SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the transition period from __________ to __________
Commission File Number 000-31957
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
(Exact name of registrant as specified in its charter)
MARYLAND 32-0135202
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 S. SECOND AVENUE, ALPENA, MICHIGAN 49707
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (989) 356-9041
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90
days. Yes X No
--- ---
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes No X .
--- ---
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date.
Common Stock, Par Value $0.01 Outstanding at November 14, 2007
----------------------------- --------------------------------
(Title of Class) 2,884,924 shares
Transitional Small Business Disclosure Format: Yes No X .
--- ---
1
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2007
INDEX
PAGE
----
PART I - FINANCIAL INFORMATION
ITEM 1 - UNAUDITED FINANCIAL STATEMENTS
Consolidated Balance Sheet at September 30, 2007 and
December 31, 2006......................................... 3
Consolidated Statements of Income for the Three and Nine
Months Ended September 30, 2007 and September 30, 2006.... 4
Consolidated Statement of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 2007.............. 5
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2007 and September 30, 2006........... 6
Notes to Unaudited Consolidated Financial Statements......... 7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATION............................................ 16
ITEM 3 - CONTROLS AND PROCEDURES......................................... 22
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS............................................... 23
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS..... 23
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES................................. 23
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............. 23
ITEM 5 - OTHER INFORMATION............................................... 23
ITEM 6 - EXHIBITS........................................................ 23
When used in this Form 10-QSB or future filings by First Federal of Northern
Michigan Bancorp, Inc. (the "Company") with the Securities and Exchange
Commission ("SEC"), in the Company's press releases or other public or
stockholder communications, or in oral statements made with the approval of an
authorized executive officer, the words or phrases "would be," "will allow,"
"intends to," "will likely result," "are expected to," "will continue," "is
anticipated," "estimate," "project," or similar expressions are intended to
identify "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995.
The Company wishes to caution readers not to place undue reliance on any such
forward-looking statements, which speak only as of the date made, and to advise
readers that various factors, including regional and national economic
conditions, changes in levels of market interest rates, credit and other risks
of lending and investment activities and competitive and regulatory factors,
could affect the Company's financial performance and could cause the Company's
actual results for future periods to differ materially from those anticipated or
projected.
The Company does not undertake, and specifically disclaims any obligation, to
update any forward-looking statements to reflect occurrences or unanticipated
events or circumstances after the date of such statements.
2
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
September 30, December 31,
2007 2006
------------- ------------
(Unaudited)
ASSETS
Cash and cash equivalents:
Cash on hand and due from banks ............................................... $ 2,585,836 $ 4,159,833
Overnight deposits with FHLB .................................................. 600,330 832,968
------------ ------------
Total cash and cash equivalents ............................................... 3,186,166 4,992,801
Securities AFS ................................................................ 27,767,690 43,100,430
Securities HTM ................................................................ 2,795,000 1,750,000
Loans held for sale ........................................................... -- 72,000
Loans receivable, net of allowance for loan losses of $2,197,253 and
$2,079,069 as of September 30, 2007 and December 31, 2006, respectively .... 207,542,822 209,518,068
Foreclosed real estate and other repossessed assets ........................... 1,055,750 475,312
Real estate held for investment ............................................... 135,543 135,543
Federal Home Loan Bank stock, at cost ......................................... 4,196,900 4,196,900
Premises and equipment ........................................................ 7,797,019 8,075,238
Accrued interest receivable ................................................... 2,044,334 2,138,667
Intangible assets ............................................................. 2,218,738 2,589,463
Goodwill ...................................................................... 1,396,854 1,396,854
Other assets .................................................................. 2,386,836 2,517,548
------------ ------------
Total assets .................................................................. $262,523,652 $280,958,824
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits ...................................................................... $166,590,112 $177,057,993
Advances from borrowers for taxes and insurance ............................... 92,384 44,389
Federal Home Loan Bank advances and Note Payable .............................. 60,068,395 66,042,134
Accrued expenses and other liabilities ........................................ 1,945,190 2,361,573
------------ ------------
Total liabilities ............................................................. 228,696,081 245,506,089
------------ ------------
Stockholders' equity:
Common stock ($0.01 par value 20,000,000 shares authorized
3,191,999 and 3,190,999 shares issued, respectively) ....................... 31,920 31,910
Additional paid-in capital .................................................... 24,313,129 24,261,737
Retained earnings ............................................................. 13,901,485 14,576,468
Treasury stock at cost (307,750 and 156,000 shares, respectively) ............. (2,963,918) (1,565,359)
Unallocated ESOP .............................................................. (986,560) (1,059,130)
Unearned compensation ......................................................... (445,477) (528,987)
Accumulated other comprehensive loss .......................................... (23,008) (263,904)
------------ ------------
Total stockholders' equity .................................................... 33,827,571 35,452,735
------------ ------------
Total liabilities and stockholders' equity .................................... $262,523,652 $280,958,824
============ ============
See accompanying notes to consolidated financial statements.
3
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
----------------------- -------------------------
2007 2006 2007 2006
---------- ---------- ----------- -----------
(Unaudited) (Unaudited)
Interest income:
Interest and fees on loans ............................ $3,709,722 $4,045,724 $10,896,898 $11,070,141
Interest and dividends on investments ................. 416,676 508,482 1,363,039 1,617,813
Interest on mortgage-backed securities ................ 13,395 48,621 82,730 156,610
---------- ---------- ----------- -----------
Total interest income ................................. 4,139,793 4,602,827 12,342,667 12,844,564
---------- ---------- ----------- -----------
Interest expense:
Interest on deposits .................................. 1,391,569 1,426,972 4,200,920 3,993,494
Interest on borrowings ................................ 708,554 826,375 2,247,734 2,252,832
---------- ---------- ----------- -----------
Total interest expense ................................ 2,100,123 2,253,347 6,448,654 6,246,326
---------- ---------- ----------- -----------
Net interest income ................................... 2,039,670 2,349,480 5,894,013 6,598,238
Provision for loan losses ............................. 110,957 216,357 309,937 418,857
---------- ---------- ----------- -----------
Net interest income after provision for loan losses ... 1,928,713 2,133,123 5,584,076 6,179,381
---------- ---------- ----------- -----------
Non Interest income:
Service charges and other fees ........................ 236,870 280,096 649,844 801,226
Mortgage banking activities ........................... 77,673 72,779 277,104 239,172
Loss on sale of available-for-sale investments ........ -- -- -- (43,565)
Net loss on sale of premises and equipment,
real estate owned and other repossessed assets ..... (6,691) (6,971) (19,109) (2,965)
Other ................................................. 12,756 32,863 38,094 79,791
Net loss on trading activities ........................ (282,354) -- (115,554) --
Insurance & brokerage commissions ..................... 701,520 712,119 2,043,519 2,219,190
---------- ---------- ----------- -----------
Total other income .................................... 739,774 1,090,886 2,873,898 3,292,849
---------- ---------- ----------- -----------
Non interest expenses:
Compensation and employee benefits .................... 1,560,340 1,518,219 4,651,267 4,677,125
SAIF insurance premiums ............................... 5,070 5,877 15,936 18,330
Advertising ........................................... 75,301 64,924 160,623 197,636
Occupancy ............................................. 358,052 326,637 1,101,993 1,028,724
Amortization of intangible assets ..................... 122,531 124,881 370,725 374,642
Service bureau charges ................................ 73,593 93,970 237,178 271,842
Insurance & brokerage commission expense .............. 245,193 252,757 719,391 799,997
Professional services ................................. 76,537 38,134 247,443 198,552
Other ................................................. 335,954 309,680 948,952 949,054
---------- ---------- ----------- -----------
Other expenses ........................................ 2,852,571 2,735,079 8,453,508 8,515,902
---------- ---------- ----------- -----------
Income before income tax expense ...................... (184,084) 488,930 4,466 956,328
Income tax (benefit) expense .......................... (85,614) 163,275 (62,464) 319,955
---------- ---------- ----------- -----------
Net income ............................................ $ (98,470) $ 325,655 $ 66,930 $ 636,373
========== ========== =========== ===========
Per share data:
Basic earnings per share .............................. $ (0.03) $ 0.11 $ 0.02 $ 0.21
Weighted average number of shares outstanding ......... 2,884,010 3,039,173 2,938,665 3,097,204
Diluted earnings per share ............................ $ (0.03) $ 0.11 $ 0.02 $ 0.21
Weighted average number of shares outstanding,
including dilutive stock options ................... 2,921,131 3,040,130 2,976,264 3,098,168
Dividends per common share ............................ $ 0.05 $ 0.05 $ 0.15 $ 0.15
See accompanying notes to consolidated financial statements.
