Edgar Filing: MBT FINANCIAL CORP

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 2012

Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 000-30973

MBT FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

Michigan		38-3516922
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

102 E. Front Street

Monroe, Michigan 48161

(Address of principal executive offices)

(Zip Code)

(734) 241-3431

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨

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). Yes þ 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 the definitions of “large accelerated filer”, “accelerated filer”, and “smaller accelerated filer” in Rule 12b-2 of the Exchange Act (check one).

Large accelerated filer ¨	Accelerated Filer ¨
Non-accelerated filer ¨	Smaller reporting company þ

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

As of November 13, 2012, there were 17,384,934 shares of the Company’s Common Stock outstanding.

Part I Financial Information

Item 1. Financial Statements

MBT FINANCIAL CORP.

CONSOLIDATED BALANCE SHEETS

	September 30, 2012
Dollars in thousands	(Unaudited)			December 31, 2011

ASSETS
Cash and Cash Equivalents
Cash and due from banks
Non-interest bearing	$	19,915		$	18,201
Interest bearing		68,980			57,794
Total cash and cash equivalents		88,895			75,995

Securities - Held to Maturity		28,038			35,364
Securities - Available for Sale		379,583			354,899
Federal Home Loan Bank stock - at cost		10,605			10,605

Loans held for sale		1,491			1,035

Loans		649,727			679,475
Allowance for Loan Losses		(19,123	)		(20,865	)
Loans - Net		630,604			658,610

Accrued interest receivable and other assets		6,065			7,700
Other Real Estate Owned		13,676			16,650
Bank Owned Life Insurance		48,731			47,653
Premises and Equipment - Net		28,376			29,516
Total assets	$	1,236,064		$	1,238,027

LIABILITIES
Deposits:
Non-interest bearing	$	168,448		$	164,852
Interest-bearing		851,962			857,458
Total deposits		1,020,410			1,022,310

Federal Home Loan Bank advances		107,000			107,000
Repurchase agreements		15,000			20,000
Interest payable and other liabilities		14,556			13,006
Total liabilities		1,156,966			1,162,316

STOCKHOLDERS' EQUITY
Common stock (no par value; 50,000,000 shares authorized, 17,324,063 and 17,291,729 shares issued and outstanding)		2,187			2,099
Retained earnings		75,593			72,735
Unearned compensation		(32	)		(87	)
Accumulated other comprehensive income		1,350			964
Total stockholders' equity		79,098			75,711
Total liabilities and stockholders' equity	$	1,236,064		$	1,238,027

The accompanying notes to consolidated financial statements are an integral part of these statements.

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MBT FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED

	Three Months Ended September 30,						Nine Months Ended September 30,
Dollars in thousands, except per share data	2012			2011			2012			2011

Interest Income
Interest and fees on loans	$	8,696		$	10,026		$	26,773		$	30,370
Interest on investment securities-
Tax-exempt		341			346			1,076			1,069
Taxable		1,894			2,050			6,023			6,211
Interest on balances due from banks		56			44			145			112
Total interest income		10,987			12,466			34,017			37,762

Interest Expense
Interest on deposits		1,488			2,646			4,964			8,621
Interest on borrowed funds		878			864			2,720			2,838
Total interest expense		2,366			3,510			7,684			11,459

Net Interest Income		8,621			8,956			26,333			26,303
Provision For Loan Losses		1,550			2,700			4,850			11,300

Net Interest Income After
Provision For Loan Losses		7,071			6,256			21,483			15,003

Other Income
Income from wealth management services		1,063			972			2,859			2,955
Service charges and other fees		1,177			1,226			3,392			3,522
Net gain on sales of securities available for sale		99			555			1,239			651
Origination fees on mortgage loans sold		298			102			624			271
Bank owned life insurance income		375			405			1,078			1,207
Other		1,011			1,059			3,072			3,234
Total other income		4,023			4,319			12,264			11,840

Other Expenses
Salaries and employee benefits		5,069			4,878			15,128			14,611
Occupancy expense		707			781			2,058			2,246
Equipment expense		677			722			2,226			2,164
Marketing expense		151			214			524			695
Professional fees		534			540			1,646			1,833
Collection expenses		28			47			188			181
Net loss on other real estate owned		373			818			872			2,943
Other real estate owned expenses		350			586			1,258			1,458
FDIC Deposit Insurance Assessment		694			618			2,067			2,254
Other		1,106			739			3,356			2,651
Total other expenses		9,689			9,943			29,323			31,036

Income (Loss ) Before Income Taxes		1,405			632			4,424			(4,193	)
Income Tax Expense		17			-			1,566			-
Net Income (Loss)	$	1,388		$	632		$	2,858		$	(4,193	)

Other Comprehensive Income (Net of Tax)
Unrealized gains (losses) on securities		894			1,586			1,048			5,387
Reclassification adjustment for gains included in net income		(66	)		(367	)		(818	)		(430	)
Postretirement benefit liability		52			53			156			156
Total Other Comprehensive Income (Net of Tax)		880			1,272			386			5,113

Comprehensive Income	$	2,268		$	1,904		$	3,244		$	920

Basic Earnings (Loss) Per Common Share	$	0.08		$	0.04		$	0.16		$	(0.24	)

Diluted Earnings (Loss) Per Common Share	$	0.08		$	0.04		$	0.16		$	(0.24	)

Common Stock Dividends Declared Per Share	$	-		$	-		$	-		$	-

The accompanying notes to consolidated financial statements are an integral part of these statements.

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MBT FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY - UNAUDITED

								Accumulated
								Other
	Common		Retained		Unearned			Comprehensive
Dollars in thousands	Stock		Earnings		Compensation			Income (Loss)			Total
Balance - January 1, 2012	$	2,099	$	72,735	$	(87	)	$	964		$	75,711

Issuance of Common Stock (32,334 shares)		56		-		-			-			56
Equity Compensation		32		-		55			-			87

Comprehensive income:
Net income		-		2,858		-			-			2,858
Change in net unrealized gain (loss) on securities available for sale - Net of tax effect of $(540)		-		-		-			1,048			1,048
Reclassification adjustment for gains included in net income - Net of tax effect of $421		-		-		-			(818	)		(818	)
Change in postretirement benefit obligation
Net of tax effect of $(80)		-		-		-			156			156
Total Comprehensive Income												3,244

Balance - September 30, 2012	$	2,187	$	75,593	$	(32	)	$	1,350		$	79,098

The accompanying notes to consolidated financial statements are an integral part of these statements.

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MBT FINANCIAL CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

	Nine Months Ended September 30,
Dollars in thousands	2012			2011
Cash Flows from Operating Activities
Net Income (Loss)	$	2,858		$	(4,193	)
Adjustments to reconcile net loss to net cash from operating activities
Provision for loan losses		4,850			11,300
Depreciation		1,477			1,535
Net amortization of investment premium and discount		1,513			762
Writedowns of Other Real Estate Owned		1,291			2,970
Net increase in interest payable and other liabilities		1,542			1,074
Net increase (decrease) in interest receivable and other assets		1,294			(6,906	)
Equity based compensation expense		132			122
Net gain on sale/settlement of securities		(1,239	)		(651	)
Increase in cash surrender value of life insurance		(1,078	)		(1,206	)
Net cash provided by operating activities	$	12,640		$	4,807

Cash Flows from Investing Activities
Proceeds from maturities and redemptions of investment securities held to maturity	$	12,423		$	9,154
Proceeds from maturities and redemptions of investment securities available for sale		229,516			119,180
Proceeds from sales of investment securities available for sale		32,824			5,068
Net decrease in loans		15,814			39,776
Proceeds from sales of other real estate owned		8,813			6,602
Proceeds from sales of other assets		99			229
Purchase of investment securities held to maturity		(5,089	)		(14,875	)
Purchase of Bank Owned Life Insurance		-			(63	)
Proceeds from surrender of Bank Owned Life Insurance		-			3,654
Purchase of investment securities available for sale		(286,957	)		(145,110	)
Purchase of bank premises and equipment		(339	)		(426	)
Net cash provided by investing activities	$	7,104		$	23,189

Cash Flows from Financing Activities
Net decrease in deposits	$	(1,900	)	$	(2,246	)
Repayment of Federal Home Loan Bank borrowings		-			(3,500	)
Repayment of repurchase agreements		(5,000	)		(10,000	)
Proceeds from issuance of common stock		56			41
Net cash used for financing activities	$	(6,844	)	$	(15,705	)

Net Increase in Cash and Cash Equivalents	$	12,900		$	12,291

Cash and Cash Equivalents at Beginning of Period		75,995			86,300
Cash and Cash Equivalents at End of Period	$	88,895		$	98,591

Supplemental Cash Flow Information
Cash paid for interest	$	7,793		$	11,778
Cash paid for federal income taxes	$	69		$	-

Supplemental Schedule of Non Cash Investing Activities
Transfer of loans to other real estate owned	$	6,741		$	8,597
Transfer of loans to other assets	$	145		$	82

The accompanying notes to consolidated financial statements are an integral part of these statements.

