Fentura Financial, Inc. Form 10-Q

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

FORM 10-Q

[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004

OR

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

For the transition period from _______________ to _______________

Commission file number 000-23550

Fentura Financial, Inc.
(Exact name of registrant as specified in its charter)

Michigan
(State or other jurisdiction of
incorporation or organization)
38-2806518
(IRS Employer Identification No.)

175 N Leroy, P.O. Box 725, Fenton, Michigan 48430
(Address of Principal Executive Offices)

(810) 629-2263
(Registrant’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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. [X] Yes [__] No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). [__] Yes [X] No

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: August 1, 2004

Class — Common Stock             Shares Outstanding — 1,885,662


Fentura Financial Inc.
Index to Form 10-Q

Page
Part I - Financial Information
   
    Item 1 - Consolidated Financial Statements (Unaudited)    3  
   
    Item 2 - Management's Discussion and Analysis of  
    Financial Condition and Results of Operations    12  
   
    Item 3 - Quantitative and Qualitative Disclosures about Market Risk    22  
   
    Item 4 - Controls and Procedures    24  
   
   
Part II - Other Information  
   
    Item 1 - Legal Proceedings    25  
   
    Item 2 - Changes in Securities, Use of Proceeds, and  
    Issuer Purchases of Equity Securities    25  
   
    Item 3 - Defaults Upon Senior Securities    25  
   
    Item 4 - Submission of Matters to a Vote of Security Holders    25  
   
    Item 5 - Other Information    25  
   
    Item 6 - Exhibits and Reports on Form 8-K    25  
   
Signatures    27  
   
Exhibit Index    28  

PART I — FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

Fentura Financial, Inc.
Consolidated Balance Sheets



(000's omitted Except share data)
JUN 30,
2004
(unaudited)
DEC 31,
2003

ASSETS            
   Cash and due from banks   $ 23,566   $ 16,509  
   Federal funds sold    5,300    3,650  

     Total cash & cash equivalents    28,866    20,159  
   Securities-available for sale    100,405    113,833  
   Securities-held to maturity, (fair value of $13,727  
      at June 30, 2004 and $12,519 at December 31, 2003)    13,661    12,169  

       Total securities    114,066    126,002  
   Loans held for sale    1,044    1,095  
   Loans:  
     Commercial    239,983    146,450  
     Real estate loans - mortgage    30,488    18,335  
     Real estate loans - construction    38,901    32,913  
     Consumer loans    73,081    55,547  

   Total loans    382,453    253,245  
   Less: Allowance for loan losses    (4,917 )  (3,414 )

   Net loans    377,536    249,831  
    Bank Owned Life Insurance    6,748    6,458  
   Bank premises and equipment    14,238    9,606  
    Federal Home Loan Bank stock    2,204    854  
   Accrued interest receivable    2,211    1,884  
    Goodwill and other intangible assets    9,480    0  
   Other assets    3,508    4,077  

     Total assets   $ 559,901   $ 419,966  

   
LIABILITIES  
   Deposits:  
        Non-interest bearing deposits   $ 74,196   $ 58,708  
     Interest bearing deposits    402,555    289,817  

       Total deposits    476,751    348,525  
   Borrowings    4,027    3,449  
   Federal Home Loan Bank Advances    12,091    1,108  
    Repurchase Agreements    12,500    12,500  
    Subordinated debentures    12,000    12,000  
   Accrued taxes, interest and other liabilities    2,232    1,502  

       Total liabilities    519,601    379,084  

SHAREHOLDERS' EQUITY  
   Common stock - no par value  
   1,883,647 shares issued (1,880,485 in Dec. 2003)    32,875    32,769  
   Retained earnings    9,010    8,238  
   Accumulated other comprehensive loss    (1,585 )  (125 )

     Total shareholders' equity    40,300    40,882  

       Total Liabilities and Shareholders' Equity   $ 559,901   $ 419,966  

3

See notes to consolidated financial statements.


Fentura Financial, Inc.
Consolidated Statements of Income (Unaudited)

Three Months Ended
June 30,
Six Months Ended
June 30,
(000's omitted except per share data) 2004 2003 2004 2003

INTEREST INCOME                    
   Interest and fees on loans   $ 5,566   $ 3,978   $ 9,830   $ 7,902  
   Interest and dividends on  
     securities:  
     Taxable    751    331    1,575    659  
     Tax-exempt    183    172    343    341  
   Interest on federal funds sold    12    35    21    61  

         Total interest income    6,512    4,516    11,769    8,963  
   
   INTEREST EXPENSE  
   Deposits    1,792    1,293    3,214    2,589  
   Borrowings    290    28    562    50  

         Total interest expense    2,082    1,321    3,776    2,639  

   
   NET INTEREST INCOME    4,430    3,195    7,993    6,324  
   Provision for loan losses    363    668    636    964  

     Net interest income after  
       Provision for loan losses    4,067    2,527    7,357    5,360  
   
   NONINTEREST INCOME  
     Service charges on deposit accounts    973    934    1,852    1,742  
     Gain on sale of mortgages    145    434    242    788  
     Trust income    292    121    450    233  
     Gain (Loss) on sale of securities    0    19    0    31  
       Gain (Loss) on sale of fixed assets    0    201    (2 )  201  
     Other income and fees    421    344    902    633  

       Total noninterest income    1,831    2,053    3,444    3,628  
   
   NONINTEREST EXPENSE  
     Salaries and employee benefits    2,581    1,762    4,657    3,598  
     Occupancy    426    269    769    561  
     Furniture and equipment    574    365    987    723  
     Loan and collection    105    84    184    143  
     Advertising and promotional    150    98    258    187  
     Other operating expenses    955    774    1,733    1,456  

       Total noninterest expense    4,791    3,352    8,588    6,668  

   
   INCOME BEFORE TAXES    1,107    1,228    2,213    2,320  
   Applicable income taxes    286    318    570    589  

   NET INCOME   $ 821   $ 910   $ 1,643   $ 1,731  

   
   Per share:  
   Net income - basic   $ 0.44   $ 0.48   $ 0.87   $ 0.92  




   Net income - diluted   $ 0.43   $ 0.48   $ 0.87   $ 0.92  




    Cash Dividends declared   $ 0.23   $ 0.21   $ 0.46   $ 0.63  




See notes to consolidated financial statements.

4


Fentura Financial, Inc.
Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

Six Months
Ended
Six Months
Ended

(000's omitted) June 30,
2004
June 30,
2003

COMMON STOCK            
   Balance, beginning of period   $ 32,769   $ 30,236  
   Issuance of shares under  
     Director stock purchase plan &  
     Dividend reinvestment program    228    200  
    Repurchase stock    (122 )  (657 )


   Balance, end of period    32,875    29,779  
   
RETAINED EARNINGS  
   Balance, beginning of period    8,238    9,395  
     Net income    1,643    1,731  
        Cash dividends declared    (871 )  (1,187 )


   Balance, end of period    9,010    9,939  
   
ACCUMULATED OTHER COMPREHENSIVE  
   INCOME (LOSS)  
   Balance, beginning of period    (125 )  297  
     Change in unrealized gain (loss)  
     on securities, net of tax    (1,460 )  101  


   Balance, end of period    (1,585 )  398  


TOTAL SHAREHOLDERS' EQUITY   $ 40,300   $ 40,116  


See notes to consolidated financial statements.

