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

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-QSB

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

For the quarterly period ended June 30, 2006

OR

o 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	38-3412321
(State of other jurisdiction of incorporation or organization)	(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. Yesþ Noo

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

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 August 15, 2006.

Transitional Small Business Disclosure Format (check one): Yeso Noþ

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
Certificate of the Chief Executive Officer to Section 302
Certificate of the Chief Financial Officer to Section 302
Certificate of the CEO and CFO to Section 906

2

Part I Financial Information (unaudited)

CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
June 30, 2006 (unaudited) and December 31, 2005
(dollars in thousands)

	June 30,			December 31,
	2006			2005
	(Unaudited)
ASSETS
Cash and cash equivalents
Total cash and due from banks	$	6,117		$	3,305
Federal funds sold		9,850			4,785
Total cash and cash equivalents		15,967			8,090
Securities available for sale, at fair value		48,009			48,982
Loans held for sale		217			314
Loans
Total loans		140,601			133,230
Less: Allowance for loan losses		(1,560	)		(1,930	)
Net loans		139,041			131,300
Banking premises and equipment		4,824			3,911
Deferred tax asset		846			851
Interest receivable and other assets		2,317			2,128
Total assets	$	211,221		$	195,576
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Noninterest-bearing		25,656			23,633
Interest-bearing		151,891			137,699
Total deposits		177,547			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		2,191			1,493
Total liabilities		193,938			177,025
Minority interest in consolidated subsidiary		3,299			3,420
Shareholders’ equity
Common stock, no par value: 10,000,000 shares authorized; 1,245,722 shares issued and outstanding as of June 30, 2006 and December 31, 2005		6,163			6,163
Capital surplus		6,163			6,163
Restricted stock — unearned compensation		(61	)		(85	)
Retained earnings		3,058			3,610
Accumulated other comprehensive loss		(1,339	)		(720	)
Total shareholders’ equity		13,984			15,131
Total liabilities and shareholders’ equity	$	211,221		$	195,576

See accompanying notes to consolidated financial statements

3

CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF INCOME
Three and Six Month Periods Ended June 30, 2006 and June 30, 2005
(dollars in thousands, except per share data)
(unaudited)

	Three Months			Three Months		Six Months			Six Months
	Ended			Ended		Ended			Ended
	June 30, 2006			June 30, 2005		June 30, 2006			June 30, 2005
Interest Income
Loans, including fees	$	2,698		$	2,285	$	5,123		$	4,386
Securities
Taxable		446			303		883			591
Tax-exempt		87			74		174			168
Federal funds sold		89			37		156			54
Total interest income		3,320			2,699		6,336			5,199
Interest Expense
Deposits		1,432			997		2,682			1,871
Borrowings		228			173		445			318
Total interest expense		1,660			1,170		3,127			2,189
Net Interest Income		1,660			1,529		3,209			3,010
Provision for loan losses		534			260		1,366			355
Net interest income After provision for loan losses		1,126			1,269		1,843			2,655
Noninterest income
Gain on sale of securities		—			—		3			1
Gain on sale of loans		12			28		34			75
Service charges and other fees		154			221		354			412
Other income		—			4		2			9
Total noninterest income		166			253		393			497
Noninterest expense
Salaries and benefits		839			783		1,630			1,527
Occupancy expense		280			201		534			384
Computer and data processing expenses		68			87		219			165
Advertising and public relations		110			57		141			102
Professional fees		120			74		254			168
Supplies		30			17		59			41
Other expense		216			177		358			360
Total noninterest expense		1,663			1,396		3,195			2,747
Income/(loss) before federal income tax expense and minority interest		(370	)		126		(959	)		405
Federal income tax expense/(benefit)		(113	)		10		(280	)		110
Income/(loss) before minority interest		(257	)		116		(679	)		295
Minority interest in net loss of consolidated subsidiary		(59	)		—		(127	)		—
Net income/(loss)	$	(198	)	$	116	$	(552	)	$	295
Basic earnings/(loss) per share	$	(.16	)	$	.11	$	(.44	)	$	0.28
Diluted earnings/(loss) per share	$	(.16	)	$	.11	$	(.44	)	$	0.27

See accompanying notes to consolidated financial statements.