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MBT FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES

The unaudited consolidated financial statements include the accounts of MBT Financial Corp. (the “Company”) and its 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 branches in Monroe County, Michigan, seven branches in Wayne County, Michigan, and a mortgage loan office in Monroe County. 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 Company’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 valuation of other real estate owned, the deferred tax asset valuation allowance, and the fair value of investment securities.

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, such information reflects all adjustments (consisting of normal recurring adjustments), which are, in the opinion of Management, necessary for fair statement of results for the interim periods.

The significant accounting policies are as follows:

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of the Company and its subsidiary. All material intercompany transactions and balances have been eliminated.

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.

BUSINESS SEGMENTS

While the Company's chief decision makers monitor the revenue streams of various products and services, operations are managed and financial performance is evaluated on a company wide basis. Accordingly, all of the Company’s operations are considered by management to be aggregated in one reportable segment.

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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.

ACCOUNTING PRONOUNCEMENTS

No recent accounting pronouncements are expected to have a significant impact on the Corporation’s financial statements.

In May 2011, the FASB issued Accounting Standards Update 2011-04, Fair Value Measurement (ASU 2011-04). ASU 2011-04 is the result of the work of the FASB and the IASB to develop common requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRSs. Disclosure of the fair value levels of our financial assets and financial liabilities was added to Note 7 upon adoption of this ASU in the first quarter of 2012.

In June 2011, the FASB issued Accounting Standards Update 2011-05, Presentation of Comprehensive Income (ASU 2011-05). ASU 2011-05 provides entities with the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both choices, an entity is required to present each component of net income along with total net income, each component of other comprehensive income, along with a total for other comprehensive income, and a total amount for comprehensive income. Regardless of whether an entity chooses to present comprehensive income in a single continuous statement or in two separate but consecutive statements, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. This update applies retrospectively effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. We adopted this statement in the first quarter of 2012, electing to present each component of other comprehensive income in a single continuous statement.

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2. EARNINGS PER SHARE

The calculations of earnings (loss) per common share are as follows:

	For the three months ended Sept. 30,				For the nine months ended Sept. 30,
	2012		2011		2012		2011
Basic
Net profit (loss)	$	1,388,000	$	632,000	$	2,858,000	$	(4,193,000	)
Average common shares outstanding		17,321,337		17,274,436		17,313,965		17,265,394
Earnings (Loss) per common share - basic	$	0.08	$	0.04	$	0.16	$	(0.24	)

	2012		2011		2012		2011
Diluted
Net profit (loss)	$	1,388,000	$	632,000	$	2,858,000	$	(4,193,000	)
Average common shares outstanding		17,321,337		17,274,436		17,313,965		17,265,394
Equity compensation		81,316		-		50,916		-
Average common shares outstanding - diluted		17,402,653		17,274,436		17,364,881		17,265,394
Earnings (Loss) per common share - diluted	$	0.08	$	0.04	$	0.16	$	(0.24	)

3. STOCK BASED COMPENSATION

Stock Options - The following table summarizes the options that had been granted to certain key executives in accordance with the Long-Term Incentive Compensation Plan that was approved by shareholders at the Annual Meeting of Shareholders on April 6, 2000.

			Weighted Average
	Shares		Exercise Price
Options Outstanding, January 1, 2012		436,503	$	17.34
Granted		-		-
Exercised		-		-
Forfeited		22,168		13.85
Options Outstanding, Sept. 30, 2012		414,335	$	17.53
Options Exercisable, Sept. 30, 2012		414,335	$	17.53

Stock Only Stock Appreciation Rights (SOSARs) - On February 23, 2012, Stock Only Stock Appreciation Rights (SOSARs) were awarded to certain executives in accordance with the MBT 2008 Stock Incentive Plan that was approved by shareholders on May 1, 2008. The SOSARs have a term of ten years and vest in three equal annual installments beginning on December 31, 2012. 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.

The fair value of $1.11 for the SOSARs was estimated at the date of the grant, using the Black-Scholes option pricing model, with the following assumptions: expected option lives of 7 years, expected volatility of 60.7%, a risk free interest rate of 1.40% and dividend yield of 0.00%. The following table summarizes the SOSARs that have been granted:

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			Weighted Average
	Shares		Exercise Price
SOSARs Outstanding, January 1, 2012		320,000	$	4.08
Granted		104,000		1.85
Exercised		-		-
Forfeited		6,000		5.13
SOSARs Outstanding, Sept. 30, 2012		418,000	$	3.51
SOSARs Exercisable, Sept. 30, 2012		247,321	$	4.65

Restricted Stock Unit Awards – On February 23, 2012, performance restricted stock units were awarded to certain key executive officers in accordance with the MBT 2008 Stock Incentive Plan that was approved by shareholders on May 1, 2008. Each Restricted Stock Unit (RSU) is equivalent to one share of MBT Financial Corp. common stock. Stock will be issued to the participants following a two year performance period that ends on December 31, 2013. Up to 50% of the aggregate RSUs granted may be earned in each year of the performance period subject to satisfying weighted performance thresholds. Earned RSUs vest on December 31, 2014.

The total expense for equity based compensation was $41,000 in the third quarter of 2012 and $37,000 in the third quarter of 2011. The total expense for equity based compensation was $131,000 in the first nine months of 2012 and $122,000 in the first nine months of 2011.

4. LOANS

The Bank makes commercial, consumer, and mortgage loans primarily to customers in Monroe County, Michigan, southern and western Wayne County, Michigan, and surrounding areas. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent on the automotive, manufacturing, and real estate development economic sectors.

Loans consist of the following (000s omitted):

	September 30,		December 31,
	2012		2011
Residential real estate loans	$	248,155	$	255,555
Commercial and Construction real estate loans		311,769		330,498
Agriculture and agricultural real estate loans		14,760		15,931
Commercial and industrial loans		58,983		63,762
Loans to individuals for household, family, and other personal expenditures		16,060		13,729
Total loans, gross	$	649,727	$	679,475
Less: Allowance for loan losses		19,123		20,865
	$	630,604	$	658,610

Loans are placed in a nonaccrual status when, in the opinion of Management, the collection of additional interest is doubtful. All loan relationships over $250,000 that are classified by Management as nonperforming as well as selected performing accounts and all renegotiated loans are reviewed for impairment each quarter. Allowances for loans determined to be impaired are included in the allowance for loan losses. All cash received on nonaccrual loans is applied to the principal balance. Nonperforming assets consist of nonaccrual loans, loans 90 days or more past due, restructured loans, nonaccrual investment securities, and other real estate owned. Other real estate owned includes real estate that has been acquired in full or partial satisfaction of loan obligations or upon foreclosure and real estate that the bank has purchased but no longer intends to use for bank premises.

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The following table summarizes nonperforming assets (000’s omitted):

	September 30,			December 31,
	2012			2011
Nonaccrual loans	$	44,422		$	51,066
Loans 90 days past due and accruing		138			20
Restructured loans		28,184			24,774
Total nonperforming loans	$	72,744		$	75,860

Other real estate owned		13,676			16,650
Other assets		108			61
Nonperforming investment securities		2,916			2,984
Total nonperforming assets	$	89,444		$	95,555

Nonperforming assets to total assets		7.24	%		7.72	%
Allowance for loan losses to nonperforming loans		26.29	%		27.50	%

5. ALLOWANCE FOR LOAN LOSSES

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.

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Activity in the allowance for loan losses during the three and nine months ended September 30, 2012 was as follows (000’s omitted):

	Agriculture and Agricultural Real Estate			Commercial			Commercial Real Estate			Construction Real Estate			Residential Real Estate			Consumer and Other			Total

Allowance for loan losses: For the three months ended September 30, 2012
Beginning Balance	$	-		$	2,781		$	8,737		$	2,011		$	5,643		$	314		$	19,486
Charge-offs		-			(68	)		(1,337	)		(429	)		(225	)		(97	)		(2,156	)
Recoveries		-			77			13			66			54			33			243
Provision		13			110			1,706			23			(668	)		366			1,550
Ending balance	$	13		$	2,900		$	9,119		$	1,671		$	4,804		$	616		$	19,123

Allowance for loan losses: For the nine months ended September 30, 2012
Beginning Balance	$	64		$	2,184		$	9,351		$	2,632		$	6,227		$	407		$	20,865
Charge-offs		-			(330	)		(4,399	)		(1,030	)		(1,420	)		(178	)		(7,357	)
Recoveries		-			246			35			207			157			120			765
Provision		(51	)		800			4,132			(138	)		(160	)		267			4,850
Ending balance	$	13		$	2,900		$	9,119		$	1,671		$	4,804		$	616		$	19,123

