MBT Financial (MBTF) 10-K 2013 FY Annual report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year endedDecember 31, 2013

Commission File Number:000-30973

MBT FINANCIAL CORP.

(Exact Name of Registrant as Specified in its Charter)

MICHIGAN	38-3516922
(State of Incorporation)	(I.R.S. Employer Identification No.)
102 E. Front St.
Monroe, Michigan	48161
(Address of Principal Executive Offices)	(Zip Code)

(734) 241-3431

(Registrant’s Telephone Number, Including Area Code)

None

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to section 12(b) of the Act: Common Stock, No Par Value, Registered on NASDAQ Global Select Market

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

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES¨NOþ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.YES¨NOþ

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.YESþNO¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YESþNO¨

Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, indefinitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any of the amendments of this Form 10-K.¨

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

Large accelerated filer¨           Accelerated filer¨           Non-accelerated filer¨           Smaller reporting companyþ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).YES¨NOþ

As of June 30, 2013, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $65.9 million based on the closing sale price as reported on the NASDAQ Global Select system.

As of March 14, 2014, there were 21,263,584 shares of the registrant’s common stock, no par value, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the 2014 Annual Meeting of Shareholders of MBT Financial Corp. to be held on May 1, 2014 are incorporated by reference in this Form 10-K in response to Part III, Items 10, 11, 12, 13, and 14.

 

Special Note regarding Forward Looking Information

This document, including the documents that are incorporated by reference, contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Exchange Act (the “Exchange Act”). You can identify forward-looking statements by words or phrases such as “will likely result,” “may,” “are expected to,” “predict,” “is anticipated,” “estimate,” “forecast,” “projected,” “future,” “intends to,” or may include other similar words or phrases such as “believes,” “plans,” “trend,” “objective,” “continue,” “remain,” or similar expressions, or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “may,” “hope,” “can,” “predict,” “potential,” “continue,” or similar verbs, or the negative of those terms or other words of similar meaning. You should read statements that contain these words carefully because they discuss our future expectations or state other “forward-looking” information. We believe that it is important to communicate our future expectations to our investors. Such forward-looking statements may relate to our financial condition, results of operations, plans, objectives, future performance, or business and are based upon the beliefs and assumptions of our management and the information available to our management at the time these disclosures are prepared. These forward-looking statements involve risks and uncertainties that we may not be able to accurately predict or control and our actual results may differ materially from the expectations we describe in our forward-looking statements. Shareholders should be aware that the occurrence of certain events could have an adverse effect on our business, results of operations, and financial condition. These events, many of which are beyond our control, include the following:

· general economic conditions and weakening in the economy, specifically the real estate market, either nationally or in Michigan;

· potential limitations on our ability to access and rely on wholesale funding sources;

· changes in accounting principles, policies, and guidelines applicable to bank holding companies and the financial services industry;

· fluctuation of our stock price;

· ability to attract and retain key personnel;

· ability to receive dividends from our subsidiaries;

· operating, legal, and regulatory risks, including risks relating to further deteriorations in credit quality, our allowance for loan losses, potential losses on dispositions of non-performing assets, and impairment of goodwill;

· the use of estimates in determining fair value of certain of our assets, which estimates may prove to be incorrect and result in significant declines in valuation;

· legislative or regulatory changes that adversely affect our business including changes in regulatory policies and principles, including the interpretation of regulatory capital or other rules;

· the results of examinations of us by the Federal Reserve and our bank subsidiary by the Federal Deposit Insurance Corporation, or other regulatory authorities, who could require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings;

· compliance with regulatory enforcement actions, including the Consent Order, legislative or regulatory changes that adversely affect our business, including changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules;

· the availability of resources to address changes in laws, rules, or regulations or to respond to regulatory actions; adverse changes in the securities markets;

· economic, political, and competitive forces affecting our banking, securities, asset management, insurance, and credit services businesses;

· the impact on net interest income from changes in monetary policy and general economic conditions; and

· the risk that our analyses of these risks and forces could be incorrect and/or that the strategies developed to address them could be unsuccessful.

Other factors not currently anticipated may also materially and adversely affect our results of operations, cash flows, financial position, and prospects. We cannot assure you that our future results will meet expectations. While we believe the forward-looking statements in this report and the information incorporated herein by reference are reasonable, you should not place undue reliance on any forward-looking statement. The forward-looking statements contained or incorporated by reference in this document relate only to circumstances as of the date on which the statements are made. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

 

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Part I

Item 1.Business

General

MBT Financial Corp. (the “Corporation” or the “Company”) is a bank holding company as defined by the Bank Holding Company Act of 1956, as amended (the “BHCA”) headquartered in Monroe, Michigan. It was incorporated under the laws of the State of Michigan in January 2000, at the direction of the management of Monroe Bank & Trust (the “Bank”), for the purpose of becoming a bank holding company by acquiring all the outstanding shares of Monroe Bank & Trust.

Monroe Bank & Trust was incorporated and chartered as Monroe State Savings Bank under the laws of the State of Michigan in 1905.In 1940, Monroe Bank & Trust consolidated with Dansard Bank and moved to the present address of its main office. Monroe Bank & Trust operated as a unit bank until 1950 when it opened its first branch office in Ida, Michigan.It then continued its expansion to its present total of 24 branch offices, including its main office.Monroe Bank & Trust changed its name from "Monroe State Savings Bank" to "Monroe Bank & Trust" in 1968.

Monroe Bank & Trust provides customary retail and commercial banking and trust services to its customers, including checking and savings accounts, time deposits, safe deposit facilities, commercial loans, personal loans, real estate mortgage loans, installment loans, IRAs, ATM and night depository facilities, treasury management services, telephone and internet banking, personal trust, employee benefit and investment management services. Monroe Bank & Trust’s service areas are comprised of Monroe and Wayne counties in Southern Michigan.

Monroe Bank & Trust's deposits are insured by the Federal Deposit Insurance Corporation ("FDIC") to applicable legal limits and Monroe Bank & Trustis supervised and regulated by the FDIC and Michigan Office of Financial and Insurance Regulation.

Competition

MBT Financial Corp., through its subsidiary, Monroe Bank & Trust, operates in a highly competitive industry.Monroe Bank & Trust's main competition comes from other commercial banks, national or state savings and loan institutions, credit unions, securities brokers, mortgage bankers, finance companies and insurance companies.Banks generally compete with other financial institutions through the banking products and services offered, the pricing of services, the level of service provided, the convenience and availability of services, and the degree of expertise and personal manner in which these services are offered.Monroe Bank & Trust encounters strong competition from most of the financial institutions in Monroe Bank & Trust's extended market area.

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The Bank’s primary market area is Monroe County, Michigan. According to the most recent market data, there are ten deposit taking/lending institutions competing in the Bank’s market. According to the most recent FDIC Summary of Deposits, the Bank ranks first in market share in Monroe County with 50.31% of the market. In 2001, the Bank began expanding into Wayne County, Michigan, and currently ranks thirteenth out of twenty-seven institutions operating in Wayne County with a market share of 0.35%. For the combined Monroe and Wayne County market, the Bank ranks sixth of twenty-eight institutions with a market share of 2.41%.

Supervision and Regulation

General

As a bank holding company, we are required by federal law to file reports with, and otherwise comply with, the rules and regulations of the Board of Governors of the Federal Reserve System (“Federal Reserve” or “Federal Reserve Board.”) The Bank is a Michigan state chartered commercial bank and is not a member of the Federal Reserve, and therefore, is regulated and supervised by the Commissioner of the Michigan Department of Insurance and Financial Services (“Michigan DIFS”) and the Federal Deposit Insurance Corporation (“FDIC”).The Michigan DIFS and the FDIC conduct periodic examinations of the Bank.The Bank is also a member of the Federal Home Loan Bank of Indianapolis (“FHLBI”) and subject to its regulations.The deposits of the Bank are insured under the provisions of the Federal Deposit Insurance Act by the FDIC to the fullest extent provided by law. The Corporation is also subject to regulation by the Securities and Exchange Commission (the “SEC”) by virtue of its status as a public company.

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The system of supervision and regulation applicable to the Corporation establishes a comprehensive framework for its operations and is intended primarily for the protection of the FDIC's Deposit Insurance Fund (“DIF”), the Bank's depositors and the public, rather than the Corporation’s shareholders and creditors.Changes in the regulatory framework, including changes in statutes, regulations and the agencies that administer those laws, could have a material adverse impact on the Corporation and its operations.

The federal and state laws and regulations that are applicable to banks and to some extent bank holding companies regulate, among other matters, the scope of their business, their activities, their investments, their reserves against deposits, the timing of the availability of deposited funds, the amount of loans to individual and related borrowers and the nature, amount of and collateral for certain loans, and the amount of interest that may be charged on loans. Various federal and state consumer laws and regulations also affect the services provided to consumers.

The Corporation and/or its subsidiary are required to file various reports with, and is subject to examination by regulators, including the FRB, the FDIC and DIFS. The FRB, FDIC and DIFS have the authority to issue orders to bank holding companies and/or banks to cease and desist from certain banking practices and violations of conditions imposed by, or violations of agreements with, the FRB, FDIC and DIFS. Certain of the Corporation's and/or its banking subsidiary regulators are also empowered to assess civil money penalties against companies or individuals in certain situations, such as when there is a violation of a law or regulation. Applicable state and federal law also grant certain regulators the authority to impose additional requirements and restrictions on the activities of the Corporation and or its banking subsidiary and, in some situations, the imposition of such additional requirements and restrictions will not be publicly available information.

Recent Regulatory Enforcement Actions

On July 12, 2010, the Bank entered into a stipulation and consent to the issuance of a consent order (the “Consent Order”) with the FDIC and the Michigan DIFS. The Consent Order became effective July 22, 2010 and requires the following:

· The Bank must increase its Tier 1 Leverage ratio to a minimum of 8.0 percent and its Total Risk Based Capital ratio to a minimum of 11 percent within 90 days of the effective date of the Consent Order.

· The Bank must increase its Tier 1 Leverage ratio to a minimum of 9.0 percent and its Total Risk Based Capital ratio to a minimum of 12 percent within 180 days of the effective date of the Consent Order.

· The Bank must charge off any loans classified as “Loss” in the Report of Examination (“ROE”) dated October 26, 2009. The Bank completed this prior to December 31, 2009.

· The Bank may not extend additional credit to any borrower who has uncollected debt to the Bank that has been charged off or is classified as “Loss” in the ROE.

· The Bank may not extend additional credit to any borrower who has uncollected debt to the Bank that is classified as “Substandard” or “Doubtful” in the ROE without prior approval of the Bank’s board of directors.

· The Bank is required to adopt a written plan to reduce the Bank’s risk position in each asset in excess of $1,000,000 which is more than 90 days delinquent or classified “Substandard” or “Doubtful” in the ROE.

· The Bank may not declare or pay any dividend without the prior written consent of the Regional Director of the FDIC and the Chief Deputy Commissioner of DIFS.

· Prior to the submission of all Reports of Condition and Income required by the FDIC, the Bank’s board must review the adequacy of the allowance for loan and lease losses.

· Within 60 days of the effective date of the Consent Order, the Bank is to adopt a written profit plan and comprehensive budget for 2010 and 2011.

· The Bank is required to provide its shareholder with a copy of the Consent Order. The Bank’s sole shareholder is the Registrant.

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· Within 30 days of the effective date of the Consent Order, the Bank’s board of directors shall have in place a program for monitoring compliance with the Consent Order.

· While the Consent Order is in effect, the Bank shall furnish quarterly progress reports detailing the actions taken to secure compliance with the Consent Order and the results thereof to the FDIC and DIFS.

As of December 31, 2013, the Bank has achieved all of the requirements of the Consent Order except for the Tier 1 Leverage ratio target. A failure to achieve and maintain the capital ratio targets referred to in the Consent Order may result in further adverse regulatory actions, including the imposition of additional restrictions under the FDIC’s Prompt Corrective Action regulations.

Regulatory Reform

Congress, U.S. Department of the Treasury (“Treasury”), and the federal banking regulators, including the FDIC, have taken broad action since early September 2008 to address volatility in the U.S. banking system and financial markets.Beginning in late 2008, the U.S. and global financial markets experienced deterioration of the worldwide credit markets, which created significant challenges for financial institutions both in the United States and around the world. Dramatic declines in the housing market in 2009 and 2010, marked by falling home prices and increasing levels of mortgage foreclosures, resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. In addition, many lenders and institutional investors reduced and, in some cases, ceased to provide funding to borrowers, including other financial institutions, as a result of concern about the stability of the financial markets and the strength of counterparties.

In response to the financial market crisis and continuing economic uncertainty, the United States government, specifically the Treasury, the Federal Reserve Board and the FDIC working in cooperation with foreign governments and other central banks, took a variety of extraordinary measures designed to restore confidence in the financial markets and to strengthen financial institutions, including measures available under the Emergency Economic Stabilization Act of 2008(“EESA”), as amended by the American Recovery and Reinvestment Act of 2009 (“ARRA”), which included the Troubled Asset Relief Program (“TARP”).The stated purpose of TARP was to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other. As part of TARP, Treasury purchased debt or equity securities from participatingfinancial institutions through the Treasury’s Capital Purchase Plan (“CPP”).Participants in the CPP are subject to various restrictions regarding dividends, stock repurchases, corporate governance and executive compensation. We withdrew our application to participate in the program before it was determined whether or not we would be allowed to participate and, therefore, we are not subject to the restrictions imposed on CPP participants.

EESA also temporarily increased FDIC deposit insurance on most accounts from $100,000 to $250,000. This increase became permanent at the end of 2010 under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”).Following a systemic risk determination, on October 14, 2008, the FDIC established a Temporary Liquidity Guarantee Program (“TLGP”).Under the Transaction Account Guarantee Program of the TLGP, the FDIC temporarily provided a 100% guarantee of the deposits in non-interest-bearing transaction deposit accounts in participating financial institutions. This program ended December 31, 2012 and deposit insurance is now limited to $250,000 on all non-interest bearing transaction accounts.

The Dodd-Frank Act is aimed, in part, at accountability and transparency in the financial system and includes numerous provisions that apply to and/or could impact the Corporation and its banking subsidiary. The Dodd-Frank Act implements changes that, among other things, affect the oversight and supervision of financial institutions, provide for a new resolution procedure for large financial companies, create a new agency responsible for implementing and enforcing compliance with consumer financial laws, introduce more stringent regulatory capital requirements, effect significant changes in the regulation of over the counter derivatives, reform the regulation of credit rating agencies, implement changes to corporate governance and executive compensation practices, incorporate requirements on proprietary trading and investing in certain funds by financial institutions (known as the "Volcker Rule"), require registration of advisers to certain private funds, and effect significant changes in the securitization market. In order to fully implement many provisions of the Dodd-Frank Act, various government agencies, in particular banking and other financial services agencies are required to promulgate regulations. Set forth below is a discussion of some of the major sections the Dodd-Frank Act and implementing regulations that have or could have a substantial impact on the Corporation and its banking subsidiary. Due to the volume of regulations required by the Dodd-Frank Act, not all proposed or final regulations that may have an impact on the Corporation or its banking subsidiary are necessarily discussed.

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Debit Card Interchange Fees

The Dodd-Frank Act provides for a set of new rules requiring that interchange transaction fees for electronic debit transactions be "reasonable" and proportional to certain costs associated withprocessing the transactions. The FRB was given authority to, among other things, establish standards for assessing whether interchange fees are reasonable and proportional. In June 2011, the FRB issued a final rule establishing certain standards and prohibitions pursuant to the Dodd-Frank Act, including establishing standards for debit card interchange fees and allowing for an upward adjustment if the issuer develops and implements policies and procedures reasonably designed to prevent fraud. The provisions regarding debit card interchange fees and the fraud adjustment became effective October 1, 2011. The rules impose requirements on the Corporation and its banking subsidiary and may negatively impact our revenues and results of operations.

Consumer Issues

The Dodd-Frank Act creates a new bureau, the Consumer Financial Protection Bureau (the “CFPB”), which has the authority to implement regulations pursuant to numerous consumer protection laws and has supervisory authority, including the power to conduct examinations and take enforcement actions, with respect to depository institutions with more than $10 billion in consolidated assets. The CFPB also has authority, with respect to consumer financial services to, among other things, restrict unfair, deceptive or abusive acts or practices, enforce laws that prohibit discrimination and unfair treatment and to require certain consumer disclosures.

Corporate Governance

The Dodd-Frank Act clarifies that the SEC may, but is not required to promulgate rules that would require that a company's proxy materials include a nominee for the board of directors submitted by a shareholder. Although the SEC promulgated rules to accomplish this, these rules were invalidated by a federal appeals court decision. The SEC has said that it will not challenge the ruling, but has not ruled out the possibility that new rules could be proposed.The Corporation is presently a “smaller reporting company” as defined by SEC regulations and is therefore exempt from these provisions. The Dodd-Frank Act requires stock exchanges to have rules prohibiting their members from voting securities that they do not beneficially own (unless they have received voting instructions from the beneficial owner) with respect to the election of a member of the board of directors (other than an uncontested election of directors of an investment company registered under the Investment Company Act of 1940), executive compensation or any other significant matter, as determined by the SEC by rule.

Executive Compensation

The Dodd-Frank Act provides for a say on pay for shareholders of all public companies. Under the Dodd-Frank Act, each company must give its shareholders the opportunity to vote on the compensation of its executives at least once every three years. The Dodd-Frank Act also adds disclosure and voting requirements for golden parachute compensation that is payable to named executive officers in connection with sale transactions.

The Dodd-Frank Act requires the SEC to issue rules directing the stock exchanges to prohibit listing classes of equity securities if a company's compensation committee members are not independent. The Dodd-Frank Act also provides that a company's compensation committee may only select a compensation consultant, legal counsel or other advisor after taking into consideration factors to be identified by the SEC that affect the independence of a compensation consultant, legal counsel or other advisor.

The SEC is required under the Dodd-Frank Act to issue rules obligating companies to disclose in proxy materials for annual meetings of shareholders information that shows the relationship between executive compensation actually paid to their named executive officers and their financial performance, taking into account any change in the value of the shares of a company's stock and dividends or distributions.

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The Dodd-Frank Act provides that the SEC must issue rules directing the stock exchanges to prohibit listing any security of a company unless the company develops and implements a policy providing for disclosure of the policy of the company on incentive-based compensation that is based on financial information required to be reported under the securities laws and that, in the event the company is required to prepare an accounting restatement due to the material noncompliance of the company with any financial reporting requirement under the securities laws, the company will recover from any current or former executive officer of the company who received incentive-based compensation during the three-year period preceding the date on which the company is required to prepare the restatement based on the erroneous data, any exceptional compensation above what would have been paid under the restatement.

The Dodd-Frank Act requires the SEC, by rule, to require that each company disclose in the proxy materials for its annual meetings whether an employee or board member is permitted to purchase financial instruments designed to hedge or offset decreases in the market value of equity securities granted as compensation or otherwise held by the employee or board member.

The Corporation is presently a “smaller reporting company” as defined by SEC regulations and is therefore exempt presently from some of the provisions noted above regarding compensation disclosures. As a smaller reporting company, the Company was required to comply with say on pay and say on frequency shareholder proposal requirements beginning with its 2013 Annual Meeting of Shareholders.

Basel III

Internationally, both the Basel Committee on Banking Supervision and the Financial Stability Board (established in April 2009 by the Group of Twenty (“G-20”) Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation and transparency) have committed to raise capital standards and liquidity buffers within the banking system (“Basel III”). On September 12, 2010, the Group of Governors and Heads of Supervision agreed to the calibration and phase-in of the Basel III minimum capital requirements (raising the minimum Tier 1 common equity ratio to 4.5% and minimum Tier 1 equity ratio to 6.0%, with full implementation by January 2015) and introducing a capital conservation buffer of common equity of an additional 2.5% with implementation by January 2019. In July 2013, the Federal Reserve Board released interim final rules regarding implementation of the Basel III regulatory capital rules for U.S. banking organizations. The interim final rules address a significant number of outstanding issues and questions regarding how certain provisions of Basel III are proposed to be adopted in the United States. Key provisions of the proposed rules include the total phase-out from Tier 1 capital of trust preferred securities with grandfathering for bank holding companies with less than $15 billion in assets, a capital conservation buffer of 2.5% above minimum capital ratios, inclusion of accumulated other comprehensive income in Tier 1 common equity, inclusion in Tier 1 capital of perpetual preferred stock, and an effective minimum Tier 1 common equity ratio of 7.0%.

Bank Regulation

Michigan banks are regulated and supervised by the Commissioner of the Michigan DIFS and as a state non-member the Bank is regulated and supervised by the FDIC.Summarized below are some of the more important regulatory and supervisory laws and regulations applicable to the Bank.

Business Activities. The activities of state banks are governed by state as well as federal law and regulations. These laws and regulations delineate the nature and extent of the investments and activities in which state institutions may engage.

Loans to One Borrower. Michigan law provides that a Michigan commercial bank may not provide loans or extensions of credit to a person in excess of 15% of the capital and surplus of the bank. The limit, however, may be increased to 25% of capital and surplus if approval of two-thirds of the Bank’s board of directors is granted. At December 31, 2013, the Bank’s regulatory limit on loans to one borrower was $13.887 million or $23.145 million for loans approved by two-thirds of the Board of Directors. If the Michigan DIFS determines that the interests of a group of more than one person, co-partnership, association or corporation are so interrelated that they should be considered as a unit for the purpose of extending credit, the total loans and extensions of credit to that group are combined. At December 31, 2013, the Bank did not have any loans with one borrower that exceeded its regulatory limit.

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At December 31, 2013, loans that had high loan to value ratios at origination were quantified by management and represented less than 10% of total outstanding loans as of the balance sheet date. Additionally, management quantified all loans (mortgage, consumer and commercial) that required interest only payments as of the balance sheet date and determined that these types of loans were less than 10% of total loans outstanding at December 31, 2013. Based on these facts, management concluded no concentrations of credit risk existed at December 31, 2013.

Dividends.The Corporation’s ability to pay dividends on its common stock depends on its receipt of dividends from the Bank. The Bank is subject to restrictions and limitations in the amount and timing of the dividends it may pay to the Corporation. Dividends may be paid out of a Michigan commercial bank’s net income after deducting all bad debts. A Michigan commercial bank may only pay dividends on its common stock if the bank has a surplus amounting to not less than 20% of its capital after the payment of the dividend. If a bank has a surplus less than the amount of its capital, it may not declare or pay any dividend until an amount equal to at least 10% of net income for the preceding one-half year (in the case of quarterly or semi-annual dividends) or at least 10% of net income of the preceding two consecutive half-year periods (in the case of annual dividends) has been transferred to surplus.

Federal law also affects the ability of a Michigan commercial bank to pay dividends. The FDIC’s prompt corrective action regulations prohibit an insured depository institution from making capital distributions, including dividends, if the institution has a regulatory capital classification of “undercapitalized,” or if it would be undercapitalized after making the distribution.The FDIC may also prohibit the payment of dividends if it deems any such payment to constitute an unsafe and unsound banking practice.Under the terms of the Consent Order issued by the FDIC and the Michigan DIFS, the Bank is prohibited from paying dividends without the consent of the FDIC and Michigan DIFS.

Michigan DIFS Assessments.Michigan commercial banks are required to pay supervisory fees to the Michigan DIFS to fund the operations of the Michigan DIFS. The amount of supervisory fees paid by a bank is based upon a formula involving the bank’s total assets, as reported to the Michigan DIFS.

State Enforcement.Under Michigan law, the Michigan DIFS has broad enforcement authority over state chartered banks and, under certain circumstances, affiliated parties, insiders, and agents. If a Michigan commercial bank does not operate in accordance with the regulations, policies and directives of the Michigan DIFS or is engaging, has engaged or is about to engage in an unsafe or unsound practice in conducting the business of the bank, the Michigan DIFS may issue and serve upon the bank a notice of charges with respect to the practice or violation. The Michigan DIFS enforcement authority includes: cease and desist orders, receivership, conservatorship, removal and suspension of officers and directors, assessment of monetary penalties, emergency closures, liquidation and the power to issue orders and declaratory rulings.

Federal Enforcement. The FDIC has primary federal enforcement responsibility over state non-member banks and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants, who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive, cease and desist, consent order to removal of officers and/or directors of the institution as well as receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1 million per day in especially egregious cases. Federal law also establishes criminal penalties for certain violations.

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Capital Requirements. Under FDIC regulations, federally-insured state-chartered banks that are not members of the Federal Reserve (“state non-member banks”), such as the Bank, are required to comply with minimum leverage capital requirements. For an institution determined by the FDIC not to be anticipating or experiencing significant growth and to be in general a strong banking organization, rated composite 1 under the Uniform Financial Institutions Ranking System established by the Federal Financial Institutions Examination Council, the minimum capital leverage requirement is a ratio of Tier 1 capital to total assets of 3%. For all other institutions, the minimum leverage capital ratio is not less than 4%. Tier 1 capital is principally composed of the sum of common stockholders’ equity, noncumulative perpetual preferred stock (including any related surplus) and minority investments in certain subsidiaries, less intangible assets (except for certain servicing rights and credit card relationships). As of December 31, 2013, the Tier 1 capital to average total assets ratio for the Bank was 8.48%.

The Bank must also comply with the FDIC risk-based capital guidelines. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items to four risk-weighted categories ranging from 0% to 100%, with higher levels of capital being required for the categories perceived as representing greater risk. For example, under the FDIC’s risk-weighting system, cash and securities backed by the full faith and credit of the U.S. Government are given a 0% risk weight, loans fully secured by one-to-four family residential properties generally have a 50% risk weight and commercial loans have a risk weight of 100%.

State non-member banks must maintain a minimum ratio of total capital to risk-weighted assets of at least 8%, of which at least one-half must be Tier 1 capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary capital items, the principal elements of which include allowances for loan losses in an amount of up to 1.25% of risk-weighted assets, cumulative preferred stock, a portion of the net unrealized gain on equity securities and other capital instruments such as subordinated debt.

The FDIC has adopted a regulation providing that it will take into account the exposure of a bank’s capital and economic value to changes in interest rate risk in assessing a bank’s capital adequacy. For more information about interest rate risk, see “Management’s Discussion and Analysis - Quantitative and Qualitative Disclosures about Market Risk.”

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) established a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories ("well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized"), and all institutions are assigned one such category. Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed.At December 31, 2013, the Bank’s regulatory capital classification was “adequately capitalized.” Although the Bank’s nominal capital ratios are above those required to be considered “well capitalized”, the existence of a written agreement with the FDIC limits the Bank’s capital classification to “adequately capitalized.”

For further discussion regarding the Corporation’s regulatory capital requirements, see Note 13 to the 2013 Consolidated Financial Statements.

Deposit Insurance Assessments.All of the Bank’s deposits are insured under the Federal Deposit Insurance Act by the FDIC to the fullest extent permitted by law. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC. The FDIC has adopted a risk-based assessment system whereby FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators.