4
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Stockholders' Equity (Unaudited)
Accumulated
Additional Other
Common Treasury Paid-in Unearned Retained Unallocated Comprehensive
Stock Stock Capital Compensation Earnings ESOP Income Total
------- ----------- ----------- ------------ ----------- ----------- ------------- -----------
Balance at December
31, 2006 ............. $31,910 $(1,565,359) $24,284,606 $(551,856) $14,576,468 $(1,059,130) $(263,904) $35,452,735
Cumulative effect of
change in accounting
principal (Note 1) ... -- -- -- -- (303,938) -- -- (303,938)
Treasury Stock at Cost
(151,750 shares) ..... -- (1,398,559) -- -- -- -- -- (1,398,559)
Stock Options/Awards
Expensed ............. -- -- 26,798 114,424 -- -- -- 141,222
MRP shares awarded
(1,500 shares) ....... 15 -- 12,855 (12,870) -- -- -- --
MRP shares forfeited
(500 shares) ......... (5) -- (4,820) 4,825 -- -- -- --
Unallocated ESOP ........ -- -- (6,310) -- -- 72,570 -- 66,260
Net income for the
period ............... -- -- -- -- 66,930 -- -- 66,930
Changes in unrealized
loss:
on available-
for-sale securities
(net of tax of
$124,098) ............ -- -- -- -- -- -- 240,896 240,896
-----------
Total comprehensive
income ............... -- -- -- -- -- -- -- 307,826
Dividends declared ...... -- -- -- -- (437,975) -- -- (437,975)
------- ----------- ----------- --------- ----------- ----------- --------- -----------
Balance at September
30, 2007 ............. $31,920 $(2,963,918) $24,313,129 $(445,477) $13,901,485 $ (986,560) $ (23,008) $33,827,571
======= =========== =========== ========= =========== =========== ========= ===========
5
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
For the Nine Months Ended
September 30,
---------------------------
2007 2006
------------ ------------
(Unaudited)
Cash flows from operating activities:
Net income ............................................................... $ 66,930 $ 636,373
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization ......................................... 825,067 778,455
Provision for loan loss ............................................... 309,937 418,857
Amortization and accretion on securities .............................. 8,834 64,961
Loss on sale of securities ............................................ -- 43,565
Net loss from trading activities ...................................... 115,554 --
Originations of loans held for sale ................................... (10,595,936) (10,484,134)
Principal amount of loans sold ........................................ 10,667,936 10,093,134
Proceeds from sale of real estate held for sale ....................... 74,138 912,590
Gain on sale of real estate held for investment ....................... (937) (1,412)
Loss on sale of premises and equipment ................................ 23,041 3,309
Change in accrued interest receivable ................................. 94,333 (439,117)
Change in other assets ................................................ 163,189 553,231
Change in accrued expenses and other liabilities ...................... (416,383) (532,194)
Stock options/awards expensed ......................................... 141,222 95,051
------------ ------------
Net cash provided by operating activities ................................ 1,476,925 2,142,669
------------ ------------
Net (increase) decrease in loans ...................................... 1,665,309 (10,800,355)
Proceeds from maturity and sale of available-for-sale securities ...... 15,577,074 8,801,285
Purchase of securities ................................................ (1,045,000) (1,976,205)
Proceeds from sale of Federal Home Loan Bank stock .................... -- 403,500
Purchase of premises and equipment .................................... (852,803) (1,771,725)
------------ ------------
Net cash provided by (used in) investing activities ...................... 15,344,580 (5,343,500)
------------ ------------
Net decrease in deposits .............................................. (10,467,881) (7,552,624)
Dividend paid on common stock ......................................... (437,975) (461,854)
ESOP shares committed to be released .................................. 66,260 63,711
Net increase in advances from borrowers ............................... 47,995 166,389
Additions to advances from Federal Home Loan Bank and notes payable .. 30,500,000 19,240,000
Repayments of Federal Home Loan Bank advances and notes payable ....... (36,937,980) (6,617,288)
Stock retired ......................................................... -- (60,365)
Proceeds from exercise of stock options ............................... -- 98,950
Purchase of treasury shares ........................................... (1,398,559) (1,565,359)
------------ ------------
Net cash provided by (used in) financing activities ...................... (18,628,140) 3,311,560
------------ ------------
Net increase (decrease) in cash and cash equivalents .................. (1,806,635) 110,729
Cash and cash equivalents at beginning of period ...................... 4,992,801 4,779,194
------------ ------------
Cash and cash equivalents at end of period ............................ $ 3,186,166 $ 4,889,923
============ ============
Supplemental disclosure of cash flow information:
Cash paid during the period for income taxes .......................... $ 25,000 $ 363,790
============ ============
Cash paid during the period for interest .............................. $ 6,580,063 $ 6,193,470
============ ============
See accompanying notes to the consolidated financial statements
6
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.
The accompanying consolidated financial statements have been prepared on an
accrual basis of accounting and include the accounts of First Federal of
Northern Michigan Bancorp, Inc., and its wholly owned subsidiary, First Federal
of Northern Michigan (the "Bank") and its wholly owned subsidiaries Financial
Service and Mortgage Corporation ("FSMC") and the InsuranCenter of Alpena
("ICA"). FSMC invests in real estate that includes leasing, selling, developing,
and maintaining real estate properties. ICA is a licensed insurance agency
engaged in the business of property, casualty and health insurance. All
significant intercompany balances and transactions have been eliminated in the
consolidation.
These interim financial statements are prepared without audit and reflect
all adjustments, which, in the opinion of management, are necessary to present
fairly the consolidated financial position of the Company at September 30, 2007,
and its results of operations and statement of cash flows for the periods
presented. All such adjustments are normal and recurring in nature. The
accompanying consolidated financial statements do not purport to contain all the
necessary financial disclosures required by generally accepted accounting
principles that might otherwise be necessary and should be read in conjunction
with the consolidated financial statements and notes thereto of the Company
included in the Annual Report for the year ended December 31, 2006. Results for
the three and nine months ended September 30, 2007 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2007.
CRITICAL ACCOUNTING POLICIES
Our accounting and reporting policies are prepared in accordance with
accounting principles generally accepted in the United States of America and
conform to general practices within the banking industry. We consider accounting
policies that require significant judgment and assumptions by management that
have, or could have, a material impact on the carrying value of certain assets
or on income to be critical accounting policies. Changes in underlying factors,
assumptions or estimates could have a material impact on our future financial
condition and results of operations. Based on the size of the item or
significance of the estimate, the following accounting policies are considered
critical to our financial results.