5


Fentura Financial, Inc.
Consolidated Statements of Cash Flows (Unaudited)

Six Months Ended
June 30,

(000's omitted) 2004 2003

OPERATING ACTIVITIES:            
   
   Net income   $ 1,643   $ 1,731  
   Adjustments to reconcile net income to cash  
     Provided by Operating Activities:  
       Depreciation and amortization    676    486  
       Provision for loan losses    636    964  
       Amortization (accretion) on securities    350    485  
       Loans originated for sale    (11,089 )  (47,748 )
       Proceeds from the sale of loans    12,082    50,611  
            Gain on sale of securities    0    (31 )
            Gain on sales of fixed assets    2    0  
       Gain on sales of loans    (242 )  (788 )
            Net increase in bank owned life insurance    (106 )  (114 )
       Net (increase) decrease in interest receivable & other assets    1,056    (938 )
       Net increase (decrease) in interest payable & other liabilities    (964 )  375  

Total Adjustments    2,401    3,302  

Net Cash Provided By (Used In) Operating Activities    4,044    5,033  

Cash Flows From Investing Activities:  
   
   Proceeds from maturities of securities - HTM    1,063    1,803  
   Proceeds from maturities of securities - AFS    2,216    2,540  
    Proceeds from calls of securities - HTM    3    0  
   Proceeds from calls of securities - AFS    36,196    16,962  
    Proceeds from sales of securities - AFS    0    10,998  
   Purchases of securities - HTM    (2,536 )  (1,030 )
   Purchases of securities - AFS    (650 )  (56,133 )
   Net increase in loans    (31,764 )  (10,338 )
    Net cash from acquisition of WMFC    2,080    0  
   Capital expenditures    (571 )  (209 )

Net Cash Provided By (Used in) Investing Activities    6,037    (35,407 )
   
Cash Flows From Financing Activities:  
   
   Net increase (decrease) in deposits    18,398    43,362  
   Net increase (decrease) in borrowings    (19,007 )  17  
    Net increase (decrease) in repurchase agreements    0    12,500  
   Net proceeds from stock issuance and purchase    106    (457 )
   Cash dividends    (871 )  (1,187 )

Net Cash Provided By (Used In) Financing Activities    (1,374 )  54,235  
   
NET INCREASE IN CASH AND CASH EQUIVALENTS   $ 8,707   $ 23,861  
   
CASH AND CASH EQUIVALENTS - BEGINNING   $ 20,159   $ 30,562  

CASH AND CASH EQUIVALENTS - ENDING   $ 28,866   $ 54,423  

   
CASH PAID FOR:  
   INTEREST   $ 3,754   $ 2,650  
   INCOME TAXES   $ 180   $ 513  
Noncash investing and financing activities:  
   Securities acquired (including FHLB)   $ 26,973  
   Loans acquired    97,277  
   Premises and equipment acquired    4,737  
   Acquisition intangibles recorded    9,578  
   Other assets acquired    900  
   Deposits assumed    109,828  
   Borrowings assumed    30,568  
   Other liabilities assumed    1,149  
   Value of common stock and converted stock options    8,220  

See notes to consolidated financial statements.

6


Fentura Financial, Inc.
Consolidated Statements of Comprehensive Income (Unaudited)

Three Months Ended
June 30,
Six Months Ended
June 30,
(000's omitted) 2004 2003 2004 2003

Net Income
    $ 821   $ 910   $ 1,643   $ 1,731  
Other comprehensive income (loss), net of tax:  
   Unrealized holding gains (losses) arising  
       during period    (1,833 )  149    (1,460 )  132  
   Less: reclassification adjustment for  
       gains/losses included in net income    0    19    0    31  

Other comprehensive income (loss)    (1,833 )  130    (1,460 )  101  

Comprehensive income (loss)    ($1,012 ) $ 1,040   $ 183   $ 1,832  

Fentura Financial, Inc.
Notes to Consolidated Financial Statements (Unaudited)

Note 1. Basis of presentation

The consolidated financial statements at December 31, 2003 include Fentura Financial, Inc. (the Corporation) and its wholly owned subsidiaries, The State Bank in Fenton, Michigan and Davison State Bank in Davison, Michigan. The June 30, 2004 consolidated financial statements also include West Michigan Community Bank in Hudsonville, Michigan (collectively the Banks). As further discussed in Note 5, on March 15, 2004, the Corporation completed the acquisition of West Michigan Financial Corporation (WMFC) and its subsidiary, West Michigan Community Bank (WMCB). WMFC was merged with and into the Corporation on the date of the acquisition. WMCB remains a subsidiary of the Corporation. The acquisition was accounted for as a purchase and accordingly, these financial statements include the results of operations of WMFC and WMCB subsequent to March 15, 2004. Intercompany transactions and balances are eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions for Form — 10Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. For further information, refer to the consolidated financial statements and footnotes thereto included in the Corporation’s annual report on Form 10-K for the year ended December 31, 2003.

Reclassifications: Some items in the prior year financial statements were reclassified to conform to the current presentation.

All share and per share data has been adjusted for the 10% stock dividend paid on February 13, 2004.

Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.

A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgage, consumer, and credit card loans, and on an individual loan basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.

7


Stock Option Plans

The Nonemployee Director Stock Option Plan provides for the grant of options to nonemployee directors to purchase the Corporation’s common stock on April 1 each year. The purchase price of the shares is the fair market value at the date of the grant, and there is a three-year vesting period before options may be exercised. Options to acquire no more than 6,720 shares of stock may be granted under the Plan in any calendar year and options to acquire not more than 67,200 shares in the aggregate may be outstanding at any one time.

The Employee Stock Option Plan provides for the grant of options to eligible employees to purchase the Corporation’s common stock at or above, the fair market value of the stock at the date of the grant. Awards granted under this plan are limited to an aggregate of 72,000 shares. The administrator of the plan is a committee of directors. The administrator has the power to determine the number of options to be granted, the exercise price of the options and other terms of the options, subject to consistency with the terms of the plan. Options covering 14,575 shares were granted under this Plan on June 26, 2003.

The following table summarizes stock option activity:

Number of Options Weighted Average Price


Options outstanding at December 31, 2002      25,044   $ 23.83  
Options granted 2003    14,575    31.14  
Options exercised 2003    (1,822 )  17.58  
Options forfeited 2003    (3,036 )  23.96  

Options outstanding at December 31, 2003    34,761    26.99  
Options granted 2004    0    0.00  
Options forfeited 2004    (110 )  34.25  

Options outstanding at June 30, 2004    34,651   $ 26.99  

The stock option plans are accounted for in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) as permitted under Financial Accounting Standards No. 123, Accounting for Stock Based Compensation (SFAS 123). In accordance with APB 25, no compensation expense is required nor has been recognized for the options issued under existing plans. Had the Corporation chosen not to elect APB 25, SFAS 123 would apply and compensation expense would have been recognized, and the Corporation’s earnings would have been as follows (in thousands, except per share data):

Three Months Ended June 30, Six Months Ended June 30,
2004 2003 2004 2003




     Net Income                    
          As reported   $ 821   $ 910   $ 1,643   $ 1,731  
          Proforma    812    893    1,634    1,705  
   
     Basic net income   
          per share  
          As reported    0.44    0.48    0.87    0.92  
          Proforma    0.43    0.47    0.87    0.90  
   
     Diluted net income   
          per share  
          As reported    0.43    0.48    0.87    0.92  
          Proforma    0.43    0.47    0.87    0.90  

Proforma net income includes compensation cost for the Corporation’s stock option plan based on the fair values of the grants as of the dates of the awards consistent with the method prescribed by SFAS 123. The fair value of each option grant is estimated using the Black-Scholes option-pricing model. Assumptions used in the model for options granted during 2003 were as follows: an expected life of 6 years, a dividend yield of 3.6%, a risk free return of 2.78% and expected volatility of 24% resulting in a value of $5.97 per option.

