest payable and other liabilities	5,864		1,493
Total liabilities	183,860		177,025
Minority interest in consolidated subsidiary	3,360		3,420
Shareholders' equity
Common stock, no par value: 10,000,000 shares authorized;
1,245,722 and 1,045,909 shares issued and outstanding
as of March 31, 2006 and December 31, 2005	6,163		6,163
Capital surplus	6,163		6,163
Restricted stock - unearned compensation	(72	)	(85	)
Retained earnings	3,256		3,610
Accumulated other comprehensive loss	(843	)	(720	)
Total shareholders' equity	14,667		15,131	��
Total liabilities and shareholders' equity	$201,887		$195,576

See accompanying notes to consolidated financial statements

3

CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
Three and Nine Month Periods Ended March 31, 2006 and March 31, 2005
(dollars in thousands, except per share data)
(unaudited)

	Three Months Ended March 31, 2006		Three Months Ended March 31, 2005
Interest Income
Loans, including fees	$2,425		$2,101
Securities
Taxable	437		288
Tax-exempt	87		94
Federal funds sold	67		17
Total interest income	3,016		2,500
Interest Expense
Deposits	1,250		874
Borrowings	217		145
Total interest expense	1,467		1,019
Net Interest Income	1,549		1,481
Provision for loan losses	832		95
Net interest income
After provision for loan losses	717		1,386
Noninterest income
Gain/(loss) on sale of securities	3		1
Gain on sale of loans	22		47
Service charges and other fees	200		191
Other income	2		5
Total noninterest income	227		244
Noninterest expense
Salaries and benefits	791		744
Occupancy expense	254		183
Computer and data processing expenses	109		78
Advertising and public relations	73		45
Professional fees	134		94
Other expense	172		207
Total noninterest expense	1,533		1,351
Income/(loss) before federal income tax expense and minority interest	(589	)	279
Federal income tax expense/(benefit)	(167	)	100
Income/(loss) before minority interest	(422	)	179
Minority interest in net loss of consolidated subsidiary	(68	)	--
Net income/(loss)	$(354	)	$179
Basic earnings per share	$(0.28	)	$0.17
Diluted earnings per share	$(0.28	)	$0.17

See accompanying notes to consolidated financial statements.

4

CLARKSTON FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
Three Month Period ended March 31, 2006
(dollars in thousands)
(unaudited)

	Common Stock	Capital Surplus	Unearned Comp.		Retained Earnings		Accumulated Other Comprehensive (loss)		Total Stockholders' Equity
Balance December 31, 2005	$6,163	$6,163	$(85	)	$3,610		$(720	)	$15,131
Recognition of compensation for
restricted stock award	-	-	13		-		-		13
Comprehensive income:
Net income/(loss) for three months ended March 31, 2006	-	-	-		(354	)	-		(354	)
Change in unrealized loss on
securities available for sale
net of tax of ($63)	-	-	-		-		(123	)	(123	)
Net comprehensive loss									(477	)
Balance March 31, 2006	$6,163	$6,163	$(72	)	$3,256		$(843	)	$14,667

5

CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
Three Month Periods ended March 31, 2006 and March 31, 2005
(dollars in thousands)
(unaudited)

	Three Months Ended March 31, 2006		Three Months Ended March 31, 2005
Net Cash Provided by Operating Activities:
Net cash provided by/(used in) operating activities	$5,151		$21
Cash Flows from Investing Activities:
Net increase in loans	(6,733	)	(13,373	)
Purchase of available-for-sale securities	(3,214	)	(2,257	)
Proceeds from sales of available-for-sale securities	2,024		7,160
Property and equipment expenditures	(1,059	)	(352	)
Net cash used in investing activities	(8,982	)	(8,822	)
Cash Flows from Financing Activities:
Increase in deposits	2,464		9,026
Increase in federal funds purchased	--		1,500
Resources provided by minority interest	(60	)	--
Net cash provided by financing activities	2,404		10,526
Net increase/(decrease) in cash and cash equivalents	(1,427	)	1,725
Cash and cash equivalents at beginning of period	8,090		3,865
Cash and cash equivalents at end of period	$6,663		$5,590
Supplemental Cash Flow Information - Cash paid for:
Interest	1,433		954
Taxes	--		11

See accompanying notes to consolidated financial statements.

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NOTE 1 – BASIS OF FINANCIAL STATEMENT PRESENTATION

The accompanying unaudited consolidated interim financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America with the instructions to Form 10-QSB. Accordingly, certain information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements are not included herein. The interim financial statements should be read in conjunction with the financial statements of Clarkston Financial Corporation (the “Corporation”) and the notes thereto included in the Corporation’s annual report on Form 10-KSB for the year ended December 31, 2005.

All adjustments, consisting of normal recurring adjustments, which in the opinion of management are necessary for a fair presentation of financial position, results of operations, and cash flows, have been made. The results of operations for the three and nine month periods ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ended December 31, 2006.

Certain amounts in prior period’s financial statements have been reclassified to conform to the current period’s presentation.