4

CLARKSTON FINANCIAL CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY
Six Month Period ended June 30, 2006
(dollars in thousands)
(unaudited)

											Accumulated
											Other			Total
	Common		Capital		Unearned			Retained			Comprehensive			Stockholders’
	Stock		Surplus		Comp.			Earnings			Loss			Equity
Balance, December 31, 2005	$	6,163	$	6,163	$	(85	)	$	3,610		$	(720	)	$	15,131
Recognition of compensation for restricted stock award						24									24
Comprehensive income:
Net loss for the six months ended June 30, 2006									(552	)					(552	)
Change in unrealized loss on securities available for sale net of tax of ($319)												(619	)		(619	)
Net comprehensive loss									(552	)		(619	)		(1,171	)
Balance, June 30, 2006	$	6,163	$	6,163	$	(61	)	$	3,058		$	(1,339	)	$	13,984

5

CLARKSTON FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
Six Month Periods ended June 30, 2006 and June 30, 2005
(dollars in thousands)
(unaudited)

	Six Months			Six Months
	Ended			Ended
	June 30,			June 30,
	2006			2005
Net Cash Provided by Operating Activities:
Net cash provided by/(used in) operating activities	$	2,029		$	267
Cash Flows from Investing Activities:
Net increase in loans		(9,107	)		(17,884	)
Purchase of available-for-sale securities		(3,214	)		(3,255	)
Proceeds from sales of available-for-sale securities		3,171			10,073
Property and equipment expenditures		(1,096	)		(560	)
Net cash used in/(provided by) investing activities		(10,246	)		(11,626	)
Cash Flows from Financing Activities:
Increase in deposits		16,215			22,715
Resources used by minority interest		(121	)		—
Net cash provided by financing activities		16,094			22,715
Net increase in cash and cash equivalents		7,877			11,356
Cash and cash equivalents at beginning of period		8,090			3,865
Cash and cash equivalents at end of period	$	15,967		$	15,221
Supplemental Cash Flow Information – Cash paid for:
Interest		2,847			2,150
Taxes		—			211

See accompanying notes to consolidated financial statements.

6

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 six month periods ended June 30, 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. The Company has 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.

7

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 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 and six months ended June 30, 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		Six Months
	Ended June 30,		Ended June 30,
	2005		2005
As reported net income available to common stockholders	$	116	$	295
Less stock-based compensation expense determined under fair value method – net of tax		4		8
	$	112	$	287
Pro forma net income
As reported earnings per share	$	0.11	$	0.28
Pro forma earnings per share	$	0.11	$	0.27
As reported earnings per diluted share	$	0.11	$	0.27
Pro forma earnings per diluted share	$	0.10	$	0.27

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 June 30:

	2006				2005
			Weighted				Weighted
			Average				Average
	Number		Exercise		Number		Exercise
	of shares		Price		of shares		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

8

NOTE 3 – STOCK BASED COMPENSATION (CONTINUED)

The following table shows summary information about fixed stock options outstanding at June 30, 2006:

	Stock Options Outstanding and Exercisable
					Weighted
					Average	Weighted
	Range of				Remaining	Average		Aggregate
	Exercise		Number of		Contractual	Exercise		Intrinsic
	Prices		Shares		Life	Price		Value
Contingent	$	9.09		24,060	2.4 years	$	9.09	$	106,105
Non-contingent	$	9.09		25,476	2.4 years	$	9.09		112,349

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					Six Months
	Ended June 30,					Ended June 30,
	2006			2005		2006			2005
Net income/(loss) available to common stockholders	$	(198	)	$	116	$	(552	)	$	295
Average number of common shares outstanding		1,246			1,049		1,246			1,047
Effect of dilutive options		19			27		18			28
Average number of common shares outstanding used to calculate diluted earnings/(loss) per common share		1,265			1,076		1,264			1,075
Number of antidilutive stock options excluded from diluted earnings per share computation		—			—		—			—

9

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

			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Market
	Cost		Gains		Losses		Value
June 30, 2006 (unaudited)
U.S. Treasury securities and obligations of U.S. government corporations and agencies	$	8,339	$	—	$	204	$	8,135
Mortgage-backed securities		27,740		—		1,183		26,557
Collateralized mortgage obligations		3,218		—		151		3,067
Obligations of state and political subdivisions		10,631		—		381		10,250
	$	49,928	$	—	$	1,919	$	48,009
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):