8


Note 2. Earnings per common share

A reconciliation of the numerators and denominators used in the computation of basic earnings per common share and diluted earnings per common share is presented below. Earnings per common share are presented below for the three and six months ended June 30, 2004 and 2003:

Three Months Ended
June 30,
Six Months Ended
June 30,
2004 2003 2004 2003




Basic Earnings Per Common Share:                    
Numerator  
   Net Income   $ 821,000   $ 910,000   $ 1,643,000   $ 1,731,000  




Denominator  
   Weighted average common shares  
   Outstanding    1,882,390    1,883,872    1,881,992    1,887,673  




Basic earnings per common share   $ 0.44   $ 0.48   $ 0.87   $ 0.92  




Diluted Earnings Per Common Share:  
Numerator  
   Net Income   $ 821,000   $ 910,000   $ 1,643,000   $ 1,731,000  




Denominator  
   Weighted average common shares  
   Outstanding for basic earnings per  
   Common share    1,882,390    1,883,872    1,881,992    1,887,673  
   
Add: Dilutive effects of assumed  
   Exercises of stock options    6,153    6,838    5,091    6,870  




   Weighted average common shares  
   And dilutive potential common  
   Shares outstanding    1,888,543    1,890,710    1,887,083    1,894,543  




Diluted earnings per common share   $ 0.43   $ 0.48   $ 0.87   $ 0.92  




Stock options for 5,096 shares and 19,561 shares of common stock for the three and six months period ended June 30, 2004 and stock options for 5,737 shares and 6,841 shares of common stock for the three and six month periods ended June 30, 2003 were not considered in computing diluted earnings per common share because they were not dilutive.

Note 3. Commitments and contingencies

There are various contingent liabilities that are not reflected in the financial statements including claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material effect on the Corporation’s consolidated financial condition or results of operations.

9


Note 4. Securities

June 30, 2004 securities and year-end 2003 securities are as follows:

Available for Sale
June 30, 2004
Fair Value Gross Unrealized Gains Gross Unrealized Losses




  U.S. Government & federal agency     $ 42,588   $ 14   $ (686 )
  State and Municipal    7,144    34    (29 )
  Mortgage-backed    49,628    60    (1,794 )
  Corporate    0    0    0  
  Equity securities    1,045    0    0  



         Total   $ 100,405   $ 108   $ (2,509 )



December 31, 2003  
  U.S. Government & federal agency   $ 62,882   $ 243   $ (38 )
  State and Municipal    6,791    83    (5 )
  Mortgage-backed    42,744    82    (571 )
  Corporate    1,021    16    0  
  Equity securities    395    0    0  



         Total   $ 113,833   $ 424   $ (614 )





Held to Maturity June 30, 2004 Amortized Cost Gross Unrealized Gain Gross Unrealized Losses Fair Value





State & municipal     $ 13,634   $ 209   $ (145 ) $ 13,698  




Mortgage-backed    27   $ 2   $ 0   $ 29  




           Total   $ 13,661   $ 211   $ (145 ) $ 13,727  




   
December 31, 2003  
State & municipal   $ 12,169   $ 364   $ (14 ) $ 12,519  




           Total   $ 12,169   $ 364   $ (14 ) $ 12,519  




Note 5. Acquisition

On October 15, 2003, the Corporation announced the signing of a definitive agreement to acquire West Michigan Financial Corporation (“WMFC”), a commercial bank headquartered in Hudsonville, Michigan. The purpose of the acquisition was to establish a presence in the West Michigan market resulting in a foundation to grow the Corporations asset base, primarily loans, in that market. Under the terms of the transaction, the Corporation acquired all of the outstanding stock of WMFC in exchange for cash. The total cost of the transaction was $12.9 million. The Corporation closed the transaction on March 15, 2004.

The acquisition has been accounted for using the purchase method of accounting, and, accordingly, the purchase price has been allocated to the tangible and identified intangible assets purchased and the liabilities assumed based upon the estimated fair values at the date of acquisition. Identified intangible assets and purchase accounting fair value adjustments are being amortized under various methods over the expected lives of the corresponding assets and liabilities. Goodwill will not be amortized, but will be reviewed for impairment on a yearly basis. Identified intangible assets aggregate to $1.7 million and include a core deposit intangible and customer relationship value related to WMFC’s loan, deposit and wealth management customers. Goodwill aggregates to $7.9 million.

In conjunction with the acquisition, the fair values of significant assets and liabilities assumed are as follows, stated in thousands of dollars:

Cash and cash equivalents     $ 15,926  
Securities    26,973  
Loans    97,277  
Acquisition intangibles    9,578  
Deposits    109,828  
Other borrowings    27,368  

10


The following table presents pro forma information stated in thousands of dollars for the six months ended June 30, 2004 and the year ended December 31, 2003 as if the acquisition of WMFC had occurred at the beginning of 2004 and 2003. The pro forma information includes adjustments for the amortization of intangibles arising from the transaction, the elimination of acquisition related expenses, and the related income tax effects. The pro forma financial information is not necessarily indicative of the results of operations as they would have been had the transactions been effected on the assumed dates.

2004 2003


Interest income     $ 13,160   $ 25,333  
Interest expense    4,204    8,185  


     Net interest income    8,956    17,148  
Provision for loan losses    673    2,464  


     Net interest income after provision    8,283    14,684  
Noninterest income    3,707    8,739  
Noninterest expense    9,579    18,905  


     Income before federal income tax    2,411    4,518  
Federal income tax expense    632    1,131  


Net income   $ 1,779   $ 3,387  


Basic earnings per share   $ 0.95   $ 1.80  
Diluted earnings per share    0.94    1.79  

11


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

Results of Operations

Certain of the Corporation’s accounting policies are important to the portrayal of the Corporation’s financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances, which could affect these judgments, include, but without limitation, changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses and determining the fair value of securities and other financial instruments.

As indicated in the income statement, earnings for the three months ended June 30, 2004 were $821,000 compared to $910,000 for the same period in 2003. Year to date earnings for the first six months of 2004 were $1,643,000 compared to $1,731,000 for the same period in 2003. Earnings decreased in the second quarter of 2004 due to lower noninterest income and higher noninterest expense. Net interest income was higher due to significantly higher loan and security balances during the first six months of 2004 compared with the same period in 2003. Also the Corporation completed the acquisition of West Michigan Financial Corporation (“WMFC”) on March 15, 2004. As a privately held entity, WMFC experienced operating losses in 2002 and 2003. The company operated profitably during the first quarter of 2004 prior to the acquisition by Fentura Financial. Carrying costs associated with the Trust Preferred Securities issued in connection with the acquisition, coupled with legal, accounting and consulting acquisition expenses more than offset the income contribution of West Michigan Community Bank since the date of acquisition. The Corporation continues to focus on core banking activities and new opportunities in current and surrounding markets.

Net income per share — basic and diluted was $0.87 in the first six months of 2004 compared to $0.92 net income per share – basic and diluted for the same period in 2003. Net income per share – basic was $0.44 and diluted was $0.43 in the second quarter of 2004 compared to $0.48 for net income – basic and diluted for the same period in 2003.

Net Interest Income

Net interest income and average balances and yields on major categories of interest-earning assets and interest-bearing liabilities for the six months ended June 30, 2004 and 2003 are summarized in Table 2. The effects of changes in average interest rates and average balances are detailed in Table 1 below.