NOTE 2 – PRINCIPLES OF CONSOLIDATION

The Corporation is a Michigan Corporation and the holding company for Clarkston State Bank (CSB) and Huron Valley State Bank (HVSB). The consolidated financial statements include the accounts of the Corporation, its wholly owned subsidiary Clarkston State Bank and its majority owned subsidiary Huron Valley State Bank. All significant intercompany transactions are eliminated in consolidation.

The Corporation also owns all of the common stock of Clarkston Capital Trust I. This is a grantor trust that issued trust preferred securities and is not consolidated with the Company per FASB Interpretation No. 46.

NOTE 3 – STOCK BASED COMPENSATION

The Corporation has two stock-based compensation plans. Under the employees’ Stock Compensation Plan (“Employee Plan”), the Corporation may grant options or issue restricted stock to key employees for up to 27,500 shares of common stock, of which 15,153 shares of common stock are available for grant. Under the 1998 Founding Directors Stock Option Plan (“Director Plan”), the Corporation may grant options for up to 82,500 shares of common stock, of which 10,580 shares of common stock are available for grant. Under both plans, there is a minimum vesting period of between one to three years before the options may be exercised, and all options expire 10 years after the date of their grant. Certain options (contingent options) under both plans vest on an accelerated basis upon the achievement of various future financial and operational goals. All such options vest 9.5 years after the date of grant regardless of achievement of future goals. Under both plans, the exercise price of each option equals the market price of the Corporation’s common stock on the date of grant.

Prior to January 1, 2006, the Company accounted for stock awards and options under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. As discussed in Note 2 under New Accounting Pronouncements, the Company adopted the fair value recognition provisions of Statement of Financial Standards (SFAS) No. 123 (R), Share Based Payment effective January 1, 2006 using the modified-prospective transition method. SFAS No. 123(R), Share Based Payment, established a fair value method of accounting for stock options whereby compensation expense would be recognized based on the computed fair value of the options on the grant date.

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NOTE 3 – STOCK BASED COMPENSATION (CONTINUED)

The Company recognizes compensation expense related to restricted stock awards over the period the services are performed. No options were granted during the first quarter of 2006. The Company determined that implementation of SFAS No. 123(R) did not have a material impact on the financial results of the Company. The Company has provided below pro forma disclosures of net income and earnings per share for the three months ended March 31, 2005, as if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except per share data):

	Three Months Ended March 31, 2005
As reported net income/(loss) available to common stockholders	$179
Less stock-based compensation expense determined under fair value method - net of tax	4
Pro forma net income/(loss)	$175
As reported earnings/(loss) per share	$0.17
Pro forma earnings/(loss) per share	$0.17
As reported earnings/(loss) per diluted share	$0.17
Pro forma earnings/(loss) per diluted share	$0.16

Compensation expense in the pro forma disclosures is not indicative of future amounts, as options vest over several years and additional grants may be made each year.

The following table summarizes stock option transactions for both plans and the related average exercise prices for the three month periods ended March 31:

	2006		2005
	Number of shares	Weighted Average Exercise Price	Number of shares	Weighted Average Exercise Price
Options Outstanding - Beginning of Year	49,536	$9.09	49,536	$9.09
Options granted - Employee Plan	-	-	-	-
Options exercised	-	-	-	-
Options expired	-	-	-	-
Options Outstanding - End of Period	49,536	$9.09	49,536	$9.09

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NOTE 3 – STOCK BASED COMPENSATION (CONTINUED)

The following table shows summary information about fixed stock options outstanding at March 31, 2006:

	Stock Options Outstanding and Exercisable
	Range of Exercise Prices	Number of Shares	Weighted Average Remaining Contractual Life		Weighted Average Exercise Price	Aggregate Intrinsic Value
Contingent	$9.09	24,060		2.6 years	$9.09	125,353
Non-contingent	9.09	25,476		2.6 years	9.09	132,730

NOTE 4 – EARNINGS PER SHARE

Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Corporation relate solely to outstanding stock options and are determined using the treasury stock method.

Earnings per share have been computed based on the following: (in dollars in thousands)

	Three Months Ended March 31,
	2006		2005
Net income/(loss) available to common stockholders	$  (354	)	$   179
Average number of common shares outstanding	1,246		1,046
Effect of dilutive options	19		27
Average number of common shares outstanding used to calculate diluted earnings/(loss) per common share	1,265		1,073
Number of antidilutive stock options excluded
from diluted earnings per share computation	--		--

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NOTE 5 — SECURITIES

The Bank does not have any securities in its portfolio that are classified as held to maturity. All securities are classified as available for sale and the amortized cost and fair values of those securities are as follows (dollars in thousands):

Available for Sale

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Market Value
March 31, 2006 (Unaudited)
U.S. Treasury securities and obligations of
U.S. government corporations and agencies	$	8,331	$	--	$	95	$	8,236
Mortgage-backed securities		28,850		--		805		28,029
Collateralized mortgage obligations		3,356		--		105		3,251
Obligations of state and political subdivisions		10,654		--		222		10,432
	$	51,191	$	--	$	1,227	$	49,948
December 31, 2005
U.S. Treasury securities and obligations of
U.S. government corporations and agencies	$	7,842	$	--	$	61	$	7,781
Mortgage-backed securities		28,044		3		663		27,384
Collateralized mortgage obligations		3,508		--		110		3,398
Obligations of state and political subdivisions		10,677		--		258		10,419
	$	50,071	$	3	$	1,092	$	48,982