	June 30,
	2006		December 31,
	(unaudited)		2005
Commercial	$	21,596	$	24,316
Real estate:
Commercial		76,576		62,776
Residential		16,027		14,976
Construction		24,265		28,764
Total real estate		116,868		106,516
Consumer		2,138		2,398
Total	$	140,601	$	133,230

10

NOTE 6 – LOANS (CONTINUED)

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

	Three Months						Six Months
	Ended June 30,						Ended June 30,
	2006			2005			2006			2005
Balance – Beginning of period	$	2,118		$	1,363		$	1,930		$	1,280
Provision charged to operations		534			260			1,366			355
Charge-offs		(1,115	)		(117	)		(1,766	)		(130	)
Recoveries		23			—			30			1
Balance – End of period	$	1,560		$	1,506		$	1,560		$	1,506
Allowance for loan losses to total Loans		1.12	%		1.16	%		1.12	%		1.16	%

NOTE 7 — DEPOSITS

Deposits are summarized as follows (dollars in thousands):

	June 30,
	2006		December 31,
	(Unaudited)		2005
Non-interest bearing demand deposit accounts	$	25,656	$	23,633
Interest-bearing demand deposit accounts		5,515		5,981
Savings accounts		4,663		4,730
Money market accounts		57,255		60,179
Certificates of deposit		84,458		66,809
Total deposits	$	177,547	$	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 June 30, 2006 and December 31, 2005. The weighted average interest rate at June 30, 2006 and December 31, 2005 is 4.35%. Maturity dates range from November 2006 to October 2010. The weighted average remaining maturity at June 30, 2006 is 782 days, or August 20, 2008. Advances from the FHLB are collateralized by qualifying investment securities with estimated market values of $11,231,000 and $12,210,000 at June 30, 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.

11

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 June 30, 2006 and December 31, 2005.

The Banks’ and Corporation’s actual capital amounts and ratios as of June 30, 2006 and December 31, 2005 are presented in the following table (dollars in thousands):

					For Capital				To be
	Actual				Adequacy Purposes				Well-Capitalized
			Ratio				Ratio				Ratio
	Amount		(Percent)		Amount		(Percent)		Amount		(Percent)
As of June 30, 2006:
Total risk-based capital (to risk weighted assets)
CSB	$	15,097		10.19	$	11,849		8.00	$	14,811		10.00
HVSB		7,568		75.78		799		8.00		999		10.00
Consolidated		20,810		13.09		12,718		8.00		15,898		10.00
Tier I Capital (to risk weighted assets)
CSB	$	13,609		9.19	$	5,925		4.00	$	8,887		6.00
HVSB		7,496		75.06		399		4.00		559		6.00
Consolidated		19,250		12.11		6,359		4.00		9,539		6.00
Tier I Capital (to average assets)
CSB	$	13,609		7.28	$	7,479		4.00	$	9,348		5.00
HVSB		7,496		40.40		742		4.00		928		5.00
Consolidated		19,250		9.46		8,136		4.00		10,170		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

12

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 June 30, 2006 and December 31, 2005, the following financial instruments were outstanding whose contract amounts represent credit risk (dollars in thousands):

	June 30, 2006
	(Unaudited)		December 31, 2005
Commitments to grant loans	$	11,585	$	6,902
Unfunded commitments under lines of credit		22,887		18,649
Commercial and standby letters of credit		211		169

NOTE 11 – RECENT ACCOUNTING PRONOUNCEMENTS

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. Adoption of this statement is not expected to have a material effect on results of operations or financial condition of the Company.

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets- an amendment of FASB Statement No. 140 . SFAS No.156 requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in specific situations. Additionally, the servicing asset or servicing liability shall be initially measured at fair value; however, an entity may elect the “amortization method” or “fair value method” for subsequent balance sheet reporting periods. SFAS No.156 is effective as of an entity’s first fiscal year beginning after September 15, 2006. Early adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including interim financial statements, for any period of that fiscal year. Adoption of this statement is not expected to have a material effect on results of operations or financial condition of the Company.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation requires that the Company recognize in the financial statements, the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. The provisions of FIN 48 are effective as of the beginning of our 2007 fiscal year, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. The Company is currently evaluating the impact of adopting FIN 48 on its financial statements.

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.

14

The principal markets for financial services provided are in the 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.