Table 1

SIX MONTHS ENDED
JUNE 30,
2004 COMPARED TO 2003
INCREASE (DECREASE)
DUE TO:

(000'S OMITTED) VOL YIELD/RATE TOTAL

TAXABLE SECURITIES     $ 802   $ 114   $ 916  
TAX-EXEMPT SECURITIES    (47 )  50    3  
FEDERAL FUNDS SOLD    (36 )  (4 )  (40 )
   
TOTAL LOANS    3,305    (1,278 )  2,027  
LOANS HELD FOR SALE    (88 )  (19 )  (107 )

   TOTAL EARNING ASSETS    3,936    (1,137 )  2,799  
   
INTEREST BEARING DEMAND DEPOSITS    191    146    337  
SAVINGS DEPOSITS    180    120    300  
TIME CD'S $100,000 AND OVER    16    (46 )  (30 )
OTHER TIME DEPOSITS    243    (225 )  18  
OTHER BORROWINGS    791    (279 )  512  

   TOTAL INTEREST BEARING LIABILITIES    1,421    (284 )  1,137  

      NET INTEREST INCOME   $ 2,515    ($ 853 ) $ 1,662  

12


As indicated in Table 1, during the six months ended June 30, 2004, net interest income increased compared to the same period in 2003, principally because of the increase in securities interest income and the increase in loan interest income. Both loan and investment interest income increased due to higher balances during the first six months of 2004 compared to the same period in 2003. Interest expense increased compared to the first quarter of 2003 due to the increase in deposit balances and an increase in borrowings for the Corporation.

Net interest income (displayed with consideration of full tax equivalency), average balance sheet amounts, and the corresponding yields for the three months ended June 30, 2004 and 2003 are shown in Table 2. Actual net interest income for the six months ended June 30, 2004 was $7,993,000, an increase of $1,669,000, or 26.4%, over the same period in 2003. The primary factor contributing to the net interest income increase was the addition of West Michigan Community Bank, which increased net interest income $1,309,000. Higher interest income also resulted in part from an increase in loan and investment income resulting from higher balances carried at the Corporation’s other subsidiary banks during the first six months of 2004 compared to the same period in 2003. However, the increased volume was at a lower spread and as a result the net interest margin declined during the 2004 period.

Management reviews economic forecasts and strategy on a monthly basis. Accordingly, the Corporation will continue to strategically manage the balance sheet structure in an effort to create stability in net interest income. The Corporation expects to continue to seek out new loan opportunities while continuing to maintain sound credit quality.

As indicated in Table 2, for the six months ended June 30, 2004, the Corporation’s net interest margin (with consideration of full tax equivalency) was 3.63% compared with 4.24% for the same period in 2003. This decline is attributable to the impact of an increase in volume at a lower spread, which helped increase net interest income but decreased the net interest margin. The Corporation’s net interest margin was also negatively impacted by the Federal Reserve reducing interest rates at the end of the second quarter in 2003 and by the Corporation’s investment of excess cash in lower yielding securities.

Average earning assets increased 45.9% or approximately $143,196,000, of which $72,760,000 was attributable to West Michigan Community Bank, comparing the first six months of 2004 to the same time period in 2003. Loans, the highest yielding component of earning assets, represented 71.3% of earning assets in 2004 compared to 73.5% in 2003. Average interest bearing liabilities increased 52.2% or $134,152,000, of which $62,766,000 was attributable to West Michigan Community Bank, comparing the first six months of 2004 to the same time period in 2003. Non-interest bearing deposits amounted to 16.1% of average earning assets in the first six months of 2004 compared with 15.4% in the same time period of 2003.

Management continually monitors the Corporation’s balance sheet to insulate net interest income from significant swings caused by interest rate volatility. If market rates change in 2004, corresponding changes in funding costs will be considered to avoid any potential negative impact on net interest income. The Corporation’s policies in this regard are further discussed in the section titled “Interest Rate Sensitivity Management.”

13


Table 2

SIX MONTHS ENDED JUNE 30,
AVERAGE BALANCES AND RATES
(000's omitted)(Annualized)
ASSETS
AVERAGE
BALANCE
2004
INCOME/
EXPENSE
YIELD/
RATE
AVERAGE
BALANCE
2003
INCOME/
EXPENSE
YIELD/
RATE






   Securities:                            
     U.S. Treasury and Government Agencies   $ 104,752   $ 1,515    2.91 % $ 44,865   $ 587    2.64 %
     State and Political (1)    19,065    520    5.48 %  21,034    517    4.95 %
     Other    1,729    60    6.98 %  3,303    72    4.40 %






     Total Securities    125,546    2,095    3.36 %  69,202    1,176    3.43 %
     Fed Funds Sold    4,316    21    0.98 %  10,613    61    1.16 %
   Loans:  
     Commercial    227,535    6,797    6.01 %  156,565    5,284    6.81 %
     Tax Free (1)    4,732    148    6.29 %  5,370    174    6.54 %
     Real Estate-Mortgage    26,312    863    6.60 %  13,299    449    6.81 %
     Consumer    65,776    2,052    6.27 %  53,937    1,926    7.20 %






   Total loans    324,355    9,860    6.11 %  229,171    7,833    6.89 %
   Allowance for Loan Losses    (4,302 )  (3,251 )
   Net Loans    320,053    9,860    6.20 %  225,920    7,833    6.99 %






   Loans Held for Sale    891    20    4.51 %  2,926    127    8.75 %






   TOTAL EARNING ASSETS   $ 455,108   $ 11,996    5.30 % $ 311,912   $ 9,197    5.95 %






   Cash Due from Banks    21,682    17,609  
   All Other Assets    35,153    20,021  


TOTAL ASSETS   $ 507,641   $ 346,291  


LIABILITIES & SHAREHOLDERS' EQUITY:  
   Deposits:  
   Interest bearing - DDA   $ 97,619    523    1.08 % $ 48,246    186    0.78 %
   Savings Deposits    130,761    890    1.37 %  100,520    590    1.18 %
   Time CD's $100,000 and Over    44,019    505    2.31 %  31,710    535    3.40 %
   Other Time CD's    81,610    1,296    3.19 %  74,244    1,278    3.47 %






   Total Deposits    354,009    3,214    1.83 %  254,720    2,589    2.05 %
   Other Borrowings    37,073    562    3.05 %  2,210    50    4.56 %






   INTEREST BEARING LIABILITIES   $ 391,082   $ 3,776    1.94 % $ 256,930   $ 2,639    2.07 %






   Non-Interest bearing - DDA    73,435    48,141  
   All Other Liabilities    1,445    1,046  
   Shareholders' Equity    41,679    40,174  


   TOTAL LIABILITIES & SHAREHOLDERS'
   EQUITY
   $ 507,641   $ 346,291  


Net Interest Rate Spread    3.36 %  3.87 %


Net Interest Income/Margin   $ 8,220    3.63 %   $6,558  4.24 %




(1) – Presented on a fully taxable equivalent basis using a federal income tax rate of 34%.

14


Table 3

THREE MONTHS ENDED JUNE 30,
AVERAGE BALANCES AND RATES
(000's omitted)(Annualized)
ASSETS
AVERAGE
BALANCE
2004
INCOME/
EXPENSE
YIELD/
RATE
AVERAGE
BALANCE
2003
INCOME/
EXPENSE
YIELD/
RATE






   Securities:                            
     U.S. Treasury and Government Agencies   $ 100,644   $ 719    2.87 % $ 44,912   $ 300    2.68 %
     State and Political (1)    21,428    277    5.23 %  20,998    261    4.98 %
     Other    1,635    32    7.87 %  2,758    31    4.51 %






     Total Securities    123,707    1,028    3.34 %  68,668    592    3.46 %
     Fed Funds Sold    5,151    12    0.94 %  12,211    35    1.15 %
   Loans:  
     Commercial    262,943    3,850    5.89 %  158,847    2,675    6.75 %
     Tax Free (1)    4,641    74    6.41 %  5,241    86    6.61 %
     Real Estate-Mortgage    32,042    531    6.67 %  14,036    233    6.66 %
     Consumer    73,134    1,128    6.20 %  53,532    945    7.08 %






   Total loans    372,760    5,583    6.02 %  231,656    3,939    6.82 %
   Allowance for Loan Losses    (4,900 )  (3,256 )
   Net Loans    367,860    5,583    6.10 %  228,400    3,939    6.92 %