NOTE 6 — LOANS

Loans are as follows (dollars in thousands):

	March 31, 2006 (unaudited)	December 31, 2005
Commercial	$23,899	$24,316
Real estate:
Commercial	71,813	62,776
Residential	15,766	14,976
Construction	25,652	28,764
Total real estate	113,231	106,516
Consumer	2,189	2,398
Total	$139,319	$133,230

Activity in the allowance for loan losses is as follows (dollars in thousands):

	Three Months Ended March 31,
	2006		2005
Balance - Beginning of period	$1,930		$1,280
Provision charged to operations	832		95
Charge-offs	(651	)	(13	)
Recoveries	7		1
Balance - End of period	$2,118		$1,363
Allowance for loan losses to total loans	1.52%		1.02%

10

NOTE 7 — DEPOSITS

Deposits are summarized as follows (dollars in thousands):

	March 31, 2006 (unaudited)	December 31, 2005
Non-interest bearing demand deposit accounts	$22,491	$23,633
Interest-bearing demand deposit accounts	5,910	5,981
Savings accounts	5,232	4,730
Money market accounts	56,067	60,179
Certificates of deposit	74,096	66,809
Total deposits	$163,796	$161,332

NOTE 8 – FHLB ADVANCES

The Company has various term advances from the Federal Home Loan Bank of Indianapolis (“FHLB”) with fixed and variable interest rates ranging from 3.75% to 4.86% at March 31, 2006 and December 31, 2005. The weighted average interest rate at March 31, 2006 and December 31, 2005 is 4.35%. Maturity dates range from November 2006 to October 2010. The weighted average remaining maturity at March 31, 2006 is 873 days, or August 20, 2008. Advances from the FHLB are collateralized by qualifying investment securities with estimated market values of $11,711,000 and $12,210,000 at March 31, 2006 and December 31, 2005. The advances are due in full at maturity and the fixed rate advances are subject to a prepayment penalty if repaid prior to maturity.

NOTE 9 – MINIMUM REGULATORY CAPITAL REQUIREMENTS

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for Banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can initiate regulatory action. The prompt corrective action regulations provide five classifications, well capitalized, adequately capitalized, undercapitalized and critical undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and plans for capital restoration are required. The Banks and the Corporation were well-capitalized as of March 31, 2006 and December 31, 2005.

11

NOTE 9 – MINIMUM REGULATORY CAPITAL REQUIREMENTS (CONTINUED)

The Banks’ and Corporation’s actual capital amounts and ratios as of March 31, 2006 and December 31, 2005 are presented in the following table (dollars in thousands):

	Actual		For Capital Adequacy Purposes		To be Well-Capitalized
	Amount	Ratio (Percent)	Amount	Ratio (Percent)	Amount	Ratio (Percent)
As of March 31, 2006:
Total risk-based capital
(to risk-weighted assets)
CSB	$15,655	11.07	$11,316	8.00	$14,145	10.00
HVSB	7,690	85.52	719	8.00	899	10.00
Consolidated	21,595	14.28	12,102	8.00	15,128	10.00
Tier I Capital
(to risk weighted assets)
CSB	$13,598	9.61	$5,658	4.00	$8,487	6.00
HVSB	7,629	84.84	360	4.00	540	6.00
Consolidated	19,477	12.88	6,051	4.00	9,077	6.00
Tier I Capital
(to average assets)
CSB	$13,598	7.51	$7,240	4.00	$9,050	5.00
HVSB	7,629	50.56	604	4.00	754	5.00
Consolidated	19,477	9.78	7,964	4.00	9,954	5.00
As of December 31, 2005:
Total risk-based capital
(to risk-weighted assets)
CSB	$15,516	10.99	$11,291	8.00	$14,113	10.00
HVSB	7,803	144.97	431	8.00	538	10.00
Consolidated	21,780	14.82	11,759	8.00	14,699	10.00
Tier I Capital
(to risk weighted assets)
CSB	$13,753	9.74	$5,645	4.00	$8,468	6.00
HVSB	7,771	144.37	215	4.00	323	6.00
Consolidated	19,850	13.50	5,879	4.00	8,819	6.00
Tier I Capital
(to average assets)
CSB	$13,753	7.62	$7,221	4.00	$9,027	5.00
HVSB	7,771	62.43	498	4.00	622	5.00
Consolidated	19,850	12.58	6,311	4.00	7,888	5.00

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NOTE 10 — STANDBY AND COMMERCIAL LETTERS OF CREDIT AND FINANCIAL GUARANTEES

The Corporation is a party to credit-related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commercial and standby letters of credit, and unfunded commitments under lines of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The Corporation’s exposure to credit loss is represented by the contractual amount of these commitments. The Corporation follows the same credit policies in making commitments as it does for on-balance-sheet instruments.