The Dodd-Frank Act makes permanent the general $250,000 deposit insurance limit for insured deposits. The Dodd-Frank Act changes the deposit insurance assessment framework, primarily by basing assessments on an institution’s average total consolidated assets less average tangible equity (subject to risk-based adjustments that would further reduce the assessment base for custodial banks) rather than domestic deposits, which is expected to shift a greater portion of the aggregate assessments to large banks, as described in detail below. The Dodd-Frank Act also eliminates the upper limit for the reserve ratio designated by the FDIC each year, increases the minimum designated reserve ratio of the DIF from 1.15% to 1.35% of the estimated amount of total insured deposits by September 30, 2020, and eliminates the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds.On December 20, 2010, the FDIC raised the minimum designated reserve ratio of DIF to 2%. The ratio is higher than the minimum reserve ratio of 1.35% as set by the Dodd-Frank Act. Under the Dodd-Frank Act, the FDIC is required to offset the effect of the higher reserve ratio on small insured depository institutions, defined as those with consolidated assets of less than $10 billion.

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On February 7, 2011, the FDIC approved a final rule on Assessments, Dividends, Assessment Base and Large Bank Pricing. The final rule, mandated by the Dodd-Frank Act, changes the deposit insurance assessment system from one that is based on domestic deposits to one that is based on average consolidated total assets minus average tangible equity. Because the new assessment base under the Dodd-Frank Act is larger than the current assessment base, the final rule’s assessment rates are lower than the current rates, which achieves the FDIC’s goal of not significantly altering the total amount of revenue collected from the industry. In addition, the final rule adopts a “scorecard” assessment scheme for larger banks and suspends dividend payments if the DIF reserve ratio exceeds 1.5% but provides for decreasing assessment rates when the DIF reserve ratio reaches certain thresholds. The final rule also determines how the effect of the higher reserve ratio will be offset for institutions with less than $10 billion of consolidated assets.

The FDIC may terminate a depository institution’s deposit insurance upon a finding that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution’s regulatory agency.

Transactions with Related Parties. The Bank’s authority to engage in transactions with an “affiliate” (generally, any company that controls or is under common control with a depository institution) is limited by federal law. Federal law places quantitative and qualitative restrictions on these transactions and imposes specified collateral requirements for certain transactions. The purchase of low quality assets from affiliates is generally prohibited. Transactions with affiliates must be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies.

The Bank’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is also governed by federal law. Among other restrictions, these loans are generally required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of failure to make required repayment. The Sarbanes-Oxley Act of 2002 generally prohibits the Corporation from extending or maintaining credit, arranging for the extension of credit, or renewing an extension of credit, in the form of a personal loan to or for any director or executive officer (or equivalent thereof), except for extensions of credit made, maintained, arranged or renewed by the Corporation that are subject to the federal law restrictions discussed above.

Standards for Safety and Soundness. The federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions. The guidelines address internal controls and information systems, the internal audit system, credit underwriting, loan documentation, interest rate risk exposure, asset growth, asset quality, earnings and compensation, and fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit an acceptable plan to achieve compliance with the standard.

Investment Activities. Since the enactment of the FDIC Improvement Act, all state-chartered FDIC insured banks have generally been limited to activities of the type and in the amount authorized for national banks, notwithstanding state law. The FDIC Improvement Act and the FDIC permit exceptions to these limitations. For example, the FDIC is authorized to permit such institutions to engage in state authorized activities or investments that do not meet this standard (other than direct equity investments) for institutions that meet all applicable capital requirements if it is determined that such activities or investments do not pose a significant risk to the DIF.

 

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Mergers and Acquisitions. The Bank may engage in mergers or consolidations with other depository institutions or their holding companies, subject to review and approval by applicable state and federal banking agencies. When reviewing a proposed merger, the federal banking regulators consider numerous factors, including the effect on competition, the financial and managerial resources and future prospects of existing and proposed institutions, the effectiveness of FDIC-insured institutions involved in the merger in addressing money laundering activities and the convenience and needs of the community to be served, including performance under the Community Reinvestment Act.

Interstate Branching. Beginning June 1, 1997, federal law permitted the responsible federal banking agencies to approve merger transactions between banks located in different states, regardless of whether the merger would be prohibited under the law of the two states. The law also permitted a state to “opt in” to the provisions of the Interstate Banking Act before June 1, 1997, and permitted a state to “opt out” of the provisions of the Interstate Banking Act by adopting appropriate legislation before that date. Michigan did not “opt out” of the provisions of the Interstate Banking Act. Accordingly, beginning June 1, 1997, a Michigan commercial bank could acquire an institution by merger in a state other than Michigan unless the other state had opted out. The Interstate Banking Act also authorizesde novo branching into another state, but only if the host state enacts a law expressly permitting out of state banks to establish such branches within its borders. Effective with the enactment ofThe Dodd-Frank Act, the FDI Act and the National Bank Act have been amended to remove the expressly required “opt-in” concept applicable tode novo interstate branching and now permits national and insured state banks to engage inde novo in interstate branching if, under the laws of the state where the new branch is to be established, as a state bank chartered in that state would be permitted to establish a branch.

Community Reinvestment Act.The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve, the FDIC, or the OCC, shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. The Bank received a “satisfactory” rating in its most recent Community Reinvestment Act evaluation by the FDIC. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.

Privacy.The FRB, FDIC and other bank regulatory agencies have adopted final guidelines (the "Guidelines) for safeguarding confidential, personal customer information. The Guidelines require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to create, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of such information and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. The Corporation has adopted a customer information security program that has been approved by the Corporation's Board of Directors (the "Board”).The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to non-affiliated third parties. In general, the statute requires explanations to consumers on policies and procedures regarding the disclosure of such nonpublic personal information, and, except as otherwise required by law, prohibits disclosing such information except as provided in the banking subsidiary's policies and procedures. The Corporation's banking subsidiary has implemented a privacy policy.

Anti-Money Laundering Initiatives and the USA Patriot Act.A major focus of federal governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA Patriot Act of 2001 (the “USA Patriot Act”) substantially broadened the scope of United States’ anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The U.S. Department of the Treasury has issued a number of implementing regulations which apply to various requirements of the USA Patriot Act to financial institutions such as us. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputation consequences for the institution, including the imposition of enforcement actions and civil monetary penalties.

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Federal Home Loan Bank.The Bank is a member of the Federal Home Loan Bank of Indianapolis (“FHLBI”), one of the 12 regional Federal Home Loan Banks. The FHLBI provides a central credit facility primarily for member institutions. The Bank, as a member of the FHLBI, is required to acquire and hold shares of capital stock in the FHLBI in an amount equal to at least 1.0% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the FHLBI, whichever is greater. The Bank was in compliance with this requirement and its investment in FHLBI stock at December 31, 2013 was $10.6 million. The FHLB Banks function as a central reserve bank by providing credit for financial institutions throughout the United States. Advances are generally secured by eligible assets of a member, which include principally mortgage loans and obligations of, or guaranteed by, the U.S. government or its agencies. Advances can be made to the Bank under several different credit programs of the FHLBI. Each credit program has its own interest rate, range of maturities and limitations on the amount of advances permitted based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit.

Federal Reserve Board.The Federal Reserve Board regulations require banks to maintain non-interest-earning reserves against their net transaction accounts, nonpersonal time deposits and Eurocurrency liabilities (collectively referred to as reservable liabilities).

Overdraft Regulation.The Federal Reserve Board amended Regulation E (Electronic Fund Transfers) effective July 1, 2010 to require consumers to opt in, or affirmatively consent, to the institution’s overdraft service for ATM and one-time debit card transactions before overdraft fees may be assessed on the account. Consumers also must be provided a clear disclosure of the fees and terms associated with the institution’s overdraft service.

Other Regulations.Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank's loan operations are also subject to federal laws applicable to credit transactions, such as:

• the federal "Truth-In-Lending Act," governing disclosures of credit terms to consumer borrowers;

• the "Home Mortgage Disclosure Act of 1975," requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

• the "Equal Credit Opportunity Act," prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

• the "Fair Credit Reporting Act of 1978," governing the use and provision of information to credit reporting agencies;

• the "Fair Debt Collection Act," governing the manner in which consumer debts may be collected by collection agencies; and

• the rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.

The deposit operations of the Bank are subject to:

• the "Right to Financial Privacy Act," which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and

• the "Electronic Funds Transfer Act" and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking services.

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Holding Company Regulation

General. The Corporation, as a bank holding company registered under the Bank Holding Company Act of 1956, as amended, is subject to regulation, supervision, and examination by the Board of Governors of the Federal Reserve System. The Corporation is also required to file annually a report of its operations with the Federal Reserve Board. This regulation and oversight is generally intended to ensure that the Corporation limits its activities to those allowed by law and that it operates in a safe and sound manner without endangering the financial health of the Bank.

Under the Bank Holding Company Act, the Corporation must obtain the prior approval of the Federal Reserve Board before it may acquire control of another bank or bank holding company, merge or consolidate with another bank holding company, acquire all or substantially all of the assets of another bank or bank holding company, or acquire direct or indirect ownership or control of any voting shares of any bank or bank holding company if, after such acquisition, the Corporation would directly or indirectly own or control more than 5% of such shares.

Federal statutes impose restrictions on the ability of a bank holding company and its nonbank subsidiaries to obtain extensions of credit from its subsidiary bank, on the subsidiary bank’s investments in the stock or securities of the holding company, and on the subsidiary bank’s taking of the holding company’s stock or securities as collateral for loans to any borrower. A bank holding company and its subsidiaries are also prevented from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property, or furnishing of services by the subsidiary bank.

A bank holding company is required to serve as a source of financial and managerial strength to its subsidiary banks and may not conduct its operations in an unsafe or unsound manner. In addition, it is the Federal Reserve Board policy that a bank holding company should stand ready to use available resources to provide adequate capital to its subsidiary banks during periods of financial stress or adversity and should maintain the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks. A bank holding company’s failure to meet its obligations to serve as a source of strength to its subsidiary banks will generally be considered by the Federal Reserve Board to be an unsafe and unsound banking practice or a violation of the Federal Reserve Board regulations, or both.

Non-Banking Activities. The business activities of the Corporation, as a bank holding company, are restricted by the Bank Holding Company Act. Under the Bank Holding Company Act and the Federal Reserve Board’s bank holding company regulations, the Corporation may only engage in, acquire, or control voting securities or assets of a company engaged in, (1) banking or managing or controlling banks and other subsidiaries authorized under the Bank Holding Company Act and (2) any non-banking activity the Federal Reserve Board has determined to be so closely related to banking or managing or controlling banks to be a proper incident thereto. These include any incidental activities necessary to carry on those activities as well as a lengthy list of activities that the Federal Reserve Board has determined to be so closely related to the business of banking as to be a proper incident thereto.

Financial Modernization. The Gramm-Leach-Bliley Act, which became effective in March 2000, permits greater affiliation among banks, securities firms, insurance companies, and other companies under a new type of financial services company known as a “financial holding company.” A financial holding company essentially is a bank holding company with significantly expanded powers. Financial holding companies are authorized by statute to engage in a number of financial activities previously impermissible for bank holding companies, including securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; and merchant banking activities. The Act also permits the Federal Reserve Board and the Treasury Department to authorize additional activities for financial holding companies if they are “financial in nature” or “incidental” to financial activities. A bank holding company may become a financial holding company if each of its subsidiary banks is well capitalized, well managed, and has at least a “satisfactory” CRA rating. A financial holding company must provide notice to the Federal Reserve Board within 30 days after commencing activities previously determined by statute or by the Federal Reserve Board and Department of the Treasury to be permissible. The Corporation has not submitted notice to the Federal Reserve Board of our intent to be deemed a financial holding company.

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Regulatory Capital Requirements. The Federal Reserve Board has adopted capital adequacy guidelines under which it assesses the adequacy of capital in examining and supervising a bank holding company and in analyzing applications to it under the Bank Holding Company Act. The Federal Reserve Board’s capital adequacy guidelines are similar to those imposed on the Bank by the FDIC.

Restrictions on Dividends. The Corporation relies on dividends from the Bank to pay dividends to shareholders.The Michigan Banking Code of 1999 states, in part, that bank dividends may be declared and paid only out of accumulated net earnings and may not be declared or paid unless surplus (retained earnings) is at least equal to contributed capital. The Bank has not declared or paid any dividends that have caused its retained earnings to be reduced below the amount required. Finally, dividends may not be declared or paid if the Bank is in default in payment of any assessment due the Federal Deposit Insurance Corporation.

The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve Board’s view that a bank holding company should pay cash dividends only to the extent that the holding company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the holding company’s capital needs, asset quality and overall financial condition. The Federal Reserve Board also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the federal prompt corrective action regulations, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”

Employees

MBT Financial Corp. has no employees other than its three officers, each of whom is also an employee and officer of Monroe Bank & Trust and who serve in their capacity as officers of MBT Financial Corp. without compensation. As of December 31, 2013, Monroe Bank & Trust had367 full-time employees and 14 part-time employees.Monroe Bank & Trust provides a number of benefits for its full-time employees, including health and life insurance, workers' compensation, social security, paid vacations, numerous bank services, and a 401(k) plan.

Executive Officers of the Registrant

NAME	AGE	POSITION
H. Douglas Chaffin	58	President & Chief Executive Officer
Donald M. Lieto	58	Executive Vice President, Senior Administration
		Manager, Monroe Bank & Trust
Scott E. McKelvey	54	Executive Vice President, Regional President
		Wayne County, Monroe Bank & Trust
		Secretary, MBT Financial Corp.
Audrey Mistor	56	Executive Vice President, Wealth Management
		Group Manager
Thomas G. Myers	57	Executive Vice President & Chief
		Lending Manager, Monroe Bank & Trust
John L. Skibski	49	Executive Vice President & Chief
		Financial Officer, Monroe Bank & Trust;
		Treasurer, MBT Financial Corp.

There is no family relationship between any of the Directors or Executive Officers of the registrant and there is no arrangement or understandings between any of the Directors or Executive Officers and any other person pursuant to which he was selected a Director or Executive Officer nor with any respect to the term which each will serve in the capacities stated previously.

The Executive Officers of the Bank are elected to serve for a term of one year at the Board of Directors Annual Organizational Meeting, held in May.

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H. Douglas Chaffin was President & Chief Executive Officer in each of the last five years. Donald M. Lieto was Executive Vice President, Senior Administration Manager in each of the last five years. Scott E. McKelvey was Executive Vice President, Senior Wealth Management Officer in 2009-2013 and became Executive Vice President, Regional President Wayne County in 2013. Audrey Mistor was Senior Vice President, Community President in 2009-2013 and became Executive Vice President, Wealth Management Group Manager in 2013. Thomas G. Myers was Executive Vice President & Chief Lending Manager in each of the last five years. John L. Skibski was Executive Vice President & Chief Financial Officer in each of the last five years.

Available Information

MBT Financial Corp. makes its annual report on Form 10-K, its quarterly reports on Form 10-Q, its current reports on Form 8-K, and all amendments to those reports available on its website as soon as reasonably practicable after they are filed with or furnished to the SEC, free of charge. The website address is www.mbandt.com.

Item 1A. Risk Factors

Not applicable for smaller reporting companies.

Item 1B. Unresolved Staff Comments

None.

Item 2. Properties

MBT Financial Corp. does not conduct any business other than its ownership of Monroe Bank & Trust’s stock. MBT Financial Corp. operates its business from Monroe Bank & Trust’s headquarters facility. Monroe Bank & Trust operates its business from its main office complex located at 102 E. Front Street, Monroe, Michigan, its 24 full service branches in the counties of Monroe and Wayne, Michigan, and a mortgage loan origination office in Monroe, Michigan. The Bank owns its main office complex and 23 of its branches. The mortgage loan origination office and one of the Bank’s branches are leased.

Item 3. Legal Proceedings

MBT Financial Corp. and its subsidiaries are not a party to, nor is any of their property the subject of any material pending legal proceedings other than ordinary routine litigation incidental to their respective businesses, nor are any such proceedings known to be contemplated by governmental authorities.

MBT Financial Corp. and its subsidiaries have not been required to pay a penalty to the IRS for failing to make disclosures required with respect to certain transactions that have been identified by the IRS as abusive or that have a significant tax avoidance purpose.

Item 4. Mine Safety Disclosures

Not Applicable.

 

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Part II

Item 5. Market for the Registrant’s Common Equity, Related Security Holder Matters, and Issuer Purchases of Equity Securities

Common stock consists of 20,605,493 shares with a book value of $5.37. No dividends were declared on common stock during 2013.The common stock is traded on the NASDAQ Stock Market under the symbol MBTF.Below is a schedule of the high and low trading price for the past two years by quarter. These prices represent those known to Management, but do not necessarily represent all transactions that occurred.

	2013				2012
	High		Low		High		Low
1st quarter	$	4.37	$	2.35	$	2.50	$	0.96
2nd quarter	$	4.20	$	3.46	$	3.70	$	1.82
3rd quarter	$	4.30	$	3.53	$	3.10	$	2.57
4th quarter	$	4.49	$	3.57	$	2.98	$	2.21

No dividends were declared during the past three years.

As of December 31, 2013, the number of holders of record of the Corporation’s common shares was 1,181.The payment of future cash dividends is at the discretion of the Board of Directors and is subject to a number of factors, including results of operations, general business conditions, growth, financial condition, and other factors deemed relevant. Further, the Corporation’s ability to pay future cash dividends is subject to certain regulatory requirements and restrictions discussed in the sections captioned “Recent Regulatory Enforcement Actions” and “Bank Regulation-Dividends” in Item 1 above. Given the Corporation’s operating results and need to raise additional capital, Management’s expectation is that the payment of dividends will continue to be suspended for the foreseeable future.

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Item 6. Selected Financial Data

The selected financial data for the five years ended December 31, 2013 are derived from the audited Consolidated Financial Statements of the Corporation. The financial data set forth below contains only a portion of our financial statements and should be read in conjunction with the Consolidated Financial Statements and related notes and "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in this Form 10-K.

Selected Consolidated Financial Data

Dollar amounts are in thousands,
except per share data	2013			2012			2011			2010			2009
Consolidated Statements of Income
Interest Income	$	39,238		$	44,535		$	49,560		$	56,586		$	71,004
Interest Expense		6,037			9,886			14,433			19,758			29,989
Net Interest Income		33,201			34,649			35,127			36,828			41,015
Provision for Loan Losses		2,200			7,350			13,800			20,500			36,000
Net Interest Income after      Provision for Loan Losses		31,001			27,299			21,327			16,328			5,015
Other Income		15,931			16,437			18,230			19,436			10,480
Other Expenses		39,508			38,694			42,819			44,480			49,774
Income (Loss) before provision for      (benefit from) Income Taxes		7,424			5,042			(3,262)			(8,716)			(34,279)
Provision for (benefit from)      Income Taxes		(18,113)			(3,503)			500			3,183			(102)
Net Income (Loss)	$	25,537		$	8,545		$	(3,762)		$	(11,899)		$	(34,177)
Per Common Share
Basic Net Income (Loss)	$	1.43		$	0.49		$	(0.22)		$	(0.72)		$	(2.11)
Diluted Net Income (Loss)		1.41			0.49			(0.22)			(0.72)			(2.11)
Cash Dividends Declared		-			-			-			-			0.02
Book Value at Year End		5.37			4.80			4.38			4.29			5.04
Average Common Shares      Outstanding		17,882,070			17,332,012			17,270,528			16,498,734			16,186,478
Consolidated Balance Sheets (Year End)
Total Assets	$	1,222,682		$	1,268,595		$	1,238,027		$	1,259,377		$	1,383,369
Total Securities		440,407			443,158			400,868			325,000			356,865
Total Loans		597,590			627,249			679,475			752,887			848,979
Allowance for Loan Losses		16,209			17,299			20,865			21,223			24,063
Deposits		1,069,718			1,048,830			1,022,310			1,031,893			1,031,791
Borrowings		27,000			122,000			127,000			143,500			258,500
Total Shareholders' Equity		110,608			83,574			75,711			73,998			81,764
Selected Financial Ratios
Return on Average Assets		2.12	%		0.69	%		-0.30	%		-0.92	%		-2.36	%
Return on Average Equity		28.78	%		11.03	%		-5.11	%		-14.06	%		-29.53	%
Net Interest Margin		2.98	%		3.02	%		3.07	%		3.10	%		3.06	%
Dividend Payout Ratio		0.00	%		0.00	%		0.00	%		0.00	%		-0.95	%
Allowance for Loan Losses      to Period End Loans		2.71	%		2.75	%		3.07	%		2.82	%		2.83	%
Allowance for Loan Losses      to Non Performing Loans		28.84	%		24.78	%		27.63	%		25.98	%		27.94	%
Non Performing Loans      to Period End Loans		9.39	%		11.10	%		11.10	%		10.84	%		10.13	%
Net Charge Offs to Average Loans		0.54	%		1.65	%		1.97	%		2.89	%		3.36	%

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction – The Company is a bank holding company with one subsidiary, Monroe Bank & Trust (“Bank”). The Bank is a commercial bank that operates 17 branch offices in Monroe country, Michigan and 7 branches in Wayne County, Michigan. The Bank’s primary source of income is interest income on its loans and investments and its primary expense is interest expense on its deposits and borrowings. This discussion and analysis should be read in conjunction with the accompanying consolidated statements and footnotes.

Executive Overview – The Bank is operated as a community bank, primarily providing loan, deposit, and wealth management services to the people, businesses, and communities in its market area. In addition to our commitment to our mission of serving the needs of our local communities, we are focused on improving our asset quality, profitability, and capital.

The national economic recovery is continuing slowly, and the pace of improvement in economic conditions in southeast Michigan is improving. Local unemployment rates improved during 2013, and are now comparable to the state and national averages, but remain above the historical norms. Commercial and residential development property values continue to show some stability with some areas improving slightly. Our total problem assets, which include nonperforming loans, other real estate owned, non-accrual investments, and performing loans that are internally classified as potential problems, decreased $30.7 million, or 24.5% during 2013. The improvement in our asset quality over the past year, the decrease in our net charge offs from $10.9 million in 2012 to $3.3 million in 2013, and the decrease in our total loans outstanding allowed us to decrease our Allowance for Loan and Lease Losses (ALLL) from $17.3 million to $16.2 million in 2013. The portfolio of loans held for investment decreased $29.7 million during the year, and the ALLL as a percent of loans decreased from 2.75% to 2.71%. Local property values and the unemployment rate have stabilized over the past two years and the pace of the recovery in our local markets improved in 2013. Although the recovery is continuing, it is still tenuous, and we will continue to focus our efforts on improving asset quality and strengthening capital in 2014. We also plan to focus on growing our loan portfolio and increasing revenue.

Net Interest Income decreased $1,448,000 in 2013 compared 2012 as the average earning assets decreased $32.6 million, or 2.8% and the net interest margin decreased from 3.02% to 2.98%. The provision for loan losses decreased from $7.35 million in 2012 to $2.2 million in 2013. Decreases in the historical loss rates, the size of the loan portfolio, and the amount of specific allocations during 2013 decreased the amount of ALLL required. As a result, we were able to record a provision that was smaller than the net charge offs for the year. Non-interest income decreased $0.5 million or 3.1%, primarily due to a decrease in gains on securities transactions. Non-interest expenses increased $0.8 million, or 2.1% primarily due to higher salary and benefits costs in 2013, partially offset by lower credit related costs. We expect credit related expenses to continue to improve in 2014. In addition, in 2013 the Company recorded a tax benefit of $18.8 million to eliminate the remaining valuation allowance on our deferred tax asset and we recorded a tax expense of $0.7 million for the tax expense on our fourth quarter 2013 income.

Critical Accounting Policies - The Bank’s Allowance for Loan Losses is a “critical accounting estimate” because it is an estimate that is based on assumptions that are highly uncertain, and if different assumptions were used or if any of the assumptions used were to change, there could be a material impact on the presentation of the Corporation’s financial condition. These assumptions include, but are not limited to, collateral values and the effect of economic conditions on the financial condition of the Bank’s borrowers. To determine the Allowance for Loan Losses, the Bank estimates losses on all loans that are not classified as non-accrual or renegotiated by applying historical loss rates, adjusted for environmental factors, to those loans. This portion of the analysis utilizes the loss history for the most recent twelve quarters, adjusted for qualitative factors including recent delinquency rates, real estate values, and economic conditions. In addition, all loans over $250,000 that are nonaccrual and all loans that are renegotiated are individually tested for impairment. Impairment exists when the carrying value of a loan is greater than the realizable value of the collateral pledged to secure the loan or the present value of the cash flow of the loan. Any amount of monetary impairment is included in the Allowance for Loan Losses. Management is of the opinion that the Allowance for Loan Losses of $16,209,000 as of December 31, 2013 was adequate.

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of fair value less costs to sell or the loan carrying amount at the date of foreclosure. Subsequent to foreclosure, appraisals or other independent valuations are periodically obtained by Management and the assets are carried at the lower of carrying amount or fair value less costs to sell.

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Income tax accounting standards require companies to assess whether a valuation allowance should be established against deferred tax assets based on the consideration of all evidence using a “more likely than not” standard. We reviewed our deferred tax asset, considering both positive and negative evidence and analyzing changes in near term market conditions as well as other factors that may impact future operating results. Significant negative evidence is our net operating losses for 2008 through 2011, combined with a challenging economic environment consisting of slowly improving unemployment and a fragile economic recovery in southeast Michigan. Positive evidence includes our history of strong earnings prior to 2008, our strong capital position, our steady net interest margin, our non interest expense control initiatives, our ten consecutive quarterly profits, and our forecasted profits for the foreseeable future. As of December 31, 2011, we maintained a valuation allowance equal to the full amount of our $24.2 million deferred tax asset. Our analysis of the evidence in December 2012 indicated that we would be able to utilize a portion of our deferred tax asset and we recorded a tax benefit of $5.0 million in 2012 to reduce the valuation allowance. Based on our most recent analysis of all evidence available, both positive and negative, we believe that it is more likely than not that we will be able to utilize the entire deferred tax asset. Accordingly, we reversed our valuation allowance and recorded a tax benefit of $18.8 million in the third quarter of 2013.

The Bank holds three pooled Trust Preferred Collateralized Debt Obligation (CDO) securities in its investment securities portfolio. Due to the lack of an active market for securities of this type, the Bank utilizes an independent third party valuation firm to calculate fair values. This valuation analysis includes a determination of the portion of the fair value impairment that is the result of credit losses. The portion of the impairment that is the result of credit losses is recognized in earnings as Other Than Temporary Impairment and the impairment related to all other factors is recognized in Other Comprehensive Income.

The other-than-temporary-impairment analysis of each of the CDO securities owned by the Company is conducted by projecting the expected cash flows from the security, discounting the cash flows to determine the present value of the cash flows, and comparing the present value to the amortized cost to determine if there is impairment. The cash flow projection for each security is developed using estimated prepayment speeds, estimated rates at which payments will be deferred, estimated rates at which issuers will default, and the severity of the losses on the securities which default. Prepayment estimates are negatively impacted by the lack of an active market for issuers to refinance their trust preferred securities; however, prepayment of trust preferred securities is expected to increase due to recent restrictions on the treatment of trust preferred debt as regulatory capital. The size and creditworthiness of each institution in the CDO pool are the most significant pieces of evidence in estimating prepayment speeds. Deferral and default rates are the key drivers of the cash flow projections for each of the securities. Deferral of interest payments is allowed for up to five years, and estimates of deferral rates are determined by examining the current deferral status of the issuers, the current financial condition of the issuers, and the historical deferral levels of the issuers in each CDO pool. Key evidence examined includes whether or not an issuer has received TARP funding, the most recent credit ratings from outside services, stock price information, capitalization, asset quality, profitability, and liquidity. The most significant evidence in estimating deferrals is the comparison of key financial ratios to industry benchmarks. Near term (next 12 months) deferral rates are estimated for each security by analyzing the credit characteristics of each individual issuer in the pool. When an issuer is expected to defer interest payments, the analysis assumes that the deferral will continue for the entire five year period allowed and then, depending on the individual credit characteristics of that issuer, begin performing or move to default. Longer term annual default rates for each CDO are estimated using the credit analysis of each individual issuer compared to industry benchmarks to modify the historical default rates of financial companies. Finally, loss severity is estimated using analytical research provided by Standard and Poor’s and Moody’s, which supports the assumption that a small percentage of defaulted trust preferred securities recover without loss. The projected cash flows are discounted using the contractual rate of each security.