Allowance for loan losses as of September 30, 2012
Ending balance individually evaluated for impairment	$	-		$	1,809		$	3,483		$	772		$	1,575		$	75		$	7,714
Ending balance collectively evaluated for impairment		13			1,091			5,636			899			3,229			541			11,409
Ending balance	$	13		$	2,900		$	9,119		$	1,671		$	4,804		$	616		$	19,123

Loans as of September 30, 2012
Ending balance individually evaluated for impairment	$	784		$	5,196		$	41,684		$	6,607		$	17,600		$	263		$	72,134
Ending balance collectively evaluated for impairment		13,976			53,787			251,586			11,892			230,555			15,797			577,593
Ending balance	$	14,760		$	58,983		$	293,270		$	18,499		$	248,155		$	16,060		$	649,727

Activity in the allowance for loan losses during the three and nine months ended September 30, 2011 was as follows (000’s omitted):

	Agriculture and Agricultural Real Estate			Commercial			Commercial Real Estate			Construction Real Estate			Residential Real Estate			Consumer and Other			Total

Allowance for loan losses: For the three months ended September 30, 2011
Beginning Balance	$	182		$	1,794		$	10,898		$	3,344		$	5,933		$	478		$	22,629
Charge-offs		-			(227	)		(2,178	)		(411	)		(1,223	)		(66	)		(4,105	)
Recoveries		-			104			197			45			248			51			645
Provision		(1	)		631			1,443			(511	)		790			348			2,700
Ending balance	$	181		$	2,302		$	10,360		$	2,467		$	5,748		$	811		$	21,869

Allowance for loan losses: For the nine months ended September 30, 2011
Beginning Balance	$	77		$	3,875		$	9,040		$	3,285		$	4,596		$	350		$	21,223
Charge-offs		-			(1,650	)		(5,857	)		(1,258	)		(3,162	)		(212	)		(12,139	)
Recoveries		1			278			317			66			611			212			1,485
Provision		103			(201	)		6,860			374			3,703			461			11,300
Ending balance	$	181		$	2,302		$	10,360		$	2,467		$	5,748		$	811		$	21,869

Allowance for loan losses as of September 30, 2011
Ending balance individually evaluated for impairment	$	86		$	660		$	3,707		$	848		$	1,030		$	94		$	6,425
Ending balance collectively evaluated for impairment		95			1,642			6,653			1,619			4,718			717			15,444
Ending balance	$	181		$	2,302		$	10,360		$	2,467		$	5,748		$	811		$	21,869

Loans as of September 30, 2011
Ending balance individually evaluated for impairment	$	1,120		$	2,291		$	37,056		$	7,398		$	18,484		$	197		$	66,546
Ending balance collectively evaluated for impairment		21,008			64,599			271,421			19,901			244,698			14,601			636,228
Ending balance	$	22,128		$	66,890		$	308,477		$	27,299		$	263,182		$	14,798		$	702,774

-11-

Activity in the allowance for loan losses during the year ended December 31, 2011 was as follows (000s omitted):

	Agriculture and Agricultural Real Estate			Commercial			Commercial Real Estate			Construction Real Estate			Residential Real Estate			Consumer and Other			Total

Allowance for loan losses: For the year ended December 31, 2011
Beginning Balance	$	77		$	3,875		$	9,040		$	3,285		$	4,596		$	350		$	21,223
Charge-offs		—			(1,893	)		(7,456	)		(2,177	)		(4,097	)		(249	)		(15,872	)
Recoveries		1			376			324			81			689			243			1,714
Provision		(14	)		(174	)		7,443			1,443			5,039			63			13,800
Ending balance	$	64		$	2,184		$	9,351		$	2,632		$	6,227		$	407		$	20,865

Allowance for loan losses as of December 31, 2011
Ending balance individually evaluated for impairment	$	64		$	700		$	3,906		$	1,394		$	2,923		$	46		$	9,033
Ending balance collectively evaluated for impairment		—			1,484			5,445			1,238			3,304			361			11,832
Ending balance	$	64		$	2,184		$	9,351		$	2,632		$	6,227		$	407		$	20,865


Loans as of December 31, 2011
Ending balance individually evaluated for impairment	$	1,078		$	2,566		$	36,424		$	8,589		$	21,929		$	217		$	70,803
Ending balance collectively evaluated for impairment		14,853			61,196			270,651			14,834			233,626			13,512			608,672
Ending balance	$	15,931		$	63,762		$	307,075		$	23,423		$	255,555		$	13,729		$	679,475

Each period the provision for loan losses in the income statement 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, all renegotiated loans, and each commercial credit relationship. 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.

•

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.

-12-

•

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 September 30, 2012 are as follows (000s omitted):

Credit Quality Indicators as of September 30, 2012

Credit Risk by Internally Assigned Grade

	Agriculture and Agricultural Real Estate		Commercial		Commercial Real Estate		Construction Real Estate		Residential Real Estate		Consumer and Other		Total
Not Rated	$	129	$	1,128	$	155	$	2,784	$	165,684	$	11,588	$	181,468
1		-		2,608		-		-		-		-		2,608
2		212		98		2,231		86		740		-		3,367
3		923		5,335		11,372		181		2,025		9		19,845
4		11,896		31,288		162,360		2,777		41,777		21		250,119
5		590		11,307		51,936		5,392		8,651		3,999		81,875
6		1,010		7,219		65,216		7,279		29,278		443		110,445
7		-		-		-		-		-		-		-
8		-		-		-		-		-		-		-
9		-		-		-		-		-		-		-
Total	$	14,760	$	58,983	$	293,270	$	18,499	$	248,155	$	16,060	$	649,727

Performing	$	13,976	$	55,280	$	252,899	$	11,445	$	227,759	$	15,624	$	576,983
Nonperforming		784		3,703		40,371		7,054		20,396		436		72,744
Total	$	14,760	$	58,983	$	293,270	$	18,499	$	248,155	$	16,060	$	649,727

The portfolio segments in each credit risk grade as of December 31, 2011 are as follows (000s omitted):

	Agriculture and Agricultural Real Estate		Commercial		Commercial Real Estate		Construction Real Estate		Residential Real Estate		Consumer and Other		Total
Not Rated	$	158	$	823	$	139	$	3,021	$	181,853	$	13,454	$	199,448
1		-		1,188		-		-		-		-		1,188
2		145		341		3,735		95		770		-		5,086
3		3,547		7,049		14,331		322		1,853		26		27,128
4		10,337		32,726		163,586		3,261		29,984		31		239,925
5		274		14,556		65,611		6,124		10,969		-		97,534
6		1,470		7,079		59,673		10,600		30,126		218		109,166
7		-		-		-		-		-		-		-
8		-		-		-		-		-		-		-
9		-		-		-		-		-		-		-
Total	$	15,931	$	63,762	$	307,075	$	23,423	$	255,555	$	13,729	$	679,475

Performing	$	14,753	$	61,054	$	270,072	$	13,657	$	230,729	$	13,350	$	603,615
Nonperforming		1,178		2,708		37,003		9,766		24,826		379		75,860
Total	$	15,931	$	63,762	$	307,075	$	23,423	$	255,555	$	13,729	$	679,475

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 September 30, 2012 and December 31, 2011 (000s omitted):

-13-

September 30, 2012	30-59 Days Past Due		60-89 Days Past Due		>90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment >90 Days Past Due and Accruing

Agriculture and Agricultural Real Estate	$	62	$	91	$	359	$	512	$	14,248	$	14,760	$	-
Commercial		1,494		19		581		2,094		56,889		58,983		10
Commercial Real Estate		2,882		1,958		14,283		19,123		274,147		293,270		-
Construction Real Estate		100		86		2,092		2,278		16,221		18,499		-
Residential Real Estate		5,881		2,421		4,576		12,878		235,277		248,155		128
Consumer and Other		190		32		84		306		15,754		16,060		-
Total	$	10,609	$	4,607	$	21,975	$	37,191	$	612,536	$	649,727	$	138

December 31, 2011	30-59 Days Past Due		60-89 Days Past Due		>90 Days Past Due		Total Past Due		Current		Total Loans		Recorded Investment >90 Days Past Due and Accruing

Agriculture and Agricultural Real Estate	$	614	$	-	$	364	$	978	$	14,953	$	15,931	$	-
Commercial		1,530		50		1,240		2,820		60,942		63,762		11
Commercial Real Estate		3,340		286		11,988		15,614		291,461		307,075		-
Construction Real Estate		460		2,093		2,134		4,687		18,736		23,423		-
Residential Real Estate		5,604		1,337		5,344		12,285		243,270		255,555		-
Consumer and Other		188		58		130		376		13,353		13,729		9
Total	$	11,736	$	3,824	$	21,200	$	36,760	$	642,715	$	679,475	$	20

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 September 30, 2012 and December 31, 2011 (000s omitted):

	9/30/2012		12/31/2011
Agriculture and Agricultural Real Estate	$	359	$	867
Commercial		2,407		2,309
Commercial Real Estate		23,381		23,557
Construction Real Estate		3,839		6,653
Residential Real Estate		14,208		17,484
Consumer and Other		228		196
Total	$	44,422	$	51,066

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.