   Loans Held for Sale    628    8    5.12 %  3,069    68    8.89 %






   TOTAL EARNING ASSETS   $ 502,246   $ 6,631    5.31 % $ 315,604   $ 4,634    5.89 %






   Cash Due from Banks    22,215    17,452  
   All Other Assets    34,512    19,886  


TOTAL ASSETS   $ 554,073   $ 349,686  


LIABILITIES & SHAREHOLDERS' EQUITY:  
   Deposits:  
   Interest bearing - DDA   $ 108,482    316    1.17 % $ 46,871    91    0.78 %
   Savings Deposits    149,351    451    1.21 %  103,407    308    1.19 %
   Time CD's $100,000 and Over    44,427    293    2.65 %  29,421    256    3.49 %
   Other Time CD's    93,210    732    3.16 %  75,659    638    3.38 %






   Total Deposits    395,470    1,792    1.82 %  255,358    1,293    2.03 %
   Other Borrowings    42,184    290    2.76 %  2,726    28    4.12 %






   INTEREST BEARING LIABILITIES   $ 437,654   $ 2,082    1.91 % $ 258,084   $ 1,321    2.05 %






   Non-Interest bearing - DDA    72,292    50,032  
   All Other Liabilities    2,232    1,066  
   Shareholders' Equity    41,895    40,504  


   TOTAL LIABILITIES & SHAREHOLDERS'  
   EQUITY   $ 554,073   $ 349,686  


Net Interest Rate Spread    3.40 %  3.84 %


Net Interest Income /Margin   $ 4,549    3.64 % $3,313  4.21 %




(2) – Presented on a fully taxable equivalent basis using a federal income tax rate of 34%.

15


ALLOWANCE AND PROVISION FOR LOAN LOSSES

The Corporation maintains formal policies and procedures to control and monitor credit risk. Management believes the allowance for loan losses is adequate to provide for probable incurred losses in the loan portfolio. The Corporation’s loan portfolio has no significant concentrations in any one industry or any exposure in foreign loans. The Corporation has not extended credit to finance highly leveraged transactions nor does it intend to do so in the future. Employment levels and other economic conditions in the Corporation’s local markets may have a significant impact on the level of loan losses. Management continues to identify and devote attention to credits that are not performing as agreed. Of course, deterioration of economic conditions could have an impact on the Corporation’s credit quality, which could impact the need for greater provision for loan losses and the level of the allowance for loan losses as a percentage of gross loans. Non-performing loans are discussed further in the section titled “Non-Performing Assets.”

The allowance for loan losses (ALL) reflects management’s judgment as to the level considered appropriate to absorb probable losses in the loan portfolio. Fentura’s subsidiary banks’ methodology in determining the adequacy of the ALL includes a review of individual loans, historical loss experience, current economic conditions, portfolio trends, and other pertinent factors. Although portions of the allowance have been allocated to various portfolio segments, the ALL is general in nature and is available for the portfolio in its entirety. At June 30, 2004, the ALL was $4,917,000, or 1.29% of total loans. This compares with $3,414,000, or 1.35%, at December 31, 2003. The decrease of the ALL as a percentage of total loans reflects a small increase in the allowance for loan losses and a large increase in total loans. Management believes that the allowance to gross loans percentage is appropriate given identified risk in the loan portfolio based on asset quality.

Table 4 also summarizes loan losses and recoveries for the first six months of 2004 and 2003. During the first six months of 2004 the Corporation experienced net charge-offs of $292,000 or .08% of loans (annualized) compared with net charge-offs of $1,083,000 or .46% in the first six months of 2003. The provision for loan losses was $636,000 in the first six months of 2004 and $964,000 for the same time period in 2003.

Table 4 ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES

(000's omitted) Six Months Ended
June 30,
2004
Six Months Ended
June 30,
2003


Balance at Beginning of Period     $ 3,414   $ 3,184  


Charge-Offs:  
     Commercial, Financial and Agriculture    (260 )  (915 )
     Real Estate-Mortgage    0    0  
     Installment Loans to Individuals    (138 )  (254 )


         Total Charge-Offs    (398 )  (1,169 )
Recoveries:  
     Commercial, Financial and Agriculture    26    27  
     Real Estate-Mortgage    0    0  
     Installment Loans to Individuals    80    59  


         Total Recoveries    106    86  


Net Charge-Offs    (292 )  (1,083 )
Provision    636    964  


Addition from WMCB acquisition    1,159    0  


Balance at End of Period   $ 4,917   $ 3,065  


Ratio of Net Charge-Offs to Gross Loans    0.08 %  0.46 %


16


NON-INTEREST INCOME

Non-interest income decreased during the six months ended June 30, 2004 as compared to the same period in 2003, primarily due to the decrease in gain on sale of mortgages and gains taken on securities and fixed assets in 2003. Overall non-interest income was $3,444,000 for the six months ended June 30, 2004 compared to $3,628,000 for the same period in 2003. These figures represent a decrease of 5.1%. Non-interest income declined 10.8% in the second quarter of 2004 compared to the same period in 2003. The income statement provides a detailed breakdown of the components of non-interest income.

The most significant category of non-interest income is service charges on deposit accounts. These fees were $1,852,000 in the first six months of 2004 compared to $1,742,000 for the same period of 2003. This represents an increase of 6.3%. In the second quarter of 2004 services charges increased 4.2% over the same period in 2003. Increases are attributable to service charges from growth in core deposits, the continued success of the overdraft privilege product and a full quarter of service charges from West Michigan Community Bank of $76,000.

Gains on the sale of mortgage loans originated by the Banks and sold in the secondary market were $242,000 in the six months ended June 30, 2004 and $788,000 in the same period in 2003. In the second quarter of 2004 gain on the sale of mortgages decreased 66.6% over the same period in 2003. The decline resulted from the decline in residential mortgage refinance activity and lower new loan volumes due to the higher interest rates compared to the historically low market interest rates during the first six months of 2003. The addition of West Michigan Community Bank did not materially affect the decline in gain on sale of mortgage loans.

Trust income increased $217,000 (93.1%) in the first six months of 2004 compared to the same period in the prior year. In the second quarter of 2004 trust fees increased $171,000 compared with the same period in 2003. The increase in fees is attributable to the increase in the average market value of assets under management, the addition of several new trust accounts within the Corporation’s Trust Department and a full quarter of trust income from West Michigan Community Bank of $142,000.

Gain on sale of securities decreased $31,000 in the first six months of 2004, due to the Banks not selling any securities in the first six months of 2004. The Banks sold securities in the first six months of 2003, which produced a gain of $31,000; this gain made up less than 1 percent of the 2003 first six months non–interest income.

A loss on sale of fixed assets of $2,000 was recorded in the first six months of 2004, due to the sale of equipment in one of the Bank subsidiaries. The Corporation had a gain of $201,000 in the first six months of 2003 due to the sale of a branch location in one of the Bank subsidiaries.

Other operating income increased $269,000 (42.5%) to $902,000 in the first six months of 2004 compared to $633,000 in the same time period in 2003. In the second quarter of 2004 other operating income increased 23.4% over the same period in 2003. Other operating income increased due to the gain of $79,000 resulting from the surrender of insurance related to a terminated benefit plan, an insurance claim for damage to other real estate property in one of the Bank subsidiaries, increased cash surrender value of life insurance, an the increase in debit and ATM income and West Michigan Community Bank other operating income of $52,000.

17


Non-Interest Expense

Total non-interest expense increased 28.8% to $8,588,000 in the six months ended June 30, 2004, compared with $6,668,000 in the same period of 2003. In the second quarter of 2004 total non-interest expenses were $4,791,000 compared to $3,352,000 in the same quarter of 2003. This increase was largely attributable to an increase in salaries and benefits expense, occupancy expenses and other operating expenses.