Recent Accounting Pronouncements – No recent accounting pronouncements are expected to have a significant impact on the Corporation’s financial statements. Accounting Standards Update 2013-02 (ASU 2013-02), “Comprehensive Income: Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income” was issued in February 2013. ASU 2013-02 requires an entity to provide information about the amounts reclassified out of Accumulated Other Comprehensive Income (AOCI) by component. In addition, an entity is required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income, but only if the amount reclassified is required to be reclassified in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures that provide additional details about those amounts. ASU 2013-02 does not change the current requirements for reporting net income or other comprehensive income in the financial statements. ASU 2013-02 is effective for interim and annual periods beginning on or after December 15, 2012. The Company adopted ASU 2013-02 on January 31, 2013.

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Accounting Standards Update 2014-04 (ASU 2014-04), “Receivables – Troubled Debt Restructurings by Creditors – Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” was issued in January 2014. ASU 2014-04 clarifies that an in substance foreclosure repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (a) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure; or (b) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additional disclosures are required. ASU 2014-04 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2014. The adoption of ASU 2014-04 by the Company is not expected to have a material impact.

Results of Operations

Comparison of 2013 to 2012 – The Company reported a Net Profit of $25.5 million in 2013, compared to the Net Profit of $8.5 million in 2012 mainly due to the increase of $14.6 million in the Benefit From Income Taxes caused by the elimination of the remaining deferred tax asset valuation allowance in 2013. The Income Before Provision for Taxes increased $2.4 million, or 47.2%, primarily due to the reduction in the Provision for Loan Losses, which exceeded the reductions in net interest income and non-interest income and the increase in non-interest expenses. The primary source of earnings for the Bank is its net interest income, which decreased $1.4 million, or 4.2% compared to 2012. Net interest income decreased as the net interest margin decreased from 3.02% to 2.98% and the average earning assets decreased 2.8%. The historically low interest rate environment inhibits the Company’s ability to further reduce rates paid on deposits and reduce funding costs on pace with the yields on interest earning assets. Earning assets decreased during 2013 as the Company decreased its use of non-deposit funding by paying off $95 million of maturing Federal Home Loan Bank borrowings in the second quarter. Interest income decreased $5.3 million during 2013 as the yield on earnings assets decreased from 3.89% to 3.53%, the amount of average earning assets was decreased from $1.14 billion to $1.11 billion. Interest expense decreased $3.8 million compared to 2012 as the average amount of interest bearing liabilities decreased $57.9 million and the cost of the interest bearing liabilities decreased from 1.01% in 2012 to 0.65% in 2013. The decrease in the average interest bearing liabilities and the average cost of funds was due to the repayment of $95 million in Federal Home Loan Bank borrowings in the second quarter of 2013. The average cost of the borrowings that were repaid was 2.57%.

The Provision for Loan Losses decreased 70.1% from $7.35 million in 2012 to $2.2 million in 2013 as the amount of net charge offs decreased from $10.9 million in 2012 to $3.3 million in 2013. The improving economic conditions and continued high credit standards and collection efforts contributed to the decrease in charge offs. The net charge offs exceeded the provision by $1.1 million, causing a decrease of that amount in our Allowance for Loan Losses. The Allowance as a percent of loans decreased from 2.75% as of December 31, 2012 to 2.71% as of December 31, 2013 as the Allowance decreased by 6.3% while the loan portfolio decreased by 4.7%.

Other Income decreased 3.1% from $16.4 million in 2012 to $15.9 million in 2013. Wealth Management income increased $323,000, or 8.0% as improvement in market values of financial assets led to an increase in assets under management. Security gains decreased $856,000 as the Bank realized less gains on sales of securities in 2013 as market interest rates moved higher. Mortgage loan origination income decreased 22.2% from 2012 to 2013 as refinance activity decreased due to the increase in interest rates. Other non-interest income increased $424,000 from 2012 to 2013 mainly due to increases of $291,000 in rental income on OREO properties and $114,000 in investment services commissions.

Other expenses increased $814,000, or 2.1% in 2013 compared to 2012. Salaries and benefits expense increased $1.2 million, or 5.9% as salaries increased $0.4 million due to increases in salary rates and the number of employees, the resumption of the officers’ incentive plan in 2013 caused an increase of $0.9 million, and benefits expense decreased $0.1 million. Occupancy expense increased $376,000 or 14.0% mainly due to an increase in maintenance costs due to an increase in the environmental cleanup costs at our Temperance branch location. Completion of this project was delayed by wetter than normal weather in the summer of 2013, and we accrued additional expense for the estimated costs to complete the work in 2014. Professional fees decreased 13.2% from $2.3 million in 2012 to $2.0 million in 2013 as a decrease in legal fees due to reduced collection activity and lower accounting and legal fees related to the ongoing IRS audit. Losses on Other Real Estate Owned increased $364,000, or 33.8% as several properties were liquidated at auctions. Maintenance, insurance, and property tax costs on OREO properties decreased $495,000 or 33.1% due to the reduction in properties owned.

 

20

 

The Company’s net income for 2013, before provision for income taxes, was $7.4 million, an increase of $2.4 million compared to the pretax income of $5.0 million in 2012. In 2013 we recorded a tax benefit of $18.8 million to eliminate the remaining valuation allowance on our deferred tax asset and we recorded a tax expense of $0.7 million for the tax expense on our fourth quarter 2013 income. In 2012 we recorded a tax benefit of $5.0 million to reverse a portion of the valuation allowance on our deferred tax asset and a tax expense of $1.5 million to accrue for an estimated adjustment to our 2009 tax return resulting from the ongoing IRS audit of the Company’s tax returns filed for its 2004, 2005, 2007, 2008, 2009, and 2010 tax years. The total tax recorded in 2013 was a benefit of $18.1 million, for an effective tax rate of (244%). The total tax recorded in 2012 was a benefit of $3.5 million, for an effective rate of (69.5%). The net income in 2013 was $25.5 million, an improvement of $17.0 million compared to the net income of $8.5 million in 2012.

Comparison of 2012 to 2011 – The Company recorded a Net Profit of $8.5 million in 2012, compared to the Net Loss of $3.8 million in 2011 mainly due to the decrease of $6.45 million in the Provision for Loan Losses, a $5.0 million reduction in the valuation allowance on our deferred tax asset (which net of our current provisions resulted in a decrease of $4.0 million in federal income tax expense), and the decrease of $4.1 million in non-interest expenses. The primary source of earnings for the Bank is its net interest income, which decreased $0.5 million, or 1.4% compared to 2011. Net interest income decreased as the net interest margin decreased from 3.07% to 3.02% and the average earning assets increased less than 0.1%. Earning assets were little changed during 2012 as loan demand remained weak and Management continued its efforts to improve the Bank’s capital ratios by restricting asset growth. Interest income decreased $5.0 million during 2012 as the yield on earnings assets decreased from 4.33% to 3.89%, while the amount of earning assets was essentially unchanged at $1.14 billion. Interest expense decreased $4.5 million compared to 2011 as the average amount of interest bearing liabilities decreased $29.4 million and the cost of the interest bearing liabilities decreased from 1.43% in 2011 to 1.01% in 2012. The decrease in the average cost of funds was due to the historically low level of market interest rates throughout the year and because the outstanding balances of interest bearing liabilities shifted from higher cost borrowed funds, certificates of deposit, and money market deposits to lower cost savings and interest bearing demand deposits.

The Provision for Loan Losses decreased 46.7% from $13.8 million in 2011 to $7.35 million in 2012 as the amount of net charge offs decreased from $14.2 million in 2011 to $10.9 million in 2012. The slowly improving economic conditions and continued high credit standards and collection efforts contributed to the decrease in charge offs. The net charge offs exceeded the provision by $3.6 million, causing a decrease of that amount in our Allowance for Loan Losses. The Allowance as a percent of loans decreased from 3.07% as of December 31, 2011 to 2.75% as of December 31, 2012 as the Allowance decreased by 17.1% while the loan portfolio decreased by 7.7%.

Other Income decreased 9.8% from $18.2 million in 2011 to $16.4 million in 2012. Security gains increased $0.2 million as the Bank realized more gains on sales of securities in 2012 as interest rates moved lower. Mortgage loan origination income increased 87.1% from 2011 to 2012 as the real estate market conditions improved slightly and refinance activity increased sharply. Income from Bank Owned Life Insurance decreased $2.1 million, or 59.6%, due to the proceeds of a death claim for one of our directors in 2011.

Other expenses decreased $4.1 million, or 9.6% in 2012 compared to 2011. Salaries and benefits expense increased $838,000, or 4.3% as salaries increased due to increases in salary rates and the number of employees, and retirement benefits, health care, and payroll taxes all increased. Occupancy expense decreased 13.7% mainly due to a reduction in maintenance costs due to an accrual of $340,000 in 2011 for additional environmental cleanup costs at our Temperance branch location. Depreciation and property tax expenses also decreased. Professional fees decreased 8.6% from $2.5 million in 2011 to $2.3 million in 2012 as a decrease in legal fees due to reduced collection activity was partially offset by higher accounting and legal fees due to an ongoing IRS audit. Expenses and losses on Other Real Estate Owned decreased $3.1 million, or 54.6% as real estate values began to recover, decreasing the need to write down our properties. Maintenance, insurance, and property tax costs on OREO properties also decreased. Death benefit obligation expense decreased $1.6 million due to the accrual of a death benefit payable to the beneficiary of one of our board members in 2011. Other expenses increased $783,000, or 22.5% due to an interest accrual on the proposed IRS audit settlement, an excise tax paid on a retirement plan ERISA violation, various legal settlements, and increased employee training expenses.

The Company’s net income for 2012, before provision for income taxes, was $5.0 million, an increase of $8.3 million compared to the pretax loss of $3.3 million in 2011. In 2011 we recorded a tax expense to accrue $500,000 for an estimated adjustment to our 2009 tax return resulting from the ongoing IRS audit of the Company’s tax returns filed for its 2004, 2005, 2007, 2008, 2009, and 2010 tax years. The ultimate resolution of the audit is still uncertain. The issues being challenged mainly involve the timing of income recognition and would normally result in an increase in the deferred tax asset. In 2012 we proposed a settlement to the IRS and recorded an additional tax expense accrual of $1.5 million to reflect the amount of that proposed settlement. Based on current knowledge, the Company believes that the accrued tax liability is adequate to absorb the effect relating to the ultimate resolution of the uncertain tax positions challenged by the IRS. In 2012, we also recorded a tax benefit of $5.0 million to reduce the valuation allowance on our deferred tax asset. The total tax recorded in 2012 was a benefit of $3.5 million, for an effective tax rate of (69.5%). The net income in 2012 was $8.5 million, an improvement of $12.3 million compared to the loss of $3.8 million in 2011.

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Earnings for the Bank are usually highly reflective of the Net Interest Income. In 2008, during the economic crisis, the Federal Open Market Committee (FOMC) of the Federal Reserve lowered the fed funds rate target to 0-0.25%, where it remained through 2013 and into 2014. The yield curve shape became steeply, positively sloped in 2009 and through 2010. Due to continued high unemployment and the absence of inflation, the Fed extended its quantitative easing program through 2012 in an attempt to keep longer term market rates low and encourage borrowing, which reduced the slope from the yield curve. Labor markets began to gain strength in 2012 and into 2013, and the fed began to taper its securities purchases in 2013, which caused an increase in longer term market interest rates and an increase in the slope of the yield curve in the second half of 2013. Loan and investment yields follow long term market yields, and the yield on our loans decreased from 5.53% in 2011 to 5.30% in 2012 and 4.96% in 2013. The yields on our investment securities also decreased each year, from 2.31% in 2011 to 1.96% in 2012 and 1.76% in 2013. In the current environment of low interest rates and low, but increasing, loan demand, we have been maintaining our investment portfolio in shorter duration securities and cash reserves. This liquidity will help us fund loan growth and benefit from increases in interest rates, but it currently is contributing to the low investment yields. Funding costs are more closely tied to the short term rates, and the average cost of our deposits decreased from 1.04% in 2011 to 0.62% in 2012 and to 0.41% in 2013. Borrowed funds costs are primarily based on the 3 month LIBOR, which increased late in 2011 before decreasing slightly in 2012 and 2013. As a result our average cost of borrowed funds increased from 2.76% in 2011 to 2.85% in 2012 and decreased to 2.73% in 2013. This caused our net interest margin to decrease from 3.07% in 2011 to 3.02% in 2012 and to 2.98% in 2013. The average cost of interest bearing deposits was 0.50%, 0.74%, and 1.22%, for 2013, 2012, and 2011, respectively. The following table shows selected financial ratios for the same three years.

	2013		2012		2011
Return on Average Assets	2.12	%	0.69	%	-0.30	%
Return on Average Equity	28.78	%	11.03	%	-5.11	%
Dividend Payout Ratio	0.00	%	0.00	%	0.00	%
Average Equity to Average Assets	7.36	%	6.27	%	5.84	%

Balance Sheet Activity– Compared to 2012, the total assets of the Company decreased $45.9 million, or 3.6%. The decrease was the result of repayment of non-deposit funding, which decreased $95 million. The decrease in borrowed funds was offset by increases of $20.9 million in deposits and 27.0 million in stockholders’ equity. We continued to reduce our non-core funding, and in 2013 $7.6 million in brokered certificates of deposit and $95.0 million in Federal Home Loan Bank advances matured and were not replaced. We reduced our total brokered CDs from $16.3 million at December 31, 2012 to $8.7 million at December 31, 2013. Loan demand improved in 2013, but it was not sufficient to replace the amount of principal payments received and charge offs during the year. As a result, total loans held for investment decreased $29.7 million, or 4.7%. We expect the loan portfolio to continue to stabilize in the first quarter of 2014 before beginning to increase before the end of the year. Although deposit funding increased and loans decreased, the decrease in borrowed funds led to a decrease of $37.5 million in our cash and investment securities. The investment portfolio primarily consists of mortgage backed securities issued by GNMA, and debt securities issued by U.S government agencies and states and political subdivisions. Due to the low interest rate environment and our anticipated cash needs for 2014, we are holding a large amount of our excess funds in cash and cash equivalents instead of investing it in securities. Capital increased $27.0 million, due to the earnings of $25.5 million and stock issuance of $12.3 million; partially offset by a reduction of $10.8 million in accumulated other comprehensive income that was caused by an increase in the unrealized losses on our available for sale investment securities.

Asset Quality -The Corporation uses an internal loan classification system as a means of tracking and reporting problem and potential problem credit assets. Loans that are rated one to four are considered “pass” or high quality credits, loans rated five are “watch” credits, and loans rated six and higher are “problem assets”, which includes non performing loans. Nonperforming assets include all loans that are 90 days or more past due, non-accrual loans, Other Real Estate Owned (OREO), and Troubled Debt Restructurings (TDRs). Asset quality began to weaken in 2007 and problem assets increased to $157.8 million, or 12.5% of total assets at December 31, 2010. From 2011 through 2013, economic conditions nationally and in southeast Michigan improved moderately. Although unemployment remains elevated, property values are recovering, economic activity is increasing, and problem assets decreased to $125.2 million, or 9.9% of total assets at December 31, 2012 and $94.5 million, or 7.7% of total assets at December 31, 2013.

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The Corporation monitors the Allowance for Loan and Lease Losses (ALLL) and the values of the OREO each quarter, making adjustments when necessary. We believe that the ALLL adequately provides for the losses in the portfolio and that the reported OREO value is accurate as of December 31, 2013. We expect the recovery of the local economic environment to continue along with the rest of the country in 2014. This may result in continued improvement in employment and property values in our market area. Loans that were 30-89 days past due decreased from $15.6 million, or 2.29% of loans, as of December 31, 2011 to $12.4 million, or 1.98% of loans as of December 31, 2012 and to $6.5 million, or 1.09% of loans as of December 31, 2013. Delinquency is one of the indications of potential problems with a loan, and this second consecutive decrease in early delinquencies may be an indication that the problem asset level will continue to improve in 2014. We also expect the provision for loan losses to improve again in 2014.

Cash Flow –Cash flows provided by operations decreased compared to 2012 even though the net income increased from $8.5 million to $25.5 million. This occurred because the primary contributors to the improved earnings were the reduction in the provision for loan losses and the decrease in the deferred tax asset valuation allowance, and both of these are noncash items. Cash flows used from investing activities increased from ($2.5) million in 2012 to $12.5 million in 2013 because less of the cash generated by securities maturities and sales was reinvested into investment securities in 2013 as we used the cash for repayment of debt. Cash flows from financing activity decreased $83.9 million in 2013 due to an increase of $90.1 million in the repayment of borrowed funds and $5.6 million less growth in deposits. This increase in cash used for financing activities was partially offset by an increase of $11.8 million in stock issued. As a result, total cash and cash equivalents decreased $34.7 million in 2013 and the Company decreased its cash held at the Federal Reserve. Management believes that the Bank has adequate cash to fund its anticipated loan growth and deposit activity in 2014.

Deferred Tax Asset Valuation Allowance –ASC 740 guidance requires that a corporation assess whether a valuation allowance should be established against its deferred tax asset based on the consideration of all available evidence using a “more likely than not” standard. In making such judgments, the corporation should consider both positive and negative evidence and analyze changes in near term market conditions as well as other factors which may impact future operating results. The Company first established a valuation allowance of $13.8 million against its $17 million deferred tax asset effective December 31, 2009. The valuation allowance was increased to 100% of the $20.9 million deferred tax asset effective December 31, 2010. The valuation allowance was maintained at 100% of the deferred tax asset, which increased to $24.2 million during 2011. In 2012, the deferred tax asset increased to $24.9 million, but based on the two year budget and five year financial projections, the Company believed it would be able to utilize a sufficient amount of its net operating loss carry forwards to make it “more likely than not” it would be able to realize at least $5 million of its deferred tax assets. Therefore, the Company elected to reduce its deferred tax asset valuation allowance by $5 million as of December 31, 2012. In September 2013, after experiencing increasing positive evidence and decreasing negative evidence, the Company determined that it was more likely than not that it will utilize all of its net operating loss carry forwards and all of its deferred tax assets.

The negative evidence evaluated in 2013 consists primarily of the economic conditions and the Company’s financial results during the 2008-2010 period. In 2008, the southeast Michigan region led the nation into a prolonged recession due to weak sales in the automotive sector. In the years leading up to the recession, housing values increased rapidly, and when unemployment began to rise, the housing market suffered and real estate values declined. The decline in real estate values resulted in an abrupt reduction in mortgage loan originations and the ability of homeowners to use the equity in their homes to fund their spending. The Bank’s loan portfolio primarily consisted of loans secured by real estate, including residential and commercial development and 1-4 family residential property, and we experienced significant increases in defaults in these loans. Nonperforming loans as a percent of total loans increased from 3.39% as of December 2007 to 10.84% as of December 31, 2010, and net charge offs as a percent of average loans increased from 0.49% in 2007 to 2.89% in 2010. Due to the deterioration of the Bank’s loan portfolio, we needed to increase our allowance for loan losses from $13.8 million at the end of 2006 to $24.1 million at the end of 2009. This required an increase in our provision for loan losses from $11.4 million in 2007 to $36.0 million in 2009, and our net income decreased from a profit of $7.7 million in 2007 to a loss of $34.3 million in 2009.

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The positive evidence evaluated in 2013 consists of the improvements in the economic conditions in 2011 through 2013, the improvements in the Bank’s asset quality and earnings in 2011, 2012, and 2013, the expectations of future earnings improvements for the Company, and the Company’s long history of strong financial performance prior to 2008. During the recession, the national unemployment rate increased from 5.0% at the end of 2007 to its peak of 10.0% in October, 2009. Since the recovery began, the national unemployment rate declined to 6.7% at the end of 2013. During the same period, the unemployment rate for Michigan increased from 7.2% to a high of 14.2% in August, 2009 and has declined to 8.3% at the end of 2013. From December 2007 to July 2009, the Case Shiller housing price index for southeast Michigan decreased 32.3%, and from that low point, the index recovered 30.4% as of December 2013. These economic improvements have resulted in asset quality and earnings improvements at the Bank. Problem assets declined $66 million, or 41% from 2010 to 2013 and net charge offs decreased 85.8% from $23.3 million in 2010 to $3.3 million in 2013. The improvement in asset quality has enabled the Bank to reduce its allowance for loan losses 22.3% over the same three year period. The asset quality improvement has led to an improvement in earnings for the Company, which has posted ten consecutive quarterly profits and has positive cumulative pretax earnings for sixteen quarters. Prior to 2008, the Company had consistently strong financial performance, and since its incorporation has not had any net operating loss carry forwards expire unused. Throughout the recent economic challenges, the Company maintained strong core earnings and only experienced losses recently due to high credit related costs. With the asset quality improving and credit costs returning to normal levels, the Company expects its profits to continue to grow for the foreseeable future. The Company operates thorough and detailed Asset/Liability Management and budgeting models and has historically been able to accurately forecast its earnings. The current two year budget and five year financial projections indicate that the Company will be able to utilize all of its net operating loss carry forwards to make it “more likely than not” that the Company will be able to realize all of its deferred tax assets. Based on its evaluation of the positive and negative evidence, the Company elected to eliminate its deferred tax asset valuation allowance as of September 30, 2013.

Liquidity and Capital -The Corporation has maintained sufficient liquidity to allow for fluctuations in deposit levels. Internal sources of liquidity are provided by the maturities of loans and securities as well as holdings of securities Available for Sale. External sources of liquidity include a line of credit with the Federal Home Loan Bank of Indianapolis, a Federal funds line that has been established with a correspondent bank, and Repurchase Agreements with money center banks that allow us to pledge securities as collateral for borrowings. The Federal Reserve Bank discount window, which also allows us to pledge securities and loans as collateral for borrowings, is only available to us under the secondary credit program, and therefore is no longer part of our liquidity planning process. As of December 31, 2013, the Bank utilized $12 million of its authorized limit of $275 million with the Federal Home Loan Bank of Indianapolis and none of its $25 million federal funds line with its correspondent bank.

Total stockholders’ equity of the Corporation was $110.6 million at December 31, 2013 and $83.6 million at December 31, 2012. The stockholders’ equity increased $27.0 million during the year, the ratio of equity to assets increased from 6.59% as of December 31, 2012 to 9.05% as of December 31, 2013. Federal bank regulatory agencies have set capital adequacy standards for Total Risk Based Capital, Tier 1 Risk Based Capital, and Leverage Capital. These regulatory standards require banks to maintain Leverage and Tier 1 ratios of at least 4% and a Total Capital ratio of at least 8% to be adequately capitalized. The regulatory agencies consider a bank to be “well capitalized” if its Total Risk Based Capital is at least 10% of Risk Weighted Assets, Tier 1 Capital is at least 6% of Risk Weighted Assets, the Leverage Capital Ratio is at least 5%, and the Bank is not subject to any written agreements or order issued by the FDIC pursuant to Section 8 of the Federal Deposit Insurance Act.

The following table summarizes the capital ratios of the Corporation:

					Minimum to be Well
	December 31, 2013		December 31, 2012		Capitalized
Tier 1 Leverage Ratio	8.61	%	6.43	%	5	%
Tier 1 Risk based Capital	13.29	%	10.27	%	6	%
Total Risk Based Capital	14.55	%	11.53	%	10	%

At December 31, 2013 and December 31, 2012, the Bank exceeded the minimum capital ratios to be considered “well capitalized”. However, since July 22, 2010 the Bank has been operating under a Consent Order with the FDIC, and as of December 31, 2013 and December 31, 2012, the Bank was considered to be “Adequately Capitalized” under the regulatory standards. As an “Adequately Capitalized” institution, the Bank is not allowed to issue new brokered certificates of deposit or to replace maturing brokered certificates of deposit without a waiver from the FDIC. The Bank maintains a high level of liquidity and its balance sheet management strategy involves reducing the use of out of market funding, so the capital classification does not have an impact on the Bank’s operations. The Consent Order from the FDIC is a written agreement the Bank has with its regulators requiring, among other things, improvement in our capital ratios and asset quality.As a part of this written agreement, the Bank agreed to take certain actions to improve the Bank's credit administration and developed a written plan to target a minimum Tier 1 Leverage Capital ratio of 9% and a Total Risked Based Capital ratio of 12%.

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On December 23, 2013, the Company entered into securities purchase agreements (the “Purchase Agreements”) with Castle Creek Capital Partners IV, LP, an affiliate of Castle Creek Capital (“Castle Creek”), and Patriot Financial Partners II, L.P. and Patriot Financial Partners Parallel II, L.P. (together, “Patriot” and, collectively with Castle Creek, the “Investors”) pursuant to which the Investors agreed to invest in private placement transactions an aggregate of $14.0 million in the Company in exchange for 3,294,118 newly issued shares of the Company’s no par value common stock (the “Common Stock”).The Company received $7.00 million through the issuance and sale of 1,647,059 shares of Common Stock to Patriot, and $4.25 million through the issuance and sale of 1,000,000 shares of Common Stock to Castle Creek on December 23, 2013. Under the terms of the Purchase Agreements, Castle Creek, subject to certain regulatory terms and conditions, purchased an additional 647,059 shares in exchange for $2.75 million ($4.25 per share of Common Stock) on March 3, 2014.

The Bank’s Tier 1 Leverage Capital ratio increased from 6.38% at December 31, 2012 to 8.48% at December 31, 2013. The Total Risk Based Capital ratio increased from 11.46% at December 31, 2012 to 14.36% at December 31, 2013. The Company expects to attain the 9% Tier 1 Leverage Ratio target set forth in the Consent Order during 2014. As of December 31, 2013, the Bank’s Tier 1 Capital was $99.2 million, or 8.48% of its average total assets. The Bank needs $6.1 million in additional Tier 1 Capital, or a total of $105.3 million of Tier 1 to comply with the 9% Tier 1 Leverage ratio target required by the Consent Order.

The following table shows the investment portfolio for the last three years (000s omitted).