Our principal source of revenue is interest and fees on loans. On a consolidated basis, interest and fees on loans accounted for 76.1% of total revenue year to date in 2006 compared to 77.0% year to date in 2005. The share of total revenue from interest and fees on loans decreased in the current year as a result of slower growth in the loan portfolio resulting in elevated federal funds sold. Revenue share of interest from investments (including Federal Funds sold), increased to 18.0%, from 14.3% year over year. Noninterest income in total declined from 8.7% to 5.9% in 2006 and 2005, respectively. The decrease in noninterest income’s share of revenue is due primarily to decreased deposit service charges and fees, and to a lesser extent decreased mortgage loan sales volume.

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 June 30, 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 valuation of the allowance for loan losses, income taxes and stock-based compensation.

Comparison of Financial Condition at June 30, 2006 and December 31, 2005

     Our total assets increased by $15.6 million or 8.0% to $211.2 million at June 30, 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 $20.0 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, increased $7.9 million or 97.5% to $16.0 million at June 30, 2006 from $8.1 million at December 31, 2005. This increase is due to loan growth lagging deposit growth at both banks and the maintenance of the excess funds being kept liquid in anticipation of redeployment into the loan portfolios.

     Securities decreased $1.0 million or 2.0% to $48.0 million at June 30, 2006 from $49.0 million at December 31, 2005. The decrease in securities was due primarily to principal paydowns on mortgage backed securities. 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 value of these securities have not been written down as of June 30, 2006.

     Total portfolio loans increased by $7.4 million or 5.6% to $140.6 million at June 30, 2006 from $133.2 million at December 31, 2005. This growth rate is slightly behind our business plan and a similar, rate is expected to continue throughout 2006. The difficult economic climate in Michigan, staffing issues and competitive pressures in the banks’ contiguous markets has created a challenging environment in which to make loans. Approximately $4.0 million of the growth was from Huron Valley State Bank.

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Total loan growth continues to be driven by the commercial real estate portfolio which increased $13.8 million, or 22.0% over the balance at December 31, 2005. This large increase was partially offset by a $4.5 million, or 15.6% decrease in the construction portfolio and a $2.7 million, or 11.1% decrease in the commercial and industrial portfolio. The decrease in the commercial and industrial portfolio was caused primarily by charge-offs of approximately $400,000 and the paydown or payoff of a number of larger credits. The residential real estate portfolio contributed positively showing a 6.7%, or $1.0 million increase from December 31, 2005. There was a slight decrease in consumer loans from December 31, 2005. The banks continue to focus on real estate lending, evidenced by the fact that 83.2% of the loan portfolio is secured by some type of real estate. Management views that this is prudent at the current time given the uncertainty of the local economy, especially as it relates to small businesses.

The nonperforming loan balance shown below as of June 30, 2006 is made up of 9 relationships, a reduction of 7 relationships compared to the prior quarter. One of the previously non-performing credits ($50,000) was sold to a third party at a slight discount, 2 were paid off in full (totaling $505,000) and 3 were brought current by the borrowers (totaling $1.1 million). In addition, 8 credits totaling $1.1 million were charged off in the current quarter, 4 of which (totaling $1.0 million) had previously been reported as non-performing. Of the loans charged-off, management expects to realize significant recoveries at some point in the future on 2 of them. However, during the recent regulatory examination it was determined that these credits need to be charged-off due to being greater than 180 days past due without sufficient collateral coverage, pursuant to the Michigan bad debt statute. These loans made up approximately 60% of the charge-offs taken in the current quarter, and have significant guarantors for at least a portion of the debt. The Corporation has received a summary judgment against the guarantors in one of the two loans and the guarantors have inquired about settling the matter and dropping their appeal. The partial guarantor on the other credit has reaffirmed his position and has since made significant paydowns of the debt. An extensive loan review, performed by an independent consultant, of the commercial portfolio is currently in process. Management anticipates completion of this review during the 3^rd quarter of the year. In addition, the credit policy has been completely rewritten to address shortfalls that may have contributed to previous credit problems. A reorganization of the lending area is also in process, whereby the credit function will be separated and centrally managed at the Holding Company level for both subsidiary institutions. The new structure will allow the Corporation to better manage it’s credit risk.

