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MSFN Mainstreet Financial Corp (CE)

0.0001
0.00 (0.00%)
14 Jun 2024 - Closed
Delayed by 15 minutes
Share Name Share Symbol Market Type
Mainstreet Financial Corp (CE) USOTC:MSFN OTCMarkets Common Stock
  Price Change % Change Share Price Bid Price Offer Price High Price Low Price Open Price Shares Traded Last Trade
  0.00 0.00% 0.0001 0.00 01:00:00

- Quarterly Report (10-Q)

14/11/2008 1:58pm

Edgar (US Regulatory)




UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

 (Mark One)

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

For the quarterly period ended September  30, 2008

OR

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

For the transition period from _______ to ________

Commission file number:    005-82164


MAINSTREET FINANCIAL CORPORATION
(Exact name of small business issuer as specified in its charter)
 
 
United States
 
20-1867479
(State or other jurisdiction of
incorporation of organization
 
(IRS Employer Identification No.)
 
 
629 W. State Street, Hastings, Michigan 49058-1643
(Address of principal executive offices)
 
 
(269) 945-9561
(Issuer's telephone number)
 
 
None
(former name, former address and former fiscal year, if changed since last report)
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 and 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes [ X ]                      No [   ]

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 definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Act.  (Check one)

Large accelerated filer  _____                                  Accelerated filer  _____

Non-accelerated filer    _____                                Smaller reporting company   X
           (Do not check if smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes [   ]                           No [ X ]

Indicate the number of shares outstanding of each issuer's classes of common equity, as of the latest practicable date:

At October 31, 2008, there were 756,068 shares of the issuers' common stock outstanding.

 
 
 
 

MAINSTREET FINANCIAL CORPORATION

Index
   
Page Number
PART I       FINANCIAL INFORMATION
 
 
Item 1.         Financial Statements
 
 
Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007
 
1
Consolidated Statements of Operations for the Three-Month and Nine-Month Periods ended September 30, 2008 and 2007
 
2
Consolidated Statements of Changes in Shareholders' Equity for the Nine-Month Periods ended September 30, 2008
 
3
Consolidated Statements of Cash Flows for the Nine-Month Periods ended September 30, 2008 and 2007
 
4
Notes to Consolidated Financial Statements
 
6
Item 2.      Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
8
Item 3.     Quantitative and Qualitative Disclosures about Market Risk
 
18
Item 4T.      Controls and Procedures
 
18
PART II      OTHER INFORMATION
 
 
Item 1.         Legal Proceedings
 
20
Item 1A        Risk Factors
 
20
Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds
 
20
Item 3.     Defaults Upon Senior Securities
 
20
Item 4.     Submission of Matters to a Vote of Security Holders
 
20
Item 5.     Other Information
 
20
Item 6.     Exhibits
 
21
SIGNATURES
 
 
EXHIBITS
 


 
 
 
 

PART I       FINANCIAL INFORMATION

Item 1         Financial Statements

MAINSTREET FINANCIAL CORPORATION

Consolidated Balance Sheets as of
September 30, 2008 and December 31, 2007
(Unaudited)
 
   
September 30, 2008
   
December 31, 2007
 
ASSETS
           
Cash and due from financial institutions
  $ 1,965,852     $ 1,995,698  
Interest-bearing deposits
    1,207,023       3,175,605  
Cash and cash equivalents
    3,172,875       5,171,303  
Securities available for sale
    1,694,630       1,924,413  
Loans, net of allowance of $675,397 at September 30, 2008
and $508,364 at December 31, 2007
    93,668,735       100,149,716  
Federal Home Loan Bank (FHLB) stock
    1,680,000       1,589,000  
Accrued interest receivable
    537,096       605,241  
Premises and equipment, net
    3,422,815       3,557,518  
Intangible assets
    736,529       856,035  
Other real estate owned
    1,877,461       910,846  
Other assets
     205,185       264,076  
    $ 106,995,326     $ 115,028,148  
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
Liabilities
               
Deposits
               
Noninterest-bearing
  $ 5,107,282     $ 5,278,694  
Interest-bearing
    60,082,359       74,126,373  
      65,189,641       79,405,067  
FHLB advances
    33,600,000       26,400,000  
Note payable
    700,000       700,000  
ESOP note payable
    255,852       255,852  
Accrued interest payable
    102,926       189,015  
Advance payments by borrowers for taxes and insurance
    334,753       100,412  
Deferred compensation liability
    519,007       506,737  
Accrued expenses and other liabilities
    259,749        316,796  
Total liabilities
    100,961,928       107,873,879  
                 
Shareholders’ equity
               
Common stock - $.01 par value, 9,000,000 shares authorized,
     756,068 shares issued and outstanding
    7,561       7,561  
Additional paid in capital
    2,806,803       2,821,602  
Unearned ESOP shares
    (222,267 )     (247,856 )
Retained earnings
    3,447,273       4,603,116  
Accumulated other comprehensive income (loss)
     (5,972 )     (30,154 )
        Total shareholders’ equity
    6,033,398       7,154,269  
        Total liabilities and shareholders’ equity
  $ 106,995,326     $ 115,028,148  

See accompanying notes to consolidated financial statements.

 
1
 
 

MAINSTREET FINANCIAL CORPORATION

Consolidated Statements of Operations for the
Three-Month and Nine-Month Periods Ended
September 30 , 2008 and 2007 (Unaudited)
 
   
Three Months
Ended September 30,
   
Nine months
Ended September 30,
 
   
2008
   
2007
   
2008
   
2007
 
Interest income
                       
Loans, including related fees
  $ 1,412,681     $ 1,625,617     $ 4,525,613     $ 4,880,446  
Taxable securities
    40,771       47,429       128,299       145,571  
Other
     10,415        75,348       52,047        163,506  
      1,463,867       1,748,394       4,705,959       5,189,523  
                                 
Interest expense
                               
Deposits
    504,020       798,834       1,801,053       2,352,927  
FHLB advances
    292,382       293,947       939,956       874,886  
Other
     10,351        14,955        34,219        42,105  
      806,753       1,107,736       2,775,228       3,269,918  
                                 
Net interest income
    657,114       640,658       1,930,731       1,919,605  
                                 
Provision for loan losses
    161 ,000       45,000        296,000        173,000  
                                 
Net interest income after provision for loan losses
    496,114       595,658       1,634,731       1,746,605  
                                 
Non-interest income
                               
Fees and service charges
    97,047       103,733       272,523       283,567  
Loss on securities
    (86,227 )             (188,632 )        
Gain  on sale of loans
    7,394       2,773       23,003       21,786  
Gain / ( loss ) on sale of repossessed assets
            13,466       (36,954 )     50,712  
Other
    12,500       7,346       37,121       25,375  
      30,714       127,318       107,061       381,440  
Non-interest expenses
                               