-14-

The following is a summary of impaired loans as of September 30, 2012 and 2011 (000s omitted):

September 30, 2012	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment for the Three Months Ended		Interest Income Recognized in the Three Months Ended		Average Recorded Investment for the Nine Months Ended		Interest Income Recognized in the Nine Months Ended

With no related allowance recorded:
Agriculture and Agricultural Real Estate	$	784	$	1,310	$	-	$	836	$	12	$	833	$	42
Commercial		231		578		-		280		8		320		24
Commercial Real Estate		14,048		20,062		-		16,117		166		16,698		465
Construction Real Estate		399		664		-		419		2		419		5
Residential Real Estate		8,667		12,815		-		9,997		132		10,443		446
Consumer and Other		86		86		-		86		1		88		3

With an allowance recorded:
Agriculture and Agricultural Real Estate		-		-		-		-		-		-		-
Commercial		4,965		5,218		1,809		4,853		50		4,650		170
Commercial Real Estate		27,636		31,444		3,483		27,183		220		27,015		817
Construction Real Estate		6,208		8,973		772		6,791		40		6,891		166
Residential Real Estate		8,933		9,328		1,575		9,094		94		9,144		298
Consumer and Other		177		177		75		178		3		181		9

Total:
Agriculture and Agricultural Real Estate	$	784	$	1,310	$	-	$	836	$	12	$	833	$	42
Commercial		5,196		5,796		1,809		5,133		58		4,970		194
Commercial Real Estate		41,684		51,506		3,483		43,300		386		43,713		1,282
Construction Real Estate		6,607		9,637		772		7,210		42		7,310		171
Residential Real Estate		17,600		22,143		1,575		19,091		226		19,587		744
Consumer and Other		263		263		75		264		4		269		12

September 30, 2011	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment for the Three Months Ended		Interest Income Recognized in the Three Months Ended		Average Recorded Investment for the Nine Months Ended		Interest Income Recognized in the Nine Months Ended

With no related allowance recorded:
Agriculture and Agricultural Real Estate	$	509	$	1,049	$	-	$	571	$	14	$	578	$	37
Commercial		312		584		-		359		8		378		21
Commercial Real Estate		8,326		11,203		-		8,687		88		8,760		257
Construction Real Estate		1,544		2,284		-		1,542		28		1,541		21
Residential Real Estate		9,221		11,161		-		10,171		165		10,358		579
Consumer and Other		34		34		-		34		-		34		-

With an allowance recorded:
Agriculture and Agricultural Real Estate		611		611		86		611		8		612		4
Commercial		1,979		2,613		660		2,043		42		2,420		70
Commercial Real Estate		28,730		36,198		3,707		30,278		372		35,200		961
Construction Real Estate		5,854		9,326		848		6,408		96		7,799		72
Residential Real Estate		9,263		12,011		1,030		9,607		185		10,319		444
Consumer and Other		163		163		94		165		2		165		7

Total:
Agriculture and Agricultural Real Estate	$	1,120	$	1,660	$	86	$	1,182	$	22	$	1,190	$	41
Commercial		2,291		3,197		660		2,402		50		2,798		91
Commercial Real Estate		37,056		47,401		3,707		38,965		460		43,960		1,218
Construction Real Estate		7,398		11,610		848		7,950		124		9,340		93
Residential Real Estate		18,484		23,172		1,030		19,778		350		20,677		1,023
Consumer and Other		197		197		94		199		2		199		7

The following is a summary of impaired loans as of December 31, 2011 (000s omitted):

December 31, 2011	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment for the Year Ended		Interest Income Recognized in the Year Ended

With no related allowance recorded:
Agriculture and Agricultural Real Estate	$	425	$	974	$	-	$	527	$	43
Commercial		335		602		-		398		27
Commercial Real Estate		8,284		11,811		-		7,760		291
Construction Real Estate		330		569		-		350		18
Residential Real Estate		7,423		9,697		-		8,527		609
Consumer and Other		107		107		-		108		4

With an allowance recorded:
Agriculture and Agricultural Real Estate		653		654		64		655		8
Commercial		2,231		2,942		700		2,272		113
Commercial Real Estate		28,140		36,889		3,906		3,173		1,337
Construction Real Estate		8,259		11,930		1,394		9,046		220
Residential Real Estate		14,506		17,157		2,923		15,413		790
Consumer and Other		110		110		46		149		11

Total:
Agriculture and Agricultural Real Estate	$	1,078	$	1,628	$	64	$	1,182	$	51
Commercial		2,566		3,544		700		2,670		140
Commercial Real Estate		36,424		48,700		3,906		10,933		1,628
Construction Real Estate		8,589		12,499		1,394		9,396		238
Residential Real Estate		21,929		26,854		2,923		23,940		1,399
Consumer and Other		217		217		46		257		15

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”).

-15-

Loans that have been classified as TDRs during the three and nine month periods ended September 30, 2012 are as follows (000s omitted from dollar amounts):

	Three months ended						Nine months ended
	September 30, 2012						September 30, 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		3		168		163		9		950		553
Commercial Real Estate		5		4,030		4,030		14		6,433		6,075
Construction Real Estate		-		-		-		5		2,686		2,633
Residential Real Estate		3		743		743		17		2,450		2,403
Consumer and Other		1		44		43		3		71		69
Total		12	$	4,985	$	4,979		48	$	12,590	$	11,733

The Bank considers TDRs that become 90 days or more past due under the modified terms as defaulted. There were no loans that became TDRs during the nine months ended September 30, 2012 that subsequently defaulted during the nine months ended September 30, 2012.

6. INVESTMENT SECURITIES

The following is a summary of the Bank’s investment securities portfolio as of September 30, 2012 and December 31, 2011 (000’s omitted):

	Held to Maturity
	September 30, 2012
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Market
	Cost		Gains		Losses			Value
Obligations of States and Political Subdivisions	$	28,038	$	1,067	$	(112	)	$	28,993
	$	28,038	$	1,067	$	(112	)	$	28,993

	Available for Sale
	September 30, 2012
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Market
	Cost		Gains		Losses			Value
Obligations of U.S. Government Agencies	$	176,773	$	3,574	$	(2	)	$	180,345
Mortgage Backed Securities issued by U.S. Government Agencies		158,969		4,080		(23	)		163,026
Obligations of States and Political Subdivisions		15,698		686		(1	)		16,383
Trust Preferred CDO Securities		9,530		-		(4,371	)		5,159
Corporate Debt Securities		11,959		122		(30	)		12,051
Equity Securities		2,567		201		(149	)		2,619
	$	375,496	$	8,663	$	(4,576	)	$	379,583

-16-

	Held to Maturity
	December 31, 2011
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Market
	Cost		Gains		Losses			Value
Obligations of States and Political Subdivisions	$	35,364	$	688	$	(240	)	$	35,812
	$	35,364	$	688	$	(240	)	$	35,812

	Available for Sale
	December 31, 2011
			Gross		Gross			Estimated
	Amortized		Unrealized		Unrealized			Market
	Cost		Gains		Losses			Value
Obligations of U.S. Government Agencies	$	161,483	$	4,071	$	(22	)	$	165,532
Mortgage Backed Securities issued by U.S. Government Agencies		156,883		3,320		(35	)		160,168
Obligations of States and Political Subdivisions		14,616		567		(5	)		15,178
Trust Preferred CDO Securities		9,542		-		(4,075	)		5,467
Corporate Debt Securities		6,070		-		(91	)		5,979
Equity Securities		2,567		156		(148	)		2,575
	$	351,161	$	8,114	$	(4,376	)	$	354,899

The amortized cost and estimated market values of securities by contractual maturity as of September 30, 2012 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.

	Held to Maturity				Available for Sale
			Estimated				Estimated
	Amortized		Market		Amortized		Market
	Cost		Value		Cost		Value
Contractual maturity in
1 year or less	$	4,644	$	4,668	$	1,870	$	1,877
After 1 year through five years		9,801		10,077		38,796		39,085
After 5 years through 10 years		8,959		9,275		160,686		164,629
After 10 years		4,634		4,973		12,608		8,347
Total		28,038		28,993		213,960		213,938
Mortgage Backed Securities		-		-		158,969		163,026
Securities with no stated maturity		-		-		2,567		2,619
Total	$	28,038	$	28,993	$	375,496	$	379,583

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 does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before a recovery of their amortized costs bases, which may be maturity. The following table shows the gross unrealized losses and fair value of the Company’s investments with unrealized losses (in thousands), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2012 and December 31, 2011.