During the quarter, the Bank experienced a significant decrease (43.2%) in nonperforming loans. Only one new credit appeared in the nonperforming portfolio in the current quarter, and it is secured by residential real estate. Two credits migrated from greater than 90 past due and still accruing to nonaccrual, totaling $650,000. In accordance with our policy, loans that are well secured and in the process of collection are not put on non-accrual status. 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.

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

	June 30,			December 31,
	2006			2005
	(unaudited)
(dollars in thousands)
Nonaccrual loans
Secured by real estate	$	677		$	1,066
Secured by other than real estate		239			—
Loans 90 days past due and still accruing
Secured by real estate		221			989
Secured by other than real estate		270			424
Total nonperforming loans		1,407			2,479
Foreclosed and repossessed assets		182			205
Total nonperforming assets	$	1,589		$	2,684
Nonperforming assets to total loans		1.13	%		2.01	%
Nonperforming assets to total assets		0.75	%		1.37	%

     The allowance for loan losses as of June 30, 2006 was $1.6 million representing approximately 1.12% of total loans outstanding, compared to $1.9 million, or 1.45% of loans outstanding as of December 31, 2005. The charge-off of loans which had previously been reserved for was the primary cause of the decrease in the allowance balance. 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 $900,000, or 23.1% to $4.8 million at June 30, 2006 from $3.9 million at December 31, 2005. This increase is due to the purchase of the building from which

17

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.

     The deferred tax asset increased $200,000, or 22.2% to $1.1 million at June 30, 2006, from $850,000 at December 31, 2005. This increase is primarily due to further increase in the unrealized loss on investment securities.

     Total deposit balances increased $16.2 million or 10.0% to $177.5 million at June 30, 2006 from $161.3 million at December 31, 2005. The largest increase in terms of percentage was seen in time deposits which increased 26.5%, or $17.7 million since December 31, 2005. This increase was offset by a $2.9 million, or 4.8% decrease in the money market portfolio. Demand and other savings accounts saw a solid 5.4% increase from $29.6 million at December 31, 2005 to $31.2 million at June 30, 2006. Approximately $2.0 million of the growth in money market balances and $3.0 million of the growth in demand deposit balances is known by management to be funds that will be very short-term in nature. Additionally, the Corporation utilized the wholesale funding market for the 1^st time during the 2^nd quarter, purchasing $5.0 million in brokered time deposits to payoff federal funds that were purchased during the quarter. The local market for 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. When time deposit funding is needed, management feels that the total cost of wholesale funds is less than what would be required to raise a similar level of funds through retail outlets. Additionally, as noted above, we would prefer that the branch staff remain focused on gathering and servicing lower cost non-time deposits, rather than opening a large quantity of certificates. Overall, we feel that the transition to utilizing the wholesale market will contribute positively to the margin given sound execution of the other aspects of the funding plan. A renewed focus on our Waterford market along with growth in the Milford market by HVSB will also assist us in meeting our deposit gathering goals.

     CSB is a member of the Federal Home Loan Bank of Indianapolis, and utilizes advances from this institution to bolster liquidity. At June 30, 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 June 30, 2006, we had retained earnings of $3.1 million compared to $3.6 million at December 31, 2005 which was the result of a net loss of $552,000. Accumulated other comprehensive income saw a decrease of $600,000, or 85.7%. 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 June 30, 2006 and 2005

     Our net loss was $198,000, or $0.16 per diluted share for the second quarter of 2006 compared to net income of $116,000, or $0.11 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.

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     Net interest income increased 8.6% or $131,000 from $1.53 million in the first quarter of 2005 to $1.66 million for 2006. The primary contributor to the increase was elevated balances in earning assets, which increased by 15.0% to $191.9 million at June 30, 2006 from $166.9 million at June 30, 2005. This effectively added $364,000 to the margin. This growth in earning assets was funded mostly by interest bearing deposits, which increased by 16.5%, or $19.8 million. The majority of this growth was in time deposits which grew $16.4 million, or 29.6%. Growth in loans provided almost 50% of the increase in earning assets, with increases in securities (primarily at HVSB) and fed funds sold providing the remainder of the increase. Increasing rates reduced net interest income by $41,000, as the cost of interest bearing funds increased 82 basis points, while the yield on earning assets only increased by only 42 basis points. The $800,000 increase in average non-interest bearing deposits also helped the margin in the current quarter. Additionally, the interaction of changes in rates and portfolio mixes caused a $26,000 decrease in net interest income. The net interest margin decreased from 3.66% for the quarter ended June 30, 2005 to 3.46% for the same period in 2006. As mentioned above, management is developing a strategy to generate additional demand deposit account volume to reduce our reliance on higher cost time and other savings accounts.