At March 31, 2006 and December 31, 2005, the following financial instruments were outstanding whose contract amounts represent credit risk (dollars in thousands):

	March 31, 2006 (unaudited)	December 31, 2005
Commitments to grant loans	$9,331	$6,902
Unfunded commitments under lines of credit	23,013	18,649
Commercial and standby letters of credit	169	169

NOTE 11 – RECENT ACCOUNTING PRONOUNCEMENTS

Statement of Financial Standards (SFAS) No.123(R), Share Based Payment , establishes accounting requirements for share-based compensation to employees and carries forward prior guidance on accounting for awards to non-employees. This Statement requires an entity to recognize the cost of employee services received in share-based payment transactions as compensation expense and measure the cost on the grant-date fair value of the award. The Corporation was required to adopt SFAS 123(R) beginning January 1, 2006. Effective December 31, 2005, the Corporation’s Board of Directors accelerated the vesting of all of its outstanding stock options, in conjunction with an overall review of the compensation system. The adoption of this Statement did not have a material impact on the results of operations of the Company.

         In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Instruments, which is an amendment of SFAS No: 133 and 140. SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. The Statement also establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation and clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives. SFAS No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006. Management is currently evaluating the impact this Statement may have on the Company’s results of operations or financial condition.

13

Item 2

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

The following analysis discusses changes in the financial condition and results of operations of the Corporation for the periods presented and should be read in conjunction with the Corporation’s Consolidated Financial Statements and notes thereto, appearing in Part I, Item 1 of this document.

Forward Looking Statements

        This report includes “forward-looking statements” as that term is used in the securities laws. All statements regarding the Corporation’s expected financial position, business and strategies are forward-looking statements. In addition, the words “anticipates,” “believes,” “estimates,” “seeks,” “expects,” “plans,” “intends,” and similar expressions, as they relate to the Corporation and its management, are intended to identify forward-looking statements. The presentation and discussion of the provision and allowance for loan and lease losses, determining the fair value of securities and other financial instruments, the valuation of mortgage servicing rights and statements concerning future profitability or future growth or increases, are examples of inherently forward looking statements in that they involve judgments and statements of belief as to the outcome of future events. The Corporation’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse affect on the Corporation’s operations and future prospects include, but are not limited to, changes in: interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Corporation’s market area and accounting principles, policies and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Further information concerning the Corporation and its business, including additional factors that could materially affect the Corporation’s financial results, is included in its filings with the Securities and Exchange Commission.

General

Clarkston Financial Corporation (the “Corporation”, “us” or “we”) is a Michigan corporation incorporated on May 18, 1998. The Corporation is the bank holding company for Clarkston State Bank (“CSB”) and Huron Valley State Bank (“HVSB”) (collectively the “Banks”). CSB commenced operations on January 4, 1999, and HVSB commenced operations on August 15, 2005. The Banks are chartered by the State of Michigan with depository accounts insured by the Federal Deposit Insurance Corporation. As such, our primary business is concentrated in a single industry segment — commercial banking. The Banks provide a full range of banking services to individuals, commercial businesses and industries located in their service areas. The Banks maintain diversified loan portfolios, including loans to individuals for home mortgages, automobiles and personal expenditures, and loans to business enterprises for current operations and expansion. The Banks also offer a variety of deposit products, including checking accounts, savings accounts, money market accounts, individual retirement accounts and certificates of deposit.

The principal markets for financial services provided are in northern Oakland County communities in which the Banks are located and the areas immediately surrounding these communities. The Banks serve these markets through 7 locations in or near their communities. The Banks do not have any material foreign assets or income.

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Our principal source of revenue is interest and fees on loans. On a consolidated basis, interest and fees on loans accounted for 74.8% of total revenue in 2006 compared to 76.6% in 2005. Interest and fees on loans increased in the current year as a result of growth in the loan portfolio. This growth in the loan portfolio is due in part to the addition of HVSB and also to continued growth in CSB’s loan portfolio. Purchases of securities and increased Federal Funds balances at HVSB were the primary causes of the decrease in the share of total revenue attributed to loan interest and fees. Revenue share of interest from investments (including Federal Funds sold), increased to 18.2%, from 14.5% year over year. Service fees on deposit accounts declined from 7.0% to 6.2% in 2005 and 2004, respectively. This decrease in revenue share was due to faster growth in other revenue sources, as the deposit fee income as a % of checking accounts increased slightly from 2.6% in 2005 to 2.8% in 2006.

The formation of HVSB in 2005 was a significant event for Clarkston Financial Corporation. We own 55% of the outstanding shares of common stock of HVSB. The remaining 45% is owned by private investors. We expect to recognize operating losses from HVSB in the near term as the Bank grows out of the de novo stage.

Critical Accounting Policies

As of March 31, 2006, there have been no material changes in the disclosures regarding critical accounting policies as disclosed in the Company’s Form 10-K for the year ended December 31, 2005. The Company’s critical accounting policies are described in the financial section of its 2005 Annual Report. Management believes its critical accounting policies relate to the Company’s securities, allowance for loan losses.