Allowance for Loan Losses. The allowance for loan losses is calculated with
the objective of maintaining an allowance sufficient to absorb estimated
probable loan losses. Management's determination of the adequacy of the
allowance is based on periodic evaluations of the loan portfolio and other
relevant factors. However, this evaluation is inherently subjective, as it
requires an estimate of the loss content for each risk rating and for each
impaired loan, an estimate of the amounts and timing of expected future cash
flows, and an estimate of the value of collateral.
We have established a systematic method of periodically reviewing the
credit quality of the loan portfolio in order to establish an allowance for
losses on loans. The allowance for losses on loans is based on our current
judgments about the credit quality of individual loans and segments of the loan
portfolio. The allowance for losses on loans is established through a provision
for loan losses based on our evaluation of the losses inherent in the loan
portfolio, and considers all known internal and external factors that affect
loan collectibility as of the reporting date. Our evaluation, which includes a
review of all loans on which full collectibility may not be reasonably assured,
considers among other matters, the estimated net realizable value or the fair
value of the underlying collateral, economic conditions, historical loan loss
experience, our knowledge of inherent losses in the portfolio that are probable
and reasonably estimable and other factors that warrant recognition in providing
an appropriate loan loss allowance. Management believes this is a critical
accounting policy because this evaluation involves a high degree of complexity
and requires us to make subjective judgments that often require assumptions or
7
estimates about various matters. Historically, we believe our estimates and
assumptions have proven to be relatively accurate.
The analysis of the allowance for loan losses has two components: specific
and general allocations. Specific allocations are made for loans that are
determined to be impaired. Impairment is measured by determining the present
value of expected future cash flows or, for collateral-dependent loans, the fair
value of the collateral adjusted for market conditions and selling expenses. The
general allocation is determined by segregating the remaining loans by type of
loan, risk weighting (if applicable) and payment history. We also analyze
delinquency trends, which have remained stable, general economic conditions and
geographic and industry concentrations. This analysis establishes factors that
are applied to the loan groups to determine the amount of the general reserve.
The principal assumption used in deriving the allowance for loan losses is the
estimate of loss content for each risk rating. As an example, if recent loss
experience dictated that the projected loss ratios would be changed by 10% (of
the estimate) across all risk ratings, the allocated allowance as of September
30, 2007 would have changed by approximately $213,000. Actual loan losses may be
significantly more than the allowances we have established, which could have a
material negative effect on our financial results.
Mortgage Servicing Rights. We sell to investors a portion of our originated
one- to four-family residential real estate mortgage loans. When we acquire
mortgage servicing rights through the origination and sale of mortgage loans
with servicing rights retained, we allocate a portion of the total cost of the
mortgage loans to the mortgage servicing rights based on their relative fair
value. As of September 30, 2007, we were servicing loans sold to others totaling
$132.1 million. We amortize capitalized mortgage servicing rights as a reduction
of servicing fee income in proportion to, and over the period of, estimated net
servicing income by use of a method that approximates the level-yield method. We
periodically evaluate capitalized mortgage servicing rights for impairment using
a model that takes into account several variables including expected prepayment
speeds and prevailing interest rates. If we identify impairment, we charge the
amount of the impairment to earnings by establishing a valuation allowance
against the capitalized mortgage servicing rights asset. The primary risk of
material changes to the value of the servicing rights resides in the potential
volatility in the economic assumptions used, particularly the prepayment speed.
We monitor this risk and adjust the valuation allowance as necessary to
adequately record any probable impairment in the portfolio. Management believes
the estimation of these variables makes this a critical accounting policy. For
purposes of measuring impairment, the mortgage servicing rights are stratified
based on financial asset type and interest rates. In addition, we obtain an
independent third-party valuation of the mortgage servicing portfolio on a
quarterly basis. In general, the value of mortgage servicing rights increases as
interest rates rise and decreases as interest rates fall. This is because the
estimated life and estimated income from a loan increase as interest rates rise
and decrease as interest rates fall. The key economic assumptions made in
determining the fair value of the mortgage servicing rights at September 30,
2007 included the following:
Annual constant prepayment speed (CPR): 11.48%
Weighted average life remaining (in months): 243
Discount rate used: 9.00%
At the September 30, 2007 valuation, we calculated the value of our
mortgage servicing rights to be $1.3 million and the weighted average life
remaining of those rights was 46 months. The book value of our mortgage
servicing rights as of September 30, 2007 was $513,000 which was $764,000 less
than the independent valuation, so there was no need to establish a valuation
allowance.
Impairment of Intangible Assets. Goodwill arising from business
acquisitions represents the value attributable to unidentifiable intangible
elements in the business acquired. The fair value of goodwill is dependent upon
many factors, including our ability to provide quality, cost-effective services
in the face of competition. Because of these many factors, management believes
this is a critical accounting policy. A decline in earnings as a result of
business or market conditions or a run-off of insurance customers over sustained
periods could lead to an impairment of goodwill that could adversely affect
earnings in future periods.
A significant portion of our intangible assets, including goodwill, relates
to the acquisition
8
premiums recorded with the purchase of the InsuranCenter of Alpena ("ICA") and
certain branches over the last several years. Intangible assets are reviewed
periodically for impairment by comparing the fair value of the intangible asset
to the book value of the intangible asset. If the book value is in excess of the
fair value, impairment is indicated and the intangibles must be written down to
their fair value.
In connection with our acquisition in 2003 of ICA, we allocated the excess
of the purchase price paid over the fair value of net assets acquired to
intangible assets, including goodwill. These intangible assets included the ICA
customer list and a third-party contract to which ICA is a party. From the date
of acquisition through April 30, 2005 we amortized the value assigned to the
customer list and contract over a period of 20 years. On May 1, 2005 the former
owner of ICA retired. As a result, the amortization period for these intangible
assets was reduced to a 10 year period beginning May 1, 2005. Effective January
1, 2006, the exclusive third-party contract between ICA and Blue Cross Blue
Shield of Michigan was terminated. Prior to January 1, 2006 the ICA exclusive
agent contract with Blue Cross Blue Shield entitled ICA to an override
commission of 1.9% on all health premiums written through local Chambers of
Commerce in Northeast Michigan. On any health insurance contracts in place as of
December 31, 2005, ICA will continue to receive the 1.9% commission; however,
there will be no new groups added to this program effective January 1, 2006.
Management considered the potential effect this could have on ICA health
insurance commissions in future years and made the decision to reduce the
amortization period of the third-party contract intangible asset to 5 years
effective January 1, 2006.
Goodwill is not amortized. The impairment test of goodwill and identified
intangible assets that have an indefinite useful life, performed as of September
30, 2007 and December 31, 2006 in accordance with SSFAS No. 142, did not
indicate that an impairment charge was required. If, through testing, we
determine that there is impairment based, for example, on significant runoff of
the customer list or material changes to the third-party contract, then we may
determine to reduce the recorded value of those intangible assets, which would
increase expense and reduce our earnings.
In connection with branch office acquisitions, we assigned the excess of
the purchase price over the fair value of the assets acquired to a core deposit
intangible. The core deposit intangible is tested periodically for impairment.
Our original estimates for the expected life of the deposits have proven to be
relatively accurate as evidenced by the fact that no impairment has been
recorded. If we determine through testing that a significant portion of the
acquired customers no longer do business with us, then the asset would be deemed
to be impaired thereby requiring a charge to earnings to the extent appropriate
given all of the known factors. We amortize core deposit intangibles over a
period of between 10 and 15 years.
Financial Accounting Standard Number 159 - The Fair Value Option for
Financial Assets and Financial Liabilities. In February 2007, the Financial
Accounting Standards Board ("FASB") issued SFAS 159, The Fair Value Option for
Financial Assets and Financial Liabilities. SFAS 159 is effective for fiscal
years beginning after November 15, 2007. Early adoption is permitted subject to
specific requirements outlined in the new Statement. Calendar-year companies are
able to adopt SFAS 159 for their first quarter 2007 financial statements.