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 June 30, 2006								3 Months ended June 30, 2005
	Average					Yield/			Average					Yield/
	Balance			Interest		Cost			Balance			Interest		Cost
Assets:
Short term investment	$	6,287		$	89		5.66	%	$	3,982		$	37		3.72	%
Securities:
Taxable		40,093			446		4.45	%		29,847			303		4.06	%
Tax-exempt		10,663			87		3.26	%		11,116			74		2.66	%
Loans		134,866			2,698		8.00	%		121,968			2,285		7.49	%
Total earning assets/total interest income		191,909			3,320		6.92	%		166,912			2,699		6.47	%
Cash and due from banks		3,909								3,684
Unrealized (loss) on AFS securities		(1,242	)							(462	)
Allowance for loan loss		(1,949	)							(1,346	)
All other assets		6,801								4,345
Total assets		199,429								173,133
Liabilities and Stockholders’ Equity
Interest bearing deposits:
MMDA, Savings/NOW accounts		68,042			538		3.16	%		64,633			491		3.04	%
Time		71,891			894		4.98	%		55,458			506		3.65	%
Fed Funds Purchased		2,611			33		4.99	%		1,046			4		1.68	%
FHLB Advances		10,200			112		4.39	%		12,200			107		3.50	%
Trust Preferred Securities		4,000			82		8.24	%		4,000			62		6.18	%
Other borrowings		18			1		22.86	%		8			—		0.00	%
Total interest bearing liabilities/interest expense		156,761			1,660		4.23	%		137,344			1,170		3.41	%
Noninterest bearing deposits		23,022								22,202
All other liabilities		4,658								1,281
Stockholders’ Equity:
Unrealized holding (loss)		(833	)							(294	)
Common Stock, Surplus, Retained Earnings		15,820								12,601
Total liabilities and stockholders’ equity		199,429								173,133
Interest spread					1,660		2.69	%					1,529		3.06	%
Net Interest Margin as a Percentage of Average
Earnings Assets – FTE		191,909			1,660		3.46	%		166,912			1,529		3.66	%

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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			Change			Change
		Due to			Due to			Due to			Total
		Rate			Volume			Mix			Change
	(Dollars in thousands)
Short term investment	$	19		$	21		$	12		$	52
Investment securities – taxable		29			104			10			143
Investment securities – tax exempt		17			(3	)		(1	)		13
Loans, net of unearned income		155			242			16			413
Total interest income		220			364			37			621
Interest bearing deposits		204			176			55			435
Federal funds borrowed		9			7			12			28
FHLB advances		27			(17	)		(5	)		5
Trust preferred securities		21			—			—			21
Other borrowings		—			—			1			1
Total interest expense		261			166			63			490
Net interest income	$	(41	)	$	198		$	(26	)	$	131

     Total provision for loan losses was $534,000 for the second quarter ended June 30, 2006, compared to $260,000 for the second quarter of 2005. The majority of the provision for loan loss in the current quarter is due to the aforementioned charge-offs mandated by the Banks’ regulators to conform to state banking law. In addition, the higher level of charge-offs relative to the Corporation’s history have adversely affected the Corporation’s historical loss ratios 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 June 30, 2006. Bank management is continuing to evaluate the financial condition of the borrowers and the value of the collateral.

     Non-interest income decreased $87,000, or 34.4% 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 fees on deposit accounts, which decreased $67,000, or 30.3% relative to the same quarter in the prior year. This decrease is due in part to the second quarter of 2005 being higher than normal due to a small number of customers. Management at the Bank subsidiaries has actively worked with the customers who were habitually overdrawing their accounts to either help them better manage their funds or help them to find another bank because management feels that the reduction in credit risk is worth the reduction in deposit (primarily NSF) fees. 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.