Salary and benefit costs, Fentura’s largest non-interest expense category, were $4,657,000 in the first six months of 2004, compared with $3,598,000, or an increase of 29.4%, for the same time period in 2003 In the second quarter of 2004 salary and benefit costs were $2,581,000 compared with $1,762,000, or an increase of 46.5% for the same quarter in 2003. Increased costs were primarily a result of the addition of a full quarter of salaries for West Michigan Community Bank totaling $688,000. A modest salary increase for employees and an increase in employee benefit costs and modest staffing increases also affected salary and benefit costs in both quarters.

Occupancy expenses at $769,000 increased in the six months ended June 30, 2004 compared to the same period in 2003 by $208,000 or 37.1%. Occupancy expenses increased 58.4% in the second quarter of 2004 compared to 2003. The increases were attributable to increases in facility repairs, an increase in rent due to the opening of the Grand Blanc executive office in November of 2003, maintenance contracts expense and a full quarter of occupancy expenses for West Michigan Community Bank, which totaled $93,000.

During the six months ended June 30, 2004 furniture and equipment expenses were $987,000 compared to $723,000 for the same period in 2003, an increase of 36.5%. In the second quarter of 2004 furniture and equipment expenses increased 57.3% from the second quarter of 2003. The increases in expenses were attributable to increases in equipment maintenance contracts, equipment depreciation and a full quarter of furniture and equipment expenses for West Michigan Community Bank, which totaled $151,000.

Loan and collection expenses, at $184,000, were up $41,000 during the six months ended June 30, 2004 compared to the same time period in 2003. In the second quarter loan and collection expense increased 25.0% compared to the second quarter of 2003. The increase was primarily attributable to the addition of West Michigan Community Bank for the full second quarter of 2004 which increased loan and collection expense by a total of $38,000.

Advertising expenses were $258,000 in the six months ended June 30, 2004, up 38.0% compared with $187,000 for the same period in 2003. Advertising expenses increased 53.1% in the second quarter of 2004 compared to the same quarter in 2003. The increases were primarily due to the addition of West Michigan Community Bank to the Fentura Financial family which increased the advertising expense by $55,000.

Other operating expenses were $1,733,000 in the six months ended June 30, 2004 compared to $1,456,000 in the same time period in 2003, an increase of $277,000 or 19.0%. Other operating expenses were $955,000 in the second quarter of 2004 compared to $774,000 in the same period of 2003. The increases were primarily attributable to the costs for the full quarter of West Michigan Community Bank expenses, which totaled $222,000, the majority of which were for outside services and consulting.

18


Financial Condition

Proper management of the volume and composition of the Corporation’s earning assets and funding sources is essential for ensuring strong and consistent earnings performance, maintaining adequate liquidity and limiting exposure to risks caused by changing market conditions. The Corporation’s securities portfolio is structured to provide a source of liquidity through maturities and to generate an income stream with relatively low levels of principal risk. The Corporation does not engage in securities trading. Loans comprise the largest component of earning assets and are the Corporation’s highest yielding assets. Customer deposits are the primary source of funding for earning assets while short-term debt and other sources of funds could be further utilized if market conditions and liquidity needs change.

On March 15, 2004, the Corporation acquired WMFC, as more fully described in Note 5. This transaction significantly increased the Corporation’s consolidated assets and liabilities, as compared to year-end 2003.

The Corporation’s total assets were $560 million at June 30, 2004 compared to December 31, 2003 total assets of $420 million. Loans comprised 68.3% of total assets at June 30, 2004 compared to 60.3% at December 31, 2003. Loans grew $129.2 million for the Corporation with $97.3 million due to the acquisition of West Michigan Financial Corporation. The loans for the other two subsidiary banks grew $33.5 million with commercial loans and real estate- construction loans leading the advance. The ratio of non-interest bearing deposits to total deposits was 15.6% at June 30, 2004 compared to 16.8% at December 31, 2003. Interest bearing deposit liabilities totaled $403 million at June 30, 2004 compared to $290 million at December 31, 2003. Total deposits increased $112.7 million with non-interest bearing demand deposits increasing $15.5 million and interest bearing deposits increasing $96.0 million due to the acquisition of West Michigan Financial Corporation. Short-term borrowings increased $578,000 due to the acquisition of West Michigan Financial Corporation. FHLB advance balances increased $11.0 million during the period due to the acquisition of West Michigan Financial Corporation. Repurchase agreement balances remained steady comparing the two periods. Repurchase agreements are instruments with deposit type characteristics, which are secured by bank securities. The repurchase agreements were leveraged against securities to increase net interest income.

Bank premises and equipment increased $4.6 million to $14.2 million at June 30, 2004 compared to $9.6 million at December 31, 2003. The increase was due to the acquisition of West Michigan Financial Corporation. The other bank subsidiaries’ fixed assets declined due to depreciation expense.

NON-PERFORMING ASSETS

Non-performing assets are assets that have more than a normal risk of loss and include loans on which interest accruals have ceased, loans that have been renegotiated, and real estate acquired through foreclosure. Past due loans are loans which are delinquent 90 days or more, but have not been placed on non-accrual status. Table 5 reflects the levels of these assets at June 30, 2004 and December 31, 2003.

Non-performing assets increased at June 30, 2004 compared to December 31, 2003. The level of non-performing loans increased as compared to December 31, 2003 primarily due to the increase in non-accrual loans. Non-accrual loans include one $1,004,000 real estate secured commercial loan. Renegotiated loans were reduced significantly due to reclassification of a real estate secured loan to REO-in-Redemption.

Other non-performing assets decreased, primarily due to a significant decrease in Other Real Estate due to the sale of several properties in the first six months of 2004. REO-in-Redemption increased $614,000 primarily due to the reclassification of a single-family residential loan from the renegotiated category. The Corporation provided $636,000 to the loan loss allowance in the first six months of 2004.

The level and composition of non-performing assets are affected by economic conditions in the Corporation’s local markets. Non-performing assets, charge-offs, and provisions for loan losses tend to decline in a strong economy and increase in a weak economy, potentially impacting the Corporation’s operating results. In addition to non-performing loans, management carefully monitors other credits that are current in terms of principal and interest payments but, in management’s opinion, may deteriorate in quality if economic conditions change.

19


Table 5
Non-Performing Assets and Past Due Loans

June 30,
2004
December 31,
2003


Non-Performing Loans:            
     Loans Past Due 90 Days or More & Still  
         Accruing   $ 288   $ 47  
     Non-Accrual Loans    1,353    229  
     Renegotiated Loans    477    1,262  


         Total Non-Performing Loans    2,118    1,538  


Other Non-Performing Assets:  
     Other Real Estate    356    1,081  
     REO in Redemption    798    184  
     Other Non-Performing Assets    9    79  


         Total Other Non-Performing Assets    1,163    1,344  


Total Non-Performing Assets   $ 3,281   $ 2,882  


Non-Performing Loans as a % of  
     Total Loans    0.55 %  0.61 %
Allowance for Loan Losses as a % of  
     Non-Performing Loans    232.15 %  221.98 %
Accruing Loans Past Due 90 Days or  
     More to Total Loans    0.08 %  0.20 %
Non-performing Assets as a % of  
     Total Assets    0.59 %  0.69 %

LIQUIDITY AND INTEREST RATE RISK MANAGEMENT

Asset/Liability management is designed to assure liquidity and reduce interest rate risks. The goal in managing interest rate risk is to maintain a strong and relatively stable net interest margin. It is the responsibility of the Asset/Liability Management Committee (ALCO) to set policy guidelines and to establish short-term and long-term strategies with respect to interest rate exposure and liquidity. The ALCO, which is comprised of key members of management, meets regularly to review financial performance and soundness, including interest rate risk and liquidity exposure in relation to present and prospective markets, business conditions, and product lines. Accordingly, the committee adopts funding and balance sheet management strategies that are intended to maintain earnings, liquidity, and growth rates consistent with policy and prudent business standards.