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September 30, 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	$	-	$	-	$	1,115	$	2	$	1,115	$	2
Mortgage Backed Securities issued by U.S. Government Agencies		9,273		23		-		-		9,273		23
Obligations of States and Political Subdivisions		8,100		112		425		1		8,525		113
Trust Preferred CDO Securities		-		-		5,159		4,371		5,159		4,371
Corporate Debt Securities		3,986		14		1,983		16		5,969		30
Equity Securities		-		-		392		149		392		149
	$	21,359	$	149	$	9,074	$	4,539	$	30,433	$	4,688

December 31, 2011

	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	$	14,729	$	22	$	-	$	-	$	14,729	$	22
Mortgage Backed Securities issued by U.S. Government Agencies		26,453		35		-		-		26,453		35
Obligations of States and Political Subdivisions		12,766		239		1,261		6		14,027		245
Trust Preferred CDO Securities		-		-		5,467		4,075		5,467		4,075
Corporate Debt Securities		5,979		91		-		-		5,979		91
Equity Securities		-		-		392		148		392		148
	$	59,927	$	387	$	7,120	$	4,229	$	67,047	$	4,616

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. Because the Company does not intend to sell the investments and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider those investments to be other than temporarily impaired at September 30, 2012.

The Trust Preferred CDO Securities are issued by companies in the financial services industry, including banks, thrifts, and insurance companies. Each of the three securities owned by the Company is in an unrealized loss position. 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. In determining whether the impairment is not other-than-temporary, the Company analyzed each security’s expected cash flows. The assumptions used in the cash flow analysis were developed following a review of historical losses and prepayment activity and the financial condition of the individual obligors in the pools. Key assumptions utilized in the cash flow projections include prepayment speeds, obligor deferral and default rates, and loss severity rates on obligor defaults. The analysis concluded that disruption of our cash flows due to defaults by issuers is currently expected to occur in one of the three securities owned. A disruption of cash flows has been expected for this security since 2009. The impairment calculated by the analysis was determined to be other than temporary in 2009, and at that time the credit related portion of the impairment was charged to earnings. As a result of uncertainties in the market place affecting companies in the financial services industry, it is at least reasonably possible that a change in the estimates will occur in the near term. Because the Company does not intend to sell the investment and it is not more likely than not that the Company will be required to sell the investment before recovery of its amortized cost basis, which may be maturity, the Company does not consider this investment to have additional other than temporary impairment in the quarter ended September 30, 2012.

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7. FAIR VALUE OF FINANCIAL INSTRUMENTS

Fair value, as defined in ASC Topic 820, is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability is not adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for market activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.

The Corporation utilizes fair value measurements to record fair value adjustments to certain assets and to determine fair value disclosures. Fair value is used on a recurring basis for 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. 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:

The following tables present information about the Company’s financial assets and liabilities measured at fair value on a recurring basis at September 30, 2012 and December 31, 2011, and the valuation techniques used by the Company to determine those fair values.

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									Total
	Carrying								Estimated
September 30, 2012	Value		Level 1		Level 2		Level 3		Fair Value
Financial Assets:
Cash and due from banks	$	88,895	$	88,895	$	-	$	-	$	88,895
Securities - Held to Maturity
Obligations of States and Political Subdivisions		28,038		-		28,993				28,993

Securities - Available for Sale
Obligations of U.S. Government Agencies		180,345		-		180,345		-		180,345
MBS issued by U.S. Government Agencies		163,026		-		163,026		-		163,026
Obligations of States and Political Subdivisions		16,383		-		16,383		-		16,383
Trust Preferred CDO Securities		5,159		-		-		5,159		5,159
Corporate Debt Securities		12,051		-		12,051		-		12,051
Other Securities		2,619		2,227		392		-		2,619

Federal Home Loan Bank Stock		10,605		-		10,605		-		10,605
Loans Held for Sale		1,491		-		-		1,491		1,491
Loans, net		630,604		-		-		650,092		650,092
Accrued Interest Receivable		3,848		-		3,848		-		3,848

Financial Liabilities:
Noninterest Bearing Deposits		168,448		168,448		-		-		168,448
Interest Bearings Deposits		851,962		-		858,643		-		858,643
Borrowed funds
FHLB Advances		107,000		-		108,356		-		108,356
Repurchase Agreements		15,000		-		17,269		-		17,269
Accrued Interest Payable		368		-		368		-		368

									Total
	Carrying								Estimated
December 31, 2011	Value		Level 1		Level 2		Level 3		Fair Value
Financial Assets:
Cash and due from banks	$	75,995	$	75,995					$	75,995
Securities - Held to Maturity
Obligations of States and Political Subdivisions		35,364		-		35,812				35,812

Securities - Available for Sale
Obligations of U.S. Government Agencies		165,532		-		165,532		-		165,532
MBS issued by U.S. Government Agencies		160,168		-		160,168		-		160,168
Obligations of States and Political Subdivisions		15,178		-		15,178		-		15,178
Trust Preferred CDO Securities		5,467		-		-		5,467		5,467
Corporate Debt Securities		5,979		-		5,979		-		5,979
Other Securities		2,575		2,183		392		-		2,575

Federal Home Loan Bank Stock		10,605		-		10,605		-		10,605
Loans Held for Sale		1,035		-		-		1,035		1,035
Loans, net		658,610		-		-		684,007		684,007
Accrued Interest Receivable		3,582		-		3,582		-		3,582

Financial Liabilities:
Noninterest Bearing Deposits		164,852		164,852		-		-		164,852
Interest Bearings Deposits		857,458		-		864,496		-		864,496
Borrowed funds
FHLB Advances		107,000		-		109,664		-		109,664
Repurchase Agreements		20,000		-		22,773		-		22,773
Accrued Interest Payable		477		-		477		-		477

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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.

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

Investment Securities - Available for Sale	2012			2011
Balance at January 1	$	5,467		$	5,188
Total realized and unrealized gains (losses) included in income		(12	)		(14	)
Total unrealized gains (losses) included in other comprehensive income		(296	)		67
Net purchases, sales, calls and maturities		-			-
Net transfers in/out of Level 3		-			-
Balance at September 30	$	5,159		$	5,241

Of the Level 3 assets that were held by the Company at September 30, 2012, the unrealized loss for the nine months ended September 30, 2012 was $296,000, which is recognized in other comprehensive income in the consolidated statements of financial condition. The Company did not have any sales or purchases of Level 3 available for sale securities during the period.

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 owns pooled Trust Preferred Securities (“TRUPs”) with a fair value of $5,159,000 as of September 30, 2012. Trading of these types of securities has increased recently but is primarily conducted on a distress sale or forced liquidation basis. As a result, the Company measures the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

The Company also has assets that under certain conditions are subject to measurement at fair value on a nonrecurring basis. These assets include loans and Other Real Estate Owned. The Company estimated the fair values of these assets using Level 3 inputs, specifically discounted cash flow projections.

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

	Balance at September 30, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired loans	$	72,134	$	-	$	-	$	72,134
Other Real Estate Owned	$	13,676	$	-	$	-	$	13,676

	Balance at December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Impaired loans	$	70,803	$	-	$	-	$	70,803
Other Real Estate Owned	$	16,650	$	-	$	-	$	16,650

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Impaired loans categorized as Level 3 assets consist of non-homogenous loans that are considered impaired. The Company 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 Company utilizes independent appraisals to estimate the fair value of OREO properties.

9. 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 statements of condition.

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 were as follows (000s omitted):

	Contractual Amount
	September 30,		December 31,
	2012		2011
Commitments to extend credit:
Unused portion of commercial lines of credit	$	55,843	$	65,460
Unused portion of credit card lines of credit		2,966		2,756
Unused portion of home equity lines of credit		16,306		15,026
Standby letters of credit and financial guarantees written		3,865		4,461
All other off-balance sheet commitments		-		-

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, and generally have fixed expiration dates or other termination clauses. 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 counterparty.

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.

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

Introduction

MBT Financial Corp. (the “Company”) is a bank holding company with one subsidiary, Monroe Bank & Trust (“the Bank”). The Bank is a commercial bank with a wholly owned subsidiary, MB&T Financial Services. MB&T Financial Services is an insurance agency which sells insurance policies to the Bank. The Bank operates 17 branch offices in Monroe County, Michigan and 7 offices 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. The 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 products and 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 asset quality, profitability, and capital.

The national economic recovery is continuing slowly, and conditions in southeast Michigan are also slowly improving. Local unemployment rates improved significantly over the past year, 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, increased $5.0 million, or 3.9% during the third quarter of 2012, but decreased $10.3 million or 7.2% compared to a year ago. The improvement in our asset quality over the past year and the decrease in our net charge offs in each of the last three quarters allowed us to decrease our Allowance for Loan and Lease Losses (ALLL) from $19.5 million to $19.1 million in the third quarter. The loan portfolio decreased $17.4 million during the quarter, and the ALLL as a percent of loans increased from 2.91% to 2.94%. Although local property values and the unemployment rate have stabilized over the past several quarters, we anticipate that the recovery in our local markets will continue at a slower than normal pace though 2013. We will continue to focus our efforts on improving asset quality, maintaining liquidity, strengthening capital, and controlling expenses.