     Non-interest expense was $1.7 million for the first quarter of 2006, a $300,000 or 21.4% increase over the first quarter of 2005 when non-interest expense was $1.4 million. The fact that HVSB is now

20

operating as a fully staffed bank is the primary cause of the increase in operating expenses, with the exception of professional fees, which increased $46,000, or 62.2% over the second quarter of 2005, mostly due to expenses related to collecting on troubled credits. Salary and benefit costs increased $56,000, or 7.2%. Occupancy expense has increased $79,000, or 39.3% as a result of HVSB and additional real estate taxes related to CSB’s newest branch. The increases seen in advertising, supplies and outside processing can be attributed to the addition of HVSB. 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 June 30, 2006 increased to 91.0% from 78.3% at June 30, 2005.

Comparison of Operating Results for the Six Months Ended June 30, 2006 and 2005

     Our net loss was $552,000, or $0.44 per diluted share for the six months ended June 30, 2006 compared to net income of $295,000, or $0.27 per diluted share for the same period in 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.

     Net interest income increased 6.7% or $200,000 from $3.0 million in six months ended June 30, 2005 to $3.2 million for 2006. The primary contributor to the increase was elevated balances in earning assets, which increased by 14.9% to $194.3 million at June 30, 2006 from $169.1 million at June 30, 2005. This effectively added $674,000 to the margin. This increase in earning assets was funded primarily with interest bearing deposits which increased $20.6 million, or 16.9%, effectively reducing the margin by $351,000. The majority of this increase was in time deposits, which grew $18.5 million, or 33.1%. Growth in loans provided almost 50% of the increase in earning assets, with increases in securities (primarily at HVSB) and fed funds sold providing the remainder of the increase. Increasing rates reduced net interest income by $115,000, as the cost of interest bearing funds increased 77 basis points, while the yield on earning assets only increased by only 37 basis points. Additionally, the interaction of changes in rates and portfolio mixes caused a $17,000 decrease in net interest income. The net interest margin decreased from 3.56% for the six months ended June 30, 2005 to 3.30% for the same period in 2006. As mentioned above, management is developing 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):

	6 Months ended June 30, 2006								6 Months ended June 30, 2005
	Average					Yield/			Average					Yield/
	Balance			Interest		Cost			Balance			Interest		Cost
Assets:
Short term investment	$	6,398		$	156		4.88	%	$	3,982		$	54		2.61	%
Securities:
Taxable		40,471			883		4.36	%		29,847			591		3.93	%
Tax-exempt		10,657			174		3.27	%		11,116			168		3.20	%
Loans		136,783			5,123		7.49	%		121,968			4,386		7.05	%
Total earning assets/total interest income		194,309			6,336		6.52	%		166,912			5,199		6.15	%
Cash and due from banks		3,785								3,819
Unrealized (loss) on AFS securities		(1,376	)							(492	)
Allowance for loan loss		(1,975	)							(1,363	)
All other assets		7,043								4,874
Total assets		201,786								175,932
Liabilities and Stockholders’ Equity
Interest bearing deposits:
MMDA, Savings/NOW accounts		67,805			1,064		3.14	%		65,711			900		2,74	%
Time		74,437			1,618		4.35	%		55,882			971		3.48	%
Fed Funds Purchased		2,539			64		5.04	%		881			12		2.72	%
FHLB Advances		10,200			223		4.37	%		12,200			189		3.10	%
Trust Preferred Securities		4,000			157		7.85	%		4,000			117		5.85	%
Other borrowings		15			1		13.33	%		—			—		0.00	%
Total interest bearing liabilities/interest expense		158,996			3,127		3.93	%		138,674			2,189		3.16	%
Noninterest bearing deposits		23,282								23,331
All other liabilities		4,682								1,607
Stockholders’ Equity:
Unrealized holding (loss)		(934	)							(318	)
Common Stock, Surplus, Retained Earnings		15,760								12,638
Total liabilities and stockholders’ equity		201,786								175,932
Interest spread					3,209		2.59	%					3,010		2.99	%
Net Interest Margin as a Percentage of Average
Earnings Assets – FTE		194,309			3,209		3.30	%		169,094			3,010		3.56	%

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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			Change			Change
	Due to			Due to			Due to			Total
	Rate			Volume			Mix			Change
	(Dollars in thousands)
Short term investment	$	47		$	30		$	25		$	102
Investment securities – taxable		64			205			23			292
Investment securities – tax exempt		3			3			—			6
Loans, net of unearned income		274			436			27			737
Total interest income		388			674			75			1,137
Interest bearing deposits		375			351			85			811
Federal funds borrowed		10			23			19			52
FHLB advances		78			(31	)		(13	)		34
Trust preferred securities		40			—			—			40
Other borrowings		—			—			1			1
Total interest expense		503			343			92			938
Net interest income	$	(115	)	$	331		$	(17	)	$	199