The new Statement allows entities to choose, at specified election dates,
to measure eligible financial assets and liabilities at fair value that are not
otherwise required to be measured at fair value. If a company elects the fair
value option for an eligible item, changes in that item's fair value in
subsequent reporting periods must be recognized in current earnings. SFAS 159
also establishes presentation and disclosure requirements designed to draw
comparison between entities that elect different measurement attributes for
similar assets and liabilities.
The Company early adopted SFAS 159 and SFAS 157 (discussed below) as of
January 1, 2007. Upon adoption of SFAS 159, the Company selected the fair value
measurement option for various existing financial assets, including certain
"available-for-sale" securities and putable FHLB advances.
The available-for-sale securities totaled $4.9 million and represented
10.9% of the Company's securities portfolio. The initial fair value measurement
of the securities elected for SFAS 159 resulted in a $140,000 pre-tax
cumulative-effect adjustment recorded as a reduction in retained earnings as of
January 1, 2007. Under SFAS 159, this one-time charge will not be recognized in
current earnings.
9
As a result of the fair value measurement election for these securities,
the Company recorded gains in the first nine months of 2007 of $28,000. The
Company has since sold these investments. The Company had originally intended to
replace these investments with similiar investments, which were to be recorded
at fair value. Our initial assessment was that the adoption of SFAS 159 would
have a positive impact on our ability to manage interest rate risk and
potentially benefit interest income during the remainder of 2007 as well as
future periods.
The Company also elected the adoption of SFAS 159 for $10.0 million in
putable Federal Home Loan Bank advances. The initial fair value measurement of
the advances resulted in a $320,000 pre-tax, charge to retained earnings. In the
first nine months of 2007 the Company recorded $144,000 in pre-tax
mark-to-market losses related to these advances.
The above investment securities and advances were chosen for the fair value
option based on the desire of the Company to improve its net interest margin and
reduce interest rate risk. Subsequent to the adoption of SSFAS 159, the Company
had planned on repositioning its balance sheet by obtaining new investment
securities and Federal Home Loan Bank advances that improve overall interest
rate margin and mitigate future interest rate risk. The Company has since
determined that the election of SFAS 159 did not provide the balance sheet
management opportunities that were initially anticipated. As of September 30,
2007 the Company no longer has any assets or liabilities carried at fair value
and it does not intend to adopt SFAS 159 for eligible financial assets and
liabilities in the future.
The following table represents all items in which the fair value option was
elected as of January 1, 2007 and the impact on the financial statements.
Impact on Impact on Impact on
Retained Net Income Net Income
Earnings Three Months Nine Months
Effective Ended Ended
Par Value 1/1/2007 9/30/2007 9/30/2007
--------- --------- ------------ -----------
(dollars in thousands) (dollars in thousands)
$ 4,856 Investment Securities ($140) $ 0 $ 28
$10,000 FHLB Advances ($320) ($282) ($144)
----- ------ ------
Total ($460) ($282) ($116)
Adjusted for Taxes ($304) ($186) ($77)
Financial Accounting Standard Number 157 Fair Value Measurements. In
September 2006, SFASB issued SFAS 157, Fair Value Measurements. This statement
establishes a framework for measuring fair value in accordance with generally
accepted accounting principles, clarifies the definition of fair value within
that framework, and expands disclosures about the use of fair value
measurements. SFAS 157 is effective for fiscal years beginning after November
15, 2007. Upon adoption of SFAS 159, the Company concurrently adopted the
provisions of SFAS 157 as of January 1, 2007. Accordingly, the Company has
developed a framework to measure the fair value of financial assets and
financial liabilities and expanded disclosures in accordance with the
requirements.
10
The following information pertains to assets and liabilities measured by
fair value on a recurring basis:
Change in fair value Quoted Prices in Significant
Fair Value recognized in other Fair Value as active markets Other Significant
as of income for the nine of for Indentical Observable Unobservable
January 1, month period ended September 30, Assets/Liabilities Inputs Inputs
Description 2007 September 30, 2007 2007 (Level 1) (Level 2) (Level 3)
----------- ---------- -------------------- ------------- ------------------ ----------- ------------
(Dollars in thousands)
Investments
accounted
for under
FVO $ 4,864 $ 28 $0 $0
FHLB advances $10,000 ($144) $0 $0
RECENT ACCOUNTING PRONOUNCEMENTS
In March 2006, FASB issued Statement of Financial Accounting Standard No.
156, Accounting for Servicing of Financial Assets - an amendment of FASB
Statement No. 140. SFAS 156 amends SFAS Statement No.140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities",
with respect to the accounting for separately recognized servicing assets and
servicing liabilities. The Statement addresses the recognition and measurement
of separately recognized servicing assets and liabilities and provides an
approach to simplify efforts to obtain hedge-like (offset) accounting. SFAS 156
was adopted by the Company on January 1, 2007 as required by the statement. The
adoption of SFAS 156 did not have a material effect on the financial position,
results of operations, or cash flows.
In July 2006, the FASB issued SFASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes - an interpretation of SFASB Statement No. 109 (FIN
48), which clarifies the accounting for uncertainty in tax positions. This
Interpretation requires that the Company recognize in the financial statements
the impact of a tax position if that position is more likely than not to be
sustained on audit based on technical merits of the position. The provisions of
FIN 48 are effective as of the beginning of the Company's 2007 fiscal year, with
the cumulative effect of the change in accounting principle recorded as an
adjustment to operating retained earnings. The adoption of FIN 48 did not have a
material effect on the financial position, results of operations, or cash flows.
NOTE 2--REORGANIZATION.
On April 1, 2005, we consummated the second-step mutual-to-stock conversion
of Alpena Bancshares, M.H.C., in which shares of common stock representing
Alpena Bancshares, M.H.C.'s ownership interest in Alpena Bancshares, Inc. were
sold to investors. As a result of the conversion and stock offering, Alpena
Bancshares, M.H.C. ceased to exist and Alpena Bancshares, Inc. was succeeded by
First Federal of Northern Michigan Bancorp, Inc., a Maryland corporation and new
holding company for First Federal of Northern Michigan.
The plan of conversion and reorganization of Alpena Bancshares, M.H.C. and
the issuance and contribution of cash and common stock to First Federal
Community Foundation, a charitable foundation established by the Company, were
approved by the stockholders of Alpena Bancshares, Inc. and the members of
Alpena Bancshares, M.H.C. on March 23, 2005.
First Federal of Northern Michigan Bancorp, Inc. accepted orders to
purchase 1,699,869 shares of common stock at a purchase price of $10.00 per
share. As a part of the conversion, public stockholders of the Company as of the
consummation date received 1.8477 shares of First Federal of Northern Michigan
Bancorp, Inc. common stock in exchange for each of their existing shares of
Company common stock. Cash was issued in lieu of any fractional shares. The
share exchange occurred on April 1, 2005.
NOTE 3--DIVIDENDS.
Payment of dividends on the common stock is subject to determination and
declaration by the Board
11
of Directors and depends upon a number of factors, including capital
requirements, regulatory limitations on the payment of dividends, the Company's
results of operations and financial condition, tax considerations and general
economic conditions.
On September 18, 2007, the Company declared a cash dividend on its common
stock, payable on or about October 19, 2007, to shareholders of record as of
September 30, 2007, equal to $0.05 per share. The dividend on all shares
outstanding totaled $144,212.
NOTE 4--1996 STOCK OPTION PLAN, 1996 RECOGNITION AND RETENTION PLAN AND 2006
STOCK-BASED INCENTIVE PLAN.