Salaries and employee benefits
    459,226       418,858       1,355,077       1,303,191  
Premises and equipment, net
    112,957       124,104       371,542       428,685  
Administrative and general
    152,544       124,688       401,786       388,018  
Data processing through service bureau
    62,547       63,955       194,087       190,618  
Amortization of intangible assets
    38,765       40,491       119,507       122,887  
Regulatory assessments
    82,565       28,352       165,266       61,394  
Professional services
    120,229       67,855       235,530       201,223  
Advertising and public relations
    22,966       23,575       54,840       58,251  
      1,051,799       891,878       2,897,635       2,754,267  
                                 
Loss  before taxes
    (524,971 )     (168,902 )     (1,155,843 )     (626,222 )
                                 
Income tax benefit
    -- -       (56,712 )     -- -       (212,194 )
                                 
Net loss
  $ (524,971 )   $ (112,190 )   $ (1,155,843 )   $ (414,028 )
                                 
Comprehensive loss
  $ (524,485 )   $ (120,243 )   $ (1,131,661 )   $ ( 422 , 261 )
                                 
Basic and diluted loss per share
  $ ( 0 .72 )   $ (0.15 )   $ ( 1.58 )   $ (0.57 )

See accompanying notes to consolidated financial statements.
 
 
2
 
 


 
MAINSTREET FINANCIAL CORPORATION
 
Consolidated Statements of Changes in Shareholders' Equity
For the Nine-Month Period Ended September 30, 2008  (Unaudited)
 
   
Common
Stock
   
Additional
Paid-In Capital
   
Retained
Earnings
   
Unearned
ESOP Shares
   
Accumulated
Other
Comprehensive
Income (Loss)
   
Total
Shareholders’
Equity
 
                                     
Balance – January 1, 2008
  $ 7,561     $ 2,821,602     $ 4,603,116     $ (247,856 )   $ (30,154 )   $ 7,154,269  
                                                 
Net loss
    ---       ---       (1,155,843 )     ---       ---       (1,155,843 )
                                                 
Change in unrealized gain/loss on
      securities available for sale,
      net of reclassifications
      ---         ---         ---         ---         24,182         24,182  
                                                 
Earned ESOP shares
    ---       (14,799 )     ---       25,589        ---       10,790  
                                                 
Balance – September 30, 2008
  $ 7,561     $ 2,806,803     $ 3,447,273     $ (222,267 )   $ (5,972 )   $ 6,033,398  

See accompanying notes to consolidated financial statements.

 
3
 
 

MAINSTREET FINANCIAL CORPORATION

Notes to Consolidated Statements of Cash Flows for the
Nine-Month Periods Ended September 30, 2008 and 2007 (Unaudited)
 

   
Nine Months
Ended September 30,
 
   
2008
   
2007
 
       
Cash flows from operating activities
           
Net loss
  $ (1,155,843 )   $ (414,028 )
Adjustments to reconcile net loss to net cash from operating activities
               
Depreciation
    141,539       191,383  
Amortization, net of accretion
               
Securities
    2,282       2,913  
Loans
    (1,267 )     (167 )
Intangible assets
    119,506       122,887  
Provision for loan losses
    296,000       173,000  
Loans originated for sale
    (2,276,300 )     (1,724,640 )
Proceeds from sales of loans originated for sale
    2,299,303       1,746,425  
    Other–than–temporary impairment of securities
    188,632       ---  
Gain on sale of loans
    (23,003 )     (21,786 )
    ESOP expense
    10,790       24,255  
    (Gain) loss on sale of repossessed real estate
    36,954       (50,712 )
Change in assets and liabilities
               
Change in deferred fees and discounts
    18,985       30,948  
Accrued interest receivable
    68,145       68,590  
Other assets
    58,891       (236,836 )
Accrued interest payable
    (86,089 )     62,621  
Other liabilities
    (44,777 )     183,120  
Net cash from (used in) operating activities
    ( 346,252 )     157 , 973  
                 
Cash flows from investing activities
               
Activity in available-for-sale securities:
               
Principal repayments, maturities, sales and calls
    63,051       115,969  
       Purchases of FHLB stock
    (91,000 )      ---  
Loan originations and payments, net
    1, 266,396       976,057  
Loans sold from portfolio
    3,874,571        ---  
Sales of other real estate owned
    257,068       466,230  
(Purchases) sales of premises and equipment, net
    (6,836 )     (120,212 )
Net cash used in investing activities
    5, 363,250       1,438,044  


(Continued)

 
4
 
 

MAINSTREET FINANCIAL CORPORATION

Consolidated Statements of Cash Flows for the
Nine-Month Periods Ended September 30, 2008 and 2007 (Unaudited)




   
Nine Months
Ended September 30,
 
   
2008
   
2007
 
       
             
Cash flows from financing activities
           
Net change in deposits
    (14,215,426 )     (1,883,189 )
Proceeds from FHLB advances
    29,780,000       13,000,000  
Repayment of FHLB advances
    (22,580,000 )     (10,000,000 )
Public offering costs
    ---       (114,993 )
Net cash from (used for) financing activities
    (7,015,426 )     1,001,818  
                 
Net change in cash and cash equivalents
    (1,998,428 )     2,597,835  
                 
Cash and cash equivalents at beginning of period
    5,171,303       3,840,265  
                 
Cash and cash equivalents at end of period
  $ 3,172,875     $ 6,438,100  
                 
Supplemental disclosures of cash flow information
               
Cash paid during the year for
               
Interest
  $ 2,861,317     $ 3 ,207,297  
Taxes
    ---       ---  
Supplemental disclosures of non cash activities
               
Transfer of loans to other real estate
  $ 1,260,637     $ 687 ,151  
                 
                 

See accompanying notes to consolidated financial statements.

 
5
 
 

MAINSTREET FINANCIAL CORPORATION

Notes to Consolidated Financial Statements


1.             BASIS OF PRESENTATION:

The unaudited, consolidated financial statements include the consolidated results of operations of MainStreet Financial Corporation ("Company"), MainStreet Savings Bank ("Bank") and MainStreet Financial Services, Inc., a wholly owned subsidiary of the Bank.  These financial statements do not include the accounts of the Company’s parent company, Mainstreet Financial Corporation, MHC.  These consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and Article 8 of Regulation S-X and do not include all disclosures required by generally accepted accounting principles for a complete presentation of the Company's financial condition and results of operations.  In the opinion of management, the information reflects all adjustments (consisting only of normal recurring adjustments) which are necessary in order to make the financial statements not misleading and for a fair representation of the results of operations for such periods.  The results for the period ended September 30, 2008, should not be considered as indicative of results for a full year.  For further information, refer to the consolidated financial statements and footnotes included in the Company's Form 10-KSB for the year ended December 31, 2007.