     Total provision for loan losses was $1.4 million for the six months ended June 30, 2006, compared to $400,000 for the same period in 2005. The majority of the provision for loan loss is due to the aforementioned charge-offs mandated by the Banks’ regulators to conform to state banking law and two large charge-offs taken in the first quarter. In addition, the higher level of charge-offs relative to the Corporation’s history have adversely affected the Corporation’s historical loss ratios 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 June 30, 2006. Bank management is continuing to evaluate the financial condition of the borrowers and the value of the collateral.

     Non-interest income decreased $104,000, or 20.9% for the six months ended June 30, 2006 compared to the same period in 2005. The largest portion of the change in non-interest income was due to reduced fees on deposit accounts, which decreased $58,000, or 14.1% relative to the same quarter in the prior year. This decrease is due in part to the second quarter of 2005 being higher than normal due to a small number of customers. Management at the Bank subsidiaries has actively worked with the customers who were habitually overdrawing their accounts to either help them better manage their funds or help them to find another bank. Management feels that the reduction in credit risk is worth the reduction in deposit (primarily NSF) fees. 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. Reduced gains on sales of mortgage loans also contributed to the decrease in non-interest income, falling 54.7%, to $34,000 for the six months ended June 30, 2006 compared to $75,000 for the same period in 2005. Local real estate market conditions are very poor contributing to

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very low purchase business, and long-term rates are still above those seen in the preceding few years reducing chances for refinance business. Management hopes that as local market conditions stabilize and the steady climb in rates ends that this volume will pick up providing more opportunities for fee income.

     Non-interest expense was $3.2 million for the six months ended June 30, 2006, a $500,000 or 18.5% increase over the six months ended June 30, 2005 when non-interest expense was $2.7 million. The fact that HVSB is now operating as a fully staffed bank is the primary cause of the increase in operating expenses, with the exception of professional fees, which increased $86,000, or 51.2% over the 2005, mostly due to expenses related to collecting on troubled credits. Salary and benefit costs increased $100,000, or 6.7%. Occupancy expense has increased $150,000, or 39.1% as a result of HVSB and additional real estate taxes related to CSB’s newest branch. The increases seen in advertising, supplies and outside processing can be attributed to the addition of HVSB. 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 six months ended June 30, 2006 increased to 88.7% from 78.3% at June 30, 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.

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Capital Resources at June 30, 2006 (in thousands)

	Tier 1
	Leverage			Tier 1			Total Risk-Based
	Ratio			Capital Ratio			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		7.28	%		9.19	%		10.19	%
HVSB		40.40	%		75.06	%		75.78	%
Consolidated		9.46	%		12.11	%		13.09	%

     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:

					Total
	Tier 1		Tier 1		Risk-Based
	Leverage		Capital		Capital
	(in thousands of dollars)
Capital balances at June 30, 2006
Required regulatory capital	$	8,136	$	6,359	$	12,718
Capital in excess of regulatory minimums		11,114		12,891		8,092
Actual capital balances	$	19,250	$	19,250	$	20,810

     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 six months ended June 30, 2006, operating activities generated $2.0 million. Normal operations were the primary generator of cash in the current year, notwithstanding the large provision for loan loss. In addition, deposit generation and security sales provided $16.2 million and $3.2 million in cash to our operation. The primary uses of funds in the current year were loan originations of $9.1 million, purchases of securities of $3.2 million and the purchase of our corporate office location of $1.0 million.

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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 1A. Risk Factors

          As of June 30, 2006, there have been no material changes in the discussion pertaining to risk factors as disclosed in the Company’s Form 10-K for the year ended December 31, 2005.

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

The annual meeting was held on May 2, 2006. At the meeting, two directors were elected, each for a three year term. The votes were as follows:

		Vote
Director Nominee:	Term Expires	For:	Withheld:
Bruce McIntyre	2009	1,100,407	39,592
Mark Murvay	2009	1,100,407	39,592

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 June 30, 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: August 10, 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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