Effective January 1, 2006, the Company adopted Statement of Financial
Accounting Standard (SSFAS) No. 123 (Revised) "Shareholder Based Payments",
which requires that the grant-date fair value of awarded stock options be
expensed over the requisite service period. The Company's 1996 Stock Option Plan
(the "1996 Plan"), which was approved by shareholders, permits the grant of
share options to its employees for up to 127,491 shares of common stock
(retroactively adjusted for the exchange ratio applied in the Company's 2005
stock offering and related second-step conversion). The Company's 2006
Stock-Based Incentive Plan (the "2006 Plan"), which was approved by the
shareholders on May 17, 2006, permits the award of up to 242,740 shares of
common stock of which the maximum number to be granted as Stock Options is
173,386 and the maximum that can be granted as Restricted Stock Awards is
69,354. Option awards are granted with an exercise price equal to the market
price of the Company's stock at the date of grant; those option awards generally
vest based on five years of continual service and have ten year contractual
terms. Certain options provide for accelerated vesting if there is a change in
control (as defined in the Plans).
During the three months ended September 30, 2007 the Company awarded 500
shares under the Recognition and Retention Plan ("RRP"). Shares issued under the
RRP and exercised pursuant to the exercise of the stock option plan may be
either authorized but unissued shares or reacquired shares held by the Company
as treasury stock.
STOCK OPTIONS - A summary of option activity under the Plan during the nine
months ended September 30, 2007 is presented below:
Weighted- Remaining
Average Contractual Term Aggregate
Options Shares Exercise Price (Years) Intrinsic Value
------- ------- -------------- ---------------- ---------------
Outstanding at January 1, 2007 204,532 $9.50
Granted 6,200 $8.79
Exercised 0 N/A
Forfeited or expired (9,390) $9.54
Oustanding at September 30, 2007 201,342 $9.48 8.76 $ 0
Exercisable at September 30, 2007 43,462 $9.29 7.30 -$54,762
As of September 30, 2007 there was $263,000 of total unrecognized
compensation cost, net of expected forfeitures, related to nonvested options
under the Plan. That cost is expected to be recognized over a weighted-average
period of 3.67 years. The total fair value of shares vested during the nine
months ended September 30, 2007 was $0.
RESTRICTED STOCK AWARDS - As of September 30, 2007 there was $453,000 of
unrecognized compensation cost related to nonvested restricted stock awards
under the plan.
12
NOTE 5 - COMMITMENTS TO EXTEND CREDIT
The Company is a party to credit-related financial instruments with
off-balance sheet risk in the normal course of business to meet the financing
needs of its customers. These financial instruments include commitments to
extend credit, stand by letters of credit, and commercial lines of credit. Such
commitments involve, to varying degrees, elements of credit and interest rate
risk in excess of the amounts recognized in the consolidated balance sheet. The
Company's exposure to credit loss is represented by the contracted amount of
these commitments. The Company follows the same credit policies in making
commitments as it does for on-balance sheet instruments.
At September 30, 2007, the Company had outstanding commitments to originate
loans of $30.4 million. These commitments included $9.2 million for permanent
one-to-four family dwellings, $4.1 million for non-residential loans, $665,000
of undisbursed loan proceeds for construction of one-to-four family dwellings,
$8.3 million of undisbursed lines of credit on home equity loans, $589,000 of
unused credit card lines, $4.4 million of unused commercial lines of credit,
$1.3 million of undisbursed commercial construction, $5,000 of unused Letters of
Credit and $1.8 million in unused Bounce Protection.
NOTE 6 - SUBSEQUENT EVENTS
Following a management evaluation of the Company's operations from both a
financial and customer service perspective, the Board of Directors approved the
closure of the Company's branch office in Mancelona, Michigan effective February
1, 2008. The branch accounts for about 2.6% of the Company's deposits.
Management believes that a majority of the deposits will not be retained by the
Company, and has factored this into its analysis. The Company owns and intends
to sell this branch facility. Management believes the costs to exit this market,
including any impairment on fixed and intangible assets, will not exceed
$25,000.
NOTE 7 - SEGMENT REPORTING
The Company's principal activities include banking through its wholly owned
subsidiary, First Federal of Northern Michigan, and the sale of insurance
products through its indirect wholly owned subsidiary, ICA, purchased in 2003.
The Bank provides financial products including retail and commercial loans as
well as retail and commercial deposits. ICA receives commissions from the sale
of various insurance products including health, life, and property. The segments
were determined based on the nature of the products provided to customers.
The financial information for each operating segment is reported on the
basis used internally to evaluate performance and allocate resources. The
allocations have been consistently applied for all periods presented. Revenues
and expenses between affiliates have been transacted at rates that unaffiliated
parties would pay. The only transaction between the segments thus far relates to
a deposit on behalf of ICA included in the Bank. The interest income and
interest expense for this transaction has been eliminated. All other
transactions are with external customers. The performance measurement of the
operating segments is based on the management structure of the Company and is
not necessarily comparable with similar information for any other financial
institution. The information presented is also not necessarily indicative of the
segment's financial condition and results of operations if they were independent
entities.
13
NOTE 7 - SEGMENT REPORTING (CONTINUED)
For the Three Months Ended
September 30, 2007
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 4,140 $ 11 $ (11) $ 4,140
INTEREST EXPENSE 2,108 3 (11) 2,100
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for
loan losses 2,032 8 -- 2,040
PROVISION FOR LOAN LOSSES 111 -- -- 111
-------- ------ ----- --------
NET INTEREST INCOME - After provision for
loan losses 1,921 8 -- 1,929
OTHER INCOME 28 712 -- 740
OPERATING EXPENSES 2,200 653 -- 2,853
-------- ------ ----- --------
INCOME - Before federal income tax (251) 67 -- (184)
FEDERAL INCOME TAX (109) 23 -- (86)
-------- ------ ----- --------
NET INCOME $ (142) $ 44 $ -- $ (98)
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 186 $ 86 $ -- $ 272
======== ====== ===== ========
ASSETS $258,797 $4,516 $(789) $262,524
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 32 -- -- 32
-------- ------ ----- --------
TOTAL $ 32 $ -- $ -- $ 32
======== ====== ===== ========
For the Three Months Ended
September 30, 2006
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 4,602 $ 8 $ (8) $ 4,602
INTEREST EXPENSE 2,256 5 (8) 2,253
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for
loan losses 2,346 3 -- 2,349
PROVISION FOR LOAN LOSSES 217 -- -- 217
-------- ------ ----- --------
NET INTEREST INCOME - After provision for
loan losses 2,129 3 -- 2,132
OTHER INCOME 377 714 -- 1,091
OPERATING EXPENSES 2,042 693 -- 2,735
-------- ------ ----- --------
INCOME - Before federal income tax 465 24 -- 489
FEDERAL INCOME TAX 156 8 -- 163
-------- ------ ----- --------
NET INCOME $ 309 $ 16 $ -- $ 326
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 177 $ 86 $ -- $ 263
======== ====== ===== ========
ASSETS $282,694 $4,475 $(712) $286,457
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 447 -- -- 447
-------- ------ ----- --------
TOTAL $ 447 $ -- $ -- $ 447
======== ====== ===== ========
14
For the Nine Months Ended
September 30, 2007
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 12,343 $ 22 $ (22) $ 12,343
INTEREST EXPENSE 6,463 8 (22) 6,449
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 5,880 14 -- 5,894
PROVISION FOR LOAN LOSSES 310 -- -- 310
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 5,570 14 -- 5,584
OTHER INCOME 811 2,063 -- 2,874
OPERATING EXPENSES 6,441 2,013 -- 8,454
-------- ------ ----- --------
INCOME - Before federal income tax (60) 64 -- 4
FEDERAL INCOME TAX (85) 22 -- (63)
-------- ------ ----- --------
NET INCOME $ 25 $ 42 $ -- $ 67
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 566 $ 258 $ -- $ 824
======== ====== ===== ========
ASSETS $258,797 $4,516 $(789) $262,524
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 176 23 -- 199
-------- ------ ----- --------
TOTAL $ 176 $ 23 $ -- $ 199
======== ====== ===== ========
For the Nine Months Ended
September 30, 2006
(Dollars in Thousands)
-------------------------------------------
Bank ICA Eliminations Total
-------- ------ ------------ --------
INTEREST INCOME $ 12,844 $ 15 $ (15) $ 12,844
INTEREST EXPENSE 6,246 15 (15) 6,246
-------- ------ ----- --------
NET INTEREST INCOME - Before provision for loan losses 6,598 -- -- 6,598
PROVISION FOR LOAN LOSSES 419 -- -- 419
-------- ------ ----- --------
NET INTEREST INCOME - After provision for loan losses 6,179 -- -- 6,179
OTHER INCOME 1,069 2,224 -- 3,293
OPERATING EXPENSES 6,376 2,140 -- 8,516
-------- ------ ----- --------
INCOME - Before federal income tax 872 84 -- 956
FEDERAL INCOME TAX 292 28 -- 320
-------- ------ ----- --------
NET INCOME $ 580 $ 56 $ -- $ 636
======== ====== ===== ========
DEPRECIATION AND AMORTIZATION $ 520 $ 258 $ -- $ 778
======== ====== ===== ========
ASSETS $282,694 $4,475 $(712) $286,457
======== ====== ===== ========
EXPENDITURES RELATED TO LONG-LIVED ASSETS:
Goodwill $ -- $ -- $ -- $ --
Intangible assets -- -- -- --
Property and equipment 1,195 21 -- 1,216
-------- ------ ----- --------
TOTAL $ 1,195 $ 21 $ -- $ 1,216
======== ====== ===== ========
15
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
AND SUBSIDIARIES
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion compares the consolidated financial condition of the
Company at September 30, 2007 and December 31, 2006, and the results of
operations for the three- and nine-month periods ended September 30, 2007 and
2006. This discussion should be read in conjunction with the interim financial
statements and footnotes included herein.