Net Interest Income decreased $335,000 compared to the third quarter of 2011 even though the average earning assets increased $1.6 million, or 0.1% as the net interest margin decreased from 3.16% to 3.05%. The provision for loan losses decreased from $2.7 million in the third quarter of 2011 to $1.55 million in the third quarter of 2012. Decreases in the historical loss rates and in the amount of specific allocations during the quarter 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 quarter. Non interest income decreased $296,000 or 6.9%, as the decrease in gains on securities transactions exceeded the increases in wealth management fees and mortgage loan origination income. Non interest expenses decreased $254,000, or 2.6% as credit related costs, including collection costs, losses on Other Real Estate Owned (OREO), and OREO carrying costs decreased significantly. We expect credit related expenses to continue to improve, but still remain above normal levels, into 2013.

-23-

Critical Accounting Policies

The Company’s Allowance for Loan Losses, Deferred Tax Asset Valuation Allowance, Fair Value of Investment Securities, and Other Real Estate Owned are “critical accounting estimates” because they are estimates that are 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 Company’s financial condition. These assumptions include, but are not limited to, collateral values, the effect of economic conditions on the financial condition of the borrowers, the Company, and the issuers of investment securities, market interest rates, and projected earnings for the Company.

To determine the Allowance for Loan Losses, the Company estimates losses on all loans that are not classified as non accrual or renegotiated by applying historical loss rates, adjusted for current conditions, to those loans. In addition, all non accrual loan relationships over $250,000 that are classified by Management as nonperforming as well as selected performing accounts and all renegotiated loans are individually tested for impairment. Any amount of monetary impairment is included in the Allowance for Loan Losses.

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 the last three full years, combined with a difficult economic environment and the slow pace of the economic recovery in southeast Michigan. Positive evidence includes our history of strong earnings prior to 2008, our fifth consecutive quarterly profit in the third quarter of 2012, our strong capital position, our steady core earnings, our improving asset quality, and our non interest expense control initiatives. Based on our analysis of the evidence, we believed that it was appropriate to maintain a valuation allowance of $24.9 million, which is equal to the full amount of the deferred tax asset as of September 30, 2012. If the amount of positive evidence continues to increase, we may begin to recognize a tax benefit in late 2012 or early 2013.

To determine the fair value of investment securities, the Company utilizes quoted prices in active markets for identical assets, quoted prices for similar assets in active markets, or discounted cash flow calculations for investments where there is little, if any, market activity for the asset.

To determine the fair value of Other Real Estate Owned, the Company utilizes independent appraisals to estimate the fair value of the property.

Financial Condition

National economic conditions began to recover in the second half of 2009, but regional conditions remained weak until 2010. Local unemployment and property values stabilized during 2011 and began to improve in 2012. The economic environment in southeast Michigan is continuing to slowly improve. Our nonperforming assets increased 9.2% during the quarter, from $81.9 million to $89.4 million, and total problem assets increased from $126.8 million to $131.8 million. Both of these measures were impacted by a small number of large credit relationships, and both still reflect improvement compared to the third quarter of 2011. Total loans decreased $17.4 million during the quarter as payments received in the ordinary course of business, transfers to OREO, and charge offs of existing loans exceeded new loan production. The decrease in loans caused an increase in lower yielding cash and investments, which, along with the prolonged historically low interest rate environment caused a decrease in our net interest margin. As the local economy is slowly recovering, lending opportunities are beginning to increase. We expect the slow recovery to continue in our market area into 2013. The Company expects low deposit growth and a reduction in total assets due to a reduced use of non deposit funding in 2013. Management intends to continue to focus efforts on improving credit quality, managing capital, and mitigating enterprise risk.

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Since December 31, 2011, total loans decreased $29.3 million (4.3%) because the loan demand did not result in enough new loan activity to offset write downs recorded and payments received. At the same time, deposits decreased $1.9 million, or 0.2% as maturities of brokered certificates of deposit were partially offset by an increase in local deposit activity. The reductions in loans and deposits resulted in a decrease of $2.0 million (0.2%) in total assets since the end of 2011. Total capital increased $3,387,000 or 4.5%, due to the year to date profit of $2.9 million and the increase of $386,000 in the accumulated other comprehensive income (AOCI). AOCI increased mainly due to an increase in the value of our securities available for sale. The decrease in total assets and the increase in capital caused the capital to assets ratio to increase from 6.12% at December 31, 2011 to 6.40% at September 30, 2012.

The amount of nonperforming assets (“NPAs”) decreased $5.8 million or 6.1% during the first three quarters of 2012. NPAs include non performing loans, which decreased 3.7% from $75.5 million to $72.7 million, and Other Real Estate Owned and Other Assets (“OREO”), which decreased 17.5% from $16.7 million to $13.8 million. Total problem assets, which includes all NPAs and performing loans that are internally classified as substandard, decreased $5.0 million, or 3.6%. The Company’s Allowance for Loan and Lease Losses (“ALLL”) decreased $1.7 million since December 31, 2011, due to a decrease in the size of the portfolio and an improvement in the quality of the assets in the loan portfolio. The ALLL is now 2.94% of loans, down from 3.07% at December 31, 2011 and 3.11% at September 30, 2011. The ALLL is 26.29% of nonperforming loans (“NPLs”), compared to 27.63% at year end and 29.66% at September 30, 2011. In light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in the loan portfolio.

Results of Operations – Third Quarter 2012 vs. Third Quarter 2011

Net Interest Income - A comparison of the income statements for the three months ended September 30, 2011 and 2012 shows a decrease of $335,000, or 3.7%, in Net Interest Income. Interest income on loans decreased $1.3 million or 13.3% as the average loans outstanding decreased $52.5 million and the average yield on loans decreased from 5.58% to 5.23%. The interest income on investments, fed funds sold, and interest bearing balances due from banks decreased $149,000 as the average amount of investments, fed funds sold, and interest bearing balances due from banks increased $54.1 million but the yield decreased from 2.25% to 1.88%. The yield on investments decreased because the Company is maintaining its strong liquidity position by keeping its excess funds in low yielding short term investments and deposits in the Federal Reserve Bank. A continued low overall level of interest rates and the maturity of some high cost borrowings and brokered certificates of deposit helped reduce the funding costs. The interest expense on deposits decreased $1,158,000 or 43.8% as the average deposits decreased $5.9 million and the average cost of deposits decreased from 1.02% to 0.58%. The cost of borrowed funds increased $14,000 even though the average amount of borrowed funds decreased $4.2 million as the average cost of the borrowings increased from 2.63% to 2.83%.

Provision for Loan Losses - The Provision for Loan Losses decreased from $2.7 million in the third quarter of 2011 to $1.55 million in the third quarter of 2012. Net charge offs were $1.9 million during the third quarter of 2012, compared to $3.5 million in the third quarter of 2011. Each quarter, the Company conducts a review and analysis of its ALLL to determine its adequacy. This analysis involves specific allocations for impaired credits and a general allocation for losses expected based on historical experience adjusted for current conditions. Due to a decrease in the size of the portfolio, and a decrease in the historical loss percentages, we were able to maintain an adequate ALLL in the third quarter of 2012 even though we recorded a provision that was less than our net charge offs. The ALLL is 2.94% of loans as of September 30, 2012, and, in light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in our loan portfolio.

-25-

Other Income – Non interest income decreased $296,000, or 6.9% compared to the third quarter of 2011. Excluding gains on securities transactions, non interest income increased $160,000 or 4.3% Wealth management income increased $91,000 due to an increase in the market value of assets managed and new business brought in to the bank. Origination fees on mortgage loan sold increased $196,000, or 192.2% due to an increase in mortgage loan origination volume compared to 2011.

Other Expenses – Total non interest expenses decreased $254,000, or 2.6% compared to the third quarter of 2011. Salaries and Employee Benefits increased $191,000, or 3.9%, as an increase in salaries was partially offset by a decrease in the retirement plan contribution. Occupancy expense decreased $74,000 due to lower depreciation and property tax expenses. Marketing expense decreased $63,000, or 29.4% due to the elimination of our debit card rewards program and a reduction in advertising activity due to the reduced need to attract deposits. Losses on Other Real Estate Owned (OREO) properties decreased $445,000 compared to the third quarter of 2011 as the property values stabilized over the last year, requiring fewer write downs of properties owned, and some of the OREO property sales that closed during the quarter produced gains. Other OREO expenses decreased $236,000 as the reduction in OREO properties owned resulted in a decrease in insurance, property tax, and maintenance costs. Other non interest expense increased $367,000, or 49.7% mainly due to the accrual of $126,000 for an excise tax payment in the third quarter of 2012 and an increase of $122,000 in state tax expense due to a refund received in the third quarter of 2011. The expense was also impacted by increases in employee training and other insurance expenses in 2012.