	Held to Maturity
	December 31, 2013				December 31, 2012				December 31, 2011
			Estimated				Estimated				Estimated
	Amortized		Market		Amortized		Market		Amortized		Market
	Cost		Value		Cost		Value		Cost		Value
U.S. Government agency and corporation obligations	$	-	$	-	$	-	$	-	$	-	$	-
Mortgage Backed Securities issued by U.S. Government Agencies		-		-		-		-		-		-
Securities issued by states and political subdivisions in the U.S.		34,346		34,539		38,286		39,630		35,364		35,812
Corporate Debt Securities		500		500		500		500		-		-
Total	$	34,846	$	35,039	$	38,786	$	40,130	$	35,364	$	35,812
Pledged securities	$	25	$	25	$	335	$	339	$	1,111	$	1,125

	Available for Sale
	December 31, 2013				December 31, 2012				December 31, 2011
			Estimated				Estimated				Estimated
	Amortized		Market		Amortized		Market		Amortized		Market
	Cost		Value		Cost		Value		Cost		Value
U.S. Government agency and corporation obligations (excluding mortgage-backed securities)	$	277,383	$	266,713	$	222,099	$	225,451	$	161,483	$	165,532
Mortgage Backed Securities issued by U.S. Government Agencies		97,168		96,526		127,082		129,818		156,883		160,168
Securities issued by states and political subdivisions in the U.S.		15,197		15,363		17,804		18,370		14,616		15,178
Trust Preferred CDO Securities		9,509		5,751		9,525		5,406		9,542		5,467
Corporate Debt Securities		7,967		8,071		11,961		12,077		6,070		5,979
Other domestic securities (debt and equity)		2,584		2,532		2,580		2,645		2,567		2,575
Total	$	409,808	$	394,956	$	391,051	$	393,767	$	351,161	$	354,899
Pledged securities	$	108,454	$	107,925	$	131,678	$	137,706	$	131,616	$	137,220

25

 

The following table shows average daily balances, interest income or expense amounts, and the resulting average rates for interest earning assets and interest bearing liabilities for the last three years. Also shown are the net interest income, total interest rate spread, and the net interest margin for the same periods.

	Years Ended December 31,
	2013						2012						2011
	Average		Interest				Average		Interest				Average		Interest
	Daily		Earned		Average		Daily		Earned		Average		Daily		Earned		Average
(Dollars in Thousands)	Balance		or Paid		Yield		Balance		or Paid		Yield		Balance		or Paid		Yield
Investments
Interest Bearing Balances      Due From Banks	$	57,200	$	146	0.26	%	$	76,079	$	195	0.26	%	$	58,558	$	151	0.26	%
Obligations of US      Government Agencies		361,345		6,367	1.76	%		332,119		6,944	2.09	%		304,422		7,722	2.54	%
Obligations of States &      Political Subdivisions1		50,220		1,475	2.94	%		48,355		1,552	3.21	%		43,235		1,542	3.57	%
Other Securities		30,286		780	2.58	%		28,204		794	2.82	%		20,720		433	2.09	%
Total Investments		499,051		8,768	1.76	%		484,757		9,485	1.96	%		426,935		9,848	2.31	%
Loans
Commercial		433,702		21,455	4.95	%		459,797		24,423	5.31	%		495,581		27,380	5.52	%
Mortgage		167,320		7,848	4.69	%		186,778		9,239	4.95	%		204,311		10,469	5.12	%
Consumer		12,824		1,167	9.10	%		14,125		1,388	9.83	%		17,880		1,863	10.42	%
Total Loans2		613,846		30,470	4.96	%		660,700		35,050	5.30	%		717,772		39,712	5.53	%
Federal Funds Sold		-		-	n/a			-		-	n/a			41		-	n/a
Total Interest Earning Assets		1,112,897		39,238	3.53	%		1,145,457		44,535	3.89	%		1,144,748		49,560	4.33	%
Cash & Non Interest Bearing      Due From Banks		14,756						18,187						18,207
Interest Receivable and Other Assets		89,734						77,524						86,614
Total Assets	$	1,217,387					$	1,241,168					$	1,249,569
Savings Accounts	$	159,308	$	88	0.06	%	$	141,949	$	194	0.14	%	$	121,378	$	219	0.18	%
Interest Bearing DDA & NOW Accounts		217,328		250	0.12	%		161,545		286	0.18	%		109,587		266	0.24	%
Money Market Deposits		219,905		313	0.14	%		244,710		555	0.23	%		267,650		758	0.28	%
Certificates of Deposit		263,707		3,663	1.39	%		308,116		5,295	1.72	%		376,806		9,455	2.51	%
Fed Funds Purch & Other Borrowings		47		4	8.51	%		138		11	7.97	%		135		11	8.50	%
Repurchase Agreements		15,000		707	4.71	%		17,842		828	4.64	%		23,918		1,101	4.60	%
FHLB Advances		48,096		1,012	2.10	%		107,000		2,717	2.54	%		111,197		2,623	2.36	%
Total Interest Bearing Liabilities		923,391		6,037	0.65	%		981,300		9,886	1.01	%		1,010,671		14,433	1.43	%
Non-interest Bearing Deposits		190,814						169,592						155,504
Other Liabilities		15,687						12,977						10,370
Total Liabilities		1,129,892						1,163,869						1,176,545
Stockholders' Equity		87,495						77,299						73,024
Total Liabilities & Stockholders' Equity	$	1,217,387					$	1,241,168					$	1,249,569
Net Interest Income			$	33,201					$	34,649					$	35,127
Interest Rate Spread					2.88	%					2.88	%					2.90	%
Net Interest Income as a percent of      average earning assets					2.98	%					3.02	%					3.07	%

¹Interest income on Obligations of States and Political Subdivisions is not on a taxable equivalent basis.

²Total Loans excludes Overdraft Loans, which are non-interest earning. These loans are included in Other Assets. Total Loans includes nonaccrual loans. When a loan is placed in nonaccrual status, all accrued and unpaid interest is charged against interest income. Loans on nonaccrual status do not earn any interest.

26

The following table summarizes the changes in interest income and interest expense attributable to changes in interest rates and changes in the volume of interest earning assets and interest bearing liabilities for the period indicated:

	Years Ended December 31,
	2013 versus 2012						2012 versus 2011						2011 versus 2010
	Changes due to						Changes due to						Changes due to
	increased (decreased)						increased (decreased)						increased (decreased)
(Dollars in Thousands)	Rate		Volume		Net		Rate		Volume		Net		Rate		Volume			Net
Interest Income
Investments
Interest Bearing Balances      Due From Banks	$	-	$	(49)	$	(49)	$	(1)	$	45	$	44	$	(3)	$	23		$	20
Obligations of US      Government Agencies		(1,188)		611		(577)		(1,480)		702		(778)		(1,555)		1,388			(167)
Obligations of States &      Political Subdivisions		(137)		60		(77)		(173)		183		10		(196)		(216)			(412)
Other Securities		(73)		59		(14)		205		156		361		(124)		(45)			(169)
Total Investments		(1,398)		681		(717)		(1,449)		1,086		(363)		(1,878)		1,150			(728)
Loans
Commercial		(1,582)		(1,386)		(2,968)		(980)		(1,977)		(2,957)		(668)		(3,336)			(4,004)
Mortgage		(428)		(963)		(1,391)		(332)		(898)		(1,230)		(283)		1,731	��		1,448
Consumer		(94)		(127)		(221)		(83)		(392)		(475)		621		(4,363)			(3,742)
Total Loans		(2,104)		(2,476)		(4,580)		(1,395)		(3,267)		(4,662)		(330)		(5,968)			(6,298)
Federal Funds Sold		-		-		-		-		-		-		-		-			-
Total Interest Income		(3,502)		(1,795)		(5,297)		(2,844)		(2,181)		(5,025)		(2,208)		(4,818)			(7,026)
Interest Expense
Savings Accounts		(130)		24		(106)		(62)		37		(25)		(99)		18			(81)
Interest Bearing DDA and NOW Accounts		(134)		98		(36)		(106)		126		20		(313)		34			(279)
Money Market Deposits		(186)		(56)		(242)		(138)		(65)		(203)		(230)		5			(225)
Certificates of Deposit		(869)		(763)		(1,632)		(2,437)		(1,723)		(4,160)		(1,268)		(543)			(1,811)
Fed Funds Purch & Other Borrrowings		0		(7)		(7)		0		0		-		11		0			11
Repurchase agreements		11		(132)		(121)		7		(280)		(273)		(6)		(281)			(287)
FHLB Advances		(209)		(1,496)		(1,705)		194		(100)		94		(1,063)		(1,590)			(2,653)
Total Interest Expense		(1,517)		(2,332)		(3,849)		(2,542)		(2,005)		(4,547)		(2,968)		(2,357)			(5,325)
Net Interest Income	$	(1,985)	$	537	$	(1,448)	$	(302)	$	(176)	$	(478)	$	760	$	(2,461)		$	(1,701)

For a variety of reasons, including volatile economic conditions, fluctuating interest rates, and large amounts of local municipal deposits, we have attempted, for the last several years, to maintain a liquid investment position. The percentage of securities held as Available for Sale was 91.9% as of December 31, 2013 and 91.0% as of December 31, 2012. The percentage of securities that mature within five years was 15.3% as of December 31, 2013 and 16.7% as of December 31, 2012. The following table presents the scheduled maturities for each of the investment categories, and the average yield on the amounts maturing. The yields presented for the Obligations of States and Political Subdivisions are not tax equivalent yields. The interest income on a portion of these securities is exempt from federal income tax. The Corporation’s statutory federal income tax rate was thirty-four percent in 2013.

27

	Maturing
	Within 1 year				1 - 5 years				5 - 10 Years				Over 10 Years				Total
	Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield		Amount		Yield
(Dollars in Thousands)
Obligations of US      Government Agencies	$	-	0.00	%	$	31,205	1.27	%	$	229,285	1.85	%	$	6,223	2.02	%	$	266,713	1.79	%
Mortgage Backed Securities      issued by US Gov't      Agencies		-	0.00	%		-	0.00	%		5,736	2.81	%		90,790	2.92	%		96,526	2.91	%
Obligations of States &      Political      Subdivisions		10,182	1.83	%		16,012	2.49	%		18,352	3.66	%		5,163	4.38	%		49,709	2.98	%
Trust Preferred CDO Securities		-	0.00	%		-	0.00	%		-	0.00	%		5,751	1.07	%		5,751	1.07	%
Corporate Debt Securities		-	0.00	%		8,571	2.12	%		-	0.00	%		-	0.00	%		8,571	2.12	%
Other Securities		-	0.00	%		-	0.00	%		-	0.00	%		2,532	0.00	%		2,532	0.00	%
Total	$	10,182	1.83	%	$	55,788	1.75	%	$	253,373	2.00	%	$	110,459	2.77	%	$	429,802	2.16	%

Our loan policies also reflect our awareness of the need for liquidity.We have short average terms for most of our loan portfolios, in particular real estate mortgages, the majority of which are normally written for five years or less. The following table shows the maturities or repricing opportunities (whichever is earlier) for the Bank’s interest earning assets and interest bearing liabilities at December 31, 2013. The repricing assumptions shown are consistent with those established by the Bank’s Asset and Liability Management Committee (ALCO). Savings accounts and interest bearing demand deposit accounts are non-maturing, variable rate deposits, which may reprice as often as daily, but are not included in the zero to six month category because in actual practice, these deposits are only repriced if there is a large change in market interest rates. The effect of including these accounts in the zero to six-month category is depicted in a subsequent table. Money Market deposits are also non-maturing, variable rate deposits; however, these accounts are included in the zero to six-month category because they may get repriced following smaller changes in market rates.

	Assets/Liabilities at December 31, 2013, Maturing or Repricing in:
	0 - 6		6 - 12		1 - 2		2 - 5		Over 5		Total
(Dollars in Thousands)	Months		Months		Years		Years		Years		Amount
Interest Earning Assets
US Treas Secs & Obligations of      US Gov't Agencies	$	222,365	$	9,726	$	32,070	$	44,913	$	54,165	$	363,239
Obligations of States & Political      Subdivisions		16,621		1,331		5,871		21,156		4,730		49,709
Other Securities		10,751		-		2,000		500		3,603		16,854
Commercial Loans		101,526		36,747		51,868		201,077		15,986		407,204
Mortgage Loans		20,855		29,686		15,705		31,246		15,177		112,669
Consumer Loans		30,538		3,651		4,241		12,698		1,158		52,286
Interest Bearing DFB		62,350		-		-		-		-		62,350
Total Interest Earning Assets	$	465,006	$	81,141	$	111,755	$	311,590	$	94,819	$	1,064,311
Interest Bearing Liabilities
Savings Deposits	$	369,217	$	-	$	-	$	-	$	-	$	369,217
Other Time Deposits		74,823		58,805		48,784		55,654		-		238,066
FHLB Advances		12,000		-		-		-		-		12,000
Repurchase Agreements		-		-		-		15,000		-		15,000
Total Interest Bearing Liabilities	$	456,040	$	58,805	$	48,784	$	70,654	$	-	$	634,283
Gap	$	8,966	$	22,336	$	62,971	$	240,936	$	94,819	$	430,028
Cumulative Gap	$	8,966	$	31,302	$	94,273	$	335,209	$	430,028	$	430,028
Sensitivity Ratio		1.02		1.38		2.29		4.41		n/a		1.68
Cumulative Sensitivity Ratio		1.02		1.06		1.17		1.53		1.68		1.68

28

 

If savings and interest bearing demand deposit accounts were included in the zero to six months category, the Bank’s gap would be as shown in the following table:

	Assets/Liabilities at December 31, 2013, Maturing or Repricing in:
	0-6		6-12		1-2		2-5		Over 5
	Months		Months		Years		Years		Years		Total
Total Interest Earning Assets	$	465,006	$	81,141	$	111,755	$	311,590	$	94,819	$	1,064,311
Total Interest Bearing Liabilities	$	757,640	$	58,805	$	48,784	$	70,654	$	-	$	935,883
Gap	$	(292,634)	$	22,336	$	62,971	$	240,936	$	94,819	$	128,428
Cumulative Gap	$	(292,634)	$	(270,298)	$	(207,327)	$	33,609	$	128,428	$	128,428
Sensitivity Ratio		0.61		1.38		2.29		4.41		n/a		1.14
Cumulative Sensitivity Ratio		0.61		0.67		0.76		1.04		1.14		1.14

The amount of loans due after one year with floating interest rates is $132,656,000. The amount of loans due after one year with fixed interest rates is $325,608,000

The following table shows the remaining maturity for Certificates of Deposit with balances of $100,000 or more as of December 31 (000s omitted):

	Years Ended December 31,
(Dollars in Thousands)	2013		2012		2011
Maturing Within
3 Months	$	17,383	$	18,365	$	18,623
3 - 6 Months		10,596		13,498		19,673
6 - 12 Months		22,538		20,807		17,816
Over 12 Months		32,078		45,128		56,231
Total	$	82,595	$	97,798	$	112,343

For 2014, we expect the FOMC to keep the fed funds target rate between zero and one-quarter percent all year. We also expect the fed to continue to taper its bond purchases, keeping longer term rates in the same range throughout the year. Other factors in the economic environment, such as elevated unemployment rates and low real estate values, will continue to improve, and opportunities for lending activity will continue to increase in 2014. In the near term, our focus will be on controlling our asset quality, pursuing new lending opportunities, and improving our earnings by improving our net interest income and non-interest income and controlling our non-interest expenses. Both the Consent Order entered into by the Bank with the FDIC in July, 2010, and the Bank’s internal capital policy require maintaining higher levels of capital than the federal banking regulators require in order to have a regulatory capital classification of “well capitalized.” Based on our earnings expectations and our current capital levels, we expect to reach our targeted level of capital in 2014. As a result, we expect an improvement in our net interest margin but not a significant change in our net interest income in 2014.

In 2013 our provision for loan losses was significantly less than in 2012, due to a decrease in actual losses recognized and a decrease in the amount of Allowance for Loan Losses required. We believe that our Allowance for Loan Losses provides adequate coverage for the losses in our portfolio, and because we expect asset quality to continue to improve in 2014, we expect that we will be able to maintain the adequacy of the allowance while recording a provision for loan losses expense that is less than our net charge offs again in 2014. We also expect the net charge offs to be lower in 2014 due to the improvements in the asset quality and the economic environment.

We anticipate that non interest income will be little changed as improvement in wealth management income will be offset by a reduction in the gains on sales of investment securities. We expect non-interest expenses to be flat in 2014 compared to 2013 as lower losses on OREO sales and write downs and lower OREO holding costs will be offset by higher employee costs and increased marketing expenses.

29

The following table shows the loan portfolio for the last five years (000s omitted).

	Book Value at December 31,
	2013		2012		2011		2010		2009
Domestic Loans:
Agriculture and Agricultural Real Estate	$	14,997	$	12,004	$	15,931	$	20,453	$	17,470
Commercial and industrial		59,440		58,194		63,762		76,783		93,865
Commercial Real Estate		265,912		283,014		307,075		323,351		351,027
Construction Real Estate		14,667		18,419		23,423		46,310		64,520
Residential Real Estate		228,024		240,332		255,555		269,153		299,287
Consumer and Other		14,550		15,286		13,729		16,837		22,810
Total loans and leases, net of unearned income	$	597,590	$	627,249	$	679,475	$	752,887	$	848,979
Nonaccrual loans	$	23,710	$	31,343	$	51,066	$	67,581	$	56,938
Loans 90 days or more past due and accruing	$	46	$	1	$	20	$	4	$	20
Troubled debt restructurings	$	32,450	$	38,460	$	24,774	$	14,098	$	29,102

The Troubled Debt Restructurings reported in the table above are performing in accordance with the terms of the restructuring. Troubled Debt Restructurings that are not performing are included in the Nonaccrual amounts reported above. The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. In all cases, loans are placed on nonaccrual or charged off at an earlier date if principal or interest is considered doubtful. Interest paid on nonaccrual loans is applied to the principal balance outstanding, so no interest income was recognized on nonaccrual loans in 2013. If the nonaccrual loans outstanding as of December 31, 2013 had been current in accordance with their original terms, the Bank would have recorded $2,725,000 in gross interest income on those loans during 2013.

The following is an analysis of the transactions in the allowance for loan losses:

	Years Ended December 31,
(Dollars in Thousands)	2013			2012			2011			2010			2009
Balance Beginning of Period	$	17,299		$	20,865		$	21,223		$	24,063		$	18,528
Loans Charged Off (Domestic)
Agriculture and Agricultural Real Estate		-			97			-			-			932
Commercial		928			499			1,893			2,907			6,186
Commercial Real Estate		2,920			8,156			7,456			10,024			6,362
Construction Real Estate		103			1,036			2,177			5,303			8,858
Residential Real Estate		1,391			2,031			4,097			5,370			9,021
Consumer and Other		282			196			249			951			635
Recoveries (Domestic)
Agriculture and Agricultural Real Estate		5			-			1			1			-
Commercial		349			347			376			219			607
Commercial Real Estate		811			80			324			295			241
Construction Real Estate		352			240			81			22			126
Residential Real Estate		661			274			689			119			227
Consumer and Other		156			158			243			559			328
Net Loans Charged Off		3,290			10,916			14,158			23,340			30,465
Provision Charged to Operations		2,200			7,350			13,800			20,500			36,000
Balance End of Period	$	16,209		$	17,299		$	20,865		$	21,223		$	24,063
Ratio of Net Loans Charged Off to      Average Total Loans Outstanding		0.54	%		1.65	%		1.97	%		2.89	%		3.36	%

30

The following analysis shows the allocation of the allowance for loan losses:

	Years Ended December 31,
	2013				2012				2011				2010				2009
	$		% of loans		$		% of loans		$		% of loans		$		% of loans		$		% of loans
(Dollars in Thousands)	Amount		to total loans		Amount		to total loans		Amount		to total loans		Amount		to total loans		Amount		to total loans
Balance at end of period applicable to:
Domestic
Agriculture and Agricultural Real Estate	$	171	2.5	%	$	76	1.9	%	$	64	2.3	%	$	77	2.7	%	$	142	2.1	%
Commercial		1,989	9.9	%		2,224	9.3	%		2,184	9.4	%		3,875	10.2	%		6,360	11.0	%
Commercial Real Estate		7,030	44.5	%		7,551	45.2	%		9,351	45.2	%		9,040	43.0	%		8,331	41.3	%
Construction Real Estate		1,397	2.5	%		2,401	2.9	%		2,632	3.4	%		3,285	6.1	%		2,351	7.6	%
Residential Real Estate		4,606	38.2	%		4,715	38.3	%		6,227	37.7	%		4,596	35.8	%		6,382	35.3	%
Consumer and Other		1,016	2.4	%		332	2.4	%		407	2.0	%		350	2.2	%		497	2.7	%
Foreign		-	0.0	%		-	0.0	%		-	0.0	%		-	0.0	%		-	0.0	%
Total	$	16,209	100.0	%	$	17,299	100.0	%	$	20,865	100.0	%	$	21,223	100.0	%	$	24,063	100.0	%

Each period the provision for loan losses in the statement of operations results from the combination of an estimate by Management of loan losses that occurred during the current period and the ongoing adjustment of prior estimates of losses.

To serve as a basis for making this provision, the Bank maintains an extensive credit risk monitoring process that considers several factors including: current economic conditions affecting the Bank’s customers, the payment performance of individual loans and pools of homogeneous loans, portfolio seasoning, changes in collateral values, and detailed reviews of specific loan relationships. For loans deemed to be impaired due to an expectation that all contractual payments will probably not be received, impairment is measured by comparing the Bank’s recorded investment in the loan to the present value of expected cash flows discounted at the loan’s effective interest rate, the fair value of the collateral, or the loan’s observable market price. Year-end nonperforming assets, which include nonaccrual loans, loans ninety days or more past due, renegotiated debt, nonaccrual securities, and other real estate owned, decreased $18.0 million, or 20.7%, from 2012 to 2013. Nonperforming assets as a percent of total assets at year-end decreased from 6.9% in 2012 to 5.7% in 2013. The Allowance for Loan Losses as a percent of nonperforming loans at year-end increased from 24.8% in 2012 to 28.8% in 2013.

The provision for loan losses increases the allowance for loan losses, a valuation account which appears on the consolidated statements of condition. As the specific customer and amount of a loan loss is confirmed by gathering additional information, taking collateral in full or partial settlement of the loan, bankruptcy of the borrower, etc., the loan is charged off, reducing the allowance for loan losses. If, subsequent to a charge off, the Bank is able to collect additional amounts from the customer or sell collateral worth more than earlier estimated, a recovery is recorded.

Contractual Obligations –The following table shows the Corporation’s contractual obligations.

	Payment Due by Period
			Less than		1 - 3		3 - 5		Over 5
(Dollars in Thousands)	Total		1 year		Years		Years		Years
Long Term Debt Obligations	$	27,000	$	12,000	$	15,000	$	-	$	-
Operating Lease Obligations		335		171		84		43		37
Salary Continuation Obligations		1,077		58		116		116		787
Total Contractual Obligations	$	28,412	$	12,229	$	15,200	$	159	$	824

Off-Balance Sheet Arrangements –Please see Note 17 to the audited financial statements provided under Item 8 to this Annual Report for information regarding the Corporation’s off-balance sheet arrangements.

 

31

 

Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Market risk for the Bank, as is typical for most banks, consists mainly of interest rate risk and market price risk. The Bank’s earnings and the economic value of its equity are exposed to interest rate risk and market price risk, and monitoring this risk is the responsibility of the Asset/Liability Management Committee (ALCO) of the Bank, which committee monitors such risk on a monthly basis.

The Bank faces market risk to the extent that the fair values of its financial instruments are affected by changes in interest rates. The Bank does not face market risk due to changes in foreign currency exchange rates, commodity prices, or equity prices. The asset and liability management process of the Bank seeks to monitor and manage the amount of interest rate risk. This is accomplished by analyzing the differences in repricing opportunities for assets and liabilities (gap analysis, as shown in Item 7), by simulating operating results under varying interest rate scenarios, and by estimating the change in the net present value of the Bank’s assets and liabilities due to interest rate changes.

Each month, ALCO, which includes the senior management of the Bank, estimates the effect of interest rate changes on the projected net interest income of the Bank. The sensitivity of the Bank’s net interest income to changes in interest rates is measured by using a computer based simulation model to estimate the impact on earnings of gradual increases or decreases of 100, 200, and 300 basis points in the prime rate. The net interest income projections are compared to a base case projection, which assumes no changes in interest rates. The table below summarizes the net interest income sensitivity as of December 31, 2013 and 2012.

	Base		Rates			Rates			Rates			Rates			Rates			Rates
(Dollars in Thousands)	Projection		Up 1%			Up 2%			Up 3%			Down 1%			Down 2%			Down 3%
Year-End 2013 12 Month Projection
Interest Income	$	38,072	$	39,264		$	40,447		$	41,647		$	37,373		$	36,614		$	38,123
Interest Expense		4,201		4,453			4,708			4,960			4,157			4,123			4,105
Net Interest Income	$	33,871	$	34,811		$	35,739		$	36,687		$	33,216		$	32,491		$	34,018
Percent Change From Base Projection				2.8	%		5.5	%		8.3	%		-1.9	%		-4.1	%		0.4	%
ALCO Policy Limit (+/-)				5.0	%		7.5	%		10.0	%		5.0	%		7.5	%		10.0	%

	Base		Rates			Rates			Rates			Rates			Rates			Rates
(Dollars in Thousands)	Projection		Up 1%			Up 2%			Up 3%			Down 1%			Down 2%			Down 3%
Year-End 2012 12 Month Projection
Interest Income	$	37,843	$	39,469		$	41,084		$	42,660		$	36,967		$	35,996		$	35,131
Interest Expense		7,938		8,649			9,365			10,070			7,743			7,722			7,720
Net Interest Income	$	29,905	$	30,820		$	31,719		$	32,590		$	29,224		$	28,274		$	27,411
Percent Change From Base Projection				3.1	%		6.1	%		9.0	%		-2.3	%		-5.5	%		-8.3	%
ALCO Policy Limit (+/-)				5.0	%		7.5	%		10.0	%		5.0	%		7.5	%		10.0	%

The Bank’s ALCO has established limits in the acceptable amount of interest rate risk, as measured by the change in the Bank’s projected net interest income, in its policy. At December 31, 2013, the estimated variability of the net interest income under all rate scenarios was within the policy guidelines. Throughout 2013, the estimated variability of the net interest income was within the Bank’s established policy limits in the rate scenarios analyzed.

The ALCO also monitors interest rate risk by estimating the effect of changes in interest rates on the economic value of the Bank’s equity each month. The actual economic value of the Bank’s equity is first determined by subtracting the fair value of the Bank’s liabilities from the fair value of the Bank’s assets. The fair values are determined in accordance withFair Value Measurement. The Bank estimates the interest rate risk by calculating the effect of market interest rate shocks on the economic value of its equity. For this analysis, the Bank assumes immediate increases or decreases of 100, 200, and 300 basis points in the prime lending rate. The discount rates used to determine the present values of the loans and deposits, as well as the prepayment rates for the loans, are based on Management’s expectations of the effect of the rate shock on the market for loans and deposits. The table below summarizes the amount of interest rate risk to the fair value of the Bank’s assets and liabilities and to the economic value of the Bank’s equity.

32

	Fair Value at December 31, 2013
						Rates
(Dollars in Millions)	Base		Up 1%			Up 2%			Up 3%			Down 1%			Down 2%			Down 3%
Assets	$	1,215,170	$	1,186,803		$	1,157,719		$	1,129,823		$	1,236,620		$	1,248,596		$	1,254,897
Liabilities		1,073,402		1,053,753			1,034,720			1,016,289			1,090,436			1,091,432			1,091,432
Stockholders' Equity	$	141,768	$	133,050		$	122,999		$	113,534		$	146,184		$	157,164		$	163,465
Change in Equity				-6.1	%		-13.2	%		-19.9	%		3.1	%		10.9	%		15.3	%
ALCO Policy Limit (+/-)				10.0	%		20.0	%		30.0	%		10.0	%		20.0	%		30.0	%

	Fair Value at December 31, 2012
						Rates
(Dollars in Millions)	Base		Up 1%			Up 2%			Up 3%			Down 1%			Down 2%			Down 3%
Assets	$	1,312,995	$	1,290,522		$	1,263,229		$	1,235,347		$	1,324,316		$	1,328,017		$	1,330,511
Liabilities		1,184,155		1,163,946			1,144,366			1,125,386			1,197,232			1,197,232			1,197,232
Stockholders' Equity	$	128,840	$	126,576		$	118,863		$	109,961		$	127,084		$	130,785		$	133,279
Change in Equity				-1.8	%		-7.7	%		-14.7	%		-1.4	%		1.5	%		3.4	%
ALCO Policy Limit (+/-)				10.0	%		20.0	%		30.0	%		10.0	%		20.0	%		30.0	%

The Bank’s ALCO has established limits in the acceptable amount of interest rate risk, as measured by the change in economic value of the Bank’s equity, in its policy. Throughout 2013, the estimated variability of the economic value of equity was within the Bank’s established policy limits.