OVERVIEW
For the quarter ended September 30, 2007, the Company reported a net loss
of $98,000 compared to earnings of $326,000 for the year earlier period, a
decrease of $424,000. Year to date 2007 net income was $67,000 compared to the
first nine months of 2006 when net income was $636,000.
Total assets decreased by $18.4 million, or 6.6% from December 31, 2006 to
September 30, 2007. Investment securities available for sale decreased by $15.3
million from December 31, 2006 to September 30, 2007. Net loans receivable
decreased $2.0 million during the nine months ended September 30, 2007. Total
deposits decreased $10.5 million, or 5.9% from December 31, 2006 to September
30, 2007. Federal Home Loan Bank advances decreased by $6.0 million from
December 31, 2006 to September 30, 2007. Equity decreased by $1.6 million, or
4.6% from December 31, 2006 to September 30, 2007.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2007 AND DECEMBER 31, 2006
ASSETS: Total assets decreased $18.4 million, or 6.6%, to $262.5 million at
September 30, 2007 from $281.0 million at December 31, 2006. Investment
securities available for sale decreased $15.3 million, or 35.6%, from December
31, 2006 to September 30, 2007, due to the maturity of $8.5 million in AFS
investment securities during the nine months ended September 30, 2007, the
proceeds of which were used to pay-down high-cost FHLB advances, and due to the
sale of $4.7 million in securities which had been reclassified from AFS
securities to trading securities in connection with our early adoption of SFAS
159 effective January 1, 2007. Net loans receivable decreased $2.0 million, or
0.9%, to $207.5 million at September 30, 2007 from $209.5 million at
December 31, 2006. Total mortgage loans decreased by $700,000 and total
commercial loans decreased by $1.2 million as loan originations declined due to
economic conditions in our markets.
LIABILITIES: Deposits decreased $10.5 million, or 5.9%, to $166.6 million at
September 30, 2007 from $177.1 million at December 31, 2006. The decrease was
primarily in statements savings and CD balances reflecting continued competition
for deposits and increased pressure on market deposit rates. FHLB advances
decreased $6.0 million, or 9.1%, to $60.0 million at September 30, 2007 from
$66.0 million at December 31, 2006 due to the pay-down of advances from the
maturity of AFS investment securities.
EQUITY: Stockholders' equity decreased to $33.9 million at September 30, 2007
from $35.5 million at December 31, 2006, a decline of $1.6 million. Also
impacting the decrease in stockholders' equity from December 31, 2006 to
September 30, 2007 was the Company's repurchase of 151,750 shares of its common
stock at a total cost of $1,398,558, in connection with its stock repurchase
program which was announced and commenced in March 2007. Dividends were $144,000
and $438,000 for the three and nine months ended September 30, 2007,
respectively. As mentioned in the previous quarter, the Company chose to
restructure its balance sheet through an early adoption of SFAS 159, resulting
in a $461,000 one-time cumulative-effect adjustment to retained earnings during
the quarter ended March 31, 2007. The unrealized loss on available for sale
securities, net
16
of tax, was $23,000 at September 30, 2007 as compared to $264,000 at December
31, 2006, an improvement of $241,000. The cumulative loss in value on securities
was due to changes in interest rates and was not considered by management to be
other than temporary.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2006
GENERAL: Net income decreased by $424,000 to a loss of $98,000 for the three
months ended September 30, 2007 from net income of $326,000 for the same period
ended September 30, 2006. During the quarter ended September 30, 2007 the
Company experienced a loss of $282,000 on trading activities related to FHLB
advances which were recorded at fair value as a result of the Company's early
adoption of SFAS 159. In addition, during the quarter ended September 30, 2006
the Company collected a large non-accrual commercial loan relationship which
resulting in an additional $279,000 in interest income and $8,000 in late fees
for that quarter. The provision for loan loss for the quarter ended September
30, 2007 was $111,000 as compared to $216,000 for the same quarter in 2006.
INTEREST INCOME: Interest income was $4.1 million for the three months ended
September 30, 2007, compared to $4.6 million for the comparable period in 2006.
The decrease in interest income quarter over quarter was due in large part to
the collection of a large commercial non-accrual loan relationship which
resulted in an additional $279,000 in interest income for the quarter ended
September 30, 2006. In addition, we experienced decreases quarter over quarter
in the average balances of every category of interest-earning assets. The
average balances of AFS investment securities decreased $14.0 million as
securities matured or were called and the proceeds were used to pay-down
higher-cost FHLB advances, rather than reinvest in lower-yielding investments
securities. The average balances of mortgage loans decreased $2.5 million period
over period and the average balances of non-mortgage loans decreased $1.4
million quarter over quarter as we continue to experience a decline in loan
originations due to economic conditions nationwide, statewide, and in our market
areas.
INTEREST EXPENSE: Interest expense was $2.1 million for the three month period
ended September 30, 2007, compared to $2.3 million for the same period in 2006.
NET INTEREST INCOME: Net interest income decreased to $2.0 million for the three
month period ended September 30, 2007 compared to $2.3 million for the same
period in 2006. For the three months ended September 30, 2007, average
interest-earning assets decreased $21.3 million, or 3.4%, to $246.5 million when
compared to the same period in 2006. Average interest-bearing liabilities
decreased $21.6 million, or 5.2%, to $216.6 million for the quarter ended
September 30, 2007 from $238.2 million for the quarter ended September 30, 2006.