As a result of the above activity, the Profit Before Income Taxes in the third quarter of 2012 was $1,405,000, an improvement of $773,000 compared to the profit of $632,000 in the third quarter of 2011. Due to our net operating loss carry forward, we are not recording a federal income tax expense, however, we expensed an alternative minimum tax payment of $17,000 in the third quarter of 2012. No income tax benefit or expense was recorded in the third quarter of 2011 due to the net operating loss carry forwards and the uncertainty of our expected ability to utilize our deferred tax assets. The Net profit for the third quarter of 2012 was $1,388,000, an increase of 119.6% compared to the net profit of $632,000 in the third quarter of 2011.

Results of Operations – Nine months ended September 30, 2012 vs. Nine months ended September 30, 2011

Net Interest Income - A comparison of the income statements for the nine months ended September 30, 2011 and 2012 shows an increase of $30,000, or 0.1%, in Net Interest Income. Interest income on loans decreased $3.6 million or 11.8% as the average loans outstanding decreased $59.5 million and the average yield on loans decreased from 5.59% to 5.36%. The interest income on investments, fed funds sold, and interest bearing balances due from banks decreased $148,000 as the average amount of investments, fed funds sold, and interest bearing balances due from banks increased $52.5 million but the yield decreased from 2.33% to 2.03%. The yield on investments decreased because the Company is maintaining its strong liquidity position by keeping its excess funds in low yielding short term investments and deposits in the Federal Reserve Bank. A continued low overall level of interest rates and the maturity of some high cost borrowings and brokered certificates of deposit caused the funding costs to decrease also. The interest expense on deposits decreased $3,657,000 or 42.4% as the average deposits decreased $11.6 million and the average cost of deposits decreased from 1.11% to 0.65%. The cost of borrowed funds only decreased $118,000 as the average amount of borrowed funds decreased $11.2 million while the average cost of the borrowings increased from 2.77% to 2.89%.

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Provision for Loan Losses - The Provision for Loan Losses decreased from $11.3 million in the first nine months of 2011 to $4.85 million in the first nine months of 2012. Net charge offs were $6.6 million during the first nine months of 2012, compared to $10.7 million in the first nine months of 2011. Each quarter, the Company conducts a review and analysis of its ALLL to determine its adequacy. This analysis involves specific allocations for impaired credits and a general allocation for losses expected based on historical experience adjusted for current conditions. Due to a decrease in the size of the portfolio, a decrease in the historical loss percentages, and a decrease in the specific allocations, we were able to maintain an adequate ALLL in the first nine months of 2012 even though we recorded a provision that was less than our net charge offs. The ALLL is 2.94% of loans as of September 30, 2012, and, in light of current economic conditions, we believe that at this level the ALLL adequately estimates the potential losses in our loan portfolio.

Other Income – Non interest income increased $424,000, or 3.6% compared to the first nine months of 2011, primarily because gains on the sales of securities increased $588,000. Some federal government agency securities were sold in 2012 to rebalance the Bank’s interest rate risk. The sales had the additional benefit of producing the gain, which improved the bank’s capital ratios. Wealth management fees decreased $96,000, or 3.2% as a fee refund to a large employee benefit account in 2012 offset increases created by new business activity and higher market values of assets managed. Service charges and other fees on deposit accounts decreased $130,000, or 3.7%, primarily due to a decrease in overdraft fees on checking accounts. Origination fees on mortgage loan sold increased $353,000, or 130.3% due to an increase in mortgage loan origination volume in 2012. Income on Bank Owned Life Insurance policies decreased $129,000, or 10.7% due to a decrease in the yields on the policies this year and a decrease in the cash surrender value enhancement feature on some of the policies this year. Other non interest income decreased $162,000, or 5.0% due to decreases in rental income on OREO properties and commission income on brokerage activity and check sales.

Other Expenses – Total non interest expenses decreased $1.7 million, or 5.5% compared to the first nine months of 2011. Salaries and Employee Benefits increased $517,000, or 3.5%, as salaries increased $541,000 or 4.9%. Benefits decreased slightly, as increases in life insurance and payroll tax expenses were offset by decreases in medical insurance and retirement contributions. Occupancy expense decreased $188,000 due to lower maintenance costs as a result of the mild winter weather in 2012 and lower property taxes due to a successful appeal of the assessment of one of our branches in 2012. Equipment expense increased $62,000 due to higher computer expenses. Marketing expense decreased $171,000, or 24.6% due to the elimination of our debit card rewards program and a reduction in our advertising activity. Professional fees decreased $187,000, or 10.2% due to a decrease in credit related legal fees, partially offset by an increase in accounting and legal fees due to the IRS audit. Losses on Other Real Estate Owned (OREO) properties decreased $2.1 million compared to the first nine months of 2011 as the property values stabilized in the second half of 2011 and sales have been completed at prices close to the carrying values in 2012. Other OREO expenses decreased $200,000 as the reduction in OREO properties owned resulted in a decrease in insurance, property tax, and maintenance costs. FDIC deposit insurance premium expense decreased $187,000, or 8.3%, due to a change in the assessment method in 2011.

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As a result of the above activity, the Profit Before Income Taxes in the first nine months of 2012 was $4.4 million, an improvement of $8.6 million compared to the loss of $4.2 million in the first nine months of 2011. In the first nine months of 2012, we recorded a federal income tax expense of $1.6 million. The Company is currently being audited by the IRS, and the ultimate resolution of the exam is still uncertain. This accrual, along with the $500,000 accrued in the fourth quarter of 2011, reflects the amount of a settlement offer that we made to the IRS in an attempt to resolve the audit. The issues being challenged mainly involve the timing of income recognition and would normally result in an increase in the deferred tax asset. However, the Company is maintaining a valuation allowance against 100% of its deferred tax asset, so the estimated tax adjustment was expensed. No income tax benefit or expense was recorded in the first nine months of 2011 due to the net operating loss carry forwards and the uncertainty of our expected ability to utilize our deferred tax assets. The Net profit for the first nine months of 2012 was $2,858,000, compared to a net loss of $4,193,000 in the first nine months of 2011.

Cash Flows

Cash flows provided by operating activities increased $7.8 million compared to the first nine months of 2011 as the net income increased mainly due to the decreases in the provision for loan losses and other non interest expenses. Cash flows from investing activities decreased $16.1 million in the first nine months of 2012 compared to the first nine months of 2011 as more of the cash provided by sales and redemptions of investment securities and loan payments was reinvested in securities. The amount of cash used for financing activities decreased $8.9 million in the first nine months of 2012 compared to the first nine months of 2011 as less non deposit funding matured in 2012. Total cash and cash equivalents decreased $9.7 million as of September 30, 2012 compared to September 30, 2011 as the Company has invested more of its excess cash in order to improve its interest income.

Liquidity and Capital

The Company believes it has sufficient liquidity to fund its lending activity and allow for fluctuations in deposit levels. Internal sources of liquidity include the maturities of loans and securities in the ordinary course of business as well as our available for sale securities portfolio. External sources of liquidity include a line of credit with the Federal Home Loan Bank of Indianapolis, the Federal funds line that has been established with our correspondent bank, and Repurchase Agreements with money center banks that allow us to pledge securities as collateral for borrowings. As of September 30, 2012, the Bank utilized $107.0 million of its authorized limit of $265 million with the Federal Home Loan Bank of Indianapolis, none of its $10 million overdraft line of credit with the Federal Home Loan Bank of Indianapolis, and none of its $25 million of federal funds line with a correspondent bank.

The Company’s Funds Management Policy includes guidelines for desired amounts of liquidity and capital. The Funds Management Policy also includes contingency plans for liquidity and capital that specify actions to take if liquidity and capital ratios fall below the levels contained in the policy. Throughout the first nine months of 2012 the Company was in compliance with its Funds Management Policy regarding liquidity and capital.

Total stockholders’ equity of the Company was $79.1 million at September 30, 2012 and $75.7 million at December 31, 2011. The ratio of equity to assets was 6.40% at September 30, 2012 and 6.12% at December 31, 2011. Federal bank regulatory agencies have set capital adequacy standards for Total Risk Based Capital, Tier 1 Risk Based Capital, and Leverage Capital. These 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, and the Leverage Capital Ratio is at least 5%.