Item 8.Financial Statements and Supplementary Data

Financial Statements and Supplementary Data

See Pages 35 – 69.

33

 

 

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders

MBT Financial Corp. and Subsidiaries

Monroe, Michigan

We have audited the accompanying consolidated balance sheets of MBT Financial Corp. and Subsidiaries (the Corporation) as of December 31, 2013 and 2012, and the related consolidated statements of operations and comprehensive income, changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2013. These financial statements are the responsibility of the Corporation’s management.Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Corporation’s internal control over financial reporting. Accordingly, we express no such opinion.An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of MBT Financial Corp. and Subsidiaries as of December 31, 2013 and 2012, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2013, in conformity with accounting principles generally accepted in the United States of America.

/s/ Plante & Moran, PLLC

Auburn Hills, Michigan

March 14, 2014

 

34

 

Consolidated Balance Sheets

	December 31,
Dollars in thousands	2013		2012
Assets
Cash and Cash Equivalents (Note 2)
Cash and due from banks
Non-interest bearing	$	15,448	$	17,116
Interest bearing		62,350		95,391
Total cash and cash equivalents		77,798		112,507
Securities - Held to Maturity (Note 3)		34,846		38,786
Securities - Available for Sale (Note 3)		394,956		393,767
Federal Home Loan Bank stock - at cost		10,605		10,605
Loans held for sale		668		1,520
Loans (Note 4)		597,590		627,249
Allowance for Loan Losses (Note 5)		(16,209)		(17,299)
Loans - Net		581,381		609,950
Accrued interest receivable and other assets (Note 12)		34,094		10,037
Other Real Estate Owned		9,628		14,262
Bank Owned Life Insurance (Note 9)		50,493		49,111
Premises and Equipment - Net (Note 6)		28,213		28,050
Total assets	$	1,222,682	$	1,268,595
Liabilities
Deposits:
Non-interest bearing	$	215,844	$	183,016
Interest-bearing (Note 7)		853,874		865,814
Total deposits		1,069,718		1,048,830
Federal Home Loan Bank advances (Note 8)		12,000		107,000
Securities sold under repurchase agreements (Note 8)		15,000		15,000
Interest payable and other liabilities (Note 9)		15,356		14,191
Total liabilities		1,112,074		1,185,021
Stockholders' Equity (Notes 10, 13 and 15)
Common stock (no par value; 50,000,000 shares authorized,     20,605,493 and 17,396,179 shares issued and outstanding)		14,671		2,397
Retained Earnings		106,817		81,280
Unearned Compensation		(7)		(27)
Accumulated other comprehensive loss		(10,873)		(76)
Total stockholders' equity		110,608		83,574
Total liabilities and stockholders' equity	$	1,222,682	$	1,268,595

The accompanying notes are an integral part of these statements.

35

 

Consolidated Statements of Operations and Comprehensive Income

		Years Ended December 31,
Dollars in thousands	2013		2012		2011
Interest Income
Interest and fees on loans	$	30,470	$	35,050	$	39,712
Interest on investment securities-
Tax-exempt		1,255		1,405		1,415
Taxable		7,367		7,885		8,282
Interest on balances due from banks		146		195		151
Total interest income		39,238		44,535		49,560
Interest Expense
Interest on deposits (Note 7)		4,314		6,330		10,698
Interest on borrowed funds		1,723		3,556		3,735
Total interest expense		6,037		9,886		14,433
Net Interest Income		33,201		34,649		35,127
Provision For Loan Losses (Note 5)		2,200		7,350		13,800
Net Interest Income After
Provision For Loan Losses		31,001		27,299		21,327
Other Income
Wealth management income		4,351		4,028		3,919
Service charges and other fees		4,325		4,564		4,694
Debit Card Income		2,032		1,998		1,909
Net gain on sales of securities		424		1,280		1,084
Origination fees on mortgage loans sold		702		902		482
Bank owned life insurance income		1,466		1,458		3,607
Other		2,631		2,207		2,535
Total other income		15,931		16,437		18,230
Other Expenses
Salaries and employee benefits (Notes 9 and 15)		21,520		20,313		19,475
Occupancy expense (Note 6)		3,053		2,677		3,103
Equipment expense		2,679		2,915		2,941
Marketing expense		725		701		849
Professional fees		1,965		2,263		2,477
Collection expense		193		238		233
Net loss on other real estate owned		1,442		1,078		3,561
Other real estate owned expense		1,001		1,496		2,108
FDIC insurance premium		2,773		2,744		2,947
Death benefit obligation expense		-		-		1,639
Other		4,157		4,269		3,486
Total other expenses		39,508		38,694		42,819
Income (Loss) Before Provision For Income Taxes		7,424		5,042		(3,262)
Provision For (Benefit From) Income Taxes (Note 12)		(18,113)		(3,503)		500
Net Income (Loss)	$	25,537	$	8,545	$	(3,762)
Other Comprehensive Income (Net of Tax)
Unrealized gains (losses) on securities		(11,315)		171		6,088
Reclassification adjustment for gains     included in net income		(280)		(845)		(716)
Postretirement benefit liability		798		(366)		50
Total Other Comprehensive Income (Loss), net of tax		(10,797)		(1,040)		5,422
Comprehensive Income	$	14,740	$	7,505	$	1,660
Basic Earnings (Loss) Per Common Share (Note 14)	$	1.43	$	0.49	$	(0.22)
Diluted Earnings (Loss) Per Common Share (Note 14)	$	1.41	$	0.49	$	(0.22)

The accompanying notes are an integral part of these statements.

36

 

Consolidated Statements of Changes in Stockholders’ Equity

							Accumulated
							Other
	Common		Retained		Unearned		Comprehensive
Dollars in thousands	Stock		Earnings		Compensation		Income (Loss)		Total
Balance - January 1, 2011	$	2,146	$	76,497	$	(187)	$	(4,458)	$	73,998
Issuance of Common Stock (39,400     shares)		54		-		-		-		54
Stock Offering Expense		(151)		-		-		-		(151)
Equity Compensation		50		-		100		-		150
Comprehensive income:
Net loss		-		(3,762)		-		-		(3,762)
Other comprehensive income - net of      tax		-		-		-		5,422		5,422
Total Comprehensive Income										1,660
Balance - December 31, 2011	$	2,099	$	72,735	$	(87)	$	964	$	75,711
Issuance of Common Stock (104,450     shares)		243		-		-		-		243
Equity compensation		55		-		60		-		115
Comprehensive income:
Net income		-		8,545		-		-		8,545
Other comprehensive loss - net of     tax		-		-		-		(1,040)		(1,040)
Total Comprehensive Income										7,505
Balance - December 31, 2012	$	2,397	$	81,280	$	(27)	$	(76)	$	83,574
Issuance of Common Stock
SOSARs exercised (13,084 shares)		19		-		-		-		19
Restricted stock units (20,760 shares)		22		-		-		-		22
Other stock issued (3,175,470 shares)		13,096		-		-		-		13,096
Stock Offering Expense		(1,013)		-		-		-		(1,013)
Equity compensation		150		-		20		-		170
Comprehensive income:
Net income		-		25,537		-		-		25,537
Other comprehensive loss - net of tax		-		-		-		(10,797)		(10,797)
Total Comprehensive Income										14,740
Balance - December 31, 2013	$	14,671	$	106,817	$	(7)	$	(10,873)	$	110,608

The accompanying notes are an integral part of these statements.

37

 

Consolidated Statements of Cash Flows

	Years Ended December 31,
Dollars in thousands	2013		2012		2011
Cash Flows from Operating Activities
Net Income (Loss)	$	25,537	$	8,545	$	(3,762)
Adjustments to reconcile net income (loss) to net cash from operating     activities
Provision for loan losses		2,200		7,350		13,800
Depreciation		1,819		1,964		2,021
Increase in net deferred federal income tax asset		(18,155)		(5,000)		(497)
Net amortization of investment premium and discount		1,688		2,092		1,137
Writedowns on other real estate owned		1,708		1,426		3,733
Net increase in interest payable and other liabilities		2,569		1,057		1,457
Net (increase) decrease in interest receivable and other assets		(787)		2,323		4,130
Equity based compensation expense		151		185		150
Net gain on sale/settlement of securities		(424)		(1,280)		(1,084)
Net gain on life insurance claims		-		-		(385)
Increase in cash surrender value of life insurance		(1,382)		(1,458)		(1,583)
Net cash provided by operating activities	$	14,924	$	17,204	$	19,117
Cash Flows from Investing Activities
Proceeds from maturities and redemptions of investment securities held       to maturity	$	20,652	$	13,576	$	11,721
Proceeds from maturities and redemptions of investment securities       available for sale		70,563		289,772		138,264
Proceeds from sales of investment securities available for sale		81,875		53,034		10,365
Net decrease in loans		22,036		29,978		48,097
Proceeds from sales of other real estate owned		8,434		12,024		10,428
Proceeds from sales of other assets		274		166		210
Purchase of investment securities held to maturity		(16,712)		(16,989)		(23,281)
Purchase of bank owned life insurance		-		-		(62)
Proceeds from surrender of bank owned life insurance		-		-		3,654
Proceeds from bank owned life insurance claims		-		-		3,026
Purchase of investment securities available for sale		(172,459)		(383,516)		(204,847)
Purchase of bank premises and equipment		(2,132)		(500)		(968)
Net cash provided by (used for) investing activities	$	12,531	$	(2,455)	$	(3,393)
Cash Flows from Financing Activities
Net increase (decrease) in deposits	$	20,888	$	26,520	$	(9,583)
Repayment of long term debt		(135)		-		-
Repayment of Federal Home Loan Bank borrowings		(95,000)		-		(6,500)
Repayment of repurchase agreements		-		(5,000)		(10,000)
Issuance of common stock		12,083		243		54
Net cash provided by (used for) financing activities	$	(62,164)	$	21,763	$	(26,029)
Net Increase (Decrease) in Cash and Cash Equivalents	$	(34,709)	$	36,512	$	(10,305)
Cash and Cash Equivalents at Beginning of Year (Note 1)		112,507		75,995		86,300
Cash and Cash Equivalents at End of Year (Note 1)	$	77,798	$	112,507	$	75,995
Supplemental Cash Flow Information
Cash paid for interest	$	6,211	$	10,010	$	14,838
Cash paid for federal income taxes	$	-	$	69	$	-
Supplemental Schedule of Non Cash Investing Activities
Transfer of loans to other real estate owned	$	5,058	$	10,702	$	11,001
Transfer of loans to other assets	$	127	$	145	$	94

The accompanying notes are an integral part of these statements.

38

 

Notes To Consolidated Financial Statements

(1)   Summary of Significant Accounting Policies

The consolidated financial statements include the accounts of MBT Financial Corp. (the “Corporation”) and its wholly owned subsidiary, Monroe Bank & Trust (the “Bank”). The Bank includes the accounts of its wholly owned subsidiary, MB&T Financial Services, Inc. The Bank operates seventeen banking offices and a mortgage loan office in Monroe County, Michigan and seven banking offices in Wayne County, Michigan. The Bank’s primary source of revenue is from providing loans to customers, who are predominantly small and middle-market businesses and middle-income individuals. The Corporation’s sole business segment is community banking.

The accounting and reporting policies of the Bank conform to practice within the banking industry and are in accordance with accounting principles generally accepted in the United States. Preparation of financial statements in conformity with generally accepted accounting principles requires Management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near term are the determination of the allowance for loan losses, the fair value of investment securities, and the valuation of other real estate owned and the deferred tax asset.

The significant accounting policies are as follows:

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Corporation and its subsidiary. All material intercompany transactions and balances have been eliminated. Certain prior year amounts have been reclassified to conform to the current year presentation.

SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK

Most of the Corporation's activities are with customers located within southeast Michigan.  Notes 3 and 4 discuss the types of securities and lending that the Corporation engages in. The Corporation does not have any significant concentrations in any one industry or to any one customer.

INVESTMENT SECURITIES

Investment securities that are classified as “held to maturity” are stated at cost, and adjusted for accumulated amortization of premium and accretion of discount.  The Bank has the intention and, in Management’s opinion, the ability to hold these investment securities until maturity. Investment securities that are classified as “available for sale” are stated at estimated market value, with the related unrealized gains and losses reported as an amount, net of taxes, as a component of stockholders’ equity. The market value of securities is based on quoted market prices. For securities that do not have readily available market values, estimated market values are calculated based on the market values of comparable securities.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses.  In estimating other-than-temporary impairment losses, management considers the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, and the intent and ability of the Corporation to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

Management evaluates securities for other-than-temporary impairment (“OTTI”) on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. When evaluating investment securities consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, whether the market decline was affected by macroeconomic conditions and whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, or U.S. Government sponsored enterprises, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment. If a security is determined to be other-than-temporarily impaired, but the entity does not intend to sell the security, only the credit portion of the estimated loss is recognized in earnings, with the other portion of the loss recognized in other comprehensive income.

39

LOANS

The Bank grants mortgage, commercial, and consumer loans to customers. Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans.  Interest income is accrued on the unpaid principal balance.  Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

The accrual of interest on loans is discontinued at the time the loan is 90 days delinquent unless the credit is well secured and in the process of collection. In all cases, loans are placed on nonaccrual or charged off at an earlier date if principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash basis or cost recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

FEDERAL HOME LOAN BANK STOCK

The Bank is a member of the Federal Home Loan Bank of Indianapolis (FHLBI). Members are required to own a certain amount of stock based on the level of borrowings and other factors. Stock in the FHLBI is recorded at redemption value which approximates fair value. The Company periodically evaluates the FHLBI stock for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income.

LOANS HELD FOR SALE

Loans held for sale consist of fixed rate residential mortgage loans with maturities of15 to30 years. Such loans are recorded at the lower of aggregate cost or estimated fair value.

ALLOWANCE FOR LOAN LOSSES

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific and general components. The specific component relates to loans that are classified as non-accrual or renegotiated. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience, adjusted for qualitative factors.

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

Troubled debt restructuring of loans is undertaken to improve the likelihood that the loan will be repaid in full under the modified terms in accordance with a reasonable repayment schedule. All modified loans are evaluated to determine whether the loans should be reported as Troubled Debt Restructurings (TDR). A loan is a TDR when the Bank, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower by modifying a loan. To make this determination, the Bank must determine whether (a) the borrower is experiencing financial difficulties and (b) the Bank granted the borrower a concession. This determination requires consideration of all of the facts and circumstances surrounding the modification. An overall general decline in the economy or some deterioration in a borrower’s financial condition does not automatically mean the borrower is experiencing financial difficulties.

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Large groups of homogeneous loans are collectively evaluated for impairment. Accordingly, the Corporation does not separately identify individual consumer and residential loans for impairment disclosures.

FORECLOSED ASSETS (INCLUDES OTHER REAL ESTATE OWNED)

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of fair value less costs to sell or the loan carrying amount at the date of the foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by Management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed assets.

BANK PREMISES AND EQUIPMENT

Bank premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed generally on the straight-line method over the estimated useful lives of the assets. Upon the sale or other disposition of assets, the cost and related accumulated depreciation are retired and the resulting gain or loss is recognized. Maintenance and repairs are charged to expense as incurred, while renewals and improvements are capitalized. Software costs related to externally developed systems are capitalized at cost less accumulated amortization. Amortization is computed on the straight-line method over the estimated useful life. 

BANK OWNED LIFE INSURANCE

Bank owned life insurance policies are stated at the current cash surrender value of the policy, or the policy death proceeds less any obligation to provide a death benefit to an insured’s beneficiaries if that value is less than the cash surrender value. Increases in the asset value are recorded as earnings in other income.

COMPREHENSIVE INCOME

Accounting principles generally require that revenue, expenses, gains, and losses be included in net income. Certain changes in assets and liabilities, however, such as unrealized gains and losses on securities available for sale, and amounts recognized related to postretirement benefit plans (gains and losses, prior service costs, and transition assets or obligations), are reported as a direct adjustment to the equity section of the balance sheet. Such items, along with net income, are components of comprehensive income.

The components of accumulated other comprehensive income (loss) and related tax effects are as follows:

Dollars in thousands	2013		2012		2011
Unrealized gains (losses) on securities available for sale	$	(14,428)	$	3,997	$	4,822
Reclassification adjustment for losses (gains) realized in income		(424)		(1,280)		(1,084)
Net unrealized gains (losses)	$	(14,852)	$	2,717	$	3,738
Post retirement benefit obligations		(1,624)		(2,832)		(2,277)
Tax effect		5,603		39		(497)
Accumulated other comprehensive income (loss)	$	(10,873)	$	(76)	$	964

CASH AND CASH EQUIVALENTS

For the purpose of the consolidated statement of cash flows, cash and cash equivalents include cash and balances due from banks and federal funds sold which mature within 90 days.

INCOME TAXES

Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the various temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.

STOCK-BASED COMPENSATION

The amount of compensation is measured at the fair value of the awards when granted, and this cost is expensed over the required service period, which is normally the vesting period of the options. Compensation cost is recorded for awards that were granted after January 1, 2006 and prior option grants that vest after January 1, 2006.

The weighted average fair value of options granted was $1.43, $1.11, and $0.80, in 2013, 2012, and 2011, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 2013, 2012, and 2011: expected option lives of seven years for all three; expected volatility of62.09%,60.7%, and53.0%; risk-free interest rates of1.25%,1.40%, and1.90%; and dividend yields of0.00%,0.00%, and3.00%, respectively.

41

OFF BALANCE SHEET INSTRUMENTS

In the ordinary course of business, the Corporation has entered into commitments to extend credit, including commitments under credit card arrangements, commercial letters of credit and standby letters of credit. Such financial instruments are recorded when they are funded. Additional information regarding Off Balance Sheet Instruments is included in Note 17 in these Notes to Consolidated Financial Statements.

FAIR VALUE

The Corporation measures or monitors many of its assets and liabilities on a fair value basis. Fair value is used on a recurring basis for assets and liabilities that are elected to be accounted for under the Fair Value Option as well as for certain assets and liabilities in which fair value is the primary basis of accounting. Examples of these include derivative instruments and available for sale securities. Additionally, fair value is used on a non-recurring basis to evaluate assets or liabilities for impairment or for disclosure purposes. Examples of these non-recurring uses of fair value include certain loans held for sale accounted for on a lower of cost or market basis. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Depending on the nature of the asset or liability, the Corporation uses various valuation techniques and assumptions when estimating fair value.

The Corporation applied the following fair value hierarchy:

Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. The Corporation’s mutual fund investments where quoted prices are available in an active market generally are classified within Level 1 of the fair value hierarchy.

Level 2 – Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. The Corporation’s borrowed funds and investments in U.S. government agency securities, government sponsored mortgage backed securities, and obligations of states and political subdivisions are generally classified in Level 2 of the fair value hierarchy. Fair values for these instruments are estimated using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows.

Level 3 – Inputs to the valuation methodology are unobservable and significant to the fair value measurement. Private equity investments and trust preferred collateralized debt obligations are classified within Level 3 of the fair value hierarchy. Fair values are initially valued based on transaction price and are adjusted to reflect exit values.

When determining the fair value measurements for assets and liabilities required or permitted to be recorded at and/or marked to fair value, the Corporation considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. When possible, the Corporation looks to active and observable markets to price identical assets or liabilities. When identical assets and liabilities are not traded in active markets, the Corporation looks to market observable data for similar assets or liabilities. Nevertheless, certain assets and liabilities are not actively traded in observable markets and the Corporation must use alternative valuation techniques to derive a fair value measurement.

RECENT ACCOUNTING PRONOUNCEMENTS

Accounting Standards Update 2013-02 (ASU 2013-02), “Comprehensive Income: Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income” was issued in February 2013. ASU 2013-02 requires an entity to provide information about the amounts reclassified out of Accumulated Other Comprehensive Income (AOCI) by component. In addition, an entity is required to present, either on the face of the financial statements or in the notes, significant amounts reclassified out of AOCI by the respective line items of net income, but only if the amount reclassified is required to be reclassified in its entirety in the same reporting period. For amounts that are not required to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures that provide additional details about those amounts. ASU 2013-02 does not change the current requirements for reporting net income or other comprehensive income in the financial statements. ASU 2013-02 is effective for interim and annual periods beginning on or after December 15, 2012. The Company adopted ASU 2013-02 on January 1, 2013 by including the required disclosures in Note 3 to the consolidated financial statements.

Accounting Standards Update 2014-04 (ASU 2014-04), “Receivables – Troubled Debt Restructurings by Creditors – Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” was issued in January 2014. ASU 2014-04 clarifies that an in substance foreclosure repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either: (a) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure; or (b) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additional disclosures are required. ASU 2014-04 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2014. The adoption of ASU 2014-04 by the Company is not expected to be material.

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(2) Cash and Due from Banks

The Bank is required by regulatory agencies to maintain legal reserve requirements based on the level of balances in deposit categories. Cash balances restricted from usage due to these requirements were $4,364,000 and $3,223,000 at December 31, 2013 and 2012, respectively. Cash and due from banks includes uninsured deposits held at correspondent banks of $5,378,000 and $0 at December 31, 2013 and 2012, respectively.

(3) Investment Securities

The following is a summary of the Bank’s investment securities portfolio as of December 31, 2013 and 2012 (000s omitted):

	Held to Maturity
	December 31, 2013
			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Market
	Cost		Gains		Losses		Value
Obligations of States and Political
Subdivisions		34,346		557		(364)		34,539
Corporate Debt Securities		500		-		-		500
	$	34,846	$	557	$	(364)	$	35,039

	Held to Maturity
	December 31, 2012
				Gross	Gross		Estimated
	Amortized		Unrealized		Unrealized		Market
	Cost		Gains		Losses		Value
Obligations of States and Political
Subdivisions		38,286		1,380		(36)		39,630
Corporate Debt Securities		500		-		-		500
	$	38,786	$	1,380	$	(36)	$	40,130

	Available for Sale
	December 31, 2013
			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Market
	Cost		Gains		Losses		Value
Obligations of U.S. Government     Agencies	$	277,383	$	1,147	$	(11,817)	$	266,713
Mortgage Backed Securities issued by     U.S. Government Agencies		97,168		995		(1,637)		96,526
Obligations of States and Political     Subdivisions		15,197		289		(123)		15,363
Trust Preferred CDO Securities		9,509		-		(3,758)		5,751
Corporate Debt Securities		7,967		104		-		8,071
Other Securities		2,584		43		(95)		2,532
	$	409,808	$	2,578	$	(17,430)	$	394,956

	Available for Sale
	December 31, 2012
			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Market
	Cost		Gains		Losses		Value
Obligations of U.S. Government     Agencies	$	222,099	$	3,442	$	(90)	$	225,451
Mortgage Backed Securities issued by     U.S. Government Agencies		127,082		2,826		(90)		129,818
Obligations of States and Political     Subdivisions		17,804		630		(64)		18,370
Trust Preferred CDO Securities		9,525		-		(4,119)		5,406
Corporate Debt Securities		11,961		156		(40)		12,077
Other Securities		2,580		173		(108)		2,645
	$	391,051	$	7,227	$	(4,511)	$	393,767

43

The amortized cost, estimated market value, and weighted average yield of securities at December 31, 2013, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties (000s omitted).

	Held to Maturity						Available for Sale
			Estimated		Weighted				Estimated		Weighted
	Amortized		Market		Average		Amortized		Market		Average
	Cost		Value		Yield		Cost		Value		Yield
Maturing within
1 year	$	6,564	$	6,586	1.80	%	$	3,610	$	3,618	2.40	%
1 through 5 years		12,556		12,814	2.66	%		43,894		43,232	1.47	%
6 through 10 years		11,961		11,930	3.73	%		244,768		235,676	1.90	%
Over 10 years		3,765		3,709	4.48	%		17,784		13,372	1.67	%
Total		34,846		35,039	3.06	%		310,056		295,898	1.83	%
Mortgage Backed Securities		-		-	0.00	%		97,168		96,526	2.91	%
Securities with no stated maturity		-		-	0.00	%		2,584		2,532	0.00	%
Total	$	34,846	$	35,039	3.06	%	$	409,808	$	394,956	2.08	%

 

The investment securities portfolio is evaluated for impairment throughout the year. Impairment is recorded against individual securities, unless the decrease in fair value is attributable to interest rates or the lack of an active market, and management determines that the Company has the intent and ability to hold the investment for a period of time sufficient to allow for an anticipated recovery in the market value. The fair values of investments with an amortized cost in excess of their fair values at December 31, 2013 and December 31, 2012 are as follows (000s omitted):

December 31, 2013

	Less than 12 months				12 months or longer				Total
	Aggregate Fair Value		Gross Unrealized Losses		Aggregate Fair Value		Gross Unrealized Losses		Aggregate Fair Value		Gross Unrealized Losses
Obligations of United States     Government Agencies	$	234,264	$	10,828	$	13,614	$	989	$	247,878	$	11,817
Mortgage Backed Securities issued by     U.S. Government Agencies		49,202		1,005		14,544		632		63,746		1,637
Obligations of States and     Political Subdivisions		10,384		321		3,113		166		13,497		487
Trust Preferred CDO Securities		-		-		5,751		3,758		5,751		3,758
Equity Securities		-		-		445		95		445		95
	$	293,850	$	12,154	$	37,467	$	5,640	$	331,317	$	17,794

December 31, 2012

	Less than 12 months				12 months or longer				Total
	Aggregate Fair Value		Gross Unrealized Losses		Aggregate Fair Value		Gross Unrealized Losses		Aggregate Fair Value		Gross Unrealized Losses
Obligations of United States     Government Agencies	$	29,499	$	89	$	1,111	$	1	$	30,610	$	90
Mortgage Backed Securities issued by     U.S. Government Agencies		22,217		90		-		-		22,217		90
Obligations of States and     Political Subdivisions		7,801		90		1,540		10		9,341		100
Trust Preferred CDO Securities		-		-		5,406		4,119		5,406		4,119
Corporate Debt Securities		1,960		40		-		-		1,960		40
Equity Securities		-		-		432		108		432		108
	$	61,477	$	309	$	8,489	$	4,238	$	69,966	$	4,547

The amount of investment securities issued by government agencies, states, and political subdivisions with unrealized losses and the amount of unrealized losses on those investment securities are primarily the result of market interest rates and not the result of the credit quality of the issuers of the securities. The company has the ability and intent to hold these securities until recovery, which may be until maturity. The fair value of these securities is expected to recover as the securities approach maturity. As of December 31, 2013 and December 31, 2012, there were 175 and 42 securities in an unrealized loss position, respectively.