The yield on average interest-earning assets decreased to 6.69% for the three
month period ended September 30, 2007 from 6.84% for the same period ended in
2006, due again in large part to the collection of a large commercial
non-accrual loan, and the cost of average interest-bearing liabilities increased
to 3.83% from 3.73% for the three month periods ended September 30, 2007 and
September 30, 2006, respectively. The decrease in asset yields on interest
earning assets combined with the impact of the increase in the cost of funds
created a decrease in the net interest margin of 20 basis points to 3.32% for
the three month period ended September 30, 2007 from 3.52% for same period in
2006.
PROVISION FOR LOAN LOSSES: The allowance for loan losses is established through
a provision for loan losses charged to earnings. Loan losses are charged against
the allowance when management believes the uncollectibility of a loan balance is
confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and
is based upon management's periodic review of the collectibility of the loans in
light of historical experience, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective, as it requires estimates that are
susceptible to significant revision as more information becomes available. The
provision for loan losses amounted to $111,000 for the three month period ended
September 30, 2007 and $216,000 for the comparable period in 2006. During the
quarter ended September 30, 2006, the Company had increased its reserves on
certain commercial and mortgage loans based on deterioration of those
17
credits during the quarter, which accounts for the higher provision in the third
quarter of 2006 as compared to 2007.
NON INTEREST INCOME: Non interest income was $740,000 for the three month period
ended September 30, 2007, a decrease of $351,000 or 32.2%, from the same period
in 2006. The primary reasons for the decrease were a $282,000 net loss on
trading activities for the quarter related to our early adoption of SFAS 159 and
mortgage banking activities income which was $43,000 lower in the quarter ended
September 30, 2007 as compared to year earlier period due to a decline in
mortgage activity related to general economic conditions.
NON INTEREST EXPENSE: Non interest expense was $2.9 million for the three month
period ended September 30, 2007, an $117,000 or 4.3%, increase from the same
period in 2006. The increase was primarily due to increases of $42,000 in
compensation and employee benefits, $10,000 in advertising, $31,000 in occupancy
and $38,000 in professional services expenses partially offset by a decrease of
$20,000 in service bureau expenses.
INCOME TAXES: Federal income taxes decreased to a tax benefit of $86,000 for the
three month period ended September 30, 2007 compared to tax expense of $163,000
for the same period in 2006. The decrease for the three month period was
attributable to a decrease in pre-tax income as well as an increase quarter over
quarter in tax-exempt income.
NINE MONTHS ENDED SEPTEMBER 30, 2007 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2006
GENERAL: Net income decreased $569,000 to $67,000 for the nine months ended
September 30, 2007 from $636,000 for the same period ended September 30, 2006.
The decrease in earnings period over period was primarily attributable to a
decline of $419,000 in non-interest income, including $151,000 in service
charges and other fees, $116,000 in loss on trading activities, and $176,000
decline in insurance and brokerage commissions. In addition during the nine
months ended September 30, 2006 the Company collected $279,000 (approximately
$191,000 after tax) in interest and $8,000 in late charges on a non-accrual
commercial loan relationship. The income tax expense for the nine months ended
September 30, 2007 decreased by $382,000 as compared to the same period in 2006
due to the decrease in pre-tax income period over period and the increase in
tax-exempt income period over period.
INTEREST INCOME: Interest income was $12.3 million for the nine months ended
September 30, 2007, compared to $12.9 million for the comparable period in 2006.
This decrease of $502,000, or 3.9%, in interest income was due in large part to
a decrease of $15.9 million in average balances of AFS investment securities to
$37.2 million for the period ended September 30, 2007 compared to $53.1 million
for the period ended September 30, 2006. In addition, as mentioned above, during
the nine-month period ended September 30, 2006, the Company collected a large
commercial non-accrual relationship, resulting in an additional $279,000 in
commercial loan interest income for that period.
INTEREST EXPENSE: Interest expense was $6.4 million for the nine month period
ended September 30, 2007 compared to $6.2 million for the same period in 2006.
The 3.2% increase in interest expense was primarily attributable to an increased
cost of funds on certificates of deposit for the period ended September 30, 2007
compared to September 30, 2006. The cost of certificates of deposit increased
from 3.88% for the nine-month period ended September 30, 2006 to 4.51% for the
same period ended September 30, 2007, reflecting upward market pressure on
deposit rates period over period. The effect of the increase in cost of deposits
was offset by the decline in the average balances of certificates of deposit of
$11.2 million period over period as non-relationship customers took certificate
of deposit dollars to institutions paying higher deposit rates.
NET INTEREST INCOME: Net interest income decreased by $704,000 for the nine
month period ended September 30, 2007 compared to the same period in 2006. For
the nine months ended September 30, 2007, average interest-earning assets
decreased $15.6 million, or 5.8%, when compared to the same period in 2006.
Average interest-bearing liabilities decreased $14.7 million, or 6.2% for the
same period. The yield on average interest-earning assets increased to 6.55% for
the nine month period ended September 30, 2007 from 6.34% for the same period
ended in 2006. The cost of average interest-bearing liabilities increased to
3.87% from
18
3.52% for the nine month periods ended September 30, 2007 and September 30,
2006, respectively. The net result of the 21 basis point increase in asset
yields and 35 basis point increase in the cost of funds was a net interest rate
margin decrease of 9 basis points to 3.14% for the nine month period ended
September 30, 2007, from 3.23% for the same period in 2006.
DELINQUENT LOANS AND NONPERFORMING ASSETS. The following table sets forth
information regarding loans delinquent 90 days or more and real estate
owned/other repossessed assets of the Bank at the dates indicated. As of the
dates indicated, the Bank did not have any material restructured loans within
the meaning of SSFAS 15.
SEPTEMBER 30, DECEMBER 31,
2007 2006
------------- ------------
(Dollars in thousands)
Total non-accrual loans ................................ $3,040 $2,490
------ ------
Accrual loans delinquent 90 days or more:
One- to four-family residential ..................... 512 645
Other real estate loans ............................. -- 221
Consumer/Commercial ................................. 1,030 624
------ ------
Total accrual loans delinquent 90 days or more ... $1,542 $1,490
------ ------
Total nonperforming loans (1) .......................... 4,582 3,980
Total real estate owned-residential mortgages (2) ...... 1,049 437
Total real estate owned-Consumer and other (2) ......... 7 38
====== ======
Total nonperforming assets ............................. $5,638 $4,455
====== ======
Total nonperforming loans to loans receivable .......... 2.18% 1.90%
Total nonperforming assets to total assets ............. 2.15% 1.59%
(1) All of the Bank's loans delinquent more than 90 days are classified as
nonperforming.
(2) Represents the net book value of property acquired by the Bank through
foreclosure or deed in lieu of foreclosure. Upon acquisition, this property
is recorded at the lower of its fair market value or the principal balance
of the related loan.
PROVISION FOR LOAN LOSSES: The provision for loan losses amounted to $310,000
for the nine month period ended September 30, 2007 and $419,000 for the
comparable period in 2006. The ratio of nonperforming loans to total loans was
2.18% at September 30, 2007 and 1.90% at December 31, 2006. As a percent of
total assets, nonperforming loans increased to 2.15% at September 30, 2007 from
1.59% at December 31, 2006. Total nonperforming assets increased by $1.2 million
from December 31, 2006 to September 30, 2007. It should be noted that $888,000
of the $1.2 million increase in non-performing assets related to two matured
commercial loans which were in the renewal process at September 30, 2007 and
which are well collateralized. Management expects there to be no loss on either
of these loans.
NON INTEREST INCOME: Non interest income was $2.9 million for the nine month
period ended September 30, 2007, a decrease of $419,000 or 12.7%, from the same
period in 2006. The primary reasons for the decrease were decreases of $151,000
in service charges and other fees, $116,000 in loss on trading activities
related mainly to FHLB advances, and $176,000 in insurance and brokerage
commissions period over period.