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The following table summarizes the capital ratios of the Company and the Bank:

	Actual					Minimum to Qualify as Well Capitalized
	Amount		Ratio			Amount		Ratio
As of September 30, 2012:
Total Capital to Risk-Weighted Assets
Consolidated	$	87,657		11.20	%	$	78,265		10	%
Monroe Bank & Trust		87,226		11.15	%		78,216		10	%
Tier 1 Capital to Risk-Weighted Assets
Consolidated		77,730		9.93	%		46,959		6	%
Monroe Bank & Trust		77,239		9.88	%		46,929		6	%
Tier 1 Capital to Average Assets
Consolidated		77,730		6.27	%		61,957		5	%
Monroe Bank & Trust		77,239		6.24	%		61,931		5	%

	Actual					Minimum to Qualify as Well Capitalized
	Amount		Ratio			Amount		Ratio
As of December 31, 2011:
Total Capital to Risk-Weighted Assets
Consolidated	$	84,970		10.48	%	$	81,084		10	%
Monroe Bank & Trust		84,441		10.42	%		81,033		10	%
Tier 1 Capital to Risk-Weighted Assets
Consolidated		74,695		9.21	%		48,650		6	%
Monroe Bank & Trust		74,106		9.15	%		48,620		6	%
Tier 1 Capital to Average Assets
Consolidated		74,695		6.07	%		61,505		5	%
Monroe Bank & Trust		74,106		6.03	%		61,481		5	%

On July 12, 2010, the Bank entered into a Consent Order with its state and federal regulators. While the Bank is under the Consent Order, it is classified as “adequately capitalized” even if its ratios meet the “well capitalized” guidelines. The Consent Order requires the Bank to raise its Tier 1 Leverage ratio to 9% and its Total Risk Based Capital Ratio to 12%. As of September 30, 2012, the Bank is not in compliance with the capital requirements of the Consent Order. The table below indicates the amount of capital the Bank needed to be in compliance with the Consent Order as of September 30, 2012:

											Additional
											Capital
						Minimum Capital Required					Required to
	Actual Capital					by Consent Order					Comply with
	Amount		Ratio			Amount		Ratio			Consent Order
Total Capital to Risk-Weighted Assets	$	87,226		11.15	%	$	93,859		12	%	$	6,633
Tier 1 Capital to Average Assets	$	77,239		6.24	%	$	111,476		9	%	$	34,237

The Company increased its common shares authorized in 2011 and is monitoring the capital market conditions. Currently, the Company does not believe that the market conditions are suitable for a bank holding company of our size located in the Midwest to conduct an offering large enough to generate the amount of capital required to comply with the Consent Order. While we continue to monitor the capital market conditions, we are focusing our efforts to improve our capital position on generating capital by improving our earnings. We are also improving our capital ratios by reducing the size of our balance sheet by repaying our non deposit funding as it matures.

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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. The Bank’s market risk is monitored monthly and it has not changed significantly since year-end 2011.

Internal Revenue Service Audit

Since the fourth quarter of 2010, the Internal Revenue Service (IRS) has been conducting an audit of our tax returns for the 2004, 2005, 2007, 2008, 2009, and 2010 tax years. The IRS is nearing completion of the audit and has proposed adjustments to our taxable income, mainly challenging our treatment of interest on non accrual loans, OREO valuations, OREO carrying costs, and loan charge-offs. Although our loan charge-offs were in compliance with state and federal bank regulatory agency guidelines, the IRS examining agent conducting the audit has called into question the deductibility of certain charge-offs for income tax purposes based on the facts and circumstances of a loan at the time of the charge-off and certain differences between tax and financial accounting for charge-offs. We believe that the charge-off deductions were proper when taken, and our belief is supported by confirmation of our charge off methodology by our federal and state banking regulators.

According to ASC 740, Accounting for Uncertainty in Income Taxes, an entity is required to evaluate the validity of uncertain tax positions and determine if the relevant taxing authority would conclude that it is more likely than not (greater than fifty percent) that the position taken will be sustained, based upon technical merits, upon examination. We have reviewed our tax positions and have concluded that it is appropriate to record a liability for potential reimbursement to the IRS. We have concluded, based on all relevant facts at the present time that the potential tax liability from the current audit ranges from $0.9 million to $3.1 million.

As of June 30, 2012, the Company calculated the potential tax liability to be $0.9 million, based on allowance of the deduction for bad debt losses and the corresponding OREO valuations. The IRS has proposed a resolution of the audit that the Company estimates would result in the Company having to pay a net amount of $3.1 million in federal income tax for the years under audit after taking into account a carry back of losses from later tax years to offset a portion of the deductions disallowed by the IRS.

Since the audit began in 2010, the Company has incurred over $200,000 of professional fees expenses with its accountants and lawyers for assistance in resolution. In order to resolve the audit without incurring significant additional expenses, the Company offered a settlement proposal to the IRS in the beginning of the third quarter of 2012. The Company’s proposal resulted in a current tax liability of $2.0 million. The Company has concluded that its offer to settle of $2.0 million is the best estimate of potential liability at this time. The Company expects the audit to be resolved without incurring significant additional tax or professional fees expenses.

Although the timing of the resolution and/or closure of the audit remains highly uncertain, the Company believes it is reasonably possible that the IRS will conclude this audit within the next six months. Adjustments could be necessary in future periods to the estimated range of the potential federal income tax payable noted above based on issues raised by the IRS. Management will re-evaluate the estimate quarterly based on current, relevant facts.

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Forward-Looking Statements

Certain statements contained herein are not based on historical facts and are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements which are based on various assumptions (some of which are beyond the Company's control), may be identified by reference to a future period or periods, or by the use of forward-looking terminology, such as "may," "will," "believe," "expect," "estimate," "anticipate," "continue," or similar terms or variations on those terms, or the negative of these terms. Actual results could differ materially from those set forth in forward-looking statements, due to a variety of factors, including, but not limited to, those related to the economic environment, particularly in the market areas in which the Company operates, competitive products and pricing, fiscal and monetary policies of the U.S. Government, changes in government regulations affecting financial institutions, including regulatory fees and capital requirements, changes in prevailing interest rates, acquisitions and the integration of acquired businesses, credit risk management, asset/liability management, changes in the financial and securities markets, including changes with respect to the market value of our financial assets, the availability of and costs associated with sources of liquidity, and the ability of the Company to resolve or dispose of problem loans.

The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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, 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, the Asset and Liability Committee (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 both gradual and sudden increases or decreases of 100, 200, 300, and 400 basis points in the interest rates. The net interest income projections are compared to a base case projection, which assumes no changes in interest rates.

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. Throughout the first nine months of 2012, the Bank’s interest rate risk has remained within its policy limits.

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 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 Bank estimates the interest rate risk by calculating the effect of market interest rate changes on that economic value of its equity. For this analysis, the Bank assumes immediate parallel shifts of plus or minus 100, 200, and 300 basis points in interest rates. 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 changes on the market for loans and deposits. In addition, each quarter, the Bank conducts additional analyses that utilize other rate scenarios, such as larger shifts in rates and changes in the shape of the yield curve, to assess the Bank’s exposure to interest rate risk in stress scenarios.

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The Bank’s interest rate risk, as measured by the net interest income and economic value of equity simulations, has not changed significantly from December 31, 2011.

Item 4. Controls and Procedures

The Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures as of September 30, 2012, pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of September 30, 2012, in alerting them in a timely manner to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company's periodic SEC filings.

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter ended September 30, 2012, that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II Other Information

Item 1. Legal Proceedings

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

Item 1A. Risk Factors

Not applicable for smaller reporting companies.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

No matters to be reported.

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Item 6. 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. Director Deferred Compensation Plan.

10.2

Irrevocable Trust for the Director Deferred Compensation Plan.

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

The following material from the Corporation’s Form 10-Q Report for the quarterly period ended September 30, 2012, formatted in XBRL: (1) Unaudited Condensed Consolidated Balance Sheets, (2) Unaudited Condensed Consolidated Statements of Operations, (3) Unaudited Condensed Consolidated Statement of Changes in Shareholders’ Equity, (4) Unaudited Condensed Consolidated Statements of Cash Flows, and (5) the Notes to Unaudited Condensed Consolidated Financial Statements.

Signatures

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

	MBT Financial Corp.
	(Registrant)

November 14, 2012	By	/s/ H. Douglas Chaffin
Date	H. Douglas Chaffin
	President &
	Chief Executive Officer

November 14, 2012	By	/s/ John L. Skibski
Date	John L. Skibski
	Executive Vice President and
	Chief Financial Officer

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Exhibit Index

Exhibit Number		Description of Exhibits
10.1		MBT Financial Corp. Director Deferred Compensation Plan.

10.2		Irrevocable Trust for the Director Deferred Compensation Plan.

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**		The following material from the Corporation’s Form 10-Q Report for the quarterly period ended September 30, 2012, formatted in XBRL: (1) Unaudited Condensed Consolidated Balance Sheets, (2) Unaudited Condensed Consolidated Statements of Operations, (3) Unaudited Condensed Consolidated Statement of Changes in Shareholders’ Equity, (4) Unaudited Condensed Consolidated Statements of Cash Flows, and (5) the Notes to Unaudited Condensed Consolidated Financial Statements.

** Users of this data are advised that, pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, and are otherwise not subject to liability under these sections.

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