2.             EARNINGS PER SHARE:

Basic earnings (loss) per share is net income (loss) divided by the weighted average number of common shares outstanding during the periods which were 732,704 and 729,142 shares for the nine months ended September 30, 2008 and 2007 respectively. For the three months ended September 30, 2008 and 2007 the weighted shares outstanding were 733,557 and 730,040, respectively. ESOP shares are considered outstanding for this calculation, unless unearned.  There are currently no potentially dilutive common shares issuable under stock options or other programs.  Earnings (loss) and dividends per share are restated for all stock splits and dividends through the date of the financial statements.

3           RECENT ACCOUNTING DEVELOPMENTS:

                In September 2006, the FASB issued Statement No. 157, Fair Value Measurements .  This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements.  This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset.  The standard is effective for fiscal years beginning after November 15, 2007.  In February 2008, the FASB issued Staff Position (FSP) 157-2, Effective Date of FASB Statement No. 157 .  This FSP delays the effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.  The Bank adopted the standard and disclosures have been added to Note 4.

            In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities.  The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities.  The new standard is effective for the Company on January 1, 2008.  The Company did not elect the fair value option for any financial assets or financial liabilities as of January 1, 2008,  and therefore this standard did not have a material effect on the Bank as of September 30, 2008.


 
6
 
 

4.            FAIR VALUE MEASUREMENTS:

Statement 157 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

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

 
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

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

The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs) or matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

Assets and Liabilities Measured on a Recurring Basis

Assets and liabilities measured at fair value on a recurring basis are summarized below:
 
         
Fair Value Measurements at September 30, 2008 Using
 
   
September 30,   2008
   
Quoted Prices in Active Markets for Identical Assets
(Level 1)
   
Significant Other Observable Inputs (Level 2)
   
Significant Unobservable Inputs
(Level 3)
 
Assets:
                       
  Available for sale securities
  $ 1,694,630       ---     $ 1,694,630       ---  

Assets and Liabilities Measured on a Non-Recurring Basis


Assets and liabilities measured at fair value on a non-recurring basis are summarized below:
 
       
Fair Value Measurements at September 30, 2008 Using
 
   
September 30, 2008
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
Significant Other Observable Inputs (Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Assets:
               
   Impaired loans
  $ 1,082 ,000         $ 1,082 ,000  


 
7
 
 

The following represent impairment charges recognized during the period ended September 30, 2008.

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $1,082,000, with a valuation allowance of $160 ,000 , resulting in an additional provision for loan losses of $160 ,000 for the nine month period ended September 30, 2008.

            The fair value of impaired loans is estimated using one of several methods, including collateral value or market value of similar debt.  At September 30, 2008, substantially all of the total impaired loans were evaluated based on the fair value of the collateral.  When the fair value of the collateral is based on an observable market price or a current appraised value, we classify the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, we classify the impaired loan as nonrecurring Level 3.


Item 2       Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This report contains certain ‘forward-looking statements’ that may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” and “estimated” with respect to our financial condition. Results of operations and business are subject to various factors which could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, general and local economic conditions, changes in interest rates and the relationship between short- and long-term interest rates, deposit flows, demand for mortgage, consumer and other loans, real estate values, competition, changes in accounting principles, policies or guidelines, changes in legislation or regulation, and other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services.

General and Recent Regulatory Matters
 
            The principal business of MainStreet Financial Corporation (“Company”) is operating our wholly owned subsidiary, MainStreet Savings Bank (“Bank”).  The Bank is a community oriented institution primarily engaged in attracting retail deposits from the general public and originating one- to four-family residential loans in its primary market area, including construction loans and home equity lines of credit.  The Bank also originates a limited amount of construction or development, consumer and commercial loans.  The Company is in a mutual holding company structure and 53% of its stock is owned by MainStreet Financial Corporation, MHC (“MHC”).

Our results of operations depend primarily on our net interest income.  Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans, investments and mortgage-backed securities, and the interest we pay on our interest-bearing liabilities, consisting of savings and checking accounts, money market accounts, time deposits and borrowings.  Our results of operations also are affected by our provision for loan losses, non-interest income and non-interest expense .  As a result of the slower economy, declining household net worth and an overall decline in consumer and business activity , loan originations have decreased.  Non-interest income consists primarily of service charges on deposit accounts, transaction fees and commissions from investment services.  Non-interest expense consists primarily of salaries and employee benefits, occupancy, equipment and data processing, advertising and other costs.  Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, governmental policies and actions of regulatory authorities.

 
8
 
 


During the first nine months of 2008, the Company’s earnings continued to be negatively impacted by decreased interest income, due to a lower volume of loan originations and the slower economy in southwest Michigan.  The economic environment significantly reduced loan demand and increased loan delinquencies and associated losses, particularly due to decreased property values.  We have experienced a $1,156,000 loss in the first nine months of 2008, which reduced our capital.  This continuing weak economy has caused a $752,000 increase in other real estate owned during the quarter ended September 30, 2008.  During the first nine months of 2008, $1,301,000 in delinquent real estate loans were converted to other real estate owned, as compared to only $687,000 during the first nine months of 2007.  We experienced a $37,000 loss on the sale of repossessed properties during the first nine months of 2008, compared to a $51,000 gain during the first nine months of 2007.  

The allowance for loan losses has increased to $ 675 ,000 at September 30, 2008 from $508,000 at December 31, 2007.  The increase during the nine months is the result of a $296,000 provision for loan losses and recoveries of $16,000, less charge-offs of $145,000.  These charge offs include a $36,000 loss attributable to the sale of property by a borrower, which was security for a delinquent land development loan.  Additionally, there were $26,000 in write downs experienced on two other real estate owned (“OREO”) properties which are currently listed for sale by the bank, $56,000 in charge offs on six consumer loans, four of which were unsecured and two secured by vehicles in the process of being repossessed, a  $14,000  write down of a repossessed vehicle and a $13,000 charge off on a commercial loan secured by a vehicle.   Management believes the allowance at September 30, 2008 is adequate given the collateralization of delinquent and non-performing loans.  