Comparison of Financial Condition at March 31, 2006 and December 31, 2005

        Our total assets increased by $6.3 million or 3.2% to $201.9 million at March 31, 2006, from $195.6 million at December 31, 2005. The addition of HVSB in the 3^rd quarter of 2005 has contributed significantly to our asset growth, providing approximately $16.8 million in total assets. We anticipate that our assets will continue to grow during 2006.

        Cash and cash equivalents, which include federal funds sold and short-term investments, decreased $1.4 million or 17.3% to $6.7 million at March 31, 2006 from $8.1 million at December 31, 2005. The decrease is due mostly to these excess funds being deployed into higher yielding loans and investments. It is anticipated that this trend will continue during the year.

        Securities increased $966,000 or 2.0% to $49.9 million at March 31, 2006 from $49.0 million at December 31, 2005. This increase was caused by the purchase of securities at HVSB, These purchases were made to achieve an increased amount of interest income on excess funds until they can be redeployed into the loan portfolio. The Corporation continues to have excellent liquidity and will monitor its level of securities to ensure proper liquidity is maintained. While there are a number of securities that have market values less than 95% of the book value, and could be construed as impaired relative to market value, management has the intent and ability to hold these specific securities until maturity and no loss is expected to be realized on these securities. As a result, the book value of these securities have not been written down as of March 31, 2006.

15

        Total portfolio loans increased by $6.1 million or 4.6% to $139.3 million at March 31, 2006 from $133.2 million at December 31, 2005. This growth rate is in line with our business plan and a similar, or slightly slower rate is expected to continue throughout 2006. The difficult economic climate in Michigan and competitive pressures in the banks’ contiguous markets has created a challenging environment in which to make loans. Approximately $3.0 million of the growth was from Huron Valley State Bank. Total loan growth continues to be driven by the commercial real estate portfolio which increased $9.0 million, or 14.3% over the balance at December 31, 2005. This large increase was partially offset by a $3.1 million decrease in the construction portfolio, caused by the payoff of a number of larger credits. Commercial and industrial loans saw a slight decrease of $417,000, or 1.7% from December 31, 2005. The residential real estate portfolio also contributed positively showing a 5.3%, or $790,000 increase from December 31, 2005. There was a slight decrease in consumer loans from December 31, 2005. We continue to focus on commercial lending as evidenced by the fact that commercial and construction loans make up 87.1% of the loan portfolio, with residential loans making up 11.3% and consumer loans 1.6%.

The nonperforming loan balance shown below as of March 31, 2006 is made up of 16 relationships. Subsequent to the end of the quarter, the Corporation received a favorable ruling from the court on one such credit which makes up 6.1% of the balance of nonperforming loans. Based on this favorable ruling, we anticipate being paid in full on this credit (including accrued interest) during the 2^nd quarter. The employee who was hired to deal with workout credits on a contract basis in the 3^rd quarter of 2005 has been hired as a full-time employee for that purpose.

During the quarter, the Bank experienced a 111.1% increase in loans 90 or more days past due and still accruing. In accordance with our policy, loans that are well secured and in the process of collection are not put on non-accrual status. Of the $2.3 million of new credits which went 90 days past due during the quarter, $1.3 million, or 56.5% were secured by real estate. The unsecured credit is a matured loan for which we were awaiting additional information to make a renewal decision. Additionally, a charge-off of a $624,000 credit which was previously 100% reserved reduced the nonaccrual balances, however $650,000 of loans (2 credits) migrated from 90 days past due to nonaccrual and 1 additional credit (secured by real estate) was placed on non-accrual during the quarter. All loans greater than 90 days delinquent, regardless of accrual status, are included on management’s watch list and monitored monthly. Management is working through these credits and believes that any losses inherent in these credits are adequately reserved for in the allowance for loan loss.

The table below shows the composition and amount of our nonperforming assets.

(dollars in thousands)	March 31, 2006 (unaudited)		December 31, 2005
Nonaccrual loans
Secured by real estate	$757		$1,066
Secured by other than real estate	385		--
Unsecured	--		--
Loans 90 days past due and still accruing	--		--
Secured by real estate	1,991		989
Secured by other than real estate	512		424
Unsecured	475		--
Total nonperforming loans	4,120		2,479
Foreclosed and repossessed assets	189		205
Total nonperforming assets	$4,309		$2,684
Nonperforming assets to total loans	3.09	%	2.01	%
Nonperforming assets to total assets	2.13	%	1.37	%

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        The allowance for loan losses as of March 31, 2006 was $2.1 million representing approximately 1.52% of total loans outstanding, compared to $1.9 million, or 1.45% of loans outstanding as of December 31, 2005. The charge-off of the $625,000 credit which was fully reserved in the 3^rd quarter of 2005 caused a reduction in the allowance, though this was more than offset by the additional provision required during the 1^st quarter. A thorough internal review of the loan portfolio was commenced during the quarter and is ongoing. Management believes that the high risk credits are appropriately reserved for and are all being monitored appropriately. At the same time, the economic climate in the Banks’ home state is not favorable and the possibility for additional losses caused by this economic weakness still exists. We believe that the allowance for loan losses is sufficient to cover losses inherent in the portfolio.