Liquidity maintenance together with a solid capital base and strong earnings performance are key objectives of the Corporation. The Corporation’s liquidity is derived from a strong deposit base comprised of individual and business deposits. Deposit accounts of customers in the mature market represent a substantial portion of deposits of individuals. The Banks’ deposit base plus other funding sources (federal funds purchased, other liabilities and shareholders’ equity) provided primarily all funding needs in the first half of 2004. While these sources of funds are expected to continue to be available to provide funds in the future, the mix and availability of funds will depend upon future economic conditions. The Corporation does not foresee any difficulty in meeting its funding requirements.

The following table discloses information on the maturity of the Corporation’s contractual long-term obligations (in thousands):

Table 6
 
Total Less than
1 year
1 - 3 years 3 - 5 years More than
5 years

Short-term borrowings
    $ 4,027   $ 4,027   $ 0   $ 0   $ 0  
   
FHLB Advances    12,091    2,000    4,000    5,000    1,091  
   
Repurchase agreements    12,500    7,500    0    5,000    0  
   
Subordinated debt    12,000    0    0    0    12,000  
   
Operating leases    699    279    244    176    0  





Total   $ 41,317   $ 13,806   $ 4,244   $ 10,176   $ 13,091  

20


Primary liquidity is provided through short-term investments or borrowings (including federal funds sold and purchased) while the securities portfolio provides secondary liquidity. The securities portfolio has decreased $11.9 million due to the higher loan demand in the bank subsidiaries. The Corporation has decided to invest the excess funds in the security or loan portfolio to increase yield and income versus keeping the excess funds in federal funds sold at a lower yield. As of June 30, 2004 federal funds sold represented less than 1 percent of total assets, which is about the same when compared to December 31, 2003. The Corporation regularly monitors liquidity to ensure adequate cash flows to cover unanticipated reductions in the availability of funding sources.

Interest rate risk is managed by controlling and limiting the level of earnings volatility arising from rate movements. The Corporation entered into a leverage strategy in the second quarter of 2003, which was purchasing securities funded by repurchase agreements. This strategy helped leverage more capital of the Corporation and limit volatility if interest rates dropped further. The Corporation regularly performs reviews and analysis of those factors impacting interest rate risk. Factors include maturity and re-pricing frequency of balance sheet components, impact of rate changes on interest margin and prepayment speeds, market value impacts of rate changes, and other issues. Both actual and projected performance are reviewed, analyzed, and compared to policy and objectives to assure present and future financial viability.

CAPITAL MANAGEMENT

Total shareholders’ equity decreased 1.4% to $40,299,000 at June 30, 2004 compared with $40,882,000 at December 31, 2003. The Corporation’s equity to asset ratio was 7.2% at June 30, 2004 and 9.7% at December 31, 2003. The decrease in the amount of capital resulted primarily from the increase in the unrealized loss position of the security portfolio that is recognized in the equity section of the balance sheet.

As indicated on the balance sheet at December 31, 2003 the Corporation had an accumulated other comprehensive loss of $125,000 compared to an accumulated other comprehensive loss at June 30, 2004 of $1,585,000. The decline to a further loss position is attributable to the fluctuation of the market price of securities held in the available for sale portfolio.

The Corporation issued trust preferred securities in the fourth quarter of 2003 to help fund the acquisition of West Michigan Financial Corporation. The Corporation acquired West Michigan Financial Corporation in Hudsonville, Michigan, on March 15, 2004, following approval by West Michigan Financial Corporation shareholders and receipt of regulatory approvals.

West Michigan Financial Corporation was a one-bank holding company for West Michigan Community Bank, which became the third affiliate bank owned by Fentura Financial, Inc.

Regulatory Capital Requirements

Bank holding companies and their bank subsidiaries are required by banking industry regulators to maintain certain levels of capital. These are expressed in the form of certain ratios. These ratios are based on the degree of credit risk in the Corporation’s assets. All assets and off-balance sheet items such as outstanding loan commitments are assigned risk factors to create an overall risk-weighted asset total. Capital is separated into two levels, Tier I capital (essentially total common shareholders’ equity plus qualifying cumulative preferred securities (limited to 33% of common equity), less goodwill) and Tier II capital (essentially the allowance for loan losses limited to 1.25% of gross risk-weighted assets). Capital levels are then measured as a percentage of total risk weighted assets. The regulatory minimum for Tier I capital to risk weighted assets is 4% and the minimum for Total capital (Tier I plus Tier II) to risk weighted assets is 8%. The Tier I leverage ratio measures Tier I capital to average assets and must be a minimum of 4%. As reflected in Table 7, at June 30, 2004 and at December 31, 2003, the Corporation was well in excess of the minimum capital and leverage requirements necessary to be considered a “well capitalized” banking company.

The FDIC has adopted a risk-based insurance premium system based in part on a bank’s capital adequacy. Under this system a depository institution is classified as well capitalized, adequately capitalized, or undercapitalized according to its regulatory capital levels. Subsequently, a financial institution’s premium levels are based on these classifications and its regulatory supervisory rating (the higher the classification the lower the premium). It is the Corporation’s goal to maintain capital levels sufficient to retain a designation of “well capitalized.”

21


Table 7

Capital Ratios
Regulatory Minimum Fentura Financial, Inc.
For "Well Capitalized" June 30,
2004
December 31,
2003
June 30,
2003

Total Capital to risk
                   
     Weighted assets    10 %  10.98 %  18.00 %  14.53 %
Tier 1 Capital to risk    6 %  9.90 %  16.90 %  13.49 %
     Weighted assets  
Tier 1 Capital to average  
     Assets    5 %  8.10 %  14.00 %  11.47 %

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The information concerning quantitative and qualitative disclosures about market risk contained on page 47 in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2003, is here incorporated by reference.

Fentura Financial, Inc. faces market risk to the extent that both earnings and the fair value of its financial instruments are affected by changes in interest rates. The Corporation manages this risk with static GAP analysis and has begun simulation modeling. For the first six months of 2004, the results of these measurement techniques were within the Corporation’s policy guidelines. The Corporation does not believe that there has been a material change in the nature of the Corporation’s primary market risk exposures, including the categories of market risk to which the Corporation is exposed and the particular markets that present the primary risk of loss to the Corporation, or in how those exposures have been managed in 2004 compared to 2003.

The Corporation’s market risk exposure is mainly comprised of its vulnerability to interest rate risk. Prevailing interest rates and interest rate relationships in the future will be primarily determined by market factors, which are outside of the Corporation’s control. All information provided in this section consists of forward-looking statements. Reference is made to the section captioned “Forward Looking Statements” in this quarterly report for a discussion of the limitations on the Corporation’s responsibility for such statements.

INTEREST RATE SENSITIVITY MANAGEMENT

Interest rate sensitivity management seeks to maximize net interest income as a result of changing interest rates, within prudent ranges of risk. The Corporation attempts to accomplish this objective by structuring the balance sheet so that re-pricing opportunities exist for both assets and liabilities in roughly equivalent amounts at approximately the same time intervals. Imbalances in these re-pricing opportunities at any point in time constitute a bank’s interest rate sensitivity. The Corporation currently does not utilize derivatives in managing interest rate risk.

An indicator of the interest rate sensitivity structure of a financial institution’s balance sheet is the difference between rate sensitive assets and rate sensitive liabilities, and is referred to as “GAP.”

Table 8 sets forth the distribution of re-pricing of the Corporation’s earning assets and interest bearing liabilities as of June 30, 2004, the interest rate sensitivity GAP, as defined above, the cumulative interest rate sensitivity GAP, the interest rate sensitivity GAP ratio (i.e. interest rate sensitive assets divided by interest rate sensitive liabilities) and the cumulative sensitivity GAP ratio. The table also sets forth the time periods in which earning assets and liabilities will mature or may re-price in accordance with their contractual terms.