Primarily as a result of our continuing operating losses, our bank subsidiary received a letter from the OTS dated February 5, 2008, stating that the Bank is deemed to be in troubled condition, and, as a result, is subject to specified operating restrictions.  These operating restrictions provide that: (1) the Bank must limit its quarterly asset growth to net interest credited on deposit liabilities during the quarter (unless additional asset growth is permitted by the OTS); (2) the Bank must obtain prior OTS approval prior to appointing any new director or senior executive officer; (3) the Bank’s ability to enter into certain severance agreements or make certain severance payments is limited by 12 C.F.R. § 359; (4) the Bank must receive OTS approval of any new, renewed or amended arrangements providing compensation or benefits to its directors and officers; (5) the Bank must obtain OTS approval of all third-party contracts outside the normal course of business; and (6) the Bank must provide the OTS with 30-days notice of all proposed transactions with affiliates.

On April 4, 2008, the Bank entered into a supervisory agreement with the OTS to address the OTS’s concerns regarding the financial condition of the Bank.  Among other things, the supervisory agreement requires the Bank to: (1) prepare and submit a three-year business plan; (2) revise its liquidity management policy; (3) enhance compliance training; (4) prepare and submit quarterly reports on classified assets; and (5) continue to abide by the limits in the February 5, 2008 “troubled condition” letter.  

On August 8, 2008 the Bank lost well capitalized status under prompt corrective action regulations of the OTS and became adequately capitalized effective June 30, 2008.  See “Capital.”

Difficult market conditions and economic trends have adversely affected our industry and our business.

Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant writedowns of assets by many financial institutions.  General downward economic trends, reduced availability of commercial credit and increasing unemployment have negatively impacted the credit performance of commercial and consumer credit, resulting in additional writedowns.  Concerns over the stability of the financial markets and the economy

 
9
 
 

have resulted in decreased lending by financial institutions to their customers and to each other.  This market turmoil and tightening of credit has led to increased commercial and consumer deficiencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity.  Southwestern Michigan has experienced the adverse impact of these economic trends for over two years.  Financial institutions have experienced decreased access to deposits or borrowings.  Our access to Federal Home Loan Bank advances has decreased in recent months as the required collateral level has increased.

The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets has adversely affected our business, financial condition, results of operations and stock price.

Our ability to assess the creditworthiness of customers and to estimate the losses inherent in our credit exposure is made more difficult and complex under these difficult market and economic conditions.  We also expect to face increased regulation and government oversight as a result of these downward trends.  This increased government action may increase our costs and limit our ability to pursue certain business opportunities.  We also may be required to pay even higher FDIC premiums than the recently increased level, because financial institution failures resulting from the depressed market conditions have and may continue to deplete the insurance fund of the FDIC and reduce the FDIC’s ratio of reserves to insured deposits.

We do not expect these difficult conditions to likely improve in the near future.  A worsening of these conditions would likely exacerbate the adverse effects of these difficult market and economic conditions on us, our customers and the other financial institutions in our market.  We may experience increases in foreclosures, delinquencies and customer bankruptcies, as well as more restricted access to funds.

Recent legislative and regulatory initiatives to address these difficult market and economic conditions may not stabilize the U.S. banking system.

The recently enacted Emergency Economic Stabilization Act of 2008 (“EESA”) authorizes the Treasury Department to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a troubled asset relief program (”TARP”).  The 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.  The Treasury Department has allocated $250 billion towards the TARP Capital Purchase Program (“CPP”).  Under the CPP, Treasury will purchase debt or equity securities from participating institutions.  The TARP also will include direct purchases or guarantees of troubled asset of financial institutions.

EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000.  This increase is in place until the end of 2009 and is not covered by deposit insurance premiums paid by the banking industry.  In addition, the FDIC has implemented two temporary programs to provide deposit insurance for the full amount of most non-interest bearing transaction accounts through the end of 2009 and to guarantee certain unsecured debt of financial institutions and their holding companies through June 2012.  Financial institutions have until November 12, 2008 to opt out of these two programs.  The purpose of these legislative and regulatory actions was to stabilize the volatility in the U.S. banking system.

EESA, TARP and the FDIC’s recent regulatory initiatives may not stabilize the U.S. banking system and financial markets.  If the volatility in the market and the economy continue or worsen, our business, financial condition, results of operations, access to funds and the price of our stock could be materially and adversely impacted.


 
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Evolution of Business Strategy

The Bank’s business strategy has been modified to reflect the continued weakness in the West Michigan economy, including the real estate market, the growth limitations imposed by the Bank’s capital position and the regulatory constraints imposed by OTS.  We continue initiatives to improve net interest margin and attract core deposits and have undertaken a series of new initiatives to reduce operating expenses.  New loan production, to the extent that it increases to the point where it exceeds the normal monthly decrease in the portfolio due to amortization and prepayments, will be offset by the sale of newly originated loans and/or the sale of participation interests in existing loans in the portfolio.  Cash from loan sales will be used to increase liquidity and/or reduce the reliance on brokered deposits.

Critical Accounting Policies
 
We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider our critical accounting policies to be those related to our allowance for loan losses and deferred income taxes.  The allowance for loan losses is maintained to cover losses that are probable and can be estimated on the date of the evaluation in accordance with U.S. generally accepted accounting principles.  It is our estimate of probable incurred credit losses that are in our loan portfolio.  Our methodologies for analyzing the allowance for loan losses and determining our net deferred tax assets is described in our Form 10-KSB for the year ended December 31, 2007.
 
Comparison of Financial Condition at September 30, 2008 and December 31, 2007
 
General .   Total assets decreased by $8.0 million, or 7.01%, to $107.0 million at September 30, 2008, from $115.0 million at December 31, 2007.  A significant reason for this decrease was a sale of $3.8 million in residential real estate loans during the first quarter of 2008, in order to maintain the Bank’s then well-capitalized status and to comply with the growth limits in the supervisory directive and supervisory agreement.  These sold loans had balloon notes with an average remaining term of less than five years and contained terms typical of current offerings and portfolio averages.  Our cash and securities decreased $2.2 million during the first nine months of 2008.  Our loan portfolio decreased $6.4 million after the loan sale due to delinquent loans converting to other real estate owned, decreased demand for loans and the retention of the proceeds of loan repayments for liquidity purposes.
 
 Cash and Securities. Cash and cash equivalents decreased by $2.0 million during the period, to $3.2 million at September 30, 2008. Though our current liquidity strategy is to maintain higher levels of available funds to meet expenses and commitments, we experienced this decrease because of the use of cash in part to fund maturing wholesale deposits.  Our securities portfolio decreased by $230,000 during the nine months, which primarily was a result of a $189,000 other-than-temporary impairment adjustment on a mutual fund investment . That portfolio is designated as available for sale and we have substantially all of our securities investments in shorter-term instruments.  Cash and securities were 4.6 % and 6.2% of total assets at September 30, 2008, and December 31, 2007, respectively.  See also   Liquidity and   Off-Balance Sheet Commitments.”
 