        The loan loss allowance represents management’s assessment of both current and future losses inherent within the loan portfolio. Consideration is also given to off-balance sheet items that may involve credit risk, such as commitments to extend credit. This analysis is conducted on a quarterly basis utilizing a methodology that has been employed since our inception. The methodology employed utilizes several factors to determine the appropriateness of the allowance. Specifically, historical loss experience, financial condition of borrowers, collateral adequacy, credit risk rating system and current economic conditions are incorporated in this analysis.

        The primary risk element considered by management regarding each installment and residential real estate loan is the lack of timely payments. We have a reporting system that monitors past due loans and have adopted policies to pursue our creditor’s rights in order to preserve our position. The primary risk elements concerning commercial loans are the financial condition of the borrower, the sufficiency of the collateral and lack of timely payment. Management has a policy of requesting and reviewing annual financial statements from its commercial loan customers and periodically reviews the existence and value of collateral for selected loans.

        The adequacy of the allowance is based on the application of our credit risk rating system which identifies problem credits and ranks loans by specific categories. Moreover, we use peer comparisons and industry data for similar type loans to further assess the proper level of the loan loss allowance.

        Total premises and equipment increased $1.0 million, or 25.6% to $4.9 million at March 31, 2006 from $3.9 million at December 31, 2005. This increase is due to the purchase of the building from which the holding company operates from a company controlled by the Chairman. This purchase was made at the fair market value of the property. CSB operates a retail branch out of this building and it was determined to be cost efficient to purchase the building.

        Total deposit balances increased $2.5 million or 1.5% to $163.8 million at March 31, 2006 from $161.3 million at December 31, 2005. The largest increase in terms of percentage was seen in time deposits which increased 10.9%, or $7.3 million since December 31, 2005. This increase was offset by a $4.1 million, or 6.8% decrease in the money market portfolio. Demand and other savings accounts saw a slight decrease from December 2005. The local market for non-time deposits is extremely competitive, and we continue to focus on gathering lower cost savings and DDA accounts to fund our future growth and reduce our reliance on higher cost time deposits. A renewed focus on our Waterford market along with growth in the Milford market by HVSB will assist us in meeting our deposit gathering goals.

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        CSB is a member of the Federal Home Loan Bank of Indianapolis, and utilizes advances from this institution to bolster liquidity. At March 31, 2006, we have $10.2 million in advances outstanding. No repayments or additional advances occurred during the quarter The Corporation continues to view the FHLB as a source of liquidity and may borrow additional funds as market conditions dictate.

        We have no other off-balance sheet liabilities other than commitments to extend credit in the form of letters and lines of credit.

        As of March 31, 2006, we had retained earnings of $3.3 million compared to $3.6 million at December 31, 2005 which was a result of a net loss of $354,000. Accumulated other comprehensive income saw a decrease of $123,000, or 17.1%. This decrease was primarily the result of changes in interest rates causing a decrease in the market value of the Corporation’s security portfolio. We do not believe that the value of any of the securities in the portfolio are permanently impaired.

Comparison of Operating Results for the Three Months Ended March 31, 2006 and 2005

        Our net loss was $354,000, or $0.28 per diluted share for the first quarter of 2006 compared to net income of $179,000, or $0.17 per diluted share for the first quarter of 2005. The net loss was caused primarily by increased loan loss provisions and operating expenses related to HVSB being open and fully staffed, while last year it was operating with limited staff as a loan center. While still in the start-up phase, the losses since the opening of Huron Valley State Bank have been less than the initial projections.

        Net interest income increased 4.6% or $68,000 from $1.48 million in the first quarter of 2005 to $1.55 million for 2006. The primary contributor to the increase was elevated balances in earning assets, which increased by 15.7% to $197.1 million at March 31, 2006 from $170.3 million at December 31, 2005. This effectively added $219,000 to the margin. A large quantity of loans were booked by both banks in the latter stages of the quarter, therefore the full effect of these additional loans are not reflected within the average balances shown in the table below. Increasing rates reduced net interest income by $42,000, as the cost of interest bearing funds increased 80 basis points, while the yield on earning assets only increased by 30 basis points. The increase in non-interest bearing deposits also helped the margin in the current quarter. The net interest margin decreased from 3.60% for the quarter ended March 31, 2005 compared to 3.27% for the same period in 2006. As mentioned above, management is devising a strategy to generate additional demand deposit account volume to reduce our reliance on higher cost time and other savings accounts.

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The following schedule presents the average daily balances, interest income, interest expense and average rates earned and paid for the Corporation’s major categories of assets, liabilities, and shareholders’ equity for the periods indicated (dollars in thousands):