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The Trust Preferred CDO Securities consist of three pooled trust Preferred Collateralized Debt Obligations (CDOs). These CDOs are debt securities issued by special purpose entities that own trust preferred stock issued by banks and insurance companies. The trust preferred stock owned by the special purpose entities is the collateral that backs the debt securities we own. The three pooled CDOs that we own have each been in an unrealized loss position for more than 12 months. These securities have final maturity dates of 2033, 2035, and 2037. The main reasons for the impairment are the overall decline in market values for financial industry securities and the lack of an active market for these types of securities in particular.

To determine whether or not the impairment is other-than-temporary, the Company utilizes a third party valuation service to conduct a fair value analysis of each individual security. The other-than-temporary-impairment analysis of each of the CDO securities owned by the Company is conducted by projecting the expected cash flows from the security, discounting the cash flows to determine the present value of the cash flows, and comparing the present value to the amortized cost to determine if there is impairment. The cash flow projection for each security is developed using estimated prepayment speeds, estimated rates at which payments will be deferred, estimated rates at which issuers will default, and the severity of the losses on the securities which default. Prepayment estimates are negatively impacted by the lack of an active market for issuers to refinance their trust preferred securities; however, prepayment of trust preferred securities is expected to increase prepayment due to recent restrictions on the treatment of trust preferred debt as regulatory capital.

The size and creditworthiness of each institution in the CDO pool are the most significant pieces of evidence in estimating prepayment speeds. Deferral and default rates are the key drivers of the cash flow projections for each of the securities. Deferral of interest payments is allowed for up to five years, and estimates of deferral rates are determined by examining the current deferral status of the issuers, the current financial condition of the issuers, and the historical deferral levels of the issuers in each CDO pool. Key evidence examined includes whether or not an issuer has received TARP funding, the most recent credit ratings from outside services, stock price information, capitalization, asset quality, profitability, and liquidity. The most significant evidence in estimating deferrals is the comparison of key financial ratios to industry benchmarks. Near term (next 12 months) deferral rates are estimated for each security by analyzing the credit characteristics of each individual issuer in the pool. When an issuer is expected to defer interest payments, the analysis assumes that the deferral will continue for the entire five year period allowed and then, depending on the individual credit characteristics of that issuer, begin performing or move to default. Longer term annual default rates for each CDO are estimated using the credit analysis of each individual issuer compared industry benchmarks to modify the historical default rates of financial companies. Finally, loss severity is estimated using analytical research provided by Standard and Poor’s and Moody’s, which supports the assumption that a small percentage of defaulted trust preferred securities recover without loss. The projected cash flows are discounted using the contractual rate of each security.

In the Other-Than-Temporary-Impairment (OTTI) analysis of our CDO securities as of December 31, 2009, it was expected that there would be cash flow disruptions on two of the CDOs we own. These credit losses were recorded through a charge to earnings in 2009. In subsequent analyses in 2010, 2011, 2012, and 2013, the expectation of a disruption of cash flows diminished on both of these CDO securities, with one of the securities no longer expected to experience a disruption of cash flow. The present value of the expected cash flows is at least as great as the amortized costs bases following the charges to earnings recorded in 2009, so no additional charges to earnings have been recorded.

Investment securities carried at $107,950,000 and $138,041,000 were pledged or set aside to secure borrowings, public and trust deposits, and for other purposes required by law at December 31, 2013 and December 31, 2012, respectively.

At December 31, 2013, Obligations of U. S. Government Agencies included securities issued by the Federal Home Loan Banks with an estimated market value of $139,825,000 and securities issued by the Federal Farm Credit Banks with an estimated market value of $126,888,000. At December 31, 2013, Mortgage Backed Securities issued by U. S. Government Agencies included securities issued by the Government National Mortgage Association with an estimated market value of $96,526,000. At December 31, 2012, Obligations of U. S. Government Agencies included securities issued by the Federal Home Loan Banks with an estimated market value of $103,023,000 and Mortgage Backed Securities issued by U. S. Government Agencies included securities issued by the Government National Mortgage Association of $129,820,000.

For the years ended December 31, 2013, 2012, and 2011, proceeds from sales of securities amounted to $81,875,000, $53,034,000, and $10,365,000, respectively. Gross realized gains amounted to $823,000, $1,546,000, and $1,086,000, respectively. Gross realized losses amounted to $399,000, $266,000, and $2,000, respectively. The tax provision applicable to these net realized gains and losses amounted to $144,000, $435,000, and $368,000, respectively.

The sales of securities available for sale resulted in reclassifications of $424,000 ($280,000 net of tax) and $1,280,000 ($845,000 net of tax) from accumulated other comprehensive income to net gain on sales of securities in the consolidated statements of operations in the years ended December 31, 2013 and 2012, respectively.

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(4) Loans

Loan balances outstanding as of December 31 consist of the following (000s omitted):

	2013		2012
Residential real estate loans	$	228,024	$	240,332
Commercial and Construction real estate loans		280,579		301,433
Agriculture and agricultural real estate loans		14,997		12,004
Commercial and industrial loans		59,440		58,194
Loans to individuals for household, family,     and other personal expenditures		14,550		15,286
Total loans, gross	$	597,590	$	627,249
Less: Allowance for loan losses		16,209		17,299
	$	581,381	$	609,950

Included in Loans are loans to certain officers, directors, and companies in which such officers and directors have 10 percent or more beneficial ownership in the aggregate amount of $3,436,000 and $6,455,000 at December 31, 2013 and 2012, respectively. In 2013, new loans and other additions amounted to $414,000, and repayments and other reductions amounted to $3,433,000. In 2012, new loans and other additions amounted to $22,643,000, and repayments and other reductions amounted to $25,707,000. In Management’s judgment, these loans were made on substantially the same terms and conditions as those made to other borrowers, and do not represent more than the normal risk of collectibility or present other unfavorable features.

There were no loans pledged to secure Federal Home Loan Bank advances as of December 31, 2013. As of December 31, 2012, loans carried at $80,567,000 were pledged to secure Federal Home Loan Bank advances.

(5)  Allowance For Loan Losses and Credit Quality of Loans

The Company separates its loan portfolio into segments to perform the calculation and analysis of the allowance for loan losses. The six segments analyzed are Agriculture and Agricultural Real Estate, Commercial, Commercial Real Estate, Construction Real Estate, Residential Real Estate, and Consumer and Other. The Agriculture and Agricultural Real Estate segment includes all loans to finance agricultural production and all loans secured by agricultural real estate. This segment does not include loans to finance agriculture that are secured by residential real estate, which are included in the Residential Real Estate segment. The Commercial segment includes loans to finance commercial and industrial businesses that are not secured by real estate. The Commercial Real Estate segment includes loans secured by non-farm, non-residential real estate. The Construction Real Estate segment includes loans to finance construction and land development. This includes residential and commercial construction and land development. The Residential Real Estate segment includes all loans, other than construction loans, that are secured by single family and multi-family residential real estate properties. The Consumer and Other segment includes all loans not included in any other segment. These are primarily loans to consumers for household, family, and other personal expenditures, such as autos, boats, and recreational vehicles.

Activity in the allowance for loan losses for the years ended December 31, 2013 and 2012 was as follows (000s omitted):

2013	Agriculture and Agricultural Real Estate		Commercial		Commercial Real Estate		Construction Real Estate		Residential Real Estate		Consumer and Other		Total
Allowance for loan losses:
Beginning Balance	$	76	$	2,224	$	7,551	$	2,401	$	4,715	$	332	$	17,299
Charge-offs		-		(928)		(2,920)		(103)		(1,391)		(282)		(5,624)
Recoveries		5		349		811		352		661		156		2,334
Provision		90		344		1,588		(1,253)		621		810		2,200
Ending balance	$	171	$	1,989	$	7,030	$	1,397	$	4,606	$	1,016	$	16,209
Ending balance individually     evaluated for impairment	$	1	$	1,031	$	2,697	$	1,194	$	1,809	$	265	$	6,997
Ending balance collectively     evaluated for impairment		170		958		4,333		203		2,797		751		9,212
Ending balance	$	171	$	1,989	$	7,030	$	1,397	$	4,606	$	1,016	$	16,209
Loans:
Ending balance individually     evaluated for impairment	$	398	$	2,409	$	35,592	$	4,780	$	16,674	$	618	$	60,471
Ending balance collectively     evaluated for impairment		14,599		57,031		230,320		9,887		211,350		13,932		537,119
Ending balance	$	14,997	$	59,440	$	265,912	$	14,667	$	228,024	$	14,550	$	597,590

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2012	Agriculture and Agricultural Real Estate		Commercial		Commercial Real Estate		Construction Real Estate		Residential Real Estate		Consumer and Other		Total
Allowance for loan losses:
Beginning Balance	$	64	$	2,184	$	9,351	$	2,632	$	6,227	$	407	$	20,865
Charge-offs		(97)		(499)		(8,156)		(1,036)		(2,031)		(196)		(12,015)
Recoveries		-		347		80		240		274		158		1,099
Provision		109		192		6,276		565		245		(37)		7,350
Ending balance	$	76	$	2,224	$	7,551	$	2,401	$	4,715	$	332	$	17,299
Ending balance individually     evaluated for impairment	$	-	$	1,316	$	2,084	$	1,820	$	1,994	$	124	$	7,338
Ending balance collectively     evaluated for impairment		76		908		5,467		581		2,721		208		9,961
Ending balance	$	76	$	2,224	$	7,551	$	2,401	$	4,715	$	332	$	17,299
Loans:
Ending balance individually     evaluated for impairment	$	409	$	4,519	$	36,471	$	7,410	$	18,051	$	389	$	67,249
Ending balance collectively     evaluated for impairment		11,595		53,675		246,543		11,009		222,281		14,897		560,000
Ending balance	$	12,004	$	58,194	$	283,014	$	18,419	$	240,332	$	15,286	$	627,249

 

Each period the provision for loan losses in the statement ofoperations results from the combination of an estimate by Management of loan losses that occurred during the current period and the ongoing adjustment of prior estimates of losses occurring in prior periods.

The provision for loan losses increases the allowance for loan losses, a valuation account which appears on the consolidated balance sheets. As the specific customer and amount of a loan loss is confirmed by gathering additional information, taking collateral in full or partial settlement of the loan, bankruptcy of the borrower, etc., the loan is charged off, reducing the allowance for loan losses. If, subsequent to a charge off, the Bank is able to collect additional amounts from the customer or sell collateral worth more than earlier estimated, a recovery is recorded.

To serve as a basis for making this provision, the Bank maintains an extensive credit risk monitoring process that considers several factors including: current economic conditions affecting the Bank’s customers, the payment performance of individual loans and pools of homogeneous loans, portfolio seasoning, changes in collateral values, and detailed reviews of specific loan relationships.

The Company utilizes an internal loan grading system to assign a risk grade to all commercial loans and each credit relationship with more than $250,000 of aggregate credit exposure. Grades 1 through 4 are considered “pass” credits and grades 5 through 9 are considered “watch” credits and are subject to greater scrutiny. Loans with grades 6 and higher are considered substandard and most are evaluated for impairment. A description of the general characteristics of each grade is as follows:

⋅ Grade 1 – Excellent – Loans secured by marketable collateral, with adequate margin, or supported by strong financial statements. Probability of serious financial deterioration is unlikely. Possess a sound repayment source and a secondary source. This classification will also include all loans secured by certificates of deposit or cash equivalents.

⋅ Grade 2 – Satisfactory – Loans that have less than average risk and clearly demonstrate adequate debt service coverage. These loans may have some vulnerability, but are sufficiently strong to have minimal deterioration if adverse factors are encountered, and are expected to be fully collectable.

⋅ Grade 3 – Average – Loans that have a reasonable amount of risk and may exhibit vulnerability to deterioration if adverse factors are encountered. These loans should demonstrate adequate debt service coverage but warrant a higher level of monitoring to ensure that weaknesses do not advance.

⋅ Grade 4 – Pass/Watch – Loans that are considered “pass credits” yet appear on the “watch list”. Credit deficiency or potential weakness may include a lack of current or complete financial information. The level of risk is considered acceptable so long as the loan is given additional management supervision.

⋅ Grade 5 – Watch – Loans that possess some credit deficiency or potential weakness that if not corrected, could increase risk in the future. The source of loan repayment is sufficient but may be considered inadequate by the Bank’s standards.

47

⋅ Grade 6 – Substandard – Loans that exhibit one or more of the following characteristics: (1) uncertainty of repayment from primary source and financial deterioration currently underway; (2) inadequate current net worth and paying capacity of the obligor; (3) reliance on secondary source of repayment such as collateral liquidation or guarantees; (4) distinct possibility the Bank will sustain loss if deficiencies are not corrected; (5) unusual courses of action are needed to maintain probability of repayment; (6) insufficient cash flow to repay principal but continuing to pay interest; (7) the Bank is subordinated or unsecured due to flaws in documentation; (8) loans are restructured or are on nonaccrual status due to concessions to the borrower when compared to normal terms; (9) the Bank is contemplating foreclosure or legal action due to deterioration in the loan; or (10) there is deterioration in conditions and the borrower is highly vulnerable to these conditions.

⋅ Grade 7 – Doubtful – Loans that exhibit one or more of the following characteristics: (1) loans with the weaknesses of Substandard loans and collection or liquidation is not probable to result in payment in full; (2) the primary source of repayment is gone and the quality of the secondary source is doubtful; or (3) the possibility of loss is high, but important pending factors may strengthen the loan.

⋅ Grades 8 & 9 - Loss – Loans are considered uncollectible and of such little value that carrying them on the Bank’s financial statements is not feasible.

The assessment of compensating factors may result in a rating plus or minus one grade from those listed above. These factors include, but are not limited to collateral, guarantors, environmental conditions, history, plan/projection reasonableness, quality of information, and payment delinquency.

The portfolio segments in each credit risk grade as of December 31, 2013 and 2012 are as follows (000s omitted):

	Agriculture
	and
	Agricultural				Commercial		Construction		Residential		Consumer
2013	Real Estate		Commercial		Real Estate		Real Estate		Real Estate		and Other		Total
Not Rated	$	144	$	2,151	$	-	$	3,643	$	141,102	$	9,656	$	156,696
1		-		4,054		-		-		-		194		4,248
2		31		153		931		-		142		-		1,257
3		788		4,000		10,755		99		1,040		-		16,682
4		12,304		34,130		172,592		4,825		53,047		3,743		280,641
5		838		11,594		41,914		2,525		9,005		251		66,127
6		892		3,358		39,720		3,575		23,688		706		71,939
7		-		-		-		-		-		-		-
8		-		-		-		-		-		-		-
9		-		-		-		-		-		-		-
Total	$	14,997	$	59,440	$	265,912	$	14,667	$	228,024	$	14,550	$	597,590
Performing	$	14,428	$	56,941	$	235,531	$	9,732	$	211,149	$	13,603	$	541,384
Nonperforming		569		2,499		30,381		4,935		16,875		947		56,206
Total	$	14,997	$	59,440	$	265,912	$	14,667	$	228,024	$	14,550	$	597,590

	Agriculture
	and
	Agricultural				Commercial		Construction		Residential		Consumer
2012	Real Estate		Commercial		Real Estate		Real Estate		Real Estate		and Other		Total
Not Rated	$	126	$	4,182	$	-	$	2,927	$	159,743	$	10,706	$	177,684
1		-		2,977		-		-		-		-		2,977
2		48		114		1,850		82		731		-		2,825
3		880		4,894		10,735		163		1,885		7		18,564
4		9,907		29,935		167,207		3,184		40,392		16		250,641
5		322		9,713		45,262		5,086		8,426		3,940		72,749
6		721		6,379		57,960		6,977		29,155		617		101,809
7		-		-		-		-		-		-		-
8		-		-		-		-		-		-		-
9		-		-		-		-		-		-		-
Total	$	12,004	$	58,194	$	283,014	$	18,419	$	240,332	$	15,286	$	627,249
Performing	$	11,397	$	54,730	$	246,107	$	10,783	$	219,753	$	14,675	$	557,445
Nonperforming		607		3,464		36,907		7,636		20,579		611		69,804
Total	$	12,004	$	58,194	$	283,014	$	18,419	$	240,332	$	15,286	$	627,249

Loans are considered past due when contractually required payment of interest or principal has not been received. The amount classified as past due is the entire principal balance outstanding of the loan, not just the amount of payments that are past due. The following is a summary of past due loans as of December 31, 2013 and 2012 (000s omitted):

48

													Recorded
													Investment >90
	30-59 Days		60-89 Days		>90 Days		Total Past						Days Past Due
2013	Past Due		Past Due		Past Due		Due		Current		Total  Loans		and Accruing
Agriculture and Agricultural Real Estate	$	210	$	-	$	171	$	381	$	14,616	$	14,997	$	-
Commercial		87		93		210		390		59,050		59,440		46
Commercial Real Estate		1,640		535		3,506		5,681		260,231		265,912		-
Construction Real Estate		90		265		1,177		1,532		13,135		14,667		-
Residential Real Estate		2,612		803		2,342		5,757		222,267		228,024		-
Consumer and Other		150		52		153		355		14,195		14,550		-
Total	$	4,789	$	1,748	$	7,559	$	14,096	$	583,494	$	597,590	$	46

													Recorded
													Investment >90
	30-59 Days		60-89 Days		>90 Days		Total Past						Days Past Due
2012	Past Due		Past Due		Past Due		Due		Current		Total  Loans		and Accruing
Agriculture and Agricultural Real Estate	$	208	$	-	$	145	$	353	$	11,651	$	12,004	$	-
Commercial		927		19		1,100		2,046		56,148		58,194		1
Commercial Real Estate		1,789		930		11,350		14,069		268,945		283,014		-
Construction Real Estate		127		1,437		1,867		3,431		14,988		18,419		-
Residential Real Estate		5,738		978		3,121		9,837		230,495		240,332		-
Consumer and Other		222		61		164		447		14,839		15,286		-
Total	$	9,011	$	3,425	$	17,747	$	30,183	$	597,066	$	627,249	$	1

Loans are placed on non-accrual status when, in the opinion of Management, the collection of additional interest is doubtful. Loans are automatically placed on non-accrual status upon becoming ninety days past due, however, loans may be placed on non-accrual status regardless of whether or not they are past due. All cash received on non-accrual loans is applied to the principal balance. Loans are considered for return to accrual status on an individual basis when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

The following is a summary of non-accrual loans as of December 31, 2013 and 2012 (000s omitted):

	2013		2012
Agriculture and Agricultural Real Estate	$	172	$	198
Commercial		1,035		1,578
Commercial Real Estate		13,289		17,950
Construction Real Estate		2,009		3,438
Residential Real Estate		6,865		7,870
Consumer and Other		340		309
Total	$	23,710	$	31,343

For loans deemed to be impaired due to an expectation that all contractual payments will probably not be received, impairment is measured by comparing the Bank’s recorded investment in the loan to the present value of expected cash flows discounted at the loan’s effective interest rate, the fair value of the collateral, or the loan’s observable market price.

49

 

The following is a summary of impaired loans as of December 31, 2013 and 2012 (000s omitted):

2013	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Agriculture and Agricultural Real Estate	$	-	$	-	$	-	$	-	$	-
Commercial		869		966		-		1,057		51
Commercial Real Estate		19,567		23,005		-		21,074		913
Construction Real Estate		1,165		2,408		-		1,826		88
Residential Real Estate		7,929		9,035		-		8,405		389
Consumer and Other		33		36		-		35		3
With an allowance recorded:
Agriculture and Agricultural Real Estate		398		397		1		642		33
Commercial		1,540		1,627		1,031		1,653		69
Commercial Real Estate		16,025		20,032		2,697		18,310		812
Construction Real Estate		3,615		4,236		1,194		4,109		328
Residential Real Estate		8,745		9,194		1,809		9,168		403
Consumer and Other		585		581		265		596		23
Total:
Agriculture and Agricultural Real Estate	$	398	$	397	$	1	$	642	$	33
Commercial		2,409		2,593		1,031		2,710		120
Commercial Real Estate		35,592		43,037		2,697		39,384		1,725
Construction Real Estate		4,780		6,644		1,194		5,935		416
Residential Real Estate		16,674		18,229		1,809		17,573		792
Consumer and Other		618		617		265		631		26

2012	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Agriculture and Agricultural Real Estate	$	409	$	923	$	-	$	469	$	54
Commercial		2,540		2,961		-		2,968		220
Commercial Real Estate		17,153		21,317		-		18,313		924
Construction Real Estate		1,007		1,375		-		1,284		201
Residential Real Estate		9,013		10,390		-		10,213		373
Consumer and Other		-		-		-		-		-
With an allowance recorded:
Agriculture and Agricultural Real Estate		-		-		-		-		-
Commercial		1,979		2,157		1,316		2,032		88
Commercial Real Estate		19,318		26,508		2,084		22,119		918
Construction Real Estate		6,403		9,060		1,820		6,946		211
Residential Real Estate		9,038		9,520		1,994		9,189		413
Consumer and Other		389		383		124		393		26
Total:
Agriculture and Agricultural Real Estate	$	409	$	923	$	-	$	469	$	54
Commercial		4,519		5,118		1,316		5,000		308
Commercial Real Estate		36,471		47,825		2,084		40,432		1,842
Construction Real Estate		7,410		10,435		1,820		8,230		412
Residential Real Estate		18,051		19,910		1,994		19,402		786
Consumer and Other		389		383		124		393		26

The Bank may agree to modify the terms of a loan in order to improve the Bank’s ability to collect amounts due. These modifications may include reduction of the interest rate, extension of the loan term, or in some cases, reduction of the principal balance. Modifications that are performed due to the debtor’s financial difficulties are considered Troubled Debt Restructurings (TDRs).

50

Loans that were classified as TDRs during the years ended December 31, 2013 and December 31, 2012 are as follows (000s omitted from dollar amounts):

	December 31, 2013					December 31, 2012
	Number of Contracts	Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance		Number of Contracts	Pre- Modification Recorded Principal Balance		Post- Modification Recorded Principal Balance
Agriculture and Agricultural Real Estate	-	$	-	$	-	-	$	-	$	-
Commercial	16		2,635		689	9		1,000		595
Commercial Real Estate	11		2,534		1,626	19		8,334		7,352
Construction Real Estate	-		-		-	7		3,658		3,563
Residential Real Estate	32		3,042		2,205	47		9,524		9,124
Consumer and Other	7		540		295	6		210		198
Total	66	$	8,751	$	4,815	88	$	22,726	$	20,832

The Bank considers TDRs that become past due under the modified terms as defaulted. Loans that became TDRs during the years ended December 31, 2013 and December 31, 2012 that subsequently defaulted during the years ended December 31, 2013 and December 31, 2012, respectively, are as follows (000s omitted from dollar amounts):

	December 31, 2013			December 31, 2012
	Number of Contracts	Recorded Principal Balance		Number of Contracts	Recorded Principal Balance
Agriculture and Agricultural Real Estate	-	$	-	-	$	-
Commercial	2		12	-		-
Commercial Real Estate	-		-	-		-
Construction Real Estate	-		-	-		-
Residential Real Estate	2		33	-		-
Consumer and Other	-		-	-		-
Total	4	$	45	-	$	-

A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Corporation offers various types of concessions when modifying a loan, however, forgiveness of principal is rarely granted. Commercial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor may be requested. Loans modified in a TDR are typically already on nonaccrual status and partial charge-offs have in some cases already been taken against the outstanding loan balance. As a result, loans modified in a TDR for the Corporation may have the financial effect of increasing the specific allowance associated with the loan. The allowance for impaired loans that have been modified in a TDR is measured based on the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent or on the present value of expected future cash flows discounted at the loan’s effective interest rate. Management exercises significant judgment in developing these estimates.

The regulatory guidance requires loans to be accounted for as collateral-dependent loans when borrowers have filed Chapter 7 bankruptcy, the debt has been discharged and the borrower has not reaffirmed the debt, regardless of the delinquency status of the loan. The filing of bankruptcy by the borrower is evidence of financial difficulty and the discharge of the obligation by the bankruptcy court is deemed to be a concession granted to the borrower.

At December 31, 2013 the Corporation had or no commitments to lend additional funds to the related debtors whose terms have been modified in a TDR.

(6)   Bank Premises and Equipment

Bank premises and equipment as of year-end are as follows (000s omitted):

	2013		2012
Land, buildings and improvements	$	45,955	$	44,320
Equipment, furniture and fixtures		22,705		22,396
Total Bank premises and equipment	$	68,660	$	66,716
Less accumulated depreciation		40,447		38,666
Bank premises and equipment, net	$	28,213	$	28,050

51

Bank Premises and Equipment includes Construction in Progress of $1,772,000 as of December 31, 2013 and $35,000 as of December 31, 2012.The projects in progress will be completed in 2014. The estimated cost to complete all projects in process as of December 31, 2013 is$400,000.

The Company has entered into lease commitments for office locations. Rental expense charged to operations was $231,000, $203,000, and $193,000 for the years ended December 31, 2013, 2012, and 2011, respectively. The future minimum lease payments are as follows:

	Minimum
Year	Payment
2014	$	115,000
2015		7,000
2016		-
2017		-
Thereafter		-

(7)   Deposits

Interest expense on time certificates of deposit of $100,000 or more in the year 2013 amounted to $1,324,000, as compared with $1,839,000 in 2012, and $3,009,000 in 2011. At December 31, 2013, the balance of time certificates of deposit of $100,000 or more was $82,595,000, as compared with $97,798,000 at December 31, 2012. The amount of time deposits with a remaining term of more than 1 year was $106,377,000 at December 31, 2013 and $136,749,000 at December 31, 2012. The following table shows the scheduled maturities of Certificates of Deposit as of December 31, 2013 (000s omitted):

	Under $100,000		$100,000 and over
2014	$	80,927	$	50,517
2015		37,035		13,456
2016		18,357		8,095
2017		13,434		6,372
2018		5,473		4,155
Thereafter		-		-
Total	$	155,226	$	82,595

Time certificates of deposit under $100,000 include $8,665,000 of brokered certificates of deposit as of December 31, 2013, and $16,182,000 as of December 31, 2012. The Bank did not have any brokered certificates of deposit over $100,000 as of December 31, 2013 and December 31, 2012.

(8)   Federal Home Loan Bank Advances and Repurchase Agreements

The following is a summary of the Bank’s borrowings from the Federal Home Loan Bank of Indianapolis as of December 31, 2013 and 2012 (000s omitted):

December 31, 2013
	Floating Rate				Fixed Rate
Maturing in	Amount		Rate		Amount		Rate
2014		12,000	0.40	%		-	-
	$	12,000	0.40	%	$	-	0.00	%
December 31, 2012
		Floating Rate				Fixed Rate
Maturing in	Amount		Rate		Amount		Rate
2013		95,000	2.59	%		-	-
2014		12,000	0.47	%		-	-
	$	107,000	2.35	%	$	-	0.00	%

52

 

The weighted average maturity of the Federal Home Loan Bank advances was0.5 years and0.5 years as of December 31, 2013 and 2012, respectively.The interest rates on the floating rate advances reset quarterly based on the three month LIBOR rate plus a spread ranging of 16 basis points. The advances are subject to prepayment penalties and the provisions and conditions of the credit policy of the Federal Home Loan Bank of Indianapolis.

The Bank maintains an overdraft line of credit with the Federal Home Loan Bank of Indianapolis. The amount outstanding on the line of credit was $0 as of December 31, 2013 and 2012. The amount of credit available was $20,000,000 as of December 31, 2013 and $10,000,000 as of December 31, 2012. The interest rate on the line of credit is equal to the variable advance rate and is only charged on amounts advanced. The variable advance rate was 0.50% on December 31, 2013 and December 31, 2012.