22


Table 8 GAP ANALYSIS JUNE 30, 2004

(000's Omitted) Within
Three
Months
Three
Months to
One Year
One to
Five
Years
After
Five
Years
Total





Earning Assets:                        
    Federal Funds Sold   $ 5,300   $ 0   $ 0   $ 0   $ 5,300  
    Securities    24,307    16,612    39,568    33,579    114,066  
    Loans    226,246    29,728    78,958    47,521    382,453  
      Loans Held for Sale    1,044    0    0    0    1,044  
    FHLB Stock    2,204    0    0    0    2,204  





       Total Earning Assets   $ 259,101   $ 46,340   $ 118,526   $ 81,100   $ 505,067  





   
Interest Bearing Liabilities:  
    Interest Bearing Demand Deposits   $ 113,700   $ 0   $ 0   $ 0   $ 113,700  
    Savings Deposits    148,328    0    0    0    148,328  
    Time Deposits Less than $100,000    21,234    29,763    23,369    16,572    90,938  
    Time Deposits Greater than $100,000    13,130    11,448    17,568    7,443    49,589  
      Short term borrowings    4,027    0    0    0    4,027  
      Other Borrowings    1,000    1,000    7,000    3,091    12,091  
      Repurchase agreements    2,500    5,000    5,000    0    12,500  
    Subordinated debentures    12,000    0    0    0    12,000  





       Total Interest Bearing Liabilities   $ 315,919   $ 47,211   $ 52,937   $ 27,106   $ 443,173  





Interest Rate Sensitivity GAP    ($ 56,818 )  ($ 871 ) $ 65,589   $ 53,994   $ 61,894  
Cumulative Interest Rate  
    Sensitivity GAP    ($ 56,818 )  ($57,689 ) $ 7,900   $ 61,894  
Interest Rate Sensitivity GAP Ratio    (0.82 )  (0.98 )  2.24  2.99
Cumulative Interest Rate  
    Sensitivity GAP Ratio    (0.82 )  (0.84 )  1.02  1.14

As indicated in Table 8, the short-term (one year and less) cumulative interest rate sensitivity gap is negative. Accordingly, if market interest rates increase, this negative gap position would have a short-term negative impact on interest margin. Conversely, if market rates continue to decline this should theoretically have a short-term positive impact. However, gap analysis is limited and may not provide an accurate indication of the impact of general interest rate movements on the net interest margin since the re-pricing of various categories of assets and liabilities is subject to the Corporation’s needs, competitive pressures, and the needs of the Corporation’s customers. In addition, various assets and liabilities indicated as re-pricing within the same period may in fact re-price at different times within such period and at different rate volumes. These limitations are evident when considering the Corporation’s Gap position at June 30, 2004 and the change in net interest margin for the six months ended June 30, 2004 compared to the same time period in 2003. At June 30, 2003 the Corporation was negatively gapped through one year and since that time interest rates have declined further, yet net interest margin decreased when the first six months of 2004 is compared to the same period in 2003. This occurred because certain deposit categories, specifically interest bearing demand and savings deposits, repriced at the same time but not at the same level as the asset portfolios resulting in a decrease in net interest margin. Additionally, simulation modeling, which measures the impact of upward and downward movements of interest rates on interest margin and the market value of equity, indicates that an upward movement of interest rates would not significantly impact net interest income.

23


FORWARD LOOKING STATEMENTS

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

ITEM 4: CONTROLS AND PROCEDURES

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

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

24


PART II — OTHER INFORMATION

Item 1. Legal Proceedings. — None

Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities.

Period Total Number
of Shares
Purchased
Average
Price Paid
Per Share
Total Number of Shares
Purchased as Part of
Publicly Announced Plan
Maximum Number of Shares
That May Yet Be Purchased
Under the Plan





April 1, 2004     0   0   0   0  
April 30, 2004     0    0    0    0 
May 1, 2004     0    0    0    0 
May 31, 2004*     200    $32.35    200    63 
June 1, 2004     0    0    0    0 
June 30, 2004     0    0    0    0 

*  Shares were repurchased under a Stock Repurchase Plan to repurchase up to 50,000 shares. The Plan was publicly announced in February 2002.

Item 3. Defaults Upon Senior Securities. — None

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

  The annual meeting of shareholders of the Registrant was held on April 27, 2004. The shareholders voted on the following matter at the meeting:

  (a) Election of two directors for terms expiring at the 2007 annual meeting:

Director Nominee For Withhold Abstain
    J. David Karr      1,561,372.83    869.78  0  
   Thomas P. McKenney    1,538,543.47    23,699.14  0  
   Brian P. Petty    1,538,631.47    23,611.14  0  

Item 5. Other Information. - The Audit Committee of the Board of Directors approved the categories of all non-audit services performed by the Registrant's independent accountants during the period covered by this report.

Item 6. Exhibits and Reports on Form 8-K.

  (a) Exhibits

  31.1 Certificate of the President and Chief Executive Officer of Fentura Financial, Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

  31.2 Certificate of the Chief Financial Officer of Fentura Financial, Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

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

  32.2 Certificate of the Chief Financial Officer of Fentura Financial, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

25


  (b) Reports on 8-K

  Report on Form 8-K dated April 1, 2004 submitting a press release announcing a quarterly dividend.

  Report on Form 8-K/A filed May 7, 2004 amending a Form 8-K dated March 15, 2004 and filing financial and pro forma financial information concerning an acquired business, West Michigan Financial Corporation.

  Report on Form 8-K dated June 30, 2004 submitting a press release announcing a quarterly dividend.

26


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.




Date August 12, 2004
        ——————————————


Date August 12, 2004
        ——————————————
Fentura Financial, Inc.


By: /s/ Donald L. Grill
      ——————————————
      Donald L. Grill
      President & CEO


By: /s/ Douglas J. Kelley
      ——————————————
      Douglas J. Kelley
      Chief Financial Officer

27


EXHIBIT INDEX

Exhibit Description

31.1 Certificate of the President and Chief Executive Officer of Fentura Financial, Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certificate of the Chief Financial Officer of Fentura Financial, Inc. pursuant to 15 U.S.C. Section 7241, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

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

32.2 Certificate of the Chief Financial Officer of Fentura Financial, Inc. pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

28


Exhibit 31.1

I, Donald L. Grill, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Fentura Financial, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

  (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

  (b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

  (c) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

  (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

  (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting;

Dated: August 12, 2004


/s/ Donald L. Grill
——————————————
Donald L. Grill
President and Chief Executive Officer

29


Exhibit 31.2

I, Douglas J. Kelley, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Fentura Financial, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and we have:

  (a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

  (b) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

  (c) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

  (a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

  (b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting;

Dated: August 12, 2004


/s/ Douglas J. Kelley
——————————————
Douglas J. Kelley
Chief Financial Officer

30


Exhibit 32.1

I, Donald L. Grill, Chief Executive Officer of Fentura Financial Inc. certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 which this statement accompanies fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and

(2) the information contained in the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 fairly presents, in all material respects, the financial condition and results of operations of Fentura Financial, Inc.

Dated: August 12, 2004


/s/ Donald L. Grill
——————————————
Donald L. Grill
President and Chief Executive Officer

31


Exhibit 32.2

I, Douglas J. Kelley, Chief Financial Officer of Fentura Financial, Inc. certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 which this statement accompanies fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and

(2) the information contained in the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2004 fairly presents, in all material respects, the financial condition and results of operations of Fentura Financial, Inc.

Dated: August 12, 2004


/s/ Douglas J. Kelley
——————————————
Douglas J. Kelley
Chief Financial Officer

32