	3 Months ended March 31, 2006								3 Months ended March 31, 2005
	Average Balance			Interest		Yield/ Cost			Average Balance			Interest		Yield/ Cost
Assets:
Short term investment	$	6,177		$	67		4.34	%	$	3,831		$	17		1.77	%
Securities:
Taxable		39,716			437		4.40	%		29,651			288		3.89	%
Tax-exempt		10,668			87		3.26	%		11,738			94		3.20	%
Loans		132,949			2,425		7.30	%		119,510			2,101		7.03	%
Total earning assets/total
interest income		189,509			3,016		6.37	%		164,730			2,500		6.07	%
Cash and due from banks		4,003								3,549
Unrealized (loss) on AFS securities		(1,107	)							(432	)
Allowance for loan loss		(1,922	)							(1,328	)
All other assets		6,559								3,815
Total assets		197,071			3,016					170,334			2,500
Liabilities and Stockholders' Equity
Interest bearing deposits:
MMDA, Savings/NOW accounts		68,278			526		3.08	%		63,555			409		2.57	%
Time		69,344			724		4.18	%		55,033			465		3.38	%
Fed Funds Purchased		2,683			31		4.69	%		1,211			8		2.51	%
FHLB Advances		10,200			111		4.35	%		12,200			82		2.70	%
Trust Preferred Securities		4,000			75		7.46	%		4,000			55		5.50	%
Other borrowings		20			--		0.00	%		15			--		0.00	%
Total interest bearing
liabilities/interest expense		154,526			1,467		3.80	%		136,014			1,019		3.00	%
Noninterest bearing
deposits		22,763								21,073
All other liabilities		4,634								954
Stockholders' Equity:
Unrealized holding (loss)		(731	)							(270	)
Common Stock, Surplus, Retained Earnings		15,880								12,563
Total liabilities and stockholders' equity		197,071								170,334
Interest spread					1,549		2.57	%					1,481		3.07	%
Net Interest Margin as a
Percentage of Average
Earnings Assets - FTE		189,509			1,549		3.27	%		164,730			1,481		3.60	%

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        Rate / Volume Analysis of Net Interest Income.The following schedule presents the dollar amount of changes in interest income and expense for major components of earning assets and interest-bearing liabilities, distinguishing between changes related to outstanding balances and changes due to interest rates.

	2006 Compared to 2005
	Change Due to Rate		Change Due to Volume		Change Due to Mix		Total Change
	(Dollars in thousands)
Short term investment	$25		$10		$15		$50
Investment securities--taxable	38		98		13		149
Investment securities--tax-exempt	2		(9	)	--		(7	)
Loans, net of unearned income	79		236		9		324
Total interest income	144		335		37		516
Interest bearing deposits	110		121		28		259
Federal funds borrowed	7		9		8		24
FHLB advances	50		(14	)	(7	)	29
Trust preferred securities	19		--		--		19
Other borrowings	--		--		--		--
Total interest expense	186		116		29		331
Net interest income	$(42	)	$219		$8		$185

        Total provision for loan losses was $832,000 for the first quarter ended March 31, 2006, compared to $95,000 for the first quarter of 2005. Of the total first quarter loan loss provision, approximately $559,000 relates primarily to an aggregate principal balance of approximately $1.01 million of loans to three commercial borrowers which have become impaired. The borrowers have been unable to meet the repayment terms of the loans and one of the borrowers has filed for Chapter 7 bankruptcy. The loans are secured by liens on commercial real estate and certain other collateral, but in all cases the collateral is no longer of sufficient value to cover the outstanding principal balance on the loans. As a result of Clarkston State Bank’s ongoing monitoring of the loan portfolio, these loans were determined to be impaired. In addition to specific reserves, these impairments have adversely affected the Corporation’s loss history resulting in additional provision for loan losses.

        The level of the provision made in connection with the loans reflects the amount necessary to maintain the allowance for loan losses at an adequate level, based upon Clarkston State Bank’s current analysis of probable incurred losses in its loan portfolio, with respect to loans held at March 31, 2006. Bank management is continuing to evaluate the financial condition of the borrowers and the value of the collateral. The impairment charge is based on the information currently available and may change as new information is received.

        Non-interest income decreased $17,000, or 7.0% for the first quarter of 2006 compared to the same period in 2005. The largest portion of the change in non-interest income was due to reduced gains on sale of mortgage loans. As the sales team builds up the volume in this area, we anticipate increased fee income. Fees on deposit accounts increased $9,000, or 4.7% over the same quarter in the prior year. The Corporation’s large checking account portfolio continues to generate fees, though a review of these fees relative to our local market peers may result in the modification of our fee structure. It is, however, anticipated that any modification of the fee structure will result in increased fee income.

20

        Non-interest expense was $1.53 million for the first quarter of 2006, a $182,000 or 13.5% increase over the first quarter of 2005 when non-interest expense was $1.35 million. The increase is primarily attributable to higher salary and benefit costs of $47,000, or 6.3% due primarily to the full staffing of HVSB and normal increases in compensation. Occupancy expense has increased $71,000, or 38.8% as a result of HVSB and additional real estate taxes related to CSB’s newest branch. Professional fees are 42.6%, or $40,000 higher than the same period last year, mostly due to legal costs related to the collection efforts on troubled loans. Advertising expense is elevated from the 1^st quarter of 2005 primarily due to the opening of the new Bank. As Huron Valley State Bank and the mortgage operation gain critical mass, we anticipate our efficiency ratio to improve to the levels more common throughout our history. The ratio for the quarter ended March 31, 2006 increased to 86.3% from 78.3% at March 31, 2005.