As of December 31, 2013 investment securities totaling $39,520,000 were pledged to secure the Federal Home Loan Bank advances and line of credit. As of December 31, 2012 investment securities totaling $72,841,000 and qualified residential real estate loans totaling $80,567,000 were pledged to secure the Federal Home Loan Bank advances and line of credit.

The following is a summary of the Bank’s borrowings under repurchase agreements as of December 31, 2013 and 2012 (000s omitted):

Securities Sold Under Agreements to Repurchase
December 31, 2013
	Floating Rate			Fixed Rate
Maturing in	Amount		Rate	Amount		Rate
2016		-	-		15,000	4.65	%
	$	-	-	$	15,000	4.65	%
Securities Sold Under Agreements to Repurchase
December 31, 2012
	Floating Rate			Fixed Rate
Maturing in	Amount		Rate	Amount		Rate
2016		-	-		15,000	4.65	%
	$	-	-	$	15,000	4.65	%

The average daily balance of Repurchase Agreements was $15,000,000 in 2013 and $17,842,000 in 2012. The weighted average interest rate on Repurchase Agreements was4.65% in 2013 and4.57% in 2012. The maximum month end balance of Repurchase Agreements was $15,000,000 in 2013 and $20,000,000 in 2012.

Investment securities issued by U.S. Government agencies with a carrying value of $21.5 million and $22.8 million were pledged to secure the repurchase agreement borrowings at December 31, 2013 and December 31, 2012, respectively.

(9)   Retirement Plans and Postretirement Benefit Plans

In 2000, the Bank implemented a retirement plan that included both a money purchase pension plan, as well as a voluntary profit sharing 401(k) plan for all employees who meet certain age and length of service eligibility requirements. In 2002, the Bank amended its retirement plan to freeze the money purchase plan and retain the 401(k) plan. To ensure that the plan meets the Safe Harbor provisions of the applicable sections of the Internal Revenue Code, theBank contributes an amount equal to four percent of the employee’s base salary to the 401(k) plan for all eligible employees who contribute at least 5% of their salary. In addition, an employee may contribute from 1 to 75 percent of his or her base salary, up to a maximum of $23,000 in 2013. In 2013 and 2012 the Bank made a matching contribution of 100% on the first three percent of employee deferrals and 50% on the next two percent of deferrals. The Bank did not match employee’s elective contributions in 2011. Depending on the Bank’s profitability, an additional profit sharing contribution may be made by the Bank to the 401(k) plan. There were no profit sharing contributions in 2013, 2012, and 2011. The total retirement plan expense was $515,000, for the year ended December 31, 2013, $474,000 for the year ended December 31, 2012, and $582,000 for the year ended December 31, 2011.

The Bank has a postretirement benefit plan that generally provides for the continuation of medical benefits for all employees hired before January 1, 2007 who retire from the Bank at age 55 or older, upon meeting certain length of service eligibility requirements. The Bank does not fund its postretirement benefit obligation. Rather, payments are made as costs are incurred by covered retirees. The amount of benefits paid under the postretirement benefit plan was $206,000 in 2013, $177,000 in 2012, and $167,000 in 2011. The amount of insurance premium paid by the Bank for retirees is capped at200% of the cost of the premium as of December 31, 1992.

53

A reconciliation of the accumulated postretirement benefit obligation (“APBO”) to the amounts recorded in the consolidated balance sheets in Interest Payable and Other Liabilities at December 31 is as follows (000s omitted):

	2013		2012
APBO	$	2,781	$	3,074
Unrecognized net transition obligation		-		-
Unrecognized prior service costs		(2)		(6)
Unrecognized net gain (loss)		143		(285)
Accrued benefit cost at fiscal year end	$	2,922	$	2,783

The changes recorded in the accumulated postretirement benefit obligation were as follows (000s omitted):

	2013		2012
APBO at beginning of year	$	3,074	$	2,479
Service cost		134		109
Interest cost		106		109
Actuarial loss (gain)		(428)		467
Plan participants' contributions		101		87
Benefits paid during year		(206)		(177)
APBO at end of year	$	2,781	$	3,074

Components of the Bank’s postretirement benefit expense were as follows:

	2013		2012		2011
Service cost	$	134	$	109	$	102
Interest cost		106		109		111
Amortization of transition obligation		-		54		54
Prior service costs		4		4		4
Amortization of gains		-		-		(2)
Net postretirement benefit expense	$	244	$	276	$	269

The APBO as of December 31, 2013 and 2012 was calculated using assumed discount rates of4.50% and3.50%, respectively. Based on the provisions of the plan, the Bank’s expense is capped at200% of the 1992 expense, with all expenses above the cap incurred by the retiree. The expense reached the cap in 2004, and accordingly the impact of an increase in health care costs on the APBO was not calculated.

The Bank Owned Life Insurance policies fund a Death Benefit Only (DBO) obligation that the Bank has with6 of its active directors,5 retired directors,12 active executives, and10 retired executives. The DBO plan, which replaced previous split dollar agreements, provides a taxable death benefit. The benefit for directors is grossed up to provide a net benefit to each director’s beneficiaries based on that director’s length of service on the board. The directors’ net death benefits are $500,000 for director service of less than 3 years, $600,000 for service up to 5 years, $750,000 for service up to 10 years, and $1,000,000 for director service of 10 years or more. The active directors who participate in the plan have all waived the postretirement benefit. The executives’ beneficiaries will receive a grossed up benefit that will provide a net benefit equal to two times the executive’s base salary if death occurs during employment and a postretirement benefit equal to the executive’s final annual salary rate at the time of retirement if death occurs after retirement.

54

  

Information for the postretirement death benefits and health care benefits is as follows as of the December 31 measurement date (000s):

	Postretirement Death Benefit Obligations				Postretirement Health Care Benefits
	2013		2012		2013		2012
Change in benefit obligation
Benefit obligation at beginning of year	$	6,087		5,372	$	3,074	$	2,479
Service cost		21		18		134		109
Interest cost		223		237		106		109
Plan participants' contributions		-		-		101		87
Actuarial loss (gain)		(590)		460		(428)		467
Benefits paid		-		-		(206)		(177)
Benefit obligation at end of year	$	5,741	$	6,087	$	2,781	$	3,074
Change in accrued benefit cost
Accrued benefit cost at beginning of year	$	3,545	$	2,976	$	2,783	$	2,598
Service cost		21		18		134		109
Interest cost		223		237		106		109
Amortization		187		314		4		57
Employer contributions		-		-		(105)		(90)
Net gain		-		-		-		-
Accrued benefit cost at end of year	$	3,976	$	3,545	$	2,922	$	2,783
Change in plan assets
Fair value of plan assets at beginning of year	$	-	$	-	$	-	$	-
Employer contributions		-		-		105		90
Plan participants' contributions		-		-		101		87
Benefits paid during year		-		-		(206)		(177)
Fair value of plan assets at end of year	$	-	$	-	$	-	$	-
Funded status at end of year	$	(5,741)	$	(6,087)	$	(2,781)	$	(3,074)

Amounts recognized in other liabilities as of December 31 consist of (000s):

	Postretirement Death Benefit Obligations				Postretirement Health Care Benefits
	2013		2012		2013		2012
Assets	$	-		-	$	-	$	-
Liabilities		5,741		6,087		2,781		3,074
Total	$	5,741	$	6,087	$	2,781	$	3,074

Amounts recognized in accumulated other comprehensive income as of December 31 consist of (000s):

	Postretirement Death Benefit Obligations				Postretirement Health Care Benefits
	2013		2012		2013		2012
Net loss (gain)	$	(33)		558	$	(143)	$	285
Transition obligation (asset)		-		-		-		-
Prior service cost (credit)		1,798		1,984		2		6
Total included in AOCI	$	1,765	$	2,542	$	(141)	$	291

55

(10) Stockholders’ Equity

On March 15, 2013, the Corporation completed a private placement offering of500,000 shares of its no par value common stock. The shares of common stock sold were not registered under the Securities Act of 1933 (the “Act”) in reliance of the exemption from registration provided by Section 4(2) of the Act and Rule 506 of SEC Regulation D. The500,000 shares were sold for an aggregate purchase price of $1,736,000.

On December 23, 2013, the Corporation completed a private placement offering of2,647,059 shares of its no par value common stock. The shares of common stock sold were not registered under the Securities Act of 1933 (the “Act”) in reliance of the exemption from registration provided by Section 4(2) of the Act and Rule 506 of SEC Regulation D. The2,647,059 shares were sold for an aggregate purchase price of $11,250,000.

During 2013, the Corporation issued28,411 shares of its no par value common stock to its Employee Stock Purchase Plan and for retirement and years of service awards. The aggregate value of these shares was $113,000.

(11) Disclosures about Fair Value of Financial Instruments

Certain of the Bank’s assets and liabilities are financial instruments that have fair values that differ from their carrying values in the accompanying consolidated balance sheets. These fair values, along with the methods and assumptions used to estimate such fair values, are discussed below. The fair values of all financial instruments not discussed below are estimated to be equal to their carrying amounts as of December 31, 2013 and 2012.

CASH AND CASH EQUIVALENTS

The carrying amounts of cash and cash equivalents approximate fair values.

INVESTMENT SECURITIES

Fair value for the Bank’s investment securities was determined using the market value in active markets, where available. When not available, fair values are estimated using the fair value hierarchy. In the fair value hierarchy, Level 2 fair values are determined using observable inputs other than Level 1 market prices, such as quoted prices for similar assets. Level 3 values are determined using unobservable inputs, such as discounted cash flow projections. These estimated market values are disclosed in Note 3 and the required fair value disclosures are in Note 19.The carrying value of Federal Home Loan Bank of Indianapolis stock approximates fair value based on the redemption provisions of the issuer.

LOANS AND LOANS HELD FOR SALE

Loans Held for Sale consists of fixed rate mortgage loans originated by the Bank. The fair value of Loans Held for Sale is the estimated value the Bank will receive upon sale of the loan. The fair value of all other loans is estimated by discounting the future cash flows associated with the loans, using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

DEPOSIT LIABILITIES

The fair values for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (i.e. the carrying amounts). The carrying amounts of variable rate certificates of deposit approximate their fair values at the reporting date. Fair values of fixed rate, fixed maturity, certificates of deposit is estimated by discounting the related cash flows using the rates currently offered for deposits of similar remaining maturities.

FHLB ADVANCES AND SECURITIES SOLD UNDER REPURCHASE AGREEMENTS

The estimated fair value of the Federal Home Loan Bank advances and Securities Sold under Repurchase Agreements is estimated by discounting the related cash flows using the rates currently available for similarly structured borrowings with similar maturities.

ACCRUED INTEREST

The carrying amounts of accrued interest approximate fair value.

OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS

The fair values of commitments to extend credit and standby letters of credit and financial guarantees written are estimated using the fees currently charged to engage into similar agreements. The fair values of these instruments are not significant.

FAIR VALUES

The carrying amounts and approximate fair values as of December 31, 2013 and December 31, 2012 are as follows (000s omitted):

56

									Total
	Carrying								Estimated
December 31, 2013	Value		Level 1		Level 2		Level 3		Fair Value
Financial Assets:
Cash and due from banks	$	77,798	$	77,798	$	-	$	-	$	77,798
Securities - Held to Maturity
Obligations of States and Political Subdivisions		34,346		-		34,539		-		34,539
Corporate Debt Securities		500		-		500		-		500
Securities - Available for Sale
Obligations of U.S. Government Agencies		266,713		-		266,713		-		266,713
MBS issued by U.S. Government Agencies		96,526		-		96,526		-		96,526
Obligations of States and Political Subdivisions		15,363		-		15,363		-		15,363
Trust Preferred CDO Securities		5,751		-		-		5,751		5,751
Corporate Debt Securities		8,071		-		8,071		-		8,071
Other Securities		2,532		2,087		445		-		2,532
Federal Home Loan Bank Stock		10,605		-		10,605		-		10,605
Loans Held for Sale		668		-		-		668		668
Loans, net		581,381		-		-		591,471		591,471
Accrued Interest Receivable		3,502		-		-		3,502		3,502
Financial Liabilities:
Noninterest Bearing Deposits		215,844		215,844		-		-		215,844
Interest Bearings Deposits		853,874		-		857,149		-		857,149
Borrowed funds
FHLB Advances		12,000		-		12,000		-		12,000
Repurchase Agreements		15,000		-		16,352		-		16,352
Accrued Interest Payable		179		-		-		179		179

									Total
	Carrying								Estimated
December 31, 2012	Value		Level 1		Level 2		Level 3		Fair Value
Financial Assets:
Cash and due from banks	$	112,507	$	112,507	$	-	$	-	$	112,507
Securities - Held to Maturity
Obligations of States and Political Subdivisions		38,286		-		39,630		-		39,630
Corporate Debt Securities		500		-		500		-		500
Securities - Available for Sale
Obligations of U.S. Government Agencies		225,451		-		225,451		-		225,451
MBS issued by U.S. Government Agencies		129,818		-		129,818		-		129,818
Obligations of States and Political Subdivisions		18,370		-		18,370		-		18,370
Trust Preferred CDO Securities		5,406		-		-		5,406		5,406
Corporate Debt Securities		12,077		-		12,077		-		12,077
Other Securities		2,645		2,213		432		-		2,645
Federal Home Loan Bank Stock		10,605		-		10,605		-		10,605
Loans Held for Sale		1,520		-		-		1,520		1,520
Loans, net		609,950		-		-		627,171		627,171
Accrued Interest Receivable		3,457		-		-		3,457		3,457
Financial Liabilities:
Noninterest Bearing Deposits		183,016		183,016		-		-		183,016
Interest Bearings Deposits		865,814		-		872,070		-		872,070
Borrowed funds
FHLB Advances		107,000		-		107,785		-		107,785
Repurchase Agreements		15,000		-		17,141		-		17,141
Accrued Interest Payable		353		-		-		353		353

57

 

(12) Federal Income Taxes

Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be reversed. The Corporation and the Bank file a consolidated Federal income tax return.

The provision for Federal income taxes consists of the following (000s omitted):

	2013		2012		2011
Federal income taxes currently payable	$	42	$	1,497	$	500
Provision (credit) for deferred taxes on:
Book (over) under tax loan loss provision		(466)		1,386		390
Accretion of bond discount		45		(5)		(1)
Net deferred loan origination fees		10		(56)		9
Accrued postretirement benefits		(280)		(296)		(254)
Tax over (under) book depreciation		(462)		180		(83)
Non-accrual loan interest		602		(770)		(953)
Other real estate owned		805		(253)		(103)
Net operating loss carry forward		1,559		(697)		(2,039)
Other, net		(87)	��	(173)		(236)
Total deferred benefit		1,726		(684)		(3,270)
Valuation allowance deferred tax assets		(19,881)		(4,316)		3,270
Net deferred provision (benefit)		(18,155)		(5,000)		-
Tax expense (benefit)	$	(18,113)	$	(3,503)	$	500

The effective tax rate differs from the statutory rate applicable to corporations as a result of permanent differences between accounting and taxable income as follows:

	2013		2012		2011
Statutory rate	34.0	%	34.0	%	(34.0)	%
Municipal interest income	(5.4)		(7.9)		(13.4)
Other, net	(4.8)		(10.0)		(37.6)
Valuation allowance	(267.8)		(85.6)		100.3
Effective tax rate	(244.0)	%	(69.5)	%	15.3	%

In accordance with ASC 740, the Company is required to establish a valuation allowance for deferred tax assets when it is “more likely than not” that a portion or the entire deferred tax asset will not be realized. The evaluation requires significant judgment and extensive analysis of all available positive and negative evidence, the forecast of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions.

During 2009, the Company established a deferred tax valuation allowance of $13.9 million after evaluating all positive and negative evidence. The Company determined that it was more likely than not that it would not be able to utilize its entire deferred tax asset of $17.0 million. The expense for recording the valuation allowance was a non cash item, and recording the expense does not imply that the Company owes additional taxes. As business and economic conditions changed, the Company reevaluated the criteria related to the recognition of deferred tax assets, and during 2010, The Company increased its valuation allowance to $20.9 million, which equaled 100% of the deferred tax asset. After its review of the relevant data in 2011, the Company decided to continue to maintain its valuation allowance at 100% of the deferred tax asset of $24.2 million.

In December 2012, the Company again evaluated the positive and negative evidence regarding its expected utilization of its deferred tax asset. Positive evidence included improving local and regional economic conditions, six consecutive quarterly profits, consistent improvement in asset quality, reduction in credit related expenses, and projections for continued improvements in earnings for the foreseeable future. Negative evidence included the large amount of net operating loss carry forwards that the Company has accumulated, persistent concern about the strength of the economic recovery, and still elevated problem asset levels at the Company. The Company determined that, as of December 31, 2012, it was more likely than not that the Company will be able to utilize a portion of its deferred tax asset, but it was not more likely than not that all of the deferred tax asset would be utilized. Based on its projection of the amount of deferred tax asset that it expected to utilize in the future, the Company concluded to reduce the valuation allowance by $5.0 million. The reduction in the valuation allowance was recorded by recognizing a benefit to federal income tax expense.

58

In September, 2013, the Company’s evaluation of the positive and negative evidence regarding its expected utilization of its deferred tax asset indicated that that it was more likely than not that the Company would utilize its entire deferred tax asset. The positive evidence, consisting of nine consecutive profitable quarters and projections for future taxable earnings exceeded the negative evidence, which was primarily the prior net operating losses experienced. As a result, the Company eliminated the remaining $18.8 million valuation allowance in the third quarter of 2013 by recording a benefit to federal income tax expense.

In the ordinary course of business, the Company enters into certain transactions that have tax consequences. From time to time, the Internal Revenue Service (IRS) questions and/or challenges the tax positions taken by the Company with respect to those transactions. The Company believes that its tax returns were filed based upon applicable statutes, regulations, and case law in effect at the time of the transactions. The IRS, an administrative authority of a court, if presented with the transactions could disagree with the Company’s interpretation of the tax law.

The Company is currently under an audit of its tax returns filed for the 2004, 2005, 2007, 2008, 2009 and 2010 tax years. The Company recorded a tax liability in the second quarter of 2012 to reflect the amount of a settlement offer that the Company proposed to the IRS in an attempt to resolve the audit. Based on current knowledge, the Company believes that the accrued tax liability is adequate to absorb the effect relating to the ultimate resolution of the uncertain tax positions challenged by the IRS.

The components of the net deferred Federal income tax asset (included in Interest Receivable and Other Assets on the accompanying consolidated balance sheets) at December 31 are as follows (000s omitted):

	2013		2012
Deferred Federal income tax assets:
Allowance for loan losses	$	6,547	$	6,081
Net deferred loan origination fees		243		253
Tax versus book depreciation differences		460		-
Net unrealized losses on securities available for sale		5,050		-
Accrued postretirement benefits		3,265		3,396
Alternative minimum tax		771		771
Non-accrual loan interest		1,486		2,088
Other real estate owned		1,401		2,207
Other than temporary impairment AFS securities		566		566
Net operating loss		8,127		9,686
Other, net		1,248		1,277
Gross deferred tax asset		29,164		26,325
Valuation allowance		-		(19,881)
Total deferred federal tax asset	$	29,164	$	6,444
Deferred Federal income tax liabilities:
Accretion of bond discount	$	(63)	$	(18)
Net unrealized gains on securities available for sale		-		(924)
Tax versus book depreciation differences		-		(2)
Other		(345)		(461)
Total deferred federal tax liabilities	$	(408)	$	(1,405)
Net deferred Federal income tax asset (liability)	$	28,756	$	5,039

The Corporation has net operating loss carry forwards of approximately $23.9 million that are available to reduce future taxable income through the year ending December 31, 2032.

(13) Regulatory Capital Requirements

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

59

Quantitative measures established by regulation to ensure capital adequacy require the Corporation and the Bank to maintain minimum amounts and ratios (set forth in the accompanying tables) of Total and Tier 1 capital to risk weighted assets and of Tier 1 capital to average assets.

As of December 31, 2013 and 2012, the Bank’s capital ratios exceeded the required minimums to be considered well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Total risk based, Tier 1 risk based, and Tier 1 leverage ratios as set forth in the tables, as well as meeting other requirements specified by the federal banking regulators, including not being subject to any written agreement or order issued by the FDIC pursuant to section 8 of the Federal Deposit Insurance Act.

Since July 22, 2010, the Bank has been under a Consent Order (the “Consent Order”) with the FDIC and the Michigan DIFS. The Consent Order requires the Bank to, among other things, increase its Tier 1 Leverage ratio to9.0% and its Total Risk Based Capital ratio to12.0%. The Bank is in compliance with all of the other provisions of the Consent Order, which include a requirement to charge off all loans classified as “Loss” in the Report of Examination; a prohibition against extending additional credit to borrowers whose debt has been charged off; a prohibition against extending additional credit to borrowers whose debt is classified as “Substandard” or “Doubtful” without board of directors approval; a requirement to develop a written plan to reduce the Bank’s risk position in each asset in excess of $1,000,000 which is more than 90 days delinquent or classified as “Substandard” or “Doubtful”; a prohibition against declaring or paying dividends without written permission from the FDIC and the Michigan DIFS; a requirement for board approval of the allowance for loan and lease losses prior to filing the Bank’s quarterly Reports of Condition and Income required by the FDIC; adoption of a two year written profit plan; implementation of a plan to monitor compliance with the Consent Order; and a requirement to furnish quarterly progress reports to the FDIC and Michigan DIFS detailing action taken to secure compliance with the Consent Order. If the Bank is unable to timely comply with the Consent Order, there could be material adverse effects on the Bank and the Corporation.

Due to the existence of the Consent Order, the Bank is considered to be “Adequately Capitalized” as of December 31, 2013 and 2012. There are no conditions or events since December 31, 2013 that Management believes have changed the Bank’s category.

The Corporation’s and Bank’s actual capital amounts and ratios are also presented in the table (000s omitted in dollar amounts).

	Actual				Minimum to Qualify as Well Capitalized*
	Amount		Ratio		Amount		Ratio
As of December 31, 2013:
Total Capital to Risk-Weighted Assets
Consolidated	$	110,414	14.55	%	$	75,899	10	%
Monroe Bank & Trust		108,818	14.36	%		75,760	10	%
Tier 1 Capital to Risk-Weighted Assets
Consolidated		100,839	13.29	%		45,540	6	%
Monroe Bank & Trust		99,242	13.10	%		45,456	6	%
Tier 1 Capital to Average Assets
Consolidated		100,839	8.61	%		58,593	5	%
Monroe Bank & Trust		99,242	8.48	%		58,522	5	%

 

60

					Minimum to Qualify as
	Actual				Well Capitalized*
	Amount		Ratio		Amount		Ratio
As of December 31, 2012:
Total Capital to Risk-Weighted Assets
Consolidated	$	89,615	11.53	%	$	77,691	10	%
Monroe Bank & Trust		88,992	11.46	%		77,623	10	%
Tier 1 Capital to Risk-Weighted Assets
Consolidated		79,776	10.27	%		46,615	6	%
Monroe Bank & Trust		79,113	10.19	%		46,574	6	%
Tier 1 Capital to Average Assets
Consolidated		79,776	6.43	%		62,041	5	%
Monroe Bank & Trust		79,113	6.38	%		62,008	5	%

* Although the Bank’s capital ratios exceed the “Well Capitalized” minimums, the Bank is categorized as “Adequately Capitalized” as of December 31, 2013 and 2012 due to its Consent Order with the FDIC.

(14) Earnings (Loss) Per Share

The calculation of earnings (loss) per common share for the years ended December 31 is as follows:

	2013		2012		2011
Basic
Net income (loss)	$	25,537,000	$	8,545,000	$	(3,762,000)
Less preferred dividends		-		-		-
Net income (loss) applicable to common stock	$	25,537,000	$	8,545,000	$	(3,762,000)
Average common shares outstanding		17,882,070		17,332,012		17,270,528
Income (loss) per common share - basic	$	1.43	$	0.49	$	(0.22)

	2013		2012		2011
Diluted
Net income (loss)	$	25,537,000	$	8,545,000	$	(3,762,000)
Less preferred dividends		-		-		-
Net income (loss) applicable to common stock	$	25,537,000	$	8,545,000	$	(3,762,000)
Average common shares outstanding		17,882,070		17,332,012		17,270,528
Stock option adjustment		203,024		101,801		-
Average common shares outstanding - diluted		18,085,094		17,433,813		17,270,528
Income (loss) per common share - diluted	$	1.41	$	0.49	$	(0.22)

Stock options totaling283,900,396,835, and436,503 shares were not included in the computation of diluted earnings per share in the years ended December 31, 2013, 2012, and 2011, respectively, because they were antidilutive.

(15) Stock-Based Compensation Plan

The Long-Term Incentive Compensation Plan approved by shareholders at the April 6, 2000 Annual Meeting of Shareholders of Monroe Bank & Trust authorized the Board of Directors to grant nonqualified stock options to key employees and non-employee directors. Such grants could be made until January 2, 2010 for up to1,000,000 shares of the Corporation’s common stock. The amount that could be awarded to any one individual was limited to100,000 shares in any one calendar year. The MBT Financial Corp. 2008 Stock Incentive Plan was approved by shareholders at the May 1, 2008 Annual meeting of shareholders of MBT Financial Corp. This plan replaced the Long-Term Incentive Compensation Plan and authorized the Board of Directors to grant equity incentive awards to key employees and non-employee directors. Such grants may be made until May 1, 2018 for up to1,000,000 shares of the Corporation’s common stock. The amount that may be awarded to any one individual is limited to100,000 shares in any one calendar year. As of December 31, 2013, the number of shares available under the plan is237,369. This includes162,523 shares that were previously awarded that have been forfeited.

61

Stock Option Awards -Stock options granted under the plans have exercise prices equal to the fair market value at the date of grant. Options granted under the plan may be exercised for a period of no more than ten years from the date of grant. All options granted are fully vested at December 31, 2013.

Stock Only Stock Appreciation Rights (SOSARs) –On January 2, 2013, Stock Only Stock Appreciation Rights (SOSARs) were awarded to certain executives in accordance with the MBT Financial Corp. 2008 Stock Incentive Plan. The SOSARs have a term of10 years and vest in three equal annual installments beginning on December 31, 2013. SOSARs granted under the plan are structured as fixed grants with the exercise price equal to the market value of the underlying stock on the date of the grant. Upon exercise, the executive will generally receive common shares equal in value to the excess of the market value of the shares over the exercise price on the exercise date.

The fair value of each option and SOSAR grant is estimated on the date of grant using the Black-Scholes option pricing model with the assumptions disclosed in Note 1 to the consolidated financial statements.

A summary of the status of stock options and SOSARs under the plans is presented in the table below.