NON INTEREST EXPENSE: Non interest expense was $8.5 million for both the nine
month periods ended September 30, 2007 and September 30, 2006. There were no
notable differences in expense structure nine month period over nine month
period.
INCOME TAXES: Federal income tax expense decreased to a benefit of $63,000 for
the nine months ended September 30, 2007 compared to expense of $320,000 for the
same period in 2006. The decrease for the nine month period was attributable to
a decrease in pre-tax income as well as an increase period over period in
tax-exempt income.
19
LIQUIDITY
The Company's current liquidity position is more than adequate to fund expected
asset growth. The Company's primary sources of funds are deposits, FHLB
advances, proceeds from principal and interest payments, prepayments on loans
and mortgage-backed and investment securities and sale of long-term fixed-rate
mortgages into the secondary market. While maturities and scheduled amortization
of loans and mortgage-backed securities are a predictable source of funds,
deposit flows, mortgage prepayments and sale of mortgage loans into the
secondary market are greatly influenced by general interest rates, economic
conditions and competition.
Liquidity represents the amount of an institution's assets that can be quickly
and easily converted into cash without significant loss. The most liquid assets
are cash, short-term U.S. Government securities, U.S. Government agency
securities and certificates of deposit. The Company is required to maintain
sufficient levels of liquidity as defined by OTS regulations. This requirement
may be varied at the direction of the OTS. Regulations currently in effect
require that the Bank must maintain sufficient liquidity to ensure its safe and
sound operation. The Company's objective for liquidity is to be above 20%.
Liquidity as of September 30, 2007 was $42.9 million, or 25.3%, compared to
$55.7 million, or 29.3%, at December 31, 2006. The levels of these assets are
dependent on the Company's operating, financing, lending and investing
activities during any given period. The liquidity calculated by the Company
includes additional borrowing capacity available with the FHLB. This borrowing
capacity is based on the FHLB stock owned by the Bank along with pledged
collateral. As of September 30, 2007, the Bank had unused borrowing capacity
totaling $24.4 million at the FHLB based on the FHLB stock ownership.
The Company intends to retain for its portfolio certain originated residential
mortgage loans (primarily adjustable rate, balloon and shorter term fixed rate
mortgage loans) and to generally sell the remainder in the secondary market. The
Bank will from time to time participate in or originate commercial real estate
loans, including real estate development loans. During the nine month period
ended September 30, 2007 the Company originated $12.9 million in residential
mortgage loans, of which $5.7 million were retained in portfolio while the
remainder were sold in the secondary market or are being held for sale. This
compares to $24.5 million in originations during the first nine months of 2006
of which $15.1 million were retained in portfolio. The Company also originated
$19.7 million of commercial loans and $7.2 million of consumer loans in the
first nine months of 2007 compared to $17.9 million of commercial loans and
$12.7 million of consumer loans for the same period in 2006. Of total loans
receivable, excluding loans held for sale, mortgage loans comprised 48.5% and
48.4%, commercial loans 37.3% and 37.6% and consumer loans 14.2% and 14.0% at
September 30, 2007 and December 31, 2006, respectively.
Deposits are a primary source of funds for use in lending and for other general
business purposes. At September 30, 2007 deposits funded 63.4% of the Company's
total assets compared to 63.0% at December 31, 2006. Certificates of deposit
scheduled to mature in less than one year at September 30, 2007 totaled $78.7
million. Management believes that a significant portion of such deposits will
remain with the Bank. The Bank monitors the deposit rates offered by competition
in the area and sets rates that take into account the prevailing market
conditions along with the Bank's liquidity position. Moreover, management
believes that the growth in assets is not expected to require significant
in-flows of liquidity. As such, the Bank does not expect to be a market leader
in rates paid for liabilities.
Borrowings may be used to compensate for seasonal or other reductions in normal
sources of funds or for deposit outflows at more than projected levels.
Borrowings may also be used on a longer-term basis to support increased lending
or investment activities. At September 30, 2007 the Company had $59.0 million in
FHLB advances. FHLB borrowings as a percentage of total assets were 22.5% at
September 30, 2007 as compared to 23.1% at December 31, 2006. The Company has
sufficient available collateral to obtain additional advances of $7.7 million.
When this is combined with current FHLB stock ownership the Company could obtain
up to an additional $32.1 million in advances from the FHLB.
20
CAPITAL RESOURCES
Stockholders' equity at September 30, 2007 was $33.9 million, or 12.9% of total
assets, compared to $35.5 million, or 12.6% of total assets, at December 31,
2006 (See "Consolidated Statement of Changes in Stockholders' Equity"). The Bank
is subject to certain capital-to-assets levels in accordance with OTS
regulations. The Bank exceeded all regulatory capital requirements at September
30, 2007. The following table summarizes the Bank's actual capital with the
regulatory capital requirements and with requirements to be "Well Capitalized"
under prompt corrective action provisions, as of September 30, 2007:
Regulatory Minimum to be
Actual Minimum Well Capitalized
--------------- --------------- ----------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- ------
Dollars in Thousands
Tier 1 (Core) capital (to risk -
weighted assets) $28,512 11.02% $10,346 4.00% $12,932 5.00%
Total risk-based capital (to risk-
weighted assets) $30,775 16.38% $15,034 8.00% $18,793 10.00%
Tier 1 risk-based capital (to
tangible assets) $28,512 15.17% $ 7,517 4.00% $11,276 6.00%
Tangible Capital (to
tangible assets) $28,512 11.02% $ 3,880 1.50% $ 5,173 2.00%
21
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2007
PART I - FINANCIAL INFORMATION
ITEM 3 - CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management, including
the Company's Chief Executive Officer and Chief Financial Officer, the Company
evaluated the effectiveness of the design and operation of its disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934) as of the end of the period covered by this
report. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that, as of the end of the period covered by this
report, the Company's disclosure controls and procedures were effective to
ensure that information required to be disclosed in the reports the Company
files or submits under the Securities Exchange Act of 1934, is recorded,
processed, summarized and reported, within the time periods specified by the
SEC's rules and forms and in timely alerting them to material information
relating to the Company (or its consolidated subsidiaries) required to be
included in its periodic SEC filings.
There were no significant changes made in the Company's internal control over
financial reporting or in other factors that could significantly affect the
Company's internal controls over financial reporting during the period covered
by this report that has materially affected, or is reasonably likely to
materially affect, the Company's internal control over financial reporting.
22
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2007
PART II - OTHER INFORMATION
Item 1 - Legal Proceedings:
There are no material legal proceedings to which the Company is a party
or of which any of its property is subject. From time to time the
Company is a party to various legal proceedings incident to its
business.
Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds:
Not applicable
Item 3 - Defaults upon Senior Securities:
Not applicable.
Item 4 - Submission of Matters to a Vote of Security Holders:
Not applicable
Item 5 - Other Information:
Not applicable
Item 6 - Exhibits
Exhibit 10.1 Change in Control Agreement for Martin A. Thomson
Exhibit 10.2 Change in Control Agreement for Michael W. Mahler
Exhibit 31.1 Certification by Chief Executive Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2 Certification by Chief Financial Officer pursuant to
section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1 Statement of Chief Executive Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 Statement of Chief Financial Officer furnished pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
23
FIRST FEDERAL OF NORTHERN MICHIGAN BANCORP, INC.
FORM 10-QSB
QUARTER ENDED SEPTEMBER 30, 2007
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
FIRST FEDERAL OF NORTHERN MICHIGAN
BANCORP, INC.
By: /s/ Martin A. Thomson
------------------------------------
Martin A. Thomson
Chief Executive Officer
Date: November 14, 2007
By: /s/ Amy E. Essex
------------------------------------
Amy E. Essex,
Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: November 14, 2007
24