Loans .   Our loan portfolio decreased $ 6.5 million or 6.5 %, from $100.2 million at December 31, 2007 to $9 3.7 million at September 30, 2008.  In March 2008, we sold $3.8 million in residential loans in order to comply with the OTS growth limit and to maintain the Bank’s well - capitalized status.     The slower economy in southwest Michigan has significantly reduced loan demand, particularly for residential purchase mortgage, construction and development loans.   That slower economy also has resulted in increased foreclosures described below.  Additionally, new competitors in our primary market are pursuing new lending opportunities with aggressive pricing .    The decrease in our loan portfolio consisted of a 5.1% decrease in one- to four-family residential mortgages (including the $3.8 million in loans sold),
 

 
11
 
 

a 9.6% decrease in commercial real estate and business loans, a 6.2% decrease in consumer loans, a 2.0% decrease in home equity lines of credit and a 37.7% decrease in construction and development loans.
 
Other Real Estate Owned.   Other real estate owned (“OREO”) increased by $967,000 or 108.6% from $911,000 at December 31, 2007 to $1.9 million at September 30, 2008. During the first nine months of 2008, $1.3 million in delinquent real estate loans were converted to other real estate owned, as compared to only $687,000 during the first nine months of 2007.  This increase in 2008 reflects foreclosures or properties deeded in lieu of foreclosure on nine single family homes with loan balances totaling $1.3 million.  The bank is in the process of foreclosing on four additional one-to-four-family residential loans with balances of $415,000, one vacant land loan with a balance of $90,000, and one commercial land development loan with a balance of $411,000.  
 
Allowance for Loan Losses .   Our allowance for loan losses at September 30, 2008, was $675,000 or 0.72% of gross loans, compared to $508,000 or 0.51% of loans at December 31, 2007.  The increase in the allowance for loan losses from year end was in response to the continuing stagnation in our local economy, including increases in non-performing assets.
 
The following table is an analysis of the activity in the allowance for loan losses for the periods shown.
 
   
Nine Months
  Ended September 30
 
   
2008
   
2007
 
Balance at beginning of period
  $ 508,000     $ 538,000  
Provision charged to income
    296,000       173,000  
Recoveries
    16,000       48,000  
Charge-offs
    (145,000 )     (198,000 )
Balance at end of period
  $ 675,000     $ 561,000  

 
Nonperforming loans remained similar to those at December 31, 2007 with a balance of $2.0 million.  Our overall nonperforming loans to total loans ratio increased from 2.02% at December 31, 2007, to 2.13%   at September 30, 2008.  At September 30, 2008, we had 17 nonperforming loans as follows:
 
 
·
One large commercial relationship – A $411,000 loan for the development of residential lots, which is in non-accrual status and in the process of foreclosure.  We believe the value of the collateral for this land development loan currently exceeds the outstanding balance .
 
 
·
Four commercial loans - One participation loan secured by multi unit housing for $217,000 that is in non-accrual status.  One loan for $39,000 secured by corporate assets and two loans to a landscaping company totaling $17,000, secured by vehicles and equipment.
 
 
·
Ten one-to-four-family mortgage loans totaling $1,231,000, nine of which are in various stages of foreclosure.  Six of these loans totaling $830,000 are in non-accrual status.  Five of the ten loans totaling $501,000 are believed to be adequately collateralized with respect to the outstanding balances and the bank expects no material loss related to these loans. Two of the  loans totaling $239,000 have insufficient collateral values on which the bank expects to incur a loss.  The other three loans totaling $491,000 are to the same borrower and these properties have a pending purchase offer that would result in a short sale and a loss to the bank.  
 

 
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·
A $90,000 vacant land loan that is in the process of foreclosure.
 
 
·
One consumer loan totaling $1,000 .  
 
           The Bank has purchased participation interests in two loans to a commercial real estate development company, both of which are now classified troubled debt restructured.  One loan in the amount of $476,000 is for the development of residential lots in a now partially completed condominium project.  The lead bank has provided construction financing for all of the homes in the project.  The second loan of $153,000 is secured by a commercial building in Lansing, Michigan.  The lead lender, with our concurrence, has reduced the interest rate of these loans, as they did on all of this borrower’s loans held in their own portfolio, in order to reduce the required payments to a level that can be supported by the borrower’s current cash flow.  Both loans are considered to be adequately secured and no specific reserves have been established.

Our loan delinquencies decreased during the nine months to $3.4 million, or 3.6% of total loans, at September 30, 2008, compared to $4.5 million, or 4.5% of total loans, at December 31, 2007.  The decrease in loan delinquencies during the first nine months of 2008 was primarily the result of borrowers making payments and bringing loans current.  This is attributed to income tax refunds and the government stimulus payouts.  Included in this trend was the pay-off of a $371,000  land development loan, ten one-to - four - family foreclosed real estate loans moving to ORE O totaling $1,300,000 and $79,000 in charged-off consumer loans.
 
On September 30, 2008, the Bank was monitoring other loans of concern classified as substandard or doubtful on the bank’s monthly delinquency report.  These consist of  two participation loans on commercial real estate totaling $629,000, one second mortgage loan totaling $25,000 and six consumer loans totaling $28,000.  All loans are being actively monitored and collection efforts are continuing.
 
Past due loans classified as special mention that are being monitored by the Bank’s loan review committee include five commercial loans to a landscaping company that are secured by vehicles and business equipment totaling $79,000, five commercial loans totaling $363,000 to a business that are secured by one-to-four-family real estate and corporate assets and four loans to business partners that are secured by a land development, commercial real estate and their personal residences totaling $850,000.
 
With our market area continuing to experience sluggish economic conditions, we anticipate high levels of delinquencies and net charge-offs will continue during the remainder of 2008.
 
Deposits .   Total deposits decreased by $14.2 million, or 17.9%, to $65.2 million at September 30, 2008, from $79.4 million at December 31, 2007.  This decrease is primarily the result of our decision not to renew $13.1 million in wholesale deposits during the nine months.  We have not experienced a material decrease in retail deposits in our local market.
 
During the quarter, demand deposits increased $622,000 and savings and money market accounts increased $12,000.  The amount of time deposits or certificates at September 30, 2008 was $1.6 million less than at the end of 2007, primarily due to the decision of our customers holding cash in more liquid accounts.  
 
Borrowings.   Federal Home Loan Bank advances increased $7.2 million, or 27.3%, to $33.6 million at September 30, 2008, from $26.4 million at December 31, 2007.  We increased Federal Home Loan Bank borrowings to replace higher cost wholesale certificates of deposit, which we chose not to renew.  At September 30, 2008, we had the ability to borrow an additional $4.5 million from the Federal Home Loan Bank.
 