	2013			2012			2011
		Weighted			Weighted			Weighted
		Average			Average			Average
		Exercise			Exercise			Exercise
Stock Options	Shares	Price		Shares	Price		Shares	Price
Options Outstanding, January 1	396,835	$	17.57	436,503	$	17.34	444,575	$	17.28
Granted	-		-	-		-	-		-
Exercised	-		-	-		-	-		-
Forfeited/Expired	112,935		15.44	39,668		15.05	8,072		13.90
Options Outstanding, December 31	283,900	$	18.41	396,835	$	17.57	436,503	$	17.34
Options Exercisable, December 31	283,900	$	18.41	396,835	$	17.57	436,503	$	17.34

	2013			2012			2011
		Weighted			Weighted			Weighted
		Average			Average			Average
Stock Only Stock Appreciation Rights (SOSARs)	Shares	Exercise Price		Shares	Exercise Price		Shares	Exercise Price
SOSARs Outstanding, January 1	410,666	$	3.53	320,000	$	4.08	224,000	$	5.12
Granted	112,369		2.35	104,000		1.85	107,000		1.85
Exercised	35,464		2.28	-		-	-		-
Forfeited/Expired	15,300		7.09	13,334		3.68	11,000		3.64
SOSARs Outstanding, December 31	472,271	$	3.23	410,666	$	3.53	320,000	$	4.08
SOSARs Exercisable, December 31	373,560	$	3.50	319,630	$	4.01	253,321	$	4.67
Weighted Average Fair Value of Options     or SOSARs Granted During Year		$	1.43		$	1.11		$	0.80

The options and SOSARs exercisable as of December 31, 2013 are exercisable at prices ranging from $1.52 to $23.40. The number of options and SOSARs and remaining life at each exercise price are as follows:

Outstanding and Exercisable Options
Exercise Price		Shares	Remaining Life (in years)
$	15.33	64,200	3.01
$	16.24	53,200	2.01
$	16.69	77,000	0.01
$	23.40	89,500	1.01
		283,900	1.38

62

Outstanding SOSARs				Exercisable SOSARs
Exercise Price		Shares	Remaining Life (in years)	Shares	Remaining Life (in years)
$	1.52	12,000	6.01	12,000	6.01
$	1.85	178,002	7.63	147,974	7.52
$	2.35	112,369	9.01	43,686	9.01
$	3.03	97,700	5.01	97,700	5.01
$	8.53	72,200	4.60	72,200	4.60
		472,271	6.91	373,560	6.42

A summary of the status of the Corporation’s non-vested SOSARs as of December 31, 2013 and changes during the year ended December 31, 2013 is as follows:

Nonvested SOSAR Shares	Shares	Weighted Average Grant Date Fair Value
Nonvested at January 1, 2013	91,036	$	1.01
Granted	112,369		1.43
Vested	(104,694)		1.16
Forfeited	-		0.00
Nonvested at December 31, 2013	98,711	$	1.33

As of December 31, 2013, there was $132,000 of total unrecognized compensation cost related to nonvested share based compensation arrangements granted under the Plan. The cost is expected to be recognized over a weighted average period of1.70 years.

Restricted Stock Awards – On September 23, 2010,120,000 restricted shares were awarded to certain key executives in accordance with the MBT Financial Corp. 2008 Stock Incentive Plan. As of December 31, 2013,95,000 of those shares were vested. The remaining restricted shares will vest on September 23, 2014.

A summary of the status of the Corporation’s non-vested restricted stock awards as of December 31, 2013, 2012, and 2011, and changes during the years then ended is as follows:

Restricted Stock Awards	2013	2012	2011
Nonvested at January 1	50,000	120,000	135,000
Granted	-	10,000	-
Vested	25,000	80,000	15,000
Forfeited	-	-	-
Nonvested at December 31	25,000	50,000	120,000

The total expense recorded for the restricted stock awards was $20,000 in 2013, $70,000 in 2012, and $100,000 in 2011. The amount of unrecognized compensation cost related to the nonvested portion of restricted stock awards under the plan was $7,000 as of December 31, 2013, $27,000 as of December 31, 2012, and $87,000 as of December 31, 2011.

Restricted Stock Unit Awards –Restricted stock units granted under the plan result in an award of common shares to key employees based on selected performance metrics during the performance period. Key executives were granted30,000 Restricted Stock Units (RSUs) on January 2, 2013. The RSUs will vest on December 31, 2015 based on the Bank achieving the performance targets in the following schedule, with up to 50% of the RSUs earned in 2013 and up to 50% of the RSUs earned in 2014.

Performance Metric	Weighting Percentage		Performance Requirement	2013 Performance Threshold			2014 Performance Threshold
Net Income before tax	25	%	At or greater than	$	6,400,000		$	9,000,000
Tier 1 leverage ratio	25	%	At or greater than		7.75	%		8.25	%
Texas Ratio	50	%	At or less than		50	%		35	%

63

The Texas ratio goal was not achieved in 2013. As a result, 50% of the15,000 RSUs(7,500) that could be earned in 2013 will be awarded upon completion of the vesting period. The current expectation is that the 15,000 RSUs that may be earned in 2014 will be awarded.

Key executives were granted30,000 Restricted Stock Units (RSUs) on February 23, 2012. The RSUs will vest on December 31, 2014 based on the Bank achieving the performance targets in the following schedule, with up to 50% of the RSUs earned in 2012 and up to 50% of the RSUs earned in 2013.

Performance Metric	Weighting Percentage		Performance Requirement		2012 Performance Threshold			2013 Performance Threshold
Net Income before tax	25	%	At or greater than	$	1,245		$	6,370,000
Tier 1 leverage ratio	25	%	At or greater than		6.42	%		7.76	%
Texas Ratio	50	%	At or less than		75	%		50	%

The Texas ratio goal was not achieved in 2013 or 2012 and the Tier 1 leverage ratio was not achieved in 2012. As a result, 75% of the15,000 RSUs(11,250) that could have been earned in 2013 and 50% of the 15,000 RSUs (7,500) that could have been earned in 2012 will be awarded upon completion of the vesting period.

Accordingly, the Company recorded expenses of $38,000 in 2013 and $54,000 in 2012 for the RSUs.

(16) Parent Company

Condensed parent company financial statements, which include transactions with the subsidiary, are as follows (000s omitted):

Balance Sheets

	December 31,
	2013		2012
Assets
Cash and due from banks	$	493	$	212
Securities		446		432
Investment in subsidiary bank		109,039		82,983
Other assets		902		220
Total assets	$	110,880	$	83,847
Liabilities
Dividends payable and other liabilities	$	272	$	273
Total liabilities		272		273
Stockholders' Equity
Total stockholders' equity		110,608		83,574
Total liabilities and stockholders' equity	$	110,880	$	83,847

64

Statements of Operations

		Years Ended December 31,
	2013		2012		2011
Income
Dividends from subsidiary bank	$	-	$	-	$	-
Other operating income		-		-		-
Total income		-		-		-
Expense
Interest on borrowed funds		4		12		11
Other expense		274		272		399
Total expense		278		284		410
Loss before tax and equity in undistributed
net loss of subsidiary bank		(278)		(284)		(410)
Income tax benefit		(432)		-		-
Loss before equity in undistributed
net loss of subsidiary bank		154		(284)		(410)
Equity in undistributed net income (loss)
of subsidiary bank		25,383		8,829		(3,352)
Net Income (Loss)	$	25,537	$	8,545	$	(3,762)

Statements of Cash Flows

	Years Ended December 31,
	2013		2012		2011
Cash Flows Provided By Operating Activities:
Net income (loss)	$	25,537	$	8,545	$	(3,762)
Equity in undistributed net income of subsidiary bank		(25,383)		(8,829)		3,352
Net decrease in other liabilities		134		138		-
Net (increase) decrease in other assets		(605)		(1)		133
Net cash used for operating activities	$	(317)	$	(147)	$	(277)
Cash Flows Used For Investing Activities:
Investment in subsidiary	$	(11,350)	$	-	$	-
Net cash used for investing activities	$	(11,350)	$	-	$	-
Cash Flows Used For Financing Activities:
Issuance of common stock	$	12,083	$	243	$	54
Dividends paid		-		-		-
Issuance of long term debt		(135)		-		-
Net cash provided by financing activities	$	11,948	$	243	$	54
Net Increase (Decrease) In
Cash And Cash Equivalents	$	281	$	96	$	(223)
Cash And Cash Equivalents
At Beginning Of Year		212		116		339
Cash And Cash Equivalents At End Of Year	$	493	$	212	$	116

Under current regulations, the Bank is limited in the amount it may loan to the Corporation. Loans to the Corporation may not exceed ten percent of the Bank’s capital stock, surplus, and undivided profits plus the allowance for loan losses. Loans from the Bank to the Corporation are required to be collateralized. Accordingly, at December 31, 2013, Bank funds available for loans to the Corporation amounted to $13,690,000. The Bank has not made any loans to the Corporation.

65

Federal and state banking laws place certain restrictions on the amount of dividends a bank may make to its parent company. Michigan law limits the amount of dividends that the Bank can pay to the Corporation without regulatory approval to the amount of net income then on hand. The Bank entered in to a Consent Order with the FDIC effective July 22, 2010 that prohibits the Bank from declaring dividends payable to the Company without regulatory approval.

(17) Financial Instruments with Off-Balance Sheet Risk  

The Bank is a party to 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 and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. 

The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for its other lending activities.

Financial instruments whose contractual amounts represent off-balance sheet credit risk at December 31 were as follows (000s omitted): 

	Contractual Amount
	2013		2012
Commitments to extend credit:
Unused portion of commercial lines of credit	$	68,159	$	59,826
Unused portion of credit card lines of credit		3,255		3,048
Unused portion of home equity lines of credit		16,769		16,356
Standby letters of credit and financial guarantees written		3,667		3,730
All other off-balance sheet assets		-		-

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Most commercial lines of credit are secured by real estate mortgages or other collateral, generally have fixed expiration dates or other termination clauses, and require payment of a fee. Since the lines of credit may expire without being drawn upon, the total committed amounts do not necessarily represent future cash requirements. Credit card lines of credit have various established expiration dates, but are fundable on demand. Home equity lines of credit are secured by real estate mortgages, a majority of which have ten year expiration dates, but are fundable on demand. The Bank evaluates each customer’s creditworthiness on a case by case basis. The amount of the collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on Management’s credit evaluation of the counter party.  

Standby letters of credit written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and other business transactions. For the letters of credit, $3,655,000 expires in 2014 and $12,000 expires in 2015. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.  

Various legal claims also arise from time to time in the normal course of business, which, in the opinion of management, will have no material effect on the Company’s consolidated financial statements.

66

 

(18) Quarterly Financial Information (Unaudited) (000s omitted):

2013	First		Second		Third		Fourth
Total Interest Income	$	10,061	$	9,741	$	9,764	$	9,672
Total Interest Expense		2,017		1,652		1,225		1,143
Net Interest Income		8,044		8,089		8,539		8,529
Provision for Loan Losses		1,500		400		200		100
Other Income		3,988		3,989		4,116		3,838
Other Expenses		9,418		10,182		9,963		9,945
Income Before Provision For Income Taxes		1,114		1,496		2,492		2,322
Provision For (Benefit From) Income Taxes		-		-		(18,795)		682
Net Income	$	1,114	$	1,496	$	21,287	$	1,640
Basic Earnings Per Common Share	$	0.06	$	0.08	$	1.19	$	0.10
Diluted Earnings Per Common Share	$	0.06	$	0.08	$	1.17	$	0.10
Dividends Declared Per Share	$	-	$	-	$	-	$	-

2012	First		Second		Third		Fourth
Total Interest Income	$	11,696	$	11,334	$	10,987	$	10,518
Total Interest Expense		2,768		2,550		2,366		2,202
Net Interest Income		8,928		8,784		8,621		8,316
Provision for Loan Losses		2,250		1,050		1,550		2,500
Other Income		4,677		3,564		4,023		4,173
Other Expenses		10,012		9,622		9,689		9,371
Income Before Provision For Income Taxes		1,343		1,676		1,405		618
Provision For (Benefit From) Income Taxes		126		1,423		17		(5,069)
Net Income	$	1,217	$	253	$	1,388	$	5,687
Basic Earnings Per Common Share	$	0.07	$	0.01	$	0.08	$	0.33
Diluted Earnings Per Common Share	$	0.07	$	0.01	$	0.08	$	0.33
Dividends Declared Per Share	$	-	$	-	$	-	$	-

(19) Fair Value Disclosures

The following tables present information about the Corporation’s assets measured at fair value on a recurring basis at December 31, 2013 and 2012, and the valuation techniques used by the Corporation to determine those fair values.

In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets that the Company has the ability to access.

Fair values determined by Level 2 inputs use other inputs that are observable, either directly or indirectly. These Level 2 inputs include quoted prices for similar assets in active markets, and other inputs such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs are unobservable inputs, including inputs that are available in situations where there is little, if any, market activity for the related asset.

In instances where inputs used to measure fair value fall into different levels in the above fair value hierarchy, fair value measurements in their entirety are categorized based on the lowest level input that is significant to the valuation. The Company’s assessment of the significance of particular inputs to these fair value measurements requires judgment and considers factors specific to each asset.

67

Assets measured at fair value on a recurring basis are as follows (000’s omitted):

Investment Securities Available for Sale at December 31, 2013	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Obligations of U.S. Government Agencies	$	-	$	266,713	$	-
MBS issued by U.S. Government Agencies				96,526
Obligations of States and Political Subdivisions		-		15,363		-
Trust Preferred CDO Securities		-		-		5,751
Corporate Debt Securities		-		8,071		-
Other Securities		2,087		445		-
Total Securities Available for Sale	$	2,087	$	387,118	$	5,751

Investment Securities Available for Sale at December 31, 2012	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Obligations of U.S. Government Agencies	$	-	$	225,451	$	-
MBS issued by U.S. Government Agencies				129,818
Obligations of States and Political Subdivisions		-		18,370		-
Trust Preferred CDO Securities		-		-		5,406
Corporate Debt Securities		-		12,077		-
Other Securities		2,213		432		-
Total Securities Available for Sale	$	2,213	$	386,148	$	5,406

The changes in Level 3 assets measured at fair value on a recurring basis were (000’s omitted):

Investment Securities - Available for Sale	2013		2012
Balance at January 1	$	5,406	$	5,467
Total realized and unrealized gains (losses) included in income		-		-
Total unrealized gains (losses) included in other comprehensive income		361		(44)
Net purchases, sales, calls and maturities		(16)		(17)
Net transfers in/out of Level 3		-		-
Balance at December 31	$	5,751	$	5,406

Of the Level 3 assets that were held by the Corporation at December 31, 2013, the unrealized gain for the year was $361,000. That gain is recognized in other comprehensive income in the consolidated statements of financial condition. The Company did not purchase or sell any Level 3 available for sale securities during 2013 or 2012.

Both observable and unobservable inputs may be used to determine the fair value of positions classified as Level 3 assets. As a result, the unrealized gains and losses for these assets presented in the tables above may include changes in fair value that were attributable to both observable and unobservable inputs.

The Company also has assets that under certain conditions are subject to measurement at fair value on a non-recurring basis. These assets include held to maturity investments and loans. The Company estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

68

Assets measured at fair value on a nonrecurring basis are as follows (000’s omitted):

	Balance at December 31, 2013		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	60,471	$	-	$	-	$	60,471
Other Real Estate Owned	$	9,628	$	-	$	-	$	9,628

	Balance at December 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans	$	67,249	$	-	$	-	$	67,249
Other Real Estate Owned	$	14,262	$	-	$	-	$	14,262

Impaired loans categorized as Level 3 assets consist of non-homogenous loans that are considered impaired. The Corporation estimates the fair value of the loans based on the present value of expected future cash flows using management’s best estimate of key assumptions. These assumptions include future payment ability, timing of payment streams, and estimated realizable values of available collateral (typically based on outside appraisals). Other Real Estate Owned (OREO) consists of property received in full or partial satisfaction of a receivable. The Corporation utilizes outside appraisals to estimate the fair value of OREO properties.

(20) Subsequent Events

On March 3, 2014, the Company completed a private placement of its common stock. The total amount of stock sold was647,059 shares and the aggregate amount of proceeds was $2,750,000. The proceeds will be used to provide working capital at the Company and invested as additional equity in the Bank.

69

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None

Item 9A. Controls and Procedures

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

MBT Financial Corp. carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures as of December 31, 2013, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures were effective as of December 31, 2013, in timely alerting them to material information relating to the Corporation (including its consolidated subsidiaries) required to be in the Corporation’s periodic SEC filings.

Management’s Report on Internal Control Over Financial Reporting

The management of MBT Financial Corp. is responsible for establishing and maintaining adequate internal control over financial reporting. MBT Financial Corp.’s internal control over financial reporting is a process designed under the supervision of the Corporation’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Corporation’s financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.

MBT Financial Corp.’s management assessed the effectiveness of the Corporation’s internal control over financial reporting as of December 31, 2013 based on criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in “Internal Control-Integrated Framework.” Based on that assessment, management determined that, as of December 31, 2013, the Corporation’s internal control over financial reporting is effective, based on those criteria.

There was no change in the Company's internal control over financial reporting that occurred during the Company's fiscal quarter ended December 31, 2013, that materially affected, or is reasonably likely to affect, the Company's internal control over financial reporting.

Item 9B. Other Information

None.

70

 

Part III

Item 10. Directors and Executive Officers of the Registrant

(a) Executive Officers – See “Executive Officers” in part I, Item 1 hereof.

(b) Directors and Executive Officers –information required by this item is incorporated by reference from the sections entitled “Proposal One: Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement for the Annual Meeting of Shareholders that is to be filed with the Securities Exchange Commission.

(c) Audit Committee –The Company has a separately-designated standing Audit Committee established in accordance with Section 3(a)(58)(A) of the Exchange Act (15 U.S.C. 78c(a)(58)(A)).

(d) Audit Committee Financial Expert –The Board of Directors has determined that Peter H. Carlton, member of the Audit Committee, is an “audit committee financial expert” and “independent” as defined under applicable SEC and Nasdaq rules.

(e) MBT Financial Corp. has adopted itsCode of Ethics, a code of ethics that applies to all its directors, officers, and employees, including its Chief Executive Officer, Chief Financial Officer, and internal auditor. A copy of the Code of Ethics is posted on our website at http://www.mbandt.com. In the event we make any amendment to, or grant any waiver of, a provision of the Code of Ethics that applies to the principal executive officers, principal financial officer, principal accounting officer, or controller, or persons performing similar functions that require disclosure under applicable SEC rules, we intend to disclose such amendment or waiver, the reasons for it, and the nature of any waiver, the name of the person to whom it was granted, and the date, on our internet website.

Item 11. Executive Compensation

Information required by this item is incorporated by reference from the section entitled “Executive Compensation” in the Proxy Statement for the Annual Meeting of Shareholders that is to be filed with the Securities and Exchange Commission.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information required by this item is incorporated by reference from the section entitled “Ownership of Voting Shares” in the Proxy Statement for the Annual Meeting of Shareholders that is to be filed with the Securities and Exchange Commission.

Securities authorized for issuance under equity compensation plans as of December 31, 2013 were as follows:

	Number of securities to be	Weighted average		Number of securities remaining
	issued upon exercise of	exercise price of		available for future issuance under
	outstanding options, warrants,	outstanding options,		equity compensation plans (excluding
	and rights	warrants, and rights		securities reflected in column ( a ))
	( a )	( b )		( c )
Equity Compensation plans approved by security holders	797,421	$	8.47	237,369
Equity Compensation plans not approved by security holders	0		0	0
Total	797,421	$	8.47	237,369

71

Item 13. Certain Relationships and Related Transactions

Information required by this item is incorporated by reference from the sections entitled “Corporate Governance – Board Independence” and “Related Party Transactions” in the Proxy Statement for the Annual Meeting of Shareholders that is to be filed with the Securities and Exchange Commission.

Item 14. Principal Accountant Fees and Services

Information required by this item is incorporated by reference from the section entitled “Principal Accounting Firm Fees” in the Proxy Statement for the Annual Meeting of Shareholders that is to be filed with the Securities and Exchange Commission.

Part IV

Item 15. Exhibits and Financial Statement Schedules

Contents

Financial Statements

Reports of Independent Registered Public Accounting Firm – Page 34

Consolidated Balance Sheets as of December 31, 2013 and 2012 – Page 35

Consolidated Statements of Operations and Comprehensive Income for the Years Ended

December 31, 2013, 2012, and 2011 – Page 36

Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended

December 31, 2013, 2012, and 2011 – Page 37

Consolidated Statements of Cash Flows for the Years Ended

December 31, 2013, 2012, and 2011 – Page 38

Notes to Consolidated Financial Statements – Pages 39-69

72

Exhibits

The following exhibits are filed as a part of this report:

3.1	Articles of Incorporation of MBT Financial Corp. Previously filed as Exhibit 3.1 to MBT Financial Corp.’s Form 10-Q for its quarter ended June 30, 2011.
3.2	Amended and Restated Bylaws of MBT Financial Corp. Previously filed as Exhibit 3.2 to MBT Financial Corp.’s Form 10-Q for its quarter ended March 31, 2008.
10.1	MBT Financial Corp. 2008 Stock Incentive Compensation Plan. Previously filed as Exhibit 10 on Form 8-K filed by MBT Financial Corp. on June 5, 2008.
10.2	Monroe Bank & Trust Salary Continuation Agreement with Ronald D. LaBeau. Previously filed as Exhibit 10.2 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2000.
10.3	MBT Financial Corp. Amended and Restated Change in Control Agreement with H. Douglas Chaffin. Previously filed as Exhibit 10.5 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2005.
10.4	Monroe Bank & Trust Group Director Death Benefit Only Plan. Previously filed as Exhibit 10.4 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2006.
10.5	Monroe Bank & Trust Group Executive Death Benefit Only Plan. Previously filed as Exhibit 10.5 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2006.
10.6	Monroe Bank & Trust Amended and Restated Supplemental Executive Retirement Agreement with H. Douglas Chaffin. Previously filed as Exhibit 10.1 to MBT Financial Corp.’s Form 10-Q for its quarter ended September 30, 2011.
10.7	MBT Financial Corp. Severance Agreements with Donald M. Lieto, James E. Morr, Thomas G. Myers, and John L. Skibski. Previously filed as Exhibit 10 on Form 8-K filed by MBT Financial Corp. on January 26, 2006.
10.8	MBT Financial Corp. Severance Agreement with Scott E. McKelvey. Previously filed as Exhibit 10.1 to MBT Financial Corp.’s Form 10-Q for its quarter ended June 30, 2007.
10.9	Stipulation and consent to the issuance of a Consent Order with the FDIC and Michigan DIFS dated July 12, 2010. Previously filed as Exhibit 10 to the Form 8-K filed by MBT Financial Corp. on July 13, 2010.
10.10	Amendment to MBT Financial Corp. Executive Severance Agreements with Donald M. Lieto, Scott E. McKelvey, Thomas G. Myers, and John L. Skibski. Previously filed as Exhibit 10.10 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2012.
10.11	Securities Purchase Agreement dated December 23, 2013 with Castle Creek Capital Partners IV, L.P. Previously filed as Exhibit 10.1 to the Form 8-K filed by MBT Financial Corp. on December 31, 2013.
10.12	Securities Purchase Agreement dated December 23, 2013 with Patriot Financial Partners II L.P. and Patriot Financial Partners Parallel II, L.P. Previously filed as Exhibit 10.2 to the Form 8-K filed by MBT Financial Corp. on December 31, 2013.
10.13	Engagement Letter between MBT Financial Corp. and Donnelly Penman & Partners. Previously filed as Exhibit 1.1 to the Form S-1/A filed by MBT Financial Corp. on February 3, 2014.
21	Subsidiaries of the Registrant. Previously filed as Exhibit 21 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2000.
23	Consent of Independent Auditors.
31.1	Certification by Chief Executive Officer required by Securities and Exchange Commission Rule 13a-14.
31.2	Certification by Chief Financial Officer required by Securities and Exchange Commission Rule 13a-14.
32.1	Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS	XBRL Instance Document(1)
101.SCH	XBRL Taxonomy Extension Schema Document(1)
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document(1)
101.LAB	XBRL Taxonomy Extension Label Linkbase Document(1)
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document(1)
101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document(1)

⁽¹⁾As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for the purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 or otherwise subject to liability under those sections.

73

Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

Dated: March 14, 2014		MBT FINANCIAL CORP.
	By:	/s/ John L. Skibski
		John L. Skibski
		Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.

Dated: March 14, 2014

/s/ H. Douglas Chaffin	/s/ John L. Skibski
H. Douglas Chaffin	John L. Skibski
President, Chief Executive	Chief Financial Officer &
Officer & Director	Director
/s/ Michael J. Miller	/s/ Peter H. Carlton
Michael J. Miller	Peter H. Carlton
Chairman	Director
/s/ Joseph S. Daly	/s/ Edwin L. Harwood
Joseph S. Daly	Edwin L. Harwood
Director	Director
/s/ Debra J. Shah	/s/ Karen Wilson Smithbauer
Debra J. Shah	Karen Wilson Smithbauer
Director	Director

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Exhibit Index

Number	Description of Exhibits
3.1	Articles of Incorporation of MBT Financial Corp. Previously filed as Exhibit 3.1 to MBT Financial Corp.’s Form 10-Q for its quarter ended June 30, 2011.
3.2	Amended and Restated Bylaws of MBT Financial Corp. Previously filed as Exhibit 3.2 to MBT Financial Corp.’s Form 10-Q for its quarter ended March 31, 2008.
10.1	MBT Financial Corp. 2008 Stock Incentive Compensation Plan. Previously filed as Exhibit 10 on Form 8-K filed by MBT Financial Corp. on June 5, 2008.
10.2	Monroe Bank & Trust Salary Continuation Agreement with Ronald D. LaBeau. Previously filed as Exhibit 10.2 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2000.
10.3	MBT Financial Corp. Amended and Restated Change in Control Agreement with H. Douglas Chaffin. Previously filed as Exhibit 10.5 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2005.
10.4	Monroe Bank & Trust Group Director Death Benefit Only Plan. Previously filed as Exhibit 10.4 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2006.
10.5	Monroe Bank & Trust Group Executive Death Benefit Only Plan. Previously filed as Exhibit 10.5 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2006.
10.6	Monroe Bank & Trust Amended and Restated Supplemental Executive Retirement Agreement with H. Douglas Chaffin. Previously filed as Exhibit 10.1 to MBT Financial Corp.’s Form 10-Q for its quarter ended September 30, 2011.
10.7	MBT Financial Corp. Severance Agreements with Donald M. Lieto, James E. Morr, Thomas G. Myers, and John L. Skibski. Previously filed as Exhibit 10 on Form 8-K filed by MBT Financial Corp. on January 26, 2006.
10.8	MBT Financial Corp. Severance Agreement with Scott E. McKelvey. Previously filed as Exhibit 10.1 to MBT Financial Corp.’s Form 10-Q for its quarter ended June 30, 2007.
10.9	Stipulation and consent to the issuance of a Consent Order with the FDIC and Michigan DIFS. Previously filed as Exhibit 10 to the Form 8-K filed by MBT Financial Corp. on July 13, 2010.
10.10	Amendment to MBT Financial Corp. Executive Severance Agreements with Donald M. Lieto, Scott E. McKelvey, Thomas G. Myers, and John L. Skibski. Previously filed as Exhibit 10.10 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2012.
21	Subsidiaries of the Registrant. Previously filed as Exhibit 21 to MBT Financial Corp.’s Form 10-K for its fiscal year ended December 31, 2000.
23	Consent of Independent Auditors.
31.1	Certification by Chief Executive Officer required by Securities and Exchange Commission Rule 13a-14.
31.2	Certification by Chief Financial Officer required by Securities and Exchange Commission Rule 13a-14.
32.1	Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as enacted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS	XBRL Instance Document(1)
101.SCH	XBRL Taxonomy Extension Schema Document(1)
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document(1)
101.LAB	XBRL Taxonomy Extension Label Linkbase Document(1)
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document(1)
101.DEF	XBRL Taxonomy Extension Definitions Linkbase Document(1)

⁽¹⁾As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for the purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 or otherwise subject to liability under those sections.

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