Liquidity and Capital Resources

        The Corporation obtained its initial equity capital in an initial public offering of its common stock in November 1998. We have successfully grown through our first five years of operation. In December 2003, we completed an offering of $4.0 million of cumulative preferred securities (“Trust Preferred Securities”) to further support the Corporation’s growth.

        In July 2005, the Corporation completed a rights offering which allowed each holder of the Corporation’s common stock as of the June 6, 2005 record date to purchase 1 additional share of common stock for every 4 shares held, while also offering an opportunity to purchase a limited number of shares above their basic subscription right (the over-subscription privilege). A total of 165,776 shares were purchased in the rights offering (63.2% of the 262,192 shares offered). Of the 165,776 shares purchased, 127,183 shares were basic subscriptions and 38,593 shares were over-subscriptions. The Corporation received approximately $2,856,000 in net proceeds in connection with the rights offering, which was used to purchase a majority interest in Huron Valley State Bank.

        Also in July 2005, 28,000 shares were sold to one investor through the community offering provisions of the rights offering. These shares were sold at $18.00, netting the corporation $504,000.

        Management believes that its current capital will provide us with adequate capital to support our expected level of deposit and loan growth and to otherwise meet our capital requirements for the next year.

Capital Resources at March 31, 2006 (in thousands)

	Tier 1 Leverage Ratio		Tier 1 Capital Ratio		Total Risk-Based Capital Ratio
Minimum regulatory requirement for
Capital adequacy	4	.00%	4	.00%	8	.00%
Well capitalized regulatory level	5	.00%	6	.00%	10	.00%
CSB	7	.51%	9	.61%	11	.07%
HVSB	50	.56%	84	.84%	85	.52%
Consolidated	9	.78%	12	.88%	14	.28%

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The following table shows the dollar amounts by which the Corporation’s capital (on a consolidated basis) exceeds current regulatory requirements on a dollar-enumerated basis:

	Tier 1 Leverage		Tier 1 Capital		Total Risk-Based Capital
	(in thousands of dollars)
Capital balances at March 31, 2006
Required regulatory capital	$	7,964	$	6,051	$	12,102
Capital in excess of regulatory minimums		11,513		13,426		9,493
Actual capital balances	$	19,477	$	19,477	$	21,595

        The liquidity of a financial institution reflects its ability to provide funds to meet loan requests, to accommodate possible outflows of deposits and to take advantage of interest rate market opportunities. Our sources of liquidity include our borrowing capacity with the Federal Home Loan Bank, loan payments by our borrowers, maturity and sales of our securities available for sale, growth of our deposits and deposit equivalents and various capital resources. Liquidity management involves the ability to meet the cash flow requirements of our customers. Our customers may be either borrowers with credit needs or depositors wanting to withdraw funds. We believe our liquidity position is sufficient to meet these needs.

As indicated by the consolidated statement of cash flows for the three months ended March 31, 2006, operating activities generated $5.2 million in the current quarter. The primary cause of this increase was the outstanding cashier’s checks related to loan closings which took place at the end of the quarter. In addition, deposit generation and security sales provided $2.5 million and $2.0 million in cash to our operation. The primary uses of funds in the current quarter were loan originations of $6.7 million, purchases of securities of $3.2 million and the purchase of our corporate office location of $1.0 million.

Item 3 CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. The Corporation’s Chief Executive Officer and Chief Financial Officer, after evaluating the effectiveness of the Corporation’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Form 10-QSB Quarterly Report, have concluded that the Corporation’s disclosure controls and procedures were adequate and effective to ensure that material information relating to the Corporation would be made known to them by others within the Corporation, particularly during the period in which this Form 10-QSB Quarterly Report was being prepared.

(b) Changes in Internal Controls. During the period covered by this report, there have been no changes in the Corporation’s internal control over financial reporting that have materially affected or are reasonably likely to materially affect the Corporation’s internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings.

        From time to time, we may be involved in various legal proceedings that are incidental to our business. In our opinion, we are not a party to any current legal proceedings that are material to our financial condition, either individually or in the aggregate.

Item 2. Changes in Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Submission of Matters to a Vote of Securities Holders

None.

Item 5. Other Information.

None.

Item 6. Exhibits.

Exhibits

31.1 Certificate of the Chief Executive Officer of Clarkston Financial Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certificate of the Chief Financial Officer of Clarkston Financial Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certificate of the Chief Executive Officer and Chief Financial Officer of Clarkston Financial Corporation pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

        In accordance with the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Quarterly Report on Form 10-QSB for the quarter ended March 31, 2006, to be signed on its behalf by the undersigned, thereunto duly authorized.

CLARKSTON FINANCIAL CORPORATION


/s/ Edwin L. Adler
——————————————
Edwin L. Adler
Chairman of the Board and Chief Executive Officer


/s/ James W. Distelrath
——————————————
James W. Distelrath
Chief Financial Officer

DATE: May 15, 2006

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EXHIBIT LIST

31.1 Certificate of the Chief Executive Officer of Clarkston Financial Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.  

31.2 Certificate of the Chief Financial Officer of Clarkston Financial Corporation pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.  

32.1 Certificate of the Chief Executive Officer and Chief Financial Officer of Clarkston Financial Corporation pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.  

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