 
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At September 30, 2008, we had $700,000 outstanding on our loan from another bank, which is secured by 100% of the outstanding common stock of the Bank.  The interest rate on this loan at September 30, 2008 was 5.8%.  Our operating losses and level of non-accrual loans and other real estate owned have been a violation of financial covenants of the loan and an event of default.  On March 31, 2008, the lender provided a letter agreeing to forbear from enforcing those covenants for the balance of 2008 so long as we otherwise remain in compliance with the loan documents and forbearance letter for this loan and the lender’s other loan to our employee stock ownership plan.  At September 30, 2008 we were not in compliance with these require ments.   Failure to maintain well-capitalized status is a default under our bank loan and the 2008 forbearance letters for previous events of default under that loan.  We will ask the lending bank for additional forbearance if the Bank does not return to well-capitalized status by December 31, 2008.  However, that forbearance may not be granted.
 
Equity.   Total equity decreased $1.0 million, or 15.5%, to $6.0 million at September 30, 2008, from $7.1 million at December 31, 2007.  The decrease in equity was primarily due to a net loss of $1.2 million for the nine months.  On August 8, 2008 the Bank lost well-capitalized status under prompt corrective action regulations of the OTS and became adequately capitalized.  The change in status was effective June 30, 2008.  See “Capital.”
 
Comparison of Operating Results for the Three Months and Nine Months Ended September 30, 2008 and 2007

            General.   The net loss for the three months ended September 30, 2008 was $525,000, as compared to a net loss of $112,000 for the three months ended September 30, 2007.  The net loss for the nine months ended September 30, 2008 was $1.2 million as compared to a net loss of $414,000 for the same period in 2007 .  The net loss for the nine months reflects a $11,000 increase in net interest income primarily attributable to declining interest rates. Our provision for loan losses increased $123,000 for the nine months.  Regulatory assessments increased $104,000 and salaries and employee benefits increased $52,000 while professional services increased $34,000 during the first nine months of 2008.  These increases were offset by a $57,000 decrease in premises and equipment expense.  Non -interest income decreased during the nine months by $274,000.  The decrease is primarily attributable to a $189,000 impairment of a mortgage backed mutual fund that was determined to be other than temporarily impaired and a $37,000 loss on the sale of repossessed property.  In 2007, we recognized a tax benefit of $212,000 compared to no tax benefit in 2008.

 
            Interest Income.   Interest income decreased by $285,000, or 16.7%, to $1.5 million for the three-month period ended September 30, 2008, from $1.7 million for the same period in 2007.  Interest income decreased by $484,000, or 9.3% to $4.7 million for the nine months ended September 30, 2008 from $ 5.2 million for the nine months ended September 30, 2007.  The decrease in interest income is primarily related to the decrease in the weighted average yield of the residential loan portfolio during the nine months, as well as the decrease in loan portfolio balances.

The weighted average yield on loans decreased to 5.57% for the quarter ended September 30, 2008, from 6.35% for the quarter ended September 30, 2007.  The weighted average yield on loans decreased from 6.35% for the nine months ended September 30, 2007 to 5.91% for the nine months ended September 30, 2008.  The decrease was primarily the result of prime rate based adjustable rate loans, home equity loans and commercial loans re-pricing to lower rates as the prime rate decreased from 8.25% to 5.0% as the result of Federal Reserve rate cuts.  Interest rates on other types of loans have remained relatively stable.  We anticipate this trend to continue for the shorter term.
 
            Interest Expense.   Interest expense decreased $ 301 ,000, or 27.4 %, to $ 807 ,000 for the quarter ended September 30, 2008 from $1.1 million for the quarter ended September 30, 2007.  Interest expense decreased $ 495,000, or 15.5%, to $2.8 million for the nine months ended September 30, 2008, from $3.2 million for the nine months ended September 30, 2007.  The decrease was a result of a decrease in the average balance of deposits and a decrease in the average rate paid on both deposits and Federal Home

 
14
 
 

Loan Bank advances due to the lower interest rate environment and our decreased reliance on wholesale and brokered deposits.  We paid $10,000 and $15,000 in interest, respectively, on our bank line of credit during the quarter ended September 30, 2008 and September 30, 2007.  We paid $34,000 in interest on our bank line of credit during the nine months ended September 30, 2008 and $42,000 for same period in 2007.  The average cost of interest-bearing liabilities decreased from 4.40% for the quarter ended September 30, 2007 to 3.32% for the quarter ended September 30, 2008.  The average cost of interest-bearing liabilities decreased from 4.32% for the nine months ended September 30 , 2007 to 3.76% for the nine months ended September 30, 2008 .

Interest paid on deposits decreased $295,000, or 36.9%, to $504,000 for the three months ended September 30, 2008 from $799,000 for the three months ended September 30, 2007.  In addition, interest paid on deposits decreased $552,000, or 23.0%, to $1.8 million for the nine months ended September 30, 2008 from $2.4 million for the nine months ended September 30, 2007 .  This reflects our decision to replace wholesale and brokered deposits with Federal Home Loan Bank advances, lower interest rates generally as well as a relative increase in lower cost demand accounts.
 
Interest expense on Federal Home Loan Bank advances decreased $1,500 or 0.50%, to $ 292 ,000 for the three months ended September 30, 2008, from $294,000 for the three months ended September 30, 2007.  In addition, interest expense on Federal Home Loan Bank advances increased $65,000, or 7.4%, from $875,000 for the nine months ended September 30, 2007 to $940,000 for the nine months ended September 30, 2008.  This increase resulted from decreasing rates on the repricing of our advances and an increase in the average balance of outstanding Federal Home Loan Bank advances of $28.7 million for the nine months ended September 30, 2008, from $21.9 million for the nine months ended September 30, 2007.
 
            Net Interest Income.   Net interest income before the provision for loan losses increased by $16,000, or 2.5%, to $657,000 for the three-month period ended September 30, 2008, compared to $641,000 for the same period in 2007.  Net interest income increased by $11,000, or 0.6%, to $1.9 million for the nine months ended September 30, 2008, compared to $1.9 million for the nine months ended September 30, 2007.  Our net interest margin was 2.45% for the three months ended September 30, 2008, compared to 2.32% for the three months ended September 30, 2007, and was 2.39 % for the nine months ended September 30, 2008, compared to 2.33% for the nine months ended September 30, 2007.

Provision for Loan Losses.   We establish the provision for loan losses, which is charged to operations, at a level management believes will adjust the allowance for loan losses to reflect probable incurred credit losses in the loan portfolio.  In evaluating the level of the allowance for loan losses, management considers the types of loans and the amount of loans in the loan portfolio, historical loss experience, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions.
 
Based on management’s evaluation of these factors, provisions of $ 161 ,000 and $45,000 were made during the quarters ended September 30, 2008 and 2007, respectively and provisions of $2 96 ,000 and $173,000 were made during the nine months ended Sept 30, 2008 and 2007 respectively.  The increase in the provision for loan losses was primarily in response to increased delinquencies in the first nine months of 2008 as compared to the same period in 2007.  During the nine months ended September 30, 2008, net charge-offs were $129,000, compared to $150,000 for the same period in 2007. The ratio of non-performing loans to total loans was 2.13% at September 30, 2008, compared to 2.13% at September 30, 2007, and 2.02% at December 31, 2007.   Non-performing loans at September 30, 2008, consisted of $1.3 million in residential mortgage loans and $685,000 in commercial loans and $1,000 in consumer loans.
 
Non-interest Income.   Non-interest income decreased $97,000 or 76.4% to $31,000 for the three months ended September 30, 2008, compared to $127,000 for the same period in 2007, and decreased $274,000, or 71.9%, to $107,000 for the nine months ended September 30, 2008, compared to $381,000
 

 
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for the same period in 2007.  The decrease in non-interest income during the 2008 period was primarily due to a $188,000 impairment of a mortgage -backed mutual fund and a $37,000 loss on a repossessed property compared to a $ 51 ,000 gain on the sale of a property in the same period of 2007.  
 
Non-interest Expense.   Non- interest expense increased $160,000, or 14.5%, from $892,000 for the three-month period ended September 30, 2007 to $1.1 million for the three months ended September 30, 2008.  In addition, non-interest expense increased $143,000, or 5.1%, from $2.8 million for the nine months ended September 30, 2007 to $2.9 million for the nine months ended September 30, 2008.  Increases in expenses of $104,000 for regulatory assessments, $52,000 for salaries and employee benefits, $4,000 for data processing services, $13,000 for administrative services and $34,000 for professional services were offset by decreases of $ 57,000 for premises and equipment, $3,000 in advertising costs and $3,000 for the amortization of intangibles.  The increase in regulatory assessments is primarily due to an increase in the general assessment rate from 2007.
 
Income Tax Benefit.   During 2007 management concluded, based on higher than expected operating losses and a difficult operating environment, that a valuation allowance should be established to reduce the net deferred tax asset at December 31, 2007 to zero.  This valuation allowance increased the net loss for the year ended December 31, 2007 and decreased shareholders’ equity but did not affect regulatory capital.  As a result of the establishment of the valuation allowance, no tax benefit has been recorded in the income statement at September 30, 2008 .
 
Liquidity
 
Liquidity management is both a daily and long-term function of the management of the Company and the Bank.  Excess liquidity is generally invested in short-term investments, such as overnight deposits and federal funds.  On a longer term basis, we maintain a strategy of investing in various lending products and investment securities, including mortgage-backed securities.  The Bank uses its sources of funds primarily to meet its ongoing commitments, pay maturing deposits, fund deposit withdrawals and to fund loan commitments.  The Bank has adopted the new liquidity management policy required in its supervisory agreement with the OTS.  
 
We maintain cash and investments that qualify as liquid assets to maintain liquidity to ensure safe and sound operation and meet demands for funds (particularly withdrawals of deposits ).  At September 30, 2008, the Company had $4.9 million in cash and investment securities available for sale generally available for its cash needs, of which $4.8 million was available to the Bank on an unconsolidated basis.  
 
The Bank’s liquidity position at September 30, 2008 was $ 4.9 million compared to $7.1 million at December 31, 2007.   This reduction reflects   the decrease in wholesale deposits using the proceeds from the sale of $3.8 million of residential loans, new Federal Home Loan Bank advances of $7.2 million and  decreased liquidity of $1.9 million.  For liquidity management purposes w e can generate funds from additional borrowings, deposit gathering activities and loan sales.  At September 30, 2008, we had $6.4 million in outstanding loan commitments, including unused lines of credit .  Certificates of deposit scheduled to mature in one year or less at September 30, 2008, totaled $3 5 .0 million .  It is management’s policy to maintain deposit rates that are competitive with other local financial institutions.  Based on this management strategy, we believe that a majority of maturing deposits will remain with the Bank.  However, because the Bank has become adequately capitalized, it may not accept or renew brokered deposits without regulatory approval. See “Capital.” At September 30, 2008, we had $11.6 million in wholesale or brokered deposits, which is a $17.5 million, or 60.2%, decrease from the level at September 30, 2007.  We plan to continue to decrease wholesale deposits and replace them with lower cost Federal Home Loan Bank advances to the extent possible.  At September 30, 2008, the Bank had the ability to borrow an additional $4.5 million in Federal Home Loan Bank advances.  
 
In the event we experience unexpected withdrawals of deposits or are unable to renew the majority of our maturing certificates of deposit at acceptable rates, we could have difficulty funding our

 
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ongoing operations.  Without FDIC approval to accept or renew brokered deposits, we have limited access to other sources of liquidity in the current banking environment.

Off-Balance Sheet Activities and Commitments

            In the normal course of operations, the Company engages in a variety of financial transactions that are not recorded in our financial statements.  These transactions involve varying degrees of off-balance sheet credit, interest rate and liquidity risks.  These transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.  For the nine months ended September 30, 2008, we engaged in no off-balance sheet transactions likely to have a material effect on our financial condition, results of operations or cash flows .  Our liquidity management includes monitoring our ability to meet outstanding commitments to extend credit.  
 
A summary of our off-balance sheet commitments to extend credit at September 30, 2008, is as follows:
 
Off-balance sheet commitments :
     
Commitments to make loans                                                                    
  $ 161 ,000  
Undisbursed portion of loans closed
    634,000  
Unused lines of credit                                                                    
    5,635,000  
Total loan commitments                                                               
  $ 6,430,000  

 
Capital
 
The Bank is subject to minimum capital requirements imposed by the OTS.  Based on its capital levels at September 30, 2008, the Bank exceeded these requirements as of that date. Our policy is for MainStreet Savings Bank to maintain a “well-capitalized” status under the capital categories of the OTS.  On August 8, 2008, as a result of the $78,000 write down of its mortgage backed securities mutual fund investment due to the declining price of the fund during the quarter, the Bank’s risk based capital fell to 9.8% and it lost well–capitalized status. The change to adequately capitalized was effective June 30, 2008.   As reflected below, MainStreet Savings Bank met the minimum capital ratios to be considered adequately-capitalized by the OTS based on its capital levels at September 30, 2008.   If our losses continue, there can be no assurance that we will continue to meet the adequately-capitalized standards.

   
Actual
   
Minimum Required to
Be Adequately
Capitalized
Under Prompt
Corrective
Action Provisions
   
Minimum Required to
Be Well Capitalized
Under Prompt
Corrective
Action Provisions
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
   
(Dollars in thousands)
 
Risk-Based Capital
(to risk-weighted assets)
  $ 6,455       9. 26 %   $ 5,5 81       8.0 %   $ 6,9 76       10.0 %
                                                 
Core Capital
(to risk-weighted assets)
  $ 5, 780       8. 29 %   $ 2,7 90       4.0 %   $ 4,1 85       6.0 %
                                                 
Core Capital
(to total adjusted  assets)
  $ 5,780       5. 45 %   $ 4,24 5       4.0 %   $ 5,3 07       5.0 %

The Bank is currently under a supervisory directive and supervisory agreement from the OTS.  Because the Bank’s capital level has fallen below well-capitalized status, the OTS may initiate additional enforcement action against the Bank.  Failure to maintain well-capitalized status is also a default under our bank loan and the 2008 forbearance letters for previous events of default under that loan.  We will ask the lending bank for additional forbearance if the Bank does not return to well-capitalized status by December 31, 2008.  However, that forbearance may not be granted.  Because the Bank has fallen below
 

 
17
 
 

well-capitalized status, it may not accept or renew brokered deposits without regulatory approval from the Federal Deposit Insurance Corporation, which has been applied for.  There can be no assurances when, or if, this FDIC approval will be received.
 
Impact of Inflation
 
The consolidated financial statements presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America.  These principles require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation.
 
Our primary assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation.  Interest rates, however, do not necessarily move in the same direction or with the same magnitude as the price of goods and services, since these prices are affected by inflation.  In a period of rapidly rising interest rates the liquidity and maturity structures of our assets and liabilities are critical to the maintenance of acceptable performance levels.
 
The principal effect of inflation, as distinct from levels of interest rates on earnings, is in the area of non-interest expense.  Employee compensation, employee benefits and occupancy and equipment costs may be subject to increases as a result of inflation.  An additional effect of inflation is the possible increase in the dollar value of the collateral securing loans that we have made.  We are unable to determine the extent, if any, to which properties securing our loans have appreciated in dollar value due to inflation.
 
Item 3     Quantitative and Qualitative Disclosures about Market Risk

             Not required, the Company is a smaller reporting company.


Item 4T Controls and Procedures    

An evaluation of the Company's disclosure controls and procedures as defined in Rule 13a -15(e) under the Securities Exchange Act of 1934 (the "Act") as of September 30, 2008, was carried out under the supervision and with the participation of the Company's Chief Executive Officer, Chief Financial Officer and several other members of the Company's senior management. The Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2008, the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Act is: (i) accumulated and communicated to the Company's management (including the Chief Executive Officer and the Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. There were no changes in our internal control over financial reporting (as defined in Rule 13a - 15(f) under the Act) that occurred during the nine months ended September 30, 2008, that have materially affected or are likely to materially affect our internal control over financial reporting.
 
The Company intends to continually review and evaluate the design and effectiveness of its disclosure controls and procedures and to improve its controls and procedures over time and to correct any deficiencies that it may discover in the future. The goal is to ensure that senior management has timely access to all material financial and non-financial information concerning the Company's business. While the Company believes the present design of its disclosure controls and procedures is effective to achieve its goal, future events affecting its business may cause the Company to modify its disclosure controls and procedures.
 

 
18
 
 

 
The Company does not expect that its disclosure controls and procedures will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons by collusion of two or more people or by management override of the control. The design of any control procedure is also based in part upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions or the degree of compliance with the policies and procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
 

 
19
 
 


PART II      OTHER INFORMATION

Item 1          Legal Proceedings

In the normal course of business, the Company occasionally becomes involved in various legal proceedings.  In the opinion of management, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.


Item 1A        Risk Factors

            Not required; the Company is a smaller reporting company.


Item 2           Unregistered Sales of Equity Securities and Use of Proceeds

Nothing to report.


Item 3           Defaults Upon Senior Securities

Nothing to report.


Item 4           Submission of Matters to a Vote of Security Holders

Nothing to report.

Item 5          Other Information

Nothing to report.

 
 

 
20
 
 



Item 6           Exhibits
 
Regulation
SK
Exhibit Number
Document
 
 
Reference to
Prior Filing
or Exhibit Number
Attached Hereto
3(i)
Charter of Mainstreet Financial Corporation
*
3(ii)
Bylaws of Mainstreet Financial Corporation
*
 
4
Stock Certificate of Mainstreet Financial Corporation
*
 
10.1
Loan Agreement with Independent Bank
*
 
10.4
Employee Stock Ownership Plan
**
 
10.6
Deferred Compensation Plan for Directors and Officers
*
 
10.7
Named Executive Officer Salary and Bonus Arrangements for 2008
+
 
10.8
Current Director Fee Arrangements
+
 
10.9
Forbearance Letter from Independent Bank for Holding Company Loan
+
 
10.10
Forbearance Letter from Independent Bank for ESOP Loan
   
11
Statement re Computation of Earnings
None
 
14
Code of Conduct and Ethics
++
 
15
Letter on unaudited interim financial information
None
 
18
Letter re change in accounting principles
None
 
19
Reports furnished to security holders
None
 
20
Other documents to security holders or incorporated by reference
None
 
22
Published report on matters submitted for shareholder vote
None
 
23
Consents
None
 
24
Power of Attorney
None
 
31.1
Rule 13a–14(a) Certification of Chief Executive Officer
31.1
 
31.2
Rule 13a–14(a) Certification of Chief Financial Officer
31.2
 
32
Section 1350 Certification
32
 
 
*
Filed as an exhibit to the Company's Form SB 2 registration statement filed on September 22, 2006 (File No. 333 137523) pursuant to Section 5 of the Securities Act of 1933.
   
**
Filed as an exhibit to Pre-effective Amendment No . 1 to the Company's Form SB 2 registration statement filed on November 3, 2006 (File No. 333 137523) pursuant to Section 5 of the Securities Act of 1933.
   
+
Filed as an exhibit to the Company s Form 10-KSB filed on March 30, 2008 (File No. 000-52298).
   
++
Filed as an exhibit to the Company s form 10-QSB filed on December 21, 2007 (File No. 000-52298).
   



 
21
 
 


SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.




   
MAINSTREET FINANCIAL CORPORATION
       
       
       
Date:
November 14, 2008
By:
/s/  David L. Hatfield
     
David L. Hatfield
     
President and Chief Executive Officer
       
       
       
Date:
November 14, 2008
By:
/s/  James R Toburen
     
James R. Toburen
     
Senior Vice President and
     
Chief Financial Officer





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